|Edgar Online, Inc.|
Introduction and Overview
United Security Bancshares, Inc., a Delawarecorporation ("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, Tuscaloosaand Woodstock, Alabama. The Bank owns all of the stock of Acceptance Loan Company, Inc.("ALC"), an Alabamacorporation. ALC is a finance company organized for the purpose of making and purchasing consumer loans. ALC operates twenty-four finance company offices located in Alabamaand 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 Arizonacorporation 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 millionand 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) millionin 2011 to income of $2.2 millionin 2012. Net income attributable to USBI per share increased from a loss of $(1.51)in 2011 to income of $0.36in 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.
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: 19
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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.,
Alabamaand Mississippieconomies, 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 Stateshas 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
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 Americaand 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. 20
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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) millionfor the year ended December 31, 2011. Basic and diluted net income attributable to USBI per common share was $0.36for 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
• Total assets decreased 8.8% to
$567.1 millionsince year-end 2011.
• Deposits decreased 7.2% to
December 31, 2011.
• Loans net of unearned interest and fees decreased 11.6% to
$403.4 millionat 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." 21
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• Our net interest income decreased 3.2% to
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 millionfor 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
on investment securities of
$2.6 million, which declined to $1,000in 2012.
• Non-interest expense decreased 19.4% to
2011, with no impairment charged in 2012. Impairment of OREO decreased
$2.8 millionin 2012 compared to 2011. • Shareholders' equity totaled $68.6 million, with a corresponding book value of $11.40per 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. 22
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Net interest income decreased 3.2% to
$34.2 millionin 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 millionin 2012: $2.6 millionwas the result of decreased interest-earning assets, and $1.0 millionwas due to a 35 basis point decline in the yield on interest-earning assets. Interest expense declined $2.5 millionin 2012: $0.8 millionresulted from decreased interest-bearing liabilities, and $1.6 millionwas 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 millionduring 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 millionand 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 23
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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
are included in interest income amounts above. 24
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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 millionin 2012, and a provision of $4.3 millionwas expensed for loan losses in 2012, compared to $18.8 millionin 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 millionfor the year ending December 31, 2012, compared to $14.2 millionfor the year ending December 31, 2011. At the Bank, net charge-offs of commercial real estate decreased from $12.9 millionin 2011 to $2.8 millionin 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 millionfor the year ending December 31, 2012, compared to $3.2 millionfor the year ending December 31, 2011. For the Company, net charge-offs as a percentage of average loans were 2.0% and 4.3% for the years ended December 31, 2012and 2011, respectively.
We believe that growing the loan portfolio at the Bank and ALC with quality customers, along with working through and reducing non-performing loans, should result in both lower provisions for loan losses and a reduced allowance for loans losses.
The ratio of the allowance to loans, net of unearned income, at
December 31, 2012and 2011 was 5.40% and 5.52%, respectively. For additional information regarding the Company's allowance for loan losses, see "Loans and Allowance for Loan Losses." 25
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The following table presents the major components of non-interest income for the years indicated. 2012 2011 (In Thousands of Dollars)
Service Charges and Other Fees on Deposit Accounts $ 2,522 $
Credit Life Insurance Commissions and Fees 955
Bank-Owned Life Insurance 461
Investment Securities Gains, Net 1 2,550 Other Income 1,626 1,884 Total Non-Interest Income $ 5,565 $ 8,728 Total non-interest income decreased by
$3.2 million, or 36.2%, in 2012 compared to 2011. Service charges and fees on deposit accounts decreased by $366,000, or 12.7%, in 2012, compared to 2011. In 2012, fees generated from customer overdrafts and non-sufficient funds decreased by $354,000, and regular account service charges decreased by $12,000. The decrease in overdraft and non-sufficient funds charges can be attributed to a change in the regulations that prohibits the Bank from assessing these charges for certain non-recurring electronic transactions. Regular account service charges continued to decline as customers switched from accounts with a monthly service charge to a no-service charge account. This no-service charge account, introduced in the fourth quarter of 2007, has allowed the Bank to attract new customers and has otherwise been profitable by requiring electronic statements and encouraging ATM and debit card use, which generates additional fees. Service charges and other fees on deposit accounts is the largest component of non-interest income. Revenues from this source have declined in recent years, which appears to be a trend that will continue. Management constantly searches for new sources of fee income from new financial services and products, however, income from these non-interest sources will continue to decline as a percentage of total revenue. Net gains on security sales were $1,000and $2.6 millionin 2012 and 2011, respectively. Income generated in the area of securities gains and losses is dependent on factors that include investment portfolio strategies, interest rate changes and asset liability management strategies. Other income includes fee income generated from other banking services, such as letters of credit, ATMs, debit and credit cards, check cashing and wire transfers. Other income decreased by $258,000, or 13.7%, in 2012, compared to an increase of 65.1% in 2011, due to a non-recurring $4.2 millioninsurance settlement received in 2010. 26
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The following table presents the major components of non-interest expense for the years indicated. Year Ended December 31, 2012 2011 (In Thousands of Dollars) Salaries and Employee Benefits $ 14,590 $ 14,491 Occupancy 1,899 1,922 Furniture and Equipment 1,293 1,283 Impairment on Limited Partnerships 70
Legal, Accounting and Other Professional Fees 1,361 1,429 Stationery and Supplies 510 538 Telephone/Communication 631 686 Advertising 307 389 Collection and Recovery 499 516 Impairment on Other Real Estate 3,583
Impairment of Goodwill -
Realized Loss on Sale of OREO 1,283
FDIC Insurance Assessments 787
