-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AvJ7LoROgaMGoh3BI43rx7SV5Cs744ayLaJnRGA/i7rRDc3O/gBevfEkR8+U0/Vl yMESB00deQr1deYniR8GEg== 0000913738-99-000020.txt : 19990403 0000913738-99-000020.hdr.sgml : 19990403 ACCESSION NUMBER: 0000913738-99-000020 CONFORMED SUBMISSION TYPE: 10-K/A PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990401 FILER: COMPANY DATA: COMPANY CONFORMED NAME: UNITED SECURITY BANCSHARES INC CENTRAL INDEX KEY: 0000717806 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 630843362 STATE OF INCORPORATION: AL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K/A SEC ACT: SEC FILE NUMBER: 000-14549 FILM NUMBER: 99585907 BUSINESS ADDRESS: STREET 1: P O BOX 249 STREET 2: 131 WEST FRONT STREET CITY: THOMASVILLE STATE: AL ZIP: 36784 BUSINESS PHONE: 2056365424 MAIL ADDRESS: STREET 1: P O BOX 249 STREET 2: 131 WEST FRONT STREET CITY: THOMASVILLE STATE: AL ZIP: 36784 10-K/A 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark one) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission File Number 0-14549 UNITED SECURITY BANCSHARES, INC. (Exact name of registrant as specified in its charter) Alabama 63-0843362 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 131 West Front Street Post Office Box 249 Thomasville, Alabama 36784 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (334) 636-5424 Securities registered pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered None None Securities registered pursuant to Section 12(g) of the Act: Common Stock, Par Value $0.01 per share (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X]. No . Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ___ Shares of common stock ($0.01 par value) outstanding as of December 31, 1998: 3,546,845. The aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the sales price of shares sold in a private transaction on February 17, 1999, is $119,152,280. (There is no established public trading market for the Registrant's voting stock.) DOCUMENTS INCORPORATED BY REFERENCE Portions of the Company's definitive proxy statement for the 1999 annual meeting of its shareholders are incorporated by reference into Part III. United Security Bancshares, Inc. Annual Report on Form 10-K for the fiscal year ended December 31, 1998 TABLE OF CONTENTS Sequential Part Item Caption Page No. I 1 Business...............................................3 2 Properties.............................................8 3 Pending Legal Proceedings..............................9 4 Submission of Matters to a vote of Security Holders....9 II 5 Market for Registrant's Common Equity and Related Stockholder Matters............................9 6 Selected Financial Data...............................11 7 Management's Discussion and Analysis of Financial Condition and Results of Operations...................12 7A Quantitative and Qualitative Disclosures About Market Risk...........................................37 8 Financial Statements and Supplementary Data...........38 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...................69 III 10 Directors and Executive Officers of the Registrant....70 11 Executive Compensation................................70 12 Security Ownership of Certain Beneficial Owners and Management........................................70 13 Certain Relationships and Related Transactions........70 IV 14 Exhibits, Financial Statement Schedules and Reports on Form 8-K...............................71 Signatures..............................................................72 Exhibits................................................................74 PART I Item 1. Business. General United Security Bancshares, Inc. ("Bancshares") is an Alabama corporation organized in 1984. Bancshares is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and it operates one banking subsidiary, First United Security Bank (the "Bank"). The Bank's name was changed from United Security Bank to First United Security Bank on July 9, 1997. The Bank owns all of the stock of Acceptance Loan Company, Inc. ("ALC"), a finance company organized for the purpose of making consumer loans and purchasing consumer loans from vendors. Bancshares owns all the stock of First Security Courier Corporation ("First Security"), an Alabama corporation organized for the purpose of providing certain bank courier services. The Bank has sixteen banking offices, which are located in Thomasville, Coffeeville, Fulton, Gilbertown, Grove Hill, Butler, Jackson, Brent, Centreville, North Bibb and Harpersville, Alabama, and its market area includes portions of Bibb, Clarke, Choctaw, Marengo, Shelby, Sumter, Tuscaloosa, Washington, and Wilcox Counties in Alabama, as well as Clarke, Lauderdale and Wayne Counties in Mississippi. The Bank conducts a general commercial banking business and offers banking services such as the receipt of demand, savings and time deposits, making personal and commercial loans, credit card and safe deposit box services, and the purchase and sale of government securities. The Bank encounters vigorous competition from 10 banks located in its service area for, among other things, new deposits, loans, savings deposits, certificates of deposit, interest-bearing transaction accounts, and other banking and financial services. As of December 31, 1998, the Bank had 197 full-time equivalent employees, ALC had 89 full-time equivalent employees, and Bancshares had no employees, other than the officers of Bancshares who are indicated in Part III, Item 10 of this report. Legislation The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "IBBEA") authorized bank holding companies to acquire banks and other bank holding companies without geographic limitations beginning September 30, 1995. The arrival of interstate banking is expected to increase further the competitiveness of the banking industry. In addition, beginning on June 1, 1997, the IBBEA authorized interstate mergers and consolidations of existing banks, provided that neither bank's home state has opted out of interstate branching by May 31, 1997. The State of Alabama has opted into interstate branching effective on or before June 1, 1997. Once a bank has established branches in a state through an interstate merger, the bank generally may establish and acquire additional branches at any location in the state where any bank involved in the interstate merger could have established or acquired branches under applicable federal or state law. Alabama banks may also establish branches or offices in any other state, any territory of the United States, or any foreign country, provided that the branch or office is established in compliance with federal law and the law of the proposed location and is approved by the Alabama Superintendent of Banks. Under former law, Alabama banks could not establish a branch in any location other than its principal place of business, except as authorized by local laws or general laws of local application. These more liberal branching laws are likely to increase competition within the State of Alabama among banking institutions located in Alabama and from banking institutions outside of Alabama, many of which are larger than Bancshares. Size gives the larger banks certain advantages in competing for business from large corporations. These advantages include higher lending limits and the ability to offer services in other areas of Alabama and the southeast region. Supervision, Regulation and Governmental Policy Bank Holding Company Regulation. As a registered bank holding company, Bancshares is subject to supervision and regulation by the Board of Governors of the Federal Reserve System ("Board of Governors") under the Bank Holding Company Act of 1956, as amended. As a bank holding company, Bancshares is required to furnish the Board of Governors an annual report of its operations at the end of each fiscal year and to furnish such additional information as the Board of Governors may require pursuant to the Bank Holding Company Act. The Board of Governors may also make examinations of Bancshares. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Board of Governors (i) before it may acquire direct or indirect ownership or control of any voting shares of any bank if, after such acquisition, such bank holding company will directly or indirectly own or control more than five percent of the voting shares of such bank; (ii) before it or any of its subsidiaries, other than a bank, may acquire all or substantially all of the assets of a bank; or (iii) before it may merge or consolidate with any other bank holding company. In reviewing a proposed acquisition, the Board of Governors considers financial, managerial and competitive aspects, and must take into consideration the future prospects of the companies and banks concerned and the convenience and needs of the community to be served. As part of its review, the Board of Governors concentrates on the pro forma capital position of the bank holding company and reviews the indebtedness to be incurred by a bank holding company in connection with the proposed acquisition to ensure that the bank holding company can service such indebtedness in a manner that does not adversely affect the capital requirements of the holding company or its subsidiaries. The Bank Holding Company Act further requires that consummation of approved acquisitions or mergers be delayed for a period of not less than 30 days following the date of such approval. During the 30 day period, complaining parties with respect to competitive issues may obtain a review of the Board of Governors' order granting its approval by filing a petition in the appropriate United States Court of Appeals petitioning that the order be set aside. The Bank Holding Company Act prohibits (with specific exceptions) Bancshares from engaging in nonbanking activities or from acquiring or retaining direct or indirect control of any company engaged in nonbanking activities. The Board of Governors by regulation or order may make exceptions for activities determined to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Board of Governors considers whether the performance of such an activity can reasonably be expected to produce benefits to the public, such as greater convenience, increased competition or gains in efficiency that outweigh possible adverse effects, such as undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. For example, making, acquiring or servicing loans, leasing personal property, providing certain investment or financial advice, performing certain data processing services, acting as agent or broker in selling credit life insurance and certain other types of insurance in connection with credit transactions by the bank holding company and certain limited insurance underwriting activities have all been determined by regulations of the Board of Governors to be permissible activities. The Bank Holding Company Act does not place territorial limitations on permissible bank-related activities of bank holding companies. However, despite prior approval, the Board of Governors has the power to order a holding company or its subsidiaries to terminate any activity, or terminate its ownership or control of any subsidiary, when it has reasonable cause to believe that continuation of such activity or such ownership or control constitutes a serious risk to the financial safety, soundness or stability of any bank subsidiary of that holding company. Federal Reserve policy requires a bank holding company to act as a source of financial strength to each of its bank subsidiaries and to take measures, including possible loans to its subsidiaries in the form of capital notes or other instruments, to preserve and protect bank subsidiaries in situations where additional investments in a troubled bank may not otherwise be warranted. However, any loans from the holding company to a subsidiary depository institution likely would be unsecured and subordinated to such institution's depositors and certain other creditors. Bank Regulation. The Alabama State Banking Department and the Federal Deposit Insurance Corporation ("FDIC") are the primary regulators for the Bank. These regulatory authorities regulate or monitor all areas of the Bank's operations, including security devices and procedures, adequacy of capital loan reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rates payable on deposits, interest rates or fees chargeable on loans, establishment of branches, corporate reorganizations, maintenance of books and records and adequacy of staff training to carry on safe lending and deposit gathering practices. The Bank must maintain certain capital ratios and is subject to limitations on aggregate investments in real estate, bank premises and furniture and fixtures. The Bank's deposits are insured by the FDIC to the extent provided by law. The major responsibility of the FDIC with respect to insured banks is to protect depositors as provided by law in the event a bank is closed without adequate provision having been made to pay claims of depositors. It also acts to prevent the development or continuation of unsafe or unsound banking practices. The FDIC is authorized to examine the Bank in order to determine its condition for insurance purposes. The FDIC must approve any merger or consolidation involving the Bank where the resulting bank is a state-chartered, non-Federal Reserve member bank. The Bank is not a member of the Federal Reserve System. The FDIC is also authorized to approve conversions, mergers, consolidations, and assumption of deposit liability transactions between insured and noninsured banks or institutions, and to prevent capital or surplus diminution in such transactions where the resulting, continuing or assumed bank is an insured bank that is not a member of the Federal Reserve System. Since the Bank is chartered under the laws of the State of Alabama, it is also subject to supervision and examination by the Alabama State Banking Department (the "Department") and is subject to regulation by the Department of all areas of its operations. Alabama law and the regulations of the Department restrict the payment of dividends by state chartered banks. Under Alabama law, a bank must transfer to surplus each year at least 10% of its net earnings until the surplus of the bank is equal to at least 20% of its capital. During this accumulation period, a bank may not pay a dividend in excess of 90% of its net earnings. After this accumulation period, banks must obtain prior written approval of the Superintendent of the Alabama State Banking Department if the total of all dividends declared by the bank in any calendar year will exceed the total of the bank's net earnings (as defined by statute) for that year combined with its retained net earnings for the preceding two years, less any required transfers to surplus. In addition, no dividends may be paid from surplus without the prior written approval of the Superintendent. In accordance with regulatory restrictions, the Bank had at December 31, 1998, $4,531,000 of undistributed earnings included in consolidated retained earnings available for distribution to Bancshares as dividends without prior regulatory approval. Supervision, regulation and examination of banks by the bank regulatory agencies are intended primarily for the protection of depositors rather than for holders of Bancshares common stock. Other Applicable Regulatory Provisions. Banks are also subject to the provisions of the Community Reinvestment Act of 1977, which require the appropriate federal bank regulatory agency, in connection with its regular examination of a bank, to assess the bank's record in meeting the credit needs of the community serviced by the bank, including low and moderate-income neighborhoods. The regulatory agency's assessment of the bank's record is made available to the public. Further, such assessment is required of any bank that has applied to, among other things, establish a new branch office that will accept deposits, relocate an existing office or merge or consolidate with, or acquire the assets or assume the liabilities of, a federally regulated financial institution. In August 1989, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 ("FIRREA") was enacted. FIRREA, among other things, abolished the Federal Savings and Loan Insurance Corporation and established two new insurance funds under the jurisdiction of the Federal Deposit Insurance Corporation: the Savings Association Insurance Fund (the "SAIF") and the Bank Insurance Fund ("BIF"). The Bank's deposits are insured by the BIF. Effective January 1, 1996, the FDIC adopted a new risk-based premium schedule of rates for annual insurance assessments paid by banks whose deposits are insured by the BIF. The new schedule will reduce assessments for all but the riskiest institutions. Under this schedule, annual assessments range from $.00 to $.27 for every $100.00 of the Bank's assessment base (which is the sum of all demand and savings deposits plus accrued interest less unposted debits, pass through reserve balances, and other items) with a minimum assessment of $1,000.00 per institution per semi-annual period. The FDIC may adjust the assessment rates semiannually as necessary to maintain BIF reserves of at least 1.25% of total deposits insured ($1.25 per $100.00 of deposits insured) but cannot increase or decrease the rates by any more than 5 basis points (.05%) in the aggregate without opportunity for notice and comment. The actual assessment rate applicable to a particular institution depends upon a risk assessment classification assigned to the institution by the FDIC. The FDIC will assign each financial institution to one of three capital groups--well capitalized, adequately capitalized, or undercapitalized, as defined in the regulations implementing the prompt corrective action provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA")--and to one of three subgroups within a capital group on the basis of supervisory evaluations by the institution's primary federal, and, if applicable, state supervisors and other information relevant to the institution's financial condition and the risk posed to the applicable insurance fund. The Bank's current risk assessment classification is "well-capitalized," for which the current assessment rate is $.04 per $100 of its assessment base. FIRREA also imposes, with certain limited exceptions, a "cross guarantee" on the part of commonly-controlled depository institutions. Under this provision, if one depository institution's subsidiary of a multi-unit holding company fails or requires FDIC assistance, the FDIC may assess a commonly-controlled depository institution for the estimated losses suffered by the FDIC. Although the FDIC's claim is junior to the claims of nonaffiliated depositors, holders of secured liabilities, general creditors, and subordinated creditors, it is superior to the claims of shareholders. FDICIA authorizes the BIF to borrow up to $30 billion from the United States Treasury to be repaid by the banking industry through deposit insurance assessments. FDICIA required the federal banking agencies and the FDIC, as insurer, to take prompt action to resolve the problems of insured depository institutions. All depository institutions will be classified into one of five categories ranging from well-capitalized to critically undercapitalized. As an institution's capital level declines, it would become subject to increasing regulatory scrutiny and tighter restrictions. FDICIA further requires an increase in the frequency of "fullscope, on-site" examinations and expands the current audit requirements. In addition, federal banking agencies are mandated to review and prescribe uniform accounting standards that are at least as stringent as Generally Accepted Accounting Principles. FDICIA permits the merger or acquisition of any depository institutions with any other, provided that the transaction is approved by the resulting entity's appropriate federal banking agency. This would permit, for the first time, direct mergers between banks and thrift institutions. Among other things, FDICIA requires the federal banking agencies to take "prompt corrective action" in respect of banks that do not meet minimum capital requirements, as defined by the regulations implementing FDICIA. If a depository institution fails to meet regulatory capital requirements, regulatory agencies can require submission and funding of a capital restoration plan by the institution to limit growth, require the raising of additional capital and, ultimately, require the appointment of a conservator or receiver for the institution. Under FDICIA, a bank holding company must guarantee that an undercapitalized subsidiary bank meets its capital restoration plan, subject to certain limitations. Because of concerns relating to the competitiveness and the safety and soundness of the industry, the Congress is considering, even after the enactment of FIRREA and FDICIA, a number of wide-ranging proposals for altering the structure, regulation and competitive relationships of the nation's financial institutions. Among such bills are proposals to prohibit banks and bank holding companies from conducting certain types of activities, to subject banks to increased disclosure and reporting requirements, to alter the statutory separation of commercial and investment banking and to further expand the powers of banks, bank holding companies and competitors of banks. In September 1996, legislation was enacted to recapitalize the SAIF and ensure against default on Financing Corp. ("FICO") bonds. The legislation provided for a one-time payment into the BIF in an amount approximating $.68 per $100 of SAIF insured deposits. Thereafter and through December 31, 1999, the former assessment rate of between $-0- and $.31 per $100 of insured deposits is reduced to between $.0130 and $.2830 per $100, including a FICO rate of $.0130 per $100, for bank deposits and a rate of between $.0650 and $.3350 per $100, including a FICO rate of $.0650 per $100, for previously SAIF insured deposits. After December 31, 1999, the BIF rate will be approximately $.0243 per $100 for all deposits. Federal law and regulations adopted by the Board of Governors and the FDIC (the "Agencies") require banks to define the geographic areas they serve and the services provided in these geographic areas. These agencies are required to consider compliance with these regulations and the services made available to geographic areas served in ruling on applications by banks for branches and other deposit facilities, relocation of banking offices and approval of mergers, consolidations, acquisitions of assets or assumptions of liabilities. The Board of Governors is also required to consider compliance with these regulations in ruling on applications under the Bank Holding Company Act for, among other things, the approval of the acquisition of shares of a bank. Under federal law, restrictions are placed on extensions of credit by the Bank to insiders of Bancshares, to insiders of the Bank and to insiders of correspondent banks and on extensions of credit by such correspondent banks to insiders of Bancshares or the Bank. Dividend Restrictions. In addition to the Alabama statutory dividend restrictions discussed above under the caption "Bank Regulation," federal banking regulators are authorized to prohibit banks and bank holding companies from paying dividends which would constitute an unsafe and unsound banking practice. The Board of Governors has indicated that it would generally be an unsafe and unsound practice to pay dividends except out of operating earnings. Effect of Governmental Policies. The earnings and business of Bancshares and the Bank are and will be affected by the policies of various regulatory authorities of the United States, especially the Board of Governors. Important functions of the Board of Governors, in addition to those enumerated above, are to regulate the supply of credit and to deal with general economic conditions within the United States. The instruments of monetary policy employed by the Board of Governors for these purposes influence in various ways the overall level of investments, loans, other extensions of credit and deposits, and the interest rates paid on liabilities and received on assets. In view of the changing conditions in the national economy, in the money markets, in the federal government's fiscal policies and in the relationships of international currencies, as well as the effect of actions by the Board of Governors, no predictions can be made as to how these external variables, over which Bancshares' management has no control, may in the future affect possible interest rates, deposit levels, loan demand or the business and earnings of Bancshares and the Bank. Capital Adequacy Requirements. The federal bank regulatory authorities have adopted risk-based capital guidelines for banks and bank holding companies that are designed to account for off-balance sheet exposure, minimize disincentives for holding liquid assets and make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies. The resulting capital ratios represent qualifying capital as a percentage of total risk-weighted assets and off-balance sheet items. The guidelines are minimums, and the federal regulators have noted that banks and bank holding companies contemplating significant expansion programs should not allow expansion to diminish their capital ratios and should maintain ratios well in excess of the minimums. The current guidelines require all bank holding companies and federally-regulated banks to maintain a minimum risk-based total capital ratio equal to 8%, of which at least 4% must be Tier 1 capital. Tier 1 capital includes common stockholders' equity, qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, but excludes goodwill and most other intangibles and excludes the allowance for loan and lease losses. Tier 2 capital includes the excess of any preferred stock not included in Tier 1 capital, mandatory convertible securities, hybrid capital instruments, subordinated debt and intermediate term-preferred stock and general reserves for loan and lease losses up to 1.25% of risk-weighted assets. Under these guidelines, banks' and bank holding companies' assets are given risk-weights of 0%, 20%, 50% or 100%. In addition, certain off-balance sheet items are given credit conversion factors to convert them to asset equivalent amounts to which an appropriate risk-weight will apply. These computations result in the total risk-weighted assets. Most loans are assigned to the 100% risk category, except for first mortgage loans fully secured by residential property and, under certain circumstances, residential construction loans, both of which carry a 50% rating. Most investment securities are assigned to the 20% category, except for municipal or state revenue bonds, which have a 50% rating, and direct obligations of or obligations guaranteed by the United States Treasury or United States Government agencies, which have a 0% rating. The federal bank regulatory authorities have also implemented a leverage ratio, which is Tier 1 capital as a percentage of average total assets less intangibles, to be used as a supplement to the risk-based guidelines. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank holding company may leverage its equity capital base. The minimum required leverage ratio for top-rated institutions is 3%, but most institutions are required to maintain an additional cushion of at least 100 to 200 basis points. FDICIA established a new capital-based regulatory scheme designed to promote early intervention for troubled banks. The new capital-based regulatory framework contains five categories of compliance with regulatory capital requirements, including "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." To qualify as a "well capitalized" institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6% and a total risk-based capital ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. As of December 31, 1998, Bancshares and the Bank qualified as "well-capitalized." Under FDICIA, the applicable agency can treat an institution as if it were in the next lower category if the agency determines (after notice and an opportunity for hearing) that the institution is in an unsafe or unsound condition or is engaging in an unsafe or unsound practice. The degree of regulatory scrutiny of a financial institution will increase, and the permissible activities of the institution will decrease, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to (i) submit a capital restoration plan; (ii) raise additional capital; (iii) restrict their growth, deposit interest rates and other activities; (iv) improve their management; (v) eliminate management fees; or (vi) divest themselves of all or a part of their operations. Bank holding companies controlling financial institutions can be called upon to boost the institutions' capital and to partially guarantee the institutions' performance under their capital restoration plans. FDICIA requires the federal banking regulators to revise the risk-based capital standards to provide for explicit consideration of interest-rate risk, concentration of credit risk and the risks of non-traditional activities. It is uncertain what effect these regulations, when implemented, will have on Bancshares and the Bank. Recent Legislative Developments. From time to time, various bills are introduced in the United States Congress with respect to the regulation of financial institutions. Certain of these proposals, if adopted, could significantly change the regulation of banks and the financial services industry. Bancshares cannot predict whether any of these proposals will be adopted or, if adopted, how these proposals would affect Bancshares. There have been a number of legislative and regulatory proposals that would have an impact on the operation of bank holding companies and their banks. It is impossible to predict whether or in what form these proposals may be adopted in the future and, if adopted, what their effect will be on Bancshares and the Bank. For example, on May 13, 1998, the U.S. House of Representatives passed H.R. 10, the "Financial Services Competition Act of 1998," which calls for a sweeping modernization of the banking system that would permit affiliations between commercial banks, securities firms, insurance companies and, subject to certain limitations, other commercial enterprises. The stated purposes of H.R. 10 are to enhance consumer choice in the financial services marketplace, level the playing field among providers of financial services, and increase competition. H.R. 10 removes many of the statutory restrictions contained in current laws regulating the financial services industry and calls for a new regulatory framework of financial institutions and their holding companies. Although H.R. 10 failed to reach the voting stage in the United States Senate before the adjournment of the 105th Congress in 1998, H.R. 10 was reintroduced in the House of Representatives on January 6, 1999, and is currently under consideration. At this time, it is unknown whether H.R. 10 will be enacted into law, or if enacted, what form the final version of such legislation might take and how such legislation may affect Bancshares' business and operations. One consequence may be increased competition from large financial services companies that, under the bill, would be permitted to provide many types of financial service to customers. Statistical Information Statistical information concerning the business of Bancshares is set forth in Part II of this report. Item 2. Properties. Bancshares owns no property and does not expect to own any. The business of Bancshares is conducted from the offices of the Bank. ALC leases office space throughout Alabama but owns no property. The aggregate annual rental payments for office space for ALC totals approximately $268,000. The Bank has operated from its main office at 131 West Front Street since 1959. It is in a two-story building with approximately 17,000 square feet. During 1986, construction upon Bancshares' and the Bank's main offices at 131 West Front Street, Thomasville, was completed. Approximately 10,000 square feet of office space was added as a result of this construction. The Bank operates fifteen branches in addition to its main office. The Highway 43 South branch is located at the intersection of State Highway 43 and Nichol Avenue and is in a one-story brick building with approximately 3,500 square feet. The Coffeeville branch is located on Highway 84 in Coffeeville, approximately 33 miles from Thomasville, and it is in a one-story brick building of approximately 2,000 square feet. The Fulton branch is located on State Highway 178, approximately eight miles from Thomasville, in a one-story frame building of approximately 2,000 square feet. The Butler branch is located at 305 South Mulberry Street, Butler, Alabama in a one-story brick building of approximately 12,000 square feet. There are four drive-in teller facilities at this location. The Gilbertown branch, which consists of a one-story brick building of approximately 2,000 square feet, is located at the intersection of High Street and Highway 17 in Gilbertown, Alabama. There is one drive-in facility at this location. The Coffeeville Road branch in Jackson opened on November 19, 1990, and is located at the intersection of Highway 69 and College Avenue in Jackson, Alabama. The building is a one-story brick building of approximately 2,800 square feet with two drive-in facilities. The Brent branch was acquired on May 31, 1996. This branch is located in Brent, Alabama in a one-story brick building with approximately 8,500 square feet. There are three drive-in facilities at this location. The following branches were acquired as a result of the merger of First Bancshares, Inc. with and into Bancshares in 1997: The Centreville branch is located at the corner of Davidson Street and Court Square in Centreville, Alabama. That building, a two-story brick building of approximately 9,000 square feet with two drive-in facilities, has been sold. The Bank is currently renting the building while a new building is constructed. The Grove Hill branch is located at the corner of Main Street and Court in Grove Hill, Alabama. This branch is in a one-story brick building with approximately 10,500 square feet and three drive-in facilities. The two new Jackson branches are located on (1) Commerce Street in a two-story brick building with approximately 9,000 square feet and three drive-in facilities and (2) College Avenue in a one-story brick building with approximately 7,800 square feet and four drive-in facilities. The branch in Thomasville is located in a one-story brick building with approximately 3,800 square feet and three drive-in facilities. The branch in North Bibb County is located on Highway 11 in a one-story brick building with two drive-in facilities. The Cobb Street branch has three drive-in facilities and is located in a one-story brick building of approximately 1,000 square feet. Finally, the Harpersville branch has three drive-in facilities and is located in a 3,500 square foot building. Except as noted, all of the Bank's offices are owned in fee simple by the Bank without encumbrance. Item 3. Pending Legal Proceedings. Bancshares and the Bank, because of the nature of their businesses, are subject at various times to numerous legal actions, threatened or pending. In the opinion of Bancshares, based on review and consultation with legal counsel, the outcome of any litigation presently pending against Bancshares or the Bank will not have a material effect on Bancshares' consolidated financial statements or results of operations. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. There are currently 3,610,945 shares of Bancshares common stock issued and 3,546,845 shares outstanding. As of December 31, 1998, there were approximately 940 shareholders of Bancshares. The Bank is authorized by its Articles of Incorporation to issue 25,000 shares of common stock, par value $1.00 per share, all of which are outstanding. Bancshares is the only shareholder of the Bank. There is no established public trading market for Bancshares common stock. Management of Bancshares is aware that from time to time Bancshares common stock is bought or sold in private transactions or in transactions directly with a securities broker-dealer making a limited market in Bancshares' common stock. Management of Bancshares is aware of approximately 112 sales of Bancshares common stock since January 1, 1998 at prices ranging from $34.00 to $40.00 per share. Bancshares has paid dividends on its common stock on a quarterly basis in the past three years as follows: Dividend paid on Common Stock Fiscal Year (per share) 1996 $.40 1997 $.53 1998 $.72 As a holding company, Bancshares, except under extraordinary circumstances, will not generate earnings of its own, but will rely solely on dividends paid to it by the Bank as the source of income to meet its expenses and pay dividends. Under normal circumstances, Bancshares' ability to pay dividends will depend entirely on the ability of the Bank to pay dividends to Bancshares. The Bank is a state banking corporation, and the payment of dividends by the Bank is governed by the Alabama Banking Code. The restrictions upon payment or dividends imposed by the Alabama Banking Code are described in Part II, Item 5 of Bancshares' Annual Report on Form 10-K for the year ended December 31, 1984 (filed with the Commission in Washington, D.C., file no. 0-14549), and such description is incorporated herein by reference. Item 6. Selected Financial Information. UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARY SELECTED FINANCIAL INFORMATION
Year Ended December 31, 1998 1997 1996 1995 1994 (In Thousands of Dollars, Except Per Share Amounts) RESULTS OF OPERATIONS Interest Revenue $ 43,255 $ 37,648 $ 34,551 $ 30,571 $ 23,340 Interest Expense 15,518 15,376 15,081 13,298 9,095 Net Interest Revenue 27,737 22,272 19,470 17,273 14,245 Provision for Loan Losses 3,187 1,710 800 255 224 Non-Interest Revenue 4,558 4,361 2,725 2,555 2,250 Non-Interest Expense 17,008 15,229 11,765 10,898 10,351 Income Before Income Taxes 12,100 9,694 9,630 8,675 5,920 Income Taxes 3,521 2,713 2,659 2,225 1,367 Net Income $ 8,579 $ 6,981 $ 6,971 $ 6,450 $ 4,553 Net Income Per Share: Basic $ 2.42 $ 1.97 $ 1.97 $ 1.83 $ 1.30 Diluted $ 2.40 $ 1.96 $ 1.97 $ 1.83 $ 1.30 Average Number of Shares Outstanding (000) 3,543 3,537 3,537 3,520 3,497 PERIOD END STATEMENT OF CONDITION Total Assets $450,073 $425,941 $430,383 $377,120 $308,569 Loans 235,060 215,897 204,886 182,000 129,603 Deposits 326,645 322,418 346,306 304,381 247,534 Shareholders' Equity 60,568 52,711 47,616 41,795 31,597 AVERAGE BALANCES Total Assets $439,080 $434,010 $410,541 $364,330 $301,112 Average Earning Assets 408,506 402,271 382,458 337,921 280,096 Loans 231,792 212,570 198,327 172,146 135,450 Deposits 320,958 345,442 327,531 294,063 244,788 Shareholders' Equity 57,409 50,164 44,044 37,588 32,175 PERFORMANCE RATIOS Net Income to: Average Total Assets 1.95% 1.61% 1.70% 1.77% 1.51% Average Shareholders' Equity 14.94% 13.92% 15.83% 17.16% 14.15% Average Shareholders' Equity to Average Total Assets 13.07% 11.55% 10.73% 10.32% 10.69% Dividend Payout Ratio 31.40% 26.79% 20.21% 18.12% 24.07%
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Introduction The following discussion and financial information are presented to aid in an understanding of the current financial position and results of operations of United Security Bancshares, Inc. ("United Security"), and should be read in conjunction with the Audited Financial Statements and Notes thereto included herein. The emphasis of this discussion will be on the years 1998, 1997, and 1996. All yields presented and discussed herein are based on an accrual basis and not on the tax-equivalent basis. On June 30, 1997, First Bancshares, the parent holding company of First Bank and Trust, merged with and into United Security. The merger was accounted for as a pooling of interests, and, accordingly, financial information for all prior periods has been restated to present the combined financial condition and results of operations of both companies as if the merger had been in effect for all periods presented. United Security is the parent holding company of First United Security Bank (the "Bank"). The Bank operates a finance company, Acceptance Loan Company, that currently has twenty-five offices in Alabama and Northwest Florida. United Security also began a courier company as a subsidiary, First Security Courier Corporation, in 1997 mainly for the purpose of delivering checks and documents to the Federal Reserve to aid in check clearing. This courier company performs courier services for First United Security Bank as well as other financial institutions in our market area. At December 31, 1998, United Security had consolidated assets of approximately $450.1 million and operated sixteen banking locations in four counties. These sixteen locations contributed approximately $7.8 million to consolidated net income in 1998. First United Security Bank's sole business is banking; therefore, loans and investments are its principal source of income. This discussion contains certain forward looking statements with respect to the financial condition, results of operation and business of United Security and the Bank related to, among other things: (A) trends or uncertainties which will impact future operating results, liquidity and capital resources, and the relationship between those trends or uncertainties and nonperforming loans and other loans; (B) the diversification of product production among timber related entities and the effect of that diversification on the Bank's concentration of loans to timber related entities; (C) the composition of United Security's derivative securities portfolio and its interest rate hedging strategies and volatility caused by uncertainty over the economy, inflation and future interest rate trends; (D) the effect of the market's perception of future inflation and real returns and the monetary policies of the Federal Reserve Board on short and long term interest rates; (E) the effect of interest rate changes on liquidity and interest rate sensitivity management; (F) the amount of anticipated (i) net loan charge offs; (ii) loans on a non-accrual basis; and (iii) options income and other off-balance-sheet income; (G) the success of the Company's prior and continuing efforts to address issues stemming from potential automation problems associated with the transition to the Year 2000; and (H) the expectations, beliefs, and plans of Management as set forth in the letter to shareholders contained in this Annual Report. These forward looking statements involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward looking statements include, among others, the following possibilities: (1) the perceived diversification in product production within the timber industry fails to protect the Bank from its concentration of loans to the timber industry as a result of, for example, the emergence of technological developments or market difficulties that affect the timber industry as a whole, (2) periods of lower interest rates continue to accelerate the rate at which the underlying obligations of mortgage-backed securities and collateralized mortgage obligations are prepaid, thereby affecting the yield on such securities held by the Bank; (3) inflation grows at a greater-than-expected rate with a material adverse effect on interest rate spreads and the assumptions management of United Security has used in its interest rate hedging strategies and interest rate sensitivity gap strategies; (4) rising interest rates adversely affect the demand for consumer credit; (5) unexpected problems arise from the transition to the Year 2000, including failure of third parties with whom the Company does business, or governmental or regulatory bodies, to address Year 2000 issues; and (6) general economic conditions, either nationally or in Alabama, are less favorable than expected. Financial Condition United Security's financial condition depends primarily on the quality and nature of the Bank's assets, liabilities, and capital structure, the quality of its personnel, and prevailing market and economic conditions. The majority of the assets and liabilities of a financial institution are monetary and, therefore, differ greatly from most commercial and industrial companies that have significant investments in fixed assets and inventories. Inflation has an important impact on the growth of total assets in the banking industry, resulting in the need to increase equity capital at rates greater than the applicable inflation rate in order to maintain an appropriate equity to asset ratio. Also, the category of other expenses tends to rise during periods of general inflation. The acquisition of Brent Banking Company contributed significantly to United Security's growth during 1996. It added approximately $34 million in assets. In conjunction with the merger on June 30, 1997, First United Security Bank sold the deposits, branch facility and associated assets of its branch office in Grove Hill effective November 1, 1997 as directed by the United States Department of Justice as a requirement for the merger approval. This divestiture reduced deposits by approximately $9.8 million. The Bank owns all of the stock of Acceptance Loan Company, Inc. ("ALC"), an Alabama corporation. ALC is a finance company organized for the purpose of making consumer loans. The Bank is ALC's only source of funds and ALC'S funding makes up approximately $65 million of the Bank's loans. Management believes the most significant factor in producing quality financial results is the Bank's ability to react properly and timely to changes in interest rates. Management is therefore attempting to maintain a more balanced position between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations. The following table reflects the distribution of average assets, liabilities, and shareholders' equity for each of the three years ended December 31, 1998, 1997, and 1996. Distribution of Assets, Liabilities, and Shareholders' Equity, with Interest Rates and Interest Differentials
December 31, 1998 1997 1996 Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate % Balance Interest Rate % Balance Interest Rate % (In Thousands of Dollars, Except Percentages) ASSETS Interest-Earning Assets: Loans (Note A) $231,792 $ 29,397 12.68% $212,570 $22,964 10.80% $198,327 $20,219 10.19% Taxable Investments (Note B) 150,678 12,292 8.16% 161,125 12,854 7.98% 149,337 12,311 8.24% Non-Taxable Investments 24,206 1,469 6.07% 26,704 1,736 6.50% 31,971 1,873 5.86% Federal Funds Sold 1,830 97 5.30% 1,872 95 5.07% 2,823 148 5.24% Total Interest-Earning Assets 408,506 43,255 10.59% 402,271 37,649 9.36% 382,458 34,551 9.03% Non-Interest Earning Assets: Other Assets 30,574 31,739 28,083 Total $439,080 $434,010 $410,541 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-Bearing Liabilities: Demand Deposits $ 59,794 $ 1,387 2.32% $ 64,607 $ 1,644 2.54% $ 69,461 $ 1,905 2.74% Savings Deposits 41,728 1,137 2.72% 43,797 1,218 2.78% 30,939 887 2.87% Time Deposits 180,128 9,971 5.44% 193,738 10,413 5.37% 185,588 10,230 5.51% Other Liabilities 54,383 3,023 5.56% 34,605 2,101 6.07% 35,383 2,059 5.82% Total Interest-Bearing Liabilities $336,033 $ 15,518 4.62% $336,747 $15,376 4.57% $321,371 $15,081 4.69% Non-Interest Bearing Liabilities: Demand Deposits $ 39,308 $ 43,300 $ 41,543 Other Liabilities 6,330 3,799 3,583 Shareholders' Equity 57,409 50,164 44,044 Total $439,080 $434,010 $410,541 Net Interest Income (Note C) $ 27,737 $ 22,273 $ 19,470 Net Yield on Interest- Earning Assets 6.79% 5.54% 5.09% Note A -- For the purpose of these computations, non-accruing loans are included in the average loan amounts outstanding. Note B -- Taxable investments include all held-to-maturity, available-for-sale, and trading account securities. Note C -- Loan fees of $1,099,758, $815,566, and $704,194 for 1998 1997 and 1996, respectively, are included in interest income amounts above.
Loans and Allowance for Loan Losses Total loans outstanding increased by $21.3 million in 1998 with $245.0 million outstanding at year end. Real estate loans decreased by $3.6 million to $123.3 million outstanding at December 31, 1998. Real estate loans made up 50.3% of total gross loans at year end 1998. Construction activity in the trade areas continue to be predominately commercial. The Company continues to offer a home equity loan and a long-term fixed-rate mortgage loan program. Real estate loans consist of construction loans to both businesses and individuals. These loans relate to residential and commercial development, commercial buildings and apartment complexes. Real estate loans also consist of other loans secured by real estate such as one-to-four family dwellings including mobile homes, loans on land only, multi-family dwellings, non farm non-residential real estate and home equity loans. Acceptance Loan Company had a total of $9.8 million in real estate loans or 8.0% of total real estate loans at year end 1998. Commercial loans totaled $35.4 million at December 31, 1998. These loans increased $.4 million or 1.2% from December 31, 1997. Consumer installment loans totaled $86.3 million at December 31, 1998. This increase of $24.5 million or 39.6% is almost all attributed to growth in Acceptance Loan Company. These loans include loans to individuals for household, family and other personal expenditures including credit cards and related plans. Loans by ALC represent $61.4 million or 71.1% of total consumer installment loans. Acceptance Loan Company is a wholly-owned subsidiary of First United Security Bank. ALC was organized in 1995 primarily to make consumer loans. At December 31, 1995, three offices were in operation with $1.9 million in total loans outstanding. At December 31, 1996, six offices were open with $11.3 million in total loans outstanding. At December 31, 1997, twenty offices were open with $39.4 million in total loans. There were twenty-five offices open on December 31, 1998, with $71.2 million in gross loans outstanding. Twenty-two offices are located in Alabama and three in Northwest Florida. Combined loans from these offices make up 29.1 % of total loans of First United Security Bank. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio and changes in its risk profile, credit concentrations, historical trends, specific impaired loans, and economic conditions. This evaluation also considers the balance of impaired loans. Losses on individually identified impaired loans are measured based on the present value of expected future cash flows discounted at each loan's original effective market interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through the provision added to the allowance for loan losses. One-to-four family residential mortgages and consumer installment loans are subjected to a collective evaluation for impairment, considers delinquency and repossessive statistics, historical loss experience, and other factors. Though management believes the allowance for loan losses to be adequate, ultimate losses may vary from their estimates. However, estimates are reviewed periodically, and as adjustments become necessary, they are reported in earnings during periods they become known. The Bank's loan policy requires immediate recognition of a loss if significant doubt exists as to the repayment of the principal balance of a loan. Consumer installment loans at the Bank and ALC are generally recognized as losses if they become 90 days and 120 days or more delinquent, respectively. The only exception to this policy occurs when the underlying value of the collateral or the customer's financial position makes a loss unlikely. A credit review of the Bank's individual loans is conducted periodically by branch and by officer. A risk rating is assigned to each loan and is reviewed at least annually. In assigning risk, management takes into consideration the capacity of the borrower to repay, collateral values, current economic conditions and other factors. Loan officers and other personnel handling loan transactions undergo frequent training dedicated to improving the credit quality as well as the yield of the loan portfolio. First United Security Bank operates under a written loan policy which attempts to guide lending personnel in maintaining a consistent lending function. This policy is intended to aid loan officers and lending personnel in making sound credit decisions and to assure compliance with state and federal regulations. In addition, the intent of the loan policy is to provide lending officers with a guide to making loans which will provide an adequate return while providing services to the communities and trade areas in which we are located. The balance in the allowance for loan losses as of December 31, 1998, was $5.0 million. This increase of approximately $1,000,000 over year end 1997 reflects the continuing evaluation of the Bank's portfolio and the growth in Acceptance Loan Company. Management considers this reserve adequate for coverage of losses inherent in the loan portfolio. This allowance is 2% of total loans. The following table shows the Bank's loan distribution as of December 31, 1998, 1997, 1996, 1995 and 1994.
December 31, 1998 1997 1996 1995 1994 (In Thousands of Dollars) Commercial, Financial and Agricultural $ 35,444 $ 35,036 $ 36,387 $ 33,696 $ 33,106 Real Estate 123,264 126,824 126,666 114,985 83,530 Installment 86,282 61,822 49,119 36,301 24,814 Total $244,990 $223,682 $212,172 $184,982 $141,450
The amounts of total loans (excluding installment loans) outstanding at December 31, 1998, which, based on the remaining scheduled repayments of principal, are due in (1) one year or less, (2) more than one year but within five years, and (3) more than five years, are shown in the following table.
