<LETTER> March 29, 2000 FILED VIA EDGAR Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: United Security Bancshares, Inc. Annual Report on Form 10-K (File No., 01-14549) On behalf of our client, United Security Bancshares, Inc., we are filing the above-referenced Form 10-K via the EDGAR system. Please do not hesitate to contact the undersigned if you have any questions or comments. Very truly yours, /s/ J. Michael Savage ______________________ J. Michael Savage JMS/mrm Enclosures cc: R. Terry Phillips Larry M. Sellers C. Matthew Lusco James M. Pool </LETTER> <LETTER> United Security Bancshares, Inc. 131 West Front Street P.O. Box 249 Thomasville, Alabama 36784 334-636-5424 March 16, 2000 FILED VIA EDGAR Securities and Exchange Commission 450 Fifth Street, NW Washington, D.C. 20549 Gentlemen: Management of United Security Bancshares, Inc. hereby informs the Securities and Exchange Commission that the financial statements in its Annual Report on Form 10-K for the year ended December 31, 1999, transmitted herewith, do not reflect a change from the preceding year in any accounting principles or practices or in the method of applying any such principles or practices. UNITED SECURITY BANCSHARES, INC. /s/ R. Terry Phillips _____________________ By: R. Terry Phillips Its: President & CEO </LETTER> UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission File Number 0-14549 UNITED SECURITY BANCSHARES, INC. _____________________________________________________ (Exact name of registrant as specified in its charter) Alabama 63-0843362 _______________________________ __________________ (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 131 West Front Street Post Office Box 249 Thomasville, Alabama 36784 ________________________________________ __________ (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (334) 636-5424 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ___________________ __________________________________________ None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $0.01 per share (Title of class) 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ Shares of common stock ($0.01 par value) outstanding as of December 31, 1999: 3,568,081. The aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the sales price of shares sold in a private transaction on January 25, 2000, is $26.00. There is no established public trading market for the Registrant's voting stock. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's definitive proxy statement for the 2000 annual meeting of its shareholders are incorporated by reference into Part III. UNITED SECURITY BANCSHARES, INC. ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 TABLE OF CONTENTS Sequential Part Item Caption Page No. I 1 Business 3 2 Properties 8 3 Legal Proceedings 9 4 Submission of Matters to a Vote of Security Holders 9 II 5 Market for Registrant's Common Equity and Related Stockholder Matters 9 6 Selected Financial Data 11 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 12 7A Quantitative and Qualitative Disclosures About Market Risk 37 8 Financial Statements and Supplementary Data 38 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 69 III 10 Directors and Executive Officers of the Registrant 70 11 Executive Compensation 70 12 Security Ownership of Certain Beneficial Owners and Management 70 13 Certain Relationships and Related Transactions 70 IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K 71 Signatures 72 Exhibits 74 PART I Item 1. Business. General United Security Bancshares, Inc. ("Bancshares") is a Delaware corporation organized in 1999, as a successor by merger to United Security Bancshares, Inc., an Alabama corporation. Bancshares is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and it operates one banking subsidiary, First United Security Bank (the "Bank"). The Bank's name was changed from United Security Bank to First United Security Bank on July 9, 1997. The Bank owns all of the stock of Acceptance Loan Company, Inc. ("ALC"), a finance company organized for the purpose of making consumer loans and purchasing consumer loans from vendors. Bancshares owns all the stock of First Security Courier Corporation ("First Security"), an Alabama corporation organized for the purpose of providing certain bank courier services. The Bank has eighteen banking offices, which are located in Thomasville, Coffeeville, Fulton, Gilbertown, Grove Hill, Butler, Jackson, Brent, Centreville, North Bibb, Bucksville and Harpersville, Alabama, and its market area includes portions of Bibb, Clarke, Choctaw, Jefferson, Marengo, Shelby, Sumter, Tuscaloosa, Washington, and Wilcox Counties in Alabama, as well as Clarke, Lauderdale and Wayne Counties in Mississippi. The Bank conducts a general commercial banking business and offers banking services such as the receipt of demand, savings and time deposits, personal and commercial loans, credit card and safe deposit box services, and the purchase and sale of government securities. As of December 31, 1999, the Bank had 189 full-time equivalent employees, ALC had 126 full-time equivalent employees, and Bancshares had no employees, other than the officers of Bancshares who are indicated in Part III, Item 10 of this report. The Bank is in the process of completing the organization of a wholly-owned subsidiary in the State of Arizona. The subsidiary, FUSB Reinsurance, Inc. ("FUSB Reinsurance"), will reinsure or "underwrite" credit life and credit accident and health insurance policies sold to the Bank's consumer loan customers. FUSB Reinsurance will be responsible for the first level of risk on these policies up to a specified maximum amount, and the primary third-party insurer will retain the remaining risk. The third-party insurer and/or a third-party administrator will be responsible for performing most of the administrative functions of FUSB Reinsurance on a contact basis. Competition The Bank encounters strong competition in making loans, acquiring deposits and attracting customers for investment services. Competition among financial institutions is based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the services rendered, the convenience of banking facilities and, in the case of loans to commercial borrowers, relative lending limits. The Bank competes with other commercial banks (including at least 10 in its service area), savings and loan associations, credit unions, finance companies, mutual funds, insurance companies, brokerage and investment banking companies, and other financial intermediaries operating in Alabama and elsewhere. Many of these competitors, some of which are affiliated with large bank holding companies, have substantially greater resources and lending limits. In addition, many of the Bank's non-bank competitors are not subject to the same extensive federal regulations that govern bank holding companies and federally-insured banks. On November 12, 1999, President Clinton signed into law the Gramm-Leach-Bliley Act (the "GLB Act"). Effective March 11, 2000, the GLB Act permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. See "Supervision and Regulation." Under the GLB Act, securities firms and insurance companies that elect to become financial holding companies may acquire banks and other financial institutions. The GLB Act, which represents the most sweeping reform of financial services regulation in over sixty years, may significantly change the competitive environment in which Bancshares and the Bank conduct business. At this time, however, it is not possible to predict the full effect that the GLB Act will have on Bancshares. One consequence may be increased competition from large financial services companies that will be permitted to provide many types of financial services, including bank products, to their customers. The financial services industry is also likely to become more competitive as further technological advances enable more companies to provide financial services. These technological advances may diminish the importance of depository institutions and other financial intermediaries in the transfer of funds between parties. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") authorized bank holding companies to acquire banks and other bank holding companies without geographic limitations beginning September 30, 1995. The arrival of interstate banking is expected to increase further the competitiveness of the banking industry. In addition, beginning on June 1, 1997, the IBBEA authorized interstate mergers and consolidations of existing banks, provided that neither bank's home state had opted out of interstate branching by May 31, 1997. The State of Alabama opted in with respect to interstate branching. Once a bank has established branches in a state through an interstate merger, the bank may establish and acquire additional branches at any location in the state where any bank involved in the interstate merger could have established or acquired branches under applicable federal or state law. Under the IBBEA, Alabama banks may also establish branches or offices in any other state, any territory of the United States or any foreign country, provided that the branch or office is established in compliance with federal law and the law of the proposed location and is approved by the Alabama Superintendent of Banks. Under former law, Alabama banks could not establish a branch in any location other than its principal place of business, except as authorized by local laws or general laws of local application. These more liberal branching laws are likely to increase competition within the State of Alabama among banking institutions located in Alabama and from those located outside of Alabama, many of which are larger than Bancshares. Size gives the larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services in other areas of Alabama and the southeast region. Supervision and Regulation Bancshares and the Bank are subject to state and federal banking laws and regulations which impose specific requirements and restrictions on, and provide for general regulatory oversight with respect to, virtually all aspects of operations. These laws and regulations are generally intended to protect depositors, not stockholders. To the extent that the following summary describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory and regulatory provisions. Any change in applicable laws or regulations may have a material effect on the business and prospects of Bancshares. Beginning with the enactment of the Financial Institutions Reform, Recovery and Enforcement Act of 1989 and following in December 1991 with the Federal Deposit Insurance Corporation Act ("FDICIA"), numerous additional regulatory requirements have been placed on the banking industry in the past ten years, and additional changes have been proposed. The operations of Bancshares and the Bank may be affected by legislative changes and the policies of various regulatory authorities. Bancshares is unable to predict the nature or the extent of the effect on its business and earnings that fiscal or monetary policies, economic control or new federal or state legislation may have in the future. As a bank holding company, Bancshares is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (the "Board of Governors"). Bancshares is required to file with the Board of Governors an annual report and such additional information as the Board of Governors may require. The Board of Governors may also conduct examinations of Bancshares and each of its subsidiaries. The Bank Holding Company Act imposes numerous restrictions on Bancshares. In particular, the Act requires a bank holding company to obtain the prior approval of the Board of Governors before it may acquire substantially all of the assets of any bank or control of any voting shares of any bank, if, after such acquisition, it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. The Board of Governors may not approve an acquisition by Bancshares of substantially all the assets or the voting shares of any bank located outside Alabama unless such acquisition is specifically authorized by the laws of the state in which the bank to be acquired is located. The GLB Act permits bank holding companies to become financial holding companies and thereby affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. A bank holding company may become a financial holding company by filing a declaration if each of its subsidiary banks is well capitalized under the FDICIA prompt corrective action provisions, is well managed, and has at least a satisfactory rating under the Community Reinvestment Act ("CRA"). No regulatory approval will be required for a financial holding company to acquire a company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Board of Governors. The GLB Act defines "financial in nature" to include securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting and agency; and activities that the Board of Governors has determined to be closely related to banking. A national bank also may engage, subject to limitations on investment, in activities that are financial in nature (other than insurance underwriting, insurance company portfolio investment, merchant banking, real estate development and real estate investment) through a financial subsidiary of the bank, if the bank is well capitalized, well managed and has at least a satisfactory CRA rating. Subsidiary banks of a financial holding company or national banks with financial subsidiaries must continue to be well capitalized and well managed in order to continue to engage in activities that are financial in nature without regulatory actions or restrictions, which could include divestiture of the financial subsidiary or subsidiaries. In addition, a financial holding company or a bank may not acquire a company that is engaged in activities that are financial in nature unless each of the subsidiary banks of the financial holding company or the bank at issue has a CRA rating of satisfactory or better. The GLB Act preserves the role of the Board of Governors as the umbrella supervisor for holding companies while at the same time incorporating a system of functional regulation designed to take advantage of the strengths of the various federal and state regulators. In particular, the GLB Act replaces the broad exemption from Securities and Exchange Commission regulation that banks previously enjoyed with more limited exemptions, and it reaffirms that states are the regulators for the insurance activities of all persons, including federally-chartered banks. Subsidiary banks of a bank holding company are subject to certain restrictions on extensions of credit to the bank holding company or any of its non-bank subsidiaries, on investments in the stock or other securities thereof, and on the acceptance of such stocks or securities as collateral for loans to any borrower. Among other requirements, transactions between a bank and its affiliates must be on an arm's-length basis. The Bank is subject to extensive supervision and regulation by the Alabama State Banking Department and the Federal Deposit Insurance Corporation (the "FDIC"). Among other things, these agencies have the authority to prohibit the Bank from engaging in any activity (such as paying dividends) that, in the opinion of the agency, would constitute an unsafe or unsound practice. The Bank is also subject to various requirements and restrictions under federal and state law. Areas subject to regulation include dividend payments, reserves, investments, loans (including loans to insiders and significant shareholders), mergers, issuance of securities, establishment of branches and other aspects of operation, including compliance with truth-in-lending laws, usury laws and other consumer protection laws. The recently enacted GLB Act establishes minimum federal standards of financial privacy pursuant to which financial institutions will be required to institute written privacy policies that must be disclosed to customers at certain required intervals. In addition to the impact of regulation, commercial banks are affected significantly by the actions of the Board of Governors as it attempts to control the money supply and credit availability in order to influence the economy. There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance fund in the event the depository institution becomes in danger of default or is in default. For example, under a policy of the Board of Governors with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and commit resources to support such institutions in circumstances where it might not do so absent such policy. In addition, the "cross-guarantee" provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated as a result of the default of a commonly controlled insured depository institution or for any assistance provided by the FDIC to a commonly controlled insured depository institution in danger of default. Although the FDIC's claim is junior to the claims of non-affiliated depositors, holders of secured liabilities, general creditors, and subordinated creditors, it is superior to the claims of shareholders. The federal banking agencies have broad powers under current federal law to take prompt corrective action to resolve problems of insured depository institutions. The extent of these powers depends upon whether the institutions in question are "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" or"critically undercapitalized" as such terms are defined under regulations issued by the federal banking agencies. In general, the agencies measure capital adequacy within a framework that makes capital requirements sensitive to the risk profiles of individual banking companies. The guidelines define capital as either Tier 1 (primarily common shareholders' equity) or Tier 2 (certain debt instruments and a portion of the allowance for loan losses). Bancshares and the Bank are subject to a minimum Tier 1 capital ratio (Tier 1 capital to risk-weighted assets) of 4%, total capital ratio (Tier 1 plus Tier 2 to risk-weighted assets) of 8% and Tier 1 leverage ratio (Tier 1 to average quarterly assets) of 3%. To be considered a "well capitalized" institution, the Tier 1 capital ratio, the total capital ratio, and the Tier 1 leverage ratio must equal or exceed 6%, 10% and 5%, respectively. The CRA requires that, in connection with examinations of a financial institution such as the Bank, the FDIC must evaluate the record of the financial institution in meeting the credit needs of its local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community. These factors are considered in evaluating mergers, acquisitions and applications to open a branch or facility. The CRA also requires all institutions to make public disclosure of their CRA ratings. The Bank received a satisfactory rating in its most recent evaluation. From time to time, various bills are introduced in the United States Congress with respect to the regulation of financial institutions. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. Bancshares cannot predict whether any of these proposals will be adopted or, if adopted, how these proposals would affect Bancshares. FDIC regulations require that management report on its responsibility for preparing its institution's financial statements and for establishing and maintaining an internal control structure and procedures for financial reporting and compliance with designated laws and regulations concerning safety and soundness. Supervision, regulation and examination of banks by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of Bancshares common stock. Statistical Information Statistical information concerning the business of Bancshares is set forth in Part II of this report. Item 2. Properties. Bancshares owns no property and does not expect to own any. The business of Bancshares is conducted from the offices of the Bank. With the exception of leasing a small facility in Centreville, the Bank owns all of its offices in fee without encumbrances. ALC leases office space throughout Alabama but owns no property. The aggregate annual rental payments for office space for ALC total approximately $338,340. Item 3. Legal Proceedings. Bancshares and the Bank, because of the nature of their businesses, are subject at various times to numerous legal actions, threatened or pending. In the opinion of Bancshares, based on review and consultation with legal counsel, the outcome of any litigation presently pending against Bancshares or the Bank will not have a material effect on Bancshares' consolidated financial statements or results of operations. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. There were 3,634,431 shares of Bancshares common stock issued and 3,570,431 shares outstanding as of March 8, 2000. As of March 8, 2000, there were approximately 1016 shareholders of Bancshares. The Bank is authorized by its Articles of Incorporation to issue 25,000 shares of common stock, par value $1.00 per share, all of which are outstanding. Bancshares is the only shareholder of the Bank. There is no established public trading market for Bancshares common stock. Management of Bancshares is aware that from time to time Bancshares common stock is bought or sold in private transactions or in transactions directly with a securities broker-dealer making a limited market in Bancshares' common stock. Management of Bancshares is aware of approximately 50 sales of Bancshares common stock since January 1, 1999 at prices ranging from $26.00 to $42.00 per share. Bancshares has paid dividends on its common stock on a quarterly basis in the past three years as follows: Dividend paid on Common Stock Fiscal Year (per share) ___________ _______________ 1997 $.58 1998 $.72 1999 $.82 As a holding company, Bancshares, except under extraordinary circumstances, will not generate earnings of its own, but will rely solely on dividends paid to it by the Bank as the source of income to meet its expenses and pay dividends. Under normal circumstances, Bancshares' ability to pay dividends will depend entirely on the ability of the Bank to pay dividends to Bancshares. The Bank is a state banking corporation, and the payment of dividends by the Bank is governed by the Alabama Banking Code. The restrictions upon payment or dividends imposed by the Alabama Banking Code are described in Part II, Item 5 of Bancshares' Annual Report on Form 10-K for the year ended December 31, 1984, (file no. 0-14549) and such description is incorporated herein by reference. Item 6. Selected Financial Information. UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES SELECTED FINANCIAL INFORMATION Year Ended December 31, ____________________________________________________________ 1999 1998 1997 1996 1995 ________ _________ ________ ________ ________ (In Thousands of Dollars, Except Per Share Amounts) RESULTS OF OPERATIONS Interest Revenue $ 44,919 $ 43,255 $ 37,648 $ 34,551 $ 30,571 Interest Expense 15,365 15,518 15,376 15,081 13,298 ________ ________ ________ ________ ________ Net Interest Revenue 29,554 27,737 22,272 19,470 17,273 Provision for Loan Losses 4,305 3,187 1,710 800 255 Non-Interest Revenue 4,747 4,558 4,361 2,725 2,555 Non-Interest Expense 18,534 17,008 15,229 11,765 10,898 ________ ________ ________ _______ ________ Income Before Income Taxes 11,462 12,100 9,694 9,630 8,675 Income Taxes 3,302 3,521 2,713 2,659 2,225 ________ ________ ________ _______ ________ Net Income $ 8,160 $ 8,579 $ 6,981 $ 6,971 $ 6,450 ________ ________ ________ _______ ________ ________ ________ _______ Net Income Per Share: Basic $ 2.29 $ 2.42 $ 1.97 $ 1.97 $ 1.83 Diluted $ 2.28 $ 2.40 $ 1.96 $ 1.97 $ 1.83 Average Number of Shares Outstanding (000) 3,561 3,543 3,537 3,537 3,520 PERIOD END STATEMENT OF CONDITION Total Assets $476,599 $450,073 $425,941 $430,383 $377,120 Loans 276,172 235,060 215,897 204,886 182,000 Deposits 326,751 326,645 322,418 346,306 304,381 Shareholders' Equity 61,671 60,568 52,711 47,616 41,795 AVERAGE BALANCES Total Assets $459,922 $439,080 $434,010 $410,541 $364,330 Average Earning Assets 424,074 408,506 402,271 382,458 337,921 Loans 256,192 231,792 212,570 198,327 172,146 Deposits 328,263 320,958 345,442 327,531 294,063 Shareholders' Equity 61,140 57,409 50,164 44,044 37,588 PERFORMANCE RATIOS Net Income to: Average Total Assets 1.77% 1.95% 1.61% 1.70% 1.77% Average Shareholders' Equity 13.35% 14.94% 13.92% 15.83% 17.16% Average Shareholders' Equity to Average Total Assets 13.29% 13.07% 11.55% 10.73% 10.32% Dividend Payout Ratio 36.67% 31.40% 26.79% 20.21% 18.12% Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Management's Discussion and Analysis of Financial Condition and Results of Operations Introduction The following discussion and financial information are presented to aid in an understanding of the current financial position and results of operations of Bancshares, Inc. ("United Security"), and should be read in conjunction with the Audited Financial Statements and Notes thereto included herein. The emphasis of this discussion will be on the years 1999, 1998, and 1997. All yields presented and discussed herein are based on the accrual basis and not on the tax-equivalent basis. On June 30, 1997, First Bancshares, the parent holding company of First Bank and Trust, merged with and into United Security. The merger was accounted for as a pooling of interests, and, accordingly, financial information for all prior periods has been restated to present the combined financial condition and results of operations of both companies as if the merger had been in effect for all periods presented. United Security is the parent holding company of First United Security Bank (the "Bank"). The Bank operates a finance company, Acceptance Loan Company, that currently has thirty-three offices in Alabama, Northwest Florida, and Southeast Mississippi. United Security also began a courier company as a subsidiary, First Security Courier Corporation, in 1997 mainly for the purpose of delivering checks and documents to the Federal Reserve to aid in check clearing. This courier company performs courier services for First United Security Bank as well as other companies in our market area. At December 31, 1999, United Security had consolidated assets of approximately $476.6 million and operated eighteen banking locations in five counties. These eighteen locations contributed approximately $7.9 million to consolidated net income in 1999. First United Security Bank's sole business is banking; therefore, loans and investments are its principal source of income. This discussion contains certain forward looking statements with respect to the financial condition, results of operation and business of United Security and the Bank related to, among other things: (A) trends or uncertainties which will impact future operating results, liquidity and capital resources, and the relationship between those trends or uncertainties and nonperforming loans and other loans; (B) the diversification of product production among timber related entities and the effect of that diversification on the Bank's concentration of loans to timber related entities; (C) the composition of United Security's derivative securities portfolio and its interest rate hedging strategies and volatility caused by uncertainty over the economy, inflation and future interest rate trends; (D) the effect of the market's perception of future inflation and real returns and the monetary policies of the Federal Reserve Board on short and long term interest rates; (E) the effect of interest rate changes on liquidity and interest rate sensitivity management; (F) the amount of anticipated (i) net loan charge offs; (ii) loans on a non-accrual basis; and (iii) options income and other off-balance-sheet income; and (G) the expectations, beliefs, and plans of Management as set forth in the letter to shareholders contained in this Annual Report. These forward looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among other possibilities: (1) the perceived diversification in product production within the timber industry fails to protect the Bank from its concentration of loans to the timber industry as a result of, for example, the emergence of technological developments or market difficulties that affect the timber industry as a whole; (2) periods of lower interest rates continue to accelerate the rate at which the underlying obligations of mortgage-backed securities and collateralized mortgage obligations are prepaid, thereby affecting the yield on such securities held by the Bank; (3) inflation grows at a greater-than-expected rate with a material adverse effect on interest rate spreads and the assumptions management of United Security has used in its interest rate hedging strategies and interest rate sensitivity gap strategies; (4) rising interest rates adversely affect the demand for consumer credit; and (5) general economic conditions, either nationally or in Alabama, are less favorable than expected. Financial Condition United Security's financial condition depends primarily on the quality and nature of the Bank's assets, liabilities, capital structure, the quality of its personnel, and prevailing market and economic conditions. The majority of the assets and liabilities of a financial institution are monetary and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets and inventories. Inflation has an important impact on the growth of total assets in the banking industry, resulting in the need to increase equity capital at rates greater than the applicable inflation rate in order to maintain an appropriate equity to asset ratio. Also, the category of other expenses tends to rise during periods of general inflation. In conjunction with the First Bancshares merger on June 30, 1997, First United Security Bank sold the deposits, branch facility and associated assets of its branch office in Grove Hill effective November 1, 1997 as directed by the United States Department of Justice as a requirement for the merger approval. This divestiture reduced deposits by approximately $9.8 million. The Bank owns all of the stock of Acceptance Loan Company, Inc. ("ALC"), an Alabama Corporation. ALC is a finance company organized for the purpose of making consumer loans. The Bank is ALC's only source of funds and ALC's funding makes up approximately $76 million of the Bank's loans. Management believes the most significant factor in producing quality financial results is the Bank's ability to react properly and timely to changes in interest rates. Management is, therefore, attempting to maintain a more balanced position between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations. The following table reflects the distribution of average assets, liabilities, and shareholders' equity for each of the three years ended December 31, 1999, 1998, and 1997. Distribution of Assets, Liabilities, and Shareholders' Equity, with Interest Rates and Interest Differentials December 31, _______________________________________________________________________________________________________ 1999 1998 1997 _______________________________ ________________________________ _______________________________ Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate % Balance Interest Rate % Balance Interest Rate % ________ ________ ______ ________ ________ ______ ________ ________ ______ (In Thousands of Dollars, Except Percentages) ASSETS Interest-Earning Assets: Loans (Note A) $256,192 $33,776 13.18% $231,792 $29,397 12.68% $212,570 $22,964 10.80% Taxable Investments (Note B) 140,387 9,498 6.77% 150,678 12,292 8.16% 161,125 12,854 7.98% Non-Taxable Investments 25,029 1,528 6.10% 24,206 1,469 6.07% 26,704 1,736 6.50% Federal Funds Sold 2,466 117 4.74% 1,830 97 5.30% 1,872 95 5.07% ________ _______ ______ Total Interest-Earning Assets 424,074 44,919 10.59% 408,506 43,255 10.59% 402,271 37,649 9.36% ________ _______ _____ ________ _______ _____ ________ _______ _____ Non-Interest Earning Assets: Other Assets 35,848 30,574 31,739 ________ ________ ________ Total $459,922 $439,080 $434,010 ________ ________ ________ ________ ________ ________ LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Demand Deposits $ 59,885 $ 1,225 2.05% $ 59,794 $ 1,387 2.32% $ 64,607 $ 1,644 2.54% Savings Deposits 39,896 1,026 2.57% 41,728 1,137 2.72% 43,797 1,218 2.78% Time Deposits 188,170 9,932 5.28% 180,128 9,971 5.44% 193,738 10,413 5.37% Other Liabilities 62,700 3,182 5.07% 54,383 3,023 5.56% 34,605 2,101 6.07% ________ _______ _____ ________ _______ _____ ________ _______ _____ Total Interest-Bearing Liabilities 350,651 15,365 4.38% 336,033 15,518 4.62% 336,747 $15,376 4.57% Non-Interest Bearing Liabilities: Demand Deposits $ 40,312 $ 39,308 $ 43,300 Other Liabilities 7,819 6,330 3,799 Shareholders' Equity 61,140 57,409 50,164 ________ ________ ________ Total $459,922 $439,080 $434,010 ________ ________ ________ ________ ________ ________ Net Interest Income (Note C) $29,554 $27,737 $22,273 _______ _______ _______ _______ _______ _______ Net Yield on Interest- Earning Assets 6.97% 6.79% 5.54% _____ _____ _____ _____ _____ _____ <FN> Note A -- For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. Note B -- Taxable investments include all held-to-maturity, available-for-sale, and trading account securities. Note C -- Loan fees of $1,665,872, $1,099,758, and $815,566 for 1999, 1998, and 1997, respectively, are included in interest income amounts above. </FN> Loans and Allowances for Loan Losses Total loans outstanding increased by $41.7 million in 1999 with $281.8 million outstanding at year end. Real estate loans increased by $33.7 million to $157.0 million outstanding at December 31, 1999. Real estate loans made up 55.7% of total gross loans at year end 1999. Construction activity in the trade areas continues to be predominately commercial. The Company continues to offer a home equity loan and a long-term fixed-rate mortgage loan program. Real estate loans consist of construction loans to both businesses and individuals. These loans relate to residential and commercial development, commercial buildings and apartment complexes. Real estate loans also consist of other loans secured by real estate such as one-to-four family dwellings including mobile homes, loans on land only, multi-family dwellings, non-farm non-residential real estate and home equity loans. Acceptance Loan Company had a total of $15.6 million in real estate loans or 10.5% of total real estate loans at year end 1999. Commercial loans totaled $40.0 million at December 31, 1999. These loans increased $4.5 million or 12.8% from December 31, 1998. Consumer installment loans totaled $90.6 million at December 31, 1999. This increase of $4.3 million or 5.0% is almost all attributed to growth in Acceptance Loan Company. These loans include loans to individuals for household, family and other personal expenditures including credit cards and other related credit plans. Consumer installment loans by ALC represent $65.0 million or 71.4% of total consumer installment loans. The yields on these loans average over 22% A.P.R. and enhance the Bank's net interest margin. However, these loans carry a higher risk than the average bank loan and accordingly require a higher loan loss reserve. Acceptance Loan Company is a wholly-owned subsidiary of First United Security Bank. ALC was organized in 1995 primarily to make consumer loans. At December 31, 1995, three offices were in operation with $1.9 million in total loans outstanding. At December 31, 1996, six offices were open with total loans outstanding. At December 31, 1997, twenty offices were open with $39.4 million in total loans. There were twenty-five offices open on December 31, 1998, with $71.2 million in gross loans outstanding. Thirty-three offices were open on December 31, 1999, with twenty-five offices located in Alabama, three in Mississippi and five in Florida. Combined loans from these offices total $80.6 million and make up 28.6% of total loans of First United Security Bank. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio and changes in its risk profile, credit concentrations, historical trends, specific impaired loans, and economic conditions. This evaluation also considers the balance of impaired loans. Losses on individually identified impaired loans are measured based on the present value of expected future cash flows discounted at each loan's original effective market interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through the provision added to the allowance for loan losses. One-to-four family residential mortgages and consumer installment loans are subjected to a collective evaluation for impairment, considering delinquency and repossession statistics, historical loss experience, and other factors. Though management believes the allowance for loan losses to be adequate, ultimate losses may vary from their estimates. However, estimates are reviewed periodically, and as adjustments become necessary, they are reported in earnings during periods they become known. The Bank's loan policy requires immediate recognition of a loss if significant doubt exists as to the repayment of the principal balance of a loan. Consumer installment loans at the Bank and ALC are generally recognized as losses if they become 90 days and 120 days or more delinquent, respectively. The only exception to this policy occurs when the underlying value of the collateral or the customer's financial position makes a loss unlikely. A credit review of the Bank's individual loans is conducted periodically by branch and by loan officer. A risk rating is assigned to each loan and is reviewed at least annually. In assigning risk, management takes into consideration the capacity of the borrower to repay, collateral values, current economic conditions and other factors. Loan officers and other personnel handling loan transactions undergo frequent training dedicated to improving the credit quality as well as the yield of the loan portfolio. First United Security Bank operates under a written loan policy which attempts to guide lending personnel in maintaining a consistent lending function. This policy is intended to aid loan officers and lending personnel in making sound credit decisions and to assure compliance with state and federal regulations. In addition, the intent of the loan policy is to provide lending officers with a guide to making loans which will provide an adequate return while providing services to the communities and trade areas in which we are located. The balance in the allowance for loan losses as of December 31, 1999, was $5.6 million. This increase of approximately $600,000 over year end 1998 reflects the continuing evaluation of the Bank's portfolio and the growth in Acceptance Loan Company. Management considers this allowance adequate for coverage of losses inherent in the loan portfolio. This allowance remains at 2% of total loans. In order to better manage credit risk, ALC's lending policy requires credit information for each applicant to determine income, payment obligations, indebtedness, paying habits, and length and stability of employment. The information is obtained from the applicants, the applicant's employers, creditors of the applicants, and credit reporting agencies. Acceptance Loan Company also carefully oversees its portfolio through monitoring of customer payments and active follow-up. ALC believes that its large number of customers, their broad range of occupations, and geographical distribution minimize any risk to its business, which may be created by unfavorable local conditions. ALC has an established process to determine the adequacy of the allowance for loan losses which is conducted on an aggregate level based upon recent delinquency status. Acceptance Loan Company policy requires charge off of all loans over a specified delinquent period. The CEO of the company must approve any exception to this policy. The following table shows the Bank's loan distribution as of December 31, 1999, 1998, 1997, 1996 and 1995. December 31, ____________________________________________________________ 1999 1998 1997 1996 1995 ________ _________ _________ ________ ________ (In Thousands of Dollars) Commercial, Financial and Agricultural $ 39,996 $ 35,444 $ 35,036 $ 36,387 $ 33,696 Real Estate 156,979 123,264 126,824 126,666 114,985 Installment 90,599 86,282 61,822 49,119 36,301 Less: Unearned Interest, Commissions & Fees 5,823 4,941 3,738 4,153 1,525 ________ ________ ________ ________ ________ Total $281,751 $240,049 $219,944 $208,019 $183,457 ________ ________ ________ ________ ________ ________ ________ ________ ________ ________ The amounts of total loans (excluding installment loans) outstanding at December 31, 1999, which, based on the remaining scheduled repayments of principal, are due in (1) one year or less, (2) more than one year but within five years, and (3) more than five years, are shown in the following table. Maturing ________________________________________________ After One Within But Within One Year Five Years Five Years Total ________ __________ __________ ________ (In Thousands of Dollars) Commercial, Financial, and Agricultural $ 25,787 $ 9,387 $ 4,822 $ 39,996 Real Estate - Mortgage 67,982 45,514 43,483 156,979 ________ ________ ________ ________ Total $ 93,769 $ 54,901 $ 48,305 $196,975 ________ ________ ________ ________ ________ ________ ________ Variable rate loans totaled approximately $59.4 million and are included in the one-year category. First United Security Bank and Acceptance Loan Company (a wholly owned subsidiary of First United Security Bank) began the year with a combined balance in the allowance for loan losses of $5.0 million. Total loans charged off in 1999 totaled $4.5 million. Recoveries on loans previously charged off totaled $514,000, resulting in net charge-offs of $4.0 million. Net charge-offs for 1998 totaled $2.2 million. Management allocated and charged to operations $4.3 million in 1999 as an addition to the allowance for loan losses. This compares to $3.2 million charged to operations for 1998. The balance of $5.6 million at year end 1999 represented 2.0% of total loans outstanding and is considered adequate for losses inherent in the portfolio. Total loans outstanding on December 31, 1999 were $281.8 million. Of this total, loans by ALC amounted to $80.6 million. This represents 28.6% of total loans outstanding. Of the $5.6 million balance in the allowance for loan losses account at December 31, 1999, $2.5 million or 44.6% is represented by reserves maintained for ALC loans. Non-Performing Assets The following table presents information on non-performing loans and real estate acquired in settlement of loans. December 31, __________________________________________________ 1999 1998 1997 1996 1995 ______ ______ ______ ______ ______ (In Thousands of Dollars) Non-Performing Assets: Loans Accounted for on a Non-Accrual Basis $1,725 $3,460 $1,488 $1,797 $ 169 Accruing Loans Past Due 90 Days or More 1,347 1,610 1,285 1,122 1,390 Real Estate Acquired in Settlement of Loans 286 215 506 18 63 ______ ______ ______ ______ ______ Total $3,358 $5,285 $3,279 $2,937 $1,622 ______ ______ ______ ______ ______ ______ ______ ______ ______ Percent of Net Loans and Other Real Estate 1.21% 2.25% 1.52% 1.44% 0.90% ______ ______ ______ ______ ______ ______ ______ ______ ______ Accruing loans past due 90 days or more at December 31, 1999, totaled $1.3 million. These loans are well secured and taking into consideration the collateral value and the financial strength of the borrowers, management believed there would be no loss in these accounts and allowed the loans to continue accruing. Those loans 90 days and more past due, whether on accrual or non-accrual, are reviewed by the Board of Directors each month. Loans past due 90 days produced by Acceptance Loan Company totaled $1.1 million at December 31, 1999, or 81.7% of all loans past due 90 days and more and still accruing. At December 31, 1999, the Company had one loan considered to be impaired. The amount of this loan, which is on non-accrual, is $457,468 and the related allowance is $228,734. The average recorded investment in impaired loans during the year ended December 31, 1999 was approximately $472,147. For the year ended December 31, 1999, the Company did not recognize interest income on the