Index

Part I - FINANCIAL CONDITION
Item 1 - Financial Statements

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2

Index

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

United Community Banks, Inc. and Subsidiaries

Notes to Consolidated Financial Statements

Note 1 - Accounting Policies   

The accounting and financial reporting policies of United Community Banks, Inc. (“United”) and its subsidiaries conform to accounting principles generally accepted in the United States of America and general banking industry practices.  The accompanying interim consolidated financial statements have not been audited.  All material intercompany balances and transactions have been eliminated.  A more detailed description of United’s accounting policies is included in the 2002 annual report filed on Form 10-K.

In management’s opinion, all accounting adjustments necessary to accurately reflect the financial position and results of operations on the accompanying financial statements have been made. These adjustments are considered normal and recurring accruals considered necessary for a fair and accurate presentation. The results for interim periods are not necessarily indicative of results for the full year or any other interim periods.

Note 2  - Stock-Based Compensation

United’s stock-based compensation plans are accounted for based on the intrinsic value method set forth in Accounting Principles Board (APB) Opinion 25, Accounting for Stock Issued to Employees, and related interpretations.  Compensation expense for employee stock options is not recognized if the exercise price of the option equals or exceeds the fair value of the stock on the date of grant.  Compensation expense for restricted share awards is ratably recognized over the period of service, usually the restricted period, based on the fair value of the stock on the date of grant. Had compensation costs been determined based upon the fair value of the options at the grant dates consistent with the method of SFAS No. 123, United’s net income and earnings per common share would have reflected the pro forma amounts below (in thousands, except per share data):

The weighted average fair value of options at grant date in the first quarter of 2002 was $4.75.  No options were granted during the first quarter of 2003.

The fair value of each option granted in 2002 was estimated on the date of grant using the Black-Scholes model with the following weighted average assumptions: dividend yield of 1%; a risk free interest rate of 4.25%; expected volatility of 15%; and, an expected life of 7 years.  Since United’s Nasdaq trading history dates back only to March 18, 2002, United used the Nasdaq Bank Index to determine volatility.  The fair value of each option granted prior to 2002 was estimated on the date of grant using the minimum value method with the following weighted average assumptions: dividend yield of 1%; a risk free interest rate of 5%; and, an expected life of 7 years.  The compensation expense included in the proforma results was determined based on the fair value at the time of grant multiplied by the number of options vested during the period, net of tax.

Note 3  - Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share for the three months ended March 31.  All amounts have been restated to reflect the two for one stock split effective May 29, 2002, for shareholders of record May 15, 2002, that was announced on April 25, 2002.

(in thousands, except per share data)

Note 4 – Mergers and Acquisitions

On March 31, 2003, United acquired 100 percent of the outstanding common shares of First Central Bancshares, Inc. a community bank holding company headquartered in Lenoir City, Tennessee.  The results of First Central’s operations will be included in the consolidated financial statements beginning April 1, 2003.  First Central Bancshares is the parent company of First Central Bank, a community bank serving east Tennessee along the Interstate 75 corridor between Knoxville and Chattanooga.  United has long sought to enter the east Tennessee market with its attractive demographics and its close proximity to United’s existing markets.

The aggregate purchase price was $29.6 million including $9 million of cash and 821,160 shares of United’s common stock valued at $20.6 million.  The value of the common shares issued was determined based on the average market price of United’s common shares over the 2-day period before and after the terms of the acquisition were agreed to and announced.

The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition.

At March 31, 2003
(in thousands)

The $2.9 million of core deposit intangible is being amortized over a period of 10 years.

In connection with the acquisition of First Central, United incurred charges of $840 thousand during the first quarter.  The charges are included in operating expenses in the consolidated statement of income.  The table below provides a summary of the merger charge showing the amounts paid during the period and the amounts remaining accrued at March 31, 2003.

On May 1, 2003, United completed its acquisition of First Georgia Holding, parent company of First Georgia Bank   headquartered in Brunswick, Georgia.  First Georgia had assets of approximately $300 million including purchase accounting related intangibles on the acquisition date.  The transaction was valued at approximately $42 million including cash of approximately $13 million and 1,177,000 shares of United’s stock valued at $29 million based on the market price of United’s common shares over the two-day period before and after the terms of the acquisition were announced.  United had long targeted coastal Georgia for potential expansion due to the attractive demographics and the similarities to its existing markets.  First Georgia has an 18% deposit market share in Glynn county, Georgia.  United is in the process of obtaining valuations of the balance sheet components and certain intangible assets thus the allocation of the purchase price is not complete.

