SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Act of 1934 Filed by the Registrant /X/ Filed by a Party other than the Registrant / / Check the appropriate box: /X/ Preliminary Proxy Statement / / Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(6)(2) / / Definitive Proxy Statement / / Definitive Additional Materials / / Soliciting Material Under Rule 14A-12 UNITED COMMUNITY BANKS, INC. ------------------------------------------------ (Name of Registrant as Specified in Its Charter) Payment of Filing Fee (Check the appropriate box): /X/ No fee required. / / Fee computed on table below per Exchange Act Rules 14a-6(i)(1)(4) and 0-11. (1) Title of each class of securities to which transaction applies:________________________ (2) Aggregate number of class of securities to which transaction applies:________________________ (3) Per unit price or other underlying value of transaction computed pursuant to Exchange Act Rule 0-11 (set forth the amount on which the filing fee is calculated and state how it was determined): / / Check box if any part of the fee is offset as provided by Exchange Act Rule O-11(a)(2) and identify the filing for which the offsetting fee was paid previously. Identify the previous filing by registration statement number, or the Form or Schedule and the date of its filing. 1) Amount Previously Paid:_______________________________________ 2) Form, Schedule or Registration Statement No.:_________________ 3) Filing Party:_________________________________________________ 4) Date Filed:___________________________________________________ UNITED COMMUNITY BANKS, INC. POST OFFICE BOX 398 63 HIGHWAY 515 BLAIRSVILLE, GEORGIA 30512-2569 June __, 2000 Dear Shareholder of United Community Banks, Inc.: It is my pleasure to invite you to attend the annual meeting of shareholders of United Community Banks, Inc. which will be held at 2:00 p.m. on June __, 2000 at The Brasstown Valley Resort, Highway 515, Young Harris, Georgia. Shareholders of record as of May 15, 2000 are entitled to vote at the meeting. The following proposals are to be presented at the annual meeting: (i) to elect 12 directors of United; (ii) to approve United's 2000 Key Employee Stock Option Plan; (iii) to approve an amendment to United's Restated Articles of Incorporation to increase the number of authorized shares of United common stock from 10,000,000 to 50,000,000; and (iv) to transact such other business as may properly come before the annual meeting. I urge you to read the accompanying proxy statement which provides specific information concerning the proposals to be presented at the annual meeting. The proposals listed above have been unanimously approved by your board of directors and are recommended by the board for your approval. APPROVAL OF THE AMENDMENT TO THE RESTATED ARTICLES OF INCORPORATION REQUIRES THE AFFIRMATIVE VOTE OF A MAJORITY OF THE SHARES OF UNITED COMMON STOCK ENTITLED TO VOTE AT THE MEETING. CONSEQUENTLY, A FAILURE TO VOTE WILL HAVE THE SAME EFFECT AS A VOTE AGAINST THE AMENDMENT TO THE RESTATED ARTICLES OF INCORPORATION. THE AFFIRMATIVE VOTE OF A MAJORITY OF THE UNITED COMMON STOCK PRESENT IN PERSON OR REPRESENTED BY PROXY AT THE ANNUAL MEETING WILL BE REQUIRED TO APPROVE THE OTHER PROPOSALS. IF YOU HAVE ANY QUESTIONS CONCERNING THE DELIVERY OF THE ENCLOSED PROXY CARD, PLEASE CALL CHRIS BLEDSOE AT (706) 745-2151. Whether or not you are able to attend the meeting, please mark, sign, and return the proxy card. If you do attend the meeting and would like to vote in person, you may do so even if you already sent in a proxy card. On behalf of the directors, officers, and employees of United Community Banks, Inc., I want to thank you for your continued support. Sincerely, Jimmy C. Tallent, PRESIDENT AND CHIEF EXECUTIVE OFFICER UNITED COMMUNITY BANKS, INC. 63 HIGHWAY 515 POST OFFICE BOX 398 BLAIRSVILLE, GEORGIA 30514 --------------------------------------------------- NOTICE OF ANNUAL MEETING OF SHAREHOLDERS OF UNITED COMMUNITY BANKS, INC. --------------------------------------------------- TO BE HELD ON JUNE __, 2000 The annual meeting of shareholders of United Community Banks, Inc. will be held on June __, 2000 at 2:00 p.m. at The Brasstown Valley Resort, Highway 515, Young Harris, Georgia, for the following purposes: 1. To elect 12 directors to constitute the board of directors to serve until the next annual meeting and until their successors are elected and qualified; 2. To consider a proposal to approve the 2000 Key Employee Stock Option Plan; 3. To consider a proposal to amend the United Restated Articles of Incorporation to increase the number of authorized shares of common stock from 10,000,000 to 50,000,000 shares; and 4. To consider and act upon any other matters that may properly come before the meeting and any adjournment thereof. Only shareholders of record at the close of business on May 15, 2000 will be entitled to notice of, and to vote at, the meeting. Enclosed are a proxy statement and a proxy solicited by the board of directors. Please sign, date, and return the proxy promptly in the enclosed business reply envelope. If you attend the meeting you may, if you wish, withdraw your proxy and vote in person. By Order of the Board of Directors, Jimmy C. Tallent, PRESIDENT AND CHIEF EXECUTIVE OFFICER June ___, 2000 Blairsville, Georgia ----------------------------------------------------------------------- | PLEASE COMPLETE AND RETURN THE ENCLOSED PROXY PROMPTLY SO THAT | | YOUR VOTE MAY BE RECORDED AT THE MEETING IF YOU DO NOT ATTEND. | |---------------------------------------------------------------------- TABLE OF CONTENTS Section Page No. - ------- -------- Summary Term Sheet.......................................................................................................iv Where You Can Find More Information......................................................................................iv Incorporation of Certain Documents by Reference...........................................................................v A Warning about Forward Looking Statements................................................................................v The Annual Meeting........................................................................................................1 Security Ownership of Certain Beneficial Owners and Management............................................................2 Nomination and Election of Directors......................................................................................3 Information about Nominees for Director...................................................................................4 Executive Compensation....................................................................................................5 Compensation of Directors.................................................................................................6 Joint Report on Executive Compensation....................................................................................8 Shareholder Return Performance Graph.....................................................................................10 Meetings and Committees of the Board of Directors........................................................................11 Approval of the 2000 Key Employee Stock Option Plan......................................................................12 Summary of the 2000 Key Employee Stock Option Plan.......................................................................12 i Approval to Amend the Restated Articles of Incorporation to Increase the Number of Authorized Shares of Common Stock of United..............................................................................................16 Purpose of Authorizing Additional Common Stock........................................................................16 Effect of Proposal....................................................................................................16 Vote Required For Approval............................................................................................16 Information about United Community Banks, Inc............................................................................17 Description of Business...............................................................................................17 United's Management's Discussion and Analysis of Financial Condition and Results of Operations........................27 Comparative Share Data...................................................................................................61 Summary Consolidated Financial Information...............................................................................62 Pro Forma Selected Financial Data........................................................................................65 The Proposed North Point Merger..........................................................................................67 Background of the Merger..............................................................................................67 The Agreement and Plan of Reorganization and the Agreement and Plan of Merger Between United and North Point..........67 Expenses..............................................................................................................68 Accounting Treatment..................................................................................................69 Regulatory Approvals..................................................................................................69 Information about North Point Bancshares, Inc............................................................................70 Description of Business...............................................................................................70 ii Voting Securities and Principal Shareholders..........................................................................70 North Point's Management's Discussion and Analysis of Financial Condition and Results of Operations......................71 The Proposed Independent Merger..........................................................................................84 Background of and Reasons for the Merger..............................................................................84 The Agreement and Plan of Reorganization and the Agreement and Plan of Merger Between United and Independent..........85 Expenses..............................................................................................................86 Accounting Treatment..................................................................................................86 Regulatory Approvals..................................................................................................86 Information about Independent Bancshares, Inc............................................................................87 Description of Business...............................................................................................87 Voting Securities and Principal Shareholders..........................................................................88 Independent's Management's Discussion and Analysis of Financial Condition and Results of Operations......................89 Pro Forma Consolidated Financial Information............................................................................102 Information Concerning United's Accountants.............................................................................110 Shareholder Proposals by United Shareholders............................................................................110 Report on Form 10-K.....................................................................................................110 Experts for United, North Point, and Independent........................................................................110 Other Matters That May Come Before the Meeting..........................................................................110 Index to Financial Data.................................................................................................F-1 Appendix A: United Community Banks, Inc. 2000 Key Employee Stock Option Plan............................................A-1 Appendix B: Amendment to Articles of Incorporation......................................................................B-1 iii SUMMARY TERM SHEET The following description is a summary of the material terms of the proposed mergers and is qualified in its entirety by reference to the description of the proposed mergers of North Point Bancshares, Inc. and Independent Bancshares, Inc. into United beginning in this proxy statement on page ___ for North Point and page ___ for Independent as well as the Agreement and Plan of Reorganization for the North Point Merger included as Exhibit 2.1 to United's registration statement on Form S-4, File Number 333-________, filed with the SEC on _______________, and the Agreement and Plan of Reorganization for the North Point Merger included as Exhibit 2.1 to United's registration statement on Form S-4, File Number 333-__________, filed with the SEC on ________________, 2000. THE NORTH POINT MERGER o If the merger of North Point and United is approved, North Point will be merged with United, United will remain as the surviving company, and Dawson County Bank will become a subsidiary of United. o As a result of the merger, North Point shareholders will receive 2.2368 shares of United common stock for each share of North Point common stock that they own for an aggregate of 958,211 shares of United stock. o The merger must be approved by the holders of a majority of the North Point common stock. o The approval of the Board of Governors of the Federal Reserve System, and the Department of Banking and Finance of the State of Georgia has been received. o A condition to the closing of the merger is the approval by United shareholders of the increase in United's authorized common stock from 10,000,000 to 50,000,000 shares. o We expect the merger to be accounted for as a pooling of interests, which means that we will treat North Point and United as if they had always been combined for accounting and financial reporting purposes. THE INDEPENDENT MERGER o If the merger of Independent and United is approved, Independent will be merged with United, United will remain as the surviving company, and Independent Bank & Trust will become a subsidiary of United. o As a result of the merger, Independent shareholders will receive 0.4211 shares of United common stock for each share of Independent common stock that they own for an aggregate of 870,595 shares of United stock. o The merger must be approved by the holders of a majority of the Independent common stock. o The approval of the Board of Governors of the Federal Reserve System, and the Department of Banking and Finance of the State of Georgia has been received. o A condition to the closing of the merger is the approval by United shareholders of the increase in United's authorized common stock from 10,000,000 to 50,000,000 shares. o We expect the merger to be accounted for as a pooling of interests, which means that we will treat Independent and United as if they had always been combined for accounting and financial reporting purposes. WHERE YOU CAN FIND MORE INFORMATION United is subject to the information requirements of the Securities Exchange Act of 1934, which means that United is required to file reports, proxy statements, and other information that you can read and copy at the Public Reference Section of the Securities and Exchange Commission (the "SEC") at Room 1024, 450 Fifth Street, NW, Washington, D.C. 20549. You may also obtain copies of the reports, proxy statements, and other information from the Public Reference Section of the SEC, at prescribed rates, by calling 1-800-SEC-0330 or by visiting the SEC's Website at http://www.sec.gov. iv A WARNING ABOUT FORWARD LOOKING STATEMENTS We have made forward-looking statements in this proxy statement (and in other documents to which we refer in this proxy statement) that are subject to risks and uncertainties. These statements are based on the beliefs and assumptions of United's management and on information currently available to members of management. Forward-looking statements include information concerning possible or assumed future results of operations of United. Factors that could cause actual results to differ from results discussed in forward-looking statements include: 1. economic conditions (both generally and in the markets where United operates); 2. competition from other companies that provide financial services similar to those offered by United; 3. government regulation and legislation; 4. changes in interest rates; and 5. unexpected changes in the financial stability and liquidity of United's credit customers. Although we believe these forward-looking statements are reasonable, you should not place undue reliance on them because they are based on current expectations. Forward-looking statements are not guarantees of performance; rather, they involve risks, uncertainties, and assumptions. The future results and shareholder values of United following completion of the mergers of North Point and Independent into United may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results and values are beyond United's ability to control or predict. For those statements, United claims the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. v THE ANNUAL MEETING This proxy statement is furnished in connection with the solicitation of proxies by United's board of directors for use at the annual meeting of United shareholders to be held on June __, 2000, and any adjournment thereof, for the purposes set forth in the accompanying notice of the meeting. The expenses of this solicitation, including the cost of preparing and mailing this proxy statement, will be paid by United. Copies of solicitation materials may be furnished to banks, brokerage houses, and other custodians, nominees, and fiduciaries for forwarding to beneficial owners of shares of United's common stock, and normal handling charges may be paid for such forwarding services. In addition to solicitations by mail, directors and employees of United may solicit proxies in person or by telephone. It is anticipated that this proxy statement and the accompanying proxy will first be mailed to shareholders on June __, 2000. At the meeting, United's shareholders will elect 12 directors who will serve a one-year term that will expire at the next annual meeting when their successors are elected and qualified, will vote upon the 2000 Key Employee Stock Option Plan, and will vote upon an amendment to United's Restated Articles of Incorporation to increase the authorized common stock of United. The record of shareholders entitled to vote at the annual meeting was taken as of the close of business on May 15, 2000. On that date, United had outstanding and entitled to vote 8,035,868 shares of common stock, par value $1.00 per share, with each shareholder entitled to one vote per share. Any proxy given pursuant to this solicitation may be revoked by any shareholder who attends the meeting and gives oral notice of his or her election to vote in person, without compliance with any other formalities. In addition, any proxy given pursuant to this solicitation may be revoked before the meeting by delivering an instrument revoking it or a duly executed proxy bearing a later date to the Secretary of United. If the proxy is properly completed and returned by the shareholder and is not revoked, it will be voted at the meeting in the manner specified thereon. If the proxy is returned but no choices are indicated, it will be voted for (i) all the persons named below under the caption "Information about Nominees for Director"; (ii) the approval of the 2000 Key Employee Stock Option Plan; and (iii) the approval of the amendment to the Restated Articles of Incorporation. 1 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth as of May 1, 2000 the beneficial ownership of United's common stock by each director or nominee, by each named executive officer, and by all directors and officers as a group. As of May 1, 2000, there were no "persons" (as that term is defined by the SEC) known by United to be the beneficial owner of more than five percent of United's common stock other than indicated in the table below. The outstanding percentages of common stock as of May 1, 2000 are based on 8,442,990 shares of common stock, including 140,000 shares deemed outstanding pursuant to United's prime plus 1/4% Convertible Subordinated Payable-in-Kind Debentures due December 31, 2006 and presently exercisable options to acquire 267,122 shares. Unless otherwise indicated, the address of each beneficial owner of more than five percent of United's common stock is 63 Highway 515, Blairsville, Georgia 30512. SHAREHOLDER NUMBER OF SHARES OWNED BENEFICIALLY PERCENT OF CLASS Jimmy C. Tallent 166,036<F1> 1.97% Billy M. Decker 138,122<F2> 1.64% Thomas C. Gilliland 183,931<F3> 2.18% Robert H. Blalock 41,260<F4> 0.49% Robert L. Head, Jr. 672,743<F5> 7.97% Charles E. Hill 156,332<F6> 1.85% Hoyt O. Holloway 48,085<F7> 0.57% Deral P. Horne 25,000<F8> 0.30% John R. Martin 57,633 0.68% Clarence W. Mason, Sr. 30,382<F9> 0.36% Zell B. Miller 1,000 0.01% W.C. Nelson, Jr. 672,622<F10> 7.97% Charles E. Parks 102,259<F11> 1.21% Tim Wallis 53,829 0.64% Christopher J. Bledsoe 23,633<F12> 0.28% Guy W. Freeman 41,018<F13> 0.49% All Directors and Executive Officers (19 persons) 2,418,635<F14> 28.65% - ------------------------ <FN> <F1> Includes 10,000 shares beneficially owned by Mr. Tallent pursuant to debentures and 37,000 shares beneficially owned pursuant to stock options exercisable within 60 days of May 1, 2000. <F2> Includes 10,000 shares beneficially owned by Mr. Decker pursuant to debentures and 13,600 shares beneficially owned pursuant to stock options exercisable within 60 days of May 1, 2000. Does not include 9,613 shares owned by Mr. Decker's wife, for which he disclaims beneficial ownership. <F3> Includes 6,270 shares beneficially owned by Mr. Gilliland as custodian for his children, 10,000 shares beneficially owned pursuant to debentures, and 23,000 shares beneficially owned pursuant to stock options exercisable within 60 days of May 1, 2000. <F4> Includes 80 shares owned by Mr. Blalock's minor children and 30,993 shares owned by Blalock Insurance Agency, Inc., a company owned by Mr. Blalock. <F5> Includes 96,555 shares beneficially owned by a trust over which Mr. Head has voting power and 10,000 shares owned pursuant to debentures. Does not include 18,465 shares owned by Mr. Head's wife, for which he disclaims beneficial ownership. <F6> Includes 10,000 shares beneficially owned by Mr. Hill pursuant to debentures. Does not include 77,455 shares owned by Mr. Hill's wife, for which he disclaims beneficial ownership. <F7> Includes 10,000 shares beneficially owned pursuant to debentures and 35,565 shares beneficially owned by Holloway Motors, Inc., a company Mr. Holloway owns; but not 485 shares Mr. Holloway's wife owns, for which he disclaims beneficial ownership. <F8> Includes 10,000 shares beneficially owned by Mr. Horne pursuant to debentures. Does not include 1,920 shares owned by Mr. Horne's wife, for which he disclaims beneficial interest. <F9> Includes 10,000 shares beneficially owned by Mr. Mason pursuant to debentures. Does not include 16,958 shares owned by Mr. Mason's wife, for which he disclaims beneficial ownership. <F10> Includes 11,250 shares beneficially owned by a trust over which Mr. Nelson has voting power and 10,000 shares owned pursuant to debentures. Does not include 15,005 shares owned by Mr. Nelson's wife, for which he disclaims beneficial ownership. <F11> Includes 10,000 shares beneficially owned by Mr. Parks pursuant to debentures. <F12> Includes 6,000 shares beneficially owned by Mr. Bledsoe pursuant to debentures and 10,500 shares beneficially owned pursuant to stock options exercisable within 60 days of May 1, 2000. <F13> Includes 6,000 shares beneficially owned by Mr. Freeman pursuant to debentures and 21,500 shares beneficially owned pursuant to stock options exercisable within 60 days of May 1, 2000. <F14> Includes 110,600 shares beneficially owned pursuant to stock options exercisable within 60 days of May 1, 2000, and 112,000 shares beneficially owned pursuant to debentures. </FN> 2 NOMINATION AND ELECTION OF DIRECTORS (PROPOSAL ONE) The Bylaws of United provide that the number of directors may range from eight to fourteen directors. The board of directors of United has set the number of directors at twelve. The number of directors may be increased or decreased from the foregoing from time to time by the board of directors by amendment of the bylaws, but no decrease shall have the effect of shortening the term of an incumbent director. The terms of office for directors continue until the next annual meeting and until their successors are elected and qualified. During 1999, P. Deral Horne reached the mandatory retirement age as established in the bylaws and, accordingly, will not stand for re-election. John R. Martin will not stand for re-election and Robert H. Blalock is being proposed to serve in his stead. In addition, in December of 1999, the board of directors elected Tim Wallis as a director. Mr. Wallis previously served as a director of 1st Floyd Bankshares, which was acquired by United in 1999. Each proxy executed and returned by a shareholder will be voted as specified thereon by the shareholder. If no specification is made, the proxy will be voted for the election of the nominees named below to constitute the entire board of directors. If any nominee withdraws or for any reason is not able to serve as a director, the proxy will be voted for such other person as may be designated by the board of directors as a substitute nominee, but in no event will the proxy be voted for more than 12 nominees. Management of United has no reason to believe that any nominee will not serve if elected. All of the nominees, with the exception of Robert H. Blalock, are currently directors of United. Directors are elected by a plurality of the votes cast by the holders of the shares entitled to vote in an election at a meeting at which a quorum is present. A quorum is present when the holders of a majority of the shares outstanding on the record date are present at a meeting in person or by proxy. An abstention or a broker non-vote would be included in determining whether a quorum is present at a meeting, but would not have an effect on the outcome of a vote. THE BOARD OF DIRECTORS OF UNITED UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THE NOMINEES. 3 INFORMATION ABOUT NOMINEES FOR DIRECTOR The following information as of May 1, 2000 has been furnished by the respective nominees for director. Except as otherwise indicated, each nominee has been or was engaged in his present or last principal employment, in the same or a similar position, for more than five years. Director of Name (Age) Information About Nominee United Since ---------- ------------------------- ------------ Jimmy C. Tallent (47) President and Chief Executive Officer of United 1987 Robert H. Blalock (52) Owner of Blalock Insurance Agency, Inc., Clayton, Georgia Nominee Billy M. Decker (56) Senior Vice President and Secretary of United 1988 Thomas C. Gilliland (52) Executive Vice President of United and President of Peoples Bank of Fannin County 1992 Robert L. Head, Jr. (61) Chairman of the Board of Directors of United; Owner of Head Construction 1988 Company, Head-Westgate Corp., a commercial construction company, and Mountain Building Supply, Blairsville, Georgia Charles E. Hill (62) Retired Director of Pharmacy at Union General Hospital, Blairsville, Georgia 1988 Hoyt O. Holloway (59) Owner of H&H Farms, a poultry farm, Blue Ridge, Georgia 1993 Clarence W. Mason, Sr. (64) Owner of Mason Lawn and Garden, Blue Ridge, Georgia 1992 Zell B. Miller (68) Governor of Georgia from 1991 to 1999; director of Post Properties, Inc., 1999 Georgia Power Company, and Gray Communications, Inc. W. C. Nelson, Jr. (57) Vice Chairman of the Board of United; Owner of Nelson Tractor Company, 1988 Blairsville, Georgia Charles E. Parks (69) Former Owner of Parks Lumber Co., Murrayville, Georgia 1997 Tim Wallis (48) Owner of Wallis Printing Co., Rome, Georgia 1999 ============================================================================================================================= There are no family relationships between any director, executive officer, or nominee for director of United or any of its subsidiaries. ============================================================================================================================= 4 EXECUTIVE COMPENSATION The following table provides information regarding the compensation paid or accrued by United and its subsidiaries for the fiscal years ended December 31, 1997, 1998, and 1999, to or on behalf of the Chief Executive Officer and the four other most highly compensated executive officers. These individuals are referred to in this proxy statement as "named executive officers." Annual Compensation Long-Term Compensation ----------------------------------------------- ---------------------------- Securities All Name and Principal Offices Underlying Other HELD DURING 1999 Year Salary Bonus Other Options Compensation -------------------------- -------- ---------- -------- --------- ------------ --------------- Jimmy C. Tallent........................ 1999 $236,500 $150,000 $ 45,100<F1> 8,750 $ 21,111<F2> President and Chief Executive 1998 $231,125 $100,000 $ 36,900<F1> 8,750 $ 29,118 Officer of United 1997 $215,000 $ 90,000 $ 32,875<F1> 8,750 $ 27,058 Thomas C. Gilliland..................... 1999 $167,500 $ 55,000 $ 9,400<F1> 5,250 $ 10,250<F3> President and Chief Executive 1998 $165,000 $ 45,000 $ 5,400<F1> 5,250 $ 8,250 Officer of Peoples Bank of Fannin 1997 $157,500 $ 42,500 $ 5,400<F1> 5,250 $ 13,388 County; Executive Vice President of United Guy W. Freeman.......................... 1999 $165,000 $ 75,000 $ 7,300<F1> 4,000 $ 10,430<F3> President and Chief Executive 1998 $158,550 $ 50,000 $ 7,300<F1> 4,000 $ 19,343 Officer of Carolina Community 1997 $139,200 $ 40,000 $ 7,000<F1> 10,000 $ 16,892 Bank; Senior Vice President of United Billy M. Decker......................... 1999 $122,700 $ 32,000 $ 18,600<F1> 2,000 $ 9,900<F3> Senior Vice President and 1998 $121,450 $ 30,000 $ 18,600<F1> 2,500 $ 14,817 Secretary of United 1997 $117,700 $ 30,000 $ 18,600<F1> 3,500 $ 14,359 Christopher J. Bledsoe.................. 1999 $120,000 $ 35,000 -- 3,500 $ 10,625<F4> Senior Vice President and Chief 1998 $116,250 $ 27,500 -- 3,500 $ 14,183 Financial Officer of United 1997 $102,500 $ 25,000 -- 3,500 $ 12,505 - ---------- <FN> <F1> Directors' fees for service on United's bank subsidiaries' boards of directors. Other perquisites do not meet the SEC threshold for disclosure, which is the lesser of $50,000 or 10% of the total salary and bonus for any named executive. <F2> Represents a contribution by United of $21,285 on behalf of Mr. Tallent to United's Profit Sharing Plan and insurance premiums of $1,008 paid by United on behalf of Mr. Tallent on a life insurance policy. <F3> Represents United's contribution on behalf of the named individual to United's Profit Sharing Plan. </FN> United has never granted restricted stock, stock appreciation rights, or similar awards to any of its present or past executive officers, other than awards of stock options under the 1995 United Community Banks, Inc. Key Employee Stock Option Plan. Proposal Two of this proxy statement is for consideration of the 2000 Key Employee Stock Option Plan which will provide for grants of restricted stock. 5 COMPENSATION OF DIRECTORS Directors of United, other than directors who are a president or vice president of a bank subsidiary, received $2,000 per board meeting attended during 1999. Certain members of United's board of directors also serve as members of one or more of the boards of directors of United's bank subsidiaries, for which they are compensated by the bank subsidiaries. OPTION GRANTS IN LAST FISCAL YEAR The following table sets forth information concerning stock options granted to the named executive officers under the 1995 Key Employee Stock Option Plan during fiscal year 1999 and the projected value of those options at assumed annual rates of appreciation. - -------------------------------------------------------------------------------------- -------------------------------------------- Potential Realizable Value at Assumed Annual Rates of Stock Price Appreciation Individual Grants for Option Term<F2> - -------------------------------------------------------------------------------------- -------------------------------------------- Number of Securities Percent of Total Underlying Options Granted to Options Employees in Fiscal Expiration Name Granted<F1> Year Date 5% 10% - ----------------------------- ------------------ ----------------------- ------------- ------------------------ ------------------- Jimmy C. Tallent 8,750 10.6% 1/1/09 $ 220,113 $557,810 - ----------------------------------------------------------------------------------------------------------------------------------- Thomas C. Gilliland 5,250 6.4% 1/1/09 $ 132,068 $334,686 - ----------------------------------------------------------------------------------------------------------------------------------- Guy W. Freeman 4,000 4.9% 1/1/09 $ 100,623 $254,999 - ----------------------------------------------------------------------------------------------------------------------------------- Christopher J. Bledsoe 3,500 4.3% 1/1/09 $ 88,045 $223,124 - ----------------------------------------------------------------------------------------------------------------------------------- Billy M. Decker 2,000 2.4% 1/1/09 $ 50,312 $127,499 - ----------------------------------------------------------------------------------------------------------------------------------- - -------------------------- <FN> <F1> 20% of the options were vested at the date of grant and an additional 20% vest at each of the first four anniversaries of the date of grant. The exercise price of the options is $40.00 per share, the fair market value on the date of grant of the options. <F2> "Potential Realizable Value" is disclosed in response to SEC regulations that require such disclosure for illustration only. The values disclosed are not intended to be, and should not be interpreted as, representations or projections of the future value of United's common stock or of the stock price. Amounts are calculated at 5% and 10% assumed appreciation of the value of the common stock (compounded annually over the option term) and are not intended to forecast actual expected future appreciation, if any, of the common stock. The potential realizable value is the difference between the exercise price and the appreciated stock price at the assumed annual rates of appreciation multiplied by the number of shares underlying the options. </FN> 6 OPTION FISCAL YEAR-END VALUES Shown below is information with respect to options exercised during 1999 and unexercised options to purchase the common stock granted under the 1995 Key Employee Stock Option Plan to the named executive officers and held by them at December 31, 1999. - ----------------------------- ---------------- ----------------- ---------------------------- ------------------------------------- Number of Unexercised Value of Unexercised in the Money # Shares Options at Fiscal Year End Options at Fiscal Year End <F2> Acquired on $ Value Exercisable/ Exercisable/ Name Exercise Realized <F1> Unexercisable Unexercisable - ----------------------------- ---------------- ----------------- ---------------------------- ------------------------------------- Jimmy C. Tallent - - 30,000/17,500 $718,500/$189,000 Thomas C. Gilliland - - 18,000/10,500 $431,000/$113,400 Billy M. Decker - - 11,300/5,200 $282,000/$66,000 Guy W. Freeman - - 16,200/10,300 $368,000/$132,000 Christopher J. Bledsoe 5,000 $204,000 7,000/7,000 $127,400/$75,600 - ----------------------------- ---------------- ----------------- ---------------------------- ------------------------------------- <FN> <F1> Market price at time of exercise less option exercise price. <F2> Based on $42.00 per share, the last sale price known to United during 1999. United's common stock is not publicly traded. </FN> SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Section 16(a) of the Securities and Exchange Act of 1934, requires United's executive officers, directors, and persons who own more than 10% of United's common stock to file reports of ownership and changes in ownership with the SEC. Based solely on its review of the forms filed with the SEC and representations of reporting persons, United believes that everyone who was an executive officer, director, or greater than 10% beneficial owner at any time during 1999 complied with all filing requirements applicable to them during 1999. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION The board of directors of United reviewed the compensation of Messrs. Tallent, Gilliland, Freeman, Decker, and Bledsoe and of United's other executive officers for the 1999 fiscal year. Although all members of the board of directors participated in deliberations regarding the salaries of executive officers, no officer participated in any decisions regarding his own compensation as an executive officer. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Mr. Robert L. Head, Jr., chairman of the board of directors of United, is the owner of a construction company that United and two of its bank subsidiaries hired during the course of the year to perform various construction projects totaling approximately $1.1 million. The banks have had, and expect to have in the future, banking transactions in the ordinary course of business with directors and officers of United and their associates, including corporations in which such officers or directors are shareholders, directors, and/or officers, on the same terms (including interest rates and collateral) as those prevailing at the time for comparable transactions with unaffiliated third parties. Such transactions have not involved more than the normal risk of collectability or presented other unfavorable features. 7 JOINT REPORT ON EXECUTIVE COMPENSATION GENERAL Under rules established by the SEC, United is required to provide certain information with respect to compensation provided to United's president and chief executive officer and to United's other executive officers. The SEC regulations require a report setting forth a description of United's executive compensation policy in general and the considerations that led to the compensation decisions affecting Messrs. Tallent, Gilliland, Decker, Freeman, and Bledsoe. In fulfillment of this requirement, the board of directors and compensation committee has prepared the following report for inclusion in this proxy statement. The fundamental policy of United's compensation program is to offer competitive compensation and benefits for all employees, including the president and chief executive officer and the other officers of United, to compete for and retain talented personnel who will lead United in achieving levels of financial performance which will enhance shareholder value. United's executive compensation package historically has consisted of salary, annual incentive compensation, matching profit sharing contributions, and other customary fringe benefits. The grant of stock options under the 1995 Key Employee Stock Option Plan is also a part of United's compensation package for certain executive officers, including the named executive officers. SALARY All members of the board of directors of United participated in deliberation regarding salaries of executive officers. Although subjective in nature, factors considered by the board in setting the salaries of executive officers (other than Mr. Tallent) were Mr. Tallent's recommendations, compensation paid by comparable banks to their executive officers (although such information was obtained informally and United did not attempt to pay any certain percentage of salary for comparable positions with other banks), each executive officer's performance, contribution to United, tenure in his or her position, and internal comparability considerations. The board of directors set the salary of Mr. Tallent based on Mr. Tallent's salary during the preceding fiscal year, his tenure, the salaries of chief executive officers of comparable banks (although such information was obtained informally and United did not attempt to pay any certain percentage of salary for a comparable position with other banks), and the increase in earnings of United in recent years. The board did not assign relative weights to the factors considered in setting salaries of executive officers, including Mr. Tallent. ANNUAL INCENTIVE COMPENSATION Annual incentive compensation for 1999, paid in the form of a cash bonus during the fourth quarter of the fiscal year, was based on annual financial results of United and its bank subsidiaries, including general targets with respect to net income and earnings per share growth relative to the prior year results and the current year's budget. Cash bonuses were granted by the board to Mr. Tallent, and the board set a range of bonuses (based on a percentage of salary) for all employees other than Mr. Tallent, within which range Mr. Tallent determined each officer's bonus, based on individual performance. UNITED'S 1995 KEY EMPLOYEE STOCK OPTION PLAN Options to acquire 82,300 shares of common stock were awarded under the 1995 Key Employee Stock Option Plan in fiscal 1999, including options to acquire 23,500 shares of common stock awarded to the named executive officers by the compensation committee. 8 UNITED BOARD OF DIRECTORS Jimmy C. Tallent P. Deral Horne Billy M. Decker John R. Martin Thomas C. Gilliland Clarence W. Mason, Sr. Robert L. Head, Jr. Zell B. Miller Charles E. Hill W. C. Nelson, Jr. Hoyt O. Holloway Charles E. Parks Tim Wallis COMPENSATION COMMITTEE OF THE BOARD OF DIRECTORS Robert L. Head, Jr. John R. Martin Charles E. Hill Clarence W. Mason, Sr. Hoyt O. Holloway Zell B. Miller P. Deral Horne W. C. Nelson, Jr. Charles E. Parks Tim Wallis 9 SHAREHOLDER RETURN PERFORMANCE GRAPH Set forth below is a line graph comparing the yearly percentage change in the cumulative total shareholder return on United's common stock against the cumulative total return on The Nasdaq Stock Market (U.S. Companies) Index and The Nasdaq Bank Stocks Index for the period of five fiscal years commencing January 1, 1995 and ending on December 31, 1999. This graph was prepared at United's request by Research Data Group, San Francisco, California. United's common stock is not publicly traded; therefore, the total shareholder return is based on stock trades known to United during the periods presented. _______________________________________ GRAPHICS APPEARS HERE IS REPRESENTED IN THE TABULAR CHART BELOW _______________________________________ _____________________________________________________________________________________________ | | | | | | | CUMULATIVE TOTAL RETURN | |__________________________________|__|_____________________________________________________| | | | | | | | | | | | 12/94 | 12/95 | 12/96 | 12/97 | 12/98 | 12/99 | |__________________________________|__|________|________|________|________|________|________| | | | | | | | | | | UNITED COMMUNITY BANKS, INC. | | 100 | 161 | 212 | 305 | 408 | 430 | |__________________________________|__|________|________|________|________|________|________| | | | | | | | | | | NASDAQ STOCK MARKET (U.S.) | | 100 | 141 | 174 | 213 | 300 | 542 | |__________________________________|__|________|________|________|________|________|________| | | | | | | | | | | NASDAQ BANK | | 100 | 149 | 197 | 329 | 327 | 314 | |__________________________________|__|________|________|________|________|________|________| * $100 INVESTED ON 12/31/94 IN STOCK OR INDEX - INCLUDING REINVESTMENT OF DIVIDENDS. FISCAL YEAR ENDING DECEMBER 31. 10 MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS The United board of directors held three meetings during 1999. All of the directors attended at least 75% of the meetings of the board and meetings of the committees of the board on which they sat that were held during their tenure as directors. The board of directors does not have a standing nominating committee. The compensation committee of the board of directors is comprised of all members of the board who are not employees of the bank subsidiaries of United. The compensation committee makes compensation decisions for executive officers and key employees and administers the 1995 Key Employee Stock Option Plan. The board of directors formed an audit committee to be comprised of three members at the December 1999 meeting. Directors Holloway and Nelson were appointed to the audit committee at the December meeting and the remaining vacancy was filled with director Charles E. Parks on April 20, 2000. The audit committee will be responsible for recommending the selection of independent auditors; meeting with the independent auditors to review the scope and results of the audit; reviewing with management and the internal auditor the system of internal control and internal audit reports; ensuring that the books, records, and external financial reports of United are in accordance with generally accepted accounting principles; and reviewing all reports of examination made by regulatory authorities and ascertaining that any and all operational deficiencies are satisfactorily corrected. The audit committee consisting of Holloway and Nelson met one time during 1999. 11 APPROVAL OF THE 2000 KEY EMPLOYEE STOCK OPTION PLAN (PROPOSAL TWO) The board of directors of United has adopted, subject to shareholder approval, the 2000 Key Employee Stock Option Plan (the "2000 Plan"), effective December 8, 1999. United's shareholders previously approved the 1995 United Community Banks Key Employee Stock Option Plan to promote United's interests by providing an incentive for key employees to improve shareholder value through profitable growth of United and to remain in the employ of United and also to assist management in the recruitment and retention of capable personnel of a caliber required to ensure future success. The 2000 Plan has been adopted by the board of directors to serve these same purposes, and the board of directors believes that the accomplishment of these purposes will result in increased shareholder value. At the annual meeting, the shareholders of United will be asked to approve the 2000 Plan which is required to provide the option recipients with the favorable tax treatment afforded incentive stock options under Section 422 of the Internal Revenue Code. The 2000 Plan will be approved upon the affirmative vote of a majority of the shares represented at the meeting at which a quorum is present. An abstention or broker non-vote would be included in determining whether a quorum is present at a meeting, but would not affect the outcome of a vote. Unless otherwise instructed, shares represented by properly executed proxies will be voted in favor of the 2000 Plan. Shareholder approval of the 2000 Plan is also sought to qualify the 2000 Plan under Section 162(m) of the Internal Revenue Code and to thereby allow United to deduct for federal income tax purposes all compensation paid under the 2000 Plan to named executive officers. SUMMARY OF THE 2000 KEY EMPLOYEE STOCK OPTION PLAN GENERAL The purpose of the 2000 Plan is to secure for United and its shareholders the benefits of the incentive inherent in United stock ownership by key employees who perform services for United and its subsidiaries and who are largely responsible for its future growth and continued success. The Key Employee Stock Option Plan is further intended to provide flexibility to United in its ability to motivate, attract, and retain the services of individuals upon whose judgment, interest, and special effort the successful conduct of United's operation largely depends. The 2000 Plan became effective on December 8, 1999 and will continue in effect, unless earlier terminated, until December 7, 2009. Awards issued pursuant to the 2000 Plan prior to the relevant termination date which have not expired or otherwise terminated as of such date may be exercised after such time in accordance with their terms. A maximum of 490,000 shares of common stock are available for the grant of stock options under the 2000 Plan. If the number of United's issued and outstanding shares of common stock is increased after December 8, 1999, however, the maximum number of shares for which awards may be granted will be increased so that the ratio of the number of shares available for grant to outstanding shares remains the same as it was on December 8, 1999. Outstanding shares shall for the purposes of such calculation include the number of shares into which other securities or instruments issued by United are currently convertible (e.g., convertible preferred stock or convertible debentures, but not outstanding options to acquire stock). The maximum number of shares available for grant as incentive stock options under the 2000 Plan is 400,000 shares. The 2000 Plan is not subject to any provisions of the Employee Retirement Income Security Act of 1974, nor is it subject to Section 401 of the Internal Revenue Code of 1986. A summary of the more important provisions of the 2000 Plan is set forth below. This summary does not purport to be complete, and reference to the full text of the 2000 Plan, attached hereto as Appendix A should be made for further information. ADMINISTRATION The 2000 Plan is administered by the compensation committee of United's board of directors, or by any other committee appointed by the board that is granted authority to administer the plan. The members of the compensation committee serve at the pleasure of the board of directors. Each employee of United or of a subsidiary (including an employee who is a member of the board) whose judgment, initiative, and efforts contribute or may be expected to contribute materially to the successful performance of United or any subsidiary, is eligible to participate in the plan. Individuals who are not employees of United or a subsidiary are not eligible to receive grants of incentive stock options. The compensation committee is empowered to select the individuals who will participate in the plan, the form and amount of the awards, the dates of grant, and the terms and provisions of each award, and to interpret 12 the plan and any agreement entered into pursuant to the plan. All decisions and determinations of the compensation committee in the administration of the plan and on all questions concerning the plan are final and conclusive. Participants in the plan are selected in the discretion of the compensation committee. Awards granted under the plan will be evidenced by a written agreement in such form and containing such terms and conditions (which need not be identical for all award agreements) as the committee determines, so long as the award agreement is in compliance with the terms of the plan. TERMS OF GRANT AND EXERCISE OF AWARDS STOCK OPTIONS. Stock options granted under the plan may be incentive stock options. An option entitles a participant to purchase shares of common stock from United at the option price. The exercise price of an incentive stock options may not be less than the fair market value of the common stock on the date of the grant, or less than 110% of the fair market value if the participant owns more than 10% of the total combined voting power of all classes of stock of United. The exercise price of non-qualified stock options may be equal to, less than, or more than the fair market value of the common stock on the date that the option is awarded. The maximum number of shares subject to options which can be granted under the 2000 Plan during any calendar year to any individual is 200,000 shares. Full payment of the option price must be made when an option is exercised. The purchase price may be paid in cash or in such other form of consideration as the compensation committee may approve, which may include shares of common stock valued at their fair market value on the date of exercise, or by any other means which the compensation committee determines to be consistent with the plan's purpose and applicable law. Options granted under the 2000 Plan will be exercisable, in whole or in part, by the option holder upon such terms and conditions as may be determined by the compensation committee. Options vest according to the schedule provided for by the compensation committee in the corresponding award agreement and are not exercisable later than ten years after the date of grant, but any incentive stock option granted to a participant who owns more than 10% of the combined voting power of all classes of United stock will not be exercisable after the expiration of five years after the date the option is granted. Incentive stock options are also subject to the further restriction that the aggregated fair market value, determined as of the date of grant, of common stock as to which any incentive stock option first becomes exercisable in any calendar year is limited to $100,000 per recipient. To the extent that options granted pursuant to the plan exceed such amount (or otherwise fail to qualify as incentive stock options), they will constitute non-qualified stock options. STOCK APPRECIATION RIGHTS. The compensation committee may grant stock appreciation rights separately or in connection with another stock incentive, and the committee may provide that the holder may exercise them at any time or that they will be paid at a certain time or times or upon the occurrence or non-occurrence of certain events. Stock appreciation rights may be settled in shares of common stock or in cash, according to terms established by the compensation committee with respect to any particular award. The maximum number of stock appreciation rights which can be granted under the 2000 Plan during any calendar year to any individual is 200,000. RESTRICTED STOCK; STOCK AWARDS. Participants may also be awarded shares of common stock pursuant to a stock award. The compensation committee, in its discretion, may prescribe that a participant's rights in a stock award shall be nontransferable or forfeitable or both unless certain conditions are satisfied. These conditions may include, for example, a requirement that the participant continue employment with United for a specified period or that United or the participant achieve stated objectives. In addition, the restrictions may lapse incrementally. At the time a grant of restricted stock is made, the compensation committee shall establish a period or periods of time applicable to such grant which, unless the compensation committee otherwise provides, shall not be less than one year. Subject to certain provisions, at the end of the restricted period, all restrictions shall lapse and the restricted stock shall vest in the participant. The compensation committee may, in its discretion, shorten or terminate the restricted period, or waive any conditions for the lapse or termination of restrictions with respect to all or any portion of the restricted stock at any time after the date the grant is made. Upon a grant of restricted stock, a stock certificate representing the number of shares of restricted stock granted to the participant shall be registered in the participant's name and shall be held in custody by United or a bank selected by the compensation committee for the participant's account. Following such registration, the participant shall, subject to certain restrictions, have the rights and privileges of a shareholder as to such restricted stock, including the right to receive dividends and to vote such restricted stock, except that the right to receive cash dividends shall be the right to receive such dividends either in cash currently or by payment in 13 restricted stock, as the compensation committee shall determine. The maximum number of shares of restricted stock or stock awards which can be granted under the 2000 Plan during any calendar year to any individual is 200,000. PERFORMANCE SHARE AWARDS. The 2000 Plan also provides for the award of performance shares. A performance share award entitles the participant to receive a payment equal to the fair market value of a specified number of shares of common stock if certain performance standards are met. The compensation committee will prescribe the requirements that must be satisfied before a performance share award is earned. To the extent that performance shares are earned, the obligation may be settled in cash, in common stock or by a combination of the two. No participant has, as a result of receiving a performance share award, any rights as a shareholder until and to the extent that the performance shares are earned and common stock is transferred to such participant. If the award agreement so provides, a participant may receive a cash payment equal to the dividends that would have been payable with respect to the number of shares of common stock covered by an award between (a) the date that the performance shares are awarded and (b) the date that a transfer of common stock to the participant, cash settlement, or combination thereof is made pursuant to the performance share award. TERMINATION OF AWARDS The terms of an award may provide that it will terminate, among other reasons, upon the holder's termination of employment or other status with United or its subsidiaries, upon a specified date, upon the holder's death or disability, or upon the occurrence of a change in control. Also, the compensation committee may, within the terms of the 2000 Plan, provide in the award agreement for the acceleration of vesting for any of the above reasons. AMENDMENT AND TERMINATION OF THE 2000 KEY EMPLOYEE STOCK OPTION PLAN; ADJUSTMENT OF SHARES The board of directors may terminate, suspend, or amend the plan at any time, but certain amendments will not become effective without shareholder approval. Generally, the board or the compensation committee may not adversely affect the rights of a holder of an award without the holder's consent. The compensation committee may, in such manner as it shall determine in its sole discretion, appropriately adjust the number of shares subject to awards under the 2000 Plan, the purchase price per share, and the aggregate number of shares available for issuance in the event of any stock dividend issued by United, recapitalization of United's capital structure or exchange of the outstanding shares of common stock for shares of another class or company. EXPENSES United pays the administrative costs of the 2000 Plan, including the expenses of the compensation committee and the costs of issuing and delivering the shares subject to the plan. COMPLIANCE WITH SECTION 162(M) OF THE INTERNAL REVENUE CODE Section 162(m) of the Internal Revenue Code denies a deduction by an employer for certain compensation in excess of $1 million per year paid by a publicly traded corporation to the named executive officers at the end of the taxable year. Compensation with respect to stock options, including upon exercise of a non-qualified stock option or upon a disqualifying disposition of an incentive stock option, as described below under "Federal Income Tax Effects," or other compensation pursuant to the 2000 Plan, will be excluded from this deduction limit if it satisfies certain requirements. The requirements include: (i) the stock option or right must be granted at an exercise price not lower than fair market value at date of grant (or the award must be made on account of the attainment of performance goals that meet the requirements of Section 162(m)); (ii) the stock option grant or other stock award must be made by a committee composed of two or more "outside directors" within the meaning of Section 162(m); (iii) the plan under which the award is granted must state the maximum number of shares with respect to which options or rights may be granted during a specified period to any individual; and (iv) the material terms pursuant to which the compensation is to be paid must be disclosed to, and approved by, shareholders in a separate vote prior to payment. The 2000 Plan meets the requirements of paragraphs (i) through (iii) above, and approval of the 2000 Plan by United's shareholders is being proposed to comply with requirement (iv), so that compensation with respect to stock options and stock awards may be excluded from the deduction limit under 162(m) of the Internal Revenue Code. THE BOARD OF DIRECTORS OF UNITED UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR PROPOSAL TWO. 14 APPROVAL TO AMEND THE RESTATED ARTICLES OF INCORPORATION TO INCREASE THE NUMBER OF AUTHORIZED SHARES OF COMMON STOCK OF UNITED (PROPOSAL THREE) The United board of directors believes that it would be in the best interest of United and its shareholders for the Restated Articles of Incorporation to be amended to increase the number of authorized shares of common stock, $1.00 par value, from 10,000,000 to 50,000,000 shares. On May 1, 2000, United had 8,035,868 shares outstanding, 286,404 shares reserved for issuance in connection with the 1995 Key Employee Stock Option Plan, 52,898 shares reserved for issuance in connection with the stock option plan of 1st Floyd Bankshares, which was assumed by United, and $3.5 million in outstanding subordinated debt, which is convertible into 140,000 shares of common stock. An additional 490,000 shares will be reserved in connection with the approval of the 2000 Key Employee Stock Option Plan referenced in Proposal Two. Accordingly, United currently has a total of 994,830 authorized but unissued shares of common stock uncommitted to any specific purpose. PURPOSE OF AUTHORIZING ADDITIONAL COMMON STOCK The board of directors believes it is in United's best interest to increase the number of authorized shares of common stock because 9,005,170 shares of the 10,000,000 shares of common stock currently authorized are outstanding or have been reserved for issuance as of May 1, 2000, assuming approval of Proposal Two. The board believes that the 994,830 shares remaining available for use are insufficient to enable the board of directors to act quickly to take advantage of various business opportunities, including acquisitions, financings, raising additional capital, stock splits and dividends, compensation plans, and other corporate purposes. On March 3, 2000, United entered into definitive agreements to acquire North Point, pursuant to which United will issue 958,211 shares of common stock, and to acquire Independent, pursuant to which United will issue 870,595 shares of common stock. The consummations of both acquisitions are conditioned upon shareholder approval of United to increase the authorized shares of United common stock from 10,000,000 to 50,000,000. United has also commenced a public offering, for cash, of between 350,000 and 450,000 shares of common stock from which it expects to receive proceeds of approximately between $13.3 million and $17.1 million to provide more capital for its subsidiary banks and for other corporate purposes. EFFECT OF PROPOSAL If this proposal is approved, the board of directors will have the authority to issue the additional authorized shares to the persons and for the consideration as it may determine without further action by the shareholders. Any issues of additional common stock could have the effect of discouraging an attempt to acquire control of United. For example, stock could be issued to persons, firms, or entities known to be friendly to management. An issuance of common stock at a price below the book value per share will have a dilutive effect on the book value of the outstanding shares and may also have a dilutive effect on earnings per share and the relative voting power of current shareholders. The issuance of common stock in a merger or acquisition may also have a dilutive effect. Except as set forth in the preceding paragraph, United does not currently have any material commitments, arrangements, or understanding which would require the issuance of additional shares of common stock. The board of directors does not believe that an increase in the number of authorized shares of common stock will have a significant impact on any attempt to gain control of United. It is possible, however, that the availability of authorized but unissued shares of common stock could discourage third parties from attempting to gain control since the board could authorize the issuance of shares of common stock in a manner that could dilute the voting power of a person attempting to acquire control of United, increase the cost of acquiring such control or otherwise hinder such efforts. The board is not aware of any present threat or attempt to gain control of United and Proposal Three is not in response to any such action nor is it being presented with the intent that it be utilized as a type of anti-takeover device. If this proposal is adopted, the text of the first paragraph of Article V in United's Restated Articles of Incorporation would be as set forth in Appendix B. VOTE REQUIRED FOR APPROVAL The affirmative vote of holders of a majority of the shares of common stock outstanding on the record date is required to approve the amendment. Accordingly, any abstention or broker non-vote will count as a vote against the proposal. THE BOARD OF DIRECTORS OF UNITED UNANIMOUSLY RECOMMENDS THAT YOU VOTE FOR THIS PROPOSAL. 15 INFORMATION ABOUT UNITED COMMUNITY BANKS, INC. DESCRIPTION OF BUSINESS United was incorporated under the laws of the state of Georgia in 1987. All of United's activities are currently conducted through its wholly-owned subsidiaries: United Community Bank, organized as a Georgia banking corporation in 1950; Carolina Community Bank, acquired in 1990; Peoples Bank of Fannin County, acquired in 1992; Towns County Bank, also acquired in 1992; White County Bank, acquired in 1995; First Clayton Bank & Trust, acquired in 1998; Bank of Adairsville, acquired in 1999; and 1st Floyd Bank, also acquired in 1999. In addition, United owns two consumer finance companies: United Family Finance Co. and United Family Finance Co. of North Carolina. United's executive office is located at 63 Highway 515, Blairsville, Georgia 30512, and its telephone number is (706) 745-2151. United has not been convicted in a criminal proceeding during the past five years, nor has it been a party to any judicial or administrative proceeding that resulted in a judgment, decree, or final order enjoining the person from future violations of, or prohibiting activities subject to, federal or state securities laws, or a finding of any violation of federal or state securities laws. At March 31, 2000, United had total consolidated assets of approximately $2.2 billion, total loans of approximately $1.5 billion, total deposits of approximately 1.7 billion, and shareholders' equity of approximately $98.5 million. Our banks are community-oriented and offer a full range of retail and corporate banking services, including checking, savings, and time deposit accounts, secured and unsecured loans, wire transfers, trust services, and rental of safe deposit boxes. As of December 31, 1999, our banks operated a total of 34 locations. To emphasize the commitment to community banking, both United Community Bank and Peoples Bank of Fannin County operate offices under trade names that are closely identified with the communities in which they are located. United Community Bank operates two offices in Union County under the trade name "Union County Bank," two offices in Lumpkin County, Georgia, under the trade name "United Community Bank of Lumpkin County," two offices in Habersham County, Georgia, under the trade name "First Bank of Habersham," and one office in Hall County, Georgia, under the trade name "United Community Bank of Hall County." Peoples Bank of Fannin County operates one office in Gilmer County, Georgia, under the trade name of "United Community Bank of Gilmer County." The operation of bank offices under trade names is permissible under current state and federal banking regulations and requires certain customer disclosures, which both United Community Bank and Peoples Bank of Fannin County provide. The Mortgage People Company, a division of United Community Bank, is a full-service retail mortgage lending operation approved as a seller/servicer for Federal National Mortgage Association and Federal Home Mortgage Corporation. The Mortgage People Company was organized to provide fixed and adjustable-rate mortgages. During 1999, it originated $129 million of residential mortgage loans for the purchase of homes and to refinance existing mortgage debt, substantially all of which were sold along with the servicing rights into the secondary market with no recourse. We operate two consumer finance companies - United Family Finance Co., which operates two offices in Georgia, and United Family Finance Co. of North Carolina, which operates two offices in North Carolina. In addition, we own an insurance agency, United Agencies, Inc. RECENT DEVELOPMENTS United is currently conducting a public offering of between 350,000 and 450,000 shares of United common stock at $38.00 per share, pursuant to which United plans to raise between $13.3 and $17.1 million in additional capital for its subsidiary banks and for general corporate purposes. On March 3, United entered into separate agreements to acquire North Point Bancshares, Inc., and Independent Bancshares, Inc., in exchange for 958,211 and 870,595 shares, respectively of United Stock. See pages _____ and for more information about these proposed acquisitions. 16 SERVICES Our banks are community-oriented, with an emphasis on retail banking, and offer such customary banking services as customer and commercial checking accounts, NOW accounts, savings accounts, certificates of deposit, lines of credit, MasterCard and VISA accounts, money transfers, and trust services. Our banks finance commercial and consumer transactions, make secured and unsecured loans, including residential mortgage loans, and provide a variety of other banking services. The Mortgage People Company, a division of United Community Bank, is a full-service mortgage lending operation approved as a seller/servicer for the Federal National Mortgage Association and the Federal Home Mortgage Corporation and offers fixed and adjustable-rate mortgages. United Family Finance Company, is a traditional consumer finance company. United Family Finance, formerly known as Mountain Mortgage and Loan Company, is based in Hiawassee, Georgia, and also has been granted a license to conduct business in Blue Ridge, Georgia. United Family Finance Co. of North Carolina operates two offices in Murphy and Franklin, North Carolina. MARKETS We conduct banking activities primarily through United Community Bank in Union, Lumpkin, and Habersham Counties; through Peoples Bank in Fannin County, Georgia and Polk County, Tennessee; through Towns County Bank in Towns County, Georgia; through Carolina Community Bank in Cherokee, Macon, Haywood, Graham, and Clay Counties, North Carolina; through White County Bank in White County, Georgia; through First Clayton Bank and Trust in Clayton County, Georgia; through Bank of Adairsville in Adairsville, Georgia; and through 1st Floyd Bank in Floyd County, Georgia. Mortgage People Company makes mortgage loans inside the banks' market areas. Customers of our subsidiary banks are primarily consumers and small businesses. DEPOSITS Our banks offer a full range of depository accounts and services to both consumers and businesses. At December 31, 1999, our deposit base, totaling approximately $1.6 billion, consisted of approximately $192 million in non-interest-bearing demand deposits (12% of total deposits), approximately $329 million in interest-bearing demand and money market deposits (20% of total deposits), approximately $74 million in savings deposits (4% of total deposits), approximately $743 million in time deposits in amounts less than $100,000 (45% of total deposits), and approximately $312 million in time deposits of $100,000 or more (19% of total deposits). Certificates of deposit in excess of $100,000 may be more volatile than other deposits because those deposits, to the extent that they exceed $100,000, are not insured by the FDIC. Our management is of the opinion that its time deposits of $100,000 or more are customer-relationship oriented and represent a reasonably stable source of funds. Time deposits of less than $100,000 include approximately $70 million of "brokered" deposits, which have an average maturity of less than one year. 17 LOANS Our banks make both secured and unsecured loans to individuals and businesses. Secured loans include first and second real estate mortgage loans. The banks also make direct installment loans to consumers on both a secured and unsecured basis. At December 31, 1999, the break out of loans by collateral type was: >/R> (DOLLAR AMOUNTS IN THOUSANDS) Percent of Amount Total Loans ---------- ----------- Secured by real estate: Residential first liens $ 506,729 36.1% Residential second liens 27,177 1.9% Home equity lines of credit 53,191 3.8% Construction and land development 161,774 11.6% Non-farm, non-residential 355,269 25.4% Farmland 16,173 1.2% Multi-family residential 10,846 0.8% ---------- ------- Total real estate $1,131,159 80.8% Other Loans: Commercial and industrial $ 105,221 7.5% Agricultural production 9,923 0.7% States and municipalities 10,101 0.7% Consumer installment loans 136,983 9.8% Credit cards and other revolving credit 6,973 0.5% ---------- ------- Total other loans 269,201 19.2% ---------- ------- Total loans $1,400,360 100.0% ========== ======= Specific risk elements associated with each of the banks' lending categories are as follows: Commercial, financial, and Industry concentrations, inability to agricultural monitor the condition of collateral (inventory, accounts receivable, and vehicles), lack of borrower management expertise, increased competition, and specialized or obsolete equipment as collateral Real estate - construction Inadequate collateral and long-term financing agreements Real estate - mortgage Changes in local economy and rate limits on variable rate loans Installment loans to individuals Loss of borrower's employment, changes in local economy, and the inability to monitor collateral (vehicles, boats, and mobile homes) COMPETITION The market for banking and bank-related services is highly competitive. Our banks actively compete in their respective market areas, which collectively cover portions of north Georgia and western North Carolina, with other providers of deposit and credit services. These competitors include other commercial banks, thrift institutions, credit unions, mortgage companies, and brokerage firms. The following table displays each of our banks and the respective percentage of total deposits in each county where each bank has operations. The darker shaded counties, Paulding, Cobb, Dawson, and Forsyth, represent the markets of our pending acquisitions of North Point and Independent. The table also indicates the ranking by deposit size in each of the local markets. All information in the table was obtained from the Federal Deposit Insurance Corporation Summary of Deposits as of June 30, 1999. 18 [GRAPHIC OMITTED but is represented by the list of counties on the next page the graphic on this page is a partial Map of the states of Georgia, North Carolina and Tennessee and shades in counties where the Company is represented] 19 United Community Banks, Inc. Share of Local Market (County) Banks and Savings Institutions Market Share Rank in Market ------------ -------------- UNITED COMMUNITY Habersham 15% 4 Lumpkin 24% 2 Union 83% 1 CAROLINA Cherokee 45% 1 Clay 64% 1 Graham 40% 1 Haywood 7% 6 Henderson 2% 13 Jackson 13% 3 Macon 7% 6 Swain 21% 2 Transylvania 6% 5 FANNIN Fannin 59% 1 Gilmer 17% 3 WHITE White 50% 1 TOWNS Towns 36% 2 FIRST CLAYTON Rabun 29% 3 ADAIRSVILLE Bartow 7% 7 FLOYD Floyd 8% 6 INDEPENDENT* Cobb 2% 11 Paulding 2% 5 NORTH POINT* Dawson 47% 1 *Pending acquisitions. 