SCHEDULE 14A INFORMATION Proxy Statement Pursuant to Section 14(a) of the Securities Exchange Age of 1934 Filed by the Registrant [X] Filed by a Party other than the Registrant [ ] Check the appropriate box: [ ] Preliminary Proxy Statement [ ] Confidential, for Use of the Commission Only (as permitted by Rule 14a-6(6)(2) [X] Definitive Proxy Statement [ ] Definitive Additional Materials [ ] Soliciting Material Pursuant to Section 240.14a-11(c) orSection 240.14a-12 UNITED COMMUNITY BANKS, INC. (Name of Registrant as Specified in Its Charter) (Name of Person(s) Filing Proxy Statement) 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. LOGO] Notice of 1998 Annual Meeting _________________ Proxy Statement _________________ Annual Financial Statements and Review of Operations Table of Contents Page Notice of Annual Meeting of Shareholders i Proxy Statement 1 Voting Securities and Principal Holders 2 Nomination and Election of Directors 2 Information About Nominees for Director 3 Executive Compensation 5 Section 16(a) Beneficial Ownership Reporting Compliance 7 Compensation Committee Interlocks and Insider Participation 7 Joint Report on Executive Compensation 8 Shareholder Return Performance Graph 9 Meetings and Committees of the Board of Directors 10 Information Concerning United's Accountants 10 Shareholder Proposals 10 Other Matters that May Come Before the Meeting 10 Appendix: Annual Report to Shareholders A-1 General Description of the Business A-2 Selected Financial Data A-3 Management's Discussion and Analysis of Financial Condition and Results of Operations A-4 Quantitative and Qualitative Disclosures About Market Risk A-20 Market and Dividend Data A-21 Report of Independent Certified Public Accountants A-22 Consolidated Balance Sheets - December 31, 1997 and 1996 A-23 Consolidated Statements of Earnings - For the Years Ended December 31, 1997 and 1996 A-24 Consolidated Statements of Changes in Stockholders' Equity - For the Years Ended December 31, 1997, 1996 and 1995 A-25 Consolidated Statements of Cash Flows - For the Years Ended December 31, 1997, 1996 and 1995 A-26 Notes to Consolidated Financial Statements A-27 March 24, 1998 Dear Shareholder: It is my pleasure to invite you to attend the 1998 Annual Meeting of Shareholders of United Community Banks, Inc. which will be held April 16, 1998 at The Brasstown Valley Resort, Trackrock Amphitheater, Highway 515, Young Harris, Georgia at 2:30 p.m. The accompanying Notice of Annual Meeting of Shareholders and Proxy Statement describe the items of business which will be discussed during the meeting. A report to shareholders, containing certain financial information, is included as an appendix to the Proxy Statement. To be sure that your vote is counted, we urge you to carefully review the Proxy Statement and vote your choices on the enclosed proxy card as soon as possible. If you wish to attend the meeting, any ballot that you submit at the meeting will supersede your proxy. On behalf of the management, employees and directors 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. 59 Highway 515 P.O. Box 398 Blairsville, Georgia 30512 ___________________________________________________ NOTICE OF ANNUAL MEETING OF SHAREHOLDERS ___________________________________________________ To be Held on April 16, 1998 The annual meeting of shareholders of United Community Banks, Inc. ("United") will be held on April 16, 1998 at 2:30 p.m. at The Brasstown Valley Resort, Trackrock Amphitheater, Highway 515, Young Harris, Georgia, for the purposes of considering and voting upon: 1. The election of eleven directors to constitute the Board of Directors to serve until the next annual meeting and until their successors are elected and qualified; and 2. Such other matters as may properly come before the meeting or any adjournment thereof. Only shareholders of record at the close of business on March 18, 1998 will be entitled to notice of and to vote at the meeting or any adjournment thereof. A Proxy Statement and a Proxy solicited by the Board of Directors are enclosed herewith. 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. Also enclosed as an appendix to the Proxy Statement is a report to shareholders, including United's audited annual financial statements, management's discussion and analysis of financial condition and results of operations, selected financial data, market and dividend data and certain other matters. By Order of the Board of Directors, Jimmy C. Tallent, President and Chief Executive Officer March 24, 1998 [BOXED ITEM] PLEASE COMPLETE AND RETURN THE ENCLOSED PROXY PROMPTLY SO THAT YOUR VOTE MAY BE RECORDED AT THE MEETING IF YOU DO NOT ATTEND PERSONALLY. UNITED COMMUNITY BANKS, INC. 59 Highway 515 P.O. Box 398 Blairsville, Georgia 30512 _____________________ PROXY STATEMENT _____________________ This Proxy Statement is furnished in connection with the solicitation of Proxies by the Board of Directors of United Community Banks, Inc. ("United" or the "Company") for use at the Annual Meeting of Shareholders of United to be held on April 16, 1998, 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 regular 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 approximately March 25, 1998. The record of shareholders entitled to vote at the Annual Meeting was taken as of the close of business on March 18, 1998. On that date, United had outstanding and entitled to vote 7,385,105 shares of common stock, par value $1.00 per share (the "Common Stock"). 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 choice is specified thereon, it will be voted for all the persons named below under the caption "Information About Nominees For Director". The percentages outstanding of Common Stock are based on 7,646,209 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 ("2006 Debentures") and presently exercisable options to acquire 121,604 shares. United will furnish without charge a copy of its Annual Report on Form 10-K filed with the Securities and Exchange Commission (the "SEC") for the fiscal year ended December 31, 1997, including financial statements and schedules, to any shareholder of record or any beneficial owner of its Common Stock as of March 18, 1998 who requests a copy of such report. Any request for the Form 10-K should be in writing and addressed to: Lois Jones 59 Highway 515 P.O. Box 398 Blairsville, Georgia 30512 If the person requesting the report was not a shareholder of record on March 18, 1998, the request must include a representation that the person was a beneficial owner of United's Common Stock on that date. Copies of any exhibits to the Form 10-K will also be furnished on request and upon the payment of United's expense in furnishing the exhibits. VOTING SECURITIES AND