Note 5 – Stock Split

On April 25, 2002, United announced a two-for-one stock split in the form of a 100% stock dividend effective May 29, 2002 for shareholders of record May 15, 2002.  All financial statements and per share amounts included in the financial statements and accompanying notes have been restated to reflect the change in the number of shares outstanding as of the beginning of the earliest period presented.

Note 6 – Reclassification

Certain amounts for the comparative periods of 2002 have been reclassified to conform to the 2003 presentation.

Part I

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

This Form 10-Q, contains forward-looking statements regarding United Community Banks, Inc., including, without limitation, statements relating to United’s expectations with respect to revenue, credit losses, levels of nonperforming assets, expenses, earnings and other measures of financial performance.  Words such as “may”, “could”, “would”, “should”, “believes”, “expects”, “anticipates”, “estimates”, “intends”, “plans”, “targets” or similar expressions are intended to identify forward-looking statements.  These forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties that are subject to change based on various factors (many of which are beyond United’s control).  The following factors, among others, could cause United’s financial performance to differ materially from the expectations expressed in such forward-looking statements:  (1) business increases, productivity gains and other investments are lower than expected or do not occur as quickly as anticipated;  (2) competitive pressures among financial services companies increase significantly;  (3) the strength of the United States economy in general and/or the strength of the local economies of the states in which United conducts operations changes;  (4) trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System, change;  (5) inflation, interest rates and/or market conditions fluctuate;  (6) conditions in the stock market, the public debt market and other capital markets deteriorate;  (7) United fails to develop competitive new products and services and/or new and existing customers do not accept these products and services;  (8) financial services laws and regulations change;  (9) technology changes and United fails to adapt to those changes;  (10) consumer spending and saving habits change;  (11) unanticipated regulatory or judicial proceedings occur; and (12) United is unsuccessful at managing the risks involved in the foregoing.  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.  United cautions that the foregoing list of factors is not exclusive and undue reliance should not be placed 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-Q.

Overview

United is a bank holding company registered under the Bank Holding Company Act of 1956, and was incorporated under the laws of the state of Georgia in 1987 and commenced operations in 1988.  United’s activities are primarily conducted by its wholly-owned banking subsidiaries (which are collectively referred to as the “Banks” in this discussion) and Brintech, Inc. a consulting firm providing professional services to the financial services industry.

On March 18, 2002, United began trading on The Nasdaq Stock Market under the symbol UCBI.  Previously, the stock was listed on the over-the-counter market on the Pink Sheets.

On May 29, 2002, United had a two-for-one stock split.  All financial information and per share amounts included in Management’s Discussion and Analysis have been restated to reflect the change in the number of shares outstanding as of the beginning of the earliest period presented.

At March 31, 2003, United had total consolidated assets of $3.6 billion, total loans of $2.5 billion, total deposits of $2.7 billion and stockholders’ equity of $246 million.

Mergers and Acquisitions

On March 31, 2003, United completed its acquisition of First Central Bancshares, a one-bank holding company   headquartered in Lenoir City, Tennessee.  On March 31, 2003, First Central had assets of $195 million, including purchase accounting related intangibles.  United exchanged 821,160 shares of its common stock valued at $20.6 million and approximately $9 million in cash for all of the outstanding shares of First Central.  United operates First Central’s wholly-owned Tennessee bank subsidiary, First Central Bank.

On January 23, 2003, United announced a definitive agreement to acquire First Georgia Holding, a one-bank holding company headquartered in Brunswick, Georgia, for approximately $42 million.  The acquisition of First Georgia was completed on May 1, 2003, at which time First Georgia was merged into United.  On May 1, 2003, First Georgia had assets of approximately $300 million, including purchase accounting related intangibles.  United paid First Georgia’s shareholders 1,177,000 shares of its common stock valued at approximately $29 million and approximately $13 million in cash for all of the outstanding shares of First Georgia.  First Georgia’s wholly-owned Georgia bank subsidiary, First Georgia Bank, was merged into United’s Georgia bank subsidiary, United Community Bank, and will operate as a separate Community bank doing business as “First Georgia Bank”, pending completion of all conversion activities.

Index

Critical Accounting Policies

The accounting and reporting policies of United Community Banks, Inc. and its subsidiaries are in accordance with accounting principles generally accepted in the United States and conform to general practices within the banking industry.  The more critical accounting and reporting policies include United’s accounting for securities, loans and the allowance for loan losses.  In particular, United’s accounting policies relating to the allowance for loan losses involve the use of estimates and require significant judgments to be made by management.  Different assumptions in the application of these policies could result in material changes in United’s consolidated financial position or consolidated results of operations.  See “Asset Quality and Risk Elements” herein for a complete discussion of United’s accounting methodologies related to the allowance.

