UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
| x |
ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934 FOR
THE FISCAL YEAR ENDED DECEMBER 31,
2007.
|
| o |
TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
|
ACT
OF
1934 FOR THE TRANSITION PERIOD FROM________TO______.
Commission
file number: 000-32987
UNITED
SECURITY BANCSHARES
(Exact
name of registrant as specified in its charter)
|
CALIFORNIA
|
91-2112732
|
|
(State
or other jurisdiction of
incorporation
or organization)
|
(I.R.S.
Employer
Identification
No.)
|
|
2126
Inyo Street, Fresno,
California
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93721
|
|
(Address
of principal executive offices)
|
(Zip
Code)
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Registrant’s
telephone number, including area code (559)
248-4943
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Securities
registered pursuant to Section 12(b) of the Act:
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Common
Stock, no par value on Nasdaq
(Title of Class)
|
Securities
registered pursuant to Section 12(g) of the Act: NONE
Indicate
by check mark whether the registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities Act.
Yes
o
No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Securities Act. Yes
o
No
x
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing for the past
90
days.
Yes
x
No
o
Indicate
by check mark if disclosure of delinquent filers pursuant to item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrants knowledge, in the definitive proxy or information statements
incorporated by reference in Part III of this form 10-K or any amendment to
this
Form 10-K. [ ]
Indicate
by check mark whether the registrant is an accelerated filer (as defined in
Rule
12b-2 of the Act).
Large
accelerated filer o
Accelerated filer x
Non-accelerated
filer o Small reporting company
o
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes [ ] No [ X ]
Aggregate
market value of the Common Stock held by non-affiliates as of the last business
day of the registrant's most recently completed second fiscal quarter - June
30,
2007: $176,229,651
Shares
outstanding as of February 29, 2008: 11,844,970
DOCUMENTS
INCORPORATED BY REFERENCE
Certain
portions of the Definitive Proxy Statement for the 2008 Meeting of Part
III, Items 10, 11, 12, 13 and 14 Shareholders
is incorporated by reference into Part III.
UNITED
SECURITY BANCSHARES
TABLE
OF CONTENTS
|
PART
I:
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|
|
Item
1 - Business
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3
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|
Item
1A - Risk Factors
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11
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Item
1B - Unresolved Staff Comments
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15
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Item
2 - Properties
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15
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Item
3 - Legal Proceedings
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16
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Item
4 - Submission of Matters to a Vote of Security Holders
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16
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PART
II:
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|
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Item
5 - Market for the Registrant's Common Equity, Related Stockholder
Matters, and
Issuer Purchases of Equity Securities
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17
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Item
6 - Selected Financial Data
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20
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Item
7 - Management's Discussion and Analysis of Financial Conditio
and
Results of Operations
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21
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Item
7A - Quantitative and Qualitative Disclosure About Market
Risk
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53
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Item
8 - Financial Statements and Supplementary Data
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56
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Item
9 - Changes in and Disagreements with Accountants on Accounting
and
Financial Disclosure
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93
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Item
9A - Controls and Procedures
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93
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Item
9B - Other Information
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94
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PART
III:
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|
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Item
10 - Directors, Executive Officers, and Corporate
Governance
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94
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Item
11 - Executive Compensation
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94
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Item
12 - Security Ownership of Certain Beneficial Owners and Management
and
Related Stockholder Matters
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94
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Item
13 - Certain Relationships and Related Transactions, and Director
Independence
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94
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Item
14 - Principal Accounting Fees and Services
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94
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PART
IV:
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|
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Item
15 - Exhibits and Financial Statement Schedules
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95
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2
PART
1
Certain
matters discussed or incorporated by reference in this Annual Report of Form
10-K including, but not limited to, those described in "Item 7 - Management's
Discussion and Analysis of Financial Condition and Results of Operations",
are
forward-looking statements as defined under the Securities Litigation Reform
Act
of 1995 that are subject to risks and uncertainties that could cause actual
results to differ materially from those projected in the forward-looking
statements. Such risks and uncertainties include, among others, (1) competitive
pressure in the banking industry increases significantly; (2) changes in the
interest rate environment which may reduce margins and devalue assets; (3)
general economic conditions, either nationally or regionally, are less favorable
than expected, resulting in, among other things, a deterioration in credit
quality; (4) changes in the regulatory environment; (5) changes in business
conditions and inflation; (6) changes in securities markets; (7) asset/liability
matching risks and liquidity risks; (8) loss of key personnel; and (9)
operational interruptions including data processing systems failure and
fraud. Therefore, the information set forth therein should be carefully
considered when evaluating the business prospects of the
Company.
Item
1 - Business
General
United
Security Bancshares (the “Company”) is a California corporation incorporated
during March of 2001and is registered with the Board of Governors of the Federal
Reserve System as a bank holding company under the Bank Holding Company Act
of
1956, as amended. The Company’s stock is listed on NASDAQ under the symbol
“UBFO”. United Security Bank (the “Bank”) is a wholly-owned bank subsidiary of
the Company and was formed in 1987. United Security Bancshares Capital Trust
I
(the “Trust”) was formed during June of 2001 as a Delaware business trust for
the sole purpose of issuing Trust Preferred securities. The Trust was originally
formed as a subsidiary of the Company, but was deconsolidated during 2004
pursuant to the adoption of FIN 46 (as revised), “Consolidation of Variable
Interest Entities”. During July 2007, the Trust Preferred Securities issued
under USB Capital Trust I were redeemed, and upon retirement, the USB Capital
Trust I was dissolved. During July the Company formed United Security Bancshares
Capital Trust II and issued $15.0 million in Trust Preferred Securities with
terms similar to those originally issued under USB Capital Trust I, except
at a
lower interest rate. At present, the Company does not engage in any material
business activities other than ownership of the Bank.
United
Security Bank
On
June
12, 2001, the Bank became the wholly owned subsidiary of United Security
Bancshares, through a tax-free holding company reorganization, accounted for
on
a basis similar to the pooling of interest method. In the transaction, each
share of Bank stock was exchanged for a share of Company stock on a one-to-one
basis.
The
Bank
is a California state-chartered bank headquartered in Fresno, California. It
is
also a member of the Federal Reserve System (“Fed member”). The Bank originally
commenced business on December 21, 1987 as a national bank and, during the
fourth quarter of 1998, filed an application with the California Department
of
Financial Institutions and other regulatory authorities to become a
state-chartered bank. The shareholders approved the conversion in January of
1999, and the Bank was granted approval to operate as a state-chartered bank
on
February 3, 1999. The Bank’s operations are currently subject to federal and
state laws applicable to state-chartered, Fed member banks and its deposits
are
insured up to the applicable limits by the Federal Deposit Insurance Corporation
(the "FDIC"). The Bank is also subject to the Federal Deposit Insurance Act
and
regulatory reporting requirements of the FDIC. As a state-chartered bank and
a
member of the Federal Reserve System, the Bank is subject to supervision and
regular examinations by the Board of Governors of the Federal Reserve System
(the “FRB”) and the California Department of Financial Institutions (the “DFI”).
In addition, the Bank is required to file reports with the FRB and provide
such
additional information as the FRB may require.
Effective
August 25, 1995, the Bank consummated a merger with Golden Oak Bank, a two
branch California state chartered bank located in Oakhurst, California, with
assets of approximately $45 million at the date of merger. The merger was
accounted for as a pooling of interests.
During
February of 1997, the Bank completed the purchase of the deposits and certain
assets of two branches of Wells Fargo Bank located in Caruthers and San Joaquin,
both located in Fresno County. This brought the total branches operated at
that
time by the Bank to six and the total assets to approximately $190 million.
The
Bank paid a premium of approximately $1.2 million to purchase deposit accounts
totaling approximately $33.4 million. The Bank also purchased cash balances
as
well as certain fixed assets of the branch operations.
3
During
October of 1997, the Bank completed the purchase from Bank of America of two
of
its branches located in Firebaugh and Coalinga, both located in Fresno County.
The acquisition brought the total branches operated by the Bank to eight at
that
time and the total assets to approximately $238 million. The premium paid by
the
Bank totaled approximately $3.0 million and the amount of deposits totaled
approximately $44.4 million. The transaction included the receipt of cash
balances of approximately $1.0 million and the purchase of premises and
equipment totaling approximately $600,000.
USB
Investment Trust Inc. was incorporated effective December 31, 2001 as a special
purpose real estate investment trust (“REIT”) under Maryland law. The REIT is a
subsidiary of the Bank and was funded with $133.0 million in real estate-secured
loans contributed by the Bank. USB Investment Trust was originally formed to
give the Bank flexibility in raising capital, and reduce the expenses associated
with holding the assets contributed to USB Investment Trust.
For
further discussion of the REIT, refer to Item 7 - Management’s Discussion and
Analysis of Financial Condition and Results of Operations - Income Taxes.
Effective
April 23, 2004, the Company completed a merger with Taft National Bank
headquartered in Taft, California. Taft National Bank (“Taft”) was merged into
United Security Bank and Taft’s two branches operate as branches of United
Security Bank. The total consideration paid to Taft shareholders was 241,447
shares of the Company’s Common Stock valued at just over $6 million. In the
merger, the Company acquired $15.4 million in cash and short-term investments,
$23.3 million in loans, and $48.2 million in deposits. This transaction was
accounted for using the purchase method of accounting, and resulted in the
purchase price being allocated to the assets acquired and liabilities assumed
from Taft based on the fair value of those assets and liabilities. The
consolidated statement of income for the year ended December 31, 2004 includes
the operations of Taft from the date of the acquisition to December 31,
2004.
On
February 16, 2007, the Company completed its merger with Legacy Bank, N.A.,
located in Campbell, California, with the acquisition of 100 percent of Legacy’s
outstanding common shares. At merger, Legacy Bank’s one branch was merged with
and into United Security Bank, a wholly owned subsidiary of the Company. The
total value of the merger transaction was $21.5 million,
and the
shareholders of Legacy Bank received merger consideration consisting of 976,411
shares of common stock of the Company. The merger transaction was accounted
for
as a purchase transaction, and resulted in the purchase price being allocated
to
the assets acquired and liabilities assumed from Legacy Bank based on the fair
value of those assets and liabilities. The net of assets acquired and
liabilities assumed totaled approximately $8.6 million at the date of the
merger. Fair value of Legacy assets and liabilities acquired, and resultant
goodwill, has been determined and recorded as of the date of the merger and
the
resulting operations thereafter have been included in the financial statements
as of and for the year ended December 31, 2007.
(See
Note 24 to the Company’s consolidated financial statements contained herein for
details of the merger).
During
November 2007, the Company purchased the recurring contractual revenue stream
and certain fixed assets from ICG Financial, LLC. Additionally, the Company
hired all but one of the former employees of ICG Financial, LLC and its
subsidiaries. The total purchase price was $414,000 including $378,000 for
the
recurring revenue stream and $36,000 for the fixed assets. A newly formed
department of the Bank, USB Financial Services provides wealth management,
employee benefit, insurance and loan products, as well as consulting services
for a variety of clients, utilizing employees hired from ICG Financial LLC.
The
Company believes the wealth management and related services provided by USB
Financial Services will enhance the products and services offered by the
Company, and increase noninterest income. The capitalized cost of $378,000
for
the recurring revenue stream will be amortized over a period of approximately
three years.
At
December 31, 2007, the Bank operates three branches (including its main office),
one construction lending office, and one financial services office in Fresno
and
one branch each, in Oakhurst, Caruthers, San Joaquin, Firebaugh, Coalinga,
Bakersfield, and Taft. In addition, the Company and Bank have administrative
headquarters located at 2126 Inyo Street, Fresno, California,
93721.
At
December 31, 2007, the consolidated Company had approximately $771.7 million
in
total assets, $585.6 million in net loans, $634.6 million in deposits, and
$82.4
million in shareholders' equity.
The
following discussion of the Company's services should be read in conjunction
with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF
OPERATIONS."
Bank
Services
As
a
state-chartered commercial bank, United Security Bank offers a full range of
commercial banking services primarily to the business and professional community
and individuals located in Fresno, Madera, Kern, and Santa Clara
Counties.
4
The
Bank
offers a wide range of deposit instruments including personal and business
checking accounts and savings accounts, interest-bearing negotiable order of
withdrawal ("NOW") accounts, money market accounts and time certificates of
deposit. Most of the Bank's deposits are attracted from individuals and from
small and medium-sized business-related sources.
The
Bank
also engages in a full complement of lending activities, including real estate
mortgage, commercial and industrial, real estate construction, as well as
agricultural, lease financing, and consumer loans, with particular emphasis
on
short and medium-term obligations. The Bank's loan portfolio is not concentrated
in any one industry, although approximately 68% of the Bank's loans are secured
by real estate. A loan may be secured (in whole or in part) by real estate
even
though the purpose of the loan is not to facilitate the purchase or development
of real estate. At December 31, 2007, the Bank had loans (net of unearned fees)
outstanding of $596.5 million, which represented approximately 94% of the Bank's
total deposits and approximately 77% of its total assets.
Real
estate mortgage loans are secured by deeds of trust primarily on commercial
property. Repayment of real estate mortgage loans is generally from the cash
flow of the borrower. Commercial and industrial loans have a high degree of
industry diversification. Loans may be originated in the Company’s market area,
or participated with other financial institutions outside the Company’s market
area. A substantial portion of commercial and industrial loans are secured
by
accounts receivable, inventory, leases or other collateral. The remainder are
unsecured; however extensions of credit are predicated on the financial capacity
of the borrower to repay the extension of credit. Repayment of commercial loans
is generally from the cash flow of the borrower. Real estate construction loans
consist of loans to residential contractors, which are secured by single-family
residential properties. All real estate loans have established equity
requirements. Repayment of real estate construction loans is generally from
long-term mortgages with other lending institutions. Agricultural loans are
generally secured by land, equipment, inventory and receivables. Repayment
of
agricultural loans is from the expected cash flow of the borrower.
In
the
normal course of business, the Bank makes various loan commitments and incurs
certain contingent liabilities. At December 31, 2007 and 2006, loan commitments
and letters of credit of the Bank aggregated $196.3 million and $193.1 million,
respectively. Of the $196.3 million in loan commitments outstanding at December
31, 2007, $159.7 million or 81.6% were for loans with maturities of one year
or
less. Due to the nature of the business of the Bank's customers, there are
no
seasonal patterns or absolute predictability to the utilization of unused loan
commitments; therefore the Bank is unable to forecast the extent to which these
commitments will be exercised within the current year. The Bank does not believe
that any such utilization will constitute a material liquidity demand. The
Company does however have collateralized and uncollateralized lines of credit
which could be utilized if such loan commitments were to be exercised in excess
of normal expectations.
In
addition to the loan and deposit services discussed above, the Bank also offers
a wide range of specialized services designed to attract and service the needs
of commercial customers and account holders. These services include online
banking, safe deposit boxes, ATM services, payroll direct deposit, cashier's
checks, traveler's checks, money orders, and foreign drafts. In addition, the
Bank offers a variety of specialized financial services, including wealth
management, employee benefit, insurance and loan products, as well as consulting
services for a variety of clients. The Bank does not operate a trust department;
however, it makes arrangements with its correspondent bank to offer trust
services to its customers on request. Most of the Bank's business originates
within Fresno, Madera, Kern, and Santa Clara Counties. Neither the Bank’s
business or liquidity is seasonal, and there has been no material effect upon
the Bank's capital expenditures, earnings or competitive position as a result
of
federal, state or local environmental regulation.
Competition
and Market Share
The
banking business in California generally, and in the market area served by
the
Company specifically, is highly competitive with respect to both loans and
deposits. The Company competes for loans and deposits with other commercial
banks, savings and loan associations, finance companies, money market funds,
credit unions and other financial institutions, including a number that are
substantially larger than the Company. Deregulation of the banking industry,
increased competition from non-bank entities for the cash balances of
individuals and businesses, and continuing developments in the computer and
communications industries have had, and most likely will continue to have,
a
significant impact on the Company's competitive position. With the enactment
of
interstate banking legislation in California, bank holding companies
headquartered outside of California will continue to enter the California market
and provide competition for the Company. Additionally, with the
Gramm-Leach-Bliley Act of 1999, traditional competitive barriers between
insurance companies, securities underwriters, and commercial banks have been
eased, allowing a greater number of financial intermediaries to offer a wider
assortment of financial services. Many of the major commercial banks operating
in the Company's market areas offer certain services such as trust and
international banking services, which the Company does not offer directly.
In
addition, banks with larger capitalization have larger lending limits and are
thereby able to serve larger customers.
The
Company’s primary market area at December 31, 2007 was located in Fresno,
Madera, and Kern Counties, in which approximately 34 FDIC-insured financial
institutions compete for business. Santa Clara County was added during February
2007 with the Legacy Bank acquisition, in which approximately 75 FDIC-insured
financial institutions compete for business. The following table sets forth
information regarding deposit market share and ranking by county as of June
30,
2007, which is the most current information available.
5
|
Rank
|
Share
|
||||||
|
Fresno
County
|
7th
|
5.39
|
%
|
||||
|
Madera
County
|
8th
|
4.84
|
%
|
||||
|
Kern
County
|
13th
|
1.19
|
%
|
||||
|
Total
of Fresno, Madera, Kern Counties
|
10th
|
3.80
|
%
|
||||
|
Santa
Clara County
|
17th
|
0.96
|
%
|
||||
Supervision
and Regulation
The
Company
The
Company is a bank holding company within the meaning of the Bank Holding Company
Act of 1956, as amended (the “BHC Act”), and is registered as such with the FRB.
A bank holding company is required to file with the FRB annual reports and
other
information regarding its business operations and those of its subsidiaries
and
is also subject to examination by the FRB.
The
BHC
Act requires, among other things, prior approval before acquiring, directly
or
indirectly, ownership or control of any voting shares of any bank, if after
such
acquisition it would directly or indirectly own or control more than 5% of
the
voting stock of that bank, unless it already owns a majority of the voting
stock
of that bank. The BHC Act also provides that the FRB shall not approve any
acquisition that would result in or further the creation of a monopoly, or
the
effect of which may be substantially to lessen competition, unless the
anticompetitive effects of the proposed transaction are clearly outweighed
by
the probable effect in meeting the convenience and needs of the community
served.
Furthermore,
under the BHC Act, a bank holding company is, with limited exceptions,
prohibited from (i) acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any company which is not a bank or (ii) engaging
in any activity other than managing or controlling banks. With the prior
approval of the FRB, however, a bank holding company may own shares of a company
engaged in activities which the FRB has determined to be so closely related
to
banking or managing or controlling banks as to be proper incident thereto.
The
BHC
Act requires a bank holding company to serve as a source of financial and
managerial strength to its subsidiary banks. It is the FRB’s policy that a bank
holding company should stand ready to use available resources to provide
adequate capital funds to subsidiary banks during periods of financial stress
and should maintain the financial flexibility and capital raising capacity
to
obtain additional resources for assisting a subsidiary bank. Under certain
conditions, the FRB may conclude that certain actions of a bank holding company,
such as payment of cash dividends, would constitute unsafe and unsound banking
practices because they violate the FRB’s “source of strength” doctrine.
A
bank
holding company and its subsidiaries are prohibited from certain tie-in
arrangements in connection with any extension of credit, sale or lease of
property or furnishing of services. For example, with certain exceptions, a
bank
may not condition an extension of credit on a promise by its customer to obtain
other services by it, its holding company or other subsidiaries, or on a promise
by its customer not to obtain services from a competitor. In addition, federal
law imposes certain restrictions between the Company and its subsidiaries,
including the Bank. As an affiliate of the Bank, the Company is subject, with
certain exceptions, to provisions of federal law imposing limitations on, and
requiring collateral for, extensions of credit by the Bank to its
affiliates.
In
1999
the Gramm-Leach-Bliley Act (the “GLBA”) was enacted. The GLBA became effective
in March of 2000 and is a financial services modernization law that, among
other
things, facilitates broad new affiliations among securities firms, insurance
companies and bank holding companies by repealing the 66-year old provisions
of
the Glass-Steagall Act. The GLBA allows the formation of financial holding
companies (“FHC’s”), which are bank holding companies with substantially
expanded powers. A bank holding company must acquire the approval of the FRB
to
become a FHC. Under these expanded powers, affiliations may occur between bank
holding companies, securities firms and insurance companies, subject to a blend
of umbrella supervision and regulation of the newly formed consolidated entity
by the Federal Reserve, oversight of the FHC’s bank and thrift subsidiaries by
their primary federal and state banking regulators and financial regulation
of
the FHC’s nonbank subsidiaries by their respective specialized regulators. The
Company has not applied to become a FHC.
6
As
a
public company, United Security Bancshares is subject to the Sarbanes-Oxley
Act
of 2002. The Sarbanes-Oxley Act amends the Securities and Exchange Act of 1934,
and is intended to protect investors by, among other things, improving the
reliability of financial reporting, increasing management accountability, and
increasing the independence of Directors and the Company’s external
accountants.
The
Company is subject to the periodic reporting requirements of the Securities
Exchange Act of 1934, as amended, which include but are not limited to the
filing of annual, quarterly and other current reports with the SEC.
The
Bank
The
Bank
as a state-chartered bank is subject to regulation, supervision and regular
examination by the California Department of Financial Institutions. In addition,
The Bank is also a member of the Federal Reserve System and, as such, is subject
to applicable provisions of the Federal Reserve Act and regulations issued
thereunder and, is subject to regulation, supervision and regular examination
by
the Federal Reserve Bank. The Bank is subject to California law, insofar as
they
are not preempted by federal banking law. Deposits of the Bank are insured
by
the FDIC up to the applicable limits in an amount up to $100,000 per customer,
and, as such, the Bank is subject to the regulations of the FDIC and the Federal
Deposit Insurance Act. As a consequence of the extensive regulation of
commercial banking activities in California and the United States, the Bank’s
business is particularly susceptible to changes in California and federal
legislation and regulation, which may have the effect of increasing the cost
of
doing business, limiting permissible activities or increasing
competition.
Various
other requirements and restrictions under the laws of the United States and
the
State of California affect the operations of the Bank. Federal and California
statutes and regulations relate to many aspects of the Bank’s operations,
including capital requirements and disclosure requirements to depositors and
borrowers, requirements to maintain reserves against deposits, limitations
on
interest rates payable on deposits, loans, investments, and restrictions on
borrowings and on payment of dividends. The DFI regulates the number and
location of branch offices of a state-chartered bank, and may permit a bank
to
maintain branches only to the extent allowable under state law for state banks.
California law presently permits a bank to locate a branch in any locality
in
the state. Additionally, California law exempts banks from California usury
laws.
Effect
of Governmental Policies and Recent Legislation
Banking
has traditionally been a business that depends on rate differentials. In
general, the difference between the interest rate paid by the Company on its
deposits and other borrowings and the interest rate received on loans extended
to its customers and securities held in the Company's portfolio comprise the
major portion of the Company's earnings. These rates are highly sensitive to
many factors which are beyond the control of the Company. Accordingly, the
earnings and growth of the Company are subject to the influence of domestic
and
foreign economic conditions, including, but not limited to, inflation, recession
and unemployment.
The
earnings and growth of the Company are affected not only by general economic
conditions, both domestic and foreign, but also by the monetary and fiscal
policies of the United States government and its agencies, particularly the
Federal Reserve Board (“FRB”). The FRB implements national monetary policies
(with objectives such as to curb inflation and combat recession) by its open
market operations in United States Government securities, by adjusting the
required level of reserves for financial institutions subject to reserve
requirements, and by varying the discount rates applicable to borrowing by
banks
which are members of the Federal Reserve System. The actions of the FRB in
these
areas influence the growth of bank loans, investments and deposits and also
affect interest rates charged on loans and paid on deposits. The nature and
impact that future changes in fiscal or monetary policies or economic controls
may have on the Company’s business and earnings cannot be predicted. In
addition, adverse economic conditions could make a higher provision for loan
losses a prudent course and could cause higher loan charge-offs, thus adversely
affecting the Company’s net income.
From
time
to time, legislation is enacted which has the effect of increasing the cost
of
doing business, limiting or expanding permissible activities or affecting the
competitive balance between banks and other financial institutions. Proposals
to
change the laws and regulations governing the operations and taxation of banks
and other financial institutions are frequently made in Congress, in the
California legislature and before various bank regulatory agencies. The
likelihood of any major change and the impact such change may have on the
Company is impossible to predict. Certain of the potentially significant changes
which have been enacted recently and other which are currently under
consideration by Congress or various regulatory agencies or professional
agencies are discussed below.
7
Recent
Legislation and Other Changes
Federal
and state laws affecting banking are enacted from time to time, and similarly
federal and state regulations affecting banking are also adopted from time
to
time. The following include some of the recent laws and regulations affecting
banking.
In
September 2007, the President signed into law the College Cost Reduction Act
that increases the size of Pell grants by $500 per year over the next 5 years
and cut interest rates on federal student loans from 6.8 percent to 3.4 percent
over the same period. To offset these costs, the law will reduce subsidies
to
private and nonprofit lenders by 55 and 40 basis points, respectively. The
new
law also cuts the special allowance payment subsidy and reduces lender insurance
rates and increase loan origination fees.
The
Private Student Loan Disclosure Enhancement Act (S. 1831) is being considered
by
Congress to prevent unfair and deceptive private educational lending practices
and eliminating conflicts of interest by prohibiting gifts and revenue sharing.
The proposed bill would prohibit private education lenders from directly or
indirectly offering or providing any gift to a higher education institution
or
employee in exchange for loan volume or any other advantage. The proposed bill
also prohibits institutions and employees from receiving any gifts in exchange
for preferential treatment of private student loans. Institutions of higher
education and lenders would also be prohibited from entering into revenue
sharing agreements under the proposed bill. There would also be a co-branding
prohibition in the proposed bill-that prohibits private education lenders from
using the name, emblem, mascot, or logo of an institution when marketing private
educational loans in a way that implies that an institution endorses the private
loan offered by the lender. This provision also forbids lenders from using
words, pictures, or symbols readily identified with an institution. Compensation
in Connection with Advisory Boards would also be limited in that the proposed
bill would prohibit employees of financial aid offices that serve on a private
lenders advisory board, commission, or group of lenders from receiving anything
of value from the lender. As to covered student loans, the bill would prohibit
lenders from imposing fees for early repayment or prepayment of educational
loans and required improved detailed disclosure of loan terms and rates before
consummation of the loan transaction. In addition, the bill provides a 30 day
period to review the loan before accepting the loan during which the terms
may
not be changed. The proposed bill would provide credit for lenders (used to
meet
the credit needs of its community under the Community Reinvestment Act) that
make low-cost private loans to low-income borrowers.
Congress
is also considering The Federal Housing Administration Modernization Act of
2007
(S. 2338): The FHA Modernization Act of 2007 seeks to help American families
that have been hit hard by the current crisis in the mortgage markets by
addressing problems in the mortgage market that have shut off funding for home
loans and make FHA loans a more viable alternative to the subprime market by
raising FHA loan limits, modifying downpayment requirements and expanding the
access to FHA programs. The proposed bill also removes the current cap on the
number of reverse mortgages made through the Home Equity Conversion Mortgage
program and raises the current loan limit for this program to a single national
loan limit. The proposed bill would also make the Home Equity Conversion
Mortgage program permanent.
In
December 2007, the FDIC issued a proposed rule to improve the process for
determining uninsured depositors at larger institutions in the event of a
failure. The measure is intended to allow the FDIC to make funds promptly
available to insured deposit customers in the unlikely event that a large
financial institution is closed. The proposal is broken into two parts. One
section relates to so-called covered institutions, those that have at least
$2
billion in domestic deposits, have more than 250,000 deposit accounts, or have
total assets of more than $20 billion, regardless of the number of deposits
or
accounts. A covered institution would be required to adopt mechanisms that,
in
the event of a failure, would place provisional holds on large deposit accounts
in a percentage specified by the FDIC; provide the FDIC with deposit account
data in a standard format; and allow automatic removal of provisional holds
once
the FDIC makes an insurance determination. The second part applies to all
FDIC-insured institutions, regardless of size, and governs the specific time
and
circumstance under which account balances will be determined in the event of
a
failure. The FDIC is proposing to use the end-of-day ledger balance as normally
calculated by the institution. By using the end-of-day ledger, the FDIC will
be
able to apply a single standard across all failed banks in order to treat every
transaction equally. This is also the same deposit balance used for Call Report
and assessment purposes. There would be no requirements placed on open
institutions as a result of this provision. The FDIC places a high priority
on
providing access to insured deposits promptly and, in the past, has usually
been
able to allow most depositors access to their deposits on the next business
day.
If adopted, the proposed rule would better enable the FDIC to continue this
practice, especially for the larger, more complex institutions it
insures.
The
Federal Reserve Board in November 2007 approved final rules to implement the
Basel II framework for large bank capital requirements. The new risk-based
capital requirements apply to large, internationally active banking
organizations in the United States. The new capital adequacy requirements were
designed to align regulatory capital requirements with actual risks and are
expected to strengthen banking organizations’ risk-management practices. Basel
II would replace the current U.S. rules implementing the Basel Capital Accord
of
1988 (Basel I) and be mandatory for large, internationally active banking
organizations (so-called “core” banking organizations with at least $250 billion
in total assets or at least $10 billion in foreign exposure) and optional for
others. Under Basel II, core banking organizations would be required to
enhance the measurement and management of their risks, including credit risk
and
operational risk. Core banking organizations will be required to have rigorous
processes for assessing their overall capital adequacy in relation to their
total risk profile and to publicly disclose information about their risk profile
and capital adequacy.
8
The
new
U.S. Basel II rule is technically consistent in most respects with international
approaches and includes a number of prudential safeguards as originally proposed
in September 2006. These safeguards include a requirement that banking
organizations satisfactorily complete a four-quarter parallel run period before
operating under the Basel II framework, a requirement that an institution
satisfactorily complete a series of transitional periods before operating under
Basel II without floors, and a commitment by the agencies to conduct
ongoing analysis of the framework to ensure Basel II is working as
intended. Basel II in the United States will be implemented with retention
of the leverage ratio and prompt corrective action (PCA) requirements, which
will continue to bolster capital and complement risk-based measures. Following
a
successful parallel run period, a banking organization would have to progress
through three transitional periods (each lasting at least one year), during
which there would be floors on potential declines in risk-based capital
requirements. Those transitional floors would limit maximum cumulative
reductions of a banking organization’s risk-based capital requirements to
5 percent during the first transitional floor period, 10 percent during the
second transitional floor period, and 15 percent during the third transitional
floor period. A banking organization would need approval from its primary
federal regulator to move into each of the transitional floor periods, and
at
the end of the third transitional floor period to move to full Basel
II.
In
October 2007, the Federal Trade Commission following the federal financial
institution regulatory agencies approved the final rules on identity theft
“red
flags” requiring each financial institution and creditor that holds any consumer
account, or other account for which there is a reasonably foreseeable risk
of
identity theft, to develop and implement an Identity Theft Prevention Program
(Program) for combating identity theft in connection with new and existing
accounts. The Program must include reasonable policies and procedures for
detecting, preventing, and mitigating identity theft and enable a financial
institution or creditor to:
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Identify
relevant patterns, practices, and specific forms of activity that
are “red
flags” signaling possible identity theft and incorporate those red flags
into the Program;
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·
|
Detect
red flags that have been incorporated into the
Program;
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·
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Respond
appropriately to any red flags that are detected to prevent and mitigate
identity theft; and
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·
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Ensure
the Program is updated periodically to reflect changes in risks from
identity theft.
|
The
agencies also issued guidelines to assist financial institutions and creditors
in developing and implementing a Program, including a supplement that provides
examples of red flags. The final rules require credit and debit card
issuers to develop policies and procedures to assess the validity of a request
for a change of address that is followed closely by a request for an additional
or replacement card. In addition, the final rules require users of
consumer reports to develop reasonable policies and procedures to apply when
they receive a notice of address discrepancy from a consumer reporting agency.
The final rules are effective on January 1, 2008. Covered financial institutions
and creditors must comply with the rules by November 1, 2008.
The
federal financial regulatory agencies issued final rules in October 2007 that
provide consumers with an opportunity to "opt out" before a financial
institution uses information provided by an affiliated company to market its
products and services to the consumer. The final rules on affiliate
marketing implement section 214 of the Fair and Accurate Credit Transactions
Act
of 2003, which amends the Fair Credit Reporting Act (FCRA). The final rules
generally prohibit a financial institution from using certain information
received from an affiliate to make a solicitation to a consumer unless the
consumer is given notice and a reasonable opportunity to opt out of such
solicitations, and the consumer does not opt out. The final rules apply to
information obtained from the consumer’s transactions or account relationships
with an affiliate, any application the consumer submitted to an affiliate,
and
third-party sources, such as credit reports, if the information is to be used
to
send marketing solicitations. Nothing in the final rules supersedes or
amends a consumer’s existing right to opt out of the sharing of non-transaction
or experience information under section 603(d) of the FCRA. The final rules
also
implement the statutory exceptions to the affiliate marketing notice and opt-out
requirement. The final rules are effective on January 1, 2008, and all covered
entities must comply with the rules no later than October 1, 2008.
In
September 2007, the SEC and Federal Reserve Board of Governors adopted final
rules to implement the bank “broker” provisions of the Gramm-Leach-Bliley Act.
The rules define the scope of securities activities that banks may conduct
without registering with the SEC as a securities broker and implement the most
important “broker” exceptions for banks adopted by the GLB Act.
Specifically, the rules implement the statutory exceptions that allow a bank,
subject to certain conditions, to continue to conduct securities transactions
for its customers as part of the bank’s trust and fiduciary, custodial and
deposit “sweep” functions, and to refer customers to a securities broker-dealer
pursuant to a networking arrangement with the broker-dealer. The rules are
designed to accommodate the business practices of banks and to protect
investors. The effective date for compliance is the first day of the
bank’s fiscal year commencing after September 30, 2008.
9
Also
in
September 2007, the federal regulatory banking agencies issued final rules
allowing well-managed insured depository institutions with less than $500
million in total assets to qualify for an extended 18 month on-site examination
cycle. The final rules implement a provision of the Financial Services
Regulatory Relief Act of 2006.
In
June
2007, the federal banking regulatory agencies issued a final statement on
Subprime Mortgage Lending to address issues relating to certain adjustable-rate
mortgage (ARM) products that can cause payment shock. The statement describes
the prudent safety and soundness and consumer protection standards that
institutions should follow to ensure borrowers obtain loans they can afford
to
repay. These standards include a fully indexed, fully amortized qualification
for borrowers and cautions on risk-layering features, including an expectation
that stated income and reduced documentation should be accepted only if there
are documented mitigating factors that clearly minimize the need for
verification of a borrower's repayment capacity. Consumer protection standards
include clear and balanced product disclosures to customers and limits on
prepayment penalties that allow for a reasonable period of time, typically
at
least 60 days, for customers to refinance prior to the expiration of the initial
fixed interest rate period without penalty.
In
California, a new Section 691.1 was added to the Financial Code that exempts
a
bank from obtaining a securities permit for the following
transactions:
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any
offer (but not a sale) not involving a public offering by a bank
organized
under the laws of this state of its securities
|
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·
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the
execution and delivery of any agreement for the sale of the securities
pursuant to the offer if no part of the consideration for the securities
is paid to or received by the bank and none of the securities are
issued
until the sale of the securities is authorized by the commissioner
or
exempted from authorization.
|
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·
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any
stock split by a bank organized under the laws of this state that
is
effected pursuant to an amendment to its articles, an agreement of
merger,
or a certificate of ownership that has been approved by the commissioner,
unless this exemption is withheld by order of the
commissioner
|
| · | any offer or sale of securities by a bank organized under the laws of this state that is either (1) to a person actually approved by the commissioner pursuant to Section 702 of the Financial Code to acquire control of the bank if all of the material terms and conditions of the offer and sale of securities are disclosed in the application for approval specified in Section 702 and the offer and sale of securities is in accordance with the terms and subject to the conditions of the approval to acquire control or (2) in a transaction exempted from the approval requirement of Section 701 by a regulation or an order of the commissioner, unless this exemption is withheld by order of the commissioner. |
On
February 8, 2006, the President signed The Federal Deposit Insurance Reform
Act
of 2005 (the Reform Act) into law. The Federal Deposit Insurance Reform
Conforming Amendments Act of 2005, which the President signed into law on
February 15, 2006, contains necessary technical and conforming changes to
implement deposit insurance reform, as well as a number of study and survey
requirements. The Reform Act provides for the following changes:
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·
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Merging
the Bank Insurance Fund (BIF) and the Savings Association Insurance
Fund
(SAIF) into a new fund, the Deposit Insurance Fund (DIF). This change
was
made effective March 31, 2006.
|
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·
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Increasing
the coverage limit for retirement accounts to $250,000 and indexing
the
coverage limit for retirement accounts to inflation as with the general
deposit insurance coverage limit. This change was made effective
April 1,
2006.
|
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Establishing
a range of 1.15 percent to 1.50 percent within which the FDIC Board
of
Directors may set the Designated Reserve Ratio (DRR).
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·
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Allowing
the FDIC to manage the pace at which the reserve ratio varies within
this
range.
|
|
1.
|
If
the reserve ratio falls below 1.15 percent—or is expected to within 6
months—the FDIC must adopt a restoration plan that provides that the DIF
will return to 1.15 percent generally within 5 years.
|
|
2.
|
If
the reserve ratio exceeds 1.35 percent, the FDIC must generally dividend
to DIF members half of the amount above the amount necessary to maintain
the DIF at 1.35 percent, unless the FDIC Board, considering statutory
factors, suspends the dividends.
|
|
3.
|
If
the reserve ratio exceeds 1.5 percent, the FDIC must generally dividend
to
DIF members all amounts above the amount necessary to maintain the
DIF at
1.5 percent.
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10
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·
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Eliminating
the restrictions on premium rates based on the DRR and granting the
FDIC
Board the discretion to price deposit insurance according to risk
for all
insured institutions regardless of the level of the reserve ratio.
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·
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Granting
a one-time initial assessment credit (of approximately $4.7 billion)
to
recognize institutions' past contributions to the fund.
|
The
federal financial regulatory agencies in December 2006 issued a new interagency
policy statement on the allowance for loan and lease losses (ALLL) along with
supplemental frequently asked questions. The policy statement revises and
replaces a 1993 policy statement on the ALLL. The agencies issued the revised
policy statement in view of today’s uncertain economic environment and the
presence of concentrations in untested loan products in the loan portfolios
of
insured depository institutions. The policy statement has also been revised
to
conform to generally accepted accounting principles (GAAP) and post-1993
supervisory guidance. The 1993 policy statement described the responsibilities
of the boards of directors, management, and banking examiners regarding the
ALLL; factors to be considered in the estimation of the ALLL; and the objectives
and elements of an effective loan review system, including a sound credit
grading system. The policy statement reiterates that each institution has a
responsibility for developing, maintaining and documenting a comprehensive,
systematic, and consistently applied process appropriate to its size and the
nature, scope, and risk of its lending activities for determining the amounts
of
the ALLL and the provision for loan and lease losses and states that each
institution should ensure controls are in place to consistently determine the
ALLL in accordance with GAAP, the institution’s stated policies and procedures,
management’s best judgment and relevant supervisory guidance.
The
policy statement also restates that insured depository institutions must
maintain an ALLL at a level that is appropriate to cover estimated credit losses
on individually evaluated loans determined to be impaired as well as estimated
credit losses inherent in the remainder of the loan and lease portfolio, and
that estimates of credit losses should reflect consideration of all significant
factors that affect the collectibility of the portfolio as of the evaluation
date. The policy statement states that prudent, conservative, but not excessive,
loan loss allowances that represent management’s best estimate from within an
acceptable range of estimated losses are appropriate.
It
is
impossible to predict what effect the enactment of certain of the
above-mentioned legislation will have on the Company. Moreover, it is likely
that other bills affecting the business of banks may be introduced in the future
by the United States Congress or California legislature.
Employees
At
December 31, 2007, the Company employed 155 persons on a full-time equivalent
basis. The Company believes its employee relations are excellent.
Available
Information
The
Company files period reports and other reports under the Securities and Exchange
Act of 1934 with the Securities and Exchange Commission (SEC). These reports,
as
well as the Company’s Code of Ethics, are posted and are available at no cost on
the Company’s website at http://www.unitedsecuritybank.com
as soon
as reasonably practical after the Company files such reports with the SEC.
The
Company’s periodic and other reports filed with the SEC are also available at
the SEC’s website (http://www.sec.gov).
Item
1A. Risk Factors
There
are
risk factors that may affect the Company’s business and impact the results of
operations, some of which are beyond the control of the Company.
The
Company’s financial performance is subject to interest rate
risk.
The
Company’s operations are greatly influenced by general economic conditions and
by related monetary and fiscal policies of the federal government. Deposit
flows
and the funding costs are influenced by interest rates of competing investments
and general market rates of interest. Lending activities are affected by the
demand for loans, which in turn is affected by the interest rates at which
such
financing may be offered and by other factors affecting the availability of
funds.
The
Company’s performance is substantially dependent on net interest income, which
is the difference between the interest income received from interest-earning
assets and the interest expense incurred in connection with our interest-bearing
liabilities. To reduce the Company’s exposure to interest rate fluctuations,
management seeks to manage the balances of interest sensitive assets and
liabilities, and maintain appropriate maturity and repricing parameters for
these assets and liabilities. A mismatch between the amount of rate sensitive
assets and rate sensitive liabilities in any time period may expose the Company
to interest rate risk. Generally, if rate sensitive assets exceed rate sensitive
liabilities, the net interest margin will be positively impacted during a rising
rate environment and negatively impacted during a declining rate environment.
When rate sensitive liabilities exceed rate sensitive assets, the net interest
margin will generally be positively impacted during a declining rate environment
and negatively impacted during a rising rate environment.
11
Increases
in the level of interest rates may reduce the overall level of loans originated
by the Company, and, thus, the amount of loan and commitment fees earned, as
well as the market value of investment securities and other interest-earning
assets. Moreover, fluctuations in interest rates may also result in
disintermediation, which is the flow of funds away from depository institutions
into direct investments, such as corporate securities and other investment
vehicles which, because of the absence of federal deposit insurance, generally
pay higher rates of return than depository institutions.
The
deterioration of local economic conditions in the Company’s market area could
hurt profitability.
The
Company’s operations are located primarily in Fresno, Madera, Kern, and Santa
Clara Counties, and are concentrated in Fresno County and surrounding areas.
As
a result of this geographic concentration, the Company’s financial results
depend largely upon economic conditions in these areas. The local economy in
the
Company’s market areas rely heavily on agriculture, real estate, professional
and business services, manufacturing, trade and tourism. The significant
economic downturn experienced in the sub-prime lending and credit markets
beginning during the second half of 2007, has negatively impacted the Company’s
operations and financial condition to some degree, and may further worsen with
further deterioration of local and state-wide economic conditions. Poor economic
conditions could cause the Company to incur losses associated with higher
default rates and decreased collateral values in the loan
portfolio.
Concentrations
in commercial and industrial loans, real estate-secured commercial loans, and
real estate construction loans, may expose the Company to increased lending
risks, especially in the event of a recession.
The
Company has significant concentrations in commercial real estate and real estate
construction loans. As of December 31, 2007, 17.1%, and 29.8% of the Company’s
loan portfolio was concentrated in these two categories, respectively. In
addition, the Company has many commercial loans to businesses in the
construction and real estate industry. There has been increased volatility
in
real estate values in the Company’s market area in recent years, and the
occurrence of a real estate recession affecting these market areas would likely
reduce the security for many of the Company’s loans and adversely affect the
ability of many of borrowers to repay loan balances due the Company and require
increased provisions to the allowance for loan losses. Therefore, the Company’s
financial condition and results of operations may be adversely affected by
a
decline in the value of the real estate securing the Company’s loans.
The
Company faces strong competition, which may adversely affect its operating
results.
In
recent
years, competition for bank customers, the source of deposits and loans for
the
Company has greatly intensified. This competition includes:
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·
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larger
regional and national banks and other FDIC insured depository institutions
in many of the communities the Company
serves;
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·
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finance
companies, investment banking and brokerage firms, and insurance
companies
that offer bank-like products;
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·
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credit
unions, which can offer highly competitive rates on loans and deposits
because they receive tax advantages not available to commercial banks;
and
|
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·
|
technology-based
financial institutions including large national and super-regional
banks
offering on-line deposit, bill payment, and mortgage loan application
services.
|
Some
of
the financial services organizations with which the Company competes are not
subject to the same degree of regulation as is imposed on bank holding companies
and federally insured financial institutions. As a result, these non-bank
competitors have certain advantages over the Company in accessing funding and
in
providing various banking-related services.
By
virtue
of their larger capital position, regional and national banks have substantially
larger lending limits than the Company, and can provide certain services to
their customers which the Company is not able to offer directly, such as trust
and international services. Many of these larger banks also operate with greater
economies of scale which result in lower operating costs than the Company on
a
per-unit basis.
12
Other
existing single or multi-branch community banks, or new community bank
start-ups, have marketing strategies similar to United Security Bancshares.
These other community banks can open new branches in the communities the Company
serves and compete directly for customers who want the high level of service
community banks offer. Other community banks also compete for the same
management personnel and the same potential acquisition and merger candidates.
Ultimately, competition can drive down the Company’s interest margins and reduce
profitability, as well as make it more difficult for the Company to achieve
its
growth objectives.
The
Company’s growth and expansion strategy may not prove to be successful and as a
result, its market value and profitability may suffer.
The
Company plans to grow operations within its market area and expand into new
market areas when it makes strategic business sense, however the Company’s
capacity to manage any such growth will depend primarily on the ability to
attract and retain qualified personnel, monitor operations, maintain earnings
and control costs. The Company expects to continue to grow its assets and
deposits, the products and services which it offers and accordingly the scale
of
its operations. The Company’s ability to manage growth successfully will depend
on the ability to maintain cost controls and asset quality while attracting
additional loans and deposits on favorable terms. If the Company grows too
quickly and is not able to control costs and maintain asset quality, this rapid
growth could materially adversely affect the financial performance of the
Company. The future successful growth of the Company will depend on the ability
of its officers and other key employees to continue to implement and improve
operational, credit, financial, management and other internal risk controls
and
processes, reporting systems and procedures, and to manage a growing number
of
customer relationships. The Company may not successfully implement improvements
to management information and control systems, and control procedures and
processes, in an efficient or timely manner and may discover deficiencies in
existing systems and controls. In particular, the Company’s controls and
procedures must be able to accommodate an increase in expected loan volume
and
the infrastructure that comes with growth. Thus, the Company’s growth strategy
may divert management from existing businesses and may require the Company
to
incur additional expenditures to expand its administrative and operational
infrastructure. If the Company is unable to manage future expansion in its
operations, it may experience compliance and operational problems, need to
slow
the pace of growth, or need to incur additional expenditures beyond current
projections to support such growth, any one of which could adversely affect
the
Company’s business and profitability.
The
loss of any of the Company’s executive officers or key personnel could be
damaging to the business.
The
Company depends upon the skills and reputations of its executive officers and
key employees for its future success. The loss of any of these key persons
or
the inability to attract and retain other key personnel could adversely affect
the Company’s business operations.
The
Company could experience loan losses, which exceed the overall allowance for
loan losses.
The
risk
of credit losses on loans and leases varies with, among other things, general
economic conditions, the type of loan being made, the creditworthiness of the
borrower, and, in the case of collateralized loans, the value and marketability
of the collateral. The Company maintains an allowance for loan losses based
upon, among other things, historical experience, an evaluation of economic
conditions, and regular reviews of delinquencies and loan portfolio quality.
Based upon such factors, management makes various assumptions and determinations
about the ultimate collectibility of the loan portfolio and provides an
allowance for losses based upon a percentage of the outstanding balances and
for
specific loans where their collectibility is considered to be
questionable.
As
of
December 31, 2007, the Company’s allowance for loan losses was approximately
$10.9 million representing 1.82% of gross outstanding loans. Although management
believes that the allowance is adequate, there can be no absolute assurance
that
it will be sufficient to cover future loan losses. Although the Company uses
the
best information available to make determinations with respect to adequacy
of
the allowance for loan losses, future adjustments may be necessary if economic
conditions change substantially from the assumptions used or if negative
developments occur with respect to non-performing or performing loans. If
management’s assumptions or conclusions prove to be incorrect and the allowance
for loan losses is not adequate to absorb future losses, or if Company’s
regulatory agencies require an increase in the allowance for loan losses, the
Company’s earnings, and potentially its capital, could be significantly and
adversely impacted.
The
Company may become subject to environmental liability risk associated with
lending activities.
A
significant portion of the Company’s loan portfolio is secured by real property.
During the ordinary course of business, we may foreclose on and take title
to
properties securing certain loans. In doing so, there is a risk that hazardous
or toxic substances could be found on these properties. If hazardous or toxic
substances are found, the Company may be liable for remediation costs, as well
as for personal injury and property damage. Environmental laws may require
the
Company to incur substantial expenses and may materially reduce the affected
property’s value or limit the ability to use or sell the affected property. In
addition, future laws or more stringent interpretations or enforcement policies
with respect to existing laws may increase our exposure to environmental
liability. Although the Company has policies and procedures to perform an
environmental review before initiating any foreclosure action on nonresidential
real property, these reviews may not be sufficient to detect all potential
environmental hazards. The remediation costs and any other financial liabilities
associated with an environmental hazard could have a material adverse effect
on
the Company’s financial condition and results of operations.
13
The
regulatory environment under which the Company operates may have an adverse
impact on the banking industry.
The
Company is subject to extensive regulatory supervision and oversight from both
federal and state authorities. Regulatory oversight of the Company is provided
by the Federal Reserve Bank (FRB) and the California Department of Financial
Institutions (DFI). Future legislation and government may adversely impact
the
Company and the commercial banking industry in general. Future regulatory
changes may also alter the structure and competitive relationship among
financial institutions.
The
Company may be exposed to compliance risk resulting from violations or
nonconformity with laws, rules, regulations, internal policies and procedures,
or ethical standards set forth by regulatory authorities. The Company may also
be subject to compliance risk in situations where laws or rules governing
certain products or activities of the Company’s customers may be uncertain or
untested. Compliance risk exposes the Company to fines, civil money penalties,
payment of damages, and the potential voiding of contracts. Compliance risk
can
result in diminished reputation, reduced franchise value, limited business
opportunities, and reduced growth potential.
If
the Company lost a significant portion of its low-cost core deposits, it would
negatively impact profitability.
The
Company’s profitability depends in part on its success in attracting and
retaining a stable base of low-cost deposits. As of December 31, 2007,
noninterest-bearing checking accounts comprised 21.9% of the Company’s deposit
base, and interest-bearing checking and money market accounts comprised an
additional 7.2% and 17.1%, respectively. The Company considers these deposits
to
be core deposits. If the Company lost a significant portion of these low-cost
deposits, it would negatively impact its profitability and long-term growth
objectives. While Management generally does not believe these deposits are
sensitive to interest-rate fluctuations, the competition for these deposits
in
the Company’s market area is strong and if the Company were to lose a
significant portion of these low-cost deposits, it would negatively affect
business operations.
The
Company’s Internal controls and procedures may fail or be
circumvented.
Management
regularly reviews and updates our internal controls, disclosure controls and
procedures, and corporate governance policies and procedures. Any system of
controls, however well designed and operated, is based, in part, on certain
assumptions and can provide only reasonable, not absolute, assurances that
the
objectives of the system are met. Any failure or circumvention of the Company’s
controls and procedures or failure to comply with regulations related to
controls and procedures could have a material adverse effect the Company’s
business, results of operations and financial condition.