20 LENDING POLICY The current lending policy of the banks is to make loans primarily to persons who reside, work or own property in their primary market areas. Unsecured loans are generally made only to persons who maintain depository relationships with the banks. Secured loans are made to persons who are well established and have net worth, collateral and cash flow to support the loan. Exceptions to the policy are permitted on a case-by-case basis and require the approving officer to document in writing the reason for the exception. Policy exceptions made for borrowers whose total aggregate loans exceed the approving officer's credit limit must be submitted to the bank's board of directors for approval. The banks provide each lending officer with written guidelines for lending activities. Lending authority is delegated by the boards of directors of the banks to loan officers, each of whom is limited in the amount of secured and unsecured loans which he or she can make to a single borrower or related group of borrowers. Loans in excess of individual officer credit authority must either be approved by a senior officer with sufficient approval authority, or be approved by the bank's board of directors. LOAN REVIEW AND NON-PERFORMING ASSETS The Loan Review Department of United reviews, or engages an independent third party to review, the loan portfolio of each bank on an annual basis to determine any weaknesses in the portfolio and to assess the general quality of credit underwriting. The results of the reviews by the loan review officers are presented to the Presidents of each of the banks, the President and the Chief Credit Officer of United and the Boards of Directors of each of the banks. If an individual loan or credit relationship has a weakness identified during the review process the risk rating of the loan, or all loans comprising a credit relationship, will be downgraded to a classification that most closely matches the current risk level. The review process also provides for the upgrade of loans that show improvement since the last review. Since each loan in a credit relationship may have a different credit structure, collateral and other secondary source of repayment, different loans in a relationship can be assigned different risk ratings. During 1999, United revised its loan grading system, expanding it from 8 to 10 grades. In the revised system, grades 1 through 6 are considered "pass", or acceptable, credit risk and grades 7 through 10 are "adversely classified" credits that require management's attention. The change in the number of grades was implemented to provided a more accurate means of detecting and monitoring the gradual deterioration or improvement in individual loans. Both the pass and adversely classified ratings, and the entire 10-grade rating scale, provide for a higher numeric rating for increased risk. For example, a risk rating of 1 is the least risky of all credits and would be typical of a loan that is 100% secured by a deposit at one of the banks. Risk ratings of 2 through 6 in the pass category each have incrementally more risk. The five adversely classified credit ratings and rating definitions are: 7 (Watch) - Weaknesses exist that could cause future impairment, including the deterioration of financial ratios, past-due status and questionable management capabilities. Collateral values generally afford adequate coverage, but may not be immediately marketable. 8 (Substandard) - Specific and well -defined weaknesses that may include poor liquidity and deterioration of financial ratios. Loan may be past-due and related deposit accounts experiencing overdrafts. Immediate corrective action is necessary. 9 (Doubtful) - Specific weaknesses characterized by Substandard that are severe enough to make collection in full unlikely. No strong secondary source of repayment. 10 (Loss) - Same characteristics as Doubtful; however, probability of loss is certain. Loans classified as such are generally recommended for charge-off at the next board of directors meeting of the bank. 21 In addition, the Loan Review Department conducts a quarterly analysis to determine the adequacy of the Allowance for Loan Losses for each of the banks. The aggregation of the Allowance for Loan Losses analyses for the banks provides the consolidated analysis for United. The Allowance for Loan Losses analysis starts by taking total loans and deducting loans secured by deposit accounts at the banks, which effectively have no risk of loss. Next, all loans with an adversely classified rating are deducted. The remaining loan balance is then multiplied by the average historical loss rate for the preceding five year period (1995 through 1999), which provides required minimum Allowance for Loan Losses for pass credits (component "A"). The remaining total loans in each of the four adversely classified rating categories are then multiplied by a projected loss factor to determine the Allowance for Loan Losses allocation for adversely classified credits (component "B"). The loss factors currently used are: Watch (5%); Substandard (15%); Doubtful (50%); and Loss (100%). The sum of components A and B comprises the total allocated Allowance for Loan Losses. There is no current process utilized to measure or adjust for differences between the loss factors for adversely classified loans used in the Allowance for Loan Losses analysis and actual losses charged to the Allowance for Loan Losses . The difference between the actual Allowance for Loan Losses (as presented in the consolidated financial statements) and the allocated Allowance for Loan Losses represents the unallocated Allowance for Loan Losses . The unallocated Allowance for Loan Losses provides for coverage of credit losses inherent in the loan portfolio but not provided for in the Allowance for Loan Losses analysis. United and the banks determine the level of unallocated Allowance for Loan Losses primarily by assessing the ratio of Allowance for Loan Losses to total loans of peer bank holding companies and peer banks, using the Federal Reserve Uniform Bank Performance Report and other bank industry analytical publications. ASSET/LIABILITY MANAGEMENT Committees composed of officers of each of the banks and the Chief Financial Officer and Treasurer of United are charged with managing the assets and liabilities of the banks. The committees attempt to manage asset growth, liquidity and capital in order to maximize income and reduce interest rate risk. The committees direct each Bank's overall acquisition and allocation of funds. At monthly meetings, the committees review the monthly asset and liability funds budget in relation to the actual flow of funds and peer group comparisons; the ratio of the amount of rate sensitive assets to the amount of rate sensitive liabilities; the ratio of allowance for loan losses to outstanding and non-performing loans; and other variables, such as expected loan demand, investment opportunities, core deposit growth within specified categories, regulatory changes, monetary policy adjustments and the overall state of the economy. A more comprehensive discussion of United's Asset/Liability Management and interest rate risk is contained in the UNITED'S MANAGEMENT'S DISCUSSION AND ANALYSIS and QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK sections of this proxy statement. INVESTMENT POLICY The banks' investment portfolio policy is to maximize income consistent with liquidity, asset quality and regulatory constraints. The policy is reviewed from time to time by the banks' Boards of Directors. Individual transactions, portfolio composition and performance are reviewed and approved monthly by the Boards of Directors or a committee thereof. The Chief Financial Officer of United and the President of each of the banks administer the policy and report information to the full board of directors of each of the banks on a quarterly basis concerning sales, purchases, maturities and calls, resultant gains or losses, average maturity, federal taxable equivalent yields and appreciation or depreciation by investment categories. EMPLOYEES As of December 31, 1999, United and its subsidiaries had an aggregate of 778 full-time equivalent employees. Neither United nor any of the subsidiaries is a party to any collective bargaining agreement, and United believes that employee relations are good. None of United's or the banks' executive officers is employed pursuant to an employment contract. 22 SUPERVISION AND REGULATION GENERAL. United is a registered bank holding company subject to regulation by the Board of Governors of the Federal Reserve System under the Bank Holding Company Act of 1956, as amended. United is required to file financial information with the Federal Reserve periodically and is subject to periodic examination by the Federal Reserve. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve's prior approval before (1) it may acquire direct or indirect ownership or control of more than 5% of the voting shares of any bank that it does not already control; (2) it or any of its non-bank subsidiaries may acquire all or substantially all of the assets of a bank; and (3) it may merge or consolidate with any other bank holding company. In addition, a bank holding company is generally prohibited from engaging in, or acquiring, direct or indirect control of the voting shares of any company engaged in non-banking activities. This prohibition does not apply to activities listed in the Bank Holding Company Act or found by the Federal Reserve, by order or regulation, to be closely related to banking or managing or controlling banks as to be a proper incident thereto. Some of the activities that the Federal Reserve has determined by regulation or order to be closely related to banking are: o making or servicing loans and certain types of leases; o performing certain data processing services; o acting as fiduciary or investment or financial advisor; o providing brokerage services; o underwriting bank eligible securities; o underwriting debt and equity securities on a limited basis through separately capitalized subsidiaries; and o making investments in corporations or projects designed primarily to promote community welfare. In addition, effective March 11, 2000, bank holding companies whose banking subsidiaries are all well-capitalized and well-managed may apply to become a financial holding company. Financial holding companies have the authority to engage in activities that are "financial in nature" that are not permitted for other bank holding companies. Some of the activities that the Bank Holding Company Act provides are financial in nature are: o lending, exchanging, transferring, investing for others or safeguarding money or securities; o insuring, guaranteeing, or indemnifying against loss, harm, damage, illness, disability, or death, or providing and issuing annuities, and acting as principal, agent, or broker with respect thereto; o providing financial, investment, or economic advisory services, including advising an investment company; o issuing or selling instruments representing interests in pools of assets permissible for a bank to hold directly; and o underwriting, dealing in or making a market in securities. We have no immediate plans to register as a financial holding company. United must also register with the Georgia Department of Banking and Finance ("DBF") and file periodic information with the DBF. As part of such registration, the DBF requires information with respect to the financial condition, operations, management and intercompany relationships of United and the banks and related matters. The DBF may also require such other information as is necessary to keep itself informed as to whether the provisions of Georgia law and the regulations and orders issued thereunder by the DBF have been complied with, and the DBF may examine United and each of the banks. The North Carolina Banking Commission ("NCBC"), which has the statutory authority to regulate non-banking affiliates of North Carolina banks, in 1992 began using this authority to examine and regulate the activities of North Carolina-based holding companies owning North Carolina-based banks. Although the NCBC has not exercised its authority to date to examine and regulate holding companies outside of North Carolina that own North Carolina banks, it is likely the NCBC may do so in the future. 23 United is an "affiliate" of the banks under the Federal Reserve Act, which imposes certain restrictions on (i) loans by the banks to United, (ii) investments in the stock or securities of United by the banks, (iii) the banks' taking the stock or securities of an "affiliate" as collateral for loans by the Bank to a borrower, and (iv) the purchase of assets from United by the banks. Further, a bank holding company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, lease or sale of property or furnishing of services. Each of United's subsidiaries is regularly examined by the Federal Deposit Insurance Corporation (the "FDIC"). United Community Bank, Peoples Bank of Fannin County, White County Bank, Towns County Bank, First Clayton Bank and Trust, Bank of Adairsville and 1st Floyd Bank as state banking associations organized under Georgia law, are subject to the supervision of, and are regularly examined by, the DBF. Carolina Community Bank is subject to the supervision of, and is regularly examined by, the NCBC and the FDIC. Both the FDIC and the DBF must grant prior approval of any merger, consolidation or other corporation reorganization involving United Community Bank, Peoples Bank of Fannin County, White County Bank, Towns County Bank, First Clayton Bank and Trust, Bank of Adairsville or 1st Floyd Bank, and the FDIC and the NCBC must grant prior approval of any merger, consolidation or other corporate reorganization of Carolina Community Bank. A bank can be held liable for any loss incurred by, or reasonably expected to be incurred by, the FDIC in connection with the default of a commonly-controlled institution. PAYMENT OF DIVIDENDS. United is a legal entity separate and distinct from the banks. Most of the revenues of United result from dividends paid to it by the banks. There are statutory and regulatory requirements applicable to the payment of dividends by the banks, as well as by United to its shareholders. United Community Bank, Peoples Bank of Fannin County, Towns County Bank, White County Bank, First Clayton Bank and Trust, Bank of Adairsville and 1st Floyd Bank are each state chartered banks regulated by the DBF and the FDIC. Under the regulations of the DBF, dividends may not be declared out of the retained earnings of a state bank without first obtaining the written permission of the DBF, unless such bank meets all the following requirements: (a) total classified assets as of the most recent examination of the bank do not exceed 80% of equity capital (as defined by regulation); (b) the aggregate amount of dividends declared or anticipated to be declared in the calendar year does not exceed 50% of the net profits after taxes but before dividends for the previous calendar year; and (c) the ratio of equity capital to adjusted assets is not less than 6%. Under North Carolina law, the board of directors of Carolina Community Bank may declare a dividend for as much of the undivided profits of Carolina Community Bank as it deems appropriate, so long as Carolina Community Bank's surplus is greater than 50% of its capital. The payment of dividends by United and the banks may also be affected or limited by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. In addition, if, in the opinion of the applicable regulatory authority, a bank under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice (which, depending upon the financial condition of the bank, could include the payment of dividends), such authority may require, after notice and hearing, that such bank cease and desist from such practice. The FDIC has issued a policy statement providing that insured banks should generally only pay dividends out of current operating earnings. In addition to the formal statutes and regulations, regulatory authorities consider the adequacy of each of the Bank's total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends to the banks. At December 31, 1999, net assets available from the banks to pay dividends without prior approval from regulatory authorities totaled approximately $23 million. For 1999, United's declared cash dividend payout to shareholders was 11.8% of net income. MONETARY POLICY. The results of operations of the banks are affected by credit policies of monetary authorities, particularly the Federal Reserve. The instruments of monetary policy employed by the Federal Reserve include open market operations in U.S. government securities, changes in the discount rate on bank borrowings and changes in reserve requirements against bank deposits. In view of changing conditions in the national economy and in the money markets, as 24 well as the effect of actions by monetary and fiscal authorities, including the Federal Reserve, no prediction can be made as to possible future changes in interest rates, deposit levels, loan demand or the business and income of the banks. CAPITAL ADEQUACY. The Federal Reserve and the FDIC have implemented substantially identical risk-based rules for assessing bank and bank holding company capital adequacy. These regulations establish minimum capital standards in relation to assets and off-balance sheet exposures as adjusted for credit risk. Banks and bank holding companies are required to have (1) a minimum level of total capital (as defined) to risk-weighted assets of eight percent (8%); (2) a minimum Tier One Capital (as defined) to risk-weighted assets of four percent (4%); and (3) a minimum shareholders' equity to risk-weighted assets of four percent (4%). In addition, the Federal Reserve and the FDIC have established a minimum three percent (3%) leverage ratio of Tier One Capital to total assets for the most highly-rated banks and bank holding companies. "Tier One Capital" generally consists of common equity not including unrecognized gains and losses on securities, minority interests in equity accounts of consolidated subsidiaries and certain perpetual preferred stock less certain intangibles. The Federal Reserve and the FDIC will require a bank holding company and a bank, respectively, to maintain a leverage ratio greater than three percent (3%) if either is experiencing or anticipating significant growth or is operating with less than well-diversified risks in the opinion of the Federal Reserve. The Federal Reserve and the FDIC use the leverage ratio in tandem with the risk-based ratio to assess the capital adequacy of banks and bank holding companies. The FDIC, the Office of the Comptroller of the Currency (the "OCC") and the Federal Reserve have amended, effective January 1, 1997, the capital adequacy standards to provide for the consideration of interest rate risk in the overall determination of a bank's capital ratio, requiring banks with greater interest rate risk to maintain adequate capital for the risk. The revised standards have not had a significant effect on United's capital requirements. In addition, effective December 19, 1992, a new Section 38 to the Federal Deposit Insurance Act implemented the prompt corrective action provisions that Congress enacted as a part of the Federal Deposit Insurance Corporation Improvement Act of 1991. The "prompt corrective action" provisions set forth five regulatory zones in which all banks are placed largely based on their capital positions. Regulators are permitted to take increasingly harsh action as a bank's financial condition declines. Regulators are also empowered to place in receivership or require the sale of a bank to another depository institution when a bank's capital leverage ratio reaches 2%. Better capitalized institutions are generally subject to less onerous regulation and supervision than banks with lesser amounts of capital. The FDIC has adopted regulations implementing the prompt corrective action provisions of the Federal Deposit Insurance Act, which place financial institutions in the following five categories based upon capitalization ratios: (1) a "well capitalized" institution has a total risk-based capital ratio of at least 10%, a Tier One risk-based ratio of at least 6% and a leverage ratio of at least 5%; (2) an "adequately capitalized" institution has a total risk- based capital ratio of at least 8%, a Tier One risk-based ratio of at least 4% and a leverage ratio of at least 4%; (3) an "undercapitalized" institution has a total risk-based capital ratio of under 8%, a Tier One risk-based ratio of under 4% or a leverage ratio of under 4%; (4) a "significantly undercapitalized" institution has a total risk-based capital ratio of under 6%, a Tier One risk-based ratio of under 3% or a leverage ratio of under 3%; and (5) a "critically undercapitalized" institution has a leverage ratio of 2% or less. Institutions in any of the three undercapitalized categories would be prohibited from declaring dividends or making capital distributions. The FDIC regulations also establish procedures for "downgrading" an institution to a lower capital category based on supervisory factors other than capital. As of December 31, 1999 and 1998, the most recent notifications from the FDIC categorized each of the banks as "well capitalized" under current regulations. RECENT DEVELOPMENTS. On November 12, 1999, President Clinton signed the Gramm-Leach-Bliley Act, a very significant piece of legislation intended to modernize the financial services industry. The bill repeals the anti-affiliation provisions of the 1933 Glass-Steagall Act to allow for the merger of banking and securities organizations and permits banking organizations to engage in insurance activities including insurance underwriting. The bill also allows bank holding companies to engage in financial activities that are "financial in nature or complementary to a financial activity." The act lists the expanded areas that are financial in nature and includes insurance and securities underwriting and merchant banking among others. The bill also: o prohibits non-financial entities from acquiring or establishing a thrift while grandfathering existing thrifts owned by non-financial entities. 25 o establishes state regulators as the appropriate functional regulators for insurance activities but provides that state regulators cannot "prevent or significantly interfere" with affiliations between banks and insurance firms. o contains provisions designed to protect consumer privacy. The bill requires financial institutions to disclose their policy for collecting and protecting confidential information and allows consumers to "opt out" of information sharing except with unaffiliated third parties who market the institutions' own products and services or pursuant to joint agreements between two or more financial institutions. o provides for functional regulation of a bank's securities activities by the Securities and Exchange Commission. Various portions of the bill have different effective dates, ranging from immediately to more than a year for implementation. PROPERTIES The executive offices of United are located at 63 Highway 515, Blairsville, Georgia. United owns this property. The banks conduct business from facilities primarily owned by the respective banks, all of which are in a good state of repair and appropriately designed for use as banking facilities. The banks provide services or perform operational functions at 36 locations, of which 31 locations are owned and 5 are leased. United Family Finance Co. and United Family Finance Co. of North Carolina conducts operations at four locations, all of which are leased. Note 5 to United's Consolidated Financial Statements includes additional information regarding amounts invested in premises and equipment. LEGAL PROCEEDINGS In the ordinary course of operations, United and the banks are defendants in various legal proceedings. In the opinion of management, there is no pending or threatened proceeding in which an adverse decision could result in a material adverse change in the consolidated financial condition or results of operations of United. 26 UNITED'S MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999. - ------------------------------------------------------------- INCOME SUMMARY For the three months ended March 31, 2000 United reported net income of $3.8 million, or $0.47 per diluted share, compared to $3.3 million, or $0.40 per diluted share, for the same period in 1999. The first three months' results for 2000 provided an annualized return on average assets and average shareholders' equity of 0.71% and 15.9%, respectively, compared to 0.81% and 14.0%, respectively, for the same period in 1999. Net income for the three months ended March 31, 2000 increased 16.1% compared to the same period in 1999. The following table summarizes the components of income and expense for the first three months of 2000 and 1999 and the changes in those components for the periods presented. 27 TABLE 1 - CONDENSED CONSOLIDATED STATEMENTS OF INCOME UNAUDITED (IN THOUSANDS) For the Three Months Ended March 31, Change 2000 1999 Amount Percent ---------------------------------------------------- Interest income $ 43,431 32,829 10,602 32.3% Interest expense 24,565 17,395 7,170 41.2% -------------------------------------- Net interest income 18,866 15,434 3,432 22.2% Provision for loan losses 1,546 980 566 57.8% -------------------------------------- Net interest income after provision for loan losses 17,320 14,454 2,866 19.8% Non-interest income 2,690 2,479 211 8.5% Non-interest expense 14,397 12,000 2,397 20.0% -------------------------------------- Income before taxes 5,613 4,933 680 13.8% Income tax expense 1,789 1,640 149 9.1% -------------------------------------- Net income $ 3,824 3,293 531 16.1% ====================================== Net Interest Income Net interest income is the largest source of United's operating income. Net interest income was $18.9 million for the three months ended March 31, 2000, an increase of 22% over the comparable period in 1999. The increase in net interest income for the first quarter of 2000 is primarily attributable to increases in outstanding average interest bearing assets (both loans and securities) over the comparable prior year period. The increase in average outstanding securities is primarily the result of United's leverage program that was initiated during the fourth quarter of 1998. The leverage program was designed to make optimal utilization of United's capital by using borrowed funds to purchase additional securities. The leverage borrowings are principally advances from the Federal Home Loan Bank that are secured by mortgage loans and other investment securities. The securities purchased under the leverage program are primarily mortgage-backed pass-through and other mortgage backed securities, including collateralized mortgage obligations. At March 31, 2000 United had approximately $162 million of earning assets and corresponding borrowings in the leverage program. 28 For the three months ended March 31, 2000, the net interest margin (net interest income as a percentage of average interest earning assets) on a tax-equivalent basis was 3.85%, 31 basis points less than the comparable prior year period. The compression of the margin is primarily due to continued general competitive pressures on loan and deposit pricing and the leverage program described above. Although the average prime rate for the first quarter of 2000 was 95 basis points higher than the same period in 2000, the average loan yield decreased by 12 basis points. In January 2000, United implemented a strategic initiative designed to improve key financial performance as measured by earnings per share growth, return on average assets and return on average shareholders' equity. A key component of this plan was to address the compression of the net interest margin, which declined by 62 basis points during 1999 as compared with the prior year. Excluding the impact of additional cash reserves held during the fourth quarter of 1999 as a contingency for the Year 2000, the tax-equivalent net interest margin for the first quarter of 2000 was flat compared to the prior quarter. The following table shows the relative impact of changes in average balances of interest earning assets and interest bearing liabilities, and interest rates earned (on a fully-tax equivalent basis) and paid by United on those assets and liabilities for the three month periods ended March 31, 2000 and 1999. 29 Table 2 - Average Consolidated Balance Sheets and Net Interest Analysis for the Three Months Ended March 31 Fully Tax-equivalent Basis (In Thousands) 2000 1999 ------------------------------ --------------------------------- AVERAGE INTEREST AVG. AVERAGE INTEREST AVG. BALANCE <F1> RATE BALANCE <F1> RATE ------------------------------ ------------ -------------------- Assets: Interest-earning assets: Loans, net of unearned income <F2> $ 1,444,760 34,538 9.61% 1,098,323 26,565 9.73% Taxable investments 484,182 7,849 6.52% 352,126 5,201 5.94% Tax-exempt investments 77,245 1,344 7.00% 77,256 1,376 7.16% Federal funds sold and other interest income 14,887 201 5.43% 9,798 139 5.71% --------------------- ----------- ----------- TOTAL INTEREST-EARNING ASSETS / INTEREST INCOME 2,021,074 43,932 8.74% 1,537,503 33,281 8.71% --------------------- ----------- ----------- NON-INTEREST-EARNING ASSETS: Allowance for loan losses (17,849) (13,090) Cash and due from banks 55,932 49,640 Premises and equipment 47,740 41,946 Goodwill and deposit intangibles 9,474 7,600 Other assets 38,800 29,492 ---------- ----------- TOTAL ASSETS $ 2,155,171 1,653,091 ========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits: Transaction accounts $ 342,490 3,350 3.93% 305,187 2,667 3.51% Savings deposits 75,355 545 2.91% 63,186 626 3.98% Certificates of deposit 1,063,407 15,290 5.78% 742,878 10,312 5.58% --------------------- ----------- ----------- Total interest-bearing deposits 1,481,252 19,185 5.21% 1,111,251 13,605 4.92% --------------------- ------------------------ Federal Home Loan Bank advances 289,777 4,094 5.68% 209,866 2,665 5.11% Federal funds purchased and repurchase agreements 31,404 440 5.64% 48,656 563 4.65% Long-term debt and other borrowings <F3> 40,451 846 8.41% 27,283 562 8.28% --------------------- ----------- ----------- Total borrowed funds 361,632 5,380 5.98% 285,805 3,790 5.33% --------------------- ----------- ----------- TOTAL INTEREST-BEARING LIABILITIES / INTEREST EXPENSE 1,842,884 24,565 5.36% 1,397,056 17,395 5.01% NON-INTEREST-BEARING LIABILITIES: Non-interest-bearing deposits 190,423 155,429 Other liabilities 25,166 5,231 ---------- ----------- Total liabilities 2,058,473 1,557,716 ---------- ----------- Stockholders' equity 96,698 95,375 ---------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 2,155,171 1,653,091 ========== =========== Net interest-rate spread 3.38% 3.70% Impact of non-interest bearing sources and other changes in balance sheet composition 0.47% 0.46% ------ ------ NET INTEREST INCOME / MARGIN ON INTEREST-EARNING ASSETS <F4> 19,367 3.85% 15,886 4.16% ============= ============= <FN> <F1> Interest income on tax-exempt securities and loans has been increased by 50% to reflect comparable interest on taxable securities. <F2> For computational purposes, includes non-accrual loans and mortgage loans held for sale. <F3> Includes Trust Preferred Securities. <F4> Tax equivalent net interest income as a percentage of average earning assets </FN> 30 The following table shows the relative impact on net interest income of changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by United on such assets and liabilities. Variances resulting from a combination of changes in rate AND volume are allocated in proportion to the absolute dollar amounts of the change in each category. Table 3 - Change in Interest Income and Expense On a Tax Equivalent Basis Unaudited (In Thousands) Three Months Ended March 31 2000 Compared to 1999 Increase (Decrease) in Interest Income and Expense Due to Changes In: Volume Rate Total --------- ---------- ------------- Interest-earning assets: Loans $ 8,285 (312) 7,973 Taxable investments 2,101 547 2,648 Tax-exempt investments - (32) (32) Federal funds sold and other interest income 69 (7) 62 -------- --------- ------------ TOTAL INTEREST-EARNING ASSETS 10,455 196 10,651 INTEREST-BEARING LIABILITIES: Transaction accounts 346 337 683 Savings deposits 107 (188) (81) Certificates of deposit 4,596 382 4,978 -------- --------- ------------ Total interest-bearing deposits 5,049 531 5,580 FHLB advances 1,103 326 1,429 Federal funds purchased and repurchase agreements (226) 103 (123) Long-term debt and other borrowings 275 9 284 -------- --------- ------------ Total borrowed funds 1,152 438 1,590 -------- --------- ------------ TOTAL INTEREST-BEARING LIABILITIES 6,201 969 7,170 -------- --------- ------------ INCREASE (DECREASE) IN NET INTEREST INCOME $ 4,254 (773) 3,481 ======== ========= ============ PROVISION FOR LOAN LOSS The provision for loan losses was $1.5 million, or 0.43% of average loans on an annualized basis, for the three months ended March 31, 2000, compared with $980 thousand, or 0.36% of average loans, for the same period in 1999. Net loan charge-offs for the first three months of 2000 were $346,000, or 0.10% of average loans on an annualized basis, compared to $85 thousand, or 0.03% of average loans on an annualized basis, for the same period in 1999. The provision for loan losses and allowance for loan losses reflect management's consideration of the various risks in the loan portfolio. Additional discussion of loan quality and the allowance for loan losses in provided in the ASSET QUALITY discussion section of this proxy statement. 31 Non-interest Income Non-interest income for the three months ended March 31, 2000 was $2.7 million, an increase of $193,000, or 8%, over the comparable 1999 period. Service charges on deposit accounts, which represent the largest component of non-interest income, totaled $1.5 million for the first three months of 2000, an increase of $309 thousand, or 27%, compared to the same period in 1999. This increase is primarily attributed to an increase in the number and volume of transaction deposit accounts. Mortgage banking revenue for the first three months of 2000 decreased by $228,000, or 51%, compared with the same period in 1999. This decrease is primarily attributable to increased mortgage loan interest rates and the corresponding decline in demand for mortgage refinance loans. Other non-interest income totaled $974,000 for the three months ended March 31,2000, an increase of $112,000 million, or 13%, compared to the same period in 1999. The following table summarizes the components of other non-interest income for the first three months of 2000 and 1999 and the changes in those components for the periods presented: Table 4 -Other Non-interest Income (In Thousands) For the Three Months Ended March 31, Change 2000 1999 Amount Percent ------------------------------------------------ Trust and brokerage fees 209 169 40 24% ATM fees 134 105 29 28% Bank-owned life insurance 139 96 43 45% Insurance commissions 38 - 38 n/m Credit insurance 179 223 (44) -20% Safe deposit box fees 78 57 21 37% Gain on sale of loans 9 40 (31) -78% Other 188 172 16 9% ------------------------------------ Total other non-interest income 974 862 112 13% ==================================== n/m - not meaningful The growth in trust and brokerage revenue is primarily attributable to an increase in the number of retail brokerage sale representatives and an increase in the amount of trust assets under management. The improvement in ATM fees is attributable to an increase in the number of ATM machines in service and an increase in the surcharge fee charged to non-customers implemented in February 1999. The increase in bank-owned life insurance revenue is a result of the growth of the underlying insurance policies' cash value since the first quarter of 1999 and corresponding increase in policy appreciation earnings. The increase in insurance commission revenue of $38,000 reflects commissions earned by United on sales of insurance products through its wholly-owned subsidiary, United Agencies, Inc., which actively commenced operations during the second quarter of 1999. The decrease in credit life insurance is primarily attributable to slower loan growth during the first quarter of 2000 at United's consumer finance company subsidiaries. During the first quarter of 2000 such outstanding loans declined by $996,000, compared with an increase of $1.8 million during the same period in 1999. Gains on the sale of loans recorded during the first quarter of 2000 were 78% lower than the same period in 1999. The first quarter 1999 results for this income category reflect a one-time gain of approximately $40 thousand on the sale of SBA loans. 32 Non-interest Expense For the three months ended March 31, 2000, non-interest expense totaled $14.4 million, an increase of $2.4 million, or 20%, from the same period in 1999. Salary and employee benefit expense, which represents the single largest component of non-interest expense, increased by $1.3 million, or 19%, compared with the same period in 1999. This increase is primarily attributable staff additions made to accommodate the growth of United's customer base, including staff obtained with the acquisition of Adairsville Bancshares, Inc. effective April 1, 1999; general merit increases awarded annually in April each year; and, an increase in the cost of group health insurance coverage. Occupancy and equipment expense for the first three months of 2000 totaled $2.6 million, an increase of $480,000, or 23%, over the same period in 1999. This increase is primarily attributable to the opening of new bank offices in three markets and the acquisition of Adairsville. Other non-interest expense for the three months ended March 31, 2000 was $3.7 million, an increase of 19% over the same period in 1999. This increase in primarily attributable to increases in stationery and supply expense and communications expense due to the increase in the number of bank offices and the growth of existing offices. Amortization expense for intangible assets, which is included in other non-interest expense, increase by $50,000 during the first three months of 2000 compared with the same period in 1999 as a result of purchase acquisition of Adairsville. The efficiency ratio, which is a measure of operating expenses excluding one-time expenses as a percentage of operating revenues excluding one-time gains, was 66.8% for the three months ended March 31, 2000, a three basis point improvement compared with the same period in 1999. Income Taxes Income tax expense increased by $149,000, or 9%, during the first three months of 2000 as compared to the same period in 1999. The effective tax rate (income tax expense as a percentage of pre-tax net income) for the three months ended March 31, 2000 was 31.9%, compared to 33.2% for comparable 1999 period. Investment Securities AVERAGE SECURITIES FOR THE FIRST THREE MONTHS OF 2000 WERE $561 MILLION, AN INCREASE OF $132 MILLION, OR 31%, OVER THE COMPARABLE 1999 PERIOD. AS OF MARCH 31, 2000, UNITED HAD $162 MILLION OF SECURITIES AND BORROWINGS RELATED TO THE LEVERAGE PROGRAM, COMPARED WITH $164 MILLION AT YEAR-END 1999 AND $148 MILLION AT MARCH 31, 1999. MANAGEMENT DOES NOT EXPECT TO INCREASE THE LEVEL OF SECURITIES AND RELATED BORROWINGS IN THE LEVERAGE PROGRAM DURING THE REMAINDER OF 2000. Loans United experienced annualized loan growth of 17% for the three-month period ended March 31, 2000. Total loans, net of unearned income, totaled $1.5 billion at March 31, 2000, compared to $1.4 billion at December 31, 1999. The loan growth experienced during the first three months of 2000 is attributed to continued robust economic conditions in United's market areas and corresponding strong demand for loans. Average loans for the three months ended March 31, 2000 were $1.4 billion compared to $1.1 billion for the comparable 1999 period, representing an increase of $346 million, or 32%. The average tax-equivalent yield on loans (including mortgage loans held for sale) for the three months ended March 31, 2000 was 9.61%, compared to 9.73% for the same period in 1999. This decrease is attributed to continued competitive pricing pressures for loans in the market areas where United operates. Asset Quality Non-performing assets, which include non-accrual loans, loans past-due 90 days or more and still accruing interest and other real estate owned totaled $2.9 million at March 31, 2000, compared to $2.4 million at December 31, 1999. 33 Total non-performing loans at March 31, 2000 increased by $373,000 over the year-end 1999 level. Non-performing loans at March 31, 2000 consist primarily of loans secured by real estate that are generally well secured and in the process of collection. Other real estate owned at March 31, 2000 totaled $752,000, compared to $541,000 at December 31, 1999, and comprised six properties. Management classifies loans as non-accrual when principal or interest is 90 days or more past due and the loan is not sufficiently collateralized and in the process of collection. Once a loan is classified as non-accrual, it cannot be reclassified as an accruing loan until all principal and interest payments are brought current and the prospects for future payments in accordance with the loan agreement appear relatively certain. Foreclosed properties held as other real estate owned are recorded at the lower of United's recorded investment in the loan or market value of the property less expected selling costs. The following table presents information about United's non-performing assets, including asset quality ratios. TABLE 5- NON-PERFORMING ASSETS (IN THOUSANDS) March 31, December 31, March 31, 2000 1999 1999 ------------------------------------------------------- Non-accrual loans $ 1,946 1,370 1,346 Loans past due 90 days or more and still accruing 247 450 413 ---------------------------------------------------- Total non-performing loans 2,193 1,820 1,759 Other real estate owned 752 541 809 ---------------------------------------------------- Total non-performing assets $ 2,945 2,361 2,568 ==================================================== Total non-performing loans as a percentage of total loans 0.15% 0.13% 0.15% Total non-performing assets as a percentage of total assets 0.14% 0.11% 0.14% At March 31, 2000 United had approximately $5.5 million of outstanding loans that were not included in the past-due or non-accrual categories, but for which management had knowledge that the borrowers were having financial difficulties. Although these difficulties are serious enough for management to be uncertain of the borrowers' ability to comply with the original repayment terms of the loans, no losses are anticipated at this time in connection with them based on current market conditions, cash flow generation and collateral values. These loans are subject to routine management review and are considered in determining the adequacy of the allowance for loan losses. The allowance for loan losses at March 31, 2000 totaled $18.9 million, an increase of $1.2 million, or 7%, from December 31, 1999. The ratio of allowance for loan losses to total loans at March 31, 2000 was 1.30%, compared with 1.35% at March 31, 1999 and 1.27% at December 31, 1999. At March 31, 2000 and December 31, 1999 the ratio of allowance for loan losses to total non-performing loans was 863% and 974%, respectively. The following table provides an analysis of the changes in the allowance for loan losses for the three months ended March 31, 2000 and 1999. 34 Table 6 - Summary of Loan Loss Experience (In Thousands) Three Months Ended March 31 2000 1999 -------------------------------------- Balance beginning of period $ 17,722 12,680 Provision for loan losses 1,546 980 Balance acquired from subsidary at acquisition - 1,822 Loans charged-off (533) (170) Charge-off recoveries 187 85 -------------------------------------- Net charge-offs (346) (85) -------------------------------------- Balance end of period $ 18,922 15,397 ====================================== March 31, December 31, Total loans: 2000 1999 -------------------------------------- At period end $ 1,459,469 1,400,360 Average (three months for 2000) $ 1,441,126 1,237,892 As a percentage of average loans: Net charge-offs (annualized basis for 2000) 0.10% 0.15% Provision for loan losses (annualized basis for 2000) 0.43% 0.41% Allowance as a percentage of period end loans 1.30% 1.27% Allowance as a percentage of non-performing loans 863% 974% Management believes that the allowance for loan losses at March 31, 2000 is sufficient to absorb losses inherent in the loan portfolio. This assessment is based upon the best available information and does involve a degree of uncertainty and matters of judgment. Accordingly, the adequacy of the loan loss reserve cannot be determined with precision and could be susceptible to significant change in future periods. Deposits and Borrowed Funds Total average non-interest bearing deposits for the three months ended March 31, 2000 were $190 million, an increase of $35 million, or 23%, from the same period in 1999. For the three months ended March 31, 2000, total average interest bearing deposits were $1.7 billion, an increase of $405 million, or 32%, from the comparable 1999 period. At March 31, 2000, United had $59 million of brokered certificates of deposit issued compared with $70 million at year-end 1999. Average certificates of deposit for the three months ended March 31, 2000 increased by $321million, or 43%, over the same period in 1999; brokered deposits represented $63 million, or 20%, of the total increase. Total average borrowed funds for the three months ended March 31, 2000 were $362 million, an increase of $76 million, or 27%, from the comparable 1999 period. Most of this increase is attributed to increased net borrowings from the Federal Home Loan Bank and was utilized to fund growth of the loan portfolio. At March 31, 2000, United had aggregate Federal Home Loan Bank borrowings of approximately $310 million. ASSET/LIABILITY MANAGEMENT United's financial performance is largely dependent upon its ability to manage market interest rate risk, which can be further defined as the exposure of United's net interest income to fluctuations in interest rates. Since net interest income is the largest component of United's earnings, management of interest rate risk is a top priority. United's risk management program includes a coordinated approach to managing interest rate risk and is governed by policies established by the Asset/Liability Management Committee, 35 which is comprised of members of United's senior management team. The Asset/Liability Management Committee meets regularly to evaluate the impact of market interest rates on the assets, liabilities, net interest margin, capital and liquidity of United and to determine the appropriate strategic plans to address the impact of these factors. United's balance sheet structure is primarily short-term with most assets and liabilities either repricing or maturing in five years or less. Management monitors the sensitivity of net interest income to changes in market interest rates by utilizing a dynamic simulation model. This model measures net interest income sensitivity and volatility to interest rate changes based on assumptions which management believes are reasonable. Factors considered in the simulation model include actual maturities, estimated cash flows, repricing characteristics, deposit growth and the relative sensitivity of assets and liabilities to changes in market interest rates. The simulation model considers other factors that can impact net interest income, including the mix of earning assets and liabilities, yield curve relationships, customer preferences and general market conditions. Utilizing the simulation model, management can project the impact of changes in interest rates on net interest income. At March 31, 2000, United's simulation model indicated that net interest income would increase by 3.24% if interest rates increased by 200 basis points and would decrease by 4.80% if interest rates fell by the same amount. Both of the simulation results are within the limits of United's policy, which permits an expected net interest income impact within a range of plus 10% and minus 10% for any 200 basis point increase or decrease in rates. In order to assist in achieving a desired level of interest rate sensitivity, United has entered into off-balance sheet contracts that are considered derivative financial instruments. Derivative financial instruments can be a cost and capital effective means of modifying the repricing characteristics of on-balance sheet assets and liabilities. United requires that all contract counterparties have an investment grade or better credit rating. These contracts include interest rate swap contracts in which United pays a variable rate based on Prime Rate and receives a fixed rate on a notional amount and interest rate cap contracts for which United pays an up-front premium in exchange for a variable cash flow if interest rates exceed the cap rate. United did not enter into any new derivative financial instrument contracts during the first quarter of 2000. The following table presents United's cap contracts at March 31, 2000. At that date, the cap contracts had an aggregate book value of $316 thousand. Table 7 - Cap Contracts as of March 31, 2000 (In Thousands) NOTIONAL CONTRACT CONTRACT FAIR Maturity Amount Index Rate Value ----------------------------------------------------------------------------- August 31, 2001 5,000 Prime 10.00% 10 August 27, 2001 20,000 Prime 10.00% 49 September 18, 2003 10,000 3 Month LIBOR 5.50% 511 January 4, 2004 10,000 Prime 7.75% 543 ----------- ------- Total 45,000 1,113 =========== ======= The following table presents United's swap contracts as of March 31, 2000. 36 TABLE 8 - SWAP CONTRACTS AS OF MARCH 31, 2000 (IN THOUSANDS) NOTIONAL RATE RATE FAIR Maturity Amount Received Paid Value ----------------------------------------------------------------------- April 2, 2001 15,000 8.41% 9.00% (197) April 5, 2001 10,000 9.50% 9.00% (28) May 8, 2001 10,000 8.26% 9.00% (155) June 7, 2001 10,000 8.69% 9.00% (132) July 27, 2001 10,000 8.85% 9.00% (80) October 12, 2001 10,000 9.11% 9.00% (120) June 7, 2002 10,000 9.05% 9.00% (119) June 14, 2002 10,000 9.12% 9.00% (107) June 24, 2002 20,000 8.80% 9.00% (442) July 29, 2002 25,000 9.04% 9.00% (316) August 10, 2002 10,000 9.60% 9.00% (104) December 23, 2002 10,000 9.19% 9.00% (231) ------------------------------------------------- Total/weighted average 150,000 8.95% 9.00% (2,031) ================================================= Effective January 1, 1999, United adopted Statement of Financial Accounting Standards No. 133 ("Accounting for Derivative Instruments and Hedging Activities"), that requires that all derivative financial instruments be included and recorded at fair value on the balance sheet. Currently, all of United's derivative financial instruments are classified as highly effective fair value hedges. Fair value hedges recognize currently in earnings both the impact of the change in the fair value of the derivative financial instrument and the offsetting impact of the change in fair value of the hedged asset or liability. At March 31, 2000, United's derivative financial instruments had an aggregate negative fair market value of $918,000. . United requires all derivative financial instruments be used only for asset/liability management or hedging specific transactions or positions, and not for trading or speculative purposes. Management believes that the risk associated with using derivative financial instruments to mitigate interest rate sensitivity is minimal and should not have any material unintended impact on United's financial condition or results of operations. Capital Resources and Liquidity The following table shows United's capital ratios, as calculated under regulatory guidelines, compared to the regulatory minimum capital ratio and the regulatory minimum capital ratio needed to qualify as a "well-capitalized" institution at March 31, 2000 and December 31, 1999: 37 Table 9 - Capital Ratios March 31, December 31, 2000 1999 ------------------------------------ Leverage ratio 5.61% 5.52% Regulatory minimum 3.00% 3.00% Well-capitalized minimum 5.00% 5.00% Tier I risk-based capital 8.54% 8.44% Regulatory minimum 3.00% 3.00% Well-capitalized minimum 6.00% 6.00% Total risk-based capital 10.04% 9.95% Regulatory minimum 8.00% 8.00% Well-capitalized minimum 10.00% 10.00% Management believes that it is in the best interests of United's shareholders to make optimal use of United's capital by maintaining capital levels that meet the regulatory requirements for "well-capitalized" status but do not result in a significant level of excess capital that is not utilized. In consideration of the asset growth experienced during the past year and expected continued growth during the year 2000, management recommended to United's board of directors in January 2000 that additional capital be raised through the sale of common stock. The Board subsequently approved a public offering of between 350,000 and 450,000 shares at a price of $38.00 per share, which will provide between $13.2 million and $17.0 million of additional capital, net of estimated offering expenses. Management expects to use the net proceeds of the offering, which is expected to be completed during the second quarter of 2000, to inject additional capital into United's subsidiary banks and for other corporate purposes. United is currently paying dividends on a quarterly basis and expects to continue making such distributions in the future if results from operations and capital levels are sufficient. The following table presents the cash dividends declared in the first quarter of 2000 and 1999 and the respective payout ratios as a percentage of net income. Table 10 - Dividend Payout Information 2000 1999 -------------------------- ------------------------ Dividend Payout % Dividend Payout % -------------------------- ------------------------- First quarter $ 0.075 15.6% $ 0.05 12.2% Liquidity measures the ability to meet current and future cash flow needs as they become due. Maintaining an adequate level of liquid funds, at the most economical cost, is an important component of United's asset and liability management program. United has several sources of available funding to provide the required level of liquidity. United, like most banking organizations, relies primarily upon cash inflows from financing activities (deposit gathering, short-term borrowing and issuance of long-term debt) in order to fund its investing activities (loan origination and securities purchases). The financing activity cash inflows such as loan payments and securities sales and prepayments are also a significant component of liquidity. COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999, 1998, AND 1997. 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. All of United's activities are currently conducted by its wholly-owned subsidiaries, which include the following eight banking institutions: 38 BANK NAME YEAR ACQUIRED # OF OFFICES --------- ------------- ------------ United Community Bank 1988<F1> 7 Carolina Community Bank 1990 14 Peoples Bank of Fannin County 1992 4 Towns County Bank 1992 1 White County Bank 1995 2 First Clayton Bank and Trust 1997 1 Bank of Adairsville 1999 2 1st Floyd Bank 1999 3 - -------------- <FN> <F1> Organized as a Georgia banking corporation in 1950. </FN> United's wholly-owned subsidiaries also include two consumer finance companies, collectively United Family Finance Co. and United Family Finance Co. of North Carolina, as previously defined. United Family Finance Co. and United Family Finance Co. of North Carolina operates four consumer finance offices located in Blue Ridge and Hiawassee, Georgia, and Murphy and Franklin, North Carolina. In addition, United owns an insurance agency, United Agencies, Inc.. At December 31, 1999, United had total consolidated assets of $2.1 billion, total loans of $1.4 billion, total deposits of $1.6 billion and shareholders' equity of $96 million. United's net income for 1999 was $13.6 million, an increase of $875 million, or 6.9%, from 1998. Diluted earnings per common share increased to $1.66 in 1999, from $1.57 in 1998. The following discussion is intended to provide insight into the financial condition and results of operations of United and should be read in conjunction with the consolidated financial statements and accompanying notes. RECENT DEVELOPMENTS - PENDING MERGERS AND ACQUISITIONS On March 3, 2000, United entered into a definitive agreement to acquire North Point Bancshares, Inc. of Dawsonville, Georgia for 958,211 shares of common stock in a transaction that will be accounted for as a pooling of interests. As of December 31, 1999, North Point Bancshares, Inc. had approximately $107 million of total assets, $97 million of total liabilities and $10 million of total equity. The assets included approximately $29 million of investment securities and $62 million of loans, net of allowance for loan losses. Total liabilities included approximately $97 million of deposits, of which $18 million were non-interest bearing demand deposits and $79 million were interest bearing deposits. On March 3, 2000, United entered into a definitive agreement to acquire Independent Bancshares, Inc. of Powder Springs, Georgia for 870,595 shares of common stock in a transaction that will be accounted for as a pooling of interests. As of December 31, 1999, Independent Bancshares, Inc. had approximately $145 million of total assets, $132 million of total liabilities and $13 million of total equity. The assets included approximately $26 million of investment securities and $100 million of loans, net of allowance for loan losses. Total liabilities included approximately $123 million of deposits, of which $17 million were non-interest bearing demand deposits and $106 million were interest bearing deposits. EXPANSIONS AND MERGERS SINCE DECEMBER 31, 1998 On August 27, 1999 United completed its merger with 1st Floyd Bank of Rome, Georgia, in a tax-free stock exchange. United issued 632,890 shares of common stock in the transaction and recorded merger-related expenses totaling $1.2 million, net of tax. This merger was accounted for as a pooling of interests, and all of the financial statements and ratios contained in this proxy statement have been restated to include the results of 1st Floyd Bank for all periods presented. 39 On March 31, 1999, United completed its acquisition of Bank of Adairsville of Adairsville, Georgia. Effective April 1, 1999 the results of operations for Bank of Adairsville were included in United's consolidated statements of income. This acquisition was accounted for as a purchase, for which United recorded a goodwill asset in the amount of approximately $3 million, which is being recognized through charges to expense over a term of 15 years beginning in April, 1999. Two new branch offices of the banks were opened for business during 1999. United Community Bank opened a new office in Murrayville, Georgia, which is operated under the trade name of United Community Bank of Hall County. Carolina Community Bank opened a second office in Brevard, North Carolina. EXPANSIONS PRIOR TO DECEMBER 31, 1998 Effective January 30, 1998, Peoples Bank of Fannin County assumed deposits totaling $23.4 million and purchased certain assets totaling $3.7 million of a branch bank located in Ellijay, Georgia. This office is now operated under the trade name of United Community Bank of Gilmer County. Effective September 12, 1997, United completed the acquisition of First Clayton Bank and Trust in Clayton, Georgia. United issued 646,257 shares of common stock in connection with this merger, which was accounted for as a pooling of interests. United also expanded its market area during 1998 and 1997 through de novo branching. Carolina Community Bank opened de novo branch offices in the western North Carolina cities of Etowah and Cherokee during 1998 and Brevard during 1997. United Community Bank opened a de novo branch office in Clarkesville, Georgia during 1998 that is operated under the trade name of First Bank of Habersham. INCOME STATEMENT REVIEW Net income was $13.6 million in 1999, an increase of 6.9% from the $12.8 million earned in 1998. Diluted earnings per common share were $1.66 for 1999, compared with $1.57 reported for 1998, an increase of 5.7%. Return on average assets and return on average equity for 1999 were .72% and 14.33%, respectively, compared with .94% and 14.84%, respectively, for 1998. The reported net income for 1999 includes after-tax charges of $1.2 million related to the merger with 1st Floyd Bank. Excluding these non-recurring items, net income for 1999 was $14.8 million, an increase of 15.9% over 1998. Diluted earnings per share for 1999, excluding merger-related charges, were $1.80, an increase of 14.5% over 1998. Return on average assets and return on average equity for 1999, exclusive of merger-related charges, were .78% and 15.54%, respectively. The following table summarizes the components of income and expense and the changes in those components for the past three years. 40 Table 1 - Condensed Consolidated Statements of Income For the years ended December 31 (In thousands) Change Change 1999 Amount % 1998 Amount % 1997 Interest income $ 149,740 33,526 28.8% 116,214 22,026 23.4% 94,188 Interest expense 81,766 21,762 36.3% 60,004 11,534 23.8% 48,470 ---------------------------- -------------------------- -------------- Net interest income 67,974 11,764 20.9% 56,210 10,492 22.9% 45,718 Provision for loan losses 5,104 2,492 95.4% 2,612 (202) -7.2% 2,814 ---------------------------- -------------------------- -------------- Net interest income after provision for loan losses 62,870 9,272 17.3% 53,598 10,694 24.9% 42,904 Non-interest income 10,836 1,707 18.7% 9,129 1,929 26.8% 7,200 Non-interest expense 54,165 10,201 23.2% 43,964 9,901 29.1% 34,063 ---------------------------- -------------------------- -------------- Income before income taxes 19,541 778 4.1% 18,763 2,722 17.0% 16,041 Income tax expense 5,893 (97) -1.6% 5,990 1,003 20.1% 4,987 ---------------------------- -------------------------- -------------- Net income $ 13,648 875 6.9% 12,773 1,719 15.6% 11,054 ============================ ========================== ============== The individual components of income and expense are discussed in further detail below. NET INTEREST INCOME Net interest income (the difference between the interest earned on assets and the interest paid on deposits and liabilities) is the single largest component of United's operating income. United actively manages this income source to provide an optimal level of income while balancing interest rate, credit and liquidity risks. Net interest income totaled $68.0 million in 1999, an increase of $11.8 million, or 21%, from the level recorded in 1998. Net interest income for 1998 increased $10.5 million, or 23%, over the 1997 level. On a fully tax-equivalent basis, net interest income was $70.0 million in 1999, compared with $57.9 million in 1998 and $47.0 million in 1997. In 1999, average interest earning assets increased $503 million, or 40%, over the 1998 amount. This increase was primarily due to the increased volume of loans and to increased securities acquired as part of United's leverage program. Average loans outstanding for 1999 were $1.2 billion, compared with $956 million in 1998. Average interest bearing liabilities for 1999 increased $488 million, or 43%, over the 1998 average balance. This increase was primarily due to an increase in the level of average interest bearing deposits of $256 million, or 25%, and an increase in borrowed funds of $232 million, or 204%. Approximately $150 million of the increased in average borrowed funds were in conjunction with United's leverage program, which is explained in detail in the Investment Securities section of this discussion. The majority of new borrowings were fixed and floating rate advances from the Federal Home Loan Bank (FHLB) that were at a funding cost competitive with the banks' current certificate of deposit rates. Additional information regarding the FHLB advances is provided in note 7 of the consolidated financial statements. The banking industry uses two key ratios to measure relative profitability of net interest income. The net interest rate spread measures the difference between the average yield on 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 income as a percent of average total earning assets and takes into account the positive impact of investing non-interest bearing deposits. United's net interest spread was 3.55% in 1999, 4.04% in 1998 and 4.05% in 1997, while the net interest margin (on a tax-equivalent basis) was 3.98% in 1999, 4.60% in 1998 and 4.66% in 1997. The 62 basis point decrease in the net interest margin from 1998 to 1999 is primarily attributed to the following: the narrower spread on the assets and associated liabilities in the leverage program; the increased reliance on borrowed funds; increased competitive pricing pressure on loans and deposits; increased cash balance held for Year 2000 contingency and the impact of bank-owned life insurance revenue recorded as non-interest income. 41 The average cost of interest bearing liabilities for 1999 was 5.07%, a decrease of 27 basis points from 1998. Core deposits, which include transaction accounts, savings accounts and non-brokered certificates of deposit less than $100,000, represented approximately 77% of total deposits in 1999, a decrease from 82% in 1998. The following table shows, for the past three years, the relationship between interest income and expense and the average balances of interest earning assets and interest bearing liabilities. Table 2 - Average Consolidated Balance Sheets and Net Interest Analysis For the Years Ended December 31 Fully tax-equivalent basis (in thousands) 1999 1998 1997 ------------------------- --------------------------- -------------------------- Average Interest Avg. Average Interest Avg. Average Interest Avg. Balance <F1> Rate Balance <F1> Rate Balance <F1> Rate ------------------------- --------------------------- -------------------------- Assets: Interest-earning assets: Loans, net of unearned income <F2> $21,242,418 119,669 9.63% 961,763 99,126 10.31% 777,583 80,675 10.38% Taxable investments 417,602 25,285 6.05% 200,457 12,264 6.12% 156,784 9,609 6.13% Tax-exempt investments 80,949 5,795 7.16% 67,067 4,879 7.27% 44,326 3,514 7.93% Federal funds sold and other interest income 19,769 1,050 5.31% 28,272 1,644 5.81% 31,077 1,723 5.54% ------------------- -------------------- ------------------- Total interest-earning assets / interest income 1,760,738 151,799 8.62% 1,257,559 117,913 9.38% 1,009,770 95,521 9.46% ------------------- -------------------- ------------------- Non-interest-earning assets: Allowance for loan losses (15,341) (11,805) (9,854) Cash and due from banks 63,452 45,176 30,662 Premises and equipment 45,382 35,331 24,832 Other assets 41,958 29,042 22,568 --------- ----------- ---------- Total assets $ 1,896,189 1,355,303 1,077,978 ========= =========== ========== Liabilities and Stockholders' Equity Interest-bearing liabilities: Interest-bearing deposits: Transaction accounts $ 323,180 12,237 3.79% 254,016 10,200 4.02% 188,997 7,230 3.83% Savings deposits 70,761 2,008 2.84% 54,248 1,520 2.80% 45,063 1,238 2.75% Certificates of deposit 872,077 48,414 5.55% 701,722 41,423 5.90% 604,989 36,309 6.00% -------------------- -------------------- ------------------- Total interest-bearing deposit 1,266,018 62,659 4.95% 1,009,986 53,143 5.26% 839,049 44,777 5.34% -------------------- -------------------- ------------------- Federal Home Loan Bank advances 249,755 13,096 5.24% 90,834 5,010 5.52% 39,615 2,382 6.01% Long-term debt and other borrowings <F3> 95,866 6,011 6.27% 22,922 1,851 8.08% 17,697 1,311 7.41% -------------------- -------------------- ------------------- Total borrowed funds 345,621 19,107 5.53% 113,756 6,861 6.03% 57,312 3,693 6.44% -------------------- -------------------- ------------------- Total interest-bearing liabilities / interest expense 1,611,639 81,766 5.07% 1,123,742 60,004 5.34% 896,361 48,470 5.41% Non-interest-bearing liabilities: Non-interest-bearing deposits 181,843 135,439 100,593 Other liabilities 7,454 10,040 9,903 --------- ----------- ---------- Total liabilities 1,800,936 1,269,221 1,006,857 --------- ----------- ---------- Stockholders' equity 95,253 86,082 71,121 --------- ----------- ---------- Total liabilities and stockholders' equity $ 1,896,189 1,355,303 1,077,978 ========= =========== ========== Net interest-rate spread 3.55% 4.04% 4.05% Impact of non-interest bearing sources and other changes in balance sheet composition 0.43% 0.56% 0.61% ------ ------- ------- Net interest income / margin on interest-earning assets <F4> 70,033 3.98% 57,909 4.60% 47,051 4.66% ================ ================ ================ <FN> <F1> Interest income on tax-exempt securities and loans has been increased by 50% to reflect comparable interest on taxable securities. <F2> For computational purposes, includes non-accrual loans and mortgage loans held for sale. <F3> Includes Trust Preferred Securities. <F4> Tax equivalent net interest income as a percentage of average earning assets </FN> 42 The following table shows the relative impact on net interest income of changes in the average outstanding balances (volume) of earning assets and interest bearing liabilities and the rates earned and paid by United on such assets and liabilities. Variances resulting from a combination of changes in rate AND volume are allocated in proportion to the absolute dollar amounts of the change in each category. Table 3 - Change in Interest Income and Expense on a Tax Equivalent Basis (in thousands) 1999 Compared to 1998 1998 Compared to 1997 Increase (decrease) Increase (decrease) in interest income and expense in interest income and expense due to changes in: due to changes in: Volume Rate Total Volume Rate Total ------------------------------------- ------------------------------------- Interest-earning assets: Loans $ 27,380 (6,837) 20,543 19,109 (658) 18,451 Taxable investments 13,149 (128) 13,021 2,677 (22) 2,655 Tax-exempt investments 995 (79) 916 1,803 (438) 1,365 Federal funds sold and other interest income (461) (133) (594) (156) 77 (79) ------------------------------------- ------------------------------------- Total interest-earning assets 41,063 (7,177) 33,886 23,433 (1,041) 22,392 Interest-bearing liabilities: Transaction accounts 2,646 (609) 2,037 2,487 483 2,970 Savings deposits 468 20 488 252 30 282 Certificates of deposit 9,575 (2,584) 6,991 5,806 (692) 5,114 ------------------------------------- ------------------------------------- Total interest-bearing deposits 12,689 (3,173) 9,516 8,545 (179) 8,366 FHLB advances 8,345 (259) 8,086 3,080 (452) 2,628 Long-term debt and other borrowings 4,660 (500) 4,160 387 153 540 ------------------------------------- ------------------------------------- Total borrowed funds 13,005 (759) 12,246 3,467 (299) 3,168 ------------------------------------- ------------------------------------- Total interest-bearing liabilities 25,694 (3,932) 21,762 12,012 (478) 11,534 ------------------------------------- ------------------------------------- Increase (decrease) in net interest income $ 15,369 (3,245) 12,124 11,421 (563) 10,858 ===================================== ===================================== PROVISION FOR LOAN LOSSES The provision for loan losses in 1999 was $5.1 million, compared with $2.6 million in 1998 and $2.8 million in 1997. As a percentage of average outstanding loans, the provisions recorded for 1999, 1998 and 1997 were .41%, .27% and .36%, respectively. Net loan charge-offs as a percentage of average outstanding loans for 1999 were .15%, compared with .10% for 1998 and .05% for 1997. The increase in the provision for loan loss in 1999 is primarily attributed to growth in the loan portfolio and the increased level of net charge-offs. The provision for loan losses is based on management's evaluation of inherent risks in the loan portfolio and the corresponding analysis of the allowance for loan losses. Additional discussion on loan quality and the allowance for loan losses is included in the ASSET QUALITY section of this proxy statement. NON-INTEREST INCOME Total non-interest income for 1999 was $10.8 million, compared with $9.1 million in 1998 and $7.2 million in 1997. The following table presents the components of non-interest income for 1999, 1998 and 1997. 43 Table 4 - Non-interest Income (in thousands) ------------------------------------------------------------------ Years Ended December 31, ------------------------------------------------------------------ 1999 % Change 1998 % Change 1997 - -------------------------------------------------------------------------------------------------------------------- Service charges on deposit accounts $ 5,161 22% 4,227 15% 3,681 Mortgage loan and related fees 1,638 -10% 1,822 57% 1,157 ATM fees 539 69% 319 40% 228 Insurance commissions 1,027 53% 672 159% 259 Trust and brokerage revenue 622 46% 427 132% 184 Gains (losses) on securities sales, net 543 -32% 804 9% 737 Safe deposit box rental 219 26% 174 16% 150 Bank-owned life insurance 395 n/m - n/m - Other 692 1% 684 -15% 804 ------------------------------------------------------------------ Total $ 10,836 19% 9,129 27% 7,200 ================================================================== The primary source of non-interest income for United is service charges and fees on deposit accounts held by the banks. Total deposit service charges and fees for 1999 were $5.2 million, or 48% of total non-interest income, compared with $4.2 million, or 46% of total non-interest income in 1998. The growth of deposit service charge and fee revenue for 1999 and 1998 was primarily due to the increase in the number of deposit accounts. Net gains on the sale of securities totaled $543,000 for 1999, compared with $804,000 for 1998 and $737 in 1997. The gains in 1999 were primarily related to the sale of an equity security. Securities gains recognized during 1998 and 1997 gains were primarily the result of a general decline in interest rates coupled with management's decision to shift a portion of the balance of the securities portfolios of the banks to higher yielding mortgage securities. Mortgage loan and related fees for 1999 were $1.6 million, a decrease of 10% compared with 1998. This decrease was primarily due to the higher interest rate environment during 1999 that reduced the market for mortgage refinance loans. Substantially all of the mortgage loan and related fees recorded during 1999 were received as the result of originating approximately $129 million of residential mortgages that were subsequently sold into the secondary market. These loans were all sold with the right to service the loans (the servicing asset) released to the purchaser for a fee. The decrease in mortgage loan and related fees for 1999 was offset by the effect of recognizing $72,000 less in amortization of mortgage servicing rights in 1999 compared with 1998. This reduction of amortization was in response to decreased prepayment levels within the serviced loan portfolio due to higher mortgage market interest rates. Trust and brokerage revenue for 1999 was $622,000, an increase of 46% compared with 1998. This increase is primarily attributed to management's continued focus on personal trust business opportunities within the current customer base of the banks. Insurance commissions increased $355,000, or 53%, compared with 1998. This increase is primarily attributed to loan growth-related increased credit life sales at United Family Finance Co. and United Family Finance Co. of North Carolina of $198,000 and increased commission revenue for United Agencies, Inc. of $96,000. The revenue increase at United Agencies, Inc. resulted from a one-time commission on the sale of bank-owned life insurance policies to the banks. Non-interest income for 1999 also included $395,000 of revenue related to the increase in value of $8.1 million of bank-owned life insurance contracts purchased by United in December 1998. NON-INTEREST EXPENSE Total non-interest expense for 1999 was $54.2 million, compared with $43.9 million in 1998 and $34.1 million in 1997. Non-interest expense for 1999 includes $1.8 million of charges related to the merger with 1st Floyd Bank, 44 primarily for employee contractual obligations, write-off of obsolete equipment and professional fees. The following table presents the components of non-interest expense for the years ended December 31, 1999, 1998 and 1997. Table 5 - Non-interest Expense (in thousands) ------------------------------------------------------------- Years Ended December 31, ------------------------------------------------------------- 1999 % Change 1998 % Change 1997 - -------------------------------------------------------------------------------------------------------- Salaries $ 23,571 21% 19,435 29% 15,053 Employee benefits 6,113 19% 5,125 33% 3,861 Occupancy 3,193 17% 2,719 30% 2,086 Furniture and equipment 4,439 41% 3,158 46% 2,169 Communications 1,526 29% 1,180 63% 725 Advertising and public relations 2,331 6% 2,207 2% 2,158 Postage, printing and supplies 2,710 14% 2,372 33% 1,787 Professional fees 1,467 2% 1,432 29% 1,110 Amortization of intangibles 710 39% 509 23% 414 Other expense 6,260 7% 5,827 24% 4,700 ------------------------------------------------------------- 52,320 19% 43,964 29% 34,063 Merger-related expenses 1,845 - - ------------ ------------- ------------ Total non-interest expense $ 54,165 23% 43,964 29% 34,063 ============ ============= ============ Total salaries and benefits for 1999, excluding merger-related expenses, increased by 21% over the 1998 level. This increase was primarily due to staff additions for new branch bank offices, staffing increases at existing branches that experienced growth, and the addition of several senior management positions at the holding company during the second half of 1998 and 1999. United had 778 full-time equivalent employees at December 31, 1999, compared with 687 at year-end 1998. Total occupancy expense for 1999 increased by 17% compared with 1998. This increase is primarily attributed to the opening of new branch bank offices located in the primary market areas of United during the second half of 1998 and 1999 and the acquisition of Bank of Adairsville. Total furniture and equipment expense for 1999, excluding merger-related expenses, increased by 41% compared with 1998. This increase is primarily attributed to the depreciation expense for the wide area computer network, the acquisition of Bank of Adairsville and expense associated with the operation of new branch bank offices. Communications expense, which includes data circuit costs, local phone service, long-distance service and cellular service increased by 29% during 1999 and 63% during 1998. These increases were both primarily due to the new facilities opened since 1997 and new expenses associated with installation and maintenance of frame-relay data circuits that are the communications backbone for United's wide-area computer network. Postage, printing and supply expense for 1999 increased by 14% compared with 1998. This increase is a direct result of increases in the number of deposit, loan and trust customers during the year. Amortization of intangible assets in 1999 increased 39% compared with 1998. This increase is attributed to the amortization of the goodwill asset related to the acquisition of Bank of Adairsville in March 1999. Additional information regarding United's accounting policy for goodwill and deposit-based intangible assets is included in the notes to the consolidated financial statements. 