10-K 1 ubfo-12312019x10k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2019.
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM              TO             .
Commission file number: 000-32987
UNITED SECURITY BANCSHARES
(Exact name of registrant as specified in its charter)
CALIFORNIA      
 
91-2112732
(State or other jurisdiction of incorporation or organization)  
 
(I.R.S. Employer Identification No.)
2126 Inyo Street, Fresno, California  
 
93721
(Address of principal executive offices)
 
(Zip Code)
Registrant’s telephone number, including area code    (559) 248-4943
Securities registered pursuant to Section 12(b) of the Act:  Common Stock, no par value    UBFO        Nasdaq
(Title of Class)     (Trading Symbol) (Exchange)
Securities registered pursuant to Section 12(g) of the Act:   NONE
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o  No  x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.
Yes o No  x 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing for the past 90 days.
Yes x  No o 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this form 10-K or any amendment to this Form 10-K. o 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a small reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
 Large accelerated filer o
Accelerated filer x
Non-accelerated filer o
Small reporting company x
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No  x 
Aggregate market value of the Common Stock held by non-affiliates as of the last business day of the registrant's most recently completed second fiscal quarter - June 30, 2019: $152,051,215
Shares outstanding as of January 31, 2020:   16,973,885
DOCUMENTS INCORPORATED BY REFERENCE
The information required by Items 10, 11, 12, 13 and 14 of Part III of this Annual Report on Form 10-K will be found in the Company's definitive proxy statement for its 2020 Annual Meeting of Shareholders, to be filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, and such information is incorporated herein by this reference.

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UNITED SECURITY BANCSHARES
TABLE OF CONTENTS
 
PART I:
 
 
 
 
 
 
 
 
 
 
PART II:
 
 
 
 
Item 6 - Selected Consolidated Financial Data
 
 
 
 
 
 
 
 
PART III:
 
 
 
 
 
 
 
 
 
 
PART IV:
 
 
 

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 PART 1

Certain matters discussed or incorporated by reference in this Annual Report on Form 10-K (this “Report”) including, but not limited to, those described in "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations,” are forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. All statements contained in this Report that are not clearly historical in nature are forward-looking, and the words “anticipate,” “assume,” “intend,” “believe,” “forecast,” “expect,” “estimate,” “plan,” “continue,” “will,” “should,” “look forward” and similar expressions are generally intended to identify forward-looking statements. You should not place undue reliance on these statements as they involve risks, uncertainties and contingencies, many of which are beyond our control, which may cause actual results, performance, or achievements to differ materially from those expressed in them. Actual results could differ materially from those anticipated in such forward-looking statements as a result of risks and uncertainties. Factors that might cause such differences include, but are not limited to:

our ability to compete effectively against other financial service providers in our markets;
the effect of the current low interest rate environment or impact of changes in interest rates or levels of market activity, especially on the fair value of our loan and investment portfolios;
economic deterioration or a recession that may affect the ability of borrowers to make contractual payments on loans and may affect the value of real property or other property held as collateral for such loans;
changes in credit quality and the effect of credit quality on our allowance for loan and lease losses;
our ability to attract and retain deposits and other sources of funding or liquidity;
the need to retain capital for strategic or regulatory reasons;
the impact of the Dodd-Frank Act on our business, business strategies and cost of operations;
compression of the net interest margin due to changes in the interest rate environment, forward yield curves, loan products offered, spreads on newly originated loans and leases and/or asset mix;
reduced demand for our services due to strategic or regulatory reasons;
our ability to successfully execute on initiatives relating to enhancements of our technology infrastructure, including client-facing systems and applications;
legislative or regulatory requirements or changes, including an increase to capital requirements, and increased political and regulatory uncertainty;
the impact on our reputation and business from our interactions with business partners, counterparties, service providers and other third parties;
higher than anticipated increases in operating expenses;
inability for the Bank to pay dividends to the Holding Company;
a deterioration in the overall macroeconomic conditions or the state of the banking industry that could warrant further analysis of the carrying value of goodwill and could result in an adjustment to its carrying value resulting in a non-cash charge;
the effectiveness of our risk management framework and quantitative models;
the costs and effects of legal, compliance, and regulatory actions, changes and developments, including the impact of adverse judgments or settlements in litigation, the initiation and resolution of regulatory or other governmental inquiries or investigations, and/or the results of regulatory examinations or reviews;
the impact of the Tax Cuts and Jobs Act on our business and business strategies, or if other changes are made to tax laws or regulations affecting our business, including the disallowance of tax benefits by tax authorities and/or changes in tax filing jurisdictions or entity classifications; and
our success at managing risks involved in the foregoing items and all other risk factors described in our audited consolidated financial statements, and other risk factors described in this Report and other documents filed or furnished by the Company with the SEC.

Therefore, the information set forth therein should be carefully considered when evaluating the business prospects of the Company.

Item 1 - Business

General

United Security Bancshares is a California corporation incorporated in March 2001 and is registered with the Board of Governors of the Federal Reserve System (the “FRB”) as a bank holding company under the Bank Holding Company Act of 1956, as amended (the “BHCA”). The stock of United Security Bancshares is listed on Nasdaq under the symbol “UBFO.”
   

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United Security Bank was chartered under the laws of the State of California in 1987 as a commercial bank. On June 12, 2001, United Security Bank reorganized into the bank holding company form of ownership and thereby became the wholly-owned subsidiary of United Security Bancshares and each share of United Security Bank stock was exchanged for a share of United Security Bancshares stock on a one-for-one basis. The principal business of United Security Bancshares is to serve as the holding company for United Security Bank.

References to the “Bank” refer to United Security Bank together with its wholly-owned subsidiaries, USB Investment Trust and York Monterey Properties. References to “we,” “us,” or the “Company” refer to United Security Bancshares together with its subsidiaries on a consolidated basis. References to the “Holding Company,” refer to United Security Bancshares, the parent company, on a stand-alone basis.

United Security Bank

The Bank is a California state-chartered bank headquartered in Fresno, California. At December 31, 2019, the Bank operates three branches (including its main office), one construction lending office, and one commercial lending office in Fresno, California and one branch each, in Oakhurst, Caruthers, San Joaquin, Firebaugh, Coalinga, Bakersfield, Taft, and Campbell, California. The Bank has ATMs at all branch locations and off-site ATMs at nine different non-branch locations. In addition, the Holding Company and the Bank have administrative headquarters located at 2126 Inyo Street, Fresno, California, 93721.

USB Investment Trust

USB Investment Trust was incorporated effective December 31, 2001 as a special purpose real estate investment trust (REIT) under Maryland law. The REIT was funded with $133.0 million in real estate-secured loans contributed by the Bank. USB Investment Trust was originally formed to give the Bank flexibility in raising capital, and reduce the expenses associated with holding the assets contributed to the REIT. The REIT also provided state tax benefits beginning in 2002. All of the assets of the REIT have been liquidated and the REIT was dissolved in June 2019.

York Monterey Properties, Inc.

York Monterey Properties, Inc. (“YMP”) was incorporated in California on April 17, 2019, for the purpose of holding specific parcels of real estate acquired by the Bank through, or in lieu of, foreclosures in Monterey County. YMP was funded with a $250,000 investment by the Bank. As of December 31, 2019, certain foreclosed properties, included within the consolidated balance sheets as part of “other real estate owned” or “OREO,” were in the process of being transferred by the Bank to YMP. These properties exceeded the 10-year holding period for OREO.

USB Capital Trust II

During July 2007, the Holding Company formed USB Capital Trust II as a wholly-owned special purpose entity for the purpose of issuing Trust Preferred Securities. USB Capital Trust II is a Variable Interest Entity (VIE) and a deconsolidated entity pursuant to current accounting standards related to variable interest entities. On July 23, 2007, USB Capital Trust II issued $15 million in Trust Preferred Securities. These securities have a thirty-year maturity and bear a floating rate of interest (repricing quarterly) of 1.29% over the three-month LIBOR rate. Interest is payable quarterly. Concurrent with the issuance of the Trust Preferred Securities, USB Capital Trust II used the proceeds of the Trust Preferred Securities offering to purchase a like amount of junior subordinated debentures issued by the Holding Company. The Holding Company pays interest on the junior subordinated debentures to USB Capital Trust II, which represents the sole source of dividend distributions to the holders of the Trust Preferred Securities. During 2015, $3.0 million of the $15.0 million principal balance of the subordinated debentures related to the Trust Preferred Securities was purchased by the Bank and subsequently purchased by the Company from the Bank. The Company redeemed the $3.0 million in par value of the subordinated debentures, resulting in a remaining contractual principal balance of $12.0 million since year-end 2015. The Company may redeem the junior subordinated debentures at any time at par.

The following discussion of services should be read in conjunction with "Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS."

Bank Services

The Bank offers a full range of commercial banking services primarily to the business and professional community and individuals located in Fresno, Madera, Kern, and Santa Clara Counties, including a variety of deposit instruments including personal and business checking accounts and savings accounts, interest-bearing negotiable order of withdrawal (NOW)

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accounts, money market accounts and time certificates of deposit. Most deposits are comprised of accounts from individuals and from small- and medium-sized business-related sources. Time deposits have provided a significant portion of the Bank’s deposit base amounting to 7.99% and 10.23% of total deposits at December 31, 2019 and 2018, respectively.

The Bank also offers a full complement of lending activities, including real estate mortgage (48.8% of total loans at December 31, 2019), commercial and industrial (7.6% of total loans at December 31, 2019), real estate construction (23.2% of total loans at December 31, 2019), as well as agricultural (8.7% of total loans at December 31, 2019), and installment loans (11.7% of total loans at December 31, 2019). Approximately 72.0% of the Bank's loans are secured by real estate at December 31, 2019. 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, 2019, the Bank had total loans (net of unearned fees) outstanding of $596,554,000, which represented approximately 72.9% of total deposits and approximately 62.3% of total assets.
 
Real estate mortgage loans are secured by deeds of trust primarily on commercial property. The repayment of real estate mortgage loans generally is from the cash flow of the borrower. Commercial and industrial loans are diversified by industry. Loans may be originated in the Bank's market area, or participated with other financial institutions outside the market area. A substantial portion of commercial and industrial loans are secured by accounts receivable, inventory, leases or other collateral. The remainder are unsecured. However, extensions of credit are predicated on the financial capacity of the borrower to repay. Repayment of commercial loans is generally from the cash flow of the borrower. Real estate construction loans consist of loans to residential contractors, which are secured by single-family residential properties. All real estate loans have established equity requirements. The repayment of real estate construction loans is generally from long-term mortgages with other lending institutions. Agricultural loans are generally secured by land, equipment, inventory and receivables. Repayment of agricultural loans is generally from the expected cash flow of the borrower.

Although we have a high concentration of commercial real estate loans, we are not in the business of making residential mortgage loans to individuals. Residential mortgage loans totaled $45,881,000, or 7.68% of the portfolio at December 31, 2019. The residential mortgage loan portfolio is primarily comprised of purchased residential mortgage pools. We do not originate, or have in the loan portfolio, any subprime, Alt-A, or option adjustable rate loans. We do originate interest-only loans which are generally revolving lines of credit to commercial and agricultural businesses or for real estate development where the borrowers business may be seasonal or cash flows may be restricted until the completion of the project. In addition, we have restructured certain loans to allow the borrower to continue to perform on the loan under a troubled debt restructuring plan.

We purchase loan participations from, and sell loan participations to, other financial institutions. The underwriting standards for loan participations or purchases are the same as non-participated loans, and are subject to the same limitations, collateral requirements, and borrower requirements. As of December 31, 2019, purchased participation loans totaled $5,955,000. There were no purchased loan participations held at December 31, 2018. Loan participations sold comprised 0.8% and 1.2% of the total loan portfolio at December 31, 2019 and 2018, respectively.

In the normal course of business, we make various loan commitments, including granting customers collateralized and uncollateralized lines of credit, and incur certain contingent liabilities. Due to the nature of the business of the Bank's customers, there is no absolute predictability to the utilization of unused loan commitments, including collateralized and uncollateralized lines of credit, and, therefore, we are unable to forecast the extent to which these commitments will be exercised within the current year. Although we can provide no assurances, we do not believe that any such utilization will constitute a material liquidity demand.

In addition to the loan and deposit services discussed above we also offer a wide range of specialized services designed to attract and service the needs of commercial customers and account holders. These services include online banking, mobile banking, safe deposit boxes, Interactive (Virtual) Teller "ITM" services, ATM services, payroll direct deposit, cashier's checks, and cash management services. We do not operate a trust department; however, we make arrangements with correspondent banks to offer trust services to customers upon request. Most business originates within Fresno, Madera, Kern, and Santa Clara Counties.
 
Competition and Market Share

The banking business in California generally, and in the market areas we serve specifically, is highly competitive with respect to both loans and deposits. We compete for loans and deposits with other commercial banks, savings and loan associations, money market funds, credit unions, and other financial institutions, including a number that are substantially larger than us. We compete for loans and deposits by offering competitive interest rates and by seeking to provide a higher level of personalized

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service than is generally offered by larger competitors. Regulatory restrictions on interstate bank branching and acquisitions and on banks providing a broader array of financial services, such as securities underwriting and insurance, have been reduced or eliminated. The availability of banking services over the Internet and on mobile devices continues to expand. Changes in laws and regulations governing the financial services industry cannot be predicted; however, past legislation has served to intensify the competitive environment. Many of the major commercial banks operating in the Bank's market areas offer certain services such as trust and international banking services, which we do not offer directly. In addition, banks with larger capitalization have larger lending limits and are thereby able to serve larger customers.

The primary market area at December 31, 2019 was located in Fresno, Madera, and Kern Counties, within California, in which 27 FDIC-insured financial institutions compete for business. Santa Clara County was added during February 2007, with the Legacy Bank acquisition, in which 48 FDIC-insured financial institutions compete for business. The following table sets forth information regarding deposit market share and ranking by county as of June 30, 2019, which is the most current information available.
 
Rank
Share
Fresno County
7th
4.81%
Madera County
6th
6.83%
Kern County
14th
0.89%
Total of Fresno, Madera, Kern Counties
7th
3.44%
Santa Clara County
46th
0.01%

Supervision and Regulation

Introduction        

Banking is a complex, highly regulated industry. Federal and state laws and the regulations of the federal and state bank regulatory agencies govern most aspects of a bank’s business, including capital adequacy ratios, reserves against deposits, limitations on the nature and amount of loans which may be made, the location of branch offices, borrowings, and dividends. The primary goals of the regulatory scheme are to maintain a safe and sound banking system, protect depositors and the FDIC’s insurance fund, and facilitate the conduct of sound monetary policy. In furtherance of these goals, Congress and the states have created several largely autonomous regulatory agencies and enacted numerous laws that govern banks, bank holding companies and the financial services industry. Consequently, the growth and earnings performance of the Company and the Bank can be affected not only by management decisions and general economic conditions, but also by the requirements of applicable state and federal statutes, regulations and the policies of various governmental regulatory authorities, including:

the Federal Deposit Insurance Corporation, or FDIC;
the California Department of Business Oversight, or CDBO; and
the Federal Reserve Board, or FRB.

