September 9, 2010
Via Edgar
Mr. Michael R. Clampett
Senior Attorney
U.S. Securities and Exchange Commission
Division of Corporation Finance
Washington, D.C. 20549
Re: | United Security Bancshares |
Form 10-K for the year ended December 31, 2009 and Schedule 14A for filed on April 20,
2010 and the 10-Q for the quarterly period ended March 31, 2010
File No. 000-32987
Dear Mr. Clampett:
Please find attached the response to your Staff Letter request of August 6, 2010 prepared by the staff of United Security Bancshares (the “Company”). The responses are in the same order as the order of the comments in the Staff Letter. We have also attached appendixes to show the changes in the proposed disclosure from the disclosures in the previously filed reports in issue.
Should you have any further questions, please do not hesitate to contact the undersigned.
Very truly yours, | ||
/s/ | Richard Shupe | |
Senior Vice President and | ||
Chief Financial Officer |
cc: | Mr. Dennis R. Woods |
Mr. Gary S. Findley
With respect to the responses to the Staff letter of August 6, 2010 provided by United Security Bancshares (the “Company”) and filed with the SEC, we understand that,
• | the Company is responsible for the adequacy and accuracy of the disclosure in the filing; |
• | SEC staff comments or changes to disclosure in response to staff comments do not foreclose the Commission from taking any action with respect to the filing; and |
• | the Company may not assert SEC staff comments as a defense in any proceeding initiated by the Commission or any person under the federal securities laws of the United States. |
/s/ | Dennis R. Woods | |
Dennis R. Woods | ||
Chief Executive Officer | ||
United Security Bancshares |
/s/ | Kenneth L. Donahue | |
Kenneth L. Donahue | ||
Chief Administrative Officer (previously CFO) | ||
United Security Bancshares |
/s/ | Richard B. Shupe | |
Richard B. Shupe | ||
Chief Financial Officer | ||
United Security Bancshares |
Item 1
Business, page 3
1. Please provide to us and undertake to include in your future filings, a revised business section as required by Item 101 of Regulation S-K, to disclose the following information:
• revise the fourth fifth and sixth paragraphs of the section entitled "United Security Bank," to discuss the nature and ''results'' of each of mergers and acquisitions of assets as required by Item 101(a)(1) of Regulation S-K, including the amounts of any impairment losses related to any of the transactions;
• revise your disclosure of assets, loans, deposits and shareholders' equity at December 31, 2009 in the seventh paragraph of the section entitled "United Security Bank," to discuss the amount of revenues, profit or loss and total assets for each of your last three fiscal years, as required by Item 101(b) of Regulation S-K; and
• address any changes in your business done and intended to be done as a result of your March 2010 Agreement with the Federal Reserve Bank:, economic conditions in your particular market area and your specific financial condition as required by Item 101(c)(l) (including increases in loan losses, changes in your policies on loan modifications and restructurings, changes in the composition of your loan portfolio and deposits and changes in your lending policies and procedures).
Response:
We have expanded the fourth, fifth and six paragraphs to discuss the nature and ''results'' of each of mergers and acquisitions of assets as requested (see Appendix 1 – Item1). We have also expanded the discussion disclosure of assets, loans, deposits, and shareholders' equity at December 31, 2009 (see Appendix1 – Item 1).
As a result of the March 2010 Agreement with the Federal Reserve Bank and the deterioration of economic conditions in our market area over the past two years, the Company has changed certain aspects of its business including slowing loan growth, increasing the emphasis on monitoring problem assets, and increasing the focus on liability funding including reducing reliance on wholesale funding sources. Many of these issues are specifically addressed in discussion of the Agreement with the Federal Reserve (see Items 4 and 9 of this document), and this discussion of such trends and changes in the Company’s business has been included in sections of the year ended December 31, 2009 Form 10-K, as well as the quarters ended March 31, 2010 and June 30, 2010 Form 10-Q including “Trends Affecting Results of Operations and Financial Position”, “Asset Quality”, “Liquidity”, and “Regulatory Matters” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations.
We agree to undertake to include in our future filings requiring a business section (Item 101 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 2
Bank Services. page 4
2. Please provide to us and undertake 'to include in your future filings, revised disclosure of your services as required by Item 101(c)(1) as follows:
• revise the second paragraph to disclose more detail regarding your deposits including but not limited to the percentage of your deposits that are brokered deposits and disclose that as part of your March 2010 agreement with the Federal Reserve Bank you are required to reduce the amount of brokered deposits;
• revise the third paragraph to disclose the first sentence of, as required by Item 101(c)( 1)(i), the percentage of your loan portfolio attributable to each category of loans and disclose the aggregate percent of loans that are for commercial real estate and delete your claim in the second sentence that your loan portfolio "is not concentrated in anyone industry" since it is concentrated in the real estate industry and disclose the percentage and total amount of your loan portfolio that is to borrowers or properties located in California;
• revise the third paragraph to disclose the amount and percentage of your loan portfolio that is subprime, "alt A" loans, interest-only and option adjustable rate loans; and
• revise the third paragraph to disclose the respective amount and percentage of your loan portfolio that you originated, purchased or in which you are a participant and explain your standards for purchasing or participating in loans.
Response:
We have expanded the second and third paragraphs to discuss the above requests including discussion of brokered deposits, loan percentages, and loan percentages participated. The Company does not originate subprime, “Alt-A”, or option adjustable rate loans (see Appendix 1 – Item2). The Company does make interest-only loans as revolving lines of credit to real estate developers, agricultural borrowers, commercial and industrial borrowers where the business may be seasonal or cash flows sufficient to make principal payments until the end of the project.
We agree to undertake to include in our future filings requiring a business section (Item 101 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 3
Loan Policies
3. Please provide to us and undertake to include in your future filings, a section entitled "Lending Policies," to provide detail including, but not limited to the following:
• describe in detail your loan documentation policies;
• describe your policies and procedures for participating in loans originated by others;
• discuss the extent to which you have in the past and will in the future verify information provided by each potential borrower (including assets, income and credit ratings) and the extent which you made loans similar to those commonly referred to as "no doc," or "stated income" loans;
• disclose pursuant to Item 101(c)(1)(vii) the extent to which you are dependent on any individual customers/ entities or group of related entities for deposits or have made a significant percentage of loans to borrowers;
• disclose the extent to which your loans are unsecured and the extent to which you require any collateral or guarantees beyond the property being financed by the loan;
• describe your historic policy on extending, renewing or restructuring or otherwise changing the terms of loans or other extensions of credit and whether you continue to classify the loans as performing and describe how you have changed the policy in response to the findings of the Federal Reserve Bank in its June 2009 Report of Examination and its March 2010 Agreement;
• describe your policy on making additional loans to a borrower or any related interest of the borrower who is past due in principal or interest more than 90 days; and
• disclose whether you have a lending limit to a borrower and to any entity in which the borrower has an interest, direct, or indirect.
Response:
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. Regarding construction lending, the analyses have been enhanced to investigate and analyze real estate projects being financed by other lenders. |
§ | The Company is not dependent on any individual customer, entity, or group of related entities for deposits or have a 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 $78.7 million, $91.6 million, and $82.6 million at December 31, 2009, 2008, and 2007, 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 of lines of credit or loans may occur based on the occurrence of pre-determined event or time, as part of the original underwriting. The renewal or restructuring of criticized credits has changed since the March 2010 Agreement. The restructure or renewal 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 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. |
We agree to undertake to include in our future filings requiring a business section (Item 101 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 4
Regulatory Action, pages 8 and 66
4. Please provide to us and undertake to include in your future filings, revision of these sections as follows:
• revise the caption to reflect the Federal Reserve Bank took regulatory action against you in March 2010;
• use bullet points and provide more detail regarding each of the eleven major components of the Agreement;
• disclose that the Federal Reserve Bank found and you agreed that you had violated federal laws and banking regulations and identify those laws and regulations;
• delete your claim in the first sentence of the second paragraph that the agreement "relates primarily to the Bank's asset quality;" and
• revise the last sentence of the second paragraph to state whether you are in compliance with the terms of the agreement including the numerous deadlines.
Response:
We have revised the appropriate sections to reflect the above requested information (see Appendix 1 – Item 4). Expanded disclosures have already been made to the June 30, 2010 10-Q as filed.
We agree to undertake to include in our future filings requiring a business section (Item 101 of Regulation S-K) and a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 5
Risk Factors, page 18
5. Please provide to us and undertake to include in your future filings, revision of this section to comply with Item 503(c) of Regulation S-K. Item 503(c) requires that you disclose in this section "the most significant factors that make the ..offering speculative or risky." Item 503(c) explicitly directs: "Do not present risks that could apply to any issuer or any offering." Please delete those risk factors that do not comply with Item 503 including) but not limited to, the following:
• the third risk factor, which is on page 19, regarding the risks of market volatility;
• the fifteenth risk factor) which is on page 23, regarding the risks of loss of executive officers;
• the sixteenth risk factor, which is on page 23, regarding the risks of your growth and expansion strategy;
• the twenty fourth risk factor, which is on page 24, regarding the risks of internal controls failing;
• the twenty fifth risk factor, which is on page 25, regarding the risks of breaches in information systems;
• the twenty sixth risk factor, which is on page 25, regarding the risks of technological change; and
• the twenty seventh risk factor, which is on page 27, regarding the risks of natural disasters.
Response:
We agree to undertake to delete in our future filings requiring a risk factors section (Item 503(c) of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Those items to be deleted include, but are not limited to:
Risks of market volatility – third factor page 19
Risk of loss of executive officers – 15th factor page 23
Risk of growth and expansion strategies – 16th risk page 23
Risks of internal control failures – 24th risk page 24
Risk of breaches in information systems – 25th risk page 25
Risk of technology change – 26th risk page 25
Risk of natural disasters – 27th risk page 27
Item 6
6. Please provide to us and undertake to include in your future filings, revision of the section to address, in detail, each of the risks raised by the Federal Reserve Bank in its March 2010 Agreement including, but not limited to, the following:
• add a risk factor addressing risks from the Board of Directors of the Bank not exercising adequate oversight of the management and operations of the Bank and disclosing the requirements of the March 2010 agreement with the Federal Reserve Bank which requires your Bank's board of directors to submit various plans to the Federal Reserve Bank and secure the approval of each plan from the Federal Reserve Bank which includes plans for your Bank's board of directors to:
o "strengthen" the Bank' s Board oversight of the management and operations of the Bank including but not limited to, credit risk management, liquidity, and earnings;
o monitor management'8 adherence to approved policies and procedures, and applicable laws and regulations;
o regularly review information relating to the operations and management of the Bank, including information on the Bank's adversely classified assets, allowance for loan and lease losses, capital, liquidity, and earnings;
o establish appropriate credit risk tolerance guidelines and credit risk limits; overview, at least quarterly, the allowances for loan and lease losses; and
o enhance its monitoring of the bank's liquidity.
• revision of the second risk factor, which is on page 19, regarding risks relating to your being "subject to certain operating restrictions" as follows:
o identify each of the "certain financial ratios" and o "operating restrictions" to which you refer; and
o reconcile your statement in the last two sentences that there are risks to your not fully addressing the agreement with your Form 8-K filed March 29,2010 which states that ''most of the conditions have already been met;"
• revision of the fourth risk factor, which is on page 19, regarding liquidity risk;
• revision of the eleventh risk factor, which is on page 20, regarding risks of needing to raise more capital;
• revision of the twelfth risk factor, which is on page 20, regarding risks of losses exceeding the allowance for loan losses including the agreement with the Federal Reserve to charge off within ten days of the Agreement certain loans identified in the June 2009 Report of Examination and the requirement that you "maintain a sound process for determining documenting and recording an adequate allowance for loan and lease losses" and that you submit to the Federal Reserve Bank a program.to do so; and
• revision of the twenty first and twenty second risk factors, which are on page 24, regarding interest payments to delete your statements that you have "elected to defer" these payments and disclose that, under paragraph 11 of your agreement with the Federal Reserve, you are explicitly prohibited from making these payments.
Response:
We have added a risk factor addressing risks from the Board of Directors of the Bank not exercising adequate oversight of the management and operations of the Bank and disclosing the requirements of the March 2010 agreement with the Federal Reserve Bank (see Appendix 1 – Item 6.) We have also revised the second, fourth, eleventh, twelfth, twenty first, and twenty second risk factors to address additional risks associated with the March 2010 agreement with the Federal Reserve Bank (see Appendix 1 – Item 6.)
As to the Staff’s comment (second bullet point) in the second risk factor, management is currently in compliance with the conditions of the Agreement. This will be made clear in future filings that compliance is ongoing, and that comments about Company compliance with the Agreement and Order will be as of a time certain and that future noncompliance is an ongoing risk .
We agree to undertake to include in our future filings requiring a risk factors section (Item 503(c) of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 7
7. Please provide to us and undertake to include in your future filings, revision of the nineteenth risk factor, which is on page 23, regarding risks to your deposits as follows:
• address the risks that you will lose deposits after December 31, 2010 with the expiration of the FDIC's Transaction Account Guarantee ("TAG") Program, in which you have volunteered to participate, under which the FDIC extends guarantees to all noninterest-bearing transaction accounts without any limitation on the amount; and
• discuss the additional risk that deposits will decline since under your March 2010 Agreement with the Federal Reserve, you are required to reduce the amount of your brokered deposits and other short term wholesale funding.
Response:
We have revised the nineteenth risk factor to provide additional information related to our deposits with regard to the TAG Program and the March 2010 agreement with the Federal Reserve (see Appendix 1 – Item 7.)
We agree to undertake to include in our future filings requiring a risk factors section (Item 503(c) of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 8
8. Please provide to us and undertake to include in your future filings, a risk factor addressing the risk to your corporate governance by the fact that your Chairman and CEO beneficially owns over seven percent of the outstanding stock, your named executive officers (including your CEO) beneficially own over twelve percent of your outstanding stock and your other directors (excluding your Chairman and CEO) own over seventeen percent of your outstanding stock. Address the risks that due to their positions and their beneficial ownership of stock, your directors and named officers have significant control over the company. Address the risks that the stock ownership may affect whom the Board nominates to serve as directors and how the Board supervises the named executive officers.
Response:
In that Mr. Dennis Woods, Chairman and CEO of the Company beneficially owns approximately 7.2% of the outstanding shares of Company common stock, the named executive officers of the Company as a group (excluding Mr. Woods) beneficially owns approximately 5.1% of the outstanding shares of Company common stock, and the directors of the Company as a group (excluding Mr. Woods) beneficially owns 17.1% of the outstanding shares of Company common stock, these persons will be able to control certain corporate governance matters. Such matters may include the selection of nominees for the board of directors and the supervision of management. The officers and directors also have the ability to control other matters requiring shareholders’ approval including the election of directors which may result in the entrenchment of management (see Appendix 1 – Item 8.)
We agree to undertake to include in our future filings requiring a risk factors section (Item 503(c) of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Management's Discussion and Analysis of Financial Condition and Results of Operations, page 31
Item 9
9. With regard to each of the provisions in the March 2010 Agreement, please provide to us and undertake to include in your future filings:
• a detailed analysis of the particular facts and circumstances at your institution that led the Federal Reserve and you to agree that it was necessary for you to undertake immediate corrective action including which of these issues in the Agreement were raised by the Federal Reserve in its June 2009 Report of Examination;
• analysis of how you have responded and will respond to the March 2010 Agreement with the Federal Reserve Bank including but not limited to a summary of each of the plans required by the Agreement;
• disclosure of the status of each plan including whether you have submitted each plan to the Federal Reserve Bank within the time limits of the Agreement, whether the Federal Reserve Bank has approved the plan and whether you have implemented the plan;
• identify the violation of law and regulation referred to in the 2010 Agreement with the Federal Reserve Bank and cited in its June 2009 report of Examination and state the extent to which you have cured each of the violations; and
• discuss the extent to which you are in compliance with the relevant guidance including, Interagency Guidance on Concentration in Commercial Real Estate Lending, Sound Risk Management Practices.
Response:
We have provided the information requested above related to the March 2010 agreement with the Federal Reserve (see Appendix 1 – Item 9.)
