United Community Bank - 10-Q quarterly report FY

 

 

 

   UNITED COMMUNITY BANKS, INC.

   Consolidated Statement of Income (unaudited)

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

   UNITED COMMUNITY BANKS, INC.

   Consolidated Balance Sheet        

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Notes to Consolidated Financial Statements

     The accounting and financial reporting policies of United Community Banks, Inc. (“United”) and its subsidiaries conform to accounting principles generally accepted in the United States of America and general banking industry practices. The accompanying interim consolidated financial statements have not been audited. All material intercompany balances and transactions have been eliminated. A more detailed description of United’s accounting policies is included in the 2006 annual report filed on Form 10-K.

     In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments are normal and recurring accruals considered necessary for a fair and accurate presentation. The results for interim periods are not necessarily indicative of results for the full year or any other interim periods.

     United has an equity compensation plan that allows for grants of incentive stock options, nonqualified stock options, restricted stock awards (also referred to as “nonvested stock” awards), stock awards, performance share awards or stock appreciation rights. Options granted under the plan can have an exercise price no less than the fair market value of the underlying stock at the date of grant. The general terms of the plan include a vesting period (usually four years) with an exercisable period not to exceed ten years. Certain option and restricted stock awards provide for accelerated vesting if there is a change in control (as defined in the plan). As of September 30, 2007, approximately 1,900,000 additional awards could be granted under the plan. Through September 30, 2007, only incentive stock options, nonqualified stock options and restricted stock awards and units had been granted under the plan.

     The following table shows stock option activity for the first nine months of 2007.

     The weighted average fair value of stock options granted in the first nine months of 2007 and 2006 was $8.29 and $8.51, respectively. The fair value of each option granted was estimated on the date of grant using the Black-Scholes model. The key assumptions used to determine the fair value of stock options are presented in the table below.

     United’s stock trading history began in March of 2002 when United listed on the Nasdaq National Market. For 2007 and 2006, expected volatility was determined using United’s historical monthly volatility over the period beginning in March of 2002 through the end of the last completed year. Compensation expense for stock options was $1,564,000 and $1,381,000 for the nine months ended September 30, 2007 and 2006, respectively, which was net of deferred tax benefits of $492,000 and $240,000, respectively. The amount of compensation expense for both periods was determined based on the fair value of the options at the time of grant, multiplied by the number of options granted that were expected to vest, which was then amortized, net of any applicable tax benefit, over the vesting period. The forfeiture rate for options is estimated to be approximately 3% per year. The total intrinsic value of options exercised during the nine months ended September 30, 2007 was $2,163,000.

     The table below presents the activity in restricted stock for the first nine months of 2007.

     Compensation expense for restricted stock is based on the fair value of United’s common stock on the date of grant. The value of restricted stock grants that are expected to vest is amortized into expense over the vesting period. For the nine months ended September 30, 2007 and 2006, compensation expense of $555,000 and $612,000, respectively, was recognized related to restricted stock awards. The total intrinsic value of the restricted stock was $2,217,000 at September 30, 2007.

     As of September 30, 2007, there was $9,651,000 of unrecognized compensation cost related to non-vested stock options and restricted stock awards granted under the plan. That cost is amortized into expense over the vesting period, which is usually 48 months and is expected to be recognized over a weighted-average period of 1.6 years. The aggregate grant date fair value of options and restricted stock awards that vested during the nine months ended September 30, 2007, was $3,258,000.

     United provides a Dividend Reinvestment and Share Purchase Plan (DRIP) to its shareholders. Under the plan, shareholders of record can voluntarily reinvest all or a portion of their cash dividends into shares of United’s common stock, as well as purchase additional stock through the plan for cash. United’s 401(k) retirement plan regularly purchases shares of United’s common stock directly from United. In addition, United has an Employee Stock Purchase Program (ESPP) that allows eligible employees to purchase shares of common stock at a 5% discount, with no commission charges. For the nine months ended September 30, 2007 and September 30, 2006, United issued 123,692 shares and 128,244 shares, respectively, and increased capital by $3.6 million and $3.7 million, respectively, through these programs.

