UNITED STATESSECURITIES AND EXCHANGE COMMISSION
FORM 10-Q
For the Quarterly Period Ended March 31, 2004
OR
For the Transition Period from ___________ to ___________
Commission file number 0-21656
UNITED COMMUNITY BANKS, INC.
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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Common stock, par value $1 per share: 35,331,010 sharesoutstanding as of March 31, 2004
INTRODUCTORY NOTE
All financial statements and per share amounts included in this Quarterly Report on Form 10-Q have been restated to reflect the three-for-two split of United’s common stock effective on April 28, 2004.
INDEX
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Item 1 – Financial StatementsUNITED COMMUNITY BANKS, INC.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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United Community Banks, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Note 1 — Accounting Policies
The accounting and financial reporting policies of United Community Banks, Inc. (“United”) and its subsidiaries conform to accounting principles generally accepted in the United States of America and general banking industry practices. The accompanying interim consolidated financial statements have not been audited. All material intercompany balances and transactions have been eliminated. A more detailed description of United’s accounting policies is included in the 2003 annual report filed on Form 10-K.
In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments are considered normal and recurring accruals considered necessary for a fair and accurate presentation. The results for interim periods are not necessarily indicative of results for the full year or any other interim periods.
Note 2 — Stock Split
On March 15, 2004, United announced that its Board of Directors had approved a three-for-two split of its common stock effective on April 28, 2004 to shareholders of record on April 14, 2004. 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.
Note 3 — Stock-Based Compensation
United’s stock-based compensation plans are accounted for based on the intrinsic value method set forth in Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations. Compensation expense for employee stock options is not recognized if the exercise price of the option equals or exceeds the fair value of the stock on the date of grant. Compensation expense for restricted share awards is ratably recognized over the period of service, usually the restricted period, based on the fair value of the stock on the date of grant. Had compensation costs been determined based upon the fair value of the options at the grant dates consistent with the method of SFAS No. 123, United’s net income and earnings per common share would have reflected the pro forma amounts below (in thousands, except per share data):
The weighted average fair value of options granted in the first quarter of 2004 and 2003 was $5.15 and $3.15, respectively. The fair value of each option granted was estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions: dividend yield of 1%; a risk free interest rate of 3.65% in 2004 and 3.48% in 2003; expected volatility of 15%; and, an expected life of 7 years. Since United’s stock trading history dates back only to March of 2002, when United listed on Nasdaq, the Nasdaq Bank Index was used to determine volatility. The fair value of each option granted prior to 2002 was estimated on the date of grant using the minimum value method with the following weighted average assumptions: dividend yield of 1%; a risk free interest rate of 5%; and, an expected life of 7 years. Compensation expense, included in the proforma results, was determined based on the fair value of the options at the time of grant, multiplied by the number of options granted, which was then amortized, net of tax, over the vesting period.
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Note 4 — Earnings Per Share
The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31.
(in thousands, except per share data)
Note 5 — Mergers and Acquisitions
On March 16, 2004, United announced a definitive agreement to acquire Fairbanco Holding Company, Inc., a thrift holding company with assets of $190 million headquartered in Fairburn, Georgia. The transaction is valued at approximately $24.5 million and is expected to close during the second quarter of 2004. United will exchange 914,680 shares of its stock and approximately $3.7 million in cash for all of the outstanding shares of Fairbanco.
Note 6 — Reclassification
Certain amounts for the comparative periods of 2003 have been reclassified to conform to the 2004 presentation.
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Part I
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Form 10-Q, 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 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 and/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 and/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 its business. 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 undue reliance should not be placed on forward-looking statements. United does not intend to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Form 10-Q.
Overview
United is a bank holding company registered under the Bank Holding Company Act of 1956, and was incorporated under the laws of the state of Georgia in 1987 and commenced operations in 1988. At March 31, 2004, United had total consolidated assets of $4.1 billion, total loans of $3.1 billion, total deposits of $3.1 billion and stockholders’ equity of $311 million.
United’s activities are primarily conducted by its wholly-owned banking subsidiaries (which are collectively referred to as the “Banks” in this discussion) and Brintech, Inc. a consulting firm providing professional services to the financial services industry.
The remainder of this discussion reflects the three-for-two stock split announced on March 15, 2004 that will be effective on April 28, 2004 to shareholders of record on April 14, 2004.
