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United Community Banks 10-Q 2011 Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-Q
For the Quarterly Period Ended September 30, 2011
OR
For the Transition Period from to
Commission file number 001-35095
UNITED COMMUNITY BANKS, INC.
(Exact name of registrant as specified in its charter)
(706) 781-2265
(Telephone Number) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 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 þ NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Date 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 þ NO o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
or 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act).
YES o NO þ
Common stock, par value $1 per share 41,611,596 shares voting and 15,914,209 shares non-voting
outstanding as of October 31, 2011
INDEX
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Part I — Financial Information
UNITED COMMUNITY BANKS, INC.
Consolidated Statement of Operations
(Unaudited)
See accompanying notes to consolidated financial statements.
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UNITED COMMUNITY BANKS, INC.
Consolidated Balance Sheet
See accompanying notes to consolidated financial statements.
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UNITED COMMUNITY BANKS, INC.
Consolidated Statement of Changes in Shareholders’ Equity
(Unaudited)
For the Nine Months Ended September 30,
Comprehensive loss for the third quarters of 2011 and 2010 was $10.2 million and $241 million,
respectively.
See accompanying notes to consolidated financial statements.
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UNITED COMMUNITY BANKS, INC.
Consolidated Statement of Cash Flows
(Unaudited)
See accompanying notes to consolidated financial statements.
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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
(“GAAP”) 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 2010
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 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.
Foreclosed property is initially recorded at fair value, less estimated costs to sell. If the fair
value, less estimated costs to sell at the time of foreclosure, is less than the loan balance, the
deficiency is charged against the allowance for loan losses. If the fair value, less cost to sell,
of the foreclosed property decreases during the holding period, a valuation allowance is
established with a charge to operating expenses. When the foreclosed property is sold, a gain or
loss is recognized on the sale for the difference between the sales proceeds and the carrying
amount of the property. Financed sales of foreclosed property are accounted for in accordance with
the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification Topic 360,
Subtopic 20, Real Estate Sales (“ASC 360-20”).
Note 2 — Accounting Standards Updates
In July 2011, the FASB issued Accounting Standards Update No. 2011-06, Fees Paid to the Federal
Government by Health Insurers (“ASU No. 2011-06”). ASU No. 2011-06 states that the liability for
the annual fee for health insurers mandated by the Patient protection and Affordable Care Act as
amended by the Health Care and Education Reconciliation Act, should be estimated and recorded in
full once the entity provides qualifying health insurance. Along with the fee liability, a
corresponding deferred cost should be recorded and amortized into expense, typically using a
straight-line method. ASU No. 2011-06 is effective for calendar years beginning after December 31,
2013, and does not apply to United.
In July 2011, the FASB issued Accounting Standards Update No. 2011-07, Presentation and Disclosure
of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts for
Certain Health Care Entities (“ASU No. 2011-07”). ASU No. 2011-07 requires certain health care
entities to change the presentation of their statement of operations by reclassifying the provision
for bad debts associated with patient service revenue from an operating expense to a deduction from
patient service revenue. Also, these entities are required to provide enhanced disclosure about
their policies on recognizing revenue and assessing bad debts. The guidance is effective for fiscal
years and interim periods within those fiscal years beginning after December 15, 2012, and does not
apply to United.
In September 2011, the FASB issued Accounting Standards Update No. 2011-08, Testing Goodwill for
Impairment (“ASU No. 2011-08”). ASU No. 2011-08 allows an entity first to assess qualitatively
whether it is necessary to perform step one of the two-step annual goodwill impairment test. An
entity is required to perform step one only if the entity concludes that it is more likely than not
that a reporting unit’s fair value is less than its carrying amount (that is, a likelihood of more
than 50 percent). This amends the existing guidance, which required entities to perform step one of
the test, at least annually, by calculating and comparing the fair value of a reporting unit to its
carrying amount. The revised standard is effective for annual and interim goodwill impairment
tests performed for fiscal years beginning after December 15, 2011. However, an entity can choose
to early adopt the revised standard even if its annual test date is before September 15, 2011 (the
date on which the revised standard was issued), provided that the entity has not yet issued its
financial statements for the period that includes its annual test date. Since United has no
goodwill balance, ASU No. 2011-08 will not currently have an impact on the Company’s financial
position, results of operation, or disclosures.
In September 2011, the FASB issued Accounting Standards Update No. 2011-09, Disclosures about an
Employer’s Participation in a Multiemployer Plan (“ASU No. 2011-09”). ASU No. 2011-09 is intended
to provide more information about an employer’s financial obligations to a multiemployer pension
plan and, therefore help financial statement users better understand the financial health of all
significant plans in which the employer participates. It is effective for public entities for
fiscal years ending after December 15, 2011, with a one year deferral for non-public entities.
United does not participate in a multiemployer plan, so this revised standard does not apply to the
Company.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 3 — Mergers and Acquisitions
On June 19, 2009, United Community Bank (“UCB” or the “Bank”) purchased substantially all the
assets and assumed substantially all the liabilities of Southern Community Bank (“SCB”) from the
Federal Deposit Insurance Corporation (“FDIC”), as Receiver of SCB. UCB and the FDIC entered loss
sharing agreements regarding future losses incurred on loans and foreclosed loan collateral
existing at June 19, 2009. Under the terms of the loss sharing agreements, the FDIC will absorb 80
percent of losses and share 80 percent of loss recoveries on the first $109 million of losses and,
absorb 95 percent of losses and share in 95 percent of loss recoveries on losses exceeding $109
million. The term for loss sharing on 1-4 Family loans is ten years, while the term for loss
sharing on all other loans is five years.
Under the loss sharing agreement, the portion of the losses expected to be indemnified by the FDIC
is considered an indemnification asset in accordance with ASC 805 Business Combinations. The
indemnification asset, referred to as “estimated loss reimbursement from the FDIC,” is included in
the balance of “Assets covered by loss sharing agreements with the FDIC” on the Consolidated
Balance Sheet. The indemnification asset was recognized at fair value, which was estimated at the
acquisition date based on the terms of the loss sharing agreement. The indemnification asset is
expected to be collected over a four-year average life. No valuation allowance was required.
Loans, foreclosed property and the estimated FDIC reimbursement resulting from the loss sharing
agreements with the FDIC are reported as “Assets covered by loss sharing agreements with the FDIC”
in the consolidated balance sheet.
The table below shows the components of covered assets at September 30, 2011 (in thousands).
Note 4 — Securities
Realized gains and losses are derived using the specific identification method for determining the
cost of securities sold. The following table summarizes securities sales activity for the three and
nine month periods ended September 30, 2011 and 2010 (in thousands).
Substantially all securities with a carrying value of $1.89 billion, $1.43 billion, and $1.26
billion were pledged to secure public deposits, FHLB advances and other secured borrowings at
September 30, 2011, December 31, 2010 and September 30, 2010, respectively.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Securities are classified as held to maturity when management has the positive intent and ability
to hold them until maturity. Securities held to maturity are carried at amortized cost. The
amortized cost, gross unrealized gains and losses and fair value of securities held to maturity at
September 30, 2011, December 31, 2010 and September 30, 2010 are as follows (in thousands).
