SECURITIES AND EXCHANGE COMMISSION
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2003
Commission File Number 0-21656
UNITED COMMUNITY BANKS, INC.
Registrant’s telephone number, including area code: (706) 781-2265
Securities registered pursuant to Section 12(b) of the Act: None
Name of exchange on which registered: None
Securities registered pursuant to Section 12(g) of the Act:Common Stock, $1.00 par value
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
Aggregate market value of the voting stock held by non-affiliates of the Registrant: $475,153,011 (based on shares held by non-affiliates at $24.98 per share, the closing stock price on the Nasdaq stock market on June 30, 2003).
As of February 29, 2004, 23,749,177 shares of common stock were issued and outstanding, including 248,000 shares deemed outstanding pursuant to prime plus 1/4% convertible subordinated payable-in-kind debentures due December 31, 2006 and presently exercisable options to acquire 723,604 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on April 28, 2004 are incorporated herein into Part III by reference.
TABLE OF CONTENTS
INDEX
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PART I
ITEM 1. BUSINESS.
United and the Banks
United Community Banks, Inc. (“United”), a bank holding company registered under the Bank Holding Company Act of 1956, was incorporated under the laws of Georgia in 1987 and commenced operations in 1988 by acquiring 100% of the outstanding shares of Union County Bank, Blairsville, Georgia, now known as United Community Bank (“UCB-Georgia”). Substantially all of United’s activities are currently conducted by its wholly-owned state chartered bank subsidiaries: UCB-Georgia, which was organized in 1949 and began business in 1950; United Community Bank, Brevard, North Carolina (“UCB-North Carolina”), which United acquired in 1990; and United Community Bank Tennessee, Lenoir City, Tennessee (“UCB-Tennessee”), which United acquired in 2003. UCB-Georgia, UCB-North Carolina and UCB-Tennessee are collectively referred to in this report as the “Banks.”
Since the early 1990’s, United has actively expanded its market coverage through organic growth and through a series of acquisitions, primarily of banks whose managements share United’s community banking and customer service philosophies. Although those acquisitions have contributed approximately thirty percent of United’s overall growth since 1993, their contribution has mostly been to open up new markets that have above average organic growth potential. Organic growth and selective openings of de novo offices, as well as acquisitions, will continue to be a focus of United’s growth strategy to extend United’s reach into new and existing markets.
The Banks are community-oriented, offering a full range of retail and corporate banking services, including checking, savings, and time deposit accounts, secured and unsecured loans, wire transfers, brokerage services, and rental of safe deposit boxes. As of December 31, 2003, the Banks operated through 72 locations. To emphasize the commitment to community banking, United’s three bank subsidiaries operate with decentralized management that is currently organized as twenty community banks (“Community Banks”) with local bank presidents (referred to herein as the “Presidents”) who are tied to the communities they serve and have the authority, alone or with other local officers, to make most credit decisions.
United completed its acquisitions of First Central Bancshares, Inc., a Tennessee bank holding company, First Georgia Holding, Inc., a coastal Georgia bank holding company, and three western North Carolina RBC Centura Bank branches during 2003. These acquisitions added $518 million in assets and $484 million in deposits. In addition, United opened a de novo bank in Savannah, Georgia, two de novo banking offices in western North Carolina and a de novo banking office in north Georgia during 2003.
Non-Bank Activities
In addition, United owns an insurance agency, United Community Insurance Services, Inc. (“UCIS”), which is a subsidiary of UCB-Georgia.
United Community Mortgage Services (“UCMS”), formerly known as The Mortgage People Company, a division of UCB-Georgia, is a full-service retail mortgage lending operation approved as a seller/servicer for Federal National Mortgage Association and Federal Home Mortgage Corporation and provides fixed and adjustable-rate home mortgages. During 2003, UCMS originated $373 million of residential mortgage loans for the purchase of homes and to refinance existing mortgage debt, of which substantially all were sold into the secondary market with no recourse to UCMS.
Acquired by United in 2000, Brintech, Inc. (“Brintech”) is a consulting firm for the financial services industry. Brintech provides consulting, advisory, and implementation services in the areas of strategic planning, profitability improvement, technology, efficiency, security, network, Internet banking, web site development, marketing, core processing, and telecommunications.
United provides retail brokerage services through an affiliation with a third party broker/dealer.
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Forward-Looking Statements
This Form 10-K contains forward-looking statements regarding United Community Banks, Inc., 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: (1) business increases, productivity gains and other investments are lower than expected or do not occur as quickly as anticipated; (2) competitive pressures among financial services companies increase significantly; (3) the strength of the United States economy in general and/or the strength of the local economies of the states in which United conducts operations changes; (4) trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, change; (5) inflation, interest rates or market conditions fluctuate; (6) conditions in the stock market, the public debt market and other capital markets deteriorate; (7) United fails to develop competitive new products and services or new and existing customers do not accept these products and services; (8) financial services laws and regulations change; (9) technology changes and United fails to adapt to those changes; (10) consumer spending and saving habits change; (11) unanticipated regulatory or judicial proceedings occur; and (12) United is unsuccessful at managing the risks involved in the foregoing. 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-K.
Monetary Policy And Economic Conditions
The Banks’ profitability depends to a substantial extent on the difference between revenue the Banks receive from their loans, investments, and other earning assets, and the interest the Banks pay on their deposits and other liabilities. These rates are highly sensitive to many factors that are beyond the control of the Banks, including national and international economic conditions and the monetary policies of various governmental and regulatory authorities.
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Competition
The market for banking and bank-related services is highly competitive. The Banks actively compete in their respective market areas, which collectively include metro Atlanta, north Georgia, coastal Georgia, western North Carolina and east Tennessee, with other providers of deposit and credit services. These competitors include other commercial banks, savings banks, savings and loan associations, credit unions, mortgage companies, and brokerage firms. The following table displays each of the Banks and the respective percentage of total bank and thrift deposits in each county where the Bank has operations. The table also indicates the ranking by deposit size in each of the local markets. All information in the table was obtained from the Federal Deposit Insurance Corporation Summary of Deposits as of June 30, 2003.
United Community Banks, Inc.Share of Local Markets by CountyBanks and Savings Institutions
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Loans
The Banks make both secured and unsecured loans to individuals, firms, and corporations. Secured loans include first and second real estate mortgage loans. The Banks also make direct installment loans to consumers on both a secured and unsecured basis. At December 31, 2003, commercial (commercial and industrial), commercial (secured by real estate), construction (secured by real estate), residential mortgage and installment loans represented approximately 6%, 26%, 31%, 32% and 5%, respectively, of United’s total loan portfolio.
Specific risk elements associated with each of the Banks’ lending categories include, but are not limited to:
Lending Policy
The current lending policy of the Banks is to make loans primarily to persons or businesses that reside, work, own property, or operate in their primary market areas. Unsecured loans are generally made only to persons who qualify for such credit based on net worth and liquidity. Secured loans are made to persons who are well established and have net worth, collateral, and cash flow to support the loan. Exceptions to the Banks’ policies are permitted on a case-by-case basis and require the approving officer to document in writing the reason for the exception. Policy exceptions made for borrowers whose total aggregate loans exceed the approving officer’s credit limit must be approved through the credit approval process. Policy exceptions made for borrowers whose aggregate loans exceed $5 million must be approved by the Banks’ Boards of Directors for ratification.
United’s Credit Administration department provides each lending officer with written guidelines for lending activities as approved by the Banks’ Boards of Directors. Limited lending authority is delegated to lending officers by United’s Management Credit and Policy Committee as authorized by the Banks’ Boards of Directors. Loans in excess of individual officer credit authority must be approved by a senior officer with sufficient approval authority delegated by the Management Credit and Policy Committee as authorized by the Banks’ Boards of Directors. Loans to borrowers whose total aggregate loans exceed $12.5 million require the additional approval of two United directors.
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Regional Credit Managers
United utilizes its Regional Credit Managers to provide credit administration support to the Banks as needed. The Regional Credit Managers have joint lending approval authority with the Presidents within varying limits set by the Management Credit and Policy Committee based on characteristics of each market. The Regional Credit Managers also provide credit underwriting support as needed by the Banks they serve.
Loan Review and Non-performing Assets
The Loan Review Department of United reviews, or engages an independent third party to review, the Banks’ loan portfolios on an ongoing basis to identify any weaknesses in the portfolio and to assess the general quality of credit underwriting. The results of such reviews are presented to the Presidents of each of the Community Banks, the Chief Credit Officer of United, and the Boards of Directors of each of the Community Banks. If an individual loan or credit relationship has a weakness identified during the review process, the risk rating of the loan, or all loans comprising a credit relationship, will be downgraded to a classification that most closely matches the current risk level. The review process also provides for the upgrade of loans that show improvement since the last review. Since each loan in a credit relationship may have a different credit structure, collateral, and other secondary source of repayment, different loans in a relationship can be assigned different risk ratings. Under United’s 10-grade loan grading system, grades 1 through 6 are considered “pass” (acceptable) credit risk, grade 7 is a “watch” rating, and grades 8 through 10 are “adversely classified” credits that require management’s attention. Both the pass and adversely classified ratings, and the entire 10-grade rating scale, provide for a higher numeric rating for increased risk. For example, a risk rating of 1 is the least risky of all credits and would be typical of a loan that is 100% secured by a deposit at one of the Banks. Risk ratings of 2 through 6 in the pass category each have incrementally more risk. The four watch list credit ratings and rating definitions are:
In addition, the Loan Review Department conducts a quarterly analysis to determine the adequacy of the Allowance for Loan Losses (“ALL”) for each of the Banks. The aggregation of these ALL analyses provides the consolidated analysis for United. The ALL analysis starts by taking total loans and deducting loans secured by deposit accounts at the Banks, which effectively have no risk of loss. Next, all loans with an adversely classified rating are deducted, including loans considered impaired. The remaining loan balance is then multiplied by loss factors that were derived from the average historical loss rate for the preceding two year period, adjusted to reflect current economic conditions, which provides a required minimum ALL for pass credits. The remaining total loans in each of the four watch list rating categories are then multiplied by the following loss factors: Watch (5%); Substandard (25%); Doubtful (50%); and Loss (100%). Loans that are considered impaired are evaluated separately and are assigned specific reserves as necessary.