     United offers its common stock as an investment option in its deferred compensation plan. The common stock component of the deferred compensation plan is accounted for as an equity instrument and is reflected in the consolidated financial statements as common stock issuable. At September 30, 2007 and September 30, 2006, 66,336 shares and 22,741 shares, respectively, were issuable under the deferred compensation plan.

     United had in place a Board approved repurchase authorization of 1,000,000 shares of its outstanding common stock that expires on December 31, 2007. At its July 19, 2007 meeting, United’s Board of Directors increased the authorization to 2,000,000 shares. In the third quarter, United repurchased 1,304,775 shares of its outstanding common stock at a cost of $31.9 million. At its October 18, 2007 board meeting, United’s Board further increased the authorization to 3,000,000 shares and extended the expiration date to December 31, 2008.

The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30.

     On June 1, 2007, United acquired 100 percent of the outstanding common shares of Gwinnett Commercial Group, Inc. (Gwinnett), a community bank holding company headquartered in Lawrenceville, Georgia. Gwinnett’s results of operations are included in consolidated financial results from the acquisition date. Gwinnett was the parent company of First Bank of the South, a community bank with five full service banking offices serving the north metro Atlanta counties of Gwinnett, DeKalb and north Fulton and a commercial loan office in Walton County. United has continued to expand its presence in metropolitan Atlanta and the acquisition of Gwinnett accomplishes a long standing strategic goal of encircling metro Atlanta. The aggregate purchase price was approximately $222.9 million, including 5,691,948 shares of United’s common stock and $31.5 million in cash that was exchanged for all of the outstanding common shares and options to purchase common shares of Gwinnett. The value of the common stock issued of $33.62 per share was determined based on the average of the closing market price of United’s common shares over the period beginning two days before and ending two days after the terms of the acquisition were agreed to and announced.

     The following table summarizes the estimated fair values of assets acquired and liabilities assumed on the acquisition date (in thousands):

     The financial information below presents the pro forma earnings of United assuming that the results of operations of Gwinnett and Southern Bancorp, Inc., acquired on December 1, 2006, were included in consolidated earnings as of the beginning of the earliest reported period (in thousands):

     At September 30, 2007, accrued merger costs of $2,480,000 remained unpaid relating to acquisitions closed in 2007, 2006 and 2004. The severance and related costs include change in control payments for which payment had been deferred, the majority of which will be paid in January of 2008. Professional fees include legal fees, investment banker fees, and fees for other professional services related to the business combinations. Contract termination costs include amounts claimed by service providers as a result of early termination of service contracts related to the acquisitions. During the first quarter, the one contract termination charge that was in dispute was resolved, and goodwill was reduced accordingly. A reconciliation of the activities in 2007 related to accrued merger costs is below (in thousands):

     Certain amounts for the comparative periods of 2006 have been reclassified to conform to the 2007 presentation.

     In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 159 (SFAS No. 159), The Fair Value for Financial Assets and Financial Liabilities—including an amendment of FASB Statement No. 115. This statement permits entities to choose to measure many financial instruments and certain other items at fair value. 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. This statement is expected to expand the use of fair value measurement, which is consistent with the FASB’s long-term measurement objective for accounting for financial instruments. This statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of a fiscal year that begins on or before November 15, 2007, provided the entity also elects to apply SFAS No. 157, Fair Value Measurements. United expects to adopt this standard beginning January 1, 2008. The financial statement impact is being evaluated; however, it is not expected to be material to United’s financial position, results of operations or disclosures.

     United adopted Financial Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109, on January 1, 2007. The adoption of FIN 48 had no effect on United’s financial statements. The amount of unrecognized tax benefits as of January 1, 2007 totaled $2.0 million. All of this amount would increase income from continuing operations, and thus impact United’s effective tax rate, if ultimately recognized into income. Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

     It is United’s policy to recognize interest and penalties accrued relative to unrecognized tax benefits in their respective federal or state income taxes accounts. As of January 1, 2007, $403,000 in interest and penalties had been accrued.

