UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2015
OR
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
For the Transition Period from ___________ to ___________
Commission file number 001-35095
(706) 781-2265
(Telephone Number)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES x NO ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
YES ¨ NO x
Common stock, par value $1 per share 63,193,854 shares voting and 8,285,516 shares non-voting outstanding as of October 31, 2015.
INDEX
Part I – Financial Information
See accompanying notes to consolidated financial statements.
Before-tax
Amount
Tax(Expense)
Benefit
Net of Tax
UNITED COMMUNITY BANKS, INC.
Consolidated Statement of Changes in Shareholders' Equity(Unaudited)
For the Nine Months Ended September 30,
UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 1 – Accounting Policies
The accounting and financial reporting policies of United Community Banks, Inc. (“United”) and its subsidiaries conform to accounting principles generally accepted in the United States of America (“GAAP”) and general banking industry practices. The accompanying interim consolidated financial statements have not been audited. All material intercompany balances and transactions have been eliminated. A more detailed description of United’s accounting policies is included in its Annual Report on Form 10-K for the year ended December 31, 2014.
In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments are normal and recurring accruals considered necessary for a fair and accurate presentation. The results for interim periods are not necessarily indicative of results for the full year or any other interim periods.
Certain 2014 amounts have been reclassified to conform to the 2015 presentation.
Note 2 –Accounting Standards Updates and Recently Adopted Standards
In February 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, effective for fiscal years beginning after December 15, 2015 and interim periods within those years with early adoption permitted. The new standard is intended to improve targeted areas of the consolidation guidance for legal entities such as limited partnerships, limited liability corporations, and securitization structures. The amendments in the ASU affect the consolidation evaluation for reporting organizations. In addition, the amendments in this ASU simplify and improve current GAAP by reducing the number of consolidation models. United is currently evaluating the impact of this guidance on its consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest – Imputation of Interest (Subtopic 835-30) Simplifying the Presentation of Debt Issuance Costs. To simplify presentation of debt issuance costs, the amendments in this update require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability consistent with debt discounts. The standard will be effective for the United’s fiscal year beginning after December 15, 2015 and subsequent interim periods. The adoption of ASU 2015-03 is not expected to have a material effect on United’s consolidated financial statements.
In May 2015, the FASB issued ASU 2015-07,Disclosures for Investments in Certain Entities that Calculate Net Asset Value Per Share (or its Equivalent). ASU 2015-07 removes the requirement to categorize within the fair value hierarchy investments for which fair values are estimated using the net asset value practical expedient provided by ASC 820. Disclosures about investments in certain entities that calculate net asset value per share are limited under ASU 2015-07 to those investments for which the entity has elected to estimate the fair value using the net asset value practical expedient. ASU 2015-07 is effective for fiscal years beginning after December 15, 2015, with retrospective application to all periods presented. Early application is permitted. The adoption of this update is not expected to have a material impact on United’s consolidated financial statements.
In June 2015, the FASB issued ASU 2015-10:Technical Corrections and Improvements. The amendments in this Update cover a wide range of topics in the Codification including guidance clarification and reference corrections, simplification and minor improvements. Transition guidance varies based on the amendments. The amendments that require transition guidance are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted, including adoption in an interim period. All other amendments will be effective upon issuance. United retrospectively applied the provisions of ASU 2015-10 during the second quarter of 2015, with no material impact on United’s financial position or results of operations. The adoption of ASU 2015-10 did affect certain disclosures related to nonrecurring fair value measurements as presented in Note 14.
In July 2015, the FASB issued ASU 2015-12,Plan Accounting: Defined Benefit Pension Plans (Topic 960), Defined Contribution Pension Plans (Topic 962), and Health and Welfare Benefit Plans (Topic 965). The guidance in the update designates contract value as the only required measure for fully benefit-responsive investment contracts and simplifies the disclosure of investments by requiring that investments be grouped only by general type rather than disaggregated in multiple ways. The amendments are effective for fiscal years beginning after December 15, 2015, with earlier application permitted. The adoption of this update is not expected to have a material impact on United’s consolidated financial statements.
In August 2015, the FASB issued ASU 2015-14,Revenue from Contracts with Customers (Topic 606). The guidance in this update delays the effective date of ASU 2014-09,Revenue from Contracts with Customers (Topic 606): Summary and Amendments that Create Revenue from Contracts with Customers (Topic 606) and Other Assets and Deferred Costs—Contracts with Customers (Subtopic 340-40), which supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the industry topics of the codification. For public companies, ASU 2014-09 was originally effective for interim and annual periods beginning after December 15, 2016. ASU 2015-14 delays the effective date for public companies to interim and annual reporting periods beginning after December 15, 2017. United is currently assessing the impact that this guidance will have on its consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. The guidance in this update requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. In addition, the acquirer will record, in the same period financial statements, the effect on earnings of changes in depreciation, amortization or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The update requires disclosure of amounts recorded in current-period earnings that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. For public entities, this update is effective for fiscal years beginning after December 15, 2015 with early application permitted. United applied the provisions of ASU 2015-16 during the third quarter of 2015, with no material impact on United’s financial position or results of operations.
Note 3 – Acquisitions
Acquisition of Palmetto Bancshares, Inc.
On September 1, 2015, United completed the acquisition of Palmetto Bancshares, Inc. (“Palmetto”) and its wholly-owned bank subsidiary The Palmetto Bank. Palmetto operated 25 branches in South Carolina. In connection with the acquisition, United acquired $1.15 billion of assets and assumed $1.02 billion of liabilities. Total consideration transferred was $244 million of common equity and cash. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $108 million, which consisted largely of the intangible value of Palmetto’s business and reputation within the market it serves. None of the goodwill recognized is expected to be deductible for income tax purposes. United will amortize the related core deposit intangible of $12.9 million using the sum-of-the-years-digits method over 12 years, which represents the expected useful life of the asset.
The fair value of the 8.7 million common shares issued as part of the consideration paid for Palmetto was determined on the basis of the closing market price of United’s common shares on the acquisition date.
The purchased assets and assumed liabilities were recorded at their acquisition date fair values and are summarized in the table below (in thousands).
Purchased loans that show evidence of credit deterioration since origination are accounted for pursuant to Accounting Standards Codification (“ASC”) Topic 310-30,Loans and Debt Securities Acquired with Deteriorated Credit Quality. The following table presents additional information related to the acquired loan portfolio at acquisition date (in thousands):
United’s operating results for the nine months ended September 30, 2015 include the operating results of the acquired assets and assumed liabilities for the days subsequent to the acquisition date of September 1, 2015.
Acquisition of MoneyTree Corporation
On May 1, 2015, United completed the acquisition of MoneyTree Corporation (“MoneyTree”) and its wholly-owned bank subsidiary, First National Bank (“FNB”). FNB operated ten branches in east Tennessee. In connection with the acquisition, United acquired $460 million of assets and assumed $409 million of liabilities and $9.99 million of preferred stock. Total consideration transferred was $54.6 million of common equity and cash. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $14.1 million, which consisted largely of the intangible value of FNB’s business and reputation within the market it serves. None of the goodwill recognized is expected to be deductible for income tax purposes. United will amortize the related core deposit intangible of $4.22 million using the sum-of-the-years-digits method over 6.67 years, which represents the expected useful life of the asset. The deposit premium of $917,000 will be amortized using the effective yield method over 5 years, which represents the weighted average maturity of the underlying deposits.
The fair value of the 2.36 million common shares issued as part of the consideration paid for MoneyTree was determined on the basis of the closing market price of United’s common shares on the acquisition date.
Upon completion of the acquisition, each share of preferred stock issued by MoneyTree as part of the Small Business Lending Fund (“SBLF”) program of the United States Department of Treasury (9,992 shares in the aggregate with a liquidation preference amount of $1,000 per share) was converted automatically into one substantially identical share of preferred stock of the Company. See Note 12 for further detail.
The purchased assets and assumed liabilities were recorded at their acquisition date fair values, and are summarized in the table below (in thousands).
United’s operating results for the nine months ended September 30, 2015 include the operating results of the acquired assets and assumed liabilities for the days subsequent to the acquisition date of May 1, 2015.
Pro forma information
The following table discloses the impact of the merger with Palmetto and MoneyTree since the respective acquisition dates through September 30, 2015. The table also presents certain pro forma information as if Palmetto and MoneyTree had been acquired on January 1, 2014. These results combine the historical results of Palmetto and MoneyTree with United’s consolidated statement of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not necessarily indicative of what would have occurred had the acquisition taken place on January 1, 2014.
Merger-related costs of $8.92 million from the acquisitions have been excluded from the 2015 pro forma information presented below and included in the 2014 pro forma information presented below. Furthermore, no adjustments have been made to the pro forma information to eliminate the pre-acquisition provision for loan losses for the nine months ended September 30, 2015 or 2014 of Palmetto or MoneyTree. No adjustments have been made to reduce the impact of any OREO write downs recognized by Palmetto or MoneyTree in either the nine months ended September 30, 2015 or 2014. In addition, expenses related to systems conversions and other costs of integration are expected to be recorded during the next several quarters. United expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the pro forma amounts below. The actual results and pro forma information were as follows (in thousands):
Acquisition of Business Carolina, Inc.
On June 26, 2014, United completed the acquisition of substantially all of the assets of Business Carolina, Inc., a specialty Small Business Administration (“SBA”) / United States Department of Agriculture (“USDA”) lender headquartered in Columbia, South Carolina. On the closing date, United paid $31.3 million in cash for loans having a fair value on the purchase date of $24.8 million, accrued interest of $83,000, servicing rights with a fair value on the purchase date of $2.13 million, premises and equipment with a fair value on the purchase date of $2.60 million and goodwill in the amount of $1.51 million representing the premium paid over the fair value of the separately identifiable assets and liabilities acquired. The gross contractual amount of loans receivable was $28.0 million as of the acquisition date. United has not identified any material separately identifiable intangible assets resulting from the acquisition.
The valuation of loans and servicing assets that were acquired in this transaction included unobservable inputs. Therefore, United considers those valuations to be level 3 in the ASC 820 hierarchy. For the loans, the valuations were derived by estimating the expected cash flows using a combination of prepayment speed and default estimates. The cash flows are then discounted using the rates implied by observed transactions in the market place.
Note 4 – Balance Sheet Offsetting
United enters into reverse repurchase agreements in order to invest short-term funds. In addition, United enters into repurchase agreements and reverse repurchase agreements with the same counterparty in transactions commonly referred to as collateral swaps that are subject to master netting agreements under which the balances are netted in the balance sheet in accordance with ASC 210-20, Offsetting.
The following table presents a summary of amounts outstanding under reverse repurchase agreements and derivative financial instruments including those entered into in connection with the same counterparty under master netting agreements as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Gross
Amounts of
Amounts
Offset on the
Gross Amounts not Offset
in the Balance Sheet
Recognized
Assets
Balance
Sheet
Net Asset
Financial
Instruments
Collateral
Received
Liabilities
Liability
Pledged
Note 5 – Securities
The amortized cost basis, gross unrealized gains and losses and fair value of securities held-to-maturity at September 30, 2015, December 31, 2014 and September 30, 2014 are as follows (in thousands).
The following table summarizes held-to-maturity securities in an unrealized loss position as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Management evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, among other factors. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. No impairment charges were recognized during the three or nine months ended September 30, 2015 or 2014.
The cost basis, unrealized gains and losses, and fair value of securities available-for-sale at September 30, 2015, December 31, 2014 and September 30, 2014 are presented below(in thousands).
The following table summarizes available-for-sale securities in an unrealized loss position as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Unrealized
Loss
At September 30, 2015, there were 137 available-for-sale securities and 15 held-to-maturity securities that were in an unrealized loss position. United does not intend to sell nor believes it will be required to sell securities in an unrealized loss position prior to the recovery of their amortized cost basis. Unrealized losses at September 30, 2015, December 31, 2014 and September 30, 2014 were primarily attributable to changes in interest rates and therefore, United does not consider them to be impaired.
Realized gains and losses are derived using the specific identification method for determining the cost of securities sold. The following table summarizes available-for-sale securities sales activity for the three and nine months ended September 30, 2015 and 2014 (in thousands).
Three Months Ended
September 30,
Nine Months Ended
Securities with a carrying value of $1.45 billion, $1.51 billion and $1.38 billion were pledged to secure public deposits and other secured borrowings at September 30, 2015, December 31, 2014 and September 30, 2014, respectively.
The amortized cost and fair value of held-to-maturity and available-for-sale securities at September 30, 2015, by contractual maturity, are presented in the following table (in thousands).
Expected maturities may differ from contractual maturities because issuers and borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Note 6 – Loans and Allowance for Credit Losses
Major classifications of loans as of September 30, 2015, December 31, 2014 and September 30, 2014, are summarized as follows (in thousands).
At September 30, 2015, December 31, 2014 and September 30, 2014, loans totaling $2.51 billion, $2.35 billion and $2.21 billion, respectively, were pledged as collateral to secure FHLB advances and other contingent funding sources.