impaired loan during the period the loan was considered impaired. The Company had approximately $487,000 considered to be impaired at December 31, 1998. In the opinion of management, non-performing loans and any other loans which have been classified for regulatory purposes do not represent or result from trends or uncertainties which will materially impact future operating results, liquidity, or capital resources. Management is not aware of information which would cause serious doubts as to the ability of borrowers to comply with present repayment terms. Non-performing assets as a percentage of net loans and other real estate was 1.21% at December, 1999. Loans past due 90 days or more and still accruing are reviewed closely by management and are allowed to continue accruing only when underlying collateral values and management's belief that the financial strength of the borrowers is sufficient to protect the Bank from loss. If at any time management determines there may be a loss of interest or principal, these loans will be changed to non-accrual and their asset value downgraded. Through frequent training, our lending officers are directed by the Bank's written loan policy to make loans within our trade area, to obtain adequate down payments on purchase-money transactions, and to lend within policy guidelines on other transactions. In addition, the Bank's loan review officer conducts an independent review of individual loans by branch and officer. First United Security Bank discontinues the accrual of interest on a loan when management has reason to believe the financial condition of the borrower has deteriorated so that the collection of interest is in doubt. When a loan is placed on non-accrual, all unpaid accrued interest is reversed against current income unless the collateral securing the loan is sufficient to cover the accrued interest. Interest received on non-accrual loans is generally either applied against the principal or cash basis, according to management's judgement as to whether the borrower can ultimately repay the loan. A loan may be restored to accrual status if the obligation is brought current, performs in accordance with the contract for a reasonable period, and if management determines that the repayment of the total debt is no longer in doubt. It is the policy of the Bank to charge-off immediately as loss all amounts judged to be uncollectible. Management is aware that certain losses may exist in the loan portfolio which have not been specifically identified. The allowance for loan losses is established for this reason. This allowance was $5.6 million at year-end and represented 2% of total loans outstanding. Management believes this allowance is adequate to absorb any future loan losses. Allocation of Allowance for Loan Losses The following table shows an allocation of the allowance for loan losses for each of the five years indicated. December 31, ________________________________________________________________________________________________________________ 1999 1998 1997 1996 1995 ____________________ ____________________ ____________________ ____________________ ____________________ Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans in Each in Each in Each in Each in Each Category Category Category Category Category Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allocation Loans Allocation Loans Allocation Loans Allocation Loans Allocation Loans __________ ________ __________ ________ __________ ________ __________ ________ __________ ________ (In Thousands of Dollars) Commercial, Financial, and Agricultural $ 837 14% $ 748 15% $1,416 16% $1,097 17% $ 370 18% Real Estate 558 55 499 50 405 57 313 60 493 62 Installment 4,184 31 3,742 35 2,225 27 1,724 23 1,604 20 ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ Totals $5,579 100% $4,989 100% $4,046 100% $3,134 100% $2,467 100% ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ ______ ___ <FN> Note: First Bank & Trust did not allocate Allowance for Loan Losses by category. Percentages for United Security Bank were used 1995-1996. </FN> The allowance for loan losses is established by risk group as follows: Large classified loans and nonaccrual loans are evaluated individually with specific reserves allocated based on management's review. Smaller nonaccrual and adversely classified loans are assigned a portion of the allowance based on loan grading. Smaller past due loans are assigned a portion of the allowance using a formula that is based on the severity of the delinquency. The remainder of the portfolio is also allocated a portion of the allowance based on past loss experience and the economic conditions for the particular loan portfolio. Allocation weights are assigned based on the Company's historical loan loss experience in each category, although a higher allocation weight may be used if current conditions indicate that loan losses may exceed historical experience. The unallocated portion of the allowance is for inherent losses which probably exist as of the valuation date even though they may not have been identified by the more objective processes used for the allocated portion of the allowance. This portion of the allowance is particularly subjective and requires judgements based upon qualitative factors which do not lend themselves to exact mathematical calculations. Some of the factors considered are changes in credit concentrations, loan mix, changes in underwriting practices, historical loss experience, and the general economic environment in the Company's markets. While the total allowance is described as consisting of an allocated and an unallocated portion, these terms are primarily used to describe a process. Both portions are available to support inherent losses in the loan portfolio. The table above is based in part on the loan portfolio make-up, the Bank's internal risk evaluation, historical charge-offs, past-due loans, non-accrual loans and management's judgement. The portion of the allowance that has not been identified by the Company as related to specific loan categories has been allocated to the individual loan categories on a pro rata basis for purposes of the table above. Net charge-offs as shown in the "Summary of Loan Loss Experience" below indicates the trend for the last five years. Net loan charge-offs as a percentage of average loans increased from .97% in 1998 to 1.54% in 1999. Summary of Loan Loss Experience This table summarizes the Bank's loan loss experience for each of the five years indicated. December 31, ____________________________________________________________ 1999 1998 1997 1996 1995 ________ ________ ________ ________ ________ (In Thousands of Dollars) Balance at Beginning of Period $ 4,989 $ 4,046 $ 3,134 $ 2,467 $ 1,904 Charge-Offs: Commercial, Financial, and Agricultural (94) (94) (299) (246) (201) Real Estate - Mortgage (116) (111) (20) (21) (6) Installment (4,232) (2,373) (694) (497) (179) Credit Cards (30) (11) (26) (9) (8) _______ _______ _______ _______ _______ $(4,472) $(2,589) $(1,039) $ (773) $ (394) Recoveries: Commercial, Financial and Agricultural $ 166 $ 120 $ 110 $ 96 $ 52 Real Estate - Mortgage 21 15 18 0 5 Installment 418 305 107 117 62 Credit Cards 9 5 6 4 8 _______ _______ _______ _______ _______ $ 514 $ 345 $ 241 $ 217 $ 127 Net Charge-Offs (Deduction) $(3,958) $(2,244) $ (798) $ (556) $ (267) Additions Charged to Operations 4,305 3,187 1,710 800 255 Allowances Acquired 243*** 0 0 423** 575* _______ _______ _______ _______ _______ Balance at End of Period $ 5,579 $ 4,989 $ 4,046 $ 3,134 $ 2,467 _______ _______ _______ _______ _______ _______ _______ _______ _______ _______ Ratio of Net Charge-Offs During Period to Average Loans Outstanding 1.54% 0.97% 0.38% 0.28% 0.16% <FN> * Acquisition of Bibb County Branches by First Bank and Trust in 1995. ** Acquisition of Brent Banking Company by United Security Bank in 1996. *** Branch acquisitions by ALC in 1999. </FN> Non-Accruing Loans Summarized below is information concerning the income on those loans with deferred interest or principal payments resulting from a deterioration in the financial condition of the borrower. December 31, ____________________________ 1999 1998 1997 ______ ______ ______ (In Thousands of Dollars) Total Loans Accounted for on a Non-Accrual Basis $1,725 $3,460 $1,488 Interest Income that Would Have Been Recorded under Original Terms $ 247 $ 340 $ 154 Interest Income Reported and Recorded During the Year $ 211 $ 298 $ 108 Total loans on non-accrual decreased by $1.7 million from December 31, 1998 to December 31, 1999. The majority of the loans in this category are in process of liquidation or management has commitments from the principals involved for reduction during the year. Underlying collateral values support those loans which are not already in liquidation. Management continues to emphasize asset quality and expects an increase in non-accrual loans during the year 2000 as the $1.1 million in loans past due 90 days and more on the books of ALC are moved to non-accrual or charged to the loan loss reserve. The Company believes that at December 31, 1999, it has adequate reserves for losses inherent in this portion of the portfolio. Lending officers and other personnel involved in the lending process receive ongoing training in compliance as well as asset quality. The Company has no foreign loans. The Company does not make loans on commercial property outside our market area without prior approval of the Board of Directors or the Directors' Loan Committee. The Company is conservative in its lending directives. Industry Concentration Factors The First United Security Bank trade area includes Clarke, Choctaw, Bibb, Tuscaloosa, and Shelby Counties in Alabama. In addition, parts of Chilton, Hale, Jefferson, Marengo, Monroe, Perry, Washington, Sumter and Wilcox Counties in Alabama as well as parts of Clarke, Lauderdale and Wayne Counties in Mississippi are included. There are several major paper mills in our trade area including the Alabama River Companies, Boise Cascade, Fort James and Weyerhauser. In addition, there are several sawmills, lumber companies, and pole and piling producers. The table below shows the dollar amount of loans made to timber and timber related companies as of December 31, 1999. The amount of timber related loans decreased from $41.5 million in 1998 to $31.2 million in 1999. The percentage of timber related loans to gross loans decreased from 16.9% to 11.07%. The growth in ALC loans of $10.5 million during 1999 helped to reduce the timber industry concentration. Timber Total Percentage of Related Loans Gross Loans Total Loans _____________ ______________ _____________ $31.2 million $281.8 million 11.07% Management understands the concern about concentration of loans in timber and timber-related industries. However, we continue to feel these risks are reduced by the diversification of product production within these industries. Some of the mills and industries specialize in paper and pulp, some in lumber and plywood, some in poles and pilings, and others in wood and veneer. We do not believe that this concentration is excessive or that it represents a trend which might materially impact future earnings, liquidity, or capital resources of the Bank. Management realizes that the Company is heavily dependent on the economic health of the timber related industries. The Company continues to benefit from the area industries engaged in the growing, harvesting, processing and marketing of timber and timber-related products. The majority of the land in our trade area is used to grow pine and hardwood timber. Agricultural production loans make up less than 1% of the Company's total loan portfolio. Investments in Limited Partnerships First United Security Bank invests in limited partnerships that operate qualified affordable housing projects to receive tax benefits in the form of tax deductions from operating losses and tax credits. The Bank accounts for the investments under either the equity or the cost method based on the percentage ownership and influence over operations. The Company's interest in these partnerships was $5.5 million and $4.2 million for 1999 and 1998, respectively. Costs associated with the partnerships carried under the equity method amounted to approximately $119,000, $128,000, and $122,000 for 1999, 1998, and 1997, respectively. Management analyzes these investments annually for potential impairment. The assets and liabilities of these partnerships consist primarily of apartment complexes and related mortgages. United Security's carrying value approximates cost or its underlying equity in the net assets of the partnerships. The Company has remaining cash commitments to these partnerships at December 31, 1999 in the amount of $36,000. Although these investments are considered non-earning assets they do contribute to the bottom line in the form of Federal income tax credits. These credits amounted to $541,000 in 1998 and are estimated to be approximately $540,000 for 1999. Also, operating losses related to these partnerships are available as deductions for taxes on the Company's books. Deposits Average total deposits were up a modest amount, with a 2.3% increase in 1999. Management believes this deposit level was affected by the competitive interest rate environment, and the availability of other low cost funding sources for the Bank. Average non-interest bearing demand deposits have decreased 6.9% over the last three years, while the increase for 1999 was 2.6%. The ratio of average non-interest bearing deposits to average total deposits remained relatively steady in 1999 at 12.3% from 12.2% in 1998 and 12.5% in 1997. Average interest-bearing transaction accounts have decreased 7.3% during the last three years partly because the Bank reclassified a portion of interest-bearing transaction accounts to money market savings accounts in 1997. Nevertheless, interest-bearing transaction accounts continue to be an important source of funds for the Bank, accounting for 18.2% of average total deposits in 1999. Average time deposits increased by 4.5% in 1999, compared to a decrease of 7% in 1998. Time deposits represented 57.3% of the total average deposits in 1999 compared to 56.1% in 1998 and 56.1% in 1997. Average savings deposits have declined 8.9% since 1997. Average savings declined 4.4% in 1999. The ratio of average savings to average total deposits decreased to 12.2% in 1999 compared to 13.0% in 1998 and 12.7% in 1997. First United Security Bank's deposit base remains the primary source of fund. These deposits represented 77.4% of the average earning assets in 1999 and 78.6% of the average earning assets in 1998. As seen in the following table, overall rates on the deposits decreased to 3.71% in 1999, compared to 3.89% in 1998 and 3.84% in 1997. Emphasis continues to be placed on attracting consumer deposits. Management, as part of an overall program to emphasize the growth of transaction accounts, is now introducing "on-line" banking and a bill paying program as well as enhancing the telephone banking product and the employee incentive plan. In addition, an increased effort is being placed on promotions, direct mail campaigns and cross selling efforts. This is being accomplished by remaining safe and sound, emphasizing our products and providing quality service. Other Interest-Bearing Liabilities - Other interest-bearing liabilities include all interest-bearing liabilities except deposits, such as: federal funds purchased and Federal Home Loan Bank advances. This category continues to be more fully utilized as an alternative source of funds as evidenced by the $8.3 million or 15.3% increase in average borrowing during 1999. The increase was representative of both volume increases of long term advances from the Federal Home Loan Bank (FHLB) and short term federal funds purchased. The appeal of this alternative funding was further illustrated by the fact that average rates on the other liabilities declined by 49 basis points, while total average deposit rates declined by only 18 basis points in 1999. Average Daily Amount of Deposits and Rates The average daily amount of deposits and rates paid on such deposits is summarized for the periods in the following table. December 31, ________________________________________________________________ 1999 1998 1997 __________________ __________________ ____________________ Amount Rate Amount Rate Amount Rate ________ ____ ________ _____ ________ _____ (In Thousands of Dollars, Except Percentages) Non-Interest Bearing DDA $ 40,312 $ 39,308 $ 43,300 Interest-Bearing DDA 59,885 2.05% 59,794 2.32% 64,607 2.54% Savings Deposits 39,896 2.57 41,728 2.72 43,797 2.78 Time Deposits 188,170 5.28 180,128 5.44 193,738 5.37 ________ ____ ________ ____ ________ ____ Total $328,263 3.71% $320,958 3.89% $345,442 3.84% ________ ____ ________ ____ ________ ____ ________ ____ ________ ____ ________ ____ Maturities of Time Certificates of Deposits and Other Time Deposits of $100,000 or more outstanding at December 31, 1999, are summarized as follows: Time Other Certificates Time Maturities of Deposits Deposits Total __________ ____________ ___________ ___________ (In Thousands of Dollars) 3 Months or Less $20,155,468 $16,303,081 $26,458,549 Over 3 Through 6 Months 8,391,139 0 8,391,139 Over 6 Through 12 Months 3,781,780 0 3,781,780 Over 12 Months 13,722,161 0 13,722,161 ___________ ___________ ___________ Total $46,053,294 $16,303,081 $52,356,375 ___________ ___________ ___________ ___________ ___________ ___________ Investment Securities and Securities Available for Sale Investment securities available for sale included Mortgage-Backed Securities of $127.1 million, U.S. treasury and agency securities of $2.8 million, state, county and municipal securities of $24.4 million, and other securities of $3.5 million. The securities portfolio is carried at fair value and it decreased $6.1 million from December 1998 to December 1999 as a result of unrealized losses due to changes in the rate environment. At December 1999, approximately $33.4 million in CMOs had floating interest rates which reprice monthly and $54.5 million had fixed interest rates. Because of their liquidity, credit quality and yield characteristics, the majority of the purchases of taxable securities have been purchases of agency guaranteed mortgage-backed obligations and collateralized mortgage obligations. The mortgage-backed obligations in which United Security invests represent an undivided interest in a pool of residential mortgages or may be collateralized by a pool of residential mortgages ("mortgage-backed securities"). Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying mortgages and are subject to any prepayments of principal due to prepayment, refinancing, or foreclosure of the underlying mortgages. Although maturities of the underlying mortgage loans may range up to 30 years, amortization and prepayments substantially shorten the effective maturities of mortgage-backed securities. Transactions in these securities have focused on the three to seven year average maturity range. Principal and interest payments also add significant liquidity to the balance sheet. In 1999, there was a continuing emphasis in CMOs, all of which are collateralized by U. S. Government and Agency Mortgage Pools. The CMO market in existence since 1983 was created to add liquidity to the mortgage-backed security ("MBS") market by furnishing better distribution of risk/reward profiles. Since CMOs are derived from MBS pools, they are labeled mortgage derivatives. Although the Federal Financial Institution Examination Council no longer requires that all MBS derivatives be tested for suitability as an investment in the portfolio of financial institutions, First United Security Bank continues to run these tests at purchase and periodically thereafter. The three tests being performed are as follows: #1 -- Average Life Test -- The expected average life of the security must be less than or equal to 10 years. #2 -- Average Life Sensitivity Test -- The average life of the security will not extend by more than 4 years or shorten by more than 6 years for immediate Treasury curve shifts of +/- 300 basis points (3%). #3 -- Price Sensitivity Test -- The estimated price of the security will not change by more than 17% for immediate Treasury curve shifts of +/- 300 basis points. Securities that do not pass all three tests are designated "high risk". United Security held $17 million in securities which, at December 31, 1999, were designated high risk. $7 million of these securities were floating rate, $9.4 million were inverse floating rate securities and $.6 million were fixed rate securities. These securities were purchased and/or are being held to hedge certain areas of interest rate risk in the portfolio and balance sheet. There were unrealized losses in this portion of the portfolio at December 31, 1999 of $918,224. The overall securities portfolio is formally monitored on a monthly basis, and assessments are made continually relative to United Security's exposure to fluctuations in interest rates. Changes in the level of earnings and fair values of securities are generally attributable to fluctuations in interest rates, as well as volatility caused by general uncertainty over the economy, inflation, and future interest rate trends. MBS and CMOs present some degree of additional risk s collateralizing these securities can be prepaid, thereby affecting the yield and market value of the portfolio. The composition of United Security's investment portfolio reflects United Security's investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of United Security's investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling United Security's interest rate position while at the same time producing adequate levels of interest income. Fair market values of securities vary significantly as interest rates change. The gross unrealized gains and losses in the securities portfolio are not expected to have a material impact on future income, liquidity or other funding needs. There were unrealized losses (net of taxes) of $1.8 million in the securities portfolio on