First US Bancshares (FUSB) 10-Q 2008 Q3 Quarterly report

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 September 30, 2008

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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ¨	Accelerated filer  x
Non-accelerated filer  ¨	Smaller reporting company  ¨
(Do not check if a smaller reporting company)

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 November 7, 2008
Common Stock, $0.01 par value	6,020,154 shares

UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES

		PAGE
PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS
Condensed Consolidated Statements of Financial Condition at September  30, 2008, (Unaudited) and December 31, 2007		4
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September  30, 2008 and 2007 (Unaudited)		5
Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2008 and 2007 (Unaudited)		6
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September  30, 2008 and 2007 (Unaudited)		7
Notes to Condensed Consolidated Financial Statements		8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	16
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	19
ITEM 4.	CONTROLS AND PROCEDURES	20
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	21
ITEM 1A.	RISK FACTORS	21
ITEM 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	22
ITEM 6.	EXHIBITS	22
Signature Page		23

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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. (the “Company”), 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 the Company’s best judgment based upon current information and involve a number of risks and uncertainties, and various factors could cause results to differ materially from those contemplated by such forward-looking statements. Such factors could include those identified from time to time in the Company’s Securities and Exchange Commission filings and other public announcements, including the factors described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007. With respect to the adequacy of the allowance for loan losses for the Company, these factors include, but are not limited to, the rate of growth in the economy, the relative strength and weakness in the consumer and commercial credit sectors and in the real estate markets, and collateral values. Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to revise forward-looking statements to reflect circumstances or events that occur after the dates on which 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, Except Per Share Data)

	September 30, 2008			December 31, 2007
	(Unaudited)
ASSETS
Cash and Due from Banks	$	12,988		$	13,247
Interest-Bearing Deposits in Banks		15,142			7,427
Cash and Cash Equivalents		28,130			20,674
Investment Securities Available-for-Sale		172,493			144,531
Federal Home Loan Bank Stock		5,236			5,096
Loans, net of allowance for loan losses of $7,916 and $8,535, respectively		399,463			427,588
Premises and Equipment, net		17,744			18,132
Cash Surrender Value of Bank-Owned Life Insurance		11,264			10,946
Accrued Interest Receivable		4,918			6,141
Goodwill		4,098			4,098
Investment in Limited Partnerships		2,034			2,037
Other Real Estate Owned		17,126			11,156
Other Assets		7,725			9,497
Total Assets	$	670,231		$	659,896
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits	$	488,204		$	478,554
Accrued Interest Expense		3,345			3,936
Short-Term Borrowings		2,078			11,212
Long-Term Debt		90,000			77,518
Other Liabilities		8,627			9,108
Total Liabilities	$	592,254		$	580,328
Shareholders’ Equity:
Common Stock, par value $0.01 per share, 10,000,000 shares authorized; 7,317,560 shares issued; 6,026,656 and 6,085,192 shares outstanding, respectively		73			73
Surplus		9,233			9,233
Accumulated Other Comprehensive Income		589			875
Retained Earnings		89,044			89,348
Less Treasury Stock: 1,290,904 and 1,232,368 shares at cost, respectively		(20,962	)		(19,961	)
Total Shareholders’ Equity	$	77,977		$	79,568
Total Liabilities and Shareholders’ Equity	$	670,231		$	659,896

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 OPERATIONS

(Dollars in Thousands, Except Per Share Data)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008		2007			2008		2007
	(Unaudited)					(Unaudited)
INTEREST INCOME:
Interest and Fees on Loans	$	10,535	$	13,056		$	32,860	$	39,760
Interest on Investment Securities		2,299		2,027			6,541		5,666
Total Interest Income		12,834		15,083			39,401		45,426
INTEREST EXPENSE:
Interest on Deposits		3,047		4,112			10,174		11,504
Interest on Borrowings		941		987			2,867		3,073
Total Interest Expense		3,988		5,099			13,041		14,577
NET INTEREST INCOME		8,846		9,984			26,360		30,849
PROVISION FOR LOAN LOSSES		1,927		6,786			5,467		17,690
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		6,919		3,198			20,893		13,159
NON-INTEREST INCOME:
Service and Other Charges on Deposit Accounts		842		856			2,448		2,421
Credit Life Insurance Income		295		186			554		440
Other Income		404		489			1,572		1,263
Total Non-Interest Income		1,541		1,531			4,574		4,124
NON-INTEREST EXPENSE:
Salaries and Employee Benefits		3,276		3,192			9,641		10,196
Occupancy Expense		503		571			1,403		1,410
Furniture and Equipment Expense		361		355			1,064		1,019
Other Expense		2,263		3,170			6,414		6,820
Total Non-Interest Expense		6,403		7,288			18,522		19,445
INCOME (LOSS) BEFORE INCOME TAXES		2,057		(2,559	)		6,945		(2,162	)
PROVISION FOR (BENEFIT FROM) INCOME TAXES		655		(692	)		2,159		(605	)
NET INCOME (LOSS)	$	1,402	$	(1,867	)	$	4,786	$	(1,557	)
BASIC AND DILUTED NET INCOME (LOSS) PER SHARE	$	0.23	$	(0.30	)	$	0.79	$	(0.25	)
DIVIDENDS PER SHARE	$	0.27	$	0.26		$	0.81	$	0.93