Index

Merger-Related Charges

During the first quarter of 2003, United recorded merger-related charges of $840,000 in connection with the acquisition and integration of First Central Bancshares.  The charges are included in operating expense in the consolidated statement of income.  These charges have been excluded from the presentation of operating earnings as management believes that excluding merger-related expenses as a financial measure provides useful information to investors because it provides information about United’s financial performance from its ongoing business operations.

The table below presents a reconciliation of United’s operating earnings to earnings for the quarter ended March 31, 2003 using accounting principles generally accepted in the United States of America (GAAP).  There were no merger-related charges in 2002.

Results of Operations

Net operating income was $8.6 million for the three months ended March 31, 2003, an increase of $.9 million, or 12%, from the same period in 2002. Diluted earnings per share were $.39 for the three months ended March 31, 2003, compared with $.35 for the same period in 2002, an increase of 11%.  Operating return on average common stockholders’ equity for the first quarter of 2003 was 16.55%, compared with 16.52% for the first quarter of 2002.  Operating return on average assets for the three months ended March 31, 2003 was 1.07%, compared with 1.12% for the three months ended March 31, 2002.

Net Interest Revenue (Taxable Equivalent)

Net interest revenue (the difference between the interest earned on assets and the interest paid on deposits and liabilities) is the single largest component of United's total revenue.  United actively manages this revenue source to provide an optimal level of revenue while balancing interest rate, credit and liquidity risks.  Net interest revenue for the first quarter of 2003 was $30.8 million, up 5% over last year.  The main driver of this increase was loan growth.  Average loans increased $337 million or 16% from the first quarter of last year.  This was due to continued higher demand in the current low rate environment and the addition of commercial lenders in the metro Atlanta markets.  The quarter-end total loans balance increased $392 million over last year.  Of this increase, $150 million was across United’s markets in north Georgia and western North Carolina, $154 million was in the metro Atlanta market and $88 million was related to the acquisition of First Central.

Average interest-earning assets for the first quarter of 2003 increased $448 million, or 17%, over the same period for 2002, reflecting the growth in loans, as well as an increase in the investment securities portfolio.  The majority of the increase in interest-earning assets was funded by interest-bearing sources as the increase in average interest-bearing liabilities for the quarter was approximately $414 million over the first quarter of 2002.

The banking industry uses two key ratios to measure relative profitability of net interest revenue.  The net interest rate 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 impact of non-interest-bearing deposits and gives a direct perspective on the effect of market interest rate movements.  The net interest margin is defined as net interest revenue as a percent of average total interest-earning assets and takes into account the positive impact of investing non interest-bearing deposits and capital.

For the three months ended March 31, 2003 and 2002, United’s net interest spread was 3.76% and 4.10%, respectively, while the net interest margin was 4.05% and 4.51%, respectively.  The decline in the net interest margin reflects the continuation of the low interest rate environment.  Since United’s balance sheet had remained asset sensitive during most of 2002, primarily due to growth in floating rate loans, the declining rate environment had a greater effect on interest-earning assets than on interest-bearing liabilities causing compression in the net interest spread.  Combined with a flat yield curve, the low rate environment resulted in reinvestment of maturing fixed rate loans and securities at rates lower than the assets they were replacing.  Growth in floating rate loans also contributed to the margin compression.  At March 31, 2003, United had approximately $1.2 billion in loans indexed to the daily Wall Street prime rate compared with $700 million a year ago.  The effect of the margin compression was partially offset by improvement in asset mix caused by the increase in loans.

The average yield on interest-earning assets for the first quarter of 2003 was 6.38%, compared with 7.55% in the first quarter of 2002.  The main drivers of this decrease were loan yields which were down 118 basis points and yields on taxable securities which were down 160 basis points comparing first quarter 2003 to the same period in 2002.  The shift toward floating rate loans contributed to the decline caused by the lower rate environment.  In the fourth quarter of 2002, United began purchasing securities to increase net interest revenue and reduce the interest rate sensitivity of the balance sheet.  Although the securities purchases have a positive impact on net interest revenue, they contributed to the net interest margin compression since they were purchased at a yield lower than the existing portfolio.

The average cost of interest-bearing liabilities for the first quarter 2003 was 2.62%, a decrease of 83 basis points from first quarter 2002.  The decrease was primarily due to lower rates paid on interest-bearing demand deposits and savings accounts, lower pricing on new and renewed time deposits and lower rates on FHLB advances.  As the rate of loan growth has exceeded core deposits, United increased its use of wholesale funding sources such as FHLB advances and brokered time deposits.  Such funding carries a higher cost of funds which has hampered United’s ability to reduce cost of funds in line with the rate movement of asset categories.

 The following table shows the relationship between interest revenue and expense and the average balances of interest-earning assets and interest-bearing liabilities for the three months ended March 31, 2003 and 2002.