UBH Usb Holdings CO

U.S.B. HOLDING CO., INC.

(Exact Name of Registrant as Specified in Its Charter)

DELAWARE		36-3197969
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

CLASS		NUMBER OF SHARES OUTSTANDING AT NOVEMBER 1, 2007
Common stock, par value $0.01 per share			22,023,291

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FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007

(000’s except share data)

 

		Common Stock Shares Outstanding			Common Stock Par Value			Additional Paid-In Capital			Retained Earnings			Treasury Stock			Common Stock Held for Benefit Plans			Deferred Compensation Obligation			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance at January 1, 2007			21,902,023		$	231		$	212,398		$	40,777		$	(22,348	)	$	(3,390	)	$	3,390		$	(7,622	)	$	223,436
Net Income												19,057															19,057
Other comprehensive income:
Net unrealized securities gains arising during the period, net of tax of $207																								386			386
Reclassification adjustment of net gain for securities sold, net of tax of $2																								(4	)		(4	)
Compensation cost related to The Retirement Plan for Non-Employee Directors, net of tax benefit of $15																								27			27
Other comprehensive income																								409			409
Total comprehensive income																											19,466
Cash dividends:
Common ($0.45 per share)												(9,880	)														(9,880	)
Junior preferred stock												(10	)														(10	)
Common stock options exercised and related tax benefit			120,389						(173	)					2,184												2,011
Compensation cost related to stock options									1,879																		1,879
Deferred compensation obligation																		(246	)		246						―
Balance at September 30, 2007			22,022,412		$	231		$	214,104		$	49,944		$	(20,164	)	$	(3,636	)	$	3,636		$	(7,213	)	$	236,902

  See notes to condensed consolidated financial statements.

 

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U.S.B. HOLDING CO., INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006

(000’s except share data)

 

		Common Stock Shares Outstanding			Common Stock Par Value			Additional Paid-In Capital			Retained Earnings			Treasury Stock			Common Stock Held for Benefit Plans			Deferred Compensation Obligation			Accumulated Other Comprehensive Loss			Total Stockholders’ Equity
Balance at January 1, 2006			21,713,805		$	231		$	211,686		$	21,654		$	(21,670	)	$	(2,927	)	$	2,927		$	(7,748	)	$	204,153
Net Income												23,485															23,485
Other comprehensive loss:
Net unrealized securities loss arising during the period, net of tax benefit of $272																								(505	)		(505	)
Reclassification adjustment of net gain for securities sold, net of tax of $2																								(3	)		(3	)
Other comprehensive loss																								(508	)		(508	)
Total comprehensive income																											22,977
Cash dividends:
Common ($0.42 per share)												(9,139	)														(9,139	)
Junior preferred stock												(10	)														(10	)
Common stock options exercised and related tax benefit			216,186						317						3,171												3,488
Compensation cost related to stock options									868																		868
Purchases of treasury stock			(188,822	)					(456	)					(4,113	)											(4,569	)
Deferred compensation obligation																		(164	)		164						―
Balance at September 30, 2006			21,741,169		$	231		$	212,415		$	35,990		$	(22,612	)	$	(3,091	)	$	3,091		$	(8,256	)	$	217,768

  See notes to condensed consolidated financial statements.

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.	Principles of Consolidation

The condensed consolidated financial statements include the accounts of U.S.B. Holding Co., Inc. and its wholly-owned subsidiaries (the “Company”), Union State Bank (the “Bank”) and Ad Con, Inc. The condensed consolidated financial statements also include the Bank’s wholly-owned subsidiaries, Dutch Hill Realty Corp., U.S.B. Financial Services, Inc., and USB Delaware Inc., including its majority-owned subsidiary, TPNZ Preferred Funding Corporation (“TPNZ”). All significant intercompany accounts and transactions are eliminated in consolidation.

The Company also has four subsidiary trusts, Union State Capital Trust I, Union State Statutory Trust II, USB Statutory Trust III (through June 26, 2007, as described in Note 10 of these notes to condensed consolidated financial statements), and Union State Statutory Trust IV (collectively, the “Trusts”), that are not consolidated with the Company for financial reporting purposes in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Trusts were established by the Company in 1997, 2001, 2002, and 2004, respectively, for the purpose of issuing corporation-obligated mandatory redeemable capital securities (“Capital Securities”) and acquiring junior subordinated debt from the Company. See Note 10 to the Company’s Consolidated Financial Statements included in the Company’s 2006 Annual Report to Stockholders for a further discussion of the Capital Securities and the junior subordinated debt issued by the Company. The Company owns 100 percent of the voting securities of each of the Trusts. The Company has fully and unconditionally guaranteed the Capital Securities along with all obligations of the Trusts under the trust agreements relating to the Capital Securities. The Company’s ability to make interest payments on the subordinated debt is primarily dependent on the receipt of dividends from the Bank. See Note 9 of these notes to condensed consolidated financial statements for a discussion of the limits on the Bank’s ability to pay dividends to the Company.

2.	Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements include all adjustments (comprised of only normal and recurring adjustments) necessary to present fairly the financial position of the Company as of September 30, 2007, the Company’s operations for the three and nine months ended September 30, 2007 and 2006, and the Company’s cash flows and changes in stockholders’ equity for the nine months ended September 30, 2007 and 2006. For purposes of presenting the condensed consolidated statements of cash flows, cash and cash equivalents include cash and due from banks, as well as federal funds sold. Certain reclassifications have been made to prior year accounts to conform to the current year’s presentations.

The condensed consolidated financial statements have been prepared in accordance with GAAP and predominant practices used within the banking industry. A summary of the Company's significant accounting policies is set forth in Note 3 to the Consolidated Financial Statements included in the Company's 2006 Annual Report to Stockholders. In preparing such financial statements, management is required to make estimates and assumptions that affect the reported amounts of actual and contingent assets and liabilities as of the dates of the condensed consolidated statements of condition and the revenues and expenses for the periods reported. Actual results could differ significantly from those estimates.

 

7

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

These condensed consolidated financial statements should be read in conjunction with the Company’s Consolidated Financial Statements for the year ended December 31, 2006 and related notes included in the Company’s 2006 Annual Report to Stockholders and Form 10-K.

3.	Accounting Pronouncements

Accounting for Uncertainty in Income Tax Positions: In June 2006, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - An Interpretation of FASB Statement No. 109” (“FIN No. 48”). FIN No. 48 prescribes a recognition threshold and measurement attribute, as well as clear criteria for subsequently recognizing, derecognizing and measuring income tax positions, for financial statement purposes. FIN No. 48 establishes a “more-likely-than-not” recognition threshold that must be met before an income tax benefit can be recognized in the consolidated financial statements. To meet this threshold, a company must determine that, upon examination by the taxing authority, the income tax position is more likely than not to be sustained based on the technical merits of the position. Once the recognition threshold has been met, a company is required to recognize the largest amount of income tax benefit that is greater than 50 percent likely of being realized upon ultimate settlement with the taxing authority.

The Company adopted FIN No. 48 on January 1, 2007. Upon adoption of FIN No. 48 by the Company, the total amount of unrecognized income tax benefit was $0.5 million, of which the total amount, if recognized, that would favorably affect the effective income tax rate was $0.2 million. Unrecognized income tax benefits of $0.3 million are related to interest that would be incurred as a result of the Internal Revenue Service (“IRS”) and New York State Tax Department (“NYS Tax Department”) disallowing the income tax benefit during the year in which the benefits were recognized by the Company. Accrued interest on uncertain income tax positions and related penalties, when applicable, are recognized in the provision for income taxes. The Company’s adoption of FIN No. 48 did not have a material impact on the Company’s condensed consolidated financial statements.

The Company’s tax years for 2003, 2004, 2005, and 2006 can be subject to examination by the IRS according to a three year statute of limitations. The Company is currently under examination by the NYS Tax Department for the tax years 2003, 2004, and 2005. The Company can also be subject to examination by the NYS Tax Department for tax year 2006.

The Company’s uncertain income tax positions may change over the subsequent 12-month period as a result of completing the current NYS Tax Department examination for tax years 2003, 2004, and 2005. Upon adoption of FIN No. 48, unrecognized income tax benefits related to these tax years was $0.3 million.

Pending Accounting Pronouncement - Fair Value Measurements: In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements” (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. A fair value measurement should be determined based on the assumptions that market participants would use in pricing an asset or liability. SFAS No. 157 applies only to fair value measurements already required or permitted by other accounting standards and does not impose requirements for additional fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Management is currently evaluating the impact that the adoption of SFAS No. 157 will have on the Company’s consolidated financial statements.

 

8

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Pending Accounting Pronouncement - Fair Value Option for Financial Assets and Financial Liabilities: In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment to FASB Statement No. 115” (“SFAS No. 159”), which permits companies to choose to measure eligible items at fair value at specified election dates. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. SFAS No. 159 is effective as of the beginning of the first fiscal year that begins after November 15, 2007. Management is in the process of evaluating the effects of choosing to measure eligible items at fair value under SFAS No. 159.

4.	Accounting for Share-Based Compensation

SFAS No. 123R, “Share-Based Payment” (“SFAS No. 123R”), requires accounting for share-based compensation cost using a fair value method in the financial statements. Compensation cost is recognized, net of estimated forfeitures, for the portion of outstanding awards for which the requisite service has not yet been rendered, based on the grant-date fair value of those awards.

In 2005, 1998 and 1989, the stockholders of the Company approved Director Stock Option Plans (the “Director Plans”) under which options to purchase an aggregate of 2,041,358 shares (after adjustment for stock splits and dividends) of the Company’s common stock may be granted to all non-employee members of the Company’s Board of Directors. There have been options to purchase 292,459 shares (as adjusted for common stock dividends) granted under the 2005 Director Stock Option Plan, and there were options to purchase 232,541 shares (as adjusted for common stock dividends) remaining to be granted at September 30, 2007. No further options may be granted under the 1998 and 1989 Director Stock Option Plans.