Maturing After One Within But Within After One Year Five Years Five Years Total (In Thousands of Dollars) Commercial, Financial, and Agricultural $ 25,571 $ 6,746 $ 3,127 $ 35,444 Real Estate -- Mortgage 59,526 43,109 20,629 123,264 Total $ 85,097 $ 49,855 $ 23,756 $158,708 Variable rate loans totaled approximately $36.8 million and are included in the one-year category.
First United Security Bank and Acceptance Loan Company (a wholly owned subsidiary of First United Security Bank) began the year with a combined balance in the allowance for loan losses of $4.0 million. Total loans charged off in 1998 totaled $2.6 million. Recoveries on loans previously charged off totaled $345,000, resulting in net loan losses of $2.2 million. Net loan losses for 1997 totaled $798,000. Management allocated and charged to operations $3.2 million in 1998 as an addition to the allowance for loan losses. This compares to $1.7 million charged to operations for 1997. The balance of $5.0 million at year end 1998 represented 2.0% of total loans outstanding and is considered adequate for losses inherent in the portfolio. Total loans outstanding on December 31, 1998 were $245 million. Of this total, loans by ALC amounted to $71.2 million. This represents 29.1% of total loans outstanding. Of the $5.0 million balance in the allowance for loan losses account at December 31, 1998, $1.9 million or 38.0% is represented by reserves maintained for ALC loans. Non-Performing Assets The following table presents information on non-performing loans and real estate acquired in settlement of loans.
December 31, 1998 1997 1996 1995 1994 (In Thousands of Dollars) Non-Performing Assets: Loans Accounted for on a Non-Accrual Basis $3,460 $1,488 $1,797 $ 169 $ 571 Accruing Loans Past Due 90 Days or More 1,610(1) 1,285 1,122 1,390 612 Real Estate Acquired in Settlement of Loans 215 506 18 63 429 Total $5,285 $3,279 $2,937 $1,622 $1,612 Percent of Net Loans and Other Real Estate 2.25% 1.52% 1.44% 0.90% 1.16% (1) Acceptance Loan Company represents 57.5% of accruing loans past due 90 days or more.
Accruing loans past due 90 days or more at December 31, 1998, totaled $1.6 million. These loans are well secured and taking into consideration the collateral value and the financial strength of the borrowers, management believed there would be no loss in these accounts and allowed the loans to continue accruing. These loans 90 days and more past due, whether on accrual or non-accrual, are reviewed by the Board of Directors each month. Loans past due 90 days and more on Acceptance Loan Company totaled $925,370 at December 31, 1998, or 57.5% of all loans past due 90 days and more and still accruing. At December 31, 1998, the Company had one loan considered to be impaired. The amount of this loan, which is on non-accrual, is $486,826 and the related allowance is $243,000. The average recorded investment in impaired loans during the year ended December 31, 1998 was approximately $512,750. For the year ended December 31, 1998, the Company did not recognize interest income on the impaired loan during the period the loan was considered impaired. The Company had approximately $539,000 considered to be impaired at December 31, 1997. In the opinion of management, non-performing loans and any other loans which have been classified for regulatory purposes do not represent or result from trends or uncertainties which will materially impact future operating results, liquidity, or capital resources. Management is not aware of information which would cause serious doubts as to the ability of borrowers to comply with present repayment terms. Non-performing assets as a percentage of net loans and other real estate was 2.25% at December 31, 1998. Loans past due 90 days or more and still accruing are reviewed closely by management and are allowed to continue accruing only because of underlying collateral values and management's belief that the financial strength of the borrowers is sufficient to protect the Bank from loss. If at any time management determines there may be a loss of interest or principal, these loans will be changed to non-accrual and their asset value downgraded. Through frequent training, our lending officers are directed by the Bank's written loan policy to make loans within our trade area, to obtain adequate down payments on purchase-money transactions, and to lend within policy guidelines on other transactions. In addition, the Bank's loan review officer conducts an independent review of individual loans by branch and officer. First United Security Bank discontinues the accrual of interest on a loan when management has reason to believe the financial condition of the borrower has deteriorated so that the collection of interest is in doubt. When a loan is placed on non-accrual, all unpaid accrued interest is reversed against current income unless the collateral securing the loan is sufficient to cover the accrued interest. Interest received on non-accrual loans is generally either applied against the principal or reported as interest income, according to management's judgement as to whether the borrower can ultimately repay the loan. A loan may be restored to accrual status if the obligation is brought current, performs in accordance with the contract for a reasonable period, and if management determines that the repayment of the total debt is no longer in doubt. It is the policy of First United Security Bank to charge-off immediately as loss all amounts judged to be uncollectible. Management is aware that certain losses may exist in the loan portfolio which have not been specifically identified. The allowance for loan losses is established for this reason. This allowance was $5.0 million at year-end and represented 2% of total loans outstanding. Management believes this allowance is adequate to absorb loan losses inherent in the portfolio. Allocation of Allowance for Loan Losses The following table shows an allocation of the allowance for loan losses for each of the five years indicated.
December 31, 1998 1997 1996 1995 1994 Percent Percent Percent Percent Percent of Loans of Loans of Loans of Loans of Loans in Each in Each in Each in Each in Each Category Category Category Category Category Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allowance to Total Allocation Loans Allocation Loans Allocation Loans Allocation Loans Allocation Loans (In Thousands of Dollars) Commercial, Financial, and Agricultural $ 748 15% $1,416 16% $1,097 17% $ 370 18% $ 286 23% Real Estate 499 50 405 57 313 60 493 62 190 59 Installment 3,742 35 2,225 27 1,724 23 1,604 20 1,428 18 Totals $4,989 100% $4,046 100% $3,134 100% $2,467 100% $1,904 100% Note: First Bank & Trust did not allocate Allowance for Loan Losses by category. Percentages for United Security Bank were used 1994-1996.
The table above is based, in part, on the loan portfolio make-up, the Bank's internal risk evaluation, historical charge-offs, past-due loans, non-accrual loans and management's judgment. The reallocation of a larger percentage of the consolidated allowance for loan losses to installment loans resulted from growth in the ALC loan portfolio and the increase in net charge-offs in the portfolio discussed below. Net charge-offs as shown in the "Summary of Loan Loss Experience" below indicates the trend for the last five years. Net loan charge-offs as a percentage of average loans increased from .38% in 1997 to .97% in 1998.
December 31, 1998 1997 1996 1995 1994 (In Thousands of Dollars) Balance at Beginning of Period $ 4,046 $ 3,134 $2,467 $1,904 $1,792 Charge-Offs: Commercial, Financial, and Agricultural (94) (299) (246) (201) (41) Real Estate -- Mortgage (111) (20) (21) (6) (10) Installment (2,373) (694) (497) (179) (144) Credit Cards (11) (26) (9) (8) (9) $(2,589) $(1,039) $ (773) $ (394) $ (204) Recoveries: Commercial, Financial and Agricultural $ 120 $ 110 $ 96 $ 52 $ 38 Real Estate -- Mortgage 15 18 0 5 0 Installment 305 107 117 62 51 Credit Cards 5 6 4 8 3 $ 345 $ 241 $ 217 $ 127 $ 92 Net Charge-Offs (Deduction) $(2,244) $ (798) $ (556) $ (267) $ (112) Additions Charged to Operations 3,187 1,710 800 255 224 Allowances Acquired 0 0 423** 575* 0 Balance at End of Period $ 4,989 $ 4,046 $3,134 $2,467 $1,904 Ratio of Net Charge-Offs During Period to Average Loans Outstanding 0.97% 0.38% 0.28% 0.16% 0.08% * Acquisition of Bibb County Branches by First Bank and Trust in 1995. ** Acquisition of Brent Banking Company by United Security Bank in 1996.
Non-Accruing Loans Summarized below is information concerning the income on those loans with deferred interest or principal payments resulting from a deterioration in the financial condition of the borrower.
December 31, 1998 1997 1996 (In Thousands of Dollars) Total Loans Accounted for on a Non-Accrual Basis $3,460 $1,488 $1,798 Interest Income that Would Have Been Recorded under Original Terms 340 154 91 Interest Income Reported and Recorded During the Year 298 108 37
Total loans on non-accrual increased by $1,972,000 from December 31, 1997 to December 31, 1998. The majority of the loans in this category are in process of liquidation or management has commitments from the principals involved for reduction during the year. Underlying collateral values support those loans which are not already in liquidation. Management continues to emphasize asset quality and expects a significant reduction in 1999 of the $3.5 million still on non-accrual at year-end 1998. The Company believes that it has adequate reserves for losses inherent in this portion of the portfolio. Lending officers and other personnel involved in the lending process receive ongoing training in compliance as well as asset quality. The Company has no foreign loans. The Company does not make loans on commercial property outside our market area without prior approval of the Board of Directors or the Directors' Loan Committee. The Company is conservative in its lending directives. Industry Concentration Factors The First United Security Bank trade area includes Clarke, Choctaw, and Bibb Counties in Alabama. In addition, parts of Chilton, Hale, Jefferson, Marengo, Monroe, Perry, Shelby, Tuscaloosa, Washington, Sumter and Wilcox Counties in Alabama as well as parts of Clarke, Lauderdale and Wayne Counties in Mississippi are included. There are several major paper mills in our trade area including the Alabama River Companies, Boise Cascade, Fort James and MacMillan Bloedel. In addition, there are several sawmills, lumber companies, and pole and piling producers. The table below shows the dollar amount of loans made to timber and timber related companies as of December 31, 1998. The amount of timber related loans decreased from $49.2 million in 1997 to $41.5 million in 1998. The percentage of timber related loans to gross loans decreased from 22.0% to 17.3%. The growth in ALC loans of $27.3 million during 1998 helped to lower timber industry concentration. Timber Total Percentage of Related Loans Gross Loans Total Loans $41.5 million $245.0 million 16.94% Management understands the concern about concentration of loans in timber and timber-related industries. However, we continue to feel these risks are reduced by the diversification of product production within these industries. Some of the mills and industries specialize in paper and pulp, some in lumber and plywood, some in poles and pilings, and others in wood and veneer. We do not believe that this concentration is excessive or that it represents a trend which might materially impact future earnings, liquidity, or capital resources of the Bank. Management does realize the Company is heavily dependent on the economic health of the timber-related industries. The Company continues to benefit from the area industries engaged in the growing, harvesting, processing and marketing of timber and timber-related products. The majority of the land in our trade area is used to grow pine and hardwood timber. Agricultural production loans make up less than 1 % of the Company's total loan portfolio. The Company's market area for Bibb County, Alabama, and surrounding counties gives us an opportunity to diversify. With the opening of the Mercedes Benz manufacturing plant in Vance, Alabama, in 1997, we now have three offices within 25 miles of the plant site. One office is located only 7 miles from the plant. This area continues to be one of the fastest growing corridors in the state. The Company plans to open another new office in the area in the spring of this year. Investments in Limited Partnerships First United Security Bank invests in limited partnerships that operate qualified affordable housing projects to receive tax benefits in the form of tax deductions from operating losses and tax credits. The Bank accounts for the investments under either the equity or the cost method based on the percentage ownership and influence over operations. The Company's interest in these partnerships was $4,234,447 and $4,272,547 for 1998 and 1997, respectively. Costs associated with the partnerships carried under the equity method amounted to approximately $128,000 and $122,000 for 1998 and 1997, respectively. Management analyzes these investments annually for potential impairment. The assets and liabilities of these partnerships consist primarily of apartment complexes and related mortgages. United Security's carrying value approximates cost or its underlying equity in the net assets of the partnerships. The Company has remaining cash commitments to these partnerships at December 31, 1998 in the amount of $360,000. Although these investments are considered non-earning assets they do contribute to the bottom line in the form of Federal income tax credits. These credits amounted to $480,000 in 1997 and are estimated to be approximately $490,000 for 1998. Also, operating losses related to these partnerships are available as deductions for taxes on the Company's books. Deposits Average total deposits have declined 2% during the last three years, with a 7% decline in 1998. This lower deposit level was affected by the competitive interest rate environment, the sale of one branch facility and the availability of other low rate funding. Average non-interest bearing demand deposits have decreased 5.4% over the last three years, while the decline for 1998 was 9.2%. The ratio of average non-interest bearing deposits to average total deposits remained relatively steady in 1998 at 12.2% from 12.5% in 1997 and 12.7% in 1996. Average interest-bearing transaction accounts have decreased 13% during the last three years partly because the Bank reclassified a portion of interest-bearing transaction accounts to money market savings accounts, resulting in a 7.0% decline in 1997. Nevertheless, interest-bearing transaction accounts continue to be an important source of funds for the Bank, accounting for 18.6 % of average total deposits in 1998. During the last three years, average time deposits declined 2.9%. This represents a decrease of over $5 million. Average time deposits decreased by 7% in 1998, compared to an increase of 4.2% in 1997. Time deposits represented 56.1% of the total average deposits in 1998 and 1997 compared to 56.7% in 1996. This decline was a result of a repricing strategy to reduce the dependency on mostly high cost price sensitive certificates of deposit. Average savings deposits have grown 34.9% since 1996. Average savings declined 4.7% in 1998. The ratio of average savings to average total deposits increased to 13.0% in 1998 compared to 12.7% in 1997 and 9.4% in 1996. First United Security Bank's deposit base remains the primary source of funding for the Bank. These deposits represented 73.1% of the average earning assets in 1998 and 85.9% of the average earning assets in 1997. As seen in the following table, overall rates on the deposits increased to 3.89% in 1998, compared to 3.84% in 1997 and 3.98% in 1996. This rate change reflects a somewhat stable interest rate environment. Emphasis continues to be placed on placed on attracting consumer deposits. It is First United Security Bank's intent to expand its consumer deposit base in order to continue to fund asset growth through growth in demand deposits and consumer certificates of deposit. In June, 1996, Brent Banking Company was acquired ition contributed approximately $33 mile in the conrion to the total deposits; however, the average total calculation for 1996 was limited to a partial year. Effective November 1997, approximately $9.8 million in deposits were sold as directed by the United States Department of Justice to facilitate the merger between First Bank and Trust and United Security Bank. The sale of deposits had a significant impact on the reduced average deposits in 1998. Management, as part of an overall program to emphasize the growth of transaction accounts, will introduce "on-line" banking and a bill paying program as well as enhance the existing "Loyalty" banking program and telephone banking. In addition, an increased effort will be placed on promotions, direct mail campaigns and cross selling efforts. This will be accomplished by remaining safe and sound, emphasizing our products and providing quality service. Other Interest-Bearing Liabilities -- Other interest-bearing liabilities include all interest-bearing liabilities except deposits, such as: federal funds purchased, securities sold under agreement to repurchase (repurchase agreements), and Federal Home Loan Bank advances. This category continues to be used as an alternative source of funds. The $19.8 million or 57.1% average increase in 1998 is due to an increase in volume of long term advances from the Federal Home Loan Bank (FHLB). While deposit rates increased slightly in 1998, the average rates on the other liabilities declined by 51 basis points in 1998. Average Daily Amount of Deposits and Rates The average daily amount of deposits and rates paid on such deposits is summarized for the periods in the following table.
December 31, 1998 1997 1996 Amount Rate Amount Rate Amount Rate (In Thousands of Dollars, Except Percentages) Non-Interest Bearing DDA $ 39,308 $ 43,300 $ 41,543 Interest-Bearing DDA 59,794 2.32% 64,607 2.54% 69,461 2.74% Savings Deposits 41,728 2.72 43,797 2.78 30,939 2.87 Time Deposits 180,128 5.44 193,738 5.37 185,588 5.51 Total $320,958 3.89% $345,442 3.84% $327,531 3.98%
Maturities of Time Certificates of Deposits and Other Time Deposits of $100,000 or more outstanding at December 31, 1998, are summarized as follows:
Time Other Certificates Time Maturities of Deposits Deposits Total (In Thousands of Dollars) 3 Months or Less $12,985,179 $16,840,928 $19,826,107 Over 3 Through 6 Months 6,708,330 0 6,708,330 Over 6 Through 12 Months 5,665,526 0 5,665,526 Over 12 Months 15,189,138 0 15,189,138 Total $40,548,173 $16,840,928 $47,389,101
Investment Securities and Securities Available for Sale Securities available for sale include Collateralized Mortgage Obligations ("CMOs") of $101.3 million, other mortgage backed securities of $31.3 million, state, county and municipal securities of $23.8 million, and other securities of $3.1 million. The total securities portfolio decreased $8.5 million or 4.9% from December 1997 to December 1998. The decrease is a result of increased loan demand and general market conditions. At December 1998, approximately $90.5 million in CMOs had floating interest rates which reprice monthly and $10.8 million had fixed interest rates. Because of their liquidity, credit quality and yield characteristics, the majority of the purchases of taxable securities have been purchases of agency guaranteed mortgage-backed obligations and collateralized mortgage obligations. The mortgage-backed obligations in which United Security invests represent an undivided interest in a pool of residential mortgages or may be collateralized by a pool of residential mortgages ("mortgage-backed securities"). Mortgage-backed securities have yield and maturity characteristics corresponding to the underlying mortgages and are subject to any prepayments of principal due to prepayment, refinancing, or foreclosure of the underlying mortgages. Although maturities of the underlying mortgage loans may range up to 30 years, amortization and prepayments substantially shorten the effective maturities of mortgage-backed securities. Transactions in these securities have focused on the three to seven year average maturity range. Principal and interest payments also add significant liquidity to the balance sheet. In 1997, there was a continuing emphasis in CMOs, all of which are collateralized by U. S. Government and Agency Mortgage Pools. The CMO market in existence since 1983 was created to add liquidity to the mortgage-backed security ("MBS") market by furnishing better distribution of risk/reward profiles. Since CMOs are derived from MBS pools, they are labeled mortgage derivatives. Although the Federal Financial Institution Examination Council no longer requires that all MBS derivatives be tested for suitability as an investment in the portfolio of financial institutions, First United Security Bank continues to run these tests at purchase and periodically thereafter. The three tests being performed are as follows: #1 -- Average Life Test -- The expected average life of the security must be less than or equal to 10 years. #2 -- Average Life Sensitivity Test -- The average life of the security will not extend by more than 4 years or shorten by more than 6 years for immediate Treasury curve shifts of +/- 300 basis points (3%). #3 -- Price Sensitivity Test -- The estimated price of the security will not change by more than 17% for immediate Treasury curve shifts of +/- 300 basis points. Securities that do not pass all three tests are designated "high risk". United Security held $37.7 million in securities which, at December 31, 1998, were designated high risk. $5 million of these securities were floating rate, and $24.8 million were inverse floating rate securities and $7.9 million were fixed rate securities. These securities were purchased and/or are being held to hedge certain areas of interest rate risk in the portfolio and balance sheet. There were unrealized losses in this portion of the portfolio at December 31, 1998 of $800,000. The overall securities portfolio is formally monitored on a monthly basis, and assessments are made continually relative to United Security's exposure to fluctuations in interest rates. Changes in the level of earnings and fair values of securities are generally attributable to fluctuations in interest rates, as well as volatility caused by general uncertainty over the economy, inflation, and future interest rate trends. MBS and CMOs present some degree of additional risk in that mortgages collateralizing these securities can be prepaid, thereby affecting the yield and market value of the portfolio. The composition of United Security's investment portfolio reflects United Security's investment strategy of maximizing portfolio yields commensurate with risk and liquidity considerations. The primary objectives of United Security's investment strategy are to maintain an appropriate level of liquidity and provide a tool to assist in controlling United Security's interest rate position while at the same time producing adequate levels of interest income. Fair market value of securities vary significantly as interest rates change. The gross unrealized gains and losses in the securities portfolio are not expected to have a material impact on future income, liquidity or other funding needs.12,620 one year ago. United Security uses other off balance sheet derivative products for hedging purposes. These include interest rate swaps, caps, floors and options. The use and detail regarding these products are fully discussed under "Liquidity and Interest Rate Sensitivity Management" and in Note 19 in the "Notes to Consolidated Financial Statements". Investment Securities Available-for-Sale The following table sets forth the carrying value of investment securities at the dates indicated.