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 (LOSS)

(Dollars in Thousands)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2008		2007			2008			2007
	(Unaudited)					(Unaudited)
Net income (loss)	$	1,402	$	(1,867	)	$	4,786		$	(1,557	)
Other comprehensive income (loss):
Reclassification adjustment for net gains realized on derivatives in net income (loss), net of taxes of $0, $20, $5 and $60, respectively		0		(34	)		(7	)		(101	)
Change in unrealized holding gains (losses) on available-for-sale securities arising during period, net of tax (benefits) of $460, $563, ($215), and $120, respectively		766		938			(358	)		200
Reclassification adjustment for net (gains) losses realized on available-for-sale securities realized in net income (loss), net of tax (benefits) of ($48), $1, ($48) and ($1), respectively		80		(2	)		80			2
Other comprehensive income (loss)		846		902			(285	)		101
Comprehensive income (loss)	$	2,248	$	(965	)	$	4,501		$	(1,456	)

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)

	Nine Months Ended September 30,
	2008			2007
	(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income (Loss)	$	4,786		$	(1,557	)
Adjustments to reconcile net income (loss) to cash provided by operating activities:
Depreciation		700			684
Accretion of premiums and discounts, net		(178	)		(109	)
Provision for loan losses		5,467			17,690
Net other operating activities		4,664			(2,859	)
Total adjustment		10,653			15,406
Net cash provided by operating activities		15,439			13,849
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and prepayments of investment securities available-for-sale		36,923			27,482
Proceeds from sales of investment securities available-for-sale		10,806			5,189
Proceeds from redemption of Federal Home Loan Bank stock		338			983
Purchase of premises and equipment, net		(673	)		(338	)
Purchase of investment securities available-for-sale		(76,087	)		(46,114	)
Decrease in cash acquired in consolidation of limited partnership		(20	)		(2	)
Purchase of Federal Home Loan Bank stock		(478	)		(450	)
Net decrease in federal funds sold		0			25
Net increase (decrease) in loan portfolio		14,115			(16,666	)
Net cash used in investing activities		(15,076	)		(29,891	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in customer deposits		9,650			36,670
Dividends paid		(4,905	)		(5,753	)
Increase (decrease) in borrowings		3,349			(9,671	)
Purchase of treasury stock		(1,001	)		(4,524	)
Net cash provided by financing activities		7,093			16,722
NET INCREASE IN CASH AND CASH EQUIVALENTS		7,456			680
CASH AND CASH EQUIVALENTS, beginning of period		20,674			28,459
CASH AND CASH EQUIVALENTS, end of period	$	28,130		$	29,139
SUPPLEMENTAL DISCLOSURES:
Cash paid for:
Interest	$	13,632		$	13,852
Income Taxes		111			3,979
NON-CASH TRANSACTIONS:
Other real estate acquired in settlement of loans	$	8,686		$	9,886

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, except for the $12.2 million adjustment for losses resulting from the loan irregularities at Acceptance Loan Company, Inc. (“ALC”) reported for the three- and nine-month periods ended September 30, 2007. The results of operations for any interim period are not necessarily indicative of results expected for the fiscal year ending December 31, 2008. While certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”), 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, 2007. The accounting policies followed by the Company are set forth in Note 2, Summary of Significant Accounting Policies, in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

2. NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the three- and nine-month periods ended September 30, 2008 and 2007. Common stock outstanding consists of issued shares less treasury stock. Diluted net income (loss) per share for the three- and nine-month periods ended September 30, 2008 and 2007 are computed based on the weighted average shares outstanding during the period plus the dilutive effect of outstanding stock options. There were no outstanding options during the periods ended September 30, 2008 or 2007.

The following table represents the net income (loss) per share calculations for the three- and nine-month periods ended September 30, 2008 and 2007 (dollars in thousands, except per share data):

	Net Income (Loss)			Weighted Average Shares	Net Income (Loss) Per Share
For the Three Months Ended:
September 30, 2008	$	1,402		6,031,632	$	0.23
September 30, 2007	$	(1,867	)	6,165,568	$	(0.30	)
For the Nine Months Ended:
September 30, 2008	$	4,786		6,045,526	$	0.79
September 30, 2007	$	(1,557	)	6,193,272	$	(0.25	)

3. COMPREHENSIVE INCOME (LOSS)

Comprehensive income (loss) consists of net income (loss), 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 (loss), certain reclassification adjustments are made to avoid double counting items that are displayed as part of net income (loss) for a period that also had been displayed as part of other comprehensive income (loss) in that period or earlier periods.

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4. RECENT ACCOUNTING PRONOUNCEMENTS

Fair Value Measurements

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 157,Fair Value Measurements. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances. On February 12, 2008, the Financial Accounting Standards Board (the “FASB”) issued Staff Position 157-2 which defers the effective date of SFAS No. 157 for certain nonfinancial assets and liabilities to fiscal years beginning after November 15, 2008. All other provisions of SFAS No. 157 are effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.