PRINCIPAL HOLDERS The following table sets forth as of December 31, 1997, beneficial ownership of United's Common Stock by each "person" (as that term is defined by the SEC) known by United to be the beneficial owner of more than 5% of United's voting securities and all directors and executive officers of United as a group. Name and Address Number of Shares Percent of Beneficial Owner Owned Beneficially of Class - ------------------- ------------------ -------- Robert L. Head, Jr. Blairsville Highway Blairsville, Georgia 30512 725,000 (1) 9.5% W. C. Nelson, Jr. P.O. Box 127 Blairsville, Georgia 30512 689,783 (2) 9.0% All directors and executive officers as a group (19 persons) 2,507,126 (3) 32.9% ____________________ (1) Includes 50,758 shares beneficially owned by Mr. Head as custodian for his children and 10,000 shares owned pursuant to the 2006 Debentures. Does not include 16,965 shares owned by Mr. Head's wife, for which he disclaims beneficial ownership. (2) Includes 11,250 shares beneficially owned by a trust over which Mr. Nelson has voting power and 10,000 shares owned pursuant to the 2006 Debentures. Does not include 10,150 shares owned by Mr. Nelson's wife, for which he disclaims beneficial ownership. (3) Includes presently exerciseable options to acquire 81,802 shares and 132,000 shares beneficially owned pursuant to the 2006 Debentures. NOMINATION AND ELECTION OF DIRECTORS (Proposal 1) 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 eleven. 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. 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. In the event that 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 eleven nominees. Management of United has no reason to believe that any nominee will not serve if elected. All of the nominees 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 and 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. INFORMATION ABOUT NOMINEES FOR DIRECTOR The following information as of December 31, 1997 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. Number of Shares Information Owned Beneficially Name (Age) About Nominee (Percent of Class) - ---------- ------------- ------------------ Jimmy C. Tallent President, Chief Executive Officer and Director of 148,672 (1.9%) (1) (45) Union County Bank ("UCB") since 1984 and of United since 1987. Director of Carolina Community Bank, Murphy, North Carolina ("Carolina") since 1990, of Peoples Bank of Fannin County ("Peoples") since 1992, of White County Bank ("White") since 1995, and of First Clayton Bank and Trust ("Clayton") since 1997. Chairman of the Board of Towns County Bank ("Towns") since 1992 and Chairman of the Board of White since 1995. Director of United Family Finance Co. ("Finance") since 1997. Billy M. Decker Senior Vice President and Cashier of UCB from 134,767 (1.8%) (2) (54) 1986 to 1990, Mr. Decker became President, Chief Executive Officer and a Director of Carolina in 1990. He has been a Director of United since 1988, a Vice President of United since 1992 and a Director of UCB since 1980. He has been Secretary of United since 1988. Thomas C. Gilliland A Director of United since 1992 and Vice Chairman 177,650 (2.3%) (3) (49) of the Peoples' Board since 1986, Mr. Gilliland became President and Chief Executive Officer of Peoples and Vice President of United in 1993 and was named Executive Vice President of United in 1994. Chairman of the Board of Finance since 1997. Robert L. Head, Jr. Chairman of the Board of Directors of United since 725,000 (9.5%) (4) (58) 1988, Mr. Head has served as a Director of UCB since 1973. Mr. Head operates Head Construction Company, a general construction firm, and Head-Westgate Corp., a construction and real estate development firm in Blairsville, Georgia. He also owns Mountain Building Supply in Blairsville, Georgia. Charles E. Hill A Director of United since 1988 and of UCB since 1972, 170,977 (2.2%) (5) (60) Mr. Hill is the Director of Pharmacy at Union General Hospital in Blairsville, Georgia. Hoyt O. Holloway A Director of United since 1993 and of Peoples since 48,085* (6) (58) 1986, Mr. Holloway owns H&H Farms, a poultry farm in Blue Ridge, Georgia. P. Deral Horne A Director of Carolina since 1988 and of United since 30,000* (7) (71) 1992, Mr. Horne owns Mountain and Valley Properties, a land development and sales business in Murphy, North Carolina. John R. Martin A Director of United since 1997, a Director of Clayton since 48,378* (48) 1990, and Chairman of the Board of Directors of Clayton since 1996, Mr. Martin is also the owner of John Martin Construction and of several mini-warehouse facilities in northeast Georgia and western South Carolina, as well as being a registered pharmacist. Clarence W. Mason, Sr. Chairman of the Board of Directors of Peoples since 82,340 (1.1%) (8) (61) 1986 and a Director of United since 1992, Mr. Mason owns Mason Tractor, a retail equipment sales operation in Blue Ridge, Georgia. W. C. Nelson, Jr. A Director of United since 1988 and of UCB since 1975, 689,763 (9.0%) (9) (54) Mr. Nelson is Vice Chairman of the United Board of Directors and owns Nelson Tractor Company, a retail equipment sales firm in Blairsville, Georgia. Charles E. Parks A retired businessman, Mr. Parks is the former owner of (68) Parks Lumber Co., a retail building supply firm located in Murrayville, Georgia. 102,109 (1.3%) (10) ________________ * Less than one percent. (1) Includes 10,000 shares beneficially owned by Mr. Tallent pursuant to the 2006 Debentures and 17,750 shares beneficially owned by Mr. Tallent pursuant to currently-exercisable options. (2) Includes 10,000 shares beneficially owned by Mr. Decker pursuant to the 2006 Debentures and 7,100 shares beneficially owned by Mr. Decker pursuant to currently-exercisable options. Does not include 9,613 shares owned by Mr. Decker's wife, for which he disclaims beneficial ownership. (3) Includes 6,270 shares beneficially owned by Mr. Gilliland as custodian for his children, 10,000 shares beneficially owned pursuant to the 2006 Debentures and 12,750 shares beneficially owned pursuant to currently exercisable stock options. (4) Includes 50,758 shares beneficially owned by Mr. Head as custodian for his children and 10,000 shares owned pursuant to the 2006 Debentures. Does not include 16,965 shares owned by Mr. Head's wife, for which he disclaims beneficial ownership. (5) Includes 10,000 shares beneficially owned by Mr. Hill pursuant to the 2006 Debentures. Does not include 88,932 shares owned by Mr. Hill's wife, for which he disclaims beneficial ownership. (6) Includes 10,000 shares beneficially owned pursuant to the 2006 Debentures and 35,565 beneficially owned by Holloway Motors, Inc., a company 100% owned by Mr. Holloway. Does not