The
Company’s information systems may experience an interruption or breach in
security.
The
Company relies heavily on communications and information systems to conduct
its
business. Any failure, interruption or breach in security of these systems
could
result in failures or disruptions in customer relationship management, general
ledger, deposit, loan and other systems. While the Company has policies and
procedures designed to prevent or limit the effect of the failure, interruption
or security breach of its information systems, there can be no assurance that
we
can prevent any such failures, interruptions or security breaches or, if they
do
occur, that they will be adequately addressed. The occurrence of any failures,
interruptions or security breaches of the Company’s information systems could
damage our reputation, result in a loss of customer business, subject the
Company to additional regulatory scrutiny, or expose it to civil litigation
and
possible financial liability, any of which could have a material adverse effect
on the Company’s financial condition and results of operations.
The
Company continually encounters technological change.
The
financial services industry is continually undergoing rapid technological change
with frequent introductions of new technology-driven products and services.
The
effective use of technology increases efficiency and enables financial
institutions to better serve customers and to reduce costs. The Company’s future
success depends, in part, upon its ability to address the needs of its customers
by using technology to provide products and services that will satisfy customer
demands, as well as to create additional efficiencies in the Company’s
operations. Many of the Company’s competitors have substantially greater
resources to invest in technological improvements. We may not be able to
effectively implement new technology-driven products and services or be
successful in marketing these products and services to the company’s customers
and even if such products and services are implemented, the Company may incur
substantial costs in doing so. Failure to successfully keep pace with
technological change affecting the financial services industry could have a
material adverse impact on the Company’s business, financial condition and
results of operations
14
The
Company relies on dividends from its subsidiaries for most of its
revenue.
United
Security Bancshares is a separate and distinct legal entity from its
subsidiaries. The Company receives substantially all of its revenue from
dividends from its subsidiary, United Security Bank. These dividends are the
principal source of funds to pay dividends on common stock and interest on
the
Company’s junior subordinated debt. Various federal and/or state laws and
regulations limit the amount of dividends that United Security Bank and certain
non-bank subsidiaries may pay to United Security Bancshares. Also, United
Security Bancshares’ right to participate in a distribution of assets upon a
subsidiary’s liquidation or reorganization is subject to the prior claims of the
subsidiary’s creditors. In the event United Security Bank is unable to pay
dividends to United Security Bancshares, the Company may not be able to service
debt, pay obligations or pay dividends on common stock. The inability to receive
dividends from United Security Bank could have a material adverse effect on
United Security Bancshares’ business, financial condition and results of
operations.
The
holders of the Company’s junior subordinated debentures have rights that are
senior to those of the Company’s shareholders.
On
July
25, 2007 the Company issued $15.5 million of floating rate junior subordinated
debentures in connection with a $15.0 million trust preferred securities
issuance by its subsidiary, United Security Bancshares Capital Trust II. The
junior subordinated debentures mature in July 2037.
The
Company conditionally guarantees payments of the principal and interest on
the
trust preferred securities. The Company’s junior subordinated debentures are
senior to holders of common stock. As a result, the Company must make payments
on the junior subordinated debentures (and the related trust preferred
securities) before any dividends can be paid on our common stock and, in the
event of bankruptcy, dissolution or liquidation, the holders of the debentures
must be satisfied before any distributions can be made to the holders of common
stock. The Company has the right to defer distributions on our junior
subordinated debentures (and the related trust preferred securities) for up
to
five years, during which time no dividends may be paid to holders of common
stock.
Severe
weather, natural disasters, acts of war or terrorism and other external events
could significantly impact the Company’s business.
Severe
weather, natural disasters, including but not limited to earthquakes and
droughts, acts of war or terrorism and other adverse external events could
have
a significant impact on the Company’s ability to conduct business. Such events
could affect the stability of our deposit base, impair the ability of borrowers
to repay outstanding loans, impair the value of collateral securing loans,
cause
significant property damage, result in loss of revenue and/or cause the Company
to incur additional expenses. Severe weather or natural disasters, acts of
war
or terrorism or other adverse external events may occur in the future. Although
management has established disaster recovery policies and procedures, there
can
be no assurance of the effectiveness of such policies and procedures, and the
occurrence of any such event could have a material adverse effect on the
Company’s business, financial condition and results of operations.
Item
1B. - Unresolved Staff Comments
The
Company had no unresolved staff comments at December 31, 2007.
Item
2 - Properties
The
Bank’s Main bank branch is located at 2151 West Shaw Avenue, Fresno, California.
The Company owns the building and leases the land under a sublease dated
December 1, 1986 between Central Bank and USB. The current sublessor under
the
master ground lease is Bank of the West, which acquired the position through
the
purchase of Central Bank. The lessor under the ground lease (Master Lease)
is
Thomas F. Hinds. The lease expires on December 31, 2015 and the Company has
options to extend the term for four (4) ten-year periods and one seven (7)
year
period.
15
The
Company leases the banking premises of approximately 6,450 square feet for
its
second of three Fresno branches at 7088 N. First Ave, Fresno, California.,
under
a lease which commenced August 2005 for a term of ten years expiring in July
2015. The branch was previously located at 1041 E. Shaw Avenue, Fresno,
California, under a lease extension expiring February 28, 2005. The lease was
renewed until August 2005. The 7088 N. First location provides space for the
relocated branch as well as the Real Estate Construction Department and the
Indirect Consumer Lending Department.
The
Company leases the Oakhurst bank branch located at the Old Mill Village Shopping
Center, 40074 Highway 49, Oakhurst, California. The branch facility consists
of
approximately 5,000 square feet with a lease term of 15 years ending April
2014,
and has two five-year options to extend the lease term after that date.
The
Company owns the Caruthers bank branch located at 13356 South Henderson,
Caruthers, California, which consists of approximately 5,000 square feet of
floor space.
The
Company owns the San Joaquin branch facilities located at 21574 Manning Avenue,
San Joaquin, California. The bank branch is approximately 2,500 square feet.
The
Company owns the Firebaugh bank branch located at 1067 O Street, Firebaugh,
California. The premises are comprised of approximately 4,666 square feet of
office space situated on land totaling approximately one-third of an
acre.
The
Company owns the Coalinga bank branch located at 145 East Durian, Coalinga,
California. The office building has a total of 6,184 square feet of interior
floor space situated on approximately 0.45 acres of land.
The
Company leases the Convention Center branch located at 855 “M” Street, Suite
130, Fresno, California. Total space leased is approximately 4,520 square feet,
and was occupied during March 2004. The fifteen-year lease expires in March
2019. There are no extension provisions.
The
Company owns the Taft branch office premises located at 523 Cascade Place,
Taft,
California. The branch facilities consist of approximately 9,200 square feet
of
office space.
The
Company owns the branch facilities located at 3404 Coffee Road, Bakersfield,
California, which has approximately 6,130 square feet of office space located
on
1.15 acres.
The
Company leases the Campbell branch located at 125 E. Campbell Ave, Campbell,
California, which has approximately 6,995 square feet which it occupied after
the merger completed in February 2007. The lease expires on December 31,
2010.
The
Company subleases the space for its USB Financial Services offices at 855 “M”
Street, Suite 1120, Fresno, California from Centex Homes, Inc. The subleased
facility totals 3,656 square feet and the lease expires on March 31, 2008.
The
Company owns its administrative headquarters at 2126 Inyo Street, Fresno,
California. The facility consists of approximately 21,400 square feet. A portion
of the premises has been subleased to a third-party under a lease term of
approximately seven years.
Item
3 - Legal Proceedings
From
time
to time, the Company is party to claims and legal proceedings arising in the
ordinary course of business. At this time, the management of the Company is
not
aware of any material pending litigation proceedings to which it is a party
or
has recently been party to, which will have a material adverse effect on the
financial condition or results of operations of the Company.
Item
4 - Submission of Matters to a Vote of Security Holders
No
matters
were submitted to a vote of shareholders during the fourth quarter of 2007.
16
PART
II
Item
5 - Market for the Registrant's Common Equity, Related Stockholder Matters,
and
Issuer Purchases of Equity Securities
Trading
History
The
Company became a NASDAQ National Market listed company on May 31, 2001, then
became a Global Select listed company during 2006, and trades under the symbol
UBFO.
The
Company currently has four market makers for its common stock. These include,
Stone & Youngberg, LLC, Howe Barnes Hoeffer & Arnett, Sandler O’Neill
& Partners, and Hill Thompson, Magid & Company. The Company is aware of
two other securities dealers: Smith Barney and Dean Witter Reynolds Inc., which
periodically act as brokers in the Company's stock.
On
March
28, 2006, the Company announced a 2-for-1 stock split of the Company’s no-par
common stock payable May 1, 2006 effected in the form of a 100% stock dividend.
Share information for all periods presented in this 10-K have been restated
to
reflect the effect of the stock split.
The
Company has been included in the Russell 2000 Stock Index since June 2006.
The
inclusion of the Company’s stock in the index has provided additional exposure
for the Company in equity markets, and increased the transaction
volume.
The
following table sets forth the high and low closing sales prices by quarter
for
the Company's common stock, for the years ended December 31, 2007 and 2006.
|
Closing
Prices
|
Volume
|
|||||||||
|
Quarter
|
High
|
Low
|
||||||||
|
4th
Quarter 2007
|
$
|
20.00
|
$
|
14.34
|
1,505,900
|
|||||
|
3rd
Quarter 2007
|
$
|
21.00
|
$
|
13.99
|
1,167,700
|
|||||
|
2nd
Quarter 2007
|
$
|
22.63
|
$
|
17.14
|
2,083,400
|
|||||
|
1st
Quarter 2007
|
$
|
25.00
|
$
|
19.07
|
1,649,400
|
|||||
|
|
||||||||||
|
4th
Quarter 2006
|
$
|
26.06
|
$
|
21.54
|
632,400
|
|||||
|
3rd
Quarter 2006
|
$
|
24.41
|
$
|
20.26
|
1,124,600
|
|||||
|
2nd
Quarter 2006
|
$
|
24.87
|
$
|
21.39
|
1,456,300
|
|||||
|
1st
Quarter 2006
|
$
|
22.65
|
$
|
15.26
|
389,000
|
|||||
At
January 31, 2008, there were approximately 864 record holders of common stock
of
the Company. This does not reflect the number of persons or entities who hold
their stock in nominee or street name through various brokerage
firms.
Dividends
The
Company's shareholders are entitled to cash dividends when and as declared
by
the Company’s Board of Directors out of funds legally available therefore.
Dividends paid to shareholders by the Company are subject to restrictions set
forth in California General Corporation Law, which provides that a corporation
may make a distribution to its shareholders if retained earnings immediately
prior to the dividend payout are at least equal the amount of the proposed
distribution. As a bank holding company without significant assets other than
its equity position in the Bank, the Company’s ability to pay dividends to its
shareholders depends primarily upon dividends it receives from the Bank. Such
dividends paid by the Bank to the Company are subject to certain limitations.
See “Management’s Discussion and Analysis of Financial and Results of Operations
- Regulatory Matters”.
The
Company paid cash dividends to shareholders of $0.125 per share on January
25,
2007, April 18, 2007, July 18, 2007 and October 24, 2007. During the previous
year, the Company paid cash dividends to shareholders of $0.10 per share on
January 25, 2006, and $0.11 per share on April 19, 2006, July 19, 2006 and
October 25, 2006.
The
amount and payment of dividends by the Company to shareholders are set by the
Company's Board of Directors with numerous factors involved including the
Company's earnings, financial condition and the need for capital for expanded
growth and general economic conditions. No assurance can be given that cash
or
stock dividends will be paid in the future.
17
Securities
Authorized for Issuance under Equity Compensation
Plans
The
following table sets forth securities authorized for issuance under equity
compensation plans as for December 31, 2007.
|
Plan
Category
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights (column a)
|
Weighted-average
exercise price of outstanding options, warrants and rights
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
|
|||||||
|
Equity
compensation plans approved by security holders
|
212,500
|
$
|
16.14
|
305,200
|
||||||
|
Equity
compensation plans not approved by security holders
|
N/A
|
N/A
|
N/A
|
|||||||
|
Total
|
212,500
|
$
|
16.14
|
305,200
|
||||||
A
complete description of the above plans is included in Note 12 of
the
Company’s Financial Statements in Item 8 of this Annual Report on Form 10K, and
is hereby incorporated by reference.
Purchases
of Equity Securities by Affiliates and Associated
Purchasers
|
Total
Number of
|
Maximum
Number
|
||||||||||||
|
Weighted
|
Shares
Purchased
|
of
Shares That May
|
|||||||||||
|
Total
Number
|
Average
|
as
Part of Publicly
|
Yet
be Purchased
|
||||||||||
|
Of
Shares
|
Price
Paid
|
Announced
Plan
|
Under
the Plans
|
||||||||||
|
Period
|
Purchased
|
per
Share
|
or
Program
|
or
Programs
|
|||||||||
|
10/01/07
to 10/31/07
|
9,009
|
$
|
18.50
|
9,009
|
314,574
|
||||||||
|
11/01/07
to 11/30/07
|
35,149
|
$
|
15.73
|
35,149
|
279,425
|
||||||||
|
12/01/07
to 12/31/07
|
15,097
|
$
|
15.08
|
15,097
|
264,328
|
||||||||
|
Total
fourth quarter 2007
|
59,255
|
$
|
18.32
|
59,255
|
|||||||||
On
August
30, 2001 the Company announced that its Board of Directors approved a plan
to
repurchase, as conditions warrant, up to 280,000 shares (560,000 shares adjusted
for May 2006 stock split) of the Company's common stock on the open market
or in
privately negotiated transactions. The duration of the program was open-ended
and the timing of purchases was dependent on market conditions. A total of
215,423 shares (430,846 shares adjusted for May 2006 stock split) had been
repurchased under that plan as of December 31, 2003, at a total cost of $3.7
million.
On
February 25, 2004 the Company announced a second stock repurchase plan under
which the Board of Directors approved a plan to repurchase, as conditions
warrant, up to 276,500 shares (553,000 shares adjusted for May 2006 stock split)
of the Company's common stock on the open market or in privately negotiated
transactions. As with the first plan, the duration of the new program is
open-ended and the timing of purchases will depend on market conditions.
Concurrent with the approval of the new repurchase plan, the Board terminated
the 2001 repurchase plan and canceled the remaining 64,577 shares (129,154
shares adjusted for May 2006 stock split) yet to be purchased under the earlier
plan.
On
May
16, 2007, the Company announced another stock repurchase plan to repurchase,
as conditions warrant, up to 610,000 shares of the Company's common stock on
the
open market or in privately negotiated transactions. The repurchase plan
represents approximately 5.00% of the Company's currently outstanding common
stock. The duration of the program is open-ended and the timing of purchases
will depend on market conditions. Concurrent with the approval of the new
repurchase plan, the Company canceled the remaining 75,733 shares available
under the 2004 repurchase plan.
During
the year ended December 31, 2007, 512,332 shares were repurchased at a total
cost of $10.1 million and an average per share price of $19.71. Of the shares
repurchased during 2007, 166,660 shares were repurchased under the 2004 plan
at
an average cost of $20.46 per shares, and 345,672 shares were repurchased under
the 2007 plan at an average cost of $19.35 per share.
18
Financial
Performance
The
following performance
graph does not constitute soliciting material and should not be deemed filed
incorporated by reference into any other Company under the Securities Act of
1933 or the Securities Exchange Act of 1934, except to the extent the Company
specifically incorporates the
performance graph by reference therein.
|
Period
Ending
|
|||||||||||||||||||
|
Index
|
12/31/02
|
|
12/31/03
|
|
12/31/04
|
|
12/31/05
|
|
12/31/06
|
|
12/31/07
|
|
|||||||
|
United
Security Bancshares
|
100.00
|
156.95
|
150.50
|
184.96
|
298.54
|
192.86
|
|||||||||||||
|
Russell
2000
|
100.00
|
147.25
|
174.24
|
182.18
|
215.64
|
212.26
|
|||||||||||||
|
Russell
3000
|
100.00
|
131.06
|
146.71
|
155.69
|
180.16
|
189.42
|
|||||||||||||
|
SNL
Bank $500M-$1B Index
|
100.00
|
144.19
|
163.41
|
170.41
|
193.81
|
155.31
|
|||||||||||||
19
Item
6 - Selected Financial Data
The
following table sets forth certain selected financial data for the Bank for
each
of the years in the five-year periods ended December 31, 2007 and should be
read
in conjunction with the more detailed information and financial statements
contained elsewhere herein (in thousands except per share data and
ratios).
|
December
31,
|
||||||||||||||||
|
(in
thousands except per share data and ratios)
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Summary
of Year-to-Date Earnings:
|
||||||||||||||||
|
Interest
income and loan fees
|
$
|
57,156
|
$
|
47,356
|
$
|
38,898
|
$
|
30,874
|
$
|
27,050
|
||||||
|
Interest
expense
|
20,573
|
14,175
|
9,658
|
6,433
|
7,260
|
|||||||||||
|
Net
interest income
|
36,583
|
33,181
|
29,240
|
24,441
|
19,790
|
|||||||||||
|
Provision
for credit losses
|
5,697
|
880
|
1,140
|
1,145
|
1,713
|
|||||||||||
|
Net
interest income after
|
||||||||||||||||
|
Provision
for credit losses
|
30,886
|
32,301
|
28,100
|
23,296
|
18,077
|
|||||||||||
|
Noninterest
income
|
9,664
|
9,031
|
6,280
|
4,742
|
6,148
|
|||||||||||
|
Noninterest
expense
|
22,732
|
19,937
|
16,982
|
14,667
|
11,855
|
|||||||||||
|
Income
before taxes on income
|
17,818
|
21,395
|
17,398
|
13,371
|
12,370
|
|||||||||||
|
Taxes
on income
|
6,561
|
8,035
|
6,390
|
4,966
|
4,664
|
|||||||||||
|
Net
Income
|
$
|
11,257
|
$
|
13,360
|
$
|
11,008
|
$
|
8,405
|
$
|
7,706
|
||||||
|
Per
Share Data:
|
||||||||||||||||
|
Net
Income - Basic
|
$
|
0.94
|
$
|
1.18
|
$
|
0.97
|
$
|
0.75
|
$
|
0.71
|
||||||
|
Net
Income - Diluted
|
$
|
0.94
|
$
|
1.17
|
$
|
0.96
|
$
|
0.74
|
$
|
0.70
|
||||||
|
Average
shares outstanding - Basic
|
11,925,767
|
11,344,385
|
11,369,848
|
11,260,512
|
10,919,852
|
|||||||||||
|
Average
shares outstanding - Diluted
|
11,960,514
|
11,462,313
|
11,453,152
|
11,334,486
|
11,023,340
|
|||||||||||
|
Cash
dividends paid
|
$
|
0.50
|
$
|
0.43
|
$
|
0.35
|
$
|
0.325
|
$
|
0.285
|
||||||
|
Financial
Position at Period-end:
|
||||||||||||||||
|
Total
assets
|
$
|
771,715
|
$
|
678,314
|
$
|
628,859
|
$
|
611,696
|
$
|
506,588
|
||||||
|
Total
net loans and leases
|
585,580
|
491,204
|
409,409
|
390,334
|
338,716
|
|||||||||||
|
Total
deposits
|
634,617
|
587,127
|
546,460
|
536,672
|
440,444
|
|||||||||||
|
Total
shareholders' equity
|
82,431
|
66,042
|
59,014
|
53,236
|
45,036
|
|||||||||||
|
Book
value per share
|
$
|
6.95
|
$
|
5.84
|
$
|
5.19
|
$
|
4.69
|
$
|
4.09
|
||||||
|
Selected
Financial Ratios:
|
||||||||||||||||
|
Return
on average assets
|
1.47
|
%
|
2.04
|
%
|
1.76
|
%
|
1.52
|
%
|
1.51
|
%
|
||||||
|
Return
on average shareholders' equity
|
13.73
|
%
|
20.99
|
%
|
19.46
|
%
|
16.81
|
%
|
17.80
|
%
|
||||||
|
Average
shareholders' equity to average assets
|
10.73
|
%
|
9.70
|
%
|
9.02
|
%
|
9.01
|
%
|
8.48
|
%
|
||||||
|
Allowance
for credit losses as a percentage
|
||||||||||||||||
|
of
total nonperforming loans
|
50.45
|
%
|
64.13
|
%
|
55.62
|
%
|
42.51
|
%
|
32.58
|
%
|
||||||
|
Net
charge-offs to average loans
|
0.76
|
%
|
0.05
|
%
|
0.15
|
%
|
0.12
|
%
|
0.34
|
%
|
||||||
|
Allowance
for credit losses as a percentage
|
||||||||||||||||
|
of
period-end loans
|
1.83
|
%
|
1.67
|
%
|
1.86
|
%
|
1.82
|
%
|
1.76
|
%
|
||||||
|
Dividend
payout ratio
|
53.12
|
%
|
38.18
|
%
|
38.50
|
%
|
43.16
|
%
|
40.07
|
%
|
||||||
20
Item
7. Management's Discussion and Analysis of Financial Condition and Results
of
Operations
Overview
Certain
matters discussed or incorporated by reference in this Annual Report on Form
10-K are forward-looking statements that are subject to risks and uncertainties
that could cause actual results to differ materially from those projected in
the
forward-looking statements. Such risks and uncertainties include, but are not
limited to, those described in Management’s Discussion and Analysis of Financial
Condition and Results of Operations. Such risks and uncertainties include,
but
are not limited to, the following factors: i) competitive pressures in the
banking industry and changes in the regulatory environment; ii) exposure to
changes in the interest rate environment and the resulting impact on the
Company’s interest rate sensitive assets and liabilities; iii) decline in the
health of the economy nationally or regionally which could reduce the demand
for
loans or reduce the value of real estate collateral securing most of the
Company’s loans; iv) credit quality deterioration that could cause an increase
in the provision for loan losses; v) Asset/Liability matching risks and
liquidity risks; volatility and devaluation in the securities markets, and
vi)
expected cost savings from recent acquisitions are not realized. Therefore,
the
information set forth therein should be carefully considered when evaluating
the
business prospects of the Company.
The
Company
On
June
12, 2001, the United Security Bank (the “Bank”) became the wholly owned
subsidiary of United Security Bancshares (the “Company”) through a tax-free
holding company reorganization, accounted for on a basis similar to the pooling
of interest method. In the transaction, each share of Bank stock was exchanged
for a share of Company stock on a one-to-one basis. No additional equity was
issued as part of this transaction. In the following discussion, references
to
the Bank are references to United Security Bank. References to the Company
are
references to United Security Bancshares (including the Bank).
On
June
28, 2001, United Security Bancshares Capital Trust I (the “Trust”) was formed as
a Delaware business trust for the sole purpose of issuing Trust Preferred
securities. On July 16, 2001, the Trust completed the issuance of $15 million
in
Trust Preferred securities, and concurrently, the Trust used the proceeds from
that offering to purchase Junior Subordinated Debentures of the Company. The
Company contributed $13.7 million of the $14.5 million in net proceeds received
from the Trust to the Bank to increase its regulatory capital and used the
rest
for the Company’s business. Effective January 1, 2007, the Company adopted the
fair value provisions of SFAS No. 159 for its junior subordinated debt issued
by
the Trust. As a result of the adoption of SFAS No. 159, the Company recorded
a
fair value adjustment of $1.3 million, reflected as an adjustment to beginning
retained earnings. On July 25, 2007, the Company redeemed the $15.0 million
in
subordinated debentures plus accrued interest of $690,000 and a 6.15% prepayment
penalty totaling $922,500. Concurrently, the Trust Preferred securities issued
by Capital Trust I were redeemed. The prepayment penalty of $922,500 had
previously been a component of the fair value adjustment for the junior
subordinated debt at the initial adoption of SFAS No. 159.
Effective
December 31, 2001, United Security Bank formed a subsidiary Real Estate
Investment Trust (“REIT”) through which preferred stock was offered to private
investors, to raise capital for the bank in accordance with the laws and
regulations in effect at the time. The principal business purpose of the REIT
was to provide an efficient and economical means to raise capital. The REIT
also
provided state tax benefits beginning in 2002. On December 31, 2003 the
California Franchise Tax Board (FTB) announced certain tax transactions related
to real estate investment trusts (REITs) and regulated investment companies
(RICs) will be disallowed pursuant to Senate Bill 614 and Assembly Bill 1601,
which were signed into law in the 4th quarter of 2003 (For
further discussion see Income Taxes section of Results of Operations contained
in this Management’s Discussion and Analysis of Financial Condition and Results
of Operations).
Effective
April 23, 2004, the Company completed its merger with Taft National Bank
headquartered in Taft, California. Taft National Bank (“Taft”) was merged into
United Security Bank and Taft’s two branches began operating as branches of
United Security Bank. The total consideration paid to Taft shareholders was
241,447 shares of the Company’s common stock valued at just over approximately
$6.0 million. As a result of the merger, the Company acquired $15.4 million
in
cash and short-term investments, $23.3 million in loans, and $48.2 million
in
deposits. This transaction was accounted for using the purchase accounting
method, and resulted in the purchase price being allocated to the assets
acquired and liabilities assumed from Taft based on the fair value of those
assets and liabilities. The consolidated statements of income include the
operations of Taft from the date of the acquisition forward.
During
August 2005, the Bank formed a new subsidiary named United Security Emerging
Capital Fund (the Fund) for the purpose of providing investment capital for
Low-Income Communities (LIC’s). The new subsidiary was formed as a Community
Development Entity (CDE) and as such, must be certified by the Community
Development Financial Institutions Fund of the United States Department of
the
Treasury in order to apply for New Market Tax Credits (NMTC). The Fund submitted
an application to the Department of the Treasury to become certified as a CDE
in
August 2005 and was approved in February 2006. Subsequent to that application,
the Fund submitted an application to apply for an allocation of New Market
Tax
Credits in September 2005. The Fund was not awarded funding from the Department
of Treasury during the 2006 allocation process, but applied for the 2007
allocation of New Market Tax Credits in August 2006. The Fund was not awarded
funding during the 2007 allocation process. The Fund did not apply for the
2008
allocation of New Market Credits during 2007. If the Fund’s NMTC is ever
approved for the allocation of New Market Credits, the Fund can attract
investments and make loans and investments in LIC’s and thereby qualify its
investors to receive Federal Income Tax Credits. The maximum that can be applied
for under the New Markets Tax Credit program by any one CDE is $150 million,
and
the Bank is subject to an investment limitation of 10% of its risk-based
capital. Federal new market tax credits would be applied over a seven-year
period, 5% for the first three years, and 6% for the next four years for a
total
of 39%.
21
On
February 16, 2007, the Company completed its merger of Legacy Bank, N.A. with
and into United Security Bank, a wholly owned subsidiary of the Company. Legacy
Bank which began operations in 2003 operated one banking office in Campbell,
California serving small business and retail banking clients. With its small
business and retail banking focus, Legacy Bank provides a unique opportunity
for
United Security Bank to serve a loyal and growing small business niche and
individual client base in the San Jose area. Upon completion of the merger,
Legacy Bank's branch office began operating as a branch office of United
Security Bank. As of February 16, 2007 Legacy Bank had net assets of
approximately of $8.6 million, including net loans of approximately $62.4
million and deposits of approximately $69.6 million.
In
the
merger with Legacy Bank, the Company issued 976,411 shares of its stock in
a tax
free exchange for all of the Legacy Bank common shares. The total value of
the
transaction was approximately $21.7 million. The
merger transaction was accounted for using the purchase accounting method,
and
resulted in the purchase price being allocated to the assets acquired and
liabilities assumed from Legacy based on the fair value of those assets and
liabilities.
Fair-market-value adjustments and intangible assets totaled approximately $12.9
million, including $8.8 million in goodwill. The
allocations of purchase price based upon the fair market value of assets
acquired and liabilities assumed were finalized in the fourth quarter of
2007.
During
July 2007, the Company formed USB Capital Trust II, a wholly-owned special
purpose entity, for the purpose of issuing Trust Preferred Securities. Like
USB
Capital Trust I formed in July 2001, USB Capital Trust II is a Variable Interest
Entity (VIE) and a deconsolidated entity pursuant to FIN 46. On July 23, 2007
USB Capital Trust II issued $15 million in Trust Preferred securities. The
securities have a thirty-year maturity and bear a floating rate of interest
(repricing quarterly) of 1.29% over the three-month LIBOR rate (initial coupon
rate of 6.65%). Interest will be paid quarterly. Concurrent with the issuance
of
the Trust Preferred securities, USB Capital Trust II used the proceeds of the
Trust Preferred securities offering to purchase a like amount of junior
subordinated debentures of the Company. The Company will pay interest on the
junior subordinated debentures to USB Capital Trust II, which represents the
sole source of dividend distributions to the holders of the Trust Preferred
securities. The Company may redeem the junior subordinated debentures at anytime
before October 2008 at a redemption price of 103.3, and thereafter each October
as follows: 2008 at 102.64, 2009 at 101.98, 2010 at 101.32, 2011 at 100.66,
and
at par anytime after October 2012.
The
Bank
currently has eleven banking branches, one construction lending office, and
one
financial services office, which provide banking and financial services in
Fresno, Madera, Kern, and Santa Clara counties. As a community-oriented bank
holding company, the Company continues to seek ways to better meet its
customers' needs for financial services, and to expand its business
opportunities in today's ever-changing financial services environment. The
Company's strategy is to be a better low-cost provider of services to its
customer base while enlarging its market area and corresponding customer base
to
further its ability to provide those services.
Current
Trends Affecting Results of Operations and Financial
Position
The
Company’s overall operations are impacted by a number of factors, including not
only interest rates and margin spreads, which impact results of operations,
but
also the composition of the Company’s balance sheet. One of the primary
strategic goals of the Company is to maintain a mix of assets that will generate
a reasonable rate of return without undue risk, and to finance those assets
with
a low-cost and stable source of funds. Liquidity and capital resources must
also
be considered in the planning process to mitigate risk and allow for
growth.
The
following table summarizes the year-to-date averages of the components of
interest-bearing assets as a percentage of total interest bearing assets, and
the components of interest-bearing liabilities as a percentage of total
interest-bearing liabilities:
|
YTD
Average
|
YTD
Average
|
YTD
Average
|
||||||||
|
12/31/07
|
12/31/06
|
12/31/05
|
||||||||
|
Loans
|
85.00
|
%
|
80.26
|
%
|
72.50
|
%
|
||||
|
Investment
securities
|
13.46
|
%
|
15.65
|
%
|
19.81
|
%
|
||||
|
Interest-bearing
deposits in other banks
|
1.02
|
%
|
1.33
|
%
|
1.36
|
%
|
||||
|
Federal
funds sold
|
0.52
|
%
|
2.76
|
%
|
6.33
|
%
|
||||
|
Total
earning assets
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
||||
|
NOW
accounts
|
8.82
|
%
|
11.21
|
%
|
12.14
|
%
|
||||
|
Money
market accounts
|
25.99
|
%
|
31.56
|
%
|
28.63
|
%
|
||||
|
Savings
accounts
|
8.79
|
%
|
8.02
|
%
|
8.45
|
%
|
||||
|
Time
deposits
|
50.05
|
%
|
44.72
|
%
|
46.78
|
%
|
||||
|
Other
borrowings
|
3.40
|
%
|
0.96
|
%
|
0.32
|
%
|
||||
|
Trust
Preferred Securities
|
2.95
|
%
|
3.53
|
%
|
3.68
|
%
|
||||
|
Total
interest-bearing liabilities
|
100.00
|
%
|
100.00
|
%
|
100.00
|
%
|
||||
22
The
Company continues its business development and expansion efforts throughout
a
dynamic and growing market area, and as a result, realized substantial increases
in both loan and deposit volumes during the year ended December 31, 2007. With
approximately 65% of the increase resulting from the Legacy Bank merger
completed during February 2007, the Company experienced increases of $97.7
million in loans, while other interest earning assets, including federal funds
sold and interest-bearing deposits in other banks, declined during 2007, as
loan
growth exceeded deposit growth during the year. The Company experienced growth
in all loan categories except lease financing, with growth being strongest
in
commercial and industrial loans, and commercial real estate loans. Deposit
growth totaled $47.5 million during the year ended December 31, 2007, with
deposit increases being the result of the merger with Legacy Bank during
February 2007. Deposit growth occurred almost exclusively in time deposits,
with
moderate increases experienced in savings deposits. NOW and money market
accounts, as well as noninterest-bearing deposits, declined $30.7 million and
$20.0 million, respectively, during the year ended December 31, 2007 as core
deposits became increasingly competitive. Deposit pricing was a significant
factor during 2007 as depositors were attracted to money market accounts and
time deposits over $100,000, as they sought higher yields.
With
market rates of interest remaining level through much of 2007, then declining
100 basis points during the fourth quarter of 2007, and another 75 basis points
during January 2008, the Company has begun to experience declines in its net
interest margin. The Company’s net interest margin was 5.35% for the year ended
December 31, 2007, as compared to 5.67% and 5.26% for the years ended December
31, 2006 and 2005, respectively. With approximately 62% of the loan portfolio
in
floating rate instruments at December 31, 2007, the effects of market rates
continue to be realized almost immediately on loan yields. Loans yielded 9.07%
during the year ended December 31, 2007, as compared to 9.13% for the year
ended
December 31, 2006, and 8.21% for the year ended December 31, 2005. Loan yield
was enhanced during 2007, as a nonperforming loan was paid off during the first
quarter of 2007, providing an additional $902,000 in previously unrecognized
interest income that would not have otherwise been recognized during 2007,
and
an enhancement to loan yield of approximately 15 basis points. The Company
continues to experience pricing pressures on deposits, especially money market
accounts and time deposits, as increased competition for deposits continues
throughout the Company’s market area. The Company’s average cost of funds was
3.91% for the year ended December 31, 2007 as compared to 3.24% and 2.30% for
the years ended December 31, 2006 and 2005, respectively.
Noninterest
income continues to be driven by customer service fees, which totaled $4.8
million for the year ended December 31, 2007, representing an increase of $1.0
million or 26.8% over the $3.8 million in customer service fees reported for
the
year ended December 31, 2006. Total noninterest income increased by $633,000
between the year-to-date periods ended December 31, 2006 and December 31, 2007,
primarily as the result of a $2.5 million gain recognized during the year ended
December 31, 2007 resulting from favorable fair value adjustments to the
Company’s junior subordinated debt. The Company accounts for its junior
subordinated debt at fair value and records fair value changes through earnings.
Offsetting this were several reductions in noninterest income including, a
nonrecurring $1.9 million gain on the sale of an investment in correspondent
bank stock recognized during the first quarter of 2006, and a $1 million gain
on
the sale of the Company’s administrative headquarters during the third quarter
of 2006, both of which were not repeated during 2007. Other noninterest income
increased approximately $279,000 as the result of a number of items including
increases in rental and OREO income experienced during 2007.
Noninterest
expense increased approximately $2.8 million or 14.0% between the years ended
December 31, 2006 and December 31, 2007. The primary components of the increase
experienced during 2007 were employee salary and benefit costs, including
additional employee costs associated with the new financial services department,
increased legal fess associated with the resolution of impaired loans, losses
on
lease assets held, and increased amortization costs for intangible assets.
As
part of noninterest expense, OREO expense actually declined by $2.0 million
or
90.5% between the years ended December 31, 2006 and December 31, 2007 as costs
associated with an OREO property the Company was in the process of liquidating
during 2006, were not again incurred during 2007.
23
The
Company has maintained a strong balance sheet, with sustained loan growth and
sound deposit growth. With the Legacy merger completed during February 2007,
total assets have grown more than $93.4 million between December 31, 2006 and
December 31, 2007, while net loans have grown $94.4 million, and deposits have
grown $47.5 million during the year ended December 31, 2007. With increased
loan
growth during 2007, average loans comprised approximately 85% of overall average
earning assets during the year ended December 31, 2007. In total, average core
deposits, including NOW accounts, money market accounts, and savings accounts,
continue to comprise a high percentage of total interest-bearing liabilities
for
the year ended December 31, 2007, although time deposits as a percentage of
average deposits for the period have increased during 2007 as the Company has
sought brokered deposits to fund continued loan demand. Effectively utilizing
brokered deposits to help fund asset growth has allowed the Company to better
control the cost of its core deposit base. To further fund loan demand, the
Company has utilized its overnight borrowing lines, with overnight borrowings
totaling $22.3 million at December 31, 2007. In addition, the Company utilized
its FHLB term credit line during the first quarter of 2007, borrowing $10.0
million for a term of two years at a fixed rate of 4.92%.
During
July 2007, the Company formed USB Capital Trust II, a wholly-owned special
purpose entity, for the purpose of issuing Trust Preferred securities. At the
same time, the Company redeemed the $15 million in junior subordinated debt
issued to USB Capital Trust I which in turn had issued Trust Preferred
securities to investors. The Trust Preferred securities issued by USB Capital
Trust I during 2001 carried a floating interest rate of six-month LIBOR plus
3.75% and had a maturity term of thirty years. During July, USB Capital Trust
II
issued $15 million in Trust Preferred securities at a floating rate of
three-month LIBOR plus 1.29% and had a maturity term of thirty years. Concurrent
with the issuance of the Trust Preferred securities, USB Capital Trust II used
the proceeds of the Trust Preferred securities offering to purchase a like
amount of junior subordinated debentures of the Company with substantially
like
terms to the Trust Preferred securities issued by the Trust. The new
subordinated debentures will reduce the cost of the Company’s $15 million debt
by 246 basis points, and should result in pre-tax interest cost savings of
approximately $30,000 per month. Effective January 1, 2007, the Company elected
the fair value option for the Company’s junior subordinated debt pursuant to
SFAS No. 159. The Company also elected the fair value option for the
subordinated debentures issued to USB Capital Trust II during July 2007. As
a
result of favorable quarterly fair value adjustments at September 30, 2007
and
December 31, 2007, the Company recorded a total gain $2.4 million gain on its
junior subordinated debt issued under USB Capital Trust II, primarily resulting
from an overall deterioration of the credit markets during the third and fourth
quarters of 2007 which increased pricing spreads from base rates on similar
debt
instruments.
The
Company continues to emphasize relationship banking and core deposit growth,
and
has focused greater attention on its market area of Fresno, Madera, and Kern
Counties, as well as its new market area of Campbell, in Santa Clara County.
The
San Joaquin Valley and other California markets continue to benefit from
construction lending and commercial loan demand from small and medium size
businesses, although commercial and residential real estate markets have
softened during 2007. Average loans have increased more than $110.9 million
between the year-to-date periods ended December 31, 2006 and December 31, 2007,
and end-of-period loans have increased more than $97.7 million between December
31, 2006 and December 31, 2007. Growth continues primarily in commercial and
industrial loans, and commercial real estate loans, and to a lesser degree
in
construction loans and agricultural loans. In the future, the Company will
continue to maintain an emphasis on its core lending strengths of commercial
real estate and construction lending, as well as small business financing,
while
expanding opportunities in agricultural, installment, and other loan categories
when possible. The third and fourth quarters of 2007 presented challenges with
credit tightening, weakening real estate markets, and loan losses affecting
the
loan portfolio. The charge-off of a $1.6 million land development loan during
the third quarter of 2007, combined with an increase in impaired loans,
necessitated an additional $1.7 million in loan loss provision for the quarter
ended September 30, 2007. Further deteriorating real estate markets during
the
fourth quarter resulted in additional loan charge-offs totaling $2.6 million,
and additional loan loss provisions of $3.3 million during the fourth quarter.
Additionally, OREO increased $4.7 million during the year ended December 31,
2007 resulting from the transfer of collateral for three loan relationships
to
foreclosed property, one of which was ultimately sold. As a result of these
events, nonperforming assets as a percentage of total assets increased from
2.19% at December 31, 2006 to 4.73% at December 31, 2007.
The
Company continually evaluates its strategic business plan as economic and market
factors change in its market area. Growth and increasing market share will
be of
primary importance during 2008 and beyond. The Company is excited about its
recent merger with Legacy Bank located in Campbell, California. This new
acquisition brings additional opportunities in a dynamic new market, and
will
enable the Company to expand its ability to serve Legacy’s current clients and
increase lending capabilities in the market area of Santa Clara
County.
The
banking industry is currently experiencing continued pressure on net margins
as
well as asset quality resulting from concerns in the sub-prime real estate
market, and a general deterioration in credit markets. As a result, market
rates
of interest and asset quality will continue be an important factor in the
Company’s ongoing strategic planning process.
24
Application
of Critical Accounting Policies and Estimates
The
Company’s consolidated financial statements are prepared in accordance with
generally accepted accounting principles and follow general practices within
the
industry in which it operates. Application of these principles requires
management to make estimates, assumptions, and judgments that affect the amounts
reported in the financial statements and accompanying notes. These estimates,
assumptions, and judgments are based on information available as of the date
of
the financial statements; accordingly, as this information changes, the
financial statements could reflect different estimates, assumptions, and
judgments. Certain policies inherently have a greater reliance on the use of
estimates, assumptions, and judgments and as such have a greater possibility
of
producing results that could be materially different than originally reported.
Estimates, assumptions, and judgments are necessary when assets and liabilities
are required to be recorded at fair value, when a decline in the value of an
asset not carried on the financial statements at fair value warrants an
impairment write-down or valuation reserve to be established, or when an asset
or liability needs to be recorded contingent upon a future event. Carrying
assets and liabilities at fair value inherently results in more financial
statement volatility. The fair values and the information used to record
valuation adjustments for certain assets and liabilities are based either on
quoted market prices or are provided by other third-party sources, when
available. When third-party information is not available, valuation adjustments
are estimated using the Company’s own assumptions about the assumptions that
market participants would use in pricing the asset or liability.
The
most
significant accounting policies followed by the Company are presented in Note
1
to the Company’s consolidated financial statements included herein. These
policies, along with the disclosures presented in the other financial statement
notes and in this financial review, provide information on how significant
assets and liabilities are valued in the financial statements and how those
values are determined. Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods, assumptions, and
estimates underlying those amounts, management has identified the determination
of the allowance for loan losses to be the accounting area that requires the
most subjective or complex judgments, and as such could be most subject to
revision as new information becomes available.
Allowance
for Credit Losses
The
allowance for credit losses represents management's estimate of probable credit
losses inherent in the loan portfolio. Determining the amount of the allowance
for credit losses is considered a critical accounting estimate because it
requires significant judgment and the use of estimates related to the amount
and
timing of expected future cash flows on impaired loans, estimated losses on
pools of homogeneous loans based on historical loss experience, and
consideration of current economic trends and conditions, all of which may be
susceptible to significant change. The loan portfolio also represents the
largest asset type on the consolidated balance sheet. Note 1 to the consolidated
financial statements describes the methodology used to determine the allowance
for credit losses and a discussion of the factors driving changes in the amount
of the allowance for credit losses is included in the Asset Quality and
Allowance for Credit Losses section of this financial review.
If
the
loan portfolio were to increase by 10% proportionally throughout all loan
classifications, the additional estimated provision to the allowance that would
be required, based on the percentage loss allocations utilized at December
31,
2007, would be approximately $652,000 pretax ($378,000 net of tax, or $0.03
per
share basic and diluted). This estimate is comprised of an additional $246,000
($143,000 net of tax, or $0.01 per share basic and diluted) for criticized
loans
(those classified as special mention or worse and excluding those considered
impaired under SFAS No. 114), and an additional $406,000 ($235,000 net of tax,
or $0.02 per share basic and diluted) for the remainder of the loan portfolio
that is performing.
Other
Real Estate Owned
Real
estate properties acquired through, or in lieu of, loan foreclosure are to
be
sold and are initially recorded at fair value of the property, less estimated
costs to sell. The excess, if any, of the loan amount over the fair value of
the
collateral is charged to the allowance for credit losses. The determination
of
fair value is generally based upon pre-approved, external appraisals. Subsequent
declines in the fair value of other real estate owned, along with related
revenue and expenses from operations, are charged to noninterest expense. The
fair market valuation of such properties is based upon estimates, and as such,
is subject to change as circumstances in the Company’s market area, or general
economic trends, change.
Goodwill
Business
combinations involving the Company’s acquisition of the equity interests or net
assets of another enterprise or the assumption of net liabilities in an
acquisition of branches constituting a business may give rise to goodwill.
The
acquisition of Taft National Bank during April 2004 gave rise to goodwill
totaling approximately $1.6 million, and the recent acquisition of Legacy Bank
resulted in goodwill of approximately $8.8 million. Goodwill represents the
excess of the cost of an acquired entity over the net of the amounts assigned
to
assets acquired and liabilities assumed in transactions accounted for under
the
purchase method of accounting. The value of goodwill is ultimately derived
from
the Company’s ability to generate net earnings after the acquisition. A decline
in net earnings could be indicative of a decline in the fair value of goodwill
and result in impairment. For that reason, goodwill is assessed for impairment
at a reporting unit level at least annually using an internal cash flow
model. While the Company believes all assumptions utilized in its
assessment of goodwill for impairment are reasonable and appropriate, changes
in
earnings, the effective tax rate, historical earnings multiples and the cost
of
capital could all cause different results for the calculation of the present
value of future cash flows.
25
Income
Taxes
Deferred
income taxes are provided for the temporary differences between the financial
reporting basis and the tax basis of the Company's assets and liabilities.
Deferred taxes are measured using current tax rates applied to such taxable
income in the years in which those temporary differences are expected to be
recovered. If the Company’s future income is not sufficient to apply the
deferred tax assets within the tax years to which they may be applied, the
deferred tax asset may not be realized and the Company’s income will be
reduced.
On
January 1, 2007 the Company adopted Financial Accounting Standards Board (FASB)
Interpretation 48 (FIN 48), “Accounting
for Uncertainty in Income Taxes: an interpretation of FASB Statement No.
109”.
FIN 48
clarifies SFAS No. 109, “Accounting
for Income Taxes”,
to
indicate a criterion that an individual tax position would have to meet for
some
or all of the income tax benefit to be recognized in a taxable entity’s
financial statements. Under the guidelines of FIN48, an entity should recognize
the financial statement benefit of a tax position if it determines that it
is
more
likely than not that
the
position will be sustained on examination. The term “more likely than not” means
a likelihood of more than 50 percent.” In assessing whether the
more-likely-than-not criterion is met, the entity should assume that the tax
position will be reviewed by the applicable taxing authority.
The
Company reviewed its various tax positions, including its ongoing REIT case
with
the California Franchise Tax Board (FTB), as of January 1, 2007 (adoption date),
and then again each subsequent quarter during 2007 in light of the adoption
of
FIN48. The Bank, with guidance from advisors believes the case related to
consent dividends taken by the Bank’s REIT during 2002 has merit with regard to
points of law, and that the tax law at the time allowed for the deduction of
the
consent dividend. However, the Bank, with the concurrence of advisors, cannot
conclude that it is “more than likely” (as defined in FIN48) that the Bank will
prevail in its case with the FTB. As a result of this determination, effective
January 1, 2007 the Company recorded an adjustment of $1,298,470 to beginning
retained earnings upon adoption of FIN48 to recognize the potential tax
liability under the guidelines of the interpretation. The adjustment includes
amounts for assessed taxes, penalties, and interest. During the year ended
December 31, 2007, the Company increased the unrecognized tax liability by
an
additional $87,091 in interest for the period, bringing the total recorded
tax
liability under FIN48 to $1,385,561 at December 31, 2007. It is the Company’s
policy to recognize interest and penalties under FIN48 as a component of income
tax expense.
Pursuant
to FIN 48, the Company will continue to re-evaluate existing tax positions,
as
well as new positions as they arise. If the Company determines in the future
that its tax positions are not “more likely than not” to be sustained (as
defined) by taxing authorities, the Company may need to recognize additional
tax
liabilities.
Stock-Based
Compensation
For
all
years presented in the Consolidated Financial Statements prior to 2006, the
Company accounted for stock options, which were issued “at-the-money” under the
provisions of APB No. 25. Accordingly, no compensation expense related to
the issuance of stock options is reflected in the income statements prior to
2006. Pro forma disclosures of the impact of compensation expense (and related
tax benefit) associated with stock options are included in Note 12 in the Notes
to the Consolidated Financial Statements. The pro forma amounts are calculated
on the estimated fair value of the options at the date of the grant, based
on
assumptions made during the year of the grant. Those assumptions are outlined
in
Note 12 “Stock Options and Stock Based Compensation” in the Company’s Notes to
Consolidated Financial Statements.
On
January 1, 2006, the Company adopted the provisions of SFAS No. 123 (revised
2004) (“SFAS 123R”), “Share-Based Payment”, which is a revision of SFAS No. 123,
“Accounting
for Stock-Based Compensation.”
SFAS
No. 123R eliminates the ability to account for share-based compensation
transactions using Accounting Principles Board Opinion No. 25 and requires
that
such transactions be accounted for using a fair value-based method. The Company
adopted the requirements of SFAS No. 123R using the modified-prospective method
during the first quarter of 2006. SFAS No. 123R requires the Company to
recognize as compensation expense, the fair value of stock options granted
to
employees and board of directors of the Company beginning with the effective
date (a) based on the requirements of Statement 123R for all share-based
payments granted after the effective date and (b) based on the requirements
of
Statement 123 for all awards granted to employees and directors prior to the
effective date of Statement 123R that remain unvested on the effective date.
The
total compensation expense recognized pursuant to SFAS No. 123R during 2007
and
2006 totaled $187,000 and $248,000, respectively.
26
Impairment
of Investment Securities
Investment
securities classified as available for sale (“AFS”) are carried at fair value
and the impact of changes in fair value are recorded on the Company’s
consolidated balance sheet as an unrealized gain or loss in “Accumulated other
comprehensive income (loss),” a separate component of shareholders’ equity.
Securities classified as AFS or held to maturity (“HTM”) are subject to review
to identify when a decline in value is other than temporary. Factors considered
in determining whether a decline in value is other than temporary include:
whether the decline is substantial; the duration of the decline; the reasons
for
the decline in value; whether the decline is related to a credit event or to
a
change in interest rate; our ability and intent to hold the investment for
a
period of time that will allow for a recovery of value; and the financial
condition and near-term prospects of the issuer. When it is determined that
a
decline in value is other than temporary, the carrying value of the security
is
reduced to its estimated fair value, with a corresponding charge to earnings.
At
December 31, 2007, the Company did not have any investment securities considered
other than temporarily impaired.
Revenue
recognition
The
Company’s primary sources of revenue are interest income from loans and
investment securities. Interest income is generally recorded on an accrual
basis, unless the collection of such income is not reasonably assured or cannot
be reasonably estimated. Pursuant to SFAS No. 91, “Accounting for Nonrefundable
Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases”, nonrefundable fees and costs associated with originating or
acquiring loans are recognized as a yield adjustment to the related loans by
amortizing them into income over the term of the loan using a method which
approximates the interest method. Other credit-related fees, such as standby
letter of credit fees, loan placement fees and annual credit card fees are
recognized as noninterest income during the period the related service is
performed.
For
loans
placed on nonaccrual status, the accrued and unpaid interest receivable may
be
reversed at management's discretion based upon management's assessment of
collectibility, and interest is thereafter credited to principal to the extent
necessary to eliminate doubt as to the collectibility of the net carrying amount
of the loan.