Under the Tappan Zee Directors’ Stock Option Plan (the “Tappan Zee Directors’ Plan”), which was assumed by the Company, options to purchase 80,057 shares (as adjusted for common stock dividends) were authorized for grant to non-employee directors. There have been options to purchase an aggregate of 66,710 shares (as adjusted for common stock dividends) granted under this plan. This plan expired at the end of August 2006, and no further options may be granted under this plan.

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

A summary of the activity in the Director Plans and related information for the nine months ended September 30, 2007 is as follows:

 

		2007
		Options			Weighted-Average Exercise Price			Aggregate Intrinsic Value ($ in 000’s)
Vested outstanding at January 1, 2007			583,884		$	14.74
Unvested outstanding at January 1, 2007			97,486			21.88
Outstanding at January 1, 2007			681,370			15.76
Granted			100,162			20.59
Exercised			(24,915	)		10.30
Outstanding at September 30, 2007			756,617			16.58		$	5,029
Exercisable at September 30, 2007			656,455		$	15.97		$	4,765
Weighted average fair value of options granted during the nine months ended September 30, 2007					$	6.25

A summary of the activity in the Director Plans and Tappan Zee Directors’ Plan and related information for the nine months ended September 30, 2006 is as follows:  

 

		2006
		Options			Weighted-Average Exercise Price			Aggregate Intrinsic Value ($ in 000’s)
Vested outstanding at January 1, 2006			558,082		$	13.09
Unvested outstanding at January 1, 2006			94,811			20.14
Outstanding at January 1, 2006			652,893			14.11
Granted			97,486			21.88
Exercised			(69,009	)		8.79
Outstanding at September 30, 2006			681,370			15.76		$	4,290
Exercisable at September 30, 2006			583,884		$	14.74		$	4,273
Weighted average fair value of options granted during the nine months ended September 30, 2006					$	7.38

Under the 1993 and 1984 Incentive Stock Option Plans and the 2005, 2001, and 1997 Employee Stock Option Plans (collectively, the “Employee Stock Option Plans”), both incentive and non-qualified options to purchase an aggregate of 8,288,717 shares (after adjustment for stock splits and stock dividends) of the Company’s common stock were authorized to be granted to key employees of the Company and its subsidiaries. There have been options to purchase 1,038,447 shares (as adjusted for common stock dividends) granted under the 2005 Employee Stock Option Plan, and there were options to purchase 851,553 shares (as adjusted for common stock dividends) remaining to be granted at September 30, 2007. No further options may be granted under the 1993 and 1984 Incentive Stock Option Plans and the 2001 and 1997 Employee Stock Option Plans.

Under the Tappan Zee Stock Option Plan, which was assumed by the Company, options to purchase 186,798 shares (as adjusted for common stock dividends) were authorized for grant to employees. There have been options to purchase 133,430 shares (as adjusted for common stock dividends) granted under this plan. This plan expired at the end of August 2006, and no further options may be granted under this plan.

 

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

A summary of the activity in the Employee Stock Option Plans and related information for the nine months ended September 30, 2007 is as follows:

 

		2007
		Options			Weighted-Average Exercise Price			Aggregate Intrinsic Value ($ in 000’s)
Vested outstanding at January 1, 2007			1,990,693		$	14.96
Unvested outstanding at January 1, 2007			596,539			23.16
Outstanding at January 1, 2007			2,587,232			16.85
Granted			321,669			21.96
Cancelled			(3,205	)		21.87
Exercised			(95,474	)		15.29
Outstanding at September 30, 2007			2,810,222			17.48		$	16,524
Exercisable at September 30, 2007			2,000,376		$	15.31		$	15,843
Weighted average fair value of options granted
during the nine months ended September 30, 2007					$	6.55

A summary of the activity in the Employee Stock Option Plans and Tappan Zee Stock Option Plan and related information for the nine months ended September 30, 2006 is as follows:

 

		2006
		Options			Weighted-Average Exercise Price			Aggregate Intrinsic Value ($ in 000’s)
Vested outstanding at January 1, 2006			2,651,175		$	14.16
Unvested outstanding at January 1, 2006			1,560			22.26
Outstanding at January 1, 2006			2,652,735			14.16
Granted			321,586			21.96
Cancelled			(200	)		21.93
Exercised			(147,177	)		10.77
Expired			(69,858	)		22.34
Outstanding at September 30, 2006			2,757,086			15.04		$	19,345
Exercisable at September 30, 2006			2,439,267		$	14.14		$	19,313
Weighted average fair value of options granted
during the nine months ended September 30, 2006					$	6.92

For the three months ended September 30, 2007 and 2006, share-based compensation expense under SFAS No. 123R was $0.7 million and $0.4 million, resulting in a decrease in net income of $0.4 million and $0.2 million, a decrease in basic earnings per common share of $0.02 and $0.01, and a decrease in diluted earnings per common share of $0.02 and $0.01, respectively. The income tax benefit related to the share-based compensation cost for both the three months ended September 30, 2007 and 2006 was $0.2 million. For the three months ended September 30, 2007 and 2006, $1.3 million and $0.4 million was received from the exercise of stock options, and $0.2 million and $0.1 million was realized as income tax benefits, respectively.

For the nine months ended September 30, 2007 and 2006, share-based compensation expense under SFAS No. 123R was $1.9 million and $0.9 million, resulting in a decrease in net income of $1.2 million and $0.6 million, a decrease in basic earnings per common share of $0.06 and $0.03, and a decrease in diluted earnings per common share of $0.05 and $0.02, respectively. The income tax benefit related to the share-based compensation cost for the nine months ended September 30, 2007 and 2006 was $0.6 million and $0.3 million, respectively. For the nine months ended September 30, 2007 and 2006, $1.7 million and $2.0 million was received from the exercise of stock options, and $0.3 million and $0.8 million was realized as income tax benefits, respectively.

 

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

As of September 30, 2007, there was $4.8 million of total unrecognized compensation cost related to non-vested share-based compensation awards granted under the stock option plans. The cost will be recognized over thirty-one months or a lesser period based upon the vesting of these share-based compensation awards. The fair value for these options was estimated at the date of grant using a Black-Scholes option-pricing model and is recognized over the options’ vesting period.

The following weighted average assumptions were used for the Director Plans and Employee Stock Option Plans for the nine months ended September 30, 2007 and 2006:

 

		Three months ended						Nine months ended
Director Plan Assumptions:		September 30, 2007			September 30, 2006			September 30, 2007			September 30, 2006
Expected stock price volatility			29.89	%		31.31	%		30.59	%		32.22	%
Risk-free interest rate			4.85			5.07			4.96			4.56
Expected dividend yield			2.85			2.43			2.64			2.51
Expected annual forfeitures			1.99			1.70			1.85			1.70
Expected life (in years)			7.92			7.81			7.87			7.75
Employee Plan Assumptions:
Expected stock price volatility			29.92	%		30.52	%		29.92	%		30.54	%
Risk-free interest rate			4.78			5.03			4.78			5.03
Expected dividend yield			2.58			2.43			2.58			2.43
Expected annual forfeitures			1.31			1.29			1.31			1.29
Expected life (in years)			7.42			6.86			7.42			6.87

5.	Intangible Assets

The gross carrying amounts of intangible assets acquired in connection with branch and bank acquisitions and a favorable lease were $9.0 million at both September 30, 2007 and December 31, 2006, and accumulated amortization on such intangible assets was $7.3 million and $6.4 million at September 30, 2007 and December 31, 2006, respectively. Intangible assets of $8.4 million are amortized using the straight line method and $0.6 million of an intangible asset is amortized based on a deposit market study performed at the time of acquisition. The intangible amortization expense was $0.3 million and $0.8 million for both the three and nine months ended September 30, 2007 and 2006, respectively. The annual amortization expense for the remaining life of all intangibles will vary throughout the amortization periods.

 

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

6.	Earnings Per Common Share (“EPS”)

The computation of basic and diluted earnings per common share for the three and nine months ended September 30, 2007 and 2006 is as follows:

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2007			2006			2007			2006
Numerator:
Net Income		$	5,802		$	8,145		$	19,057		$	23,485
Less: preferred dividends			―			―			10			10
Net income for basic and diluted earnings per common share - net income available to common stockholders		$	5,802		$	8,145		$	19,047		$	23,475
Denominator:
Denominator for basic earnings per common share - weighted average shares			22,006,642			21,751,565			21,934,259			21,746,909
Effects of dilutive securities - director and employee stock options			545,092			889,975			508,501			961,122
Denominator for diluted earnings per common share - adjusted weighted average shares			22,551,734			22,641,540			22,442,760			22,708,031
Basic earnings per common share		$	0.26		$	0.37		$	0.87		$	1.08
Diluted earnings per common share			0.26			0.36			0.85			1.03

 

7.	Securities

In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” the Company’s investment policies include a determination of the appropriate classification of securities at the time of purchase. Securities that may be sold as part of the Company’s asset/liability or liquidity management, or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for similar factors, are classified as available for sale. Securities that the Company has the ability and positive intent to hold to maturity are classified as held to maturity and carried at amortized cost. Realized gains and losses on the sales of all securities, determined by using the specific identification method, are reported in earnings. Securities available for sale are shown in the condensed consolidated statements of financial condition at estimated fair value and the resulting net unrealized gains and losses, net of tax, are shown in accumulated other comprehensive income (loss).

The decision to sell securities available for sale is based on management’s assessment of changes in economic or financial market conditions, interest rate risk, and the Company’s financial position and liquidity. Estimated fair values for securities are based on quoted market prices, where available. If quoted market prices are not available, estimated fair values are based on quoted market prices of similar instruments. Securities in an unrealized loss position are periodically evaluated for other-than-temporary impairment. Management considers the effect of interest rates, credit ratings and other factors on the valuation of such securities, as well as the Company’s intent and ability to hold such securities until a forecasted recovery or maturity occurs. The Company does not acquire a significant amount of securities for the purpose of engaging in trading activities.

 

13

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The Company had gross realized gains on securities transactions of $4,000 and $426,000 during the three months ended September 30, 2007 and 2006, respectively. The Company had gross realized gains on securities transactions of $6,000 and $431,000 during the nine months ended September 30, 2007 and 2006, respectively. The Company did not have realized losses on securities transactions during the three and nine months ended September 30, 2007 and 2006, respectively.