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Asset/Liability Committees (ALCO)
United’s ALCO Committee is composed of the Executive Officers and the Treasurer of United. The Banks’ ALCO Committees are composed of executive officers of each of the Banks and the Treasurer of United. The ALCO Committees are charged with managing the assets and liabilities of United and each of the Banks. The ALCO Committees attempt to manage asset growth, liquidity, and capital to maximize income and reduce interest rate risk, market risk and liquidity risk. The ALCO Committees direct each Bank’s overall acquisition and allocation of funds. At periodic meetings, the committees review the monthly asset and liability funds budget in relation to the actual flow of funds; the ratio of the amount of rate sensitive assets to the amount of rate sensitive liabilities; the ratio of allowance for loan losses to outstanding and non-performing loans; and other variables, such as stress testing expected loan demand, investment opportunities, core deposit growth within specified categories, regulatory changes, monetary policy adjustments and the overall state of the economy. A more comprehensive discussion of United’s Asset/Liability Management and interest rate risk is contained in theManagement’s Discussion and Analysis (Part II, Item 7) and Quantitative and Qualitative Disclosures About Market Risk (Part II, Item 7A) sections of this report.
Investment Policy
The Banks’ investment portfolio policy is to maximize income within liquidity, asset quality and regulatory constraints. The policy is reviewed from time to time by United’s Asset/Liability Committee and the Banks’ Boards of Directors. Individual transactions, portfolio composition, and performance are reviewed and approved periodically by the Banks’ Boards of Directors or a committee thereof. The Chief Financial Officer and Treasurer of United and the President of each of the Banks administer the policy and report information to the Boards of Directors on a quarterly basis concerning sales, purchases, maturities and calls, resultant gains or losses, average maturity, federal taxable equivalent yields, and appreciation or depreciation by investment categories.
Employees
As of December 31, 2003, United and its subsidiaries had 1,296 full-time equivalent employees. Neither United nor any of the subsidiaries was a party to any collective bargaining agreement, and United believes that employee relations are good.
Supervision And Regulation
The following is an explanation of the supervision and regulation of United and the Banks as financial institutions. This explanation does not purport to describe state, federal or Nasdaq National Market supervision and regulation of general business corporations or Nasdaq listed companies.
General. United is a registered bank holding company subject to regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) under the Bank Holding Company Act of 1956, as amended (the “Act”). United is required to file financial information with the Federal Reserve periodically and is subject to periodic examination by the Federal Reserve.
The Act requires every bank holding company to obtain the Federal Reserve’s prior approval before (1) it may acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank that it does not already control; (2) it or any of its non-bank subsidiaries may acquire all or substantially all of the assets of a bank; and (3) it may merge or consolidate with any other bank holding company. In addition, a bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of the voting shares of any company engaged in non-banking activities. This prohibition does not apply to activities listed in the Act or found by the Federal Reserve, by order or regulation, to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve has determined by regulation or order to be closely related to banking are:
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Although the activities of bank holding companies have traditionally been limited to the business of banking and activities closely related or incidental to banking (as discussed above), the Gramm-Leach-Bliley Act relaxed the previous limitations thus permitting bank holding companies to engage in a broader range of financial activities. Specifically, bank holding companies may elect to become financial holding companies which may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Among the activities that are deemed “financial in nature” include:
A bank holding company may become a financial holding company under this statute only if each of its subsidiary banks is well capitalized, is well managed and has at least a satisfactory rating under the Community Reinvestment Act. A bank holding company that falls out of compliance with such requirement may be required to cease engaging in certain activities. Any bank holding company that does not elect to become a financial holding company remains subject to the current restrictions of the Act.
Under this legislation, the Federal Reserve Board serves as the primary “umbrella” regulator of financial holding companies with supervisory authority over each parent company and limited authority over its subsidiaries. The primary regulator of each subsidiary of a financial holding company will depend on the type of activity conducted by the subsidiary. For example, broker-dealer subsidiaries will be regulated largely by securities regulators and insurance subsidiaries will be regulated largely by insurance authorities.
United has no immediate plans to register as a financial holding company.
United must also register with the Georgia Department of Banking and Finance (“DBF”) and file periodic information with the DBF. As part of such registration, the DBF requires information with respect to the financial condition, operations, management and intercompany relationships of United and the Banks and related matters. The DBF may also require such other information as is necessary to keep itself informed as to whether the provisions of Georgia law and the regulations and orders issued thereunder by the DBF have been complied with, and the DBF may examine United and each of the Banks. The North Carolina Banking Commission (“NCBC”), which has the statutory authority to regulate non-banking affiliates of North Carolina banks, in 1992 began using this authority to examine and regulate the activities of North Carolina-based holding companies owning North Carolina-based banks. Although the NCBC has not exercised its authority to date to examine and regulate holding companies outside of North Carolina that own North Carolina banks, it is likely the NCBC may do so in the future. The Tennessee Department of Financial Institutions (“TDFI”) does not examine and regulate out-of-state holding companies.
United is an “affiliate” of the Banks under the Federal Reserve Act, which imposes certain restrictions on (1) loans by the Banks to United, (2) investments in the stock or securities of United by the Banks, (3) the Banks’ taking the stock or securities of an “affiliate” as collateral for loans by the Bank to a borrower, and (4) the purchase of assets from United by the Banks. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.
Each of United’s subsidiaries is regularly examined by the Federal Deposit Insurance Corporation (the “FDIC”). UCB-Georgia as a state banking association organized under Georgia law, is subject to the supervision of, and is regularly examined by, the DBF. UCB-North Carolina is subject to the supervision of, and is regularly examined by, the NCBC. UCB-Tennessee is subject to the supervision of, and is regularly examined by, the TDFI. Both the FDIC and the respective state bank regulators must grant prior approval of any merger, consolidation or other corporation reorganization involving UCB-Georgia, UCB-North Carolina and UCB-Tennessee. A bank can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly-controlled institution.
Payment of Dividends. United is a legal entity separate and distinct from the Banks. Most of the revenue of United results from dividends paid to it by the Banks. There are statutory and regulatory requirements applicable to the payment of dividends by the Banks, as well as by United to its shareholders.
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UCB-Georgia is a state chartered bank regulated by the DBF and the FDIC. Under the regulations of the DBF, dividends may not be declared out of the retained earnings of a state bank without first obtaining the written permission of the DBF, unless such bank meets all the following requirements:
Under North Carolina law, the Board of Directors of UCB-North Carolina may declare a dividend for as much of the undivided profits of UCB-North Carolina as it deems appropriate.
UCB-Tennessee is a state chartered bank regulated by the TDFI and the FDIC. Under Tennessee law, dividends may not be declared out of undivided profits of a state bank without first obtaining the written permission of the TDFI unless:
The payment of dividends by United and the Banks may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending upon the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The FDIC has issued a policy statement providing that insured banks should generally only pay dividends out of current operating earnings. In addition to the formal statutes and regulations, regulatory authorities consider the adequacy of each of the Bank’s total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends to the Banks. At December 31, 2003, net assets available from the Banks to pay dividends without prior approval from regulatory authorities totaled approximately $21 million. For 2003, United’s declared cash dividend payout to common stockholders (Based on operating earnings which excludes merger-related charges. See page 18 for a discussion of merger-related charges and use of non-GAAP earnings measures.) was 17.3% of net income.
Monetary Policy. The results of operations of the Banks are affected by credit policies of monetary authorities, particularly the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. In view of changing conditions in the national economy and in the money markets, as well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand, or the business and income of the Banks.
