Attached files
| file | filename |
|---|---|
| EX-32.1 - EXHIBIT 32.1 UBFO 12312015 - UNITED SECURITY BANCSHARES | ubfo12312015ex321.htm |
| EX-31.2 - EXHIBIT 31.2 UBFO 12312015 - UNITED SECURITY BANCSHARES | ubfo12312015ex312.htm |
| EX-21 - EXHIBIT 21 UBFO 12312015 - UNITED SECURITY BANCSHARES | ubfo12312015ex21.htm |
| EX-23.1 - EXHIBIT 23.1 UBFO 12312015 - UNITED SECURITY BANCSHARES | ubfo12312015ex231.htm |
| EX-32.2 - EXHIBIT 32.2 UBFO 12312015 - UNITED SECURITY BANCSHARES | ubfo12312015ex322.htm |
| EX-31.1 - EXHIBIT 31.1 UBFO 12312015 - UNITED SECURITY BANCSHARES | ubfo12312015ex311.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x | ANNUALREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2015. |
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO . |
Commission file number: 000-32987
UNITED SECURITY BANCSHARES
(Exact name of registrant as specified in its charter)
CALIFORNIA | 91-2112732 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
2126 Inyo Street, Fresno, California | 93721 | |
(Address of principal executive offices) | (Zip Code) | |
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 o 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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o | Small reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Aggregate market value of the Common Stock held by non-affiliates as of the last business day of the registrant's most recently completed second fiscal quarter - June 30, 2015: $56,416,013
Shares outstanding as of February 29, 2016: 16,051,406
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Definitive Proxy Statement for the 2016 Meeting of Part III, Items 10, 11, 12, 13 and 14
Shareholders is incorporated by reference into Part III.
1
UNITED SECURITY BANCSHARES
TABLE OF CONTENTS
PART I: | ||
PART II: | ||
PART III: | ||
PART IV: | ||
2
PART 1
Certain matters discussed or incorporated by reference in this Annual Report of Form 10-K including, but not limited to, those described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations", are forward-looking statements as defined under the Securities Litigation Reform Act of 1995 that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, among others, (1) competitive pressure in the banking industry increasing significantly; (2) changes in the interest rate environment which may reduce margins and devalue assets; (3) general economic conditions, either nationally or regionally, are less favorable than expected, resulting in, among other things, a deterioration in credit quality; (4) changes in the regulatory environment; (5) changes in business conditions and inflation; (6) changes in securities markets; (7) asset/liability matching risks and liquidity risks; (8) potential impairment of goodwill and other intangible assets; (9) loss of key personnel; and (10) operational interruptions including data processing systems failure and fraud. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company.
Item 1 - Business
General
United Security Bancshares (the “Company”) is a California corporation incorporated during March of 2001 and is registered with the Board of Governors of the Federal Reserve System as a bank holding company under the Bank Holding Company Act of 1956, as amended. The Company’s stock is listed on NASDAQ under the symbol “UBFO”. United Security Bank (the “Bank”) is a wholly-owned bank subsidiary of the Company and was formed in 1987. United Security Bancshares Capital Trust I (the “Trust”) was formed during June of 2001 as a Delaware business trust for the sole purpose of issuing Trust Preferred securities. The Trust was originally formed as a subsidiary of the Company, but was deconsolidated during 2004 pursuant to the adoption of ASC 810 (as revised), “Consolidation of Variable Interest Entities." During July 2007, the Trust Preferred Securities issued under USB Capital Trust I were redeemed, and upon retirement, the USB Capital Trust I was dissolved. During July 2007, the Company formed United Security Bancshares Capital Trust II and issued $15.0 million in Trust Preferred Securities with terms similar to those originally issued under USB Capital Trust I, except at a lower interest rate. During 2015, $3.0 million in Trust Preferred Securities were redeemed. At present, the Company does not engage in any material business activities other than ownership of the Bank.
United Security Bank
On June 12, 2001, the Bank became the wholly-owned subsidiary of United Security Bancshares through a tax-free holding company reorganization, accounted for on a basis similar to the pooling of interest method. In the transaction, each share of Bank stock was exchanged for a share of Company stock on a one-to-one basis.
The Bank is a California state-chartered bank headquartered in Fresno, California. It is also a member of the Federal Reserve System (“Fed member”). The Bank originally commenced business on December 21, 1987, as a national bank and, during the fourth quarter of 1998, filed an application with the California Department of Financial Institutions and other regulatory authorities to become a state-chartered bank. The shareholders approved the conversion in January of 1999, and the Bank was granted approval to operate as a state-chartered bank on February 3, 1999. The Bank’s operations are currently subject to federal and state laws applicable to state-chartered, Fed member banks, and its deposits are insured up to the applicable limits by the Federal Deposit Insurance Corporation (FDIC). The Bank is also subject to the Federal Deposit Insurance Act and regulatory reporting requirements of the FDIC. As a state-chartered bank and a member of the Federal Reserve System, the Bank is subject to supervision and regular examinations by the Board of Governors of the Federal Reserve System (FRB) and the California Department of Business Oversight (DBO). In addition, the Bank is required to file reports with the FRB and provide such additional information as the FRB may require.
USB Investment Trust Inc. was incorporated effective December 31, 2001 as a special purpose real estate investment trust (REIT) under Maryland law. The REIT is a subsidiary of the Bank and was funded with $133.0 million in real estate-secured loans contributed by the Bank. USB Investment Trust was originally formed to give the Bank flexibility in raising capital, and reduce the expenses associated with holding the assets contributed to USB Investment Trust. For further discussion of the REIT, refer to Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Income Taxes.
Effective April 23, 2004, the Company completed a merger with Taft National Bank headquartered in Taft, California. Taft National Bank (Taft) was merged into United Security Bank and Taft’s two branches, one located in Taft and the other located
3
in Bakersfield, California, operate as branches of United Security Bank. This transaction was accounted for using the purchase method of accounting, and resulted in the purchase price being allocated to the assets acquired and liabilities assumed from Taft based on the fair value of those assets and liabilities, with resultant goodwill of $1.6 million and core deposits intangibles of $1.9 million. Goodwill is not amortized but is reviewed at least annually for impairment, while core deposit intangibles were amortized over a period of 7 years. At the time of the merger, the Company sought opportunities to expand its market area to the south with the expectation that the Bakersfield area would have significant growth given its strategic location just north of Los Angeles. The Company has recorded no impairment on either the goodwill or core deposit intangible related to the Taft merger.
On February 16, 2007, the Company completed its merger with Legacy Bank, N.A., located in Campbell, California, with the acquisition of 100 percent of Legacy’s outstanding common shares. At the time of the merger, Legacy Bank’s one branch was merged with and into United Security Bank, a subsidiary of the Company. The purchase of Legacy Bank provided the Company with an opportunity to expand its market area into Santa Clara County and to serve a growing small business niche and individual client base built by Legacy. The Company believes that as the economy continues to recover from the recent significant downturn, there will be increased opportunities to expand business within the greater Campbell area particularly in lending to small-to-medium sized businesses, The merger transaction was accounted for as a purchase transaction, and resulted in the purchase price being allocated to the assets acquired and liabilities assumed from Legacy Bank based on the fair value of those assets and liabilities, with resultant goodwill of $8.8 million and core deposits intangibles of $1.9 million. Goodwill is not amortized but is reviewed at least annually for impairment, while core deposit intangibles are being amortized over a period of approximately 7 years. The Company recognized no impairment charges related to goodwill or core deposit intangibles related to the Legacy merger.
At December 31, 2015, the Bank operates three branches (including its main office), one construction lending office, and one financial services office in Fresno and one branch each, in Oakhurst, Caruthers, San Joaquin, Firebaugh, Coalinga, Bakersfield, Taft, and Campbell. In addition, the Company and Bank have administrative headquarters located at 2126 Inyo Street, Fresno, California, 93721. The Company operates as one operating segment.
At December 31, 2015 and 2014, the consolidated Company had total assets of approximately $725,644,000, and $663,169,000, respectively. For the year ended December 31, 2015, the Company reported net income of $6,810,000, as compared to $6,216,000 for the year ended December 31, 2014. At December 31, 2015, the consolidated Company had approximately $505,663,000 in net loans, $621,805,000 in deposits, and $89,635,000 in shareholders' equity.
The Company has increased loan growth over the last two years as the economy and real estate markets have improved. Total loans increased 16.35% between December 31, 2013 and December 31, 2014, and increased an additional 13.17% between December 31, 2014 and December 31, 2015. During the same periods, nonperforming assets increased and related loan losses decreased. Nonperforming assets declined from $32,048,000 at December 31, 2013, to $29,586,000 at December 31, 2014, but increased $2,508,000 to $32,094,000 at December 31, 2015. Negative loan loss provisions totaled $1,098,000 for the year ended December 31, 2013. Negative provisions were recorded for the years ended December 31, 2014, and December 31, 2015, of $845,000 and $41,000, respectively. Over the past few years, housing starts have increased and housing prices in the Company’s market area have improved. Unemployment and other economic factors continue to strengthen. As a result, Management’s focus over the past year, has been to concentrate its efforts on developing new business and growing the loan portfolio. Lending policies and procedures have been enhanced, and loan modifications, including rate and maturity concessions, and forbearance agreements, continue to be utilized in order to minimize loss exposure in the loan portfolio.
While loan growth prior to 2007 was funded to some degree by brokered deposits and other wholesale funding sources, the current state of the economy and the financial condition of the Company have made it increasingly important to continue to develop core deposits and reduce the Company’s dependence on brokered and other wholesale funding sources, including lines of credit with the Federal Reserve Bank and the FHLB. The Company increased its efforts early in 2009 to develop core deposit growth with employee training throughout the entire organization and a deposit-gathering program that incented employees to bring in new deposits from our local market area and establish more extensive relationships with our customers. As a result, the Bank has reduced its dependence on wholesale funding sources, including brokered deposits, to a level more in-line with peers.
The Company's percentage of brokered deposits are now in line with peers. Total brokered deposits decreased from $11,480,000 at December 31, 2014, to $8,546,000 at December 31, 2015, representing a decrease of $2,934,000. Despite additions to the loan portfolio and securities purchases, the Company has enhanced its liquidity positions with an increase in fed funds sold and other overnight investments of $82,229,000 at December 31, 2014 to $96,018,000 at December 31, 2015.
4
The following discussion of the Company's services should be read in conjunction with "MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."
Bank Services
As a state-chartered commercial bank, United Security Bank offers a full range of commercial banking services primarily to the business and professional community and individuals located in Fresno, Madera, Kern, and Santa Clara Counties.
The Bank offers a wide range of deposit instruments including personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal (NOW) accounts, money market accounts and time certificates of deposit. Most of the Bank's deposits are 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 11.12% and 13.82% of total deposits at December 31, 2015 and 2014, respectively. A portion of those time deposits are brokered deposits which are considered wholesale funding sources generally from out of the Bank’s market area. Brokered deposits comprised 1.37% and 2.03% of total deposits at December 31, 2015 and 2014, respectively.
The Bank also engages in a full complement of lending activities, including real estate mortgage (48.9% of total loans at December 31, 2015), commercial and industrial (10.8% of total loans at December 31, 2015), real estate construction (25.3% of total loans at December 31, 2015), as well as agricultural (10.1% of total loans at December 31, 2015), and installment loans (4.9% of total loans at December 31, 2015), with particular emphasis on short and medium-term obligations. Approximately 77% of the Bank's loans are secured by real estate at December 31, 2015. 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, 2015, the Bank had loans (net of unearned fees) outstanding of $515,376,000, which represented approximately 82.9% of the Bank's total deposits and approximately 71.0% of its total assets.
Real estate mortgage loans are secured by deeds of trust primarily on commercial property. Repayment of real estate mortgage loans is generally from the cash flow of the borrower. Commercial and industrial loans have a high degree of industry diversification. Loans may be originated in the Company’s market area, or participated with other financial institutions outside the Company’s market area. A substantial portion of the Company’s 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. Real estate construction loans consist of loans to residential contractors, which are secured by single-family residential properties. All real estate loans have established equity requirements. Repayment of real estate construction loans is generally from long-term mortgages with other lending institutions. Agricultural loans are generally secured by land, equipment, inventory and receivables. Repayment of agricultural loans is generally from the expected cash flow of the borrower.
Although the Bank has a high concentration of commercial real estate loans, the Bank is not in the business of making residential mortgage loans to individuals. Residential mortgage loans totaled $68,811,000 or 13.35% of the portfolio at December 31, 2015. The residential mortgage loan portfolio is comprised of purchased residential mortgage pools. The Bank does not originate, or have in its loans portfolio, any subprime, Alt-A, or option adjustable rate loans. The Bank does 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, the Bank has restructured certain loans to allow the borrower to continue to perform on the loan under a troubled debt restructuring plan.
The Bank purchases loan participations from, and sells 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. The Bank has reduced its level of loan participations over the past several years. Currently, the Bank holds no participation purchased loans. Loan participations sold comprised 5.6% and 1.4% of the total loan portfolio at December 31, 2015 and 2014, respectively. During the past year, participation lending activity has increased and currently the Company is participating in more participation sales.
In the normal course of business, the Bank makes various loan commitments and incurs certain contingent liabilities. At December 31, 2015 and 2014, loan commitments of the Bank totaled $107,084,000 and $105,434,000, respectively, and letters of credit totaled $3,295,000 and $3,800,000, respectively. Of the $110,379,000 in total commitments outstanding at December 31, 2015, $15,989,000, or 14.5%, were for loans with maturities of one year or less. Due to the nature of the business of the Bank's customers, there are no seasonal patterns or absolute predictability to the utilization of unused loan commitments; therefore, the Bank is unable to forecast the extent to which these commitments will be exercised within the
5
current year. The Bank does not believe that any such utilization will constitute a material liquidity demand. The Company does however have collateralized and uncollateralized lines of credit which could be utilized if such loan commitments were to be exercised in excess of normal expectations.
In addition to the loan and deposit services discussed above, the Bank also offers a wide range of specialized services designed to attract and service the needs of commercial customers and account holders. These services include online banking, mobile banking, safe deposit boxes, ATM services, payroll direct deposit, cashier's checks, traveler's checks, money orders, and foreign drafts. In addition, the Bank offers a variety of specialized financial services, including wealth management, employee benefit, insurance and loan products, as well as consulting services for a variety of clients. The Bank does not operate a trust department; however, it makes arrangements with its correspondent bank to offer trust services to its customers upon request. Most of the Bank's business originates within Fresno, Madera, Kern, and Santa Clara Counties. Neither the Bank’s business nor liquidity are seasonal, and there has been no material effect upon the Bank's capital expenditures, earnings or competitive position as a result of federal, state or local environmental regulation.
Lending Policies
The following is a summary of the Bank’s loan policies.
▪ | Loan Documentation – All loan documentation is prepared by a centralized loan servicing department or by legal counsel based on the terms contained in the approved Credit Authorizations. The documentation, upon completion, is reviewed by a third party (Bank employee) in the loan servicing department prior to forwarding to the relationship managers, who then review the documents to ensure that they have been correctly prepared in accordance with the credit approval before execution by the borrowers. |
▪ | Purchased Participations – The Bank independently underwrites, using the Bank’s same guidelines for direct originations, and reviews the loan documentation of participation loans originated by other lenders for acceptability. |
▪ | Verification of Information – The Bank, principally a commercial business lender, has not and does not make any “No Doc” or “Stated Income” loans. In the underwriting of a commercial loan request, the Bank performs an enterprise analysis of the financial information for trends, verifies major assets and liabilities, and obtains Dun and Bradstreet Credit reports on the entities and credit bureau reports on the principals of the entity. |
▪ | The Company is not dependent on any individual customer, entity, or group of related entities for deposits nor on any significant percentage of loans to borrowers. |
▪ | Unsecured - Whether unsecured or secured, guarantees are usually obtained from the principals or from 3rd party guarantors if necessary for additional financial support. Unsecured loans totaled $35,626,000 and $46,982,000 at December 31, 2015 and 2014, respectively. |
▪ | Historic policy on renewals - The renewal or extension of existing performing lines of credit or loans has not been changed; the credits are re-underwritten for the renewal period. The restructure or renewal of substandard loans is certified to the Board of Directors that the renewal is necessary to improve and protect the Bank’s ultimate interest in the collection of the credit or maximize its potential for collection, that the renewal reflects prudent underwriting based on reasonable repayment terms and is adequately secured, that the Bank has performed a comprehensive credit analysis indicating the borrower has the willingness and ability to repay the debt as per the terms of the restructure plan and that the Bank’s Loan Committee, designated by the Board, believes that the renewal will be repaid in accordance with the terms. |
▪ | Additional Loans to nonaccrual borrowers. – The Bank as a general rule does not make additional loans to borrowers that are past due in principal or interest more than 90-days. However, in selected and limited instances as part of the workout or restructure of non-performing assets, to effect repayment, additional secured advances may be made. |
▪ | Lending Limits – The Bank approves revolving lines of credit or loans for each borrower with terms and limits. Consideration is given for the aggregate direct borrowing exposure of the borrower, as well as, their indirect liability, plus the indirect liability of any guarantor. Overall, the Bank has established normal “House” lending limits at 50% of the Legal Lending Limit. The Legal Lending Limit is calculated for unsecured loans at 15% of total regulatory capital, and for secured loans at 25% of total regulatory capital. The Board of Directors must approve any borrowing relationship that exceeds the House Lending Limit. |
Competition and Market Share
The banking business in California generally, and in the market area served by the Company specifically, is highly competitive with respect to both loans and deposits. The Company competes for loans and deposits with other commercial banks, savings
6
and loan associations, finance companies, money market funds, credit unions and other financial institutions, including a number that are substantially larger than the Company. Deregulation of the banking industry, increased competition from non-bank entities for the cash balances of individuals and businesses, and continuing developments in the computer and communications industries have had, and most likely will continue to have, a significant impact on the Company's competitive position. With the enactment of interstate banking legislation in California, bank holding companies headquartered outside of California will continue to enter the California market and provide competition for the Company. Additionally, with the Gramm-Leach-Bliley Act of 1999, traditional competitive barriers between insurance companies, securities underwriters, and commercial banks have been eased, allowing a greater number of financial intermediaries to offer a wider assortment of financial services. Many of the major commercial banks operating in the Company's market areas offer certain services such as trust and international banking services, which the Company does not offer directly. In addition, banks with larger capitalization have larger lending limits and are thereby able to serve larger customers.
The Company’s primary market area at December 31, 2015 was located in Fresno, Madera, and Kern Counties, 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, 2015, which is the most current information available.
Rank | Share | |
Fresno County | 9th | 3.44% |
Madera County | 10th | 4.31% |
Kern County | 14th | 0.96% |
Total of Fresno, Madera, Kern Counties | 12th | 2.58% |
Santa Clara County | 42nd | 0.02% |
Supervision and Regulation
General
The Company and the Bank are subject to significant regulation and restrictions by federal and state laws and regulatory agencies. This regulation is intended primarily for the protection of depositors and the deposit insurance fund, and secondarily for the stability of the U.S. banking system. It is not intended for the benefit of shareholders of financial institutions. 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.
The Company
The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended (the “BHC Act”), and is registered as such with the FRB. A bank holding company is required to file annual reports with the FRB regarding its business operations and those of its subsidiaries. The Company is also subject to examination by the FRB.
The BHC Act requires, among other things, prior approval before acquiring, directly or indirectly, ownership or control of any voting shares of any bank, if after such acquisition it would directly or indirectly own or control more than 5% of the voting stock of that bank, unless it already owns a majority of the voting stock of that bank. The BHC Act also provides that the FRB shall not approve any acquisition that would result in or further the creation of a monopoly, or the effect of which may be substantially to lessen competition, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the probable effect in meeting the convenience and needs of the community served.
Furthermore, under the BHC Act, a bank holding company is, with limited exceptions, prohibited from (i) acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or (ii) engaging in any activity other than managing or controlling banks. With the prior approval of the FRB, however, a bank holding company may own shares of a company engaged in activities which the FRB has determined to be so closely related to banking or managing or controlling banks as to be proper incident thereto. Amendments to the BHC Act expand the circumstances under which a bank holding company may acquire control of all or substantially all of the assets of a bank located outside the State of California.
7
The Company is a legal entity, separate and distinct from the Bank. The Company has the ability to raise capital on its own behalf or borrow from external sources. The Company may also obtain additional funds from dividends paid by, and fees charged for services provided to, the Bank. Those dividends may come from funds legally available for those dividends, as specified and limited by the California Financial Code. If the Bank’s regulatory authorities determine that the Bank’s capital is not adequate or that the payment of the dividend would be unsafe or unsound, the regulatory authorities may order the Bank not to pay or reduce the amount of the dividend.
Moreover, the BHC Act requires a bank holding company to serve as a source of financial and managerial strength to its subsidiary banks. It is the FRB’s policy that a bank holding company should stand ready to use available resources to provide adequate capital funds to subsidiary banks during periods of financial stress and should maintain the financial flexibility and capital raising capacity to obtain additional resources for assisting a subsidiary bank. Under certain conditions, the FRB may conclude that certain actions of a bank holding company, such as payment of cash dividends to its shareholders, or the receipt of dividends from its subsidiary bank, would constitute unsafe and unsound banking practices because they violate the FRB’s “source of strength” doctrine.
A bank holding company and its subsidiaries are prohibited from certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services. For example, with certain exceptions, a bank may not condition an extension of credit on a promise by its customer to obtain other services by it, its holding company or other subsidiaries, or on a promise by its customer not to obtain services from a competitor. In addition, federal law imposes certain restrictions between the Company and its subsidiaries, including the Bank. As an affiliate of the Bank, the Company is subject, with certain exceptions, to provisions of federal law imposing limitations on, and requiring collateral for, extensions of credit by the Bank to its affiliates.
As a public company, United Security Bancshares is subject to the Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act amends the Securities and Exchange Act of 1934, and is intended to protect investors by, among other things, improving the reliability of financial reporting, increasing management accountability, and increasing the independence of Directors and the Company’s external accountants.
The Company is subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended, which include but are not limited to the filing of annual, quarterly and other current reports with the SEC.
The Bank
The Bank as a state-chartered bank and a member of the Federal Reserve, is subject to regulation, supervision and regular examination by the FRB, the California Department of Business Oversight (the “DBO”) and the Consumer Financial Protection Bureau (the “CFPB”). 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 the applicable provisions of the Federal Deposit Insurance Act 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.
Capital Standards
The Company is subject to consolidated regulatory capital requirements administered by the FRB and the Bank is subject to similar capital requirements also administered by the FRB. The Dodd‑Frank Act applied the same leverage and risk‑based capital requirements that apply to insured depository institutions to bank holding companies, such as the Company. The guidelines of the FRB and the other federal banking agencies are intended to ensure that banking organizations have adequate capital given the risk levels of assets and off‑balance sheet financial instruments.
General Risk Based Capital Rules
8
Prior to January 1, 2015, the FRB risk-based capital guidelines were based upon the 1988 Capital Accord (“Basel I”) of the Basel Committee on Banking Supervision (the “Basel Committee”). The Basel Committee is a committee of central banks and bank supervisors/regulators from the major industrialized countries that develops broad policy guidelines that each country’s supervisors can use to determine the supervisory policies that apply.
Under the general risk-based capital rules, applicable through December 31, 2014, banking organizations were required to maintain minimum ratios of Tier 1 capital and total capital to total risk‑weighted assets (including certain off‑balance sheet items, such as letters of credit). For purposes of calculating the ratios, a banking organization’s assets and some of its specified off‑balance sheet commitments and obligations are assigned to various risk categories. A depository institution’s or holding company’s capital, in turn, is classified in one of two tiers relevant to us, depending on type:
Core Capital (Tier 1). Tier 1 capital includes common equity, retained earnings, qualifying non‑cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual stock at the holding company level, minority interests in equity accounts of consolidated subsidiaries, and qualifying trust preferred securities (subject to phase‑out as described under “-Basel III Capital Rules” below) minus goodwill, most intangible assets and certain other assets.
Supplementary Capital (Tier 2). Tier 2 capital includes, among other things, perpetual preferred stock and trust preferred securities not meeting the Tier 1 definition, qualifying mandatory convertible debt securities, qualifying subordinated debt, and allowances for possible credit losses, subject to limitations.
As a bank holding company, the Company currently was required to maintain Tier 1 capital and total capital equal to at least 4.0% and 8.0%, respectively, of its total risk‑weighted assets (including various off‑balance sheet items, such as letters of credit). The Bank was required to maintain equivalent capital levels under the FDIC’s capital adequacy guidelines. In addition, as a depository institution, the Bank is subject to minimum capital ratios under the regulatory framework for prompt corrective action discussed under “-Prompt Corrective Action.”
The Company and the Bank are also required to comply with minimum leverage ratio requirements. The leverage ratio is the ratio of a banking organization’s Tier 1 capital to its total adjusted quarterly average assets (as defined for regulatory purposes). Bank holding companies and FRB‑supervised banks, such as the Company and the Bank, are required to maintain a minimum leverage ratio of 4.0%, unless a different minimum is specified by an appropriate regulatory authority. In addition, for a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its leverage ratio must be at least 5.0%.
Regulatory capital requirements limit the amount of deferred tax assets that may be included when determining the amount of regulatory capital. Deferred tax asset amounts in excess of the calculated limit are deducted from regulatory capital.
The Company issued subordinated debentures to trusts that were established by us which, in turn, issued trust preferred securities. The Company includes in Tier 1 capital an amount of trust preferred securities equal to no more than 25% of the sum of all core capital elements, which is generally defined as shareholders’ equity less goodwill, net of any related deferred income tax liability. At December 31, 2015, the amount of trust preferred securities included in Tier I capital was $7,836,000.
Basel III Capital Rules
In July 2013, the FRB and the other federal banking regulators approved final rules (the “New Capital Rules”) establishing a new comprehensive capital framework for U.S. banking organizations. The New Capital Rules generally implement the Basel Committee’s December 2010 final capital framework referred to as “Basel III” for strengthening international capital standards. The New Capital Rules substantially revise the risk‑based capital requirements applicable to bank holding companies and their depository institution subsidiaries, including the Company and the Bank, as compared to the current U.S. general risk‑based capital rules. The New Capital Rules revise the definitions and the components of regulatory capital, as well as address other issues affecting the numerator in banking institutions’ regulatory capital ratio calculations. The New Capital Rules also address asset risk weights and other matters affecting the denominator in banking institutions’ regulatory capital ratio calculations and replace the existing general risk‑weighting approach, which was derived from the Basel Committee’s 1988 “Basel I” capital accords, with a more risk‑sensitive approach based, in part, on the “standardized approach” in the Basel Committee’s 2004 “Basel II” capital accords. The New Capital Rules also implement the requirements of Section 939A of the Dodd‑Frank Act to remove references to credit ratings from the federal regulators’ rules. The New Capital Rules were effective for the Company and the Bank as of January 1, 2015, subject to phase‑in periods for certain of their components and other provisions.
9
The New Capital Rules, among other things: (i) introduce a new capital measure called Common Equity Tier 1 (“CET1”) and related regulatory capital ratio of CET1 to risk‑weighted assets; (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements; (iii) mandate that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital; and (iv) expand the scope of the deductions from and adjustments to capital as compared to existing regulations. Under the New Capital Rules, for most banking organizations the most common form of Additional Tier 1 capital is non‑cumulative perpetual preferred stock and the most common form of Tier 2 capital is subordinated notes and a portion of the allowance for loan and lease losses, in each case, subject to the New Capital Rules’ specific requirements.
Pursuant to the New Capital Rules, the minimum capital ratios as of January 1, 2015 are as follows:
■ 4.5% CET1 to risk‑weighted assets;
■ 6.0% Tier 1 capital (that is, CET1 plus Additional Tier 1 capital) to risk‑weighted assets;
■ 8.0% Total capital (that is, Tier 1 capital plus Tier 2 capital) to risk‑weighted assets; and
■ 4% Tier 1 capital to average consolidated assets as reported on regulatory financial statements (known as the “leverage ratio”).
The New Capital Rules also introduce a new “capital conservation buffer,” composed entirely of CET1, on top of these minimum risk‑weighted asset ratios. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of CET1 to risk‑weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall. The implementation of the capital conservation buffer began on January 1, 2016 at a 0.625% level and increase by 0.625% on each subsequent January 1st, until it reaches 2.5% on January 1, 2019. When fully phased‑in, the Company and the Bank will be required to maintain such additional capital conservation buffer of 2.5% of CET1, effectively resulting in minimum ratios of: (i) CET1 to risk‑weighted assets of at least 7%; (ii) Tier 1 capital to risk‑weighted assets of at least 8.5%; and (iii) Total capital to risk‑weighted assets of at least 10.5%.
The New Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non‑consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such items, in the aggregate, exceed 15% of CET1.
In addition, under the current general risk‑based capital rules, the effects of accumulated other comprehensive income or loss (“AOCI”) items included in shareholders’ equity (for example, unrealized gains and losses of securities held in the available-for-sale portfolio) under U.S. GAAP are reversed for the purposes of determining regulatory capital ratios. Pursuant to the New Capital Rules, the effects of certain AOCI items are not excluded; however, non‑advanced approaches banking organizations, including the Company and the Bank, were able to make a one‑time permanent election to continue to exclude these items in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of our securities portfolio.
Implementation of the deductions and other adjustments to CET1 commenced on January 1, 2015 and will be phased‑in over a 4‑year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter).
The New Capital Rules prescribe a new standardized approach for risk weightings that expand the risk‑weighting categories from the previous four Basel I‑derived categories (0%, 20%, 50% and 100%) to a larger and more risk‑sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, resulting in higher risk weights for a variety of asset classes.
We are continuing to evaluate the impact of the New Capital Rules on our capital ratios and related calculations and believe that, as of December 31, 2015, the Company and the Bank were "well-capitalized" under the New Capital Rules. The regulatory capital guidelines as well as the actual capitalization for the Bank and the Company as of December 31, 2015 are as follows:
10
Requirement to be: | December 31, 2015 | ||||
Adequately Capitalized | Well Capitalized | Company | Bank | ||
Tier 1 leverage capital ratio | 4.0% | 5.0% | 12.95% | 12.94% | |
Common equity tier 1 capital ratio | 4.5% | 6.5% | 14.10% | 15.43% | |
Tier 1 risk-based capital ratio | 6.0% | 8.0% | 15.40% | 15.43% | |
Total risk-based capital ratio | 8.0% | 10.0% | 16.65% | 16.69% | |
Liquidity Requirements
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. The federal banking agencies have not yet proposed rules to implement the NSFR.
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: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. 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.
Under the prompt corrective action provisions of FDICIA (“PCA”), an insured depository institution generally will be classified as undercapitalized if its total risk‑based capital is less than 8% or its Tier 1 risk‑based capital or leverage ratio is less than 4%. The New Capital Rules revised the PCA regulations by: (i) introducing a CET1 ratio requirement at each PCA category (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well capitalized status being 8% (as compared to the current 6%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized (under the New Capital Rules a 5% leverage ratio is required for an institution to be well capitalized and a 4% leverage ratio is required to be adequately capitalized). The New Capital Rules do not change the total risk‑based capital requirement for any PCA category. An institution that, based upon its capital levels, 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 hearing, determines that an unsafe or unsound condition or an unsafe or unsound practice warrants such treatment. At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, restrictions on interest rates paid on deposits, prohibitions on payment of dividends and restrictions on the acceptance of brokered deposits. Furthermore, if a bank is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to its federal bank regulator, and the holding company must guarantee the performance of that plan. The obligation of a controlling bank holding company to fund a capital restoration plan is limited to the lower of 5% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements.
11
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.
Premiums for Deposit Insurance. 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. The initial base assessment rates range from five to 35 basis points. 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. The Bank’s assessment rate for 2011 fell at the high end of this range. 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 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, 2015 the Bank owned 22,214 shares of the FHLB-SF capital stock.
Federal Reserve. 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, 2015, the Bank was in compliance with these requirements.
Regulatory Agreement with the Federal Reserve Bank of San Francisco
12
On March 23, 2010, the Company and the Bank entered into a formal written agreement (the “Agreement”) with the Federal Reserve Bank of San Francisco (the “Federal Reserve”) as a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions (now the Department of Business Oversight, or “DBO”) in June 2009. That examination found significant increases in nonperforming assets, both classified loans and OREO, during 2008 and 2009, and heightened concerns about the Bank’s use of brokered and other wholesale funding sources to fund loan growth, which created increased risk to equity capital and potential volatility in earnings.
Under the terms of the Agreement, the Company and the Bank agreed, among other things: to maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses; to improve the management of the Bank's liquidity position and funds management policies; to maintain sufficient capital at the Company and Bank level; and to improve the Bank’s earnings and overall condition. The Company and Bank also agreed not to increase or guarantee any debt, purchase or redeem any shares of stock, declare or pay any cash dividends, or pay interest on the Company's junior subordinated debt or trust preferred securities, without prior written approval from the Federal Reserve. The Company generates no revenue of its own and, as such, relies on dividends from the Bank to pay its operating expenses and interest payments on the Company’s junior subordinated debt.
Effective November 19, 2014, the Federal Reserve terminated the Agreement with the Bank and the Company and replaced it with an informal supervisory agreement that requires, among other things, obtaining written approval from the Federal Reserve prior to the payment of dividends from the Bank to the Company or the payment of dividends by the Company or interest on the Company’s junior subordinated debt. The inability of the Bank to pay cash dividends to the Company may hinder the Company’s ability to meet its ongoing operating obligations.
Regulatory Order from the California Department of Business Oversight
On May 20, 2010, the DBO issued a formal written order (the “Order”) pursuant to a consent agreement with the Bank as a result of the same June 2009 joint regulatory examination. The terms of the Order were essentially similar to the Federal Reserve’s Agreement, except for a few additional requirements.
On September 24, 2013, the Bank entered into an informal Memorandum of Understanding (the “MOU”) with the DBO and on October 15, 2013, the Order was terminated. The Order and the MOU require the Bank to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0% and also requires the DBO’s approval for the Bank to pay a dividend to the Company.
Accordingly, reflecting the Company’s and the Bank’s improved financial condition and performance, as of November 19, 2014, the Bank and the Company have been relieved of all formal regulatory agreements. Some of the governance and procedures established by the Agreement and the Order remain in place, including submission of certain plans and reports to the Federal Reserve and DBO, the Bank’s obligation to maintain a 9.0% tangible shareholder’s equity ratio, and the requirement to seek approvals from the Federal Reserve and the DBO for either the Bank or the Company to pay dividends and for the Company to pay interest on its outstanding junior subordinated debt. While no assurances can be given as to future regulatory approvals, over the last two years the DBO and the Federal Reserve have been approving the Bank's quarterly payment of dividends to the Company to cover the Company's operating expenses, tax obligations and interest payments on the junior subordinated debt and the Company's payment of quarterly interest on the junior subordinated debt.
Effect of Governmental Policies and Recent Legislation
Impact of Monetary Policies
Banking has traditionally been a business that depends on rate differentials. In general, the difference between the interest earned on loans extended to the Company’s customers and securities held in the Company's portfolio and the interest paid by the Company on its deposits and other borrowings comprise the major portion of the Company's earnings. The amounts of interest earned and paid are impacted by the volumes of interest-earning assets and interest-bearing liabilities and the interest rates, which rates are highly sensitive to many factors that are beyond the control of the Company. Accordingly, the earnings and growth of the Company are subject to the influence of domestic and foreign economic conditions, including, but not limited to, inflation, recession and unemployment.
The earnings and growth of the Company are also affected by the monetary and fiscal policies of the United States government and its agencies, particularly the FRB. The FRB implements national monetary policies (with objectives such as to curb inflation and combat recession) by its open market operations in United States Government securities, by adjusting the required level of reserves for financial institutions subject to reserve requirements, and by varying the discount rates applicable to
13
borrowing by banks. The actions of the FRB in these areas influence the growth of bank loans, investments and deposits and also affect interest rates charged on loans and paid on deposits. The FRB’s policies have had a significant effect on the operating results of commercial banks and are expected to continue to do so in the future. The nature and timing of any future changes in monetary policies are not predictable; however, the FRB has indicated its intention of slowing raising interest rates from their current historic lows.
In addition, adverse economic conditions could make a higher provision for loan losses a prudent course and could cause higher loan charge-offs, thus adversely affecting the Company’s net income.
Extensions of Credit to Insiders
The Federal Reserve Act and the FRB’s Regulation O place limitations and conditions on loans or extensions of credit to:
■ a bank’s or bank holding company’s executive officers, directors and principal shareholders (i.e., in most cases, those persons who own, control or have power to vote more than 10% of any class of voting securities),
■ 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.
Loans and leases extended to any of the above persons 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 terms (including interest rates and collateral) as, and follow credit-underwriting procedures that are not less stringent than, those prevailing at the time for comparable transactions with non-insiders, and must not involve more than the normal risk of repayment or present other unfavorable features. In addition, Regulation O provides that the aggregate limit on extensions of credit to all insiders of a bank as a group cannot exceed the bank’s unimpaired capital and unimpaired surplus. Regulation O also prohibits a bank from paying an overdraft on an account of an executive officer or director, except pursuant to a written pre-authorized interest-bearing extension of credit plan that specifies a method of repayment or a written pre-authorized transfer of funds from another account of the officer or director at the bank.
Transactions with Affiliates
Sections 23A and 232B of the Federal Reserve Act and the FRB’s Regulation W impose quantitative and qualitative limitations on the ability of a bank to make loans to or enter into certain types of transactions with its holding company and other subsidiaries of the holding company (“affiliates”). Under Sections 23A and 23B and Regulation W, loans by the Bank to affiliates, investments by the Bank in affiliates' stock, and taking affiliates' stock as collateral for loans to any borrower are limited to 10% of the Bank's capital, in the case of any one affiliate, and are 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.
Consumer Protection Laws and Regulations
The banking regulatory agencies are focusing greater attention on compliance with consumer protection laws and their implementing regulations. Examination and enforcement have become more intense in nature, and insured institutions have been advised to monitor carefully compliance with such laws and regulations. The Company is subject to many federal and state consumer protection and privacy statutes and regulations, some of which are discussed below.
The Community Reinvestment Act (the “CRA”) is intended to encourage insured depository institutions to help meet the credit needs of their communities. The CRA specifically directs the federal regulatory agencies, in examining insured depository institutions, to assess a bank’s record of helping meet the credit needs of its entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. The CRA further requires the agencies to take a financial institution’s record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, mergers or acquisitions, or holding company formations. The agencies use the CRA assessment factors in order to provide a rating to the financial institution. The ratings range from a high of “outstanding” to a low of “substantial noncompliance.” In its last examination for CRA compliance, as of October 2012, the Bank was rated “satisfactory.”
14
The Equal Credit Opportunity Act (the “ECOA”) generally prohibits discrimination in any credit transaction, whether for consumer or business purposes, on the basis of race, color, religion, national origin, sex, marital status, age (except in limited circumstances), receipt of income from public assistance programs, or good faith exercise of any rights under the Consumer Credit Protection Act.
The Truth in Lending Act (the “TILA”) is designed to ensure that credit terms are disclosed in a meaningful way so that consumers may compare credit terms more readily and knowledgeably. As a result of the TILA, all creditors must use the same credit terminology to express rates and payments, including the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule, among other things. As a result of Dodd Frank, Regulation Z promulgated under TILA includes new limits on loan originator compensation for all closed-end mortgages. These changes include, prohibiting certain payments to a mortgage broker or loan officer based on the transaction’s terms or conditions, prohibiting dual compensation, and prohibiting a mortgage broker or loan officer from ‘‘steering’’ consumers to transactions not in their interest, to increase mortgage broker or loan officer compensation.
