SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2017
Commission File Number 001-35095
UNITED COMMUNITY BANKS, INC.
(Exact name of registrant as specified in its charter)
|(State or other jurisdiction of incorporation or organization)||(I.R.S. Employer Identification No.)|
|125 Highway 515 East, Blairsville, Georgia||30512|
|(Address of principal executive offices)||(Zip Code)|
Registrant’s telephone number, including area code: (706) 781-2265
Securities registered pursuant to Section 12(b) of the Act: None
Name of exchange on which registered: Nasdaq Global Select
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $1.00 par value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Sections 13 or 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):
|Large accelerated filer x||Accelerated filer ¨|
|Non-accelerated filer ¨ (Do not check if a smaller reporting company)||Smaller Reporting Company ¨|
|Emerging growth company ¨|
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 7(a)(2)(B) of the Securities Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $1,947,033,771 (based on shares held by non-affiliates at $27.80 per share, the closing stock price on the Nasdaq stock market on June 30, 2017).
As of February 1, 2018, 79,110,975 shares of common stock were issued and outstanding. Also outstanding were presently exercisable options to acquire 53,287 shares, presently exercisable warrants to acquire 219,909 shares and 599,932 shares issuable under United Community Banks, Inc.’s deferred compensation plan.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s Proxy Statement for the 2018 Annual Meeting of Shareholders are incorporated herein into Part III by reference.
|Item 1A.||Risk Factors||18|
|Item 1B.||Unresolved Staff Comments||25|
|Item 3.||Legal Proceedings||25|
|Item 4.||Mine Safety Disclosures||25|
|Item 5.||Market for United’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities||26|
|Item 6.||Selected Financial Data||28|
|Item 7.||Management’s Discussion and Analysis of Financial Condition and Results of Operations||30|
|Item 7A.||Quantitative and Qualitative Disclosures About Market Risk||58|
|Item 8.||Financial Statements and Supplementary Data||59|
|Item 9.||Changes in and Disagreements with Accountants on Accounting and Financial Disclosure||131|
|Item 9A.||Controls and Procedures||131|
|Item 9B.||Other Information||131|
|Item 10.||Directors, Executive Officers and Corporate Governance||132|
|Item 11.||Executive Compensation||132|
|Item 12.||Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters||132|
|Item 13.||Certain Relationships and Related Transactions, and Director Independence||132|
|Item 14.||Principal Accounting Fees and Services||132|
|Item 15.||Exhibits, Financial Statement Schedules||133|
|Item 16.||Form 10-K Summary||136|
United Community Banks, Inc. (“United”), a bank holding company registered under the Bank Holding Company Act of 1956, as amended (the “BHC Act”), was incorporated under the laws of Georgia in 1987 and commenced operations in 1988 by acquiring 100% of the outstanding shares of Union County Bank, Blairsville, Georgia, now known as United Community Bank, Blairsville, Georgia (the “Bank”).
Since the early 1990s, United has actively expanded its market coverage through organic growth complemented by selective acquisitions, primarily of banks whose managements share United’s community banking and customer service philosophies. Although those acquisitions have directly contributed to United’s growth, their contribution has primarily been to provide United access to new markets with attractive organic growth potential. Organic growth in assets includes growth through existing offices as well as growth at de novo locations and post-acquisition growth at acquired banking offices.
To emphasize its commitment to community banking, United conducts substantially all of its operations through a community-focused operating model of separate “community banks”, which as of December 31, 2017, operated at 156 locations throughout markets in Georgia, South Carolina, North Carolina, and Tennessee. The community banks offer a full range of retail and corporate banking services, including checking, savings and time deposit accounts, secured and unsecured loans, wire transfers, brokerage services and other financial services, and are led by local bank presidents (referred to herein as the “Community Bank Presidents”) and management with significant experience in, and ties to, their communities. Each of the Community Bank Presidents has authority, alone or with other local officers, to make most credit decisions. In recent years, United has developed a number of specialized lending areas focusing on asset-based lending, commercial real estate, middle market businesses, United States Small Business Administration (“SBA”) and United States Department of Agriculture (“USDA”) guaranteed loans, senior living, builder finance and renewable energy. Although the specialized lending areas have their own customers, they also work with the community banks to provide their specialized lending expertise to better serve their customers. This partnership helps United position itself as a community bank with large bank resources. Management believes that this operating model provides a competitive advantage.
The Bank, through its full-service retail mortgage lending division, United Community Mortgage Services (“UCMS”), is approved as a seller/servicer for the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and provides fixed and adjustable-rate home mortgages. During 2017, the Bank originated $745 million of residential mortgage loans throughout its footprint in Georgia, North Carolina, Tennessee and South Carolina for the purchase of homes and to refinance existing mortgage debt. The majority of these mortgages were sold into the secondary market without recourse to the Bank, other than for breaches of warranties. With the acquisition of The Palmetto Bank in late 2015, United began retaining the servicing on most of its mortgage production. United’s residential mortgage servicing portfolio included $847 million in loans at December 31, 2017.
The Bank owns an insurance agency, United Community Insurance Services, Inc. (“UCIS”), known as United Community Advisory Services, which is a subsidiary of the Bank. United also owns a captive insurance subsidiary, United Community Risk Management Services, Inc. (“UCRMSI”) that provides risk management services for United’s subsidiaries. Another Bank subsidiary, United Community Payment Systems, LLC (“UCPS”), provides payment processing services for the Bank’s commercial and small business customers. UCPS is a joint venture with Security Card Services, LLC, a merchant services provider headquartered in Oxford, Mississippi and owned by First Data Corporation.
United produces fee revenue through its sale of non-deposit investment products. Those products are sold by employees of United who are licensed financial advisors doing business as United Community Advisory Services. United has an affiliation with a third party broker/dealer, Linsco Private Ledger, to facilitate this line of business.
This Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, (the “Securities Act’), and Section 21E of the Securities Exchange Act of 1934, (the “Exchange Act”), about United and its subsidiaries. These forward-looking statements are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not statements of historical fact, and can be identified by the use of forward-looking terminology such as “believes”, “expects”, “may”, “will”, “could”, “should”, “projects”, “plans”, “goal”, “targets”, “potential”, “estimates”, “pro forma”, “seeks”, “intends”, or “anticipates” or the negative thereof or comparable terminology. Forward-looking statements include discussions of strategy, financial projections, guidance and estimates (including their underlying assumptions), statements regarding plans, objectives, expectations or consequences of various transactions, and statements about the future performance, operations, products and services of United and its subsidiaries. We caution our shareholders and other readers not to place undue reliance on such statements.
Our businesses and operations are and will be subject to a variety of risks, uncertainties and other factors. Consequently, actual results and experience may materially differ from those contained in any forward-looking statements. Such risks, uncertainties and other factors that could cause actual results and experience to differ from those projected include, but are not limited to, the following factors:
|·||the condition of the general business and economic environment;|
|·||the results of our internal credit stress tests may not accurately predict the impact on our financial condition if the economy were to deteriorate;|
|·||our ability to maintain profitability;|
|·||our ability to fully realize the balance of our net deferred tax asset, including net operating loss carryforwards;|
|·||the impact of lower federal income tax rates on the carrying amount of our deferred tax asset;|
|·||the impact of the Tax Cuts and Jobs Act of 2017 and related regulations (the “Tax Act”);|
|·||the risk that we may be required to increase the valuation allowance on our net deferred tax asset in future periods;|
|·||the condition of the banking system and financial markets;|
|·||our ability to raise capital;|
|·||our ability to maintain liquidity or access other sources of funding;|
|·||changes in the cost and availability of funding;|
|·||the success of the local economies in which we operate;|
|·||our lack of geographic diversification;|
|·||our concentrations of residential and commercial construction and development loans and commercial real estate loans are subject to unique risks that could adversely affect our earnings;|
|·||changes in prevailing interest rates may negatively affect our net income and the value of our assets and other interest rate risks;|
|·||our accounting and reporting policies;|
|·||if our allowance for loan losses is not sufficient to cover actual loan losses;|
|·||losses due to fraudulent and negligent conduct of our loan customers, third party service providers or employees;|
|·||risks related to our communications and information systems, including risks with respect to cybersecurity breaches;|
|·||our reliance on third parties to provide key components of our business infrastructure and services required to operate our business;|
|·||competition from financial institutions and other financial service providers;|
|·||risks with respect to our ability to successfully expand and complete acquisitions and integrate businesses and operations that are acquired;|
|·||deteriorating conditions in the stock market, the public debt market and other capital markets;|
|·||the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and related regulations (the “Dodd-Frank Act”);|
|·||changes in laws and regulations or failures to comply with such laws and regulations;|
|·||changes in regulatory capital and other requirements;|
|·||the costs and effects of litigation, examinations, investigations, or similar matters, or adverse facts and developments related thereto;|
|·||possible regulatory or judicial proceedings, board resolutions, informal memorandums of understanding or formal enforcement actions imposed by regulators;|
|·||changes in tax laws, regulations and interpretations or challenges to our income tax provision; and|
|·||our ability to maintain effective internal controls over financial reporting and disclosure controls and procedures.|
Additional information with respect to factors that may cause actual results to differ materially from those contemplated by such forward-looking statements may also be included in other reports that United files with the Securities and Exchange Commission (the “SEC”). United cautions that the foregoing list of factors is not exclusive, and not to place undue reliance on forward-looking statements. United does not intend to update any forward-looking statement, whether written or oral, relating to the matters discussed in this Form 10-K.
The financial statements and information contained herein have not been reviewed, or confirmed for accuracy or relevance, by the Federal Deposit Insurance Corporation (the “FDIC”).
Monetary Policy and Economic Conditions
United’s profitability depends to a substantial extent on the difference between interest revenue received from loans, investments, and other earning assets, and the interest paid on deposits and other liabilities. These rates are highly sensitive to many factors that are beyond the control of United, including national and international economic conditions and the monetary policies of various governmental and regulatory authorities, particularly the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits.
The market for banking and bank-related services is highly competitive. United actively competes in its market areas, which include both rural and metropolitan parts of Georgia, North Carolina, Tennessee and South Carolina, with other providers of deposit and credit services. These competitors include other commercial banks, savings banks, savings and loan associations, credit unions, mortgage companies, financial technology companies and brokerage firms.
The tables on the following pages display the respective percentage of total bank and thrift deposits for the last five years in each county where the Bank has deposit operations. The tables also indicate the Bank’s ranking by deposit size in each county. All information in the tables was obtained from the FDIC Summary of Deposits as of June 30 of each year. The following information only shows market share in deposit gathering, which may not be indicative of market presence in other areas.
|Share of Local Deposit Markets by County - Banks and Savings Institutions|
|Market Share||Rank in Market|
|Atlanta, Georgia MSA|
|Gainesville, Georgia MSA|
|Share of Local Deposit Markets by County - Banks and Savings Institutions, continued|
|Market Share||Rank in Market|
The Bank makes both secured and unsecured loans to individuals and businesses. Secured loans include first and second real estate mortgage loans and commercial loans secured by non-real estate assets. The Bank also makes direct loans to consumers on both a secured and unsecured basis.
Specific risk elements associated with the Bank’s lending categories include, but are not limited to:
|Commercial real estate - owner occupied||25||%||General economic conditions; consumer spending; effect of rising interest rates; market's loosening of credit underwriting standards and structures; and business confidence.|
|Commercial real estate - income producing||21||%||Effect of rising interest rates, supply and demand of property type; consumer sentiment; business confidence; effect of financial markets, general economic conditions in the U.S and abroad and recovery of operating fundamentals.|
|Commercial and industrial||15||%||Industry concentrations; inability to monitor the condition of collateral (inventory, accounts receivable and other non-real estate assets); use of specialized or obsolete equipment as collateral; insufficient cash flow from operations to service debt payments; declines in general economic conditions.|
|Commercial construction||9||%||Effect of rising interest rates; changes in market demand for property; deterioration of operating fundamentals; market's loosening of credit underwriting standards and structures; and fluctuations in both the debt and equity markets.|
|Residential mortgage||13||%||Loan portfolio concentrations; changes in general economic conditions or in the local economy; loss of borrower’s employment; insufficient collateral value due to decline in property value; rising interest rates; and consumer sentiment.|
|Home equity lines of credit||9||%||Unemployment and underemployment levels; rise in interest rates; household income growth; declining home values reducing the amount of equity; lines of credit nearing their "end-of-draw" period; effect of tax reform on interest deductibility.|
|Residential construction||2||%||Inadequate long-term financing arrangements; inventory levels; cost overruns, changes in market demand for property; rising interest rates.|
|Consumer direct||2||%||Consumer sentiment; elevated umemployment and underemployment in many of our local markets; household income stagnation; and increases in consumer prices.|
|Indirect auto||4||%||Consumer sentiment; unemployment and underemployment levels; rise in interest rates; increases in consumer prices; decline in household income and loosening of credit structures; decline in vehicle values.|
The Bank makes loans primarily to persons or businesses that reside, work, own property, or operate in its primary market areas, except for specific lending strategies such as SBA and franchise lending. Unsecured loans are generally made only to persons who qualify for such credit based on their credit history, net worth, income and liquidity. Secured loans are made to persons who are well established and have the credit history, net worth, collateral, and cash flow to support the loan. Exceptions to the Bank’s policies are permitted on a case-by-case basis. Major policy exceptions require an approving officer to document the reason for the exception. Loans exceeding a lending officer’s credit limit must be approved through a credit approval process involving Regional Credit Managers. Consumer loans are approved through centralized consumer credit centers.
United’s Credit Administration department provides each lending officer with written guidelines for lending activities as approved by the Bank’s Board of Directors. Limited lending authority is delegated to lending officers as authorized by the Bank’s Board of Directors. Loans in excess of individual officer credit authority must be approved by a senior officer with sufficient approval authority delegated by Credit Administration as authorized by the Bank’s Board of Directors. The Senior Credit Committee approves loans where the total relationship exposure exceeds $8.5 million. At December 31, 2017, the Bank’s secured legal lending limit was $293 million; however, the Board of Directors has established an internal lending guideline of $30 million and an individual real estate project guideline of $18 million.
United utilizes its Regional Credit Managers and Senior Credit Officers to provide credit administration support for commercial loans to the Bank as needed. The Regional Credit Managers have lending authority set by Credit Administration based on characteristics of the markets they serve. The Regional Credit Managers also provide credit underwriting support as needed by the community banks they serve. For commercial loans less than $250,000, United utilizes a centralized small business lending/underwriting department.
Consumer Credit Center
United has a centralized consumer credit center that provides underwriting, regulatory disclosure and document preparation for all consumer loan requests originated by the bank’s market lenders. Applications are processed through an automated loan origination software platform and decisioned by the credit center underwriters.
Loan Review and Nonperforming Assets
United’s Loan Review Department reviews, or engages an independent third party to review, the Bank’s loan portfolio on an ongoing basis to identify any weaknesses in the portfolio and to assess the general quality of credit underwriting. The results of such reviews are presented to Executive Management, the Community Bankers, Commercial Banking Solutions, Credit Administration Management and the Risk Committee of the Board of Directors. If an individual borrower has a significant weakness identified during the review process, the risk rating of the loans to that borrower will be downgraded to the classification that most closely matches the current risk level. The review process also provides for the upgrade of loans that show improvement since the last review. Since each borrower in a credit relationship may have a different credit structure, source of repayment and guarantors, loans to different borrowers in a relationship can be assigned different risk ratings. United adopted a dual risk rating system for commercial loans whereby risk is defined at the obligor level and the facility level. The obligor risk rating assigns a rating based on qualitative and quantitative metrics that measure the financial viability of the borrower which is an estimate of the probability that the borrower will default. The facility risk rating considers the loss protection provided by assigned collateral factoring in control and the loan-to-value ratio. This rating estimates the probability of loss once the borrower has defaulted.
Under United’s 10-tier loan grading system for commercial loans, grades 1 through 6 are considered “pass” (acceptable) credit risk, grade 7 is a “watch” rating, and grades 8 through 10 are “adversely classified” credits that require management’s attention. The entire 10-grade rating scale provides for a higher numeric rating for increased risk. For example, a risk rating of 1 is the least risky of all credits and would be typical of an investment grade borrower. Risk ratings of 2 through 6 in the pass category each have incrementally more risk. The four criticized list credit ratings and rating definitions are:
|7 (Watch)||Loans in this category are presently protected from apparent loss; however weaknesses exist that could cause future impairment, including the deterioration of financial ratios, past due status and questionable management capabilities. These loans require more than the ordinary amount of supervision. Collateral values generally afford adequate coverage, but may not be immediately marketable.|
|8 (Substandard)||These loans are inadequately protected by the current net worth and paying capacity of the obligor or by the collateral pledged. Specific and well-defined weaknesses exist that may include poor liquidity and deterioration of financial ratios. The loan may be past due and related deposit accounts experiencing overdrafts. There is the distinct possibility that United will sustain some loss if deficiencies are not corrected. If possible, immediate corrective action is taken.|
|9 (Doubtful)||Specific weaknesses characterized as Substandard that are severe enough to make collection in full highly questionable and improbable. There is no reliable secondary source of full repayment.|
|10 (Loss)||Loans categorized as Loss have the same characteristics as Doubtful, however, loss is certain. Loans classified as Loss are charged-off.|
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans. Consumer loans are part of a pass / fail grading system designed to segment loans based upon the risk of default resulting in a loss to the Bank. Specifically, a failed credit will be a loan that has an increased risk of default that could result in a loss to the Bank.