Capital Adequacy. The Federal Reserve and the FDIC have implemented substantially identical risk-based rules for assessing bank and bank holding company capital adequacy. These regulations establish minimum capital standards in relation to assets and off-balance sheet exposures as adjusted for credit risk. Banks and bank holding companies are required to have (1) a minimum level of total capital (as defined) to risk-weighted assets of eight percent (8%); and (2) a minimum Tier I Capital (as defined) to risk-weighted assets of four percent (4%). In addition, the Federal Reserve and the FDIC have established a minimum three percent (3%) leverage ratio of Tier I Capital to quarterly average total assets for the most highly-rated banks and bank holding companies. “Tier I Capital” generally consists of common equity excluding unrecognized gains and losses on available for sale securities, plus minority interests in equity accounts of consolidated subsidiaries and certain perpetual preferred stock less certain intangibles. The Federal Reserve and the FDIC will require a bank holding company and a bank, respectively, to maintain a leverage ratio greater than three percent (3%) if either is experiencing or anticipating significant growth or is operating with less than well-diversified risks in the opinion of the Federal Reserve. The Federal Reserve and the FDIC use the leverage ratio in tandem with the risk-based ratio to assess the capital adequacy of banks and bank holding companies. The FDIC, the Office of the Comptroller of the Currency (the “OCC”) and the Federal Reserve have amended, effective January 1, 1997, the capital adequacy standards to provide for the consideration of interest rate risk in the overall determination of a bank’s capital ratio, requiring banks with greater interest rate risk to maintain adequate capital for the risk. The revised standards have not had a significant effect on United’s capital requirements.
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In addition, Section 38 of the Federal Deposit Insurance Act implemented the prompt corrective action provisions that Congress enacted as a part of the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “1991 Act”). The “prompt corrective action” provisions set forth five regulatory zones in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a bank’s financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank’s capital leverage ratio reaches 2%. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with lesser amounts of capital.
The FDIC has adopted regulations implementing the prompt corrective action provisions of the 1991 Act, which place financial institutions in the following five categories based upon capitalization ratios: (1) a “well capitalized” institution has a total risk-based capital ratio of at least 10%, a Tier I risk-based ratio of at least 6% and a leverage ratio of at least 5%; (2) an “adequately capitalized” institution has a total risk-based capital ratio of at least 8%, a Tier I risk-based ratio of at least 4% and a leverage ratio of at least 4%; (3) an “undercapitalized” institution has a total risk-based capital ratio of under 8%, a Tier I risk-based ratio of under 4% or a leverage ratio of under 4%; (4) a “significantly undercapitalized” institution has a total risk-based capital ratio of under 6%, a Tier I risk-based ratio of under 3% or a leverage ratio of under 3%; and (5) a “critically undercapitalized” institution has a leverage ratio of 2% or less. Institutions in any of the three undercapitalized categories would be prohibited from declaring dividends or making capital distributions. The FDIC regulations also establish procedures for “downgrading” an institution to a lower capital category based on supervisory factors other than capital. As of December 31, 2003 and 2002, the most recent notifications from the FDIC categorized each of the Banks as “well capitalized” under current regulations.
Inter-agency guidelines adopted by federal bank regulators mandate that financial institutions establish real estate lending policies with maximum allowable real estate loan-to-value limits, subject to an allowable amount of non-conforming loans as a percentage of capital. The Banks adopted the federal guidelines as their maximum allowable limits in 2001; however, policy exceptions are permitted for real estate loan customers with justification.
Transactions with Affiliates. Under federal law, all transactions between and among a state nonmember bank and its affiliates, which include holding companies, are subject to Sections 23A and 23B of the Federal Reserve Act and Regulation W promulgated thereunder as interpreted by the FDIC. Generally, these requirements limit these transactions to a percentage of the bank’s capital and require all of them to be on terms at least as favorable to the bank as transactions with non-affiliates. In addition, a bank may not lend to any affiliate engaged in non-banking activities not permissible for a bank holding company or acquire shares of any affiliate that is not a subsidiary. The FDIC is authorized to impose additional restrictions on transactions with affiliates if necessary to protect the safety and soundness of a bank. The regulations also set forth various reporting requirements relating to transactions with affiliates.
Available Information. United’s Internet website address is www.ucbi.com. United makes available free of charge through its website Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after they are filed with, or furnished to, the Securities & Exchange Commission.
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Executive Officers Of United
Executive Officers of United are elected by the Board of Directors annually and serve at the pleasure of the Board of Directors.
The Executive Officers of United, and their ages, positions with United and terms of office as of February 29, 2004, are as follows:
None of the above officers is related and there are no arrangements or understandings between them and any other person pursuant to which any of them was elected as an officer, other than arrangements or understandings with directors or officers of United acting solely in their capacities as such.
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ITEM 2. PROPERTIES.
The executive offices of United are located at 220 Earnest Street, Blairsville, Georgia. United leases this property. The Banks conduct business from facilities primarily owned by the respective banks, all of which are in a good state of repair and appropriately designed for use as banking facilities. The Banks provide services or perform operational functions at 87 locations, of which 68 locations are owned and 19 are leased. Note 7 to United’s Consolidated Financial Statements includes additional information regarding amounts invested in premises and equipment.
ITEM 3. LEGAL PROCEEDINGS.
In the ordinary course of operations, United and the Banks are defendants in various legal proceedings. In the opinion of management, there is no pending or threatened proceeding in which an adverse decision could result in a material adverse change in the consolidated financial condition or results of operations of United.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matters were submitted to a vote of the security holders of United during the fourth quarter of the fiscal year covered by this report.
PART II
ITEM 5. MARKET FOR UNITED’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Stock. On March 18, 2002, United began trading on The Nasdaq Stock Market under the symbol UCBI. Previously, the stock was not listed on an exchange, nor was it included on an automated quotation system. The closing price for the period ended December 31, 2003 was $32.87. Below is a schedule of high and low stock sales prices for all quarters in 2003 and 2002. For periods prior to March 18, 2002, prices are based on high and low bid information known to United.
Stock Price Information(All prior period amounts have been restated to reflect the 2 for 1 stock split effective May 29, 2002)
At March 10, 2004, there were approximately 8,700 shareholders of record.
Stock Split. On May 29, 2002, United effected a two-for-one stock split in the form of a 100% stock dividend for shareholders of record May 15, 2002. All financial statements and per share amounts included in the financial statements and accompanying notes have been restated to reflect the change in the number of shares outstanding as of the beginning of the earliest period presented.
Dividends. United declared cash dividends of $.30, $.25 and $.20 per common share in 2003, 2002 and 2001, respectively. Federal and state laws and regulations impose restrictions on the ability of United and the Banks to pay dividends. Additional information regarding this item is included in Note 15 to the Consolidated Financial Statements and under the heading of “Supervision and Regulation” in Part I of this report.
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ITEM 6. SELECTED FINANCIAL DATAUNITED COMMUNITY BANKS, INC.Selected Financial InformationFor the Years Ended December 31,
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UNITED COMMUNITY BANKS, INC.Selected Financial Information (continued)
[Additional columns below]
[Continued from above table, first column(s) repeated]
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
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.
Net operating income, excluding merger-related charges, was $39.5 million in 2003, an increase of 20% from the $32.8 million earned in 2002. Diluted operating earnings per common share were $1.68 for 2003, compared with $1.48 for 2002, an increase of 14%. Operating return on tangible equity for 2003 was 19.24%, compared with 17.88% for 2002. Operating return on assets for 2003 was 1.06% as compared to 1.11% in 2002.
Earnings for 2003 were influenced by acquisitions, strong loan growth and historically low interest rates. Growth in the loan portfolio drove the $19.2 million or 16% increase in net interest revenue despite a 34 basis point decrease in the net interest margin caused by lower interest rates. The majority of the decrease in the net interest margin decline related to the recent low interest rate environment during 2002 when the net interest margin fell from 4.51% in the first quarter to 4.03% in the fourth quarter. During 2003, the net interest margin stabilized and remained close to the 4.00% level through the year. Despite a slow national economy, United’s markets remained vibrant allowing United to enjoy strong business growth. Loan growth during 2003 occurred across all of United’s markets with the majority of the growth occurring in the commercial and construction categories.
United chose not to aggressively compete for higher-priced retail time deposits, growth in deposits did not keep pace with the growth in loans. Instead, United increased in the use of wholesale borrowings to fund loan growth. Pricing on those funding sources was more favorable than retail time deposits and the rate characteristics could be more closely matched to the new loans. This allowed United to preserve its interest rate risk profile as slightly asset sensitive. Most of the increase in wholesale borrowings came in the form of Federal Home Loan Bank advances, federal funds purchased and brokered time deposits.
Credit quality remained superior with most credit quality indicators showing improvement over 2002. Nonperforming assets, which includes nonaccrual loans, loans past due more than 90 days and foreclosed real estate, were down $430,000 from 2002, despite an increase in loans of $634 million. As a result, nonperforming assets at December 31, 2003 represent .19% of total assets compared with .25% at the end of 2002. Net charge offs as a percentage of average loans were .15% compared with .14% for 2002. Management believes that United’s outstanding credit quality is the result of a combination of factors, most important of which is United’s community bank structure that consists of community bank presidents and local boards of directors who know their markets and their customers. The majority of United’s loans are secured by real estate located within United’s geographic footprint. These markets have shown economic strength relative to the national economy, as reflected in a strong housing market and rising real estate values.
Fee revenue increased $7.5 million or 24% from 2002, driven primarily by acquisitions, an increase in mortgage refinancing activity and an increase in service charges and fees on deposit accounts. The low interest rate environment of 2003 had a very positive impact on the mortgage lending business, driving mortgage loan and related fees to $10.5 million in 2003 from $7.8 million in 2002. Refinancing activity peaked in the second and third quarters as long term interest rates dropped to their lowest levels in decades. Service charges and fees continued to increase due to the popularity of new deposit products and services and an increase in the number of deposit accounts and transaction volume. In the fourth quarter, United incurred losses from the prepayment of Federal Home Loan Bank (“FHLB”) advances that were offset by gains from the sale of securities. The prepayment of the FHLB advances and the securities sales were both part of a balance sheet management strategy to improve United’s interest rate risk profile and increase net interest revenue.