The Fair Housing Act (the “FH Act”) regulates many practices, including making it unlawful for any lender to discriminate in its housing-related lending activities against any person because of race, color, religion, national origin, sex, handicap or familial status. A number of lending practices have been found by the courts to be, or may be considered, illegal under the FH Act, including some that are not specifically mentioned in the FH Act itself.
The Home Mortgage Disclosure Act (the “HMDA”), in response to public concern over credit shortages in certain urban neighborhoods, requires public disclosure of information that shows whether financial institutions are serving the housing credit needs of the neighborhoods and communities in which they are located. The HMDA also includes a "fair lending" aspect that requires the collection and disclosure of data about applicant and borrower characteristics as a way of identifying possible discriminatory lending patterns and enforcing anti-discrimination statutes.
The Right to Financial Privacy Act (the “RFPA”) imposes a new requirement for financial institutions to provide new privacy protections to consumers. Financial institutions must provide disclosures to consumers of its privacy policy, and state the rights of consumers to direct their financial institution not to share their nonpublic personal information with third parties.
Finally, the Real Estate Settlement Procedures Act (the “RESPA”) requires lenders to provide noncommercial borrowers with disclosures regarding the nature and cost of real estate settlements. Also, RESPA prohibits certain abusive practices, such as kickbacks, and places limitations on the amount of escrow accounts.
Penalties for noncompliance or violations under the above laws may include fines, reimbursement and other penalties. Due to heightened regulatory concern related to compliance with CRA, ECOA, TILA, FH Act, HMDA, RFPA and RESPA generally, the Company has incurred additional compliance costs and has expended additional funds for investments in its local communities.
Recent Legislation and Other Changes
From time to time, legislation is enacted which has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of banks and other financial institutions are frequently made in Congress, in the California legislature and before various bank regulatory agencies. The likelihood of any major change and the impact such change may have on the Company is impossible to predict. Certain of the potentially significant changes which have been enacted in the last several years recently and other which are currently under consideration by Congress or various regulatory agencies or professional agencies are discussed below.
The Dodd-Frank Wall Street Reform and Consumer Protection Act
The Dodd-Frank Act has significantly changed the bank regulatory structure and has impacted the lending, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act created a new interagency council, the Financial System Oversight Council that is charged with identifying and monitoring the systemic risk to the U.S. economy posed by systemically significant, large financial companies, including bank holding companies and non-bank financial companies. The Office of Thrift Supervision was eliminated and its powers distributed among the Office of the Comptroller of the Currency, the Federal Reserve Board and the FDIC. The legislation also established a floor for capital of insured depository institutions that cannot be lower than the standards then in effect, and directed the federal banking regulators
15
to implement new leverage and capital requirements that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act additionally created a new independent federal regulator to administer federal consumer protection laws. Among the provisions of the Dodd-Frank Act are the following:
Deposit Insurance. The Dodd-Frank Act permanently increased the maximum deposit insurance amount for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009. The Dodd-Frank Act also broadened the base for FDIC insurance assessments. Assessments are based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminated the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds. The Dodd-Frank Act eliminated the federal statutory prohibition against the payment of interest on business checking accounts.
Interstate Branching. The Dodd-Frank Act authorized national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch. Previously, banks could only establish branches in other states if the host state expressly permitted out-of-state banks to establish branches in that state. Accordingly, banks will be able to enter new markets more freely, potentially increasing competition.
Limits on Derivatives. The Dodd-Frank Act prohibited state-chartered banks from engaging in derivatives transactions unless the loans to one borrower limits of the state in which the bank is chartered take into consideration credit exposure to derivatives transactions. For this purpose, derivative transactions include any contract, agreement, swap, warrant, note or option that is based in whole or in part on the value of, any interest in, or any quantitative measure or the occurrence of any event relating to, one or more commodities securities, currencies, interest or other rates, indices or other assets.
Final Volcker Rule
In December 2013, the federal bank regulatory agencies adopted final rules that implement a part of the Dodd-Frank Act commonly referred to as the “Volcker Rule.” Under these rules and subject to certain exceptions, banking entities are restricted from engaging in activities that are considered proprietary trading and from sponsoring or investing in certain entities, including hedge or private equity funds that are considered “covered funds.” These rules became effective April 1, 2014, although certain provisions are subject to delayed effectiveness under rules promulgated by the FRB. The Company and the Bank held no investment positions at December 31, 2015 which were subject to the final rule. Therefore, while these new rules may require us to conduct certain internal analysis and reporting, we believe that they will not require any material changes in our operations or business.
Transactions with Affiliates and Insiders. The Dodd-Frank Act expanded the definition of “affiliate” for purposes of the quantitative and qualitative limitations of Section 23A of the Federal Reserve Act to include mutual funds advised by a depository institution or its affiliates. The Dodd-Frank Act applied Section 23A and Section 22(h) of the Federal Reserve Act (governing transactions with insiders) to derivative transactions, repurchase agreements and securities lending and borrowing transactions that create credit exposure to an affiliate or an insider. Any such transactions with affiliates must be fully secured. The Dodd-Frank Act also prohibits an insured depository institution from purchasing an asset from or selling an asset to an insider unless the transaction is on market terms and, if representing more than 10% of capital, is approved in advance by disinterested directors.
Debit Card Interchange Fees. The Dodd-Frank Act requires that the amount of any interchange fee charged by a debit card issuer with respect to a debit card transaction must be reasonable and proportional to the cost incurred by the issuer. The FRB has established standards for reasonable and proportional fees which take into account the costs of preventing fraud. The restrictions on interchange fees, however, do not apply to banks that, together with their affiliates, have assets of less than $10 billion, such as the Bank.
Consumer Financial Protection Bureau. The Dodd-Frank Act created a new, independent federal agency called the Consumer Financial Protection Bureau (“CFPB”), which was granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the ECOA, the TILA, the RESPA, the Fair Credit Reporting Act, the Fair Debt Collection Act, the consumer financial privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions will be subject to rules promulgated by the CFPB but will continue to be examined and supervised by the other federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act
16
authorized the CFPB to establish certain minimum standards for the origination of residential mortgages, including a determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a “qualified mortgage,” as defined by the CFPB. The Dodd-Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
The Electronic Funds Transfer Act
The Electronic Funds Transfer Act (the “EFTA”) provides a basic framework for establishing the rights, liabilities, and responsibilities of consumers who use electronic funds transfer (“EFT”) systems. The EFTA is implemented by the FRB's Regulation E, which governs transfers initiated through ATMs, point-of-sale terminals, payroll cards, automated clearinghouse (“ACH”) transactions, telephone bill-payment plans, or remote banking services. Regulation E was amended in January 2010 to require consumers to opt in (affirmatively consent) to participation in the Bank’s overdraft service program for ATM and one-time debit card transactions before overdraft fees may be assessed on the consumer’s account. Notice of the opt-in right must be provided to all existing and new customers who are consumers, and the customer’s affirmative consent must be obtained, before charges may be assessed on the consumer’s account for paying such overdrafts.
Regulation E provides bank customers with an ongoing right to revoke consent to participation in an overdraft service program for ATM and one-time debit card transactions, as opposed to being automatically enrolled in such a program. Regulation E also prohibits banks from conditioning the payment of overdrafts for checks, ACH transactions, or other types of transactions that overdraw the consumer’s account on the consumer’s opting into an overdraft service for ATM and one-time debit card transactions. For customers who do not affirmatively consent to overdraft service for ATM and one-time debit card transactions, a bank must provide those customers with the same account terms, conditions, and features that it provides to consumers who do affirmatively consent, except for the overdraft service for ATM and one-time debit card transactions.
Incentive Compensation
On June 21, 2010, the federal banking agencies issued final guidance on incentive compensation which applies to all banks. Except for the largest banking organizations, enforcement of this guidance is handled through the agencies’ regular risk-focused examination process. The employees covered by the final guidance are senior executives and others who are responsible for oversight of the organization’s firm-wide activities or material business lines; individual employees, including non-executive employees, whose activities may expose the organization to material amounts of risk; and groups of employees who are subject to the same or similar incentive compensation arrangements and who, in the aggregate, may expose the organization to material amounts of risk, even if no individual employee is likely to expose the organization to material risk. The guidance provides for three principles for safe and sound incentive compensation arrangements:
■ Balanced Risk-Taking: Incentive compensation arrangements should balance risk and financial results in a manner that does not encourage employees to expose their organizations to imprudent risks;
■ Compatibility with Effective Controls and Risk-Management: A banking organization’s risk-management processes and internal controls should reinforce and support the development and maintenance of balanced incentive compensation arrangements; and
■ Strong Corporate Governance: Banking organizations should have strong and effective corporate governance to help ensure sound compensation practices, including active and effective oversight by the board of directors.
Helping Families Save Their Homes Act
In May 2009 the Helping Families Save Their Homes Act of 2009 was enacted to help consumers avoid mortgage foreclosures on their homes through certain loss mitigation actions including special forbearance, loan modification, pre-foreclosure sale, deed in lieu of foreclosure, support for borrower housing counseling, subordinate lien resolution, and borrower relocation. This law permits the Secretary of Housing and Urban Development (“HUD”), for mortgages either in default or facing imminent default, to: (1) authorize the modification of such mortgages; and (2) establish a program for payment of a partial claim to a mortgagee who agrees to apply the claim amount to payment of a mortgage on a 1- to 4-family residence. In implementing the law, the Secretary of HUD is authorized to (1) provide compensation to the mortgagee for lost income on monthly mortgage payments due to interest rate reduction; (2) reimburse the mortgagee from a guaranty fund in connection with activities that the mortgagee is required to undertake concerning repayment by the mortgagor of the amount owed to HUD; (3) make payments to the mortgagee on behalf of the borrower, under terms defined by HUD; and (4) make mortgage modification with terms
17
extended up to 40 years from the modification date. The new law also authorizes the Secretary of HUD to: (1) reassign the mortgage to the mortgagee; (2) act as a Government National Mortgage Association (“GNMA” or “Ginnie Mae”) issuer, or contract with an entity for such purpose, in order to pool the mortgage into a Ginnie Mae security; or (3) resell the mortgage in accordance with any program established for purchase by the federal government of insured mortgages. The law also amended the Foreclosure Prevention Act of 2008, with respect to emergency assistance for the redevelopment of abandoned and foreclosed homes (neighborhood stabilization), to authorize each state that has received certain minimum allocations and has fulfilled certain requirements, to distribute any remaining amounts to areas with homeowners at risk of foreclosure or in foreclosure without regard to the percentage of home foreclosures in such areas.
Credit Card Act of 2009
Also in May 2009, the Credit Card Act of 2009 was enacted to help consumers and ban certain practices of credit card issuers. This law allows interest rate hikes on existing balances only under limited conditions, such as when a promotional rate ends, there is a variable rate or if the cardholder makes a late payment. Interest rates on new transactions can increase only after the first year. Significant changes in terms on accounts cannot occur without 45 days' advance notice of the change. The law bans raising interest rates on customers based on their payment records with other unrelated credit issuers (such as utility companies and other creditors) for existing credit card balances, though card issuers would still be allowed to use universal default on future credit card balances if they give at least 45 days' advance notice of the change. The law allows consumers to opt out of certain significant changes in terms on their accounts. Opting out means cardholders agree to close their accounts and pay off the balance under the old terms. They have at least five years to pay the balance. Credit card issuers will be banned from issuing credit cards to anyone under 21, unless they have adult co-signers on the accounts or can show proof they have enough income to repay the card debt.
The law requires card issuers to give card account holders "a reasonable amount of time" to make payments on monthly bills. That means payments would be due at least 21 days after they are mailed or delivered. Credit card issuers would no longer be able to set early morning or other arbitrary deadlines for payments. When consumers have accounts that carry different interest rates for different types of purchases payments in excess of the minimum amount due must go to balances with higher interest rates first. Consumers must "opt in" to over-limit fees. Those who opt out would have their transactions rejected if they exceed their credit limits, thus avoiding over-limit fees. Fees charged for going over the limit must be reasonable. Finance charges on outstanding credit card balances would be computed based on purchases made in the current cycle rather than going back to the previous billing cycle to calculate interest charges. Fees on credit cards cannot exceed 25 percent of the available credit limit in the first year of the card.
Other Aspects of Banking Law
The Bank is also be 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.
Conclusion
Future legislation is also likely to impact the Company’s business; however, it is impossible to predict what legislation might be enacted or what regulations might be adopted on the state or federal level or the effects thereof.
The foregoing summary of the laws, regulations and rules governing the Bank and the Company is not a complete summary of all applicable laws, regulations and rules.
Employees
At December 31, 2015, the Company employed 129 persons on a full-time equivalent basis. The Company believes its employee relations are excellent.
Available Information
The Company files period reports and other reports under the Securities and Exchange Act of 1934 with the Securities and Exchange Commission (SEC). These reports, as well as the Company’s Code of Ethics, are posted and are available at no cost on the Company’s website at http://www.unitedsecuritybank.com as soon as reasonably practical after the Company files such
18
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 1B. - Unresolved Staff Comments
The Company had no unresolved staff comments at December 31, 2015.
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, and 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 branch was previously located at 1041 E. Shaw Avenue, Fresno, California, under a lease extension expiring February 28, 2005. The 7088 N. First location provides space for the relocated branch as well as the Real Estate Construction Department and the Indirect Consumer Lending Department.
The Company leases the Oakhurst bank branch located at the Old Mill Village Shopping Center, 40074 Highway 49, Oakhurst, California. The branch facility consists of approximately 5,000 square feet with a lease term of 5 years ending April 2019, and has a five-year option to extend the lease term after that date.
The Company owns the Caruthers bank branch located at 13356 South Henderson, Caruthers, California, which consists of approximately 5,000 square feet of floor space.
The Company owns the San Joaquin branch facilities located at 21574 Manning Avenue, San Joaquin, California. The bank branch is approximately 2,500 square feet.
The Company owns the Firebaugh bank branch located at 1067 O Street, Firebaugh, California. The premises are comprised of approximately 4,666 square feet of office space situated on land totaling approximately one-third of an acre.
The Company owns the Coalinga bank branch located at 145 East Durian, Coalinga, California. The office building has a total of 6,184 square feet of interior floor space situated on approximately 0.45 acres of land.
The Company leases the Convention Center branch located at 855 “M” Street, Suite 130, Fresno, California. Total space leased is approximately 4,520 square feet, and was occupied during March 2004. The fifteen-year lease expires in March 2019. There are no extension provisions.
The Company owns the Taft branch office premises located at 523 Cascade Place, Taft, California. The branch facilities consist of approximately 9,200 square feet of office space.
The Company owns the branch facilities located at 3404 Coffee Road, Bakersfield, California, which has approximately 6,130 square feet of office space located on 1.15 acres.
The Company leases the Campbell branch located at 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, 2021.
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 of approximately seven years.
The Company leases its financial services facility located at 9 River Park Place, Suite 420, Fresno, CA. The lease commenced on October 1, 2013 and expires on September 30, 2016.
Item 3 - Legal Proceedings
19
From time to time, the Company is party to claims and legal proceedings arising in the ordinary course of business. At this time, the management of the Company is not aware of any material pending litigation proceedings to which it is a party or has recently been party to, which will have a material adverse effect on the financial condition or results of operations of the Company.
Item 4 – Mine Safety Disclosures
Not applicable
20
PART II
Item 5 - Market for the Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities
Trading History
The Company became a NASDAQ National Market listed company on May 31, 2001, then became a Global Select listed company during 2006, and trades under the symbol UBFO.
The Company currently has four market makers for its common stock. These include, Stone & Youngberg, LLC, Howe Barnes Hoeffer & Arnett, Sandler O’Neill & Partners, and Hill Thompson, Magid & Company. The Company is aware of two other securities dealers: Smith Barney and Dean Witter Reynolds Inc., which periodically act as brokers in the Company's stock.
On March 28, 2006, the Company announced a 2-for-1 stock split of the Company’s no-par common stock payable May 1, 2006 effected in the form of a 100% stock dividend. Share information for all periods presented in this 10-K have been restated to reflect the effect of the stock split.
During the third quarter ended September 30, 2008 and the fourth quarter ended December 31, 2008, the Company declared 1% stock dividends. During each of the twenty-eight consecutive quarters beginning March 31, 2009 through December 31, 2015, the Company again declared 1% stock dividends. Share information for all periods presented in this Form 10-K has been restated to reflect the effect of the 1% stock dividends.
The following table sets forth the high and low closing sales prices by quarter for the Company's common stock, for the years ended December 31, 2015 and 2014.
Closing Prices | Volume | |||||||
Quarter | High | Low | ||||||
4th Quarter 2015 | $ | 5.39 | $ | 5.18 | 454,200 | |||
3rd Quarter 2015 | $ | 5.32 | $ | 5.02 | 439,400 | |||
2nd Quarter 2015 | $ | 5.37 | $ | 4.90 | 375,700 | |||
1st Quarter 2015 | $ | 5.49 | $ | 4.97 | 439,500 | |||
4th Quarter 2014 | $ | 5.70 | $ | 5.28 | 294,300 | |||
3rd Quarter 2014 | $ | 5.94 | $ | 5.41 | 502,400 | |||
2nd Quarter 2014 | $ | 5.73 | $ | 5.07 | 491,800 | |||
1st Quarter 2014 | $ | 5.74 | $ | 4.56 | 423,700 | |||
At December 31, 2015, there were approximately 693 record holders of common stock of the Company. This does not reflect the number of persons or entities who hold their stock in nominee or street name through various brokerage firms.
Dividends
The Company's shareholders are entitled to dividends when and as declared by the Company’s Board of Directors out of funds legally available therefore. Dividends paid to shareholders by the Company are subject to restrictions set forth in California General Corporation Law, which provides that a corporation may make a distribution to its shareholders if retained earnings immediately prior to the dividend payout are at least equal the amount of the proposed distribution. As a bank holding company without significant assets other than its equity position in the Bank, the Company’s ability to pay dividends to its shareholders depends primarily upon dividends it receives from the Bank. Such dividends paid by the Bank to the Company are subject to certain limitations. See “Management’s Discussion and Analysis of Financial and Results of Operations – Regulatory Matters”.
The Company distributed a 1% stock dividend to shareholders on January 21, 2015, April 17, 2015, July 17, 2015, and October 16, 2015. The Company distributed a 1% stock dividend to shareholders on January 22, 2014, April 23, 2014, July 23, 2014, and October 22, 2014.
21
The amount and payment of dividends by the Company to shareholders are set by the Company's Board of Directors with numerous factors involved including the Company's earnings, financial condition and the need for capital for expanded growth and general economic conditions. No assurance can be given that cash or stock dividends will be paid in the future.
Securities Authorized for Issuance under Equity Compensation Plans
The following table sets forth securities authorized for issuance under equity compensation plans as for December 31, 2015.
Plan Category | Number of securities to be issued upon exercise of outstanding options, warrants and rights (column a) | Weighted-average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | ||||
Equity compensation plans approved by security holders | 115,927 | $ | 9.39 | 706,921 | |||
Equity compensation plans not approved by security holders | N/A | N/A | N/A | ||||
Total | 115,927 | $ | 9.39 | 706,921 | |||
A complete description of the above plans is included in Note 10 of the Company’s Financial Statements, in Item 8 of this Annual Report on Form 10K, and is hereby incorporated by reference.
Purchases of Equity Securities by Affiliates and Associated Purchasers
On May 16, 2007, the Company announced a stock repurchase plan to repurchase, as conditions warrant, up to 813,111 shares of the Company's common stock on the open market or in privately negotiated transactions. The repurchase plan represents approximately 5.00% of the Company's currently outstanding common stock. The duration of the program is open-ended and the timing of purchases will depend on market conditions.
As of December 31, 2015, there were 703,972 shares available for repurchase. The Company did not repurchase any common shares during the years ended December 31, 2015 and 2014.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K are forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Such risks and uncertainties include, but are not limited to, those described in Management’s Discussion and Analysis of Financial Condition and Results of Operations. Such risks and uncertainties include, but are not limited to, the following factors: i) competitive pressures in the banking industry and changes in the regulatory environment; ii) exposure to changes in the interest rate environment and the resulting impact on the Company’s interest rate sensitive assets and liabilities; iii) decline in the health of the economy nationally or regionally which could reduce the demand for loans or reduce the value of real estate collateral securing most of the Company’s loans; iv) credit quality deterioration that could cause an increase in the for loan losses; v) Asset/Liability matching risks and liquidity risks; volatility and devaluation in the securities markets, vi) failure to comply with the regulatory agreement under which the Company is subject, vii) expected cost savings from recent acquisitions are not realized, and, viii) potential impairment of goodwill and other intangible assets. Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company.
The Company
On June 12, 2001, the United Security Bank (the “Bank”) became the wholly owned subsidiary of United Security Bancshares (the “Company”) through a tax-free holding company reorganization, accounted for on a basis similar to the pooling of interest method. In the transaction, each share of Bank stock was exchanged for a share of Company stock on a one-to-one basis. No
22
additional equity was issued as part of this transaction. In the following discussion, references to the Bank are references to United Security Bank. References to the Company are references to United Security Bancshares (including the Bank).
On June 28, 2001, United Security Bancshares Capital Trust I (the “Trust”) was formed as a Delaware business trust for the sole purpose of issuing Trust Preferred securities. On July 16, 2001, the Trust completed the issuance of $15 million in Trust Preferred securities, and concurrently, the Trust used the proceeds from that offering to purchase Junior Subordinated Debentures of the Company. The Company contributed $13.7 million of the $14.5 million in net proceeds received from the Trust to the Bank to increase its regulatory capital and used the rest for the Company’s business. Effective January 1, 2007, the Company adopted the fair value option for its junior subordinated debt issued by the Trust. As a result of the adoption of the accounting standards related to the fair value option, the Company recorded a fair value adjustment of $1.3 million, reflected as an adjustment to beginning retained earnings. On July 25, 2007, the Company redeemed the $15.0 million in subordinated debentures plus accrued interest of $690,000 and a 6.15% prepayment penalty totaling $922,500. Concurrently, the Trust Preferred securities issued by Capital Trust I were redeemed. The prepayment penalty of $922,500 had previously been a component of the fair value adjustment for the junior subordinated debt at the initial adoption of the fair value option.
Effective December 31, 2001, United Security Bank formed a subsidiary Real Estate Investment Trust (“REIT”) through which preferred stock was offered to private investors, to raise capital for the bank in accordance with the laws and regulations in effect at the time. The principal business purpose of the REIT was to provide an efficient and economical means to raise capital. The REIT also provided state tax benefits beginning in 2002. On December 31, 2003, the California Franchise Tax Board (FTB) announced certain tax transactions related to real estate investment trusts (REITs) and regulated investment companies (RICs) will be disallowed pursuant to Senate Bill 614 and Assembly Bill 1601, which were signed into law in the 4th quarter of 2003 (For further discussion see Income Taxes section of Results of Operations contained in this Management’s Discussion and Analysis of Financial Condition and Results of Operations).
Effective April 23, 2004, the Company completed a merger with Taft National Bank headquartered in Taft, California. Taft National Bank (“Taft”) was merged into United Security Bank and Taft’s two branches, one located Taft and the other located in Bakersfield, California, began operating as branches of United Security Bank. The merger was accounted for using the purchase method of accounting, and resulted in the purchase price being allocated to the assets acquired and liabilities assumed from Taft based on the fair value of those assets and liabilities, with resultant goodwill of $1.6 million and core deposits intangibles of $1.9 million. Goodwill is not amortized but is reviewed at least annually for impairment, while core deposit intangibles were amortized over a period of 7 years. The Company has recognized no impairment on either the goodwill or core deposit intangible related to the Taft merger.
On February 16, 2007, the Company completed its merger of Legacy Bank, N.A. with and into United Security Bank, a wholly owned subsidiary of the Company. Legacy Bank which began operations in 2003 operated one banking office in Campbell, California serving small business and retail banking clients. With its small business and retail banking focus, Legacy Bank provides a unique opportunity for United Security Bank to serve a loyal and growing small business niche and individual client base in the San Jose area. Upon completion of the merger, Legacy Bank's branch office began operating as a branch office of United Security Bank. The merger transaction was accounted for using the purchase accounting method, and resulted in the purchase price being allocated to the assets acquired and liabilities assumed from Legacy based on the fair value of those assets and liabilities. Fair value adjustments and intangible assets totaled approximately $12.9 million, including $8.8 million in goodwill. Goodwill is not amortized but is reviewed at least annually for impairment, while core deposit intangibles are being amortized over a period of 7 years. The Company has recognized no impairment on either the goodwill or core deposit intangibles related to the Legacy merger.
During July 2007, the Company formed USB Capital Trust II, a wholly-owned special purpose entity, for the purpose of issuing Trust Preferred Securities. Like USB Capital Trust I formed in July 2001, USB Capital Trust II is a Variable Interest Entity (VIE) and a deconsolidated entity pursuant current accounting standards related to variable interest entities. On July 23, 2007, USB Capital Trust II issued $15 million in Trust Preferred securities. The securities have a thirty-year maturity and bear a floating rate of interest (repricing quarterly) of 1.29% over the three-month LIBOR rate. 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 of the Company. The Company is to pay interest on the junior subordinated debentures to USB Capital Trust II, which represents the sole source of dividend distributions to the holders of the Trust Preferred securities. Effective September 30, 2009 and beginning with the quarterly interest payment due October 1, 2009, the Company elected to defer interest payments on the Company's $15.0 million of junior subordinated debentures relating to its trust preferred securities. The terms of the debentures and trust indentures allow for the Company to defer interest payments for up to 20 consecutive quarters without default or penalty. During the period that the interest deferrals were elected, the 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 is currently making quarterly
23
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 at year-end 2015. The Company may redeem the junior subordinated debentures at anytime at par.
The Bank currently has eleven banking branches, one construction lending office, and one financial services office, which provide banking and financial services in Fresno, Madera, Kern, and Santa Clara counties. As a community-oriented bank holding company, the Company continues to seek ways to better meet its customers' needs for financial services, and to expand its business opportunities in today's ever-changing financial services environment. The Company's strategy is to be a better low-cost provider of services to its customer base while enlarging its market area and corresponding customer base to further its ability to provide those services.
On March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a formal written agreement (the “Agreement”) with the Federal Reserve Bank of San Francisco (the “Federal Reserve”) as a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions (the “DFI”) in June 2009. That examination found significant increases in nonperforming assets, both classified loans and OREO, during 2008 and 2009, and heightened concerns about the Bank’s use of brokered and other wholesale funding sources to fund loan growth, which created increased risk to equity capital and potential volatility in earnings. Under the terms of the Agreement, the Company and the Bank agreed, among other things: to maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses; to improve the management of the Bank's liquidity position and funds management policies; to maintain sufficient capital at the Company and Bank level; and to improve the Bank’s earnings and overall condition. The Company and Bank also agreed not to increase or guarantee any debt, purchase or redeem any shares of stock, declare or pay any cash dividends, or pay interest on the Company's junior subordinated debt or trust preferred securities, without prior written approval from the Federal Reserve. The Company generates no revenue of its own and, as such, relies on dividends from the Bank to pay its operating expenses and interest payments on the Company’s junior subordinated debt. Effective November 19, 2014, the Federal Reserve terminated the Agreement with the Bank and the Company and replaced it with an informal supervisory agreement that requires, among other things, obtaining written approval from the Federal Reserve prior to the payment of dividends from the Bank to the Company or the payment of dividends by the Company or interest on the Company’s junior subordinated debt. The inability of the Bank to pay cash dividends to the Company may hinder the Company’s ability to meet its ongoing operating obligations. (For more information on the Agreement see the “Regulatory Matters” section included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.)
On May 20, 2010, the DFI (now known as the Department of Business Oversight (the “DBO”)) issued a formal written order (the “Order”) pursuant to a consent agreement with the Bank as a result of the same June 2009 joint regulatory examination. The terms of the Order were essentially similar to the Federal Reserve’s Agreement, except for a few additional requirements. On September 24, 2013, the Bank entered into an informal Memorandum of Understanding (the “MOU”) with the DBO and on October 15, 2013, the Order was terminated. The Order and the MOU require the Bank to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0% and also requires the DBO’s approval for the Bank to pay a dividend to the Company. Accordingly, reflecting the Company’s and the Bank’s improved financial condition and performance, as of November 19, 2014, the Bank and the Company have been relieved of all formal regulatory agreements. Some of the governance and procedures established by the Agreement and the Order remain in place, including submission of certain plans and reports to the Federal Reserve and DBO, the Bank’s obligation to maintain a 9.0% tangible shareholder’s equity ratio, and the requirement to seek approvals from the Federal Reserve and the DBO for either the Bank or the Company to pay dividends and for the Company to pay interest on its outstanding junior subordinated debt. While no assurances can be given as to future regulatory approvals, over the last five quarters the DBO and the Federal Reserve have been approving the Bank's payment of dividends to the Company to cover the Company's operating expenses and its interest payments and the Company's payment of quarterly interest on the junior subordinated debt. The Bank is currently in full compliance with the requirements of the MOU including its deadlines. (For more information on the Agreement see the “Regulatory Matters” section included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations.)
Current Trends Affecting Results of Operations and Financial Position
The Company’s overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact results of operations, but also the composition of the Company’s balance sheet. One of the primary strategic goals of the Company is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources are considered as well in the planning process to mitigate risk and allow for growth. Net interest income increased during 2015, totaling $26,129,000 and $23,617,000 for the years ended December 31, 2015 and 2014, respectively. The increase in net interest income was primarily the result of an increase in the rates on interest-earning assets. Average interest-earning assets increased approximately
24
$30,333,000 between 2015 and 2014 and the rate on interest earning assets increased 19 basis points during the two periods. The increase in average earning assets between 2015 and 2014 consisted of an increase of $70,615,000 in loans, offset by decreases of $31,686,000 in interest-bearing deposits held at the Federal Reserve Bank and $8,603,000 in investment securities. The Company’s cost of interest-bearing liabilities declined during 2015, with the average cost of interest-bearing liabilities dropping from 0.38% during 2014 to 0.35% for the year ended December 31, 2015.
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:
YTD Average 12/31/15 | YTD Average 12/31/14 | ||||
Loans | 79.68 | % | 71.78 | % | |
Investment securities available for sale | 6.56 | % | 8.36 | % | |
Interest-bearing deposits in other banks | 0.25 | % | 0.26 | % | |
Interest-bearing deposits in FRB | 13.51 | % | 19.60 | % | |
Total earning assets | 100.00 | % | 100.00 | % | |
NOW accounts | 21.91 | % | 17.99 | % | |
Money market accounts | 38.15 | % | 40.86 | % | |
Savings accounts | 17.03 | % | 14.99 | % | |
Time deposits | 20.33 | % | 23.12 | % | |
Other borrowings | — | % | — | % | |
Subordinated debentures | 2.58 | % | 3.04 | % | |
Total interest-bearing liabilities | 100.00 | % | 100.00 | % | |
Since the Bank primarily conducts banking operations in California’s Central Valley, its 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 the Bank. In addition, the Central Valley remains largely dependent on agriculture. A downturn in agriculture and agricultural related business could indirectly and adversely affect the Company as many borrowers and customers are involved in, or are impacted to some extent, by the agricultural industry. While a great number of our borrowers are not directly involved in agriculture, they would likely be impacted by difficulties in the agricultural industry since many jobs in our market areas are ancillary to the regular production, processing, marketing and sale of agricultural commodities. The state of California is currently experiencing the worst drought in recorded history, and, of course, it is not possible to predict the potential impact on businesses and consumers located in the Company's market areas or the duration of the drought.
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 2015. 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 the Company’s operations and increased the levels of nonperforming assets, increased expenses related to foreclosed properties, and decreased profit margins. As the Company continues its business development and expansion efforts throughout its market areas, it will also maintain its 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 between June 2013 to December 2015.
During the year ended December 31, 2015, the Company experienced increases in real estate mortgage loans, commercial real estate loans, agriculture loans and installment loans and decreases in commercial and industrial loans and real estate construction and development loans, compared to the same period ended December 31, 2014. Loans increased $57,399,000 between December 31, 2014 and December 31, 2015. Real estate mortgage loans increased $37,355,000 between December 31, 2014 and December 31, 2015. Agricultural loans increased $20,424,000 between December 31, 2014 and December 31, 2015. Commercial and industrial loans decreased $6,543,000 between December 31, 2014 and December 31, 2015. 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 35.43% and 33.78%, of the total loan portfolio at December 31, 2015 and
25
December 31, 2014, respectively. Commercial real estate loans increased $27,882,000 during 2015. Residential mortgage loans are not generally a large part of the Company’s loan portfolio, but some residential mortgage loans have been made over the past few years to facilitate take-out loans for construction borrowers who were unable to obtain permanent financing elsewhere. Additionally, the Company purchases residential mortgage pools. Residential mortgage loans are generally 30-year amortizing loans with maturities of between three and five years. These loans totaled $68,811,000 or 13.35% of the portfolio at December 31, 2015, and $59,095,000, or 12.91% of the portfolio at December 31, 2014. The Bank held no purchased loan participations at December 31, 2015 or December 31, 2014. Loan participations sold increased from $6,230,000 or 1.4% of the portfolio at December 31, 2014, to $29,025,000, or 5.6%, at December 31, 2015.
Although market rates of interest are at historically low levels, the Company’s disciplined deposit pricing efforts have helped maintain adequate margins. The Company’s net interest margin increased to 4.22% for the year ended December 31, 2015, when compared to 4.01% for the year ended December 31, 2014. The net interest margin has improved due to growth of the loan portfolio, which is a higher yielding asset, compared to overnight investments with the Federal Reserve Bank. The Company has successfully sought to mitigate the low interest rate environment with loan floors included in new and renewed loans when practical. Loans yielded 5.36% during the year ended December 31, 2015, as compared to 5.62% for the year ended December 31, 2014. The decrease in the Company’s cost of funds over the past few years has also contributed to the improved net interest margin. The Company’s average cost of funds was 0.35% for the year ended December 31, 2015, as compared to 0.38% for the year ended December 31, 2014. The Company does not intend to increase its brokered deposits and expects brokered deposit balances to remain level at least in the short-term. Currently, CDARs reciprocal deposits are the only brokered deposits held by the Company. The CDARs reciprocal deposit is preferred by some depositors.
Total noninterest income of $4,735,000 reported for the year ended December 31, 2015 decreased $426,000 or 8.25% as compared to the year ended December 31, 2014. Noninterest income continues to be driven by customer service fees, which totaled $3,620,000 for the year ended December 31, 2015. The decrease in noninterest income between the years ended December 31, 2015 and December 31, 2014, was primarily the result of a $714,000 decrease in gain on sale of other investments between the two periods. A $691,000 gain on sale was realized in 2014 as compared to a $23,000 loss realized in 2015.
Noninterest expense increased approximately $383,000 or 1.99% between the years ended December 31, 2014 and December 31, 2015. The increases experienced during the year ended December 31, 2015, were primarily the result of increases of $282,000 in occupancy expense and $268,000 in salary and employment benefits, partially offset by decreases of $319,000 in professional fees.
On March 24, 2015, June 23, 2015, September 22, 2015, and December 15, 2015, the Company’s Board of Directors declared a one-percent (1%) quarterly stock dividend on the Company’s outstanding common stock. The Company believes that, given the current uncertainties in the economy, it is prudent to retain capital and better position the Company for future growth opportunities. Based upon the number of outstanding common shares on the record date of April 6, 2015, July 6 2015, October 5, 2015, and January 4, 2016, respectively, an additional 154,249, 155,796, 157,357, and 158,918 shares, respectively, were issued to shareholders. For purposes of earnings per share calculations, the Company’s weighted average shares outstanding and potentially dilutive shares used in the computation of earnings per share have been restated after giving retroactive effect to the 1% stock dividends to shareholders for all periods presented.
The Company has sought to maintain a strong, yet conservative balance sheet while continuing to reduce the level of nonperforming assets and maintain adequate liquidity during the year ended December 31, 2015. Total assets increased approximately $62,475,000 during the year ended December 31, 2015, as a result of increases of $58,839,000 in net loans and $22,174,000 in cash and cash equivalents, partially offset by decreases of $17,408,000 in investment securities and $1,137,000 in OREO. Total deposits increased $56,432,000, including an increase of $46,729,000 in noninterest-bearing deposits, and an increase of $18,689,000 in savings, NOW and money market accounts, offset by a decrease of $8,986,000 in time deposits during the year ended December 31, 2015. Average loans comprised approximately 79.68% and 71.79% of overall average earning assets during the years ended December 31, 2015 and December 31, 2014, respectively.
Nonperforming assets, which are primarily related to the real estate loan and other real estate owned portfolio, remained high during the year ended December 31, 2015, and increased $2,508,000 from a balance of $29,586,000 at December 31, 2014 to a balance of $32,094,000 at December 31, 2015. Nonaccrual loans totaling $8,193,000 at December 31, 2015, decreased $1,742,000 from the balance of $9,935,000 reported at December 31, 2014. In determining the adequacy of the underlying collateral related to these loans, management monitors trends within specific geographical areas, loan-to-value ratios, appraisals, and other credit issues related to the specific loans. Impaired loans increased $7,642,000 during the year ended December 31, 2015 to a balance of $23,679,000 at December 31, 2015. Other real estate owned through foreclosure decreased
26
$1,137,000 between December 31, 2014 and December 31, 2015. As a result of the related events, nonperforming assets as a percentage of total assets decreased from 4.46% at December 31, 2014 to 4.42% at December 31, 2015.
The following table summarizes various nonperforming components of the loan portfolio, the related allowance for loan and lease losses and provision for credit losses for the periods shown.
(In thousands) | December 31, 2015 | December 31, 2014 | December 31, 2013 | ||||||||
Recovery of provision for credit losses during period | $ | (41 | ) | $ | (845 | ) | $ | (1,098 | ) | ||
Allowance as % of nonperforming loans | 50.53 | % | 69.15 | % | 60.70 | % | |||||
Nonperforming loans as % total loans | 3.73 | % | 3.40 | % | 4.58 | % | |||||
Restructured loans as % total loans | 3.59 | % | 3.28 | % | 2.29 | % | |||||
When the economy declined along with asset valuations, increased emphasis was placed on impairment analysis of both tangible and intangible assets on the balance sheet. As of March 31, 2014, the Company conducted annual impairment testing on the largest component of its outstanding balance of goodwill, that of the Campbell operating unit (resulting from the Legacy merger during February 2007.) The Company completed a "Step 0" analysis for the Campbell reporting unit as of March 31, 2015 and March 31, 2014, and concluded that there was no impairment of the goodwill related to the Campbell operating unit for the years ended December 31, 2015 and 2014.