Fair
Value
Effective
January 1, 2007, the Company adopted SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities,
and
SFAS
No. 157,
Fair
Value Measurements, choosing
to apply the pronouncement to its junior subordinated debt. SFAS No 157 defines
how applicable assets and liabilities are to be valued, and requires expanded
disclosures about financial instruments carried at fair value. SFAS No. 157
establishes a hierarchical disclosure framework associated with the level of
pricing observability utilized in measuring financial instruments at fair value.
The degree of judgment utilized in measuring the fair value of financial
instruments generally correlates to the level of pricing observability.
Financial instruments with readily available active quoted prices or for which
fair value can be measured from actively quoted prices generally will have
a
higher degree of pricing observability and a lesser degree of judgment utilized
in measuring fair value. Conversely, financial instruments infrequently traded
or not quoted in an active market will generally have little or no pricing
observability and a higher degree of judgment utilized in measuring fair value.
Pricing observability is impacted by a number of factors, including the type
of
financial instrument, whether the financial instrument is new to the market
and
not yet established and the characteristics specific to the transaction.
Determining fair values under SFAS No. 157 may include judgments related to
measurement factors that may vary from actual transactions executed in the
marketplace. For the year ended December 31, 2007, the Company recorded fair
value gains related to its junior subordinated debt totaling $2.5 million.
(See
Note 15 of the
Notes to Consolidated Financial Statements
for
additional information about financial instruments carried at fair
value.)
Results
of Operations
For
the
year ended December 31, 2007, the Company reported net income of $11.3 million
or $0.94 per share ($0.94 diluted) as compared to $13.4 million or $1.18 per
share ($1.17 diluted) for the year ended December 31, 2006, and $11.0 million
or
$0.97 per share ($0.96 diluted) for the year ended December 31, 2005. Net income
decreased $2.1 million between December 31, 2006 and December 31, 2007 primarily
as the result of increased provisions for credit losses taken during the fourth
quarter, which more than offset increased net interest income realized from
increased volume in earning assets. Net income for 2006 increased $2.4 million
from the previous year as the result of increased volume in earning assets
combined with an increase in net interest margin in 2006, as well as from
additional unusual or non-recurring gains and operating expenses discussed
elsewhere in this Management's Discussion and Analysis of Financial Condition
and Results of Operations.
27
The
Company’s return on average assets was 1.47 % for the year ended December 31,
2007 as compared to 2.04 % and 1.76 % for the same twelve-month periods of
2006
and 2005, respectively. The Company’s return on average equity was 13.73% for
the year ended December 31, 2007 as compared to 20.99 % and 19.46 % for the
same
twelve-month periods of 2006 and 2005, respectively. Declines in the return
on
average assets and average equity experienced by the Company during 2007 were
primarily the result of decreasing net interest margins, and additional loan
loss provisions taken during the year.
Net
Interest Income
Net
interest income, the most significant component of earnings, is the difference
between the interest and fees received on earning assets and the interest paid
on interest-bearing liabilities. Earning assets consist primarily of loans,
and
to a lesser extent, investments in securities issued by federal, state and
local
authorities, and corporations, as well as interest-bearing deposits and
overnight funds with other financial institutions. These earning assets are
funded by a combination of interest-bearing and noninterest-bearing liabilities,
primarily customer deposits and short-term and long-term borrowings.
Net
interest income before provision for credit losses totaled $36.6 million for
the
year ended December 31, 2007 as compared to $33.2 million for the year ended
December 31, 2006, and $29.2 million for the year ended December 31, 2005.
This
represents an increase of $3.4 million or 10.3 % between the years ended
December 31, 2006 and 2007, as compared to an increase of $3.9 million or 13.5%
between 2005 and 2006. The increase in net interest income between 2006 and
2007
is the result of increased volume in earning assets which more than outweighed
rate and volume increases experienced in interest-bearing liabilities. The
increase in net interest income between 2005 and 2006 is the result of increased
volume in earning assets combined with a substantial increase in market rates
of
interest throughout the first half of 2006.
Table
1. - Distribution of Average Assets, Liabilities and Shareholders’
Equity:
Interest
rates and interest differentials
Years
Ended December 31, 2007, 2006, and 2005
|
2007
|
2006
|
2005
|
||||||||||||||||||||||||||
|
|
Average
|
Yield/
|
Average
|
Yield/
|
Average
|
Yield/
|
||||||||||||||||||||||
|
(Dollars
in thousands)
|
Balance
|
Interest
|
Rate
|
Balance
|
Interest
|
Rate
|
Balance
|
Interest
|
Rate
|
|||||||||||||||||||
|
Assets:
|
||||||||||||||||||||||||||||
|
Interest-earning
assets:
|
||||||||||||||||||||||||||||
|
Loans
(1)
|
$
|
580,873
|
$
|
52,690
|
9.07
|
%
|
$
|
469,959
|
$
|
42,902
|
9.13
|
%
|
$
|
402,820
|
$
|
33,078
|
8.21
|
%
|
||||||||||
|
Investment
Securities - taxable
|
89,765
|
3,896
|
4.34
|
%
|
89,378
|
3,254
|
3.64
|
%
|
107,761
|
4,163
|
3.86
|
%
|
||||||||||||||||
|
Investment
Securities - nontaxable (2)
|
2,227
|
108
|
4.85
|
%
|
2,226
|
108
|
4.85
|
%
|
2,261
|
112
|
4.95
|
%
|
||||||||||||||||
|
Interest
on deposits in other banks
|
7,001
|
271
|
3.87
|
%
|
7,771
|
324
|
4.17
|
%
|
7,539
|
308
|
4.09
|
%
|
||||||||||||||||
|
Federal
funds sold and reverse repos
|
3,527
|
191
|
5.42
|
%
|
16,166
|
768
|
4.75
|
%
|
35,139
|
1,237
|
3.52
|
%
|
||||||||||||||||
|
Total
interest-earning assets
|
683,393
|
$
|
57,156
|
8.36
|
%
|
585,500
|
$
|
47,356
|
8.09
|
%
|
555,520
|
$
|
38,898
|
7.00
|
%
|
|||||||||||||
|
Allowance
for possible credit losses
|
(9,787
|
)
|
(8,067
|
)
|
(7,608
|
)
|
||||||||||||||||||||||
|
Noninterest-bearing
assets:
|
||||||||||||||||||||||||||||
|
Cash
and due from banks
|
25,255
|
26,426
|
29,940
|
|||||||||||||||||||||||||
|
Premises
and equipment, net
|
15,899
|
12,706
|
9,551
|
|||||||||||||||||||||||||
|
Accrued
interest receivable
|
4,061
|
3,597
|
2,661
|
|||||||||||||||||||||||||
|
Other
real estate owned
|
3,187
|
3,354
|
1,639
|
|||||||||||||||||||||||||
|
Other
assets
|
42,326
|
32,570
|
35,496
|
|||||||||||||||||||||||||
|
Total
average assets
|
$
|
764,334
|
$
|
656,086
|
$
|
627,199
|
||||||||||||||||||||||
|
Liabilities
and Shareholders' Equity:
|
||||||||||||||||||||||||||||
|
Interest-bearing
liabilities:
|
||||||||||||||||||||||||||||
|
NOW
accounts
|
$
|
46,382
|
$
|
292
|
0.63
|
%
|
$
|
49,118
|
$
|
286
|
0.58
|
%
|
$
|
51,043
|
$
|
244
|
0.48
|
%
|
||||||||||
|
Money
market accounts
|
136,720
|
4,246
|
3.11
|
%
|
138,242
|
3,701
|
2.68
|
%
|
120,318
|
2,332
|
1.94
|
%
|
||||||||||||||||
|
Savings
accounts
|
46,225
|
883
|
1.91
|
%
|
35,135
|
198
|
0.56
|
%
|
35,500
|
175
|
0.49
|
%
|
||||||||||||||||
|
Time
deposits
|
263,196
|
12,993
|
4.94
|
%
|
195,922
|
8,412
|
4.29
|
%
|
196,642
|
5,772
|
2.94
|
%
|
||||||||||||||||
|
Other
borrowings
|
17,891
|
925
|
5.17
|
%
|
4,209
|
223
|
5.30
|
%
|
1,335
|
44
|
3.30
|
%
|
||||||||||||||||
|
Trust
Preferred securities
|
15,537
|
1,234
|
7.94
|
%
|
15,464
|
1,355
|
8.76
|
%
|
15,464
|
1,091
|
7.06
|
%
|
||||||||||||||||
|
Total
interest-bearing liabilities
|
525,951
|
$
|
20,573
|
3.91
|
%
|
438,090
|
$
|
14,175
|
3.24
|
%
|
420,302
|
$
|
9,658
|
2.30
|
%
|
|||||||||||||
|
Noninterest-bearing
liabilities:
|
||||||||||||||||||||||||||||
|
Noninterest-bearing
checking
|
146,954
|
146,722
|
144,146
|
|||||||||||||||||||||||||
|
Accrued
interest payable
|
2,207
|
2,021
|
1,421
|
|||||||||||||||||||||||||
|
Other
liabilities
|
7,221
|
5,615
|
4,773
|
|||||||||||||||||||||||||
|
Total
average liabilities
|
682,333
|
592,448
|
570,642
|
|||||||||||||||||||||||||
|
|
||||||||||||||||||||||||||||
|
Total
average shareholders' equity
|
82,001
|
63,638
|
56,557
|
|||||||||||||||||||||||||
|
Total
average liabilities and
|
||||||||||||||||||||||||||||
|
Shareholders'
equity
|
$
|
764,334
|
$
|
656,086
|
$
|
627,199
|
||||||||||||||||||||||
|
Interest
income as a percentage of average earning
assets
|
8.36
|
%
|
8.09
|
%
|
7.00
|
%
|
||||||||||||||||||||||
|
Interest
income as a percentage of average earning
assets
|
3.01
|
%
|
2.42
|
%
|
1.74
|
%
|
||||||||||||||||||||||
|
Net
interest margin
|
5.35
|
%
|
5.67
|
%
|
5.26
|
%
|
||||||||||||||||||||||
| (1) |
Loan
amounts include nonaccrual loans, but the related interest income
has been
included only if collected for the period prior to the loan being
placed
on a nonaccrual basis. Loan interest income includes loan fees of
approximately $3,076,000, $3,536,000, and $3,480,000 for the years
ended
December 31, 2007, 2006, and 2005,
respectively.
|
| (2) |
Applicable
nontaxable securities yields have not been calculated on a tax-equivalent
basis because they are not material to the Company’s results of
operations.
|
28
As
summarized in Table 2, the increase in net interest income between the two
twelve-month periods ended December 31, 2007 and 2006 is comprised of an
increase in total interest income of approximately $9.8 million, which was
only
partially offset by an increase in total interest expense of approximately
$6.4
million. The Bank's net interest margin, as shown in Table 1, decreased to
5.35%
at December 31, 2007 from 5.67% at December 31, 2006, a decrease of 32 basis
points (100 basis points = 1%) between the two periods. The net margin of 5.67%
reported during 2006 represents an increase of 41 basis points from the 5.26%
net margin realized by the Company during 2005. While assets have grown over
the
past three years and the balance sheet mix has changed, interest rate movements
over those three years have played a significant role in net interest income
trends. As a result of changes in market rates of interest, the prime rate
averaged 8.05% for the year ended December 31, 2007 as compared to 7.96% and
6.19% for the years ended December 31, 2006 and 2005, respectively.
Both
the
Company's net interest income and net interest margin are affected by changes
in
the amount and mix of interest-earning assets and interest-bearing liabilities,
referred to as "volume change." Both are also affected by changes in yields
on
interest-earning assets and rates paid on interest-bearing liabilities, referred
to as "rate change." The following table sets forth the changes in interest
income and interest expense for each major category of interest-earning asset
and interest-bearing liability, and the amount of change attributable to volume
and rate changes for the years indicated. Changes in interest income and
expense, which are not attributable specifically to either rate or volume,
are
allocated proportionately between the two variances based on the absolute dollar
amounts of the change in each.
Table
2. Rate and Volume Analysis
|
2007
compared to 2006
|
2006
compared to 2005
|
||||||||||||||||||
|
(In
thousands)
|
Total
|
Rate
|
Volume
|
Total
|
Rate
|
Volume
|
|||||||||||||
|
Increase
(decrease) in interest income:
|
|||||||||||||||||||
|
Loans
|
$
|
9,788
|
$
|
(275
|
)
|
$
|
10,063
|
$
|
9,824
|
$
|
3,942
|
$
|
5,882
|
||||||
|
Investment
securities
|
642
|
628
|
14
|
(913
|
)
|
(227
|
)
|
(686
|
)
|
||||||||||
|
Interest-bearing
deposits in other banks
|
(53
|
)
|
(25
|
)
|
(28
|
)
|
16
|
6
|
10
|
||||||||||
|
Federal
funds sold and securities purchased
|
|||||||||||||||||||
|
under
agreements to resell
|
(577
|
)
|
95
|
(672
|
)
|
(469
|
)
|
341
|
(810
|
)
|
|||||||||
|
Total
interest income
|
9,800
|
423
|
9,377
|
8,458
|
4,062
|
4,396
|
|||||||||||||
|
Increase
(decrease) in interest expense:
|
|||||||||||||||||||
|
Interest-bearing
demand accounts
|
551
|
643
|
(92
|
)
|
1,366
|
1,107
|
259
|
||||||||||||
|
Savings
accounts
|
685
|
605
|
80
|
23
|
25
|
(2
|
)
|
||||||||||||
|
Time
deposits
|
4,581
|
1,391
|
3,190
|
2,685
|
2,706
|
(21
|
)
|
||||||||||||
|
Other
borrowings
|
702
|
(6
|
)
|
708
|
179
|
39
|
140
|
||||||||||||
|
Trust
Preferred securities
|
(121
|
)
|
(127
|
)
|
6
|
264
|
264
|
0
|
|||||||||||
|
Total
interest expense
|
6,398
|
2,506
|
3,892
|
4,517
|
4,141
|
376
|
|||||||||||||
|
Increase
(decrease) in net interest income
|
$
|
3,402
|
$
|
(2,083
|
)
|
$
|
5,485
|
$
|
3,941
|
$
|
(79
|
)
|
$
|
4,020
|
|||||
29
Total
interest income increased approximately $9.8 million or 20.7% between the years
ended December 31, 2006 and 2007, and was attributable primarily to increase
in
earning asset volume, as well as the yields on those earning assets to a lesser
degree. Earning asset growth was almost exclusively in loans, with minimal
growth in investments. On average, loans grew by approximately $111.0 million
between 2006 and 2007. The Company continues to maintain a high percentage
of
loans in its earning asset mix with loans averaging 85.0% of total earning
assets for the year ended December 31, 2007, as compared to 80.3% and 72.5%
for
the years ended December 31, 2006 and 2005, respectively.
Total
interest expense increased approximately $6.4 million between the years ended
December 31, 2006 and 2007, both as a result of increased volumes in time
deposits and other borrowings, as well as increased rates paid on deposit
accounts as
deposit rates continued to rise throughout much of 2007. Deposit rates began
to
decline during the fourth quarter of 2007 as market rates of interest declined
as a result of the Federal Reserves’ actions to protect a faltering
economy.
Between the years ended December 31, 2007 and December 31, 2006, rates paid
on
interest-bearing liabilities increased in all categories except other borrowing
and junior subordinated debt, with the greatest increases experienced in time
deposits, money market deposits, and savings
accounts.
The increases experienced in savings account rates during 2007 were largely
the
result of more than $25.0 million in savings accounts purchased with Legacy
Bank
during February 2007, many of which carried high preferential interest rates.
Some of those savings accounts have been closed, and the Company has been able
to reduce the cost of the remaining accounts as the preferential rate terms
of
the savings accounts expired.
Total
interest income increased approximately $8.5 million or 21.7% between the years
ended December 31, 2005 and 2006, and is attributable to both an increase in
earning asset volume, as well as the yields on those earning assets. As with
the
previous year, earning asset growth was mainly in loans, with minor volume
declines experienced in investments and federal funds sold during 2006. On
average, loans grew by approximately $67.12 million between 2005 and
2006.
Total
interest expense increased approximately $4.5 million between the years ended
December 31, 2005 and 2006, primarily as a result of increased rates paid on
deposit accounts as market rates of interest continued to rise throughout the
first half of 2006. Rates paid on interest-bearing liabilities increase in
all
categories, with the greatest increases experienced in time deposits and money
market deposit
accounts.
The Company’s deposit mix changed during 2006 with declines in average NOW and
time deposit volume, which was more than offset by increases in the average
volume of money market accounts. On average, NOW accounts and time deposits
decreased $1.9 million and $720,000, respectively, while money market accounts
increased on average by $17.9 million between the years ended December 31,
2005
and December 31, 2006. Between the years ended December 31, 2005 and December
31, 2006, rates paid on interest-bearing liabilities increased in all categories
as a result of general increases in market rates of interest, with the greatest
increases experienced in rates on time deposits and other borrowings
Provision
for Credit Losses
Provisions
for credit losses and the amount added to the allowance for credit losses is
determined on the basis of management's continuous credit review of the loan
portfolio, consideration of past loan loss experience, current and future
economic conditions, and other pertinent factors. Such factors consider the
allowance for credit losses to be adequate when it covers estimated losses
inherent in the loan portfolio. Based on the condition of the loan portfolio,
management believes the allowance is sufficient to cover risk elements in the
loan portfolio. For the year ended December 31, 2007 the provision to the
allowance for credit losses amounted to $5.7 million as compared to $880,000
and
$1.1 million for the years ended December 31, 2006 and 2005, respectively.
Increases in the provision to the allowance for credit losses during 2007,
including provisions of $2.0 million and $3.3 million in the third and fourth
quarters of 2007, respectively, were the result of higher levels of
nonperforming loans during the year, and general deterioration in the housing
and credit markets during the later part of 2007. The amount provided to the
allowance for credit losses during 2007 brought the allowance to 1.83% of net
outstanding loan balances at December 31, 2007, as compared to 1.67% of net
outstanding loan balances at December 31, 2006, and 1.86% at December 31,
2005.
Noninterest
Income
The
following table summarizes significant components of noninterest income for
the
years indicated and the net changes between those years:
|
|
Years
Ended December 31,
|
Increase
(decrease)
during
Year
|
||||||||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
2007
|
2006
|
|||||||||||
|
Customer
service fees
|
$
|
4,790
|
$
|
3,779
|
$
|
4,399
|
$
|
1,011
|
$
|
(620
|
)
|
|||||
|
Gain
on sale of securities
|
0
|
27
|
163
|
(27
|
)
|
(136
|
)
|
|||||||||
|
Gain
(loss) on sale of OREO
|
209
|
50
|
325
|
159
|
(275
|
)
|
||||||||||
|
Proceeds
from life insurance
|
483
|
482
|
0
|
1
|
482
|
|||||||||||
|
Gain
(loss) on swap ineffectiveness
|
66
|
(75
|
)
|
0
|
141
|
(75
|
)
|
|||||||||
|
Gain
on fair value option of financial assets
|
2,504
|
0
|
0
|
2,504
|
0
|
|||||||||||
|
Gain
on sale of investment
|
0
|
1,877
|
0
|
(1,877
|
)
|
1,877
|
||||||||||
|
Gain
(loss) on sale of fixed assets
|
2
|
1,018
|
(5
|
)
|
(1,016
|
)
|
1,023
|
|||||||||
|
Shared
appreciation income
|
42
|
567
|
393
|
(525
|
)
|
174
|
||||||||||
|
Other
|
1,568
|
1,306
|
1,005
|
262
|
301
|
|||||||||||
|
Total
|
$
|
9,664
|
$
|
9,031
|
$
|
6,280
|
$
|
633
|
$
|
2,751
|
||||||
30
Noninterest
income consists primarily of fees and commissions earned on services that are
provided to the Company’s banking customers and, to a lesser extent, gains on
sales of Company assets and other miscellaneous income. Noninterest income
for
the year ended December 31, 2007 increased $633,000 when compared to the
previous year, and increased $3.4 million when compared to the year ended
December 31, 2005. Increases
in noninterest income experienced during 2007 were the result of increased
customer services fees which were partially offset by changes in nonrecurring
or
unusual items between the two years.
Customer
service fees continue to provide a substantial part of noninterest income over
the three years presented. Increases of $1.0 million in customer service fees
between 2006 and 2007 were comprised of increases in ATM and overdraft charges,
as well as additional fee revenue generated by the Campbell branch acquired
during February 2007. Customer service fees decreased $620,000 between the
years
ended December 2005 and December 31, 2006, which is attributable, in part,
to
declines in ATM fee income, as well as overdraft charges and business analysis
fees.
Other
than customer service fees, increases in noninterest income experienced during
2007 were primarily the result of a $2.5 million gain recognized on the change
in fair value to the Company’s junior subordinated debt. With the deterioration
in credit markets during the second half of 2007, the rate on the Company’s
junior subordinated debt was far below current market rates of interest on
similar instruments, resulting in the significant gains recorded during the
third and fourth quarters of 2007. This was offset during 2007 by a decline
in
gain on sale of investments, and gain on sale of fixed assets. Declines in
gain
on sale of investments resulted from a $1.8 million gain on the sale of an
investment in correspondent bank during the first quarter of 2006, which was
not
again experienced during 2007. Declines in gain on sale of fixed assets resulted
from a $1.0 million gain on the sale of the Company’s administrative
headquarters during the third quarter of 2006, which was not again experienced
during 2007. Noninterest
income was further enhanced during the years ended December 31, 2007 and
December 31, 2006 from death-benefit proceeds realized from the Company’s bank
owned life insurance totaling $483,000 and $482,000 during those two years,
respectively.
Shared
appreciation income has fluctuated over the three years presented, with
decreases of $525,000 between 2006 and 2007, as compared to increases of
$174,000 between 2005 and 2006. Shared
appreciation income results from agreements between the Company and the borrower
on certain construction loans where the Company agrees to receive interest
on
the loan at maturity rather than monthly and the borrower agrees to share in
the
profits of the project. The profit is determined by the appraised value of
the
completed project and subsequent refinancing or sale of the project. Due to
the
difficulty in calculating future values, shared appreciation income is
recognized when received. The Company does not participate in a significant
number of shared appreciation projects, and as a result, does not anticipate
large
amounts
of shared appreciation income on an ongoing basis. Gains on sales of investment
securities decreased $136,000 between 2005 and 2006, as the result of securities
sales during the fourth quarter of 2005 when the Company restructured the
investment portfolio to reduce the risk profile of the Company.
Noninterest
Expense
The
following table sets forth the components of total noninterest expense in
dollars and as a percentage of average earning assets for the years ended
December 31, 2007, 2006 and 2005:
|
2007
|
2006
|
2005
|
|||||||||||||||||
|
%
of
|
%
of
|
%
of
|
|||||||||||||||||
|
Average
|
Average
|
Average
|
|||||||||||||||||
|
Earning
|
Earning
|
Earning
|
|||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Assets
|
Amount
|
Assets
|
Amount
|
Assets
|
|||||||||||||
|
Salaries
and employee benefits
|
$
|
10,830
|
1.58
|
%
|
$
|
9,915
|
1.69
|
%
|
$
|
8,046
|
1.45
|
%
|
|||||||
|
Occupancy
expense
|
3,787
|
0.55
|
%
|
2,556
|
0.44
|
%
|
2,327
|
0.42
|
%
|
||||||||||
|
Data
processing
|
420
|
0.06
|
%
|
470
|
0.08
|
%
|
624
|
0.11
|
%
|
||||||||||
|
Professional
fees
|
1,811
|
0.27
|
%
|
998
|
0.17
|
%
|
1,234
|
0.22
|
%
|
||||||||||
|
Directors
fees
|
268
|
0.04
|
%
|
222
|
0.04
|
%
|
210
|
0.04
|
%
|
||||||||||
|
Amortization
of intangibles
|
1,021
|
0.15
|
%
|
537
|
0.09
|
%
|
537
|
0.10
|
%
|
||||||||||
|
Correspondent
bank service charges
|
476
|
0.07
|
%
|
204
|
0.03
|
%
|
359
|
0.06
|
%
|
||||||||||
|
Writedown
on investment
|
17
|
0.00
|
%
|
0
|
0.00
|
%
|
702
|
0.13
|
%
|
||||||||||
|
Loss
on lease assets held for sale
|
820
|
0.12
|
%
|
0
|
0.00
|
%
|
0
|
0.00
|
%
|
||||||||||
|
Loss
on CA Tax Credit Partnership
|
430
|
0.06
|
%
|
440
|
0.08
|
%
|
458
|
0.08
|
%
|
||||||||||
|
OREO
expense
|
209
|
0.03
|
%
|
2,193
|
0.37
|
%
|
38
|
0.01
|
%
|
||||||||||
|
Other
|
2,643
|
0.39
|
%
|
2,402
|
0.41
|
%
|
2,447
|
0.44
|
%
|
||||||||||
|
Total
|
$
|
22,732
|
3.33
|
%
|
$
|
19,937
|
3.41
|
%
|
$
|
16,982
|
3.06
|
%
|
|||||||
31
Noninterest
expense, excluding provision for credit losses and income tax expense, totaled
$22.7 million for the year ended December 31, 2007 as compared to $19.9 million
and $17.0 million for the years ended December 31, 2006 and 2005, respectively.
These figures represent an increase of $2.8 million or 14.0% between the years
ended December 31, 2006 and 2007 and an increase of $3.0 million or 17.4%
between the years ended December 31, 2005 and 2006.
Increases
in noninterest expense between the three years presented are associated
primarily with normal continued growth of the Company including additional
staffing costs, as well as additional costs incurred in each of those three
years. As a percentage of average earning assets, total noninterest expense
has
remained relatively stable over the past three years as the Company has
successfully controlled overhead expenses while experiencing profitable growth.
Noninterest expense amounted to 3.33% of average earning assets for the year
ended December 31, 2007 as compared to 3.41% at December 31, 2006 and 3.06%
at
December 31, 2005.
Increases
in noninterest expense during 2007 included costs associated with the new branch
operations in Campbell, California, resulting from the merger with Legacy Bank,
additional employee costs associated with the new financial services department
acquired during November 2007, increased professional fees associated with
the
resolution of impaired loans, losses on lease assets held for sale, and
increased amortization costs for intangible assets. Losses on lease assets
held
for sale totaled $820,000 for the year ended December 31, 2007 and are the
result of charge-offs of foreclosed lease assets, mainly equipment and
furniture, which the Company has determined have no value or cannot be located.
Decreases in OREO expense during 2007 were the primarily result of additional
disposal and clean-up costs, incurred during 2006 on a single OREO property,
which was in the process of liquidation. These additional OREO costs were not
incurred again during 2007.
Expenses
on OREO increased approximately $2.2 million between the years ended December
31, 2005 and December 31, 2006. As previously discussed, increases in OREO
expense experienced during 2006 were primarily the result of additional expenses
related to the clean-up and disposal of a single OREO property during 2006
of
liquidation. Professional fees decreased $236,000 between the year ended
December 31, 2005 and December 31, 2006 primarily as the result of reductions
in
legal expenses associated with impaired loans. Noninterest expense incurred
during 2005 included a write-down of $702,000 on the Company’s investment in a
title company, Diversified Holding Corporation.
Pursuant
to the adoption of SFAS No. 123R during the first quarter of 2006, the Company
recognized stock-based compensation expense of $187,000 ($0.02 per share basic
and diluted) during the year ended December 31, 2007, and $248,000 ($0.02 per
share basic and diluted) for year ended December 31, 2006. This expense is
included in noninterest expense under salaries and employee benefits. Under
the
current pool of stock options, the Company expects stock-based compensation
expense to be about $29,000 per quarter during 2008, then to $17,000 per quarter
for 2009, and decline after that through 2011. If new stock options are issued,
or existing options fail to vest due, for example, to forfeiture, actual
stock-based compensation expense in future periods will change.
Income
Taxes
On
December 31, 2003 the California Franchise Tax Board (FTB) announced certain
tax
transactions related to real estate investment trusts (REITs) and regulated
investment companies (RICs) will be disallowed pursuant to Senate Bill 614
and
Assembly Bill 1601, which were signed into law in the 4th quarter of 2003.
As a
result, the Company reversed related net state tax benefits recorded in the
first three quarters of 2003 and has taken no related tax benefits since that
time. The Company continues to review the information available from the FTB
and
its financial advisors and believes that the Company's position has merit.
The
Company will pursue its tax claims and defend its use of these entities and
transactions. At this time, the Company cannot predict the ultimate outcome.
32
During
the first quarter of 2005, the FTB notified the Company of its intent to audit
the REIT for the tax years ended December 2001 and 2002. The Company has
retained legal counsel to represent it in the tax audit, and counsel has
provided the FTB with documentation supporting the Company's position. The
FTB
concluded its audit during January 2006. During April 2006, the FTB issued
a
Notice of Proposed Assessment to the Company, which included proposed tax and
penalty assessments related to the tax benefits taken for the REIT during 2002.
The Company still believes the case has merit based upon the fact that the
FTB
is ignoring certain facts of law in the case. The issuance of the Notice of
Proposed Assessment by the FTB will not end the administrative processing of
the
REIT issue because the Company has asserted its administrative protest and
appeal rights pending the outcome of litigation by another taxpayer presently
in
process on the REIT issue in the Los Angeles Superior Court (City National
v.
Franchise Tax Board). The case is ongoing and may take several years to
complete.
On
January 1, 2007 the Company adopted Financial Accounting Standards Board (FASB)
Interpretation 48 (FIN 48), “Accounting
for Uncertainty in Income Taxes: an interpretation of FASB Statement No.
109”.
FIN 48
clarifies SFAS No. 109, “Accounting
for Income Taxes”,
to
indicate a criterion that an individual tax position would have to meet for
some
or all of the income tax benefit to be recognized in a taxable entity’s
financial statements. Under the guidelines of FIN48, an entity should recognize
the financial statement benefit of a tax position if it determines that it
is
more
likely than not that
the
position will be sustained on examination. The term “more likely than not” means
a likelihood of more than 50 percent.” In assessing whether the
more-likely-than-not criterion is met, the entity should assume that the tax
position will be reviewed by the applicable taxing authority.
The
Company has reviewed its REIT tax position as of January 1, 2007 (adoption
date), and then again each subsequent quarter during 2007 in light of the
adoption of FIN48. The Bank, with guidance from advisors believes that the
case
has merit with regard to points of law, and that the tax law at the time allowed
for the deduction of the consent dividend. However, the Bank, with the
concurrence of advisors, cannot conclude that it is “more than likely” (as
defined in FIN48) that the Bank will prevail in its case with the FTB. As a
result of this determination, effective January 1, 2007 the Company recorded
an
adjustment of $1.3 million to beginning retained earnings upon adoption of
FIN48
to recognize the potential tax liability under the guidelines of the
interpretation. The adjustment includes amounts for assessed taxes, penalties,
and interest. During the year ended December 31, 2007, the Company increased
the
unrecognized tax liability by an additional $87,000 in interest for the period,
bringing the total recorded tax liability under FIN48 to $1.4 million at
December 31, 2007. It is the Company’s policy to recognize interest and
penalties under FIN48 as a component of income tax expense. The Company has
reviewed all of its tax positions as of December 31, 2007, and has determined
that, other than the REIT, there are no other material amounts that should
be
recorded under the guidelines of FIN48.
Financial
Condition
Total
assets increased by $93.4 million or 13.8% during the year to $771.7 million
at
December 31, 2007, and increased $142.9 million or 22.7% from the balance of
$628.9 million at December 31, 2005. The Legacy Bank acquisition completed
during February 2007 added $62.4 million in net loans, $7.4 in investments,
and
$69.6 in deposits to the Company’s balance sheet. During the year ended December
31, 2007, significant increases were experienced in loans, while federal funds
sold and investment securities declined as loan growth outpaced deposit growth
during the year. During 2007, net loans increased $94.4 million, while federal
funds sold decreased $14.3 million, and investment securities increased $6.0
million between the two period-ends.
Total
deposits of $634.6 million at December 31, 2007 increased $47.5 million or
8.1%
from the balance reported at December 31, 2006, and increased $88.2 million
or
16.1% from the balance of $546.5 million reported at December 31, 2005. During
2007, growth was experienced in time deposits, and savings accounts, with
declines experienced in other deposit categories.
Earning
assets averaged approximately $683.4 million during the year ended December
31,
2007, as compared to $585.5 million and $555.5 million for the years ended
December 31, 2006 and 2005, respectively. Average interest-bearing liabilities
increased to $526.0 million for the year ended December 31, 2007, as compared
to
$438.1 million for the year ended December 31, 2006, and increased from the
balance of $420.3 million for the year ended December 31, 2005.
Loans
The
Company's primary business is that of acquiring deposits and making loans,
with
the loan portfolio representing the largest and most important component of
its
earning assets. Loans totaled $598.2 million at December 31, 2007, representing
an increase of $97.7 million or 19.5% when compared to the balance of $500.6
million at December 31, 2006, and an increase of $180.3 million or 43.2% when
compared to the balance of $417.9 million reported at December 31, 2005. Average
loans totaled $580.9 million, $470.0 million, and $402.8 million for the years
ended December 31, 2007, 2006 and 2005, respectively. During 2007 average loans
increased 23.6% when compared to the year ended December 31, 2006 and increased
44.2% compared to the year ended December 31, 2005.
33
The
following table sets forth the amounts of loans outstanding by category and
the
category percentages as of the year-end dates indicated:
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||||||||||||||||||
|
Dollar
|
%
of
|
Dollar
|
%
of
|
Dollar
|
%
of
|
Dollar
|
%
of
|
Dollar
|
%
of
|
||||||||||||||||||||||
|
(In
thousands)
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
Amount
|
Loans
|
|||||||||||||||||||||
|
Commercial
and industrial
|
$
|
204,385
|
34.2
|
%
|
$
|
155,811
|
31.1
|
%
|
$
|
113,263
|
27.1
|
%
|
$
|
123,720
|
31.0
|
%
|
$
|
116,991
|
33.9
|
%
|
|||||||||||
|
Real
estate - mortgage
|
142,565
|
23.8
|
113,613
|
22.7
|
89,503
|
21.4
|
88,187
|
22.1
|
96,381
|
27.9
|
|||||||||||||||||||||
|
Real
estate - construction
|
178,296
|
29.8
|
168,378
|
33.7
|
162,873
|
38.9
|
137,523
|
34.5
|
97,930
|
28.3
|
|||||||||||||||||||||
|
Agricultural
|
46,055
|
7.7
|
35,102
|
7.0
|
24,935
|
6.0
|
23,416
|
5.9
|
15,162
|
4.4
|
|||||||||||||||||||||
|
Installment/other
|
18,171
|
3.0
|
16,712
|
3.3
|
15,002
|
3.6
|
13,257
|
3.3
|
6,617
|
1.9
|
|||||||||||||||||||||
|
Lease
financing
|
8,748
|
1.5
|
10,952
|
2.2
|
12,334
|
3.0
|
12,581
|
3.2
|
12,581
|
3.6
|
|||||||||||||||||||||
|
Total
Loans
|
$
|
598,220
|
100.0
|
%
|
$
|
500,568
|
100.0
|
%
|
$
|
417,910
|
100.0
|
%
|
$
|
398,684
|
100.0
|
%
|
$
|
345,662
|
100.0
|
%
|
|||||||||||
Loan
volume continues to be greatest in what has historically been the Bank’s primary
lending emphasis: commercial, real estate mortgage, and construction lending.
During 2007 as with 2006, loan growth occurred in all categories except lease
financing. During 2007, significant increases occurred in commercial and
industrial loans, as well as real estate mortgage loans, with increases of
$48.6
million or 31.2% and $29.0 million or 25.5% in those two categories,
respectively. Agricultural loans increased $11.0 million or 31.2% during 2007,
and real estate construction loans increased $9.9 million or 5.9% during
2007.
During
the fourth quarter of 2007 loan volume declined approximately $27.7 million
or
4.4% as the Company slowed additional loan growth as part of its asset/liability
management and liquidity plan. Core deposit growth lagged loan growth throughout
much of 2007 and the Company relied to a greater degree on brokered time
deposits and the use of credit lines to fund additional loan growth throughout
the much of the year. As the loan-to-deposit ratio increased and brokered
deposits reached the Company’s policy limits, the Company utilized to greater
extent its borrowing lines of credit while at the same time controlling
additional loan growth to better manage the balance sheet.
Gross
loans acquired in the acquisition of Legacy Bank in Campbell, California totaled
approximately $63.9 million at the date of merger (February 16, 2007). Exclusive
of the loans acquired from Legacy Bank during the first quarter, loan balances
attributable to the Company’s previously existing loan portfolio increased
approximately $33.7 million during the year ended December 31, 2007. The
following table shows the net change experienced during the year ended December
31, 2007, removing the effect of the loans acquired in the Legacy Bank
merger.
|
Dec
31, 2007
|
Net
Change
|
||||||||||||
|
Total
Loans
|
Legacy
Loans
|
Loans
without
|
Year
Ended
|
||||||||||
|
Dec
31, 2007
|
at
merger
|
Legacy
Loans
|
Dec
31, 2007 (1)
|
||||||||||
|
Commercial
and industrial
|
$
|
204,385
|
$
|
31,735
|
$
|
172,650
|
$
|
16,839
|
|||||
|
Real
estate - mortgage
|
142,565
|
14,417
|
128,148
|
14,535
|
|||||||||
|
Real
estate - construction
|
178,296
|
12,817
|
165,479
|
(2,899
|
)
|
||||||||
|
Agricultural
|
46,055
|
0
|
46,055
|
10,953
|
|||||||||
|
Installment/other
|
18,171
|
4,957
|
13,214
|
(3,498
|
)
|
||||||||
|
Lease
financing
|
8,748
|
0
|
8,748
|
(2,204
|
)
|
||||||||
|
Total
Loans
|
$
|
598,220
|
$
|
63,926
|
$
|
534,294
|
$
|
33,726
|
|||||
(1)
Net
change in loans between December 31, 2006 and December 31, 2007, excluding
balance of loans acquired from Legacy Bank at merger date (2/16/07). At December
31, 2007, loans at the Campbell branch, including new volume since the
acquisition, totaled $63.9 million.
During
2006, loan growth occurred in all categories except lease financing. The most
significant loan increases during 2006 occurred in commercial and industrial
loans, real estate mortgage loans, and agricultural loans, with increases of
$42.5 million, $24.1 million, and $10.2 million experienced in those three
categories, respectively. Real estate construction loans increased a modest
$5.5
million or 3.4% during 2006 as the real estate construction market remained
stable within the San Joaquin Valley.
During
2005, loan growth occurred in all categories except commercial and industrial
loans, and lease financing, with total loans growing by $19.2 million or 4.8%
between December 31, 2004 and December 31, 2005. The majority of that increase
during 2005 was experienced in real estate construction loans. Real estate
construction lending continued to be a substantial business line for the
Company, as housing demand and business development remained strong throughout
the Central San Joaquin Valley. Modest increases were experienced in real estate
mortgage, agricultural, and installment consumer loans, while commercial and
industrial loans declined by nearly $10.5 million as several large commercial
relationships matured during the later part of 2005.
34
At
December 31, 2007, approximately 62% of commercial and industrial loans have
floating rates and, although some may be secured by real estate, many are
secured by accounts receivable, inventory, and other business assets. Although
residential housing markets suffered during the later half of 2007, residential
construction loans continue to be a significant focus for the Company and
increased $9.9 million or 5.9 % during 2007, increased $5.5 million or 3.4%
during 2006, and increased $25.4 million or 18.4% during 2005. Construction
loans are generally short-term, floating-rate obligations, which consist of
both
residential and commercial projects. Agricultural loans consisting of mostly
short-term, floating rate loans for crop financing, increased $11.0 million
or
31.2% between December 31, 2006 and December 31, 2007, while installment loans
increased $1.5 million or 8.7% during that same period.
The
real
estate mortgage loan portfolio totaling $142.6 million at December 31, 2007
consists of commercial real estate, residential mortgages, and home equity
loans. Commercial real estate is the core of this segment of the portfolio,
with
balances of $102.4 million, $71.7 million, and $43.6 million at December 31,
2007, 2006, and 2005, respectively. Commercial real estate loans are generally
a
mix of short to medium-term, fixed and floating rate instruments and, are mainly
tied to commercial income and multi-family residential properties. The
Company does not currently offer traditional residential mortgage loans, but
may
purchase mortgage portfolios. As a result of real estate mortgage purchases
over
the past several years, that portion of the portfolio has remained stable with
balances of $37.2 million, $39.2 million, and $43.3 million at December 31,
2007, 2006 and 2005, respectively.
The
Company also offers short to medium-term, fixed-rate, home equity loans, which
totaled $3.0 million at December 31, 2007, $2.7 million at December 31, 2006,
and $2.6 million at December 31, 2005.
The
following table sets forth the maturities of the Bank's loan portfolio at
December 31, 2007. Amounts presented are shown by maturity dates rather than
repricing periods:
|
Due
after one
|
|||||||||||||
|
|
Due
in one
|
Year
through
|
Due
after
|
||||||||||
|
(In
thousands)
|
year
or less
|
Five
years
|
Five
years
|
Total
|
|||||||||
|
Commercial
and agricultural
|
$
|
157,315
|
$
|
68,697
|
$
|
24,428
|
$
|
250,440
|
|||||
|
Real
estate - construction
|
169,990
|
6,618
|
1,688
|
178,296
|
|||||||||
|
327,305
|
75,315
|
26,116
|
428,736
|
||||||||||
|
Real
estate - mortgage
|
17,631
|
66,928
|
58,006
|
142,565
|
|||||||||
|
All
other loans
|
10,146
|
13,871
|
2,902
|
26,919
|
|||||||||
|
Total
Loans
|
$
|
355,082
|
$
|
156,114
|
$
|
87,024
|
$
|
598,220
|
|||||
The
average yield on loans was 9.07% for the year ended December 31, 2007,
representing a decrease of 7 basis points when compared to the year ended
December 31, 2006 and was a result of increased loan pricing pressures
experienced during 2007 which more than outweighed an average increase of 9
basis point in the prime rate between the year ended December 31, 2006 and
December 31, 2007. For the year ended December 31, 2006, the average yield
on
loans was 9.13%, representing an increase of 92 basis points when compared
to
the year ended December 31, 2005 and was a result of a significant increase
in
average market rates of interest throughout 2005 and 2006. The Bank’s loan
portfolio is generally comprised of short-term or floating rate loans and is
therefore susceptible to fluctuations in market rates of interest. At December
31, 2007, 2006 and 2005, approximately 62.3%, 59.5% and 58.1% of the Bank's
loan
portfolio consisted of floating rate instruments, with the majority of those
tied to the prime rate.
The
following table sets forth the contractual maturities of the Bank's fixed and
floating rate loans at December 31, 2007. Amounts presented are shown by
maturity dates rather than repricing periods, and do not consider renewals
or
prepayments of loans:
|
Due
after one
|
|||||||||||||
|
|
Due
in one
|
Year
through
|
Due
after
|
||||||||||
|
(In
thousands)
|
year
or less
|
Five
years
|
Five
years
|
Total
|
|||||||||
|
Accruing
loans:
|
|||||||||||||
|
Fixed
rate loans
|
$
|
54,256
|
$
|
82,256
|
$
|
73,648
|
$
|
210,160
|
|||||
|
Floating
rate loans
|
282,536
|
71,324
|
12,616
|
366,476
|
|||||||||
|
Total
accruing loans
|
336,792
|
153,580
|
86,264
|
576,636
|
|||||||||
|
Nonaccrual
loans:
|
|||||||||||||
|
Fixed
rate loans
|
12,673
|
2,436
|
428
|
15,537
|
|||||||||
|
Floating
rate loans
|
5,617
|
98
|
332
|
6,047
|
|||||||||
|
Total
nonaccrual loans
|
18,290
|
2,534
|
760
|
21,584
|
|||||||||
|
Total
Loans
|
$
|
355,082
|
$
|
156,114
|
$
|
87,024
|
$
|
598,220
|
|||||
35
Securities
Following
is a comparison of the amortized cost and approximate fair value of
available-for-sale for the three years indicated:
|
December
31, 2007
|
December
31, 2006
|
||||||||||||||||||||||||
|
Gross
|
Gross
|
Fair
Value
|
Gross
|
Gross
|
Fair
Value
|
||||||||||||||||||||
|
Amortized
|
Unrealized
|
Unrealized
|
(Carrying
|
Amortized
|
Unrealized
|
Unrealized
|
(Carrying
|
||||||||||||||||||
|
(In
thousands)
|
Cost
|
Gains
|
Losses
|
Amount)
|
Cost
|
Gains
|
Losses
|
Amount)
|
|||||||||||||||||
|
Available-for-sale:
|
|||||||||||||||||||||||||
|
U.S.
Government agencies
|
$
|
65,764
|
$
|
524
|
$
|
(302
|
)
|
$
|
65,986
|
$
|
69,746
|
$
|
51
|
$
|
(1,293
|
)
|
$
|
68,504
|
|||||||
|
U.S.
Government agency
|
|||||||||||||||||||||||||
|
collateralized
mortgage
|
|||||||||||||||||||||||||
|
obligations
|
7,782
|
44
|
(4
|
)
|
7,822
|
17
|
0
|
(1
|
)
|
16
|
|||||||||||||||
|
Obligations
of state and
|
|||||||||||||||||||||||||
|
political
subdivisions
|
2,227
|
54
|
0
|
2,281
|
2,226
|
65
|
(1
|
)
|
2,290
|
||||||||||||||||
|
Other
investment securities
|
13,752
|
0
|
(426
|
)
|
13,326
|
13,000
|
0
|
(444
|
)
|
12,556
|
|||||||||||||||
|
Total
available-for-sale
|
$
|
89,525
|
$
|
622
|
$
|
(732
|
)
|
$
|
89,415
|
$
|
84,989
|
$
|
116
|
$
|
(1,739
|
)
|
$
|
83,366
|
|||||||
|
December
31, 2005
|
|||||||||||||
|
Gross
|
Gross
|
||||||||||||
|
|
Amortized
|
Unrealized
|
Unrealized
|
Fair
|
|||||||||
|
(In
thousands)
|
Cost
|
Gains
|
Losses
|
Value
|
|||||||||
|
Available-for-sale:
|
|||||||||||||
|
U.S.
Government agencies
|
$
|
82,215
|
$
|
110
|
$
|
(2,002
|
)
|
$
|
80,323
|
||||
|
U.S.
Government agency
|
|||||||||||||
|
collateralized
mortgage obligations
|
22
|
0
|
(1
|
)
|
21
|
||||||||
|
Obligations
of state and
|
|||||||||||||
|
political
subdivisions
|
2,226
|
94
|
0
|
2,320
|
|||||||||
|
Other
investment securities
|
13,000
|
0
|
(428
|
)
|
12,572
|
||||||||
|
Total
available-for-sale
|
$
|
97,463
|
$
|
204
|
$
|
(2,431
|
)
|
$
|
95,236
|
||||
Included
in other investment securities at December 31, 2007, is a short-term government
securities mutual fund totaling $7.7 million, a CRA-qualified mortgage fund
totaling $4.9 million, and an overnight money-market mutual fund totaling
$752,000. Included in other investment securities at December 31, 2006, is
a
short-term government securities mutual fund totaling $7.7 million, and a
CRA-qualified mortgage fund totaling $4.8 million. Included in other investment
securities at December 31, 2005, is a short-term government securities mutual
fund totaling $7.7 million, and a CRA-qualified mortgage fund totaling $4.9
million. The commercial asset-backed trust consists of fixed and floating rate
commercial and multifamily mortgage loans. The short-term government securities
mutual fund invests in debt securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, with a maximum duration equal
to
that of a 3-year U.S. Treasury Note.
There
were no realized gains or losses on securities available-for-sale during 2007,
Realized gains on securities available-for-sale totaled $27,000 during 2006,
and
$163,000 during 2005. There were no realized losses on securities
available-for-sale during 2006 or 2005.
Investment
securities increased $6.0 million between December 2006 and December 2007
primarily as the result of the Legacy merger during February 2007 in which
approximately $6.8 million in U.S Agency securities and $625,000 in other
investment securities were added to the Company’s portfolio. Investment
securities decreased $11.9 million between December 2005 and December 2006,
as
U.S. government agencies were paid down or matured. Proceeds from maturing
securities were utilized to fund loan growth which exceeded deposit growth
during 2006.
36
Securities
that have been temporarily impaired less than 12 months at December 31, 2007
are
comprised of one U.S. government agency collateralized mortgage obligation
with
a weighted average life of 1.19 years. As of December 31, 2007, there were
nine
U.S. government agency securities, and two other investment securities with
a
total weighted average life of 0.97 years that have been temporarily impaired
for twelve months or more. Because the decline in market value is attributable
to changes in market rates of interest rather than credit quality, and because
the Company has the ability and intent to hold these investments until a
recovery of fair value, which may be maturity, the Company does not consider
these investments to be other-than-temporarily impaired at December 31,
2007.
The
following summarizes temporarily impaired investment securities at December
31,
2007
|
Less
than 12 Months
|
12
Months or More
|
Total
|
|||||||||||||||||
|
(In
thousands)
|
Fair
Value
|
Fair
Value
|
Fair
Value
|
||||||||||||||||
|
(Carrying
|
Unrealized
|
(Carrying
|
Unrealized
|
(Carrying
|
Unrealized
|
||||||||||||||
|
Securities
available for sale:
|
Amount)
|
Losses
|
Amount)
|
Losses
|
Amount)
|
Losses
|
|||||||||||||
|
U.S.
Government agencies
|
$
|
0
|
$
|
0
|
$
|
30,241
|
$
|
(302
|
)
|
$
|
30,241
|
$
|
(302
|
)
|
|||||
|
U.S.
Government agency
|
|||||||||||||||||||
|
collateralized
mortgage
|
|||||||||||||||||||
|
Obligations
|
4,129
|
(4
|
)
|
0
|
0
|
4,129
|
(4
|
)
|
|||||||||||
|
Obligations
of state and
|
|||||||||||||||||||
|
political
subdivisions
|
0
|
0
|
0
|
0
|
0
|
0
|
|||||||||||||
|
Other
investment securities
|
0
|
0
|
12,574
|
(426
|
)
|
12,574
|
(426
|
)
|
|||||||||||
|
Total
impaired securities
|
$
|
4,129
|
$
|
(4
|
)
|
$
|
42,815
|
$
|
(728
|
)
|
$
|
46,944
|
$
|
(732
|
)
|
||||
Securities
that have been temporarily impaired less than 12 months at December 31, 2006
are
comprised of one U.S. government agency security with a weighted average life
of
13.2 years. As of December 31, 2006, there were nineteen U.S. government agency
securities, one collateralized mortgage obligation, one municipal security,
and
two other investment securities with a total weighted average life of 2.29
years
that have been temporarily impaired for twelve months or more. Because the
decline in market value is attributable to changes in market rates of interest
rather than credit quality, and because the Company has the ability and intent
to hold these investments until a recovery of fair value, which may be maturity,
the Company does not consider these investments to be other-than-temporarily
impaired at December 31, 2006.
The
following summarizes temporarily impaired investment securities at December
31,
2006
|
Less
than 12 Months
|
12
Months or More
|
Total
|
|||||||||||||||||
|
Fair
Value
|
Fair
Value
|
Fair
Value
|
|||||||||||||||||
|
(In
thousands)
|
(Carrying
|
Unrealized
|
(Carrying
|
Unrealized
|
(Carrying
|
Unrealized
|
|||||||||||||
|
Securities
available for sale:
|
Amount)
|
Losses
|
Amount)
|
Losses
|
Amount)
|
Losses
|
|||||||||||||
|
U.S.