Total Non-Interest Expense $ 32,484 $
Efficiency Ratio 81.7 %
Total Non-Interest Expense to Average Assets 5.4 %
Non-interest expense decreased by
$7.8 million, or 19.4%, to $32.5 millionin 2012, from $40.3 millionin 2011. Impairment of goodwill was $4.1 millionin 2011, with no impairment charged in 2012. Impairment of OREO decreased by $2.8 millionin 2012 compared to 2011. Impairment on OREO at the Bank was $3.0 millionand $0.6 millionat ALC for 2012, compared to $5.0 millionat the Bank and $1.4 millionat ALC in 2011. The severely depressed real estate market, along with the continued decline in real estate values, have had a negative effect on these expenses. If the economy remains weak and real estate values decline, further impairment and losses could result. Premiums paid to the FDICin the form of deposit assessments decreased slightly in 2012 compared to 2011. These assessments were $787,000in 2012, compared to $835,000in 2011. Estimated assessments for 2013 are $0.8 million. Salaries and employee benefits expense increased by $99,000, or 0.7%, in 2012, compared to an increase of 5.3% in 2011. In 2012, salary expense increased by $16,000, or 0.1%, health insurance expense decreased by $132,000, or 8.3%, and all other compensation and benefit costs increased by $215,000, or 14.2%, when compared with 2011. All other compensation and benefits includes the accrual for the long-term incentive compensation plan in the amount of $408,500for 2012 and $38,200for 2011. The 2011 accrual was reduced due to an adjustment as a result of the severance agreement with an executive officer. In 2011, the Company made discretionary contributions on behalf of participants in the United Security Bancshares, Inc. Employee Stock Ownership Plan (With 401(k) Provisions) (the "Plan") in the form of a match that was equal to 2% of each participant's elective deferrals. No discretionary match was made in 2012. The Company's matching contributions to the Plan totaled $297,728and $427,291in 2012 and 2011, respectively. The Bank invests in limited partnerships that operate qualified affordable housing projects. These partnerships receive tax benefits in the form of tax deductions from operating losses and tax credits. Although the Bank accounts for certain of these investments utilizing the cost method, management analyzes the Bank's investments in limited partnerships for potential impairment on an annual basis. The investment balances in these 27
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$836,000at December 31, 2012and $1.5 millionat December 31, 2011. Losses in these investments amounted to $70,000and $76,000for 2012 and 2011, respectively. Provision for Income Taxes A net operating income before tax generated a tax expense of $0.7 millionfor 2012, compared to a tax benefit of $6.0 millionin 2011. The calculation of the income tax provision requires the use of estimates and judgments of management. As part of the Company's overall business strategy, management must take into account tax laws and regulations that apply to specific tax issues faced by the Company in each year. This analysis includes an evaluation of the amount and timing of the realization of income tax assets or liabilities. Management's determination of the realization of the net deferred tax asset is based upon an evaluation of the four possible sources of taxable income: 1) the future reversals of taxable temporary differences; 2) future taxable income, exclusive of reversing temporary differences and carryforwards; 3) taxable income in prior carryback years; and 4) tax-planning strategies. In making a conclusion, management has evaluated the available positive and negative evidence impacting these sources of taxable income. The primary sources of positive and negative evidence impacting taxable income are summarized below: Positive Evidence
• History of earnings - The Company has a strong history of generating
earnings and has demonstrated positive earnings in 18 of the last 20
years. After carryback of the 2011 loss, the Company still has
addition to the remaining taxable income available in a carryback year,
the Company has a full 19-year carryforward period for federal tax
purposes and seven years for the
operating losses triggered as a result of reversing deductible
differences, such as loan charge-offs or sales of other real estate. • Creation of future taxable income - The Company has projected future
taxable income that will be sufficient to absorb the remaining deferred
tax assets after the reversal of future taxable temporary differences. The
taxable income forecasting process utilizes the forecasted pre-tax earnings and adjusts for book-tax differences that will be exempt from taxation, primarily tax-exempt interest income and bank-owned life insurance, as well as temporary book-tax differences, including the allowance for loan losses. The projections relied upon for this process
are consistent with those used from the Company's financial forecasting
process. Management believes that the projections resulting from the taxable income forecasting process are sound, however, there can be no
assurance that such taxable income will be realized due to unanticipated
changes in economic and competitive factors. • Strong capital position - At
December 31, 2012, the Company had a Tier 1
capital ratio of 10.51% calculated as a percent of 2012 average assets,
substantially above the 5.00% minimum standard to be considered well
capitalized per regulatory guidelines. Also, the total risk-based capital
ratio of 17.05% substantially exceeds the 10.00% minimum standard to be considered well capitalized.
• Ability to implement tax-planning strategies - The Company has the ability
to implement tax planning strategies to maximize the realization of
deferred tax assets, such as the sale of assets. As an example, during the
available for sale had
could accelerate the recognition of the associated taxable temporary
differences, which management would consider to be a tax planning strategy
to maximize the realization of the deferred tax assets that may expire unutilized.
The largest losses experienced were in one type of loan - real estate development. Of the loan loss provision expensed in 2011, 44.1%, or
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million, was in the category of real estate development loans, raw land or residential lots. Impairment of OREO originated from these loans amounted to
$2.1 millionand $1.6 millionfor 2011 and 2012, respectively. Except in unusual circumstances, the Company no longer invests in these types of loans and is focused on managing this segment of the loan portfolio aggressively.
• Cumulative loss position - The Company is currently in a three-year
cumulative loss position. Excluding the goodwill impairment in 2011, as
this item is nondeductible for income tax purposes, the cumulative
continuing operations pre-tax loss position for 2010 through 2012 is $9.6
million. The cumulative loss primarily has resulted from the unprecedented
provision for loan losses of
management believes will continue to be reduced in future periods. During
2012, the provision for loan losses decreased
million, as compared to the provision for loan losses of
The Company believes that the positive evidence, when considered in its entirety, outweighs the negative evidence of recent pre-tax losses. See Note 2, "Summary of Significant Accounting Policies," and Note 12, "Income Taxes," in the "Notes to Consolidated Financial Statements" included in this Annual Report for additional information about income taxes.