As defined in SFAS No. 157, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods, including market, income, and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and or the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable inputs. The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

• Level 1 — Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. Level 1 also includes U.S. Treasury and federal agency securities and federal agency mortgage-backed securities, which are traded by dealers or brokers in active markets. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

• Level 2 — Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained from third party pricing services for identical or similar assets or liabilities.

• Level 3 — Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models, and similar techniques, and not based on market exchange, dealer, or broker traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities.

Assets Measured at Fair Value on a Recurring Basis

Following is a description of the valuation methodologies used for instruments measured at fair value on a recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Available-for-Sale Securities

Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products, and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flows. Level 2 securities include U.S. agency securities, mortgage-backed agency securities, obligations of states and political subdivisions, and certain corporate, asset backed, and other securities. In certain cases where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy. Currently, all of the Company’s available-for-sale securities are considered to be Level 2 securities, except for $247,008 in equity securities which are considered to be Level 1 securities.

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Assets Measured at Fair Value on a Nonrecurring Basis

Following is a description of the valuation methodologies used for instruments measured at fair value on a non-recurring basis and recognized in the accompanying balance sheet, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Impaired Loans

Loan impairment is reported when full payment under the loan terms is not expected. Impaired loans are carried at the present value of estimated future cash flows using the loan’s existing rate, or the fair value of collateral if the loan is collateral dependent. A portion of the allowance for loan losses is allocated to impaired loans if the value of such loans is deemed to be less than the unpaid balance. If these allocations cause the allowance for loan losses to require increase, such increase is reported as a component of the provision for loan losses. Loan losses are charged against the allowance when management believes the uncollectability of a loan is confirmed. During 2008, certain impaired loans were partially charged-off or re-evaluated for impairment, resulting in a remaining balance for these loans, net of specific allowances, of $16,792,647 as of September 30, 2008. This valuation would be considered Level 3, consisting of appraisals of underlying collateral and discounted cash flow analysis.

Other Accounting Standards Recently Adopted

The following is a list of other accounting standards recently adopted that did not have a material impact on the Company’s financial statements.

SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities –SFAS No. 159 permits companies to elect to measure certain eligible items at fair value. Subsequent unrealized gains and losses on those items will be reported in earnings. Upfront costs and fees related to those items will be reported in earnings as incurred and not deferred. As the Company did not elect to apply SFAS No. 159 to any of its existing eligible items as of January 1, 2008, the adoption of SFAS No. 159 did not have an impact on the Company’s financial statements. The Company may elect to apply SFAS No. 159 to certain newly recognized eligible items in the future.

Emerging Issues Task Force (“EITF”) 06-4,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements – EITF 06-4 stipulates that an agreement by the employer to share a portion of the proceeds of a life insurance policy with the employee during the postretirement period is a postretirement benefit arrangement for which a liability must be recorded.

EITF 06-10,Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements – EITF 06-10 stipulates that a liability should be recognized for a postretirement benefit obligation associated with a collateral assignment arrangement if, on the basis of the substantive agreement with the employee, the employer has agreed to maintain a life insurance policy during the postretirement period or provide a death benefit. The employer also must recognize and measure the associated asset on the basis of the terms of the collateral assignment arrangement.

SEC Staff Accounting Bulletin (“SAB”) No. 109,Written Loan Commitments Recorded at Fair Value Through Earnings – SAB No. 109 requires that the expected net future cash flows related to servicing of a loan be included in the measurement of all written loan commitments that are accounted for at fair value through earnings.

Accounting Standards Not Yet Adopted

In May 2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted Accounting Principles. Under SFAS No. 162, the GAAP hierarchy will now reside in the accounting literature established by the FASB. SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements in conformity with GAAP. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board Auditing amendments to AU Section 411,The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. SFAS No. 162 will not impact our financial statements.

In December 2007, the FASB issued SFAS No. 141(R),Business Combinations, which is a revision of SFAS No. 141,Business Combinations. SFAS No. 141(R) establishes principles and requirements for how an acquirer in a business combination: recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and discloses information to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This Statement is

10

effective for fiscal years beginning after December 15, 2008, and is to be applied prospectively. The Company is currently assessing the potential impact that SFAS No. 141(R) will have on the financial statements.

In December 2007, the FASB issued SFAS No. 160,Noncontrolling Interests in Consolidated Financial Statements. SFAS No. 160 amends Accounting Research Bulletin 51,Consolidated Financial Statements, to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be clearly reported as equity in the consolidated financial statements. Additionally, SFAS No. 160 requires that the amount of consolidated net income attributable to the parent and to the controlling interests be clearly identified and presented on the face of the consolidated statement of income. The provisions of this Statement are effective for fiscal years beginning on or after December 15, 2008, and earlier application is prohibited. Prospective application of this Statement is required, except for the presentation and disclosure requirements, which must be applied retrospectively. The Company is currently assessing the potential impact that SFAS No. 160 will have on the financial statements.

