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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2007
Commission File Number: 0-14549
United Security Bancshares, Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 63-0843362 | |
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification No.) |
131 West Front Street Post Office Box 249 Thomasville, AL | 36784 | |
| (Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code:
(334) 636-5424
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “larger accelerated filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at May 9, 2007 | |
Common Stock, $0.01 par value | 6,183,564 shares |
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UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
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FORWARD-LOOKING STATEMENTS
Statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995). In addition, United Security Bancshares, Inc. (“Bancshares”), through its senior management, from time to time makes forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) concerning its expected future operations and performance and other developments. Such forward-looking statements are necessarily estimates reflecting Bancshares’ 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 Bancshares’ Securities and Exchange Commission filings and other public announcements, including the factors described in Bancshares’ Annual Report on Form 10-K for the year ended December 31, 2006. With respect to the adequacy of the allowance for loan losses for Bancshares, these factors include, but are not limited to, the rate of growth in the economy and the relative strength and weakness in the consumer and commercial credit sectors and in the real estate markets. Forward-looking statements speak only as of the date they are made, and Bancshares 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.
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PART I. FINANCIAL INFORMATION
| ITEM 1. | FINANCIAL STATEMENTS |
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Dollars in Thousands)
| March 31, | December 31, | |||||||
| 2007 | 2006 | |||||||
| (Unaudited) | ||||||||
ASSETS | ||||||||
Cash and Due from Banks | $ | 15,470 | $ | 14,668 | ||||
Interest Bearing Deposits in Other Banks | 22,284 | 13,791 | ||||||
Federal Funds Sold | 0 | 25 | ||||||
Investment Securities Available-for-Sale | 116,457 | 119,763 | ||||||
Federal Home Loan Bank Stock | 4,647 | 5,180 | ||||||
Loans, net of allowance for loan losses of $7,786 and $7,664, respectively | 450,147 | 441,574 | ||||||
Premises and Equipment, net | 18,817 | 18,864 | ||||||
Cash Surrender Value of Bank-Owned Life Insurance | 10,632 | 10,531 | ||||||
Accrued Interest Receivable | 5,586 | 6,096 | ||||||
Goodwill | 4,098 | 4,098 | ||||||
Investment in Limited Partnerships | 1,943 | 2,011 | ||||||
Other Assets | 10,591 | 9,695 | ||||||
Total Assets | $ | 660,672 | $ | 646,296 | ||||
| LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||
Deposits | $ | 478,748 | $ | 450,062 | ||||
Accrued Interest Expense | 3,221 | 3,170 | ||||||
Short-Term Borrowings | 11,418 | 1,757 | ||||||
Long-Term Debt | 67,544 | 87,553 | ||||||
Other Liabilities | 11,083 | 12,158 | ||||||
Total Liabilities | 572,014 | 554,700 | ||||||
Shareholders’ Equity: | ||||||||
Common Stock, par value $0.01 per share, 10,000,000 shares authorized; 7,317,560 shares issued | 73 | 73 | ||||||
Surplus | 9,233 | 9,233 | ||||||
Accumulated Other Comprehensive Loss | (132 | ) | (274 | ) | ||||
Retained Earnings | 97,215 | 96,713 | ||||||
Less Treasury Stock: 1,133,996 and 1,010,708 shares at cost, respectively | (17,731 | ) | (14,149 | ) | ||||
Total Shareholders’ Equity | 88,658 | 91,596 | ||||||
Total Liabilities and Shareholders’ Equity | $ | 660,672 | $ | 646,296 | ||||
The accompanying notes are an integral part of these Consolidated Statements.