Moreover, changes in applicable law or regulations, and in their application by the regulatory agencies, whether as the result of changes in the political climate or otherwise, cannot be predicted and may have a material effect on the business, operations, and financial results of the Company or the Bank.

Described below are elements of selected laws and regulations applicable to the Company and/or the Bank. The descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations described.

Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), significantly revised and expanded the rulemaking, supervisory and enforcement authority of the federal bank regulatory agencies. The numerous rules and regulations being promulgated pursuant to the Dodd-Frank Act are impacting banks’ operations and compliance costs. Certain provisions of the Dodd-Frank Act include: revisions in the deposit insurance assessment base for FDIC insurance and the permanent increase in deposit insurance coverage to $250,000; reduced interchange fees on debit card transactions; the permissibility of paying interest on business checking accounts; the removal of barriers to interstate branching; and required disclosure and shareholder advisory votes on executive compensation. Some of the other provisions

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of the Dodd-Frank Act that affect banks are the following:

Capital Requirements. The Dodd-Frank Act: increased the minimum Tier 1 capital ratio from 4.00% to 6.00% of risk-weighted assets; created a new category and required 4.50% of risk-weighted assets ratio for “common equity Tier 1” as a subset of Tier 1 capital limited to common equity; established a minimum non-risk-based leverage ratio set at 4.00%, eliminating a 3.00% exception for higher rated banks; changed the permitted composition of Tier 1 capital to exclude trust preferred securities (unless issued prior to May 19, 2010 by a bank holding company with less than $15 billion in assets), mortgage servicing rights and certain deferred tax assets and included unrealized gains and losses on available for sale debt and equity securities; added an additional capital conservation buffer of 2.5% of risk-weighted assets over each of the required capital ratios, which must be met to avoid limitations on the ability to pay dividends, repurchase shares or pay discretionary bonuses; changed the risk weights of certain assets for purposes of calculating the risk-based capital ratios for high volatility commercial real estate acquisition, development and construction loans, certain past due non-residential mortgage loans and certain mortgage-backed and other securities exposures.
Deposit Insurance. The Dodd-Frank Act broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution. The Dodd-Frank Act requires the FDIC to increase the reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits by 2020 and eliminates the requirement that the FDIC pay dividends to insured depository institutions when the reserve ratio exceeds certain thresholds.
Corporate Governance. The Dodd-Frank Act directed the federal banking regulators to promulgate rules prohibiting excessive compensation paid to executives of depository institutions and their holding companies with assets in excess of $1.0 billion.
Interstate Branching. The Dodd-Frank Act authorized national and state banks to establish branches in other states to the same extent as a bank chartered by that state would be permitted to branch.
Consumer Financial Protection Bureau. The Dodd-Frank Act created an independent federal agency called the Consumer Financial Protection Bureau (the "CFPB"), which has been granted broad rulemaking, supervisory, and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the Consumer Financial Privacy provisions of the GLBA, and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion or more in assets. Smaller institutions are subject to rules promulgated by the CFPB but are still examined and supervised by their federal banking regulators for consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. The Dodd-Frank Act authorized the CFPB to establish certain minimum standards for the origination of residential mortgages including a determination of the borrower's ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan other than a "qualified mortgage" as defined by the CFPB. The Dodd- Frank Act permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws and regulations.
Final Volcker Rule. In December 2013, the federal bank regulatory agencies adopted final rules that implement a part of the Dodd-Frank Act commonly referred to as the "Volcker Rule." The final rules were amended in August 2019. Under these rules and subject to certain exceptions, banking entities, including the Bank, will be restricted from engaging in activities that are considered proprietary trading and from sponsoring or investing in certain entities, including hedge or private equity funds that are considered "covered funds." Banks that do not have significant trading activities, such as the Bank, will be assumed to operate under a presumption of compliance.

The Dodd-Frank Act was enacted under the administration of former President Barack Obama and many of the rules and regulations implementing the provisions of the Dodd-Frank Act were enacted during that administration. The current administration under President Donald Trump has sought to roll-back key pieces of the Dodd-Frank Act in an effort to loosen regulatory restrictions on financial institutions including, but not limited to, easing the “Volker Rule,” stress tests, and other constraints on financial institutions. Federal banking regulators are currently seeking public input on revisions to key provisions of the Dodd-Frank Act and its implementing regulations in order to effectuate the current Administration’s initiatives of continued financial deregulation. In light of the current administration’s continuing efforts in this regard, the Company cannot predict which provisions of the Dodd-Frank Act will be repealed, put in to effect, delayed, or enforced under the current administration and, therefore, cannot predict the effect, if any,

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that the Dodd-Frank Act will have on its future results of operations and financial condition.

The Holding Company

General

The Holding Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, as amended, and is registered with, and regulated and examined by, the Board of Governors of the Federal Reserve System, or FRB. The Holding Company is also subject to regulation by the Securities and Exchange Commission ("SEC") and to the disclosure and regulatory requirements of the Securities Act of 1933, as amended (the "Securities Act"), and the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and through the listing of its common stock on Nasdaq, the Holding Company is subject to the listing standards and rules of Nasdaq.

Source of Strength

The Dodd-Frank Act codified existing FRB policy requiring the Holding Company to act as a source of financial strength to the Bank, and to commit resources to support the Bank in circumstances where it might not otherwise do so. However, because the Gramm-Leach-Bliley Act (“GLBA”) provides for functional regulation of financial holding company activities by various regulators, the GLBA prohibits the FRB from requiring payment by a holding company to a depository institution if the functional regulator of the depository institution objects to the payment. In those cases, the FRB could instead require the divestiture of the depository institution and impose operating restrictions pending the divestiture. As a result of the Dodd-Frank Act, non-bank subsidiaries of a holding company that engage in activities permissible for an insured depository institution must be examined and regulated in a manner that are at least as stringent as if the activities were conducted by the lead depository institution of the holding company.

Bank Holding Company Liquidity

As a legal entity, separate and distinct from the Bank, the Holding Company must rely on its own resources to pay its operating expenses and dividends to its shareholders. In addition to raising capital on its own behalf or borrowing from external sources, the Holding Company may also obtain funds from dividends paid by, and fees charged for services provided to, the Bank. However, statutory and regulatory constraints on the Bank may restrict or totally preclude the payment of dividends by the Bank to the Holding Company.

Transactions with Affiliates and Insiders

The Holding Company and any subsidiaries it may purchase or organize are deemed to be affiliates of the Bank within the meaning of Sections 23A and 23B of the Federal Reserve Act, and the FRB's Regulation W. Under Sections 23A and 23B and Regulation W, loans by the Bank to affiliates, investments by them in affiliates' stock, and taking affiliates' stock as collateral for loans to any borrower is limited to 10% of the Bank's capital, in the case of any one affiliate, and is limited to 20% of the Bank's capital, in the case of all affiliates. In addition, transactions between the Bank and any affiliates must be on terms and conditions that are consistent with safe and sound banking practices and substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving nonaffiliates. In particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act. These restrictions also prevent a bank holding company and a bank subsidiary’s other affiliates from borrowing from the bank subsidiary unless the loans are secured by marketable collateral of designated amounts.
 
The Holding Company and the Bank are also subject to certain restrictions with respect to engaging in the underwriting, public sale and distribution of securities.

The Federal Reserve Act and FRB Regulation O place limitations and conditions on loans or extensions of credit to a bank or bank holding company’s executive officers, directors and principal shareholders; any company controlled by any such executive officer, director or shareholder; or any political or campaign committee controlled by such executive officer, director or principal shareholder. Additionally, such loans or extensions of credit must comply with loan-to-one-borrower limits; require prior full board approval when aggregate extensions of credit to the person exceed specified amounts; must be made on substantially the same and follow credit-underwriting procedures no less stringent than those prevailing at the time for comparable transactions with non-insiders; must not involve more than the normal risk of repayment or present other unfavorable features; and must not exceed the bank’s unimpaired capital and unimpaired surplus in the aggregate.

Limitations on Business and Investment Activities

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Under the BHCA, a bank holding company must obtain the FRB’s approval before: (i) directly or indirectly acquiring more than 5% ownership or control of any voting shares of another bank or bank holding company; (ii) acquiring all or substantially all of the assets of another bank; (iii) or merging or consolidating with another bank holding company.

The FRB may allow a bank holding company to acquire banks located in any state of the United States without regard to whether the acquisition is prohibited by the law of the state in which the target bank is located. In approving interstate acquisitions, however, the FRB must give effect to applicable state laws limiting the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institutions in the state in which the target bank is located, provided that those limits do not discriminate against out-of-state depository institutions or their holding companies, and state laws which require that the target bank have been in existence for a minimum period of time, not to exceed five years, before being acquired by an out-of-state bank holding company.

In addition to owning or managing banks, bank holding companies may own subsidiaries engaged in certain businesses that the FRB has determined to be “so closely related to banking as to be a proper incident thereto.” The Holding Company, therefore, is permitted to engage in a variety of banking-related businesses.

Additionally, qualifying bank holding companies making an appropriate election to the FRB may engage in a full range of financial activities, including insurance, securities, and merchant banking. The Holding Company has not elected to qualify for these financial services.

Federal law prohibits a bank holding company and any subsidiary banks from engaging in certain tie-in arrangements in connection with the extension of credit. Thus, for example, the Bank may not extend credit, lease or sell property, or furnish any services, or fix or vary the consideration for any of the foregoing on the condition that:

the customer must obtain or provide some additional credit, property, or services from or to the Bank other than a loan, discount, deposit or trust services;
the customer must obtain or provide some additional credit, property, or service from or to the Holding Company or any subsidiaries; or
the customer must not obtain some other credit, property, or services from competitors, except reasonable requirements to assure soundness of credit extended.

Capital Adequacy

Bank holding companies must maintain minimum levels of capital under the FRB’s risk-based capital adequacy guidelines. If capital falls below minimum guideline levels, a bank holding company, among other things, may be denied approval to acquire or establish additional banks or non-bank businesses.

The FRB’s risk-based capital adequacy guidelines, discussed in more detail below in the section entitled “The Bank - Capital Standards,” assign various risk percentages or weights to different categories of assets and capital is measured as a percentage of risk-weighted assets. Under the terms of the guidelines, bank holding companies are expected to meet capital adequacy guidelines based both on total risk-weighted assets and on total assets, without regard to risk weights.

The risk-based guidelines are minimum requirements. Higher capital levels will be required if warranted by the particular circumstances or risk profiles of individual organizations. For example, the FRB’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Moreover, any banking organization experiencing or anticipating significant growth or expansion into new activities, particularly under the expanded powers under the Gramm-Leach-Bliley Act, would be expected to maintain capital ratios, including tangible capital positions, well above the minimum levels.

Limitations on Dividend Payments

As applicable to the Holding Company, California Corporations Code Section 500 provides that neither the Holding Company nor any of its subsidiaries shall make a distribution to the Holding Company’s shareholders unless the board of directors has determined in good faith that either:

The amount of retained earnings of the Holding Company immediately prior to the distribution equals or exceeds the sum of (A) the amount of the proposed distribution plus (B) the preferential dividends arrears amount; or

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Immediately after the distribution, the value of the Holding Company's assets would equal or exceed the sum of its total liabilities plus the preferential rights amount.

Additionally, the FRB’s policy regarding dividends provides that a bank holding company should not pay cash dividends exceeding its net income for the past year or which can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The FRB also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations.

Securities Registration and Listing

The Company's common stock is registered with the SEC under the Exchange Act and, as a result, we are subject to the information, proxy solicitation, insider trading, corporate governance, and other disclosure requirements and restrictions of the Exchange Act, as well as the Securities Act, both administered by the SEC. We are required to file annual, quarterly and other current reports with the SEC. The SEC maintains an Internet site, http://www.sec.gov, where SEC filings may be accessed. The SEC filings are also available on the Bank's website at http://investors.unitedsecuritybank.com/Docs.

Our common stock is listed on Nasdaq and trades under the symbol “UBFO.” As a company listed on Nasdaq, the Company is subject to Nasdaq standards for listed companies. Nasdaq has also adopted corporate governance rules, which are intended to allow shareholders and investors to more easily and efficiently monitor the performance of companies and their directors.

The Bank

General

As a California state-chartered bank and a member of the FRB, the Bank is subject to regulation, supervision and regular examination by the FRB and the DBO. The Bank is subject to California laws insofar as they are not preempted by federal banking law. Deposits of the Bank are insured by the FDIC up to the applicable limits in an amount up to $250,000 per customer and, as such, the Bank is subject to the applicable provisions of the Federal Deposit Insurance Act and the regulations of the FDIC. As a consequence of the extensive regulation of commercial banking activities in California and the United States, the Bank’s business is particularly susceptible to changes in California and federal legislation and regulation, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition.

Capital Standards

Federal regulations require FDIC-insured depository institutions, including the Bank, to meet several minimum capital standards: a common equity tier 1 capital to risk-based assets ratio; a tier 1 capital to risk-based assets ratio; a total capital to risk-based assets; and a tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.

The capital standards require the maintenance of common equity tier 1 capital, tier 1 capital and total capital to risk-weighted assets of at least 4.5%, 6% and 8%, respectively. The regulations also establish a minimum required leverage ratio of at least 4%. Common equity tier 1 capital is generally defined as common stockholders' equity and retained earnings. Tier 1 capital is generally defined as common equity tier 1 capital and additional tier 1 capital. Additional tier 1 capital generally includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes tier 1 capital (common equity tier 1 capital plus additional tier 1 capital) and tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of accumulated other comprehensive income ("AOCI"), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity tier 1 capital (including unrealized gains and losses on available-for-sale-securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, an institution's

10


assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests), are multiplied by a risk weight factor assigned by the regulations based on the risk deemed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned to cash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one to four-family residential mortgages, a risk weight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% is assigned to permissible equity interests, depending on certain specified factors.

The federal banking agencies recently adopted a final rule, that will become effective April 1, 2020, that is designed to simplify several of the requirements of the regulatory capital rules, such as simplifying the treatment of mortgage servicing assets and certain deferred tax assets.