Loans and Allowance for Loan Losses
Total loans outstanding net of unearned interest decreased by
$46.7 millionin 2012, with a loan portfolio totaling $356.7 millionas of December 31, 2012. Total loans at the Bank declined 12.5% to $281.6 millionin 2012, representing 77.9% of the Company's loans. Loans at ALC declined 8.1% to $75.1 millionin 2012. For 2012, on an average basis, loans represented 68.4% of the Company's earning assets and provided 91.3% of the Company's interest income. More stringent underwriting standards at the Bank and ALC, and difficult economic conditions, have led to decreased lending activity. Although quarterly loan growth is a major focus for management in the coming years, quality loan growth will remain a major challenge. Real estate loans decreased 14.4% to $256.4 millionin 2012. The Bank's real estate loan portfolio is comprised of construction loans to both businesses and individuals for commercial and residential development, commercial buildings, both rental property and owner occupied, with most of this activity being commercial. Real estate loans also consist of other loans secured by real estate, such as one-to-four family dwellings, including mobile homes, loans on land only, multi-family dwellings, non-farm, non-residential real estate and home equity loans. Real estate loans at the Bank declined by $35.8 million, or 13.8%, in 2012 to a balance of $223.3 millionat December 31, 2012. Real estate loans at ALC are primarily secured by residential properties, mobile homes and land. These loans declined 18.5% to $33.0 millionas of year-end 2012. Real estate loans remain the largest component of the Company's loan portfolio, comprising 70.9% of total loans outstanding, down from 73.4% at year-end 2011. Real estate lending will likely be the largest segment of the Bank's portfolio. Management will focus on growing owner occupied commercial loans with decreased reliance on development lending in 2013. Consumer loans represent the second largest component of the Company's loan portfolio. These loans include loans to individuals for household, family and other personal expenditures, including credit cards and other related credit plans. Consumer loans increased by $1.3 millionat ALC and declined by $4.3 millionat the Bank during 2012. ALC's consumer loans represent 75.2% of the total consumer loans, with a balance at year-end 2012 of $62.5 million. These loans at the Bank amounted to $15.5 millionat December 31, 2012. The increase at ALC was the result of a shift of emphasis away from real estate loans to consumer loans. The decline in consumer loans at the Bank resulted from decreased demand due to bad economic conditions and an overall tightening of underwriting standards. 29
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Commercial, financial and agricultural loans decreased by 3.6% during 2012 to
$42.9 millionat December 31, 2012. Loans to tax exempt entities, such as municipalities and counties, increased by $9.2 millionin 2012 and decreased by $2.8 millionin 2011. All other commercial loans declined by $9.8 millionin 2012. All of the commercial loans originated at the Bank. The increase in 2012 resulted from one loan to a municipal water authority in the amount of $10.5 millionthat was funded in 2012. The allowance for loan losses is maintained at a level that, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio and changes in its risk profile, credit concentrations, historical trends and economic conditions. This evaluation also considers the balance of impaired loans. Losses on individually-identified impaired loans may be measured based on the present value of expected future cash flows discounted at each loan's original effective market interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through the provision and added to the allowance for loan losses. Large pools of smaller balance, homogeneous loans are subjected to a collective evaluation for impairment, considering delinquency and repossession statistics, historical charge-off trends, trends in the economy and other factors. Though management believes the allowance for loan losses to be adequate, taking into consideration the views of regulators, the current economic environment and the amount of subjective judgment involved in the calculation, there can be no assurance that the allowance for loan losses is sufficient, and ultimate losses may vary from their estimates. Estimates are reviewed periodically, and, as adjustments become necessary, they are reported in earnings during the periods in which they become known. The Bank's loan policy requires immediate recognition of a loss if significant doubt exists as to the repayment of the principal balance of a loan. Consumer installment loans at the Bank and ALC are generally recognized as losses if they become 120 days delinquent. Exceptions are made specifically for loans that are secured by real estate and if the borrower is in a repayment plan under the bankruptcy statutes. At the time of the plan approval, any amount above the cash flow value of the plan is charged-off, and as long as the loans are paying in accordance with the bankruptcy plan, they are not charged-off. A credit review of the Bank's individual loans is conducted periodically. A risk rating is assigned to each loan and is reviewed at least annually. In assigning risk, management takes into consideration the capacity of the borrower to repay, collateral values, current economic conditions and other factors. Management also monitors the credit quality of the loan portfolio through the use of an annual outside comprehensive loan review. Based on the underwriting standards in the loan policy, the Bank does not actively market mortgages to subprime borrowers. However, over time, some of the Bank's customers could migrate into categories that might demonstrate some of the same characteristics as subprime borrowers. With current underwriting standards and ongoing monitoring of credit quality within the portfolio, the volume of such customers is inconsequential. The Bank utilizes a written loan policy, which guides lending personnel in applying consistent underwriting standards. This policy is intended to aid loan officers and lending personnel in making sound credit decisions and to assure compliance with state and federal regulations. The policy is comprehensive in scope and includes guidance on both desirable and undesirable loans. Individual loan officer lending limits are reviewed and approved annually by the Board of Directors. Documentation requirements for various loan types are also included in the policy. The lending function is managed by utilizing various committees, consisting of management and board members. The Executive Loan Committee, made up of senior management, has lending authority up to $2.0 million. Loan requests exceeding $2.0 millionrequire approval of the Directors' Loan Committee, made up of four outside directors and the Chief Executive Officer ("CEO"). Loans in excess of $10.0 millionrequire the approval of the Board of Directors. The Problem Asset Review Committee, composed of the CEO, the Chief Credit Officer ("CCO"), the Executive Vice President ("EVP"), Commercial Division, and the EVP, Retail Division, with attendance of the Special Assets Manager, meets monthly to review problem assets. Impaired loans in excess of $500,000are reviewed monthly to assist the CCO in calculating and evaluating the 30
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adequacy of the allowance for loan losses. OREO with balances of
$500,000and over are also reviewed at the monthly meetings, along with non-performing loans of $250,000and greater. This same committee reviews non-performing loans of $50,000and over on a quarterly basis. The Credit Policy Committee, chaired by the CCO, consisting of the CEO, the EVP, Commercial Division, the EVP, Retail Division, and one senior lender, meets weekly to review loan downgrades, upgrades, charge-offs, and any loan policy changes. The Credit Quality Control Committee, chaired by the CCO, meets quarterly to assess the adequacy of the allowance for loan losses. This committee, consisting of senior management, as well as various lending and credit administration personnel, reviews valuations for non-performing loans and OREO prior to the release of financial statements and the filing of quarterly results. ALC's management oversees its loan portfolio by establishing credit criteria and underwriting standards through a loan committee comprised of members of ALC's Board of Directors and ALC's district and office managers. This Committee is aided by a formal loan policy, which is reviewed at least annually with revisions made as directed by ALC's Board of Directors and management. ALC's individual branches are supervised by three district managers who report to the ALC COO. Because of the very nature of ALC's business, many of the borrowers served by ALC could be deemed to demonstrate some of the same characteristics as subprime borrowers. Although the Company and ALC believe that serving the communities in which ALC is located includes service to these customers, ALC's management and loan officers remain diligent in making careful loan decisions based on the credit criteria and underwriting standards established by the loan committee. The following table shows the Company's loan distribution as of December 31, 2012and 2011. Year Ended December 31, 2012 2011 (In Thousands of Dollars) Real Estate $ 256,354 $ 299,594 Installment (Consumer) 62,521 65,483 Commercial, Financial and Agricultural 42,903