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UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Dollars in Thousands, Except Per Share Data)
Three Months Ended March 31, | ||||||
| 2007 | 2006 | |||||
| (Unaudited) | ||||||
INTEREST INCOME: | ||||||
Interest and Fees on Loans | $ | 13,332 | $ | 12,669 | ||
Interest on Investment Securities | 1,802 | 1,496 | ||||
Total Interest Income | 15,134 | 14,165 | ||||
INTEREST EXPENSE: | ||||||
Interest on Deposits | 3,535 | 2,466 | ||||
Interest on Borrowings | 1,095 | 964 | ||||
Total Interest Expense | 4,630 | 3,430 | ||||
NET INTEREST INCOME | 10,504 | 10,735 | ||||
PROVISION FOR LOAN LOSSES | 1,041 | 815 | ||||
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES | 9,463 | 9,920 | ||||
NON-INTEREST INCOME: | ||||||
Service and Other Charges on Deposit Accounts | 757 | 727 | ||||
Credit Life Insurance Income | 99 | 107 | ||||
Other Income | 386 | 450 | ||||
Total Non-Interest Income | 1,242 | 1,284 | ||||
NON-INTEREST EXPENSE: | ||||||
Salaries and Employee Benefits | 3,533 | 3,510 | ||||
Occupancy Expense | 415 | 390 | ||||
Furniture and Equipment Expense | 321 | 319 | ||||
Other Expense | 1,899 | 1,526 | ||||
Total Non-Interest Expense | 6,168 | 5,745 | ||||
INCOME BEFORE INCOME TAXES | 4,537 | 5,459 | ||||
PROVISION FOR INCOME TAXES | 1,495 | 1,779 | ||||
NET INCOME | $ | 3,042 | $ | 3,680 | ||
BASIC AND DILUTED NET INCOME PER SHARE | $ | 0.49 | $ | 0.57 | ||
DIVIDENDS PER SHARE | $ | 0.41 | $ | 0.38 | ||
The accompanying notes are an integral part of these Consolidated Statements.
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UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in Thousands)
| Three Months Ended March 31, | ||||||||
| 2007 | 2006 | |||||||
| (Unaudited) | ||||||||
Net income | $ | 3,042 | $ | 3,680 | ||||
Other comprehensive income (loss): | ||||||||
Change in unrealized holding losses for derivatives arising during period, net of tax of $8 in 2006 | 0 | (13 | ) | |||||
Reclassification adjustment for net gains realized on derivatives in net income, net of taxes of $20 and $20, respectively | (34 | ) | (34 | ) | ||||
Change in unrealized holding gains (losses) on available-for-sale securities arising during period, net of tax (benefits) of $105 and ($110), respectively | 176 | (182 | ) | |||||
Other comprehensive income (loss) | 142 | (229 | ) | |||||
Comprehensive income | $ | 3,184 | $ | 3,451 | ||||
The accompanying notes are an integral part of these Consolidated Statements.
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UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in Thousands)
| Three Months Ended March 31, | ||||||||
| 2007 | 2006 | |||||||
| (Unaudited) | ||||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||
Net Income | $ | 3,042 | $ | 3,680 | ||||
Adjustments to reconcile net income to cash provided by operating activities: | ||||||||
Depreciation | 224 | 258 | ||||||
(Accretion) amortization of premiums and discounts, net | (5 | ) | 20 | |||||
Provision for loan losses | 1,041 | 815 | ||||||
Changes in assets and liabilities: | ||||||||
(Increase) in other assets | (2,286 | ) | (146 | ) | ||||
Increase in other liabilities | 703 | 234 | ||||||
Total adjustment | (323 | ) | 1,181 | |||||
Net cash provided by operating activities | 2,719 | 4,861 | ||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | ||||||||
Proceeds from maturities and prepayments of investment securities available-for-sale | 10,583 | 6,450 | ||||||
Proceeds from sales of investment securities available-for-sale | 215 | 0 | ||||||
Net redemption of Federal Home Loan Bank stock | 533 | 317 | ||||||
Purchase of premises and equipment, net | (176 | ) | (131 | ) | ||||
Purchase of investment securities available-for-sale | (7,206 | ) | (17,947 | ) | ||||
Net decrease in federal funds sold | 25 | 0 | ||||||
Net change in loan portfolio | (9,614 | ) | (10,356 | ) | ||||
Net cash used in investing activities | (5,640 | ) | (21,667 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||
Net increase in customer deposits | 28,685 | 9,245 | ||||||
Dividends paid | (2,540 | ) | (2,443 | ) | ||||
(Decrease) increase in borrowings | (10,347 | ) | 3,186 | |||||
Purchase of treasury stock | (3,582 | ) | (415 | ) | ||||
Net cash provided by financing activities | 12,216 | 9,573 | ||||||
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS | 9,295 | (7,233 | ) | |||||
CASH AND CASH EQUIVALENTS, beginning of period | 28,459 | 21,553 | ||||||
CASH AND CASH EQUIVALENTS, end of period | $ | 37,754 | $ | 14,320 | ||||
SUPPLEMENTAL DISCLOSURES: | ||||||||
Cash paid for: | ||||||||
Interest | $ | 4,579 | $ | 3,643 | ||||
Income Taxes | 276 | 69 | ||||||
NON-CASH TRANSACTIONS: | ||||||||
Other real estate acquired in settlement of loans | $ | 4,046 | $ | 179 | ||||
The accompanying notes are an integral part of these Consolidated Statements.