While real estate markets have strengthened over the last few years, management continues to monitor economic conditions in the real estate market for signs of either deterioration or improvement which may impact the level of the allowance for loan losses required to cover identified losses in the loan portfolio. Management continues to monitor and reduce the level of problem assets by working with borrowers to identify options, including loan restructures, in order to work through difficulties a borrower might face. Restructured loans numbers have been greatly reduced over the last four years. The number of restructured loans decreased from 58 loans totaling $16,773,000 at December 31, 2012, to approximately 35 loans totaling $9,059,000 at December 31, 2013, but increased to 33 loans totaling $15,000,000 at December 31, 2014. The number of restructures decreased in 2015 to 29 loan restructures but the balance increased to $18,508,000 at December 31, 2015. A recovery of provision was made to the allowance for credit losses totaling $41,000 during the year ended December 31, 2015, as compared to $845,000 for the year ended December 31, 2014. The level in the allowance for credit losses is deemed adequate to cover inherent losses in the loan portfolio. Net loan charge-offs during the year ended December 31, 2015 totaled $1,017,000, as compared to $629,000 in net recoveries for the year ended December 31, 2014. The Company charged-off approximately 9 loans during the year ended December 31, 2015, compared to 13 loans during the year ended December 31, 2014. Net loan charge-offs totaling $1,017,000 during the year ended December 31, 2015, included $60,000 in net recoveries during the quarter ended March 31, 2015, $264,000 in net recoveries during the quarter ended June 30, 2015, $39,000 in net recoveries during the quarter ended September 30, 2015, and $1,380,000 in net charge-offs during the fourth quarter of 2015. The percentage of net charge-offs to average loans was 0.21%, for the year ended December 31, 2015. The percentages for the years ended December 31, 2014 and 2013 reflected net recoveries to average loans of 0.15% and net recoveries of 0.08%, respectively.
Deposits increased by $56,432,000 during the year ended December 31, 2015, with increases in savings, NOW, and money market accounts and non interest bearing deposits, partially offset by decreases in time accounts. Time deposits decreased $8,986,000 during the year ended December 31, 2015, due to management's focus on reducing time deposits and lowering the bank's average cost of funds.
The Company continues to maintain a low reliance on brokered deposits, while maintaining sufficient liquidity. Currently, the Company does not utilize wholesale funding sources. Brokered deposits totaled $8,546,000 or 1.37% of total deposits at December 31, 2015, as compared to $11,480,000, or 2.03%. The Company has reduced its reliance on brokered deposits to 1.37%, a level comparable with peers, which is currently about 2.75% of total deposits.
The Company had no borrowings at December 31, 2015 and 2014, but the Company will maintain overnight borrowing and other term credit lines as deemed prudent.
The cost of the Company’s subordinated debentures issued by USB Capital Trust II has remained low along 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 1.90% and 1.55% at December 31, 2015 and 2014, respectively. Pursuant to fair value accounting guidance, the Company has recorded $73,000 in pretax fair value losses on its junior subordinated debt during the year ended December 31, 2015, bringing the total cumulative gain recorded on the debt to $4,214,000 at December 31, 2015.
27
The Company continues to emphasize relationship banking and core deposit growth, focusing greatest attention on its market areas of Fresno, Madera, and Kern Counties, as well as Campbell, in Santa Clara County. The San Joaquin Valley and other California markets are exhibiting improving demand for construction lending and commercial lending from small and medium size businesses. We have seen improvement over the last four years, and are optimistic that these positive trends will continue. There are continued challenges for the banking industry with tight credit markets and relatively weak real estate markets adversely affecting the Banking industry and the Company.
The Company continually evaluates its strategic business plan as economic and market factors change in its market area. Balance sheet management, enhancing revenue sources, and maintaining market share will continue to be of primary importance during 2016 and beyond. The banking industry is still experiencing downward pressure on net margins as interest rates remain at historical lows. As a result, market rates of interest and asset quality will continue be important factors in the Company’s ongoing strategic planning process.
Application of Critical Accounting Policies and Estimates
The Company’s consolidated financial statements are prepared in accordance with generally accepted accounting principles and follow general practices within the 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 the Company’s own assumptions in regard to the assumptions that market participants would use in pricing the asset or liability.
The most significant accounting policies followed by the Company are presented in Note 1 to the Company’s consolidated financial statements included herein. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses, other real estate owned through foreclosure, impairment of collateralized mortgage obligations and other investment securities, and 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 credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Asset Quality and Allowance for Credit Losses section of this financial review.
Other Real Estate Owned
Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value of the property, less estimated costs to sell. The excess, if any, of the loan amount over the fair value of the collateral is charged to the allowance for credit losses. The determination of fair value is generally based upon pre-approved, external appraisals. Subsequent declines in the fair value of other real estate owned, along with related revenue and expenses from operations, are charged to noninterest expense. The fair market valuation of such properties is based upon estimates, and as such, is subject to change as circumstances in the Company’s market area, or general economic trends, change.
28
Fair Value
Effective January 1, 2007, the Company adopted fair value option accounting standards choosing to apply the standards to its junior subordinated debt. The Company concurrently adopted the accounting standards related to fair value measurements. The accounting standards related to fair value measurements defines 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, 2015 and 2014, the Company recorded fair value adjustments related to its junior subordinated debt totaling losses of $73,000 and $102,000, respectively. (See Notes 8 and 13 of the Notes to Consolidated Financial Statements for additional information about financial instruments carried at fair value.)
Income Taxes
Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities. Deferred taxes are measured using current tax rates applied to such taxable income in the years in which those temporary differences are expected to be recovered. If the Company’s future income is not sufficient to apply the deferred tax assets within the tax years to which they may be applied, the deferred tax asset may not be realized and the Company’s income will be reduced. The Company recorded no valuation allowance against its deferred tax assets at December 31, 2015 and 2014.
On January 1, 2007, the Company 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, the Company will continue to re-evaluate existing tax positions, as well as new positions as they arise. If the Company determines in the future that its tax positions are not “more likely than not” to be sustained (as defined) by taxing authorities, the Company may need to recognize additional tax liabilities.
Revenue recognition
The Company’s primary sources of revenue are interest income from loans and investment securities. Interest income is generally recorded on an accrual basis, unless the collection of such income is not reasonably assured or cannot be reasonably estimated. Pursuant to 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.
Results of Operations
29
On a year-to-date basis, the Company reported net income of $6,810,000 or $0.42 per share ($0.42 diluted) for the year ended December 31, 2015, as compared to $6,216,000 or $0.39 per share ($0.39 diluted) for the same period in 2014. The increase of $594,000 between December 31, 2014 and December 31, 2015 was primarily the result of increases in interest-earning assets. Interest income increased by $2,448,000 between December 31, 2014 and December 31, 2015 and non-interest income decreased by $426,000.
The Company’s return on average assets was 0.98% for the year ended December 31, 2015, as compared to 0.93% for the year ended December 31, 2014. The Company’s return on average equity was 7.88% for the year ended December 31, 2015, as compared to 7.80% for the year ended December 31, 2014.
As with variances in net income, changes in the return on average assets and average equity experienced by the Company during 2015 and 2014 were effected by increases in average loan balances and net income.
The following table sets forth certain selected financial data for the Bank for each of the years in the five-year periods ended December 31, 2015, 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).
(In thousands except per share data and ratios) | 2015 | 2014 | 2013 | 2012 | 2011 | |||||
Selected Financial Ratios: | ||||||||||
Return on average assets | 0.98 | % | 0.93 | % | 1.13 | % | 0.97 | % | (1.64 | )% |
Return on average shareholders' equity | 7.88 | % | 7.80 | % | 10.09 | % | 9.23 | % | (15.86 | )% |
Average shareholders' equity to average assets | 12.41 | % | 11.88 | % | 11.20 | % | 10.55 | % | 10.36 | % |
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 for credit losses totaled $26,129,000 for the year ended December 31, 2015, representing an increase of $2,512,000, or 10.64%, when compared to the $23,617,000 reported for the same period of the previous year. The Company’s year-to-date net interest margin, as shown in Table 1, increased to 4.22% at December 31, 2015 from 4.01% at December 31, 2014, an increase of 21 basis points (100 basis points = 1%) between the two periods.
Table 1. – Distribution of Average Assets, Liabilities and Shareholders’ Equity:
Interest rates and interest differentials
Years ended December 31, 2015 and 2014
30
2015 | 2014 | ||||||||||||||||||||
Average Balance | Interest | Yield/Rate | Average Balance | Interest | Yield/Rate | ||||||||||||||||
(Dollars in thousands) | |||||||||||||||||||||
Assets: | |||||||||||||||||||||
Interest-earning assets: | |||||||||||||||||||||
Loans and leases (1) | $ | 493,375 | $ | 26,469 | 5.36 | % | $ | 422,760 | $ | 23,777 | 5.62 | % | |||||||||
Investment Securities – taxable | 40,616 | 722 | 1.78 | % | 49,219 | 901 | 1.83 | % | |||||||||||||
Interest-bearing deposits in other banks | 1,525 | 6 | 0.39 | % | 1,518 | 7 | 0.46 | % | |||||||||||||
Interest-bearing deposits in FRB | 83,709 | 213 | 0.25 | % | 115,395 | 277 | 0.24 | % | |||||||||||||
Total interest-earning assets | 619,225 | $ | 27,410 | 4.43 | % | 588,892 | $ | 24,962 | 4.24 | % | |||||||||||
Allowance for credit losses | (11,357 | ) | (11,118 | ) | |||||||||||||||||
Noninterest-earning assets: | |||||||||||||||||||||
Cash and due from banks | 22,279 | 20,447 | |||||||||||||||||||
Premises and equipment, net | 11,174 | 11,936 | |||||||||||||||||||
Accrued interest receivable | 1,601 | 1,434 | |||||||||||||||||||
Other real estate owned | 13,466 | 14,188 | |||||||||||||||||||
Other assets | 40,086 | 45,254 | |||||||||||||||||||
Total average assets | $ | 696,474 | $ | 671,033 | |||||||||||||||||
Liabilities and Shareholders' Equity: | |||||||||||||||||||||
Interest-bearing liabilities: | |||||||||||||||||||||
NOW accounts | $ | 79,977 | $ | 108 | 0.14 | % | $ | 63,251 | $ | 77 | 0.12 | % | |||||||||
Money market accounts | 139,220 | 461 | 0.33 | % | 143,627 | 504 | 0.35 | % | |||||||||||||
Savings accounts | 62,163 | 159 | 0.26 | % | 52,681 | 130 | 0.25 | % | |||||||||||||
Time deposits | 74,193 | 328 | 0.44 | % | 81,271 | 393 | 0.48 | % | |||||||||||||
Junior subordinated debentures | 9,410 | 225 | 2.39 | % | 10,681 | 241 | 2.26 | % | |||||||||||||
Total interest-bearing liabilities | 364,963 | $ | 1,281 | 0.35 | % | 351,511 | $ | 1,345 | 0.38 | % | |||||||||||
Noninterest-bearing liabilities: | |||||||||||||||||||||
Noninterest-bearing checking | 237,034 | 230,876 | |||||||||||||||||||
Accrued interest payable | 73 | 76 | |||||||||||||||||||
Other liabilities | 8,005 | 8,878 | |||||||||||||||||||
Total average liabilities | 610,075 | 591,341 | |||||||||||||||||||
Total average shareholders' equity | 86,399 | 79,692 | |||||||||||||||||||
Total average liabilities and shareholders' equity | $ | 696,474 | $ | 671,033 | |||||||||||||||||
Interest income as a percentage of average earning assets | 4.43 | % | 4.24 | % | |||||||||||||||||
Interest expense as a percentage of average earning assets | 0.21 | % | 0.23 | % | |||||||||||||||||
Net interest margin | 4.22 | % | 4.01 | % | |||||||||||||||||
(1) Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan fees of approximately $163,000 and $419,000 for the years ended December 31, 2015 and 2014, respectively.
The prime rate was raised from its long-standing rate of 3.25% to 3.50% in December 2015 and is expected to see further increases during 2016. These increases will affect rates for both loans and customer deposits, both of which are likely to increase as the prime rate increases.
31
Both the Company's net interest income and net interest margin are affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Both are also affected by changes in yields on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change." The following table sets forth the changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the years indicated. Changes in interest income and expense, which are not attributable specifically to either rate or volume, are allocated proportionately between the two variances based on the absolute dollar amounts of the change in each.
Table 2. Rate and Volume Analysis
2015 compared to 2014 | 2014 compared to 2013 | ||||||||||||||||||||
(In thousands) | Total | Rate | Volume | Total | Rate | Volume | |||||||||||||||
Increase (decrease) in interest income: | |||||||||||||||||||||
Loans | $ | 2,692 | $ | (1,136 | ) | 3,828 | $ | 1,798 | $ | 87 | 1,711 | ||||||||||
Investment securities | (179 | ) | (25 | ) | (154 | ) | 198 | (174 | ) | 372 | |||||||||||
Interest-bearing deposits in other banks | (1 | ) | (1 | ) | — | (1 | ) | (1 | ) | — | |||||||||||
Interest-bearing deposits in FRB | (64 | ) | 20 | (84 | ) | 35 | 1 | (36 | ) | ||||||||||||
Total interest income | 2,448 | (1,142 | ) | 3,590 | 1,960 | (87 | ) | 2,047 | |||||||||||||
Increase (decrease) in interest expense: | |||||||||||||||||||||
Interest-bearing demand accounts | (12 | ) | (45 | ) | 33 | (94 | ) | (121 | ) | 27 | |||||||||||
Savings accounts | 29 | 5 | 24 | 46 | 24 | 22 | |||||||||||||||
Time deposits | (65 | ) | (32 | ) | (33 | ) | (178 | ) | (111 | ) | (67 | ) | |||||||||
Subordinated debentures | (16 | ) | 14 | (30 | ) | (40 | ) | (41 | ) | 1 | |||||||||||
Total interest expense | (64 | ) | (58 | ) | (6 | ) | (266 | ) | (249 | ) | (17 | ) | |||||||||
Increase (decrease) in net interest income | $ | 2,512 | $ | (1,084 | ) | 3,596 | $ | 2,226 | $ | 162 | 2,064 | ||||||||||
For the year ended December 31, 2015, total interest income increased approximately $2,448,000 or 9.81% as compared to the year ended December 31, 2014, reflective of an increase of $2,692,000 in loan interest income. Earning asset volumes decreased in investment securities available for sale, which on average decreased $8,603,000 between the two periods, and remained constant in interest-bearing deposits in other banks between the two periods. Interest-bearing deposits in FRB decreased by $31,686,000 on average between the two periods. The average rates on loans decreased 26 basis points between the two periods, and the average rate on investment securities decreased approximately 5 basis points during the year ended December 31, 2015, as compared to the same period of 2014.
For the year ended December 31, 2015, total interest expense decreased approximately $64,000, or 4.76%, as compared to the year ended December 31, 2014. Between those two periods, average interest-bearing liabilities increased by $13,452,000, while the average rates paid on these liabilities decreased by 3 basis points.
Provision for Credit Losses
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 sufficient to cover risk elements in the loan portfolio.
For the year ended December 31, 2015, the recovery of provision to the allowance for credit losses amounted to $41,000. The recovery of provision for the year ended December 31, 2014 totaled $845,000.
The allowance for credit losses decreased to 1.88% of total loans during the year ended December 31, 2015, as compared to a 2.35% balance at December 31, 2014. The negative loan loss provisions recorded during 2014 and 2015 are a result of continuing improvements in the overall credit quality of the loan portfolio, overall improvements in the loss history over the recent years, and improvements in property values that serve as loan collateral through December 31, 2014 and December 31, 2015.
32
Noninterest Income
The following table summarizes significant components of noninterest income for the years indicated and the net changes between those years:
(In thousands) | 2015 | 2014 | Amount of Change | Percent Change | ||||||||||
Customer service fees | $ | 3,620 | $ | 3,473 | $ | 147 | 4.23 | % | ||||||
Increase in cash surrender value of BOLI/COLI | 519 | 514 | 5 | 0.97 | % | |||||||||
Loss on fair value option of financial liabilities | (73 | ) | (102 | ) | 29 | (28.43 | )% | |||||||
Gain on sale of other assets | 10 | 25 | (15 | ) | (60.00 | )% | ||||||||
Gain on redemption of junior subordinated debenture | 78 | — | 78 | 100.00 | % | |||||||||
(Loss) gain on other investments | (23 | ) | 691 | (714 | ) | (103.33 | )% | |||||||
Other | 604 | 560 | 44 | 7.86 | % | |||||||||
Total | $ | 4,735 | $ | 5,161 | $ | (426 | ) | (8.25 | )% | |||||
Noninterest income consists primarily of fees and commissions earned on services that are provided to the Company’s banking customers and, to a lesser extent, gains on sales of Company assets and other miscellaneous income.
Noninterest income for the year ended December 31, 2015 decreased $426,000 or 8.25% when compared to the same period of 2014. Customer service fees, the primary component of noninterest income, increased $147,000 or 4.23% between the two periods presented. The decrease in noninterest income of $426,000 between the two periods is the result of a gain on sale of other investments of $691,000 realized in 2014 on the sale of a local property investment contrasted with a loss of $23,000 realized in 2015.
Noninterest Expense
The following table sets forth the components of total noninterest expense in dollars and as a percentage of average earning assets for the years ended December 31, 2015 and 2014:
2015 | 2014 | ||||||||||
(Dollars in thousands) | Amount | % of Average Earning Assets | Amount | % of Average Earning Assets | |||||||
Salaries and employee benefits | $ | 9,921 | 1.60 | % | $ | 9,653 | 1.64 | % | |||
Occupancy expense | 4,042 | 0.65 | % | 3,760 | 0.64 | % | |||||
Data processing | 126 | 0.02 | % | 134 | 0.02 | % | |||||
Professional fees | 1,137 | 0.18 | % | 1,456 | 0.25 | % | |||||
FDIC/DFI assessments | 959 | 0.15 | % | 943 | 0.16 | % | |||||
Directors fees | 277 | 0.04 | % | 232 | 0.04 | % | |||||
Amortization of intangibles | — | — | % | 62 | 0.01 | % | |||||
Correspondent bank service charges | 75 | 0.01 | % | 117 | 0.02 | % | |||||
Loss on CA Tax Credit Partnership | 73 | 0.01 | % | 39 | 0.01 | % | |||||
OREO expense | 619 | 0.10 | % | 571 | 0.10 | % | |||||
Other | 2,369 | 0.38 | % | 2,248 | 0.38 | % | |||||
Total | $ | 19,598 | 3.17 | % | $ | 19,215 | 3.26 | % | |||
Noninterest expense increased $383,000 between the years ended December 31, 2015 and 2014. The net increase in noninterest expense between the comparative periods is primarily the result of increases in salaries and employee benefits and occupancy expense, partially offset by decreases in professional fees and correspondent bank charges.
33
Included in net costs on operations of OREO for the years ended December 31, 2015 and 2014, are gains on the sale of OREO totaling $16,000 and $114,000, respectively, and OREO operating expenses totaling $447,000 and $685,000, respectively. Net cost on operation of OREO for the year ended December 31, 2015 also includes a $188,000 write-down on OREO.
During the years ended December 31, 2015 and 2014, the Company recognized stock-based compensation expense of $26,000 and $28,000 (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 are issued, or existing options fail to vest due, for example, to forfeiture, actual stock-based compensation expense in future periods will change.
Income Taxes
The Company’s 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 the Company’s 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 the Company’s 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 the Company’s statements of operations and comprehensive income.
The Company reviews its current tax positions at least quarterly based 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.
The Company has reviewed all of its tax positions as of December 31, 2015, and has determined that, there are no material amounts that should be recorded under the current income tax accounting guidelines.
Financial Condition
Total assets increased by $62,475,000 or 9.42% during the year from a balance of $663,169,000 at December 31, 2014 to $725,644,000 at December 31, 2015, and increased $89,715,000 or 14.11% from the balance of $635,929,000 at December 31, 2013. During the year ended December 31, 2015, increases of $58,839,000 were experienced in net loans. Overnight interest-bearing deposits in the Federal Reserve Bank and federal funds sold increased a net $13,789,000, while investment securities decreased by $17,408,000 during the year ended December 31, 2015. Total deposits of $621,805,000 at December 31, 2015, increased $56,432,000 or 9.98% from the balance reported of $565,373,000 at December 31, 2014, and increased $79,316,000, or 14.62%, from the balance of $542,489,000 reported at December 31, 2013.
During the year ended December 31, 2014, increases of $62,602,000 were experienced in net loans. Overnight interest-bearing deposits in the Federal Reserve Bank and federal funds sold, decreased a net $32,790,000, while investment securities increased by $4,685,000 during the year ended December 31, 2014. Total deposits of $565,373,000 at December 31, 2014 increased $22,884,000, or 4.22%, from the balance reported at December 31, 2013 of $542,489,000, and $2,086,000 or 0.37% from the balance of $563,287,000 reported at December 31, 2012.
Earning assets averaged approximately $619,225,000 during the year ended December 31, 2015, as compared to $588,892,000 for the year ended December 31, 2014. Average interest-bearing liabilities increased to $364,963,000 for the year ended December 31, 2015, as compared to $351,511,000 for the year ended December 31, 2014.
Loans
The Company's primary business is that of acquiring deposits and making loans, with the loan portfolio representing the largest and most important component of its earning assets. Loans totaled $515,318,000 at December 31, 2015, representing an increase of $57,399,000 or 12.53% when compared to the balance of $457,919,000 at December 31, 2014. During 2015, average loans increased 16.70% when compared to the year ended December 31, 2014. Average loans totaled $493,375,000, $422,760,000, and $392,340,000 for the years ended December 31, 2015, 2014 and 2013, respectively.
34
The following table sets forth the amounts of loans outstanding by category and the category percentages as of the year-end dates indicated:
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||||||||||||
(In thousands) | Dollar Amount | % of Loans | Dollar Amount | % of Loans | Dollar Amount | % of Loans | Dollar Amount | % of Loans | Dollar Amount | % of Loans | |||||||||||||||||||
Commercial and Industrial | $ | 55,826 | 10.8 | % | $ | 62,369 | 13.6 | % | $ | 70,686 | 17.9 | % | $ | 72,117 | 18.0 | % | $ | 99,060 | 24.2 | % | |||||||||
Real estate mortgage | 252,232 | 48.9 | % | 214,877 | 46.9 | % | 197,365 | 49.9 | % | 189,934 | 47.5 | % | 182,131 | 44.6 | % | ||||||||||||||
RE construction & development | 130,596 | 25.3 | % | 137,158 | 30.0 | % | 87,004 | 22.0 | % | 90,941 | 22.7 | % | 70,877 | 17.3 | % | ||||||||||||||
Agricultural | 52,137 | 10.1 | % | 31,713 | 6.9 | % | 30,932 | 7.8 | % | 36,169 | 9.0 | % | 45,483 | 11.1 | % | ||||||||||||||
Installment/other | 24,527 | 4.9 | % | 11,802 | 2.6 | % | 9,330 | 2.4 | % | 10,884 | 2.7 | % | 11,115 | 2.8 | % | ||||||||||||||
Lease financing | — | — | % | — | — | % | — | — | % | 12 | 0.1 | % | 49 | — | % | ||||||||||||||
Total Loans | $ | 515,318 | 100.0 | % | $ | 457,919 | 100.0 | % | $ | 395,317 | 100.0 | % | $ | 400,057 | 100.0 | % | $ | 408,715 | 100.0 | % | |||||||||
Loan volume continues to be greatest in what has historically been the Bank’s primary lending emphasis: commercial, real estate mortgage, and construction lending. Total loans increased $57,399,000 during 2015. With continuing recovery in the real estate markets, the Company experienced increases of $37,355,000, or 17.4%, in real estate mortgage, which includes purchased residential mortgage pools, and an increase in commercial real estate of $27,882,000, or 18.03%. Commercial and industrial loans decreased $6,543,000 or 10.49%, agriculture loans increased $20,424,000, or 64.4% Installment loans increased $12,725,000, or 107.8% when compared to the previous year due to growth in the student loan portfolio.
During 2014, the Company experienced an increase of $50,154,000 or 57.6% in construction loans, an increase of $17,512,000 or 8.9% in real estate mortgage loans, an increase of $781,000 or 2.5% in agricultural loans and an increase of $2,472,000 or 26.5% in installment loans.
At December 31, 2015, approximately 53.4% 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. Residential housing markets regained some momentum in 2015, and as a result, real estate mortgage loans increased $37,355,000. However, real estate construction loans decreased $6,562,000 or 4.8% during 2015, as compared to an increase in real estate construction loans of $50,154,000 or 57.6% during 2014. 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 $20,424,000 or 64.4% between December 31, 2014 and December 31, 2015; and commercial loans consisting primarily of loans for non real estate business operations, decreased $6,543,000 or 10.49%. Installment loans increased $12,725,000 or 107.8% during that same period.
The real estate mortgage loan portfolio totaling $252,232,000 at December 31, 2015, consists of commercial real estate, residential mortgages, and home equity loans. Commercial real estate is the predominate segment of the portfolio, with balances of $182,554,000, and $154,672,000 at December 31, 2015 and 2014, 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 purchases mortgage portfolios. The residential real estate mortgage portfolio had balances of $68,811,000 and $59,095,000 at December 31, 2015 and 2014, respectively. The Company also offers short to medium-term, fixed-rate, home equity loans, which totaled $867,000 at December 31, 2015 and $1,110,000 at December 31, 2014.
The following table sets forth the maturities of the Bank's loan portfolio at December 31, 2015. Amounts presented are shown by maturity dates rather than repricing periods:
35
(In thousands) | Due in one year or less | Due after one year through five years | Due after five years | Total | |||||||||||
Commercial and agricultural | $ | 38,250 | $ | 37,942 | $ | 31,771 | $ | 107,963 | |||||||
Real estate construction & development | 47,438 | 83,059 | 99 | 130,596 | |||||||||||
Real estate – mortgage | 30,250 | 123,814 | 98,168 | 252,232 | |||||||||||
All other loans | 2,455 | 22,043 | 29 | 24,527 | |||||||||||
Total Loans | $ | 118,393 | $ | 266,858 | $ | 130,067 | $ | 515,318 | |||||||
For the year ended December 31, 2015 and 2014, the average yield on loans was 5.36% and 5.62%, respectively. This consistent yield was due in part to the Company utilizing rate floors intended to mitigate interest rate risk if interest rates fall, as well as to compensate the Company for additional credit risk under current market conditions. The Bank’s loan portfolio is generally comprised of short-term or floating rate loans and is therefore susceptible to fluctuations in market rates of interest.
At December 31, 2015 and 2014, approximately 43.2% and 39.9% of the Bank's loan portfolio consisted of floating rate instruments, with the majority of those tied to the prime rate.
The following table sets forth the contractual maturities of the Bank's fixed and floating rate loans at December 31, 2015. Amounts presented are shown by maturity dates rather than repricing periods, and do not consider renewals or prepayments of loans:
Due in one | Due after one Year through | Due after | |||||||||||||
(In thousands) | year or less | Five years | Five years | Total | |||||||||||
Accruing loans: | |||||||||||||||
Fixed rate loans | $ | 31,378 | $ | 214,196 | $ | 40,291 | $ | 285,865 | |||||||
Floating rate loans | 80,263 | 51,548 | 89,449 | 221,260 | |||||||||||
Total accruing loans | 111,641 | 265,744 | 129,740 | 507,125 | |||||||||||
Nonaccrual loans: | |||||||||||||||
Fixed rate loans | 5,719 | 1,113 | — | 6,832 | |||||||||||
Floating rate loans | 1,034 | — | 327 | 1,361 | |||||||||||
Total nonaccrual loans | 6,753 | 1,113 | 327 | 8,193 | |||||||||||
Total Loans | $ | 118,394 | $ | 266,857 | $ | 130,067 | $ | 515,318 | |||||||
Securities
Following is a comparison of the amortized cost and approximate fair value of available-for-sale for the years indicated:
December 31, 2015 | December 31, 2014 | ||||||||||||||||||||||||
(In thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value (Carrying Amount) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value (Carrying Amount) | |||||||||||||||||
Available-for-sale: | |||||||||||||||||||||||||
U.S. Government agencies | $ | 9,778 | $ | 453 | $ | (108 | ) | $ | 10,123 | $ | 12,097 | $ | 399 | $ | — | $ | 12,496 | ||||||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | 16,835 | 175 | (52 | ) | 16,958 | 31,659 | 336 | (13 | ) | 31,982 | |||||||||||||||
Mutual Funds | 4,000 | — | (188 | ) | 3,812 | 4,000 | — | (177 | ) | 3,823 | |||||||||||||||
Total available-for-sale | $ | 30,613 | $ | 628 | $ | (348 | ) | $ | 30,893 | $ | 47,756 | $ | 735 | $ | (190 | ) | $ | 48,301 | |||||||
36
The contractual maturities of investment securities as well as yields based on amortized cost of those securities at December 31, 2015 are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.
One year or less | After one year to five years | After five years to ten years | After ten years | Total | |||||||||||||||||||||
(Dollars in thousands) | Amount | Yield (1) | Amount | Yield (1) | Amount | Yield (1) | Amount | Yield (1) | Amount | Yield (1) | |||||||||||||||
Available-for-sale: | |||||||||||||||||||||||||
U.S. Government agencies | $ | — | — | % | $ | 13 | 2.55 | % | $ | 1,025 | 0.71 | % | $ | 8,740 | 1.36 | % | $ | 9,778 | 1.29 | % | |||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | — | — | % | 4,130 | 1.88 | % | 11,883 | 1.74 | % | 822 | 2.04 | % | 16,835 | 1.79 | % | ||||||||||
Mutual Funds | — | — | % | — | — | % | — | — | % | 4,000 | 2.02 | % | 4,000 | 2.02 | % | ||||||||||
Total estimated fair value | $ | — | — | % | $ | 4,143 | 1.88 | % | $ | 12,908 | 1.66 | % | $ | 13,562 | 1.60 | % | $ | 30,613 | 1.66 | % | |||||
(1) Weighted average yields are not computed on a tax equivalent basis | |||||||||||||||||||||||||
At December 31, 2015 and 2014, available-for-sale securities with an amortized cost of approximately $16,253,074 and $20,865,000, respectively (fair value of $16,670,290 and $21,503,000, respectively) were pledged as collateral for public funds and FHLB borrowings.
Deposits
The Bank attracts commercial deposits primarily from local businesses and professionals, as well as retail checking accounts, savings accounts and time deposits. Total deposits increased $56,432,000 or 9.98% during the year to a balance of $621,805,000 at December 31, 2015. Core deposits, consisting of all deposits other than time deposits of $250,000 or more and brokered deposits, continue to provide the foundation for the Bank's principal sources of funding and liquidity. These core deposits amounted to 96.9% and 95.8% of the total deposit portfolio at December 31, 2015 and 2014, respectively.
The following table sets forth the year-end amounts of deposits by category for the years indicated, and the dollar change in each category during the year:
December 31, | Change during Year | ||||||||||||||
(In thousands) | 2015 | 2014 | 2013 | 2015 | 2014 | ||||||||||
Noninterest-bearing deposits | $ | 262,168 | $ | 215,439 | $ | 214,317 | $ | 46,729 | $ | 1,122 | |||||
Interest-bearing deposits: | |||||||||||||||
NOW and money market accounts | 226,886 | 211,290 | 198,928 | 15,596 | 12,362 | ||||||||||
Savings accounts | 63,592 | 60,499 | 45,758 | 3,093 | 14,741 | ||||||||||
Time deposits: | |||||||||||||||
Under $250,000 | 58,122 | 65,844 | 73,829 | (7,722 | ) | (7,985 | ) | ||||||||
$250,000 and over | 11,037 | 12,301 | 9,657 | (1,264 | ) | 2,644 | |||||||||
Total interest-bearing deposits | 359,637 | 349,934 | 328,172 | 9,703 | 21,762 | ||||||||||
Total deposits | $ | 621,805 | $ | 565,373 | $ | 542,489 | $ | 56,432 | $ | 22,884 | |||||
The Company continues to have a low reliance on brokered and other wholesale funding sources. As of December 31, 2015, brokered deposits totaled 1.37% of total deposits, which the Company believes to be in line with peers.
During the year ended December 31, 2015, increases were experienced across all categories except for time deposits. Total time deposits decreased $8,986,000, or 11.50%, during the year ended December 31, 2015, and brokered deposits, a component of total time deposits, decreased slightly by $2,934,000, or 1.37%, during the year. Noninterest-bearing deposits increased $46,729,000 during the year and increases in savings accounts and NOW and money market accounts of $3,093,000, or 5.11%, and $15,596,000, or 7.38%, respectively, were also realized during the year ended December 31, 2015.
37
During the year ended December 31, 2014, increases were experienced across all categories except for time deposits. Total time deposits decreased $5,341,000, or 1.63%, during the year ended December 31, 2014, and brokered deposits, a component of total time deposits, decreased slightly by $20,000, or 2.03%, during the year. Noninterest bearing deposits increased $1,122,000 during the year. Additionally, increases in savings accounts and NOW and money market accounts of $14,741,000, or 32.22%, and $12,362,000, or 6.21%, respectively, were realized during the year ended December 31, 2014.
The Company's deposit base consists of two major components represented by noninterest-bearing (demand) deposits and interest-bearing deposits. Interest-bearing deposits consist of time certificates, NOW and money market accounts and savings deposits. Significant increases in deposits were realized during 2015. Total noninterest-bearing deposits increased $46,729,000, or 21.7%, between December 31, 2014 and December 31, 2015, and total interest-bearing deposits increased $9,703,000, or 2.8%, during the same period. Between December 31, 2013 and December 31, 2014, total interest-bearing deposits increased $21,762,000, or 6.6%, and total noninterest-bearing deposits increased $1,122,000, or 0.5%.
On a year-to-date average basis, total deposits increased $20,881,000, or 3.7%, between the years ended December 31, 2014 and December 31, 2015. Of that total, interest-bearing deposits increased by $14,723,000, or 4.3%, and noninterest-bearing deposits increased $6,158,000, or 2.67%, during 2015. On average, the Company experienced decreases in time deposits, while NOW accounts, money market and savings accounts increased between the years ended December 31, 2014 and December 31, 2015. On a year-to-date average basis, total deposits increased by $16,979,000 or 3.1% between the years ended December 31, 2013 and December 31, 2014. Of that total, interest-bearing deposits increased by $6,106,000 or 1.8%, while noninterest-bearing deposits increased $10,873,000 or 4.94% during 2014. On average, the Company experienced decreases in time deposits, while NOW accounts, money market and savings accounts increased between the years ended December 31, 2013 and December 31, 2014.
The following table sets forth the average deposits and average rates paid on those deposits for the years ended December 31, 2015, 2014, and 2013:
2015 | 2014 | 2013 | |||||||||||||
(Dollars in thousands) | Average Balance | Rate % | Average Balance | Rate % | Average Balance | Rate % | |||||||||
Interest-bearing deposits: | |||||||||||||||
Checking accounts | $ | 219,197 | 0.26 | % | $ | 206,878 | 0.28 | % | $ | 198,651 | 0.34 | % | |||
Savings | 62,163 | 0.26 | % | 52,681 | 0.25 | % | 42,837 | 0.20 | % | ||||||
Time deposits (1) | 74,193 | 0.44 | % | 81,271 | 0.48 | % | 93,236 | 0.61 | % | ||||||
Noninterest-bearing deposits | 237,034 | 230,876 | 220,003 | ||||||||||||
(1) Included at December 31, 2015, are $11,037,000 in time certificates of deposit of $250,000 or more, of which $11,383,000 matures in three months or less, $19,391,000 matures in three to twelve months, and $7,392,000 matures in more than twelve months.
Short-term Borrowings
The Company has the ability to obtain borrowed funds consisting of federal funds purchased, discount window borrowings, securities sold under agreements to repurchase (“repurchase agreements”) and Federal Home Loan Bank (“FHLB”) advances as alternatives to retail deposit funds. The Company has established collateralized and uncollateralized lines of credit with several correspondent banks, the FRB discount window, as well as a securities dealer, for the purpose of obtaining borrowed funds as needed. The Company may continue to borrow funds in the future as part of its asset/liability strategy, and may use these funds to acquire certain other assets as deemed appropriate by management for investment purposes and to better utilize the capital resources of the Bank. Federal funds purchased represent temporary overnight borrowings from correspondent banks and are generally unsecured. Repurchase agreements are collateralized by mortgage backed securities and securities of U.S. Government agencies, and generally have maturities of one to six months, but may have longer maturities if deemed appropriate as part of the Company’s asset/liability management strategy. FHLB advances are collateralized by the Company’s investment in FHLB stock, securities, and certain qualifying mortgage loans. In addition, the Company has the ability to obtain borrowings from the Federal Reserve Bank of San Francisco ("FRB"), collateralized by certain pledged loans in the Company’s loan portfolio. The lines of credit are subject to periodic review of the Company’s financial statements by the grantors of the credit lines. Lines of credit may be modified or revoked at any time if the grantors feel there are adverse trends in the Company’s financial position.
38
The Company had collateralized lines of credit with the FRB of $302,456,000 and $286,993,000, as well as FHLB lines of credit totaling $2,854,000 and $5,814,000 at December 31, 2015 and 2014, respectively. In addition, the Company obtained a $10,000,000 uncollateralized line of credit during 2013 from Pacific Coast Bankers Bank and a $20,000,000 uncollateralized line of credit during 2014 from Zion's Bank. At December 31, 2015, the Company had no outstanding balances drawn against any of its lines of credit. These lines of credit generally have interest rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR.
Asset Quality and Allowance for Credit Losses
Lending money is the Company's principal business activity, and ensuring appropriate evaluation, diversification, and control of credit risks is a primary management responsibility. Losses are implicit in lending activities and the amount of such losses will vary, depending on the risk characteristics of the loan portfolio as affected by local economic conditions and the financial experience of borrowers.
The allowance for credit losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in existing loans and commitments to extend credit. The adequacy of the allowance for credit losses is based upon management's continuing assessment of various factors affecting the collectability of loans and commitments to extend credit; including current economic conditions, past credit experience, collateral, and concentrations of credit. There is no precise method of predicting specific losses or amounts which may ultimately be charged off on particular segments of the loan portfolio. The conclusion that a loan may become uncollectible, either in part or in whole is judgmental and subject to economic, environmental, and other conditions which cannot be predicted with certainty. When determining the adequacy of the allowance for credit losses, the Company follows, in accordance with GAAP, the guidelines set forth in the Revised Interagency Policy Statement on the Allowance for Loan and Lease Losses (“Statement”) issued by banking regulators in December 2006. The Statement is a revision of the previous guidance released in July 2001, and outlines characteristics that should be used in segmentation of the loan portfolio for purposes of the analysis including risk classification, past due status, type of loan, industry or collateral. It also outlines factors to consider when adjusting the loss factors for various segments of the loan portfolio, and updates previous guidance that describes the responsibilities of the board of directors, management, and bank examiners regarding the allowance for credit losses. Securities and Exchange Commission Staff Accounting Bulletin No. 102 was released during July 2001, and represents the SEC staff’s view relating to methodologies and supporting documentation for the Allowance for Loan and Lease Losses that should be observed by all public companies in complying with the federal securities laws and the Commission’s interpretations. It is also generally consistent with the guidance published by the banking regulators.