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 10
Current Trends Affecting Results of Operations and Financial Position, page 33
10. Please provide to us and undertake to include in your future filings, revision of this section to comply with Item 303(a) and Release No. 33-8350 by identifying and analyzing known trends (over the past three fiscal years and the current fiscal year), events, demands, commitments and uncertainties that are reasonably likely to have a material effect on your capital resources and results of operations including, but not limited to, analysis of both the causes and effects of the following:
• revise the first paragraph to analyze "the causes and effects of trends over the past three years in net income, net interest income (despite the historically low interest rates charged by the federal reserve to banks), revenues and the dollar amount of loans;
• add a new third paragraph to analyze the causes and effects of trends over the past three years and the current fiscal year in the number, size and types of new loans that you are originating and, separately, that you are either purchasing or participating from other entities and the size and composition of your loan portfolio including the dollar amount and percentage of your portfolio in commercial real estate and the dollar amount and percentage in residential real estate and the amount of participatory loans;
• revise your reference in the third paragraph to "continued weakness in the real estate markets" to analyze the causes and effects of trends over the past three years and the current fiscal year in commercial real "estate prices, commercial real estate sales and commercial building permits in your particular market in California;
• revise the third paragraph to analyze the causes and effects of trends over the past three years and the current fiscal year in home price index, residential real estate sales and single family home permits and multifamily building permits and nonbusiness bankruptcy filings in your market areas in California;
• revise the third paragraph to analyze the causes and effects of trends over the past three years and the current fiscal year in the unemployment rate and in median household income in your market areas in California;
• revise the third paragraph to explain in detail what you have accomplish and what you plan.to accomplish to "reducing nonperforming assets" and ''providing customers more options to help work through this difficult economic period;”
• revise the last paragraph on page 34 and the second paragraph on" page 35 to analyze the causes and effects of trends over the past three years in the amount of your provision for loan losses and ratio of allowance for loan losses to nonperforming loans, the number and percentage of loans that are non-performing, that you have charged off foreclosed, restructured (including the number of “troubled debt restructurings")and the type and magnitude of concessions you have made (including the number of loans that you have restructured into multiple new loans); and
• revise the third paragraph on page 35 to analyze the causes and effects of trends over the past three years and the current fiscal year in the amount of deposits and the amount and percent of your deposits that are brokered deposits.
Response:
We have provided the information requested above related to past and future trends (see Appendix 1 – Item 10.)
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 11
11. Please provide to us and undertake to include in your future filings, revision of this section to provide detailed analysis of each subject addressed by your March 2010 Agreement with the Federal Reserve Bank including, but not limited to, the sections entitled "Deposits," which is on page 51;"Asset Quality and Allowance for Credit Losses" which is on page 53, "Liquidity and asset/Liability Management," which is on page 63;"Capital Adequacy" which is on page 66 and "Dividends" which is on page 67. For instance, revise the section on Capital Adequacy to include the following:
• Bancshares and United Security Bank are required to secure approval of the Reserve Bank of written plans to ''maintain sufficient capital" at United Security Bank, as a separate legal entity and at Bancshares on as consolidated basis;
• each plan must address the "adequacy" of the capital of United Security Bank, "taking into account" the following:
o the volume of classified credits;
o concentrations of credit;
o allowance for loan and lease losses;
o current and projected asset growth; and
o projected retained earnings;"
• the plans are required to address the extent of compliance by both Bancshares and United Security Bank with the Federal Reserve's "Capital Adequacy Guidelines”; and • describe each of the prohibitions on Bancshares and United Security Bank on paying dividends or distributions, increasing debt, repurchasing shares or any actions that would reduce capital.
Response:
We have revised the sections entitled "Deposits," which is on page 51;"Asset Quality and Allowance for Credit Losses" which is on page 53, "Liquidity and asset/Liability Management," which is on page 63;"Capital Adequacy" which is on page 66 and "Dividends" which is on page 67, to provide detailed analysis of each subject addressed by the March 2010 Agreement with the Federal Reserve Bank (see Appendix 1 – Item 11).
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 12
Impairment of Investment Securities, page 37
12. We note the unrealized loss of approximately $5.4m related to three non-agency label collateralized mortgage obligations. Please provide us with your full detailed impairment analysis of these securities' as of December 31, 2009 and for each interim period of fiscal 2010. The analysis should identify all available evidence, explain the relative significance of each piece of evidence, and identify the primary evidence on which you rely to support a realizable value equal to or greater than the carrying value of the investment Also tell us to what you attribute the severity of the fair value decline and tell us how you considered this information in your impairment analysis. Please also revise future filings to include the disclosure required by ASC 320-10-50-8A.
Response:
We have included the full detailed analysis as performed each quarter for the three non-agency label collateralized mortgage obligations considered to be impaired and to have OTTI here as Appendix 2 (December 31, 2009, March 31, 2010, and June 30, 2010). As the analysis indicates, we utilize a wide array of information including market prices, credit ratings, delinquency percentages, LTV ratios, credit support percentages, and CPR speeds. We review these each quarter and assess the changes from previous quarters to determine trends in the performance of the securities. Our determination that the securities ultimately have a realizable value equal to or greater than the carrying value of the investment, is based upon a detailed cash flow analysis utilizing information provided to us by an unrelated third party, Performance Trust Investment Advisors, LLC. We utilize cash flow scenarios which we believe approximate the estimated lifetime losses in those securities, and those should approximate lifetime loss percentages estimated by other third parties including S&P and Fitch (that information is also provided in the Performance Trust reports).
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures required by ASC 320-10-50-8A.
Asset Quality and Allowance for Credit Losses, page 53
Item 13
13. Please tell us and revise your future filings to disclose the following information related to your troubled debt restructurings (TDR's):
• TDRs quantified by loan type classified separately as accrual/non-accrual;
• Policy regarding how many payments the borrower needs to make on restructured loans before returning loans to accrual status; and
• Quantification of the types of concessions made (e.g. rate reductions, payment extensions, forgiveness of principal, forbearance or other actions) and discussion of your success with the different types of concessions.
Response:
The following quantifies TDR’s by type classified separately as accrual or nonaccrual at December 31, 2009:
Total TDR's | Nonaccrual TDR's | Accruing TDR's | ||||||||||
(Dollars in 000’s) | Dec 31, 2009 | Dec 31, 2009 | Dec 31, 2009 | |||||||||
Commercial and industrial | $ | 3,877 | $ | 227 | $ | 3,650 | ||||||
Real estate - mortgage: | ||||||||||||
Commercial real estate | 3,593 | 0 | 3,593 | |||||||||
Residential mortgages | 3,961 | 337 | 3,624 | |||||||||
Home equity loans | 51 | 0 | 51 | |||||||||
Total real estate mortgage | 7,605 | 337 | 7,268 | |||||||||
RE construction & development | 14,405 | 9,475 | 4,930 | |||||||||
Agricultural | 0 | 0 | 0 | |||||||||
Installment/other | 178 | 0 | 178 | |||||||||
Lease financing | 0 | 0 | 0 | |||||||||
Total Troubled Debt Restructurings | $ | 26,065 | $ | 10,039 | $ | 16,026 |
At December 31, 2008, the Company had one TDR totaling $378,000. It was a residential mortgage and was on nonaccrual status.
In addition, the following quantifies TDR’s by type classified separately as accrual or nonaccrual at March 31, 2010 and June 30, 2010:
Total TDR's | Nonaccrual TDR's | Accruing TDR's | ||||||||||
(Dollars in 000’s) | March 31, 2010 | March 31, 2010 | March 31, 2010 | |||||||||
Commercial and industrial | $ | 4,000 | $ | 274 | $ | 3,726 | ||||||
Real estate - mortgage: | ||||||||||||
Commercial real estate | 6,029 | 0 | 6,029 | |||||||||
Residential mortgages | 3,562 | 333 | 3,229 | |||||||||
Home equity loans | 51 | 0 | 51 | |||||||||
Total real estate mortgage | 9,642 | 333 | 9,309 | |||||||||
RE construction & development | 15,511 | 12,607 | 2,904 | |||||||||
Agricultural | 0 | 0 | 0 | |||||||||
Installment/other | 173 | 0 | 173 | |||||||||
Lease financing | 0 | 0 | 0 | |||||||||
Total Troubled Debt Restructurings | $ | 29,326 | $ | 13,214 | $ | 16,112 |
Total TDR's | Nonaccrual TDR's | Accruing TDR's | ||||||||||
(Dollars in 000’s) | June 30, 2010 | June 30, 2010 | June 30, 2010 | |||||||||
Commercial and industrial | $ | 3,552 | $ | 1,182 | $ | 2,371 | ||||||
Real estate - mortgage: | ||||||||||||
Commercial real estate | 6,013 | 1,338 | 4,675 | |||||||||
Residential mortgages | 3,386 | 192 | 3,194 | |||||||||
Home equity loans | 96 | 45 | 50 | |||||||||
Total real estate mortgage | 9,495 | 1,575 | 7,919 | |||||||||
RE construction & development | 15,969 | 11,000 | 4,969 | |||||||||
Agricultural | 0 | 0 | 0 | |||||||||
Installment/other | 82 | 0 | 82 | |||||||||
Lease financing | 0 | 0 | 0 | |||||||||
Total Troubled Debt Restructurings | $ | 29,098 | $ | 13,757 | $ | 15,341 |
For a restructured loan to return to accrual status there needs to be at least 6 months successful payment history. In addition, our 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, 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.
The Company makes various types of concessions when structuring TDR’s including rate reductions, payment extensions, and forbearance. At December 31, 2009, more than $14.0 million of the total $26.1 million in TDR’s was for real estate construction and development, and there was another $3.3 million and $1.8 million related to those developers in commercial real estate and commercial and industrial, respectively at December 31, 2009. The majority of these credits are related to real estate construction projects that have slowed significantly or stalled, and the Company has sought to restructure the credits to allow the construction industry time to recover, and the developers time to finish projects at a slower pace which reflects current market conditions in the San Joaquin Valley. Concessions granted in these circumstances include lengthened maturity terms, lower lot release prices, or rate reductions that will enable the borrower to finish the construction projects and repay their loans to the Company. The downturn in the real estate construction market has been protracted, and although the Company has had some success in its restructuring efforts, it is difficult to conclude that we will be entirely successful in our efforts. Areas such as Bakersfield California have been slow to recover, and during the first quarter, the Company charged off approximately $1.3 million in unsecured loans to a single real estate construction developer in the market. The Company may be required to make additional concessions in the future including lower lot release prices to allow borrowers to complete and sell construction units at lower prices currently reflected in the real estate market.
At December 31, 2009, the Company had approximately $4.0 million in restructured residential mortgage loans as the result of borrowers that were unable to get take-out financing at the end of their construction loan with the Company. In part to aid the borrowers retain their newly completed homes under California Senate Bill SB1137, the Company termed these loans at market rates of interest with loans fully amortizing over 30 years with a three-to-five year repayment term.
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 14
14. Please tell us and revise your future filings to disclose whether you have performed any commercial real estate (CRE) workouts whereby an existing loan was restructured into multiple new loans (i.e., A Note/B Note structure). To the extent that you have performed these types of CRE workouts, please provide us with and revise your future filings to disclose the following:
• Quantify the amount of loans that have been restructured using this type of workout strategy in each period presented;
• Discuss the benefits of this workout strategy, including the impact on interest income and credit classification;
• Discuss the general terms of the new loans and how the A note and B note differ, particularly whether the A note is underwritten in accordance with your customary underwriting standards and at current market rates;
• Clarify whether the B note is immediately charge-off upon restructuring. If not, clarify whether you combine the restructured notes in your evaluation of whether the notes should be returned to accrual status;
• Confirm that the A note is classified as a TDR and explain your policy for removing such loans from TDR classification; and
• Clarify your policy for returning the A note to accrual status, including how you consider the borrower's payment performance prior to the restructuring.
Response:
The Company has not performed any commercial real estate (CRE) workouts whereby an existing loan was restructured into multiple new loans (i.e., A Note/B Note structure).
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 15
15. We note the significant deterioration in the credit quality of your loan portfolio during both 2008 and 2009, as well as into 2010, which has resulted in significant increases in the levels of nonperforming loans and assets as well as significant increases in the loan loss provision and charge-offs during that time frame. We also note that the allowance for loan losses as a percentage of nonperforming loans has continued to decrease while the ratio of net charge-offs to average loans outstanding has continued to increase. Please tell us and revise future filings as follows:
• Revise your disclosure to comprehensively bridge the gap between the significant increases in the balance of your loan portfolio and nonperforming and impaired loans with the change in your allowance for loan losses;
• Provide an analysis of each component of your allowance for loan losses detailing how you determined that each component was directionally consistent with the underlying credit quality of the applicable loan portfolio;
• Clearly explain how you considered specific factors, including the levels of nonperforming loans at each period end as well as the charge-offs for the period, when determining the amount of your allowance; and
• To the extent that the significant changes in your nonperforming loans were due to a few large credits or a large number of small credits, please discuss this fact.
Response:
We have provided the information requested above related to the loan portfolio, levels of problem loans and related changes in allowance of loan losses and provisions made to the allowance for loan losses (see Appendix 1 – Item 15.)
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 16
16. Please revise your future filings to disclose the ratio of Allowance for Loan Loss to Non-Performing Loans and provide a discussion for the reasons for the change from one period to the next.
Response:
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 17
17. We note your disclosure on page 54, that loss factors for problem graded loans are based on a migration model which incorporates twelve quarters of loan losses when determining the loss factors used in determining the level of ALLL required. Provide us with additional information so that we may have a better understanding of your basis for utilizing a twelve quarter period. Specifically, explain how you considered the current economic environment when determining the number of periods to use in your analysis. Further, address how the migration analysis is utilized in the determination of the formula allowance for loans which have homogeneous characteristics.
Response:
Management determines the loss factors for problem graded loans (substandard, doubtful, and loss), special mention loans, and pass graded loans, based on a rolling 12-quarter loss migration model. The migration analysis incorporates loan losses recognized in eleven segments of the portfolio over the past twelve quarters (three years). Segment loss factors are developed for each quarter. The twelfth quarter loss factor is compared to the 4th and 8th quarter loss factors and the average loss factor for the 12 quarters. The model may be more heavily weighted on the most current periods if those periods are more indicative of future trends because losses are accelerating in the shorter term. Based on an analysis of the information, current economic conditions and current and historical loss trends for the Bank, the existing net loss factors, prior to qualitative adjustment, are adjusted to recognize and quantify the loss exposure from changes in loss histories and trends in the Company’s loan portfolio. For purposes of this analysis, loans are grouped by internal risk classifications, which are “pass”, “special mention”, “substandard”, “doubtful”, and “loss”. Certain loans are homogenous in nature and are therefore pooled by risk grade. These homogenous loans include consumer installment and home equity loans. Special mention loans are currently performing but are potentially weak, as the borrower has begun to exhibit deteriorating trends, which if not corrected, could jeopardize repayment of the loan and result in further downgrade.
Item 18
Regulatory Agreement, page 66
18. Please tell us and revise your future filings to disclose what changes the Company has made to comply with the March 23, 2010 agreement with the Federal Reserve Bank of San Francisco.
Response:
To comply with the March 23, 2010 agreement with the Federal Reserve Bank of San Francisco, the Company has, among other things:
§ | Formed a Compliance Committee comprised of the Board of Directors to oversee the operations of the Bank, the Company, and the fulfillment of the agreement; |
§ | Written plans as required under the agreement and submitted those plans to the Federal Reserve Bank; |
§ | Dedicated staff and resources to fulfilling the written plans; |
§ | Remedied technical violations of law as concluded in June 2009 examination, and |
§ | Submitted quarterly progress reports to the Federal Reserve Bank. |
See Item 4 in this document for additional information on the steps taken to comply with the agreement.
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 9A(T). Controls and Procedures, page 111
Item 19
19. We note your disclosure in Item 9A(T) on page 111. Please revise your Form 10K to include the requirements of Item 308T of Regulation S-K or tell us why you believe the requirements have been meet in your current disclosure.
Response:
We have revised Item 9A(T) in the December 31, 2009 Form 10K to include the requirements of Item 308T of Regulation S-K. While Management’s Report on Internal Control over Financial Reporting was included in Item 9A(T), it should have included other disclosures in regulation 308T. We have made this change, and have marked to show such change (see Appendix 1 – Item 19). In addition we have added in this filing the statement that the annual report does not include an attestation report of the company's registered public accounting firm regarding internal control over financial reporting. We inadvertently omitted the specified information and the statement that the annual report did not include an attestation report of the company's registered public accounting firm regarding internal control over financial reporting, and do not believe that such additional information materially affected the overall disclosure provided under Item 9A(T) by the Company as a nonaccelerated filer as indicated on the cover of the 2009 Form 10-K.
We agree to undertake to include in our future filings requiring a Controls and Procedures (Item 307, 308, and 308T of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 20
Form 10-Q for the Quarter Ended March 31, 2010
Management's Discussion and Analysis of Financial Condition and Results of Operations
20. Please revise future filings to address each of the following:
• Include a table which identifies impaired loans by loan type along with information detailing the specific allowance attributable to each impaired loan type. You should also indicate the loans which have no allowance as a result of charge-offs which have been taken or loans where no valuation allowance has been required due to the loan being carried at its estimated collateral fair value less disposal costs;
• Include a table which identifies restructured loans by loan type; and
• Include a table which separately discloses both Classified and Special Mention loans by loan type at each reporting period.