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a "capital conservation buffer" consisting of 2.5% of common equity tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements. Institutions that do not maintain the required capital buffer will become subject to progressively most stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to executive management.

The following table sets forth the regulatory capital requirements for “adequately capitalized” and “well capitalized” institutions:
 
Adequately Capitalized
Well
Capitalized
Total risk-based capital
8.00%
10.00%
Tier 1 risk-based capital ratio
6.00%
8.00%
Common Equity Tier 1
4.50%
6.50%
Tier 1 leverage capital ratio
4.00%
5.00%

As of December 31, 2019, the Company and the Bank were "well-capitalized" under these capital standards. The actual capitalization raitos for the Bank and the Company as of December 31, 2019 are set forth under the section entitled “MANAGEMENT’S DISCUSSION AND ANALYSIS OF OPERATIONS - Regulatory Matters - Capital Adequacy.”

Prompt Corrective Action

The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires each federal banking agency to take prompt corrective action to resolve the problems of insured depository institutions, including but not limited to those that fall below one or more prescribed minimum capital ratios. Pursuant to FDICIA, the FRB promulgated regulations defining the following five categories in which an insured depository institution will be placed, based on the level of its capital ratios:

Under the regulations, a bank shall be deemed to be:

“well capitalized” if it has a total risk-based capital ratio of 10% or more, has a Tier 1 risk-based capital ratio of 8% or more, has a common equity Tier 1 capital ratio of 6.5% or more, has a Tier 1 leverage capital ratio of 5% or more, and is not subject to specified requirements to meet and maintain a specific capital level for any capital measure;
“adequately capitalized” if it has a total risk-based capital ratio of 8% or more, a Tier 1 risk-based capital ratio of 6% or more and a leverage capital ratio of 4% or more (3% under certain circumstances) and does not meet the definition of “well capitalized”;
“undercapitalized” if it has a total risk-based capital ratio that is less than 8%, a Tier 1 risk-based capital ratio that is less than 4%, or a leverage capital ratio that is less than 4% (3% under certain circumstances);
“significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital ratio that is less than 3% or a leverage capital ratio that is less than 3%; and
“critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2%.

A bank’s category is determined solely for the purpose of applying prompt corrective action regulations, and the capital category may not constitute an accurate representation of the bank’s overall financial condition or prospects for other purposes.

11



While these benchmarks have not changed, due to market turbulence, the regulators have strongly encouraged and, in many instances, required, banks and bank holding companies to achieve and maintain higher ratios as a matter of safety and soundness.

Banks are prohibited from paying dividends or management fees to controlling persons or entities if, after making the payment, the bank would be “undercapitalized,” that is, the bank fails to meet the required minimum level for any relevant capital measure. Asset growth and branching restrictions apply to “undercapitalized” banks. Banks classified as “undercapitalized” are required to submit acceptable capital plans guaranteed by its holding company, if any. Broad regulatory authority was granted with respect to “significantly undercapitalized” banks, including forced mergers, growth restrictions, ordering new elections for directors, forcing divestiture by its holding company, if any, requiring management changes, and prohibiting the payment of bonuses to senior management. Even more severe restrictions are applicable to “critically undercapitalized” banks. Restrictions for these banks include the appointment of a receiver or conservator. All of the federal banking agencies have promulgated substantially similar regulations to implement this system of prompt corrective action.

A bank, based upon its capital levels, that is classified as “well capitalized,” “adequately capitalized” or “undercapitalized” may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for a hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. Further, a bank that otherwise meets the capital levels to be categorized as “well capitalized,” will be deemed to be “adequately capitalized,” if the bank is subject to a written agreement requiring that the bank maintain specific capital levels. At each successive lower capital category, an insured bank is subject to more restrictions. The federal banking agencies, however, may not treat an institution as “critically undercapitalized” unless its capital ratios actually warrant such treatment.

In addition to measures taken under the prompt corrective action provisions, commercial banking organizations, such as the Bank, may be subject to potential enforcement actions by the federal or state banking agencies for unsafe or unsound practices in conducting their businesses or for violations of any law, rule, regulation or any condition imposed in writing by the agency or any written agreement with the agency. Enforcement actions may include the imposition of a conservator or receiver, the issuance of a cease‑and‑desist order that can be judicially enforced, the termination of insurance for deposits (in the case of a depository institution), the imposition of civil money penalties, the issuance of directives to increase capital, the issuance of formal and informal agreements, and the issuance of removal and prohibition orders against institution‑affiliated parties.

Brokered Deposit Restrictions

Well-capitalized institutions are not subject to limitations on brokered deposits, while an adequately capitalized institution is able to accept, renew or roll over brokered deposits only with a waiver from the FDIC and subject to certain restrictions on the rate paid on such deposits. Undercapitalized institutions are generally not permitted to accept, renew, or roll over brokered deposits. As of December 31, 2019, the Bank was deemed to be “well-capitalized” and, therefore, eligible to accept brokered deposits.

Limitations on Dividend Payments

California law restricts the amount available for cash dividends the Bank may pay to the Holding Company.. Under California law, funds available for cash dividend payments by a bank are restricted to the lesser of: (1) retained earnings; or (2) the bank’s net income for its last three fiscal years (less any distributions to shareholders made during such period). Cash dividends may also be paid out of the greater of: (i) net income for a bank’s last preceding fiscal year; (ii) a bank’s retained earnings; or (iii) net income for a bank’s current fiscal year, upon the prior approval of the DBO. If the DBO finds that the stockholders’ equity of a bank is not adequate or that the payment of a dividend would be unsafe or unsound for the bank, the DBO may order the bank not to pay any dividends.

Premiums for Deposit Insurance

The FDIC insures deposits up to $250,000 per qualified account. The FDIC utilizes a risk-based assessment system to set quarterly insurance premium assessments which categorizes banks into four risk categories based on capital levels and supervisory “CAMELS” ratings and names them Risk Categories I, II, III and IV. The CAMELS rating system is based upon an evaluation of the six critical elements of an institution’s operations: Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to risk. This rating system is designed to take into account and reflect all significant financial and operational factors financial institution examiners assess in their evaluation of an institution’s performance.


12


The Dodd-Frank Act requires the FDIC to take such steps as necessary to increase the reserve ratio of the FDIC’s deposit insurance fund from 1.15% to 1.35% of insured deposits by 2020. In setting the assessments, the FDIC is required to offset the effect of the higher reserve ratio against insured depository institutions with total consolidated assets of less than $10 billion. the Dodd-Frank Act also broadens the base for FDIC insurance assessments so that assessments will be based on the average consolidated total assets less average tangible equity capital of a financial institution rather than on its insured deposits. The FDIC has adopted a new restoration plan to increase the reserve ratio to 1.35% by September 30, 2020 and will issue additional rules regarding the method to be used to achieve a 1.35% reserve ratio by that date and offset the effect on institutions with assets less than $10 billion in assets.

The FDIC is authorized to terminate a depository institution’s deposit insurance upon a finding by the FDIC that the institution’s financial condition is unsafe or unsound or that the institution has engaged in unsafe or unsound practices or has violated any applicable rule, regulation, order or condition enacted or imposed by the institution’s regulatory agency. The termination of deposit insurance would result in the forced closure of the Bank which would have a material adverse effect on the Company’s business, financial condition, and results of operations.

Safety and Soundness Standards

The federal banking agencies have adopted guidelines designed to assist the federal banking agencies in identifying and addressing potential safety and soundness concerns before capital becomes impaired. The guidelines set forth operational and managerial standards relating to: (i) internal controls, information systems and internal audit systems; (ii) loan documentation; (iii) credit underwriting; (iv) asset growth; (v) earnings; and (vi) compensation, fees and benefits. In addition, the federal banking agencies have also adopted safety and soundness guidelines with respect to asset quality and earnings standards. These guidelines provide nine standards for establishing and maintaining a system to identify problem assets and prevent those assets from deteriorating.

Federal Home Loan Bank System

The Bank is a member of the Federal Home Loan Bank of San Francisco (the “FHLB-SF”).  Among other benefits, each Federal Home Loan Bank (“FHLB”) serves as a reserve or central bank for its members within its assigned region.  Each FHLB is financed primarily from the sale of consolidated obligations of the FHLB system.  Each FHLB makes available loans or advances to its members in compliance with the policies and procedures established by the Board of Directors of the individual FHLB. The FHLB-SF utilizes a single class of stock with a par value of $100 per share, which may be issued, exchanged, redeemed and repurchased only at par value. As an FHLB member, the Bank is required to own FHLB –SF capital stock in an amount equal to the greater of:

a membership stock requirement with an initial cap of $25 million (100% of “membership asset value” as defined), or
an activity based stock requirement (based on percentage of outstanding advances).

The FHLB – SF capital stock is redeemable on five years' written notice, subject to certain conditions. At December 31, 2019 the Bank owned 28,598 shares of the FHLB-SF capital stock.

Federal Reserve Bank

The FRB requires all depository institutions to maintain non-interest bearing reserves at specified levels against their transaction accounts and non-personal time deposits.  At December 31, 2019, the Bank was in compliance with these requirements.

Consumer Regulation

We are subject to a number of federal and state consumer protection laws that extensively govern relationships with customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act, and these laws’ respective state-law counterparts, as well as state usury laws and laws regarding unfair and deceptive acts and practices. Violations of applicable consumer protection laws can result in significant potential liability from litigation brought by customers, including actual damages, restitution and attorneys’ fees. Federal bank regulators, state attorneys general and state and local consumer protection agencies may also seek to enforce consumer protection requirements and obtain these and other remedies, including regulatory sanctions, customer rescission rights, action by the state and local attorneys general in each jurisdiction in which we operate, and civil money penalties. Failure to comply with consumer protection regulations may result in the failure to obtain required bank regulatory approval for merger or acquisition transactions or other transactions where approval is not required.

13



The Consumer Financial Protection Bureau ("CFPB") has broad rulemaking, supervisory, and enforcement powers under various federal consumer financial protection laws. The CFPB is also authorized to engage in consumer financial education, track consumer complaints, request data, and promote the availability of financial services to underserved consumers and communities. The Bank is subject to direct oversight and examination by the CFPB. The CFPB has broad supervisory, examination, and enforcement authority over various consumer financial products and services, including the ability to require reimbursements and other payments to customers for alleged legal violations and to impose significant penalties, as well as injunctive relief that prohibits lenders from engaging in allegedly unlawful practices. The CFPB also has the authority to obtain cease and desist orders providing for affirmative relief or monetary penalties. State regulation of financial products and potential enforcement actions could also adversely affect business, financial condition, or results of operations. For example, California’s governor has recently proposed changing the title of the Department of Business Oversight to the Department of Financial Protection and Innovation and restructuring and expanding its authority to have an increased emphasis on consumer protection that many view as an effort to create a state-run equivalent of the CFPB.

USA PATRIOT Act and Anti-Money Laundering

The PATRIOT Act, designed to deny terrorists and others the ability to obtain access to the United States financial system, has significant implications for depository institutions, brokers, dealers, and other businesses involved in the transfer of money. The PATRIOT Act, as implemented by various federal regulatory agencies, requires the Company and the Bank to establish and implement policies and procedures with respect to, among other matters, anti‑money laundering, compliance, suspicious activity and currency transaction reporting and due diligence on customers and prospective customers. The PATRIOT Act and its underlying regulations permit information sharing for counter‑terrorist purposes between federal law enforcement agencies and financial institutions, as well as among financial institutions, subject to certain conditions, and require the FRB, the FDIC and other federal banking agencies to evaluate the effectiveness of an applicant in combating money laundering activities when considering a bank holding company acquisition and/or a bank merger.
 
We regularly evaluate and continue to enhance the systems and procedures to continue to comply with the PATRIOT Act and other anti‑money laundering initiatives. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal, strategic, and reputational consequences for the institution and result in material fines and sanctions.

Office of Foreign Assets Control ("OFAC") Regulation

The United States has imposed economic sanctions that affect transactions with designated foreign countries, designated nationals, and others. These rules are based on their administration by OFAC. The OFAC‑administered sanctions targeting designated countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment‑related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off, or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal, strategic, and reputational consequences, and result in civil money penalties on the Company and the Bank.

Community Reinvestment Act

The Community Reinvestment Act (the “CRA”) generally requires the Bank to identify the communities it serves and to make loans and investments, offer products, make donations in, and provide services designed to meet the credit needs of these communities. The CRA also requires the Bank to maintain comprehensive records of its CRA activities to demonstrate how we are meeting the credit needs of the Bank's communities. These documents are subject to periodic examination by the FRB. During these examinations, the FRB rates such institutions’ compliance with CRA as “Outstanding,” “Satisfactory,” “Needs to Improve” or “Substantial Noncompliance.” The CRA requires the FRB to take into account the record of a bank in meeting the credit needs of all of the communities served, including low‑and moderate‑income neighborhoods, in determining such rating. Failure of an institution to receive at least a “Satisfactory” rating could inhibit such institution or its holding company from undertaking certain activities, including acquisitions. The Bank received a CRA rating of “Satisfactory” as of its most recent examination. In the case of a bank holding company, such as the Company, when applying to acquire a bank, savings association, or a bank holding company, the FRB will assess the CRA record of each depository institution of the applicant bank holding company in considering the application.

14



Customer Information Privacy and Cybersecurity

The FRB and other bank regulatory agencies have adopted guidelines for safeguarding confidential, personal, and non‑public customer information. These guidelines require each financial institution, under the supervision and ongoing oversight of its board of directors or an appropriate committee thereof, to create, implement, and maintain a comprehensive written information security program designed to ensure the security and confidentiality of customer information, protect against any anticipated threats or hazard to the security or integrity of such information, and protect against unauthorized access to or use of such information that could result in substantial harm or inconvenience to any customer. We have adopted a customer information security program to comply with these requirements.

In March 2015, federal regulators issued two related statements regarding cybersecurity. One statement indicates that financial institutions should design multiple layers of security controls to establish lines of defense and to ensure that their risk management processes also address the risk posed by compromised customer credentials, including security measures to reliably authenticate customers accessing Internet-based services of the financial institution. The other statement indicates that a financial institution’s management is expected to maintain sufficient business continuity planning processes to ensure the rapid recovery, resumption and maintenance of the institution’s operations after a cyber-attack involving destructive malware. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations and address rebuilding network capabilities and restoring data if the institution or its critical service providers fall victim to this type of cyber-attack. If we fail to observe the regulatory guidance, we could be subject to various regulatory sanctions, including financial penalties.

