Executive Summary / Key Takeaways

• Profitability Under Pressure: United Security Bancshares (UBFO) experienced a significant decline in net income for Q2 and H1 2025, primarily due to a substantial increase in the provision for credit losses, particularly from its student loan portfolio, and rising operating expenses.
• Resilient Net Interest Margin: Despite increasing deposit costs, UBFO successfully expanded its net interest margin to 4.46% for the first half of 2025, driven by higher loan yields and reduced short-term borrowing expenses, showcasing disciplined balance sheet management.
• Strategic Focus on Core Banking: The company maintains a strong emphasis on its long-term, core customer relationships in California's Central Valley, leveraging its local presence and standard banking technologies like ITMs to deliver personalized service and manage credit risk.
• Asset Quality Headwinds: The student loan portfolio remains a notable challenge, with persistent high charge-offs post-pandemic forbearance, contributing significantly to credit loss provisions, while real estate construction loan volume also increased provisions.
• Solid Capital and Liquidity: UBFO demonstrates robust capital ratios and ample liquidity, with $727 million in unused credit lines, providing a stable foundation amidst market uncertainties and supporting its ability to manage future growth and obligations.

The Central Valley's Anchor: United Security Bancshares' Enduring Strategy

United Security Bancshares, founded in 1987 and headquartered in Fresno, California, operates as a dedicated regional bank holding company through its wholly-owned subsidiary, United Security Bank. The company's core mission revolves around providing comprehensive commercial banking services to businesses, professionals, and individuals across 13 branches and several interactive teller machines (ITMs) in California's Fresno, Madera, Kern, and Santa Clara counties. This deep-rooted local presence forms the bedrock of its strategy: cultivating long-term, core customer relationships by offering tailored deposit and lending solutions.

The banking industry, particularly for regional players like UBFO, is currently shaped by a confluence of macroeconomic and geopolitical forces. Inflationary pressures, labor shortages, and global conflicts contribute to economic unpredictability, impacting financial markets and the cost of capital. Furthermore, the Federal Reserve's monetary policy, which saw a 100-basis point interest rate decrease in 2024, now faces uncertainty regarding future rate actions due to market turmoil. Regional banks also contend with the lingering effects of 2023 and 2024 bank failures, which have influenced depositor behavior and investor sentiment.

In this dynamic environment, UBFO's overarching strategy prioritizes maintaining adequate liquidity, diligently managing credit risk, and fostering responsible balance sheet growth. The company's primary lending emphasis remains in real estate mortgage and real estate construction and development, reflecting the economic drivers of its Central Valley footprint. While residential mortgages are offered, a significant portion comprises purchased conventional mortgage pools, indicating a strategic approach to portfolio diversification.

Competitive Landscape: Local Expertise Versus Scale and Innovation

UBFO operates in a competitive California banking market, vying for customers against a mix of larger regional banks and more specialized institutions. Key direct competitors include CVB Financial Corp. (CVBF), Heritage Commerce Corp. (HTBK), East West Bancorp (EWBC), and Cathay General Bancorp (CATY).

UBFO's competitive advantage lies in its strong local presence and personalized customer service. This community-centric approach fosters deep customer loyalty, potentially leading to stable, low-cost deposits and reduced customer acquisition costs. For instance, while larger rivals like CVBF might offer a broader network, UBFO's tailored engagement in niche local markets can lead to superior operational execution and potentially better pricing power in specific segments. Compared to East West Bancorp (EWBC), with its expansive global reach and strong financial performance, UBFO's localized focus allows for a more intimate understanding of regional economic nuances, such as the Central Valley's agricultural dependence.