At September 30, 2015, the carrying value and unpaid principal balance of purchased credit impaired (“PCI”) loans accounted for under ASC 310-30 was $52.2 million and $73.1 million, respectively. The following table presents changes in the value of the accretable yield for acquired loans accounted for under ASC Topic 310-30 for the three and nine months ended September 30, 2015 (in thousands):
In addition to the accretable yield on loans accounted for under ASC Topic 310-30, the fair value adjustments on purchased loans outside the scope of ASC Topic 310-30 are also accreted to interest income over the life of the loans. At September 30, 2015, the remaining accretable fair value mark on loans acquired through a business combination and not accounted for under ASC Topic 310-30 was $7.71 million. In addition, indirect auto loans purchased at a premium outside of a business combination have a remaining premium of $11.0 million.
The allowance for loan losses represents management’s estimate of probable incurred losses in the loan portfolio as of the end of the period. The allowance for unfunded commitments is included in other liabilities in the consolidated balance sheet. Combined, the allowance for loan losses and allowance for unfunded commitments are referred to as the allowance for credit losses.
The following table presents the balance and activity in the allowance for credit losses by portfolio segment for the three and nine months ended September 30, 2015 and 2014 (in thousands).
Beginning
Charge-
Offs
Ending
Allocation
of
Unallocated
In the first quarter of 2014, United modified its allowance for loan losses methodology to incorporate a loss emergence period. The increase in precision resulting from the use of the loss emergence period led to the full allocation of the portion of the allowance that had previously been unallocated.
The following table represents the recorded investment in loans by portfolio segment and the balance of the allowance for loan losses assigned to each segment based on the method of evaluating the loans for impairment as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Individually
evaluated for
impairment
Collectively
Purchased
with
deteriorated
credit quality
Excluding loans accounted for under ASC Topic 310-30, management considers all loans that are on nonaccrual with a balance of $500,000 or greater and all troubled debt restructurings (“TDRs”) to be impaired. In addition, management reviews all accruing substandard loans greater than $2 million to determine if the loan is impaired. A loan is considered impaired when, based on current events and circumstances, it is probable that all amounts due according to the original contractual terms of the loan will not be collected. All TDRs are considered impaired regardless of accrual status. Impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. For TDRs less than $500,000, impairment is estimated based on the average impairment of TDRs greater than $500,000 by loan category. For loan types that do not have TDRs greater than $500,000, the average impairment for all TDR loans is used to quantify the amount of required specific reserve. A specific reserve is established for impaired loans for the amount of calculated impairment. Interest payments received on impaired nonaccrual loans are applied as a reduction of the outstanding principal balance. For impaired loans not on nonaccrual status, interest is accrued according to the terms of the loan agreement. Loans are evaluated for impairment quarterly and specific reserves are established in the allowance for loan losses for any measured impairment.
Each quarter, United’s management prepares an analysis of the allowance for credit losses to determine the appropriate balance that measures and quantifies the amount of probable incurred losses in the loan portfolio and unfunded loan commitments. The allowance is comprised of specific reserves on individually impaired loans, which are determined as described above, and general reserves which are determined based on historical loss experience as adjusted for current trends and economic conditions multiplied by a loss emergence period factor. Management uses eight quarters of historical loss experience to determine the loss factors to be used in the reserve calculation for loans evaluated in the aggregate. Eight quarters has been determined to be an appropriate time period as it is recent enough to be relevant to current conditions and covers a length of time sufficient to minimize distortions caused by nonrecurring and unusual activity that might otherwise influence a shorter time period. In previous years, the loss rates were weighted toward more recent quarters by multiplying each quarter’s annualized historical net charge-off rate by 1 through 8, with 8 representing the most recent quarter and 1 representing the oldest quarter. Management adopted this method of weighting quarterly loss rates to capture the rapidly deteriorating credit conditions in its loss factors during the financial crisis. In the first quarter of 2014, in light of stabilizing credit conditions, management concluded that it was appropriate to apply a more level weighting to capture the full range and impacts of credit losses experienced during the most recent economic and credit cycle. For the four quarters of 2014, management applied a weighting factor of 1.75 to the most recent four quarters and a weighting of 1.00 for the four oldest quarters. Beginning with the first quarter of 2015, management began applying equal weight to all eight quarters to capture the full range of the loss cycle. Management believes the current weightings are more appropriate to measure the probable losses incurred within the loan portfolio.
Also, beginning in the first quarter of 2014, management updated its method for measuring the loss emergence period in the calculation of the allowance for credit losses. The rapidly deteriorating credit conditions during the peak of the credit cycle shortened the length of time between management’s estimation of the incurrence of a loss and its recognition as a charge-off. In most cases, the loss emergence period was within a twelve month period which made the use of annualized loss factors appropriate for measuring the amount of incurred yet unconfirmed credit losses within the loan portfolio. As United has moved out beyond the peak of the financial crisis, management has observed that the loss emergence period has extended. Management calculates the loss emergence period for each pool of loans based on the average length of time between the date a loan first exceeds 30 days past due and the date the loan is charged off.
The updates to the weightings to the eight quarters of loss history and the update to our estimation of the loss emergence period did not have a material effect on the total allowance for loan losses or the provision for loan losses, however, the revised loss emergence period resulted in the full allocation of the previously unallocated portion of the allowance for loan losses.
On junior lien home equity loans, management has limited ability to monitor the delinquency status of the first lien unless the first lien is also held by United. As a result, management applies the weighted average historical loss factor for this category and appropriately adjusts it to reflect the increased risk of loss from these credits.
Management carefully reviews the resulting loss factors for each category of the loan portfolio and evaluates whether qualitative adjustments are necessary to take into consideration recent credit trends such as increases or decreases in past due, nonaccrual, criticized and classified loans, and other macro environmental factors such as changes in unemployment rates, lease vacancy rates and trends in property values and absorption rates.
Management believes that its method of determining the balance of the allowance for credit losses provides a reasonable and reliable basis for measuring and reporting losses that are incurred in the loan portfolio as of the reporting date.
When a loan officer determines that a loan is uncollectible, he or she is responsible for recommending that the loan be placed on nonaccrual and charged off. Full or partial charge-offs may also be recommended by the Collections Department, the Special Assets Department, the Loss Mitigation Department and the Foreclosure/OREO Department. Nonaccrual real estate loans that are collateral dependent are generally charged down to 80% of the appraised value of the underlying collateral at the time they are placed on nonaccrual status.
Commercial and consumer asset quality committees consisting of the Chief Credit Officer, Senior Risk Officers and Senior Credit Officers meet monthly to review charge-offs that have occurred during the previous month.
Generally, closed-end retail loans (installment and residential mortgage loans) past due 90 cumulative days are written down to their collateral value less estimated selling costs unless the loan is well secured and in process of collection (within the next 90 days). Open-end (revolving) unsecured retail loans which are past due 90 cumulative days from their contractual due date are generally charged-off.
The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Excluding loans accounted for under ASC Topic 310-30, there were no loans more than 90 days past due and still accruing interest at September 30, 2015, December 31, 2014 or September 30, 2014. Nonaccrual loans include both homogeneous loans that are collectively evaluated for impairment and individually evaluated impaired loans. United’s policy is to place loans on nonaccrual status when, in the opinion of management, the principal and interest on a loan is not likely to be repaid in accordance with the loan terms or when the loan becomes 90 days past due and is not well secured and in the process of collection. When a loan is classified on nonaccrual status, interest previously accrued but not collected is reversed against current interest revenue. Principal and interest payments received on a nonaccrual loan are applied to reduce outstanding principal.
Loans accounted for under ASC Topic 310-30 are considered past due or delinquent when the contractual principal or interest due in accordance with the terms of the loan agreement remains unpaid after the due date of the scheduled payment. However, these loans are considered as performing, even though they may be contractually past due, as any non-payment of contractual principal or interest is considered in the periodic re-estimation of expected cash flows and is included in the resulting recognition of current period covered loan loss provision or future period yield adjustments. Loans accounted for under ASC Topic 310-30 were not classified as nonaccrual at September 30, 2015 as the carrying value of the respective loan or pool of loans cash flows were considered estimable and probable of collection. Therefore, interest income, through accretion of the difference between the carrying value of the loans and the expected cash flows, is being recognized on all acquired loans being accounted for under ASC Topic 310-30.
The gross additional interest revenue that would have been earned if the loans classified as nonaccrual had performed in accordance with the original terms was approximately $262,000 and $705,000 for the three months ended September 30, 2015 and 2014, respectively and $686,000 and $1.37 million for the nine months ended September 30, 2015 and 2014, respectively. The gross additional interest revenue that would have been earned for the three and nine months ended September 30, 2015 and 2014 had performing TDRs performed in accordance with the original terms is immaterial.
The average balances of impaired loans and income recognized on impaired loans while they were considered impaired are presented below for the three and nine months ended September 30, 2015 and 2014 (in thousands).
The following table presents the recorded investment in nonaccrual loans by loan class as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
The following table presents the aging of the recorded investment in past due loans as of September 30, 2015, December 31, 2014 and September 30, 2014 by class of loans(in thousands).
As of September 30, 2015, December 31, 2014, and September 30, 2014, $5.66 million, $9.72 million and $9.82 million, respectively, of specific reserves were allocated to customers whose loan terms have been modified in TDRs. United committed to lend additional amounts totaling up to $189,000, $51,000 and $38,000 as of September 30, 2015, December 31, 2014 and September 30, 2014, respectively, to customers with outstanding loans that are classified as TDRs.
The modification of the terms of the TDRs included one or a combination of the following: a reduction of the stated interest rate of the loan or an extension of the amortization period that would not otherwise be considered in the current market for new debt with similar risk characteristics; a restructuring of the borrower’s debt into an “A/B note structure” where the A note would fall within the borrower’s ability to pay and the remainder would be included in the B note; a mandated bankruptcy restructuring; or interest-only payment terms greater than 90 days where the borrower is unable to amortize the loan.
The following table presents information on TDRs including the number of loan contracts restructured and the pre- and post-modification recorded investment as of September 30, 2015, December 31, 2014 and September 30, 2014 (dollars in thousands).
Loans modified under the terms of a TDR during the three and nine months ended September 30, 2015 and 2014 are presented in the table below. In addition, the following table presents loans modified under the terms of a TDR that became 90 days or more delinquent during the three and nine months ended September 30, 2015 and 2014, that were initially restructured within one year prior to becoming delinquent (dollars in thousands).
Collateral dependent TDRs that subsequently default and are placed on nonaccrual are charged down to the fair value of the collateral consistent with United’s policy for nonaccrual loans. Impairment on TDRs that are not collateral dependent continues to be measured on discounted cash flows regardless of whether the loan has subsequently defaulted.
As of September 30, 2015, December 31, 2014 and September 30, 2014, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands).
Risk Ratings
United categorizes commercial loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current industry and economic trends, among other factors. United analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a continual basis. United uses the following definitions for its risk ratings:
Watch. Loans in this category are presently protected from apparent loss; however, weaknesses exist that could cause future impairment, including the deterioration of financial ratios, past due status and questionable management capabilities. These loans require more than the ordinary amount of supervision. Collateral values generally afford adequate coverage, but may not be immediately marketable.
Substandard. These loans are inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged. Specific and well-defined weaknesses exist that may include poor liquidity and deterioration of financial ratios. The loan may be past due and related deposit accounts experiencing overdrafts. There is the distinct possibility that United will sustain some loss if deficiencies are not corrected. If possible, immediate corrective action is taken.
Doubtful. Specific weaknesses characterized as Substandard that are severe enough to make collection in full highly questionable and improbable. There is no reliable secondary source of full repayment.
Loss. Loans categorized as Loss have the same characteristics as Doubtful; however, probability of loss is certain. Loans classified as Loss are charged off.
Consumer Purpose Loans. United applies a pass / fail grading system to all consumer purpose loans. Under the pass / fail grading system, consumer purpose loans meeting the criteria of substandard are classified as “fail” and all other loans are classified as “pass”. For reporting purposes, consumer purpose loans classified as “fail” are reported in the performing substandard or nonaccrual columns and all other consumer purpose loans are reported in the “pass” column. Loan balances reported in the “watch” column for residential mortgage are generally commercial purpose loans secured by the borrower’s residence.
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.
Note 7 – Servicing Rights for Government Guaranteed Loans
United accounts for servicing rights for government guaranteed loans serviced for others at fair value and includes them in other assets. Changes in the balances of servicing assets and servicing liabilities subsequently measured using the fair value measurement method for the three and nine months ended September 30, 2015 and 2014 are recorded as follows (in thousands).
A summary of the key characteristics, inputs, and economic assumptions used to estimate the fair value of the Company’s government guaranteed servicing assets as of September 30, 2015 and December 31, 2014, and the sensitivity of the fair values to immediate adverse changes in those assumptions are shown in the table below (in thousands).
Note 8 – Reclassifications Out of Accumulated Other Comprehensive Income
The following table presents the details regarding amounts reclassified out of accumulated other comprehensive income for the three and nine months ended September 30, 2015 and 2014 (in thousands).
Amounts shown above in parentheses reduce earnings
Note 9 – Earnings Per Share
United is required to report on the face of the consolidated statement of income, earnings per common share with and without the dilutive effects of potential common stock issuances from instruments such as options, convertible securities and warrants. Basic earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in diluted earnings per common share.
During the three and nine months ended September 30, 2015 and 2014, United accrued dividends on preferred stock as shown in the following table (in thousands).
The preferred stock dividends were subtracted from net income in order to arrive at net income available to common shareholders.
The following table sets forth the computation of basic and diluted earnings per share for the three and nine months ended September 30, 2015 and 2014 (in thousands, except per share data).
