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UCBI > SEC Filings for UCBI > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for UNITED COMMUNITY BANKS INC

Form 10-K for UNITED COMMUNITY BANKS INC


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.

Overview

The following discussion is intended to provide insight into the financial condition and results of operations of United and its subsidiaries and should be read in conjunction with the consolidated financial statements and accompanying notes.

Operating earnings (loss) and operating earnings (loss) per diluted share are non-GAAP performance measures. United's management believes that operating performance measures are useful in analyzing the Company's financial performance trends since they exclude items that are non-recurring in nature and therefore most of the discussion in this section will refer to operating performance measures. A reconciliation of these operating performance measures to GAAP performance measures is included in the table on pages 31 through 33.

United's financial condition improved considerably in 2013, as several of its strategic goals were achieved. We reduced nonperforming assets to pre-crisis levels, restored our deferred tax asset, and redeemed $75 million of our Series B Preferred Stock which was followed by the redemption of the remaining $105 million in early January 2014. Loans grew despite the fragile economic conditions in United's markets and intense competition for quality loans. United reported net income of $273 million in 2013 compared to net income of $33.9 million in 2012. Diluted earnings per common share was $4.44 for the year ended December 31, 2013, compared with diluted earnings per common share of $.38 for 2012. Net income and earnings per share for the year ended December 31, 2013 were elevated by the recognition of substantial tax benefits with the reversal of United's deferred tax valuation allowance in the second quarter of 2013. The effect of the tax benefit on net income was partially offset by higher net charge-offs resulting from the accelerated disposition of classified assets in the second quarter of 2013.

United's approach to managing through the challenging economic cycle has been to aggressively deal with credit problems and dispose of troubled assets quickly, taking losses as necessary. United's provision for credit losses was $65.5 million in 2013 compared with $62.5 million in 2012. Net charge-offs for 2013 were $93.7 million compared with $69.8 million in 2012. During the second quarter of 2013, in conjunction with a large bulk sale transaction, classified loans totaling approximately $131 million were sold for approximately $77.5 million, increasing net charge-offs by $53.5 million.

Since disposing of a significant amount of problem assets in the first quarter of 2011, United's allowance for loan losses analysis has indicated a lower allowance requirement each quarter than the previous quarter, resulting in provisions for loan losses being at or below the amount of net charge-offs. The only exception was the third quarter of 2011 due to the classification of United's then largest lending relationship. As United's historical loss experience and other credit measures have improved, the amount of estimated probable incurred losses in the loan portfolio, as measured by United's quarterly analysis of the allowance for credit losses, has decreased accordingly.

As of December 31, 2013, United's allowance for loan losses was $76.8 million, or 1.77% of loans compared to $107 million, or 2.57% of loans at the end of 2012. Nonperforming assets of $31.0 million, which excludes $3.00 million of assets that are covered by loss sharing agreements with the FDIC, were .42% of total assets at December 31, 2013, compared to 1.88% as of December 31, 2012.

Taxable equivalent net interest revenue was $220 million for 2013, compared to $230 million in 2012. The $10.1 million, or 4%, decrease in net interest revenue, was primarily the result of lower yields on the loan and securities portfolios, which were due to loan pricing competition and the reinvestment of maturing and called securities proceeds at lower interest rates. The decrease in interest revenue was partially offset by lower deposit interest expense.

Net interest margin decreased 21 basis points from 3.51% in 2012 to 3.30% in 2013 due primarily to lower yields on loans and securities. The 50 basis point decrease in the average loan yield and 25 basis point decrease in the average securities yield were partially offset by the 19 basis point reduction in the average rate paid on interest bearing deposits.

Fee revenue of $56.6 million was up $486,000, or 1%, from 2012. Overdraft fees declined $877,000, or 7%, which is consistent with the decline from 2011 to 2012. Overdraft fees have been on a declining trend. This decline was more than offset by a $1.40 million increase in ATM and debit card fee revenue. Mortgage loan and related fees decreased $558,000 compared to the prior year, due to lower origination volumes that were driven by interest rates. For 2013, brokerage fees increased $1.38 million, or 45%, compared to 2012, as United intensified its focus on growing this line of business.

For 2013, operating expenses of $174 million were down $12.5 million, or 7%, from 2012. United's focus on reducing costs and improving operating efficiency resulted in reductions of several expense categories in 2013. Foreclosed property costs of $7.87 million were $6.12 million lower in 2013, driven by decreased volumes partially due to the classified asset sales in the second quarter of 2013. Other expense of $15.2 million for 2013 was down $4.78 million compared to 2012 due to a $4.00 million litigation reserve established in 2012. Salaries and employee benefit costs of $96.2 million remained relatively flat year over year, as a lower headcount was offset by incentives paid for meeting financial targets and completing strategic initiatives.

Loans at December 31, 2013 were $4.33 billion, up $154 million from the end of 2012. A significant portion of the loan growth resulted from United's entrance into the Greenville, South Carolina and Nashville, Tennessee markets. These new markets added $88 million in loan growth in 2013. United's successful home equity line of credit promotion added another $56 million in new loans during the year. In addition, United purchased $202 million of indirect auto loans during 2013, which drove the increase in the consumer category. These increases more than offset the $131 million of classified loans sold in the second quarter bulk sale transaction. Deposits were up $249 million to $6.20 billion, as United focused on increasing low cost core transaction deposits which grew $224 million in 2013, excluding public funds deposits. At the end of 2013, total equity capital was $796 million, up $214 million from December 31, 2012, reflecting the earnings for the year and United's reversal of the deferred tax valuation allowance offset by the redemption of $75 million in preferred stock. At December 31, 2013, all of United's regulatory capital ratios were above well capitalized levels.

Critical Accounting Policies

The accounting and reporting policies of United and its subsidiaries are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The more critical accounting and reporting policies include United's accounting for the allowance for loan losses, fair value measurements and income taxes. Application of these principles requires management to make estimates or judgments that affect the amounts reported in the financial statements and the accompanying notes. These estimates are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates or judgments. Certain policies inherently have a greater reliance on the use of estimates, and as such have a greater possibility of producing results that could be materially different than originally reported.

Estimates or judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon future events. Carrying assets and liabilities at fair value results in more financial statement volatility. The fair values and the information used to record the valuation adjustments for certain assets and liabilities are based either on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal cash flow modeling techniques.

The most significant accounting policies for United are presented in Note 1 to the consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this financial review, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Management views critical accounting policies to be those that are highly dependent on subjective or complex judgments, estimates and assumptions, and where changes in those estimates and assumptions could have a significant effect on the financial statements.

Management considers the following accounting policies to be critical accounting policies:

Allowance for Credit Losses

The allowance for credit losses is an estimate and represents management's estimate of probable incurred credit losses in the loan portfolio and unfunded loan commitments. It consists of two components: the allowance for loan losses and the allowance for unfunded commitments. Estimating the amount of the allowance for credit losses requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on non-impaired loans based on historical loss experience, management's evaluation of the current loan portfolio, and consideration of current economic trends, events and conditions. The loan portfolio also represents the largest asset type on the consolidated balance sheet. Loan losses are charged against the allowance, while recoveries of amounts previously charged off are credited to the allowance. A provision for credit losses is charged to operations based on management's periodic evaluation of the factors previously mentioned, as well as other pertinent factors.

The allowance for loan losses is an estimate and consists of an allocated component and an unallocated component. The allocated component of the allowance for loan losses reflects probable incurred losses in the loan portfolio and is based on analyses developed through specific credit allocations for individual loans and historical loss experience for each loan category. The specific credit allocations are based on impairment analyses of all nonaccrual loans over $500,000, accruing substandard loans in relationships over $2 million and troubled debt restructurings ("TDRs"), which are all considered impaired loans including certain primary home mortgages in the process of restructure. These analyses involve judgment in estimating the amount of loss associated with specific loans, including estimating the amount and timing of future cash flows and collateral values. The historical loss element is determined using the weighted average of actual losses incurred over the prior eight quarters for each type of loan, updated quarterly. The weighted average is weighted toward the most recent quarters' loss experience. The historical loss experience is adjusted for known changes in economic trends, events and conditions and credit quality trends such as changes in the amount of past due and nonperforming loans. The resulting loss allocation factors are applied to the balance of each type of loan after removing the balance of impaired loans and other specifically allocated loans from each category. The loss allocation factors are updated quarterly. The allocated component of the allowance for loan losses also includes consideration of concentrations of credit and changes in portfolio mix.

The unallocated portion of the allowance reflects management's estimate of probable incurred but unconfirmed losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower's financial condition, the difficulty in identifying triggering events that correlate to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors. In addition, the unallocated allowance includes a component that accounts for the inherent imprecision in loan loss estimation based on historical loss experience as a result of United's growth through acquisitions, which have expanded the geographic footprint in which it operates, and changed its portfolio mix. Also, loss data representing a complete economic cycle is not available for all sectors. Uncertainty surrounding the strength and timing of economic cycles also affects estimates of loss. The historical losses used in developing loss allocation factors may not be representative of actual losses incurred in the portfolio.

There are many factors affecting the allowance for credit losses; some are quantitative while others require qualitative judgment. Although management believes its processes for determining the allowance adequately considers all the potential factors that could potentially result in credit losses, the process includes subjective elements and may be susceptible to significant change. To the extent actual outcomes differ from management estimates, additional provision for loan losses could be required that could adversely affect earnings or financial position in future periods.

Additional information on United's loan portfolio and allowance for credit losses can be found in the sections of Management's Discussion and Analysis titled "Asset Quality and Risk Elements" and "Nonperforming Assets" and in the sections of Part I, Item 1 titled "Lending Policy" and "Loan Review and Nonperforming Assets". Note 1 to the consolidated financial statements includes additional information on United's accounting policies related to the allowance for loan losses.

Fair Value Measurements

United's impaired loans and foreclosed assets may be measured and carried at fair value, the determination of which requires management to make assumptions, estimates and judgments. At December 31, 2013, the percentage of total assets measured at fair value was 25%. See Note 24 "Fair Value" in the consolidated financial statements herein for additional disclosures regarding the fair value of our assets and liabilities.

When a loan is considered individually impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan's existing rate or at the fair value of collateral if repayment is expected solely from the collateral. In addition, foreclosed assets are carried at the lower of cost, fair value, less cost to sell, or listed selling price less cost to sell, following foreclosure. Fair value is defined by GAAP "as the price that would be received to sell an asset in an orderly transaction between market participants at the measurement date." GAAP further defines an "orderly transaction" as "a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets. It is not a forced transaction (for example, a forced liquidation or distress sale)." Although management believes its processes for determining the value of impaired loans and foreclosed properties are appropriate and allow United to arrive at a fair value, the processes require management judgment and assumptions and the value of such assets at the time they are revalued or divested may be significantly different from management's determination of fair value. In addition, because of subjectivity in fair value determinations, there may be grounds for differences in opinions, which may result in disagreements between management and the Bank's regulators, disagreements which could cause the Bank to change its judgments about fair value.

The fair values for available-for-sale and held-to-maturity securities are generally based upon quoted market prices or observable market prices for similar instruments. United utilizes a third-party pricing service to assist with determining the fair value of its securities portfolio. The pricing service uses observable inputs when available including benchmark yields, reported trades, broker-dealer quotes, issuer spreads, benchmark securities, bids and offers. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, which generally occurs due to the lack of liquidity for certain securities, the valuation of the security is subjective and may involve substantial judgment by management. As of December 31, 2013, United had $350,000 of available-for-sale securities valued using unobservable inputs. This amount represents less than .01% of total assets. United periodically reviews available-for-sale securities that are in an unrealized loss position to determine whether other-than-temporary impairment exists. An unrealized loss exists when the current fair value of an individual security is less than its amortized cost-basis. The primary factors United considers in determining whether impairment is other-than-temporary are long term expectations and recent experience regarding principal and interest payments, and United's ability and intent to hold the security until the amortized cost basis is recovered.

United uses derivatives primarily to manage interest rate risk. The fair values of derivative financial instruments are determined based on quoted market prices, dealer quotes and internal pricing models that are primarily sensitive to market observable data. United mitigates the credit risk by subjecting counterparties to credit reviews and approvals similar to those used in making loans and other extensions of credit. In addition, certain counterparties are required to provide collateral to United when their unsecured loss positions exceed certain negotiated limits.

Income Tax Accounting

Income tax liabilities or assets are established for the amount of taxes payable or refundable for the current or prior years. Deferred tax liabilities and assets are also established for the future tax consequences of events that have been recognized in the financial statements or tax returns. A deferred tax liability or asset is recognized for the estimated future tax effects attributable to temporary differences and deductions that can be carried forward
(used) in future years. The valuation of current and deferred tax liabilities and assets is considered critical as it requires management to make estimates based on provisions of the enacted tax laws. The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of regulatory agencies and federal and state taxing authorities, will not differ from management's current assessment, the impact of which could be significant to the consolidated results of operations and reported earnings.

At December 31, 2013, United reported a net deferred tax asset totaling $259 million, and a valuation allowance of $4.77 million. Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a "more likely than not" standard. United's management considers both positive and negative evidence. In making such judgments, significant weight is given to evidence that can be objectively verified.

Regulatory risk-based capital rules limit the amount of deferred tax assets that a bank or bank holding company can include in Tier 1 capital. Generally, deferred tax assets that are dependent upon future taxable income are limited to the lesser of: (i) the amount of such deferred tax assets that the bank expects to realize within one year of the calendar quarter-end date, based on its projected future taxable income for that year or (ii) 10% of the amount of the bank's Tier 1 capital.

Mergers and Acquisitions

United selectively engages in the evaluation of strategic partnerships. Mergers and acquisitions present opportunities to enter new markets with an established presence and a capable management team already in place. United employs certain criteria to ensure that any merger or acquisition candidate meets strategic growth and earnings objectives that will build future franchise value for shareholders. Additionally, the criteria include ensuring that management of a potential partner shares United's community banking philosophy of premium service quality and operates in attractive markets with excellent opportunities for further organic growth.

United will continue to evaluate potential transactions as they are presented, including acquisitions of failed banks.

GAAP Reconciliation and Explanation

This Form 10-K contains non-GAAP financial measures determined by methods other than in accordance with GAAP. Such non-GAAP financial measures include, among others, the following: taxable equivalent interest revenue, taxable equivalent net interest revenue, operating provision for loan losses, operating fee revenue, total operating revenue, operating expense, operating income (loss), operating earnings (loss) per share and operating earnings (loss) per diluted share. Management uses these non-GAAP financial measures because it believes they are useful for evaluating our operations and performance over periods of time, as well as in managing and evaluating our business and in discussions about our operations and performance. Management believes these non-GAAP financial measures provide users of our financial information with a meaningful measure for assessing our financial results and credit trends, as well as comparison to financial results for prior periods. These non-GAAP financial measures should not be considered as a substitute for operating results determined in accordance with GAAP and may not be comparable to other similarly titled financial measures used by other companies. A reconciliation of these operating performance measures to GAAP performance measures is included on the tables on pages 31 through 33.

In 2010, United recorded a non-cash goodwill impairment charge of $211 million in the third quarter. Also in 2010, United received a partial recovery of $11.8 million, net of recovery costs, in the fourth quarter resulting from fraud losses incurred in 2007 relating to two failed real estate developments near Spruce Pine, North Carolina. In 2009, United recorded non-cash goodwill impairment charges of $25 million and $70 million during the third and first quarters, respectively. In addition, United recorded severance costs of $2.9 million during the first quarter of 2009 and a bargain purchase gain on the acquisition of Southern Community Bank in the amount of $11.4 million during the second quarter of 2009.

Net operating income (loss) excludes the effect of the goodwill impairment charge of $211 million and the $11.8 million fraud loss partial recovery in 2010; the goodwill impairment charges of $95 million, the $11.4 million bargain purchase gain on acquisition, and the $2.9 million in severance costs in 2009, because management believes that the circumstances leading to those items were isolated, non-recurring events and do not reflect overall trends in United's earnings and financial performance. Management believes this non-GAAP net operating loss provides users of United's financial information with a meaningful measure for assessing United's financial results and credit trends, as well as comparison to financial results for prior periods.

The following table contains a reconciliation of net operating income to GAAP net income.

                                                                       For the Years
(in thousands, except per share                                     Ended December 31,
data; taxable equivalent)                     2013          2012           2011           2010           2009

Interest revenue reconciliation
Interest revenue - taxable equivalent      $  247,323     $ 267,667     $  304,308     $  344,493     $  404,961
Taxable equivalent adjustment                  (1,483 )      (1,690 )       (1,707 )       (2,001 )       (2,132 )
  Interest revenue (GAAP)                  $  245,840     $ 265,977     $  302,601     $  342,492     $  402,829

Net interest revenue reconciliation
Net interest revenue - taxable
equivalent                                 $  219,641     $ 229,758     $  238,670     $  244,637     $  244,834
Taxable equivalent adjustment                  (1,483 )      (1,690 )       (1,707 )       (2,001 )       (2,132 )
  Net interest revenue (GAAP)              $  218,158     $ 228,068     $  236,963     $  242,636     $  242,702

Provision for credit losses
reconciliation
Operating provision for credit losses      $   65,500     $  62,500     $  251,000     $  234,750     $  310,000
Partial recovery of special
fraud-related loan loss                             -             -              -        (11,750 )            -
  Provision for credit losses (GAAP)       $   65,500     $  62,500     $  251,000     $  223,000     $  310,000

Fee revenue reconciliation
Operating fee revenue                      $   56,598     $  56,112     $   44,907     $   46,963     $   51,357
Gain from acquisition                               -             -              -              -         11,390
  Fee revenue (GAAP)                       $   56,598     $  56,112     $   44,907     $   46,963     $   62,747

Total revenue reconciliation
Total operating revenue                    $  210,739     $ 223,370     $   32,577     $   56,850     $  (13,809 )
Taxable equivalent adjustment                  (1,483 )      (1,690 )       (1,707 )       (2,001 )       (2,132 )
Gain from acquisition                               -             -              -              -         11,390
Partial recovery of special
fraud-related loan loss                             -             -              -         11,750              -
  Total revenue (GAAP)                     $  209,256     $ 221,680     $   30,870     $   66,599     $   (4,551 )

Expense reconciliation
Operating expense                          $  174,304     $ 186,774     $  261,599     $  288,301     $  217,050
Noncash goodwill impairment charge                  -             -              -        210,590         95,000
Severance costs                                     -             -              -              -          2,898
  Operating expense (GAAP)                 $  174,304     $ 186,774     $  261,599     $  498,891     $  314,948

Income (loss) before taxes
reconciliation
Income (loss) before taxes                 $   36,435     $  36,596     $ (229,022 )   $ (231,451 )   $ (230,859 )
Taxable equivalent adjustment                  (1,483 )      (1,690 )       (1,707 )       (2,001 )       (2,132 )
Gain from acquisition                               -             -              -              -         11,390
Noncash goodwill impairment charge                  -             -              -       (210,590 )      (95,000 )
Severance costs                                     -             -              -              -         (2,898 )
Partial recovery of special
fraud-related loan loss                             -             -              -         11,750              -
  Income (loss) before taxes (GAAP)        $   34,952     $  34,906     $ (230,729 )   $ (432,292 )   $ (319,499 )

Income tax expense (benefit)
reconciliation
Income tax expense (benefit)               $ (236,705 )   $   2,740     $   (2,276 )   $   73,218     $  (91,754 )
Taxable equivalent adjustment                  (1,483 )      (1,690 )       (1,707 )       (2,001 )       (2,132 )
. . .
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