Operating expenses, excluding the $2.1 million in merger-related charges, were up $17 million or 18% from 2002 reflecting the additional operating expenses of the two banks and three branches acquired in 2003. Excluding the operating expenses of the acquired banks and branches, operating expenses were up approximately 7% from 2002 primarily due to the increase in core business volume. Aside from the acquisitions, headcount at the end of 2003 was held to an increase of only five staff from December 31, 2002.
On May 29, 2002, United effected a two-for-one stock split in the form of a 100% stock dividend for shareholders of record May 15, 2002. All financial statements and per share amounts included in the financial statements and accompanying notes for periods prior to May 29, 2002 have been restated to reflect the change in the number of shares outstanding as of the beginning of the earliest period presented.
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Critical Accounting Policies
The accounting and reporting policies of United and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and the accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported.
Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record the valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.
The most significant accounting policies for United are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates and assumptions, and were changes in those estimates and assumptions could have a significant impact on the financial statements. Management currently views the determination of the allowance for loan losses to be the only critical accounting policy.
The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Estimating the amount of the allowance for loan losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Loan losses are charged off against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for loan losses is charged to operations based on management’s periodic evaluation of the factors previously mentioned, as well as other pertinent factors.
The allowance for loan losses consists of an allocated component and an unallocated component. The components of the allowance for loan losses represent an estimation done pursuant to either Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, or SFAS 114,Accounting by Creditors for Impairment of a Loan. The allocated component of the allowance for loan losses reflects expected losses resulting from analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on regular analyses of all loans over a fixed-dollar amount where the internal credit rating is at or below a predetermined classification. These analyses involve a high degree of judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The historical loss element is determined using the average of actual losses incurred over the prior two years for each type of loan. The historical loss experience is adjusted for known changes in economic conditions and credit quality trends such as changes in the amount of past due and nonperforming loans. The resulting loss allocation factors are applied to the balance of each type of loan after removing the balance of impaired loans from each category. The loss allocation factors are updated quarterly. The allocated component of the allowance for loan losses also includes consideration of concentrations of credit and changes in portfolio mix.
The unallocated portion of the allowance reflects management’s estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. In addition, the unallocated allowance includes a component that accounts for the inherent imprecision in loan loss estimation based on historical loss experience. United has grown through acquisitions, expanded the geographic footprint in which it operates, and changed its portfolio mix in recent years. As a result, historical loss experience data used to establish allocation estimates may not precisely correlate to the current portfolio. Also, loss data representing a complete economic cycle is not available for all sectors. Uncertainty surrounding the strength and timing of
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economic cycles also affects estimates of loss. The historical losses used in developing loss allocation factors may not be representative of actual unrealized losses inherent in the portfolio.
There are many factors affecting the allowance for loan losses; some are quantitative while others require qualitative judgment. Although management believes its process for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect earnings or financial position in future periods.
Additional information on United’s loan portfolio and allowance for loan losses can be found in the sections of Management’s Discussion and Analysis titled “Asset Quality and Risk Elements” and “Nonperforming Assets” and in the sections of Part I, Item 1 titled “Lending Policy” and “Loan Review and Non-performing Assets”. Note 1 to the consolidated financial statements includes additional information on United’s accounting policies related to the allowance for loan losses.
Mergers and Acquisitions
On November 7, 2001, United completed the acquisition of Peoples Bancorp, Inc. (“West Georgia”), a single-bank holding company located in Carrollton, Georgia. United exchanged 716,252 shares of common stock in exchange for all outstanding shares of West Georgia. The transaction was recorded as a purchase, with the results of operations of West Georgia included in earnings from the date of merger.
On March 31, 2003, United completed the acquisition of First Central Bancshares, Inc. (“First Central”), a bank holding company headquartered in Lenoir City, Tennessee, and its wholly-owned Tennessee bank subsidiary, First Central Bank. On March 31, 2003, First Central Bank had assets of $195 million, including purchase accounting related intangibles. United exchanged 821,160 shares of its common stock valued at $20.6 million and approximately $9 million in cash for all of the outstanding shares. First Central Bank’s name was changed to United Community Bank Tennessee.
On May 1, 2003, United completed the acquisition of First Georgia Holding, Inc. (“First Georgia”), a bank holding company headquartered in Brunswick, Georgia, and its wholly-owned Georgia subsidiary, First Georgia Bank. On May 1, 2003, First Georgia Bank had assets of $303 million, including purchase accounting related intangibles. United exchanged 1,177,298 shares of its common stock valued at $29.3 million and approximately $12.8 million in cash for all of the outstanding shares. First Georgia Bank was merged into UCB-Georgia, and operates as a separate community bank.
On October 24, and November 14, 2003, United completed the acquisition of three branches from another financial institution in western North Carolina in Avery, Mitchell and Graham counties. These branches complimented United’s existing western North Carolina markets and were a natural extension of its existing franchise. United paid a premium for each branch of between 7% and 11% of average deposits.
Merger-Related and Restructuring Charges
During 2003, United recorded merger-related charges of $2.1 million for the purchases of First Central, First Georgia and the three branches in western North Carolina. The charges were included in operating expenses.
During the fourth quarter of 2001, United recorded merger-related charges of $1.6 million in connection with the acquisition and integration of West Georgia. The charges were included in operating expenses for 2001.
The charges are discussed further in Note 3 to the consolidated financial statements. These charges have been excluded from the presentation of operating earnings. Management believes operating earnings provide a helpful measure for assessing financial performance trends.
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The table below presents a reconciliation of United’s operating earnings to earnings for the years 2003 and 2001 using accounting principles generally accepted in the United States of America (GAAP). There were no merger-related or restructuring charges in 2002.
Table 1 - Operating Earnings to GAAP Earnings Reconciliation
Results of Operations
The remainder of this financial discussion focuses on operating earnings which exclude merger-related charges. Management believes operating earnings provide a meaningful basis for analysis. For additional information on merger-related and restructuring charges, refer to the section on “Merger-Related and Restructuring Charges” immediately preceding this section and Note 3 to the Consolidated Financial Statements.
Net Interest Revenue (Taxable Equivalent)
Net interest revenue (the difference between the interest earned on assets and the interest paid on deposits and other liabilities) is the single largest component of United’s revenue. United actively manages this revenue source to provide an optimal level of revenue while balancing interest rate risk, credit and liquidity risks. Net interest revenue totaled $138.7 million in 2003, an increase of $19.2 million, or 16% from the level recorded in 2002. Net interest revenue for 2002 increased $10.4 million or 10% over the 2001 level.
The main driver of this increase was loan growth. Average loans increased $514 million, or 23%, from last year. This loan growth was primarily driven by core loan growth of approximately $300 million across existing markets, with the balance of the growth due to the acquisitions of First Central Bank, First Georgia Bank and the branches in western North Carolina (collectively, the “2003 Acquisitions”). Year-end loan balances increased $634 million from year-end 2002. Of this increase, $123 million was across markets in north Georgia, $59 million was in western North Carolina, $125 million was in the metro Atlanta market, $105 million was
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in Tennessee related to the acquisition of First Central Bank and $222 million was in coastal Georgia, primarily related to the acquisition of First Georgia Bank.
Average interest-earning assets for the year increased $715 million, or 26%, over 2002. The increase reflects the core growth in loans and acquisitions, as well as an increase in the investment securities portfolio. The majority of the increase in interest-earning assets was funded by interest-bearing sources as the increase in average interest-bearing liabilities for the year was approximately $632 million over 2002.
The banking industry uses two key ratios to measure relative profitability of net interest revenue, which are the interest rate spread and the net interest margin. The interest rate spread measures the difference between the average yield on earning assets and the average rate paid on interest bearing liabilities. The interest rate spread eliminates the impact of non-interest bearing deposits and other non-interest bearing funding sources and gives a direct perspective on the effect of market interest rate movements. The net interest margin is defined as net interest revenue as a percentage of total average earning assets which includes the positive impact of funding a portion of earning assets with customers’ non-interest bearing deposits and with stockholders’ equity.
For 2003, 2002 and 2001, United’s net interest spread was 3.71%, 3.95% and 3.90%, respectively, while the net interest margin was 3.99%, 4.33% and 4.51%, respectively. The decline in the net interest margin reflects the continuation of the historically low rate environment, which reduces the relative value of non-interest bearing sources of funds. Since United’s balance sheet had remained asset sensitive during most of 2002, primarily due to growth in floating rate loans, the declining rate environment had a greater effect on interest-earning assets than on interest-bearing liabilities causing compression in the net interest spread and margin. Combined with a flat yield curve, the low rate environment resulted in reinvestment of maturing fixed rate loans and securities at rates lower than the assets they were replacing. At December 31, 2003, United had approximately $1.4 billion in loans indexed to the daily Prime Rate as published in the Wall Street Journal compared with $1.0 billion a year ago. The effect of the margin compression was partially offset by improvement in asset mix caused by the increase in loans. United has also actively managed liability pricing and mix to offset the reduction in asset yields. Over the last five quarters, net interest margin has stabilized near the 4.00% level.
