SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2002
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 o
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 o
Aggregate market value of the voting stock held by non-affiliates of the Registrant as of June 28, 2002: $528,611,049 (based on shares held by non-affiliates at $29.62 per share, the closing stock price on the Nasdaq stock market on June 28, 2002).
As of March 14, 2003, 22,547,837 shares of common stock were issued, including 280,000 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 1,061,320 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the Annual Meeting of Shareholders to be held on April 30, 2003 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 bank subsidiaries: UCB-Georgia, which was organized as a Georgia banking corporation in 1949 and began business in 1950; and United Community Bank, Brevard, North Carolina (“UCB-North Carolina”), which United acquired in 1990. UCB-Georgia and UCB-North Carolina 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, as well as a series of acquisitions of banks whose managements share United’s community banking and customer service philosophies. Although those acquisitions have only contributed to approximately thirty percent of United’s overall growth, their contribution has mostly been to open up new markets that have above average organic growth potential. Organic growth and acquisitions will continue to be a part of United’s growth strategy and will be used to extend United’s reach into new markets.
The Banks are community-oriented, and offer 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, 2002, the Banks operated through 53 locations. To emphasize the commitment to community banking, United’s two bank subsidiaries operate with a decentralized management structure that is currently organized as seventeen community banks (“Community Banks”) with local bank presidents (referred to herein as the “Presidents”) who are closely tied to the communities they serve and have the authority, alone or with local officers, to make most credit decisions.
On January 8, 2003, United announced a definitive agreement to acquire First Central Bancshares, a one-bank holding company with assets of $150 million headquartered in Lenoir City, Tennessee, for approximately $30 million and is expected to close on March 31, 2003. United will pay First Central’s shareholders 821,600 shares of its common stock and approximately $9 million in cash for all of the outstanding shares of First Central. United will operate First Central’s wholly-owned Tennessee bank subsidiary, First Central Bank, following the merger.
On January 23, 2003, United announced a definitive agreement to acquire First Georgia Holding, a one-bank holding company with assets of $260 million headquartered in Brunswick, Georgia, for approximately $43 million and is expected to close on May 1, 2003, subject to shareholder and regulatory approval, at which time First Georgia will merge into United. United will pay First Georgia’s shareholders 1,177,000 shares of its common stock and approximately $13 million in cash for all of the outstanding shares of First Georgia. First Georgia’s wholly-owned Georgia bank subsidiary, First Georgia Bank, will be merged into UCB-Georgia and will operate as a separate Community Bank doing business as “First Georgia Bank”.
In addition, United owns an insurance agency, United Community Insurance Services, Inc. (“UCIS”), which is a subsidiary of UCB-Georgia, and United Intellectual Property Holdings, Inc. (“UIP”), which was formed to hold intellectual property rights such as trademarks and tradenames.
The Mortgage People Company (“TMPC”), 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. TMPC was organized to provide fixed and adjustable-rate mortgages. During 2002, TMPC originated $310 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 TMPC.
Acquired by United in 2000, Brintech, Inc. (“Brintech”) is a consulting firm for the financial services industry. Brintech provides consulting and other 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.
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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 income 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 north Georgia, metro Atlanta and western North Carolina, 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 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, 2002.
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, 2002, commercial, real estate construction, commercial real estate, residential mortgage and installment loans represented approximately 6%, 22%, 28%, 38% and 6% respectively, of United’s total loan portfolio.
Specific risk elements associated with each of the Banks’ lending categories include, but are not limited to:
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 strong financial credentials.
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 upon net worth. Secured loans are made to persons who are well established and have net worth, collateral, and cash flow to support the loan. Exceptions to these 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 reported through the credit approval process. Policy exceptions made for borrowers whose aggregate loans exceed $5 million must be reported to the Banks’ Boards of Directors for approval.
United’s Credit Administration department provides each lending officer with written guidelines for lending activities as approved by the Banks’ Boards of Directors. Lending authority is delegated to lending officers by United’s Management Credit and Policy Committee as authorized by the Banks’ Boards of Directors. Said authority is limited to the amount of secured and unsecured loans that can be made to a single borrower or related group of borrowers. 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 (holding company) directors.