Response:
We agree to undertake to include in our future filings requiring a Management Discussion and Analysis of Financial Condition and Results of Operations (Item 305 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Schedule 14A
Item 21
Consideration of Director Nominees. Page 6
21. Please provide to us and undertake to include in your future filings, revision of this section as required by Item 407(c)(2) of Regulation S-K and by the Instruction to Item 407(c)(2) to include the following:
• disclose in the proxy statement the procedures you require of security holders in their submitting recommendations for candidates, as required by Item 407(c)(2)(iv); and
• disclose the process you use for identifying nominees and evaluating nominees for director, as required by Item 407(c)(2)(vi).
Response:
We have revised the Consideration of Director Nominees section of the 2010 Proxy to disclose the procedures required of security holders in their submitting recommendations for candidates, as required by Item 407(c)(2)(iv); and to disclose the process for identifying nominees and evaluating nominees for director, as required by Item 407(c)(2)(vi). (see Appendix 1 – Item 21)
We agree to undertake to include in our future filings requiring information related to Consideration of Director Nominees (Item 407 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 22
Compensation Committee, page 9
22. Please provide to us and undertake to include in your future filings, revision of this section as required-by Item 407(e)(3)(4) and (5) of Regulation S-K. Please explain, on page 14, the reasons for your decision in January 2010 for "delinking" executive compensation from Company net income and for increasing the annual base salary for your named officers at a time when you suffered a loss for the year, assets dropped by nine percent and other operating results have declined and you received the Examination Report from the Federal Reserve Bank finding that you had violated various laws and regulations and requiring action to correct many weaknesses in your board and management. Disclose the role of executive officers in this and other decisions involving both executive and director compensation, as required by Item 407(e){3)(ii).
Response:
The “delinking” of the bonus program for 2010 was the result of the Compensations Committee’s effort to reduce risk to the Company related to incentives that may cause an imbalance in the focus by management on short run profits and insufficient focus on risk. As a result, the Compensation Committee removed the incentive bonus based upon net income, and made any future incentive bonuses discretionary. As stated in the Proxy, no base salary increases were been approved in at least three years because the Company’s net income had grown on average 10-15% annually and incentive bonuses, linked to net income helped ensure total compensation levels were comparable with peers and the Company’s level of performance. Elimination of the incentive bonuses revealed total compensation no longer compared favorably with peers. The Compensation Committee reviewed peer compensation of senior executives of banks with similar asset size, which included approximately 8 peer banks to determine commensurate salary levels.
The fact that the Bank experienced a loss during 2009 was in large part a result of the severe economic downturn experienced over the past several years, particularly in real estate, an area in which the Bank had a sizable exposure given the economic and business structure existing in our market area. The volatility in the Company’s earnings and the increase in adversely classified assets, while not good, are not considered permanent. In addition, the Company realized a net goodwill impairment loss of $3.0 million during 2009 which contributed materially to the net loss that year. Competent and experienced senior management are very important during a period of economic strife, and need to be compensated properly to ensure they remain with the Company to help work through the problems. In fact, senior management has made great strides to improve the condition of the Company over last year, including continued reductions in adversely classified assets, improved liquidity, reduced reliance on wholesale funding, and increased capital ratios.
The actions of the Compensation Committee were based in part on the following:
ACTION
a. Suggest the elimination of fixed percentage of net income bonuses for all executives, the bonus was too focused on short term profits and added to risk in the Company
b. Any bonus in the future is at the discretion of the Compensation Committee and/or full Board
c. If Committee eliminates the bonus, salaries should be adjusted, otherwise USB executive total compensation will be too far below peers.
d. Increase Salaries by (various) %
FACTS
• CEO - Total compensation to peer average is 86% of peers and the peer data is end of 2008 (one year old).
• The average CEO salary increase over the last three years was 7.1%
• Peer Bank average earnings were few hundred thousand dollars after nine months of operation - USB lost about $3.4 million
• CEO salary is above peer average by 34% but without options or cost of retirement falls below overall to 86% of peers
• Salary is $360M
• CFO - Total compensation to peer average is 60% of peers and the peer data is end of 2008 (one year old).
• The average CFO salary increase over the last three years was 10.0%
• Peer Bank average earnings were few hundred thousand dollars after nine months of operation - USB lost about $3.4 million
• CFO salary is below peer average by 21 % and without options or cost of retirement falls below peers overall to 60% of peers
• Salary is $142M
• CCO - Total compensation to peer average is 73% of peers and the peer data is end of 2008 (one year old).
• The average CCO salary increase over the last three years was 5.5%
• Peer Bank average earnings were few hundred thousand dollars after nine months of operation - USB lost about $3.4 million
• CCO salary is below peer average by 9% and without options or cost of retirement falls below peers overall to 73% of peers
• Salary is $142M
• CCO announced retirement when a replacement can be located
• COO -Total compensation to peer average is 69% of peers and the peer data is end of 2008 (one year old).
• The average CCO salary increase over the last three years was 6.4%
• Peer Bank average earnings were few hundred thousand dollars after nine months of operation - USB lost about $3.4 million
• CCO salary is below peer average by 13% and without options or cost of retirement falls below peers overall to 69% of peers
• Salary is $142M
• CBO - Total compensation to peer average is 100% of peers and the peer data is end of 2008 (one year old).
• The average CBO salary increase over the last three years was 7.4%
• Peer Bank average earnings were few hundred thousand dollars after nine months of operation - USB lost about $3.4 million
• CBO salary is below peer average by 2% including options & cost of retirement are 100% of peers
• Salary is $118M
We agree to undertake to include in our future filings requiring information related to the Compensation Committee (Item 407 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 23
Nominees, page 10
23. Please provide to us and undertake to include in your future filings, revision of the business experience of each nominee as required by Item 401 (e)(1) of Regulation S-K to include discussion of the "specific experience, qualifications, 'attributes or skills that led to the conclusion that the person should serve as a director in light of the registrant's business and structure." Please provide "information relating to the level of... professional competence, which may include ... such specific information as the size of the operation supervised." For instance, with regard to your description of your Chairman, describe his "specific experience, qualifications, attributes or skills," name the company for which he served as CEO before he founded your company, name the companies and describe his positions in the ''real estate investment business" and "diversified fanning," and name the organizations for which he serves as a member of the board of directors. For instance, with regard to your description of Mr. Henry, who serves as Chairman of your audit committee and your audit committee expert, please describe when he practiced accounting and the exact nature of his experience as a certified public accountant, disclose when he became "inactive" and describe the business of Henry & Company.
Response:
We have expanded the proxy disclosures under Item 401 of Regulation S-K to provide more detailed information about specific experience, qualifications, 'attributes or skills that led to the conclusion that the person should serve as a director in light of the registrant's business and structure (see Appendix 1 – Item 23.)
We agree to undertake to include in our future filings requiring information related to Nominees (Item 401 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Item 24
Certain Transactions, page 25
24. Please provide to us and undertake to include in your future filings, the following information:
• revise the last sentence in the paragraph to comply with the requirement of Instruction 4(c) .to Item 404(a) by stating that the loans were made on substantially the same terms "as those prevailing at the time for comparable loans with persons not related to the lender" (instead of ''prevailing for comparable transactions with other persons of similar creditworthiness");
• confirm to us that none of these loans are nonaccrual, past due, restructured or potential problems consistent with Instruction 4(c);
• confirm to us that you have not made and there are currently not any proposed transactions (as that term is defined in Instruction 2) requiring disclosure pursuant to Item 404(a); and
• provide the disclosure required by Item 404(b).
Response:
We have provided the revision of the last sentence in the paragraph to comply with the requirement of Instruction 4(c) .to Item 404(a), and have provided the disclosures required by Item 404(b) (see Appendix 1 – Item 24.)
We confirm to you that that none of the loans to directors or executive officers are nonaccrual, past due, restructured or potential problems consistent with Instruction 4(c); and that we have not made and there are currently not any proposed transactions (as that term is defined in Instruction 2) requiring disclosure pursuant to Item 404(a).
We agree to undertake to include in our future filings requiring information related to Certain Transactions (Item 404 of Regulation S-K) the expanded disclosures as discussed in the aforementioned response.
Appendix 1
Business – Page 3
Item 1 – paragraph 4
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 in Bakersfield, California, operate as branches of United Security Bank. The total consideration paid to Taft shareholders was 241,447 shares of the Company’s Common Stock valued at just over $6 million. In the merger, the Company acquired $15.4 million in cash and short-term investments, $23.3 million in loans, and $48.2 million in deposits. This transaction was accounted for using the purchase method of accounting, and resulted in the purchase price being allocated to the assets acquired and liabilities assumed from Taft based on the fair value of those assets and liabilities, 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 are being amortized over a period of approximately 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 two branches purchased have grown since the merger in 2004, with loans totaling $72.5 million, and deposits totaling $62.6 million at December 31, 2009. Like much of the rest of the San Joaquin Valley, the Bakersfield area has been impacted to a large degree by the slowdown in residential real estate markets and resulting depressed real estate prices. Of the $59.0 million in total impaired loans reported by the Company at December 31, 2009, $20.1 million was related to the Bakersfield operation with a specific reserve of $3.6 million. The Company has recognized no impairment on either the goodwill or core deposit intangible related to the Taft merger.
Item 1 – paragraph 5
On February 16, 2007, the Company completed its merger with Legacy Bank, N.A., located in Campbell, California, with the acquisition of 100 percent of Legacy’s outstanding common shares. At merger, Legacy Bank’s one branch was merged with and into United Security Bank, a 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. At the time of the merger, Legacy had $62.5 million in net loans and $69.6 million in total deposits. At December 31, 2009 net loans and total deposits related to the Campbell branch totaled $42.7 million and $24.4 million, respectively, and have decreased as the result of declines in lending markets in that area as well as significant competition for deposits. Impaired loans related to the Campbell branch at December 31, 2009 totaled $3.7 million with a related specific reserve of $1.2 million. The Company believes that as the economy recovers from the recent significant downturn, the will be increased opportunities to expand business within the greater Campbell area particularly in lending to small-to-medium sized businesses. The total value of the merger transaction was $21.5 million, and the shareholders of Legacy Bank received merger consideration consisting of 976,411 shares of common stock of the Company. The merger transaction was accounted for as a purchase transaction, and resulted in the purchase price being allocated to the assets acquired and liabilities assumed from Legacy Bank based on the fair value of those assets and liabilities, 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 goodwill impairment charges of $3.0 million and impairment charges related to core deposit intangibles of $57,000 for the year ended December 31, 2009. The Company recognized no impairment charges related to goodwill or core deposit intangibles prior to 2009. The net of assets acquired and liabilities assumed totaled approximately $8.6 million at the date of the merger. Fair value of Legacy assets and liabilities acquired, and resultant goodwill, has been determined and recorded as of the date of the merger and the resulting operations thereafter have been included in the consolidated financial statements.
Item 1 – paragraph 6
During November 2007, the Company purchased the recurring contractual revenue stream and certain fixed assets from ICG Financial, LLC. Additionally, the Company hired all but one of the former employees of ICG Financial, LLC and its subsidiaries. The total purchase price was $414,000 including $378,000 for the recurring revenue stream and $36,000 for the fixed assets. As A newly formed a department of the Bank, USB Financial Services provides wealth management, employee benefit, insurance and loan products, as well as consulting services for a variety of clients, utilizing employees hired from ICG Financial LLC. The At the time of the purchase the Company believed believes the wealth management and related services provided by USB Financial Services would will enhance the products and services offered by the Company, and increase noninterest income. The original capitalized cost of $378,000 for the recurring contractual revenue stream is being amortized over a period of approximately three years. While the addition of USB Financial Services has broadened the products and services offered by the Company, the operation has not performed as well as originally anticipated resulting in marginal or no profitability over the past several years. The staff of the department has been reduced mostly through attrition, and the Company has recognized impairment charges of $25,000 and $24,000 for the years ended December 31, 2009 and 2008, respectively, related to the recurring revenue stream some of which has ended earlier than the three-year anticipated life.
Bullet point 2:
At December 31, 2009, the Bank operates three branches (including its main office), one construction lending office, and one financial services office in Fresno and one branch each, in Oakhurst, Caruthers, San Joaquin, Firebaugh, Coalinga, Bakersfield, and Taft. In addition, the Company and Bank have administrative headquarters located at 2126 Inyo Street, Fresno, California, 93721. The Company operates as one operating segment.
At December 31, 2009, 2008, and 2007, the consolidated Company had total assets of approximately $692.6 million, $761.1 million, and $771.7 million, respectively. For the year ended December 31, 2009, the Company reported a net loss of $4.5 million, as compared to net income of $4.1 million and $11.3 million for the years ended December 2008 and 2007, respectively. At December 31, 2009, the consolidated Company had approximately $692.6 million in total assets, $492.7 million in net loans, $561.7 million in deposits, and $75.8 million in shareholders' equity.
Bullet point 3: (included just before Bank Services)
Effective March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a written agreement with the Federal Reserve Bank of San Francisco (see “Regulatory Action” included below Supervision and Regulation for further information on terms of the written agreement). As a result of the agreement, the Company will, among other things, continues to focus its attention on reducing the level of problem assets while maintaining adequate liquidity and capital, and reducing its dependence on brokered and other wholesale deposits.
The Company has slowed its loan growth significantly over the past three years as a result of the economic downturn, and will continue to do so as a result of the recent agreement with the Federal Reserve Bank. While total loans declined 8.1% between December 31, 2007 and December 31, 2008, and declined 6.6% between December 31, 2008 and December 31, 2009, real estate construction and development loans declined 24.8% and 30.4% between those periods, and decreased as a percentage of total loans from 33.8% of total loans at December 31, 2007 to 20.7% of total loans at December 31, 2009. During the same three-year period, nonperforming assets and related loan losses were increasing, with loan loss provisions of $6.2 million, $9.5 million, and $13.4 million for the years ended December 31, 2007, 2008, and 2009, respectively. The largest impact of nonperforming assets was in the real estate construction and development area with significant slowdowns in housing starts combined with swift and severe declines in housing prices in the Company’s market area as well as the rest of the country during 2008 and 2009. Management’s focus over the past two years, as a result of the depressed economy as well as the recent agreement with the Federal Reserve Bank, has been to concentrate its efforts on reducing the level of nonperforming assets rather than developing new business and growing the loan portfolio. This has been challenging in an economic environment where real estate construction all but stopped in late 2008 and early 2009, and housing prices continued to decline quarter after quarter, while unemployment and other economic factors grew worse. Lending policies and procedures have been enhanced, exposure to real estate loans have been reduced, and loan modifications, including rate and maturity concessions, and forbearance agreements, have been utilized more frequently 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 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. The Company continues its deposit gathering program and has committed additional resources to its efforts during 2010 including two full time employees dedicated to business development. As a result of the formal agreement with the Federal Reserve Bank issued in March 2010, the Bank will reduce its dependence on wholesale funding sources, including brokered deposits, to a level more in-line with peers. The Bank, as part of its Liquidity Improvement Plan, will reduce levels of brokered deposits to peer levels over a period of approximately two years.
While we still have a higher percentage of brokered deposits than peers at December 31, 2009, efforts to restructure the balance sheet through reducing the level of total assets, and specifically real estate loans, are proving successful. Total wholesale borrowings and brokered deposits decreased from $248.4 million at December 31, 2008 to $169.4 million at December 31, 2009, representing a decrease of $79.1 million, and the Company went from being a net purchaser of overnight federal funds at December 31, 2008 with $66.5 million in federal funds purchased to a net seller of overnight funds with $11.6 in federal funds sold at December 31, 2009.
Bank Services – Page 4
Item 2
First bullet point (2nd paragraph)
The Bank offers a wide range of deposit instruments including personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal ("NOW") accounts, money market accounts and time certificates of deposit. Most of the Bank's deposits are attracted from individuals and from small and medium-sized business-related sources. Time deposits have provided a significant portion of the Bank’s deposit base amounting to 40.8%, 36.3%, and 47.6% of total deposits as December 31, 2009, 2008, and 2007, 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 23.0%, 18.0%, and 22.0% of total deposits as December 31, 2009, 2008, and 2007, respectively. As a result of the formal agreement with the Federal Reserve Bank issued in March 2010, the Bank will reduce its dependence on wholesale funding sources, including brokered deposits, to a level more in-line with peers which is currently approximately 5% of total deposits. The Bank, as part of its Liquidity Improvement Plan, will reduce levels of brokered deposits to peer levels over a period of approximately two years.
Second-fourth bullet points (3rd paragraph)
The Bank also engages in a full complement of lending activities, including real estate mortgage (32.6% of total loans at December 31, 2009), commercial and industrial (33.0% of total loans at December 31, 2009), real estate construction (20.7% of total loans at December 31, 2009), as well as agricultural (10.0% of total loans at December 31, 2009), lease financing (0.1% of total loans at December 31, 2009), and consumer loans (3.6% of total loans at December 31, 2009), with particular emphasis on short and medium-term obligations. At December 31, 2009, more than 99% of the loan portfolio is to borrowers or for properties in California. Approximately 48.3%, 50.5%, and 54.6% of the loan portfolio was comprised of commercial real estate loans at December 31, 2009, 2008, and 2007, respectively. The Bank's loan portfolio is not concentrated in any one industry, although aApproximately 68% of the Bank's loans are secured by real estate at December 31, 2009. 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, 2009, the Bank had loans (net of unearned fees) outstanding of $507.7 million, which represented approximately 90% of the Bank's total deposits and approximately 73% of its total assets.