The cost basis, unrealized gains and losses, and fair value of securities available for sale
at September 30, 2011, December 31, 2010 and September 30, 2010 are presented below (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table summarizes held to maturity securities in an unrealized loss position as
of September 30, 2011, December 31, 2010 and September 30, 2010 (in thousands).
The following table summarizes available for sale securities in an unrealized loss position as
of September 30, 2011, December 31, 2010 and September 30, 2010 (in thousands).
At September 30, 2011, there were 32 available for sale securities and 2 held to maturity
securities that were in an unrealized loss position. United does not intend to sell nor believes
it will be required to sell securities in an unrealized loss position prior to the recovery of
their amortized cost basis. Unrealized losses at September 30, 2011 were primarily attributable to
changes in interest rates.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis,
and more frequently when economic or market concerns warrant such evaluation. Consideration is
given to the length of time and the extent to which the fair value has been less than cost, the
financial condition and near-term prospects of the issuer, among other factors. In analyzing an
issuer’s financial condition, management considers whether the securities are issued by the federal
government or its agencies, whether downgrades by bond rating agencies have occurred, and industry
analyst’s reports. During the nine months ended September 30, 2010, United recorded impairment
losses of $950,000 on investments in financial institutions that showed evidence of
other-than-temporary impairment. No impairment losses were identified in the first nine months of
2011.
The amortized cost and fair value of held to maturity and available for sale securities at
September 30, 2011, by contractual maturity, are presented in the following table (in thousands).
Expected maturities may differ from contractual maturities because issuers and borrowers may
have the right to call or prepay obligations with or without call or prepayment penalties.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 5 — Loans and Allowance for Loan Losses
Major classifications of loans as of September 30, 2011, December 31, 2010 and September 30, 2010,
are summarized as follows (in thousands).
The Bank makes loans and extensions of credit to individuals and a variety of firms and
corporations located primarily in counties in north Georgia, the Atlanta, Georgia MSA, the
Gainesville, Georgia MSA, coastal Georgia, western North Carolina and east Tennessee. Although the
Bank has a diversified loan portfolio, a substantial portion of the loan portfolio is
collateralized by improved and unimproved real estate and is dependent upon the real estate market.
Changes in the allowance for loan losses for the three and nine months ended September 30, 2011 and
2010 are summarized as follows (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
At September 30, 2011, December 31, 2010 and September 30, 2010, loans with a carrying value
of $1.37 billion, $1.02 billion and $1.10 billion were pledged as collateral to secure FHLB
advances and other contingent funding sources.
The following table presents the balance and activity in the allowance for loan losses by portfolio
segment and the recorded investment in loans by portfolio segment based on the impairment method as
of September 30, 2011, December 31, 2010 and September 30, 2010 (in thousands).
United reviews all loans that are on nonaccrual with a balance of $500,000 or greater for
impairment. A loan is considered impaired when, based on current events and circumstances, it is
probable that all amounts due, according to the contractual terms of the loan, will not be
collected. All troubled debt restructurings are considered impaired regardless of accrual status.
Impaired loans are measured based on the present value of expected future cash flows, discounted at
the loan’s effective interest rate, at the loan’s observable market price, or the fair value of the
collateral if the loan is collateral dependent. Interest payments received on impaired nonaccrual
loans are applied as a reduction of the outstanding principal balance. Impairment amounts
calculated for nonaccrual collateral-dependent loans $500,000 and greater are recorded quarterly.
Specific reserves are recorded in the allowance for loan losses for impairment amounts calculated
on nonaccrual, non-collateral-dependent loans $500,000 and greater, and all accruing troubled debt
restructured loans.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
In the first quarter 2011, United’s Board of Directors adopted an accelerated problem asset
disposition plan which included the bulk sale of $267 million in classified loans. Those loans
were classified as held for sale at the end of the first quarter and were written down to the
expected proceeds from the sale. The charge-offs on the loans transferred to held for sale in
anticipation of the bulk loan sale which closed on April 18, 2011, increased first quarter 2011
loan charge-offs by $186 million. The actual loss on the bulk loan sale at closing was less than
the amount charged-off in the first quarter, resulting in a $7.27 million reduction of second
quarter 2011 charge-offs.
The recorded investments in individually evaluated impaired loans at September 30, 2011, December
31, 2010 and September 30, 2010 were as follows (in thousands).
The average balances of impaired loans and income recognized on impaired loans while they were
considered impaired is presented below for the three and nine months ended September 30, 2011 and
2010 (in thousands).
The following table presents loans individually evaluated for impairment by class of loans as
of September 30, 2011, December 31, 2010 and September 30, 2010 (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
There were no loans more than 90 days past due and still accruing interest at September 30,
2011, December 31, 2010 or September 30, 2010. Nonaccrual loans at September 30, 2011, December
31, 2010 and September 30, 2010 were $144 million, $179 million and
$218 million, respectively. Nonaccrual loans include both smaller balance homogeneous loans that
are collectively evaluated for impairment and individually evaluated impaired loans with larger
balances.
The following table presents the recorded investment (unpaid principal less amounts charged-off) in
nonaccrual loans by loan class as of September 30, 2011, December 31, 2010 and September 30, 2010
(in thousands).
The following table presents the aging of the recorded investment in past due loans as of September
30, 2011, December 31, 2010 and September 30, 2010 by class of loans (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of September 30, 2011 and December 31, 2010, $7.75 million and $173,000 of specific
reserves were allocated to customers whose loan terms have been modified in troubled debt
restructurings. There were no specific reserves established for loans considered to be troubled
debt restructurings at September 30, 2010. United committed to lend additional amounts totaling up
to $1.06 million, $1.17 million, and $256,000 as of September 30, 2011 and December 31, 2010, and
September 30, 2010 respectively, to customers with outstanding loans that are classified as
troubled debt restructurings.
The following table presents additional information on troubled debt restructurings including the
number of loan contracts restructured and the pre and post modification recorded investment.
(dollars in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table presents the number of contracts and the recorded investment for those
trouble debt restructurings that have subsequently defaulted which we define as 90 days or more
past due (dollars in thousands).
Risk Ratings
United categorizes loans into risk categories based on relevant information about the ability of
borrowers to service their debt such as: current financial information, historical payment
experience, credit documentation, public information, current industry and economic trends, among
other factors. United analyzes loans individually by classifying the loans as to credit risk.
This analysis is performed on a continuous basis. United uses the following definitions for its
risk ratings:
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.
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 the Company will
sustain some loss if deficiencies are not corrected. Immediate corrective action is necessary.
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.
Loss. Loans categorized as Loss have the same characteristics as Doubtful however probability of
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. Loans listed as not rated are generally deposit
account overdrafts that have not been assigned a grade.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As of September 30, 2011, December 31, 2010 and September 30, 2010, and based on the most recent
analysis performed, the risk category of loans by class of loans is as follows (in thousands).