     United and its subsidiaries file a consolidated U.S. federal income tax return, as well as filing various returns in the states where its banking offices are located. The Company’s filed income tax returns are no longer subject to examination by taxing authorities for years before 2003.

     The second quarter 2007 provision for loan losses included a special $15 million provision for fraud related loan losses in two real estate developments located near Spruce Pine, North Carolina. During the second quarter of 2007, the North Carolina Attorney General obtained a receiver to take custody of the developers’ assets citing possible fraud on the part of the developers. United has loans outstanding to 83 individual borrowers that total $23.6 million secured by undeveloped lots in these developments. United was one of twelve banks that had loaned money to borrowers to finance the purchase of lots. The loans were made to appropriately qualified borrowers in accordance with United’s standard underwriting procedures. At the time the loans were made, we were not aware that most of the borrowers were simultaneously obtaining loans for additional lots at other banks and thereby taking on debt possibly beyond their repayment ability. We were also unaware that the borrowers’ down payments were not paid in cash as indicated on the closing statements but were financed by a second mortgage from the developer and that the developer agreed to service the borrowers’ debts. We have also subsequently learned that the appraisals relied upon in the underwriting process had been inflated by using comparable sales that were not at arms length to persons related to the developer and that many of the lots were subdivided into parcels that are too small to be used for their intended purpose. Based on our findings and our internal estimate of expected losses, we recorded a $15 million special provision for loan losses. We are working with the receiver, the other banks involved, the borrowers and our insurance carrier in order to minimize our losses. As of September 30, 2007, none of the loans had been charged off, but all are on non-accrual status and included in nonperforming assets.

     United is currently undergoing routine income tax audits by the Georgia Department of Revenue and the North Carolina Department of Revenue for the 2003, 2004, and 2005 tax years. The audits are still in process and no additional taxes have yet been assessed. United believes it has appropriately complied with the tax laws of each state and does not expect the results of the audits to have a material effect on United’s financial statements.

     This Form 10-Q contains forward-looking statements regarding United Community Banks, Inc. (“United”), including, without limitation, statements relating to United’s expectations with respect to revenue, credit losses, levels of nonperforming assets, expenses, earnings and other measures of financial performance. Words such as “may”, “could”, “would”, “should”, “believes”, “expects”, “anticipates”, “estimates”, “intends”, “plans”, “targets” or similar expressions are intended to identify forward-looking statements. These forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond United’s control). The following factors, among others, could cause United’s financial performance to differ materially from the expectations expressed in such forward-looking statements:

     Additional information with respect to factors that may cause actual results to differ materially from those contemplated by such forward-looking statements may also be included in other reports that United files with the Securities and Exchange Commission. United cautions that the foregoing list of factors is not exclusive and not to place undue reliance on forward-looking statements. United does not intend to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Form 10-Q.

     The following discussion is intended to provide insight into the financial condition and results of operations of United and its subsidiaries and should be read in conjunction with the consolidated financial statements and accompanying notes.

     United is a bank holding company registered with the Federal Reserve under the Bank Holding Company Act of 1956 that was incorporated under the laws of the state of Georgia in 1987 and commenced operations in 1988. At September 30, 2007, United had total consolidated assets of $8.2 billion, total loans of $6.0 billion, total deposits of $6.2 billion and stockholders’ equity of $833.8 million.

     United’s activities are primarily conducted by its wholly owned Georgia and North Carolina banking subsidiaries (which are collectively referred to as the “Banks” in this discussion) and Brintech, Inc., a consulting firm providing professional services to the financial services industry.