Recent Mergers and Acquisitions
On March 31, 2003, United completed its acquisition of First Central Bancshares, a community 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 $196 million, including purchase accounting related intangibles. United exchanged 1,231,740 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 its acquisition of First Georgia Holding, a community 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 $304 million, including purchase accounting related intangibles. United exchanged 1,765,947 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 United’s Georgia bank subsidiary, and in January of 2004 changed its name to United Community Bank.
During the fourth quarter of 2003, United acquired three branches in western North Carolina in Avery, Mitchell and Graham counties. The three branches had aggregate deposits and loans of $72 million and $11 million, respectively. These branches complimented United’s existing western North Carolina markets and were a natural extension of the existing franchise. United paid a premium for each branch of between 7% and 11% of average deposits.
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Critical Accounting Policies
The accounting and reporting policies of United Community Banks and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry. The more critical accounting and reporting policies include United’s accounting for loans and the allowance for loan losses. In particular, United’s accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in United’s consolidated financial position or consolidated results of operations. See “Asset Quality and Risk Elements” herein for a complete discussion of United’s accounting methodologies related to the allowance.
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Table 1 – Financial HighlightsUNITED COMMUNITY BANKS, INC.Selected Financial InformationFor the Three Months Ended March 31, 2004
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Merger-Related Charges
During the first quarter of 2003, United recorded merger-related charges of $840,000 for termination of equipment leases, professional fees and other systems conversion costs in connection with the acquisition of First Central Bank. The charges are included in operating expense in the Consolidated Statement of Income. These charges have been excluded from the presentation of operating earnings as management believes that excluding merger-related charges as a financial measure provides useful information to investors because it better demonstrates United’s financial performance from its ongoing business operations. A more detailed description of these charges is in footnote 5 to the Consolidated Financial Statements.
The table below presents a reconciliation of United’s operating earnings to earnings for the first, second and fourth quarters of 2003, using accounting principles generally accepted in the United States (GAAP). There were no merger-related charges in the third quarter of 2003, or the first quarter of 2004.
Table 2 – Operating Earnings to GAAP Earnings ReconciliationFor the Three Months Ended( in thousands)
Results of Operations
Net operating income was $10.9 million for the three months ended March 31, 2004, an increase of $2.3 million, or 27%, from the same period in 2003. Diluted operating earnings per share were $.30 for the three months ended March 31, 2004, compared with $.26 for the same period in 2003, an increase of 15%. Operating return on tangible equity for the first quarter of 2004 was 19.87%, compared with 17.79% for the first quarter of 2003. Operating return on assets for the three months ended March 31, 2004 was 1.08%, compared with 1.07% for the three months ended March 31, 2003.
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Net Interest Revenue (Taxable Equivalent)
Net interest revenue (the difference between the interest earned on assets and the interest paid on deposits and borrowed funds) is the single largest component of total revenue. United actively manages this revenue source to provide an optimal level of revenue while balancing interest rate, credit and liquidity risks. Net interest revenue for the three months ended March 31, 2004 was $37.8 million, up 23%, over last year. The main driver of this increase was loan growth. Average loans increased $673 million, or 28%, from the first quarter of last year. This loan growth was due to the acquisitions of First Central Bank, First Georgia Bank and three North Carolina branches, which added $337 million to the first quarter 2004 average loan balances, as well as continued high loan demand across all of United’s markets in this current low rate environment. The quarter-end loan balances increased $601 million since March 31, 2003. Of this increase, $154 million was in the north Georgia markets, $84 million in western North Carolina, $108 million in the metro Atlanta market, $21 million in east Tennessee, and $234 million in the coastal Georgia markets, mostly related to the acquisition of First Georgia Bank.
Average interest-earning assets for the first quarter of 2004 increased $736 million, or 24%, over the same period for 2003. The increase reflects the acquisitions, loan growth, as well as an increased leveraging of 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 quarter was approximately $615 million as compared to the same period in 2003.
The banking industry uses two ratios to measure relative profitability of net interest revenue. The net interest rate spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. The interest rate spread eliminates the impact of non-interest-bearing deposits 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 percent of average total interest-earning assets and takes into account the positive impact of investing non interest-bearing deposits and capital.