The allowance for loan losses includes an asset-specific component, as well as a general or formula-based component. The Company segments the loan and lease portfolio into eleven (11) segments, primarily by loan class and type, that have homogeneity and commonality of purpose and terms for analysis under the formula-based component of the allowance. Those loans which are determined to be impaired under current accounting guidelines are not subject to the formula-based reserve analysis, and are instead evaluated individually for specific impairment under the asset-specific component of the allowance. The eleven segments of the Company’s loan portfolio are as follows (subtotals are provided as needed to allow the reader to reconcile the amounts to the Company’s loan classification reported elsewhere in these financial statements):
39
Loan Segments for Loan Loss Reserve Analysis | Loan Balances at December 31, | ||||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||
Commercial and Business Loans | $ | 54,503 | $ | 60,422 | $ | 68,460 | $ | 69,780 | $ | 96,076 | |||||
Government Program Loans | 1,323 | 1,947 | 2,226 | 2,337 | 2,984 | ||||||||||
Total Commercial and Industrial | 55,826 | 62,369 | 70,686 | 72,117 | 99,060 | ||||||||||
Commercial Real Estate Term Loans | 182,554 | 154,672 | 143,919 | 133,599 | 140,590 | ||||||||||
Single Family Residential Loans | 68,811 | 59,095 | 52,036 | 55,016 | 39,682 | ||||||||||
Home Improvement/Home Equity Loans | 867 | 1,110 | 1,410 | 1,319 | 1,859 | ||||||||||
Total Real Estate Mortgage | 252,232 | 214,877 | 197,365 | 189,934 | 182,131 | ||||||||||
RE Construction and Development Loans | 130,596 | 137,158 | 87,004 | 90,941 | 70,877 | ||||||||||
Agricultural Loans | 52,137 | 31,713 | 30,932 | 36,169 | 45,483 | ||||||||||
Consumer Loans | 24,527 | 11,802 | 9,330 | 10,639 | 10,907 | ||||||||||
Overdraft protection Lines | — | — | — | 90 | 85 | ||||||||||
Overdrafts | — | — | — | 155 | 124 | ||||||||||
Total Installment/other | 24,527 | 11,802 | 9,330 | 10,884 | 11,116 | ||||||||||
Commercial Lease Financing | — | — | — | 12 | 49 | ||||||||||
Total Loans | $ | 515,318 | $ | 457,919 | $ | 395,317 | $ | 400,057 | $ | 408,716 | |||||
The Company’s methodology for assessing the adequacy of the allowance for credit losses consists of several key elements, which include:
- the formula allowance,
- specific allowances for problem graded loans identified as impaired
- and the unallocated allowance
The formula allowance is calculated by applying loss factors to outstanding loans and certain unfunded loan commitments. Loss factors are based on the Company’s historical loss experience and on the internal risk grade of those loans and, may be adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date. Factors that may affect collectability of the loan portfolio include:
• | Levels of, and trends in delinquencies and nonaccrual loans; |
• | Trends in volumes and term of loans; |
• | Effects of any changes in lending policies and procedures including those for underwriting, collection, charge-off, and recovery; |
• | Experience, ability, and depth of lending management and staff; |
• | National and local economic trends and conditions and; |
• | Concentrations of credit that might affect loss experience across one or more components of the portfolio, including high-balance loan concentrations and participations. |
Management determines the loss factors for problem graded loans (substandard, doubtful, and loss), special mention loans, and pass graded loans, based on a loss migration model. The migration analysis incorporates loan losses over the previous quarters as determined by management (time horizons adjusted as business cycles or environment changes) and loss factors are adjusted to recognize and quantify the loss exposure from changes in market conditions and trends in the Company’s loan portfolio. For purposes of this analysis, loans are grouped by internal risk classifications and categorized as pass, special mention, substandard, doubtful, or loss. Certain loans are homogeneous in nature and are therefore pooled by risk grade. These homogeneous loans include consumer installment and home equity loans. Special mention loans are currently performing but are potentially weak, as the borrower has begun to exhibit deteriorating trends which, if not corrected, could jeopardize repayment of the loan and result in further downgrades. Substandard loans have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A loan classified as doubtful has critical weaknesses that make full collection of the obligation improbable. Classified loans, as defined by the Company, include impaired loans and loans categorized as substandard, doubtful, and loss which are not considered impaired. At December 31, 2015, “classified” loans totaled $39,512,000 or 7.67% of gross loans as compared to $34,358,000 or 7.50% of gross loans at December 31, 2014.
Loan participations are reviewed for allowance adequacy under the same guidelines as other loans in the Company’s portfolio, with an additional participation factor added, if required, for specific risks associated with participations. In general,
40
participations are subject to certain thresholds set by the Company, and are reviewed for geographic location as well as the well-being of the underlying agent bank.
The formula allowance includes reserves for certain off-balance sheet risks including letters of credit, unfunded loan commitments, and lines of credit. Reserves for undisbursed commitments are generally formula allocations based on the Company’s historical loss experience and other loss factors, rather than specific loss contingencies. At December 31, 2015 and 2014, the formula reserve allocated to undisbursed commitments totaled $299,000 and $294,000, respectively. The reserve for unfunded commitments is considered a reserve for contingent liabilities and is therefore carried as a liability on the balance sheet for all periods presented.
Specific allowances are established based on management’s periodic evaluation of loss exposure inherent in impaired loans. For impaired loans, specific allowances are determined based on the net realizable value of the underlying collateral, the net present value of the anticipated cash flows, or the market value of the underlying assets. Formula allowances for classified loans, excluding impaired loans, are determined on the basis of additional risks involved with individual loans that may be in excess of risk factors associated with the loan portfolio as a whole. The specific allowance is different from the formula allowance in that the specific allowance is determined on a loan-by-loan basis based on risk factors directly related to a particular loan, as opposed to the formula allowance which is determined for a pool of loans with similar risk characteristics, based on past historical trends and other risk factors which may be relevant on an ongoing basis.
The unallocated portion of the allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to, general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.
The following table summarizes the specific allowance, formula allowance, and unallocated allowance at December 31, 2015, 2014 and 2013.
(In thousands) | December 31, 2015 | December 31, 2014 | December 31, 2013 | ||||||
Specific allowance – impaired loans | $ | 3,097 | $ | 715 | $ | 762 | |||
Formula allowance – classified loans not impaired | 1,385 | 2,450 | 3,205 | ||||||
Formula allowance – special mention loans | 75 | 39 | 31 | ||||||
Total allowance for special mention and classified loans | 4,557 | 3,204 | 3,998 | ||||||
Formula allowance for pass loans | 5,086 | 6,739 | 6,595 | ||||||
Unallocated allowance | 70 | 847 | 395 | ||||||
Total allowance | 9,713 | 10,790 | 10,988 | ||||||
Impaired loans | 23,612 | 16,037 | 18,132 | ||||||
Classified loans not considered impaired | 15,900 | 18,321 | 20,233 | ||||||
Total classified loans | 39,512 | 34,358 | 38,365 | ||||||
Special mention loans not considered impaired | 2,562 | 1,766 | 1,825 | ||||||
The loan portfolio increased from $395,317,000 at December 31, 2013, to $457,919,000 at December 31, 2014, and increased to $515,318,000 at December 31, 2015. Nonperforming loans increased to $19,221,000 at December 31, 2015, from $15,576,000 at December 31, 2014, and $18,102,000 at December 31, 2013. Nonaccrual loans and accruing restructured loans are included in nonperforming loans. During the same period, total classified loans increased from $34,358,000 at December 31, 2014, to $39,512,000 at December 31, 2015.
41
(Dollars in thousands) | December 31, 2015 | December 31, 2014 | December 31, 2013 | ||||||
Allowance for loan losses - period end | $ | 9,713 | $ | 10,771 | $ | 10,988 | |||
Net loans charged off (recovered) during period | 1,017 | (629 | ) | (302 | ) | ||||
Recovery of provision for credit loss | (41 | ) | (845 | ) | (1,098 | ) | |||
Loans outstanding at period-end | 515,318 | 457,919 | 395,317 | ||||||
ALLL as % of loans at period-end | 1.88 | % | 2.35 | % | 2.78 | % | |||
Nonaccrual loans | 8,193 | 9,935 | 12,341 | ||||||
Restructured Loans | 11,028 | 5,641 | 5,761 | ||||||
Total nonperforming loans | 19,221 | 15,576 | 18,102 | ||||||
ALLL as % of nonperforming loans | 50.53 | % | 69.15 | % | 60.7 | % | |||
Impaired loans | 23,612 | 16,037 | 18,132 | ||||||
Classified loans not considered impaired | 15,900 | 18,321 | 20,233 | ||||||
Total classified loans | $ | 39,512 | $ | 34,358 | $ | 38,365 | |||
ALLL as % of classified loans | 24.58 | % | 31.35 | % | 28.64 | % | |||
Impaired loans increased $7,642,000 between December 31, 2014 and December 31, 2015 and the specific allowance related to those impaired loans increased $2,382,000 between December 31, 2014 and December 31, 2015. The formula allowance related to criticized loans that are not impaired (including special mention and substandard) decreased by $1,029,000 between December 31, 2014 and December 31, 2015. The reduction in nonaccrual loans between December 31, 2014 and December 31, 2015 is attributed to $1,412,000 in charge-offs during the period ended December 31, 2015. The level of “pass” loans increased approximately $51,377,000 between December 31, 2014 and December 31, 2015, while the related formula allowance decreased $1,653,000 during the same period. The formula allowance for “pass loans” is derived from the loan loss factors under migration analysis. Due to improvements in economic conditions and credit quality, less reserve is required for pass loans.
The Company’s methodology attempts to accurately estimate losses. The specific allowance portion of the analysis is designed to be self-correcting by taking into account the current loan loss experience based on that portion of the portfolio. By analyzing the estimated losses inherent in the loan portfolio on a quarterly basis, management is able to adjust specific and inherent loss estimates using the most recent information available. In performing the periodic migration analysis, management believes that historical loss factors used in the computation of the formula allowance need to be adjusted to reflect current changes in market conditions and trends in the Company’s loan portfolio. There are a number of other factors which are reviewed when determining adjustments in the historical loss factors. Those factors include 1) trends in delinquent and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes in lending policies, 4) concentrations of credit, 5) competition, 6) national and local economic trends and conditions, 7) experience of lending staff, 8) loan review and Board of Directors oversight, 9) high balance loan concentrations, and 10) other business conditions.
The general reserve requirements (ASC 450-70) decreased with the continued strengthening of local, state, and national economies and their impact on our local lending base, which has resulted in a lower qualitative component for the general reserve calculation. These positive factors were partially offset by the Company including OREO financial results in loss history and extending the look back period used to capture the loss history for the quantitative portion of the ALLL. In the third quarter of 2013, the look back period was changed from 4 years to stake-in-the-ground (December 31, 2005), in an effort to include higher losses experienced during the credit crisis. Changes in the mix of historical losses in the look back period resulted in a reallocation of the general reserve component of the allowance amount within the various loan segments as compared to December 31, 2015, as loss experience by segment has fluctuated over time. The stake-in-the-ground methodology requires the Company to use December 31, 2005 as the starting point of the look back period to capture loss history. Time horizons are subject to Management's assessment of the current period, taking into consideration changes in business cycles and environment changes.
Management and the Company’s lending officers evaluate the loss exposure of classified and impaired loans on a weekly/monthly basis and through discussions and officer meetings as conditions change. The Company’s Loan Committee meets weekly and also serves as a forum to discuss specific problem assets that pose significant concerns to the Company, and to keep the Board of Directors informed through committee minutes. All special mention and classified loans are reported quarterly on Problem Asset Reports and Impaired Loan Reports and are reviewed by senior management. Migration analysis and impaired
42
loan analysis are performed on a quarterly basis and adjustments are made to the allowance as deemed necessary. The Board of Directors is kept abreast of any changes or trends in problem assets on a monthly basis, or more often if required.
The specific allowance for impaired loans is measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans is not directly comparable to the amount of nonperforming loans disclosed later in this section. The primary differences between impaired loans and nonperforming loans are: i) all loan categories are considered in determining nonperforming loans while impaired loan recognition is limited to commercial and industrial loans, commercial and residential real estate loans, construction loans, and agricultural loans, and ii) impaired loan recognition considers not only loans 90 days or more past due, restructured loans and nonaccrual loans but may also include problem loans other than delinquent loans.
The Company considers a loan to be impaired when, based upon current information and events, it believes it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans include nonaccrual loans, troubled debt restructures, and performing loans in which full payment of principal or interest is not expected. Management bases the measurement of these impaired loans either on the fair value of the loan's collateral or the expected cash flows on the loans discounted at the loan's stated interest rates. Cash receipts on impaired loans not performing to contractual terms and that are on nonaccrual status are used to reduce principal balances. Impairment losses are included in the allowance for credit losses through a charge to the provision, if applicable.
At December 31, 2015 and 2014, the Company's recorded investment in loans for which impairment has been recognized totaled $23,679,000 and $16,037,000, respectively. Included in total impaired loans at December 31, 2015, are $16,404,000 of impaired loans for which the related specific allowance is $3,097,000, as well as $7,275,000 of impaired loans that as a result of write-downs or the fair value of the collateral, did not have a specific allowance. Total impaired loans at December 31, 2014 included $4,478,000 of impaired loans for which the related specific allowance was $715,000, as well as $11,559,000 of impaired loans that as a result of write-downs or the fair value of the collateral, did not have a specific allowance. The average recorded investment in impaired loans was $17,462,000 and $15,045,000 during the years ended December 31, 2015 and 2014, respectively. In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructuring for which the loan is performing under the current contractual terms, income is recognized under the accrual method.
The largest category of impaired loans at December 31, 2015 was real estate construction and development loans, comprising of 52.87% of total impaired loans at December 31, 2015. Impaired construction loans increased $6,148,000, impaired commercial and industrial loans increased $3,780,000, impaired real estate mortgage loans decreased $2,220,000, and impaired agricultural loans decreased $16,000 during the year ended December 31, 2015. Specific collateral related to impaired loans is reviewed for current appraisal information, economic trends within geographic markets, loan-to-value ratios, and other factors that may impact the value of the loan collateral. Adjustments are made to collateral values as needed for these factors. Of total impaired loans, approximately $10,730,000, or 45.3%, are secured by real estate at December 31, 2015, as compared to $13,961,000, or 87.1%, of total impaired loans at December 31, 2014. The following table summarizes the components of impaired loans and their related specific allowance at December 31, 2015, 2014 and 2013.
Balance | Allowance | Balance | Allowance | Balance | Allowance | ||||||||||||||||||
(In thousands) | December 31, 2015 | December 31, 2015 | December 31, 2014 | December 31, 2014 | December 31, 2013 | December 31, 2013 | |||||||||||||||||
Commercial and industrial | $ | 5,201 | $ | 530 | $ | 1,421 | $ | 64 | $ | 677 | $ | 9 | |||||||||||
Real estate – mortgage | 5,293 | 635 | 7,513 | 648 | 15,573 | 753 | |||||||||||||||||
Real estate construction and development | 12,519 | 1,282 | 6,371 | — | 1,789 | — | |||||||||||||||||
Agricultural | 16 | — | 32 | — | 45 | — | |||||||||||||||||
Installment/other | 650 | 650 | 700 | 3 | 48 | — | |||||||||||||||||
Lease financing | — | — | — | — | — | — | |||||||||||||||||
Total impaired loans | $ | 23,679 | $ | 3,097 | $ | 16,037 | $ | 715 | $ | 18,132 | $ | 762 | |||||||||||
Included in impaired loans are loans modified in troubled debt restructurings (TDRs), where concessions have been granted to borrowers experiencing financial difficulties in an attempt to enhance collection. The Company makes various types of concessions when structuring TDRs including rate reductions, payment extensions, and forbearance.
43
At December 31, 2015, residential mortgages comprised $3,533,000 of the $18,508,000 in TDRs and commercial real estate loans comprised $12,168,000 of total TDRs.
Total TDRs decreased by 19.59% at December 31, 2015, as compared to December 31, 2014. Nonaccrual TDRs decreased by 20.09% and accruing TDRs declined by 18.76% over the same period. All TDR categories decreased when compared on a year-over-year basis. Many of these credits are related to real estate projects that slowed significantly or stalled during the recession, leading the Company to pursue restructuring of the qualified credits allowing the real estate market time to recover and developers opportunity to finish projects at a slower pace. Concessions granted in these circumstances include lengthened maturities and/or rate reductions that enabled the borrower to finish the projects and may be entirely successful. In large part, current successes are related to a recovering real estate market.
The following tables summarizes TDRs by type, classified separately as nonaccrual or accrual, which are included in impaired loans at December 31, 2015 and December 31, 2014.
Total TDRs | Nonaccrual TDRs | Accruing TDRs | |||||||
(In thousands) | December 31, 2015 | December 31, 2015 | December 31, 2015 | ||||||
Commercial and industrial | $ | 898 | $ | 327 | $ | 571 | |||
Real estate - mortgage: | |||||||||
Commercial real estate | 1,243 | 1,243 | — | ||||||
Residential mortgages | 3,533 | — | 3,533 | ||||||
Home equity loans | — | — | — | ||||||
Total real estate mortgage | 4,776 | 1,243 | 3,533 | ||||||
Real estate construction and development | 5,722 | 5,259 | 463 | ||||||
Agricultural | 16 | — | 16 | ||||||
Installment/other | 650 | 650 | — | ||||||
Lease financing | — | — | — | ||||||
Total Troubled Debt Restructurings | $ | 12,062 | $ | 7,479 | $ | 4,583 | |||
Total TDRs | Nonaccrual TDRs | Accruing TDRs | |||||||
(In thousands) | December 31, 2014 | December 31, 2014 | December 31, 2014 | ||||||
Commercial and industrial | $ | 1,306 | $ | 421 | $ | 885 | |||
Real estate - mortgage: | |||||||||
Commercial real estate | 2,713 | 2,713 | — | ||||||
Residential mortgages | 4,225 | 1,084 | 3,141 | ||||||
Home equity loans | — | — | — | ||||||
Total real estate mortgage | 6,938 | 3,797 | 3,141 | ||||||
Real estate construction and development | 6,029 | 5,141 | 888 | ||||||
Agricultural | 32 | — | 32 | ||||||
Installment/other | 695 | — | 695 | ||||||
Lease financing | — | — | — | ||||||
Total Troubled Debt Restructurings | $ | 15,000 | $ | 9,359 | $ | 5,641 | |||
Of the $12,062,000 in total TDRs at December 31, 2015, $7,479,000 were on nonaccrual status at period-end. Of the $15,000,000 in total TDRs at December 31, 2014, $9,359,000 were on nonaccrual status at period-end. As of December 31, 2015, the Company has no commercial real estate (CRE) workouts whereby an existing loan was restructured into multiple new loans (i.e., A Note/B Note structure).
For a restructured loan to return to accrual status there needs to be at least 6 months successful payment history. In addition, the Company’s Credit Administration performs a financial analysis of the credit to determine whether the borrower has the ability to continue to perform successfully over the remaining life of the loan. This includes, but is not limited to, a review of financial statements and a cash flow analysis of the borrower. Only after determining that the borrower has the ability to perform under the terms of the loans will the restructured credit be considered for accrual status.
44
The following table summarizes special mention loans by type for the years ended December 31, 2015 and December 31, 2014.
(In thousands) | December 31, 2015 | December 31, 2014 | |||||
Commercial and industrial | $ | 946 | $ | 342 | |||
Real estate - mortgage: | |||||||
Commercial real estate | 1,616 | 1,095 | |||||
Residential mortgages | — | 216 | |||||
Home equity loans | — | — | |||||
Total real estate mortgage | 1,616 | 1,311 | |||||
RE construction & development | — | — | |||||
Agricultural | — | 113 | |||||
Installment/other | — | — | |||||
Lease financing | — | — | |||||
Total Special Mention Loans | $ | 2,562 | $ | 1,766 | |||
The Company focuses on competition and other economic conditions within its market area and other geographical areas in which it does business, which may ultimately affect the risk assessment of the portfolio. The Company continues to experience increased competition from major banks, local independents and non-bank institutions affects loan pricing. Low interest rates and a weaker economy continue to dominate, even though real estate prices show signs of stabilization. The Company continues to place increased emphasis on reducing both the level of nonperforming assets and the level of losses on the disposition of these assets. It is in the best interest of both the Company and the borrowers to seek alternative options to foreclosure in an effort to reduce the impacts on the real estate market. As part of this strategy, the Company has agreed to increasing its level of troubled debt restructurings, when doing so makes economic sense. While business and consumer spending show improvement in recent quarters, current GDP remains anemic. It is difficult to forecast what impact the Federal Reserve actions to hold rates low will have on the economy. Local unemployment rates in the San Joaquin Valley have improved, but remain elevated compared with other regions and historically are higher as a result of the area's agricultural dynamics. The Company believes that the Central San Joaquin Valley will continue to grow and diversify as property and housing costs remain low relative to other areas of the state. Management recognizes increased risk of loss due to the Company's exposure to local and worldwide economic conditions, as well as potentially volatile real estate markets, and takes these factors into consideration when analyzing the adequacy of the allowance for credit losses.
The following table provides a summary of the Company's allowance for credit losses, provisions made to that allowance, and charge-off and recovery activity affecting the allowance for the years indicated.
45
December 31, | |||||||||||||||
(Dollars in thousands) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||
Total loans outstanding at end of period before deducting allowances for credit losses | $ | 515,376 | $ | 457,595 | $ | 395,013 | $ | 400,033 | $ | 408,715 | |||||
Average net loans outstanding during period | 493,375 | 422,760 | 392,340 | 398,377 | 424,961 | ||||||||||
Balance of allowance at beginning of period | 10,771 | 10,988 | 11,784 | 13,648 | 16,520 | ||||||||||
Loans charged off: | |||||||||||||||
Real estate | — | (200 | ) | (635 | ) | (630 | ) | (7,224 | ) | ||||||
Commercial, Industrial & Agricultural | (1,397 | ) | (318 | ) | (678 | ) | (3,397 | ) | (9,340 | ) | |||||
Commercial lease financing | — | — | — | — | (110 | ) | |||||||||
Installment and other | (489 | ) | (16 | ) | (273 | ) | (251 | ) | (620 | ) | |||||
Total loans charged off | (1,886 | ) | (534 | ) | (1,586 | ) | (4,278 | ) | (17,294 | ) | |||||
Recoveries of loans previously charged off: | |||||||||||||||
Real estate | 225 | 728 | 1,538 | 698 | 159 | ||||||||||
Commercial and industrial & agricultural | 630 | 330 | 279 | 648 | 650 | ||||||||||
Installment and other | 14 | 104 | 71 | 49 | 11 | ||||||||||
Total loan recoveries | 869 | 1,162 | 1,888 | 1,395 | 820 | ||||||||||
Net loans (charged off) recovered | (1,017 | ) | 628 | 302 | (2,883 | ) | (16,474 | ) | |||||||
Provision charged to operating expense | (41 | ) | (845 | ) | (1,098 | ) | 1,019 | 13,602 | |||||||
Balance of allowance for credit losses at end of period | $ | 9,713 | $ | 10,771 | $ | 10,988 | $ | 11,784 | $ | 13,648 | |||||
Net loan (recoveries) charge-offs to total average loans | 0.21 | % | (0.15 | )% | (0.08 | )% | 0.74 | % | 3.88 | % | |||||
Net loan (recoveries) charge-offs to loans at end of period | 0.20 | % | (0.14 | )% | (0.08 | )% | 0.72 | % | 4.03 | % | |||||
Allowance for credit losses to total loans at end of period | 1.88 | % | 2.35 | % | 2.78 | % | 2.95 | % | 3.34 | % | |||||
Net loan (recoveries) charge-offs to allowance for credit losses | 10.47 | % | (5.84 | )% | (2.75 | )% | 24.47 | % | 120.71 | % | |||||
Net loan charge-offs (recoveries) to provision for credit losses | 5.38 | % | (134.55 | )% | (27.50 | )% | 282.92 | % | 121.11 | % | |||||
Loan charge-offs increased $1,352,000 during the year ended December 31, 2015, when compared to the year ended December 31, 2014. Loan recoveries decreased $293,000 during the same period. Net loan charge-offs totaled $1,380,000 during the fourth quarter, consisting primarily of one installment loan and one commercial and industrial loan. The loans charged off during fourth quarter 2015 had been fully reserved for since first quarter 2015.
The following is a summary of the quarterly activity in the allowance for loan losses for the year ended December 31, 2015 (in thousands).
Description | Loss | Recoveries | Provision | Balance | ||||||||
Balance Forward | $ | 10,771 | ||||||||||
1st quarter - 2015 | $ | 218 | $ | 278 | $ | 459 | 11,290 | |||||
2nd quarter- 2015 | 190 | 454 | (2 | ) | 11,552 | |||||||
3rd quarter - 2015 | 11 | 50 | (23 | ) | 11,568 | |||||||
4th quarter - 2015 | 1,467 | 87 | (475 | ) | 9,713 | |||||||
Total YTD - 2015 | $ | 1,886 | $ | 869 | $ | (41 | ) | $ | 9,713 | |||
At December 31, 2015 and 2014, $299,000 and $294,000, respectively, of the formula allowance is allocated to unfunded loan commitments and is, therefore, carried separately in other liabilities.
46
Management believes that the 1.88% credit loss allowance to total loans at December 31, 2015 is adequate to absorb known and inherent risks in the loan portfolio. No assurance can be given, however, that economic conditions may materialize which differ and more adversely affect the Company's service areas or other circumstances will not be reflected in increased losses in the loan portfolio. Management is not currently aware of any conditions that may adversely affect the levels of losses incurred in the Company’s loan portfolio.
Although the Company does not normally allocate the allowance for credit losses to specific loan categories, an allocation to the major categories has been made for the purposes of this report as set forth in the following table. The allocations are estimates based on the same factors as considered by management in determining the amount of additional provisions to the credit loss allowance and the overall adequacy of the allowance for credit losses.
2015 | 2014 | 2013 | 2012 | 2011 | |||||||||||||||||||||||||
(Dollars in thousands) | Allowance for Credit Losses | % of Loans | Allowance for Credit Losses | % of Loans | Allowance for Credit Losses | % of Loans | Allowance for Credit Losses | % of Loans | Allowance for Credit Losses | % of Loans | |||||||||||||||||||
Commercial and industrial | $ | 1,652 | 10.8 | % | $ | 1,218 | 13.6 | % | $ | 2,340 | 18.0 | % | $ | 1,614 | 18.0 | % | $ | 4,782 | 40.7 | % | |||||||||
Real estate – mortgage | 1,449 | 48.9 | % | 1,653 | 46.9 | % | 1,862 | 47.6 | % | 1,292 | 47.6 | % | 2,070 | 35.4 | % | ||||||||||||||
RE construction and development | 4,629 | 25.3 | % | 6,278 | 30.0 | % | 5,533 | 22.7 | % | 2,814 | 22.7 | % | 5,634 | 12.3 | % | ||||||||||||||
Agricultural | 655 | 10.1 | % | 482 | 6.9 | % | 583 | 9.0 | % | 352 | 9.0 | % | 803 | 8.8 | % | ||||||||||||||
Installment/other | 1,258 | 4.9 | % | 293 | 2.6 | % | 275 | 2.7 | % | 288 | 2.7 | % | 117 | 2.8 | % | ||||||||||||||
Lease financing | — | — | % | — | — | % | — | — | % | 1 | — | % | 1 | — | % | ||||||||||||||
Not allocated | 70 | — | % | 847 | — | % | 395 | — | % | 5,423 | — | % | 241 | — | % | ||||||||||||||
$ | 9,713 | 100.0 | % | $ | 10,771 | 100.0 | % | $ | 10,988 | 100.0 | % | $ | 11,784 | 100.0 | % | $ | 13,648 | 100.0 | % | ||||||||||
During 2015, reserve allocations decreased for real estate mortgage and real estate construction and development loans. Increases in reserve allocation for agricultural, and installment loans are primarily due to the growth of those loan segments.
During 2014, reserve allocations decreased for commercial and industrial loans, real estate mortgage loans, and agricultural loans. Increases in the reserve allocation for real estate construction and development loans was primarily due to the growth of that loan segment.
During 2013, reserve allocations increased in all categories during the year, except for small decreases in the reserve for installment loans. Increases in reserve allocations for most categories were the result of increased loss factors, which decreased the unallocated portion of the reserve.
The following summarizes the Company’s allowance for credit losses related to the specific, formula, and unallocated reserves for the year-ends shown:
December 31, | |||||||||||||||
(In thousands) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||
Formula allowance | $ | 6,546 | $ | 9,209 | $ | 9,831 | $ | 5,703 | $ | 12,153 | |||||
Specific allowance | 3,097 | 715 | 762 | 658 | 1,254 | ||||||||||
Unallocated allowance | 70 | 847 | 395 | 5,423 | 241 | ||||||||||
Total allowance | $ | 9,713 | $ | 10,771 | $ | 10,988 | $ | 11,784 | $ | 13,648 | |||||
At December 31, 2015, the allowance for credit losses totaled $9,713,000, and consisted of $6,546,000 in formula allowance, $3,097,000 in specific allowance, and $70,000 in unallocated allowance. At December 31, 2015, $1,282,000 of the specific allowance was allocated to real estate construction and development, $635,000 was allocated to real estate mortgage loans, $530,000 was allocated to commercial and industrial loans, and the remaining $650,000 was allocated to installment loans.
47
At December 31, 2014, the allowance for credit losses totaled $10,771,000, and consisted of $9,209,000 in formula allowance, $715,000 in specific allowance, and $847,000 in unallocated allowance. At December 31, 2014, $648,000 of the specific allowance was allocated to real estate loans, $64,000 was allocated to commercial and industrial loans, and the remaining $3,000 was allocated to installment loans.
At December 31, 2013, the allowance for credit losses totaled $10,988,000, and consisted of $9,831,000 in formula allowance, $762,000 in specific allowance, and $395,000 in unallocated allowance. At December 31, 2013, $753,000 of the specific allowance was allocated to real estate loans, and the remaining $9,000 was allocated to commercial and industrial loans.
The total formula allowance decreased $2,682,000 between 2014 and 2015 and the specific allowance increased $2,382,000. The unallocated allowance decreased to $70,000 from $847,000. The increase in the specific allowance and decrease in the unallocated allowance were primarily the result of an increase in impaired loans. The decrease in total formula allowance is the result of a decline in net loss factors and improvement of qualitative factors during 2015.
The total formula allowance decreased $603,000 between 2013 and 2014 and the specific allowance decreased $47,000. The unallocated allowance rose to $847,000. The decrease in formula allowance is due to the decrease in substandard loans and improvement of qualitative factors between 2013 and 2014. The increase in unallocated allowance is due to a reduction in impaired and substandard loans during 2014.
The total formula allowance increased approximately $4,128,000 between 2012 and 2013, due to an increase in the reserve factor as the Company reviewed and updated their allowance for loan loss methodology during the year.
The total formula allowance decreased approximately $6,450,000 between 2011 and 2012, primarily due to a decrease in the percentage loss factors as well as the Company's internal review of loan classification definitions as they pertain to risk.
There were no loans classified as doubtful at December 31, 2015 or December 31, 2014.
Although in some instances, the downgrading of a loan resulting from the factors used by the Company in its allowance analysis has been reflected in the formula allowance, management believes that in some instances, the impact of material events and trends not known are not reflected in the level of nonperforming loans or the internal risk grading process regarding these loans. Accordingly, the Company’s evaluation of probable losses related to these factors may be reflected in the unallocated allowance. The evaluation of the inherent losses concerning these factors involves a higher degree of uncertainty because they are not identified with specific problem credits, and therefore the Company does not allocate the unallocated allowance among segments of the portfolio. At December 31, 2015 and December 31, 2014, the Company had unallocated allowances of $70,000 and $847,000. Management’s estimates of the unallocated allowance are based upon a number of underlying factors including 1) the effect of deteriorating national and local economic trends, 2) the effects of export market conditions on certain agricultural and manufacturing borrowers, 3) the effects of abnormal weather patterns on agricultural borrowers, as well as other borrowers that may be impacted by such conditions, 4) the effect of increased competition in the Company’s market area and the resultant potential impact of more relaxed underwriting standards to borrowers with multi-bank relationships, 5) the effect of soft real estate markets, and 6) the effects of having a larger number of borrowing relationships which are close to the Company’s lending limit, which, if any one were not to perform to contractual terms, would have a material impact on the allowance.
While the Company's loan portfolio has elevated concentrations in commercial real estate, commercial, and construction loans, the portfolio percentages fall within the Company's loan policy guidelines.
It is the Company's policy to discontinue the accrual of interest income on loans for which reasonable doubt exists with respect to the timely collectability of interest or principal due to the inability of the borrower to comply with the terms of the loan agreement. Such loans are placed on nonaccrual status whenever the payment of principal or interest is 90 days past due or earlier when the conditions warrant, and interest collected is thereafter credited to principal to the extent necessary to eliminate doubt as to the collectability of the net carrying amount of the loan. Management may grant exceptions to this policy if the loans are well secured and in the process of collection.
The following table sets forth the Company’s nonperforming assets as of the dates indicated:
48
December 31, | |||||||||||||||
(Dollars in thousands, except footnote) | 2015 | 2014 | 2013 | 2012 | 2011 | ||||||||||
Nonaccrual loans (1) | $ | 8,193 | $ | 9,935 | $ | 12,341 | $ | 13,425 | $ | 18,098 | |||||
Accruing restructured loans | 11,028 | 5,641 | 5,761 | 9,716 | 11,885 | ||||||||||
Total non-performing loans | 19,221 | 15,576 | 18,102 | 23,141 | 29,983 | ||||||||||
Other real estate owned | 12,873 | 14,010 | 13,946 | 23,932 | 27,091 | ||||||||||
Total non-performing assets | $ | 32,094 | $ | 29,586 | $ | 32,048 | $ | 47,073 | $ | 57,074 | |||||
Loans, past due 90 days or more, still accruing | — | — | — | — | 74 | ||||||||||
Non-performing loans to total gross loans | 3.73 | % | 3.40 | % | 4.58 | % | 5.78 | % | 7.34 | % | |||||
Non-performing assets to total gross loans | 6.23 | % | 6.47 | % | 8.11 | % | 11.77 | % | 14.96 | % | |||||
Allowance for loan losses to nonperforming loans | 50.53 | % | 69.15 | % | 60.70 | % | 50.92 | % | 45.52 | % | |||||
(1) Included in nonaccrual loans at December 31, 2015 and 2014 are restructured loans totaling $7,480,000 and $9,359,000, respectively.
Non-performing assets remain elevated at December 31, 2015, but have increased $2,508,000 between December 31, 2014 and December 31, 2015, due to a decrease in nonaccrual loans of $1,742,000, a decrease of $1,059,000 in accruing restructured loans, and a decrease of $1,137,000 in other real estate owned. There was one write-down of $188,000 for other real estate owned during the year ended December 31, 2015.
Non-performing assets decreased $2,462,000 between December 31, 2013 and December 31, 2014, due to a decrease in nonaccrual loans of $2,406,000, partially offset by an increase in other real estate owned of $64,000. There were no write-downs to other real estate owned during the year ended December 31, 2014.
Non-performing assets decreased $15,025,000 between December 31, 2012 and December 31, 2013, due to decreases in restructured loans of $3,995,000, and decreases in nonaccrual loans and other real estate owned of $1,084,000 and $9,986,000, respectively. The net decrease in other real estate owned includes additions of approximately $437,000 in properties transferred from loans, write-downs of $214,000, and gross sales of more than $11,454,000 during the year ended December 31, 2013.
Non-performing assets decreased $10,001,000 between December 31, 2011 and December 31, 2012. Nonaccrual loans decreased $4,673,000 between December 31, 2011 and December 31, 2012, while restructured loans not included in the nonaccrual totals decreased $2,169,000. The net decrease of $3,159,000 in other real estate owned includes additions of approximately $2,436,000 in properties transferred from loans, write-downs of $463,000 and gross sales of more than $7,472,000 during the year ended December 31, 2012.
The following table summarizes the nonaccrual totals by loan category for the periods shown:
Balance | Change from | |||||||||||||||||||
(In thousands) | December 31, 2015 | December 31, 2014 | December 31, 2013 | December 31, 2014 | December 31, 2013 | |||||||||||||||
Commercial and industrial | $ | 328 | $ | 433 | $ | — | $ | (105 | ) | $ | 328 | |||||||||
Real estate - mortgage | 1,635 | 4,361 | 11,873 | (2,726 | ) | (10,238 | ) | |||||||||||||
Real estate - construction | 5,580 | 5,141 | 468 | 439 | 5,112 | |||||||||||||||
Agricultural | — | — | — | — | — | |||||||||||||||
Installment/other | 650 | — | — | 650 | 650 | |||||||||||||||
Total Nonaccrual Loans | $ | 8,193 | $ | 9,935 | $ | 12,341 | $ | (1,742 | ) | $ | (4,148 | ) | ||||||||
Loans past due more than 30 days are receiving increased management attention and are monitored for increased risk. The Company continues to move past due loans to nonaccrual status in its ongoing effort to recognize loan problems at an earlier point in time when they may be dealt with more effectively. As impaired loans, nonaccrual and restructured loans are reviewed for specific reserve allocations and the allowance for credit losses is adjusted accordingly.
Except for the loans included in the above tables, there were no loans at December 31, 2015, where the known credit problems of a borrower caused the Company to have serious doubts as to the ability of such borrower to comply with the present loan
49
repayment terms and which would result in such loan being included as a nonaccrual, past due or restructured loan at some future date.
Liquidity and Asset/Liability Management
The primary function of asset/liability management is to provide adequate liquidity and maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities.
Liquidity
Liquidity management may be described as the ability to maintain sufficient cash flows to fulfill both on- and off-balance sheet financial obligations, including loan funding commitments and customer deposit withdrawals, without straining the Company’s equity structure. To maintain an adequate liquidity position, the Company relies on, in addition to cash and cash equivalents, cash inflows from deposits and short-term borrowings, repayments of principal on loans and investments, and interest income received. The Company's principal cash outflows are for loan origination, purchases of investment securities, depositor withdrawals and payment of operating expenses. Other sources of liquidity not on the balance sheet at December 31, 2015, include unused collateralized and uncollateralized lines of credit from other banks, the Federal Home Loan Bank, Pacific Coast Banker's Bank, Zion's Bank, and from the Federal Reserve Bank totaling $315,310,000.
Cash and cash equivalents have fluctuated during the three years ended December 31, 2015, 2014, and 2013, with period-end balances as follows (from Consolidated Statements of Cash Flows – in 000’s):
Balance | |||
December 31, 2015 | $ | 125,751 | |
December 31, 2014 | $ | 103,577 | |
December 31, 2013 | $ | 135,212 | |
Cash and cash equivalents increased $22,174,000 during the year ended December 31, 2015, as compared to a decrease of $31,635,000 during the year ended December 31, 2014.
The Company had a net cash inflow from operations of $9,264,000 for the year ended December 31, 2015, and a positive cash inflow from operations totaling $9,002,000 for the period ended December 31, 2014. The Company experienced net cash outflows from investing activities totaling $41,722,000 and net cash outflows of $63,616,000 during the years ended December 31, 2015 and December 31, 2014. For the year ended December 31, 2015, increases in loans outweighed proceeds from sales of OREO and maturities and principal payments on available for sale securities. For the year ended December 31, 2014, the growth in loans and purchases of available for sale securities outweighed principal payments on securities and proceeds from sale of OREO.
During the year ended December 31, 2015, the Company experienced net cash inflows from financing activities totaling $54,632,000, primarily as the result of increases in demand deposit and savings accounts. For the year ended December 31, 2014, the Company experienced net cash inflows of $22,979,000 primarily as the result of increases in demand deposits and savings accounts.
Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or the Company may become unduly reliant on alternative funding sources. The Company maintains a liquidity risk management policy to address and manage this risk. The policy identifies the primary sources of liquidity, sets wholesale funding limits, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements, which comply with regulatory guidance. The liquidity position is continually monitored and reported on a monthly basis to the Board of Directors.