However, UBFO faces vulnerabilities due to its smaller scale and potentially slower pace of technological innovation compared to some rivals. While the company utilizes interactive teller machines (ITMs) and offers online and mobile banking services to enhance customer experience and operational efficiency, the company does not detail any proprietary or truly differentiated technological moats. Instead, UBFO appears to leverage standard banking technologies to support its community banking model. This contrasts with competitors like Heritage Commerce Corp. (HTBK), which, with its alignment to California's tech sector, may adopt digital tools more rapidly, potentially gaining advantages in efficiency and customer acquisition. The absence of specific R&D initiatives or new technological developments with quantifiable targets suggests UBFO's technology strategy is more focused on enabling its service model rather than creating a distinct technological edge.

Financially, UBFO's gross profit margin of 68.93% and net profit margin of 17.07% (TTM) are competitive within the regional banking sector, though some larger peers like CVBF (Gross Profit Margin 73%, Net Profit Margin 30%) demonstrate higher profitability. UBFO's Price-to-Book (P/B) ratio of 1.19 and Price-to-Earnings (P/E) ratio of 14.34 (TTM) suggest a valuation that reflects its regional standing and recent performance. The company's dividend yield of 5.16% (TTM) is attractive, but its payout ratio of 56% (2024) indicates a significant portion of earnings is distributed, which could limit capital for aggressive growth or technology investments compared to rivals with lower payout ratios.

Financial Performance: Navigating Headwinds with Margin Resilience

United Security Bancshares reported a challenging first half of 2025, with net income significantly impacted by increased credit loss provisions. For the six months ended June 30, 2025, net income decreased by 42.66% to $4.85 million, down from $8.46 million in the comparable 2024 period. This decline translated into a reduced annualized return on average assets (ROAA) of 0.82% (down from 1.42%) and an annualized return on average equity (ROAE) of 7.31% (down from 13.64%). The primary drivers for this contraction were a substantial increase in the provision for credit losses, higher deposit interest expense, and elevated noninterest expenses.

Despite these pressures, UBFO demonstrated resilience in its core banking operations, particularly in its net interest margin. The net interest margin expanded to 4.46% for the six months ended June 30, 2025, an increase of 15 basis points from 4.31% in the prior year. This improvement was largely a result of rising loan yields and a decrease in short-term borrowing costs, which offset the impact of increased deposit interest expenses. Management's "disciplined deposit pricing efforts" were instrumental in keeping the cost of funds relatively low, even as overall deposit rates climbed from 0.75% to 1.10% year-over-year.

Loan and fee income saw a modest increase, including a notable $890,000 in foregone interest collected from a nonaccrual loan payoff. Total loans, net of unearned fees, grew by 2.03% to $947.3 million at June 30, 2025, from $928.5 million at December 31, 2024. This growth was primarily driven by increases in agricultural loans (up $15.4 million or 31.09%), real estate construction and development loans (up $15.2 million or 13.64%), and real estate mortgage loans (up $4.2 million or 0.63%). These gains were partially offset by decreases in commercial and industrial loans and installment loans, particularly student loans.

Noninterest income, however, decreased by 17.46% to $2.12 million for the six months ended June 30, 2025. This was mainly due to the absence of a $573,000 gain on life insurance proceeds realized in the prior year and a $48,000 loss from the fair value adjustment of junior subordinated debentures, influenced by SOFR yield curve fluctuations. Noninterest expenses increased by 11.93% to $15.34 million, driven by higher salaries and employee benefits (including group insurance, stock-based compensation, and deferred compensation) and increased data processing costs. These were partially mitigated by lower professional fees and a recovery of $168,000 in loan-related legal expenses.

Asset Quality and Liquidity: Managing Risk and Maintaining Stability

The most significant headwind for UBFO's recent performance has been asset quality, specifically within its student loan portfolio. The provision for credit losses surged to $3.92 million for the six months ended June 30, 2025, a stark contrast to $306,000 in the same period of 2024. This increase was largely attributed to "persistent high rate of student loan charge-offs," primarily due to the expiration of pandemic-related payment forbearance programs. Student loan charge-offs totaled $4.15 million for the first half of 2025, leading to a net charge-off to average loans ratio of 0.87%, significantly higher than 0.14% in the prior year.