Privacy

The GLBA and the California Financial Information Privacy Act require financial institutions to implement policies and procedures regarding the disclosure of non-public personal information about consumers to non‑affiliated third parties. In general, the statutes require disclosures to consumers on policies and procedures regarding the disclosure of such non-public personal information and, except as otherwise required by law, prohibit disclosing such information except as provided in the Bank’s policies and procedures. We have implemented privacy policies addressing these restrictions that are distributed regularly to all existing and new customers of the Bank.

Other Aspects of Banking Law

The Bank is subject to federal statutory and regulatory provisions covering, among other things, security procedures, management interlocks, funds availability and truth-in-savings. There are also a variety of federal statutes that regulate acquisitions of control and the formation of bank holding companies, and the activities beyond owning banks that are permissible.

Moreover, additional initiatives may be proposed or introduced before Congress, the California Legislature, and other government bodies in the future which, if enacted, may further alter the structure, regulation, and competitive relationship among financial institutions and may subject the bank holding companies and banks to increased supervision and disclosure, compliance costs and reporting requirements. In addition, the various bank regulatory agencies often adopt new rules and regulations and policies to implement and enforce existing legislation. Bank regulatory agencies have been very aggressive in responding to concerns and trends identified in examinations, and this has resulted in the increased issuance of enforcement actions to financial institutions requiring action to address credit quality, liquidity and risk management, capital adequacy, compliance with Bank Secrecy Act, as well as other safety and soundness concerns.

It cannot be predicted whether, or in what form, any such legislation or regulatory changes in policy may be enacted or the extent to which the Bank’s businesses would be affected thereby. In addition, the outcome of examinations, any litigation, or any investigations initiated by state or federal authorities may result in necessary changes in the Bank’s operations and increased compliance costs. 

Employees

At December 31, 2019, the Company employed 119 persons on a full-time equivalent basis. The Company believes its employee relations are excellent.

Available Information

15



The Company files periodic reports and other reports under the Securities Exchange Act of 1934 with the Securities and Exchange Commission. These reports, as well as the Company’s Code of Ethics, are posted and are available at no cost on the Company’s website at http://www.unitedsecuritybank.com as soon as reasonably practical after the Company files such reports with the SEC. The Company’s periodic and other reports filed with the SEC are also available at the SEC’s website (http://www.sec.gov).
Item 1B - Unresolved Staff Comments

The Company had no unresolved staff comments at December 31, 2019.
 
Item 2 - Properties

The Bank’s main bank branch is located at 2151 West Shaw Avenue, Fresno, California. The Company owns the building and leases the land under a sublease dated December 1, 1986, between Central Bank and USB. The current sublessor under the master ground lease is Bank of the West, which acquired the position through the purchase of Central Bank. The lessor under the ground lease (Master Lease) is Thomas F. Hinds. The lease was renewed on January 1, 2016 set to expire December 31, 2020. The Company has options to extend the term for three (3) additional periods of five (5) years under the same terms and conditions.

The Company leases the banking premises of approximately 6,450 square feet for its second of three Fresno branches at 7088 N. First St, Fresno, California, under a lease which commenced August 2005 and renewed July 2015 for a term of 10 years expiring July 2025. The facility provides space for the branch as well as the Real Estate Construction Department and the Indirect Consumer Lending Department.
 
The Company leases the Oakhurst bank branch located at the Old Mill Village Shopping Center, 40074 Highway 49, Oakhurst, California. The branch facility consists of approximately 5,000 square feet. The original lease agreement was signed April 1999 for 15 years with two 5-year options to extend the lease. In May 2019, the Company renegotiated terms and signed a new 5-year lease which is set to expire in April 2024.

The Company owns the Caruthers bank branch located at 13356 South Henderson, Caruthers, California, which consists of approximately 5,000 square feet of floor space.

The Company owns the San Joaquin bank branch facility located at 21574 Manning Avenue, San Joaquin, California. The bank branch is approximately 2,500 square feet.

The Company owns the Firebaugh bank branch located at 1067 O Street, Firebaugh, California. The premises are comprised of approximately 4,666 square feet of office space situated on land totaling approximately one-third of an acre.

The Company owns the Coalinga bank branch located at 145 East Durian, Coalinga, California. The office building has a total of 6,184 square feet of interior floor space situated on approximately 0.45 acres of land.

The Company leases the Convention Center bank branch located at 855 “M” Street, Suite 130, Fresno, California. Total space leased is approximately 4,520 square feet, and was occupied during March 2004. The Company signed a new 5-year lease in June 2019 which is set to expire in May 2024. The new lease provides two potential 5-year options to extend.

The Company owns the Taft bank branch office premises located at 523 Cascade Place, Taft, California. The branch facility consists of approximately 9,200 square feet of office space.
 
 The Company owns the Bakersfield bank branch facility located at 3404 Coffee Road, Bakersfield, California, which has approximately 6,130 square feet of office space located on 1.15 acres.

The Company leases the Campbell bank branch located at 1875 S. Bascom Ave., Suite 19, Campbell, California, which has approximately 2,984 square feet. The lease commenced on January 1, 2011 and expires on December 31, 2020.

The Company owns its administrative headquarters at 2126 Inyo Street, Fresno, California and is occupied by the Company’s administrative staff. The facility consists of approximately 21,400 square feet. A portion of the premises has been subleased to a third-party under a lease term which expires in March 2020 with a 5-year option for renewal.

The Company also has nine remote ATM or ITM locations leased from unrelated parties.

16



Item 3 - Legal Proceedings

From time to time, the Company is party to claims and legal proceedings arising in the ordinary course of business. At this time, the management of the Company is not aware of any material pending litigation proceedings to which it is a party or has recently been party to, which will have a material adverse effect on the financial condition or results of operations of the Company.
 
Item 4 - Mine Safety Disclosures

Not applicable
 

17


PART II

Item 5 - Market for the Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

Trading History

The common stock trades on The Nasdaq Global Select Market and is traded under the symbol UBFO. At December 31, 2019, there were approximately 582 record holders of common stock. This does not reflect the number of persons or entities who hold their stock in nominee or street name through various brokerage firms.

The following table sets forth the high and low closing sales prices by quarter for the common stock, for the years ended December 31, 2019 and 2018.

 
Closing Prices
Volume
Quarter
High
Low
 
4th Quarter 2019
$
10.81

$
10.03

1,565,811

3rd Quarter 2019
$
11.34

$
10.15

1,048,900

2nd Quarter 2019
$
11.39

$
10.03

1,296,647

1st Quarter 2019
$
11.01

$
9.44

630,726

4th Quarter 2018
$
11.18

$
9.41

877,712

3rd Quarter 2018
$
11.50

$
10.65

753,907

2nd Quarter 2018
$
11.45

$
10.70

745,092

1st Quarter 2018
$
10.75

$
10.15

1,134,156


Dividends

The Company's shareholders are entitled to dividends when and as declared by the Board of Directors out of funds legally available therefore. Dividends paid to shareholders are subject to restrictions set forth in the California General Corporation Law, which provides that a California corporation may make a distribution, including paying dividends on its capital stock, from retained earnings to the extent that the retained earnings exceed (a) the amount of the proposed distribution plus (b) the amount, if any, of dividends in arrears on shares with preferential dividend rights. Alternatively, a California corporation may make a distribution, if, immediately after the distribution, the value of its assets equals or exceeds the sum of (a) its total liabilities plus (b) the liquidation preference of any shares which have a preference upon dissolution over the rights of shareholders receiving the distribution. As a bank holding company without significant assets other than its equity position in the Bank, the ability to pay dividends to shareholders depends primarily upon dividends received from the Bank. Such dividends paid by the Bank to our Holding Company are subject to certain limitations. See “Management’s Discussion and Analysis of Financial and Results of Operations - Regulatory Matters.”

The Company declared and paid an $0.11 cash dividend to shareholders on March 26, 2019, June 25, 2019, September 24, 2019, and December 17, 2019. We declared and paid a $0.09 cash dividend to shareholders on March 27, 2018 and June 26, 2018, a $0.10 cash dividend to shareholders on September 25, 2018, and an $0.11 cash dividend to shareholders on December 18, 2018.

The amount and payment of dividends to our shareholders are set by the Board of Directors with numerous factors being taken into consideration including but not limited to earnings, financial condition, and the need for capital for expanded growth and general economic conditions. No assurance can be given that cash or stock dividends will be paid in the future.


Securities Authorized for Issuance under Equity Compensation Plans

The following table sets forth securities authorized for issuance under equity compensation plans as of December 31, 2019.

18


 
 
 
 
 
Plan Category
Number of securities to
be issued upon exercise
of outstanding options,
warrants and rights
(column a)
 
Weighted-average
exercise price of
outstanding options,
warrants and rights
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (a))
Equity compensation plans approved by security holders
94,601

(1
)
$
7.87

528,647

Equity compensation plans not approved by security holders
N/A

 
N/A

N/A

Total
94,601

 
$
7.87

528,647

(1) Under the United Security Bancshares 2015 Equity Incentive Award Plan (the "2015 Plan"), we are authorized to issue restricted stock awards. Restricted stock awards are not included in the total in column (a). At December 31, 2019, there were 35,572 shares of restricted stock issued and outstanding.

A complete description of the above plans is included in Note 12 of the Financial Statements, in Item 8 of this Report, and is hereby incorporated by reference.

Recent Sales of Unregistered Securities and Use of Proceeds

None.

Purchases of Equity Securities by Affiliates and Associated Purchasers

On April 25, 2017, the Company’s Board of Directors approved the repurchase of up to $3 million of the outstanding common stock of the Company. The duration of the program is open-ended and the timing of purchases will depend on market conditions. We did not repurchase any common shares under the stock repurchase plan during the years ended December 31, 2019 and 2018.
 
Item 6 - Selected Consolidated Financial Data

The following table sets forth selected historical consolidated financial information for each of the years in the five‑year period ended December 31, 2019. The selected financial data should be read in conjunction with our "Management's Discussion and Analysis of Financial Condition and Results of Operations," the audited consolidated financial statements as of December 31, 2019 and 2018, and the related Notes to Consolidated Financial Statements contained in “Item 8. Financial Statements and Supplementary Data.”


19


 
For the Year Ended December 31,
(in thousands except per share data and ratios)
2019
2018
2017
2016
2015
Summary of Year-to-Date Earnings:
 
 
 
 
 
Interest income
$
40,702

$
36,615

$
32,930

$
29,473

$
27,410

Interest expense
3,888

2,703

1,730

1,409

1,281

   Net interest income
36,814

33,912

31,200

28,064

26,129

Provision (recovery of provision) for credit losses
20

(1,764
)
24

(21
)
(41
)
Net interest income after provision (recovery of provision) for credit losses
36,794

35,676

31,176

28,085

26,170

Noninterest income
5,754

4,605

4,306

4,514

4,735

Noninterest expense
21,279

20,932

19,803

20,345

19,598

    Income before taxes on income
21,269

19.349

15.679

12,254

11,307

Taxes on income
6,097

5,332

7,039

4,869

4,497

   Net income
$
15,172

$
14,017

$
8,640

$
7,385

$
6,810

 
 
 
 
 
 
Per Share Data:
 
 
 
 
 
Net income - Basic
$
0.90

$
0.83

$
0.51

$
0.44

$
0.40

Net income - Diluted
$
0.89

$
0.83

$
0.51

$
0.44

$
0.40

Average shares outstanding - Basic
16,951,955

16,899,960

16,885,587

16,881,379

16,880,563

Average shares outstanding - Diluted
16,984,796

16,938,772

16,904,915

16,889,027

16,882,787

Book value per share
$
6.83

$
6.45

$
6.00

$
5.79

$
5.58

 
 
 
 
 
 
Financial Position at Period-end:
 
 
 
 
 
Total assets
$
956,919

$
933,058

$
805,836

$
787,972

$
725,644

Total net loans and leases
588,646

579,419

593,123

561,931

505,663

Total deposits
818,362

805,643

687,693

676,629

621,805

Total shareholders' equity
115,988

109,240

101,353

96,654

89,635

 
 
 
 
 
 
Selected Financial Ratios:
 
 
 
 
 
Return on average assets
1.58
%
1.61
 %
1.07
 %
0.98
%
0.98
%
Return on average equity
13.30
%
13.23
 %
8.63
 %
7.86
%
7.88
%
Average equity to average assets
11.89
%
12.14
 %
12.46
 %
12.43
%
12.41
%
Net interest margin (1)
4.22
%
4.28
 %
4.27
 %
4.11
%
4.22
%
Allowance for credit losses as a percentage of total nonperforming assets
37.26
%
38.81
 %
52.62
 %
47.15
%
30.26
%
Net charge-offs (recoveries) to net loans
0.08
%
(0.20
)%
(0.06
)%
0.14
%
0.20
%
Allowance of credit losses as a percentage of period-end loans
1.33
%
1.43
 %
1.54
 %
1.56
%
1.88
%
   Dividend payout ratio
49.16
%
42.17
 %
33.22
 %
%
%
1.
Fully taxable equivalent

20



Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

The Company

United Security Bancshares, a California corporation, is a bank holding company registered under the BHCA with corporate headquarters located in Fresno, California. The principal business of United Security Bancshares is to serve as the holding company for its wholly-owned subsidiary, United Security Bank. References to the “Bank” refer to United Security Bank together with its wholly-owned subsidiaries, USB Investment Trust, a special purpose real estate investment trust organized under Maryland law, and York Monterey Properties, Inc. References to the “Company” refer to United Security Bancshares together with its subsidiaries on a consolidated basis. References to the “Holding Company” refer to United Security Bancshares, the parent company, on a stand-alone basis.

Current Trends Affecting Results of Operations and Financial Position
Overall operations are impacted by a number of factors, including not only interest rates and margin spreads, which impact the results of operations, but also the composition of the balance sheet. One of the primary strategic goals is to maintain a mix of assets that will generate a reasonable rate of return without undue risk, and to finance those assets with a low-cost and stable source of funds. Liquidity and capital resources are also considered in the planning process to mitigate risk and allow for growth.
Since the Bank primarily conducts banking operations in California’s Central Valley, its operations and cash flows are subject to changes in the economic condition of the Central Valley. Our business results are dependent in large part upon the business activity, population, income levels, deposits and real estate activity in the Central Valley, and declines in economic conditions can have adverse material effects upon the Bank. In addition, the Central Valley remains largely dependent on agriculture. A downturn in agriculture and agricultural related business could indirectly and adversely affect the Company as many borrowers and customers are involved in, or are impacted to some extent, by the agricultural industry. While a great number of our borrowers are not directly involved in agriculture, they would likely be impacted by difficulties in the agricultural industry since many jobs in our market areas are ancillary to the regular production, processing, marketing and sale of agricultural commodities. Beginning in 2011, the state of California recently experienced one of the worst droughts in recorded history. While the drought has subsequently been declared over, it is not possible to quantify the drought's impact on businesses and consumers located in the Company's market areas or to predict adverse economic impacts related to future droughts. In response to the prolonged drought, the California state legislature passed the Sustainable Groundwater Management Act with the purpose to ensure better local and regional management of groundwater use and sustainable groundwater management in California by 2042. The local districts will develop, prepare, and begin implementation of the Groundwater Sustainability Plans as early as 2020. The effect of such plans to Central Valley agriculture, if any, is still unknown.