For the three months ended March 31, 2004 and 2003, net interest spread was 3.74% and 3.76%, respectively, while net interest margin was 3.99% and 4.05%, respectively. The net interest spread and the net interest margin were held at a relatively consistent level over the last six quarters by managing liability mix and pricing, so as to offset the continued decline in loan and securities yields. Most of the loan growth over the last year has been prime-based, adjusted daily, which has accounted for most of the decline in loan yields. Also, on June 25, 2003, the Federal Reserve lowered the targeted federal funds rate by 25 basis points that was immediately reflected in the prime rate being lowered to 4.00%. At March 31, 2004, United had approximately $1.6 billion in loans indexed to the daily Prime Rate published in the Wall Street Journal compared with $1.2 billion a year ago. The effect of declining loan and securities yields was somewhat offset by a slight positive shift in the mix of earning assets. For the first quarter of 2004, loans comprised approximately 81% of interest-earning assets compared with 79% for the first quarter of 2003.
The average yield on interest-earning assets for the first quarter of 2004 was 5.76%, compared with 6.38% in the first quarter of 2003. The main driver of this decrease was loan yields which were down 70 basis points for the quarter, as well as yields on taxable securities which were down 30 basis points comparing first quarter 2004 to the same period in 2003. The shift toward floating rate loans and the 25 basis point reduction in the Prime Rate in June of 2003 contributed to the decline in the average loan yield.
The average cost of interest-bearing liabilities for the first quarter was 2.02%, a decrease of 60 basis points from the same period in 2003. The decrease was due to lower rates paid on all sources of funding. United lowered deposit pricing across all of its products to offset rate reductions initiated by the Federal Reserve in June 2003. Additionally, United continued to experience strong loan growth over the last twelve months that outpaced the growth in 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 runoff in certificates of deposit over the last three quarters.
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The following table shows the relationship between interest revenue and expense and the average balances of interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2004 and 2003.
Table 3 – Average Consolidated Balance Sheets and Net Interest AnalysisFor the Three Months Ended March 31,(in thousands, taxable equivalent)
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The following table shows the relative impact on net interest revenue for changes in the average outstanding balances (volume) of interest-earning assets and interest-bearing liabilities and the rates earned and paid on such assets and liabilities. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category.
Table 4 – Change in Interest Revenue and Expense on a Taxable Equivalent Basis(in thousands)
Provision for Loan Losses
The provision for loan losses was $1.8 million for the first quarter of 2004, compared with $1.5 million for the same period in 2003. Net loan charge-offs as a percentage of average outstanding loans for the three months ended March 31, 2004 were .08%, as compared with .17% for the first three months of 2003. The level of charge-offs for the current quarter was lower, due to timing of the charge-offs. The historic level of charge-offs for the prior two years was 15 basis points and is more reflective of management’s expectation for the balance of 2004.
The provision for loan losses is based on management’s evaluation of losses inherent in the loan portfolio and the corresponding analysis of the allowance for loan losses. Additional discussion on loan quality and the allowance for loan losses is included in the Asset Quality section of this report.
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Fee Revenue
Fee revenue for the first quarter of 2004, totaled $9.3 million, compared with $8.4 million, for the same period in 2003. Fee revenue for the first quarter of 2004 was approximately 20% of total revenue, compared with 22% for the first quarter of 2003. United is focused on increasing fee revenue through new products and services. The following table presents the components of fee revenue for the first quarter of 2004 and 2003.
Table 5 – Fee RevenueFor the Three Months Ended March 31,(in thousands, taxable equivalent)
Comparability between current and prior year periods is affected by the acquisitions of First Central Bank on March 31, 2003, First Georgia Bank on May 1, 2003 and three branches acquired in the fourth quarter of 2003 (collectively referred to herein as the “2003 Acquisitions”). Earnings for the 2003 Acquisitions are included in consolidated earnings after their respective acquisition dates. In the first quarter of 2004, the 2003 Acquisitions contributed approximately $1.3 million in fee revenue, mostly service charges and fees and mortgage loan and related fees. Excluding the contributions of these mergers, fee revenue for the quarter was down 4% as compared to last year, primarily due to lower mortgage-related fees.
Service charges on deposit accounts of $5.0 million, were up $1.4 million, or 41%, over the first quarter of 2003. The increase in service charges and fees was primarily due to the 2003 Acquisitions, new products and services, an increase in the number of accounts and transaction activity, and growth in ATM fees. Excluding acquisitions, the growth for the first quarter in service charges and fees was approximately 13%.