At September 30, 2015, United had the following potentially dilutive stock options and warrants outstanding: a warrant to purchase 219,909 shares of common stock at $61.40 per share; 255,229 shares of common stock issuable upon exercise of stock options granted to employees with a weighted average exercise price of $90.10; and 735,280 shares of common stock issuable upon completion of vesting of restricted stock unit awards.
At September 30, 2014, United had the following potentially dilutive stock options and warrants outstanding: a warrant to purchase 219,909 common shares at $61.40 per share originally issued to the U.S. Treasury; 305,291 common shares issuable upon exercise of stock options granted to employees with a weighted average exercise price of $95.98; 801,334 shares issuable upon completion of vesting of restricted stock awards; and warrants to purchase common stock equivalent junior preferred stock that would be convertible into 1,411,765 common shares exercisable at $21.25 per share granted to Fletcher International Ltd. (“Fletcher”) in connection with a 2010 asset purchase and sale agreement. United repurchased the warrant from Fletcher in the fourth quarter of 2014.
Note 10 – Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
United is exposed to certain risks arising from both its business operations and economic conditions. United principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. United manages interest rate risk primarily by managing the amount, sources, and duration of its investment securities portfolio and wholesale funding and through the use of derivative financial instruments. Specifically, United enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Derivative financial instruments are used to manage differences in the amount, timing, and duration of known or expected cash receipts and its known or expected cash payments principally related to loans, investment securities, wholesale borrowings and deposits.
In conjunction with the FASB’s fair value measurement guidance, United made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a gross basis.
The table below presents the fair value of United’s derivative financial instruments as well as their classification on the consolidated balance sheet as of September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Derivatives designated as hedging instruments under ASC 815
Derivative contracts that are not accounted for as hedging instruments under ASC 815, Derivatives and Hedging, and are described as “customer derivatives,” are between United and certain commercial loan customers with offsetting positions to dealers under a back-to-back swap program. United also has three interest rate swap contracts that are not designated as hedging instruments but are economic hedges of market linked brokered certificates of deposit. The market linked brokered certificates of deposit contain embedded derivatives that are bifurcated from the host instruments and marked to market through earnings. The marks on the market linked swaps and the bifurcated embedded derivatives tend to move in opposite directions with changes in 90-day LIBOR and therefore provide an effective economic hedge.
In addition, United originates certain residential mortgage loans with the intention of selling these loans. Between the time United enters into an interest-rate lock commitment to originate a residential mortgage loan that is to be held for sale and the time the loan is funded and eventually sold, the Company is subject to the risk of variability in market prices. United also enters into forward sale agreements to mitigate risk and to protect the expected gain on the eventual loan sale. Most of this activity is on a matched basis, with a loan sale commitment hedging a specific loan. The commitments to originate residential mortgage loans and forward loan sales commitments are freestanding derivative instruments. The underlying loans are accounted for under the lower of cost or fair value method and are not reflected in the table above. Fair value adjustments on these derivative instruments are recorded within mortgage loan and other related fee income in the consolidated statement of income.
Cash Flow Hedges of Interest Rate Risk
United’s objectives in using interest rate derivatives are to add stability to net interest revenue and to manage its exposure to interest rate movements. To accomplish this objective, United uses interest rate swaps as part of its interest rate risk management strategy. United’s interest rate swaps designated as cash flow hedges involved the payment of fixed-rate amounts to a counterparty in exchange for United receiving variable-rate payments over the life of the agreements without exchange of the underlying notional amount. United’s cash flow hedges were for the purpose of converting variable rate deposits and wholesale borrowings to the economic equivalent of a fixed rate to protect United in a rising rate environment. At September 30, 2015 United did not have any active cash flow hedges. At December 31, 2014, United had one swap contract outstanding with a total notional amount of $175 million that was designated as a cash flow hedge of indexed money market accounts. At September 30, 2014, United had two swap contracts outstanding with a total notional amount of $275 million that were designated as cash flow hedges of indexed money market accounts. During the second and fourth quarters of 2014, United de-designated swaps with a notional of $500 million and put on offsetting positions which had a similar effect to terminating the positions. In addition, in the first quarter of 2015, United terminated its one remaining cash flow hedge with a notional of $175 million. Changes in United’s balance sheet composition and interest rate risk position made the hedges no longer necessary as protection against rising interest rates. The loss remaining in other comprehensive income on the de-designated swaps is being amortized into earnings over the original term of the swaps as the forecasted transactions that the swaps were originally designated to hedge are still expected to occur.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense when the swaps become effective, as interest payments are made on United’s LIBOR based, variable-rate wholesale borrowings and indexed deposit accounts. United expects that $1.93 million will be reclassified as an increase to deposit interest expense over the next twelve months related to these cash flow hedges.
The table below presents the effect of United’s cash flow hedges on the consolidated statement of operations for the three and nine months ended September 30, 2015 and 2014 (in thousands).
Fair Value Hedges of Interest Rate Risk
United is exposed to changes in the fair value of certain of its fixed rate obligations due to changes in interest rates. United uses interest rate swaps to manage its exposure to changes in fair value on these instruments attributable to changes in interest rates. Interest rate swaps designated as fair value hedges of brokered deposits involve the receipt of fixed-rate amounts from a counterparty in exchange for United making variable rate payments over the life of the agreements without the exchange of the underlying notional amount. Interest rate swaps designated as fair value hedges of fixed rate investments involve the receipt of variable-rate payments from a counterparty in exchange for United making fixed rate payments over the life of the instrument without the exchange of the underlying notional amount. At September 30, 2015, United had 14 interest rate swaps with an aggregate notional amount of $174 million that were designated as fair value hedges of interest rate risk and were pay-variable / receive-fixed swaps hedging the changes in the fair value of fixed rate brokered time deposits resulting from changes in interest rates. Also at September 30, 2015, United had one interest rate swap with a notional of $30 million that was designated as a pay-fixed / receive variable fair value hedge of changes in the fair value of a fixed rate corporate bond. At September 30, 2014, United had 16 interest rate swaps with an aggregate notional amount of $199 million that were designated as fair value hedges of interest rate risk. These contracts were pay-variable / receive-fixed swaps hedging changes in the fair value of fixed rate brokered time deposits resulting from changes in interest rates.
For derivatives designated and that qualify as fair value hedges, the gain or loss on the derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in earnings. United includes the gain or loss on the hedged items in the same income statement line item as the offsetting loss or gain on the related derivatives. During the three and nine months ended September 30, 2015, United recognized net gains of $14,000 and $184,000, respectively, and during the three and nine months ended September 30, 2014, United recognized net losses of $312,000 and $937,000, respectively, related to ineffectiveness in the fair value hedging relationships. United also recognized net reductions of interest expense of $1.12 million and $3.39 million, respectively, for the three and nine months ended September 30, 2015 and net reductions of interest expense of $1.04 million and $3.47 million, respectively, for the three and nine months ended September 30, 2014 related to United’s fair value hedges of brokered time deposits, which includes net settlements on the derivatives. United recognized reductions of interest revenue on securities during the three and nine months ended September 30, 2015 of $142,000 and $361,000, respectively, and a reduction of interest revenue on securities during the nine months ended September 30, 2014 of $955,000 related to United’s fair value hedges of corporate bonds that were terminated in the second quarter of 2014.
The table below presents the effect of United’s derivatives in fair value hedging relationships on the consolidated statement of operations for the three and nine months ended September 30, 2015 and 2014 (in thousands).
In certain cases, the estate of deceased brokered certificate of deposit holders may put the certificate of deposit back to the issuing bank at par upon the death of the holder. When these estate puts occur, a gain or loss is recognized for the difference between the fair value and the par amount of the deposits put back. The change in the fair value of brokered time deposits that are being hedged in fair value hedging relationships reported in the table above includes gains and losses from estate puts and such gains and losses are included in the amount of reported ineffectiveness gains or losses.
Credit-Risk-Related Contingent Features
United manages its credit exposure on derivatives transactions by entering into a bilateral credit support agreement with each counterparty. The credit support agreements require collateralization of exposures beyond specified minimum threshold amounts. The details of these agreements, including the minimum thresholds, vary by counterparty. As of September 30, 2015, collateral totaling $28.2 million was pledged toward derivatives in a liability position.
United’s agreements with each of its derivative counterparties contain a provision where if either party defaults on any of its indebtedness, then it could also be declared in default on its derivative obligations. The agreements with derivatives counterparties also include provisions that if not met, could result in United being declared in default. United has agreements with certain of its derivative counterparties that contain a provision where if United fails to maintain its status as a well-capitalized institution or is subject to a prompt corrective action directive, the counterparty could terminate the derivative positions and United would be required to settle its obligations under the agreements.
Note 11 – Stock-Based Compensation
United has an equity compensation plan that allows for grants of incentive stock options, nonqualified stock options, restricted stock and restricted stock unit awards (also referred to as “nonvested stock” awards), stock awards, performance share awards or stock appreciation rights. Options granted under the plan can have an exercise price no less than the fair market value of the underlying stock at the date of grant. The general terms of the plan include a vesting period (usually four years) with an exercisable period not to exceed ten years. Certain options, restricted stock and restricted stock unit awards provide for accelerated vesting if there is a change in control (as defined in the plan). As of September 30, 2015, 212,000 additional awards could be granted under the plan. Through September 30, 2015, incentive stock options, nonqualified stock options, restricted stock and restricted stock unit awards, base salary stock grants and performance share awards have been granted under the plan.
The following table shows stock option activity for the first nine months of 2015.
The fair value of each option is estimated on the date of grant using the Black-Scholes model. No stock options were granted during the nine months ended September 30, 2015 and 2014.
Most of United’s outstanding stock options were granted prior to the economic downturn during which time United’s stock price decreased sharply. The lower stock price has rendered most of United’s outstanding options severely out of the money and potentially worthless to the grantee. Therefore, historical exercise patterns do not provide a reasonable basis for determining the expected life of new option grants. United therefore uses the formula provided by the SEC in ASC Topic 718-10-S99 to determine the expected life of options.
United recognized $28,000 and $5,000, respectively, in compensation expense related to stock options during the nine months ended September 30, 2015 and 2014. The amount of compensation expense was determined based on the fair value of the options at the time of grant, multiplied by the number of options granted that were expected to vest, which was then amortized over the vesting period. The forfeiture rate for new options issued is estimated to be approximately 3% per year. No options were exercised during the first nine months of 2015 or 2014.
The table below presents restricted stock units activity for the first nine months of 2015.
Compensation expense for restricted stock units is based on the fair value of restricted stock unit awards at the time of grant, which is equal to the value of United’s common stock on the date of grant. The value of restricted stock unit awards that are expected to vest is amortized into expense over the vesting period. For the nine months ended September 30, 2015 and 2014, compensation expense of $3.22 million and $3.23 million, respectively, was recognized related to restricted stock unit awards. In addition, for the nine months ended September 30, 2015 and 2014, $95,000 and $76,000, respectively, was recognized in other operating expense for restricted stock unit awards granted to members of United’s board of directors. The total intrinsic value of outstanding restricted stock unit awards was $15.0 million at September 30, 2015.
As of September 30, 2015, there was $10.2 million of unrecognized compensation cost related to non-vested stock options and restricted stock unit awards granted under the plan. That cost is expected to be recognized over a weighted-average period of 2.64 years. The aggregate grant date fair value of options and restricted stock unit awards that vested during the nine months ended September 30, 2015, was $4.11 million.
Note 12 – Common and Preferred Stock Issued / Common Stock Issuable
United sponsors a Dividend Reinvestment and Share Purchase Plan (“DRIP”) that allows participants who already own United’s common stock to purchase additional shares directly from United. The DRIP also allows participants to automatically reinvest their quarterly dividends in additional shares of common stock without a commission. No shares were issued through the DRIP in the first nine months of 2014. The DRIP, which was suspended during the first six months of 2014, was re-activated following United’s reinstatement of its quarterly dividend in the second quarter of 2014. In the nine months ended September 30, 2015, 1,564 shares were issued through the DRIP.
United’s 401(k) Plan has routinely purchased shares of United’s common stock directly from United. Effective January 1, 2015, the 401(k) Plan discontinued offering shares of United’s common stock as an investment option. During the nine months ended September 30, 2014, United’s 401(k) Plan purchased 17,373 shares directly from United at the average of the high and low stock prices on the transaction dates which increased capital by $297,000.
In addition, United has an Employee Stock Purchase Program (“ESPP”) that allows eligible employees to purchase shares of common stock at a 5% discount, with no commission charges. Effective January 1, 2015, the discount was increased to 10% on purchases made through the ESPP. During the first nine months of 2015 and 2014, United issued 10,197 shares and 7,911 shares, respectively, through the ESPP.
United offers its common stock as an investment option in its deferred compensation plan. United also allows for the deferral of restricted stock unit awards. The common stock component of the deferred compensation plan is accounted for as an equity instrument and is reflected in the consolidated financial statements as common stock issuable. The deferred compensation plan does not allow for diversification once an election is made to invest in United’s common stock and settlement must be accomplished in shares at the time the deferral period is completed. At September 30, 2015 and 2014, 454,870 and 354,961 shares of common stock, respectively, were issuable under the deferred compensation plan.
