Executive Summary / Key Takeaways

• United Security Bancshares, a community bank rooted in California's Central Valley, saw its first-quarter 2025 net income decline significantly by 35.54% year-over-year, primarily driven by a substantial increase in the provision for credit losses.
• Despite the earnings pressure, the bank demonstrated strength in core profitability metrics, expanding its net interest margin to 4.58% in Q1 2025 from 4.35% in Q1 2024, benefiting from higher loan yields and disciplined deposit pricing.
• Asset quality remains a key area of focus, with elevated net charge-offs in the student loan portfolio ($2.76 million in Q1 2025) and an increase in Other Real Estate Owned (OREO) balances ($7.90 million at March 31, 2025) impacting results and requiring increased provisioning.
• The bank maintains a solid capital position, with a Bank Tier 1 Leverage Ratio of 12.84% well above regulatory minimums, providing a buffer against potential future credit losses and supporting strategic initiatives.
• UBFO operates in a competitive California market, leveraging its local brand and relationships as key differentiators against larger, more technologically advanced regional banks, while facing challenges related to scale and the need for continued investment in digital capabilities.

Setting the Scene: A Community Bank's Foundation in the Golden State

United Security Bancshares (UBFO) operates as the holding company for United Security Bank, a community bank established in 1987 and headquartered in Fresno, California. With 13 banking branches and several interactive teller machines (ITMs), UBFO serves communities across Fresno, Madera, Kern, and Santa Clara counties. The bank's core business revolves around the fundamental pillars of community banking: acquiring deposits and originating loans, primarily serving small-to-medium businesses and individuals within its geographic footprint.

UBFO's history is marked by a focus on building deep local relationships, particularly within the Central Valley, a region significantly influenced by agriculture and real estate. This localized approach forms the bedrock of its strategy, aiming to provide tailored financial solutions and maintain a stable, core deposit base.

The competitive landscape in California banking is dynamic and intense. UBFO competes directly with larger regional banks like CVB Financial Corp. (CVBF), Pacific Premier Bancorp (PPBI), and Westamerica Bancorporation (WABC), as well as smaller local independent banks. Indirect competition comes from fintech firms and online banks offering digital-first alternatives. While larger peers often boast greater scale, more advanced digital platforms, and higher efficiency metrics (e.g., CVBF and WABC with higher net margins and ROIC), UBFO's strategic positioning emphasizes its local brand and established community ties. These relationships foster customer loyalty, potentially leading to better deposit retention and recurring revenue streams. Additionally, the bank's regulatory licenses for community banking enable a focus on local lending with potentially lower origination costs in its specific niches. However, UBFO faces inherent disadvantages in terms of scale, which can result in higher operating costs per unit compared to larger rivals, and lags in the speed of technological innovation relative to some peers.

Operationally, UBFO's business is centered on its loan portfolio, the largest component of its earning assets. This portfolio is diversified across commercial real estate, residential mortgages, real estate construction and development, agricultural loans, and installment loans, including a notable student loan portfolio. The bank utilizes third-party servicers for specific portfolios, such as Dovenmuehle Mortgage, Inc. for purchased residential mortgages and ZuntaFi for its student loans, allowing it to manage these specialized assets. The bank's technology infrastructure includes its branch network, ITMs, and mobile banking capabilities, which are essential for customer service and operational efficiency. While these tools provide necessary access points, the competitive analysis suggests that some larger peers have invested more heavily in digital platforms, potentially enabling faster processing times and lower costs per transaction, highlighting a strategic area for potential enhancement for UBFO.

Financial Performance: Navigating Profitability and Provisioning

The first quarter of 2025 presented a mixed financial picture for United Security Bancshares, demonstrating core margin strength alongside significant pressure from credit quality. Net income for the quarter ended March 31, 2025, totaled $2.70 million, a notable decrease of 35.54% compared to $4.20 million reported in the same period of 2024. This decline was primarily attributable to a substantial increase in the provision for credit losses and higher noninterest expenses.

The provision for credit losses surged to $2.30 million in Q1 2025, a significant increase from just $173,000 in Q1 2024. This increase was largely driven by elevated charge-offs within the student loan portfolio. Noninterest expense also rose by 12.9% year-over-year, reaching $7.60 million, primarily due to increases in salaries and employee benefits, professional fees (including consulting and legal expenses), and data processing costs. Partially offsetting these expense increases was a decrease in loan-related expenses, benefiting from the recovery of legal expenses tied to a nonaccrual loan payoff.

Despite the impact of provisioning and expenses, UBFO's core interest-generating engine showed resilience. Net interest income increased to $12.30 million in Q1 2025 from $11.71 million in Q1 2024. This improvement was reflected in an expanded net interest margin, which rose to 4.58% from 4.35% over the same period. The margin expansion was primarily a result of an increase in loan yields (averaging 6.17% in Q1 2025 vs. 6.00% in Q1 2024) and a decrease in short-term borrowing costs, partially offset by a higher cost of deposits (averaging 1.09% in Q1 2025 vs. 0.72% in Q1 2024). The collection of $890,000 in foregone interest from a nonaccrual loan payoff also contributed to the increase in net interest income. Noninterest income saw a significant increase of 29.2% to $1.36 million, largely influenced by a $270,000 gain from the change in fair value of junior subordinated debentures in Q1 2025, compared to a $294,000 loss in Q1 2024.

The decrease in net income naturally impacted profitability ratios, with annualized return on average assets (ROAA) falling to 0.91% from 1.40% and annualized return on average equity (ROAE) decreasing to 8.19% from 13.51% compared to the prior year quarter.