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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 annual 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 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 the average historical loss rate for the preceding three year period (2000 through 2002), as adjusted to reflect current economic conditions, which provides 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 when necessary. The balance of impaired loans is therefore not included in the balance applied to the loss factors for adversely classified loans.
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 officers of each of the Banks and the Treasurer of United. All of 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. 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 the Management’s Discussion and Analysis (Part II, Item 7) andQuantitative and Qualitative Disclosures About Market Risk (Part II, Item 7A) sections of this report.
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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 Board of Directors of each of the Banks 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, 2002, United and its subsidiaries had 1,097 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. None of United’s or the Banks’ Executive Officers were employed pursuant to an employment contract although United’s Executive Officers have change of control agreements in the event of termination upon change of control. Those agreements are included as exhibits.
Supervision And Regulation
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:
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 became effective in 2000, and 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 will be deemed “financial in nature” include:
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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.
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. Both the FDIC and the DBF must grant prior approval of any merger, consolidation or other corporation reorganization involving UCB-Georgia, and the FDIC and the NCBC must grant prior approval of any merger, consolidation, or other corporate reorganization of UCB-North Carolina. 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 revenues of United result 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.
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.
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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, 2002, net assets available from the Banks to pay dividends without prior approval from regulatory authorities totaled approximately $19 million. For 2002, United’s declared cash dividend payout to common stockholders was 16.3% 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 total assets for the most highly-rated banks and bank holding companies. “Tier I Capital” generally consists of common equity not including unrecognized gains and losses on securities, 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.
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, 2002 and 2001, the most recent notifications from the FDIC categorized each of the Banks as “well capitalized” under current regulations.
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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 the Banks and terms of office as of March 14, 2003, are as follows:
None of the above officers is related to another 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 61 locations, of which 50 locations are owned and 11 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, 2002 was $24.37. Below is a schedule of high and low stock sales prices for all quarters in 2002 and 2001. 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 14, 2003, there were approximately 7,500 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 $.25, $.20 and $.15 per common share in 2002, 2001 and 2000, 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 DATA
UNITED COMMUNITY BANKS, INC.Selected Financial InformationFor the Years Ended December 31,
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UNITED COMMUNITY BANKS, INC.Selected Financial Information (continued)
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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.
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.
Mergers and Acquisitions
On November 7, 2001, United completed its merger with Peoples Bancorp, Inc. (“West Georgia”), a single-bank holding company located in Carrollton, Georgia. United issued 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.
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. Policies for accounting for the allowance for loan losses, loans, investment securities and income taxes are the most critical for United. In particular, accounting policies related to the allowance for loan losses and income taxes involve the use of estimates and require significant judgment on behalf of management. Different assumptions in the application of these policies could result in material changes to United’s consolidated financial position and results of operations. See “Asset Quality and Risk Elements” herein for a complete discussion of United’s accounting methodology related to the allowance for loan losses. Please also refer to Note 1 to the consolidated financial statements for details regarding all of United’s critical and significant accounting policies.
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Merger-Related and Restructuring Charges
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 are included in non-interest expense in the consolidated statement of income. At December 31, 2001, approximately $268,000 remained unpaid, most of which was for legal fees and system conversion costs, all of which was paid during 2002.
During 2000, United recorded merger-related and restructuring charges of $7.6 million in connection with the acquisitions and integration of North Point Bancshares, Inc., Independent Bancshares, Inc. and Brintech, Inc. The charges are included in non-interest expense in the consolidated statement of income. The amounts of the merger-related charges that were accrued and unpaid at December 31, 2000 were paid during 2001. United also recorded an additional $.4 million in the provision for loan losses to conform the credit policies of the acquired banks to United, including underwriting and risk rating standards, charge-offs, past due and nonaccrual loans, as well as to reflect the impending changes in the management of problem loans. As part of a balance sheet restructuring program related to the integration of the acquired companies, United sold securities and recognized losses of $2.7 million.