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 $45.8 million or 9.0% of the total portfolio at December 31, 2009, and $18.4 million of that amount represents two purchased conventional 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. Interest-only loans comprised 48.1%, 57.4%, and 61.6% of total loans at December 31, 2009, 2008, and 2007, respectively.
The Bank does purchase loan participations from, and does sell loan participations to, other financial institutions. The underwriting standards for loan participations or purchases are the same as non-participated loans, and are subject to the same limitations, collateral requirements, and borrower requirements. The Bank has reduced its level of loan participations over the past several years. Loan participations purchased comprised 4.7%, 6.6%, and 8.4% of the total loan portfolio at December 31, 2009, 2008, and 2007, respectively. Loan participations sold comprised 3.1%, 5.4%, and 5.0% of the total loan portfolio at December 31, 2009, 2008, and 2007, respectively. During the past year, participation lending activity has decreased and currently the Company is participating in few if any participation sales or purchases.
Item 3 – Lending Policies (Rhodlee)
<No Appendix>
Regulatory Federal Reserve Bank Action against the Company and the Bank dated March 10, 2010Action, Pages 8 and 66
Item 4
During March 2010, the Federal Reserve Bank took regulatory action against the Company and the Bank. As a result, Eeffective March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a written agreement with the Federal Reserve Bank of San Francisco. Under the terms of the agreement, the Company and the Bank agreed, among other things, to strengthen board oversight of management and the Bank's operations; submit an enhanced written plan to strengthen credit risk management practices and improve the Bank’s position on the past due loans, classified loans, and other real estate owned; maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses; improve the management of the Bank's liquidity position and funds management policies; maintain sufficient capital at the Company and Bank level; and improve the Bank’s earnings and overall condition. The Company and Bank have 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 Bank.
The Agreement’s major components and requirements for the Bank are as follows:
· | Strengthen board oversight of the Bank’s management and operations by the Bank submitting a written plan to the Federal Reserve Bank to address and include (i) the actions that the board will take to improve the Bank’s conditions and maintain effect control over, and supervision of the Bank’s major operations and activities, (ii) the responsibility of the board to monitor management’s adherence to approved policies and procedures, and applicable laws and regulations; and (iii) a description of the information and reports that are regularly reviewed by the board in its oversight of the operations and management of the Bank; |
· | Strengthen credit risk management practices of the Bank by the Bank submitting a written plan to the Federal Reserve Bank to address and include (i) the responsibility of the board of directors to establish appropriate risk tolerance guidelines and risk limits; (ii) timely and accurate identification and quantification of credit risk within the loan portfolio; (iii) strategies to minimize credit losses and reduce the level of problem assets; (iv) procedures for the on-going review of the investment portfolio to evaluate other-than temporary-impairment (“OTTI”) and accurate accounting for OTTI; (v) stress testing of commercial real estate loan and portfolio segments; and (vi) measures to reduce the amount of other real estate owned; |
· | Strengthen asset quality at the Bank by (i) not extending, renewing, or restructuring any credit to or for the benefit of any borrower, including any related interest of the borrower, whose loans or other extensions of credit were criticized in the Report of Examination or in any subsequent report of examination, without appropriate underwriting analysis, documentation, board or committee approval and certification that the board or committee reasonably believes that the extension of credit will not impair the Bank’s interest in obtaining repayment of the already outstanding credit and that the extension of credit or renewal will be repaid according to its terms, (ii) submitting to the Federal Reserve Bank an acceptable written plan designed to improve the Bank’s position through repayment, amortization, liquidation, additional collateral, or other means on each loan or other asset in excess of $1.5 million including other real estate owned that is past due as to principal or interest more than 90 days, on the Bank’s problem loan list, or were adversely classified in the Report of Examination or subsequent report of examination; |
· | Improve management of the Bank’s allowance for loan losses by (i) eliminating from its books, by charge-off or collection, all assets or portions of assets classified “loss” in the Report of Examination that have not been previously collected in full or charged off within 10 days of the Agreement, and within 30 days from the receipt of any federal or state report of examination, charge off all assets classified “loss” unless otherwise approved in writing by the Federal Reserve Bank, (ii) maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses (“ALLL”) in accordance with regulatory reporting instructions and relevant supervisory guidance, and (iii) within 60 days of the date of the Agreement, submitting to the Federal Reserve Bank an acceptable written program for the maintenance of an adequate ALLL, including provision for a review of the ALLL by the board on at least a quarterly calendar basis and remedying any deficiency found in the ALLL in the quarter it is discovered, and the board maintaining written documentation of its review of the ALLL; |
· | Maintain sufficient capital at the Company and Bank by submitting to the Federal Reserve Bank an acceptable written plan to maintain sufficient capital at the Company, on a consolidated basis, and the Company and the Bank shall jointly submit to the Reserve Bank an acceptable written plan to maintain sufficient capital at the Bank, as a separate legal entity on a stand-alone basis that (i) complies with the applicable bank and bank holding company capital maintenance regulations and regulatory guidelines and that also considers the adequacy of the Bank’s capital, (ii) takes into account the volume of classified credits, concentrations of credit, ALLL, current and projected asset growth, and projected retained earnings, the source and timing of additional funds to fulfill the Company’s and the Bank’s future capital requirements, and a provision to notify the Federal Reserve Bank when either entity falls below the capital ratios in the accepted plan;. |
· | Submit a revised business plan and budget to the Federal Reserve Bank for 2010 and subsequent calendar years that the Bank is subject to the Agreement to improve the Bank’s earnings and overall condition, which plan at a minimum provides a realistic and comprehensive budget for the remainder of calendar year 2010, and description of the operating assumptions that form the basis for, and adequately support, major projected income, expense, and balance sheet components; |
· | Not make certain distributions, dividends, and payments, specifically that (i) the Company and Bank agreeing not to declare or pay any dividends without the prior written approval of the Federal Reserve Bank and the Director of the Division of Banking Supervision and Regulation of the Board of Governors (“Director”), (ii) the Company not taking any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank, and (iii) the Company and its nonbank subsidiaries not making any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank and the Director; |
· | Not incur debt or redeem stock, specifically, that except with the prior written approval of the Federal Reserve Bank, the Company each agree not to incur, increase, or guarantee any debt or purchase or redeem any shares of its stock; |
· | Correct violations of the laws by (i) the Bank immediately taking all necessary steps to correct all violations of law and regulation cited in the Report of Examination, (ii) the board of the Bank taking the necessary steps to ensure the Bank’s future compliance with all applicable laws and regulations, (iii) complying with the notice provisions of Section 32 of the FDI Act (12 U.S.C. § 1831i) and Subpart H of Regulation Y of the Board of Governors of the Federal Reserve System (12 C.F.R. §§ 225.71 et seq) prior to appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, and (iv) complying with the restrictions on indemnification and severance payments of Section 18(k) of the FDI Act (12 U.S.C. § 1828(k)) and Part 359 of the FDIC’s regulations (12 C.F.R. Part 359); |
· | Comply with the Agreement by (i) appointing a compliance committee of the Bank (“Compliance Committee”) within 10 days of the date of the Agreement to monitor and coordinate the Bank’s compliance with the provisions of the Agreement, which Compliance Committee is composed of a majority of outside directors who are not executive officers or principal shareholders of the Bank and which is to meet at least monthly and report its findings to the board of directors of the Bank, and (ii) the Company and Bank within 30 days after the end of each calendar quarter following the date of the Agreement submitting to the Federal Reserve Bank written progress reports detailing the form and manner of all actions taken to secure compliance with the Agreement and the results of such actions. |
A copy of the Agreement with the Federal Reserve Bank of San Francisco, see the Company’s current Form 8-K filed with the Securities and Exchange Commission on March 25, 2010.
In addition to the submission of the plans referred to in the Agreement to the Federal Reserve Bank for approval, and implementation of those plans, the Bank is required within 30 days after the end of each calendar quarter to submit written progress reports to the Federal Reserve Bank detailing actions taken to secure compliance with the Agreement. On April 28, 2010 and July 30, 2010, respectively, the Bank submitted progress reports to the Federal Reserve for the first and second quarters of 2010. As of the July 30, 2010 progress report submitted for the second quarter of 2010 the Company and the Bank believe they are in compliance with the Agreement, including remediation of technical violations of laws and regulations regarding stale loan appraisals and the various deadlines in the Agreement.
This agreement was a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions in June 2009, and relates primarily to the Bank’s asset quality. Progress on these items has been made since the completion of the examination and management and the Board are committed to resolving all of the items addressed by the Federal Reserve in the agreement. Both the Company and the Bank will submit quarterly written progress reports to the Federal Reserve Bank.
Risk Factors – Page 18
Item 5
<No Appendix>
Item 6
First bullet point (from 6/30/10 10-Q - State Order not signed until May 17, 2010, after filing of March 31, 2010 10-Q so only mention in that filing was that State Order was expected but not finalized )
We are operating subject to the terms and conditions of an Agreement entered into with the Federal Reserve Bank of San Francisco and Order issued by the California Department of Financial Institutions.
On March 23, 2010, the Company and the Bank voluntarily entered into a written agreement (“Agreement”) with the Federal Reserve Bank of San Francisco, and on May 17, 2010 the Bank consented to the issuance of a final order by the California Department of Financial Institutions (the “Order”).
The Order and Agreement are substantially similar. Each establishes timeframes for the completion of remedial measures identified by the regulators as important to improve our financial soundness. Some of the specific provisions in the Order and/or Agreement include us being required to:
· | Strengthen board oversight of the Bank’s management and operations; |
· | Strengthen credit risk management practices of the Bank; |
· | Strengthen asset quality at the Bank by (i) not extending, renewing, or restructuring certain credits, and (ii) submitting to the Federal Reserve Bank an acceptable written plan designed to improve the Bank’s position through repayment, amortization, liquidation, additional collateral, or other means on each loan or other asset in excess of $1.5 million including other real estate owned that is past due as to principal or interest more than 90 days, on the Bank’s problem loan list, or were adversely classified in the Report of Examination or subsequent report of examination; |
· | Improve management of the Bank’s allowance for loan losses; |
· | Maintain sufficient capital at the Company and Bank; |
· | Submit a revised business plan and budget to the Federal Reserve Bank for 2010 and subsequent calendar years that the Bank is subject to the Agreement to improve the Bank’s earnings and overall condition; |
· | Not make certain distributions, dividends, and payments, specifically that (i) the Company and Bank agreeing not to declare or pay any dividends without the prior written approval of the Federal Reserve Bank, (ii) the Company not taking any other form of payment representing a reduction in capital from the Bank without the prior written approval of the Federal Reserve Bank, and (iii) the Company and its nonbank subsidiaries not making any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without the prior written approval of the Federal Reserve Bank; |
· | Not incur debt or redeem stock, specifically, that except with the prior written approval of the Federal Reserve Bank, the Company each agree not to incur, increase, or guarantee any debt or purchase or redeem any shares of its stock; |
· | Correct violations of the laws by (i) the Bank immediately taking all necessary steps to correct all violations of law and regulation cited in the Report of Examination, (ii) the board of the Bank taking the necessary steps to ensure the Bank’s future compliance with all applicable laws and regulations, (iii) complying with the notice provisions of applicable federal banking law prior to appointing any new director or senior executive officer, or changing the responsibilities of any senior executive officer so that the officer would assume a different senior executive officer position, and (iv) complying with the restrictions on indemnification and severance payments of federal bank law and regulations; |
· | Comply with the Agreement by (i) appointing a compliance committee of the Bank (“Compliance Committee”) within 10 days of the date of the Agreement to monitor and coordinate the Bank’s compliance with the provisions of the Agreement, which Compliance Committee is composed of a majority of outside directors who are not executive officers or principal shareholders of the Bank and which is to meet at least monthly and report its findings to the board of directors of the Bank, and (ii) the Company and Bank within 30 days after the end of each calendar quarter following the date of the Agreement submitting to the Federal Reserve Bank written progress reports detailing the form and manner of all actions taken to secure compliance with the Agreement and the results of such actions; |
· | Develop and adopt a capital plan for the California Department of Financial Institutions to maintain a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5% and include in such capital plan a capital contingency plan for raising additional capital in the event of various contingencies; |
· | Maintain at the Bank a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5%; |
· | Maintain at the Bank an adequate allowance for loan losses and remedy any deficiency in the allowance for loan losses in the calendar quarter in which it is discovered; |
· | Not establish any new branches or other offices of the Bank without the prior written consent of the Commissioner of the California Department of Financial Institutions; and |
· | Provide progress reports within 30 days after the end of each calendar quarter following the date of the Order to the California Department of Financial Institutions detailing the form and manner of all actions taken to secure compliance with the Order and Agreement and the results of such actions. |
Any material failure to comply with any the provisions of the Order or Agreement, including the or failure of the Board of Directors to provide adequate oversight of the management of the Bank and Company, could result in enforcement actions by our regulators, including, in some cases, the assessment of civil money penalties against us, enforcement of the agreements through court proceedings, or in the worse case, placing us into receivership with the FDIC. If the Bank is placed into FDIC receivership, we would be required to cease operations and you could lose your entire investment. While we intend to take such actions as may be necessary to enable us to comply with the requirements of the Order and Agreement, there can be no assurance that we will be able to comply fully with their provisions, or to do so within the timeframes required, that compliance with the Order and Agreement will not be more time consuming or more expensive than anticipated, that compliance with the Order and Agreement will enable us to resume profitable operations, or that efforts to comply with the Order and Agreement will not have adverse effects on our operations and financial condition. In addition, the material failure to comply the provisions of the Order or Agreement relating to the Company or Bank’s financial condition or results of operations may result in the weakening of the Company’s and Bank’s financial condition, losses, or improper financial reporting of the Company’s financial condition and results of operations. Compliance with the Agreement’s provisions as to restrictions on borrowing and growth through branching may restrict the ability of the Bank to grow and may limit the amount of growth and potential future earnings of the Bank. Also compliance with the Agreement’s provisions may require the Company and Bank to incur higher expenses in connection with such compliance. Additional, if the Company is not allowed by bank regulators to pay interest on the subordinated debentures of its trust preferred securities for 20 consecutive quarters, there will be an event of default on the trust preferred securities, and the trustee of the indenture of the subordinated debentures may bring an action against the Company for nonpayment.
Second bullet point
We propose replacing with more specific and detailed risk factors with respect to certain operating restrictions above.
Third bullet point (will expand in future filings to include State Order dated May 17, 2010)
Liquidity risk could impair the Company’s ability to fund operations and jeopardize its financial condition.
Liquidity is essential to the Company’s business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on its liquidity. The Company’s access to funding sources in amounts adequate to finance its activities or on terms which are acceptable to it could be impaired by factors that affect the Company specifically or the financial services industry or economy in general. As a result of the March 2010 agreement between the Federal Reserve Bank and the Company, the Company is required to submit to the Federal Reserve Bank an acceptable plan to improve management of the Bank’s liquidity position and funds management practices. The Bank will be required to enhance the monitoring, measurement, and reporting of the Bank’s liquidity position to the Board, while reducing the reliance on brokered and other wholesale funding sources, enhancing written contingency funding plans, and maintaining sufficient liquidity to meet the Company’s contractual obligations. Failure to accomplish these requirements could result in additional regulatory enforcement actions, and could impair or severely damage the ongoing operations of the Company. The Company could experience liquidity shortfalls if it were to dispose of brokered deposits pursuant to the March 2010 agreement and were not able to replace them with other funding sources, or was not able to reduce assets quickly enough to cover liquidity shortfalls. Factors that could detrimentally impact the Company’s access to liquidity sources include a decrease in the level of its business activity as a result of a downturn in the markets in which its loans are concentrated or adverse regulatory action against it. The Company’s ability to borrow could also be impaired by factors that are not specific to it, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and the continued deterioration in credit markets.
Fourth bullet point (will expand in future filings to include State Order dated May 17, 2010)
The Company may need to raise additional capital in the future and such capital may not be available when needed or at all
The Company may need to raise additional capital in the future to provide it with sufficient capital resources and liquidity to meet its commitments and business needs. In addition, the Company may elect to raise additional capital to support its business or to finance acquisitions, if any. The Company’s ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of its control of the Company, and its financial performance. The economic downturn and significantly increased levels of nonperforming assets at the Company has placed additional strain on the Company’s capital position. The Company may experience additional loan losses and lower levels of net income which may require increased levels of capital in the future. As a result of the March 2010 agreement between the Federal Reserve Bank and the Company, the Company is required to submit to the Federal Reserve Bank an acceptable plan to maintain sufficient capital at both the Bank and the Company to comply with current regulatory guidelines taking into account the current level of classified assets, concentrations of credit, current and projected assets growth, and projected retained earnings. The ongoing liquidity crisis and the loss of confidence in financial institutions may increase the Company’s cost of funding and limit its access to some of its customary sources of capital, including, but not limited to, inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve.