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UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. GENERAL
The accompanying unaudited condensed consolidated financial statements include the accounts of United Security Bancshares, Inc. and its subsidiaries (the “Company”). All significant intercompany transactions and accounts have been eliminated.
The interim financial statements are unaudited but, in the opinion of management, reflect all adjustments necessary for a fair presentation of financial position and results of operations for such periods presented. Such adjustments are of a normal, recurring nature. The results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2007. While certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission, management believes that the disclosures herein are adequate to make the information presented not misleading. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006. The accounting policies followed by the Company are set forth in Note 2, Summary of Significant Accounting Policies, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
2. EARNINGS PER SHARE
Basic earnings per share are computed by dividing net income by the weighted average number of shares of common stock outstanding during the three-month periods ended March 31, 2007, and 2006. Common stock outstanding consists of issued shares less treasury stock. Diluted earnings per share for the three-month periods ended March 31, 2007, and 2006, are computed based on the weighted average shares outstanding during the period plus the dilutive effect of outstanding stock options. There are no outstanding options as of March 31, 2007.
The following table represents the earnings per share calculations for the three-month periods ended March 31, 2007, and 2006 (dollars in thousands):
For the Three Months Ended: | Net Income | Weighted Average Shares | Net Income Per Share | |||||
March 31, 2007 | $ | 3,042 | 6,237,848 | $ | 0.49 | |||
March 31, 2006 | $ | 3,680 | 6,424,412 | $ | 0.57 | |||
3. COMPREHENSIVE INCOME
Total comprehensive income consists of net income, the change in the unrealized gains or losses on the Company’s available-for-sale securities portfolio arising during the period, and the change in the effective portion of cash-flow hedges marked to market. In the calculation of comprehensive income, certain reclassification adjustments are made to avoid double counting items that are displayed as part of net income for a period that also had been displayed as part of other comprehensive income in that period or earlier periods.
4. RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under U.S. GAAP. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is effective prospectively for fiscal years beginning after November 15, 2007. The Company will adopt SFAS 157 on January 1, 2008, and is assessing the impact of the adoption of this Statement.
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In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 would allow the Company an irrevocable election to measure certain financial assets and liabilities at fair value, with unrealized gains and losses on the elected items recognized in earnings at each reporting period. The fair value option may only be elected at the time of initial recognition of a financial asset or financial liability or upon the occurrence of certain specified events. The election is applied on an instrument-by-instrument basis, with a few exceptions, and is applied only to entire instruments and not to portions of instruments. SFAS 159 also provides expanded disclosure requirements regarding the effects of electing the fair value option on the financial statements. SFAS 159 is effective prospectively for fiscal years beginning after November 15, 2007. The Company is currently evaluating this Statement and has not yet determined the financial assets and liabilities, if any, for which the fair value option would be elected or the potential impact on the consolidated financial statements, if such election were made.