Note 6 — Foreclosed Property
Major classifications of foreclosed properties at September 30, 2011, December 31, 2010 and
September 30, 2010 are summarized as follows (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Activity in the valuation allowance for foreclosed property is presented in the following
table (in thousands).
Expenses related to foreclosed assets include (in thousands).
Note 7 — Earnings Per Share
United is required to report on the face of the consolidated statement of operations, earnings
(loss) per common share with and without the dilutive effects of potential common stock issuances
from instruments such as options, convertible securities and warrants. Basic earnings per common
share is based on the weighted average number of common shares outstanding during the period while
the effects of potential common shares outstanding during the period are included in diluted
earnings per common share. During the three and nine months ended September 30, 2011 and 2010,
United accrued dividends on preferred stock, including accretion of discounts, as shown in the
following table (in thousands).
All preferred stock dividends are payable quarterly.
Series B preferred stock was issued at a discount. Dividend amounts shown include discount
accretion for each period.
There is no dilution from potentially dilutive securities for the three and nine months ended
September 30, 2011 and the three and nine months ended September 30, 2010, due to the antidilutive
effect of the net loss for those periods.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table sets forth the computation of basic and diluted loss per share for the three
and nine months ended September 30, 2011 and 2010 (in thousands, except per share data).
At September 30, 2011, United had a number of potentially dilutive securities outstanding
including a warrant to purchase 219,909 common shares at $61.40 per share issued to the U.S.
Treasury in connection with the issuance of United’s Series B preferred stock; 129,670 shares
issuable upon exercise of warrants attached to trust preferred securities with an exercise price of
$100 per share; 585,829 shares issuable upon exercise of stock options granted to employees with a
weighted average exercise price of $94.33; 404,644 shares issuable upon completion of vesting of
restricted stock awards; 1,411,765 shares issuable upon exercise of warrants exercisable at $21.25
per share granted to Fletcher International in connection with a 2010 asset purchase and sale
agreement; 2,476,191 shares issuable upon conversion of preferred stock if Fletcher International
exercises its option to purchase $65 million in convertible preferred stock, convertible at $26.25
per share; 1,162,791 shares issuable upon exercise of warrants, exercisable at $30.10 per share to
be granted to Fletcher International upon exercise of its option to acquire preferred stock; and
1,551,126 shares issuable upon exercise of warrants owned by Elm Ridge Off Shore Fund and Elm Ridge
Value Fund, exercisable at $12.50 per share.
Note 8 — Derivatives and Hedging Activities
Risk Management Objective of Using Derivatives
United is exposed to certain risks arising from both its business operations and economic
conditions. United principally manages its exposures to a wide variety of business and operational
risks through management of its core business activities. United manages interest rate risk
primarily by managing the amount, sources, and duration of its investment securities portfolio and
debt funding and through the use of derivative financial instruments. Specifically, United enters
into derivative financial instruments to manage exposures that arise from business activities that
result in the receipt or payment of future known and uncertain cash amounts, the value of which are
determined by interest rates. United’s derivative financial instruments are used to manage
differences in the amount, timing, and duration of United’s known or expected cash receipts and its
known or expected cash payments principally related to United’s loans and wholesale borrowings.
As of September 30, 2011, December 31, 2010 and September 30, 2010 United had no active derivative
instruments outstanding.
Cash Flow Hedges of Interest Rate Risk
United’s objectives in using interest rate derivatives are to add stability to net interest revenue
and to manage its exposure to interest rate movements. To accomplish this objective, United
primarily uses interest rate swaps as part of its interest rate risk management strategy. For
United’s variable-rate loans, interest rate swaps designated as cash flow hedges involve the
receipt of fixed-rate amounts from a counterparty in exchange for United making variable-rate
payments over the life of the agreements without exchange of the underlying notional amount.
Interest rate floors designated as cash flow hedges involve the receipt of variable-rate amounts
from a counterparty if interest rates fall below the strike rate on the contract in exchange for an
up front premium. United had no active derivative contracts outstanding at September 30, 2011,
December 31, 2010 or September 30, 2010 that were designated as cash flow hedges of interest rate
risk however, United had unrecognized gains from terminated derivative contracts that are being
amortized, straight line, over the original instruments’ remaining contractual terms.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The effective portion of changes in the fair value of derivatives designated, and that qualify as
cash flow hedges is recorded in accumulated other comprehensive income and is subsequently
reclassified into earnings in the period that the hedged forecasted transaction affects earnings.
Such derivatives were originally used to hedge the variable cash flows associated with existing
prime-based, variable-rate loans. The ineffective portion of the change in fair value of the
derivatives is recognized directly in earnings. During the three and nine months ended September
30, 2011, $575,000 and $4.69 million, respectively, in hedge ineffectiveness was
recognized in other fee revenue. During the three and nine months ended September 30, 2010,
$327,000 and $970,000, respectively, in hedge ineffectiveness was recognized in other fee revenue.
Amounts reported in accumulated other comprehensive income related to derivatives will be
reclassified to interest revenue as interest payments are received on United’s prime-based,
variable-rate loans. At September 30, 2011, the amount included in other comprehensive income
represents deferred gains from terminated cash flow hedges where the forecasted hedging transaction
is expected to remain effective over the remaining unexpired term of the original contract. Such
gains are being deferred and recognized over the remaining life of the contract on a straight line
basis. During the next twelve months, United estimates that an additional $5.33 million of the
deferred gains on terminated cash flow hedging positions will be reclassified as an increase to
interest revenue.
Fair Value Hedges of Interest Rate Risk
United is exposed to changes in the fair value of certain of its fixed rate obligations due to
changes in LIBOR, a benchmark interest rate. United uses interest rate swaps to manage its exposure
to changes in fair value on these instruments attributable to changes in the benchmark interest
rate. Interest rate swaps designated as fair value hedges involve the receipt of fixed-rate amounts
from a counterparty in exchange for United making variable rate payments over the life of the
agreements without the exchange of the underlying notional amount. As of September 30, 2011,
December 31, 2010 and September 30, 2010, United had no active derivatives designated as fair value
hedges of interest rate risk.
For derivatives designated and that qualify as fair value hedges, the gain or loss on the
derivative as well as the offsetting loss or gain on the hedged item attributable to the hedged
risk are recognized in earnings. United includes the gain or loss on the hedged items in the same
line item as the offsetting loss or gain on the related derivatives. During the three and nine
months ended September 30, 2010, United recognized net gains of $9,000 and $215,000, respectively,
related to ineffectiveness of the fair value hedging relationships. There were no active fair
value hedges during the first nine months of 2011.
Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement
The tables below present the effect of United’s derivative financial instruments on the
consolidated statement of operations for the three and nine months ended September 30, 2011 and
2010.
Derivatives in Fair Value Hedging Relationships (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Derivatives in Cash Flow Hedging Relationships (in thousands).
Credit-risk-related Contingent Features
United manages its credit exposure on derivatives transactions by entering into a bi-lateral credit
support agreement with each counterparty. The credit support agreements require collateralization
of exposures beyond specified minimum threshold amounts. The details of these agreements,
including the minimum thresholds, vary by counterparty. At September 30, 2011, United had no
active derivative positions and therefore no credit support agreements remained in effect.