December 31, 1998 1997 1996 (In Thousands of Dollars) Investment Securities Available for Sale: U.S. Treasury and Agencies Securities $ 2,090 $ 2,096 $ 4,987 Obligations of States, Counties, and Political Subdivisions 23,841 22,228 32,113 Mortgage-Backed Securities 132,588 144,310 145,098 Other Securities 3,076 2,245 3,336 Unrealized Gains (Losses) 4,514 1,620 1,672 Total $164,019 $172,499 $187,206
Investment Securities Available-for-Sale Maturity Schedule
Maturing After One After Five Within But Within But Within After One Year Five Years 10 Years 10 Years Amount Yield Amount Yield Amount Yield Amount Yield (In Thousands of Dollars, Except Yields) Investment Securities Available for Sale: U.S. Treasury and Agency Securities $ 500 0.00% $ 0 0.00% $ 0 0.00% $ 1,560 0.00% State, County and Municipal Obligations 1,081 6.79% 3,994 6.88% 3,498 6.46% 16,955 5.53% Mortgage-Backed Securities 90 7.68% 35 3.97% 13,911 7.52% 121,350 6.67% Other 3,094 7.18% 11 7.93% 0 0.00% 0 0.00% Total $4,265 7.09% $4,040 6.85% $17,409 7.31% $138,305 6.53% TOTAL $164,019 6.64% *Available for Sale Securities are stated at Market Value and Market Yield
The maturities and weighted average yields of investment securities available-for-sale at the end of 1998 are presented in the preceding table based on stated maturity. While the average stated maturity of the Mortgage Backed Securities (excluding CMO's) was 25.40 years, the average life expected is 6.83 years. The average stated maturity of the CMO portion of the portfolio was 23.02 years, and the average expected life was 4.06 years. The average expected life of investment securities available-for-sale was 5.02 years with an average yield of 6.64 percent. Condensed Portfolio Maturity Schedule
Dollar Portfolio Maturity Summary Amount Percentage Maturing in 3 months or less $ 1,398,017 0.25% Maturing in 3 months to 1 year 841,254 0.52 Maturing in 1 to 3 years 2,313,859 1.44 Maturing in 3 to 5 years 1,931,698 1.20 Maturing in 5 to 15 years 29,626,597 18.40 Maturing in over 15 years 125,880,884 78.19 Total $160,992,309 100.00%
The following Marketable Equity Securities have been excluded from the above Maturity Summary due to no stated maturity date. Federal Home Loan Bank Stock $2,795,400 Mutual Funds $2,710,014 Other Marketable Equity Securities $2,221,688 Condensed Portfolio Repricing Schedule
Dollar Portfolio Repricing Summary Amount Percentage Repricing in 30 days or less $192,105,929 57.21% Repricing in 31 days to 1 year 841,254 0.52 Repricing in 1 to 3 years 2,313,859 1.44 Repricing in 3 to 5 years 1,726,891 1.07 Repricing in 5 to 15 years 17,801,650 11.06 Repricing in over 15 years 46,202,726 28.70 Total $160,992,309 100.00%
Repricing in 30 days or less does not include: Mutual Funds $2,710,014 Repricing in 31 days to 1 year does not include: Federal Home Loan Bank Stock $2,795,400 Other Marketable Equity Securities $ 221,688 The tables above reflect all securities at market value on December 31, 1998. Securities Gains and Losses Non-interest income from securities transactions, trading account transactions, and associated option premium income increased dramatically in 1998 compared to 1997, as can be seen in the table below. The majority of the profits realized in 1998 were generated through the sale of securities. Gains in the investment securities area occurred in connection with United Security's asset and liability management activities and strategies. Options income and other off-balance sheet income declined 19.37% from $396,772 to $319,918. Although this income should be considered non-recurring, it is expected that $123,000 will be recognized in 1999. This income which will be received in 1999 is the result of early termination of interest rate contracts and the deferred gains and losses associated with these interest rate risk management tools, and is being amortized over the original life of the hedge. The table below shows the associated net gains or (losses) for the periods 1998, 1997, and 1996:
1998 1997 1996 Investment Securities $ 410,987 $ 105,254 $ (186,802) Trading Account 0 10,187 (2,031) Total $ 410,987 $ 115,441 $ (188,833)
Gains in 1998 from sales of investment securities were net of losses of $829,183. Volume of sales as well as other information on securities is further discussed in Note 4 to the financial statements. Short-Term Borrowings Purchased funds can be used to satisfy daily funding needs, and when advantageous, for arbitrage. The following table shows information for the last three years regarding the Bank's short- and long-term borrowings consisting of U. S. Treasury demand notes included in its Treasury, Tax, and Loan Account, securities sold under repurchase agreements, Federal Fund purchases (one day purchases), and other borrowings from the Federal Home Loan Bank.
Short-Term Long-Term Borrowings Borrowings Maturity Maturity Less Than One Year One Year or Greater (In Thousands of Dollars) Year Ended December 31,: 1998 $22,212 $55,847 1997 3,913 40,966 1996 22,443 9,088 Weighted Average Interest Rate at Year-end: 1998 4.41% 5.04% 1997 5.23% 5.83% 1996 5.44% 7.50% Maximum Amount Outstanding at Any Month's End: 1998 $11,620 $55,906 1997 11,936 40,973 1996 43,310 9,164 Average Amount Outstanding During the Year: 1998 $3,929 $55,454 1997 3,210 30,296 1996 26,669 9,130 Weighted Average Interest Rate During the Year: 1998 5.87% 5.53% 1997 5.80% 5.83% 1996 5.49% 7.50%
During January of 1997, United Security converted Federal Home Loan Bank short-term borrowings to long-term borrowings. Balances in these accounts fluctuate dramatically on a day-to-day basis. Rates on these balances also fluctuate daily, but as reflected in the chart above, they generally depicit the current interest rate environment. Shareholders' Equity United Security has always placed great emphasis on maintaining its strong capital base. At December 31, 1998, shareholders' equity totaled $60.5 million, or 13.5% of total assets compared to 12.4% and 11.1% for the same periods in 1997 and 1996, respectively. This level of equity indicates to United Security's shareholders, customers and regulators that United Security is financially sound and offers the ability to sustain an appropriate degree of leverage to provide a desirable level of profitability and growth. Over the last three years shareholders' equity grew from $41.8 million at the beginning of 1996 to $60.5 million at the end of 1998. All of this growth was the result of internally generated retained earnings, with the exception of the market value adjustment of $2.8 million made for the available for sale investments as required by Statement of Financial Accounting Standards No. 115 and $179,930 from treasury stock retirement and stock options being exercised. The internal capital generation rate (net income less cash dividends as a percentage of average shareholders' equity) was 10.3% in 1998, 10.2% in 1997 and 12.6% in 1996. United Security is required to comply with capital adequacy standards established by the Federal Reserve and FDIC. Currently, there are two basic measures of capital adequacy: a risk-based measure and a leverage measure. The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profile among banks and bank holding companies, to account for off-balance sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance sheet items are assigned to risk categories, each with a specified risk weighting factor. The resulting capital ratios represented capital as a percentage of total risk weighted assets and off-balance sheet items. The minimum standard for the ratio of total capital to risk-weighted assets is 8%. At least 50% of that capital level must consist of common equity, undivided profits, and non-cumulative perpetual preferred stock, less goodwill and certain other intangibles ("Tier l Capital"). The remainder ("Tier II Capital") may consist of a limited amount of other preferred stock, mandatory convertible securities, subordinated debt, and a limited amount of the allowance for loan losses. The sum of Tier l Capital and Tier II Capital is "total risk-based capital". The banking regulatory agencies have also adopted regulations which supplement the risk based guidelines to include a minimum leverage ratio of 3% of Tier l Capital to total assets less goodwill (the "leverage ratio"). Depending upon the risk profile of the institution and other factors, the regulatory agencies may require a leverage ratio of 1% or 2% higher than the minimum 3 % level. The following chart summarizes the applicable regulatory capital requirements. United Security's capital ratios at December 31, 1998, substantially exceeded all regulatory requirements. Risk-Based Capital Requirements
Minimum United Security's Regulatory Ratio at Requirement December 31, 1998 Tier I Capital to Risk-Adjusted Assets 4.00% 16.20% Total Capital to Risk-Adjusted Assets 8.00% 17.37% Tier I Leverage Ratio 3.00% 12.07%
Total capital also has an important effect on the amount of FDIC insurance premiums paid. Lower capital ratios can cause the rates paid for FDIC insurance to increase. United Security plans to maintain the capital necessary to keep FDIC insurance rates at a minimum. United Security attempts to balance the return to shareholders through the payment of dividends with the need to maintain strong capital levels for future growth opportunities. Total cash dividends paid were $2.7 million or $.76 per share in 1998 compared to $.53 per share in 1997 and $.40 per share in 1996. The total cash dividends represented a payout ratio of 31.4% in 1998 with a payout ratio of 26.8% and 20.2% in 1997 and 1996 respectively. This is the tenth consecutive year that United Security has increased cash dividends. Ratio Analysis The following table presents operating and capital ratios for each of the last three years.
Year Ended December 31, 1998 1997 1996 Return on Average Assets 1.95% 1.61% 1.70% Return on Average Equity 14.94% 13.92% 15.83% Cash Dividend Payout Ratio 31.40% 26.79% 20.21% Average Equity to Average Assets Ratio 13.07% 11.55% 10.73%
Liquidity and Interest Rate Sensitivity Management The primary function of asset and liability management is to assure adequate liquidity and to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities. Liquidity management involves the ability to meet day-to-day cash flow requirements of United Security's customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, United Security would not be able to perform the primary function of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their repricing during changes in market interest rates. Effective interest rate sensitivity management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable time frame, thereby minimizing the effect of such interest rate movements on the net interest margin. The asset portion of the balance sheet provides liquidity primarily from loan principal payments and maturities and through sales, maturities, and payments from the investment portfolio. Other short-term investments such as Federal Funds Sold are additional sources of liquidity. Loans maturing or repricing in one year or less amounted to $116.5 million at December 31, 1998. Investment securities maturing or repricing in the same time frame totaled $96 million or 58.5% of the investment portfolio at year-end 1998. In addition, principal payments on mortgage backed securities totaled $9.3 million in 1998. For repricing purposes, $13.6 million in payments have been included in the one year or less categories in the "Interest Rate Sensitivity Analysis", reflecting recent prepayment experience. The liability portion of the balance sheet provides liquidity through interest-bearing and non interest bearing deposit accounts. Federal Funds purchased, securities sold under agreements to repurchase, short-term, and long-term borrowings are additional sources of liquidity. Liquidity management involves the continual monitoring of the sources and uses of funds to maintain an acceptable cash position. Long-term liquidity management focuses on considerations related to the total balance sheet structure. As shown in the Consolidated Statements of Cash Flows, operating activities provided significant levels of funds in 1998, 1997 and 1996, due primarily to high levels of net income. In 1998, other items providing cash from operating activities were depreciation, provision for loan losses and amortization of premiums and discounts. Cash flows from investing activities saw most of the proceeds from maturities and prepayments on investment securities being used to finance loan growth. Cash flows from financing activities saw an increase in customer deposits and $2.7 million in dividends paid. Advances from the Federal Home Loan Bank and other borrowings increased $11 million. Net cash and cash equivalents increased $12.3 million as a result of the activities mentioned above. Although the majority of the securities portfolio has stated maturities in excess of ten years, the entire portfolio consists of securities that are readily marketable and which are easily convertible into cash. However, management does not necessarily rely upon the investment portfolio to generate cash flows to fund loans, capital expenditures, dividends, debt repayment, etc. Instead, these activities are funded by cash flows from operating activities and increases in deposits and short-term borrowings. The proceeds from sales and maturities of investments have been used either to purchase additional investments or to fund loan growth. United Security, at December 31, 1998, had long-term debt and short-term borrowings that on average represent 13.5 percent of total liabilities and equity. United Security currently has up to $75 million in borrowing capacity from the Federal Home Loan Bank and $17 million in established Federal Funds Lines. Interest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. These repricing characteristics are the time frames during which the interest-bearing assets and liabilities are subject to changes in interest rates, either at replacement or maturity, during the life of the instruments. Sensitivity is measured as the difference between the volume of assets and the volume of liabilities in the current portfolio that are subject to repricing in future time periods. These differences are known as interest sensitivity gaps and are usually calculated for segments of time and on a cumulative basis. Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly, while the timing of repricing for both the asset and the liability remains the same, thus affecting net interest income. It should be noted, therefore, that a matched interest-sensitive position by itself will not ensure maximum net interest income. Management continually evaluates the condition of the economy, the pattern of market interest rates, and other economic data to determine the types of investments that should be made and at what maturities. Using this analysis, management from time to time assumes calculated interest sensitivity gap positions to maximize net interest income based upon anticipated movements in general levels of interest rates. Measuring Interest Rate Sensitivity: Gap analysis is a technique used to measure interest rate sensitivity, an example of which is presented below. Assets and liabilities are placed in gap intervals based on their repricing dates. Assets and liabilities for which no specific repricing dates exist are placed in gap intervals based on management's judgment concerning their most likely repricing behaviors. Derivatives used in interest rate sensitivity management are also included in the applicable gap intervals. A net gap for each time period is calculated by subtracting the liabilities repricing in that interval from the assets repricing. A positive gap -- more assets repricing than liabilities - -- will benefit net interest income if rates are rising and will detract from net interest income in a falling rate environment. Conversely, a negative gap -- more liabilities repricing than assets - -- will benefit net interest income in a declining interest rate environment and will detract from net interest income in a rising interest rate environment. Gap analysis is the simplest representation of United Security's interest rate sensitivity. However, it cannot reveal the impact of factors such as administered rates (e.g., the prime lending rate), pricing strategies on consumer and business deposits, changes in balance sheet mix, or the effect of various options embedded in balance sheet instruments. The accompanying table shows United Security's rate sensitive position at December 31, 1998, as measured by gap analysis. Over the next 12 months approximately $364,000 more interest earning assets than interest bearing liabilities can be repriced to current market rates at least once. This analysis indicates that United Security has a positive gap within the next 12 month range and net interest income should benefit slightly from a rising rate environment according to the table. Interest Rate Sensitivity Analysis
December 31, 1998 (In Thousands of Dollars) Total 0-3 4-12 1 Year 1-5 Over 5 Non-Rate Months Months or Less Years Years Sensitive Total Earning Assets: Loans (Net of Unearned Income) $ 72,706 $ 43,794 $116,500 $102,150 $21,399 $ 0 $240,049 Investment Securities 98,322 10,931 109,253 22,637 32,129 0 164,019 Interest Bearing Deposits in Other Banks 928 0 928 0 0 928 Total Earning Assets $171,956 $ 54,725 $226,681 $124,787 $53,528 $ 0 $404,996 Percent of Total Earning Assets 42.5% 13.5% 56.0% 30.8% 13.2% 100.0% Interest-Bearing Liabilities: Interest-Bearing Deposits and Liabilities Demand Deposits (1) $ 51,669 $ 0 $ 51,669 $ 12,917 $ 0 $ 0 $ 64,586 Savings Deposits (1) 19,901 0 19,901 19,901 0 0 39,802 Time Deposits 58,930 77,192 136,122 46,529 0 0 182,651 Other Liabilities 10,041 7,587 17,628 37,964 267 0 55,859 Non-Interest-Bearing Liabilities Demand Deposits 997 0 997 0 0 38,789 39,786 Equity 0 0 0 0 0 22,312 22,312 Total Funding Sources $141,538 $ 84,779 $226,317 $117,311 $ 267 $ 61,101 $404,996 Percent of Total Funding Sources 34.9% 20.9% 55.9% 29.0% 0.1% 15.1% 100.0% Interest Sensitivity Gap (Balance Sheet) $ 30,418 $(30,054) $ (9,364 $ 37,476 $53,261 $(61,101) $ 0 Off-Balance Sheet $ (5,000) $ 0 $ (5,000) $ 5,000 $ 0 $ 0 $ 0 Interest Sensitive Gap $ 25,418 $(30,054) $ (4,636) $ 12,476 $53,261 $(61,101) $ 0 Cumulative Interest- Sensitive Gap $ 25,418 $ (4,636) $ N/A $ 27,840 $61,101 $ 0 $ 0
Over 5 Total Years 0-3 4-12 1 Year 1-5 Non-Rate Months Months or Less Years Sensitive Total Ratio of Earning Assets to Funding Sources and Off-Balance Sheet 1.17% 0.65% 0.98% 1.11% 0.87% 1.00% Cumulative Ratio 1.17% 0.98% N/A 1.02% 1.00% 1.00% (1) Management adjustments reflects the Company's anticipated repricing sensitivity of non-maturity deposit products. Historically, balances on non-maturity deposit accounts have remained relatively stable despite changes in market interest rates. Management has classified certain of these accounts as non-rate sensitive based on management's historical pricing practices and runoff experience. Approximately 20% of the interest-bearing demand deposit account balances and 50% of the savings account balances are classified as over one year. Certain interest-sensitive assets and liabilities are included in the table based on historical repricing experience and expected prepayments in the case of Mortgage Backed Securities rather than contractual maturities. Non-accruing loans are included in loans at the contractual maturity.
United Security also uses additional tools to monitor and manage interest rate risk sensitivity. These tools include income simulation analysis and duration analysis. Both analyses are methods of estimating earnings at risk and capital at risk under varying interest rate conditions. They are used to test the sensitivity of net interest income and stockholders' equity to the level of interest and include adjustments for the expected timing and the magnitude of assets and liability cash flows. Also, these measures capture adjustments for the lag between movements in market interest rates and the movement of administered rates on prime rate loans, interest bearing transaction accounts, regular savings, and money market savings accounts. Income simulation analysis indicates that United Security is slightly asset sensitive. Condensed Balance Sheet Duration Analysis
Estimated Book Modified Duration Value Down 1% Up 1% ASSETS Cash and Due From Banks Total Cash and Cash Equivalent $ 12,103 4.36 4.36 Investment Securities Available-for-Sale 164,019 0.16 2.66 Fed Funds Sold & FHLB 14,728 0.01 0.01 Loans 235,060 1.95 1.50 Premises and Equipment 8,225 4.36 4.36 Accrued Interest Receivable 4,521 4.36 4.36 Investment in Limited Partnerships 4,234 4.36 4.36 Other Assets 7,183 4.36 4.36 Total Assets $450,073 1.43 2.10 LIABILITIES AND SHAREHOLDERS' EQUITY Demand, Non-interest Bearing $ 39,786 4.36 4.36 Demand, Interest Bearing 64,586 0.04 0.14 Savings 39,802 0.04 3.10 Time 182,471 0.73 0.77 Total Deposits $326,645 Other Liabilities $ 7,001 4.36 4.36 Short-Term Borrowing 12 0.08 0.08 Long-Term Borrowing 55,847 1.82 1.82 Shareholders' Equity 60,568 4.36 4.36 Total Liabilities and Shareholders' Equity $450,073 1.57 1.87 Modified Duration Differential (0.14) 0.23 *Suggested Change in Market Value of Equity (Pre-tax) ($000) $ (642) $(1,045) * The change in the market value of equity should represent the present value of the Company's future earnings exposure to a 1% rise or fall in interest rates.