Government agencies
|
$
|
506
|
$
|
(6
|
)
|
$
|
65,626
|
$
|
(1,287
|
)
|
$
|
66,132
|
$
|
(1,293
|
)
|
||||
|
U.S.
Government agency
|
|||||||||||||||||||
|
collateralized
mortgage
|
|||||||||||||||||||
|
Obligations
|
0
|
0
|
12
|
(1
|
)
|
12
|
(1
|
)
|
|||||||||||
|
Obligations
of state and
|
|||||||||||||||||||
|
political
subdivisions
|
0
|
0
|
34
|
(1
|
)
|
34
|
(1
|
)
|
|||||||||||
|
Other
investment securities
|
0
|
0
|
12,556
|
(444
|
)
|
12,556
|
(444
|
)
|
|||||||||||
|
Total
impaired securities
|
$
|
506
|
$
|
(6
|
)
|
$
|
78,228
|
$
|
(1,733
|
)
|
$
|
78,734
|
$
|
(1,739
|
)
|
||||
The
contractual maturities of investment securities as well as yields based on
amortized cost of those securities at December
31, 2007
are
shown below. Actual maturities may differ from contractual maturities because
issuers have the right to call or prepay obligations with or without call or
prepayment penalties.
|
One
year or less
|
After
one year to five years
|
After
five years to ten years
|
After
ten years
|
Total
|
|||||||||||||||||||||||||||
|
(Dollars
in thousands)
|
Amount
|
Yield
(1)
|
Amount
|
Yield
(1)
|
Amount
|
Yield
(1)
|
Amount
|
Yield
(1)
|
Amount
|
Yield
(1)
|
|||||||||||||||||||||
|
Available-for-sale:
|
|||||||||||||||||||||||||||||||
|
U.S.
Government agencies
|
$
|
24,058
|
4.09
|
%
|
$
|
883
|
3.80
|
%
|
$
|
8,341
|
5.28
|
%
|
$
|
32,704
|
4.53
|
%
|
$
|
65,986
|
4.09
|
%
|
|||||||||||
|
U.S.
Government agency
|
|||||||||||||||||||||||||||||||
|
collateralized
mortgage
|
|||||||||||||||||||||||||||||||
|
obligations
|
—
|
—
|
—
|
—
|
3,679
|
4.81
|
%
|
4,143
|
6.38
|
%
|
7,822
|
5.67
|
%
|
||||||||||||||||||
|
Obligations
of state and
|
|||||||||||||||||||||||||||||||
|
political
subdivisions
|
—
|
—
|
170
|
3.03
|
%
|
2,111
|
4.83
|
%
|
—
|
—
|
2,281
|
4.76
|
%
|
||||||||||||||||||
|
Other
investment securities
|
13,326
|
4.94
|
%
|
—
|
—
|
—
|
—
|
—
|
—
|
13,326
|
4.94
|
%
|
|||||||||||||||||||
|
Total
estimated fair value
|
$
|
37,384
|
3.76
|
%
|
$
|
1,053
|
3.83
|
%
|
$
|
14,131
|
5.09
|
%
|
$
|
36,847
|
4.74
|
%
|
$
|
89,415
|
4.36
|
%
|
|||||||||||
(1)
Weighted average yields are not computed on a tax equivalent
basis
37
At
December 31, 2007 and 2006, available-for-sale securities with an amortized
cost
of approximately $71.0 million and $70.9 million, respectively (fair value
of
$71.3 million and $69.7 million, respectively) were pledged as collateral for
public funds, FHLB borrowings, and treasury tax and loan balances.
Deposits
The
Bank
attracts commercial deposits primarily from local businesses and professionals,
as well as retail checking accounts, savings accounts and time deposits. Total
deposits increased $47.5 million or 8.1% during the year to a balance of $634.6
million at December 31, 2007 and increased $40.7 million or 7.4% between
December 31, 2005 and December 31, 2006. Core deposits, consisting of all
deposits other than time deposits of $100,000 or more and brokered deposits,
continue to provide the foundation for the Bank's principal sources of funding
and liquidity. These core deposits amounted to 59.9%, 71.0% and 75.7% of the
total deposit portfolio at December 31, 2007, 2006 and 2005,
respectively.
The
following table sets forth the year-end amounts of deposits by category for
the
years indicated, and the dollar change in each category during the
year:
|
|
December
31,
|
Change
during Year
|
||||||||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
2007
|
2006
|
|||||||||||
|
Noninterest-bearing
deposits
|
$
|
139,066
|
$
|
159,002
|
$
|
153,113
|
$
|
(19,936
|
)
|
$
|
5,889
|
|||||
|
Interest-bearing
deposits:
|
||||||||||||||||
|
NOW
and money market accounts
|
153,717
|
184,384
|
175,852
|
(30,667
|
)
|
8,532
|
||||||||||
|
Savings
accounts
|
40,012
|
31,933
|
33,590
|
8,079
|
(1,657
|
)
|
||||||||||
|
Time
deposits:
|
||||||||||||||||
|
Under
$100,000
|
52,297
|
42,428
|
53,254
|
9,869
|
(10,826
|
)
|
||||||||||
|
$100,000
and over
|
249,525
|
169,380
|
130,651
|
80,146
|
38,729
|
|||||||||||
|
Total
interest-bearing deposits
|
495,551
|
428,125
|
393,347
|
67,427
|
34,778
|
|||||||||||
|
Total
deposits
|
$
|
634,617
|
$
|
587,127
|
$
|
546,460
|
$
|
47,491
|
$
|
40,667
|
||||||
During
the year ended December 31, 2007 increases were experienced primarily in time
deposits, and to a lesser degree in saving accounts. Increases in time deposits
during 2007 were largely the result brokered time deposits obtained by the
Company as part of its liquidity strategy begun during 2006 to fund loan growth
as core deposits became increasingly difficult to obtain and pricing became
more
competitive. This liquidity strategy has allowed the Company to obtain the
additional funding sources need to fund loan growth without adversely impacting
the cost of its core deposit base. The Company has utilized brokered deposits
over the past several years to enhance its funding needs, with brokered deposits
totaling $139.3 million, $67.7 million, and $32.8 million at December 31, 2007,
2006 and 2005, respectively. In addition, the Company has been able to obtain
time deposits from the State of California, which totaled $45.0 million at
both
December 31, 2007 and December 31, 2006, and $40.0 million at December 31,
2005.
The time deposits of the State of California are collateralized by pledged
securities in the Company’s investment portfolio. The Company will continue to
use pricing strategies to control the overall level of time deposits as part
of
its growth and liquidity planning process. NOW and money market accounts, as
well as noninterest-bearing deposits declined $30.7 million and $19.9 million,
respectively, between December 31, 2006 and December 31, 2007 as these deposits
became increasingly competitive. The Company continues to emphasize core
deposits as part of its relationship banking strategy. As a result, core
deposits, including NOW and money market accounts, and savings accounts, as
well
as noninterest-bearing checking accounts, continue to provide the Company’s
primary funding source.
38
During
the year ended December 31, 2006 increases were experienced in all deposit
categories, except in time deposits under $100,000 and savings deposits.
Increases experienced during 2006 in money market accounts and time deposits
in
excess of $100,000 are primarily the result of depositors seeking higher yields
during the year as competitors such as brokerage firms and credit unions have
drove up rates to attract deposits. Increases in time deposits of $100,000
and
over experienced during 2006 were largely the result of brokered time deposits
obtained by the Company as part of its liquidity strategy to fund loan growth
during the year.
The
overall level of time deposits declined during 2005, as the Company was able
to
control the level of these deposits to some degree with pricing strategies.
Time
deposits, including brokered and other out-of-market deposits were allowed
to
run-off as they matured as the need for such deposits diminished. Then, as
loan
growth exceeded deposit growth during 2006, the Company sought to increase
time
deposits, including brokered deposits, to fund that asset growth.
The
Company's deposit base consists of two major components represented by
noninterest-bearing (demand) deposits and interest-bearing deposits.
Interest-bearing deposits consist of time certificates, NOW and money market
accounts and savings deposits. Total interest-bearing deposits increased $67.4
million or 15.6% between December 31, 2006 and December 31, 2007, while
noninterest-bearing deposits decreased $19.9 million or 12.5% between the same
two periods presented. Between December 31, 2005 and December 31, 2006, total
interest-bearing deposits increased $34.8 million or 8.8%, while
noninterest-bearing deposits increased $5.9 million or 3.9%.
Deposit
balances acquired in the acquisition of Legacy Bank totaled approximately $69.6
million at the date of merger (February 16, 2007). Exclusive of the deposits
acquired from Legacy Bank during the first quarter, deposit balances
attributable to the Company’s previously existing deposit base decreased
approximately $22.1 million during the year ended December 31, 2007. The
following table shows the net change experienced during the year ended December
31, 2007, removing the effect of the deposit balances acquired in the Legacy
Bank merger.
|
Legacy
|
Dec
31, 2007
|
Net
Change
|
|||||||||||
|
Total
Deposits
|
Deposits
|
Deposits
|
Year
Ended
|
||||||||||
|
Dec
31, 2007
|
at
merger
|
Without
Legacy
|
Dec
31, 2007 (1)
|
||||||||||
|
Noninterest
bearing deposits
|
$
|
139,066
|
$
|
17,970
|
$
|
121,096
|
($37,906
|
)
|
|||||
|
Interest
bearing deposits:
|
|||||||||||||
|
NOW
and money market accounts
|
153,717
|
10,541
|
143,176
|
(41,208
|
)
|
||||||||
|
Savings
accounts
|
40,012
|
28,752
|
11,260
|
(20,673
|
)
|
||||||||
|
Time
deposits:
|
|||||||||||||
|
Under
$100,000
|
52,297
|
2,860
|
49,437
|
7,009
|
|||||||||
|
$100,000
and over
|
249,525
|
9,477
|
240,048
|
70,668
|
|||||||||
|
Total
interest bearing deposits
|
495,551
|
51,630
|
443,921
|
15,796
|
|||||||||
|
Total
deposits
|
$
|
634,617
|
$
|
69,600
|
$
|
565,017
|
$
|
(22,110
|
)
|
||||
(1)
Net
change between December 31, 2006 and December 31, 2007 in deposit balances,
excluding deposits acquired from Legacy Bank at merger date (2/16/07). At
December 31, 2007, deposits at the Campbell branch, including new volume since
the acquisition, totaled $42.1 million
On
a
year-to-date average, the Company experienced an increase of $74.3 million
or
3.2 % in total deposits between the years ended December 31, 2006 and December
31, 2007. Between these two periods, average interest-bearing deposits increased
$74.1 million or 17.7%, while total noninterest-bearing checking increased
$232,000 or 0.16% on a year-to-date average basis. On average, the Company
experienced increases in savings accounts and time deposits between the years
ended December 31, 2006 and December 31, 2007, while other deposit categories
experienced moderate declines on average during 2007. On a year-to-date average
basis, total deposits increased $17.5 million or 3.2% between the years ended
December 31, 2005 and December 31, 2006. Of that total, interest-bearing
deposits increased by $14.9 million or 3.7%, while noninterest-bearing deposits
increased $2.6 million or 1.8% during 2006.
The
following table sets forth the average deposits and average rates paid on those
deposits for the years ended December 31, 2007, 2006 and 2005:
|
|
2007
|
2006
|
2005
|
||||||||||||||||
|
Average
|
Average
|
Average
|
|||||||||||||||||
|
(Dollars
in thousands)
|
Balance
|
Rate
%
|
Balance
|
Rate
%
|
Balance
|
Rate
%
|
|||||||||||||
|
Interest-bearing
deposits:
|
|||||||||||||||||||
|
Checking
accounts
|
$
|
183,102
|
2.48
|
%
|
$
|
187,360
|
2.10
|
%
|
$
|
171,361
|
1.50
|
%
|
|||||||
|
Savings
|
46,225
|
1.91
|
%
|
35,135
|
0.56
|
%
|
35,500
|
0.49
|
%
|
||||||||||
|
Time
deposits (1)
|
263,196
|
4.94
|
%
|
195,922
|
4.32
|
%
|
196,642
|
2.94
|
%
|
||||||||||
|
Noninterest-bearing
deposits
|
146,954
|
146,722
|
144,146
|
||||||||||||||||
| (1) |
Included
at December 31, 2007, are $249.5 million in time certificates of
deposit
of $100,000 or more, of which $111.0 million matures in three months
or
less, $80.6 million matures in 3 to 6 months, $44.2 million matures
in 6
to 12 months, and $13.7 million matures in more than 12 months.
|
39
Short-term
Borrowings
The
Company has the ability to obtain borrowed funds consisting of federal funds
purchased, securities sold under agreements to repurchase (“repurchase
agreements”) and Federal Home Loan Bank (“FHLB”) advances as alternatives to
retail deposit funds. The Company has established collateralized and
uncollateralized lines of credit with several correspondent banks, as well
as a
securities dealer, for the purpose of obtaining borrowed funds as needed. The
Company may continue to borrow funds in the future as part of its
asset/liability strategy, and may use these funds to acquire certain other
assets as deemed appropriate by management for investment purposes and to better
utilize the capital resources of the Bank. Federal funds purchased represent
temporary overnight borrowings from correspondent banks and are generally
unsecured. Repurchase agreements are collateralized by mortgage backed
securities and securities of U.S. Government agencies, and generally have
maturities of one to six months, but may have longer maturities if deemed
appropriate as part of the Company’s asset/liability management strategy. FHLB
advances are collateralized by the Company’s investment in FHLB stock,
securities, and certain qualifying mortgage loans. In addition, the Company
has
the ability to obtain borrowings from the Federal Reserve Bank of San Francisco,
which would be collateralized by certain pledged loans in the Company’s loan
portfolio. The lines of credit are subject to periodic review of the Company’s
financial statements by the grantors of the credit lines. Lines of credit may
be
modified or revoked at any time if the grantors feel there are adverse trends
in
the Company’s financial position.
The
Company had collateralized and uncollateralized lines of credit aggregating
$386.7 million and $308.3 million, as well as FHLB lines of credit totaling
$22.0 million and $28.0 million at December 31, 2007 and 2006, respectively.
At
December 31, 2007, the Company had total outstanding balances of $21.9 million
drawn against its FHLB line of credit. Of the $21.9 million in FHLB borrowings
outstanding at December 31, 2007, $11.9 million was in overnight borrowings,
and
the other $10.0 million consists of a two-year FHLB advance, at a fixed rate
of
4.92%, and a maturity date of March 30, 2009. These lines of credit generally
have interest rates tied to the Federal Funds rate or are indexed to short-term
U.S. Treasury rates or LIBOR.
The
table below provides further detail of the Company’s federal funds purchased,
repurchase agreements and FHLB advances for the years ended December 31, 2007,
2006 and 2005:
|
|
December
31,
|
|||||||||
|
(Dollars
in thousands)
|
2007
|
|
2006
|
|
2005
|
|||||
|
At
period end:
|
|
|
|
|||||||
|
Federal
funds purchased
|
$
|
10,380
|
$
|
0
|
$
|
0
|
||||
|
Repurchase
agreements
|
0
|
0
|
0
|
|||||||
|
FHLB
advances
|
21,900
|
0
|
0
|
|||||||
|
Total
at period end
|
$
|
32,280
|
$
|
0
|
$
|
0
|
||||
|
Average
ending interest rate - total
|
4.10
|
%
|
0.00
|
%
|
0.00
|
%
|
||||
|
Average
for the year:
|
||||||||||
|
Federal
funds purchased
|
$
|
4,660
|
$
|
4,209
|
$
|
1,331
|
||||
|
Repurchase
agreements
|
0
|
0
|
0
|
|||||||
|
FHLB
advances
|
13,231
|
0
|
0
|
|||||||
|
Total
average for the year
|
$
|
17,891
|
$
|
4,209
|
$
|
1,331
|
||||
|
Average
interest rate - total
|
5.17
|
%
|
5.30
|
%
|
3.32
|
%
|
||||
|
Maximum
total borrowings outstanding at
|
||||||||||
|
any
month-end during the year:
|
||||||||||
|
Federal
funds purchased
|
$
|
16,400
|
$
|
17,100
|
$
|
8,255
|
||||
|
Repurchase
agreements/FHLB advances
|
20,000
|
0
|
0
|
|||||||
|
Total
|
$
|
36,400
|
$
|
17,100
|
$
|
8,255
|
||||
40
Asset
Quality and Allowance for Credit Losses
Lending
money is the Company's principal business activity, and ensuring appropriate
evaluation, diversification, and control of credit risks is a primary management
responsibility. Implicit in lending activities is the fact that losses will
be
experienced and that the amount of such losses will vary from time to time,
depending on the risk characteristics of the loan portfolio as affected by
local
economic conditions and the financial experience of borrowers.
The
allowance for credit losses is maintained at a level deemed appropriate by
management to provide for known and inherent risks in existing loans and
commitments to extend credit. The adequacy of the allowance for credit losses
is
based upon management's continuing assessment of various factors affecting
the
collectibility of loans and commitments to extend credit; including current
economic conditions, past credit experience, collateral, and concentrations
of
credit. There is no precise method of predicting specific losses or amounts
which may ultimately be charged off on particular segments of the loan
portfolio. The collectibility of a loan is subjective to some degree, but must
relate to the borrower’s financial condition, cash flow, quality of the
borrower’s management expertise, collateral and guarantees, and the state of the
local economy. When determining the adequacy of the allowance for credit losses,
the Company follows, in accordance with GAAP, the guidelines set forth in the
Interagency Policy Statement on the Allowance for Loan and Lease Losses
(“Statement”) issued jointly by banking regulators during 2003, and updated and
revised in 2006. The Statement outlines characteristics that should be used
in
segmentation of the loan portfolio for purposes of the analysis including risk
classification, past due status, type of loan, industry or collateral. It also
outlines factors to consider when adjusting the loss factors for various
segments of the loan portfolio. Securities and Exchange Commission Staff
Accounting Bulletin No. 102 was also released at this time which represents
the
SEC staff’s view relating to methodologies and supporting documentation for the
Allowance for Loan and Lease Losses that should be observed by all public
companies in complying with the federal securities laws and the Commission’s
interpretations. It is also generally consistent with the guidance published
by
the banking regulators.
The
Company segments the loan and lease portfolio into eleven (11) segments,
primarily by loan class and type, that have homogeneity and commonality of
purpose and terms for analysis under SFAS No. 5. Those loans which are
determined to be impaired under SFAS No. 114 are not subject to the general
reserve analysis under SFAS No. 5, and evaluated individually for specific
impairment. The eleven segments of the Company’s loan portfolio are as follows
(subtotals are provided as needed to allow the reader to reconcile the amounts
to the Company’s loan classification reported elsewhere in these financial
statements):
|
Loan
Balance at December 31,
|
|||||||||||||||||
|
Loan
Segments for Loan Loss Reserve Analysis
(dollars
in 000's)
|
2007
|
2006
|
2005
|
2004
|
2003
|
||||||||||||
|
1
|
Commercial
and Business Loans
|
$
|
196,682
|
$
|
152,070
|
$
|
109,783
|
$
|
115,831
|
$
|
107,068
|
||||||
|
2
|
Government
Program Loans
|
7,703
|
3,741
|
3,480
|
7,889
|
9,923
|
|||||||||||
|
Total
Commercial and Industrial
|
204,385
|
155,811
|
113,263
|
123,720
|
116,991
|
||||||||||||
|
|
|||||||||||||||||
|
3
|
Commercial
Real Estate Term Loans
|
102,399
|
71,697
|
43,644
|
62,501
|
86,142
|
|||||||||||
|
4
|
Single
Family Residential Loans
|
37,194
|
39,184
|
43,308
|
21,567
|
5,240
|
|||||||||||
|
5
|
Home
Improvement/Home Equity Loans
|
2,972
|
2,732
|
2,551
|
4,119
|
4,999
|
|||||||||||
|
Total
Real Estate Mortgage
|
142,565
|
113,613
|
89,503
|
88,187
|
96,381
|
||||||||||||
|
|
|||||||||||||||||
|
6
|
Total
Real Estate Construction Loans
|
178,296
|
168,378
|
162,873
|
137,523
|
97,930
|
|||||||||||
|
|
|||||||||||||||||
|
7
|
Total
Agricultural Loans
|
46,055
|
35,102
|
24,935
|
23,416
|
15,162
|
|||||||||||
|
|
|||||||||||||||||
|
8
|
Consumer
Loans
|
17,521
|
16,327
|
14,373
|
12,476
|
6,134
|
|||||||||||
|
9
|
Overdraft
protection Lines
|
85
|
82
|
102
|
117
|
142
|
|||||||||||
|
10
|
Overdrafts
|
565
|
303
|
527
|
664
|
341
|
|||||||||||
|
|
Total
Installment/other
|
18,171
|
16,712
|
15,002
|
13,257
|
6,617
|
|||||||||||
|
|
|||||||||||||||||
|
11
|
Total
Lease Financing
|
8,748
|
10,952
|
12,334
|
12,581
|
12,581
|
|||||||||||
|
|
|||||||||||||||||
|
|
Total
Loans
|
$
|
598,220
|
$
|
500,568
|
$
|
417,910
|
$
|
398,684
|
$
|
345,662
|
||||||
The
Company’s methodology for assessing the adequacy of the allowance for credit
losses consists of several key elements, which include:
·
the formula allowance,
·
specific allowances for problem graded
loans (“classified loans”)
·
and the unallocated allowance
41
In
addition, the allowance analysis also incorporates the results of measuring
impaired loans as provided in:
·
Statement of Financial Accounting Standards
(“SFAS”) No. 114, “Accounting by Creditors for Impairment of a Loan”
and
·
SFAS
118, “Accounting by Creditors for
Impairment of a Loan - Income Recognition and Disclosures.”
The
formula allowance is calculated by applying loss factors to outstanding loans
and certain unfunded loan commitments. Loss factors are based on the Company’s
historical loss experience and on the internal risk grade of those loans and,
may be adjusted for significant factors that, in management's judgment, affect
the collectibility of the portfolio as of the evaluation date. Factors that
may
affect collectibility of the loan portfolio include:
|
·
|
Levels
of, and trends in delinquencies and nonaccrual
loans;
|
|
·
|
Trends
in volumes and term of loans;
|
|
·
|
Effects
of any changes in lending policies and procedures including those
for
underwriting, collection, charge-off, and
recovery;
|
|
·
|
Experience,
ability, and depth of lending management and
staff;
|
|
·
|
National
and local economic trends and conditions
and;
|
|
·
|
Concentrations
of credit that might affect loss experience across one or more components
of the portfolio, including high-balance loan concentrations and
participations.
|
Management
determines the loss factors for problem-graded loans (substandard, doubtful,
and
loss), special mention loans, and pass graded loans, based on a loss migration
model. The migration analysis incorporates loan losses over the past twelve
quarters (three years) and loss factors are adjusted to recognize and quantify
the loss exposure from changes in market conditions and trends in the Company’s
loan portfolio. For purposes of this analysis, loans are grouped by internal
risk classifications, which are “pass”, “special mention”, “substandard”,
“doubtful”, and “loss.” Certain loans are homogenous in nature and are therefore
pooled by risk grade. These homogenous loans include consumer installment and
home equity loans. Special mention loans are currently performing but are
potentially weak, as the borrower has begun to exhibit deteriorating trends,
which if not corrected, could jeopardize repayment of the loan and result in
further downgrade. Substandard loans have well-defined weaknesses which, if
not
corrected, could jeopardize the full satisfaction of the debt. A loan classified
as “doubtful” has critical weaknesses that make full collection of the
obligation improbable. Classified loans, as defined by the Company, include
loans categorized as substandard, doubtful, and loss.
Loan
participations are reviewed for allowance adequacy under the same guidelines
as
other loans in the Company’s portfolio, with an additional participation factor
added, if required, for specific risks associated with participations. In
general, participations are subject to certain thresholds set by the Company,
and are reviewed for geographic location as well as the well-being of the
underlying agent bank.
The
formula allowance includes reserves for certain off-balance sheet risks
including letters of credit, unfunded loan commitments, and lines of credit.
Reserves for undisbursed commitments are generally formula allocations based
on
the Company’s historical loss experience and other loss factors, rather than
specific loss contingencies. At December 31, 2007, 2006 and 2005 the formula
reserve allocated to undisbursed commitments totaled $548,000, $526,000 and
$542,000, respectively. Prior to 2004, the reserves for these off-balance sheet
commitments are included in the Company’s allowance for credit losses, rather
than a separate liability on the balance sheet because the reserve amounts
are
considered to be immaterial in relation to total liabilities.
Specific
allowances are established based on management’s periodic evaluation of loss
exposure inherent in classified loans, impaired loans, and other loans in which
management believes there is a probability that a loss has been incurred in
excess of the amount determined by the application of the formula allowance.
Specific allowance amounts include those calculated under SFAS No. 114. Under
SFAS No. 114, for impaired loans, specific allowances are determined based
on
the collateralized value of the underlying properties, the net present value
of
the anticipated cash flows, or the market value of the underlying assets. Under
SFAS No. 5, for classified loans excluding impaired loans, specific allowances,
where required, are determined on the basis of additional risks involved with
individual loans that may be in excess of risk factors associated with the
loan
portfolio as a whole. The specific allowance is different from the formula
allowance in that the specific allowance is determined on a loan-by-loan basis
based on risk factors directly related to a particular loan, as opposed to
the
formula allowance which is determined for a pool of loans with similar
characteristics, based on past historical trends and other risk factors which
may be relevant on an ongoing basis.
42
The
unallocated portion of the allowance is the result of both expected and
unanticipated changes in various conditions that are not directly measured
in
the determination of the formula and specific allowances. The conditions may
include, but are not limited to, general economic and business conditions
affecting the key lending areas of the Company, credit quality trends,
collateral values, loan volumes and concentrations, and other business
conditions.
The
Company’s methodology includes features that are intended to reduce the
difference between estimated and actual losses. The specific allowance portion
of the analysis is designed to be self-correcting by taking into account the
current loan loss experience based on that portion of the portfolio. By
analyzing the probable estimated losses inherent in the loan portfolio on a
quarterly basis, management is able to adjust specific and inherent loss
estimates using the most recent information available. In performing the
periodic migration analysis, management believes that historical loss factors
used in the computation of the formula allowance need to be adjusted to reflect
current changes in market conditions and trends in the Company’s loan portfolio.
There are a number of other factors, which are reviewed when determining
adjustments in the historical loss factors. They include 1) trends in delinquent
and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes
in lending policies, 4) concentrations of credit, 5) competition, 6) national
and local economic trends and conditions, 7) experience of lending staff, 8)
loan review and Board of Directors oversight, 9) high balance loan
concentration, and 10) other business conditions.
There
were
no changes in estimation methods or assumptions during 2007 that affected the
methodology for assessing the overall adequacy of the allowance for credit
losses.
Management
and the Company’s lending officers evaluate the loss exposure of classified and
impaired loans on a weekly and monthly basis, and through discussions and
officer meetings as conditions change. The Company’s Loan Committee meets weekly
and serves as a forum to discuss specific problem assets that pose significant
concerns to the Company, and to keep the Board of Directors informed through
committee minutes. All special mention and classified loans are reported
quarterly on Criticized Asset Reports, which are reviewed by senior management.
With this information, the migration analysis and the impaired loan analysis
are
performed on a quarterly basis and adjustments are made to the allowance as
deemed necessary.
The
Company considers a loan to be impaired when, based upon current information
and
events, it believes it is probable the Company will be unable to collect all
amounts due according to the contractual terms of the loan agreement. Impaired
loans include nonaccrual loans, restructured debt, and currently performing
loans in which full payment of principal or interest is not expected. Management
bases the measurement of these impaired loans on the fair value of the loan's
collateral or the expected cash flows on the loans discounted at the loan's
stated interest rates. Cash receipts on impaired loans not performing to
contractual terms and that are on nonaccrual status are used to reduce principal
balances. Impairment losses are included in the allowance for credit losses
through a charge to the provision, if applicable. Impaired loans are measured
based on the present value of the expected future cash flows discounted at
the
loan's effective interest rate or the fair value of the collateral if the loan
is collateral dependent. The amount of impaired loans is not directly comparable
to the amount of nonperforming loans disclosed later in this section. The
primary differences between impaired loans and nonperforming loans are: i)
all
loan categories are considered in determining nonperforming loans while impaired
loan recognition is limited to commercial and industrial loans, commercial
and
residential real estate loans, construction loans, and agricultural loans,
and
ii) impaired loan recognition considers not only loans 90 days or more past
due,
restructured loans and nonaccrual loans but also may include problem loans
other
than delinquent loans.
At
December 31, 2007 and 2006, the Company's recorded investment in loans for
which
impairment has been recognized totaled $20.6 million and $8.9 million,
respectively. Included in total impaired loans at December 31, 2007, are $10.7
million of impaired loans for which the related specific allowance is $4.5
million, as well as $9.9 million of impaired loans that as a result of
write-downs or the fair value of the collateral, did not have a specific
allowance. Total impaired loans at December 31, 2006 included $5.7 million
of
impaired loans for which the related specific allowance is $4.1 million, as
well
as $3.2 million of impaired loans that as a result of write-downs or the fair
value of the collateral, did not have a specific allowance. The average recorded
investment in impaired loans was $15.9 million, $10.1 million and $15.9 million
during the years ended December 31, 2007, 2006 and 2005, respectively. In most
cases, the Company uses the cash basis method of income recognition for impaired
loans. In the case of certain troubled debt restructuring for which the loan
is
performing under the current contractual terms, income is recognized under
the
accrual method. For the year ended December 31, 2007, the Company recognized
no
income on such loans. For the years ended December 31, 2006 and 2005, the
Company recognized income of $65,000 and $34,000, respectively, on such
loans.
The
Company focuses on competition and other economic conditions within its market
area, which may ultimately affect the risk assessment of the portfolio. The
Company continues to experience increased competition from major banks, local
independents and non-bank institutions creating pressure on loan pricing. With
interest rates decreasing 100 basis points during the fourth quarter of 2007,
and another 75 basis points during January 2008, indications are that rates
will
continue to drop in the near future as a result of sub-prime lending problems,
a
weakened real estate market, and tight credit markets. Both business and
consumer spending have improved during the past several years, but current
GDP
projections for the next year have softened. It is difficult to determine to
what degree the Federal Reserve will adjust short-term interest rates in its
efforts to influence the economy. It is likely that the business environment
in
California will continue to be influenced by these domestic as well as global
events. The local market has remained relatively stable economically during
the
past several years while much of the rest of the state and the nation have
experienced more volatile economic trends. Although the local area residential
housing markets have softened to some degree, they continue to perform better
than other parts of the state, which should bode well for sustained growth
in
the Company’s market areas of Fresno and Madera, Kern, and Santa Clara Counties.
Local unemployment rates in the San Joaquin Valley remain high primarily as
a
result of the areas’ agricultural dynamics, however unemployment rates have
improved during the past several years. It is difficult to predict what impact
this will have on the local economy. The Company believes that the Central
San
Joaquin Valley will continue to grow and diversify as property and housing
costs
remain reasonable relative to other areas of the state. Management recognizes
increased risk of loss due to the Company's exposure from local and worldwide
economic conditions, as well as potentially volatile real estate markets, and
takes these factors into consideration when analyzing the adequacy of the
allowance for credit losses.
43
The
following table provides a summary of the Company's allowance for credit losses,
provisions made to that allowance, and charge-off and recovery activity
affecting the allowance for the years indicated.
|
|
December
31,
|
|||||||||||||||
|
(Dollars
in thousands)
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Total
loans outstanding at end of period before
|
||||||||||||||||
|
deducting
allowances for credit losses
|
$
|
596,480
|
$
|
499,570
|
$
|
417,156
|
$
|
397,584
|
$
|
344,797
|
||||||
|
Average
net loans outstanding during period
|
$
|
580,873
|
$
|
469,959
|
$
|
402,820
|
$
|
374,748
|
$
|
353,562
|
||||||
|
Balance
of allowance at beginning of period
|
$
|
8,365
|
$
|
7,748
|
$
|
7,251
|
$
|
6,081
|
$
|
5,556
|
||||||
|
Loans
charged off:
|
||||||||||||||||
|
Real
estate
|
(22
|
)
|
0
|
0
|
0
|
0
|
||||||||||
|
Commercial
and industrial
|
(4,286
|
)
|
(290
|
)
|
(323
|
)
|
(14
|
)
|
(1,080
|
)
|
||||||
|
Lease
financing
|
(8
|
)
|
(164
|
)
|
(364
|
)
|
(496
|
)
|
(161
|
)
|
||||||
|
Installment
and other
|
(177
|
)
|
(48
|
)
|
(86
|
)
|
(80
|
)
|
(33
|
)
|
||||||
|
Total
loans charged off
|
(4,493
|
)
|
(502
|
)
|
(773
|
)
|
(590
|
)
|
(1,274
|
)
|
||||||
|
Recoveries
of loans previously charged off:
|
||||||||||||||||
|
Real
estate
|
0
|
0
|
0
|
0
|
0
|
|||||||||||
|
Commercial
and industrial
|
46
|
195
|
108
|
82
|
61
|
|||||||||||
|
Lease
financing
|
0
|
1
|
3
|
29
|
25
|
|||||||||||
|
Installment
and other
|
18
|
43
|
54
|
25
|
0
|
|||||||||||
|
Total
loan recoveries
|
64
|
239
|
165
|
136
|
86
|
|||||||||||
|
Net
loans charged off
|
(4,429
|
)
|
(263
|
)
|
(608
|
)
|
(454
|
)
|
(1,188
|
)
|
||||||
|
Reclassification
of off-balance sheet reserve
|
0
|
0
|
(35
|
)
|
(507
|
)
|
0
|
|||||||||
|
Reserve
acquired in business acquisition
|
1,268
|
0
|
0
|
986
|
0
|
|||||||||||
|
Provision
charged to operating expense
|
5,697
|
880
|
1,140
|
1,145
|
1,713
|
|||||||||||
|
Balance
of allowance for credit losses
|
||||||||||||||||
|
at
end of period
|
$
|
10,901
|
$
|
8,365
|
$
|
7,748
|
$
|
7,251
|
$
|
6,081
|
||||||
|
Net
loan charge-offs to total average loans
|
0.76
|
%
|
0.06
|
%
|
0.15
|
%
|
0.12
|
%
|
0.34
|
%
|
||||||
|
Net
loan charge-offs to loans at end of period
|
0.74
|
%
|
0.05
|
%
|
0.15
|
%
|
0.11
|
%
|
0.34
|
%
|
||||||
|
Allowance
for credit losses to total loans at end of period
|
1.83
|
%
|
1.67
|
%
|
1.86
|
%
|
1.82
|
%
|
1.76
|
%
|
||||||
|
Net
loan charge-offs to allowance for credit losses
|
40.63
|
%
|
3.14
|
%
|
7.85
|
%
|
6.26
|
%
|
19.54
|
%
|
||||||
|
Net
loan charge-offs to provision for credit losses
|
77.74
|
%
|
29.89
|
%
|
53.33
|
%
|
39.65
|
%
|
69.35
|
%
|
||||||
Management
believes that the 1.83% credit loss allowance to total loans at December 31,
2007 is adequate to absorb known and inherent risks in the loan portfolio.
No
assurance can be given, however, that the economic conditions which may
adversely affect the Company's service areas or other circumstances will not
be
reflected in increased losses in the loan portfolio. Management
is not currently aware of any conditions that may adversely affect the levels
of
losses incurred in the Company’s loan portfolio.
44
Although
the Company does not normally allocate the allowance for credit losses to
specific loan categories, an allocation to the major categories has been made
for the purposes of this report as set forth in the following table. The
allocations are estimates based on the same factors as considered by management
in determining the amount of additional provisions to the credit loss allowance
and the overall adequacy of the allowance for credit losses.
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||||||||||||||||||
|
Allowance
|
Allowance
|
Allowance
|
Allowance
|
Allowance
|
|||||||||||||||||||||||||||
|
|
for
Credit
|
%
of
|
for
Credit
|
%
of
|
For
Credit
|
%
of
|
for
Credit
|
%
of
|
for
Credit
|
%
of
|
|||||||||||||||||||||
|
(Dollars
in thousands)
|
Losses
|
Loans
|
Losses
|
Loans
|
Losses
|
Loans
|
Losses
|
Loans
|
Losses
|
Loans
|
|||||||||||||||||||||
|
Commercial
and industrial
|
$
|
3,254
|
34.2
|
%
|
$
|
1,905
|
31.1
|
%
|
$
|
1,397
|
27.1
|
%
|
$
|
2,497
|
31.0
|
%
|
$
|
1,755
|
33.9
|
%
|
|||||||||||
|
Real
estate - mortgage
|
593
|
23.8
|
%
|
619
|
22.7
|
%
|
330
|
21.4
|
%
|
386
|
22.1
|
%
|
508
|
27.9
|
%
|
||||||||||||||||
|
Real
estate - construction
|
2,824
|
29.8
|
%
|
1,039
|
33.7
|
%
|
1,598
|
38.9
|
%
|
1,753
|
34.5
|
%
|
1,067
|
28.3
|
%
|
||||||||||||||||
|
Agricultural
|
559
|
7.7
|
%
|
310
|
7.0
|
%
|
316
|
6.0
|
%
|
197
|
5.9
|
%
|
188
|
4.4
|
%
|
||||||||||||||||
|
Installment/other
|
133
|
3.0
|
%
|
187
|
3.3
|
%
|
112
|
3.6
|
%
|
103
|
3.3
|
%
|
97
|
1.9
|
%
|
||||||||||||||||
|
Lease
financing
|
3,538
|
1.5
|
%
|
4,165
|
2.2
|
%
|
3,619
|
3.0
|
%
|
2,312
|
3.2
|
%
|
2,466
|
3.6
|
%
|
||||||||||||||||
|
Not
allocated
|
0
|
—
|
140
|
—
|
376
|
—
|
3
|
—
|
0
|
—
|
|||||||||||||||||||||
|
$
|
10,901
|
100.0
|
%
|
$
|
8,365
|
100.0
|
%
|
$
|
7,748
|
100.0
|
%
|
$
|
7,251
|
100.0
|
%
|
$
|
6,081
|
100.0
|
%
|
||||||||||||
During
2007, reserve allocations increased significantly for commercial and industrial
loans, construction loans, and to lesser extent, agricultural loans. As with
prior years, the significant reserve allocation for lease financing loans is
the
result of specific reserves allocated to a lease portfolio that has been
nonperforming since 2002 and is in the process of litigation (see discussion
following). Increased reserve allocations for commercial and industrial loans,
as well as agricultural loans are the result of increased loan volume, as well
as increases in substandard loans in those categories. Increases in reserve
allocations for construction loans are primarily the result of increases in
special mention and substandard loans in those categories. Reserve allocations
decreased for lease financing loans as a result of positive results in the
litigation process related to the Company’s nonperforming purchased lease
portfolio.
During
2006, reserve allocations increased for commercial and industrial loans, leasing
financing, real estate mortgage loans, and installment loans. As with prior
years, the increase in reserve allocation for lease financing loans is the
result of additional reserves allocated to a nonperforming lease portfolio
(see
discussion following). Increased reserve allocations for commercial and
industrial loans are the result of increased loan volume, while increases in
reserve allocations for real estate mortgage and installment loans are primarily
the result of increases in substandard loans in those categories. Reserve
allocations decreased for real estate construction loans as a result of
significant decreases in the level of substandard loans in that category between
December 31, 2005 and December 31, 2006.
Reserve
allocations increased during 2005 for both leasing financing and agricultural
loans. The increase in reserve allocation for lease financing loans is the
result of additional reserves allocated to a nonperforming lease portfolio
(see
discussion following), while increases in reserve allocations for agricultural
loans are the result of increases in substandard loans in that category. Reserve
allocations decreased for commercial and industrial loans as a result of
significant decreases in the level of substandard commercial and industrial
loans between December 31, 2004 and December 31, 2005.
The
increased reserve allocations for lease financing loans since 2003 are the
result of the nonperformance of a purchased lease portfolio. The
Company purchased a schedule of payments collateralized by Surety Bonds and
lease payments in September 2001 that have a current balance owing of $5.4
million plus interest. The leases have been nonperforming since June of 2002.
The impaired lease portfolio is on non-accrual status and has a specific
allowance allocation of $3.5 million and $4.0 million allocated at December
31,
2007 and 2006, respectively, and a net carrying value of $2.0 million at
December 31, 2007. The specific allowance was determined based on an estimate
of
expected future cash flows, based upon the probable outcome of the current
litigation.
The
Company believes that under generally accepted accounting principles, a total
loss of principal is not probable at this time and the specific allowance of
$3.5 million calculated for the impaired lease portfolio at December 31, 2007
under SFAS No. 114 is in accordance with GAAP.
During
a
regulatory examination in the fourth quarter of 2003, the lease portfolio in
question was classified as doubtful by the Bank’s regulators based upon state
regulatory guidelines. California Financial Code No. 1951 requires that a
credit, where interest is past due and unpaid for more than one year and is
not
well secured and not in the process of collection, be charged off. The
regulators requested that the Bank charge-off the principal balance in the
first
or second quarter of 2004 for regulatory purposes if the judge had not made
a
ruling on the case by March 31, 2004 or, if a ruling had been made but no
principal payments have been received by June 30, 2004. The court did not rule
by March 31, 2004, and has not made a final ruling on the case at the time
of
this 10-K filing. As a result, effective March 31, 2004, the Company charged
off
the entire $5.5 million principal balance for regulatory purposes. As a result
of the regulatory charge-off, the Company carries a difference between its
regulatory accounting principles (RAP) books and its generally accepted
accounting principles (GAAP) books. The financial entries made for regulatory
reporting purposes resulted in a $5.5 million reduction in loan balances with
a
corresponding reduction in the reserve for credit losses. Additional provisions
for credit losses of $3.5 million were also required for regulatory accounting
purposes, which resulted in a reduction of $2.1 million in regulatory net income
(net tax benefit of $1.3 million) for the year ended December 31, 2004 as
compared to the financial statements presented under GAAP in the Company’s 2004
Annual Report on Form 10-K.
45
The
following summarizes the Company’s allowance for credit losses related to the
specific, formula, and unallocated reserves for the year-ends
shown:
|
December
31,
|
||||||||||||||||
|
(Dollars
in 000’s)
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Formula
allowance
|
$
|
3,990
|
$
|
3,637
|
$
|
2,976
|
$
|
2,827
|
$
|
3,737
|
||||||
|
Specific
allowance
|
6,911
|
4,588
|
4,396
|
4,421
|
2,344
|
|||||||||||
|
Unallocated
allowance
|
0
|
140
|
376
|
3
|
0
|
|||||||||||
|
Total
allowance
|
$
|
10,901
|
$
|
8,365
|
$
|
7,748
|
$
|
7,251
|
$
|
6,081
|
||||||
At
December 31, 2007, the allowance for credit losses totaled $10.9 million, and
consisted of $4.0 million in formula allowance, and $6.9 million in specific
allowance. At December 31, 2007, $3.5 million of the specific allowance was
allocated to lease financing loans, and the remaining $40,000, $311,000,
$38,000, $1.0 million and $2.0 million were allocated to commercial real estate,
agricultural, installment, commercial and industrial loans, and real estate
construction loans, respectively.
The
allowance for credit losses totaled $8.4 million at December 31, 2006, and
consisted of $3.6 million in formula allowance, $4.6 million in specific
allowance, and $140,000 in unallocated allowance. At December 31, 2006, $4.0
million of the specific allowance was allocated to lease financing loans, and
the remaining $227,000, $111,000, $76,000, $69,000 and $58,000 were allocated
to
commercial real estate, agricultural, installment, commercial and industrial
loans, and real estate construction loans, respectively.
At
December 31, 2005, the allowance for credit losses totaled $7.7 million, and
consisted of $3.0 million in formula allowance, $4.4 million in specific
allowance, and $376,000 in unallocated allowance. At December 31, 2005, $3.5
million of the specific allowance was allocated to lease financing loans, and
the remaining $669,000, $187,000 and $83,000 were allocated to real estate
construction loans, agricultural loans, and commercial and industrial loans,
respectively.
The
total
formula allowance increased approximately $353,000 between 2006 and 2007,
primarily as the result of increased volume in “pass” loans. There were only
minor formula allowance allocation changes between loan categories occurring
between December 31, 2006 and December 31, 2007, and so most changes in the
formula allowance during 2007 were the result of volume changes. Between
December 31, 2006 and December 31, 2007, sub-substandard loans increased $35.0
million, while special mention and doubtful loans increased $8.6 million and
$891,000 million, respectively. Increases in loan downgrades experienced during
2007 were primarily the result of deteriorating economic factors in the
residential construction market, which in turn has impacted other sectors of
the
lending portfolio.
The
total
formula allowance increased approximately $661,000 between 2005 and 2006,
primarily as the result of increased volume in “pass” loans. There were only
minor formula allowance allocation changes between loan categories occurring
between December 31, 2005 and December 31, 2006, although the formula allowance
for commercial and industrial loans increased nearly $491,000 during 2006.
Between December 31, 2005 and December 31, 2006, substandard loans decreased
$6.1 million, while special mention and doubtful loans increased $5.3 million
and $5.5 million, respectively.
Although
in some instances, the downgrading of a loan resulting from the factors used
by
the Company in its allowance analysis has been reflected in the formula
allowance, management believes that in some instances, the impact of material
events and trends has not yet been reflected in the level of nonperforming
loans
or the internal risk grading process regarding these loans. Accordingly, the
Company’s evaluation of probable losses related to these factors may be
reflected in the unallocated allowance. The evaluation of the inherent losses
concerning these factors involve a higher degree of uncertainty because they
are
not identified with specific problem credits, and therefore the Company does
not
spread the unallocated allowance among segments of the portfolio. At December
31, 2007, the Company had no unallocated allowance. At December 31, 2006 the
Company had an unallocated allowance of $140,000, reflecting a decrease from
the
balance of $376,000 at December 31, 2005. Management’s estimates of the
unallocated allowance are based upon a number of underlying factors including
1)
the effect of deteriorating national and local economic trends, 2) the effects
of export market conditions on certain agricultural and manufacturing borrowers,
3) the effects of abnormal weather patterns on agricultural borrowers, as well
as other borrowers that may be impacted by such conditions, 4) the effect of
increased competition in the Company’s market area and the resultant potential
impact of more relaxed underwriting standards to borrowers with multi-bank
relationships, 5) the effect of soft real estate markets, and 6) the effects
of
having a larger number of borrowing relationships which are close to the
Company’s lending limit, any one if which were not to perform to contractual
terms, would have a material impact on the allowance.
46
The
Company's loan portfolio has concentrations in commercial real estate,
commercial, and construction loans, however these portfolio percentages fall
within the Company's loan policy guidelines.
It
is the
Company's policy to discontinue the accrual of interest income on loans for
which reasonable doubt exists with respect to the timely collectibility of
interest or principal due to the inability of the borrower to comply with the
terms of the loan agreement. Such loans are placed on nonaccrual status whenever
the payment of principal or interest is 90 days past due or earlier when the
conditions warrant, and interest collected is thereafter credited to principal
to the extent necessary to eliminate doubt as to the collectibility of the
net
carrying amount of the loan. Management may grant exceptions to this policy
if
the loans are well secured and in the process of collection.
The
following table sets forth the Company’s nonperforming assets as of the dates
indicated:
|
December
31,
|
||||||||||||||||
|
(Dollars
in thousands, except footnote)
|
2007
|
2006
|
2005
|
2004
|
2003
|
|||||||||||
|
Nonaccrual
loans (1)
|
$
|
21,583
|
$
|
8,138
|
$
|
13,930
|
$
|
16,682
|
$
|
18,656
|
||||||
|
Restructured
loans
|
23
|
4,906
|
0
|
0
|
9
|
|||||||||||
|
Total
non-performing loans
|
21,606
|
13,044
|
13,930
|
16,682
|
18,665
|
|||||||||||
|
Other
real estate owned
|
6,666
|
1,919
|
4,356
|
1,615
|
2,718
|
|||||||||||
|
Total
non-performing assets
|
$
|
28,272
|
$
|
14,963
|
$
|
18,286
|
$
|
18,297
|
$
|
21,383
|
||||||
|
Loans,
past due 90 days or more, still accruing
|
$
|
189
|
$
|
0
|
$
|
0
|
$
|
375
|
$
|
0
|
||||||
|
Non-performing
loans to total gross loans
|
3.61
|
%
|
2.61
|
%
|
3.33
|
%
|
4.18
|
%
|
5.40
|
%
|
||||||
|
Non-performing
assets to total gross loans
|
4.73
|
%
|
2.99
|
%
|
4.38
|
%
|
4.59
|
%
|
6.19
|
%
|
||||||
| (1) |
There
are no nonaccrual loans at December 31, 2007 and 2006, which are
restructured. Included in nonaccrual loans at December 31, 2005 are
restructured loans totaling $5,114. The interest income that would
have
been earned on nonaccrual loans outstanding at December 31, 2007
in
accordance with their original terms is approximately $1.5 million.
|
Non-performing
assets increased between December 31, 2006 and December 2007 as housing
markets and related sectors experienced declines during the second half of
the
year as a result of sub-prime lending problems which impacted credit markets
and
the overall economy worldwide. Economic conditions in the San Joaquin Valley
remained strong during much of 2007, although as a result of the decline in
the
housing sector and related real estate valuations, nonperforming assets
increased during the years and additional charge-offs were taken during the
third and fourth quarters of 2007. Non-performing assets increased during 2007,
totaling 4.73% of total loans at December 31, 2007 as compared to 2.99% of
total
loans at December 31, 2006. Non-performing loans, a component of non-performing
assets, increased nearly $8.6 million during 2007 primarily as the result of
real estate construction and real estate development loans which become impaired
during the period. Some, but not all, of these nonperforming real estate credits
were outside the Company’s immediate market area, specifically Southern
California and the San Francisco Bay area.
A
nonaccrual land development loan transferred to other real estate owned during
the fourth quarter of 2007 with a principal balance of $6.0 million and accrued
interest of $865,000 ($6.9 million total)is a shared appreciation credit, and
as
such, the Company agreed to receive interest on the loan as lots sold rather
than monthly, and the borrower agreed to share in the profits of the project.
Interest was accrued and recognized in income on an ongoing basis. Upon moving
the credit to nonaccrual status during the first quarter of 2007, the Company
ceased to accrue additional interest on the loan and continued to carry, on
its
books, the previously accrued interest amount of $865,000, because it was
supported by the most recent appraised value of the property at that time plus
an added value for the recording of the approved map for the 177 lots which
was
imminent. Upon foreclosure and transfer to other real estate owned during the
fourth quarter of 2007, the Company obtained an updated appraisal to determine
the current fair value of the property. As a result of significant deterioration
in the housing markets during this period, the Company adjusted the carrying
value of the property down by $2.4 million during the fourth quarter of 2007
with a charge against the allowance for credit losses.
47
Other
real estate owned through foreclosure increased to $6.7 million or 0.86% of
total assets at December 31, 2007, as compared to $1.9 million or 0.28% of
total
assets at December 31, 2006. During 2007, three properties with net collateral
value totaling $5.3 million were transferred from nonaccrual loans, one of
which
was subsequently sold during the year. The Company increased its focus on the
resolution of impaired assets during the later part of 2007 and will continue
to
do so until nonperforming assets return to minimal levels.