include 485 shares owned by Mr. Holloway's wife, for which he disclaims beneficial ownership. (7) Includes 10,000 shares beneficially owned pursuant to the 2006 Debentures. (8) Includes 10,000 shares beneficially owned pursuant to the 2006 Debentures. (9) Includes 11,250 shares beneficially owned by a trust over which Mr. Nelson has voting power and 10,000 shares owned pursuant to the 2006 Debentures; does not include 10,150 shares owned by Mr. Nelson's wife, for which he disclaims beneficial ownership. (10) Includes 10,000 shares beneficially owned pursuant to the 2006 Debentures. There are no family relationships between any director, executive officer or nominee for director of United or any of its subsidiaries. EXECUTIVE COMPENSATION The table below sets forth the annual and other compensation paid by United and its bank subsidiaries to the following persons who served in the designated offices during 1997: Jimmy C. Tallent, President and Chief Executive Officer of United and UCB, Billy M. Decker, Senior Vice President of United, Guy Freeman, President and Chief Executive Officer of Carolina and Senior Vice President of United, Thomas C. Gilliland, President and Chief Executive Officer of Peoples and Executive Vice President of United, Christopher J. Bledsoe, Senior Vice President and Chief Financial Officer of United and UCB (individually a "Named Executive Officer, collectively, the "Named Executive Officers"). Long-Term Annual Compensation Compensation --------------------------------------------- Securities All Name and Principal Offices Underlying Other Held During 1997 Year Salary Bonus Other Options Compensation - --------------------------- ---- ------ ----- ----- ---------- ------------ Jimmy C. Tallent 1997 $215,000 $90,000 $32,875(1) 8,750 $27,058(2) President and Chief Executive 1996 $188,650 $65,000 $10,000(1) 8,750 $23,781 Officer of United and UCB 1995 $167,200 $57,000 $ 9,000(1) 12,500 $21,085 Thomas C. Gilliland 1997 $157,500 $42,500 $ 5,400(1) 5,250 $13,388(3) President and Chief Executive 1996 $142,188 $35,000 $ 6,400(1) 5,250 $12,086 Office of Peoples; Executive 1995 $132,563 $30,000 $ 5,400(1) 7,500 $ 6,628 Vice President of United Billy M. Decker 1997 $117,700 $30,000 $18,600(1) 3,500 $14,359(3) Senior Vice and Secretary of United 1996 $107,500 $35,500 $10,000(1) 3,500 $13,115 1995 $ 98,010 $30,000 $ 8,100(1) 5,000 11,957 Guy W. Freeman President and Chief Executive 1997 $139,200 $40,000 7,000(1) 10,000 $16,982(3) Officer of Carolina; Senior 1996 $117,500 $20,000 3,850(1) 3,500 $14,335 Vice President of United 1995 $ 87,929(4) $10,000 1,400(1) 5,000 -- Christopher J. Bledsoe(5) 1997 $102,500 $25,000 -- 3,500 $12,505(3) Senior Vice President and Chief 1996 $ 91,500 $20,500 -- 3,500 $11,163 Financial Officer of United and UCB 1995 $ 80,000 $17,000 -- 5,000 $ 9,760 ___________________________ (1) Directors' fees for service on United's bank subsidiaries' boards of directors. Other perquisites do not meet the Securities and Exchange Commission threshold for disclosure. (2) Represents a contribution by United of $26,230 on behalf of Mr. Tallent to United's Profit Sharing Plan and insurance premiums of $828 paid by UCB on behalf of Mr. Tallent on a life insurance policy. (3) Represents United's contribution on behalf of the named individual to United's Profit Sharing Plan. (4) Mr. Freeman commenced employment with United and its subsidiaries in March 1995. Mr. Freeman beneficially owns 26,618 shares of Common Stock. (5) Mr. Bledsoe beneficially owns 18,886 shares of Common Stock. 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 United Community Banks Key Employee Stock Option Plan. Directors of United, other than a President or Vice President of a bank subsidiary who serves on United's Board of Directors, received $1,000 per board meeting attended during 1997. 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 Plan during fiscal year 1997 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(2) Securities Percent of Total ------------------ Underlying Options Granted Options to Employees in Expiration Name Granted(1) Fiscal Year Date 0% 5% 10% ---- ------------ ---------------- ----------- -- --- --- Jimmy C. Tallent 8,750 16% 1/1/07 $0 $121,100 $306,775 Thomas C. Gilliland 5,250 9% 1/1/07 $0 $ 72,660 $184,065 Billy M. Decker 3,500 6% 1/1/07 $0 $ 48,440 $122,710 Guy W. Freeman 10,000 18% 1/1/07 $0 $138,400 $350,600 Christopher J. Bledsoe 3,500 6% 1/1/07 $0 $ 48,440 $122,710 __________________________ (1) 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. Exercise price of the options is $22.00 per share, the fair market value on the date of grant of the options. (2) "Potential Realizable Value" is disclosed in response to SEC regulations that require such disclosure for illustration only. The values disclosed are not intended to be, and should not be interpreted as, representations or projections of the future value of United's Common Stock or of the stock price. Amounts are calculated at 0%, 5% and 10% assumed appreciation of the value of the Common Stock (compounded annually over the option term) and are not intended to forecast actual expected future appreciation, if any, of the Common Stock. The potential realizable value to the optionee is the difference between the exercise price and the appreciated stock price at the assumed annual rates of appreciation multiplied by the number of shares underlying the options. Option Fiscal Year-End Values Shown below is information with respect to unexercised options to purchase the Common Stock granted under the Plan to the Named Executive Officers and held by them at December 31, 1997. No options were exercised during 1997 by a Named Executive Officer. Fiscal Year-End Option Values Number of Unexercised Options at Fiscal Year End Value of Unexercised in the Money Name Exercisable/Unexercisable (#) Options at Fiscal Year End ($)(1) ---- --------------------------- ---------------------------------- Jimmy C. Tallent 17,750/12,250 $306,000 Thomas C. Gilliland 10,650/7,350 $183,600 Billy M. Decker 7,100/4,900 $122,400 Guy W. Freeman 8,400/10,100 $132,800 Christopher J. Bledsoe 7,100/4,900 $122,400 ____________________ (1) Based on $30.00 per share, the last sale price known to United during 1997. United's Common Stock is not publicly traded. SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Stephen L. Cockerham, Senior Vice President and Chief Credit Officer of the Company and United, inadvertently failed to file on a timely basis a Form 4 reporting the purchase of Company Common Stock. 