5. SEGMENT REPORTING
Under SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” certain information is disclosed for the two reportable operating segments of the Company. The reportable segments were determined using the internal management reporting system. They are composed of the Company’s and First United Security Bank’s (the “Bank”) significant subsidiaries. The accounting policies for each segment are the same as those described in Note 2, Summary of Significant Accounting Policies, in the Company’s Annual Report on Form 10-K for the period ended December 31, 2006. The segment results include certain overhead allocations and intercompany transactions that were recorded at current market prices. All intercompany transactions have been eliminated to determine the consolidated balances. The results for the two reportable segments of the Company are included in the following table:
| First United Security Bank | Acceptance Loan Company | All Other | Eliminations | Consolidated | ||||||||||||
| (In Thousands of Dollars) | ||||||||||||||||
For the three months ended | ||||||||||||||||
March 31, 2007: | ||||||||||||||||
Net interest income | $ | 6,253 | $ | 4,236 | $ | 15 | $ | 0 | $ | 10,504 | ||||||
Provision for loan losses | 212 | 829 | 0 | 0 | 1,041 | |||||||||||
Total non-interest income | 1,110 | 111 | 3,257 | (3,236 | ) | 1,242 | ||||||||||
Total non-interest expense | 4,167 | 1,900 | 194 | (93 | ) | 6,168 | ||||||||||
Income before income taxes | 2,984 | 1,618 | 3,078 | (3,143 | ) | 4,537 | ||||||||||
Provision for income taxes | 892 | 599 | 4 | 0 | 1,495 | |||||||||||
Net income (loss) | $ | 2,092 | $ | 1,019 | $ | 3,074 | $ | (3,143 | ) | $ | 3,042 | |||||
Other significant items: | ||||||||||||||||
Total assets | $ | 651,907 | $ | 139,220 | $ | 102,365 | $ | (232,820 | ) | $ | 660,672 | |||||
Total investment securities | 116,037 | 0 | 420 | 0 | 116,457 | |||||||||||
Total loans, net | 443,489 | 133,332 | 0 | (126,674 | ) | 450,147 | ||||||||||
Goodwill | 3,111 | 0 | 987 | 0 | 4,098 | |||||||||||
Investment in subsidiaries | 1,792 | 63 | 88,314 | (90,091 | ) | 78 | ||||||||||
Fixed asset addition | 90 | 87 | 0 | 0 | 177 | |||||||||||
Depreciation and amortization expense | 185 | 37 | 2 | 0 | 224 | |||||||||||
Total interest income from external customers | 8,795 | 6,333 | 6 | 0 | 15,134 | |||||||||||
Total interest income from affiliates | 2,096 | 0 | 9 | (2,105 | ) | 0 | ||||||||||
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| First United Security Bank | Acceptance Loan Company | All Other | Eliminations | Consolidated | ||||||||||||
| (In Thousands of Dollars) | ||||||||||||||||
For the three months ended | ||||||||||||||||
March 31, 2006: | ||||||||||||||||
Net interest income | $ | 6,722 | $ | 3,999 | $ | 14 | $ | 0 | $ | 10,735 | ||||||
Provision for loan losses | 131 | 684 | 0 | 0 | 815 | |||||||||||
Total non-interest income | 1,133 | 139 | 3,884 | (3,872 | ) | 1,284 | ||||||||||
Total non-interest expense | 3,896 | 1,780 | 181 | (112 | ) | 5,745 | ||||||||||
Income before income taxes | 3,828 | 1,674 | 3,717 | (3,760 | ) | 5,459 | ||||||||||
Provision for income taxes | 1,145 | 630 | 4 | 0 | 1,779 | |||||||||||
Net income (loss) | $ | 2,683 | $ | 1,044 | $ | 3,713 | $ | (3,760 | ) | $ | 3,680 | |||||
Other significant items: | ||||||||||||||||
Total assets | $ | 625,571 | $ | 134,144 | $ | 101,438 | $ | (226,477 | ) | $ | 634,676 | |||||
Total investment securities | 121,217 | 0 | 661 | 0 | 121,878 | |||||||||||
Total loans, net | 436,910 | 130,442 | 0 | (126,284 | ) | 441,068 | ||||||||||
Goodwill | 3,111 | 0 | 987 | 0 | 4,098 | |||||||||||
Investment in subsidiaries | 2,067 | 63 | 86,471 | (88,523 | ) | 78 | ||||||||||
Fixed asset addition | 96 | 30 | 0 | 0 | 126 | |||||||||||
Depreciation and amortization expense | 191 | 34 | 2 | 0 | 227 | |||||||||||
Total interest income from external customers | 8,065 | 6,093 | 7 | 0 | 14,165 | |||||||||||
Total interest income from affiliates | 2,094 | 0 | 7 | (2,101 | ) | 0 | ||||||||||
6. DERIVATIVE FINANCIAL INSTRUMENTS
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and in connection with its interest rate risk management, investing, and trading activities. These financial instruments include commitments to extend credit and standby letters of credit.
The Bank’s principal objective in holding derivative financial instruments is asset-liability management. The operations of the Bank are subject to a risk of interest rate fluctuations to the extent that there is a difference between the amount of the Bank’s interest earning assets and the amount of interest bearing liabilities that mature or reprice in specified periods. The principal objective of the Bank’s asset-liability management activities is to provide maximum levels of net interest income while maintaining acceptable levels of interest rate and liquidity risk and facilitating the funding needs of the Bank. To achieve that objective, the Bank uses a combination of derivative financial instruments, including interest rate swaps.