A
$4.9
million loan classified as restructured at December 31, 2006, paid off during
the first quarter of 2007, resulting in the recognition of approximately $1.1
million in previously unrecognized interest income during 2007, and the overall
reduction of restructured loans at December 31, 2007.
The
overall level of nonperforming assets declined between December 31, 2005 and
December 31, 2006 primarily as the result of declines in other real estate
owned. The decline in other real estate owned experienced during 2006
is
the
result of the partial sale of an OREO property during the third quarter of
2006.
The Company incurred approximately $2.2 million in disposal and cleanup costs
related to this property during 2006. Nonaccrual loans declined between December
31, 2005 and December 31, 2006 as the result of a transfer of a single lending
relationship from nonaccrual status to accrual status during the first quarter
of 2006. The $4.9 million loan, which was restructured during the first quarter
of 2006 has been reclassified as such for reporting purposes.
Loans
past due more than 30 days are receiving increased management attention and
are
monitored for increased risk. The Company continues to move past due loans
to
nonaccrual status in its ongoing effort to recognize loan problems at an earlier
point in time when they may be dealt with more effectively. As impaired loans,
nonaccrual and restructured loans are reviewed for specific reserve allocations
and the allowance for credit losses is adjusted accordingly.
Except
for the loans included in the above table, and the land development loan
discussed above, there were no loans at December 31, 2007 where the known credit
problems of a borrower caused the Company to have serious doubts as to the
ability of such borrower to comply with the present loan repayment terms and
which would result in such loan being included as a nonaccrual, past due or
restructured loan at some future date.
Liquidity
and Asset/Liability Management
The
primary function of asset/liability management is to provide adequate liquidity
and maintain an appropriate balance between interest-sensitive assets and
interest-sensitive liabilities.
Liquidity
Liquidity
management may be described as the ability to maintain sufficient cash flows
to
fulfill both on- and off-balance sheet financial obligations, including loan
funding commitments and customer deposit withdrawals, without straining the
Company’s equity structure. To maintain an adequate liquidity position, the
Company relies on, in addition to cash and cash equivalents, cash inflows from
deposits and short-term borrowings, repayments of principal on loans and
investments, and interest income received. The Company's principal cash outflows
are for loan origination, purchases of investment securities, depositor
withdrawals and payment of operating expenses. Other sources of liquidity not
on
the balance sheet at December 31, 2007 include unused collateralized and
uncollateralized lines of credit from other banks, the Federal Home Loan Bank,
and from the Federal Reserve Bank totaling $376.4 million. The Company has
maintained significant positive cash flows from operations over the past three
years, which amounted to $19.0 million, $16.2 million, and $14.0 million for
the
years ended December 31, 2007, 2006, and 2005, respectively. The Company has
experienced net cash outflows from investing activities over the past three
years as loan growth has exceeded proceeds received from maturities and sales
of
investment securities, as well as other investment instruments. Net cash flows
from financing activities, including deposit growth and borrowings, have
traditionally provided funding sources for loan growth, but during 2007 the
Company experienced net cash outflows totaling $6.3 million as declines in
demand deposit and savings accounts, as well as repurchases of the Company’s
common stock, exceeded growth in other deposit and financing categories,
including borrowings. The Company has the ability to decrease loan growth,
increase deposits and borrowings, or a combination of both, to manage balance
sheet liquidity.
Liquidity
risk arises from the possibility the Company may not be able to satisfy current
or future financial commitments, or the Company may become unduly reliant on
alternative funding sources. The Company maintains a liquidity risk management
policy to address and manage this risk. The policy identifies the primary
sources of liquidity, establishes procedures for monitoring and measuring
liquidity, and establishes minimum liquidity requirements, which comply with
regulatory guidance. The liquidity position is continually monitored and
reported on a monthly basis to the Board of Directors.
48
The
policy also includes a contingency funding plan to address liquidity needs
in
the event of an institution-specific or a systemic financial market
crisis.
In
addition to lines of credit from other banks totaling $408.7 million, the
contingency plan includes steps that may be taken in the event the total
liquidity ratio falls or is projected to fall below 15% for any extended period
of time. The Bank ALCO committee shall take steps to correct this condition
using one or more of the following methods as needed:
|
1)
|
Investments
near maturity may be sold to meet temporary funding needs but may
need to
be replaced to maintain liquidity ratios within acceptable
limits.
|
|
2)
|
Unsecured
Fed Funds lines with correspondents may be used to fund short-term
peaks
in loan demand or deposit run-off. Other off-balance sheet funding
sources
such as credit lines at FHLB or the FRB may be used for longer
periods.
|
|
3)
|
The
Bank will not rely on brokered money as a primary source of funds.
However, if may be prudent to utilize brokered deposits particularly
at
times when the interest costs are lower than could be obtained in
the
local market. However, the sum of all brokered deposits will not
exceed
15% of the total deposits of the Bank.
|
|
4)
|
The
Bank may elect to operate a Telemarketing Money Desk for the purpose
of
acquiring Certificates of Deposits from both the local market and
national
market. The Board of Directors and management recognize that deposits
acquired through money desk operations may be considered a higher
cost and
more volatile type of deposit than traditional bank
deposits.
|
|
5)
|
Selling
whole loans or participation in loans or by increasing the amounts
sold in
existing participation loans are additional means for increasing
liquidity.
|
|
6)
|
The
State of California Treasurer is a reliable source of deposits. The
bank
can typically accept CD’s from this source up to 90% of equity as long as
it has sufficient collateral pledged.
|
| 7) |
Marketing
for CD’s within our marketplace is another means for raising funds or
through programs that post our rates on their Website, deposits from
these
sources should not exceed 15% of the banks total deposits for extended
periods beyond 90 days without board approval.
|
|
8)
|
Should
the Bank become illiquid in spite of these steps, it will curtail
its
lending activities. The first step in this process will be to curtail
credit marketing and tighten pricing guidelines. The second step
will be
to encourage loan payoffs on a selective basis where circumstances
and
loan documentation provide this opportunity. Only as a last resort
will
the Bank totally curtail lending activities to credit worthy
customers.
|
The
Company continues to utilize liability management, when needed, as part of
its
overall asset/liability management strategy. Through the discretionary
acquisition of short term borrowings, the Company has been able to provide
liquidity to fund asset growth while, at the same time, better utilizing its
capital resources, and better controlling interest rate risk. The borrowings
are
generally short-term and more closely match the repricing characteristics of
floating rate loans, which comprise approximately 62.3% of the Company’s loan
portfolio at December 31, 2007. This does not preclude the Company from selling
assets such as investment securities to fund liquidity needs but, with favorable
borrowing rates, the Company has maintained a positive yield spread between
borrowed liabilities and the assets which those liabilities fund. If, at some
time, rate spreads become unfavorable, the Company has the ability to utilize
an
asset management approach and, either control asset growth or, fund further
growth with maturities or sales of investment securities.
The
Company's liquid asset base which generally consists of cash and due from banks,
federal funds sold, securities purchased under agreements to resell (“reverse
repos”) and investment securities, is maintained at a level deemed sufficient to
provide the cash outlay necessary to fund loan growth as well as any customer
deposit runoff that may occur. Within this framework is the objective of
maximizing the yield on earning assets. This is generally achieved by
maintaining a high percentage of earning assets in loans, which historically
have represented the Company's highest yielding asset. At December 31, 2007,
the
Bank had 75.9% of total assets in the loan portfolio and a loan-to-deposit
ratio
of 94.0%. Liquid assets at December 31, 2007 include cash and cash equivalents
totaling $25.3 million as compared to $43.1 million at December 31,
2006.
Liabilities
used to fund liquidity sources include core and non-core deposits as well as
short-term borrowings. Core deposits, which comprise approximately 59.9% of
total deposits at December 31, 2007, provide a significant and stable funding
source for the Company. At December 31, 2007, unused lines of credit with the
Federal Home Loan Bank and the Federal Reserve Bank totaling $321.8 million
are
collateralized in part by certain qualifying loans in the Company’s loan
portfolio. The carrying value of loans pledged on these used and unused
borrowing lines totaled $475.4 million at December 31, 2007. For further
discussion of the Company’s borrowing lines, see “Short Term Borrowings”
included in previously in the financial condition section of this financial
review.
49
The
liquidity of the parent company, United Security Bancshares, is primarily
dependent on the payment of cash dividends by its subsidiary, United Security
Bank, subject to limitations imposed by the Financial Code of the State of
California. During 2007 and 2006, total dividends paid by the Bank to the parent
company totaled $17.6 million and $7.3 million, respectively. As a bank holding
company formed under the Bank Holding Act of 1956, United Security Bancshares
continues to provide a source of financial strength for its subsidiary bank(s).
To help provide financial strength to the Bank, United Security Bancshares’
trust subsidiary, United Security Bancshares Capital Trust I completed a $15
million offering in Trust Preferred Securities during 2001, the proceeds of
which were used to purchase Junior Subordinated Debentures of the Company.
Of
the $14.5 million in net proceeds received by the Company, $13.7 million
in
cash
was contributed as capital to United Security Bank
enhancing the liquidity and capital positions of the Bank, and the remainder
provided liquidity to the holding company. The Trust Preferred Securities issued
under United Security Bancshares Capital Trust I were redeemed during July
2007,
and subsequently, new Trust Preferred Securities totaling $15 million were
issued under United Security Bancshares Capital Trust II. The issuance of the
new Trust Preferred Securities reduced the Company’s cost of the debt by 246
basis points.
Contractual
Obligations, Commitments, Contingent Liabilities, and Off-Balance Sheet
Arrangements
The
following table presents, as of December 31, 2007, the Company's significant
fixed and determinable contractual obligations by payment date. The payment
amounts represent those amounts contractually due to the recipient and do not
include any unamortized premiums or discounts, or other similar carrying value
adjustments. Further discussion of the nature of each obligation is included
in
the referenced note to the consolidated financial statements.
|
Payments
Due In
|
|||||||||||||||||||
|
(In
thousands)
|
Note
Reference
|
One
Year
Or
Less
|
One
to
Three
Years
|
Three
to
Five
Years
|
Over
Five
Years
|
Total
|
|||||||||||||
|
Deposits
without a stated maturity
|
7
|
$
|
332,795
|
$
|
—
|
$
|
—
|
$
|
—
|
$
|
332,795
|
||||||||
|
Time
Deposits
|
7
|
282,259
|
18,572
|
382
|
610
|
301,823
|
|||||||||||||
|
Junior
Subordinated Debt (at FV)
|
9,
10
|
13,341
|
13,341
|
||||||||||||||||
|
Operating
Leases
|
14
|
637
|
1,363
|
781
|
1,403
|
4,184
|
|||||||||||||
|
Contingent
tax liabilities under FIN 48
|
11
|
1,385
|
1,385
|
||||||||||||||||
A
schedule of significant commitments at December 31, 2007
follows:
|
(In
thousands)
|
||||
|
Commitments
to extend credit:
|
||||
|
Commercial
and industrial
|
$
|
87,082
|
||
|
Real
estate - mortgage
|
779
|
|||
|
Real
estate - construction
|
81,114
|
|||
|
Agricultural
|
22,425
|
|||
|
Installment
|
4,136
|
|||
|
Revolving
home equity and credit card lines
|
722
|
|||
|
Standby
letters of credit
|
6,726
|
|||
Further
discussion of these commitments is included in Notes 3 and 14 to the
consolidated financial statements.
Regulatory
Matters
Capital
Adequacy
Capital
adequacy for bank holding companies and their subsidiary banks has become
increasingly important in recent years. Continued deregulation of the banking
industry since the 1980's has resulted in, among other things, a broadening
of
business activities allowed beyond that of traditional banking products and
services. Because of this volatility within the banking and financial services
industry, regulatory agencies have increased their focus upon ensuring that
banking institutions meet certain capital requirements as a means of protecting
depositors and investors against such volatility.
50
During
July 2007, the Company redeemed its $15.0 million in Trust Preferred Securities
originally issued during 2001 under United Security Bancshares Capital Trust
I.
During the same month, the Company issued $15.0 million in new Trust Preferred
Securities with similar terms under newly formed United Security Bancshares
Capital Trust II. Under applicable regulatory guidelines, the Trust Preferred
Securities qualify as Tier 1 capital up to a maximum of 25% of Tier 1 capital.
Any additional portion will qualify as Tier 2 capital. As shareholders’ equity
increases, the amount of Tier 1 capital that can be comprised of Trust Preferred
Securities will increase.
The
Board
of Governors of the Federal Reserve System (“Board of Governors”) has adopted
regulations requiring insured institutions to maintain a minimum leverage ratio
of Tier 1 capital (the sum of common stockholders' equity, noncumulative
perpetual preferred stock and minority interests in consolidated subsidiaries,
minus intangible assets, identified losses and investments in certain
subsidiaries, plus unrealized losses or minus unrealized gains on available
for
sale securities) to total assets. Institutions which have received the highest
composite regulatory rating and which are not experiencing or anticipating
significant growth are required to maintain a minimum leverage capital ratio
of
3% Tier 1 capital to total assets. To be considered well capitalized, the
institution must maintain a leverage capital ratio of 5%. All other institutions
are required to maintain a minimum leverage capital ratio of at least 100 to
200
basis points above the minimum requirements.
The
Board
of Governors has also adopted a statement of policy, supplementing its leverage
capital ratio requirements, which provides definitions of qualifying total
capital (consisting of Tier 1 capital and Tier 2 supplementary capital,
including the allowance for loan losses up to a maximum of 1.25% of
risk-weighted assets) and sets forth minimum risk-based capital ratios of
capital to risk-weighted assets. The most highly rated insured institutions
are
required to maintain a minimum ratio of qualifying total capital to risk
weighted assets of 8%, at least one-half (4%) of which must be in the form
of
Tier 1 capital. To be considered well capitalized, institutions must maintain
a
ratio of qualifying total capital to risk weighted assets of 10%, at least
one-half (6%) of which must be in the form of Tier 1 capital.
The
following table sets forth the Company’s and the Bank's actual capital positions
at December 31, 2007 and the regulatory minimums for the Company and the Bank
to
be well capitalized under the guidelines discussed above:
|
Company
|
Bank
|
Regulatory
|
||||||||
|
Actual
|
Actual
|
Minimums
-
|
||||||||
|
Capital
Ratios
|
Capital
Ratios
|
Well
Capitalized
|
||||||||
|
Total
risk-based capital ratio
|
12.18
|
%
|
11.79
|
%
|
10.00
|
%
|
||||
|
Tier
1 capital to risk-weighted assets
|
10.93
|
%
|
10.54
|
%
|
6.00
|
%
|
||||
|
Leverage
ratio
|
10.30
|
%
|
9.93
|
%
|
5.00
|
%
|
||||
Under
Federal Reserve guidelines, the Company and the Bank are required to maintain
a
total risk-based capital ratio of 10%, tier 1 capital to risk-weighted assets
of
8%, and a leverage ratio of 7%, to be considered well capitalized. As is
indicated by the above table, the Company and the Bank exceeded all applicable
regulatory capital guidelines at December 31, 2007. Management believes that,
under the current regulations, both will continue to meet their minimum capital
requirements in the foreseeable future.
Dividends
Dividends
paid to shareholders by the Company are subject to restrictions set forth in
the
California General Corporation Law. The California General Corporation Law
provides that a corporation may make a distribution to its shareholders if
retained earnings immediately prior to the dividend payout are at least equal
the amount of the proposed distribution. The primary source of funds with which
dividends will be paid to shareholders will come from cash dividends received
by
the Company from the Bank. During the year ended December 31, 2007, the Company
received $17.6 million in cash dividends from the Bank, from which the Company
declared $6.0 million in dividends to shareholders.
The
Bank
as a state-chartered bank is subject to dividend restrictions set forth in
California state banking law, and administered by the California Commissioner
of
Financial Institutions (“Commissioner”). Under such restrictions, the Bank may
not pay cash dividends in an amount which exceeds the lesser of the retained
earnings of the Bank or the Bank’s net income for the last three fiscal years
(less the amount of distributions to shareholders during that period of time).
If the above test is not met, cash dividends may only be paid with the prior
approval of the Commissioner, in an amount not exceeding the Bank’s net income
for its last fiscal year or the amount of its net income for the current fiscal
year. Such restrictions do not apply to stock dividends, which generally require
neither the satisfaction of any tests nor the approval of the Commissioner.
Notwithstanding the foregoing, if the Commissioner finds that the shareholders’
equity is not adequate or that the declarations of a dividend would be unsafe
or
unsound, the Commissioner may order the state bank not to pay any dividend.
The
FRB may also limit dividends paid by the Bank. This is not the case with the
Bank. Year-to-date dividends of $6.0 million and $17.6 million paid to
shareholders and the Company, respectively, through December 31, 2007 were
well
within the maximum allowed under those regulatory guidelines, and did not
require prior approval of the Commissioner.
51
Stock
Repurchase Plan (all figures have been restated to reflect effect of 2-for-1
stock split during May 2006)
|
For
the Quarters Ended
|
||||||||||||||||
|
March
31,
|
June
30,
|
September
30,
|
December
31,
|
YTD
|
||||||||||||
|
Shares
repurchased - 2007
|
117,403
|
306,758
|
28,916
|
59,255
|
512,332
|
|||||||||||
|
Average
price paid - 2007
|
$
|
21.48
|
$
|
19.89
|
$
|
18.32
|
$
|
18.32
|
$
|
19.71
|
||||||
|
Shares
repurchased - 2006
|
84
|
13,121
|
84,215
|
10,585
|
108,005
|
|||||||||||
|
Average
price paid - 2006
|
$
|
16.57
|
$
|
23.13
|
$
|
22.21
|
$
|
24.58
|
$
|
22.55
|
||||||
|
Shares
repurchased - 2005
|
7,152
|
4,936
|
0
|
14,074
|
26,162
|
|||||||||||
|
Average
price paid - 2005
|
$
|
12.28
|
$
|
12.78
|
$
|
—
|
$
|
16.16
|
$
|
14.46
|
||||||
|
Shares
repurchased - 2004
|
19,800
|
109,490
|
45,986
|
3,564
|
178,840
|
|||||||||||
|
Average
price paid - 2004
|
$
|
12.85
|
$
|
11.41
|
$
|
11.29
|
$
|
12.11
|
$
|
11.55
|
||||||
|
Shares
repurchased - 2003
|
33,226
|
14,696
|
22,000
|
0
|
69,922
|
|||||||||||
|
Average
price paid - 2003
|
$
|
8.54
|
$
|
10.80
|
$
|
11.32
|
N/A
|
$
|
9.89
|
|||||||
On
August
30, 2001 the Company announced that its Board of Directors approved a plan
to
repurchase, as conditions warrant, up to 280,000 shares (560,000 shares adjusted
for May 2006 stock split) of the Company's common stock on the open market
or in
privately negotiated transactions. The duration of the program was open-ended
and the timing of purchases was dependent on market conditions. A total of
215,423 shares (430,846 shares adjusted for May 2006 stock split) had been
repurchased under that plan as of December 31, 2003, at a total cost of $3.7
million.
On
February 25, 2004 the Company announced a second stock repurchase plan under
which the Board of Directors approved a plan to repurchase, as conditions
warrant, up to 276,500 shares (553,000 shares adjusted for May 2006 stock split)
of the Company's common stock on the open market or in privately negotiated
transactions. As with the first plan, the duration of the new program is
open-ended and the timing of purchases will depend on market conditions.
Concurrent with the approval of the new repurchase plan, the Board terminated
the 2001 repurchase plan and canceled the remaining 64,577 shares (129,154
shares adjusted for May 2006 stock split) yet to be purchased under the earlier
plan.
On
May
16, 2007, the Company announced another stock repurchase plan to repurchase,
as conditions warrant, up to 610,000 shares of the Company's common stock on
the
open market or in privately negotiated transactions. The repurchase plan
represents approximately 5.00% of the Company's currently outstanding common
stock. The duration of the program is open-ended and the timing of purchases
will depend on market conditions. Concurrent with the approval of the new
repurchase plan, the Company canceled the remaining 75,733 shares available
under the 2004 repurchase plan.
During
the year ended December 31, 2007, 512,332 shares were repurchased at a total
cost of $10.1 million and an average per share price of $19.71. Of the shares
repurchased during 2007, 166,660 shares were repurchased under the 2004 plan
at
an average cost of $20.46 per shares, and 345,672 shares were repurchased under
the 2007 plan at an average cost of $19.35 per share.
Reserve
Balances
The
Bank
is required to maintain average reserve balances with the Federal Reserve Bank.
During 2005, the Company implemented a deposit reclassification program, which
allows the Company to reclassify a portion of transaction accounts to
non-transaction accounts for reserve purposes. The deposit reclassification
program was provided by a third-party vendor, and has been approved by the
Federal Reserve Bank. At December 31, 2007 the Bank's qualifying balance with
the Federal Reserve was approximately $25,000.
52
Item
7A. Quantitative and Qualitative Disclosures about Market
Risk
Interest
Rate Sensitivity and Market Risk
An
interest rate-sensitive asset or liability is one that, within a defined time
period, either matures or is subject to interest rate adjustments as market
rates of interest change. Interest rate sensitivity is the measure of the
volatility of earnings from movements in market rates of interest, which is
generally reflected in interest rate spread. As interest rates change in the
market place, yields earned on assets do not necessarily move in tandem with
interest rates paid on liabilities. Interest rate sensitivity is related to
liquidity in that each is affected by maturing assets and sources of funds.
Interest rate sensitivity is also affected by assets and liabilities with
interest rates that are subject to change prior to maturity.
The
object of interest rate sensitivity management is to minimize the impact on
earnings from interest rate changes in the marketplace. In recent years,
deregulation, causing liabilities to become more interest rate sensitive,
combined with interest rate volatility in the capital markets, has placed
additional emphasis on this principal. When management decides to maintain
repricing imbalances, it usually does so on the basis of a well- conceived
strategy designed to ensure that the risk is not excessive and that liquidity
is
properly maintained. The Company's interest rate risk management is the
responsibility of the Asset/Liability Management Committee (ALCO), which reports
to the Board of Directors on a periodic basis, pursuant to established operating
policies and procedures.
As
part
of its overall risk management, the Company pursues various asset and liability
management strategies, which may include obtaining derivative financial
instruments to mitigate the impact of interest fluctuations on the Company’s net
interest margin. During the second quarter of 2003, the Company entered into
an
interest rate swap agreement with the purpose of minimizing interest rate
fluctuations on its interest rate margin and equity.
Under
the
interest rate swap agreement, the Company receives a fixed rate and pays a
variable rate based on the Prime Rate (“Prime”). The swap qualifies as a cash
flow hedge under SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities”, as amended, and is designated as a hedge of the variability
of cash flows the Company receives from certain variable-rate loans indexed
to
Prime. In accordance with SFAS No. 133, the swap agreement is measured at fair
value and reported as an asset or liability on the consolidated balance sheet.
The portion of the change in the fair value of the swap that is deemed effective
in hedging the cash flows of the designated assets are recorded in accumulated
other comprehensive income and reclassified into interest income when such
cash
flow occurs in the future. Any ineffectiveness resulting from the hedge is
recorded as a gain or loss in the consolidated statement of income as part
of
noninterest income. The amortizing hedge has a remaining notional value of
$1.8
million and duration of approximately three months. As of December 31, 2007,
the
maximum length of time over which the Company is hedging its exposure to the
variability of future cash flows is approximately nine months. As of December
31, 2007, the loss amounts in accumulated other comprehensive income associated
with these cash flows totaled $2,000. During the year ended December 31, 2007,
$310,000 was reclassified from accumulated other comprehensive income as a
reduction to interest income.
The
Company performed a quarterly analysis of the effectiveness of the interest
rate
swap agreement at December 31, 2007. As a result of a correlation analysis,
the
Company has determined that the swap remains highly
effective in achieving offsetting cash flows attributable to the hedged risk
during the term of the hedge and, therefore, continues to qualify for hedge
accounting under the guidelines of SFAS No. 133. However,
during
the
second quarter of 2006, the Company determined that the underlying loans being
hedged were paying off faster than the notional value of the hedge instrument
was amortizing. As a result, the notional value of the hedge instrument was
approximately $3.8 million greater than the underlying loans being hedged at
June 30, 2006, $3.3 million greater than the underlying loans being hedged
at
September 30, 2006, and $3.3 million greater than the underlying loans being
hedged at December 31, 2006 . This difference between the notional value of
the
hedge and the underlying hedged assets is considered an “overhedge” pursuant to
SFAS No. 133 guidelines and may constitute ineffectiveness if the difference
is
other than temporary. At June 30, 2006, the Company determined that the
difference was other than temporary and, as a result, reclassified $147,000
of
the pretax hedge loss reported in other comprehensive income into earnings.
During the third and fourth quarters of 2006, the Company adjusted the pretax
loss reported in other comprehensive income by $72,000 resulting in a
year-to-date loss related to swap ineffectiveness of $75,000 reported in
earnings at December 31, 2006.
As
of
December 31, 2007, the notional value of the hedge was still in excess of the
value of the underlying loans being hedged by approximately $1.3 million, but
had improved from the $3.3 million difference existing at December 31, 2006.
As
a result, the Company recorded a pretax hedge gain related to swap
ineffectiveness of approximately $66,000 during the year ended December 31,
2007. Amounts recognized as hedge ineffectiveness gains or losses are reflected
in noninterest income.
Interest
rate risk can be measured through various methods including gap, duration and
market value analysis as well as income simulation models, which provides a
dynamic view of interest rate sensitivity based on the assumptions of the
Company’s Management. The Company employs each of these methods and refines
these processes to make the most accurate measurements possible. The information
provided by these calculations is the basis for management decisions in managing
interest rate risk.
53
From
the
“Gap” report below, the Company is apparently subject to interest rate risk to
the extent that its liabilities have the potential to reprice more quickly
than
its assets within the next year. At December 31, 2007, the Company had a
cumulative negative 12-month Gap of $9.0 million or -1.3% of total earning
assets. Management believes the Gap analysis shown below is not entirely
indicative of the Company’s actual interest rate sensitivity, because certain
interest-sensitive liabilities would not reprice to the same degree as
interest-sensitive assets. For example, if the prime rate were to change by
50
basis points, the floating rate loans included in the $350.0 million immediately
adjustable category would change by the full 50 basis points. Interest bearing
checking and savings accounts which are also included in the immediately
adjustable column probably would move only a portion of the 50 basis point
rate
change and, in fact, might not even move at all. The effects of market value
risk have been mitigated to some degree by the makeup of the Bank's balance
sheet. Loans are generally short-term or are floating-rate instruments. At
December 31, 2007, $458.0 million or 79.4% of the loan portfolio matures or
reprices within one year, and only 1.0% of the portfolio matures or reprices
in
more than 5 years.
Total
investment securities including call options and prepayment assumptions, have
a
combined duration of approximately 1.7 years. Nearly $516.3 million or 95.4%
of
interest-bearing liabilities mature or can be repriced within the next 12
months, even though the rate elasticity of deposits with no defined maturities
may not necessarily be the same as interest-earning assets.
The
following table sets forth the Company's gap, or estimated interest rate
sensitivity profile based on ending balances as of December 31, 2007,
representing the interval of time before earning assets and interest-bearing
liabilities may respond to changes in market rates of interest. Assets and
liabilities are categorized by remaining interest rate maturities rather than
by
principal maturities of obligations.
Maturities
and Interest Rate Sensitivity
December
31, 2007
|
After
Three
|
After
One
|
||||||||||||||||||
|
Next
Day But
|
Months
|
Year
But
|
After
|
||||||||||||||||
|
|
Within
Three
|
Within
12
|
Within
Five
|
Five
|
|||||||||||||||
|
(In
thousands)
|
Immediately
|
Months
|
Months
|
Years
|
Years
|
Total
|
|||||||||||||
|
Interest
Rate Sensitivity Gap:
|
|||||||||||||||||||
|
Loans
(1)
|
$
|
350,022
|
$
|
52,814
|
$
|
55,119
|
$
|
113,009
|
$
|
5,673
|
$
|
576,637
|
|||||||
|
Investment
securities
|
21,572
|
25,091
|
15,608
|
27,144
|
89,415
|
||||||||||||||
|
Interest
bearing deposits in other banks
|
2,742
|
167
|
0
|
2,909
|
|||||||||||||||
|
Federal
funds sold and reverse repos
|
0
|
||||||||||||||||||
|
Total
earning assets
|
$
|
350,022
|
$
|
74,386
|
$
|
82,952
|
$
|
128,784
|
$
|
32,817
|
$
|
668,961
|
|||||||
|
Interest-bearing
|
|||||||||||||||||||
|
transaction
accounts
|
153,717
|
153,717
|
|||||||||||||||||
|
Savings
accounts
|
40,012
|
40,012
|
|||||||||||||||||
|
Time
deposits (2)
|
17,991
|
126,039
|
142,941
|
14,241
|
610
|
301,822
|
|||||||||||||
|
Federal
funds purchased/other borrowings
|
22,280
|
10,000
|
32,280
|
||||||||||||||||
|
Junior
subordinated debt
|
13,341
|
13,341
|
|||||||||||||||||
|
Total
interest-bearing liabilities
|
$
|
234,000
|
$
|
139,380
|
$
|
142,941
|
$
|
24,241
|
$
|
610
|
$
|
541,172
|
|||||||
|
Interest
rate sensitivity gap
|
$
|
116,022
|
($64,994
|
)
|
($59,989
|
)
|
$
|
104,543
|
$
|
32,207
|
$
|
127,789
|
|||||||
|
Cumulative
gap
|
$
|
116,022
|
$
|
51,028
|
($8,961
|
)
|
$
|
95,582
|
$
|
127,789
|
|||||||||
|
Cumulative
gap percentage to
|
|||||||||||||||||||
|
Total
earning assets
|
17.3
|
%
|
7.6
|
%
|
-1.34
|
%
|
14.3
|
%
|
19.1
|
%
|
|||||||||
(1)
Loan balance does not include nonaccrual loans of $21.583
million.
(2)
See above for discussion of the impact of floating rate CD’s.
The
Company utilizes a vendor-purchased simulation model to analyze net interest
income sensitivity to movements in interest rates. The simulation model projects
net interest income based on a 100, 200, and 300 basis point rise and a 100,
200, and 300 basis point fall in interest rates ramped over a twelve-month
period, with net interest impacts projected out as far as twenty-four months.
In
addition, a “most likely” scenario is projected based upon expected rate changes
over the 24-month period. The model is based on the actual maturity and
repricing characteristics of the Company's interest-sensitive assets and
liabilities. The model incorporates assumptions regarding the impact of changing
interest rates on the prepayment of certain assets and liabilities. Projected
net interest income is calculated assuming customers will reinvest maturing
deposit accounts and the Company will originate new loans. The balance sheet
growth assumptions utilized correspond closely to the Company's strategic growth
plans and annual budget. Excess cash is invested in overnight funds or other
short-term investments such as U.S. Treasuries. Cash shortfalls are covered
through additional borrowing of overnight or short-term funds. The Board of
Directors has adopted an interest rate risk policy which establishes maximum
decreases in net interest income of 12% and 15% in the event of a 100 BP and
200
BP increase or decrease in market interest rates over a twelve month period.
Based on the information and assumptions utilized in the simulation model at
December 31, 2007, the resultant projected impact on net interest income falls
within policy limits set by the Board of Directors for all rate scenarios
simulated.
54
The
Company also utilizes the same vendor-purchased simulation model to project
the
impact of changes in interest rates on the underlying market value of all the
Company's assets, liabilities, and off-balance sheet accounts under alternative
interest rate scenarios. The resultant net value, as impacted under each
projected interest rate scenario, is referred to as the market value of equity
("MV of Equity"). This technique captures the interest rate risk of the
Company's business mix across all maturities. The market analysis is performed
using an immediate rate shock of 100, 200, and 300 basis points up and down
calculating the present value of expected cash flows under each rate environment
at applicable discount rates. The market value of loans is calculated by
discounting the expected future cash flows over either the term to maturity
for
fixed rate loans or scheduled repricing for floating rate loans using the
current rate at which similar loans would be made to borrowers with similar
credit ratings. The market value of investment securities is based on quoted
market prices obtained from reliable independent brokers. The market value
of
time deposits is calculated by discounting the expected cash flows using current
rates for similar instruments of comparable maturities. The market value of
deposits with no defined maturities, including interest-bearing checking, money
market and savings accounts is calculated by discounting the expected cash
flows
at a rate equal to the difference between the cost of these deposits and the
alternate use of the funds, federal funds in this case. Assumed maturities
for
these deposits are estimated using decay analysis and are generally assumed
to
have implied maturities of less than five years. For noninterest sensitive
assets and liabilities, the market value is equal to their carrying value
amounts at the reporting date. The Company's interest rate risk policy
establishes maximum decreases in the Company's market value of equity of 12%
and
15% in the event of an immediate and sustained 100 BP and 200 BP increase or
decrease in market interest rates. As shown in the table below, the percentage
changes in the net market value of the Company's equity are within policy limits
for both rising and falling rate scenarios.
The
following sets forth the analysis of the Company's market value risk inherent
in
its interest-sensitive financial instruments as they relate to the entire
balance sheet at December 31, 2007 and December 31, 2006 ($ in thousands).
Fair
value estimates are subjective in nature and involve uncertainties and
significant judgment and, therefore, cannot be determined with absolute
precision. Assumptions have been made as to the appropriate discount rates,
prepayment speeds, expected cash flows and other variables. Changes in these
assumptions significantly affect the estimates and as such, the obtained fair
value may not be indicative of the value negotiated in the actual sale or
liquidation of such financial instruments, nor comparable to that reported
by
other financial institutions. In addition, fair value estimates are based on
existing financial instruments without attempting to estimate future
business.
|
December
31, 2007
|
December
31, 2006
|
||||||||||||||||||
|
Change
in
|
Estimated
MV
|
Change
in MV
|
Change
in MV
|
Estimated
MV
|
Change
in MV
|
Change
in MV
|
|||||||||||||
|
Rates
|
of
Equity
|
Of
Equity $
|
Of
Equity %
|
of
Equity
|
of
Equity $
|
Of
Equity %
|
|||||||||||||
|
+
200 BP
|
$
|
105,596
|
$
|
3,028
|
2.95
|
%
|
$
|
90,317
|
$
|
912
|
1.02
|
%
|
|||||||
|
+
100 BP
|
105,207
|
2,639
|
2.57
|
%
|
90,524
|
1,118
|
1.25
|
%
|
|||||||||||
|
0 BP
|
102,568
|
0
|
0.00
|
%
|
89,406
|
0
|
0.00
|
%
|
|||||||||||
|
-
100 BP
|
97,410
|
(5,158
|
)
|
-5.03
|
%
|
87,291
|
(2,115
|
)
|
-2.37
|
%
|
|||||||||
|
-
200 BP
|
91,212
|
(11,356
|
)
|
-11.07
|
%
|
84,278
|
(5,128
|
)
|
-5.74
|
%
|
|||||||||
55
Item
8 - Financial Statements and Supplementary Data
Index
to Consolidated Financial Statements:
|
Reports
of Independent Registered Public Accounting Firm
|
57
|
|
Consolidated
Balance Sheets - December 31, 2007 and 2006
|
58
|
|
Consolidated
Statements of Income and Comprehensive Income - Years Ended December
31,
2007, 2006 and 2005
|
59
|
|
Consolidated
Statements of Shareholders' Equity - Years Ended December 31, 2007,
2006
and 2005
|
60
|
|
Consolidated
Statements of Cash Flows - Years Ended December 31, 2007, 2006
and
2005
|
61
|
|
|
|
|
Notes
to Consolidated Financial Statements
|
62
|
56
Moss
Adams LLP
Certified
Public Accountants
Report
of Independent Registered Public Accounting Firm
To
the
Board of Directors
United
Security Bancshares
We
have
audited the accompanying consolidated balance sheets of United Security
Bancshares and Subsidiaries (Company) as of December 31, 2007 and 2006, and
the
related consolidated statements of income and comprehensive income,
shareholders' equity and cash flows for each of the three years in the period
ended December 31, 2007. These consolidated financial statements are the
responsibility of 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 the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audits 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, assessing the accounting principles used and
significant estimates made by management, and evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In
our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of United Security
Bancshares and Subsidiaries as of December 31, 2007 and 2006, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the Company’s internal control over financial
reporting as of December 31, 2007, based on criteria established in Internal
Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission, and
our
report dated March 14, 2008 expressed an unqualified opinion
thereon.
As
discussed in Note 1 to the consolidated financial statements, effective January
1, 2006, the Company changed its method of accounting for share-based payment
arrangements to conform to Statement of Financial Accounting Standard (SFAS)
No.
123R, Share
-Based Payments.
As
discussed in Note 10 and 15 to the consolidated financial statements, effective
January 1, 2007, the Company adopted the provisions of SFAS No. 159,
The
Fair Value Option for Financial Assets and Financial
Liabilities,
and
SFAS No. 157, Fair
Value Measurements.
As
discussed in Note 11 to the consolidated financial statements, effective January
1, 2007, the Company adopted the provisions of FIN 48, Accounting
for uncertainty in Income Taxes.
/s/
Moss
Adams LLP
Stockton,
California
March
14,
2008
57
Report
of Independent Registered Public Accounting Firm
To
the
Board of Directors and Stockholders of
United
Security Bancshares and Subsidiaries
We
have
audited United
Security Bancshares and Subsidiaries
(the
Company) internal control over financial reporting as of December 31, 2007,
based on criteria established in Internal Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(the COSO criteria). The Company’s management is responsible for maintaining
effective internal control over financial reporting and for its assessment
of
the effectiveness of internal control over financial reporting included in
the
accompanying Management Report on Internal Control over Financial Reporting.
Our
responsibility is to express an opinion on the Company’s internal control over
financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over
financial reporting, assessing the risk that a material weakness exists and
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also includes performing such
other procedures, as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.
A
company's internal control over financial reporting is a process designed
to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles in the United States of America.
A
company's internal control over financial reporting includes those policies
and
procedures that (1) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and
that
receipts and expenditures of the company are being made only in accordance
with
authorizations of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of unauthorized
acquisition, use, or disposition of the company's assets that could have
a
material effect on the financial statements.
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
In
our
opinion, United
Security Bancshares and Subsidiaries
maintained, in all material respects, effective internal control over financial
reporting as of December 31, 2007, based on the COSO criteria.
We
also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of United
Security Bancshares and Subsidiaries
as of
December 31, 2007 and 2006, and the related consolidated statements of
operations, shareholders’ equity, and cash flows for each of the three years in
the period ended December 31, 2007, and our report dated March 14, 2008
expressed an unqualified opinion thereon.
/s/
Moss
Adams LLP
Stockton,
California
March
14
2008
58
|
United
Security Bancshares and Subsidiaries
|
|
|
Consolidated
Balance Sheets
|
|
|
December
31, 2007 and 2006
|
|
December
31,
|
|||||||
|
2007
|
2006
|
||||||
|
(in
thousands except shares)
|
|||||||
|
Assets
|
|||||||
|
Cash
and due from banks
|
$
|
25,300
|
$
|
28,771
|
|||
|
Federal
funds sold
|
0
|
14,297
|
|||||
|
Cash
and cash equivalents
|
25,300
|
43,068
|
|||||
|
Interest-bearing
deposits in other banks
|
2,909
|
7,893
|
|||||
|
Investment
securities available for sale at fair value
|
89,415
|
83,366
|
|||||
|
Loans
and leases
|
598,220
|
500,568
|
|||||
|
Unearned
fees
|
(1,739
|
)
|
(999
|
)
|
|||
|
Allowance
for credit losses
|
(10,901
|
)
|
(8,365
|
)
|
|||
|
Net
loans
|
585,580
|
491,204
|
|||||
|
Accrued
interest receivable
|
3,658
|
4,237
|
|||||
|
Premises
and equipment - net
|
15,574
|
15,302
|
|||||
|
Other
real estate owned
|
6,666
|
1,919
|
|||||
|
Intangible
assets
|
4,621
|
2,264
|
|||||
|
Goodwill
|
10,417
|
750
|
|||||
|
Cash
surrender value of life insurance
|
13,852
|
13,668
|
|||||
|
Investment
in limited partnerships
|
3,134
|
3,564
|
|||||
|
Deferred
income taxes
|
4,301
|
5,307
|
|||||
|
Other
assets
|
6,288
|
5,772
|
|||||
|
Total
assets
|
$
|
771,715
|
$
|
678,314
|
|||
|
Liabilities
& Shareholders' Equity
|
|||||||
|
Liabilities
|
|||||||
|
Deposits
|
|||||||
|
Noninterest
bearing
|
$
|
139,066
|
$
|
159,002
|
|||
|
Interest
bearing
|
495,551
|
428,125
|
|||||
|
Total
deposits
|
634,617
|
587,127
|
|||||
|
Other
borrowings
|
32,280
|
0
|
|||||
|
Accrued
interest payable
|
1,903
|
2,477
|
|||||
|
Accounts
payable and other liabilities
|
7,143
|
7,204
|
|||||
|
Junior
subordinated debt
|
13,341
|
15,464
|
|||||
|
Total
liabilities
|
689,284
|
612,272
|
|||||
|
Commitments
and Contingent Liabilities
|
—
|
—
|
|||||
|
Shareholders'
Equity
|
|||||||
|
Common
stock, no par value
|
|||||||
|
20,000,000
shares authorized, 11,855,192 and 11,301,113
|
|||||||
|
issued
and outstanding, in 2007 and 2006, respectively
|
32,587
|
20,448
|
|||||
|
Retained
earnings
|
49,997
|
46,884
|
|||||
|
Accumulated
other comprehensive loss
|
(153
|
)
|
(1,290
|
)
|
|||
|
Total
shareholders' equity
|
82,431
|
66,042
|
|||||
|
Total
liabilities and shareholders' equity
|
$
|
771,715
|
$
|
678,314
|
|||
|
See
notes to consolidated financial statements
|
|||||||
59
|
United
Security Bancshares and Subsidiaries
|
||||||||||
|
Consolidated
Statements of Income and Comprehensive Income
|
||||||||||
|
Years
Ended December 31, 2007, 2006 and 2005
|
||||||||||
|
|
||||||||||
|
(in
thousands except shares and EPS)
|
2007
|
2006
|
2005
|
|||||||
|
Interest
Income
|
||||||||||
|
Loans,
including fees
|
$
|
52,690
|
$
|
42,902
|
$
|
33,078
|
||||
|
Investment
securities - AFS - taxable
|
3,896
|
3,254
|
4,163
|
|||||||
|
Investment
securities - AFS - nontaxable
|
108
|
108
|
112
|
|||||||
|
Federal
funds sold and securities purchased
|
||||||||||
|
under
agreements to resell
|
191
|
768
|
1,237
|
|||||||
|
Interest
on deposits in other banks
|
271
|
324
|
308
|
|||||||
|
Total
interest income
|
57,156
|
47,356
|
38,898
|
|||||||
|
Interest
Expense
|
||||||||||
|
Interest
on deposits
|
18,414
|
12,597
|
8,523
|
|||||||
|
Interest
on other borrowed funds
|
2,159
|
1,578
|
1,135
|
|||||||
|
Total
interest expense
|
20,573
|
14,175
|
9,658
|
|||||||
|
Net
Interest Income Before
|
||||||||||
|
Provision
for Credit Losses
|
36,583
|
33,181
|
29,240
|
|||||||
|
Provision
for Credit Losses
|
5,697
|
880
|
1,140
|
|||||||
|
Net
Interest Income
|
30,886
|
32,301
|
28,100
|
|||||||
|
Noninterest
Income
|
||||||||||
|
Customer
service fees
|
4,790
|
3,779
|
4,399
|
|||||||
|
Gain
on sale of securities
|
0
|
27
|
163
|
|||||||
|
Gain
on sale of other real estate owned
|
209
|
50
|
325
|
|||||||
|
Gains
from life insurance
|
483
|
482
|
0
|
|||||||
|
Gain
(loss) on interest swap ineffectiveness
|
66
|
(75
|
)
|
0
|
||||||
|
Gain
on sale of investment
|
0
|
1,877
|
0
|
|||||||
|
Gain
on fair value option of financial liability
|
2,504
|
0
|
0
|
|||||||
|
Gain
(loss) on sale of premises and equipment
|
2
|
1,018
|
(5
|
)
|
||||||
|
Shared
appreciation income
|
42
|
567
|
393
|
|||||||
|
Other
|
1,568
|
1,306
|
1,005
|
|||||||
|
Total
noninterest income
|
9,664
|
9,031
|
6,280
|
|||||||
|
Noninterest
Expense
|
||||||||||
|
Salaries
and employee benefits
|
10,830
|
9,915
|
8,046
|
|||||||
|
Occupancy
expense
|
3,787
|
2,556
|
2,327
|
|||||||
|
Data
processing
|
420
|
470
|
624
|
|||||||
|
Professional
fees
|
1,811
|
998
|
1,234
|
|||||||
|
Director
fees
|
268
|
222
|
210
|
|||||||
|
Amortization
of intangibles
|
1,021
|
537
|
537
|
|||||||
|
Correspondent
bank service charges
|
476
|
204
|
359
|
|||||||
|
Writedown
on investments
|
17
|
0
|
702
|
|||||||
|
Loss
on lease assets held for sale
|
820
|
0
|
0
|
|||||||
|
Loss
in equity of limited partnership
|
430
|
440
|
458
|
|||||||
|
Expense
on other real estate owned
|
209
|
2,193
|
38
|
|||||||
|
Other
|
2,643
|
2,402
|
2,447
|
|||||||
|
Total
noninterest expense
|
22,732
|
19,937
|
16,982
|
|||||||
|
Income
Before Provision for Taxes on Income
|
17,818
|
21,395
|
17,398
|
|||||||
|
Provision
for Taxes on Income
|
6,561
|
8,035
|
6,390
|
|||||||
|
Net
Income
|
$
|
11,257
|
$
|
13,360
|
$
|
11,008
|
||||
|
Other
comprehensive income, net of tax
|
||||||||||
|
Unrealized
income (loss) on available for sale securities, interest
rate
|
||||||||||
|
swaps,
and unrecognized post-retirement costs - net income
|
||||||||||
|
tax
(benefit) of $757, $382, and ($733), respectively
|
1,137
|
631
|
(854
|
)
|
||||||
|
Comprehensive
Income
|
$
|
12,394
|
$
|
13,991
|
$
|
10,154
|
||||
|
Net
Income per common share
|
||||||||||
|
Basic
|
$
|
0.94
|
$
|
1.18
|
$
|
0.97
|
||||
|
Diluted
|
$
|
0.94
|
$
|
1.17
|
$
|
0.96
|
||||
|
Weighted
shares on which net income per common share
|
||||||||||
|
were
based
|
||||||||||
|
Basic
|
11,925,767
|
11,344,385
|
11,369,848
|
|||||||
|
Diluted
|
11,960,514
|
11,462,313
|
11,453,152
|
|||||||
|
See
notes to consolidated financial
statements
|
||||||||||
60
|
United
Security Bancshares and Subsidiaries
|
|||||||||||||||||||
|
Consolidated
Statements of Changes in Shareholders' Equity
|
|||||||||||||||||||
|
Years
Ended December 31, 2007
|
|||||||||||||||||||
|
Accumulated
|
|||||||||||||||||||
|
Common
stock
|
Other
|
||||||||||||||||||
|
Number
|
Retained
|
Unearned
|
Comprehensive
|
||||||||||||||||
|
(in
thousands except shares)
|
of
Shares
|
Amount
|
Earnings
|
ESOP
Shares
|
Income
(Loss)
|
Total
|
|||||||||||||
|
Balance
January 1, 2005
|
11,367,588
|
$
|
22,322
|
$
|
31,879
|
$
|
(67
|
)
|
$
|
(898
|
)
|
$
|
53,236
|
||||||
|
Director/Employee
stock options exercised
|
12,000
|
118
|
118
|
||||||||||||||||
|
Tax
benefit of stock options exercised
|
13
|
13
|
|||||||||||||||||
|
Net
changes in unrealized loss
|
|||||||||||||||||||
|
on
available for sale securities
|
|||||||||||||||||||
|
(net
of income tax benefit of $709 )
|
(1,064
|
)
|
(1,064
|
)
|
|||||||||||||||
|
Net
changes in unrealized gain
|
|||||||||||||||||||
|
on
interest rate swaps
|
|||||||||||||||||||
|
(net
of income tax benefit of $24)
|
210
|
210
|
|||||||||||||||||
|
Dividends
on common stock ($0.37 per share)
|
(4,205
|
)
|
(4,205
|
)
|
|||||||||||||||
|
Repurchase
and retirement of common shares
|
(26,162
|
)
|
(377
|
)
|
(377
|
)
|
|||||||||||||
|
Release
of unearned ESOP shares
|
7,692
|
8
|
67
|
75
|
|||||||||||||||
|
Net
Income
|
11,008
|
11,008
|
|||||||||||||||||
|
Balance
December 31, 2005
|
11,361,118
|
22,084
|
38,682
|
0
|
(1,752
|
)
|
59,014
|
||||||||||||
|
Director/Employee
stock options exercised
|
48,000
|
335
|
335
|
||||||||||||||||
|
Tax
benefit of stock options exercised
|
218
|
218
|
|||||||||||||||||
|
Net
changes in unrealized gain
|
|||||||||||||||||||
|
on
available for sale securities
|
|||||||||||||||||||
|
(net
of income tax of $242 )
|
363
|
363
|
|||||||||||||||||
|
Net
changes in unrealized gain
|
|||||||||||||||||||
|
on
interest rate swaps
|
|||||||||||||||||||
|
(net
of income tax of $140)
|
268
|
268
|
|||||||||||||||||
|
Adjustment
to initially apply SFAS No. 158
|
|||||||||||||||||||
|
(net
of income tax benefit of $112)
|
(169
|
)
|
(169
|
)
|
|||||||||||||||
|
Dividends
on common stock ($0.445 per share)
|
(5,158
|
)
|
(5,158
|
)
|
|||||||||||||||
|
Repurchase
and retirement of common shares
|
(108,005
|
)
|
(2,437
|
)
|
(2,437
|
)
|
|||||||||||||
|
Stock-based
compensation expense
|
248
|
248
|
|||||||||||||||||
|
Net
Income
|
13,360
|
13,360
|
|||||||||||||||||
|
Balance
December 31, 2006
|
11,301,113
|
20,448
|
46,884
|
0
|
(1,290
|
)
|
66,042
|
||||||||||||
|
Director/Employee
stock options exercised
|
90,000
|
510
|
510
|
||||||||||||||||
|
Net
changes in unrealized gain
|
|||||||||||||||||||
|
on
available for sale securities
|
|||||||||||||||||||
|
(net
of income tax of $605)
|
909
|
909
|
|||||||||||||||||
|
Net
changes in unrealized gain
|
|||||||||||||||||||
|
on
interest rate swaps
|
|||||||||||||||||||
|
(net
of income tax of $97)
|
145
|
145
|
|||||||||||||||||
|
Net
changes in unrecognized past service
|
|||||||||||||||||||
|
Costs
of employee benefit plans
|
|||||||||||||||||||
|
(net
of income tax of $55)
|
83
|
83
|
|||||||||||||||||
|
Dividends
on common stock ($0.50 per share)
|
(6,001
|
)
|
(6,001
|
)
|
|||||||||||||||
|
Repurchase
and retirement of common shares
|
(512,332
|
)
|
(10,094
|
)
|
(10,094
|
)
|
|||||||||||||
|
Issuance
of shares for business combination
|
976,411
|
21,536
|
21,536
|
||||||||||||||||
|
Stock-based
compensation expense
|
187
|
187
|
|||||||||||||||||
|
Cumulative
effect of adoption of SFAS No. 159(net
income tax benefit of $613)
|
(845 | ) | (845 | ) | |||||||||||||||
|
|
|
|
|
|
|||||||||||||||
|
Cumulative
effect of adoption of FIN48
|
(1,298
|
)
|
(1,298
|
)
|
|||||||||||||||
|
Net
Income
|
11,257
|
11,257
|
|||||||||||||||||
|
Balance
December 31, 2007
|
11,855,192
|
$
|
32,587
|
$
|
49,997
|
$
|
0
|
$
|
(153
|
)
|
$
|
82,431
|
|||||||
|
See
notes to consolidated financial statements
|
|||||||||||||||||||
61
|
United
Security Bancshares and Subsidiaries
|
||||||||||
|
Consolidated
Statements of Cash Flows
|
||||||||||
|
Years
December 31, 2007, 2006 and 2005
|
||||||||||
|
(in
thousands)
|
2007
|
2006
|
2005
|
|||||||
|
Cash
Flows From Operating Activities:
|
||||||||||
|
Net
income
|
$
|
11,257
|
$
|
13,360
|
$
|
11,008
|
||||
|
Adjustments
to reconcile net income to cash provided
|
||||||||||
|
by
operating activities:
|
||||||||||
|
Provision
for credit losses
|
5,697
|
880
|
1,140
|
|||||||
|
Depreciation
and amortization
|
2,655
|
1,658
|
1,459
|
|||||||
|
Accretion
of investment securities
|
(95
|
)
|
(70
|
)
|
(74
|
)
|
||||
|
Gain
on sale of securities
|
0
|
(27
|
)
|
(163
|
)
|
|||||
|
Gain
on sale of stock
|
0
|
(1,877
|
)
|
0
|
||||||
|
Decrease
(increase) in accrued interest receivable
|
930
|
(843
|
)
|
(871
|
)
|
|||||
|
(Decrease)
increase in accrued interest payable
|
(339
|
)
|
602
|
709
|
||||||
|
Increase
(decrease) in unearned fees
|
509
|
246
|
(346
|
)
|
||||||
|
Increase
(decrease) in income taxes payable
|
150
|
(245
|
)
|
575
|
||||||
|
Excess
tax benefits from stock-based payment arrangements
|
0
|
(1
|
)
|
0
|
||||||
|
Stock-based
compensation expense
|
187
|
248
|
0
|
|||||||
|
Deferred
income taxes
|
248
|
(382
|
)
|
86
|
||||||
|
(Increase)
decrease in accounts payable and accrued liabilities
|
(130
|
)
|
1,290
|
229
|
||||||
|
Write-down
of other investments
|
17
|
0
|
702
|
|||||||
|
Loss
on lease assets held for sale
|
820
|
0
|
0
|
|||||||
|
(Gain)
loss on sale of other real estate owned
|
(209
|
)
|
(50
|
)
|
(325
|
)
|
||||
|
(Gain)
loss on swap ineffectiveness
|
(66
|
)
|
75
|
0
|
||||||
|
Gain
on fair value option of financial assets
|
(2,504
|
)
|
0
|
0
|
||||||
|
Income
from life insurance proceeds
|
(483
|
)
|
(482
|
)
|
0
|
|||||
|
(Gain)
loss on sale of premises and equipment
|
(2
|
)
|
(1,018
|
)
|
5
|
|||||
|
(Increase)
decrease in surrender value of life insurance
|
(184
|
)
|
88
|
(379
|
)
|
|||||
|
Loss
in limited partnership interest
|
430
|
440
|
458
|
|||||||
|
Net
decrease (increase) in other assets
|
84
|
2,268
|
(214
|
)
|
||||||
|
Net
cash provided by operating activities
|
18,972
|
16,160
|
13,999
|
|||||||
|
Cash
Flows From Investing Activities:
|
||||||||||
|
Net
decrease (increase) in interest-bearing deposits with
banks
|
4,984
|
(237
|
)
|
(227
|
)
|
|||||
|
Purchases
of available-for-sale securities
|
(33,859
|
)
|
0
|
(4,804
|
)
|
|||||
|
Net
redemption (purchase) of FHLB/FRB and other bank stock
|
103
|
51
|
(267
|
)
|
||||||
|
Maturities,
calls, and principal payments on available-for-sale
securities
|
36,833
|
12,571
|
13,486
|
|||||||
|
Proceeds
from sales of available-for-sale securities
|
0
|
0
|
6,795
|
|||||||
|
Investment
in limited partnership
|
0
|
0
|
(126
|
)
|
||||||
|
Investment
in bank stock
|
(372
|
)
|
0
|
0
|
||||||
|
Proceeds
from sale of investment in title company
|
0
|
149
|
527
|
|||||||
|
Premiums
paid on life insurance
|
0
|
(227
|
)
|
(579
|
)
|
|||||
|
Net
increase in loans
|
(43,454
|
)
|
(84,795
|
)
|
(25,971
|
)
|
||||
|
Cash
and equivalents received in bank acquisitions,
|
||||||||||
|
net
of assets and liabilities acquired
|
6,373
|
0
|
0
|
|||||||
|
Cash
proceeds from sale of correspondent bank stock
|
0
|
2,607
|
0
|
|||||||
|
Cash
proceeds from sales of foreclosed leased assets
|
39
|
1,946
|
258
|
|||||||
|
Cash
proceeds from sales of other real estate owned
|
72
|
2,487
|
1,895
|
|||||||
|
Capital
expenditures for premises and equipment
|
(1,200
|
)
|
(5,880
|
)
|
(3,857
|
)
|
||||
|
Cash
proceeds from sales of premises and equipment
|
9
|
1,520
|
21
|
|||||||
|
Net
cash used in investing activities
|
(30,472
|
)
|
(69,808
|
)
|
(12,849
|
)
|
||||
|
Cash
Flows From Financing Activities:
|
||||||||||
|
Net
increase in demand deposit
|
||||||||||
|
and
savings accounts
|
(99,787
|
)
|
12,764
|
25,867
|
||||||
|
Net
increase (decrease) in certificates of deposit
|
77,677
|
27,903
|
(16,079
|
)
|
||||||
|
Net
increase in federal funds purchased
|
22,280
|
0
|
0
|
|||||||
|
Net
increase in FHLB borrowings
|
10,000
|
0
|
0
|
|||||||
|
Redemption
of junior subordinated debt
|
(15,923
|
)
|
0
|
0
|
||||||
|
Proceeds
from issuance of junior subordinated debt
|
15,000
|
0
|
0
|
|||||||
|
Director/Employee
stock options exercised
|
510
|
335
|
118
|
|||||||
|
Excess
tax benefits from stock-based payment arrangements
|
0
|
1
|
0
|
|||||||
|
Repurchase
and retirement of common stock
|
(10,095
|
)
|
(2,436
|
)
|
(377
|
)
|
||||
|
Repayment
of ESOP borrowings
|
0
|
0
|
(75
|
)
|
||||||
|
Payment
of dividends on common stock
|
(5,930
|
)
|
(4,881
|
)
|
(3,980
|
)
|
||||
|
Net
cash (used in) provided by financing activities
|
(6,268
|
)
|
33,686
|
5,474
|
||||||
|
Net
(decrease) increase in cash and cash equivalents
|
(17,768
|
)
|
(19,962
|
)
|
6,624
|
|||||
|
Cash
and cash equivalents at beginning of year
|
43,068
|
63,030
|
56,406
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
25,300
|
$
|
43,068
|
$
|
63,030
|
||||
|
See
notes to consolidated statements
|
||||||||||
62
Notes
to Consolidated Financial Statements
Years
Ended December 31, 2007, 2006, and 2005
| 1. |
Organization
and Summary of Significant Accounting and Reporting
Policies
|
Basis
of Presentation
- The
consolidated financial statements include the accounts of United Security
Bancshares, and its wholly owned subsidiary, United Security Bank and subsidiary
(the “Bank”).United Security Bancshares Capital Trust II (the “Trust”) is
deconsolidated pursuant to FIN46. As a result, the Trust’s Trust Preferred
Securities are not presented on the Company’s consolidated financial statements,
but instead the Company’s Subordinated Debentures are presented as a separate
liability category. (see Note 10 to the Company’s consolidated financial
statements). Intercompany accounts and transactions have been eliminated in
consolidation. In the following notes, references to the Bank are references
to
United Security Bank. References to the Company are references to United
Security Bancshares, (including the Bank and Trust). United Security Bancshares
operates as one business segment providing banking services to commercial
establishments and individuals primarily in the San Joaquin Valley of
California.