Balance Sheet Dynamics and Asset Quality Focus

UBFO's balance sheet saw modest shifts in the first quarter of 2025. Total assets decreased slightly to $1.19 billion at March 31, 2025, from $1.21 billion at December 31, 2024. Total loans, net of unearned fees, also decreased by 0.84% to $920.7 million from $928.5 million over the same period, driven by decreases in real estate construction, real estate mortgage, installment, and commercial and industrial loans, partially offset by an increase in agricultural loans. Total deposits decreased by 2.97% to $1.03 billion from $1.06 billion, primarily due to decreases in NOW and money market accounts.

Asset quality remains a critical area for management attention. Total nonperforming assets decreased by 17.4% to $14.20 million at March 31, 2025, from $17.20 million at December 31, 2024. This improvement was primarily due to a decrease in nonaccrual loans, which fell by 53.3% to $5.70 million. The decrease in nonaccrual loans was a result of the payoff of one loan ($3.2 million) and the transfer of another loan ($3.3 million) related to the York Monterey Properties subdivision to Other Real Estate Owned (OREO). The OREO balance consequently increased significantly to $7.90 million from $4.60 million. At quarter-end, the nonaccrual loan balance consisted of a single real estate construction loan deemed well-collateralized and in the process of collection.

The student loan portfolio, totaling $30.6 million, continues to be a source of asset quality pressure. Net charge-offs for the quarter ended March 31, 2025, totaled $2.76 million, a substantial increase from $289,000 in the prior year quarter. The majority of these charge-offs ($2.8 million) occurred within the student loan portfolio, leading to the significant increase in the provision for credit losses. The allowance for credit losses on loans stood at $15.36 million, representing 1.66% of total loans at March 31, 2025, compared to 1.72% at December 31, 2024. Management believes the allowance is adequate to cover estimated inherent losses, but the elevated charge-offs highlight the ongoing risk in specific portfolios.

Liquidity and Capital Strength

A key strength for UBFO is its solid liquidity and capital position. The bank maintains a robust liquid asset base, including cash and investment securities, and relies on a stable funding mix. Core deposits, excluding time deposits over $250,000 and brokered deposits, constitute a significant 87.3% of total deposits, providing a reliable funding source. The bank has also strategically utilized brokered deposits, holding $100.3 million at March 31, 2025, with an average cost of 4.55% in Q1 2025, to manage its funding needs.

UBFO has substantial borrowing capacity through collateralized lines of credit with the Federal Reserve Bank and the Federal Home Loan Bank, totaling $716.0 million in unused capacity at March 31, 2025, in addition to unsecured lines. Outstanding borrowings totaled $8.0 million at quarter-end. The loan-to-deposit ratio was 89.70% at March 31, 2025, indicating a healthy balance between lending and funding.

Capital levels remain strong, exceeding regulatory requirements. The Bank's Tier 1 Leverage Ratio was 12.84% at March 31, 2025, comfortably above the 9.00% minimum required to be considered well-capitalized under the Community Bank Leverage Ratio Framework. Management expresses confidence in the ability of both the Company and the Bank to continue meeting minimum capital requirements for the foreseeable future. The Company also maintains a stock repurchase program authorized for up to $3.0 million, although no shares were repurchased in the recent quarter. The regular quarterly cash dividend of $0.12 per share underscores the bank's commitment to returning capital to shareholders, supported by cash flow from the Bank to the Holding Company.

Outlook and Risks

UBFO's future performance will be shaped by its ability to execute its strategic priorities and navigate external economic forces. Management's key focus areas include managing the balance sheet, enhancing revenue sources, attracting and retaining deposit customers, and maintaining market share.

The bank's earnings are sensitive to changes in interest rates, which impact both loan yields and deposit costs. While the net interest margin expanded in Q1 2025, future movements in the prime rate and the Federal Reserve's monetary policy remain uncertain, influenced by factors such as inflation, unemployment, and international instability.

The local economic conditions in California's Central Valley, particularly the health of the agricultural sector and real estate markets, pose significant risks. Downturns in agriculture due to factors like water allocation reductions or trade policies could negatively impact borrower cash flows and collateral values, potentially leading to increased loan losses. The increase in OREO and elevated student loan charge-offs in Q1 2025 serve as recent examples of these risks materializing.

Competition from larger banks with greater scale and technological resources could pressure loan pricing and deposit costs, potentially impacting UBFO's margins and market share if it cannot effectively leverage its local advantages or enhance its digital offerings. Cybersecurity threats and operational risks inherent in banking also require continuous vigilance.

While management is not currently aware of conditions expected to adversely affect overall loan loss levels beyond those already identified, the concentration of risk in specific portfolios, such as real estate and the student loan book, warrants close monitoring.

Conclusion

United Security Bancshares operates as a well-capitalized community bank with a strong local presence in its California markets. The first quarter of 2025 highlighted the dual nature of its current performance: solid underlying net interest margin expansion driven by effective asset-liability management, juxtaposed with significant pressure from asset quality deterioration, particularly within the student loan portfolio and leading to an increase in OREO.

The core investment thesis for UBFO rests on its ability to leverage its established community banking model, maintain a stable core deposit base, and capitalize on favorable interest rate dynamics to drive net interest income. However, the recent increase in credit loss provisioning and charge-offs underscores the inherent risks within its loan portfolio, demanding vigilant credit risk management. While UBFO benefits from its local market expertise and relationships, it must also strategically address the competitive challenges posed by larger, more technologically advanced institutions to ensure long-term growth and profitability. Investors should closely monitor trends in asset quality, particularly in the student loan and real estate portfolios, alongside the bank's ability to control expenses and adapt its operational technology in a competitive environment.