45 The efficiency ratio measures a bank's total operating expenses as a percentage of net interest income (before provision for loan losses) and non-interest income, excluding net gains or losses on the sale of securities and merger-related expenses. United's efficiency ratio for 1999 was 66.9%, compared with 68.1% in 1998 and 65.2% in 1997. During 1999 United recognized $1.8 million of expenses related to the merger with 1st Floyd Bank. These charges consisted of compensation expense ($692,000); equipment write-offs ($424,000); professional fees ($522,000) and, other expense ($207,000). At December 31, 1999, $455,000 of the total $1.8 million merger charge was recorded as an accrued liability. INCOME TAXES United had income tax expense of $5.9 million in 1999, compared with $6.0 million in 1998 and $5.0 million in 1997. United's effective tax rates (tax expense expressed as a percentage of pre-tax net income) for 1999, 1998 and 1997 were 30.2%, 31.9% and 31.1%, respectively. These effective rates are lower than the statutory Federal tax rate primarily because of interest income on certain investment securities and loans that is exempt from income taxes. Additional information regarding United's income taxes can be found in note 11 to the consolidated financial statements. BALANCE SHEET REVIEW Total assets at December 31, 1999 were $2.1 billion, an increase of $541 million, or 34%, from December 31, 1998. On an average basis, total assets increased $541 million, or 40%, from 1998 to 1999. Average interest earning assets for 1999 were $1.8 billion, compared with $1.3 million for 1998, an increase of 40%. LOANS Total loans averaged $1.2 billion in 1999, compared with $956 million in 1998, an increase of 29%. At December 31, 1999, total loans were $1.4 billion, an increase of $339 million, or 32%, from December 31, 1998. Over the past five years, United has experienced strong loan growth in all markets, with particular strength in loans secured by real estate, both residential and non-residential. The following table presents a summary of the loan portfolio by category over that period. Table 6 - Loans Outstanding (in thousands) December 31, 1999 1998 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------------------- Commercial $ 125,245 109,647 119,262 110,402 68,427 Real estate - construction 161,774 121,900 83,528 55,045 31,663 Real estate - mortgage 969,385 694,561 545,556 390,294 300,666 Consumer 143,956 135,057 124,153 106,504 88,504 -------------------------------------------------------------------------- Total loans $ 1,400,360 1,061,165 872,499 662,245 489,260 ========================================================================== As a percentage of total loans: Commercial 8.9% 10.3% 13.7% 16.7% 14.0% Real estate - construction 11.6% 11.5% 9.6% 8.3% 6.5% Real estate - mortgage 69.2% 65.5% 62.5% 58.9% 61.4% Consumer 10.3% 12.7% 14.2% 16.1% 18.1% -------------------------------------------------------------------------- Total 100.0% 100.0% 100.0% 100.0% 100.0% ========================================================================== Substantially all of United's loans are to customers located in Georgia and North Carolina, in the immediate market areas of the banks. This includes loan customers who have a seasonal residence in the banks' market areas. The following table indicates United's loans by specific collateral type or loan purpose as of December 31, 1999: 46 Table 7 - Loans by Collateral Type or Purpose (in thousands) Percent of Total Loans ------------ Secured by real estate: Residential first liens $ 506,729 36.1% Residential second liens 27,177 1.9% Home equity lines of credit 53,191 3.8% Construction and land development 161,774 11.6% Non-farm, non-residential 355,269 25.4% Farmland 16,173 1.2% Multi-family residential 10,846 0.8% --------------- ------------ Total real estate 1,131,159 80.8% --------------- ------------ Other loans: Commercial and industrial 105,221 7.5% Agricultural production 9,923 0.7% States and municpalities 10,101 0.7% Consumer installment loans 136,983 9.8% Credit cards and other revolving credit 6,973 0.5% --------------- ------------ Total other loans 269,201 19.2% --------------- ------------ Total loans $ 1,400,360 100.0% =============== ============ As of December 31, 1999, United's 20 largest credit relationships consisted of loans and loan commitments ranging from $2.4 to $10.0 million, with an aggregate total credit exposure of $77 million. All of these credits have been underwritten in a prudent manner and structured in order to minimize United's potential exposure to loss. The following table sets forth the maturity distribution of real estate construction and commercial loans, including the interest rate sensitivity for loans maturing in greater than one year, as of December 31, 1999. United's loan policy does not permit automatic roll-over of matured loans. Table 8 - Loan Portfolio Maturity (in thousands) Rate Structure for Loans Maturity Maturing Over One Year ------------------------------------------------------------------------- One Year One through Over Five Fixed Floating or Less Five Years Years Total Rate Rate - ---------------------------------------------------------------------------------------------------------- Commercial $ 61,266 42,493 21,486 125,245 57,214 6,765 Real estate - construction 130,607 31,167 - 161,774 7,581 23,586 ------------------------------------------------------------------------- Total $ 191,873 73,660 21,486 287,019 64,795 30,351 ========================================================================= ASSET QUALITY AND RISK ELEMENTS United manages asset quality and controls credit risk through diversification of the loan portfolio and the application of policies designed to promote sound underwriting and loan monitoring practices. United's loan administration function is charged with monitoring asset quality, establishing credit policies and procedures and enforcing the consistent application of these policies and procedures at all of the banks. The provision for loan losses is the annual cost of providing an adequate allowance for anticipated potential future losses on loans. The amount each year is dependent upon many factors including loan growth, net charge-offs, changes in the composition of the loan portfolio, delinquencies, management's 47 assessment of loan portfolio quality, the value of collateral, and economic factors and trends. The evaluation of these factors is performed by United's credit administration department through an analysis of the adequacy of the allowance for loan losses. Reviews of non-performing, past due loans and larger credits, designed to identify potential charges to the allowance for loan losses, as well as determine the adequacy of the allowance, are conducted on a regular basis during the year. These reviews are performed by the responsible lending officers, as well as a separate loan review department, and consider such factors as the financial strength of borrowers, the value of the applicable collateral, past loan loss experience, anticipated loan losses, growth in the loan portfolio, prevailing and anticipated economic conditions and other factors. United does not currently allocate the allowance for loan losses to the various loan categories and there were no significant changes in the estimation methods and assumptions used to determine the adequacy of the allowance for loan losses during 1999. The following table presents a summary of changes in the allowance for loan losses for each of the past five years. Table 9 Years Ended December 31, 1999 1998 1997 1996 1995 - ---------------------------------------------------------------------------------------------------------- Balance beginning of period $ 12,680 10,989 8,536 5,316 4,415 Provision for loan losses 5,104 2,612 2,814 1,751 1,128 Allowance for loan losses acquired from subsidiary at acquisition date 1,822 - - 1,813 - Amounts charged-off: Commercial 357 460 73 329 148 Real estate - construction 4 - - - 24 Real estate - residential mortgage 556 233 99 13 337 Consumer 1,936 770 658 361 205 ------------------------------------------------------ Total loans charged-off 2,853 1,463 830 703 714 ------------------------------------------------------ Recoveries of charged-off loans: Commercial 167 287 22 251 187 Real estate - construction 5 - - - - Real estate - residential mortgage 323 36 296 49 188 Consumer 474 219 151 59 112 ------------------------------------------------------ Total recoveries 969 542 469 359 487 ------------------------------------------------------ Net charge-offs 1,884 921 361 344 227 ------------------------------------------------------ Balance end of period $ 17,722 12,680 10,989 8,536 5,316 ====================================================== Total loans: At year-end $ 1,400,360 1,061,165 872,499 662,245 489,260 Average $ 1,237,892 956,452 773,245 567,456 434,682 As a percentage of average loans: Net charge-offs 0.15% 0.10% 0.05% 0.06% 0.05% Provision for loan losses 0.41% 0.27% 0.36% 0.31% 0.26% Allowance as a percentage of year-end loans 1.27% 1.19% 1.26% 1.29% 1.09% Allowance as a percentage of non-performing loans 974% 1174% 964% 527% 220% Management believes that the allowance for loan losses at December 31, 1999 is sufficient to absorb losses inherent in the loan portfolio as of that date based on the best information available, including the credit risks related to the Year 2000 issue described in detail later in this discussion. This assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examination of the banks, may require additional charges to the provision for loan losses in future periods if the results of their review warrant. 48 Additional information on the process United uses to determine the adequacy of the allowance for loan losses is provided in Part I, Item I of this proxy statement under the heading Loan Review and Non-performing Assets. NON-PERFORMING ASSETS Non-performing loans, which included non-accrual loans and accruing loans past due over 90 days, totaled $1.8 million at year-end 1999, compared with $1.1 million at December 31, 1998. At December 31, 1999, the ratio of non-performing loans to total loans was .13%, compared with .10% at year-end 1998. Non-performing assets, which include non-performing loans and foreclosed real estate, totaled $2.4 million at December 31, 1999, compared with $1.5 million at year-end 1998. It is the general policy of the banks to place loans on non-accrual status when, in the opinion of management, the principal and interest on a loan is not likely to be repaid in accordance with the loan terms. When a loan is placed on non-accrual status, interest previously accrued but not collected is reversed against current interest income. Depending on management's evaluation of the borrower and loan collateral, interest on a non-accrual loan may be recognized on a cash basis as payments are received. Loans made by the banks to facilitate the sale of other real estate are made on terms comparable to loans of similar risk. There were no commitments to lend additional funds to loan customers with loans on non-accrual status at December 31, 1999. The table below summarizes United's non-performing assets for each of the last five years. Table 10 - Non-Performing Assets (in thousands) December 31, 1999 1998 1997 1996 1995 - --------------------------------------------------------------------------------------------------------------- Non-accrual loans $ 1,370 612 601 992 2,018 Loans past due 90 days or more and still accruing 450 468 539 628 402 -------------------------------------------------------------- Total non-performing loans 1,820 1,080 1,140 1,620 2,420 Other real estate owned 541 424 386 210 65 -------------------------------------------------------------- Total non-performing assets $ 2,361 1,504 1,526 1,830 2,485 ============================================================== Total non-performing loans as a percentage of total loans 0.13% 0.10% 0.13% 0.24% 0.49% Total non-performing assets as a percentage of total assets 0.11% 0.09% 0.13% 0.20% 0.34% At December 31, 1999, United had $5.1 million of loans which were not classified as non-performing but for which known information about the borrowers' financial condition caused management to have concern about the ability of the borrowers to comply with the repayment terms of the loans. These loans were identified through the loan review process described in the ASSET QUALITY AND RISK ELEMENTS section of this discussion above that provides for assignment of a risk rating based on an ten-grade scale to all commercial and commercial real estate loans. Based on the evaluation of current market conditions, loan collateral, other secondary sources of repayment and cash flow generation, management does not anticipate any significant losses related to these loans. These loans are subject to continuing management attention and are considered in the determination of the allowance for loan losses. INVESTMENT SECURITIES The composition of the securities portfolio reflects United's investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The securities portfolio also provides a balance to interest rate risk and credit risk in other categories of 49 the balance sheet while providing a vehicle for the investment of available funds, furnishing liquidity, and supplying securities to pledge as required collateral for certain deposits. During 1999, United expanded its leverage program, which uses borrowed funds to purchase investment securities, by approximately $89 million over year-end 1998. Total average securities increased 86% during 1999 and 33% during 1998. The following table shows the carrying value of United's securities, by security type, as of December 31, 1999, 1998 and 1997. Table 11 - Carrying Value of Securities (in thousands) December 31, 1999 1998 1997 - ------------------------------------------------------------------------------------------------- Securities held to maturity: U.S. Treasury $ - - 500 U.S. Government agencies - 1,885 22,361 State and political subdivisions - 53,386 42,330 Mortgage-backed securities - 2,122 4,368 Other securities - 913 146 --------------------------------------------- Total securites held to maturity - 58,306 69,705 --------------------------------------------- Securities available for sale: U.S. Treasury 32,400 33,080 47,442 U.S. Government agencies 102,730 46,904 51,762 State and political subdivisions 78,824 22,610 12,243 Mortgage-backed securities 297,932 220,636 36,139 Other securities 22,617 10,557 6,190 --------------------------------------------- Total securities available for sale 534,503 333,787 153,776 --------------------------------------------- Total securities $ 534,503 392,093 223,481 ============================================= On January 1, 1999, United adopted Statement of Financial Accounting Standards No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES" ("SFAS No. 133"). As permitted by SFAS No. 133, United transferred all securities classified as held to maturity at January 1, 1999 to available for sale. Accordingly, the carrying value of United's entire securities portfolio at December 31, 1999 is recorded on the balance sheet at its fair market value of $535 million. At year-end 1998, United had $58 million of securities classified as held to maturity. These securities had a fair market value at year-end 1998 of $60 million. United's investment portfolio consists principally of U.S. Government and agency securities, municipal securities, various equity securities and U.S. Government sponsored agency mortgage-backed securities. A mortgage-backed security relies on the underlying mortgage pools of loans to provide a cash flow of principal and interest. The actual maturities of these securities will differ from the contractual maturities because the loans underlying the security may prepay with or without prepayment penalties. Decreases in interest rates will generally cause an increase in prepayment levels. In a declining interest rate environment, United may not be able to reinvest the proceeds from these prepayments in assets that have comparable yields. However, because the majority of the mortgage-backed securities have adjustable rates, the negative effects of changes in interest rates on income and the carrying values of these securities are somewhat mitigated. During the fourth quarter of 1998, management initiated a leverage program designed to make optimal utilization of United's assets and capital. This program provides for using borrowed funds (principally FHLB advances) secured by mortgage loans and securities of the banks to purchase additional securities. The securities purchased in conjunction with the leverage program during 1998 and 1999 are primarily mortgage backed pass-through and other mortgage backed securities, including collateralized mortgage obligations. As of December 31, 1999, the leverage program at United added $164 million in total borrowings and earning assets. Management does not expect any increase in the 50 leverage program assets during 2000, and plans to use proceeds from the leverage securities paydowns to fund loan growth and reduce associated leverage program borrowings. At December 31, 1999, United had 25% of its total investment portfolio in mortgage backed pass-through securities, all of which are issued or backed by Federal agencies, compared with 35% at December 31, 1998. United did not have securities of any issuer in excess of 10% of equity at year-end 1999 or 1998. Other mortgage-backed securities, including collateralized mortgage obligations, represented 14% of the total securities portfolio at December 31, 1999, compared with 29% at year-end 1998. Approximately 81% of the other mortgage-backed securities portfolio was collateralized by mortgage-backed securities issued or backed by Federal agencies as of December 31, 1999. DEPOSITS Total average deposits for 1999 were $1.4 billion, an increase of $302 million, or 26% from 1998. Average non-interest bearing demand deposit accounts increased $46 million, or 34%, and average interest bearing transaction accounts increased $69 million, or 27%, from 1998. Average time deposits for 1999 were $872 million, an increase of 24% from 1998. Time deposits of $100,000 and greater totaled $312 million at December 31, 1999, compared with $220 million at year-end 1998. During 1999, United began to utilize "brokered" time deposits, issued in certificates of less than $100,000, as an alternative source of cost-effective funding. Average brokered time deposits outstanding in 1999 were $23 million; no material amounts of brokered time deposits were outstanding during 1998. Total interest paid on time deposits of $100,000 and greater during 1999 was $13.5 million. The following table sets forth the scheduled maturities of time deposits of $100,000 and greater and brokered time deposits at December 31, 1999. Table 12 - Maturities of Time Deposits of $100 Thousand and Greater and Brokered Deposits (in thousands) $100 Thousand and Greater: Three months or less $ 99,463 Over three through six months 77,963 Over six through twelve months 74,866 Over one year 60,074 ----------------- Total $ 312,366 ================= Brokered Deposits: Three months or less $ 10,250 Over three through six months 15,250 Over six through twelve months 32,000 Over one year 12,000 ----------------- Total $ 69,500 ================= Short-term Borrowings At December 31, 1999, all of the banks were shareholders in the Federal Home Loan Bank of Atlanta. Through this affiliation, secured advances totaling $288 million were outstanding at rates competitive with time deposits of like maturities. United anticipates continued utilization of this short and long term source of funds to minimize interest rate risk. The FHLB advances outstanding at December 31, 1999 had both fixed and floating interest rates ranging from 4.35% to 7.81%. Approximately 28% of the FHLB advances mature prior to December 31, 2000. Additional information regarding FHLB advances, including scheduled maturities, is provided in note 7 to the consolidated financial statements. 51 INTEREST RATE SENSITIVITY MANAGEMENT The absolute level and volatility of interest rates can have a significant impact on United's profitability. The objective of interest rate risk management is to identify and manage the sensitivity of net interest income to changing interest rates, in order to achieve United's overall financial goals. Based on economic conditions, asset quality and various other considerations, management establishes tolerance ranges for interest rate sensitivity and manages within these ranges. United uses income simulation modeling as the primary tool in measuring interest rate risk and managing interest rate sensitivity. Simulation modeling considers not only the impact of changing market rates of interest on future net interest income, but also such other potential causes of variability as earning asset volume, mix, yield curve relationships, customer preferences and general market conditions. Interest rate sensitivity is a function of the repricing characteristics of United's portfolio of assets and liabilities. These repricing characteristics are the time frames within which the interest bearing assets and liabilities are subject to change in interest rates either at replacement, repricing or maturity during the life of the instruments. Interest rate sensitivity management focuses on the maturity structure of assets and liabilities and their repricing characteristics during periods of changes in market interest rates. Effective interest rate sensitivity management seeks to ensure that both assets and liabilities respond to changes in interest rates within an acceptable timeframe, thereby minimizing the impact of interest rate changes on net interest income. Interest rate sensitivity is measured as the difference between the volumes of assets and liabilities in United's current portfolio that are subject to repricing at various time horizons: immediate; one to three months; four to twelve months; one to five years; over five years, and on a cumulative basis. The differences are known as interest sensitivity gaps. The following table shows interest sensitivity gaps for these different intervals as of December 31, 1999. Table 13 - Interest Rate Gap Sensitivity (in thousands) One Four One Over Five Through Through Through Years and Three Twelve Five Non-rate Immediate Months Months Years Sensitive Total - -------------------------------------------------------------------------------------------------------------- Interest earning assets: Federal funds sold $ 23,380 - - - - 23,380 Securities - 74,762 36,415 180,943 242,383 534,503 Mortgage loans held for sale - 6,326 - - - 6,326 Loans - 302,510 520,066 433,361 144,423 1,400,360 ---------------------------------------------------------------- Total interest earning assets 23,380 383,598 556,481 614,304 386,806 1,964,569 --------------------------------------------------------------- Interest bearing liabilities: Demand deposits - 328,815 - - - 328,815 Savings deposits - - 73,953 - - 73,953 Time deposits - 292,233 519,000 243,385 - 1,054,618 Fed funds purchased/repurchase agreements 31,812 - - - - 31,812 FHLB advances 37,625 20,000 26,750 203,197 287,572 Notes payable 15,365 - 2,142 9 - 17,516 Convertible subordinated debentures - - - - 3,500 3,500 Trust preferred securities - - - - 21,000 21,000 --------------------------------------------------------------- Total interest bearing liabilities 84,802 641,048 621,845 446,591 24,500 1,818,786 --------------------------------------------------------------- Non-interest bearing sources of funds - - - - 192,006 192,006 ---------------------------------------------------------------- Interest sensitivity gap (61,422) (257,450) (65,364) 167,713 170,300 (46,223) ---------------------------------------------------------------- Cumulative sensitivity gap $ (61,422) (318,872) (384,236)(216,523) (46,223) - ================================================================ As seen in the preceding table, during the first year 74% of interest bearing liabilities will reprice compared with 49% of all interest earning assets. Changes in the mix of earning assets or supporting liabilities can 52 either increase or decrease the net interest margin without affecting interest rate sensitivity. In addition, the interest rate spread between an asset and its supporting liability can vary significantly while the timing of repricing for both the asset and the liability remains the same, thus impacting net interest income. This characteristic is referred to as basis risk and generally relates to the possibility that the repricing characteristics of short-term assets tied to United's prime lending rate are different from those of short-term funding sources such as certificates of deposit. Varying interest rate environments can create unexpected changes in prepayment levels of assets and liabilities that are not reflected in the interest rate sensitivity analysis. These prepayments may have significant impact on United's net interest margin. Because of these factors, an interest sensitivity gap analysis may not provide an accurate assessment of United's exposure to changes in interest rates. Table 13 indicates United is in a liability sensitive or negative gap position for the first twelve months. This liability sensitive position would generally indicate that United's net interest income would decrease should interest rates rise and would increase should interest rates fall. Due to the factors cited previously, current simulation results indicate only minimal sensitivity to parallel shifts in interest rates; however, no assurance can be given that United is not at risk from interest rate increases or decreases. Management also evaluates the condition of the economy, the pattern of market interest rates and other economic data to determine the appropriate mix and repricing characteristics of assets and liabilities necessary to optimize the net interest margin. The following table presents the expected maturity of the total securities by maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis) at December 31, 1999. The composition and maturity/repricing distribution of the securities portfolio is subject to change depending on rate sensitivity, capital and liquidity needs. Table 14 - Expected Maturity of Securities Available for Sale (in thousands) Over One Over Five Year Years One Year Through Through Over or Less Five Years Ten Years Ten Years Total - -------------------------------------------------------------------------------------------------------------------- U.S. Treasury 9,252 23,148 - - 32,400 U.S. Government agencies 4,405 61,903 33,202 3,220 102,730 State and political subdivisions 5,324 32,280 24,749 16,471 78,824 Other securities <F1> - - - 320,549 320,549 ------------------------------------------------------------------ ------------------------------------------------------------------ Total securities available for sale 18,981 117,331 57,951 340,240 534,503 ------------------------------------------------------------------ Percent of total 3.6% 22.0% 10.8% 63.6% 100.0% Weighted average yield <F2> 5.66% 6.37% 7.47% 6.07% 6.27% <FN> <F1> Includes mortgage-backed securities. <F2> Based on amortized cost. </FN> In order to assist in achieving a desired level of interest rate sensitivity, United has entered into off-balance sheet contracts that are considered derivative financial instruments during 1999, 1998 and 1997. Derivative financial instruments can be a cost and capital effective means of modifying the repricing characteristics of on-balance sheet assets and liabilities. These contracts include interest rate swaps under which United pays a variable rate and receives a fixed rate, and interest rate cap contracts for which United pays an up-front premium in exchange for a variable cash flow if interest rates exceed the cap contract rate. In order to minimize the credit risk of derivative financial instruments, United requires all contract counterparties to have an investment grade or better credit rating. The cost of the cap contracts is included in other assets in the consolidated balance sheet and is being amortized on a straight-line basis over the five-year term of the contracts. At December 31, 1999 the cap contracts had an aggregate remaining book value of $373,000. The following table presents United's cap contracts outstanding at December 31, 1999. 53 Table 15 - Cap Contracts as of December 31, 1999 (in thousands) Notional Contract Contract Fair Maturity Amount Index Rate Value August 31, 2001 5,000 Prime 10.00% 9 August 27, 2001 20,000 Prime 10.00% 46 September 18, 2003 10,000 3 Month LIBOR 5.50% 476 January 4, 2004 10,000 Prime 7.75% 506 ---------------- ------------ Total 45,000 1,037 ================ ============ The following table presents United's swap contracts outstanding at December 31, 1999. Table 16 - Swap Contracts as of December 31, 1999 (in thousands) Notional Rate Rate Fair Maturity Amount Received Paid (<F1> Value April 2, 2001 15,000 8.41% 8.50% (169) April 5, 2001 10,000 9.50% 8.50% 15 May 8, 2001 10,000 8.26% 8.50% (138) June 7, 2001 10,000 8.69% 8.50% (96) July 27, 2001 10,000 8.85% 8.50% (70) October 12, 2001 10,000 9.11% 8.50% (57) June 7, 2002 10,000 9.05% 8.50% (114) June 14, 2002 10,000 9.12% 8.50% (102) June 24, 2002 20,000 8.80% 8.50% (304) July 29, 2002 25,000 9.04% 8.50% (281) August 10, 2002 10,000 9.60% 8.50% (51) December 23, 2002 10,000 9.19% 8.50% (164) ------------------------------------------------ Total/weighted average 150,000 8.95% 8.50% (1,531) ================================================ <FN> <F1> Based on prime rate at December 31, 1999. </FN> Effective January 1, 1999, United adopted SFAS No. 133, which requires all derivative financial instruments be included and recorded at fair value on the balance sheet. Currently, all of United's derivative financial instruments are classified as highly effective fair value hedges. Fair value hedges recognize currently in earnings both the impact of change in the fair value of the derivative financial instrument and the offsetting impact of the change in fair value of the hedged asset or liability. At December 31, 1999, United's derivative financial instruments had an aggregate negative fair value of $494,000. United requires all derivative financial instruments be used only for asset/liability management through the hedging of specific transactions or positions, and not for trading or speculative purposes. Management believes that the risk associated with using derivative financial instruments to mitigate interest rate risk sensitivity is minimal and should not have any material unintended impact on United's financial condition or results of operations. 54 LIQUIDITY MANAGEMENT The objective of liquidity management is to ensure that sufficient funding is available, at reasonable cost, to meet the ongoing operational cash needs of United and to take advantage of income producing opportunities as they arise. While the desired level of liquidity will vary depending upon a variety of factors, it is the primary goal of United to maintain a sufficient level of liquidity in all expected economic environments. Liquidity is defined as the ability of a bank to convert assets into cash or cash equivalents without significant loss and to raise additional funds by increasing liabilities. Liquidity management involves maintaining United's ability to meet the daily cash flow requirements of the banks' customers, both depositors and borrowers. The primary objectives of asset/liability management are to provide for adequate liquidity in order to meet the needs of customers and to maintain an optimal balance between interest-sensitive assets and interest-sensitive liabilities, so that United can also meet the investment requirements of its shareholders as market interest rates change. Daily monitoring of the sources and use of funds is necessary to maintain a position that meets both requirements. The asset portion of the balance sheet provides liquidity primarily through loan principal repayments and the maturities and sales of securities. Mortgage loans held for sale totaled $6.3 million at December 31, 1999, and typically turn over every 45 days as the closed loans are sold to investors in the secondary market. Real estate-construction and commercial loans that mature in one year or less amounted to $192 million, or 14%, of the total loan portfolio at December 31, 1999. Other short-term investments such as federal funds sold are additional sources of liquidity. The liability section of the balance sheet provides liquidity through depositors' interest bearing and non-interest bearing deposit accounts. Federal funds purchased, FHLB advances and securities sold under agreements to repurchase are additional sources of liquidity and represent United's incremental borrowing capacity. These sources of liquidity are short-term in nature and are used as necessary to fund asset growth and meet other short-term liquidity needs. As disclosed in United's consolidated statements of cash flows included in the consolidated financial statements, net cash provided by operating activities was $26.8 million during 1999. The major sources of cash provided by operating activities are net income partially offset by funding of mortgage loans held for sale and changes in other assets and other liabilities. Net cash used in investing activities of $478.7 million consisted primarily of a net increase in loans of $325.8 million and securities purchases of $244.9 million funded largely by sales, maturities and paydowns of securities of $99.4 million and additional net borrowings from the FHLB of $100.7 million. Net cash provided by financing activities provided the remainder of funding sources for 1999. The $502.1 million of net cash provided by financing activities consisted primarily of a $381 million net increase in deposits and a net increase in FHLB advances of $100.7 million. In the opinion of management, United's liquidity position at December 31,1999, is sufficient to meet its expected cash flow requirements. Reference should be made to the consolidated statements of cash flows appearing in the consolidated financial statements for a three-year analysis of the changes in cash and cash equivalents resulting from operating, investing and financing activities. CAPITAL RESOURCES AND DIVIDENDS Shareholders' equity at December 31, 1999 was $96.2 million, an increase of $2.4 million, or 2.6%, from December 31, 1998. Excluding the change in the capital category of accumulated other comprehensive income (loss), shareholders' equity increased by 13.3%. Accumulated other comprehensive income (loss) is not included in the calculation of regulatory capital adequacy ratios. For additional information on accumulated other comprehensive income (loss), please refer to the statements of other comprehensive income, which is included with the consolidated financial statements. Dividends of $1.5 million, or $.20 per share, were declared on common stock in 1999, an increase of 33% per share from the amount declared per share in 1998. The dividend payout ratios for 1999 and 1998 were 11.8% and 9.4%, respectively. United has historically retained the majority of its earnings in order to provide a cost-effective source of capital for continued growth and expansion. However, in recognition that cash dividends 55 are an important component of shareholder value, management has instituted a dividend program that provides for increased cash dividends when earnings and capital levels permit. In July 1998, a statutory business trust, United Community Capital Trust, was created by United which in July 1998, issued guaranteed preferred beneficial interests in United's junior subordinated deferrable interest debentures ("Trust Preferred Securities") to institutional investors in the amount of $21 million. This issuance represented the guaranteed preferred beneficial interests in $21.7 million in junior subordinated deferrable interest debentures ("Subordinated Debentures") issued by United to United Community Capital Trust. For regulatory purposes, the Trust Preferred Securities will be treated as Tier I capital of United. The subordinated debentures are the sole assets of United Community Capital Trust and bear an interest rate of 8.125% with a maturity date of July 15, 2028, which may be shortened to a date not earlier than July 15, 2008. If the subordinated debentures are redeemed in part or in whole prior to July 15, 2008, the redemption price of the Subordinated Debentures and the Trust Preferred Securities will include a premium ranging from 4.06% in 2008 to .41% in 2017. In March 1997, United completed an offering to the public of 300,000 shares of United common stock registered under the Securities Act of 1933, pursuant to which $6.5 million in additional capital was raised after deducting certain issuance costs. United used the proceeds of the offering primarily to invest additional capital in United Community Bank, Carolina Community Bank and Towns County Bank to support the asset growth that the banks were experiencing. On December 31, 1996, United completed a private placement of convertible subordinated payable-in-kind debentures due December 31, 2006 (the "2006 Debentures"). The 2006 Debentures bear interest at the rate of one quarter of one percentage point over the prime rate per annum as quoted in the WALL STREET JOURNAL, payable on a quarterly basis. The 2006 Debentures may be redeemed, in whole or in part, on or after January 1, 1998, at the option of United upon at least 20 days and not more than 60 days notice, at a redemption price equal to 100% of the principal amount of the debentures to be redeemed plus interest accrued and unpaid as of the date of redemption. The holders of the 2006 Debentures have the right, excercisable at any time up to December 31, 2006, to convert such debentures at the principal amount thereof into shares of Common Stock of United at the conversion price of $25 per share, subject to adjustment for stock splits and stock dividends. The Board of Governors of the Federal Reserve System has issued guidelines for the implementation of risk-based capital requirements by U.S. banks and bank holding companies. These risk-based capital guidelines take into consideration risk factors, as defined by regulators, associated with various categories of assets, both on and off balance sheet. Under the guidelines, capital strength is measured in two tiers which are used in conjunction with risk adjusted assets to determine the risk based capital ratios. The guidelines require an 8% total risk-based capital ratio, of which 4% must be Tier I capital. United's Tier I capital, which consists of shareholders' equity and qualifying trust preferred securities less other comprehensive income, goodwill and deposit-based intangibles, totaled to $117 million at December 31, 1999. Tier II capital components include supplemental capital components such as a qualifying allowance for loan losses and qualifying subordinated debt. Tier I capital plus Tier II capital components is referred to as Total Risk-based Capital and was $137 million at December 31, 1999. The percentage ratios, as calculated under the guidelines, were 8.44% and 9.95% for Tier I and Total Risk-based Capital, respectively, at December 31, 1999. A minimum leverage ratio is required in addition to the risk-based capital standards and is defined as period end shareholders' equity and qualifying trust preferred securities, less other comprehensive income, goodwill and deposit-based intangibles divided by average assets adjusted for goodwill and deposit-based intangibles. Although a minimum leverage ratio of 4% is required for the highest-rated bank holding companies which are not undertaking significant expansion programs, the Federal Reserve Board requires a bank holding company to maintain a leverage ratio greater than 4% if it is experiencing or anticipating significant growth or is operating with less than well-diversified risks in the opinion of the Federal Reserve Board. The Federal Reserve Board uses the leverage and risk-based capital ratios to assess capital adequacy of banks and bank holding companies. United's leverage ratios at December 31, 1999 and 1998 were 5.52% and 7.11%, respectively. 56 All three of the capital ratios of United and the banks currently exceed the minimum ratios required in 1999 as defined by federal regulators. United monitors these ratios to ensure that United and the banks remain within regulatory guidelines. Further information regarding the actual and required capital ratios of United and the banks is provided in note 13 to the consolidated financial statements. IMPACT OF INFLATION AND CHANGING PRICES A bank's asset and liability structure is substantially different from that of an industrial firm in that primarily all assets and liabilities of a bank are monetary in nature, with relatively little investments in fixed assets or inventories. Inflation has an important impact on the growth of total assets and the resulting need to increase equity capital at higher than normal rates in order to maintain an appropriate equity to assets ratio. United's management believes the impact of inflation on financial results depends on United's ability to react to changes in interest rates and, by such reaction, reduce the inflationary impact on performance. United has an asset/liability management program which attempts to manage United's interest rate sensitivity position. In addition, periodic reviews of banking services and products are conducted to adjust pricing in view of current and expected costs. YEAR 2000 The "Year 2000" issue refers to potential problems that could result from the improper processing of dates and date-dependent calculations by computers and other microchip-embedded technology. In simple terms, problems with Year 2000 can result from a computer's inability to recognize a two-digit date field (00) as representing Year 2000 and, incorrectly, recognize the year as 1900. Failure to identify and correct this problem prior to January 1, 2000 could result in system processing errors that would disrupt a company's normal business operations. In recognition of the seriousness of this issue, United established a Year 2000 Committee in January 1998. The committee was chaired by United's Chief Information Officer and reported directly to United's board of directors on a quarterly basis. United complied with all aspects of a Year 2000 directive issued in May 1997 by the Federal Financial Institutions Examination Council ("FFIEC") that established key milestones that all financial institutions needed to meet with regard to Year 2000 testing and remediation. None of United's systems, including systems provided to United by third parties, sustained a failure related to Year 2000 and no contingency plans were subject to implementation as a result of system failure. In addition, there was no material impact on the liquidity of United or the banks resulting from excessive deposit withdrawal activity. Although management is not aware of any Year 2000 failures experienced by commercial loan customers, such problems could take several months to surface in the form of increased loan delinquencies. Management believes that the allowance for loan losses at December 31, 1999 is sufficient to absorb losses inherent in the loan portfolio, including losses related to failure of borrowers to adequately prepare the direct and indirect impact a Year 2000 computer failure had on their business. The following table sets forth United's budget for the Year 2000 issue and actual amounts expended as of December 31, 1999. All amounts shown are pre-tax. In addition, the table indicates the percentage of each budget line category that was recognized as current period expense through December 1999, and the percentage that was recorded as a new asset(s) with expense recognized over the useful life of the asset through charges to depreciation expense. Management does not expect any additional expenditures related to Year 2000. 57 Table 17 - Year 2000 Budget (in thousands) Actual Costs % of Budget % of Total Incurred as of Expended as of % of Costs to Be: Budget Budget 31-Dec-99 31-Dec-99 Expensed Amortized ------------------------------------------------------------ --------------------------- Consulting $ 175 9% 34 19% 100% 0% Inventory 70 4% 60 86% 100% 0% Testing 82 4% 28 34% 100% 0% Remediation 1,520 80% 1,344 88% 15% 85% Resources 53 3% 36 68% 100% 0% ----------------------------------------------------------- --------------------------- Total $1,900 100% 1,502 79% 12% 88% ============================================================ =========================== In accordance with recently issued accounting guidelines on how Year 2000 costs should be recognized for financial statement purposes, United recognized as current period expense all costs associated with the consulting, inventory, testing and resources components of the Year 2000 budget. The costs associated with remediation, which comprised approximately 90% of the Year 2000 expenditures, are primarily related to the installation of a new wide-area desktop computer network ("WAN") that replaced virtually all of the desktop computers, file servers and peripheral equipment. In addition to being Year 2000 compliant, the new WAN provides United with a uniform standard desktop computer configuration, internal and external e-mail capability, Internet access and savings on telephone communication costs through utilization of the WAN communications backbone for voice communication. United intends to leverage this new WAN technology to increase the levels of employee productivity and improve operating efficiency. The costs of the WAN component of the Year 2000 remediation budget is being recognized over a useful life of three years at a cost of approximately $450,000 per year starting in the first quarter of 1999. This annual cost does not include any of the anticipated savings that United expects to achieve through improved operating efficiency and reduced telecommunications costs. United funded the costs associated with preparing for Year 2000 out of its normal operating cash flows. No major information technology initiatives were postponed as a result of Year 2000 preparation that would have materially impacted United's financial condition or results of operations. 58 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK United's net interest income and the fair value of its financial instruments (interest earning assets and interest bearing liabilities) are influenced by changes in market interest rates. United actively manages its exposure to interest rate fluctuations through policies established by its Asset/Liability Management Committee. The Asset/Liability Management Committee meets regularly and is responsible for approving asset/liability management policies, developing and implementing strategies to improve balance sheet positioning and net interest income and assessing the interest rate sensitivity of the banks. United utilizes an interest rate simulation model to monitor and evaluate the impact of changing interest rates on net interest income. The estimated impact on United's net interest income sensitivity over a one-year time horizon as of December 31, 1999 is indicated in the table below. The table assumes an immediate and sustained parallel shift in interest rates of 200 basis points and no change in the composition of United's balance sheet. Net Interest Income Sensitivity December 31, 1999 (in thousands) Percentage Increase (Decrease) in Interest Income/Expense Given Principal/Notional Immediate and Sustained Parallel Amounts of Earning Interest Rate Shifts Assets, Interest Bearing ------------------------------------------ Liabilities and Derivatives at Down 200 Up 200 December 31, 1999 Basis Points Basis Points ------------------------ ----------------- ----------------- Assets repricing in: One year or less $ 963,549 Over one year 1,001,110 ---------------- Total $ 1,964,659 -7.41% 7.30% ================ Liabilities repricing in: One year or less $ 1,347,695 Over one year 471,091 ---------------- Total $ 1,818,786 12.62% 11.88% ================ Derivative hedge instruments $ 195,000 Net interest income sensitivity -0.81% 1.49% United's Asset/Liability Management Committee policy requires that a 200 basis point shift in interest rates not result in a decrease of net interest income of more than 10%. The information presented in the tables above is based on the same assumptions set forth in United's Asset/Liability Management Committee policy. There have been no material changes in United's quantitative and qualitative disclosures about market risk as of March 31, 2000 from that presented in United's Annual Report on Form 10-K for the year ended December 31, 1999. 59 COMPARATIVE SHARE DATA The following table shows selected comparative unaudited per share data for United, North Point, and Independent on a historical basis, a pro forma basis assuming the mergers have been effective for the periods indicated, and on a pro forma equivalent basis. The mergers will be accounted for as pooling of interests transactions in accordance with generally accepted accounting principles. Equivalent earnings per share amounts for North Point have been calculated by multiplying the pro forma combined earnings per share by the exchange ratio (2.2368 shares of the United common stock for each share of North Point common stock). Equivalent earnings per share amounts for Independent have been calculated by multiplying the pro forma combined earnings per share by the exchange ratio (0.4211 shares of the United common stock for each share of Independent common stock). The North Point and Independent pro forma equivalent cash dividends per common share represent historical dividends declared by United multiplied by the applicable exchange ratio. The purpose of the pro forma equivalent per share amounts is for informational purposes only to show the pro forma net earnings that would have been earned for each share of North Point or Independent had the merger been completed for the periods indicated. This data should be read together with the historical financial statements of United, North Point, and Independent including the related notes included elsewhere in this proxy statement. AS OF THE QUARTER ENDED AS OF THE YEAR ENDED DECEMBER 31, MARCH 31, 2000 1999 1998 1997 -------------------------------------------------------------- NET INCOME PER COMMON SHARE United Historical 0.48 1.70 1.60 1.42 North Point Historical 0.92 2.35 3.82 3.13 Independent Historical 0.23 0.83 0.56 0.60 United, North Point, and Independent Pro Forma Combined <F1> 0.48 1.66 1.59 1.41 North Point Pro Forma Equivalent <F2> 1.07 3.71 3.56 3.15 Independent Pro Forma Equivalent <F3> 0.20 0.70 0.67 0.59 CASH DIVIDENDS PER COMMON SHARE United Historical 0.075 0.20 0.15 0.10 North Point Historical 0.30 1.20 0.96 0.88 Independent Historical 0.20 0.15 0.10 0.06 United, North Point, and Independent Pro Forma 0.08 0.20 0.15 0.10 Combined <F1> <F4><F5><F6> North Point Pro Forma Equivalent 0.17 0.45 0.34 0.22 Independent Pro Forma Equivalent 0.03 0.08 0.06 0.04 BOOK VALUE PER COMMON SHARE (PERIOD END) United Historical 12.25 11.98 11.72 10.15 North Point Historical 21.94 21.43 21.88 18.84 Independent Historical 6.66 6.70 6.27 5.86 United, North Point, and Independent Pro Forma Combined <F1> 12.31 12.08 11.80 11.24 North Point Pro Forma Equivalent <F2> 27.54 27.02 26.91 25.68 Independent Pro Forma Equivalent<F3> 5.19 5.09 5.07 4.83 <FN> <F1> Computed giving effect to the merger. <F2> Computed based on the North Point per share exchange ratio of 2.2368 shares of United common stock for each share of North Point common stock. <F3> Computed based on Independent per share exchange ratio of 0.4211 shares of United common stock for each share of Independent common stock. <F4> Represents historical dividends paid by United, as it is assumed that United will not change its dividend policy as a result of the merger. <F5> Represents historical dividends paid per share by United multiplied by the exchange ratio of 2.2368 shares of United common stock for each share of North Point common stock. <F6> Represents historical dividends paid per share by United multiplied by the exchange ratio of 0.4211 shares of United common stock for each share of Independent common stock. </FN> 60 SUMMARY CONSOLIDATED FINANCIAL INFORMATION The following tables present certain selected historical financial information for United, North Point, and Independent. The data should be read in conjunction with the historical financial statements, including the related notes, and other financial information concerning United, North Point, and Independent incorporated by reference in or accompanying this proxy statement. AS OF AND FOR THE AS OF AND FOR THE (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) QUARTERS ENDED MARCH 31, YEARS ENDED DECEMBER 31, 2000 1999 1999 1998 1997 1996 1995 ------------------------------------------------------------------------------------ - ----------------------------------- UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES - ----------------------------------- INCOME STATEMENT Net interest income $ 18,866 15,434 67,974 56,210 45,718 35,461 26,076 Provision for loan losses 1,546 980 5,104 2,612 2,814 1,751 1,128 Non-interest income 2,672 2,479 10,836 9,129 7,200 5,866 4,698 Non-interest expense 14,379 12,000 54,165 43,964 34,063 26,341 20,165 Income taxes 1,789 1,640 5,893 5,990 4,987 4,180 2,634 Net income $ 3,824 3,293 13,648 12,773 11,054 9,055 6,847 PER COMMON SHARE Net income - basic $ 0.48 0.41 1.70 1.60 1.42 1.22 0.99 Net income - diluted 0.47 0.40 1.66 1.57 1.40 1.20 0.97 Cash dividends declared 0.075 0.05 0.20 0.15 0.10 0.10 0.08 Book value $ 12.25 12.12 11.98 11.72 10.15 8.21 7.13 Basic average shares outstanding 8,034 8,004 8,020 7,973 7,810 7,399 6,919 Diluted average shares outstanding 8,317 8,269 8,316 8,246 8,031 7,590 7,105 AT PERIOD END Loans $ 1,459,469 1,142,102 1,400,360 1,061,165 872,499 662,245 489,260 Earning assets 2,012,897 1,629,736 1,964,569 1,474,398 1,108,362 861,360 683,782 Assets 2,174,621 1,771,645 2,131,440 1,591,399 1,216,693 926,844 738,651 Deposits 1,668,485 1,318,544 1,649,392 1,238,323 1,033,756 809,149 660,146 Shareholders' equity $ 98,456 97,005 96,270 93,836 80,086 62,357 53,126 Common shares outstanding $ 8,034 8,004 8,034 8,004 7,894 7,594 7,454 AVERAGE BALANCES Loans $ 1,441,126 1,093,080 1,237,892 956,452 773,245 567,456 434,682 Earning assets 2,021,074 1,537,503 1,760,738 1,257,559 1,009,770 755,201 586,997 Assets 2,155,171 1,625,091 1,896,189 1,355,303 1,077,978 817,682 631,247 Deposits $ 1,671,675 1,266,680 1,447,861 1,145,425 939,642 724,845 558,423 Shareholders' equity $ 96,698 95,375 95,253 86,082 71,121 57,886 45,478 Weighted average shares outstanding 8,034 8,004 8,020 7,973 7,810 7,399 6,919 PERFORMANCE RATIOS Return on average assets 0.71% 0.81% 0.72% 0.94% 1.03% 1.11% 1.08% Return on average shareholders' equity 15.91% 14.0% 14.33% 14.84% 15.54% 15.64% 15.06% Average equity to average assets 4.49% 5.77% 5.02% 6.47% 6.82% 6.93% 6.98% Average loans to average deposits 86.21% 86.29% 85.50% 83.50% 82.29% 78.29% 77.84% Retroactively adjusted for stock dividends EXCLUDING MERGER-RELATED CHARGES<F1> Net income $ 3,824 3,293 14,803 12,773 11,054 9,055 6,847 Basic earnings per share $ 0.48 0.41 1.85 1.60 1.42 1.22 0.99 Diluted earnings per share $ 0.47 0.40 1.80 1.57 1.40 1.20 0.97 Return on average assets 0.71% 0.81% 0.78% 0.94% 1.03% 1.11% 1.08% Return on average shareholders' equity 15.91% 14.00% 15.54% 14.84% 15.54% 15.64% 15.06% <FN> <F1> Amounts and ratios exclude merger-related charges recorded in 1999 in connection with the merger of United Community Banks, Inc. and 1st Floyd Bankshares, Inc. </FN> 61 AS OF AND FOR THE AS OF AND FOR THE (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) QUARTERS ENDED MARCH 31, YEARS ENDED DECEMBER 31, 2000 1999 1999 1998 1997 1996 1995 ----------------------------------------------------------------------------------- - ----------------------------------------------- NORTH POINT BANCSHARES, INC. AND SUBSIDIARY - ----------------------------------------------- INCOME STATEMENT Net interest income $ 1,195 1,064 4,527 4,690 4,040 3,457 2,877 Provision for loan losses 20 30 620 200 175 160 70 Non-interest income 182 162 625 653 626 580 406 Non-interest expense 814 676 3,070 2,692 2,490 2,316 2,085 Income taxes 151 160 453 814 662 487 328 Net income $ 392 360 1,009 1,637 1,339 1,074 800 PER COMMON SHARE Basic earnings $ 0.92 0.84 2.35 3.82 3.13 2.51 1.87 Diluted earnings 0.92 0.84 2.35 3.82 3.13 2.51 1.87 Cash dividends declared 0.30 0.30 1.20 0.96 0.88 0.80 0.73 Book value $ 21.94 21.91 21.43 21.88 18.84 16.49 14.74 Basic average shares outstanding 428 428 428 428 428 428 428 Diluted average shares outstanding 428 428 428 428 428 428 428 AT PERIOD END Loans $ 75,336 56,295 62,212 54,547 48,111 40,716 32,958 Earning assets 106,576 95,947 98,507 87,912 80,294 70,891 59,040 Assets 115,110 102,185 106,478 93,880 85,299 77,361 63,801 Deposits 103,638 92,174 96,565 84,115 76,804 69,753 57,231 Shareholders' equity $ 9,389 9,378 9,180 9,372 8,071 7,064 6,315 Common shares outstanding 428 428 428 428 428 428 428 AVERAGE BALANCES Loans $ 64,305 55,855 57,961 55,554 45,137 37,443 31,583 Earning assets 101,728 92,230 96,435 84,280 74,637 66,663 55,656 Assets 109,594 98,316 102,774 89,725 80,597 71,416 61,148 Deposits $ 97,093 86,323 92,980 80,472 74,048 65,704 55,233 Shareholders' equity $ 9,333 9,050 9,276 8,722 7,568 6,690 6,009 Weighted average shares $ 428 428 428 428 428 428 428 outstanding PERFORMANCE RATIOS Return on average assets 1.44% 1.47% 0.98% 1.82% 1.66% 1.50% 1.31% Return on average shareholders' equity 16.89% 16.00% 10.88% 18.77% 17.69% 16.06% 13.31% Average equity to average assets 8.52% 9.20% 9.03% 9.72% 9.39% 9.37% 9.83% Average loans to average deposits 66.23% 64.70% 64.01% 69.04% 60.96% 56.99% 57.18% 62 AS OF AND FOR THE AS OF AND FOR THE (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) QUARTERS ENDED MARCH 31, YEARS ENDED DECEMBER 31, 2000 1999 1999 1998 1997 1996 1995 ---------------------------------------------------------------------------------- - ---------------------------------------------- INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY - ---------------------------------------------- INCOME STATEMENT Net interest income $ 1,713 1,455 6,290 5,355 4,284 2,724 2,427 Provision for loan losses 45 76 242 201 262 26 45 Noninterest income 223 259 1,104 938 671 393 337 Noninterest expense 1,190 1,153 4,746 4,443 3,543 2,705 2,406 Income taxes 246 175 785 549 346 130 98 Net income $ 455 310 1,621 1,100 804 256 215 PER COMMON SHARE Basic earnings $ 0.23 0.16 0.83 0.56 0.60 0.23 0.19 Diluted earnings 0.22 0.16 0.82 0.55 0.59 0.23 0.19 Cash dividends declared 0.20 0.15 0.15 0.10 0.06 0.05 -- Book value $ 6.66 6.25 6.70 6.27 5.86 5.08 5.17 Basic average shares outstanding 1,948 1,948 1,948 1,948 1,348 1,116 1,116 Diluted average shares outstanding 2,023 1,985 1,988 1,995 1,366 1,116 1,116 AT PERIOD END Loans $ 101,294 91,567 101,576 87,782 71,268 50,049 37,576 Earning assets 148,068 119,194 132,636 115,706 98,176 75,597 59,965 Assets 161,084 131,827 145,102 127,306 108,079 82,687 66,035 Deposits 141,441 112,516 123,422 109,786 92,793 75,179 58,945 Shareholders' equity $ 12,965 12,173 13,045 12,207 11,414 5,474 5,775 Common shares outstanding 1,948 1,948 1,948 1,948 1,948 1,116 1,116 AVERAGE BALANCES Loans $ 101,188 89,826 96,005 78,135 62,372 43,813 40,076 Earning assets 141,550 121,195 126,853 108,999 88,724 67,781 57,471 Assets 153,469 137,720 139,471 119,799 96,904 74,361 62,933 Deposits 132,432 111,151 118,693 102,946 84,644 67,062 56,139 Shareholders' equity 13,005 12,457 11,790 11,163 7,098 5,722 5,683 Weighted average shares $ 1,948 1,948 1,945 1,948 1,348 1,116 1,116 outstanding PERFORMANCE RATIOS Return on average assets 1.19% 0.91% 1.16% 0.92% 0.83% 0.34% 0.34% Return on average shareholders' equity 14.07% 10.01% 13.75% 9.85% 11.33% 4.47% 3.78% Average equity to average assets 8.47% 9.04% 8.45% 9.32% 7.32% 7.69% 9.03% Average loans to average deposits 76.41% 80.81% 80.89% 75.90% 73.69% 65.33% 71.39% 63 PRO FORMA SELECTED FINANCIAL DATA The following unaudited selected financial data presents selected pro forma financial information for United, North Point, and Independent. The selected pro forma financial information gives effect to the acquisitions of North Point and Independent as of the date or at the beginning of the period indicated, assuming the acquisitions are accounted for as pooling of interests transactions. The pro forma balance sheet information has been prepared as if the acquisitions had been completed on March 31, 2000. The pro forma operating data has been prepared as if the acquisitions had been completed on January 1, 1997. The unaudited pro forma financial data is presented for informational purposes only and is not necessarily indicative of the combined financial position or results of operation which actually would have occurred if the transaction had been completed at the date and for the periods indicated or which may be obtained in the future. See "Pro Forma Consolidated Financial Information." (DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) UNITED, INDEPENDENT, AND NORTH POINT FOR THE QUARTERS ENDED MARCH 31, FOR THE YEARS ENDED DECEMBER 31, 2000 1999 1999 1998 1997 ----------------------------------- ------------------------------------------- BALANCE SHEET DATA Total assets $2,450,816 Federal funds sold 16,846 Investment securities 607,423 Loans held for sale 4,588 Loans, net of allowance for 1,616,011 loan losses Deposits 1,913,564 Long-term debt and other 372,490 borrowings Trust preferred securities 21,000 Shareholders' equity $ 120,810 EARNINGS DATA Interest income $ 48,790 37,372 $ 168,992 $ 134,255 $ 109,576 Interest expense 27,151 19,419 90,200 67,630 55,321 Net interest income 21,639 18,052 78,792 66,625 54,255 Provision for loan losses 1,611 1,086 5,966 3,014 3,251 Non-interest income 3,077 2,900 12,564 10,350 8,284 Non-interest expense 16,383 13,829 61,981 51,098 40,095 Income taxes 2,186 1,975 7,131 7,353 5,995 Net income 4,671 3,963 16,278 15,510 13,198 Basic earnings per share 0.48 0.41 1.66 1.59 1.41 Diluted earnings per share 0.47 0.40 1.63 1.56 1.40 Cash dividends per share $ 0.114 0.084 $ 0.246 $ 0.185 $ 0.133 64 THE PROPOSED NORTH POINT MERGER BACKGROUND OF THE MERGER In a strategic planning session in 1999, the board of directors and senior management of North Point considered a variety of possible alternatives for North Point to pursue. In mid-December 1999, Don Gordon, the Chief Executive Officer of North Point, approached Jimmy Tallent, President and Chief Executive Officer of United, to determine if there might be some interest in considering a merger of the institutions. On December 23, 1999, Don Gordon and Greg Gordon, a Vice President of North Point, met with Mr. Tallent and other members of United's senior management in Blairsville to discuss the proposal in greater detail. On January 28, 2000, United's board of directors passed a resolution which approved the Agreement and Plan of Reorganization and the Agreement and Plan of Merger between North Point and United. This decision was based on the consideration by United's board of directors of the business and operations and asset quality of North Point as well as the attractiveness of the North Point franchise and its management team and the compatibility of that franchise with the operations of United. On February 1, 2000, at a special called meeting of the North Point board of directors, Don Gordon reported to the board of directors about their meeting with United's senior management and reviewed financial information on United and North Point related to the valuation, and the terms and conditions of the United proposal. This financial information included the pro forma financial impact of the merger at a range of prices. The board of directors authorized Mr. Gordon to proceed with negotiations. On February 7, 2000, Mr. Tallent made a presentation to the North Point board of directors at a special called meeting. On that date, the parties entered into a letter of intent outlining terms and conditions of a proposed merger. On February 9, 2000, United and North Point issued a joint press release describing the transaction, and on March 3, 2000, the parties executed the Agreement and Plan of Reorganization and the Agreement and Plan of Merger. SUMMARY OF THE MATERIAL FEATURES OF THE MERGER BETWEEN UNITED AND NORTH POINT EFFECTIVE DATE. The merger will be effective upon the approval of the merger agreement by the North Point shareholders and the filing of a certificate of merger with the Georgia Secretary of State. The merger also is subject to approval by the Board of Governors of the Federal Reserve System and the Department of Banking and Finance of the State of Georgia. The approval of the Board of Governors of the Federal Reserve System has been received. Management of United and North Point anticipate that the merger will become effective in the third quarter of 2000. TERMS OF THE MERGER. On the effective date of the merger, each outstanding share of North Point common stock will be converted into and exchanged for 2.2368 shares of United common stock. If, prior to the effective date, the outstanding shares of United common stock are increased through a stock dividend, stock split, subdivision, recapitalization, or reclassification of shares, or are combined into a lesser number of shares by reclassification, recapitalization, or reduction of capital, the number of shares of United common stock to be delivered pursuant to the merger in exchange for a share of North Point common stock will be proportionately adjusted. United will not issue fractional share certificates of common stock in connection with the merger, and an outstanding fractional share interest will not entitle the owner to vote, to receive dividends, or to any rights of a shareholder of United with respect to that fractional interest. Instead of issuing any fractional shares of common stock, United will pay in cash an amount (computed to the nearest cent) equal to the fraction of the share multiplied by $38.00 per share. If the merger is completed, shareholders of North Point will become shareholders of United, North Point will be merged with United, and North Point will cease to exist as a separate entity. Following the merger, the Restated Articles of Incorporation, Bylaws, corporate identity, and existence of United will not be changed. TERMINATION AND CONDITIONS OF CLOSING. The merger agreement may be terminated and the merger abandoned at any time either before or after approval of the merger agreement by the shareholders of North Point, but not later than the effective date: o by either party, if the other party has a material adverse change in its financial condition or business; o by either party, if the other party materially breaches any of the representations or warranties or any covenant or agreement it made under the merger agreement; 65 o by either party, if it learns of information not disclosed in the merger agreement or related documents which the other party was required to disclose pursuant to the merger agreement, which materially and adversely affects the business, properties, assets, or earnings of the other party; o by either party, if a lawsuit is filed or threatened which could prohibit or otherwise materially affect the merger agreement or the completion of the merger and which either party believes, in good faith, would make completion of the merger inadvisable; o by either party, if the merger is not completed by August 31, 2000; o by United, if the holders of 32,128 or more of the outstanding shares of North Point common stock choose to dissent from the merger and demand payment in cash; o by either party, if the North Point shareholders do not approve the merger agreement; or o by either party, if it learns of any potential liability of the other party resulting from that party's non-compliance with any environmental law or from the environmental condition of the properties or assets of the other party. The following are some of the required conditions of closing: o the accuracy of the representations and warranties of all parties contained in the merger agreement and related documents as of the date when made and the effective date; o the performance of all agreements and conditions required by the merger agreement; o the delivery of officers certificates, resolutions, and legal opinions to North Point and United; o approval of the merger by the North Point shareholders; o receipt of all necessary authorizations of government authorities and the expiration of any regulatory waiting periods; o effectiveness of the registration statement of United relating to the shares of United common stock to be issued to North Point shareholders in the merger; o receipt by North Point of Kilpatrick Stockton LLP's opinion of the tax consequences to North Point shareholders; o the receipt by United of an opinion of Porter Keadle Moore LLP that the merger will be accounted for as a pooling of interests; and o the issuance of a certificate of merger by the Secretary of State of Georgia. EXPENSES United will pay all its expenses in connection with the authorization, preparation, execution, and performance of the merger agreement, including all fees and expenses of its agents, representatives, counsel, and accountants and the fees and expenses related to filing regulatory applications with state and federal authorities in connection with the transactions contemplated thereby. North Point will pay all of its expenses incurred in connection with the authorization, preparation, execution, and performance of the merger agreement, including all fees and expenses of agents, representatives, counsel, and accountants for North Point. ACCOUNTING TREATMENT United will account for the merger as a pooling of interests transaction in accordance with generally accepted accounting principles. Under this accounting method, holders of North Point common stock will be deemed to have combined their existing voting common stock interests with the holders of United common stock by exchanging their shares for shares of United common 66 stock, and as a result, the assets and liabilities of North Point will be added to those of United at their recorded book value, and the shareholders' equity accounts of North Point and United would be combined on United's consolidated balance sheet. The unaudited pro forma financial information contained in this proxy statement has been prepared using the pooling of interests accounting method to account for the merger. REGULATORY APPROVALS The Board of Governors of the Federal Reserve System and the Department of Banking and Finance of the State of Georgia have approved the North Point merger. In determining whether to grant that approval, the Federal Reserve and the Department of Banking and Finance considered the effect of the merger on the financial and managerial resources and future prospects of the companies and banks concerned and the convenience and needs of the communities served. [The Department of Banking and Finance of the State of Georgia also has approved the merger.] 