Nature
of Operations
- United
Security Bancshares is a bank holding company, incorporated in the state of
California for the purpose of acquiring all the capital stock of the Bank
through a holding company reorganization (the “Reorganization”) of the Bank. The
Reorganization, which was accounted for in a manner similar to a pooling of
interests, was completed on June 12, 2001. Management believes the
Reorganization has provided the Company greater operating and financial
flexibility and has permitted expansion into a broader range of financial
services and other business activities.
United
Security Bancshares Capital Trust I was formed during June 2001 as a Delaware
statutory business trust for the exclusive purpose of issuing and selling Trust
Preferred Securities. The Trust was deconsolidated
in 2004 pursuant to FIN46. During July 2007, the Trust Preferred Securities
were
redeemed by USB Capital Trust I, and upon retirement, the Trust was dissolved.
During July 2007 the Company formed United Security Bancshares Capital Trust
II
and issued $15.0 million in Trust Preferred Securities with terms similar to
those originally issued under USB Capital Trust I. (See
Note
10. “Junior Subordinated Debt/Trust Preferred Securities”).
USB
Investment Trust Inc was incorporated effective December 31, 2001 as a special
purpose real estate investment trust (“REIT”) under Maryland law. The REIT is a
subsidiary of the Bank and was funded with $133.0 million in real estate-secured
loans contributed by the Bank. USB Investment Trust was originally formed to
give the Bank flexibility in raising capital, and reduce the expenses associated
with holding the assets contributed to USB Investment Trust (See Note 11.
“Income Taxes”).
On
February 16, 2007, the Company completed its merger with Legacy Bank, N.A.,
located in Campbell, California, with the acquisition of 100 percent of Legacy’s
outstanding common shares. At merger, Legacy Bank’s one branch was merged with
and into United Security Bank, a wholly owned subsidiary of the Company. The
total value of the merger transaction was $21.5 million,
and the
shareholders of Legacy Bank received merger consideration consisting of 976,411
shares of common stock of the Company. The merger transaction was accounted
for
as a purchase transaction, and resulted in the purchase price being allocated
to
the assets acquired and liabilities assumed from Legacy Bank based on the fair
value of those assets and liabilities. The net of assets acquired and
liabilities assumed totaled approximately $8.6 million at the date of the
merger. Fair value of Legacy assets and liabilities acquired, including
resultant goodwill of approximately $8.8 million, has been determined, with
final purchase adjustments made during the fourth quarter of 2007.
(See
Note 24 to the Company’s consolidated financial statements contained herein for
details of the merger).
During
November 2007, the Company purchased the recurring revenue stream and certain
fixed assets from ICG Financial, LLC. Additionally, the Company hired all but
one of the former employees of ICG Financial, LLC and its subsidiaries. The
total purchase price was $414,000 including $378,000 for the recurring revenue
stream and $36,000 for the fixed assets. ICG Financial, LLC provided wealth
management, employee benefit, insurance and loan products, as well as consulting
services for a variety of clients. Now operating as a newly formed department
of
the Bank, USB Financial Services provides those same services utilizing the
employees hired from ICG Financial LLC. The Company believes the wealth
management and related services provided by USB Financial Services will enhance
the products and services offered by the Company, and increase noninterest
income. The capitalized cost of $378,000 for the recurring revenue stream will
be amortized over a period of approximately three years, and will be tested
periodically for impairment.
The
Bank
was founded in 1987 and currently operates eleven branches and one construction
lending office in an area from eastern Madera County to western Fresno County,
as well as Taft and Bakersfield in Kern County, and Campbell in Santa Clara
County. The Bank also operates one financial services department located in
Fresno, California. The Bank’s primary source of revenue is providing loans to
customers, who are predominantly small and middle-market businesses and
individuals. The Bank engages in a full compliment of lending activities,
including real estate mortgage, commercial and industrial, real estate
construction, agricultural and consumer loans, with particular emphasis on
short
and medium term obligations.
63
The
Bank
offers a wide range of deposit instruments. These include personal and business
checking accounts and savings accounts, interest-bearing negotiable order of
withdrawal ("NOW") accounts, money market accounts and time certificates of
deposit. Most of the Bank's deposits are attracted from individuals and from
small and medium-sized business-related sources.
The
Bank
also offers a wide range of specialized services designed to attract and service
the needs of commercial customers and account holders. These services include
cashiers checks, travelers checks, money orders, and foreign drafts. In
addition, the Bank offers Internet banking services to its commercial and retail
customers, and offers certain financial and wealth management services through
its financial services department. The Bank does not operate a trust department,
however it makes arrangements with its correspondent bank to offer trust
services to its customers upon request.
Use
of Estimates in the Preparation of Financial
Statements
- The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities
and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting
period. Actual results could differ from those estimates.
Material
estimates that are particularly susceptible to significant change, relate to
the
determination of the allowance for loan losses, determination of goodwill,
fair
value of junior subordinated debt, and the valuation of real estate acquired
in
connection with foreclosures or in satisfaction of loans. In connection with
the
determination of the allowance for loan losses and the valuation of foreclosed
assets held for sale, management obtains independent appraisals for significant
properties.
Significant
Accounting Policies
- The
accounting and reporting policies of the Company conform to generally accepted
accounting principles and to prevailing practices within the banking industry.
The following is a summary of significant policies:
| a. |
Cash
and cash equivalents
-
Cash and cash equivalents include cash on hand, amounts due from
banks,
federal funds sold and repurchase agreements. At times throughout
the
year, balances can exceed FDIC insurance limits. Generally, federal
funds
sold and repurchase agreements are sold for one-day periods. Repurchase
agreements are with a registered broker-dealer affiliated with a
correspondent bank and work much like federal funds sold, except
that the
transaction is collateralized by various investment securities. The
securities collateralizing such transactions generally consist of
U.S.
Treasuries, U.S. Government and U.S. Government-sponsored agencies.
The
Bank did not have any repurchase agreements during 2007 or 2006,
or at
December 31, 2007 or 2006. All cash and cash equivalents have maturities
when purchased of three months or less.
|
| b. |
Securities
-
Debt and equity securities classified as available for sale are reported
at fair value, with unrealized gains and losses excluded from net
income
and reported, net of tax, as a separate component of comprehensive
income
and shareholders’ equity. Debt securities classified as held to maturity
are carried at amortized cost. Gains and losses on disposition are
reported using the specific identification method for the adjusted
basis
of the securities sold.
|
The
Company classifies its securities as available for sale or held to maturity,
and
periodically reviews its investment portfolio on an individual security basis.
Securities that are to be held for indefinite periods of time (including, but
not limited to, those that management intends to use as part of its
asset/liability management strategy, those which may be sold in response to
changes in interest rates, changes in prepayments or any such other factors)
are
classified as securities available for sale. Securities which the Company has
the ability and intent to hold to maturity are classified as held to
maturity.
Declines
in fair value of individual held-to-maturity and available-for-sale securities
below their cost that are other than temporary are recognized by write-downs
of
the individual securities to fair value. Such write-downs would be included
in
earnings as realized losses. Premiums and discounts are recognized in interest
income using the interest method over the period to maturity.
Investments
with fair values that are less than amortized cost are considered impaired.
Impairment may result from either a decline in the financial condition of the
issuing entity or, in the case of fixed interest rate investments, from rising
interest rates. At
each
financial statement date, management
assesses each investment to determine if impaired investments are temporarily
impaired or if the impairment is other-than-temporary based upon the positive
and negative evidence available. Evidence evaluated includes, but is not limited
to, industry analyst reports, credit market conditions, and interest rate
trends. If negative evidence outweighs positive evidence that the carrying
amount is recoverable within
a
reasonable period of time, the impairment is deemed to be other-than-temporary
and the security is written down in the period in which such determination
is
made.
64
| c. |
Loans
-
Interest income on loans is credited to income as earned and is calculated
by using the simple interest method on the daily balance of the principal
amounts outstanding. Loans are placed on non-accrual status when
principal
or interest is past due for 90 days and/or when management believes
the
collection of amounts due is doubtful. For loans placed on nonaccrual
status, the accrued and unpaid interest receivable may be reversed
at
management's discretion based upon management's assessment of
collectibility, and interest is thereafter credited to principal
to the
extent necessary to eliminate doubt as to the collectibility of the
net
carrying amount of the loan.
|
Nonrefundable
fees and related direct costs associated with the origination or purchase of
loans are deferred and netted against outstanding loan balances. The net
deferred fees and costs are generally amortized into interest income over the
loan term using a method, which approximates the interest method. Other
credit-related fees, such as standby letter of credit fees, loan placement
fees
and annual credit card fees are recognized as noninterest income during the
period the related service is performed.
Impaired
loans are measured based on the present value of expected future cash flows
discounted at the loan’s effective interest rate or as a practical expedient at
the loan’s observable market rate or the fair value of the collateral if the
loan is collateral dependent.
| d. |
Allowance
for Credit Losses and Reserve
for Unfunded Loan Commitments -
The allowance for credit losses is maintained to provide for losses
that
can reasonably be anticipated. The allowance is based on ongoing
quarterly
assessments of the probable losses inherent in the loan portfolio,
and to
a lesser extent, unfunded loan commitments. The reserve for unfunded
loan
commitments is a liability on the Company’s consolidated financial
statements and is included in other liabilities. The liability is
computed
using a methodology similar to that used to determine the allowance
for
credit losses, modified to take into account the probability of a
drawdown
on the commitment.
|
The
allowance for credit losses is increased by provisions charged to operations
during the current period and reduced by loan charge-offs net of recoveries.
Loans are charged against the allowance when management believes that the
collection of the principal is unlikely. The allowance is an amount that
management believes will be adequate to absorb losses inherent in existing
loans, based on evaluations of the probability of collection. In evaluating
the
probability of collection, management is required to make estimates and
assumptions that affect the reported amounts of loans, allowance for credit
losses and the provision for credit losses charged to operations. Actual results
could differ significantly from those estimates. These evaluations take into
consideration such factors as the composition of the portfolio, overall
portfolio quality, loan concentrations, specific problem loans, and current
economic conditions that may affect the borrowers' ability to pay. The Company’s
methodology for assessing the adequacy of the allowance for credit losses
consists of several key elements, which include the formula allowance, specific
allowances, and the unallocated allowance.
The
formula allowance is calculated by applying loss factors to outstanding loans
and certain unfunded loan commitments. Loss factors are based on the Company’s
historical loss experience and may be adjusted for significant factors that,
in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date. The Company determines the loss factors for problem-graded
loans (substandard, doubtful, and loss), special mention loans, and pass graded
loans, based on a loss migration model. The migration analysis incorporates
the
Company’s losses over the past twelve quarters (three years) and loss factors
are adjusted to recognize and quantify the loss exposure from changes in market
conditions and trends in the loan portfolio. For purposes of this analysis,
loans are grouped by internal risk classifications, which are “pass”, “special
mention”, “substandard”, “doubtful”, and “loss”. Certain loans are homogenous in
nature and are therefore pooled by risk grade. These homogenous loans include
consumer installment and home equity loans. Special mention loans are currently
performing but are potentially weak, as the borrower has begun to exhibit
deteriorating trends, which if not corrected, could jeopardize repayment of
the
loan and result in further downgrade. Substandard loans have well-defined
weaknesses which, if not corrected, could jeopardize the full satisfaction
of
the debt. A loan classified as “doubtful” has critical weaknesses that make full
collection of the obligation improbable. Classified loans, as defined by the
Company, include loans categorized as substandard, doubtful, and loss.
Specific
allowances are established based on management’s periodic evaluation of loss
exposure inherent in classified loans, impaired loans, and other loans in which
management believes it is probable that a loss has been incurred in excess
of
the amount determined by the application of the formula allowance.
The
unallocated portion of the allowance is based upon management’s evaluation of
various conditions that are not directly measured in the determination of the
formula and specific allowances. The conditions may include, but are not limited
to, general economic and business conditions affecting the key lending areas
of
the Company, credit quality trends, collateral values, loan volumes and
concentration, and other business conditions.
65
The
allowance analysis also incorporates the results of measuring impaired loans
as
provided in Statement of Financial Accounting Standards (“SFAS”) No. 114,
“Accounting by Creditors for Impairment of a Loan” and SFAS 118, “Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures”. A loan
is considered impaired when management determines that it is probable that
the
Company will be unable to collect all amounts due according to the original
contractual terms of the loan agreement. Impairment is measured by the
difference between the original recorded investment in the loan and the
estimated present value of the total expected cash flows, discounted at the
loan’s effective rate, or the fair value of the collateral, if the loan is
collateral dependent. Any differences in the specific allowance amounts
calculated in the impaired loan analysis and the migration analysis are
reconciled by management and changes are made to the allowance as deemed
necessary.
| e. |
Loans
held-for-sale
-
Loans originated and designated as held-for-sale are carried at the
lower
of cost or estimated fair value, as determined by quoted market prices,
in
aggregate. Net unrealized losses are recognized in a valuation allowance
by charges to income. Gains or losses on the sale of such loans are
based
on the specific identification method. The Company held no loans
for sale
at December 31, 2007 or 2006.
|
| f. |
Premises
and Equipment
-
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation expense is computed principally on the straight-line
method
over the estimated useful lives of the assets. Estimated useful lives
are
as follows:
|
|
Buildings 31
Years
|
Furniture and equipment 3-7 Years |
| g. |
Other
Real Estate Owned
-
Real estate properties acquired through, or in lieu of, loan foreclosure
are to be sold and are initially recorded at fair value of the property,
less estimated costs to sell. The excess, if any, of the loan amount
over
the fair value is charged to the allowance for credit losses. Subsequent
declines in the fair value of other real estate owned, along with
related
revenue and expenses from operations, are charged to noninterest
expense
at foreclosure.
|
| h. |
Intangible
Assets and Goodwill
-
Intangible assets are comprised of core deposit intangibles, other
specific identifiable intangibles, and goodwill acquired in branch
acquisitions in which the fair value of the liabilities assumed exceeded
the fair value of the assets acquired. Core deposit intangibles of
$3,611,000 and $1,475,000 (net of accumulated amortization of $3,386,000
and $2,121,000) at December 31, 2007 and 2006 are amortized over
the
estimated useful lives of the existing deposit bases (average of
7 years)
using a method which approximates the interest method. Other specific
identifiable intangibles resulting from the purchase of certain bank
branches during 1997, which were non self-sustaining businesses,
of
$653,000 and $790,000 (net accumulated amortization of $1.3 million
and
$1.4 million) at December 31, 2007 and 2006 are being amortized using
a
method which approximates the interest method over a period of 15
years.
The identifiable intangible asset resulting from the purchase of
the
recurring income stream from ICG Financial Services totaled $357,000
at
December 31, 2007 (net accumulated amortization of $21,000) and will
be
amortized over a period of three years. As with other intangible
assets,
we will review them for impairment on an annual basis, or sooner
if
circumstances or events warrant such a
review.
|
The
estimated aggregate amortization expense related to intangible assets for each
of the five succeeding years is as follows (in 000’s):
|
Year
|
Amortization
expense
|
|||
|
2008
|
$
|
944
|
||
|
2009
|
874
|
|||
|
2010
|
770
|
|||
|
2011
|
565
|
|||
|
2012
|
446
|
|||
|
Total
|
$
|
3,599
|
||
Goodwill
amounts resulting from the acquisitions of Taft National Bank during April
2004,
and Legacy Bank during February 2007 are considered to have an indefinite life
and are not amortized. At December 31, 2007 goodwill related to Taft National
Bank totaled $1.6 million, and goodwill related to Legacy Bank totaled $8.8
million. Pursuant to SFAS No. 142, Goodwill
and Other Intangible Assets,
goodwill is evaluated annually for impairment. Impairment testing of goodwill
is
performed during April of each year at a reporting unit level for Taft, and
will
be performed during March of each year for Legacy. The Company had no impairment
adjustments during 2007, 2006, or 2005.
66
| i. |
Income
Taxes
-
Deferred income taxes are provided for the temporary differences
between
the financial reporting basis and the tax basis of the Company's
assets
and liabilities using the liability method, and are reflected at
currently
enacted income tax rates applicable to the period in which the deferred
tax assets or liabilities are expected to be realized or settled.
|
| j. |
Net
Income per Share
-
Basic income per common share is computed based on the weighted average
number of common shares outstanding. Diluted income per share includes
the
effect of stock options and other potentially dilutive securities
using
the treasury stock method. Leveraged ESOP shares, if any, are only
considered outstanding for earnings per share calculations when they
are
committed to be released. The Company had no leveraged ESOP shares
outstanding at December 31, 2007, 2006 or 2005. (see Note
18).
|
| k. |
Cash
Flow Reporting
-
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, noninterest-bearing amounts due from banks, federal
funds
sold and securities purchased under agreements to resell. Federal
funds
and securities purchased under agreements to resell are generally
sold for
one-day periods.
|
| l. |
Transfers
of Financial Assets
-
Transfers of financial assets are accounted for as sales when control
over
the assets has been surrendered. Control over transferred assets
is deemed
to be surrendered when (1) the assets have been isolated from the
Company,
(2) the transferee obtains the right (free of conditions that constrain
it
from taking advantage of that right) to pledge or exchange the transferred
assets, and (3) the Company does not maintain effective control over
the
transferred assets through an agreement to repurchase them before
their
maturity.
|
| m. |
Advertising
Costs
-
The Company expenses marketing costs as they are incurred. Advertising
expense was $113,000, $105,000, and $98,000 for the years ended December
31, 2007, 2006 and 2005,
respectively.
|
| n. |
Stock
Based Compensation - At
December 31, 2006, the Company has a stock-based employee compensation
plan, which is described more fully in Note 12. On January 1, 2006
the
Company adopted the disclosure provisions of Financial Accounting
Standards Board (FASB) Statement No. 123 R, “Accounting for Share-Based
Payments”. SFAS No. 123R requires all share-based payments to employees,
including grants of employee stock options, to be recognized in the
financial statements based on the grant-date fair value of the award.
The
fair value is amortized over the requisite service period (generally
the
vesting period). Included in salaries and employee benefits for the
years
ended December 31, 2007 and 2006 is $187,000 and $248,000, respectively,
of share-based compensation. The related tax benefit, recorded in
the
provision for income taxes, was not significant.
|
Prior
to
January 1, 2006, the Company accounted for stock-based awards to employees
using
the intrinsic value method in accordance with APB No. 25, "Accounting for Stock
Issued to Employees", and related interpretations. No stock-based employee
compensation cost is reflected in net income, as all options granted under
those
plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. See Note 12 to the Company’s consolidated financial
statements for a table that illustrates the effect on net income and earnings
per share if the Company had applied the fair value recognition provisions
of SFAS
No.
148, “Accounting for Stock-Based Compensation - Transition and Disclosure an
amendment of FASB Statement No. 123” during 2005.
| o. |
Long-Lived
Assets
-
The Company periodically evaluates the carrying value of long-lived
assets
to be held and used, including other specific intangible assets,
and core
deposit intangible assets in accordance with SFAS No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets.” Based on such
evaluation, the Bank determined that there is no impairment loss
to be
recognized in 2007, 2006, or 2005.
|
| p. |
Employee
Stock Ownership Plan (“ESOP”) - The
Company accounts for shares acquired by leveraged ESOP’s, if any, in
accordance with the guidelines established by the American Institute
of
Certified Public Accounts Statement of Position 93-6, “Employers’
Accounting for Employee Stock Ownership Plans” (“SOP 93-6”). Under SOP
93-6, the Company recognizes compensation cost equal to the fair
value of
the ESOP shares during the periods in which they become committed
to be
released. To the extent that the fair value of the Company’s ESOP shares
committed to be released differ from the cost of those shares, the
differential is charged or credited to equity. For externally leveraged
ESOPs, the ESOP debt is recorded as a liability and interest expense
is
recorded on that debt. The ESOP shares not yet committed to be released
are accounted for as a reduction of shareholders’ equity. The credit line
related to the Company’s leveraged ESOP matured during 2005, and as
result, all remaining balances were repaid during the first quarter
of
2005. The Company had no leveraged ESOP transactions during 2007
or
2006.
|
67
| q. |
Derivative
Financial Instruments
-
All derivative instruments (including certain derivative instruments
embedded in other contracts) are recognized in the consolidated balance
sheet at fair value. The Company’s accounting treatment for gains or
losses from changes in the derivative instrument’s fair value is
contingent on whether the derivative instrument qualifies as a hedge.
On
the date the Company enters into a derivative contract, the Company
designates the derivative instruments as (1) a hedge of the fair
value of a recognized asset or liability or of an unrecognized firm
commitment (fair value hedge), (2) a hedge of a forecasted
transaction or of the variability of cash flows to be received or
paid
related to a recognized asset or liability (cash flow hedge) or (3),
a
hedge for trading, customer accommodation or not qualifying for hedge
accounting (free-standing derivative instruments). For a fair value
hedge,
changes in the fair value of the derivative instrument and changes
in the
fair value of the hedged asset or liability or of an unrecognized
firm
commitment attributable to the hedged risk are recorded in current
period
net income. For a cash flow hedge, changes in the fair value of the
derivative instrument to the extent that it is highly effective are
recorded in other comprehensive income, net of tax, within shareholders’
equity and subsequently reclassified to net income in the same period(s)
that the hedged transaction impacts net income. For freestanding
derivative instruments, changes in the fair values are reported in
current
period net income. The Company formally documents the relationship
between
hedging instruments and hedged items, as well as the risk management
objective and strategy for undertaking any hedge transaction. This
process
includes relating all derivative instruments that are designated
as fair
value or cash flow hedges to specific assets and liabilities on the
balance sheet or to specific forecasted transactions. The Company
also
formally assesses both at the inception of the hedge and on an ongoing
basis, whether the derivative instruments used are highly effective
in
offsetting changes in fair values or cash flows of hedged items.
If it is
determined that the derivative instrument is not, and will not be,
highly
effective as a hedge, hedge accounting is
discontinued.
|
| r. |
Federal
Home Loan Bank stock and Federal Reserve Stock
- As
a member of the Federal Home Loan Bank (FHLB), the Company is required
to
maintain an investment in capital stock of the FHLB. In addition,
as a
member of the Federal Reserve Bank (FRB), the Company is required
to
maintain an investment in capital stock of the FRB. The investments
in
both the FHLB and the FRB are carried at cost in the accompanying
consolidated balance sheets under other assets and are subject to
certain
redemption requirements by the FHLB and
FRB.
|
| s. |
Comprehensive
Income
-Comprehensive income is comprised of net income and other comprehensive
income. Other comprehensive income includes items previously recorded
directly to equity, such as unrealized gains and losses on securities
available-for-sale, unrecognized costs of salary continuation defined
benefit plans, and certain derivative instruments used as a cash
flow
hedge. Comprehensive income is presented in the consolidated statement
of
shareholders’ equity.
|
| t. |
Segment
Reporting
-
The Company's operations are solely in the financial services industry
and
include providing to its customers traditional banking and other
financial
services. The Company operates primarily in the San Joaquin Valley
region
of California. Management makes operating decisions and assesses
performance based on an ongoing review of the Company's consolidated
financial results. Therefore, the Company has a single operating
segment
for financial reporting purposes.
|
|
u.
|
New
Accounting Standards:
|
Statements
of Financial Accounting Standards
In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling
Interests in Consolidated Financial Statements," which
provides guidance for accounting and reporting of noncontrolling (minority)
interests in consolidated financial statements. The statement is effective
for
fiscal years and interim periods within fiscal years beginning on or after
December 15, 2008. The Company does not hold minority interests in subsidiaries,
therefore it is expected that SFAS No. 160 will have no impact on its financial
condition or results of operations.
In
February 2007, the FASB issued SFAS 159,
The
Fair Value Option for Financial Assets and Financial Liabilities, including
an
amendment of FASB Statement No. 115.
SFAS 159
allows entities to irrevocably elect fair value as the initial and subsequent
measurement attribute for certain financial assets and financial liabilities
that are not otherwise required to be measured at fair value, with changes
in
fair value recognized in earnings as they occur. SFAS 159 also requires entities
to report those financial assets and financial liabilities measured at fair
value in a manner that separates those reported fair values from the carrying
amounts of similar assets and liabilities measured using another measurement
attribute on the face of the statement of financial position. Lastly, SFAS
159
establishes presentation and disclosure requirements designed to improve
comparability between entities that elect different measurement attributes
for
similar assets and liabilities. SFAS 159 is effective for fiscal years beginning
after November 15, 2007, with early adoption permitted if an entity also early
adopts the provisions of SFAS 157. Effective January 1, 2007, the Company
elected early adoption of the fair value option to value its junior subordinated
debt. The initial impact upon adoption of SFAS No. 159 was to record a $1.3
million loss, reflected as an adjustment to beginning retained earnings at
January 1, 2007. Subsequent to adoption, the Company recorded total gains
resulting from fair value adjustments on its junior subordinated debt totaling
$2.5 million during the year ended December 31, 2007, which are reflected as
a
component of other noninterest income. (see Note 10).
68
In
September 2006, the FASB issued Statement of Financial Accounting Standards
No.
158, Employers
Accounting for Defined Benefit Pension and Other Postretirement
Plans
(“SFAS
No. 158”). SFAS No. 158 amends SFAS No. 87 and SFAS No. 106. SFAS No. 158 amends
previous applicable accounting statements and requires companies to better
disclose, among other things, the funded status of benefit plans, and to
recognize as a component of other comprehensive income, net of tax, the gains
or
losses and prior service costs or credits that arise during the period but
are
not recognized as components of net periodic benefit cost pursuant to FASB
Statement No. 87, Employers’
Accounting for Pensions,
or No.
106, Employers’
Accounting for Postretirement Benefits Other Than Pensions.
Amounts
recognized in accumulated other comprehensive income, including the gains or
losses, prior service costs or credits, and the transition asset or obligation
remaining from the initial application of Statements 87 and 106, are adjusted
as
they are subsequently recognized as components of net periodic benefit cost
pursuant to the recognition and amortization provisions of those Statements.
SFAS No. 158 is effective for public companies with fiscal years ending after
December 15, 2006. The Company adopted SFAS No. 158 effective December 31,
2006,
and has made required disclosures since December 31, 2006. As a result, the
Company upon adoption at December 31, 2006, recorded $169,000 in accumulated
other comprehensive income (net tax of $112,000) for the previously unrecognized
cost of post-retirement benefits related to the Company’s Salary Continuation
Plan, and had $85,000 in other comprehensive income (net tax of $57,000) for
the
previously unrecognized at December 31, 2007 (see Note 13, Employee
Benefit Plans).
In
September 2006, the FASB issued SFAS 157, Fair
Value Measurements. SFAS
No.
157 clarifies the definition of fair value, describes methods used to
appropriately measure fair value in accordance with generally accepted
accounting principles and expands fair value disclosure requirements. This
statement applies whenever other accounting pronouncements require or permit
fair value measurements and is effective for fiscal years beginning after
November 15, 2007. Effective January 1, 2007, the Company adopted SFAS No.
157
as a result of its early adoption of SFAS No. 159 (see Note 15).
Financial
Accounting Standards Board Staff Positions and Interpretations
On
July
13, 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation 48 (FIN 48), Accounting
for Uncertainty in Income Taxes: an interpretation of FASB Statement No.
109.
FIN 48
clarifies SFAS No. 109, Accounting
for Income Taxes,
to
indicate a criterion that an individual tax position would have to meet for
some
or all of the income tax benefit to be recognized in a taxable entity’s
financial statements. Under the guidelines of the Interpretation, an entity
should recognize the financial statement benefit of a tax position if it
determines that it is more
likely than not that
the
position will be sustained on examination. The term “more likely than not” means
“a likelihood of more than 50 percent.” In assessing whether the
more-likely-than-not criterion is met, the entity should assume that the tax
position will be reviewed by the applicable taxing authority. The scope of
FIN
48 is broad and includes all
tax
positions accounted for in accordance with SFAS No. 109. Additionally, besides
business enterprises, FIN 48 applies to pass-through entities, and entities
whose tax liability is subject to 100 percent credit for dividends paid (such
as
real estate investment trusts). FIN 48 is effective for the Company beginning
after January 1, 2007. The cumulative effect of applying FIN 48 totaling $1.3
million was reported as an adjustment to retained earnings at January 1, 2007
(see Note 11).
In
September 2006, the Emerging Issues Task Force (EITF) reached a final consensus
on Issue No. 064-4 (EITF 06-4),
"Accounting for Deferred Compensation and Postretirement Benefit Aspects of
Endorsement Split-Dollar Life Insurance Arrangements." EITF
06-4
requires employers to recognize a liability for future benefits provided through
endorsement split-dollar life insurance arrangements that extend into
postretirement periods in accordance with SFAS No. 106, "Employers'
Accounting for Postretirement Benefits Other Than Pensions or
APB
Opinion No. 12, Omnibus
Opinion-1967." The
provisions of EITF 06-4 become effective on January 1, 2008 and are to be
applied as a change in accounting principle either through a cumulative-effect
adjustment to retained earnings or other components of equity or net assets
in
the statement of financial position as of the beginning of the year of adoption,
or through retrospective application to all prior periods. The Company's
split-dollar life insurance benefits are limited to the employee's active
service period. Therefore it is expected that EITF 06-4 will have no impact
on
financial condition or results of operations.
| v. |
Reclassifications
-
Certain reclassifications have been made to the 2006 and 2005 financial
statements to conform to the classifications used in
2007.
|
69
| 2. |
Investment
Securities
|
Following
is a comparison of the amortized cost and approximate fair value of investment
securities for the years ended December 31, 2007 and December 31, 2006:
|
(In
thousands)
|
Gross
|
Gross
|
Fair
Value
|
||||||||||
|
December
31, 2007:
|
Amortized
|
Unrealized
|
Unrealized
|
(Carrying
|
|||||||||
|
Securities
available for sale:
|
Cost
|
Gains
|
Losses
|
Amount)
|
|||||||||
|
U.S.
Government agencies
|
$
|
65,764
|
$
|
524
|
($302
|
)
|
$
|
65,986
|
|||||
|
U.S.
Government agency
|
|||||||||||||
|
collateralized
mortgage obligations
|
7,782
|
44
|
(4
|
)
|
7,822
|
||||||||
|
Obligations
of state and
|
|||||||||||||
|
political
subdivisions
|
2,227
|
54
|
0
|
2,281
|
|||||||||
|
Other
investment securities
|
13,752
|
0
|
(426
|
)
|
13,326
|
||||||||
|
Total
securities available for sale
|
$
|
89,525
|
$
|
622
|
($732
|
)
|
$
|
89,415
|
|||||
|
December
31, 2006:
|
|||||||||||||
|
Securities
available for sale:
|
|||||||||||||
|
U.S.
Government agencies
|
$
|
69,746
|
$
|
51
|
($1,293
|
)
|
$
|
68,504
|
|||||
|
U.S.
Government agency
|
|||||||||||||
|
collateralized
mortgage obligations
|
17
|
0
|
(1
|
)
|
16
|
||||||||
|
Obligations
of state and
|
|||||||||||||
|
political
subdivisions
|
2,226
|
65
|
(1
|
)
|
2,290
|
||||||||
|
Other
investment securities
|
13,000
|
0
|
(444
|
)
|
12,556
|
||||||||
|
Total
securities available for sale
|
$
|
84,989
|
$
|
116
|
($1,739
|
)
|
$
|
83,366
|
|||||
Included
in other investment securities at December 31, 2007, is a short-term government
securities mutual fund totaling $7.7 million, a CRA-qualified mortgage fund
totaling $4.9 million, and an overnight money-market mutual fund totaling
$752,000. Included in other investment securities at December 31, 2006, is
a
short-term government securities mutual fund totaling $7.7 million, and a
CRA-qualified mortgage fund totaling $4.8 million. The
commercial asset-backed trust consists of fixed and floating rate commercial
and
multifamily mortgage loans. The short-term government securities mutual fund
invests in debt securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, with a maximum duration equal to that of a 3-year
U.S. Treasury Note.
Management
periodically evaluates each available-for-sale investment security in an
unrealized loss position to determine if the impairment is temporary or
other-than-temporary. Management has determined that no investment security
is
other than temporarily impaired. The unrealized losses are due solely to
interest rate changes and the Company has the ability and intent to hold all
investment securities with identified impairments resulting from interest rate
changes to the earlier of the forecasted recovery or the maturity of the
underlying investment security.
The
following summarizes temporarily impaired investment securities at December
31,
2007 and 2006:
|
Less
than 12 Months
|
12
Months or More
|
Total
|
|||||||||||||||||
|
(In
thousands)
|
Fair
Value
|
Fair
Value
|
Fair
Value
|
||||||||||||||||
|
December
31, 2007:
|
(Carrying
|
Unrealized
|
(Carrying
|
Unrealized
|
(Carrying
|
Unrealized
|
|||||||||||||
|
Securities
available for sale:
|
Amount)
|
Losses
|
Amount)
|
Losses
|
Amount)
|
Losses
|
|||||||||||||
|
U.S.
Government agencies
|
$
|
0
|
$
|
0
|
$
|
30,241
|
$
|
(302
|
)
|
$
|
30,241
|
$
|
(302
|
)
|
|||||
|
U.S.
Govt. agency CMO’s
|
4,129
|
(4
|
)
|
0
|
0
|
4,129
|
(4
|
)
|
|||||||||||
|
Obligations
of state and
|
|||||||||||||||||||
|
political
subdivisions
|
0
|
0
|
0
|
0
|
0
|
0
|
|||||||||||||
|
Other
investment securities
|
0
|
0
|
12,574
|
(426
|
)
|
12,574
|
(426
|
)
|
|||||||||||
|
Total
impaired securities
|
$
|
4,129
|
$
|
(4
|
)
|
$
|
42,815
|
$
|
(728
|
)
|
$
|
46,944
|
$
|
(732
|
)
|
||||
|
December
31, 2006:
|
|||||||||||||||||||
|
Securities
available for sale:
|
|||||||||||||||||||
|
U.S.
Government agencies
|
$
|
506
|
$
|
(6
|
)
|
$
|
65,626
|
$
|
(1,287
|
)
|
$
|
66,132
|
$
|
(1,293
|
)
|
||||
|
U.S.
Govt. agency CMO’s
|
0
|
0
|
12
|
(1
|
)
|
12
|
(1
|
)
|
|||||||||||
|
Obligations
of state and
|
|||||||||||||||||||
|
political
subdivisions
|
0
|
0
|
34
|
(1
|
)
|
34
|
(1
|
)
|
|||||||||||
|
Other
investment securities
|
0
|
0
|
12,556
|
(444
|
)
|
12,556
|
(444
|
)
|
|||||||||||
|
Total
impaired securities
|
$
|
506
|
$
|
(6
|
)
|
$
|
78,228
|
$
|
(1,733
|
)
|
$
|
78,734
|
$
|
(1,739
|
)
|
||||
70
Temporarily
impaired securities at December 31, 2007 are comprised of nine (9) U.S.
government agency securities, one U.S. agency collateralized mortgage
obligation, and two other investment securities, with a total weighted average
life of 1.0 years. Temporarily impaired securities at December 31, 2006 are
comprised of nineteen (19) U.S. government agency securities, two other
investment securities, one municipal bond, and one U.S. agency collateralized
mortgage obligation with a total weighted average life of 2.4
years.
There
were no gross realized gains or losses on available-for-sale securities during
the year ended December 31, 2007. There were gross realized gains on sales
of
available-for-sale securities totaling $27,000, and $163,000 during the years
ended December 31, 2006, and 2005, respectively. There were no gross realized
losses on available-for-sale securities during the year ended December 31,
2006
or 2005.
The
amortized cost and fair value of securities available for sale at December
31,
2007, by contractual maturity, are shown below. Actual maturities may differ
from contractual maturities because issuers have the right to call or prepay
obligations with or without call or prepayment penalties. Contractual maturities
on collateralized mortgage obligations cannot be anticipated due to allowed
paydowns.
|
December
31, 2007
|
|||||||
|
|
Amortized
|
Fair
Value
|
|||||
|
(In
thousands)
|
Cost
|
(Carrying
Amount)
|
|||||
|
Due
in one year or less
|
$
|
37,980
|
$
|
37,419
|
|||
|
Due
after one year through five years
|
1,110
|
1,104
|
|||||
|
Due
after five years through ten years
|
10,103
|
10,365
|
|||||
|
Due
after ten years
|
32,550
|
32,704
|
|||||
|
Collateralized
mortgage obligations
|
7,782
|
7,823
|
|||||
|
$
|
89,525
|
$
|
89,415
|
||||
At
December 31, 2007 and 2006, available-for-sale securities with an amortized
cost
of approximately $71.0 million and $70.9 million (fair value of $71.3 million
and $69.7 million) were pledged as collateral for public funds, treasury tax
and
loan balances, and repurchase agreements.
The
Company had no held-to-maturity or trading securities at December 31, 2007
or
2006.
| 3. |
Loans
|
Loans
are comprised of the following:
|
December
31,
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
|||||
|
Commercial
and industrial
|
$
|
204,385
|
$
|
155,811
|
|||
|
Real
estate - mortgage
|
142,565
|
113,613
|
|||||
|
Real
estate - construction
|
178,296
|
168,378
|
|||||
|
Agricultural
|
46,055
|
35,102
|
|||||
|
Installment
|
18,171
|
16,712
|
|||||
|
Lease
financing
|
8,748
|
10,952
|
|||||
|
Total
Loans
|
$
|
598,220
|
$
|
500,568
|
|||
The
Company's loans are predominantly in the San Joaquin Valley, and the greater
Oakhurst/East Madera County area, as well as the Campbell area of Santa Clara
County, although the Company does participate in loans with other financial
institutions, primarily in the state of California.
71
Commercial
and industrial loans represent 34.2% of total loans at December 31, 2007 and
have a high degree of industry diversification. A substantial portion of the
commercial and industrial loans are secured by accounts receivable, inventory,
leases or other collateral including real estate. The remainder are unsecured;
however, extensions of credit are predicated upon the financial capacity of
the
borrower. Repayment of commercial loans is generally from the cash flow of
the
borrower.
Real
estate mortgage loans, representing 23.8% of total loans at December 31, 2007,
are secured by trust deeds on primarily commercial property. Repayment of real
estate mortgage loans is generally from the cash flow of the
borrower.
Real
estate construction loans, representing 29.8% of total loans at December 31,
2007, consist of loans to residential contractors, which are secured by
single-family residential properties. All real estate loans have established
equity requirements. Repayment on construction loans is generally from long-term
mortgages with other lending institutions.
Agricultural
loans represent 7.7% of total loans at December 31, 2007 and are generally
secured by land, equipment, inventory and receivables. Repayment is from the
cash flow of the borrower.
Lease
financing loans, representing 1.5% of total loans at December 31, 2007, consist
of loans to small businesses, which are secured by commercial equipment.
Repayment of the lease obligation is from the cash flow of the
borrower.
Occasionally,
shared appreciation agreements are made between the Company and the borrower
on
certain construction loans where the Company agrees to receive interest on
the
loan at maturity rather than monthly and the borrower agrees to share in the
profits of the project. Due to the difficulty in calculating future values,
shared appreciation income is recognized when received. The Company does not
participate in a significant number of shared appreciation projects.
Shared
appreciation income totaled $42,000, $567,000, and $393,000 for the years ended
December 31, 2007, 2006, and 2005, respectively.
Loans
over 90 days past due and still accruing consisted of one loan totaling $189,000
at December 31, 2007. There were no loans over 90 days past due and still
accruing at December 31, 2006. Nonaccrual loans totaled $21.6 million and $8.1
million at December 31, 2007 and 2006, respectively. There were remaining
undisbursed commitments to extend credit on nonaccrual loans of $12,000 at
December 31, 2007, and no remaining undisbursed commitments at December 31,
2006. The interest income that would have been earned on nonaccrual loans
outstanding at December 31, 2007 in accordance with their original terms is
approximately $1.5 million. There was no interest income recorded on such loans
during the year ended December 31, 2007. The interest income recorded on such
loans during 2006 and 2005 totaled $65,000 and $34,000, respectively.
The
Company has, and expects to have, lending transactions in the ordinary course
of
its business with directors, officers, principal shareholders and their
affiliates. These loans are granted on substantially the same terms, including
interest rates and collateral, as those prevailing on comparable transactions
with unrelated parties, and do not involve more than the normal risk of
collectibility or present unfavorable features.
Loans
to directors, officers, principal shareholders and their affiliates are
summarized below:
|
December
31,
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
|||||
|
Aggregate
amount outstanding, beginning of year
|
$
|
1,605
|
$
|
2,440
|
|||
|
New
loans or advances during year
|
9,734
|
1,897
|
|||||
|
Repayments
during year
|
(3,903
|
)
|
(2,732
|
)
|
|||
|
Aggregate
amount outstanding, end of year
|
$
|
7,436
|
$
|
1,605
|
|||
|
Loan
commitments
|
$
|
6,799
|
$
|
2,241
|
|||
An
analysis of changes in the allowance for credit losses is as
follows:
|
|
Years
Ended December 31,
|
|||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
|||||||
|
Balance,
beginning of year
|
$
|
8,365
|
$
|
7,748
|
$
|
7,251
|
||||
|
Provision
charged to operations
|
5,697
|
880
|
1,140
|
|||||||
|
Losses
charged to allowance
|
(4,493
|
)
|
(502
|
)
|
(773
|
)
|
||||
|
Recoveries
on loans previously charged off
|
64
|
239
|
165
|
|||||||
|
Reserve
acquired in merger
|
1,268
|
—
|
—
|
|||||||
|
Reclass
off-balance sheet reserve
|
—
|
—
|
(35
|
)
|
||||||
|
Balance
at end-of-period
|
$
|
10,901
|
$
|
8,365
|
$
|
7,748
|
||||
72
The
allowance for credit losses represents management's estimate of the risk
inherent in the loan portfolio based on the current economic conditions,
collateral values and economic prospects of the borrowers. Significant changes
in these estimates might be required in the event of a downturn in the economy
and/or the real estate markets in the San Joaquin Valley, the greater Oakhurst
and East Madera County area, and in Santa Clara County.
At
December 31, 2007 and 2006, the Company's recorded investment in loans for
which
impairment has been recognized totaled $20.6 million and $8.9 million,
respectively. Included in total impaired loans at December 31, 2007 are $10.7
million of impaired loans for which the related specific allowance is $4.5
million, as well as $9.9 million of impaired loans that as a result of
write-downs or the fair value of the collateral, did not have a specific
allowance. At December 31, 2006, total impaired loans included $5.7 million
for
which the related specific allowance is $4.1 million, as well as $3.2 million
of
impaired loans that as a result of write-downs to the fair value of the
collateral did not have a specific allowance. The average recorded investment
in
impaired loans was $15.9 million, $10.1 million, and $15.9 million for the
years
ended December 31, 2007, 2006, and 2005, respectively. In most cases, the
Company uses the cash basis method of income recognition for impaired loans.
In
the case of certain troubled debt restructuring for which the loan is performing
under the current contractual terms, income is recognized under the accrual
method. For the year ended December 31, 2007, the Company recognized no income
on impaired loans. For the year ended December 31, 2006 and 2005, the Company
recognized income of $65,000 and $34,000, respectively, on such loans.