The charges are discussed further in Note 3 to the consolidated financial statements. These charges have been excluded from the presentation of operating earnings as management believes they are not reflective of underlying financial performance trends.
The table below presents a reconciliation of United’s operating earnings to earnings for the years 2001 and 2000 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
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Results of Operations
The remainder of this financial discussion will focus on operating earnings which exclude merger related charges. Management believes operating earnings provide a useful 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 operating income, excluding merger related charges, was $32.8 million in 2002, an increase of 16% from the $28.3 million earned in 2001. Diluted operating earnings per common share were $1.48 for 2002, compared with $1.30 for 2001, an increase of 14%. Return on common equity for 2002 was 16.54%, compared with 16.73% for 2001. Return on average assets for 2002 was 1.11% as compared to 1.10% in 2001.
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 $119.6 million in 2002, an increase of $10.4 million, or 10% from the level recorded in 2001. Net interest revenue for 2001 increased $12.6 million or 13% over the 2000 level.
Average interest earning assets increased $342 million, or 14% over 2001 reflecting loan growth net of attrition in the securities portfolio. Loan demand continued despite softening economic conditions, resulting in a 21% increase in average loan balances from 2001. The majority of the increase in interest-earning assets was funded by interest-bearing sources as the increase in interest-bearing liabilities was approximately $311 million over 2001.
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 obtaining a portion of the funding of earning assets with customers’ non-interest bearing deposits. United’s long-term objective is to manage the net interest margin in the 4.25% to 4.50% range.
For the years 2002, 2001 and 2000, United’s net interest spread was 3.95%, 3.90% and 3.53% while the net interest margin was 4.33%, 4.51% and 4.16%, respectively. While the net interest spread in 2002 increased 5 basis points over 2001, the net interest margin declined 18 basis points. The reduced impact of non-interest bearing funds, brought about by declining interest rates, caused the net interest margin to decrease. As interest rates decline, the relative value of non-interest bearing sources of funds declines, negatively impacting the net interest margin. The increase in net interest revenue, the net interest spread and the net interest margin in 2001 over 2000 was mostly due to actively managing the funding costs in the declining rate environment in 2001.
The 5 basis point increase in the net interest spread in 2002 over 2001 was primarily caused by improvement in earning asset mix due to strong growth in the loan portfolio. This increase in loan volume was also the primary driver of the increase in net interest revenue over 2001.
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The following table shows, for the past three years, the relationship between interest revenue and interest expense and the average balances of interest-earning assets and interest-bearing liabilities.
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 $6.9 million in 2002, compared with $6.0 million in 2001, and $7.6 million in 2000. The provision as a percentage of average outstanding loans for 2002, 2001 and 2000 was .31%, .32% and .45%, respectively. The ratio of net loan charge-offs to average outstanding loans for 2002 was .14%, compared with .25% for 2001, and .18% for 2000. The provision for loan losses for each year is the amount 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. As mentioned in the section titled “Merger-Related and Restructuring Charges”, the provision for loan losses in 2000 included an additional charge of $367,000 to conform the accounting for allowance for loan loss methodologies of acquired companies to that of United.
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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Operating Fee Revenue
Total operating fee revenue for 2002 was $30.7 million, compared with $25.3 million in 2001 and $18.9 million in 2000. Operating fee revenue for 2000 excludes $2.7 million in losses incurred to restructure the securities portfolio. The losses are described in more detail in the section of Management’s Discussion and Analysis titled “Merger-Related and Restructuring Charges”. Fee revenue was approximately 21% of total revenue for 2002, compared with 20% for 2001 and 17% for 2000. The following table presents the components of fee revenue for 2002, 2001 and 2000.
Table 4 — Fee RevenueFor the Years Ended December 31,(in thousands)
A significant source of fee revenue for United is service charges and fees on deposit accounts. Total deposit service charges and fees for 2002 were $13.5 million compared with $9.9 million in 2001. The increase in service charges and fees was primarily due to higher fees related to new products and services introduced in the first half of 2002, as well as an increase in the number of accounts and transaction activity.