Two cash-flow hedges with a notional amount of $18.0 million were terminated on March 31, 2005, that resulted in a $592,000 gain, which is reported in other comprehensive income. This gain will be reclassified from other comprehensive income to income over the original remaining term of the swaps. During the first quarter of 2007 and 2006, $53,755 was reclassified into income. The remaining balance not reclassified to income was $161,962 at March 31, 2007.
Two interest rate swaps with a total notional value of $10.0 million were used to convert fixed-rate brokered certificates of deposit to floating rate. On January 1, 2006, the Company began accounting for these interest rate swaps under hedge accounting. This required the Company to increase the carrying value of the two certificates of deposit by $39,900 during the first quarter of 2007. Net cash flows from these swaps increased interest expense on certificates of deposit by $33,268 for the quarter ended March 31, 2007, and $26,384 for the quarter ended March 31, 2006.
7. GUARANTEES, COMMITMENTS AND CONTINGENCIES
The Company is a defendant in certain claims and legal actions arising in the normal course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial position or results of operations of the Company.
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The Bank’s exposure to credit loss in the event of nonperformance by the other party for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments as it does for on-balance sheet instruments. For interest rate swap transactions, and commitments to purchase or sell securities for forward delivery, the contract or notional amounts do not represent exposure to credit loss. The Bank controls the credit risk of these derivative instruments through credit approvals, limits, and monitoring procedures. Certain derivative contracts have credit risk for the carrying value plus the amount to replace such contracts in the event of counter party default. All of the Bank’s financial instruments are held for risk management and not for trading purposes. During the period ending March 31, 2007, there were no credit losses associated with derivative contracts.
In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit, letters of credit, and others, which are not included in the consolidated financial statements. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the financial statements. A summary of these commitments and contingent liabilities is presented below.
| March 31, 2007 | December 31, 2006 | |||||
Standby Letters of Credit | $ | 1,304 | $ | 1,869 | ||
Commitments to Extend Credit | $ | 47,585 | $ | 54,777 | ||
Standby letters of credit are contingent commitments issued by the Company generally to guarantee the performance of a customer to a third party. The Company has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit. Revenues are recognized over the lives of the standby letters of credit. The potential amount of future payments the Company could be required to make under its standby letters of credit at March 31, 2007, is $1.3 million and represents the Company’s total credit risk.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counter party. Collateral held varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties.
Commitments to purchase securities for delayed delivery require the Bank to purchase a specified security at a specified price for delivery on a specified date. Similarly, commitments to sell securities for delayed delivery require the Bank to sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in security values and interest rates between the commitment and delivery dates. At March 31, 2007, there were no outstanding commitments to purchase and sell securities for delayed delivery.
| ITEM 2. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The following discussion and financial information are presented to aid in an understanding of the current financial position and results of operations of the Company. The Company is the parent holding company of the Bank. The Bank operates a finance company, Acceptance Loan Company (“ALC”). The Company has no operations of any consequence other than the ownership of its subsidiaries.
The accounting principles and reporting policies of the Company, and the methods of applying these principles, conform with accounting principles generally accepted in the United States (“GAAP”) and with general practices within the financial services industry. Critical accounting policies relate to securities, loans, allowance for loan losses, derivatives and hedging. A description of these policies, which significantly affect the determination of financial position, results of operations and cash-flows, is set forth in Note 2, Summary of Significant Accounting Policies, in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
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The emphasis of this discussion is a comparison of assets, liabilities, and shareholder’s equity as of March 31, 2007, to year-end 2006, while comparing income and expense for the three-month periods ended March 31, 2007, and 2006.
All yields and ratios presented and discussed herein are based on the accrual basis and not on the tax-equivalent basis, unless otherwise indicated.
This information should be read in conjunction with the Company’s unaudited consolidated financial statements and related notes appearing elsewhere in this report and Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006.