A summary of the amortized cost, estimated fair values, and related gross unrealized gains and losses on securities at September 30, 2007 and December 31, 2006 is as follows:

 

		(000’s)
September 30, 2007		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
Available for Sale:
U.S. government agencies		$	72,931		$	―		$	948		$	71,983
Mortgage-backed securities			426,337			2,060			4,954			423,443
Obligations of states and political subdivisions			226			10			―			236
Corporate securities			111			33			―			144
Total securities available for sale		$	499,605		$	2,103		$	5,902		$	495,806
Held to Maturity:
U.S. government agencies		$	615,398		$	121		$	5,509		$	610,010
Obligations of states and political subdivisions			97,613			1,694			284			99,023
Total securities held to maturity		$	713,011		$	1,815		$	5,793		$	709,033

		(000’s)
December 31, 2006		Amortized Cost			Gross Unrealized Gains			Gross Unrealized Losses			Estimated Fair Value
Available for Sale:
U.S. government agencies		$	72,927		$	—		$	1,027		$	71,900
Mortgage-backed securities			361,904			2,027			4,932			358,999
Obligations of states and political subdivisions			230			12			―			242
Corporate securities			109			44			―			153
Total securities available for sale		$	435,170		$	2,083		$	5,959		$	431,294
Held to Maturity:
U.S. government agencies		$	639,846		$	178		$	6,033		$	633,991
Obligations of states and political subdivisions			112,102			1,800			386			113,516
Total securities held to maturity		$	751,948		$	1,978		$	6,419		$	747,507

 

Available for sale and held to maturity qualified obligations of states and political subdivisions are not subject to Federal income tax.

 

14

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

A summary of gross unrealized losses on securities that are not other-than-temporarily impaired, which have been in a continuous unrealized loss position for less than 12 months and for 12 months or longer as of September 30, 2007 and December 31, 2006, is as follows:

 

Securities in an Unrealized Loss Position that are not Other-Than-Temporarily Impaired

 

		(000’s)
		Less Than 12 Months						12 Months or More						Total
September 30, 2007		Fair Value			Gross Unrealized Losses			Fair Value			Gross Unrealized Losses			Fair Value			Gross Unrealized Losses
U.S. government agencies		$	169,484		$	67		$	381,513		$	6,390		$	550,997		$	6,457
Mortgage-backed securities			109,467			149			130,496			4,805			239,963			4,954
Obligations of states and political subdivisions			28,509			75			9,792			209			38,301			284
Corporate securities			1			—			—			—			1			—
Total temporarily impaired securities		$	307,461		$	291		$	521,801		$	11,404		$	829,262		$	11,695

 

		(000’s)
December 31, 2006		Fair Value			Gross Unrealized Losses			Fair Value			Gross Unrealized Losses			Fair Value			Gross Unrealized Losses
U.S. government agencies		$	120,536		$	511		$	406,325		$	6,549		$	526,861		$	7,060
Mortgage-backed securities			6,550			22			145,583			4,910			152,133			4,932
Obligations of states and political subdivisions			41,195			148			8,914			238			50,109			386
Total temporarily impaired securities		$	168,281		$	681		$	560,822		$	11,697		$	729,103		$	12,378

The Company’s U.S. government agency and mortgage-backed securities that are in an unrealized loss position at September 30, 2007 and December 31, 2006 are credit rated AAA or Aaa by nationally recognized statistical rating organizations. Substantially all obligations of states and political subdivisions are credit rated AAA or Aaa due to insurance, which guarantees the obligations against default, by private insurance companies. At September 30, 2007 and December 31, 2006, approximately $3.1 million and $14.4 million, respectively, of issuances were not rated, substantially all of which were bond or tax anticipation notes from local municipalities.

 

At September 30, 2007, the number of securities in an unrealized loss position included 20 U.S. government agencies, 35 mortgage-backed securities, and 80 obligations of states and political subdivisions. At December 31, 2006, the number of securities in an unrealized loss position included 17 U.S. government agencies, 29 mortgage-backed securities, and 107 obligations of states and political subdivisions. The temporary impairment on securities of less than 12 months and 12 months or more at September 30, 2007 and December 31, 2006 is due to the higher interest rate environment, as compared to the periods in which the securities were initially purchased. The higher interest rates resulted in a decline in the market value of the securities. The temporary impairment will fluctuate as the interest rate environment changes. In a rising interest rate environment, the temporary impairment will increase, while a decrease in the temporary impairment will occur in a declining interest rate environment. Management does not consider the impairment of the securities to be other than temporary due to the high credit quality or insurance provided by private insurance companies, and the intent and ability of the Company to hold such securities until a forecasted recovery or maturity occurs.

 

15

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

8.

Loans

Nonaccrual loans were $9.7 million and $9.8 million at September 30, 2007 and December 31, 2006, respectively. Restructured loans were $0.1 million at both September 30, 2007 and December 31, 2006. At September 30, 2007 and December 31, 2006, the recorded investment in loans that are considered to be impaired approximated $7.7 million and $9.2 million, respectively. Such loans were also in nonaccrual status at September 30, 2007 and December 31, 2006, respectively. The average recorded investment in impaired loans for the nine months ended September 30, 2007 and 2006 and for the year ended December 31, 2006 was $8.4 million, $14.7 million, and $14.1 million, respectively. There was no interest income recognized by the Company on impaired loans for the three and nine months ended September 30, 2007, and $0.2 million and $0.5 million of interest income on impaired loans was recognized for the three and nine months ended September 30, 2006, respectively.

As applicable, each impaired loan has a related allowance for loan losses in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan - an amendment of FASB Statements No. 5 and 15.” As of September 30, 2007, impaired and nonaccrual loans primarily consisted of one customer relationship. The loans related to this customer relationship, aggregating $7.4 million of commercial loans as of September 30, 2007, involve problems with sources of repayment from operating cash flows. No specific allowance for loan loss was allocated to the impaired loans related to this customer relationship due to the market value of the real estate collateral. The impaired loans mentioned above are also supported by personal guarantees.

Substantially all of the nonaccruing and restructured loans are collateralized by real estate. At September 30, 2007, the Company had and continues to have no commitments to lend additional funds to any customers with nonaccrual or restructured loan balances, with the exception of a commitment to lend an additional $0.1 million with respect to a commercial loan included in the $7.4 million commercial loan relationship described above. At September 30, 2007, accruing loans denoted as potential problem loans, which may result in the loans being placed on nonaccrual status in the near future, were not significant. Accruing loans that are contractually past due 90 days or more at September 30, 2007 were not significant.

9.	Borrowings and Stockholders’ Equity

The Company utilizes short-term and long-term borrowings primarily to meet funding requirements for its asset growth, balance sheet leverage, and to manage its interest rate risk.

Short-term borrowings include securities sold under agreements to repurchase, federal funds purchased, and short-term Federal Home Loan Bank of New York (“FHLB”) advances. Short-term securities sold under agreements to repurchase have original maturities between one and 365 days. The Bank has borrowing availability under master security sale and repurchase agreements through four primary investment firms, the FHLB, and to a lesser extent, its customers. At September 30, 2007 and December 31, 2006, the Bank had no short-term repurchase agreements outstanding with the FHLB or primary investment firms.

 

16

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

At September 30, 2007 and December 31, 2006, the Bank had short-term repurchase agreements with customers of $7.4 million and $0.9 million at a weighted average interest rate of 3.97 percent and 3.83 percent, respectively. These short-term customer borrowings were collateralized by securities with an aggregate carrying value of $7.8 million and an estimated fair value of $7.6 million at September 30, 2007 and an aggregate carrying value and estimated fair value of $0.7 million at December 31, 2006.

Federal funds purchased represent overnight funds. The Bank has federal funds purchase lines available with six financial institutions for a total of $90.0 million. At September 30, 2007 and December 31, 2006, the Bank had no federal funds purchased balances outstanding.

Short-term FHLB advances are borrowings with original maturities between one and 365 days. There were no short-term FHLB advances outstanding at September 30, 2007 and December 31, 2006.

Additional information with respect to short-term borrowings as of and for the nine months ended September 30, 2007 and 2006 is presented in the following table:

 

		(000’s except percentages)
Short-Term Borrowings		2007			2006
Balance at September 30		$	7,412		$	863
Average balance outstanding		$	2,685		$	46,901
Weighted-average interest rate:
As of September 30			3.97	%		3.88	%
Paid during period			3.95	%		4.72	%

The Bank had long-term borrowings, which have original maturities of over one year, of $586.0 million and $605.5 million in securities sold under agreements to repurchase at September 30, 2007 and December 31, 2006, respectively. These borrowings have an original term of ten years at interest rates between 2.83 percent and 6.08 percent at September 30, 2007, and between 1.99 percent and 6.08 percent at December 31, 2006 that are callable on certain dates after an initial noncall period at the option of the counterparty to the repurchase agreements. The long-term borrowings in securities sold under agreements to repurchase may not be repaid in full prior to maturity without penalty. As of September 30, 2007, long-term repurchase agreements with the FHLB were collateralized by securities with an aggregate carrying value of $605.0 million and an estimated fair value of $602.9 million. As of December 31, 2006, long-term repurchase agreements with the FHLB were collateralized by securities with an aggregate carrying value of $653.8 million and an estimated fair value of $650.8 million.

At September 30, 2007 and December 31, 2006, long-term FHLB advances totaled $126.8 million and $101.8 million at interest rates between 4.04 percent and 5.99 percent and between 4.05 percent and 5.99 percent, respectively. At September 30, 2007, borrowings totaling $1.8 million consisted of amortizing advances having scheduled payments. Other borrowings totaling $125.0 million have an original term of ten years that are callable on certain dates after an initial noncall period at the option of the counterparty to the advance. Advances at December 31, 2006 included $1.8 million of amortizing advances having scheduled periodic payments and $100.0 million that are callable on certain dates after an initial noncall period at the option of the issuer. The long-term FHLB advances may not be repaid in full prior to maturity without penalty. At September 30, 2007 and December 31, 2006, these borrowings were collateralized by a pledge to the FHLB of a security interest in certain residential mortgage-related assets having an aggregate book value of $156.3 million and $125.6 million, respectively.