In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities. SFAS No. 161 amends SFAS No. 133,Accounting for Derivative Instruments and Hedging Activities, by requiring expanded disclosures about an entity’s derivative instruments and hedging activities, but does not change SFAS No. 133’s scope or accounting. This Statement requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance, and cash flows. To meet those objectives, this Statement requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures in a tabular format about fair value amounts of and gains and losses on derivative instruments, including specific disclosures regarding the location and amounts of derivative instruments in the financial statements, and disclosures about credit-risk-related contingent features in derivative agreements. SFAS No. 161 also amends SFAS No. 107,Disclosures about Fair Value of Financial Instruments, to clarify that derivative instruments are subject to the SFAS No. 107 concentration of credit-risk disclosures. The provisions of this Statement are effective for fiscal years beginning after November 15, 2008, and earlier application is permitted. The Company is currently assessing the potential impact that SFAS No. 161 will have on the financial statements.

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 Notes to Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the period ended December 31, 2007. 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:

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	First United Security Bank		Acceptance Loan Company		All Other			Eliminations			Consolidated
	(In Thousands of Dollars)
For the three months ended September 30, 2008:
Net interest income (expense)	$	5,726	$	3,158	$	(38	)	$	0		$	8,846
Provision for loan losses		611		1,316		0			0			1,927
Total non-interest income		1,002		222		1,930			(1,613	)		1,541
Total non-interest expense		4,197		1,890		619			(303	)		6,403
Income before income taxes		1,920		174		1,273			(1,310	)		2,057
Provision for income taxes		556		92		7			0			655
Net income	$	1,364	$	82	$	1,266		$	(1,310	)	$	1,402
Other significant items:
Total assets	$	666,869	$	112,088	$	92,590		$	(201,316	)	$	670,231
Total investment securities		172,123		0		370			0			172,493
Total loans, net		412,325		95,988		0			(108,850	)		399,463
Goodwill		3,112		0		986			0			4,098
Investment in subsidiaries		9,825		63		78,437			(88,247	)		78
Fixed asset addition		137		68		247			0			452
Depreciation and amortization expense		181		52		0			0			233
Total interest income from external customers		7,828		4,999		7			0			12,834
Total interest income from affiliates		1,780		0		16			(1,796	)		0
For the nine months ended September 30, 2008:
Net interest income	$	16,968	$	9,390	$	2		$	0		$	26,360
Provision for loan losses		1,750		3,717		0			0			5,467
Total non-interest income		3,596		478		5,863			(5,363	)		4,574
Total non-interest expense		12,117		5,689		1,172			(456	)		18,522
Income before income taxes		6,697		462		4,693			(4,907	)		6,945
Provision for income taxes		1,970		174		15			0			2,159
Net income	$	4,727	$	288	$	4,678		$	(4,907	)	$	4,786
Other significant items:
Fixed asset addition	$	318	$	108	$	247		$	0		$	673
Depreciation and amortization expense		555		145		0			0			700
Total interest income from external customers		24,332		15,047		22			0			39,401
Total interest income from affiliates		5,596		0		41			(5,637	)		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 September 30, 2007:
Net interest income (expense)	$	6,418	$	3,608		$	(42	)	$	0		$	9,984
Provision for loan losses		347		6,439			0			0			6,786
Total non-interest income		1,157		126			1,937			(1,689	)		1,531
Total non-interest expense		4,226		2,814			481			(233	)		7,288
Income (loss) before income taxes		3,002		(5,519	)		1,414			(1,456	)		(2,559	)
Provision for (benefit from) income taxes		321		(1,018	)		5			0			(692	)
Net income (loss)	$	2,681	$	(4,501	)	$	1,409		$	(1,456	)	$	(1,867	)
Other significant items:
Total assets	$	662,657	$	121,157		$	96,950		$	(221,808	)	$	658,956
Total investment securities		133,223		0			415			0			133,638
Total loans, net		441,456		112,892			0			(123,551	)		430,797
Goodwill		3,112		0			986			0			4,098
Investment in subsidiaries		1,777		63			82,996			(84,758	)		78
Fixed asset addition		10		39			18			0			67
Depreciation and amortization expense		182		46			3			0			231
Total interest income from external customers		9,351		5,724			8			0			15,083
Total interest income from affiliates		2,062		0			15			(2,077	)		0
For the nine months ended September 30, 2007:
Net interest income (expense)	$	19,100	$	11,756		$	(7	)	$	0		$	30,849
Provision for loan losses		705		16,985			0			0			17,690
Total non-interest income		3,405		364			2,744			(2,389	)		4,124
Total non-interest expense		12,226		6,732			902			(415	)		19,445
Income (loss) before income taxes		9,574		(11,597	)		1,835			(1,974	)		(2,162	)
Provision for (benefit from) income taxes		2,690		(3,311	)		16			0			(605	)
Net income (loss)	$	6,884	$	(8,286	)	$	1,819		$	(1,974	)	$	(1,557	)
Other significant items:
Fixed asset addition	$	149	$	154		$	35		$	0		$	338
Depreciation and amortization expense		552		124			8			0			684
Total interest income from external customers		27,316		18,091			19			0			45,426
Total interest income from affiliates		6,280		0			38			(6,318	)		0

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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. During the period ending September 30, 2008, no interest rate swaps were used.