The Company cannot be assured you that such capital will be available to it on acceptable terms or at all given the current financial position of the Company and the state of the overall economy. Any occurrence that may limit its access to the capital markets, such as failure to comply with the Federal Reserve Bank regulatory agreement, a decline in the confidence of investors, depositors of the Banks or counterparties participating in the capital markets, may adversely affect the Company’s capital costs and its ability to raise capital and, in turn, its liquidity. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on the Company’s business, financial condition and results of operations, and may also result in additional regulatory enforcement actions that could impair or severely damage the ongoing operations of the Company.
Fifth bullet point (will expand in future filings to include State Order dated May 17, 2010)
The Company could experience loan losses, which exceed the overall allowance for loan losses.
The risk of credit losses on loans and leases varies with, among other things, general economic conditions, the type of loan being made, the creditworthiness of the borrower, and, in the case of collateralized loans, the value and marketability of the collateral. The Company maintains an allowance for loan losses based upon, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Based upon such factors, management makes various assumptions and determinations about the ultimate collectibility of the loan portfolio and provides an allowance for losses based upon a percentage of the outstanding balances and for specific loans where their collectibility is considered to be questionable. As a result of the March 2010 agreement between the Federal Reserve Bank and the Company, the Company is required to submit to the Federal Reserve Bank an acceptable program to maintain an adequate allowance for loan and lease losses including a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses. In addition, the Bank was required to eliminate or charge-off all assets classified as “loss” in the most recent examination by the Federal Reserve, a requirement which ash been complied with.
As of December 31, 2009, the Company’s allowance for loan losses was approximately $15.0 million representing 2.96% of gross outstanding loans. Although management believes that the allowance is adequate, there can be no absolute assurance that it will be sufficient to cover future loan losses given the current level of classified loans. In addition, if the Company after implementing its new program to determine and maintain an adequate loan and lease losses, needs to increase its provision for loan and lease losses, such additional provision will result in an additional loss for the Company. Although the Company uses the best information available to make determinations with respect to adequacy of the allowance for loan losses, future adjustments may be necessary if economic conditions change substantially from the assumptions used or if negative developments occur with respect to non-performing or performing loans. If management’s assumptions or conclusions prove to be incorrect and the allowance for loan losses is not adequate to absorb future losses, or if Company’s regulatory agencies require an increase in the allowance for loan losses, the Company’s earnings, and potentially its capital, could be significantly and adversely impacted.
Sixth bullet point (will expand in future filings to include State Order dated May 17, 2010)
We have elected to defer deferred interest payments on our trust preferred securities which prevents us from paying dividends on our capital stock until those payments are brought current.
We have not paid any cash dividends on our common stock since the second quarter of 2008 and do not expect to resume cash dividends on our common stock dividends for the foreseeable future. In order to preserve capital, we elected at September 30, 2009 towe defered quarterly payments of interest on our junior subordinated debentures issued in connection with our trust preferred securities beginning with the quarterly payment due October 1, 2009. As a result of the of the March 2010 agreement between the Federal Reserve Bank and the Company, the Company is currently prohibited from paying interest on its trust preferred securities, and is also prohibited from paying cash dividends on its common stock. The terms of the debentures related to the trust preferred securities permit us to defer payment of interest for up to 20 consecutive quarters. Interest continues to accrue while interest payments are deferred. Under the terms of the trust preferred securities we are prohibited from paying cash dividends on our capital stock (including common stock) during the deferral period.
The holders of the Company’s junior subordinated debentures have rights that are senior to those of the Company’s shareholders.
On July 25, 2007 the Company issued $15.5 million of floating rate junior subordinated debentures in connection with a $15.0 million trust preferred securities issuance by its subsidiary, United Security Bancshares Capital Trust II. The junior subordinated debentures mature in July 2037.
The Company conditionally guarantees payments of the principal and interest on the trust preferred securities. The Company’s junior subordinated debentures are senior to holders of common stock. As a result, the Company must make payments on the junior subordinated debentures (and the related trust preferred securities) before any dividends can be paid on our common stock and, in the event of bankruptcy, dissolution or liquidation, the holders of the debentures must be satisfied before any distributions can be made to the holders of common stock. Effective September 30, 2009, tThe Company has elected to defer distributions on our junior subordinated debentures (and the related trust preferred securities) for up to five years, during which time no cash dividends may be paid to holders of common stock. As a result of the March 2010 agreement between the Federal Reserve Bank and the Company, the Company is currently prohibited from paying interest on its junior subordinated debentures.
Item 7
If the Company lost a significant portion of its low-cost core deposits, it would negatively impact profitability.
The Company’s profitability depends in part on its success in attracting and retaining a stable base of low-cost deposits. As of December 31, 2009, noninterest-bearing checking accounts comprised 24.9% of the Company’s deposit base, and interest-bearing checking and money market accounts comprised an additional 8.6% and 19.7%, respectively. The Company considers these deposits to be core deposits. If the Company lost a significant portion of these low-cost deposits, it would negatively impact its profitability and long-term growth objectives. While Management generally does not believe these deposits are sensitive to interest-rate fluctuations, the competition for these deposits in the Company’s market area is strong and if the Company were to lose a significant portion of these low-cost deposits, it would negatively affect business operations.
The Company currently participates in the FDIC’s Transaction Account (“TAG”) Program. Participation is voluntary, and under the program participating financial institutions obtain unlimited FDIC insurance coverage for all noninterest-bearing transaction accounts without limitation, and coverage for all interest-bearing accounts which pay (or will never pay more than) 0.50%. The TAG program will expire on December 31, 2010. However, the Dodd-Frank Wall Street Reform and Consumer Protection Act provides unlimited FDIC insurance for noninterest-bearing transaction accounts in all banks effective on December 31, 2010 and continuing through December 31, 2012. If after December 31, 2012, ior Congress the TAG program was not continued, the Company could loose some, or a substantial portion, of those deposits which would not otherwise be subject to FDIC insurance coverage. The loss of noninterest-bearing or low-cost deposits could adversely impact the Company’s liquidity position and the Company would need to seek higher-cost funding sources which could impair the Company financial position and results of operations.
As a result of the March 2010 regulatory agreement between the Federal Reserve and the Company, the Company will reduce its reliance on brokered deposits and other wholesale funding over the next two years to near peer levels. Reductions in brokered deposits may be difficult to replace with other types of deposit accounts. As a result, the Company may be limited in its ability to grow assets, and may experience liquidity constraints if unable to effectively replace maturing brokered deposits and other wholesale funding sources.
Item 8
Possible Control by Certain Persons. In that Mr. Dennis Woods, Chairman and CEO of the Company beneficially owns approximately 7.2% of the outstanding shares of Company common stock, the named executive officers of the Company as a group (excluding Mr. Woods) beneficially owns approximately 5.1% of the outstanding shares of Company common stock, and the directors of the Company as a group (excluding Mr. Woods) beneficially owns 17.1% of the outstanding shares of Company common stock, these persons will be able to control certain corporate governance matters. Such matters may include the selection of nominees for the board of directors and the supervision of management. The officers and directors also have the ability to control other matters requiring shareholders’ approval including the election of directors which may result in the entrenchment of management.
Management’s Discussion and Analysis of Financial Condition and Results of Operations – Page 31
Item 9
Regulatory Agreement with the Federal Reserve Bank of San Francisco
Effective March 23, 2010, United Security Bancshares (the "Company") and its wholly owned subsidiary, United Security Bank (the "Bank"), entered into a written agreement (the “Agreement”) with the Federal Reserve Bank of San Francisco. Under the terms of the Agreement, the Company and the Bank agreed, among other things, to strengthen board oversight of management and the Bank's operations; submit an enhanced written plan to strengthen credit risk management practices and improve the Bank’s position on the past due loans, classified loans, and other real estate owned; maintain a sound process for determining, documenting, and recording an adequate allowance for loan and lease losses; improve the management of the Bank's liquidity position and funds management policies; maintain sufficient capital at the Company and Bank level; and improve the Bank’s earnings and overall condition. The Company and Bank have 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 Bank. The Holding Company generates no revenue of its own and as such, relies on dividends from the Bank to pay operating expenses and interest payments on the Company’s junior subordinated debt. The inability of the Bank to pay cash dividends to the Holding Company may hinder the Holding Company’s ability to meet its ongoing operating obligations, although for the current year, directors provided funding to the Holding Company by making individual loans and will likely do so again if necessary.
This Agreement entered into with the Federal Reserve Bank of San Francisco during March 2010 was a result of a regulatory examination conducted by the Federal Reserve and the California Department of Financial Institutions in June 2009, using financial data as of March 31, 2009 and certain loan data as of April 30, 2009. The following issues related to the June 2010 examination led to the agreement between the Federal Reserve Bank and the Company that corrective action was required:
§ | Asset quality continued to deteriorate as adversely classified assets increased over four consecutive target and full-scope examinations conducted from 2006 through the June 2009 exam. The dollar volume of adversely classified assets increased by 16.7% during the six months prior to the exam to $142.1 million at the June 2009 examination. |
§ | Below investment grade investment securities classified substandard at the previous examination totaling $9.1 million increased to $17.1 million at the June 2010 examination, representing 18.6% of tier 1 capital and reserves as of March 31, 2009. The classified investment securities are comprised of three private-label residential mortgage backed securities that are below investment grade as graded by a national rating agency, were divided between $16.9 million in substandard and $163,000 in loss. The portion listed as loss represented the amount identified as other-than-temporary-impairment (OTTI) and had been recognized as loss as of March 31, 2009. |
§ | During the June 2009 examination, it was the opinion of the Federal Reserve Bank that the Bank's methodology related to the allowance for loan and leases losses was flawed, leading the Federal Reserve Bank to conclude that additional provisions were required to raise reserves to an appropriate level. In addition, weaknesses in the ALLL policy were identified and needed to be addressed, which included improvements in documentation related to identification and analysis of loans under SFAS No. 114 and SFAS No. 5, and more detailed justification for the qualitative factors used in the ALLL process. During the six months ended June 30, 2010, several large lending relationships to developers in the San Joaquin Valley deteriorated significantly, requiring an additional $1.8 million in ALLL. In addition, during that period, the Bank experienced increases in other problem loans or potentially problem loans including nonaccrual loans and special mention loans, and real estate valuations continued to decline. Regulators required an increase in the reserves as calculated by the Federal Reserve Bank using a model they call the “Atlanta Model.” The Atlanta Model calculated an estimated range of allowance for loan losses using a blend of national, regional, and local peer bank data. The reserve calculated by the Bank for June 30, 2009 under GAAP included additions to ALLL required for increases in adversely classified and special mention loans experienced during the first half of 2009, and although at the lower range of ALLL as estimated by the Federal Reserve, corresponded favorably with the Federal Reserves’ “Atlanta Model”. The reserve adjustment required for the second quarter of 2009 totaled $6.8 million bringing the ALLL level to $15.8 million (including reserve for unfunded commitments) at June 30, 2009. The ALLL findings of the Federal Reserve Bank included recommendations to better align actual practices with the regulatory governing policy as well as to provide a more specific framework for analyzing, determining, and supporting the factors used in the ALLL methodology. |
§ | Earnings performance declined as of June 30, 2009, due in large part to the additional $6.8 million provision recorded for the second quarter ($8.2 million year-to-date) resulting in a net loss for the Company of $4.8 million for the six months ended June 30, 2009. Earnings for the period were also adversely impacted by: a goodwill impairment loss of $3.0 million (pre-tax and net); year-to-date pre-tax impairment losses of $403,000 on the real estate mortgage-backed securities; year-to-date pre-tax operating expenses and impairment losses of $1.3 million related to other real estate owned through foreclosure. |
§ | Although the Bank’s Tier 1 leverage capital, Tier 1 risk-based capital, and total risk-based capital ratios remained above regulatory Prompt Corrective Action guidelines of adequately capitalized banks at 10.8%, 11.3%, and 12.6%, respectively, at June 30, 2009, the Federal Reserve concluded that capital levels were less than adequate to support the Bank's high risk profile resulting primarily from the continued decline in asset quality. At the June 2009 examination adversely classified assets were in excess of 150.0% of Tier 1 capital and reserves. |
§ | The Bank's liquidity position had tightened since the last examination and was considered marginal at the June 2009 examination. The Bank's tight liquidity position was the result of low levels of liquid assets, high percentage of investment securities pledged against borrowing lines, and higher levels of wholesale borrowings including $64.0 million borrowed from the Federal Home Loan Bank line and $71.3 million borrowed from the Federal Reserve Bank discount window. Brokered deposits total $99.3 million, 19.4% of total deposits at June 30, 2009, and compared unfavorably with the peer group at 6.3%. |
§ | The Federal Reserve concluded in the June 2009 examination that oversight by the Board of Directors and senior management was not adequate given the escalating risk profile of the Bank's activities Although the severe economic downturn was a significant factor in the decline in asset quality, the Board of Directors and senior management were deemed responsible for implementing a business strategy which allowed concentrations in higher-risk speculative residential construction lending. The Board of Directors and senior management had taken measures to maintain asset quality, capital, earnings, and liquidity, but had had not responded in a timely manner to the rapidly changing real estate conditions. As of March 31, 2009, the concentration in construction and land development loans represented high levels in relation to equity capital and reserves, although the exposures were declining over the prior few years. For example, management increased the ALLL in the second quarter of 2009, ordered new appraisals on property remargined collateral on loans, and was seeking sources for new equity capital. In addition, several transactions to reduce or restructure problem assets were in process. However, these actions had not resulted in material tangible improvements in the overall condition of the Bank as of the June 2009 examination. In addition, the June 2009 examination identified nine technical violations of Regulation Y Subpart B that deal with the failure to obtain the prescribed appraisals or evaluations on loan extensions or renewals. These violations of law were subsequently remedied. |
§ | The June 2009 examination indicated that risk management practices needed improvement. Management information systems needed to be redesigned and implemented to more accurately measure fundamental exposures, such as the ongoing credit risk posed by the residential construction and land development loan portfolio and the emerging liquidity risks. The Bank needed to continue its efforts to address and reduce the increasing volume of problem assets. While the loan grading process showed improvement over the prior several examinations, the ALLL methodology was identified as flawed in the June 2009 examination. While the Board of Directors and management made some progress to address the findings of the June 2009 examination, management needed to make further progress on improving several key areas to identify, measure, monitor, and control the exposures presented by credit, liquidity, market, operational, reputation, and legal risks. |
The result of significant increases in nonperforming assets, both classified loans and OREO, during 2008 and the first half of 2009 increased the overall risk profile of the Bank. The increased risk profile of the Bank included heightened concerns about the Bank’s use of brokered and other whole funding sources which had been used to fund loan growth and reduce the Company’s overall cost of interest bearing liabilities. With loan growth funded to materially from wholesale funding sources, liquidity risk increased, and higher levels of nonperforming assets increased risk to equity capital and potential volatility in earnings. In addition, the Federal Reserve Bank identified nine technical violations of Regulation Y Subpart B that deal with the failure to obtain the prescribed appraisals or evaluations on loan extensions or renewals.
As part of the Agreement, the Board of Directors of the Bank has appointed a Compliance Committee to monitor and coordinate the Bank’s compliance with the provisions of the Agreement. The Compliance Committee is comprised of the outside Directors and they meet on a monthly basis.
Among other things, the Agreement required the Bank to submit a number of written plans to the Federal Reserve Bank within specified time frames. The following is a list written plans required to be submitted to the Federal Reserve Bank.