December 31, 1999 versus net unrealized gains (net of taxes) of $2.8 million one year ago. United Security uses other off balance sheet derivative products for hedging purposes. These include interest rate swaps and caps. The use and detail regarding these products are fully discussed under "Liquidity and Interest Rate Sensitivity Management" and in Note 19 in the "Notes to Consolidated Financial Statements". Investment Securities Available-for-Sale The following table sets forth the amortized costs of investment securities as well as their fair value and related unrealized gains or loss at the dates indicated. December 31, __________________________________ 1999 1998 1997 _________ ________ ________ (In Thousands of Dollars) Investment Securities Available for Sale: U.S. Treasury and Agencies Securities $ 2,891 $ 2,090 $ 2,096 Obligations of States, Counties, and Political Subdivisions 24,550 23,841 22,228 Mortgage-Backed Securities 129,737 132,588 144,310 Other Securities 3,501 3,076 2,245 Total Book Value 160,679 159,505 170,879 Net Unrealized Gains/Losses (2,805) 4,514 1,620 ________ ________ ________ Total Market Value $157,874 $164,019 $172,499 ________ ________ ________ ________ ________ ________ Investment Securities Available-for-Sale Maturity Schedule Maturing __________________________________________________________________________________ After One After Five Within But Within But Within After One Year Five Years 10 Years 10 Years ________________ ________________ _________________ __________________ Amount Yield Amount Yield Amount Yield Amount Yield ______ _____ ______ _____ ______ _____ ________ _____ (In Thousands of Dollars, Except Yields) Investment Securities Available for Sale: U.S. Treasury and Agency Securities $ 500 0.00% $ 0 0.00% $ 2,844 7.12% $ 1,560 0.00% State, County and Municipal Obligations 3,046 6.63% 5,211 7.15% 3,192 6.26% 12,923 5.59% Mortgage-Backed Securities 7 0% 1,275 7.18% 10,504 6.78% 115,340 7.13% Corporate Bank Notes 0 0.00% 11 7.87% 0 0.00% 0 0.00% ______ ____ ______ ____ _______ ____ ________ ____ Total $3,053 6.61% $6,497 7.16% $16,540 6.73% $128,263 6.98% ______ ____ ______ ____ _______ ____ ________ ____ ______ ____ ______ ____ _______ ____ ________ ____ 154,353 6.95% Equity Securities 3,521 7.38% TOTAL $157,874 6.96% <FN> *Available for Sale Securities are stated at Market Value and Market Yield </FN> The maturities and weighted average yields of investment securities available-for-sale at the end of 1999 are presented in the preceding table based on stated maturity. While the average stated maturity of the Mortgage Backed Securities (excluding CMO's) was 24.01 years, the average life expected is 9.87 years. The average stated maturity of the CMO portion of the portfolio was 21.24 years, and the average expected life was 7.33 years. The average expected life of investment securities available-for-sale was 8.40 years with an average yield of 6.96 percent. Condensed Portfolio Maturity Schedule Dollar Portfolio Maturity Summary Amount Percentage ________________ ____________ __________ Maturing in 3 months or less $ 1,966,564 0.63% Maturing in 3 months to 1 year 2,086,219 1.35 Maturing in 1 to 3 years 4,741,992 3.07 Maturing in 3 to 5 years 1,753,901 1.14 Maturing in 5 to 15 years 24,537,786 15.89 Maturing in over 15 years 120,266,910 77.92 ____________ ______ Total $154,353,372 100.00% ____________ ______ ____________ ______ The following Marketable Equity Securities have been excluded from the above Maturity Summary due to no stated maturity date. Federal Home Loan Bank Stock $3,289,500 Mutual Funds $ 9,618 Other Marketable Equity Securities $ 221,453 Condensed Portfolio Repricing Schedule Dollar Portfolio Repricing Summary Amount Percentage _________________ ____________ __________ Repricing in 30 days or less $131,244,405 20.24% Repricing in 31 days to 1 year 2,086,219 1.35 Repricing in 1 to 3 years 4,589,794 2.97 Repricing in 3 to 5 years 1,753,901 1.14 Repricing in 5 to 15 years 21,868,799 14.17 Repricing in over 15 years 92,810,254 60.13 ____________ ______ Total $154,353,372 100.00% ____________ ______ ____________ ______ Repricing in 30 days or less does not include: Mutual Funds $ 9,618 Repricing in 31 days to 1 year does not include: Federal Home Loan Bank Stock $3,289,500 Other Marketable Equity Securities $ 221,453 The tables above reflect all securities at market value on December 31, 1999. Securities Gains and Losses Non-interest income from securities transactions, trading account transactions, and associated option premium income increased in 1999 compared to 1998, as can be seen in the table below. The majority of the profits realized in 1999 were generated through the sale of securities. Gains in this area occurred in connection with United Security's asset and liability management activities and strategies. Option income and other off-balance sheet income declined 34.87% from $319,918 to $208,377. Although this income should be considered non-recurring, it is expected that $90,902 will be recognized in 2000. This income which will be received in 2000 is the result of early termination of interest rate contracts and deferred gains and losses associated with these interest rate risk management tools, and is being amortized over the original life of the hedge. During 1998, the FASB issued SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement replaces existing pronouncements and practices with a single, integrated accounting framework for derivatives and hedging activities requiring companies to formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. During 1999, the FASB issued SFAS No. 137, which deferred the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. Presently, the Company has not yet quantified the effect adoption will have on the consolidated financial statements. The table below shows the associated net gains or (losses) for the periods 1999, 1998, and 1997: 1999 1998 1997 _________ _________ _________ Investment Securities $ 533,806 $ 410,987 $ 105,254 Trading Account 0 0 10,187 Options & Off Balance Sheet Transactions 208,377 310,918 396,772 _________ _________ _________ Total $ 742,183 $ 721,905 $ 512,213 _________ _________ _________ _________ _________ _________ Gains in 1999 from sales of investment securities were net of losses of $578,768. Volume of sales as well as other information on securities is further discussed in Note 4 to the financial statements. Short-Term Borrowings Purchased funds can be used to satisfy daily funding needs, and when advantageous, for arbitrage. The following table shows information for the last three years regarding the Bank's short- and long-term borrowings consisting of U. S. Treasury demand notes included in its Treasury, Tax, and Loan Account, securities sold under repurchase agreements, Federal Fund purchases (one day purchases), and other borrowings from the Federal Home Loan Bank. Short-Term Borrowings Long-Term Borrowings Maturity Less Than One Year Maturity One Year or Greater ___________________________ ____________________________ (In Thousands of Dollars) Year Ended December 31,: 1999 $17,045 $65,729 1998 12 55,847 1997 3,913 40,966 Weighted Average Interest Rate at Year-end: 1999 5.34% 5.80% 1998 4.41% 5.04% 1997 5.23% 5.83% Maximum Amount Outstanding at Any Month's End: 1999 $17,105 $65,788 1998 11,620 55,906 1997 11,936 40,973 Average Amount Outstanding During the Year: 1999 $ 4,919 $57,781 1998 3,929 55,454 1997 3,210 30,296 Weighted Average Interest Rate During the Year: 1999 5.19% 5.07% 1998 5.87% 5.53% 1997 5.80% 5.83% During January of 1997, United Security converted Federal Home Loan Bank short-term borrowings to long-term borrowings. Balances in these accounts fluctuate dramatically on a day-to-day basis. Rates on these balances also fluctuate daily, but as reflected in the chart above, they generally depict the current interest rate environment. Shareholders' Equity United Security has always placed great emphasis on maintaining its strong capital base. At December 31, 1999, shareholders' equity totaled $61.7 million, or 12.9% of total assets compared to 13.5% and 12.4% for the same periods in 1998 and 1997, respectively. This level of equity indicates to United Security's shareholders, customers and regulators that United Security is financially sound and offers the ability to sustain an appropriate degree of leverage to provide a desirable level of profitability and growth. Over the last three years shareholders' equity grew from $47.6 million at the beginning of 1997 to $61.7 million at the end of 1999. All of this growth was the result of internally generated retained earnings, with the exception of approximately $700,000 from stock options being exercised. Shareholders' equity was also impacted by the market value adjustment of $(4.6) million made for the available for sale investments as required by Statement of Accounting Standards No. 115. The internal capital generation rate (net income less cash dividends as a percentage of average shareholders' equity) was 8.5% in 1999, 10.3% in 1998 and 10.2% in 1997. United Security is required to comply with capital adequacy standards established by the Federal Reserve and FDIC. Currently, there are two basic measures of capital adequacy: a risk-based measure and a leverage measure. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to risk categories, each with a specified risk weighting factor. The resulting capital ratios represent capital as a percentage of total risk weighted assets and off-balance sheet items. The banking regulatory agencies have also adopted regulations which supplement the risk based guidelines to include a minimum leverage ratio of 3% of Tier l Capital to total assets less goodwill (the "leverage ratio"). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% or 2% higher than the minimum 3% level. The minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits, and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles ("Tier l Capital"). The remainder ("Tier II Capital") may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt, and a limited amount of the allowance for loan losses. The sum of Tier l Capital and Tier II Capital is "total risk-based capital". The following chart summarizes the applicable regulatory capital requirements. United Security's capital ratios at December 31, 1999, substantially exceeded all regulatory requirements. Risk-Based Capital Requirements Minimum United Security's Regulatory Ratio at Requirement December 31, 1999 ___________ _________________ Tier I Capital to sets 8.00% 19.05% Total Capital to Risk-Adjusted Assets 4.00% 17.79% Tier I Leverage Ratio 3.00% 12.47% Total capital also has an important effect on the amount of FDIC insurance premiums paid. Lower capital ratios can cause the rates paid for FDIC insurance to increase. United Security plans to maintain the capital necessary to keep FDIC insurance rates at a minimum. United Security attempts to balance the return to shareholders through the payment of dividends with the need to maintain strong capital levels for future growth opportunities. Total cash dividends declared were $3.0 million or $.84 per share in 1999 compared to $.76 per share in 1998 and $.53 per share in 1997. The total cash dividends represented a payout ratio of 36.7% in 1999 with payout ratio of 31.4% and 26.8% in 1998 and 1997 respectively. This is the eleventh consecutive year that United Security has increased cash dividends. Ratio Analysis The following table presents operating and capital ratios for each of the last three years. Year Ended December 31, ____________________________ 1999 1998 1997 ______ ______ ______ Return on Average Assets 1.77% 1.95% 1.61% Return on Average Equity 13.35% 14.94% 13.92% Cash Dividend Payout Ratio 36.67% 31.40% 26.79% Average Equity to Average Assets Ratio 13.29% 13.07% 11.55% Liquidity and Interest Rate Sensitivity Management The primary function of asset and liability management is to assure adequate liquidity and to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities. Liquidity management involves the ability to meet day-to-day cash flow requirements of United Security's customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, United Security 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 seeks to ensure 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 loan principal payments and maturities and through sales, maturities, and 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 $126.8 million at December 31, 1999. Investment securities maturing or repricing in the same time frame totaled $36.4 million or 23.6% of the investment portfolio at year-end 1999. In addition, principal payments on mortgage-backed securities totaled $8 million in 1999. The liability portion of the balance sheet provides liquidity through interest-bearing and non-interest bearing deposit accounts. Federal Funds purchased, securities sold under agreements to repurchase, 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. Although the majority of the securities portfolio has stated maturities in excess of ten years, the entire portfolio consists of securities that are readily marketable and which are easily convertible into cash. However, management does not necessarily rely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment, etc. Instead, these activities are funded by cash flows from operating activities and increases in deposits and short-term borrowings. The proceeds from sales and maturities of investments have been used either to purchase additional investments or to fund loan growth. United Security, at December 31, 1999, had long-term debt and short-term borrowings that on average represent 13.9 percent of total liabilities and equity. United Security currently has up to $85 million in borrowing capacity from the Federal Home Loan Bank and $38 million in established Federal Funds Lines. 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. Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly, while the timing of repricing for both the asset and the liability remains the same, thus affecting net interest income. It should be noted, therefore, that a matched interest-sensitive position by itself will not ensure maximum net interest income. Management continually evaluates the condition of the economy, the pattern of market interest rates, and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in general levels of interest rates. Measuring Interest Rate Sensitivity: Gap analysis is a technique used to measure interest rate sensitivity, an example of which is presented below. Assets and liabilities are placed in gap intervals based on their repricing dates. Assets and liabilities for which no specific repricing dates exist are placed in gap intervals based on management's judgment concerning their most likely repricing behaviors. Derivatives used in interest rate sensitivity management are also 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 United Security's interest rate sensitivity. However, it cannot reveal the impact of factors such as ad (e.g., the prime lending rate), pricing strategies on consumer and business deposits, changes in balance sheet mix, or the effect of various options embedded in balance sheet instruments. The accompanying table shows United Security's rate sensitive position at December 31, 1999, as measured by gap analysis. Over the next 12 months approximately $92.9 million more interest earning assets than interest bearing liabilities can be repriced to current market rates at least once. This analysis indicates that United Security has a negative gap within the next 12 month range. Therefore, net interest income would benefit slightly from a falling interest rate environment and would be adversely impacted slightly by a rising rate environment according to the table. Interest Rate Sensitivity Analysis December 31, 1999 _____________________________________________________________________________________________ (In Thousands of Dollars) Total 0-3 4-12 1 Year 1-5 Over 5 Non-Rate Months Months or Less Years Years Sensitive Total _________ _________ _________ ________ ________ _________ ________ Earning Assets: Loans (Net of Unearned Income) $ 86,083 $ 40,741 $ 126,824 $108,477 $ 46,450 $ 0 $281,751 Investment Securities 35,850 6,115 41,965 39,874 76,035 0 157,874 Interest Bearing Deposits in Other Banks 365 0 365 0 0 365 _________ _________ _________ ________ ________ ________ ________ Total Earning Assets $ 122,298 $ 46,856 $ 169,154 $148,351 $122,485 $ 0 $439,990 Percent of Total Earning Assets 27.8% 10.6% 38.4% 33.7% 27.8% 100.0% Interest-Bearing Liabilities: Interest-Bearing Deposits and Liabilities Demand Deposits (1) $ 48,248 $ 0 $ 48,248 $ 12,062 $ 0 $ 0 $ 60,310 Savings Deposits (1) 19,551 0 19,551 19,551 0 0 39,102 Time Deposits 80,049 64,119 144,168 44,113 0 0 188,281 Other Liabilities 43,982 5,087 49,069 32,964 149 0 82,182 Non-Interest-Bearing Liabilities Demand Deposits 981 0 981 0 0 38,254 39,235 Equity 0 0 0 0 0 30,880 30,880 _________ _________ _________ ________ ________ ________ ________ Total Funding Sources $ 192,811 $ 69,206 $ 262,017 $108,690 $ 149 $ 69,134 $439,990 Percent of Total Funding Sources 43.8% 15.7% 59.6% 24.7% 0.0% 15.7% 100.0% Interest Sensitivity Gap (Balance Sheet) $ (70,513) $ (22,350) $ (92,863) $ 39,661 $122,336 $(69,134) $ 0 Off-Balance Sheet $ (40,000) $ 0 $ (40,000) $ 0 $ 0 $ 0 $(40,000) Interest Sensitive Gap $(110,513) $ (22,350) $(132,863) $ 39,661 $122,336 $(69,134) $(40,000) Cumulative Interest-Sensitive Gap $(110,513) $(132,863) $ N/A $(93,202) $ 29,134 $(40,000) $ 0 Over 5 Total Years 0-3 4-12 1 Year 1-5 Non-Rate Months Months or Less Years Sensitive Total ______ ______ _______ _____ _________ _____ Ratio of Earning Assets to Funding Sources and Off-Balance Sheet 0.53% 0.68% 0.56% 1.36% 1.77% 1.10% Cumulative Ratio 0.53% 0.56% N/A 0.77% 0.92% 0.92% <FN> (1) Management adjustments reflect the Company's anticipated repricing sensitivity of non-maturity deposit products. Historically, balances on non-maturity deposit accounts have remained relatively stable despite changes in market interest rates. Management has classified certain of these accounts as non-rate sensitive based on management's historical pricing practices and runoff experience. Approximately 20% of the interest- bearing demand deposit account balances and 50% of the savings account balances are classified as over one year. Certain interest-sensitive assets and liabilities are included in the table based on historical repricing experience and expected prepayments in the case of Mortgage Backed Securities rather than contractual maturities. Non-accruing loans are included in loans at the contractual maturity. </FN> United Security also uses additional tools to monitor and manage interest rate risk sensitivity. These tools include income simulation analysis and duration analysis. Both analyses are methods of estimating earnings at risk and capital at risk under varying interest rate conditions. They are used to test the sensitivity of net interest income and stockholders' equity to changing levels of interest rates and include adjustments for the expected timing and the magnitude of assets and liability cash flows. Also, these measures capture adjustments for the lag between movements in market interest rates and the movement of administered rates on prime rate loans, interest bearing transaction accounts, regular savings, and money market savings accounts. Income simulation analysis indicates that United Security is slightly liability sensitive. Condensed Balance Sheet Duration Analysis Estimated Book Modified Duration Value Down 1% Up 1% _________ _______ ______ ASSETS Cash and Due From Banks $ 12,223 4.36% 4.36% Investment Securities Available-for-Sale 157,874 3.65 4.67 Interest Bearing Deposits in Other Banks 666 0.01 0.01 Loans 276,172 1.95 1.99 Premises and Equipment 9,541 4.36 4.36 Accrued Interest Receivable 5,663 4.36 4.36 Investment in Limited Partnerships 5,470 4.36 4.36 Other Assets 8,990 4.36 4.36 ________ ____ ____ Total Assets $476,599 2.72% 3.08% ________ ____ ____ ________ ____ ____ LIABILITIES AND SHAREHOLDERS' EQUITY Demand, Non-interest Bearing $ 39,235 4.36% 4.36% Demand, Interest Bearing 60,310 2.24 2.24 Savings 39,102 3.72 3.72 Time Deposits 188,104 1.53 1.52 ________ Total Deposits $326,751 Other Liabilities $ 5,403 4.36% 4.36% Short-Term Borrowing 17,045 0.01 0.01 Long-Term Borrowing 65,729 1.08 1.08 Shareholders' Equity 61,671 4.36 4.36 ________ ____ ____ Total Liabilities and Shareholders' Equity $476,599 2.32% 2.32% ________ ____ ____ ________ ____ ____ Modified Duration Differential 0.40 0.77 * Suggested Change in Market Value of Equity (Pre-tax) ($000) $1,918 $(3,658) <FN> * The change in the market value of equity should represent the present value of the Company's future earnings exposure to a 1% rise or fall in interest rates. </FN> United Security uses a five step process to calculate the duration of each asset and liability category. The first step is to assemble maturity and repricing data on loans, investments, CD's and other financial instruments with contractual maturities. The second step is to determine how bank management would alter the interest rate for each category of assets and liabilities assuming market interest rates rose or fell 1%. The third step is to combine the maturity analysis and repricing assumptions in order to formulate a modified duration estimate for each category. The fourth step is to calculate a weighted average for total assets and liabilities, and the fifth step is to multiply the modified duration differential as calculated (for both up 1% and down 1% interest rate scenarios) in step four by total assets. Based on the current position of the balance sheet, management believes these present value calculations approximate United Security's aggregate pre-tax earnings exposure for the next 5 years. In this methodology, all non-rate sensitive assets, liabilities, and shareholders' equity are assigned a modified duration based on a five year time horizon (4.36 years). Additionally, estimates of modified duration incorporate the likelihood that the investment portfolio would shorten maturity if interest rates fell and lengthen maturity if interest rates rose. The model also incorporates management's belief that deposit and loan rates would not rise or fall equally either by category or by interest rate scenario. Increases in loan prepayments are considered in the methodology. There is no allowance for growth or runoff in deposit or loan balances. The duration analysis presented above suggests long term (the market value of equity) that the Company's earnings should decline slightly if interest rates rise and should increase slightly if interest rates fall. As part of the ongoing monitoring of interest-sensitive assets and liabilities, United Security enters into various interest rate contracts ("interest rate protection contracts") to help manage United Security's interest sensitivity. Such contracts generally have a fixed notional principal amount and include (i) interest rate swaps where United Security typically receives or pays a fixed rate and a counterparty pays or receives a floating rate based on a specified index, (ii) interest rate caps and floors purchased where United Security receives interest if the specified index falls below the floor rate or rises above t 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 are ultimately reflected as adjustments to interest income or expense. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized. A discussion of interest rate risks, credit risks and concentrations in off-balance sheet financial instruments is included in Note 19 of the "Notes to Consolidated Financial Statement". Commitments The Bank maintains financial instruments with risk exposure not reflected in the Consolidated Financial Statements. These financial instruments are executed in the normal course of business to meet the financing needs of its customers and in connection with its investing and trading activities. These financial instruments include commitments to make loans, options written, standby letters of credit, and commitments to purchase securities for forward delivery. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank applies the same credit policy in making these commitments that it uses for on-balance sheet items. Collateral obtained upon exercise of the commitment is determined based on management's credit evaluation of the borrower and may include accounts receivable, inventory, property, land, and other items. The Bank does not normally require collateral for standby letters of credit. As of December 31, 1999, the Bank had outstanding standby letters of credit and commitments to make loans of $6.2 million and $21.8 million, respectively. For options written and commitments to purchase securities for forward delivery, the contractual amounts reflect the extent of the Bank's involvement in various classes of financial instruments and does not represent exposure to credit loss. The Bank controls the credit risk of these instruments through credit approvals, limits, and monitoring procedures. Options are contracts that allow the buyer of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from or to the seller or writer of the option. As a writer of options, the Bank is paid a premium at the outset and then bears the risk of an unfavorable change in the price of the financial instrument underlying the option. As of December 31, 1999, the Bank had no outstanding options. Commitments to buy and sell securities for delayed delivery require the Bank to buy and sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in securities values and interest rates between the commitment and delivery dates. There were no commitments to sell securities for delayed delivery and no commitments to purchase securities as of December 31, 1999. The Bank is prepared to fulfill the above commitments through scheduled maturities of loans and securities along with cash flows from operations, anticipated growth in deposits, and short-term borrowings. Operating Results Net Interest Income Net interest income is an effective measurement of how well management has matched interest-rate sensitive assets and interest-bearing liabilities. The fluctuations in interest rates materially affect net interest income. The accompanying table analyzes these changes. Net interest income increased by $1.8 million or 6.6% in 1999 compared to 24.5% and 14.4% increases in 1998 and 1997 respectively. Volume, rate, and yield changes contributed to the growth in net interest income. Much of this change has resulted in an increase in loan volume and a decrease in investment securities volume since 1997 as a result of a change in earnings asset strategy. Average interest-earning assets increased by $15.6 million or 3.8% in 1999, while average interest-bearing liabilities increased $14.6 million. Volume changes of equal amounts in interest-earning assets and interest-bearing liabilities generally increase net interest income because of the spread between the yield on loans and investments and the rates paid on interest-bearing liabilities. In 1999, average interest-earning assets outgained average interest-bearing liabilities by $1 million. United Security's ability to produce net interest income is measured by a ratio called the interest margin. The interest margin is net interest income as a percent of average earning assets. The interest margin was 7.0% in 1999 compared to 6.8% in 1998 and 5.5% in 1997. Interest margins are affected by several factors, one of which is the relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities. This factor determines the effect that fluctuating interest rates will have on net interest income. Rate-sensitive earning assets and interest-bearing liabilities are those which can be repriced to current market rates within a relatively short time. United Security's objective in managing interest rate sensitivity is to achieve reasonable stability in the interest margin throughout interest rate cycles by maintaining the proper balance of rate sensitive assets and liabilities. For further analysis and discussion of interest rate sensitivity, refer to the preceding section entitled "Liquidity and Interest Rate Sensitivity Management." Another factor that affects the interest margin is the interest rate spread. The interest rate spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. This measurement gives a more accurate representation of the effect market interest rate movements have on interest rate-sensitive assets and liabilities. The average volume of the interest-bearing liabilities as noted in the table, "Distribution of Assets, Liabilities, and Shareholders' Equity, with Interest Rates and Interest Differentials," decreased 4.4% in 1999, while the average rate of interest paid decreased from 4.62% in 1998 to 4.38% in 1997. Average interest-earning assets increased 3.8% in 1999, while the average yield on earning assets remained the same at 10.59% in both 1998 and 1999. Net yield on average interest earning assets increased 123 basis points from 1997 to 1998. This increase is primarily the result of the higher loan yields associated with loans made by Acceptance Loan Company. The percentage of earning assets funded by interest-bearing liabilities also affects the Bank's interest margin. United Security's earning assets are funded by interest-bearing liabilities, non-interest bearing demand deposits, and shareholders' equity. The net return on earning assets funded by non-interest-bearing demand deposits and shareholders' equity exceeds the net return on earning assets funded by interest-bearing liabilities. United Security maintains a relatively consistent percentage of earning assets funded by interest-bearing liabilities. In 1999, 82.7% of the Bank's average earning assets were funded by interest-bearing liabilities as opposed to 82.2% in 1998 and 83.7% in 1997. Net interest income is improved as earning assets are funded by a decreasing percentage of interest-bearing liabilities. Summary of Operating Results Year Ended December 31, _______________________________ 1999 1998 1997 _______ _______ _______ (In Thousands of Dollars) Total Interest Income $44,919 $43,255 $37,648 Total Interest Expense 15,365 15,518 15,376 Net Interest Income 29,554 27,737 22,272 Provision for Loan Losses 4,305 3,187 1,710 Net Interest Income After Provision for Loan Losses 25,249 24,550 20,562 Non-Interest Income 4,747 4,558 4,361 Non-Interest Expense 18,534 17,008 15,229 _______ _______ _______ Income Before Income Taxes 11,462 12,100 9,694 Applicable Income Taxes 3,302 3,521 2,713 _______ _______ _______ Net Income $ 8,160 $ 8,579 $ 6,981 _______ _______ _______ _______ _______ _______ Changes in Interest Earned and Interest Expense Resulting from Changes in Volume and Changes in Rates 1999 Compared to 1998 1998 Compared to 1997 1997 Compared to 1996 _______________________________ ______________________________ _____________________________ Increase (Decrease) Increase (Decrease) Increase (Decrease) Due to Change In: Due to Change In: Due to Change In: _______________________________ ______________________________ _____________________________ Average Average Average Volume Rate Net Volume Rate Net Volume Rate Net _______ ________ ________ _______ _______ _______ _______ _______ _______ (In Thousands of Dollars) Interest Earned On: Loans $3,183 $ 1,196 $ 4,379 $2,200 $4,233 $6,433 $1,499 $1,246 $2,745 Taxable Investments (799) (1,995) (2,794) (862) 300 (562) 919 (376) 543 Non-Taxable Investments 50 9 59 (156) (111) (267) (410) 273 (137) Federal Funds 29 (9) 20 (2) 4 2 (48) (5) (53) ______ _______ _______ ______ ______ ______ ______ ______ ______ Total Interest- Earning Assets $2,463 $ (799) $ 1,664 $1,180 $4,426 $5,606 $1,960 $1,138 $3,098 ______ _______ _______ ______ ______ ______ ______ ______ ______ Interest Expense On: Demand Deposits $ 2 $ (314) $ (312) $ (118) $ (139) $ (257) $ (128) $ (133) $ (261) Savings Deposits (50) (91) (141) (57) (24) (81) 357 (26) 331 Time Deposits 401 (260) 141 (770) 328 (442) 423 (240) 183 Other Liabilities 369 (210) 159 982 (60) 922 (43) 85 42 ______ _______ _______ ______ ______ ______ ______ ______ ______ Total Interest- Bearing Liabilities $ 722 $ (875) $ (153) $ 37 $ 105 $ 142 $ 609 $ (314) $ 295 ______ _______ _______ ______ ______ ______ ______ ______ ______ Increase in Net Interest Income $1,741 $ (76) $ 1,817 $1,143 $4,321 $5,464 $1,351 $1,452 $2,803 ______ _______ _______ ______ ______ ______ ______ ______ ______ ______ _______ _______ ______ ______ ______ ______ ______ ______ Provision for Loan Losses The provision for loan losses is an expense used to establish the allowance for loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance. The expense recorded each year is a reflection of actual losses experienced during the year and management's judgment as to the adequacy of the allowance to absorb losses inherent to the portfolio. Charge-offs exceeded recoveries by $3.9 million during the year, an increase of $1.6 million over the prior year, and accordingly a provision of $4.3 million was expensed for loan losses in 1999. The allowance remained at 2% of total loans outstanding at December 31, 1999. For additional information and discussion of the allowance for loan losses, refer to the section entitled "Loans and Allowances for Loan Losses". Non-Interest Income Non-interest income consists of revenues generated by a broad range of financial services and activities including fee-based services and commissions earned through insurance sales and trading activities. In addition, gains and losses from the sale of investment portfolio securities and option transactions are included in non-interest income. Non-recurring items of non-interest income include all the securities gains (losses) discussed in a previous section. Investment securities had a net gain of $533,806 in 1999 compared to a $410,987 gain in 1998 and a $105,254 gain in 1997. Income generated in the area of securities gains and losses is dependent on many factors including investment portfolio strategies, interest rate changes, and the short, intermediate, and long-term outlook for the economy. In 1997, the United States Department of Justice required the divestiture of approximately $9.8 million in deposits, branch facility and associated assets in order to approve the merger of United Security Bank and First Bank and Trust. The sale of these deposits and assets resulted in a non-recurring net gain of $592,000. The Bank also sold the building that once housed the Centreville Branch Office in order to move to a new facility that was completed in the spring of 1999. This sale along with other less significant asset sales resulted in a gain of $310,224 in 1997. Acceptance Loan Company opened fourteen new offices in 1997, five in 1998, added eight more in 1999 and currently has a total of thirty-three offices. Additionally, the Bank opened a new office in 1998 and two new offices in 1999. These events coupled with the Bank's Bond Division formation in 1996 contributed to a $189,016 or 4.2% increase, in 1999 compared to $197,306 and $1,636,171 increases in 1998 and 1997, respectively. United Security continues to search for new sources of non-interest income. These sources will come from innovative ways of performing banking services now as well as providing new services in the future. This philosophy can be seen in the Bond Division organized in 1996. This division of the Bank was formed to offer bond services to community banks and contributed $426,230 to non-interest income in 1999 compared to $402,194 in 1998 and $266,476 in 1997. Non-Interest Expense Non-interest expense consists primarily of four major categories: salaries and employee benefits, occupancy expense, furniture and equipment expense, and other expense. United Security's non-interest expense has been impacted by the start up of thirty-one offices of Acceptance Loan Company since 1996 for a total of thirty-three offices, the merger of United Security Bank and First Bank and Trust in 1997, and the start up of four offices of United Security Bank since 1997. The ratio of non-interest expenses to average assets increased to 4.0% in 1999 compared to 3.8% and 3.5% in 1998 and 1997 respectively. This ratio was significantly impacted by the events noted above. Salaries and employee benefits increased $989,257 or 10.1% in 1999. Most of this increase is attributable to staffing the eight new offices of Acceptance Loan Company and the Bucksville office of First United Security Bank in 1999. At December 31, 1999, United Security had 315 full-time equivalent employees compared to 286 in 1998 and 266 in 1997. United Security sponsors an Employee Stock Ownership Plan with 401(k) provisions. The Company made matching contributions totaling $451,483, $376,120 and $238,190 in 1999, 1998, and 1997, respectively. Furniture and equipment expense increased 6.9% in 1999, 5.3% in 1998, and 37% in 1997. Most of the 1997 increase of $375,497 is a direct result of the computer and check processing equipment lease and depreciation expenses associated with the merger as well as the expenses associated with the new Acceptance Loan Company offices. The increase of $100,833 and $74,292 in 1999 and 1998, respectively, is due to the new offices opened and the equipment upgrade in preparation for the Year 2000. Occupancy expense includes rents, depreciation, utilities, maintenance, insurance, taxes, and other expenses associated with maintaining eighteen banking offices and thirty-three finance company offices. All but one banking offices are owned by the Company and all Acceptance Loan Company offices are leased. Net occupancy expense increased 12.3% in 1999, 21.3% in 1998, and 26.3% in 1997. The increases reflect the new offices opened by Acceptance Loan Company and First United Security Bank in 1999, 1998 and 1997. Other expenses consists of stationery, printing supplies, advertising, postage, telephone, legal and other professional fees, other non-credit losses, and other insurance including deposit insurance, and other misses. Other expenses increased 6.5% in 1999, decreased 8.3% in 1998 and increased 39.7% in 1997. The 1997 increase was due to costs associated with the merger of United Security Bank and First Bank and Trust. Year 2000 Issues The Company has not experienced any material effects as a result of the year 2000 issues. However, there may be situations where third party commercial lending customer or vendors could be adversely affected by the year 2000 issue. If problems do materialize with commercial lending customers or vendors, the customers' abilities to repay borrowings to the Company or vendors' abilities to provide service could be affected. Management currently believes that the risk of detrimental impact on the Company's results of operations and financial position because of the year 2000 issues is low. During 1997, 1998, and 1999, the Company paid approximately $250,000 related to Year 2000 compliance. A substantial portion of these costs have been capitalized in the installation of software and hardware and will be amortized over the life of the related assets. There has been no material increase in salaries expense due to Year 2000 compliance activities as many of the system renovations have coincided with previously planned system replacements or enhancements, the costs of which have been included in the costs disclosed above. The deferral of certain other projects in order to assure Year 2000 readiness has not had, and is not expected to have, a material impact on the Company's financial condition and results of operations. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Information required by this item is contained in Item 7 herein under the heading "Liquidity and Interest Rate Sensitivity Management." Item 8. Financial Statements and Supplementary Data. REPORT OF INDEPENDNT PUBLIC ACCOUNTANTS To United Security Bancshares, Inc.: We have audited the accompanying consolidated statements of condition of United Security Bancshares, Inc. (a Delaware corporation) and subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Security Bancshares, Inc. and subsidiaries as of December 31, 1999 and 1998 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. Arthur Andersen LLP Birmingham, Alabama January 28, 2000 UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CONDITION December 31, 1999 and 1998 ASSETS 1999 1998 ____________ ____________ Cash and due from banks $ 12,222,761 $ 12,102,669 Interest bearing deposits in other banks 665,663 14,728,357 ____________ ____________ Total cash and cash equivalents 12,888,424 26,831,026 Investment securities available for sale 157,873,943 164,019,411 Loans, net of allowance for loan losses of $5,579,072 and $4,989,173, respectively 276,172,120 235,059,761 Premises and equipment, net depreciation of $9,432,896 and $8,436,763, respectively 9,541,383 8,225,007 Accrued interest receivable 5,663,118 4,520,783 Investment in limited partnerships 5,469,829 4,234,447 Other assets 8,989,879 7,182,352 ____________ ____________ Total assets $476,598,696 $450,072,787 ____________ ____________ ____________ ____________ LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand, noninterest bearing $ 39,235,317 $ 39,786,298 Demand, interest bearing 60,309,668 64,585,952 Savings 39,102,161 39,801,921 Time, $100,000 and over 46,053,294 40,548,173 Other time 142,050,237 141,922,237 ____________ ____________ Total deposits 326,750,677 326,644,581 OTHER LIABILITIES 5,403,417 7,001,153 SHORT-TERM BORROWINGS 17,044,989 11,742 LONG-TERM DEBT 65,728,802 55,847,223 ____________ ____________ Total liabilities 414,927,885 389,504,699 ____________ ____________ COMMITMENTS AND CONTINGENCIES (Note 18) SHAREHOLDERS' EQUITY: Common stock, par value $.01 per share; 10,000,000 shares authorized; 3,632,081 and 3,610,945 shares issued, respectively 36,320 36,109 Surplus 8,727,877 8,218,651 Accumulated other comprehensive income (loss), net of tax (1,752,880) 2,821,556 Retained earnings 54,911,314 49,743,592 Less treasury stock, 64,000 shares at cost (251,820) (251,820) ____________ ____________ Total shareholders' equity 61,670,811 60,568,088 ____________ ____________ Total liabilities and shareholders' equity $476,598,696 $450,072,787 ____________ ____________ ____________ ____________ <FN> The accompanying notes are an integral part of these consolidated statements. </FN> UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1999, 1998, and 1997 1999 1998 1997 ___________ ___________ ___________ INTEREST INCOME: Interest and fees on loans $33,776,492 $29,397,310 $22,964,581 Interest on investment securities available for sale: Taxable 9,229,339 12,087,389 12,702,142 Tax-exempt 1,527,535 1,468,851 1,735,501 Other interest and dividends 223,114 188,786 132,802 ___________ ___________ ___________ 10,979,988 13,745,026 14,570,445 Interest on trading account securities 45,335 15,267 18,323 Interest on federal funds sold 117,424 97,350 95,023 ___________ ___________ ___________ Total interest income 44,919,239 43,254,953 37,648,372 INTEREST EXPENSE: Interest on deposits 12,183,430 12,495,765 13,274,760 Interest on short-term borrowings 254,008 230,738 335,505 Interest on long-term debt 2,927,719 2,791,794 1,765,440 ___________ ___________ ___________ 15,365,157 15,518,297 15,375,705 NET INTEREST INCOME 29,554,082 27,736,656 22,272,667 PROVISION FOR LOAN LOSSES 4,305,450 3,187,103 1,710,128 ___________ ___________ ___________ Net interest income after provision for loan losses 25,248,632 24,549,553 20,562,539 NONINTEREST INCOME: Service and other charges on deposit accounts 2,044,260 2,067,722 1,878,828 Credit life insurance commissions 653,525 670,694 312,757 Investment securities gains (losses), net 533,806 410,987 105,254 Trading securities gains (losses), net 0 0 10,187 Other income 1,515,567 1,408,738 2,053,809 ___________ ___________ ___________ Total noninterest income 4,747,158 4,558,141 4,360,835 ___________ ___________ ___________ NONINTEREST EXPENSE: Salaries and employee benefits 10,755,337 9,766,080 7,823,601 Furniture and equipment expense 1,562,705 1,461,872 1,387,580 Occupancy expense 1,192,610 1,061,902 