The student loan portfolio, totaling $29.4 million at June 30, 2025, has not seen new originations or purchases since 2019. While repayment is predicated on students becoming high-income earners, with approximately one-third of the portfolio supported by non-student co-borrowers, the current environment presents challenges. The allowance for credit losses (ACL) stood at 1.68% of outstanding loan balances at June 30, 2025, and management believes it remains sufficient to absorb inherent risks, despite the recent surge in charge-offs. Nonperforming assets decreased to $13.82 million at June 30, 2025, from $17.20 million at December 31, 2024, primarily due to the payoff of one nonaccrual loan and the transfer of another to Other Real Estate Owned (OREO), which increased to $7.85 million.

In terms of liquidity and capital, UBFO maintains a robust position. Core deposits, representing approximately 87.43% of total deposits, serve as a stable and significant funding source. At June 30, 2025, the company had $727 million in unused lines of credit with the Federal Reserve Bank and the Federal Home Loan Bank, collateralized by $839.3 million in loans and investment securities. The Bank's Tier 1 Leverage Ratio stood at 12.56%, and the Company's at 12.83%, both well above regulatory minimums. Management anticipates continuing to meet minimum capital requirements for the foreseeable future. Furthermore, UBFO demonstrated proactive balance sheet management by executing a partial redemption of $3.0 million in junior subordinated debentures on July 1, 2025, reducing its contractual principal balance to $9.0 million. The company also has an authorized share repurchase program of up to $3.0 million, though no shares were repurchased in the recent periods.

Outlook and Risks: Navigating an Unpredictable Horizon

UBFO's outlook is shaped by its ability to manage ongoing macroeconomic uncertainties and specific portfolio risks. The company operates in California's Central Valley, an economy heavily reliant on agriculture, making it susceptible to factors like declining agricultural prices, yields, and water allocation reductions due to severe droughts. The long-term implications of the Sustainable Groundwater Management Act, aiming for sustainable groundwater management by 2042, are yet to be fully determined but pose a future risk. Trade policies, including tariffs and trade wars, could also negatively impact the local agricultural and construction industries.

While management is "not currently aware of any conditions that may adversely affect the levels of losses incurred in the Company’s loan portfolio" beyond the student loan segment, the persistent high charge-offs in student loans remain a critical area to monitor. The broader financial services industry also presents risks, with recent bank failures highlighting potential impacts on depositor behavior and investor sentiment. UBFO's smaller scale compared to larger regional and national banks could make it more sensitive to these industry-wide shifts and competitive pressures on loan pricing.

The appointment of Jay Gill as Vice Chairman is a strategic move aimed at shaping the company's long-term strategy, identifying new business opportunities, and driving continued organic growth. This leadership enhancement signals a proactive approach to adapting to market conditions and enhancing revenue sources, attracting and retaining deposit customers, and maintaining market share.

Conclusion

United Security Bancshares presents an investment thesis centered on a resilient regional bank with deep community ties in California's Central Valley. Its strategic focus on core customer relationships, disciplined balance sheet management, and robust capital and liquidity position provide a stable foundation. The company's ability to expand its net interest margin despite rising deposit costs highlights operational effectiveness in a challenging interest rate environment.

However, the significant decline in recent profitability, primarily driven by persistent charge-offs in the legacy student loan portfolio and increased operating expenses, represents a material headwind. While management believes its allowance for credit losses is sufficient, the ongoing performance of this portfolio and the broader economic conditions in its agriculturally dependent market warrant close observation. UBFO's competitive standing, while strong in local, personalized service, faces pressure from larger, more technologically advanced rivals. Investors should weigh UBFO's fundamental strengths and attractive dividend yield against the continued challenges in asset quality and the need for sustained organic growth in a competitive and uncertain economic landscape.