Item 1. Business.
General
United Security Bancshares, Inc. (“Bancshares”) is a Delaware corporation organized in 1999, as a successor by merger with 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 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’s wholly-owned Arizona subsidiary, FUSB Reinsurance, Inc. (“FUSB Reinsurance”), reinsures or “underwrites” credit life and credit accident and health insurance policies sold to the Bank’s consumer loan customers. FUSB Reinsurance is responsible for the first level of risk on these policies up to a specified maximum amount, and the primary third-party insurer retains the remaining risk. The third-party insurer and/or a third-party administrator is responsible for performing most of the administrative functions of FUSB Reinsurance on a contract basis.
The Bank has eighteen banking offices, which are located in Thomasville, Coffeeville, Fulton, Gilbertown, Grove Hill, Butler, Jackson, Brent, Centreville, Woodstock, Bucksville, Calera, Harpersville and Tuscaloosa, Alabama, and its market area includes portions of Bibb, Chilton, Clarke, Choctaw, Hale, Jefferson, Marengo, Monroe, Perry, 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, 2003, the Bank had 184 full-time equivalent employees, ALC had 100 full-time equivalent employees and Bancshares had no employees, other than the executive officers of Bancshares who are indicated in Part III, Item 10 of this report.
Competition
Bancshares and its subsidiaries encounter 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 ten 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.
The Gramm-Leach-Bliley Act (the “GLB Act”), which became effective March 11, 2000, 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 represented at the time of enactment 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 among 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, which has increased 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 have increased and are likely to continue increasing 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 southeastern United States.
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 shareholders. 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 1991 with the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), numerous additional regulatory requirements have been placed on the banking industry in the past fifteen 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 (“the 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.
The GLB Act also establishes a minimum federal standard of financial privacy. In general, the applicable regulations issued by the various federal regulatory agencies prohibit affected financial institutions (including banks, insurance agencies and broker/dealers) from sharing information about their customers with non-affiliated third parties unless (1) the financial institution has first provided a privacy notice to the customer; (2) the financial institution has given the customer an opportunity to opt out of the disclosure; and (3) the customer has not opted out after being given a reasonable opportunity to do so.
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 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.
On October 26, 2001, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”) was signed into law. The USA Patriot Act broadened the application of anti-money laundering regulations to apply to additional types of financial institutions, such as broker-dealers, and strengthened the ability of the U.S. government to detect and prosecute international money laundering and the financing of terrorism. The principal provisions of Title III of the USA Patriot Act require that regulated financial institutions: (i) establish an anti-money laundering program that includes training and audit components; (ii) comply with regulations regarding the verification of the identity of any person seeking to open an account; (iii) take additional required precautions with non-U.S. owned accounts; and (iv) perform certain verification and certification of money laundering risk for their foreign correspondent banking relationships. The USA Patriot Act also expanded the conditions under which funds in a U.S. interbank account may be subject to forfeiture and increased the penalties for violation of anti-money laundering regulations. Failure of a financial institution to comply with the USA Patriot Act’s requirements could have serious legal and reputational consequences for the institution. Bancshares has adopted policies, procedures and controls to address compliance with the requirements of the USA Patriot Act under the existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA Patriot Act and implementing regulations.
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.
Available Information
The Bank’s website address is http://www.firstusbank.com (Bancshares does not maintain a website). Bancshares’ annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act are not currently available on the Bank’s website; however, Bancshares is currently assessing the expense associated with implementing this feature on the Bank’s website. These reports are available on the Securities and Exchange Commission’s website, http://www.sec.gov, and Bancshares will provide paper copies of these reports free of charge upon written request.
Item 2.
Item 2.
Properties.
Bancshares owns no property and does not expect to own any property. The business of Bancshares is conducted from the eighteen offices of the Bank. The Bank owns all of its offices in fee without encumbrances. ALC leases office space throughout Alabama and Mississippi but owns no property. During 2003, the aggregate annual rental payments for office space for ALC totaled approximately $336,672.
Item 3.
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 legal proceedings presently pending against Bancshares or the Bank will not have a material effect on Bancshares’ consolidated financial statements or results of operations.
Item 4.
Item 4.
Submission of Matters to a Vote of Security Holders.
Not applicable.
PART II
Item 5.
Item 5.
Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Bancshares’ common stock trades under the symbol, “USBI,” on The Nasdaq SmallCap Market. The sales price range for Bancshares’ common stock during each calendar quarter of 2002 and 2003 are shown below. On June 19, 2003, the Board of Directors of Bancshares declared a two-for-one stock split in which shareholders of record at the close of business on June 30, 2003 received one additional share for every share held. The market prices represent sales prices as reported in the Nasdaq Historical Quotes, as adjusted for the two-for-one stock split that was payable July 22, 2003. Additionally, Bancshares has declared dividends on its common stock on a quarterly basis in the past two years, as adjusted for the two-for-one stock split, as shown below.
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 Alabama Banking Code imposes certain restrictions on banks regarding the payment of dividends. The Bank is required by Alabama law to obtain approval of the Superintendent of the State Banking Department of Alabama (the “Superintendent”) prior to the payment of dividends if the total of
all dividends declared by the Bank in any calendar year will exceed the total of (a) the Bank’s net earnings (as defined by statute) for that year plus (b) its retained net earnings for the preceding two years, less any required transfers to surplus. Also, no dividends may be paid from the Bank’s surplus without the prior written approval of the Superintendent.
Bancshares’ management currently expects that comparable cash dividends will continue to be paid in the future.
Bancshares has only one class of common stock. As of March 1, 2004, there were approximately 960 shareholders of Bancshares.
Item 6.
Item 6.
Selected Financial Data.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
SELECTED FINANCIAL DATA
* A two-for-one stock split was authorized and implemented in 2003. Accordingly all shares outstanding in prior years have been adjusted to reflect the stock split.
Item 7.
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
United Security Bancshares, Inc., a Delaware Corporation (herein referred to as “United Security” or the “Company”), is a bank holding company with its principal offices in Thomasville, Alabama. United Security operates a commercial banking subsidiary, First United Security Bank (the “Bank”). The Bank has eighteen banking offices located in Thomasville, Coffeeville, Fulton, Gilbertown, Grove Hill, Butler, Jackson, Brent, Centreville, Woodstock, Harpersville, Calera, Bucksville and Tuscaloosa, Alabama. Its market area includes Clarke, Choctaw, Bibb, Shelby, Tuscaloosa and portions of Marengo, Sumter, Washington, Wilcox, Chilton, Hale, Monroe, Perry and Jefferson Counties in Alabama, as well as Clarke, Lauderdale, and Wayne Counties in Mississippi. United Security is also the parent company 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 companies located in Southwest Alabama.
The Bank’s sole business is banking; therefore, loans and investments are its principal sources of income. The Bank contributed approximately $9.1 million to consolidated net income in 2003, while ALC contributed approximately $2.5 million. A wide range of commercial banking services are provided to small and medium-sized businesses, real estate developers, property managers, business executives, professionals and other individuals.
The Bank owns all of the stock of Acceptance Loan Company, Inc. (“ALC”), an Alabama corporation. ALC is a finance company organized for the purpose of making and purchasing consumer loans. ALC has twenty-six offices located in Central and South Alabama and Southeast Mississippi. The headquarters of ALC is located in Jackson, Alabama. The Bank represents the funding source for ALC.
FUSB Reinsurance, Inc. (“FUSB Reinsurance”), an Arizona Corporation and wholly-owned subsidiary of the Bank, reinsures or “underwrites” credit life and credit accident and health insurance policies sold to the Bank’s and ALC’s consumer loan customers. FUSB Reinsurance is responsible for the first level of risk on these policies up to a specified maximum amount, and the primary third-party insurer retains the remaining risk. The third-party insurer is also responsible for performing most of the administrative functions of FUSB Reinsurance on a contract basis.
At December 31, 2003, United Security had consolidated assets of $567.2 million, deposits of $387.7 million, and shareholders’ equity of $73.3 million. Total assets increased by $31.9 million, or 6.0%, in 2003. This increase is primarily attributed to the loan growth realized by the Bank.
A two-for-one stock split was implemented in July 2003. This stock split increased common stock to an average of 6.4 million shares outstanding; however, total shareholders’ equity was not affected by the split. All shares outstanding and dividend per share numbers for prior years have been adjusted as a result of the stock split.
A high priority continues to be placed on efficiency and uniformity among the Bank’s eighteen offices and ALC’s twenty-six offices in an effort to improve the delivery of services to our customers. The loan review process continues to receive strong emphasis in our quality-control program. Particular emphasis is being directed toward effective loan origination and credit quality control.
Delivery of the best possible services to customers remains an overall operational focus of the Bank. We recognize that attention to details and responsiveness to customers’ desires are critical to customer satisfaction. The Bank continues to employ the most current technology, both in its financial services and in the training of its 284 full-time equivalent employees, to ensure customer satisfaction and convenience.
The following discussion and financial information are presented to aid in an understanding of the current financial position and results of operations of United Security, and should be read in conjunction with the Audited Consolidated Financial Statements and Notes thereto included herein. The emphasis of this discussion will be on the years 2003, 2002, and 2001. All yields presented and discussed herein are based on the accrual basis and not on the tax-equivalent basis, unless otherwise indicated.