875,523 Other expense 5,023,291 4,718,118 5,142,485 ___________ ___________ ___________ Total noninterest expense 18,533,943 17,007,972 15,229,189 INCOME BEFORE INCOME TAXES 11,461,847 12,099,722 9,694,185 PROVISION FOR INCOME TAXES 3,302,131 3,521,072 2,712,727 ___________ ___________ ___________ NET INCOME $ 8,159,716 $ 8,578,650 $ 6,981,458 ___________ ___________ ___________ ___________ ___________ ___________ AVERAGE NUMBER OF SHARES OUTSTANDING 3,561,051 3,543,325 3,536,642 ___________ ___________ ___________ ___________ ___________ ___________ NET INCOME PER SHARE: Basic $ 2.29 $ 2.42 $ 1.97 ___________ ___________ ___________ ___________ ___________ ___________ Diluted $ 2.28 $ 2.40 $ 1.96 ___________ ___________ ___________ ___________ ___________ ___________ DIVIDENDS PER SHARE $ .84 $ .76 $ .53 ___________ ___________ ___________ ___________ ___________ ___________ <FN> The accompanying notes are an integral part of these consolidated statements. </FN> UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY For the Years Ended December 31, 1999, 1998 and 1997 Accumulated Other Total Common Comprehensive Retained Treasury Shareholders' Stock Surplus Income Earnings Stock at Cost Equity ________ __________ _____________ ___________ _____________ _____________ BALANCE AT DECEMBER 31, 1996 $ 36,016 $8,046,542 $ 1,045,178 $38,747,595 $(259,548) $47,615,783 Comprehensive income: Net income 0 0 0 6,981,458 0 6,981,458 Net change in unrealized gain (loss) on securities available for sale, net of tax 0 0 (32,558) 0 0 (32,558) ___________ Comprehensive income 6,948,900 Dividends declared 0 0 0 (1,870,515) 0 (1,870,515) Retirement of treasury stock (9) (5,119) 0 0 5,128 0 Exercise of stock options 11 16,369 0 0 0 16,380 ________ __________ __________ ___________ ________ ___________ BALANCE AT DECEMBER 31, 1997 36,018 8,057,792 1,012,620 43,858,538 (254,420) 52,710,548 Comprehensive income: Net income 0 0 0 8,578,650 0 8,578,650 Net change in unrealized gain (loss) on securities available for sale, net of tax 0 0 1,808,936 0 0 1,808,936 ___________ Comprehensive income 10,387,586 Dividends declared 0 0 0 (2,693,596) 0 (2,693,596) Sale of treasury stock 0 651 0 0 2,600 3,251 Exercise of stock options 91 160,208 0 0 0 160,299 ________ __________ __________ ___________ ________ ___________ BALANCE AT DECEMBER 31, 1998 36,109 8,218,651 2,821,556 49,743,592 (251,820) 60,568,088 Comprehensive income: Net income 0 0 0 8,159,716 0 8,159,716 Net change in unrealized gain (loss) on securities available for sale, net of tax 0 0 (4,574,436) 0 0 (4,574,436) ___________ Comprehensive income 3,585,280 Dividends declared 0 0 0 (2,991,994) 0 (2,991,994) Exercise of stock options 211 509,226 0 0 0 509,437 ________ __________ ___________ ___________ _________ ___________ BALANCE AT DECEMBER 31, 1999 $ 36,320 $8,727,877 $(1,752,880) $54,911,314 $(251,820) $61,670,811 ________ __________ ___________ ___________ _________ ___________ ________ __________ ___________ ___________ _________ ___________ <FN> The accompanying notes are an integral part of these consolidated statements. </FN> UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1999, 1998 and 1997 1999 1998 1997 ____________ ____________ ____________ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 8,159,716 $ 8,578,650 $ 6,981,458 Adjustments: Depreciation 878,828 797,959 894,702 Provision for loan losses 4,305,450 3,187,103 1,710,128 Deferred income tax expense (benefit) 505,053 (1,191,833) (335,835) Amortization of intangibles 549,720 636,651 604,811 (Gain) loss on sale of securities, net (533,806) (410,987) (105,254) Gain on sale of branch 0 0 (592,012) Gain on sale of fixed assets 0 0 (364,378) Equity in loss of unconsolidated investee 0 0 150,000 Amortization of premium and discounts, net 937,849 630,654 1,297,363 Changes in assets and liabilities: Increase in accrued interest receivable (1,142,335) (472,115) (381,024) (Increase) decrease in other assets (117,638) 154,628 (515,295) Increase (decrease) in interest payable (362,578) 218,808 48,849 Increase (decrease) in other liabilities (561,139) 706,108 900,534 ____________ ____________ ____________ Net cash provided by operating activities 12,619,120 12,835,626 10,294,047 ____________ ____________ ____________ CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investment securities available for sale (102,868,215) (81,139,966) (49,711,539) Proceeds from sales of investment securities available for sale 49,314,030 38,509,727 47,507,930 Proceeds from maturities and prepayments of investment securities available for sale 52,470,612 54,511,409 15,948,700 Purchases of Federal Home Loan Bank stock (494,100) (746,700) (211,260) Net cash paid in sale of branch 0 0 (6,518,424) Loan (originations) and principal repayments, net (46,653,191) (22,311,330) (15,555,151) Purchase of premises and equipment, net (2,195,204) (2,185,886) (970,598) ____________ ____________ ____________ Net cash used in investing activities (50,426,068) (13,362,746) (9,510,342) ____________ ____________ ____________ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in customer deposits 106,096 4,226,208 (14,008,721) Net increase (decrease) in short-term borrowings 17,033,247 (3,901,079) (79,260) Proceeds from FHLB advances and other borrowings 20,000,000 30,000,000 37,281,088 Repayment of FHLB advances and other borrowings (10,118,421) (15,118,421) (23,854,663) Proceeds from issuance of common stock 509,437 160,299 16,380 Dividends paid (3,666,013) (2,550,690) (1,605,654) Sale of treasury stock 0 3,251 0 ____________ ____________ ____________ Net cash (used in) provided by financing activities 23,864,346 12,819,568 (2,250,830) ____________ ____________ ____________ Net increase (decrease) in cash and cash equivalents (13,942,602) 12,292,448 (1,467,125) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 26,831,026 14,538,578 16,005,703 ____________ ____________ ____________ CASH AND CASH EQUIVALENTS, END OF YEAR $ 12,888,424 $ 26,831,026 $ 14,538,578 ____________ ____________ ____________ ____________ ____________ ____________ <FN> The accompanying notes are an integral part of these consolidated statements. </FN> UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1999 and 1998 1. DESCRIPTION OF BUSINESS United Security Bancshares, Inc. (the "Company" or "USB") and its subsidiary, First United Security Bank (the "Bank" or "FUSB") provide commercial banking services to customers located primarily in Clarke, Choctaw, Bibb, and surrounding counties in Alabama and Mississippi. The Company also owns all the stock of First Security Courier Corporation, ("FSCC") an Alabama corporation. FSCC is a courier service organized to transport items for processing to the Federal Reserve for financial institutions located in Southwest Alabama. The Bank owns all of the stock of Acceptance Loan Company, Inc. ("Acceptance" or "ALC"), an Alabama corporation. Acceptance is a finance company organized for the purpose of making consumer loans and purchasing consumer loans from vendors. Acceptance has offices located within the communities served by the Bank as well as offices outside the Bank's market area in north and southeast Alabama, eastern Mississippi, and northwest Florida. The Bank also invests in limited partnerships that operate qualified affordable housing projects to receive tax benefits. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the accounts of the Company, FSCC, the Bank and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated. The Bank's investment in limited partnerships are carried on an unconsolidated basis under either the equity or cost method based on the percentage of ownership and influence over operations. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Federal funds are generally purchased and sold for one-day periods. Supplemental disclosures of cash flow information and noncash transactions related to cash flows for the years ended December 31, 1999, 1998, and 1997 are as follows: 1999 1998 1997 ___________ ___________ ___________ Cash paid during the period for: Interest $15,296,156 $15,284,661 $15,326,856 Income taxes 3,823,494 3,648,211 2,351,304 Supplemental schedule of noncash investment and financing activities: Dividends declared but unpaid 12,061 686,080 542,796 Details of branch sale: Fair value of assets sold 0 0 3,433,740 Liabilities transferred 0 0 9,952,164 Securities Securities may be held in three portfolios: trading account securities, held to maturity securities, and securities available for sale. Trading account securities are carried at market value, with unrealized gains and losses included immediately in other income. Investment securities held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts. With regard to investment securities held to maturity, management has the intent and the Bank has the ability to hold such securities until maturity. Investment securities available for sale are carried at market value, with any unrealized gains or losses excluded from earnings and reflected, net of tax, as a separate component of shareholders' equity. Investment securities available for sale are so classified because management may decide to sell certain securities prior to maturity for liquidity, tax planning, or other valid business purposes. The Company held no securities in their trading and held to maturity portfolios at December 31, 1999 and 1998. Included in investment securities available for sale is stock in the Federal Home Loan Bank ("FHLB") of Atlanta. FHLB stock is carried at cost, has no contractual maturity, has no quoted fair value, and no ready market exists; therefore, the fair value of such stock is assumed to approximate cost. The investment in the stock is required of every member of the FHLB system. Interest earned on investment securities held to maturity, investment securities available for sale, and trading account securities is included in interest income. Amortization of premiums and discounts on investment securities is by the interest method. Net gains and losses on the sale of investment securities held to maturity and investment securities available for sale, computed principally on the specific identification method, are shown separately in noninterest income in the consolidated statements of income. Derivative Financial Instruments To hedge interest rate exposure, the Company uses derivative financial instruments consisting of interest rate swaps, caps, and floors which are accounted for using the accrual method. Net interest income or expense related to interest rate swaps, caps, and floors is recorded over the life of the agreement as an adjustment to net interest income. The premiums paid for the caps and floors are amortized straight-line over the life of the agreement. Changes in the estimated fair values of derivative financial instruments used as hedges are not reflected in the financial statements until realized. Gains or losses realized on the sales or terminations of interest rate swaps are deferred and amortized into interest income over the maturity period of the contract. The Company's criteria for use of derivatives as hedges include reduction of the risk associated with the exposure being hedged and such derivatives must be designated as a hedge at the inception of the derivative contract. Derivatives that do not meet these criteria are carried at fair value with changes in value recognized currently in earnings. Loans and Interest Income Loans are reported at the principal amounts outstanding, adjusted for unearned income, deferred loan origination fees and costs, purchase premiums and discounts, writedowns, and the allowance for loan losses. Loan origination fees, net of certain deferred origination costs, and purchase premiums and discounts are recognized as an adjustment to yield of the related loan. Interest on commercial and real estate loans is accrued and credited to income based on the principal amount outstanding. Interest on installment loans is recognized using the interest method and according to the rule of 78's, which approximates the interest method. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current and has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Allowance for Loan Losses The allowance for loan losses is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, changes in its risk profile, credit concentrations, historical trends, and economic conditions. This evaluation also considers the balance of impaired loans. Losses on individually identified impaired loans are measured based on the present value of expected future cash flows discounted at each loan's original effective market interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through the provision added to the allowance for loan losses. One-to-four family residential mortgages and consumer installment loans are subjected to a collective evaluation for impairment, considering delinquency and repossession statistics, historical loss experience, and other factors. Though management believes the allowance for loan losses to be adequate, ultimate losses may vary from their estimates. However, estimates are reviewed periodically, and as adjustments become necessary, they are reported in earnings during periods they become known. Long-Lived Assets Premises and equipment are stated at cost less accumulated depreciation. The provision for depreciation is computed using the straight-line and accelerated methods over the estimated useful lives of the assets. Goodwill intangibles are included in other assets and are amortized using the straight-line method. Goodwill is being amortized over 20 years. Impairment of long-lived ass by management based upon an event or changes in circumstances surrounding the underlying assets. Other Real Estate Real estate properties acquired through, or in lieu of, loan foreclosures are to be sold and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Costs to maintain or hold the property are expensed and amounts incurred to improve the property, to the extent that fair value is not exceeded, are capitalized. Valuations are periodically performed by management, and a valuation allowance is established by a charge to income if the carrying value of a property exceeds its fair value less the estimated costs to sell. Other real estate aggregated $295,468 and $215,250 at December 31, 1999 and 1998, respectively, and is included in other assets. Income Taxes The Company accounts for income taxes through the use of the asset and liability method. Under the asset and liability method, deferred taxes are recognized for the tax-consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates would be recognized in income in the period that includes the enactment date. Treasury Stock Treasury stock repurchases and sales are accounted for using the cost method. Earnings Per Share Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted EPS, presented now in accordance with a new accounting standard, is computed in the same manner as fully diluted EPS presented in earlier periods, except that, among other changes, the average share price for the period is used in all cases when applying the treasury stock method to potentially dilutive securities. The following table represents the earnings per share calculations for the years ended December 31, 1999, 1998, and 1997: Per Share For the Years Ended Income Shares Amount ___________________ __________ _________ ________ December 31, 1999: Net income $8,159,716 __________ Basic earnings per share 8,159,716 3,561,051 $2.29 ===== Dilutive securities 0 20,340 __________ _________ _____ Diluted earnings per share $8,159,716 3,581,391 $2.28 __________ _________ _____ __________ _________ _____ December 31, 1998: Net income $8,578,650 __________ Basic earnings per share 8,578,650 3,543,325 $2.42 ===== Dilutive securities 0 27,056 __________ _________ _____ Diluted earnings per share $8,578,650 3,570,381 $2.40 __________ _________ _____ __________ _________ _____ December 31, 1997: Net income $6,981,458 __________ Basic earnings per share 6,981,458 3,536,642 $1.97 ===== Dilutive securities 0 17,205 __________ _________ _____ Diluted earnings per share $6,981,458 3,553,847 $1.96 __________ _________ _____ __________ _________ _____ Use of Estimates The accounting principles and reporting policies of the Company, and the methods of applying these principles, conform with generally accepted accounting principles ("GAAP") and with general practices within the financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan losses and real estate owned, management obtains independent appraisals for significant properties, evaluates the overall portfolio characteristics and delinquencies and monitors economic conditions. A substantial portion of the Company's loans are secured by real estate in its primary market area. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio and the recovery of a portion of the carrying amount of foreclosed real estate are susceptible to changes in economic conditions in the Company's primary market. Reclassifications Certain 1998 and 1997 balances have been reclassified to conform to the 1999 presentation. These reclassifications have no effect on previously reported net income. Recent Accounting Pronouncements During 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities. This statement replaces existing pronouncements and practices with a single, integrated accounting framework for derivatives and hedging activities requiring companies to formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. During 1999, the FASB issued SFAS No. 137, which deferred the effective date of SFAS No. 133 to fiscal years beginning after June 15, 2000. Presently, the Company has not yet quantified the effect adoption will have on the consolidated financial statements. During 1999, the Company adopted Statement of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. This statement requires capitalization of external direct costs of materials and services; payroll and payroll-related costs for employees directly associated; and interests costs during development of computer for internal use (planning and preliminary costs should be expensed). Also, capitalized costs of computer software developed or obtained for internal use should be amortized on a straight-line basis unless another systematic and rational basis is more representative of the software's use. It is management's assertion that adoption of this Statement of Position did not have a material effect on the consolidated financial statements. During 1999, the Company implemented FASB No. 134, Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. This Statement, an amendment to SFAS No. 65, requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability to sell or hold those investments. This Statement is effective the first fiscal quarter beginning after December 15, 1998. Based on the Company's current operating activities, management contends that the implementation of this Statement did not have a material impact on the presentation of the Company's financial condition or results of operations. 3. BUSINESS COMBINATION On August 19, 1996, the Company signed a definitive agreement to merge with First Bancshares, Inc. ("FBI") of Grove Hill, Alabama effective June 30, 1997. The agreement called for the exchange of 1,398,788 shares of the Company's common stock (5.8321 shares of the Company's common stock for each share of FBI's common stock) for 100% of FBI's common stock in a transaction accounted for as a pooling-of-interests. Accordingly, the Company's financial statements were restated to include the results of FBI for all periods presented. Merger costs of approximately $650,000 were expensed in the accompanying 1997 consolidated statement of income. Combined and separate results of the Company and FBI during the period preceding the merger were as follows: USB FBI Combined ___________ ___________ ___________ Six months ended June 30, 1997 (unaudited): Net interest income $ 5,352,810 $ 5,265,778 $10,618,588 ___________ ___________ ___________ ___________ ___________ ___________ Net income $ 2,272,489 $ 1,201,565 $ 3,474,054 ___________ ___________ ___________ ___________ ___________ ___________ In conjunction with the merger, the U.S. Justice Department required the divestiture of a branch in Grove Hill, Alabama. On October 31, 1997, USB sold the branch and related assets with carrying values of $2.9 million and $10.0 million, respectively, for a net cash payment from USB of $6.5 million. The resulting gain of $592,000 is included in other income. 4. INVESTMENT SECURITIES Details of investment securities available for sale at December 31, 1999 and 1998 are as follows: December 31, 1999 _____________________________________________________________ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ____________ __________ ____________ ____________ Obligations of states, counties, and political subdivisions $ 24,550,127 $ 0 $ (178,371) $ 24,371,756 U.S. treasury securities and obligations of U.S. government agencies 2,890,727 0 (46,340) 2,844,387 Mortgage-backed securities 129,736,586 23,363 (2,633,855) 127,126,094 Equity securities 200,123 30,948 0 231,071 Corporate notes 11,488 0 (353) 11,135 FHLB stock 3,289,500 0 0 3,289,500 ____________ __________ ___________ ____________ Total $160,678,551 $ 54,311 $(2,858,919) $157,873,943 ____________ __________ ___________ ____________ ____________ __________ ___________ ____________ December 31, 1998 _____________________________________________________________ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ____________ ___________ ____________ ____________ Obligations of states, counties, and political subdivisions $ 23,841,566 $ 1,686,442 $ 0 $ 25,528,008 Mortgage-backed securities 132,587,552 3,559,540 (761,265) 135,385,827 Equity securities 200,123 45,598 (14,019) 231,702 Corporate notes 80,279 0 (1,805) 78,474 FHLB stock 2,795,400 0 0 2,795,400 ____________ ___________ ____________ ____________ Total $159,504,920 $ 5,291,580 $ (777,089) $164,019,411 ____________ ___________ ____________ ____________ ____________ ___________ ____________ ____________ The scheduled maturities of investment securities available for sale at December 31, 1999 are presented in the following table: Amortized Market Cost Value ____________ ____________ Maturing within one year $ 3,000,740 $ 3,052,783 Maturing after one but before five years 6,214,082 6,495,893 Maturing after five but before fifteen years 22,141,934 24,537,786 Maturing after fifteen years 125,832,172 120,266,910 Equity securities and FHLB stock 3,489,623 3,520,571 ____________ ____________ Total $160,678,551 $157,873,943 ____________ ____________ ____________ ____________ For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities generally mature earlier than their weighted-average contractual maturities because of principal prepayments. Investment securities with a carrying value of $75,431,232 and $70,149,059 at December 31, 1999 and 1998, respectively, were pledged to secure public deposits and for other purposes. Gross gains realized on sales of securities available for sale were $1,112,574 in 1999, $1,240,170 in 1998, and $512,843 in 1997. Gross realized losses on those sales were $578,768 in 1999, $829,183 in 1998, and $407,589 in 1997. Gross realized gains on trading account securities were $0 in 1999, $0 in 1998, and $19,111 in 1997. Gross realized losses on those sales were $0 in 1999, $0 in 1998, and $8,924 in 1997. 