· | Plan to Strengthen Board Oversight – Includes actions that the Board of Directors will take to improve the Bank’s condition, and maintain effective control and supervision over the Bank’s operations including credit risk management, liquidity, and earnings. Also includes the Board’s responsibility to monitor adherence to policies and procedures and applicable laws and regulations, and lists information and reports that will enable the Board to perform this oversight function. |
· | Plan to Strengthen Credit Risk Management Practices – includes the responsibility of Board to establish appropriate risk tolerance guidelines and limits, timely and accurate identification and quantification of credit risk, strategies to minimize credit losses and reduce the level of problem assets, procedures for the ongoing review of the investment portfolio to evaluate other-than-temporary-impairment, stress testing for commercial real estate loans and portfolio segments, and measures to reduce the levels of other real estate owned. |
· | Plan to Improve Adversely Classified Assets – Includes specific plans and strategies to improve the Bank’s asset position through repayment, amortization, liquidation, additional collateral, or other means on each loan, relationship, or other asset in excess of $1.5 million including OREO, that are past due more than 90 days as of the date of the written agreement. |
· | Plan for Maintenance of Adequate Allowance for Loan Losses – Includes policies and procedures to ensure adherence to the Bank’s revised ALLL methodology, provides for periodic reviews of the methodology as appropriate, and provides for review of ALLL by the Board at least quarterly. |
· | Capital Plan – 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. Also contains contingency strategies to obtain additional capital as required to fulfill future capital requirements. |
· | Plan to Improve Liquidity Position – Includes measures to enhance the monitoring, measurement, and reporting of the Bank’s liquidity to the Board, a timetable to reduce the Bank’s reliance on brokered deposits and other wholesale funding, and specific liquidity targets and parameters to meet contractual obligations and unanticipated demands. |
· | Contingency Funding Plan – Includes adverse scenario planning, and identifies and quantifies available sources of liquidity for each scenario. |
· | Earnings Plan and Budget – Includes a revised business plan for the remainder of 2010, including operating assumptions that support for projected income, expense, and balance sheet components. |
As of June 30, 2010 the Bank had completed and submitted to the Federal Reserve Bank all the plans listed above within the designated timeframes. The Federal Reserve responded on July 27, 2010 by letter that stated “We have reviewed your submissions and acknowledge the steps taken by the Bank and Bancshares to achieve compliance with the Agreement's provisions. However, we noted that the Plan to Strengthen Board Oversight omitted references to actions to be taken with regard to Bank earnings as required by the first provision.” At the August 24, 2010 regular meeting of the Board, an amended version of the Plan was approved and the amended Plan has been submitted to the Federal Reserve.
In addition to the submission of the above plans to the Federal Reserve Bank for approval, and implementation of the above plans, the Bank is required within 30 days after the end of each calendar quarter to submit written progress reports to the Federal Reserve Bank detailing actions taken to secure compliance with the Agreement. On April 28, 2010 and July 30, 2010, respectively, the Bank submitted progress reports to the Federal Reserve for the first and second quarters of 2010. As of the July 30, 2010 progress report submitted for the second quarter of 2010 the Company and the Bank believe they are in compliance with the Agreement, including remediation of technical violations of laws and regulations regarding stale loan appraisals.
Regulatory Order from the California Department of Financial Institutions
During May of 2010, the California Department of Financial Institutions issued a written order (the “Order”) pursuant to section 1913 of the California Financial Code to the Bank as a result of a regulatory examination that was conducted by the Federal Reserve and the California Department of Financial Institutions in June 2009. The Order issued by the California Department of Financial Institutions is basically similar to the written agreement with the Federal Reserve Bank of San Francisco, except for certain additional requirements. The additional requirements in the Order for the Bank are as follows:
· | Develop and adopt a capital plan to maintain a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5% and include in such capital plan a capital contingency plan for raising additional capital in the event of various contingencies; |
· | Maintain a ratio of tangible shareholders’ equity to total tangible assets equal to or greater than 9.5% |
· | Maintain an adequate allowance for loan losses and remedy any deficiency in the allowance for loan losses in the calendar quarter in which it is discovered; and |
· | Not establish any new branches or other offices without the prior written consent of the Commissioner of the California Department of Financial Institutions |
· | Provide progress reports within 30 days after the end of each calendar quarter following the date of the Order to the California Department of Financial Institutions detailing the form and manner of all actions taken to secure compliance with the Order and Agreement and the results of such actions. |
The Bank is currently in full compliance with the requirements of the Order including its deadlines.
Item 10
Current Trends Affecting Results of Operations and Financial Position
First paragraph
The Company’s overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact results of operations, but also the composition of the Company’s balance sheet. One of the primary strategic goals of the Company is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources must also be considered in the planning process to mitigate risk and allow for growth. Net interest income has declined over the past three years, totaling $28.4 million, $30.2 million, and $36.6 million for the years ended December 31, 2009, 2008, and 2007, respectively. The decline in net interest income between 2007 and 2008 was primarily the result of significant declines in interest rates during 2008, while the decrease in net interest income between 2008 and 2009 was the result of both decreases in interest rates and declines in the average volumes of earning assets and interest-bearing liabilities. Average interest-earning assets increased approximately $14.5 million between 2007 and 2008, but declined $64.0 million between 2008 and 2009, as the Company reduced the size of the balance sheet and sought to control the rising level of problem assets. Of the $64.0 million decrease in earning assets between 2008 and 2009, $47.7 million was in loans, and an additional $15.5 million was in investment securities. During the last three years, the Company’s cost of interest-bearing liabilities has declined significantly as market rates of interest declined, with the average cost of interest-bearing liabilities dropping from 3.91% during 2007, to 2.75% during 2008, and then to 1.43% for the year ended December 31, 2009. During that three-year period, the mix of average interest-bearing liabilities changed, with interest-bearing deposits declining on average by $53.9 million between the years ended December 31, 2007 and 2008, and decreasing $36.4 million on average between the years ended December 2008 and 2009. Borrowings increased $73.5 million on average between the years ended December 31, 2007 and 2008 as the Company took advantage of low borrowing rates, and increased $8.5 million between the years ended December 31, 2008 and 2009.
New third paragraph
As a result of the economic downturn over the past three years, particularly in real estate market, the Company has experienced declines in the loan portfolio. The greatest decreases have been experienced in real estate construction and development loans and commercial and industrial loans, as the Company has reduced its exposure to real estate markets which have been hard hit over the past three years. Loans decreased $48.2 million between December 31, 2007 and December 312, 2008, and decreased $40.0 million between December 31, 2008 and December 31, 2009. Total loans decreased an additional $13.4 million during the six months ended June 30, 2010. During these periods, real estate construction and development loans decreased nearly $50.0 million between December 31, 2007 and December 31, 2008, decreased $45.9 million between December 31, 2008 and December 31, 2009, and decreased $12.2 million between December 31, 2009 and June 30, 2010, as real estate construction has declined significantly in the San Joaquin Valley and California overall. The Company has not made any material additions to the real estate construction and development loan portfolio over the past several years as a result of the depressed real estate markets, and has focused its attention on working out existing construction loans in the portfolio. Real estate construction and development loans amounted to 33.8%, 27.7%, and 20.7% of the total loan portfolio at December 31, 2007, 2008, and 2009, respectively, and decreased to 18.8% of the total loan portfolio at June 30, 2010. Additionally, commercial real estate loans (a component of real estate mortgage loans) amounted to 16.0%, 15.8%, 23.0%,and 26.4% of the total loan portfolio at December 31, 2007, 2008, 2009, and June 30, 2010, respectively. 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 several years to facilitate take-out loans for construction borrowers when they were not able to obtain permanent financing elsewhere. These loans are generally 30-year amortizing loans with maturities of between three and five years. In addition, the Company purchased two real estate mortgage pools in the past which totaled $23.7 million, $21.0 million, and $18.4 million at December 31, 2007, 2008, and 2009, respectively. These real estate mortgage pools were subsequently sold during the second quarter of 2010. Residential mortgages totaled $37.2 million or 6.3% of the portfolio at December 31, 2007, $41.6 million or 7.7% of the portfolio at December 31, 2008, and $45.8 million or 9.0% of the portfolio at December 31, 2009. With the sale of the two residential mortgage pools during the second quarter of 2010, residential mortgages totaled $27.0 million of 5.4% of the total loan portfolio at June 30, 2010. Loan participations, both sold and purchased, have declined over the past three years as lending originations have slowed significantly and the loan participation market with it. As a result, loan participations purchased have declined from $49.8 million or 8.4% of the portfolio at December 31, 2007 to $36.0 million or 6.6% of the portfolio at December 31, 2008, to $23.8 million or 4.7% of the portfolio at December 31, 2009, and then to $21.5 million or 3.2% of the portfolio at June 30, 2010. In addition, loan participations sold have declined from $29.7 million or 5.0% of the portfolio at December 31, 2007 to $29.4 million or 5.4% of the portfolio at December 31, 2008, then to $15.6 million or 3.1% of the portfolio at December 31, 2009, and remained at $15.6 million or 3.2% of the portfolio at June 30, 2010.
Third paragraph revised
Continued weakness in the real estate markets and the general economy have impacted the Company’s operations during the past year with increased levels of nonperforming assets, increased expenses related to foreclosed properties, and decreased profit margins. Although the Company continues its business development and expansion efforts throughout its market area, increased attention has been placed on reducing nonperforming assets and providing customers more options to help work through this difficult economic period. Options have included a combination of rate and term concessions, as well as forbearance agreements with borrowers. While the level of restructured loans increased during 2009, and into 2010 to a balance of $29.1 million at June 30, 2010, total nonperforming loans have actually decreased approximately $3.9 million during the first six months of 2010.
Fresno and Kern Counties have both been heavily impacted by the real estate downturn over the past three years. Prices have continued to decline slowly in these areas during 2010 even as they have stabilized or increased in other parts of California. The fundamentals of the Fresno real estate market are more solid than other hard hit areas of inland California. Both commercial and residential vacancy rates have increased during 2008, 2009, and into 2010, and remain significantly below the U.S. average and show little sign of overbuilding, and population growth has been relatively steady and not subject to the boom and bust of more exurban areas. However, single family home permits in the Fresno area, which declined between 30% and 35% during both 2008 and 2009, have continued to decline in 2010 and foreclosure and mortgage negative equity rates remain among the top 20 metro areas in the U.S. Employment and income growth in the Fresno area remains very slow, and in fact the unemployment in Fresno County has risen from a little over 8% in 2007 to almost 10% in 2008, almost 15% in 2009, and increased slightly above that in the first six months of 2010. A very high concentration of middle-class jobs in the Fresno area are dependent on state and local governments which are under very heavy pressure in the near term. The next several years will likely remain very challenging for Fresno real estate, but the fundamentals suggest a strong recovery in commercial and residential development in the medium and long-term.
Kern County looks a little different than Fresno. Kern County has performed slightly better in employment and income growth than Fresno County, but its real estate markets show greater signs of oversupply and stress from the foreclosure crisis over the past three years. Commercial and residential vacancy rates have risen sharply in the Bakersfield area, and its foreclosure and negative equity rates are consistently in the top 10 in the U.S. Business and residential vacancy rates of approximately of 4.2% during the second quarter of 2010 are now above the US average after being substantially below average two years ago. The rate of population growth has fallen significantly from near 3% per year to between 1% and 1.5%, but remains above the state average. Through the first 7 months of 2010, the value of commercial building permits has fallen faster than any other area of California, and single family homes also decline. Due to higher inventories and exposure to foreclosures, it is anticipated that Kern County real estate will be slower to recover than Fresno. On the positive side, the Bakersfield area continues to lead all inland California areas in job growth, and is enjoying the favorable economic climate for its oil industry which complements the Valley’s mainstay agriculture industry in this area.
Compared to most areas in California and the West, Santa Clara has experienced a steep “V” shaped recession. Santa Clara has not been as heavily impacted by foreclosures and construction, but experienced a sharp decline in 2009 and has rebounded well through the first half of 2010. Santa Clara is one of the few areas with consistent job and income growth in 2010 on the strength of its high-tech manufacturing sector that has benefited from increasing business investment. It is one of the few areas where unemployment rates are lower in 2010 than in 2009. Real estate prices have followed a similar pattern, posting some of the highest gains in the U.S. in 2010 after big declines in 2008 and 2009. Foreclosure rates and negative equity rates are comparable to the rest of the U.S., but significantly lower than other areas in the West. Above average job and income growth and very low vacancy rates in both the commercial and residential market mean that Santa Clara County should fare relatively well in a troubled regional real estate market..
Last paragraph – page 34
Nonperforming assets, which are primarily related to the real estate loan and property portfolio, remained high during the year ended December 31, 2009 as real estate markets continue to suffer from the mortgage crisis which began during mid−2007. Nonaccrual loans totaling $34.8 million at December 31, 2009, decreased $10.5 million from the balance reported at December 31, 2008, and decreased $20.4 million from the balance reported at September 30, 2009. 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. Valuations on these loans and the underlying collateral continued to deteriorate during much of 2009, resulting in increased charge-offs and levels of impaired loans. Impaired loans increased $4.8 million during the year ended December 31, 2009 to a balance of $53.8 million at December 31, 2009, but decreased $20.0 million during the quarter ended December 31, 2009. Other real estate owned through foreclosure increased $6.1 million between December 31, 2008 and December 31, 2009, as transfers of $21.7 million in loans to other real estate owned during the year more than offset write-downs and sales of those assets during the year. As a result of these events, nonperforming assets as a percentage of total assets increased from 9.96% at December 31, 2008 to 12.56% at December 31, 2009.
The following table summarizes various nonperforming components of the loan portfolio, the related allowance for loan and lease losses and prevision for credit losses for the periods shown.
(in thousands) | June 30, 2010 | Dec 31, 2009 | Dec 31, 2008 | |||||||||
Provision for credit losses during period | $ | 2,150 | $ | 13,375 | $ | 9,526 | ||||||
Allowance as % of noperforming loans | 38.24 | % | 43.20 | % | 25.24 | % | ||||||
Nonperforming loans as % total loans | 9.47 | % | 9.99 | % | 8.39 | % | ||||||
Restructured loans as % total loans | 5.88 | % | 5.13 | % | - |
Second paragraph – page 35
Management continues to monitor economic conditions in the real estate market for signs of further deterioration or improvement which may impact the level of the allowance for credit losses required to cover identified losses in the loan portfolio. As the real estate market declined through 2008 and accelerated throughout much of 2009 the level of problem assets increased, and valuations on many of those assets decreased resulting in increased charge-offs or write-downs of those assets. Greater focus has been placed on identifying and reducing the level of problem assets, while working with borrowers to find more options, including loan restructures, to work through these difficult economic times. As a result of these efforts, restructured loans increased from a single loan totaling $378,000 at December 31, 2008 to approximately 50 loans totaling $26.1 million at December 31, 209 and $29.1 million at June 30, 2010. Increased charge-offs resulting from the depressed real estate market, and significant provisions for loan losses made during 2009 materially impacted earnings, but the provisions made to the allowance for credit losses, totaling $1.4 million during the first quarter of 2009, $6.8 million during the second quarter of 2009, $435,000 made during the third quarter of 2009, and $4.8 million made during the fourth quarter of 2009, provided a level in the allowance for credit losses that is deemed adequate to cover inherent losses in the loan portfolio. The Company charged-off approximately 25 loans during 2007, compared to 50 during 2008, 70 during 2009, and 30 during the six months ended June 30, 2010. The percentage charge-offs to average loans were 0.8%, 0.9%, 1.9%, and 2.0% for the years ended December 31, 2007, 2008, 2009, and the six month ended June 30, 2010. As a Loan and lease charge-offs totaling $10.1 million during the year ended December 31, 2009 included $2.6 million during the quarter ended March 31, 2009, $1.5 million during the quarter ended June 30, 2009, $1.9 million during the quarter ended September 30, 2009, and an additional $4.2 million during the fourth quarter of 2009.
Third paragraph – page 35
Deposits increased by $53.2 million during the year ended December 31, 2009, with increases experienced in both interest-bearing checking accounts and time deposits. Increases in time deposits experienced during the later part of 2009 were the result of a plan to reduce the Company’s reliance on borrowed funds.
Brokered deposits and other wholesale funding sources were used to some degree to fund loan growth in 2007 and 2008, but 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 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. The Company continues its deposit gathering program and has committed additional resources to its efforts during 2010 including two full time employees dedicated to business development. As a result of the formal agreement with the Federal Reserve Bank issued in March 2010, the Bank will reduce its dependence on wholesale funding sources, including brokered deposits, to a level more in-line with peers, which is currently about 5% of total deposits. The Bank, as part of its Liquidity Improvement Plan, will reduce levels of brokered deposits to peer levels over a period of approximately two years.
While we still have a higher percentage of brokered deposits than peers at December 31, 2009, efforts to restructure the balance sheet through reducing the level of total assets, and specifically real estate loans, are proving successful. Total wholesale borrowings and brokered deposits decreased from $248.4 million at December 31, 2008 to $169.4 million at December 31, 2009, representing a decrease of $79.1 million, and the Company went from being a net purchaser of overnight funds at December 31, 2008 with $66.5 million in federal funds purchased to a net seller of overnight funds with $11.6 million in federal funds sold at December 31, 2009. Total wholesale borrowings and brokered deposits decreased d$19.5 million during the six months of 2010 to a balance of $149.9 million at June 30, 2010.
Item 11
Deposits – page 51
As a result of the March 2010 agreement with the Federal Reserve Bank, the Company will reduce its reliance on brokered and other wholesale funding sources. The Company has a written plan, approved by the Federal Reserve Bank, to improve its liquidity position which includes a timetable to reduce the Bank’s reliance on brokered deposits and other wholesale funding, and specific liquidity targets and parameters to meet contractual obligations and unanticipated demands. Under the plan, the Company will systematically reduce the level of brokered deposits to peer levels (as percentage of total deposits) over a period of approximately two years. This will be achieved by letting some or all of the maturing brokered deposits run-off as needed to achieve planned reductions in brokered deposits at the end of each quarter over the two-year period.