 

17

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

At September 30, 2007 a $28.0 million FHLB letter of credit was used as collateral for a New York State governmental deposit. The FHLB letter of credit was collateralized by a pledge to the FHLB of residential mortgage loans at September 30, 2007 having an aggregate book value of $34.5 million. At December 31, 2006, a $20.0 million FHLB letter of credit was used as collateral for a New York State government deposit and collateralized by a pledge to the FHLB of residential mortgage loans having an aggregate book value of $24.7 million.

A summary of long-term, fixed-rate borrowings distributed based upon remaining contractual payment date and expected option call date at September 30, 2007, with comparative totals for December 31, 2006, is as follows:

 

		(000’s except percentages)
Long-Term Borrowings		Within 1 Year			After 1 But Within 5 Years			After 5 Years			2007 Total			2006 Total
Contractual Payment Date:
Total long-term borrowing		$	50,021		$	120,096		$	542,677		$	712,794		$	707,309
Weighted average interest rate			5.63	%		5.71	%		4.13	%		4.50	%		4.46	%
Expected Call Date:
Total long-term borrowing		$	131,021		$	145,096		$	436,677		$	712,794		$	707,309
Weighted average interest rate			4.01	%		5.30	%		4.38	%		4.50	%		4.46	%

At September 30, 2007 and December 31, 2006, the Bank held 348,726 and 345,227 shares, respectively, of capital stock of the FHLB with a carrying value of $34.9 million and $34.5 million, respectively, which is required in order to borrow under the short- and long-term advances and securities sold under agreements to repurchase programs from the FHLB. The FHLB generally limits borrowings to an aggregate of 50 percent of total assets upon the prerequisite purchase of additional shares of FHLB stock. Any advances made from the FHLB are required to be collateralized by the FHLB stock and certain other assets of the Bank.

The ability of the Company and Bank to pay cash dividends in the future is restricted by various regulatory requirements. The Company's ability to pay cash dividends to its stockholders is primarily dependent upon the receipt of dividends from the Bank. The Bank's dividends to the Company in any year may not exceed the sum of the Bank's undistributed net income for that year and its undistributed net income for the preceding two years, less any required transfers to additional paid-in capital. In addition, the Bank may not declare and pay dividends more often than quarterly, and no dividends may be declared or paid if there is any impairment of the Bank’s capital stock. At September 30, 2007, the Bank could pay dividends of $36.9 million to the Company without having to obtain prior regulatory approval.

 

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

For the nine months ended September 30, 2006, the Company purchased 179,900 shares of its common stock at an aggregate cost of $3.9 million under its 2005 repurchase plan, which expired December 31, 2006. As of September 30, 2007, the Company’s Board of Directors has not authorized a new repurchase plan. For the nine months ended September 30, 2007, there was no common stock acquired in connection with stock option exercises compared to 8,922 shares of common stock acquired for the nine months ended September 30, 2006.

10.	Corporation-Obligated Mandatory Redeemable Capital Securities of Subsidiary Trusts

At September 30, 2007, the Company had outstanding $51.5 million of junior subordinated debt in connection with the issuance of $51.5 million of Capital Securities. Capital Securities are generally permitted to be included in Tier I regulatory capital in an amount not in excess of 25 percent of Tier I Capital, with the remainder included in Total Capital. At September 30, 2007, Tier I Capital totaled $291.1 million, which included $50.0 million of Capital Securities.

On June 26, 2007, the Capital Securities of USB Statutory Trust III were redeemed at a redemption price equal to the $1,000 liquidation amount of each security, plus all accrued and unpaid interest per security to, but not including, the redemption date. The redemption of the Capital Securities was made in connection with the concurrent redemption by the Company of all of its $10.3 million Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Debentures”) due June 26, 2032, which were held exclusively by USB Statutory Trust III, on June 26, 2007 at a redemption price equal to the principal outstanding amount of the Debentures, plus interest accrued and unpaid on the Debentures to, but not including, the redemption date.

11.	Commitments and Contingencies

In the normal course of business, various commitments to extend credit are made that are not reflected in the accompanying condensed consolidated financial statements. At September 30, 2007, the Company had approximately $476.4 million in formal credit lines outstanding, $54.2 million in loan commitments outstanding, which are loans primarily collateralized by real estate, $31.4 million of standby letters of credit outstanding, and $46.2 million of credit card lines outstanding. Such amounts represent the maximum risk of loss on these commitments.

Standby letters of credit are issued to guarantee financial performance or obligations of the Bank’s customers. Generally, standby letters of credit are either partially or fully collateralized by cash, real estate, or other assets. In most cases, personal guarantees are obtained. Standby letters of credit are considered in the Bank’s evaluation of its reserve for unfunded loan commitments.

Effective May 19, 1999, the Company adopted the Retirement Plan for Non-Employee Directors of U.S.B. Holding Co., Inc. and Certain Affiliates (the “Director Retirement Plan”), which is described in Note 17 to the Company’s Consolidated Financial Statements included in the 2006 Annual Report to Stockholders. At September 30, 2007 and December 31, 2006, the Company had a recorded liability of $604,000 and $580,000, respectively, to provide for the present value of payments expected to be made under the Director Retirement Plan. The discount rate used to compute the present value obligation is 5.25 percent for both periods.

 

19

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The Company adopted SFAS No. 158, “Employers Accounting for Deferred Pension and Other Postretirement Plans - An Amendment of FASB Statements No. 87, 88, 106, and 132(R)” (“SFAS No. 158”) as of December 31, 2006. The adoption of SFAS No. 158 required the Company to record the unamortized prior service cost, which is being amortized over the average remaining service period of the current non-employee directors, as a component of accumulated other comprehensive income (loss). Benefit cost for the Director Retirement Plan for the three months ended September 30, 2007 and 2006 was approximately $22,000 and $31,000, of which $8,000 and $7,000 represents current service cost and $14,000 and $24,000 represents prior service cost, respectively. Benefit cost for the Director Retirement Plan for the nine months ended September 30, 2007 and 2006 was approximately $66,000 and $94,000, of which $24,000 and $21,000 represents current service cost and $42,000 and $73,000 represents amortization of prior service cost, respectively.

On July 25, 2007, the Company and the Bank entered into amended and restated employment agreements with each of Thomas E. Hales and Raymond J. Crotty (collectively, the “Employment Agreements”) in order to renew the terms to five years for Mr. Hales and three years for Mr. Crotty. In addition, the Employment Agreements were amended to comply with section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), and regulations or other guidance of the Internal Revenue Service published thereunder (collectively, “Section 409A”). Among other requirements, Section 409A requires restrictions on payment timing to specified individuals under certain types of compensation agreements.

On July 25, 2007, the Bank entered into a letter agreement with Mr. Thomas Buonaiuto which provides change of control benefit protections to Mr. Buonaiuto in certain circumstances.

On July 25, 2007, the Company adopted the U.S.B. Holding Co., Inc. Amended and Restated Severance Plan (the “Severance Plan”), which will provide severance protections to eligible full time employees of both the Company and Bank following a change in control (as defined in the Severance Plan) of the Company.

Other commitments are also described in Note 16 to the Company’s Consolidated Financial Statements included in the Company’s 2006 Annual Report to Stockholders.

The Company is party to various legal proceedings arising in the ordinary course of business. Because litigation is inherently unpredictable, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early phases, the Company cannot predict with certainty the loss or range of loss related to such matters, how such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, fine, penalty, or other relief might be, if any. Consequently, the Company cannot estimate losses or ranges of losses for matters where there is only a reasonable possibility that a loss may have been incurred. Although the ultimate outcome of these matters cannot be ascertained at this time, it is the opinion of management, after consultation with counsel, that the resolution of such matters will not have a material adverse effect on the financial statements of the Company, taken as a whole; such resolution may, however, have a material effect on the operating results or cash flows in any future period, depending on the level of income for such period.

 

20

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U.S.B. HOLDING CO., INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

The Company provides reserves in accordance with SFAS No. 5, “Accounting for Contingencies,” as required. The ultimate resolution of any legal proceedings may differ from the amounts reserved, if any. As of September 30, 2007, reserves were not required in accordance with SFAS No. 5.

12.	Segment Information

The Company has one reportable segment, “Community Banking.” All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, commercial lending is dependent upon the ability of the Bank to fund itself with deposits and other borrowings and to manage interest rate and credit risk. This situation is also similar for consumer and residential mortgage lending. Accordingly, all significant operating decisions are based upon analysis of the Company as one operating segment or unit.

The Company operates only in the U.S. domestic market, specifically the lower Hudson Valley, which includes the counties of Rockland, Westchester, Orange, Putnam and Dutchess, New York, as well as New York City and Long Island, New York, and Southern Connecticut and the surrounding area. For the nine months ended September 30, 2007 and 2006, there is no customer that accounted for more than ten percent of the Company’s revenue.

13.	Merger Agreement with KeyCorp

The Company has entered into an Amended and Restated Agreement and Plan of Merger dated as of October 22, 2007 among KeyCorp, KYCA LLC, and U.S.B. Holding Co., Inc. (the “Agreement”), pursuant to which the Company will merge into KYCA LLC, a Delaware limited liability company and a direct wholly-owned subsidiary of KeyCorp, in exchange for cash and stock, and the Bank will merge into KeyBank National Association (the “Merger”). Under the terms of the Agreement, stockholders of the Company will be entitled to receive 0.455 shares of KeyCorp common stock and $8.925 in cash for each share of Company common stock that they own. Consummation of the Merger is subject to a number of customary conditions, including, but not limited to, the approval of the Agreement by the Company’s stockholders and the receipt of all required bank regulatory approvals.

On November 2, 2007, the Merger was approved by the Federal Reserve Board. A special meeting of stockholders of the Company has been set for November 28, 2007 for stockholders of record on October 22, 2007 to vote on the Merger. For both the three and nine months ended September 30, 2007, the Company incurred $2.3 million of acquisition costs related to the Merger. The acquisition costs primarily consisted of investment banker and legal fees.