United Security uses a five step process to calculate the duration of each asset and liability category. The first step is to assemble maturity and repricing data on loans, investments, CD's and other financial instruments with contractual maturities. The second step is to determine how bank management would alter the interest rate for each category of assets and liabilities assuming market interest rates rose or fell 1%. The third step is to combine the maturity analysis and repricing assumptions in order to formulate a modified duration estimate for each category. The fourth step is to calculate a weighted average for total assets and liabilities, and the fifth step is to multiply the modified duration differential as calculated (for both up 1% and down 1% interest rate scenarios) in step four by total assets. Based on the current position of the balance sheet, management believes these present value calculations approximate United Security's aggregate pre-tax earnings exposure for the next 5 years. In this methodology, all non-rate sensitive assets, liabilities, and shareholders' equity are assigned a modified duration based on a five year time horizon (4.24 years). Additionally, estimates of modified duration incorporate the likelihood that the investment portfolio would shorten maturity if interest rates fell and lengthen maturity if interest rates rose. The model also incorporates management's belief that deposit and loan rates would not rise or fall equally either by category or by interest rate scenario. Increases or decreases in loan prepayments are not modeled as they are in the investment portfolio, nor is there an allowance for growth or runoff in deposit or loan balances. The duration analysis presented above suggests long term (the market value of equity) that the Company's earnings should improve slightly if interest rates rise and should decline with a 1 % fall in interest rates. As part of the ongoing monitoring of interest-sensitive assets and liabilities, United Security enters into various interest rate contracts ("interest rate protection contracts") to help manage United Security's interest sensitivity. Such contracts generally have a fixed notional principal amount and include (i) interest rate swaps where United Security typically receives or pays a fixed rate and a counterparty pays or receives a floating rate based on a specified index, (ii) interest rate caps and floors purchased where United Security receives interest if the specified index falls below the floor rate or rises above the cap rate. All interest rate swaps represent end-user activities and are designed as hedges. The interest rate risk factor in these contracts is considered in the overall interest management strategy and the Company's interest risk management program. The income or expense associated with interest rate swaps, caps and floors classified as hedges are ultimately reflected as adjustments to interest income or expense. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized. A discussion of interest rate risks, credit risks and concentrations in off-balance sheet financial instruments is included in Note 19 of the "Notes to Consolidated Financial Statement". Commitments The Bank maintains financial instruments with risk exposure not reflected in the Consolidated Financial Statements. These financial instruments are executed in the normal course of business to meet the financing needs of its customers and in connection with its investing and trading activities. These financial instruments include commitments to make loans, options written, standby letters of credit, and commitments to purchase securities for forward delivery. The Bank's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank applies the same credit policy in making these commitments that it uses for on-balance sheet items. Collateral obtained upon exercise of the commitment is determined based on management's credit evaluation of the borrower and may include accounts receivable, inventory, property, land, and other items. The Bank does not normally require collateral for standby letters of credit. As of December 31, 1998, the Bank had outstanding standby letters of credit and commitments to make loans of $6.5 million and $23.5 million, respectively. For options written and commitments to purchase securities for forward delivery, the contractual amounts reflect the extent of the Bank's involvement in various classes of financial instruments and does not represent exposure to credit loss. The Bank controls the credit risk of these instruments through credit approvals, limits, and monitoring procedures. Options are contracts that allow the buyer of the option to purchase or sell a financial instrument at a specified price and within a specified period of time from or to the seller or writer of the option. As a writer of options, the Bank is paid a premium at the outset and then bears the risk of an unfavorable change in the price of the financial instrument underlying the option. As of December 31, 1998, the Bank had no outstanding options. Commitments to buy and sell securities for delayed delivery require the Bank to buy and sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in securities values and interest rates between the commitment and delivery dates. There were $12 million in commitments to sell securities for delayed delivery and no commitments to purchase securities as of December 31, 1998. The Bank is prepared to fulfill the above commitments through scheduled maturities of loans and securities along with cash flows from operations, anticipated growth in deposits, and short-term borrowings . Operating Results Net Interest Income Net interest income is an effective measurement of how well management has matched interest-rate sensitive assets and interest-bearing liabilities. The fluctuations in interest rates materially affect net interest income. The accompanying table analyzes these changes. Net interest income increased by $5.5 million or 24.5% in 1998 compared to 14.4% and 12.7% increases in 1997 and 1996 respectively. Volume, rate, and yield changes contributed to the growth in net interest income. Average interest-earning assets increased by $6.2 million or 1.5 % in 1998, while average interest-bearing liabilities decreased $.7 million. Volume changes of equal amounts in interest-earning assets and interest-bearing liabilities generally increase net interest income because of the spread between the yield on loans and investments and the rates paid on interest bearing liabilities. In 1998, average interest-earning assets outgained average interest-bearing liabilities by $5.5 million. United Security's ability to produce net interest income is measured by a ratio called the interest margin. The interest margin is net interest income as a percent of average earning assets. The interest margin was 6.8% in 1998 compared to 5.5 % in 1997 and 5.1 % in 1996. Interest margins are affected by several factors, one of which is the relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities. This factor determines the effect that fluctuating interest rates will have on net interest income. Rate-sensitive earning assets and interest bearing liabilities are those which can be repriced to current market rates within a relatively short time. United Security's objective in managing interest rate sensitivity is to achieve reasonable stability in the interest margin throughout interest rate cycles by maintaining the proper balance of rate sensitive assets and liabilities. For further analysis and discussion of interest rate sensitivity, refer to the preceding section entitled "Liquidity and Interest Rate Sensitivity Management." Another factor that affects the interest margin is the interest rate spread. The interest rate spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. This measurement gives a more accurate representation of the effect market interest rate movements have on interest rate-sensitive assets and liabilities. The average volume of the interest-bearing liabilities as noted in the table, "Distribution of Assets, Liabilities, and Shareholders' Equity, with Interest Rates and Interest Differentials," decreased .7 % in 1998, while the average rate of interest paid increased from 4.57% in 1997 to 4.62% in 1998, an increase of 5 basis points. Average interest-earning assets increased 1.5% in 1998, while the average yield increased from 9.36% in 1997 to 10.59% in 1998, an increase of 123 basis points. Net yield on average interest earning assets increased 118 basis points from 1997 to 1998. This increase is the result of the higher loan yields associated with loans made by Acceptance Loan Company. The percentage of earning assets funded by interest-bearing liabilities also affects the Bank's interest margin. United Security's earning assets are funded by interest-bearing liabilities, non-interest bearing demand deposits, and shareholders' equity. The net return on earning assets funded by non interest-bearing demand deposits and shareholders' equity exceeds the net return on earning assets funded by interest-bearing liabilities. United Security maintains a relatively consistent percentage of earning assets funded by interest-bearing liabilities. In 1998, 82% of the Bank's average earning assets were funded by interest-bearing liabilities as opposed to 84% in 1997 and 82% in 1996. Net interest income is improved as earning assets are funded by a decreasing percentage of interest bearing liabilities. Summary of Operating Results
Year Ended December 31, 1998 1997 1996 (In Thousands of Dollars) Total Interest Income $43,255 $37,648 $34,551 Total Interest Expense 15,518 15,376 15,081 Net Interest Income 27,737 22,272 19,470 Provision for Loan Losses 3,187 1,710 800 Net Interest Income After Provision for Loan Losses 24,550 20,562 18,670 Non-Interest Income 4,558 4,361 2,725 Non-Interest Expense 17,008 15,229 11,765 Income Before Income Taxes 12,100 9,694 9,630 Applicable Income Taxes 3,521 2,713 2,659 Net Income $ 8,579 $ 6,981 $ 6,971
Changes in Interest Earned and Interest Expense Resulting from Changes in Volume and Changes in Rates
1998 Compared to 1997 1997 Compared to 1996 1996 Compared to 1995 Increase (Decrease) Increase (Decrease) Increase (Decrease) Due to Change In: Due to Change In: Due to Change In: Average Average Average Volume Rate Net Volume Rate Net Volume Rate Net (In Thousands of Dollars) Interest Earned On: Loans $2,200 $4,233 $6,433 $1,499 $1,246 $2,745 $2,665 $ 276 $2,941 Taxable Investments (862) 300 (562) 919 (376) 543 1,365 (308) 1,057 Non-Taxable Investments (156) (111) (267) (410) 273 (137) 265 (126) 139 Federal Funds (2) 4 2 (48) (5) (53) (174) 16 (158) Total Interest- Earning Assets $1,180 $4,426 $5,606 $1,960 $1,138 $3,098 $4,121 $(142) $3,979 Interest Expense On: Demand Deposits $ (118) $ (139) $ (257) $ (128) $ (133) $ (261) $ 217 $ (8) $ 209 Savings Deposits (57) (24) (81) 357 (26) 331 59 (29) 30 Time Deposits (770) 328 (442) 423 (240) 183 1,265 87 1,352 Other Liabilities 982 (60) 922 (43) 85 42 295 (104) 191 Total Interest- Bearing Liabilities $ 37 $ 105 $ 142 $ 609 $ (314) $ 295 $1,836 $ (54) $1,782 Increase in Net Interest Income $1,143 $4,321 $5,464 $1,351 $1,452 $2,803 $2,285 $ (88) $2,197
Provision for Loan Losses The provision for loan losses is an expense used to establish the allowance for loan losses. Actual loan losses, net of recoveries, are charged directly to the allowance. The expense recorded each year is a reflection of actual losses experienced during the year and management's judgment as to the adequacy of the allowance to absorb losses inherent in the portfolio. Charge-offs exceeded recoveries by $2.2 million during the year, an increase of $1.4 million over the prior years, and accordingly a provision of $3.2 million was expensed for loan losses in 1998. This increased the allowance to 2% of total loans outstanding at December 31, 1998. For additional information and discussion of the allowance for loan losses, refer to the section entitled "Loans and Allowance for Loan Losses". Non-Interest Income Non-interest income consists of revenues generated by a broad range of financial services and activities including fee-based services and commissions earned through insurance sales and trading activities. In addition, gains and losses from the sale of investment portfolio securities and option transactions are included in non-interest income. In 1997, the United States Department of Justice required the divestiture of approximately $9.8 million in deposits, branch facility and associated assets in order to approve the merger of United Security Bank and First Bank and Trust. The sale of these deposits and assets resulted in a non-recurring net gain of $592,000. The Bank also sold the building currently housing the Centreville Office in order to move to a new facility that will be completed in the spring of 1999. This sale along with other less significant asset sales resulted in a gain of $310,224 in 1997. Acceptance Loan Company opened four new offices in 1996, fourteen in 1997, added five more in 1998 and currently has a total of twenty-five offices. These events coupled with the Bank's Bond Division formation in 1996 contributed to a $197,306 or 4.5% increase in 1998 compared to a $1,636,171 and $168,806 increase in 1997 and 1996 respectively. Fee income from service charges increased $341,310, or 17.4%, from 1996 to 1998, and credit life commission increased $465,165, or 226%, during the same period. This significant growth is attributed to the growth of the ALC operation and changes in products and pricing of certain deposit accounts and related services. Non-recurring items of non-interest income include all the securities gains (losses) discussed in a previous section. Investment securities had a net gain of $410,987 in 1998 compared to a $105,254 gain in 1997 and a $186,802 loss in 1996. Income generated in the area of securities gains and losses is dependent on many factors including investment portfolio strategies, interest rate changes, and the short, intermediate, and long-term outlook for the economy. Other income decreased $563,744 or 32.4% in 1998. As previously mentioned, this decrease is a result of the extraordinary non-recurring gain realized on the sale of the Bank's assets in 1997. United Security continues to search for new sources of non-interest income. These sources will come from innovative ways of performing banking services now as well as providing new services in the future. This philosophy can be seen in the Bond Division organized in 1996. This division of the Bank was formed to offer bond services to community banks and contributed $402,194 to non-interest income in 1998 compared to $266,476 in 1997 and $16,233 in 1996. Non-Interest Expense Non-interest expenses consist primarily of four major categories: salaries and employee benefits, occupancy expense, furniture and equipment expense, and other expense. United Security's non-interest expense was impacted by the Brent Banking Company acquisition in 1996, the start up of twenty-three offices of Acceptance Loan Company since 1996 for a total of twenty-five offices, and the merger of United Security Bank and First Bank and Trust in 1997. The ratio of non-interest expenses to average assets increased to 3.8% in 1998 compared to 3.5% and 2.9% in 1997 and 1996 respectively. This ratio was significantly impacted by the events noted above. Salaries and employee benefits increased $1.9 million or 24.8% in 1998. 1998 was the first full year of the Bank merger, therefore, it was the first year of a combined incentive program for the combined banks increasing benefits by approximately $420,000. The Bank's salary expense was reduced by about $292,000 in 1998 due mainly to attrition. Additionally, Acceptance Loan Company added 12 employees in 1998 to staff the five new offices and maintained the fourteen new offices added in 1997 for a full year in 1998 for an increase of approximately $1.7 million in salary and benefits expense. At December 31, 1998, United Security had 286 full-time equivalent employees compared to 266 in 1997 and 226 in 1996. The increase is attributable to Acceptance Loan Company's growth and one new office opened by the Bank in Harpersville, Alabama . United Security sponsors an Employee Stock Ownership Plan with 401(k) provisions. The Company made matching contributions totaling $376,120, $238,190 and $216,686 in 1998, 1997, and 1996, respectively. Furniture and equipment expense increased 5.35% in 1998, 37% in 1997, and 9.6% in 1996. Most of the 1997 increase of $375,497 is a direct result of the computer and check processing equipment lease and depreciation expenses associated with the merger as well as the expenses associated with the new Acceptance Loan Company offices. The 1998 increase of $74,292 is due to the five new ALC offices and the equipment upgrade in preparation for the Year 2000. Occupancy expense includes rents, depreciation, utilities, maintenance, insurance, taxes, and other expenses associated with maintaining sixteen banking offices and twenty-five finance company offices. All, but one, banking offices are owned by the Company. The Bank's Centreville Office and all Acceptance Loan Company offices are leased. Net occupancy expense increased 21.3% in 1998, 26.3% in 1997, and 22.7% in 1996. The increases reflect the new offices of Acceptance Loan Company opened in 1998, 1997 and 1996. Other expenses consists of stationery, printing supplies, advertising, postage, telephone, legal and other professional fees, other non-credit losses, and other insurance including deposit insurance, and other miscellaneous expenses. Other expenses decreased 8.3 % in 1998, increased 39.7% in 1997 and decreased 6.8% in 1996. The 1997 increase was due to costs associated with the merger of United Security Bank and First Bank and Trust. Year 2000 - Technology Considerations The Year 2000 issue is the result of computer systems using a two-digit format, as opposed to four digits, to indicate the year. Any of the Company's computer programs or hardware that have date-sensitive software or embedded chips may not appropriately interpret dates beyond the year 1999. This could result in a system failure, miscalculation or other computer errors causing disruption of operations. The Company believes that it has an effective program in place to resolve the Year 2000 issue in a timely manner and that is unlikely that Year 2000 issues will cause any significant problems with customer service or otherwise have a material adverse impact on the Company's operations or financial performance. Management has approved a Year 2000 plan, which includes multiple phases, tasks to be completed, and target dates for completion. Issues addressed therein include awareness, assessment, validation, implementation, testing and contingency planning. Progress under this plan is reported to the Board of Directors on a regular basis. The Company's core bank operating software has been certified by the vendor to be Year 2000 compliant. To verify this compliance, the Company loaded the software along with general ledger data on a separate test system. Dates on the test system were advanced to 2000, and results from this test have been validated by Company personnel. The Company's testing and validation of results indicates that the core bank operating software is 100% Year 2000 compliant. The Company also has a number of secondary systems, and testing on these systems is either complete or in process. The Company's target date for completion of such testing is March 31, 1999. While the Company's plans are to complete testing of inhouse systems prior to March 31, 1999, there are several industry-wide tests which require participation of the Company as well as the testing of new systems. In addition to the systems outlined above, the Company is tracking the Year 2000 readiness of its utility companies and is finalizing contingency plans for these services to critical operations. Since it routinely upgrades and purchases technologically advanced software and hardware, the Company has determined that the cost of making modifications to correct any Year 2000 issues will not materially affect reported operating results. The Company estimates that its remaining capital expenditures to prepare for Year 2000 and correct any Year 2000 issues should not exceed $100,000, and its remaining operating expenditures should not exceed $25,000. This cost estimate does not include salaries or employee benefits of Company employees working on the Year 2000 project, as these costs are not separately tracked. The Company also recognizes the importance of determining that its borrowers are addressing the Year 2000 problem to avoid deterioration of the loan portfolio solely due to this issue. All material relationships have been identified to assess the inherent risks and Year 2000 questionnaires are being obtained from such borrowers where considered appropriate. The target date for the completion of this assessment is June 30, 1999. Deposit customers have received statement stuffers and informational matter in this regard. The Company is working on a one-on-one basis with any borrower that has been identified as having high Year 2000 risk exposure. The Company has contacted all of its essential suppliers regarding their Year 2000 compliance and has substantially completed an analysis of the possible impact of noncompliance on their ability to fulfill their commitments to the Company. To date, the Company is not aware of any external supplier with a Year 2000 issue that would materially impact the Company's results of operations, liquidity or capital resources. Management does not believe that the Company will incur significant additional costs associated with the Year 2000 issue. However, management cannot predict the amount of financial difficulties it may incur due to customer and vendor inability to perform according to their agreements with the Company or the effects that other third parties may bring as a result of this issue. The Company also anticipates that deposit customers may perceive a need for increased cash in the latter part of 1999, and management has made liquidity contingency plans to address this potential additional need for currency. Management has held discussions with the Federal Reserve and the Federal Home Loan Bank with regard to such potential increased currency and funding needs. Although the Federal Reserve has announced plans to increase the amount of currency in circulation in preparing for Year 2000, a lack of liquidity in the financial system could have a significant negative impact on the Company. Accordingly, there can be no assurance that the failure or delay of others to address the issue or that the costs involved in such process will not have a material adverse impact on the Company's business, financial condition and results of operations. The Company's contingency plans are being tested and may be modified as testing progresses. The Securities and Exchange Commission has asked reporting companies to address a reasonable "worst case" scenario with respect to the Year 2000 issue. Management's estimate of the "worst case" scenario is a loss of electrical power and telecommunication service. The Company has a backup electrical power generator to run its mainframe computer system in case of difficulties with the electricity vendor, but is unable to ascertain how such a loss of electrical power would impact its operations and those of its customers if such power loss was sustained. Item 7A. Quantitative and Qualitative Disclosures About Market Risk The Information required by this item is contained in Item 7 herein under the heading "Liquidity and Interest Rate Sensitivity Management." Item 8. Financial Statements and Supplementary Data. INDEPENDENT AUDITOR'S REPORT To United Security Bancshares, Inc.: We have audited the accompanying consolidated statements of condition of United Security Bancshares, Inc. (an Alabama corporation) and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We did not audit the accompanying consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for the year ended December 31, 1996. United Security Bancshares, Inc. and First Bancshares, Inc. merged during 1997 in a transaction accounted for as a pooling of interests, as discussed in Note 3. The consolidated statements of income, shareholders' equity and comprehensive income, and cash flows for the year December 31, 1996, of United Security Bancshares, Inc. and First Bancshares, Inc. were audited by other auditors whose reports dated January 17, 1997 and January 24, 1997, respectively, expressed unqualified opinions on those separate financial statements. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Security Bancshares, Inc. and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for years then ended in conformity with generally accepted accounting principles. Birmingham, Alabama January 22, 1999 UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CONDITION December 31, 1998 and 1997 ASSETS
1998 1997 CASH AND DUE FROM BANKS $ 12,102,669 $ 14,312,127 INTEREST BEARING DEPOSITS IN OTHER BANKS 14,728,357 226,451 Total cash and cash equivalents 26,831,026 14,538,578 INVESTMENT SECURITIES AVAILABLE FOR SALE 164,019,411 172,499,227 LOANS, net of allowance for loan losses of $4,989,173 and $4,045,844, respectively 235,059,761 215,897,434 PREMISES AND EQUIPMENT, net of accumulated depreciation of $8,436,763 and $7,559,857 8,225,007 6,837,080 ACCRUED INTEREST RECEIVABLE 4,520,783 4,048,668 INVESTMENT IN LIMITED PARTNERSHIPS 4,234,447 4,272,547 OTHER ASSETS 7,182,352 7,847,183 Total assets $450,072,787 $425,940,717 LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Demand, noninterest bearing $ 39,786,298 $ 40,983,995 Demand, interest bearing 64,585,952 61,217,614 Savings 39,801,921 41,352,245 Time, $100,000 and over 40,548,173 34,099,172 Other time 141,922,237 144,765,347 Total deposits 326,644,581 322,418,373 OTHER LIABILITIES 7,001,153 5,933,331 SHORT-TERM BORROWINGS 11,742 3,912,821 LONG-TERM DEBT 55,847,223 40,965,644 Total liabilities 389,504,699 373,230,169 COMMITMENTS AND CONTINGENCIES (Note 18) Shareholders' equity: Common stock, par value $.01 per share; 10,000,000 shares authorized; 3,610,945 and 3,601,604 shares issued, respectively 36,109 36,018 Surplus 8,218,651 8,057,792 Accumulated other comprehensive income, net of tax 2,821,556 1,012,620 Retained earnings 49,743,592 43,858,538 Less treasury stock, 64,100 shares and 65,015 shares, respectively, at cost (251,820) (254,420) Total shareholders' equity 60,568,088 52,710,548 Total liabilities and shareholders' equity $450,072,787 $425,940,717 The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1998, 1997, and 1996
1998 1997 1996 INTEREST INCOME: Interest and fees on loans $29,397,310 $22,964,581 $20,219,182 Interest on investment securities available for sale: Taxable 12,087,389 12,702,142 12,136,212 Tax-exempt 1,468,851 1,735,501 1,872,279 Other interest and dividends 188,786 132,802 166,321 13,745,026 14,570,445 14,174,812 Interest on trading account securities 15,267 18,323 8,844 Interest on federal funds sold 97,350 95,023 148,030 Total interest income 43,254,953 37,648,372 34,550,868 INTEREST EXPENSE: Interest on deposits 12,495,765 13,274,760 13,021,430 Interest on short-term borrowings 230,738 335,505 1,732,150 Interest on long-term debt 2,791,794 1,765,440 327,164 15,518,297 15,375,705 15,080,744 NET INTEREST INCOME 27,736,656 22,272,667 19,470,124 PROVISION FOR LOAN LOSSES 3,187,103 1,710,128 799,527 Net interest income after provision for loan losses 24,549,553 20,562,539 18,670,597 NONINTEREST INCOME: Service and other charges on deposit accounts 2,302,530 2,194,963 1,961,220 Credit life insurance commissions 670,694 312,757 205,529 Investment securities gains (losses), net 410,987 105,254 (186,802) Trading securities gains (losses), net 0 10,187 (2,031) Other income 1,173,930 1,737,674 746,748 Total noninterest income 4,558,141 4,360,835 2,724,664 NONINTEREST EXPENSE: Salaries and employee benefits 9,766,080 7,823,601 6,379,413 Furniture and equipment expense 1,461,872 1,387,580 1,012,083 Occupancy expense 1,061,902 875,523 693,188 Other expense 4,718,118 5,142,485 3,680,994 Total noninterest expense 17,007,972 15,229,189 11,765,678 INCOME BEFORE INCOME TAXES 12,099,722 9,694,185 9,629,583 PROVISION FOR INCOME TAXES 3,521,072 2,712,727 2,658,593 NET INCOME $ 8,578,650 $ 6,981,458 $ 6,970,990 AVERAGE NUMBER OF SHARES OUTSTANDING 3,543,325 3,536,642 3,536,585 NET INCOME PER SHARE: Basic $ 2.42 $ 1.97 $ 1.97 Diluted $ 2.40 $ 1.96 $ 1.97 DIVIDENDS PER SHARE $ .76 $ .53 $ .40 The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME For the Years Ended December 31, 1998, 1997 and 1996
Accumulated Other Total Common Comprehensive Retained Treasury Shareholders' Stock Surplus Income Earnings Stock at Cost Equity BALANCE AT JANUARY 1, 1996 $ 36,016 $8,046,542 $ 786,900 $33,185,749 $(259,548) $41,795,659 Comprehensive income: Net income 0 0 0 6,970,990 0 6,970,990 Net change in unrealized gain (loss) on securities available for sale, net of tax 0 0 258,278 0 0 258,278 Comprehensive income 7,229,268 Dividends declared 0 0 0 (1,409,144) 0 (1,409,144) BALANCE AT DECEMBER 31, 1996 36,016 8,046,542 1,045,178 38,747,595 (259,548) 47,615,783 Comprehensive income: Net income 0 0 0 6,981,458 0 6,981,458 Net change in unrealized gain (loss) on securities available for sale, net of tax 0 0 (32,558) 0 0 (32,558) Comprehensive income 6,948,900 Dividends declared 0 0 0 (1,870,515) 0 (1,870,515) Retirement of treasury stock (9) (5,119) 0 0 5,128 0 Exercise of stock options 11 16,369 0 0 0 16,380 BALANCE AT DECEMBER 31, 1997 36,018 8,057,792 1,012,620 43,858,538 (254,420) 52,710,548 Comprehensive income: Net income 0 0 0 8,578,650 0 8,578,650 Net change in unrealized gain (loss) on securities available for sale, net of tax 0 0 1,808,936 0 0 1,808,936 Comprehensive income 10,387,586 Dividends declared 0 0 0 (2,693,596) 0 (2,693,596) Sale of treasury stock 0 651 0 0 2,600 3,251 Exercise of stock options 91 160,208 0 0 0 160,299 BALANCE AT DECEMBER 31, 1998 $ 36,109 $8,218,651 $2,821,556 $49,743,592 $(251,820) $60,568,088 The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1998, 1997 and 1996
1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 8,578,650 $ 6,981,458 $ 6,970,990 Adjustments: Depreciation 797,959 894,702 969,983 Provision for loan losses 3,187,103 1,710,128 799,527 Deferred income tax benefit (1,191,833) (335,835) (118,683) Amortization of intangibles 636,651 604,811 338,689 (Gain) loss on sale of securities, net 410,987 (105,254) 186,802 (Gain) on sale of branch 0 (592,012) 0 (Gain) loss on sale of fixed assets 0 (364,378) 1,004 Equity in loss of unconsolidated investee 0 150,000 6,029 Amortization of premium and discounts, net 630,654 1,297,363 1,285,411 Changes in assets and liabilities: (Increase) decrease in accrued interest receivable (472,115) (381,024) 143,129 (Increase) decrease in other assets 162,925 (515,295) (410,413) Increase (decrease) in interest payable 218,808 48,849 (2,643) Increase in other liabilities 840,717 900,534 932,434 Net cash provided by operating activities 13,800,506 10,294,047 11,102,259 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investment securities available for sale (81,139,966) (49,711,539) (68,311,896) Proceeds from sales of investment securities available for sale 37,687,753 47,507,930 39,166,424 Proceeds from maturities and prepayments of investment securities available for sale 54,511,409 15,948,700 8,851,014 Proceeds from redemptions of Federal Home Loan Bank stock 0 0 503,000 Purchases of Federal Home Loan Bank stock (746,700) (211,260) (398,900) Net cash received in acquisition of bank 0 0 8,605,941 Net cash paid in sale of branch 0 (6,518,424) 0 Loan (originations) and principal repayments, net (22,311,330) (15,555,151) (9,372,493) (Purchase of) proceeds from sale of premises and equipment, net (2,185,886) (970,598) (820,777) Net cash used in investing activities (14,184,720) (9,510,342) (21,777,687) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in customer deposits 4,226,208 (14,008,721) 8,361,670 Net increase (decrease) in short-term borrowings (3,901,079) (79,260) 34,398 Proceeds from FHLB advances and other borrowings 30,000,000 37,281,088 4,964,913 Repayment of FHLB advances and other borrowings (15,118,421) (23,854,663) (673,833) Proceeds from issuance of common stock 160,299 16,380 0 Dividends paid (2,693,596) (1,605,654) (1,366,386) Sale of treasury stock 3,251 0 0 Net cash (used in) provided by financing activities 12,676,662 (2,250,830) 11,320,762 Net increase (decrease) in cash and cash equivalents 12,292,448 (1,467,125) 645,334 Cash and cash equivalents, beginning of year 14,538,578 16,005,703 15,360,369 Cash and cash equivalents, end of year $26,831,026 $14,538,578 $16,005,703 The accompanying notes are an integral part of these consolidated statements.