Note 9 — Stock-Based Compensation
United has an equity compensation plan that allows for grants of incentive stock options,
nonqualified stock options, restricted stock awards (also referred to as “nonvested stock” awards),
stock awards, performance share awards or stock appreciation rights. Options granted under the
plan can have an exercise price no less than the fair market value of the underlying stock at the
date of grant. The general terms of the plan include a vesting period (usually four years) with an
exercisable period not to exceed ten years. Certain option and restricted stock awards provide for
accelerated vesting if there is a change in control (as defined in the plan). As of September 30,
2011, 328,505 additional awards could be granted under the plan, subject to shareholder approval of
a 612,488 increase in shares available under the plan. Through September 30, 2011, incentive stock
options, nonqualified stock options, restricted stock awards and units and base salary stock grants
had been granted under the plan.
The following table shows stock option activity for the first nine months of 2011.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The fair value of each option is estimated on the date of grant using the Black-Scholes model.
Because United’s option plan has not been in place long enough to gather sufficient information
about exercise patterns to establish an expected life, United uses the formula provided by the SEC
in Staff Accounting Bulletin (“SAB”) No. 107 to determine the expected life of options.
The weighted average assumptions used to determine the fair value of stock options are presented in
the table below.
Compensation expense relating to stock options of $651,000 and $1.55 million was included in
earnings for the nine months ended September 30, 2011 and 2010, respectively. Deferred tax
benefits of $253,000 and $603,000, respectively, were included in the determination of income tax
benefit for the nine month periods ended September 30, 2011 and 2010. The amount of compensation
expense for both periods was determined based on the fair value of the options at the time of
grant, multiplied by the number of options granted that are expected to vest, which was then
amortized over the vesting period. The forfeiture rate for options is estimated to be
approximately 3% per year. No options were exercised during the first nine months of 2011 or 2010.
The table below presents the activity in restricted stock awards for the first nine months of 2011.
Compensation expense for restricted stock is based on the fair value of restricted stock
awards at the time of grant, which is equal to the value of United’s common stock on the date of
grant. The value of restricted stock grants that are expected to vest is amortized into expense
over the vesting period. For the nine months ended September 30, 2011 and 2010, compensation
expense of $779,000 and $360,000, respectively, was recognized related to restricted stock awards.
The total intrinsic value of the restricted stock was $3.44 million at September 30, 2011.
As of September 30, 2011, there was $4.70 million of unrecognized compensation cost related to
non-vested stock options and restricted stock awards granted under the plan. That cost is expected
to be recognized over a weighted-average period of 2.4 years. The aggregate grant date fair value
of options and restricted stock awards that vested during the nine months ended September 30, 2011,
was $2.05 million.
Note 10 — Common and Preferred Stock Issued / Common Stock Issuable
United sponsors a Dividend Reinvestment and Share Purchase Plan (“DRIP”) that allows participants
who already own United’s common stock to purchase additional shares directly from the company. The
DRIP also allows participants to automatically reinvest their quarterly dividends in additional
shares of common stock without a commission. United’s 401(k) retirement plan regularly purchases
shares of United’s common stock directly from United. In addition, United has an Employee Stock
Purchase Program (“ESPP”) that allows eligible employees to purchase shares of common stock at a 5%
discount, with no commission charges. For the nine months ended September 30, 2011 and 2010,
United issued 113,787 and 72,281 shares, respectively, and increased capital by $1.10 million and
$1.40 million, respectively, through these programs. The DRIP program has been suspended until
2012 when United expects to regain its S-3 filing status.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
United offers its common stock as an investment option in its deferred compensation plan. The
common stock component of the deferred compensation plan is accounted for as an equity instrument
and is reflected in the consolidated financial statements as common stock issuable. At September
30, 2011 and 2010, 88,501 and 61,119 shares, respectively, were issuable under the deferred
compensation plan.
On February 22, 2011, United entered into a share exchange agreement (the “Share Exchange
Agreement”) with Elm Ridge Offshore Master Fund, Ltd. and Elm Ridge Value Partners, L.P.
(collectively referred to as “Elm Ridge Parties”). Under the Share Exchange Agreement, the Elm
Ridge Parties agreed to transfer to the Company 1,551,126 shares of the Company’s common stock in
exchange for 16,613 shares of the Company’s cumulative perpetual preferred stock, Series D, and
warrants to purchase 1,551,126 common shares with an exercise price of $12.50 per share that
expires on August 22, 2013. This exchange transaction did not result in a net increase or decrease
to total shareholder’s equity for the nine months ended September 30, 2011.
During the first quarter of 2011, United entered into investment agreements (the “Investment
Agreements”) with Corsair Georgia, L.P. (“Corsair”) and a group of institutional investors (the
“Additional Investors”). United issued 3,467,699 of the Company’s common stock for $9.50 per
share, 195,872 shares of mandatorily convertible cumulative non-voting perpetual preferred stock,
Series F (the “Series F Preferred Stock”), and 151,185 shares of mandatorily convertible cumulative
non-voting perpetual preferred stock, Series G (the “Series G Preferred Stock”). Under the terms of
the Investment Agreements and following receipt of required shareholder approvals which were
received on June 16, 2011, at United’s annual shareholders’ meeting, the Series F Preferred Stock
converted into 20,618,156 shares of voting common stock and the Series G Preferred Stock converted
into 15,914,209 shares of non-voting common stock. This private placement transaction resulted in
an increase to shareholders’ equity of $362 million, net of $18.4 million
in issuance costs. Following conversion of the convertible preferred stock, Corsair owned
approximately 22.5% of United’s total outstanding common stock. The Additional Investors owned
approximately 47.2% of United’s total outstanding common stock.
Note 11 — Reclassifications and Reverse Stock Split
Certain 2010 amounts have been reclassified to conform to the 2011 presentation. On June 17, 2011,
United completed a 1-for-5 reverse stock split, whereby each 5 shares of United’s common stock was
reclassified into one share of common stock, and each 5 shares of United’s non-voting common stock
was reclassified into one share of non-voting common stock. All share and per share amounts for
all periods presented have been adjusted to reflect the reverse split as though it had occurred
prior to the earliest period presented.
Note 12 — Discontinued Operations
On March 31, 2010, United completed the sale of its consulting subsidiary, Brintech, Inc.
(“Brintech”). The sales price was $2.9 million with United covering certain costs related to the
sale transaction resulting in a net, pre-tax gain of $2.1 million. As a result of the sale,
Brintech is presented in the consolidated financial statements as a discontinued operation with all
revenue and expenses related to the sold operations deconsolidated from the consolidated statement
of operations for all periods presented. The net results of operations from Brintech are reported
on a separate line on the consolidated statement of operations titled “Loss from discontinued
operations, net of income taxes.” The gain from the sale, net of income taxes and selling costs,
is presented on a separate line titled “Gain from sale of subsidiary, net of income taxes and
selling costs.”