Forward-Looking Statements
This Annual Report on Form 10-K, other periodic reports filed by the Company under the Securities Exchange Act of 1934, as amended, and any other written or oral statements made by or on behalf of the Company may include “forward-looking statements,” within the meaning of the Private Securities Litigation Reform Act of 1995, that reflect the Company’s current views with respect to future events and financial performance. Such forward-looking statements are based on general assumptions and are subject to various risks, uncertainties and other factors that may cause actual results to differ materially from the views, beliefs and projections expressed in such statements. These risks, uncertainties and other factors include, but are not limited to:
1. Possible changes in economic and business conditions that may affect the prevailing interest rates, the prevailing rates of inflation, or the amount of growth, stagnation, or recession in the global, U.S., and Alabama and Mississippi economies, the value of investments, the collectibility of loans and the ability to retain and grow deposits;
2. Possible changes in monetary and fiscal policies, laws and regulations, and other activities of governments, agencies and similar organizations;
3. The effects of easing of restrictions on participants in the financial services industry, such as banks, securities brokers and dealers, investment companies and finance companies, and changes evolving from the enactment of the Gramm-Leach-Bliley Act which became effective in 2000, and attendant changes in patterns and effects of competition in the financial services industry; and
4. The ability of the Company to achieve its expected operating results including (i) the continued growth of the markets in which the Company operates consistent with recent historical experience and (ii) the Company’s ability to expand into new markets and to maintain profit margins.
The words, “believe,” “expect,” “anticipate,” “project” and similar expressions, signify forward-looking statements. Readers are cautioned not to place undue reliance on any forward-looking statements made by or on behalf of the Company. Any such statements speak only as of the date such statements were made, and the Company undertakes no obligation to update or revise any forward-looking statements.
Critical Accounting Policies
The accounting principles followed by the Company and the methods of applying these principles conform with accounting principles generally accepted in the United States and with general practices within the banking industry. Critical accounting policies relate to securities, loans, allowance for loan losses, accounting estimates, derivatives and hedging. A description of these policies, which significantly affect the determination of financial position, results of operations and cash flows, are summarized in Note 2, “Summary of Significant Accounting Policies” in the “Notes to Consolidated Financial Statements.”
Supplemental Compensation Benefits Agreements
The Bank has entered into supplemental compensation benefits agreements with the directors and certain executive officers. The measurement of the liability under these agreements includes estimates involving life expectancy, length of time before retirement and the expected returns on the Bank-owned life insurance policies used to fund those agreements. Should these estimates prove materially wrong, we could incur additional or reduced expense to provide the benefits.
Rescission Offer
During a review of the Company’s compliance with the Securities and Exchange Commission (the “SEC”) rules and regulations in October 2003, it was discovered that the United Security Bancshares, Inc. Employee Stock Ownership Plan (With 401(k) Provisions) (the “Plan”), maintained for the benefit of the Company’s employees, had purchased a greater number of shares of common stock than had been initially registered under the Plan by the Company. Although all of the purchases under the Plan were made in a manner consistent with the Plan and the investment elections of the Plan participants, the Company determined that the purchases of up to 30,790 shares of common stock by participants in the Plan may not have been properly registered in accordance with the Securities Act of 1933. Since participants who purchased such securities may have had a right to require the Company to rescind the sale of such common stock, it offered to rescind the purchase of such stock issued to the Plan participants. The rescission offer expired on March 10, 2004, and no participants elected to accept the rescission offer by the Company. Accordingly, no contingent liability relating to this rescission offer was recorded.
Operating Results
Summary of Operating Results
Net Interest Income
Net interest income (interest income less interest expense) is an effective measurement of how well management has matched interest-rate sensitive assets and interest-bearing liabilities and is the Bank’s principal source of income. Fluctuations in interest rates materially affect net interest income. The accompanying graph analyzes these changes.
Net interest income increased by $4.0 million, or 12.6%, in 2003, compared to a 7.7% increase and a 2.2% decrease in 2002 and 2001, respectively. Volume, rate and yield changes in interest-earning assets and interest-bearing liabilities contributed to the increase in net interest income. Average interest-earning assets increased by $12.4 million, or 2.5%, in 2003, while average interest-bearing liabilities increased $11.1 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 2003, average interest-earning assets outgained average interest-bearing liabilities by $1.3 million, and while the continued declining interest rates had a relatively neutral effect on interest income, it had a more positive effect on lowering interest expense.
The Bank’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 2003 compared to 6.3% in 2002 and 6.0% in 2001.
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. The Bank’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 subsequent 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 amount of the interest-bearing liabilities as noted in the table, “Yields Earned on Average Interest Earning Assets and Rates Paid on Average Interest Bearing Liabilities,” increased 2.6% in 2003, while the average rate of interest paid decreased from 3.4% in 2002 to 2.6% in 2003. Average interest-earning assets increased 2.5% in 2003, while the average yield on earning assets decreased from 9.2% in 2002 to 9.1% in 2003.
The percentage of earning assets funded by interest-bearing liabilities also affects the Bank’s interest margin. The Bank’s earning assets are funded by interest-bearing liabilities, non-interest bearing demand deposits, and shareholders’ equity. The net return on earning assets funded by non-interest bearing demand deposits and shareholders’ equity exceeds the net return on earning assets funded by interest-bearing liabilities. The Bank maintains a relatively consistent percentage of earning assets funded by interest-bearing liabilities. In 2003, 83.9% of the Bank’s average earning assets was funded by interest-bearing liabilities as opposed to 83.8% in 2002 and 83.0% in 2001.
Yields Earned on Average Interest Earning Assets and
Rates Paid on Average Interest Bearing Liabilities
Note A
-
For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. These loans amounted to $1,897,007, $6,228,740 and $2,594,868 for 2003, 2002, and 2001, respectively.
Note B
-
Taxable investments include all held-to-maturity, available-for-sale, and trading account securities.
Note C
-
Loan fees of $3,015,525, $2,821,752, and $2,932,596 for 2003, 2002, and 2001, respectively, are included in interest income amounts above.
Changes in Interest Earned and Interest Expense Resulting from
Changes in Volume and Changes in Rates
For purposes of the table, changes attributable to both rate and volume which cannot be segregated have been allocated to rate.
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 $3.3 million during the year, a decrease of $0.5 million over the prior year, and accordingly a provision of $3.5 million was expensed for loan losses in 2003, $3.9 million in 2002 and $5.3 million in 2001. The allowance is at 1.77% of total loans outstanding at December 31, 2003, compared to 1.85% in 2002. The decrease in charge-offs (net of recoveries) was due to management’s emphasis on collections during the year at both ALC and the Bank. 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
The following table presents the major components of non-interest income for the years indicated.
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 are included in non-interest income.
Total non-interest income increased $592,929 or 11.7% in 2003. This compares to an increase of 7.2% in 2002, and a decrease of 3.1% in 2001. The 2003 increase can be attributed to the 11.8%, or $349,627, increase in service and other
charges on deposit accounts. This increase in service charge income is due to the overdraft protection products and other daily fees, the new deposit accounts generated by the new banking offices as well as a renewed emphasis on increasing overall demand deposit accounts. Additionally, the increase of $364,533 or 38.3% in other income in 2003 contributed to the increase in total non-interest income. The increase in other income was due to Bank-owned life insurance purchased in 2002. This insurance generated income of $370,318 in 2003 and $94,107 in 2002.
Non-recurring items of non-interest income include securities gains and losses. Investment securities had a net gain of $51,680 in 2003 compared to a $198,064 gain in 2002 and a $165,984 gain in 2001. 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.
The Bank organized a wholly-owned subsidiary, FUSB Reinsurance, Inc. (“FUSB Reinsurance”), in 2000. FUSB Reinsurance reinsures or “underwrites” credit life, credit accident and health insurance policies sold to the Bank’s consumer loan customers. FUSB Reinsurance is responsible for the first level of risk on the policies up to a specified maximum amount, and the primary third party insurer retains the remaining risk. As a result, more credit life insurance premiums and commissions are retained by the Bank. These premiums and commissions were $977,183 in 2003, $952,031 in 2002 and $916,685 in 2001.
The Bank entered into supplemental compensation benefit agreements with the directors and certain executive officers in 2002. The Bank purchased Bank-owned life insurance policies used to fund those agreements. The income recognized on these Bank-owned policies was $370,318 in 2003 and $94,107 in 2002.
The Bank continues to search for new sources of non-interest income. These sources will come from innovative ways of performing currently provided banking services as well as providing new services in the future. FUSB Reinsurance is an example of this philosophy.
Non-Interest Expense
The following table presents the major components of non-interest expense for the years indicated.
Non-interest expense consists primarily of four major categories: salaries and employee benefits, occupancy expense, furniture and equipment expense, and other expense. These expenses were positively impacted by the closing of three ALC offices in 2001 and three offices in 2002. Additionally, the Bank opened one new branch office in each of 2002 and 2003. These events impacted the ratio of non-interest expense to average assets, and the ratio remained stable during the period at 3.9%, 3.8% and 3.8% in 2003, 2002, and 2001, respectively.
The efficiency ratio was computed by dividing total non-interest expense by net interest income and non-interest income. An increase in the efficiency ratio indicates that more resources are being utilized to generate the same (or greater) volume of income while a decrease would indicate a more efficient allocation of resources. Our efficiency ratio for 2003 was 51.7%, compared to 54.6% in 2002 and 57.2% during 2001.
Total compensation and benefits increased approximately $882,000, or 7.7%, in 2003. This increase is attributable to a combination of normal merit adjustments, the staffing of our new Calera office in 2002 and the opening of our new Tuscaloosa office in 2003. The increase of 3.8% in 2002 was due to the Calera office opening, and the decrease of 1.2% in 2001 was due to the ALC closures. At December 31, 2003, the Bank had 284 full-time equivalent employees compared to 280 in 2002 and 290 in 2001. The reduction in staff was accomplished by closing six ALC offices during this three-year period and managing attrition.
United Security sponsors an Employee Stock Ownership Plan with 401(k) provisions. The Company made matching contributions totaling $402,710, $365,173 and $349,533 in 2003, 2002, and 2001, respectively.