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 1997 fiscal year. Although all members of the Board of Directors participated in deliberations regarding the salaries of executive officers, none of such officers participated in any decisions regarding his own compensation as an executive officer. UCB and Carolina have retained the services of a construction company operated by Robert L. Head, Jr., who is Chairman of the Board of Directors of United and a director of UCB. During 1997, UCB and Carolina made payments of approximately $1.2 million to such construction company 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. 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 Mr. Tallent, Mr. Gilliland, Mr. Decker, Mr. Freeman and Mr. 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, in order to compete for and retain talented personnel who will lead United in achieving levels of financial performance which 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 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 1997, paid in the form of a cash bonus during the fourth quarter of the fiscal year, was based on annual financial results of United's bank subsidiaries, including general targets with respect to net earnings and return on average assets. 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. Key Employee Stock Option Plan Options to acquire 79,704 shares of Common Stock were awarded under the Plan in fiscal 1997, including options to acquire 31,000 shares of Common Stock awarded to the Named Executive Officers by the Compensation Committee. United Community Banks, Inc. Board of Directors Jimmy C. Tallent Hoyt O. Holloway Billy M. Decker P. Deral Horne Thomas C. Gilliland John R. Martin Robert L. Head, Jr. Clarence W. Mason, Sr. Charles E. Hill W. C. Nelson, Jr. Charles E. Parks Compensation Committee of the Board of Directors Robert L. Head, Jr. John R. Martin Charles E. Hill Clarence W. Mason, Sr. Hoyt O. Holloway W. C. Nelson, Jr. P. Deral Horne Charles E. Parks 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 commenced on June 28, 1993, the date on which United's Common Stock was registered under the Securities Exchange Act of 1934, as amended, and ended on December 31, 1997. United's Common Stock is not publicly traded; therefore, the total shareholder return is based on stock trades known to United during the period presented. [PERFORMANCE GRAPH GOES HERE] Cumulative Total Return ------------------------------------------------------------- 6/93 12/93 12/94 12/95 12/96 12/97 ---- ----- ----- ----- ----- ----- UNITED COMMUNITY BANKS INC. 100.00 118.96 186.79 300.79 396.57 569.36 NASDAQ STOCK MARKET (U.S.) 100.00 110.56 108.07 152.84 187.99 230.69 NASDAQ BANK 100.00 106.65 106.26 158.25 208.93 352.97 MEETINGS AND COMMITTEES OF THE BOARD OF DIRECTORS The United Board of Directors held four meetings during 1997. All of the directors attended at least seventy-five percent (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 audit or 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 Plan. INFORMATION CONCERNING UNITED'S ACCOUNTANTS Porter Keadle Moore, LLP ("Porter Keadle") was the principal independent public accountant for United during the year ended December 31, 1997. Representatives of Porter Keadle 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 will be United's accountants for the current fiscal year. SHAREHOLDER PROPOSALS Proposals of shareholders intended to be presented at United's 1999 annual meeting must be received by December 12, 1998, in order to be eligible for inclusion in United's Proxy Statement and Proxy for that meeting. 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 as proxies 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 APPENDIX A GENERAL DESCRIPTION OF THE BUSINESS United Community Banks, Inc. ("United") was incorporated under the laws of Georgia in 1987 and commenced operations in 1988 by acquiring 100% of the outstanding shares of Union County Bank ("UCB"). United is a registered bank holding company. All of United's activities are currently conducted by its wholly-owned subsidiaries, UCB, which was organized as a Georgia banking corporation in 1950, Carolina Community Bank, Murphy, North Carolina ("Carolina"), which United acquired in 1990, Peoples Bank, Blue Ridge, Georgia ("Peoples"), which United acquired in 1992, Towns County Bank, Hiawassee, Georgia ("Towns"), which United also acquired in 1992, White County Bank, Cleveland, Georgia ("White"), which United acquired in 1995, and First Clayton Bancshares, Inc. ("First Clayton"), which United acquired in 1997. UCB, Carolina, Peoples, Towns, White and First Clayton (collectively, the "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. The Banks finance commercial and consumer transactions, make secured and unsecured loans, including residential mortgage loans, and provide a variety of other banking services. UCB also offers travel agency services for the Banks' customers. The Mortgage People Company ("MPC"), a division of UCB, is a full-service mortgage lending operation approved as a seller/servicer for Federal National Mortgage Association and Federal Home Mortgage Corporation. MPC was organized to provide fixed and adjustable-rate mortgages. United Family Finance Company is a traditional consumer finance company which is based in Blue Ridge, Georgia and also has been granted a license to conduct business in Hiawassee, Georgia and Murphy, North Carolina. UNITED COMMMUNITY BANKS, INC. SELECTED FINANCIAL DATA 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- (in thousands except per share data) FOR THE YEAR Net interest income $ 43,232 33,815 25,015 20,067 16,024 Provision for loan losses 2,634 1,597 1,116 998 931 Noninterest income 6,980 5,666 4,523 3,962 3,918 Noninterest expense 32,077 24,843 19,204 15,125 12,810 Income taxes 4,766 4,114 2,549 2,205 1,592 Net earnings 10,735 8,927 6,669 5,701 4,609 PER COMMON SHARE Net earnings 1.47 1.29 1.03 0.91 0.74 Net earnings - assuming dilution 1.46 1.26 1.01 0.89 0.72 Cash dividends declared 0.10 0.10 0.08 0.09 0.06 Book value 10.17 8.14 7.09 5.56 4.76 AT YEAR END Loans 816,934 633,176 480,360 366,916 305,398 Earning assets 1,049,159 824,476 659,548 458,446 399,674 Assets 1,153,367 886,103 712,298 496,527 427,483 Deposits 977,079 773,300 637,832 427,998 378,920 Stockholders' equity 75,113 57,675 49,207 34,871 29,876 Common shares outstanding 7,385,105 7,084,621 6,945,081 6,274,903 6,278,900 AVERAGE BALANCES Loans 737,889 551,043 423,953 332,793 270,199 Earning assets 960,346 723,994 565,523 429,152 365,711 Assets 1,024,730 783,509 607,877 464,767 393,541 Deposits 894,200 695,391 538,518 408,645 351,526 Stockholders' equity 66,333 53,472 42,110 32,463 27,539 Weighted average shares outstanding 7,300,874 6,919,437 6,499,264 6,275,014 6,235,452 KEY PERFORMANCE RATIOS Return on average assets 1.05% 1.14% 1.10% 1.23% 1.17% Return on average