UNITED COMMUNITY BANKS INC quarterly report, Q1 FY2017

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Business context and reporting period

United Community Banks, Inc. (United), a bank holding company operating primarily through United Community Bank, filed this unaudited Form 10-Q for the quarter ended March 31, 2017. It reported $10.73 billion in assets and operated 134 locations across Georgia, the Carolinas and Tennessee. Comparisons are with Q1 2016 for income and cash flows, and December 31, 2016 for balance-sheet amounts. Q1 2017 results include Tidelands, acquired in July 2016, affecting year-over-year comparisons. Unless stated otherwise, amounts below are USD millions.

Financial results and key metrics

  • Revenue and earnings: Total revenue was $104.8, up 12% year over year. Net interest revenue was $83.6, up 11%; fee revenue was $22.1, up 19%. GAAP net income was $23.5, up 6%, and diluted EPS was $0.33 versus $0.31. Management-reported operating net income was $28.2 versus $23.9, excluding specified merger-related and tax items.
  • Interest margin: Net interest margin on a fully taxable-equivalent basis was 3.45%, versus 3.41%; net interest spread was unchanged at 3.30%. Average loans rose 15% to $6.90 billion, partly reflecting Tidelands. The average cost of interest-bearing liabilities increased to 0.44% from 0.37%.
  • Expenses and profitability: Operating expenses were $62.8, up 9%, principally reflecting Tidelands, added specialized-lending staff and higher activity. The GAAP efficiency ratio improved to 59.29% from 61.94%; the operating ratio was 57.35% versus 59.10%. GAAP return on assets was 0.89%, compared with 0.93%.
  • Credit quality: Provision for credit losses was $0.8, compared with a $0.2 release in Q1 2016. Net charge-offs were $1.68 versus $2.14. The allowance for loan losses was $60.5, or 0.87% of loans, versus $61.4, or 0.89%, at year-end. Nonperforming assets declined to $24.9 from $29.5; nonperforming loans were $19.8 versus $21.5.
  • Cash flow: Operating activities provided $62.6, compared with $2.9 in Q1 2016; investing activities used $12.4 versus $195.5; financing activities used $36.6 versus providing $135.1. Cash and cash equivalents ended the quarter at $231.0, up from $217.3 at year-end. Operating cash flow included substantial noncash deferred tax expense and a decrease in mortgage loans held for sale.
  • Balance sheet, debt and liquidity: Total assets were $10.73 billion, up slightly from year-end; loans were $6.96 billion and deposits were $8.75 billion. FHLB advances declined to $569.1 from $709.2; long-term debt was $175.2, and short-term borrowings were zero. Shareholders’ equity was $1.10 billion. Management reported $828 million of additional FHLB advance capacity and $1.22 billion of Federal Reserve discount-window capacity. Consolidated regulatory capital ratios included 11.44% common equity Tier 1, 12.25% total capital and 8.63% leverage; United stated that capital remained well-capitalized.

Material changes versus comparable periods

  • Growth in net interest revenue reflected a larger earning-asset base, loan growth and the Tidelands acquisition; higher rates on floating-rate assets also supported margin expansion.
  • Fee growth reflected higher mortgage fees, SBA/USDA loan-sale gains, brokerage fees and other revenue. Mortgage fees increased 35%, and gains on government-guaranteed loan sales increased 58%.
  • Operating expenses increased $4.9, while merger-related and other charges decreased to $2.1 from $2.7.
  • The effective tax rate rose to 44.0% from 37.9%, primarily because $3.4 of tax expense was recognized when a disproportionate tax effect related to terminated cash-flow hedges was released from accumulated other comprehensive income.
  • Credit indicators improved from year-end: nonperforming assets and performing classified loans declined, while the allowance-to-loans ratio also decreased.

Outlook, risks, contingencies and unusual items

  • Outlook: The filing provides no specific earnings or revenue guidance. Management said liquidity was sufficient for expected cash-flow needs and described its approach to interest-rate and liquidity risk management.
  • Subsequent event: On April 20, 2017, United announced an agreement to acquire HCSB Financial Corporation for stock, with an indicated deal value of approximately $66 million. The transaction, expected to close in Q3 2017, remained subject to regulatory and shareholder approvals and other conditions.
  • Unusual accounting and tax items: United elected fair-value measurement for residential mortgage servicing rights effective January 1, 2017, recording a $0.437 million cumulative adjustment to retained earnings. It also adopted updated stock-compensation accounting; management expected greater effective-tax-rate volatility from recognizing certain tax effects in earnings.
  • Commitments and legal matters: Off-balance-sheet commitments to extend credit totaled $1.61 billion and letters of credit $28.5 million. Management did not expect pending or threatened litigation to have a material adverse effect. No material changes to previously disclosed risk factors were reported.
  • Principal risks: The filing identifies credit-loss estimation, concentrations in commercial real estate and construction lending, local economic and geographic concentration, interest-rate exposure, funding and liquidity access, deferred-tax-asset realization, cybersecurity and technology dependence, regulatory and legal matters, and acquisition execution and integration.

Important facts for investors to verify

  1. How much of loan, revenue and expense growth reflects Tidelands rather than organic performance, and whether integration costs continue.
  2. Whether margin gains persist as deposit costs reprice and funding costs change; review the filing’s interest-rate sensitivity analysis.
  3. Credit trends and reserve adequacy, especially in commercial real estate, construction, home-equity and indirect-auto portfolios.
  4. The sustainability of reported earnings after separating recurring operations from the $3.4 million tax item and merger-related charges.
  5. The terms, approvals, timing, expected costs and integration risks of the proposed HCSB acquisition.
  6. Assumptions supporting realization of the $139 million net deferred tax asset and the potential effect of changes in taxable-income forecasts or tax law.