Item 5 - Market for The Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Item 6 - Selected Consolidated Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 8 - Financial Statements and Supplementary Data
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Item 10 - Directors, Executive Officers, and Corporate Governance
Item 11 - Executive Compensation
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13 - Certain Relationships and Related Transactions, and Director Independence
Item 14 - Principal Accounting Fees and Services
Item 15 - Exhibits and Financial Statement Schedules
United Security Bancshares Earnings 2018-12-31
UBFO 10K Annual Report
10-K 1 ubfo-12312018x10k.htm 10-K Document
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2018.
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO .
Commission file number: 000-32987
UNITED SECURITY BANCSHARES
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
2126 Inyo Street, Fresno, California
(Address of principal executive offices)
Registrant’s telephone number, including area code (559) 248-4943
Securities registered pursuant to Section 12(b) of the Act: Common Stock, no par value on Nasdaq
(Title of Class)
Securities registered pursuant to Section 12(g) of the Act: NONE
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.
Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.
Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a small reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer o
Accelerated filer o
Non-accelerated filer o
Small reporting company x
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Aggregate market value of the Common Stock held by non-affiliates as of the last business day of the registrant's most recently completed second fiscal quarter - June 30, 2018: $149,471,739
Shares outstanding as of February 28, 2019: 16,946,622
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K will be found in the Company's definitive proxy statement for its 2019 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, and such information is incorporated herein by this reference.
Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K (this “Report”) including, but not limited to, those described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations,” are forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. All statements contained in this Form 10-K that are not clearly historical in nature are forward-looking, and the words “anticipate,” “assume,” “intend,” “believe,” “forecast,” “expect,” “estimate,” “plan,” “continue,” “will,” “should,” “look forward” and similar expressions are generally intended to identify forward-looking statements. You should not place undue reliance on these statements as they involve risks, uncertainties and contingencies, many of which are beyond our control, which may cause actual results, performance, or achievements to differ materially from those expressed in them. Actual results could differ materially from those anticipated in such forward-looking statements as a result of risks and uncertainties more fully described under "Item 1A. Risk Factors." Factors that might cause such differences include, but are not limited to:
our ability to compete effectively against other financial service providers in our markets;
the effect of the current low interest rate environment or impact of changes in interest rates or levels of market activity, especially on the fair value of our loan and investment portfolios;
economic deterioration or a recession that may affect the ability of borrowers to make contractual payments on loans and may affect the value of real property or other property held as collateral for such loans;
changes in credit quality and the effect of credit quality on our allowance for loan and lease losses;
our ability to attract and retain deposits and other sources of funding or liquidity;
the need to retain capital for strategic or regulatory reasons;
the impact of the Dodd-Frank Act on our business, business strategies and cost of operations;
compression of the net interest margin due to changes in the interest rate environment, forward yield curves, loan products offered, spreads on newly originated loans and leases and/or asset mix;
reduced demand for our services due to strategic or regulatory reasons;
our ability to successfully execute on initiatives relating to enhancements of our technology infrastructure, including client-facing systems and applications;
legislative or regulatory requirements or changes, including an increase to capital requirements, and increased political and regulatory uncertainty;
the impact on our reputation and business from our interactions with business partners, counterparties, service providers and other third parties;
higher than anticipated increases in operating expenses;
inability for the bank to pay dividends to the holding company;
a deterioration in the overall macroeconomic conditions or the state of the banking industry that could warrant further analysis of the carrying value of goodwill and could result in an adjustment to its carrying value resulting in a non-cash charge;
the effectiveness of our risk management framework and quantitative models;
the costs and effects of legal, compliance, and regulatory actions, changes and developments, including the impact of adverse judgments or settlements in litigation, the initiation and resolution of regulatory or other governmental inquiries or investigations, and/or the results of regulatory examinations or reviews;
the impact of the Tax Cuts and Jobs Act on our business and business strategies, or if other changes are made to tax laws or regulations affecting our business, including the disallowance of tax benefits by tax authorities and/or changes in tax filing jurisdictions or entity classifications; and
our success at managing risks involved in the foregoing items and all other risk factors described in our audited consolidated financial statements, and other risk factors described in this Form 10-K and other documents filed or furnished by the Company with the SEC.
Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company.
Item 1 - Business
United Security Bancshares is a California corporation incorporated in March 2001 and is registered with the Board of Governors of the Federal Reserve System (“FRB”) as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The stock of United Security Bancshares is listed on NASDAQ under the symbol “UBFO.”
United Security Bank was chartered under the laws of the State of California in 1987 as a commercial bank. On June 12, 2001, United Security Bank reorganized into the bank holding company form of ownership and thereby became the wholly-owned subsidiary of United Security Bancshares and each share of United Security Bank stock was exchanged for a share of United Security Bancshares stock on a one-to-one basis. The principal business of United Security Bancshares is to serve as the holding company for United Security Bank.
References to the “Bank” refer to United Security Bank together with its wholly-owned subsidiary, USB Investment Trust Inc., a special purpose real estate investment trust organized under the laws of the State of Maryland. References to “we,” “us,” or the “Company” refer to United Security Bancshares together with its subsidiaries on a consolidated basis. References to the “Holding Company,” refer to United Security Bancshares, the parent company, on a stand-alone basis.
United Security Bank
The Bank is a California state-chartered bank headquartered in Fresno, California. At December 31, 2018, the Bank operates three branches (including its main office), one construction lending office, and one commercial lending office in Fresno, California and one branch each, in Oakhurst, Caruthers, San Joaquin, Firebaugh, Coalinga, Bakersfield, Taft, and Campbell, California. The Bank has ATMs at all branch locations and off-site ATMs at nine different non-branch locations. In addition, the Holding Company and the Bank have administrative headquarters located at 2126 Inyo Street, Fresno, California, 93721.
USB Investment Trust Inc.
USB Investment Trust Inc. was incorporated effective December 31, 2001 as a special purpose real estate investment trust (REIT) under Maryland law. The REIT is a subsidiary of the Bank and was funded with $133.0 million in real estate-secured loans contributed by the Bank. USB Investment Trust was originally formed to give the Bank flexibility in raising capital, and reduce the expenses associated with holding the assets contributed to USB Investment Trust. The REIT also provided state tax benefits beginning in 2002.
USB Capital Trust II
During July 2007, the Holding Company formed USB Capital Trust II as a wholly-owned special purpose entity for the purpose of issuing Trust Preferred Securities. USB Capital Trust II is a Variable Interest Entity (VIE) and a deconsolidated entity pursuant to current accounting standards related to variable interest entities. On July 23, 2007, USB Capital Trust II issued $15 million in Trust Preferred Securities. These securities have a thirty-year maturity and bear a floating rate of interest (repricing quarterly) of 1.29% over the three-month LIBOR rate. Interest is payable quarterly. Concurrent with the issuance of the Trust Preferred Securities, USB Capital Trust II used the proceeds of the Trust Preferred Securities offering to purchase a like amount of junior subordinated debentures issued by the Holding Company. The Holding Company pays interest on the junior subordinated debentures to USB Capital Trust II, which represents the sole source of dividend distributions to the holders of the Trust Preferred Securities. Effective September 30, 2009 and beginning with the quarterly interest payment due October 1, 2009, the Holding Company elected to defer interest payments on the $15.0 million of junior subordinated debentures relating to the Trust Preferred Securities. The terms of the debentures and trust indentures allow for the Holding Company to defer interest payments for up to 20 consecutive quarters without default or penalty. During this deferral period, the Holding Company continued to record interest expense associated with the debentures. As of June 30, 2014, the Company ended the extension period, paid all accrued and unpaid interest and, as of December 31, 2018, was current on its quarterly interest payments. During 2015, $3.0 million of the $15.0 million principal balance of the subordinated debentures related to the Trust Preferred Securities was purchased by the Bank and subsequently purchased by the Company. The Company redeemed the $3.0 million in par value of the subordinated debentures, resulting in a remaining contractual principal balance of $12.0 million since year-end 2015. The Company may redeem the junior subordinated debentures at any time at par.
The following discussion of our services should be read in conjunction with "Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
We offer a full range of commercial banking services primarily to the business and professional community and individuals located in Fresno, Madera, Kern, and Santa Clara Counties, including a variety of deposit instruments including personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal (NOW) accounts, money market accounts and time certificates of deposit. Most of our deposits are comprised of accounts from individuals and from small- and medium-sized business-related sources. Time deposits have provided a significant portion of the Bank’s deposit base amounting to 10.23% and 9.43% of total deposits at December 31, 2018 and 2017, respectively.
We also offer a full complement of lending activities, including real estate mortgage (49.2% of total loans at December 31, 2018), commercial and industrial (9.7% of total loans at December 31, 2018), real estate construction (18.5% of total loans at December 31, 2018), as well as agricultural (10.4% of total loans at December 31, 2018), and installment loans (12.2% of total loans at December 31, 2018). Approximately 67.7% of our loans are secured by real estate at December 31, 2018. A loan may be secured (in whole or in part) by real estate even though the purpose of the loan is not to facilitate the purchase or development of real estate. At December 31, 2018, we had loans (net of unearned fees) outstanding of $587,814,000, which represented approximately 73.0% of our total deposits and approximately 63.0% of our total assets.
Our real estate mortgage loans are secured by deeds of trust primarily on commercial property. The repayment of real estate mortgage loans generally is from the cash flow of the borrower. Commercial and industrial loans have a high degree of industry diversification. Our loans may be originated in our market area, or participated with other financial institutions outside our market area. A substantial portion of our commercial and industrial loans are secured by accounts receivable, inventory, leases or other collateral. The remainder are unsecured. However, extensions of credit are predicated on the financial capacity of the borrower to repay. Repayment of commercial loans is generally from the cash flow of the borrower. Our real estate construction loans consist of loans to residential contractors, which are secured by single-family residential properties. All real estate loans have established equity requirements. The repayment of real estate construction loans is generally from long-term mortgages with other lending institutions. Our agricultural loans are generally secured by land, equipment, inventory and receivables. Repayment of agricultural loans is generally from the expected cash flow of the borrower.
Although we have a high concentration of commercial real estate loans, we are not in the business of making residential mortgage loans to individuals. Residential mortgage loans totaled $59,431,000, or 10.11% of the portfolio at December 31, 2018. The residential mortgage loan portfolio is primarily comprised of purchased residential mortgage pools. We do not originate, or have in our loan portfolio, any subprime, Alt-A, or option adjustable rate loans. We do originate interest-only loans which are generally revolving lines of credit to commercial and agricultural businesses or for real estate development where the borrowers business may be seasonal or cash flows may be restricted until the completion of the project. In addition, we have restructured certain loans to allow the borrower to continue to perform on the loan under a troubled debt restructuring plan.
We purchase loan participations from, and sell loan participations to, other financial institutions. The underwriting standards for loan participations or purchases are the same as non-participated loans, and are subject to the same limitations, collateral requirements, and borrower requirements. We have reduced our level of loan participations over the past several years and as of December 31, 2018, we do not have any participation purchased loans. Loan participations sold comprised 1.2% and 1.3% of the total loan portfolio at December 31, 2018 and 2017, respectively.
