United Community Banks, Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Financial statements are unaudited. Amounts are in U.S. dollars; financial figures below are in millions unless otherwise stated.
Business context
United is a Georgia-based bank holding company operating primarily through United Community Bank across Georgia, the Carolinas and Tennessee. At September 30, 2017, it reported $11.13 billion in assets and operated 142 locations. HCSB, acquired July 31, 2017, added eight branches in coastal South Carolina; its results are included from the acquisition date.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $109.3 | $105.7 | $322.2 | $298.1 |
| Net interest revenue | $89.8 | $79.0 | $258.5 | $228.9 |
| Fee revenue | $20.6 | $26.4 | $66.3 | $68.5 |
| Operating expenses | $65.7 | $64.0 | $191.7 | $180.0 |
| Net income | $27.9 | $25.9 | $79.7 | $73.4 |
| Diluted EPS | $0.38 | $0.36 | $1.10 | $1.02 |
| Net interest margin, fully taxable equivalent | 3.54% | 3.34% | 3.49% | 3.36% |
- Q3 net income rose 8%; nine-month net income rose 9%. Management attributed the improvement principally to higher net interest revenue, partly offset by lower fee revenue and higher expenses.
- Net interest revenue increased 14% in Q3 and 13% year to date. Management cited loan growth, HCSB, and higher yields on floating-rate loans and securities. Q3 average loan yield rose 32 basis points year over year; the cost of interest-bearing liabilities also increased.
- Fee revenue fell 22% in Q3 and 3% year to date. Debit interchange revenue was reduced by about $2.7 million versus Q2 following the Durbin Amendment’s July 1 applicability to United.
- Q3 GAAP return on assets was 1.01%, return on common equity 9.22%, and efficiency ratio 59.27%. Operating net income, a non-GAAP measure, was $30.2 million for Q3 and $87.9 million year to date; Q3 operating diluted EPS was $0.41.
Balance sheet, cash flow and capital
- At September 30, total assets were $11.13 billion, loans net of allowance were $7.14 billion, deposits were $9.13 billion, and shareholders’ equity was $1.22 billion. Since December 31, 2016, assets grew 4%, gross loans 4%, deposits 6%, and equity 13%.
- Cash and cash equivalents were $246.8 million, up from $217.3 million at year-end. For the first nine months, operating activities provided $147.0 million; investing activities used $0.2 million; financing activities used $117.3 million. Net cash increased $29.5 million.
- Deposits were the principal funding source. FHLB advances were $494.5 million, down from $709.2 million at year-end; long-term debt was $135.7 million, down from $175.1 million. United repaid $40 million of long-term debt during the period and, on October 15, paid off a further $35 million of debt bearing 9% interest.
- Management stated liquidity was sufficient. The company reported $834 million of additional FHLB borrowing capacity against qualifying collateral and $1.17 billion of Federal Reserve discount-window capacity. It also reported $16 million of short-term borrowings.
- Consolidated regulatory capital ratios at September 30 included 12.22% common equity tier 1, 12.27% Tier 1, 13.02% total capital and 9.30% leverage. The filing states capital levels were “well-capitalized.”
Credit quality and material changes
- The allowance for loan losses was $58.6 million, or 0.81% of loans, versus $61.4 million, or 0.89%, at year-end. The total allowance for credit losses, including unfunded commitments, was $61.1 million. Provision expense was $1.0 million in Q3 and $2.6 million year to date, compared with provision releases in the comparable 2016 periods.
- Q3 net charge-offs were $1.6 million versus $1.4 million a year earlier; the nine-month total was $4.9 million versus $5.2 million. Nonperforming assets were $25.7 million, or 0.23% of assets, down from $29.5 million, or 0.28%, at year-end. Nonperforming loans were $22.9 million, slightly above $21.5 million at year-end.
- HCSB was acquired for $65.8 million in United shares plus $31,000 cash, with $23.9 million of preliminary goodwill recorded. The acquisition added $390 million of assets and $347 million of liabilities. Purchase-accounting fair values remain subject to refinement.
- Operating expenses increased 3% in Q3 and 7% year to date, with acquired operations, staffing, incentives and lending-related costs contributing. Q3 merger-related and other charges were $3.42 million; these included $2.04 million of merger costs and $1.14 million of property impairment charges, as well as noncompete amortization reported separately in the expense detail.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management described liquidity as adequate and continued use of FHLB funding as anticipated.
- United completed its Four Oaks Fincorp acquisition on November 1, 2017. Four Oaks had $740 million of assets, $498 million of loans and $560 million of deposits as of June 30; consideration was approximately $128 million. Purchase accounting and pro forma disclosures were not yet complete. Systems conversion was planned for the second quarter of 2018.
- In November, the board extended the $50 million share repurchase authorization through December 31, 2018; $36.3 million remained available at September 30. No shares were repurchased in the first nine months of 2017. The board approved a $0.10 quarterly dividend payable January 5, 2018.
- A $3.40 million tax expense in Q1 2017 from reversing disproportionate tax effects associated with terminated cash-flow hedges contributed to the 38.9% nine-month effective tax rate. Management judged nearly all of the $129 million net deferred tax asset realizable, but that assessment depends on forecasts; a valuation-allowance increase could materially affect results.
- Interest-rate sensitivity modeling showed that an immediate 100-basis-point decrease was estimated to reduce 12-month net interest revenue by 8.7%; an immediate 100-basis-point increase was estimated to raise it by 0.6%. These are model estimates, not forecasts. The filing identifies credit, funding, interest-rate, geographic concentration, real-estate lending, acquisition integration, cybersecurity, regulatory and tax risks.
- Management reported no material change in previously disclosed risk factors, no material expected adverse effect from pending litigation, and effective disclosure controls. No material market-risk change from the 2016 Form 10-K was reported.
Important facts for investors to verify
- Whether HCSB and Four Oaks deliver expected growth and integration benefits, and the eventual Four Oaks purchase-accounting and pro forma results.
- Whether net interest margin gains persist as deposit costs rise and rates change, including actual outcomes versus interest-rate sensitivity models.
- The sustainability of fee revenue after Durbin-related interchange reductions and changes in mortgage, brokerage and customer-derivative fees.
- Loan performance, classified and nonaccrual trends, charge-offs, and whether the allowance remains adequate as the portfolio grows.
- Deferred-tax-asset realizability and the potential effects of tax-law changes, forecast revisions, or valuation-allowance adjustments.
- Cash, borrowing capacity, deposit mix, FHLB funding and debt maturities, along with capital levels after the Four Oaks acquisition and planned dividend.
- Acquisition-related expenses, property impairments and other excluded items when comparing GAAP results with management’s non-GAAP operating measures.