Less: Unearned Interest, Commissions and Fees (5,100 ) (4,786 ) Total $ 356,678 $ 403,351
The amounts of total loans (excluding installment loans) outstanding at
Maturing After One Within but Within After Five One Year Five Years Years Total (In Thousands of Dollars) Commercial, Financial and Agricultural $ 31,383 $ 11,298 $ 222 $ 42,903 Real Estate-Mortgage 104,855 121,791 29,708 256,354 Total $ 136,238 $ 133,089 $ 29,930 $ 299,257
Variable rate loans totaled approximately
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Accruing loans past due 90 days or more at
December 31, 2012declined to $1.6 million, a decrease of $761,000compared to year-end 2011. Accruing loans past due 90 days or more at the Bank declined by $224,000to $0at December 31, 2012. These loans at ALC declined by $537,000 millionto $1.6 millionover the same period. These loans are closely monitored, and, if any deterioration in the borrowers ability to pay occurs, they are placed on non-accrual status. Impaired loans totaled $54.3 millionand $61.9 millionas of December 31, 2012and 2011, respectively. The decrease in impaired loans at December 31, 2012resulted from paydowns of $6.9 million, charge-offs of $3.4 million, transfers to other real estate or repossessions of $6.7 million, and upgrades of $3.4 million, offset somewhat by the addition of $12.8 millionin newly impaired loans. The decline in real estate values and the severely depressed real estate market have affected the value of the underlying collateral and the borrowers' ability to service the debt on these loans. There was approximately $11.1 millionin the allowance for loan losses specifically allocated to these impaired loans at each of December 31, 2012and 2011. Loans totaling $28.1 millionand $34.6 millionfor 2012 and 2011, respectively, although considered impaired under Financial Accounting Standards Board("FASB") Accounting Standards Codification ("ASC") Topic 310, have no measurable impairment, and no allowance for loan losses is specifically allocated to these loans. The average recorded investment in impaired loans for 2012 and 2011 was approximately $54.2 millionand $49.5 million, respectively. Income recognized on impaired loans amounted to approximately $2.5 millionin 2012 and $2.2 millionin 2011. Non-performing assets as a percentage of loans net of unearned interest and other real estate was 10.4% at December 31, 2012, compared to 8.5% at December 31, 2011. Non-performing assets increased by $2.9 millionin 2012 compared to 2011, loans on non-accrual increased by $7.1 millionand loans past due 90 days or more declined by $761,000. Other real estate acquired in settlement of loans consisted of 4 residential properties and 38 commercial properties totaling $11.1 millionat the Bank and 71 residential properties and 12 commercial properties totaling $2.2 millionat ALC. Management is making every effort to dispose of these properties in a timely manner, but the national economic downturn and the severely depressed real estate market in the market areas of the Bank and ALC are negatively impacting this process. Management reviews these loans and reports to the Bank's Board of Directors monthly. Loans are considered restructured loans if concessions have been granted to borrowers that are experiencing financial difficulty. The concessions granted generally involve the modification of terms of the loan, such as changes in payment schedule or interest rate, which generally would not otherwise be considered. Restructured loans can involve loans remaining on nonaccrual, moving to nonaccrual or continuing on accrual status, depending on the individual facts and circumstances of the borrower. Nonaccrual restructured loans are included and treated with all other nonaccrual loans. In addition, all accruing restructured loans are being reported as troubled debt restructurings. Generally, restructured loans remain on nonaccrual until the customer has attained a sustained period of repayment performance under the modified loan terms (generally a minimum of six months). However, performance prior to the restructuring, or significant events that coincide with the restructuring, are considered in assessing whether the borrower can meet the new terms and whether the loan should be returned to or maintained on nonaccrual status. If the borrower's ability to meet the revised payment schedule is not reasonably assured, the loan remains on nonaccrual. Based on the above, the Company had $12,397,049and $1,821,696of non-accruing loans that were restructured and remained on nonaccrual status at December 31, 2012and 2011, respectively. In addition, the Company had $119,020of restructured loans that were restored to accrual status based on a sustained period of repayment performance at December 31, 2012, compared to $2.5 millionat December 31, 2011. 32
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The following table presents information on non-performing loans and real estate acquired in settlement of loans.
December 31, December 31, 20122011 (In Thousands of Dollars) Non-Performing Assets:
Loans Accounted for on a Non-Accrual Basis $ 23,618 $ 16,502
Accruing Loans Past Due 90 Days or More 1,571
Real Estate Acquired in Settlement of Loans 13,286 16,774 Total $ 38,475 $ 35,608 Non-Performing Assets as a Percent of Net Loans and Other Real Estate 10.40 % 8.48 % FUSB December 31, December 31, 2012 2011 (In Thousands of Dollars) Non-Performing Assets:
Loans Accounted for on a Non-Accrual Basis $ 23,351 $ 14,616
Accruing Loans Past Due 90 Days or More -
Real Estate Acquired in Settlement of Loans 11,089 12,606 Total $ 34,440 $ 27,446 Non-Performing Assets as a Percent of Net Loans and Other Real Estate 11.77 % 8.21 % ALC December 31, December 31, 2012 2011 (In Thousands of Dollars) Non-Performing Assets:
Loans Accounted for on a Non-Accrual Basis $ 267 $ 1,886
Accruing Loans Past Due 90 Days or More 1,571
Real Estate Acquired in Settlement of Loans 2,197 4,168 Total $ 4,035 $ 8,162
Non-Performing Assets as a Percent of Net
Other Real Estate5.22 %
Summarized below is information concerning income on those loans with deferred interest or principal payments resulting from deterioration in the financial condition of the borrower. December 31, 2012 2011 (In Thousands of Dollars) Total Loans Accounted for on a Non-Accrual Basis $ 23,618
Interest Income Reported and Recorded During the Year 158 36 33
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Allocation of Allowance for Loan Losses
The following table shows an allocation of the allowance for loan losses for the two years indicated. December 31, 2012 2011 Percent Percent of Loans of Loans in Each In Each Category Category Allocation to Total Allocation To Total Allowance Loans Allowance Loans (In Thousands of Dollars, Except Percentages) Commerical, Financial and Agricultural $ 977 12 % $ 1,145 11 % Real Estate 15,334 71 18,163 73 Installment (Consumer) 2,967 17 2,959 16 Total $ 19,278 100 % $ 22,267 100 %
In establishing the allowance for loan losses, management created the following risk groups for evaluating the loan portfolio:
• Large classified loans and impaired loans are evaluated individually, with
specific reserves allocated based on management's review, consistent with
ASC Topic 310. • The allowance for large pools of smaller-balance, homogeneous loans is
based on such factors as changes in the nature and volume of the portfolio,
overall portfolio quality, adequacy of the underlying collateral value,
loan concentrations, historical charge-off trends and economic conditions
that may affect the borrowers' ability to pay, consistent with ASC Topic 450.
Net charge-offs as shown in the "Summary of Loan Loss Experience" table below indicate the trend for the last two years.
Summary of Loan Loss Experience
This table summarizes the Bank's loan loss experience for each of the two years indicated.