Note 13 — Transaction with Fletcher International
On April 1, 2010, United entered into a securities purchase agreement with Fletcher International,
Ltd. and the Bank entered into an asset purchase and sale agreement with Fletcher International,
Inc. and certain affiliates thereof. Under the terms of the agreements, the Bank sold $103 million
in nonperforming commercial and residential mortgage loans and foreclosed properties to Fletcher’s
affiliates with a nominal aggregate sales price equal to the Bank’s carrying amount. The
nonperforming assets sale transaction closed on April 30, 2010. The consideration for the sale
consisted of $20.6 million in cash and a loan for $82.4 million. Fletcher formed six affiliated
LLCs to purchase the nonperforming assets from United. A separate loan was made to each of the
affiliated LLCs with the assets of each LLC cross pledged as collateral to each of the six loans.
The loans each have a five year term with principal and interest payments required according to a
20-year amortization table. Interest accrues at a fixed rate of 3.5%. Additional principal
payments are required prior to the release of properties serving as collateral for the loans as
those properties are sold. The loans have paid according to their contractual terms since their
inception.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
As part of the agreement, Fletcher received a warrant to acquire 1,411,765 shares of United’s
common stock at a price of $21.25 per share. The warrant has a nine year term and expires on May
26, 2019. To date, the warrant has not been exercised. In accordance with the terms of the
securities purchase agreement, Fletcher has the right during the next two years to purchase up to
$65 million in United’s Series C Convertible Preferred Stock. The Series C Convertible Preferred
Stock pays a dividend equal to the lesser of 8% or LIBOR plus 4%. The Series C Convertible
Preferred Stock is convertible by Fletcher into common stock at $26.25 per share (2,476,191
shares). If Fletcher had not purchased all of the Series C Convertible Preferred Stock by May 31,
2011, it was required to pay United 5% of the commitment amount not purchased by such date, and it
must pay United an additional 5% of the commitment amount not purchased by May 31, 2012. Fletcher
paid United $3.25 million as it had not purchased the Series C Convertible Preferred Stock as of
May 31, 2011. The payment was recorded directly in shareholders’ equity, net of applicable income
tax effects. Fletcher will receive an additional warrant to purchase $35 million in common stock at
$30.10 per share (1,162,791 shares) when it purchases the last $35 million of Series C Convertible
Preferred Stock. All of the warrants settle on a cashless exercise basis and the net shares to be
delivered upon cashless exercise will be less than what would have been issuable if the warrant had
been exercised for cash.
All of the components of the transaction, including all equity instruments issued under the
securities purchase agreement and the notes receivable received as consideration from the sale of
nonperforming assets were recorded at fair value. Because the value of the equity instruments and
assets exchanged in the transaction exceeded the value of the cash and notes receivable received,
United recorded a loss of $45.3 million on the transaction with Fletcher in the second quarter of
2010.
The table below presents a summary of the assets and equity instruments transferred and received at
their respective fair values ($ in thousands, except per share amounts).
The $17.6 million value of the warrant to purchase $30 million in common stock was determined
as of April 1, 2010, the date the terms were agreed to. The following modeling assumptions were
used: dividend yield — 0%; risk-free interest rate — 3.89%; current stock price — $23.85; term — 9
years; and volatility — 33%. Although most of the modeling assumptions were based on observable
data, because of the subjectivity involved in estimating expected volatility, the valuation is
considered Level 3.
The $22.2 million value of the option to purchase convertible preferred stock and warrant was
determined by an independent valuation firm using a Monte Carlo Simulation method appropriate for
valuing complex securities with derivatives. The model uses 50,000 simulations of daily stock
price paths using geometric Brownian motion and incorporates in a unified way all conversion,
exercise and contingency conditions. Because of the significant assumptions involved in the
valuation process, not all of which were based on observable data, the valuation is considered to
be Level 3.
The $103 million of nonperforming assets sold were transferred at United’s carrying amount which
had previously been written down to appraised value. Because the appraisals were based on sales of
similar assets (observable data), the valuation is considered to be Level 2.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The $82.5 million of notes receivable were recorded at their estimated fair value of $77.9 million,
net of a $4.5 million interest discount, which was determined based on discounted expected cash
flows over the term at a rate commensurate with the credit risk inherent in the notes. The
contractual rate on the notes is fixed at 3.5% for five years. The discount rate used for purposes
of determining the fair value of the notes was 5.48% based on the terms, structure and risk profile
of the notes. Note prepayments were estimated based on the expected marketing time for the
underlying collateral since the notes require that principal be reduced as the underlying assets
are sold. The valuation is considered Level 3 due to estimated prepayments which have a
significant impact on the value and are not based on observable data.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Note 14 — Assets and Liabilities Measured at Fair Value
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The table below presents United’s assets and liabilities measured at fair value on a recurring
basis as of September 30, 2011, December 31, 2010 and September 30, 2010, aggregated by the level
in the fair value hierarchy within which those measurements fall (in thousands).
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
The following table shows a reconciliation of the beginning and ending balances for assets
measured at fair value on a recurring basis using significant unobservable inputs that are
classified as Level 3 values (in thousands).
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
United may be required, from time to time, to measure certain assets at fair value on a
nonrecurring basis. These include assets that are measured at the lower of cost or market that
were recognized at fair value below cost at the end of the period. The table below presents
United’s assets and liabilities measured at fair value on a nonrecurring basis as of September 30,
2011, December 31, 2010 and September 30, 2010, aggregated by the level in the fair value hierarchy
within which those measurements fall (in thousands).
Assets and Liabilities Not Measured at Fair Value
For financial instruments that have quoted market prices, those quotes are used to determine fair
value. Financial instruments that have no defined maturity, have a remaining maturity of 180 days
or less, or reprice frequently to a market rate, are assumed to have a fair value that
approximates reported book value, after taking into consideration any applicable credit risk. If
no market quotes are available, financial instruments are valued by discounting the expected cash
flows using an estimated current market interest rate for the financial instrument. For
off-balance sheet derivative instruments, fair value is estimated as the amount that United would
receive or pay to terminate the contracts at the reporting date, taking into account the current
unrealized gains or losses on open contracts.
The short maturity of United’s assets and liabilities results in having a significant number of
financial instruments whose fair value equals or closely approximates carrying value. Such
financial instruments are reported in the following balance sheet captions: cash and cash
equivalents, mortgage loans held for sale, federal funds purchased, repurchase agreements and other
short-term borrowings. The fair value of securities available for sale equals the balance sheet
value. United did not have any active derivative contracts outstanding at September 30, 2011,
December 31, 2010 or September 30, 2010.
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UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Fair value estimates are made at a specific point in time, based on relevant market information and
information about the financial instrument. These estimates do not reflect the premium or discount
on any particular financial instrument that could result from the sale of United’s entire holdings.