67 INFORMATION ABOUT NORTH POINT BANCSHARES, INC. DESCRIPTION OF BUSINESS North Point is a one-bank holding company which, through its subsidiary, Dawson County Bank, provides banking services through its two full-service banking offices in Dawsonville, Georgia, and one full-service banking office in Cumming, Georgia. The Company's executive office is located at 109 Highway 53 West, Dawsonville, Georgia 30534, and its telephone number is (706) 265-3232. Dawson County Bank offers a broad range of customary banking services including commercial, mortgage, and consumer loans; checking, savings, and time deposit accounts; wire transfers; and rental of safety deposit boxes. North Point was incorporated on October 10, 1984, as a Georgia business corporation. On January 11, 1985, North Point acquired all of the shares of common stock of Dawson County Bank, which was organized as a Georgia banking corporation in 1953. As of March 31, 2000, North Point had total consolidated assets of approximately $115.1 million, total deposits of approximately $103.6 million, and total shareholders' equity of approximately $9.4 million. At that date, North Point and Dawson County Bank had an aggregate of 36 full-time employees. VOTING SECURITIES AND PRINCIPAL SHAREHOLDERS The following lists each shareholder of record that directly or indirectly owned, controlled, or held with power to vote 5% or more of the 428,385 outstanding shares of North Point common stock as of May 1, 2000, and the amount of North Point common stock held by each executive officer and director of North Point. Unless otherwise indicated, each person has sole voting and investment powers over the indicated shares. Information relating to beneficial ownership of the North Point common stock is based upon "beneficial ownership" concepts set forth in rules issued under the Securities Exchange Act of 1934. Under those rules, a person is deemed to be a "beneficial owner" of a security if that person has or shares "voting power," which includes the power to vote or to direct the voting of that security, or "investment power," which includes the power to dispose or to direct the disposition of that security. Under the rules, more than one person may be deemed to be a beneficial owner of the same securities. Unless otherwise indicated, the address of each beneficial owner of more than 5% of North Point's stock is 109 Highway 53 West, Dawsonville, Georgia 30534. NAME AND ADDRESS NUMBER OF SHARES BENEFICIALLY OWNED PERCENTAGE OF CLASS - ---------------- ----------------------------------- ------------------- Don D. Gordon 64,977<F1> 15.17% Raymond R. Gilleland<F2> 45,575 10.64% Taft Fouts 28,690 6.70% Dwight Gilleland 23,781 5.55% Ben Overstreet 13,680 3.19% Robert Polatty 4,002 0.93% Jimmy C. Bruce 3,072(3) 0.62% Deborah Pelfrey 2,200 0.51% Judy Abercrombie 815 0.19% Clayton Bartlett 900 0.21% ALL DIRECTORS AND OFFICERS AS A GROUP 142,097 33.08% - ----------------------------------------------------------- <FN> <F1> Includes 17,418 shares owned by Mr. Gordon's wife. <F2> Mr. Raymond Gilleland's address is 4226 Smithfield Road, Tucker, Georgia 30084. <F3> Includes 395 shares owned by Mr. Bruce's wife. </FN> 68 NORTH POINT'S MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS COMPARISON OF THE QUARTERS ENDED MARCH 31, 2000 AND 1999 NET INCOME Net income for the three months ended March 31, 2000 was $392,000, compared with $360,000 for the same period in 1999. Diluted earnings per share for the first quarter of 2000 were $0.92, an increase of $0.08, or 10%, compared with the same period in 1999. The return on average shareholders' equity and return on average assets for the first quarter of 2000 were 16.9% and 1.44%, respectively, compared with 16.0% and 1.47%, respectively, for the same period in 1999. NET INTEREST INCOME Net interest income for the three months ended March 31, 2000 totaled $1.2 million, an increase of $131,000, or 12%, over the same period in 1999. This increase was primarily due to the increase in average interest-earning assets of $9.5 million, or 10%, compared with the first quarter of 1999. The net interest margin for the first three months of 2000 was 4.72%, an increase of four basis points over the same period in 1999. PROVISION FOR LOAN LOSSES The provision for loan losses for the three months ended March 31, 2000 totaled $20,000, a decrease of $10,000 compared with the same period in 1999. As a percentage of average loans on an annualized basis, the provision for loan losses for the first quarter of 2000 was 0.12%. The ratio of allowance for loan losses to outstanding loans at March 31, 2000 was 1.61%, compared with 1.92% at December 31, 1999. NON-INTEREST INCOME Non-interest income for the first three months of 2000 totaled $182,000, an increase of $20,000, or 12%, from the same period in 1999. Service charges on deposit accounts totaled $116,000 for the first quarter of 2000, an increase of $17,000 thousand over the comparable 1999 period. This increase was primarily attributable to an increase in the number of deposit accounts. Other non-interest income for the first quarter of 2000 was $66,000, an increase of $3,000, or 5%, over the same period in 1999. NON-INTEREST EXPENSE Total non-interest expense for the three months ended March 31, 2000 was $814,000, an increase of $138,000 thousand, or 20% over the same period last year. Employee salary and benefit expense increased by $62,000, or 16% during the first quarter of 2000 compared with the same period in 1999. This increase in primarily attributable to staffing additions made during the second and third quarters of 1999 for the new banking office opened in Cumming, Georgia. This banking office operates under the trade name of "North Point Bank." Occupancy expense for the first quarter of 2000 was $102,000, an increase of $21,000, or 26%, over the first quarter of 1999. This increase is primarily attributed to building, furniture and equipment expense associated with the new banking office in Cumming, Georgia, which was opened in September 1999. Other non-interest expense for the first quarter of 2000 was $260,000, an increase of $55,000, or 27%, over the same period in 1999. Data processing expense for the first quarter of 2000 increased by $9,000 over the prior year due the increased number of accounts and transactions related to the new banking office in Cumming, Georgia. Advertising and public relations expense for the first three months of 2000 increased by $9,000 over the 1999 level due to promotions associated with the new banking office in Cumming, Georgia. Other 69 non-interest expense for the first quarter of 2000 also included a non-credit related operating loss of approximately $24,000 associated with a customer checking account. North Point's efficiency ratio, which measures a bank's total operating expenses as a percentage of net interest income (before provision for loan losses) plus non-interest income was 59.1%, compared with 56.5% for the same period in 1999. INCOME TAXES Income taxes for the first three months of 2000 were $151,000, compared with $160,000 for the same period in 1999. The effective tax rate (income tax as a percentage of pre-tax income) for the first three months of 2000 was 27.8%, compared with 30.1% for the same period in 1999. BALANCE SHEET OVERVIEW Total assets at March 31, 2000 were $115.1 million, an increase of $8.6 million from year-end 1999. Average assets for the first quarter of 2000 were $109.6 million, compared with $98.3 million for the same period in 1999. Total loans at March 31, 2000 were $75.3 million, an increase of $13.1 million from year-end 1999. The growth of the loan portfolio during the first quarter of 2000 is primarily attributed to the purchase of approximately $7 million of commercial and commercial real estate loan participations from United's affiliate banks and the direct origination of loans in North Point's primary market area, which continues to experience strong economic conditions. Average loans for the first quarter of 2000 were $64.3 million, compared with $55.9 million for the same period in 1999. At March 31, 2000, investment securities available for sale were $25.1 million, compared with $25.4 million at year-end 1999. Total investment securities held to maturity at March 31, 2000 were $3.5 million, compared with $3.7 million at December 31, 1999. The estimated fair value of securities held to maturity at March 31, 2000 was $3.5 million. Total deposits at March 31, 2000 were $103.6 million, compared with $96.6 million at December 31, 1999. The most significant deposit growth during the first quarter of 2000 was in the category of interest bearing demand accounts, which increased by $4.2 million, or 16%, for the quarter. This increase is primarily attributable to an increase in the deposit balances of a local governmental authority related to annual tax collections. Average deposits for the first quarter of 2000 were $97.1 million, compared with $86.3 million for the same period in 1999. ASSET QUALITY Non-performing assets, which include non-accrual loans, loans past-due 90 days or more and still accruing interest and other real estate owned totaled $1.02 million, compared with $1.26 million at December 31, 1999. Total other real estate owned at March 31, 2000 was $247,000, unchanged from December 31, 1999, and consisted of two properties: a single-family residence and a parcel of unimproved real estate. Approximately $624,000 of the total non-performing loans at March 31, 2000, represent loans to a single borrower. These loans were partially charged-off and placed on non-accrual status during the fourth quarter of 1999. Subsequent to March 31, 2000, North Point completed foreclosure on the real estate that secured two of these loans totaling approximately $540,000 of this relationship. Upon receipt of title to the property, the balance of these two loans was transferred to other real estate owned. The allowance for loan losses at March 31, 2000 totaled $1.2 million compared with $1.11 million at December 31, 1999. The ratio of allowance for loan losses to outstanding loans at March 31, 2000 was 1.61% compared with 1.92% at year-end 1999. Net charge-offs for the three months ended March 31, 2000 were $6,000, or 0.04% of average loans on an annualized basis. 70 Management believes the allowance for loan losses at March 31, 2000 is sufficient to absorb credit losses inherent in the loan portfolio. This judgment is based on the best available information and involves a significant degree of uncertainty. CAPITAL AND DIVIDENDS The leverage, tier I risk-based and total risk-based capital ratios of North Point were 9.08%, 12.53% and 13.78%, respectively, as of March 31, 2000. These three capital ratios were all in excess of the regulatory requirement for "well capitalized" status for a bank at March 31, 2000 and December 31, 1999. A quarterly cash dividend of $0.30 per common share was paid during the first quarter of 2000, the same amount as paid in the first quarter of 1999. COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 1998 INCOME STATEMENT REVIEW Net income was $1.09 million in 1999, a decrease of 38.4% from the $1.64 million earned in 1998. Diluted earnings per share were $2.35 for 1999, compared with $3.82 reported for 1998, a decrease of 38.5%. Return on average assets and return on average shareholders' equity for 1999 were 0.98% and 10.88%, respectively, compared with 1.82% and 18.77%, respectively, for 1998 and 1.66% and 17.69%, respectively, for 1997. NET INTEREST INCOME Net interest income, which represents the difference between interest earned on assets and interest paid on deposits and other borrowings, is the single largest component of North Point's operating income. Net interest income totaled $4.53 million in 1999, compared with $4.69 million in 1998 and $4.04 million in 1997. The decrease in net interest income during 1999 is primarily attributable to increased competitive pressure on both loan and deposit rates and the placement of one large loan relationship on non-accrual status, offset by an increase in average earning assets. The net interest margin, on a tax-equivalent basis, was 4.84% in 1999, compared with 5.71% in 1998 and 5.57% in 1997. The compression of the net interest margin of 87 basis points from 1998 to 1999 is primarily attributable to increased competitive pricing pressure on both loans and deposits, and the placement of one large loan relationship on non-accrual status. The competitive pricing pressure on deposits was principally due to a single interest-bearing transaction account relationship for a municipal government authority that was awarded on a bid basis for a two-year period that commenced on January 1, 1999. 71 The following table shows, for the past three years, the relationship between interest income and interest expense and the average balances of interest earning assets and interest bearing liabilities. TABLE 1 - AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS (DOLLAR AMOUNTS IN THOUSANDS) FOR THE YEARS ENDED DECEMBER 31 1999 1998 1997 ----------- ---------- ------- ----------- --------- ------- ---------- --------- ------- AVG. INTEREST AVG. AVG. INTEREST AVG. AVG. INTEREST AVG. BALANCE <F1> RATE BALANCE <F1> RATE BALANCE <F1> RATE ----------- ---------- ------- ----------- --------- ------- ---------- ----------- ------ ASSETS: Interest-earning assets: Loans, net of unearned income <F2> $57,961 $5,973 10.31% $ 55,554 $5,965 10.74% $45,137 $5,032 11.15% Taxable investments 24,538 1,499 6.11% 19,630 1,261 6.42% 21,363 1,392 6.52% Tax-exempt investments 6,087 431 7.08% 4,808 356 7.40% 4,684 348 7.43% Federal funds sold and other interest income 7,849 397 5.06% 4,288 231 5.39% 3,453 186 5.39% ----------- --------- ----------- --------- ---------- --------- TOTAL INTEREST-EARNING ASSETS/ INTEREST INCOME 96,435 8,300 8.61% 84,280 7,813 9.27% 74,637 6,958 9.32% ----------- --------- ----------- --------- ---------- --------- NON-INTEREST-EARNING ASSETS: Allowance for loan losses (870) (777) (657) Cash and due from banks 3,979 3,244 3,498 Premises and equipment 2,342 1,792 1,656 Other assets 888 1,186 1,463 ----------- ----------- ---------- TOTAL ASSETS $102,774 $ 89,725 $ 80,597 =========== =========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits: Transaction accounts $24,964 $1,108 4.44% $ 20,947 $ 685 3.27% $15,950 $ 570 3.57% Savings and money market deposits 5,907 176 2.98% 5,666 168 2.97% 5,504 157 2.85% Certificates of deposit 43,846 2,337 5.33% 37,941 2,140 5.64% 36,497 2,066 5.66% ----------- --------- ----------- --------- ---------- --------- Total interest-bearing deposits 74,717 3,621 4.85% 64,554 2,993 4.64% 57,951 2,793 4.82% ----------- --------- ----------- --------- ---------- --------- Long-term debt and other borrowings 150 8 5.33% 175 10 5.71% 155 9 5.81% ----------- --------- ----------- --------- ---------- --------- Total borrowed funds 150 8 5.33% 175 10 5.71% 155 9 5.81% ----------- --------- ----------- --------- ---------- --------- TOTAL INTEREST-BEARING LIABILITIES/ INTEREST EXPENSE 74,867 3,629 4.85% 64,729 3,003 4.64% 58,106 2,802 4.82% NON-INTEREST-BEARING LIABILITIES: Non-interest-bearing deposits 18,263 15,918 14,439 Other liabilities 368 356 484 ---------- ----------- ---------- Total liabilities 93,468 81,004 73,029 ---------- ----------- ---------- Shareholders' equity 9,276 8,722 7,568 --------- ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $102,774 $89,725 $80,597 =========== ========== ========== Net interest-rate spread 3.76% 4.63% 4.50% Impact of non-interest bearing sources and other changes in balance sheet composition 1.08% 1.08% 1.07% --------- -------- --------- NET INTEREST INCOME/MARGIN ON INTEREST-EARNING ASSETS <F3> $4,671 4.84% $4,810 5.71% $4,156 5.57% ========= ========= ========= ======= ========= ========= <FN> <F1> Interest income on tax-exempt securities and loans is adjusted to reflect comparable interest on taxable securities. <F2> For computational purposes, includes non-accrual loans. <F3> Tax equivalent net interest income as a percentage of average earning assets. </FN> 72 The following table shows the relative impact on net interest income of changes in the average outstanding balances (volume) of interest earning assets and interest bearing liabilities and the rates earned and paid by North Point on such assets and liabilities from 1997 to 1998 and 1998 to 1999. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category. TABLE 2 - CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS (DOLLAR AMOUNTS IN THOUSANDS) 1999 Compared to 1998 Increase 1998 Compared to 1997 Increase (Decrease) in Interest Income and (Decrease) in Interest Income and Expense Due to Changes In: Expense Due to Changes In: Volume Rate Total Volume Rate Total -------------------------------------- --------------------------------------- INTEREST-EARNING ASSETS Loans $ 253 $ (245) $ 8 $ 1,161 $ (228) $ 933 Taxable Investments 302 (64) 238 (113) (18) (131) Tax-exempt investments 91 (16) 75 9 (1) 8 Federal funds sold and other interest income 181 (15) 166 45 -- 45 ------------------------------------- ------------------------------------- TOTAL INTEREST-EARNING ASSETS $ 827 $ (340) $ 487 $ 1,102 $ (247) $ 855 INTEREST-BEARING LIABILITIES: Transaction accounts $ 148 $ 275 $ 423 $ 179 $ (64) $ 115 Savings deposits 7 1 8 5 6 11 Certificates of deposit 320 (123) 197 82 (8) 74 -------------------------------------- ------------------------------------- Total interest-bearing deposits 475 153 628 266 (66) 200 Long-term debt and other borrowings (1) (1) (2) 1 -- 1 -------------------------------------- ------------------------------------- Total borrowed funds (1) (1) (2) 1 -- 1 -------------------------------------- ------------------------------------- TOTAL INTEREST-BEARING LIABILITIES $ 474 $ 152 $ 626 $ 267 $ (66) $ 201 -------------------------------------- ------------------------------------- INCREASE (DECREASE) IN NET INTEREST INCOME $ 353 $ (492) $ (139) $ 835 $ (181) $ 654 ====================================== ===================================== <FN> <F1> Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category. </FN> PROVISION FOR LOAN LOSS The provision for loan losses in 1999 was $620,000, compared with $200,000 in 1998 and $175,000 in 1997. As a percentage of average outstanding loans, the provisions recorded in 1999, 1998 and 1997 were 1.07%, 0.36% and 0.39%, respectively. Net loan charge-offs as a percentage of average outstanding loans for 1999 were 0.46 %, compared with 0.12% in 1998 and 0.09% in 1997. The increase in provision and net charge-offs in 1999 is the result of an increase in non-performing loans and growth in the loan portfolio. The provision for loan losses is based on management's evaluation of inherent risks in the loan portfolio as of the balance sheet date and conjunction with an analysis of the adequacy of the allowance for loan losses. Management believes that the allowance for loan losses is adequate as of the balance sheet date. NON-INTEREST INCOME Total non-interest income for 1999 was $625,000, compared with $654,000 in 1998 and $656,000 in 1997. The primary source of non-interest income for North Point is service charges and fees on deposit accounts. Total service charges on deposit accounts for 1999 were $451,000, compared with $484,000 in 1998 and $475,000 in 1997. The decline in service fees on deposits from 1998 to 73 1999 of $33,000 is primarily attributable to lower returned check/non-sufficient funds charges resulting from wider customer use of overdraft protection services Other services charges and fees for 1999 totaled $70,000, compared with $56,000 in 1998 and $54,000 in 1997. The increase in this income category from 1998 to 1999 is primarily attributable to increased fees for issuance of letters of credit and increased fees associated with general bank services such as wire transfers. Other non-interest income for 1999 was $104,000, compared with $113,000 in 1998 and $99,000 in 1997. The two main components of this revenue category are ATM fees and safe deposit rental fees, which collectively increased by $5,000 in 1999. This income category also includes net gains or losses on the sale of foreclosed property. During 1999, total net losses of $5,000 were recorded, compared with net gains of $7,000 in 1998. NON-INTEREST EXPENSE Total non-interest expense for 1999 was $3.07 million, compared with $2.69 million in 1998 and $2.49 million in 1997. The single largest component of non-interest expense is employee salaries and benefits, which totaled $1.64 million in 1999, compared with $1.43 million in 1998 and $1.32 million in 1997. The increase in salary and benefit expense during 1999 is related to general increases and to the hiring of two managers for the new branch office located in Cumming, Georgia. Although this office was not opened until the fourth quarter, the new managers were hired during the second quarter to allow for sufficient time to become familiar with North Point's systems, policies, and procedures. Occupancy and equipment expense for 1999 was $349,000, compared with $348,000 in 1998 and $348,000 in 1997. Other operating expense for 1999 was $1.08 million, compared with $914,000 in 1998 and $826,000 in 1997. The increase in other operating expense of $165,000, or 18%, from 1998 to 1999 in primarily attributable to an increase in advertising, contributions and stationery/supply expense associated with the opening of the new office in Cumming, Georgia; an increase in data processing costs associated with an upgrade of the branch automation system; and expenses associated with the write-down of foreclosed real estate. The efficiency ratio, which measures a bank's total operating expenses as a percentage of net interest income (before provision for loan losses) plus non-interest income, was 59.6% for 1999, compared with 50.4% and 53.4% for 1998 and 1997, respectively. INCOME TAXES North Point had income tax expense of $453,000 in 1999, compared with $814,000 in 1998 and $662,000 in 1997. North Point's effective tax rate (expressed as a percentage of pre-tax income) for 1999, 1998, and 1997 was 31.0%, 33.2% and 33.1%, respectively. The effective tax rates are lower than the statutory federal tax rate primarily because of interest income on certain investment securities that is exempt from income taxes. BALANCE SHEET OVERVIEW Total assets at December 31, 1999 were $106.5 million, compared with $93.9 million and $85.3 million at year-end 1998 and 1997, respectively. Average assets for 1999, 1998, and 1997 were $102.8 million, $89.7 million, and $80.6 million, respectively. The asset growth experienced by North Point during the past three years is attributed to the strong economic conditions in the local market area in which North Point operates. LOANS Total loans at December 31, 1999 were $62.2 million, compared with $54.6 million at December 31, 1998 and $48.1 million at December 31, 1997. Average loans for 1999, 1998, and 1997 were $58.0 million, $55.6 million, and $45.1 million, respectively. Loan growth has been particularly strong in the commercial and real estate - construction loan categories during the past three years. The decline in consumer loans from 1998 to 1999 is attributed to a reclassification of certain consumer loans to the real estate - mortgage category. 74 The following table presents a summary of the loan portfolio by loan type as of December 31 for the years 1995 through 1999. TABLE 3 - LOAN PORTFOLIO (DOLLAR AMOUNTS IN THOUSANDS) DECEMBER 31, 1999 1998 1997 1996 1995 ----------------- ---------------- ---------------- ----------------- ---------------- Commercial 10,064 6,677 4,327 6,450 7,566 Real estate - construction 12,556 8,299 6,354 4,821 2,733 Real estate - mortgage 33,378 27,059 27,153 22,773 17,542 Consumer 6,214 12,512 10,277 6,672 5,117 ----------------- ---------------- ---------------- ----------------- ---------------- Total loans 62,212 54,547 48,111 40,716 32,958 ================= ================ ================ ================= ================ As a percentage of total loans: Commercial 16.2% 12.2% 9.0% 15.8% 22.9% Real estate - construction 20.2% 15.2% 13.2% 11.8% 8.3% Real estate - mortgage 53.6% 49.7% 56.4% 56.0% 53.3% Consumer 10.0% 22.9% 21.4% 16.4% 15.5% ----------------- ---------------- ---------------- ----------------- ---------------- Total loans 100.0% 100.0% 100.0% 100.0% 100.0% ================= ================ ================ ================= ================ Substantially all of North Point's loans are to customers located in its immediate market area of Dawson and Forsyth Counties in north Georgia. A significant decline in the value of real estate in North Point's primary market or a downturn in the local economy could result in an increase in the provision for loan losses and charge-offs. The following table sets forth the maturity distribution of real estate construction and commercial loans, including the interest sensitivity for loans maturing in more than one year, as of December 31, 1999. TABLE 4 - LOAN PORTFOLIO MATURITY (DOLLAR AMOUNTS IN THOUSANDS) Rate Structure for Loans Maturity Maturing Over One Year ----------------------------------------------------------- --------------------------- One Year One through Over Five Fixed Rate Floating or less Five Years Years Total Rate - -------------------------------------- --------------- ----------------- ------------- ----------- ------------ -------------- Commercial 5,208 4,763 93 10,064 2,995 1,861 Real estate - construction 12,556 - - 12,556 - - --------------- ----------------- ------------- ----------- ------------ -------------- Total 17,764 4,763 93 22,620 2,995 1,861 =============== ================= ============= =========== ============ ============== ASSET QUALITY Non-performing loans, which include non-accrual loans and loans past due over 90 days and still on accrual status, totaled $1.01 million at December 31, 1999, compared with $552,000 at December 31, 1998 and $116,000 at December 31, 1997. The increase in non-performing loans at year-end 1999 is primarily attributable to loans made to one borrower that are principally secured by unimproved real estate. All loans in this relationship were placed on non-accrual status during the fourth quarter of 1999. Based upon management's evaluation of the collateral value, these loans were also partially charged-off during 1999 and no material additional loss on this loan relationship is expected. The increase in non-performing loans at year-end 1998 is primarily attributable to three residential construction loans that were place on non-accrual status. Subsequently to December 31, 1999, two of the three loans were paid in full and one loan was transferred to foreclosed real estate. At December 31, 1999, the ratio of non-performing loans to total loans was 1.63%, compared with 1.01% and .24% at year-end 1998 and 1997, respectively. Non-performing assets, which included non-performing loans and foreclosed real 75 estate, totaled $1.26 million at December 31, 1999, compared with $552,000 at December 31, 1998 and $175,000 at December 31, 1997. Foreclosed real estate at December 31, 1999, consisted of two properties - one single-family residence, which at year-end 1999 was classified as a non-accrual loan, and one parcel of unimproved real estate. The carrying value of the single family residence was reduced by $50,000 (charged to current period expense) during the fourth quarter of 1999 to reflect management's estimate of current fair market value. It is North Point's general policy to place a loan on non-accrual status when, in the opinion of management, the principal and interest on a loan is not likely to be repaid in accordance with the loan terms. When a loan is placed on non-accrual, all accrued but unpaid interest is reversed against current interest income. Depending on management's evaluation of the borrower's financial condition and the loan collateral, interest on a non-accrual loan may be recognized on a cash basis as payments are received. The table below presents North Point's non-performing loans and assets at December 31 for each of the past five years. TABLE 5 - NON-PERFORMING ASSETS (DOLLAR AMOUNTS IN THOUSANDS) DECEMBER 31, 1999 1998 1997 1996 1995 - ----------------------------------------------- ---------------- --------------- --------------- -------------- --------------- Non-accrual loans $ 706 $ 473 $ 72 $ 59 $ 65 Loans past due 90 days or more and still accruing 308 79 44 57 84 ---------------- --------------- --------------- -------------- --------------- Total non-performing loans 1,014 552 116 116 149 Other real estate owned 247 - 59 - 48 ---------------- --------------- --------------- -------------- --------------- Total non-performing assets $ 1,261 $ 552 $ 175 $ 116 $ 197 ================ =============== =============== ============== =============== Total non-performing loans as a percentage of 1.63% 1.01% 0.24% 0.28% 0.45% total loans Total non-performing assets as a percentage of total assets 1.18% 0.59% 0.21% 0.15% 0.31% At December 31, 1999, there were loans within North Point's portfolio that were not classified as non-performing but for which known information about the borrowers' financial condition caused management to have concerns about the ability of the borrowers to comply with the repayment terms of the loans. These loans are identified and monitored through a routine loan review process and are considered in the determination of the allowance for loan losses. Based on management's evaluation of current market conditions, loan collateral and secondary sources of repayment, no significant losses are anticipated in connection with these loans. 76 The table below summarizes changes in the allowance for loan losses for each of the past five years. TABLE 6 - ALLOWANCE FOR LOAN LOSSES (DOLLAR AMOUNTS IN THOUSANDS) YEARS ENDED DECEMBER 31, 1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------------------- Balance beginning of period $ 844 $ 710 $ 574 $ 396 $ 429 Provision for loan losses 620 200 175 160 70 Amounts charged-off: Commercial 5 9 7 69 130 Real estate - construction - - - Real estate - mortgage 226 16 29 Consumer 69 62 50 ----------------------------------------------------------------------------------- Total loans charged-off $ 300 $ 87 $ 86 $ 69 $ 130 Recoveries of charged-off loans: Commercial - - 4 87 27 Real estate - construction - - - Real estate - mortgage 8 4 20 Consumer 24 17 23 ----------------------------------------------------------------------------------- Total recoveries 32 21 47 87 27 ----------------------------------------------------------------------------------- Net charge-offs 268 66 39 (18) 103 ----------------------------------------------------------------------------------- Balance end of period $1,196 $ 844 $ 710 $ 574 $ 396 =================================================================================== Total loans: At year-end $62,212 $ 54,547 $ 48,111 $ 40,716 $ 32,958 Average 57,961 55,554 45,137 37,443 31,583 As a percentage of average loans: Net charge-offs 0.46% 0.12% 0.09% (0.05%) 0.33% Provision for loan losses 1.07% 0.36% 0.39% 0.43% 0.22% Allowance as a percentage of year- end loans 1.92% 1.55% 1.48% 1.41% 1.20% SECURITIES Total securities at December 31, 1999 were $29.1 million, compared with $25.0 million and $26.9 million at year-end 1998 and 1997, respectively. Total securities at December 31, 1999 included $3.76 million of securities classified as held to maturity, which had an estimated fair value of $3.78 million. Average securities for 1999 and 1998 were $30.6 million and $24.4 million, respectively. The composition and growth of the securities portfolio is reflective of management's desire to provide balance sheet liquidity while providing a stable source of interest income that has virtually no credit risk. The securities portfolio at year-end 1999 primarily consists of U.S. Government agency, state, and municipal securities, and mortgage-backed securities. 77 The following table shows the carrying value of securities, by security type, as of December 31, 1999, 1998, and 1997. TABLE 7 - SECURITIES PORTFOLIO (DOLLAR AMOUNTS IN THOUSANDS) CARRYING VALUE OF SECURITIES AVAILABLE FOR SALE December 31, 1999 1998 1997 - ---------------------------------------------------------------------------------------------------------------- U.S. Treasury $ 251 $ 761 $ 1,001 U.S. Government agencies 19,931 15,183 10,844 State and political subdivisions 2,956 2,565 946 Mortgage-backed securities 2,142 1,733 1,393 Other securities 92 92 92 --------------------------------------------------------- Total $25,372 $20,334 $14,276 ========================================================= HELD TO MATURITY December 31, 1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------ U.S. Treasury $ -- $ -- $ 497 U.S. Government agencies 247 743 7,081 State and political subdivisions 3,111 3,452 3,626 Mortgage-backed securities 404 506 1,450 ========================================================= Total $ 3,762 $ 4,701 $12,654 --------------------------------------------------------- --------------------------------------------------------- TOTAL SECURITIES $29,134 $25,035 $26,930 ========================================================= The following table shows the expected maturity of the securities portfolio by maturity date and the average yield based on amortized cost on a fully tax-equivalent basis as of December 31, 1999. TABLE 8 - MATURITIES AND YIELDS OF SECURITIES AS OF DECEMBER 31, 1999 (DOLLAR AMOUNTS IN THOUSANDS) Over One Over Five Year Years One Year Through Through Over or Less Five years Ten Years Ten Years Total ----------------- ---------------- ---------------- ----------------- ---------------- U.S. Treasury $ 251 $ -- $ -- $ -- $ 251 U.S. Government agencies 996 16,348 2,834 -- 20,178 State and political subdivisions 765 3,254 1,579 469 6,067 Mortgage-backed securities 253 596 452 1,245 2,546 Other securities -- -- -- 92 92 ------- ------- ------- ------- ------- Total $ 2,265 $20,198 $ 4,865 $ 1,806 $29,134 ======= ======= ======= ======= ======= Weighted average yield 5.99% 6.31% 6.54% 6.33% 6.32% Percent of total 7.8% 69.3% 16.7% 6.2% 100.0% 78 INTEREST RATE SENSITIVITY MANAGEMENT North Point actively manages interest rate sensitivity through its Asset/Liability Management Committee. The primary objectives of asset/liability management are to ensure that North Point can meet the investment return expectations of its shareholders in the event that interest rates change and to provide adequate liquidity to meet the needs of customers. Effective interest rate risk management seeks to ensure that both interest sensitive assets and liabilities respond to changes in market rates in a manner that provides for a minimal fluctuation of net interest income, which is the primary source of operating revenue. North Point's Asset/Liability Management Committee utilizes a gap analysis to determine the overall sensitivity of the balance sheet to changes in market interest rates. A negative gap (more liabilities than assets repricing within one year) indicates that the bank's net interest income will fall in a rising rate environment. A positive gap (more assets repricing than liabilities within one year) indicates the bank's net interest income will decline in a falling rate environment. The following table summarizes the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1999 and the amounts that are expected to mature or reprice in each of the five time periods shown. The amounts of assets and liabilities shown are based on contractual terms and maturities. TABLE 9 - INTEREST RATE GAP SENSITIVITY (DOLLAR AMOUNTS IN THOUSANDS) One Four One Over Five Through Through Through Years and Three Twelve Five Non-rate Immediate Months Months Years Sensitive Total - -------------------------------------------- -------------- ------------- ------------- -------------- ------------- ------------ Interest earning assets: Federal funds sold $ 4,180 $ -- $ -- $ -- $ -- $ 4,180 Interest bearing deposits in banks 2,981 -- -- -- -- 2,981 Securities 92 215 2,248 18,732 7,847 29,134 Loans 2,262 12,723 23,118 22,483 1,626 62,212 --------------------------------------------------------------------------------- Total interest earning assets $ 9,515 $ 12,938 $ 25,366 $ 41,215 $ 9,473 $ 98,507 --------------------------------------------------------------------------------- Interest bearing liabilities: Transaction accounts $ -- $ 26,991 $ -- $ -- $ -- $ 26,991 Savings deposits -- 5,350 -- -- -- 5,350 Time deposits -- 12,262 26,891 7,333 -- 46,486 Other borrowings -- 389 -- -- -- 389 --------------------------------------------------------------------------------- Total interest bearing liabilities -- 44,992 26,891 7,333 -- 79,216 --------------------------------------------------------------------------------- Non-interest bearing sources of funds -- -- -- -- 17,738 17,738 --------------------------------------------------------------------------------- Interest sensitivity gap 9,515 (32,054) (1,525) 33,882 (8,265) 1,553 --------------------------------------------------------------------------------- Cumulative sensitivity gap $ 9,515 $(25,539) $(24,064) $ 9,818 $ 1,553 $ -- ================================================================================= Percentage of assets repricing 9.66% 13.13% 25.75% 41.84% 9.62% 100.0% At December 31, 1999, the one-year gap was a negative $ 27.0 million. This generally indicates that North Point's net interest income will decrease in a rising rate environment and increase in a declining rate environment. This is commonly referred to as being "liability sensitive." There are significant limitations of gap analysis for determining the impact of rate changes on a bank's net interest income. For example, although certain assets and liabilities may have similar maturity or repricing characteristics, they may react differently to changes in market rates. In addition, some assets that have adjustable rates may have contractual terms that limit the frequency and amount of rate increases. 79 DEPOSITS AND OTHER BORROWINGS Total deposits at December 31, 1999 were $96.6 million, compared with $84.1 million and $76.8 million at year-end 1999 and 1998, respectively. Average deposits for 1999, 1998, and 1997 were $92.9 million, $80.4 million, and $72.4 million, respectively. As a community-oriented bank, North Point views core deposits as the primary source of funding growth in interest earning assets. Time deposits of $100,000 or more totaled $16.3 million at December 31, 1999, compared with $12.3 million and $10.9 million at year-end 1998 and 1997, respectively. North Point had no brokered deposits at year-end 1999 or 1998. The following table sets forth the maturities of time deposits of $100,000 and greater as of December 31, 1999. TABLE 10 - MATURITIES OF TIME DEPOSITS OF $100,000 AND GREATER (DOLLAR AMOUNTS IN THOUSANDS) Three months or less $ 4,091 Over three months through six months 3,825 Over six months through twelve months 6,006 Over one year 2,403 ------- Total $16,325 ======= CAPITAL, LIQUIDITY, AND DIVIDENDS Total shareholders' equity at December 31, 1999 was $9.2 million, compared with $9.4 million and $8.1 million at year-end 1998 and 1997, respectively. Total cash dividends of $1.20 per share were paid in 1999, compared with $0.96 and $0.88 in 1998 and 1997, respectively. The dividend payout ratios, as a percentage of net income, were approximately 51%, 25%, and 28% for 1999, 1998, and 1997, respectively. During the first quarter of 1997 and 1999, North Point's board of directors declared the following common stock dividends: YEAR DIVIDEND % NEW SHARES 1997 20% 57,118 1998 - - 1999 25% 85,677 The common stock dividends resulted in a reduction of retained earnings and offsetting increase in common stock for the number of new shares issued, at a par value of $5.00. All per-share amounts presented in this discussion are calculated based on the retroactive adjustment of outstanding common shares for the stock dividends for all periods presented. North Point is subject to various regulatory capital requirements administered by banking regulatory agencies. The minimum ratios to be considered "well capitalized" for banks as defined by banking regulations are five percent for leverage ratio, six percent for Tier I capital ratio, and ten percent for total risk-based capital ratio. The following table shows North Point's bank subsidiary capital ratios as of December 31, 1999 and 1998 and the amounts required for minimum capital adequacy purposes. 80 TABLE 11 - REGULATORY CAPITAL (DOLLAR AMOUNTS IN THOUSANDS) LEVERAGE TIER I RISK-BASED TOTAL RISK-BASED ------------------------------------------------------------------------------------------- 1999 AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------------------------------------------------------------------------------------------- Actual Amount $ 9,712 9.09% $ 9,712 14.25% $ 10,568 15.50% Regulatory Minimum 3,206 3.00% 2,045 4.00% 5,453 8.00% ------------------------------------------------------------------------------------------- Excess $ 6,506 6.09% $ 7,667 10.25% $ 5,115 7.50% 1998 Actual Amount $ 9,140 9.80% $ 9,140 16.09% $ 9,852 17.34% Regulatory Minimum 2,798 3.00% 1,704 4.00% 4,545 8.00% ------------------------------------------------------------------------------------------- Excess $ 6,342 6.80% $ 7,436 12.09% $ 5,307 9.34% (1) As of December 31, 1999 and 1998, the most recent notification from the Federal Deposit Insurance Corporation categorized Dawson County Bank as "well capitalized" under the current regulatory framework for prompt corrective action. Prompt corrective action guidelines do not apply to bank holding companies. North Point's liquidity management policy is designed to ensure that the daily cash flow needs of Dawson County Bank and its customers (both depositors and borrowers) are met in a cost-effective manner. Liquidity represents the ability of a bank to convert assets into cash or to obtain additional funds through borrowings. In the opinion of management, North Point's liquidity position at December 31, 1999 is sufficient to meet expected cash flow requirements. Reference should be made to the statements of cash flows appearing in the consolidated financial statements for a three-year analysis of the changes in cash (and equivalents) attributed to operating, investing, and financing activities. IMPACT OF INFLATION AND PRICE CHANGES North Point's asset and liabilities, like most financial services companies, are mostly financial in nature. Unlike industrial firms, relatively little investment is held in fixed assets or inventory. Inflation can have a significant impact on asset growth and the resulting need to increase equity capital at higher than expected rates in order to maintain required capital ratios. Management believes the potential impact of inflation on the North Point's financial performance is dependent upon how well North Point reacts to inflationary pressures. North Point's asset/liability management policy and the periodic review of the pricing of North Point's banking products and services are both designed to manage the risk of inflation. YEAR 2000 North Point complied with all aspects of the Federal Financial Institutions Examination Council's directive regarding Year 2000 testing and remediation. None of North Point's systems sustained a failure related to Year 2000. North Point established a budget of $85,000 for Year 2000 testing and remediation and, as of December 31, 1999, approximately $85,000 was actually spent and no additional expenditures are expected. In accordance with recently issued accounting guidelines on how Year 2000 costs should be recognized for financial statement purposes, North Point recognized as current period expense all costs associated with the consulting, inventory, testing and resources components of the Year 2000 budget. North Point funded the Year 2000 costs out of its normal operating cash flows. 81 THE PROPOSED INDEPENDENT MERGER BACKGROUND OF THE MERGER In a strategic planning session in June of 1998, the board of directors and senior management of Independent reviewed a variety of possible alternatives for Independent to pursue. After a number of board discussions and educational efforts, the Chairman of the board of directors appointed a three-member committee to pursue merger possibilities and report back to the board of directors. On November 22, 1999, James H. Powell, President and Chief Executive Office of Independent met with Jimmy Tallent, President and Chief Executive Officer of United, to determine if there might be some interest in considering a merger of the institutions. On December 3, 1999, Mr. Powell and Director Bob Prillaman visited Mr. Tallent to discuss the proposal in greater detail. On December 21, 1999, Messrs. Prillaman and Powell reported to Independent's board of directors on the visit to United, reviewed financial information on United and Independent related to the valuation, and proposed that Independent enter into formal discussions with United about a merger. On December 29, 1999, Mr. Tallent visited Independent and toured its facilities at Powder Springs, Marietta, Lost Mountain, and Hiram, and he discussed management depth and asset quality with Mr. Powell. On January 7, 2000, Mr. Powell visited Blairsville to tour United's facilities and to meet with key personnel. On January 12, 2000, Mr. Powell received a letter of intent from Mr. Tallent outlining terms and conditions of a proposed merger. A copy of this letter, supporting financial data, and other materials were sent to each member of the Independent board of directors for review. At the conclusion of the meeting of the board of directors of Independent on January 25, 2000, the board authorized proceeding with due diligence in preparation for entering into a definitive agreement to merge. On January 28, 2000, the board of directors of United considered the business and operations and asset quality of Independent as well as the attractiveness of the Independent franchise and its management team and the compatibility of that franchise with the operations of United. After that consideration, United's board of directors approved the execution of the Agreement and Plan of Reorganization, subject to satisfactory completion of a due diligence investigation of Independent. On January 31 and February 1, 2000, on-site due diligence was conducted by representatives of United. Subsequently, both companies undertook additional due diligence and discussions with legal counsel. After completion of the due diligence, Mr. Tallent and Mr. Powell signed a letter of intent on February 10, 2000, and United and Independent issued a joint press release describing the transaction. At a meeting on February 29, 2000, Independent's board of directors met with legal counsel and, after review of pertinent documents, unanimously agreed to execute the definitive agreement, which was executed on March 3, 2000. Prior to the engagement of The Carson Medlin Company to render its opinion as to the fairness, from a financial potion of view, of the merger, Independent had negotiated to retain a financial advisory firm with experience in banking transactions to act as its financial advisor. This financial advisory firm advised Independent, however, that it would not be able to issue an opinion regarding the consideration to be received by the Independent shareholders, citing, among other factors, concerns with the value of the United common stock due to the lack of a liquid trading market, and its lack of familiarity with United. The Carson Medlin Company had previously assisted United with a placement of shares in North Carolina and, as a result of its greater familiarity with United, did not share the level of concern expressed by the other financial advisory firm. The Board of Independent considered both the concerns of the other financial advisory firm and the analysis of The Carson Medlin Company in retaining The Carson Medlin Company as its financial advisor. SUMMARY OF THE MATERIAL FEATURES OF THE MERGER BETWEEN UNITED AND INDEPENDENT EFFECTIVE DATE. The merger will be effective upon the approval of the merger agreement by the Independent shareholders and the filing of a certificate of merger with the Georgia Secretary of State. The merger also is subject to approval by the Board of Governors of the Federal Reserve System and the 82 Department of Banking and Finance of the State of Georgia. Management of United and Independent anticipate that the merger will become effective in the third quarter of 2000. TERMS OF THE MERGER. On the effective date of the merger, each outstanding share of Independent common stock will be converted into and exchanged for 0.4211 shares of United common stock. If, prior to the effective date, the outstanding shares of United common stock are increased through a stock dividend, stock split, subdivision, recapitalization, or reclassification of shares, or are combined into a lesser number of shares by reclassification, recapitalization, or reduction of capital, the number of shares of United common stock to be delivered pursuant to the merger in exchange for a share of Independent common stock will be proportionately adjusted. United will not issue fractional share certificates of common stock in connection with the merger, and an outstanding fractional share interest will not entitle the owner to vote, to receive dividends, or to any rights of a shareholder of United with respect to that fractional interest. Instead of issuing any fractional shares of common stock, United will pay in cash an amount (computed to the nearest cent) equal to the fraction of the share multiplied by $38.00 per share. If the merger is completed, shareholders of Independent will become shareholders of United, Independent will be merged with United, and Independent will cease to exist as a separate entity. Following the merger, the Restated Articles of Incorporation, Bylaws, corporate identity, and existence of United will not be changed. TERMINATION AND CONDITIONS OF CLOSING. The merger agreement may be terminated and the merger abandoned at any time either before or after approval of the merger agreement by the shareholders of Independent, but not later than the Effective Date: o by either party, if the other party has a material adverse change in its financial condition or business; o by either party, if the other party materially breaches any of the representations or warranties or any covenant or agreement it made under the merger agreement; o by either party, if it learns of information not disclosed in the merger agreement or related documents which the other party was required to disclose pursuant to the merger agreement, which materially and adversely affects the business, properties, assets, or earnings of the other party; o by either party, if a lawsuit is filed or threatened which could prohibit or otherwise materially affect the merger agreement or the completion of the merger and which either party believes, in good faith, would make completion of the merger inadvisable; o by either party, if the merger is not completed by August 31, 2000; o by United, if the holders of 155,852 or more of the outstanding shares of Independent common stock choose to dissent from the merger and demand payment in cash; o by either party, if the Independent shareholders do not approve the merger agreement; or o by either party, if it learns of any potential liability of the other party which results from the other party's non-compliance with any environmental law or from the environmental condition of the properties or assets of the other party. The following are some of the required conditions of closing: o the accuracy of the representations and warranties of all parties contained in the merger agreement and related documents as of the date when made and the effective date; o the performance of all agreements and conditions required by the merger agreement; o the delivery of officers certificates, resolutions, and legal opinions to Independent and United; 83 o approval of the merger by the Independent shareholders; o receipt of all necessary authorizations of governmental authorities, and the expiration of any regulatory waiting periods; o effectiveness of the registration statement of United relating to the shares of United common stock to be issued to Independent shareholders in the merger; o the receipt by Independent of the opinion of Kilpatrick Stockton LLP as to the tax consequences to Independent shareholders; o the receipt by United of an opinion of Porter Keadle Moore LLP that the merger will be accounted for as a pooling of interests; o the issuance of a certificate of merger by the Secretary of State of Georgia; and o the receipt by Independent of a fairness opinion from Independent's financial advisor. EXPENSES United will pay all of its expenses incurred in connection with the authorization, preparation, execution, and performance of the merger agreement, including all fees and expenses of its agents, representatives, counsel, and accountants and the fees and expenses related to filing regulatory applications with state and federal authorities in connection with the transactions contemplated thereby. Independent will pay all of its expenses incurred in connection with the authorization, preparation, execution, and performance of the merger agreement, including all fees and expenses of agents, representatives, counsel, and accountants for Independent and the cost of reproducing and mailing the proxy statement. ACCOUNTING TREATMENT United will account for the merger as a pooling of interests transaction in accordance with generally accepted accounting principles. Under this accounting method, holders of Independent common stock will be deemed to have combined their existing voting common stock interests with the holders of United common stock by exchanging their shares for shares of United common stock, and as a result, the assets and liabilities of Independent will be added to those of United at their recorded book value, and the shareholders' equity accounts of Independent and United would be combined on United's consolidated balance sheet. The unaudited pro forma financial information contained in this proxy statement has been prepared using the pooling of interests accounting method to account for the merger. REGULATORY APPROVALS The Board of Governors of the Federal Reserve System and the Department of Banking and Finance of the State of Georgia have approved the Independent merger. In determining whether to grant that approval, the Federal Reserve and the Department of Banking and Finance considered the effect of the merger on the financial and managerial resources and future prospects of the companies and banks concerned and the convenience and needs of the communities served. 84 INFORMATION ABOUT INDEPENDENT BANCSHARES, INC. DESCRIPTION OF BUSINESS Independent is a one-bank holding company which, through its subsidiary, Independent Bank & Trust, provides banking services through its four full-service banking offices, two in Powder Springs, Georgia and one each in Hiram and Marietta, Georgia. The Company's executive office is located at 4484 Marietta Street, Powder Springs, Georgia 30127, and its telephone number is (770) 943-5000. Independent Bank & Trust offers a broad range of customary banking services including commercial, mortgage, and consumer loans; checking, savings, and time deposit accounts; wire transfers; and rental of safety deposit boxes. Independent was incorporated on July 15, 1996, as a Georgia business corporation. On July 15, 1996, Independent acquired all of the shares of common stock of Independent Bank & Trust, which was organized as a Georgia banking corporation on March 4, 1988. As of March 31, 2000, Independent had total consolidated assets of approximately $161.1 million, total deposits of approximately $141.4 million, and total shareholders' equity of approximately $13.0 million. At March 31, 2000, Independent had 57 full-time employees. 85 VOTING SECURITIES AND PRINCIPAL SHAREHOLDERS The following table lists each shareholder of record that directly or indirectly owned, controlled, or held with power to vote 5% or more of the 1,948,148 outstanding shares of Independent common stock as of May 1, 2000, and the amount of Independent common stock held by each executive officer and director of Independent. Unless otherwise indicated, each person has sole voting and investment powers over the indicated shares. Information relating to beneficial ownership of the Independent common stock is based upon "beneficial ownership" concepts set forth in rules issued under the Securities Exchange Act of 1934. Under those rules, a person is deemed to be a "beneficial owner" of a security if that person has or shares "voting power," which includes the power to vote or to direct the voting of that security, or "investment power," which includes the power to dispose or to direct the disposition of that security. Under the rules, more than one person may be deemed to be a beneficial owner of the same securities. Unless otherwise indicated, the address of each beneficial owner of more than 5% of Independent's stock is 4484 Marietta Street, Powder Springs, Georgia 30127. Name Number of Shares Beneficially Owned Percentage of Class - ---- ----------------------------------- ------------------- Wayne Ingram<F1> 243,600 11.78% Bob M. Prillaman 170,311<F2> 8.24% Joseph Mykytyn 157,922<F3> 7.64% James H. Powell 129,748<F4> 6.28% J. Al Cochran 105,503<F5> 5.10% Jimmy W. Jones 93,618<F6> 4.53% Henry P. Wilson 29,107<F7> 1.41% Delmas L. Lindsey 23,464<F8> 1.13% J. Daniel Oliver 22,893<F9> 1.11% Roy N. Vanderslice 22,084<F8> 1.07% M. Gregson Griggs 22,097<F9> 1.07% Jack D. Hall 11,499 0.56% ALL DIRECTORS AND OFFICERS AS A GROUP 1,031,846<F3> - <F9> 49.91% <FN> <F1> Mr. Ingram's address is 430127.ipp Road, Powder Springs, Georgia <F2> Includes currently exercisable stock options for 29,612 shares, but does not include 168,623 shares owned by Mr. Prillaman's adult children. <F3> Includes currently exercisable stock options for 24,802 shares. <F4> Includes currently exercisable stock options for 25,000 shares. <F5> Includes currently exercisable stock options for 13,048 shares. <F6> Includes currently exercisable stock options for 10,214 shares. <F7> Includes currently exercisable stock options for 6,607 shares. <F8> Includes currently exercisable stock options for 1,250 shares. <F9> Includes currently exercisable stock options for 2,500 shares. </FN> 86 INDEPENDENT'S MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS COMPARISON OF THE THREE MONTHS ENDED MARCH 31, 2000 AND 1999 NET INCOME Net income for the three months ended March 31, 2000 was $455,000, compared with $310,000 for the same period in 1999. Diluted earnings per share for the first quarter of 2000 were $0.22, an increase of $0.06, or 38%, compared with the same period in 1999. The return on average shareholders' equity and return on average assets for the first quarter of 2000 were 14.1% and 1.19%, respectively, compared with 10.0% and 0.91%, respectively, for the same period in 1999. NET INTEREST INCOME Net interest income for the three months ended March 31, 2000 totaled $1.71 million, an increase of $258,000, or 18%, over the same period in 1999. This increase was primarily due to the increase in average interest bearing assets of $20.1 million, or 31%, compared with the first quarter of 1999. The increase in average interest bearing assets was funded by growth in average deposits of $14.2 million and net additional borrowings from the Federal Home Loan Bank of $5.0 million. The net interest margin for the first three months of 2000 was 4.87%, down slightly from the same period in 1999. PROVISION FOR LOAN LOSSES The provision for loan losses for the three months ended March 31, 2000 totaled $45,000, a decrease of $31,000 compared with the same period in 1999. As a percentage of average loans on an annualized basis, the provision for loan losses for the first quarter of 2000 was 0.18%. The ratio of allowance for loan losses to outstanding loans at March 31, 2000 was 1.15%, compared with 1.11% at December 31, 1999. NON-INTEREST INCOME Non-interest income for the first three months of 2000 totaled $223,000, a decrease of $36,000, or 14%, from the same period in 1999. Service charges on deposit accounts totaled $111,000 for the first quarter of 2000, an increase of $11,000 over the comparable 1999 period. This increase was primarily attributable to an increase in the volume and number of deposit accounts during the past year. Mortgage banking revenue for the first quarter of 2000 was $25,000, a decrease of $71,000, or 74% over the same period in 1999. This decrease is attributable to the general increase in mortgage loan interest rates and corresponding reduction in the demand for mortgage refinance loans. Other loan fee income, which includes fees received for issuance of letters of credit and the sale and subsequent servicing of SBA loans, totaled $44,000 for the first three months of 2000. There was no revenue recorded for this income category during the first quarter of 1999. NON-INTEREST EXPENSE Total non-interest expense for the three months ended March 31, 2000 was $1.19 million, an increase of $37,000, or 3% over the same period in 1999. Employee salary and benefit expense for the first three months of 2000 decreased by $69,000 compared with the same period in 1999. This decrease is primarily attributable to a decrease in commissions paid to mortgage loan originators, lower group medical insurance premiums, and a decrease in the expense associated with Independent's stock incentive plan and executive supplemental retirement plan. Occupancy expense for the first quarter of 2000 increased by $42,000 over the same period in 1999. This increase is primarily attributable to increased building expense (utilities, property taxes, and maintenance) associated with the new full-service office in Marietta, Georgia, that was 87 opened during the fourth quarter of 1998 and increased equipment expense. The increase in equipment expense is principally depreciation and maintenance expense associated with check imaging and desktop computer equipment that was purchased during the second and third quarters of 1999. Other non-interest expense for the first three months of 2000 increased by $64,000, or 23%, compared with the same period in 1999. Increases in advertising/customer relations expense, postage and supply expense, professional fees, and data processing expense accounted for $53,000 of the increase in this expense category and are attributable to the general growth of Independent's customer account base. Independent's efficiency ratio, which measures a bank's total operating expenses as a percentage of net interest income (before provision for loan losses) plus non-interest income was 61.5% for the first quarter of 2000 compared with 67.3% for the first quarter of 1999. INCOME TAXES Income taxes for the first three months of 2000 were $246,000, compared with $175,000 for the same period in 1999. The effective tax rate (income tax as a percentage of pre-tax income) for the first three months of 2000 was 35.1%, compared with 36.1% for the same period in 1999. BALANCE SHEET OVERVIEW Total assets at March 31, 2000 were $161.1 million, an increase of $16.0 million from year-end 1999. Average assets for the first quarter of 2000 were $153.5 million, compared with $137.8 million for the same period in 1999. Total loans at March 31, 2000 were $101.3 million, compared with $101.6 million at year-end 1999. Although Independent originated a significant amount of new loans during the first quarter of 2000, repayments of principal on construction loans that were originated during 1999 by a loan officer who is no longer employed by Independent caused loan growth to fall below historical levels. Average loans for the first quarter of 2000 were $101.8 million, compared with $89.9 million for the same period in 1999. At March 31, 2000, investment securities available for sale were $23.4 million, compared with $18.9 million at year-end 1999. Substantially all of this increase is the result of purchase of securities issued by U. S. Government-sponsored agencies. Total investment securities held to maturity at March 31, 2000 were $6.7 million, compared with $7.2 million at December 31, 1999. The estimated fair market value of investment securities held to maturity at March 31, 2000 was $5.8 million. At March 31, 2000, Independent had federal funds sold totaling $16.7 million, an increase of $11.7 million from year-end 1999. This was the result of investing funds received in a short-term deposit described below. Total deposits at March 31, 2000 were $141.4 million, compared with $123.4 million at December 31, 1999. Of the total $18 million of deposit growth during the first quarter of 2000, approximately $12 million was related to tax deposits of a local government authority that were place in an interest bearing transaction account for a pre-determined period of time. Subsequent to March 31, 2000, these funds were withdrawn. Average deposits for the first quarter of 2000 were $132.4 million, compared with $111.2 million for the same period in 1999. ASSET QUALITY Non-performing assets, which includes non-accrual loans, loans past-due 90 days or more and still accruing interest and other real estate owned totaled $26,000, compared with $30,000 at December 31, 1999. Independent had no other real estate owned as of March 31, 2000 or December 31, 1999. The allowance for loan losses at March 31, 2000 totaled $1.16 million, compared with $1.12 million at December 31, 1999. The ratio of allowance for loan losses to outstanding loans at March 31, 2000 was 1.15%, an increase of four basis points from year-end 1999. Net charge-offs for the three months ended March 31, 2000 were $4,000, or 0.02% of average loans on an annualized basis. 88 Management believes the allowance for loan losses at March 31, 2000 is sufficient to absorb credit losses inherent in the loan portfolio. This judgment is based on the best available information and involves a significant degree of uncertainty. CAPITAL AND DIVIDENDS The leverage, tier I risk-based and total risk-based capital ratios were 8.82 %, 11.14%, and 12.10%, respectively, as of March 31, 2000. These three capital ratios are all in excess of the regulatory requirement for "well capitalized" status for a bank at March 31, 2000 and December 31, 1999. An annual cash dividend of $0.20 per common share was paid during the first quarter of 2000, representing an increase 33% over the 1999 dividend level. The dividend of $0.20 per common share represented a payout ratio for the year 2000 of 24% of net income for the year ended December 31, 1999. COMPARISON OF THE YEARS ENDED DECEMBER 31, 1999 AND 1998 INCOME STATEMENT REVIEW Net income was $1.62 million in 1999, an increase of 47% from the $1.10 million earned in 1998. Diluted earnings per share were $0.82 for 1999, compared with $0.55 reported for 1998, an increase of 49%. Return on average assets and return on average shareholders' equity for 1999 were 1.16% and 13.75%, respectively, compared with 0.92% and 9.85%, respectively, for 1998 and 0.83% and 7.32%, respectively, for 1997. NET INTEREST INCOME Net interest income, which represents the difference between interest earned on assets and interest paid on deposits and other borrowings, is the single largest component of Independent's operating income. Net interest income totaled $6.29 million in 1999, compared with $5.36 million in 1998 and $4.28 million in 1997. The increase in net interest income during the past two years is primarily attributable to the increase in average interest earning assets, funded with both new deposits and borrowings from the Federal Home Loan Bank. The net interest margin, on a tax-equivalent basis, was 4.97% in 1999, compared with 4.92% in 1998 and 4.84% in 1997. 89 The following table shows, for the past three years, the relationship between interest income and interest expense and the average balances of interest earning assets and interest bearing liabilities. TABLE 1 - AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS FOR THE YEARS ENDED DECEMBER 31 (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 1999 1998 1997 -------------------------------- ----------------------------- ----------------------------- AVG. INTEREST AVG. AVERAGE AVG. AVG. AVG. BALANCE <F1> RATE BALANCE INTEREST RATE BALANCE INTEREST RATE <F1> <F1> ASSETS: Interest-earning assets: Loans, net of unearned income <F2> $ 96,005 $9,471 9.87% $78,135 $8,329 10.66% $62,372 $6,890 11.05% Taxable investments 25,919 1,388 5.36% 23,446 1,252 5.34% 22,717 1,245 5.48% Tax-exempt investments 737 50 6.78% 269 18 6.69% 275 18 6.55% Federal funds sold and other interest income 4,192 204 4.87% 7,149 385 5.39% 3,360 186 5.54% ------------------------ --------------------- -------------------- TOTAL INTEREST-EARNING ASSETS / INTEREST INCOME 126,853 11,113 8.76% 108,999 9,984 9.16% 88,724 8,339 9.40% ------------------------ --------------------- -------------------- NON-INTEREST-EARNING ASSETS: Allowance for loan losses (1,019) (802) (662) Cash and due from banks 4,186 3,567 2,481 Premises and equipment 5,328 3,597 3,263 Other assets 4,123 4,438 3,098 ----------- ------------ ---------- TOTAL ASSETS $ 139,471 $119,799 $96,904 =========== ============ ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Interest-bearing deposits: Transaction accounts $ 41,525 $1,357 3.27% $34,209 $1,347 3.94% $25,803 $1,037 4.02% Savings deposits 5,278 127 2.41% 4,312 142 3.29% 3,453 115 3.33% Certificates of deposit 54,120 2,951 5.45% 50,035 2,946 5.89% 44,670 2,722 6.09% ------------------------ --------------------- -------------------- Total interest-bearing deposits 100,923 4,435 4.39% 88,556 4,435 5.01% 73,936 3,874 5.24% ------------------------ --------------------- -------------------- Long-term debt and other borrowings 5,846 371 6.35% 2,878 188 6.53% 2,254 175 7.76% ------------------------ --------------------- -------------------- Total borrowed funds 5,846 371 6.35% 2,878 188 6.53% 2,254 175 7.76% ------------------------ --------------------- -------------------- TOTAL INTEREST-BEARING LIABILITIES / INTEREST EXPENSE 106,769 4,806 4.50% 91,434 4,623 5.06% 76,180 4,049 5.32% NON-INTEREST-BEARING LIABILITIES: Non-interest-bearing deposits 17,770 14,390 10,718 Other liabilities 3,142 2,812 2,908 ----------- ------------ ---------- Total liabilities 127,681 108,636 89,806 ----------- ------------ ---------- Shareholders' equity 11,790 11,163 7,098 ----------- ------------ ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 139,471 $119,799 $96,904 =========== ============ ========== Net interest-rate spread 4.26% 4.10% 4.08% Impact of non-interest bearing sources and other changes in balance sheet composition 0.71% 0.82% 0.76% -------- -------- -------- NET INTEREST INCOME / MARGIN ON INTEREST-EARNING ASSETS <F3> $6,307 4.97% $5,361 4.92% $4,290 4.84% ===================== ================= ================== <FN> <F1> Interest income on tax-exempt securities and loans has been increased by 50% to reflect comparable interest on taxable securities. <F2> For computational purposes, includes non-accrual loans. <F3> Tax equivalent net interest income as a percentage of average earning assets </FN> 90 The following table shows the relative impact on net interest income of changes in the average outstanding balances (volume) of interest earning assets and interest bearing liabilities and the rates earned and paid by Independent on such assets and liabilities from 1997 to 1998 and 1998 to 1999. Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category. TABLE 2 - CHANGE IN INTEREST INCOME AND EXPENSE ON A TAX EQUIVALENT BASIS <F1> IN THOUSANDS 1999 COMPARED TO 1998 INCREASE 1998 COMPARED TO 1997 INCREASE (DECREASE) (DECREASE) IN INTEREST INCOME AND EXPENSE DUE IN INTEREST INCOME AND EXPENSE DUE TO TO CHANGES IN: CHANGES IN: VOLUME RATE TOTAL VOLUME RATE TOTAL ------------ ------------ ------------ ------------- ------------ ------------ INTEREST-EARNING ASSETS: Loans $ 1,798 $ (656) $ 1,142 $ 1,741 $ (302) $ 1,439 Taxable Investments 132 4 136 40 (33) 7 Tax-exempt investments 32 -- 32 -- -- -- Federal funds sold and other interest income (147) (34) (181) 210 (11) 199 ------------ ------------ ------------ ------------- ------------ ------------ TOTAL INTEREST-EARNING ASSETS $ 1,815 $ (686) $ 1,129 $ 1,991 $ (346) $ 1,645 INTEREST-BEARING LIABILITIES: Transaction accounts $ 261 $ (251) $ 10 $ 338 $ (28) $ 310 Savings deposits 28 (43) (15) 29 (2) 27 Certificates of deposit 231 (226) 5 327 (103) 224 ------------ ------------ ------------ ------------- ------------ ------------ Total interest-bearing deposits $ 520 $ (520) $ -- $ 694 $ (133) $ 561 Long-term debt and other borrowings 189 (6) 183 48 (35) 13 ------------ ------------ ------------ ------------- ------------ ------------ Total borrowed funds 189 (6) 183 48 (35) 13 ------------ ------------ ------------ ------------- ------------ ------------ ------------ ------------ ------------ ------------- ------------ ------------ TOTAL INTEREST-BEARING LIABILITIES $ 709 $ (526) $ 183 $ 742 $ (168) $ 574 ------------ ------------ ------------ ------------- ------------ ------------ INCREASE (DECREASE) IN NET INTEREST INCOME $ 1,106 $ (160) $ 946 $ 1,249 $ (178) $ 1,071 ============ ============ ============ ============= ============ ============ <FN> <F1> Variances resulting from a combination of changes in rate and volume are allocated in proportion to the absolute dollar amounts of the change in each category. </FN> PROVISION FOR LOAN LOSS The provision for loan losses in 1999 was $242,000, compared with $202,000 in 1998 and $262,000 in 1997. As a percentage of average outstanding loans, the provisions recorded in 1999, 1998, and 1997 were 0.25%, 0.26%, and 0.42%, respectively. Net loan charge-offs as a percentage of average outstanding loans for 1999 were 0.00%, compared with 0.04% in 1998 and 0.26% in 1997. The provision for loan losses is based on management's evaluation of inherent risks in the loan portfolio as of the balance sheet date and in conjunction with an analysis of the adequacy of the allowance for loan losses. Management believes that the allowance for loan losses is adequate as of the balance sheet date. 91 NON-INTEREST INCOME Total non-interest income for 1999 was $1.1 million, compared with $938,000 in 1998 and $671,000 in 1997. The principal source of non-interest income for Independent is service charges and fees on deposit accounts. Total service charges on deposit accounts for 1999 were $467,000, compared with $419,000 in 1998, and $367,000 in 1997. This revenue growth from 1998 to 1999 is attributed to the increased number of deposit accounts and changes to the fee pricing structure; the increase from 1997 to 1998 is primarily due to the increased number of deposit accounts. Mortgage banking and other loan fee income totaled $398,000 in 1999, compared with $380,000 in 1998 and $222,000 in 1997. This income category includes fees received for the origination and sale of residential mortgage loans and the related servicing assets to third parties and fees related to the origination, sale and subsequent servicing of commercial loans guaranteed by the Small Business Administration. The increase in this income category from 1998 to 1999 was the result of an increase in SBA loan fees of approximately $46,000, offset by a decrease in mortgage banking fees due to the decrease in mortgage refinance activity resulting from higher interest rates. The increase in fees from 1997 to 1998 was primarily attributed to a strong demand for mortgage refinance loans due to lower interest rates and to the Independent's initial entry into the SBA lender program. Other non-interest income for 1999 was $238,000, compared with $138,000 in 1998 and $88,000 in 1997. The increase in this income category from 1998 to 1999 is primarily attributed to: an increase in safe deposit box rental fees; check printing fees associated with a new in-house print production system that was introduced in late 1998; commissions received for a program which clears the company's official checks through a third-party processor that was renegotiated during the third quarter of 1998; and increased revenue related to increase in value of company-owned life insurance policies. The increase in other non-interest income from 1997 to 1998 is primarily attributed to improved brokerage services commissions; fees associated with the third party check processing program described above; and increased revenue related to the increase in value of company-owned life insurance policies. NON-INTEREST EXPENSE Total non-interest expense for 1999 was $4.7 million, compared with $4.4 million in 1998 and $3.5 million in 1997. The single largest component of non-interest expense is employee salary and benefits, which totaled $2.8 million in 1999, compared with $2.8 million in 1998 and $2.1 million in 1997. The increase in salary and benefit expense from 1997 to 1998 of approximately 32% was primarily due to the opening of two new banking facilities, a limited service branch in Alpharetta, Georgia and a temporary banking office in Marietta, Georgia. The increase in salary and benefit expense from 1998 to 1999 was approximately one percent. This lower percentage increase is primarily attributed staff reduction resulting from closure of the limited service branch opened in 1997 on December 31, 1998, and the elimination of three management positions during 1999. Occupancy and equipment expense for 1999 was $755,000, compared with $564,000 in 1998 and $468,000 in 1997. The increase this expense category in 1999 is primarily attributed to depreciation expense for new full-service banking facility located in Marietta, Georgia, which was occupied during the fourth quarter of 1998 and replaced the temporary building; costs associated with check image processing introduced in mid-1999; and increased equipment depreciation expense related to the purchase of desktop computers acquired as part of the Year 2000 remediation project. Other operating expense for 1999 totaled $1.2 million, compared with $1.1 million in 1998 and $1 million in 1997. The increases during 1999 and 1998 are primarily related to increases in postage, stationery, supply, data processing, and telephone expenses resulting from growth. Independent's efficiency ratio, which measures a bank's total operating expenses as a percentage of net interest income (before provision for loan losses) plus non-interest income, was 64.2% for 1999, compared with 70.6% and 71.5% for 1998 and 1997, respectively. This improvement in operating efficiency is attributed to Independent's revenue growth over the past two years exceeding the need to proportionally increase operating expenses. 92 INCOME TAXES Independent had income tax expense of $785,000 in 1999, compared with $550,000 in 1998 and $346,000 in 1997. Independent's effective tax rates (expressed as a percentage of pre-tax income) for 1999, 1998, and 1997 were 32.6%, 33.3%, and 30.1%, respectively. The effective tax rates are lower than the statutory Federal tax rate primarily because of interest income on certain investment securities that is exempt from income taxes. BALANCE SHEET OVERVIEW Total assets at December 31, 1999 were $145.1 million, compared with $127.3 million and $108.1 million at year-end 1998 and 1997, respectively. Average assets for 1999, 1998, and 1997 were $139.5 million, $119.8 million and $96.9 million, respectively. The significant asset growth experienced by Independent during the past three years is attributed to the strong economic conditions in the local market area in which Independent operates. LOANS Total loans at December 31, 1999 were $101.6 million, compared with $87.8 million at December 31, 1998 and $71.3 million at December 31, 1997. Average loans for 1999, 1998 and 1997 were $96 million, $78.1 million and $62.4 million, respectively. Loan growth has been particularly strong in the categories of construction/development and consumer loans during the past three years. The following table presents a summary of the loan portfolio by loan type as of December 31 for the years 1995 through 1999. TABLE 3 - LOAN PORTFOLIO IN THOUSANDS DECEMBER 31, 1999 1998 1997 1996 1995 ----------------- ---------------- ---------------- ----------------- ---------------- Commercial $ 21,719 $ 25,419 $ 23,050 $ 18,986 $ 11,531 Real estate - construction 37,458 31,058 22,308 10,218 4,352 Real estate - mortgage 29,867 24,119 21,016 16,550 16,286 Consumer 12,531 7,186 4,894 4,295 5,407 ----------------- ---------------- ---------------- ----------------- ---------------- Total loans $ 101,575 $ 87,782 $ 71,268 $ 50,049 $ 37,576 ================= ================ ================ ================= ================ As a percentage of total loans: 1999 1998 1997 1996 1995 ----------------- ---------------- ---------------- ----------------- ---------------- Commercial 21.4% 29.0% 32.3% 37.9% 30.7% Real estate - construction 36.9% 35.3% 31.3% 20.4% 11.6% Real estate - mortgage 29.4% 27.5% 29.5% 33.1% 43.3% Consumer 12.3% 8.2% 6.9% 8.6% 14.4% ----------------- ---------------- ---------------- ----------------- ---------------- Total loans 100.0% 100.0% 100.0% 100.0% 100.0% ================= ================ ================ ================= ================ The decrease in commercial loans from 1998 to 1999 is attributable to the reclassification of certain loans from the commercial category to the real estate mortgage category during 1999 and the introduction of the SBA lending program, which resulted in the sale of approximately $2.0 million of commercial loans that would have otherwise been retained in the portfolio. Substantially all of Independent's loans are to customers located in its immediate market area of Cobb, Paulding, and surrounding counties located in northwest Georgia. All loans are underwritten in a prudent manner and structured to minimize Independent's exposure to loss. A significant decline in the value of real estate in Independent's primary market or a downturn in the local economy could, however, result in an increase in the provision for loan losses and charge-offs. 93 The following table sets forth the maturity distribution of real estate construction and commercial loans, including the interest sensitivity for loans maturing in more than one year, as of December 31, 1999. INDEPENDENT BANCSHARES, INC. LOAN PORTFOLIO MATURITY (DOLLAR AMOUNTS IN THOUSANDS) Rate Structure for Loans Maturity Maturing Over One Year ------------------------------------------------------------- ---------------------------- One Year One through Over Five Fixed Rate Floating or less Five Years Years Total Rate - -------------------------------------- --------------- ----------------- ------------- ------------- ------------- -------------- Commercial $ 7,626 $ 9,742 $ 4,351 $21,719 $7,878 $6,215 Real estate - construction 2,711 34,747 - 37,458 22,158 12,589 --------------- ----------------- ------------- ------------- ------------- -------------- Total $ 10,337 $ 44,489 $ 4,351 $59,177 $30,036 $18,804 =============== ================= ============= ============= ============= ============== ASSET QUALITY Non-performing loans, which include non-accrual loans and loans past due over 90 days and still on accrual status, totaled $30,000 at December 31, 1999, compared with $98,000 at December 31, 1998 and $166,000 at December 31, 1997. At December 31, 1999, the ratio of non-performing loans to total loans was 0.03%, compared with 0.11% and 0.23% at year-end 1998 and 1997, respectively. Non-performing assets, which include non-performing loans and foreclosed real estate, totaled $30,000 at December 31, 1999, compared with $218,000 and December 31, 1998 and $351,000 at December 31, 1997. It is Independent's policy to place a loan on non-accrual status when, in the opinion of management, the principal and interest on a loan is not likely to be repaid in accordance with the loan terms or when a loan becomes 90 days past-due. When a loan is placed on non-accrual, all accrued but unpaid interest is reversed against current interest income. Depending on management's evaluation of the borrowers financial condition and the loan collateral, interest on a non-accrual loan may be recognized on a cash basis as payments are received. The table below presents Independent's non-performing loans and assets at December 31 for each of the past five years. TABLE 5 - NON-PERFORMING ASSETS IN THOUSANDS DECEMBER 31, 1999 1998 1997 1996 1995 - ----------------------------------------------- ---------------- --------------- --------------- -------------- --------------- Non-accrual loans $ 30 $ 98 $ 166 $ 223 $ 467 Loans past due 90 days or more and still accruing -- -- -- -- -- ---------------- --------------- --------------- -------------- --------------- Total non-performing loans 30 98 166 223 467 Other real estate owned -- 120 185 389 1,274 ---------------- --------------- --------------- -------------- --------------- Total non-performing assets $ 30 $ 218 $ 351 $ 612 $ 1,741 ================ =============== =============== ============== =============== Total non-performing loans as a percentage of total loans 0.03% 0.11% 0.23% 0.45% 1.24% Total non-performing assets as a percentage of total assets 0.02% 0.17% 0.32% 0.74% 2.64% At December 31, 1999, there were loans within Independent's portfolio that were not classified as non-performing but for which known information about the borrower's financial condition caused management to have concerns about the ability of the borrowers to comply with the repayment terms of the loans. These loans are identified and monitored through a routine loan review process and are 94 considered in the determination of the allowance for loan losses. Based on management's evaluation of current market conditions, loan collateral, and secondary sources of repayment, no significant losses are anticipated in connection with these loans. The table below summarizes changes in the allowance for loan losses for each of the past five years. TABLE 6 -ALLOWANCE FOR LOAN LOSSES (DOLLAR AMOUNTS IN THOUSANDS) YEARS ENDED DECEMBER 31, 1999 1998 1997 1996 1995 - ----------------------------------------------------- -------------- --------------- -------------- ------------- ------------- Balance beginning of period $ 878 $ 705 $ 608 $ 661 $ 727 Provision for loan losses 242 201 262 26 45 Amounts charged-off: Commercial -- 7 120 74 69 Real estate - construction -- -- -- -- -- Real estate - mortgage -- 50 39 6 57 Consumer 32 17 31 49 64 -------------- --------------- -------------- ------------- ------------- Total loans charged-off 32 74 190 129 190 Recoveries of charged-off loans: Commercial 13 9 3 25 28 Real estate - construction -- -- -- -- -- Real estate - mortgage -- 28 1 3 1 Consumer 23 9 21 22 50 -------------- --------------- -------------- ------------- ------------- Total recoveries 36 46 25 50 79 -------------- --------------- -------------- ------------- ------------- Net charge-offs (4) 28 165 79 111 -------------- --------------- -------------- ------------- ------------- Balance end of period $ 1,124 $ 878 $ 705 $ 608 $ 661 ============== =============== ============== ============= ============= Total loans: $101,576 $ 87,782 $ 71,268 $ 50,049 $ 37,576 At year-end $ 96,005 $ 78,135 $ 62,372 $ 43,813 $ 40,076 Average As a percentage of average loans: Net charge-offs 0.00% 0.04% 0.26% 0.18% 0.28% Provision for loan losses 0.25% 0.26% 0.42% 0.06% 0.11% Allowance as a percentage of year-end loans 1.11% 1.00% 0.99% 1.21% 1.76% SECURITIES Total securities at December 31, 1999 were $26.1 million, compared with $26.2 million and $24.1 million at year-end 1998 and 1997, respectively. Total securities at December 31, 1999 included $7.2 million of securities classified as held to maturity, which had an estimated fair value of $6.1 million. Average securities for 1999, 1998, and 1997 were $26.7 million, $23.7 million and $23.0 million, respectively. The composition and growth in the securities portfolio is reflective of management's desire to provide balance sheet liquidity while providing a stable source of interest income that has virtually no credit risk. The securities portfolio at year-end 1999 consists of U.S. Government agency and mortgage-backed securities. 95 The following table shows the carrying value of securities, by security type, as of December 31, 1999, 1998, and 1997. TABLE 7 - CARRYING VALUE OF SECURITIES IN THOUSANDS AVAILABLE FOR SALE DECEMBER 31, 1999 1998 1997 - ---------------------------------------------- ---------------------- ------------------------ ------------------------- U.S. Treasury $ -- $ 1,525 $ 2,016 U.S. Government agencies 12,038 9,956 10,842 State and political subdivisions 809 -- -- Mortgage-backed securities 5,458 6,442 1,752 Other securities 529 563 658 ---------------------- ------------------------ ------------------------- Total $ 18,834 $ 18,486 $ 15,268 ====================== ======================== ========================= HELD TO MATURITY DECEMBER 31, 1999 1998 1997 - ---------------------------------------------- ---------------------- ------------------------ ------------------------- U.S. Treasury $ 499 $ 498 $ 496 U.S. Government agencies 6,075 6,072 6,815 State and political subdivisions 260 266 272 Mortgage-backed securities 392 871 1,247 Other securities -- -- -- ---------------------- ------------------------ ------------------------- Total $ 7,226 $ 7,707 $ 8,830 ====================== ======================== ========================= The following table shows the expected maturity of the securities portfolio by maturity date and the average yield based on amortized cost as of December 31, 1999. TABLE 8 - MATURITIES AND YIELDS OF SECURITIES AS OF DECEMBER 31, 1999 Over One Over Five Year Years One Year Through Through Over or Less Five years Ten Years Ten Years Total ----------------- ---------------- ---------------- ----------------- ---------------- U.S. Treasury $ 499 $ -- $ -- $ - $ 499 U.S. Government agencies 2,169 14,496 5,771 1,527 23,963 State and political subdivisions -- -- 500 569 1,069 Mortgage-backed securities -- -- -- 529 529 Other securities ----------------- ---------------- ---------------- ----------------- ---------------- Total $ 2,668 $ 14,496 $ 6,271 $ 2,625 $ 26,060 ================= ================ ================ ================= ================ Weighted average yield 5.72% 5.85% 4.11% 6.43% 5.48% Percent of total 10.2% 55.6% 24.1% 10.1% 100.0% 96 INTEREST RATE SENSITIVITY MANAGEMENT Independent actively manages interest rate sensitivity through its Asset/Liability Management Committee. The primary objectives of asset/liability management are to ensure that Independent can meet the investment return expectations of its shareholders in the event that interest rates change and to provide adequate liquidity to meet the needs of customers. Effective interest rate risk management seeks to ensure that both interest sensitive assets and liabilities respond to changes in market rates in a manner that provides for a minimal fluctuation of net interest income, which is the primary source of operating revenue. Independent's Asset/Liability Management Committee uses a gap analysis to determine the overall sensitivity of the balance sheet to changes in market interest rates. A negative gap (more liabilities than assets repricing within one year) indicates that the bank's net interest income will fall in a rising rate environment. A positive gap (more assets repricing than liabilities within one year) indicates the bank's net interest income will decline in a falling rate environment. The following table summarizes the amounts of interest-earning assets and interest-bearing liabilities outstanding at December 31, 1999 and the amounts that are expected to mature or reprice in each of the five time periods shown. The amounts of assets and liabilities shown are based on contractual terms and maturities. TABLE 9 - INTEREST RATE GAP SENSITIVITY (DOLLAR AMOUNTS IN THOUSANDS) One Four One Over Five Through Through Through Years and Three Twelve Five Non-rate Immediate Months Months Years Sensitive Total - ------------------------------------------- -------------- --------------- ------------ ------------ ------------- ------------- Interest earning assets: Federal funds sold $ 5,000 $ -- $ -- $ -- $ -- $ 5,000 Securities -- 1,100 7,033 13,609 4,318 26,060 Loans 56,427 3,878 6,948 18,816 15,507 101,576 --------------------------------------------------------------------------------- Total interest earning assets $ 61,427 $ 4,978 $ 13,981 $ 32,425 $ 19,825 $132,636 --------------------------------------------------------------------------------- Interest bearing liabilities: Demand deposits -- 38,333 -- -- -- 38,333 Savings deposits -- 5,169 -- -- -- 5,169 Time deposits -- 8,864 33,197 21,184 61 63,306 FHLB advances -- -- 2,000 1,107 3,600 6,707 --------------------------------------------------------------------------------- Total interest bearing liabilities -- 52,366 35,197 22,291 3,661 113,515 ---------------------------------------------------------------------------------- Non-interest bearing sources of funds -- -- -- -- 16,614 16,614 --------------------------------------------------------------------------------- Interest sensitivity gap 61,427 (47,388) (21,216) 10,134 (450) 2,507 --------------------------------------------------------------------------------- Cumulative sensitivity gap $ 61,427 $ 14,039 $ (7,177) $ 2,957 $ 2,507 $ -- ================================================================================= Percentage of assets repricing 46.31% 3.75% 10.54% 24.45% 14.95% 100.00% At December 31, 1999, the one-year gap was a negative $7.2 million. This indicates that Independent's net interest income will decrease in a rising rate environment and increase in a declining rate environment. This is commonly referred to as being "liability sensitive." There are significant limitations of gap analysis for determining the impact of rate changes on a bank's net interest income. For example, although certain assets and liabilities may have similar maturity or repricing characteristics, they may react differently to changes in market rates. In addition, some assets that have adjustable rates may have contractual terms that limit the frequency and amount of rate increases. 97 DEPOSITS AND OTHER BORROWINGS Total deposits at December 31, 1999 were $123.4 million, compared with $109.8 million and $92.8 million at year-end 1998 and 1997, respectively. Average deposits for 1999, 1998, and 1997 were $118.7 million, $102.9 million and $84.6 million, respectively. As a community-oriented bank, Independent views core deposits as the primary source of funding growth in interest earning assets. Time deposits of $100,000 or more totaled $20.7 million at December 31, 1999, compared with $14.8 million and $16.5 million at year-end 1998 and 1997, respectively. Independent had no brokered deposits at year-end 1999, 1998 or 1997. The following table sets forth the maturities of time deposits of $100,000 and greater as of December 31, 1999. TABLE 9 - MATURITIES OF TIME DEPOSITS OF $100,000 AND GREATER (DOLLAR AMOUNTS IN THOUSANDS) Three months or less $ 2,391 Over three months through six months 1,666 Over six months through twelve months 11,846 Over one year 4,748 -------- Total $ 20,651 CAPITAL, LIQUIDITY, AND DIVIDENDS Total shareholders' equity at December 31, 1999 was $13 million, compared with $12.2 million and $11.4 million at year-end 1998 and 1997, respectively. Total cash dividends of $0.15 per share were paid in 1999, compared with $0.10 and $0.06 in 1998 and 1997, respectively. The dividend payout ratios, as a percentage of net income, for 1999, 1998, and 1997 were approximately 27%, 17%, and 26%, respectively. During September 1997, Independent completed a stock offering of 831,796 shares that were substantially sold to existing shareholders at a price of $6.00 per share. These shares were not registered under the Securities Act of 1933. The net proceeds from the stock sale were contributed as capital to Independent Bank & Trust to allow for additional asset growth. Independent is subject to various regulatory capital requirements administered by banking regulatory agencies. The minimum ratios to be considered "well capitalized" as defined by banking regulations are five percent for leverage ratio, six percent for Tier I capital ratio, and ten percent for total risk-based capital ratio. The table below shows Independent Bank & Trust's capital ratios as of December 31, 1999 and 1998 and the amounts required for capital adequacy purposes. 98 TABLE 11 - REGULATORY CAPITAL (DOLLAR AMOUNTS IN THOUSANDS) Leverage Tier I Risk-based Total Risk-based Actual Amount Ratio Actual Amount Ratio Actual Amount Ratio 1999 Actual $13,456 9.03% $13,456 11.93% $14,581 12.92% Regulatory minimum 4,470 3.00% 4,513 4.00% 9,027 8.00% --------------------------------------------------------------------------------------------------- Excess $ 8,986 6.03% $ 8,943 7.93 $ 5,554 4.92% 1998 Actual 12,138 9.28% 12,138 12.87% 13,016 13.27% Regulatory minimum 3,924 3.00% 3,923 4.00% 7,845 8.00% --------------------------------------------------------------------------------------------------- Excess $ 8,214 6.28% $ 8,215 8.87% $ 5,171 5.27% (1) As of December 31, 1999 and 1998, the most recent notification from the FDIC categorized Independent Bank & Trust Company as "well capitalized" under the current regulatory framework for prompt corrective action. Prompt corrective action guidelines to do not apply to bank holding companies. Independent's liquidity management policy is designed to ensure that the daily cash flow needs of the Bank and its customers (both depositors and borrowers) are met in a cost-effective manner. Liquidity represents the ability of a bank to convert assets into cash or to obtain additional funds through borrowings. In the opinion of management, Independent's liquidity position at December 31, 1999 is sufficient to meet expected cash flow requirements. Reference should be made to the statements of cash flows appearing in the consolidated financial statements for a three-year analysis of the changes in cash (an equivalents) attributed to operating, investing and financing activities. IMPACT OF INFLATION AND PRICE CHANGES Independent's asset and liabilities, like most financial services companies, are mostly financial in nature. Unlike industrial firms, relatively little investment is held in fixed assets or inventory. Inflation can have a significant impact on asset growth and the resulting need to increase equity capital at higher than expected rates to maintain required capital ratios. Management believes the potential impact of inflation on the Independent's financial performance is dependent upon how well Independent reacts to inflationary pressures. Independent's asset/liability management policy and the periodic review of the pricing of Independent's banking products and services are both designed to manage the risk of inflation. YEAR 2000 Independent complied with all aspects of the Federal Financial Institutions Examination Council's directive that established key milestones that all financial institutions needed to meet with regard to Year 2000 testing and remediation. None of Independent's systems sustained a failure related to Year 2000 and no contingency plans were subject to implementation as a result of system failure. Independent established a budget of $180,000 for Year 2000 testing and remediation and, as of December 31, 1999, approximately $200,000 was actually spent and no additional expenditures are expected. In accordance with recently issued accounting guidelines on how Year 2000 costs should be recognized for financial statement purposes, Independent recognized as current period expense all costs associated with the consulting, inventory, testing, and resources components of the Year 2000 budget. Independent funded the costs associated with preparing for Year 2000 out of its normal operating cash flows. 99 PRO FORMA CONSOLIDATED FINANCIAL INFORMATION The following unaudited pro forma consolidated financial statements have been prepared from the historical results of operations of United and to give effect to the pending acquisitions of North Point and Independent, and the statements reflect adjustments for outstanding debentures. These statements should be read in conjunction with the historical consolidated financial statements of United, including the notes thereto, included elsewhere in this proxy statement. The pro forma combined results are not necessarily indicative of the combined results of future operations. In the Independent merger, United will exchange 0.4211 of a share of United common stock for each share of Independent common stock. Independent had 2,067,431 shares of common stock outstanding at May 1, 2000, which will be exchanged for approximately 870,595 shares of United common stock. In connection with the Independent merger, United and Independent expect to incur pre-tax merger related charges of approximately $2.33 million. These charges are expected to include approximately $1,040,000 of occupancy related charges (equipment write-offs and contract terminations), $170,000 of merger-related professional fees (investment banking, accounting, and legal), $920,000 of losses incurred to liquidate certain investment securities, and $200,000 in other merger costs. In the North Point merger, United will exchange 2.2368 shares of United common stock for each share of North Point common stock. North Point had 428,385 shares of common stock outstanding at May 1, 2000, which will be exchanged for approximately 958,211 shares of United common stock. In connection with the North Point merger, United and North Point expect to incur pre-tax merger related charges of approximately $1.3 million. These charges are expected to include approximately $250,000 of severance and change in control related payments, $880,000 of occupancy related charges (equipment write-offs and contract terminations), $135,000 of merger-related professional fees (investment banking, accounting, and legal), and $35,000 in other merger costs. These amounts and the related tax effects have not been reflected in the unaudited pro forma consolidated financial information because they will not have a material impact on the shareholders' equity of the combined company and are not expected to have a continuing impact on the operations of the combined company. 100 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Balance Sheet March 31, 2000 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers ------------------------------- United as Historical Historical Pro Forma Reported North Point Independent Adjustments Consolidated --------------------------------------------------------------------- ASSETS Cash and due from banks $ 82,294 7,295 5,168 94,757 Federal funds sold 170 -- 16,676 16,846 -------------------------------------------------------------------- Cash and cash equivalents 82,464 7,295 21,844 -- 111,603 Securities held to maturity (estimated fair values of $4,224 and $5,802) -- 3,544 6,704 10,248 Securities available for sale 548,670 25,111 23,394 597,175 Mortgage loans held for sale 4,588 -- - 4,588 Loans, net of unearned income 1,459,469 75,336 101,294 1,636,099 Less: Allowance for loan losses (18,922) (1,210) (1,166) (21,298) -------------------------------------------------------------------- Loans, net 1,440,547 74,126 100,128 -- 1,614,801 Premises and equipment, net 47,644 2,796 5,468 55,026 Other assets 50,708 2,238 3,528 56,474 -------------------------------------------------------------------- Total assets $ 2,174,621 115,110 161,084 -- 2,450,815 ==================================================================== LIABILITIES AND SHAREHOLDERS EQUITY Deposits: Demand $ 210,248 18,536 20,160 248,944 Interest bearing demand 352,448 31,175 51,783 435,406 Savings 78,147 5,643 5,381 89,171 Time 1,027,642 48,284 64,117 1,140,043 -------------------------------------------------------------------- Total deposits 1,668,485 103,638 141,441 -- 1,913,564 Accrued expenses and other liabilities 20,149 595 1,630 23,374 Federal funds purchased and repurchase agreements 33,760 1,488 - 35,248 Federal Home Loan Bank advances 309,940 -- 4,417 314,411 Long-term debt and other borrowings 19,331 -- - 19,331 Convertible subordinated debentures 3,500 -- - 3,500 Guaranteed preferred beneficial interests in company's junior subordinated debentures (Trust Preferred 21,000 -- - 21,000 Securities) -------------------------------------------------------------------- Total liabilities 2,076,165 105,721 147,542 -- 2,329,428 Commitments and contingent liabilities: Redeemable common 577 577 stock held by KSOP (44,432 shares outstanding) Shareholders' Equity: Preferred stock -- -- - -- -- Common stock 8,034 2,142 1,948 (2,142) 9,812 957 Capital surplus 30,310 1,985 8,615 (1,985) 43,222 3,170 Retained earnings 69,807 5,861 2,888 78,556 Accumulated other comprehensive income (loss) (9,695) (599) (486) -- (10,780) -------------------------------------------------------------------- Total shareholders' equity 98,456 9,389 12,965 -- 120,810 Total liabilities and shareholders' equity $ 2,174,621 115,110 161,084 -- 2,450,815 ==================================================================== Outstanding common shares 8,034 9,812 Book value per common share $ 12.25 12.31 See notes to consolidated financial statements. 101 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Balance Sheet December 31, 1999 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers United ---------------------------------- as Historical Historical Pro Forma Reported North Point Independent Adjustments Consolidated -------------- ---------------- ----------------- ---------------- -------------- ASSETS Cash and due from banks $ 89,231 7,250 4,639 101,120 Federal funds sold 23,380 4,180 5,000 32,560 -------------- ------------- ----------------- ---------------- ---------------- Cash and cash equivalents 112,611 11,430 9,639 - 133,680 Securities held to maturity (estimated fair values of $3,784 and $6,169) - 3,762 7,226 10,988 Securities available for sale 534,503 25,372 18,834 578,709 Mortgage loans held for sale 6,326 - - 6,326 Loans, net of unearned income 1,400,360 62,212 101,576 1,564,148 Less: Allowance for loan losses (17,722) (1,196) (1,125) (20,043) -------------- ------------- ----------------- ---------------- ---------------- Loans, net 1,382,638 61,016 100,451 - 1,544,105 Premises and equipment, net 47,365 2,746 5,543 - 55,654 Other assets 47,997 2,152 3,409 53,558 -------------- ------------- ----------------- ---------------- ---------------- Total assets $ 2,131,440 106,478 145,102 2,383,020 ============== ============= ================= ================ ================ LIABILITIES AND SHAREHOLDERS EQUITY Deposits: Demand $ 192,006 17,738 16,614 226,358 Interest bearing demand 328,815 26,991 38,333 394,139 Savings 73,953 5,350 5,169 84,472 Time 1,054,618 46,486 63,306 1,164,410 -------------- ------------- ----------------- ---------------- ---------------- Total deposits 1,649,392 96,565 123,422 - 1,869,379 Accrued expenses and other liabilities 24,378 344 1,351 26,073 Federal funds purchased and repurchase 31,812 389 - 32,201 agreements Federal Home Loan Bank advances 287,572 - 6,707 294,279 Long-term debt and other borrowings 17,516 - - 17,516 Convertible subordinated debentures 3,500 - - 3,500 Guaranteed preferred beneficial interests in company's junior subordinated debentures (Trust Preferred Securities) 21,000 - - 21,000 -------------- ------------- ----------------- ---------------- ---------------- Total liabilities 2,035,170 97,298 131,480 - 2,263,948 Commitments and contingent liabilities: Redeemable common stock held by KSOP - - 577 - 577 (44,432 shares outstanding) Shareholders' Equity: Preferred stock - - - - - Common stock 8,034 2,142 1,948 (4,090) 9,812 1,778 Capital surplus 30,310 1,985 8,614 (10,599) 43,221 12,911 Retained earnings 66,606 5,629 2,822 75,057 Accumulated other comprehensive income (loss) (8,680) (576) (339) - (9,595) -------------- ------------- ----------------- ---------------- ---------------- Total shareholders' equity 96,270 9,180 13,045 - 118,501 -------------- ------------- ----------------- ---------------- ---------------- Total liabilities and shareholders' equity $ 2,131,440 106,478 145,102 - 2,383,020 ============== ============= ================= ================ ================ Outstanding common shares 8,034 9,812 Book value per common share $ 11.98 12.08 102 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Balance Sheet December 31, 1998 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers -------------------------- Historical Historical Pro Forma as Reported North Point Independent Adjustments Consolidated -------------- ------------ ------------- ------------ -------------- ASSETS Cash and due from banks $ 51,102 5,679 4,050 60,831 Federal funds sold 13,010 6,340 1,730 21,080 -------------- ------------ ------------- ------------ -------------- Cash and cash equivalents 64,112 12,019 5,780 - 81,911 Securities held to maturity (estimated fair 58,306 4,701 7,707 70,714 values of $60,018, $4,832 and $6,786) Securities available for sale 333,787 20,334 18,487 372,608 Mortgage loans held for sale 8,129 - - 8,129 Loans, net of unearned income 1,061,166 54,546 87,782 1,203,494 Less: Allowance for loan losses (12,680) (844) (878) (14,402) -------------- ------------ ------------- ------------ -------------- Loans, net 1,048,486 53,702 86,904 - 1,189,092 Premises and equipment, net 41,247 1,939 5,400 48,586 Other assets 37,332 1,185 3,028 41,545 -------------- ------------ ------------- ------------ -------------- Total assets $ 1,591,399 93,880 127,306 - 1,812,585 ============== ============ ============= ============ ============== LIABILITIES AND SHAREHOLDERS EQUITY Deposits: Demand $ 152,201 16,403 17,015 185,619 Interest bearing demand 295,549 21,044 37,109 353,702 Savings 65,323 5,644 4,636 75,603 Time 725,250 41,024 51,026 817,300 -------------- ------------ ------------- ------------ -------------- Total deposits 1,238,323 84,115 109,786 - 1,432,224 Accrued expenses and other liabilities 20,089 368 1,430 21,887 Federal funds purchased and repurchase 26,520 25 - 26,545 agreements Federal Home Loan Bank advances 186,854 - 3,350 190,204 Long-term debt and other borrowings 1,277 - - 1,277 Convertible subordinated debentures 3,500 - - 3,500 Guaranteed preferred beneficial interests in company's junior subordinated debentures (Trust Preferred Securities) 21,000 - - 21,000 -------------- ------------ ------------- ------------ -------------- Total liabilities 1,497,563 84,508 114,566 - 1,696,637 Commitments and contingent liabilities: Redeemable common stock held by KSOP - - 533 - 533 (44,432 shares outstanding) Shareholders' Equity: Preferred stock - - - - - Common stock 8,004 2,142 1,948 (4,090) 9,782 1,778 Capital surplus 29,999 1,985 8,615 (10,600) 42,911 12,912 Retained earnings 54,500 5,136 1,538 61,174 Accumulated other comprehensive income 1,333 109 106 - 1,548 (loss) -------------- ------------ ------------- ------------ -------------- Total shareholders' equity 93,836 9,372 12,207 - 115,415 -------------- ------------ ------------- ------------ -------------- Total liabilities and shareholders' equity $ 1,591,399 93,880 127,306 - 1,812,585 ============== ============ ============= ============ ============== Outstanding common shares 8,004 9,782 Book value per common share $ 11.72 11.80 103 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Statements of Income For the Three Months Ended March 31, 2000 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers ---------------------------------- United as Historical Historical Pro Forma Reported North Point Independent Adjustments Consolidated ------------- ---------------- ----------------- ------------------ ----------------- Interest income $ 43,431 2,255 3,104 48,790 Interest expense 24,565 1,060 1,391 27,016 ------------------------------------------------------------------------------------- Net interest income 18,866 1,195 1,713 - 21,774 Provision for loan losses 1,546 20 45 1,611 ------------------------------------------------------------------------------------- Net interest income after 17,320 1,175 1,668 - 20,163 provision for loan losses Non-interest income 2,672 182 223 3,077 Non-interest expense 14,379 814 1,190 16,383 ------------------------------------------------------------------------------------- Income before income taxes 5,613 543 701 - 6,857 ------------------------------------------------------------------------------------- Income taxes 1,789 151 246 2,186 ------------------------------------------------------------------------------------- Net income $ 3,824 392 455 - 4,671 ===================================================================================== Basic earnings per share $ 0.48 0.48 Diluted earnings per share $ 0.47 0.47 Basic average shares outstanding 8,034 9,812 Diluted average shares outstanding 8,317 10,126 104 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Statements of Income For the Three Months Ended March 31, 1999 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers ---------------------------------- United as Historical Historical Pro Forma Reported North Point Independent Adjustments Consolidated ------------------------------------------------------------------------------------- Interest income $ 32,829 1,933 2,610 37,372 Interest expense 17,395 869 1,155 18,052 ------------------------------------------------------------------------------------- Net interest income 15,434 1,064 1,455 - 17,953 Provision for loan losses 980 30 76 1,086 ------------------------------------------------------------------------------------- Net interest income after 14,454 1,034 1,379 - 16,867 provision for loan losses Non-interest income 2,479 162 259 2,900 Non-interest expense 12,000 676 1,153 13,829 ------------------------------------------------------------------------------------- Income before income taxes 4,933 520 485 - 5,938 ------------------------------------------------------------------------------------- Income taxes 1,640 160 175 1,975 ------------------------------------------------------------------------------------- Net income $ 3,293 360 310 - 3,963 ===================================================================================== Basic earnings per share $ 0.41 0.41 Diluted earnings per share $ 0.40 0.40 Basic average shares outstanding 8,004 9,780 Diluted average shares outstanding 8,269 10,062 105 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Statements of Income For the Year Ended December 31, 1999 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers ------------------------------- as Historical Historical Pro Forma Reported North Point Independent Adjustments Consolidated ------------- -------------- ---------------- ----------------- ---------------- Interest income $ 149,740 8,156 11,096 168,992 Interest expense 81,766 3,629 4,805 90,200 ------------- -------------- ---------------- ----------------- ---------------- Net interest income 67,974 4,527 6,291 - 78,792 Provision for loan losses 5,104 620 242 5,966 ------------- -------------- ---------------- ----------------- ---------------- Net interest income after 62,870 3,907 6,049 - 72,826 provision for loan losses Non-interest income 10,836 625 1,103 12,564 Non-interest expense 54,165 3,070 4,746 61,981 ------------- -------------- ---------------- ----------------- ---------------- Income before income taxes 19,541 1,462 2,406 - 24,409 ------------- -------------- ---------------- ----------------- ---------------- Income taxes 5,893 453 785 7,131 ------------- -------------- ---------------- ----------------- ---------------- Net income $ 13,648 1,009 1,621 - 16,278 ============= ============== ================ ================= ================ Basic earnings per share $ 1.70 1.66 Diluted earnings per share $ 1.66 1.63 Basic average shares outstanding 8,020 9,796 Diluted average shares outstanding 8,316 10,110 106 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Unaudited Pro Forma Consolidated Statements of Income For the Year Ended December 31, 1998 (DOLLAR AMOUNTS IN THOUSANDS) Pending Mergers ------------------------------- as Historical Historical Pro Forma Reported North Point Independent Adjustments Consolidated ------------- -------------- ---------------- ------------------ ---------------- Interest income $ 116,214 7,693 9,978 133,885 Interest expense 60,004 3,003 4,623 67,630 ------------- -------------- ---------------- ------------------ ---------------- Net interest income 56,210 4,690 5,355 - 66,255 Provision for loan losses 2,612 200 202 3,014 ------------- -------------- ---------------- ------------------ ---------------- Net interest income after 53,598 4,490 5,153 - 63,241 provision for loan losses Non-interest income 9,129 653 938 10,720 Non-interest expense 43,964 2,692 4,442 51,098 ------------- -------------- ---------------- ------------------ ---------------- Income before income taxes 18,763 2,451 1,649 - 22,863 ------------- -------------- ---------------- ------------------ ---------------- Income taxes 5,990 814 549 7,353 ------------- -------------- ---------------- ------------------ ---------------- Net income $ 12,773 1,637 1,100 - 15,510 ============= ============== ================ ================== ================ Basic earnings per share $ 1.60 1.59 Diluted earnings per share $ 1.57 1.56 Basic average shares outstanding 7,973 9,751 Diluted average shares outstanding 8,246 10,043 107 INFORMATION CONCERNING UNITED'S ACCOUNTANTS Porter Keadle Moore, LLP was the principal independent public accountant for United during the year ended December 31, 1999. Representatives of Porter Keadle Moore are expected to be present at the annual meeting and will have the opportunity to make a statement if they desire to do so and to respond to appropriate questions. United anticipates that Porter Keadle Moore will be United's accountants for the 2000 fiscal year. During United's two most recent fiscal years, United did not change accountants and had no disagreement with its accountants on any matters of accounting principles or practices or financial statement disclosure. SHAREHOLDER PROPOSALS BY UNITED SHAREHOLDERS No proposals by non-management have been presented for consideration at the annual meeting. United expects that its 2001 annual meeting will be held in April 2001. Any proposals by non-management shareholders intended for presentation at the 2001 annual meeting must be received by United at its principal executive offices, attention of the Secretary, no later than ___________, 2000, to be included in the proxy material for the annual meeting. United must be notified of any other shareholder proposal intended to be presented for action at the meeting not later than __________, 2001, or else proxies may be voted on such proposal at the discretion of the person or persons holding these proxies. REPORT ON FORM 10-K United's Annual Report on Form 10-K, as amended, for the fiscal year ended December 31, 1999, as filed with the SEC, is available to shareholders who make written request therefor to United at 63 Highway 515, Blairsville, Georgia 30512-2569, Attention Pat Rusnak. You may also request a copy by telephone at (706) 745-2151. Copies of exhibits and basic documents filed with that report or referenced therein will be furnished to shareholders of record upon request. All documents subsequently filed by United pursuant to Sections 13(a), 13(c), 14, or 15(d) of the Exchange Act prior to the date of the United Special Meeting will be deemed to be incorporated by reference. To assure timely delivery, you must make a request by June ____, 2000. EXPERTS FOR UNITED, NORTH POINT, AND INDEPENDENT The audited consolidated financial statements of United and its subsidiaries included or incorporated by reference in this proxy statement and elsewhere have been audited by Porter Keadle Moore LLP, certified public accountants, as indicated in their related audit reports, and are included on the authority of that firm as experts in giving those reports. The audited consolidated financial statements of North Point included in this proxy statement and elsewhere have been audited by Mauldin & Jenkins, LLC, independent certified public accountants, as indicated in their related audit reports, and are included on the authority of that firm as experts in giving those reports. The audited consolidated financial statements of Independent included in this proxy statement and elsewhere have been audited by Mauldin & Jenkins, LLC, independent certified public accountants, as indicated in their related audit reports, and are included on the authority of that firm as experts in giving those reports. OTHER MATTERS THAT MAY COME BEFORE THE MEETING Management of United knows of no matters other than those stated above that are to be brought before the meeting. If any other matters should be presented for consideration and voting, however, it is the intention of the persons named in the enclosed proxy to vote in accordance with their judgment as to what is in the best interest of United. By Order of the Board of Directors, Jimmy C. Tallent PRESIDENT AND CHIEF EXECUTIVE OFFICER 108 INDEX TO FINANCIAL DATA Page ---- NORTH POINT Report of North Point Certified Public Accountants.................................................................F-1 Consolidated Balance Sheets as of December 31, 1999 and 1998.......................................................F-2 Consolidated Statements of Earnings for the Years Ended December 31, 1999 and 1998.................................F-3 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1999 and 1998..................................................................F-4 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999 and 1998...............................F-5 Notes to Consolidated Financial Statements.........................................................................F-6 Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999 (Unaudited).................................F-7 Consolidated Statements of Income for the Three Months Ended March 31, 2000 and 1999 (Unaudited)...................F-8 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2000 and 1999 (Unaudited)...............F-9 Notes to Consolidated Financial Statements (Unaudited).............................................................F-10 INDEPENDENT Report of Independent Certified Public Accountants.................................................................F-11 Consolidated Balance Sheets as of December 31, 1999 and 1998.......................................................F-12 Consolidated Statements of Earnings for the Years Ended December 31, 1999 and 1998.................................F-13 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1999 and 1998.......................................................................................F-14 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999 and1998................................F-15 Notes to Consolidated FinancialStatements..........................................................................F-16 Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999(Unaudited)..................................F-17 Consolidated Statements of Income for the Three Months Ended March 31, 2000 and 1999(Unaudited)....................F-18 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2000 and 1999(Unaudited)................F-19 Notes to Consolidated Financial Statements(Unaudited)..............................................................F-20 UNITED Report of Independent Certified Public Accountants.................................................................F-21 Consolidated Balance Sheets as of December 31, 1999 and 1998.......................................................F-22 Consolidated Statements of Earnings for the Years Ended December 31, 1999 and 1998.................................F-23 Consolidated Statements of Changes in Shareholders' Equity for the Years Ended December 31, 1999 and 1998.......................................................................................F-24 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999 and 1998...............................F-25 Notes to Consolidated Financial Statements.........................................................................F-26 Consolidated Balance Sheets as of March 31, 2000 and December 31, 1999 (Unaudited).................................F-27 Consolidated Statements of Income for the Three Months Ended March 31, 2000 and 1999 (Unaudited)...................F-28 Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2000 and 1999 (Unaudited)...............F-29 Notes to Consolidated Financial Statements (Unaudited) ............................................................F-30 F-0 INDEPENDENT AUDITOR'S REPORT - ------------------------------------------------------------------------------- TO THE BOARD OF DIRECTORS NORTH POINT BANCSHARES, INC. AND SUBSIDIARY DAWSONVILLE, GEORGIA We have audited the accompanying consolidated balance sheets of NORTH POINT BANCSHARES, INC. AND SUBSIDIARY as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of North Point Bancshares, Inc. and subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. /s/ MAULDIN & JENKINS, LLC Atlanta, Georgia February 11, 2000, except for Note 16 as to which the date is March 3, 2000 F-1 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998 - ----------------------------------------------------------------------------------------------- Assets 1999 1998 ------ ------------- ------------- Cash and due from banks $ 4,268,780 $ 3,689,204 Interest-bearing deposits in banks 2,981,000 1,990,000 Federal funds sold 4,180,000 6,340,000 Securities available-for-sale 25,371,787 20,334,308 Securities held-to-maturity (fair value $3,784,371 and $4,832,239) 3,762,312 4,701,141 Loans 62,212,476 54,546,899 Less allowance for loan losses 1,196,321 844,379 ------------- ------------- Loans, net 61,016,155 53,702,520 ------------- ------------- Premises and equipment 2,746,140 1,938,640 Other assets 2,152,249 1,184,627 ------------- ------------- TOTAL ASSETS $ 106,478,423 $ 93,880,440 ============= ============= Liabilities and Stockholders' Equity ------------------------------------ Deposits Noninterest-bearing demand $ 17,738,035 $ 16,403,479 Interest-bearing demand 26,990,521 21,043,825 Savings 5,349,760 5,643,648 Time, $100,000 and over 16,324,953 12,282,921 Other time 30,161,356 28,741,569 ------------- ------------- Total deposits 96,564,625 84,115,442 Other borrowings 389,302 25,008 Other liabilities 344,041 368,237 ------------- ------------- TOTAL LIABILITIES 97,297,968 84,508,687 ------------- ------------- Commitments and contingent liabilities Stockholders' equity Common stock, par value $5; 5,000,000 shares authorized, 428,385 and 342,708 issued and outstanding 2,141,925 1,713,540 Capital surplus 1,985,091 1,985,091 Retained earnings 5,629,760 5,563,657 Accumulated other comprehensive income (loss) (576,321) 109,465 ------------- ------------- TOTAL STOCKHOLDERS' EQUITY 9,180,455 9,371,753 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 106,478,423 $ 93,880,440 ============= ============= SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-2 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - -------------------------------------------------------------------------------------------------------------------- 1999 1998 1997 -------------- --------------- --------------- INTEREST INCOME Loans $ 5,972,797 $ 5,965,847 $ 5,032,816 Taxable securities 1,331,696 1,163,460 1,322,346 Nontaxable securities 287,978 236,637 232,097 Deposits in other banks 136,152 79,521 58,680 Federal funds sold 396,947 230,671 185,863 Other investments 30,758 17,648 11,081 -------------- -------------- -------------- TOTAL INTEREST INCOME 8,156,328 7,693,784 6,842,883 -------------- -------------- -------------- INTEREST EXPENSE Deposits 3,621,042 2,993,253 2,792,901 Other borrowings 8,161 10,199 9,040 -------------- -------------- -------------- 3,629,203 3,003,452 2,801,941 -------------- -------------- -------------- NET INTEREST INCOME 4,527,125 4,690,332 4,040,942 PROVISION FOR LOAN LOSSES 620,000 200,000 175,000 -------------- -------------- -------------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,907,125 4,490,332 3,865,942 -------------- -------------- -------------- OTHER INCOME Service charges on deposit accounts 451,007 484,551 474,507 Loss on sale of securities available-for-sale 0 0 (2,021) Other service charges and fees 69,800 56,382 54,061 Other operating income 104,039 112,659 99,188 -------------- -------------- -------------- Total other income 624,846 653,592 625,735 -------------- -------------- -------------- OTHER EXPENSES Salaries and employee benefits 1,642,029 1,429,959 1,316,192 Equipment expenses 200,714 209,403 211,429 Occupancy expenses 148,006 139,373 137,127 Other operating expenses 1,079,125 913,725 825,581 -------------- -------------- -------------- Total other expenses 3,069,874 2,692,460 2,490,329 -------------- -------------- -------------- INCOME BEFORE INCOME TAXES 1,462,097 2,451,464 2,001,348 INCOME TAX EXPENSE 453,547 814,165 662,344 -------------- -------------- -------------- NET INCOME $ 1,008,550 $ 1,637,299 $ 1,339,004 ============== ============== ============== BASIC AND DILUTED EARNINGS PER COMMON SHARE $ 2.35 $ 3.82 $ 3.13 ============== ============== ============== SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-3 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - -------------------------------------------------------------------------------------------------------- 1999 1998 1997 ----------- ----------- ----------- NET INCOME $ 1,008,550 $ 1,637,299 $ 1,339,004 ----------- ----------- ----------- OTHER COMPREHENSIVE INCOME (LOSS): Net unrealized holding gains (losses) on securities available-for-sale arising during period, net of tax (benefits) of $(353,284), $38,235, and $24,341, respectively (685,786) 74,221 44,601 Reclassification adjustment for losses realized in net income, net of tax (benefit) of $(667) - - 1,354 ----------- ----------- ----------- Other comprehensive income (loss) (685,786) 74,221 45,955 ----------- ----------- ----------- COMPREHENSIVE INCOME $ 322,764 $ 1,711,520 $ 1,384,959 =========== =========== =========== SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-4 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 1998 and 1997 - ----------------------------------------------------------------------------------------------------------------------------------- Common Stock Accumulated -------------------------- Other Total Par Capital Retained Comprehensive Stockholders' Shares Value Surplus Earnings Income (Loss) Equity ---------- ---------- ---------- ----------- ------------- ------------- Balance, December 31, 1996 285,590 $1,427,950 $1,985,091 $ 3,661,173 $ (10,711) $ 7,063,503 Net income - - - 1,339,004 - 1,339,004 Cash dividends declared, $.88 per share - - - (376,979) - (376,979) 20% stock dividend 57,118 285,590 - (285,590) - - Other comprehensive income - - - - 45,955 45,955 ------- ---------- ---------- ----------- --------- ----------- Balance, December 31, 1997 342,708 1,713,540 1,985,091 4,337,608 35,244 8,071,483 Net income - - - 1,637,299 - 1,637,299 Cash dividends declared, $.96 per share - - - (411,250) - (411,250) Other comprehensive income - - - - 74,221 74,221 ------- ---------- ---------- ----------- --------- ----------- Balance, December 31, 1998 342,708 1,713,540 1,985,091 5,563,657 109,465 9,371,753 Net income - - - 1,008,550 - 1,008,550 Cash dividends declared, $ 1.20 per share - - - (514,062) - (514,062) 25% stock dividend 85,677 428,385 - (428,385) - - Other comprehensive loss - - - - (685,786) (685,786) ------- ---------- ---------- ----------- --------- ----------- Balance, December 31, 1999 428,385 $2,141,925 $1,985,091 $ 5,629,760 $(576,321) $ 9,180,455 ======= ========== ========== =========== ========= =========== See Notes to Consolidated Financial Statements. F-5 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - ------------------------------------------------------------------------------------------------------------ 1999 1998 1997 ------------ ------------ ----------- OPERATING ACTIVITIES Net income $ 1,008,550 $ 1,637,299 $ 1,339,004 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 78,151 78,151 78,151 Depreciation 149,528 139,037 163,508 Provision for loan losses 620,000 200,000 175,000 Deferred income taxes (152,100) (55,541) (55,927) Loss on sales of securities available-for-sale 0 0 2,021 Increase in interest receivable (216,218) (41,806) (113,304) Increase (decrease) in interest payable 36,645 20,709 (18,921) Decrease in income taxes payable (67,280) (70,441) (111,638) Other operating activities (15,460) 5,676 40,587 ------------ ------------ ----------- Net cash provided by operating activities 1,441,816 1,913,084 1,498,481 ------------ ------------ ----------- INVESTING ACTIVITIES Purchases of securities available-for-sale (18,922,053) (13,298,729) (8,915,404) Proceeds from maturities of securities available-for-sale 12,845,504 7,352,886 3,791,959 Proceeds from sales of securities available-for-sale 0 0 1,244,560 Purchases of securities held-to-maturity (114,046) 0 (100,000) Proceeds from maturities of securities held-to-maturity 1,052,875 7,952,472 4,737,671 Net (increase) decrease in Federal funds sold 2,160,000 (2,280,000) (2,500,000) Net increase in interest-bearing deposits in banks (991,000) (797,000) (198,000) Net increase in loans (8,346,907) (6,777,643) (7,492,399) Proceeds from sale of other real estate owned 111,000 334,500 0 Purchase of premises and equipment (957,028) (433,834) (139,207) ------------ ------------ ----------- Net cash used in investing activities (13,161,655) (7,947,348) (9,570,820) ------------ ------------ ----------- FINANCING ACTIVITIES Net increase in deposits 12,449,183 7,719,212 6,852,788 Net increase (decrease) in other borrowings 364,294 (383,193) 198,282 Dividends paid (514,062) (411,250) (376,979) ------------ ------------ ----------- Net cash provided by financing activities 12,299,415 6,924,769 6,674,091 ------------ ------------ ----------- Net increase (decrease) in cash and due from banks 579,576 890,505 (1,398,248) Cash and due from banks at beginning of year 3,689,204 2,798,699 4,196,947 ------------ ------------ ----------- Cash and due from banks at end of year $ 4,268,780 $ 3,689,204 $ 2,798,699 ============ ============ =========== F-6 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - ----------------------------------------------------------------------------------------------- 1999 1998 1997 ----------- ----------- ----------- SUPPLEMENTAL DISCLOSURES Cash paid for: Interest $ 3,592,558 $ 2,982,743 $ 2,820,862 Income taxes $ 672,927 $ 940,147 $ 829,909 NONCASH TRANSACTION Unrealized (gains) losses on securities available-for-sale $ 1,039,070 $ (112,456) $ (69,629) Principal balances of loans transferred to other real estate owned $ 413,272 $ 275,500 $ 0 See Notes to Consolidated Financial Statements. F-7 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS North Point Bancshares, Inc., (the "Company") is a bank holding company whose business is conducted by its wholly-owned subsidiary, Dawson County Bank (the "Bank"). The Bank is a commercial bank located in Dawsonville, Dawson County, Georgia. The Bank provides a full range of banking services in its primary market area of Dawson County, Georgia and the surrounding counties. BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and its subsidiary. Significant intercompany transactions and accounts are eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of other real estate owned, and deferred tax assets. CASH AND DUE FROM BANKS Cash on hand, cash items in process of collection, and amounts due from banks are included in cash and due from banks. The Company maintains amounts due from banks which, at times, may exceed Federally insured limits. The Company has not experienced any losses in such accounts. F-8 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SECURITIES Securities are classified based on management's intention on the date of purchase. Securities which management has the intent and ability to hold to maturity are classified as held-to-maturity and recorded at amortized cost. All other debt securities are classified as available-for-sale and recorded at fair value with net unrealized gains and losses reported in other comprehensive income (loss). Equity securities without a readily determinable fair value are classified as available-for-sale and recorded at cost. Interest and dividends on securities, including amortization of premiums and accretion of discounts, are included in interest income. Realized gains and losses from the sale of securities are determined using the specific identification method. LOANS Loans are reported at their outstanding principal balance less unearned income and the allowance for loan losses. Interest income is accrued based on the principal balance outstanding. Loan origination fees and certain direct costs of most loans are recognized at the time the loan is recorded. Loan origination fees incurred for other loans are deferred and recognized as income over the life of the loan. Because net origination loan fees and costs are not material, the results of operations are not materially different than the results which would be obtained by accounting for loan fees and costs in accordance with generally accepted accounting principles. The allowance for loan losses is maintained at a level that management believes to be adequate to absorb potential losses in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries are credited to the allowance. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current economic conditions, volume, growth, composition of the loan portfolio, and other risks inherent in the portfolio. This evaluation is inherently subjective as it requires material estimates that are susceptible to significant change including the amounts and timing of future cash flows expected to be received on impaired loans. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses, and may require the Company to record additions to the allowance based on their judgment about information available to them at the time of their examinations. F-9 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) LOANS (CONTINUED) The accrual of interest on loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. Interest income is subsequently recognized only to the extent cash payments are received. A loan is impaired when it is probable the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Individually identified impaired loans are measured based on the present value of payments expected to be received, using the contractual loan rate as the discount rate. Alternatively, measurement may be based on observable market prices or, for loans that are solely dependent on the collateral for repayment, measurement may be based on the fair value of the collateral. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. Changes to the valuation allowance are recorded as a component of the provision for loan losses. PREMISES AND EQUIPMENT Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation computed principally by the straight-line method over the estimated useful lives of the assets. OTHER REAL ESTATE OWNED Other real estate owned represents properties acquired through foreclosure. Other real estate owned is held for sale and is carried at the lower of the recorded amount of the loan or fair value of the properties less estimated selling costs. Any write-down to fair value at the time of transfer to other real estate owned is charged to the allowance for loan losses. Subsequent gains or losses on sale and any subsequent adjustment to the value are recorded as other expenses. The carrying amount of other real estate owned as of December 31, 1999 and 1998 was $247,272 and $ --, respectively. F-10 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) PENSION PLAN The Company recognizes pension costs as paid, the results of which are not materially different than the results which would be obtained by accounting for net periodic pension costs in accordance with generally accepted accounting principles. INCOME TAXES Income tax expense consists of current and deferred taxes. Current income tax provisions approximate taxes to be paid or refunded for the applicable year. Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Recognition of deferred tax balance sheet amounts is based on management's belief that it is more likely than not that the tax benefit associated with certain temporary differences will be realized. A valuation allowance would be recorded for those deferred tax items for which it is more likely than not that realization would not occur. The Company and the Bank file a consolidated income tax return. Each entity provides for income taxes based on its contribution to income taxes (benefits) of the consolidated group. EARNINGS PER SHARE Earnings per share are computed by dividing net income by the weighted average number of shares of common stock outstanding. As of December 31, 1999, 1998 and 1997, the weighted average number of shares was 428,385 adjusted for stock dividends declared. F-11 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) COMPREHENSIVE INCOME Statement of Financial Accounting Standards ("SFAS") No. 130 describes comprehensive income as the total of all components of comprehensive income, including net income. Other comprehensive income refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income but excluded from net income. Currently, the Company's other comprehensive income (loss) consists of unrealized gains and losses on available-for-sale securities. RECENT DEVELOPMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The effective date of this statement has been deferred by SFAS No. 137 until fiscal years beginning after June 15, 2000. However, the statement permits early adoption as of the beginning of any fiscal quarter after its issuance. The Company expects to adopt this statement effective January 1, 2001. SFAS No. 133 requires the Company to recognize all derivatives as either assets or liabilities in the balance sheet at fair value. For derivatives that are not designated as hedges, the gain or loss must be recognized in earnings in the period of change. For derivatives that are designated as hedges, changes in the fair value of the hedged assets, liabilities, or firm commitments must be recognized in earnings or recognized in other comprehensive income until the hedged item is recognized in earnings, depending on the nature of the hedge. The ineffective portion of a derivative's change in fair value must be recognized in earnings immediately. Management has not yet determined what effect the adoption of SFAS No. 133 will have on the Company's earnings or financial position. There are no other recent accounting pronouncements that have had, or are expected to have, a material effect on the Company's financial statements. F-12 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 2. SECURITIES The amortized cost and fair value of securities are summarized as follows: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------- --------- ------------ ----------- SECURITIES AVAILABLE-FOR-SALE DECEMBER 31, 1999: U. S. GOVERNMENT AND AGENCY SECURITIES $20,850,538 $ 537 $ (670,319) $20,180,756 STATE AND MUNICIPAL SECURITIES 3,089,172 7,820 (140,936) 2,956,056 MORTGAGE-BACKED SECURITIES 2,213,290 1,768 (72,084) 2,142,974 EQUITY SECURITIES 92,001 -- -- 92,001 ----------- --------- ------------ ----------- $26,245,001 $ 10,125 $ (883,339) $25,371,787 =========== ========= ============ =========== December 31, 1998: U. S. Government and agency securities $15,841,108 $ 123,045 $ (19,317) $15,944,836 State and municipal securities 2,513,785 56,026 (4,858) 2,564,953 Mortgage-backed securities 1,721,558 10,960 -- 1,732,518 Equity securities 92,001 -- -- 92,001 ----------- --------- ------------ ----------- $20,168,452 $ 190,031 $ (24,175) $20,334,308 =========== ========= ============ =========== SECURITIES HELD-TO-MATURITY DECEMBER 31, 1999: U. S. GOVERNMENT AND AGENCY SECURITIES $ 247,031 $ 719 $ -- $ 247,750 STATE AND MUNICIPAL SECURITIES 3,110,776 25,887 (6,904) 3,129,759 MORTGAGE-BACKED SECURITIES 404,505 2,357 -- 406,862 ----------- --------- ------------ ----------- $ 3,762,312 $ 28,963 $ (6,904) $ 3,784,371 =========== ========= ============ =========== December 31, 1998: U. S. Government and agency securities $ 743,441 $ 10,591 $ -- $ 754,032 State and municipal securities 3,451,796 118,212 (695) 3,569,313 Mortgage-backed securities 505,904 4,716 (1,726) 508,894 ----------- --------- ------------ ----------- $ 4,701,141 $ 133,519 $ (2,421) $ 4,832,239 =========== ========= ============ =========== F-13 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 2. SECURITIES (CONTINUED) The amortized cost and fair value of securities as of December 31, 1999 by contractual maturity are shown below. Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without penalty. Therefore, these securities and equity securities are not included in the maturity categories in the following summary. SECURITIES AVAILABLE-FOR-SALE SECURITIES HELD-TO-MATURITY ----------------------------- -------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ----------- ----------- ---------- ---------- Due in one year or less $ 1,349,600 $ 1,345,948 $ 515,000 $ 514,158 Due from one year to five years 16,561,713 16,033,003 1,864,031 1,876,728 Due from five years to ten years 4,733,397 4,558,531 675,352 679,013 Due after ten years 1,295,000 1,199,330 303,424 307,610 Mortgage-backed securities 2,213,290 2,142,974 404,505 406,862 Equity securities 92,001 92,001 -- -- ----------- ----------- ---------- ---------- $26,245,001 $25,371,787 $3,762,312 $3,784,371 =========== =========== ========== ========== Securities with a carrying value of $17,171,093 and $12,247,226 at December 31, 1999 and 1998, respectively, were pledged to secure public deposits and for other purposes. Gross realized losses on sales of securities available-for-sale for the year ended December 31, 1997 amounted to $2,021. There were no sales of securities during 1999 or 1998. F-14 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES The composition of loans is summarized as follows: DECEMBER 31, ------------------------------- 1999 1998 ------------ ----------- Commercial, financial and agricultural $ 8,068,000 $ 5,484,000 Real estate - construction 12,556,000 8,299,000 Real estate - mortgage 33,380,000 27,059,000 Consumer 6,214,000 12,512,000 Other 2,045,204 1,247,667 ------------ ------------ 62,263,204 54,601,667 Unearned income (50,728) (54,768) Allowance for loan losses (1,196,321) (844,379) ------------ ------------ Loans, net $ 61,016,155 $ 53,702,520 ============ ============ Changes in the allowance for loan losses are as follows: YEARS ENDED DECEMBER 31, ----------------------------------------- 1999 1998 1997 ----------- --------- --------- BALANCE, BEGINNING OF YEAR $ 844,379 $ 710,259 $ 574,186 Provision for loan losses 620,000 200,000 175,000 Loans charged off (300,200) (86,857) (85,608) Recoveries of loans previously charged off 32,142 20,977 46,681 ----------- --------- --------- BALANCE, END OF YEAR $ 1,196,321 $ 844,379 $ 710,259 =========== ========= ========= F-15 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED) The total recorded investment in impaired loans was $706,288 and $473,502 at December 31, 1999 and 1998, respectively. There were no loans which had related allowances for loan losses determined in accordance with SFAS No. 114, ("Accounting by Creditors for Impairment of a Loan") at December 31, 1999 and 1998. The average recorded investment in impaired loans for 1999 and 1998 was $143,057 and $174,420, respectively. Interest income recognized for cash payments received on impaired loans was not material for the years ended 1999, 1998, and 1997. The Company has granted loans to certain directors, executive officers, and their related entities. The interest rates on these loans were substantially the same as rates prevailing at the time of the transaction and repayment terms are customary for the type of loan involved. Changes in related party loans for the year ended December 31, 1999 are as follows: BALANCE, BEGINNING OF YEAR $ 616,371 Advances 845,023 Repayments (666,199) --------- BALANCE, END OF YEAR $ 795,195 ========= NOTE 4. PREMISES AND EQUIPMENT Premises and equipment is summarized as follows: DECEMBER 31, ------------------------------ 1999 1998 ----------- ------------ Land $ 770,000 $ 770,000 Buildings and improvements 1,973,469 1,387,893 Equipment 1,908,034 1,536,582 ----------- ----------- 4,651,503 3,694,475 Accumulated depreciation (1,905,363) (1,755,835) ----------- ----------- $ 2,746,140 $ 1,938,640 =========== =========== F-16 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 5. DEPOSITS At December 31, 1999, the amount of scheduled maturities of time deposits are as follows: 2000 $ 39,153,309 2001 5,647,000 2002 797,000 2003 675,000 2004 214,000 -------------- $ 46,486,309 ============== As of December 31, 1999, the Company had a concentration of deposits with one depositor totaling $9,273,783. In addition, the Company had $1,762,958 in related party deposits as of December 31, 1999. NOTE 6. OTHER BORROWINGS Other borrowings consist of the following: DECEMBER 31, -------------------- 1999 1998 -------- -------- Treasury, tax and loan note option account, with interest at .25% less than the Federal funds rate, due on demand $389,302 $25,008 ======== ======= NOTE 7. INCOME TAXES Income tax expense consists of the following: YEARS ENDED DECEMBER 31, --------------------------------------- 1999 1998 1997 --------- --------- --------- Current $ 605,647 $ 869,706 $ 718,271 Deferred (152,100) (55,541) (55,927) --------- --------- --------- Income tax expense $ 453,547 $ 814,165 $ 662,344 ========= ========= ========= F-17 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 7. INCOME TAXES (CONTINUED) The Company's income tax expense differs from the amounts computed by applying the Federal income tax statutory rates to income before income taxes. A reconciliation of the differences is as follows: YEARS ENDED DECEMBER 31, --------------------------------------------------------------- 1999 1998 1997 -------------------- -------------------- -------------------- AMOUNT PERCENT Amount Percent Amount Percent --------- ------- --------- ------- --------- ------- Income taxes at statutory rate $ 497,113 34 % $ 833,498 34 % $ 680,458 34 % Tax-exempt interest (148,317) (10) (118,070) (5) (100,796) (5) Disallowed interest expense 20,060 1 16,153 1 13,519 -- State income taxes (benefits) (12,919) -- 42,198 2 46,429 3 Goodwill amortization 26,572 2 26,571 1 26,571 1 Other items, net 71,038 4 13,815 -- (3,837) -- --------- ---- --------- ---- --------- --- Income tax expense $ 453,547 31 % $ 814,165 33 % $ 662,344 33 % ========= ==== ========= === ========= === The components of deferred income taxes are as follows: DECEMBER 31, ---------------------- 1999 1998 -------- -------- Deferred tax assets: Loan loss reserves $379,854 $247,031 Securities available-for-sale 296,893 -- Other 26,338 -- -------- -------- 703,085 247,031 -------- -------- Deferred tax liabilities: Depreciation 53,632 43,478 Securities available-for-sale -- 56,391 Other -- 3,093 -------- -------- 53,632 102,962 -------- -------- Net deferred tax assets $649,453 $144,069 ======== ======== F-18 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 8. EMPLOYEE BENEFITS The Company has a defined benefit pension plan covering substantially all employees. Plan benefits are based on an employee's years of service and cumulative earnings. The Company's funding policy is to make contributions annually equal to the minimum amount as determined by the plan sponsor. Contributions charged to expense were $102,000, $92,777, and $91,999 for the years ended December 31, 1999, 1998 and 1997, respectively, which amounts were not materially different from periodic pension costs as determined in accordance with generally accepted accounting principles. The following sets forth the plan's funded status for the plan years ended September 30, 1999, 1998, and 1997, respectively. 1999 1998 1997 --------- --------- --------- Change in benefit obligations: Benefit obligation at beginning of year $ 740,021 $ 666,383 $ 578,386 Service cost 49,162 42,462 39,453 Interest cost 64,577 57,066 49,427 Actuarial gain (loss) 13,650 (25,890) (883) Benefits paid -- -- -- --------- --------- --------- Benefit obligation at end of year 867,410 740,021 666,383 --------- --------- --------- Change in plan assets: Fair value of plan assets at beginning of year 579,552 500,978 402,896 Return on plan assets 15,640 (14,203) 6,083 Employer contribution 102,000 92,777 91,999 Benefits paid -- -- -- --------- --------- --------- Fair value of plan assets at end of year 697,192 579,552 500,978 --------- --------- --------- Funded status (170,218) (160,469) (165,405) Unrecognized net transition obligation 140,393 152,092 163,791 Unrecognized net loss 107,969 60,129 28,535 --------- --------- --------- Prepaid pension cost not included in balance sheet $ 78,144 $ 51,752 $ 26,921 ========= ========= ========= F-19 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 8. EMPLOYEE BENEFITS (CONTINUED) The components of net periodic pension cost are as follows: YEARS ENDED SEPTEMBER 30, ----------------------------------------- 1999 1998 1997 -------- -------- -------- Service cost $ 49,162 $ 42,462 $ 39,453 Interest cost 64,577 57,066 49,427 Actual return on plan assets (19,847) (15,001) (6,932) Amortization of unrecognized net transition obligation 11,699 11,699 11,699 Deferred investment loss (29,983) (28,280) (28,569) -------- -------- -------- $ 75,608 $ 67,946 $ 65,078 ======== ======== ======== Assumptions used were as follows: 1999 1998 1997 -------- -------- -------- Annual discount rate 8 % 8 % 8 % Expected long-term rate of return on plan assets 8 % 8 % 8 % Rate of increase in compensation 4 % 4 % 4 % In 1998, the Company adopted a 401(k) retirement plan covering substantially all employees. Contributions to the plan charged to expense during 1999 and 1998 amounted to $25,525 and $19,496, respectively. NOTE 9. COMMITMENTS AND CONTINGENT LIABILITIES In the normal course of business, the Company has entered into off-balance-sheet financial instruments which are not reflected in the financial statements. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are included in the financial statements when funds are disbursed or the instruments become payable. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. F-20 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 9. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. A summary of the Company's commitments is as follows: DECEMBER 31, --------------------------- 1999 1998 ----------- ----------- Commitments to extend credit $11,312,834 $11,991,000 Standby letters of credit 1,016,067 535,500 ----------- ----------- $12,328,901 $12,526,500 =========== =========== Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The credit risk involved in issuing these financial instruments is essentially the same as that involved in extending loans to customers. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include real estate and improvements, marketable securities, accounts receivable, inventory, equipment, and personal property. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary. In the normal course of business, the Company is involved in various legal proceedings. In the opinion of management of the Company, any liability resulting from such proceedings would not have a material effect on the Company's financial statements. NOTE 10. CONCENTRATIONS OF CREDIT The Company originates primarily commercial, residential, and consumer loans to customers in Dawson County and surrounding counties. The ability of the majority of the Company's customers to honor their contractual loan obligations is dependent on the economy in Dawson County. F-21 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 10. CONCENTRATIONS OF CREDIT (CONTINUED) Seventy-four percent of the Company's loan portfolio is secured by real estate, of which a substantial portion is secured by real estate in the Company's primary market area. Accordingly, the ultimate collectibility of the loan portfolio is susceptible to changes in market conditions in the Company's primary market area. The other significant concentrations of credit by type of loan are set forth in Note 3. The Company, as a matter of policy, does not generally extend credit to any single borrower or group of related borrowers in excess of 25% of the Bank's statutory capital, or approximately $1,650,000. NOTE 11. REGULATORY MATTERS The Bank is subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. At December 31, 1999, approximately $540,000 of retained earnings were available for dividend declaration without regulatory approval. The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The holding company is not subject to prompt corrective action provisions. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier I capital to risk-weighted assets and of Tier I capital to average assets. Management believes, as of December 31, 1999, the Company and Bank met all capital adequacy requirements to which they are subject. F-22 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 11. REGULATORY MATTERS (CONTINUED) As of December 31, 1999, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank's category. The Company and Bank's actual capital amounts and ratios are presented in the following table. TO BE WELL FOR CAPITAL CAPITALIZED UNDER ADEQUACY PROMPT CORRECTIVE ACTUAL PURPOSES ACTION PROVISIONS ---------------------- ------------------ ----------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------- ----- ------ ----- ------ ----- (DOLLARS IN THOUSANDS) ----------------------------------------------------------------------- AS OF DECEMBER 31, 1999: TOTAL CAPITAL TO RISK WEIGHTED ASSETS: CONSOLIDATED $10,613 15.56% $5,453 8% $ N/A N/A BANK $10,568 15.50% $5,453 8% $6,816 10% TIER I CAPITAL TO RISK WEIGHTED ASSETS: CONSOLIDATED $ 9,757 14.31% $2,727 4% $ N/A N/A BANK $ 9,712 14.25% $2,727 4% $4,090 6% TIER I CAPITAL TO AVERAGE ASSETS: CONSOLIDATED $ 9,757 9.13% $4,275 4% $ N/A N/A BANK $ 9,712 9.09% $4,275 4% $5,343 5% As of December 31, 1998: Total Capital to Risk Weighted Assets: Consolidated $ 9,895 17.45% $4,536 8% $ N/A N/A Bank $ 9,852 17.34% $4,545 8% $5,682 10% Tier I Capital to Risk Weighted Assets: Consolidated $ 9,184 16.20% $2,268 4% $ N/A N/A Bank $ 9,140 16.09% $2,272 4% $3,408 6% Tier I Capital to Average Assets: Consolidated $ 9,184 9.85% $3,729 4% $ N/A N/A Bank $ 9,140 9.80% $3,731 4% $4,663 5% F-23 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flow models. Those models are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different methodologies may have a material effect on the estimated fair value amounts. Also, the fair value estimates presented herein are based on pertinent information available to management as of December 31, 1999 and 1998. Such amounts have not been revalued for purposes of these financial statements since those dates and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein: CASH, DUE FROM BANKS, INTEREST-BEARING DEPOSITS IN BANKS, AND FEDERAL FUNDS SOLD: The carrying amounts of cash, due from banks, interest-bearing deposits in banks, and Federal funds sold approximate their fair value. SECURITIES: Fair values for securities are based on available quoted market prices. The carrying values of equity securities with no readily determinable fair value approximate fair values. LOANS: For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. For other loans, the fair values are estimated using discounted cash flow models, using current market interest rates offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral. F-24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) DEPOSITS: The carrying amounts of demand deposits, savings deposits, and variable-rate certificates of deposit approximate their fair values. Fair values for fixed-rate certificates of deposit are estimated using discounted cash flow models, using current market interest rates offered on certificates with similar remaining maturities. OTHER BORROWINGS: Other borrowings consist of short term obligations under a treasury, tax and loan note option account which is due on demand. The carrying amounts approximate their fair values. ACCRUED INTEREST: The carrying amounts of accrued interest approximate their fair values. Fair values of the Company's off-balance-sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit and standby letters of credit do not represent a significant value to the Company until such commitments are funded. The Company has determined that these instruments do not have a distinguishable fair value and no fair value has been assigned. F-25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 12. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) ACCRUED INTEREST (CONTINUED): The estimated fair values and related carrying amounts of the Company's financial instruments were as follows: DECEMBER 31, 1999 December 31, 1998 ------------------------------ -------------------------------- CARRYING FAIR Carrying Fair AMOUNT VALUE Amount Value ----------- ----------- ----------- ----------- Financial assets: Cash, due from banks, interest-bearing deposits in banks, and Federal funds sold $11,429,780 $11,429,780 $12,019,204 $12,019,204 Securities available-for-sale 25,371,787 25,371,787 20,334,308 20,334,308 Securities held-to-maturity 3,762,312 3,784,371 4,701,141 4,832,239 Loans 61,016,155 62,356,054 53,702,520 54,738,647 Accrued interest receivable 1,163,588 1,163,588 947,370 947,370 Financial liabilities: Deposits 96,564,625 96,367,570 84,115,442 84,456,649 Other borrowings 389,302 389,302 25,008 25,008 Accrued interest payable 331,929 331,929 295,284 295,284 NOTE 13. STOCK DIVIDEND On June 12, 1997 and January 14, 1999, the Company effected a one-for-five and a one-for-four stock split, respectively, both in the form of a stock dividend. Stockholders of record as of July 1, 1997 and January 20, 1999 received one additional share for every five shares they owned and one additional share for every four shares they owned on those dates, respectively. An amount equal to the par value of common shares declared was transferred from retained earnings to common stock. Earnings per share of common stock and all per share amounts presented herein have been adjusted to give effect to both splits. F-26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 14. SUPPLEMENTAL FINANCIAL DATA Components of other operating expenses in excess of 1% of total revenue are as follows: DECEMBER 31, ---------------------------------------- 1999 1998 1997 -------- -------- -------- Advertising $104,490 $ 68,916 $ 58,242 Printing, stationery and supplies 117,195 82,861 87,007 Data processing services 189,119 159,761 137,365 NOTE 15. PARENT COMPANY FINANCIAL INFORMATION The following information presents the condensed balance sheets of North Point Bancshares, Inc. as of December 31, 1999 and 1998 and the condensed statements of income and cash flows for the three years ended December 31, 1999: CONDENSED BALANCE SHEETS 1999 1998 --------- ---------- ASSETS Cash $ 39,335 $ 41,751 Investment in subsidiary 9,135,365 9,249,606 Goodwill, net -- 78,151 Other assets 26,182 2,571 ---------- ---------- Total assets $9,200,882 $9,372,079 ========== ========== LIABILITIES $ 20,427 $ 326 STOCKHOLDERS' EQUITY 9,180,455 9,371,753 ---------- ---------- Total liabilities and stockholders' equity $9,200,882 $9,372,079 ========== ========== F-27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 15. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED) CONDENSED STATEMENTS OF INCOME 1999 1998 1997 ----------- ---------- ----------- INCOME Interest $ 1,360 $ 1,278 $ 1,073 Dividends from subsidiary 516,000 420,000 384,000 ----------- ---------- ----------- Total income 517,360 421,278 385,073 ----------- ---------- ----------- EXPENSE Salaries 3,000 3,000 3,000 Goodwill amortization 78,151 78,151 78,151 Other expense 2,715 5,085 4,232 ----------- ---------- ----------- Total expense 83,866 86,236 85,383 ----------- ---------- ----------- Income before income tax expense (benefits) and equity in undistributed income of subsidiary 433,494 335,042 299,690 INCOME TAX EXPENSE (BENEFITS) (3,513) 3,165 (5,066) ----------- ---------- ----------- Income before equity in undistributed income of subsidiary 437,007 331,877 304,756 EQUITY IN UNDISTRIBUTED INCOME OF SUBSIDIARY 571,543 1,305,422 1,034,248 ----------- ---------- ----------- Net income $ 1,008,550 $1,637,299 $ 1,339,004 =========== ========== =========== F-28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 15. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS 1999 1998 1997 ----------- ----------- ----------- OPERATING ACTIVITIES Net income $ 1,008,550 $ 1,637,299 $ 1,339,004 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 78,151 78,151 78,151 Undistributed income of subsidiary (571,543) (1,305,422) (1,034,248) Other operating activities (3,512) 7,848 (5,067) ----------- ----------- ----------- Net cash provided by operating activities 511,646 417,876 377,840 ----------- ----------- ----------- FINANCING ACTIVITIES Dividends paid (514,062) (411,250) (376,979) ----------- ----------- ----------- Net cash used in financing activities (514,062) (411,250) (376,979) ----------- ----------- ----------- Net increase (decrease) in cash (2,416) 6,626 861 Cash at beginning of year 41,751 35,125 34,264 ----------- ----------- ----------- Cash at end of year $ 39,335 $ 41,751 $ 35,125 =========== =========== =========== NOTE 16. BUSINESS COMBINATION On March 3, 2000, the Company entered into an definitive agreement with United Community Bank, Inc. ("United") of Blairsville, Georgia. Under this agreement, the Company will merge with and into United. Upon consummation of the merger, each share of Company stock will be converted into and exchanged for the right to receive approximately 2.25 shares of United common stock. Consummation is subject to certain conditions, including regulatory and stockholder approval and will be accounted for as a pooling of interests. F-29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 16. BUSINESS COMBINATION (CONTINUED) Also, on March 3, 2000, United entered into a definitive agreement to acquire Independent Bancshares, Inc. ("Independent"), a $145 million one-bank holding company for Independent Bank & Trust, located in Powder Springs, Georgia. Each share of Independent stock will be converted into and exchanged for the right to receive approximately .4211 shares of United common stock. The following unaudited proforma data summarizes operating data as if the combinations had been consummated on January 1, 1997. AS OF AND FOR THE YEAR ENDED (IN THOUSANDS, EXCEPT SHARE AMOUNTS) ---------------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Total assets $2,383,486 $1,812,585 $1,410,071 Stockholders' equity 118,887 115,415 99,571 Net income 16,692 15,510 13,197 Basic income per share 1.70 1.59 1.41 Diluted income per share 1.67 1.56 1.40 F-30 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED BALANCE SHEET (IN THOUSANDS) - ----------------------------------------------------------------------------------------------------------------- MARCH 31, DECEMBER 31, 2000 1999 - ----------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 7,295 7,250 Federal funds sold - 4,180 - ----------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 7,295 11,430 Securities held to maturity (estimated fair value of $3,550 and $3,784) 3,544 3,762 Securities available for sale 25,111 25,372 Loans, net of unearned income 75,336 62,212 Less: Allowance for loan losses (1,210) (1,196) - ----------------------------------------------------------------------------------------------------------------- Loans, net 74,126 61,016 Premises and equipment, net 2,796 2,746 Other assets 2,238 2,152 - ----------------------------------------------------------------------------------------------------------------- Total assets $ 115,110 106,478 - ----------------------------------------------------------------------------------------------------------------- LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand $ 18,536 17,738 Interest bearing demand 31,175 26,991 Savings 5,643 5,350 Time 48,284 46,486 - ----------------------------------------------------------------------------------------------------------------- Total deposits 103,638 96,565 Accrued expenses and other liabilities 595 344 Other borrowings 1,488 389 - ----------------------------------------------------------------------------------------------------------------- Total liabilities 105,721 97,298 Stockholders' equity: Common stock ($5 par value; 5,000,000 shares authorized; 428,385 2,142 2,142 shares issued and outstanding) Capital surplus 1,985 1,985 Retained earnings 5,861 5,629 Accumulated other comprehensive income (599) (576) - ----------------------------------------------------------------------------------------------------------------- Total stockholders' equity 9,389 9,180 - ----------------------------------------------------------------------------------------------------------------- - ----------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 115,110 106,478 - ----------------------------------------------------------------------------------------------------------------- Outstanding common shares 428,385 428,385 Book value per common share $ 21.92 21.43 See notes to unaudited consolidated financial statements. F-31 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY Unaudited Consolidated Statements of Income (in thousands except, except per share data) For the Three Months ENDED MARCH 31, 2000 1999 ----------------------------------------- Interest income: Interest and fees on loans $ 1,670 1,431 Interest on federal funds sold 99 132 Interest on investment securities: Tax exempt 70 70 Taxable 416 300 - --------------------------------------------------------------------------------------------------------- Total interest income 2,255 1,933 - --------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Interest on deposits: Demand 384 253 Savings 41 43 Time 632 571 Other borrowings 3 2 - --------------------------------------------------------------------------------------------------------- Total interest expense 1,060 869 - --------------------------------------------------------------------------------------------------------- Net interest income 1,195 1,064 Provision for loan losses 20 30 - --------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 1,175 1,034 - --------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Service charges and fees 116 99 Securities gains, net - - Other non-interest income 66 63 - --------------------------------------------------------------------------------------------------------- Total noninterest income 182 162 - --------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Salaries and employee benefits 452 390 Occupancy 102 81 Other noninterest expense 260 205 - --------------------------------------------------------------------------------------------------------- Total noninterest expense 814 676 - --------------------------------------------------------------------------------------------------------- Income before income taxes 543 520 Income taxes 151 160 - --------------------------------------------------------------------------------------------------------- NET INCOME $ 392 360 - --------------------------------------------------------------------------------------------------------- Basic earnings per share $ 0.92 0.84 Diluted earnings per share $ 0.92 0.84 Average shares outstanding 428 428 Diluted average shares outstanding 428 428 See notes to unaudited consolidated financial statements. F-32 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY UNAUDITED STATEMENT OF EARNINGS PER SHARE (IN THOUSANDS, EXCEPT PER SHARE DATA) For the Three Months Ended March 31, 2000 1999 - ---------------------------------------------------------------------------------------------------- Basic earnings per share: Weighted average shares outstanding 428 428 Net income 392 360 Basic earnings per share 0.92 0.84 Diluted earnings per share 0.92 0.84 F-33 NORTH POINT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS) FOR THE THREE MONTHS ENDED MARCH 31 ------------- ------------- 2000 1999 ------------- ------------- Net income $ 392 360 Other comprehensive income (loss), before tax: Unrealized holding gains (losses) on investment securities available for sale (34) (154) Less reclassification adjustment for gains on investment securities available for sale - - ------------- ------------- Total other comprehensive income (loss), before tax (34) (154) ------------- ------------- INCOME TAX EXPENSE (BENEFIT) RELATED TO OTHER COMPREHENSIVE INCOME Unrealized holding gains (losses) on investment securities (11) (51) Less reclassification adjustment for gains on investment securities available for sale - - ------------- ------------- Total income tax expense (benefit) related to other comprehensive income (loss) (11) (51) ------------- ------------- Total other comprehensive income (loss), net of tax (23) (103) ------------- ------------- Total comprehensive income $ 369 257 ============= ============= F-34 UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) FOR THE THREE MONTHS ENDED MARCH 31 2000 1999 ------------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 392 360 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation, amortization and accretion 40 (7) Provision for loan losses 20 30 Change in assets and liabilities: Interest receivable 83 136 Other assets (301) (204) Accrued expenses and other liabilities 260 71 ------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 494 386 ------------------------- CASHFLOWS FROM INVESTING ACTIVITIES, NET OF PURCHASE ACQUISITIONS: Proceeds from maturities and calls of securities held to maturity 218 588 Proceeds from maturities and calls of securities available for sale 734 5,025 Purchases of securities available for sale (500) (8,175) Net increase in loans (13,124) (1,749) Proceeds from sale of other real estate - - Purchase of bank premises and equipment (1) (71) ------------------------- NET CASH USED IN INVESTING ACTIVITIES (12,673) (4,382) ------------------------- CASHFLOWS FROM FINANCING ACTIVITIES, NET OF PURCHASE ACQUISITIONS Net change in demand and savings deposits 5,275 6,133 Net change in time deposits 1,798 1,926 Net change in long-term debt and other borrowings 1,099 177 Dividends paid (128) (128) ------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 8,044 8,108 ------------------------- Net change in cash and cash equivalents (4,135) 4,112 Cash and cash equivalents at beginning of period 11,430 12,019 ------------------------- Cash and cash equivalents at end of period $ 7,295 16,131 ========================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 1,054 864 Income Taxes $ 146 170 F-35 NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION NOTE 1 - BASIS OF PRESENTATION The unaudited pro forma condensed combined financial information has been prepared assuming that the Merger will be accounted for under the pooling of interests accounting method and is based on the historical consolidated financial statements of United Community Banks, Inc. ("United") and North Point Bancshares, Inc. ("North Point"). NOTE 2 - SHAREHOLDERS' EQUITY In the Merger, United will exchange 2.2368 shares of United common stock for each share of North Point common stock. North Point had 428,385 shares of common stock outstanding at March 31, 2000, which will be exchanged for approximately 958,211 shares of United common stock. NOTE 3 - Merger Related Charges In connection with the Merger, United and North Point expect to incur pre-tax merger related charges of approximately $1.3 million. These are expected to include approximately $880,000 of occupancy related expenses (equipment write-offs and contract terminations), $250,000 of compensation expense, $135,000 of merger-related professional fees (investment banking, legal and accounting) and $35,000 of other merger expenses. These amounts and the related tax effects have not been reflected in the unaudited pro forma consolidated financial information because they are will not have a material impact on the shareholders' equity of the combined company and are not expected to have a continuing impact on the operations of the combined company. F-36 > INDEPENDENT AUDITOR'S REPORT - ------------------------------------------------------------------------------- To the Board of Directors Independent Bancshares, Inc. and Subsidiary Powder Springs, Georgia We have audited the accompanying consolidated balance sheets of INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY as of December 31, 1999 and 1998, and the related consolidated statements of income, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Independent Bancshares, Inc. and Subsidiary as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. Atlanta, Georgia February 18, 2000, except for Note 17 as to which the date is March 3, 2000 F-37 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998 - ------------------------------------------------------------------------------------------------- Assets 1999 1998 ------ ------------- ------------ Cash and due from banks $ 4,639,144 $ 4,050,320 Federal funds sold 5,000,000 1,730,000 Securities available-for-sale 18,833,904 18,486,575 Securities held-to-maturity (fair value of $6,169,214 and $6,785,561, respectively) 7,226,331 7,706,711 Loans 101,575,447 87,782,190 Less allowance for loan losses 1,124,854 878,459 ------------- ------------ Loans, net 100,450,593 86,903,731 ------------- ------------ Premises and equipment 5,543,302 5,400,883 Other assets 3,408,682 3,027,977 ------------- ------------ Total assets $ 145,101,956 $127,306,197 ============= ============ Liabilities, Redeemable Common Stock ------------------------------------ and Stockholders' Equity ------------------------ Deposits Noninterest-bearing demand $ 16,614,339 $ 17,015,431 Interest-bearing demand 38,332,760 37,109,488 Savings 5,169,227 4,636,405 Time, $100,000 and over 20,651,039 14,846,249 Other time 42,654,772 36,178,702 ------------- ------------ Total deposits 123,422,137 109,786,275 Other borrowings 6,707,143 3,350,000 Other liabilities 1,350,320 1,430,103 ------------- ------------ Total liabilities 131,479,600 114,566,378 ------------- ------------ Commitments and contingent liabilities Redeemable common stock held by KSOP, 44,398 and 44,432 shares outstanding at December 31, 1999 and 1998, respectively 577,174 533,184 ------------- ------------ Stockholders' equity Common stock, par value $1; 5,000,000 shares authorized; 1,948,148 and 1,948,156 issued and outstanding, respectively 1,948,148 1,948,156 Capital surplus 8,614,516 8,614,604 Retained earnings 2,822,452 1,538,130 Accumulated other comprehensive income (loss) (339,934) 105,745 ------------- ------------ Total stockholders' equity 13,045,182 12,206,635 ------------- ------------ Total liabilities, redeemable common stock, and stockholders' equity $ 145,101,956 $127,306,197 ============= ============ See Notes to Consolidated Financial Statements F-38 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - ------------------------------------------------------------------------------------------------------------ 1999 1998 1997 ----------- ---------- ----------- INTEREST INCOME Interest and fees on loans $ 9,470,892 $8,328,655 $ 6,889,972 Taxable securities 1,381,973 1,250,112 1,243,564 Nontaxable securities 32,835 12,371 12,371 Federal funds sold 203,444 384,777 186,403 Deposits in banks 6,409 2,463 683 ----------- ---------- ----------- TOTAL INTEREST INCOME 11,095,553 9,978,378 8,332,993 ----------- ---------- ----------- INTEREST EXPENSE Deposits 4,434,900 4,435,258 3,873,922 Other borrowings 370,589 187,978 175,141 ----------- ---------- ----------- TOTAL INTEREST EXPENSE 4,805,489 4,623,236 4,049,063 ----------- ---------- ----------- NET INTEREST INCOME 6,290,064 5,355,142 4,283,930 PROVISION FOR LOAN LOSSES 242,000 201,732 262,211 ----------- ---------- ----------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 6,048,064 5,153,410 4,021,719 ----------- ---------- ----------- OTHER INCOME Service charges on deposit accounts 466,964 418,897 367,383 Other loan fee income 114,010 62,815 93,244 Mortgage origination income 284,648 318,434 129,060 Net realized gains (losses) on sale of securities 627 0 (7,216) Other operating income 237,558 138,031 88,465 ----------- ---------- ----------- TOTAL OTHER INCOME 1,103,807 938,177 670,936 ----------- ---------- ----------- OTHER EXPENSES Salaries and employee benefits 2,802,675 2,781,916 2,105,895 Equipment expenses 443,265 334,515 261,232 Occupancy expenses 312,169 228,828 206,763 Other operating expenses 1,188,498 1,097,253 968,971 ----------- ---------- ----------- TOTAL OTHER EXPENSES 4,746,607 4,442,512 3,542,861 ----------- ---------- ----------- INCOME BEFORE INCOME TAXES 2,405,264 1,649,075 1,149,794 INCOME TAX EXPENSE 784,728 549,574 345,943 ----------- ---------- ----------- NET INCOME $ 1,620,536 $1,099,501 $ 803,851 =========== ========== =========== BASIC EARNINGS PER SHARE $ 0.83 $ 0.56 $ 0.60 =========== ========== =========== DILUTED EARNINGS PER SHARE $ 0.82 $ 0.55 $ 0.59 =========== ========== =========== SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-39 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - ------------------------------------------------------------------------------------------------------------- 1999 1998 1997 ----------- ---------- -------- Net income $ 1,620,536 $1,099,501 $803,851 ----------- ---------- -------- Other comprehensive income (loss): Unrealized gains (losses) on securities available-for-sale: Unrealized holding gains (losses) arising during period, net of tax (benefits) of $(229,380), $29,387 and $34,119, respectively (445,265) 57,046 66,232 Reclassification adjustment for (gains) losses realized in net income, net of tax of $(213), $-0- and $2,453, respectively (414) -- 4,763 ----------- ---------- -------- Other comprehensive income (loss) (445,679) 57,046 70,995 ----------- ---------- -------- Comprehensive income $ 1,174,857 $1,156,547 $874,846 =========== ========== ======== SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-40 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - --------------------------------------------------------------------------------------------------------- Common Stock --------------------------- Capital Retained Shares Par Value Surplus Earnings ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 1996 1,116,438 $ 1,116,438 $ 4,465,752 $ 234,215 Net income -- -- 0 803,851 Dividends declared, $.06 per share -- -- -- (66,986) Issuance of stock 831,796 831,796 4,158,980 -- Stock offering costs -- -- (32,592) -- Other comprehensive income -- -- -- -- Decrease in KSOP debt guarantee -- -- -- -- Adjustment for shares owned by KSOP -- -- -- (175,237) Purchase of treasury stock -- -- -- -- Sale of treasury stock -- -- 29,053 -- ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 1997 1,948,234 1,948,234 8,621,193 795,843 Net income -- -- -- 1,099,501 Dividends declared, $.10 per share -- -- -- (194,823) Issuance of stock 4,255 4,255 21,275 -- Other comprehensive income -- -- -- -- Purchase of treasury stock -- -- -- -- Adjustment for shares owned by KSOP -- -- -- (162,391) Sale of treasury stock -- -- 300 -- Retirement of treasury stock (4,333) (4,333) (28,164) -- ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 1998 1,948,156 1,948,156 8,614,604 1,538,130 Net income -- -- -- 1,620,536 Dividends declared, $.15 per share -- -- -- (292,224) Other comprehensive loss -- -- -- -- Adjustment for shares owned by KSOP -- -- -- (43,990) Purchase of treasury stock -- -- -- -- Retirement of treasury stock (8) (8) (88) -- ---------- ----------- ----------- ----------- BALANCE, DECEMBER 31, 1999 1,948,148 $ 1,948,148 $ 8,614,516 $ 2,822,452 ========== =========== =========== =========== Accumulated Treasury Stock Other KSOP Total ---------------------- Comprehensive Debt Stockholders' Shares Cost Income(Loss) Guarantee Equity ------- --------- ----------- --------- ------------ BALANCE, DECEMBER 31, 1996 -- $ -- $ (22,296) $(320,413) $ 5,473,696 Net income -- -- -- -- 803,851 Dividends declared, $.06 per share -- -- -- -- (66,986) Issuance of stock -- -- -- -- 4,990,776 Stock offering costs -- -- -- -- (32,592) Other comprehensive income -- -- 70,995 -- 70,995 Decrease in KSOP debt guarantee -- -- -- 320,413 320,413 Adjustment for shares owned by KSOP -- -- -- -- (175,237) Purchase of treasury stock 52,308 (289,827) -- -- (289,827) Sale of treasury stock (52,308) 289,827 -- -- 318,880 ------- --------- --------- --------- ------------ BALANCE, DECEMBER 31, 1997 -- -- 48,699 -- 11,413,969 Net income -- -- -- -- 1,099,501 Dividends declared, $.10 per share -- -- -- -- (194,823) Issuance of stock -- -- -- -- 25,530 Other comprehensive income -- -- 57,046 -- 57,046 Purchase of treasury stock 10,617 (81,827) -- -- (81,827) Adjustment for shares owned by KSOP -- -- -- -- (162,391) Sale of treasury stock (6,284) 49,330 -- -- 49,630 Retirement of treasury stock (4,333) 32,497 -- -- -- ------- --------- --------- --------- ------------ BALANCE, DECEMBER 31, 1998 -- -- 105,745 -- 12,206,635 Net income -- -- -- -- 1,620,536 Dividends declared, $.15 per share -- -- -- -- (292,224) Other comprehensive loss -- -- (445,679) -- (445,679) Adjustment for shares owned by KSOP -- -- -- -- (43,990) Purchase of treasury stock 8 (96) -- -- (96) Retirement of treasury stock (8) 96 -- -- -- ------- --------- --------- --------- ------------ BALANCE, DECEMBER 31, 1999 -- $ -- $(339,934) $ -- $ 13,045,182 ======= ========= ========= ========= ============ SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-41 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - ------------------------------------------------------------------------------------------------------------------ 1999 1998 1997 ------------ ------------ ------------ OPERATING ACTIVITIES Net income $ 1,620,536 $ 1,099,501 $ 803,851 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 242,000 201,732 262,211 Depreciation 413,957 279,196 226,572 Amortization 4,653 4,653 4,653 Deferred income tax benefits (89,000) (66,510) (35,210) Net realized (gains) losses on sale of securities (627) 0 7,216 (Gain) loss on sale of other real estate (13,566) 11,054 (793) Write-down of repossessed assets 0 0 60,291 Increase (decrease) in interest receivable 3,320 (11,755) (284,000) Decrease in interest payable (77,155) (99,987) (212,898) Other operating activities (192,713) (210,699) 337,734 ------------ ------------ ------------ Net cash provided by operating activities 1,911,405 1,207,185 1,169,627 ------------ ------------ ------------ INVESTING ACTIVITIES Purchases of securities available-for-sale (7,979,440) (9,629,840) (7,975,857) Proceeds from sales of securities available-for-sale 1,001,300 0 1,192,156 Proceeds from maturities of securities available-for-sale 5,956,166 6,498,029 5,366,556 Proceeds from maturities of securities held-to-maturity 480,380 1,123,217 767,067 Net (increase) decrease in Federal funds sold (3,270,000) 1,080,000 (610,000) Net increase in loans (13,811,702) (16,947,792) (21,384,636) Proceeds from sale of other real estate 156,406 459,082 144,863 Payment of life insurance premiums 0 (233,626) (876,631) Purchase of premises and equipment (556,376) (2,103,118) (714,650) ------------ ------------ ------------ Net cash used in investing activities (18,023,266) (19,754,048) (24,091,132) ------------ ------------ ------------ FINANCING ACTIVITIES Net increase in deposits 13,635,862 16,993,333 17,613,960 Net increase in other borrowings 3,357,143 1,557,143 1,771,407 Dividends paid (292,224) (194,823) (66,986) Net proceeds from issuance of stock 0 25,530 4,958,184 Purchase of treasury stock (96) (81,827) (289,827) Sale of treasury stock 0 49,630 318,880 ------------ ------------ ------------ Net cash provided by financing activities 16,700,685 18,348,986 24,305,618 ------------ ------------ ------------ F-42 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 - --------------------------------------------------------------------------------------------------------------- 1999 1998 1997 ---------- ----------- ----------- Net increase (decrease) in cash and due from banks $ 588,824 $ (197,877) $ 1,384,113 Cash and due from banks at beginning of year 4,050,320 4,248,197 2,864,084 ----------- ----------- ------------ Cash and due from banks at end of year $4,639,144 $ 4,050,320 $ 4,248,197 =========== =========== =========== SUPPLEMENTAL DISCLOSURES CASH PAID FOR: Interest $4,882,644 $ 4,723,223 $ 4,231,961 Income taxes $ 924,411 $ 923,755 $ 54,849 NONCASH TRANSACTIONS Unrealized (gains) losses on securities available-for-sale $ 675,272 $ (86,433) $ (107,567) Principal balances on loans transferred to other real estate $ 85,000 $ 405,135 $ 0 SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS. F-43 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES NATURE OF BUSINESS Independent Bancshares, Inc. (the "Company") is a bank holding company whose business is conducted by its wholly-owned subsidiary, Independent Bank & Trust Company, (the "Bank"). The Bank is a commercial bank located in Powder Springs, Cobb County, Georgia with branches located in Powder Springs, Marietta, and Hiram, Georgia. The Bank provides a full range of banking services in its primary market area of Cobb County and portions of Paulding, Douglas, and Fulton counties. In addition to normal banking services, the Bank originates mortgage loans and small business administration ("SBA") loans and provides investment services to its customers. BASIS OF PRESENTATION The consolidated financial statements include the accounts of the Company and its subsidiary. Significant intercompany transactions and accounts are eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and deferred tax assets. CASH AND DUE FROM BANKS Cash on hand, cash items in process of collection, and amounts due from banks are included in cash and due from banks. The Company maintains amounts due from banks which, at times, may exceed Federally insured limits. F-44 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) SECURITIES Securities are classified based on management's intention on the date of purchase. Securities which management has the intent and ability to hold to maturity are classified as held-to-maturity and recorded at amortized cost. All other debt securities are classified as available-for-sale and recorded at fair value with net unrealized gains and losses reported in other comprehensive income (loss), net of tax. Equity securities without a readily determinable fair value are classified as available-for-sale and are recorded at cost. Interest and dividends on securities, including amortization of premiums and accretion of discounts, are included in interest income. Realized gains and losses from the sale of securities are determined using the specific identification method. LOANS Loans are reported at their outstanding principal balances less the allowance for loan losses. Interest income is accrued based on the principal balance outstanding. Loan origination fees and certain direct costs of most short-term loans are recognized at the time the loan is recorded. The net loan origination fees and costs incurred for other loans are deferred and recognized in income over the life of the loan. The accrual of interest on loans is discontinued when, in management's opinion, the borrower may be unable to meet payments as they become due. Interest income is subsequently recognized only to the extent cash payments are received. The allowance for loan losses is maintained at a level that management believes to be adequate to absorb potential losses in the loan portfolio. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries are credited to the allowance. Management's determination of the adequacy of the allowance is based on an evaluation of the portfolio, past loan loss experience, current economic conditions, volume, growth, composition of the loan portfolio, and other risks inherent in the portfolio. This evaluation is inherently subjective as it requires material estimates that are susceptible to significant change including the amounts and timing of future cash flows expected to be received on impaired loans. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses, and may require the Company to record additions to the allowance based on their judgment about information available to them at the time of their examinations. F-45 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) LOANS (CONTINUED) A loan is considered impaired when it is probable the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. Individually identified impaired loans are measured based on the present value of expected payments, using the contractual loan rate as the discount rate, the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. If the recorded investment in the impaired loan exceeds the measure of fair value, a valuation allowance is established as a component of the allowance for loan losses. Changes to the valuation allowance are recorded as a component of the provision for loan losses. Nonaccrual loans are included in total impaired loans. PREMISES AND EQUIPMENT Land is carried at cost. Premises and equipment are carried at cost less accumulated depreciation computed principally by the straight-line method over the estimated useful lives of the assets. OTHER REAL ESTATE OWNED Other real estate owned represents properties acquired through foreclosure. Other real estate owned is held for sale and is carried at the lower of the recorded amount of the loan or fair value of the properties less estimated selling costs. Any write-down to fair value at the time of transfer to other real estate owned is charged to the allowance for loan losses. Subsequent gains or losses on sale and any subsequent adjustment to the value are recorded in current income. The carrying amount of other real estate owned at December 31, 1998 was $120,000. There was no other real estate owned at December 31, 1999. F-46 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) INCOME TAXES Income tax expense consists of current and deferred taxes. Current income tax provisions approximate taxes to be paid or refunded for the applicable year. Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Recognition of deferred tax balance sheet amounts is based on management's belief that it is more likely than not that the tax benefit associated with certain temporary differences will be realized. A valuation allowance would be recorded for those deferred tax items for which it is more likely than not that realization would not occur. The Company and the Bank file a consolidated income tax return. Each entity provides for income taxes based on its contribution to income taxes (benefits) of the consolidated group. SALE OF LOANS The Bank originates and sells participations in certain loans. Gains are recognized at the time the sale is consummated. The amount of gain recognized on the sale of a specific loan is equal to the percentage resulting from determining the fair value of the portion of the loan sold relative to the fair value of the entire loan including servicing rights. EARNINGS PER SHARE Basic earnings per share are computed by dividing net income by the weighted-average number of shares of common stock outstanding. Diluted earnings per share are computed by dividing net income by the sum of the weighted-average number of shares of common stock outstanding and potential common shares. Potential common shares consist of stock options. F-47 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) COMPREHENSIVE INCOME (LOSS) Statement of Financial Accounting Standards ("SFAS") No. 130 describes comprehensive income (loss) as the total of all components of comprehensive income (loss), including net income. Other comprehensive income (loss) refers to revenues, expenses, gains and losses that under generally accepted accounting principles are included in comprehensive income (loss) but excluded from net income. Currently, the Company's other comprehensive income (loss) consists of unrealized gains and losses on available-for-sale securities. RECENT DEVELOPMENTS In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities". The effective date of this statement has been deferred by SFAS No. 137 until fiscal years beginning after June 15, 2000. However, the statement permits early adoption as of the beginning of any fiscal quarter after its issuance. The Company expects to adopt this statement effective January 1, 2001. SFAS No. 133 requires the Company to recognize all derivatives as either assets or liabilities in the balance sheet at fair value. For derivatives that are not designated as hedges, the gain or loss must be recognized in earnings in the period of change. For derivatives that are designated as hedges, changes in the fair value of the hedged assets, liabilities, or firm commitments must be recognized in earnings or recognized in other comprehensive income until the hedged item is recognized in earnings, depending on the nature of the hedge. The ineffective portion of a derivative's change in fair value must be recognized in earnings immediately. Management has not yet determined what effect the adoption of SFAS No. 133 will have on the Company's earnings or financial position. There are no other recent accounting pronouncements that have had, or are expected to have, a material effect on the Company's financial statements. F-48 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ NOTE 2. SECURITIES The amortized cost and fair value of securities are summarized as follows: GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ----------- ----------- ------------ ----------- SECURITIES AVAILABLE-FOR-SALE DECEMBER 31, 1999: U. S. GOVERNMENT AND AGENCY SECURITIES $12,288,087 $ -- $ (250,120) $12,037,967 STATE AND MUNICIPAL SECURITIES 848,532 -- (39,817) 808,715 MORTGAGE-BACKED SECURITIES 5,683,271 -- (225,115) 5,458,156 FEDERAL HOME LOAN BANK STOCK 444,000 -- -- 444,000 EQUITY SECURITIES 85,066 -- -- 85,066 ----------- ----------- ------------ ----------- $19,348,956 $ -- $ (515,052) $18,833,904 =========== =========== ============ =========== December 31, 1998: U. S. Government and agency securities $11,323,512 $ 158,937 $ -- $11,482,449 Mortgage-backed securities 6,439,996 18,819 (17,536) 6,441,279 Federal Home Loan Bank stock 482,600 -- -- 482,600 Equity securities 80,247 -- -- 80,247 ----------- ----------- ------------ ----------- $18,326,355 $ 177,756 $ (17,536) $18,486,575 =========== =========== ============ =========== SECURITIES HELD-TO-MATURITY DECEMBER 31, 1999: U. S. GOVERNMENT AND AGENCY SECURITIES $ 6,574,578 $ 1,051 $ (1,040,978) $ 5,534,651 STATE AND MUNICIPAL SECURITIES 260,275 50 -- 260,325 MORTGAGE-BACKED SECURITIES 391,478 -- (17,240) 374,238 ----------- ----------- ------------ ----------- $ 7,226,331 $ 1,101 $ (1,058,218) $ 6,169,214 =========== =========== ============ =========== December 31, 1998: U. S. Government and agency securities $ 6,569,238 $ 10,505 $ (943,132) $ 5,636,611 State and municipal securities 266,029 3,946 -- 269,975 Mortgage-backed securities 871,444 7,531 -- 878,975 ----------- ----------- ------------ ----------- $ 7,706,711 $ 21,982 $ (943,132) $ 6,785,561 =========== =========== ============ =========== F-49 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 2. SECURITIES (CONTINUED) Securities with a carrying value of $4,101,929 and $5,075,075 at December 31, 1999 and 1998, respectively, were pledged to secure public deposits and for other purposes. Gross gains and losses on sales of securities available-for-sale consist of the following for the years ended December 31, 1999, 1998, and 1997. 1999 1998 1997 -------- ----------- ----------- Gross gains $ 753 $ -- $ -- Gross losses (126) -- (7,216) -------- ----------- ---------- Net realized gains (losses) $ 627 $ -- $ (7,216) ======== =========== ========== The amortized cost and fair value of debt securities as of December 31, 1999 by contractual maturity are shown below. Maturities may differ from contractual maturities of mortgage-backed securities because the mortgages underlying the securities may be called or prepaid with or without penalty. Therefore, these securities are not included in the maturity categories in the following summary. SECURITIES AVAILABLE-FOR-SALE SECURITIES HELD-TO-MATURITY ----------------------------- --------------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ----------- ----------- ---------- ---------- Due in one year or less $ 500,763 $ 500,000 $1,599,256 $1,595,901 Due from one to five years 11,787,324 11,537,967 500,000 431,250 Due from five to ten years 848,532 808,715 4,475,322 3,507,500 Due after ten years -- -- 260,275 260,325 Mortgage-backed securities 5,683,271 5,458,156 391,478 374,238 ----------- ----------- ---------- ---------- $18,819,890 $18,304,838 $7,226,331 $6,169,214 =========== =========== ========== ========== F-50 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES LOANS The composition of loans is summarized as follows: DECEMBER 31, ------------------------------- 1999 1998 ------------- ------------ Real estate - construction $ 37,458,000 $ 31,058,000 Real estate - mortgage 29,867,000 24,119,000 Commercial 21,719,000 25,419,000 Consumer and other loans 12,531,447 7,186,190 ------------- ------------ 101,575,447 87,782,190 Allowance for loan losses (1,124,854) (878,459) ------------- ------------ Loans, net $ 100,450,593 $ 86,903,731 ============= ============ ALLOWANCE FOR LOAN LOSSES Changes in the allowance for loan losses for the years ended December 31, 1999, 1998, and 1997 are as follows: 1999 1998 1997 ----------- --------- --------- Balance, beginning of year $ 878,459 $ 705,074 $ 608,146 Provision for loan losses 242,000 201,732 262,211 Loans charged off (31,905) (73,856) (190,403) Recoveries of loans previously charged off 36,300 45,509 25,120 ----------- --------- --------- Balance, end of year $ 1,124,854 $ 878,459 $ 705,074 =========== ========= ========= F-51 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 3. LOANS AND ALLOWANCE FOR LOAN LOSSES (CONTINUED) ALLOWANCE FOR LOAN LOSSES (CONTINUED) The following is a summary of information pertaining to impaired loans: December 31, ------------------------ 1999 1998 --------- --------- Impaired loans without a valuation allowance $ 29,900 $ 98,682 Impaired loans with a valuation allowance -- -- --------- --------- Total impaired loans $ 29,900 $ 98,682 ========= ========= Valuation allowance related to impaired loans $ -- $ -- ========= ========= Average investment in impaired loans $ 79,549 $ 521,878 ========= ========= Interest recognized on impaired loans for the years ended December 31, 1999, 1998 and 1997 was insignificant. RELATED PARTY LOANS The Company has granted loans to certain related parties including directors, executive officers and their related entities. The interest rates on these loans were substantially the same as rates prevailing at the time of the transaction and repayment terms are customary for the type of loan involved. Changes in related party loans for the year ended December 31, 1999 are as follows: Balance, beginning of year $ 613,780 Advances 8,725,934 Repayments (4,740,650) Change in related parties (394,566) ------------- Balance, end of year $ 4,204,498 ============= F-52 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 4. PREMISES AND EQUIPMENT Premises and equipment are summarized as follows: December 31, ---------------------------- 1999 1998 ----------- ----------- Land $ 1,087,774 $ 1,087,774 Buildings 3,876,795 3,699,323 Equipment 2,118,001 1,614,420 Construction in process -- 124,677 ----------- ----------- 7,082,570 6,526,194 Accumulated depreciation (1,539,268) (1,125,311) ----------- ----------- $ 5,543,302 $ 5,400,883 =========== =========== NOTE 5. DEPOSITS At December 31, 1999, the scheduled maturities of time deposits are as follows: 2000 $ 41,887,513 2001 9,612,617 2002 2,844,352 2003 1,660,864 2004 7,239,407 Thereafter 61,058 ---------------- $ 63,305,811 ================ F-53 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 6. OTHER BORROWINGS Other borrowings consist of the following: December 31, ------------------------ 1999 1998 ---------- ---------- FHLB advance, interest payable quarterly at 6.96%, principal $ 607,143 $ 750,000 due in quarterly installments of $35,714. Advance matures on March 22, 2004 FHLB advance, interest payable semi-annually at 6.53%, 500,000 700,000 principal due in semi-annual installments of $100,000 Advance matures on January 9, 2002 FHLB advance, interest payable semi-annually at 6.19%, 1,700,000 1,900,000 principal due in semi-annual instal1ments of $100,000 Advance matures on May 7, 2008 FHLB advance, interest payable semi-annually at 5.58%, 1,900,000 -- principal due in semi-annual installments of $100,000 Advance matures on January 20, 2009 FHLB advance, interest and principal due at maturity 2,000,000 -- with interest at 5.95%. Advance matures March 15, 2000 ---------- ---------- $6,707,143 $3,350,000 ========== ========== Aggregate maturities required on other borrowings at December 31, 1999 are as follows: 2000 $ 2,742,856 2001 742,856 2002 642,856 2003 542,856 2004 435,719 Thereafter 1,600,000 -------------- $ 6,707,143 ============== The advances from the Federal Home Loan Bank are collateralized by a blanket floating lien on qualifying first mortgages and the Company's Federal Home Loan Bank stock. F-54 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 7. EMPLOYEE STOCK OWNERSHIP PLAN The Company has an Employee Stock Ownership Plan with 401(k) provisions ("KSOP"). Employees are eligible at the earlier of January 1 or July 1 following their initial hire date. Each participant must be 18 years of age and provide 1,000 hours of service. The Company's Board of Directors establishes a matching percentage each year. For 1999, 1998 and 1997, the Company's contributions were based on 50% of the participants' contributions up to 6% of eligible compensation. Other types of contributions are available to the Company on a discretionary basis, though none have been made for the years ended December 31, 1999 and 1998. The Company's matching contributions are allocated based on participants' salary contributions and allocated to those participants employed by the Company on December 31st. Employee contributions and Company matching contributions are 100% vested. For the years ended December 31, 1999, 1998 and 1997, the Company incurred expenses totaling $65,785, $76,302, and $58,823, respectively, related to the KSOP plan. These expenses are included in salaries and benefits expense in the accompanying statement of income. In the event a terminated KSOP participant desires to sell his or her shares of the Company's stock, or for certain employees who elect to diversify their account, the KSOP is required to purchase their shares from the participant at fair market value, if the value of the participant's total account is less than $3,500. If the participant's account exceeds $3,500, the participant has the option of cash and/or Company stock. In any event, the Company has right of first refusal to purchase any Company stock distributed to the participant. For the years ended December 31, 1999, 1998, and 1997, the Company purchased 31, 1,969.565, and -0- shares, respectively, from participants. In accordance with the Plan, the Company is expected to honor the rights of certain participants to diversify their account balances or to liquidate their ownership of the common stock in the event of distribution. The purchase price of the common stock would be based on the fair market value of the Company's common stock as of the annual valuation date which precedes the date the put option is exercised. Since the redemption of common stock is outside the control of the Company, the Company's maximum cash obligation based on the approximate market prices of common stock as of the reporting date has been presented outside of stockholders' equity. The amount presented as redeemable common stock held by the KSOP in the consolidated balance sheet represents the Company's maximum cash obligation and has been reflected as a reduction of retained earnings. F-55 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 7. EMPLOYEE STOCK OWNERSHIP PLAN (CONTINUED) At December 31, 1999 and 1998, the KSOP held 44,398 and 44,432 shares. Shares held by the KSOP are considered outstanding for purposes of calculating the Company's earnings per share. NOTE 8. DEFERRED COMPENSATION The Company has adopted a deferred compensation plan which provides retirement benefits to eligible officers of the Company. The deferred compensation is to be paid to the individuals or their beneficiaries over a period of ten years commencing with the first year following the termination of employment after completion of required services. The estimated amounts to be paid under the compensation plan are being funded through the purchase of life insurance policies on the officers. The Company records periodic accruals for the cost of providing such benefits by charges to income. The present value of the estimated liability under the plan is being accrued ratably over the remaining years to the date when the employee is first eligible for benefits. Cash surrender values of $1,973,374 and $1,767,843 on the insurance policies as of December 31, 1999 and 1998, respectively, are included in other assets. NOTE 9. STOCK OPTIONS The Company has an incentive stock option plan with 78,000 shares of common stock reserved for selected senior officers. At December 31, 1999, 43,000 shares are available for grant. The Company also has a nonqualified stock option plan with 87,000 shares of common stock reserved for the Board of Directors. All options under the nonqualified plan were granted in 1997. The options are granted at the greater of the book value or fair market value of the Company's common stock on the date of grant. If the optionee owns shares of the Company representing more than 10% of the total combined voting power, then the price shall not be less than 110% of the fair market value of such shares on the date the option is granted. The nonqualified stock options are exercisable immediately upon grant and the incentive stock options are exercisable in varying amounts upon grant at the discretion of the administrative committee. These options will expire ten years from the grant date. Other pertinent information related to the options is as follows: F-56 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 9. STOCK OPTIONS (CONTINUED) 1999 1998 1997 ---------------------------- ---------------------------- ------------------------- WEIGHTED- Weighted- Weighted- AVERAGE Average Average EXERCISE Exercise Exercise NUMBER PRICE Number Price Number Price ----------- -------------- ------------ -------------- ----------- ------------ Under option, beginning of year 119,283 $ 6.00 122,000 $ 6.00 - $ - Granted - - - 122,000 6.00 Exercised - - (2,717) 6.00 - - Terminated - - - - - - ----------- ------------ ----------- Under option, end of year 119,283 6.00 119,283 6.00 122,000 6.00 =========== ============ =========== WEIGHTED- WEIGHTED- AVERAGE AVERAGE REMAINING RANGE OF EXERCISE CONTRACTUAL NUMBER PRICES PRICE LIFE ------------ ----------------- ----------------- --------------- Under option and exercisable, end of year 119,283 $ 6.00 $ 6.00 $ 8.0 =========== ================ ================ ============== The Company applies APB Opinion 25 and related interpretations in accounting for the stock option plan. Accordingly, no compensation cost has been recognized. Had compensation cost for the stock option plan been determined based on the fair value at the grant dates for awards under the plan consistent with the method prescribed by SFAS No. 123, net income and earnings per share would have been adjusted to the pro forma amounts indicated below. YEARS ENDED DECEMBER 31, ---------------------------------------- 1999 1998 1997 ---------------------------------------- (IN THOUSANDS, EXCEPT PER SHARE DATA) ---------------------------------------- Net income As reported $ 1,621 $ 1,100 $ 804 Pro forma $ 1,621 $ 1,077 $ 671 Earnings per share As reported $ 0.83 $ 0.56 $ 0.60 Pro forma $ 0.83 $ 0.55 $ 0.50 Earnings per share - As reported $ 0.82 $ 0.55 $ 0.59 assuming dilution Pro forma $ 0.82 $ 0.54 $ 0.49 F-57 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 9. STOCK OPTIONS (CONTINUED) The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: Year Ended December 31, 1997 ---------------------- Dividend yield (as a percent of the fair value of the stock) 1.33% Expected life 10 years Expected volatility 6.70% Risk-free interest rate 5.97% NOTE 10. LEASES The Company leases office space in Alpharetta, Georgia under a noncancelable operating lease. The lease has a term of three years and expires on February 28, 2000. On January 4, 1999, the Company entered into a sublease agreement with a third party under the same terms as the current lease agreement. Sublease rental income is netted against rental expense in the statement of income. Total rental expense amounted to $40,640, $63,154 and $33,956 for the years ended December 31, 1999, 1998 and 1997, respectively. NOTE 11. INCOME TAXES Income tax expense consists of the following: Years Ended December 31, --------------------------------------- 1999 1998 1997 --------- --------- --------- Current $ 873,728 $ 616,084 $ 381,153 Deferred (89,000) (66,510) (35,210) --------- --------- --------- Income tax expense $ 784,728 $ 549,574 $ 345,943 ========= ========= ========= F-58 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------ NOTE 11. INCOME TAXES (CONTINUED) The Company's income tax expense differs from the amounts computed by applying the Federal income tax statutory rates to income before income taxes. A reconciliation of the differences is as follows: YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------------------- 1999 1998 1997 ------------------------ ------------------------ ------------------------ AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ---------- -------- ----------- ---------- ---------- ---------- Income taxes at statutory rate $ 817,790 34 % $ 560,685 34 % $ 390,930 34 % Other items, net (33,062) (1) (11,111) (1) (44,987) (4) --------- ---- --------- ---- --------- ---- Income tax expense $ 784,728 33 % $ 549,574 33 % $ 345,943 30 % ========= ==== ========= ==== ========= ==== The components of deferred income taxes are as follows: DECEMBER 31, ----------------------- 1999 1998 -------- --------- Deferred Tax Assets: Loan Loss Reserves $251,905 $160,585 Accounting for Other Real Estate -- 5,849 Securities Available-for-sale 175,118 -- Other 9,749 -- -------- -------- 436,772 166,434 -------- -------- Deferred Tax Liabilities: Depreciation 61,899 55,679 Securities Available-for-sale -- 54,475 -------- -------- 61,899 110,154 -------- -------- Net Deferred Tax Assets $374,873 $ 56,280 ======== ======== F-59 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 12. EARNINGS PER SHARE Diluted earnings per common share were computed by dividing net income by the weighted average number of shares of common stock and common stock equivalents outstanding. The number of common shares was increased by the number of shares issuable upon the exercise of the stock options described in Note 9. This theoretical increase in the number of common shares was reduced by the number of common shares which are assumed to have been repurchased for the treasury with the proceeds from the exercise of the options; these purchases were assumed to have been made at the price per share that approximates average market price. The treasury stock method for determining the amount of dilution of stock options is based on the concept that common shares which could have been purchased with the proceeds of the exercise of common stock options at market price are not actually outstanding common shares. Presented below is a summary of the components used to calculate basic and diluted earnings per share for the years ended December 31, 1999, 1998, and 1997. Year Ended December 31, ---------------------------------------- 1999 1998 1997 ---------- ---------- ---------- Net income $1,620,536 $1,099,501 $ 803,851 ========== ========== ========== Weighted average common shares outstanding 1,945,154 1,948,000 1,347,882 Net effect of the assumed exercise of stock options based on the treasury stock method using average market price for the year $ 43,148 $ 46,647 $ 17,715 ---------- ---------- ---------- Total weighted average common shares and common stock equivalents outstanding 1,988,302 1,994,647 1,365,597 ========== ========== ========== Diluted earnings per share $ 0.82 $ 0.55 $ 0.59 ========== ========== ========== F-60 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 13. COMMITMENTS AND CONTINGENT LIABILITIES In the normal course of business, the Company has entered into off-balance sheet financial instruments which are not reflected in the financial statements. These financial instruments include commitments to extend credit and standby letters of credit. Such financial instruments are included in the financial statements when funds are disbursed or the instruments become payable. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. A summary of the Company's commitments is as follows: DECEMBER 31, --------------------------- 1999 1998 ----------- ----------- Commitments to extend credit $13,380,341 $ 9,888,349 Construction loan commitments 16,595,545 17,805,276 Standby letters of credit 551,747 912,131 Credit card commitments 3,710,887 3,055,255 ----------- ----------- $34,238,520 $31,661,011 =========== =========== Commitments to extend credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The credit risk involved in issuing these financial instruments is essentially the same as that involved in extending loans to customers. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the customer. Collateral held varies but may include real estate and improvements, marketable securities, accounts receivable, inventory, equipment, and personal property. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. Collateral held varies as specified above and is required in instances which the Company deems necessary. F-61 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 13. COMMITMENTS AND CONTINGENT LIABILITIES (CONTINUED) Credit card commitments are unsecured. In the normal course of business, the Company may be involved in various legal proceedings. In the opinion of management of the Company, there were no such proceedings pending or threatened at December 31, 1999. NOTE 14. CONCENTRATIONS OF CREDIT The Company originates primarily commercial, residential, and consumer loans to customers in Cobb, Paulding, Fulton, and Douglas counties. The ability of the majority of the Company's customers to honor their contractual loan obligations is dependent on the economy in the metro Atlanta area. Sixty-three percent of the Company's loan portfolio is concentrated in loans secured by real estate, of which thirty-seven percent consists of construction loans. A substantial portion of these loans are in the Company's primary market area. Accordingly, the ultimate collectibility of the loan portfolio is susceptible to changes in market conditions in the Company's primary market area. The other significant concentrations, including a twenty-one percent concentration in commercial loans, are set forth in Note 3. The Company is not allowed, by regulation, to extend credit to any single borrower or group of related borrowers in excess of 15% if unsecured, and 25% if fully secured, of statutory capital, or approximately $1,660,000 and $2,770,000, respectively. NOTE 15. REGULATORY MATTERS The Bank is subject to certain restrictions on the amount of dividends that may be declared without prior regulatory approval. At December 31, 1999, approximately $810,000 of retained earnings were available for dividend declaration without regulatory approval. F-62 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 15. REGULATORY MATTERS (CONTINUED) The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company and Bank capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets. Management believes, as of December 31, 1999, the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 1999, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum Total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the Bank's category. F-63 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 15. REGULATORY MATTERS (CONTINUED) The Company and Bank's actual capital amounts and ratios are presented in the following table. to be Well for Capital Capitalized Under Adequacy Prompt Corrective Actual Purposes Action Provisions ----------------------- --------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio --------- ------ -------- ----- --------- ------ Dollars in Thousands ----------------------------------------------------------------------------------- AS OF DECEMBER 31, 1999: TOTAL CAPITAL TO RISK WEIGHTED ASSETS: CONSOLIDATED $ 15,087 13.37% $ 9,029 8.00% $ N/A N/A BANK $ 14,581 12.92% $ 9,027 8.00% $ 11,284 10.00% TIER 1 CAPITAL TO RISK WEIGHTED ASSETS: CONSOLIDATED $ 13,962 12.37% $ 4,515 4.00% $ N/A N/A BANK $ 13,456 11.93% $ 4,513 4.00% $ 6,770 6.00% TIER 1 CAPITAL TO AVERAGE ASSETS: CONSOLIDATED $ 13,962 9.34% $ 5,977 4.00% $ N/A N/A BANK $ 13,456 9.03% $ 5,961 4.00% $ 7,451 5.00% As of December 31, 1998: Total Capital to Risk Weighted Assets: Consolidated $ 13,513 13.77% $ 7,853 8.00% $ N/A N/A Bank $ 13,016 13.27% $ 7,845 8.00% $ 9,806 10.00% Tier 1 Capital to Risk Weighted Assets: Consolidated $ 12,634 12.87% $ 3,927 4.00% $ N/A N/A Bank $ 12,138 12.38% $ 3,923 4.00% $ 5,884 6.00% Tier 1 Capital to Average Assets: Consolidated $ 12,634 9.62% $ 5,254 4.00% $ N/A N/A Bank $ 12,138 9.28% $ 5,234 4.00% $ 6,543 5.00% F-64 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE 16. FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using discounted cash flow models. Those models are significantly affected by the assumptions used, including the discount rates and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. The use of different methodologies may have a material effect on the estimated fair value amounts. Also, the fair value estimates presented herein are based on pertinent information available to management as of December 31, 1999 and 1998. Such amounts have not been revalued for purposes of these financial statements since that date and, therefore, current estimates of fair value may differ significantly from the amounts presented herein. CASH, DUE FROM BANKS, AND FEDERAL FUNDS SOLD: The carrying amounts of cash, due from banks, and Federal funds sold approximate their fair value. SECURITIES: Fair values for securities are based on available quoted market prices. The carrying values of equity securities with no readily determinable fair value approximate fair values. LOANS: For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. For other loans, the fair values are estimated using discounted cash flow models, using current market interest rates offered for loans with similar terms to borrowers of similar credit quality. Fair values for impaired loans are estimated using discounted cash flow models or based on the fair value of the underlying collateral. DEPOSITS: The carrying amounts of demand deposits, savings deposits, and variable-rate certificates of deposit approximate their fair values. Fair values for fixed-rate certificates of deposit are estimated using discounted cash flow models, using current market interest rates offered on certificates with similar remaining maturities. F-65 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 16. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED) OTHER BORROWINGS: The fair values of the Company's other borrowings are estimated using discounted cash flow models based on the Company's current incremental borrowing rates for similar types of borrowing arrangements. ACCRUED INTEREST: The carrying amounts of accrued interest approximate their fair values. REDEEMABLE COMMON STOCK: The fair values of the Company's redeemable common stock approximates the recorded amounts. OFF-BALANCE SHEET INSTRUMENTS: Fair values of the Company's off-balance sheet financial instruments are based on fees charged to enter into similar agreements. However, commitments to extend credit, standby letters of credit, and credit cards do not represent a significant value to the Company until such commitments are funded. The Company has determined that these instruments do not have a distinguishable fair value and no fair value has been assigned. The carrying value and estimated fair value of the Company's financial instruments were as follows: December 31, 1999 December 31, 1998 ---------------------------------- ------------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value ---------------- --------------- -------------- ------------------ Financial assets: Cash, due from banks, and Federal funds sold $ 9,639,144 $ 9,639,144 $ 5,780,320 $ 5,780,320 Securities 26,060,235 25,003,118 26,193,286 25,272,136 Loans 100,450,539 100,799,326 86,903,731 86,710,000 Accrued interest 929,867 929,867 933,187 933,187 receivable Financial liabilities: Deposits 123,422,137 122,816,249 109,786,275 110,781,000 Other borrowings 6,707,143 6,452,980 3,350,000 3,432,000 Accrued interest payable 1,087,610 1,087,610 1,164,765 1,164,765 F-66 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 17. BUSINESS COMBINATION On March 3, 2000, the Company entered into a definitive agreement with United Community Bank, Inc. ("United") of Blairsville, Georgia. Under this agreement, the Company will merge with and into United Community. Upon consummation of the merger, each share of Company stock will be converted into and exchanged for the right to receive .4211 share of United common stock. Consummation is subject to certain conditions, including regulatory and stockholder approval and will be accounted for as a pooling of interests. Also, on March 3, 2000, United entered into a definitive agreement to acquire North Point Bancshares, Inc. ("North Point"), a $107 million one-bank holding company for Dawson County Bank, located in Dawsonville, Georgia for approximately 958,000 shares of its common stock. The following unaudited pro forma data summarizes operating data as if the combinations had been consummated on January 1, 1997: as of and for the Year Ended (In Thousands, Except Share Amounts) ------------------------------------------------------------ 1999 1998 1997 ----------------- ------------------- ---------------- Total assets $ 2,383,486 $ 1,812,585 $ 1,410,071 Stockholders' equity 118,887 115,415 99,571 Net income 16,692 15,510 13,197 Basic income per share 1.70 1.59 1.41 Diluted income per share 1.67 1.56 1.40 NOTE 18. SUPPLEMENTAL FINANCIAL DATA Components of other operating expenses in excess of 1% of total revenue are as follows: December 31, ------------------------------------------- 1999 1998 1997 ----------- ----------- ---------- Data processing $195,045 $175,335 $152,294 Director fees 112,000 112,000 90,000 Stationery and supplies 149,344 125,823 114,379 F-67 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 19. PARENT COMPANY FINANCIAL INFORMATION The following information presents the condensed balance sheets, statements of income and cash flows of Independent Bancshares, Inc. as of December 31, 1999 and 1998 and for the years ending December 31, 1999, 1998 and 1997. CONDENSED BALANCE SHEETS 1999 1998 ----------- --------- ASSETS Cash $ 498,730 $ 467,016 Investment in subsidiary 13,116,646 12,234,296 Other assets 6,980 38,507 ----------- --------- TOTAL ASSETS $ 13,622,356 $12,739,819 =========== ========== Stockholders' equity $ 13,622,356 $12,739,819 =========== ========== CONDENSED STATEMENTS OF INCOME 1999 1998 1997 ------------ ----------- --------- INCOME Interest $ 20,975 $ 24,564 $ 5,578 Dividends from subsidiary 292,223 194,823 100,801 ------------ ----------- --------- TOTAL INCOME 313,198 219,387 106,379 ------------ ----------- --------- EXPENSE Interest -- -- 12,542 Other 21,697 14,609 8,413 ------------ ----------- --------- TOTAL EXPENSE 21,697 14,609 20,955 ------------ ----------- --------- Income before income taxes (benefits) and equity in undistributed income of subsidiary 291,501 204,778 85,424 INCOME TAXES (BENEFITS) (1,005) 3,300 (5,228) ------------ ----------- --------- Income before equity in undistributed income of subsidiary 292,506 201,478 90,652 Equity in undistributed income of subsidiary 1,328,030 898,023 713,199 ------------ ----------- --------- NET INCOME $ 1,620,536 $ 1,099,501 $ 803,851 ============ =========== ========= F-68 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- NOTE 19. PARENT COMPANY FINANCIAL INFORMATION (CONTINUED) CONDENSED STATEMENTS OF CASH FLOWS 1999 1998 1997 ----------- ----------- ----------- OPERATING ACTIVITIES Net income $ 1,620,536 $ 1,099,501 $ 803,851 Adjustments to reconcile net income to net cash provided by operating activities: Amortization 4,653 4,653 4,653 Undistributed income of subsidiary (1,328,030) (898,023) (713,199) Other operating activities 26,875 5,099 (11,947) ----------- ----------- ----------- NET CASH PROVIDED BY OPERATING ACTIVITIES 324,034 211,230 83,358 ----------- ----------- ----------- INVESTING ACTIVITIES Purchases of securities available-for-sale -- -- (25,055) Investment in subsidiary -- -- (4,500,000) ----------- ----------- ----------- NET CASH USED IN INVESTING ACTIVITIES -- -- (4,525,055) ----------- ----------- ----------- FINANCING ACTIVITIES Net decrease in other borrowings -- -- (21,450) Dividends paid (292,224) (194,823) (66,986) Net proceeds from issuance of stock -- 25,530 4,958,184 Purchase of treasury stock (96) (81,827) (289,827) Sale of treasury stock -- 49,630 318,880 ----------- ----------- ----------- NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES (292,320) (201,490) 4,898,801 ----------- ----------- ----------- Net increase in cash 31,714 9,740 457,104 Cash at beginning of year 467,016 457,276 172 ----------- ----------- ----------- Cash at end of year $ 498,730 $ 467,016 $ 457,276 =========== =========== =========== F-69 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED BALANCE SHEET (IN THOUSANDS) - ------------------------------------------------------------------------------------------------------------ MARCH 31, DECEMBER 31, 2000 1999 - ------------------------------------------------------------------------------------------------------------ ASSETS Cash and due from banks $ 5,168 4,639 Federal funds sold 16,676 5,000 - ------------------------------------------------------------------------------------------------------------ Cash and cash equivalents 21,844 9,639 Securities held to maturity (estimated fair value of $5,802 and $6,169) 6,704 7,226 Securities available for sale 23,394 18,834 Loans, net of unearned income 101,294 101,576 Less: Allowance for loan losses (1,166) (1,125) - ------------------------------------------------------------------------------------------------------------ Loans, net 100,128 100,451 Premises and equipment, net 5,486 5,543 Other assets 3,528 3,409 - ------------------------------------------------------------------------------------------------------------ Total assets $ 161,084 145,102 ============================================================================================================ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand $ 20,160 16,614 Interest bearing demand 51,783 38,333 Savings 5,381 5,169 Time 64,117 63,306 - ------------------------------------------------------------------------------------------------------------ Total deposits 141,441 123,422 Accrued expenses and other liabilities 1,630 1,351 Federal Home Loan Bank advances 4,471 6,707 - ------------------------------------------------------------------------------------------------------------ Total liabilities 147,542 131,480 Commitments and contingent liabilities: Redeemable common stock held by KSOP (44,432 shares outstanding) 577 577 Stockholders' equity: Common stock ($1 par value; 5,000,000 shares authorized; 1,948,148 1,948 1,948 shares issued and outstanding) Captial surplus 8,615 8,614 Retained earnings 2,888 2,822 Accumulated other comprehensive income (486) (339) - ------------------------------------------------------------------------------------------------------------ Total stockholders' equity 12,965 13,045 - ------------------------------------------------------------------------------------------------------------ - ------------------------------------------------------------------------------------------------------------ Total liabilities and stockholders' equity $ 161,084 145,102 ============================================================================================================ Outstanding common shares 1,948,148 1,948,148 Book value per common share $ 6.66 6.70 See notes to unaudited consolidated financial statements. INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY Unaudited Consolidated Statements of Income (in thousands except, except per share data) For the Three Months ENDED MARCH 31, 2000 1999 ----------------------------------------- Interest income: Interest and fees on loans $ 2,533 2,215 Interest on federal funds sold 156 57 Interest on investment securities: Tax exempt 13 3 Taxable 402 335 - --------------------------------------------------------------------------------------------------------- Total interest income 3,104 2,610 - --------------------------------------------------------------------------------------------------------- INTEREST EXPENSE: Interest on deposits: Demand 359 341 Savings 26 36 Time 913 703 Federal funds purchased and FHLB advances 93 75 - --------------------------------------------------------------------------------------------------------- Total interest expense 1,391 1,155 - --------------------------------------------------------------------------------------------------------- Net interest income 1,713 1,455 Provision for loan losses 45 76 - --------------------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 1,668 1,379 - --------------------------------------------------------------------------------------------------------- NONINTEREST INCOME: Service charges and fees 111 100 Other loan fee income 44 - Mortgage banking revenue 25 96 Other non-interest income 43 63 - --------------------------------------------------------------------------------------------------------- Total noninterest income 223 259 - --------------------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Salaries and employee benefits 628 697 Occupancy 219 177 Other noninterest expense 343 279 - --------------------------------------------------------------------------------------------------------- Total noninterest expense 1,190 1,153 - --------------------------------------------------------------------------------------------------------- Income before income taxes 701 485 Income taxes 246 175 - --------------------------------------------------------------------------------------------------------- NET INCOME $ 455 310 - --------------------------------------------------------------------------------------------------------- Basic earnings per share $ 0.23 0.16 Diluted earnings per share $ 0.22 0.16 Average shares outstanding 1,948 1,948 Diluted average shares outstanding 2,023 1,985 See notes to unaudited consolidated financial statements. F-70 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY UNAUDITED STATEMENT OF EARNINGS PER SHARE (IN THOUSANDS, EXCEPT PER SHARE DATA) For the Three Months Ended March 31, 2000 1999 - ---------------------------------------------------------------------------------------------------- Basic earnings per share: Weighted average shares outstanding 1,948 1,948 Net income 455 310 Basic earnings per share 0.23 0.16 Diluted earnings per share: Neteffect of the assumed exercise of stock options based on the treasury stock method using average market price for the period 78 37 Total weighted average shares and common stock equivalents outstanding 2,026 1,985 Net income, as reported 455 310 Diluted earnings per share 0.22 0.16 F-71 UNITED COMMUNITY BANKS, INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (IN THOUSANDS) FOR THE THREE MONTHS ENDED MARCH 31 ------------- ------------- 2000 1999 ------------- ------------- Net income $ 455 310 Other comprehensive income (loss), before tax: Unrealized holding gains (losses) on investment securities available for sale (219) (78) Less reclassification adjustment for gains on investment securities available for sale - - ------------- ------------- Total other comprehensive income (loss), before tax (219) (78) ------------- ------------- INCOME TAX EXPENSE (BENEFIT) RELATED TO OTHER COMPREHENSIVE INCOME Unrealized holding gains (losses) on investment securities (72) (26) Less reclassification adjustment for gains on investment securities available for sale - - ------------- ------------- Total income tax expense (benefit) related to other comprehensive income (loss) (72) (26) ------------- ------------- Total other comprehensive income (loss), net of tax (147) (52) ------------- ------------- Total comprehensive income $ 308 258 ============= ============= See notes to unaudited consolidated financial statements. F-72 INDEPENDENT BANCSHARES, INC. AND SUBSIDIARY UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) FOR THE THREE MONTHS ENDED MARCH 31 2000 1999 ---------------------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 455 310 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation, amortization and accretion 112 94 Provision for loan losses 45 76 Loss (gain) on sale of investment securities -- -- Change in assets and liabilities: Interest receivable (72) 10 Other assets (47) (89) Accrued expenses and other liabilities 350 (486) -------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 843 (85) -------------------------- CASHFLOWS FROM INVESTING ACTIVITIES, NET OF PURCHASE ACQUISITIONS: Proceeds from maturities and calls of securities held to maturity 534 88 Purchases of securities held to maturity (2) (3) Proceeds from sales of securities available for sale -- -- Proceeds from maturities and calls of securities available for sale 176 2,779 Purchases of securities available for sale (4,967) (2,992) Net increase in loans 282 (3,785) Purchase of bank premises and equipment (54) (42) -------------------------- NET CASH USED IN INVESTING ACTIVITIES (4,031) (3,955) -------------------------- CASHFLOWS FROM FINANCING ACTIVITIES, NET OF PURCHASE ACQUISITIONS: Net change in demand and savings deposits 17,208 5,185 Net change in time deposits 811 (1,985) Net change in FHLB advances (2,236) 1,864 Dividends paid (390) (292) -------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 15,393 4,772 -------------------------- Net change in cash and cash equivalents 12,205 732 Cash and cash equivalents at beginning of period 9,639 5,780 -------------------------- Cash and cash equivalents at end of period $21,844 6,512 =========================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 1,174 1,155 Income Taxes $ 16 13 F-73 NOTES TO UNAUDITED PRO FORMA CONSOLIDATED FINANCIAL INFORMATION NOTE 1 - BASIS OF PRESENTATION The unaudited pro forma condensed combined financial information has been prepared assuming that the Merger will be accounted for under the pooling of interests accounting method and is based on the historical consolidated financial statements of United Community Banks, Inc. ("United") and Independent Bancshares, Inc. ("Independent"). NOTE 2 - SHAREHOLDERS' EQUITY In the Merger, United will exchange 0.4211 of a share of United common stock for each share of Independent common stock. Independent had 1,948,148 shares of common stock outstanding at March 31, 2000, which will be exchanged for approximately 820,365 shares of United common stock. In addition, the 119,283 outstanding options to purchase Independent common stock will be converted into 50,230 options to purchase United common stock. NOTE 3 - Merger Related Charges In connection with the Merger, United and Independent expect to incur pre-tax merger related charges of approximately $2.3 million. These are expected to include approximately $1,040,000 of occupancy related expenses (equipment write-offs and contract terminations), $920,000 of losses incurred to liquidate certain investment securities, $170,000 of merger-related professional fees (investment banking, legal and accounting), $100,000 of compensation expense and $200,000 of other merger expenses. These amounts and the related tax effects have not been reflected in the unaudited pro forma consolidated financial information because they are will not have a material impact on the shareholders' equity of the combined company and are not expected to have a continuing impact on the operations of the combined company. F-74 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors and Stockholders United Community Banks, Inc. Blairsville, Georgia We have audited the consolidated balance sheets of United Community Banks, Inc. and subsidiaries as of December 31, 1999 and 1998 and the related statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Community Banks, Inc. and subsidiaries as of December 31, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. \s\ PORTER KEADLE MOORE, LLP Atlanta, Georgia February 25, 2000, except for note 20 as to which the date is March 3, 2000 F-75 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998 Assets ------ 1999 1998 ---- ---- (IN THOUSANDS) Cash and due from banks, including reserve requirements of $25,890 and $18,205 $ 89,231 51,102 Federal funds sold 23,380 13,010 --------- --------- Cash and cash equivalents 112,611 64,112 --------- --------- Securities held to maturity (estimated fair value of $60,018) - 58,306 Securities available for sale 534,503 333,787 Mortgage loans held for sale 6,326 8,129 Loans 1,400,360 1,061,166 Less allowance for loan losses 17,722 12,680 --------- --------- Loans, net 1,382,638 1,048,486 --------- --------- Premises and equipment, net 47,365 41,247 Accrued interest receivable 17,861 14,019 Other assets 30,136 23,313 --------- --------- Total assets $ 2,131,440 1,591,399 ========= ========= Liabilities and Stockholders' Equity ------------------------------------ Liabilities: Deposits: Demand $ 192,006 152,201 Interest-bearing demand 328,815 295,549 Savings 73,953 65,323 Time 1,054,618 725,250 --------- --------- Total deposits 1,649,392 1,238,323 --------- --------- Accrued expenses and other liabilities 24,378 20,089 Federal funds purchased and repurchase agreements 31,812 26,520 Federal Home Loan Bank advances 287,572 186,854 Long-term debt and other borrowings 17,516 1,277 Convertible subordinated debentures 3,500 3,500 Guaranteed preferred beneficial interests in company's junior subordinated debentures (Trust Preferred Securities) 21,000 21,000 --------- --------- Total liabilities 2,035,170 1,497,563 --------- --------- Commitments Stockholders' equity: Preferred stock - - Common stock, $1 par value; 10,000,000 shares authorized; 8,034,268 and 8,003,722 shares issued and outstanding 8,034 8,004 Capital surplus 30,310 29,999 Retained earnings 66,606 54,500 Accumulated other comprehensive income (loss) (8,680) 1,333 --------- --------- Total stockholders' equity 96,270 93,836 --------- --------- Total liabilities and stockholders' equity $ 2,131,440 1,591,399 ========= ========= See accompanying notes to consolidated financial statements. F-76 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ---- ---- ---- (IN THOUSANDS EXCEPT PER SHARE DATA) Interest income: Interest and fees on loans $ 119,542 99,057 80,537 Interest on federal funds sold 1,050 1,645 1,723 Interest on investment securities: Taxable 25,285 12,260 9,609 Tax exempt 3,863 3,252 2,319 --------- --------- --------- Total interest income 149,740 116,214 94,188 --------- --------- --------- Interest expense: Interest on deposits: Demand 12,236 10,200 7,230 Savings 2,008 1,520 1,238 Time 48,415 41,423 36,309 --------- --------- --------- 62,659 53,143 44,777 Other borrowings 19,107 6,861 3,693 --------- --------- --------- Total interest expense 81,766 60,004 48,470 --------- --------- --------- Net interest income 67,974 56,210 45,718 Provision for loan losses 5,104 2,612 2,814 --------- --------- --------- Net interest income after provision for loan losses 62,870 53,598 42,904 --------- --------- --------- Non-interest income: Service charges and fees 5,161 4,227 3,681 Securities gain, net 543 804 737 Mortgage loan and other related fees 1,638 1,822 1,157 Other non-interest income 3,494 2,276 1,625 --------- --------- --------- Total non-interest income 10,836 9,129 7,200 --------- --------- --------- Non-interest expense: Salaries and employee benefits 30,366 24,560 18,914 Occupancy 9,582 7,057 4,980 Other non-interest expense 14,217 12,347 10,169 --------- --------- --------- Total non-interest expense 54,165 43,964 34,063 --------- --------- --------- Income before income taxes 19,541 18,763 16,041 Income taxes 5,893 5,990 4,987 --------- --------- --------- Net income $ 13,648 12,773 11,054 ========= ========= ========= Basic income per share $ 1.70 1.60 1.42 ========= ========= ========= Diluted income per share $ 1.66 1.57 1.40 ========= ========= ========= See accompanying notes to consolidated financial statements. F-77 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ---- ---- ---- (IN THOUSANDS) Net income $ 13,648 12,773 11,054 ------ ------ ------ Other comprehensive income: Unrealized holding gains (losses) on investment securities available for sale (15,608) 1,581 2,272 Less reclassification adjustment for gains on sales of investment securities available for sale 543 804 737 ------ ------ ------ Total other comprehensive income (loss), before income taxes (16,151) 777 1,535 ------ ------ ------ Income tax expense (benefit) related to other comprehensive income: Unrealized holding gains (losses) on investment securities available for sale (5,932) 601 864 Less reclassification adjustment for gains (losses) on sales of investment securities available for sale 206 306 280 ------ ------ ------ Total income tax expense (benefit) related to other comprehensive income (6,138) 295 584 ------ ------ ------ Total other comprehensive income (loss), net of tax (10,013) 482 951 ------- ------ ------ Total comprehensive income $ 3,635 13,255 12,005 ======= ====== ====== See accompanying notes to consolidated financial statements. F-78 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 Accumulated Common Stock Other ------------ Capital Retained Comprehensive Shares Amount Surplus Earnings Income/(Loss) Total ------ ------ ------- -------- ------------- ----- (IN THOUSANDS EXCEPT SHARE AND PER SHARE DATA) Balance, December 31, 1996, as previously reported 7,084,621 $ 7,085 18,516 32,162 (88) 57,675 Adjustment in connection with pooling of interests 508,393 509 3,733 452 (12) 4,682 --------- ------ ------ ------ ------ ------ Balance, December 31, 1996, as restated 7,593,014 7,594 22,249 32,614 (100) 62,357 Change in unrealized gain on securities available for sale, net of tax - - - - 951 951 Cash dividends declared, ($.10 per share) - - - (759) - (759) Net income - - - 11,054 - 11,054 Proceeds from common stock offering, net of offering cost 300,000 300 6,177 - - 6,477 Proceeds from resale of treasury stock of pooled entity 484 - 6 - - 6 --------- --------- ------ ------ ------ ------ Balance, December 31, 1997 7,893,498 7,894 28,432 42,909 851 80,086 Change in unrealized gain on securities available for sale, net of tax - - - - 482 482 Cash dividends declared, ($.15 per share) - - - (1,182) - (1,182) Net income - - - 12,773 - 12,773 Proceeds from common stock offering, net of offering costs 101,724 102 1,458 - - 1,560 Proceeds from exercise of stock options 8,500 8 109 - - 117 --------- ------- ------ ------ ------ ------ Balance, December 31, 1998 8,003,722 8,004 29,999 54,500 1,333 93,836 Change in unrealized gain (loss) on securities available for sale, net of tax - - - - (10,013) (10,013) Cash dividends declared, ($.20 per share) - - - (1,542) - (1,542) Net income - - - 13,648 - 13,648 Proceeds from exercise of stock options, including disqualified disposition tax benefit 30,546 30 311 - - 341 --------- ------- ------ ------ ------ ------ Balance, December 31, 1999 8,034,268 $ 8,034 30,310 66,606 (8,680) 96,270 ========= ======= ====== ====== ====== ====== See accompanying notes to consolidated financial statements. F-79 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ---- ---- ---- (IN THOUSANDS) Cash flows from operating activities: Net income $ 13,648 12,773 11,054 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation, amortization and accretion 5,135 3,027 2,542 Provision for loan losses 5,104 2,612 2,814 Deferred income tax benefit (1,616) (766) (404) Gain on sale of securities available for sale (543) (810) (737) Change in assets and liabilities, net of effects of purchase acquisitions: Other assets and accrued interest receivable (4,859) (411) (4,470) Accrued expenses and other liabilities 6,292 (10,561) 725 Mortgage loans held for sale 1,803 (4,167) 2,765 ------- ------- ------- Net cash provided by operating activities 24,964 1,697 14,289 ------- ------- ------- Cash flows from investing activities, net of effects of purchase acquisitions: Cash acquired from (paid for) acquisitions and branch purchases (2,757) 20,282 - Proceeds from maturities and calls of securities held to maturity - 25,439 18,009 Purchases of securities held to maturity - (14,087) (10,564) Proceeds from sales of securities available for sale 8,131 44,193 36,683 Proceeds from maturities and calls of securities available for sale 91,280 68,363 22,470 Purchases of securities available for sale (241,019) (268,590) (121,996) Net increase in loans (325,833) (186,254) (210,706) Purchases of premises and equipment (8,318) (14,842) (9,875) Purchases of life insurance contracts - (8,117) - Transaction costs associated with Trust Preferred Securities - (959) - ------- ------- ------- Net cash used in investing activities (478,516) (334,572) (275,979) ------- ------- ------- Cash flows from financing activities, net of effects of purchase acquisitions: Net change in demand and savings deposits 64,998 119,487 67,709 Net change in time deposits 316,005 61,683 156,897 Net change in federal funds purchased and repurchase agreements 5,292 (6,901) 33,421 Proceeds from notes payable and other borrowings 16,239 - 4,747 Proceeds from FHLB advances 201,625 221,249 16,636 Proceeds from Trust Preferred Securities - 21,000 - Repayments of notes payable - (12,792) (1,131) Repayments of FHLB advances (100,907) (78,715) (7,389) Proceeds from exercise of stock options 216 117 - Proceeds from sale of common stock - 1,560 6,477 Proceeds from resale of treasury stock of pooled entity - - 6 Cash paid for dividends (1,417) (1,089) (825) ------- ------- ------- Net cash provided by financing activities 502,051 325,599 276,548 ------- ------- ------- Net change in cash and cash equivalents 48,499 (7,276) 14,858 Cash and cash equivalents at beginning of period 64,112 71,388 56,530 ------- ------- ------- Cash and cash equivalents at end of period $ 112,611 64,112 71,388 ======= ======== ======= See accompanying notes to consolidated financial statements. F-80 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting principles followed by United Community Banks, Inc. ("United") and its subsidiaries and the methods of applying these principles conform with generally accepted accounting principles and with general practices within the banking industry. The following is a description of the more significant of those policies. ORGANIZATION AND BASIS OF PRESENTATION - -------------------------------------- United is an eight-bank holding company whose business is conducted by its wholly-owned bank subsidiaries. United is subject to regulation under the Bank Holding Company Act of 1956. The consolidated financial statements include the accounts of United Community Banks, Inc. and its wholly-owned commercial bank subsidiaries, United Community Bank, Blairsville, Georgia ("UCB"), Carolina Community Bank, Murphy, North Carolina ("Carolina"), Peoples Bank of Fannin County, Blue Ridge, Georgia ("Peoples"), Towns County Bank, Hiawassee, Georgia ("Towns"), White County Bank, Cleveland, Georgia ("White"), First Clayton Bank and Trust, Clayton, Georgia ("Clayton"), Bank of Adairsville, Adairsville, Georgia ("Adairsville"), 1st Floyd Bank, Rome, Georgia ("Floyd") (collectively, the "Banks") and United Family Finance Company, Inc. ("Finance"), a finance company subsidiary. All significant intercompany accounts and transactions have been eliminated in consolidation. Certain items in prior years' financial statements have been reclassified to conform to the current financial statement presentations. The Banks are commercial banks that serve markets throughout North Georgia and Western North Carolina and provide a full range of customary banking services. The Banks are insured and subject to the regulation of the Federal Deposit Insurance Corporation ("FDIC"). In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with these valuations, management obtains independent appraisals for significant properties. A substantial portion of United's loans are secured by real estate located in North Georgia and Western North Carolina. Accordingly, the ultimate collectibility of a substantial portion of United's loan portfolio is susceptible to changes in the real estate market conditions of this market area. INVESTMENT SECURITIES - --------------------- United classifies its securities in one of three categories: held to maturity, available for sale, or trading. Trading securities are bought and held principally for the purpose of selling them in the near term. United does not have investments classified in the trading category. Held to maturity securities are those securities for which United has the ability and intent to hold until maturity. All other securities are classified as available for sale. Available for sale securities are recorded at fair value. Held to maturity securities are recorded at cost, adjusted for the amortization or accretion of premiums or discounts. Unrealized holding gains and losses, net of the related tax effect, on securities available for sale are excluded from income and are reported as a separate component of stockholders' equity until realized. Transfers of securities between categories are recorded at fair value at the date of transfer. Unrealized holding gains or losses associated with transfers of securities from held to maturity to available for sale are recorded as a separate component of stockholders' equity. The unrealized holding gains or losses included in the separate component of stockholders' equity for securities transferred from available for sale to held to maturity are maintained and amortized into income over the remaining life of the security as an adjustment to the yield in a manner consistent with the amortization or accretion of premium or discount on the associated security. F-81 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued INVESTMENT SECURITIES, continued - --------------------- A decline in the market value of any available for sale or held to maturity investment below cost that is deemed other than temporary is charged to income and establishes a new cost basis for the security. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to the yield. Realized gains and losses for securities classified as available for sale and held to maturity are included in income and are derived using the specific identification method for determining the cost of securities sold. MORTGAGE LOANS HELD FOR SALE - ---------------------------- Mortgage loans held for sale are carried at the lower of aggregate cost or market value. The amount by which cost exceeds market value is accounted for as a valuation allowance. Changes in the valuation allowance are included in the determination of net income of the period in which the change occurs. No market valuation allowances were required at December 31, 1999 or 1998. LOANS AND ALLOWANCE FOR LOAN LOSSES - ----------------------------------- All loans are stated at principal amount outstanding. Interest on loans is primarily calculated by using the simple interest method on daily balances of the principal amount outstanding. Accrual of interest is discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower's financial condition is such that collection of interest is doubtful. When a loan is placed on nonaccrual status, previously accrued and uncollected interest is charged to interest income on loans. Generally, payments on nonaccrual loans are applied to principal. A loan is impaired when, based on current information and events, it is probable that all amounts due, according to the contractual terms of the loan, will not be collected. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan's effective interest rate, or at the loan's observable market price, or the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is recognized using the cash-basis method of accounting during the time within the period in which the loans were impaired. The Banks had no material amounts of impaired loans at December 31, 1999 or 1998. The allowance for loan losses is established through a provision for loan losses charged to expense. Loans are charged against the allowance for loan losses when management believes that the collectibility of the principal is unlikely. The allowance represents an amount, which, in management's judgment, will be adequate to absorb probable losses on existing loans that may become uncollectible. Management's judgment in determining the adequacy of the allowance is based on evaluations of the collectibility of loans. These evaluations take into consideration such factors as changes in the nature and volume of the loan portfolio, current economic conditions that may affect the borrower's ability to pay, overall portfolio quality, and review of specific problem loans. In determining the adequacy of the allowance for loan losses, management uses a loan grading system that rates loans in ten different categories. Grades seven through ten are assigned allocations of loss based on the standard regulatory loss percentages set forth in the FDIC Interagency Policy Statement on the Allowance for Loan and Lease Losses issued in 1993. Loans graded one through six are allocated loss ranges based on historical loss experience for the previous five years. The combination of these results are compared quarterly to the recorded allowance for loan losses and material deficiencies are adjusted by increasing the provision for loan losses. Management has a devoted internal loan review department that is independent of the lending function to challenge and corroborate the loan grading system and provide additional analysis in determining the adequacy of the allowance for loan losses and the future provisions for estimated loan losses. F-82 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued LOANS AND ALLOWANCE FOR LOAN LOSSES, continued - ----------------------------------- Management believes the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review United's allowance for loan losses. Such agencies may require United to recognize additions to the allowance based on their judgments of information available to them at the time of their examination. PREMISES AND EQUIPMENT - ---------------------- Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed primarily using the straight-line method over the estimated useful lives of the related assets. Costs incurred for maintenance and repairs are expensed currently. The range of estimated useful lives for buildings and improvements is 15 to 40 years, and for furniture and equipment, 3 to 10 years. GOODWILL AND DEPOSIT-BASED INTANGIBLES - -------------------------------------- Goodwill, arising from the excess cost over the fair value of net assets acquired of purchased bank subsidiaries, is amortized on a straight-line basis over periods not exceeding 25 years. Deposit assumption premiums paid in connection with branch bank purchases are being amortized over 15 years, the estimated life of the deposit base acquired. On an ongoing basis, management reviews the valuation and amortization periods of goodwill and the deposit assumption premiums to determine if events and circumstances require the remaining lives to be reduced. MORTGAGE SERVICING RIGHTS - ------------------------- United's mortgage banking division accounts for mortgage servicing rights as a separate asset regardless of whether the servicing rights are acquired through purchase or origination. United's mortgage servicing rights represent the unamortized cost of purchased and originated contractual rights to service mortgages for others in exchange for a servicing fee and ancillary loan administration income. Mortgage servicing rights are amortized over the period of estimated net servicing income and are periodically adjusted for actual and anticipated prepayments of the underlying mortgage loans. Impairment analysis is performed quarterly after stratifying the rights by interest rate. Impairment, defined as the excess of the asset's carrying value over its current fair value, is recognized through a valuation allowance. At December 31, 1999 and 1998, no valuation allowances were required for United's mortgage servicing rights. United recognized approximately $15,000 in servicing assets during 1997, and recognized amortization expense relating to servicing assets of approximately $315,000, $387,000, and $144,000 during 1999, 1998 and 1997, respectively. Income Taxes Deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Future tax benefits, such as net operating loss carryforwards, are recognized to the extent that realization of such benefits is more likely than not. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which the assets and liabilities are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. In the event the future tax consequences of differences between the financial reporting bases and the tax bases of United's assets and liabilities results in deferred tax assets, an evaluation of the probability of being able to realize the future benefits indicated by such asset is required. A valuation allowance is provided for the portion of the deferred tax asset when it is more likely than not that some portion or all of the deferred tax asset will not be realized. In assessing the realizability of the deferred tax assets, management considers the scheduled reversals of deferred tax liabilities, projected future taxable income and tax planning strategies. F-83 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES - --------------------------------------------- Effective January 1, 1999, United adopted Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS No. 133"), which establishes accounting and reporting standards for hedging activities and for derivative instruments including derivative instruments embedded in other contracts. It requires the fair value recognition of derivatives as assets or liabilities in the financial statements. The accounting for the changes in the fair value of a derivative depends on the intended use of the derivative instrument at inception. The change in fair value of instruments used as fair value hedges is accounted for in the income of the period simultaneous with accounting for the fair value change of the item being hedged. The change in fair value of the effective portion of cash flow hedges is accounted for in comprehensive income rather than income, and the change in fair value of foreign currency hedges is accounted for in comprehensive income as part of the translation adjustment. The change in fair value of derivative instruments that are not intended as a hedge is accounted for in the income of the period of the change. At the date of initial application, an entity may transfer any held to maturity security into the available for sale or trading categories without calling into question the entity's intent to hold other securities to maturity in the future. In 1999, the Banks transferred all held to maturity investment securities to available for sale under this provision of SFAS No. 133. The held to maturity securities had amortized cost of $58.3 million and net unrealized gains of $1.8 million. The result of the transfer was to increase stockholders' equity by $1.1 million, which represented the net of tax effect of the unrealized gains associated with the held to maturity investments transferred. OTHER - ----- Property (other than cash deposits) held by the Banks in a fiduciary or agency capacity for customers is not included in the consolidated balance sheets since such items are not assets of the Banks. F-84 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued INCOME PER SHARE - ---------------- United is required to report on the face of the statements of income, income per common share with and without the dilutive effects of potential common stock issuances from instruments such as options, convertible securities and warrants. Basic income 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 income per common share. Additionally, United must reconcile the amounts used in the computation of both basic income per share and diluted income per share. Income per common share amounts for the years ended December 31, 1999, 1998 and 1997 are as follows (dollars and shares in thousands, except for per share data): FOR THE YEAR ENDED DECEMBER 31, 1999 Weighted Average Common Net Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic income per share $ 13,648 8,020 $ 1.70 ==== Effect of dilutive securities: Stock options - 156 Convertible debentures 191 140 ------ ----- Diluted income per share $ 13,839 8,316 $ 1.66 ====== ===== ==== FOR THE YEAR ENDED DECEMBER 31, 1998 Weighted Average Common Net Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic income per share $ 12,773 7,973 $ 1.60 ==== Effect of dilutive securities: Stock options - 133 Convertible debentures 187 140 ------ ----- Diluted income per share $ 12,960 8,246 $ 1.57 ====== ===== ==== F-85 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued INCOME PER SHARE, continued ---------------- FOR THE YEAR ENDED DECEMBER 31, 1997 Weighted Average Common Net Income Shares Per Share (Numerator) (Denominator) Amount ----------- ------------- ------ Basic income per share $ 11,054 7,810 $ 1.42 ==== Effect of dilutive securities: Stock options - 81 Convertible debentures 189 140 ------ ----- Diluted income per share $ 11,243 8,031 $ 1.40 ====== ===== ==== (1) MERGERS AND ACQUISITIONS Effective August 27, 1999, the Company acquired, for 632,890 shares of its $1 par value common stock and approximately $8,700 paid for fractional shares, all of the outstanding common stock of 1st Floyd Bankshares, Inc., a $115 million one-bank holding company, located in Rome, Georgia. The acquisition was accounted for as a pooling of interests and accordingly, the consolidated financial statements for all periods presented have been restated to include the financial position and results of operations as if the combination had occurred on January 1, 1997. The following is a reconciliation of the amounts of net interest income and net earnings previously reported with the restated amounts (in thousands): 1999 1998 1997 ---- ---- ---- Net interest income: The Company, as previously reported in 1998 and 1997 $ 63,298 52,499 43,232 Floyd 4,676 3,711 2,486 ------ ------- ------ As restated $ 67,974 56,210 45,718 ====== ====== ====== Net income: The Company, as previously reported in 1998 and 1997 $ 13,231 12,152 10,735 Floyd 417 621 319 ------ ------- ------- As restated $ 13,648 12,773 11,054 ====== ====== ====== United recorded merger, integration and restructuring charges of $1.8 million during 1999 associated with the acquisition of 1st Floyd Bankshares, Inc. The components of the charges are shown below (in thousands): Severance and related costs $ 692 Premises and equipment write-downs 424 Professional fees 522 Other merger-related expenses 207 ----- Total $ 1,845 ===== F-86 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (1) MERGERS AND ACQUISITIONS, continued The following table presents a summary of activity with respect to the merger-related accrual (in thousands): Balance at beginning of year $ - Merger-related charge 1,845 Cash payments (956) Noncash write-downs (434) ------- Balance at end of year $ 455 ======= On March 15, 1999, United acquired all the outstanding common stock of Adairsville Bancshares, Inc., the parent company of Bank of Adairsville, Adairsville, Georgia, for $7.1 million plus certain acquisition costs. United accounted for this transaction using the purchase method, and accordingly, the original purchase price was allocated to assets and liabilities acquired based upon their fair values at the date of acquisition. The excess of the purchase price over the fair value of the net assets acquired (goodwill) was approximately $2.9 million and is being amortized over 15 years using the straight-line method. On January 30, 1998, Peoples assumed deposits of $23.4 million and purchased certain assets totaling $3.7 million of a branch in Ellijay, Georgia. Effective September 12, 1997, United acquired, for 646,257 shares of its $1 par value common stock and approximately $7,000 paid for fractional shares, all of the outstanding common stock of First Clayton Bancshares, Inc., a $73 million one-bank holding company, located in Clayton, Georgia. The acquisition was accounted for as a pooling of interests. (2) CASH FLOWS United paid approximately $78 million, $59 million and $47 million in interest on deposits and other liabilities during 1999, 1998 and 1997, respectively. In connection with United's 1999 acquisition of Adairsville, assets having a fair value of $36 million were acquired and liabilities totaling $32 million were assumed. For the Years Ended December 31, -------------------------------- 1999 1998 1997 ---- ---- ---- Schedule of noncash investing and financing activities (in thousands): Change in unrealized gains (losses) on securities available for sale, net of tax $ (10,013) 482 951 Change in dividends payable $ 125 93 (66) Deposit liabilities assumed in branch acquisition $ - 23,399 - Assets acquired in branch acquisition, other than cash and cash equivalents $ - 3,246 - Investment securities purchase obligations $ 14,500 10,645 - Transfer of securities held to maturity to available for sale $ 58,306 - - Income tax benefit of disqualified disposition of shares under option $ 125 - - F-87 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (3) INVESTMENT SECURITIES Investment securities at December 31, 1999 and 1998, are as follows (in thousands): December 31, 1999 ----------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair SECURITIES AVAILABLE FOR SALE: Cost Gains Losses Value ---- ------ ------- ----- U.S. Treasuries $ 32,674 28 302 32,400 U.S. Government agencies 105,219 2 2,491 102,730 State and political subdivisions 81,116 253 2,545 78,824 Mortgage-backed securities 305,951 449 8,468 297,932 Other 23,403 - 786 22,617 ------- --- ------ ------- Total $ 548,363 732 14,592 534,503 ======= === ====== ======= December 31, 1998 ----------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair SECURITIES AVAILABLE FOR SALE: Cost Gains Losses Value ---- ------ ------- ----- U.S. Treasuries $ 32,090 990 - 33,080 U.S. Government agencies 46,421 492 9 46,904 State and political subdivisions 22,305 369 64 22,610 Mortgage-backed securities 220,171 945 480 220,636 Other 10,615 1 59 10,557 ------- ----- --- ------- Total $ 331,602 2,797 612 333,787 ======= ===== === ======= SECURITIES HELD TO MATURITY: U.S. Government agencies $ 1,885 9 5 1,889 State and political subdivisions 53,386 1,691 33 55,044 Mortgage-backed securities 2,122 55 5 2,172 Other 913 - - 913 ------- ----- --- ------ Total $ 58,306 1,755 43 60,018 ====== ===== == ====== F-88 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTs, continued (3) INVESTMENT SECURITIES, continued The amortized cost and estimated fair value of the securities portfolio at December 31, 1999, by contractual maturity, is presented in the following table. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities Available for Sale Amortized Estimated Cost Fair Value ---- ---------- U.S. Treasuries: Within 1 year $ 9,246 9,252 1 to 5 years 23,428 23,148 ------ ------ $ 32,674 32,400 ====== ====== U.S. Government agencies: Within 1 year $ 4,450 4,405 1 to 5 years 63,670 61,903 5 to 10 years 33,611 33,202 More than 10 years 3,488 3,220 ------- ------- $ 105,219 102,730 ======= ======= State and political subdivisions: Within 1 year $ 5,322 5,324 1 to 5 years 32,469 32,280 5 to 10 years 25,420 24,749 More than 10 years 17,905 16,471 ------- ------- $ 81,116 78,824 ======= ======= Other: More than 10 years $ 23,403 22,617 ======= ======= Total securities other than mortgage-backed securities: Within 1 year $ 19,018 18,981 1 to 5 years 119,567 117,331 5 to 10 years 59,031 57,951 More than 10 years 44,796 42,308 Mortgage-backed securities 305,951 297,932 ------- ------- $ 548,363 534,503 ======= ======= There were no sales of securities held to maturity during 1999, 1998 and 1997. Proceeds from sales of securities available for sale during 1999, 1998 and 1997 were $8 million, $44 million and $37 million, respectively. Gross gains of $646,000, $807,000 and $767,000 for 1999, 1998 and 1997, respectively, along with gross losses of $103,000, $3,000 and $30,000 for 1999, 1998 and 1997, respectively, were realized on those sales. Income tax expense recognized on these gains and losses was $206,000, $306,000 and $280,000 in 1999, 1998 and 1997, respectively. Securities with a carrying value of $141 million and $102 million at December 31, 1999 and 1998, respectively, were pledged to secure public deposits and Federal Home Loan Bank advances. F-89 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (4) LOANS AND ALLOWANCE FOR LOAN LOSSES Major classifications of loans at December 31, 1999 and 1998, are summarized as follows (in thousands): 1999 1998 ---- ---- Commercial, financial and agricultural $ 121,325 109,647 Real estate - construction 161,020 121,900 Real estate - mortgage 971,543 694,561 Consumer 146,472 135,058 ---------- ---------- Total loans 1,400,360 1,061,166 Less allowance for loan losses 17,722 12,680 ----------- ----------- Loans, net $ 1,382,638 1,048,486 ========= ========= The Banks grant loans and extensions of credit to individuals and a variety of firms and corporations located primarily in counties in North Georgia and Western North Carolina. Although the Banks have diversified loan portfolios, a substantial portion of the loan portfolios is collateralized by improved and unimproved real estate and is dependent upon the real estate market. During 1999 and 1998, certain executive officers and directors of United and its Banks, including their immediate families and companies with which they are associated, maintained a variety of banking relationships with the Banks. Total loans outstanding to these persons at December 31, 1999 and 1998 amounted to $39,559,000 and $22,755,000, respectively. The change from December 31, 1998 to December 31, 1999 reflects payments amounting to $25,188,000 and advances of $41,992,000. Such loans are made in the ordinary course of business at normal credit terms, including interest rate and collateral requirements, and do not represent more than normal credit risk. Changes in the allowance for loan losses are summarized as follows (in thousands): 1999 1998 1997 ---- ---- ---- Balance at beginning of year $ 12,680 10,989 8,536 Allowance for loan losses acquired from Adairsville 1,822 - - Provisions charged to income 5,104 2,612 2,814 Loans charged off (2,854) (1,463) (830) Recoveries of loans previously charged off 970 542 469 -------- -------- -------- Balance at end of year $ 17,722 12,680 10,989 ====== ====== ====== United serviced approximately $55.0 million and $73.6 million of mortgage loans for others at December 31, 1999 and 1998, respectively. F-90 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (5) PREMISES AND EQUIPMENT Premises and equipment at December 31, 1999 and 1998, are summarized as follows (in thousands): 1999 1998 ---- ---- Land and land improvements $ 10,662 8,187 Building and improvements 25,217 19,074 Furniture and equipment 25,449 20,714 Construction in progress 2,881 5,907 ------ ------ 64,209 53,882 Less accumulated depreciation 16,844 12,635 ------ ------ $ 47,365 41,247 ====== ====== Depreciation expense was approximately $4.2 million, $2.8 million and $2.2 million in 1999, 1998 and 1997, respectively. (6) TIME DEPOSITS The aggregate amount of time deposit accounts with a minimum denomination of $100,000 was approximately $312,000,000 and $219,968,000 at December 31, 1999 and 1998, respectively. At December 31, 1999, contractual maturities of time deposits are summarized as follows (in thousands): Maturing In: ----------- 2000 $ 829,681 2001 186,062 2002 28,983 2003 7,990 2004 1,512 Thereafter 390 --------- $ 1,054,618 ========= (7) Federal Home Loan Bank Advances The Banks have advances from the Federal Home Loan Bank ("FHLB") with monthly interest payments and principal payments due at various maturity dates and interest rates ranging from 4.35% to 7.81% at December 31, 1999. The FHLB advances are collateralized by first mortgage loans, mortgage-backed securities and FHLB stock. Advances from FHLB outstanding at December 31, 1999 mature as follows (in thousands): Year ---- 2000 $ 80,682 2001 10,308 2002 56,433 2003 37,469 2004 39,255 Thereafter 63,425 ------- $ 287,572 ======= F-91 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (8) LONG-TERM DEBT AND OTHER BORROWINGS Long-term debt and other borrowings at December 31, 1999 and 1998 consisted of the following (in thousands): 1999 1998 ---- ---- Note payable, due at maturity with monthly interest payments through March 2001, secured by common stock of the Bank Subsidiaries. Interest is variable based on the prime rate less 1.25%. The loan agreement contains covenants and restrictions pertaining to the maintenance of certain financial ratios, limitations on the incurrence of additional debt, and the declaration of dividends or other capital transactions. As of December 31, 1999, the Company had violated certain financial covenants; however, the Company has obtained a waiver of these violations. $ 15,365 - Commercial paper of Finance, due at maturity during 2000 and unsecured. Interest is from 6.50% to 7.00% and is payable monthly. 2,151 1,277 ------- ----- $ 17,516 1,277 ====== ===== (9) CONVERTIBLE SUBORDINATED DEBENTURES On December 31, 1996, United completed a private placement of convertible subordinated debentures due December 31, 2006 (the "Debentures"). The Debentures bear interest at the rate of one quarter of one percentage point over the prime rate per annum, payable in quarterly installments. The Debentures may be redeemed, in whole or in part at the option of United upon at least 20 days and not more than 60 days notice, at a redemption price equal to 100% of the principal amount of the Debentures to be redeemed plus interest accrued and unpaid as of the date of redemption. The holders of the Debentures not called for redemption will have the right, exercisable at any time up to December 31, 2006, to convert such Debenture at the principal amount thereof into shares of common stock of United at the conversion price of $25 per share, subject to adjustment for stock splits and stock dividends. Certain directors and executive officers of United held convertible debentures totaling $2,800,000 at December 31, 1999 and 1998. (10) TRUST PREFERRED SECURITIES In July, 1998, United formed a wholly owned Delaware statutory business trust, United Community Capital Trust ("United Trust"), which issued $21 million of guaranteed preferred beneficial interests in United's junior subordinated deferrable interest debentures that qualify as Tier 1 capital under Federal Reserve Board guidelines. All of the common securities of United Trust are owned by United. The proceeds from the issuance of the Common Securities and the Trust Preferred Securities were used by United Trust to purchase $21.7 million of junior subordinated debentures of United which carry a fixed interest rate of 8.125 percent. The proceeds received by United from the sale of the junior subordinated debentures were used to prepay line of credit borrowings of approximately $11.8 million and for further investments in the Banks. The debentures represent the sole asset of United Trust. The debentures and related income statement effects are eliminated in United's financial statements. The Trust Preferred Securities accrue and pay distributions semiannually at a fixed rate of 8.125 percent per annum of the stated liquidation value of $1,000 per capital security. United has entered into contractual arrangements which, taken collectively, fully and unconditionally guarantee payment of: (i) accrued and unpaid distributions required to be paid on the Trust Preferred Securities; (ii) the redemption price with respect to any Trust Preferred Securities called for redemption by United Trust, and (iii) payments due upon a voluntary or involuntary dissolution, winding up or liquidation of United Trust. F-92 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (10) TRUST PREFERRED SECURITIES, continued The Trust Preferred Securities are mandatorily redeemable upon maturity of the debentures on July 15, 2028, or upon earlier redemption as provided in the indenture. United has the right to redeem the debentures purchased by United Trust: (i) in whole or in part, on or after July 15, 2008, and (ii) in whole (but not in part) at any time within 90 days following the occurrence and during the continuation of a tax event, investment company event or capital treatment time (as defined in the offering circular). As specified in the indenture, if the debentures are redeemed prior to maturity, the redemption price will be the principal amount, any accrued but unpaid interest, plus a premium ranging from 4.06 percent in 2008 to 0.41 percent in 2017. (11) INCOME TAXES During 1999, 1998 and 1997, United made income tax payments of approximately $6.9 million, $6.3 million and $5.8 million, respectively. The components of income tax expense for the years ended December 31, 1999, 1998 and 1997 are as follows (in thousands): 1999 1998 1997 ---- ---- ---- Current $ 7,509 6,756 5,391 Deferred (reduction) (1,616) (766) (404) ----- ----- ----- $ 5,893 5,990 4,987 ===== ===== ===== The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate (34 percent) to income before income taxes are as follows (in thousands): 1999 1998 1997 ---- ---- ---- Pretax income at statutory rates $ 6,644 6,379 5,454 Add (deduct): Tax-exempt interest income (1,360) (1,158) (878) Nondeductible interest expense 256 224 147 Other 353 545 264 ----- ----- ----- $ 5,893 5,990 4,987 ===== ===== ===== The following summarizes the sources and expected tax consequences of future taxable deductions (income) which comprise the net deferred tax asset at December 31, 1999 and 1998 (in thousands): 1999 1998 ---- ---- Deferred tax assets: Allowance for loan losses $ 6,823 4,848 Net operating loss and credit carryforwards 561 - Unrealized loss of securities available for sale 5,099 - Other 253 122 ------ ----- Gross deferred tax assets 12,736 4,970 ------ ----- Deferred tax liabilities: Premises and equipment (1,983) (1,567) Unrealized gain on securities available for sale - (879) Other (216) (423) ------ ----- Gross deferred tax liabilities (2,199) (2,869) ------ ----- Net deferred tax asset $ 10,537 2,101 ====== ===== F-93 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (12) EMPLOYEE BENEFIT PLANS United has contributory employee benefit plans covering substantially all employees, subject to certain minimum service requirements. United's contribution to the plans is determined annually by the Board of Directors and amounted to approximately $1,215,000, $1,025,000 and $803,000 in 1999, 1998, and 1997, respectively. The companies acquired in 1999 sponsored certain defined contribution employee benefit plans that have been or will be merged into the existing plan of United. Under these plans, the acquired companies recognized expenses of approximately $113,000, $77,000 and $25,000 in 1999, 1998 and 1997, respectively. During 1998, United initiated a defined post-retirement benefit plan to provide retirement benefits to certain executive officers and other key employees and to provide death benefits for their designated beneficiaries. Under this plan, United purchased split-dollar whole life insurance contracts on the lives of each participant. At December 31, 1999 and 1998, the cash surrender value of the insurance contracts was approximately $8.6 million and $8.1 million, respectively. Expenses incurred for benefits were approximately $204,000 during 1999. No expenses were incurred for benefits during 1998. (13) REGULATORY MATTERS United and the Banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, action by regulators that, if undertaken, could have a direct material effect on the Banks' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Banks must meet specific capital guidelines that involve quantitative measures of the Banks' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Banks' capital amounts and classification are also subject to qualitative judgements by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Banks to maintain minimum amounts and ratios of total and Tier 1 capital (as defined) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 1999, that the Banks meet all capital adequacy requirements to which they are subject. Minimum ratios required by the Banks to ensure capital adequacy are 8% for total capital to risk weighted assets and 4% each for Tier 1 capital to risk weighted assets and Tier 1 capital to average assets. Minimum ratios required by the Banks to be well capitalized under prompt corrective action provisions are 10% for total capital to risk weighted assets, 6% for Tier 1 capital to risk weighted assets and 5% for Tier 1 capital to average assets. Minimum amounts required for capital adequacy purposes and to be well capitalized under prompt corrective action provisions are presented below for United and its most significant subsidiaries (in thousands). Prompt corrective action provisions do not apply to bank holding companies. Minimum Minimum Minimum Total Risk Based Tier 1 Risk Based Tier 1 Leverage ---------------- ------------------ --------------- Prompt Prompt Prompt Capital Corrective Capital Corrective Capital Corrective 1999 Adequacy Action Adequacy Action Adequacy Action ---- -------- ------ -------- ------ -------- ------ Consolidated $ 110,443 N/A 55,221 N/A 75,471 N/A UCB 31,744 39,680 15,872 23,808 24,370 30,463 Carolina 30,176 37,720 15,088 22,632 22,933 28,666 1998 Consolidated $ 88,550 N/A 44,275 N/A 59,805 N/A UCB 27,819 34,774 13,910 20,864 18,811 23,514 Carolina 22,814 28,517 11,407 17,110 16,965 21,207 F-94 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (13) REGULATORY MATTERS, continued Actual capital amounts and ratios for United and its most significant Banks as of December 31, 1999 and 1998, are as follows (in thousands): Actual Actual Actual Total Risk Based Tier 1 Risk Based Tier 1 Leverage ----------------- ------------------ --------------- Actual Actual Actual 1999 Amount Ratio Amount Ratio Amount Ratio ---- ------ ----- ------ ----- ------ ----- Consolidated $ 137,298 9.95% 116,536 8.44% 116,536 5.52% UCB 43,825 11.05% 38,865 9.80% 38,865 6.38% Carolina 39,521 10.48% 34,991 9.28% 34,991 6.10% 1998 Consolidated $ 122,468 11.06% 106,269 9.60% 106,269 7.11% UCB 39,272 11.29% 35,209 10.13% 35,209 7.49% Carolina 30,374 10.65% 26,808 9.40% 26,808 6.32% As of December 31, 1999 and 1998, the most recent notification from the FDIC categorized each of the Banks as well capitalized under the regulatory framework for prompt corrective action. (14) COMMITMENTS The Banks are parties to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of their customers. These financial instruments include commitments to extend credit, letters of credit and financial guarantees. These instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the balance sheet. The contract amounts of these instruments reflect the extent of involvement the Banks have in particular classes of financial instruments. The exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit, letters of credit and financial guarantees written is represented by the contractual amount of these instruments. The Banks use the same credit policies in making commitments and conditional obligations as for on-balance-sheet instruments. In most cases, collateral or other security is required to support financial instruments with credit risk. The following table summarizes, as of December 31, 1999 and 1998, the contract amount of off-balance sheet instruments (in thousands): 1999 1998 ---- ---- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $ 212,099 136,281 Standby letters of credit $ 6,523 8,698 Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Banks evaluate each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management's credit evaluation. Collateral held varies, but may include unimproved and improved real estate, certificates of deposit, personal property or other acceptable collateral. F-95 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (14) Commitments, continued Standby letters of credit and financial guarantees written are conditional commitments issued by the Banks to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to local businesses. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Banks hold real estate, certificates of deposit, equipment and automobiles as collateral supporting those commitments for which collateral is deemed necessary. The extent of collateral held for those commitments varies. United maintains an overall interest rate risk-management strategy that incorporates the use of derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. The goal is to manage interest rate sensitivity by modifying the repricing or maturity characteristics of certain balance sheet assets and liabilities so that the net interest margin is not, on a material basis, adversely affected by movements in interest rates. As a result of interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation will generally be offset by income or loss on the derivative instruments that are linked to the hedged assets and liabilities. United views this strategy as a prudent management of interest rate sensitivity, such that earnings are not exposed to undue risk presented by changes in interest rates. Derivative instruments that are used as part of United's interest rate risk-management strategy include interest rate contracts (swaps and caps). As a matter of policy, United does not use highly leveraged derivative instruments for interest rate risk management. Interest rate swaps generally involve the exchange of fixed- and variable-rate interest payments between two parties, based on a common notional principal amount and maturity date. Interest rate cap agreements provide for a variable cash flow if interest rates exceed the cap rate, based on a notional principal amount and maturity date. By using derivative instruments, United is exposed to credit and market risk. If the counterparty fails to perform, credit risk is equal to the extent of the fair-value gain in a derivative. When the fair value of a derivative contract is positive, this generally indicates that the counterparty owes United, and, therefore, creates a repayment risk for United. When the fair value of a derivative contract is negative, United owes the counterparty and, therefore, it has no repayment risk. United minimizes the credit (or repayment) risk in derivative instruments by entering into transactions with high-quality counterparties that are reviewed periodically by United. United's derivative activities are monitored by its asset/liability management committee as part of that committee's oversight of United's asset/liability and treasury functions. United's asset/liability committee is responsible for implementing various hedging strategies that are developed through its analysis of data from financial simulation models and other internal and industry sources. The resulting hedging strategies are then incorporated into the overall interest-rate risk management. As described more fully in the summary of significant accounting policies, United adopted SFAS No. 133 during 1999. All of United's derivative financial instruments are classified as highly effective fair value hedges. United enters into interest-rate swaps and caps to convert a portion of its fixed rate loans and a portion of its fixed-rate liabilities to variable. For the year ended December 31, 1999, there were no material amounts recognized which represented the ineffective portion of fair-value hedges. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness, unless otherwise noted. F-96 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (15) PREFERRED STOCK United may issue preferred stock in one or more series as established by resolution of the Board of Directors, up to a maximum of 10,000,000 shares. Each resolution shall include the number of shares issued, preferences, special rights and limitations as determined by the Board of Directors. At December 31, 1999 and 1998, there were no preferred shares issued or outstanding. (16) STOCKHOLDERS' EQUITy Dividends paid by the Banks are the primary source of funds available to United for payment of dividends to its stockholders and other needs. Applicable federal and state statutes and regulations impose restrictions on the amount of dividends that may be declared by the Banks. At December 31, 1999, approximately $23 million of the Banks' net assets were available for payment of dividends without prior approval from the regulatory authorities. In addition to the formal statutes and regulations, regulatory authorities also consider the adequacy of each Bank's total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends from the Banks. During 1997, United issued 300,000 shares of common stock for approximately $6,477,000, net of offering costs. The proceeds from this sale of stock were used to inject capital into the Banks and for general corporate purposes. During 1995, the Board of Directors adopted the Key Employee Stock Option Plan. Under this plan, options can be granted for shares of United's common stock at a price equal to the fair market value at the date of grant. At December 31, 1999, no shares were available for grant under this plan. Floyd also previously adopted a stock option plan for its key employees. This plan had provisions similar to United's plan. Holders of options under the Floyd plan were issued options in connection with the merger of United and Floyd at the exchange ratio of .8477 per option held. All option amounts detailed below have been restated to reflect the options outstanding under Floyd's plan. SFAS No. 123, "Accounting for Stock-Based Compensation," encourages, but does not require, entities to compute the fair value of options at the date of grant and to recognize such costs as compensation expense immediately if there is no vesting period or ratably over the vesting period of the options. United has chosen not to adopt the cost recognition principles of this statement and accounts for stock options under Accounting Principles Board Opinion No. 25 and its related interpretations. No compensation expense has been recognized in 1999, 1998 or 1997 related to the stock option plan. Had compensation cost been determined based upon the fair value of the options at the grant dates consistent with the method of SFAS No. 123, United's income and income per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data): 1999 1998 1997 ---- ---- ---- Net income As reported $ 13,648 12,773 11,054 Pro forma $ 13,277 12,562 10,798 Basic income per share As reported $ 1.70 1.60 1.42 Pro forma $ 1.66 1.58 1.38 Diluted income per share As reported $ 1.66 1.57 1.40 Pro forma $ 1.62 1.55 1.37 The fair value of each option granted is estimated on the date of grant using the minimum value method with the following weighted average assumptions used for grants in 1999, 1998 and 1997: dividend yield of 1%, risk free interest rate of 6% and an expected life of 10 years. F-97 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (16) STOCKHOLDERS' EQUITY, continued A summary of activity in United's stock option plan is presented below: Weighted Average Range Option Option Price of Price Shares Per Share Per Share ------ --------- --------- Options outstanding at December 31, 1996 92,000 $ 13.65 $ 10.00 - 18.00 Options granted in 1997 146,671 $ 17.77 $ 11.80 - 22.51 ------- Options outstanding at December 31, 1997 238,671 $ 16.18 $ 10.00 - 22.51 Options granted in 1998 63,477 $ 28.08 $ 15.34 - 32.50 Options exercised in 1998 (8,500) $ 13.95 $ 10.00 - 22.00 Options forfeited in 1998 (3,500) $ 20.40 $ 18.00 - 22.00 ------- Options outstanding at December 31, 1998 290,148 $ 18.80 $ 10.00 - 32.50 Options granted in 1999 82,300 $ 37.75 $ 37.75 - 40.00 Options exercised in 1999 (30,546) $ 12.15 $ 10.00 - 30.00 Options forfeited in 1999 (1,000) $ 26.80 $ 22.00 - 30.00 ------- Options outstanding at December 31, 1999 340,902 $ 24.37 $ 10.00 - 40.00 ======= Options on 214,562, 124,404, and 102,104 shares were exercisable at December 31, 1999, 1998 and 1997, respectively. The weighted average grant-date fair value of options granted in 1999, 1998 and 1997 was $15.65, $9.65 and $5.90, respectively. Such options have a weighted average remaining contractual life of approximately 7 years as of December 31, 1999. (17) SUPPLEMENTAL FINANCIAL DATA Components of other non-interest expenses in excess of 1% of total interest and non-interest income for the years ended December 31, 1999, 1998 and 1997 included advertising expenses of $1,673,000, $1,484,000, and $1,566,000, respectively. F-98 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (18) UNITED COMMUNITY BANKS, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION BALANCE SHEETS DECEMBER 31, 1999 AND 1998 1999 1998 ---- ---- (IN THOUSANDS) Assets ------ Cash $ 247 424 Investment in subsidiaries 128,402 109,780 Other assets 11,361 8,982 ------- --------- $ 140,010 119,186 ======= ======= Liabilities and Stockholders' Equity ------------------------------------ Other liabilities $ 3,225 200 Notes payable 15,365 - Convertible subordinated debentures 3,500 3,500 Junior subordinated debentures 21,650 21,650 Stockholders' equity 96,270 93,836 ------- -------- $ 140,010 119,186 ======= ======= STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ---- ---- ---- (In Thousands) Income: Dividends from subsidiaries $ 4,000 3,927 1,210 Other 4,955 2,868 730 ------- ------- -------- Total income 8,955 6,795 1,940 ------- ------- ------- Expenses: Interest 2,671 1,560 1,045 Other 10,397 5,638 2,097 ------ ------- ------- Total expense 13,068 7,198 3,142 ------ ------- ------- Loss before income tax benefit and equity in undistributed income of subsidiaries (4,113) (403) (1,202) Income tax benefit 2,684 1,410 823 ------ ------- -------- Income (loss) before equity in undistributed income of subsidiaries (1,429) 1,007 (379) Equity in undistributed income of subsidiaries 15,077 11,766 11,433 ------ ------ ------ Net income $ 13,648 12,773 11,054 ====== ====== ====== F-99 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (18) UNITED COMMUNITY BANKS, INC. (PARENT COMPANY ONLY) FINANCIAL INFORMATION, continued STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ---- ---- ---- (IN THOUSANDS) Cash flows from operating activities: Net income $ 13,648 12,773 11,054 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in undistributed income of the subsidiaries (15,077) (11,766) (11,433) Depreciation, amortization and accretion 779 387 300 Change in: Other assets 503 1,600 (2,567) Other liabilities 3,138 (736) (27) ------- ------ ------ Net cash provided by (used in) operating activities 2,991 2,258 (2,673) ------- ------ ------ Cash flows from investing activities: Purchase of premises and equipment (737) (2,173) (1,273) Capital contributions to the subsidiaries (9,300) (7,899) (5,250) Purchase of bank subsidiary (7,191) - - Purchase of investments (104) - - ------- ------ ------ Net cash used in investing activities (17,332) (10,072) (6,523) ------- ------ ------ Cash flows from financing activities: Proceeds from junior subordinated debentures - 21,650 - Proceeds from notes payable 15,365 - 3,400 Repayments of notes payable - (12,722) (1,131) Proceeds from exercise of stock options 216 118 - Proceeds from sale of common stock - - 6,477 Purchase and retirement of treasury stock of pooled entity - - (408) Proceeds from resale of treasury stock of pooled entity - - 6 Dividends paid (1,417) (1,089) (825) ------- ------ ------ Net cash provided by financing activities 14,164 7,957 7,927 ------- ------ ------ Net change in cash (177) 143 (1,269) Cash at beginning of year 424 281 1,550 ------- ------ ------ Cash at end of year $ 247 424 281 ======== ====== ====== F-100 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (19) FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized on the face of the balance sheet, for which it is practicable to estimate that value. The assumptions used in the estimation of the fair value of United's financial instruments are detailed below. Where quoted prices are not available, fair values are based on estimates using discounted cash flows and other valuation techniques. The use of discounted cash flows can be significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. The following disclosures should not be considered a surrogate of the liquidation value of United or its Banks, but rather a good-faith estimate of the increase or decrease in value of financial instruments held by United since purchase, origination, or issuance. Cash and Cash Equivalents ------------------------- For cash, due from banks and federal funds sold the carrying amount is a reasonable estimate of fair value. Securities Held to Maturity and Securities Available for Sale ------------------------------------------------------------- Fair values for investment securities are based on quoted market prices. Loans and Mortgage Loans Held for Sale -------------------------------------- The fair value of fixed rate loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings. For variable rate loans, the carrying amount is a reasonable estimate of fair value. Cash Surrender Value of Life Insurance -------------------------------------- The carrying value of cash surrender value of life insurance is a reasonable estimate of fair value. Deposits -------- The fair value of demand deposits, savings accounts and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities. Federal Funds Purchased and Repurchase Agreements ------------------------------------------------- The carrying amount of federal funds purchased and repurchase agreements is a reasonable estimate of fair value. Federal Home Loan Bank Advances ------------------------------- The fair value of United's fixed rate borrowings are estimated using discounted cash flows, based on United's current incremental borrowing rates for similar types of borrowing arrangements. For variable rate borrowings the carrying amount is a reasonable estimate of fair value. Long-Term Debt and Convertible Subordinated Debentures ------------------------------------------------------ Long-term debt and convertible subordinated debentures are made using variable rates; thus, the carrying amount is a reasonable estimate of fair value. Trust Preferred Securities -------------------------- The fair value of United's trust preferred securities is estimated using discounted cash flows, based on United's current incremental borrowing rates for similar types of borrowing arrangements. Interest Rate Swaps, Floors and Caps ------------------------------------ The fair value of interest rate swaps, floors and caps is obtained from dealer quotes. These values represent the estimated amount United would receive or pay to terminate the contracts or agreements, taking into account current interest rates and, when appropriate, the current creditworthiness of the counterparties. Commitments to Extend Credit, Standby Letters of Credit and Financial --------------------------------------------------------------------- Guarantees Written ------------------ Because commitments to extend credit and standby letters of credit are made using variable rates or are commitments recently made, the contract value is a reasonable estimate of fair value. F-101 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, continued (19) FAIR VALUE OF FINANCIAL INSTRUMENTS, continued Limitations ----------- 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 any premium or discount that could result from offering for sale at one time United's entire holdings of a particular financial instrument. Because no 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 a significant effect on fair value estimates and have not been considered in the estimates. The carrying amount and estimated fair values of United's financial instruments at December 31, 1999 and 1998 are as follows (in thousands): December 31, 1999 December 31, 1998 ------------------ ----------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value ------ ---------- ------ ---------- Assets: Cash and cash equivalents $ 112,611 112,611 64,112 64,112 Securities held to maturity - - 58,306 60,018 Securities available for sale 534,503 534,503 333,787 333,787 Mortgage loans held for sale 6,326 6,326 8,129 8,129 Loans, net 1,382,638 1,378,299 1,048,486 1,051,252 Cash surrender value of life insurance 8,550 8,550 8,130 8,130 Liabilities: Deposits 1,649,392 1,648,947 1,238,323 1,240,000 Federal funds purchased and repurchase agreements 31,812 31,812 26,520 26,520 Federal Home Loan Bank advances 287,572 287,126 186,854 182,485 Long-term debt and other borrowings 17,516 17,516 1,277 1,277 Convertible subordinated debentures 3,500 3,500 3,500 3,500 Trust Preferred Securities 21,000 17,188 21,000 19,336 Interest rate contracts 113 113 - - Unrecognized financial instruments: Commitments to extend credit 212,099 212,099 136,281 136,281 Standby letters of credit 6,523 6,523 8,698 8,698 Interest rate contracts $ - - 437 448 F-102 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (20) SUBSEQUENT EVENTS On March 3, 2000, United entered into a definitive agreement to acquire North Point Bancshares, Inc. (North Point), a $107 million one-bank holding company for