In
the
normal course of business, the Company is party to financial instruments with
off-balance sheet risk to meet the financing needs of its customers. At December
31, 2007 and 2006 these financial instruments include commitments to extend
credit of $196.3 million and $188.2 million, respectively, and standby letters
of credit of $6.7 million and $4.9 million, respectively. These instruments
involve elements of credit risk in excess of the amount recognized on the
balance sheet. The contract amounts of these instruments reflect the extent
of
the involvement the Company has in off-balance sheet financial
instruments.
The
Company’s exposure to credit loss in the event of nonperformance by the
counterparty to the financial instrument for commitments to extend credit and
standby letters of credit is represented by the contractual amounts of those
instruments. The Company uses the same credit policies as it does for on-balance
sheet instruments.
Commitments
to extend credit are agreements to lend to a customer, as long as there is
no
violation of any condition established in the contract. Substantially all of
these commitments are at floating interest rates based on the Prime rate.
Commitments generally have fixed expiration dates. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary, is based on management's credit evaluation.
Collateral held varies but includes accounts receivable, inventory, leases,
property, plant and equipment, residential real estate and income-producing
properties.
Standby
letters of credit are generally unsecured and are issued by the Company to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loans to customers.
| 4. |
Lease
Assets held for Sale
|
The
Company had a lease portfolio totaling $8.7 million and $11.0 million at
December 31, 2007 and December 31, 2006, respectively. The lease portfolio
is
included as a component of total loans. Leases, like other types of loans,
may
become nonperforming at which time they are foreclosed upon and the remaining
lease assets, including equipment and furniture, are transferred to lease assets
held for sale which is included in other assets. Valuation adjustments, if
required, at the time of foreclosure are charged to the allowance for loan
losses. The Company discontinued making new leases during the first quarter
of
2007, and since that time the balances in the lease portfolio have declined.
The
Company previously utilized a third-party broker to aid in the collection and
ultimate disposition of lease assets held for sale. During the third quarter
of
2007, the Company determined that the third-party broker no longer wished to
continue collection and disposition efforts for the Company due to the Company’s
exit strategy from the leasing business. During the fourth quarter of 2007,
the
Company increased its efforts to dispose of existing lease assets held through
foreclosure, while during the same period, additional lease assets were being
foreclosed upon due to general declines in the economy. As a result, the Company
reviewed the collectability of values recorded for lease assets held for sale
during the fourth quarter of 2007 and charged-off $820,000 of the lease assets
held for sale. The expense is recorded as a component of noninterest expense
for
the year ended December 31, 2007.
73
|
5.
|
Premises
and Equipment
|
The
components of premises and equipment are as follows:
|
December
31,
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
|||||
|
Land
|
$
|
968
|
$
|
968
|
|||
|
Buildings
and improvements
|
14,160
|
13,017
|
|||||
|
Furniture
and equipment
|
8,776
|
7,399
|
|||||
|
23,904
|
21,384
|
||||||
|
Less
accumulated depreciation and amortization
|
(8,330
|
)
|
(6,082
|
)
|
|||
|
Total
premises and equipment
|
$
|
15,574
|
$
|
15,302
|
|||
During
February 2007, the Company purchased Legacy Bank, N.A. in Campbell, California
which included net fixed assets totaling $729,000. Included in this amount
were
buildings and improvements of $631,000, furniture and equipment of $713,000,
and
accumulated depreciation of $615,000. The Company determined that the net
carrying value of Legacy fixed assets reasonably approximated fair value, and
therefore did not make any fair value adjustments pursuant to purchase
accounting guidelines.
During
September 2006, the Company sold its administrative headquarters at 1525 E.
Shaw
Avenue in Fresno, California in preparation for a move to the Company’s new
administrative headquarters located in downtown Fresno during mid-November
2006.
The Company rented the East Shaw premises during the two months for transition
purposes pending its move to the new administrative location. Proceeds from
the
sale totaled $1.5 million for the building and certain furniture and fixtures.
The total carrying value of the building and furniture sold amounted to
$498,000, resulting in a realized gain of $1.0 million during the third quarter
of 2006.
During
November 2006, the Company moved its administrative headquarters to its new
location at 2126 Inyo Street, in downtown Fresno. The location was originally
acquired in June 2003 as a real estate foreclosure (OREO). During 2005, the
Company provided improvements to the building for a tenant that leases a portion
of the building. Then during 2006, the Company completed the improvements to
the
building required to prepare it for occupancy as the Company’s administrative
headquarters. The Company owns the building with a total capitalized cost of
$7.8 million, including building and improvements of $6.0 million, land and
land
improvements of $1.1 million, and furniture and fixtures of $710,000.
Total
depreciation expense on Company premises and equipment totaled $1.6 million,
$1.1 million, and $906,000 for the years ended December 31, 2007, 2006 and
2005,
respectively, and is included in occupancy expense in the accompanying
consolidated statements of income.
| 6. |
Investment
in Limited
Partnership
|
The
Bank
owns limited interests in a private limited partnerships that acquire affordable
housing properties in California that generate Low Income Housing Tax Credits
under Section 42 of the Internal Revenue Code of 1986, as amended. The Bank's
limited partnership investment is accounted for under the equity method. The
Bank's noninterest expense associated with the utilization and expiration of
these tax credits for the year ended December 31, 2007, 2006 and 2005 was
$430,000, $440,000, and $458,000, respectively. The limited partnership
investments are expected to generate remaining tax credits of approximately
$3.1
million over the life of the investment. The tax credits expire between 2009
and
2014. Tax credits utilized for income tax purposes for the years ended December
31, 2007, 2006, and 2005 totaled $545,000, $547,000, and $547,000,
respectively.
| 7. |
Deposits
|
Deposits
include the following:
|
December
31,
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
|||||
|
Noninterest-bearing
deposits
|
$
|
139,066
|
$
|
159,002
|
|||
|
Interest-bearing
deposits:
|
|||||||
|
NOW
and money market accounts
|
153,717
|
184,384
|
|||||
|
Savings
accounts
|
40,012
|
31,933
|
|||||
|
Time
deposits:
|
|||||||
|
Under
$100,000
|
52,297
|
42,428
|
|||||
|
$100,000
and over
|
249,525
|
169,380
|
|||||
|
Total
interest-bearing deposits
|
495,551
|
428,125
|
|||||
|
Total
deposits
|
$
|
634,617
|
$
|
587,127
|
|||
74
At
December 31, 2007, the scheduled maturities of all certificates of deposit
and
other time deposits are as follows:
|
(In
thousands)
|
||||
|
One
year or less
|
$
|
282,258
|
||
|
More
than one year, but less than or equal to two years
|
16,725
|
|||
|
More
than two years, but less than or equal to three years
|
1,847
|
|||
|
More
than three years, but less than or equal to four years
|
300
|
|||
|
More
than four years, but less than or equal to five years
|
82
|
|||
|
More
than five years
|
610
|
|||
|
$
|
301,822
|
|||
The
Company may utilize brokered deposits as an additional source of funding. At
December 31, 2007 and 2006, the Company held brokered time deposits totaling
$139.3 million and $67.7 million, with average rates of 4.93% and 5.06%,
respectively. Of this balance at December 31, 2007, $134.0 million is included
in time deposits of $100,000 or more, and the remaining $5.3 million is included
in time deposits of less than $100,000. Included in brokered time deposits
at
December 31, 2007 are balances totaling $40.4 million maturing in three months
or less, $59.9 million maturing in three to six months, $30.5 million maturing
in 6 to twelve months, and $8.5 million maturing in more than one
year.
Deposit
balances representing overdrafts reclassified as loan balances totaled $565,000
and $303,000 as of December 31, 2007 and 2006, respectively.
Deposits
of directors, officers and other related parties to the Bank totaled $5.9
million and $6.2 million at December 31, 2007 and 2006, respectively. The rates
paid on these deposits were those customarily paid to the Bank's customers
in
the normal course of business.
| 8. |
Short-term
Borrowings/Other
Borrowings
|
At
December 31, 2007, the Company had collateralized and uncollateralized lines
of
credit with the Federal Reserve Bank of San Francisco and other correspondent
banks aggregating $386.7 million, as well as Federal Home Loan Bank (“FHLB”)
lines of credit totaling $22.0 million. At December 31, 2007, the Company had
total outstanding balances of $32.3 million in borrowings, including $10.4
million in federal funds purchased from correspondent banks at an average rate
of 4.2%, and $21.9 million drawn against its FHLB lines of credit. Of the $21.9
million in FHLB borrowings outstanding at December 31, 2007, $11.9 million
was
in overnight borrowings at an average rate of 3.3%, and the other $10.0 million
consists of a two-year FHLB advance, at a fixed rate of 4.92%, and a maturity
date of March 30, 2009. The weighted average cost of borrowings for the year
ended December 31, 2007 was 5.17%. These lines of credit generally have interest
rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury
rates or LIBOR. FHLB advances are collateralized by all of the Company’s stock
in the FHLB and certain qualifying mortgage loans. As of December 31, 2007,
$46.5 million in real estate-secured loans were pledged as collateral for FHLB
advances. Additionally, $428.9 million in real estate-secured loans were pledged
at December 31, 2007 as collateral for used and unused borrowing lines with
the
Federal Reserve Bank totaling $321.7 million. All lines of credit are on an
“as
available” basis and can be revoked by the grantor at any time.
The
Company had collateralized and uncollateralized lines of credit with the Federal
Reserve Bank of San Francisco and other correspondent banks aggregating $308.3
million, as well as Federal Home Loan Bank (“FHLB”) lines of credit totaling
$20.8 million at December 31, 2006. At December 31, 2006, the Company had no
advances on its lines of credit.
| 9. |
Fair
Value - Adoption of SFAS No.
159
|
Effective
January 1, 2007, the Company elected early adoption of SFAS No.159,
“The
Fair
Value Option for Financial Assets and Financial Liabilities, including an
amendment of FASB Statement No. 115”.
The
Company also adopted the provisions of SFAS No. 157, “Fair
Value Measurements”,
effective January 1, 2007, in conjunction with the adoption of SFAS No. 159.
SFAS No. 159 generally permits the measurement of selected eligible financial
instruments at fair value at specified election dates. Upon adoption of SFAS
No.
159, the Company elected the fair value measurement option for all the Company’s
pre-existing junior subordinated debentures with a carrying cost of $15.5
million, prior to the adoption of SFAS No. 159.
75
The
Company believes its adoption of SFAS No. 159 will have a positive impact on
its
ability to better manage the balance sheet and interest rate risks associated
with this liability while potentially benefiting the net interest margin, net
interest income, net income and earnings per common share in future periods.
Specifically, the Company believes the election of fair value accounting for
the
junior subordinated debentures better reflects the true economic value of the
debt instrument on the balance sheet. The Company’s junior subordinated
debentures were issued in 2001 when the Trust Preferred Securities market was
new and less liquid than today. As a result, subordinated debentures are
available in the market at narrower spreads and lower issuing costs. With a
higher-than-market spread to LIBOR, and remaining capitalized issuance costs
of
more than $400,000 on the balance sheet, the Company’s cost-basis of the
subordinated debentures recorded on the balance sheet does not properly reflect
the true opportunity costs to the Company.
The
initial fair value measurement at adoption resulted in a $1,053,000
cumulative-effect adjustment to the opening balance of retained earnings at
January 1, 2007. The adjustment resulted in an increase of $1,053,000 in the
reported balance of the junior subordinated debentures, an increase in deferred
tax assets of $443,000 and the corresponding reduction in retained earnings
of
$610,000. Under SFAS No. 159, this one-time charge to shareholders’ equity was
not recognized in earnings. In addition to the fair value adjustment of the
junior subordinated debentures recorded effective January 1, 2007, the Company
also removed the remaining $405,000 in unamortized issuance costs of the debt
instrument. The remaining issuance costs were removed in accordance with SFAS
159 effective January 1, 2007, with corresponding charges of $170,000 to
deferred taxes and $235,000 to retained earnings.
As
a
requirement of electing early adoption of SFAS 159, the Company also adopted
SFAS 157, “Fair Value Measurement” effective January 1, 2007. The Company
utilized the guidelines of SFAS No. 157 to perform the fair value analysis
on
the junior subordinated debentures. In its analysis, the Company used a
net-present-value approach based upon observable market rates of interest,
over
a term that considers the most advantageous market for the liability, and the
most reasonable behavior of market participants.
The
following table summarizes the effects of the adoption of SFAS No. 159 at both
adoption date and December 31, 2007 (in 000’s) on the Company’s junior
subordinated debentures. Changes in fair value (FV) for periods subsequent
to
adoption are recorded in current earnings. The pretax change in fair value
for
the year ended December 31, 2007 totaled $2.5 million and is included as a
gain
in other noninterest income.
|
Balance
of junior subordinated debentures at December 31, 2006
|
$
|
15,464
|
||
|
Adjustments
upon adoption:
|
||||
|
Combine
accrued interest 1/1/07
|
613
|
|||
|
Total
carrying value 1/1/07
|
16,077
|
|||
|
FV
adjustment upon adoption of SFAS No. 159
|
1,053
|
|||
|
Total
FV of junior subordinated debentures at adoption - January 1,
2007
|
$
|
17,130
|
||
|
|
||||
|
Total
FV of junior subordinated debentures at December 31, 2007
|
$
|
13,341
|
| 10. |
Junior
Subordinated Debt/Trust Preferred
Securities
|
At
June
30, 2007, the Company held junior subordinated debentures issued to capital
trusts commonly known as "Trust Preferred securities.” The debt instrument was
issued by the Company’s wholly-owned special purpose trust entity, USB Capital
Trust I on July 25, 2001 in the amount of $15,000,000 with a thirty-year
maturity, interest benchmarked at the 6-month-LIBOR rate (re-priced in January
and July each year) plus 3.75%. The Company had the ability to redeem the
debentures at its option. The prepayment provisions of the instrument allowed
repayment after five years (July 25, 2006) with certain prepayment penalties.
On
July 25, 2007, the Company redeemed the $15.0 million in subordinated debentures
plus accrued interest of $690,000 and a 6.15% prepayment penalty totaling
$922,500. Concurrently, the Trust Preferred securities issued by Capital Trust
I
were redeemed. The prepayment penalty of $922,500 had previously been a
component of the fair value adjustment for the junior subordinated debt at
the
initial adoption of SFAS No. 159, and as a result was recorded through retained
earnings effective January 1, 2007.
76
During
July 2007, the Company formed USB Capital Trust II, a wholly-owned special
purpose entity, for the purpose of issuing Trust Preferred Securities. Like
USB
Capital Trust I formed in July 2001, USB Capital Trust II is a Variable Interest
Entity (VIE) and will be considered a deconsolidated entity pursuant to FIN
46.
On July 23, 2007 USB Capital Trust II issued $15 million in Trust Preferred
securities. The securities have a thirty-year maturity and bear a floating
rate
of interest (repricing quarterly) of 1.29% over the three-month LIBOR rate
(initial coupon rate of 6.65%). Interest will be paid quarterly. Concurrent
with
the issuance of the Trust Preferred securities, USB Capital Trust II used the
proceeds of the Trust Preferred securities offering to purchase a like amount
of
junior subordinated debentures of the Company. The Company will pay interest
on
the junior subordinated debentures to USB Capital Trust II, which represents
the
sole source of dividend distributions to the holders of the Trust Preferred
securities. The Company may redeem the junior subordinated debentures at anytime
before October 2008 at a redemption price of 103.3, and thereafter each October
as follows: 2008 at 102.64, 2009 at 101.98, 2010 at 101.32, 2011 at 100.66,
and
at par anytime after October 2012.
As
with
the previous junior subordinated securities issued under USB Capital Trust
I,
the Company
has elected the fair value measurement option for all the Company’s new junior
subordinated debentures issued under USB Capital Trust II. During the year
ended
December 31, 2007, the Company recorded pre-tax gains of $2.5 million pursuant
to SFAS No. 159 as measured under fair value measurement guidelines of SFAS
No.
157. The initial gain of $2.1 million realized on USB Capital Trust II during
the third quarter resulted from an overall deterioration of the credit markets
during the third quarter of 2007 which increased pricing spreads from base
rates
on similar debt instruments. The Company recorded an additional gain on the
junior subordinated debt of $270,000 during the fourth quarter of 2007 bring
the
year-to-date gain on the junior subordinated debt issued by USB Capital Trust
II
to $2.4 million.
| 11. |
Taxes
on Income
|
The
tax effects of significant items comprising the Company’s net deferred tax
assets (liabilities) are as follows:
|
December
31,
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
|||||
|
Deferred
tax assets:
|
|||||||
|
Credit
losses not currently deductible
|
$
|
4,646
|
$
|
3,688
|
|||
|
State
franchise tax
|
525
|
777
|
|||||
|
Deferred
compensation
|
1,249
|
1,051
|
|||||
|
Net
operating losses
|
1,830
|
—
|
|||||
|
Startup/organizational
costs
|
113
|
—
|
|||||
|
Accrued
reserves
|
133
|
3
|
|||||
|
Amortization
of core deposit intangible
|
—
|
353
|
|||||
|
Write-down
on other real estate owned
|
15
|
15
|
|||||
|
Deferred
gain on sale of other real estate owned
|
0
|
89
|
|||||
|
Unrealized
gain on interest rate swap
|
39
|
136
|
|||||
|
Unrealized
loss on AFS securities
|
44
|
649
|
|||||
|
Unrecognized
costs on post-retirement benefits
|
57
|
112
|
|||||
|
Amortization
of premium on time deposits
|
46
|
70
|
|||||
|
Other
|
38
|
93
|
|||||
|
Total
deferred tax assets
|
8,735
|
7,036
|
|||||
|
Deferred
tax liabilities:
|
|||||||
|
Depreciation
|
(24
|
)
|
(56
|
)
|
|||
|
FHLB
dividend
|
(204
|
)
|
(50
|
)
|
|||
|
Loss
on limited partnership investment
|
(1,590
|
)
|
(1,354
|
)
|
|||
|
Amortization
of core deposit intangible
|
(1,249
|
)
|
—
|
||||
|
Deferred
gain SFAS No. 159 - fair value option
|
(998
|
)
|
—
|
||||
|
Prepaid
expenses
|
(369
|
)
|
(269
|
)
|
|||
|
Total
deferred tax liabilities
|
(4,434
|
)
|
(1,729
|
)
|
|||
|
Net
deferred tax assets
|
$
|
4,301
|
$
|
5,307
|
|||
The
Company periodically evaluates its deferred tax assets to determine whether
a
valuation allowance is required based upon a determination that some or all
of
the deferred assets may not be ultimately realized. The Company has concluded
that it is more likely than not that the deferred tax assets will be recognized
in the normal course of business, therefore no valuation allowance is considered
necessary at December 31, 2007 and 2006.
77
Taxes
on income for the years ended December 31, consist of the
following:
|
(In
thousands)
|
||||||||||
|
2007:
|
Federal
|
State
|
Total
|
|||||||
|
Current
|
$
|
3,640
|
$
|
1,507
|
$
|
5,147
|
||||
|
Deferred
|
1,091
|
323
|
1,414
|
|||||||
|
$
|
4,731
|
$
|
1,830
|
$
|
6,561
|
|||||
|
2006:
|
||||||||||
|
Current
|
$
|
6,284
|
$
|
2,133
|
$
|
8,417
|
||||
|
Deferred
|
(390
|
)
|
8
|
(382
|
)
|
|||||
|
$
|
5,894
|
$
|
2,141
|
$
|
8,035
|
|||||
|
2005:
|
||||||||||
|
Current
|
$
|
4,686
|
$
|
1,618
|
$
|
6,304
|
||||
|
Deferred
|
(86
|
)
|
172
|
86
|
||||||
|
$
|
4,600
|
$
|
1,790
|
$
|
6,390
|
|||||
A
reconciliation of the statutory federal income tax rate to the effective income
tax rate is as follows:
|
Years
Ended December 31,
|
||||||||||
|
2007
|
2006
|
2005
|
||||||||
|
Statutory
federal income tax rate
|
35.0
|
%
|
35.0
|
%
|
34.3
|
%
|
||||
|
State
franchise tax, net of federal income tax benefit
|
7.0
|
7.0
|
7.2
|
|||||||
|
Tax
exempt interest income
|
(0.2
|
)
|
(0.2
|
)
|
(0.6
|
)
|
||||
|
Low
Income Housing - federal credits
|
(3.1
|
)
|
(2.6
|
)
|
(3.1
|
)
|
||||
|
Other
|
(1.9
|
)
|
(1.4
|
)
|
(1.1
|
)
|
||||
|
|
36.8
|
%
|
37.8
|
%
|
36.7
|
%
|
||||
At
December 31, 2007 the Company has remaining federal net operating loss
carry-forwards totaling $4.4 million which expire between 2023 and 2027, and
remaining state net operating loss carry-forwards totaling $4.2 million which
expire between 2014 and 2017.
The
Company adopted the provisions of FASB Interpretation No. 48, “Accounting for
Uncertainty in Income Taxes” (FIN48), on January 1, 2007. FIN 48 clarifies SFAS
No. 109, “Accounting
for Income Taxes,”
to
indicate a criterion that an individual tax position would have to meet for
some
or all of the income tax benefit to be recognized in a taxable entity’s
financial statements. Under the guidelines of FIN48, an entity should recognize
the financial statement benefit of a tax position if it determines that it
is
more
likely than not that
the
position will be sustained on examination. The term, “more likely than not”,
means a likelihood of more than 50 percent.” In assessing whether the
more-likely-than-not criterion is met, the entity should assume that the tax
position will be reviewed by the applicable taxing authority and all available
information is known to the taxing authority.
The
Company and a subsidiary file income tax returns in the U.S federal
jurisdiction, and several states within the U.S. There are no filings in foreign
jurisdictions. The Company is not currently aware of any tax jurisdictions
where
the Company or any subsidiary is subject examination by federal, state, or
local
taxing authorities before 2001. The Internal Revenue Service (IRS) has not
examined the Company’s or any subsidiaries federal tax returns since before
2001, and the Company currently is not aware of any examination planned or
contemplated by the IRS. The California Franchise Tax Board (FTB) concluded
an
audit of the Company’s 2004 state tax return during the fourth quarter of 2007,
resulting in a disallowance of approximately $19,000 related to Enterprise
Zone
loan interest deductions taken during 2004. The $19,000 was recorded as a
component of tax expense for the year ended December 31, 2007.
78
During
the second quarter of 2006, the FTB issued the Company a letter of proposed
adjustments to, and assessments for, (as a result of examination of the tax
years 2001 and 2002) certain tax benefits taken by the REIT during 2002. The
Company continues to review the information available from the FTB and its
financial advisors and believes that the Company's position has merit. The
Company is pursing its tax claims and will defend its use of these entities
and
transactions. The Company will continue to assert its administrative protest
and
appeal rights pending the outcome of litigation by another taxpayer presently
in
process on the REIT issue in the Los Angeles Superior Court (City National
v.
Franchise Tax Board).
The
Company reviewed its REIT tax position as of January 1, 2007 (adoption date)
and
again during subsequent quarter during 2007 in light of the adoption of FIN48.
The Bank, with guidance from advisors believes that the case has merit with
regard to points of law, and that the tax law at the time allowed for the
deduction of the consent dividend. However, the Bank, with the concurrence
of
advisors, cannot conclude that it is “more than likely” (as defined in FIN48)
that the Bank will prevail in its case with the FTB. As a result of the
implementation of FIN48, the Company recognized approximately a $1.3 million
increase in the liability for unrecognized tax benefits (included in other
liabilities), which was accounted for as a reduction to the January 1, 2007
balance of retained earnings. The adjustment provided at adoption included
penalties proposed by the FTB of $181,000 and interest totaling $210,000. During
the year ended December 31, 2007, the Company recorded an additional $87,000
in
interest liability pursuant to the provisions of FIN48. The Company had
approximately $456,000 accrued for the payment of interest and penalties at
December 31, 2007. Subsequent to the initial adoption of FIN48, it is the
Company’s policy to recognize interest expense related to unrecognized tax
benefits, and penalties, as a component tax expense. A reconciliation of the
beginning and ending amount of unrecognized tax benefits is as follows (in
000’s):
|
Balance
at January 1, 2007
|
$
|
1,298
|
||
|
Additions
for tax provisions of prior years
|
87
|
|||
|
Balance
at December 31, 2007
|
$
|
1,385
|
| 12. |
Stock
Options and Stock Based
Compensation
|
On
January 1, 2006 the Company adopted the disclosure provisions of Financial
Accounting Standards Board (FASB) Statement No. 123 R, “Accounting for
Share-Based Payments”. SFAS No. 123R requires all share-based payments to
employees, including grants of employee stock options, to be recognized in
the
financial statements based on the grant-date fair value of the award. The fair
value is amortized over the requisite service period (generally the vesting
period). The Company previously accounted for stock-based awards to employees
under the intrinsic value provisions of APB 25 in which no compensation cost
was
required to be recognized for options granted that had an exercise price equal
to the market value of the underlying common stock on the date of the grant.
The
Company has adopted SFAS No. 123 R using the modified-prospective-transition
method. Under that transition method, compensation cost recognized in the year
ended December 31, 2006 includes: a) compensation cost for all share-based
awards granted prior to, but not yet vested as of January 1, 2006 and b)
compensation cost for all share-based awards granted subsequent to January
1,
2006. Compensation cost was determined using proforma disclosure information
previously calculated under SFAS No. 123. Pursuant to the
modified-prospective-transition method, the results for prior periods have
not
been restated.
As
of
January 1, 2006, options have been granted to officers and key employees at
an
exercise price equal to estimated fair value at the date of grant as determined
by the Board of Directors. All options granted are service awards, and as such
are based solely upon fulfilling a requisite service period (the vesting
period). In May 2005, the Company’s shareholders approved the adoption of the
United Security Bancshares 2005 Stock Option Plan (2005 Plan). At the same
time,
all previous plans, including the 1995 Plan, were terminated. The 2005 Plan
provides for the granting of up to 500,000 shares (adjusted for the 2-for-1
stock split effective May 2006) of authorized and unissued shares of common
stock at option prices per share which must not be less than 100% of the fair
market value per share at the time each option is granted. The 2005 Plan further
provides that the maximum aggregate number of shares that may be issued as
incentive stock options under the 2005 Plan is 500,000 (as adjusted for stock
split).
The
options granted (incentive stock options for employees and non-qualified stock
options for Directors) have an exercise price at the prevailing market price
on
the date of grant under the 1995 or 2005 Stock Option Plans. The options granted
under both the 1995 and 2005 Stock Option Plans are exercisable 20% each year
commencing one year after the date of grant and expire ten years after the
date
of grant. Pursuant to the adoption of the 2005 Stock Option Plan, there are
no
remaining shares reserved under the 1995 Stock Option Plan.
79
The
number of shares granted remaining under the 1995 Plan was 36,000 shares (24,000
exercisable) as of December 31, 2007. Under the 2005 Plan, 176,500 shares
granted shares remain (168,500 incentive stock options and 8,000 nonqualified
stock options) as of December 31, 2007, of which 46,700 are vested.
Options
outstanding, exercisable, exercised and forfeited are as
follows:
|
Weighted
|
Weighted
|
||||||||||||
|
2005
|
Average
|
1995
|
Average
|
||||||||||
|
Plan
|
Exercise
Price
|
Plan
|
Exercise
Price
|
||||||||||
|
Options
outstanding January 1, 2005
|
—
|
—
|
216,000
|
$
|
8.02
|
||||||||
|
Granted
during the year
|
70,000
|
$
|
14.18
|
30,000
|
12.16
|
||||||||
|
Exercised
during the year
|
0
|
—
|
(12,000
|
)
|
$
|
9.86
|
|||||||
|
Canceled
or expired
|
0
|
—
|
(62,000
|
)
|
$
|
12.20
|
|||||||
|
Options
outstanding December 31, 2005
|
0
|
—
|
172,000
|
$
|
7.11
|
||||||||
|
Granted
during the year
|
103,500
|
$
|
18.91
|
—
|
—
|
||||||||
|
Exercised
during the year
|
(2,000
|
)
|
$
|
12.65
|
(46,000
|
)
|
$
|
6.73
|
|||||
|
Options
outstanding December 31, 2006
|
171,500
|
$
|
17.05
|
126,000
|
$
|
7.25
|
|||||||
|
Granted
during the year
|
5,000
|
$
|
20.24
|
—
|
—
|
||||||||
|
Exercised
during the year
|
—
|
—
|
(90,000
|
)
|
$
|
5.67
|
|||||||
|
Options
outstanding December 31, 2007
|
176,500
|
$
|
17.14
|
36,000
|
$
|
11.21
|
|||||||
Included
in total outstanding options at December 31, 2007, are 24,000 exercisable shares
under the 1995 plan, at a weighted average price of $10.74, and 46,700
exercisable shares under the 2005 plan, at a weighted average price of $16.34.
Included in total outstanding options at December 31, 2006, are 108,000
exercisable shares under the 1995 plan, at a weighted average price of $6.43,
and 12,000 exercisable shares under the 2005 plan, at a weighted average price
of $14.44. Included in total outstanding options at December 31, 2005, are
70,000 exercisable shares under the 1995 plan, at a weighted average price
of
$12.31. There were no shares exercisable under the 2005 Plan at December 31,
2005.
Additional
information regarding options as of December 31, 2007 is as
follows:
|
Options
Outstanding
|
Options
Exercisable
|
|||||||||||||||
|
Range
of
Exercise
Prices
|
Number
Outstanding
|
Weighted
Avg
Remaining
Contract
Life (yrs)
|
Weighted
Avg Exercise
Price
|
Number
Exercisable
|
Weighted
Avg
Exercise
Price
|
|||||||||||
|
$8.75
|
10,000
|
3.2
|
$
|
8.75
|
10,000
|
$
|
8.75
|
|||||||||
|
$12.08
to $14.44
|
94,000
|
7.5
|
$
|
13.65
|
40,000
|
$
|
13.55
|
|||||||||
|
$16.88
to $18.10
|
58,000
|
8.1
|
$
|
17.04
|
11,600
|
$
|
17.04
|
|||||||||
|
$19.38
to $22.54
|
50,500
|
8.4
|
$
|
21.18
|
9,100
|
$
|
21.28
|
|||||||||
|
Total
|
212,500
|
70,700
|
||||||||||||||
Included
in salaries and employee benefits for the years ended December 31, 2007 and
2006
is $187,000 and $248,000 of share-based compensation, respectively. The related
tax benefit on share-based compensation recorded in the provision for income
taxes was not material to either year.
As
of
December 31, 2007 and 2006, there was $223,500 and $388,000, respectively,
of
total unrecognized compensation expense related to nonvested stock options.
This
cost is expected to be recognized over a weighted average period of
approximately 1.0 years and 1.5 years, respectively. The Company received
$510,000 and $335,000 in cash proceeds on options exercised during the year
ended December 31, 2007 and 2006, respectively. No tax benefits were realized
on
stock options exercised during the year ended December 31, 2007, because all
options exercised during the period were incentive stock options. Tax benefits
realized on options exercised during the year ended December 31, 2006 totaled
$218,000.
80
|
Year
Ended
|
Year
Ended
|
||||||
|
December
31,
2007
|
December
31,
2006
|
||||||
|
Weighted
average grant-date fair value of stock options granted
|
$
|
4.51
|
$
|
4.30
|
|||
|
Total
fair value of stock options vested
|
$
|
167,028
|
$
|
61,030
|
|||
|
Total
intrinsic value of stock options exercised
|
$
|
1,517,000
|
$
|
661,840
|
|||
The
Bank
determines fair value at grant date using the Black-Scholes-Merton pricing
model
that takes into account the stock price at the grant date, the exercise price,
the expected life of the option, the volatility of the underlying stock and
the
expected dividend yield and the risk-free interest rate over the expected life
of the option.
The
weighted average assumptions used in the pricing model are noted in the table
below. The expected term of options granted is derived using the simplified
method, which is based upon the average period between vesting term and
expiration term of the options. The risk free rate for periods within the
contractual life of the option is based on the U.S. Treasury yield curve in
effect at the time of the grant. Expected volatility is based on the historical
volatility of the Bank's stock over a period commensurate with the expected
term
of the options. The Company believes that historical volatility is indicative
of
expectations about its future volatility over the expected term of the
options.
For
options granted after January 1, 2006, and valued in accordance with FAS 123R,
the Bank expenses the fair value of the option on a straight-line basis over
the
vesting period for each separately vesting portion of the award. The Bank
estimates forfeitures and only recognizes expense for those shares expected
to
vest. Based upon historical evidence, the Company has determined that because
options are granted to a limited number of key employees rather than a broad
segment of the employee base, expected forfeitures, if any, are not
material.
|
Year
Ended
|
|
||||||
|
|
|
December
31,
2007
|
|
December
31,
2006
|
|||
|
Risk
Free Interest Rate
|
4.53
|
%
|
4.60
|
%
|
|||
|
Expected
Dividend Yield
|
2.47
|
%
|
2.65
|
%
|
|||
|
Expected
Life in Years
|
6.50
Years
|
6.50
Years
|
|||||
|
Expected
Price Volatility
|
20.63
|
%
|
18.38
|
%
|
|||
The
Black-Scholes-Merton option valuation model requires the input of highly
subjective assumptions, including the expected life of the stock based award
and
stock price volatility. The assumptions listed above represent management's
best
estimates, but these estimates involve inherent uncertainties and the
application of management judgment. As a result, if other assumptions had been
used, the Bank's recorded stock-based compensation expense could have been
materially different from that previously reported in proforma disclosures.
In
addition, the Bank is required to estimate the expected forfeiture rate and
only
recognize expense for those shares expected to vest. If the Bank's actual
forfeiture rate is materially different from the estimate, the share-based
compensation expense could be materially different.
As
stated
previously, the Company has adopted SFAS No. 123 R using the
modified-prospective-transition method, and as such, the results for prior
periods have not been restated. The following table illustrates the effect
on
net income and earnings per share for the year ended December 31, 2005, if
the
Company had applied the fair value recognition provisions of SFAS
No.
148, “Accounting for Stock-Based Compensation - Transition and Disclosure”, an
amendment of FASB Statement No. 123” (earnings per share information has been
restated to reflect 2-for-1 stock split effective May 1, 2006).
|
Year
Ended Dec 31,
|
||||
|
(In
thousands except earnings per share)
|
2005
|
|||
|
Net
income, as reported
|
$
|
11,008
|
||
|
Deduct:
Total stock-based employee
|
||||
|
compensation
expense determined under fair
|
||||
|
value
based method for all awards, net of
|
||||
|
related
tax effects
|
(46
|
)
|
||
|
Pro
forma net income
|
$
|
10,962
|
||
|
Earnings
per share:
|
||||
|
Basic
- as reported
|
$
|
0.97
|
||
|
Basic
- pro forma
|
$
|
0.96
|
||
|
Diluted
- as reported
|
$
|
0.96
|
||
|
Diluted
- pro forma
|
$
|
0.96
|
||
81
13.
Employee Benefit Plans
Employee
Stock Ownership Plan
The
Company has an Employee Stock Ownership Plan and Trust, (the “ESOP”), designed
to enable eligible employees to acquire shares of common stock. ESOP eligibility
is based upon length of service requirements. The Bank contributes cash to
the
ESOP in an amount determined at the discretion of the Board of Directors. The
trustee of the ESOP uses such contribution to purchase shares of common stock
currently outstanding, or to repay debt on the leveraged portion of the ESOP,
if
applicable. The shares of stock purchased by the trustee are then allocated
to
the accounts of the employees participating in the ESOP on the basis of total
relative compensation. Employer contributions vest over a period of six years.
During
June of 2000, the Company’s Employee Stock Ownership Plan (“ESOP”) established
an unsecured five-year variable-rate line of credit (“the loan”) in the amount
of $1.0 million for the purpose of purchasing common stock of the Company.
The
loan was with a correspondent bank
and
was guaranteed by the plan’s sponsor, United Security Bancshares. The loan
matured and final payment was made during the first quarter of 2005. Concurrent
with the loan payoff, the final 3,846 shares remaining unallocated leveraged
ESOP shares, with an average cost of $17.33 per share, were committed to be
released. There are no further commitments on the line of credit.
The
ESOP
used the proceeds of the loan to acquire shares of the Company’s common stock,
which were held in a suspense account by the ESOP. At the end of each year,
shares were released for allocation to the accounts of the individual ESOP
participants in proportion to the principal and interest paid on the loan during
the year. The ESOP loan was recorded as a liability of the Company and the
unreleased shares purchased with the loan were reported as unearned ESOP shares
in shareholders’ equity. Unreleased shares were not recognized as outstanding
for earnings per share and capital computations. Dividends on unallocated ESOP
shares were used to pay debt service on the ESOP loan and, as such, were
recorded as a reduction of debt and accrued interest. Dividends on unallocated
ESOP shares used to pay debt service on the ESOP loan amounted to $3,000 for
the
year ended December 31, 2005.
ESOP
compensation expense totaled $501,000, $409,000, and $467,000 for the years
ended December 31, 2007, 2006, and 2005 respectively. Interest expense incurred
on the ESOP loan totaled $408 for the year ended December 31, 2005.
Allocated,
committed-to-be-released, and unallocated ESOP shares as of December 31, 2007,
2006 and 2005 were as follows (shares adjusted for 2-for-1 stock split of May
2006):
|
2007
|
2006
|
2005
|
||||||||
|
Allocated
|
402,988
|
375,639
|
349,564
|
|||||||
|
Committed-to-be-released
|
0
|
0
|
7,692
|
|||||||
|
Unallocated
|
0
|
0
|
0
|
|||||||
|
Total
ESOP shares
|
402,988
|
375,639
|
357,256
|
|||||||
|
Fair
value of unreleased shares
|
N/A
|
N/A
|
N/A
|
|||||||
401K
Plan
The
Company has a Cash or Deferred 401(k) Stock Ownership Plan (the “401(k) Plan”)
organized under Section 401(k) of the Code. All employees of the Company are
initially eligible to participate in the 401(k) Plan upon the first day of
the
month after date of hire. Under the terms of the plan, the participants may
elect to make contributions to the 401(k) Plan as determined by the Board of
Directors. Participants are automatically vested 100% in all employee
contributions. Participants may direct the investment of their contributions
to
the 401(k) Plan in any of several authorized investment vehicles. The Company
contributes funds to the Plan up to 5% of the employees’ eligible annual
compensation. Company contributions are subject to certain vesting requirements
over a period of six years. Contributions made by the Company are invested
in
Company stock. During 2007, 2006 and 2005, the Company contributed a total
of
$286,000, $242,000, and $214,000, respectively, to the Deferral Plan.
82
Salary
Continuation Plan
The
Company has an unfunded, non-qualified Salary Continuation Plan for senior
executive officers and certain other key officers of the Company, which provides
additional compensation benefits upon retirement for a period of 15 years.
Future compensation under the Plan is earned by the employees for services
rendered through retirement and vests over a period of 12 to 15 years. The
Company accrues for the salary continuation liability based on anticipated
years
of service and vesting schedules provided under the Plan. The Company’s current
benefit liability is determined based upon vesting and the present value of
the
benefits at a corresponding discount rate. The discount rate used is an
equivalent rate for high-quality investment-grade bonds with lives matching
those of the service periods remaining for the salary continuation contracts,
which averages approximately 20 years. At December 31, 2007 and 2006, $3.0
million and $2.7 million, respectively, had been accrued to date, based on
a
discounted cash flow using a discount rate of 6.40% and 6.42%, respectively,
and
is included in other liabilities. In connection with the implementation of
the
Salary Continuation Plans, the Company purchased single premium universal life
insurance policies on the life of each of the key employees covered under the
Plan. The Company is the owner and beneficiary of these insurance policies.
The
cash surrender value of the policies was $3.7 million and $3.6 million December
31, 2007 and 2006, respectively. Although the Plan is unfunded, the Company
intends to utilize the proceeds of such policies to settle the Plan obligations.
Under Internal Revenue Service regulations, the life insurance policies are
the
property of the Company and are available to satisfy the Company's general
creditors.
Effective
December 31, 2006, the Company adopted Statement of Financial Accounting
Standards No. 158, Employers
Accounting for Defined Benefit Pension and Other Postretirement
Plans
(“SFAS
No. 158”). SFAS No. 158 amends SFAS No. 87 and SFAS No. 106, which the Bank
previously has followed for accounting for its salary continuation plan.
SFAS
No.
158 amends previous applicable accounting statements and requires companies
to
better disclose, among other things, the funded status of benefit plans, and
to
recognize as a component of other comprehensive income, net of tax, the gains
or
losses and prior service costs or credits that arise during the period but
are
not recognized as components of net periodic benefit cost pursuant to FASB
Statement No. 87, Employers’
Accounting for Pensions,
or No.
106, Employers’
Accounting for Postretirement Benefits Other Than Pensions.
Amounts
recognized in accumulated other comprehensive income, including the gains or
losses, prior service costs or credits, and the transition asset or obligation
remaining from the initial application of Statements 87 and 106, are adjusted
as
they are subsequently recognized as components of net periodic benefit cost
pursuant to the recognition and amortization provisions of those
Statements.
In
addition to expanded disclosure requirements under the Statement, the Company
is
required to recognize in accumulated other comprehensive income, the amounts
that have not yet been recognized as components of net periodic benefit costs.
These unrecognized costs arise from of changes in estimated interest rates
used
in the calculation of net liabilities under the plan. Under SFAS No. 87 and
SFAS
No. 106, these differences were previously recognized over the remaining
required service period of the salary continuation contracts. SFAS No. 158
requires the Company to record those unrecognized periodic benefit costs from
previous period as a component of accumulated other comprehensive
income.
As
of
December 31, 2007 and 2006, the Company had approximately $142,000 and $281,000,
respectively, in unrecognized net periodic benefit costs arising from changes
in
interest rates used in calculating the current post-retirement liability
required under the plan. This amount represents the difference between the
plan
liabilities calculated under net present value calculations, and the net plan
liabilities actually recorded on the Company’s books at December 31, 2007 and
2006. Pursuant to the adoption of SFAS No. 158, the Company recorded $169,000
(net of tax of $112,000), as a component of other comprehensive income at
December 31, 2006. The average remaining life of the service terms of the Salary
Continuation contracts to which the unrecognized service costs related at the
time of adoption, was approximately two years. During the year ended December
31, 2007, approximately $140,000 of the unrecognized prior service cost was
recognized in earnings as additional salary expense, reflected as an adjustment
to accumulated other comprehensive income.
For
the
for the year ended December 31, 2006, a transition adjustment in the amount
of
$169,000 net of tax benefit of $112,000, was recognized as a component of the
ending balance of Accumulated Other Comprehensive Income/(Loss) on the Company’s
balance sheet as the result of the adoption of SFAS No. 158, “Employer’s
Accounting for Defined Benefit Pension and Other Postretirement Plans”. This
adjustment was misapplied as a component of Comprehensive Income on the
Company’s consolidated statement of income and comprehensive income for the year
ended December 31, 2006. The table below reflects the effects of the
misapplication of this adjustment at December 31, 2006.
|
(in
000’s)
|
As
Reported
|
Adjustment
|
As
Adjusted
|
|||||||
|
Other
comprehensive income (loss), net of tax
|
$
|
462
|
$
|
(169
|
)
|
$
|
631
|
|||
|
Comprehensive
income
|
$
|
13,822
|
$
|
(169
|
)
|
$
|
13,991
|
|||
83
The
Company has corrected the other comprehensive income presentations in the
financial statements for the fiscal years ended December 31, 2007 and 2006
to
reflect the adjusted amounts shown above.
Salary
continuation expense is included in salaries and benefits expense, and totaled
$504,000, $448,000, and $331,000 for the years ended December 31, 2007, 2006,
and 2005, respectively.
Officer
Supplemental Life Insurance Plan
During
2004, the Company purchased single premium Bank-owned life insurance policies
(BOLI) on certain officers with a portion of the death benefits available to
the
officers’ beneficiaries. The single premium paid at policy commencement of
the BOLI in 2004 totaled $9.0 million. Additional BOLI policies totaling
$227,000 and $579,000 were purchased during 2006 and 2005, respectively. The
BOLI’s initial net cash surrender value is equivalent to the premium paid, and
it adds income through non-taxable increases in its cash surrender value, net
of
the cost of insurance, plus any death benefits ultimately received by the
Company. The cash surrender value of these insurance policies totaled $10.2
million and $10.1 million at December 31, 2007 and December 31, 2006, and
is included on the consolidated balance sheet in cash surrender value of life
insurance. Income on these policies, net of expense, totaled approximately
$408,000, $400,000, and $353,000 for the years ended December 31, 2007,
2006 and 2005, respectively.
14.
Commitments and Contingent Liabilities
Lease
Commitments:
The
Company leases land and premises for its branch banking offices and
administration facilities. The initial terms of these leases expire at various
dates through 2019. Under the provisions of most of these leases, the Company
has the option to extend the leases beyond their original terms at rental rates
adjusted for changes reported in certain economic indices or as reflected by
market conditions. The total expense on land and premises leased under operating
leases was $877,000, $407,000, and $455,000 during 2007, 2006, and 2005,
respectively. Total rent expense of $877,000 for the year ended December 31,
2007 included approximately $165,000 related to adjustments made under SFAS
No.
13, “Accounting for Leases”.
During
the fourth quarter of 2007 the Company reviewed accounting methods for recording
rent expense under operating leases pursuant to SFAS No. 13 “Accounting for
Leases”. The Company had previously recognized periodic rent expense as those
contractual rent payments became payable to the lessor, rather than on a
straight-line basis throughout the life of the lease. The difference in
methodology was not previously considered material, but as the Company has
grown, it was determined that adjustments should be made to properly comply
with
SFAS No. 13. The expense adjustment to record the difference between the
contractual rental payment amounts and straight-line expense over the lease
terms as applicable under SFAS No. 13 totaled $165,000 ($95,000 net of tax,
and
less than $0.01 per share) and was recorded as a liability as of December 31,
2007. This timing difference will result in an increase of approximately $19,000
in the liability for rental obligations between December 31, 2007 and December
31, 2009, then should reverse and decline over the remaining term of the
Company’s leases through 2019.
Future
minimum rental commitments under existing non-cancelable leases as of December
31, 2007 are as follows:
|
(In
thousands):
|
||||
|
2007
|
$
|
637
|
||
|
2008
|
671
|
|||
|
2009
|
692
|
|||
|
2010
|
389
|
|||
|
2011
|
392
|
|||
|
Thereafter
|
1,403
|
|||
|
$
|
4,184
|
|||
Financial
Instruments with Off-Balance Sheet Risk:
The
Company is party to financial instruments with off-balance sheet risk which
arise in the normal course of business. These instruments may contain elements
of credit risk, interest rate risk and liquidity risk, and include commitments
to extend credit and standby letters of credit. The credit risk associated
with
these instruments is essentially the same as that involved in extending credit
to customers and is represented by the contractual amount indicated in the
table
below:
|
Contractual
amount -
December
31,
|
|||||||
|
(in
thousands)
|
2007
|
2006
|
|||||
|
Commitments
to extend credit
|
$
|
196,258
|
$
|
188,166
|
|||
|
Standby
letters of credit
|
6,726
|
4,936
|
|||||
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. Substantially all of
these commitments are at floating interest rates based on the Prime rate, and
most have fixed expiration dates. The Company evaluates each customer's
creditworthiness on a case-by-case basis, and the amount of collateral obtained,
if deemed necessary, is based on management's credit evaluation. Collateral
held
varies but includes accounts receivable, inventory, leases, property, plant
and
equipment, residential real estate and income-producing properties. Many of
the
commitments are expected to expire without being drawn upon and, as a result,
the total commitment amounts do not necessarily represent future cash
requirements of the Company.
Standby
letters of credit are generally unsecured and are issued by the Company to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loans to customers. The Company’s letters of credit are short-term
guarantees and have terms from less than one month to approximately 2.5 years.
At December 31, 2007, the maximum potential amount of future undiscounted
payments the Company could be required to make under outstanding standby letters
of credit totaled $6.7 million.
15.
Fair Value Measurements and Disclosure
The
following summary disclosures are made in accordance with the provisions of
Statement of Financial Accounting Standards No. 107, “Disclosures About Fair
Value of Financial Instruments,” which requires the disclosure of fair value
information about both on- and off- balance sheet financial instruments where
it
is practicable to estimate that value.
|
|
December
31, 2007
|
December
31, 2006
|
|||||||||||
|
Estimated
|
Estimated
|
||||||||||||
|
|
Carrying
|
Fair
|
Carrying
|
Fair
|
|||||||||
|
(In
thousands)
|
Amount
|
Value
|
Amount
|
Value
|
|||||||||
|
Financial
Assets:
|
|||||||||||||
|
Cash
and cash equivalents
|
$
|
25,300
|
$
|
25,300
|
$
|
43,068
|
$
|
43,068
|
|||||
|
Interest-bearing
deposits
|
2,909
|
2,918
|
7,893
|
7,779
|
|||||||||
|
Investment
securities
|
89,415
|
89,415
|
83,366
|
83,366
|
|||||||||
|
Loans,
net
|
596,481
|
594,054
|
499,569
|
494,695
|
|||||||||
|
Bank-owned
life insurance
|
13,852
|
13,852
|
13,668
|
13,668
|
|||||||||
|
Investment
in limited partnerships
|
3,134
|
3,134
|
3,564
|
3,564
|
|||||||||
|
Investment
in bank stock
|
372
|
372
|
0
|
0
|
|||||||||
|
Interest
rate swap contracts
|
(12
|
)
|
(12
|
)
|
(320
|
)
|
(320
|
)
|
|||||
|
Financial
Liabilities:
|
|||||||||||||
|
Deposits
|
634,617
|
633,408
|
587,127
|
587,438
|
|||||||||
|
Borrowings
|
32,280
|
32,162
|
0
|
0
|
|||||||||
|
Junior
Subordinated Debt
|
13,341
|
13,341
|
15,464
|
15,464
|
|||||||||
|
Commitments
to extend credit
|
—
|
—
|
—
|
—
|
|||||||||
|
Standby
letters of credit
|
—
|
—
|
—
|
—
|
|||||||||
Effective
January 1, 2007, the Company adopted SFAS 157, “Fair
Value Measurements”, concurrent with its early adoption of SFAS No. 159.
SFAS
No.
157 clarifies the definition of fair value, describes methods generally used
to
appropriately measure fair value in accordance with generally accepted
accounting principles and expands fair value disclosure requirements. Fair
value
is defined in SFAS No. 157 as the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. The statement applies whenever other
accounting pronouncements require or permit fair value
measurements.
84
The
fair
value hierarchy under SFAS No. 157 prioritizes the inputs to valuation
techniques used to measure fair value into three broad levels (Level 1, Level
2,
and Level 3). Level 1 inputs are unadjusted quoted prices in active markets
(as
defined) for identical assets or liabilities that the Company has the ability
to
access at the measurement date. Level 2 inputs are inputs other than quoted
prices included within Level 1 that are observable for the asset or liability,
either directly or indirectly. Level 3 inputs are unobservable inputs for the
asset or liability, and reflect the Company’s own assumptions about the
assumptions that market participants would use in pricing the asset or liability
(including assumptions about risk) in a principal market.