Because no ready market exists for a significant portion of United’s financial instruments, fair
value estimates are based on many judgments. These estimates are subjective in nature and involve
uncertainties and matters of significant judgment and therefore cannot be determined with
precision. Changes in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on and off-balance sheet financial instruments without
attempting to estimate the value of anticipated future business and the value of assets and
liabilities that are not considered financial instruments. Significant assets and liabilities that
are not considered financial instruments include the mortgage banking operation, brokerage network,
deferred income taxes, premises and equipment and goodwill. In addition, the tax ramifications
related to the realization of the unrealized gains and losses can have significant effect on fair
value estimates and have not been considered in the estimates.
Off-balance sheet instruments (commitments to extend credit and standby letters of credit) are
generally short-term and at variable rates. Therefore, both the carrying amount and the estimated
fair value associated with these instruments are immaterial.
The carrying amount and fair values for other financial instruments that are not measured at fair
value on a recurring basis in United’s balance sheet at September 30, 2011, December 31, 2010, and
September 30, 2010 are as follows (in thousands).
Note 15 — Bulk Sale of Loans
On April 18, 2011, United completed the bulk sale of $80.6 million of loans that were reported as
held for sale at March 31, 2011. The proceeds from the bulk sale were $87.9 million which resulted
in a reduction of charge-offs in the second quarter of 2011.
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Forward-Looking Statements
This Form 10-Q 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, as amended, (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 risk factors set forth in our Annual Report on Form 10-K for the year ended December 31, 2010,
as well as the following:
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 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-Q.
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Overview
The following discussion is intended to provide insight into the results of operations and
financial condition of United Community Banks, Inc. (“United”) and its subsidiaries and should be
read in conjunction with the consolidated financial statements and accompanying notes.
United is a bank holding company registered with the Federal Reserve under the Bank Holding Company
Act of 1956 that was incorporated under the laws of the state of Georgia in 1987 and commenced
operations in 1988. At September 30, 2011 United had total consolidated assets of $7.16 billion,
total loans of $4.11 billion, excluding the loans acquired from Southern Community Bank (“SCB”)
that are covered by loss sharing agreements and therefore have a different risk profile. United
also had total deposits of $6.01 billion and stockholders’ equity of $848 million.
United’s activities are primarily conducted by its wholly owned Georgia banking subsidiary (the
“Bank”). The Bank operations are conducted under a community bank model that operates 27
“community banks” with local bank presidents and boards in north Georgia, the Atlanta-Sandy
Springs-Marietta, Georgia metropolitan statistical area (the “Atlanta MSA”), the Gainesville,
Georgia metropolitan statistical area (the “Gainesville MSA”), coastal Georgia, western North
Carolina, and east Tennessee.
Operating income (loss) from continuing operations and operating income (loss) from continuing
operations per diluted share are non-GAAP (accounting principles generally accepted in the United
States of America (“GAAP”)) performance measures. United’s management believes that operating
performance is useful in analyzing United’s financial performance trends since it excludes items
that are non-recurring in nature and therefore most of the discussion in this section will refer to
operating performance measures. A reconciliation of these operating performance measures to GAAP
performance measures is included in the table on page 36.
United reported a net loss from continuing operations of $6.20 million for the third quarter of
2011. This compared to a net operating loss from continuing operations of $25.8 million for the
third quarter of 2010. The 2010 net operating loss from continuing operations excluded goodwill
impairment charges of $211 million. The loss for the third quarter of 2011 was due to the
classification of United’s largest lending relationship which resulted in the recording of a $25.0
million provision for loan losses. Diluted operating loss from continuing operations per common
share was $.16 for the third quarter of 2011, compared to a diluted operating loss from continuing
operations per common share of $1.50 for the third quarter of 2010. The noncash goodwill
impairment charges added $11.12 per share to the diluted operating loss from continuing operations
for the third quarter of 2010 bringing the total net loss per share from continuing operations for
the third quarter of 2010 to $12.62.
For the nine months ended September 30, 2011, United reported a net operating loss from continuing
operations of $141 million, which primarily reflects the credit losses taken in the first quarter
associated with the Problem Asset Disposition Plan. This compared to a net operating loss from
continuing operations of $120 million for the first nine months of 2010, which included the $30.0
million after-tax loss from the Fletcher transaction and excluded the $211 million goodwill
impairment charge. Net loss for the nine months ended September 30, 2010, which includes
discontinued operations and goodwill impairment, totaled $329 million. Diluted operating loss from
continuing operations per common share was $4.41 for the nine months ended September 30, 2011,
compared with diluted operating loss from continuing operations per common share of $6.75 for the
same period in 2010. The diluted operating loss per share from continuing operations for the first
nine months of 2010 excluded $11.14 per share in loss related to the third quarter 2010 goodwill
impairment charge bringing the total net loss from continuing operations per share for the first
nine months of 2010 to $17.89.
United’s operating provision for loan losses was $36.0 million for the three months ended September
30, 2011, compared to $50.5 million for the same period in 2010. The third quarter 2011 loan loss
provision included a $25.0 million loan loss allocation established for United’s largest lending
relationship. Net charge-offs for the third quarter of 2011 were $17.5 million, compared to $50.0
million for the third quarter of 2010. For the nine months ended September 30, 2011, United’s
operating provision for loan losses was $237 million, compared to $187 million for the same period
of 2010. Net charge-offs for the first nine months of 2011 were $266 million, compared to $168
million for the first nine months of 2010. During the first quarter of 2011, performing substandard
loans with a pre-charge down carrying amount of $166 million and nonperforming loans with a
pre-charge down carrying amount of $101 million were collectively written down to the expected
sales proceeds of $80.6 million, in conjunction with a bulk transaction (the “Bulk Loan Sale”).
United recognized net charge-offs of $186 million related to the transfer of loans to the held for
sale classification in the first quarter. The Bulk Loan Sale was completed on April 18, 2011.
Proceeds from the sale were greater than originally estimated, resulting in a reduction of second
quarter charge-offs of $7.27 million. As of September 30, 2011, United’s allowance for loan losses
was $146 million, or 3.55% of loans, compared to $175 million, or 3.67% of loans, at September 30,
2010. Nonperforming assets of $189 million, which excludes assets of Southern Community Bank
(“SCB”) that are covered by loss sharing agreements with the FDIC, decreased to 2.64% of total
assets at September 30, 2011, compared to 4.32% as of December 31, 2010 and 4.96% as of September
30, 2010. The decrease in this ratio was due to the execution of a plan to sell approximately $293
million in substandard and nonperforming loans, and to accelerate the disposition of approximately
$142 million in foreclosed properties (the “Problem Asset Disposition Plan”) as well as a general
improving trend in credit quality indicators. During the third quarter of 2011, United classified
its largest lending relationship of $76.6 million, which caused nonperforming assets to increase
from 1.60% of total assets at June 30, 2011.
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Taxable equivalent net interest revenue was $59.3 million for the third quarter of 2011, compared
to $60.0 million for the same period of 2010. The decrease in net interest revenue was primarily
the result of a decrease in average loan balances and a 2 basis point decrease in the net interest
margin. Average loans for the quarter declined $702 million from the third quarter of 2010. The
impact of the decrease in average loan balances was substantially offset by lower deposit rates.