Occupancy expense includes rents, depreciation, utilities, maintenance, insurance, taxes, and other expenses associated with maintaining eighteen banking offices and twenty-six finance company offices. The Bank owns all banking offices, and all ALC offices are leased. Net occupancy expense increased 3.6% in 2003, 0.7% in 2002, and 1.8% in 2001. The increase in 2003 is due to the two new branch offices in Calera and Tuscaloosa.
Furniture and equipment expense decreased 2.5% in 2003, compared to a decrease of 4.5% in 2002 and a decrease of 11.5% in 2001. The decrease in 2002 and 2001 relates to the ALC office closures.
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 the equity method. The investment balances in these partnerships were $2,979,847, $3,873,813 and $4,732,036 at December 31, 2003, 2002 and 2001, respectively. Losses amounted to $562,105, $826,364, and $534,638 for 2003, 2002, and 2001, respectively. Management analyzes these investments annually for potential impairment.
During 2003, legal, accounting and other professional fees increased $134,000, compared to increases of $120,000 for 2002 and $19,000 for 2001. This increase relates to ongoing projects and planning designed to improve efficiency, control and the
enhancement of our risk management, as well as legal and accounting requirements for the stock split and the Employee Stock Ownership Plan with 401(k) provisions.
The increases in the stationary and supplies, telephone, and advertising expenses, as well as other expenses, were related to the new office openings.
Financial Condition
United Security’s financial condition depends primarily on the quality and nature of the Bank’s assets, liabilities, and 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.
The Bank owns all of the stock of Acceptance Loan Company, Inc. (“ALC”), an Alabama corporation. ALC is a finance company with twenty-six offices organized for the purpose of making consumer loans. The Bank is ALC’s only source of funds, which amounts to approximately $105.8 million. ALC reported net income of $2.5 million for the year ended December 31, 2003. This is an improvement over the $1.2 million of net income in 2002 and a loss of $1.4 million in 2001.
Management believes the most significant factor in producing quality financial results is the Bank’s ability to react properly and in a timely manner to changes in interest rates. Management, therefore, continues to maintain a more balanced position between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations.
Provision for Income Taxes
United Security’s provision for income taxes increased 38.7% in 2003. This increase was caused, in part, by a 28.5% increase in income before taxes. The Company’s effective income tax rates for 2003, 2002, and 2001 were 31%, 28%, and 28%, respectively. Note 11 to the “Notes to Consolidated Financial Statements” provides additional information about the provision for income taxes.
Management’s determination of the realization of the deferred tax asset is based upon management’s judgment of various future events and uncertainties, including the timing and amount of future income earned by subsidiaries and the implementation of various tax planning strategies to maximize realization of the deferred tax asset. Management believes that the subsidiaries may be able to generate sufficient operating earnings to realize the deferred tax benefits. However, a portion of the amount of the deferred tax asset that can be realized in any year is subject to certain statutory federal income tax limitations. Because of these uncertainties, a valuation allowance has been established. Management periodically evaluates the realizability of the deferred tax asset and, if necessary, records a valuation allowance accordingly.
Loans and Allowance for Loan Loss
Total loans outstanding increased by $28.5 million in 2003 with $386.6 million outstanding at year-end. Loans represent 72.7% of the Company’s earning assets and provide 82.2% of interest income.
Real estate loans make up 68.7% of total gross loans at year-end 2003, up from 67.5% last year. These loans consist of construction loans to both businesses and individuals on residential and commercial development, commercial buildings and apartment complexes, with most of this activity being commercial. Real estate loans also consist of other loans secured by real estate, such as one-to-four family dwellings, including mobile homes, loans on land only, multi-family dwellings, non-farm non-residential real estate and home equity loans.
Commercial loans totaled $34.8 million at year-end 2003. These loans decreased $5.3 million or 13.2% from year-end 2002 to year-end 2003. This decrease over the past year is due to an uncertain economy and several large line payoffs.
Consumer loans are the second largest group of loans which represents 24.2% of total loans outstanding. They amount to $93.6 million at year-end 2003, a 13.3% increase from 2002. These loans include loans to individuals for household, family and other personal expenditures, including credit cards and other related credit plans. 56.1% of these loans are originated at ALC. Consumer loans at ALC increased 15.3% from 2002 to 2003, all of which is attributed to normal growth in existing offices. Consumer loans at the Bank grew $2.7 million, or 8.3%, from year-end 2002 to 2003.
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, 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 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. The Bank utilizes a written loan policy, which attempts to guide lending personnel in maintaining consistent underwriting standards. This policy is intended to aid loan officers and lending personnel in making sound credit decisions and to assure compliance with state and federal regulations.
In order to better manage credit risk, ALC carefully oversees its portfolio through formal underwriting standards, monitoring of customer payments and active follow-up. ALC assesses the adequacy of the allowance for loan losses on an aggregate level based upon recent delinquency status and estimates of inherent loss from historical experience within these portfolios. ALC continues to concentrate more on loans secured by real estate and places less emphasis on automobile loans.
The following table shows the Company’s loan distribution as of December 31, 2003, 2002, 2001, 2000, and 1999.
The amounts of total loans (excluding installment loans) outstanding at December 31, 2003, 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.
Variable rate loans totaled approximately $66.2 million and are included in the one-year category.
The Bank and ALC ended the year with an allowance for loan losses of $6.8 million, an increase of $0.2 million from December 31, 2002. Total loans charged off in 2003 totaled $4.1 million. Recoveries on loans previously charged off totaled $0.8 million, resulting in net charge-offs of $3.3 million. Net charge-offs for 2002 totaled $3.8 million. Management charged to operations $3.5 million in 2003 as an addition to the allowance for loan losses. This compares to $3.9 million charged to operations for 2002 and $5.3 million for 2001. Of the 2003 net charge-offs of $3.3 million, $2.1 million represents charge-offs from ALC loans and $1.2 million from the Bank. Net loan charge-offs as a percentage of average loans decreased from 1.11% in 2002 to 0.90% in 2003.
Non-Performing Assets
The following table presents information on non-performing loans and real estate acquired in settlement of loans.
Accruing loans past due 90 days or more at December 31, 2003, totaled $382,000. These loans are secured, and, taking into consideration the collateral value and the financial strength of the borrowers, management believes there will be no loss in these accounts and allowed the loans to continue accruing.
At December 31, 2003, the recorded investment in loans that were considered impaired was $1,320,822 compared to $3,815,189 at December 31, 2002. All such loans were on a non-accrual basis at December 31, 2002; however, at December 31, 2003, the one loan considered impaired was restructured and has improved to the point accrual of interest has resumed. There was approximately $198,123 and $573,161 at December 31, 2003 and 2002, respectively, in the allowance for loan losses specifically allocated to these loans. The average recorded investment in impaired loans was approximately $1,740,672 and $2,402,336 at years ended December 31, 2003 and 2002, respectively.
Non-performing assets as a percentage of net loans and other real estate was 1.26% at December 31, 2003. This decrease from 2.5% at December 31, 2002, represents the emphasis placed on reducing non-performing assets during the year. Management reviews these loans and reports to the Board of Directors monthly. Management set a goal to maintain this category at 1.5% or lower during 2003. 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.
The 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 status, 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 recognized on a cash basis, according to management’s judgment 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.
Summarized below is information concerning the income on those loans with deferred interest or principal payments resulting from deterioration in the financial condition of the borrower.
At December 31, 2003 non-accrual loans totaled $1.9 million or 0.5% of loans, compared to $6.2 million or 1.8% of loans at December 31, 2002. This decrease in non-accrual loans at December 31, 2003, represents management’s emphasis on loan quality and underwriting at both ALC and the Bank. One large line was charged against the Bank’s loan loss reserve during the year, and one was moved to other real estate through foreclosure. The majority of the loans remaining in this category are in the 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 believes that at December 31, 2003, it has adequate reserves for losses inherent in this portion of the portfolio although no assurances can be given to this effect because ultimate losses may vary from management’s estimates.
Lending officers and other personnel involved in the lending process receive ongoing training in compliance as well as asset quality. The Bank has no foreign loans. The Bank does not make loans on commercial property outside its market area without prior approval of the Board of Directors or the Directors’ Loan Committee.
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.
The allowance for loan losses is established by risk group as follows:
• Large classified loans, non-accrual loans, and impaired loans are evaluated individually with specific reserves allocated based on management’s review.
• Smaller non-accrual 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 Bank’s historical loan loss experience in each category, although a higher allocation weight may be used if current conditions indicate that the loan losses may exceed historical experience. While the total allowance is described as consisting of the portions described above, all portions are available to support inherent losses in the loan portfolio.
Net charge-offs as shown in the “Summary of Loan Loss Experience” table below indicate the trend for the last five years.
Summary of Loan Loss Experience
This table summarizes the Bank’s loan loss experience for each of the five years indicated.
* Acquisitions by ALC in 1999.
Industry Concentration Factors
The Bank’s trade area includes Clarke, Choctaw, Bibb, Tuscaloosa, and Shelby Counties in Alabama, and 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. There are several major paper mills in our trade area including the Alabama River Companies, Boise Cascade, Georgia Pacific 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, 2003. The amount of timber-related loans decreased from $26.7 million in 2002 to $24.4 million in 2003. The percentage of timber-related loans to gross loans decreased from 7.46% in 2002 to 6.31% in 2003.
Management realizes that the Bank is reasonably dependent on the economic health of the timber-related industries. Accordingly, this represents a concentration of loans in timber and timber-related industries. 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 Company. Historically, the Company has benefited from the industries engaged in the growing, harvesting, processing and marketing of timber and timber-related products.