During the year ended December 31, 2009, increases were experienced in interest-bearing checking accounts and time deposits of $100,000 or more, while other deposit categories experienced small decreases. The Company increased brokered deposits during 2009 as part of its liquidity strategy to reduce dependence on overnight and term borrowings from the Federal Reserve and FHLB. Although pricing on borrowing remains attractive, access to credit lines has become more vulnerable as risk profiles of most banks, including the Company, have increased in the current economic environment. Pricing of brokered time deposits and other wholesale deposits remain extremely low at this time and have provided currently provides a viable alternate to borrowings from the Federal Reserve or the FHLB. The Company believes this rate structure will eventually turn, and wholesale funding sources, both deposits and borrowings, will again become expensive relative to other core deposits in the marketplace. Although Tthe Company will continue to use pricing strategies to control the overall level of time deposits and other borrowings as part of its balance sheet growth and liquidity planning process, the recent agreement with the Federal Reserve Bank requires reductions in brokered deposits, which places increased emphasis on but will continue to emphasize core deposits as part of the Company’s its long-term relationship banking strategy. As a result, core deposits, including NOW and money market accounts, and savings accounts, as well as noninterest-bearing checking accounts, continue to provide the Company’s primary funding source.
Asset Quality and Allowance for Credit Losses – page 53
As a result of the March 2010 agreement with the Federal Reserve Bank, the Company has written several plans to address the management of asset quality and the adequacy of the allowance for loan and lease losses. Specifically, the Company has three written plans which directly address these issues:
· | Plan to Strengthen Credit Risk Management Practices – includes the responsibility of Board to establish appropriate risk tolerance guidelines and limits, timely and accurate identification and quantification of credit risk, strategies to minimize credit losses and reduce the level of problem assets, procedures for the ongoing review of the investment portfolio to evaluate other-than-temporary-impairment, stress testing for commercial real estate loans and portfolio segments, and measures to reduce the levels of other real estate owned. |
· | Plan to Improve Adversely Classified Assets – Includes specific plans and strategies to improve the Bank’s asset position through repayment, amortization, liquidation, additional collateral, or other means on each loan, relationship, or other asset in excess of $1.5 million including OREO, that are past due more than 90 days as of the date of the written agreement. |
· | Plan for Maintenance of Adequate Allowance for Loan Losses – Includes policies and procedures to ensure adherence to the Bank’s revised ALLL methodology, provides for periodic reviews of the methodology as appropriate, and provides for review of ALLL by the Board at least quarterly. |
Also as part of the agreement with the Federal Reserve Bank, Board oversight has been enhanced to monitor the operations of the Company including, but not limited to, asset improvement and adequacy of the allowance for loan and lease losses. With regard to asset improvement, the Company will not, directly or indirectly, extend, renew, or restructure any loan to any borrower, including any related interest of the borrower, whose loans were criticized by the Federal Reserve Bank in their June 2009 examination, or any subsequent examination, without prior approval of a majority of the Board of Directors. Any extensions of credit, renewals, or restructurings on loans to such borrowers approved by the Board of Directors, will be supported with detailed written justification. Any additional loan, relationship, or asset in excess of $1.5 million that becomes past due more than 90 days, will be subject to a written plan to improve the Company’s position with regard to the asset, and that plan will be submitted to the Federal Reserve Bank. The Company will submit written reports to the Federal Reserve Bank on a quarterly basis to include updates to progress made on asset improvement, as well as review and monitoring of the adequacy of the allowance for loan and lease losses.
Capital Adequacy – page 66
Pursuant to the March 2010 Agreement with the Federal Reserve Bank, the Company and the Bank are required to maintain sufficient capital to support current and future capital needs, including compliance with Capital Adequacy Guidelines taking into account the volume of classified assets, concentrations of credit, the level of the allowance for loan losses, current and projected growth, and projected retained earnings.
As part of the Agreement, the Company has written, and submitted to the Federal Reserve Bank, 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 capital plan also addresses the requirement of both the Bank and the Company to comply with the Federal Banks’ Capital Adequacy Guidelines, and contingency plans to ensure the maintenance of adequate capital levels under those guidelines.
Dividends – page 67
Dividends paid to shareholders by the Company are subject to restrictions set forth in the California General Corporation Law. The California General Corporation Law provides that a corporation may make a distribution to its shareholders if retained earnings immediately prior to the dividend payout are at least equal the amount of the proposed distribution. The primary source of funds with which dividends will be paid to shareholders will come from cash dividends received by the Company from the Bank.
As noted earlier, the Company and the Bank have entered into an agreement with the Federal Reserve Bank that, among other things, require us to obtain the prior approval before paying a cash dividend or otherwise making a distribution on our 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, effective October 1, 2009, the Company has elected to defer regularly scheduled quarterly interest payments on its junior subordinated debentures issued in connection with its trust preferred securities. Under the subordinated debenture indenture agreement, Tthe Company is prohibited from paying any dividends or making any other distribution on its common stock for so long as interest payments are being deferred. 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, 2009, the Company received $200,000 in cash dividends from the Bank. During the same period, the Company paid $6,000 in cash dividends to shareholders representing cash-in-lieu amounts paid in connection quarterly stock dividends.
The Bank as a state-chartered bank is subject to dividend restrictions set forth in California state banking law, and administered by the California Commissioner of Financial Institutions (“Commissioner”). Under such restrictions, the Bank may not pay cash dividends in an amount which exceeds the lesser of the retained earnings of the Bank or the Bank’s net income for the last three fiscal years (less the amount of distributions to shareholders during that period of time). If the above test is not met, cash dividends may only be paid with the prior approval of the Commissioner, in an amount not exceeding the Bank’s net income for its last fiscal year or the amount of its net income for the current fiscal year. Such restrictions do not apply to stock dividends, which generally require neither the satisfaction of any tests nor the approval of the Commissioner. Notwithstanding the foregoing, if the Commissioner finds that the shareholders’ equity is not adequate or that the declarations of a dividend would be unsafe or unsound, the Commissioner may order the state bank not to pay any dividend. The FRB may also limit dividends paid by the Bank. As noted above, the terms of the regulatory agreement with the Federal Reserve prohibit both the Company and the Bank from paying dividends without prior approval of the Federal Reserve.
Item 12
See Appendix 2
Item 13
<No Appendix>
Item 14
<No Appendix>
Item 15
Although the total loan portfolio has declined over the past three years from $591.1 million at December 31, 2007 to $543.3 million at December 31, 2008, to $507.7 million at December 31, 2009, and then to $494.6 million at June 30, 2010, the level of nonperforming loans has increased over the past three years, but declined from $51.1 million at December 31, 2009 to $46.9 million at June 30, 2010. During the same period, total classified loans increased to a high of $82.7 million at December 31, 2008 and then decreased to $69.6 million at December 31, 2009 and then decreased to $54.6 million at June 20, 2010.
June 30, | December 31, | December 31, | December 31, | |||||||||||||
2010 | 2009 | 2008 | 2007 | |||||||||||||
Allowance for loan losses - period end | $ | 12,057 | $ | 15,016 | $ | 11,529 | $ | 7,431 | ||||||||
Net loans charged off during period | (5,109 | ) | (9,888 | ) | (5,428 | ) | (4,429 | ) | ||||||||
LLR Provision during period | 2,150 | 13,375 | 9,526 | 6,231 | ||||||||||||
Loans outstanding at period-end | $ | 494,463 | $ | 507,709 | $ | 543,317 | $ | 591,056 | ||||||||
ALLL as % of loans at period-end | 2.44 | % | 2.96 | % | 2.12 | % | 1.26 | % | ||||||||
Nonaccrual loans | $ | 31,531 | $ | 51,096 | $ | 45,671 | $ | 16,158 | ||||||||
Restructured Loans | 15,341 | 0 | 0 | 23 | ||||||||||||
Total nonperforming loans | 46,872 | 51,096 | 45,671 | 16,181 | ||||||||||||
ALLL as % of nonperforning loans | 25.72 | % | 29.39 | % | 25.24 | % | 45.92 | % | ||||||||
Impaired loans | $ | 46,653 | $ | 53,794 | $ | 48,946 | $ | 15,202 | ||||||||
Classified loans not considered impaired | 7,963 | 15,816 | 33,758 | 31,135 | ||||||||||||
Total classified loans | $ | 54,616 | $ | 69,610 | $ | 82,704 | $ | 46,337 | ||||||||
ALLL as % of classified loans | 22.08 | % | 21.57 | % | 13.94 | % | 16.04 | % |
During the three years ended December 31, 2007, 2008, and 2009 net loan charge-offs increased from $4.4 million during 2007 to $5.4 million during 2008 and $9.9 million during 2009, while at the same time increased provisions for loans losses over those three years enabled the Company to increase the allowance for loan losses from $7.3 million at December 31, 2007 to $11.5 million at December 31, 2008, and then to $15.0 million at December 31, 2009. Over the period between December 31, 2007 and December 31, 2009, the allowance for loan losses increased as a percentage of classified loans from 16.4 % at December 31, 2007 to 21.6 % of classified loans at December 31, 2009. During the second quarter of 2010, two nonaccrual loans had charge-offs totaling approximately $3.0 million. Excluding these two charge-offs, the ratio of allowance to nonperforming loans and the ratio of allowance to total classified loans would have been 30.2% and 26.1%, respectively, at June 30, 2010, representing increases in both ratios from those reported at December 31, 2009. Both of these loans had been fully reserved at December 31, 2009 for the amount of the charge-offs taken during 2010.
Between December 31, 2007 and December 31, 2009, impaired loans increased from $15.2 million at December 31, 2007 to $53.8 million at December 31, 2009, and nonaccrual loans, most of which are generally included in impaired loans, increased proportionately also. During the same period the overall level of the loan portfolio, including pass loans, was decreasing, as was the level of classified loans not considered impaired. This placed additional emphasis on specific reserves for impaired loans, while the level of loans subject to a formula reserve has been steadily declining since December 31, 2007. Total special mention loans and substandard loans not considered impaired have also been decreasing since December 31, 2008. As impaired loans increased, specific reserve related to impaired loans increased from $982,000 at December 31, 2007 to $5.0 million at December 31, 2008, then to $8.0 million at December 31, 2009. Specific reserves declined to $5.1 million at June 30, 2010 primarily as the result of $3.0 million charged-off between two impaired loans during the second quarter of 2010. The most severe decrease in asset valuations and increase in impaired and classified assets occurred during 2009, while both factors showed slowed deterioration and some improvement during the first six months of 2010. While the total of special mention loans, substandard loans not considered impaired, and pass loans, have decreased since December 31, 2008, the formula reserves related to those loans has remained level over the period and has increased as a percent of those loans totals from 1.3% at December 31, 2008 to 1.6% at both December 31, 2009 and June 30, 2010 as the result of portfolio mix and modest increases in loss factors applied to those non-impaired loans. The increase in nonperforming loans during 2008 and 2009 is due in part to two large real estate construction development relationships in Kern County which totaled approximately $17.8 million of 34.8% of nonperforming assets at December 31, 2009.
For loans other than impaired under SFAS No. 114, Loss factors were used to develop a range of estimated allowance for loan losses. The loss factors are based on either Bank historical losses for each of the eleven loan segments (discussed in Asset Quality and Allowance for Credit Losses section of Management’s Discussion and Analysis of Financial Condition and Results of Operations) over a rolling twelve quarter time horizon, or for those segments that have not historically had any losses, computed loss factors developed from Federal Reserve quarterly data of charge off rates seasonally adjusted for All Banks other than the 100 largest. These loss factors are adjusted by an aggregation of qualitative factors to account for ten subjective areas covering portfolio trends, economic conditions, concentrations, competition, level of participations, loan review and oversight, lending policies and staff.
The most prominent qualitative factors used to help determine the level of allowance for loan losses at June 30, 2010 were as follows:
§ | The high level of delinquency and nonaccrual loans remains high, but there continues to be ongoing declines in nonperforming assets, that began in the third quarter of 2009. The level of delinquent and nonaccrual loans is indicative of continued high inherent risk within the portfolio at June 30, 2010, even though all groups within these sectors appear adequately reserved. |
§ | The June 30, 2010 loans outstanding are less than the median for the prior year, indicating a contraction in the portfolio by $40 Million over the past 12-months or 7.72%. The Bank’s goal is to continue to reduce the loan portfolio and shrink the Bank. |
§ | While the statistical data would suggest that the U. S. is in an economic recovery and warrant consideration for a decrease because of the improving statistical economic data; due to the continued uncertainty resulting is volatile markets changes and the prognosis that the markets will be sluggish and lethargic into and through 2011, the factor will not be adjusted downward, but will be maintained at the current level. |
§ | Single family residential construction loan concentration levels as well as commercial real estate concentration level continue to decline. While restrictions on new residential acquisition and development loans are in place, the existing portfolio represents higher risk due to the slowed market absorption and the increased level of illiquidity. However, the construction portfolio is both down in absolute dollars and as a percent of capital below the Banks’ minimum concentration limits. |
§ | Competition is almost non-existent for new transactions, but also the market is very narrow and illiquid, increasing risk levels due to the inability of customers to refinance debt. A significant number of borrowers report difficulties finding loans. |
§ | Purchased participations have declined, both in dollar and percentage of capital from high, but have been stable for most of 2010. |
§ | The lending policies were enhanced during each quarter of 2008, were revised in 2009 and have had revisions in 2010 to incorporate more conservative underwriting guidelines. New credits undergo enhanced critical review in the approval process. The Bank is taking a very proactive stance in underwriting loans and risk ratings. |
Item 16
<No Appendix>
Item 17
<No Appendix>
Item 18
<No Appendix>
Item 19
Item 9A(T). Controls and Procedures
Evaluation of Disclosure Controls and Procedures:
We maintain controls and procedures designed to ensure that we are able to collect the information we are required to disclose in the reports we file with the SEC, and to record, process, summarize and disclose this information within the time periods specified in the rules promulgated by the SEC. Our Chief Executive and Chief Financial Officers are responsible for establishing and maintaining these disclosure controls and procedures and as required by the rules of the SEC, to evaluate their effectiveness. Based on their evaluation of our disclosure controls and procedures as of the end of the period covered by this Annual Report on Form 10-K, our Chief Executive and Chief Financial Officers believe that these procedures are functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities Exchange Act of 1934 is (i) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and (ii) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding disclosures.
a) 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, 2009. 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, 2009 based upon criteria in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on this assessment, Management determined that the Company’s internal control over financial reporting was effective as of December 31, 2009.
This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to the attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
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, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective on a timely manner to alert them to material information relating to the Company which is required to be included in the Company’s periodic Securities and Exchange Commission filings.
(b) Changes in Internal Controls over Financial Reporting: During the quarter ended December 31, 2009, the Company did not make any significant changes in, nor take any corrective actions regarding, its internal controls over financial reporting or other factors that could significantly affect these controls.
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.
Management Report on Internal Control over Financial Reporting:
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of United Security Bancshares and Subsidiaries (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting, and for performing an assessment of the effectiveness of internal control over financial reporting as of December 31, 2009. 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 in the Company's definitive Proxy Statement for its 2010 Annual Meeting of Shareholders ("Proxy Statement").
Item 20
<No Appendix>
Item 21
Consideration of Director Nominees
Shareholder Nominees and Shareholder Process to Submit Director Candidates
United Security Bancshares’ independent directors meeting in executive session will consider candidates nominated by shareholders for next year’s meeting if the nomination is made in writing. Shareholder nominations must be made in accordance with the procedures outlined in the Company’s Bylaws and must be addressed to the
Corporate Secretary
United Security Bancshares
2126 Inyo Street
Fresno, California 93721
Shareholders who wish to nominate a candidate for consideration by the executive committee (“Independent Executive Committee”) of independent directors of our Board of Directors must comply with the procedures outlined herein. The Independent Executive Committee will evaluate qualified candidates in the same manner as nominees submitted by the Board as set forth in the section below entitled “Selection and Evaluation of Director Candidates.”
Authority to Make Nominations. Pursuant to our Bylaws, nominations for Directors may be made by the Board of Directors or by any holder of record of any outstanding class of capital stock of the Company entitled to vote for the election of Directors.
Nomination Procedure. Shareholder nominations for Directors must be made in writing and delivered or mailed to the President of the Company by the later of: (i) the close of business twenty-one (21) days prior to any meeting of shareholders called for the election of directors; or (ii) ten (10) days after the date of mailing of notice of the meeting to shareholders.
Any shareholder nomination must be accompanied by a written statement signed and acknowledged by the nominee consenting to his or her nomination and agreeing to serve as director if elected, and must contain the following information, to the extent known to the nominating shareholder:
· | The name and address of each proposed nominee; |
· | The principal occupation of each proposed nominee; |
· | the number of shares of capital stock of the corporation owned by each proposed nominee; |
· | the name and residence address of the notifying shareholder; |
· | the number of shares of capital stock of the corporation owned by the notifying shareholder; |
· | the number of shares of capital stock of any bank, bank holding company, savings and loan association or other depository institution owned beneficially by the nominee or by the notifying shareholder and the identities and locations of any such institutions and; |
· | whether the proposed nominee has ever been convicted of or pleaded nolo contendere to any criminal offense involving dishonesty or breach of trust, filed a petition in bankruptcy or been adjudged bankrupt. |
Process for Identifying and Evaluating Candidates.