5. LOANS At December 31, 1999 and 1998, the composition of the loan portfolio was as follows: 1999 1998 ____________ ____________ Commercial, financial, and agricultural $ 39,996,482 $ 35,443,976 Real estate mortgage 156,978,808 123,263,732 Installment 90,599,352 86,282,286 Less: Allowance for loan losses 5,579,072 4,989,173 Unearned interest, commissions, and fees 5,823,450 4,941,060 ____________ ____________ Total $276,172,120 $235,059,761 ____________ ____________ ____________ ____________ The Bank grants commercial, real estate, and installment loans to customers primarily in Clarke, Choctaw, Bibb, and surrounding counties in southwest Alabama, northwest Florida, and southeast Mississippi. Although the Bank has a diversified loan portfolio, the ability of a substantial number of the Bank's loan customers to honor their obligations is dependent upon the timber and timber-related industries. At December 31, 1999, approximately $31,245,000 of the Bank's loan portfolio consisted of loans to customers in the timber and timber-related industries. In the ordinary course of business, the Bank makes loans to certain officers and directors of the Company and Bank, including companies with which they are associated. These loans are made on substantially the same terms as those prevailing for comparable transactions with others. Such loans do not represent more than normal risk of collectibility nor do they present other unfavorable features. The amounts of such related party loans and commitments at December 31, 1999 and 1998 were $2,073,267 and $1,692,312, respectively. During the year ended December 31, 1999, new loans to these parties totaled $918,719 and repayments were $537,764. A summary of the transactions in the allowance for loan losses follows: 1999 1998 1997 ___________ ___________ ___________ Balance at beginning of year $4,989,173 $4,045,844 $3,133,768 Acquired in branch acquisitions 242,887 0 0 Provision 4,305,450 3,187,103 1,710,128 Loans charged off (4,472,699) (2,589,300) (1,038,585) Recoveries of loans previously charged off 514,261 345,526 240,533 __________ __________ __________ Balance at end of year $5,579,072 $4,989,173 $4,045,844 __________ __________ __________ __________ __________ __________ At December 31, 1999, the Company had one loan considered to be impaired. The amount of this loan, which is on nonaccrual, is $457,468 and the related allowance is $228,734 The average recorded investment in impaired loans during the year ended December 31, 1999 was approximately $472,147. For the year ended December 31, 1999, the Company did not recognize interest income on the impaired loan during the period the loan was considered impaired. The Company had approximately $486,826 considered to be impaired at December 31, 1998. Loans on which the accrual of interest has been discontinued amounted to $1,725,008 and $3,459,814 at December 31, 1999 and 1998, respectively. If interest on those loans had been accrued, such income would have approximated $247,391, $339,710, and $153,870 for 1999, 1998, and 1997, respectively. Interest income actually recorded on those loans amounted to $211,264, $298,335, and $108,060 for 1999, 1998, and 1997, respectively. 6. PREMISES AND EQUIPMENT Premises and equipment are summarized as follows: 1999 1998 ___________ ___________ Land $ 1,037,436 $ 1,037,436 Premises (40 years) 8,539,348 7,656,911 Furniture, fixtures, and equipment (3-7 years) 9,397,495 7,967,423 ___________ ___________ 18,974,279 16,661,770 Less accumulated depreciation 9,432,896 8,436,763 ___________ ___________ Total $ 9,541,383 $ 8,225,007 ___________ ___________ ___________ ___________ Depreciation expense of $878,828, $797,959, and $894,702 was recorded in 1999, 1998, and 1997, respectively, on premises and equipment. 7. INVESTMENT IN LIMITED PARTNERSHIPS The Bank invests in limited partnerships that operate qualified affordable housing projects to receive tax benefits in the form of tax deductions from operating losses and tax credits. The Bank accounts for the investments under either the equity or cost method based on the percentage ownership and influence over operations. The Bank's interest in these partnerships was $5,469,829 and $4,234,447 at December 31, 1999 and 1998, respectively. Losses related to these partnerships amounted to approximately $119,000, $128,000, and $122,000 for 1999, 1998, and 1997 respectively. Management analyzes these investments annually for potential impairment. The assets and liabilities of these partnerships consist primarily of apartment complexes and related mortgages. The Bank's carrying value approximates cost or its underlying equity in the net assets of the partnerships. Market quotations are not available for any of the aforementioned partnerships. The Bank has remaining cash commitments to these partnerships at December 31, 1999 in the amount of approximately $36,000. 8. DEPOSITS At December 31, 1999, the scheduled maturities of the Bank's time deposits greater than $100,000 are as follows: 2000 $32,328,387 2001 9,073,991 2002 1,773,247 2003 2,011,135 2004 and thereafter 866,534 ___________ $46,053,294 ___________ ___________ Additionally, included in the Bank's other time deposits at December 31, 1999 is $6,303,081 in state and municipal time deposits greater than $100,000 and maturing within one year. 9. SHORT-TERM BORROWINGS Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase which generally mature within one to four days from the transaction date, treasury tax and loan deposits which are withdrawable on demand, and FHLB advances with original maturities in less than one year. Information concerning short-term borrowings is as follows: 1999 __________________________________________ Treasury Federal Tax and Funds Repurchase Loan Purchased Agreements Deposits ____________ ___________ ___________ Average balance during the year $ 4,070,482 $ 82,914 $ 765,458 ___________ __________ __________ ___________ __________ __________ Average interest rate during the year 5.07% 5.46% 5.66% ___________ __________ __________ ___________ __________ __________ Maximum month-end balance during the year $14,600,000 $ 0 $2,504,952 ___________ __________ __________ ___________ __________ __________ 1998 ___________________________ Treasury Federal Tax and Funds Loan Purchased Deposits ___________ ___________ Average balance during the year $3,081,863 $ 846,955 __________ __________ __________ __________ Average interest rate during the year 5.83% 5.90% __________ __________ __________ __________ Maximum month-end balance during the year $9,100,000 $2,520,307 __________ __________ __________ __________ At December 31, 1999, the Bank has $23.4 million in available federal fund lines from correspondent banks. 10. LONG-TERM DEBT The Company uses Federal Home Loan Bank advances as an alternative to funding sources with similar maturities such as certificates of deposit or other deposit programs. These advances generally offer more attractive rates when compared to other mid-term financing options. They are also flexible, allowing the Company to quickly obtain the necessary maturities and rates that best suit its overall asset/liability strategy. Investment securities and 1-4 family mortgage loans secure these borrowings. The following summarizes information concerning Federal Home Loan Bank advances and other borrowings: 1999 1998 ____________ ___________ Average balance $57,781,427 $55,453,921 Maximum month-end balance during year $65,788,012 $55,906,433 Average rate paid 5.07% 5.53% Weighted average remaining maturity 6.14 years 7.25 years Scheduled maturities of Federal Home Loan Bank advances in 2000 are approximately $5 million. Maturities during 2001 are approximately $10 million. There are no scheduled maturities in 2002. In 200 million in scheduled maturities. In years subsequent to 2003, maturities total approximately $40 million. At December 31, 1999, the Bank has $18.2 million in available credit from the Federal Home Loan Bank. 11. INCOME TAXES The consolidated provisions (benefits) for income taxes for the years ended December 31 were as follows: 1999 1998 1997 __________ ____________ ___________ Federal Current $2,441,731 $ 4,146,035 $2,714,017 Deferred 449,361 (1,059,525) (298,811) __________ ___________ __________ 2,891,092 3,086,510 2,415,206 State Current 355,347 566,870 334,545 Deferred 55,692 (132,308) (37,024) __________ ___________ __________ 411,039 434,562 297,521 __________ __________ __________ Total $3,302,131 $3,521,072 $2,712,727 __________ __________ __________ __________ __________ __________ The consolidated tax provision differed from the amount computed by applying the federal statutory income tax rate to pretax earnings for the following reasons: 1999 1998 1997 __________ __________ __________ Income tax expense at federal statutory rate $3,897,028 $4,113,755 $3,294,833 Increase (decrease) resulting from: Tax-exempt interest (508,501) (561,148) (600,744) State income tax expense net of federal income tax benefit 271,286 286,810 196,364 Tax credits (low income housing) (540,000) (490,000) (480,000) Other 182,318 171,655 302,274 __________ __________ __________ Total $3,302,131 $3,521,072 $2,712,727 __________ __________ __________ __________ __________ __________ Effective tax rate 29% 29% 28% __________ __________ __________ __________ __________ __________ The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998, are presented below: 1999 1998 ___________ ___________ Deferred tax assets: Allowance for loan losses $1,498,068 $2,095,795 Accrued vacation 22,200 22,200 Capital loss carryover 27,041 80,443 Deferred commissions and fees 594,909 514,925 Unrealized loss on securities available for sale 1,051,728 0 Other 167,272 574,715 __________ __________ Total gross deferred tax asset 3,361,218 3,288,078 Valuation allowance 27,041 (75,903) __________ __________ Net deferred tax assets 3,334,177 3,212,175 __________ __________ Deferred tax liabilities: Premises and equipment 518,225 501,986 Limited partnerships 210,522 224,035 Unrealized gain on securities available for sale 0 1,692,935 Other deferred tax liabilities 327,526 754,945 __________ __________ Total gross deferred tax liabilities 1,056,273 3,173,901 __________ __________ Net deferred tax asset (liability) $2,227,904 $ 38,274 __________ __________ __________ __________ 12. EMPLOYEE BENEFIT PLANS The Company sponsors an Employee Stock Ownership Plan with 401(k) provisions. This plan covers substantially all employees and allows employees to contribute up to 15% of their compensation on a before-tax basis. The Company may make discretionary contributions to match employee contributions dollar for dollar up to 6% of an employee's compensation. Employees have the option to allocate some or all of their contributions towards the purchase of Company stock. The Company made matching contributions totaling $451,483 and $284,432 in 1999 and 1998, respectively. 13. LONG-TERM INCENTIVE COMPENSATION PLAN During 1997, the Company's shareholders' approved the adoption of the United Security Bancshares, Inc. Long Term Incentive Compensation Plan ("LTICP"). This plan provides for a number of forms of stock based compensation for key employees of USB and its subsidiaries. Under the plan, eligible employees may be awarded incentive and nonqualified stock options, stock appreciation rights, and restricted stock. The LTICP provides for the issuance of up to 60,000 shares of USB common stock with a par value of $.01 per share. In addition, each option expires no later than five years after the grant date. The exercise price of each option is determined by the compensation committee, but in the case of incentive stock options, the price shall not be less than the fair market value on the grant date. The Company continues to record compensation cost under Accounting Principles Board Opinion ("APB") No. 25. Had compensation cost been determined, consistent with the fair value based method of recording for stock-based compensation allowed for under SFAS No. 123, the Company's net income would have been decreased to the following pro forma amounts: Fiscal Year Fiscal Year Fiscal Year Ended Ended Ended December 31, December 31, December 31, 1999 1998 1997 ____________ ____________ ____________ Net income-as reported $8,159,716 $8,578,650 $6,981,458 Net income-pro forma 7,953,163 8,372,098 6,805,635 Basic net income per share-as reported 2.29 2.42 1.97 Basic net income per share-pro forma 2.23 2.36 1.92 Diluted net income per share-as reported 2.28 2.40 1.96 Diluted net income per share-pro forma 2.22 2.34 1.91 A summary of the status of the Company's stock option plan at December 31, 1999, 1998, and 1997 and the changes during the year then ended is as follows: 1999 1998 1997 __________________ __________________ __________________ Exercise Exercise Exercise Shares Price Shares Price Shares Price ______ ________ ______ ________ ______ ________ Outstanding at beginning of year 47,690 $17.72 56,250 $17.50 0 $ 0.00 Granted 2,050 36.25 600 35.00 57,350 17.50 Exercised 21,136 17.50 9,160 17.50 1,100 17.50 ______ ______ ______ ______ ______ ______ Outstanding at end of year 28,604 $19.21 47,690 $17.72 56,250 $17.50 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ Exercisable at end of year 28,604 $19.21 47,690 $17.72 56,250 $17.50 ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ ______ Fair value of options granted $4.71 $4.33 $4.22 ______ ______ ______ ______ ______ ______ The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: a risk free interest rate based on zero coupon governmental issues at grant date with the maturity equal to the expected term of the options (5.00%, 4.54%, and 6.27% for 1999, 1998, and 1997), no expected forfeiture rate as options are immediately vested at date of grant, an expected stock volatility of 29%, 26%, and 26% and an expected annual dividend yield of $.84, $.76, and $.53 per share for 1999, 1998, 1997, respectively. 14. SHAREHOLDERS' EQUITY Dividends are paid by the Company from its assets, which are primarily dividends from the Bank. However, certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans, or advances. As of December 31, 1999, approximately $9.7 million of the Bank's retained earnings was available for dividend distribution without prior regulatory approval. The Company is subject to various regulatory capital requirements that prescribe quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items. The Company's regulators have also imposed qualitative guidelines for capital amounts and classifications such as risk weightings, capital components, and other details. The quantitative measures to ensure capital adequacy require that the Company maintain amounts and ratios, as set forth in the schedule below, of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and Tier I capital to average total assets (as defined). Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Management believes, as of December 31, 1999, that the Company meets all capital adequacy requirements imposed by its regulators. As of December 31, 1999 and 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There have been no conditions or events since that notification that Management believes have changed the institution's category. Actual capital amounts as well as required and well capitalized Tier I, total, and Tier I leverage ratios as of December 31 for the Company and the Bank are as follows: 1999 _______________________________________________________________ To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions __________________ _________________ _________________ Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) Total Capital (to Risk Weighted Assets): United Security Bancshares, Inc. $62,672 19.05% $26,312 8.00% N/A N/A First United Security Bank 58,519 16.52 28,332 8.00 35,415 10.00% Tier I Capital (to Risk Weighted Assets): United Security Bancshares, Inc. 58,528 17.79 13,156 4.00 N/A N/A First United Security Bank 54,083 15.27 14,166 4.00 21,249 6.00 Tier I Leverage (to Average Assets): United Security Bancshares, Inc. 58,528 12.47 14,080 3.00 N/A N/A First United Security Bank 54,083 11.77 13,785 3.00 22,976 5.00 1998 _______________________________________________________________ To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio _______ _______ _______ _____ _______ _____ (Dollars in thousands) Total Capital (to Risk Weighted Assets): United Security Bancshares, Inc. $56,370 17.37% $25,967 8.00% N/A N/A First United Security Bank 52,531 16.28 25,809 8.00 $32,261 10.00% Tier I Capital (to Risk Weighted Assets): United Security Bancshares, Inc. 52,590 16.20 12,983 4.00% N/A N/A First United Security Bank 48,499 15.03 12,905 4.00 19,357 6.00 Tier I Leverage (to Average Assets): United Security Bancshares, Inc. 52,590 12.07 13,067 3.00% N/A N/A First United Security Bank 48,499 11.24 12,941 3.00 21,568 5.00 Comprehensive Income Comprehensive Income. Comprehensive income is the change in equity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. In addition to net income, the Company has identified changes related to other nonowner transactions in the consolidated statement of changes in stockholders' equity and comprehensive income. For the Company, changes in other nonowner transactions consist entirely of changes in unrealized gains and losses on securities available for sale. In the calculation of comprehensive income, certain reclassification adjustments are made to avoid double counting items that are displayed as part of net income and other comprehensive income in that period or earlier periods. The following table reflects the reclassification amounts and the related tax effects for the three years ended December 31: 1999 _______________________________________________ Before After Tax Tax Tax Amount Effect Amount ____________ ____________ ____________ Unrealized gains (losses) arising during the period $(6,785,292) $(2,547,154) $(4,238,138) Less reclassification adjustments for (gains) losses included in net income (533,806) (197,508) (336,298) ___________ ___________ ___________ Net unrealized gain/(loss) on securities $(7,319,098) $(2,744,662) $(4,574,436) ___________ ___________ ___________ ___________ ___________ ___________ 1998 _______________________________________________ Before After Tax Tax Tax Amount Effect Amount ____________ ____________ ____________ Unrealized gains (losses) arising during the period $ 3,282,314 $ 1,214,456 $ 2,067,858 Less reclassification adjustments for (gains) losses included in net income (410,987) (152,065) (258,922) ___________ ___________ ___________ Net change in unrealized gain/(loss) on securities $ 2,871,327 $ 1,062,391 $ 1,808,936 ___________ ___________ ___________ ___________ ___________ ___________ 1997 _______________________________________________ Before After Tax Tax Tax Amount Effect Amount ____________ _____________ ____________ Unrealized gains (losses) arising during the period $ 53,575 $ 19,823 $ 33,752 Less reclassification adjustments for (gains) losses included in net income (105,254) (38,944) (66,310) ___________ ___________ ___________ Net change in unrealized gain/(loss) on securities $ (51,679) $ (19,121) $ (32,558) ___________ ___________ ___________ ___________ ___________ ___________ 15. SEGMENT REPORTING Under SFAS No. 131, "Disclosure 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 significant subsidiaries. The accounting policies for each segment are the same as those used by the Company as described in Note 2--Summary of Significant Accounting Policies. 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. 