COMPARING THE THREE MONTHS ENDED MARCH 31, 2007, TO THE THREE MONTHS ENDED MARCH 31, 2006
Net income during the first quarter decreased $638,000, or 17.3%, resulting in a decrease of basic net income per share from $0.57 to $0.49. Annualized return on assets was 1.89% for the first three months of 2007, compared to 2.37% for the same period during 2006. Average return on shareholders’ equity decreased to 13.69% for the first three months of 2007, from 16.87% during the first three months of 2006.
Interest income for the first quarter increased $969,000, or 6.8%, compared to the first quarter of 2006. The increase in interest income was primarily due to an increase in interest earned on loans. This increase is due to an overall increase in the average yield and an increase in the volume of loans outstanding.
Interest expense for the first quarter increased $1.2 million, or 35.0%, compared to the first quarter of 2006. This increase was the result of increased rates and volume of interest bearing deposits, primarily certificates of deposit. Funding rates have increased more than asset yields since the Federal Reserve last raised rates in June of 2006.
Net interest income decreased $231,000, or 2.2%, for the first quarter of 2007, as a result of an increase in the yield on loans and securities, which was offset by an increase in interest paid on deposits and borrowings.
The provision for loan losses was $1.0 million, or 0.8%, annualized of average loans in the first quarter of 2007, compared to $815,000, or 0.7%, annualized of average loans in the first quarter of 2006. Charge-offs exceeded recoveries by $919,000 for the quarter, an increase of approximately $72,000 over the same period in the prior year.
Total non-interest income (excluding security gains and losses) decreased $39,000, or 3.0%, for the first quarter of 2007. Service charges and fees on deposit accounts increased $30,000. Income on bank-owned life insurance increased $9,000, while commissions on credit insurance declined $8,000. Gains on sale of assets declined $26,000. Letters of credit and commitment fees declined $23,000 and all other fees and charges declined $20,000.
Total non-interest expense increased $423,000, or 7.4%, in the first quarter of 2007. Salary and employee benefits increased $23,000; occupancy expense increased $25,000; advertising expense increased $11,000; stationary and supplies expense increased $22,000; telephone and data circuit expense increased $86,000; and legal and attorney fees increased $126,000.
Income tax expense for the first quarter of 2007 decreased $284,000 over the first quarter of 2006. The decrease during the first three months of 2007 compared to 2006 resulted from lower levels of taxable income. Management estimates the effective tax rate for the Company to be approximately 33.0% of pre-tax income for the remainder of the year.
COMPARING THE MARCH 31, 2007, STATEMENT OF FINANCIAL CONDITION TO DECEMBER 31, 2006
In comparing financial condition at December 31, 2006, to March 31, 2007, total assets increased $14.4 million to $660.7 million, while liabilities increased $17.3 million to $572.0 million. Shareholders’ equity decreased $2.9 million as a result of earnings in excess of dividends of $502,000, a decrease in other comprehensive loss of $142,000, and an increase in treasury stock of $3.6 million during the first three months of 2007.
Investment securities decreased $3.3 million, or 2.8%, during the first three months of 2007. Investments provide the Company with a stable form of liquidity while maximizing earnings yield. Loans, net of unearned income, increased $8.7 million, from $449.2 million at December 31, 2006, to $457.9 million at March 31, 2007, as a result of continued construction and real estate development in the trade areas served by the Company. Deposits increased $28.7 million, or 6.4%, during the first three months of 2007.
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CREDIT QUALITY
At March 31, 2007, the allowance for loan losses was $7.8 million, or 1.7%, of loans net of unearned income, compared to $7.7 million, or 1.7%, of loans net of unearned income at March 31, 2006, and December 31, 2006. The coverage ratio of the allowance for loan losses to non-performing assets decreased to 60.7% at March 31, 2007, compared to 71.8% at December 31, 2006, due to an increase in accruing loans past due 90 days or more and other real estate owned, offset somewhat by a decrease in non-accrual loans.
Activity in the allowance for loan losses is summarized as follows (amounts in thousands):
Three Months Ended March 31, | ||||||||
| 2007 | 2006 | |||||||
Balance at Beginning of Period | $ | 7,664 | $ | 7,694 | ||||
Charge-Offs | (1,216 | ) | (1,070 | ) | ||||
Recoveries | 297 | 223 | ||||||
Net Loans Charged-Off | (919 | ) | (847 | ) | ||||
Additions Charged to Operations | 1,041 | 815 | ||||||
Balance at End of Period | $ | 7,786 | $ | 7,662 | ||||
Net charge-offs for the quarter ended March 31, 2007, were $919,000, or 0.8%, of average loans, on an annualized basis, an increase of 8.5%, or $72,000, from the charge-offs of $847,000, or 0.8%, of average loans, on an annualized basis, reported a year earlier. The provision for loan losses for the first three months of 2007 was $1.0 million compared to $815,000 in the first three months of 2006.