 

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains a number of “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements may be identified by the use of such words as “believe,” “expect,” “anticipate,” “intend,” “should,” “ “would,” “could,” “may,” “planned,” “estimated,” “potential,” “outlook,” “predict,” “project” and similar terms and phrases, including references to assumptions.

Forward-looking statements are based on various assumptions and analyses made by the Company in light of management's experience and its perception of historical trends, current conditions and expected future developments, as well as other factors the Company believes are appropriate under the circumstances. These statements are not guarantees of future performance and are subject to risks, uncertainties and other factors (many of which are beyond the Company’s control) that could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. These factors include, without limitation, the following: the timing and occurrence or non-occurrence of events may be subject to circumstances beyond the Company’s control; there may be increases in competitive pressure among financial institutions or from non-financial institutions; changes in the interest rate environment may reduce interest margins or affect the value of the Company’s investments; changes in deposit flows, loan demand or real estate values may adversely affect the Company’s business; changes in accounting principles, policies or guidelines may cause the Company’s financial condition to be perceived differently; general economic conditions, either nationally or locally in some or all of the areas in which the Company does business, or conditions in the securities markets or the banking industry may be less favorable than the Company currently anticipates; legislative or regulatory changes may adversely affect the Company’s business; applicable technological changes may be more difficult or expensive than the Company anticipates; success or consummation of new business initiatives may be more difficult or expensive than the Company anticipates; or litigation or matters before regulatory agencies, whether currently existing or commencing in the future, may delay the occurrence or non-occurrence of events longer than the Company anticipates.

The Company's forward-looking statements are only as of the date on which such statements are made. By making any forward-looking statements, the Company assumes no duty to update them to reflect new, changing or unanticipated events or circumstances. These risks and uncertainties should be considered in evaluating forward-looking statements and undue reliance should not be placed on these statements.

MERGER AGREEMENT WITH KEYCORP

The Company has entered into an Amended and Restated Agreement and Plan of Merger dated October 22, 2007 among KeyCorp, KYCA LLC, and U.S.B. Holding Co., Inc. (the “Agreement”), pursuant to which the Company will merge into KYCA LLC, a Delaware limited liability company and a direct wholly-owned subsidiary of KeyCorp, in exchange for cash and stock, and the Bank will merge into KeyBank National Association (the “Merger). Under the terms of the Agreement, stockholders of the Company will be entitled to receive 0.455 shares of KeyCorp common stock and $8.925 in cash for each share of Company common stock that they own. Consummation of the Merger is subject to a number of customary conditions, including, but not limited to, the approval of the Agreement by the Company’s stockholders and the receipt of all required bank regulatory approvals.

On November 2, 2007, the Merger was approved by the Federal Reserve Board. A special meeting of stockholders of the Company has been set for November 28, 2007 for stockholders of record on October 22, 2007 to vote on the Merger. For both the three and nine months ended September 30, 2007, the Company incurred $2.3 million of acquisition costs related to the Merger. The acquisition costs primarily consisted of investment banker and legal fees.

22

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

The Company’s primary business is obtaining deposits through its retail branch system, and commercial and municipal relationships, and lending to both a retail and commercial customer base. A substantial amount of loans are collateralized by real estate, including construction projects. The Bank’s residential mortgage portfolio does not contain sub-prime loans and, therefore, has not been affected by the sub-prime loan market. The Company also acquires triple-A credit rated securities and obligations of local municipalities to invest deposits in excess of loan production and borrows on a wholesale basis to leverage capital and manage interest rate risk. The credit quality of the Company’s securities portfolio has not been affected by the sub-prime loan market. The Company operates through its 30 full service branches (31 full service branches as of September 30, 2007 before the closing of the Bank’s Chestnut Ridge office located in Rockland County, New York) and its four loan centers in Rockland, Westchester, and Orange counties, and New York City in New York and Stamford, Connecticut.

 

The Company’s primary source of revenue is net interest income, which is the difference between interest income on interest earning assets and interest expense on interest bearing liabilities. The Company also derives income from non-interest income sources such as service charges on deposit accounts, gains on sales of securities and other forms of income. Net interest income and non-interest income support the Company’s operating expenses and provision for credit losses.

 

As the Company’s primary source of income is net interest income, the interest rate environment has a significant effect on revenue. The market for and credit quality of loans is impacted by interest rates, as well as the local economy. Deposits are also sensitive to interest rates, local economic conditions, and the attractiveness of alternative investments, such as stocks, bonds, mutual funds, and annuities.

 

The Company’s core revenue, net interest income, has been adversely affected during the nine months ended September 30, 2007 by a decrease in the net interest margin as a result of a reduction in interest rate spreads between interest earning assets and interest bearing liabilities compared to the 2006 period and pricing pressures from increased competition for loans and deposits. Ongoing pricing pressures on deposits and loans in the Company’s marketplace could continue to negatively affect net interest income by causing the net interest margin to compress further.

 

Also significant to the Company’s net income and earnings per common share is the ability to generate quality interest earning assets in the form of loans and securities at reasonable interest rate spreads to maintain or increase net interest income. Increasing the Company’s interest earning assets is challenging as a result of intense competition for loans, and difficulty in obtaining acceptable yields and structures on security investments, while managing interest rate risk. In addition, loan prepayments, particularly on commercial mortgage loans, also impact the Company’s ability to increase interest earning assets.

 

Critical Accounting Policies

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Company’s significant accounting policies are more fully described in Note 3 to the Company’s Consolidated Financial Statements included in the Company’s 2006 Annual Report to Stockholders. Certain accounting policies require management to make estimates and assumptions that affect the reported amounts of actual and contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. On an on-going basis, management evaluates its estimates and assumptions, and the effects of revisions are reflected in the financial statements in the period in which they are determined to be necessary.

 

23

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The critical policies given the Company’s current business strategy and asset/liability structure are accounting for non-performing loans, the allowance for loan losses, the reserve for unfunded loan commitments and standby letters of credit, the provision for credit losses, the classification of securities as either held to maturity or available for sale, the evaluation of other than temporary impairment of securities, and the evaluation of the valuation reserves for net deferred tax assets. These accounting policies are those that most frequently require management to make estimates and judgments and, therefore, are critical to understanding the Company’s results of operations. The Company’s critical accounting policies are described in greater detail under the heading “Critical Accounting Policies” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2006 Annual Report to Stockholders. The Company’s practice on each of these accounting policies is further described in the applicable sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s 2006 Annual Report to Stockholders.

COMPARISON OF FINANCIAL CONDITION AS OF SEPTEMBER 30, 2007 AND DECEMBER 31, 2006

At September 30, 2007, the Company had total assets of $3,070.9 million, an increase of $147.6 million from December 31, 2006. The increase in total assets was primarily due to increases in cash and due from banks, federal funds sold, and the securities portfolio. The increase in cash and due from banks and federal funds sold was primarily due to receipt of seasonal tax deposits from local municipalities.

The securities portfolio, including investments in FHLB stock, totaled $1,243.7 million and $1,217.8 million at September 30, 2007 and December 31, 2006, respectively, an increase of $25.9 million during the nine months ended September 30, 2007. The securities portfolio consisted of securities held to maturity at amortized cost of $713.0 million and $751.9 million, securities available for sale at estimated fair value totaling $495.8 million and $431.3 million, and FHLB stock of $34.9 million and $34.5 million at September 30, 2007 and December 31, 2006, respectively.

Securities are selected to provide safety of principal and liquidity, produce income on excess funds during structural changes in the composition of deposits and during cyclical and seasonal changes in loan demand, and to leverage capital. The amount of securities purchased and maintained in the investment portfolio is dependent on the level of deposit growth in excess of loan growth, the ability to leverage capital, while maintaining adequate capital ratios and managing interest rate risk, and the ability of the Bank to borrow wholesale funds. In order to manage liquidity and control interest rate risk, the Company’s investment strategy focuses on a combination of securities that have short-term maturities, adjustable-rate securities or those whose cash flow patterns result in a lower degree of interest rate risk, and investments in fixed rate securities with longer-term maturities and call options by the issuer to increase yield.

Generally, most securities may be used to collateralize borrowings and public deposits. As a result, the investment portfolio is an integral part of the Company’s funding strategy. The Company will continue to seek opportunities in utilizing the investment portfolio to invest excess cash flow and leverage capital, while managing interest rate risk. The weighted average life of the investment portfolio at September 30, 2007 and December 31, 2006 was 6.48 years and 7.87 years, respectively.

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

During the nine months ended September 30, 2007, U.S. government agency securities decreased $24.4 million due primarily to redemptions of $25.0 million, partially offset by an increase of $0.5 million in amortization of the loss on transfer of available for sale securities to held to maturity and an increase of $0.1 million in estimated fair value of available for sale securities. U.S. government agency securities of $687.3 million as of September 30, 2007 consisted of fixed-rate securities with longer-term maturities and call options by the issuer to increase yield. Mortgage-backed securities increased by $64.4 million primarily due to purchases of $105.9 million and an increase of $0.1 million in discount accretion, partially offset by principal paydowns of $41.6 million. The Bank’s investment in obligations of states and political subdivisions, or municipal securities, decreased by $14.5 million. This was primarily due to maturities and redemptions of $31.9 million, partially offset by purchases of $17.4 million. Municipal securities are considered core investments having favorable tax equivalent yields and diversified maturities. These obligations are principally of New York State political subdivisions and substantially all are classified as held to maturity. Purchases of municipal securities are dependent upon their availability in the marketplace and the comparative tax equivalent yields of such securities compared to other securities of similar credit risk and maturity.

The Company invests in medium-term corporate debt securities and bank and other equity securities. The Company had outstanding balances in corporate securities of $0.1 million and $0.2 million at September 30, 2007 and December 31, 2006, respectively, consisting of bank and other equity securities.