1999 ______________________________________________________________ FUSB ALC All Other Eliminations Consolidated ________ ________ _________ ____________ ____________ (In thousands) Total interest income $ 34,390 $16,251 $ 173 $ (5,895) $ 44,919 Total interest expense 15,365 5,895 0 (5,895) 15,365 ________ ________ ________ _________ ________ Net interest income 19,025 10,356 174 0 29,554 Provision for loan losses 153 4,152 0 0 4,305 ________ ________ ________ _________ ________ Net interest income after provision 18,872 6,204 174 0 25,249 Total noninterest income 3,669 1,046 8,353 (8,321) 4,747 Total noninterest expense 11,651 6,591 299 (7) 18,534 ________ _______ ________ _________ ________ Income (loss) before income taxes (tax benefit) 10,890 659 8,227 (8,314) 11,462 Provision for income taxes (income tax benefit) 3,027 279 (4) 0 3,302 ________ _______ _______ _________ Net income (loss) $ 7,863 $ 380 $ 8,231 $ (8,314) $ 8,160 ________ _______ _______ _________ ________ ________ _______ _______ _________ ________ Other significant items: Total assets $470,889 $79,399 $85,092 $(158,781) $476,599 Total investment securities 153,946 0 3,928 0 157,874 Total loans, net 279,642 72,695 0 (76,165) 276,172 Investment in subsidiaries 1,241 0 56,215 (57,456) 0 Total interest income from external customers 28,494 16,251 174 0 44,919 Total interest income from affiliates 5,895 0 0 (5,895) 0 1998 ______________________________________________________________ FUSB ALC All Other Eliminations Consolidated ________ ________ _________ ____________ ____________ (In thousands) Total interest income $ 35,523 $12,141 $ 133 $ (4,542) $ 43,255 Total interest expense 15,518 4,542 0 (4,542) 15,518 ________ ________ ________ _________ ________ Net interest income 20,005 7,599 133 0 27,737 Provision for loan losses 762 2,425 0 0 3,187 ________ ________ ________ _________ ________ Net interest income after provision 19,243 5,174 133 0 24,550 Total noninterest income 3,580 936 9,096 (9,054) 4,558 Total noninterest expense 12,015 4,696 313 (16) 17,008 ________ ________ ________ _________ ________ Income (loss) before income taxes (tax benefit) 10,808 1,414 8,916 (9,038) 12,100 Provision for income taxes (tax benefit) 2,967 557 (3) 0 3,521 ________ _______ _______ _________ ________ Net income (loss) $ 7,841 $ 857 $ 8,919 $ (9,038) $ 8,579 ________ _______ _______ _________ ________ ________ _______ _______ _________ ________ Other significant items: Total assets $444,408 $67,902 $61,816 $(124,053) $476,599 Total investment securities 160,916 0 3,103 0 164,019 Total loans, net 236,274 64,486 0 (65,700) 235,060 Investment in wholly-owned subsidiaries 384 0 55,338 (55,722) 0 Total interest income from external customers 30,981 12,141 133 0 43,255 Total interest income from affiliates 2,560 0 0 (2,560) 0 1997 ______________________________________________________________ FUSB ALC All Other Eliminations Consolidated ________ _______ _________ ____________ ____________ (In thousands) Total interest income $ 35,213 $ 4,166 $ 5 $ (1,736) $ 37,648 Total interest expense 15,253 1,731 127 (1,736) 15,375 Net interest income 19,960 2,435 (122) 0 22,273 Provision for loan losses 657 1,053 0 0 1,710 ________ ________ ________ _________ Net interest income after provision 19,303 1,382 (122) 0 20,563 Total noninterest income 4,113 309 7,569 (7,631) 4,360 Total noninterest expense 12,441 2,264 600 (76) 15,229 ________ ________ ________ _________ Income (loss) before income taxes (tax benefit) 10,975 (573) 6,847 (7,555) 9,694 Provision for income taxes (tax benefit) 3,081 (228) (140) 0 2,713 ________ _______ _______ _________ Net income (loss) $ 7,894 $ (345) $ 6,987 $ (7,555) $ 6,981 ________ _______ _______ _________ ________ _______ _______ _________ Other significant items: Total assets $428,851 $36,624 $53,384 $ (92,918) $425,941 Total investment securities 172,436 0 63 0 172,499 Total loans, net 217,363 34,134 0 (35,600) 215,897 Investment in subsidiaries 842 0 51,026 (51,868) 0 Total interest income from external customers 33,482 4,166 0 0 37,648 Total interest income from affiliates 1,736 0 0 (1,736) 0 16. OTHER OPERATING EXPENSES Other operating expenses for the years 1999, 1998, and 1997 consist of the following: 1999 1998 1997 __________ __________ __________ Telephone expense $ 548,122 $ 543,509 $ 478,060 Amortization of intangibles 549,720 636,651 604,811 Postage, stationery, and supplies 762,201 246,051 680,248 Merger expense 0 0 650,330 Other 3,163,248 3,291,907 2,729,036 __________ __________ __________ Total $5,023,291 $4,718,118 $5,142,485 __________ __________ __________ __________ __________ __________ 17. OPERATING LEASES The Company leases office space, data processing, and other equipment under operating leases. The following is a schedule, by years, of future minimum rental payments required under operating leases having initial or remaining noncancellable terms in excess of one year as of December 31, 1999: Year ending December 31, 2000 $390,844 2001 227,550 2002 93,592 2003 32,500 2004 and thereafter 31,633 Total rental expense under all operating leases was $389,519, $532,056, and $347,377 in 1999, 1998, and 1997, respectively. 18. 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, the ultimate disposition of these matters is not expected to have a material adverse effect on the financial position or results of operations of the Company. 19. 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 make loans, options written, standby letters of credit, commitments to purchase or sell securities for forward delivery, interest rate caps and floors purchased, caps sold, and interest rate swaps. 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 caps, floors, and swap transactions, options written, 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 instruments through credit approvals, limits, and monitoring procedures. The Bank has credit risk on caps and floors for the carrying value plus the amount to replace such contracts in the event of counterparty default. The Bank is fully cross-collateralized with counterparties on all interest rate swap agreements. At December 31, 1999, the Bank estimates its credit risk on purchased caps and floors in the event of total counterparty default to be $301,000. All of the Bank's financial instruments are held for risk management and not for trading purposes. 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. December 31, __________________ 1999 1998 _______ ______ (In thousands) Standby letters of credit $ 6,175 $ 6,477 Commitments to extend credit 21,819 23,546 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, and equipment, and income-producing commercial properties. At December 31, 1999 and 1998, commitments to purchase and sell securities for delayed delivery are summarized as follows: December 31, ____________________ 1999 1998 ________ _______ (In thousands) Commitments to purchase securities for delayed delivery $ 0 $ 0 Commitments to sell securities for delayed delivery 0 12,000 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. 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 and caps. An interest rate swap is an agreement in which two parties agree to exchange, at specified intervals, interest payment streams calculated on an agreed-upon notional principal amount with at least one stream based on a specified floating-rate index. Interest rate swaps are used by the Bank to effectively convert floating-rate securities with a one-month LIBOR rate index to a five-year constant maturity treasury index. Interest rate caps and floors are option-like contracts that require the seller to pay the purchaser at specified future dates the amount, if any, by which a specified market interest rate exceeds the fixed cap rate or falls below the fixed floor rate, applied to a notional principal amount. The Bank uses floors to protect CMO floaters and variable rate loans against a decline in rates. The Bank uses caps purchased to partially hedge against rising interest rates on their floating rate short-term borrowings and to uncap a portion of their floating rate CMO portfolio. They also use caps purchased matched with sold caps to raise, by 100 basis points, the cap on certain CMO floaters. These matches are also referred to as "corridors." The cost of the caps and floors are amortized straight-line over the life of these instruments. The income derived from these instruments is recorded on the accrual basis. The income and amortization from these instruments is recorded in net interest income and resulted in a reduction in net interest income of $223,217, $164,006, and $208,316 in 1999, 1998, and 1997, respectively. Interest-rate futures contracts are entered into by the Bank as hedges against exposure to interest-rate risk and are not for speculative purposes. Changes in the market value of interest-rate futures contracts are deferred while the contracts are open and subsequently amortized into interest income or expense over the maturity period of the hedged assets or liabilities after the contract closes. The following table details various information regarding swaps, caps, floors and forward contracts used for purposes other than trading as of December 31, 1999: Weighted Weighted Average Weighted Average Repricing Notional Carrying Estimated Average Rate Years to Frequency Amount Value Fair Value Received Paid Expiration (Days) ________ ______ __________ ________ ______ __________ _________ (Dollars in thousands) Swaps: Pay floating, receive 5 year 1 month floating $ 20,000 $ 0 $(103) CMT LIBOR 2.04 30 Caps: Purchased 62,000 211 302 0.0175% N/A 1.15 30-90 Sold 10,000 0 0 N/A 0.00% .13 30 ________ ______ _____ $ 92,000 $ 211 $ 199 ________ ______ _____ ________ ______ _____ Swaps, caps, and floors acquired for other than trading purposes are used to help reduce the risk of interest rate movements for specific categories of assets and liabilities. At December 31, 1999, such swaps, caps, and floors were associated with the following asset or liability categories: Notional Principal Associated With __________________________ Notional Fixed Floating Rate Amount Rate Loans Securities ________ __________ ___________ (In thousands) Swaps: Pay floating, receive floating $ 20,000 $ 0 $ 20,000 Caps: Purchased 62,000 44,130 17,870 Sold 10,000 0 10,000 ________ _______ ________ $ 92,000 $44,130 $ 47,870 ________ _______ ________ ________ _______ ________ Income or expense on derivative financial instruments used to manage interest rate exposure is recorded on an accrual basis as an adjustment to the yield of the related interest-earning assets or interest-bearing liabilities over the periods covered by the contracts. If a derivative financial instrument that is used to manage interest rate risk is terminated early, any resulting gain or loss is deferred and amortized over the remaining periods originally covered by the derivative financial instrument. Deferred gains on early termination of interest rate swaps used to manage interest rate risk are $253,069, $132,834, and $229,221 as of December 31, 1999, 1998, and 1997, respectively, with related amortization into income of $150,043, $147,887, and $234,459 for the years ended December 31, 1997, respectively. Fiscal 1999 amounts are scheduled to be amortized into income in the following periods: $90,902 gain in 2000, $81,083 gain in 2001, and $81,083 gain in 2002. All of the Bank's derivative financial instruments are over-the-counter instruments and are not exchange traded. Market values are obtained from the counterparties to each instrument. The Bank only uses other commercial banks as a counterparty to their derivative activity. The Bank performs stress tests and other models to assess risk exposure. 20. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the statement of condition, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company's financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination, or issuance. The Company has not undertaken any steps to value any intangibles. The Company in estimating the fair value of its financial instruments used the following methods and assumptions: Cash and due from banks: Fair value equals the carrying value of such assets. Investment securities available for sale: Fair values for investment securities are based on quoted market prices. Accrued interest receivable and payable: Fair value equals the carrying value of these instruments. Loans: For variable rate loans, those repricing within six months, fair values are based on carrying values. Fixed rate commercial loans, other installment loans, and certain real estate mortgage loans were valued using discounted cash flows. The discount rate used to determine the present value of these loans was based on interest rates currently being charged by the Bank on comparable loans as to credit risk and term. Off-balance-sheet instruments: Fair values of the Company's off-balance-sheet instruments (futures, forwards, swaps, caps, floors, and options written) are based on values obtained from counterparties, or other quotations received from third parties. The Company's loan commitments are negotiated at current market rates and are relatively short-term in nature. As a matter of policy, the Company generally makes commitments for fixed rate loans for relatively short periods of time. Because of this policy and the absence of any known credit exposure, the estimated value of the Company's loan commitments is nominal. Demand and savings deposits: The fair values of demand deposits are equal to the carrying value of such deposits. Demand deposits include noninterest bearing demand deposits, savings accounts, NOW accounts, and money market demand accounts. Time deposits: The fair value of relatively short-term time deposits is equal to their carrying values. Discounted cash flows have been used to value long-term time deposits. The discount rate used is based on interest rates currently being offered by the Bank on comparable deposits as to amount and term. Short-term borrowings: These borrowings may consist of federal funds purchased, securities sold under agreements to repurchase, floating rate borrowings from the Federal Home Loan Bank and the U.S. Treasury Tax and Loan account. Due to the short-term nature of these borrowings, fair values approximate carrying values. Long-term debt: The fair value of this debt is estimated using discounted cash flows based on the Company's current incremental borrowing rate for similar types of borrowing arrangements. At December 31, 1999 At December 31, 1998 _______________________ ______________________ Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value _________ __________ ________ __________ (In thousands) Assets: Cash and cash equivalents $ 12,888 $ 12,888 $ 26,831 $ 26,831 Investment securities available for sale 157,874 157,874 164,019 164,019 Accrued interest receivable 5,663 5,663 4,521 4,521 Loans, net 281,751 280,045 235,060 237,246 Off-balance-sheet instruments 211 198 501 (237) Liabilities: Deposits 326,751 327,353 326,645 327,774 Short-term borrowing 17,045 17,045 12 12 Long-term debt 65,729 65,968 55,847 56,000 21. UNITED SECURITY BANCSHARES, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION Statements of Condition December 31, ___________________________ 1999 1998 ___________ ___________ ASSETS: Cash on deposit $ 502,355 $ 1,826,501 Investment in subsidiaries 56,133,015 55,337,773 Investments available for sale 3,928,026 3,103,340 Other assets 1,139,832 1,185,211 ___________ ___________ $61,703,228 $61,452,825 ___________ ___________ ___________ ___________ LIABILITIES: Other liabilities $ 32,417 $ 884,737 SHAREHOLDERS' EQUITY 61,670,811 60,568,088 ___________ ___________ $61,703,228 $61,452,825 ___________ ___________ ___________ ___________ Statements of Income Year Ended December 31, ________________________________________ 1999 1998 1997 __________ __________ __________ INCOME Dividend income, First United Security Bank $2,991,994 $6,183,651 $5,526,531 Interest income 179,103 137,654 496 Investment securities gains (losses), net 0 24,797 0 __________ __________ __________ Total income 3,171,097 6,346,102 5,527,027 EXPENSES 256,910 278,990 573,588 __________ __________ __________ INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 2,914,187 6,067,112 4,953,439 EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 5,245,529 2,511,538 2,028,019 __________ __________ __________ Net income $8,159,716 $8,578,650 $6,981,458 __________ __________ __________ __________ __________ __________ Statements of Cash Flows Year Ended December 31, ___________________________________________ 1999 1998 1997 ___________ ___________ ___________ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 8,159,716 $ 8,578,650 $ 6,981,458 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed income of subsidiaries (5,245,529) (2,511,538) (2,028,019) (Increase) decrease in other assets 45,379 41,538 548,541 Increase (decrease) in other liabilities (356,583) 85,864 36,876 ___________ ___________ ___________ Net cash provided by operating activities 2,602,983 6,194,513 5,485,577 ___________ ___________ ___________ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investment securities available for sale (770,553) (3,003,161) 0 ____________ ___________ ___________ Net cash used in investing activities (770,553) (3,003,161) 0 CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on other borrowings 0 0 (3,004,000) Proceeds from sale of treasury stock 0 3,251 0 Proceeds from issuance of common stock 509,437 160,299 16,380 Cash dividends paid (3,666,013) (2,550,690) (1,650,654) ___________ ___________ ___________ Net cash used in financing activities (3,156,576) (2,387,140) (4,593,024) INCREASE IN CASH (1,324,146) 804,212 892,553 CASH AT BEGINNING OF YEAR 1,826,501 1,022,289 129,736 ___________ ___________ ___________ CASH AT END OF YEAR $ 502,355 $ 1,826,501 $ 1,022,289 ___________ ___________ ___________ ___________ ___________ ___________ Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. PART III Item 10. Directors and Executive Officers of the Registrant. The information called for in this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Election of Directors," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1999. Item 11. Executive Compensation. The information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Executive Compensation and Benefits," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1999. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Voting Securities and Principal Stockholders," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1999. Item 13. Certain Relationships and Related Transactions. The information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Certain Relationships and Related Transactions," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1999. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a)1. Financial Statements Report of Independent Public Accountants. Consolidated Statements of Condition, December 31, 1999 and 1998. Consolidated Statements of Shareholders' Equity, December 31, 1999, 1998, and 1997. Consolidated Statements of Income, December 31, 1999, 1998, and 1997. Consolidated Statements of Cash Flows, December 31, 1999, 1998, and 1997. Notes to Consolidated Financial Statements. (a)2. Financial Statements Schedules Included in Part II of this report: The financial statement schedules required to be included pursuant to this Item are not included herein because they are not applicable or the required information is shown in the financial statements or notes thereto, which are included at Part II, Item 8, of this report. (a)3. Exhibits (3)(a) Certificate of Incorporation of Bancshares incorporated herein by reference to the Exhibits to Form 10-Q for the Quarter ended September 30, 1999. (3)(b) Bylaws of Bancshares, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 1999. (10)(a) The United Security Bancshares, Inc. Employee Stock Ownership Plan, as amended dated January 1, 1992, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1992, file with the Commission in Washington, D.C., File No. 0-14549. (10)(b) Amendments to the United Security Bancshares, Inc. Employee Stock Ownership Plan, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1997. (10)(c) Employment Agreement dated January 1, 1999, between Bancshares and R. Terry Phillips incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1998. (10)(d) Form of Indemnification Agreement between Bancshares and its directors, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1994, filed with the Commission in Washington, D.C., File No. 0-14549. (10)(e) United Security Bancshares, Inc. Long Term Incentive Compensation Plan, incorporated herein by reference to the Exhibits to Form S-4 dated April 16, 1997 (No. 333-21241). (13) Bancshares' definitive proxy statement for 2000 annual meeting of shareholders, to be days after the end of the fiscal year ended December 31, 1999, furnished for the information of the Commission. (21) List of Subsidiaries of Bancshares. (27) Financial Data Schedule (b) Reports on Form 8-K No reports on Form 8-K were filed during the fourth quarter of the year ended December 31, 1999. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. By: /s/ R. Terry Phillips March 23, 2000 _____________________ R. Terry Phillips Its President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date _____________________ ______________________________ ______________ /s/ R. Terry Phillips President, Chief Executive March 23, 2000 ________________________ Officer, and Director R. Terry Phillips (Principal Executive Officer) /s/ Larry M. Sellers Treasurer (Principal Financial March 23, 2000 ________________________ Officer, Principal Accounting Larry M. Sellers Officer) /s/ Dan Barlow Director March 23, 2000 ________________________ Dan Barlow /s/ Linda Breedlove Director March 23, 2000 ________________________ Linda Breedlove /s/ Gerald P. Corgill Director March 23, 2000 ________________________ Gerald P. Corgill Director March 23, 2000 ________________________ Roy G. Cowan /s/ Waynce C. Curtis Director March 23, 2000 ________________________ Wayne C. Curtis /s/ John C. Gordon Director March 23, 2000 ________________________ John C. Gordon /s/ William G. Harrison Director March 23, 2000 ________________________ William G. Harrison /s/ Fred L. Huggins Director March 23, 2000 ________________________ Fred L. Huggins /s/ Hardie B. Kimbrough Director March 23, 2000 ________________________ Hardie B. Kimbrough /s/ Jack W. Meigs Director March 23, 2000 ________________________ Jack W. Meigs /s/ James L. Miller Director March 23, 2000 ________________________ James L. Miller /s/ Ray Sheffield Director March 23, 2000 ________________________ Ray Sheffield /s/ James C. Stanley Director March 23, 2000 ________________________ James C. Stanley /s/ Clarence Watters Director March 23, 2000 ________________________ Clarence Watters /s/ Howard M. Whitted Director March 23, 2000 ________________________ Howard M. Whitted /s/ Bruce N. Wilson Director March 23, 2000 ________________________ Bruce N. Wilson EXHIBIT 21 List of Subsidiaries Name Where Organized ____ _______________ First United Security Bank Alabama Acceptance Loan Company, Inc. Alabama First Security Courier Corporation Alabama FUSB Reinsurance, Inc. Arizona