The average yield on interest-earning assets for 2003 was 6.02%, compared with 7.10% in 2002. The main driver of this decrease was the average loan yield which was down 96 basis points, as well as the average yield on taxable securities which was down 151 basis points. The shift toward floating rate loans contributed to the decline caused by the lower rate environment. In the fourth quarter of 2002, United began purchasing securities to increase net interest revenue and reduce the interest rate sensitivity of the balance sheet. Although the securities purchases have a positive impact on net interest revenue, they contributed partially to the net interest margin compression that occurred in late 2002 since they were purchased at a yield lower than the existing portfolio.
The average cost of interest-bearing liabilities for 2003 was 2.31%, compared with 3.15% in 2002. The decrease was primarily due to lower rates paid on interest-bearing demand deposits and savings accounts, lower pricing on new and renewed time deposits and lower rates on FHLB advances. United lowered deposit pricing to offset rate reductions initiated by the Federal Reserve in November 2002 and June 2003. Additionally, United continued to experience strong loan growth in 2003, which outpaced the growth of core deposits. Instead of funding with certificates of deposit, United turned to lower cost funding sources such as FHLB advances and brokered time deposits. This resulted in some intentional runoff in non-brokered certificates of deposit over the last few quarters.
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The following table shows the relationship between interest revenue and interest expense and the average balances of interest-earning assets and interest-bearing liabilities for the three years ended December 31, 2003.
Table 2 — Average Consolidated Balance Sheet and Net Interest Margin AnalysisFor the Years Ended December 31,(In thousands, taxable equivalent)
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The following table shows the relative impact on net interest revenue of changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by United on such assets and liabilities.
Table 3 - Change in Interest Revenue and Interest Expense(in thousands, taxable equivalent)
Any variance attributable jointly to volume and rate changes is allocated to the volume and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.
Provision for Loan Losses
The provision for loan losses was $6.3 million in 2003, compared with $6.9 million in 2002, and $6.0 million in 2001. The provision as a percentage of average outstanding loans for 2003, 2002 and 2001 was .23%, .31% and .32%, respectively. The ratio of net loan charge-offs to average outstanding loans for 2003 was .15%, compared with .14% for 2002, and .25% for 2001. The provision for loan losses for each year is the amount management believes is necessary to position the allowance for loan losses at an amount adequate to absorb losses inherent in the loan portfolio as of the balance sheet date.
The provision for loan losses is based on management’s evaluation of inherent risks in the loan portfolio and the corresponding analysis of the allowance for loan losses. Additional discussions on loan quality and the allowance for loan losses are included in the Asset Quality section of this report and Note 1 to the Consolidated Financial Statements.
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Fee Revenue
Total fee revenue for 2003 was $38.2 million, compared with $30.7 million in 2002 and $25.3 million in 2001. Fee revenue was approximately 22% of total revenue for 2003, compared with 21% for 2002 and 20% for 2001. The following table presents the components of fee revenue for 2003, 2002 and 2001.
Table 4 - Fee RevenueFor the Years Ended December 31,(in thousands)
Comparability between current and prior years is affected by the 2003 Acquisitions. Earnings for the 2003 Acquisitions are included in consolidated earnings after their respective acquisition dates. The 2003 Acquisitions contributed approximately $4.0 million in fee revenue, mostly service charges and fees and mortgage loan and related fees. Excluding the contributions of recent mergers, fee revenue for the year grew approximately 11% compared to 2002.
Total deposit service charges and fees for 2003 were $18.3 million compared with $13.5 million in 2002. The increase in service charges and fees was primarily due to the 2003 Acquisitions and new products and services introduced in 2002, as well as an increase in the number of accounts and transaction activity and the growth in ATM fees. Excluding acquisitions, the growth in service charges and fees was approximately 16%
Mortgage loan and related fees for 2003 were $10.5 million, up 36% over the amount in 2002. Mortgage loan originations were up $63 million over 2002, as mortgage rates fell from their already low levels. Substantially all of the mortgages were subsequently sold into the secondary market, including the right to service these loans. United does not service loans for others.
Other fee revenue for 2003 and 2002 included losses of $787 thousand and $552 thousand, respectively, for the early prepayment of fixed rate FHLB advances. The prepayment penalties, which were recorded as a reduction of fee revenue, were offset substantially by securities gains that were taken as part of the ongoing balance sheet management activities. The fixed rate advances were replaced with brokered deposits and other primarily floating rate sources of wholesale funds that more closely matched the rate characteristics of the mostly prime-based loans that were made during the year.
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Operating Expense
Total operating expenses, excluding merger-related charges, were $107.9 million in 2003 as compared with $91.1 million in 2002 and $83.9 million in 2001. Operating expenses for 2003 and 2001 exclude $2.1 million and $1.6 million, respectively, of merger-related charges. These charges primarily consisted of professional fees, contract termination costs and systems conversion costs that are described in more detail in the section of Management’s Discussion and Analysis titled “Merger-Related and Restructuring Charges”. Operating expenses for the 2003 Acquisitions accounted for $10 million of the increase over 2002, leaving the underlying core expense growth rate (excluding acquisitions) at 9%. The following table presents the components of operating expenses for the three years ended December 31, 2003.
Table 5 - Operating ExpensesFor the Years Ended December 31,(in thousands)
Salaries and benefits for 2003 totaled $68 million, up $10.3 million, or 18% over 2002. The 2003 Acquisitions accounted for approximately $6 million of the increase, with remainder due to normal merit increases and higher incentive costs related primarily to the growth in mortgage loan fee revenue.
Communications and equipment expense of $8.6 million were up $2 million, or 31%, over 2002. Excluding mergers, the costs increased 21%, mainly due to higher costs for investments in software, telecommunications and other technology equipment over last year.
Postage, printing and supplies expense of $4.4 million was up 19% compared to 2002. This increase was mostly due to the 2003 Acquisitions.
Professional fees of $3.9 million were up 16%, over 2002. The increase was mostly due to the higher level of business activity during 2003.
The $.7 million increase in intangible costs reflects the increase in amortization of core deposit intangibles that were recorded in connection with the 2003 acquisitions. United recorded $11.4 million in core deposit intangibles in 2003 associated with the 2003 Acquisitions. Those core deposit intangibles are being amortized straight line over ten years.
Other expenses for 2003 of $10 million were up $1.9 million, or 23% compared to 2002. Excluding the impact of the 2003 Acquisitions, other expenses increased approximately $.6 million, or 8%, due to core business growth.
The efficiency ratio measures total operating expenses as a percentage of total revenue and excludes the provision for loan losses, net securities gains (losses), and merger-related charges. The FHLB prepayment losses taken during the fourth quarters of 2003 and 2002 are also excluded from the efficiency ratio calculation since they were part of the same balance sheet restructuring activities that resulted in the securities gains. United’s efficiency ratio for 2003 was 60.89% as compared with 60.66% and 62.52% for 2002 and 2001, respectively. The increase in the efficiency ratio from 2002 is primarily due to the margin compression that began in the latter half of 2002 that slowed the growth in net interest revenue.
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Income Taxes
Income tax expense, including tax benefits relating to merger and restructuring charges, was $20.4 million in 2003 compared with $17.1 million in 2002 and $13.5 million in 2001. The effective tax rates (as a percentage of pre-tax net income) for 2003, 2002 and 2001 were 34.8%, 34.3% and 33.2%, respectively. These effective tax rates are lower than the statutory tax rate primarily due to interest revenue on certain investment securities and loans that are exempt from income taxes and tax credits received on affordable housing investments. The effective tax rate has increased over the three year period as tax exempt interest income on securities and loans has declined as a proportion of pre-tax earnings. Additional information regarding income taxes can be found in Note 13 to the Consolidated Financial Statements.
Fourth Quarter Discussion
Taxable equivalent net interest revenue for the fourth quarter of 2003 rose $7.2 million, or 24%, to $36.8 million from the same period a year ago. The 2003 Acquisitions contributed approximately $4.0 million of this increase, leaving the core growth rate at approximately 12%. Taxable equivalent net interest margin for the fourth quarter was 3.96% versus 4.03% a year ago.
The 2003 fourth quarter provision for loan losses was $1.8 million, unchanged from a year earlier. Non-performing assets totaled $7.6 million, down $.4 million from a year ago, while loans outstanding increased $634 million. Non-performing assets as a percentage of total assets were .19% at December 31, 2003, compared with .25% at December 31, 2002.
Fee revenue of $9.1 million for the fourth quarter of 2003 increased $.3 million, or 3%, from $8.8 million a year ago. Mortgage loan and related fees were $1.8 million and down $.9 million from a year ago, due to the lower level of mortgage refinancing activity caused by a rise in long-term interest rates in the latter half of 2003. Service charges and fees on deposit accounts were $5.0 million, up $1.4 million due to the recent acquisitions, increasing popularity of new products and services introduced last year, and growth in transactions and new accounts. Fee revenue was reduced by net charges of $150,000, representing $787,000 in charges for the early prepayment of fixed rate FHLB advances that were partially offset by taking securities gains of $622,000. Both transactions were part of the same overall balance sheet management strategy. A similar strategy and restructuring took place in the fourth quarter of 2002.