The
Company performs fair value measurements on certain assets and liabilities
as
the result of the application of accounting guidelines and pronouncements that
were relevant prior to the adoption of SFAS No. 157. Some fair value
measurements, such as for available-for-sale securities, junior subordinated
debt, impaired loans that are collateral dependent, and interest rate swaps,
are
performed on a recurring basis, while others, such as impairment of goodwill
and
other intangibles, are performed on a nonrecurring basis.
The
following tables summarize the Company’s assets and liabilities that were
measured at fair value on a recurring basis during the year ended December
31,
2007 (in 000’s):
|
December
31,
|
Quoted
Prices in Active Markets for Identical Assets
|
Significant
Other Observable Inputs
|
Significant
Unobservable Inputs
|
||||||||||
|
Description
of Assets
|
2007
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||
|
AFS
Securities
|
$
|
89,415
|
$
|
89,415
|
|||||||||
|
Interest
Rate Swap
|
(12
|
)
|
($12
|
)
|
|||||||||
|
Impaired
Loans
|
16,175
|
13,964
|
$
|
2,211
|
|||||||||
|
Total
|
$
|
105,578
|
$
|
89,415
|
$
|
13,952
|
$
|
2,211
|
|||||
|
December
31,
|
Quoted
Prices in Active Markets for Identical Assets
|
Significant
Other Observable Inputs
|
Significant
Unobservable Inputs
|
||||||||||
|
Description
of Liabilities
|
2007
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||
|
Junior
subordinated debt
|
$
|
13,341
|
$
|
13,341
|
|||||||||
|
Total
|
$
|
13,341
|
$
|
0
|
$
|
13,341
|
$
|
0
|
|||||
Upon
adoption of SFAS No. 159 on January 1, 2007, the Company elected the fair value
measurement option for all the Company’s pre-existing junior subordinated
debentures, and subsequently for new junior subordinated debentures issued
during July 2007 under USB Capital Trust II. The fair value of the debentures
was determined based upon discounted cash flows utilizing observable market
rates and credit characteristics for similar instruments. In its analysis,
the
Company used characteristics that distinguish market participants generally
use,
and considered factors specific to (a) the liability, (b) the principal (or
most
advantageous) market for the liability, and (c) market participants with whom
the reporting entity would transact in that market. The adjustment for fair
value at adoption was recorded as a cumulative-effect adjustment to the opening
balance of retained earnings at January 1, 2007. Fair value adjustments
subsequent to adoption were recorded in current earnings.
The
following tables summarize the Company’s assets and liabilities that were
measured at fair value on a nonrecurring basis during the year ended December
31, 2007 (in 000’s):
|
(in
000’s)
Dec
31
|
Quoted
Prices in Active Markets for Identical Assets
|
Significant
Other Observable Inputs
|
Significant
Unobservable Inputs
|
||||||||||
|
Description
of Assets
|
2007
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||
|
Business
combination:
|
|||||||||||||
|
Securities
- AFS
|
$
|
7,414
|
$
|
7,414
|
|||||||||
|
Loans,
net allowance for losses
|
62,426
|
$
|
62,426
|
||||||||||
|
Premises
and Equipment
|
729
|
|
729
|
||||||||||
|
Goodwill
|
8,790
|
8,790
|
|||||||||||
|
Other
assets
|
6,928
|
6,928
|
|||||||||||
|
Total
assets
|
$
|
86,287
|
$
|
7,414
|
$
|
0
|
$
|
78,873
|
|||||
85
|
(in
000’s)
Dec
31,
|
Quoted
Prices in Active Markets for Identical Assets
|
Significant
Other Observable Inputs
|
Significant
Unobservable Inputs
|
||||||||||
|
Description
of Liabilities
|
2007
|
(Level
1)
|
(Level
2)
|
(Level
3)
|
|||||||||
|
Business
combination:
|
|||||||||||||
|
Deposits
(net CDI)
|
$
|
66,600
|
$
|
66,600
|
|||||||||
|
Other
liabilities
|
286
|
286
|
|||||||||||
|
Total
liabilities
|
$
|
66,886
|
$
|
0
|
$
|
0
|
$
|
66,886
|
|||||
The
Company completed its merger with Legacy Bank in February 2007. The merger
transaction was accounted for using the purchase accounting method, and resulted
in the purchase price being allocated to the assets acquired and liabilities
assumed from Legacy Bank based on the fair value of those assets and
liabilities. The allocations of purchase price based upon the fair value of
assets acquired and liabilities assumed were finalized during the fourth quarter
of 2007. The fair value measurements for Legacy’s loan portfolio included
certain market rate assumptions on segmented portions of the loan portfolio
with
similar credit characteristics, and credit risk assumptions specific to the
individual loans within that portfolio. Available-for sale securities were
valued based upon open-market quotes obtained from third-party sources. Legacy’s
deposits were valued based upon anticipated net present cash flows related
to
Legacy’s deposit base, and resulted in a core deposit intangible (CDI)
adjustment of $3.0 million that is carried as an asset on the Company’s balance
sheet. Assumptions used to determine the CDI included anticipated costs of,
and
revenues generated by, those deposits, as well as the estimated life of the
deposit base. Other assets and liabilities generally consist of short-term
items
including cash, overnight investments, and accrued interest receivable or
payable, and as such, it was determined that carrying value approximated fair
value.
The
following tables provide a reconciliation of assets and liabilities at fair
value using significant unobservable inputs (Level 3) on both a recurring
(impaired loans) and nonrecurring (business combination) basis during the period
(in 000’s):
|
Reconciliation
of Assets:
|
Impaired
Loans
|
|||
|
Beginning
balance
|
$
|
1,521
|
||
|
Total
gains or (losses) included in earnings (or changes in net
assets)
|
(203
|
)
|
||
|
Transfers
in and/or out of Level 3
|
893
|
|||
|
Ending
balance
|
$
|
2,211
|
||
|
The
amount of total gains or (losses) for the period included in earnings
(or
changes in net assets) attributable to the change in unrealized gains
or
losses relating to assets still held at the reporting date
|
($203
|
)
|
||
The
following methods and assumptions were used in estimating the fair values of
financial instruments:
Cash
and Cash Equivalents
- The
carrying amounts reported in the balance sheets for cash and cash equivalents
approximate their estimated fair values.
Interest-bearing
Deposits - Interest
bearing deposits in other banks consist of fixed-rate certificates of deposits.
Accordingly, fair value has been estimated based upon interest rates currently
being offered on deposits with similar characteristics and
maturities.
Investments
-
Available-for-sale securities are valued based upon open-market quotes obtained
from reputable third-party brokers. Market pricing is based upon specific CUSIP
identification for each individual security.
Loans
- Fair
values of variable rate loans, which reprice frequently and with no significant
change in credit risk, are based on carrying values. Fair values for all other
loans, except impaired loans, are estimated using discounted cash flows over
their remaining maturities, using interest rates at which similar loans would
currently be offered to borrowers with similar credit ratings and for the same
remaining maturities.
Impaired
Loans - Fair
value measurements for impaired loans are performed pursuant to SFAS No. 114,
and are based upon either collateral values supported by appraisals, or observed
market prices. The change in fair value of impaired assets that were valued
based upon level three inputs was approximately $690,000 for the year ended
December 31, 2007. This loss is not recorded directly as an adjustment to
current earnings or comprehensive income, but rather as an adjustment component
in determining the overall adequacy of the loan loss reserve. Such adjustments
to the estimated fair value of impaired loans may result in increases or
decreases to the provision for credit losses recorded in current
earnings.
Bank-owned
Life Insurance -
Fair
values of life insurance policies owned by the Company are based upon the
insurance contract’s cash surrender value.
Investment
in limited partnerships -
Investment in limited partnerships which invest in qualified low-income housing
projects generate tax credits to the Company. The investment is amortized using
the effective yield method based upon the estimated remaining utilization of
low-income housing tax credits. The Company’s carrying value approximates fair
value.
Investments
in Bank Stock -
Equity
investments in bank stock are carried at fair value. Fair values are based
upon
quoted market prices.
Interest
Rate Swaps
- The
Company records interest rate swap contracts at fair value on the balance sheet.
The fair value of interest rate swap contracts is based on the discounted net
present value of the swap using third party dealer quotes.
Deposits
- In
accordance with SFAS No. 107, fair values for transaction and savings accounts
are equal to the respective amounts payable on demand at December 31, 2007
and
2006 (i.e., carrying amounts). The Company believes that the fair value of
these
deposits is clearly greater than that prescribed by SFAS No. 107. Fair values
of
fixed-maturity certificates of deposit were estimated using the rates currently
offered for deposits with similar remaining maturities.
Borrowings
-
Borrowings consist of federal funds sold, securities sold under agreements
to
repurchase, and other short-term borrowings. Fair values of borrowings were
estimated using the rates currently offered for borrowings with similar
remaining maturities.
Junior
Subordinated Debt
- The
fair value of junior subordinated debt is estimated using discounted cash flows
based upon rates currently offered for junior subordinated debt with similar
remaining repricing characteristics.
86
Off-balance
sheet Instruments
-
Off-balance sheet instruments consist of commitments to extend credit, standby
letters of credit and derivative contracts. The contract amounts of commitments
to extend credit and standby letters of credit are disclosed in Note 14. Fair
values of commitments to extend credit are estimated using the interest rate
currently charged to enter into similar agreements, taking into account the
remaining terms of the agreements and the present counterparties’ credit
standing. There was no material difference between the contractual amount and
the estimated value of commitments to extend credit at December 31, 2007 and
2006.
Fair
values of standby letters of credit are based on fees currently charged for
similar agreements. The fair value of commitments generally approximates the
fees received from the customer for issuing such commitments. These fees are
deferred and recognized over the term of the commitment, and are not material
to
the Company’s consolidated balance sheet and results of operations.
16.
Regulatory Matters
Capital
Guidelines
-
The
Company (on a consolidated basis) and the Bank are subject to various regulatory
capital requirements adopted by the Board of Governors of the Federal Reserve
System (“Board of Governors”). Failure to meet minimum capital requirements can
initiate certain mandates and possible additional discretionary actions by
regulators that, if undertaken, could have a direct material effect on the
Company’s consolidated financial statements. Under capital adequacy guidelines
and the regulatory framework for prompt corrective action, the consolidated
Company and the Bank must meet specific capital guidelines that involve
quantitative measures of their assets, liabilities, and certain off-balance
sheet items as calculated under regulatory accounting practices. The capital
amounts and classification are also subject to qualitative judgments by the
regulators about components, risk weightings, and other factors. Prompt
corrective action provisions are not applicable to bank holding companies.
Quantitative
measures established by regulation to ensure capital adequacy require insured
institutions to maintain a minimum leverage ratio of Tier 1 capital (the sum
of
common stockholders' equity, noncumulative perpetual preferred stock and
minority interests in consolidated subsidiaries, minus intangible assets,
identified losses and investments in certain subsidiaries, plus unrealized
losses or minus unrealized gains on available for sale securities) to total
assets. Institutions which have received the highest composite regulatory rating
and which are not experiencing or anticipating significant growth are required
to maintain a minimum leverage capital ratio of 3% of Tier 1 capital to total
assets. All other institutions are required to maintain a minimum leverage
capital ratio of at least 100 to 200 basis points above the 3% minimum
requirement.
|
To
Be Well Capitalized Under
|
|||||||||||||||||||
|
For
Capital
|
Prompt
Corrective
|
||||||||||||||||||
|
Actual
|
Adequacy
Purposes
|
Action
Provisions
|
|||||||||||||||||
|
(In
thousands)
|
Amount
|
Ratio
|
Amount
|
Ratio
|
Amount
|
Ratio
|
|||||||||||||
|
As
of December 31, 2007 (Company):
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
$
|
89,136
|
12.18
|
%
|
$
|
58,531
|
8.00
|
%
|
N/A
|
N/A
|
|||||||||
|
Tier
1 Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
79,986
|
10.93
|
%
|
29,265
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
Tier
1 Capital ( to Average Assets)
|
79,986
|
10.30
|
%
|
23,299
|
3.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
As
of December 31, 2007 (Bank):
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
$
|
86,294
|
11.79
|
%
|
$
|
58,531
|
8.00
|
%
|
$
|
73,164
|
10.00
|
%
|
|||||||
|
Tier
1 Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
77,144
|
10.54
|
%
|
29,265
|
4.00
|
%
|
43,898
|
6.00
|
%
|
||||||||||
|
Tier
1 Capital ( to Average Assets)
|
77,144
|
9.93
|
%
|
23,299
|
3.00
|
%
|
38,832
|
5.00
|
%
|
||||||||||
|
As
of December 31, 2006 - (Company):
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
$
|
84,826
|
13.85
|
%
|
$
|
48,989
|
8.00
|
%
|
N/A
|
N/A
|
|||||||||
|
Tier
1 Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
77,891
|
12.72
|
%
|
24,494
|
4.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
Tier
1 Capital ( to Average Assets)
|
77,891
|
11.55
|
%
|
20,228
|
3.00
|
%
|
N/A
|
N/A
|
|||||||||||
|
As
of December 31, 2006 - (Bank):
|
|||||||||||||||||||
|
Total
Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
$
|
82,644
|
13.52
|
%
|
$
|
48,884
|
8.00
|
%
|
$
|
61,105
|
10.00
|
%
|
|||||||
|
Tier
1 Capital (to Risk Weighted
|
|||||||||||||||||||
|
Assets)
|
75,709
|
12.39
|
%
|
24,442
|
4.00
|
%
|
36,663
|
6.00
|
%
|
||||||||||
|
Tier
1 Capital ( to Average Assets)
|
75,709
|
11.23
|
%
|
20,228
|
3.00
|
%
|
33,714
|
5.00
|
%
|
||||||||||
87
The
Board
of Governors has also adopted a statement of policy, supplementing its leverage
capital ratio requirements, which provides definitions of qualifying total
capital (consisting of Tier 1 capital and supplementary capital, including
the
allowance for loan losses up to a maximum of 1.25% of risk-weighted assets)
and
sets forth minimum risk-based capital ratios of capital to risk-weighted assets.
Insured institutions are required to maintain a ratio of qualifying total
capital to risk weighted assets of 8%, at least one-half of which must be in
the
form of Tier 1 capital. Management believes, as of December 31, 2007, that
the
Company and the Bank meet all capital adequacy requirements to which they are
subject.
As
of
December 31, 2007 and 2006, the most recent notifications from the Bank’s
regulators categorized the Bank as well-capitalized under the regulatory
framework for prompt corrective action. To be categorized as well-capitalized,
the Bank must maintain minimum total capital and Tier 1 capital (as defined)
to
risk-based assets (as defined), and a minimum leverage ratio of Tier 1 capital
to average assets (as defined) as set forth in the proceeding discussion. There
are no conditions or events since the notification that management believes
have
changed the institution’s category.
Under
regulatory guidelines, the $15 million in Trust Preferred Securities issued
by
USB Capital Trust II in July of 2007 qualifies as Tier 1 capital up to 25%
of
Tier 1 capital. Any additional portion of Trust Preferred Securities qualifies
as Tier 2 capital.
Dividends
-
Dividends paid to shareholders are paid by the bank holding company, subject
to
restrictions set forth in the California General Corporation Law. The primary
source of funds with which dividends will be paid to shareholders will come
from
cash dividends received by the Company from the Bank. Year-to-date as of
December 31, 2007, the Company received $17.6 million in cash dividends from
the
Bank, from which the Company has declared $6.0 million in dividends to
shareholders.
Under
California state banking law, the Bank may not pay cash dividends in an amount
which exceeds the lesser of the retained earnings of the Bank or the Bank’s net
income for the last three fiscal years (less the amount of distributions to
shareholders during that period of time). If the above test is not met, cash
dividends may only be paid with the prior approval of the California State
Department of Financial Institutions, in an amount not exceeding the greater
of:
(i) the Bank’s retained earnings; (ii) its net income for the last fiscal year;
or (iii) its net income for the current fiscal year. As of December 31, 2007,
approximately $7.5 million was available to the Bank for cash dividend
distributions without prior approval. Year-to-date, the Bank has paid dividends
of $17.6 million to the Company.
Cash
Restrictions
- The
Bank is required to maintain average reserve balances with the Federal Reserve
Bank. During 2005, the Company implemented a deposit reclassification program,
which allows the Company to reclassify a portion of transaction accounts to
non-transaction accounts for reserve purposes. The deposit reclassification
program was provided by a third-party vendor, and has been approved by the
Federal Reserve Bank. At both December 31, 2007 and 2006, the Bank’s qualifying
balance with the Federal Reserve Bank was $25,000 consisting of vault cash
and
balances.
17.
Supplemental Cash Flow Disclosures
|
|
Years
Ended December 31,
|
|||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
|||||||
|
Cash
paid during the period for:
|
||||||||||
|
Interest
|
$
|
21,147
|
$
|
13,574
|
$
|
8,949
|
||||
|
Income
Taxes
|
6,411
|
8,287
|
5,689
|
|||||||
|
Noncash
investing activities:
|
||||||||||
|
Loans
transferred to foreclosed property
|
7,837
|
0
|
4,311
|
|||||||
|
Dividends
declared not paid
|
1,483
|
1,413
|
1,135
|
|||||||
|
Supplemental
disclosures related to acquisitions:
|
||||||||||
|
Deposits
|
69,600
|
—
|
—
|
|||||||
|
Other
liabilities
|
286
|
—
|
—
|
|||||||
|
Securities
available for sale
|
(7,414
|
)
|
—
|
—
|
||||||
|
Loans,
net of allowance for loan loss
|
(62,426
|
)
|
—
|
—
|
||||||
|
Premises
and equipment
|
(728
|
)
|
—
|
—
|
||||||
|
Intangibles
|
(11,085
|
)
|
—
|
—
|
||||||
|
Accrued
interest and other assets
|
(3,396
|
)
|
—
|
—
|
||||||
|
Stock
issued
|
21,536
|
—
|
—
|
|||||||
|
Net
cash and equivalents acquired
|
6,373
|
—
|
—
|
|||||||
18.
Net Income Per Share
The
following table provides a reconciliation of the numerator and the denominator
of the basic EPS computation with the numerator and the denominator of the
diluted EPS computation. (Weighted average shares have been adjusted to give
retroactive recognition for 2-for-1 stock split during May
2006):
|
Years
Ended December 31,
|
||||||||||
|
(In
thousands, except earnings per share data)
|
2007
|
|
2006
|
|
2005
|
|||||
|
Net
income available to common shareholders
|
$
|
11,257
|
$
|
13,360
|
$
|
11,008
|
||||
|
Weighted
average shares outstanding
|
11,926
|
11,344
|
11,370
|
|||||||
|
Add:
dilutive effect of stock options
|
35
|
118
|
84
|
|||||||
|
Weighted
average shares outstanding
|
||||||||||
|
adjusted
for potential dilution
|
11,961
|
11,462
|
11,454
|
|||||||
|
Basic
earnings per share
|
$
|
0.94
|
$
|
1.18
|
$
|
0.97
|
||||
|
Diluted
earnings per share
|
$
|
0.94
|
$
|
1.17
|
$
|
0.96
|
||||
|
Anti-dilutive
shares excluded from earnings
per share calculation
|
57
|
33
|
30
|
|||||||
19.
Other Comprehensive Income
The
following table provides a
reconciliation of the amounts included in comprehensive
income:
|
Years
Ended December 31
|
||||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
|||||||
|
Unrealized
(loss) gain on available-for-sale securities:
|
||||||||||
|
Unrealized
(loss) gain on sale securities - net of income
|
||||||||||
|
tax
(benefit) of $605, $253, and $(644)
|
$
|
909
|
$
|
379
|
$
|
(966
|
)
|
|||
|
Less:
Reclassification adjustment for loss (gain) on sale of
|
||||||||||
|
available-for-sale
securities included in net income -
|
||||||||||
|
net
of income tax (benefit) of $0, $11, and $65
|
0
|
(16
|
)
|
(98
|
)
|
|||||
|
Net
unrealized (loss) gain on available-for-sale securities -
|
||||||||||
|
net
income tax (benefit) of $605, $242, and $(709)
|
$
|
909
|
$
|
363
|
$
|
(1,064
|
)
|
|||
|
Unrealized
loss on interest rate swaps:
|
||||||||||
|
Unrealized
losses arising during period - net of income tax
|
||||||||||
|
benefit
of $110, $150 and $24
|
$
|
(165
|
)
|
$
|
(225
|
)
|
$
|
(36
|
)
|
|
|
Less:
reclassification adjustments to interest income
|
310
|
493
|
246
|
|||||||
|
Net
change in unrealized loss on interest rate swaps -
|
||||||||||
|
net
of income tax $97, $140 and $24
|
$
|
145
|
$
|
268
|
$
|
210
|
||||
|
Previously
unrecognized past service costs of employee
benefit plans (net tax of $55)
|
$ |
85
|
— | — | ||||||
|
Total
other comprehensive income (loss)
|
$
|
1,137
|
$
|
631
|
$
|
(854
|
)
|
|||
88
20.
Derivative Financial Instruments and Hedging
Activities
As
part
of its overall risk management, the Company pursues various asset and liability
management strategies, which may include obtaining derivative financial
instruments to mitigate the impact of interest fluctuations on the Company’s net
interest margin. During the second quarter of 2003, the Company entered into
an
interest rate swap agreement with the purpose of minimizing interest rate
fluctuations on its interest rate margin and equity.
Under
the
interest rate swap agreement, the Company receives a fixed rate and pays a
variable rate based on the Prime Rate (“Prime”). The swap qualifies as a cash
flow hedge under SFAS No. 133, “Accounting for Derivative Instruments and
Hedging Activities”, as amended, and is designated as a hedge of the variability
of cash flows the Company receives from certain variable-rate loans indexed
to
Prime. In accordance with SFAS No. 133, the swap agreement is measured at fair
value and reported as an asset or liability on the consolidated balance sheet.
The portion of the change in the fair value of the swap that is deemed effective
in hedging the cash flows of the designated assets are recorded in accumulated
other comprehensive income and reclassified into interest income when such
cash
flow occurs in the future. Any ineffectiveness resulting from the hedge is
recorded as a gain or loss in the consolidated statement of income as part
of
noninterest income.
At
December 31, 2007 and 2006, the information pertaining to the outstanding
interest rate swap is as follows:
|
December
31,
|
December
31,
|
||||||
|
(000’s
in millions)
|
2007
|
2006
|
|||||
|
Notional
amount
|
$
|
1,753
|
$
|
14,107
|
|||
|
Weighted
average pay rate
|
8.05
|
%
|
7.86
|
%
|
|||
|
Weighted
average receive rate
|
4.88
|
%
|
4.88
|
%
|
|||
|
Weighted
average maturity in years
|
0.3
|
1.0
|
|||||
|
Unrealized
loss relating to interest rate swaps
|
$
|
12
|
$
|
320
|
|||
The
amortizing hedge has a remaining notional value of $1.8 million and a duration
of approximately three months. As of December 31, 2007, the maximum length
of
time over which the Company is hedging its exposure to the variability of future
cash flows is approximately nine months. As of December 31, 2007, the net loss
amounts in accumulated other comprehensive income associated with these cash
flows totaled $2,000. During the year ended December 31, 2007, $310,000 was
reclassified from accumulated other comprehensive income as a reduction to
interest income. As
of December 31, 2007, the amounts in accumulated OCI associated with these
cash
flows that are expected to be reclassified into interest income during the
remainder of the hedge instrument in 2008 total $9,000.
The
Company performed a quarterly analysis of the effectiveness of the interest
rate
swap agreement at December 31, 2007. As a result of a correlation analysis,
the
Company has determined that the swap remains highly
effective in achieving offsetting cash flows attributable to the hedged risk
during the term of the hedge and, therefore, continues to qualify for hedge
accounting under the guidelines of SFAS No. 133. However,
during
the
second quarter of 2006, the Company determined that the underlying loans being
hedged were paying off faster than the notional value of the hedge instrument
was amortizing. This difference between the notional value of the hedge and
the
underlying hedged assets is considered an “overhedge” pursuant to SFAS No. 133
guidelines and may constitute ineffectiveness if the difference is other than
temporary. The Company determined during 2006 that the difference was other
than
temporary and, as a result, reclassified a net total of $75,000 of the pretax
hedge loss reported in other comprehensive income into earnings during 2006.
As
of December 31, 2007, the notional value of the hedge was still in excess of
the
value of the underlying loans being hedged by approximately $1.3 million, but
had improved from the $3.3 million difference existing at December 31, 2006.
As
a result, the Company recorded a pretax hedge gain related to swap
ineffectiveness of approximately $66,000 during the December 31, 2007. Amounts
recognized as hedge ineffectiveness gains or losses are reflected in noninterest
income.
21.
Investment in Bank Stock
During
December 2007, the Company purchased 33,854 common shares of Northern California
Bancorp, Inc. (NRLB) in a privately negotiated transaction for a price of $11.50
per share or approximately $389,000. This purchase equals approximately 1.9%
of
NRLB’s outstanding stock and will be treated as an marketable equity investment
by the Company with changes in fair value recorded in earnings. NRLB is the
holding company of Monterey County Bank. At December 31, 2007, the Company
recorded a loss in its equity investment in NRLB of $17,000 based on a quoted
market price of $11.00 per share at that date. The Company may purchase
additional common shares of NRLB as shares become available.
89
22.
Stock Split
On
March
28, 2006, the Company’s Board of Directors approved a 2-for-1 stock split of the
Company’s no par common stock effected in the form of a 100% stock dividend. The
stock dividend was payable May 1, 2006 to shareholders of record as of April
7,
2006. Effective May 1, 2006, each shareholder received one additional share
for
each common share held as of the record date. All periods presented in the
financial statements have been restated to reflect the effect of the 2-for-1
stock split.
23.
Common Stock Repurchase Plan
During
August 2001, the Company’s Board of Directors approved a plan to repurchase, as
conditions warrant, up to 280,000 shares (effectively 580,000 shares adjusted
for 2-for-1 stock split in May 2006) of the Company’s common stock on the open
market or in privately negotiated transactions. The duration of the program
is
open-ended and the timing of the purchases will depend on market conditions.
On
February 25, 2004, the Company announced another stock repurchase plan under
which the Board of Directors approved a plan to repurchase, as conditions
warrant, up to 276,500 shares (effectively 553,000 shares adjusted for 2-for-1
stock split in May 2006) of the Company's common stock on the open market or
in
privately negotiated transactions. As with the first plan, the duration of
the
new program is open-ended and the timing of purchases will depend on market
conditions. Concurrent with the approval of the new repurchase plan, the Board
terminated the 2001 repurchase plan. During
the year ended December 31, 2005, 13,081 shares (26,162 shares effected for
2006
2-for-1 stock split) were repurchased at a total cost of $377,000 and an average
price per share of $28.92 ($14.46 effected for 2006 2-for-1 stock split). During
the year ended December 31, 2006, 108,005 shares were repurchased at a total
cost of $2.4 million and an average price per share of $22.55.
On
May
16, 2007, the Company announced a third stock repurchase plan to repurchase,
as conditions warrant, up to 610,000 shares of the Company's common stock on
the
open market or in privately negotiated transactions. The repurchase plan
represents approximately 5.00% of the Company's currently outstanding common
stock. The duration of the program is open-ended and the timing of purchases
will depend on market conditions. Concurrent with the approval of the new
repurchase plan, the Company canceled the remaining 75,733 shares available
under the 2004 repurchase plan.
During
the year ended December 31, 2007, 512,332 shares were repurchased at a total
cost of $10.1 million and an average per share price of $19.71. Of the shares
repurchased during 2007, 166,660 shares were repurchased under the 2004 plan
at
an average cost of $20.46 per shares, and 345,672 shares were repurchased under
the 2007 plan at an average cost of $19.35 per shares.
24.
Business Combination
On
February 16, 2007, the Company acquired 100 percent of the outstanding common
shares of Legacy Bank, N.A., located in Campbell, California. At merger, Legacy
Bank’s one branch was merged with and into United Security Bank, a wholly owned
subsidiary of the Company. The purchase of Legacy Bank provided the Company
with
an opportunity to expand its market area into Santa Clara County and to serve
a
loyal and growing small business niche and individual client base build by
Legacy.
The
aggregate purchase price for Legacy was $21.7 million, which included $177,000
in direct acquisition costs related to the merger. At the date of merger, Legacy
Bank had 1,674,373 shares of common stock outstanding. Based upon an exchange
rate of approximately .58 shares of the Company’s stock for each share of Legacy
stock, Legacy shareholders received 976,411 shares of the Company’s common
stock, amounting to consideration of approximately $12.86 per Legacy common
share.
Legacy’s
results of the operations have been included in the Company’s results beginning
February 17, 2007.
During
the second quarter of 2007, the Company re-evaluated the preliminary estimate
of
the core deposit intangible related to savings accounts acquired from Legacy
and
determined that the initial run-off of those deposits was faster than originally
anticipated. As a result, the Company reduced the core deposits intangible
by
approximately $215,000 from the amount reported at March 31, 2007.
Correspondingly, resultant goodwill was increased by that same $215,000. During
the fourth quarter of 2007 recorded the final purchase accounting adjustments
which reflected Legacy’s final book-to-tax deferred tax amounts, and other
deferred tax adjustments related to purchase accounting guidelines under SFAS
No. 141. The result of adjustments made during the fourth quarter of 2007 was
to
increase the recorded NOL benefit by $22,000, record deferred tax liabilities
of
$727,000, and to increase goodwill by $705,000.
90
The
following summarizes the purchase and the resultant allocation to
fair-market-value adjustments and goodwill:
|
Purchase
Price:
|
||||
|
Total
value of the Company's common stock exchanged
|
$
|
21,536
|
||
|
Direct
acquisition costs
|
177
|
|||
|
Total
purchase price
|
21,713
|
|||
|
Allocation
of Purchase Price:
|
||||
|
Legacy's
shareholder equity
|
8,588
|
|||
|
Estimated
adjustments to reflect assets acquired and
liabilities assumed at fair value:
|
||||
|
Investments
|
23
|
|||
|
Loans
|
(118
|
)
|
||
|
Deferred
taxes
|
1,430
|
|||
|
Core
Deposit Intangible
|
3,000
|
|||
|
Estimated
fair value of net assets acquired
|
12,923
|
|||
|
Goodwill
resulting from acquisition
|
$
|
8,790
|
||
The
following condensed balance sheet summarizes the amount assigned for each major
asset and liability category of Legacy at the merger date:
|
Assets:
|
||||
|
Cash
|
$
|
3,173
|
||
|
Federal
Funds Purchased
|
3,200
|
|||
|
Securities
available for sale
|
7,414
|
|||
|
Loans,
net of allowance for loan losses
|
62,426
|
|||
|
Premises
and equipment
|
729
|
|||
|
Deferred
taxes
|
1,430
|
|||
|
Core
deposit intangibles
|
3,000
|
|||
|
Goodwill
|
8,790
|
|||
|
Accrued
interest and other assets
|
1,437
|
|||
|
Total
Assets
|
$
|
91,599
|
||
|
Liabilities:
|
||||
|
Deposits:
|
||||
|
Non-interest
bearing
|
$
|
17,262
|
||
|
Interest-bearing
|
52,338
|
|||
|
Total
deposits
|
$
|
69,600
|
||
|
Accrued
interest payable and other liabilities
|
286
|
|||
|
Total
liabilities
|
$
|
69,886
|
||
|
Net
assets assigned to purchase
|
$
|
21,713
|
||
The
merger transaction was accounted for using the purchase accounting method,
and
resulted in the purchase price being allocated to the assets acquired and
liabilities assumed from Legacy Bank based on the fair value of those assets
and
liabilities. The allocations of purchase price based upon the fair value of
assets acquired and liabilities assumed were finalized during the fourth quarter
of 2007. Management believes the Company will be able to fully utilize the
net
operating loss carry-forward (NOL) obtained in the Legacy merger. The Company
has utilized a fair value approach for Legacy’s loan portfolio which includes
certain market rate assumptions on segmented portions of the loan portfolio
with
similar credit characteristics, and credit risk assumptions specific to the
individual loans within that portfolio.
Core
deposit intangibles totaling $3.0 million will be amortized for financial
statement purposes over an estimated life of approximately 7 years using a
method that approximates the interest method. Core deposit intangibles will
be
reviewed for impairment on an annual basis.
91
Goodwill
totaling $8.8 million will not be amortized for book purposes under current
accounting guidelines. Because the merger was a tax-deferred stock-for-stock
purchase, goodwill is not deductible for tax purposes. Goodwill will be reviewed
for impairment on an annual basis.
25.
Parent Company Only Financial Statements
The
following are the condensed financial statements of United Security Bancshares
and should be read in conjunction with the consolidated financial
statements:
|
United
Security Bancshares - (parent only)
|
|||||||
|
Balance
Sheets - December 31, 2007 and 2006
|
|||||||
|
(In
thousands)
|
2007
|
2006
|
|||||
|
Assets
|
|||||||
|
Cash
and equivalents
|
$
|
2,546
|
$
|
2,417
|
|||
|
Investment
in bank subsidiary
|
94,589
|
79,835
|
|||||
|
Investment
in nonbank entity
|
122
|
122
|
|||||
|
Investment
in bank stock
|
372
|
0
|
|||||
|
Other
assets
|
470
|
944
|
|||||
|
Total
assets
|
$
|
98,099
|
$
|
83,318
|
|||
|
|
|||||||
|
Liabilities
& Shareholders' Equity
|
|||||||
|
Liabilities:
|
|||||||
|
Junior
subordinated debt securities (at fair value) 12/31/07)
|
$
|
13,341
|
$
|
15,464
|
|||
|
Accrued
interest payable
|
0
|
613
|
|||||
|
Deferred
taxes
|
998
|
0
|
|||||
|
Other
liabilities
|
1,329
|
1,199
|
|||||
|
Total
liabilities
|
15,668
|
17,276
|
|||||
|
|
|||||||
|
Shareholders'
Equity:
|
|||||||
|
Common
stock, no par value
|
|||||||
|
20,000,000
shares authorized, 11,855,192 and 11,301,113
|
|||||||
|
issued
and outstanding, in 2007 and 2006
|
32,587
|
20,448
|
|||||
|
Retained
earnings
|
49,997
|
46,884
|
|||||
|
Accumulated
other comprehensive loss
|
(153
|
)
|
(1,290
|
)
|
|||
|
Total
shareholders' equity
|
82,431
|
66,042
|
|||||
|
Total
liabilities and shareholders' equity
|
$
|
98,099
|
$
|
83,318
|
|||
|
United
Security Bancshares - (parent only)
Income
Statements
|
Years
Ended December 31,
|
|||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
|||||||
|
Income
|
||||||||||
|
Dividends
from subsidiaries
|
$
|
17,600
|
$
|
7,300
|
$
|
5,012
|
||||
|
Gain
on fair value option of financial assets
|
2,504
|
0
|
0
|
|||||||
|
Other
income
|
0
|
0
|
20
|
|||||||
|
Total
income
|
20,104
|
7,300
|
5,032
|
|||||||
|
Expense
|
||||||||||
|
Interest
expense
|
1,234
|
1,355
|
1,091
|
|||||||
|
Other
expense
|
469
|
378
|
1,033
|
|||||||
|
Total
expense
|
1,703
|
1,733
|
2,124
|
|||||||
|
Income
before taxes and equity in undistributed
|
||||||||||
|
income
of subsidiary
|
18,401
|
5,567
|
2,908
|
|||||||
|
Income
tax expense (benefit)
|
337
|
(729
|
)
|
(866
|
)
|
|||||
|
(Deficit)
equity in undistributed income of subsidiary
|
(6,807
|
)
|
7,064
|
7,234
|
||||||
|
Net
Income
|
$
|
11,257
|
$
|
13,360
|
$
|
11,008
|
||||
92
|
United
Security Bancshares - (parent only)
Income
Statements
|
Years
Ended December 31,
|
|||||||||
|
(In
thousands)
|
2007
|
2006
|
2005
|
|||||||
|
Cash
Flows From Operating Activities
|
||||||||||
|
Net
income
|
$
|
11,257
|
$
|
13,360
|
$
|
11,008
|
||||
|
Adjustments
to reconcile net earnings to cash
|
||||||||||
|
provided
by operating activities:
|
||||||||||
|
Deficit
(equity) in undistributed income of subsidiary
|
6,807
|
(7,064
|
)
|
(7,234
|
)
|
|||||
|
Deferred
taxes
|
998
|
0
|
0
|
|||||||
|
Write-down
of other investments
|
17
|
0
|
702
|
|||||||
|
Gain
on fair value option of financial liability
|
(2,504
|
)
|
0
|
0
|
||||||
|
Amortization
of issuance costs
|
0
|
17
|
17
|
|||||||
|
Net
change in other liabilities
|
381
|
297
|
(92
|
)
|
||||||
|
Net
cash provided by operating activities
|
16,956
|
6,610
|
4,401
|
|||||||
|
|
||||||||||
|
Cash
Flows From Investing Activities
|
||||||||||
|
Investment
in bank stock
|
(389
|
)
|
0
|
0
|
||||||
|
Proceeds
from sale of investment in title company
|
0
|
149
|
527
|
|||||||
|
Net
cash (used in) provided by investing activities
|
(389
|
)
|
149
|
527
|
||||||
|
Cash
Flows From Financing Activities
|
||||||||||
|
Proceeds
from stock options exercised
|
510
|
335
|
118
|
|||||||
|
Net
proceeds from issuance of junior subordinated debt
|
(923
|
)
|
0
|
0
|
||||||
|
Repurchase
and retirement of common stock
|
(10,095
|
)
|
(2,436
|
)
|
(377
|
)
|
||||
|
Payment
of dividends on common stock
|
(5,930
|
)
|
(4,881
|
)
|
(3,980
|
)
|
||||
|
Net
cash used in financing activities
|
(16,438
|
)
|
(6,982
|
)
|
(4,239
|
)
|
||||
|
|
||||||||||
|
Net
increase decrease in cash and cash equivalents
|
129
|
(223
|
)
|
689
|
||||||
|
Cash
and cash equivalents at beginning of year
|
2,417
|
2,640
|
1,951
|
|||||||
|
Cash
and cash equivalents at end of year
|
$
|
2,546
|
$
|
2,417
|
$
|
2,640
|
||||
|
|
||||||||||
|
Supplemental
cash flow disclosures
|
||||||||||
|
Noncash
financing activities:
|
||||||||||
|
Dividends
declared not paid
|
$
|
1,483
|
$
|
1,413
|
$
|
1,135
|
||||
26.
Quarterly Financial Data (unaudited)
Selected
quarterly financial data for the years ended December 31, 2007 and 2006 are
presented below:
|
2007
|
2006
|
||||||||||||||||||||||||
|
(In
thousands except per share data)
|
4th
|
3rd
|
2nd
|
1st
|
4th
|
3rd
|
2nd
|
1st
|
|||||||||||||||||
|
Interest
income
|
$
|
14,245
|
$
|
14,713
|
$
|
13,962
|
$
|
14,236
|
$
|
12,847
|
$
|
12,548
|
$
|
11,409
|
$
|
10,552
|
|||||||||
|
Interest
expense
|
5,450
|
5,494
|
5,126
|
4,503
|
4,126
|
3,999
|
3,311
|
2,739
|
|||||||||||||||||
|
Net
interest income
|
8,795
|
9,219
|
8,836
|
9,733
|
8,721
|
8,549
|
8,098
|
7,813
|
|||||||||||||||||
|
Provision
for credit losses
|
3,337
|
1,950
|
208
|
202
|
241
|
276
|
123
|
240
|
|||||||||||||||||
|
Gain
(loss) on sale of securities
|
0
|
0
|
0
|
0
|
27
|
0
|
0
|
0
|
|||||||||||||||||
|
Other
noninterest income
|
2,110
|
4,019
|
1,954
|
1,581
|
1,872
|
2,331
|
1,594
|
3,207
|
|||||||||||||||||
|
Noninterest
expense
|
6,723
|
5,292
|
5,517
|
5,200
|
5,293
|
5,060
|
5,036
|
4,548
|
|||||||||||||||||
|
Income
before income tax expense
|
845
|
5,996
|
5,065
|
5,912
|
5,086
|
5,544
|
4,533
|
6,232
|
|||||||||||||||||
|
Income
tax expense
|
156
|
2,339
|
1,757
|
2,309
|
2,113
|
2,083
|
1,471
|
2,368
|
|||||||||||||||||
|
Net
income
|
$
|
689
|
$
|
3,657
|
$
|
3,308
|
$
|
3,603
|
$
|
2,973
|
$
|
3,461
|
$
|
3,062
|
$
|
3,864
|
|||||||||
|
Net
income per share:
|
|||||||||||||||||||||||||
|
Basic
|
$
|
0.06
|
$
|
0.31
|
$
|
0.27
|
$
|
0.30
|
$
|
0.26
|
$
|
0.30
|
$
|
0.27
|
$
|
0.34
|
|||||||||
|
Diluted
|
$
|
0.06
|
$
|
0.31
|
$
|
0.27
|
$
|
0.30
|
$
|
0.26
|
$
|
0.30
|
$
|
0.27
|
$
|
0.34
|
|||||||||
|
Dividends
declared per share
|
$
|
0.125
|
$
|
0.125
|
$
|
0.125
|
$
|
0.125
|
$
|
0.125
|
$
|
0.11
|
$
|
0.11
|
$
|
0.11
|
|||||||||
|
Average
shares outstanding
|
|||||||||||||||||||||||||
|
For
net income per share:
|
|||||||||||||||||||||||||
|
Basic
|
11,887
|
11,925
|
12,078
|
11,947
|
11,302
|
11,358
|
11,369
|
11,370
|
|||||||||||||||||
|
Diluted
|
11,900
|
11,946
|
12,135
|
12,006
|
11,430
|
11,476
|
11,496
|
11,490
|
|||||||||||||||||
93
Item
9 - Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
Item
9A. Controls and Procedures
Evaluation
of Disclosure Controls and Procedures:
a)
As of
the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company’s
management, including the Chief Executive Officer and the Chief Financial
Officer, of the effectiveness of the design and operation of the Company’s
disclosure controls and procedures, as defined in the Securities and Exchange
Act Rule 13(a)-15(e). Based upon that evaluation, the CEO and CFO concluded
that, as of the end of the period covered in this report, the Company’s
disclosure controls and procedures were effective to ensure that information
required to be disclosed by the Company in reports that it files under the
Securities Exchange Act of 1934 is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms, and that material information relating to our consolidated operations
is made known to the Company’s management, including the CEO and CFO,
particularly during the period when the Company’s periodic reports are being
prepared.
(b)
Changes in Internal Controls over Financial Reporting: There was no change
in
the Company’s internal control over financial reporting that occurred during the
fourth quarter of 2007 that has materially affected, or is reasonably likely
to
materially affect, the Company’s internal control over financial
reporting.
Management
Report on Internal Control over Financial Reporting:
MANAGEMENT’S
REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management
of United Security Bancshares and Subsidiaries (the “Company”) is responsible
for establishing and maintaining adequate internal control over financial
reporting, and for performing an assessment of the effectiveness of internal
control over financial reporting as of December 31, 2007. The Company’s
internal control over financial reporting is a process designed under the
supervision of the Company’s management, including the Chief Executive Officer
and Chief Financial Officer, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States.
The
Company’s system of internal control over financial reporting includes policies
and procedures that (i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect transactions and dispositions
of assets of the Company; (ii) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States, and that receipts and expenditures of the Company are being
made
only in accordance with authorizations of management and directors of the
Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use or disposition of the
Company’s assets that could have a material effect on the financial statements.
Management
recognizes that there are inherent limitations in the effectiveness of any
system of internal control, and accordingly, even effective internal control
can
provide only reasonable assurance with respect to financial statement
preparation and fair presentation. Further, because of changes in conditions,
the effectiveness of internal control may vary over time.
Under
the
supervision and with the participation of the Company’s management, including
the Company’s Chief Executive Officer and Chief Financial Officer, the
Company
performed an assessment of the effectiveness of the Company’s internal control
over financial reporting as of December 31, 2007 based upon criteria in
Internal
Control — Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”). Based on this assessment, Management determined that the Company’s
internal control over financial reporting was effective as of December 31,
2007.
The
Company’s independent registered public accounting firm, Moss Adams LLP, who
audits the Company’s consolidated financial statements, have issued an
attestation report on the effectiveness of the Company’s internal control over
financial reporting. This report is included in Item 8, “financial statements
and supplementary data” to the Form 10-K.
Dated
March 14, 2008
94
Item
9B. Other Information
None
PART
III
Item
10 - Directors, Executive Officers, and Corporate
Governance
Pursuant
to Instruction G, the information required by this item is hereby incorporated
herein by reference from the captions entitled "Election of Directors and
Executive Officers" and “Corporate Governance Principles and Board Matters” set
forth in the Company's definitive Proxy Statement for its 2008 Annual Meeting
of
Shareholders ("Proxy Statement").
Item
11 - Executive Compensation
Pursuant
to Instruction G, the information required by this item is hereby incorporated
herein by reference from the captions entitled "Executive Compensation" and
“Director Compensation” set forth in the Company's definitive Proxy Statement
for its 2008 Annual Meeting of Shareholders ("Proxy Statement").
Item
12 - Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters
Pursuant
to Instruction G, the information required by this item is hereby incorporated
herein by reference from the caption entitled "Shareholdings of Certain
Beneficial Owners and Management" set forth in the Company's definitive Proxy
Statement for its 2008 Annual Meeting of Shareholders ("Proxy
Statement").
Item
13 - Certain Relationships and Related Transactions, and Director
Independence
Pursuant
to Instruction G, the information required by this item is hereby incorporated
herein by reference from the captions entitled "Certain Transactions" and
“Corporate Governance Principles” set forth in the Company's definitive Proxy
Statement for its 2008 Annual Meeting of Shareholders ("Proxy
Statement").
Item
14. Principal Accountant Fees and Services
Pursuant
to Instruction G, the information required by this item is hereby incorporated
herein by reference from the caption entitled "Independent Accountant Fees
and
Services" set forth in the Company's definitive Proxy Statement for its 2008
Annual Meeting of Shareholders ("Proxy Statement").
95
PART
IV
Item
15 - Exhibits and Financial Statement Schedules
(a)(1) Financial
Statements
The
Consolidated Financial Statements and related documents set forth in “Item 8.
Financial Statements and Supplementary Data” of this report are filed as part of
this report.
(a)(2) Financial
Statement Schedules
All
financial statement schedules are omitted because they are not applicable or
not
required or because the information is included in the financial statements
or
notes thereto or is not material.
(a)(3) Exhibits
|
3.1
|
Articles
of Incorporation of Registrant (1)
|
| 3.2 |
Bylaws
of Registrant (1)
|
| 4.1 |
Specimen
common stock certificate of United Security Bancshares
(1)
|
|
10.1
|
Amended
and Restated Executive Salary Continuation Agreement for Dennis
Woods
|
|
10.2
|
Amended
and Restated Employment Agreement for Dennis R.
Woods
|
|
10.3
|
Amended
and Restated Executive Salary Continuation Agreement for Kenneth
Donahue
|
|
10.4
|
Amended
and Restated Change in Control Agreement for Kenneth
Donahue
|
|
10.5
|
Amended
and Restated Executive Salary Continuation Agreement for David
Eytcheson
|
|
10.6
|
Amended
and Restated Change in Control Agreement for David
Eytcheson
|
|
10.7
|
Amended
and Restated Executive Salary Continuation Agreement for Rhodlee
Braa
|
|
10.8
|
Amended
and Restated Change in Control Agreement for Rhodlee
Braa
|
|
10.9
|
Amended
and Restated Executive Salary Continuation Agreement for William
F.
Scarborough
|
|
10.10
|
Amended
and Restated Change in Control Agreement for William F.
Scarborough
|
|
10.11
|
USB
2005 Stock Option Plan. Filed as Exhibit B to the Company's 2005
Schedule
14A Definitive Proxy filed April 18, 2005 and incorporated herein
by
reference.
|
| 10.12 |
Stock
Option Agreement for William F. Scarborough dated August 1, 2005
(2)
|
| 10.13 |
Stock
Option Agreement for Dennis R. Woods dated February 6, 2006 (3)
|
| 11.1 |
Computation
of earnings per share.
|
See
Note
18 to Consolidated Financial Statements and related documents set forth in
“Item
8. Financial Statements and Supplementary Data” of this report are filed as part
of this report.
| 21 |
Subsidiaries
of the Company
|
96
| 23.1 |
Consent
of Moss Adams LLP, Independent Registered Public Accounting
Firm
|
| 31.1 |
Certification
of the Chief Executive Officer of United Security Bancshares pursuant
to
Section 302 of the Sarbanes-Oxley Act of
2002.
|
| 31.2 |
Certification
of the Chief Financial Officer of United Security Bancshares pursuant
to
Section 302 of the Sarbanes-Oxley Act of
2002.
|
|
32.1
|
Certification
of the Chief Executive Officer of United Security Bancshares pursuant
to
Section 906 of the Sarbanes-Oxley Act of
2002
|
| 32.2 |
Certification
of the Chief Financial Officer of United Security Bancshares pursuant
to
Section 906 of the Sarbanes-Oxley Act of
2002
|
(1)
Previously filed on April 4, 2001 as an exhibit to the Company’s filing on Form
S-4 (file number 333-58256).
(2)
Previously filed on March 15, 2006 as an exhibit to the Company’s filing on Form
10-K for the year ended December 31, 2006 (file number 000-32987).
(3)
Previously filed on November 7, 2006 as an exhibit to the Company’s filing on
Form 10-Q/A for the period ended March 31, 2006 (file number
000-32987).
(b) Exhibits
filed:
See
Exhibit Index under Item 15(a)(3) above for the list of exhibits required to
be
filed by Item 601 of regulation S-K with this report.
(c) Financial
statement schedules filed:
See
Item
15(a)(2) above.
97
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 on Form 10-K for the year
ended
December 31, 2007 to be signed on its behalf by the undersigned thereunto duly
authorized, in Fresno, California, on the 14th day of March, 2008
| United Security Bancshares | ||
| |
|
|
| March 14, 2008 | /S/ Dennis R. Woods | |
|
Dennis R. Woods |
||
| President and Chief Executive Officer | ||
| March 14, 2008 | /S/ Kenneth L. Donahue | |
|
Kenneth L. Donahue |
||
| Senior Vice President and | ||
| Chief Financial Officer | ||
| March 14, 2008 | /S/ Richard B. Shupe | |
|
Richard B. Shupe |
||
| Vice President and | ||
|
Controller
|
||
98
Signatures
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 on the date indicated:
|
Date:
|
3/14/2008
|
/s/
Robert G. Bitter
|
|
|
Director
|
|||
|
Date:
|
3/14/2008
|
/s/
Stanley J. Cavalla
|
|
|
Director
|
|||
|
Date:
|
3/14/2008
|
/s/
Tom Ellithorpe
|
|
|
Director
|
|||
|
|
|||
|
Date:
|
3/14/2008
|
/s/
R. Todd Henry
|
|
|
Director
|
|||
|
|
|||
|
Date:
|
3/14/2008
|
/s/
Ronnie D. Miller
|
|
|
Director
|
|||
|
Date:
|
3/14/2008
|
/s/
Robert M. Mochizuki
|
|
|
Director
|
|||
|
Date:
|
3/14/2008
|
/s/
Walter Reinhard
|
|
|
Director
|
|||
|
|
|||
|
Date:
|
3/14/2008
|
/s/
John Terzian
|
|
|
Director
|
|||
|
|
|||
|
Date:
|
3/14/2008
|
/s/
Mike Woolf
|
|
|
Director
|
|||
99