The policy also includes a contingency funding plan to address liquidity needs in the event of an institution-specific or a systemic financial market crisis. In addition to unused lines of credit from other banks totaling $315,310,000, the contingency plan includes identified funding sources, and steps that may be taken in the event the total liquidity ratio falls or is projected to fall below policy limits for any extended period of time. One of the primary directives of the contingency funding plan is to limit the Company’s overall level of wholesale funding to no more than 40% of deposits. The current funding program uses both asset-based and liability-based principles, and identifies core deposits as the favored funding source when attainable at a reasonable cost. The policy identifies a number of funding sources or methods the Bank ALCO committee may utilize to fulfill the Company’s liquidity funding requirements:
50
1) | Local core deposits are the Company’s primary funding source. The Company works to attract these deposits through service-related and competitive pricing tactics. Other liquidity funding sources are considered if local core deposits are not attractive because of maturity or pricing. |
2) | Unsecured Federal Funds lines with correspondent banks may be used to fund short-term peaks in loan demand or deposit run-off. Currently, unsecured borrowing lines with correspondents are limited and may not be reliable for long periods of time or in times of economic stress. |
3) | Other funding sources such as secured credit lines with the Federal Home Loan Bank or the Federal Reserve may be used for longer periods. The Company collateralized these available lines with a combination of investment securities and pledged loans. The Company has utilized specific loan pledging with both the FHLB and the Federal Reserve to better ensure the continued availability of those lines of credit. |
4) | The Company presently has a Discount Window facility available from the Federal Reserve Bank of San Francisco collateralized with loans as discussed above. At December 31, 2015, the Company had available credit of $302,456,000 from the Federal Reserve based upon the loans pledged at that date. The Federal Reserve will monitor use of the Discount Window closely given the current status of the Company and the economy as a whole. This credit facility may not be competitively priced under certain economic conditions. As such, the Company does not expect to use this facility except for short periods, but does consider this to be a key contingency funding source. |
5) | As long as the Bank remains “Well Capitalized,” the Company may rely on brokered deposits when core deposit rates are higher in the marketplace or maturity structures are not desirable. The Company’s current policy limit for brokered deposits is 25% of total deposits. The Company may also utilize other wholesale deposit sources such as memberships that advertise the Bank’s time deposit rates to other subscribers, typically banks and credit unions. The Company’s current policy limit on other wholesale deposits is 10% of total deposits. |
6) | The Bank may sell whole loans or participations in loans to provide additional liquidity. During economic downturns or other crises events, these funding sources may be difficult to achieve in a short period of time or at a reasonable price. As such, this strategy is better used as a long-term asset/liability management tool to effectively balance assets and liabilities to reduce liquidity risk. |
7) | The Company currently has Bank-Owned Life Insurance (BOLI) and Corporate-Owned Life Insurance (COLI) policies issued by highly rated insurance companies which may be sold to increase liquidity. |
8) | The Company owns certain real estate including its administration building and several of its branches. These may be sold and vacated or leased back from the purchaser after sale to provide additional liquidity if needed. The sales process may require substantial time to complete, and may have an adverse impact on earnings depending on market rates and other factors at the time of sale. |
9) | Investments near maturity may be sold to meet temporary funding needs but may need to be replaced to maintain liquidity ratios within acceptable limits. At the current time approximately half of the investment portfolio is pledged to secure public deposits and borrowing lines. The Company seeks to maintain an investment-grade securities portfolio to ensure quality collateral for pledging against borrowing lines of credit as well as to provide liquidity in times of needs. |
The Company's liquid asset base which generally consists of cash and due from banks, federal funds sold, securities purchased under agreements to resell (“reverse repos”) and investment securities, are maintained at levels deemed sufficient to provide the cash necessary to fund loan growth as well as projected deposit runoff. Within this framework is the objective of maximizing the yield on earning assets. This is generally achieved by maintaining a high percentage of earning assets in loans, which historically have represented the Company's highest yielding asset. At December 31, 2015, the Bank had 71.02% of total assets in the loan portfolio and a loan to deposit ratio of 82.88%, as compared to 69.00% of total assets in the loan portfolio and a loan to deposit ratio of 80.94% at December 31, 2014. Liquid assets at December 31, 2015 include cash and cash equivalents totaling $125,751,000, as compared to $103,577,000 at December 31, 2014.
Liabilities used to fund liquidity sources include core and non-core deposits as well as short-term borrowings capability. Core deposits, which comprise approximately 90.25% of total deposits at December 31, 2015, provide a significant and stable funding source for the Company. At December 31, 2015, unused lines of credit with the Federal Home Loan Bank, Pacific Coast Banker's Bank, Zion's Bank, and the Federal Reserve Bank totaling $315,310,000 are collateralized in part by certain qualifying loans in the Company’s loan portfolio. The carrying value of loans pledged on these used and unused borrowing lines totaled $444,596,000 at December 31, 2015. For further discussion of the Company’s borrowing lines, see “Short Term Borrowings” included previously in the financial condition section of this financial review.
51
The liquidity of the parent company, United Security Bancshares, is primarily dependent on the payment of cash dividends by its subsidiary, United Security Bank, subject to limitations imposed by the Financial Code of the State of California. The Bank currently has limited ability to pay dividends or make capital distributions (see Dividends section included in Regulatory Matters of this Management’s Discussion). The limited ability of the Bank to pay dividends may impact the ability of the Company to fund its ongoing liquidity requirements including ongoing operating expenses, as well as quarterly interest payments on the Company’s junior subordinated debt (Trust Preferred Securities.) Beginning the quarter ended March 31, 2009, the Bank precluded from paying a cash dividend to the Company. To conserve cash and capital resources, the Company
elected at March 31, 2009 to defer the payment of interest on its junior subordinated debt beginning with the quarterly payment
due October 1, 2009. Since the second quarter of 2014, the Bank has received approval quarterly from the Federal Reserve Bank to upstream a dividend to the parent company for the purpose of payment of interest on the Company's junior
subordinated debt and for the parent company's operating expenses. During the year ended December 31, 2015, the Bank paid $2,416,000 in cash dividends to the parent company. The Bank paid $1,519,000 in dividends to the parent company during the year ended December 31, 2014, and paid no dividends during the year ended December 31, 2013.
52
Regulatory Matters
Regulatory Agreement with the Federal Reserve Bank of San Francisco
On March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a formal written agreement (the “Agreement”) with the Federal Reserve Bank of San Francisco (the “Federal Reserve”) as a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions (the “DFI”) in June 2009. That examination found significant increases in nonperforming assets, both classified loans and OREO, during 2008 and 2009, and heightened concerns about the Bank’s use of brokered and other wholesale funding sources to fund loan growth, which created increased risk to equity capital and potential volatility in earnings.
Under the terms of the Agreement, the Company and the Bank agreed, among other things: to maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses; to improve the management of the Bank's liquidity position and funds management policies; to maintain sufficient capital at the Company and Bank level; and to improve the Bank’s earnings and overall condition. The Company and Bank also agreed not to increase or guarantee any debt, purchase or redeem any shares of stock, declare or pay any cash dividends, or pay interest on the Company's junior subordinated debt or trust preferred securities, without prior written approval from the Federal Reserve. The Company generates no revenue of its own and, as such, relies on dividends from the Bank to pay its operating expenses and interest payments on the Company’s junior subordinated debt.
Effective November 19, 2014, the Federal Reserve terminated the Agreement with the Bank and the Company and replaced it with an informal supervisory agreement that requires, among other things, obtaining written approval from the Federal Reserve prior to the payment of dividends from the Bank to the Company or the payment of dividends by the Company or interest on the Company’s junior subordinated debt. The inability of the Bank to pay cash dividends to the Company may hinder the Company’s ability to meet its ongoing operating obligations.
Regulatory Order from the California Department of Business Oversight
On May 20, 2010, the DFI (now known as the Department of Business Oversight (the “DBO”)) issued a formal written order (the “Order”) pursuant to a consent agreement with the Bank as a result of the same June 2009 joint regulatory examination. The terms of the Order were essentially similar to the Federal Reserve’s Agreement, except for a few additional requirements.
On September 24, 2013, the Bank entered into an informal Memorandum of Understanding (the “MOU”) with the DBO and on October 15, 2013, the Order was terminated. The Order and the MOU require the Bank to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0% and also requires the DBO’s approval for the Bank to pay a dividend to the Company.
Accordingly, reflecting the Company’s and the Bank’s improved financial condition and performance, as of November 19, 2014, the Bank and the Company have been relieved of all formal regulatory agreements. Some of the governance and procedures established by the Agreement and the Order remain in place, including submission of certain plans and reports to the Federal Reserve and DBO, the Bank’s obligation to maintain a 9.0% tangible shareholder’s equity ratio, and the requirement to seek approvals from the Federal Reserve and the DBO for either the Bank or the Company to pay dividends and for the Company to pay interest on its outstanding junior subordinated debt. While no assurances can be given as to future regulatory approvals, over the last three quarters the DBO and the Federal Reserve have been approving the Bank's payment of dividends to the Company to cover the Company's operating expenses and its interest payments and the Company's payment of quarterly interest on the junior subordinated debt.
The Bank is currently in full compliance with the requirements of the MOU including its deadlines.
Capital Adequacy
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements adopted by the Board of Governors of the Federal Reserve System (the “Board of Governors”). Failure to meet minimum capital requirements can initiate certain mandates and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the consolidated Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about
53
components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by the capital adequacy guidelines require insured institutions to maintain a minimum leverage ratio of Tier 1 capital (the sum of common stockholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries, minus intangible assets, identified losses and investments in certain subsidiaries, plus unrealized losses or minus unrealized gains on available for sale securities) to total assets. Institutions which have received the highest composite regulatory rating and which are not experiencing or anticipating significant growth are required to maintain a minimum leverage capital ratio of 3% of Tier 1 capital to total assets. All other institutions are required to maintain a minimum leverage capital ratio of at least 100 to 200 basis points above the 3% minimum requirement.
In addition to the general capital adequacy guidelines, pursuant to the DBO’s MOU the Bank is required to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0%. For purposes of the MOU, “tangible shareholders’ equity” is defined as shareholders’ equity minus intangible assets. The Bank’s ratio of tangible shareholders’ equity to total tangible assets was 12.9% and 13.4% at December 31, 2015 and 2014, respectively.
The Company has adopted a capital plan that includes guidelines and trigger points to ensure sufficient capital is maintained at the Bank and the Company, and that capital ratios are maintained at a level deemed appropriate under regulatory guidelines given the level of classified assets, concentrations of credit, ALLL, current and projected growth, and projected retained earnings. The capital plan also contains contingency strategies to obtain additional capital as required to fulfill future capital requirements for both the Bank, as a separate legal entity, and the Company on a consolidated basis.
The following table sets forth the Company’s and the Bank's actual capital positions at December 31, 2015, as well as the minimum capital requirements and requirements to be well capitalized under prompt corrective action provisions (Bank required only) under the regulatory guidelines discussed above:
Ratio at December 31, 2015 | Ratio at December 31, 2014 | Minimum for Capital Adequacy | Minimum requirement for "Well Capitalized" Institution | ||||
Total capital to risk weighted assets | |||||||
Company | 16.65% | 17.29% | 8.00% | N/A | |||
Bank | 16.69% | 16.91% | 8.00% | 10.00% | |||
Tier 1 capital to risk-weighted assets | |||||||
Company | 15.40% | 16.03% | 6.00% | N/A | |||
Bank | 15.43% | 15.65% | 6.00% | 8.00% | |||
Common equity tier 1 capital to risk-weighted assets | |||||||
Company | 14.10% | N/A | 4.50% | N/A | |||
Bank | 15.43% | N/A | 4.50% | 6.50% | |||
Tier 1 capital to adjusted average assets (leverage) | |||||||
Company | 12.95% | 12.49% | 4.00% | N/A | |||
Bank | 12.94% | 12.25% | 4.00% | 5.00% | |||
The Federal Reserve and the Federal Deposit Insurance Corporation approved final capital rules in July 2013 that substantially amend the existing capital rules for banks. These new rules reflect, in part, certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010 (commonly referred to as “Basel III”) as well as requirements encompassed by the Dodd-Frank Act.
The final rules set a new common equity tier 1 requirement and higher minimum tier 1 requirements for all banking organizations. They also place limits on capital distributions and certain discretionary bonus payments if a banking organization does not maintain a buffer of common equity tier 1 capital above minimum capital requirements. The rules revise the prompt corrective action framework to incorporate the new regulatory capital minimums. They also enhance risk sensitivity and address weaknesses identified over recent years with the measure of risk-weighted assets.
54
As of December 31, 2015, the Company and the Bank meet all capital adequacy requirements to which they are subject. Management believes that, under the current regulations, both will continue to meet their minimum capital requirements in the foreseeable future.
Dividends
Dividends paid to shareholders by the Company are subject to restrictions set forth in the California General Corporation Law. The California General Corporation Law provides that a corporation may make a distribution to its shareholders if retained earnings immediately prior to the dividend payout are at least equal to the amount of the proposed distribution. The primary source of funds with which dividends will be paid to shareholders will come from cash dividends received by the Company from the Bank.
As noted earlier, the Company and the Bank have entered into an informal agreement with the Federal Reserve Bank and Department of Business Oversight that, among other things, requires prior approval before paying a cash dividend or otherwise making a distribution of stock, increasing debt, repurchasing the Company’s common stock, or any other action which would reduce capital of either the Bank or the Company. In addition, under the agreement with the Federal Reserve Bank, the Company is now prohibited from making interest payments on the junior subordinated debentures without prior approval of the Federal Reserve Bank. During the year ended December 31, 2015, the Bank’s cash dividends of $2,416,000 paid to the Company were approved by the Federal Reserve and the DBO. The cash dividends funded the Company's operating costs, payments of interest on its junior subordinated debentures, estimated tax payments, and redemption of junior subordinated debentures. $3.0 in million junior subordinated debt was retired, leaving $12.0 million in outstanding junior subordinated debt as of December 31, 2015.
The Bank, as a state-chartered bank, is subject to dividend restrictions set forth in California state banking law and administered by the Commissioner of the California Department of Business Oversight (“Commissioner”). Under such restrictions, the Bank may not pay cash dividends in an amount which exceeds the lesser of the retained earnings of the Bank or the Bank’s net income for the last three fiscal years (less the amount of distributions to shareholders during that period of time). If the above test is not met, cash dividends may only be paid with the prior approval of the Commissioner, in an amount not exceeding the Bank’s net income for its last fiscal year or the amount of its net income for the current fiscal year. Such restrictions do not apply to stock dividends, which generally require neither the satisfaction of any tests nor the approval of the Commissioner. Notwithstanding the foregoing, if the Commissioner finds that the shareholders’ equity is not adequate or that the declarations of a dividend would be unsafe or unsound, the Commissioner may order the state bank not to pay any dividend. The FRB may also limit dividends paid by the Bank. As noted above, the terms of the informal agreement with the Federal Reserve prohibit both the Company and the Bank from paying dividends without prior approval of the Federal Reserve.
Reserve Balances
The Bank is required to maintain average reserve balances with the Federal Reserve Bank. During 2005, the Company implemented a deposit reclassification program, which allows the Company to reclassify a portion of transaction accounts to non-transaction accounts for reserve purposes. The deposit reclassification program was provided by a third-party vendor, and has been approved by the Federal Reserve Bank. At December 31, 2015, the bank was not subject to a reserve requirement.
Item 8 - Financial Statements and Supplementary Data
Index to Consolidated Financial Statements:
Management’s Report on Internal Control over Financial Reporting
Reports of Independent Registered Public Accounting Firm
Consolidated Balance Sheets - December 31, 2015 and 2014
Consolidated Statements of Income -
Years Ended December 31, 2015 and 2014
Consolidated Statements of Shareholders' Equity -
Years Ended December 31, 2015 and 2014
Consolidated Statements of Comprehensive Income -
55
Years Ended December 31, 2015 and 2014
Consolidated Statements of Cash Flows -
Years Ended December 31, 2015 and 2014
Notes to Consolidated Financial Statements
56
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of United Security Bancshares and Subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2015. The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s management, including the Chief Executive Officer and Chief Financial Officer, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States.
The Company’s system of internal control over financial reporting includes policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Management recognizes that there are inherent limitations in the effectiveness of any system of internal control, and accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation and fair presentation. Further, because of changes in conditions, the effectiveness of internal control may vary over time.
Under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, the Company performed an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2015 based upon criteria in Internal Control — Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). As a result of this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2015.
As a result of the enactment in our third quarter of the Dodd-Frank Wall Street Reform and Consumer Protection Act, “Exemption for Non-accelerated Filers," and in accordance with section 989G of the act, we are not required to provide an attestation report of our independent registered public accounting firm regarding internal control over financial reporting for this fiscal year or thereafter, until such time as we are no longer eligible for the exemption set forth therein.
57
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Shareholders
United Security Bancshares and Subsidiaries
We have audited the accompanying consolidated balance sheets of United Security Bancshares and Subsidiaries (Company) as of December 31, 2015 and 2014, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity and cash flows for each of the two years in the period ended December 31, 2015. These consolidated financial statements are the responsibility of Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of United Security Bancshares and Subsidiaries as of December 31, 2015 and 2014, and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.
/s/ Moss Adams LLP
Sacramento, California
March 4, 2016
58
United Security Bancshares and Subsidiaries
Consolidated Balance Sheets
December 31, 2015 and 2014
(In thousands except shares) | December 31, 2015 | December 31, 2014 | |||||
Assets | |||||||
Cash and non-interest bearing deposits in other banks | $ | 29,733 | $ | 21,348 | |||
Cash and due from Federal Reserve Bank | 96,018 | 82,229 | |||||
Cash and cash equivalents | 125,751 | 103,577 | |||||
Interest-bearing deposits in other banks | 1,528 | 1,522 | |||||
Investment securities available for sale (at fair value) | 30,893 | 48,301 | |||||
Loans | 515,318 | 457,919 | |||||
Unearned fees and unamortized loan origination costs (fees), net | 58 | (324 | ) | ||||
Allowance for credit losses | (9,713 | ) | (10,771 | ) | |||
Net loans | 505,663 | 446,824 | |||||
Accrued interest receivable | 2,220 | 1,927 | |||||
Premises and equipment - net | 10,800 | 11,550 | |||||
Other real estate owned | 12,873 | 14,010 | |||||
Goodwill | 4,488 | 4,488 | |||||
Cash surrender value of life insurance | 18,337 | 17,717 | |||||
Investment in limited partnerships | 917 | 871 | |||||
Deferred income taxes - net | 5,228 | 6,853 | |||||
Other assets | 6,946 | 5,529 | |||||
Total assets | $ | 725,644 | $ | 663,169 | |||
Liabilities & Shareholders' Equity | |||||||
Liabilities | |||||||
Deposits | |||||||
Noninterest bearing | $ | 262,168 | $ | 215,439 | |||
Interest bearing | 359,637 | 349,934 | |||||
Total deposits | 621,805 | 565,373 | |||||
Accrued interest payable | 29 | 40 | |||||
Accounts payable and other liabilities | 5,875 | 4,815 | |||||
Junior subordinated debentures (at fair value) | 8,300 | 10,115 | |||||
Total liabilities | 636,009 | 580,343 | |||||
Shareholders' Equity | |||||||
Common stock, no par value 20,000,000 shares authorized, 16,051,406 issued and outstanding at December 31, 2015, and 15,425,086 at December 31, 2014 | 52,572 | 49,271 | |||||
Retained earnings | 37,265 | 33,730 | |||||
Accumulated other comprehensive loss | (202 | ) | (175 | ) | |||
Total shareholders' equity | 89,635 | 82,826 | |||||
Total liabilities and shareholders' equity | $ | 725,644 | $ | 663,169 | |||
See notes to consolidated financial statements
59
United Security Bancshares and Subsidiaries
Consolidated Statements of Income
Years Ended December 31, 2015 and 2014
(In thousands except shares and EPS) | December 31, 2015 | December 31, 2014 | |||||
Interest Income | |||||||
Loans, including fees | $ | 26,469 | $ | 23,777 | |||
Investment securities - AFS – taxable | 722 | 901 | |||||
Interest on deposits in Federal Reserve Bank | 213 | 277 | |||||
Interest on deposits in other banks | 6 | 7 | |||||
Total interest income | 27,410 | 24,962 | |||||
Interest Expense | |||||||
Interest on deposits | 1,056 | 1,104 | |||||
Interest on other borrowings | 225 | 241 | |||||
Total interest expense | 1,281 | 1,345 | |||||
Net Interest Income Before Recovery of Provision for Credit Losses | 26,129 | 23,617 | |||||
Recovery of Provision for Credit Losses | (41 | ) | (845 | ) | |||
Net Interest Income after Recovery of Provision for Credit Losses | 26,170 | 24,462 | |||||
Noninterest Income | |||||||
Customer service fees | 3,620 | 3,473 | |||||
Increase in cash surrender value of bank owned life insurance | 519 | 514 | |||||
Loss on fair value of financial liability | (73 | ) | (102 | ) | |||
Gain on redemption of JR subordinated debentures | 78 | — | |||||
Gain on sale of premises and equipment | 10 | 25 | |||||
(Loss) gain on sale of other investment | (23 | ) | 691 | ||||
Other | 604 | 560 | |||||
Total noninterest income | 4,735 | 5,161 | |||||
Noninterest Expense | |||||||
Salaries and employee benefits | 9,921 | 9,653 | |||||
Occupancy expense | 4,042 | 3,760 | |||||
Data processing | 126 | 134 | |||||
Professional fees | 1,137 | 1,456 | |||||
Regulatory assessments | 959 | 943 | |||||
Director fees | 277 | 232 | |||||
Amortization of intangibles | — | 62 | |||||
Correspondent bank service charges | 75 | 117 | |||||
Loss on California tax credit partnership | 73 | 39 | |||||
Net cost on operation and sale of OREO | 619 | 571 | |||||
Other | 2,369 | 2,248 | |||||
Total noninterest expense | 19,598 | 19,215 | |||||
Income Before Provision for Taxes | 11,307 | 10,408 | |||||
Provision for Taxes on Income | 4,497 | 4,192 | |||||
Net Income | $ | 6,810 | $ | 6,216 | |||
Net Income per common share | |||||||
Basic | $ | 0.42 | $ | 0.39 | |||
Diluted | $ | 0.42 | $ | 0.39 | |||
Shares on which net income per common share were based | |||||||
Basic | 16,051,406 | 16,035,581 | |||||
Diluted | 16,053,426 | 16,040,865 | |||||
See notes to consolidated financial statements
60
United Security Bancshares and Subsidiaries
Consolidated Statements of Comprehensive Income
Years Ended December 31, 2015 and 2014
Year Ended December 31, | |||||||
(In thousands) | 2015 | 2014 | |||||
Net Income | $ | 6,810 | $ | 6,216 | |||
Unrealized holdings (losses) gains on securities | (265 | ) | 18 | ||||
Unrealized gains (losses) on unrecognized post retirement costs | 224 | (113 | ) | ||||
Other comprehensive loss, before tax | (41 | ) | (95 | ) | |||
Tax benefit (expense) related to securities | 106 | (7 | ) | ||||
Tax (expense) benefit related to unrecognized post retirement costs | (92 | ) | 46 | ||||
Total other comprehensive loss, net of tax | (27 | ) | (56 | ) | |||
Comprehensive income | $ | 6,783 | $ | 6,160 | |||
See notes to consolidated financial statements
United Security Bancshares and Subsidiaries
Consolidated Statements of Changes in Shareholders' Equity
Years Ended December 31, 2015 and 2014
Common stock | ||||||||||||||||||
(In thousands except shares) | Number of Shares | Amount | Retained Earnings | Accumulated Other Comprehensive Loss | Total | |||||||||||||
Balance January 1, 2014 | 14,799,888 | $ | 45,778 | $ | 30,884 | $ | (119 | ) | $ | 76,543 | ||||||||
Other comprehensive loss | (56 | ) | (56 | ) | ||||||||||||||
Common stock dividends | 601,276 | 3,370 | (3,370 | ) | — | |||||||||||||
Common stock issuance | 23,922 | 95 | 95 | |||||||||||||||
Stock-based compensation expense | 28 | 28 | ||||||||||||||||
Net Income | 6,216 | 6,216 | ||||||||||||||||
Balance December 31, 2014 | 15,425,086 | $ | 49,271 | $ | 33,730 | $ | (175 | ) | $ | 82,826 | ||||||||
Other comprehensive loss | (27 | ) | (27 | ) | ||||||||||||||
Common stock dividends | 626,320 | 3,275 | (3,275 | ) | — | |||||||||||||
Stock-based compensation expense | 26 | 26 | ||||||||||||||||
Net Income | 6,810 | 6,810 | ||||||||||||||||
Balance December 31, 2015 | 16,051,406 | $ | 52,572 | $ | 37,265 | $ | (202 | ) | $ | 89,635 | ||||||||
See notes to consolidated financial statements
61
United Security Bancshares and Subsidiaries
Consolidated Statements of Cash Flows
Years Ended December 31, 2015 and 2014
(In thousands) | December 31, 2015 | December 31, 2014 | |||||
Cash Flows From Operating Activities: | |||||||
Net Income | $ | 6,810 | $ | 6,216 | |||
Adjustments to reconcile net income to cash provided by operating activities: | |||||||
Recovery of provision for credit losses | (41 | ) | (845 | ) | |||
Depreciation and amortization | 1,462 | 1,390 | |||||
Amortization of investment securities | 266 | 263 | |||||
Accretion of investment securities | (44 | ) | (33 | ) | |||
Increase in accrued interest receivable | (293 | ) | (283 | ) | |||
Decrease in accrued interest payable | (11 | ) | (4 | ) | |||
(Decrease) increase in unearned fees | (382 | ) | 20 | ||||
Decrease in income taxes payable | (229 | ) | (398 | ) | |||
Stock-based compensation expense | 26 | 28 | |||||
Provision for deferred income taxes | 1,640 | 4,816 | |||||
Increase (decrease) in accounts payable and accrued liabilities | 29 | (1,113 | ) | ||||
Loss (gain) on sale of investment in limited partnership | 23 | (691 | ) | ||||
Gain on sale of other real estate owned | (16 | ) | (114 | ) | |||
Impairment loss on other real estate owned | 188 | — | |||||
(Gain) loss on fair value option of financial liabilities | 73 | 102 | |||||
Gain on redemption of junior subordinated debentures | (78 | ) | — | ||||
Increase in surrender value of life insurance | (519 | ) | (514 | ) | |||
Loss on tax credit limited partnership interest | 73 | 39 | |||||
Gain on sale of premises and equipment | (10 | ) | (25 | ) | |||
Amortization of intangibles | — | 62 | |||||
Net decrease in other assets | 297 | 86 | |||||
Net cash provided by operating activities | 9,264 | 9,002 | |||||
Cash Flows From Investing Activities: | |||||||
Net increase in interest-bearing deposits with banks | (6 | ) | (7 | ) | |||
Purchase of correspondent bank stock | (147 | ) | (97 | ) | |||
Maturities and calls on available-for-sale securities | 11,000 | — | |||||
Principal payments on available-for-sale securities | 5,922 | 5,295 | |||||
Purchases of available-for-sale securities | — | (10,192 | ) | ||||
Purchase of bank-owned life insurance/company-owned life insurance | (220 | ) | — | ||||
Proceeds from sales of available-for-sale securities | — | — | |||||
Net increase in loans | (58,642 | ) | (60,282 | ) | |||
Cash proceeds from sales of other real estate owned | 1,192 | 1,308 | |||||
Cash proceeds from sale of other investment | — | 1,253 | |||||
Cash proceeds from sales of premises and equipment | 23 | — | |||||
Capital expenditures for premises and equipment | (725 | ) | (768 | ) | |||
Investment in limited partnership | (119 | ) | (126 | ) | |||
Net cash used in investing activities | (41,722 | ) | (63,616 | ) | |||
Cash Flows From Financing Activities: | |||||||
Net increase in demand deposit and savings accounts | 65,418 | 28,225 | |||||
Net decrease in certificates of deposit | (8,986 | ) | (5,341 | ) | |||
Proceeds from exercise of stock options | — | 95 | |||||
Redemption of junior subordinated debentures | (1,800 | ) | — | ||||
Net cash provided by (used in) financing activities | 54,632 | 22,979 | |||||
Net increase (decrease) in cash and cash equivalents | 22,174 | (31,635 | ) | ||||
Cash and cash equivalents at beginning of year | 103,577 | 135,212 | |||||
Cash and cash equivalents at end of year | $ | 125,751 | $ | 103,577 | |||
See notes to consolidated statements
62
Notes to Consolidated Financial Statements
Years Ended December 31, 2015 and 2014
1. | Organization and Summary of Significant Accounting and Reporting Policies |
Basis of Presentation – The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States and with prevailing practices within the banking industry. The consolidated financial statements include the accounts of United Security Bancshares, and its wholly owned subsidiaries, United Security Bank and subsidiary (the “Bank”) and USB Capital Trust II (the "Trust:). The Trust is deconsolidated pursuant to ASC 810. As a result, the Trust Preferred Securities are not presented on the Company’s consolidated financial statements as equity, but instead they are presented as Junior Subordinated Debentures are presented as a separate liability category. (see Note 8 to the Company’s consolidated financial statements). Intercompany accounts and transactions have been eliminated in consolidation. In the following notes, references to the Bank are references to United Security Bank. References to the Company are references to United Security Bancshares, (including the Bank). United Security Bancshares operates as one business segment providing banking services to commercial establishments and individuals primarily in the San Joaquin Valley of California.
Nature of Operations – United Security Bancshares is a bank holding company, incorporated in the state of California for the purpose of acquiring all the capital stock of the Bank through a holding company reorganization (the “Reorganization”) of the Bank. The Reorganization, which was accounted for in a manner similar to a pooling of interests, was completed on June 12, 2001. Management believes the Reorganization has provided the Company greater operating and financial flexibility and has permitted expansion into a broader range of financial services and other business activities.
During July 2007 the Company formed USB Capital Trust II and issued $15.0 million in Trust Preferred Securities with terms similar to those originally issued under USB Capital Trust I. During 2015, the Bank purchased $3.0 million of the Company's junior subordinated debentures related to the Company's trust preferred securities at a fair value discount of 40%. Subsequently, the Company purchased those shares from the Bank and canceled $3.0 million in par value of the junior subordinated debentures, realizing a $78,000 gain on redemption. The contractual principal balance of the Company's debentures relating to its trust preferred securities is $12.0 million as of December 31, 2015. (See Note 8. “Junior Subordinated Debt/Trust Preferred Securities”).
USB Investment Trust Inc was incorporated effective December 31, 2001, as a special purpose real estate investment trust (“REIT”) under Maryland law. The REIT is a subsidiary of the Bank and was funded with $133.0 million in real estate-secured loans contributed by the Bank. USB Investment Trust was originally formed to give the Bank flexibility in raising capital, and reduce the expenses associated with holding the assets contributed to USB Investment Trust.
The Bank was founded in 1987 and currently operates eleven branches and one construction lending office in an area from eastern Madera County to western Fresno County, as well as Taft and Bakersfield in Kern County, and Campbell in Santa Clara County. The Bank also operates one financial services department located in Fresno, California. The Bank’s primary source of revenue is interest income through providing loans to customers, who are predominantly small and middle-market businesses and individuals. The Bank engages in a full compliment of lending activities, including real estate mortgage, commercial and industrial, real estate construction, agricultural and consumer loans, with particular emphasis on short and medium term obligations.
The Bank offers a wide range of deposit instruments. These include personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal (NOW) accounts, money market accounts and time certificates of deposit. Most of the Bank's deposits are attracted from individuals and from small and medium-sized business-related sources.
The Bank also offers a wide range of specialized services designed to attract and service the needs of commercial customers and account holders. These services include cashiers checks, travelers checks, money orders, and foreign drafts. In addition, the Bank offers Internet banking services to its commercial and retail customers, and offers certain financial and wealth management services through its financial services department. The Bank does not operate a trust department, however it makes arrangements with its correspondent bank to offer trust services to its customers upon request.
Use of Estimates in the Preparation of Financial Statements - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
63
Material estimates that are particularly susceptible to significant change, relate to the determination of the allowance for loan losses, determination of goodwill, fair value of junior subordinated debt and certain collateralized mortgage obligations, and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans.
Subsequent events—The Company has evaluated events and transactions for potential recognition or disclosure through the day the financial statements were issued.
Significant Accounting Policies - The Company follows accounting standards set by the Financial Accounting Standards Board, commonly referred to as “FASB.” FASB sets generally accepted accounting principles (GAAP) that the Company follows to ensure the consistent reporting of its consolidated financial condition, consolidated results of operations, and consolidated cash flows. References to GAAP issued by FASB in these footnotes are to FASB Accounting Standards Codification, sometimes referred to as the Codification or ASC. The following is a summary of significant policies:
a. | Cash and cash equivalents – Cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and repurchase agreements. At times throughout the year, balances can exceed FDIC insurance limits. Generally, federal funds sold and repurchase agreements are sold for one-day periods. The Bank did not have any repurchase agreements during 2015 or 2014, or at December 31, 2015 and 2014. All cash and cash equivalents have maturities when purchased of three months or less. |
b. | Securities - Debt and equity securities classified as available for sale are reported at fair value, with unrealized gains and losses excluded from net income and reported, net of tax, as a separate component of comprehensive income and shareholders’ equity. Debt securities classified as held to maturity are carried at amortized cost. Gains and losses on disposition are reported using the specific identification method for the adjusted basis of the securities sold. Premiums and discounts are recognized in interest income using the interest method over the period to maturity. |
The Company classifies its securities as available for sale or held to maturity, and periodically reviews its investment portfolio on an individual security basis. Securities that are to be held for indefinite periods of time (including, but not limited to, those that management intends to use as part of its asset/liability management strategy, those which may be sold in response to changes in interest rates, changes in prepayments or any such other factors) are classified as securities available for sale. Securities which the Company has the ability and intent to hold to maturity are classified as held to maturity.
Investments with fair values that are less than amortized cost are considered impaired. Impairment may result from either a decline in the financial condition of the issuing entity or, in the case of fixed interest rate investments, from rising interest rates. At each financial statement date, management assesses each investment to determine if impaired investments are temporarily impaired or if the impairment is other-than-temporary based upon the positive and negative evidence available. Evidence evaluated includes, but is not limited to, industry analyst reports, credit market conditions, and interest rate trends. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between the amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: (1) OTTI related to credit loss, which must be recognized in the income statement; and (2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings.
c. | Loans - Interest income on loans is credited to income as earned and is calculated by using the simple interest method on the daily balance of the principal amounts outstanding. Loans are placed on non-accrual status when principal or interest is past due for 90 days and/or when management believes the collection of amounts due is doubtful. For loans placed on nonaccrual status, the accrued and unpaid interest receivable may be reversed at management's discretion based upon management's assessment of 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. |
Nonrefundable fees and related direct costs associated with the origination or purchase of loans are deferred and netted against outstanding loan balances. The net deferred fees and costs are generally amortized into interest income over the loan term using 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.
64
d. | Allowance for Credit Losses and Reserve for Unfunded Loan Commitments - The allowance for credit losses is maintained to provide for losses that can reasonably be anticipated. The allowance is based on ongoing quarterly assessments of the probable losses inherent in the loan portfolio, and to a lesser extent, unfunded loan commitments. The reserve for unfunded loan commitments is a liability on the Company’s consolidated financial statements and is included in other liabilities. The liability is computed using a methodology similar to that used to determine the allowance for credit losses, modified to take into account the probability of a drawdown on the commitment. |
The allowance for credit losses is increased by provisions charged to operations during the current period and reduced by negative provisions and loan charge-offs, net of recoveries. Loans are charged against the allowance when management believes that the collection of the principal is unlikely. The allowance is an amount that management believes will be adequate to absorb losses inherent in existing loans, based on evaluations of the probability of collection. In evaluating the probability of collection, management is required to make estimates and assumptions that affect the reported amounts of loans, allowance for credit losses and the provision for credit losses charged to operations. Actual results could differ significantly from those estimates. These evaluations take into consideration such factors as the composition of the portfolio, overall portfolio quality, loan concentrations, specific problem loans, and current economic conditions that may affect the borrowers' ability to pay.
The Company’s methodology for assessing the adequacy of the allowance for credit losses consists of several key elements, which include:
- the formula allowance
- specific allowances for problem graded loans identified as impaired
- and the unallocated allowance
The formula allowance is calculated by applying loss factors to outstanding loans. Loss factors are based on the Company’s historical loss experience and on the internal risk grade of those loans and, may be adjusted for significant factors, including economic factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date. Management determines the loss factors for problem graded loans (substandard, doubtful, and loss), special mention loans, and pass graded loans, based on a loss migration model. The migration analysis incorporates loan losses over the previous quarters as determined by management (time horizons adjusted as business cycles or environment changes) and loss factors are adjusted to recognize and quantify the loss exposure from changes in market conditions and trends in the Company’s loan portfolio. Those factors include 1) trends in delinquent and nonaccrual loans, 2) trends in loan volume and terms, 3) effects of changes in lending policies, 4) concentrations of credit, 5) competition, 6) national and local economic trends and conditions, 7) experience of lending staff, 8) loan review and Board of Directors oversight, 9) high balance loan concentrations, and 10) other business conditions. For purposes of this analysis, loans are grouped by internal risk classifications, which are “pass," “special mention,” “substandard,” “doubtful,” and “loss." Certain loans are homogeneous in nature and are therefore pooled by risk grade. These homogeneous loans include consumer installment and home equity loans.
Specific allowances are established based on management’s periodic evaluation of loss exposure inherent in impaired loans. For impaired loans, specific allowances are determined based on the collateralized value of the underlying properties, the net present value of the anticipated cash flows, or the market value of the underlying assets.
A loan is considered impaired when management determines that it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the loan agreement. Impairment is measured by the difference between the original recorded investment in the loan and the estimated present value of the total expected future cash flows, discounted at the loan’s effective rate, or the fair value of the collateral, less estimated selling costs, if the loan is collateral dependent.