As discussed in Note 3, on May 1, 2015,the Company completed its previously announced acquisition of Moneytree. Upon completion of the acquisition, each share of preferred stock issued by MoneyTree as part of the SBLF program of the United States Department of Treasury (9,992 shares in the aggregate with a liquidation preference amount of $1,000 per share) was converted automatically into one substantially identical share of preferred stock of the Company with a liquidation preference amount of $1,000 per share, designated as the Company’s Non-Cumulative Perpetual Preferred Stock, Series H. The SBLF Preferred Shares have terms and conditions identical to those shares of preferred stock issued by MoneyTree to the Treasury. United will pay noncumulative dividends quarterly. The current dividend rate is 1.00% per annum through March 15, 2016. Following this date, the dividend rate will increase to 9% per annum thereafter.
The SBLF Preferred Shares may be redeemed at any time at the option of United, subject to the approval of the appropriate federal banking agency. All redemptions must be made at a per share redemption price equal to 100% of the liquidation preference, plus accrued and unpaid dividends as of the date of the redemption (“Redemption Date”) for the quarter that includes the Redemption Date, and a pro rata portion of any lending incentive fee. All redemptions must be in amounts equal to at least 25% of the number of originally issued shares, or 100% of the then outstanding shares, if less than 25% of the number of originally issued shares.
In the first quarter of 2014, United redeemed all of its outstanding Series B and D preferred stock. The preferred stock was redeemed at par and did not result in any gain or loss. The redemptions were funded from a combination of dividends from United Community Bank and cash on hand.
Note 13 – Income Taxes
The income tax provision for the three and nine months ended September 30, 2015 was $10.9 million and $32.4 million, respectively, which represents an effective tax rate of 37.8% for each period. The income tax provision for the three and nine months ended September 30, 2014 was $9.99 million and $28.7 million, respectively, which represents effective tax rates of 36.2% and 36.7%, respectively, for each period. At September 30, 2015, December 31, 2014 and September 30, 2014, United maintained a valuation allowance on its net deferred tax asset of $4.58 million, $4.12 million and $4.45 million, respectively. Management assesses the valuation allowance recorded against its net deferred tax asset at each reporting period. The determination of whether a valuation allowance for its net deferred tax asset is appropriate is subject to considerable judgment and requires an evaluation of all the positive and negative evidence.
United evaluated the need for a valuation allowance at September 30, 2015. Based on the assessment of all the positive and negative evidence, management concluded that it is more likely than not that nearly all of its net deferred tax asset will be realized based upon future taxable income. The remaining valuation allowance of $4.58 million is related to specific state income tax credits that have short carryforward periods and are expected to expire unused.
The valuation allowance could fluctuate in future periods based on the assessment of the positive and negative evidence. Management's conclusion at September 30, 2015 that it was more likely than not that United’s net deferred tax asset of $197 million will be realized is based upon management’s estimate of future taxable income. Management’s estimate of future taxable income is based on internal forecasts that consider historical performance, various internal estimates and assumptions, as well as certain external data all of which management believes to be reasonable although inherently subject to significant judgment. If actual results differ significantly from the current estimates of future taxable income, even if caused by adverse macro-economic conditions, the valuation allowance may need to be increased for some or all of its net deferred tax asset. Such an increase to the net deferred tax asset valuation allowance could have a material adverse effect on United’s financial condition and results of operations.
United is subject to income taxation in the United States and various state jurisdictions. United’s federal and state income tax returns are filed on a consolidated basis. Currently, no years for which United filed a federal income tax return are under examination by the IRS, and there are no state tax examinations currently in progress. United is no longer subject to income tax examinations from state and local income tax authorities for years before 2012. Although United is unable to determine the ultimate outcome of future examinations, United believes that the liability recorded for uncertain tax positions is appropriate.
At September 30, 2015, December 31, 2014 and September 30, 2014, unrecognized income tax benefits totaled $3.88 million, $4.20 million and $4.10 million, respectively.
Note 14 – Assets and Liabilities Measured at Fair Value
Fair value measurements are determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, United uses a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy). United has processes in place to review the significant valuation inputs and to reassess how the instruments are classified in the valuation framework.
Fair Value Hierarchy
Level 1Valuation is based upon quoted prices (unadjusted) in active markets for identical assets or liabilities that United has the ability to access.
Level 2Valuation is based upon quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals.
Level 3Valuation is generated from model-based techniques that use at least one significant assumption based on unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. United’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The following is a description of the valuation methodologies used for assets and liabilities recorded at fair value.
Securities Available-for-Sale
Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities, municipal bonds, corporate debt securities and asset-backed securities and are valued based on observable inputs that include: quoted market prices for similar assets, quoted market prices that are not in an active market, or other inputs that are observable in the market and can be corroborated by observable market data for substantially the full term of the securities. Securities classified as Level 3 include asset-backed securities in less liquid markets. Securities classified as Level 3 are valued based on estimates obtained from broker-dealers and are not directly observable.
Deferred Compensation Plan Assets and Liabilities
Included in other assets in the Consolidated Balance Sheet are assets related to employee deferred compensation plans. The assets associated with these plans are invested in mutual funds and classified as Level 1. Deferred compensation liabilities, also classified as Level 1, are carried at the fair value of the obligation to the employee, which mirrors the fair value of the invested assets and is included in other liabilities in the consolidated balance sheet.
Mortgage Loans Held for Sale
Mortgage loans held for sale are carried at the lower of cost or fair value. The fair value of mortgage loans held for sale is based on what secondary markets are currently offering for mortgage loans with similar characteristics.
Loans
United does not record loans at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment based on the present value of expected future cash flows discounted at the loan's effective interest rate, except that as a practical expedient, a creditor may measure impairment based on a loan's observable market price, or the fair value of the collateral if repayment of the loan is dependent upon the sale of the underlying collateral. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. In accordance with ASC 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, United records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, United records the impaired loan as nonrecurring Level 3.
Foreclosed Assets
Foreclosed assets are adjusted to fair value, less cost to sell, upon transfer of the loans to foreclosed assets. Subsequently, foreclosed assets are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, United records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, United records the foreclosed asset as nonrecurring Level 3.
Derivative Financial Instruments
United uses interest rate swaps and interest rate floors to manage its interest rate risk. The valuation of these instruments is typically determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts and the discounted expected variable cash payments. The variable cash payments are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. United also uses best effort and mandatory delivery forward loan sale commitments to hedge risk in its mortgage lending business.
To comply with the provisions of ASC 820, United incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, United has considered the effect of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Although management has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of September 30, 2015, management had assessed the significance of the effect of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. Additionally, in the review of the structured derivative inputs, it was determined that the broker quotes, used as a key valuation input, were not observable consistent with a level 2 disclosure. This resulted in United transferring those derivatives to Level 3 in the ASC 820 leveling disclosures as of December 31, 2014. The fair value of interest rate lock commitments, which are related to mortgage loan commitments and are categorized as Level 3, are based on quoted market prices adjusted for commitments that United does not expect to fund.
Servicing Rights for Government Guaranteed Loans
United recognizes servicing rights upon the sale of government guaranteed loans sold with servicing retained. This asset is recorded at fair value on recognition, and management has elected to carry this asset at fair value for subsequent reporting. Given the nature of the asset, the key valuation inputs are unobservable and management classifies this asset as Level 3.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The table below presents United’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2015, December 31, 2014 and September 30, 2014, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).
The following table shows a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs that are classified as Level 3 values (in thousands).
The following table presents quantitative information about Level 3 fair value measurements for fair value on a recurring basis at September 30, 2015, December 31, 2014 and September 30, 2014 (in thousands).
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
United may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis. These assets are not measured at fair value on a recurring basis, but are subject to fair value adjustments in certain circumstances. These adjustments to fair value usually result from the application of lower of amortized cost or fair value accounting or write-downs of individual assets due to impairment. The following table presents the fair value hierarchy and carrying value of all assets that were still held as of September 30, 2015, December 31, 2014 and September 30, 2014, for which a nonrecurring fair value adjustment was recorded during the periods presented (in thousands).
Loans that are reported above as being measured at fair value on a nonrecurring basis are generally impaired loans that have either been partially charged off or have specific reserves assigned to them. Nonaccrual impaired loans that are collateral dependent are generally written down to 80% of appraised value which considers the estimated costs to sell. Specific reserves are established for impaired loans based on appraised value of collateral or discounted cash flows, although only those specific reserves based on the fair value of collateral are considered nonrecurring fair value adjustments. As discussed in Note 2, United retrospectively adopted ASU 2015-10 Technical Corrections and Improvements during second quarter 2015, which clarified the guidance for disclosure of nonrecurring fair value measurements and has been reflected in the disclosures presented in the table above.
Assets and Liabilities Not Measured at Fair Value
For financial instruments that have quoted market prices, those quotes are used to determine fair value. Financial instruments that have no defined maturity, have a remaining maturity of 180 days or less, or reprice frequently to a market rate, are assumed to have a fair value that approximates reported book value, after taking into consideration any applicable credit risk. If no market quotes are available, financial instruments are valued by discounting the expected cash flows using an estimated current market interest rate for the financial instrument. For off-balance sheet derivative instruments, fair value is estimated as the amount that United would receive or pay to terminate the contracts at the reporting date, taking into account the current unrealized gains or losses on open contracts.
United’s cash and cash equivalents and repurchase agreements have short maturities and therefore the carrying value approximates fair value. The fair value of securities available-for-sale equals the balance sheet value. Due to the short-term settlement of accrued interest receivable and payable, the carrying amount closely approximates fair value.
Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These estimates do not reflect the premium or discount on any particular financial instrument that could result from the sale of United’s entire holdings. Because no ready market exists for a significant portion of United’s financial instruments, fair value estimates are based on many judgments. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include the mortgage banking operation, brokerage network, deferred income taxes, premises and equipment and goodwill. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.
Off-balance sheet instruments (commitments to extend credit and standby letters of credit) are generally short-term and at variable rates. Therefore, both the carrying amount and the estimated fair value associated with these instruments are immaterial.
The carrying amount and fair values for other financial instruments that are not measured at fair value on a recurring basis in United’s balance sheet at September 30, 2015, December 31, 2014, and September 30, 2014 are as follows (in thousands).
Note 15 – Commitments and Contingencies
United is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and letters of credit. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement United has in particular classes of financial instruments. The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. United uses the same credit policies in making commitments and conditional obligations as it uses for underwriting on-balance sheet instruments. In most cases, collateral or other security is required to support financial instruments with credit risk.
The following table summarizes, as of September 30, 2015, December 31, 2014 and September 30, 2014, the contractual amount of off-balance sheet instruments (in thousands).
United, in the normal course of business, is subject to various pending and threatened lawsuits in which claims for monetary damages are asserted. Although it is not possible to predict the outcome of these lawsuits, or the range of any possible loss, management, after consultation with legal counsel, does not anticipate that the ultimate aggregate liability, if any, arising from these lawsuits will have a material adverse effect on United’s financial position or results of operations.
Note 16 – Goodwill and Other Intangible Assets
The carrying amount of goodwill and other intangible assets is summarized below (in thousands):
The following is a summary of changes in the carrying amounts of goodwill (in thousands):
The amortization expense for intangibles subject to amortization for the three and nine months ended September 30, 2015 was $714,000 and $1.4 million, respectively, which was recognized in operating expenses. The amortization expense for intangibles subject to amortization for the three and nine months ended September 30, 2014 was $313,000 and $1.06 million, respectively. The estimated aggregate amortization expense for future periods is as follows (in thousands):
Note 17 – Long-term Debt
Long-term debt consisted of the following(in thousands):
Interest is currently paid semiannually for all senior debentures and trust preferred securities.
Senior Debentures
The 2012 senior debentures are not redeemable prior to maturity and will mature on October 15, 2017. The 2013 senior debentures are redeemable on or after August 13, 2015, at a redemption price equal to 100% of the principal amount plus any accrued and unpaid interest, and will mature on August 13, 2018 if not redeemed prior to that date. The 2022 senior debentures are redeemable, in whole or in part, on or after August 14, 2020 at a redemption price equal to 100% of the principal amount to be redeemed plus any accrued and unpaid interest, and will mature on February 14, 2022 if not redeemed prior to that date. The 2027 senior debentures are redeemable, in whole or in part, on or after August 14, 2025 at a redemption price equal to 100% of the principal amount to be redeemed plus any accrued and unpaid interest, and will mature on February 14, 2027 if not redeemed prior to that date.
Trust Preferred Securities
Trust preferred securities qualify as Tier 1 capital under risk based capital guidelines subject to certain limitations. The trust preferred securities are mandatorily redeemable upon maturity, or upon earlier redemption at a premium as provided in the indentures.
Note 18 – Subsequent Event
In October 2015, United announced its decision to exit its corporate healthcare lending business based in Nashville, Tennessee. In conjunction with the exit, United agreed to sell $190 million of corporate healthcare loans that were originated by United's Nashville-based healthcare team. United has also transferred the lease on its healthcare lending office in Nashville and the personnel there have become employees of the acquirer.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-looking Statements
This Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), about United and its subsidiaries. These forward-looking statements are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, and can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “will”, “could”, “should”, “projects”, “plans”, “goal”, “targets”, “potential”, “estimates”, “pro forma”, “seeks”, “intends”, or “anticipates”, the negative thereof or comparable terminology. Forward-looking statements include discussions of strategy, financial projections, guidance and estimates (including their underlying assumptions), statements regarding plans, objectives, expectations or consequences of various transactions or events, and statements about the future performance, operations, products and services of United and its subsidiaries. We caution our shareholders and other readers not to place undue reliance on such statements.