Mortgage loan and related fees of $1.3 million, were down $1.0 million, or 45%, from the same period in 2003. Mortgage loan originations of $55 million for the first quarter 2004 were down $42 million from the same period in 2003, as mortgage rates rose from their historically low levels. Substantially all of these originated residential mortgages were sold into the secondary market, including the right to service these loans.
Brokerage fees of $708,000 were up $288,000, or 69% from the first quarter of 2003. This increase was due to a focus on generating new business and improved stock market performance.
Other fee revenue of $1.1 million for the first quarter of 2004 increased $193,000, or 20%, from the first quarter of 2003. Approximately half of the increase was due to the 2003 Acquisitions.
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Operating Expenses
For the three months ended March 31, 2004, total operating expenses, excluding merger-related charges, were $28.2 million, compared with $23.9 million for the same period in 2003. The 2003 Acquisitions accounted for approximately $3.3 million of the increase in operating expenses for the first quarter of 2004, leaving the underlying core expense growth rate (excluding acquisitions) at 4%. The following table presents the components of operating expenses for the three months ended March 31, 2004 and 2003.
Table 6 – Operating ExpensesFor the Three Months Ended March 31,(in thousands)
Salaries and benefits for the first quarter of 2004 totaled $18.1 million, an increase of 20% over the same period in 2003. The 2003 Acquisitions accounted for approximately $2.0 million of the increase, with the remainder due to normal merit increases which were partially offset by lower incentive compensation related to the decline in mortgage refinancing activities. Staff levels, excluding the 2003 Acquisitions, were up slightly from a year ago.
Communication and equipment costs of $2.5 million were up $647,000, or 34%, over the first quarter of 2003, primarily due to the 2003 Acquisitions and further investment in technology equipment to support business growth and enhance operating efficiencies.
Postage, printing and supplies expense of $1.1 million was up $197,000, or 21%, from the same period in 2003. More than half of the increase was due to the 2003 Acquisitions and the balance was related to business growth.
The $286,000 increase in intangible amortization reflects the increase in amortization of core deposit intangibles that were recorded in connection with the 2003 Acquisitions.
The efficiency ratio measures total operating expenses, excluding merger-related charges, as a percentage of total revenue, excluding the provision for loan losses and net securities gains or losses. Based on operating income, which excludes merger-related charges, United’s efficiency ratio for the first quarter was 59.83% compared with 61.03% for the first quarter of 2003.
Income Taxes
Income taxes, excluding taxable equivalent adjustments, were $5.8 million and the effective tax rate for the first quarter was 34.5%, as compared with $4.3 million and an effective tax rate of 35.0% for the first quarter of 2003. The effective tax rates were 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. The decrease in the effective tax rate for 2004 is due to an increase in tax credits related to affordable housing investments made over the last twelve months. Additional information regarding income taxes can be found in Note 13 to the Consolidated Financial Statements filed with United’s 2003 Form 10-K.
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Balance Sheet Review
Total assets at March 31, 2004 were $4.118 billion, 1% higher than the $4.069 billion at December 31, 2003 and 15% higher than the $3.579 billion at March 31, 2003. The acquisitions of First Georgia Bank and the three North Carolina branches added approximately $322 million to total assets. Average total assets for the first quarter of 2004 were $4.085 billion, up $815 million from average assets in the first quarter of 2003.
Loans
The following table presents a summary of United’s loan portfolio.
Table 7 – Loans Outstanding(in thousands)
At March 31, 2004, total loans were $3.147 billion, an increase of $601 million, or 24%, from March 31, 2003 and an increase of $131 million, or 4%, from December 31, 2003. The acquisitions of First Georgia Bank, which closed on May 1, 2003, and the three North Carolina branches added $232 million in balances to the loan portfolio. Average total loans for the first quarter of 2004 were $3.096 billion, an increase of $673 million, or 28% over first quarter of 2003. 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. Substantially all loans are to customers located in Georgia, North Carolina and Tennessee, the immediate market areas of the Banks. This includes customers who have a seasonal residence in the Banks’ market areas. Approximately $252 million of the increase from a year ago occurred in construction and land development loans. Growth has also been strong in residential real estate loans and commercial loans secured by real estate which grew $189 million and $134 million, respectively from March 31, 2003. Residential real estate loans of $107 million, commercial loans secured by real estate of $32 million and construction loans of $54 million were added through the acquisition of First Georgia Bank.