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. Year-to-date 2008, $12,411 was reclassified into income. There was no remaining balance at September 30, 2008.

7. GUARANTEES, COMMITMENTS, AND CONTINGENCIES

On September 27, 2007, Malcomb Graves Automotive, LLC, Malcomb Graves, and Tina Graves (collectively, “Graves”) filed a lawsuit in the Circuit Court of Shelby County, Alabama against the Company, the Bank, ALC, and their respective directors and officers seeking an unspecified amount of compensatory and punitive damages. A former employee of ALC, Corey Mitchell, has been named as a co-defendant. The complaint alleges that the defendants committed fraud in allegedly misrepresenting to Graves the amounts Graves owed on certain loans and failing to credit Graves properly for certain loans. The defendants deny the allegations and intend to vigorously defend themselves in this action. The trial court denied the defendants’ motion to compel arbitration, and the defendants are in the process of appealing the trial court’s ruling to the Alabama Supreme Court. As a result, the defendants have not yet responded to the complaint, and no discovery has been exchanged between the parties. For these reasons, it is too early to assess the likelihood of a resolution of this matter or whether this matter will have a material adverse effect on the Company’s financial position or results of operations.

On April 1, 2008, E. Mark Ezell, Mark Ezell Family, LLC, Nena M. Morris, Mark Ezell Investment & Property Management, LLC, Patricia W. Ezell, J.W. Ezell, Ranier W. Ezell, and Bradley H. Ezell, all shareholders of the Company (collectively, the “Shareholder Plaintiffs”), filed a lawsuit in the Circuit Court of Choctaw County, Alabama against the Company, ALC, Robert Steen, and Mauldin & Jenkins, LLC seeking an unspecified amount of compensatory and punitive damages. On October 31, 2008, the Shareholder Plaintiffs amended the complaint to add Terry Phillips, President and Chief Executive Officer of the Company, as a co-defendant. The Shareholder Plaintiffs seek both direct and derivative relief and allege that the defendants committed fraud and various other breaches relating to loans made by ALC, resulting in damage to both the Shareholder Plaintiffs and the Company. The Company, the named officers, and ALC deny the allegations focused on them and intend to vigorously defend themselves in this action. The defendants are in the process of responding to the complaint, and no discovery has been exchanged between the parties. For these reasons, it is too early to assess the likelihood of a resolution of this matter or whether this matter will have a material adverse effect on the Company’s financial position or results of operations.

On April 29, 2008, the Company, the Bank and ALC (collectively, the “USB Companies”) filed a lawsuit in the Circuit Court of Clarke County, Alabama against McKean & Associates, P.A. (“McKean”) seeking an unspecified amount of compensatory and punitive damages. On May 13, 2008, the USB Companies filed an amended complaint adding Ernst & Young, LLP as a co-defendant in the lawsuit. The USB Companies filed an additional amended complaint on August 20, 2008 adding Mauldin & Jenkins, LLC as a co-defendant. The complaint, as amended, alleges that the defendants breached their contractual obligations to the USB Companies, the defendants breached their duty to exercise reasonable care in performing their audits on behalf of the USB Companies, and the defendants committed certain other torts relating to the audits of the USB Companies. McKean has filed a counterclaim against ALC seeking compensatory and an unspecified amount of punitive damages alleging that ALC has not paid McKean for certain services provided to ALC and that McKean has been defamed and suffered certain other injuries as a result of actions taken by ALC. The Company believes that this counterclaim is without merit and intends to vigorously defend itself against these allegations. The parties recently engaged in non-binding mediation, but no resolution of this matter was reached. The parties are now

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engaged in discovery. Because of the early nature of this litigation, it is too early to assess the likelihood of a resolution of this matter or whether this matter will have a material adverse effect on the Company’s financial position or results of operations.

The Bank was informed by letter dated September 30, 2008, that the U.S. Department of Justice (the “DOJ”) might initiate the filing of a complaint in the U.S. District Court for the Southern District of Alabama against the Bank alleging certain violations of the Fair Housing Act and the Equal Credit Opportunity Act. The Company believes that the Bank’s lending practices have complied with all applicable laws, and the Bank has been cooperating fully with the DOJ in this matter. It is too early to assess whether the resolution of this matter will have a material adverse effect on the Company’s financial position or results of operations.

The Company and its subsidiaries also are parties to other litigation, and the Company intends to vigorously defend itself in all such litigation. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such other litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations.

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 derivative financial instruments are held for risk management and not for trading purposes. During the period ending September 30, 2008, there were no derivative contracts outstanding.

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 (dollars in thousands):

	September 30, 2008		December 31, 2007
Standby Letters of Credit	$	1,575	$	620
Commitments to Extend Credit	$	56,718	$	47,275

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 that 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 September 30, 2008, is $1,575,092 and represents the Company’s total credit risk for such instruments.

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 customer. Collateral held varies but may include accounts receivable, inventory, property, plant, and 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 September 30, 2008, there were no outstanding commitments to purchase and sell securities for delayed delivery.