Net interest margin decreased from 3.57% for the three months ended September 30, 2010 to 3.55% for
the same period in 2011. For the nine months ended September 30, 2011, taxable equivalent net
interest revenue was $175 million, compared to $183 million for the same period of 2010. Net
interest margin decreased from 3.56% for the nine months ended September 30, 2010 to 3.42% for the
same period in 2011. Interest reversals on performing loans that were moved to held for sale
during the first quarter 2011 accounted for 4 basis points of the 14 basis points decrease. Over
the past year, United has maintained above normal levels of liquidity. The level of excess
liquidity peaked in 2011 and lowered the margin by approximately 49 basis points in the first
quarter, 76 basis points in the second quarter and 67 basis points in the third quarter. In order
to reduce the amount of excess liquidity, United has called its callable brokered deposits.
Additionally, United has lowered rates on retail certificates of deposit and other deposit
products, which is expected to result in some balance attrition.
Operating fee revenue decreased $1.36 million, or 11%, from the third quarter of 2010 and increased
$1.14 million, or 3%, from the first nine months of 2010. The quarterly decrease was due to a
decline in overdraft fees, which were down $886,000 for the three months ended September 30, 2011,
due to regulatory changes. The year-to-date increase was primarily attributable to the acceleration
of deferred gains related to the ineffectiveness of terminated cash flow hedges, especially during
the second quarter of 2011.
For the third quarter of 2011, operating expenses of $46.5 million were down $18.4 million from the
third quarter of 2010. This comparison excludes the $211 million goodwill impairment charge in the
third quarter of 2010. Lower foreclosed property costs accounted for $16.9 million of the
decrease. For the nine months ended September 30, 2011, operating expenses of $211 million were up
$32.5 million from the same period of 2010. This comparison excludes the $45.3 million loss on the
sale of nonperforming assets in the second quarter of 2010 and the $211 million goodwill impairment
charge in the third quarter of 2010. The increase was primarily due to an increase in foreclosed
property costs in anticipation of the Bulk Loan Sale and other accelerated asset dispositions.
Foreclosed property costs were up $24.5 million from the first nine months of 2010.
Recent Developments
On June 16, 2011 shareholders approved the conversion of $195.9 million of Series F and $151.2
million of Series G Mandatorily Convertible Perpetual Preferred Stock into 20,618,156 shares of
United’s common stock and 15,914,209 shares of United’s non-voting common stock, respectively. The
conversion occurred as of the close of business on June 20, 2011 pursuant to the March 30, 2011
private placement agreements with a group of institutional investors.
On June 17, 2011, United completed a 1-for-5 reverse stock split, whereby each 5 shares of United’s
common stock was reclassified into one share of common stock, and each 5 shares of United’s
non-voting common stock was reclassified into one share of non-voting common stock. All prior
periods presented have been adjusted to reflect the reclassification.
On February 22, 2011, the Company entered into a share exchange agreement with Elm Ridge Offshore
Master Fund, Ltd. and Elm Ridge Value Partners, L.P. (collectively, the “Elm Ridge Parties”). Under
the share exchange agreement, the Elm Ridge Parties agreed to transfer to the Company 1,551,126
shares of the Company’s common stock in exchange for 16,613 shares of the Company’s cumulative
perpetual preferred stock, Series D and warrants to purchase 1,551,126 common shares. See Note 10
to the consolidated financial statements for further details of the share exchange agreement.
Also during the first quarter of 2011, the Board of Directors approved the Problem Asset
Disposition Plan. Accordingly, substandard and nonperforming loans were sold by the Bank for an
aggregate purchase price of approximately $87.9 million in the Bulk Loan Sale on April 18, 2011
pursuant to an asset purchase and sale agreement (the “Asset Purchase Agreement”) entered into by
the Bank, CF Southeast LLC (“CF Southeast”) and CF Southeast Trust 2011-1 (“CF Trust” and together
with CF Southeast, the “Purchasers”).
Critical Accounting Policies
The accounting and reporting policies of United are in accordance with GAAP and conform to general
practices within the banking industry. The more critical accounting and reporting policies include
United’s accounting for the allowance for loan losses, fair value measurements, and income taxes.
In particular, United’s accounting policies related to allowance for loan losses, fair value
measurements and income taxes involve the use of estimates and require significant judgment 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 additional discussion of United’s accounting
methodologies related to the allowance for loan losses.
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GAAP Reconciliation and Explanation
This Form 10-Q contains non-GAAP financial measures, which are performance measures determined by
methods other than in accordance with GAAP. Such non-GAAP financial measures include, among others
the following: operating provision for loan losses, operating fee revenue, operating revenue,
operating expense, operating (loss) income from continuing operations, operating (loss) income,
operating earnings (loss) from continuing operations per share, operating earnings (loss) per
share, operating earnings (loss) from continuing operations per diluted share and operating
earnings (loss) per diluted share. Management uses these non-GAAP financial measures because it
believes they are useful for evaluating our operations and performance over periods of time, as
well as in managing and evaluating our business and in discussions about our operations and
performance. Management believes these non-GAAP financial measures provide users of our financial
information with a meaningful measure for assessing our financial results and credit trends, as
well as comparison to financial results for prior periods. These non-GAAP financial measures should
not be considered as a substitute for operating results determined in accordance with GAAP and may
not be comparable to other similarly titled financial measures used by other companies. A
reconciliation of these operating performance measures to GAAP performance measures is included in
on the table on page 36.
Discontinued Operations
Effective March 31, 2010, United sold its Brintech, Inc. (“Brintech”) subsidiary. As a result, the
operations of Brintech are being accounted for as a discontinued operation. All revenue, including
the gain from the sale, expenses and income taxes relating to Brintech have been deconsolidated
from the consolidated statement of operations and are presented on one line titled “Loss from
discontinued operations” for all periods presented. Because Brintech’s assets, liabilities and
cash flows were not material to the consolidated balance sheet and statement of cash flows, no such
adjustments have been made to those financial statements.
Transaction with Fletcher International
Description of Transaction
On April 1, 2010, the Bank entered into an asset purchase and sale agreement (the “Asset Purchase
Agreement”) with Fletcher International Inc. (“Fletcher Inc.”) and five separate limited liability
companies (“LLCs”) affiliates of Fletcher Inc. for the purpose of acquiring nonperforming assets
under the Asset Purchase Agreement. United has no ownership interest in the LLCs. The asset sale
transaction was completed on April 30, 2010 with the Bank transferring nonperforming commercial and
residential construction loans and foreclosed properties having a carrying value of $103 million in
exchange for cash of $20.6 million and notes receivable for $82.5 million.