Investments 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 the equity method. The Bank’s interest in these partnerships was $3.0 million and $3.9 million for 2003 and 2002, respectively. Decreases to earnings associated with the partnerships carried under the equity method amounted to approximately $562,000, $826,000, and $535,000 for 2003, 2002, and 2001, respectively. Management analyzes these investments annually for impairment. The assets and liabilities of these partnerships consist primarily of apartment complexes and related mortgages. The Bank’s carrying value approximates its underlying equity in the net assets of the partnerships. The Bank had no remaining cash commitments to these partnerships at December 31, 2003. 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 approximately $700,000 in 2002 and are estimated to be approximately $654,000 for 2003. Also, operating losses related to these partnerships are available as deductions for taxes on the Bank’s books.
Investment Securities Available-for-Sale and Derivative Instruments
Investment securities available-for-sale included $1.6 million government and agency securities, mortgage-backed securities of $112.9 million, state, county and municipal securities of $18.9 million, and other securities of $5.7 million. The securities portfolio is carried at fair market value, and it increased $4.6 million from December 31, 2002, to December 31, 2003.
At December 31, 2003, approximately $6.9 million in collateral mortgage obligations (“CMO”) held by the Bank had floating interest rates which reprice monthly, and $45.3 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 the Bank invests represent an undivided interest in a pool of residential mortgages or may be collateralized by a pool of residential mortgages (“mortgage-backed securities”). Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying mortgages and are subject to principal prepayment, refinancing, or foreclosure of the underlying mortgages. Although maturities of the underlying mortgage loans may range up to 30 years, scheduled principal and normal prepayments substantially shorten the effective maturities. As of December 31, 2003, the investment portfolio had an estimated average effective maturity of 4.4 years.
Interest rate risk contained in the overall securities portfolio is formally monitored on a monthly basis. Management assesses each month how risk levels in the investment portfolio affect overall company-wide interest rate risk. Expected changes in forecasted yield, earnings and market value of the bond portfolio are generally attributable to fluctuations in interest rates, as well as volatility caused by general uncertainty over the economy, inflation, and future interest rate trends. Mortgage-backed securities and CMOs present some degree of additional risk in that mortgages collateralizing these securities can be refinanced, thereby affecting the future yield and market value of the portfolio.
The composition of the Bank’s investment portfolio reflects the Bank’s investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of the Bank’s investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling the Bank’s interest rate position while at the same time producing adequate levels of interest income.
Fair market values of securities can vary significantly as interest rates change. The gross unrealized gains and losses
in the securities portfolio are not expected to have a material impact on liquidity or other funding needs. There were net unrealized gains, net of taxes, of $1.14 million in the securities portfolio on December 31, 2003, versus net unrealized gains, net of taxes, of $2.2 million one year ago.
The Bank has used certain 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 2 in the “Notes to Consolidated Financial Statements.” The Bank adopted the provisions of Statement of Financial Accounting Standards No. 133, as amended, effective January 1, 2001, as required by the Financial Accounting Standards Board. On that date, the Bank reassessed and designated derivative instruments used for risk management as fair value hedges, cash flow hedges and derivatives not qualifying for hedge accounting treatment, as appropriate. On December 31, 2003, the Bank had interest rate derivatives with a notional value of $55 million. In conjunction with FASB 133, the Bank recorded a negative $159,949, net of taxes, to Other Comprehensive Income to reflect the fair value of such instruments as of that date.
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 losses at the dates indicated.
Investment Securities Available-for-Sale Maturity Schedule
Available-for-Sale Securities are stated at Market Value and Tax Equivalent Market Yields.
The maturities and weighted average yields of the investment securities available-for-sale at the end of 2003 are presented in the preceding table based on stated maturity. While the average stated maturity of the mortgage-backed securities (excluding CMOs) was 20.1 years, the average life expected was 4.0 years. The average stated maturity of the CMO portion of the portfolio was 20.1 years, and the average expected life was 2.9 years. The average expected life of investment securities available-for-sale was 4.4 years with an average tax equivalent yield of 4.97%.
Condensed Portfolio Maturity Schedule
The following marketable equity securities have been excluded from the above Maturity Summary due to no stated maturity date.
Condensed Portfolio Repricing Schedule
The tables above reflect all securities at market value on December 31, 2003.
Security Gains and Losses
Non-interest income from securities transactions and trading account transactions decreased in 2003 compared to 2002, as can be seen in the table below. The profits realized in 2003 were generated through the sale of investment securities. Gains in this area occurred in connection with the Bank’s asset and liability management activities and strategies.
The table below shows the associated net gains or (losses) for the periods 2003, 2002, and 2001.
Volume of sales as well as other information on securities is further discussed in Note 3 in the “Notes to Consolidated Financial Statements.”
Deposits
Average total deposits increased 4.1% in 2003 compared to increases of 3.4% and 4.2% in 2002 and 2001, respectively. Management believes this deposit level continues to be 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 increased 14.9% over the last three years and increased 6.7% in 2003. The ratio of average non-interest bearing deposits to average total deposits remained stable in 2003 at 12.0% from 11.7% in 2002 and 11.2% in 2001.
Average interest-bearing transaction accounts have increased 20.5% during the last three years. Interest-bearing transaction accounts continue to be an important source of funds for the Bank, accounting for 19.6% of average total deposits in 2003.
Average time deposits increased by 0.8% in 2003, compared to a decrease of 0.5% in 2002. Average time deposits represented 55.6% of the total average deposits in 2003, compared to 57.3% in 2002 and 59.6% in 2001.
Average savings deposits have increased 18.4% since 2001. Average savings increased 9.3% in 2003 compared to 8.4% in 2002 and 1.8% in 2001. The ratio of average savings to average total deposits increased to 12.8% in 2003, compared to 12.2% in 2002 and 11.6% in 2001.
The Bank’s deposit base remains the primary source of funding for the Bank. On average, these deposits represented 72.8% of the average earning assets in 2003 and 71.7% of the average earning assets in 2002. As seen in the table below, overall rates on the deposits decreased to 1.9% in 2003, compared to 2.6% in 2002 and 3.9% in 2001. Emphasis continues to be placed on attracting consumer deposits.
The sensitivity of the Bank’s deposit rates to changes in market interest rates is reflected in its average interest rate paid on interest-bearing deposits. During 2003, market interest rates continued to decline, attributable to the recent lowering of interest rates by the Federal Reserve. The Bank’s average interest rate paid on interest-bearing deposits followed this trend.
Management, as part of an overall program to emphasize the growth of transaction accounts, continues to promote “on-line” banking and a bill paying program as well as enhancing the telephone banking product and the employee incentive plan. In addition, continued effort is being placed on deposit promotions, direct-mail campaigns and cross-selling efforts.
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 (“FHLB”) advances. This category continues to be utilized as an alternative source of funds. The average other interest bearing liabilities represent 23.7% of the average total interest bearing liabilities compared to 24.5% in 2002 and 24.0% in 2001. The
advances from the FHLB are an alternative to funding sources with similar maturities such as certificates of deposit. These advances generally offer more attractive rates when compared to other mid-term financing options. Average federal funds purchased and securities sold under agreements to repurchase decreased from $1.8 million in 2002 to $348,000 in 2003. For additional information and discussion of these borrowings, refer to Note 9 and 10 of the “Notes to Consolidated Financial Statements.”
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.
Maturities of time certificates of deposit and other time deposits of $100,000 or more outstanding at December 31, 2003, are summarized as follows:
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.
Balances in the short-term borrowings fluctuate 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, 2003, shareholders’ equity totaled $73.3 million, or 12.9% of total assets compared to 12.5% and 12.5% for year-end 2002 and 2001, 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 $67.6 million at the beginning of 2001 to $73.3 million at the end of 2003. This growth was the result of internally-generated retained earnings, with the exception of approximately $464,300 from stock options being exercised over the last three years. Shareholders’ equity was also impacted by the net change in unrealized gain (loss) on securities available-for-sale and derivatives, net of tax. This adjustment increased shareholders’ equity by $292,602 in 2001 and $921,539 in 2002, and decreased shareholders’ equity by $882,785 in 2003. A significant impact on shareholders’ equity over the last three years was the stock repurchase plan United Security initiated in May of 2001. At year-end 2001 a total of 216,924 shares were repurchased as treasury stock reducing shareholders’ equity by $5.9 million. During 2002, an additional 161,719 shares were repurchased to reduce equity by an additional $4.5 million. There were no shares repurchased in 2003.
While the stock repurchase plan reduced total shareholders’ equity in 2001 and 2002, United Security’s capital base remains a source of strength as noted above, and the internal capital generation rate (net income less cash dividends as a percentage of average shareholders’ equity) remains favorable at 10.2% in 2003, 8.1% in 2002 and 4.5% in 2001.
The two-for-one stock split authorized and implemented in 2003 increased common stock to an average of 6.4 million shares outstanding; however, total shareholders’ equity was not affected by the split. All shares outstanding and dividend per share numbers recorded in prior years have been adjusted as a result of the stock split.
United Security is required to comply with capital adequacy standards established by the Federal Reserve and the FDIC. Currently, there are two basic measures of capital adequacy: a risk-based measure and a leverage measure. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize
disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to risk categories, each with a specified risk 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 1 Capital (as defined below) to total assets less goodwill (the “leverage ratio”). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% or 2% higher than the minimum 3% level.
The minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits, and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles (“Tier 1 Capital”). The remainder (“Tier II Capital”) may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt, and a limited amount of the allowance for loan losses. The sum of Tier 1 Capital and Tier II Capital is “total risk-based capital.”