The Company maintains the allowance for loan losses at a level deemed adequate by management to absorb possible 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.
Non-performing assets were as follows (amounts in thousands):
| March 31, | December 31, | March 31, | ||||||||||
| 2007 | 2006 | 2006 | ||||||||||
Loans Accounted for on a Non-Accrual Basis | $ | 5,558 | $ | 7,318 | $ | 4,985 | ||||||
Accruing Loans Past Due 90 Days or More | 2,373 | 2,033 | 4,078 | |||||||||
Real Estate Acquired in Settlement of Loans | 4,905 | 1,318 | 1,789 | |||||||||
Total | $ | 12,836 | $ | 10,669 | $ | 10,852 | ||||||
Non-Performing Assets as a Percentage of Net Loans and Other Real Estate | 2.77 | % | 2.37 | % | 2.41 | % | ||||||
Loans accounted for on a non-accrual basis increased $0.6 million since March 31, 2006, and decreased $1.8 million since December 31, 2006. Accruing loans past due 90 days or more decreased $1.7 million compared to March 31, 2006, and increased $340,000 since December 31, 2006. Real estate acquired in settlement of loans increased $3.1 million since March 31, 2006, and $3.6 million since December 31, 2006.
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Impaired loans totaled $5.6 million, $7.3 million, and $5.0 million as of March 31, 2007, December 31, 2006, and March 31, 2006, respectively. There was approximately $828,000 and $848,000 in the allowance for loan losses specifically allocated to these impaired loans at March 31, 2007, and December 31, 2006, respectively.
LIQUIDITY AND CAPITAL RESOURCES
The Bank’s primary sources of funds are customer deposits, Federal Home Loan Bank advances, repayments of loan principal, and interest from loans and investments. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition, making them less predictable. The Bank manages the pricing of its deposits to maintain a desired deposit balance. In addition, the Bank invests in short-term interest-earning assets, which provide liquidity to meet lending requirements.
The Bank currently has up to $120.3 million in borrowing capacity from the Federal Home Loan Bank and $35.0 million in established federal fund lines.
The Bank is required to maintain certain levels of regulatory capital. At March 31, 2007, and December 31, 2006, the Company and the Bank were in compliance with all regulatory capital requirements.
Management is not aware of any condition that currently exists that would have an adverse effect on the liquidity, capital resources, or operation of the Company. However, the Company is a defendant in certain claims and legal actions arising in the ordinary course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial position or results of operations of the Company.
| ITEM 3. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
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 the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. Interest rate risk management focuses on the maturity structure of assets and liabilities and their repricing characteristics during changes 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 the net interest margin.
The asset portion of the balance sheet provides liquidity primarily from principal payments, maturities and sales relating to 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 $186.1 million at December 31, 2006, and $195.6 million at March 31, 2007.
Investment securities that are forecast to mature or reprice over the next twelve months total $16.9 million, or 14.5%, of the investment portfolio as of March 31, 2007. For comparison, principal payments on investment securities totaled $7.4 million at March 31, 2007.
Although the majority of the securities portfolio has legal final maturities longer than 10 years, the entire portfolio consists of securities that are readily marketable and easily convertible into cash. As of March 31, 2007, the bond portfolio had an expected average maturity of 3.8 years, and approximately 72.0% of the $116.0 million in bonds were 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 operating activities and 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, Federal Home Loan Bank 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.
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The Bank, at March 31, 2007, had long-term debt and short-term borrowings that, on average, represented 13.3% of total liabilities and equity, compared to 13.7% at year-end 2006.
Interest rate sensitivity is a function of the repricing characteristics of the portfolio of 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. Sensitivity is measured as the difference between the volume of assets and the volume of liabilities in the current portfolio 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. 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. Interest rate derivatives used in interest rate sensitivity management also are included in the applicable gap intervals.
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.
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.
Also 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 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.