The residential real estate markets in the five county region from Merced to Kern has strengthened greatly and that trend has continued into the fourth quarter of 2019. Housing in the Central Valley continues to be relatively more affordable than the major metropolitan areas in California. As the Company continues its business development and expansion efforts throughout its market areas, it maintains its commitment to the reduction of nonperforming assets and provision of options for borrowers experiencing difficulties. Those options include combinations of rate and term concessions, as well as forbearance agreements with borrowers.
The Company emphasizes relationship banking and core deposit growth, and has focused greater attention on the Bank’s market area of Fresno, Madera, and Kern Counties, as well as Campbell, in Santa Clara County. The San Joaquin Valley and other California markets are exhibiting strong demand for construction lending and commercial lending from small- and medium-size businesses, as commercial and residential real estate markets have shown improvements.
The Company continually evaluates its strategic business plan as economic and market factors change in its market area. Balance sheet management, enhancing revenue sources, and maintaining market share will continue to be of primary importance.

Application of Critical Accounting Policies and Estimates

The consolidated financial statements are prepared in accordance with generally accepted accounting principles and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. As this

21


information changes, the financial statements will reflect different estimates, assumptions, and judgments. Certain policies have a greater reliance on the use of estimates, assumptions, and judgments and may result in the possible production of results that could be materially different from those originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value results inherently in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated based upon assumptions that market participants would use in pricing the asset or liability.

The most significant accounting policies are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and the financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the financial statement sensitivity to underlying methods, assumptions, and estimates, the allowance for credit losses, other real estate owned through foreclosure, impairment of investment securities, revenue recognition, nonaccrual income recognition, fair value estimates on junior subordinated debt, valuation for deferred income taxes and goodwill require the most subjective judgments and may be subject to revision as new information becomes available.

Allowance for Credit Losses

The allowance for credit losses represents management's estimate of probable incurred credit losses inherent in the loan portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment. The use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions may be susceptible to significant variations. The loan portfolio represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses. A discussion of the factors driving changes in the amount of the allowance for credit losses is included in the Asset Quality and Allowance for Credit Losses section of this financial review.

Other Real Estate Owned

Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value of the property, less estimated costs to sell. The excess, if any, of the loan amount over the fair value of the collateral is charged to the allowance for credit losses. The determination of fair value is generally based upon pre-approved, external appraisals. Subsequent declines in the fair value of other real estate owned, along with related revenue and expenses from operations, are charged to noninterest expense. The fair market valuation of such properties is based upon estimates and is subject to change as circumstances in the market area, or general economic trends, fluctuate.
 
Impairment of Investment Securities

Investment securities are impaired when the amortized cost exceeds fair value. Investment securities are evaluated for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant such an evaluation. Management considers the extent and duration of the unrealized loss and assesses whether it intends to sell, or it is likely that it will be required to sell the security before the anticipated recovery. If the criteria regarding intent or requirement to sell is met, the difference between amortized cost and fair value is recognized as impairment through earnings.

For investment securities that do not meet the criteria regarding intent or requirement to sell, the present value of the remaining cash flows as estimated at the preceding evaluation date are compared to the current expected remaining cash flows to determine OTTI related to credit loss. The amount of OTTI related to credit loss is recognized in earnings, with the balance recognized in other comprehensive income.

Revenue Recognition

The Bank's primary sources of revenue is interest income from both the loan portfolio and investment securities. Interest income is generally recorded on an accrual basis, unless the collection of such income is not reasonably assured or cannot be reasonably estimated. Pursuant to accounting standards related to revenue recognition, nonrefundable fees and costs associated with originating or acquiring loans are recognized as a yield adjustment to the related loans by amortizing them into income

22


over the term of the loan using a method which approximates the interest method.  Other credit-related fees, such as standby letter of credit fees, loan placement fees, and annual credit card fees are recognized as noninterest income during the period the related service is performed.

For loans placed on nonaccrual status, the accrued and unpaid interest receivable may be reversed at management's discretion based upon management's assessment of collectability. Interest is thereafter credited to principal to the extent necessary to eliminate doubt as to the collectability of the net carrying amount of the loan.

Fair Value

Effective January 1, 2007, a fair value option accounting standard was applied to the Company's junior subordinated debt. Concurrently, the accounting standards related to fair value measurements were adopted. The accounting standards related to fair value measurements define how applicable assets and liabilities are to be valued, and requires expanded disclosures in regard to financial instruments carried at fair value. The fair value measurement accounting standard establishes a hierarchical disclosure framework associated with the level of pricing observability utilized in measuring financial instruments at fair value. The degree of judgment utilized in measuring the fair value of financial instruments generally correlates to the level of pricing observability. Financial instruments with readily available active quoted prices, or whose fair value can be measured from actively quoted prices of related financial instruments, generally will have a higher degree of pricing observability and a lesser degree of judgment utilized in measuring fair value. Conversely, financial instruments infrequently traded or not quoted in an active market will generally have little or no pricing observability and a higher degree of subjectivity. Pricing observability is impacted by a number of factors, including the type of financial instrument, whether the financial instrument is new to the market, and the characteristics specific to the transaction. Determining fair values under the accounting standards may include judgments related to measurement factors that may vary from actual transactions executed in the marketplace. For the years ended December 31, 2019 and 2018, fair value adjustments related to the junior subordinated debt resulted in losses of $661,000 and $392,000, respectively. (See Notes 10 and 15 of the Notes to Consolidated Financial Statements for additional information about financial instruments carried at fair value.)

Income Taxes

Deferred income taxes are provided for the temporary differences between the financial reporting basis and the tax basis of assets and liabilities. Deferred taxes are measured using current tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered. If future income is not sufficient to apply the deferred tax assets within the tax years to which they may be applied, the deferred tax asset may not be realized and income will be reduced. No valuation allowances were recorded against the deferred tax asset at December 31, 2019 and 2018.
 
On January 1, 2007, accounting standards related to uncertainty in income taxes were adopted. The standard prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Under the accounting standards, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of more than 50 percent. In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority.
 
Pursuant to the accounting standards related to uncertainty in income taxes, tax positions will be continually reevaluated. If it is determined that the tax positions are not “more likely than not” to be sustained (as defined by taxing authorities), additional tax liabilities may be recognized.

Results of Operations

Net income for the year ended December 31, 2019 was $15,172,000 or $0.90 per basic share ($0.89 diluted) compared to $14,017,000 or $0.83 per basic share ($0.83 diluted) for year ended December 31, 2018. The increase of $1,155,000 between December 31, 2018 and December 31, 2019 is primarily the result of increases in interest-earning assets and a gain on the fair value of a financial liability. Interest income increased by $4,087,000, or 11.16%, between December 31, 2018 and December 31, 2019. Taxes on income increased by $765,000, or 14.35%.

Return on average assets was 1.58% for the year ended December 31, 2019 compared to 1.61% for the year ended December 31, 2018. Return on average equity was 13.30% for the year ended December 31, 2019 compared to 13.23% for the year ended December 31, 2018.


23


As with variances in net income, changes in the return on average assets and average equity experienced by the Company during 2019 and 2018 were effected by increases in interest-earning assets and net interest income.

The following table sets forth certain selected financial data for each of the years in the five-year periods ended December 31, 2019, and should be read in conjunction with the more detailed information and financial statements contained elsewhere herein:
(In thousands except per share data and ratios)
2019
2018
2017
2016
2015
Selected Financial Ratios:
 
 
 
 
 
Return on average assets
1.58
%
1.61
%
1.07
%
0.98
%
0.98
%
Return on average shareholders' equity
13.30
%
13.23
%
8.63
%
7.86
%
7.88
%
Average shareholders' equity to average assets
11.89
%
12.14
%
12.46
%
12.43
%
12.41
%
Dividend payout ratio
49.16
%
42.17
%
33.22
%
%
%

Net Interest Income

Net interest income, the most significant component of earnings, is the difference between the interest and fees received on earning assets and the interest paid on interest-bearing liabilities. Earning assets consist primarily of loans and, to a lesser extent, investments in securities issued by federal, state and local authorities, and corporations, as well as interest-bearing deposits and overnight investments in federal funds loaned to other financial institutions. These earning assets are funded by a combination of interest-bearing and noninterest-bearing liabilities, primarily customer deposits, and may include short-term and long-term borrowings.
 
Net interest income before provision for credit losses was $36,814,000 for the year ended December 31, 2019, representing an increase of $2,902,000, or 8.56%, compared to net interest income before provision for credit losses of $33,912,000 for the year ended December 31, 2018. As market rates decreased in the current year, even a disciplined deposit pricing effort saw the net interest margin, as shown in Table 1 below, decrease to 4.22% for the year ended December 31, 2019. The net interest margin was 4.28% for the year ended December 31, 2018,


Table 1. Distribution of Average Assets, Liabilities and Shareholders’ Equity:
The following table summarizes the distribution of average assets, liabilities and shareholders’ equity, as well as interest income and yields earned on average interest‑earning assets and interest expense and rates paid on average interest‑bearing liabilities, presented on a tax equivalent basis for the years indicated:



24


 
 
 
2019
 
 
 
 
 
2018
 
 
 
Average Balance
 
Interest
 
Yield/Rate
 
Average Balance
 
Interest
 
Yield/Rate
(Dollars in thousands)
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Loans and leases (1)
$
576,015

 
$
34,025

 
5.91
%
 
$
581,221

 
$
32,383

 
5.57
%
Investment Securities – taxable
71,456

 
1,797

 
2.51
%
 
54,838

 
1,146

 
2.09
%
Interest-bearing deposits in other banks
1

 

 
%
 

 

 
%
Interest-bearing deposits in FRB
223,488

 
4,880

 
2.18
%
 
157,222

 
3,086

 
1.96
%
Total interest-earning assets
870,960

 
$
40,702

 
4.67
%
 
793,281

 
$
36,615

 
4.62
%
Allowance for credit losses
(8,386
)
 
 

 
 

 
(9,118
)
 
 

 
 

Noninterest-earning assets:
 

 
 

 
 

 
 

 
 

 
 

Cash and due from banks
29,169

 
 

 
 

 
27,605

 
 

 
 

Premises and equipment, net
9,596

 
 

 
 

 
10,040

 
 

 
 

Accrued interest receivable
9,115

 
 

 
 

 
7,577

 
 

 
 

Other real estate owned
5,922

 
 

 
 

 
5,745

 
 

 
 

Other assets
42,861

 
 

 
 

 
37,704

 
 

 
 

Total average assets
$
959,237

 
 

 
 

 
$
872,834

 
 

 
 

Liabilities and Shareholders' Equity:
 

 
 

 
 

 
 

 
 

 
 

Interest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

NOW accounts
$
108,048

 
$
155

 
0.14
%
 
$
102,130

 
$
145

 
0.14
%
Money market accounts
251,277

 
2,233

 
0.89
%
 
192,344

 
1,299

 
0.68
%
Savings accounts
85,954

 
235

 
0.27
%
 
86,086

 
236

 
0.27
%
Time deposits
71,419

 
809

 
1.13
%
 
69,452

 
598

 
0.86
%
Junior subordinated debentures
10,289

 
456

 
4.43
%
 
9,922

 
425

 
4.28
%
Total interest-bearing liabilities
526,987

 
$
3,888

 
0.74
%
 
459,934

 
$
2,703

 
0.59
%
Noninterest-bearing liabilities:
 

 
 

 
 

 
 

 
 

 
 

Noninterest-bearing checking
308,518

 
 

 
 

 
300,698

 
 

 
 

Accrued interest payable
191

 
 

 
 

 
130

 
 

 
 

Other liabilities
9,492

 
 

 
 

 
6,123

 
 

 
 

Total average liabilities
845,188

 
 

 
 

 
766,885

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Total average shareholders' equity
114,049

 
 

 
 

 
105,949

 
 

 
 

Total average liabilities and shareholders' equity
$
959,237

 
 

 
 

 
$
872,834

 
 

 
 

Interest income as a percentage  of average earning assets
 

 
 

 
4.67
%
 
 

 
 

 
4.62
%
Interest expense as a percentage of average earning assets
 

 
 

 
0.45
%
 
 

 
 

 
0.34
%
Net interest margin
 

 
 

 
4.22
%
 
 

 
 

 
4.28
%
(1) Loan amounts include nonaccrual loans, but the related interest income has been included only if collected for the period prior to the loan being placed on a nonaccrual basis. Loan interest income includes loan fees of approximately $96 for the year ended December 31, 2019 and loan costs of approximately $1,046 for the year ended December 31, 2018.
 
After rising to 5.50% during 2018, the prime rate decreased to 4.75% by the end of 2019. Future increases and decreases will affect rates for both loans and customer deposits.

Both net interest income and net interest margin are affected by changes in the amount and mix of interest-earning assets and interest-bearing liabilities, referred to as "volume change." Both are also affected by changes in yields on interest-earning assets and rates paid on interest-bearing liabilities, referred to as "rate change." The following table sets forth the changes in interest income and interest expense for each major category of interest-earning asset and interest-bearing liability, and the amount of change attributable to volume and rate changes for the years indicated. Changes in interest income and expense, which are not attributable specifically to either rate or volume, are allocated proportionately between the two variances based on the absolute dollar amounts of the change in each.