UNITED SECURITY BANCSHARES, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 1998 and 1997 1. DESCRIPTION OF BUSINESS United Security Bancshares, Inc. (the "Company" or "USB") and its subsidiary, First United Security Bank (the "Bank" or "FUSB") provide commercial banking services to customers located primarily in Clarke, Choctaw, Bibb and surrounding counties in Alabama and Mississippi. The Company also owns all the stock of First Security Courier Corporation, ("FSCC") an Alabama corporation. FSCC is a courier service organized to transport items for processing to the Federal Reserve for financial institutions located in Southwest Alabama. The Bank owns all of the stock of Acceptance Loan Company, Inc. ("Acceptance" or "ALC"), an Alabama corporation. Acceptance is a finance company organized for the purpose of making consumer loans and purchasing consumer loans from vendors. Acceptance has offices located within the communities served by the Bank as well as offices outside the Bank's market area in north and southeast Alabama, and northwest Florida. The Bank also invests in limited partnerships that operate qualified affordable housing projects to receive tax benefits. 2. SUMMARY OF SIGNIFICANT ACCOUNT POLICIES Principles of Consolidation The consolidated financial statements include the accounts of the Company, FSCC, the Bank and its wholly owned subsidiary. All significant intercompany balances and transactions have been eliminated. The Bank's investment in limited partnerships are carried on an unconsolidated basis under either the equity or cost method based on the percentage of ownership and influence over operations. Cash and Cash Equivalents For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold. Federal funds are generally purchased and sold for one-day periods. Supplemental disclosures of cash flow information and noncash transactions related to cash flows for the years ended December 31, 1998, 1997, and 1996 are as follows:
1998 1997 1996 Cash paid during the period for: Interest $15,284,661 $15,326,856 $15,083,387 Income taxes 3,648,211 2,351,304 2,605,267 Supplemental schedule of noncash investment and financing activities: Dividends declared but unpaid 686,080 542,796 277,935 Details of acquisition: Fair value of assets acquired 0 0 25,095,174 Liabilities assumed 0 0 (33,701,115) Details of branch sale: Fair value of assets sold 0 3,433,740 0 Liabilities transferred 0 9,952,164 0
Securities Securities may be held in three portfolios: trading account securities, held to maturity securities, and securities available for sale. Trading account securities are carried at market value, with unrealized gains and losses included immediately in other income. Investment securities held to maturity are carried at cost, adjusted for amortization of premiums and accretion of discounts. With regard to investment securities held to maturity, management has the intent and the Bank has the ability to hold such securities until maturity. Investment securities available for sale are carried at market value, with any unrealized gains or losses excluded from earnings and reflected, net of tax, as a separate component of shareholders' equity. Investment securities available for sale are so classified because management may decide to sell certain securities prior to maturity for liquidity, tax planning, or other valid business purposes. The Company held no securities in their trading and held to maturity portfolios at December 31, 1998 and 1997. Included in investment securities available for sale is stock in the Federal Home Loan Bank (FHLB) of Atlanta. FHLB stock is carried at cost, has no contractual maturity, has no quoted fair value, and no ready market exists; therefore, the fair value of such stock is assumed to approximate cost. The investment in the stock is required of every member of the FHLB system. Interest earned on investment securities held to maturity, investment securities available for sale, and trading account securities is included in interest income. Amortization of premiums and discounts on investment securities is by the interest method. Net gains and losses on the sale of investment securities held to maturity and investment securities available for sale, computed principally on the specific identification method, are shown separately in noninterest income in the consolidated statements of income. Derivative Financial Instruments To hedge interest rate exposure, the Company uses derivative financial instruments consisting of interest rate swaps, caps, and floors which are accounted for using the accrual method. Net interest income or expense related to interest rate swaps, caps, and floors is recorded over the life of the agreement as an adjustment to net interest income. The premiums paid for the caps and floors are amortized straight-line over the life of the agreement. Changes in the estimated fair values of derivative financial instruments used as hedges are not reflected in the financial statements until realized. Gains or losses realized on the sales or terminations of interest rate swaps are deferred and amortized into interest income over the maturity period of the contract. The Company's criteria for use of derivatives as hedges include reduction of the risk associated with the exposure being hedged and such derivatives must be designated as a hedge at the inception of the derivative contract. Derivatives that do not meet these criteria are carried at fair value with changes in value recognized currently in earnings. Loans and Interest Income Loans are reported at the principal amounts outstanding adjusted for unearned income, deferred loan origination fees and costs, purchase premiums and discounts, writedowns, and the allowance for loan losses. Loan origination fees, net of certain deferred origination costs, and purchase premiums and discounts are recognized as an adjustment to yield of the related loan. Interest on commercial and real estate loans is accrued and credited to income based on the principal amount outstanding. Interest on installment loans is recognized using the interest method and according to the rule of 78's which approximates the interest method. The accrual of interest on loans is discontinued when, in the opinion of management, there is an indication that the borrower may be unable to meet payments as they become due. Upon such discontinuance, all unpaid accrued interest is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest. Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectibility of principal. Generally, loans are restored to accrual status when the obligation is brought current and has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectibility of the total contractual principal and interest is no longer in doubt. Allowance for Loan Losses The allowance for loan losses is increased by a provision for loan losses, which is charged to expense, and reduced by charge-offs, net of recoveries. The allowance for loan losses is maintained at a level which, in management's judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management's evaluation of the collectibility of the loan portfolio, including the nature of the portfolio and changes in its risk profile, credit concentrations, historical trends, specific impaired loans, and economic conditions. This evaluation also considers the balance of impaired loans. Losses on individually identified impaired loans are measured based on the present value of expected future cash flows discounted at each loan's original effective market interest rate. As a practical expedient, impairment may be measured based on the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through the provision added to the allowance for loan losses. One-to-four family residential mortgages and consumer installment loans are subjected to a collective evaluation for impairment, considering delinquency and repossession statistics, historical loss experience, and other factors. Though management believes the allowance for loan losses to be adequate, ultimate losses may vary from their estimates. However, estimates are reviewed periodically, and as adjustments become necessary, they are reported in earnings during periods they become known. Long-Lived Assets Premises and equipment are stated at cost less accumulated depreciation. The provision for depreciation is computed using the straight-line and accelerated methods over the estimated useful lives of the assets. Goodwill, organization cost, and core deposit intangibles are included in other assets and are amortized using the straight-line method. Goodwill is being amortized over 20 years, organization cost over five years, and core deposits from six to ten years. Impairment of long-lived assets is evaluated by management based upon an event or changes in circumstances surrounding the underlying assets. Other Real Estate Real estate properties acquired through, or in lieu of, loan foreclosures are to be sold and are initially recorded at fair value at the date of foreclosure, establishing a new cost basis. Costs to maintain or hold the property are expensed and amounts incurred to improve the property, to the extent that fair value is not exceeded, are capitalized. Valuations are periodically performed by management, and a valuation allowance is established by a charge to income if the carrying value of a property exceeds its fair value less the estimated costs to sell. Other real estate aggregated $215,250 and $506,000 at December 31, 1998 and 1997, respectively, and is included in other assets. Income Taxes The Company accounts for income taxes through the use of the asset and liability method. Under the asset and liability method, deferred taxes are recognized for the tax-consequences of temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the bases of existing assets and liabilities. The effect on deferred taxes of a change in tax rates would be recognized in income in the period that includes the enactment date. Treasury Stock Treasury stock repurchases and sales are accounted for using the cost method. Earnings Per Share Basic earnings per share ("EPS") is computed by dividing net income by the weighted average number of shares outstanding during the period. Diluted EPS, presented now in accordance with a new accounting standard, is computed in the same manner as fully diluted EPS presented in earlier periods, except that, among other changes, the average share price for the period is used in all cases when applying the treasury stock method to potentially dilutive securities. The following table represents the earnings per share calculations for the years ended December 31, 1998, 1997, and 1996:
Per Share For the Years Ended Income Shares Amount December 31, 1998: Net income $8,578,650 Basic earnings per share 8,578,650 3,543,325 $ 2.42 Dilutive securities 0 27,056 Diluted earnings per share $8,578,650 3,570,381 $ 2.40 December 31, 1997: Net income $6,981,458 Basic earnings per share 6,981,458 3,536,642 $ 1.97 Dilutive securities 0 17,205 Diluted earnings per share $6,981,458 3,553,847 $ 1.96 December 31, 1996: Net income $6,970,990 Basic earnings per share 6,970,990 3,536,585 $ 1.97 Dilutive securities 0 0 Diluted earnings per share $6,970,990 3,536,585 $ 1.97
Use of Estimates The accounting principles and reporting policies of the Company, and the methods of applying these principles, conform with generally accepted accounting principles ("GAAP") and with general practices within the financial services industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant changes in the near-term relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan losses and real estate owned, management obtains independent appraisals for significant properties, evaluates the overall portfolio characteristics and delinquencies and monitors economic conditions. A substantial portion of the Company's loans are secured by real estate in its primary market area. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio and the recovery of a portion of the carrying amount of foreclosed real estate are susceptible to changes in economic conditions in the Company's primary market. Pending Accounting Pronouncements The AICPA has issued Statements of Position 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use. This statement requires capitalization of external direct costs of materials and services; payroll and payroll-related costs for employees directly associated; and interests costs during development of computer software for internal use (planning and preliminary costs should be expensed). Also, capitalized costs of computer software developed or obtained for internal use should be amortized on a straight-line basis unless another systematic and rational basis is more representative of the software's use. This statement is effective for financial statements for fiscal years beginning after December 15, 1998 and is not expected to have a material effect on the consolidated financial statements. In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities. This Statement establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. This Statement is effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Initial application of this Statement should be as of the beginning of an entity's fiscal quarter; on that date, hedging relationships must be designated anew and documented pursuant to the provisions of this Statement. Management believes there will be no material effect on the consolidated financial statements from the adoption of this pronouncement. In October 1998, the FASB issued No. 134, Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise. This Statement, an amendment to SFAS No. 65, requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability to sell or hold those investments. This Statement is effective the first fiscal quarter beginning after December 15, 1998. The Company adopted the provisions of this Statement on January 1, 1999. Based on the Company's current operating activities, management does not believe that adoption of this Statement will have a material impact on the presentation of the Company's financial condition or results of operations. 3. BUSINESS COMBINATIONS On August 19, 1996, the Company signed a definitive agreement to merge with First Bancshares, Inc. ("FBI") of Grove Hill, Alabama effective June 30, 1997. The agreement called for the exchange of 1,398,788 shares of the Company's common stock (5.8321 shares of the Company's common stock for each share of FBI's common stock) for 100% of FBI's common stock in a transaction accounted for as a pooling-of-interests. Accordingly, the Company's financial statements were restated to include the results of FBI for all periods presented. Merger costs of approximately $650,000 were expensed in the accompanying 1997 consolidated statement of income. Combined and separate results of the Company and FBI during the periods preceding the merger were as follows:
USB FBI Combined Six months ended June 30, 1997 (unaudited): Net interest income $ 5,352,810 $5,265,778 $10,618,588 Net income $ 2,272,489 $1,201,565 $ 3,474,054 Year ended December 31, 1996: Net interest income $10,082,957 $9,387,167 $19,470,124 Net income $ 4,262,719 $2,708,271 $ 6,970,990
In conjunction with the merger, the U.S. Justice Department required the divestiture of a branch in Grove Hill, Alabama. On October 31, 1997, USB sold the branch and related assets and liabilities with carrying values of $2.9 million and $10.0 million, respectively, for a net cash payment from USB of $6.5 million. The resulting gain of $592,000 is included in other income. On May 31, 1996, USB completed the acquisition of Brent Banking Company of Brent, Alabama, in a cash transaction. At the date of acquisition, Brent had assets of $34 million and equity of $4.5 million. The cash purchase price of $7 million exceeded the fair value of net assets acquired by approximately $2.3 million, which has been recorded as goodwill. Pro forma 1996 net income, basic and diluted earnings per share had the purchase business combination been completed as of the first day of 1996 were as follows: Net income (in thousands) $ 6,728 Basic net income per share $ 1.92 Diluted net income per share $ 1.92 4. INVESTMENT SECURITIES Details of investment securities available for sale at December 31, 1998 and 1997 are as follows
December 31, 1998 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value Obligations of states, counties, and political subdivisions $ 23,841,566 $1,686,442 $ 0 $ 25,528,008 Mortgage-backed securities 132,587,552 3,559,540 761,265 135,385,827 Equity securities 200,123 45,598 14,019 231,702 Corporate notes 80,279 0 1,805 78,474 FHLB stock 2,795,400 0 0 2,795,400 Total $159,504,920 $5,291,580 $ 777,089 $164,019,411
December 31, 1997 Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value Obligations of states, counties, and political subdivisions $ 22,227,824 $1,693,229 $ 0 $ 23,921,053 U.S. treasury securities and obligations of U.S. government agencies 2,096,057 0 30,769 2,065,288 Mortgage-backed securities 144,310,042 1,576,435 1,637,079 144,249,398 Equity securities 50,019 22,947 0 72,966 Corporate notes 146,569 0 4,747 141,822 FHLB stock 2,048,700 0 0 2,048,700 Total $170,879,211 $3,292,611 $1,672,595 $172,499,227
The scheduled maturities of investment securities available for sale at December 31, 1998 are presented in the following table:
Amortized Market Cost Value Maturing within one year $ 1,219,990 $ 1,239,271 Maturing after one but before five years 4,224,043 4,245,557 Maturing after five but before fifteen years 28,333,577 29,626,597 Maturing after fifteen years 122,731,787 125,880,884 Equity securities and FHLB stock 2,995,523 3,027,102 Total $159,504,920 $164,019,411
For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the weighted-average contractual maturities of underlying collateral. The mortgage-backed securities generally mature earlier than their weighted-average contractual maturities because of principal prepayments. Investment securities with a carrying value of $70,149,059 and $86,328,794 at December 31, 1998 and 1997, respectively, were pledged to secure public deposits and for other purposes. Gross gains realized on sales of securities available for sale were $1,240,170 in 1998, $512,843 in 1997, and $42,026 in 1996. Gross realized losses on those sales were $829,183 in 1998, $407,589 in 1997, and $228,828 in 1996. Gross realized gains on trading account securities sales were $0 in 1998, $19,111 in 1997, and $36,250 in 1996. Gross realized losses on those sales were $0 in 1998, $8,924 in 1997, and $38,281 in 1996. 5. LOANS At December 31, 1998 and 1997, the composition of the loan portfolio was as follows:
1998 1997 Commercial, financial, and agricultural $ 35,443,976 $ 35,036,350 Real estate mortgage 123,263,732 126,823,581 Installment 86,282,286 61,821,754 Less: Allowance for loan losses 4,989,173 4,045,844 Unearned interest, commissions, and fees 4,941,060 3,738,407 Total $235,059,761 $215,897,434
The Bank grants commercial, real estate, and installment loans to customers primarily in Clarke, Choctaw, Bibb, and surrounding counties in southwest Alabama and southeast Mississippi. Although the Bank has a diversified loan portfolio, the ability of a substantial number of the Bank's loan customers to honor their obligations is dependent upon the timber and timber-related industries. At December 31, 1998, approximately $41,465,784 of the Bank's loan portfolio consisted of loans to customers in the timber and timber-related industries. In the ordinary course of business, the Bank makes loans to certain officers and directors of the Company and Bank, including companies with which they are associated. These loans are made on substantially the same terms as those prevailing for comparable transactions with others. Such loans do not represent more than normal risk of collectibility nor do they present other unfavorable features. The amounts of such related party loans and commitments at December 31, 1998 and 1997 were $1,692,312 and $1,801,356, respectively. During the year ended December 31, 1998, new loans to these parties totaled $130,989 and repayments were $240,033. A summary of the transactions in the allowance for loan losses follows:
1998 1997 1996 Balance at beginning of year $4,045,844 $3,133,768 $2,466,979 Acquired in branch acquisitions 0 0 423,251 Provision for loan losses 3,187,103 1,710,128 799,527 Loans charged off (2,589,300) (1,038,585) (773,423) Recoveries of loans previously charged off 345,526 240,533 217,434 Balance at end of year $4,989,173 $4,045,844 $3,133,768