     Net income was $22.5 million for the quarter ended September 30, 2007, which is an increase of 29% from the $17.4 million earned during the quarter ended September 30, 2006. Diluted earnings per common share increased 10% to $.46 for the quarter, compared to $.42 for the third quarter 2006. Return on tangible equity for the third quarter of 2007 was 17.54%, compared to 17.29% for the third quarter of 2006. Return on assets for the third quarter of 2007 was 1.11% as compared to 1.09% for the third quarter of 2006.

     Reported earnings of $53.8 million for the nine months ended September 30, 2007 included a special $15.0 million provision for fraud related loan losses involving two halted real estate developments near Spruce Pine, North Carolina. The after-tax impact of this provision was $9.2 million, or $.20 per diluted share. Because management believes these losses are an isolated and non-recurring event we will highlight operating earnings information, which excludes the special provision, to provide a better understanding of our ongoing earnings and credit trends.

     For the first nine months of 2007, net operating income was $63.0 million compared to $50.4 million for the same period in 2006, an increase of 25%. Diluted operating earnings per share was $1.36 for the nine months ended September 30, 2007, compared with $1.22 for 2006, an increase of 11%. Operating return on tangible equity for the first nine months of 2007 was 17.42% compared to 17.54% for 2006. Operating return on assets for the nine months of 2007 was 1.11% compared to 1.09% for 2006.

     Operating earnings were driven by strong revenue growth over the past twelve months. During the first nine months of 2007, United saw a slow-down in loan growth, caused primarily by a lack of demand for new construction loans and loans for acquisition and development projects. Also during 2007, competitive pressures drove pricing on certificates of deposit above rates for similar structured wholesale borrowings leading to a shift in funding toward lower priced wholesale borrowed funds.

     Both net charge offs and nonperforming assets increased from a year ago and last quarter reflecting the current cycle in the housing market. Net charge offs as a percentage of average loans of 35 basis points compared with 15 basis points last quarter and 11 basis points a year ago. Nonperforming assets as a percentage of total assets rose to 77 basis points from 14 basis points a year ago and 54 basis points at the end of the second quarter. Included in nonperforming assets are $23.6 million in loans in the halted real estate developments near Spruce Pine, North Carolina. Excluding the Spruce Pine lot loans, the ratio of nonperforming assets to total assets was 49 basis points. The level of charge-offs increased this quarter as management deliberately pursued a strategy of aggressive liquidation to move credits off our balance sheet. Management believes this is an appropriate strategy for handling nonperforming assets.

     Fee revenue rose 29% reflecting increases in every category compared to the third quarter of 2006. For the first nine months of 2007, fee revenue increased 30% compared with 2006. Operating expenses were up 16% from the third quarter of 2006 and up 18% for the first nine months of 2007 as compared with the same periods a year ago. The increase in operating expenses reflects the added operating expenses of recently acquired banks and the significant de novo expansion activity over the last 18 months.

     The accounting and reporting policies of United Community Banks and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The more critical accounting and reporting policies include United’s accounting for the allowance for loan losses. In particular, United’s accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgment to be made by management. Different assumptions in the application of these policies could result in material changes in United’s consolidated financial position or consolidated results of operations. See “Asset Quality and Risk Elements” herein for additional discussion of United’s accounting methodologies related to the allowance.

     The presentation of United’s financial results herein highlight net operating income, which is a measure of performance determined by methods other than accounting principles generally accepted in the United States of America, or GAAP. Management included non-GAAP net operating income because it believes it is useful for evaluating United’s operations and performance over periods of time, and uses net operating income in managing and evaluating United’s business and intends to use it in discussions about United’s operations and performance.

     Net operating income excludes the pre-tax effect of the special $15 million fraud related provision for loan losses recorded in the second quarter of 2007 involving lot loans near Spruce Pine, North Carolina because management believes that the circumstances leading to the special provision were isolated, non-recurring events and do not reflect overall trends in United’s earnings. Management believes this non-GAAP net operating income provides users of United’s financial information with a meaningful measure for assessing United’s financial results and credit trends and comparing financial results to prior periods.

     A reconciliation of operating earnings measures to reported earnings measures using GAAP is presented below: