UNITED COMMUNITY BANKS INC quarterly report, Q2 FY2013

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United Community Banks, Inc. — Q2 2013 Form 10-Q

Reporting period: Three and six months ended June 30, 2013. The company is a Georgia bank holding company operating primarily through United Community Bank. Dollar amounts below are in millions unless stated otherwise; interim statements are unaudited.

Financial results and position

  • Q2 earnings: Net income was $230.0 million versus $6.5 million in Q2 2012; diluted EPS was $3.90 versus $0.06. Results included a $256.8 million income tax benefit, principally from reversing $272 million of the deferred tax asset valuation allowance. Before tax, the company recorded a $26.8 million loss.
  • First-half earnings: Net income was $241.7 million versus $18.0 million in the first half of 2012; diluted EPS was $4.05 versus $0.21. The tax benefit makes these earnings comparisons atypical and not representative of recurring operating performance.
  • Revenue and margin: Q2 taxable-equivalent net interest revenue was $54.6 million, down 4% year over year; net interest margin was 3.31%, versus 3.43%. First-half net interest revenue was $109.2 million, down 6%, and margin was 3.34%, versus 3.48%. GAAP fee revenue was $16.3 million in Q2, up 27%, and $29.1 million for the first half, up 3%.
  • Credit costs: Q2 provision for loan losses was $48.5 million, versus $18.0 million; Q2 net charge-offs were $72.4 million, versus $18.9 million. First-half provision was $59.5 million and net charge-offs were $84.8 million. These amounts were significantly affected by the classified-asset disposition.
  • Balance sheet at June 30: Assets were $7.16 billion; loans were $4.19 billion; deposits were $6.01 billion; shareholders’ equity was $829.3 million. Cash and cash equivalents were $260.6 million. Total debt and borrowings shown on the balance sheet were approximately $249.1 million: $54.2 million short-term borrowings, $70.1 million FHLB advances, and $124.8 million long-term debt.
  • Cash flow, first half: Operating activities provided $105.5 million; investing activities used $182.4 million; financing activities provided $86.3 million. Cash and cash equivalents increased $9.4 million to $260.6 million. Operating cash flow included the large, noncash tax benefit.
  • Capital and liquidity: Consolidated Tier 1 capital ratio was 13.68%, total capital ratio 15.23%, and leverage ratio 9.80%. Management said liquidity was sufficient; the company reported $1.16 billion of additional FHLB borrowing capacity and $616 million of Federal Reserve discount-window capacity, subject to applicable requirements.

Material changes versus comparable periods

  • Q2 and first-half reported earnings rose sharply primarily because of the deferred-tax valuation allowance reversal, not an equivalent improvement in pretax operating earnings.
  • United sold classified loans and foreclosed properties to accelerate resolution of legacy credit problems. In the bulk sale, assets with recorded investment of $130.9 million generated $77.5 million in proceeds and $53.5 million in net charge-offs. Q2 provision and foreclosed-property expense also rose materially.
  • Reported nonperforming assets fell to $31.8 million, or 0.44% of total assets, from $145.8 million, or 2.16%, at June 30, 2012. Nonperforming loans were $27.9 million, down from $115.3 million. These measures exclude assets covered by FDIC loss-sharing agreements.
  • Net loans increased modestly year over year, while the allowance for loan losses declined to $81.8 million, or 1.95% of loans, from $112.7 million, or 2.74%, a year earlier. Management attributed improving credit measures partly to the sale and ongoing resolution of problem assets.
  • Net interest margin declined as loan and securities yields fell; lower funding costs only partly offset the pressure. Average loan yield fell 46 basis points year over year in Q2, while average interest-bearing liability cost fell from 0.76% to 0.58%.
  • Core deposits strengthened: demand deposits rose to $1.35 billion, while time deposits excluding brokered deposits declined. Brokered deposits increased to $374.5 million, up from $210.5 million a year earlier.

Outlook, risks and unusual items

  • Management expected an effective income tax rate of approximately 35% for the remainder of 2013 and projected use of net operating loss carryforwards within five to seven years. These expectations depend on future taxable income; the company remained in a three-year cumulative loss position at quarter-end.
  • No specific revenue, earnings, or margin guidance was provided. Management cited competitive loan pricing, low reinvestment yields, continued cost-reduction efforts, and improving credit quality.
  • The $272 million deferred-tax asset recognition depends on forecasts and could be reversed in whole or in part if results disappoint. An ownership change under Internal Revenue Code Section 382 could limit use of tax benefits; the company has a tax-benefits preservation plan intended to reduce that risk.
  • The company and bank remained subject to regulatory memorandums of understanding. The holding-company MOU restricts additional debt, dividends, certain debt payments, and share repurchases without prior regulatory approval. The bank MOU requires minimum Tier 1 leverage and total risk-based capital ratios of 8% and 10%, respectively, and regulatory consent before cash dividends to the parent.
  • Management identified risks including real-estate and construction loan concentrations, loan losses exceeding the allowance, interest-rate and funding pressures, liquidity and capital access, regulatory changes including Basel III, and litigation or regulatory actions. Management did not expect pending litigation to have a material adverse effect.
  • Q2 operating expenses included higher foreclosed-property losses from the asset sales and increased legal and consulting fees. The filing reports no material change in disclosure controls and states that controls were effective.

Important facts for investors to verify

  1. Separate recurring pretax performance from the $256.8 million tax benefit and quantify the continuing earnings impact of the deferred-tax asset reversal.
  2. Review the asset-sale terms, charge-offs, remaining classified and impaired assets, and subsequent credit trends; confirm the basis for excluding FDIC-covered assets from asset-quality measures.
  3. Assess the adequacy of the $81.8 million loan-loss allowance against portfolio mix, collateral values, delinquencies, and future charge-offs.
  4. Test management’s taxable-income forecasts and the assumptions supporting realization of the $272 million deferred-tax asset, including Section 382 ownership-change exposure.
  5. Monitor net interest margin, loan and securities yields, brokered-deposit reliance, borrowing capacity, and compliance with regulatory MOU requirements and capital thresholds.