stockholders' equity 16.18% 16.69% 15.84% 17.56% 16.74% Net interest margin, taxable equivalent 4.64% 4.85% 4.64% 4.93% 4.63% Efficiency ratio 64.43% 62.93% 65.01% 62.92% 64.24% Dividend payout ratio 6.51% 7.58% 8.82% 9.89% 8.11% Average equity to average assets 6.47% 6.82% 6.93% 6.98% 7.00% MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS General United was incorporated under the laws of Georgia in 1987 and commenced operations in 1988 by acquiring 100% of the outstanding shares of UCB. United is a registered bank holding company. All of United's activities are currently conducted by its wholly-owned subsidiaries, UCB, which was organized as a Georgia banking corporation in 1950, Carolina, which United acquired in 1990, Peoples, which United acquired in 1992, Towns, which United also acquired in 1992, White which United acquired in 1995 and First Clayton, which United acquired in 1997. The following discussion focuses on significant changes in the financial condition and results of operations of United and the Banks during the three years ended December 31, 1997. The discussion and analysis is intended to supplement and highlight and should be read in conjunction with information contained in the accompanying consolidated financial statements. Year 2000 Considerations The Company is aware of the issues associated with the programming code in existing computer systems as the millennium (year 2000) approaches. The "year 2000" (Y2K) issue is pervasive and complex as virtually every computer operation will be affected in some way by the rollover of the two-digit value to 00. The issue is whether computer systems will properly recognize date-sensitive information when the year changes to 2000. Systems that do not properly recognize such information could generate erroneous data or cause a system to fail. The Company is utilizing both internal and external resources to identify, correct or reprogram, and test the systems for Y2K compliance. It is anticipated that all mainframe systems will be Y2K certified no later than the third quarter of 1998, allowing adequate time for testing during 1999. To date, confirmation has been received from the Company's primary processing vendors that plans are being developed to address processing of transactions in the year 2000. Management has not yet fully determined the Y2K compliance expense and related potential effect on the Company's earnings; however, direct costs are not expected to be material to the consolidated results of operations and will be expensed as incurred. Expenses in 1997 related to the Y2K issue were not material to the financial results of operations. Restatement of Financial Statements and Management's Discussion and Analysis Effective September 12, 1997, United completed the acquisition of First Clayton Bancshares, Inc., the parent company of the $73 million First Clayton Bank and Trust in Clayton, Georgia. United issued 646,257 shares of its common stock and paid approximately $7,000 for fractional shares in connection with this acquisition. The acquisition was accounted for as a pooling of interests and accordingly, the consolidated financial statements and management's discussion and analysis for all periods have been restated to include the financial position and results of operations as if the combination had occurred at the beginning of the earliest period presented. Financial Highlights Year Ended December 31, 1997. Net earnings totaled over $10.7 million for the year ended December 31, 1997, an increase of 20% from the $8.9 million earned in 1996. Net earnings per common share were $1.47 for 1997 compared to $1.29 reported for 1996, an increase of 14%. Return on average assets and return on average equity for the year ended December 31, 1997, were 1.05% and 16.18%, respectively. The 1996 return on average assets and return on average equity were 1.14% and 16.69%, respectively. United's balance sheet grew 30% during the year as assets ended the year at $1.2 billion. Net loans increased 30% during the year and deposits grew over 26%. The increases in both loans and deposits reflect a strong economic environment as well as market share gains from competition. Stockholders' equity increased to $75.1 million and represented 7% of year end assets. Capital Issues 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 UCB, Carolina and Towns to support the asset growth that the banks are 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 April 1, July 1, October 1 and January 1 of each year commencing on April 1, 1997, to holders of record at the close of business on the 15th day of the month immediately preceding the interest payment date. Interest is computed on the basis of the actual number of days elapsed in a year of 365 or 366 days, as applicable. The 2006 Debentures may be redeemed, in whole or in part from time to time 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 not redeemed will have the right, excercisable 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. In August 1995, United completed an offering to the public of 215,515 shares of United Common Stock registered under the Securities Act of 1933 pursuant to which $2,434,000 in additional capital was raised. United used the proceeds of the offering primarily to invest additional capital in Carolina and Towns. The additional capital for Towns was used to support the asset growth experienced by Towns. The additional capital for Carolina was necessitated by Carolina's asset growth and the acquisition of the Franklin and Waynesville branch banking offices. Expansions during 1997 In addition to the purchase of First Clayton, other United subsidiaries expanded in their respective surrounding areas. Carolina created de novo branch offices in the Western North Carolina cities of Bryson City, Brevard and Cashiers. Subsequent to December 31, 1997, Carolina has applied for and has received approval to open a branch in Etowah, North Carolina. Peoples entered into a purchase and assumption agreement to acquire certain assets and assume certain liabilities of a branch of another bank located in Ellijay (Gilmer County), Georgia. The Ellijay branch purchase was consummated in January of 1998. Effective January 30, 1998, United's subsidiary, Peoples, assumed deposits totaling $23 million and purchased certain assets totaling $4 million of a branch in Ellijay, Georgia. Expansions prior to 1997 Effective July 1, 1996, the Georgia bank branching laws were amended to permit subsidiary banks of Georgia bank holding companies to branch in an aggregate of three additional locations prior to July 1, 1998, after which time statewide branching will be permitted. On July 1, 1996, UCB changed its name from Union County Bank to United Community Bank and established a branch office in Dahlonega, Lumpkin County, Georgia. UCB simultaneously filed a tradename filing to permit it to conduct its operations in Union County, Georgia under the tradename Union County Bank. On September 28, 1996, UCB assumed deposits of $23.7 million and purchased assets of $33.2 million in Cornelia, Habersham County, Georgia, from a banking institution which sold off its operations in the county. In Habersham County, UCB operates under the trade name of First Bank of Habersham, and in Lumpkin County, UCB does business as United Community Bank. On July 1, 1996, Carolina opened a loan production office in Sylva, North Carolina. In 1995, United's subsidiary, Carolina, assumed deposits totaling $32 million and purchased certain assets totaling $12 million of three branch banks in the Western North Carolina cities of Andrews, Franklin and Waynesville. Effective August 31, 1995, United completed the acquisition of White County Bancshares, Inc., the parent company of the $71 million asset, White County Bank in Cleveland, Georgia. United issued 455,400 shares of its common stock in addition to a previously issued exchangeable payable in kind debenture for all of the issued and outstanding shares of White. This transaction was accounted for as a purchase. 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 the largest possible amount of income while balancing interest rate, credit, and liquidity risks. Net interest income, on a taxable equivalent basis, was $44.6 million in 1997, compared to $35.1 million in 1996 and $26.2 million in 1995. The 27% increase in 1997 was primarily the result of increased volume of net earning assets. Interest income increased over 32% in 1997 and 27% in 1996. The increase in 1997 was again primarily a result of an increase in interest and fees on loans of over $18.6 million. Interest on investment securities and other earning assets increased $3.3 million or 29%. Average earning assets in 1997 increased 33% when compared to 1996 due to increases in average loans of $186.8 million and average investment securities of $41.0 million. An increase in average earning assets of 28% was experienced in 1996 over 1995 primarily due to increases in average loans of $127.1 million. Table 1 represents net interest income, yields and rates on a taxable-equivalent basis and average balances for the years 1997, 1996 and 1995. Table 1 - Consolidated Average Balances, Interest and Rates Taxable Equivalent Basis (dollars in thousands) Years Ended December 31, ------------------------ 1997 1996 1995 ----------------------------- --------------------------- ------------------------- Average Yield/ Average Yield/ Average Yield/ Balance Interest Rate Balance Interest Rate Balance Interest Rate ------- -------- ------ ------- -------- ------ ------- -------- ------ ASSETS Interest earning assets: Federal funds sold $ 29,741 1,642 5.52% 20,303 1,096 5.40% 20,903 1,315 6.29% Interest bearing deposits with other banks -- -- -- 918 102 11.11% 286 4 1.40% Investment securities: Taxable 148,390 9,097 6.13% 115,480 6,735 5.83% 87,378 5,354 6.13% Tax-exempt 44,326 3,514 7.93% 36,250 3,022 8.34% 33,003 2,894 8.77% ---------- ------ ------- ------ ------- ------ Total investment securities 192,716 12,611 6.54% 151,730 9,757 6.43% 120,381 8,248 6.85% ---------- ------ ------- ------ ------- ----- Loans: Taxable 733,655 76,452 10.42% 544,247 57,495 10.56% 418,015 44,196 10.57% Tax-exempt 4,234 408 9.64% 6,796 732 10.77% 5,938 653 11.00% ---------- ------ ------- ------ ------- ------ Total loans 737,889 76,860 10.42% 551,043 58,227 10.57% 423,953 44,849 10.58% ---------- ------ ------- ------ ------- ------ Total interest earning assets 960,346 91,113 9.49% 723,994 69,182 9.56% 565,523 54,416 9.62% Allowance for loan losses (9,304) (7,530) (5,678) Cash and due from banks 28,542 21,396 17,374 Premises and equipment 23,194 18,097 15,032 Other assets 21,952 27,552 15,626 ---------- ------- ------- Total assets $1,024,730 783,509 607,877 ========== ======= ======= LIABILITIES AND STOCKHOLDERS' EQUITY Interest bearing liabilities: Deposits: Demand $ 176,054 6,712 3.81% 169,811 5,445 3.21% 104,403 3,833 3.67% Savings 43,286 1,190 2.75% 41,834 1,147 2.74% 35,236 1,100 3.12% Time 579,398 34,966 6.03% 410,656 25,569 6.23% 345,144 21,396 6.20% Federal funds purchased 3,229 184 5.70% 947 51 5.39% 975 56 5.74% FHLB advances 39,615 2,382 6.01% 17,237 981 5.69% 11,889 899 7.56% Notes payable 10,803 810 7.50% 10,291 808 7.85% 9,537 820 8.60% Convertible subordinated debentures 3,500 304 8.69% 1,000 90 9.00% 1,000 90 9.00% ---------- ------ ------- ------ ------- ------ Total interest bearing liabilities 855,885 46,548 5.44% 651,776 34,091 5.23% 508,184 28,194 5.55% ---------- ------ ------- ------ ------- ------ Noninterest bearing demand deposits 95,462 73,090 53,735 Other liabilities 7,050 5,171 3,848 Stockholders' equity 66,333 53,472 42,110 ---------- ------- ------- Total liabilities and stockholders' equity $1,024,730 783,509 607,877 ========== ======= ======= Net interest income 44,565 35,091 26,222 ------ ------ ------ Net interest spread 4.05% 4.33% 4.07% ==== ==== ==== Net interest margin 4.64% 4.85% 4.64% ==== ==== ==== Taxable equivalent adjustments: Loans 138 249 223 Investment securities 1,195 1,027 984 ------ ------ ------ Total taxable equivalent adjustments 1,333 1,276 1,207 ------ ------ ------ Net interest income $43,232 33,815 25,015 ======= ====== ====== Consolidated Average Balances, Interest and Rates 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 sources of funds. 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. The net interest spread was 4.05% in 1997, 4.33% in 1996 and 4.07% in 1995, while the net interest margin was 4.64% in 1997, 4.85% in 1996 and 4.64% in 1995. The decrease in the margin and spread are primarily due to a decrease in core deposits relative to total funding sources. Core deposits represent approximately 33% of total deposits in 1997, a decrease from 39% in 1996. Table 2 shows the change in net interest income for the past two years due to changes in volumes and rate. Table 2 - Rate/Volume Variance Analysis Taxable Equivalent Basis (dollars in thousands) 1997 Compared to 1996 1996 Compared to 1995 Increase (decrease) due to changes in Increase (decrease) due to changes in ------------------------------------- ------------------------------------- Yield/ Net Yield/ Net Volume Rate Change Volume Rate Change ------ ------ ------ ------ ------ ------ Interest earned on: Federal funds sold $ 511 35 546 $ (32) (186) (218) Interest bearing deposits with other banks (101) -- (101) 70 28 98 Investment securities: Taxable 1,935 427 2,362 1,639 (257) 1,382 Tax-exempt 687 (195) 492 271 (143) 128 Loans: Taxable 19,998 (1,041) 18,957 13,335 (36) 13,299 Tax-exempt (272) (52) (324) 92 (13) 79 ------- ------ ------ ------ ---- ------ Total interest income 22,758 (826) 21,932 15,375 (607) 14,768 ------- ------ ------ ------ ---- ------ Interest paid on: Deposits: Demand 275 992 1,267 2,097 (485) 1,612 Savings 39 4 43 181 (134) 47 Time 10,605 (1,208) 9,397 4,079 94 4,173 Federal funds purchased 123 10 133 (2) (3) (5) FHLB advances 1,280 121 1,401 304 (222) 82 Notes payable 130 (128) 2 59 (71) (12) Convertible subordinated debentures 225 (11) 214 -- -- -- ------- ------ ------ ------- ---- ------ Total interest expense 12,677 (220) 12,457 6,718 (821) 5,897 ------- ------ ------ ------- ---- ------ Net interest income $10,081 (606) 9,475 8,657 214 8,871 ======= ====== ====== ======= ==== ====== Noninterest Income Noninterest income consists primarily of revenues generated from service charges and fees on deposit accounts, mortgage loan and related fees and profits earned through sales of credit life insurance. In addition, gains or losses realized from the sale of investment portfolio securities are included in noninterest income. Total noninterest income for 1997 increased 23% or $1.3 million, with $439 thousand of the increase due to an increase in gains recognized on sales of investment securities during 1997 and a $515 thousand increase in service charges on demand deposits. Noninterest income for 1996 increased 25% or $1.1 million, more than $823 thousand of which was contributed as a result of an increase in service charges on demand deposits. The growth in non-interest income was the result of United's continuing efforts to build stable sources of fee income, which includes services charges on deposits and mortgage loan and related fees. This growth is being accomplished through the building of customer market share and expansion of United's locations. The primary contributor to non-interest income growth in both 1997 and 1996 was the continued growth in service charges on deposits. Fee income from service charges on deposit accounts increased over 17% in 1997 following a 38% increase in 1996. The growth in the number of accounts due to the branch expansions into new markets was the primary contributor to the increased levels of income for both years. Net gains on sales of investment securities in 1997 increased $439 thousand from 1996 levels as management liquidated more investment securities to meet loan demand. Mortgage loan and related fee income decreased 26% or $409 thousand during 1997 as compared to 1996 as the volume of loans originated and serviced decreased significantly from prior years. Noninterest Expense Noninterest expenses for 1997 increased 29% following an increase of 29% in 1996. The increase was primarily due to the start up costs in new markets. Salaries and employee benefits increased 32% in 1997 compared to 1996 due to employee additions resulting from the branch expansions together with the increases required to maintain continued growth. Occupancy expense increased over $1.2 million or 32% in 1997 following a 21% increase in 1996. The increase for both years is due to the new physical locations associated with the new branches. Other non-interest expenses, including advertising and stationery and supplies, increased $1.8 million or 22% compared to a 37% increase in 1996. Increases in both years are generally associated with expansion into new markets by branching. Management continues to emphasize the importance of expense management and productivity throughout United in order to further decrease the cost of providing expanded banking services to a growing market base. Investment Securities The composition of the investment securities portfolio reflects United's investment strategy of maintaining an appropriate level of liquidity while providing a relatively stable source of income. The investment portfolio also provides a balance to interest rate risk and credit risk in other categories of 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 1997, gross investment securities sales were $32.1 million as compared to $18.1 million during 1996. Maturities and paydowns were $40.5 and $54.6 million, representing 21% and 36%, respectively, of the average total portfolio for the year. Net gains associated with the sales were approximately $426 thousand during 1997 with net losses of $13 thousand during 1996, accounting for less than 10% of non-interest income. Gross unrealized gains in the total portfolio amounted to approximately $2.8 million at December 31, 1997, and gross unrealized losses amounted to approximately $189 thousand. Total average investment securities, including those available for sale, increased 27% during 1997. Average investment securities during 1996 increased 26% from the 1995 average levels. Table 3 reflects the carrying amount of the investment securities portfolio for the past three years. Table 3 - Carrying Value of Investments (dollars in thousands) December 31, ------------------------------------------- 1997 1996 1995 ---- ---- ---- Securities held to maturity: U.S. Treasuries $ 500 2,368 7,124 U.S. Government agencies 22,361 34,804 42,488 State and political subdivisions 42,330 33,036 28,055 Mortgage backed securities 4,368 7,118 7,937 -------- ------- ------- 69,559 77,326 85,604 -------- ------- ------- Securities available for sale: U.S. Treasuries 46,945 12,841 25,776 U.S. Government agencies 45,552 38,953 30,634 State and political subdivisions 11,860 6,833 6,595 Mortgage backed securities 33,347 18,635 4,290 Other 6,190 4,002 2,855 -------- ------- ------- 143,894 81,264 70,150 -------- ------- ------- Total $213,453 158,590 155,754 ======== ======= ======= Carrying Value of Investments The December 31, 1997, market value of securities held to maturity, as a percentage of amortized cost was 102%, up from 100% at December 31, 1996. The market value of the portfolio of securities held to maturity will change as interest rates change and such unrealized gains or losses will not flow through the financial statements unless the related securities are called at prices which differ from the carrying value at the time of call. United utilizes its investment portfolio to offset some of the natural mismatch of interest rate risk inherent in the loan and deposit portfolios. United experienced strong loan demand at all the Banks so there was little need for investments solely to augment income or utilize uninvested deposits. United's investment portfolio consists of U.S. Government and agency securities, municipal securities, various equity securities and Government agency sponsored 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 these borrowers may have the right