In addition, Credit Administration, with supervision and input from the Accounting Department, prepares a quarterly analysis to determine the adequacy of the Allowance for Credit Losses (“ACL”). The ACL is comprised of the allowance for loan losses and the allowance for unfunded commitments. The allowance for loan losses analysis starts with total loans and subtracts loans fully secured by deposit accounts at the Bank and the portion of loans guaranteed by the SBA or USDA, which have minimal risk of loss other than fraud-related losses. Next, all loans that are considered individually impaired are reviewed and assigned a specific reserve if one is warranted. Most collateral dependent nonaccrual loans with specific reserves are charged down to net realizable value of the underlying collateral. The remaining loan balance for each major loan category is then multiplied by its respective estimated loss factor. Loss factors for these loans are estimated and determined based on historical loss experience by type of loan. United multiplies the annualized loss factor by the calculated loss emergence period in order to quantify the estimated incurred losses in the loan portfolio. The loss emergence period is determined for each category of loans based on the average length of time between when a loan first becomes more than 30 days past due and when that loan is ultimately charged off. Management’s use of the loss emergence period is an estimate of the period of time from the first evidence of loss incurrence through the period of time until such losses are confirmed (or charged-off). Previously, United reported an unallocated portion of the allowance which was maintained due to imprecision in estimating loss factors and loss emergence periods, and economic and other conditions that cannot be entirely quantified in the analysis. With the incorporation of the loss emergence period into United’s allowance methodology in the first quarter of 2014, the previously unallocated balance has been allocated to other components of the allowance for loan losses.
United’s Asset Liability Management Committee (“ALCO”) is composed of executive and other officers and the Treasurer of United. ALCO’s primary role is to balance asset growth and income generation with the prudent management of interest rate risk, market risk and liquidity risk and with the need to maintain appropriate levels of capital. ALCO directs the Bank’s overall balance sheet strategy, including the acquisition and investment of funds. At regular meetings, ALCO reviews the interest rate sensitivity and liquidity positions, including stress scenarios, the net interest margin, the investment portfolio, the funding mix and other variables, such as regulatory changes, monetary policy adjustments and the overall state of the economy. A more comprehensive discussion of United’s asset/liability management and interest rate risk is contained in the Management’s Discussion and Analysis (Part II, Item 7) and Quantitative and Qualitative Disclosures About Market Risk (Part II, Item 7A) sections of this report.
United’s investment portfolio policy is to balance income generation with liquidity, interest rate sensitivity, pledging and regulatory needs. The Chief Financial Officer and the Treasurer of United administer the policy, and it is reviewed from time to time by United’s ALCO and the Board of Directors. Portfolio activity, composition, and performance are reviewed and approved periodically by United’s Board of Directors and Risk Committee thereof.
As of December 31, 2017, United and its subsidiaries had 2,137 full-time equivalent employees. Neither United nor any of its subsidiaries are a party to any collective bargaining agreement and management believes that employee relations are good.
United’s Internet website address is www.ucbi.com. United makes available free of charge through its website Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to those reports, as soon as reasonably practicable after they are filed with, or furnished to, the SEC.
Supervision and Regulation
The following is an explanation of the supervision and regulation of United and the Bank as financial institutions. This explanation does not purport to describe state, federal or Nasdaq Stock Market supervision and regulation of general business corporations or Nasdaq listed companies.
General. United is a registered bank holding company subject to regulation by the Federal Reserve under the BHC Act. United is required to file annual and quarterly financial information with the Federal Reserve and is subject to periodic examination by the Federal Reserve.
The BHC Act requires every bank holding company to obtain the Federal Reserve’s prior approval before (1) it may acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank that it does not already control; (2) it or any of its non-bank subsidiaries may acquire all or substantially all of the assets of a bank; and (3) it may merge or consolidate with any other bank holding company. In addition, a bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of the voting shares of any company engaged in non-banking activities. This prohibition does not apply to activities listed in the BHC Act or found by the Federal Reserve, by order or regulation, to be closely related to banking or managing or controlling banks as to be a proper incident thereto.
Some of the activities that the Federal Reserve has determined by regulation or order to be closely related to banking are:
|·||making or servicing loans and certain types of leases;|
|·||performing certain data processing services;|
|·||acting as fiduciary or investment or financial advisor;|
|·||providing brokerage services;|
|·||underwriting bank eligible securities;|
|·||underwriting debt and equity securities on a limited basis through separately capitalized subsidiaries; and|
|·||making investments in corporations or projects designed primarily to promote community welfare.|
Although the activities of bank holding companies have traditionally been limited to the business of banking and activities closely related or incidental to banking (as discussed above), the Gramm-Leach-Bliley Act (the “GLB Act”) relaxed the previous limitations and permitted bank holding companies to engage in a broader range of financial activities. Specifically, bank holding companies may elect to become financial holding companies which may affiliate with securities firms and insurance companies and engage in other activities that are financial in nature. Among the activities that are deemed “financial in nature” include:
|·||lending, exchanging, transferring, investing for others or safeguarding money or securities;|
|·||insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker with respect thereto;|
|·||providing financial, investment, or economic advisory services, including advising an investment company;|
|·||issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly; and|
|·||underwriting, dealing in or making a market in securities.|
Under this legislation, the Federal Reserve serves as the primary “umbrella” regulator of financial holding companies with supervisory authority over each parent company and limited authority over its subsidiaries. The primary regulator of each subsidiary of a financial holding company will depend on the type of activity conducted by the subsidiary. For example, broker-dealer subsidiaries will be regulated largely by securities regulators and insurance subsidiaries will be regulated largely by insurance authorities.
United has no current plans to register as a financial holding company.
United must also register with the Georgia Department of Banking and Finance (the “DBF”) and file periodic information with the DBF. As part of such registration, the DBF requires information with respect to the financial condition, operations, management and intercompany relationship of United and the Bank and related matters. The DBF may also require such other information as is necessary to keep itself informed concerning compliance with Georgia law and the regulations and orders issued thereunder by the DBF, and the DBF may examine United and the Bank. Although the Bank operates branches in North Carolina, Tennessee and South Carolina; neither the North Carolina Banking Commission, the Tennessee Department of Financial Institutions, nor the South Carolina Commissioner of Banking examines or directly regulates out-of-state holding companies.
United is an “affiliate” of the Bank under the Federal Reserve Act, which imposes certain restrictions on (1) loans by the Bank to United, (2) investments in the stock or securities of United by the Bank, (3) the Bank taking the stock or securities of an “affiliate” as collateral for loans by the Bank to a borrower, and (4) the purchase of assets from United by the Bank. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services.
The Bank and each of its subsidiaries are regularly examined by the FDIC. The Bank, as a state banking association organized under Georgia law, is subject to the supervision of, and is regularly examined by, the DBF. Both the FDIC and the DBF must grant prior approval of any merger, consolidation or other corporation reorganization involving the Bank.
The Dodd-Frank Act was enacted in 2010, and resulted in sweeping changes in the regulation of financial institutions aimed at strengthening the sound operation of the financial services sector. In 2017, both the House of Representatives and the Senate introduced legislation that would repeal or modify provisions of the Dodd-Frank Act and significantly impact financial services regulation. Although the bills vary in content, certain key aspects include revisions to rules related to mortgage loans, delayed implementation of rules related to the Home Mortgage Disclosure Act, reform and simplification of certain Volcker Rule requirements, and raising the threshold for applying enhanced prudential standards to bank holding companies with total consolidated assets equal to or greater than $50 billion to those with total consolidated assets equal to or greater than $250 billion.
Payment of Dividends. United is a legal entity separate and distinct from the Bank. Most of the revenue of United results from dividends paid to it by the Bank. There are statutory and regulatory requirements applicable to the payment of dividends by the Bank, as well as by United to its shareholders.
Under the regulations of the DBF, a state bank with an accumulated deficit (negative retained earnings) may declare dividends (reduction in capital) by first obtaining the written permission of the DBF and FDIC. If a state bank has positive retained earnings, it may declare a dividend without DBF approval if it meets all the following requirements:
|(a)||total classified assets as of the most recent examination of the bank do not exceed 80% of equity capital (as defined by regulation);|
|(b)||the aggregate amount of dividends declared or anticipated to be declared in the calendar year does not exceed 50% of the net profits after taxes but before dividends for the previous calendar year; and|
|(c)||the ratio of equity capital to adjusted assets is not less than 6%.|
The payment of dividends by United and the Bank may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending upon the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The FDIC has issued a policy statement providing that insured banks should generally only pay dividends out of current operating earnings. In addition to the formal statutes and regulations, regulatory authorities consider the adequacy of the Bank’s total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends from the Bank.
Under the Federal Reserve’s Comprehensive Capital Analysis and Review (“CCAR”) Rules, bank holding companies with $50 billion or more of total assets are required to submit annual capital plans to the Federal Reserve and generally may pay dividends and repurchase stock only under a capital plan as to which the Federal Reserve has not objected. The CCAR rules will not apply to United for so long as our total consolidated assets remain below $50 billion. However, it is anticipated that United’s capital ratios will be important factors considered by the Federal Reserve in evaluating whether proposed payments of dividends or stock repurchases may be an unsafe or unsound practice.
Due to its accumulated deficit, the Bank must receive pre-approval from the DBF and FDIC to pay cash dividends (reduction in capital) to United in 2018. In 2017, 2016 and 2015, the Bank paid a cash dividend of $103 million, $41.5 million and $77.5 million, respectively, to United after the approval of the DBF and FDIC. The dividends were paid out of capital surplus rather than the accumulated deficit. At December 31, 2017, the remaining accumulated deficit for the Bank was $162 million. United declared cash dividends on its common stock in 2017, 2016 and 2015 of 38 cents, 30 cents and 22 cents per share, respectively.
Capital Adequacy. Banks and bank holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Capital adequacy guidelines involve quantitative measures of assets, liabilities and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.
The Federal Reserve and the FDIC have implemented substantially identical risk-based rules for assessing bank and bank holding company capital adequacy. These regulations establish minimum capital standards in relation to assets and off-balance sheet exposures as adjusted for credit risk. “Total capital” is composed of Tier 1 capital and Tier 2 capital. “Tier 1 capital” includes common equity, retained earnings, qualifying non-cumulative perpetual preferred stock, a limited amount of qualifying cumulative perpetual stock at the holding company level, minority interests in equity accounts of consolidated subsidiaries, less goodwill, most intangible assets and certain other assets. “Tier 2 capital” includes, among other things, perpetual preferred stock and related surplus not meeting the Tier 1 capital definition, qualifying mandatorily convertible debt securities, qualifying subordinated debt and allowances for possible loan and lease losses, subject to limitations. The Federal Reserve and the FDIC use the leverage ratio in tandem with the risk-based ratio to assess the capital adequacy of banks and bank holding companies. The Federal Reserve will require a bank holding company to maintain a leverage ratio well above minimum levels if it is experiencing or anticipating significant growth or is operating with less than well-diversified risks in the opinion of the Federal Reserve. The FDIC, the Office of the Comptroller of the Currency (the “OCC”) and the Federal Reserve also require banks to maintain capital well above minimum levels.
In July 2013, the Federal Reserve published the Basel III Capital Rules establishing a new comprehensive capital framework applicable to all depository institutions, bank holding companies with total consolidated assets of $500 million or more and all and savings and loan holding companies except for those that are substantially engaged in insurance underwriting or commercial activities (collectively, “banking organizations”). The rules implement the December 2010 framework proposed by the Basel Committee on Banking Supervision (the “Basel Committee”), known as “Basel III”, for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act.
The Basel III Capital Rules substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions, including United and the Bank, compared to the prior U.S. risk-based capital rules. The Basel III Capital Rules:
|·||defined the components of capital and address other issues affecting the numerator in banking institutions’ regulatory capital ratios;|
|·||addressed risk weights and other issues affecting the denominator in banking institutions’ regulatory capital ratios and replaced the prior risk-weighting approach, which was derived from the Basel I capital accords of the Basel Committee, with a more risk-sensitive approach based, in part, on the standardized approach in the Basel Committee’s 2004 “Basel II” capital accords;|
|·||introduced a new capital measure called “common equity Tier 1” (“CET1”);|
|·||specified that Tier 1 capital consists of CET1 and “additional Tier 1 capital” instruments meeting specified requirements; and|
|·||implemented the requirements of Section 939A of the Dodd-Frank Act to remove references to credit ratings from the federal banking agencies’ rules.|
The Basel III Capital Rules became effective for United and the Bank on January 1, 2015, subject to a phase in period.
The Basel III Capital Rules require United and the Bank to maintain:
|·||a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a “capital conservation buffer” (which is added to the 4.5% CET1 ratio as that buffer is phased in over four years to 2.5%, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation);|
|·||a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6%, plus the capital conservation buffer (which is added to the 6% Tier 1 capital ratio as that buffer is phased in over four years to 2.5%, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation);|
|·||a minimum ratio of total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8%, plus the capital conservation buffer (which is added to the 8% total capital ratio as that buffer is phased in over four years to 2.5%, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation); and|
|·||a minimum leverage ratio of 4%, calculated as the ratio of Tier 1 capital to average assets.|
In addition, Section 38 of the Federal Deposit Insurance Act implemented the prompt corrective action provisions that Congress enacted as a part of the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “1991 Act”). The “prompt corrective action” provisions set forth five regulatory zones in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a bank’s financial condition declines. The FDIC is required to resolve a bank when its ratio of tangible equity to total assets reaches 2%. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with lesser amounts of capital.
The FDIC has adopted regulations implementing the prompt corrective action provisions of the 1991 Act, as revised by the Basel III Capital Rules effective January 1, 2015, which place financial institutions in the following five categories based upon capitalization ratios: (1) a “well-capitalized” institution has a Total risk-based capital ratio of at least 10%, a Tier 1 risk-based ratio of at least 8%, a CET1 risk-based ratio of 6.5% and a leverage ratio of at least 5%; (2) an “adequately capitalized” institution has a Total risk-based capital ratio of at least 8%, a Tier 1 risk-based ratio of at least 6%, a CET1 risk-based ratio of 4.5% and a leverage ratio of at least 4%; (3) an “undercapitalized” institution has a Total risk-based capital ratio of under 8%, a Tier 1 risk-based ratio of under 6%, a CET1 risk-based ratio of under 4.5% or a leverage ratio of under 4%; (4) a “significantly undercapitalized” institution has a Total risk-based capital ratio of under 6%, a Tier 1 risk-based ratio of under 4%, a CET1 risk-based ratio of under 3% or a leverage ratio of under 3%; and (5) a “critically undercapitalized” institution has a ratio of tangible equity to total assets of 2% or less. Institutions in any of the three undercapitalized categories would be prohibited from declaring dividends or making capital distributions. The FDIC regulations also allow it to “downgrade” an institution to a lower capital category based on supervisory factors other than capital.
As of December 31, 2017, the FDIC categorized the Bank as “well-capitalized” under current regulations.
The Basel III Capital Rules provide for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Under prior capital standards, the effects of accumulated other comprehensive income items included in capital were excluded for the purposes of determining regulatory capital ratios. Under the Basel III Capital Rules, the effects of certain accumulated other comprehensive items are not excluded; however, certain banking organizations, including United and the Bank, may make a one-time permanent election to continue to exclude these items. United and the Bank made this election in first quarter 2015 in order to avoid significant variations in the level of capital depending upon the impact of interest rate fluctuations on the fair value of United’s available-for-sale securities portfolio. The Basel III Capital Rules also eliminate the inclusion of certain instruments, such as trust preferred securities, from Tier 1 capital of bank holding companies. Instruments issued prior to May 19, 2010 are grandfathered for bank holding companies with consolidated assets of $15 billion or less (subject to the 25% of Tier 1 capital limit).
The “capital conservation buffer” is designed to absorb losses during periods of economic stress. Banking organizations with a ratio of CET1 to risk-weighted assets above the minimum but below the conservation buffer (or below the combined capital conservation buffer and countercyclical capital buffer, when the latter is applied) will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.
Implementation of the deductions and other adjustments to CET1 began on January 1, 2015 and will be phased-in over a four-year period (beginning at 40% on January 1, 2015 and an additional 20% per year thereafter). The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a four-year period increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019.
The Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories. Consistent with the Dodd-Frank Act, the Basel III Capital Rules replace the ratings-based approach to securitization exposures, which is based on external credit ratings, with the simplified supervisory formula approach in order to determine the appropriate risk weights for these exposures. Alternatively, banking organizations may use the existing gross-up approach to assign securitization exposures to a risk weight category or choose to assign such exposures a 1,250% risk weight. In addition, the Basel III Capital Rules provide more advantageous risk weights for derivatives and repurchase-style transactions cleared through a qualifying central counterparty and increase the scope of eligible guarantors and eligible collateral for purposes of credit risk mitigation.
Management believes that, as of December 31, 2017, United and the Bank would meet all capital adequacy requirements under the Basel III Capital Rules on a fully phased-in basis as if such requirements were currently in effect.