In the normal course of business, we make various loan commitments and incur certain contingent liabilities. Due to the nature of the business of our customers, there is no absolute predictability to the utilization of unused loan commitments and therefore, we are unable to forecast the extent to which these commitments will be exercised within the current year. Although we can provide no assurances, we do not believe that any such utilization will constitute a material liquidity demand. The Company does however have collateralized and uncollateralized lines of credit which could be utilized if such loan commitments were to be exercised in excess of normal expectations.
In addition to the loan and deposit services discussed above we also offer a wide range of specialized services designed to attract and service the needs of commercial customers and account holders. These services include online banking, mobile banking, safe deposit boxes, Interactive (Virtual) Teller "ITM" services, ATM services, payroll direct deposit, cashier's checks, and cash management services. We do not operate a trust department; however, we make arrangements with our correspondent bank to offer trust services to our customers upon request. Most of our business originates within Fresno, Madera, Kern, and Santa Clara Counties.
Competition and Market Share
The banking business in California generally, and in the market areas we serve specifically, is highly competitive with respect to both loans and deposits. We compete for loans and deposits with other commercial banks, savings and loan associations, money market funds, credit unions and other financial institutions, including a number that are substantially larger than us. We compete for loans and deposits by offering competitive interest rates and by seeking to provide a higher level of personalized service than is generally offered by larger competitors. Regulatory restrictions on interstate bank branching and acquisitions and on banks providing a broader array of financial services, such as securities underwriting and insurance, have been reduced or eliminated. The availability of banking services over the Internet and on mobile devices continues to expand. Changes in laws and regulations governing the financial services industry cannot be predicted; however, past legislation has served to
intensify the competitive environment. Many of the major commercial banks operating in our market areas offer certain services such as trust and international banking services, which we do not offer directly. In addition, banks with larger capitalization have larger lending limits and are thereby able to serve larger customers.
Our primary market area at December 31, 2018 was located in Fresno, Madera, and Kern Counties, within California, in which approximately 30 FDIC-insured financial institutions compete for business. Santa Clara County was added during February 2007, with the Legacy Bank acquisition, in which approximately 50 FDIC-insured financial institutions compete for business. The following table sets forth information regarding deposit market share and ranking by county as of June 30, 2018, which is the most current information available.
Total of Fresno, Madera, Kern Counties
Santa Clara County
Supervision and Regulation
We are subject to extensive regulation under federal and state banking laws that establish a comprehensive framework for our operations. Such regulation is intended to, among other things, protect the interests of customers, including depositors, and the federal deposit insurance fund, as well as to minimize risk to the banking system as a whole. These regulations are not, however, generally charged with protecting the interests of our shareholders or creditors. Described below are elements of selected laws and regulations applicable to our Holding Company and/or our Bank. The descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations described. Changes in applicable law or regulations, and in their application by regulatory agencies, cannot be predicted, and they may have a material effect on the business, operations, and results of our Company or the Bank. Recent political developments, including the change in the political composition of the U.S. Congress and the ongoing investigation of the current administration, have added additional uncertainty to the implementation, scope, and timing of regulatory reforms, including those related to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).
The following discussion of statutes and regulations is a summary and does not purport to be complete nor does it address all applicable statutes and regulations. This discussion is also qualified in its entirety by reference to the full text and to the implementation and enforcement of the statutes and regulations referred to in this discussion.
Dodd-Frank Wall Street Reform and Consumer Protection Act
Substantial changes to the regulation of bank holding companies and their subsidiaries have occurred as a result of the enactment in 2010 of the Dodd-Frank Act. Changes in applicable law or regulation, and in their application by regulatory agencies, have had and will continue to have a material effect on the business and results of the Company and its subsidiaries.
The Dodd-Frank Act significantly changed the regulatory framework for financial services companies, and since its enactment has required significant rulemaking and numerous studies and reports. Among other things, it created a new Financial Stability Oversight Council (the “Council”) with broad authority to make recommendations covering enhanced prudential standards and more stringent supervision for large bank holding companies and certain non-bank financial services companies. The Dodd-Frank Act significantly reduced interchange fees on debit card transactions, changed the preemption of state laws applicable to national banks, increased the regulation of consumer mortgage banking and made numerous other changes.
In addition to the Dodd-Frank Act, other legislative and regulatory proposals affecting banks have been made in recent years both domestically and internationally. Among other things, these proposals include significant additional capital and liquidity requirements and limitations on the size or types of activity in which banks may engage.
The Holding Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is registered with, and regulated and examined by, the Board of Governors of the Federal Reserve System, or FRB. In addition, the Bank is subject to extensive regulation and periodic examination, principally by the California Department of Business Oversight, or DBO and, as a member bank, the FRB. The Federal Deposit Insurance Corporation, or FDIC, insures the Bank's deposits up to certain prescribed limits. The Holding Company is also subject to regulation by the Securities and Exchange Commission ("SEC") and to the disclosure and regulatory requirements of the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and through the listing of its common stock on NASDAQ, the Holding Company is subject to the listing standards and rules of NASDAQ.
Source of Strength
The Dodd-Frank Act codified existing FRB policy requiring the Holding Company to act as a source of financial strength to the Bank, and to commit resources to support the Bank in circumstances where it might not otherwise do so. However, because the Gramm-Leach-Bliley Act (“GLBA”) provides for functional regulation of financial holding company activities by various regulators, the GLBA prohibits the FRB from requiring payment by a holding company to a depository institution if the functional regulator of the depository institution objects to the payment. In those cases, the FRB could instead require the divestiture of the depository institution and impose operating restrictions pending the divestiture. As a result of the Dodd-Frank Act, non-bank subsidiaries of a holding company that engage in activities permissible for an insured depository institution must be examined and regulated in a manner that is at least as stringent as if the activities were conducted by the lead depository institution of the holding company.
Bank Holding Company Liquidity
As a legal entity, separate and distinct from the Bank, the Holding Company has the ability to raise capital on its own behalf or borrow from external sources. We may also obtain additional funds from dividends paid by, and fees charged for services provided to, the Bank. However, regulatory constraints on the Bank may restrict or totally preclude the payment of dividends by the Bank to the Holding Company.
Transactions with Affiliates and Insiders
The Holding Company and any subsidiaries it may purchase or organize are deemed to be affiliates of the Bank within the meaning of Sections 23A and 23B of the Federal Reserve Act, and the FRB's Regulation W. Under Sections 23A and 23B and Regulation W, loans by the Bank to affiliates, investments by them in affiliates' stock, and taking affiliates' stock as collateral for loans to any borrower is limited to 10% of the Bank's capital, in the case of any one affiliate, and is limited to 20% of the Bank's capital, in the case of all affiliates. In addition, transactions between the Bank and other affiliates must be on terms and conditions that are consistent with safe and sound banking practices, in particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. These restrictions also prevent a bank holding company and its other affiliates from borrowing from a banking subsidiary of the bank holding company unless the loans are secured by marketable collateral of designated amounts.
The Holding Company and the Bank are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.
The Federal Reserve Act and FRB Regulation O place limitations and conditions on loans or extensions of credit to a bank or bank holding company’s executive officers, directors and principal shareholders; any company controlled by any such executive officer, director or shareholder; or any political or campaign committee controlled by such executive officer, director or principal shareholder. Additionally, such loans or extensions of credit must comply with loan-to-one-borrower limits; require prior full board approval when aggregate extensions of credit to the person exceed specified amounts; must be made on substantially the same and follow credit-underwriting procedures no less stringent than those prevailing at the time for comparable transactions with non-insiders; must not involve more than the normal risk of repayment or present other unfavorable features; and must not exceed the bank’s unimpaired capital and unimpaired surplus in the aggregate.
Under the BHCA, a bank holding company must obtain the FRB’s approval before: (i) directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank; (iii) or merging or consolidating with another bank holding company.
The FRB may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, the FRB must give effect to applicable state laws limiting the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institutions in the state in which the target bank is located, provided that those limits do not discriminate against out-of-state depository institutions or their holding companies, and state laws which require that the target bank have been in existence for a minimum period of time, not to exceed five years, before being acquired by an out-of-state bank holding company.
In addition to owning or managing banks, bank holding companies may own subsidiaries engaged in certain businesses that the FRB has determined to be “so closely related to banking as to be a proper incident thereto.” The Holding Company, therefore, is permitted to engage in a variety of banking-related businesses.
Additionally, qualifying bank holding companies making an appropriate election to the FRB may engage in a full range of financial activities, including insurance, securities and merchant banking. The Holding Company has not elected to qualify for these financial services.
Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that:
the customer must obtain or provide some additional credit, property or services from or to the Bank other than a loan, discount, deposit or trust services;
the customer must obtain or provide some additional credit, property or service from or to the Holding Company or any subsidiaries; or
the customer must not obtain some other credit, property or services from competitors, except reasonable requirements to assure soundness of credit extended.
Bank holding companies must maintain minimum levels of capital under the FRB’s risk-based capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.
The FRB’s risk-based capital adequacy guidelines, discussed in more detail below in the section entitled “Capital Standards,” assign various risk percentages to different categories of assets and capital are measured as a percentage of risk assets. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total risk assets and on total assets, without regard to risk weights.
The risk-based guidelines are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual organizations. For example, the FRB’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Moreover, any banking organization experiencing or anticipating significant growth or expansion into new activities, particularly under the expanded powers under the Gramm-Leach-Bliley Act, would be expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.
Limitations on Dividend Payments
As applicable to the Holding Company, California Corporations Code Section 500 provides that neither the Holding Company nor any of its subsidiaries shall make a distribution to the Holding Company’s shareholders unless the board of directors has determined in good faith that either:
The amount of retained earnings of the Holding Company immediately prior to the distribution equals or exceeds the sum of (A) the amount of the proposed distribution plus (B) the preferential dividends arrears amount; or
Immediately after the distribution, the value of the Holding Company's assets would equal or exceed the sum of its total liabilities plus the preferential rights amount.
Additionally, the FRB’s policy regarding dividends provides that a bank holding company should not pay cash dividends exceeding its net income or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The FRB also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.
Securities Registration and Listing
Our common stock is registered with the SEC under the Exchange Act and, as a result, we are subject to the information, proxy solicitation, insider trading, corporate governance, and other disclosure requirements and restrictions of the Exchange Act, as well as the Securities Act, both administered by the SEC. We are required to file annual, quarterly and other current reports with the SEC. The SEC maintains an Internet site, http://www.sec.gov, at which our filings with the SEC may be accessed. Our SEC filings are also available on our website at http://investors.unitedsecuritybank.com/Docs.
Our common stock is listed on NASDAQ and trades under the symbol “UBFO.” As a company listed on NASDAQ, we are subject to NASDAQ standards for listed companies. NASDAQ has also adopted corporate governance rules, which are intended to allow shareholders and investors to more easily and efficiently monitor the performance of companies and their directors.