The following chart summarizes the applicable regulatory capital requirements. United Security’s capital ratios at December 31, 2003, substantially exceeded all regulatory requirements.
Risk-Based Capital Requirements
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 $4.3 million or $0.67 per share in 2003, compared to $0.60 per share in 2002 and $0.51 per share in 2001. The total cash dividends represented a payout ratio of 37.8% in 2003, with a payout ratio of 42.4% and 54.0% in 2002 and 2001, respectively. Calendar year 2003 is the fifteenth consecutive year that United Security has increased cash dividends.
Ratio Analysis
The following table presents operating and equity performance ratios for each of the last three years.
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 the Bank’s customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, the Bank would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. Interest rate risk management focuses on the maturity structure of assets and liabilities and their repricing characteristics during changes in market interest rates. Effective interest rate sensitivity management ensures that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of such interest rate movements on the net interest margin.
The asset portion of the balance sheet provides liquidity primarily from loan principal payments and maturities and through sales, maturities, and principal payments from the investment portfolio. Other short-term investments such as Federal funds sold are additional sources of liquidity. Loans maturing or repricing in one year or less amounted to $145.7 million at December 31, 2003.
Investment securities maturing or repricing in the same time frame totaled $5.9 million or 4.4% of the investment portfolio at year-end 2003. In addition, principal payments on mortgage-backed securities and CMOs totaled $67.8 million in 2003.
The liability portion of the balance sheet provides liquidity through interest bearing and non-interest bearing deposit accounts. Federal funds purchased, Federal Home Loan Bank advances, securities sold under agreements to repurchase, 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 longer than 10 years, the entire portfolio consists of securities that are readily marketable and easily convertible into cash. As of December 31, 2003, the bond portfolio had an expected average maturity of 4.4 years, and approximately 61% of the $139 million in bonds were expected to be repaid within 5 years. However, management does not rely solely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment, and other cash requirements. Instead, these activities are funded by cash flows from operating activities and increases in deposits and short-term borrowings.
The Bank, at December 31, 2003, had long-term debt and short-term borrowings that, on average, represent 18.5% of total liabilities and equity.
The Bank currently has up to $130.6 million in additional borrowing capacity from the Federal Home Loan Bank and $40 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 at a particular point in time, an example of which is presented below. Assets and liabilities are placed in gap intervals based on their repricing dates. Assets and liabilities for which no specific repricing dates exist are placed in gap intervals based on management’s judgment concerning their most likely repricing behaviors. 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 the Bank’s interest rate sensitivity. However, it cannot reveal the impact of factors such as administered rates, pricing strategies on consumer and business deposits, changes in balance sheet mix, or the effect of various options embedded in balance sheet instruments.
The accompanying table shows the Bank’s rate sensitive position at December 31, 2003, as measured by gap analysis. Over the next 12 months approximately $80 million more interest-bearing liabilities than interest-earning assets can be repriced to current market rates at least once. This analysis indicated that the Bank has a negative gap within the next 12-month range.
Interest Rate Sensitivity Analysis-Income Simulation
(1) Management’s adjustments reflect the Bank’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.
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.
The Bank uses additional tools to monitor and manage interest rate risk. These include net interest income and margin simulation analysis as well as forecasting changes in the market value of equity. Both analyses are methods of estimating earnings and capital at risk under varying interest rate conditions. These measures incorporate adjustments for changes in the timing of asset liability and cash flows and capture adjustments for the lag between movements in market interest rates and the movements of administered rates on prime rate loans, interest-bearing transaction accounts, regular savings, and money market savings accounts. Income simulation analysis indicates that the Bank is slightly exposed to both increases and decreases in interest rates.
The following table demonstrates the expected effect a given parallel interest rate shift would have on net interest income over a two-year period.
Condensed Balance Sheet Duration Analysis - Market Value of Equity
* The change in the market value of equity approximates the present value of the Bank's future pre-tax earnings exposure to a 1% rise or fall in the interest rates measured over a 5 year time horizon given a 1% increase or decrease in market interest rates.
The Bank follows a uniform process to calculate the duration of each asset and liability category. The first step is to assemble maturity and repricing data for categories of loans, investments, CDs and other financial instruments with contractual maturities. The second step is to determine how bank management, where appropriate, would alter the interest rate for each category of assets and liabilities assuming market interest rates rose or fell 1% or 2%. The third step is to combine the maturity analysis and repricing assumptions in order to estimate modified duration 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 calculated modified duration difference (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 estimates reflect how the market value of each asset and liability would change as interest rates change, and in total, reflect the changes in market values of equity.
In this methodology, all non-rate sensitive assets and liabilities are assigned a modified duration equal to 4.5 years. Additionally, estimates of modified duration incorporate the likelihood that some assets and liabilities would change maturities as interest rates change. This method also incorporates management’s belief that deposit and loan rates would not rise or fall equally either by category or by interest rate scenario. There is no allowance for growth or runoff in deposit or loan balances.
The analysis of market value of equity presented above suggests that the Bank’s earnings should decrease slightly if interest rates rise and should increase slightly if interest rates fall over the five-year time horizon.
As part of the ongoing monitoring of interest-sensitive assets and liabilities, the Bank enters into various interest rate contracts (“interest rate protection contracts”) to help manage the Bank’s interest sensitivity. These contracts generally have a fixed notional principal amount and include (i) interest rate swaps where the Bank typically receives or pays a fixed rate and a counterparty pays or receives a floating rate based on a specified index and (ii) interest rate caps and floors purchased where the Bank receives interest if the specified index falls below the floor rate or rises above the cap rate. All interest rate swaps represent end-user activities and are designed as hedges. The interest rate risk factor in these contracts is considered in the overall interest management strategy and the Company’s interest risk management program. The income or expense associated with interest rate swaps, caps, and floors classified as hedges are ultimately reflected as adjustments to interest income or expense. Changes in the estimated market value of interest rate protection contracts are reflected in either the Bank’s income statement or balance sheet. A discussion of interest rate risks, credit risks and concentrations in derivative instruments is included in Note 19 of the “Notes to Consolidated Financial Statements.”
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, 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 normally does not require collateral for standby letters of credit. As of December 31, 2003, the Bank had outstanding standby letters of credit and commitments to make loans of $523,000 and $25.8 million, respectively.
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.
Off-Balance Sheet Arrangements
The Company does not have any off-balance sheet arrangements that have or are reasonable likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is considered material, other than operating leases, included in Note 17, guarantees, commitments and contingencies, included in Note 18, and derivative financial instruments included in Note 19, of the “Notes to Consolidated Financial Statements.”
Contractual Obligations
The following summarizes the Company’s contractual obligations as of December 31, 2003.
* Long-Term Debt consists of FHLB advances totaling $95,755,000. $255,000 are fixed rate advances, $45,000,000 are floating rate, and $50,500,000 are convertible. Interest is included and calculated at the current rate for the entire period.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk.
The information called for by this Item is contained in Item 7 herein under the heading, “Liquidity and Interest Rate Sensitivity Management.”
Item 8.
Item 8.
Financial Statements and Supplementary Data.
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Shareholders
United Security Bancshares, Inc.
We have audited the accompanying consolidated statements of condition of United Security Bancshares, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the two years in the period ended December 31, 2003. The consolidated financial statements of United Security Bancshares, Inc. and Subsidiaries as of December 31, 2001, and the results of their operations and their cash flows for the year then ended was audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated February 18, 2002. 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 auditing standards generally accepted in the United States. 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 financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Security Bancshares, Inc. and Subsidiaries as of December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States.
Birmingham, Alabama
March 5, 2004
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CONDITION
DECEMBER 31, 2003 AND 2002
ASSETS
The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002, AND 2001
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 of the stock of First Security Cou-rier Corporation (“FSCC”), an Alabama corporation. FSCC is a courier service organized to transport items for proc-essing 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 corpo-ration. 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 and Eastern Mississippi. The Bank also owns all of the stock of FUSB Reinsurance, Inc. (“Reinsurance”), an Arizona corporation. Reinsurance is an insurance company that was created to underwrite credit life and accidental death insurance related to loans written by the Bank and ALC. The Bank also invests in limited partnerships that operate qualified affordable housing projects primarily 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 subsidiaries. All significant intercompany balances and transactions have been eliminated. The Bank’s investments in limited partnerships are carried on an unconsolidated basis under either the equity or cost method based on the per-centage of ownership and influence over operations.
Use of Estimates
The accounting principles and reporting policies of the Company, and the methods of applying these principles, con-form with accounting principles generally accepted in the United States (“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, in some cases, 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 is 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.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks. The Company is required to maintain average balances by the Federal Reserve Bank. The average amount of this reserve balance was $25,000 for the years ended December 31, 2003 and 2002.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Supplemental disclosures of cash flow information and noncash transactions related to cash flows for the years ended December 31, 2003, 2002, and 2001 are as follows:
Securities
Securities may be held in three portfolios: trading account securities, held to maturity securities, and securities avail-able for sale. Trading account securities are carried at market value, with unrealized gains and losses included in earn-ings. 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 share-holders’ equity in accumulated other comprehensive income. 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 its held to maturity portfolio at December 31, 2003 or 2002.
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; there-fore, 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 are included in interest income. Amortization of premiums and discounts on investment securities is determined by the interest method. 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 sepa-rately in non-interest income in the consolidated statements of income, net of related income taxes.
Derivatives and Hedging Activities
As part of the Company’s overall interest rate risk management, the Company uses derivative instruments, which can include interest rate swaps, caps, and floors. Prior to January 1, 2001, unrealized gains and losses on derivatives used for hedging purposes were generally not recorded in the financial statements. Accounting Standards No. 133 Accounting for Derivative Instruments and Hedging Activities, as amended, (Statement 133) requires all derivative instruments to be carried at fair value on the statement of condition. Statement 133 provides special accounting provisions for derivative instruments that qualify for hedge accounting. To be eligible, the Company must specifically identify a derivative as a hedging instrument and identify the risk being hedged. The derivative instrument must be shown to meet specific requirements under Statement 133.