Asset Quality and Risk Elements
United manages asset quality and controls credit risk through close supervision of the loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. United’s loan administration function is responsible for monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures at all of the Banks. Additional information on the loan administration function is included in Item 1 under the heading Loan Review and Non-performing Assets in United’s Annual Report on Form 10-K.
The provision for loan losses charged to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level adequate to absorb probable losses. The amount each period is dependent upon many factors including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management’s assessment of loan portfolio quality, the value of collateral, and economic factors and trends. The evaluation of these factors is performed by the credit administration department through an analysis of the adequacy of the allowance for loan losses.
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Reviews of non-performing loans, 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, as well as a separate loan review department, and consider such factors as the financial strength of borrowers, the value of the applicable collateral, past loan loss experience, anticipated loan losses, growth in the loan portfolio, prevailing economic conditions and other factors. United also uses external loan review sources as necessary to support the activities of the loan review department and to ensure the independence of the loan review process.
The following table presents a summary of changes in the allowance for loan losses for the three months ended March 31, 2004 and 2003.
Table 8 – Summary of Loan Loss ExperienceFor the Three Months Ended March 31, 2004 and 2003(in thousands)
Management believes that the allowance for loan losses at March 31, 2004 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 adjustments to the provision for loan losses in future periods if, in their opinion, the results of their review warrant such additions.
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Non-performing Assets
The table below summarizes United’s non-performing assets.
Table 9 – Non-Performing Assets(in thousands)
Non-performing loans, which include non-accrual loans and accruing loans past due over 90 days, totaled $6.9 million at March 31, 2004, compared with $6.6 million at December 31, 2003 and $6.9 million at March 31, 2003. United has no concentrations of non-performing loans attributable to any specific industry. At March 31, 2004, the ratio of non-performing loans to total loans was .22%, compared with .22% at December 31, 2003 and .27% at March 31, 2003. Non-performing assets, which include non-performing loans and foreclosed real estate, totaled $7.3 million at March 31, 2004, compared with $7.6 million at December 31, 2003 and $7.7 million at March 31, 2003.
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 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 March 31, 2004.
At March 31, 2004 and 2003, there were $1.1 million and $2.9 million, respectively, of loans classified as impaired under the definition outlined in SFAS No. 114. Specific reserves allocated to these impaired loans totaled $267,000 at March 31, 2004, and $745,000 at March 31, 2003. The average recorded investment in impaired loans for the quarters ended March 31, 2004 and 2003, was $967,000 and $2.9 million, respectively. Interest revenue recognized on loans while they were impaired for the first quarter of 2004 was $3,000, compared with $4,000 for the same period in 2003.
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 investment securities portfolio also provides a balance to interest rate risk and credit 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 average investment securities for the quarter increased 6% from first quarter of 2003, as the investment portfolio was used to help stabilize the interest rate sensitivity and increase net interest revenue. The acquisition of First Georgia Bank in 2003 added approximately $19 million to the investment securities portfolio.
The investment securities portfolio consists of U.S. Government and agency securities, municipal securities and U.S. Government sponsored agency mortgage-backed securities. Mortgage-backed securities rely on the underlying pools of mortgage 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. Decreases in interest rates will generally cause an acceleration of prepayment levels. In a declining interest rate environment, United generally will not be able to reinvest the proceeds from these prepayments in assets that have comparable yields.
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Deposits
Total deposits at March 31, 2004 were $3.074 billion, an increase of $351 million from March 31, 2003, primarily due to the acquisitions of First Georgia Bank and the three North Carolina branches in 2003. Total non-interest-bearing demand deposit accounts increased $81 million and interest-bearing demand accounts increased $103 million. Total time deposits as of March 31, 2004 were $1.636 billion, an increase of $136 million from the first quarter of 2003. During 2003, United chose not to aggressively pursue certificates of deposit where local market pricing was too high or there was no other customer relationship. As a result, the level of certificates of deposit experienced some attrition during the year in favor of funding from lower-cost sources. This reduced the overall cost of funds by using more floating rate funding sources. The shift in funding mix did not significantly change United’s interest rate risk profile due to the increase in floating rate loans.
Time deposits of $100,000 and greater totaled $402 million at March 31, 2004, compared with $394 million at March 31, 2003. United utilizes “brokered” time deposits, issued in certificates of less than $100,000, as an alternative source of cost-effective funding. Brokered time deposits outstanding at March 31, 2004 and March 31, 2003 were $429 million and $346 million, respectively.