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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 United Security Bancshares, Inc. (the “Company”). The Company is the parent holding company of First United Security Bank (the “Bank”). The Bank operates a finance company, Acceptance Loan Company, Inc. (“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 Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

The emphasis of this discussion is a comparison of assets, liabilities, and shareholder’s equity as of September 30, 2008, to year-end 2007, while comparing income and expense for the three- and nine-month periods ended September 30, 2008 and 2007.

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 Operation appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007.

COMPARING THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2008, TO THE THREE- AND NINE-MONTH PERIODS ENDED SEPTEMBER 30, 2007

Net income during the third quarter of 2008 was $1.4 million, compared to a net loss of $1.9 million for the same period of 2007, resulting in an increase of basic net income (loss) per share from $(0.30) to $0.23. For the nine months, net income increased to $4.8 million, compared to a loss of $1.6 million in 2007, resulting in an increase of basic net income per share to $0.79. Annualized return on assets was 0.96% for the first nine months of 2008, compared to (1.10%) for the same period during 2007. Average return on shareholders’ equity increased to 8.10% for the first nine months of 2008, from (2.38%) during the first nine months of 2007. Net income for the quarter-to-date 2007 was reduced by $3.2 million, net of tax, and $8.8 million, net of tax, for the year-to-date 2007, due to losses resulting from the loan irregularities at ALC.

Interest income for the 2008 third quarter decreased $2.2 million, or 14.9%, compared to the third quarter of 2007. The decrease in interest income was primarily due to a decrease in interest earned on loans of $2.5 million, offset somewhat by a $0.3 million increase in interest earned on investment securities. This decrease in interest earned on loans is due to an overall decline in the average yield and volume of loans outstanding. The increase in interest earned on investment securities is due to an increase in the average volume of investment securities. For the 2008 nine-month period, interest income decreased $6.0 million, or 13.3%, over the same period last year. This decrease in interest income was primarily due to a decrease in interest earned on loans of $6.9 million, offset by a $0.9 million increase in interest earned on investment securities. The decrease in interest income on loans is due to both decreases in volume and yield. The increase in investment income was due to an increase in investment securities. Loan volume has declined, as loan demand in our market areas has been affected by the slowing economy. Investment securities have increased as loan volume has decreased.

Interest expense for the 2008 third quarter decreased $1.1 million, or 21.8%, compared to the third quarter of 2007. Interest expense decreased $1.5 million, or 10.5%, to $13.0 million for the first nine months of 2008, compared to $14.6 million for the first nine months of 2007. These decreases, quarter-to-date and year-to-date, were the result of decreased rates paid on interest bearing deposits, offset by increased volume of interest bearing deposits, primarily certificates of deposit, and decreased rates paid on borrowed funds, offset by an increase in borrowed funds.

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Net interest income decreased $1.1 million, or 11.4%, for the third quarter of 2008 and decreased $4.5 million, or 14.6%, for the first nine months of 2008, compared to the same periods in 2007, respectively. Asset yields have fallen faster than funding rates as prime adjustable loans have priced down much faster than certificates of deposit. The Federal Reserve lowered short-term interest rates by 2.00% in the first quarter of 2008 and by 0.25% in the second quarter. As interest rates stabilized, we were able to reprice maturing certificates of deposit, and our third quarter net interest margin has improved over the first and second quarter of 2008.

The provision for loan losses was $1.9 million, or 1.9% annualized of average loans, in the third quarter of 2008, compared to $6.8 million, or 6.1% annualized of average loans, in the third quarter of 2007. The provision for loan losses decreased to $5.5 million year-to-date 2008, or 1.7% annualized of average loans, compared to $17.7 million, or 5.2% annualized of average loans, in 2007. $9.1 million of the provision for loan losses in 2007 was related to losses identified in the investigation of loan irregularities at ALC. Charge-offs exceeded recoveries by $6.1 million for the 2008 nine-month period, a decrease of approximately $7.6 million over the same period in the prior year.

Total non-interest income increased $10,000, or 0.7%, for the third quarter of 2008, and $0.5 million, or 10.9%, for the first nine months of 2008. Service charges and fees on deposit accounts decreased $14,000 quarter-to-date and increased $27,000 year-to-date 2008, compared to the same periods in 2007. Income on bank-owned life insurance increased $5,000 quarter-to-date and $18,000 year-to-date 2008, compared to the same periods in 2007. Commissions on credit insurance increased $109,000 quarter-to-date and $114,000 year-to-date. Letters of credit and commitment fees decreased $500 quarter-to-date and increased $5,000 year-to-date. All other fees and charges decreased $89,000 quarter-to-date and increased $287,000 year-to-date, compared to the same periods in 2007. Net gains from the sale of other real estate owned amounted to $233,000 year-to-date 2008 and is included in other income. During the third quarter of 2008 the Company recognized an other-than-temporary impairment charge of $468,000, related to the investment in 12,000 shares of Freddie Mac preferred stock. This impairment charge is included in net loss on the sale of investment securities of $128,000 year-to-date, and is included in other income.