Our businesses and operations are and will be subject to a variety of risks, uncertainties and other factors. Consequently, actual results and experiences may differ materially from those contained in any forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experiences to differ from those projected include, but are not limited to, the risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2014 as well as the following factors:
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 (the “SEC”). United cautions that the foregoing list of factors is not exclusive and not to place undue reliance on forward-looking statements. United does not intend to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Form 10-Q.
This statement has not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation.
Overview
The following discussion is intended to provide insight into the results of operations and financial condition of United Community Banks, Inc. (“United”) and its subsidiaries and should be read in conjunction with United’s consolidated financial statements and accompanying notes.
United is a bank holding company registered with the Board of Governors of the Federal Reserve under the Bank Holding Company Act of 1956 that was incorporated under the laws of the state of Georgia in 1987 and commenced operations in 1988. At September 30, 2015, United had total consolidated assets of $9.41 billion, total loans of $6.02 billion, total deposits of $7.91 billion, and shareholders’ equity of $1.01 billion.
United conducts substantially all of its operations through its wholly-owned Georgia bank subsidiary, United Community Bank (the “Bank”), which as of September 30, 2015, operated at 133 locations throughout the Atlanta-Sandy Springs-Roswell, Georgia, and Gainesville, Georgia metropolitan statistical areas, upstate South Carolina, north and coastal Georgia, western North Carolina, and east Tennessee. Also, United has a commercial loan office in Charlotte, North Carolina.
On September 1, 2015, United completed the acquisition of Palmetto Bancshares, Inc. (“Palmetto”) and its wholly-owned bank subsidiary The Palmetto Bank. On May 1, 2015, United completed the acquisition of MoneyTree Corporation (“MoneyTree”) and its wholly-owned bank subsidiary First National Bank (“FNB”). The acquired entities’ results are included in United’s consolidated results beginning on the respective acquisition dates. Also included in management’s discussion and analysis are certain non-GAAP (accounting principles generally accepted in the United States of America (“GAAP”)) performance measures. United’s management believes that non-GAAP performance measures are useful in analyzing United’s financial performance trends and therefore this section will refer to non-GAAP performance measures. A reconciliation of these non-GAAP performance measures to GAAP performance measures is included in the table on page 48.
United reported net income of $17.9 million for the third quarter of 2015. This compared to net income of $17.6 million for the third quarter of 2014. Diluted earnings per common share were $.27 for the third quarter of 2015, compared to diluted earnings per common share of $.29 for the third quarter of 2014. The decrease in earnings per share results from $5.74 million in merger-related charges reported in the third quarter of 2015.
For the nine months ended September 30, 2015, United reported net income of $53.4 million. This compared to net income of $49.4 million for the first nine months of 2014. Diluted earnings per common share were $.84 for the nine months ended September 30, 2015, compared to diluted earnings per common share of $.81 for the nine months ended September 30, 2014.
Taxable equivalent net interest revenue increased to $65.7 million for the third quarter of 2015, compared to $57.0 million for the same period of 2014, primarily due to loan growth. Net interest margin decreased to 3.26% for the three months ended September 30, 2015 from 3.32% for the same period in 2014. For the nine months ended September 30, 2015, taxable equivalent net interest revenue was $185 million compared to $166 million for the same period of 2014, primarily due to loan growth and an increase in the net interest margin. Net interest margin increased to 3.29% for the nine months ended September 30, 2015 from 3.25% for the same period in 2014. In the second quarter of 2014, United executed a number of balance sheet management activities, including restructuring interest rate swaps, selling investment securities and repaying high cost wholesale borrowings with the intent of improving the net interest margin and increasing net interest revenue. These balance sheet management activities, along with strong loan growth over the last five quarters, had the desired effect of increasing net interest revenue and net interest margin.
United’s provision for credit losses was $700,000 for the third quarter of 2015, compared to $2.0 million for the same period in 2014. Net charge-offs for the third quarter of 2015 were $1.42 million, compared to $3.16 million for the third quarter of 2014. Strong recoveries of previously charged-off loans drove net charge-offs down in the third quarter of 2015. For the nine months ended September 30, 2015, United’s provision for loan losses was $3.40 million, compared to $6.70 million for the same period of 2014. United’s credit quality indicators have shown improvement over the last five quarters leading to lower net charge offs and provisions for credit losses.
As of September 30, 2015, United’s allowance for loan losses was $69.1 million, or 1.15% of loans, compared to $71.6 million, or 1.53% of loans, at December 31, 2014 and $71.9 million, or 1.57% of loans, at September 30, 2014. In accordance with the accounting guidance for business combinations, there was no allowance for loan losses brought forward on loans acquired from Palmetto or MoneyTree, as credit deterioration was included in the determination of fair value at acquisition date. At September 30, 2015, United recorded no allowance for loan losses on loans acquired from Palmetto or MoneyTree as there was no evidence of credit deterioration beyond that which was incorporated into the determination of fair value at acquisition date. Nonperforming assets of $27.7 million were .29% of total assets at September 30, 2015, up from .26% at December 31, 2014 and the same level as September 30, 2014. The year-to-date increase was primarily due to foreclosed properties assumed in connection with the Palmetto acquisition. During the third quarter of 2015, $8.92 million in loans were placed on nonaccrual compared with $7.67 million in the third quarter of 2014.
Fee revenue of $18.3 million for the third quarter of 2015 was up $3.89 million, or 27%, from the third quarter of 2014. The increase was partly due to $1.65 million in gains from the sales of government guaranteed loans in the third quarter of 2015, compared to $945,000 in the third quarter of 2014. United began selling the guaranteed portion of Small Business Administration (“SBA”) / United States Department of Agriculture (“USDA”) loans in the second quarter of 2014 as part of its emphasis on growing its government guaranteed lending business. Mortgage fees of $3.84 million for the third quarter of 2015 increased from $2.18 million in the third quarter of 2014. The increase was due to United’s emphasis on growing its mortgage business by recruiting lenders in metropolitan markets and continued strong refinancing activity. For the first nine months of 2015, fee revenue of $51.2 million increased $10.5 million, or 26%, from the same period in 2014, primarily due to the same factors resulting in the quarterly increase.
For the third quarter of 2015, operating expenses of $54.3 million were up $12.9 million from the third quarter of 2014, partially due to the addition of Palmetto and FNB operating expenses since acquisition. Salaries and benefits expense increased $3.68 million from a year ago mostly due to the investment in additional staff and new teams to expand the specialized lending area as well as higher incentive compensation in connection with increased lending activities and improvement in earnings performance. In addition, merger-related charges of $5.74 million were expensed in third quarter 2015. For the nine months ended September 30, 2015, operating expenses of $146 million were up $24.8 million from the same period in 2014, mainly due to the same factors that caused the quarterly increase.
Recent Developments
Critical Accounting Policies
The accounting and reporting policies of United are in accordance with GAAP and conform to general practices within the banking industry. The more critical accounting and reporting policies include United’s accounting for the allowance for loan losses, fair value measurements, and income taxes which involve the use of estimates and require significant judgments to be made by management. Different assumptions in the application of these policies could result in material changes in United’s consolidated financial position or consolidated results of operations. See “Asset Quality and Risk Elements” herein for additional discussion of United’s accounting methodologies related to the allowance for loan losses.
GAAP Reconciliation and Explanation
This Form 10-Q contains non-GAAP financial measures, which are performance measures determined by methods other than in accordance with GAAP. Such non-GAAP financial measures include, among others the following: taxable equivalent interest revenue, taxable equivalent net interest revenue, tangible book value per share, tangible equity to assets, tangible common equity to assets and tangible common equity to risk-weighted assets. Management uses these non-GAAP financial measures because it believes they are useful for evaluating our operations and performance over periods of time, as well as in managing and evaluating our business and in discussions about our operations and performance. Management believes these non-GAAP financial measures provide users of our financial information with a meaningful measure for assessing our financial results and credit trends, as well as comparison to financial results for prior periods. These non-GAAP financial measures should not be considered as a substitute for operating results determined in accordance with GAAP and may not be comparable to other similarly titled financial measures used by other companies. A reconciliation of these operating performance measures to GAAP performance measures is included in the table on page 48.
Results of Operations
United reported net income of $17.9 million for the third quarter of 2015. This compared to net income of $17.6 million for the same period in 2014. For the third quarter of 2015, diluted earnings per common share were $.27 compared to $.29 for the third quarter of 2014. For the nine months ended September 30, 2015, United reported net income of $53.4 million compared to net income of $49.4 million for the same period in 2014.
United reported net operating income of $21.7 million and $59.4 million, respectively, for the third quarter and the first nine months of 2015, compared to $17.6 million and $49.4 million, respectively, for the same periods in 2014. Operating earnings exclude the effects of merger-related charges, which, net of tax, totaled $3.84 million and $6.02 million, respectively, for the three and nine months ended September 30, 2015.
Table 1 - Financial Highlights
Selected Financial Information
(1) Excludes merger-related charges. (2)Net income available to common shareholders, which is net of preferred stock dividends, divided by average realized common equity, which excludes accumulated other comprehensive income (loss). (3) Excludes effect of acquisition related intangibles and associated amortization. (4) Annualized. (5) September 30, June 30 and March 31, 2015 calculated under Basel III rules, which became effective January 1, 2015.
Table 1 - Non-GAAP Performance Measures Reconciliation
(1) September 30, June 30 and March 31, 2015 calculated under Basel III rules, which became effective January 1, 2015.
Net Interest Revenue (Taxable Equivalent)
Net interest revenue (the difference between the interest earned on assets and the interest paid on deposits and borrowed funds) is the single largest component of total revenue. United actively manages its balance sheet to provide optimal levels of revenue while balancing interest rate, credit and liquidity risks. Taxable equivalent net interest revenue for the third quarter of 2015 was $65.7 million, up $8.75 million from the third quarter of 2014. The combination of growth in the loan portfolio and lower interest costs on deposits and borrowed funds were responsible for the increase in net interest revenue. United continues to focus on loan and deposit pricing in an effort to maintain a steady level of net interest revenue. The acquisition of Palmetto on September 1, 2015 and MoneyTree on May 1, 2015 also contributed to the increase as the acquired entities’ results are included in consolidated results beginning on the acquisition date.
While average loans increased $1.01 billion, or 23%, from the third quarter of last year, the yield on loans decreased 29 basis points, reflecting the continuing effect of the low interest rate environment and pricing competition for a limited number of quality lending opportunities. The lower loan yield also reflects a shift in new production toward more floating rate loans.
Average interest-earning assets for the third quarter of 2015 increased $1.19 billion, or 17%, from the third quarter of 2014, which was due primarily to the increase in loans, including the acquisition of Palmetto and MoneyTree loans. Average investment securities for the third quarter of 2015 increased $165 million from a year ago, partially due to the Palmetto acquisition. The average yield on the investment portfolio decreased 7 basis points from a year ago, partially due to lower yields on acquired securities.
Average interest-bearing liabilities of $5.67 billion for the third quarter of 2015 increased $645 million from the third quarter of 2014. Average noninterest bearing deposits increased $442 million from the third quarter of 2014 to $1.97 billion for the third quarter of 2015. The average cost of interest-bearing liabilities for the third quarter of 2015 was .38% compared to .50% for the same period of 2014, reflecting United’s concerted efforts to reduce its cost of funds. In the first nine months of 2015, United redeemed $49.2 million in higher-rate trust preferred securities, with rates ranging from 8.125% to 11.295%. In third quarter 2015, United issued $50 million of seven-year senior notes at 5% and $35 million of twelve-year senior notes at 5.5%. Also contributing to the overall lower rate on interest-bearing liabilities was a shift in the mix of deposits away from more expensive time deposits toward lower-rate transaction deposits.
The banking industry uses two ratios to measure relative profitability of net interest revenue. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. The interest rate spread eliminates the effect of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements. The net interest margin is an indication of the profitability of a company’s balance sheet, and is defined as net interest revenue as a percent of average total interest-earning assets, which includes the positive effect of funding a portion of interest-earning assets with customers’ non-interest-bearing deposits and stockholders’ equity.
For the third quarters of 2015 and 2014, the net interest spread was 3.15% and 3.19%, respectively, while the net interest margin was 3.26% and 3.32%, respectively. The decrease in both ratios reflects the impact of the continuing effect of the low interest rate environment and pricing competition for a limited number of quality lending opportunities.
For the first nine months of 2015, net interest revenue was $185 million, an increase of $18.6 million, or 11%, from the first nine months of 2014. Average earning assets increased $675 million, or 10%, during the first nine months of 2015, compared to the same period a year ago. The yield on earning assets decreased 7 basis points from 3.63% for the nine months ended September 30, 2014, to 3.56% for the nine months ended September 30, 2015, due to declining loan yields. The lower loan portfolio yield reflects competitive pricing pressure on new and renewed loans and a shift in loan mix to more floating rate loans. Investment yields increased 5 basis points for the first nine months of 2015 compared to the first nine months of 2014, which helped offset some of the decrease on loan yields. The rate on interest bearing liabilities over the same period decreased 13 basis points. The lower yield on interest earning assets was more than offset by the reduction in rates paid on interest bearing liabilities, resulting in the net interest margin increasing 4 basis points from the nine months ended September 30, 2014 to the nine months ended September 30, 2015.