Wholesale Funding
At March 31, 2004, each of the Banks were shareholders in the Federal Home Loan Bank. Through this affiliation, secured advances totaling $470 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. FHLB advances outstanding at March 31, 2004 had both fixed and floating interest rates ranging from .13% to 6.59%. None 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 included in United’s 2003 Form 10-K.
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.
Net interest revenue is influenced by changes in the level of interest rates. United manages its exposure to fluctuations in interest rates through policies established by the Asset/Liability Management Committee (“ALCO”). ALCO meets regularly 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 various scenarios, 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 (“flat rate scenario”) 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 runs ramp scenarios that assume gradual increases and decreases of 200 basis points each over the next twelve months. United’s policy for net interest revenue simulation is limited to a change from the flat rate scenario of less than 10% for the up or down 200 basis point ramp scenarios over twelve months. At March 31, 2004, United’s simulation model indicated that a 200 basis point increase in rates over the next twelve months would cause an approximate 3% increase in net interest revenue and a 200 basis point decrease in rates over the next twelve months would cause an approximate 6% decrease in net interest revenue.
In order to assist in achieving a desired level of interest rate sensitivity, United uses off-balance sheet contracts that are considered derivative financial instruments. Derivative financial instruments can be a cost and capital effective means of modifying the repricing characteristics of on-balance sheet assets and liabilities. At March 31, 2004, United was a party to interest rate swap contracts under which it pays a variable rate and receives a fixed rate.
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The following table presents the interest rate swap contracts outstanding at March 31, 2004.
Table 10 – Interest Rate Swap ContractsAs of March 31, 2004(in thousands)
(1) Based on prime rate at March 31, 2004
All of United’s derivative financial instruments are classified as cash flow hedges. The change in fair value of cash flow hedges is recognized in other comprehensive income. Cash flow hedges consist of interest rate swap contracts that are designated as hedges of daily repricing prime based loans. Under these contracts, United receives a fixed interest rate and pays a floating rate based on the Prime Rate as posted in the Wall Street Journal.
United’s policy requires all derivative financial instruments be used only for asset/liability management through the hedging of specific transactions or positions, and not for trading or speculative purposes. Management believes that the risk associated with using derivative financial instruments to mitigate interest rate risk sensitivity is minimal and should not have any material unintended impact on the financial condition or results of operations. In order to mitigate potential credit risk, United requires the counterparties to derivative contracts to pledge securities as collateral to cover the net exposure.
Liquidity Management
The objective of liquidity management is to ensure that sufficient funding is available, at reasonable cost, to meet the ongoing operational cash needs and to take advantage of revenue producing opportunities, as they arise. While the desired level of liquidity will vary depending upon a variety of factors, it is the primary goal of United to maintain a sufficient level of liquidity in all expected economic environments. Liquidity is defined as the ability 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 requirements of its shareholders as market interest rates change. Daily monitoring of the sources and use of funds is necessary to maintain a position that meets both requirements.
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 $14.5 million at March 31, 2004, and typically turn over every 45 days as the closed loans are sold to investors in the secondary market. Other short-term investments such as federal funds sold are additional sources of liquidity.
The liability section of the balance sheet provides liquidity through interest-bearing and noninterest-bearing deposit accounts. Federal funds purchased, FHLB advances and securities sold under agreements to repurchase are additional sources of liquidity and represent United’s incremental borrowing capacity. These sources of liquidity are generally 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 March 31, 2004, United had sufficient qualifying collateral to increase FHLB advances by $330 million. United’s internal policy limits brokered deposits to 25% of total deposits, excluding the brokered deposits. At March 31, 2004, United had the capacity to increase brokered deposits by $230 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.
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As disclosed in United’s Consolidated Statement of Cash Flows, net cash provided by operating activities was $11.8 million for the three months ended March 31, 2004. The major contributors in this category were net income of $10.9 million, depreciation, amortization and accretion of $3.6 million and an increase in accrued expenses and other liabilities of $3.6 million, partially offset by a decrease in other assets of $4.2 million and an increase in mortgage loans held for sale of $3.8 million. Net cash used by investing activities of $82.7 million consisted primarily of a net increase in loans totaling $132.2 million and $59.9 million used to purchase investment securities, partially offset by proceeds from sales, maturities and calls of investment securities of $112.4 million. Net cash provided by financing activities consisted primarily of a net increase in deposits of $216.7 million, a net increase in FHLB advances of $165.1 million and a net increase in federal funds purchased and repurchase agreements of $25.6 million, partially offset by a $43.8 million net decrease in other borrowings. In the opinion of management, the liquidity position at March 31, 2004 is sufficient to meet its expected cash flow requirements.
