United Community Banks, Inc. — Q2 2018 Form 10-Q
Business context and period. The unaudited filing covers the quarter and six months ended June 30, 2018. United is a Georgia-based bank holding company operating through United Community Bank, with 150 locations in Georgia, South Carolina, North Carolina and Tennessee. Results include NLFC/Navitas from its February 1, 2018 acquisition; United also completed acquisitions of Four Oaks in November 2017 and HCSB in July 2017. Unless noted, amounts below are in millions.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Total revenue | $130.0 | $108.0 | $251.9 | $212.9 |
| Net interest revenue | $108.5 | $85.1 | $211.8 | $168.7 |
| Provision for credit losses | $1.8 | $0.8 | $5.6 | $1.6 |
| Noninterest income | $23.3 | $23.7 | $45.7 | $45.8 |
| Noninterest expenses | $76.9 | $63.2 | $150.3 | $126.1 |
| Net income | $39.6 | $28.3 | $77.3 | $51.8 |
| Diluted EPS | $0.49 | $0.39 | $0.97 | $0.72 |
| Net interest margin, fully taxable equivalent | 3.90% | 3.47% | 3.85% | 3.46% |
- Q2 revenue increased 20% and net income increased 40% year over year; first-half revenue rose 18% and net income rose 49%. Management-reported operating net income, a non-GAAP measure excluding specified charges and tax items, was $42.4 million for Q2 and $82.1 million for the first half.
- Net interest revenue growth reflected acquired and organic loan growth and a wider margin. Q2 average loans increased 17% year over year; management attributed margin expansion to higher rates on floating-rate assets and a more favorable earning-asset mix. The average cost of interest-bearing liabilities also increased.
- At June 30, total assets were $12.39 billion, loans $8.22 billion, deposits $9.97 billion and shareholders’ equity $1.38 billion. Loans increased $485 million from year-end, including $359 million from NLFC. Total deposits rose $158 million from year-end.
- Cash and cash equivalents were $316.4 million. First-half operating cash flow was $116.4 million, investing cash outflow $123.8 million and financing cash inflow $9.5 million. Investing outflows included $56.8 million net cash paid for acquisitions and $117.5 million net loan growth; financing included $98.2 million net proceeds from subordinated debt issuance.
- Long-term debt was $308.4 million, up from $120.5 million at year-end, including $100 million of subordinated notes issued in January and securitized notes assumed with NLFC. FHLB advances were $560 million. Regulatory capital ratios remained above the stated “well-capitalized” thresholds: consolidated CET1 11.60%, total capital 13.83% and leverage 9.31%.
- GAAP efficiency ratio was 57.94% for Q2 and 57.89% for the first half. Operating efficiency ratio was 55.77% and 55.76%, respectively; operating measures are non-GAAP.
Material changes and asset quality
- Interest expense rose to $13.7 million in Q2 from $8.0 million, as deposit and borrowing costs increased. The rate paid on average interest-bearing liabilities was 0.74% versus 0.48% in Q2 2017.
- Noninterest expenses increased 22% in Q2 and 19% in the first half, principally reflecting acquisitions, additional staffing and expansion of commercial banking teams. Salaries and benefits rose 21% in Q2; full-time-equivalent headcount was 2,289 versus 1,928 a year earlier.
- Service charges and fees fell 18% in Q2, mainly due to lower debit-card interchange fees following the Durbin Amendment. Mortgage fees increased 10% in Q2, while first-half brokerage fees fell 19%, partly due to a first-quarter transition to a new third-party broker-dealer.
- Nonperforming assets were $24.4 million, or 0.20% of assets, down from $26.9 million and 0.23% at December 31, 2017. Nonperforming loans were $21.8 million; net charge-offs were $1.36 million in Q2 versus $1.62 million a year earlier.
- The allowance for loan losses was $61.1 million, or 0.74% of loans, versus $58.9 million, or 0.76%, at year-end. Management said the higher provision primarily reflected portfolio growth and incorporating NLFC loans into the allowance model, not deterioration in overall credit quality. Performing classified loans increased to $120.5 million from $111.4 million at the prior quarter-end, primarily following downgrades of two commercial relationships.
Outlook, commentary, risks and unusual items
- The filing provides no numerical earnings or revenue guidance. Management said liquidity was sufficient for expected cash requirements and reported $774 million of additional FHLB borrowing capacity and $1.40 billion of Federal Reserve discount-window capacity. It maintains an unencumbered liquid-asset reserve intended to cover at least 12 months under normal conditions and 30 days under severely adverse conditions.
- NLFC acquisition consideration was approximately $130.2 million, including $84.5 million cash and $45.7 million stock; preliminary goodwill was $87.4 million. Acquired NLFC results contributed $6.6 million of Q2 revenue and $2.7 million of Q2 net income since acquisition.
- First-half merger-related and other charges were $4.33 million. Q2 included $2.28 million of such charges, primarily severance, conversion, branch closure, legal and professional costs. Q2 also included $509,000 of additional tax expense from a partial impairment of the deferred tax asset following Georgia’s announced corporate tax-rate reduction. The lower federal tax rate under the 2017 Tax Act reduced the effective tax rate: 25.5% for Q2 2018 versus 36.9% in Q2 2017.
- First-half balance-sheet management actions generated $533,000 of Q2 gains from prepayment of FHLB advances and $1.16 million of first-quarter gains from cancellation of interest-rate swaps and caps; securities losses of $1.30 million for the first half were described as mostly offsetting those actions. Available-for-sale securities recorded $27.5 million of other comprehensive loss after tax in the first half, primarily reflecting interest-rate changes. Management said it did not intend or expect to be required to sell securities in unrealized-loss positions before recovery.
- Interest-rate sensitivity modeling at June 30 projected a 0.26% decline in 12-month net interest revenue under an immediate 100-basis-point increase and a 5.58% decline under an immediate 100-basis-point decrease. Results depend on modeling assumptions and actual outcomes may differ.
- Principal disclosed risks include economic and market conditions, interest-rate and funding/liquidity exposure, commercial real-estate and construction concentrations, geographic concentration, acquisition integration, credit losses, cybersecurity and third-party systems, regulation and tax changes, litigation, and realization of deferred tax assets. Management did not expect pending legal matters to have a material adverse effect; it reported no material risk-factor changes from the 2017 Form 10-K. Disclosure controls were assessed as effective.
- The board approved a regular $0.15-per-share quarterly dividend on August 1, 2018, payable October 5 to holders of record September 15.
Important facts for investors to verify
- How much of reported growth in loans, revenue and earnings is sustainable after separating acquisition contributions from organic performance.
- Whether the higher net interest margin persists as deposit pricing responds to rate changes and acquired funding costs flow through.
- Credit trends in commercial real estate, construction and newly acquired equipment-finance loans, including the rise in classified performing loans and the adequacy of the allowance.
- The impact of acquisition-related expenses, goodwill and amortization on future reported earnings and tangible book value.
- Whether unrealized securities losses, interest-rate sensitivity and wholesale funding reliance affect capital or liquidity under adverse scenarios.
- Management’s progress toward implementing the expected-credit-loss standard (CECL); the filing expects a higher allowance on adoption but does not provide a clear estimate of the increase.