The following table shows the relationship between interest revenue and expense, and the average amounts of interest-earning assets and interest-bearing liabilities for the three months ended September 30, 2015 and 2014.
Table 2 - Average Consolidated Balance Sheets and Net Interest Analysis
For the Three Months Ended September 30,
The following table shows the relationship between interest revenue and expense, and the average amounts of interest-earning assets and interest-bearing liabilities for the nine months ended September 30, 2015 and 2014.
Table 3 - Average Consolidated Balance Sheets and Net Interest Analysis
The following table shows the relative effect on net interest revenue for changes in the average outstanding amounts (volume) of interest-earning assets and interest-bearing liabilities and the rates earned and paid on such assets and liabilities (rate). Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category.
Table 4 - Change in Interest Revenue and Expense on a Taxable Equivalent Basis
(in thousands)
Provision for Credit Losses
The provision for credit losses is based on management’s evaluation of probable incurred losses in the loan portfolio and corresponding analysis of the allowance for credit losses at quarter-end. The provision for credit losses was $700,000 and $3.40 million, respectively, for the third quarter and first nine months of 2015, compared to $2.00 million and $6.70 million, respectively, for the same periods in 2014. The amount of provision recorded in each period was the amount required such that the total allowance for loan losses reflected the appropriate balance, in the estimation of management, sufficient to cover incurred losses in the loan portfolio. The third quarter and first nine months of 2015 loan loss provisions were lower than those for the comparable periods in 2014 due to overall improvement in portfolio credit quality. For the three and nine months ended September 30, 2015, net loan charge-offs as an annualized percentage of average outstanding loans were .10% and .13%, respectively, compared to .28% and .35%, respectively, for the same periods in 2014.
The allowance for unfunded commitments represents probable incurred losses on unfunded loan commitments that are expected to result in outstanding loan balances. The allowance for unfunded loan commitments was established through the provision for credit losses.
Additional discussion on credit quality and the allowance for loan losses is included in the “Asset Quality and Risk Elements” section of this report on page 56.
Fee Revenue
Fee revenue for the three and nine months ended September 30, 2015 was $18.3 million and $51.2 million, respectively, an increase of $3.89 million, or 27%, compared to the third quarter of 2014, and an increase of $10.5 million, or 26%, from the year-to-date period of 2014. The following table presents the components of fee revenue for the third quarters and first nine months of 2015 and 2014.
Table 5 - Fee Revenue
Overdraft fees of $3.3 million for the third quarter of 2015 were up $232,000, or 8%, from the third quarter of 2014. For the first nine months of 2015, overdraft fees of $8.63 million were down $304,000, or 3%, from the same period in 2014. Despite a slight increase in third quarter 2015 mostly due to the acquisitions, overdraft fees declined year over year as customer utilization of our courtesy overdraft services has decreased. ATM and debit card fees of $4.36 million in third quarter of 2015 and $12.2 million in the first nine months of 2015 increased from the comparable periods in 2014 due to growth in transaction volume.
Mortgage loans and related fees for the third quarter and first nine months of 2015 were up $1.66 million, or 76%, and $4.89 million, or 90%, respectively, from the same periods in 2014. The increase reflects United’s focus on growing the mortgage business by recruiting new mortgage lenders in key metropolitan markets and an increase in refinancing activity. In the third quarter of 2015, United closed 711 loans totaling $141 million compared with 492 loans totaling $84.2 million in the third quarter of 2014. Year-to-date mortgage production in 2015 amounted to 1,849 loans totaling $357 million, compared to 1,202 loans totaling $199 million for the same period in 2014. United had $80.1 million and $191 million, respectively, in home purchase mortgage originations in the third quarter and first nine months of 2015, compared with $53.0 million and $129 million, respectively, for the same periods a year ago. The volume of new purchase money mortgages in the third quarter was 62% compared with 63% in the third quarter of 2014.
Brokerage fees were approximately equal to the third quarter of 2014 and increased $352,000, or 10%, compared to the first nine months of 2014. The year-to-date increase reflects United’s continuing efforts to grow this line of business.
In the third quarter and first nine months of 2015, United realized $1.65 million and $4.28 million, respectively, in gains from the sales of the guaranteed portion of SBA and USDA loans. United has been actively growing its government guaranteed lending business with the hiring of new leadership and lenders who specialize in government guaranteed loan programs such as SBA and USDA loans. United’s SBA/USDA lending strategy includes selling a portion of the loan production each quarter. United began selling the guaranteed portion of loans in the second quarter of 2014. United retains the servicing rights on the sold loans and earns a fee for servicing the loans. In the third quarter and first nine months of 2015, United sold the guaranteed portion of loans in the amount of $17.8 million and $45.6 million, respectively, at prices ranging from 105% to 119% of par.
Customer derivative fees were up $239,000 from the third quarter of 2014 and $664,000 from the first nine months of 2014 due to an increase in customer demand for this product as commercial customers sought to lock in low fixed rates on their loans.
United realized net securities gains of $325,000 in the third quarter of 2015 compared with securities gains of $11,000 in the third quarter of 2014. For the first nine months of 2015 and 2014, net securities gains totaled $1.88 million and $4.66 million, respectively. In third quarter 2015, United incurred $256,000 in debt prepayment charges due to the redemption of $33.8 million in trust preferred securities. The securities had an average rate of approximately 8.5%. In the first nine months of 2015, United incurred $1.29 million in charges from the third quarter trust preferred redemption and the first quarter prepayment of $6 million in structured repurchase agreements that paid interest at a rate of 4% and $15 million in trust preferred securities that paid interest at an average rate in excess of 11%. The securities gains and prepayment charges in 2015 were mostly offsetting and were part of the same overall balance sheet management activities that were intended to lower the overall cost of wholesale borrowings going forward.
Other fee revenue of $1.79 million for the third quarter of 2015 was up $101,000, or 6%, from the third quarter of 2014, mostly due to gains from sales of closed branch facilities. For the first nine months of 2015, other fee revenue of $5.46 million was up $949,000, or 21%, from the same period in 2014, primarily due to volume driven increases in income from bank owned life insurance policies and an incentive payment from United’s merchant services vendor, combined with the same factors mentioned for the quarterly increase.
Operating Expenses
The following table presents the components of operating expenses for the three and nine months ended September 30, 2015 and 2014.
Table 6 - Operating Expenses
Operating expenses for the third quarter of 2015 totaled $54.3 million, up $12.9 million, or 31%, from the third quarter of 2014. The increase mostly reflects the inclusion of the operating expenses of the two acquired banks from their respective acquisition dates, higher salaries and employee benefits expense resulting from investing in specialized lending areas and other strategic hiring and merger-related charges related to the acquisition of Palmetto. For the nine months ended September 30, 2015, operating expenses totaled $146 million, an increase of $24.8 million, or 21%, from the same period in 2014, primarily due to the inclusion of the operating expenses of the two acquired banks from their respective acquisition dates, higher salaries and employee benefits expense resulting from investing in specialized lending areas and other strategic hiring, merger-related charges, charges to terminate and settle the loss sharing agreements with the FDIC related to United’s 2009 acquisition of Southern Community Bank and a loss on a fraudulent home equity line of credit transaction.
Salaries and employee benefits for the third quarter of 2015 were $29.3 million, up $3.68 million, or 14%, from the third quarter of 2014. The increase was due to a number of factors including investments in additional staff and new teams to expand specialized lending and new talent in other key areas, additional staff resulting from the Palmetto and MoneyTree acquisitions, higher incentives due to increased loan production and obtaining higher earnings performance targets. For the first nine months of 2015, salaries and employee benefits of $83.7 million were up $9.4 million, or 13%, from the first nine months of 2014. Headcount totaled 1,927 at September 30, 2015, up 412 from 1,515 at September 30, 2014, with 336 coming from the Palmetto and MoneyTree acquisitions.
Professional fees for the third quarter of 2015 of $2.67 million were up $394,000, or 17%, from the third quarter of 2014. For the nine months ended September 30, 2015, professional fees of $6.84 million were up $971,000, or 17%. The increase was due primarily to higher legal and consulting fees relating to projects that are in process.
Merger-related charges in third quarter 2015 of $5.74 million mostly related to the Palmetto acquisition and consisted primarily of severance, conversion costs, and legal and professional fees. Merger-related charges for the first nine months of 2015 also included costs related to the MoneyTree acquisition.
Other expense of $4.83 million for the third quarter of 2015 increased $1.14 million, or 31%, from the third quarter of 2014. Year-to-date, other expense of $14.3 million increased $3.08 million, or 27%, from the first nine months of 2014. The increase from the third quarter of 2014 is due to higher lending support costs due to increased lending activity, higher ATM and internet banking costs due to higher volume, and higher servicing costs on United’s indirect auto loan portfolio due to growth in that portfolio. The increase from the first nine months of 2014 is mostly due to a $690,000 charge to terminate and settle the loss sharing agreements with the FDIC related to United’s 2009 acquisition of Southern Community Bank and a $420,000 loss on a fraudulent home equity line of credit transaction in addition to the reasons given for the third quarter increase. Other expense in the first nine months of 2015 was also elevated due to higher travel and entertainment costs associated with the increase in lending activity.
Income Taxes
The income tax provision for the third quarter and first nine months of 2015 was $10.9 million and $32.4 million, respectively, as compared with $9.99 million and $28.7 million, respectively, for the same periods in 2014. The income tax provision represents an effective tax rate of 37.8% for each period of 2015 and 36.2% and 36.7%, respectively, for each period of 2014. At September 30, 2015, December 31, 2014 and September 30, 2014, United maintained a valuation allowance on its net deferred tax asset of $4.58 million, $4.12 million and $4.45 million, respectively. Management assesses the valuation allowance recorded against its net deferred tax asset at each reporting period. The determination of whether a valuation allowance for its net deferred tax asset is appropriate is subject to considerable judgment and requires an evaluation of all the positive and negative evidence.
The valuation allowance could fluctuate in future periods based on the assessment of the positive and negative evidence. Management's conclusion at September 30, 2015 that it was more likely than not that United’s net deferred tax asset of $197 million will be realized is based upon management’s estimate of future taxable income. Management’s estimate of future taxable income is based on internal forecasts that consider historical performance, various internal estimates and assumptions, as well as certain external data all of which management believes to be reasonable although inherently subject to significant judgment. If actual results differ significantly from the current estimates of future taxable income, the valuation allowance may need to be increased for some or all of its net deferred tax asset. Such an increase to the net deferred tax asset valuation allowance could have a material adverse effect on United’s financial condition and results of operations.
Additional information regarding income taxes, including a reconciliation of the differences between the recorded income tax provision and the amount of income tax computed by applying the statutory federal income tax rate to income before income taxes, can be found in Note 16 to the consolidated financial statements filed with United’s Annual Report on Form 10-K for the year ended December 31, 2014.
Balance Sheet Review
Total assets at September 30, 2015, December 31, 2014 and September 30, 2014 were $9.41 billion, $7.57 billion and $7.53 billion, respectively. Average total assets for the third quarter of 2015 were $8.63 billion, up from $7.37 billion in the third quarter of 2014.
The following table presents a summary of the loan portfolio.
Substantially all of United’s loans are to customers located in the immediate market areas of its community banks in Georgia, North Carolina, South Carolina and Tennessee, including customers who have a seasonal residence in United’s market areas. More than 76% of the loans are secured by real estate. In 2014, loan growth began to return to pre-crisis levels reflecting United’s specialized lending initiatives which resulted in increases in commercial lending. Consumer installment loans also increased due to purchases of indirect auto loans. Total loans averaged $5.46 billion in the third quarter of 2015, compared with $4.45 billion in the third quarter of 2014, an increase of 23%. At September 30, 2015, total loans were $6.02 billion, an increase of $1.45 billion, or 32%, from September 30, 2014.
Asset Quality and Risk Elements
United manages asset quality and controls credit risk through review and oversight of the loan portfolio as well as adherence to policies designed to promote sound underwriting and loan monitoring practices. United’s credit administration function is responsible for monitoring asset quality and Board of Directors approved portfolio limits, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures among all of the community banks. Additional information on the credit administration function is included in Item 1 under the heading Loan Review and Nonperforming Assets in United’s Annual Report on Form 10-K for the year ended December 31, 2014.
United classifies performing loans as “substandard” when there is a well-defined weakness or weaknesses that jeopardizes the repayment by the borrower and there is a distinct possibility that United could sustain some loss if the deficiency is not corrected.
United’s home equity lines generally require the payment of interest only for a set period after origination. After this initial period, the outstanding balance begins amortizing and requires the payment of both principal and interest. At September 30, 2015, December 31, 2014 and September 30, 2014, the funded portion of home equity lines totaled $585 million, $466 million and $459 million, respectively. Approximately 3% of the home equity lines at September 30, 2015 were amortizing. Of the $585 million in balances outstanding at September 30, 2015, $402 million, or 69%, were secured by first liens. At September 30, 2015, 58% of the total available home equity lines were drawn upon.
United monitors the performance of its home equity loans and lines secured by second liens similar to other consumer loans and utilizes assumptions specific to these loans in determining the necessary allowance. United also receives notification when the first lien holder is in the process of foreclosure and upon that notification, United obtains valuations to determine if any additional charge-offs or reserves are warranted.