As a California state-chartered bank and a member of the FRB, the Bank is subject to regulation, supervision and regular examination by the FRB, and the DBO. The Bank is subject to California laws insofar as they are not preempted by federal banking law. Deposits of the Bank are insured by the FDIC up to the applicable limits in an amount up to $250,000 per customer and, as such, the Bank is subject to the applicable provisions of the FDIA and the regulations of the FDIC. As a consequence of the extensive regulation of commercial banking activities in California and the United States, the Bank’s business is particularly susceptible to changes in California and federal legislation and regulation, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition.
Various other requirements and restrictions under the laws of the United States and the State of California affect the operations of the Bank. Federal and California statutes and regulations relate to many aspects of the Bank’s operations, including capital requirements and disclosure requirements to depositors and borrowers, requirements to maintain reserves against deposits, limitations on interest rates payable on deposits, loans, investments, and restrictions on borrowings and on payment of dividends. The DBO regulates the number and location of branch offices of a state-chartered bank, and may permit a bank to maintain branches only to the extent allowable under state law for state banks. California law presently permits a bank to locate a branch in any locality in the state. Additionally, California law exempts banks from California usury laws.
In addition to the Dodd-Frank Act, the international oversight body of the Basel Committee on Banking Supervision, or Basel III, reached agreements that introduced a minimum common equity tier 1 capital requirement of 4.50 percent, along with a capital conservation buffer of 2.50 percent to bring total common equity capital requirements to 7.00 percent. The federal banking agencies issued final rules that implemented Basel III and certain other revisions to the Basel capital framework, as well as the minimum leverage and risk-based capital requirements of the Dodd Frank Act. Federal regulators periodically propose amendments to the risk-based capital guidelines and the related regulatory framework and consider changes to the capital standards that could significantly increase the amount of capital needed to meet applicable standards. The timing of adoption, ultimate form and effect of any such proposed amendments cannot be determined at this time.
The following are among the requirements that were phased in beginning January 1, 2015:
An increase in the minimum Tier 1 capital ratio from 4.00% to 6.00% of risk-weighted assets;
A new category and a required 4.50% of risk-weighted assets ratio is established for “common equity Tier 1” as a subset of Tier 1 capital limited to common equity;
A minimum non-risk-based leverage ratio is set at 4.00% eliminating a 3.00% exception for higher rated banks;
Changes in the permitted composition of Tier 1 capital to exclude trust preferred securities, mortgage servicing rights and certain deferred tax assets and include unrealized gains and losses on available for sale debt and equity securities;
An additional capital conservation buffer of 2.5% of risk-weighted assets over each of the required capital ratios will be phased in beginning January 2016 at 0.625% of risk-weighted assets until fully implemented in January 2019. This conservation buffer level must be met to avoid limitations on the ability to pay dividends, repurchase shares or pay discretionary bonuses;
The risk weights of certain assets for purposes of calculating the risk-based capital ratios are changed for high volatility commercial real estate acquisition, development and construction loans, certain past due non-residential mortgage loans and certain mortgage-backed and other securities exposures; and
An additional “countercyclical capital buffer” is required for larger and more complex institutions.
As of December 31, 2018, the Company and the Bank were "well-capitalized" under these capital standards. The regulatory capital guidelines as well as the actual capitalization for the Bank and the Company as of December 31, 2018 are set forth under the section entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS - Regulatory Matters - Capital Adequacy.”
Historically, regulation and monitoring of bank and bank holding company liquidity has been addressed as a supervisory matter, both in the U.S. and internationally, without required formulaic measures. The Basel III framework requires banks and bank holding companies to measure their liquidity against specific liquidity tests that, although similar in some respects to liquidity measures historically applied by banks and regulators for management and supervisory purposes, going forward will be required by regulation. One test, referred to as the liquidity coverage ratio (“LCR”), is designed to ensure that the banking entity maintains an adequate level of unencumbered high‑quality liquid assets equal to the entity’s expected net cash outflow for a 30‑day time horizon (or, if greater, then 25% of its expected total cash outflow) under an acute liquidity stress scenario. The other test, referred to as the net stable funding ratio (“NSFR”), is designed to promote more medium‑ and long‑term funding of the assets and activities of banking entities over a one‑year time horizon. These requirements will incentivize banking entities to increase their holdings of U.S. Treasury securities and other sovereign debt as a component of assets and increase the use of long‑term debt as a funding source.
In September 2014, the federal banking agencies approved final rules implementing the LCR for advanced approaches banking organizations (i.e., banking organizations with $250 billion or more in total consolidated assets or $10 billion or more in total on-balance sheet foreign exposure) and a modified version of the LCR for bank holding companies with at least $50 billion in total consolidated assets that are not advanced approach banking organizations, neither of which apply to the Company or the Bank. On October 31, 2014, the Basel Committee on Banking Supervision issued its final standards for the NSFR, entitled “Basel III: The Net Stable Funding Ratio.” On May 3, 2016, the FRB issued a proposed requiring bank holding companies to maintain a minimum level of stable funding relative to the liquidity of their assets, derivatives, and commitments, over a one-year period and to publicly disclose information about their NSFR levels each quarter. However, this proposed rule would not apply to holding companies with less than $50 billion in total consolidated assets and would not apply to community banks and, therefore, would not apply to the Company and the Bank.
Prompt Corrective Action
The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. Pursuant to FDICIA, the FRB promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios:
Under the regulations, a bank shall be deemed to be:
“well capitalized” if it has a total risk-based capital ratio of 10% or more, has a Tier 1 risk-based capital ratio of 6% or more, has a leverage capital ratio of 5% or more and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure;
“adequately capitalized” if it has a total risk-based capital ratio of 8% or more, a Tier 1 risk-based capital ratio of 4% or more and a leverage capital ratio of 4% or more (3% under certain circumstances) and does not meet the definition of “well capitalized”;
“undercapitalized” if it has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage capital ratio that is less than 4% (3% under certain circumstances)
“significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3% or a leverage capital ratio that is less than 3%; and
“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2%.
A bank’s category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.
While these benchmarks have not changed, due to market turbulence, the regulators have strongly encouraged and, in many instances, required, banks and bank holding companies to achieve and maintain higher ratios as a matter of safety and soundness.
Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment, the bank would be “undercapitalized,” that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to “undercapitalized” banks. Banks classified as “undercapitalized” are required to submit acceptable capital plans guaranteed by its holding company, if any. Broad regulatory authority was granted with respect to “significantly undercapitalized” banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to “critically undercapitalized” banks. Restrictions for these banks include the appointment of a receiver or conservator. All of the federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.
A bank, based upon its capital levels, that is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. Further, a bank that otherwise meets the capital levels to be categorized as “well capitalized,” will be deemed to be “adequately capitalized,” if the bank is subject to a written agreement requiring that the bank maintain specific capital levels. At each successive lower capital category, an insured bank is subject to more restrictions. The federal banking agencies, however, may not treat an institution as “critically undercapitalized” unless its capital ratios actually warrant such treatment.
In addition to measures taken under the prompt corrective action provisions, insured banks may be subject to potential enforcement actions by the federal banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease-and-desist order that can be judicially enforced, the termination of insurance of deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution-affiliated parties. The enforcement of such actions through injunctions or restraining orders may be based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.
In addition to measures taken under the prompt corrective action provisions, commercial banking organizations, such as the Bank, may be subject to potential enforcement actions by the federal or state banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease‑and‑desist order that can be judicially enforced, the termination of insurance for deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, the issuance of removal and prohibition orders against institution‑affiliated parties. The enforcement of such actions through injunctions or restraining orders may be based upon a judicial determination that the agency would be harmed if such equitable relief was not granted.
The deposit insurance fund of the FDIC insures our customers’ deposits up to prescribed limits for each depositor. In October 2010, the FDIC under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) adopted a new restoration plan to ensure that the deposit insurance fund (the “DIF”) reserve ratio reaches 1.35% by September 30, 2020. At least semi-annually, the FDIC will update its loss and income projections for the DIF and, if needed, increase or decrease assessment rates. On February 7, 2011, the FDIC adopted a final rule modifying the risk-based assessment system from a domestic deposit base to a scorecard based assessment system, effective April 1, 2011. Effective as of April 1, 2011, the Bank was categorized as a small institution as the Bank has less than $10 billion in assets. After potential adjustments related to unsecured debt and brokered deposit balances, the final total assessment rates range from 2.5 to 45 basis points. Initial base assessment rates for small institutions ranged from five to 35 basis points. Any material increase in assessments or the assessment rate could have a material adverse effect on our business, financial condition, results of operations or cash flows, depending on the amount of the increase. Furthermore, the FDIC is authorized to raise insurance premiums under certain circumstances.
The Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”) increased the deposit insurance limit for certain retirement plan deposit accounts from $100,000 to $250,000 and the Dodd-Frank Act permanently raised the current standard maximum federal deposit insurance amount from $100,000 to $250,000 per qualified account.
The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance would result in the forced closure of the Bank which would have a material adverse effect on the Company’s business, financial condition and results of operations.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank of San Francisco (the “FHLB-SF”). Among other benefits, each Federal Home Loan Bank (“FHLB”) serves as a reserve or central bank for its members within its assigned region. Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system. Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. The FHLB-SF utilizes a single class of stock with a par value of $100 per share, which may be issued, exchanged, redeemed and repurchased only at par value. As an FHLB member, the Bank is required to own FHLB –SF capital stock in an amount equal to the greater of:
a membership stock requirement with an initial cap of $25 million (100% of “membership asset value” as defined), or
an activity based stock requirement (based on percentage of outstanding advances).
The FHLB – SF capital stock is redeemable on five years written notice, subject to certain conditions. At December 31, 2018 the Bank owned 28,228 shares of the FHLB-SF capital stock.
Federal Reserve Bank
The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts and non-personal time deposits. At December 31, 2018, the Bank was in compliance with these requirements.
We are subject to a number of federal and state consumer protection laws that extensively govern our relationship with our customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights, action by the state and local attorneys general in each jurisdiction in which we operate, and civil money penalties. Failure to comply with consumer protection regulations may also result in our failure to obtain any required bank regulatory approval for merger or acquisition transactions we may wish to pursue or our prohibition from engaging in such transactions even if approval is not required.
The CFPB has broad rulemaking, supervisory, and enforcement powers under various federal consumer financial protection laws. The CFPB is also authorized to engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities. The Bank is subject to direct oversight and examination by the CFPB. The CFPB has broad supervisory, examination, and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. State regulation of financial products and potential enforcement actions could also adversely affect our business, financial condition, or results of operations.
USA PATRIOT Act and Anti-Money Laundering
The PATRIOT Act, designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The PATRIOT Act, as implemented by various federal regulatory agencies, requires the Company and the Bank to establish and implement policies and procedures with respect to, among other matters, anti‑money laundering, compliance, suspicious activity and currency transaction reporting and due diligence on customers and prospective customers. The PATRIOT Act and its underlying regulations permit information sharing for counter‑terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB, the FDIC and other federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering a bank holding company acquisition and/or a bank merger act application.
We regularly evaluate and continue to enhance our systems and procedures to continue to comply with the PATRIOT Act and other anti‑money laundering initiatives. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal, strategic, and reputational consequences for the institution and result in material fines and sanctions.