25


Table 2.  Rate and Volume Analysis
 
2019 compared to 2018
(In thousands)
Total
 
Rate
 
Volume
Increase (decrease) in interest income:
 
 
 
 
 
Loans
$
1,642

 
$
1,946

 
(304
)
Investment securities
651

 
264

 
387

Interest-bearing deposits in other banks

 

 

Interest-bearing deposits in FRB
1,794

 
236

 
1,558

Total interest income
4,087

 
2,446

 
1,641

Increase (decrease) in interest expense:
 

 
 

 
 

Interest-bearing demand accounts
944

 
585

 
359

Savings accounts
(1
)
 

 
(1
)
Time deposits
211

 
194

 
17

Subordinated debentures
31

 
16

 
15

Total interest expense
1,185

 
795

 
390

Increase in net interest income
$
2,902

 
$
1,651

 
1,251


The net interest margin decreased in 2019 despite slight increases in loan portfolio yields, yields of overnight investments with the Federal Reserve Bank ("FRB"), and investment securities yields. Rising interest expense was the primary reason for the decrease in the current year net interest margin. In order to mitigate the low interest rate environment, loan floors are included in new and renewed loans when practical. Loans yielded 5.91% during the year ended December 31, 2019, as compared to 5.57% for the year ended December 31, 2018.  For the year ended December 31, 2019, total interest income increased approximately $4,087,000, or 11.16%, as compared to the year ended December 31, 2018, reflective of increases of $1,642,000 and $1,794,000 in loan interest income and income on interest bearing deposits with the FRB, respectively. Average interest-earning assets increased approximately $77,679,000 between 2019 and 2018 and the rate on interest-earning assets increased 5 basis points during the two periods. The increase in average earning assets between 2019 and 2018 consisted of increases of $66,266,000 in interest-bearing deposits held with the FRB and increases of $16,618,000 in investment securities, offset by a decrease of $5,206,000 in loans.

For the year ended December 31, 2019, total interest expense increased approximately $1,185,000, or 43.84%, as compared to the year ended December 31, 2018. Between the two periods, average interest-bearing liabilities increased by $67,053,000, and the average rates paid on these liabilities increased by 15 basis points. CDARs reciprocal deposits, which are preferred by some depositors, decreased from $19,471,000 to $4,838,000.


26


The following table summarizes the year-to-date averages of the components of interest-earning assets as a percentage of total interest-earning assets, and the components of interest-bearing liabilities as a percentage of total interest-bearing liabilities:

 
YTD Average
12/31/19
 
YTD Average
12/31/18
Loans
66.14
%
 
73.27
%
Investment securities available for sale
8.20
%
 
6.91
%
Interest-bearing deposits in other banks
%
 
%
Interest-bearing deposits in FRB
25.66
%
 
19.82
%
Total earning assets
100.00
%
 
100.00
%
 
 
 
 
NOW accounts
20.50
%
 
22.21
%
Money market accounts
47.69
%
 
41.82
%
Savings accounts
16.31
%
 
18.72
%
Time deposits
13.55
%
 
15.10
%
Subordinated debentures
1.95
%
 
2.15
%
Total interest-bearing liabilities
100.00
%
 
100.00
%

Provision for Credit Losses

Provisions for credit losses are determined on the basis of management's periodic credit review of the loan portfolio, consideration of past loan loss experience, current and future economic conditions, and other pertinent factors. After reviewing these factors, management, at times, makes adjustments in order to maintain an allowance for credit losses adequate for the coverage of estimated losses inherent in the loan portfolio. Based on the condition of the loan portfolio, management believes the allowance is appropriate to cover risk elements in the loan portfolio.

For the year ended December 31, 2019, a $20,000 provision was made to the allowance for credit losses. A recovery of provision was made for the year ended December 31, 2018 and totaled $1,764,000.

The allowance for credit losses decreased to 1.33% of total loans during the year ended December 31, 2019, as compared to 1.43% at December 31, 2018. The recovery of provision of $1,764,000 recorded in 2018, and the provision of $20,000 recorded during 2019, are a result of continuing improvements in the overall credit quality of the loan portfolio, improvements in economic conditions over the recent years, and improvements in loan collateral property values. For further discussion, refer to Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset Quality and Allowance for Credit Losses.

Noninterest Income

The following table summarizes significant components of noninterest income for the years indicated and the net changes between those years:
 
(In thousands)
2019
 
% of Total
 
2018
 
% of Total
Customer service fees
$
3,257

 
56.60
 %
 
$
3,544

 
76.96
 %
Increase in cash surrender value of bank-owned life insurance
528

 
9.18
 %
 
520

 
11.29
 %
Gain (loss) on fair value of marketable equity securities
117

 
2.03
 %
 
(78
)
 
(1.69
)%
Gain on proceeds from bank-owned life insurance

 

 
171

 
3.71
 %
Gain (loss) on fair value of junior subordinated debentures
1,165

 
20.25
 %
 
(424
)
 
(9.21
)%
Loss on dissolution of real estate investment trust
(115
)
 
(2.00
)%
 

 
 %
Other
802

 
13.94
 %
 
872

 
18.94
 %
Total
$
5,754

 
100.00
 %
 
$
4,605

 
100.00
 %


27


Noninterest income consists primarily of fees and commissions earned on services provided to banking customers, fair value adjustments to the value of the junior subordinated debentures, and, to a lesser extent, gains on sales of Company assets and other miscellaneous income.

Noninterest income for the year ended December 31, 2019 increased $1,149,000, or 24.95%, when compared to the same period of 2018. Customer service fees, the primary component of noninterest income, decreased $287,000, or 8.10%, between the two periods presented. The increase in noninterest income of $1,149,000 between the two periods is partially the result of a recorded gain on the fair value of junior subordinated debentures of $1,165,000 during 2019 as compared to a loss of $424,000 during 2018. The change in the fair value of junior subordinated debentures was primarily caused by fluctuations in the LIBOR yield curve. The cost of the subordinated debentures issued by USB Capital Trust II fluctuates relative to increasing and decreasing market rates. With pricing at 3-month-LIBOR plus 129 basis points, the effective cost of the subordinated debt was 3.44%% and 3.73%% at December 31, 2019 and 2018, respectively.

 Noninterest Expense

The following table sets forth the components of total noninterest expense in dollars and as a percentage of average earning assets for the years ended December 31, 2019 and 2018:
 
2019
 
2018
(Dollars in thousands)
Amount
% of
Average
Earning Assets
 
Amount
% of
Average
Earning Assets
Salaries and employee benefits
$
11,109

1.28
%
 
$
11,721

1.48
%
Occupancy expense
3,332

0.38
%
 
3,264

0.41
%
Data processing
583

0.07
%
 
414

0.05
%
Professional fees
3,180

0.37
%
 
2,482

0.31
%
Regulatory assessments
164

0.02
%
 
330

0.04
%
Director fees
373

0.04
%
 
321

0.04
%
Correspondent bank service charges
57

0.01
%
 
63

0.01
%
Loss on California tax credit partnership

%
 
25

%
Net cost on operation and sale of OREO
244

0.03
%
 
145

0.02
%
Other
2,237

0.26
%
 
2,167

0.27
%
Total
$
21,279

2.44
%
 
$
20,932

2.64
%
 
Noninterest expense increased $347,000, or 1.66%, between the years ended December 31, 2019 and 2018. The net increase in noninterest expense between the comparative periods is primarily the result of increases in professional fees and data processing fees, offset by decreases in salaries and employee benefits and regulatory assessments.

Included in net costs on operations of OREO for the years ended December 31, 2019 and 2018 are OREO operating expenses totaling $244,000 and $145,000, respectively. There were no impairment losses on OREO recorded during the years ended 2019 and 2018.

During the years ended December 31, 2019 and 2018, the Company recognized stock-based compensation expense of $349,000 ($0.02 per share basic and diluted) and $744,000 ($0.04 per share basic and diluted), respectively. This expense is included in noninterest expense under salaries and employee benefits. If new stock options or units are issued, or existing options fail to vest due, for example, to forfeiture, actual stock-based compensation expense in future periods will change.

Income Taxes

Income tax expense is impacted to some degree by permanent taxable differences between income reported for book purposes and income reported for tax purposes, as well as certain tax credits which are not reflected in the statements of operations and comprehensive income. As pretax income or loss amounts become smaller, the impact of these differences become more significant and are reflected as variances in the effective tax rate for the periods presented. In general, the permanent differences and tax credits affecting tax expense have a positive impact and tend to reduce the effective tax rates shown in the

28


statements of operations and comprehensive income. The effective tax rate for the year ended December 31, 2019 was 28.67% compared to 27.56% for the year ended December 31, 2018.

The Company's tax position is reviewed at least quarterly based upon accounting standards related to uncertainty in income taxes. An individual tax position must meet certain criteria for some or all of the income tax benefit to be recognized in a taxable entity’s financial statements. Under the income tax guidelines, an entity should recognize the financial statement benefit of a tax position if it determines that it is more likely than not that the position will be sustained on examination. The term “more likely than not” means a likelihood of "more than 50 percent.” In assessing whether the more-likely-than-not criterion is met, the entity should assume that the tax position will be reviewed by the applicable taxing authority.
 
The Company's tax position was reviewed as of December 31, 2019, and it has been determined that there are no material amounts that should be recorded under the current income tax accounting guidelines.
 
Financial Condition

Total assets increased by $23,861,000, or 2.56%, from $933,058,000 at December 31, 2018 to $956,919,000 at December 31, 2019. During the year ended December 31, 2019, net loans increased by $9,227,000. Investment securities increased by $10,003,000 during the year ended December 31, 2019, and overnight interest-bearing deposits in the Federal Reserve Bank and federal funds sold increased a net $316,000. Total deposits of $818,362,000 at December 31, 2019, increased $12,719,000, or 1.58%, from $805,643,000 at December 31, 2018.

Interest-earning assets averaged approximately $870,960,000 during the year ended December 31, 2019, as compared to $793,281,000 for the year ended December 31, 2018. Average interest-bearing liabilities increased to $526,987,000 for the year ended December 31, 2019, as compared to $459,934,000 for the year ended December 31, 2018.

Loans

The Company's primary business is that of acquiring deposits and making loans, with the loan portfolio representing the largest component of earning assets. Loans totaled $597,374,000 at December 31, 2019, an increase of $9,441,000, or 1.61%, from total loans of $587,933,000 at December 31, 2018. During 2019, average loans decreased 0.90% when compared to the year ended December 31, 2018. Average loans totaled $576,015,000 and $581,221,000 for the years ended December 31, 2019 and 2018, respectively.
 
The following table sets forth the amounts of loans outstanding by category and the category percentages as of the year-end dates indicated:
 
2019
 
2018
 
2017
 
2016
 
2015
   (In thousands)
Dollar Amount
% of Loans
 
Dollar Amount
% of Loans
 
Dollar Amount
% of Loans
 
Dollar Amount
% of Loans
 
Dollar Amount
% of Loans
Commercial and industrial
$
45,278

7.6
%
 
$
56,978

9.7
%
 
$
47,026

7.8
%
 
$
49,005

8.6
%
 
$
55,826

10.8
%
Real estate mortgage
291,237

48.8
%
 
289,200

49.2
%
 
306,293

50.9
%
 
288,200

50.6
%
 
252,232

48.9
%
RE construction & development
138,784

23.2
%
 
108,795

18.5
%
 
122,970

20.4
%
 
130,687

22.9
%
 
130,596

25.3
%
Agricultural
52,197

8.7
%
 
61,149

10.4
%
 
59,481

9.9
%
 
56,918

10.0
%
 
52,137

10.1
%
Installment and student loans
69,878

11.7
%
 
71,811

12.2
%
 
65,581

11.0
%
 
44,949

7.9
%
 
24,527

4.9
%
Total loans
$
597,374

100.0
%
 
$
587,933

100.0
%
 
$
601,351

100.0
%
 
$
569,759

100.0
%
 
$
515,318

100.0
%
 
Loan volume continues to be highest in what has historically been the primary lending emphasis: commercial, real estate mortgage, and construction lending. Total loans increased $9,441,000 during 2019. There were increases of $2,037,000, or 0.70%, in real estate mortgage loans and $29,989,000, or 27.56%, in real estate construction and development loans. There were decreases of $11,700,000, or 20.53%, in commercial and industrial loans, $1,933,000, or 2.7%, in installment loans, and $8,952,000, or 14.6%, in agriculture loans.


29


The real estate mortgage loan portfolio totaling $291,237,000 at December 31, 2019, consists of commercial real estate, residential mortgages, and home equity loans. Commercial real estate loans have remained a significant percentage of total loans over the past year, amounting to 41.04% and 39.03%, of the total loan portfolio at December 31, 2019 and December 31, 2018, respectively. Commercial real estate balances increased to $245,183,000 at December 31, 2019 from $229,448,000 at December 31, 2018. Commercial real estate loans are generally a mix of short to medium-term, fixed and floating rate instruments and are mainly secured by commercial income and multi-family residential properties. Residential mortgage loans are generally 30-year amortizing loans with maturities of between three and five years. These loans totaled $45,881,000 or 7.68% of the portfolio at December 31, 2019, and $59,431,000, or 10.11% of the portfolio at December 31, 2018. Real estate mortgage loans in total increased $2,037,000 during 2019 and decreased $17,093,000, or 5.58%, during 2018. Residential mortgage loans are not generally a large part of the loan portfolio, but some residential mortgage loans have been made over the past several years to facilitate take-out loans for construction borrowers who were unable to obtain permanent financing elsewhere. The Company does purchase residential mortgage portfolios. The home equity loan portfolio totaled $173,000 at December 31, 2019, and $321,000 at December 31, 2018.

Purchased loan participations totaled $5,955,000 at December 31, 2019. There were no purchased loan participations held at December 31, 2018. Loan participations sold decreased from $7,140,000, or 1.21%, of the portfolio at December 31, 2018, to $4,866,000, or 0.81%, at December 31, 2019.

During 2018, commercial and industrial loans increased $9,952,000, or 21.16%, installment loans increased $6,230,000, or 9.50%, and agricultural loans increase$1,668,000, or 2.80%. Real estate mortgage loans decreased $17,093,000, or 5.58%, and real estate construction and development loans decreased $14,175,000, or 11.53%.

At December 31, 2019, approximately 60.3% of commercial and industrial loans have floating rates and, although some may be secured by real estate, many are secured by accounts receivable, inventory, and other business assets. Construction loans are generally short-term, floating-rate obligations, which consist of both residential and commercial projects. Agricultural loans, are primarily short-term, floating rate loans for crop financing.