Operating expenses, excluding merger-related charges, were $27.6 million, up $4.6 million, or 20%, from the fourth quarter of 2002. Included in the fourth quarter of 2003 were normal operating expenses for the 2003 Acquisitions, which totaled approximately $3.9 million, leaving the underlying core expense growth rate under 4%. Salaries and employees benefits of $17.4 million increased $2.4 million, or 16%, with approximately $2.0 million of this increase resulting from the 2003 Acquisitions. The balance of the increase was due to normal merit increases for staff that was partially offset by lower incentive compensation associated with the slowdown in mortgage refinancing activities. Communications and equipment expenses of $2.3 million increased $.4 million, or 24%, primarily resulting from the 2003 Acquisitions. Excluding the 2003 Acquisitions, communications and equipment expenses increased approximately 9%, due to depreciation and amortization costs for software, telecommunications, and technology equipment added over the last twelve months. Increases in all other operating expense categories were primarily due to the acquisitions and business growth.
Balance Sheet Review
Total assets at December 31, 2003 were $4.1 billion, an increase of $857 million, or 27%, from December 31, 2002. The 2003 Acquisitions added approximately $510 million to total assets. On an average basis, total assets increased $762 million, or 26%, from 2002 to 2003. Average interest earning assets for 2003 were $3.5 billion, compared with $2.8 billion for 2002, an increase of 26%.
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Total loans averaged $2.8 billion in 2003, compared with $2.2 billion in 2002, an increase of 23%. At December 31, 2003, total loans were $3.0 billion, an increase of $634 million, or 27%, from December 31, 2002. The 2003 Acquisitions added approximately $320 million in balances to the loan portfolio. Over the past year, United has experienced strong loan growth in all markets, with particular strength in loans secured by real estate, both residential and non-residential. Approximately $227 million of the increase from 2002 occurred in construction and land development loans which is comprised of approximately 80% residential and 20% commercial, including $65 million from the east Tennessee and coastal Georgia acquisitions. Growth was also strong in residential real estate loans and commercial loans secured by real estate which grew $189 million and $164 million, respectively, from December 31, 2002. Residential real estate loans of $136 million and commercial loans secured by real estate of $68 million were added through the acquisitions of First Central Bank and First Georgia Bank. The following table presents a summary of the loan portfolio by category over that period.
Table 6 - Loans OutstandingAs of December 31,(in thousands)
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Substantially all loans are to customers located in Georgia, North Carolina and Tennessee, the immediate market areas of United and approximately 98% of the loans are secured by real estate and other hard assets (including customers who have a seasonal residence in United’s market areas).
As of December 31, 2003, United’s 25 largest credit relationships consisted of loans and loan commitments ranging from $6.9 million to $14.6 million, with an aggregate total credit exposure of $284.9 million, including $46 million in unfunded commitments, and $238.9 million in balances outstanding. All of these customers were underwritten in accordance with United’s credit quality standards and structured in order to minimize potential exposure to loss.
The following table sets forth the maturity distribution of commercial and construction loans, including the interest rate sensitivity for loans maturing greater than one year, as of December 31, 2003. United’s loan policy does not permit automatic roll-over of matured loans.
Table 7 - Loan Portfolio MaturityAs of December 31, 2003(in thousands)
Asset Quality and Risk Elements
United manages asset quality and controls credit risk through diversification of the loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. United’s credit administration function is charged with monitoring asset quality, establishing credit policies and procedures and managing the consistent application of these policies and procedures at all of the Banks. Additional information on United’s loan administration function is included in Item 1 under the headingLoan Review and Non-performing Assets.
The provision for loan losses is based on management’s judgment of the amount necessary to maintain the allowance at a level adequate to absorb probable losses. The amount each year is dependent upon many factors including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies and other credit quality trends, management’s assessment of loan portfolio quality, the value of collateral, and economic factors and trends. The evaluation of these factors is performed by United’s credit administration through analysis of the adequacy of the allowance for loan losses.
Reviews of non-performing, past due loans and larger credits, designed to identify potential charges to the allowance for loan losses, as well as determine the adequacy of the allowance, are conducted on a regular basis during the year. These reviews are performed by the responsible lending officers, a separate loan review function or the special assets department with consideration of such factors as the customer’s financial position, prevailing and anticipated economic conditions and other pertinent factors.
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The following table presents a summary of changes in the allowance for loan losses for each of the past five years.
Table 8 - Allowance for Loan LossesYears Ended December 31,(in thousands)
Management believes that the allowance for loan losses at December 31, 2003 is adequate to absorb losses inherent in the loan portfolio. This assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examination of the Banks, may require additional charges to the provision for loan losses in future periods if the results of their review warrant such additions.
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Non-performing Assets
Non-performing loans, which include non-accrual loans and accruing loans past due over 90 days, totaled $6.6 million at year-end 2003, compared with $6.7 million at December 31, 2002. There is no concentration of non-performing loans attributable to any specific industry. At December 31, 2003, the ratio of non-performing loans to total loans was .22%, compared with .28% at year-end 2002. Non-performing assets, which include non-performing loans and foreclosed real estate, totaled $7.6 million at December 31, 2003, compared with $8 million at year-end 2002.
United’s policy is to place loans on non-accrual status when, in the opinion of management, the principal and interest on a loan is not likely to be repaid in accordance with the loan terms or when the loan becomes 90 days past due and is not both well secured and in the process of collection. When a loan is placed on non-accrual status, interest previously accrued but not collected is reversed against current interest revenue. Depending on management’s evaluation of the borrower and loan collateral, interest revenue on a non-accrual loan may be recognized on a cash basis as payments are received.
There were no commitments to lend additional funds to customers whose loans were on non-accrual status at December 31, 2003. The table below summarizes non-performing assets at year-end for the last five years.
Table 9 - Non-Performing AssetsAs of December 31,(in thousands)
At December 31, 2003 and 2002, there were $536,000 and $2.0 million, respectively, of loans classified as impaired under the definition outlined in SFAS No. 114. Specific reserves allocated to these impaired loans totaled $118,000 at December 31, 2003, and $591,000 at December 31, 2002. The average recorded investment in impaired loans for the years ended December 31, 2003 and 2002 was $1.8 million and $3.7 million, respectively. United’s policy is to recognize interest revenue on a cash basis for loans classified as impaired under SFAS No. 114.
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Investment Securities
The composition of the investment securities portfolio reflects United’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of revenue. The securities portfolio also provides a balance to interest rate risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits.
Total securities available for sale increased $101 million from the end of 2002. Half of the increase from 2002 was due to the additional securities added by the 2003 Acquisitions. Late in 2002, United began purchasing securities as part of a program to help stabilize the interest rate sensitivity of the balance sheet and to increase net interest revenue. This program continued into the first quarter accounting for remaining increase in securities. At December 31, 2003, the average duration of the investment portfolio was 3.18 years compared with 2.55 years at December 31, 2002. The following table shows the carrying value of United’s securities as of December 31, 2003 and 2002.
Table 10 - Carrying Value of Investment SecuritiesAs of December 31,(in thousands)
The investment securities portfolio consists of U.S. Government and agency securities, municipal securities, and U.S. Government sponsored agency mortgage-backed securities. A mortgage-backed security relies on the underlying mortgage pools of loans to provide a cash flow of principal and interest. The actual maturities of these securities will differ from the contractual maturities because the loans underlying the security may prepay without prepayment penalties. Decreases in long-term interest rates will generally cause an acceleration of prepayment levels. In a declining interest rate environment, proceeds may not be able to be reinvested in assets that have comparable yields.
At December 31, 2003, United had 35% of its total investment securities portfolio in mortgage backed pass-through securities, compared with 47% at December 31, 2002. United did not have securities of any issuer in excess of 10% of equity at year-end 2003 or 2002, excluding U.S. Government issues. Other mortgage-backed securities, including collateralized mortgage obligations, represented 8% of the total securities portfolio at December 31, 2003, compared with 6% at year-end 2002. See Note 5 to the Consolidated Financial Statements for further discussion of investment portfolio and related fair value and maturity information.
Deposits
Total average deposits for 2003 were $2.7 billion, an increase of $431 million, or 19% from 2002. Average non-interest bearing demand deposit accounts increased $68 million, or 23%, and average interest bearing transaction accounts increased $142 million, or 22%, from 2002. Average time deposits for 2003 were $1.5 billion, up from $1.3 billion in 2002.
Time deposits of $100,000 and greater totaled $406 million at December 31, 2003, compared with $370 million at year-end 2002. United utilizes “brokered” time deposits, issued in certificates of less than $100,000, as an alternative source of cost-effective funding. Average brokered time deposits outstanding in 2003, 2002 and 2001 were $275 million, $145 million and $59 million, respectively. The average rate paid on brokered time deposits in 2003, 2002 and 2001 was 2.20%, 2.70% and 6.11%, respectively. Total interest expense on time deposits of $100,000 and greater during 2003 was approximately $11 million.
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The following table sets forth the scheduled maturities of time deposits of $100,000 and greater and brokered time deposits at December 31, 2003.