Loans represent the largest and highest yielding earning assets of the Company. The Company continues to originate a significant portion of loans collateralized by real estate within the markets in which it primarily conducts business. Loan volume is dependent on the Bank’s ability to originate loans in the competitive markets in which it operates. Critical factors include the credit worthiness of borrowers, the economy of the Bank’s markets, and the level of interest rates. Also impacting net loan growth is the level of loan prepayments and competition from other financial institutions.

At September 30, 2007, total loans, net were $1,547.6 million, a net decrease of $29.8 million or 1.9 percent compared to December 31, 2006. A summary of the decrease in total loans, net at September 30, 2007 compared to December 31, 2006 is as follows:

					(000’s)
		September 30, 2007			December 31, 2006			Increase/ (Decrease)
Time and demand loans		$	135,372		$	140,416		$	(5,044	)
Installment loans			25,415			28,621			(3,206	)
Credit Card			7,581			7,444			137
Real Estate
- Commercial			556,543			572,622			(16,079	)
- Residential			290,553			293,370			(2,817	)
- Construction and real estate secured			461,260			465,463			(4,203	)
- Home equity			83,316			82,452			864
Other			4,413			5,280			(867	)
Gross loans			1,564,453			1,595,668			(31,215	)
Deferred net loan commitment fees			(1,262	)		(2,248	)		986
Total loans			1,563,191			1,593,420			(30,229	)
Allowance for loan losses			(15,622	)		(16,034	)		412
Total loans, net		$	1,547,569		$	1,577,386		$	(29,817	)

In the normal course of business, various commitments to extend credit are made that are not reflected in the accompanying condensed consolidated financial statements. The Company had approximately $476.4 million in formal credit lines outstanding, $54.2 million in loan commitments outstanding, which are loans primarily collateralized by real estate, $31.4 million of standby letters of credit outstanding, and $46.2 million of credit card lines outstanding. Such amounts represent the maximum risk of loss on these commitments. Management considers its liquid resources to be adequate to fund loans in the foreseeable future, principally by utilizing excess funds temporarily placed in federal funds sold, increasing deposits and borrowings, and receiving proceeds from loan and security repayments.

 

25

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The Company's allowance for loan losses decreased $0.4 million to $15.6 million at September 30, 2007 from $16.0 million at December 31, 2006. The decrease in the allowance for loan losses was due to charge-offs of $1.2 million of nonperforming loans, as well as improved factors applied to other loan classifications. The allowance represents 1.00 percent and 1.01 percent of total loans outstanding at September 30, 2007 and December 31, 2006, respectively.

The allowance for loan losses and reserve for unfunded loan commitments and standby letters of credit reflect a provision of $0.7 million and net charge-offs of $1.2 million recorded for the nine months ended September 30, 2007. The reserve for unfunded loan commitments and standby letters of credit of $1.0 million at September 30, 2007 and $1.1 million at December 31, 2006 is included in other liabilities. At September 30, 2007, accruing loans denoted as potential problem loans, which may result in the loans being placed on nonaccrual status in the near future, were not significant.

As with any financial institution, poor economic conditions and high inflation, interest rates or unemployment may lead to increased losses in the loan portfolio. Conversely, improvements in economic conditions tend to reduce the amounts charged against the allowance. Management has established various controls, in addition to Board approved underwriting standards, in order to limit future losses, such as (1) a “watch list” of possible problem and classified loans, (2) various loan policies concerning loan administration (loan file documentation, disclosures, approvals, etc.), and (3) a loan review staff employed by the Company to determine compliance with established controls, and to review the quality and identify anticipated collectibility issues of the portfolio. Management determines which loans are uncollectible and makes additional provisions, as necessary, to state the allowance and the reserve at the appropriate levels.

An evaluation of the quality of the loan portfolio is performed by management on a quarterly basis as an integral part of the credit administration function, which includes the identification and evaluation of past due loans, non-performing loans, impaired loans and potential problem loans, assessments of the expected effects of the current economic environment, applicable industry, geographic, and customer concentrations within the loan portfolio, and a review of historical loss experience. Management takes a prudent and cautious position in evaluating various business and economic uncertainties in relation to the Company’s loan portfolio. In management’s judgment, the allowance and reserve are considered adequate to absorb losses inherent in the credit portfolio. The collectibility of the loan portfolio of the Company is subject to changes in the real estate market in which the Company operates.

 

The provisions for credit losses established for the nine months ended September 30, 2007 and 2006, and the related allowance and reserve, reflect net charge-offs incurred and risks with respect to real estate, time and demand, installment, credit card, and other loans, as well as the effect of the real estate market and general economic conditions of the New York Metropolitan area on the loan portfolio. Management believes the allowance and the reserve at September 30, 2007 appropriately reflect the risk elements inherent in the total credit portfolio at that time. There is no assurance that the Company will not be required to make future adjustments to the allowance or the reserve in response to changing economic conditions or regulatory examinations.

 

26

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The Company’s fundamental source of funds supporting interest earning assets continues to be deposits, consisting of demand deposits (non-interest bearing), NOW, money market, savings, and various forms of time deposits. Retail deposits are obtained primarily by mass marketing efforts and are fee and interest rate sensitive. Commercial deposits are generally obtained through direct marketing and business relationship development efforts, as well as a result of lending relationships. The maintenance of a strong deposit base is key to the development of lending opportunities and creates long-term customer relationships, which enhance the ability to cross sell services. Depositors include individuals, small and large businesses, and governmental entities. To meet the requirements of a diverse customer base, a full range of deposit instruments is offered, which has allowed the Company to maintain the deposit base despite intense competition from other banking institutions and non-bank financial service providers.

 

Total deposits increased $139.5 million, or 7.4 percent, for the nine months ended September 30, 2007 to $2,035.9 million. The total deposit increase resulted from net increases in retail and commercial deposits of $20.1 million and municipal deposits of $173.4 million, partially offset by a decrease in brokered deposits of $54.0 million.

A summary of the increase in total deposits at September 30, 2007 compared to December 31, 2006 is as follows:

 

		September 30, 2007			(000’s) December 31, 2006			Increase/ (Decrease)
Non-interest bearing deposits:
Individuals, partnerships, and corporations		$	258,678		$	269,468		$	(10,790	)
Certified and official checks			19,256			14,753			4,503
States and political subdivisions			98,890			10,661			88,229
Total non-interest bearing deposits			376,824			294,882			81,942
Interest bearing deposits:
NOW accounts			98,683			110,386			(11,703	)
Money market accounts			181,102			139,052			42,050
Savings deposits			371,185			370,034			1,151
States and political subdivisions - NOW, money market, and savings deposits			184,863			81,827			103,036
Time deposits of individuals, partnerships, corporations under $100,000			374,163			378,631			(4,468	)
Time deposits of individuals, partnerships, corporations over $100,000			209,543			214,039			(4,496	)
Brokered time deposits			―			54,000			(54,000	)
States and political subdivisions - time deposits			143,799			161,660			(17,861	)
IRAs and Keoghs			95,730			91,858			3,872
Total interest bearing deposits			1,659,068			1,601,487			57,581
Total deposits		$	2,035,892		$	1,896,369		$	139,523

The increase in municipal deposits was primarily due to temporary seasonal tax deposits received during the end of the 2007 third quarter. The increase in retail and commercial deposits at September 30, 2007 was primarily due to the Bank offering competitively priced tiered money market deposits. The decrease in brokered deposits was a result of maturities during the first six months of 2007. The brokered deposits were not renewed as a result of alternative sources of funding (i.e., wholesale borrowings and municipal deposits) being more competitively priced.

 

27

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

As the amounts of deposits change and earning assets increase or decrease, the Bank will manage its funding with short-term borrowings. Short-term borrowings provide management with the ability to react to changes in levels of earning assets. As of September 30, 2007, the Bank did not have any FHLB short-term borrowings as a result of an increase in municipal deposits. Management will continue to evaluate the interest rate environment in order to determine the most effective combination of borrowings and deposits.

Stockholders' equity increased to $236.9 million at September 30, 2007 from the December 31, 2006 balance of $223.4 million, an increase of 6.0 percent. The increase primarily resulted from: $19.1 million of net income for the nine months ended September 30, 2007; $2.0 million of stock options exercised and related tax benefit; $1.9 million of compensation cost related to stock options; and $0.4 million in accumulated other comprehensive income; partially offset by cash dividends paid of $9.9 million.

The Company's leverage ratio at September 30, 2007 was 9.65 percent, compared to 9.75 percent at December 31, 2006. The decrease in the Company’s leverage capital ratio is due primarily to the redemption of USB Statutory Trust III Capital Securities, partially offset by an increase in stockholders’ equity, excluding accumulated other comprehensive loss, for the nine months ended September 30, 2007. The Company's Tier I and total capital ratios under applicable risk-based capital guidelines were 16.02 percent and 16.93 percent at September 30, 2007, and 15.43 percent and 16.34 percent at December 31, 2006, respectively. In addition, the Bank exceeded all current regulatory capital requirements and was in the “well-capitalized” category at September 30, 2007 and December 31, 2006.

COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006

Earnings

Net income for the three months ended September 30, 2007 was $5.8 million compared to $8.1 million for the three months ended September 30, 2006, a decrease of $2.3 million, or 28.8 percent. Dilut ed earnings per common share for the quarter ended September 30, 2007 was $0.26 compared to $0.36 for the prior year period, a decrease of 27.8 percent. The Company’s third quarter 2007 net income result ed in a 9.97 percent return on average common stockholders’ equity and a 0.77 percent return on average total assets, as compared to 15.27 percent and 1.13 percent, respectively, for the 2006 third quarter.

Net income for the nine months ended September 30, 2007 was $19.1 million compared to $23.5 million for the nine months ended September 30, 2006, a decrease of $4.4 million, or 18.9 percent. Diluted earnings per common share for the quarter ended September 30, 2007 was $0.85 compared to $1.03 for the prior year period, a decrease of 17.5 percent. The Company’s nine months ended September 30, 2007 net income resulted in a 11.08 percent return on average common stockholders’ equity and a 0.85 percent return on average total assets, as compared to 14.94 percent and 1.11 percent, respectively, for the 2006 period.

 

28

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

A discussion of the factors impacting the changes in the various components of net income follows.