The unallocated portion of the allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to, general economic and business conditions affecting the key lending areas of the Company, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.
e. | Premises and Equipment - Premises and equipment are carried at cost less accumulated depreciation. Depreciation expense is computed principally on the straight-line method over the estimated useful lives of the assets. Estimated useful lives are as follows: |
Buildings | 31 years | Furniture and equipment | 3-7 Years |
65
f. | Other Real Estate Owned - Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value of the property, less estimated costs to sell. The excess, if any, of the loan amount over the fair value is charged to the allowance for credit losses. Subsequent declines in the fair value of other real estate owned, along with related revenue and expenses from operations, are charged to noninterest expense. |
g. | Intangible Assets and Goodwill - Intangible assets are comprised of core deposit intangibles, other specific identifiable intangibles, and goodwill acquired in branch acquisitions where the consideration given exceeded the fair value of the net assets acquired. Intangible assets and goodwill are reviewed at least annually for impairment. All core deposit intangibles related to previous mergers have been fully amortized. During 2015 and 2014, the Company recognized no impairment losses on the core deposit intangible related to the deposits purchased in the Legacy merger consummated during February 2007. The Company estimates no aggregate amortization expense related to intangible assets for the next five years. |
Goodwill amounts resulting from the acquisitions of Taft National Bank during April 2004, and Legacy Bank during February 2007 are considered to have an indefinite life and are not amortized. At December 31, 2015, goodwill related to Taft National Bank totaled $1.6 million, and goodwill related to Legacy Bank totaled $2.9 million. Impairment testing of goodwill is performed at the reporting level during April of each year for Taft, and during March of each year for Legacy. During 2015 and 2014, the Company did not recognize impairment adjustments on the goodwill related to the Legacy or Taft Bank mergers (see Note 19 to the Company’s consolidated financial statements contained herein for details of the goodwill impairment.)
h. | Income Taxes - Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of the Company's assets and liabilities using the liability method, and are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. |
i. | Net Income per Share - Basic income per common share is computed based on the weighted average number of common shares outstanding. Diluted income per share includes the effect of stock options and other potentially dilutive securities using the treasury stock method to the extent they have a dilutive impact. Net income per share has been retroactively adjusted for all stock dividends declared. |
j. | Cash Flow Reporting - For purposes of reporting cash flows, cash and cash equivalents include cash on hand, noninterest-bearing amounts due from banks, federal funds sold and securities purchased under agreements to resell. Federal funds and securities purchased under agreements to resell are generally sold for one-day periods. Net cash flows are reported for interest-bearing deposits with other banks, loans to customers, and deposits held for customers. |
k. | Transfers of Financial Assets - Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. |
l. | Advertising Costs - The Company expenses marketing costs as they are incurred. Advertising expense was $127,000 and $123,000 for the years ended December 31, 2015 and 2014, respectively. |
m. | Stock Based Compensation - The Company has a stock-based employee compensation plan, which is described more fully in Note 10. The Company accounts for all share-based payments to employees, including grants of employee stock options and restricted stock units and awards, to be recognized in the financial statements based on the grant date fair value of the award. The fair value is amortized over the requisite service period (generally the vesting period). Included in salaries and employee benefits for the years ended December 31, 2015 and 2014 are $26,000 and $28,000, respectively, of share-based compensation. The related tax benefit, recorded in the provision for income taxes, was not significant. All share data contained within the financial statements has been retroactively restated for stock based transactions (i.e. stock splits and stock dividends.) |
n. | Federal Home Loan Bank stock and Federal Reserve Stock - As a member of the Federal Home Loan Bank (FHLB), the Company is required to maintain an investment in capital stock of the FHLB. In addition, as a member of the Federal Reserve Bank (FRB), the Company is required to maintain an investment in capital stock of the FRB. The investments in both the FHLB and the FRB are carried at cost, which approximates their fair value, in the accompanying consolidated balance sheets under other assets and are subject to certain redemption requirements by the FHLB and FRB. Stock redemptions are at the discretion of the FHLB and FRB. |
66
While technically these are considered equity securities, there is no market for the FHLB or FRB stock. Therefore, the shares are considered as restricted investment securities. Management periodically evaluates the stock for other-than-temporary impairment. Management’s determination of whether these investments are impaired is based on its assessment of the ultimate recoverability of cost rather than by recognizing temporary declines in value. The determination of whether a decline affects the ultimate recoverability of cost is influenced by criteria such as (1) the significance of any decline in net assets of the FHLB or FRB as compared to the capital stock amount of the FHLB or FRB and the length of time this situation has persisted, (2) commitments by the FHLB or FRB to make payments required by law or regulation and the level of such payments in relation to the operating performance of the FHLB or FRB, (3) the impact of legislative and regulatory changes on institutions and, accordingly, the customer base of the FHLB or FRB, and (4) the liquidity position of the FHLB or FRB.
o. | Comprehensive Income - Comprehensive income is comprised of net income and other comprehensive income. Other comprehensive income includes items recorded directly to equity, such as unrealized gains and losses on securities available-for-sale and unrecognized costs of salary continuation defined benefit plans. Comprehensive income is presented in the Consolidated Statements of Other Comprehensive Income. |
p. | Segment Reporting - The Company's operations are solely in the financial services industry and include providing to its customers traditional banking and other financial services. The Company operates primarily in the San Joaquin Valley region of California. Management makes operating decisions and assesses performance based on an ongoing review of the Company's consolidated financial results. Therefore, the Company has a single operating segment for financial reporting purposes. |
q. | New Accounting Standards: |
In January 2014, FASB issued ASU 2014-04, Receivables - Troubled Debt Restructurings by Creditors. The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. An entity can elect to adopt the amendments in this ASU using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The adoption of this update did not have a significant impact on the Company’s consolidated financial statements.
In January 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-01 Accounting for Investments in Qualified Affordable Housing Projects. This ASU provides "guidance on accounting for investments by a reporting entity in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for the low-income housing tax credit." It allows the proportional amortization method to be used by a reporting entity if certain conditions are met. The ASU also defines when a qualified affordable housing project through a limited liability entity should be tested for impairment. If a qualified affordable housing project does not meet the conditions for using the proportional amortization method, the investment should be accounted for using an equity method investment or a cost method investment. The ASU is effective for fiscal years beginning after December 15, 2014, and interim periods therein. The Company will continue to account for our low-income housing tax credit investments using the equity method subsequent to the adoption of ASU 2014-01 and does not expect any impact on the Company's consolidated financial statements.
In January 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-01 Financial Instruments-Overall: Recognition and Measurements of Financial Assets and Financial Liabilities. This ASU requires equity investments to be measured at fair value, with changes in fair value recognized in net income. The amendment also simplifies the impairment assessment of equity investments for which fair value is not readily determinable by requiring an entity to perform a qualitative assessment to identify impairment. The ASU is effective for fiscal years beginning after December 15, 2017, and interim periods therein. The Company does not expect any impact on the Company's consolidated financial statements resulting from the adoption of the update.
67
r. | Reclassifications - Certain reclassifications have been made to prior year financial statements to conform to the classifications used in 2015. None of the reclassifications had an impact on equity or net income. |
2. | Investment Securities |
Following is a comparison of the amortized cost and approximate fair value of investment securities at December 31, 2015 and December 31, 2014:
(In thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value (Carrying Amount) | |||||||||||
December 31, 2015 | |||||||||||||||
Securities available for sale: | |||||||||||||||
U.S. Government agencies | $ | 9,778 | $ | 453 | (108 | ) | $ | 10,123 | |||||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | 16,835 | 175 | (52 | ) | 16,958 | ||||||||||
Mutual Funds | 4,000 | — | (188 | ) | 3,812 | ||||||||||
Total securities available for sale | $ | 30,613 | $ | 628 | $ | (348 | ) | $ | 30,893 | ||||||
December 31, 2014 | |||||||||||||||
Securities available for sale: | |||||||||||||||
U.S. Government agencies | $ | 12,097 | $ | 399 | $ | — | $ | 12,496 | |||||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | 31,659 | 336 | (13 | ) | 31,982 | ||||||||||
Mutual Funds | 4,000 | — | (177 | ) | 3,823 | ||||||||||
Total securities available for sale | $ | 47,756 | $ | 735 | $ | (190 | ) | $ | 48,301 | ||||||
There were no sales of securities and no gross realized losses on available-for-sale securities and no gross gains during the years ended December 31, 2015 and 2014.
The amortized cost and fair value of securities available for sale at December 31, 2015, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties. Contractual maturities on collateralized mortgage obligations cannot be anticipated due to allowed paydowns.
December 31, 2015 | |||||||
Amortized Cost | Fair Value (Carrying Amount) | ||||||
(In thousands) | |||||||
Due in one year or less | $ | 4,000 | $ | 3,812 | |||
Due after one year through five years | 13 | 13 | |||||
Due after five years through ten years | 1,025 | 1,043 | |||||
Due after ten years | 8,740 | 9,067 | |||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | 16,835 | 16,958 | |||||
$ | 30,613 | $ | 30,893 | ||||
At December 31, 2015 and 2014, available-for-sale securities with an amortized cost of approximately $16,253,074 and $20,865,000 (fair value of $16,670,290 and $21,503,000) were pledged as collateral for FHLB borrowings and public funds balances, respectively.
The Company had no held-to-maturity or trading securities at December 31, 2015 and 2014.
Management periodically evaluates each available-for-sale investment security in an unrealized loss position to determine if the impairment is temporary or other-than-temporary.
The following summarizes temporarily impaired investment securities at December 31, 2015 and 2014:
68
Less than 12 Months | 12 Months or More | Total | |||||||||||||||||||||
(In thousands) | Fair Value (Carrying Amount) | Unrealized Losses | Fair Value (Carrying Amount) | Unrealized Losses | Fair Value (Carrying Amount) | Unrealized Losses | |||||||||||||||||
December 31, 2015 | |||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||
U.S. Government agencies | $ | 79 | $ | (108 | ) | $ | — | $ | — | $ | 79 | $ | (108 | ) | |||||||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | 9,913 | (52 | ) | — | — | 9,913 | (52 | ) | |||||||||||||||
Mutual Funds | — | — | 3,812 | (188 | ) | 3,812 | (188 | ) | |||||||||||||||
Total impaired securities | $ | 9,992 | $ | (160 | ) | $ | 3,812 | $ | (188 | ) | $ | 13,804 | $ | (348 | ) | ||||||||
December 31, 2014 | |||||||||||||||||||||||
Securities available for sale: | |||||||||||||||||||||||
U.S. Government agencies | $ | — | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||||
U.S. Government sponsored entities & agencies collateralized by mortgage obligations | 6,478 | (13 | ) | — | — | 6,478 | (13 | ) | |||||||||||||||
Mutual Funds | — | — | 3,823 | (177 | ) | 3,823 | (177 | ) | |||||||||||||||
Total impaired securities | $ | 6,478 | $ | (13 | ) | $ | 3,823 | $ | (177 | ) | $ | 10,301 | $ | (190 | ) | ||||||||
Temporarily impaired securities at December 31, 2015, were comprised of one U.S. Government agency security, five U.S. Government sponsored entities & agencies collateralized by mortgage obligations and one mutual fund with and undefined maturity date. Temporarily impaired securities at December 31, 2014, were comprised of four U.S. Government sponsored entities & agencies collateralized by mortgage obligations and one mutual fund, with an undefined maturity date.
The Company evaluates investment securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. The investment securities portfolio is evaluated for OTTI by segregating the portfolio into two general segments and applying the appropriate OTTI model. Investment securities of high credit quality are generally evaluated for OTTI under ASC Topic 320-10, “Investments – Debt and Equity Instruments.” Certain purchased beneficial interests, including non-agency mortgage-backed securities, asset-backed securities, and collateralized debt obligations, are evaluated under ASC Topic 325-40, "Beneficial Interest in Securitized Financial Assets."
In the first segment, the Company considers many factors in determining OTTI, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an other-than-temporary decline exists involves a high degree of subjectivity and judgment and is based on the information available to the Company at the time of the evaluation.
The second segment of the portfolio uses the OTTI guidance that is specific to purchased beneficial interests including private label mortgage-backed securities. Under this model, the Company compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. An OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.
Other-than-temporary-impairment occurs when the Company intends to sell the security or more likely than not will be required to sell the security before recovery of its amortized cost basis. If an entity intends to sell or more likely than not will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary-impairment shall be recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the other-than-temporary-impairment shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total other-than-temporary-impairment related to the credit loss is recognized in earnings, and is determined based on the difference between the present value of cash flows expected to be collected and the current amortized cost of the security. The amount of the total other-than-temporary-impairment related to other factors shall be recognized in other comprehensive (loss) income, net of
69
applicable taxes. The previous amortized cost basis less the other-than-temporary-impairment recognized in earnings shall become the new amortized cost basis of the investment.
At December 31, 2015, the decline in market value of the impaired mutual fund and U.S. government agency security is attributable to changes in interest rates, and not credit quality. Because the Company does not have the intent to sell these impaired securities, and it is not more likely than not that it will be required to sell these securities before its anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2015.
3. Loans
Loans are comprised of the following:
In thousands) | December 31, 2015 | December 31, 2014 | ||||||
Commercial and Business loans | $ | 54,503 | $ | 60,422 | ||||
Government Program Loans | 1,323 | 1,947 | ||||||
Total Commercial and Industrial | 55,826 | 62,369 | ||||||
Real estate – Mortgage: | ||||||||
Commercial Real Estate | 182,554 | 154,672 | ||||||
Residential Mortgages | 68,811 | 59,095 | ||||||
Home Improvement and Home Equity loans | 867 | 1,110 | ||||||
Total Real Estate Mortgage | 252,232 | 214,877 | ||||||
Real Estate Construction and Development | 130,596 | 137,158 | ||||||
Agricultural | 52,137 | 31,713 | ||||||
Installment | 24,527 | 11,802 | ||||||
Total Loans | $ | 515,318 | $ | 457,919 | ||||
The Company's loans are predominantly in the San Joaquin Valley, and the greater Oakhurst/East Madera County area, as well as the Campbell area of Santa Clara County, although the Company does participate in loans with other financial institutions, primarily in the state of California.
Commercial and industrial loans represent 10.8% of total loans at December 31, 2015, and are generally made to support the ongoing operations of small-to-medium sized commercial businesses. Commercial and industrial loans have a high degree of industry diversification and provide, working capital, financing for the purchase of manufacturing plants and equipment, or funding for growth and general expansion of businesses. A substantial portion of commercial and industrial loans are secured by accounts receivable, inventory, leases or other collateral including real estate. The remainder are unsecured; however, extensions of credit are predicated upon the financial capacity of the borrower. Repayment of real estate mortgage loans generally comes from the cash flow of the borrower.
Real estate mortgage loans, representing 48.9% of total loans at December 31, 2015, are secured by trust deeds on primarily commercial property, but are also secured by trust deeds on single family residences. Repayment of real estate mortgage loans is generally from the cash flow of the borrower.
• | Commercial real estate mortgage loans comprise the largest segment of this loan category and are available on all types of income producing and commercial properties, including: office buildings, shopping centers; apartments and motels; owner occupied buildings; manufacturing facilities and more. Commercial real estate mortgage loans can also be used to refinance existing debt. Although real estate associated with the business is the primary collateral for commercial real estate mortgage loans, the underlying real estate is not the source of repayment. Commercial real estate loans are made under the premise that the loan will be repaid from the borrower's business operations, rental income associated with the real property, or personal assets. |
• | Residential mortgage loans are provided to individuals to finance or refinance single-family residences. Residential mortgages are not a primary business line offered by the Company, and a majority are conventional mortgages that were purchased as a pool. Most residential mortgages originated by the Company are of a shorter term than conventional mortgages, with maturities ranging from three to fifteen years on average. |
70
• | Home Improvement and Home Equity loans comprise a relatively small portion of total real estate mortgage loans, and are offered to borrowers for the purpose of home improvements, although the proceeds may be used for other purposes. Home equity loans are generally secured by junior trust deeds, but may be secured by 1st trust deeds. |
Real estate construction and development loans, representing 25.3% of total loans at December 31, 2015, consist of loans for residential and commercial construction projects, as well as land acquisition and development, or land held for future development. Loans in this category are secured by real estate including improved and unimproved land, as well as single-family residential, multi-family residential, and commercial properties in various stages of completion. All real estate loans have established equity requirements. Repayment on construction loans is generally from long-term mortgages with other lending institutions obtained at completion of the project.
Agricultural loans represent 10.1% of total loans at December 31, 2015, and are generally secured by land, equipment, inventory and receivables. Repayment is from the cash flow of the borrower.
Installment loans represent 4.9% of total loans at December 31, 2015 and generally consist of loans to individuals for household, family and other personal expenditures such as credit cards, automobiles or other consumer items.
In the normal course of business, the Company is party to financial instruments with off-balance sheet risk to meet the financing needs of its customers. At December 31, 2015 and 2014, these financial instruments include commitments to extend credit of $107,084,000 and $105,434,000, respectively, and standby letters of credit of $3,295,000 and $3,800,000, respectively. These instruments involve elements of credit risk in excess of the amount recognized on the balance sheet. The contract amounts of these instruments reflect the extent of the involvement the Company has in off-balance sheet financial instruments.
The Company’s exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amounts of those instruments. The Company uses the same credit policies as it does for on-balance sheet instruments.
Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Substantially all of these commitments are at floating interest rates based on the Prime rate. Commitments generally have fixed expiration dates. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management's credit evaluation. Collateral held varies but includes accounts receivable, inventory, leases, property, plant and equipment, residential real estate and income-producing properties.
Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
Loans to directors, officers, principal shareholders and their affiliates are summarized below:
December 31, | ||||||
(In thousands) | 2015 | 2014 | ||||
Aggregate amount outstanding, beginning of year | $ | 2,120 | $ | 2,916 | ||
New loans or advances during year | 3,946 | 796 | ||||
Repayments during year | (2,312 | ) | (1,592 | ) | ||
Aggregate amount outstanding, end of year | $ | 3,754 | $ | 2,120 | ||
Loan commitments | $ | 7,431 | $ | 3,761 | ||
Past Due Loans
The Company monitors delinquency and potential problem loans on an ongoing basis through weekly reports to the Loan Committee and monthly reports to the Board of Directors. The following is a summary of delinquent loans at December 31, 2015 (in thousands):
71
December 31, 2015 | Loans 30-60 Days Past Due | Loans 61-89 Days Past Due | Loans 90 or More Days Past Due | Total Past Due Loans | Current Loans | Total Loans | Accruing Loans 90 or More Days Past Due | ||||||||||||||||||||
Commercial and Business Loans | $ | — | $ | — | $ | — | $ | — | $ | 54,503 | $ | 54,503 | $ | — | |||||||||||||
Government Program Loans | 13 | — | — | 13 | 1,310 | 1,323 | — | ||||||||||||||||||||
Total Commercial and Industrial | 13 | — | — | 13 | 55,813 | 55,826 | — | ||||||||||||||||||||
Commercial Real Estate Loans | 721 | — | — | 721 | 181,833 | 182,554 | — | ||||||||||||||||||||
Residential Mortgages | 62 | 392 | — | 454 | 68,357 | 68,811 | — | ||||||||||||||||||||
Home Improvement and Home Equity Loans | — | 39 | — | 39 | 828 | 867 | — | ||||||||||||||||||||
Total Real Estate Mortgage | 783 | 431 | — | 1,214 | 251,018 | 252,232 | — | ||||||||||||||||||||
Real Estate Construction and Development Loans | — | 706 | — | 706 | 129,890 | 130,596 | — | ||||||||||||||||||||
Agricultural Loans | — | — | — | — | 52,137 | 52,137 | — | ||||||||||||||||||||
Consumer Loans | — | 650 | — | 650 | 23,657 | 24,307 | — | ||||||||||||||||||||
Overdraft protection Lines | — | — | — | — | 61 | 61 | — | ||||||||||||||||||||
Overdrafts | — | — | — | — | 159 | 159 | — | ||||||||||||||||||||
Total Installment | — | 650 | — | 650 | 23,877 | 24,527 | — | ||||||||||||||||||||
Total Loans | $ | 796 | $ | 1,787 | $ | — | $ | 2,583 | $ | 512,735 | $ | 515,318 | $ | — | |||||||||||||
The following is a summary of delinquent loans at December 31, 2014 (in thousands):
December 31, 2014 | Loans 30-60 Days Past Due | Loans 61-89 Days Past Due | Loans 90 or More Days Past Due | Total Past Due Loans | Current Loans | Total Loans | Accruing Loans 90 or More Days Past Due | ||||||||||||||||||||
Commercial and Business Loans | $ | 962 | $ | — | $ | — | $ | 962 | $ | 59,460 | $ | 60,422 | $ | — | |||||||||||||
Government Program Loans | 445 | — | — | 445 | 1,502 | 1,947 | — | ||||||||||||||||||||
Total Commercial and Industrial | 1,407 | — | — | 1,407 | 60,962 | 62,369 | — | ||||||||||||||||||||
Commercial Real Estate Loans | 463 | — | 0 | 463 | 154,209 | 154,672 | — | ||||||||||||||||||||
Residential Mortgages | — | 90 | 162 | 252 | 58,843 | 59,095 | — | ||||||||||||||||||||
Home Improvement and Home Equity Loans | 43 | — | 42 | 85 | 1,025 | 1,110 | — | ||||||||||||||||||||
Total Real Estate Mortgage | 506 | 90 | 204 | 800 | 214,077 | 214,877 | — | ||||||||||||||||||||
Real Estate Construction and Development Loans | — | — | — | — | 137,158 | 137,158 | — | ||||||||||||||||||||
Agricultural Loans | — | — | — | — | 31,713 | 31,713 | — | ||||||||||||||||||||
Consumer Loans | 67 | — | — | 67 | 11,428 | 11,495 | — | ||||||||||||||||||||
Overdraft protection Lines | — | — | — | — | 92 | 92 | — | ||||||||||||||||||||
Overdrafts | — | — | — | — | 215 | 215 | — | ||||||||||||||||||||
Total Installment | 67 | — | — | 67 | 11,735 | 11,802 | — | ||||||||||||||||||||
Total Loans | $ | 1,980 | $ | 90 | $ | 204 | $ | 2,274 | $ | 455,645 | $ | 457,919 | $ | — | |||||||||||||
72
Nonaccrual Loans
Commercial, construction and commercial real estate loans are placed on non-accrual status under the following circumstances:
- | When there is doubt regarding the full repayment of interest and principal. |
- | When principal and/or interest on the loan has been in default for a period of 90-days or more, unless the asset is both well secured and in the process of collection that will result in repayment in the near future. |
- | When the loan is identified as having loss elements and/or is risk rated "8" Doubtful. |
Other circumstances which jeopardize the ultimate collectability of the loan including certain troubled debt restructurings, identified loan impairment, and certain loans to facilitate the sale of OREO.
Loans meeting any of the preceding criteria are placed on non-accrual status and the accrual of interest for financial statement purposes is discontinued. Previously accrued but unpaid interest is reversed and charged against interest income.
All other loans where principal or interest is due and unpaid for 90 days or more are placed on non-accrual and the accrual of interest for financial statement purposes is discontinued. Previously accrued but unpaid interest is reversed and charged against interest income.
When a loan is placed on non-accrual status and subsequent payments of interest (and principal) are received, the interest received may be accounted for in two separate ways.
Cost recovery method: If the loan is in doubt as to full collection, the interest received in subsequent payments is diverted from interest income to a valuation reserve and treated as a reduction of principal for financial reporting purposes.
Cash basis: This method is only used if the recorded investment or total contractual amount is expected to be fully collectible, under which circumstances the subsequent payments of interest is credited to interest income as received.
Loans on non-accrual status are usually not returned to accruing status unless and until all delinquent principal and/or interest has been brought current, there is no identified element of loss, and current and continued satisfactory performance is expected (loss of the contractual amount not the carrying amount of the loan). Repayment ability is generally demonstrated through the timely receipt of at least six monthly payments on a loan with monthly amortization.
Nonaccrual loans totaled $8,193,000 and $9,935,000 at December 31, 2015 and 2014, respectively. There were no remaining undisbursed commitments to extend credit on nonaccrual loans at December 31, 2015 and 2014.
The following is a summary of nonaccrual loan balances at December 31, 2015 and 2014 (in thousands).
December 31, 2015 | December 31, 2014 | ||||||
Commercial and Business Loans | $ | — | $ | 12 | |||
Government Program Loans | 328 | 421 | |||||
Total Commercial and Industrial | 328 | 433 | |||||
Commercial Real Estate Loans | 1,243 | 3,145 | |||||
Residential Mortgages | 392 | 1,174 | |||||
Home Improvement and Home Equity Loans | — | 42 | |||||
Total Real Estate Mortgage | 1,635 | 4,361 | |||||
Real Estate Construction and Development Loans | 5,580 | 5,141 | |||||
Agricultural Loans | — | — | |||||
Consumer Loans | 650 | — | |||||
Total Installment | 650 | — | |||||
Total Loans | $ | 8,193 | $ | 9,935 | |||
73
Impaired Loans
A loan is considered impaired when based on current information and events, it is probable that the Company will be unable to collect all amounts due, including principal and interest, according to the contractual terms of the loan agreement.
The Company applies its normal loan review procedures in making judgments regarding probable losses and loan impairment. The Company evaluates for impairment those loans on nonaccrual status, graded doubtful, graded substandard or those that are troubled debt restructures. The primary basis for inclusion in impaired status under generally accepted accounting pronouncements is that it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement.
A loan is not considered impaired if there is merely an insignificant delay or shortfall in the amounts of payments and the Company expects to collect all amounts due, including interest accrued, at the contractual interest rate for the period of the delay.
Review for impairment does not include large groups of smaller balance homogeneous loans that are collectively evaluated to estimate the allowance for loan losses. The Company’s present allowance for loan losses methodology, including migration analysis, captures required reserves for these loans in the formula allowance.
For loans determined to be impaired, the Company evaluates impairment based upon either the fair value of underlying collateral, discounted cash flows of expected payments, or observable market price.
- | For loans secured by collateral including real estate and equipment, the fair value of the collateral less selling costs will determine the carrying value of the loan. The difference between the recorded investment in the loan and the fair value, less selling costs, determines the amount of impairment. The Company uses the measurement method based on fair value of collateral when the loan is collateral dependent and foreclosure is probable. For loans that are not considered collateral dependent, a discounted cash flow methodology is used. |
- | The discounted cash flow method of measuring the impairment of a loan is used for impaired loans that are not considered to be collateral dependent. Under this method, the Company assesses both the amount and timing of cash flows expected from impaired loans. The estimated cash flows are discounted using the loan's effective interest rate. The difference between the amount of the loan on the Bank's books and the discounted cash flow amounts determines the amount of impairment to be provided. This method is used for most of the Company’s troubled debt restructurings or other impaired loans where some payment stream is being collected. |
- | The observable market price method of measuring the impairment of a loan is only used by the Company when the sale of loans or a loan is in process. |
The method for recognizing interest income on impaired loans is dependent on whether the loan is on nonaccrual status or is a troubled debt restructure. For income recognition, the existing nonaccrual and troubled debt restructuring policies are applied to impaired loans. Generally, except for certain troubled debt restructurings which are performing under the restructure agreement, the Company does not recognize interest income received on impaired loans, but reduces the carrying amount of the loan for financial reporting purposes.
Loans other than certain homogeneous loan portfolios are reviewed on a quarterly basis for impairment. Impaired loans are written down to estimated realizable values by the establishment of specific reserves for loan utilizing the discounted cash flow method, or charge-offs for collateral-based impaired loans, or those using observable market pricing.
The following is a summary of impaired loans at December 31, 2015 (in thousands).
74
December 31, 2015 | Unpaid Contractual Principal Balance | Recorded Investment With No Allowance (1) | Recorded Investment With Allowance (1) | Total Recorded Investment | Related Allowance | Average Recorded Investment (2) | Interest Recognized (2) | ||||||||||||||||||||
Commercial and Business Loans | $ | 4,855 | $ | 541 | $ | 4,333 | $ | 4,874 | $ | 530 | $ | 2,537 | $ | 302 | |||||||||||||
Government Program Loans | 327 | 327 | — | 327 | — | 358 | 29 | ||||||||||||||||||||
Total Commercial and Industrial | 5,182 | 868 | 4,333 | 5,201 | 530 | 2,895 | 331 | ||||||||||||||||||||
Commercial Real Estate Loans | 1,243 | — | 1,243 | 1,243 | 477 | 1,618 | 74 | ||||||||||||||||||||
Residential Mortgages | 4,032 | 1,051 | 2,999 | 4,050 | 158 | 4,092 | 185 | ||||||||||||||||||||
Home Improvement and Home Equity Loans | — | — | — | — | — | 11 | — | ||||||||||||||||||||
Total Real Estate Mortgage | 5,275 | 1,051 | 4,242 | 5,293 | 635 | 5,721 | 259 | ||||||||||||||||||||
Real Estate Construction and Development Loans | 12,489 | 5,340 | 7,179 | 12,519 | 1,282 | 7,781 | 820 | ||||||||||||||||||||
Agricultural Loans | 16 | 16 | — | 16 | — | 22 | 9 | ||||||||||||||||||||
Consumer Loans | 650 | — | 650 | 650 | 650 | 1,043 | 21 | ||||||||||||||||||||
Total Installment | 650 | — | 650 | 650 | 650 | 1,043 | 21 | ||||||||||||||||||||
Total Impaired Loans | $ | 23,612 | $ | 7,275 | $ | 16,404 | $ | 23,679 | $ | 3,097 | $ | 17,462 | $ | 1,440 | |||||||||||||
(1) The recorded investment in loans includes accrued interest receivable of $67,000.
(2) Information is based on the twelve month period ended December 31, 2015.
The following is a summary of impaired loans at December 31, 2014 (in thousands).
75
December 31, 2014 | Unpaid Contractual Principal Balance | Recorded Investment With No Allowance (1) | Recorded Investment With Allowance (1) | Total Recorded Investment | Related Allowance | Average Recorded Investment (2) | Interest Recognized (2) | ||||||||||||||||||||
Commercial and Business Loans | $ | 996 | $ | 770 | $ | 230 | $ | 1,000 | $ | 64 | $ | 847 | $ | 76 | |||||||||||||
Government Program Loans | 421 | 421 | — | 421 | — | 250 | 28 | ||||||||||||||||||||
Total Commercial and Industrial | 1,417 | 1,191 | 230 | 1,421 | 64 | 1,097 | 104 | ||||||||||||||||||||
Commercial Real Estate Loans | 3,145 | 1,794 | 1,351 | 3,145 | 478 | 5,765 | 244 | ||||||||||||||||||||
Residential Mortgages | 4,315 | 1,474 | 2,852 | 4,326 | 170 | 4,564 | 188 | ||||||||||||||||||||
Home Improvement and Home Equity Loans | 42 | 42 | — | 42 | — | 11 | 3 | ||||||||||||||||||||
Total Real Estate Mortgage | 7,502 | 3,310 | 4,203 | 7,513 | 648 | 10,340 | 435 | ||||||||||||||||||||
Real Estate Construction and Development Loans | 6,367 | 6,371 | — | 6,371 | — | 3,362 | 209 | ||||||||||||||||||||
Agricultural Loans | 32 | 32 | — | 32 | — | 37 | 9 | ||||||||||||||||||||
Consumer Loans | 695 | 655 | 45 | 700 | 3 | 209 | 37 | ||||||||||||||||||||
Total Installment | 695 | 655 | 45 | 700 | 3 | 209 | 37 | ||||||||||||||||||||
Total Impaired Loans | $ | 16,013 | $ | 11,559 | $ | 4,478 | $ | 16,037 | $ | 715 | $ | 15,045 | $ | 794 | |||||||||||||
(1) The recorded investment in loans includes accrued interest receivable of $24,000.
(2) Information is based on the twelve month period ended December 31, 2014.
In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructuring for which the loan is performing under the current contractual terms for a reasonable period of time, income is recognized under the accrual method.
Troubled Debt Restructurings
Under the circumstances, when the Company grants a concession to a borrower as part of a loan restructuring, the restructuring is accounted for as a troubled debt restructuring (TDR). TDRs are reported as a component of impaired loans.
A TDR is a type of restructuring in which the Company, for economic or legal reasons related to the borrower's financial difficulties, grants a concession (either imposed by court order, law, or agreement between the borrower and the Bank) to the borrower that it would not otherwise consider. Although the restructuring may take different forms, the Company's objective is to maximize recovery of its investment by granting relief to the borrower.
A TDR may include, but is not limited to, one or more of the following:
- A transfer from the borrower to the Company of receivables from third parties, real estate, other assets, or an equity interest in the borrower is granted to fully or partially satisfy the loan.
- A modification of terms of a debt such as one or a combination of:
◦ | The reduction (absolute or contingent) of the stated interest rate. |
◦ | The extension of the maturity date or dates at a stated interest rate lower than the current market rate for new debt with similar risk. |
76
◦ | The reduction (absolute or contingent) of the face amount or maturity amount of debt as stated in the instrument or agreement. |
◦ | The reduction (absolute or contingent) of accrued interest. |
For a restructured loan to return to accrual status there needs to be, among other factors, at least 6 months successful payment history. In addition, the Company performs a financial analysis of the credit to determine whether the borrower has the ability to continue to meet payments over the remaining life of the loan. This includes, but is not limited to, a review of financial statements and cash flow analysis of the borrower. Only after determination that the borrower has the ability to perform under the terms of the loans, will the restructured credit be considered for accrual status. Although the Company does not have a policy which specifically addresses when a loan may be removed from TDR classification, as a matter of practice, loans classified as TDRs generally remain classified as such until the loan either reaches maturity or its outstanding balance is paid off.
The following tables illustrate TDR activity for the periods indicated (dollars in thousands):
Twelve Months Ended December 31, 2015 | |||||||||||||||||
Number of Contracts | Pre- Modification Outstanding Recorded Investment | Post- Modification Outstanding Recorded Investment | Number of Contracts in Default | Recorded Investment on Defaulted TDRs | |||||||||||||
Troubled Debt Restructurings | |||||||||||||||||
Commercial and Business Loans | 1 | $ | 81 | $ | 76 | — | $ | — | |||||||||
Government Program Loans | — | — | — | — | — | ||||||||||||
Commercial Real Estate Term Loans | — | — | — | — | — | ||||||||||||
Single Family Residential Loans | 1 | 258 | 248 | — | — | ||||||||||||
Home Improvement and Home Equity Loans | — | — | — | — | — | ||||||||||||
Real Estate Construction and Development Loans | 1 | 6,446 | 6,446 | — | — | ||||||||||||
Agricultural Loans | — | — | — | — | — | ||||||||||||
Consumer Loans | — | — | — | — | — | ||||||||||||
Overdraft protection Lines | — | — | — | — | — | ||||||||||||
Total Loans | 3 | $ | 6,785 | $ | 6,770 | — | $ | — | |||||||||
77
Twelve Months Ended December 31, 2014 | |||||||||||||||||
Number of Contracts | Pre- Modification Outstanding Recorded Investment | Post- Modification Outstanding Recorded Investment | Number of Contracts in Default | Recorded Investment on Defaulted TDRs | |||||||||||||
Troubled Debt Restructurings | |||||||||||||||||
Commercial and Business Loans | 5 | $ | 456 | $ | 437 | 1 | $ | — | |||||||||
Government Program Loans | 1 | 544 | 539 | 2 | 421 | ||||||||||||
Commercial Real Estate Term Loans | 2 | 1,948 | 1,362 | — | — | ||||||||||||
Single Family Residential Loans | — | — | — | 3 | 656 | ||||||||||||
Home Improvement and Home Equity Loans | — | — | — | — | — | ||||||||||||
Real Estate Construction and Development Loans | 2 | 5,665 | 5,548 | 2 | 394 | ||||||||||||
Agricultural Loans | — | — | — | — | — | ||||||||||||
Consumer Loans | 1 | 630 | 650 | — | — | ||||||||||||
Overdraft protection Lines | — | — | — | — | — | ||||||||||||
Total Loans | 11 | $ | 9,243 | $ | 8,536 | 8 | $ | 1,471 | |||||||||
The following tables summarize TDR activity by loan category for the years ended December 31, 2015 and 2014 (in thousands).
Twelve Months Ended December 31, 2015 | Commercial and Industrial | Commercial Real Estate | Residential Mortgages | Home Equity | Real Estate Construction and Development | Agricultural | Installment & Other | Total | |||||||||||||||||||||||
Beginning balance | $ | 1,306 | $ | 2,713 | $ | 4,225 | $ | — | $ | 6,029 | $ | 32 | $ | 695 | $ | 15,000 | |||||||||||||||
Defaults | — | — | — | — | — | — | — | — | |||||||||||||||||||||||
Additions | 81 | — | 258 | — | 6,446 | — | — | 6,785 | |||||||||||||||||||||||
Principal advances (reductions) | (489 | ) | (1,470 | ) | (950 | ) | — | (307 | ) | (16 | ) | (45 | ) | (3,277 | ) | ||||||||||||||||
Ending balance | $ | 898 | $ | 1,243 | $ | 3,533 | $ | — | $ | 12,168 | $ | 16 | $ | 650 | $ | 18,508 | |||||||||||||||
Allowance for loan loss | $ | 32 | $ | 477 | $ | 149 | $ | — | $ | 384 | $ | — | $ | 650 | $ | 1,692 | |||||||||||||||
78
Twelve Months Ended December 31, 2014 | Commercial and Industrial | Commercial Real Estate | Residential Mortgages | Home Equity | Real Estate Construction and Development | Agricultural | Installment & Other | Total | |||||||||||||||||||||||
Beginning balance | $ | 675 | $ | 1,468 | $ | 5,273 | $ | — | $ | 1,551 | $ | 44 | $ | 48 | $ | 9,059 | |||||||||||||||
Defaults | (421 | ) | — | (656 | ) | — | (394 | ) | — | — | (1,471 | ) | |||||||||||||||||||
Additions | 1,000 | 1,948 | — | — | 5,665 | — | 630 | 9,243 | |||||||||||||||||||||||
Principal reductions | 52 | (703 | ) | (392 | ) | — | (793 | ) | (12 | ) | 17 | (1,831 | ) | ||||||||||||||||||
Ending balance | $ | 1,306 | $ | 2,713 | $ | 4,225 | $ | — | $ | 6,029 | $ | 32 | $ | 695 | $ | 15,000 | |||||||||||||||
Allowance for loan loss | $ | 64 | $ | 478 | $ | 170 | $ | — | $ | — | $ | — | $ | 3 | $ | 715 | |||||||||||||||
The Company makes various types of concessions when structuring TDRs including rate reductions, payment extensions, and forbearance. At December 31, 2015, the Company had 29 restructured loans totaling $18,508,000, as compared to 33 restructured loans totaling $15,000,000 at December 31, 2014. The Company had unfunded commitments standing for TDRS of $454,000 at December 31, 2015 and none at December 31, 2014.
Credit Quality Indicators
As part of its credit monitoring program, the Company utilizes a risk rating system which quantifies the risk the Company estimates it has assumed during the life of a loan. The system rates the strength of the borrower and the facility or transaction, and is designed to provide a program for risk management and early detection of problems.
For each new credit approval, credit extension, renewal, or modification of existing credit facilities, the Company assigns risk ratings utilizing the rating scale identified in this policy. In addition, on an on-going basis, loans and credit facilities are reviewed for internal and external influences impacting the credit facility that would warrant a change in the risk rating. Each loan credit facility is to be given a risk rating that takes into account factors that materially affect credit quality.
When assigning risk ratings, the Company evaluates two risk rating approaches, a facility rating and a borrower rating as follows.
Facility Rating:
The facility rating is determined by the analysis of positive and negative factors that may indicate that the quality of a particular loan or credit arrangement requires that it be rated differently from the risk rating assigned to the borrower. The Company assesses the risk impact of these factors:
Collateral - The rating may be affected by the type and quality of the collateral, the degree of coverage, the economic life of the collateral, liquidation value and the Company's ability to dispose of the collateral.
Guarantees - The value of third party support arrangements varies widely. Unconditional guaranties from persons with demonstrable ability to perform are more substantial than that of closely related persons to the borrower who offer only modest support.
Unusual Terms - Credit may be extended on terms that subject the Company to a higher level of risk than indicated in the rating of the borrower.