December 31, 20122011 (In Thousands
of Dollars) Balance of Allowance for Loan Loss at Beginning of Period
$ 22,267 $ 20,936 Charge-Offs: Commercial, Financial and Agricultural (1,277 ) (407 ) Real Estate-Mortgage (4,307 ) (14,938 ) Installment (Consumer) (3,449 ) (3,413 ) Credit Cards (17 ) (3 ) (9,050 ) (18,761 ) Recoveries: Commercial, Financial and Agricultural 156 152 Real Estate-Mortgage 671 310 Installment (Consumer) 894 828 Credit Cards 2 - 1,723 1,290 Net Charge-Offs (7,327 ) (17,471 ) Provision for Loan Losses 4,338 18,802
Balance of Allowance for Loan Loss at End of Period
Ratio of Net Charge-Offs During Period to Average Loans Outstanding 1.95 % 4.30 % 34
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Investment Securities Available-for-Sale and Derivative Instruments
Investment securities, which are classified as available-for-sale, are carried at fair value. They include mortgage-backed securities, obligations of states, counties and political subdivisions, U.S. treasury and government sponsored agency securities and other securities. Investment securities held-to-maturity consists of obligations of states, counties and political subdivisions and U.S. government sponsored agency securities, which are carried at cost. Investment securities declined from
$123.3 millionat December 31, 2011to $113.7 millionat December 31, 2012. Because of their liquidity, credit quality and yield characteristics, the majority of the purchases of taxable securities have been purchases of agency-guaranteed mortgage-backed obligations and collateralized mortgage obligations ("CMOs"). The mortgage-backed obligations in which the Bank invests represent an undivided interest in a pool of residential mortgages or may be collateralized by a pool of residential mortgages ("mortgage-backed securities"). The Company does not invest in mortgage-backed securities that contain Alt-A type mortgages or subprime mortgages. Mortgage-backed securities and CMOs present some degree of additional risk in that mortgages collateralizing these securities can be refinanced, thereby affecting the future yield and market value of the portfolio. Management expects the annual repayment of the underlying mortgages to vary as a result of monthly repayment of principal and/or interest required under terms of the underlying promissory notes. Further, the actual rate of repayment is subject to changes depending upon the terms of the underlying mortgages, the relative level of mortgage interest rates and the structure of the securities. When relative interest rates decline to levels below that of the underlying mortgages, acceleration of principal repayment is expected as some borrowers on the underlying mortgages refinance to lower rates. When the underlying rates on mortgage loans are comparable to market rates, repayment more closely conforms to scheduled amortization in accordance with terms of the promissory note with additional repayment as a result of sales of homes collateralizing the mortgage loans constituting the security. Although maturities of the underlying mortgage loans may range up to 30 years, scheduled principal and normal prepayments substantially shorten the average maturities. Interest rate risk contained in the overall securities portfolio is formally monitored on a monthly basis. Management assesses each month how risk levels in the investment portfolio affect overall company-wide interest rate risk. Expected changes in forecasted yield, earnings and market value of the bond portfolio are generally attributable to fluctuations in interest rates, as well as volatility caused by general uncertainty over the economy, inflation and future interest rate trends. The composition of the Bank's investment portfolio reflects the Bank's investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of the Bank's investment strategy are to maintain an appropriate level of liquidity and to provide a tool to assist in controlling the Bank's interest rate position, while at the same time producing adequate levels of interest income. As of December 31, 2012, the investment portfolio had an estimated average maturity of 2.8 years. Fair market values of securities can vary significantly as interest rates change. The gross unrealized gains and losses in the securities portfolio are not expected to have a material impact on liquidity or other funding needs. There were net unrealized gains of $3.1 millionin the securities portfolio on December 31, 2012, versus $3.0 millionnet unrealized gains at year-end 2011. 35
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The following table sets forth the amortized costs of investment securities, as well as their fair value and related unrealized gains or losses on the dates indicated. Available-for-Sale December 31, 2012 2011 (In Thousands of Dollars) Mortgage-Backed Securities $ 74,117 $ 96,104 Obligations of States, Counties and Political Subdivisions 13,395
U.S. Treasury and Government Sponsored Agency Securities 80 6,565 Other Securities - 9 Total Book Value 87,592 117,362 Net Unrealized Gains 5,022 4,808 Total Market Value $ 92,614 $ 122,170 Held-to-Maturity December 31, 2012 2011 (In Thousands of Dollars)
Obligations of States, Counties and Political Subdivisions $ -
$ - Total Book Value $ 21,136 $ 1,170
Investment Securities Maturity Schedule
Maturity as of
After One But After Five But Within One Within Five Within Ten After Year Years Years Ten Years Amount Yield Amount Yield Amount Yield Amount Yield (In Thousands of Dollars, Except Yields)
Investment SecuritiesAvailable-for-Sale: U.S. Treasury and Government Sponsored Agency Securities $ - 0.00 % $ 80 0.25 % $ - 0.00 % $ - 0.00 % State, County and Municipal Obligations 403 5.81 2,341
5.62 1,760 5.61 10,477 5.74
77 3.49 2,491 3.03 24,728 2.92 50,257 2.25 Total $ 480 5.44 % $ 4,912 4.22 % $ 26,488 3.10 % $ 60,734 2.85 % Total Securities With Stated Maturity $ 92,614 3.01 %
Available-for-sale securities are stated at fair value and tax equivalent market yields.