The Company designates the derivative on the date the derivative contract is entered into as (1) a hedge of the fair value of a recognized asset or liability or of an unrecognized firm commitment (“fair-value” hedge) or (2) a hedge of a forecasted transaction of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash-flow” hedge). Changes in the fair value of a derivative that is highly effective as-and that is designated and qualifies as-a fair-value hedge, along with the loss or gain on the hedged asset or liability that is attributable to the hedged risk (including losses or gains on firm commitments), are recorded in current-period earnings. The effective portion of the changes in the fair value of a derivative that is highly effective as-and that is designated and qualifies as-a cash-flow hedge are recorded in other comprehensive income, until earnings are affected by the variability of cash flows (e.g., when periodic settlements on a variable-rate asset or liability are recorded in earnings). The remain -
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
ing gain or loss on the derivative, if any, in excess of the cumulative change in the present value of future cash flows of the hedged item is recognized in earnings.
The Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair-value or cash-flow hedges to specific assets and liabilities on the balance sheet or to specific firm commitments or forecasted transactions. The Company also formally assessed, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively, as discussed below. The Company discontinues hedge accounting prospectively when: (1) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item (including firm commitments or forecasted transactions); (2) the derivative expires or is sold, terminated, or exercised; (3) the derivative is redesignated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; (4) a hedged firm commitment no longer meets the definition of a firm commitment; or (5) management determines that designation of the derivative as a hedge instrument is no longer appropriate.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, hedge accounting is discontinued prospectively and the derivative will continue to be carried on the balance sheet at its fair value with all changes in fair value being recorded in earnings but with no offset being recorded on the hedged item or in other comprehensive income for cash flow hedges.
Loans and Interest Income
Loans are reported at principal amounts outstanding, adjusted for unearned income, deferred loan origination fees and costs, purchase premiums and discounts, 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 loans, on an effective yield basis.
Interest on commercial and real estate loans is accrued and credited to income based on the principal amount out-standing. Interest on installment loans is recognized using the interest method for a limited number of loans, 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.
Mortgage Loans Held for Sale
At December 31, 2003 and 2002, mortgage loans held for sale represented residential mortgage loans held for sale. Loans held for sale are carried at the lower of aggregate cost or market value and are included in the loan classification on the balance sheet. These loans amounted to $1,102,475 and $1,154,900 at December 31, 2003 and 2002, respectively.
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 judg-ment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectibility of the loan portfolio, including the nature of the portfolio, and changes in its risk profile, credit concentrations, historical trends, and economic conditions. This evaluation also considers the balance of impaired loans. Losses on individually identified impaired loans are measured based on the present value of
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
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 delin-quency 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. Depreciation is computed using the straight-line and accelerated methods over the estimated useful lives of the assets. Goodwill and core deposit intangibles are included in other assets. Goodwill was amortized, prior to 2002, using the straight-line method, over 20 years and core deposits from six to ten years. The amortization amounted to $361,000 in 2001. The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, which addresses how intangible assets that are acquired individually or with a group of assets should be accounted for in financial statements upon their acquisition. The statement also requires companies to no longer amortize goodwill and intangible assets with indefinite useful lives, but instead test annually for impairment. The Company had upon adoption of this statement, $4.1 million in unamortized goodwill, and, in accordance with this statement, performed a transition impairment test and an annual impairment analysis and concluded no impairment charge was needed.
Other Real Estate
Other real estate consists of properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. These properties are carried at the lower of cost or fair market value based on appraised value less esti-mated selling costs. Losses arising from the acquisition of properties are charged against the allowance for loan losses. Other real estate aggregated $2,607,726 and $1,296,285 at December 31, 2003 and 2002, respectively, and is included in other assets. Transfers from loans to other real estate amounted to $3,043,649 in 2003.
Income Taxes
The Company accounts for income taxes through the use of the liability method. Under the liability method, deferred taxes are recognized for the tax-consequences of temporary differences by applying enacted statutory tax rates appli-cable 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 purchases and sales are accounted for using the cost method.
Earnings Per Share
Basic earnings per share (“EPS”) are computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted EPS is computed based upon the weighted average number of shares outstanding during the period, plus the dilutive effect of outstanding stock options.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
The following table represents the earnings per share calculations for the years ended December 31, 2003, 2002, and 2001:
Recent Accounting Pronouncements
In November 2002, the FASB issued Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (Interpretation 45). Interpretation 45 requires cer-tain guarantees to be recorded at fair value. In general, Interpretation 45 applies to contracts or indemnification agreements that contingently require the guarantor to make payments to the guaranteed party based on changes in an underlying that is related to an asset, liability, or an equity security of the guaranteed party. The initial recognition and measurement provisions of Interpretation 45 are applicable on a prospective basis to guarantees issued or modified after December 31, 2002. Interpretation 45 also requires new disclosures, even when the likelihood of making any payments under the guarantee is remote. These disclosure requirements are effective for financial statements of interim or annual periods ending after December 15, 2002. On January 1, 2003, the Company began recording a liability and an offsetting asset for the fair value of its standby letters of credit. The impact of this new accounting was not material to the financial condition or results of operations. See Note 19 for disclosures required by Interpretation 45.
In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51 (Interpretation 46). Interpretation 46 addresses consolidation by business enterprises of variable interest entities which have one or both of the following characteristics. The equity investment at risk is not sufficient to
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
permit the entity to finance its activities without additional support from other parties, which is provided through other interests that will absorb some or all of the expected losses of the entity. The equity investors lack one or more of the following characteristics of a controlling financial interest: (1) the direct or indirect ability to make decisions about the entity’s activities through voting rights or similar rights, (2) the obligation to absorb the expected losses of the entity if they occur, which makes it possible for the entity to finance its activities, or (3) the right to receive the expected residual returns of the entity if they occur, which is the compensation for the risk of absorbing expected losses. The revised Interpretation No. 46 applies immediately to variable interest entities created after January 31, 2003. The Company has until the first fiscal year, or interim period beginning March 31, 2004, to apply Interpretation No. 46 to any variable interest entities acquired before February 1, 2003. The Company is currently assessing the impact of Interpretation No. 46 and has identified limited partnership investments in affordable housing projects that are considered variable interests. The Company has provided funding as a limited partner and receives tax credits for any losses incurred by the projects based on partnership share. At December 31, 2003, the Company has approximately $3.0 million associated with these investments, entered into prior to February 1, 2003. The Company adjusts the carrying value of these investments for any losses or impairment incurred by the partnerships through earnings. Subsequent to January 31, 2003, the Company has not invested in limited partnership investments in affordable housing projects. Although these investments are considered variable interest entities under Interpretation 46, the Company has not yet determined how many of these entities, if any, will need to be consolidated. See Note 7 for additional discussion of investments in limited partnerships.
In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities (Statement 149). The statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under Statement of Financial Accountings Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (Statement 133). Statement 149 is effective for contracts entered into or modified after June 30, 2003, with certain exceptions, and for hedging relationships designated after June 30, 2003. In addition, the provisions of the statement, with certain exceptions, are required to be applied prospectively. The implementation of Statement 149 did not have an effect on the Company’s financial condition or results of operations.
On May 15, 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liability and Equity (Statement 150). This statement requires certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity to be classified as liabilities. Many of these instruments previously were classified as equity or temporary equity. Statement 150 is effective for public companies for all financial instruments created or modified after May 31, 2003, and to other instruments at the beginning of the first interim period beginning after June 15, 2003. The adoptions of Statement 150 did not have an impact on the Company’s financial condition or results of operations.
In December 2003, the American Institute of Certified Public Accountants issued SOP 03-3, Accounting for Certain Loans and Debt Securities Acquired in a Transfer. This SOP addresses accounting for differences between contractual cash flows expected to be collected from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans and debt securities acquired in purchase business combinations. The SOP limits the yield that may be accreted to the excess of the investor’s estimate of undiscounted expected principal, interest, and other expected cash flows over the investor’s initial investment in the loan. The excess of contractual cash flows over cash flows to be collected cannot be recognized as an adjustment of yield, loss accrual, or valuation allowance. Accretable yield and nonaccretable difference cannot be displayed in the balance sheet. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively as impairment. This SOP also prohibits “carrying over” or creation of valuation allowances in the initial accounting of all loans acquired in a transfer that are within this scope. The prohibition of the valuation allowance carryover applies to the purchase of an individual loan, a pool of loans, a group of loans, and loans acquired in a purchase business combination. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. The Company does not anticipate that the adoption of this SOP will have a material impact on its financial condition or results of operations.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
3. INVESTMENT SECURITIES
Details of investment securities available for sale at December 31, 2003 and 2002 are as follows:
The scheduled maturities of investment securities available for sale at December 31, 2003 are presented in the following table:
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.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Below is a summary of available for sale securities which were in an unrealized loss position at December 31, 2003. Approximately 7% of the unrealized loss was in a continuous loss position for twelve months or more. This consisted of four securities, all of which were state, county and municipal securities, which the Company believes were attributable to changes in interest rates and not credit quality of the issuer. The Company does not believe any individual unrealized loss as of December 31, 2003, represents an other-than temporary impairment. The Company has the intent and ability to hold these securities until such time as the value recovers or the securities mature.
Investment securities available for sale with a carrying value of $99,144,957 and $84,000,993 at December 31, 2003 and 2002, respectively, were pledged to secure public deposits and for other purposes.