Borrower Rating:
The borrower rating is a measure of loss possibility based on the historical, current and anticipated financial characteristics of the borrower in the current risk environment. To determine the rating, the Company considers at least the following factors:
- Quality of management
79
- Liquidity
- Leverage/capitalization
- Profit margins/earnings trend
- Adequacy of financial records
- Alternative funding sources
- Geographic risk
- Industry risk
- Cash flow risk
- Accounting practices
- Asset protection
- Extraordinary risks
The Company assigns risk ratings to loans other than consumer loans and other homogeneous loan pools based on the following scale. The risk ratings are used when determining borrower ratings as well as facility ratings. When the borrower rating and the facility ratings differ, the lowest rating applied is:
- | Grades 1 and 2 – These grades include loans which are given to high quality borrowers with high credit quality and sound financial strength. Key financial ratios are generally above industry averages and the borrower’s strong earnings history or net worth. These may be secured by deposit accounts or high-grade investment securities. |
- | Grade 3 – This grade includes loans to borrowers with solid credit quality with minimal risk. The borrower’s balance sheet and financial ratios are generally in line with industry averages, and the borrower has historically demonstrated the ability to manage economic adversity. Real estate and asset-based loans assigned this risk rating must have characteristics, which place them well above the minimum underwriting requirements for those departments. Asset-based borrowers assigned this rating must exhibit extremely favorable leverage and cash flow characteristics, and consistently demonstrate a high level of unused borrowing capacity. |
- | Grades 4 and 5 – These include “pass” grade loans to borrowers of acceptable credit quality and risk. The borrower’s balance sheet and financial ratios may be below industry averages, but above the lowest industry quartile. Leverage is above and liquidity is below industry averages. Inadequacies evident in financial performance and/or management sufficiency are offset by readily available features of support, such as adequate collateral, or good guarantors having the liquid assets and/or cash flow capacity to repay the debt. The borrower may have recognized a loss over three or four years, however recent earnings trends, while perhaps somewhat cyclical, are improving and cash flows are adequate to cover debt service and fixed obligations. Real estate and asset-borrowers fully comply with all underwriting standards and are performing according to projections would be assigned this rating. These also include grade 5 loans which are “leveraged” or on management’s “watch list.” While still considered pass loans (loans given a grade 5), the borrower’s financial condition, cash flow or operations evidence more than average risk and short term weaknesses, these loans warrant a higher than average level of monitoring, supervision and attention from the Company, but do not reflect credit weakness trends that weaken or inadequately protect the Company’s credit position. Loans with a grade rating of 5 are not normally acceptable as new credits unless they are adequately secured or carry substantial endorser/guarantors. |
- | Grade 6 – This grade includes “special mention” loans which are loans that are currently protected but are potentially weak. This generally is an interim grade classification and should usually be upgraded to an Acceptable rating or downgraded to Substandard within a reasonable time period. Weaknesses in special mention loans may, if not checked or corrected, weaken the asset or inadequately protect the Company’s credit position at some future date. Special mention loans are often loans with weaknesses inherent from the loan origination, loan servicing, and perhaps some technical deficiencies. The main theme in special mention credits is the distinct probability that the classification will deteriorate to a more adverse class if the noted deficiencies are not addressed by the loan officer or loan management. |
- | Grade 7 – This grade includes “substandard” loans which are inadequately supported by the current sound net worth and paying capacity of the borrower or of the collateral pledged, if any. Substandard loans have a well-defined weakness or weaknesses that may impair the regular liquidation of the debt. Substandard loans exhibit a distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Substandard loans also include impaired loans. |
- | Grade 8 - This grade includes “doubtful” loans which exhibit the same characteristics as the Substandard loans with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high, but |
80
because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include a proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans.
- | Grade 9 - This grade includes loans classified “loss” which are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off the asset even though partial recovery may be achieved in the future. |
The following tables summarize the credit risk ratings for commercial, construction, and other non-consumer related loans for December 31, 2015 and 2014. The Company did not carry any loans graded as loss at December 31, 2015 or December 31, 2014.
Commercial and Industrial | Commercial RE | Real Estate Construction and Development | Agricultural | Total | |||||||||||||||
December 31, 2015 | |||||||||||||||||||
(In thousands) | |||||||||||||||||||
Grades 1 and 2 | $ | 519 | $ | — | $ | — | $ | 50 | $ | 569 | |||||||||
Grade 3 | 5,008 | 5,964 | — | — | 10,972 | ||||||||||||||
Grades 4 and 5 – pass | 44,341 | 173,731 | 103,607 | 52,087 | 373,766 | ||||||||||||||
Grade 6 – special mention | 946 | 1,616 | — | — | 2,562 | ||||||||||||||
Grade 7 – substandard | 5,012 | 1,243 | 26,989 | — | 33,244 | ||||||||||||||
Grade 8 – doubtful | — | — | — | — | — | ||||||||||||||
Total | $ | 55,826 | $ | 182,554 | $ | 130,596 | $ | 52,137 | $ | 421,113 | |||||||||
Commercial and Industrial | Commercial RE | Real Estate Construction and Development | Agricultural | Total | |||||||||||||||
December 31, 2014 | |||||||||||||||||||
(In thousands) | |||||||||||||||||||
Grades 1and 2 | $ | 591 | $ | — | $ | — | $ | — | $ | 591 | |||||||||
Grade 3 | 2,012 | 4,808 | 775 | — | 7,595 | ||||||||||||||
Grades 4 and 5 – pass | 58,179 | 144,230 | 114,766 | 31,600 | 348,775 | ||||||||||||||
Grade 6 – special mention | 342 | 1,095 | — | 113 | 1,550 | ||||||||||||||
Grade 7 – substandard | 1,245 | 4,539 | 21,617 | — | 27,401 | ||||||||||||||
Grade 8 – doubtful | — | — | — | — | — | ||||||||||||||
Total | $ | 62,369 | $ | 154,672 | $ | 137,158 | $ | 31,713 | $ | 385,912 | |||||||||
The Company follows consistent underwriting standards outlined in its loan policy for consumer and other homogeneous loans but, does not specifically assign a risk rating when these loans are originated. Consumer loans are monitored for credit risk and are considered “pass” loans until some issue or event requires that the credit be downgraded to special mention or worse.
The following tables summarize the credit risk ratings for consumer related loans and other homogeneous loans for December 31, 2015 and 2014 (in thousands).
81
December 31, 2015 | December 31, 2014 | ||||||||||||||||||||||||||||||
Residential Mortgages | Home Improvement and Home Equity | Installment | Total | Residential Mortgages | Home Improvement and Home Equity | Installment | Total | ||||||||||||||||||||||||
Not graded | $ | 47,135 | $ | 839 | $ | 23,213 | $ | 71,187 | $ | 38,207 | $ | 1,038 | $ | 10,287 | $ | 49,532 | |||||||||||||||
Pass | 19,466 | 28 | 664 | 20,158 | 17,887 | 30 | 865 | 18,782 | |||||||||||||||||||||||
Special Mention | — | — | — | — | 216 | — | — | 216 | |||||||||||||||||||||||
Substandard | 2,210 | — | 650 | 2,860 | 2,785 | 42 | 650 | 3,477 | |||||||||||||||||||||||
Total | $ | 68,811 | $ | 867 | $ | 24,527 | $ | 94,205 | $ | 59,095 | $ | 1,110 | $ | 11,802 | $ | 72,007 | |||||||||||||||
Allowance for Loan Losses
The Company analyzes risk characteristics inherent in each loan portfolio segment as part of the quarterly review of the adequacy of the allowance for loan losses. The following summarizes some of the key risk characteristics for the eleven segments of the loan portfolio (Consumer loans include three segments):
Commercial and industrial loans – Commercial loans are subject to the effects of economic cycles and tend to exhibit increased risk as economic conditions deteriorate, or if the economic downturn is prolonged. The Company considers this segment to be one of higher risk given the size of individual loans and the balances in the overall portfolio.
Government program loans – This is a relatively a small part of the Company’s loan portfolio, but has historically had a high percentage of loans that have migrated from pass to substandard given there vulnerability to economic cycles.
Commercial real estate loans – This segment is considered to have more risk in part because of the vulnerability of commercial businesses to economic cycles as well as the exposure to fluctuations in real estate prices because most of these loans are secured by real estate. Losses in this segment have however been historically low because most of the loans are real estate secured, and the bank maintains appropriate loan-to-value ratios.
Residential mortgages – This segment is considered to have low risk factors both from the Company and peer statistics. These loans are secured by first deeds of trust. The losses experienced over the past twelve quarters are isolated to approximately twelve loans and are generally the result of short sales.
Home improvement and home equity loans – Because of their junior lien position, these loans have an inherently higher risk level. Because residential real estate has been severely distressed in the recent past, the anticipated risk for this loan segment has increased.
Real estate construction and development loans –In a normal economy, this segment of loans is considered to have a higher risk profile due to construction and market value issues in conjunction with normal credit risks. Although residential real estate markets have improved, they are still distressed on a historical basis, and therefore carry higher risk.
Agricultural loans – This segment is considered to have risks associated with weather, insects, and marketing issues. In addition, concentrations in certain crops or certain agricultural areas can increase risk.
Installment loans (Includes consumer loans, overdrafts, and overdraft protection lines) – This segment is higher risk because many of the loans are unsecured.
The following summarizes the activity in the allowance for credit losses by loan category for the years ended December 31, 2015 and 2014 (in thousands).
82
December 31, 2015 | Commercial and Industrial | Real Estate Mortgage | Real Estate Construction and Development Loans | Agricultural | Installment & Other | Commercial Lease Financing | Unallocated | Total | |||||||||||||||||||||||
Beginning balance | $ | 1,218 | $ | 1,653 | $ | 6,278 | $ | 482 | $ | 293 | $ | — | $ | 847 | $ | 10,771 | |||||||||||||||
Provision for credit losses | 1,201 | (369 | ) | (1,709 | ) | 173 | 1,422 | — | (759 | ) | (41 | ) | |||||||||||||||||||
Charge-offs | (1,397 | ) | — | — | — | (467 | ) | — | (22 | ) | (1,886 | ) | |||||||||||||||||||
Recoveries | 630 | 165 | 60 | — | 10 | — | 4 | 869 | |||||||||||||||||||||||
Net recoveries(charge-offs) | (767 | ) | 165 | 60 | — | (457 | ) | — | (18 | ) | (1,017 | ) | |||||||||||||||||||
Ending balance | $ | 1,652 | $ | 1,449 | $ | 4,629 | $ | 655 | $ | 1,258 | $ | — | $ | 70 | $ | 9,713 | |||||||||||||||
Period-end amount allocated to: | |||||||||||||||||||||||||||||||
Loans individually evaluated for impairment | 530 | 635 | 1,282 | — | 650 | — | — | 3,097 | |||||||||||||||||||||||
Loans collectively evaluated for impairment | 1,122 | 814 | 3,347 | 655 | 608 | — | 70 | 6,616 | |||||||||||||||||||||||
Ending balance | $ | 1,652 | $ | 1,449 | $ | 4,629 | $ | 655 | $ | 1,258 | $ | — | $ | 70 | $ | 9,713 | |||||||||||||||
December 31, 2014 | Commercial and Industrial | Real Estate Mortgage | Real Estate Construction and Development Loans | Agricultural | Installment & Other | Commercial Lease Financing | Unallocated | Total | |||||||||||||||||||||||
Beginning balance | $ | 2,340 | $ | 1,862 | $ | 5,533 | $ | 583 | $ | 275 | $ | — | $ | 395 | $ | 10,988 | |||||||||||||||
Provision for credit losses | (1,129 | ) | (89 | ) | 97 | (106 | ) | (40 | ) | (46 | ) | 468 | (845 | ) | |||||||||||||||||
Charge-offs | (318 | ) | (140 | ) | (60 | ) | — | — | — | (16 | ) | (534 | ) | ||||||||||||||||||
Recoveries | 325 | 20 | 708 | 5 | 58 | 46 | — | 1,162 | |||||||||||||||||||||||
Net recoveries (charge-offs) | 7 | (120 | ) | 648 | 5 | 58 | 46 | (16 | ) | 628 | |||||||||||||||||||||
Ending balance | $ | 1,218 | $ | 1,653 | $ | 6,278 | $ | 482 | $ | 293 | $ | — | $ | 847 | $ | 10,771 | |||||||||||||||
Period-end amount allocated to: | |||||||||||||||||||||||||||||||
Loans individually evaluated for impairment | 64 | 648 | — | — | 3 | — | — | 715 | |||||||||||||||||||||||
Loans collectively evaluated for impairment | 1,154 | 1,005 | 6,278 | 482 | 290 | — | 847 | 10,056 | |||||||||||||||||||||||
Ending balance | $ | 1,218 | $ | 1,653 | $ | 6,278 | $ | 482 | $ | 293 | $ | — | $ | 847 | $ | 10,771 | |||||||||||||||
83
The following summarizes information with respect to the loan balances at December 31, 2015 and 2014.
December 31, 2015 | December 31, 2014 | ||||||||||||||||||||||
Loans Individually Evaluated for Impairment | Loans Collectively Evaluated for Impairment | Total Loans | Loans Individually Evaluated for Impairment | Loans Collectively Evaluated for Impairment | Total Loans | ||||||||||||||||||
(In thousands) | |||||||||||||||||||||||
Commercial and Business Loans | $ | 4,874 | $ | 49,629 | $ | 54,503 | $ | 1,000 | $ | 59,422 | $ | 60,422 | |||||||||||
Government Program Loans | 327 | 996 | 1,323 | 421 | 1,526 | 1,947 | |||||||||||||||||
Total Commercial and Industrial | 5,201 | 50,625 | 55,826 | 1,421 | 60,948 | 62,369 | |||||||||||||||||
Commercial Real Estate Loans | 1,243 | 181,311 | 182,554 | 3,145 | 151,527 | 154,672 | |||||||||||||||||
Residential Mortgage Loans | 4,050 | 64,761 | 68,811 | 4,326 | 54,769 | 59,095 | |||||||||||||||||
Home Improvement and Home Equity Loans | — | 867 | 867 | 42 | 1,068 | 1,110 | |||||||||||||||||
Total Real Estate Mortgage | 5,293 | 246,939 | 252,232 | 7,513 | 207,364 | 214,877 | |||||||||||||||||
Real Estate Construction and Development Loans | 12,519 | 118,077 | 130,596 | 6,371 | 130,787 | 137,158 | |||||||||||||||||
Agricultural Loans | 16 | 52,121 | 52,137 | 32 | 31,681 | 31,713 | |||||||||||||||||
Installment Loans | 650 | 23,877 | 24,527 | 700 | 11,102 | 11,802 | |||||||||||||||||
Total Loans | $ | 23,679 | $ | 491,639 | $ | 515,318 | $ | 16,037 | $ | 441,882 | $ | 457,919 | |||||||||||
4. | Premises and Equipment |
The components of premises and equipment are as follows:
(In thousands) | December 31, 2015 | December 31, 2014 | |||||
Land | $ | 968 | $ | 968 | |||
Buildings and improvements | 14,791 | 14,731 | |||||
Furniture and equipment | 8,496 | 11,713 | |||||
24,255 | 27,412 | ||||||
Less accumulated depreciation and amortization | (13,455 | ) | (15,862 | ) | |||
Total premises and equipment | $ | 10,800 | $ | 11,550 | |||
Total depreciation expense on Company premises and equipment totaled $1,462,000 and $1,390,000 for the years ended December 31, 2015 and 2014, respectively, and is included in occupancy expense in the accompanying consolidated statements of operations.
5. | Investment in Limited Partnership |
The Bank owns limited interests in private limited partnerships that acquire affordable housing properties in California that generate Low Income Housing Tax Credits under Section 42 of the Internal Revenue Code of 1986, as amended. The Bank's limited partnership investment is accounted for under the equity method. The Bank's noninterest expense associated with the utilization and expiration of these tax credits for the years ended December 31, 2015 and 2014 was $73,000 and $39,000, respectively. These limited partnership investments are expected to generate tax credits of approximately $1.8 million over the life of the investment. The tax credits expired during 2015. No tax credits were available for income tax purposes for the years ended December 31, 2015 and 2014.
The Bank owns a 9.14% interest in a limited partnership which provides private capital for small to mid-sized businesses used to finance later stage growth, strategic acquisitions, ownership transitions, and recapitalizations, or mezzanine capital. The
84
Company sold its $3,559,000 or 36% interest in a commercial real estate partnership in 2014 for a $691,000 gain on sale. At December 31, 2015, the total investment in limited partnerships was $917,000. The Company realized a $23,000 loss on sale of investment during the year ended December 31, 2015 as a result of a final distribution on its investment in an economic development lending initiative.
6. | Deposits |
Deposits include the following:
(In thousands) | December 31, 2015 | December 31, 2014 | |||||
Noninterest-bearing deposits | $ | 262,168 | $ | 215,439 | |||
Interest-bearing deposits: | |||||||
NOW and money market accounts | 226,886 | 211,290 | |||||
Savings accounts | 63,592 | 60,499 | |||||
Time deposits: | |||||||
Under $250,000 | 58,122 | 65,844 | |||||
$250,000 and over | 11,037 | 12,301 | |||||
Total interest-bearing deposits | 359,637 | 349,934 | |||||
Total deposits | $ | 621,805 | $ | 565,373 | |||
At December 31, 2015, the scheduled maturities of all certificates of deposit and other time deposits are as follows:
(In thousands) | December 31, 2015 | ||
One year or less | $ | 57,835 | |
More than one year, but less than or equal to two years | 9,305 | ||
More than two years, but less than or equal to three years | 1,361 | ||
More than three years, but less than or equal to four years | 371 | ||
More than four years, but less than or equal to five years | 287 | ||
More than five years | — | ||
$ | 69,159 | ||
The Company may utilize brokered deposits as an additional source of funding. At December 31, 2015 and 2014, the Company held brokered time deposits totaling $8,546,000 and $11,480,000, respectively. All brokered time deposits are include in time deposits of less than $250,000. Included in brokered time deposits at December 31, 2015 are balances totaling $2,611,000 maturing in three months or less and $5,935,000 maturing in 3 months to a year.
Deposit balances representing overdrafts reclassified as loan balances totaled $158,000 and $215,000 as of December 31, 2015 and 2014, respectively.
Deposits of directors, officers and other related parties to the Bank totaled $13,746,000 and $8,658,000 at December 31, 2015 and 2014, respectively. The rates paid on these deposits were similar to those customarily paid to the Bank’s customers in the normal course of business.
7. | Short-term Borrowings/Other Borrowings |
At December 31, 2015, the Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $302,456,000, as well as Federal Home Loan Bank (“FHLB”) lines of credit totaling $2,854,000. At December 31, 2015, the Company had an uncollateralized line of credit with Pacific Coast Bankers Bank ("PCBB") totaling $10,000,000 and a Fed Funds line of $20,000,000 with Zions First National Bank. At December 31, 2015, and for the year then ended, the Company had no outstanding borrowing balances. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. These lines of credit have interest rates that are generally tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR. FHLB advances are collateralized by the Company’s stock in the FHLB, investment securities, and certain qualifying mortgage loans. As of December 31, 2015, $3,023,000 in investment securities at FHLB were pledged
85
as collateral for FHLB advances. Additionally, $444,596,000 in real estate-secured loans were pledged at December 31, 2015, as collateral for used and unused borrowing lines with the Federal Reserve Bank totaling $302,456,000.
The Company had collateralized lines of credit with the Federal Reserve Bank of San Francisco totaling $286,993,000, as well as Federal Home Loan Bank (“FHLB”) lines of credit totaling $5,814,000 at December 31, 2014. At December 31, 2014, the Company had an uncollateralized line of credit with Pacific Coast Bankers Bank ("PCBB") totaling $10,000,000. These lines of credit generally have interest rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR. FHLB advances are collateralized by the Company’s stock in the FHLB, investment securities, and certain qualifying mortgage loans. As of December 31, 2014, $6,106,000 in investment securities at FHLB were pledged as collateral for FHLB advances. Additionally, $406,358,000 in secured and unsecured loans were pledged at December 31, 2014, as collateral for used and unused borrowing lines with the Federal Reserve Bank totaling $286,993,000. All lines of credit are on an “as available” basis and can be revoked by the grantor at any time. At December 31, 2014, and for the year then ended, the Company had no outstanding borrowing balances.
8. | Junior Subordinated Debt/Trust Preferred Securities |
During July 2007, the Company formed USB Capital Trust II, 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 ASC 810. On July 23, 2007, USB Capital Trust II issued $15 million in Trust Preferred securities. The securities have a thirty-year maturity and bear a floating rate of interest (repricing quarterly) of 1.29% over the three-month LIBOR rate (initial coupon rate of 6.65%). Interest will be paid quarterly. Concurrent with the issuance of the Trust Preferred securities, USB Capital Trust II used the proceeds of the Trust Preferred securities offering to purchase a like amount of junior subordinated debentures of the Company. The Company will pay interest on the junior subordinated debentures to USB Capital Trust II, which represents the sole source of dividend distributions to the holders of the Trust Preferred securities. The Company may redeem the junior subordinated debentures at anytime at par.
The Company elected the fair value measurement option for all the Company’s new junior subordinated debentures issued under USB Capital Trust II.
Effective September 30, 2009 and beginning with the quarterly interest payment due October 1, 2009, the Company elected to defer interest payments on the Company’s $15.0 million of junior subordinated debentures relating to its trust preferred securities. The terms of the debentures and trust indentures allow for the Company to defer interest payments for up to 20 consecutive quarters without default or penalty. During the period that the interest deferrals were elected, the 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 is currently making quarterly interest payments. At December 31, 2015 and 2014, the Company had $50,000 and $58,000, respectively, in accrued and unpaid interest on the junior subordinated debt.
During August 2015, the Bank purchased $3.0 million of the Company's junior subordinated debentures related to the Company's trust preferred securities at a fair value discount of 40%. Subsequently, in September 2015, the Company purchased those shares from the Bank and canceled $3.0 million in par value of the junior subordinated debentures, realizing a $78,000 gain on redemption. The contractual principal balance of the Company's debentures relating to its trust preferred securities is $12.0 million as of December 31, 2015.
At December 31, 2015, as with previous periods, the Company performed a fair value measurement analysis on its junior subordinated debt using a discounted cash flow valuation model approach to determine the present value of those cash flows. The cash flow model utilizes the forward 3-month LIBOR curve to estimate future quarterly interest payments due over the life of the debt instrument. These cash flows were discounted at a rate which incorporates a current market rate for similar-term debt instruments, adjusted for additional credit and liquidity risks associated with the junior subordinated debt. Although there is little market data in the current relatively illiquid credit markets, we believe the 6.82% discount rate used represents what a market participant would consider under the circumstances based on current market assumptions.
The fair value calculation performed resulted in a realized losses of $73,000 and $102,000 for the years ended December 31, 2015 and 2014, respectively. Fair value gains and losses are reflected as a component of noninterest income.
86
9. | Taxes on Income |
The tax effects of significant items comprising the Company’s net deferred tax assets (liabilities) are as follows:
December 31, | |||||||
(In thousands) | 2015 | 2014 | |||||
Deferred tax assets: | |||||||
Credit losses not currently deductible | $ | 4,489 | $ | 4,962 | |||
Deferred compensation | 1,891 | 1,976 | |||||
Net operating losses | 459 | 1,653 | |||||
Depreciation | 338 | 346 | |||||
Accrued reserves | 73 | 54 | |||||
Write-down on other real estate owned | 534 | 404 | |||||
Unrealized gain on AFS | 147 | 133 | |||||
Interest on nonaccrual loans | 36 | 43 | |||||
Capitalized OREO expenses | 826 | 778 | |||||
Other | 2,196 | 2,973 | |||||
Total deferred tax assets | 10,989 | 13,322 | |||||
Deferred tax liabilities: | |||||||
State Tax | (1,281 | ) | (1,681 | ) | |||
FHLB dividend | (65 | ) | (53 | ) | |||
Loss on limited partnership investment | (1,286 | ) | (1,077 | ) | |||
Deferred gain ASC 825 – fair value option | (1,890 | ) | (2,425 | ) | |||
Fair value adjustments for purchase accounting | (139 | ) | (139 | ) | |||
Deferred loan costs | (868 | ) | (750 | ) | |||
Prepaid expenses | (232 | ) | (344 | ) | |||
Total deferred tax liabilities | (5,761 | ) | (6,469 | ) | |||
Net deferred tax assets | $ | 5,228 | $ | 6,853 | |||
The Company periodically evaluates its deferred tax assets to determine whether a valuation allowance is required based upon a determination that some or all of the deferred assets may not be ultimately realized. The Company did not record a valuation allowance at December 31, 2015 or December 31, 2014.
Income tax expense (benefit) for the years ended December 31, consist of the following:
(In thousands) | |||||||||||
2015 | Federal | State | Total | ||||||||
Current | $ | 2,847 | $ | 10 | $ | 2,857 | |||||
Deferred | 465 | 1,175 | 1,640 | ||||||||
$ | 3,312 | $ | 1,185 | $ | 4,497 | ||||||
2014 | |||||||||||
Current | $ | 1,129 | $ | (1,753 | ) | $ | (624 | ) | |||
Deferred | 1,994 | 2,822 | 4,816 | ||||||||
$ | 3,123 | $ | 1,069 | $ | 4,192 | ||||||
A reconciliation of the statutory federal income tax rate to the effective income tax rate is as follows:
87
Year Ended December 31, | |||||
2015 | 2014 | ||||
Statutory federal income tax rate | 34.0 | % | 34.0 | % | |
State franchise tax, net of federal income tax benefit | 6.9 | 6.8 | |||
Other | (1.1 | ) | (0.5 | ) | |
39.8 | % | 40.3 | % | ||
At December 31, 2015, the Company has no remaining federal net operating loss carry-forwards, and remaining state net operating loss carry-forwards totaling $15,790,000 which expire between 2016 and 2032. The Company anticipates that it will utilize the net operating loss carry-forwards expiring in 2016.
The Company periodically reviews its tax positions under the accounting standards related to uncertainty in income taxes, which defines 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 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 and all available information is known to the taxing authority.
The Company and its subsidiary file income tax returns in the U.S federal jurisdiction, and several states within the U.S. There are no filings in foreign jurisdictions. During 2014, the Company began the process to amend its state tax returns for the years 2009 through 2012 to file a combined report on a unitary basis with the Company and USB Investment Trust . The amended return for 2009 was filed during 2014 and the 2010 return was filed during 2015. The amended returns for 2011 and 2012 will be filed during 2016 once the FTB accepts the 2009 and 2010 amended returns.
The Company is not currently aware of any other tax jurisdictions where the Company or any subsidiary is subject to examination by federal, state, or local taxing authorities.
10. | Stock Based Compensation |
Options and restricted stock units and awards have been granted to officers and key employees at an exercise price equal to estimated fair value at the date of grant as determined by the Board of Directors. All options, units, and awards granted are service awards, and as such are based solely upon fulfilling a requisite service period (the vesting period). On December 31, 2015, the Company had two stock based compensation plans.
In May 2005, the Company’s shareholders approved the adoption of the United Security Bancshares 2005 Stock Option Plan (2005 Plan). The 2005 Plan provides for the granting of up to 673,924 shares of authorized and unissued shares of common stock at option prices per share which must not be less than 100% of the fair value per share at the time each option is granted.
In May 2015, the Company adopted the United Security Bancshares 2015 Equity Incentive Award Plan (2015 Plan). The 2015 Plan provides for the granting of up to 721,211 shares of authorized and unissued shares of common stock in the form of stock options, restricted stock units, and restricted stock awards. The 2015 Plan requires that the exercise price may not be less than the fair value of the stock at the date the option is granted, and that the option price must be paid in full at the time it is exercised.
The options granted (incentive stock options for employees and non-qualified stock options for Directors) have an exercise price at the prevailing market price on the date of grant. All options granted are exercisable 20% each year commencing one year after the date of grant and expire ten years after the date of grant.
Under the 2005 Plan, 115,927 granted shares are outstanding (115,927 incentive stock options and 0 nonqualified stock options) as of December 31, 2015, of which 94,145 are vested. No options were granted during the year ended December 31, 2015.
Under the 2015 Plan, 14,290 granted shares are outstanding as of December 31, 2015, of which none are vested.
88
A summary of the status of the Company's stock option plan and changes during the year are presented below:
Shares | Weighted Average Exercise Price | |||||
Options outstanding December 31, 2014 | 148,326 | $ | 9.74 | |||
Granted during the year | — | — | ||||
Exercised during the year | — | — | ||||
Forfeited during the year | 32,399 | 9.25 | ||||
Options outstanding December 31, 2015 | 115,927 | $ | 9.39 | |||
A summary of the status of the Company's restricted stock and changes during the year are presented below:
Shares | Weighted Average Grant-Date Fair Value | |||||
Non-vested awards at December 31, 2014 | — | $ | — | |||
Granted during the year | 14,290 | 5.39 | ||||
Vested during the year | — | — | ||||
Canceled during the year | — | — | ||||
Non-vested awards at December 31, 2015 | 14,290 | $ | 5.39 | |||
Included in total outstanding options at December 31, 2015, are 94,145 exercisable shares at a weighted average price of $11.21, a weighted average remaining contract term of 1.25 years and intrinsic value of $16,000.
Included in salaries and employee benefits for the years ended December 31, 2015 and 2014, is $26,000 and $28,000 of share-based compensation, respectively. The related tax benefit on share-based compensation recorded in the provision for income taxes was not material to either year.
As of December 31, 2015 and 2014, there was $93,000 and $85,000, respectively, of total unrecognized compensation expense related to nonvested stock options. This cost is expected to be recognized over a weighted average period of approximately 3.0 years. A total of 23,922 options were exercised during 2014, while 0 options were exercised during 2015.
December 31, 2015 | December 31, 2014 | ||||||
Weighted average grant-date fair value of stock options granted | $ | — | $ | 3.33 | |||
Total fair value of stock options vested | $ | 19,640 | $ | 31,440 | |||
Total intrinsic value of stock options exercised | $ | — | $ | 39,711 | |||
For the year ended December 31, 2015, the Company granted 14,290 shares of restricted stock with a weighted average fair value of 5.39. As of December 31, 2015, there was $44,000 in unrecognized compensation expense related to restricted stock. This cost is expected to be recognized over a weighted-average period of approximately 4.4 years.
The Bank determines fair value at grant date using the Black-Scholes-Merton pricing model that takes into account the stock price at the grant date, the exercise price, the expected life of the option, the volatility of the underlying stock and the expected dividend yield and the risk-free interest rate over the expected life of the option.
The weighted average assumptions used in the pricing model are noted in the table below. The expected term of options and restricted shares granted is derived from management's experience, which is based upon historical data on employee exercise and post-vesting behavior. The risk free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. Expected volatility is based on the historical volatility of the Bank's stock over a period commensurate with the expected term of the options. The Company believes that historical volatility is indicative of expectations about its future volatility over the expected term of the options.
89
The Bank expenses the fair value of the option on a straight-line basis over the vesting period for each separately vesting portion of the award. The Bank estimates forfeitures and only recognizes expense for those shares expected to vest. Based upon historical evidence, the Company has determined that because options are granted to a limited number of key employees rather than a broad segment of the employee base, expected forfeitures, if any, are not material. The Company granted 14,290 restricted stock units and 5,308 shares in incentive stock options during 2015 and 2014, respectively. The assumptions used for the 2015 and 2014 awards are as follows:
Year Ended | Year Ended | ||
December 31, 2015 | December 31, 2014 | ||
Risk Free Interest Rate | 1.25% | 1.70% | |
Expected Dividend Yield | —% | —% | |
Expected Life in Years | 10 years | 5.5 years | |
Expected Price Volatility | 64.01% | 67.02% | |
The Black-Scholes-Merton option valuation model requires the input of highly subjective assumptions, including the expected life of the stock based award and stock price volatility. The assumptions listed above represent management's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if other assumptions had been used, the Bank's recorded stock-based compensation expense could have been materially different from that previously reported in proforma disclosures. In addition, the Bank is required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If the Bank's actual forfeiture rate is materially different from the estimate, the share-based compensation expense could be materially different.
11. | Employee Benefit Plans |
401K Plan
The Company has a Cash or Deferred 401(k) Stock Ownership Plan (the “401(k) Plan”) organized under Section 401(k) of the Code. All employees of the Company are initially eligible to participate in the 401(k) Plan upon the first day of the month after date of hire. Under the terms of the plan, the participants may elect to make contributions to the 401(k) Plan as determined by the Board of Directors. Participants are automatically vested 100% in all employee contributions. Participants may direct the investment of their contributions to the 401(k) Plan in any of several authorized investment vehicles. The Company contributes funds to the Plan up to 4% of the employees’ eligible annual compensation. Company contributions are immediately 100% vested at the time of contribution. During 2015 and 2014, the Company made matching contributions of $240,000 and $239,000 to the 401(k) Plan, respectively.
Salary Continuation Plan
The Company has an unfunded, non-qualified Salary Continuation Plan for senior executive officers and certain other key officers of the Company, which provides additional compensation benefits upon retirement for a period of at least 15 years. Future compensation under the Plan is earned by the employees for services rendered through retirement and vests over a period of 12 to 32 years. In 2015, the Company entered into Salary Continuation agreements with three officers of the Bank. The Company purchased company owned life insurance (COLI) policies on the life of the officers in connection with the Salary Continuation agreements. Life insurance premium expense totaled $119,000 for the insurance policies purchased. The Company accrues for the salary continuation liability based on anticipated years of service and vesting schedules provided under the Plan. The Company’s current benefit liability is determined based upon vesting and the present value of the benefits at a corresponding discount rate. The discount rate used is an equivalent rate for high-quality investment-grade bonds with lives matching those of the service periods remaining for the salary continuation contracts, which averages approximately 20 years. At December 31, 2015 and 2014, $3,909,000 and $3,953,000, respectively, had been accrued to date, based on a discounted cash flow using an average discount rate of 3.28% and 2.69%, respectively, and is included in other liabilities. In connection with the implementation of the Salary Continuation Plans, the Company purchased single premium universal life insurance policies on the life of each of the key employees covered under the Plan. The Company is the owner and beneficiary of these insurance policies. The cash surrender value of the policies was $6,095,000 and $5,826,000 at December 31, 2015 and 2014, respectively, and is included on the consolidated balance sheet in cash surrender value of life insurance. Income on these policies, net of expense, totaled approximately $268,000 and $1,405,000 for the years ended December 31, 2015 and 2014, respectively. Although the Plan is unfunded, the Company intends to utilize the proceeds of such policies to settle the Plan
90
obligations. Under Internal Revenue Service regulations, the life insurance policies are the property of the Company and are available to satisfy the Company's general creditors.
Pursuant to the guidance contained in ASC Topic 715 “Compensation,” the Company is required to recognize in accumulated other comprehensive (loss) income, the amounts that have not yet been recognized as components of net periodic benefit costs. These unrecognized costs arise from changes in estimated interest rates used in the calculation of net liabilities under the plan.
As of December 31, 2015 and 2014, the Company had approximately $371,000 and $502,000, respectively in unrecognized net periodic benefit costs arising from changes in interest rates used in calculating the current post-retirement liability required under the plan. This amount represents the difference between the plan liabilities calculated under net present value calculations, and the net plan liabilities actually recorded on the Company’s books at December 31, 2015 and 2014.
Salary continuation expense is included in salaries and benefits expense, and totaled $193,000 and $143,000 for the years ended December 31, 2015 and 2014, respectively.
Officer Supplemental Life Insurance Plan
The Company owns single premium Bank-owned life insurance policies (BOLI) and Company owned life insurance policies (COLI) on certain officers with a portion of the death benefits available to the officers’ beneficiaries. The BOLI and COLI initial net cash surrender value is equivalent to the premium paid, and it adds income through non-taxable increases in its cash surrender value, net of the cost of insurance, plus any death benefits ultimately received by the Company. The cash surrender value of these insurance policies totaled $12,242,000 and $11,891,000 at December 31, 2015 and 2014, and is included on the consolidated balance sheet in cash surrender value of life insurance. These policies resulted in a income, net of expense, of approximately $399,000 and $514,000 for the years ended December 31, 2015 and 2014, respectively.
12. | Commitments and Contingent Liabilities |
Lease Commitments: The Company leases land and premises for its branch banking offices and administration facilities. The initial terms of these leases expire at various dates through 2025. Under the provisions of most of these leases, the Company has the option to extend the leases beyond their original terms at rental rates adjusted for changes reported in certain economic indices or as reflected by market conditions. The total expense on land and premises leased under operating leases was $782,000 and $718,000 during 2015 and 2014, respectively. Total rent expense for the years ended December 31, 2015 and 2014 included approximately $16,000 and $23,000 in reductions, respectively, related to adjustments made pursuant to ASC Topic 840, “Leases." The adjustments represent the difference between contractual rent amounts paid and rent amounts actually expensed under the straight-line method pursuant to ASC 840.
Future minimum rental commitments under existing non-cancelable leases as of December 31, 2015 are as follows:
(In thousands): | |||
2016 | $ | 685 | |
2017 | 654 | ||
2018 | 655 | ||
2019 | 478 | ||
2020 | 427 | ||
Thereafter | 342 | ||
$ | 3,241 | ||
Financial Instruments with Off-Balance Sheet Risk: The Company is party to financial instruments with off-balance sheet risk which arise in the normal course of business. These instruments may contain elements of credit risk, interest rate risk and liquidity risk, and include commitments to extend credit and standby letters of credit. The credit risk associated with these instruments is essentially the same as that involved in extending credit to customers and is represented by the contractual amount indicated in the table below:
91
Contractual amount – December 31, | |||||||
(In thousands) | 2015 | 2014 | |||||
Commitments to extend credit | $ | 107,084 | $ | 105,434 | |||
Standby letters of credit | 3,295 | 3,800 | |||||
Commitments to extend credit are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Substantially all of these commitments are at floating interest rates based on the Prime rate, and most have fixed expiration dates. The Company evaluates each customer's creditworthiness on a case-by-case basis, and the amount of collateral obtained, if deemed necessary, is based on management's credit evaluation. Collateral held varies but includes accounts receivable, inventory, leases, property, plant and equipment, residential real estate and income-producing properties. Many of the commitments are expected to expire without being drawn upon and, as a result, the total commitment amounts do not necessarily represent future cash requirements of the Company.
Standby letters of credit are generally unsecured and are issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. The Company’s letters of credit are short-term guarantees and generally have terms from less than one month to approximately 3 years. At December 31, 2015, the maximum potential amount of future undiscounted payments the Company could be required to make under outstanding standby letters of credit totaled $3,295,000.
In the ordinary course of business, the Company becomes involved in litigation arising out of its normal business activities. Management, after consultation with legal counsel, believes that the ultimate liability, if any, resulting from the disposition of such claims would not be material to the financial position of the Company.
13. | Fair Value Measurements and Disclosure |
The following summary disclosures are made in accordance with the guidance provided by ASC Topic 825 “Fair Value Measurements and Disclosures” (formerly Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments,”) which requires the disclosure of fair value information about both on- and off-balance sheet financial instruments where it is practicable to estimate that value.
Generally accepted accounting guidance clarifies the definition of fair value, describes methods used to appropriately measure fair value in accordance with generally accepted accounting principles and expands fair value disclosure requirements. This guidance applies whenever other accounting pronouncements require or permit fair value measurements.
The fair value hierarchy prioritizes the inputs to valuation techniques used to measure fair value into three broad levels (Level 1, Level 2, and Level 3). Level 1 inputs are unadjusted quoted prices in active markets (as defined) for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the asset or liability, and reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).
