UNITED COMMUNITY BANKS INC quarterly report, Q3 FY2012

United Community Banks, Inc. — Q3 2012 Form 10-Q

Reporting period: Three and nine months ended September 30, 2012. The unaudited filing covers the bank holding company and subsidiaries, primarily United Community Bank, operating across Georgia, western North Carolina and east Tennessee.

Financial performance and condition

Metric	Q3 2012 / Sep. 30, 2012	Comparable period
Net income	$10.6 million; diluted EPS $0.13	Q3 2011 net loss $11.3 million; diluted loss per share $0.25
Net interest revenue (GAAP)	$57.0 million	$58.9 million in Q3 2011
Net interest margin	3.60%	3.55% in Q3 2011
Fee revenue	$13.8 million	$11.5 million in Q3 2011
Operating expenses	$44.8 million	$46.5 million in Q3 2011
Loans, excluding FDIC-covered loans	$4.14 billion	Up 1% year over year
Deposits	$5.82 billion	$6.01 billion at Sep. 30, 2011
Cash and cash equivalents	$221.6 million	$299.2 million at Sep. 30, 2011
Total assets / shareholders’ equity	$6.70 billion / $585.3 million	$6.89 billion / $583.4 million at Sep. 30, 2011

For the first nine months, net income was $28.6 million versus a $236.6 million net loss in 2011; diluted EPS was $0.34 versus a $7.23 loss. The prior-year result included large credit losses and foreclosed-property write-downs related to the Problem Asset Disposition Plan. Nine-month operating cash flow was $139.2 million; investing activities provided $33.1 million and financing activities used $329.1 million, resulting in a $156.8 million decline in cash and cash equivalents from year-end 2011.

At quarter-end, total debt included $50.1 million of FHLB advances, $53.2 million of short-term borrowings and $120.3 million of long-term debt. Consolidated regulatory capital ratios were 14.26% Tier 1, 15.83% total risk-based and 9.76% leverage; the bank’s corresponding ratios were 14.47%, 15.73% and 9.92%. The bank was subject to regulatory minimums under an informal memorandum of understanding (MOU).

Material changes and asset quality

• Q3 provision for loan losses fell to $15.5 million from $36.0 million; nine-month provision was $48.5 million versus $237.0 million. Net charge-offs were $20.6 million in Q3 and $55.3 million year to date. Q3 charge-offs included about $4.7 million associated with note and collateral sales.
• The allowance for loan losses was $107.6 million, or 2.60% of loans, versus $146.1 million, or 3.55%, a year earlier. Nonperforming assets declined to $142.0 million from $188.7 million; nonperforming loans were $115.0 million. These asset-quality figures exclude FDIC-covered assets.
• Performing substandard loans decreased to $282.5 million from $341.3 million a year earlier. Total loans grew modestly year over year, while residential construction loans declined and commercial and residential mortgage balances increased.
• Taxable-equivalent net interest revenue decreased 3% year over year in Q3, as lower loan and securities yields and a smaller securities portfolio outweighed reduced funding costs. The margin improved to 3.60% from 3.55%. Management cited loan pricing competition and low reinvestment yields; it funded $137 million of new loans during the quarter.
• Fee revenue increased 20% in Q3, led by mortgage-related fees amid refinancing activity and higher service charges. Operating expenses fell 4%; lower staffing costs were partly offset by higher foreclosed-property costs.
• Deposits decreased year over year, including lower time deposits, while non-interest-bearing demand deposits rose 25%. Management described a shift toward lower-cost transaction deposits and reduced funding needs.

Outlook, risks and unusual items

• The filing provides no specific earnings or revenue guidance. Management said liquidity was sufficient for expected cash requirements. It reported available capacity to increase FHLB advances by $1.05 billion and Federal Reserve discount-window capacity of $496 million, subject to qualifying collateral and applicable conditions.
• After quarter-end, on October 3, 2012, the company issued $35 million of 9% senior notes due 2017. Proceeds were intended principally to repay $30.5 million of subordinated debt maturing December 15, 2012. The holding-company MOU requires prior Federal Reserve approval for additional debt and certain payments; the filing states the company believes it is compliant.
• The bank’s MOU requires Tier 1 leverage of at least 8% and total risk-based capital of at least 10%, and regulatory consent before bank dividends. The company said it did not anticipate receiving a bank dividend until 2013, limiting parent-company liquidity.
• A change in the estimated amortization period for premiums on certain mortgage-backed securities increased Q3 investment interest revenue by approximately $2 million and EPS by $0.03. The company also reported $7.0 million of securities gains and $6.7 million of debt-prepayment losses for the first nine months; management said these balance-sheet actions largely offset.
• The company reported no net deferred tax asset because of a full $272 million valuation allowance. Management cited four consecutive profitable quarters as positive evidence, but said cumulative historical losses remained significant negative evidence.
• Credit risk remains material: more than 85% of loans were secured by real estate, and management identified real-estate, construction and development exposure, economic conditions, unemployment and collateral values as key risks. Other disclosed risks include funding costs, interest-rate changes, allowance adequacy, regulatory actions, litigation and the ongoing SEC investigation referenced in the risk discussion.
• FILB sued over purported contractual rights related to a prior investment agreement and share reclassification; the company considers the claims meritless and is defending the case. The filing says management did not believe other pending or threatened legal matters would materially affect consolidated financial condition or results.

Important facts for investors to verify

• Whether credit quality continues to improve, particularly nonperforming loans, substandard loans, TDR performance and charge-offs, and whether the allowance remains adequate.
• How sustainable profitability and net interest margin are under continued low rates, loan-pricing competition and mortgage prepayments; also assess the effect of the securities-premium amortization estimate change.
• Liquidity and funding trends, including deposit outflows, reliance on wholesale funding, the use of borrowing capacity and the parent company’s obligations under its MOU.
• The cost and repayment plan for the 9% senior notes, the December 2012 subordinated-debt maturity and restrictions on dividends or debt payments.
• Whether evidence supports releasing any portion of the deferred-tax-asset valuation allowance, and the outcome of the SEC investigation and FILB litigation.