Gross gains realized on sales of securities available for sale were $51,680 in 2003, $198,064 in 2002, and $178,634 in 2001. There are $109,888 gross realized losses on those sales in 2003. There were no gross realized losses in 2002 or 2001. There were no gross realized gains or losses on sales of trading account securities for 2003 and 2002. Gross realized gains on trading account securities were $0 in 2001, and gross realized losses on those sales were $12,650.
4. LOANS AND ALLOWANCE FOR LOAN LOSS
At December 31, 2003 and 2002, the composition of the loan portfolio was as follows:
Included in real estate mortgage loans are mortgage loans held for sale of $1,102,475 and $1,154,900 at December 31, 2003 and 2002, respectively.
The Company grants commercial, real estate, and installment loans to customers primarily in Clarke, Choctaw, Bibb, and surrounding counties in Southwest Alabama, and Southeast Mississippi. Although the Company 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, 2003, approximately $24.4 million of the Company’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 the Bank, including companies with which they are associated. These loans are made on the same terms as those prevailing for comparable transactions with others. Such loans do not represent more than normal risk of collectibility nor do
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
they present other unfavorable features. The amounts of such related party loans and commitments at December 31, 2003 and 2002 were $1,455,715 and $1,409,152, respectively. During the year ended December 31, 2003, new loans to these parties totaled $662,736 and repayments were $616,173.
A summary of activity in the allowance for loan losses follows:
At December 31, 2003 and 2002, the recorded investment in loans that were considered to be impaired was $1,320,822 and $3,815,189, respectively, all of which were on a non-accrual basis at December 31, 2002; however, at December 31, 2003, the one loan considered impaired was restructured and has improved to the point accrual of interest has resumed. There was approximately $198,123 and $573,161 at December 31, 2003 and 2002, respectively, in the allowance for loan losses specifically allocated to these impaired loans. The average recorded investment in impaired loans was approximately $1,740,672 and $2,402,336 at December 31, 2003 and 2002, respectively. No material amount of interest income was recognized on impaired loans for the years ended December 31, 2003, 2002 or 2001.
Loans on which the accrual of interest has been discontinued amounted to $1,879,007 and $6,228,740 at December 31, 2003 and 2002, respectively. If interest on those loans had been accrued, such income would have approximated $359,361, $367,215, and $214,479, for 2003, 2002, and 2001, respectively. Interest income actually recorded on those loans amounted to $344,052, $97,681 and $64,045, for 2003, 2002 and 2001, respectively.
5. PREMISES AND EQUIPMENT
Premises and equipment and their depreciable lives are summarized as follows:
Depreciation expense of $906,609, $1,046,982 and $1,157,284 was recorded in 2003, 2002, and 2001, respectively, on premises and equipment.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
6. GOODWILL AND INTANGIBLE ASSETS
The Bank adopted the Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (Statement 142) on January 1, 2002, which ceased amortizing of its goodwill. This decreased non-interest expense and increased net income in 2003 and 2002 as compared to 2001. The following table shows the pro forma effects of applying Statement 142 to the 2001 period.
7. INVESTMENT IN LIMITED PARTNERSHIPS
The Bank invests in limited partnerships that operate qualified affordable housing projects primarily to receive tax benefits in the form of tax deductions from operating losses and tax credits. The Bank accounts for the investments under the equity method. The Bank’s investment balances in these partnerships were $2,979,847 and $3,873,813 at December 31, 2003 and 2002, respectively. Losses related to these partnerships are included in other expense and amounted to $562,105, $826,364 and $534,638, for 2003, 2002, and 2001, 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. See Note 2 for additional discussion on the Bank’s investment in limited partnerships, included in “Recent Accounting Pronouncements”.
The Bank had no remaining cash commitments to these partnerships at December 31, 2003.
8. DEPOSITS
At December 31, 2003, the scheduled maturities of the Bank’s time deposits greater than $100,000 are as follows:
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
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:
At December 31, 2003, the Bank has $40 million in available federal fund lines from correspondent banks.
10. LONG-TERM DEBT
The Company uses FHLB 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. At December 31, 2003, investment securities and one-to-four family mortgage loans amounting to $71,208,239 and $26,156,585, respectively, were pledged to secure these borrowings. At December 31, 2002, the Bank experienced significant paydowns of Mortgage Backed Securities due to the continuing decrease in interest rates, and therefore, did not hold sufficient collateral pledged to meet the FHLB requirements under their collateral agreement. Additional funds were pledged to meet collateral agreement requirements.
The following summarizes information concerning FHLB advances and other borrowings:
Interest rates on FHLB advances ranged from 1.12% to 6.50% and 1.29% to 6.50% at December 31, 2003 and 2002, respectively.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Scheduled maturities of FHLB advances during 2004 are approximately $31.0 million. In 2005, there are $100,000 in scheduled maturities. In 2006, there are $7.0 million scheduled maturities. In 2007, there are $5.0 million in scheduled maturities. In 2008, there are $39.7 million in scheduled maturities. There are no scheduled maturities for 2009. In 2010, there are $13.0 million in scheduled maturities.
At December 31, 2003, the Bank has $130.6 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:
The consolidated tax provision differed from the amount computed by applying the federal statutory income tax rate of 34.57% to pretax earnings for the following reasons:
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2003 and 2002, are presented below:
12. EMPLOYEE BENEFIT PLANS
The Company sponsors an employee stock ownership plan, the United Security Bancshares, Inc. 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 $402,710, $365,173, and $349,533 in 2003, 2002, and 2001, respectively.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
13. LONG-TERM INCENTIVE COMPENSATION PLAN
The Company’s Long-Term Incentive Compensation Plan (“LTICP”) 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 compensa-tion 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 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:
A summary of the status of the Company’s stock option plan at December 31, 2003, 2002, and 2001 and the changes during the year then ended is as follows:
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, no expected forfeiture rates as options are immediately vested at date of grant, with an expected stock volatility and an expected annual dividend yield.
The Bank has entered into supplemental compensation benefits agreements with the directors and certain executive officers. The measurement of the liability under these agreements includes estimates involving life expectancy, length of time before retirement and the expected returns on the Bank-owned life insurance policies used to fund those agreements. Should these estimates prove materially wrong, the Company could incur additional or reduced expense to provide the benefits.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
14. SHAREHOLDERS’ EQUITY
Dividends paid by the Company are primarily from dividends received 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, 2003, approximately $12.4 million of the Bank’s retained earnings were available for dividend distribution without prior regulatory approval.
During a review of the Company’s compliance with the Securities and Exchange Commission (the “SEC”) rules and regulations in October 2003, it was discovered that the United Security Bancshares, Inc. Employee Stock Ownership Plan (With 401(k) Provisions) (the “Plan”), maintained for the benefit of the Company’s employees, had purchased a greater number of shares of common stock than had been initially registered under the Plan by the Company. Although all of the purchases under the Plan were made in a manner consistent with the Plan and the investment elections of the Plan participants, the Company determined that the purchases of up to 30,790 shares of common stock by participants in the Plan may not have been properly registered in accordance with the Securities Act of 1933. Since participants who purchased such securities may have had a right to require the Company to rescind the sale of such common stock, it offered to rescind the purchase of such stock issued to the Plan participants. The rescission offer expired on March 10, 2004, and no participants elected to accept the rescission offer by the Company. Accordingly, no contingent liability relating to this rescission offer was recorded.
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 in the regulations) and of Tier I capital to average total assets (as defined in the regulations). 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, 2003 and 2002, that the Company met all capital adequacy requirements imposed by its regulators.
As of December 31, 2003 and 2002, 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 cate-gorized 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:
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Comprehensive Income
Comprehensive income is the change in equity during a period from transactions and other events and circumstances from non-owner sources.
In addition to net income, changes in other non-owner transactions consist entirely of changes in unrealized gains and losses on securities available for sale and derivative instruments.
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:
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
15. SEGMENT REPORTING
Under SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, certain information is dis-closed for the two reportable operating segments of the Company. The reportable segments were determined using the internal management reporting system. They are composed of the Company’s and Bank’s significant subsidiaries. The accounting policies for each segment are the same as those 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.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
16. OTHER OPERATING EXPENSES
Other operating expenses for the years 2003, 2002, and 2001 consist of the following:
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, 2003:
Total rental expense under all operating leases was $342,817, $372,186 and $424,343 in 2003, 2002, and 2001, respectively.
18. GUARANTEES, COMMITMENTS AND CONTINGENCIES
The Company is a defendant in other 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 consolidated financial position or results of operations of the Company.
The Bank’s exposure to credit loss in the event of nonperformance by the other party for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments as it does for on-balance sheet instruments. For interest rate swap trans-actions, and commitments to purchase or sell securities for forward delivery, the contract or notional amounts do not represent exposure to credit loss. The Bank controls the credit risk of these derivative instruments through credit approvals, limits, and monitoring procedures. Certain derivative contracts have credit risk for the carrying value plus the amount to replace such contracts in the event of counter party default. All of the Bank’s financial instruments are held for risk management and not for trading purposes. During the years ended December 31, 2003, 2002, and 2001, there were no credit losses associated with derivative contracts. At December 31, 2003 and 2002, there were no non-performing derivative positions.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
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.
Standby letters of credit are contingent commitments issued by the Company generally to guarantee the performance of a customer to a third party. The Company has recourse against the customer for any amount it is required to pay to a third party under a standby letter of credit. Revenues are recognized over the life of the standby letter of credit. The potential amount of future payments the Company could be required to make under its standby letter of credit at December 31, 2003, is $523,000 and represents the Company’s total credit risk. At December 31, 2003, the Company had $329,748 associated with standby letter of credit agreements entered into subsequent to December 31, 2002, as a result of the Company’s adoption of Interpretation 45 at January 1, 2003. Standby letter of credit agreements entered into prior to January 1, 2003, have a carrying value of zero.