The Independent Executive Committee’s process for identifying and evaluating director candidates is as follows:
· | The Independent Executive Committee identifies the need to add new members to the Board with specific criteria or to fill a vacancy on the Board. |
· | The independent directors identify nominees by first evaluating the current members of the Board of Directors qualified and willing to continue in service |
· | The Independent Executive Committee initiates a search, working with staff support and seeking input from the members of the Board and senior management of candidates including existing Board members that are willing to continue to serve as directors. The Independent Executive Committee also considers any candidates recommended by shareholders. |
· | The Independent Executive Committee identifies a potential slate of candidates, after taking account of the criteria discussed in the next section below. |
· | The Independent Executive Committee determines if any Board members have contacts with the potential candidates. |
· | The Chairman of the Board, the Chief Executive Officer and at least one member of the Independent Executive Committee interview prospective candidate(s) other than existing board members. |
· | The Independent Executive Committee keeps the Board informed of the selection progress. |
· | The Independent Executive Committee meets to consider and approve its slate of recommended candidates also using the criteria discussed in the next section below. The Independent Executive Committee in evaluating existing directors as nominees and nondirectors as nominees balances the value of continuity of service by existing members of the Board with that of obtaining a new perspective. The Independent Executive Committee |
· | The Nominating and Corporate Governance Committee presents its slate of recommended candidates to the Board and seeks the Board’s endorsement of such candidate(s). |
· | The Board has the full prerogative to modify the director slate recommended by the Nominating and Corporate Governance Committee. |
· | There is no third party that we currently pay to assist in identifying or evaluating potential director nominees. The Nominating and Corporate Governance Committee’s process for identifying and evaluating nominees for directors will not materially differ based on whether or not the nominee is recommended by a security holder. |
Criteria for recommending and selection of director nominee candidates
The main criteria used by the Independent Executive Committee for identifying candidates for membership on the Board are the character, judgment, leadership ability and business experience, as well as the ability of such candidate to add to the Board’s existing strengths. This assessment typically includes issues of expertise in industries important to United Security Bancshares, functional expertise in areas such as marketing, human resources, operations, finance and information technology and an assessment of an individual’s abilities to work constructively with the existing Board and management, all in the context of an assessment of the perceived needs of the Board at that point in time. The Independent Executive Committee does not have any written specific minimum qualifications or skill requirements that must be met by either their candidates or shareholder-recommended candidates in order to serve on the Board. While no specific diversity policy exists, when identifying and evaluating new directors, the Independent Executive Committee considers the diversity and mix of the existing Board, including, but not limited to, such factors as: the age of the current directors, their geographic location (being a community bank, there is a strong preference for local directors), their background, skills, employment experience and community representation, the minority and female representation on the Board, public interest considerations and the implementation of United Security Bancshares’ strategic plan.
Among other things, when examining a specific candidate’s qualifications, the Independent Executive Committee considers the candidate’s: ability to represent the best interests of United Security Bancshares, existing relationships with United Security Bancshares, interest in the affairs of United Security Bancshares and its purpose, the ability to fulfill director responsibilities, reputation within United Security Bancshares’ community, community service, integrity, ability to develop business for United Security Bancshares and the ability to work as a member of a team. All nominees to be considered at the Meeting were recommended by the Independent Executive Committee.
Item 22
Elements of Compensation
Salaries
The Committee determines the levels of the components of executive compensation after reviewing the peer and other data. Outside consultants may be utilized to assist the Committee in the effort though no such consultants were used in 2009. Executive salaries are reviewed annually, but once established, are typically left unchanged for a period of years. Prior to January 2010, salaries were last increased in January 2006. The Committee recognizes that without annual increases, Company executive salaries drift below peer average salaries. The Committee practice of not granting annual salary increases was linked to executive incentive compensation of Company net income. In January 2010, the Committee delinked executive compensation from Company net income and determined that executive compensation be administered at the discretion of the Committee. This was done to reduce the potential imbalance in the focus by management on short run profits and insufficient focus on risk. At the same time, the Committee increased the annual base salary of Mr. Woods to $480,000 and the annual base salaries of the Chief Credit Officer, the Chief Operating Officer and the Chief Financial Officer to $150,000. Mr. Donahue, the Company's Chief Financial Officer was promoted to Executive Vice President and Chief Administrative Officer with an annual salary of $190,000.
Incentive Compensation
Incentive compensation was linked to net income for all five executive officers for 2009. No incentive bonus was earned or paid for any executive officer in 2009. For 2010 the discretionary incentive bonus administered by the Committee will consider a number of factors including overall Company performance, asset quality, compliance and other performance measurements.
Item 23
Nominees
Dennis Woods
Chairman of the Board
Director since 2001
Mr. Woods is the founding chairman of the Bank, and assumed the additional duties of President and CEO in 1993. In Mr. Woods' previous business career he was the President and CEO of Hestbeck’s Incorporated, a diversified wholesale and retail food distribution company, operating retail grocery stores and U.S.D.A. inspected meat processing plants. His tenure was from 1970 through 1993, when he retired and took over the President and C.E.O. duties at the bank. His real estate ownership has included commercial warehouses, apartments and residential real estate investments for more than 30 years. He is involved in the development and farming of pistachio and almond farms from 1980 until the present. He has served on the following boards: Hestbecks Incorporated; United Security Bancshares; Pacific Coast Bankers Bank; California State University Fresno Bulldog Foundation; State Center Community College; United Way of Fresno County; Northern California Loan Fund Advisory and Denwoods Farm Company to list a few. Mr. Woods’ extensive background in various businesses, all well as his involvement in local real estate markets over the past 30 years qualifies him for service as a director. a wholesale and retail food distribution company for over 20 years. Additional businesses he has been involved with are the real estate investment business, as well has diversified farming for the last 30 years. Mr. Woods has also continuously served over the years on the boards of directors of a number of non-profit organizations.
Ronnie D. Miller
Vice Chairman
Director since 2001
Mr. Ronnie Miller has lived in Fresno, California for nearly 68 years. Mr. Miller has been involved in the auto sales industry in the Fresno area since 1972. He is currently the President of Ron Miller Enterprises, Inc., dba Fresno Motor Sales and Fresno Commercial Lenders which has been operating more than 21 years. He is active in the Fresno community as a commercial lender. He has been a real estate investor in the Fresno area for many years and currently owns a number of commercial and residential properties. Mr. Miller's relevant experience in operating an automobile dealership and lender, as well as his knowledge of local real estate markets, qualifies him for service as a director.
Robert G. Bitter, Pharm. D.
Corporate Secretary
Director since 2001
Dr. Bitter has lived in Madera, California for nearly 32 years. He is a clinical pharmacist at Madera Community Hospital and also the owner of Brenda Creek Ranch raising chickens on contract and farming pomegranates. He is a 75% owner in the Selma Shopping Center. He has been active in Rotary for fort-two years, serving as president of the Selma Rotary Club and the Madera Sunrise Rotary Club. H served District Governor of District 5220 during the 1987-1988 Rotary year. He has been awarded Rotary’s highest honor, the Service Above Self Award, and is the recipient of The Rotary Foundation Citation for Meritorious Service and the Distinguished Service Award. He has worked extensively with youth in the community, particularly with the High School Interact Club. Through Rotary, he is involved in many diverse International Service activities, currently as Zone Representative for the Open World Program bringing Russian government people to the United States to learn of democracy first hand. He also works with The Wheelchair Foundation to purchase and distribute wheelchairs to third world countries. Dr. Bitter's relevant experience in operating in different and diverse businesses, including real property management qualifies him for service as a director. His Rotary work has given him the opportunity of working with persons in many languages and cultures where he has gained an in depth knowledge of multiple of people diversity.
Dr. Bitter has lived in Madera, California for nearly 32 years. He is a clinical pharmacist at Madera Community Hospital and also the owner of Berenda Creek Ranch and a partner in Selma Shopping Center. He is active in the Madera Sunrise Rotary Club and is a Past District Governor of District 5220. He has worked extensively with youth in the community, particularly with the High School Interact Club. Through Rotary, he is involved in many diverse International Service activities. Dr. Bitter's relevant experience in operating in different and diverse businesses including real property management qualifies him for service as a director.
Stanley J. Cavalla
Director since 2001
Mr. Cavalla has lived in Fresno County for nearly 59 years. He is President of Suburban Steel, Inc. and Vice President of Tri State Stairway Corp. He is active in Fresno County as business and farmer. Mr. Cavalla's relevant experience as an executive in managing, operating manufacturing and farming businesses within the Company’s market area qualifies him for service as a director.
Tom Ellithorpe
Director since 2001
Mr. Ellithorpe has lived in Fresno, California for nearly 54 years. He is the owner of Insurance Buying Service. He is active in the Fresno community as an insurance broker, and has been involved in the California insurance industry since 1972. He has also been involved in a number of business ventures in the Company’s market area including agricultural ventures.. Mr. Ellithorpe's relevant experience as an executive in the insurance industry and his understanding of risk management, as well as his involvement as a businessman in the local market area, qualifies him for service as a director.
R. Todd Henry
Director since 2003
Mr. Henry has lived in Coursegold, California for nearly 10 years. He is a Certified Public Accountant (became inactive in October 2009), dba Henry & Company. Mr. Henry has a Masters degree in accounting and worked for Price Waterhouse from 1981 through 1987 achieving the level of tax manager before his departure in 1987. In 1987, Mr. Henry and a partner Mr. Thompson, formed Thompson, Henry & Company, a CPA firm they operated through 2004 preparing financial statements and tax returns for a variety of clients in a variety of industries. In 2004, Mr. Henry formed Henry & Company, a CPA firm he operated as a sole proprietor with a staff of 15 employees. In December 2009, Mr. Henry sold Henry & Company to devote more time to his farming interests which he had been developing for a number of years. He is currently also a principal and sole owner of Westside Farming and managing partner of Henry Family Farms LP. Mr. Henry's relevant experience as a certified public accountant and knowledge of auditing, taxation, accounting and finance, and exposure to a variety of business issues, qualifies him for service as a director, and the audit committee’s financial expert.
Robert M. Mochizuki
Director since 2004
Dr. Mochizuki has lived in Fresno, California for nearly 11 years. He is an orthopedic surgeon and CEO of Arthroscopic Surgery Associates Corp. He is active in the Fresno community as a practicing orthopedic surgeon affiliated with Saint Agnes Medical Center, Fresno Surgical Hospital and Summit Surgery Center. Mr. Mochizuki began his medical career and medical business in 1980 as a solo orthopedic surgery practice with two employees. At that time he was responsible for all aspects of the business including insurance contracts, billing, accounts receivable and collections, patient care and all other aspects of operating a service type of business. In 1987 Mr. Mochizuki formed a partnership with another orthopedic surgeon increasing the size of the business to four orthopedic surgeons and thirty employees. In 1997 Mr. Mochizuki again merged businesses to become Orthopedic Associates, the second largest orthopedic practice between Bakersfield and Sacramento, with ten orthopedic surgeons and sixty employees. As CEO of Orthopedic Associates, Mr. Mochizuki was responsible for all aspects of the business including direct supervision of the billing department, insurance contract negotiations, managing cash flow and oversight of the company’s pension plan. During Mr. Mochizuki’s tenure as CEO, Orthopedic Associates acquired an underperforming surgery center, and successfully turned the business around improving the service provided to the local community. Mr. Mochizuki has been involved with real estate development and ownership since 1982 when he invested in two redevelopment projects in Hanford, California. Since that time, Mr. Mochizuki has been involved in a number of real estate development projects in the San Joaquin Valley and Northern California including condominiums, a fast food restaurant, various medical professional office buildings, industrial development and other various lease investments.. Mr. Mochizuki's wide-array of relevant experience in managing and operating different businesses, as well as real estate development and investment, qualifies him for service as a director.
Walter Reinhard
Director since 2001
Mr. Reinhard has lived in Fresno, California for nearly 60 years. He is retired, and formerly the owner and president of Reinhard Cabinet Shop Inc. As owner of Reinhard Cabinet Shop Inc. Mr. Reinhard was involved in the daily operations of the business. Mr. Reinhard's relevant experience as a former owner and operator of Reinhard Cabinet Shop Inc. and understanding of business operations qualifies him for service as a director.
John Terzian
Director since 2001
Mr. Terzian has lived in Fresno, California for nearly 60 years. He was former owner and president of Tollhouse Enterprises, Inc. dba Peacock Market. As the owner of Peacock Market, Mr. Terzian was involved over many years with all aspects of the day-to-day operations of the business including purchasing, inventory control, employee relations, as well as budgeting, cashflow, and financial analysis of the business. He also served on various local and California grocery associations during his career in the grocery industry. He is active in the Fresno community as a volunteer for the American Cancer Society. Mr. Terzian's relevant experience as a former businessman in the grocery industry and his ongoing involvement with rental real estate properties in the Company’s market area qualifies him for service as a director.
Michael Woolf, D.D.S.
Director since 2005
Dr. Woolf has lived in Fresno, California for nearly 45 years where he . He is a dentist. He is active in the Fresno community as a dentist and has been an active farmer for 28 years. Dr. Woolf has been active in the Pistachio farming business since 1985 during which time he developed pistachio production and managed pistachio crop sales for Woolf Enterprises, and started Mike Woolf Farming Company in 2003. Dr. Woolf has had long been involved in the Western Pistachio Association where he been a board member for 18 years, chairman of the board for 16 years, and a Pistachio PAC board member for 10 years. He has been actively involved with various dental societies, including Fresno Madera Dental Society, California Dental Association, American Dental Association, and has been a board member of Fresno Metropolitan Museum Board of Trustees, and Carden Private School. Dr. Woolf's relevant experience as dentist, farmer, and member of various Boards and his understanding of the community qualifies him for service as a director.
Item 24
Certain Transactions
Some of the directors and executive officers of United Security Bancshares and their immediate families, as well as the companies with which they are associated, are customers of, or have had banking transactions with, United Security Bank in the ordinary course of United Security Bank’s business, and United Security Bank expects to have banking transactions with such persons in the future. In management’s opinion, all loans and commitments to lend in such transactions were made in compliance with applicable laws and on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to the lender as those prevailing for comparable transactions with other persons of similar creditworthiness and in the opinion of management did not involve more than a normal risk of collectibility or present other unfavorable features.
The Company maintains written policies and procedures for the review, approval or ratification of transactions with related persons including directors and executive officers. The policies and procedures cover extensions of credit to “Insiders”, defined as an executive officer, director, or principal shareholder and includes any related interest of such a person. The Company’s Credit Administration Department ("CA") is responsible for reviewing and ensuring compliance of all credit granted to Insiders and affiliated organizations. The CA presents all United Security Bank ("Bank") Insider loan requests to the Board of Directors for approval; monitoring outstanding balances; and ensuring that current financial information is maintained in credit files. In granting credit to Insiders, the Bank complies with the Federal Reserve Board Regulation “0” (12 CFR 215).
Extensions of credit to insiders must receive prior approval of a majority of the entire Board of Director's if the extension of credit, when aggregated with other credits to the person and related interest, exceeds the higher of $25,000 or 5% of the Bank's capital and unimpaired surplus. In no event may the Bank extend credit to any insider of the Bank or insider of its affiliates in an amount that, when aggregated with all other extensions of credit to that person, and all related interests of that person exceeds $500,000 except by complying with Regulation (12 CFR 215.4 (B)) through the prior approval by a majority of the Board of Directors and the interested person has abstained from participating directly or indirectly in the voting. Prior approval is not required for each individual advance or loan made pursuant to a line of credit that was the subject of any required Board of Directors approval within 14 months of the date of the making of the individual advance or loan.
Credit extensions to executive officers are prohibited except for:
• Credit in any amount to finance the education of the Officers' children.
• Credit in any amount to finance the purchase, construction, maintenance, or improvement of a residence owned by the Executive officer, provided the credit is secured by a first lien on the residence.
• Credit for any other purpose so long as the aggregate does not exceed 2.5% of the Bank's capital or $25,000. In no event will these credits total over $100,000.
• Extensions of credit to an executive officer and related interests may not exceed 15% for unsecured loans or 25% for secured and unsecured loans of the sum of shareholders' equity, allowance for loan losses, capital notes and debentures of the bank.
• Any extensions of credit to a partnership will be considered an extension of credit to each executive officer who is a member of the partnership. Extensions of credit to a partnership in which one or more executive officers are partners and, either individually or together, hold a majority interest, may not exceed the higher of 2.5% of capital and unimpaired surplus or $25,000 but in no event more than $100,000.