Table 11 - Maturities of Time Deposits of $100,000 and Greater and Brokered DepositsAs of December 31, 2003(in thousands)
Wholesale Funding
At December 31, 2003, UCB-Georgia and UCB-North Carolina were shareholders in FHLB of Atlanta. Through this affiliation, secured advances totaling $635 million were outstanding at rates competitive with time deposits of like maturities. United anticipates continued utilization of this short and long-term source of funds to minimize interest rate risk. The FHLB advances outstanding at December 31, 2003 had both fixed and floating interest rates ranging from .52% to 7.81%. Approximately 44% of the FHLB advances mature prior to December 31, 2004. Additional information regarding FHLB advances, including scheduled maturities, is provided in Note 10 to the consolidated financial statements.
Liquidity Management
The primary objective of liquidity management is to ensure that sufficient funding is available, at reasonable cost, to meet ongoing operational cash needs. While the desired level of liquidity will vary depending upon a number of factors, it is the primary goal of United to maintain a sufficient level of liquidity in reasonably foreseeable economic environments. Liquidity is defined as the ability of a bank to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining United’s ability to meet the daily cash flow requirements of the Banks’ customers, both depositors and borrowers.
The primary objectives of asset/liability management are to provide for adequate liquidity in order to meet the needs of customers and to maintain an optimal balance between interest-sensitive assets and interest-sensitive liabilities, so that United can also meet the investment objectives of its shareholders as market interest rates change. Daily monitoring of the sources and uses of funds is necessary to maintain a position that meets both goals.
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments and the maturities and sales of securities. Mortgage loans held for sale totaled $10.8 million at December 31, 2003, and typically turn over every 45 days as closed loans are sold to investors in the secondary market. Construction and commercial loans that mature in one year or less amounted to $747 million, or 25%, of the loan portfolio at December 31, 2003.
The liability section of the balance sheet provides liquidity through depositors’ interest bearing and non-interest bearing accounts. Federal funds purchased, FHLB advances and securities sold under agreements to repurchase are additional sources of
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liquidity and represent United’s incremental borrowing capacity. These sources of liquidity are short-term in nature and are used as necessary to fund asset growth and meet other short-term liquidity needs.
United has available lines of credit at its holding company with other financial institutions totaling $85 million. At December 31, 2003, $45 million was outstanding on those lines, and United had sufficient qualifying collateral to increase FHLB advances by $121 million. United’s internal policy limits brokered deposits to 25% of total deposits, excluding the brokered deposits. At December 31, 2003, United had the capacity to increase brokered deposits by $418 million and still remain within this limit. In addition to these wholesale sources, United has the ability to attract retail deposits at any time by competing more aggressively on pricing.
The following table shows United’s contractual obligations and other commitments as of December 31, 2003.
Table 12 - Contractual Obligations and Other CommitmentsAs of December 31, 2003(in thousands)
As disclosed in United’s consolidated statements of cash flows, net cash provided by operating activities was $74 million during 2003. The major sources of cash provided by operating activities were net income and a reduction in mortgages held for sale, partially offset by changes in other assets and other liabilities. Net cash used in investing activities of $318 million consisted primarily of the net increase in loans of $319 million, a net increase in securities of $69 million and cash received from acquisitions of $83 million. Net cash provided by financing activities provided the remainder of funding sources for 2003. The $298 million of net cash provided by financing activities consisted primarily of a net increase in FHLB advances of $139 million, an increase of $82 million in federal funds purchased and repurchase agreements, a $41 million increase in notes payable and other borrowings, and proceeds from issuance of subordinated debt of $35 million. In the opinion of management, United’s liquidity position at December 31, 2003, is sufficient to meet its expected cash flow requirements.
Off-Balance Sheet Arrangements
United is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of customers. These financial instruments include commitments to extend credit, letters of credit and financial guarantees.
A commitment to extend credit is an agreement to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Letters of credit and financial guarantees are conditional commitments issued to guarantee a customer’s performance to a third party and have essentially the same credit risk as extending loan facilities to customers. Those commitments are primarily issued to local businesses.
The exposure to credit loss in the event of nonperformance by the other party to the commitments to extend credit, letters of credit and financial guarantees is represented by the contractual amount of these instruments. United uses the same credit underwriting procedures for making commitments, letters of credit and financial guarantees as for on-balance sheet instruments. United evaluates each customer’s creditworthiness on a case-by-case basis and the amount of the collateral, if deemed necessary, is
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based on the credit evaluation. Collateral held varies, but may include unimproved and improved real estate, certificates of deposit, personal property or other acceptable collateral.
All of these instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The total amounts of these instruments does not necessarily represent future cash requirements because a significant portion of these instruments often expire without being used.
United is not involved in off-balance sheet contractual relationships, other than those disclosed in this report, that could result in liquidity needs or other commitments, or that could significantly impact earnings. See Notes 2 and 16 to the consolidated financial statements for additional information on off-balance sheet arrangements.
Capital Resources and Dividends
Stockholders’ equity at December 31, 2003 was $299.4 million, an increase of $77.8 million, or 35%, from December 31, 2002. Accumulated other comprehensive income, which includes unrealized gains and losses on securities available for sale and the unrealized gains and losses on derivatives qualifying as cash flow hedges, was not included in the calculation of regulatory capital adequacy ratios. Excluding the decrease in the accumulated other comprehensive income, stockholders’ equity increased $81.7 million, or 39%, with the 2003 acquisitions adding $50 million of that amount. Dividends of $6.9 million, or $.30 per share, were declared on common stock in 2003, an increase of 20% per share from the amount declared in 2002. The dividend payout ratios based on net income for 2003 and 2002 were 18.0% and 16.3%, respectively; and, excluding merger-related charges, were 17.3% and 16.3%, respectively. United has historically retained earnings in order to provide capital for continued growth and expansion. However, in recognition that cash dividends are an important component of shareholder return, management has increased the payout ratio from 12 to 17% over the past five years and has targeted a long-term payout ratio between 18 and 20% when earnings and capital levels permit.
In 1996, United issued $3.5 million of convertible subordinated debentures due December 31, 2006 (the “2006 Debentures”). The 2006 Debentures bear interest at the rate of 25 basis points over the prime rate, as quoted in theWall Street Journal, payable quarterly. The 2006 Debentures may be redeemed, in whole or in part at the option of United with 60 days notice, at a redemption price equal to 100% of the principal amount of the debentures to be redeemed plus accrued interest. The holders of the 2006 Debentures have the right, exercisable at any time up to December 31, 2006, to convert such debentures at the principal amount thereof into shares of Common Stock of United at the conversion price of $12.50 per share.
In 2002, United issued through a private placement, $31.5 million in 6.75% subordinated notes due November 26, 2012. Proceeds from the issuance were used for general business purposes. The notes qualify as Tier II capital under Risk Based Capital Guidelines.
In 2003, United issued $35 million in subordinated step-up notes due September 30, 2015. The subordinated notes qualify as Tier II capital under risk-based capital guidelines. The notes bear interest at a fixed rate of 6.25% through September 30, 2010, and at a rate of 7.50% thereafter until maturity or earlier redemption. The notes are callable at par on September 30, 2010, and September 30 of each year thereafter until maturity. The proceeds were used for general corporate purposes.
The Board of Governors of the Federal Reserve System has issued guidelines for the implementation of risk-based capital requirements by U.S. banks and bank holding companies. These risk-based capital guidelines take into consideration risk factors, as defined by regulators, associated with various categories of assets, both on and off balance sheet. Under the guidelines, capital strength is measured in two tiers which are used in conjunction with risk adjusted assets to determine the risk based capital ratios. The guidelines require an 8% total risk-based capital ratio, of which 4% must be Tier I capital.
Tier I capital consists of stockholders’ equity, excluding accumulated other comprehensive income and intangible assets (goodwill and deposit-based intangibles), plus qualifying capital securities. United’s Tier I capital totaled $259.1 million at December 31, 2003. Tier II capital components include supplemental capital such as a qualifying allowance for loan losses and qualifying subordinated debt. Tier I capital plus Tier II capital components is referred to as Total Risk-based Capital and was $366.7 million at December 31, 2003. The ratios, as calculated under the guidelines, were 8.41% and 11.91% for Tier I and Total Risk-based Capital, respectively, at December 31, 2003.
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A minimum leverage ratio is required in addition to the risk-based capital standards and is defined as Tier I capital divided by average assets reduced by the amount of goodwill and deposit-based intangibles. A minimum leverage ratio of 3% is required for the highest-rated bank holding companies which are not undertaking significant expansion programs, but the Federal Reserve Board requires a bank holding company to maintain a leverage ratio greater than 3% if it is experiencing or anticipating significant growth or is operating with less diversified risks in the opinion of the Federal Reserve Board. The Federal Reserve Board uses the leverage and risk-based capital ratios to assess capital adequacy of banks and bank holding companies. United’s leverage ratios at December 31, 2003 and 2002 were 6.66% and 7.47%, respectively.
United monitors these capital ratios to ensure that United and the Banks remain within regulatory guidelines. Further information regarding the actual and required capital ratios of United and the Banks is provided in Note 15 to the consolidated financial statements.
Impact of Inflation and Changing Prices
A bank’s asset and liability structure is substantially different from that of a general business corporation in that primarily all assets and liabilities of a bank are monetary in nature, with relatively little investment in fixed assets or inventories. Inflation has an important impact on the growth of total assets and the resulting need to increase equity capital at higher than nominal rates in order to maintain an appropriate equity to assets ratio.