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Condensed Portfolio Maturity Schedule
Maturity Summary as of
(In Thousands of Dollars) Maturing in 3 months or less $ 1
Maturing in greater than 3 months to 1 year 479
Maturing in greater than 1 to 3 years 580
Maturing in greater than 3 to 5 years 4,332
Maturing in greater than 5 to 15 years 73,711
Maturing in over 15 years 34,647 30.46 Total $ 113,750 100.00 %
Condensed Portfolio Repricing Schedule
Repricing Summary as of
(In Thousands of Dollars) Repricing in 30 days or less $ 5,332
Repricing in 31 days to 1 year 1,173
Repricing in greater than 1 to 3 years 1,339
Repricing in greater than 3 to 5 years 6,892
Repricing in greater than 5 to 15 years 71,566
Repricing in over 15 years 27,448 24.13 Total $ 113,750 100.00 %
The tables above reflect all securities at market value on
Non-interest income from securities transactions was a gain for the years ended
December 31, 2012and 2011. Transactions affecting the Bank's investment portfolio are directed by the Bank's asset and liability management activities and strategies. Although short-term losses may occur from time to time, the "pruning" of the portfolio is designed to maintain the strength of the investment portfolio. The table below shows the associated net gains for the years ended December 31, 2012and 2011. December 31, 2012 2011 Investment Securities $ 764 $ 2,549,963
Volumes of sales, as well as other information regarding investment securities, are discussed further in Note 3, "
The Company's long-lived assets consist of the excess of cost over the fair value of net assets of acquired businesses ("goodwill"). Goodwill is tested for impairment on an annual basis or more often if events and circumstances indicate that impairment may exist. 37
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A test of goodwill for impairment consists of two steps in which the need for recognition is determined in Step One. In Step Two, the measurement of the actual impairment to be recognized, if deemed required by Step One, is calculated. The Company tested its goodwill as of
October 31, 2011, which indicated impairment of all of the $4.1 millionof goodwill reported by the Company. Refer to the discussion of intangible assets in Note 2, "Summary of Significant Accounting Policies," in the "Notes to Consolidated Financial Statements" included in this Annual Report for a discussion of these approaches and Note 7, "Goodwill and Intangible Assets," in the "Notes to Consolidated Financial Statements" included in this Annual Report for a discussion of the assumptions. Deposits Core deposits, which exclude time deposits of $100,000or more, provide for a relatively stable funding source that supports earning assets. The Company's core deposits totaled $380.1 million, or 77.7% of total deposits, at December 31, 2012, and totaled $391.4 million, or 74.3% of total deposits, at December 31, 2011. Deposits, in particular core deposits, have historically been the Company's primary source of funding and have enabled the Company to successfully meet both short-term and long-term liquidity needs. Management anticipates that such deposits will continue to be the Company's primary source of funding in the future, although economic and competitive factors could affect this funding source. The Company's loan-to-deposit ratio was 69.0% at December 31, 2012and 72.3% at the end of 2011. Loans declined in 2012 by $46.7 million, and deposits declined by $38.1 million. Time deposits in excess of $100,000and brokered deposits decreased 19.7% to $108.9 millionas of December 31, 2012. Included in these large deposits are $21.9 millionin brokered certificates of deposit at year-end 2012, compared with $35.3 millionat year-end 2011. Management has used brokered deposits as a funding source when rates and terms are more attractive than other funding sources. The sensitivity of the Bank's deposit rates to changes in market interest rates is reflected in its average interest rate paid on interest-bearing deposits. During 2012, although market interest rates remained unchanged, the Bank's average rate on interest bearing deposits declined from 1.35% in 2011 to 0.97% in 2012, as longer-term certificates of deposit matured and repriced at lower rates. Management, as part of an overall program to emphasize the growth of transaction deposit accounts, continues to promote online banking and an online bill paying program, as well as enhance the telephone-banking product. In addition, continued effort is being placed on deposit promotions, direct-mail campaigns and cross-selling efforts.
Average Daily Amount of Deposits and Rates
The average daily amount of deposits and rates paid on such deposits are summarized for the periods in the following table.
December 31, 2012 2011 Amount Rate Amount Rate (In Thousands of Dollars, Except Percentages) Non-Interest Bearing Demand Deposit Accounts $ 59,443 $ 59,142 Interest-Bearing Demand Deposit Accounts 121,498 0.58 % 120,166 0.84 % Savings Deposits 67,803 0.33 54,988 0.64 Time Deposits 268,496 1.30 287,907 1.70 Total $ 517,240 0.97 % $ 522,203 1.35 % 38
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Maturities of time certificates of deposit of
Time Certificates of Maturities Deposit 3 Months or Less $ 23,270,592 Over 3 Through 6 Months 22,103,613 Over 6 Through 12 Months 16,724,667 Over 12 Months 46,828,279 Total $ 108,927,151 Other Borrowings Other interest-bearing liabilities consist of federal funds purchased, securities sold under agreements to repurchase and
Federal Home Loan Bank("FHLB") advances. This category continues to be utilized as an alternative source of funds. During 2012, the average other interest-bearing liabilities represented 1.2% of the average total interest-bearing liabilities, compared to 5.0% in 2011. The advances from the FHLB are an alternative to funding sources with similar maturities, such as certificates of deposit. These advances generally offer more attractive rates when compared to other mid-term financing options. Securities sold under agreements to repurchase averaged $449,215in 2011 and $651,752in 2012. For additional information and discussion of these borrowings, refer to Notes 10 and 11, "Short-Term Borrowings" and "Long-Term Debt," respectively, in the "Notes to Consolidated Financial Statements" included in this Annual Report.
The following table shows information for the last two years regarding the Bank's short- and long-term borrowings consisting of treasury, tax and loan deposits, federal funds purchased, securities sold under agreements to repurchase and other borrowings from the FHLB.
Short-Term Borrowings Long-Term Borrowings Maturity Less Than One Maturity One Year or Year Greater (Dollars in Thousands, Except Percentages) Year-Ended
December 31: 2012 $ 638 $ - 2011 356 20,000 Weighted Average Interest Rate at Year-End: 2012 1.50 % 0.00 % 2011 2.00 2.17 Maximum Amount Outstanding at Any Month's End: 2012 $ 1,332 $ 20,000 2011 1,595 30,000 Average Amount Outstanding During the Year: 2012 $ 654 $ 4,918 2011 884 23,370 Weighted Average Interest Rate During the Year: 2012 1.50 % 2.30 % 2011 0.77 3.12 Shareholders' Equity The Company has always placed great emphasis on maintaining its strong capital base. At December 31, 2012, shareholders' equity totaled $68.6 million, or 12.1% of total assets, compared to 10.6% for year-end 2011. 39
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This level of equity should indicate to the Company's shareholders, customers and regulators that Bancshares is financially sound and offers the ability to sustain an appropriate degree of leverage to provide a desirable level of profitability and growth. Although shareholders' equity is well above minimum regulatory capital levels, it was eroded by operating losses during 2010 and 2011. Refer to the Consolidated Statements of Shareholders' Equity in the financial statements for a complete description of the changes to the components of shareholders' equity for 2012 and 2011. In connection with the
United Security Bancshares, Inc.Non-Employee Directors' Deferred Compensation Plan, no shares were purchased in 2012, and 275 shares were purchased in 2011. The plan permits non-employee directors to invest their directors' fees and to receive the adjusted value of the deferred amounts in cash and/or shares of Bancshares' common stock. For more information related to this plan, see Note 14, "Long-Term Incentive Compensation Plan," in the "Notes to Consolidated Financial Statements" included in this Annual Report. Bancshares initiated a share repurchase program in January 2006, under which the Company was authorized to repurchase up to 642,785 shares of common stock before December 31, 2007. In December 2007, 2008, 2009, 2010, 2011 and 2012, the Board of Directors extended the expiration date of the share repurchase program for an additional year. Currently, the share repurchase program is set to expire on December 31, 2013. There are 242,303 shares available for repurchase under this plan, at management's discretion. The Company's Board of Directors evaluates dividend payments based on the Company's level of earnings and our desire to maintain a strong capital base, as well as regulatory requirements relating to the payment of dividends. There were no cash dividends declared during 2012. Bancshares is required to comply with capital adequacy standards established by the Federal Reserve and the FDIC. Currently, there are two basic measures of capital adequacy: a risk-based measure and a leverage measure. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to risk categories, each with a specified risk weight factor. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance sheet items. The banking regulatory agencies also have adopted regulations that supplement the risk-based guidelines to include a minimum leverage ratio of 3% of Tier 1 Capital (as defined below) to total assets, less goodwill (the "leverage ratio"). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% or 2% higher than the minimum 3% level. The minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles ("Tier 1 Capital"). The remainder ("Tier II Capital") may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt and a limited amount of the allowance for loan losses. The sum of Tier 1 Capital and Tier II Capital is "total risk-based capital."
Risk-Based Capital Requirements
Well- Bancshares' Minimum Capitalized Ratio at Regulatory Regulatory December 31, Requirements Requirements 2012 Total Capital to Risk-Weighted Assets 8.00 % 10.00 % 17.05 % Tier I Capital to Risk-Weighted Assets 4.00 % 6.00 % 15.76 % Tier I Leverage Ratio 3.00 % 5.00 % 10.51 % 40
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The Bank exceeded the ratios required for well-capitalized banks, as defined by federal banking regulators, in addition to meeting the minimum regulatory ratios.
The following table presents operating and equity performance ratios for each of the last two years. December 31, 2012 2011 Return on Average Assets 0.37 % (1.45 )% Return on Average Equity 3.27 % (11.76 )% Cash Dividend Payout Ratio N/A N/A Average Equity to Average Assets Ratio 11.19 % 12.33 %
Liquidity and Interest Rate Sensitivity Management
The primary functions of asset and liability management are to (1) assure adequate liquidity, (2) maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities, (3) maximize the profit of the Bank and (4) reduce risks to the Bank's capital. Liquidity management involves the ability to meet day-to-day cash flow requirements of the Bank's customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Bank would not be able to perform a primary function under its role as a financial intermediary and would not be able to meet the needs of the communities that it serves. Interest rate risk management focuses on the maturity structure and repricing characteristics of its assets and liabilities when changes occur in market interest rates. Effective interest rate sensitivity management ensures that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of such interest rate movements on short- and long-term net interest margin and net interest income. The asset portion of the balance sheet provides liquidity primarily from two sources. These are principal payments and maturities of loans and maturities and principal payments from the investment portfolio. Other short-term investments, such as federal funds sold, are additional sources of liquidity. Loans maturing or repricing in one year or less amounted to
$155.5 millionat December 31, 2012. Investment securities forecasted to mature or reprice over the twelve months ending December 31, 2013are estimated to be more than $6.5 million, or about 5.8%, of the investment portfolio as of December 31, 2012. For comparison, principal payments on investment securities totaled $32.2 millionin 2012. Although the majority of the securities portfolio has legal final maturities longer than 10 years, a substantial percentage of the portfolio provides monthly principal and interest payments and consists of securities that are readily marketable and easily convertible into cash on short notice. As of December 31, 2012, the bond portfolio had an expected average maturity of 2.8 years, and approximately 76.9% of the $92.6 millionin bonds was expected to be repaid within 5 years. However, management does not rely solely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment and other cash requirements. Instead, these activities are funded by cash flows from loan payments, as well as increases in deposits and short-term borrowings. The liability portion of the balance sheet provides liquidity through interest-bearing and non-interest-bearing deposit accounts. Federal funds purchased, FHLB advances, securities sold under agreements to repurchase and short-term and long-term borrowings are additional sources of liquidity. Liquidity management involves the continual monitoring of the sources and uses of funds to maintain an acceptable cash position. Long-term liquidity management focuses on considerations related to the total balance sheet structure. 41
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The Bank, at
December 31, 2012, had long-term debt and short-term borrowings that, on average, represented 0.93% of total liabilities and equity, compared to 3.9% at year-end 2011.
The Bank currently has up to
Interest rate sensitivity is a function of the repricing characteristics of all of the Bank's assets and liabilities. These repricing characteristics are the time frames during which the interest-bearing assets and liabilities are subject to changes in interest rates, either at replacement or maturity, during the life of the instruments. Measuring interest rate sensitivity is a function of the differences in the volume of assets and the volume of liabilities that are subject to repricing in future time periods. These differences are known as interest sensitivity gaps and are usually calculated for segments of time and on a cumulative basis. Measuring Interest Rate Sensitivity: Gap analysis is a technique used to measure interest rate sensitivity at a particular point in time, an example of which is presented below. Assets and liabilities are placed in gap intervals based on their repricing dates. Assets and liabilities for which no specific repricing dates exist are placed in gap intervals based on management's judgment concerning their most likely repricing behaviors. A net gap for each time period is calculated by subtracting the liabilities repricing in that interval from the assets repricing. A positive gap - more assets repricing than liabilities - will benefit net interest income if rates are rising and will detract from net interest income in a falling rate environment. Conversely, a negative gap - more liabilities repricing than assets - will benefit net interest income in a declining interest rate environment and will detract from net interest income in a rising interest rate environment.
Gap analysis is the simplest representation of the Bank's interest rate sensitivity. However, it cannot reveal the impact of factors, such as administered rates, pricing strategies on consumer and business deposits, changes in balance sheet mix or the effect of various options embedded in balance sheet instruments, such as refinancing rates within the loan and bond portfolios.