The loans made to the LLCs in connection with their respective purchases are the same for all six
loans. The loans have an initial term of five years and principal and interest payments are based
on a 20-year amortization schedule. The assets in the LLCs are all cross-pledged as collateral on
all six loans. Correspondingly, prepayments on the loans are required as properties are sold in
order for the collateral to be released upon sale. The interest rate during the loan term is fixed
at 3.50% for all loans and, accordingly, each loan was recorded at a discount as the interest rate
was considered below market. At the time the LLCs were formed, they were capitalized with
sufficient cash to make the required 20% down payment on the purchase and 17.5% of the purchase
price in cash and securities to cover the first three years of required cash flows. According to
the terms of the agreements, at least one year of estimated cash flow requirements must be held in
cash. These funds are held in escrow as additional collateral on the loans and cannot be removed
by Fletcher Inc. without United’s consent. The securities that can be held by the LLCs are
marketable equity securities and funds managed by Fletcher affiliates. Carrying costs include debt
service payments, servicing fees and other direct costs associated with holding and managing the
underlying properties. Cash flow from expected sales of underlying assets (loans/foreclosed real
estate) is expected to provide sufficient cash flow to service the loans for another five to six
quarters. While recent news articles and other sources have questioned the financial health of
Fletcher and its affiliates, the loans to the LCCs have performed according to their contractual
terms since inception. However, during the third quarter of 2011, United determined that the
ultimate repayment of the $76.6 million loan relationship through the sale of the underlying
collateral is unlikely due to the lack of sales activity and further decline in real estate values.
As a result, United recorded a loan loss provision of $25.0 million for the three months ended
September 30, 2011. The Company plans to obtain updated appraisals for the underlying collateral
associated with this relationship during the fourth quarter of 2011.
Also on April 1, 2010, United and Fletcher International Ltd (“Fletcher Ltd”, together with
Fletcher Inc. and their affiliates, “Fletcher”), entered into a securities purchase agreement (the
“Securities Purchase Agreement”) pursuant to which Fletcher Ltd. agreed to purchase from United,
and United agreed to issue and sell to Fletcher Ltd., 65,000 shares of United’s Series C
convertible preferred stock, par value $1.00 per share (the “Convertible Preferred Stock”), at a
purchase price of $1,000 per share, for an aggregate purchase price of $65 million. The
Convertible Preferred Stock will bear interest at an annual rate equal to the lesser of 8% or LIBOR
+ 4%. If all conditions precedent to Fletcher Ltd.’s obligations to purchase the Convertible
Preferred Stock have been satisfied and Fletcher Ltd. had not purchased all of the Convertible
Preferred Stock by May 31, 2011, it was required to pay United 5% of the commitment amount not purchased by such date, and it must pay United an additional 5% of
any commitment amount not purchased by May 31, 2012. Fletcher has paid United $3.25 million as it
had not purchased the Series C Convertible Preferred Stock as of May 31, 2011. As such penalty
payment is associated with Fletcher’s option to purchase preferred stock and is therefore
considered an equity transaction, it was recorded as an increase to capital surplus in
shareholders’ equity.
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The Convertible Preferred Stock is redeemable by Fletcher Ltd. at any time into common stock or
non-voting Common Stock Equivalent Junior Preferred Stock (“Junior Preferred Stock”) of United, at
an equivalent price of $26.25 per share of common stock (equal to 2,476,190 shares of common
stock), subject to certain adjustments. After May 26, 2015, if the closing stock price for
United’s common stock is above $60.20, United has the right to require conversion and it is
United’s intent to convert all of the then outstanding Convertible Preferred Stock into an
equivalent amount of common stock or Junior Preferred Stock.
Concurrently with the payment of the $10 million deposit under the Asset Purchase Agreement by
Fletcher, United granted a warrant to Fletcher to purchase Junior Preferred Stock. The warrant was
initially equal to $15 million and was increased to $30 million upon the completion of the asset
sale pursuant to the Asset Purchase Agreement. An additional $35 million warrant will be issued on
a dollar for dollar basis by the aggregate dollar amount of the Convertible Preferred Stock
purchased under the Securities Purchase Agreement in excess of $30 million. The $30 million
warrant price is equivalent to $21.25 per common share (cash exercise equal to 1,411,765 shares of
common stock). The warrant has a nine year term and expires on May 26, 2019. To date, the warrant
has not been exercised. The $35 million warrant price is equivalent to $30.10 per common share
(cash exercise equal to 1,162,791 shares of common stock). The warrants may only be exercised by
net share settlement (cashless exercise) and are exercisable for nine years from April 1, 2010,
subject to limited extension upon certain events specified in the warrant agreement. All of the
warrants settle on a cashless basis and the net shares to be issued to Fletcher Ltd. upon exercise
of the warrants will be less than the total shares that would have been issuable if the warrants
had been exercised for cash payments.
Also, as part of the transaction, United and Fletcher entered into a servicing agreement whereby
United will act as servicer of the nonperforming assets for Fletcher in exchange for a servicing
fee of 20 basis points. Because the servicing arrangement is considered a normal servicing
arrangement and the fee is appropriate for the services provided, United did not recognize a
servicing asset or liability related to the servicing agreement.
Accounting Treatment
Although the Asset Purchase Agreement and the Securities Purchase Agreement are two separate
agreements, they were accounted for as part of one transaction because they were entered into
simultaneously and the Securities Purchase Agreement was dependent upon the sale of nonperforming
assets. United evaluated this transaction to determine whether the transfer should be accounted
for as a sale or a secured borrowing and whether the Fletcher LLCs should be consolidated with
United. When evaluating whether the transfer should be accounted for as a sale, United primarily
evaluated whether control had been surrendered, the rights of Fletcher to exchange and pledge the
assets, and whether United retains effective control, which included evaluating any continuing
involvement in the assets. Based on the evaluation, the transfer of assets under the Asset
Purchase Agreement meets the definition as a sale under current accounting standards and was
accounted for as such. United further evaluated whether the Fletcher LLCs should be consolidated
which included evaluating whether United has a controlling financial interest and is therefore the
primary beneficiary. This evaluation principally included determining whether United directs the
activities that have the most significant impact on the LLCs economic performance and whether
United has an obligation to absorb losses or the right to receive benefits that could be
significant to the LLCs. Based on that evaluation, the LLCs have not been included as part of the
consolidated group of subsidiaries in United’s consolidated financial statements.
In addition to evaluating the accounting for the transfer of assets, United considered whether the
warrant and the option to purchase convertible preferred stock with an additional warrant should be
accounted for as liabilities or equity instruments. In making this evaluation, United considered
whether Fletcher or any subsequent holders of the instruments could require settlement of the
instruments in cash or other assets rather than common or preferred stock. Because the transaction
was structured so that the warrants and option to purchase convertible preferred stock and the
additional warrant can only be settled through the issuance of common or preferred stock, United
concluded that the warrant and option to purchase convertible preferred stock with an additional
warrant should be accounted for as equity instruments.
All of the components of the transaction, including all equity instruments issued under the
Securities Purchase Agreement and the notes receivable received as consideration from the sale of
nonperforming assets were recorded at fair value. Because the value of the equity instruments and
assets exchanged in the transaction exceeded the value of the cash and notes receivable received,
United recorded a loss of $45.3 million on the transaction with Fletcher.
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The table below presents a summary of the assets and equity instruments transferred and received at
their respective fair values ($ in thousands, except per share amounts).
Notes
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Table 1 — Financial Highlights
Selected Financial Information
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