Included within the installment loan portfolio are $65,800,000 in student loans as of December 31, 2019, as compared to $68,221,000 at December 31, 2018, a decrease of $2,421,000. The student loan portfolio consists of unsecured loans to medical and pharmacy students currently enrolled in medical and pharmacy schools in the US and the Caribbean.  The medical student loans are made to US citizens attending medical schools in the US and Antigua, while the pharmacy student loans are made to pharmacy students attending pharmacy school in the US. Upon graduation the loan is automatically placed on deferment for six months. This may be extended up to 48 months for graduates enrolling in internship, medical residency or fellowship. As approved the student may receive additional deferment for hardship or administrative reasons in the form of forbearance for a maximum of 24 months throughout the life of the loan. The outstanding balance of student loans that have not entered repayment status totaled $25,796,000 at December 31, 2019. Accrued interest on loans that have not entered repayment status totaled $5,475,000 at December 31, 2019. At December 31, 2019, there were 855 loans within repayment, deferment, and forbearance which represented $24,986,000, $4,392,000, and $10,626,000 in outstanding balances respectively. Repayment of the unsecured student loans is premised on the medical and pharmacy students graduating and becoming high wage earners. Underwriting is premised on qualifying credit scores. The weighted average credit score for the portfolio is in the mid-700s. In addition, there are non-student co-borrowers for roughly one-third of the portfolio that provide additional repayment capacity. Graduation and employment placement rates are high for both medical and pharmacy students. The average student loan balance per borrower as of December 31, 2019 was approximately $95,000. Loan interest rates range from 4.75% to 9.75%. At December 31, 2019, $24,986,000 in loans were in repayment compared to $15,526,000 as of December 31, 2018. Accrued interest on student loans was $5,678,000 and $5,984,000 as of December 31, 2019 and 2018, respectively. The student loan portfolio was previously insured through a surety bond issued by ReliaMax Surety Company and provided a reasonable expectation of collection. In June 2018, ReliaMax Surety Company was declared insolvent by the South Dakota Division of Insurance and is now in liquidation. As a result of the insolvency, risks within the student loan portfolio were assessed and the reserve balance for student loans was increased. At December 31, 2019, the reserve against the student loan portfolio totaled $2,091,000. Additionally, as of December 31, 2019, $43,000 in accrued interest receivable was reversed, due to charge-offs of $740,000. At December 31, 2018, the reserve totaled $1,520,000 and $26,000 in accrued interest was reversed due to charge-offs of $388,000. There were no TDRs within the portfolio as of December 31, 2019 or 2018.

Reunion Student Loan Finance Corporation (RSLFC) is the third-party servicer for the student loan portfolio. RSLFC provides servicing for the student loan portfolio, including application administration, processing, approval, documenting, funding, and collection. They also provide file custodial responsibilities. Except in cases where applicants/loans do not meet program requirements, or extreme delinquency, RSLFC provides complete program management. RSLFC is paid a monthly servicing fee based on the principal balance outstanding. Interest income on the student loan portfolio offsets this expense, and is presented net of expense within loan interest income.

30



The following table sets forth the maturities of the Bank's loan portfolio at December 31, 2019. Amounts presented are shown by maturity dates rather than repricing periods:
   (In thousands)
Due in one year or less
 
Due after one year through five years
 
Due after five years
 
Total
Commercial and agricultural
$
45,821

 
$
19,831

 
$
31,823

 
$
97,475

Real estate construction & development
74,867

 
61,961

 
1,956

 
138,784

Real estate – mortgage
29,278

 
140,966

 
120,993

 
291,237

All other loans
1,164

 
2,893

 
65,821

 
69,878

Total loans
$
151,130

 
$
225,651

 
$
220,593

 
$
597,374

 
For the years ended December 31, 2019 and 2018, the average yield on loans was 5.91% and 5.57%, respectively.  Rate floors are occasionally used to mitigate interest rate risk if interest rates fall, as well as to compensate for additional credit risk under current market conditions. The loan portfolio is generally comprised of short-term or floating-rate loans that adjust in alignment to changes in market rates of interest.

At December 31, 2019 and 2018, approximately 54.2% and 55.3%, respectively, of the loan portfolio consisted of floating rate instruments, with the majority of those tied to the prime rate.

The following table sets forth the contractual maturities of the Bank's fixed and floating-rate loans at December 31, 2019. Amounts presented are shown by maturity dates rather than repricing periods, and do not consider renewals or prepayments of loans:
 
Due in one
 
Due after one
Year through
 
Due after
 
 
   (In thousands)
year or less
 
Five years
 
Five years
 
Total
Accruing loans:
 
 
 
 
 
 
 
Fixed rate loans
$
36,817

 
$
183,135

 
$
44,826

 
$
264,778

Floating rate loans
102,616

 
42,517

 
175,766

 
320,899

Total accruing loans
139,433

 
225,652

 
220,592

 
585,677

Nonaccrual loans:
 

 
 

 
 

 
 

Fixed rate loans
11,478

 

 

 
11,478

Floating rate loans
219

 

 

 
219

Total nonaccrual loans
11,697

 

 

 
11,697

Total Loans
$
151,130

 
$
225,652

 
$
220,592

 
$
597,374

 
Securities
 
The following is a comparison of the amortized cost and approximate fair value of available-for-sale securities for the years indicated:
 
December 31, 2019
 
December 31, 2018
   (In thousands)
Amortized Cost
Fair Value (Carrying Amount)
 
Amortized Cost
Fair Value (Carrying Amount)
Available-for-sale:
 
 
 
 
 
U.S. Government agencies
$
28,737

$
28,699

 
$
36,665

$
36,527

U.S. Government sponsored entities & agencies collateralized by mortgage obligations
47,824

47,613

 
30,289

29,899

Total available-for-sale
$
76,561

$
76,312

 
$
66,954

$
66,426

 

31


The contractual maturities of investment securities as well as yields based on amortized cost of those securities at December 31, 2019 are shown below.  Actual maturities may differ from contractual maturities because issuers have the right to call or prepay obligations with or without call or prepayment penalties.
 
One year or less
After one year to five years
After five years to ten years
After ten years
Total
  (Dollars in thousands)
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
Amount
Yield (1)
Available-for-sale:
 
 
 
 
 
 
 
 
 
 
U.S. Government agencies
$

%
$

%
$
3,813

3.06
%
$
24,924

3.01
%
$
28,737

3.02
%
U.S. Government sponsored entities & agencies collateralized by mortgage obligations

%
5,953

2.71
%
238

2.71
%
41,633

3.26
%
47,824

3.19
%
Total amortized cost
$

%
$
5,953

2.71
%
$
4,051

3.04
%
$
66,557

3.17
%
$
76,561

3.13
%
(1) Weighted average yields are not computed on a tax equivalent basis

At December 31, 2019 and 2018, available-for-sale securities with an amortized cost of approximately $65,874,000 and $58,790,000, respectively (fair value of $65,683,000 and $58,263,000, respectively) were pledged as collateral for public funds and FHLB borrowings.

As of January 1, 2018, the Company adopted Accounting Standard Update (“ASU”) 2016-01 and reclassified its marketable equity securities from investments available for sale into a separate component of investment securities. The ASU requires marketable equity securities to be reported at fair value with changes recorded through earnings. As of January 1, 2018, unrealized losses of $184,000 were reversed from accumulated other comprehensive income to retained earnings.

During the year ended December 31, 2019, the Company recognized unrealized gains of $117,000 related to marketable equity securities held at December 31, 2019 in the consolidated statements of income. During the year ended December 31, 2018, unrealized losses of $78,000 were recorded.

Deposits

The Bank attracts commercial deposits primarily from local businesses and professionals, as well as retail checking accounts, savings accounts and time deposits. Core deposits, consisting of all deposits other than time deposits of $250,000 or more and brokered deposits, continue to provide the foundation for the Bank's principal sources of funding and liquidity. Core deposits amounted to 97.5% and 97.3% of the total deposit portfolio at December 31, 2019 and 2018, respectively. The Bank currently holds no brokered deposits as part of its continuing effort to maintain sufficient liquidity without a reliance on brokered deposits.

 The following table sets forth the year-end amounts of deposits by category for the years indicated, and the dollar change in each category during the year:
 
December 31,
   (In thousands)
2019
2018
2017
2016
2015
Noninterest-bearing deposits
$
311,950

$
292,720

$
307,299

$
262,697

$
262,168

Interest-bearing deposits:
 

 

 

 

 

NOW and money market accounts
360,934

340,445

234,154

235,873

226,886

Savings accounts
80,078

90,046

81,408

75,068

63,592

Time deposits:
 

 

 

 

 

Under $250,000
44,926

60,875

51,687

87,419

58,122

$250,000 and over
20,474

21,557

13,145

15,572

11,037

Total interest-bearing deposits
506,412

512,923

380,394

413,932

359,637

Total deposits
$
818,362

$
805,643

$
687,693

$
676,629

$
621,805



32


The following table sets forth the year-end percentages of total deposits by category for the years indicated:
 
December 31,
 
2019
2018
2017
2016
2015
Noninterest-bearing deposits
38.12
%
36.33
%
44.69
%
38.82
%
42.16
%
Interest-bearing deposits:





NOW and money market accounts
44.10
%
42.26
%
34.05
%
34.86
%
36.49
%
Savings accounts
9.79
%
11.18
%
11.84
%
11.09
%
10.23
%
Time deposits:





Under $250,000
5.49
%
7.56
%
7.52
%
12.92
%
9.35
%
$250,000 and over
2.50
%
2.68
%
1.91
%
2.30
%
1.77
%
Total interest-bearing deposits
61.88
%
63.67
%
55.31
%
61.18
%
57.84
%
Total deposits
100.00
%
100.00
%
100.00
%
100.00
%
100.00
%

The Bank's deposit base consists of two major components represented by noninterest-bearing (demand) deposits and interest-bearing deposits. Interest-bearing deposits consist of time certificates, NOW and money market accounts, and savings deposits. During the year ended December 31, 2019, NOW and money market deposits increased $20,489,000, or 6.02%, noninterest-bearing deposits increased $19,230,000, or 6.57%, total time deposits decreased $17,032,000, or 20.66%, and savings accounts decreased $9,968,000, or 11.07%
 
During the year ended December 31, 2018, noninterest-bearing deposits decreased $14,579,000, or 4.74%, total time deposits increased $17,600,000, or 27.15%, NOW and money market increased $106,291,000, or 45.39%, and savings accounts increased $8,638,000, or 10.61%.

On a year-to-date average basis, total deposits increased $74,506,000, or 9.92%, between the years ended December 31, 2018 and December 31, 2019. Interest-bearing deposits increased by $66,686,000, or 14.82%, and noninterest-bearing deposits increased $7,820,000, or 2.60%, during 2019. On average, balances increased in all categories between the years ended December 31, 2018 and December 31, 2019, except for savings accounts.

The following table sets forth the average deposits and average rates paid on those deposits for the years ended December 31, 2019 and 2018:
 
2019
2018
  (Dollars in thousands)
Average Balance
Rate %
Average Balance
Rate %
Interest-bearing deposits:
 
 
 
 
Checking accounts
$
359,325

0.66
%
$
294,474

0.49
%
Savings
85,954

0.27
%
86,086

0.27
%
Time deposits (1)
71,419

1.13
%
69,452

0.86
%
Noninterest-bearing deposits
308,518

 

300,698

 

(1) Included at December 31, 2019, are $20,474,000 in time certificates of deposit of $250,000 or more, of which $4,443,000 mature in three months or less, $11,889,000 mature between three to twelve months, and $4,142,000 mature in one to three years.

Short-term Borrowings

The Bank has access to short-term borrowings which may consist of federal funds purchased, discount window borrowings, securities sold under agreements to repurchase (“repurchase agreements”), and Federal Home Loan Bank (FHLB) advances as alternatives to retail deposit funds. Collateralized and uncollateralized lines of credit have been established with several correspondent banks. The FRB discount window, as well as a securities dealer, may also be accessed as needed. Funds may be borrowed in the future as part of the Company's asset/liability strategy, and may be used to acquire assets as deemed appropriate by management for investment purposes or for capital utilization purposes. Federal funds purchased represent temporary overnight borrowings from correspondent banks and are generally unsecured. Repurchase agreements are collateralized by mortgage backed securities and securities of U.S. Government agencies, and generally have maturities of one to six months, but may have longer maturities if deemed appropriate. FHLB advances are collateralized by investments in

33


FHLB stock, securities, and certain qualifying mortgage loans. Additionally, borrowings collateralized by pledged loans may be secured from the Federal Reserve Bank of San Francisco (FRB). Credit lines are subject to periodic review by the credit lines grantors relative to the Company's financial statements. Lines of credit may be modified or revoked at any time.

Lines of credit with the FRB of $313,445,000 and $287,446,000, as well as FHLB lines of credit totaling $5,815,000 and $4,119,000 were held at December 31, 2019 and 2018, respectively. In addition, the Company obtained a $10,000,000 uncollateralized line of credit during 2013 from Pacific Coast Bankers Bank, a $20,000,000 uncollateralized line of credit during 2014 from Zion's Bank, and a $10,000,000 uncollateralized line of credit during 2017 from Union Bank. At December 31, 2019, there were no outstanding balances drawn against any lines of credit. These lines of credit generally have interest rates tied to the Federal Funds rate or are indexed to short-term U.S. Treasury rates or LIBOR.

Asset Quality and Allowance for Credit Losses

Lending money is the principal business activity, and ensuring appropriate evaluation, diversification, and control of credit risks is a primary management responsibility. Losses are implicit in lending activities and the amount of such losses will vary, depending on the risk characteristics of the loan portfolio as affected by local economic conditions and the financial experience of borrowers.

The allowance for credit losses is maintained at a level deemed appropriate by management to provide for known and inherent risks in existing loans and commitments to extend credit. The adequacy of the allowance for credit losses is based upon management's continuing assessment of various factors affecting the collectability of loans and commitments to extend credit, including current economic conditions, past credit experience, collateral, and concentrations of credit. There is no precise method of predicting specific losses which may ultimately be charged off on particular segments of the loan portfolio. The conclusion that a loan may become uncollectible, either in part or in whole is judgmental and subject to economic, environmental, and other conditions which cannot be predicted with certainty. The allowance for credit losses is determined in accordance with GAAP and the guidelines set forth in the Revised Interagency Policy Statement on the Allowance for Loan and Lease Losses (“Statement”) issued by banking regulators in December 2006. The Statement is a revision of the previous guidance released in July 2001, and outlines characteristics that should be used in the segmentation of the loan portfolio for analytical purposes such as including risk classification, past due status, type of loan, industry and collateral. It also outlines factors to consider when adjusting the loss factors for various segments of the loan portfolio and updates previous guidance that describes the responsibilities of the board of directors, management, and bank examiners regarding the allowance for credit losses. Securities and Exchange Commission Staff Accounting Bulletin No. 102, released during July 2001, provides additional guidance regarding methodologies and supporting documentation for the Allowance for Loan and Lease Losses that are consistent with federal securities laws and the Commission’s interpretations.  Their guidance is generally consistent with the guidance published by banking regulators.

The allowance for loan losses includes an asset-specific component, as well as a general or formula-based component. The loan portfolio is divided into eight (8) segments and categorized primarily by loan class homogeneity and commonality of purpose for analysis under the formula-based component of the allowance. Loans which are determined to be impaired under current accounting guidelines are not subject to the formula-based reserve analysis, and are instead evaluated individually for specific impairment under the asset-specific component of the allowance.