Net Interest Income

Net interest income, the difference between interest income and interest expense, is the most significant component of the Company’s consolidated earnings. Net interest income is positively impacted by a combination of increases in interest earning assets over interest bearing liabilities and an increase in the net interest spread between interest earning assets and interest bearing liabilities. Net interest income is adversely impacted by a combination of decreases in interest earning assets over interest bearing liabilities and a decrease in the net interest spread between interest earning assets and interest bearing liabilities. For the three months ended September 30, 2007, net interest income decreased $0.7 million, or 3.0 percent, to $22.5 million compared to $23.2 million for the three months ended September 30, 2006. For the nine months ended September 30, 2007, net interest income decreased $2.7 million, or 3.9 percent, to $66.7 million compared to $69.4 million for the nine months ended September 30, 2006.

29

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

A summary of the average balances and interest yield/rates for the three months ended September 30, 2007 compared to the three months ended September 30, 2006 is as follows:

		(000’s, except percentages) For the three months ended September 30,
		2007									2006
		Average Balance			Interest			Average Yield/Rate			Average Balance			Interest			Average Yield/Rate
INTEREST EARNING ASSETS
Interest earning assets:
Federal funds sold		$	50,400		$	659			5.12	%	$	30,029		$	396			5.16	%
Securities:
U.S. government agencies			703,969			9,839			5.59			712,931			9,943			5.58
Mortgage-backed securities			434,083			6,093			5.61			410,217			5,780			5.64
Obligations of states and political subdivisions			103,634			1,659			6.40			98,589			1,595			6.47
Corporate securities, FHLB stock, and other securities			37,514			695			7.41			36,930			538			5.83
Loans, net			1,577,360			29,213			7.33			1,493,654			27,976			7.47
Total interest earning assets			2,906,960			48,158			6.52	%		2,782,350			46,228			6.61	%
INTEREST BEARING LIABILITIES
Deposits:
NOW		$	185,466		$	781			1.67	%	$	166,551		$	497			1.20	%
Money market			208,295			1,772			3.38			177,596			1,209			2.73
Savings			397,062			2,598			2.60			405,041			2,367			2.34
Time			855,257			10,351			4.79			799,036			8,743			4.33
Total interest bearing deposits			1,646,080			15,502			3.70			1,548,224			12,816			3.27
Federal funds purchased, securities sold under agreements to repurchase and FHLB advances			734,441			8,406			4.48			717,994			8,223			4.53
Subordinated debt issued in connection with corporation - obligated   mandatory redeemable capital securities of subsidiary trusts			51,548			1,195			9.27			61,858			1,436			9.29
Total interest bearing liabilities			2,432,069			25,103			4.05	%		2,328,076			22,475			3.82	%
NET INTEREST INCOME					$	23,055								$	23,753
NET YIELD ON INTEREST EARNING ASSETS (NET INTEREST MARGIN)									3.17	%								3.41	%

 

The data contained herein has been adjusted to a tax equivalent basis, based on the Federal statutory tax rate of 35 percent. The effect of the tax equivalent adjustment to interest income on total interest earning assets was $0.6 million for the three months ended September 30, 2007 and 2006. The estimated fair value adjustment on the available for sale securities is included in non-interest earning assets. Non accruing loans are included in average balances of loans, net. The net amortization of loan commitment fees, net of certain direct loan origination costs of $0.5 million and $0.6 million for the three months ended September 30, 2007 and 2006, respectively, are included in interest income on loans, net.

 

30

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

A summary of the average balances and interest yield/rates for the nine months ended September 30, 2007 compared to the nine months ended September 30, 2006 is as follows:

 

		(000’s, except percentages) For the nine months ended September 30,
		2007									2006
		Average Balance			Interest			Average Yield/Rate			Average Balance			Interest			Average Yield/Rate
INTEREST EARNING ASSETS
Interest earning assets:
Federal funds sold		$	59,299		$	2,324			5.17	%	$	27,472		$	1,018			4.89	%
Securities:
U.S. government agencies			709,911			29,720			5.58			712,283			29,822			5.58
Mortgage-backed securities			396,570			16,644			5.60			357,793			14,549			5.42
Obligations of states and political subdivisions			109,809			5,267			6.40			104,147			5,001			6.40
Corporate securities, FHLB stock, and other securities			37,024			2,026			4.10			35,454			1,401			5.28
Loans, net			1,596,831			88,154			7.31			1,486,081			81,023			7.22
Total interest earning assets			2,909,444			144,135			6.59	%		2,723,230			132,814			6.49	%

 

INTEREST BEARING LIABILITIES

Deposits:
NOW		$	194,182		$	2,670			1.84	%	$	184,803		$	1,790			1.29	%
Money market			189,218			4,630			3.27			156,816			2,598			2.22
Savings			399,299			7,710			2.58			420,733			6,668			2.12
Time			887,291			31,888			4.79			775,008			23,126			3.98
Total interest bearing deposits			1,669,990			46,898			3.75			1,537,360			34,182			2.97
Federal funds purchased, securities sold under agreements to repurchase and FHLB advances			718,884			24,420			4.48			685,705			23,223			4.47
Subordinated debt issued in connection with corporation - obligated mandatory redeemable capital securities of subsidiary trusts			58,195			4,283			9.81			61,858			4,145			8.93
Total interest bearing liabilities			2,447,069			75,601			4.10	%		2,284,923			61,550			3.58	%
NET INTEREST INCOME					$	68,534								$	71,264
NET YIELD ON INTEREST EARNING ASSETS (NET INTEREST MARGIN)									3.14	%								3.49	%

 

The data contained herein has been adjusted to a tax equivalent basis, based on the Federal statutory tax rate of 35 percent. The effect of the tax equivalent adjustment to interest income on total interest earning assets was $1.8 million and $1.9 million for the nine months ended September 30, 2007 and 2006, respectively. The estimated fair value adjustment on the available for sale securities is included in non-interest earning assets. Non accruing loans are included in average balances of loans, net. The net amortization of loan commitment fees, net of certain direct loan origination costs of $1.5 million and $1.6 million for the nine months ended September 30, 2007 and 2006, respectively, are included in interest income on loans, net.

 

31

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following table sets forth the dollar amount of changes in interest income, interest expense, and net interest income between the three and nine months ended September 30, 2007 and 2006 on a tax equivalent basis:

		For the three months ended September 30, 2007 compared to 2006									For the nine months ended September 30, 2007 compared to 2006
		Increase (Decrease) due to change in									Increase (Decrease) due to change in
		Average Volume			Average Rate			Total Increase (Decrease)			Average Volume			Average Rate			Total Increase (Decrease)
INTEREST INCOME:
Federal funds sold		$	284		$	(21	)	$	263		$	1,245		$	61		$	1,306
Securities			293			137			430			1,855			1,029			2,884
Loans, net			4,061			(2,824	)		1,237			6,109			1,022			7,131
Total interest earning assets			4,638			(2,708	)		1,930			9,209			2,112			11,321
INTEREST EXPENSE:
Interest bearing deposits			872			1,814			2,686			3,144			9,572			12,716
Federal funds purchased, securities sold under agreements to repurchase and FHLB advances			608			(425	)		183			1,144			53			1,197
Subordinated debt issued in connection with corporation - obligated  mandatory redeemable capital securities of subsidiary trusts			(238	)		(3	)		(241	)		(357	)		495			138
Total interest bearing liabilities			1,242			1,386			2,628			3,931			10,120			14,051
Decrease in interest differential		$	3,396		$	(4,094	)	$	(698	)	$	5,278		$	(8,008	)	$	(2,730	)

The decrease in net interest income for the three and nine months ended September 30, 2007 resulted primarily from decreases in the net interest spread and margin on a tax equivalent basis. The decreases in the net interest margin on a tax equivalent basis were primarily due to the rates on interest bearing liabilities increasing more rapidly than the yields on interest earning assets due to competitive pressures on loan and deposit pricing. The decrease was partially offset by increases in average volume on interest earning assets. As of September 30, 2007, the Company’s balance sheet is in a liability interest rate sensitive position.

The net interest margin may continue to be negatively affected if interest rate spreads between interest earning assets and interest bearing liabilities continue to narrow. Also, pricing pressures on deposits and loans in the Company’s marketplace could continue to negatively effect net interest income by causing the net interest margin to compress further.

Management uses its strong capital position to prudently leverage the balance sheet by purchasing government securities funded by borrowings. Although the leverage strategy results in narrower net interest spreads, the strategy increases net interest income without significant credit risk or increase in operating expenses. Management will continue to evaluate and manage the effect of the changing interest rate environment on the Company’s present and future operations, while continuing to competitively price its products and services throughout the markets it serves.

Provision for Credit Losses

The decrease in the provision for credit losses of $48,000 for the three months ended September 30, 2007 compared to the 2006 period was primarily due to a reversal of the reserve for unfunded loan commitments in other liabilities. The provision for credit losses for the nine months ended September 30, 2007 decreased to $693,000 compared to $1,344,000 for 2006 primarily due to the elimination of a specific reserve that was required for one non-performing real estate construction loan outstanding during 2006. The ratio of allowance for loan losses to total loans at September 30, 2007, December 31, 2006, and September 30, 2006 was 1.00 percent, 1.01 percent, and 1.03 percent, respectively. The ratio of non-performing assets to total assets at September 30, 2007 was 0.31 percent compared to 0.34 percent and 0.12 percent at December 31, 2006 and September 30, 2006, respectively. During the three and nine months ended September 30, 2007, net charge-offs totaled $0.8 million and $1.2 million compared to $0.1 million and $0.4 million for the 2006 period, respectively. Net charge-offs during the nine months ended September 30, 2007 primarily consisted of $0.4 million related to one non-performing real estate construction loan (charged-off during the 2007 first quarter) and $0.6 million related to one non-performing business loan (charged-off during the 2007 second quarter).