The accompanying table shows the Bank's interest rate sensitivity position at
December 31, 2012, as measured by Gap analysis. Over the next 12 months, approximately $12.1 millionmore interest-bearing liabilities than interest-earning assets can be repriced to current market rates at least once. This analysis indicates that the Bank has a negative gap within the next 12-month range. Simple Gap analysis is no longer considered to be as accurate a tool for measuring interest rate risk as pro forma income simulation because it does not make an allowance for how much an item reprices as interest rates change, only that it is possible that the item could reprice. Accordingly, the Bank does not rely solely on Gap analysis but instead measures changes in net interest income and net interest margin through income simulation over +/-1%, 2%, 3% and 4% interest rate shocks. Our estimates have consistently shown that the Bank has very limited, if any, net interest margin and net interest income risk to rising interest rates. 42
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December 31, 2012(In
Thousands of Dollars, Except Percentages)
Total 1 0-3 4-12 Year or 1-5 Over 5 Non-Rate Months Months Less Years Years Sensitive Total Earning Assets: Loans (Net of Unearned Income) $ 93,943 $ 61,603 $ 155,546
5,332 1,173 6,505 7,738 99,507 - 113,750 Federal Home Loan Bank Stock 936 - 936 - - - 936 Interest-Bearing Deposits in Other Banks 41,945 - 41,945 - - - 41,945 Total Earning Assets $ 142,156 $ 62,776 $ 204,932
0.0 % 100.0 % Interest-Bearing Liabilities: Interest-Bearing Deposits and Liabilities Demand Deposits $ 24,844 $ - $ 24,844 $ 99,375 $ - $ - $ 124,219 Savings Deposits 13,059 - 13,059 52,237 - - 65,296 Time Deposits 59,340 94,907 154,247 87,524 - - 241,771 Borrowings 638 - 638 - - - 638 Non-Interest-Bearing Liabilities: Demand Deposits $ - $ - $ - $ - $ - $ 57,747 $ 57,747 Total Funding Sources $ 97,881 $ 94,907 $ 192,788 $ 239,136 $ - $ 57,747 $ 489,671 Percent of Total Funding Sources 20.0 % 19.4 % 39.4 % 48.8 % 0.0 % 11.8 % 100.0 % Interest-Sensitivity Gap (Balance Sheet) $ 44,275 $ (32,131 ) $ 12,144
$ (65,585 )
$ - $ - $ -
$ - $ - $ - $ - Interest-Sensitivity Gap
$ 44,275 $ (32,131 ) $ 12,144 $ (65,585 ) $ 134,826 $ (57,747 ) $ 23,638 Cumulative Interest-Sensitivity Gap $ 44,275 $ 12,144 N/A $ (53,441 ) $ 81,385 $ 23,638 $ 47,276 Over 5 Total 1 Years 0-3 4-12 Year or 1-5 Non-Rate Months Months Less Years Sensitive Total Ratio of Earning Assets to Funding Sources and Derivative Instruments 1.45 % 0.66 % 1.06 % 0.73 % 2.33 % 1.00 % Cumulative Ratio 1.45 % 1.06 % N/A 0.88 % 1.05 % 1.05 %
Assessing Short-Term Interest Rate Risk - Net Interest Margin Simulation
On a monthly basis, the Bank simulates how changes in short- and long-term interest rates will impact future profitability, as reflected by changes in the Bank's net interest margin. The tables below depict how, as of
December 31, 2012, pre-tax net interest margins and pre-tax net income are forecast to change over time frames of six months, one year, two years and five years under the six listed interest rate scenarios. The interest rate scenarios are immediate and parallel shifts in short- and long-term interest rates. 43
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Average Change in Net Interest Margin from Level Interest Rate Forecast (basis points, pre-tax): 6 Months 1 Year 2 Years 5 Years +1% 8 7 8 12 +2% -1 -5 -3 8 +3% -18 -23 -21 - +4% -36 -44 -39 -6 -1% -4 -5 -5 -2 -2% -9 -10 -12 -10 -3% -15 -17 -19 -16 -4% -18 -21 -23 -21 Change in Net Interest Income from Level Interest Rate Forecast (dollars, pre-tax): 6 Months 1 Year 2 Years 5 Years +1% $ 237,528 $ 396,176 $ 885,058 $ 3,539,966 +2% (39,311 ) (270,012 ) (397,137 ) 2,454,320 +3% (508,015 ) (1,340,999 ) (2,426,492 ) 22,934 +4% (1,031,568 ) (2,519,222 ) (4,499,237 ) (1,741,237 ) -1% (117,678 ) (260,045 ) (536,801 ) (535,146 ) -2% (245,709 ) (597,605 ) (1,370,874 ) (2,753,727 ) -3% (423,602 ) (984,156 ) (2,197,415 ) (4,690,660 ) -4% (514,934 ) (1,198,193 ) (2,693,393 ) (6,095,184 )
Assessing Long-Term Interest Rate Risk - Market Value of Equity and Estimating Modified Durations for Assets and Liabilities
On a monthly basis, the Bank calculates how changes in interest rates would impact the market value of its assets and liabilities, as well as changes in long-term profitability. The process is similar to assessing short-term risk but emphasizes and is measured over a five-year time period, which allows for a more comprehensive assessment of longer-term repricing and cash flow imbalances that may not be captured by short-term net interest margin simulation. The results of these calculations are representative of long-term interest rate risk, both in terms of changes in the present value of the Bank's assets and liabilities, as well as long-term changes in core profitability.
Market Value of Equity and Estimated Modified Duration of Assets,
The table below is a summary of expected market value changes for the Company's assets, liabilities and equity capital, expressed both in dollar terms and as a percentage of tier one equity. +1% +2% +3% +4% -1% -2% -3% -4% Asset Modified Duration 1.79 % 1.85 % 1.88 % 1.92 % 2.61 % 1.93 % 1.94 % 1.98 % Liability Modified Duration 3.04 % 2.59 % 2.38 % 2.28 % 2.97 % 2.88 % 2.96 % 3.06 % Modified Duration Mismatch 1.25 % 0.75 % 0.50 % 0.35 % 0.37 % 0.95 % 1.02 % 1.07 % Estimated Change in Market Value of Equity (Pre-Tax) $ 7,206,281 $ 8,614,068 $ 8,600,505
$ 8,170,776 $ (2,114,017 ) $ (10,985,784 ) $ (17,715,486 )
$ (24,738,749 ) Change in Market Value of Equity / Tier One Equity Capital (Pre-Tax) 9.16 % 10.95 % 10.93 % 10.39 % -2.69 % -13.97 % -22.52 % -31.45 % 44
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The Company has contractual obligations to make future payments on debt and lease agreements. Long-term debt is reflected on the consolidated statements of condition, whereas operating lease obligations for office space and equipment are not recorded on the Consolidated Statements of Condition. The Company and its subsidiaries have not entered into any unconditional purchase obligations or other long-term obligations, other than as included in the following table. These types of obligations are more fully discussed in Note 11, "Long-Term Debt," and Note 18, "Operating Leases," in the "Notes to Consolidated Financial Statements" included in this Annual Report. Many of the Bank's lending relationships, including those with commercial and consumer customers, contain both funded and unfunded elements. The unfunded component of these commitments is not recorded in the Consolidated Statements of Condition. These commitments are more fully discussed in Note 19, "Guarantees, Commitments and Contingencies," in the "Notes to Consolidated Financial Statements" included in this Annual Report. The following table summarizes the Company's contractual obligations as of
December 31, 2012. Payment Due by Period (In Thousands of Dollars) More than Less than One to Three to Five Total One Year Three Years Five Years Years Time Deposits $ 241,771 $ 154,247 $ 59,213 $ 28,311 $ - Commitments to Extend Credit 32,123 26,648 - - 5,475 Operating Leases 1,022 352 492 149 29 Standby Letters of Credit 1,092 1,092 - - - Total $ 276,008 $ 182,339 $ 59,705 $ 28,460 $ 5,504
Off-Balance Sheet Obligations
The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are considered material, other than "Operating Leases," included in Note 18, and "Guarantees, Commitments and Contingencies," included in Note 19 in the "Notes to Consolidated Financial Statements" included in this Annual Report.