At December 31, 1998, the Company had one loan considered to be impaired. The amount of this loan, which is on nonaccrual, is $486,826 and the related allowance is $243,000. The average recorded investment in impaired loans during the year ended December 31, 1998 was approximately $512,752. For the year ended December 31, 1998, the Company did not recognize interest income on the impaired loan during the period the loan was considered impaired. The Company had approximately $538,677 considered to be impaired at December 31, 1997. Loans on which the accrual of interest has been discontinued amounted to $3,459,814 and $1,487,514 at December 31, 1998 and 1997, respectively. If interest on those loans had been accrued, such income would have approximated $339,710, $153,870, and $90,740 for 1998, 1997, and 1996, respectively. Interest income actually recorded on those loans amounted to $298,335, $108,060, and $36,719 for 1998, 1997, and 1996, respectively. 6. PREMISES AND EQUITPMENT Premises and equipment are summarized as follows:
1998 1997 Land $ 1,037,436 $ 920,041 Premises 7,656,911 6,436,849 Furniture, fixtures, and equipment 7,967,423 7,040,047 16,661,770 14,396,937 Less accumulated depreciation 8,436,763 7,559,857 Total $ 8,225,007 $ 6,837,080
Depreciation expense of $797,959, $894,702, and $969,983 was recorded in 1998, 1997, and 1996, respectively, on premises and equipment. 7. INVESTMENT IN LIMITED PARTNERSHIPS The Bank invests in limited partnerships that operate qualified affordable housing projects to receive tax benefits in the form of tax deductions from operating losses and tax credits. The Bank accounts for the investments under either the equity or cost method based on the percentage ownership and influence over operations. The Bank's interest in these partnerships was $4,234,447 and $4,272,547 at December 31, 1998 and 1997, respectively. Losses related to these partnerships amounted to approximately $128,000, $122,000, and $137,000 for 1998, 1997, and 1996, respectively. Management analyzes these investments annually for potential impairment. The assets and liabilities of these partnerships consist primarily of apartment complexes and related mortgages. The Bank's carrying value approximates cost or their underlying equity in the net assets of the partnerships. Market quotations are not available for any of the aforementioned partnerships. The Bank has remaining cash commitments to these partnerships at December 31, 1998 in the amount of $360,000. 8. DEPOSITS At December 31, 1998, the scheduled maturities of the Bank's time deposits greater than $100,000 are as follows: 1999 $25,350,035 2000 5,848,176 2001 6,361,449 2002 1,109,343 2003 and thereafter 1,879,170 $40,548,173 Additionally, included in the Bank's other time deposits at December 31, 1998 is $6,840,928 in state and municipal time deposits greater than $100,000 maturing within one year. 9. SHORT-TERM BORROWINGS Short-term borrowings consist of federal funds purchased and securities sold under agreements to repurchase which generally mature within one to four days from the transaction date, treasury tax and loan deposits which are withdrawable on demand, and FHLB advances with original maturities in less than one year. Information concerning short-term borrowings is as follows:
1998 Treasury Federal Tax and Funds Loan Purchased Deposits Average balance during the year $3,081,863 $ 846,955 Average interest rate during the year 5.83% 5.90% Maximum month-end balance during the year $9,100,000 $2,520,307
1997 Treasury Federal Tax and Funds Repurchase Loan Purchased Agreements Deposits Average balance during the year $2,450,151 $ 6,671 $ 753,181 Average interest rate during the year 5.96% 4.15% 5.28% Maximum month-end balance during the year $9,350,000 $49,445 $2,536,321
At December 31, 1998, the Bank has $17 million in available federal fund lines from correspondent banks. 10. LONG-TERM DEBT The Company uses Federal Home Loan Bank advances as an alternative to funding sources with similar maturities such as certificates of deposit or other deposit programs. These advances generally offer more attractive rates when compared to other mid-term financing options. They are also flexible, allowing the Company to quickly obtain the necessary maturities and rates that best suit its overall asset/liability strategy. Investment securities and 1-4 family mortgage loans secure these borrowings. The following summarizes information concerning Federal Home Loan Bank advances and other borrowings:
1998 1997 Average balance $55,453,921 $30,296,430 Maximum month-end balance during year $55,906,433 $40,972,587 Average rate paid 5.55% 5.83% Weighted average remaining maturity 7.25 years 2.20 years
Scheduled maturities of Federal Home Loan Bank advances in 1999 are approximately $10 million. Maturities during 2000 are approximately $5 million. There are no scheduled maturities in 2001, 2002, and 2003. In years subsequent to 2003, maturities total approximately $40 million. At December 31, 1998, the Bank has $19.15 million in available credit from the Federal Home Loan Bank. 11. INCOME TAXES The consolidated provisions (benefits) for income taxes for the years ended December 31 were as follows:
1998 1997 1996 Federal Current $4,146,035 $2,714,017 $2,366,681 Deferred (1,059,525) (298,811) (106,190) 3,086,510 2,415,206 2,260,491 State Current 566,870 334,545 410,595 Deferred (132,308) (37,024) (12,493) 434,562 297,521 398,102 Total $3,521,072 $2,712,727 $2,658,593
The consolidated tax provision differed from the amount computed by applying the federal statutory income tax rate to pretax earnings for the following reasons:
1998 1997 1996 Income tax expense at federal statutory rate $4,113,755 $3,294,833 $3,274,058 Increase (decrease) resulting from: Tax-exempt interest (561,148) (600,744) (661,223) State income tax expense net of federal income tax benefit 286,810 196,364 275,026 Tax credits (low income housing) (490,000) (480,000) (325,000) Other 171,655 302,274 95,732 Total $3,521,072 $2,712,727 $2,658,593 Effective tax rate 29% 28% 28%
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1998 and 1997, are presented below:
1998 1997 Deferred tax assets: Allowance for loan losses $2,095,795 $ 929,297 Accrued vacation 22,200 22,200 Capital loss carryover 80,443 80,443 Deferred commissions and fees 514,925 242,385 Other 574,715 233,936 Total gross deferred tax asset 3,288,078 1,508,261 Valuation allowance (75,903) (75,903) Net deferred tax assets 3,212,175 1,432,358 Deferred tax liabilities: Premises and equipment 501,986 501,825 Limited partnerships 224,035 267,589 Unrealized gain on securities available for sale 1,692,935 607,396 Other deferred tax liabilities 754,945 123,568 Total gross deferred tax liabilities 3,173,901 1,500,378 Net deferred tax asset (liability) $ 38,274 $ (68,020)
12. EMPLOYEE BENEFIT PLANS The Company sponsors an Employee Stock Ownership Plan with 401(k) provisions. This plan covers substantially all employees and allows employees to contribute up to 15% of their compensation on a before-tax basis. The Company may make discretionary contributions to match employee contributions dollar for dollar up to 6% of an employee's compensation. Employees have the option to allocate some or all of their contributions towards the purchase of Company stock. The Company made matching contributions totaling $284,432 and $238,190 in 1998 and 1997, respectively. 13. LONG-TERM INCENTIVE COMPENSATION PLAN During 1997, the Company's shareholders' approved the adoption of the United Security Bancshares, Inc. Long Term Incentive Compensation Plan ("LTICP"). This plan provides for a number of forms of stock based compensation for key employees of USB and its subsidiaries. Under the plan, eligible employees may be awarded incentive and nonqualified stock options, stock appreciation rights, and restricted stock. The LTICP provides for the issuance of up to 60,000 shares of USB common stock with a par value of $.01 per share. In addition, each option expires no later than five years after the grant date. The exercise price of each option is determined by the compensation committee, but in the case of incentive stock options, the price shall not be less than the fair market value on the grant date. The Company continues to record compensation cost under Accounting Principles Board Opinion ("APB") No. 25. Had compensation cost been determined, consistent with the fair value based method of recording for stock-based compensation allowed for under SFAS No. 123, the Company's net income would have been decreased to the following pro forma amounts:
1998 1997 Net income--as reported $8,578,650 $6,981,458 Net income--pro forma 8,372,098 6,805,635 Basic net income per share--as reported 2.42 1.97 Basic net income per share--pro forma 2.36 1.92 Diluted net income per share--as reported 2.40 1.96 Diluted net income per share--pro forma 2.34 1.91
A summary of the status of the Company's stock option plan at December 31, 1998 and the changes during the year then ended is as follows:
1998 1997 Exercise Exercise Shares Price Shares Price Outstanding at beginning of year 56,250 $17.50 0 $ 0.00 Granted 600 35.00 57,350 17.50 Exercised 9,160 17.50 1,100 17.50 Outstanding at end of year 47,690 $17.72 56,250 $17.50 Exercisable at end of year 47,690 $17.72 56,250 $17.50 Fair value of options granted $4.33 $4.22
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: a risk free interest rate based on zero coupon governmental issues at grant date with the maturity equal to the expected term of the options (4.54% and 6.27% for 1998 and 1997), no expected forfeiture rate as options are immediately vested at date of grant, an expected stock volatility of 26% and an expected annual dividend yield of $.76 and $.60 per share for 1998 and 1997. 14. SHAREHOLDERS' EQUITY Dividends are paid by the Company from its assets, which are primarily dividends from the Bank. However, certain restrictions exist regarding the ability of the Bank to transfer funds to the Company in the form of cash dividends, loans, or advances. As of December 31, 1998, approximately $4.5 million of the Bank's retained earnings was available for dividend distribution without prior regulatory approval. The Company is subject to various regulatory capital requirements that prescribe quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items. The Company's regulators have also imposed qualitative guidelines for capital amounts and classifications such as risk weightings, capital components, and other details. The quantitative measures to ensure capital adequacy require that the Company maintain amounts and ratios, as set forth in the schedule below, of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier I capital to average total assets (as defined). Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Management believes, as of December 31, 1998, that the Company meets all capital adequacy requirements imposed by its regulators. As of December 31, 1998 and 1997, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table. There have been no conditions or events since that notification that Management believes have changed the institution's category. Actual capital amounts as well as required and well capitalized Tier I, total, and Tier I leverage ratios as of December 31 for the Company and the Bank are as follows:
1998 To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) Total Capital (to Risk Weighted Assets): United Security Bancshares, Inc. $56,370 17.37% $25,967 8.00% N/A N/A First United Security Bank 52,531 16.28 25,809 8.00 $32,261 10.00% Tier I Capital (to Risk Weighted Assets): United Security Bancshares, Inc. 52,590 16.20 12,983 4.00% N/A N/A First United Security Bank 48,499 15.03 12,905 4.00 19,357 6.00 Tier I Leverage (to Average Assets): United Security Bancshares, Inc. 52,590 12.07 13,067 3.00% N/A N/A First United Security Bank 48,499 11.24 12,941 3.00 21,568 5.00
[CAPTION] 1997 To Be Well Capitalized Under For Capital Prompt Corrective Actual Adequacy Purposes Action Provisions Amount Ratio Amount Ratio Amount Ratio (Dollars in thousands) Total Capital (to Risk Weighted Assets): United Security Bancshares, Inc. $50,323 16.22% $24,827 8.00% N/A N/A First United Security Bank 49,542 16.07 24,656 8.00 $30,820 10.00% Tier I Capital (to Risk Weighted Assets): United Security Bancshares, Inc. 46,443 14.97 12,414 4.00% N/A N/A First United Security Bank 45,689 14.82 12,248 4.00 18,492 6.00 Tier I Leverage (to Average Assets): United Security Bancshares, Inc. 46,443 11.08 12,574 3.00% N/A N/A First United Security Bank 45,689 11.05 12,409 3.00 20,681 5.00
Comprehensive Income In June 1997, the FASB issued SFAS No. 130, Reporting Comprehensive Income. Comprehensive income is the change in equity during a period from transactions and other events and circumstances from nonowner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. In addition to net income, the Company has identified changes related to other nonowner transactions in the consolidated statement of changes in stockholders' equity and comprehensive income. For the Company, changes in other nonowner transactions consist entirely of changes in unrealized gains and losses on securities available for sale. In the calculation of comprehensive income, certain reclassification adjustments are made to avoid double counting items that are displayed as part of net income and other comprehensive income in that period or earlier periods. The following table reflects the reclassification amounts and the related tax effects for the three years ended December 31:
1998 Before After Tax Tax Tax Amount Effect Amount Unrealized gains (losses) arising during the period $3,282,314 $1,214,456 $2,067,858 Less reclassification adjustments for (gains) losses included in net income (410,987) (152,065) (258,922) Net change in unrealized gain/(loss) on securities $2,871,327 $1,062,391 $1,808,936
1997 Before After Tax Tax Tax Amount Effect Amount Unrealized gains (losses) arising during the period $ 53,575 $ 19,823 $ 33,752 Less reclassification adjustments for (gains) losses included in net income (105,254) (38,944) (66,310) Net change in unrealized gain/(loss) on securities $ (51,679) $ (19,121) $ (32,558)
1996 Before After Tax Tax Tax Amount Effect Amount Unrealized gains (losses) arising during the period $ 442,582 $ 301,989 $ 140,593 Less reclassification adjustments for (gains) losses included in net income 186,802 69,117 117,685 Net change in unrealized gain/(loss) on securities $ 629,384 $ 371,106 $ 258,278
15. SEGMENT REPORTING Under SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information, certain information is disclosed for the two reportable operating segments of the Company. The reportable segments were determined using the internal management reporting system. They are composed of the Company's significant subsidiaries. The accounting policies for each segment are the same as those used by the Company as described in Note 2--Summary of Significant Accounting Policies. The segment results include certain overhead allocations and intercompany transactions that were recorded at current market prices. All intercompany transactions have been eliminated to determine the consolidated balances. The results for the two reportable segments of the Company are included in the following table.
1998 FUSB ALC All Other Eliminations Consolidated (In thousands) Total interest income $ 35,523 $12,141 $ 133 $ (4,542) $ 43,255 Total interest expense 15,518 4,542 0 (4,542) 15,518 Net interest income 20,005 7,599 133 0 27,737 Provision for loan losses 762 2,425 0 0 3,187 Net interest income after provision 19,243 5,174 133 0 24,550 Total noninterest income 3,580 936 9,096 (9,054) 4,558 Total noninterest expense 12,015 4,696 313 (16) 17,008 Income (loss) before income taxes (tax benefit) 10,808 1,414 8,916 (9,038) 12,100 Provision for income taxes (tax benefit) 2,967 557 (3) 0 3,521 Net income (loss) $ 7,841 $ 857 $ 8,919 $ (9,038) $ 8,579 Other significant items: Total assets $444,408 $67,902 $61,816 $(124,053) $450,073 Total investment securities 160,916 0 3,103 0 164,019 Total loans, net 236,274 64,486 0 (65,700) 235,060 Investment in wholly-owned subsidiaries 384 0 55,338 (55,722) 0 Total interest income from external customers 30,981 12,141 133 0 43,255 Total interest income from affiliates 2,560 0 0 (2,560) 0
1997 FUSB ALC All Other Eliminations Consolidated (In thousands) Total interest income $ 35,213 $ 4,166 $ 5 $ (1,736) $ 37,648 Total interest expense 15,253 1,731 127 (1,736) 15,375 Net interest income 19,960 2,435 (122) 0 22,273 Provision for loan losses 657 1,053 0 0 1,710 Net interest income after provision 19,303 1,382 (122) 0 20,563 Total noninterest income 4,113 309 7,569 (7,631) 4,360 Total noninterest expense 12,441 2,264 600 (76) 15,229 Income (loss) before income taxes (tax benefit) 10,975 (573) 6,847 (7,555) 9,694 Provision for income taxes (tax benefit) 3,081 (228) (140) 0 2,713 Net income (loss) $ 7,894 $ (345) $ 6,987 $ (7,555) $ 6,981 Other significant items: Total assets $428,851 $36,624 $53,384 $(92,918) $425,941 Total investment securities 172,436 0 63 0 172,499 Total loans, net 217,363 34,134 0 (35,600) 215,897 Investment in subsidiaries 842 0 51,026 (51,868) 0 Total interest income from external customers 33,482 4,166 0 0 37,648 Total interest income from affiliates 1,736 0 0 (1,736) 0
1996 FUSB ALC All Other Eliminations Consolidated (In thousands) Total interest income $ 33,713 $ 1,339 $ 5 $ (506) $ 34,551 Total interest expense 15,081 506 0 (506) 15,081 Net interest income 18,632 833 5 0 19,470 Provision for loan losses 518 281 0 0 799 Net interest income after provision 18,114 552 5 0 18,671 Total noninterest income 2,628 97 2,095 (2,095) 2,725 Total noninterest expense 10,811 708 247 0 11,766 Income (loss) before income taxes (tax benefit) 9,931 (59) 1,853 (2,095) 9,630 Provision for income taxes (tax benefit) 2,681 (22) 0 0 2,659 Net income (loss) $ 7,250 $ (37) $ 1,853 $ (2,095) $ 6,971 Other significant items: Total assets $391,527 $11,861 $50,946 $(23,951) $430,383 Total investment securities 187,160 0 46 0 187,206 Total loans, net 193,555 11,331 0 0 204,886 Investment in subsidiaries (25,044) 0 48,995 (23,951) 0 Total interest income from external customers 33,207 1,339 5 0 34,551 Total interest income from affiliates 506 0 0 (506) 0
16. OTHER OPERATING EXPENSES Other operating expenses for the years 1998, 1997, and 1996 consist of the following:
1998 1997 1996 Telephone expense $ 543,509 $ 478,060 $ 340,354 Amortization of intangibles 626,651 604,811 338,689 Postage, stationery, and supplies 246,051 680,248 501,810 Merger expense 0 650,330 0 Other 3,291,907 2,729,036 2,500,141 Total $4,718,118 $5,142,485 $3,680,994
17. OPERATING LEASES The Company leases office space, data processing, and other equipment under operating leases. The following is a schedule, by years, of future minimum rental payments required under operating leases having initial or remaining noncancellable terms in excess of one year as of December 31, 1998: Year ending December 31, 1999 $394,062 2000 243,731 2001 144,864 2002 28,025 2003 9,600 Total rental expense under all operating leases was $532,056, $347,377, and $176,846 in 1998, 1997, and 1996, respectively. 18. COMMITMENTS AND CONTINGENCIES The Company is a defendant in certain claims and legal actions arising in the normal course of business. In the opinion of management, the ultimate disposition of these matters is not expected to have a material adverse effect on the financial position or results of operations of the Company. 19. DERIVATIVE FINANCIAL INSTRUMENTS The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and in connection with its interest rate risk management, investing, and trading activities. These financial instruments include commitments to make loans, options written, standby letters of credit, commitments to purchase or sell securities for forward delivery, interest rate caps and floors purchased, caps sold, and interest rate swaps. The Bank's exposure to credit loss in the event of nonperformance by the other party for commitments to make loans and standby letters of credit is represented by the contractual amount of those instruments. The Bank uses the same credit policies in making these commitments as it does for on-balance sheet instruments. For interest rate caps, floors, and swap transactions, options written, and commitments to purchase or sell securities for forward delivery, the contract or notional amounts do not represent exposure to credit loss. The Bank controls the credit risk of these instruments through credit approvals, limits, and monitoring procedures. The Bank has credit risk on caps and floors for the carrying value plus the amount to replace such contracts in the event of counterparty default. The Bank is fully cross-collateralized with counterparties on all interest rate swap agreements. At December 31, 1998, the Bank estimates its credit risk on purchased caps and floors in the event of total counterparty default to be $467,000. All of the Bank's financial instruments are held for risk management and not for trading purposes. In the normal course of business there are outstanding commitments and contingent liabilities, such as commitments to extend credit, letters of credit, and others, which are not included in the consolidated financial statements. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the financial statements. A summary of these commitments and contingent liabilities is presented below.