The eight segments of the loan portfolio are as follows (subtotals are provided as needed to allow the reader to reconcile the amounts to loan classifications reported elsewhere in this Report):

34


Loan Segments for Loan Loss Reserve Analysis
Loan Balances at December 31,
(Dollars in thousands)
2019
2018
2017
2016
2015
Commercial and business loans
$
44,534

$
55,929

$
46,065

$
47,464

$
54,503

Government program loans
744

1,049

961

1,541

1,323

Total commercial and industrial
45,278

56,978

47,026

49,005

55,826

Real estate – mortgage:
 
 
 
 
 
Commercial real estate
245,183

229,448

221,032

200,213

182,554

Residential mortgages
45,881

59,431

84,804

87,388

68,811

Home improvement and home equity loans
173

321

457

599

867

Total real estate mortgage
291,237

289,200

306,293

288,200

252,232

Real estate construction and development
138,784

108,795

122,970

130,687

130,596

Agricultural
52,197

61,149

59,481

56,918

52,137

Installment and student loans
69,878

71,811

65,581

44,949

24,527

Total loans
$
597,374

$
587,933

$
601,351

$
569,759

$
515,318


The methodology for assessing the adequacy of the allowance for credit losses consists of several key elements, which include:
- the formula allowance;
- specific allowances for problem graded loans identified as impaired; and
- and the unallocated allowance.

The formula allowance is calculated by applying loss factors to outstanding loans and certain unfunded loan commitments. Loss factors are based on the historical loss experience and on the internal risk grade of those loans and may be adjusted for significant factors that, in management's judgment, affect the collectability of the portfolio as of the evaluation date. Factors that may affect collectability of the loan portfolio include:
 
Levels of, and trends in delinquencies and nonaccrual loans;
Trends in volumes and term of loans;
Effects of any changes in lending policies and procedures including those for underwriting, collection, charge-off, and recovery;
Experience, ability, and depth of lending management and staff;
National and local economic trends and conditions; and
Concentrations of credit that might affect loss experience across one or more components of the portfolio, including high-balance loan concentrations and participations.

Management determines the loss factors for loans based on a loss migration model. The migration analysis incorporates loan losses over the previous quarters as determined by management (time horizons adjusted as business cycles or environment changes). Loss factors are adjusted to recognize and quantify the loss exposure due to changes in market conditions as well as trends in the loan portfolio. For purposes of analysis, loans are grouped by internal risk classifications and categorized as pass, special mention, substandard, doubtful, or loss. Certain loans are homogeneous in nature and are therefore pooled by risk grade. These homogeneous loans include consumer installment and home equity loans. Special mention loans are currently performing but are potentially weak, as the borrower has begun to exhibit deteriorating trends which, if not corrected, could jeopardize repayment of the loan and result in further downgrades. Substandard loans have well-defined weaknesses which, if not corrected, could jeopardize the full satisfaction of the debt. A loan classified as doubtful has critical weaknesses that make full collection of the obligation improbable. Classified loans include impaired loans and loans categorized as substandard, doubtful, and loss, which are not considered impaired. At December 31, 2019, impaired and classified loans totaled $17,664,000, or 2.96%, of gross loans as compared to $18,717,000, or 3.18%, of gross loans at December 31, 2018.

Loan participations are reviewed for allowance adequacy under the same guidelines as other loans in the portfolio, with an additional participation factor added, if required, for specific risks associated with participations. In general, participations are subject to certain thresholds and are reviewed for geographic location as well as the financial status of the underlying agent bank.

The formula allowance includes reserves for certain off-balance sheet risks including letters of credit, unfunded loan commitments, and lines of credit. Reserves for undisbursed commitments are generally formula allocations based on historical loss experience and other loss factors, rather than specific loss contingencies. At December 31, 2019 and 2018, the formula

35


reserve allocated to undisbursed commitments totaled $552,000 and $494,000, respectively. The reserve for unfunded commitments is considered a reserve for contingent liabilities and is therefore carried as a liability on the balance sheet for all periods presented.
 
Specific allowances are established based on management’s periodic evaluation of loss exposure inherent in impaired loans. For impaired loans, specific allowances are determined based on the net realizable value of the underlying collateral, the net present value of the anticipated cash flows, or the market value of the underlying assets. Formula allowances for classified loans, excluding impaired loans, are determined on the basis of additional risks involved with individual loans that may be in excess of risk factors associated with the loan portfolio as a whole. The specific allowance is different from the formula allowance in that the specific allowance is determined on a loan-by-loan basis based on risk factors directly related to a particular loan, as opposed to the formula allowance which is determined for a pool of loans with similar risk characteristics, based on past historical trends and other risk factors which may be relevant on an ongoing basis.

The unallocated portion of the allowance is based upon management’s evaluation of various conditions that are not directly measured in the determination of the formula and specific allowances. The conditions may include, but are not limited to, general economic and business conditions affecting key lending areas, credit quality trends, collateral values, loan volumes and concentrations, and other business conditions.
 
The following table summarizes the specific allowance, formula allowance, and unallocated allowance at December 31, 2019 and 2018.
(In thousands)
December 31, 2019
December 31, 2018
Specific allowance – impaired loans
$
1,145

$
1,776

Formula allowance – classified loans not impaired
59

4

Formula allowance – special mention loans
355

17

Total allowance for special mention and classified loans
1,559

1,797

Formula allowance for pass loans
6,176

6,005

Unallocated allowance
173

593

Total allowance
7,908

8,395

Impaired loans
17,072

18,683

Classified loans not considered impaired
592

34

Total classified and impaired loans
17,664

18,717

Special mention loans not considered impaired
5,846

2,228


 The following table summarizes allowance for loan losses, nonperforming loans, and classified loans for the periods shown:

36


(Dollars in thousands)
December 31, 2019
December 31, 2018
Allowance for loan losses ("ALLL") - beginning of period
$
8,395

$
9,267

Net loans charged-off (recovered) during period
507

(892
)
Provision (recovery of provision) for credit loss
20

(1,764
)
Allowance for loan losses - end of period
7,908

8,395

Loans outstanding at period-end
597,374

587,933

ALLL as % of loans at period-end
1.33
%
1.43
%
Nonaccrual loans
11,697

12,052

Accruing restructured loans
2,389

3,832

Loans, past due 90 days or more, still accruing
386


Total non-performing loans
14,472

15,884

ALLL as % of nonperforming loans
54.64
%
52.85
%
Impaired loans
17,072

18,683

Classified loans not considered impaired
592

34

Total classified and impaired loans
$
17,664

$
18,717

ALLL as % of classified loans
44.77
%
44.85
%
 
Impaired loans decreased $1,611,000 between December 31, 2018 and December 31, 2019 while the specific allowance related to those impaired loans decreased $631,000 between December 31, 2018 and December 31, 2019. This was the result of certain payoffs with higher reserves throughout the year, and the addition of newly identified collateral-dependent impaired loans. The formula allowance related to criticized loans that are not impaired (including special mention and substandard) increased by $393,000 between December 31, 2018 and December 31, 2019 through a risk upgrade of one significant-balance loan. The level of “pass” loans increased approximately $6,888,000 between December 31, 2018 and December 31, 2019, while the related formula allowance increased $171,000 during the same period. The formula allowance for "pass loans" is derived from loss factors using migration analysis and management's consideration of qualitative factors. The unallocated reserve totaled $173,000, or 2.2% of total ALLL at December 31, 2019, and $593,000, or 7.1%, of total ALLL at December 31, 2018. The decrease in the unallocated reserve was due to continuing credit improvements within the portfolio. In evaluating the level of the unallocated reserve, management considered loan relationships, construction and land development concentrations, and loss history relative to peers.

The specific allowance portion of the analysis is designed to be self-correcting by taking into account the current loan loss experience based on that segment of the portfolio. By analyzing the estimated losses inherent in the loan portfolio on a quarterly basis, management is able to adjust specific and inherent loss estimates using the most recent information available. In performing the periodic migration analysis, management believes that historical loss factors used in the computation of the formula allowance need to be adjusted to reflect current changes in market conditions and trends in the loan portfolio. There are a number of other factors which are reviewed when determining adjustments in the historical loss factors. Those factors include (1) trends in delinquent and nonaccrual loans, (2) trends in loan volume and terms, (3) effects of changes in lending policies, (4) concentrations of credit, (5) competition, (6) national and local economic trends and conditions, (7) experience of lending staff, (8) loan review and Board of Directors oversight, (9) high balance loan concentrations, and (10) other business conditions.

The general reserve requirements (ASC 450-70) decreased with the continued strengthening of local, state, and national economies and resultant impact on the local lending base. This has resulted in a lower qualitative component being used for the general reserve calculation. The stake-in-the-ground methodology requires the Company to use December 31, 2005 as the starting point of the look back period to capture loss history and better capture an entire economic cycle. Time horizons are subject to Management's assessment of the current period, taking into consideration changes in business cycles and environment changes.

Management and the Company’s lending officers evaluate the loss exposure of classified and impaired loans on a weekly basis and through discussions and officer meetings as conditions change. The Company’s Loan Committee meets weekly, serving as a forum to discuss specific problem assets that pose significant concerns to the Company and to keep the Board of Directors informed through committee minutes. All special mention and classified loans are reported quarterly on Problem Asset Reports and Impaired Loan Reports and are reviewed by senior management. Migration analysis and impaired loan analysis are

37


performed on a quarterly basis and adjustments are made to the allowance as deemed necessary. The Board of Directors is kept abreast of any changes or trends in problem assets on a monthly basis, or more often if required.

The specific allowance for impaired loans is measured based on the present value of the expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. The amount of impaired loans is not directly comparable to the amount of nonperforming loans. The primary differences between impaired loans and nonperforming loans are: (i) all loan categories are considered in determining nonperforming loans while impaired loan recognition is limited to commercial and industrial loans, commercial and residential real estate loans, construction loans, and agricultural loans, and (ii) impaired loan recognition considers not only loans 90 days or more past due, restructured loans and nonaccrual loans but may also include problem loans other than delinquent loans.

A loan is considered to be impaired when, based upon current information and events, it is probable the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement.  Impaired loans include nonaccrual loans, troubled debt restructures, and performing loans in which full payment of principal or interest is not expected. Management bases the measurement of these impaired loans either on the fair value of the loan's collateral or the expected cash flows on the loans discounted at the loan's stated interest rates. Cash receipts on impaired loans not performing to contractual terms and that are on nonaccrual status are used to reduce principal balances. Impairment losses are included in the allowance for credit losses through a charge to the provision, if applicable.

At December 31, 2019 and 2018, the recorded investment in loans for which impairment has been recognized totaled $17,072,000 and $18,683,000, respectively. Included in total impaired loans at December 31, 2019, are $3,008,000 of impaired loans for which the related specific allowance is $1,145,000, as well as $14,064,000 of impaired loans that, as a result of excess collateral or excess in the calculation of net present value of future cash flows, did not need a specific allowance. Total impaired loans at December 31, 2018 included $5,437,000 of impaired loans for which the related specific allowance was $1,776,000, as well as $13,246,000 of impaired loans that as a result of write-downs on the fair value of the collateral, did not have a specific allowance. The average recorded investment in impaired loans was $18,125,000 and $17,197,000 during the years ended December 31, 2019 and 2018, respectively. In most cases, the Company uses the cash basis method of income recognition for impaired loans. In the case of certain troubled debt restructuring for which the loan is performing under the current contractual terms, income is recognized under the accrual method.

The largest category of impaired loans at December 31, 2019 was real estate construction and development loans, comprising 67.23% of total impaired loans. Impaired commercial and industrial loans decreased $1,062,000, impaired real estate mortgage loans decreased $199,000, impaired construction loans decreased $185,000, and impaired agricultural loans decreased $124,000 during the year ended December 31, 2019. Specific collateral related to impaired loans is reviewed for current appraisal information, economic trends within geographic markets, loan-to-value ratios, and other factors that may impact the value of the loan collateral. Adjustments are made to collateral values as needed for these factors. Of total impaired loans, approximately $16,324,000, or 95.6%, were secured by real estate at December 31, 2019, as compared to $15,736,000, or 84.23%, of total impaired loans at December 31, 2018.

The following table summarizes the components of impaired loans and their related specific allowance at December 31, 2019 and 2018
 
Balance
 
Allowance
 
Balance
 
Allowance
(In thousands)
December 31, 2019
 
December 31, 2019
 
December 31, 2018
 
December 31, 2018
Commercial and industrial
$
1,754

 
$
606

 
$
2,816

 
$
787

Real estate – mortgage
3,146

 
283

 
3,345

 
469

Real estate construction and development
11,478

 

 
11,663

 

Agricultural
694

 
256

 
818

 
520

Installment and student loans

 

 
41

 

Total impaired loans
$
17,072

 
$
1,145

 
$
18,683

 
$
1,776


Included in impaired loans are loans modified in troubled debt restructurings (TDRs), where concessions have been granted to borrowers experiencing financial difficulties in an attempt to enhance collection. The Company makes various types of concessions when structuring TDRs including rate reductions, payment extensions, and forbearance.


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At December 31, 2019, total TDRs of $5,187,000 included $2,654,000 in real estate construction balances, $1,060,000 in residential mortgage balances, and $898,000 in commercial real estate balances. At December 31, 2018, total TDRs of $7,059,000 included $2,838,000 in real estate construction balances, $2,029,000 in residential mortgage balances, and $1,305,000 in commercial real estate balances.

Total TDRs decreased by 26.52% at December 31, 2019, as compared to December 31, 2018. Nonaccrual TDRs decreased by 13.29% and accruing TDRs decreased by 37.66% over the same period. All TDR categories decreased when compared on a year-over-year basis. Concessions granted include lengthened maturities and/or rate reductions that enabled the borrower to complete projects. In large part, current decreases are related to a recovering real estate market.
 
The following tables summarizes TDRs by type, classified separately as nonaccrual or accrual, which are included in impaired loans at December 31, 2019 and December 31, 2018.
 
Total TDRs
Nonaccrual TDRs
Accruing TDRs
 (In thousands)
December 31, 2019
December 31, 2019
December 31, 2019
Commercial and industrial
$
9

$

$
9

Real estate - mortgage:
 

 

 

Commercial real estate
898


898

Residential mortgages
1,060


1,060

Total real estate mortgage
1,958


1,958

Real estate construction and development
2,654

2,654


Agricultural
566

144

422

Installment and student loans



Total Troubled Debt Restructurings
$
5,187

$
2,798

$
2,389

 
Total TDRs
Nonaccrual TDRs
Accruing TDRs
 (In thousands)
December 31, 2018