Office of Foreign Assets Control Regulation
The United States has imposed economic sanctions that affect transactions with designated foreign countries, designated nationals and others. These rules are based on their administration by OFAC. The OFAC‑administered sanctions targeting designated countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment‑related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal, strategic, and reputational consequences, and result in civil money penalties on the Company and the Bank.
Community Reinvestment Act
The CRA generally requires the Bank to identify the communities it serves and to make loans and investments, offer products, make donations in, and provide services designed to meet the credit needs of these communities. The CRA also requires the Bank to maintain comprehensive records of its CRA activities to demonstrate how we are meeting the credit needs of our communities. These documents are subject to periodic examination by the FDIC. During these examinations, the FDIC rates such institutions’ compliance with CRA as “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” The CRA requires the FDIC to take into account the record of a bank in meeting the credit needs of all of the communities served, including low‑and moderate‑income neighborhoods, in determining such rating. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including acquisitions. The Bank received a CRA rating of “Satisfactory” as of its most recent examination. In the case of a bank holding company, such as the Company, when applying to acquire a bank, savings association, or a bank holding company, the FRB will assess the CRA record of each depository institution of the applicant bank holding company in considering the application.
Customer Information Privacy and Cybersecurity
The FRB and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal, non‑public customer information. These guidelines require each financial institution, under the supervision and ongoing oversight of its
board of directors or an appropriate committee thereof, to create, implement, and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information, and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We have adopted a customer information security program to comply with these requirements.
In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing Internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties. For a further discussion of risks related to cybersecurity, see "Item 1A. Risk Factors" included in this Form 10-K.
The GLBA and the California Financial Information Privacy Act require financial institutions to implement policies and procedures regarding the disclosure of non-public personal information about consumers to non‑affiliated third parties. In general, the statutes require disclosures to consumers on policies and procedures regarding the disclosure of such non-public personal information and, except as otherwise required by law, prohibit disclosing such information except as provided in the Bank’s policies and procedures. We have implemented privacy policies addressing these restrictions that are distributed regularly to all existing and new customers of the Bank.
Other Aspects of Banking Law
The Bank is also subject to federal statutory and regulatory provisions covering, among other things, security procedures, management interlocks, funds availability and truth-in-savings. There are also a variety of federal statutes that regulate acquisitions of control and the formation of bank holding companies, and the activities beyond owning banks that are permissible.
At December 31, 2018, the Company employed 125 persons on a full-time equivalent basis. The Company believes its employee relations are excellent.
The Company files period reports and other reports under the Securities and Exchange Act of 1934 with the Securities and Exchange Commission (SEC). These reports, as well as the Company’s Code of Ethics, are posted and are available at no cost on the Company’s website at http://www.unitedsecuritybank.com as soon as reasonably practical after the Company files such reports with the SEC. The Company’s periodic and other reports filed with the SEC are also available at the SEC’s website (http://www.sec.gov).
Item 1A - Risk Factors
An investment in our common stock is subject to risks inherent to our business. The material risks and uncertainties that management believes may affect our business are described below. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this Annual Report. The risks and uncertainties described below are not the only ones facing our business. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may adversely impact our business operations. If any of the events described in the following risk factors occur, our business, results of operations and financial condition could be materially
adversely affected. In addition, the trading price of our common stock could decline due to any of the events described in these risk factors.
Risks Relating to Our Bank and to the Business of Banking in General
Deterioration of economic conditions could adversely affect our business.
We conduct banking operations principally in California’s Central Valley. As a result, our financial condition, results of operations and cash flows are subject to changes in the economic conditions in California’s Central Valley. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in the Central Valley, and adverse economic conditions could have a material adverse effect upon us. In addition, the Central Valley remains largely dependent on agriculture. A downturn in agriculture and agricultural related business could indirectly and adversely affect our results of operations and financial condition.
We can provide no assurance that economic conditions in the United States in general and in the State of California and within our operating markets will not deteriorate or that such deterioration will not materially affect us. A deterioration in economic conditions locally, regionally or nationally could result in an economic downturn in the Central Valley with the following consequences, any of which could further adversely affect our business:
Loan delinquencies and defaults may increase;
Problem assets and foreclosures may increase;
Demand for loans or other products and services offered by us may decline;
Low cost or noninterest bearing deposits may decrease;
Decline in the value of our loans or other assets secured by real estate could occur;
Foreclosed assets may not be able to be sold;
Decrease in our stock price;
An impairment of goodwill or certain intangible assets; or
An increase in operating expenses associated with attending to the effects of the above-listed circumstances.
Our allowance for loan losses may not be adequate to cover actual losses.
The risk of credit losses on loans and leases varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower, and, in the case of collateralized loans, the value and marketability of the collateral. We maintain an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, our management makes various assumptions and determinations about the ultimate collectability of the loan portfolio and provides an allowance for losses based upon a percentage of the outstanding balances and for specific loans where their collectability is considered to be questionable.
As of December 31, 2018, our allowance for loan losses was $8,395,000, representing 1.43% of outstanding loans. While we believe that our allowance for loan losses is appropriate for the risk identified in our loans and lease portfolio, we cannot assure you that we will not further increase the allowance for loan losses, that it will be sufficient to address losses we actually incur, or that regulators will not require us to increase this allowance. Any of these occurrences could have a material adverse effect on our business, financial condition and results of operations. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations" for more information.
Our concentration of commercial real estate, construction and land development, and commercial and industrial loans exposes us to increased lending risks.
Commercial real estate, construction and land development, and commercial and industrial loans, which comprised approximately 67% of our total loan portfolio as of December 31, 2018, expose us to a greater risk of loss than residential real estate and consumer loans, which were a smaller percentage of the total loan portfolio. Commercial real estate and land development loans typically involve relatively large balances to a borrower or a group of related borrowers, and an adverse development with respect to a larger commercial loan relationship would expose us to greater risk of loss than would an adverse development with respect to a smaller residential mortgage loan or consumer loan.
If any particular industry or market sector were to experience economic difficulties, the overall timing and amount of collections on our loans to clients operating in those industries may differ from what we expected, which could have a material adverse impact on our financial condition or results of operations.
If we foreclose on collateral property, we may be subject to the increased costs associated with the ownership of real property, resulting in reduced revenues.
We may need to foreclose on collateral property to protect our investment and may thereafter own and operate such property, in which case we will be exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a default is dependent upon factors outside of our control, including, but not limited to: (i) general or local economic conditions; (ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) environmental remediation liabilities; (vii) ability to obtain and maintain adequate occupancy of the properties; (viii) zoning laws; (ix) governmental rules, regulations and fiscal policies; and (x) natural calamities. Certain expenditures associated with the ownership of real estate, principally real estate taxes, insurance, and maintenance costs, may adversely affect the income from the real estate, and as a result, we may be required to dispose of the real property at a loss. The foregoing expenditures and costs could adversely affect our ability to generate revenues, resulting in reduced levels of profitability.
Our financial performance is subject to interest rate risk.
Our operations are greatly influenced by general economic conditions and by related monetary and fiscal policies of the federal government. Deposit flows and funding costs are influenced by interest rates of competing investments and general market rates of interest. Lending activities are affected by the demand for loans, which in turn is affected by the interest rates at which such financing may be offered or by other factors affecting the availability of funds.
Our performance is substantially dependent on net interest income, which is the difference between the interest income received from interest-earning assets and the interest expense incurred in connection with our interest-bearing liabilities. To reduce our exposure to interest rate fluctuations, management seeks to manage the balances of interest sensitive assets and liabilities, and maintain appropriate maturity and repricing parameters for these assets and liabilities. A mismatch between the amount of rate sensitive assets and rate sensitive liabilities in any time period may expose us to interest rate risk. Generally, if rate sensitive assets exceed rate sensitive liabilities, the net interest margin will be positively impacted during a rising rate environment and negatively impacted during a declining rate environment. When rate sensitive liabilities exceed rate sensitive assets, the net interest margin will generally be positively impacted during a declining rate environment and negatively impacted during a rising rate environment. Increases in interest rates may reduce the overall level of loans we originate, and, thus, the amount of loan and commitment fees earned, as well as the market value of investment securities and other interest-earning assets. Moreover, fluctuations in interest rates may also result in disintermediation, which is the flow of funds away from depository institutions into direct investments, such as corporate securities and other investment vehicles which, because of the absence of federal deposit insurance, generally pay higher rates of return than depository institutions.
We operate in a highly regulated environment and we may be adversely affected by new laws and regulations or changes in existing laws and regulations. Regulations may prevent or impair our ability to pay dividends, engage in acquisitions or operate in other ways.
We are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact on us and our operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations, which could have a material adverse effect on our financial condition and results of operations. Further, regulators have significant discretion and power to prevent or remedy unsafe or unsound practices or violations of laws by banks and bank holding companies in the performance of their supervisory and enforcement duties. The exercise of this regulatory discretion and power may have a negative impact on us.
If we cannot attract deposits, our growth may be inhibited.
Our ability to increase our assets depends in large part on our ability to attract additional deposits at favorable rates. We intend to seek additional deposits by offering deposit products that are competitive with those offered by other financial institutions in our markets and by establishing personal relationships with our customers. We provide no assurances that these efforts will be successful. Our inability to attract additional deposits at competitive rates could have a material adverse effect on our business, financial condition, results of operations and cash flows.
Our ability to attract and retain qualified employees is critical to our success.
Our employees are our most important resource, and in many areas of the financial services industry, competition for qualified personnel is intense. We endeavor to attract talented and diverse new employees and retain and motivate our existing employees to assist in executing our growth, acquisition, and business strategies. If for any reason we are unable to continue to attract or retain qualified employees, our performance, including our competitive position, could be materially and adversely affected.
Our controls over financial reporting and related governance procedures may fail or be circumvented. As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the value of our common stock.
Management regularly reviews and updates our internal control over financial reporting, disclosure controls and procedures, and corporate governance policies and procedures. We maintain controls and procedures to mitigate risks such as processing system failures or errors and customer or employee fraud, and we maintain insurance coverage for certain of these risks. Any system of controls and procedures, however well designed and operated, is based in part on certain assumptions and provides only reasonable, not absolute, assurances that the objectives of the system are met. Events could occur which are not prevented or detected by our internal controls, are not insured against, or are in excess of our insurance limits. Any failure or circumvention of our controls and procedures, or failure to comply with regulations related to controls and procedures, could have an adverse effect on our business.
Our decisions regarding the fair value of assets acquired could be inaccurate which could materially and adversly affect our business, financial condition, result of operation, and future prospects.
To comply with U.S. GAAP, our management must exercise judgment in selecting, determining, and applying accounting methods, assumptions, and estimates. Management makes various estimates and judgments about the collectability of acquired loans, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of secured loans. If the actual performance of the acquired loans and/or the value of the collateral differs materially from management's estimates, any resulting losses or increased credit loss provisions could have a negative effect on our business, financial condition, or results of operations.
Changes in accounting standards may affect our performance.
Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. The FASB and SEC continually change the financial accounting and reporting standards that govern the preparation of our financial statements. These changes can materially impact how we report and record our financial condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in a retrospective adjustment to prior financial statements.
One such change is ASU 2016-13, which was released by the FASB in 2016 and which the Company is required to adopt no later than January 1, 2020. Currently, the impairment model used by financial institutions is based on incurred losses, and loans are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. This model will be replaced by the current expected credit loss ("CECL") model, in which financial institutions will be required to use historical information, current conditions and reasonable forecasts to estimate the expected loss over the life of the loan. The transition to the CECL model will necessitate significantly greater data requirements and changes to methodologies to accurately account for expected losses over the life of a loan. There can be no assurance that we will not be required to increase our reserves and allowance for loan loss as a result of the implementation of CECL. Increased provisions for loan losses may adversely affect our results of operations and financial condition.
We rely on communications, information, operating and financial control systems technology and we may suffer an interruption in or breach of the security of those systems.
The financial services industry is experiencing rapid technological changes with frequent introductions of new technology-driven products and services. Effective use of technology increases efficiency and enables financial institutions to better serve customers and reduce costs. Many of our competitors have substantially greater resources to invest in technological improvements than we do. Our future success will depend, to some degree, on our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as create additional efficiencies in our operations, We may not be able to effectively implement new technology-driven products or service, or be successful in marketing such products and services. Additionally, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may cause service interruptions, transaction processing errors and system conversion delays, and may cause us to fail to comply with applicable laws. Even with extraordinary care, due to the extensive work by computer hackers and others, we are also subject to potential data breaches that may result in revealing confidential information. There can be no assurance that we will be able to successfully manage the risks associated with increased dependency on technology.
Our business is highly reliant on technology and our ability and our third party service providers to manage the operational risks associated with technology.
We depend, and will continue to depend to a significant extent, on in-house hosted software and on a number of relationships with third party technology service providers. Specifically, we utilize software and hardware systems for transaction processing, essential web hosting, debit card processing, merchant bankcard processing, internet banking systems and other processing services from third party service providers. If these third party service providers experience difficulties or terminate their services, and we are unable to replace them with other qualified service providers, or we experience turnover of key staff, our operations could be interrupted. If an interruption were to continue for a significant period of time, our business, financial condition and results of operations could be materially adversely affected.
We rely on other companies to provide key components of our business infrastructure.
We rely on certain third parties to provide products and services necessary to maintain day-to-day operations, such as data processing and storage, recording and monitoring transactions, on-line banking interfaces and services, Internet connections, telecommunications, and network access. Even though we have a vendor management program to help us carefully select and monitor the performance of third parties, we do not control their actions. The failure of a third-party to perform in accordance with the contracted arrangements under service level agreements as a result of changes in the third party’s organizational structure, financial condition, support for existing products and services, strategic focus, system interruption or breaches, or for any other reason, could be disruptive to our operations, which could have a material adverse effect on our business, financial condition and results of operations.
We are subject to liquidity risk, which could adversely affect our financial condition and results of operations.
Effective liquidity management is essential for the operation of our business. Although we have implemented strategies to maintain sufficient and diverse sources of funding to accommodate planned, as well as unanticipated, changes in assets, liabilities, and off-balance sheet commitments under various economic conditions, an inability to raise funds through deposits, borrowings, the sale of investment securities and other sources could have a material adverse effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market disruption, a decrease in the borrowing capacity assigned to our pledged assets by our secured creditors, or adverse regulatory action against us. Deterioration in economic conditions and the loss of confidence in financial institutions may increase our cost of funding and limit our access to some of our customary sources of liquidity, including, but not limited to, inter-bank borrowings, repurchase agreements and borrowings from the discount window of the FRBSF. Our ability to acquire deposits or borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry generally as a result of conditions faced by banking organizations in the domestic and international credit markets.
We may be adversely affected by changes in the actual or perceived soundness or condition of other financial institutions.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial and financial soundness of other financial institutions. Financial institutions are closely related as a result of trading, investment, liquidity management, clearing, counterparty and other relationships. Loss of public confidence in any one institution, including through default, could lead to liquidity and credit problems, losses, or defaults for other institutions. Even the perceived lack of creditworthiness of, or questions about, a counterparty may lead to market-wide liquidity and credit problems, losses, or defaults by various institutions. This systemic risk may adversely affect financial intermediaries, such as clearing agencies, banks and exchanges we interact with on a daily basis or key funding providers such as the Federal Home Loan Banks, any of which could have a material adverse effect on our access to liquidity or otherwise have a material adverse effect on our business, financial condition, or results of operations.
Risks Relating to Dividends and our Common Stock
Our future ability to pay dividends is subject to restrictions.
As a holding company with no significant assets other than the Bank, we depend on dividends from the Bank to fund our operating expense, payments of interest on our junior subordinated debentures, and estimated tax payments. Our ability to continue to pay dividends depends in large part upon our receipt of dividends or other capital distributions from the Bank. The ability of the Bank to pay dividends or make other capital distributions to us is subject to the restrictions in the California Financial Code. In addition, it is possible, depending upon the financial condition of the Bank and other factors, that the FRB, the FDIC and/or the DBO could assert that payment of dividends or other payments is an unsafe or unsound practice. The amount that the Bank may pay in dividends is further restricted due to the fact that the Bank must maintain a certain minimum amount of capital to be considered a “well capitalized” institution as well as a separate capital conservation buffer, as further
described under “Item 7 - Management's Discussion and Analysis of Operations - Regulatory Matters- Dividends” in this report.
In the event the Bank is unable to pay dividends to the Holding Company, it is likely that we, in turn, would have to discontinue capital distributions in the form of dividends or share repurchases and may have difficulty meeting our other financial obligations, including payments in respect of any outstanding indebtedness or subordinated debentures. The inability of the Bank to pay dividends to the Holding Company could have a material adverse effect on our business, including the market price of our common stock.
Our Holding Company expenses and obligations with respect to our trust preferred securities and corresponding junior subordinated deferrable interest debentures issued by us may also limit or impair our ability to declare or pay dividends.
As of December 31, 2018, the Bank paid approximately $6,947,000 in dividends to our Holding Company. No assurances can be given that our future performance will justify the payment of dividends in any particular year.
Our holding company expenses and obligations with respect to our trust preferred securities and corresponding junior subordinated deferrable interest debentures issued by us may limit or impair our ability to declare or pay dividends. No assurance can be given that our future performance will justify the payment of dividends in any particular year. Finally, our ability to pay dividends is also subject to the restrictions of the California Corporations Code.
We may issue additional common stock or other equity securities in the future which could dilute the ownership interest of existing shareholders.
In order to maintain our capital at desired or regulatory-required levels, or to fund future growth, our board of directors may decide from time to time to issue additional shares of common stock, or securities convertible into, exchangeable for, or representing rights to acquire shares of our common stock. The sale of these shares may significantly dilute your ownership interest as a shareholder. New investors in the future may also have rights, preferences and privileges senior to our current shareholders which may adversely impact our current shareholders
Holders of our junior subordinated debentures have rights that are senior to those of our common shareholders.
On July 25, 2007 we issued $15,464,000 of floating rate junior subordinated debentures in connection with a $15,000,000 trust preferred securities issuance by its subsidiary, United Security Bancshares Capital Trust II. At December 31, 2017, the contractual principal balance of our debentures relating to its trust preferred securities is $12,000,000. The junior subordinated debentures mature in July 2037.
We conditionally guarantee payments of the principal and interest on the trust preferred securities. Our junior subordinated debentures are senior to holders of common stock. As a result, we must make payments on the junior subordinated debentures (and the related trust preferred securities) before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of common stock.
Item 1B. - Unresolved Staff Comments
The Company had no unresolved staff comments at December 31, 2018.
Item 2 - Properties
The Bank’s main bank branch is located at 2151 West Shaw Avenue, Fresno, California. The Company owns the building and leases the land under a sublease dated December 1, 1986, between Central Bank and USB. The current sublessor under the master ground lease is Bank of the West, which acquired the position through the purchase of Central Bank. The lessor under the ground lease (Master Lease) is Thomas F. Hinds. The lease was renewed on January 1, 2016 set to expire December 31, 2020.The Company has options to extend the term for three (3) additional periods of five (5) years under the same terms and conditions.
The Company leases the banking premises of approximately 6,450 square feet for its second of three Fresno branches at 7088 N. First St, Fresno, California., under a lease which commenced August 2005 and renewed July 2015 for a term of 10 years expiring July 2025. The facility provides space for the branch as well as the Real Estate Construction Department and the Indirect Consumer Lending Department. The branch was previously located at 1041 E. Shaw Avenue, Fresno, California, under a lease extension expiring February 28, 2005.
The Company leases the Oakhurst bank branch located at the Old Mill Village Shopping Center, 40074 Highway 49, Oakhurst, California. The branch facility consists of approximately 5,000 square feet. The original lease agreement was signed April 1999 for 15 years with two 5-year options to extend the lease. In April 2014, the Company exercised the first option which will be ending in April 2019.
The Company owns the Caruthers bank branch located at 13356 South Henderson, Caruthers, California, which consists of approximately 5,000 square feet of floor space.
The Company owns the San Joaquin bank branch facility located at 21574 Manning Avenue, San Joaquin, California. The bank branch is approximately 2,500 square feet.
The Company owns the Firebaugh bank branch located at 1067 O Street, Firebaugh, California. The premises are comprised of approximately 4,666 square feet of office space situated on land totaling approximately one-third of an acre.
The Company owns the Coalinga bank branch located at 145 East Durian, Coalinga, California. The office building has a total of 6,184 square feet of interior floor space situated on approximately 0.45 acres of land.
The Company leases the Convention Center bank branch located at 855 “M” Street, Suite 130, Fresno, California. Total space leased is approximately 4,520 square feet, and was occupied during March 2004. The fifteen-year lease expires in March 2019. There are no extension provisions.
The Company owns the Taft bank branch office premises located at 523 Cascade Place, Taft, California. The branch facility consist of approximately 9,200 square feet of office space.
The Company owns the Bakersfield bank branch facility located at 3404 Coffee Road, Bakersfield, California, which has approximately 6,130 square feet of office space located on 1.15 acres.
The Company leases the Campbell bank branch located at 1875 S. Bascom Ave., Suite 19, Campbell, California, which has approximately 2,984 square feet. The lease commenced on January 1, 2011 and expires on December 31, 2020.
The Company owns its administrative headquarters at 2126 Inyo Street, Fresno, California and is occupied by the Company’s administrative staff. The facility consists of approximately 21,400 square feet. A portion of the premises has been subleased to a third-party under a lease term which expires in March 2020 with a 5-year option for renewal.
The Company also has nine remote ATM or ITM locations leased from unrelated parties.
Item 3 - Legal Proceedings
From time to time, the Company is party to claims and legal proceedings arising in the ordinary course of business. At this time, the management of the Company is not aware of any material pending litigation proceedings to which it is a party or has recently been party to, which will have a material adverse effect on the financial condition or results of operations of the Company.