In November 2017, the federal banking agencies adopted a final rule to extend the regulatory capital treatment applicable during 2017 under the capital rules for certain items, including regulatory capital deductions, risk weights, and certain minority interest limitations. The relief provided under the final rule applies to banking organizations that are not subject to the capital rules’ advanced approaches, such as United. Specifically, the final rule extends the current regulatory capital treatment of mortgage servicing assets, deferred tax assets arising from temporary differenes that could not be realized through net operating loss carrybacks, significant investments in the capital of unconsolidated financial institutions in the form of common stock, non-significant investments in the capital of unconsolidated financial institutions, significant investments in the capital of unconsolidated financial institutions that are not in the form of common stock, and common equity tier 1 minority interest, tier 1 minority interest, and total capital minority interest exceeding the capital rules’ minority interest limitations.
In December 2017, the Basel Committee on Banking Supervision published the last version of the Basel III accord, generally referred to as “Basel IV.” The Basel Committee stated that a key objective of the revisions incorporated into the framework is to reduce excessive variability of risk-weighted assets (“RWA”), which will be accomplished by enhancing the robustness and risk sensitivity of the standardized approaches for credit risk and operational risk, which will facilitate the comparability of banks’ capital ratios; constraining the use of internally modeled approaches; and complementing the risk-weighted capital ratio with a finalized leverage ratio and a revised and robust capital floor. Leadership of the federal banking agencies who are tasked with implementing Basel IV, supported the revisions. Although it is uncertain at this time, we anticipate some, if not all, of the Basel IV accord may be incorporated into the capital requirements framework applicable to United.
Consumer Protection Laws. The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (“CFPB”), and giving it the power to promulgate and enforce federal consumer protection laws. Depository institutions are subject to the CFPB’s rule writing authority, and existing federal bank regulatory agencies retain examination and enforcement authority for such institutions. The CFPB and United’s existing federal regulator, the FDIC, are focused on the following:
|·||risks to consumers and compliance with the federal consumer financial laws;|
|·||the markets in which firms operate and risks to consumers posed by activities in those markets;|
|·||depository institutions that offer a wide variety of consumer financial products and services;|
|·||depository institutions with a more specialized focus; and|
|·||non-depository companies that offer one or more consumer financial products or services.|
The CFPB experienced a leadership change in late 2017, which is subject to ongoing litigation and may impact the CFPB’s policies and supervision and enforcement efforts.
FDIC Insurance Assessments. The Bank’s deposits are insured by the FDIC through the Deposit Insurance Fund and therefore the Bank is subject to deposit insurance assessments as determined by the FDIC. The FDIC imposes a risk-based deposit premium assessment system, which was amended pursuant to the Federal Deposit Insurance Reform Act of 2005 and further amended by the Dodd-Frank Act. Under the risk-based deposit premium assessment system, the assessment rates for an insured depository institution are calculated based on a number of factors to measure the risk each institution poses to the Deposit Insurance Fund. The assessment rate is applied to total average assets less tangible equity. Under the current system, premiums are assessed quarterly and could increase if, for example, criticized loans and/or other higher risk assets increase or balance sheet liquidity decreases.
Effective July 2016, the FDIC published final rules to increase the Deposit Insurance Fund to the statutorily required minimum level of 1.35% by imposing on financial institutions with at least $10 billion in assets a surcharge of 4.5 cents per $100 of their assessment base (after making certain adjustments), to be assessed over a period of eight quarters. As of December 31, 2016, United’s total assets exceeded $10 billion and, accordingly, the Bank became subject to this surcharge in the third quarter of 2017. If this surcharge is insufficient to increase the Deposit Insurance Fund reserve ratio to 1.35 percent by December 31, 2018, a one-time shortfall assessment will be imposed on financial institutions with total consolidated assets of $10 billion or more on March 31, 2019.
In addition to ordinary assessments described above, the FDIC has the ability to impose special assessments in certain instances. The FDIC may also terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.
Stress Testing. As required by the Dodd-Frank Act, the federal bank regulatory agencies have implemented stress testing requirements for certain financial institutions, including bank holding companies and state chartered banks, with total consolidated assets between $10 billion and $50 billion. Under these requirements, an applicable financial institution must conduct and publish annual stress tests that consider such institution’s interest rate risk management, commercial real estate concentrations and other credit-related information, and funding and liquidity management during this analysis of adverse outcomes. United must comply with these stress test requirements beginning with its formal filing in July 2018, and is currently preparing for such compliance.
Volcker Rule. The Dodd-Frank Act amended the BHC Act to require the federal bank regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). The statutory provision is commonly called the “Volcker Rule”. The Federal Reserve adopted final rules implementing the Volcker Rule on December 10, 2013. United became subject to the Volcker Rule in 2017 without a material effect on its operations and the operations of its subsidiaries, including the Bank, as United does not engage in businesses prohibited by the Volcker Rule. United may incur costs to adopt additional policies and systems to ensure compliance with the Volcker Rule.
Durbin Amendment. The Dodd-Frank Act included provisions which restrict interchange fees to those which are “reasonable and proportionate” for certain debit card issuers and limits the ability of networks and issuers to restrict debit card transaction routing. This statutory provision is known as the “Durbin Amendment”. In the Federal Reserve’s final rules implementing the Durbin Amendment, interchange fees for debit card transactions were capped at $0.21 plus five basis points in order to be eligible for a safe harbor such that the fee is conclusively determined to be reasonable and proportionate. Another related rule also permits an additional $0.01 per transaction “fraud prevention adjustment” to the interchange fee if certain Federal Reserve standards are implemented, including an annual review of fraud prevention policies and procedures. With respect to network exclusivity and merchant routing restrictions, it is now required that all debit cards participate in at least two unaffiliated networks so that the transactions initiated using those debit cards will have at least two independent routing channels. The interchange fee restrictions contained in the Durbin Amendment, and the rules promulgated thereunder, apply to debit card issuers with $10 billion or more in total consolidated assets. United became subject to the interchange fee restrictions and other requirements contained in the Durbin Amendment on July 1, 2017.
Incentive Compensation. The federal bank regulatory agencies have issued guidance on incentive compensation policies (the “Incentive Compensation Guidance”) intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Incentive Compensation Guidance, which covers all employees that have the ability to materially affect the risk profile of an institution, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the institution’s board of directors.
The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as United, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the financial institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the institution is not taking prompt and effective measures to correct the deficiencies.
The scope and content of federal bank regulatory agencies’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future. It cannot be determined at this time whether compliance with such policies will adversely affect United’s ability to hire, retain and motivate its key employees.
Cybersecurity. Recent cyber attacks against banks and other financial institutions that resulted in unauthorized access to confidential customer information have prompted the federal bank regulatory agencies to issue extensive guidance on cybersecurity. These agencies are likely to devote more resources to this part of their safety and soundness examination than they may have in the past.
Commercial Real Estate. The federal bank regulatory agencies, including the FDIC, restrict concentrations in commercial real estate lending and have noted that recent increases in banks’ commercial real estate concentrations have created safety and soundness concerns. The regulatory guidance mandates certain minimal risk management practices and categorizes banks with defined levels of such concentrations as banks requiring elevated examiner scrutiny. The Bank has concentrations in commercial real estate loans in excess of those defined levels. Although management believes that United’s credit processes and procedures meet the risk management standards dictated by this guidance, regulatory outcomes could effectively limit increases in the real estate concentrations in the Bank’s loan portfolio and require additional credit administration and management costs associated with those portfolios.
Source of Strength Doctrine. Federal Reserve regulations and policy requires bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. Under this policy, United is expected to commit resources to support the Bank.
Loans. Inter-agency guidelines adopted by federal bank regulatory agencies mandate that financial institutions establish real estate lending policies with maximum allowable real estate loan-to-value limits, subject to an allowable amount of non-conforming loans as a percentage of capital.
Transactions with Affiliates. Under federal law, all transactions between and among a state nonmember bank and its affiliates, which include holding companies, are subject to Sections 23A and 23B of the Federal Reserve Act and Regulation W promulgated thereunder. Generally, these requirements limit these transactions to a percentage of the bank’s capital and require all of them to be on terms at least as favorable to the bank as transactions with non-affiliates. In addition, a bank may not lend to any affiliate engaged in non-banking activities not permissible for a bank holding company or acquire shares of any affiliate that is not a subsidiary. The FDIC is authorized to impose additional restrictions on transactions with affiliates if necessary to protect the safety and soundness of a bank. The regulations also set forth various reporting requirements relating to transactions with affiliates.
Financial Privacy. In accordance with the GLB Act, federal banking regulatory agencies adopted rules that limit the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. The privacy provisions of the GLB Act affect how consumer information is transmitted through diversified financial companies and conveyed to outside vendors.
Anti-Money Laundering Initiatives and the USA Patriot Act. A major focus of governmental policy on financial institutions in recent years has been aimed at combating terrorist financing. This has generally been accomplished by amending existing anti-money laundering laws and regulations. The U.S. Department of the Treasury (“Treasury”) has issued a number of implementing regulations which apply various requirements of the USA Patriot Act of 2001 to the Bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
Future Legislation. Various legislation affecting financial institutions and the financial industry is from time to time introduced in Congress. Such legislation may change banking statutes and the operating environment of United and its subsidiaries in substantial and unpredictable ways, and could increase or decrease the cost of doing business, limit or expand permissible activities or affect the competitive balance depending upon whether any of this potential legislation will be enacted, and if enacted, the effect that it or any implementing regulations would have on the financial condition or results of operations of United or any of its subsidiaries. The nature and extent of future legislative and regulatory changes affecting financial institutions is not known at this time.
The Tax Act. On December 22, 2017, the Tax Act was signed into law. The Tax Act includes a number of provisions that affect United, including the following:
|·||Tax Rate. The Tax Act replaces the graduated corporate tax rates applicable under prior law, which imposed a maximum tax rate of 35%, with a reduced 21% flat tax rate. Although the reduced tax rate generally should be favorable to us by resulting in increased earnings and capital, it will decrease the value of our existing deferred tax assets. Accounting principles generally accepted in the United States of America (“GAAP”) requires that the impact of the provisions of the Tax Act be accounted for in the period of enactment. Accordingly, the incremental income tax expense recorded by United in the fourth quarter of 2017 related to the Tax Act was $38.2 million, resulting primarily from a remeasurement of United’s deferred tax assets which now total $88.0 million.|
|·||FDIC Insurance Premiums. The Tax Act prohibits taxpayers with consolidated assets over $50 billion from deducting any FDIC insurance premiums and prohibits taxpayers with consolidated assets between $10 and $50 billion, such as the Bank, from deducting the portion of their FDIC premiums equal to the ratio, expressed as a percentage, that (i) the taxpayer’s total consolidated assets over $10 billion, as of the close of the taxable year, bears to (ii) $40 billion. As a result, the Bank’s ability to deduct its FDIC premiums will now be limited.|
|·||Employee Compensation. A “publicly held corporation” is not permitted to deduct compensation in excess of $1 million per year paid to certain employees. The Tax Act eliminates certain exceptions to the $1 million limit applicable under prior to law related to performance-based compensation, such as equity grants and cash bonuses that are paid only on the attainment of performance goals. As a result, our ability to deduct certain compensation paid to our most highly compensated employees will now be limited.|
|·||Business Asset Expensing. The Tax Act allows taxpayers immediately to expense the entire cost (instead of only 50%, as under prior law) of certain depreciable tangible property and real property improvements acquired and placed in service after September 27, 2017 and before January 1, 2023 (with an additional year for certain property). This 100% “bonus” depreciation is phased out proportionately for property placed in service on or after January 1, 2023 and before January 1, 2027 (with an additional year for certain property).|
|·||Interest Expense. The Tax Act limits a taxpayer’s annual deduction of business interest expense to the sum of (i) business interest income and (ii) 30% of “adjusted taxable income,” defined as a business’s taxable income without taking into account business interest income or expense, net operating losses, and, for 2018 through 2021, depreciation, amortization and depletion. Because we generate significant amounts of net interest income, we do not expect to be impacted by this limitation.|
The foregoing description of the impact of the Tax Act on us should be read in conjunction with Note 17 to United’s consolidated financial statements.
Executive Officers of United
Senior executives of United are elected by the Board of Directors annually and serve at the pleasure of the Board of Directors.
The senior executive officers of United, and their ages, positions with United, past five year employment history and terms of office as of February 1, 2018, are as follows:
|Name (age)||Position with United and Employment History||Officer of United Since|
|Jimmy C. Tallent (65)||Chairman and Chief Executive Officer (2015 - present); President, Chief Executive Officer and Director (1988 - 2015)||1988|
|H. Lynn Harton (56)||President and Chief Operating Officer and Director (2015 - present); Executive Vice President and Chief Operating Officer (2012 - 2015)||2012|
|Jefferson L. Harralson (52)||Executive Vice President and Chief Financial Officer (2017 - present); prior to joining United was Managing Director at Keefe, Bruyette and Woods (2002 – 2017)||2017|
|Bill M. Gilbert (65)||President, Community Banking (2015-present); Director of Banking (2013 - 2015); Regional President of North Georgia and Coastal Georgia (2011 - 2013)||2000|
|Bradley J. Miller (47)||Executive Vice President, Chief Risk Officer and General Counsel (2015 - present); Senior Vice President and General Counsel (2007 - 2015)||2007|
|Robert A. Edwards (53)||Executive Vice President and Chief Credit Officer (2015 - present); prior to joining United was Senior Vice President and Executive Credit Officer of Toronto-Dominion Bank (2010 - 2015)||2015|
|Richard W. Bradshaw (56)||President, Commercial Banking Solutions (2014 - present); prior to joining United was Senior Vice President, Head of United States SBA Programs of Toronto-Dominion Bank (2010 - 2014)||2014|
None of the above officers are related and there are no arrangements or understandings between them and any other person pursuant to which any of them was elected as an officer, other than arrangements or understandings with directors or officers of United acting solely in their capacities as such.
An investment in United’s common stock involves risk. Investors should carefully consider the risks described below and all other information contained in this Form 10-K and the documents incorporated by reference before deciding to purchase common stock. It is possible that risks and uncertainties not listed below may arise or become material in the future and affect United’s business.
As a financial services company, adverse conditions in the general business or economic environment could have a material adverse effect on our financial condition and results of operations.
Adverse changes in business and economic conditions generally or specifically in the markets in which we operate could adversely impact our business, including causing one or more of the following negative developments:
|·||a decrease in the demand for loans and other products and services offered by us;|
|·||a decrease in the value of our loans secured by residential or commercial real estate;|
|·||a permanent impairment of our assets, such as our deferred tax assets; or|
|·||an increase in the number of customers or other counterparties who default on their loans or other obligations to us, which could result in a higher level of nonperforming assets, net charge-offs and provision for loan losses.|
For example, if we are unable to continue to generate sufficient taxable income in the future, then we may not be able to fully realize the benefits of our deferred tax assets. Such a development or one or more other negative developments resulting from adverse conditions in the general business or economic environment, some of which are described above, could have a material adverse effect on our financial condition and results of operations.
The results of our most recent internal credit stress test may not accurately predict the impact on our financial condition if the economy were to deteriorate.
We perform credit stress testing on our capital position no less than annually. Under the stress test, we estimate our loan losses (loan charge-offs), resources available to absorb those losses and any necessary additions to capital that would be required under the “more adverse” stress test scenario.
The results of these stress tests involve many assumptions about the economy and future loan losses and default rates, and may not accurately reflect the impact on our financial condition if the economy were to deteriorate. Any deterioration of the economy could result in credit losses significantly higher, with a corresponding impact on our financial condition and capital, than those predicted by our internal stress test.
Our industry and business may be adversely affected by conditions in the financial markets and economic conditions generally.
A return of recessionary conditions and/or a deterioration of national economic conditions could adversely affect the financial condition and operating performance of financial institutions. Specifically, declines in real estate values and sales volumes and increased unemployment levels may result in higher than expected loan delinquencies, increases in levels of non-performing and classified assets and a decline in demand for products and services offered by financial institutions. Uncertainty regarding economic conditions may also result in changes in consumer and business spending, borrowing and savings habits, which could cause us to incur losses and may adversely affect our results of operations and financial condition.
Our ability to raise additional capital may be limited, which could affect our liquidity and be dilutive to existing shareholders.
We may be required or choose to raise additional capital, including for strategic, regulatory or other reasons. Depending on the capital markets, traditional sources of capital may not be available to us on reasonable terms if we needed to raise additional capital. In such case, there is no guarantee that we will be able to successfully raise additional capital at all or on terms that are favorable or otherwise not dilutive to existing shareholders.
Capital resources and liquidity are essential to our businesses and could be negatively impacted by disruptions in our ability to access other sources of funding.
Capital resources and liquidity are essential to the Bank. We depend on access to a variety of sources of funding to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, and to accommodate the transaction and cash management needs of our customers. Sources of funding available to us, and upon which we rely as regular components of our liquidity and funding management strategy, include traditional and brokered deposits, inter-bank borrowings, Federal Funds purchased, repurchase agreements and Federal Home Loan Bank advances. We also raise funds from time to time in the form of either short-or long-term borrowings or equity issuances.
Our capital resources and liquidity could be negatively impacted by disruptions in our ability to access these sources of funding. The cost of brokered and other out-of-market deposits and potential future regulatory limits on the interest rate we pay for brokered deposits could make them unattractive sources of funding. Further, factors that we cannot control, such as disruption of the financial markets or negative views about the financial services industry generally, could impair our ability to access sources of funds. Other financial institutions may be unwilling to extend credit to banks because of concerns about the banking industry and the economy generally and there may not be a viable market for raising short or long-term debt or equity capital. In addition, our ability to raise funding could be impaired if lenders develop a negative perception of our long-term or short-term financial prospects. Such negative perceptions could be developed if we are downgraded or put on (or remain on) negative watch by the rating agencies, we suffer a decline in the level of our business activity or regulatory authorities take significant action against us, among other reasons.
Among other things, if we fail to remain “well-capitalized” for bank regulatory purposes, because we do not qualify under the minimum capital standards or the FDIC otherwise downgrades our capital category, it could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance costs, our ability to pay dividends on common and preferred stock and trust preferred securities, and our ability to make acquisitions, and we would not be able to accept brokered deposits without prior FDIC approval. To be “well-capitalized”, a bank must generally maintain a common equity Tier 1 capital ratio of 6.5%, Tier 1 leverage capital ratio of 5%, Tier 1 risk-based capital ratio of 8% and total risk-based capital ratio of 10%. In addition, our regulators may require us to maintain higher capital levels. Our failure to remain “well-capitalized” or to maintain any higher capital requirements imposed on us could negatively affect our business, results of operations and financial condition.
If we are unable to raise funds using the methods described above, we would likely need to finance or liquidate unencumbered assets to meet maturing liabilities. We may be unable to sell some of our assets, or we may have to sell assets at a discount from market value, either of which could adversely affect our results of operations and financial condition.
In addition, United is a legal entity separate and distinct from the Bank and depends on subsidiary service fees and dividends from the Bank to fund its payment of dividends to its common and preferred shareholders and of interest and principal on its outstanding debt and trust preferred securities. The Bank is also subject to other laws that authorize regulatory authorities to prohibit or reduce the flow of funds from the Bank to United and the Bank’s negative retained earnings position requires written consent of the Bank’s regulators before it can pay a dividend. Any inability of United to pay its obligations, or need to defer the payment of any such obligations, could have a material adverse effect on our business, operations, financial condition, and the value of our common stock.
Changes in the cost and availability of funding due to changes in the deposit market and credit market, or the way in which we are perceived in such markets, may adversely affect financial condition or results of operations.
In general, the amount, type and cost of our funding, including from other financial institutions, the capital markets and deposits, directly impacts our operating costs and our asset growth and therefore, can positively or negatively affect our financial condition or results of operations. A number of factors could make funding more difficult, more expensive or unavailable on any terms, including, but not limited to, our operating losses, our ability to remain “well capitalized,” events that adversely impact our reputation, enforcement actions, disruptions in the capital markets, events that adversely impact the financial services industry, changes affecting our assets, interest rate fluctuations, general economic conditions and the legal, regulatory, accounting and tax environments. Also, we compete for funding with other financial institutions, many of which are substantially larger, and have more capital and other resources than we do. In addition, as some of these competitors consolidate with other financial institutions, their competitive advantages may increase. Competition from these institutions may also increase the cost of funds.
Our business is subject to the success of the local economies and real estate markets in which we operate.
Our success significantly depends on the growth in population, income levels, loans and deposits and on stability in real estate values in our markets. If the communities in which we operate do not grow or if prevailing economic conditions locally or nationally do not improve significantly, our business may be adversely affected. If market and economic conditions deteriorate, this may lead to valuation adjustments on our loan portfolio and losses on defaulted loans and on the sale of other real estate owned. Additionally, such adverse economic conditions in our market areas, specifically decreases in real estate property values due to the nature of our loan portfolio, more than 79% of which is secured by real estate, could reduce our growth rate, affect the ability of our customers to repay their loans and generally affect our financial condition and results of operations. We are less able than a larger institution to spread the risks of unfavorable local economic conditions across a large number of more diverse economies.
Our concentration of commercial purpose construction and development loans is subject to unique risks that could adversely affect our results of operations and financial condition.
Our commercial purpose construction and development loan portfolio was $712 million at December 31, 2017, comprising 9% of total loans. Commercial purpose construction and development loans are often riskier than other loans because of the lack of ongoing income supporting the asset being financed. Consequently, economic downturns adversely affect the ability of real estate developer borrowers’ ability to repay these loans and the value of property used as collateral for such loans in a more dramatic fashion. A sustained weak economy could also result in higher levels of nonperforming loans in other categories, such as commercial and industrial loans, which may result in additional losses. As a result, these loans could represent higher risk due to slower sales and reduced cash flow that affect the borrowers’ ability to repay on a timely basis which could result in a sharp increase in our total net charge-offs and require us to significantly increase our allowance for loan losses, any of which could have a material adverse effect on our financial condition or results of operations.
Our concentration of commercial real estate loans is subject to risks that could adversely affect our results of operations and financial condition.
Our commercial real estate loan portfolio was $3.52 billion at December 31, 2017, comprising 46% of total loans. Commercial real estate loans typically involve larger loan balances than compared to residential mortgage loans. The repayment of loans secured by commercial real estate is dependent upon both the successful operation of the commercial project and the business operated out of that commercial real estate site, as over half of the commercial real estate loans are for owner-occupied properties. If the cash flows from the project are reduced or if the borrower’s business is not successful, a borrower’s ability to repay the loan may be impaired. This cash flow shortage may result in the failure to make loan payments. In such cases, we may be compelled to modify the terms of the loan. In addition, the nature of these loans is such that they are generally less predictable and more difficult to evaluate and monitor. As a result, repayment of these loans may be subject to adverse conditions in the real estate market or economy. In addition, many economists believe that the potential for deterioration in income producing commercial real estate may occur through rising vacancy rates or declining absorption rates of existing square footage and/or units. As a result, these loans could represent higher risk due to slower sales and reduced cash flow that affect the borrowers’ ability to repay on a timely basis, could result in a sharp increase in our total net charge-offs and could require us to significantly increase our allowance for loan losses, any of which could have a material adverse effect on our financial condition or results of operations.
Changes in prevailing interest rates may negatively affect net income and the value of our assets.
Changes in prevailing interest rates may negatively affect the level of our net interest revenue, the primary component of our net income. Federal Reserve policies, including interest rate policies, determine in large part our cost of funds for lending and investing and the return we earn on those loans and investments, both of which affect our net interest revenue. In a period of changing interest rates, interest expense may increase at different rates than the interest earned on assets. Accordingly, changes in interest rates could decrease net interest revenue. Changes in the interest rates may also negatively affect the value of our assets and our ability to realize gains or avoid losses from the sale of those assets, all of which also ultimately affect earnings. In addition, an increase in interest rates may decrease the demand for loans.
United’s reported financial results depend on the accounting and reporting policies of United, the application of which requires significant assumptions, estimates and judgments.
United’s accounting and reporting policies are fundamental to the methods by which we record and report our financial condition and results of operations. United’s management must make significant assumptions and estimates and exercise significant judgment in selecting and applying many of these accounting and reporting policies so they comply with GAAP and reflect management’s judgment of the most appropriate manner to report United’s financial condition and results. In some cases, management must select a policy from two or more alternatives, any of which may be reasonable under the circumstances, which may result in United reporting materially different results than would have been reported under a different alternative.
Certain accounting policies are critical to presenting United’s financial condition and results. They require management to make difficult, subjective and complex assumptions, estimates and judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions and estimates. These critical accounting policies relate to the allowance for loan losses, fair value measurement, and income taxes. Because of the uncertainty of assumptions and estimates involved in these matters, United may be required to do one or more of the following: significantly increase the allowance for loan losses and/or sustain credit losses that are significantly higher than the reserve provided; significantly decrease the carrying value of loans, foreclosed property or other assets or liabilities to reflect a reduction in their fair value; or, significantly increase or decrease accrued taxes and the value of our deferred tax assets.
If our allowance for credit losses is not sufficient to cover actual loan losses, earnings would decrease.
Our loan customers may not repay their loans according to their terms and the collateral securing the payment of these loans may be insufficient to assure repayment. We may experience significant loan losses which would have a material adverse effect on our operating results. Our management makes various assumptions and judgments about the collectability of the loan portfolio, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. We maintain an allowance for credit losses in an attempt to cover any probable incurred loan losses in the loan portfolio. In determining the size of the allowance, our management relies on an analysis of the loan portfolio based on historical loss experience, volume and types of loans, trends in classification, volume and real estate values, trends in delinquencies and non-accruals, national and local economic conditions and other pertinent information. As a result of these considerations, we have from time to time increased our allowance for credit losses. For the year ended December 31, 2017, we recorded provision expense of $3.80 million compared to a release of provision for credit losses of $800,000 and provision expense of $3.70 million for the years ended December 31, 2016 and 2015, respectively. If those assumptions are incorrect, the allowance may not be sufficient to cover future loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in the loan portfolio.
Reductions in interchange fees could reduce our non-interest income.
The Durbin Amendment to the Dodd-Frank Act has limited the amount of interchange fees that may be charged on certain debit card transactions. Beginning in July 2017, the Durbin Amendment became applicable to United because our total consolidated assets exceeded $10 billion at December 31, 2016. Complying with the Durbin Amendment will reduce United’s non-interest income from interchange fees.
We may be subject to losses due to fraudulent and negligent conduct of our loan customers, third party service providers and employees.
When we make loans to individuals or entities, we rely upon information supplied by borrowers and other third parties, including information contained in the applicant’s loan application, property appraisal reports, title information and the borrower’s net worth, liquidity and cash flow information. While we attempt to verify information provided through available sources, we cannot be certain all such information is correct or complete. Our reliance on incorrect or incomplete information could have a material adverse effect on our financial condition or results of operations.
Competition from financial institutions and other financial service providers may adversely affect our profitability.
The banking business is highly competitive and we experience competition in each of our markets from many other financial institutions. We compete with banks, credit unions, savings and loan associations, mortgage banking firms, securities brokerage firms, insurance companies, money market funds and other mutual funds, as well as community, super-regional, national and international financial institutions that operate offices in our market areas and elsewhere. We compete with these institutions both in attracting deposits and in making loans. Many of our competitors are well-established, larger financial institutions that are able to operate profitably with a narrower net interest margin and have a more diverse revenue base. We may face a competitive disadvantage as a result of our smaller size, more limited geographic diversification and inability to spread costs across broader markets. Although we compete by concentrating marketing efforts in our primary markets with local advertisements, personal contacts and greater flexibility and responsiveness in working with local customers, customer loyalty can be easily influenced by a competitor’s new products and our strategy may or may not continue to be successful. We may also be affected by the marketplace loosening of credit underwriting standards and structures.
We may face risks with respect to future expansion and acquisitions.
We may engage in de novo branch expansion and seek to acquire other financial institutions or parts of those institutions. These involve a number of risks, including:
|·||the potential inaccuracy of the estimates and judgments used to evaluate asset values and credit, operations, management and market risks with respect to an acquired branch or institution, a new branch office or a new market;|
|·||the time and costs of evaluating new markets, hiring or retaining experienced local management and opening new offices and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion;|
|·||the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse effects on results of operations;|
|·||the loss of key employees and customers of an acquired branch or institution;|
|·||the difficulty or failure to successfully integrate the acquired financial institution or portion of the institution; and|
|·||the temporary disruption of our business or the business of the acquired institution.|
Changes in laws and regulations or failures to comply with such laws and regulations may adversely affect our financial condition and results of operations.
We and our subsidiary bank are heavily regulated by federal and state authorities. This regulation is designed primarily to protect depositors, federal deposit insurance funds and the banking system as a whole, but not shareholders. Congress and state legislatures and federal and state regulatory authorities continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including interpretation and implementation of statutes, regulations or policies could affect us in substantial and unpredictable ways, including limiting the types of financial services and products we may offer or increasing the ability of non-banks to offer competing financial services and products. Any regulatory changes or scrutiny could increase or decrease the cost of doing business, limit or expand our permissible activities, or affect the competitive balance among banks, credit unions, savings and loan associations and other institutions. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
Federal and state regulators have the ability to impose or request that we consent to substantial sanctions, restrictions and requirements on our banking and nonbanking subsidiaries if they determine, upon examination or otherwise, violations of laws, rules or regulations with which we or our subsidiaries must comply, or weaknesses or failures with respect to general standards of safety and soundness. Such enforcement may be formal or informal and can include directors’ resolutions, memoranda of understanding, cease and desist or consent orders, civil money penalties and termination of deposit insurance and bank closures. Enforcement actions may be taken regardless of the capital level of the institution. In particular, institutions that are not sufficiently capitalized in accordance with regulatory standards may also face capital directives or prompt corrective action. Enforcement actions may require certain corrective steps (including staff additions or changes), impose limits on activities (such as lending, deposit taking, acquisitions or branching), prescribe lending parameters (such as loan types, volumes and terms) and require additional capital to be raised, any of which could adversely affect our financial condition and results of operations. Enforcement actions, including the imposition of monetary penalties, may have a material impact on our financial condition or results of operations, and damage to our reputation, and loss of our holding company status. In addition, compliance with any such action could distract management’s attention from our operations, cause us to incur significant expenses, restrict us from engaging in potentially profitable activities, and limit our ability to raise capital. Closure of the Bank would result in a total loss of your investment.
In 2017, both Chambers of Congress proposed comprehensive financial regulatory reform bills that would amend the Dodd-Frank Act and that could affect the banking industry as a whole, including our business and results of operations, in ways that are difficult to predict. Although the bills vary in content, certain key aspects include revisions to rules related to mortgage loans, delayed implementation of rules related to the Home Mortgage Disclosure Act, reform and simplification of certain Volcker Rule requirements, and raising the threshold for applying enhanced prudential standards to bank holding companies with total consolidated assets equal to or greater than $50 billion to those with total consolidated assets equal to or greater than $250 billion. At this time, a timeline for presentment and enactment of such regulatory relief is uncertain and adoption of any such legislation may not result in a meaningful reduction of our regulatory burden and attendant costs. The failure to adopt financial reform regulation would result in our continuing to be subject to significant regulatory compliance costs, which would increase as our asset size comes closer to $50 billion.
The financial services industry is experiencing leadership changes at the federal banking agencies, which may impact regulations and government policy applicable to us.
In 2017 and early 2018, Congress confirmed a new Chairman of the Federal Reserve and a new Vice Chairman for Supervision at the Federal Reserve. In addition, the President nominated a new Chairwoman of the FDIC, and the Director of the CFPB resigned and was replaced by an interim Director. The President, senior members of Congress, and many among this new leadership group have advocated for significant reduction of financial services regulation, which may cause broader economic changes due to changes in governing ideology and governing style. As a result of the changes and impending changes in agency leadership, new regulatory initiatives may be stalled and certain previously enacted regulations may be revisited. New appointments to the Board of Governors of the Federal Reserve could affect monetary policy and interest rates, and changes in fiscal policy could affect broader patterns of trade and economic growth. At this time, further impact of these leadership changes and the potential impact on the regulatory requirements applicable to us and our supervision by these agencies is uncertain.
We face a risk of noncompliance with the Bank Secrecy Act and other anti-money laundering statutes and regulations.
The federal Bank Secrecy Act, USA Patriot Act of 2001 and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the Treasury to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal bank regulatory agencies, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. Federal bank regulatory agencies and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, which would negatively impact our business, financial condition and results of operations.
The short-term and long-term impact of the changing regulatory capital requirements is uncertain.
The Basel III Capital Rules include new minimum risk-based capital and leverage ratios, which are being phased in and modify the capital and asset definitions for purposes of calculating those ratios. Among other things, the Basel III Capital Rules established a new common equity Tier 1 minimum capital requirement of 4.5%, a higher minimum Tier 1 capital to risk-weighted assets requirement of 6% and a higher total capital to risk-weighted assets of 8%. In addition, the Basel III Capital Rules provide, to be considered “well-capitalized”, a new common equity Tier 1 capital requirement of 6.5% and a higher Tier 1 capital to risk-weighted assets requirement of 8%. Moreover, the Basel III Capital Rules limit a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of an additional 2.5% of common equity Tier 1 capital in addition to the 4.5% minimum common equity Tier 1 requirement and the other amounts necessary to the minimum risk-based capital requirements that will be phased in and fully effective in 2019.
The application of the more stringent capital requirements described above could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in additional regulatory actions if we were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements under the Basel III Capital Rules could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in us modifying our business strategy and could limit our ability to pay dividends.
Our ability to fully utilize deferred tax assets could be impaired.
We reported a net deferred tax asset of $88.0 million as of December 31, 2017, which includes approximately $4.41 million of deferred tax benefits related to federal and state operating loss carry-forwards. Our ability to use such assets is dependent on our ability to generate future earnings within the operating loss carry-forward periods, which are generally 20 years. If we do not realize taxable earnings within the carry-forward periods, our deferred tax asset would be permanently impaired. Additionally, our ability to use such assets to offset future tax liabilities could be permanently impaired if cumulative common stock transactions over a rolling three-year period resulted in an ownership change under Section 382 of the Internal Revenue Code. There is no guarantee that our tax benefits preservation plan will prevent us from experiencing an ownership change under Section 382. Our inability to utilize these deferred tax assets (benefits) would have a material adverse effect on our financial condition and results of operations.
We could be subject to changes in tax laws, regulations and interpretations or challenges to our income tax provision.
We compute our income tax provision based on enacted tax rates in the jurisdictions in which we operate. Any change in enacted tax laws, rules or regulatory or judicial interpretations, any adverse outcome in connection with tax audits in any jurisdiction or any change in the pronouncements relating to accounting for income taxes could adversely affect our effective tax rate, tax payments and results of operations. In addition, changes in enacted tax laws, such as adoption of a lower income tax rate in any of the jurisdictions in which we operate, could impact our ability to obtain the future tax benefits represented by our deferred tax assets.
The Tax Act may have negative effects on our financial performance. For example, the Tax Act enacted limitations on certain deductions, such as the deduction of FDIC deposit insurance premiums, which will partially offset the anticipated increase in net earnings from a lower tax rate. In addition, as a result of the lower corporate tax rate, we were required under GAAP to record a tax expense due to remeasurement in the fourth quarter of 2017 with respect to our deferred tax asset amounting to $38.2 million. The impact of the Tax Act may differ from the foregoing, possibly materially, due to changes in interpretations or in assumptions that we have made, guidance or regulations that may be promulgated, and other actions that we may take as a result of the Tax Act. Similarly, the Bank’s customers are likely to experience varying effects from both the individual and business tax provisions of the Tax Act and such effects, whether positive or negative, may have a corresponding impact on our business and the economy as a whole.
System failure or cybersecurity breaches of our network security could subject us to increased operating costs as well as litigation and other potential losses.
We rely heavily on communications and information systems to conduct our business. The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure we use, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or users. Such problems could jeopardize the security of our customers’ personal information and other information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, subject us to additional regulatory scrutiny, damage our reputation, result in a loss of customers, or inhibit current and potential customers from our Internet banking services, any of all of which could have a material adverse effect on our results of operations and financial condition. Although we have security measures designed to mitigate the possibility of break-ins, breaches and other disruptive problems, including firewalls and penetration testing, there can be no assurance that such security measures will be effective in preventing such problems.
Our lack of geographic diversification increases our risk profile.
Our operations are located principally in Georgia, North Carolina, east Tennessee and South Carolina. As a result of this geographic concentration, our results depend largely upon economic and business conditions in this area. Deterioration in economic and business conditions in our service area could have a material adverse impact on the quality of our loan portfolio and the demand for our products and services, which in turn may have a material adverse effect on our results of operations.
Our interest-only home equity lines of credit expose us to increased lending risk.
At December 31, 2017, we had $731 million of home equity line of credit loans, which represented 9% of our loan portfolio as of that date. Historically, United’s home equity lines of credit generally had a 35 month or 10 year draw period with interest-only payment requirements for the term of the loan, a balloon payment requirement at the end of the draw period. Since June 2012, new home equity lines of credit generally have a 10 year interest only draw period followed by a 15 year amortized repayment period for any outstanding balance at the 10 year conversion date. United continues to offer a home equity line of credit with a 35 month draw period with interest-only payment requirements for the term of the loan with a balloon payment requirement at the end of the draw period. All home equity line of credit products, historically and currently available, have a maximum 80% combined loan to value ratio. Loan to value ratios are established on a case by case basis considering the borrower’s credit profile and the collateral type – primary or secondary residence. These loans are also secured by a first or second lien on the underlying home.
In the case of interest-only loans, a borrower’s monthly payment is subject to change when the loan converts to fully-amortizing status. Since the borrower's monthly payment may increase by a substantial amount even without an increase in prevailing market interest rates, the borrower might not be able to afford the increased monthly payment. In addition, interest-only loans have a large, balloon payment at the end of the loan term, which the borrower may be unable to pay. Also, real estate values may decline, dramatically reducing or even eliminating the borrower’s equity, and credit standards may tighten in concert with the higher payment requirement, making it difficult for borrowers to sell their homes or refinance their loans to pay off their mortgage obligations. The risks can be magnified by United’s limited ability to monitor the delinquency status of the first lien on the collateral. For these reasons, home equity lines of credit are considered to have an increased risk of delinquency, default and foreclosure than conforming loans and may result in higher levels of losses. The Bank mitigates these risks in its underwriting by calculating the fully amortizing principal and interest payment assuming 100% utilization and using that amount to determine the borrower’s ability to pay.
We rely on third parties to provide key components of our business infrastructure.
Third parties provide key components of our business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, Internet connections and network access. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including those resulting from disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, cyber attacks and security breaches at a vendor, failure of a vendor to provide services for any reason or poor performance of services, could adversely affect our ability to deliver products and services to our customers and otherwise conduct our business. Financial or operational difficulties of a third party vendor could also hurt our operations if those difficulties interfere with the vendor's ability to serve us. Furthermore, our vendors could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints. Replacing these third party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to our business operations.
There are no unresolved comments from the SEC staff regarding United’s periodic or current reports under the Exchange Act.
The executive offices of United are located at 125 Highway 515 East, Blairsville, Georgia. United owns this property. The Bank conducts business from facilities primarily owned by the Bank or its subsidiaries, all of which are in a good state of repair and appropriately designed for use as banking facilities. The Bank provides services or performs operational functions at 171 locations, of which 139 are owned and 32 are leased under operating leases. Note 8 to United’s consolidated financial statements includes additional information regarding amounts invested in premises and equipment.
In the ordinary course of operations, United and the Bank are defendants in various legal proceedings. Additionally, in the ordinary course of business, United and the Bank are subject to regulatory examinations and investigations. Based on our knowledge and advice of counsel, in the opinion of management, there is no such pending or threatened legal matter in which an adverse decision will result in a material adverse change in the consolidated financial condition or results of operations of United. No material proceedings terminated in the fourth quarter of 2017.
|ITEM 5.||MARKET FOR UNITED’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.|
Stock. United’s common stock trades on the Nasdaq Global Select Market under the symbol “UCBI”. The closing price for the period ended December 31, 2017 was $28.14. Below is a schedule of high, low and closing stock prices and average daily volume for all quarters in 2017 and 2016.
At February 1, 2018, there were 8,329 record shareholders and approximately 17,728 beneficial shareholders of United’s common stock.
Dividends. United declared cash dividends of $.38 and $.30 per share on its common stock in 2017 and 2016, respectively. Federal and state laws and regulations impose restrictions on the ability of the Bank to pay dividends to United without prior approvals.
Additional information regarding dividends is included in Note 20 to the consolidated financial statements, under the heading of “Supervision and Regulation” in Part I of this report and in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resources and Dividends.”
Share Repurchases. On March 22, 2016, United announced that its Board of Directors had authorized a program to repurchase up to $50 million of United’s outstanding common stock through December 31, 2017. In November of 2017, the Board of Directors extended this program through December 31, 2018. Under the program, the shares may be repurchased periodically in open market transactions at prevailing market prices, in privately negotiated transactions, or by other means in accordance with federal securities laws. The actual timing, number and value of shares repurchased under the program depends on a number of factors, including the market price of United’s common stock, general market and economic conditions, and applicable legal requirements. As of December 31, 2017, the remaining authorization was $36.3 million.
The following table contains information for shares repurchased during the fourth quarter of 2017.
|(Dollars in thousands, except for per share|
|Total Number of|
as Part of Publicly
|Maximum Number (or|
Value) of Shares that May
Yet Be Purchased Under
the Plans or Programs
|October 1, 2017 - October 31, 2017||-||$||-||-||$||36,342|
|November 1, 2017 - November 30, 2017||-||-||-||36,342|
|December 1, 2017 - December 31, 2017||-||-||-||36,342|
United’s Amended and Restated 2000 Key Employee Stock Option Plan allows option holders to exercise stock options by delivering previously acquired shares having a fair market value equal to the exercise price provided that the shares delivered must have been held by the option holder for at least six months. In addition, United may withhold a sufficient number of restricted stock shares at the time of vesting to cover payroll tax withholdings at the election of the restricted stock recipient. In 2017 and 2016, 62,386 and 57,628 shares, respectively, were withheld to cover payroll taxes owed at the time of restricted stock vesting. No shares were delivered to exercise stock options in 2017 or 2016.
Performance Graph. Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on United’s common stock against the cumulative total return on the Nasdaq Stock Market (U.S. Companies) Index and the Nasdaq Bank Stocks Index for the five-year period commencing December 31, 2012 and ending on December 31, 2017.
|Cumulative Total Return*|
|United Community Banks, Inc.||$||100||$||188||$||202||$||210||$||324||$||312|
|Nasdaq Stock Market (U.S.) Index||100||138||157||166||178||229|
|Nasdaq Bank Index||100||139||143||152||206||213|
* Assumes $100 invested on December 31, 2012 in United’s common stock and above noted indexes. Total return includes reinvestment of dividends at the closing stock price of the common stock on the dividend payment date and the closing values of stock and indexes as of December 31 of each year.
UNITED COMMUNITY BANKS, INC.
For the Years Ended December 31,
|(in thousands, except per share data)||2017||2016||2015||2014||2013|
|Net interest revenue||355,985||309,784||257,423||222,881||218,158|
|Provision for credit losses||3,800||(800||)||3,700||8,500||65,500|
|Income before income tax expense||172,834||162,992||115,014||107,070||34,952|
|Income tax expense (benefit)||105,013||62,336||43,436||39,450||(238,188||)|
|Merger-related and other charges||14,662||8,122||17,995||-||-|
|Income tax benefit of merger-related and other charges||(3,745||)||(3,074||)||(6,388||)||-||-|
|Impact of remeasurement of deferred tax asset resulting from 2017 Tax Cuts and Jobs Act||38,199||-||-||-||-|
|Impairment of deferred tax asset on cancelled non-qualified stock options||-||976||-||-||-|
|Release of disproportionate tax effects lodged in OCI||3,400||-||-||-||-|
|Net income - operating (1)||$||120,337||$||106,680||$||83,185||$||67,620||$||273,140|
|Per common share:|
|Diluted net income - GAAP||$||.92||$||1.40||$||1.09||$||1.11||$||4.44|
|Diluted net income - operating (1)||1.63||1.48||1.27||1.11||4.44|
|Cash dividends declared||.38||.30||.22||.11||-|
|Tangible book value (3)||13.65||12.95||12.06||12.15||11.26|
|Key performance ratios:|
|Return on common equity - GAAP (2)||5.67||%||9.41||%||8.15||%||9.17||%||46.72||%|
|Return on common equity - operating (1)(2)||10.07||9.98||9.48||9.17||46.72|
|Return on tangible common equity - operating (1)(2)(3)||12.02||11.86||10.24||9.32||47.35|
|Return on assets - GAAP||.62||1.00||.85||.91||3.86|
|Return on assets - operating (1)||1.09||1.06||.98||.91||3.86|
|Dividend payout ratio - GAAP||41.30||21.43||20.18||9.91||-|
|Dividend payout ratio - operating (1)||23.31||20.27||17.32||9.91||-|
|Net interest margin (fully taxable equivalent)||3.52||3.36||3.30||3.26||3.30|
|Efficiency ratio - GAAP||59.95||59.80||63.96||58.26||63.14|
|Efficiency ratio - operating (1)||56.67||57.78||58.51||58.26||63.14|
|Average equity to average assets||10.71||10.54||10.27||9.69||10.35|
|Average tangible equity to average assets (3)||9.29||9.21||9.74||9.67||10.31|
|Average tangible common equity to average assets (3)||9.29||9.19||9.66||9.60||7.55|
|Tangible common equity to risk-weighted assets (3)||12.05||11.84||12.82||13.82||13.17|
|Total nonperforming assets (NPAs)||26,892||29,488||27,536||19,607||31,040|
|Allowance for loan losses||58,914||61,422||68,448||71,619||76,762|
|Allowance for loan losses to loans||.76||%||.89||%||1.14||%||1.53||%||1.77||%|
|Net charge-offs to average loans||.08||.11||.12||.31||2.22|
|NPAs to loans and foreclosed properties||.35||.43||.46||.42||.72|
|NPAs to total assets||.23||.28||.29||.26||.42|
|AVERAGE BALANCES ($ in millions)|
|Common shares - basic (thousands)||73,247||71,910||65,488||60,588||58,787|
|Common shares - diluted (thousands)||73,259||71,915||65,492||60,590||58,845|
|AT PERIOD END ($ in millions)|
|Common shares outstanding (thousands)||77,580||70,899||71,484||60,259||59,432|
(1) Excludes merger-related and other charges which includes amortization of certain executive change of control benefits, the 2017 impact of remeasurement of United's deferred tax assets following the passage of tax reform legislation, a 2017 release of disproportionate tax effects lodged in OCI, a 2016 deferred tax asset impairment charge related to cancelled non-qualified stock options and 2015 impairment losses on surplus bank property. (2) Net income less preferred stock dividends, divided by average realized common equity, which excludes accumulated other comprehensive income (loss). (3) Excludes effect of acquisition related intangibles and associated amortization.
UNITED COMMUNITY BANKS, INC.
Item 6. Selected Financial Data, continued
|(in thousands, except per share data)||Quarter||Quarter||Quarter||Quarter||Quarter||Quarter||Quarter||Quarter|
|Net interest revenue||97,508||89,775||85,148||83,554||80,925||78,989||74,918||74,952|
|Provision for credit losses||1,200||1,000||800||800||-||(300||)||(300||)||(200||)|
|Income before income tax expense||42,354||43,674||44,804||42,002||44,837||41,627||40,655||35,873|
|Income tax expense||54,270||15,728||16,537||18,478||17,616||15,753||15,389||13,578|
|Merger-related and other charges||7,358||3,420||1,830||2,054||1,141||3,152||1,176||2,653|
|Income tax benefit of merger-related and other charges||(1,165||)||(1,147||)||(675||)||(758||)||(432||)||(1,193||)||(445||)||(1,004||)|
|Impact of remeasurement of deferred tax asset resulting from 2017 Tax Cuts and Jobs Act||38,199||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||-||-||-||976||-||-||-|
|Release of disproportionate tax effects lodged in OCI||-||-||-||3,400||-||-||-||-|
|Net income - operating (1)||$||32,476||$||30,219||$||29,422||$||28,220||$||28,906||$||27,833||$||25,997||$||23,944|
|Per common share:|
|Diluted net income - GAAP||$||(.16||)||$||.38||$||.39||$||.33||$||.38||$||.36||$||.35||$||.31|
|Diluted net income - operating (1)||.42||.41||.41||.39||.40||.39||.36||.33|
|Cash dividends declared||.10||.10||.09||.09||.08||.08||.07||.07|
|Tangible book value (3)||13.65||14.11||13.74||13.30||12.95||13.00||12.84||12.40|
|Key performance ratios:|
|Return on common equity - GAAP (2)(4)||(3.57||)%||9.22||%||9.98||%||8.54||%||9.89||%||9.61||%||9.54||%||8.57||%|
|Return on common equity - operating (1)(2)(4)||9.73||9.97||10.39||10.25||10.51||10.34||9.81||9.20|
|Return on tangible common equity - operating (1)(2)(3)(4)||11.93||11.93||12.19||12.10||12.47||12.45||11.56||10.91|
|Return on assets - GAAP (4)||(.40||)||1.01||1.06||.89||1.03||1.00||1.04||.93|
|Return on assets - operating (1)(4)||1.10||1.09||1.10||1.07||1.10||1.08||1.07||1.00|
|Dividend payout ratio - GAAP||(62.50||)||26.32||23.08||27.27||21.05||22.22||20.00||22.58|
|Dividend payout ratio - operating (1)||23.81||24.39||21.95||23.08||20.00||20.51||19.44||21.21|
|Net interest margin (fully taxable equivalent) (4)||3.63||3.54||3.47||3.45||3.34||3.34||3.35||3.41|
|Efficiency ratio - GAAP||63.03||59.27||57.89||59.29||57.65||60.78||59.02||61.94|
|Efficiency ratio - operating (1)||56.92||56.18||56.21||57.35||56.58||57.79||57.82||59.10|
|Average equity to average assets||11.21||10.86||10.49||10.24||10.35||10.38||10.72||10.72|
|Average tangible equity to average assets (3)||9.52||9.45||9.23||8.96||9.04||8.98||9.43||9.41|
|Average tangible common equity to average assets (3)||9.52||9.45||9.23||8.96||9.04||8.98||9.43||9.32|
|Tangible common equity to risk-weighted assets (3)||12.05||12.80||12.44||12.07||11.84||12.22||12.87||12.77|
|Total nonperforming assets (NPAs)||26,892||25,657||25,834||24,872||29,488||30,759||27,524||27,582|
|Allowance for loan losses||58,914||58,605||59,500||60,543||61,422||62,961||64,253||66,310|
|Allowance for loan losses to loans||.76||%||.81||%||.85||%||.87||%||.89||%||.94||%||1.02||%||1.09||%|
|Net charge-offs to average loans (4)||.06||.09||.09||.10||.09||.08||.11||.14|
|NPAs to loans and foreclosed properties||.35||.36||.37||.36||.43||.46||.44||.45|
|NPAs to total assets||.23||.23||.24||.23||.28||.30||.28||.28|
|AVERAGE BALANCES ($ in millions)|
|Common shares - basic (thousands)||76,768||73,151||71,810||71,700||71,641||71,556||72,202||72,162|
|Common shares - diluted (thousands)||76,768||73,162||71,820||71,708||71,648||71,561||72,207||72,166|
|AT PERIOD END ($ in millions)|
|Common shares outstanding (thousands)||77,580||73,403||70,981||70,973||70,899||70,861||71,122||71,544|
(1) Excludes merger-related and other charges which includes amortization of certain executive change of control benefits, the fourth quarter 2017 impact of remeasurement of United's deferred tax assets following the passage of tax reform legislation, a first quarter 2017 release of disproportionate tax effects lodged in OCI and a fourth quarter 2016 deferred tax asset impairment charge related to cancelled non-qualified stock options. (2) Net income less preferred stock dividends, divided by average realized common equity, which excludes accumulated other comprehensive income (loss). (3) Excludes effect of acquisition related intangibles and associated amortization. (4) Annualized.
|ITEM 7.||MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.|
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.
In the past three years, United has completed the following acquisitions:
|Four Oaks Fincorp, Inc. ("FOFN")||November 1, 2017|
|HCSB Financial Corporation ("HCSB")||July 31, 2017|
|Tidelands Bancshares, Inc. ("Tidelands")||July 1, 2016|
|Palmetto Bancshares, Inc. ("Palmetto")||September 1, 2015|
|MoneyTree Corporation ("MoneyTree")||May 1, 2015|
The acquired entities’ results are included in United’s consolidated results beginning on the respective acquisition dates.
United reported net income of $67.8 million, or $.92 per diluted share, in 2017, compared with $101 million, or $1.40 per share in 2016 and $71.6 million, or $1.09 per share, in 2015. The decrease in net income reflects the impact of the Tax Act that was signed into law on December 22, 2017. While the reduction of the federal corporate income tax rate from 35% to 21% is expected to lower United’s effective tax rate in 2018, it resulted in a requirement to remeasure United’s deferred tax assets in the period of enactment, which caused a $38.2 million increase in income tax expense in 2017.
Net interest revenue increased to $356 million for 2017, compared to $310 million in 2016 and $257 million in 2015. The increase was primarily due to higher loan volume, much of which resulted from the acquisitions of FOFN, HCSB and Tidelands (the “Acquisitions”). Net interest margin increased 16 basis points to 3.52% in 2017 from 3.36% in 2016 due to the effect of rising interest rates on floating rate loans and investment securities, as well as growth in the loan portfolio that led to a more favorable earning asset mix.
The provision for credit losses was $3.80 million for 2017, compared to a release of provision of $800,000 for 2016. Net charge-offs for 2017 were $6.00 million, compared to $6.77 million for 2016. The increase in the provision reflects growth in the loan portfolio along with stable credit quality measures.
As of December 31, 2017, the allowance for loan losses was $58.9 million, or .76% of loans, compared with $61.4 million, or .89% of loans, at the end of 2016, reflecting continued asset quality improvement. Nonperforming assets of $26.9 million were .23% of total assets at December 31, 2017 compared to .28% as of December 31, 2016.
Fee revenue of $88.3 million was down $5.44 million, or 6%, from 2016. Service charges and fees decreased 9% compared to 2016 due mainly to the effect of the Durbin Amendment of the Dodd-Frank Act, which took effect for United in the third quarter of 2017 and limited the amount of interchange fees United could earn on debit card transactions. Mortgage loan and related fees decreased 10% from 2016 due to a combination of factors including our strategic decision to hold more loans on our balance sheet, margin compression and a decline in refinance activity in a rising rate environment. Fee revenue is shown in more detail in Table 4.
For 2017, operating expenses of $268 million were up $26.3 million, or 11%, from 2016, largely due to the Acquisitions. Salaries and employee benefits expense increased $14.3 million in 2017 mostly due to the Acquisitions and higher incentive compensation in connection with increased lending activity and improvement in earnings performance. Operating expenses for 2017 included $10.3 million of merger-related charges, $1.14 million of impairment on surplus bank properties, $1.53 million of executive retirement charges and $831,000 of branch closure costs, while operating expenses for 2016 included merger-related charges of $8.12 million.
Loans at December 31, 2017 were $7.74 billion, up $815 million from the end of 2016, primarily due to the acquisition of HCSB and FOFN combined with solid growth in our community banks and Commercial Banking Solutions areas. Deposits were up $1.17 billion to $9.81 billion at December 31, 2017, as United focused on increasing low cost core transaction deposits which grew $258 million in 2017, excluding public funds deposits and the Acquisitions. At the end of 2017, total equity capital was $1.30 billion, up $228 million from December 31, 2016, reflecting net income of $67.8 million and shares issued for acquisitions of $179 million, partially offset by the payment of dividends on United’s common stock of $28.3 million. At December 31, 2017, all of United’s regulatory capital ratios were significantly 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 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 accompanying consolidated financial statements. These policies, along with the disclosures presented in the other notes to the consolidated financial statements and in this Management’s Discussion and Analysis, 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 of 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 and troubled debt restructurings (“TDRs”), which are all considered impaired loans. 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 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.
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 the 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 accounting policies related to the allowance for loan losses.
Fair Value Measurements
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, 2017, the percentage of total assets measured at fair value on a recurring basis was 23%. 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. Management 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. 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 management considers in determining whether impairment is other-than-temporary are long term expectations and recent experience regarding principal and interest payments, and the ability and intent to hold the security until the amortized cost basis is recovered.
United uses derivatives primarily to manage its interest rate risk or to help its customers manage their 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. However, United does evaluate the level of these observable inputs and there are some instances, with highly structured transactions, where United has determined that the inputs not directly observable. This is discussed in Note 24 to the consolidated financial statements. 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.
As management has expanded its SBA lending and subsequent loan sales activities, a servicing asset has been recognized (per ASC 860). This asset is recorded at fair value on recognition, and United has elected to carry this asset at fair value for subsequent reporting. United also recognizes servicing rights upon the sale of residential mortgage loans sold with servicing retained. Effective January 1, 2017, United elected to carry servicing rights for residential mortgage loans at fair value. Given the nature of these SBA/USDA and residential mortgage servicing assets, the key valuation inputs are unobservable and United discloses them as level 3 item in Note 24.
Beginning in the third quarter of 2016, management elected the fair value option for most newly originated mortgage loans held for sale. United elected the fair value option for its portfolio of mortgage loans held for sale in order to reduce certain timing differences and better match changes in fair values of the loans with changes in the value of derivative instruments used to economically hedge them. The fair value of mortgage loans held for sale is determined using quoted prices for a similar asset, adjusted for specific attributes of that loan, and as such is categorized as level 2 in Note 24.
As of December 31, 2017, United had $900,000 of available-for-sale securities, $7.74 million in servicing rights for SBA/USDA loans, $8.26 million in residential mortgage servicing rights and $12.2 million in derivative financial instruments that were valued using unobservable inputs. The sum of these items represents less than .25% of total assets. United also had $16.7 million in derivative financial instruments recorded as liabilities that were valued using unobservable inputs, which represent .16% of total liabilities.
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, 2017, United reported a net deferred tax asset totaling $88.0 million, net of a valuation allowance of $4.41 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 arise from net operating loss and tax credit carryforwards, net of any related valuation allowances and net of deferred tax liabilities, are excluded from CET1 and Tier 1 capital. Deferred tax assets arising from temporary differences that could not be realized through net operating loss carrybacks, net of related valuation allowances and net of deferred tax liabilities, that exceed certain thresholds are excluded from CET1 and 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 or enhance our market share in markets where we already have an established presence. 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.
On November 1, 2017, United completed the acquisition of FOFN and its wholly-owned bank subsidiary, Four Oaks Bank & Trust Company. FOFN operated 14 banking offices in the Raleigh, North Carolina area. In connection with the acquisition, United acquired $729 million of assets and assumed $658 million of liabilities. Under the terms of the merger agreement, FOFN shareholders received .6178 shares of United common stock and $1.90 for each share of FOFN common stock issued and outstanding at the closing date, or an aggregate of $126 million. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $54.7 million.
On July 31, 2017, United completed the acquisition of HCSB and its wholly-owned bank subsidiary, Horry County State Bank. HCSB operated eight branches in coastal South Carolina. In connection with the acquisition, United acquired $390 million of assets and assumed $347 million of liabilities. Under the terms of the merger agreement, HCSB shareholders received .0050 shares of United common stock for each share of HCSB common stock issued and outstanding at the closing date, or an aggregate of $65.8 million. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $23.9 million.
On July 1, 2016, United completed the acquisition of Tidelands and its wholly-owned bank subsidiary, Tidelands Bank. Tidelands operated seven branches in coastal South Carolina. In connection with the acquisition, United acquired $440 million of assets and assumed $440 million of liabilities. Under the terms of the merger agreement, Tidelands’ shareholders received cash equal to $0.52 per common share, or an aggregate of $2.22 million. Additionally, at closing, United redeemed all of Tidelands’ fixed-rate cumulative preferred stock that was issued to the U.S. Department of the Treasury (the “Treasury”) under the Treasury’s Capital Purchase Program, plus unpaid dividends, for $8.98 million in aggregate. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $10.7 million.
On September 1, 2015, United completed the acquisition of Palmetto and its wholly-owned bank subsidiary, The Palmetto Bank. Palmetto operated 25 branches in South Carolina. In connection with the acquisition, United acquired $1.15 billion of assets and assumed $1.02 billion of liabilities. Total consideration transferred was $244 million of common equity and cash. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $115 million.
On May 1, 2015, United completed the acquisition of MoneyTree and its wholly-owned bank subsidiary, First National Bank. MoneyTree operated ten branches in east Tennessee. In connection with the acquisition, United acquired $459 million of assets and assumed $410 million of liabilities and $9.99 million of preferred stock. Total consideration transferred was $54.6 million of common equity and cash. The fair value of consideration paid exceeded the fair value of the identifiable assets and liabilities acquired and resulted in the establishment of goodwill in the amount of $14.7 million.
United will continue to evaluate potential transactions as opportunities arise.
On January 18, 2018, United issued $100 million of 4.5% Fixed to Floating Rate Subordinated notes due January 30, 2028 (the “Notes”). The Notes will initially bear interest at a rate of 4.500% per annum, payable semi-annually in arrears, with interest commencing on the issue date, to, but excluding, January 30, 2023, and, thereafter, payable quarterly in arrears at an annual floating rate equal to three-month LIBOR as determined for the applicable quarterly period, plus 2.120%. The notes are callable after five years and qualify as Tier 2 regulatory capital.
On February 1, 2018, United completed its previously announced acquisition of NLFC Holdings Corp. (“NLFC”) and its wholly-owned subsidiary, Navitas Credit Corp (“Navitas”). Navitas is a specialty lending company providing equipment finance credit services to small and medium-sized businesses nationwide. As of December 31, 2017, NLFC had total assets of $410 million and loans of $377 million.
Under the terms of the merger agreement, NLFC shareholders received $130 million in total consideration, $84.5 million of which was paid in cash and $45.7 million was paid in United common stock.
GAAP Reconciliation and Explanation
This Form 10-K contains financial information determined by methods other than in accordance with GAAP. Such non-GAAP financial information includes the following measures: “tangible book value per common share,” “tangible equity to assets,” “tangible common equity to assets” and “tangible common equity to risk-weighted assets.” In addition, management presents non-GAAP operating performance measures, which exclude merger-related and other items that are not part of United’s ongoing business operations. Operating performance measures include “expenses – operating,” “net income – operating,” “net income available to common shareholders – operating,” “diluted income per common share – operating,” “return on common equity – operating,” “return on tangible common equity – operating,” “return on assets – operating,” “dividend payout ratio – operating” and “efficiency ratio – operating.” Management has developed internal processes and procedures to accurately capture and account for merger-related and other charges and those charges are reviewed with the audit committee of United’s Board of Directors each quarter. Management uses these non-GAAP measures because it believes they may provide useful supplemental information for evaluating United’s operations and performance over periods of time, as well as in managing and evaluating United’s business and in discussions about United’s operations and performance. Management believes these non-GAAP measures may also provide users of United’s financial information with a meaningful measure for assessing United’s financial results and credit trends, as well as a comparison to financial results for prior periods. These non-GAAP measures should be viewed in addition to, and not as an alternative to or substitute for, measures determined in accordance with GAAP and are not necessarily comparable to other similarly titled measures used by other companies. To the extent applicable, reconciliations of these non-GAAP measures to the most directly comparable measures as reported in accordance with GAAP are included in the tables on pages 35 through 36.
UNITED COMMUNITY BANKS, INC.
Table 1 - Non-GAAP Performance Measures Reconciliation - Annual
Selected Financial Information
|For the Twelve Months Ended|
|(in thousands, except per share data)||2017||2016||2015||2014||2013|
|Merger-related and other charges||(14,662||)||(8,122||)||(17,995||)||-||-|
|Expenses - operating||$||252,949||$||233,167||$||193,243||$||162,865||$||174,304|
|Net income reconciliation|
|Net income (GAAP)||$||67,821||$||100,656||$||71,578||$||67,620||$||273,140|
|Merger-related and other charges||14,662||8,122||17,995||-||-|
|Income tax benefit of merger-related and other charges||(3,745||)||(3,074||)||(6,388||)||-||-|
|Impact of tax reform on remeasurement of deferred tax asset||38,199||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||976||-||-||-|
|Release of disproportionate tax effects lodged in OCI||3,400||-||-||-||-|
|Net income - operating||$||120,337||$||106,680||$||83,185||$||67,620||$||273,140|
|Diluted income per common share reconciliation|
|Diluted income per common share (GAAP)||$||.92||$||1.40||$||1.09||$||1.11||$||4.44|
|Merger-related and other charges||.14||.07||.18||-||-|
|Impact of tax reform on remeasurement of deferred tax asset||.52||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||.01||-||-||-|
|Release of disproportionate tax effects lodged in OCI||.05||-||-||-||-|
|Diluted income per common share - operating||$||1.63||$||1.48||$||1.27||$||1.11||$||4.44|
|Book value per common share reconciliation|
|Book value per common share (GAAP)||$||16.67||$||15.06||$||14.02||$||12.20||$||11.30|
|Effect of goodwill and other intangibles||(3.02||)||(2.11||)||(1.96||)||(.05||)||(.04||)|
|Tangible book value per common share||$||13.65||$||12.95||$||12.06||$||12.15||$||11.26|
|Return on tangible common equity reconciliation|
|Return on common equity (GAAP)||5.67||%||9.41||%||8.15||%||9.17||%||46.72||%|
|Merger-related and other charges||.92||.48||1.33||-||-|
|Impact of tax reform on remeasurement of deferred tax asset||3.20||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||.09||-||-||-|
|Release of disproportionate tax effects lodged in OCI||.28||-||-||-||-|
|Return on common equity - operating||10.07||9.98||9.48||9.17||46.72|
|Effect of goodwill and other intangibles||1.95||1.88||.76||.15||.63|
|Return on tangible common equity - operating||12.02||%||11.86||%||10.24||%||9.32||%||47.35||%|
|Return on assets reconciliation|
|Return on assets (GAAP)||.62||%||1.00||%||.85||%||.91||%||3.86||%|
|Merger-related and other charges||.09||.05||.13||-||-|
|Impact of tax reform on remeasurement of deferred tax asset||.35||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||.01||-||-||-|
|Release of disproportionate tax effects lodged in OCI||.03||-||-||-||-|
|Return on assets - operating||1.09||%||1.06||%||.98||%||.91||%||3.86||%|
|Dividend payout ratio reconciliation|
|Dividend payout ratio (GAAP)||41.30||%||21.43||%||20.18||%||9.91||%||-||%|
|Merger-related and other charges||(5.65||)||(1.02||)||(2.86||)||-||-|
|Impact of tax reform on remeasurement of deferred tax asset||(11.61||)||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||(.14||)||-||-||-|
|Release of disproportionate tax effects lodged in OCI||(.73||)||-||-||-||-|
|Dividend payout ratio - operating||23.31||%||20.27||%||17.32||%||9.91||%||-||%|
|Efficiency ratio reconciliation|
|Efficiency ratio (GAAP)||59.95||%||59.80||%||63.96||%||58.26||%||63.14||%|
|Merger-related and other charges||(3.28||)||(2.02||)||(5.45||)||-||-|
|Efficiency ratio - operating||56.67||%||57.78||%||58.51||%||58.26||%||63.14||%|
|Average equity to assets reconciliation|
|Equity to assets (GAAP)||10.71||%||10.54||%||10.27||%||9.69||%||10.35||%|
|Effect of goodwill and other intangibles||(1.42||)||(1.33||)||(.53||)||(.02||)||(.04||)|
|Tangible equity to assets||9.29||9.21||9.74||9.67||10.31|
|Effect of preferred equity||-||(.02||)||(.08||)||(.07||)||(2.76||)|
|Tangible common equity to assets||9.29||%||9.19||%||9.66||%||9.60||%||7.55||%|
|Tangible common equity to risk-weighted assets reconciliation|
|Tier 1 capital ratio (Regulatory)||12.24||%||11.23||%||11.45||%||12.06||%||12.74||%|
|Effect of other comprehensive income||(.29||)||(.34||)||(.38||)||(.35||)||(.39||)|
|Effect of deferred tax limitation||.51||1.26||2.05||3.11||4.26|
|Effect of trust preferred||(.36||)||(.25||)||(.08||)||(1.00||)||(1.04||)|
|Effect of preferred equity||-||-||(.15||)||-||(2.39||)|
|Basel III intangibles transition adjustment||(.05||)||(.06||)||(.10||)||-||-|
|Basel III disallowed investments||-||-||.03||-||-|
|Tangible common equity to risk-weighted assets||12.05||%||11.84||%||12.82||%||13.82||%||13.18||%|
UNITED COMMUNITY BANKS, INC.
Table 1 (Continued) - Non-GAAP Performance Measures Reconciliation - Quarterly
Selected Financial Information
|(in thousands, except per share data)||Quarter||Quarter||Quarter||Quarter||Quarter||Quarter||Quarter||Quarter|
|Merger-related and other charges||(7,358||)||(3,420||)||(1,830||)||(2,054||)||(1,141||)||(3,152||)||(1,176||)||(2,653||)|
|Expenses - operating||$||68,524||$||62,254||$||61,399||$||60,772||$||60,180||$||60,871||$||56,884||$||55,232|
|Net income reconciliation|
|Net income (GAAP)||$||(11,916||)||$||27,946||$||28,267||$||23,524||$||27,221||$||25,874||$||25,266||$||22,295|
|Merger-related and other charges||7,358||3,420||1,830||2,054||1,141||3,152||1,176||2,653|
|Income tax benefit of merger-related and other charges||(1,165||)||(1,147||)||(675||)||(758||)||(432||)||(1,193||)||(445||)||(1,004||)|
|Impact of tax reform on remeasurement of deferred tax asset||38,199||-||-||-||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||-||-||-||976||-||-||-|
|Release of disproportionate tax effects lodged in OCI||-||-||-||3,400||-||-||-||-|
|Net income - operating||$||32,476||$||30,219||$||29,422||$||28,220||$||28,906||$||27,833||$||25,997||$||23,944|
|Diluted income per common share reconciliation|
|Diluted income per common share (GAAP)||$||(.16||)||$||.38||$||.39||$||.33||$||.38||$||.36||$||.35||$||.31|
|Merger-related and other charges||.08||.03||.02||.01||.01||.03||.01||.02|
|Impact of tax reform on remeasurement of deferred tax asset||.50||-||-||-||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||-||-||-||.01||-||-||-|
|Release of disproportionate tax effects lodged in OCI||-||-||-||.05||-||-||-||-|
|Diluted income per common share - operating||$||.42||$||.41||$||.41||$||.39||$||.40||$||.39||$||.36||$||.33|
|Book value per common share reconciliation|
|Book value per common share (GAAP)||$||16.67||$||16.50||$||15.83||$||15.40||$||15.06||$||15.12||$||14.80||$||14.35|
|Effect of goodwill and other intangibles||(3.02||)||(2.39||)||(2.09||)||(2.10||)||(2.11||)||(2.12||)||(1.96||)||(1.95||)|
|Tangible book value per common share||$||13.65||$||14.11||$||13.74||$||13.30||$||12.95||$||13.00||$||12.84||$||12.40|
|Return on tangible common equity reconciliation|
|Return on common equity (GAAP)||(3.57||)%||9.22||%||9.98||%||8.54||%||9.89||%||9.61||%||9.54||%||8.57||%|
|Merger-related and other charges||1.86||.75||.41||.47||.26||.73||.27||.63|
|Impact of tax reform on remeasurement of deferred tax asset||11.44||-||-||-||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||-||-||-||.36||-||-||-|
|Release of disproportionate tax effects lodged in OCI||-||-||-||1.24||-||-||-||-|
|Return on common equity - operating||9.73||9.97||10.39||10.25||10.51||10.34||9.81||9.20|
|Effect of goodwill and other intangibles||2.20||1.96||1.80||1.85||1.96||2.11||1.75||1.71|
|Return on tangible common equity - operating||11.93||%||11.93||%||12.19||%||12.10||%||12.47||%||12.45||%||11.56||%||10.91||%|
|Return on assets reconciliation|
|Return on assets (GAAP)||(.40||)%||1.01||%||1.06||%||.89||%||1.03||%||1.00||%||1.04||%||.93||%|
|Merger-related and other charges||.20||.08||.04||.05||.03||.08||.03||.07|
|Impact of tax reform on remeasurement of deferred tax asset||1.30||-||-||-||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||-||-||-||.04||-||-||-|
|Release of disproportionate tax effects lodged in OCI||-||-||-||.13||-||-||-||-|
|Return on assets - operating||1.10||%||1.09||%||1.10||%||1.07||%||1.10||%||1.08||%||1.07||%||1.00||%|
|Dividend payout ratio reconciliation|
|Dividend payout ratio (GAAP)||(62.50||)%||26.32||%||23.08||%||27.27||%||21.05||%||22.22||%||20.00||%||22.58||%|
|Merger-related and other charges||12.04||(1.93||)||(1.13||)||(.98||)||(.54||)||(1.71||)||(.56||)||(1.37||)|
|Impact of tax reform on remeasurement of deferred tax asset||74.27||-||-||-||-||-||-||-|
|Impairment of deferred tax asset on canceled non-qualified stock options||-||-||-||-||(.51||)||-||-||-|
|Release of disproportionate tax effects lodged in OCI||-||-||-||(3.21||)||-||-||-||-|
|Dividend payout ratio - operating||23.81||%||24.39||%||21.95||%||23.08||%||20.00||%||20.51||%||19.44||%||21.21||%|
|Efficiency ratio reconciliation|
|Efficiency ratio (GAAP)||63.03||%||59.27||%||57.89||%||59.29||%||57.65||%||60.78||%||59.02||%||61.94||%|
|Merger-related and other charges||(6.11||)||(3.09||)||(1.68||)||(1.94||)||(1.07||)||(2.99||)||(1.20||)||(2.84||)|
|Efficiency ratio - operating||56.92||%||56.18||%||56.21||%||57.35||%||56.58||%||57.79||%||57.82||%||59.10||%|
|Average equity to assets reconciliation|
|Equity to assets (GAAP)||11.21||%||10.86||%||10.49||%||10.24||%||10.35||%||10.38||%||10.72||%||10.72||%|
|Effect of goodwill and other intangibles||(1.69||)||(1.41||)||(1.26||)||(1.28||)||(1.31||)||(1.40||)||(1.29||)||(1.31||)|
|Tangible equity to assets||9.52||9.45||9.23||8.96||9.04||8.98||9.43||9.41|
|Effect of preferred equity||-||-||-||-||-||-||-||(.09||)|
|Tangible common equity to assets||9.52||%||9.45||%||9.23||%||8.96||%||9.04||%||8.98||%||9.43||%||9.32||%|
|Tangible common equity to risk-weighted assets reconciliation|
|Tier 1 capital ratio (Regulatory)||12.24||%||12.27||%||11.91||%||11.46||%||11.23||%||11.04||%||11.44||%||11.32||%|
|Effect of other comprehensive income||(.29||)||(.13||)||(.15||)||(.24||)||(.34||)||-||(.06||)||(.25||)|
|Effect of deferred tax limitation||.51||.94||.95||1.13||1.26||1.50||1.63||1.85|
|Effect of trust preferred||(.36||)||(.24||)||(.25||)||(.25||)||(.25||)||(.26||)||(.08||)||(.08||)|
|Effect of preferred equity||-||-||-||-||-||-||-||-|
|Basel III intangibles transition adjustment||(.05||)||(.04||)||(.02||)||(.03||)||(.06||)||(.06||)||(.06||)||(.07||)|
|Basel III disallowed investments||-||-||-||-||-||-||-||-|
|Tangible common equity to risk-weighted assets||12.05||%||12.80||%||12.44||%||12.07||%||11.84||%||12.22||%||12.87||%||12.77||%|
Results of Operations
United reported net income of $67.8 million for the year ended December 31, 2017. This compared to net income of $101 million in 2016. Diluted earnings per common share for 2017 were $.92, compared to diluted earnings per common share for 2016 of $1.40.
Net Interest Revenue
Net interest revenue (the difference between the interest earned on assets and the interest paid on deposits and other liabilities) is the single largest component of revenue. Management seeks to optimize this revenue while balancing interest rate, credit, and liquidity risks. Net interest revenue for 2017 was $356 million, compared to $310 million for 2016 and $257 million for 2015. Taxable equivalent net interest revenue totaled $358 million in 2017, an increase of $47.4 million, or 15%, from 2016. Taxable equivalent net interest revenue for 2016 increased $52.1 million, or 20%, from 2015.
The combination of the larger earning asset base from the Acquisitions, growth in the loan portfolio and a wider net interest margin were responsible for the increase in net interest revenue. The acquisition of FOFN on November 1, 2017, HCSB on July 31, 2017 and Tidelands on July 1, 2016 contributed to the increase as the acquired entities’ results are included in consolidated results beginning on the respective acquisition date.
Average loans increased $737 million, or 12%, from 2016, while the yield on loans increased 22 basis points, reflecting the effect of rising interest rates on the floating rate loans in the portfolio.
Average interest-earning assets for 2017 increased $905 million, or 10%, from 2016, which was due primarily to the increase in loans, including the acquisitions of FOFN, HCSB and Tidelands loans. Average investment securities for 2017 increased $156 million from a year ago, partially due to the Acquisitions. The average yield on the taxable investment portfolio increased 16 basis points from a year ago, primarily due to the impact of higher short-term interest rates on the floating rate portion of the securities portfolio as well as accelerated discount accretion on called asset-backed securities and a higher reinvestment rate on maturing fixed rate investments.
Average interest-bearing liabilities in 2017 increased $437 million, or 7%, from the prior year as funding needs increased with the increase in loans and a larger securities portfolio. Average noninterest-bearing deposits increased $390 million from 2016 to 2017 providing some of United’s 2017 funding needs. The average cost of interest-bearing liabilities for 2017 was .49% compared to .39% for 2016, reflecting a higher average rate on interest-bearing deposits.
The banking industry uses two key ratios to measure relative profitability of net interest revenue - the net interest spread and the net interest margin. The net interest spread measures the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities. The interest rate spread eliminates the effect of non-interest-bearing deposits and other non-interest-bearing funding sources and gives a direct perspective on the effect of market interest rate movements. The net interest margin is an indication of the profitability of a company’s overall balance sheet management activities and is defined as net interest revenue as a percentage of total average interest-earning assets, which includes the positive effect of funding a portion of interest-earning assets with customers’ non-interest-bearing deposits and with shareholders’ equity.
For 2017, 2016 and 2015, the net interest spread was 3.37%, 3.24%, and 3.19%, respectively, while the net interest margin was 3.52%, 3.36%, and 3.30%, respectively. Increases in loan yield and securities yield were only partially offset by an increase in the cost of interest-bearing liabilities as rates paid on core deposits lagged general increases in market rates. The increase in both ratios from 2015 to 2016 was due to an increase in the yield on investment securities, which more than offset the decrease in loan yields due to competitive pricing pressure on new and renewed loans.
The following table shows the relationship between interest revenue and interest expense and the average balances of interest-earning assets and interest-bearing liabilities.
Table 2 - Average Consolidated Balance Sheets and Net Interest Margin Analysis
For the Years Ended December 31,
(In thousands, fully taxable equivalent)
|Taxable securities (3)||2,761,983||70,172||2.54||2,665,051||63,413||2.38||2,342,533||51,143||2.18|
|Tax-exempt securities (1)(3)||85,415||3,627||4.25||26,244||1,005||3.83||25,439||1,154||4.54|
|Federal funds sold and other interest-earning assets||164,314||2,966||1.81||152,722||3,149||2.06||168,494||3,799||2.25|
|Total interest-earning assets||10,161,923||391,903||3.86||9,256,757||336,045||3.63||7,834,153||279,809||3.57|
|Allowance for loan losses||(60,602||)||(65,294||)||(71,001||)|
|Cash and due from banks||107,053||95,613||81,244|
|Premises and equipment||198,970||187,698||174,835|
|Other assets (3)||607,174||579,051||442,878|
|Liabilities and Shareholders' Equity:|
|Total interest-bearing deposits||6,126,744||17,062||.28||5,744,492||10,156||.18||5,153,612||8,825||.17|
|Federal funds purchased, repurchase agreeements, & other short-term borrowings||26,856||352||1.31||34,906||399||1.14||49,301||364||.74|
|Federal Home Loan Bank advances||576,472||6,095||1.06||499,026||3,676||.74||250,404||1,743||.70|
|Total borrowed funds||759,655||16,673||2.19||704,411||15,080||2.14||439,684||12,284||2.79|
|Total interest-bearing liabilities||6,886,399||33,735||.49||6,448,903||25,236||.39||5,593,296||21,109||.38|
|and shareholders' equity||$||11,014,518||$||10,053,825||$||8,462,109|
|Net interest revenue||$||358,168||$||310,809||$||258,700|
|Net interest-rate spread||3.37||%||3.24||%||3.19||%|
|Net interest margin (4)||3.52||%||3.36||%||3.30||%|
|(1)||Interest revenue on tax-exempt securities and loans has been increased to reflect comparable interest on taxable securities and loans. The rate used was 39%, reflecting the statutory federal rate and the federal tax adjusted state tax rate.|
|(2)||Included in the average balance of loans outstanding are loans where the accrual of interest has been discontinued.|
|(3)||Securities available for sale are shown at amortized cost. Pretax unrealized gains of $4.33 million, $16.0 million and $11.4 million in 2017, 2016 and 2015, respectively, are included in other assets for purposes of this presentation.|
|(4)||Net interest margin is taxable equivalent net-interest revenue divided by average interest-earning assets.|
The following table shows the relative effect on net interest revenue of changes in the average outstanding balances (volume) of interest-earning assets and interest-bearing liabilities and the rates earned and paid by United on such assets and liabilities.
Table 3 - Change in Interest Revenue and Interest Expense
(in thousands, fully taxable equivalent)
|2017 Compared to 2016||2016 Compared to 2015|
|Increase (decrease)||Increase (decrease)|
|due to changes in||due to changes in|
|Federal funds sold and other interest-earning assets||228||(411||)||(183||)||(340||)||(310||)||(650||)|
|Total interest-earning assets||37,081||18,777||55,858||53,819||2,417||56,236|
|Total interest-bearing deposits||817||6,089||6,906||1,259||72||1,331|
|Federal funds purchased, repurchase agreements & other short-term borrowings||(100||)||53||(47||)||(127||)||162||35|
|Federal Home Loan Bank advances||636||1,783||2,419||1,826||107||1,933|
|Total borrowed funds||(388||)||1,981||1,593||3,752||(956||)||2,796|
|Total interest-bearing liabilities||429||8,070||8,499||5,011||(884||)||4,127|
|Increase in net interest revenue||$||36,652||$||10,707||$||47,359||$||48,808||$||3,301||$||52,109|
Any variance attributable jointly to volume and rate changes is allocated to the volume and rate variance in proportion to the relationship of the absolute dollar amount of the change in each.
Provision for Credit Losses
The provision for credit losses is based on management’s evaluation of probable incurred losses in the loan portfolio and unfunded loan commitments as measured by analysis of the allowance for credit losses at the end of each reporting period. The provision for credit losses was $3.8 million in 2017, compared with a release of provision of $800,000 in 2016 and provision expense of $3.70 million in 2015. The amount of provision recorded in each year was the amount required such that the total allowance for credit losses reflected the appropriate balance, in the estimation of management, and was sufficient to cover incurred losses in the loan portfolio. The increase in 2017 was due to loan growth as credit quality measures remain favorable and stable. The improvement in 2016 reflects overall improvement in a number of troubled debt restructuruings (“TDRs”) as well as continued strong credit quality and a low overall level of net charge-offs. The ratio of net loan charge-offs to average outstanding loans for 2017 was .08% compared with .11% for 2016 and .12% for 2015.
The allowance for unfunded loan commitments, which is included in other liabilities in the consolidated balance sheets, represents probable incurred losses on unfunded loan commitments that are expected to result in outstanding loan balances. The allowance for unfunded loan commitments was established through the provision for credit losses. At December 31, 2017, the allowance for unfunded commitments was $2.31 million compared with $2.00 million at December 31, 2016 and $2.54 million at December 31, 2015.
Additional discussion on credit quality and the allowance for loan losses is included in the “Asset Quality and Risk Elements” and “Critical Accounting Polices” sections of this report, as well as Note 1 to the consolidated financial statements.
Fee revenue was $88.3 million in 2017, compared with $93.7 million in 2016 and $72.5 million in 2015. The following table presents the components of fee revenue for the periods indicated.
|Table 4 - Fee Revenue|
|For the Years Ended December 31,|
|ATM and debit card interchange fees||16,922||20,839||17,667||(19||)|
|Other service charges and fees||7,369||7,391||6,655||-|
|Service charges and fees||38,295||42,113||36,825||(9||)|
|Mortgage loan and related fees||18,320||20,292||13,592||(10||)|
|Gains from sales of USDA/SBA loans||10,493||9,545||6,276||10|
|Bank owned life insurance||3,261||1,634||995||100|
|Securities gains, net||42||982||2,255|
|Losses on prepayment of borrowings||-||-||(1,294||)|
|Total fee revenue||$||88,260||$||93,697||$||72,529||(6||)|
Service charges and fees of $38.3 million were down $3.82 million, or 9%, from 2016. The decrease is primarily due to the effect of the Durbin Amendment of the Dodd-Frank Act (the “Durbin Amendment”) which took effect for United in the third quarter of 2017 and limited the amount of interchange fees United could earn on debit card transactions. Service charges increased in 2016 compared to 2015 due to increased deposit balances driven primarily by the Acquisitions.