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.
Commitments to purchase securities for delayed delivery require the Bank to purchase a specified security at a specified price for delivery on a specified date. Similarly, commitments to sell securities for delayed delivery require the Bank to sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in security values and interest rates between the commitment and delivery dates. At December 31, 2003, there were no outstanding commitments to purchase and sell securities for delayed delivery.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
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 extend credit and standby letters of credit.
The Bank’s principal objective in holding derivative financial instruments is asset-liability management. The operations of the Bank are subject to a risk of interest rate fluctuations to the extent that there is a difference between the amount of the Bank’s interest-earning assets and the amount of interest-bearing liabilities that mature or re-price 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. Note 2 to the Consolidated Financial Statements includes a summary of how derivative instruments used for interest rate risk management are accounted for in the financial statements.
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 debt with a one month LIBOR rate index to a fixed rate five-year constant maturity treasury index. The income derived from these instruments is recorded on the accrual basis. The income from these instruments is recorded in net interest expense and resulted in an increase in net interest expense of $637,639 in 2003, $18,496 in 2002, and a reduction in net interest income of $129,548 in 2001.
The Company uses interest rate swaps to hedge the re-pricing characteristics of assets or liabilities. All components of each derivative’s gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. There were no cash-flow hedging gains and losses, which were reclassified from other comprehensive income to other income as a result of the discontinuance of cash-flow hedges related to certain forecasted transactions that are probable of not occurring.
The following table details various information regarding interest rate swaps used for purposes other than trading as of December 31, 2003:
Interest rate swaps 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, 2003, such swaps were associated with floating rate debt in the notional amount of $55 million.
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.
All of the Bank’s derivative financial instruments are over-the-counter instruments and are not exchange traded. Market values are obtained from the counter parties to each instrument. The Bank only uses other commercial banks as a counter party to their derivative activity. The Bank performs stress tests and other models to assess risk exposure.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
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 following methods and assumptions were used by the Company in estimating the fair value of its financial instruments:
Cash and cash equivalents: Fair value equals the carrying value of such assets.
Trading securities and investment securities available for sale: Fair values for trading securities and investment securities available for sale are based on quoted market prices.
Accrued interest receivable and payable: Fair value equals the carrying value of these instruments.
Loans, net: 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.
Derivative instruments: Fair values of the Company’s derivative instruments are based on values obtained from counter parties, 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 non-interest 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 as of December 31, 2003 and 2002.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
21. UNITED SECURITY BANCSHARES, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION
Statements of Condition
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
Statements of Income
Statements of Cash Flows
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
22. QUARTERLY DATA (UNAUDITED)
Item 9.
Item 9.
Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.
As reported in Bancshares’ Form 8-K filed with the Securities and Exchange Commission on March 25, 2002, the Board of Directors of Bancshares approved the engagement of Ernst & Young LLP as its independent auditors for the fiscal year ending December 31, 2002 to replace Arthur Andersen LLP, who was dismissed as auditors of Bancshares effective March 21, 2002. The Audit Committee of the Board of Directors approved the change in auditors and recommended the change to the Board of Directors.
In the past two years, the independent auditors’ reports on the financial statements did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles nor have there been any disagreements with the independent auditors on any matters of accounting principles or practices, financial statement disclosure or auditing scope or procedure.
Item 9A.
Item 9A.
Controls and Procedures.
As of December 31, 2003, the end of the period covered by this report, Bancshares carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of Bancshares’ disclosure controls and procedures pursuant to Exchange Act Rule 13a-15. Based upon that evaluation, the Chief Executive Officer and Principal Financial Officer concluded that Bancshares’ disclosure controls and procedures are effective in timely alerting them to material information relating to Bancshares that is required to be included in Bancshares’ periodic filings with the Securities and Exchange Commission.
There were no significant changes in Bancshares’ internal controls over financial reporting during the quarter ended December 31, 2003 that have materially affected, or are reasonably likely to materially affect, Bancshares’ internal control over financial reporting.
PART III
Item 10.
Item 10.
Directors and Executive Officers of the Registrant.
Bancshares has adopted a Code of Business Conduct and Ethics for directors, officers (including Bancshares’ principal executive officer, principal financial officer, principal accounting officer or controller) and employees. The Code of Business Conduct and Ethics is filed as Exhibit 14 to this report. Bancshares will provide any person a copy of the Code of Business Conduct and Ethics free of charge upon written request as follows: United Security Bancshares, Inc., Attention: Larry M. Sellers, Secretary, 131 West Front Street, Post Office Box 249, Thomasville, Alabama 36784, 334-636-5424.
Other information called for by this Item is incorporated herein by reference to Bancshares’ definitive proxy statement, under the captions, “Proposal 1: Election of Directors,” “Section 16(a) Beneficial Ownership Reporting Compliance” and “Corporate Governance,” 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, 2003.
Item 11.
Item 11.
Executive Compensation.
The information called for by this Item is incorporated herein by reference to Bancshares’ definitive proxy statement, under the captions, “Proposal 1: Election of Directors,” “Executive Compensation Benefits,” “Compensation Committee Interlocks and Insider Participation” and “Compensation Committee Report,” 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, 2003.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information called for by this Item is incorporated herein by reference to Bancshares’ definitive proxy statement, under the captions, “Security Ownership of Certain Beneficial Owners and Management” and “Compensation Committee Report,” 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, 2003.
Item 13.
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, 2003.
Item 14.
Item 14.
Principal Accountant Fees and Services.
The information called for by this Item is incorporated herein by reference to Bancshares’ definitive proxy statement, under the caption, “Auditor Services and Fees,” 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, 2003.
PART IV
Item 15.
Item 15.
Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a)1. Financial Statements.
Report of Independent Accountants.
Consolidated Statements of Condition, December 31, 2003 and 2002.
Consolidated Statements of Income, December 31, 2003, 2002 and 2001.
Consolidated Statements of Shareholders’ Equity, December 31, 2003, 2002 and 2001.
Consolidated Statements of Cash Flows, December 31, 2003, 2002 and 2001.
Notes to Consolidated Financial Statements.
(a)2. Financial Statement 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 in Part II, Item 8, of this report.
(a)3. Exhibits.
(3.1) Certificate of Incorporation of Bancshares incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 1999.
(3.2) Bylaws of Bancshares, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 1999.
(10.1) Employment Agreement dated January 1, 2000, between Bancshares and R. Terry Phillips, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 2000.*
(10.2) 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).*
(10.3) United Security Bancshares, Inc. Long Term Incentive Compensation Plan, incorporated herein by reference to the Exhibits to Form S-4 dated April 16, 1997 (File No. 333-21241).*
(10.4) First United Security Bank Salary Continuation Agreement dated September 20, 2002, with Dan Barlow, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.5) First United Security Bank Salary Continuation Agreement dated September 20, 2002, with William D. Morgan, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.6) First United Security Bank Salary Continuation Agreement dated September 20, 2002, with Terry Phillips, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.7) First United Security Bank Salary Continuation Agreement dated September 20, 2002, with Larry Sellers, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.8) First United Security Bank Salary Continuation Agreement dated September 20, 2002, with Robert Steen, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.9) First United Security Bank Director Retirement Agreement dated October 14, 2002, with Dan R. Barlow, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 2002.*
(10.10) First United Security Bank Director Retirement Agreement dated October 17, 2002, with Linda H. Breedlove, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.11) First United Security Bank Director Retirement Agreement dated October 21, 2002, with Gerald P. Corgill, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.12) First United Security Bank Director Retirement Agreement dated October 16, 2002, with Wayne C. Curtis, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.13) First United Security Bank Director Retirement Agreement dated October 17, 2002, with John C. Gordon, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.14) First United Security Bank Director Retirement Agreement dated October 16, 2002, with William G. Harrison, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 2002.*
(10.15) First United Security Bank Director Retirement Agreement dated October 17, 2002, with Hardie B. Kimbrough, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.16) First United Security Bank Director Retirement Agreement dated October 17, 2002, with Jack Meigs, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.17) First United Security Bank Director Retirement Agreement dated October 17, 2002, with R. Terry Phillips, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.18) First United Security Bank Director Retirement Agreement dated October 17, 2002, with Ray Sheffield, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.19) First United Security Bank Director Retirement Agreement dated October 16, 2002, with J. C. Stanley, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.20) First United Security Bank Director Retirement Agreement dated October 17, 2002, with Howard M. Whitted, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.21) First United Security Bank Director Retirement Agreement dated October 17, 2002, with Bruce N. Wilson, incorporated herein by reference to the Exhibits to Form 10-Q for the quarter ended September 30, 2002.*
(10.22) United Security Bancshares, Inc. Non-Employee Directors’ Deferred Compensation Plan.*
(14) Code of Business Conduct and Ethics.
(21) List of Subsidiaries of Bancshares.
(23) Consent of Independent Public Accountants.
(31.1) Certification of Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
(31.2) Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a) of the Securities Exchange Act, as amended.
(32) Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Indicates a management contract or compensatory plan or arrangement.
(b) Reports on Form 8-K.
On October 17, 2003, Bancshares filed a report on Form 8-K dated October 17, 2003 relating to the results of its third fiscal quarter ended September 30, 2003. Under the Form 8-K, Bancshares furnished (not filed) pursuant to Item 7 the press release entitled “United Security Bancshares, Inc. Announces Quarterly and Nine Month Earnings” relating to the results of its third fiscal quarter ended September 30, 2003, as well as unaudited financial highlights.
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.
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.