Mortgage loan and related fees for 2002 were $7.8 million, up 25% over the amount in 2001. Origination volume increased due to the lower interest rate environment which increased the market for mortgage refinancing. The majority of the fees were the result of a higher volume of loan originations in 2002, as compared to 2001. Substantially all of the mortgages were subsequently sold into the secondary market, including the right to service these loans. Since United does not service loans for others, it has no servicing rights and therefore had no impairment losses caused by lower rates.
Brokerage fees of $1.9 million were up 46% over the amount reported in 2001. Over the last two years, United has been building its brokerage business by recruiting brokers and offering brokerage services to its customer base.
Other fee revenue was down $.6 million compared to 2001 due principally to prepayment penalties incurred in disposing of certain fixed rate Federal Home Loan Bank advances. In the fourth quarter of 2002, United terminated certain fixed rate Federal Home Loan Bank advances and incurred $552 thousand in prepayment penalties as part of its balance sheet management activities. The prepayment penalties were recorded as a reduction of other fee revenue. The fixed rate advances were replaced with floating rate advances in order to reduce United’s exposure to downward rate movements. Also as part of those activities, United realized securities gains of $573 thousand from sales of securities.
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Operating Expense
Total operating expenses, excluding merger related charges were $91.1 million in 2002, compared with $83.9 million in 2001 and $74 million in 2000. Operating expenses for 2001 and 2000 exclude $1.6 million and $7.6 million, respectively, of merger-related charges. These charges primarily consisted of employee contractual obligations, write-off of obsolete equipment and other merger costs that are described in more detail in the section of Management’s Discussion and Analysis titled “Merger-Related and Restructuring Charges”. The following table presents the components of non-interest expenses for the years ended December 31, 2002, 2001 and 2000.
Table 5 — Operating ExpensesFor the Years Ended December 31,(in thousands)
Total salaries and benefits for 2002 were $57.8 million, an increase of $7.8 million, or 16%, over 2001 primarily due to an increase in the number of employees. United’s full-time equivalent staff increased to 1,097, from 1,035 at December 31, 2001 and 978 at December 31, 2000. Most of the 2001 staff increase occurred in the fourth quarter and most of the 2002 staff increase occurred in the first half of 2002. The head count growth was evenly divided between a merger, business development and infrastructure. The merger with West Georgia added approximately 30 staff in the fourth quarter of 2001. Business development at various banks added approximately 40 staff, including lenders in the metro Atlanta market, plus five new banking and commercial loan office locations and other customer support. Shared services and operations added approximately 40 staff, which included staff for a regional credit function, two new processing centers and other support areas. An increase in variable incentive compensation resulting from higher mortgage loan production and brokerage fees and merit increases for existing staff accounted for approximately $2.6 million of the remaining increase.
Communications and equipment expense, which includes software-related expenses, data circuit costs, local phone service, long-distance service and cellular service, increased $.6 million, or 10%, during 2002. The increase was due to several projects that were completed in order to reinforce United’s technology infrastructure to provide a stable, redundant network to support the company as it grows. The equipment purchased under these projects allows for United’s technology platform to be more scalable, as well as, increases network speeds across the company’s locations.
Postage, printing and supplies expense of $3.7 million was down $.7 million, or 16% compared to 2001. This decrease was due to the write off of old stationary and printed products in the third quarter of last year as United’s Community Banks adopted a common brand name.
Amortization of intangibles of $340,000 for the year decreased 55% from 2001. This decrease was due to adoption of Statement of Financial Accounting Standards No. 142 “Goodwill and Other Intangibles” which discontinued amortization of most goodwill effective January 1, 2002.
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The efficiency ratio measures total operating expenses as a percentage of total revenue, excluding the provision for loan losses, net securities gains (losses) and merger-related expenses. The FHLB prepayment losses taken during the fourth quarter of 2002 are also excluded from the efficiency ratio calculation since they were part of the same balance sheet management activities that resulted in the securities gains. United’s efficiency ratio for 2002 was 60.66% as compared with 62.52% and 64.15% for 2001 and 2000, respectively. The improvement in the efficiency ratio is due to managements’ focus on controlling operating expenses and improving operating results.