Total non-interest expense decreased $0.9 million, or 12.1%, quarter-to-date and decreased $0.9 million, or 4.7%, year-to-date 2008, compared to the same periods in 2007. Salary and employee benefits increased $84,000 when comparing the third quarter 2008 to 2007 and decreased $0.6 million year-to-date 2008, compared to the same period in 2007. The decrease year-to-date is due primarily to reduced incentive accruals. The increase quarter-to-date is the result of salary and benefits associated with two new executive officers hired in April and July of 2008. For the three months ending September 30, 2008, advertising expense increased $1,000, legal and professional fees increased $21,000, telephone and data circuit expense decreased $123,000, and impairment losses on limited partnerships increased $82,000, compared to the same quarter in 2007. On a year-to-date basis, advertising expense increased $61,000, legal and professional fees increased $264,000, telephone and data circuit expense decreased $78,000, and impairment losses on limited partnerships increased $42,000, compared to the same period in 2007.

Income tax expense for the third quarter of 2008 was $655,000, compared to a tax benefit of $692,000 in 2007. Income tax expense for the first nine months of 2008 was $2.2 million, compared to a tax benefit of $605,000 in 2007. For both the three-month and nine-month periods in 2007, the tax benefits were based on taxable losses while 2008 expense is based on taxable income. Management estimates the effective tax rate for the Company to be approximately 31% of pre-tax income for the year ending December 31, 2008.

COMPARING THE SEPTEMBER 30, 2008, STATEMENT OF FINANCIAL CONDITION TO DECEMBER 31, 2007

In comparing financial condition at December 31, 2007 to September 30, 2008, total assets increased $10.3 million to $670.2 million, while liabilities increased $11.9 million to $592.3 million. Shareholders’ equity decreased $1.6 million due to dividends paid of $4.9 million, net income of $4.8 million, treasury stock increase of $1.0 million, offset by a decrease in other comprehensive income of $0.3 million during the first nine months of 2008.

Investment securities increased $28.0 million, or 19.3%, during the first nine months of 2008. Investments provide the Company with a stable form of liquidity while maximizing earnings yield. Loans, net of unearned income, decreased $28.7 million, from $436.1 million at December 31, 2007, to $407.4 million at September 30, 2008, as a result of a slowdown in the overall economy, especially in construction and real estate development, in the trade areas served by the Company. Deposits increased $9.7 million, or 2.0%, during the first nine months of 2008.

CREDIT QUALITY

At September 30, 2008, the allowance for loan losses was $7.9 million, or 1.9% of loans net of unearned income, compared to $11.6 million, or 2.6% of loans net of unearned income, at September 30, 2007, and $8.5 million, or 2.0% of loans net of unearned income, at December 31, 2007. The coverage ratio of the allowance for loan losses to

17

non-performing assets decreased to 24.9% at September 30, 2008, compared to 39.4% at December 31, 2007, due to increases in loans on non-accrual and other real estate owned, offset by a small decrease in loans past due 90 days or more.

Activity in the allowance for loan losses is summarized as follows (dollars in thousands):

	Nine Months Ended September 30,
	2008			2007
Balance at Beginning of Period	$	8,535		$	7,664
Charge-Offs		(7,577	)		(14,536	)
Recoveries		1,491			812
Net Loans Charged-Off		(6,086	)		(13,724	)
Additions Charged to Operations		5,467			17,690
Balance at End of Period	$	7,916		$	11,630

Net charge-offs for the nine months ended September 30, 2008 were $6.1 million, or 1.9% of average loans on an annualized basis, a decrease of 55.7%, or $7.6 million, from the net charge-offs of $13.7 million, or 4.0% of average loans on an annualized basis, reported a year earlier. Net charge-offs at the Bank were $1.3 million as of September 30, 2008, and $0.6 million as of September 30, 2007. ALC had net charge-offs at September 30, 2008 of $4.8 million and $13.1 million at September 30, 2007. The provision for loan losses for the first nine months of 2008 was $5.5 million, compared to $17.7 million in the first nine months of 2007. The large net charge-offs and the provision for loan losses in 2007 are both attributable to losses identified in the investigation of loan irregularities at ALC.

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. 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.

Non-performing assets were as follows (dollars in thousands):

	September 30, 2008			December 31, 2007			September 30, 2007
Loans Accounted for on a Non-Accrual Basis	$	10,442		$	5,253		$	4,795
Accruing Loans Past Due 90 Days or More		4,215			5,240			8,096
Real Estate Acquired in Settlement of Loans		17,126			11,156			9,551
Total	$	31,783		$	21,649		$	22,442
Non-Performing Assets as a Percentage of Net Loans and Other Real Estate		7.49	%		4.84	%		4.97	%

Non-performing assets as a percentage of net loans and other real estate was 7.5% at September 30, 2008, compared to 4.8% at December 31, 2007. This increase is due to a $5.2 million increase in loans on non-accrual, a $1.0 million decrease in accruing loans past due 90 days or more, and a $6.0 million increase in real estate acquired in settlement of loans. Loans on non-accrual increased as a result of placing 10 commercial real estate loans totaling $11.2 million on non-accrual status, offset by transferring 3 loans totaling $4.5 million to real estate acquired in settlement of loans. Approximately $6.0 million of these loans were identified at year-end 2007 as impaired but were not on non-accrual status. Other real estate acquired in settlement of loans as of September 30, 2008 consists of 26 residential properties and 13 commercial properties totaling $11.6 million at the Bank and 119 residential