Capital Resources and Dividends
Stockholders’ equity at March 31, 2004 was $311.2 million, an increase of $65.5 million from March 31, 2003. Accumulated other comprehensive income (loss) is not included in the calculation of regulatory capital adequacy ratios. Excluding the change in the accumulated other comprehensive income, stockholders’ equity increased $66.4 million, or 28%, from March 31, 2003, of which $29.3 million was the result of shares exchanged for the acquisition of First Georgia Bank. Dividends of $2.1 million, or $.06 per share, were declared on common stock during the first quarter of 2004, an increase of 20% from the amount declared in 2003. On an operating basis, the dividend payout ratios for the first quarters of 2004 and 2003 were both 19%. United has historically retained the majority of its earnings in order to provide a cost effective source of capital for continued growth and expansion. However, in recognition that cash dividends are an important component of shareholder value, management has instituted a dividend program that provides for increased cash dividends when earnings and capital levels permit.
United’s Board of Directors has authorized the repurchase of up to 2,250,000 shares of the Company’s common stock through December 31, 2004. Through March 31, 2004, a total of 1,311,000 shares have been purchased under this program at an average cost of $14.78. No shares were purchased during the first quarter.
United trades on the NASDAQ National Market under the symbol UCBI. The closing price for the period ended March 31, 2004 was $23.73. Below is a quarterly schedule of high and low stock prices for 2004 and 2003.
Table 11 – Stock Price Information
The following table presents the quarterly cash dividends declared in 2004 and 2003 and the respective payout ratios as a percentage of basic operating earnings per share, which excludes merger-related charges.
Table 12 – Dividend Payout Information (based on operating earnings)
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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. To be considered well capitalized under the guidelines, a 10% total risk-based capital ratio is required, of which 6% must be Tier I capital.
The following table shows United’s capital ratios, as calculated under regulatory guidelines, at March 31, 2004 and 2003.
Table 13 – Capital Ratios(in thousands)
United’s Tier I capital, which excludes other comprehensive income, consists of stockholders’ equity and qualifying capital securities less goodwill and deposit-based intangibles, totaled $269 million at March 31, 2004. Tier II capital components include supplemental capital items 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 $378 million at March 31, 2004. The capital ratios, as calculated under the guidelines, were 8.12% and 11.43% for Tier I and Total Risk-based capital, respectively, at March 31, 2004.
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 adjusted for goodwill and deposit-based intangibles. Although a minimum leverage ratio of 3% is required for the highest-rated bank holding companies which are not undertaking significant expansion programs, 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 than well-diversified risks in the opinion of the Federal Reserve Board. Financial institutions with a leverage ratio exceeding 5% are considered to be well capitalized. 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 March 31, 2004 and 2003 were 6.69% and 7.37%, respectively.
The capital ratios of United and the Banks currently exceed the minimum ratios as defined by federal regulators. United monitors these ratios to ensure that United and the Banks remain above regulatory minimum guidelines.
Impact of Inflation and Changing Prices
A bank’s asset and liability structure is substantially different from that of an industrial firm 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 normal 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 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.
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Item 3. Quantitative and Qualitative Disclosure About Market Risk
There have been no material changes in United’s quantitative and qualitative disclosures about market risk as of March 31, 2004 from that presented in the Annual Report on Form 10-K for the year ended December 31, 2003. The interest rate sensitivity position at March 31, 2004 is included in management’s discussion and analysis on page 22 of this report.
Item 4. 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 March 31, 2004. Based on, and as of the date of, that evaluation, United’s 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 required 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 by United under the Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There were no significant changes in the internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
Part II. Other Information
Item 1. 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 2. Changes in Securities and Use of Proceeds – None
Item 3. Defaults upon Senior Securities – None
Item 4. Submission of Matters to a Vote of Securities Holders – None
Item 5. Other Information – None
Item 6. Exhibits and Reports on Form 8-K
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Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
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