Income Taxes
Income tax expense, including benefits relating to merger and restructuring charges, was $17.1 million in 2002 compared with $13.5 million in 2001 and $6.6 million in 2000. The effective tax rates (as a percentage of pre-tax net income) for 2002, 2001 and 2000 were 34.3%, 33.2% and 31.1%, 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. 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 of $29.6 million for the fourth quarter of 2002 was $883 thousand or 3% higher than the fourth quarter of 2001. The increase was driven by a $428 million or 22% increase in average loans that was partially offset by compression in the net interest margin. In the fourth quarter of 2002, the net interest margin was 4.03% compared with 4.59% for the same period a year ago. The decrease in the net interest margin was caused by an increase in prime based floating rate loans that caused United to become more asset sensitive. This was done intentionally in anticipation of rate increases expected in late 2002 that did not occur. Additionally, the decline was due to the prolonged historically low rate environment and the flat yield curve, proceeds from maturing loans and securities were reinvested at rates substantially below the rates of the loans and securities they replaced.
The provision for loan losses for the fourth quarter of 2002 was $1.8 million compared with $1.5 million for the same period a year earlier. The increase in provision expense was primarily due to a larger loan portfolio, as credit quality remained stable.
Fee revenue was $8.8 million, up $1.9 million or 27% from the fourth quarter of 2001. The primary driver of the increase in fee revenue was deposit service charges, which increased $1.1, million or 40%, to $3.7 million primarily due to new products and services introduced in early 2002. Mortgage loan and related fees, consulting fees, and brokerage fees also showed increases from the fourth quarter of 2001. In the fourth quarter of 2002, United realized securities gains of $573 thousand from sales of securities as part of its balance sheet management activities. Also part of those activities, United incurred $552 thousand in prepayment penalties to terminate certain fixed rate Federal Home Loan Bank advances. The prepayment penalties were recorded as a reduction of other fee revenue.
Operating expenses of $23.0 million for the fourth quarter of 2002 were up $842 thousand or 4% from the fourth quarter of 2001, excluding merger related charges incurred in the fourth quarter of 2001. An increase in salaries and benefits costs was the driver of the increase in operating expenses as most other expense categories were held to minimal increases or were down from a year ago. Salaries and employee benefits of $14.9 million for 2002 was up $1.8 million or 14% primarily due to staff additions, which was evenly divided among business development and infrastructure support. At December 31, 2002, United had 1,097 full time equivalent employees, up 62 from a year ago. Merit increases and higher mortgage and broker commissions, which are based on revenue, also contributed to the increase. Most of the decrease in the other expense categories was due to a concentrated focus on controlling discretionary spending; also, certain costs were incurred during the fourth quarter of 2001 to adopt a common brand name.
Balance Sheet Review
Total assets at December 31, 2002 were $3.211 billion, an increase of $462 million, or 17%, from December 31, 2001. On an average basis, total assets increased $374 million, or 14%, from 2001 to 2002. Average interest earning assets for 2002 were $2.761 billion, compared with $2.419 billion for 2001, an increase of 14%.
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Total loans averaged $2.240 billion in 2002, compared with $1.855 billion in 2001, an increase of 21%. At December 31, 2002, total loans were $2.382 billion, an increase of $374 million, or 19%, from December 31, 2001. Most of the growth over 2001 occurred in the metropolitan Atlanta and north Georgia markets, with particular strength in loans secured by real estate, both residential and non-residential. Real estate-construction loans grew significantly with approximately half of the growth generated by the commercial loan production offices opened in the metro Atlanta market early in the year. The following table presents a summary of the loan portfolio by category over that period.
Table 6 — Loans OutstandingAs of December 31,(in thousands)
Substantially all of United’s loans are to customers located in the immediate market areas of the Banks and approximately 98% of the loans are secured by real estate and other hard assets. This includes loan customers who have a seasonal residence in the Banks’ market areas. The following table indicates United’s loans by specific collateral type or loan purpose as of December 31, 2002 and 2001:
Table 7 — Loans by Collateral Type or PurposeAs of December 31, 2002 and 2001(in thousands)
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As of December 31, 2002, United’s 25 largest credit relationships consisted of loans and loan commitments ranging from $5.2 million to $14.7 million, with an aggregate total credit exposure including $35.5 million in unfunded commitments of $227.2 million. All of these customers have been underwritten in accordance with United’s credit quality standards and structured in order to minimize United’s potential exposure to loss.
The following table sets forth the maturity distribution of commercial and real estate construction loans, including the interest rate sensitivity for loans maturing greater than one year, as of December 31, 2002. United’s loan policy does not permit automatic roll-over of matured loans.
Table 8 — Loan Portfolio MaturityAs of December 31, 2002(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 loan 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 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 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 department through an 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 financial portfolio, prevailing and anticipated economic conditions and other 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 9 — Allowance for Loan LossesYears Ended December 31,(in thousands)
Management believes that the allowance for loan losses at December 31, 2002 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 $6.7 million at year-end 2002, compared with $8.6 million at December 31, 2001. There is no concentration of non-performing loans attributable to any specific industry. At December 31, 2002, the ratio of non-performing loans to total loans was .28%, compared with .43% at year-end 2001. Non-performing assets, which include non-performing loans and foreclosed real estate, totaled $8.0 million at December 31, 2002, compared with $9.7 million at year-end 2001.
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 nor 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, 2002. The table below summarizes non-performing assets at year-end for the last five years.
Table 10 — Non-Performing AssetsAs of December 31,(in thousands)
At December 31, 2002, United had $16.8 million of loans which were not classified as non-performing but for which known information about the borrowers’ financial condition caused management to have concern about the ability of the borrowers to comply with the repayment terms of the loans. These loans were identified through the loan review process described in theAsset Quality and Risk Elements section (see also section titled Loan Review and Non-performing Assets in Item 1) of this discussion above that provides for assignment of a risk rating based on a ten-grade scale to all commercial and commercial real estate loans. Based on the evaluation of current market conditions, loan collateral, other secondary sources of repayment and cash flow generation, management does not anticipate any significant losses related to these loans. These loans are subject to continuing management attention and are considered in the determination of the allowance for loan losses.
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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 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 decreased 5% during 2002. The decrease in the average balances for 2002 was due to paydowns on mortgage-backed securities caused by the low rate environment and natural attrition. In late 2002, United began a management strategy to reduce asset sensitivity and increase net interest revenue by purchasing investment securities. The fourth quarter securities purchases brought the December 31, 2002 balance to $559 million, 19% higher than the balance at December 31, 2001. At December 31, 2002, the average duration of the investment portfolio was 2.55 years compared with 3.14 years at December 31, 2001. The following table shows the carrying value of United’s securities as of December 31, 2002, 2001 and 2000.
Table 11 — 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 with or without prepayment penalties. Decreases in 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, 2002, United had 47% of its total investment securities portfolio in mortgage backed pass-through securities, all of which are issued or backed by Federal agencies, compared with 37% at December 31, 2001. United did not have securities of any issuer in excess of 10% of equity at year-end 2002 or 2001, excluding U.S. Government issues. Other mortgage-backed securities, including collateralized mortgage obligations, represented 6% of the total securities portfolio at December 31, 2002, compared with 12% at year-end 2001. 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 2002 were $2.312 billion, an increase of $302 million, or 15% from 2001. Average non-interest bearing demand deposit accounts increased $28 million, or 10%, and average interest bearing transaction accounts increased $176 million, or 38%, from 2001. Average time deposits for 2002 were $1.271 billion, up from $1.180 million in 2001.