Item 5 - Market for the Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Our common stock trades on The Nasdaq Global Select Market and is traded under the symbol UBFO. At December 31, 2018, there were approximately 597 record holders of our common stock. This does not reflect the number of persons or entities who hold their stock in nominee or street name through various brokerage firms.
The following table sets forth the high and low closing sales prices by quarter for our common stock, for the years ended December 31, 2018 and 2017.
4th Quarter 2018
3rd Quarter 2018
2nd Quarter 2018
1st Quarter 2018
4th Quarter 2017
3rd Quarter 2017
2nd Quarter 2017
1st Quarter 2017
The Company's shareholders are entitled to dividends when and as declared by our Board of Directors out of funds legally available therefore. Dividends paid to our shareholders are subject to restrictions set forth in the California General Corporation Law, which provides that a California corporation may make a distribution, including paying dividends on its capital stock, from retained earnings to the extent that the retained earnings exceed (a) the amount of the proposed distribution plus (b) the amount, if any, of dividends in arrears on shares with preferential dividend rights. Alternatively, a California corporation may make a distribution, if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution. As a bank holding company without significant assets other than its equity position in the Bank, our ability to pay dividends to our shareholders depends primarily upon dividends we receive from the Bank. Such dividends paid by the Bank to our Holding Company are subject to certain limitations. See “Management’s Discussion and Analysis of Financial and Results of Operations - Regulatory Matters.”
We declared and paid a $0.07 cash dividend to our shareholders on January 4, 2018, a $0.09 cash dividend to our shareholders on April 9, 2018 and July 9, 2018, and a $0.10 cash dividend to our shareholders on October 9, 2018. We declared and issued a 1% stock dividend to our shareholders on April 7, 2017, and declared and paid a $0.05 cash dividend to shareholders on May 8, 2017 and July 7, 2017, and a $0.07 cash dividend to shareholders on October 10, 2017.
The amount and payment of dividends to our shareholders are set by our Board of Directors with numerous factors being taken into consideration including but not limited to our earnings, financial condition and the need for capital for expanded growth and general economic conditions. No assurance can be given that cash or stock dividends will be paid in the future.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth securities authorized for issuance under equity compensation plans as of December 31, 2018.
Equity compensation plans approved by security holders
Equity compensation plans not approved by security holders
(1) Under the United Security Bancshares 2015 Equity Incentive Award Plan (the "2015 Plan"), we are authorized to issue restricted stock awards. Restricted stock awards are not included in the total in column (a). At December 31, 2018, there were 59,217 shares of restricted stock issued and outstanding.
A complete description of the above plans is included in Note 11 of our Financial Statements, in Item 8 of this Report, and is hereby incorporated by reference.
Recent Sales of Unregistered Securites and Use of Proceeds
Purchases of Equity Securities by Affiliates and Associated Purchasers
On April 25, 2017, the Company’s Board of Directors approved the repurchase of up to $3 million of the outstanding common stock of the Company. The duration of the program is open-ended and the timing of purchases will depend on market conditions. We did not repurchase any common shares under the stock repurchase plan during the years ended December 31, 2018 and 2017.
Item 6 - Selected Consolidated Financial Data
The following table sets forth our selected historical consolidated financial information for each of the years in the five‑year period ended December 31, 2018. The selected financial data should be read in conjunction with our "Management's Discussion and Analysis of Financial Condition and Results of Operations," our audited consolidated financial statements as of December 31, 2018 and 2017, and the related Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
United Security Bancshares, a California corporation, is a bank holding company registered under the BHCA with corporate headquarters located in Fresno, California. The principal business of United Security Bancshares is to serve as the holding company for its wholly-owned subsidiary, United Security Bank. References to the “Bank” refer to United Security Bank together with its wholly-owned subsidiary, USB Investment Trust Inc., a special purpose real estate investment trust organized under Maryland law. References to “we,” “us,” or the “Company” refer to United Security Bancshares together with its subsidiaries on a consolidated basis. References to the “Holding Company,” refer to United Security Bancshares, the parent company, on a stand-alone basis.
Current Trends Affecting Results of Operations and Financial Position
Our overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact our results of operations, but also the composition of our balance sheet. One of our primary strategic goals is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources must also be considered in the planning process to mitigate risk and allow for growth.
Since the Bank primarily conducts banking operations in California’s Central Valley, our operations and cash flows are subject to changes in the economic condition of the Central Valley. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in the Central Valley, and declines in economic conditions can have adverse material effects upon our financial condition and result of operations.
The residential real estate markets in the five county region from Merced to Kern has strengthened since 2013 and that trend has continued into the fourth quarter of 2018. The severe declines in residential construction and home prices that began in 2008 have ended and home prices are now rising on a year-over-year basis. The sustained period of double-digit price declines from 2008–2011 adversely impacted our operations and increased the levels of nonperforming assets, increased expenses related to foreclosed properties, and decreased profit margins. As we continue our business development and expansion efforts throughout our market areas, we will also maintain our commitment to the reduction of nonperforming assets and provision of options for borrowers experiencing difficulties. Those options include combinations of rate and term concessions, as well as forbearance agreements with borrowers. Median sales prices and housing start numbers improved in the five county region from Merced to Kern beginning in 2013.
We continue to emphasize relationship banking and core deposit growth, and have focused greater attention on the Bank’s market area of Fresno, Madera, and Kern Counties, as well as Campbell, in Santa Clara County. The San Joaquin Valley and other California markets are also exhibiting stronger demand for construction lending and commercial lending from small- and medium-size businesses, as commercial and residential real estate markets have shown improvements.
We continually evaluate our strategic business plan as economic and market factors change in our market area. Balance sheet management, enhancing revenue sources, and maintaining market share were of primary importance to us during 2018 and will contiue to be beyond 2018. The previous pressure on net margins as interest rates hit historic lows appears to be waning and we anticipate that interest rates will rise slowly. As a result, market rates of interest and asset quality will continue to be important factors in our ongoing strategic planning process.
Application of Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with generally accepted accounting principles and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at
fair value inherently may result in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated using our own assumptions in regard to the assumptions that market participants would use in pricing the asset or liability.
The most significant accounting policies we follow are presented in Note 1 to our consolidated financial statements included herein. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses, other real estate owned through foreclosure, impairment of investment securities, revenue recognition, nonaccrual income recognition, fair value estimates on junior subordinated debt, valuation for deferred income taxes, and goodwill, to be accounting areas that require the most subjective or complex judgments, and as such could be most subject to revision as new information becomes available.
Allowance for Credit Losses
The allowance for credit losses represents management's estimate of probable incurred credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses. A discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Asset Quality and Allowance for Credit Losses section of this financial review.
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value of the property, less estimated costs to sell. The excess, if any, of the loan amount over the fair value of the collateral is charged to the allowance for credit losses. The determination of fair value is generally based upon pre-approved, external appraisals. Subsequent declines in the fair value of other real estate owned, along with related revenue and expenses from operations, are charged to noninterest expense. The fair market valuation of such properties is based upon estimates, and as such, is subject to change as circumstances in our market area, or general economic trends, fluctuate.
Impairment of Investment Securities
Investment securities are impaired when the amortized cost exceeds fair value. We evaluate investment securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. Our management considers the extent and duration of the unrealized loss and assesses whether it intends to sell, or it is likely that it will be required to sell the security before the anticipated recovery. If the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings.
For investment securities that do not meet the criteria regarding intent or requirement to sell, we compare the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows to determine OTTI related to credit loss. The amount of OTTI related to credit loss is recognized in earnings, with the balance recognized in other comprehensive income.
Our primary sources of revenue are interest income from loans and investment securities. Interest income is generally recorded on an accrual basis, unless the collection of such income is not reasonably assured or cannot be reasonably estimated. Pursuant to accounting standards related to revenue recognition, nonrefundable fees and costs associated with originating or acquiring loans are recognized as a yield adjustment to the related loans by amortizing them into income over the term of the loan using a method which approximates the interest method. Other credit-related fees, such as standby letter of credit fees, loan placement fees and annual credit card fees are recognized as noninterest income during the period the related service is performed.
For loans placed on nonaccrual status, the accrued and unpaid interest receivable may be reversed at management's discretion based upon management's assessment of collectability, and interest is thereafter credited to principal to the extent necessary to eliminate doubt as to the collectability of the net carrying amount of the loan.
Effective January 1, 2007, we adopted fair value option accounting standards choosing to apply the standards to our junior subordinated debt. We concurrently adopted the accounting standards related to fair value measurements. The accounting standards related to fair value measurements define how applicable assets and liabilities are to be valued, and requires expanded disclosures about financial instruments carried at fair value. The fair value measurement accounting standard establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices or for which fair value can be measured from actively quoted prices generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments infrequently traded or not quoted in an active market will generally have little or no pricing observability and a higher degree of judgment utilized in measuring fair value. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market and not yet established and the characteristics specific to the transaction. Determining fair values under the accounting standards may include judgments related to measurement factors that may vary from actual transactions executed in the marketplace. For the years ended December 31, 2018 and 2017, we recorded fair value adjustments related to our junior subordinated debt totaling losses of $392,000 and $882,000, respectively. (See Notes 9 and 14 of the Notes to Consolidated Financial Statements for additional information about financial instruments carried at fair value.)
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of our assets and liabilities. Deferred taxes are measured using current tax rates applied to such taxable income in the years in which those temporary differences are expected to be recovered. If our future income is not sufficient to apply the deferred tax assets within the tax years to which they may be applied, the deferred tax asset may not be realized and our income will be reduced. We recorded no valuation allowance against our deferred tax assets at December 31, 2018 and 2017.
On January 1, 2007, we adopted accounting standards related to uncertainty in income taxes. The standard prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Under the accounting standards, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of more than 50 percent. In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority.
Pursuant to the accounting standards related to uncertainty in income taxes, we will continue to re-evaluate existing tax positions, as well as new positions as they arise. If we determine in the future that our tax positions are not “more likely than not” to be sustained (as defined) by taxing authorities, we may need to recognize additional tax liabilities.
Results of Operations
Net income for the year ended December 31, 2018 was $14,017,000 or $0.83 per share ($0.83 diluted) compared to $8,640,000 or $0.51 per share ($0.51 diluted) for year ended December 31, 2017. The increase of $5,377,000 between December 31, 2017 and December 31, 2018 is primarily the result of increases in interest-earning assets and the decrease in the tax rate as a result of the Tax Cuts and Jobs Act enacted in 2017 and effective for tax year 2018. Interest income increased by $3,685,000, or 11.19%, between December 31, 2017 and December 31, 2018. Taxes on income decreased by $1,707,000, or 24.25%.
Return on average assets was 1.61% for the year ended December 31, 2018 compared to 1.07% for the year ended December 31, 2017. Return on average equity was 13.23% for the year ended December 31, 2018 compared to 8.63% for the year ended December 31, 2017.
As with variances in net income, changes in the return on average assets and average equity experienced by the Company during 2018 and 2017 were effected by increases in average loan balances and net interest income.