18

properties and 1 commercial property totaling $5.5 million at ALC. Management is making considerable efforts to dispose of these properties in a timely manner, but the slowdown in the housing market will continue to have a negative impact on these sales. Management has been aggressive in identifying problem loans and will continue to monitor the loan portfolio for any signs of deterioration, especially in the real estate portfolio. Management believes by closely monitoring these non-performing loans, through aggressive collection efforts, non-performing assets can be reduced. Management reviews these loans and reports to the Board of Directors monthly. Loans past due 90 days or more and still accruing interest are reviewed closely by management and are allowed to continue accruing only when underlying collateral values and management’s belief in the financial strength of the borrowers are sufficient to protect the Company from loss. If at any time management determines there may be a loss of interest or principal, these loans will be placed on non-accrual status and their asset value downgraded.

Impaired loans totaled $17.9 million, $15.7 million, and $10.6 million as of September 30, 2008, December 31, 2007, and September 30, 2007, respectively. In the first nine months of 2008, impaired loans increased $2.2 million due to the following: $5.7 million was transferred to other real estate owned, $0.7 million was charged off, $9.6 million was added, and $1.0 million was upgraded or paid. There was approximately $1.2 million and $1.6 million in the allowance for loan losses specifically allocated to these impaired loans at September 30, 2008 and December 31, 2007, 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 $110.7 million in borrowing capacity from the Federal Home Loan Bank and $10 million in established federal fund lines.

The Bank is required to maintain certain levels of regulatory capital. At September 30, 2008 and December 31, 2007, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under regulatory framework for proper corrective action.

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. See Note 7 to Item 1, “Guarantees, Commitments, and Contingencies,” for a discussion of such claims and legal actions.

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 that 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 $204.8 million at December 31, 2007 and $181.1 million at September 30, 2008.

Investment securities that are forecast to mature or reprice over the next twelve months total $2.0 million, or 1.2% of the investment portfolio as of September 30, 2008. For comparison, principal payments on investment securities totaled $29.2 million at September 30, 2008.

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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 September 30, 2008, the bond portfolio had an expected average maturity of 3.7 years, and approximately 67.0% of the $172.0 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.

The Bank, at September 30, 2008, had long-term debt and short-term borrowings that, on average, represented 13.7% of total liabilities and equity, compared to 12.3% at year-end 2007.

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.

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains disclosure controls and procedures designed to provide reasonable assurance of achieving the objective that information in its reports filed with the Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized, and reported within the time periods specified and pursuant to the requirements of the SEC’s rules and forms. Disclosure controls and procedures (as defined in Rules 13a-15(e) under the Exchange Act) include controls and procedures designed to ensure that information required to be disclosed by the Company in the reports filed or submitted under the Exchange Act is accumulated and communicated to the Company’s management, including the Chief Executive Officer and Principal Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. It should be noted that any system of controls, however well designed and operated, can provide only reasonable, and

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not absolute, assurance that the objectives of the system are met.

As of September 30, 2008, 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 Exchange Act). 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 SEC 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 Exchange Act) during the quarter ended September 30, 2008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

See Note 7 to Item 1, “Guarantees, Commitments, and Contingencies,” for information regarding certain litigation matters relating to the Company and its subsidiaries.

The Company and its subsidiaries also are parties to litigation other than as described in Note 7 to Item 1, and the Company intends to vigorously defend itself in all such litigation. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations.

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 our Annual Report on Form 10-K for the year ended December 31, 2007, which could materially affect our business, financial condition, or future results. The risks described in our 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 our business, financial condition, and/or operating results.

The following update to our risk factors should be read in conjunction with the risk factors included in our Annual Report on Form 10-K for the year ended December 31, 2007:

Difficult conditions in the financial services markets may materially and adversely affect the business and results of operations of the Bank and the Company.

Dramatic declines in the housing market during the past year, along with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions, and, in some cases, to fail. Many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility, and widespread reduction of business activity generally, which could have a material adverse effect on our business and operations. A worsening of these conditions would likely exacerbate any adverse effects of these difficult market conditions on us and others in the financial institutions industry.

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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 Shares Purchased as Part of Publicly Announced Programs(1)	Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Programs(1)
July 1 – July 31	6,296	(2)	$	14.58	(2)	6,056	256,060
August 1 – August 31	1,356		$	13.99		1,356	254,704
September 1 – September 30	4,099		$	16.20		4,099	250,605
Total	11,751		$	15.08		11,511	250,605

(1) On December 20, 2007, the Board of Directors extended the share repurchase program previously approved by the Board on January 19, 2006. Under the repurchase program, the Company is authorized to repurchase up to 642,785 shares of common stock before December 31, 2008, the expiration date of the extended repurchase program.

(2) 240 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 6,056 shares were purchased under the share repurchase program.

ITEM 6. EXHIBITS

The exhibits listed in the Index to Exhibits below are filed herewith and are incorporated herein by reference.

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SIGNATURES

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: November 7, 2008

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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