UNITED COMMUNITY BANKS INC quarterly report, Q1 FY2015

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Business context and reporting period

United Community Banks, Inc. is a Georgia bank holding company operating a community-banking franchise across Georgia, North Carolina, South Carolina, and Tennessee. This unaudited Form 10-Q covers the three months ended March 31, 2015; comparisons are primarily with Q1 2014. Dollar amounts below are in millions unless stated otherwise.

Financial results and key metrics

  • Revenue and earnings: GAAP total revenue was $71.1 million, up 12% from $63.5 million. Net income was $17.7 million versus $15.4 million; diluted EPS was $0.29 versus $0.25. Net income available to common shareholders in Q1 2014 was $15.0 million after preferred dividends.
  • Net interest: GAAP net interest revenue was $57.2 million, up 6% from $53.8 million. Net interest margin rose to 3.31% from 3.21%; average loan yield declined 18 basis points to 4.28%. Taxable-equivalent figures are higher and are non-GAAP.
  • Credit costs and asset quality: Provision for credit losses was $1.8 million versus $2.5 million. Net charge-offs were $2.6 million versus $4.0 million. Nonperforming assets were $20.2 million (0.26% of assets), down from $30.8 million (0.42%) a year earlier, but up from $19.6 million at December 2014. The $70.0 million loan-loss allowance equaled 1.46% of loans, compared with 1.73% a year earlier.
  • Fees and expenses: Fee revenue increased 29% to $15.7 million, including $1.1 million of SBA loan-sale gains, $1.5 million of securities gains, and higher mortgage and brokerage fees. Operating expenses rose 10% to $43.1 million. The efficiency ratio was 59.15% versus 59.05%.
  • Cash flow and liquidity: Operating cash flow was $27.5 million; investing activities used $120.4 million, primarily reflecting $122.3 million of net loan growth; financing activities provided $85.9 million, including $111.4 million of deposit growth. Cash and cash equivalents declined $7.0 million to $185.7 million. Management said liquidity was sufficient and reported additional borrowing capacity of $959 million at the FHLB and $778 million at the Federal Reserve discount window.
  • Balance sheet and funding: Assets were $7.66 billion, loans $4.79 billion, deposits $6.44 billion, and shareholders’ equity $763.7 million. Loans grew 10% year over year; deposits grew 3%. FHLB advances were $270.1 million and long-term debt was $113.9 million. The company reported Basel III consolidated common equity Tier 1 and Tier 1 ratios of 11.82%, total capital of 13.09%, and leverage of 8.90%; it characterized capital as well-capitalized.
  • Returns and taxes: Return on assets was 0.94% versus 0.85%; return on common equity was 9.34% versus 8.64%. The effective tax rate was 37%. The net deferred tax asset was $202 million, with a $4.27 million valuation allowance.

Material changes versus the prior comparable period

  • Higher net interest revenue reflected loan growth, a higher securities yield, and lower funding costs. The company attributed margin improvement in part to 2014 balance-sheet restructuring and subsequent loan growth.
  • Loan balances increased $432 million year over year, with growth in commercial lending and indirect auto. Commercial loans were 57% of loans; management stated that more than 75% of loans were secured by real estate.
  • Fee growth was led by SBA loan sales and mortgage activity. Service charges declined 4%, principally because of lower overdraft fees.
  • Credit indicators improved year over year: performing substandard loans were $121.7 million versus $164.9 million, and nonperforming assets declined. Nonperforming loans nevertheless increased from year-end 2014.
  • Shareholders’ equity increased $24.1 million from year-end, reflecting earnings and improved unrealized gains on available-for-sale securities, partly offset by common dividends.

Outlook, risks, contingencies, and unusual items

  • No overall earnings or revenue guidance is provided. Management expected an approximately 37% effective tax rate for the rest of 2015 and approximately $1.83 million of previously accumulated cash-flow-hedge losses to increase interest expense over the next 12 months.
  • United terminated its remaining $175 million cash-flow hedge in Q1, stating that balance-sheet changes made the hedge unnecessary. It also repaid $6 million of structured repurchase agreements and $15 million of trust preferred securities, with a $1.04 million prepayment charge. Management cited expected annual interest savings, but the filing gives inconsistent estimates: approximately $1.6 million in one discussion and $1.9 million in another.
  • Other unusual Q1 costs included a $690,000 charge to terminate FDIC loss-sharing agreements and a $420,000 loss from a fraudulent home-equity transaction. Management said the FDIC termination ends the 95% sharing of recoveries on previously charged-off loans.
  • Interest-rate simulations estimated that a 200-basis-point increase would raise 12-month net interest revenue by 2.5% under an immediate shock and 2.6% under a gradual ramp, versus 5.8% and 5.6% a year earlier. These are model estimates based on assumptions, not forecasts.
  • After quarter-end, United announced an agreement to acquire Palmetto Bancshares for an estimated $240.5 million, subject to approvals and other conditions, with closing expected in Q4 2015. It also completed its MoneyTree/First National Bank acquisition on May 1, 2015.
  • Principal stated risks include economic and local-market conditions, commercial real estate and construction concentrations, credit-loss estimation, interest-rate and funding risks, deferred-tax-asset realization, regulatory requirements, cybersecurity, and acquisition integration. Management said pending legal matters were not expected to have a material adverse effect; no material risk-factor changes were reported.

Most important facts for investors to verify

  1. Reconcile the stated $1.6 million versus $1.9 million estimate of annual interest savings from debt repayments.
  2. Assess whether loan growth, especially commercial real estate, construction, and indirect auto, is maintaining underwriting quality as the allowance ratio declines.
  3. Track nonperforming loans and other credit indicators, including the recent increase in nonperforming loans from year-end.
  4. Evaluate the assumptions supporting realization of the $202 million deferred tax asset and the effect of any future valuation allowance change.
  5. Review the terms, approvals, financing, integration risks, and expected impact of the Palmetto and MoneyTree transactions.
  6. Confirm capital and liquidity remain adequate as Basel III requirements phase in and funding needs change.