The following table sets forth certain selected financial data for each of the years in the five-year periods ended December 31, 2018, and should be read in conjunction with the more detailed information and financial statements contained elsewhere herein:
(In thousands except per share data and ratios)
Selected Financial Ratios:
Return on average assets
Return on average shareholders' equity
Average shareholders' equity to average assets
Dividend payout ratio
Net Interest Income
Net interest income, the most significant component of earnings, is the difference between the interest and fees received on earning assets and the interest paid on interest-bearing liabilities. Earning assets consist primarily of loans, and to a lesser extent, investments in securities issued by federal, state and local authorities, and corporations, as well as interest-bearing deposits and overnight investments in federal funds loaned to other financial institutions. These earning assets are funded by a combination of interest-bearing and noninterest-bearing liabilities, primarily customer deposits, and may include short-term and long-term borrowings.
Net interest income before provision (benefit) for credit losses was $33,912,000 for the year ended December 31, 2018, representing an increase of $2,712,000, or 8.69%, compared to net interest income before provision for credit losses of $31,200,000 for the year ended December 31, 2017. Although market rates of interest are at historically low levels, our disciplined deposit pricing efforts have helped maintain adequate margins. Our net interest margin, as shown in Table 1 below, increased to 4.28% for the year ended December 31, 2018, when compared to 4.27% for the year ended December 31, 2017 and 4.11% for the year ended December 31, 2016.
Table 1. – Distribution of Average Assets, Liabilities and Shareholders’ Equity:
The following table summarizes the distribution of average assets, liabilities and shareholders’ equity, as well as interest income and yields earned on average interest‑earning assets and interest expense and rates paid on average interest‑bearing liabilities, presented on a tax equivalent basis for the years indicated:
Total average liabilities and shareholders' equity
Interest income as a percentage of average earning assets
Interest expense as a percentage of average earning assets
Net interest margin
(1) Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan costs of approximately $1,046 for the year ended December 31, 2018, loan costs of approximately $537 for the year ended December 31, 2017, and loan costs of $163 for the year ended December 31, 2016.
The prime rate rose from 4.50% to 5.50% during 2018 and is expected to see further increases during 2019. These increases will affect rates for both loans and customer deposits, both of which are likely to increase as the prime rate increases.
Both our net interest income and net interest margin are affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Both are also affected by changes in yields on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change." The following table sets forth the changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the years indicated. Changes in interest income and expense, which are not attributable specifically to either rate or volume, are allocated proportionately between the two variances based on the absolute dollar amounts of the change in each.
Table 2. Rate and Volume Analysis
2018 compared to 2017
2017 compared to 2016
Increase (decrease) in interest income:
Interest-bearing deposits in other banks
Interest-bearing deposits in FRB
Total interest income
Increase (decrease) in interest expense:
Interest-bearing demand accounts
Total interest expense
Increase (decrease) in net interest income
The net interest margin rose slightly in 2018 due to increase in loan portfolio yields, yields of overnight investments with the Federal Reserve Bank, and investment securities yields. We seek to mitigate the low interest rate environment with loan floors included in new and renewed loans when practical. Loans yielded 5.57% during the year ended December 31, 2018, as compared to 5.42% and 5.21% for the years ended December 31, 2017 and 2016, respectively. For the year ended December 31, 2018, total interest income increased approximately $3,685,000, or 11.19%, as compared to the year ended December 31, 2017, reflective of an increase of $1,566,000 in loan interest income. Average interest-earning assets increased approximately $62,827,000 between 2018 and 2017 and the rate on interest-earning assets increased 11 basis points during the two periods. The increase in average earning assets between 2018 and 2017 consisted of increases of $49,004,000 in interest-bearing deposits held at the Federal Reserve Bank, increases of $12,142,000 in loans, and increases of $2,325,000 in investment securities. Average interest-earning assets increased approximately $48,155,000 between 2017 and 2016 and the rate on interest-earning assets increased 19 basis points during the two periods. The average rates on loans increased 21 basis points between the two periods, and the average rate on investment securities increased approximately 6 basis points during the year ended December 31, 2017, as compared to the same period of 2016. The rate on interest-earning assets increased during the year ended December 31, 2017 due to increases in loans, overnight deposit yields, and investment securities.
For the year ended December 31, 2018, total interest expense increased approximately $973,000, or 56.24%, as compared to the year ended December 31, 2017. Between those two periods, average interest-bearing liabilities increased by $52,169,000, and the average rates paid on these liabilities increased by 17 basis points. CDARs reciprocal deposits, which are preferred by some depositors, have increased from $12.1 million to $19.5 million.
The following table summarizes the year-to-date averages of the components of interest-earning assets as a percentage of total interest-earning assets, and the components of interest-bearing liabilities as a percentage of total interest-bearing liabilities:
Provisions for credit losses are determined on the basis of management's periodic credit review of the loan portfolio, consideration of past loan loss experience, current and future economic conditions, and other pertinent factors. Such factors consider the allowance for credit losses to be adequate when it covers estimated losses inherent in the loan portfolio. Based on the condition of the loan portfolio, management believes the allowance is appropriate to cover risk elements in the loan portfolio.
For the year ended December 31, 2018, the recovery of provision to the allowance for credit losses totaled $1,764,000. The provision for the year ended December 31, 2017 totaled $24,000. The recovery of provision for the year ended December 31, 2016 totaled $21,000.
The allowance for credit losses decreased to 1.43% of total loans during the year ended December 31, 2018, as compared to 1.54% at December 31, 2017, and 1.56% at December 31, 2016. The recovery of provision recorded during 2016, the modest provision recorded in 2017, and the recovery of provision of $1,764,000 recorded during 2018, are a result of continuing improvements in the overall credit quality of the loan portfolio, net recoveries, overall improvements in economic conditions over the recent years, and improvements in loan collateral property values. For further discussion, refer to Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset Quality and Allowance for Credit Losses.
The following table summarizes significant components of noninterest income for the years indicated and the net changes between those years:
% of Total
% of Total
% of Total
Customer service fees
Increase in cash surrender value of bank-owned life insurance
Loss on fair value of marketable equity securities
Gain on proceeds from bank-owned life insurance
Loss on fair value of junior subordinated debentures
Noninterest income consists primarily of fees and commissions earned on services that are provided to our banking customers and, to a lesser extent, gains on sales of Company assets and other miscellaneous income.
Noninterest income for the year ended December 31, 2018 increased $299,000, or 6.94%, when compared to the same period of 2017. Customer service fees, the primary component of noninterest income, decreased $307,000, or 7.97%, between the two periods presented, The decrease was due primarily to the closing of the Financial Services department. The increase in noninterest income of $299,000 between the two periods is the result of a decrease in the loss on the fair value of junior subordinated debentures of $424,000 during 2018 as compared to a loss of $882,000 during 2017. The change in the fair value of junior subordinated debentures was primarily caused by fluctuations in the LIBOR yield curve. The cost of our subordinated debentures issued by USB Capital Trust II has increased in concert with market rates over the last three or four years. With pricing at 3-month-LIBOR plus 129 basis points, the effective cost of the subordinated debt was 3.73% and 3.20% at December 31, 2018 and 2017, respectively.
Noninterest income for the year ended December 31, 2017, decreased $208,000 or 4.61% when compared to the same period of 2016. Customer service fees increased $59,000 or 1.56% between the two periods. The decrease in noninterest income of $208,000 is the result of a loss on the fair value of junior subordinated debentures of $882,000 during 2017 as compared to a loss of $518,000 during 2016, partially offset by increases in customer service fees.
The following table sets forth the components of total noninterest expense in dollars and as a percentage of average earning assets for the years ended December 31, 2018, 2017, and 2016:
(Dollars in thousands)
Salaries and employee benefits
Correspondent bank service charges
Loss on California tax credit partnership
Net cost (gain) on operation and sale of OREO
Noninterest expense increased $1,129,000, or 5.70%, between the years ended December 31, 2018 and 2017. The net increase in noninterest expense between the comparative periods is primarily the result of increases in salaries and employee benefits, professional fees, and net OREO costs, partially offset by a decrease in the loss recorded on a tax credit partnership. Noninterest expense decreased $542,000 between the years ended December 31, 2017 and 2016, due to decreases in net OREO costs and regulatory assessments, partially offset by increases in salaries and employee benefits.
Included in net costs on operations of OREO for the years ended December 31, 2018 and 2017 are OREO operating expenses totaling $145,000 and $186,000, respectively, and a gain on OREO of $336,000 recorded in 2017. There were no impairment losses on OREO recorded during the years ended 2018 and 2017.
During the years ended December 31, 2018 and 2017, the Company recognized stock-based compensation expense of $744,000 ($0.04 per share basic and diluted) and $97,000 (less than $0.01 per share basic and diluted), respectively. This expense is included in noninterest expense under salaries and employee benefits. If new stock options or units are issued, or existing options fail to vest due, for example, to forfeiture, actual stock-based compensation expense in future periods will change.
Our income tax expense is impacted to some degree by permanent taxable differences between income reported for book purposes and income reported for tax purposes, as well as certain tax credits which are not reflected in our pretax income or loss shown in the statements of operations and comprehensive income. As pretax income or loss amounts become smaller, the impact of these differences become more significant and are reflected as variances in our effective tax rate for the periods presented. In general, the permanent differences and tax credits affecting tax expense have a positive impact and tend to reduce the effective tax rates shown in our statements of operations and comprehensive income. Our effective tax rate for the year ended December 31, 2018 was 27.56% compared to 44.89% for the year ended December 31, 2017. With the enactment of the Tax Cuts and Jobs Act, which was signed into law on December 22, 2017, the Company's federal income tax rate changed from 34% to 21%. At December 31, 2017, the effective tax rate rose to 45%, from 40% as a result of the revaluation of our net deferred tax asset in light of the reduction in tax for 2018. This resulted in a write-down of $986,000 on our net deferred tax asset at year end 2017. The impact to earnings for fourth quarter 2017 was $0.06 per share.
We review our current tax positions at least quarterly based upon accounting standards related to uncertainty in income taxes which includes the criteria that an individual tax position would have to meet for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the income tax guidelines, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of "more than 50 percent.” In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority.
We have reviewed all of our tax positions as of December 31, 2018, and have determined that there are no material amounts that should be recorded under the current income tax accounting guidelines.
Total assets increased by $127,222,000, or 15.79%, from $805,836,000 at December 31, 2017 to $933,058,000 at December 31, 2018. During the year ended December 31, 2018, net loans decreased by $13,704,000. Overnight interest-bearing deposits in the Federal Reserve Bank and federal funds sold increased a net $118,691,000, and investment securities increased by $24,363,000 during the year ended December 31, 2018. Total deposits of $805,643,000 at December 31, 2018, increased $117,950,000, or 17.15%, from $687,693,000 at December 31, 2017.
During the year ended December 31, 2017, net loans increased $31,191,000. Overnight interest-bearing deposits in the Federal Reserve Bank and federal funds sold decreased by $14,554,000, while investment securities decreased by $11,769,000 during the year ended December 31, 2017. Total deposits of $687,693,000 at December 31, 2017 increased $11,064,000, or 1.64%, from the balance at December 31, 2016 of $676,629,000.