Time deposits of $100,000 and greater totaled $370 million at December 31, 2002, compared with $374 million at year-end 2001. 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 2002, 2001 and 2000 were $145.2 million, $58.7 million and $53.8 million, respectively. The average rate paid on brokered time deposits in 2002, 2001 and 2000 was 2.70%, 6.11% and 6.24%, respectively. Total interest paid on time deposits of $100,000 and greater during 2002 was $13.5 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, 2002.
Table 12 — Maturities of Time Deposits of $100,000 and Greater and Brokered DepositsAs of December 31, 2002(in thousands)
Wholesale Funding
At December 31, 2002, both of the Banks were shareholders in the Federal Home Loan Bank of Atlanta. Through this affiliation, secured advances totaling $492 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, 2002 had both fixed and floating interest rates ranging from 1.16% to 7.81%. Approximately 42% of the FHLB advances mature prior to December 31, 2003. Additional information regarding FHLB advances, including scheduled maturities, is provided in Note 10 to the consolidated financial statements.
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 of United and to take advantage of revenue producing opportunities as they arise. 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 $24.1 million at December 31, 2002, and typically turn over every 45 days as closed loans are sold to investors in the secondary market. Real estate-construction and commercial loans that mature in one year or less amounted to $481 million, or 20%, of the total loan portfolio at December 31, 2002. Other short-term investments such as federal funds sold are additional sources of liquidity.
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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 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. The following table shows United’s contractual obligations and other commitments as of December 31, 2002.
Table 13 — Contractual Obligations and Other CommitmentsAs of December 31, 2002(in thousands)
As disclosed in United’s consolidated statements of cash flows, net cash provided by operating activities was $30 million during 2002. The major sources of cash provided by operating activities are net income partially offset by changes in other assets, other liabilities and mortgage loans held for sale. Net cash used in investing activities of $475 million consisted primarily of a net increase in loans of $379 million and securities purchases of $333 million partially funded by sales, maturities and paydowns of securities of $218 million. Net cash provided by financing activities provided the remainder of funding sources for 2002. The $428 million of net cash provided by financing activities consisted primarily of a $269 million net increase in deposits, a net increase in FHLB advances of $202 million, proceeds from issuance of subordinated debt of $31 million and a decrease of $57 million in federal funds purchased and repurchase agreements. In the opinion of management, United’s liquidity position at December 31, 2002, is sufficient to meet its expected cash flow requirements.
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Capital Resources and Dividends
Stockholders’ equity at December 31, 2002 was $221.6 million, an increase of $26.9 million, or 14%, from December 31, 2001. Accumulated other comprehensive income (loss), 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 increase in the accumulated other comprehensive income, stockholders’ equity increased 11%. Dividends of $5.3 million, or $.25 per share, were declared on common stock in 2002, an increase of 25% per share from the amount declared in 2001. The dividend payout ratios based on net income for 2002 and 2001 were 16.3% and 15.0%, respectively; and, excluding merger-related charges, the ratios were 16.3% and 15.6%, respectively. United has historically retained the majority of its 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 instituted a dividend program that will provide for a higher level of cash dividends when earnings and capital levels permit.
On December 31, 1996, United completed a private placement 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 the Wall Street Journal, payable quarterly. The 2006 Debentures may be redeemed, in whole or in part at the option of United upon at least 20 days and not more than 60 days notice, at a redemption price equal to 100% of the principal amount of the debentures to be redeemed plus interest accrued and unpaid as of the date of redemption. 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.
On November 26, 2002, United issued through a private placement, $31.5 million in 6.75% subordinated notes due November 26, 2012. Proceeds from the issuance are being used to finance business expansion and for general business purposes. The notes qualify as Tier II capital under Risk Based Capital Guidelines.
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 $233.5 million at December 31, 2002. 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 $298.4 million at December 31, 2002. The ratios, as calculated under the guidelines, were 9.8% and 12.5% for Tier I and Total Risk-based Capital, respectively, at December 31, 2002.
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, 2002 and 2001 were 7.5% and 8.0%, 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 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
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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 growth to continue through 2003, although at a slower rate than 2002. 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%.