As part of the ongoing monitoring of interest-sensitive assets and liabilities, the Bank enters into various interest rate contracts (“interest rate protection contracts”) to help manage the Bank’s interest sensitivity. These contracts generally have a fixed notional principal amount and include interest rate swaps where the Bank typically receives or pays a fixed-rate and a counter party pays or receives a floating-rate based on a specified index, and interest rate caps and floors purchased where the Bank receives interest if the specified index falls below the floor rate or rises above the cap rate. All interest rate swaps represent end-user activities and are designed as hedges. The interest rate risk factor in these contracts is considered in the overall interest management strategy and the Company’s interest risk management program. The income or expense associated with interest rate swaps, caps, and floors classified as hedges ultimately are reflected as adjustments to interest income or expense. Changes in the estimated market value of interest rate protection contracts are reflected in either the Bank’s income statement or balance sheet.
| ITEM 4. | CONTROLS AND PROCEDURES |
As of March 31, 2007, the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934). Based upon that evaluation, the Chief Executive Officer and Principal Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that the information required to be disclosed in the Company’s periodic filings with the Securities and Exchange Commission is recorded, processed, summarized, and reported within the time periods specified.
There were no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) during the quarter ended March 31, 2007, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
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| ITEM 1. | LEGAL PROCEEDINGS |
The Company is a defendant in certain claims and legal actions arising in the normal course of business. In the opinion of management, after consultation with legal counsel, the ultimate disposition of these matters is not expected to have a material adverse effect on the consolidated financial position or results of operations of the Company.
| ITEM 1A. | RISK FACTORS |
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, which could materially affect the Company’s business, financial condition, or future results. The risks described in the Company’s Annual Report on Form 10-K are not the only risks facing the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect the Company’s business, financial condition, and/or operating results.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
The following table sets forth purchases made by or on behalf of the Company or any “affiliated purchaser,” as defined in Rule 10b-18(a)(3) of the Exchange Act, of shares of the Company’s common stock.
| Issuer Purchases of Equity Securities | |||||||||||
Period | Total Number of Shares Purchased | Average Price Paid per Share | Total Number of Programs(1) | Maximum Number (or the Programs(1) | |||||||
January 1 – January 31 | 11,909 | (2) | $ | 28.98 | (2) | 5,107 | 519,131 | ||||
February 1 – February 28 | 108,690 | $ | 29.04 | 108,690 | 410,441 | ||||||
March 1 – March 31 | 9,491 | (3) | $ | 29.21 | (3) | 7,291 | 403,150 | ||||
Total | 130,090 | $ | 29.05 | 121,088 | 403,150 | ||||||
| (1) | On January 19, 2006, the Board of Directors approved a share repurchase program. Under the repurchase program, the Company is authorized to repurchase up to 642,785 shares of common stock before December 31, 2007, the expiration date of the repurchase program. |
| (2) | 6,802 shares were purchased in open-market transactions by an independent trustee for the United Security Bancshares Inc. Employee Stock Ownership Plan (With 401(k) Provisions), and 5,107 shares were purchased under the share repurchase program. |
| (3) | 2,200 shares were purchased by a trust, which is part of the Company’s general assets, subject to the claims of its creditors, established in connection with the United Security Bancshares, Inc. Non-Employee Directors’ Deferred Compensation Plan and 7,291 shares were purchased under the share repurchase program. |
| ITEM 6. | EXHIBITS |
The exhibits listed in the Index to Exhibits on page 17 are filed herewith and are incorporated herein by reference.
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Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
| UNITED SECURITY BANCSHARES, INC. | ||
| DATE: May 9, 2007 | ||
| BY: | /s/ Robert Steen | |
| Robert Steen | ||
| Its Assistant Vice President, Assistant Treasurer, Principal Financial Officer, and Principal Accounting Officer (Duly Authorized Officer and Principal Financial Officer) | ||
INDEX TO EXHIBITS
| Exhibit No. | Description | |
| 3.1 | Certificate of Incorporation of United Security Bancshares, Inc., incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 1999. | |
| 3.2(a) | Amended and Restated Bylaws of United Security Bancshares, Inc., incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended June 30, 2006. | |
| 3.2(b) | First Amendment to the Amended and Restated Bylaws of United Security Bancshares, Inc., incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended June 30, 2006. | |
| 31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. | |
| 31.2 | Certification of Principal Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended. | |
| 32 | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
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