Earning assets averaged approximately $793,281,000 during the year ended December 31, 2018, as compared to $730,454,000 for the year ended December 31, 2017. Average interest-bearing liabilities increased to $459,934,000 for the year ended December 31, 2018, as compared to $407,765,000 for the year ended December 31, 2017.
Our primary business is that of acquiring deposits and making loans, with the loan portfolio representing the largest and most important component of our earning assets. Loans totaled $587,933,000 at December 31, 2018, a decrease of $13,418,000, or 2.23%, from total loans of $601,351,000 at December 31, 2017. During 2018, average loans increased 2.13% when compared to the year ended December 31, 2017. Average loans totaled $581,221,000 and $569,079,000 for the years ended December 31, 2018 and 2017, respectively.
The following table sets forth the amounts of loans outstanding by category and the category percentages as of the year-end dates indicated:
% of Loans
% of Loans
% of Loans
% of Loans
% of Loans
Commercial and industrial
Real estate mortgage
RE construction & development
Installment and student loans
Loan volume continues to be highest in what has historically been our primary lending emphasis: commercial, real estate mortgage, and construction lending. Total loans decreased $13,418,000 during 2018. There were decreases of $17,093,000, or 5.58%, in real estate mortgage loans and $14,175,000, or 11.53%, in real estate construction and development loans. There were increases of $9,952,000, or 21.16%, in commercial and industrial loans, $6,230,000, or 9.5%, in installment loans, and $1,668,000, or 2.8%, in agriculture loans.
Commercial real estate loans (a component of real estate mortgage loans) have remained as a significant percentage of total loans over the past year, amounting to 39.03% and 36.76%, of the total loan portfolio at December 31, 2018 and December 31, 2017, respectively. Commercial real estate loans increased $8,416,000 during 2018. Residential mortgage loans are not generally a large part of our loan portfolio, but some residential mortgage loans have been made over the past several years to facilitate take-out loans for construction borrowers who were unable to obtain permanent financing elsewhere. Additionally, we purchase residential mortgage pools. Residential mortgage loans are generally 30-year amortizing loans with maturities of between three and five years. These loans totaled $59,431,000 or 10.11% of the portfolio at December 31, 2018, and $84,804,000, or 14.10% of the portfolio at December 31, 2017. We held no purchased loan participations at December 31, 2018 or December 31, 2017. Loan participations sold decreased from $7,535,000 or 1.25% of the portfolio at December 31, 2017, to $7,140,000, or 1.21%, at December 31, 2018.
During 2017, we experienced an increase of $18,093,000, or 6.28%, in real estate mortgage loans, an increase of $20,632,000, or 45.90%, in installment loans, an increase of $2,563,000, or 4.50%, in agricultural loans, and decreases of $1,979,000, or 4.04%, in commercial and industrial loans and $7,717,000, or 5.90%, in construction loans.
At December 31, 2018, approximately 55.3% of commercial and industrial loans have floating rates and, although some may be secured by real estate, many are secured by accounts receivable, inventory, and other business assets. Real estate mortgage loans decreased $17,093,000 during 2018 due to paydowns on purchased residential mortgage loans. Real estate construction loans decreased $14,175,000, or 11.5%, during 2018, and $7,717,000, or 5.9%, during 2017. Construction loans are generally short-term, floating-rate obligations, which consist of both residential and commercial projects. Agricultural loans, which primarily consist of short-term, floating rate loans for crop financing, increased $1,668,000, or 2.8%, between December 31, 2017 and December 31, 2018. Commercial loans, consisting primarily of loans for non real estate business operations, increased $9,952,000, or 21.16%.
The real estate mortgage loan portfolio totaling $289,200,000 at December 31, 2018, consists of commercial real estate, residential mortgages, and home equity loans. Commercial real estate is the predominate segment of the portfolio, with balances of $229,448,000, and $221,032,000 at December 31, 2018 and 2017, respectively. Commercial real estate loans are generally a mix of short to medium-term, fixed and floating rate instruments and are mainly secured by commercial income and multi-family residential properties. The Company does not currently offer traditional residential mortgage loans, but does purchase mortgage portfolios. The residential real estate mortgage portfolio balances totaled $59,431,000 and $84,804,000 at December 31, 2018 and 2017, respectively. Our home equity loan portfolio totaled $321,000 at December 31, 2018, and $457,000 at December 31, 2017.
Included within the installment loan portfolio are $68,221,000 in student loans as of December 31, 2018, as compared to $59,853,000 at December 31, 2017, an increase of $8,368,000. The student loan portfolio consists of unsecured loans to medical and pharmacy students currently enrolled in medical and pharmacy schools in the US and the Caribbean. The medical student loans are made to US citizens attending medical schools in the US and Antigua, while the pharmacy student loans are made to pharmacy students attending pharmacy school in the US. Upon graduation the loan is automatically placed on deferment for 6 months. This may be extended up to 48 months for graduates enrolling in Internship, Medical Residency or Fellowship. As approved the student may receive additional deferment for hardship or administrative reasons in the form of forbearance for a maximum of 24 months throughout the life of the loan. The outstanding balance of student loans that have not entered repayment status totaled $52,695,000 at December 31, 2018. Accrued interest on loans that have not entered repayment status totaled $5,612,000 at December 31, 2018. At December 31, 2018, there were 595 loans within repayment, deferment, and forbearance which represented $15,526,000, $1,945,000, and $7,336,000 in outstanding balances respectively. Repayment of the unsecured student loans is premised on the medical and pharmacy students graduating and becoming high wage earners. Underwriting is premised on qualifying credit scores. The weighted average credit score for the portfolio is in the mid-700s. In addition, there are non-student co-borrowers for roughly one-third of the portfolio that provide additional repayment capacity. Graduation and employment placement rates are high for both medical and pharmacy students. The average student loan balance per borrower as of December 31, 2018 was approximately $90,000. Loan interest rates range from 4.875% to 9.875%. At December 31, 2018, $15,526,000 in loans were in repayment compared to $6,473,000 as of December 31, 2017. Accrued interest on student loans was $5,984,000 and $4,261,000 as of December 31, 2018 and 2017, respectively. As of December 31, 2017 the student loan portfolio was insured through a surety bond issued by ReliaMax Surety Company which provided us a reasonable expectation of collection. As such the allowance calculated for the portfolio was included within the calculation of our general reserves. In June 2018, ReliaMax Surety Company was declared insolvent by the South Dakota Division of Insurance and is now in liquidation. As a result of the insolvency, we assessed the risks within the student loan portfolio and determined that along with the calculation of the general reserve of $880,000 an additional allowance of $640,000 was appropriate for a total reserve against the student loan portfolio of $1,520,000 as of December 31, 2018. At December 31, 2017 the reserve against the student loan portfolio was $772,000. Additionally, as of December 31, 2018, $26,000 in accrued interest receivable was reversed, due to charge-offs of $388,000. There were no TDR’s within the portfolio as of December 31, 2018 or 2017.
We utilize Reunion Student Loan Finance Corporation ("RSLFC") as our third-party servicer for the student loan portfolio. RSLFC provides servicing for the student loan portfolio, including application administration, processing, approval, documenting, funding, and collection. They also provide file custodial responsibilities. Except in cases where applicants/loans do not meet program requirements, or extreme delinquency, we are reliant on RSLFC for complete program management. We pay RSLFC a monthly servicing fee based on the principal balance outstanding. Interest income on the student loan portfolio offsets this expense, and is presented net of expense within loan interest income.
The following table summarizes the credit quality indicators for outstanding student loans as of December 31, 2018 and December 31, 2017 (in 000's, except for number of borrowers):
December 31, 2018
December 31, 2017
Number of Loans
Number of Loans
School - The time in which the borrower is still actively in school at least half time. No payments are expected during this stage, though the borrower may begin immediate payments.
Grace - A six month period of time granted to the borrower immediately upon graduation, or if deemed no longer an active student. Interest continues to accrue. Upon completion of the six month grace period the loan is transferred to repayment status. Additionally, if applicable, this status may represent a borrower activated to military duty while in their in-school period, they will be allowed to return to that status once their active duty has expired. The borrower must return to an at least half time status within six months of the active duty end date in order to return to an in-school status.
Repayment - The time in which the borrower is no longer actively in school at least half time, and has not received an approved grace, deferment, or forbearance. Regular payment is expected from these borrowers under an allotted payment plan.
Deferment - May be granted up to 48 months for borrowers who have begun the repayment period on their loans but are (1) actively enrolled in an eligible school at least half time, or (2) are actively enrolled in an approved and verifiable medical residency, internship, or fellowship program.
Forbearance - The period of time during which the borrower may postpone making principal and interest payments, which may be granted for either hardship or administrative reasons. Interest will continue to accrue on loans during periods of authorized forbearance. If the borrower is delinquent at the time the forbearance is granted, the delinquency will be covered by the forbearance and all accrued and unpaid interest from the date of delinquency or if none, from the date of beginning of the forbearance period, will be capitalized at the end of each forbearance period. The term of the loan will not change and payments may be increased to allow the loan to pay off in the required time frame. A forbearance that results in only a delay in payment considered insignificant, is not a concessionary change in terms provided the borrower affirms the obligation. Forbearance is not an uncommon status designation, this designation is standard industry practice, and is consistent with the succession of students migrating to employed medical professionals.
Claim - Occurs after a loan has been delinquent for a period of time in which the servicer believes payment may not be received. A claim can be filed at any point in the delinquency, but typically not until 180 - 210 days. ReliaMax Surety Company was declared insolvent by the South Dakota Division of Insurance and is now in liquidation. No future claims will be filed with ReliaMax.
The following table sets forth the maturities of the Bank's loan portfolio at December 31, 2018. Amounts presented are shown by maturity dates rather than repricing periods:
Due in one year or less
Due after one year through five years
Due after five years
Commercial and agricultural
Real estate construction & development
Real estate – mortgage
All other loans
For the year ended December 31, 2018 and 2017, the average yield on loans was 5.57% and 5.42%, respectively. We utilize rate floors intended to mitigate interest rate risk if interest rates fall, as well as to compensate us for additional credit risk under current market conditions. Our loan portfolio is generally comprised of short-term or floating rate loans and is therefore susceptible to fluctuations in market rates of interest.
At December 31, 2018 and 2017, approximately 55.3% and 52.0%, respectively, of our loan portfolio consisted of floating rate instruments, with the majority of those tied to the prime rate.
The following table sets forth the contractual maturities of the Bank's fixed and floating rate loans at December 31, 2018. Amounts presented are shown by maturity dates rather than repricing periods, and do not consider renewals or prepayments of loans:
The following is a comparison of the amortized cost and approximate fair value of available-for-sale securities for the years indicated:
December 31, 2018
December 31, 2017
Fair Value (Carrying Amount)
Fair Value (Carrying Amount)
U.S. Government agencies
U.S. Government sponsored entities & agencies collateralized by mortgage obligations
The contractual maturities of investment securities as well as yields based on amortized cost of those securities at December 31, 2018 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.