Dawson County Bank, located in Dawsonville, Georgia for approximately 958,000 shares of its common stock. Also on March 3, 2000, United entered into an agreement to acquire Independent Bancshares, Inc. (Independent), a $145 million one-bank holding company for Independent Bank & Trust, located in Powder Springs, Georgia for approximately 872,000 shares of its common stock. These agreements are subject to approval of applicable regulatory authorities and shareholders and will be accounted for as pooling of interests. As such, historical financial information presented in future reports will be restated to include North Point and Independent. The following unaudited pro forma data summarizes operating data as if the combinations had been consummated on January 1, 1997: As of and for the year ended (in thousands, except per share amounts) 1999 1998 1997 ---- ---- ---- Total assets $ 2,383,486 1,812,585 1,410,071 Stockholders' equity $ 118,908 115,415 99,571 Net income $ 16,692 15,510 13,197 Basic income per share $ 1.70 1.59 1.41 Diluted income per share $ 1.67 1.56 1.40 F-103 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) - --------------------------------------------------------------------------------------------------------------------- March 31, December 31, (in thousands) 2000 1999 - --------------------------------------------------------------------------------------------------------------------- ASSETS Cash and due from banks $ 82,294 89,231 Federal funds sold 170 23,380 - --------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents 82,464 112,611 - --------------------------------------------------------------------------------------------------------------------- Securities available for sale 548,670 534,503 Mortgage loans held for sale 4,588 6,326 Loans, net of unearned income 1,459,469 1,400,360 Less: Allowance for loan losses (18,922) (17,722) - --------------------------------------------------------------------------------------------------------------------- Loans, net 1,440,547 1,382,638 - --------------------------------------------------------------------------------------------------------------------- Premises and equipment, net 47,644 47,365 Accrued interest receivable 19,406 17,861 Other assets 31,302 30,136 - --------------------------------------------------------------------------------------------------------------------- Total assets $ 2,174,621 2,131,440 ===================================================================================================================== LIABILITIES AND STOCKHOLDERS' EQUITY Deposits: Demand $ 210,248 192,006 Interest bearing demand 352,448 328,815 Savings 78,147 73,953 Time 1,027,642 1,054,618 - --------------------------------------------------------------------------------------------------------------------- Total deposits 1,668,485 1,649,392 - --------------------------------------------------------------------------------------------------------------------- Accrued expenses and other liabilities 20,149 24,378 Federal funds purchased and repurchase agreements 33,760 31,812 Federal Home Loan Bank advances 309,940 287,572 Long-term debt and other borrowings 19,331 17,516 Convertible subordinated debentures 3,500 3,500 Trust Preferred Securities 21,000 21,000 - --------------------------------------------------------------------------------------------------------------------- Total liabilities 2,076,165 2,035,170 - --------------------------------------------------------------------------------------------------------------------- Stockholders' equity: Preferred Stock - - Common stock, $1 par value; 10,000,000 shares authorized; 8,034,268 shares issued and outstanding 8,034 8,034 Capital surplus 30,310 30,310 Retained earnings 69,807 66,606 Accumulated other comprehensive income (loss) (9,695) (8,680) - --------------------------------------------------------------------------------------------------------------------- Total stockholders' equity 98,456 96,270 - --------------------------------------------------------------------------------------------------------------------- - --------------------------------------------------------------------------------------------------------------------- Total liabilities and stockholders' equity $ 2,174,621 2,131,440 ===================================================================================================================== See notes to unaudted consolidated financial statements. F-104 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Consolidated Statements of Income (Unaudited) For the Three Months Ended March 31, (IN THOUSANDS , EXCEPT PER SHARE DATA) 2000 1999 - ---------------------------------------------------------------------------------------------- Interest income: Interest and fees on loans $ 34,484 26,541 Interest on federal funds sold 202 170 Interest on investment securities: Taxable 7,849 5,201 Tax exempt 896 917 - -------------------------------------------------------------------------------------------- Total interest income 43,431 32,829 - -------------------------------------------------------------------------------------------- INTEREST EXPENSE: Interest on deposits: Demand 3,350 2,667 Savings 545 626 Time 15,290 10,312 Notes payable, subordinated debentures, federal funds purchased and FHLB advances 4,950 3,360 Trust Preferred Securities 430 430 - -------------------------------------------------------------------------------------------- Total interest expense 24,565 17,395 - -------------------------------------------------------------------------------------------- Net interest income 18,866 15,434 Provision for loan losses 1,546 980 - -------------------------------------------------------------------------------------------- Net interest income after provision for loan losses 17,320 14,454 - -------------------------------------------------------------------------------------------- NONINTEREST INCOME: Service charges and fees 1,473 1,164 Securities gains, net 5 5 Mortgage loan and related fees 220 448 Other non-interest income 992 862 - -------------------------------------------------------------------------------------------- Total noninterest income 2,690 2,479 - -------------------------------------------------------------------------------------------- NONINTEREST EXPENSE: Salaries and employee benefits 8,044 6,745 Occupancy 2,566 2,086 Other noninterest expense 3,787 3,169 - -------------------------------------------------------------------------------------------- Total noninterest expense 14,397 12,000 - -------------------------------------------------------------------------------------------- Income before income taxes 5,613 4,933 Income taxes 1,789 1,640 - -------------------------------------------------------------------------------------------- NET INCOME $ 3,824 3,293 ============================================================================================ Basic earnings per share $ 0.48 0.41 Diluted earnings per share $ 0.47 0.40 Average shares outstanding 8,034 8,004 Diluted average shares outstanding 8,317 8,293 See notes to unaudited consolidated financial statements. F-105 UNITED COMMUNITY BANKS, INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) IN THOUSANDS FOR THE THREE MONTHS ENDED March 31 2000 1999 --------------------------------- (In Thousands) CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 3,824 3,293 Adjustments to reconcile net income to net cash provided (used) by operating activities: Depreciation, amortization and accretion 1,061 1,212 Provision for loan losses 1,546 980 Loss (gain) on sale of investment securities (5) (5) Change in assets and liabilities: Interest receivable (1,545) (524) Other assets (1,166) (4,205) Accrued expenses and other liabilities (4,229) 3,465 Change in mortgage loans held for sale 1,738 2,649 ----------------------------- NET CASH PROVIDED BY OPERATING ACTIVITIES 1,224 6,865 ----------------------------- CASH FLOWS FROM INVESTING ACTIVITIES, NET OF PURCHASE ACQUISITIONS: Proceeds from sales of securities available for sale 250 38 Proceeds from maturities and calls of securities available for sale 10,848 26,404 Purchases of securities available for sale (24,411) (105,289) Purchase of life insurance contracts (2,650) -- Net increase in loans (59,109) (65,751) Net cash inflow (outflow) for branch and bank acquisitions -- (2,248) Proceeds from sale of other real estate 65 20 Purchase of bank premises and equipment (1,186) (1,154) ----------------------------- NET CASH USED IN INVESTING ACTIVITIES (76,193) (147,980) ----------------------------- CASH FLOWS FROM FINANCING ACTIVITIES, NET OF PURCHASE ACQUISITIONS: Net change in demand and savings deposits 46,069 40,685 Net change in time deposits (26,976) 7,944 Net change in federal funds purchased and repurchase agreements 1,948 52,239 Net change in FHLB advances 22,368 42,769 Net change in long-term debt and other borrowings 1,815 10,960 Dividends paid (402) (276) ----------------------------- NET CASH PROVIDED BY FINANCING ACTIVITIES 44,822 154,321 ----------------------------- Net change in cash and cash equivalents (30,147) 13,206 Cash and cash equivalents at beginning of period 112,611 64,112 ----------------------------- Cash and cash equivalents at end of period $ 82,464 77,318 ============================= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 24,653 17,235 Income Taxes $ 2,330 448 F-106 UNITED COMMUNITY BANKS, INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) (in thousands) FOR THE THREE MONTHS ENDED MARCH 31 -------------------------- 2000 1999 ------- ------- Net income $ 3,824 3,293 Other comprehensive income (loss), before tax: Unrealized holding gains (losses) on investment securities available for sale (1,533) 373 Less reclassification adjustment for gains on investment securities available for sale 5 5 ------- ------- Total other comprehensive income (loss), before tax (1,528) 378 ------- ------- INCOME TAX EXPENSE (BENEFIT) RELATED TO OTHER COMPREHENSIVE INCOME Unrealized holding gains (losses) on investment securities (515) 133 Less reclassification adjustment for gains on investment securities available for sale 2 2 ------- ------- Total income tax expense (benefit) related to other comprehensive income (loss) (513) 135 ------- ------- Total other comprehensive income (loss), net of tax (1,015) 243 ------- ------- Total comprehensive income $ 2,809 3,536 ======= ======= See notes to unaudited consolidated financial statements. F-107 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES The accounting and financial reporting policies of United Community Banks, Inc. ("United") and its subsidiaries conform to generally accepted accounting principles and general banking industry practices. The following consolidated financial statements have not been audited and all material intercompany balances and transactions have been eliminated. A more detailed description of United's accounting policies is included in the 1999 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 - RECENT DEVELOPMENTS On May 8, 2000, United commenced the process of conducting a public offering of between 350,000 and 450,000 shares of common stock at a price of $38.00 per share. United plans to use the net proceeds, which will range from approximately $13.2 to $17.0 million, to provide capital for its subsidiary banks and for general corporate purposes, including the reduction of parent company debt. Management expects the public offering will be completed during the second quarter of 2000. On March 3, 2000, United entered into an agreement to acquire North Point Bancshares, Inc. ("North Point"), a single-bank holding company based in Dawsonville, Georgia, in exchange for 958,211 shares of United common stock. This merger is expected to be completed during the second quarter of 2000 and will be accounted for as a pooling of interests. At March 31, 2000, North Point had $115.0 million of total assets, $105.6 million of total liabilities and $9.4 million of total stockholders' equity. On March 3, 2000, United entered into an agreement to acquire Independent Bancshares, Inc. ("Independent"), a single-bank holding company based in Powder Springs, Georgia, in exchange for 870,595 shares of United common stock. This merger is expected to be completed during the second quarter of 2000 and will be accounted for as a pooling of interests. At March 31, 2000, Independent had $161.1 million of total assets, $147.5 million of total liabilities and $13.5 million of total stockholders' equity. F-108 NOTE 3 - EARNINGS PER SHARE For the Three Months Ended March 31, (In thousands, except per share data) 2000 1999 - -------------------------------------------------------------------------------------- Basic earnings per share: Weighted average shares outstanding 8,034 8,004 Net income $ 3,824 3,293 Basic earnings per share $ 0.48 0.41 Diluted earnings per share: Weighted average shares outstanding 8,034 8,004 Net effect of the assumed exercise of stock options based on the treasury stock method using average market price for the period 143 149 Effect of conversion of subordinated debt 140 140 ------------------------- Total weighted average shares and common stock equivalents outstanding 8,317 8,293 Net income, as reported $ 3,824 3,293 Income effect of conversion of subordinated debt, net of tax $ 47 43 ------------------------- Net income, adjusted for effect of conversion of subordinated debt, net of tax $ 3,871 3,336 ========================= Diluted earnings per share 0.47 0.40 F-109 APPENDIX A UNITED COMMUNITY BANKS, INC. 2000 KEY EMPLOYEE STOCK OPTION PLAN UNITED COMMUNITY BANKS, INC. 2000 KEY EMPLOYEE STOCK OPTION PLAN A-(i) TABLE OF CONTENTS ARTICLE 1. ESTABLISHMENT, PURPOSE, AND DURATION..................................................................1 1.1 Establishment of the Plan...................................................................1 1.2 Purpose of the Plan.........................................................................1 1.3 Duration of the Plan........................................................................1 ARTICLE 2. DEFINITIONS...........................................................................................1 ARTICLE 3. ADMINISTRATION........................................................................................4 3.1 The Committee...............................................................................4 3.2 Authority of the Committee..................................................................4 3.3 Decisions Binding...........................................................................4 ARTICLE 4. SHARES SUBJECT TO THE PLAN............................................................................4 4.1 Number of Shares............................................................................4 4.2 Lapsed Awards...............................................................................5 4.3 Adjustments In Authorized Shares............................................................5 ARTICLE 5. ELIGIBILITY AND PARTICIPATION.........................................................................5 ARTICLE 6. STOCK OPTIONS.........................................................................................5 6.1 Grant of Options............................................................................5 6.2 Agreement...................................................................................5 6.3 Option Price................................................................................5 6.4 Duration of Options.........................................................................6 6.5 Exercise of Options.........................................................................6 6.6 Payment.....................................................................................6 6.7 Limited Transferability.....................................................................6 6.8 Shareholder Rights..........................................................................7 ARTICLE 7. STOCK APPRECIATION RIGHTS.............................................................................7 7.1 Grants of SARs..............................................................................7 7.2 Duration of SARs............................................................................7 7.3 Exercise of SAR.............................................................................7 7.4 Determination of Payment of Cash and/or Common Stock Upon Exercise of SAR...................7 7.5 Nontransferability..........................................................................7 7.6 Shareholder Rights......................................................................... 7 ARTICLE 8. RESTRICTED STOCK; STOCK AWARDS........................................................................7 8.1 Grants......................................................................................7 8.2 Restricted Period; Lapse of Restrictions....................................................8 8.3 Rights of Holder; Limitations Thereon.......................................................8 8.4 Delivery of Unrestricted Shares.............................................................9 8.5 Nonassignability of Restricted Stock........................................................9 A-(ii) ARTICLE 9. PERFORMANCE SHARE AWARDS..............................................................................9 9.1 Award.......................................................................................9 9.2 Earning the Award...........................................................................9 9.3 Payment.....................................................................................9 9.4 Shareholder Rights..........................................................................9 ARTICLE 10. BENEFICIARY DESIGNATION.............................................................................10 ARTICLE 11. DEFERRALS...........................................................................................10 ARTICLE 12. RIGHTS OF EMPLOYEES.................................................................................10 12.1 Employment................................................................................10 12.2 Participation.............................................................................10 ARTICLE 13. CHANGE IN CONTROL...................................................................................10 13.1 Definition................................................................................10 13.2 Limitation on Awards......................................................................11 ARTICLE 14. AMENDMENT, MODIFICATION AND TERMINATION.............................................................11 14.1 Amendment, Modification and Termination...................................................11 14.2 Awards Previously Granted.................................................................11 14.3 Compliance With Code Section 162(m).......................................................11 ARTICLE 15. CANCELLATION AND RESCISSION OF AWARD...............................................................12 ARTICLE 16. WITHHOLDING........................................................................................12 16.1 Tax Withholding...........................................................................12 16.2 Share Withholding.........................................................................12 ARTICLE 17. INDEMNIFICATION.....................................................................................12 ARTICLE 18. SUCCESSORS..........................................................................................13 ARTICLE 19. LEGAL CONSTRUCTION..................................................................................13 19.1 Gender and Number.........................................................................13 19.2 Severability..............................................................................13 19.3 Requirements of Law.......................................................................13 19.4 Regulatory Approvals and Listing..........................................................13 19.5 Securities Law Compliance.................................................................13 19.6 Governing Law.............................................................................13 A-(iii) UNITED COMMUNITY BANKS, INC. 2000 KEY EMPLOYEE STOCK OPTION PLAN ARTICLE 1. ESTABLISHMENT, PURPOSE, AND DURATION 1.1 ESTABLISHMENT OF THE PLAN. United Community Banks, Inc., a Georgia corporation (hereinafter referred to as the "Company"), hereby establishes a stock option and incentive award plan known as the "United Community Banks, Inc. 2000 Key Employee Stock Option Plan" (the "Plan"), as set forth in this document. The Plan permits the grant of Incentive Stock Options, Nonqualified Stock Options, Restricted Stock, Stock Awards, Performance Share Awards and Stock Appreciation Rights. The Plan shall become effective on the date it is approved by the Board of Directors (the "Effective Date"), subject to approval of the Plan by the Company's shareholders within the 12-month period immediately thereafter, and shall remain in effect as provided in Section 1.3. 1.2 PURPOSE OF THE PLAN. The purpose of the Plan is to secure for the Company and its shareholders the benefits of the incentive inherent in stock ownership in the Company by key employees of the Company and its subsidiaries, who are responsible for its future growth and continued success. The Plan promotes the success and enhances the value of the Company by linking the personal interests of Participants (as defined below) to those of the Company's shareholders, and by providing Participants with an incentive for outstanding performance. The Plan is further intended to provide flexibility to the Company in its ability to motivate, attract and retain the services of Participants upon whose judgment, interest and special effort the successful conduct of its operation largely depends. 1.3 DURATION OF THE PLAN. The Plan shall commence on the Effective Date, and shall remain in effect, subject to the right of the Board of Directors to amend or terminate the Plan at any time pursuant to Article 14, until the day prior to the tenth (10th) anniversary of the Effective Date. ARTICLE 2. DEFINITIONS Whenever used in the Plan, the following terms shall have the meanings set forth below: (a) "AGREEMENT" means an agreement entered into by each Participant and the Company, setting forth the terms and provisions applicable to Awards granted to Participants under this Plan. (b) "AWARD" means, individually or collectively, a grant under this Plan of Incentive Stock Options, Nonqualified Stock Options, Restricted Stock, Stock Awards, Performance Share Awards or Stock Appreciation Rights. (c) "BENEFICIAL OWNER" or "BENEFICIAL OWNERSHIP" shall have the meaning ascribed to such term in Rule 13d-3 of the Exchange Act. (d) "BOARD" or "BOARD OF DIRECTORS" means the Board of Directors of the Company. (e) "CAUSE" means: (i) willful misconduct on the part of a Participant that is materially detrimental to the Company; or (ii) the conviction of a Participant for the commission of a felony. The existence of "Cause" under either (i) or (ii) shall be determined by the Committee. Notwithstanding the foregoing, if the Participant has entered into an employment agreement that is binding as of the date of employment termination, and if such employment agreement defines "Cause," and/or provides a means of determining whether "Cause" exists, such definition of "Cause" and means of determining its existence shall supersede this provision. (f) "CODE" means the Internal Revenue Code of 1986, as amended from time to time, or any successor act thereto. A-1 (g) "COMMITTEE" means the committee appointed to administer the Plan with respect to grants of Awards, as specified in Article 3, and to perform the functions set forth therein. (h) "COMMON STOCK" means the common stock of the Company, par value $1.00 per share. (i) "COMPANY" means United Community Banks, Inc., a Georgia corporation, or any successor thereto as provided in Article 18. (j) "CORRESPONDING SAR" means an SAR that is granted in relation to a particular Option and that can be exercised only upon the surrender to the Company, unexercised, of that portion of the Option to which the SAR relates. (k) "DIRECTOR" means any individual who is a member of the Board of Directors of the Company. (l) "DISABILITY" shall have the meaning ascribed to such term in the Company's long-term disability plan covering the Participant, or in the absence of such plan, a meaning consistent with Section 22(e)(3) of the Code. (m) "EMPLOYEE" means any employee of the Company or the Company's Subsidiaries. Directors who are not otherwise employed by the Company or the Company's Subsidiaries are not considered Employees under this Plan. (n) "EFFECTIVE DATE" shall have the meaning ascribed to such term in Section 1.1. (o) "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended from time to time, or any successor act thereto. (p) "FAIR MARKET VALUE" shall be determined as follows: (i) If, on the relevant date, the Shares are traded on a national or regional securities exchange or on The Nasdaq Stock Market ("Nasdaq") and closing sale prices for the Shares are customarily quoted, on the basis of the closing sale price on the principal securities exchange on which the Shares may then be traded or, if there is no such sale on the relevant date, then on the immediately preceding day on which a sale was reported; (ii) If, on the relevant date, the Shares are not listed on any securities exchange or traded on Nasdaq, but nevertheless are publicly traded and reported on Nasdaq without closing sale prices for the Shares being customarily quoted, on the basis of the mean between the closing bid and asked quotations in such other over-the-counter market as reported by Nasdaq; but, if there are no bid and asked quotations in the over-the-counter market as reported by Nasdaq on that date, then the mean between the closing bid and asked quotations in the over-the-counter market as reported by Nasdaq on the immediately preceding day such bid and asked prices were quoted; and (iii) If, on the relevant date, the Shares are not publicly traded as described in (i) or (ii), on the basis of the good faith determination of the Committee. (q) "INCENTIVE STOCK OPTION" OR "ISO" means an option to purchase Shares granted under Article 6 which is designated as an Incentive Stock Option and is intended to meet the requirements of Section 422 of the Code. (r) "INITIAL VALUE" means, with respect to a Corresponding SAR, the Option Price per share of the related Option, and with respect to an SAR granted independently of an Option, the Fair Market Value of one share of Common Stock on the date of grant. A-2 (s) "INSIDER" shall mean an Employee who is, on the relevant date, an officer or a director, or a ten percent (10%) beneficial owner of any class of the Company's equity securities that is registered pursuant to Section 12 of the Exchange Act or any successor provision, as "officer" and "director" are defined under Section 16 of the Exchange Act. (t) "NAMED EXECUTIVE OFFICER" means, if applicable, a Participant who, as of the date of vesting and/or payout of an Award is one of the group of "covered employees," as defined in the regulations promulgated under Code Section 162(m), or any successor statute. (u) "NONQUALIFIED STOCK OPTION" OR "NQSO" means an option to purchase Shares granted under Article 6, and which is not intended to meet the requirements of Code Section 422. (v) "OPTION" means an Incentive Stock Option or a Nonqualified Stock Option. (w) "OPTION PRICE" means the price at which a Share may be purchased by a Participant pursuant to an Option, as determined by the Committee. (x) "PARTICIPANT" means an Employee of the Company or a Subsidiary who has been determined by the Committee to contribute significantly to the profits or growth of the Company and who has been granted an Award under the Plan which is outstanding. (y) "PERFORMANCE SHARE AWARD" means an Award, which, in accordance with and subject to an Agreement, will entitle the Participant, or his estate or beneficiary in the event of the Participant's death, to receive cash, Common Stock or a combination thereof. (z) "PERSON" shall have the meaning ascribed to such term in Section 3(a)(9) of the Exchange Act and used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) thereof. (aa) "RETIREMENT" shall mean retiring from employment with the Company or any Subsidiary on or after attaining age sixty five (65). (bb) "RESTRICTED STOCK" means an Award of Common Stock granted in accordance with the terms of Article 8 and the other provisions of the Plan, and which is nontransferable and subject to a substantial risk of forfeiture. Shares of Common Stock shall cease to be Restricted Stock when, in accordance with the terms hereof and the applicable Agreement, they become transferable and free of substantial risk of forfeiture. (cc) "SAR" means a stock appreciation right that entitles the holder to receive, with respect to each share of Common Stock encompassed by the exercise of such SAR, the amount determined by the Committee and specified in an Agreement. In the absence of such specification, the holder shall be entitled to receive in cash, with respect to each share of Common Stock encompassed by the exercise of such SAR, the excess of the Fair Market Value on the date of exercise over the Initial Value. References to "SARs" include both Corresponding SARs and SARs granted independently of Options, unless the context requires otherwise. (dd) "SHARES" means the shares of Common Stock of the Company (including any new, additional or different stock or securities resulting from the changes described in Section 4.3). (ee) "STOCK AWARD" means a grant of Shares under Article 8 that is not generally subject to restrictions and pursuant to which a certificate for the Shares is transferred to the Employee. A-3 (ff) "SUBSIDIARY" means any company during any period in which it is a "subsidiary corporation" (as that term is defined in Code Section 424(f)) with respect to the Company. ARTICLE 3. ADMINISTRATION 3.1 THE COMMITTEE. The Plan shall be administered by the Board of Directors or by the Compensation Committee of the Board, or by any other committee or subcommittee appointed by the Board that is granted authority to administer the Plan. The members of the Committee shall be appointed from time to time by, and shall serve at the discretion of, the Board of Directors. 3.2 AUTHORITY OF THE COMMITTEE. Subject to the provisions of the Plan, the Committee shall have full power to select the Employees, Directors, consultants and other persons who perform services for the Company or a Subsidiary, who are responsible for the future growth and success of the Company who shall participate in the Plan (who may change from year to year); determine the size and types of Awards; determine the terms and conditions of Awards in a manner consistent with the Plan (including conditions on the exercisability of all or a part of an Option or SAR, restrictions on transferability, vesting provisions on Restricted Stock or Performance Share Awards and the duration of the Awards); construe and interpret the Plan and any agreement or instrument entered into under the Plan; establish, amend or waive rules and regulations for the Plan's administration; and (subject to the provisions of Article 14) amend the terms and conditions of any outstanding Award to the extent such terms and conditions are within the discretion of the Committee as provided in the Plan, including accelerating the time any Option or SAR may be exercised and establishing different terms and conditions relating to the effect of the termination of employment or other services to the Company. Further, the Committee shall make all other determinations which may be necessary or advisable in the Committee's opinion for the administration of the Plan. All expenses of administering this Plan shall be borne by the Company. 3.3 DECISIONS BINDING. All determinations and decisions made by the Committee pursuant to the provisions of the Plan and all related orders and resolutions of the Board shall be final, conclusive and binding on all Persons, including the Company, the shareholders, Employees, Participants and their estates and beneficiaries. ARTICLE 4. SHARES SUBJECT TO THE PLAN 4.1 NUMBER OF SHARES. Subject to adjustment as provided in Section 4.3, the total number of Shares available for grant of Awards under the Plan shall be 490,000 shares, provided that, if the number of issued and outstanding Shares is increased after the Effective Date, the maximum number of Shares for which Awards may be granted under the Plan shall be increased such that the ratio of the number of shares available for grant to outstanding shares remains the same as the ratio of the shares available to grant under the Plan to outstanding shares that existed on the Effective Date. Outstanding shares shall for the purposes of such calculations include the number of shares into which other securities or instruments issued by United are currently convertible (e.g., convertible preferred stock or convertible debentures, but not outstanding options to acquire stock). The maximum number of Shares available for grant as ISOs under the Plan shall equal an aggregate of four hundred thousand (400,000) Shares. The Shares may, in the discretion of the Company, be either authorized but unissued Shares or Shares held as treasury shares, including Shares purchased by the Company, whether on the market or otherwise. The following rules shall apply for purposes of the determination of the number of Shares available for grant under the Plan: (a) The grant of an Option, SAR, Stock Award, Restricted Stock Award or Performance Share Award shall reduce the Shares available for grant under the Plan by the number of Shares subject to such Award. (b) While an Option, SAR, Stock Award, Restricted Stock Award or Performance Share Award is outstanding, it shall be counted against the authorized pool of Shares, regardless of its vested status. A-4 4.2 LAPSED AWARDS. If any Award granted under this Plan is canceled, terminates, expires or lapses for any reason, or if Shares are withheld in payment of the Option Price or for withholding taxes, any Shares subject to such Award or that are withheld shall again be available for the grant of an Award under the Plan. However, in the event that prior to the Award's cancellation, termination, expiration or lapse, the holder of the Award at any time received one or more "benefits of ownership" pursuant to such Award (as defined by the Securities and Exchange Commission, pursuant to any rule or interpretation promulgated under Section 16 of the Exchange Act), the Shares subject to such Award shall not again be made available for regrant under the Plan. 4.3 ADJUSTMENTS IN AUTHORIZED SHARES. In the event of any change in corporate capitalization, such as a stock split, or a corporate transaction, such as any merger, consolidation, separation, including a spin-off, or other distribution of stock or property of the Company, any reorganization (whether or not such reorganization comes within the definition of such term in Code Section 368) or any partial or complete liquidation of the Company, such adjustment shall be made in the number and class of Shares which may be delivered under the Plan, and in the number and class of and/or price of Shares subject to outstanding Awards granted under the Plan, as may be determined to be appropriate and equitable by the Committee, in its sole discretion, to prevent dilution or enlargement of rights; provided, however, that the number of Shares subject to any Award shall always be a whole number and the Committee shall make such adjustments as are necessary to insure Awards of whole Shares. ARTICLE 5. ELIGIBILITY AND PARTICIPATION Any key Employee of the Company or any Subsidiary, including any such Employee who is also a director of the Company or any Subsidiary, whose judgment, initiative and efforts contribute or may be expected to contribute materially to the successful performance of the Company or any Subsidiary shall be eligible to receive an Award under the Plan. In determining the individuals to whom such an Award shall be granted and the number of Shares which may be granted pursuant to that Award, the Committee shall take into account the duties of the respective individual, his or her present and potential contributions to the success of the Company or any Subsidiary, and such other factors as the Committee shall deem relevant in connection with accomplishing the purpose of the Plan. ARTICLE 6. STOCK OPTIONS 6.1 GRANT OF OPTIONS. Subject to the terms and provisions of the Plan, Options may be granted to Participants at any time and from time to time as shall be determined by the Committee. The Committee shall have discretion in determining the number of Shares subject to Options granted to each Participant. An Option may be granted with or without a Corresponding SAR. No Participant may be granted ISOs (under the Plan and all other incentive stock option plans of the Company and any Subsidiary) which are first exercisable in any calendar year for Common Stock having an aggregate Fair Market Value (determined as of the date an Option is granted) that exceeds One Hundred Thousand Dollars ($100,000). The preceding annual limit shall not apply to NQSOs. The Committee may grant a Participant ISOs, NQSOs or a combination thereof, and may vary such Awards among Participants. The maximum number of Shares subject to Options which can be granted under the Plan during any calendar year to any individual is 200,000 Shares. 6.2 AGREEMENT. Each Option grant shall be evidenced by an Agreement that shall specify the Option Price, the duration of the Option, the number of Shares to which the Option pertains and such other provisions as the Committee shall determine. The Option Agreement shall further specify whether the Award is intended to be an ISO or an NQSO. Any portion of an Option that is not designated as an ISO or otherwise fails or is not qualified as an ISO (even if designated as an ISO) shall be a NQSO. If the Option is granted in connection with a Corresponding SAR, the Agreement shall also specify the terms that apply to the exercise of the Option and Corresponding SAR. 6.3 OPTION PRICE. The Option Price for each grant of an ISO shall not be less than one hundred percent (100%) of the Fair Market Value of a Share on the date the Option is granted. In no event, however, shall any Participant who owns (within the meaning of Section 424(d) of the Code) stock of the Company possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company be eligible to receive an ISO at an Option Price A-5 less than one hundred ten percent (110%) of the Fair Market Value of a share on the date the ISO is granted. The Option Price for each grant of a NQSO shall be established by the Committee and, in its discretion, may be less or more than the Fair Market Value of a Share on the date the Option is granted. The Committee is authorized to issue Options, whether ISOs or NQSOs, at an Option Price in excess of the Fair Market Value on the date the Option is granted (the so-called "Premium Price" Option) to encourage superior performance. 6.4 DURATION OF OPTIONS. Each Option shall expire at such time as the Committee shall determine at the time of grant; provided, however, that no Option shall be exercisable later than the tenth (10th) anniversary date of its grant; provided, further, however, that any ISO granted to any Participant who at such time owns (within the meaning of Section 424(d) of the Code) stock of the Company possessing more than ten percent (10%) of the total combined voting power of all classes of stock of the Company, shall not be exercisable later than the fifth (5th) anniversary date of its grant. 6.5 EXERCISE OF OPTIONS. Options granted under the Plan shall be exercisable at such times and be subject to such restrictions and conditions as the Committee shall in each instance approve, including conditions related to the employment of the Participant with the Company or any Subsidiary, which need not be the same for each grant or for each Participant. Each Option shall be exercisable for such number of Shares and at such time or times, including periodic installments, as may be determined by the Committee at the time of the grant. The Committee may provide in the Agreement for automatic accelerated vesting and other rights upon the occurrence of a Change in Control (as defined in Section 13.1) of the Company. Except as otherwise provided in the Agreement and Article 13, the right to purchase Shares that are exercisable in periodic installments shall be cumulative so that when the right to purchase any Shares has accrued, such Shares or any part thereof may be purchased at any time thereafter until the expiration or termination of the Option. The exercise or partial exercise of either an Option or its Corresponding SAR shall result in the termination of the other to the extent of the number of Shares with respect to which the Option or Corresponding SAR is exercised. 6.6 PAYMENT. Options shall be exercised by the delivery of a written notice of exercise to the Company, setting forth the number of Shares with respect to which the Option is to be exercised, accompanied by full payment for the Shares. The Option Price upon exercise of any Option shall be payable to the Company in full, either: (a) in cash, (b) cash equivalent approved by the Committee, (c) if approved by the Committee, by tendering previously acquired Shares (or delivering a certification of ownership of such Shares) having an aggregate Fair Market Value at the time of exercise equal to the total Option Price (provided that the Shares which are tendered must have been held by the Participant for six months, if required for accounting purposes, and for the period required by law, if any, prior to their tender to satisfy the Option Price), or (d) by a combination of (a), (b) and (c). The Committee also may allow cashless exercises as permitted under Federal Reserve Board's Regulation T, subject to applicable securities law restrictions, or by any other means which the Committee determines to be consistent with the Plan's purpose and applicable law. As soon as practicable after receipt of a written notification of exercise and full payment, the Company shall deliver to the Participant, in the Participant's name, Share certificates in an appropriate amount based upon the number of Shares purchased under the Option(s), and may place appropriate legends on the certificates representing such Shares. 6.7 LIMITED TRANSFERABILITY. If permitted by the Committee in the Agreement, a Participant may transfer an Option granted hereunder, including, but not limited to, transfers to members of his or her Immediate Family (as defined below), to one or more trusts for the benefit of such Immediate Family members, or to one or more partnerships where such Immediate Family members are the only partners, if (i) the Participant does not receive any consideration in any form whatsoever for such transfer, (ii) such transfer is permitted under applicable tax laws, and (iii) the Participant is an Insider, such transfer is permitted under Rule 16b-3 of the Exchange Act as in effect from time to time. Any Option so transferred shall continue to be subject to the same terms and conditions in the hands of the transferee as were applicable to said Option immediately prior to the transfer thereof. Any reference in any such Agreement to the employment by or performance of services for the Company by the Participant shall continue to refer to the employment of, or performance by, the transferring Participant. For purposes hereof, "Immediate Family" shall mean the Participant and the Participant's spouse, children and grandchildren. Any Option that is granted pursuant to any Agreement that did not initially expressly allow the transfer of said Option and that has not been amended to expressly permit such transfer, shall not be transferable by the Participant other than by will or by the laws of descent and distribution and such Option thus shall be exercisable in the Participant's lifetime only by the Participant. A-6 6.8 SHAREHOLDER RIGHTS. No Participant shall have any rights as a shareholder with respect to Shares subject to his Option until the issuance of such Shares to the Participant pursuant to the exercise of such Option. ARTICLE 7. STOCK APPRECIATION RIGHTS 7.1 GRANTS OF SARS. The Committee shall designate Participants to whom SARs are granted, and will specify the number of Shares of Common Stock subject to each grant. An SAR may be granted with or without a related Option. All SARs granted under this Plan shall be subject to an Agreement in accordance with the terms of this Plan. A payment to the Participant upon the exercise of a Corresponding SAR may not be more than the difference between the Fair Market Value of the Shares subject to the ISO on the date of grant and the Fair Market Value of the Shares on the date of exercise of the Corresponding SAR. The maximum number of SARs which can be granted under the Plan during any calendar year to any individual is 200,000 SARs. 7.2 DURATION OF SARS. The duration of an SAR shall be set forth in the Agreement as determined by the Committee. An SAR that is granted as a Corresponding SAR shall have the same duration as the Option to which it relates. An SAR shall terminate due to the Participant's termination of employment at the same time as the date specified in Article 6 with respect to Options, regardless of whether the SAR was granted in connection with the grant of an Option. 7.3 EXERCISE OF SAR. An SAR may be exercised in whole at any time or in part from time to time and at such times and in compliance with such requirements as the Committee shall determine as set forth in the Agreement; provided, however, that a Corresponding SAR that is related to an Incentive Stock Option may be exercised only to the extent that the related Option is exercisable and only when the Fair Market Value of the Shares exceeds the Option Price of the related ISO. An SAR granted under this Plan may be exercised with respect to any number of whole shares less than the full number of shares for which the SAR could be exercised. A partial exercise of an SAR shall not affect the right to exercise the SAR from time to time in accordance with this Plan and the applicable Agreement with respect to the remaining shares subject to the SAR. The exercise of either an Option or Corresponding SAR shall result in the termination of the other to the extent of the number of Shares with respect to which the Option or its Corresponding SAR is exercised. 7.4 DETERMINATION OF PAYMENT OF CASH AND/OR COMMON STOCK UPON EXERCISE OF SAR. At the Committee's discretion, the amount payable as a result of the exercise of an SAR may be settled in cash, Common Stock, or a combination of cash and Common Stock. A fractional share shall not be deliverable upon the exercise of an SAR, but a cash payment shall be made in lieu thereof. 7.5 NONTRANSFERABILITY. Each SAR granted under the Plan shall be nontransferable except by will or by the laws of descent and distribution. During the lifetime of the Participant to whom the SAR is granted, the SAR may be exercised only by the Participant. No right or interest of a Participant in any SAR shall be liable for, or subject to any lien, obligation or liability of such Participant. A Corresponding SAR shall be subject to the same restrictions on transfer as the ISO to which it relates. Notwithstanding the foregoing, if the Agreement so provides, a Participant may transfer an SAR (other than a Corresponding SAR that relates to an Incentive Stock Option) under the same rules and conditions as are set forth in Section 6.7. 7.6 SHAREHOLDER RIGHTS. No Participant shall have any rights as a shareholder with respect to Shares subject to an SAR until the issuance of Shares (if any) to the Participant pursuant to the exercise of such SAR. ARTICLE 8. RESTRICTED STOCK; STOCK AWARDS 8.1 GRANTS. The Committee may from time to time in its discretion grant Restricted Stock and Stock Awards to Participants and may determine the number of Shares of Restricted Stock or Stock Awards to be granted. The Committee shall determine the terms and conditions of, and the amount of payment, if any, to be made by the Employee for such Shares or Restricted Stock. A grant of Restricted Stock may, in addition to other conditions, require the Participant to pay for such Shares of Restricted Stock, but the Committee may establish a price below A-7 Fair Market Value at which the Participant can purchase the Shares of Restricted Stock. Each grant of Restricted Stock shall be evidenced by an Agreement containing terms and conditions not inconsistent with the Plan as the Committee shall determine to be appropriate in its sole discretion. The maximum number of Shares of Restricted Stock or Stock Awards which can be granted under the Plan during any calendar year to any individual is 200,000 Shares. 8.2 RESTRICTED PERIOD; LAPSE OF RESTRICTIONS. At the time a grant of Restricted Stock is made, the Committee shall establish a period or periods of time (the "Restricted Period") applicable to such grant which, unless the Committee otherwise provides, shall not be less than one year. Subject to the other provisions of this Article 8, at the end of the Restricted Period all restrictions shall lapse and the Restricted Stock shall vest in the Participant. At the time a grant is made, the Committee may, in its discretion, prescribe conditions for the incremental lapse of restrictions during the Restricted Period and for the lapse or termination of restrictions upon the occurrence of other conditions in addition to or other than the expiration of the Restricted Period with respect to all or any portion of the Restricted Stock. Such conditions may, but need not, include the following: (a) The death, Disability or Retirement of the Employee to whom Restricted Stock is granted, or (b) The occurrence of a Change in Control (as defined in Section 13.1). The Committee may also, in its discretion, shorten or terminate the Restricted Period, or waive any conditions for the lapse or termination of restrictions with respect to all or any portion of the Restricted Stock at any time after the date the grant is made. 8.3 RIGHTS OF HOLDER; LIMITATIONS THEREON. Upon a grant of Restricted Stock, a stock certificate (or certificates) representing the number of Shares of Restricted Stock granted to the Participant shall be registered in the Participant's name and shall be held in custody by the Company or a bank selected by the Committee for the Participant's account. Following such registration, the Participant shall have the rights and privileges of a shareholder as to such Restricted Stock, including the right to receive dividends, if and when declared by the Board of Directors, and to vote such Restricted Stock, except that the right to receive cash dividends shall be the right to receive such dividends either in cash currently or by payment in Restricted Stock, as the Committee shall determine, and except further that, the following restrictions shall apply: (a) The Participant shall not be entitled to delivery of a certificate until the expiration or termination of the Restricted Period for the Shares represented by such certificate and the satisfaction of any and all other conditions prescribed by the Committee; (b) None of the Shares of Restricted Stock may be sold, transferred, assigned, pledged, or otherwise encumbered or disposed of during the Restricted Period and until the satisfaction of any and all other conditions prescribed by the Committee; and (c) All of the Shares of Restricted Stock that have not vested shall be forfeited and all rights of the Participant to such Shares of Restricted Stock shall terminate without further obligation on the part of the Company, unless the Participant has remained an employee of (or non-Employee Director of or active consultant providing services to) the Company or any of its Subsidiaries, until the expiration or termination of the Restricted Period and the satisfaction of any and all other conditions prescribed by the Committee applicable to such Shares of Restricted Stock. Upon the forfeiture of any Shares of Restricted Stock, such forfeited Shares shall be transferred to the Company without further action by the Participant and shall, in accordance with Section 4.2, again be available for grant under the Plan. If the Participant paid any amount for the Shares of Restricted Stock that are forfeited, the Company shall pay the Participant the lesser of the Fair Market Value of the Shares on the date they are forfeited or the amount paid by the Participant. A-8 With respect to any Shares received as a result of adjustments under Section 4.3 hereof and any Shares received with respect to cash dividends declared on Restricted Stock, the Participant shall have the same rights and privileges, and be subject to the same restrictions, as are set forth in this Article 8. 8.4 DELIVERY OF UNRESTRICTED SHARES. Upon the expiration or termination of the Restricted Period for any Shares of Restricted Stock and the satisfaction of any and all other conditions prescribed by the Committee, the restrictions applicable to such Shares of Restricted Stock shall lapse and a stock certificate for the number of Shares of Restricted Stock with respect to which the restrictions have lapsed shall be delivered, free of all such restrictions except any that may be imposed by law, a shareholders' agreement or any other agreement, to the holder of the Restricted Stock. The Company shall not be required to deliver any fractional Share but will pay, in lieu thereof, the Fair Market Value (determined as of the date the restrictions lapse) of such fractional Share to the holder thereof. Concurrently with the delivery of a certificate for Restricted Stock, the holder shall be required to pay an amount necessary to satisfy any applicable federal, state and local tax requirements as set out in Article 16 below. 8.5 NONASSIGNABILITY OF RESTRICTED STOCK. Unless the Committee provides otherwise in the Agreement, no grant of, nor any right or interest of a Participant in or to, any Restricted Stock, or in any instrument evidencing any grant of Restricted Stock under the Plan, may be assigned, encumbered or transferred except, in the event of the death of a Participant, by will or the laws of descent and distribution. ARTICLE 9. PERFORMANCE SHARE AWARDS 9.1 AWARD. The Committee may designate Participants to whom Performance Share Awards will be granted from time to time for no consideration and specify the number of shares of Common Stock covered by the Award. 9.2 EARNING THE AWARD. A Performance Share Award, or portion thereof, will be earned, and the Participant will be entitled to receive Common Stock, a cash payment or a combination thereof, only upon the achievement by the Participant, the Company, or a Subsidiary of such performance objectives as the Committee, in its discretion, shall prescribe on the date of grant. The Committee may in determining whether performance targets have been met adjust the Company's financial results to exclude the effect of unusual charges or income items or other events, including acquisitions or dispositions of businesses or assets, restructurings, reductions in force, currency fluctuations or changes in accounting, which are distortive of financial results (either on a segment or consolidated basis). In addition, the Committee will adjust its calculations to exclude the effect on financial results of changes in the Code or other tax laws, or the regulations relating thereto. 9.3 PAYMENT. In the discretion of the Committee, the amount payable when a Performance Share Award is earned may be settled in cash, by the grant of Common Stock or a combination of cash and Common Stock. The aggregate Fair Market Value of the Common Stock received by the Participant pursuant to a Performance Share Award, together with any cash paid to the Participant, shall be equal to the aggregate Fair Market Value, on the date the Performance Shares are earned, of the number of Shares of Common Stock equal to each Performance Share earned. A fractional Share will not be deliverable when a Performance Share Award is earned, but a cash payment will be made in lieu thereof. 9.4 SHAREHOLDER RIGHTS. No Participant shall have, as a result of receiving a Performance Share Award, any rights as a shareholder until and to the extent that the Performance Shares are earned and Common Stock is transferred to such Participant. If the Agreement so provides, a Participant may receive a cash payment equal to the dividends that would have been payable with respect to the number of Shares of Common Stock covered by the Award between (a) the date that the Performance Shares are awarded and (b) the date that a transfer of Common Stock to the Participant, cash settlement, or combination thereof is made pursuant to the Performance Share Award. A Participant may not sell, transfer, pledge, exchange, hypothecate, or otherwise dispose of a Performance Share Award or the right to receive Common Stock thereunder other than by will or the laws of descent and distribution. After a Performance Share A-9 Award is earned and paid in Common Stock, a Participant will have all the rights of a shareholder with respect to the Common Stock so awarded; provided that the restrictions of Section 19.4 or any shareholders' agreement or other agreement shall, if applicable, continue to apply. ARTICLE 10. BENEFICIARY DESIGNATION To the extent applicable, each Participant under the Plan may, from time to time, name any beneficiary or beneficiaries (who may be named contingently or successively) to whom any benefit under the Plan is to be paid in case of his or her death before he or she receives any or all of such benefit. Each such designation shall revoke all prior designations by the same Participant, shall be in a form prescribed by the Company and shall be effective only when filed by the Participant, in writing, with the Company during the Participant's lifetime. In the absence of any such designation, benefits remaining unpaid at the Participant's death shall be paid to the Participant's estate. If required, the spouse of a married Participant domiciled in a community property jurisdiction shall join in any designation of a beneficiary or beneficiaries other than the spouse. ARTICLE 11. DEFERRALS The Committee may permit a Participant to defer to another plan or program such Participant's receipt of Shares or cash that would otherwise be due to such Participant by virtue of the exercise of an Option, the vesting of Restricted Stock, or the earning of a Performance Share Award. If any such deferral election is required or permitted, the Committee shall, in its sole discretion, establish rules and procedures for such payment deferrals. ARTICLE 12. RIGHTS OF EMPLOYEES 12.1 EMPLOYMENT. Nothing in the Plan shall interfere with or limit in any way the right of the Company or a Subsidiary to terminate any Participant's employment by, or performance of services for, the Company at any time, nor confer upon any Participant any right to continue in the employ or service of the Company or a Subsidiary. For purposes of the Plan, transfer of employment of a Participant between the Company and any one of its Subsidiaries (or between Subsidiaries) shall not be deemed a termination of employment. 12.2 PARTICIPATION. No Employee shall have the right to be selected to receive an Award under this Plan, or, having been so selected, to be selected to receive a future Award. ARTICLE 13. CHANGE IN CONTROL 13.1 DEFINITION. For purposes of the Plan, a "Change in Control" means any of the following events: (a) The acquisition (other than from the Company) by any Person of Beneficial Ownership of twenty percent (20%) or more of the combined voting power of the Company's then outstanding voting securities; provided, however, that for purposes of this Section 13.1, Person shall not include any person who on the date hereof owns ten percent (10%) or more of the Company's outstanding securities, and a Change in Control shall not be deemed to occur solely because twenty percent (20%) or more of the combined voting power of the Company's then outstanding securities is acquired by (i) a trustee or other fiduciary holding securities under one (1) or more employee benefit plans maintained by the Company or any of its subsidiaries, or (ii) any corporation, which, immediately prior to such acquisition, is owned directly or indirectly by the shareholders of the Company in the same proportion as their ownership of stock in the Company immediately prior to such acquisition. (b) Approval by shareholders of the Company of (1) a merger or consolidation involving the Company if the shareholders of the Company, immediately before such merger or consolidation do not, as a result of such merger or consolidation, own, directly or indirectly, more than fifty percent (50%) of the combined voting power of the then outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the combined voting power of the A-10 voting securities of the Company outstanding immediately before such merger or consolidation, or (2) a complete liquidation or dissolution of the Company or an agreement for the sale or other disposition of all or substantially all of the assets of the Company. (c) A change in the composition of the Board such that the individuals who, as of the Effective Date, constitute the Board (such Board shall be hereinafter referred to as the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, for purposes of this Section 13.1 that any individual who becomes a member of the Board subsequent to the Effective Date whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of those individuals who are members of the Board and who were also members of the Incumbent Board (or deemed to be such pursuant to this proviso) shall be considered as though such individual were a member of the Incumbent Board; but, provided, further, that any such individual whose initial assumption of office occurs as a result of either an actual or threatened election contest (as such terms are used in Rule 14a-11 of Regulation 14A promulgated under the Exchange Act, including any successor to such Rule), or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board, shall not be so considered as a member of the Incumbent Board. 13.2 LIMITATION ON AWARDS. Notwithstanding any other provisions of the Plan and unless provided otherwise in the Agreement, if the right to receive or benefit from any Award under this Plan, either alone or together with payments that a Participant has the right to receive from the Company or a Subsidiary, would constitute a "parachute payment" (as defined in Section 280G of the Code), all such payments shall be reduced to the largest amount that will result in no portion being subject to the excise tax imposed by Section 4999 of the Code. ARTICLE 14. AMENDMENT, MODIFICATION AND TERMINATION 14.1 AMENDMENT, MODIFICATION AND TERMINATION. The Board may, at any time and from time to time, alter, amend, suspend or terminate the Plan in whole or in part; provided, that, unless approved by the holders of a majority of the total number of Shares of the Company represented and voted at a meeting at which a quorum is present, no amendment shall be made to the Plan if such amendment would (a) materially modify the eligibility requirements provided in Article 5; (b) increase the manner in which the total number of Shares which may be granted under the Plan is determined (except as provided in Section 4.3); (c) extend the term of the Plan; or (d) amend the Plan in any other manner which the Board, in its discretion, determines should become effective only if approved by the shareholders even if such shareholder approval is not expressly required by the Plan or by law. 14.2 AWARDS PREVIOUSLY GRANTED. No termination, amendment or modification of the Plan shall adversely affect in any material way any Award previously granted under the Plan, without the written consent of the Participant holding such Award. The Committee shall, with the written consent of the Participant holding such Award, have the authority to cancel Awards outstanding and grant replacement Awards therefor. 14.3 COMPLIANCE WITH CODE SECTION 162(M). At all times when the Committee determines that compliance with Code Section 162(m) is required or desired, all Awards granted under this Plan to Named Executive Officers shall comply with the requirements of Code Section 162(m). In addition, in the event that changes are made to Code Section 162(m) to permit greater flexibility with respect to any Award or Awards under the Plan, the Committee may, subject to this Article 14, make any adjustments it deem appropriate. A-11 ARTICLE 15. CANCELLATION AND RESCISSION OF AWARDS The Committee may provide in the Award Agreement that if, at any time during the period that any Award is or may yet become exercisable in whole or in part, or at any time within six (6) months prior to, or after, the termination of employment with the Company, a Participant engages in any "Detrimental Activity" (as defined below), the Committee may, notwithstanding any other provision in this Plan to the contrary, cancel, rescind, suspend, withhold or otherwise restrict or limit any unexpired, unpaid or deferred Award as of the first date the Participant engages in the Detrimental Activity, unless sooner terminated by operation of another term of this Plan or any other agreement. Without limiting the generality of the foregoing, the Agreement may provide that the Participant shall also pay to the Company any gain realized by the Participant from exercising all or any portion of the Awards hereunder during a period beginning six (6) months prior to, or after, the date on which the Participant enters into such activity. For purposes of this Agreement, "Detrimental Activity" shall mean to include any of the following: (i) engaging in any commercial activity in competition with any part of the business of the Company; (ii) diverting or attempting to divert from the Company business of any kind, including, without limitation, interference with any business relationship with suppliers, customers, licensees, licensors or contractors; (iii) making, or causing or attempting to cause any other person to make, any statement, either written or oral, or conveying any information about the Company which is disparaging or which in any way reflects negatively upon the Company; (iv) engaging in any other activity that is inimical, contrary or harmful to the interests of the Company, including influencing or advising any person who is employed by or in the service of the Company to leave such employment or service to compete with the Company or to enter into the employment or service of any actual or prospective competitor of the Company, or influencing or advising any competitor of the Company to employ or to otherwise engage the services of any person who is employed by the Company or in the service of the Company, or improperly disclosing or otherwise misusing any confidential information regarding the Company; or (v) the refusal or failure of a Participant to provide, upon the request of the Company, a certification, in a form satisfactory to the Company, that he or she is in full compliance with the terms and conditions of the Plan; provided, that the Committee may provide in the Agreement that only certain of the restrictions provided above apply for purposes of the Award Agreement. Should any provision to this Article 15 be held to be invalid or illegal, such illegality shall not invalidate the whole of this Article 15, but, rather, the Plan shall be construed as if it did not contain the illegal part or narrowed to permit its enforcement, and the rights and obligations of the parties shall be construed and enforced accordingly. ARTICLE 16. WITHHOLDING 16.1 TAX WITHHOLDING. The Company shall have the power and the right to deduct or withhold, or require a Participant to remit to the Company, an amount sufficient to satisfy federal, state and local taxes (including the Participant's FICA obligation) required by law to be withheld with respect to any taxable event arising in connection with an Award under this Plan. 16.2 SHARE WITHHOLDING. With respect to withholding required upon the exercise of Options, or upon any other taxable event arising as a result of Awards granted hereunder which are to be paid in the form of Shares, Participants may elect, subject to the approval of the Committee, to satisfy the withholding requirement, in whole or in part, by having the Company withhold Shares having a Fair Market Value on the date the tax is to be determined equal to the minimum statutory total tax which could be imposed on the transaction. All elections shall be irrevocable, made in writing, signed by the Participant, and elections by Insiders shall additionally comply with all legal requirements applicable to Share transactions by such Participants. ARTICLE 17. INDEMNIFICATION Each person who is or shall have been a member of the Committee, or the Board, shall be indemnified and held harmless by the Company against and from any loss, cost, liability or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit or proceeding to which he or she may be a party or in which he or she may be involved by reason of any action taken or failure to act under the Plan and against and from any and all amounts paid by him or her in settlement thereof, with the Company's approval, or paid by him or her in satisfaction of any judgment in any such action, suit or proceeding against him or her, provided he A-12 or she shall give the Company an opportunity, at its own expense, to handle and defend the same before he or she undertakes to handle and defend it on his or her own behalf. The foregoing right of indemnification shall be in addition to any other rights of indemnification to which such persons may be entitled under the Company's Articles of Incorporation or Bylaws, as a matter of law, or otherwise, or any power that the Company may have to indemnify them or hold them harmless. ARTICLE 18. SUCCESSORS All obligations of the Company under the Plan, with respect to Awards granted hereunder, shall be binding on any successor to the Company, whether the existence of such successor is the result of a direct or indirect purchase, merger, consolidation or otherwise, of all or substantially all of the business and/or assets of the Company. ARTICLE 19. LEGAL CONSTRUCTION 19.1 GENDER AND NUMBER. Except where otherwise indicated by the context, any masculine term used herein shall also include the feminine; the plural shall include the singular and the singular shall include the plural. 19.2 SEVERABILITY. If any provision of the Plan shall be held illegal or invalid for any reason, the illegality or invalidity shall not affect the remaining parts of the Plan, and the Plan shall be construed and enforced as if the illegal or invalid provision had not been included. 19.3 REQUIREMENTS OF LAW. The granting of Awards and the issuance of Shares under the Plan shall be subject to all applicable laws, rules and regulations, and to such approvals by any governmental agencies or national securities exchanges as may be required. 19.4 REGULATORY APPROVALS AND LISTING. The Company shall not be required to issue any certificate or certificates for Shares under the Plan prior to (i) obtaining any approval from any governmental agency which the Company shall, in its discretion, determine to be necessary or advisable, (ii) the admission of such shares to listing on any national securities exchange or Nasdaq on which the Company's Shares may be listed, and (iii) the completion of any registration or other qualification of such Shares under any state or federal law or ruling or regulation of any governmental body which the Company shall, in its sole discretion, determine to be necessary or advisable. To the extent applicable, if required by the then-current Section 16 of the Exchange Act, any "derivative security" or "equity security" offered pursuant to the Plan to any Insider may not be sold or transferred for at least six (6) months after the date of grant of such Award. The terms "equity security" and "derivative security" shall have the meanings ascribed to them in the then-current Rule 16(a) under the Exchange Act. 19.5 SECURITIES LAW COMPLIANCE. To the extent applicable, with respect to Insiders, transactions under this Plan are intended to comply with all applicable conditions of Rule 16b-3 or its successors under the Exchange Act. To the extent any provisions of the Plan or action by the Committee fails to so comply, it shall be deemed null and void, to the extent permitted by law and deemed advisable by the Committee. 19.6 GOVERNING LAW. To the extent not preempted by Federal law, the Plan, and all agreements hereunder, shall be construed in accordance with and governed by the laws of the State of Georgia. AS APPROVED BY THE BOARD OF DIRECTORS OF UNITED COMMUNITY BANKS, INC. ON DECEMBER 8, 1999. A-13 APPENDIX B AMENDMENT TO ARTICLES OF INCORPORATION "The corporation shall have authority to issue 50,000,000 shares of common stock, $1.00 par value and 10,000,000 shares of preferred stock, $1.00 par value. Subject to the provisions of any applicable law or the Bylaws of the corporation (as from time to time amended) with respect to fixing the record date for the determination of shareholders entitled to vote, and except as otherwise provided by any applicable law or the by the resolution or resolutions of the board of directors providing for the issue of any series of preferred stock, the holders of the common stock shall have and possess exclusive voting power and rights for the election of directors and for all other purposes, with each share being entitled to one vote." B-1 COMMON STOCK OF UNITED COMMUNITY BANKS, INC. THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS FOR THE 2000 ANNUAL MEETING OF SHAREHOLDERS. This undersigned hereby appoints Jimmy C. Tallent or Robert L. Head, Jr. the proxy of the undersigned to vote the common stock of the undersigned at the Annual Meeting of shareholders of United Community Banks, Inc. to be held on __________, 2000, and any adjournment thereof. 1. ELECTION OF NOMINEES : Jimmy C. Tallent, Robert H. Blalock, Billy M. Decker, Thomas C. Gilliland, Robert L. Head, Jr., Charles E. Hill, Hoyt O. Holloway, Clarence W. Mason, Sr., Zell B. Miller, W. C. Nelson, Jr., Charles E. Parks, and Tim Wallis FOR the nominees listed to the right WITHHOLD AUTHORITY to vote for all nominees / / WITHHOLD AUTHORITY to vote for an individual nominee / / Write name(s) below: _________________________ _________________________ _________________________ 2. APPROVAL OF THE 2000 KEY EMPLOYEE STOCK OPTION PLAN / / FOR approval of the 2000 Key Employee Stock Option Plan / / AGAINST approval of the 2000 Key Employee Stock Option Plan 3. APPROVAL TO AMEND THE RESTATED ARTICLES OF INCORPORATION / / FOR the proposal to amend the Restated Articles of Incorporation to increase the number of authorized common shares from 10,000,000 to 50,000,000 / / AGAINST the proposal to amend the Restated Articles of Incorporation to increase the number of authorized common shares from 10,000,000 to 50,000,000 4. IN ACCORDANCE WITH THEIR BEST JUDGMENT WITH RESPECT TO ANY OTHER MATTERS THAT MAY PROPERLY COME BEFORE THE MEETING OR ANY ADJOURNMENT THEREOF. The undersigned hereby acknowledges receipt of the Notice of Annual Meeting of Shareholders dated ___________________, 2000 and the Proxy Statement furnished therewith. _______________________, 2000 Dated and signed _____________________________ Signature ____________________________ Signature (Signature(s) should agree with the name(s) hereon. Executors, administrators, trustees, guardians and attorneys should so indicate when signing. For joint accounts, each owner should sign. Corporations should sign their full corporate name by a duly authorized officer.) This proxy is revocable at or at any time prior to the meeting. Please sign and return this proxy in the accompanying prepaid envelope. __________________________________________