The table below presents performing substandard loans for the last five quarters.
Table 8 - Performing Substandard Loans
At September 30, 2015, performing substandard loans totaled $136 million and increased $20.3 million from the prior quarter-end, and decreased $12.9 million from a year ago. Performing substandard loans have been on a downward trend as credit conditions continue to improve and problem credits are resolved. The increase in the third quarter of 2015 was due to the acquisition of Palmetto.
Reviews of substandard performing and non-performing loans, troubled debt restructurings (“TDRs”), past due loans and larger credits are conducted on a regular basis and are designed to identify risk migration and potential charges to the allowance for loan losses. These reviews are presented by the responsible lending officers and specific action plans are discussed along with the financial strength of borrowers, the value of the applicable collateral, past loan loss experience, anticipated loan losses, changes in risk profile, the effect of prevailing economic conditions on the borrower and other factors specific to the borrower and its industry. In addition to United’s internal loan review, United also uses external loan review to ensure the independence of the loan review process.
The following table presents a summary of the changes in the allowance for credit losses for the three and nine months ended September 30, 2015 and 2014.
Table 9 - Allowance for Credit Losses
(1) Excludes loans covered by loss sharing agreements with the FDIC
The provision for credit losses charged to earnings is based upon management’s judgment of the amount necessary to maintain the allowance at a level appropriate to absorb probable incurred losses in the loan portfolio at the balance sheet date. The amount each quarter is dependent upon many factors, including growth and changes in the composition of the loan portfolio, net charge-offs, delinquencies, management’s assessment of loan portfolio quality, the value of collateral, and other macro-economic factors and trends. The evaluation of these factors is performed quarterly by management through an analysis of the appropriateness of the allowance for loan losses. The decreases in the provision and the declining level of the allowance for loan losses compared to the previous periods reflects stabilizing trends in substandard and nonperforming loans as well as charge-off levels. Further, the declining balance of the allowance for loan losses over the last several quarters reflects an overall improving trend in the credit quality of the loan portfolio. A general improvement in economic conditions in United’s market also contributed to the lower level of provision and allowance for loan losses.
The allowance for credit losses, which includes a portion related to unfunded commitments, totaled $72.0 million at September 30, 2015, compared with $73.5 million at December 31, 2014, and $74.3 million at September 30, 2014. At September 30, 2015, the allowance for loan losses was $69.1 million, or 1.15% of loans, compared with $71.6 million, or 1.53% of total loans, at December 31, 2014 and $71.9 million, or 1.57% of loans, at September 30, 2014. Excluding acquired loans, the allowance for loan losses as a percentage of loans at September 30, 2015 was 1.37%.
In accordance with the accounting guidance for business combinations, there was no allowance for loan losses brought forward on loans acquired from Palmetto or MoneyTree, as credit deterioration was included in the determination of fair value at acquisition date. At September 30, 2015, United recorded no allowance for loan losses on loans acquired from Palmetto or FNB as there was no evidence of credit deterioration beyond that which was incorporated into the determination of fair value at acquisition date. At September 30, 2015, for acquired loans that had no evidence of credit deterioration at the time of acquisition, the remaining unaccreted fair value discount was $7.71 million.
Management believes that the allowance for credit losses at September 30, 2015 reflects the probable incurred losses in the loan portfolio and unfunded loan commitments. This assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for credit losses cannot be determined with certainty and may be subject to change in future periods. The amount of any changes could be significant if management’s assessment of loan quality or collateral values change substantially with respect to one or more loan relationships or portfolios. In addition, bank regulatory authorities, as part of their periodic examination of the Bank, may require adjustments to the provision for credit losses in future periods if, in their opinion, the results of their review warrant such additions. See the “Critical Accounting Policies” section for additional information on the allowance for loan losses.
Nonperforming Assets
The table below summarizes nonperforming assets.
Table 10 - Nonperforming Assets
At September 30, 2015, nonperforming loans were $20.1 million compared to $17.9 million at December 31, 2014 and $18.7 million at September 30, 2014. Nonperforming assets, which include nonperforming loans and foreclosed real estate, totaled $27.7 million at September 30, 2015 compared with $19.6 million at December 31, 2014 and $21.9 million at September 30, 2014. United sold $1.92 million of foreclosed properties and added $1.90 million in new foreclosures during the third quarter of 2015.
United’s policy is to place loans on nonaccrual status when, in the opinion of management, the principal and interest on a loan is not likely to be repaid in accordance with the loan terms or when the loan becomes 90 days past due and is not well secured and in the process of collection. When a loan is classified on nonaccrual status, interest previously accrued but not collected is reversed against current interest revenue. Principal and interest payments received on a nonaccrual loan are applied to reduce outstanding principal.
The following table summarizes nonperforming assets by category and market.
Table 11 - Nonperforming Assets by Quarter
At September 30, 2015, December 31, 2014, and September 30, 2014, United had $88.7 million, $85.1 million and $88.6 million, respectively, in loans with terms that have been modified in TDRs. Included therein were $4.15 million, $3.78 million and $6.4 million, respectively, of TDRs that were not performing in accordance with their modified terms and were included in nonperforming loans. The remaining TDRs with an aggregate balance of $84.5 million, $81.3 million and $82.2 million, respectively, were performing according to their modified terms and are therefore not considered to be nonperforming assets.
At September 30, 2015, December 31, 2014 and September 30, 2014, there were $108 million, $106 million and $109 million, respectively, of loans classified as impaired under the definition outlined in the Accounting Standards Codification, including TDRs which are by definition considered impaired. Included in impaired loans at September 30, 2015, December 31, 2014 and September 30, 2014 was $30.7 million, $25.5 million and $26.9 million, respectively, that did not require specific reserves or had previously been charged down to net realizable value. The balance of impaired loans at September 30, 2015, December 31, 2014 and September 30, 2014 of $76.9 million, $81.0 million and $82.1 million, respectively, had specific reserves that totaled $6.18 million, $9.88 million and $10.3 million, respectively. The average recorded investment in impaired loans for the third quarters of 2015 and 2014 was $108 million and $110 million, respectively. For the nine months ended September 30, 2015 and 2014, the average recorded investment in impaired loans was $108 million and $109 million, respectively. For the three and nine months ended September 30, 2015, United recognized $1.28 million and $3.76 million, respectively, in interest revenue on impaired loans compared to $1.27 million and $3.77 million, respectively, for the same periods of the prior year. United’s policy is to discontinue the recognition of interest revenue for loans classified as impaired under ASC 310-10-35, Receivables, when a loan meets the criteria for nonaccrual status.
The table below summarizes activity in nonperforming assets.
Table 12 - Activity in Nonperforming Assets
Foreclosed property is initially recorded at fair value, less estimated costs to sell. If the fair value, less estimated costs to sell at the time of foreclosure, is less than the loan balance, the deficiency is charged against the allowance for loan losses. If the lesser of fair value, less estimated costs to sell or the listed selling price, less the costs to sell, of the foreclosed property decreases during the holding period, a valuation allowance is established with a charge to foreclosed property expense. When the foreclosed property is sold, a gain or loss is recognized on the sale for the difference between the sales proceeds and the carrying amount of the property. Financed sales of foreclosed property are accounted for in accordance with ASC 360-20, Real Estate Sales. For the third quarter of 2015, United transferred $1.90 million of loans into foreclosed property through foreclosures. During the same period, proceeds from sales of foreclosed property were $1.92 million, which includes $166,000 in sales that were financed by United.
Investment Securities
The composition of the investment securities portfolio reflects United’s investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of revenue. The investment securities portfolio also provides a balance to interest rate risk and credit risk in other categories of the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits and borrowings, including repurchase agreements. Total investment securities at September 30, 2015 increased $235 million from a year ago.
At September 30, 2015, December 31, 2014 and September 30, 2014, United had securities held-to-maturity with a carrying amount of $358 million, $415 million, and $432 million, respectively, and securities available-for-sale totaling $2.10 billion, $1.78 billion, and $1.79 billion, respectively. At September 30, 2015, December 31, 2014 and September 30, 2014, the securities portfolio represented approximately 26%, 29% and 30%, respectively, of total assets.
The investment securities portfolio primarily consists of U.S. Treasury securities, U.S. government agency securities, U.S. government sponsored agency mortgage-backed securities, non-agency mortgage-backed securities, corporate securities, municipal securities and asset-backed securities. Mortgage-backed securities rely on the underlying pools of mortgage loans to provide a cash flow of principal and interest. The actual maturities of these securities will usually differ from contractual maturities because loans underlying the securities can prepay. Decreases in interest rates will generally cause an acceleration of prepayment levels. In a declining or prolonged low interest rate environment, United may not be able to reinvest the proceeds from these prepayments in assets that have comparable yields. In a rising rate environment, the opposite occurs - prepayments tend to slow and the weighted average life extends. This is referred to as extension risk which can lead to lower levels of liquidity due to the delay of cash receipts and can result in the holding of a below market yielding asset for a longer period of time. United’s asset-backed securities include securities that are backed by student loans and collateralized loan obligations.
Management evaluates its securities portfolio each quarter to determine if any security is considered to be other than temporarily impaired. In making this evaluation, management considers its ability and intent to hold securities to recover current market losses. Losses on United’s fixed income securities at September 30, 2015 primarily reflect the effect of changes in interest rates. United did not recognize any other than temporary impairment losses on its investment securities during the third quarter or first nine months of 2015 or 2014.
At September 30, 2015, December 31, 2014 and September 30, 2014, 27%, 31% and 31%, respectively, of the securities portfolio was invested in floating-rate securities or fixed-rate securities that were swapped to floating rates in order to manage exposure to rising interest rates.
Goodwill and Core Deposit Intangibles
Goodwill represents the premium paid for acquired companies above the fair value of the assets acquired and liabilities assumed, including separately identifiable intangible assets.
United’s core deposit intangibles, representing the value of United’s acquired deposit relationships, are amortizing intangible assets that are required to be tested for impairment only when events or circumstances indicate that impairment may exist. There were no events or circumstances that led management to believe that any impairment exists in United’s goodwill or other intangible assets.
Deposits
United has initiated several programs to improve core earnings by growing customer transaction deposit accounts and lowering overall pricing on deposit accounts. The programs were successful in increasing core transaction deposit accounts and allowing for the reduction of more costly time deposit balances. United’s high level of service, as evidenced by its strong customer satisfaction scores, has been instrumental in attracting and retaining deposits.
Total customer deposits, excluding brokered deposits, as of September 30, 2015 were $7.39 billion, an increase of $1.55 billion from September 30, 2014, of which $1.34 billion was attributable to the Palmetto and MoneyTree acquisitions. Total core deposits (demand, NOW, money market and savings deposits, excluding public funds deposits) of $5.25 billion at September 30, 2015 increased $1.53 billion, or 41%, from a year ago, due to the acquisition of Palmetto and MoneyTree, as well as the success of core deposit programs and general industry trends.
Total time deposits, excluding brokered deposits, as of September 30, 2015 were $1.35 billion, up $42.3 million from September 30, 2014. Time deposits less than $100,000 totaled $865 million at September 30, 2015, an increase of $91.2 million, or 12%, from a year ago. Time deposits of $100,000 and greater totaled $483 million as of September 30, 2015, a decrease of $48.9 million, or 9%, from September 30, 2014. The overall increase in time deposits, excluding brokered deposits, was primarily due the Palmetto acquisition, offset by United’s continued efforts to offer low rates on certificates of deposit, allowing balances to decline as United’s funding needs were met by growth in lower cost transaction account deposits and other sources.
Brokered deposits totaled $517 million as of September 30, 2015, an increase of $111 million from a year ago. United has actively added long-term deposits to diversify our funding base. These are typically swapped to LIBOR minus a spread, which achieves low cost funding within our interest rate risk parameters.
Wholesale Funding
The Bank is a shareholder in the Federal Home Loan Bank of Atlanta (“FHLB”). Through this affiliation, FHLB secured advances totaled $200 million, $270 million and $330 million, respectively, as of September 30, 2015, December 31, 2014 and September 30, 2014. United anticipates continued use of this short and long-term source of funds. Additional information regarding FHLB advances is provided in Note 12 to the consolidated financial statements included in United’s Annual Report on Form 10-K for the year ended December 31, 2014.
At December 31, 2014 and September 30, 2014, United had $6.0 million in structured repurchase agreements outstanding. United repaid the remaining $6.0 million outstanding balance in the first quarter of 2015, incurring a charge of $540,000. United takes advantage of these additional sources of liquidity when rates are favorable compared to other forms of short-term borrowings, such as FHLB advances and brokered deposits.
Contractual Obligations
There have not been any material changes to United’s contractual obligations since December 31, 2014.
Off-Balance Sheet Arrangements
United is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of customers. These financial instruments include commitments to extend credit, letters of credit and financial guarantees.
A commitment to extend credit is an agreement to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Letters of credit and financial guarantees are conditional commitments issued to guarantee a customer’s performance to a third party and have essentially the same credit risk as extending loan facilities to customers. Those commitments are primarily issued to local businesses.
