United Community Banks, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012; balance-sheet comparisons are primarily with December 31, 2011 and June 30, 2011. The interim financial statements are unaudited. United is a Georgia-based bank holding company operating through United Community Bank in Georgia, western North Carolina, and east Tennessee.
Financial performance and condition
- Quarterly earnings: Net income was $6.5 million, versus $12.0 million in Q2 2011. Net income available to common shareholders was $3.5 million; diluted EPS was $0.06, versus $0.16.
- First-half earnings: Net income was $18.0 million and diluted EPS was $0.21, compared with a $225.3 million net loss and $10.52 loss per share in the first half of 2011. The prior-year loss largely reflected the problem-asset disposition plan and associated credit and foreclosed-property charges.
- Interest income and margins: Q2 GAAP net interest revenue was $56.4 million, down from $58.5 million; taxable-equivalent net interest revenue was $56.8 million, down 4%. Net interest margin was 3.43%, versus 3.41%. For the first half, taxable-equivalent net interest revenue was $115.7 million versus $115.3 million, and margin was 3.48% versus 3.36%.
- Credit costs: Q2 loan-loss provision was $18.0 million, up from $11.0 million; first-half provision was $33.0 million, versus $201.0 million. Net charge-offs were $18.9 million in Q2 and $34.8 million in the first half. The allowance was $112.7 million, or 2.74% of loans, versus 3.07% a year earlier.
- Fees and expenses: Q2 fee revenue was $12.9 million, down 7%; first-half fees were $28.2 million, up 10%. Q2 operating expenses were $44.3 million, down 9%; first-half expenses were $91.3 million, down 44%, with the comparison substantially affected by 2011 problem-asset disposition costs. Q2 included $6.5 million of securities gains and a $6.2 million loss on debt prepayments.
- Cash flow: First-half operating cash flow was $92.3 million and investing cash flow was $85.2 million. Financing used $251.5 million, including a $275.5 million net decrease in deposits. Cash and cash equivalents fell $74.0 million to $304.5 million.
- Balance sheet and funding: At June 30, total assets were $6.74 billion, loans $4.12 billion, deposits $5.82 billion, and shareholders’ equity $576.0 million. Compared with year-end 2011, deposits fell $275.5 million and total assets fell $246.3 million. FHLB advances were $125.1 million, other short-term borrowings $53.7 million, and long-term debt $120.3 million.
- Liquidity and capital: Management reported $646 million of excess liquidity and sufficient liquidity for expected cash needs; available capacity included $629 million in additional FHLB advances and $478 million at the Federal Reserve discount window. Consolidated Tier 1, total risk-based capital, and leverage ratios were 14.19%, 15.93%, and 9.09%, respectively. These ratios do not remove the operational restrictions described below.
Changes versus comparable periods
- Q2 earnings and net interest revenue declined year over year; margin edged higher as lower funding costs partly offset reduced asset yields and loan balances. Management attributed securities-yield pressure in part to mortgage prepayments and reinvestment at lower yields.
- First-half results improved sharply from 2011’s unusually large losses and credit charges. The 2011 comparison included the bulk sale and write-down of problem loans and substantial foreclosed-property expenses, so it is not a normalized earnings comparison.
- Loans were up modestly from year-end but down 1% from June 2011. Deposits declined year over year, while noninterest-bearing demand deposits increased 28% to $1.15 billion and time deposits contracted.
- Nonperforming assets were $145.8 million, or 2.16% of assets, versus $118.6 million and 1.66% a year earlier; they were down from $160.3 million at year-end. Nonperforming loans were $115.3 million, and no loans over 90 days past due were still accruing. The allowance covered 98% of nonperforming loans.
Outlook, risks, and unusual matters
- The filing provides no specific earnings or financial guidance. Management described loan balances as stabilizing, reported $86.5 million of new loans funded in Q2, and said liquidity was sufficient for expected requirements. It also cautioned that results for interim periods may not indicate full-year results.
- Credit risk remains material: more than 85% of loans were secured by real estate, with concentrations in commercial real estate and construction/development lending. Performing substandard loans were $323.6 million, up from $313.1 million a year earlier. TDRs totaled $167.6 million after restructuring at quarter-end; $26.0 million were not performing under modified terms.
- United reported a full $277 million valuation allowance against deferred tax assets and no net deferred tax asset. In Q1 2012 it recorded an additional tax expense and restated 2010 and the first three quarters of 2011 following SEC staff discussions. The SEC Division of Enforcement opened a formal investigation, primarily concerning deferred-tax-asset valuation allowances and 2009–2010 goodwill impairment charges; the company said it was cooperating.
- A lawsuit by FILB Co-Investments LLC asserts purported rights assigned by Fletcher, including claims involving preferred shares, warrants, and the 2011 reverse stock split. United said it considers the claims meritless and intends to defend itself. The filing also describes a dispute over Fletcher warrant calculations.
- Regulatory memoranda of understanding restrict capital and distributions. The holding-company MOU requires prior Federal Reserve approval for additional indebtedness, cash dividends, certain debt payments, and stock repurchases. The Bank MOU requires minimum capital ratios and regulatory consent before cash dividends; United said it did not expect Bank dividends until 2013 and had not received one since 2008.
- Other risks cited include profitability, capital and funding access, loan-loss adequacy, interest-rate changes, local economic conditions, real-estate exposure, deferred tax asset realization, regulation, and litigation or investigations. Management said disclosure controls were effective and reported no material changes in risk factors from the 2011 Form 10-K.
Investor verification priorities
- Review the credit migration, particularly the large lending relationship, substandard loans, impaired loans, TDR performance, and residential and commercial real-estate exposures.
- Assess the sustainability of earnings excluding securities gains, debt-prepayment losses, hedge-related effects, and first-half tax-credit/refund-related income; compare reported GAAP and taxable-equivalent measures consistently.
- Monitor deposit trends, wholesale funding, liquidity availability, and the effect of regulatory MOU restrictions on parent-company obligations and distributions.
- Follow the deferred-tax valuation allowance, any further restatements or SEC investigation developments, and the FILB/Fletcher litigation and potential dilution from outstanding warrants or preferred-stock rights.
- Verify capital ratios and the allowance against future credit losses, including any adjustments required by regulators.