United’s management believes the impact of inflation on financial results depends on United’s ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. United has an asset/liability management program to monitor and manage United’s interest rate sensitivity position. In addition, periodic reviews of banking services and products are conducted to adjust pricing in view of current and expected costs.
Outlook
Management expects internally generated loan growth to continue between 10 to 14% through 2004. Earnings per share are expected to grow at a rate of 12% to 15% based on a stable net interest margin and anticipated loan growth of 10% to 14%. We expect our net interest margin to remain near the 4% level.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Sensitivity Management
The absolute level and volatility of interest rates can have a significant impact on United’s profitability. The objective of interest rate risk management is to identify and manage the sensitivity of net interest revenue to changing interest rates, in order to achieve United’s overall financial goals. Based on economic conditions, asset quality and various other considerations, management establishes tolerance ranges for interest rate sensitivity and manages within these ranges.
United’s net interest revenue, and the fair value of its financial instruments, are influenced by changes in the level of interest rates. United manages its exposure to fluctuations in interest rates through policies established by the ALCO. The ALCO meets periodically and has responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or earnings and reviewing United’s interest rate sensitivity.
One of the tools management utilizes to estimate the sensitivity of net interest revenue to changes in interest rates is an interest rate simulation model. Such estimates are based upon a number of assumptions for each scenario, including the level of balance sheet growth, deposit repricing characteristics and the rate of prepayments. The simulation model measures the potential change in net interest revenue over a twelve-month period under six interest rate scenarios. The first scenario assumes rates remain flat over the next twelve months and is the scenario that all others are compared to in order to measure the change in net interest revenue. The second scenario is a most likely scenario that projects the most likely change in rates over the next twelve months based on the slope of the yield curve. United models ramp scenarios that assume gradual increases and decreases of 200 basis points each over the next twelve months. United has a policy for net interest revenue simulation based on rate movements of up 200 basis points ramp over twelve months and down 200 basis points ramp over twelve months from the flat rate scenario. The policy limits net interest revenue to a 10% decrease in either scenario. At both December 31, 2003 and 2002, United’s simulation model indicated that
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a 200 basis point increase in rates over the next twelve months would cause an approximate 1% increase in net interest revenue and a 200 basis point decrease in rates over the next twelve months would cause an approximate 3% decrease in net interest revenue.
Interest rate sensitivity is a function of the repricing characteristics of the portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest-earning assets and interest-bearing liabilities are subject to change in interest rates either at replacement, repricing or maturity during the life of the instruments. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate sensitivity management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable timeframe, thereby minimizing the impact of interest rate changes on net interest revenue. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in United’s current portfolio that are subject to repricing at various time horizons: immediate; one to three months; four to twelve months; one to five years; over five years, and on a cumulative basis. The differences are known as interest sensitivity gaps.
The following table shows interest sensitivity gaps for these different intervals as of December 31, 2003.
Table 13 - Interest Rate Gap Sensitivity
As of December 31, 2003
(in thousands)
(1) Cumulative interest rate sensitivity position as a percent of total interest-earning assets.
As demonstrated in the preceding table, 74% of interest-bearing liabilities will reprice within twelve months compared with 77% of interest-earning assets, however such changes may not be proportionate with changes in market rates within each balance sheet category. Changes in the mix of earning assets or supporting liabilities can either increase or decrease the net interest margin without affecting interest rate sensitivity. The interest rate spread between an asset and its supporting liability can vary significantly even when the timing of repricing for both the asset and the liability remains he same, due to the two instruments repricing according to different indices. This characteristic is referred to as basis risk.
Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities that are not reflected in the interest rate sensitivity gap analysis. These prepayments may have significant impact on the net interest margin. Because of these limitations, an interest sensitivity gap analysis may not provide an accurate assessment of exposure to changes in interest rates.
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The following table presents the contractual maturity of investment securities by maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis) at December 31, 2003. The composition and maturity/repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs.
Table 14 - Expected Maturity of Available for Sale Investment Securities
As of December 31, 2003(in thousands)
In order to assist in achieving a desired level of interest rate sensitivity, United has entered into off-balance sheet contracts that are considered derivative financial instruments during 2003, 2002 and 2001. Derivative financial instruments can be a cost effective and capital effective means of modifying the repricing characteristics of on-balance sheet assets and liabilities. These contracts consist of interest rate swaps under which United pays a variable rate and receives a fixed rate. The following table presents United’s interest rate swap contracts outstanding at December 31, 2003.
Table 15 - Interest Rate Swap Contracts
(1) Based on prime rate at December 31, 2003
United’s derivative financial instruments are classified as cash flow and fair value hedges. The change in fair value of cash flow hedges is recognized in other comprehensive income. Fair value hedges recognize currently in earnings both the impact of change in the fair value of the derivative financial instrument and the offsetting impact of the change in fair value of the hedged asset or liability. At December 31, 2003, all derivatives were designated as cash flow hedges of prime based loans.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The consolidated financial statements of the registrant and report of independent auditors are included herein as follows:
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Porter Keadle Moore, LLP
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
The Board of Directors and StockholdersUnited Community Banks, Inc.Blairsville, Georgia
We have audited the accompanying consolidated balance sheet of United Community Banks, Inc. and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2003. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Community Banks, Inc. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
Atlanta, GeorgiaJanuary 27, 2004
Certified Public Accountants
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Consolidated Statement of Income
For the Years Ended December 31, 2003, 2002 and 2001
(in thousands, except per share data)
See accompanying notes to consolidated financial statements.
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Consolidated Balance Sheet
As of December 31, 2003 and 2002
(in thousands, except share data)
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIESConsolidated Statement of Changes in Stockholders’ EquityFor the Years Ended December 31, 2003, 2002 and 2001(in thousands, except share data)
See accompanying notes to consolidated financial statements
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Consolidated Statement of Cash Flows
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Notes to Consolidated Financial Statements
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Notes to Consolidated Financial Statements, continued
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIESNotes to Consolidated Financial Statements, continued
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The following summarizes securities in an unrealized loss position as of December 31, 2003 (in thousands):
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The following summarizes securities sales activities for the years ended December 31, 2003, 2002 and 2001 (in thousands):
At December 31, 2003 and 2002, securities with a carrying value of $629 million and $533 million, respectively, were pledged to secure public deposits and Federal Home Loan Bank (“FHLB”) advances.
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(13) Income Taxes
Income tax expense (benefit) for the years ended December 31, 2003, 2002 and 2001 (in thousands):
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Statement of IncomeFor the Years Ended December 31, 2003, 2002 and 2001(in thousands)
Balance SheetAs of December 31, 2003 and 2002(in thousands)
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Statement of Cash FlowsFor the Years Ended December 31, 2003, 2002 and 2001(in thousands)
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
During the past two years, United did not change accountants nor have any disagreements with its accountants on any matters of accounting principles or practices or financial statement disclosure.
ITEM 9A. CONTROLS AND PROCEDURES
United’s management, including the Chief Executive Officer and Chief Financial Officer, supervised and participated in an evaluation of the company’s disclosure controls and procedures as of December 31, 2003. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective in accumulating and communicating information to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosures of that information under the Securities and Exchange Commission’s rules and forms and that the disclosure controls and procedures are designed to ensure that the information required to be disclosed in reports that are filed or submitted under the Act is recorded, processed, summarized and reported within the time periods specified.
Based on this evaluation, management believes there were no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF UNITED.
The information contained under the headings “Information Regarding Nominees and Other Directors”, “Code of Ethical Conduct” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Proxy Statement to be used in connection with the solicitation of proxies for United’s 2004 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference. Pursuant to instruction 3 to paragraph (b) of Item 401 of Regulation S-K, information relating to the executive officers of United is included in Item 1 of this Report.
ITEM 11. EXECUTIVE COMPENSATION.
The information contained under the heading “Executive Compensation” in the Proxy Statement to be used in connection with the solicitation of proxies for United’s 2004 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The information contained under the heading “Principal and Management Shareholders” and “Equity Compensation Awards” in the Proxy Statement to be used in connection with the solicitation of proxies for United’s 2004 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference. For purposes of determining the aggregate market value of United’s voting stock held by nonaffiliates, shares held by all directors and executive officers of United have been excluded. The exclusion of such shares is not intended to, and shall not, constitute a determination as to which persons or entities may be “Affiliates” of United as defined by the Commission.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information contained under the heading “Certain Relationships and Related Transactions” in the Proxy Statement to be used in connection with the solicitation of proxies for United’s 2004 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference.
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ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The information contained under the heading “Independent Public Accountants” in the Proxy Statement to be used connection with the solicitation of proxies for United’s 2004 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(a) of the Securities Exchange Act of 1934, United has duly caused this Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Blairsville, State of Georgia, on the 8th of March, 2004.
POWER OF ATTORNEY AND SIGNATURES
Know all men by these presents, that each person whose signature appears below constitutes and appoints Jimmy C. Tallent and Robert L. Head, or either of them, as attorney-in-fact, with each having the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K and to file the same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of United in the capacities set forth and on the 8th day of March, 2004.
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EXHIBIT INDEX
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