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 Asset/Liability Management Committee of United and of its subsidiary Banks. 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 runs 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 December 31, 2002, United’s simulation model indicated that 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. This compares with December 31, 2001 when the model indicated that 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 1% decrease in net interest revenue.
Interest rate sensitivity is a function of the repricing characteristics of United’s 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.
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The following table shows interest sensitivity gaps for these different intervals as of December 31, 2002.
Table 14 — Interest Rate Gap SensitivityAs of December 31, 2002(in thousands)
As demonstrated in the preceding table, 74% of interest-bearing liabilities will reprice within twelve months compared with 73% 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 the 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 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.
Table 14 indicates United is in a liability sensitive gap position for the first twelve months. This liability sensitive position would generally indicate that United’s net interest revenue would decrease should interest rates rise and would increase should interest rates fall. United’s simulation model indicates, however, that United is asset sensitive and that changes in net interest revenue would be directionally consistent with changes in rates. The difference between the results of the two analysis tools is primarily due to interest-bearing deposit balances that United has some discretion over the timing and extent of rate changes. In the simulation model, management has assumed that such deposits are not fully sensitive to rising rate movements, since management would delay increases in rates until warranted by competitive pressures. Additionally, interest rate swap contracts having a notional value of $165 million will mature by December 31, 2003. United uses both the interest rate gap sensitivity analysis and simulation modeling to determine its exposure to interest rate risk and neither can provide absolute assurance that United is not at risk from interest rate increases and
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decreases. Management also evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the appropriate mix and repricing characteristics of assets and liabilities necessary to optimize the net interest margin.
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, 2002. The composition and maturity/repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs.
Table 15 — Expected Maturity of Available for Sale Investment SecuritiesAs of December 31, 2002(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 2002, 2001 and 2000. 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, 2002.
Table 16 — Interest Rate Swap ContractsAs of December 31, 2002(in thousands)
Effective January 1, 1999, United adopted SFAS No. 133, as amended by SFAS No. 137 and 138 which requires all derivative financial instruments to be included and recorded at fair value on the balance sheet. United’s derivative financial instruments are classified as fair value and cash flow hedges. 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. The change in fair value of cash flow hedges is recognized in other comprehensive income.
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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 LOGO)
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, 2002 and 2001, 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, 2002. 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, 2002 and 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
/s/ Porter Keadle Moore, LLP
Atlanta, GeorgiaJanuary 28, 2003
Certified Public Accountants
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Consolidated Statement of Income
For the Years Ended December 31, 2002, 2001 and 2000
(in thousands, except per share data)
See accompanying notes to consolidated financial statements.
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Consolidated Balance Sheet
As of December 31, 2002 and 2001
(in thousands, except share data)
Assets
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIESConsolidated Statement of Changes in Stockholders’ EquityFor the Years Ended December 31, 2002, 2001 and 2000(in thousands, except share data)
See accompanying notes to consolidated financial statements
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Consolidated Statement of Cash Flows
(in thousands)
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIESNotes 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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Statement of Income
Balance Sheet
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Statement of Cash Flows
For the Years Ended December 31, 2002, 2001, and 2000
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ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
During United’s two most recent fiscal years, United did not change accountants and had no disagreement with its accountants on any matters of accounting principles or practices or financial statement disclosure.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF UNITED.
The information contained under the heading “Information Regarding Nominees and Other Directors” 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 2003 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 2003 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference.
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 2003 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 2003 Annual Meeting of Shareholders, to be filed with the SEC, is incorporated herein by reference.
ITEM 14. 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 defined in federal securities rules) within 90 days prior to the filing of this report. Based on, and as of the date of, that evaluation, United’s Chief Executive Officer and Chief Financial Officer have concluded that United’s 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 United’s 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 United’s internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
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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 20th of March, 2003.
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 17th day of March, 2003.
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Certifications
I, Jimmy C. Tallent, President and Chief Executive Officer of United, certify that:
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I, Rex S. Schuette, Executive Vice President and Chief Financial Officer of United, certify that:
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EXHIBIT INDEX
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