December 31, 1998 1997 (In thousands) Standby letters of credit $ 6,477 $ 5,310 Commitments to extend credit 23,546 35,249
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral held varies but may include accounts receivable, inventory, property, plant, and equipment, and income-producing commercial properties. At December 31, 1998 and 1997, commitments to purchase and sell securities for delayed delivery are summarized as follows:
December 31, 1998 1997 (In thousands) Commitments to purchase securities for delayed delivery $ 0 $ 3,000 Commitments to sell securities for delayed delivery 12,000 4,000
Commitments to purchase securities for delayed delivery require the Bank to purchase a specified security at a specified price for delivery on a specified date. Similarly, commitments to sell securities for delayed delivery require the Bank to sell a specified security at a specified price for delivery on a specified date. Market risk arises from potential movements in security values and interest rates between the commitment and delivery dates. The Bank's principal objective in holding derivative financial instruments is asset-liability management. The operations of the Bank are subject to a risk of interest rate fluctuations to the extent that there is a difference between the amount of the Bank's interest-earning assets and the amount of interest-bearing liabilities that mature or reprice in specified periods. The principal objective of the Bank's asset-liability management activities is to provide maximum levels of net interest income while maintaining acceptable levels of interest rate and liquidity risk and facilitating the funding needs of the Bank. To achieve that objective, the Bank uses a combination of derivative financial instruments, including interest rate swaps, caps, floors, and futures. An interest rate swap is an agreement in which two parties agree to exchange, at specified intervals, interest payment streams calculated on an agreed-upon notional principal amount with at least one stream based on a specified floating-rate index. Interest rate swaps are used by the Bank to effectively convert a portion of its floating rate securities to fixed rate securities, except for one swap which is used to convert a fixed rate loan to prime. Interest rate caps and floors are option-like contracts that require the seller to pay the purchaser at specified future dates the amount, if any, by which a specified market interest rate exceeds the fixed cap rate or falls below the fixed floor rate, applied to a notional principal amount. The Bank uses floors to protect CMO floaters and variable rate loans against a decline in rates. The Bank uses caps purchased to partially hedge against rising interest rates on their floating rate short-term borrowings and to uncap a portion of their floating rate CMO portfolio. They also use caps purchased matched with sold caps to raise, by 100 basis points, the cap on certain CMO floaters. These matches are also referred to as "corridors." The cost of the caps and floors are amortized straight-line over the life of these instruments. The income derived from these instruments is recorded on the accrual basis. The income and amortization from these instruments is recorded in net interest income and resulted in a reduction in net interest income of $164,006, $208,316, and $238,900 in 1998, 1997, and 1996, respectively. Interest-rate futures contracts are entered into by the Bank as hedges against exposure to interest-rate risk and are not for speculative purposes. Changes in the market value of interest-rate futures contracts are deferred while the contracts are open and subsequently amortized into interest income or expense over the maturity period of the hedged assets or liabilities after the contract closes. The following table details various information regarding swaps, caps, floors and forward contracts used for purposes other than trading as of December 31, 1998:
Weighted Weighted Average Weighted Average Repricing Notional Carrying Estimated Average Rate Years to Frequency Amount Value Fair Value Received Paid Expiration (Days) (Dollars in thousands) Swaps: Pay fixed versus prime $ 10,000 $ 0 $(172) 5.57% 5.59% 4.04 90 Deferred swaps: Pay floating, receive 5 year 1 month floating 20,000 0 (267) CMT LIBOR 3.04 30 Caps: Purchased 72,000 518 187 0.00% N/A 2.45 30-90 Sold 10,000 (17) 0 N/A 0.00% 2.00 30 Forward contract: Sold 12,000 0 (15) 0 6.52% 7.04 2,570 $124,000 $501 $(237)
Swaps, caps, and floors acquired for other than trading purposes are used to help reduce the risk of interest rate movements for specific categories of assets and liabilities. At December 31, 1998, such swaps, caps, and floors were associated with the following asset or liability categories:
Notional Principal Associated With Notional Fixed Floating Rate Amount Rate Loans Securities (In thousands) Swaps: Pay fixed $ 10,000 $10,000 $ 0 Caps: Purchased 72,000 0 72,000 Sold 10,000 0 10,000 Deferred swaps 20,000 0 20,000 Forward contract 12,000 12,000 0 $124,000 $22,000 $102,000
Income or expense on derivative financial instruments used to manage interest rate exposure is recorded on an accrual basis as an adjustment to the yield of the related interest-earning assets or interest-bearing liabilities over the periods covered by the contracts. If a derivative financial instrument that is used to manage interest rate risk is terminated early, any resulting gain or loss is deferred and amortized over the remaining periods originally covered by the derivative financial instrument. Deferred gains on early termination of interest rate swaps used to manage interest rate risk are $132,834 and $229,221 as of December 31, 1998 and 1997, respectively, with related amortization into income of $147,887, $234,459, and $227,847 for the years ended December 31, 1998, 1997, and 1996, respectively. Fiscal 1998 amounts are scheduled to be amortized into income in the following periods: $123,015 gain in 1999 and $9,819 in 2000. All of the Bank's derivative financial instruments are over-the-counter instruments and are not exchange traded. Market values are obtained from the counterparties to each instrument. The Bank only uses other commercial banks as a counterparty to their derivative activity. The Bank performs stress tests and other models to assess risk exposure. 20. FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, Disclosures About Fair Value of Financial Instruments, requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the statement of condition, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of the Company's financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of the Company, but rather represent a good-faith estimate of the increase or decrease in value of financial instruments held by the Company since purchase, origination, or issuance. The Company has not undertaken any steps to value any intangibles. The following methods and assumptions were used by the Company in estimating the fair value of its financial instruments: Cash and due from banks: Fair value equals the carrying value of such assets. Investment securities available for sale: Fair values for investment securities are based on quoted market prices. Accrued interest receivable and payable: Fair value equals the carrying value of these instruments. Loans: For variable rate loans, those repricing within six months, fair values are based on carrying values. Fixed rate commercial loans, other installment loans, and certain real estate mortgage loans were valued using discounted cash flows. The discount rate used to determine the present value of these loans was based on interest rates currently being charged by the Bank on comparable loans as to credit risk and term. Off-balance-sheet instruments: Fair values of the Company's off-balance-sheet instruments (futures, forwards, swaps, caps, floors, and options written) are based values obtained from counterparties, or other quotations received from third parties. The Company's loan commitments are negotiated at current market rates and are relatively short-term in nature. As a matter of policy, the Company generally makes commitments for fixed rate loans for relatively short periods of time. Because of this policy and the absence of any known credit exposure, the estimated value of the Company's loan commitments is nominal. Demand and savings deposits: The fair values of demand deposits are equal to the carrying value of such deposits. Demand deposits include noninterest bearing demand deposits, savings accounts, NOW accounts, and money market demand accounts. Time deposits: The fair value of relatively short-term time deposits is equal to their carrying values. Discounted cash flows have been used to value long-term time deposits. The discount rate used is based on interest rates currently being offered by the Bank on comparable deposits as to amount and term. Short-term borrowings: These borrowings consist of floating rate borrowings from the Federal Home Loan Bank and the U.S. Treasury Tax and Loan account. Due to the short-term nature of these borrowings, fair values approximate carrying values. Long-term debt: The fair value of this debt is estimated using discounted cash flows based on the Company's current incremental borrowing rate for similar types of borrowing arrangements.
At December 31, 1998 At December 31, 1997 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value (In thousands) Assets: Cash and cash equivalents $ 26,831 $ 26,831 $ 14,538 $ 14,538 Investment securities available for sale 164,019 164,019 172,499 172,499 Accrued interest receivable 4,521 4,521 4,049 4,049 Loans, net 235,060 237,246 215,897 216,127 Off-balance-sheet instruments 501 (237) 475 498 Liabilities: Deposits 326,645 327,774 322,418 323,889 Short-term borrowing 12 12 3,913 3,913 Long-term debt 55,847 56,000 40,965 40,984
21. UNITED SECURITY BANCSHARES,INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION Statements of Condition
December 31, 1998 1997 ASSETS: Cash on deposit $ 1,826,501 $ 1,022,289 Investment in subsidiaries 55,337,773 51,026,597 Investments available for sale 3,103,340 63,000 Other assets 1,185,211 1,226,749 $61,452,825 $53,338,635 LIABILITIES: Other liabilities $ 884,737 $ 628,087 SHAREHOLDERS' EQUITY 60,568,088 52,710,548 $61,452,825 $53,338,635
Statements of Income
Year Ended December 31, 1998 1997 1996 INCOME Dividend income, First United Security Bank $6,188,517 $5,526,531 $2,095,403 Interest income 132,788 496 4,621 Investment securities gains (losses), net 24,797 0 0 Total income 6,346,102 5,527,027 2,100,024 EXPENSES 278,990 573,588 246,763 INCOME BEFORE EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 6,067,112 4,953,439 1,853,261 EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARIES 2,511,538 2,028,019 5,117,729 Net income $8,578,650 $6,981,458 $6,970,990
Statements of Cash Flows
Year Ended December 31, 1998 1997 1996 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $8,578,650 $ 6,981,458 $ 6,970,990 Adjustments to reconcile net income to net cash provided by operating activities: Undistributed income of subsidiaries (2,511,538) (2,028,019) (5,117,729) (Increase) decrease in other assets 41,538 548,541 (10,595) Increase (decrease) in other liabilities 228,769 248,708 (30,138) Net cash provided by operating activities 6,337,419 5,750,688 1,812,528 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of investment securities available for sale (3,003,161) 0 (33,926) Net cash used in investing activities (3,003,161) 0 (33,926) CASH FLOWS FROM FINANCING ACTIVITIES: Principal payments on other borrowings 0 (3,004,000) (375,500) Proceeds from sale of treasury stock 3,251 0 0 Proceeds from issuance of common stock 160,299 16,380 0 Cash dividends paid (2,693,596) (1,870,515) (1,366,385) Net cash used in financing activities (2,530,046) (4,858,135) (1,741,885) INCREASE IN CASH 804,212 892,553 36,717 CASH AT BEGINNING OF YEAR 1,022,289 129,736 93,019 CASH AT END OF YEAR $1,826,501 $1,022,289 $ 129,736
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure. None. PART III Item 10. Directors and Executive Officers of the Registrant. The information called for in this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Election of Directors," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1998. Item 11. Executive Compensation. The information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Executive Compensation and Benefits," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1998. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Voting Securities and Principal Shareholders," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1998. Item 13. Certain Relationships and Related Transactions. The information called for by this item is incorporated herein by reference to Bancshares' definitive proxy statement, under the caption "Certain Relationships and Related Transactions," to be filed pursuant to Regulation 14A with the Securities and Exchange Commission within 120 days after the end of the fiscal year ended December 31, 1998. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a)1. Financial Statements Report of Independent Public Accountants. Consolidated Statements of Condition, December 31, 1998 and 1997. Consolidated Statements of Shareholders' Equity, December 31, 1998, 1997, and 1996. Consolidated Statements of Income, December 31, 1998, 1997, and 1996. Consolidated Statements of Cash Flows, December 31, 1998, 1997, and 1996. Notes to Consolidated Financial Statements. (a)2. Financial Statements Schedules Included in Part II of this report: The financial statement schedules required to be included pursuant to this Item are not included herein because they are not applicable or the required information is shown in the financial statements or notes thereto, which are included at Part II, Item 8, of this report. (a)3. Exhibits (3)(a) Amended and Restated Articles of Incorporation of Bancshares incorporated herein by reference to the Exhibits to Form 10-Q for the Quarter ended June 30, 1995. (3)(b) Bylaws of Bancshares, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1987, filed with the Commission in Washington, D.C., File No. 0-14549. (3)(c) Articles of Amendment to the Amended and Restated Articles of Incorporation of Bancshares incorporated herein by reference to the Exhibits to Form 10-Q for the Quarter ended June 30, 1997. (3)(d) Amendments to the Bylaws of Bancshares incorporated herein by reference to the Exhibits to Form 10-Q for the Quarter ended June 30, 1997. (10)(a) The United Security Bancshares, Inc. Employee Stock Ownership Plan, as amended dated January 1, 1992, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1992, filed with the Commission in Washington, D.C., File No. 0-14549. (10)(b) Amendments to the United Security Bancshares, Inc. Employee Stock Ownership Plan, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1997. (10)(c) Employment Agreement dated January 1, 1999, between Bancshares and R. Terry Phillips. (10)(d) Form of Indemnification Agreement between Bancshares and its directors, incorporated herein by reference to the Exhibits to Form 10-K for the year ended December 31, 1994, filed with the Commission in Washington, D.C., File No. 0-14549. (10)(e) United Security Bancshares, Inc. Long Term Incentive Compensation Plan, incorporated herein by reference to the Exhibits to Form S-4 dated April 16, 1997 (No. 333-21241). (13) Bancshares' definitive proxy statement for 1999 annual meeting of shareholders, to be filed within 120 days after the end of the fiscal year ended December 31, 1998, furnished for the information of the Commission. (21) List of Subsidiaries of Bancshares. (27) Financial Data Schedule (b) Reports on Form 8-K One report on Form 8-K, dated December 1, 1998 and filed December 15, 1998, was filed during the last quarter of the year ended December 31, 1998, reporting the employment of R. Terry Phillips as President and CEO of Bancshares. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. UNITED SECURITY BANCSHARES, INC. By: /s/ R. Terry Phillips March 18, 1999 ----------------------------- R. Terry Phillips Its President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ R. Terry Phillips President, Chief Executive March 18, 1999 - -------------------------- Officer, and Director R. Terry Phillips (Principal Executive Officer) /s/ Larry M. Sellers Treasurer (Principal Financial March 18, 1999 - -------------------------- Officer, Principal Accounting Larry M. Sellers Officer) /s/ Dan Barlow Director March 18, 1999 - -------------------------- Dan Barlow /s/ Linda Breedlove Director March 18, 1999 - -------------------------- Linda Breedlove Director March 18, 1999 - --------------------------- Gerald P. Corgill /s/ Roy G. Cowan Director March 18, 1999 - --------------------------- Roy G. Cowan /s/ John C. Gordon Director March 18, 1999 - --------------------------- John C. Gordon /s/ William G. Harrison Director March 18, 1999 - --------------------------- William G. Harrison /s/ Fred L. Huggins Director March 18, 1999 - --------------------------- Fred L. Huggins /s/ Hardie B. Kimbrough Director March 18, 1999 - --------------------------- Hardie B. Kimbrough /s/ Jack W. Meigs Director March 18, 1999 - --------------------------- Jack W. Meigs /s/ James L. Miller Director March 18, 1999 - --------------------------- James L. Miller /s/ Ray Sheffield Director March 18, 1999 - --------------------------- Ray Sheffield /s/ James C. Stanley Director March 18, 1999 - --------------------------- James C. Stanley /s/ Howard M. Whitted Director March 18, 1999 - --------------------------- Howard M. Whitted /s/ Bruce N. Wilson Director March 18, 1999 - --------------------------- Bruce N. Wilson EXHIBIT 21 List of Subsidiaries Name Where Organized First United Security Bank Alabama Acceptance Loan Company, Inc. Alabama First Security Courier Corporation Alabama EXHIBIT (10)(C) R. TERRY PHILLIPS EMPLOYMENT AGREEMENT [Execution Copy] EMPLOYMENT AGREEMENT THIS AGREEMENT made by and between UNITED SECURITY BANCSHARES, INC., a corporation organized under the laws of Alabama (hereinafter referred to as "USB"); FIRST UNITED SECURITY BANK, a banking corporation organized under the laws of Alabama (hereinafter referred to as "FUSB) USB and FUSB are hereinafter collectively referred to as the "Employer"); and R. Terry Phillips (hereinafter referred to as "Phillips"). W I T N E S S E T H, T H A T: WHEREAS, USB owns all of the issued and outstanding shares of common capital stock of FUSB; WHEREAS, the principal place of business of USB and FUSB is in Thomasville, Alabama; and WHEREAS, USB desires to employ Phillips as the President and Chief Executive Officer of USB; FUSB desires to employ Phillips as the President and Chief Executive Officer of FUSB; and Phillips desires to become employed as such; NOW, THEREFORE, in consideration of the premises and the mutual agreements hereinafter contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereby agree as follows: 1. Employment. Employer will employ Phillips in the capacity of President and Chief Executive Officer of USB and of FUSB and Phillips will serve USB and FUSB in that capacity for a term of three (3) years, commencing on January 1, 1999, and continuing through December 31, 2001. 2. Duties. As President and Chief Executive Officer of USB and of FUSB, Phillips will be the principal executive officer of USB and FUSB, and as such he will be responsible for the implementation of the policies promulgated by the Boards of Directors of USB and FUSB and for the oversight and direction of all phases of the operations of USB and FUSB, including Acceptance Loan Company, a subsidiary of FUSB. 3. Time and Efforts. Phillips shall devote his full time and best efforts to the discharge of his duties as President and Chief Executive Officer of USB and FUSB. However, it is recognized that in so discharging his duties Phillips may be called upon to serve in various civic capacities and on the boards of directors of various private and eleemosynary organizations. 4. Compensation. As compensation for services to be rendered to USB and to FUSB hereunder, Employer will pay or provide to Phillips the following: (a) A base salary of $185,000 with appropriate review annually based on individual performance and on the performance of USB and FUSB, as determined by the Boards of Directors of USB and FUSB. Salary will be payable in equal monthly or other installments in accordance with the general payroll practice of FUSB. (b) Incentive compensation calculated in accordance with (i) the plan adopted by the Board of Directors of FUSB now in effect, and all subsequent modifications, regardless of whether said plan may be terminated hereafter with respect to all other employees of FUSB. For purposes of Phillips' participation in said incentive plan, he will be treated as though he shall have remained employed through the end of FUSB's fiscal year following that in which his termination occurred. (c) A policy of "term-life" insurance on Phillips' life in the face of One Hundred Thousand and no/100 Dollars ($100,000.00), of which Phillips will be the owner. All of the premiums on such policy shall be paid by the Employer during Phillips' employment hereunder. (d) The use of a Chevrolet Tahoe automobile, or its equivalent, plus an amount equal to the costs of maintenance, repairs, insurance, and all other costs incident thereto. (e) An amount equal to the dues incurred by Phillips for membership in all local private or civic clubs of which he may become a member. 5. Severance Compensation. Upon (A) the termination of Phillips' employment hereunder for any reason other than (1) his death or disability, (2) his resignation, (3) his conviction of a crime involving moral turpitude, or (4) the termination of his agreement three years from the employment date, or upon (b) the reduction in the level or a change in nature of Phillips' responsibilities as President and Chief Executive Officer of USB or as President and Chief Executive Officer of FUSB, Phillips will be entitled to the following: (i) the Employer shall pay to Phillips an amount equal to his average annualized base salary then in effect at that time, except in the case of a change in ownership of USB or FUSB, in which case the amount will be equal to three (3) times his annualized base salary in effect at that time, and (ii) for a period of three (3) years from the date of such termination or reduction the Employer shall at its expense continue on behalf of Phillips the medical coverages and benefits provided to Phillips at any time during the 90-day period prior to the termination or reduction. The coverages and benefits provided in this Section 5(ii) shall be no less favorable to Phillips than the most favorable of such coverages and benefits provided to Phillips by Employer during the 90-day period referred to above. Employer's obligation hereunder with respect to the foregoing coverages and benefits shall be limited to the extent that Phillips obtains any such coverages or benefits pursuant to a subsequent employer's benefit plan, in which case the Employer may reduce the coverage of any benefits it is required to provide Phillips hereunder as long as the aggregate coverages and benefits of the combined benefit plans is no less favorable to Phillips than the coverages and benefits required to be provided under this Section 5(ii). 6. Disability. In the event of any illness or accident rendering Phillips totally disabled, Employer's obligations hereunder shall terminate twenty-six (26) weeks after the determination of such total disability. For purposes of this paragraph, "total disability" shall mean Phillips' inability to perform his duties. In the case of any disagreement between the parties with respect to Phillips' alleged total disability, Phillips shall be examined by a board of three (3) doctors, one (1) of whom is appointed by him, one (1) of whom is appointed by the Employer, and one (1) of whom is appointed by the two (2) doctors previously so appointed. The determination of such board of physicians shall be final, binding, and conclusive on the parties hereto. 7. Notices. All notices required or permitted to be given hereunder shall be deemed duly given if in writing and delivered in person or deposited with the U.S. Postal Service, in a postage-paid envelope marked certified mail, return receipt requested, to the parties at the following addresses or to such other addresses as either may designate in writing to the other: If to USB: United Security Bancshares, Inc. P.O. Box 239 Thomasville, AL 36784 If to FUSB: First United Security Bank 131 West Front Street Thomasville, AL 36784 If to Phillips: R. Terry Phillips Rt. 1, Box 251 Millry, AL 36558 8. Attorney's Fees. If Employer shall fail to make any payment due to Phillips hereunder, then Employer will pay Phillips cost of collection, including his reasonable attorney's fees, if the services of an attorney are utilized, whether or not suit be filed. 9. Entire Agreement. This agreement constitutes the entire understanding and agreement between Employer and Phillips with regard to all matters addressed herein. There are no other agreements, conditions, or representations oral or written, express or implied, with regard hereto. This agreement may be amended only by a written instrument executed by the parties hereto. 10. Governing Law. This agreement shall be construed and enforced in accordance with the laws of the State of Alabama. 11. Binding Effect. This agreement shall inure to the benefit of and be binding upon USB and FUSB, their successors and assigns, including, without limitation, any person, partnership, or corporation which may acquire substantially all of USB's and/or FUSB's assets or business or with or into which USB and/or FUSB may be liquidated, consolidated, merged, or otherwise combined, and shall inure to the benefit of and be binding upon Phillips, his heirs, distributees, and personal representatives. 12. Waiver. The failure any party to insist in any one or more instances upon performance of any terms or conditions of this agreement shall not be construed a waiver of future performance of any such term, covenant, or condition, but the obligations of either party with respect thereto shall continue in full force and effect. IN WITNESS WHEREOF, United Security Bancshares, Inc. and First United Security Bank have caused their corporate signatures and seals to be hereunto affixed by their duly authorized officers and R. Terry Phillips, has executed this agreement on this the 1st day of JANUARY, 1999. UNITED SECURITY BANCSHARES,INC. ATTEST: BY: /s/ Larry M. Sellers BY: /s/ J. L. Miller ---------------------------- --------------------------- ITS: Secretary ITS: Chairman [CORPORATE SEAL] FIRST UNITED SECURITY BANK ATTEST: BY: /s/ Larry M. Sellers BY: /s/ J. L. Miller ----------------------------- ---------------------------- ITS: Secretary ITS: Chairman [CORPORATE SEAL] /s/ R. Terry Phillips ---------------------------------- R. Terry Phillips EX-27 2
9 This schedule contains summary financial informationi extracted from SEC form 10-K and is qualified in its entirety by reference to such financial statements. 1,000 YEAR DEC-31-1998 DEC-31-1998 12,102 14,728 0 0 164,019 0 0 240,049 4,989 450,073 326,645 12 7,001 55,147 0 0 36 60,532 450,073 29,397 13,761 97 43,255 12,496 15,518 27,737 3,187 411 17,008 12,100 0 0 0 8,579 2.42 2.40 6.8 3,460 5,070 0 0 4,046 2,589 345 4,989 4,989 0 0
-----END PRIVACY-ENHANCED MESSAGE-----