The exposure to credit loss in the event of nonperformance by the other party to the commitments to extend credit, letters of credit and financial guarantees is represented by the contractual amount of these instruments. United uses the same credit underwriting procedures for making commitments, letters of credit and financial guarantees, as it uses for underwriting on-balance sheet instruments. United evaluates each customer’s creditworthiness on a case-by-case basis and the amount of the collateral, if deemed necessary, is based on the credit evaluation. Collateral held varies, but may include unimproved and improved real estate, certificates of deposit, personal property or other acceptable collateral.
All of these instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The total amount of these instruments does not necessarily represent future cash requirements because a significant portion of these instruments expire without being used. United is not involved in off-balance sheet contractual relationships, other than those disclosed in this report, that could result in liquidity needs or other commitments, or that could significantly affect earnings. See Note 15 to the consolidated financial statements for additional information on off-balance sheet arrangements.
Interest Rate Sensitivity Management
The absolute level and volatility of interest rates can have a significant effect 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 limits its exposure to fluctuations in interest rates through policies developed by the Asset/Liability Management Committee (“ALCO”) and approved by the Board of Directors. ALCO meets periodically and has responsibility for formulating and recommending asset/liability management policies to the Board of Directors, formulating and implementing strategies to improve balance sheet positioning and/or earnings, and reviewing United’s interest rate sensitivity.
One of the tools management uses to estimate and manage the sensitivity of net interest revenue to changes in interest rates is an asset/liability simulation model. Resulting estimates are based upon a number of assumptions for each scenario, including loan and deposit re-pricing characteristics and the rate of prepayments. ALCO periodically reviews the assumptions for accuracy based on historical data and future expectations; however, actual net interest revenue may differ from model results. The primary objective of the simulation model is to measure the potential change in net interest revenue over time using multiple interest rate scenarios. The base scenario assumes rates remain flat and is the scenario to which all others are compared in order to measure the change in net interest revenue. Policy limits are based on immediate rate shock scenarios, as well as gradually rising and falling rate scenarios, which are all compared to the base scenario. Another commonly analyzed scenario is a most-likely scenario that projects the expected change in rates based on the slope of the forward yield curve. Other scenarios analyzed may include delayed rate shocks, yield curve steepening or flattening, or other variations in rate movements. While the primary policy scenarios focus on a twelve month time frame, longer time horizons are also modeled.
United’s policy is based on the 12-month impact on net interest revenue of interest rate shocks and ramps that increase or decrease from 100 to 400 basis points from the base scenario. In the shock scenarios, rates immediately change the full amount at the scenario onset. In the ramp scenarios, rates change by 25 basis points per month. United’s policy limits the projected change in net interest revenue over the first 12 months to a 5% decrease for each 100 basis point change in the increasing and decreasing rate ramp and shock scenarios. Historically low rates on September 30, 2015 and 2014 made use of the down scenarios irrelevant. The following table presents United’s interest sensitivity position at September 30, 2015 and 2014.
Table 13 - Interest Sensitivity
Interest rate sensitivity is a function of the re-pricing characteristics of the portfolio of assets and liabilities. These re-pricing 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, re-pricing or maturity during the life of the instruments. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their re-pricing 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 on a net basis within an acceptable timeframe, thereby minimizing the adverse effect of interest rate changes on net interest revenue.
United may have some discretion in the extent and timing of deposit re-pricing depending upon the competitive pressures in the markets in which it operates. 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 re-pricing for both the asset and the liability remains the same, due to the two instruments re-pricing according to different indices. This is commonly referred to as basis risk.
In order to manage interest rate sensitivity, United periodically enters into off-balance sheet contracts that are considered derivative financial instruments. Derivative financial instruments can be a cost-effective and capital-effective means of modifying the re-pricing characteristics of on-balance sheet assets and liabilities. These contracts generally consist of interest rate swaps under which United pays a variable rate (or fixed rate, as the case may be) and receives a fixed rate (or variable rate, as the case may be).
United’s derivative financial instruments that are designated as accounting hedges are classified as either cash flow or fair value hedges. The change in fair value of cash flow hedges is recognized in other comprehensive income. Fair value hedges recognize in earnings both the effect of the change in the fair value of the derivative financial instrument and the offsetting effect of the change in fair value of the hedged asset or liability associated with the particular risk of that asset or liability being hedged. United has other derivative financial instruments that are not designated as accounting hedges but are used for interest rate risk management purposes and as an effective economic hedge. Derivative financial instruments that are not accounted for as an accounting hedge are recorded at fair value, with subsequent changes in value recorded through earnings.
In addition to derivative instruments, United uses a variety of balance sheet instruments to manage interest rate risk such as Investment Portfolio holdings, wholesale funding, and bank-issued deposits.
From time to time, United will terminate derivative positions when conditions change and the position is no longer necessary to manage United’s overall sensitivity to changes in interest rates. In those situations where the terminated contract was in an effective hedging relationship at the time of termination and the hedging relationship is expected to remain effective throughout the original term of the contract, the resulting gain or loss is amortized over the remaining life of the original contract. For swap contracts, the gain or loss is amortized over the remaining original contract term using the straight line method of amortization. United expects that $1.93 million will be reclassified as an increase to interest expense from other comprehensive income over the next twelve months related to these terminated cash flow hedges.
United’s policy requires all non-customer facing derivative financial instruments be used only for asset/liability management through the hedging of specific transactions or positions, and not for trading or speculative purposes. Management believes that the risk associated with using derivative financial instruments to mitigate interest rate risk sensitivity is minimal and should not have any material effect on our financial condition or results of operations. In order to mitigate potential credit risk, from time to time United may require the counterparties to derivative contracts to pledge securities as collateral to cover the net exposure.
Liquidity Management
The objective of liquidity management is to ensure that sufficient funding is available, at a reasonable cost, to meet ongoing operational cash needs and to take advantage of revenue producing opportunities as they arise. While the desired level of liquidity will vary depending upon a variety of factors, it is the primary goal of United to maintain a sufficient level of liquidity in all expected economic environments. To assist in determining the adequacy of its liquidity, United performs a variety of liquidity stress tests including idiosyncratic, systemic and combined scenarios for both moderate and severe events. Liquidity is defined as the ability to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining the ability to meet the daily cash flow requirements of customers, both depositors and borrowers. United maintains an unencumbered liquid asset reserve to ensure its ability to meet its obligations. The size of the reserve is determined through severe liquidity stress testing and covers a 30 day period.
The asset portion of the balance sheet provides liquidity primarily through loan principal repayments and the maturities and sales of securities, as well as the ability to use these as collateral for borrowings on a secured basis. We also maintain excess funds in short-term interest-bearing assets that provide additional liquidity. Mortgage loans held for sale totaled $23.1 million at September 30, 2015, and typically turn over every 45 days as the closed loans are sold to investors in the secondary market.
The liability section of the balance sheet provides liquidity through interest-bearing and noninterest-bearing deposit accounts. Federal funds purchased, Federal Reserve short-term borrowings, FHLB advances and securities sold under agreements to repurchase are additional sources of liquidity and represent United’s incremental borrowing capacity. These sources of liquidity are generally short-term in nature and are used as necessary to fund asset growth and meet other short-term liquidity needs.
At September 30, 2015, United had cash and cash equivalent balances of $207 million and had sufficient qualifying collateral to increase FHLB advances by $1.20 billion and Federal Reserve discount window borrowing capacity of $866 million. United also has the ability to raise substantial funds through brokered deposits. In addition to these wholesale sources, United has the ability to attract retail deposits by competing more aggressively on pricing.
As disclosed in United’s consolidated statement of cash flows, net cash provided by operating activities was $103 million for the nine months ended September 30, 2015. The net income of $53.4 million for the nine month period included the deferred income tax expense of $28.5 million, and non-cash expenses for the following: provision for credit losses of $3.40 million, depreciation, amortization and accretion of $16.8 million and stock-based compensation expense of $3.34 million. Additional sources of cash included a decrease in other assets and accrued interest receivable of $4.23 million and an increase in accrued expenses and other liabilities of $4.19 million. These sources of cash from operating activities were offset by an increase in mortgage loans held for sale of $5.56 million. Net cash used in investing activities of $225 million consisted primarily of a $325 million net increase in loans and purchases of investment securities totaling $477 million. These uses of cash were partially offset by $57.7 million in proceeds from maturities and calls of investment securities held-to-maturity, $275 million in proceeds from the sale of investment securities available-for-sale, $212 million in proceeds from maturities and calls of investment securities available-for-sale and $35.5 million in net cash received in the acquisitions. Net cash provided by financing activities of $136 million consisted primarily of a net increase in deposits of $219 million and proceeds from issuance of senior debt of $84.1 million partially offset by a net decrease in FHLB advances of $92.1 million, $48.5 million in payments to redeem trust preferred securities and $10.5 million in dividends to common shareholders. In the opinion of management, United’s liquidity position at September 30, 2015, was sufficient to meet its expected cash flow requirements.
In addition, because United’s holding company is a separate entity and apart from the Bank, it must provide for its own liquidity. United’s holding company is responsible for the payment of dividends declared for its common and preferred shareholders, and interest and principal on any outstanding debt or trust preferred securities. United’s holding company currently has internal capital resources to meet these obligations. While United’s holding company has access to the capital markets, the ultimate source of holding company liquidity is subsidiary service fees and dividends from the Bank, which are limited by applicable law and regulations.
Capital Resources and Dividends
Shareholders’ equity at September 30, 2015 was $1.01 billion, an increase of $274 million from December 31, 2014 due to the issuance of stock for the acquisitions of Palmetto and MoneyTree, year-to-date earnings less dividends declared, and an increase in the value of available-for-sale securities. Accumulated other comprehensive loss, which includes unrealized gains and losses on securities available-for-sale, the unrealized gains and losses on derivatives qualifying as cash flow hedges and unamortized prior service cost and actuarial gains and losses on United’s modified retirement plan, is excluded in the calculation of regulatory capital adequacy ratios.
The Board of Governors of the Federal Reserve System and the FDIC have approved final rules implementing the Basel III Capital Rules establishing a new comprehensive capital framework applicable to all depository institutions, bank holding companies with total consolidated assets of $500 million of more and all savings and loan holding companies except for those that are substantially engaged in insurance underwriting or commercial activities. Under the Basel III Capital Rules, minimum requirements have increased for both the quantity and quality of capital held by United. The Basel III Capital Rules include a new common equity Tier 1 capital to risk-weighted assets minimum ratio of 4.5% and, for prompt corrective action purposes, a “well capitalized” ratio of 6.5%, raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0%, require a minimum ratio of Total Capital to risk-weighted assets of 8.0%, and require a minimum Tier 1 leverage ratio of 4.0%. A new capital conservation buffer, comprised of common equity Tier 1 capital, is also established above the regulatory minimum capital requirements. This capital conservation buffer will be phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increase each subsequent year by an additional 0.625% until reaching its final level of 2.5% on January 1, 2019. Strict eligibility criteria for regulatory capital instruments were also implemented under the Basel III Capital Rules. The Basel III Capital Rules also revise the definition and calculation of Tier 1 capital, Total Capital, and risk-weighted assets.
The Basel III Capital Rules became effective for United on January 1, 2015 subject to a phase in period. The following table shows United’s capital ratios, as calculated under applicable regulatory guidelines, at September 30, 2015, December 31, 2014 and September 30, 2014. As of September 30, 2015, United’s capital levels remained characterized as “well-capitalized” under the Basel III Capital Rules based on the rules in effect at the time.
Table 14 - Capital Ratios
(dollars in thousands)
The Basel III guidelines for risk-based capital became effective January 1, 2015. The capital ratios shown above as of September 30, 2015 were calculated under the Basel III guidelines. Capital ratios for all other periods were calculated using the existing Basel I guidelines that were in effect at the time.
United’s common stock trades on the Nasdaq Global Select Market under the symbol “UCBI”. Below is a quarterly schedule of high, low and closing stock prices and average daily volume for 2015 and 2014.
Table 15 - Stock Price Information
Effect 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 effect on the growth of total assets and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio.
United’s management believes the effect of inflation on financial results depends on United's ability to react to changes in interest rates, and by such reaction, reduce the inflationary effect on performance. United has an asset/liability management program to manage interest rate sensitivity. In addition, periodic reviews of banking services and products are conducted to adjust pricing in view of current and expected costs.
There have been no material changes in United’s quantitative and qualitative disclosures about market risk as of September 30, 2015 from that presented in the Annual Report on Form 10-K for the year ended December 31, 2014. The interest rate sensitivity position at September 30, 2015 is included in management’s discussion and analysis on page 64 of this report.
United’s management, including the Chief Executive Officer and Chief Financial Officer, supervised and participated in an evaluation of United’s disclosure controls and procedures as of September 30, 2015. Based on, and as of the date of that evaluation, United’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective in accumulating and communicating information to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures of that information under the SEC’s rules and forms and that the disclosure controls and procedures are designed to ensure that the information required to be disclosed in reports that are filed or submitted by United under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
There were no significant changes in the internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.
In the ordinary course of operations, United and the Bank are defendants in various legal proceedings. Additionally, in the ordinary course of business, United and the Bank are subject to regulatory examinations and investigations. Based on our current knowledge and advice of counsel, in the opinion of management there is no such pending or threatened legal matter which would result in a material adverse change in the consolidated financial condition or results of operations of United.
There have been no material changes from the risk factors previously disclosed in United’s Annual Report on Form 10-K for the year ended December 31, 2014.
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
Senior Vice President and
Chief Accounting Officer