Mortgage loan and related fees of $18.3 million were down $1.97 million, or 10%, from 2016. The decrease reflects a combination of factors including our strategic decision to hold more mortgages on our balance sheet, margin compression and a decline in refinance activity in a rising rate environment. In addition, 2016 included the impact of moving to mandatory delivery of loans to the secondary market from best efforts, which accelerated revenue recognition to the time of the rate lock. In 2017, United closed 3,228 mortgage loans totaling $745 million compared with 3,246 loans totaling $718 million in 2016 and 2,538 loans totaling $494 million in 2015. In 2017, new home purchase mortgages of $468 million accounted for 63% of production volume compared with $382 million, or 53%, of production volume in 2016 and $272 million, or 55%, of production volume in 2015.
In 2017, United realized $10.5 million in gains from the sales of the guaranteed portion of SBA and USDA loans, compared to $9.55 million and $6.28 million, respectively, in 2016 and 2015. United’s SBA/USDA lending strategy includes selling a portion of the loan production each quarter. United retains the servicing rights on the sold loans and earns a fee for servicing the loans. In 2017, United sold the guaranteed portion of loans in the amount of $117 million, compared to $120 million and $70.7 million, respectively, for 2016 and 2015. The growth in 2017 compared to 2016 reflects an increase in the premiums received on the sold loans. The growth in 2016 compared to 2015 reflects an increase in the numbers of loans closed due to additional lenders and cross-selling through our community banks as well as the completion of construction projects.
Fees from customer swap transactions of $2.42 million were down $1.68 million from 2016 due to lower demand for this product in the current rate environment. United provides interest rate swaps to commercial customers who desire fixed rate loans. United makes a floating rate loan to those customers and enters into an interest rate swap contract with the customer to swap the floating rate to a fixed rate. United then enters into an offsetting swap with a swap dealer with terms that mirror the customer swap. The fixed and variable legs of the customer and dealer swaps offset leaving United with the equivalent of a variable rate loan. The increase in 2016 from 2015 was due to increased customer demand to lock in low fixed rates on their loans.
United recognized net securities gains of $42,000, $982,000 and $2.26 million during 2017, 2016 and 2015, respectively. In 2015, United incurred $1.29 million in debt prepayment charges due to the redemption of $49.3 million in trust preferred securities with an average rate of approximately 9% and prepayment of $6 million in structured repurchase agreements with an average rate of 4%. The losses were part of the same balance sheet management activities and had the effect of offsetting the securities gains.
Earnings from bank owned life insurance of $3.26 million increased $1.63 million or 100% from 2016 due to the purchase of $30 million of bank owned life insurance in late 2016 and early 2017, as well as the acquisition of HCSB and FOFN, both of which had bank owned life insurance policies.
Other fee revenue of $10.8 million for 2017 remained flat when compared to 2016. The increase in other fee revenue from miscellaneous bank services was offset by small losses on sales of other assets when compared to 2016 gains on sales of former branch facilities. Other fee revenue of $10.7 million for 2016 was up $3.62 million from 2015. Included in 2016 other fee revenue is a payment for the settlement of a vendor dispute over trust fees totaling $638,000. The remaining increase is primarily due to higher fees from a number of miscellaneous banking services primarily due to volume driven increases in income from merchant services combined with gains on sales of former branch facilities.
The following table presents the components of operating expenses for the periods indicated.
|Table 5 - Operating Expenses|
|For the Years Ended December 31,|
|Salaries and employee benefits||$||153,098||$||138,789||$||116,688||10||%|
|Communications and equipment||19,660||18,355||15,273||7|
|Advertising and public relations||4,242||4,426||3,667||(4||)|
|Postage, printing and supplies||5,952||5,382||4,273||11|
|FDIC assessments and other regulatory charges||6,534||5,866||5,106||11|
|Amortization of intangibles||4,845||4,182||2,444||16|
|Total excluding merger-related and other charges||253,710||233,167||193,243||9|
|Merger-related and other charges||13,901||8,122||17,995||71|
|Total operating expenses||$||267,611||$||241,289||$||211,238||11|
Operating expenses were $268 million in 2017 as compared to $241 million in 2016 and $211 million in 2015. The increase mostly reflects the inclusion of operating expenses associated with the Acquisitions. The increase in 2016 from 2015 was due to similar reasons and investing in Commercial Banking Solutions areas and other strategic hiring.
Salaries and employee benefits expense for 2017 was $153 million, an increase of $14.3 million, or 10%, from 2016. The increase was due to a number of factors including investments in additional staff and additional staff resulting from the Acquisitions. Full time equivalent headcount totaled 2,137 at December 31, 2017 compared to 1,916 at December 31, 2016 and 1,883 at December 31, 2015.
Communications and equipment expense of $19.7 million for 2017 was up $1.31 million, or 7%, from 2016 due to higher software maintenance contracts, and higher equipment depreciation charges mostly resulting from the Acquisitions. The increase in 2016 from 2015 reflects higher local and long distance telephone charges, higher data circuit charges, and also and higher equipment depreciation charges mostly resulting from the Acquisitions.
Occupancy expense of $20.3 million for 2017 was up $741,000, or 4%, compared to 2016, primarily due to higher depreciation and lease rental charges for the expanded branch network resulting from the Acquisitions. The increase from 2015 to 2016 was primarily related to the same reasons.
Postage, printing and supplies expense for 2017 was $5.95 million, an increase of 11% from 2016, partly due to the Acquisitions. Similarly, the increase from 2016 to 2015 was primarily due to acquisition activity.
FDIC assessments and other regulatory charges expense for 2017 was $6.53 million, an increase of $668,000, or 11%, from 2016 due to a larger balance sheet as well as the effect of the higher deposit insurance assessment imposed beginning in the third quarter of 2017 as a result of United’s exceeding the $10 billion asset size threshold. Amortization of intangibles increased in 2017 and 2016 due to Acquisition-related core deposit intangibles and noncompete intangibles.
In 2017, merger-related and other charges of $13.9 million consisted primarily of merger costs of $10.4 million, impairment charges on surplus bank properties of $1.14 million, executive retirement costs of $1.53 million and branch closure costs of $831,000. The 2017 merger-related costs were primarily related to HCSB and FOFN acquisitions. The 2016 charges, which included severance, conversion and legal and professional fees were primarily related to the Palmetto and Tidelands acquisitions.
Other expenses totaled $25.7 million for 2017, compared to $23.7 million in 2016 and $20.2 million in 2015, mostly due to the Acquisitions.
Income tax expense was $105 million in 2017, compared to $62.3 million in 2016 and $43.4 million in 2015. Income tax expense for 2017, 2016 and 2015 represents an effective tax rate of 60.8%, 38.2% and 37.8%, respectively. The abnormally high tax expense and effective tax rate in 2017 reflects a $38.2 million charge to remeasure United’s deferred tax assets at the new lower federal income tax rate of 21% following the passage of the Tax Act on December 22, 2017. The effective tax rate for 2018 is expected to be approximately 23.5% reflecting the lower federal income tax rate.
Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts and their respective tax basis including operating losses and tax credit carryforwards. Net deferred tax assets (deferred tax assets net of deferred tax liabilities and valuation allowance) are reported in the consolidated balance sheets as a component of total assets.
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. The determination of whether a valuation allowance for deferred tax assets is appropriate is subject to considerable judgment and requires an evaluation of all positive and negative evidence with more weight given to evidence that can be objectively verified. Each quarter, management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results.
Based on all evidence considered, as of December 31, 2017 and 2016, management concluded that it was more likely than not that the net deferred tax asset would be realized. With continuous improvements in credit quality, quarterly earnings for the past several years have closely followed management’s forecast for these periods. The improvement in management’s ability to produce reliable forecasts, continuous and significant improvements in credit quality, and a sustained period of profitability were given appropriate weighting in our analysis, and such evidence was considered sufficient to overcome the weight of the negative evidence related to the significant operating losses in prior years.
Management expects to generate higher levels of future taxable income and believes this will allow for full utilization of United’s net operating loss carryforwards within the statutory carryforward periods. In determining whether projections of future taxable income are reliable, management considered objective evidence supporting the forecast assumptions as well as recent experience demonstrating the ability to reasonably project future results of operations.
Additional information regarding income taxes, including a reconciliation of the differences between the recorded income tax provision and the amount of income tax computed by applying the statutory federal income tax rate to income before income taxes, can be found in Note 17 to the consolidated financial statements.
Fourth Quarter 2017 Discussion
Net interest revenue for the fourth quarter of 2017 increased $16.6 million, or 20%, to $97.5 million from the same period a year ago, primarily due to loan growth, the acquisitions of HCSB and FOFN, and higher yields on loans and securities. The yields on the loan and securities portfolios increased partly due to the impact of rising interest rates on the variable portion of the portfolios. The net interest margin for the fourth quarter of 2017 increased to 3.63% from 3.34% in the fourth quarter of 2016, reflecting the higher yields on earning assets, partially offset by a smaller increase in the average rate paid on interest-bearing deposits.
United recorded a provision for credit losses in the fourth quarter of 2017 of $1.2 million, compared to no provision being recorded for the fourth quarter of 2016. The increase was primarily due to loan growth as credit quality remained stable.
The following table presents the components of fee revenue for the periods indicated.
Table 6 - Quarterly Fee Revenue
|Three Months Ended|
|ATM and debit card fees||3,188||5,250||(39||)|
|Other service charges and fees||1,851||1,858||-|
|Service charges and fees||8,770||10,653||(18||)|
|Mortgage loan and related fees||4,885||6,516||(25||)|
|Gains on sales of government guaranteed loans||3,102||3,028||2|
|Securities (losses) gains, net||(148||)||60|
|Total fee revenue||$||21,928||$||25,233||(13||)|
Fee revenue for the fourth quarter of 2017 of $21.9 million decreased $3.31 million, or 13%, from the fourth quarter of 2016. Service charges and fees on deposit accounts of $8.77 million decreased $1.88 million, or 18%, from $10.7 million for the fourth quarter of 2016, since United became subject to the Durbin Amendment, which reduced debit card interchange fees. Mortgage fees of $4.89 million decreased $1.63 million, or 25%, from $6.52 million in the fourth quarter of 2016 due to the impact of moving to mandatory delivery of loans to the secondary market from best efforts in late 2016, which accelerated revenue recognition to the time of the rate lock. Sales of $33.6 million in government guaranteed loans in fourth quarter 2017 resulted in net gains of $3.10 million, compared to $41.1 million sold in fourth quarter 2016, resulting in net gains of $3.03 million. Customer derivative fees decreased in the fourth quarter of 2017 compared with a year ago due to an decrease in customer demand for the product. Other fee revenue of $3.64 million increased $394,000, or 12%, from the fourth quarter of 2016, mostly due to volume driven increases in earnings on bank owned life insurance policies.
The following table presents operating expenses for the periods indicated.
Table 7 - Quarterly Operating Expenses
|Three Months Ended|
|Salaries and employee benefits||$||41,042||$||35,677||15||%|
|Communications and equipment||5,217||4,753||10|
|Advertising and public relations||895||1,151||(22||)|
|Postage, printing and supplies||1,825||1,353||35|
|FDIC assessments and other regulatory charges||1,776||1,413||26|
|Amortization of intangibles||1,760||1,066||65|
|Total excluding merger-related and other charges||69,041||60,180||15|
|Merger-related and other charges||6,841||1,141|
|Total operating expenses||$||75,882||$||61,321||24|
Operating expenses of $75.9 million increased 24% from $61.3 million for the fourth quarter of 2016, largely due to the increases in merger-related and other charges and salaries and employee benefits. Salaries and employee benefits of $41.0 million were up $5.37 million from the fourth quarter of 2016, due primarily to additional staff resulting from the HCSB and FOFN acquisitions and higher commissions and incentives due to business growth. Occupancy expense of $5.54 million was up $332,000 for the fourth quarter of 2017 compared to 2016, primarily due to additional locations attributable to the HCSB and FOFN acquisition. Professional fees increased 33% to $3.68 million in fourth quarter 2017 compared to fourth quarter 2016 due primarily to higher consulting fees in 2017 relating to various corporate projects. Other expenses of $7.30 million were up 8% from the fourth quarter of 2016, primarily due to establishing a reserve for minor legal disputes. For the fourth quarter of 2017, merger-related and other charges of $6.84 million included merger charges primarily related to HCSB and FOFN.
Balance Sheet Review
Total assets at December 31, 2017 were $11.9 billion, an increase of $1.21 billion, or 11%, from December 31, 2016. On a daily average basis, total assets increased $961 million, or 10%, from 2016 to 2017. Average interest earning assets for 2017 and 2016 were $10.2 billion and $9.26 billion, respectively.
Substantially all of United’s loans are to customers located in the immediate market areas of its community banks in Georgia, North Carolina, South Carolina and Tennessee, including customers who have a seasonal residence in United’s market areas, or are generated by the Commercial Banking Solutions division (formerly referred to as Specialized Lending) that focuses on specific commercial loan businesses, such as SBA and franchise lending. More than 79% of loans are secured by real estate. Total loans averaged $7.15 billion in 2017, compared with $6.41 billion in 2016, an increase of 12%. At December 31, 2017, total loans were $7.74 billion, an increase of $815 million, or 12%, from December 31, 2016. Loans increased year over year due to organic growth and the acquisitions of HCSB and FOFN.
The following table presents the composition of United’s loan portfolio for the last five years.
Table 8 - Loans Outstanding
As of December 31,
|Loans by Category||2017||2016||2015||2014||2013|
|Owner occupied commercial real estate||$||1,923,993||$||1,650,360||$||1,570,988||$||1,256,779||$||1,237,623|
|Income producing commercial real estate||1,595,174||1,281,541||1,020,464||766,834||807,093|
|Commercial & industrial||1,130,990||1,069,715||784,870||709,615||470,702|
|Home equity lines of credit||731,227||655,410||589,325||455,825||430,530|
|Loans by Market||2017||2016||2015||2014||2013|
|Commercial Banking Solutions||960,657||855,283||491,928||420,693||124,505|
As of December 31, 2017, United’s 25 largest credit relationships consisted of loans and loan commitments ranging from $17.5 million to $38.1 million, with an aggregate total credit exposure of $572 million. Total credit exposure includes $204 million in unfunded commitments and $368 million in balances outstanding, excluding participations sold. United had fifteen lending relationships whose total credit exposure exceeded $20 million of which only five relationships were in excess of $25 million.
The following table sets forth the maturity distribution of commercial and construction loans, including the interest rate sensitivity for loans maturing after one year.
Table 9 - Loan Portfolio Maturity
As of December 31, 2017
|Rate Structure for Loans|
|Maturity||Maturing Over One Year|
|One Year||One through||Over Five||Fixed||Floating|
|or Less||Five Years||Years||Total||Rate||Rate|
|Commercial (commercial and industrial)||$||240,505||$||554,083||$||336,402||$||1,130,990||$||314,410||$||576,075|
|Construction (commercial and residential)||356,236||354,507||184,212||894,955||171,880||366,839|
Asset Quality and Risk Elements
United manages asset quality and controls credit risk through review and oversight of the loan portfolio as well as adherence to policies designed to promote sound underwriting and loan monitoring practices. United’s credit administration function is responsible for monitoring asset quality and Board of Directors approved portfolio concentration limits, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures among all of the community banks and commercial banking solutions areas. Additional information on United’s credit administration function is included in Item 1 under the heading “Loan Review and Nonperforming Assets.”
Home equity lines generally require the payment of interest only for a set period after origination. After this initial period, the outstanding balance begins amortizing and requires the payment of both principal and interest. At December 31, 2017 and 2016, the funded portion of home equity lines totaled $731 million and $655 million, respectively. Approximately 4% of the home equity loans at December 31, 2017 were amortizing. Of the $731 million in balances outstanding at December 31, 2017, $430 million, or 59%, were first liens. At December 31, 2017, 55% of the total available home equity lines were drawn upon.
United monitors the performance of its home equity loans and lines secured by second liens similar to other consumer loans and utilizes assumptions specific to these loans in determining the necessary allowance. United generally receives notification when the first lien holder is in the process of foreclosure and upon that notification, United determines its collection options by obtaining valuations to conclude if any additional charge-offs or reserves are warranted.
United classifies performing loans as “substandard” when there is a well-defined weakness or weaknesses that jeopardizes the repayment by the borrower and there is a distinct possibility that United could sustain some loss if the deficiency is not corrected.
The table below presents performing classified loans for the last five years.
Table 10 - Performing Classified Loans
As of December 31,
|Owner occupied commercial real estate||$||41,467||$||42,169||$||44,790||$||52,671||$||51,395|
|Income producing commercial real estate||30,061||29,379||37,638||29,194||45,363|
|Commercial & industrial||11,879||8,903||5,967||7,664||9,267|