United Community Banks, Inc. — Q2 2014 Form 10-Q
Business context and reporting period
United Community Banks, Inc. is a Georgia bank holding company operating through United Community Bank, with community banking markets in Georgia, North Carolina, Tennessee and South Carolina. This unaudited filing covers the three and six months ended June 30, 2014; comparisons are primarily with the corresponding 2013 periods.
Financial and operating highlights
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net income | $16.4 million | $230.0 million | $31.8 million | $241.7 million |
| Diluted earnings per share | $0.27 | $3.90 | $0.52 | $4.05 |
| Net interest revenue, taxable equivalent | $55.0 million | $54.9 million | $109.1 million | $109.5 million |
| Net interest margin | 3.21% | 3.33% | 3.21% | 3.35% |
| Provision for credit losses | $2.2 million | $48.5 million | $4.7 million | $59.5 million |
| Operating expenses | $40.5 million | $48.8 million | $79.6 million | $92.6 million |
Period-end position at June 30, 2014: Assets were $7.35 billion; loans, net of allowance, were $4.34 billion; deposits were $6.16 billion; and shareholders’ equity was $722.0 million. Gross loans totaled $4.41 billion, up 5% from June 30, 2013. Cash and cash equivalents were $240.1 million.
Cash flow and funding: For the first six months, operating cash flow was $39.9 million, investing cash flow was $47.7 million, and financing cash flow was negative $76.5 million. Cash and cash equivalents increased $11.2 million. Period-end short-term borrowings were $76.3 million, FHLB advances $175.1 million and long-term debt $129.9 million. Management reported $921 million of additional FHLB borrowing capacity and $682 million of Federal Reserve discount-window capacity, subject to qualifying collateral.
Credit and capital: The allowance for loan losses was $73.2 million, or 1.66% of loans; nonperforming assets were $23.7 million, or 0.32% of assets. Net charge-offs were $4.2 million for Q2, an annualized 0.38% of average loans. Consolidated Tier 1 and total risk-based capital ratios were 11.75% and 13.00%, respectively; the Bank’s ratios were 13.36% and 14.62%.
Material changes versus the prior comparable period
- The large year-over-year decline in reported earnings primarily reflects the unusual 2013 comparison: Q2 2013 included a $272 million deferred-tax valuation-allowance reversal, while the 2013 asset-disposition activity also produced a $26.8 million pretax loss and unusually high credit costs. 2013 net income and EPS are therefore not directly representative of recurring performance.
- Credit costs improved substantially versus the 2013 period, which included a bulk sale of classified assets. Q2 2014 provision was $2.2 million versus $48.5 million; net charge-offs were $4.2 million versus $72.4 million. NPAs declined to $23.7 million from $31.8 million a year earlier.
- Net interest revenue was nearly flat, but margin fell 12 basis points in Q2 and 14 basis points year to date. Management attributed pressure mainly to lower loan yields amid pricing competition, partly offset by lower deposit costs and improved securities yields.
- Q2 fee revenue fell 11% to $14.1 million, chiefly because mortgage-related fees declined with reduced refinancing activity and 2013 had nonrecurring other-fee income. Service charges and brokerage fees increased. Q2 included $4.4 million of securities gains and a $4.4 million loss on prepaying structured repurchase funding; management described these as related balance-sheet restructuring transactions.
- Operating expenses fell 17% in Q2, mainly due to lower foreclosed-property costs and FDIC assessments. Total deposits decreased $38.0 million from year-end 2013, while core customer deposits excluding brokered deposits increased year over year.
Outlook, management commentary, risks and unusual items
- Management expected an approximately 37% effective tax rate for the remainder of 2014. The filing provides no specific earnings or revenue guidance. The $233 million net deferred tax asset depends on forecasts of future taxable income; management concluded it was more likely than not to be realized, but warned that weaker results could require a valuation-allowance increase with a material adverse effect.
- United completed its June 26 acquisition of substantially all assets of Business Carolina, an SBA/USDA lender, paying $31.2 million for loans, servicing rights and other assets. The purchase accounting was still being finalized; management did not expect the final settlement to differ materially from the initial amount.
- United redeemed all preferred stock by Q1 2014. It also issued 640,000 common shares in connection with a Fletcher settlement. The settlement and related transactions were court-approved but remained subject to appeal at the filing date.
- Interest-rate risk remains material. A modeled 200-basis-point increase showed a 2.1% rise in 12-month net interest revenue under an immediate shock and 2.3% under a ramp; a 25-basis-point decrease showed a 2.1% decline in either scenario. These are model estimates, not forecasts.
- Key stated risks include local economic conditions and limited geographic diversification; concentrations in commercial real estate and construction lending; interest-rate and funding-cost changes; adequacy of loan-loss reserves; ability to realize deferred tax assets; capital and liquidity access; regulatory changes; and litigation or acquisition-related risks. Management said pending ordinary-course litigation was not expected to materially affect financial condition or results.
Important facts for investors to verify
- Separate recurring operating performance from the 2013 tax benefit and classified-asset sale effects, and assess the sustainability of 2014 earnings.
- Track loan yields, net interest margin, deposit mix and pricing, and the future cost of wholesale funding.
- Review credit trends by portfolio, including nonperforming loans, performing substandard loans, TDRs, charge-offs and allowance coverage; reserve adequacy involves management judgment.
- Assess the assumptions supporting realization of the $233 million deferred tax asset and the risk of a future valuation allowance.
- Confirm final Business Carolina purchase accounting and the status and financial consequences of the Fletcher settlement appeal.
- Monitor capital ratios, cash needs, borrowing capacity and the effect of securities transactions and debt prepayments on future revenue and funding costs.