 

32

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Nonaccrual loans were $9.7 million and $3.7 million at September 30, 2007 and 2006, respectively, compared to $9.8 million at December 31, 2006. Total nonaccrual loans at September 30, 2007 primarily consisted of one customer relationship with commercial loans aggregating $7.4 million. The loans involve problems with sources of repayment from operating cash flows. The loans are also supported by personal guarantees. No specific allowance for loan loss was allocated to these impaired loans due to the market value of the real estate collateral. Restructured loans were $0.1 million at September 30, 2007, December 31, 2006, and September 30, 2006.

It is the Company’s policy to discontinue the accrual of interest on loans when, in the opinion of management, a reasonable doubt exists as to the timely collectibility of the amounts due. Regulatory requirements generally prohibit the accrual of interest on certain loans when principal or interest is due and remains unpaid for 90 days or more (with the exception of credit card loans for which the criteria is 180 days past due).

Net income is adversely impacted by the level of non-performing assets caused by the deterioration of borrowers’ ability to meet scheduled interest and principal payments. In addition to foregone revenue, the Company must increase the level of its provision for credit losses and incur collection and other costs associated with the management and disposition of foreclosed properties. A substantial portion (89.0 percent at September 30, 2007) of total loans of the Company is collateralized by real estate, primarily located in the New York Metropolitan area. Accordingly, the collectibility of the loan portfolio of the Company is subject to changes in the real estate market in which the Company operates.

Non-Interest Income

Non-interest income decreased for the three months ended September 30, 2007 to $1.8 million and for the nine months ended September 30, 2007 to $5.3 million compared to $2.1 million and $5.7 million for the 2006 periods, respectively. The decrease for both the September 30, 2007 three and nine month periods compared to the 2006 periods was primarily due to gains on securities transactions from the sale of $47.0 million of collateralized mortgage obligations in the 2006 third quarter, partially offset by an increase in prepayment loan fees in the 2007 periods.

Non-Interest Expenses

Non-interest expenses increased $2.7 million, or 20.3 percent, and $4.5 million, or 11.5 percent, to $15.8 million and $43.3 million for the three and nine months ended September 30, 2007, respectively. The increase in non-interest expenses for the three months ended September 30, 2007 was primarily due to increases in salaries and employee benefits expense and acquisition costs. The increase in non-interest expenses for the nine months ended September 30, 2007 was primarily due to increases in salaries and employee benefits, occupancy and equipment expense, professional fees, and acquisition costs.

 

33

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Salaries and employee benefits expense, the largest component of non-interest expense, increased by $515,000, or 6.2 percent, and $1,787,000, or 7.3 percent, to $8.9 million and $26.4 million, during the three and nine months ended September 30, 2007 compared to the 2006 periods, respectively. The increases for the three and nine months ended September 30, 2007 were primarily due to an increase in stock option expense, payroll expense, medical benefit costs, and a lower level of deferred salaries and employee benefits expense related to loan originations with commitment fees. The increase was partially offset by lower levels of incentive compensation expense.

Changes in non-interest expense for the three and nine months ended September 30, 2007 compared to the three and nine months ended September 30, 2006 were also primarily due to the following:

 

·

Decrease of $4,000 (0.2 percent) and an increase of $208,000 (3.5 percent) in occupancy and equipment expense. The increase for the nine month period primarily reflects higher utility cost expense and property taxes from the opening of branch locations and maintenance contracts on new equipment purchased.

·	Decreases of $161,000 (24.2 percent) and $195,000 (10.0 percent) in advertising and business development expense. The decreases primarily reflect decreases in sponsorship events and lower radio and television advertising costs.

·

Increases of $12,000 (3.2 percent) and $159,000 (13.8 percent) in professional fees. The increases were primarily due to higher legal fees related to a previous non-performing real estate construction loan held by the Bank’s wholly-owned subsidiary, Dutch Hill Realty Corp., as well as higher audit and legal fees for Securities and Exchange Commission compliance.

·	Increase of $2.3 million in acquisition costs for both periods. The increase was primarily due to investment banker and legal fees related to the Company’s pending merger with KeyCorp.

·

Decrease of $50,000 (5.6 percent) and an increase of $109,000 (3.9 percent) in other expense. The decrease for the three month period is primarily due to reductions in travel and training expense and the charitable contribution made by the Bank to the U.S.B. Foundation. The increase for the nine month period was primarily due to higher credit card related expenses and outside printing costs and a lower level of deferred expenses related to loan originating, partially offset by lower expenses for courier runs to Bank locations.

34

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U.S.B. HOLDING CO., INC.

 

ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Income Taxes

The effective income tax rate for the three and nine months ended September 30, 2007 was 32.2 percent and 31.8 percent compared to 32.8 percent and 32.6 percent for the 2006 periods, respectively. The effective income tax rate for both the 2007 and 2006 periods reflects nontaxable income from municipal bonds.

As a result of a reduction in taxable income for New York State tax purposes, the Company has established a valuation allowance that reduces the New York State net deferred tax asset to the amount management believes will more likely than not be realized. At September 30, 2007, December 31, 2006, and September 30, 2006, the valuation allowance was $4.8 million, $3.7 million, and $3.6 million, respectively. As of September 30, 2007, the New York State deferred tax asset, net of state deferred tax liabilities, is fully reserved by the valuation allowance.

The Company adopted FIN No. 48 on January 1, 2007. For more information on the Company’s unrecognized income tax benefits identified under FIN No. 48, see Note 3 to the condensed consolidated financial statements.

 

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U.S.B. HOLDING CO., INC.

 

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Market risk is the potential for economic losses to be incurred on market risk sensitive instruments as a result of adverse changes in market indices such as interest rates, foreign currency exchange rates, and commodity prices. Quantitative and qualitative disclosures about market risk at December 31, 2006 were reported in the Company’s 2006 Annual Report to Stockholders. There were no material changes in the Company’s market risk exposures at September 30, 2007 compared to December 31, 2006. Interest rate risk continues to be the Company’s primary market risk exposure since substantially all Company transactions are denominated in U.S. dollars with no direct foreign currency exchange or changes in commodity price exposures. Substantially all market risk sensitive instruments continue to be held to maturity or available for sale with no significant financial instruments entered into or acquired for trading purposes. The Company does not use derivative financial instruments such as interest rate swaps and caps and has not been party to any derivative financial instruments during the nine months ended September 30, 2007.

The Company continues to use two methods to evaluate its sensitivity to changes in interest rates, a “Static Gap” evaluation and a simulation analysis of the impact of changes in interest rates on the Company’s net interest income and cash flow. There have been no changes in the Company’s policy limit of acceptable variances to net interest income at September 30, 2007 as compared to December 31, 2006. The Company’s “Static Gap” at September 30, 2007 was a negative cumulative gap of $339.0 million in the one-year time frame compared to a negative cumulative gap of $391.8 million at December 31, 2006. If interest rates were to gradually increase 200 basis points or decrease 200 basis points from current rates, the percentage change in estimated net interest income for the subsequent twelve month measurement period would continue to be within the Company’s policy limit of not changing by more than 5.0 percent.

 

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U.S.B. HOLDING CO., INC.

 

ITEM 4.

CONTROLS AND PROCEDURES

 

The Company has evaluated the design and operation of its disclosure controls and procedures to determine whether they are effective in ensuring that the disclosure of required information is timely made in accordance with the Securities Exchange Act of 1934 (the “Exchange Act”) and the rules and forms of the Securities and Exchange Commission. This evaluation was made under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer, as of September 30, 2007. The Chief Executive Officer and Chief Financial Officer have each concluded, based on their review, that as of September 30, 2007, the Company’s disclosure controls and procedures, as defined by Exchange Act Rules 13a-15(e) and 15d-15(e), were effective to ensure that information required to be disclosed by the Company in reports that it files under the Exchange Act is recorded, processed, summarized, and reported within the time period specified in Securities and Exchange Commission rules and forms and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. There was no change in the Company’s internal control over financial reporting that occurred during the fiscal quarter ended September 30, 2007 that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

 

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PART II - OTHER INFORMATION

ITEM 1A.   RISK FACTORS

In addition to the risk factors disclosed in the Company’s 2006 Annual Report on Form 10-K in response to Item 1A to Part I of Form 10-K, please see the risk factors included in the proxy statement dated October 23, 2007 and as filed with the Securities and Exchange Commission by the Company on October 26, 2007.

ITEM 6.   EXHIBITS

Exhibit No.		Exhibit
(2) (a)		Amended and Restated Agreement and Plan of Merger dated as of October 22, 2007 among KeyCorp, KYCA LLC, and U.S.B. Holding, Co., Inc. (incorporated herein by reference to Exhibit 99.2 to the Registrant’s Form 8-K filed on October 26, 2007).
(10) (w)		Employment Agreement dated as of July 25, 2007 among the Company, the Bank and Thomas E. Hales (incorporated herein by reference to Exhibit 10(w) to the Registrant’s Form 8-K filed on July 30, 2007).
(10) (x)		Employment Agreement dated as of July 25, 2007 among the Company, the Bank and Raymond J. Crotty (incorporated herein by reference to Exhibit 10(x) to the Registrant’s Form 8-K filed on July 30, 2007).
(10) (y)		Letter Agreement dated July 25, 2007 between the Company and Thomas Buonaiuto (incorporated herein by reference to Exhibit 10(y) to the Registrant’s Form 8-K filed on July 30, 2007).
(10) (z)		U.S.B. Holding Co., Inc. Amended and Restated Severance Plan (incorporated herein by reference to Exhibit 10(z) to the Registrant’s Form 8-K filed on July 30, 2007).
(31.1)		Certification of Chief Executive Officer Pursuant to Exchange Act Rule 13a-14(a).*
(31.2)		Certification of Chief Financial Officer Pursuant to Exchange Act Rule 13a-14(a).*
(32)		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350.*

 

* Filed Herewith

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized on November 8, 2007.

 

  U.S.B. HOLDING CO., INC.

/s/ Thomas E. Hales			/s/ Thomas M. Buonaiuto
Thomas E. Hales			Thomas M. Buonaiuto
Chairman of the Board,			Executive Vice President,
Chief Executive Officer, and Director			Chief Financial Officer, and
			Assistant Secretary (Principal Financial and Accounting Officer)

 

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