The table below is a summary of fair value estimates for financial instruments and the level of the fair value hierarchy within which the fair value measurements are categorized at the periods indicated:
92
December 31, 2015 | |||||||||||||||||||
(In thousands) | Carrying Amount | Estimated Fair Value | Quoted Prices In Active Markets for Identical Assets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | ||||||||||||||
Financial Assets: | |||||||||||||||||||
Cash and cash equivalents | $ | 125,751 | $ | 125,751 | $ | 125,751 | $ | — | $ | — | |||||||||
Interest-bearing deposits | 1,528 | 1,528 | — | 1,528 | — | ||||||||||||||
Investment securities | 30,893 | 30,893 | 3,812 | 27,081 | — | ||||||||||||||
Loans | 505,663 | 503,047 | — | — | 503,047 | ||||||||||||||
Accrued interest receivable | 2,220 | 2,220 | — | 2,220 | — | ||||||||||||||
Financial Liabilities: | |||||||||||||||||||
Deposits: | |||||||||||||||||||
Noninterest-bearing | 262,168 | 262,168 | 262,168 | — | — | ||||||||||||||
NOW and money market | 226,886 | 226,886 | 226,886 | — | — | ||||||||||||||
Savings | 63,592 | 63,592 | 63,592 | — | — | ||||||||||||||
Time deposits | 69,159 | 69,031 | — | — | 69,031 | ||||||||||||||
Total deposits | 621,805 | 621,677 | 552,646 | — | 69,031 | ||||||||||||||
Junior subordinated debt | 8,300 | 8,300 | — | — | 8,300 | ||||||||||||||
Accrued interest payable | 29 | 29 | — | 29 | — | ||||||||||||||
December 31, 2014 | |||||||||||||||||||
(In thousands) | Carrying Amount | Estimated Fair Value | Quoted Prices In Active Markets for Identical Assets Level 1 | Significant Other Observable Inputs Level 2 | Significant Unobservable Inputs Level 3 | ||||||||||||||
Financial Assets: | |||||||||||||||||||
Cash and cash equivalents | $ | 103,577 | $ | 103,577 | $ | 103,577 | $ | — | $ | — | |||||||||
Interest-bearing deposits | 1,522 | 1,522 | — | 1,522 | — | ||||||||||||||
Investment securities | 48,301 | 48,301 | 3,823 | 44,478 | — | ||||||||||||||
Loans | 446,824 | 441,186 | — | — | 441,186 | ||||||||||||||
Accrued interest receivable | 1,927 | 1,927 | — | 1,927 | — | ||||||||||||||
Financial Liabilities: | |||||||||||||||||||
Deposits: | |||||||||||||||||||
Noninterest-bearing | 215,439 | 215,439 | 215,439 | — | — | ||||||||||||||
NOW and money market | 211,290 | 211,290 | 211,290 | — | — | ||||||||||||||
Savings | 60,499 | 60,499 | 60,499 | — | — | ||||||||||||||
Time deposits | 78,145 | 78,239 | — | — | 78,239 | ||||||||||||||
Total deposits | 565,373 | 565,467 | 487,228 | — | 78,239 | ||||||||||||||
Junior subordinated debt | 10,115 | 10,115 | — | — | 10,115 | ||||||||||||||
Accrued interest payable | 40 | 40 | — | 40 | — | ||||||||||||||
The Company performs fair value measurements on certain assets and liabilities as the result of the application of current accounting guidelines. Some fair value measurements, such as available-for-sale securities (AFS) and junior subordinated debt are performed on a recurring basis, while others, such as collateral dependent impaired loans, other real estate owned, goodwill and other intangibles, are performed on a nonrecurring basis.
93
The following tables summarize the Company’s assets and liabilities that were measured at fair value on a recurring and non-recurring basis as of December 31, 2015 (in 000’s):
Description of Assets | December 31, 2015 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
AFS Securities (2): | |||||||||||||||
U.S. Government agencies | $ | 10,123 | $ | — | $ | 10,123 | $ | — | |||||||
U.S Govt collateralized mortgage obligations | 16,958 | — | 16,958 | — | |||||||||||
Mutual Funds | 3,812 | 3,812 | — | — | |||||||||||
Total AFS securities | 30,893 | 3,812 | 27,081 | — | |||||||||||
Impaired Loans (1): | |||||||||||||||
Commercial and industrial | — | — | — | — | |||||||||||
Real estate mortgage | — | — | — | — | |||||||||||
RE construction & development | — | — | — | — | |||||||||||
Agricultural | — | — | — | — | |||||||||||
Installment/Other | — | — | — | — | |||||||||||
Total impaired loans | — | — | — | — | |||||||||||
Other real estate owned (1) | 9,208 | — | — | 9,208 | |||||||||||
Total | $ | 40,101 | $ | 3,812 | $ | 27,081 | $ | 9,208 | |||||||
Description of Liabilities | December 31, 2015 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
Junior subordinated debt (2) | $ | 8,300 | $ | — | $ | — | $ | 8,300 | |||||||
Total | $ | 8,300 | $ | — | $ | — | $ | 8,300 | |||||||
(1)Nonrecurring
(2)Recurring
The following tables summarize the Company’s assets and liabilities that were measured at fair value on a recurring and non-recurring basis as of December 31, 2014 (in 000’s):
94
Description of Assets | December 31, 2014 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
AFS Securities (2): | |||||||||||||||
U.S. Government agencies | $ | 12,496 | $ | — | $ | 12,496 | $ | — | |||||||
U.S Govt collateralized mortgage obligations | 31,982 | — | 31,982 | — | |||||||||||
Mutual Funds | 3,823 | 3,823 | — | — | |||||||||||
Total AFS securities | 48,301 | 3,823 | 44,478 | — | |||||||||||
Impaired Loans (1): | |||||||||||||||
Commercial and industrial | — | — | — | — | |||||||||||
Real estate mortgage | 42 | — | — | 42 | |||||||||||
RE construction & development | — | — | — | — | |||||||||||
Agricultural | — | — | — | — | |||||||||||
Installment/Other | — | — | — | — | |||||||||||
Total impaired loans | 42 | — | — | 42 | |||||||||||
Other real estate owned (1) | — | — | — | — | |||||||||||
Total | $ | 48,343 | $ | 3,823 | $ | 44,478 | $ | 42 | |||||||
Description of Liabilities | December 31, 2014 | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | |||||||||||
Junior subordinated debt (2) | $ | 10,115 | $ | — | $ | — | $ | 10,115 | |||||||
Total | $ | 10,115 | $ | — | $ | — | $ | 10,115 | |||||||
(1)Nonrecurring
(2)Recurring
The Company recorded a $188,000 write-down on other real estate owned during the year ended December 31, 2015 and none for the same period ended 2014.
There were no transfers between levels of fair value hierarchy during 2015. Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstance that caused the transfer.
The following table presents quantitative information about Level 3 fair value measurements for the Company's assets measured at fair value on a non-recurring basis at December 31, 2015 and December 31, 2014 (in 000's).
December 31, 2015 | |||||||
Financial Instrument | Fair Value | Valuation Technique | Unobservable Input | Range, Weighted Average | |||
Other Real Estate Owned | |||||||
Other Real Estate Owned | $ | 9,208 | Market Approach | Adjustment for negotiated sales contract | 2 | % | |
95
December 31, 2014 | ||||||
Financial Instrument | Fair Value | Valuation Technique | Unobservable Input | Range, Weighted Average | ||
Impaired Loans: | ||||||
Real estate mortgage | $ | 42 | Sales Comparison Approach | Adjustment for difference between comparable sales | 1%-16%, 13.2% | |
The following methods and assumptions were used in estimating the fair values of financial instruments:
Cash and Cash Equivalents - The carrying amounts reported in the balance sheets for cash and cash equivalents approximate their estimated fair values.
Interest-bearing Deposits – Interest bearing deposits in other banks consist of fixed-rate certificates of deposits. Accordingly, fair value has been estimated based upon interest rates currently being offered on deposits with similar characteristics and maturities.
Investments – Available for sale securities are valued based upon open-market price quotes obtained from reputable third-party brokers that actively make a market in those securities. Market pricing is based upon specific CUSIP identification for each individual security. To the extent there are observable prices in the market, the mid-point of the bid/ask price is used to determine fair value of individual securities. If that data is not available for the last 30 days, a Level 2-type matrix pricing approach based on comparable securities in the market is utilized. Level-2 pricing may include using a forward spread from the last observable trade or may use a proxy bond like a TBA mortgage to come up with a price for the security being valued. Changes in fair market value are recorded through other comprehensive loss as the securities are available for sale.
Loans - Fair values of variable rate loans, which reprice frequently and with no significant change in credit risk, are based on carrying values adjusted for credit risk. Fair values for all other loans, except impaired loans, are estimated using discounted cash flows over their remaining maturities, using interest rates at which similar loans would currently be offered to borrowers with similar credit ratings and for the same remaining maturities. The allowance for loan loss is considered to be a reasonable estimate of loan discount for credit quality concerns.
Impaired Loans - Fair value measurements for collateral dependent impaired loans are performed pursuant to authoritative accounting guidance and are based upon either collateral values supported by appraisals and observed market prices. Collateral dependent loans are measured for impairment using the fair value of the collateral. Changes are recorded directly as an adjustment to current earnings.
Other Real Estate Owned - Nonrecurring adjustments to certain commercial and residential real estate properties classified as other real estate owned (OREO) are measured at the lower of carrying amount or fair value, less costs to sell. Fair values are generally based on third party appraisals of the property, resulting in a Level 3 classification. In cases where the carrying amount exceeds the fair value, less costs to sell, an impairment loss is recognized.
Deposits – In accordance with authoritative accounting guidance, fair values for transaction and savings accounts are equal to the respective amounts payable on demand at December 31, 2015 and 2014 (i.e. carrying amounts). The Company believes that the fair value of these deposits is clearly greater than that prescribed under authoritative accounting guidance. Fair values of fixed-maturity certificates of deposit were estimated using the rates currently offered for deposits with similar remaining maturities.
Junior Subordinated Debt – The fair value of the junior subordinated debt was determined based upon a discounted cash flows model utilizing observable market rates and credit characteristics for similar debt instruments. In its analysis, the Company used characteristics that market participants generally use, and considered factors specific to (a) the liability, (b) the principal (or most advantageous) market for the liability, and (c) market participants with whom the reporting entity would transact in that market. For the year ended December 31, 2015, cash flows were discounted at a rate which incorporates a current market rate for similar-term debt instruments, adjusted for credit and liquidity risks associated with similar junior subordinated debt and circumstances unique to the Company. The Company believes that the subjective nature of theses inputs, due primarily to the current economic environment, require the junior subordinated debt to be classified as a Level 3 fair value.
Accrued Interest Receivable and Payable - The carrying value of these instruments is a reasonable estimate of fair value.
96
Off-balance sheet Instruments - Off-balance sheet instruments consist of commitments to extend credit, standby letters of credit and derivative contracts. The contract amounts of commitments to extend credit and standby letters of credit are disclosed in Note 12. Fair values of commitments to extend credit are estimated using the interest rate currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present counterparties’ credit standing. There was no material difference between the contractual amount and the estimated value of commitments to extend credit at December 31, 2015 and 2014.
Fair values of standby letters of credit are based on fees currently charged for similar agreements. The fair value of commitments generally approximates the fees received from the customer for issuing such commitments. These fees are not material to the Company’s consolidated balance sheet and results of operations.
The following tables provide a reconciliation of liabilities at fair value using significant unobservable inputs (Level 3) on a recurring basis during the period (in 000’s):
December 31, 2015 | December 31, 2014 | ||||||
Reconciliation of Liabilities: | Junior Subordinated Debt | Junior Subordinated Debt | |||||
Beginning balance | $ | 10,115 | $ | 11,125 | |||
Total losses included in earnings | (73 | ) | (102 | ) | |||
Canceled debt | (1,122 | ) | — | ||||
Gain on redemption of liabilities | 78 | — | |||||
Capitalized interest | (698 | ) | (908 | ) | |||
Ending balance | $ | 8,300 | $ | 10,115 | |||
The amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains or losses relating to liabilities still held at the reporting date | $ | (73 | ) | $ | (102 | ) | |
The following table provides a description of the valuation technique, unobservable input, and qualitative information about the unobservable inputs for the Company’s liabilities classified as Level 3 and measured at fair value on a recurring basis at December 31, 2015 and 2014:
December 31, 2015 | December 31, 2014 | |||||||
Financial Instrument | Valuation Technique | Unobservable Input | Weighted Average | Financial Instrument | Valuation Technique | Unobservable Input | Weighted Average | |
Subordinated Debt | Discounted cash flow | Discount Rate | 6.82% | Subordinated Debt | Discounted cash flow | Discount Rate | 6.87% | |
Management believes that the credit risk adjusted spread utilized in the fair value measurement of the junior subordinated debentures carried at fair value is indicative of the nonperformance risk premium a willing market participant would require under current market conditions, that is, the inactive market. Management attributes the change in fair value of the junior subordinated debentures during the period to market changes in the nonperformance expectations and pricing of this type of debt, and not as a result of changes to our entity-specific credit risk. The narrowing of the credit risk adjusted spread above the Company’s contractual spreads has primarily contributed to the negative fair value adjustments. Generally, an increase in the credit risk adjusted spread and/or a decrease in the three month LIBOR swap curve will result in positive fair value adjustments (and decrease the fair value measurement). Conversely, a decrease in the credit risk adjusted spread and/or an increase in the three month LIBOR swap curve will result in negative fair value adjustments (and increase the fair value measurement).
14. | Regulatory Matters |
Regulatory Agreement with the Federal Reserve Bank of San Francisco
On March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a formal written agreement (the “Agreement”) with the Federal Reserve Bank of San Francisco (the “Federal Reserve”) as a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions (the “DFI”) in June 2009. That examination found significant increases in nonperforming assets, both classified loans and OREO, during 2008 and 2009, and heightened concerns about the Bank’s use of brokered and
97
other wholesale funding sources to fund loan growth, which created increased risk to equity capital and potential volatility in earnings.
Under the terms of the Agreement, the Company and the Bank agreed, among other things: to maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses; to improve the management of the Bank's liquidity position and funds management policies; to maintain sufficient capital at the Company and Bank level; and to improve the Bank’s earnings and overall condition. The Company and Bank also agreed not to increase or guarantee any debt, purchase or redeem any shares of stock, declare or pay any cash dividends, or pay interest on the Company's junior subordinated debt or trust preferred securities, without prior written approval from the Federal Reserve. The Company generates no revenue of its own and, as such, relies on dividends from the Bank to pay its operating expenses and interest payments on the Company’s junior subordinated debt.
Effective November 19, 2014, the Federal Reserve terminated the Agreement with the Bank and the Company and replaced it with an informal supervisory agreement that requires, among other things, obtaining written approval from the Federal Reserve prior to the payment of dividends from the Bank to the Company or the payment of dividends by the Company or interest on the Company’s junior subordinated debt. The inability of the Bank to pay cash dividends to the Company may hinder the Company’s ability to meet its ongoing operating obligations.
Regulatory Order from the California Department of Business Oversight
On May 20, 2010, the DFI (now known as the Department of Business Oversight (the “DBO”)) issued a formal written order (the “Order”) pursuant to a consent agreement with the Bank as a result of the same June 2009 joint regulatory examination. The terms of the Order were essentially similar to the Federal Reserve’s Agreement, except for a few additional requirements.
On September 24, 2013, the Bank entered into an informal Memorandum of Understanding (the “MOU”) with the DBO and on October 15, 2013, the Order was terminated. The Order and the MOU require the Bank to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0% and also requires the DBO’s approval for the Bank to pay a dividend to the Company.
Accordingly, reflecting the Company’s and the Bank’s improved financial condition and performance, as of November 19, 2014, the Bank and the Company have been relieved of all formal regulatory agreements. Some of the governance and procedures established by the Agreement and the Order remain in place, including submission of certain plans and reports to the Federal Reserve and DBO, the Bank’s obligation to maintain a 9.0% tangible shareholder’s equity ratio, and the requirement to seek approvals from the Federal Reserve and the DBO for either the Bank or the Company to pay dividends and for the Company to pay interest on its outstanding junior subordinated debt. While no assurances can be given as to future regulatory approvals, over the last seven quarters the DBO and the Federal Reserve have been approving the Bank's payment of dividends to the Company to cover the Company's tax payments, operating expenses, interest payments, and the Company's payment of quarterly interest on the junior subordinated debt.
Capital Adequacy - The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements adopted by the Board of Governors of the Federal Reserve System (the “Board of Governors”). Failure to meet minimum capital requirements can initiate certain mandates and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the consolidated Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by the capital adequacy guidelines require insured institutions to maintain a minimum leverage ratio of Tier 1 capital (the sum of common stockholders' equity, noncumulative perpetual preferred stock and minority interests in consolidated subsidiaries, minus intangible assets, identified losses and investments in certain subsidiaries, plus unrealized losses or minus unrealized gains on available for sale securities) to total assets. Institutions which have received the highest composite regulatory rating and which are not experiencing or anticipating significant growth are required to maintain a minimum leverage capital ratio of 3% of Tier 1 capital to total assets. All other institutions are required to maintain a minimum leverage capital ratio of at least 100 to 200 basis points above the 3% minimum requirement.
In addition to the general capital adequacy guidelines, pursuant to the DBO’s MOU the Bank is required to maintain a ratio of tangible shareholder’s equity to total tangible assets equal to or greater than 9.0%. For purposes of the MOU, “tangible
98
shareholders’ equity” is defined as shareholders’ equity minus intangible assets. The Bank’s ratio of tangible shareholders’ equity to total tangible assets was 12.9% and 13.4% at December 31, 2015 and 2014, respectively.
The Company has adopted a capital plan that includes guidelines and trigger points to ensure sufficient capital is maintained at the Bank and the Company, and that capital ratios are maintained at a level deemed appropriate under regulatory guidelines given the level of classified assets, concentrations of credit, ALLL, current and projected growth, and projected retained earnings. The capital plan also contains contingency strategies to obtain additional capital as required to fulfill future capital requirements for both the Bank, as a separate legal entity, and the Company on a consolidated basis.
The following table shows the Company’s and the Bank’s regulatory capital and regulatory capital ratios at December 31, 2015 and 2014, as compared to the applicable capital adequacy guidelines:
To Be Well Capitalized Under | |||||||||||||||
Actual | For Capital Adequacy Purposes | Prompt Corrective Action Provisions | |||||||||||||
(In thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||
As of December 31, 2015 (Company): | |||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 100,659 | 16.65 | % | $ | 48,358 | 8.00 | % | N/A | N/A | |||||
Tier 1 Capital (to Risk Weighted Assets) | 93,073 | 15.40 | % | 36,269 | 6.00 | % | N/A | N/A | |||||||
Common Equity Tier 1 (to Risk Weighted Assets) | 85,237 | 14.10 | % | 27,201 | 4.50 | % | N/A | N/A | |||||||
Tier 1 Leverage ( to Average Assets) | 93,073 | 12.95 | % | 28,747 | 4.00 | % | N/A | N/A | |||||||
As of December 31, 2015 (Bank): | |||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 100,544 | 16.69 | % | $ | 48,204 | 8.00 | % | $ | 71,870 | 10.00 | % | |||
Tier 1 Capital (to Risk Weighted Assets) | 92,981 | 15.43 | % | 36,153 | 6.00 | % | 57,496 | 8.00 | % | ||||||
Common Equity Tier 1 (to Risk Weighted Assets) | 92,981 | 15.43 | % | 27,115 | 4.50 | % | 46,716 | 6.50 | % | ||||||
Tier 1 Leverage ( to Average Assets) | 92,981 | 12.94 | % | 28,748 | 4.00 | % | 35,935 | 5.00 | % | ||||||
As of December 31, 2014 (Company): | |||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 91,935 | 17.29 | % | $ | 42,536 | 8.00 | % | N/A | N/A | |||||
Tier 1 Capital (to Risk Weighted Assets) | 85,234 | 16.03 | % | 21,268 | 4.00 | % | N/A | N/A | |||||||
Tier 1 Capital (to Average Assets) | 85,234 | 12.49 | % | 27,295 | 4.00 | % | N/A | N/A | |||||||
As of December 31, 2014 (Bank): | |||||||||||||||
Total Capital (to Risk Weighted Assets) | $ | 89,889 | 16.91 | % | $ | 42,536 | 8.00 | % | $ | 53,170 | 10.00 | % | |||
Tier 1 Capital (to Risk Weighted Assets) | 83,188 | 15.65 | % | 21,268 | 4.00 | % | 31,902 | 6.00 | % | ||||||
Tier 1 Capital (to Average Assets) | 83,188 | 12.25 | % | 27,164 | 4.00 | % | 33,955 | 5.00 | % | ||||||
The Federal Reserve and the Federal Deposit Insurance Corporation approved final capital rules in July 2013 that substantially amend the existing capital rules for banks. These new rules reflect, in part, certain standards initially adopted by the Basel Committee on Banking Supervision in December 2010 (commonly referred to as “Basel III”) as well as requirements encompassed by the Dodd-Frank Act.
The final rules set a new common equity tier 1 requirement and higher minimum tier 1 requirements for all banking organizations. They also place limits on capital distributions and certain discretionary bonus payments if a banking organization does not maintain a buffer of common equity tier 1 capital above minimum capital requirements. The rules revise the prompt corrective action framework to incorporate the new regulatory capital minimums. They also enhance risk sensitivity and address weaknesses identified over recent years with the measure of risk-weighted assets.
Under regulatory guidelines, the $15 million in Trust Preferred Securities issued by USB Capital Trust II in July of 2007 qualifies as Tier 1 capital up to 25% of Tier 1 capital. Any additional portion of Trust Preferred Securities qualifies as Tier 2 capital. As of December 31, 2015, the Company and the Bank meets all capital adequacy requirements to which they are subject. Management believes that, under the current regulations, both will continue to meet their minimum capital requirements in the foreseeable future.
99
Dividends – Cash dividends, if any, paid to shareholders are paid by the Company, subject to restrictions set forth in the California Corporations Code and the terms of the Federal Reserve informal supervisory agreement. All dividends paid by the Company during 2015 and 2014 were in the form of stock dividends rather than cash dividends.
The primary source of funds with which cash dividends are paid to shareholders comes from cash dividends received by the Company from the Bank. The Bank’s ability to pay dividends is subject to the restrictions set forth in the California Financial Code and the informal agreements the Bank has entered into with the Federal Reserve and the DBO. Under the Financial Code, the Bank may not pay cash dividends in an amount which exceeds the lesser of the retained earnings of the Bank or the Bank’s net income for the last three fiscal years (less the amount of distributions to shareholders during that period of time). If the above test is not met, cash dividends may only be paid with the prior approval of the DBO, in an amount not exceeding the greater of: (i) the Bank’s retained earnings; (ii) its net income for the last fiscal year; or (iii) its net income for the current fiscal year. During the year ended December 31, 2015, the Bank’s cash dividends of $2,416,000 paid to the Company were approved by the Federal Reserve and the DBO and funded the Company’s operating costs, estimated tax payments, payments of interest on its junior subordinated debentures, and redemption of $3.0 million junior subordinated debt.
Cash Restrictions - The Bank is required to maintain average reserve balances with the Federal Reserve. During 2005, the Company implemented a deposit reclassification program, which allows the Company to reclassify a portion of transaction accounts to non-transaction accounts for reserve purposes. The deposit reclassification program is provided by a third-party vendor, and has been approved by the Federal Reserve Bank.
15. | Supplemental Cash Flow Disclosures |
Year Ended December 31, | |||||||
(In thousands) | 2015 | 2014 | |||||
Cash paid during the period for: | |||||||
Interest | $ | 1,243 | $ | 2,462 | |||
Income Taxes | 3,080 | — | |||||
Noncash activities: | |||||||
Loans transferred to foreclosed property | 226 | 1,308 | |||||
Sale of limited partnership interest financed | — | 3,000 | |||||
Unrealized (losses) gains on securities | (265 | ) | 18 | ||||
Unrealized gains (losses) on unrecognized post retirement costs | 224 | (113 | ) | ||||
16. | Common Stock Dividend |
The Company declared one-percent (1)% common stock dividends during each of the four quarters ended December 31, 2015, September 30, 2015, June 30, 2015, and March 31, 2015. All 1% stock dividends were considered “small stock dividends” resulting in a transfer between retained earnings and common stock an amount equal to the number of shares issued in the stock dividend multiplied by the stock’s closing price at the date of declaration. Other than for earnings-per-share calculations, shares issued for the stock dividend have been treated prospectively for financial reporting purposes. For purposes of earnings per share calculations, the Company’s weighted average shares outstanding and potentially dilutive shares used in the computation of earnings per share have been restated after giving retroactive effect to a 1% stock dividend to shareholders for all periods presented.
The Company declared one-percent (1)% common stock dividends during each of the four quarters ended December 31, 2014, September 30, 2014, June 30, 2014, and March 31, 2014. All 1% stock dividends were considered “small stock dividends” resulting in a transfer between retained earnings and common stock an amount equal to the number of shares issued in the stock dividend multiplied by the stock’s closing price at the date of declaration. Other than for earnings-per-share calculations, shares issued for the stock dividend have been treated prospectively for financial reporting purposes. For purposes of earnings per share calculations, the Company’s weighted average shares outstanding and potentially dilutive shares used in the computation of earnings per share have been restated after giving retroactive effect to a 1% stock dividend to shareholders for all periods presented.
17. | Net Income Per Share |
100
The following table provides a reconciliation of the numerator and the denominator of the basic EPS computation with the numerator and the denominator of the diluted EPS computation. (Weighted average shares have been adjusted to give retroactive recognition for the 1% stock dividend for each of the quarters since the third quarter ended September 30, 2008):
Year Ended December 31, | |||||||
(In thousands, except earnings per share data) | 2015 | 2014 | |||||
Net income available to common shareholders | $ | 6,810 | $ | 6,216 | |||
Weighted average shares outstanding | 16,051,406 | 16,035,581 | |||||
Add: dilutive effect of stock options | 2,020 | 5,284 | |||||
Weighted average shares outstanding adjusted for potential dilution | 16,053,426 | 16,040,865 | |||||
Basic earnings per share | $ | 0.42 | $ | 0.39 | |||
Diluted earnings per share | $ | 0.42 | $ | 0.39 | |||
Anti-dilutive shares excluded from earnings per share calculation | 124,000 | 142,000 | |||||
18. Common Stock Repurchase Plan
On May 16, 2007, the Company’s Board of Directors approved a plan to repurchase, as conditions warrant, up to 813,111 shares of the Company's common stock on the open market or in privately negotiated transactions. The repurchase plan represents approximately 5.00% of the Company's currently outstanding common stock. The duration of the program is open-ended and the timing of purchases will depend on market conditions. As of December 31, 2015, there were 703,972 shares available for repurchase.
As a condition of the MOU entered into with the Federal Reserve Bank of San Francisco (FRB) on November 19, 2014, and the MOU entered into with the California Department of Business Oversight (DBO) on September 24, 2013, the Company may not repurchase any of its common stock without prior approval of the FRB and the DBO. The Company did not repurchase any common shares during the years ended December 31, 2015 and 2014.
19. Goodwill and Intangible Assets
At December 31, 2015, the Company had $4,488,000 of goodwill and no core deposit intangibles. The following table summarizes the carrying value of those assets at December 31, 2015 and 2014.
(In thousands) | December 31, 2015 | December 31, 2014 | |||||
Goodwill | $ | 4,488 | $ | 4,488 | |||
Core deposit intangible assets | — | — | |||||
Total goodwill and intangible assets | $ | 4,488 | $ | 4,488 | |||
Core deposit intangibles and other identified intangible assets are amortized over their useful lives, while goodwill is not amortized. The Company conducts periodic impairment analysis on goodwill and intangible assets and goodwill at least annually or more often as conditions require. The following table summarizes the amortization expense and impairment losses recorded on the Company’s intangible assets and goodwill for the years ended December 31, 2015 and 2014.
(In thousands) | December 31, 2015 | December 31, 2014 | |||||
Amortization expense - core deposit intangibles | $ | — | $ | 62 | |||
Amortization expense - other intangibles | — | — | |||||
Total amortization expense | $ | — | $ | 62 | |||
Impairment losses - core deposit intangibles | $ | — | $ | — | |||
Impairment losses - goodwill | — | — | |||||
Total impairment losses | $ | — | $ | — | |||
Goodwill: The largest component of goodwill is related to the Legacy merger (Campbell reporting unit) completed during February 2007 and totaled approximately $2.9 million at December 31, 2015. The Company completed a "Step 0" analysis for the Campbell reporting unit as of March 31, 2015 and March 31, 2014, with no goodwill impairment.
101
Under the Step 0 analysis, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. Determining the fair value involves a significant amount of judgment, including estimates of changes in revenue growth, changes is discount rates, competitive forces within the industry, and other specific industry and market valuation conditions. Based on the results of the Step 0 impairment analysis at March 31, 2015, the Company concluded that that the fair value of the reporting unit exceeds it carrying value. Therefore, goodwill was not impaired.
Core Deposit Intangibles: The core deposit intangible asset, which totaled $3.0 million at the time of merger, is being amortized over an estimated life of approximately seven years. The Company recognized no amortization expense related to the Legacy operating unit during the year ended December 31, 2015. At December 31, 2015, there was no remaining carrying value of the core deposit intangible related to the Legacy Bank merger.
20. Parent Company Only Financial Statements
The following are the condensed financial statements of United Security Bancshares and should be read in conjunction with the consolidated financial statements:
United Security Bancshares – (parent only) | |||||||
Balance Sheets - December 31, 2015 and 2014 | |||||||
(In thousands) | 2015 | 2014 | |||||
Assets | |||||||
Cash and equivalents | $ | 140 | $ | 224 | |||
Investment in bank subsidiary | 97,379 | 93,170 | |||||
Other assets | 2,326 | 1,975 | |||||
Total assets | 99,845 | 95,369 | |||||
Liabilities & Shareholders' Equity | |||||||
Liabilities: | |||||||
Junior subordinated debt securities (at fair value) | 8,300 | 10,115 | |||||
Deferred taxes | 1,910 | 2,428 | |||||
Total liabilities | 10,210 | 12,543 | |||||
Shareholders' Equity: | |||||||
Common stock, no par value 20,000,000 shares authorized, 16,051,406 and 15,425,086 issued and outstanding, in 2015 and 2014 | 52,572 | 49,271 | |||||
Retained earnings | 37,265 | 33,730 | |||||
Accumulated other comprehensive loss | (202 | ) | (175 | ) | |||
Total shareholders' equity | 89,635 | 82,826 | |||||
Total liabilities and shareholders' equity | $ | 99,845 | $ | 95,369 | |||
102
United Security Bancshares – (parent only) | Year ended December 31, | ||||||
Income Statements | |||||||
(In thousands) | 2015 | 2014 | |||||
Income | |||||||
Loss on fair value of financial liability | $ | (73 | ) | $ | (102 | ) | |
Gain on redemption of JR subordinated debentures | 78 | — | |||||
Dividends from subsidiary | 2,416 | 1,519 | |||||
Total income | 2,421 | 1,417 | |||||
Expense | |||||||
Interest expense | 225 | 241 | |||||
Other expense | 256 | 101 | |||||
Total expense | 481 | 342 | |||||
Income before taxes and equity in undistributed income of subsidiary | 1,940 | 1,075 | |||||
Income tax benefit | (196 | ) | (182 | ) | |||
Undistributed income of subsidiary | 4,674 | 4,959 | |||||
Net Income | $ | 6,810 | $ | 6,216 | |||
United Security Bancshares – (parent only) | Year ended December 31, | ||||||
Statement of Cash Flows | |||||||
(In thousands) | 2015 | 2014 | |||||
Cash Flows From Operating Activities | |||||||
Net income | $ | 6,810 | $ | 6,216 | |||
Adjustments to reconcile net income to cash provided by operating activities: | |||||||
Equity in undistributed income of subsidiary | (4,674 | ) | (4,959 | ) | |||
Provision for deferred income taxes | (518 | ) | (42 | ) | |||
Loss on fair value option of financial liability | 73 | 102 | |||||
Gain on redemption of junior subordinated debentures | (78 | ) | — | ||||
Decrease (increase) in income tax receivable | 117 | (140 | ) | ||||
Net change in other assets/liabilities | (14 | ) | (1,114 | ) | |||
Net cash provided by operating activities | 1,716 | 63 | |||||
Cash Flows From Financing Activities | |||||||
Proceeds from exercise of stock options | — | 95 | |||||
Redemption of junior subordinated debenture | (1,800 | ) | — | ||||
Net cash provided by financing activities | (1,800 | ) | 95 | ||||
Net (decrease) increase in cash and cash equivalents | (84 | ) | 158 | ||||
Cash and cash equivalents at beginning of year | 224 | 66 | |||||
Cash and cash equivalents at end of year | $ | 140 | $ | 224 | |||
21. Subsequent Events
Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred requiring accrual or disclosure.
103
Item 9 - Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures
CONCLUSION REGARDING THE EFFECTIVENESS OF DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as defined in the Securities and Exchange Act Rule 13(a)-15(e). Based on that evaluation and the remediation of the material weaknesses in the Company’s internal control over financial reporting above under the caption “Management’s Report on Internal Control Over Financial Reporting” in Item 8 of this report ,” the Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective at December 31, 2015 to ensure that information required to be disclosed in its reports that the Company files or submits to the Securities and Exchange Commission under the Exchange Act is recorded, processed, summarized and reported on a timely basis. The Company’s Chief Executive Officer and Chief Financial Officer have certified that, based on their knowledge, the Company’s Consolidated Financial Statements included in this report fairly present in all material respects the Company’s financial condition, results of operations and cash flows for the periods presented in this report.
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, the Company has included a report of management’s assessment of the design and operating effectiveness of its internal controls as part of this report.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There have not been any changes in the Company's internal control over financial reporting that occurred during the year ended December 31, 2015, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.
Item 9B. Other Information
None
PART III
Item 10 – Directors, Executive Officers, and Corporate Governance
Pursuant to Instruction G, the information required by this item is hereby incorporated herein by reference from the captions entitled "Election of Directors and Executive Officers" and “Corporate Governance Principles and Board Matters” set forth in the Company's definitive Proxy Statement for its 2016 Annual Meeting of Shareholders ("Proxy Statement").
Item 11 - Executive Compensation
Pursuant to Instruction G, the information required by this item is hereby incorporated herein by reference from the captions entitled "Executive Compensation" and “Director Compensation” set forth in the Company's definitive Proxy Statement for its 2016 Annual Meeting of Shareholders ("Proxy Statement").
104
Item 12 - Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Pursuant to Instruction G, the information required by this item is hereby incorporated herein by reference from the caption entitled "Shareholdings of Certain Beneficial Owners and Management" set forth in the Company's definitive Proxy Statement for its 2016 Annual Meeting of Shareholders ("Proxy Statement").
Item 13 - Certain Relationships and Related Transactions, and Director Independence
Pursuant to Instruction G, the information required by this item is hereby incorporated herein by reference from the captions entitled "Certain Transactions" and “Corporate Governance Principles” set forth in the Company's definitive Proxy Statement for its 2016 Annual Meeting of Shareholders ("Proxy Statement").
Item 14 - Principal Accounting Fees and Services
Pursuant to Instruction G, the information required by this item is hereby incorporated herein by reference from the caption entitled "Independent Accountant Fees and Services" set forth in the Company's definitive Proxy Statement for its 2016 Annual Meeting of Shareholders ("Proxy Statement").
105
PART IV
Item 15 – Exhibits and Financial Statement Schedules
(a)(1) Financial Statements
The Consolidated Financial Statements and related documents set forth in “Item 8. Financial Statements and Supplementary Data” of this report are filed as part of this report.
(a)(2) Financial Statement Schedules
All financial statement schedules are omitted because they are not applicable or not required or because the information is included in the financial statements or notes thereto or is not material.
(a)(3) Exhibits
106
3.1 | Articles of Incorporation of Registrant (1) |
3.2 | Bylaws of Registrant (1) |
4.1 | Specimen common stock certificate of United Security Bancshares (1) |
10.1 | Amended and Restated Executive Salary Continuation Agreement for Dennis Woods (3) |
10.2 | Amended and Restated Employment Agreement for Dennis R. Woods (3) |
10.3 | Amended and Restated Executive Salary Continuation Agreement for Kenneth Donahue (3) |
10.4 | Amended and Restated Change in Control Agreement for Kenneth Donahue (3) |
10.5 | Amended and Restated Executive Salary Continuation Agreement for David Eytcheson (3) |
10.6 | Amended and Restated Change in Control Agreement for David Eytcheson (3) |
10.7 | USB 2005 Stock Option Plan (4) |
10.8 | Stock Option Agreement for Dennis R. Woods dated February 6, 2006 (2) |
10.9 | Written Agreement between United Security Bancshares, United Security Bank, and the Federal Reserve Bank of San Francisco dated March 23, 2010 (5) |
10.10 | United Security Bancshares 2015 Equity Incentive Award Plan (6) |
10.11 | Amended and Restated Employment Agreement for Dennis R. Woods (filed herewith) |
10.12 | Amended and Restated Change in Control Agreement for Kenneth Donahue (filed herewith) |
10.13 | Amended and Restated Change in Control Agreement for David Eytcheson (filed herewith) |
10.14 | Executive Salary Continuation Agreement for Bhavneet Gill (filed herewith) |
10.15 | Change in Control Agreement for Bhavneet Gill (filed herewith) |
10.16 | Executive Salary Continuation Agreement for William Yarbenet (filed herewith) |
10.17 | Employment Agreement for William Yarbenet (filed herewith) |
11.1 | Computation of earnings per share. |
107
See Note 19 to Consolidated Financial Statements and related documents set forth in “Item 8. Financial Statements and Supplementary Data” of this report are filed as part of this report. | |
21 | Subsidiaries of the Company (filed herewith) |
23.1 | Consent of Moss Adams LLP, Independent Registered Public Accounting Firm (filed herewith) |
31.1 | Certification of the Chief Executive Officer of United Security Bancshares pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
31.2 | Certification of the Chief Financial Officer of United Security Bancshares pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
32.1 | Certification of the Chief Executive Officer of United Security Bancshares pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
32.2 | Certification of the Chief Financial Officer of United Security Bancshares pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) |
(1) Previously filed on April 4, 2001 as an exhibit to the Company’s filing on Form S-4 (file number 333-58256).
(2) Previously filed on November 7, 2006 as an exhibit to the Company’s filing on Form 10-Q/A for the period ended March 31, 2006 (file number 000-32897).
(3) Previously filed on March 17, 2007 as an exhibit to the Company’s filing on Form 10-K for the year ended December 31, 2007 (file number 000-32897).
(4) Previously filed on April 18, 2005 as Exhibit B to the Company's 2005 Schedule 14A Definitive Proxy (file number 000-32897).
(5) Previously filed on March 25, 2010 as an exhibit to the Company’s filing on Form 8-K (file number 000-32897).
(6) Previously filed on April 13, 2015 as Appendix A to the Company's 2015 Schedule 14A Definitive Proxy (file number 000-32897).
(b) Exhibits filed:
See Exhibit Index under Item 15(a)(3) above for the list of exhibits required to be filed by Item 601 of regulation S-K with this report.
(c) Financial statement schedules filed:
See Item 15(a)(2) above.
108
Signatures
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report on Form 10-K for the year ended December 31, 2015 to be signed on its behalf by the undersigned thereunto duly authorized, in Fresno, California, on the 3rd day of March 2016.
United Security Bancshares
March 4, 2016 | /S/ Dennis R. Woods | |
Dennis R. Woods | ||
President and Chief Executive Officer | ||
March 4, 2016 | /S/ Bhavneet Gill | |
Bhavneet Gill | ||
Senior Vice President and Chief Financial Officer | ||
109
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities on the date indicated:
Date: | March 4, 2016 | /s/ Robert G. Bitter | |||
Director | |||||
Date: | March 4, 2016 | /s/ Stanley J. Cavalla | |||
Director | |||||
Date: | March 4, 2016 | /s/ Tom Ellithorpe | |||
Director | |||||
Date: | March 4, 2016 | /s/ Kenneth D. Newby | |||
Director | |||||
Date: | March 4, 2016 | /s/ Ronnie D. Miller | |||
Director | |||||
Date: | March 4, 2016 | /s/ Robert M. Mochizuki | |||
Director | |||||
Date: | March 4, 2016 | /s/ Walter Reinhard | |||
Director | |||||
Date: | March 4, 2016 | /s/ John Terzian | |||
Director | |||||
Date: | March 4, 2016 | /s/ Mike Woolf | |||
Director | |||||
110