to prepay obligations with or without prepayment penalties. Decreases in interest rates will generally cause prepayments to accelerate. In a declining interest rate environment, United may not be able to reinvest the proceeds from these prepayments in assets which have comparable yields. However, because the majority of the mortgage-backed securities have adjustable rates, the negative effects of changes in interest rates on earnings and the carrying values of these securities are mitigated. At December 31, 1997, United had 18% of its total investment portfolio in mortgage-backed pass-through securities, all of which are issued or backed by Federal agencies. At December 31, 1997, United did not have securities of any issuer in excess of 10% of equity. Loans During 1997, average net loans increased $186.8 million, or 34% and represented 77% of average interest earning assets and 72% of average total assets. This growth generally occurred proportionally among the various loan categories and can be attributed to additional products and services marketed to existing customers and business development efforts which resulted in market share gains from competitors. The level of loans, when compared to the level of deposits, has been relatively strong over the last three years. The average loan to deposit ratio was 83%, 79% and 79% in 1997, 1996 and 1995, respectively. Table 4 breaks down the composition of the loan portfolio for each of the past five years while Table 5 shows the amount of loans outstanding for selected categories as of December 31, 1997, with maturities based on the remaining scheduled repayments of principal. Table 4 - Loan Portfolio (dollars in thousands) December 31, 1997 1996 1995 1994 1993 ------------------ ----------------- ----------------- ----------------- ------------------ Percent Percent Percent Percent Percent Amount of Total Amount of Total Amount of Total Amount of Total Amount of Total ------ -------- ------ -------- ------ -------- ------ -------- ------ -------- Commercial, financial and agri- cultural $105,462 12.8% 100,538 15.8% 64,727 13.6% 65,521 18.5% 49,192 16.9% Real estate - construction 78,699 9.6% 51,425 8.1% 30,065 6.3% 20,274 5.7% 22,104 7.6% Real estate - mortgage 523,629 63.6% 380,681 60.0% 294,724 62.1% 203,270 57.3% 163,940 56.2% Consumer 115,534 14.0% 101,930 16.1% 85,341 18.0% 65,456 18.5% 56,551 19.3% ------- ----- ------- ----- ------- ----- ------- ----- ------- ----- Total loans 823,324 100.0% 634,574 100.0% 474,857 100.0% 354,521 100.0% 291,787 100.0% Less: Allowance for loan losses 10,352 8,125 6,884 4,230 3,464 -------- ------- ------- ------- ------- $812,972 626,449 467,973 350,291 288,323 ======== ======= ======= ======= ======= Table 5 - Loan Portfolio Maturity (dollars in thousands) Rate Structure for Loans Maturity Maturing Over One Year ---------------------------------------------------- ------------------------------ Over One Year Floating or One Year Through Over Five Predetermined Adjustable or Less Five Years Years Total Interest Rate Rate -------- ------------- --------- ----- -------------- ----------- Commercial, financial and agri- cultural $ 62,826 34,486 8,150 105,462 26,861 15,775 Real estate - construction 70,226 3,773 4,700 78,699 494 7,979 -------- ------ ------ ------- ------ ------ $133,052 38,259 12,850 184,161 27,355 23,754 ======== ====== ====== ======= ====== ====== Provision and Allowance for Loan Losses United manages asset quality and controls risk through diversification of the loan portfolio and the application of policies designed to foster 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 across United. 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 assessment of loan portfolio quality, the value of collateral, and economic factors and trends. 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 made on a regular basis during the year. These reviews are made by the responsible lending officers, as well as a separate credit administration 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, and other factors, including prevailing and anticipated economic conditions. Whenever a loan, or portion thereof, is considered by management to be uncollectible, it is charged against the allowance for loan losses. Management believes that 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 the Banks' allowance for loan losses. Such agencies may require the Banks to recognize additions to the allowances based on their judgments about information available to them at the time of their examination. The provision for loan losses increased 65% in 1997 compared to 1996 and increased 43% in 1996 compared to 1995. The allowance for loan losses as a percentage of total loans remained stable at 1.26% at December 31, 1997 compared to 1.28% at December 31, 1996. The increase in the provision for loan losses is a result of the large increase in loans outstanding during 1997. Net loan charge-offs for 1997 increased 14% compared to 1996, although the average balance of loans increased 34%. United does not currently allocate the allowance for loan losses to the various loan categories. Net charge-offs during 1998 are expected to approximate those experienced during 1997. Table 6 sets forth information with respect to United's allowance for loan losses for each of the last five years. Table 6 - Analysis of the Allowance for Loan Losses (dollars in thousands) Years Ended December 31, ------------------------ 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Allowance for loan losses at beginning of year $ 8,125 6,884 4,231 3,465 2,776 Charge-offs: Commercial, financial and agricultural 73 329 148 27 6 Real estate - construction -- -- 24 -- -- Real estate - mortgage 99 13 337 49 54 Consumer 625 353 192 262 286 ------- ----- ----- ----- ------ Total charge-offs 797 695 701 338 346 ------- ----- ----- ----- ------ Recoveries: Commercial, financial and agricultural 22 251 157 6 1 Real estate - construction -- -- -- -- -- Real estate - mortgage 224 39 188 1 28 Consumer 144 49 80 99 75 ------ ----- ----- ----- ----- Total recoveries 390 339 425 106 104 ------ ----- ----- ----- ----- Net charge-offs 407 356 276 232 242 ------ ----- ----- ----- ----- Provisions charged to earnings 2,634 1,597 1,116 998 931 Allowance for loan losses acquired from White -- -- 1,813 -- -- ------ ----- ----- ----- ----- Balance at end of year $10,352 8,125 6,884 4,231 3,465 ====== ===== ===== ===== ===== Ratio of net charge-offs to average loans outstanding during the period 0.06% 0.06% 0.07% 0.07% 0.09% Asset Quality Non-performing assets, comprised of nonaccrual loans, other real estate owned and loans for which payments are more than 90 days past due totaled $1.4 million compared to $1.7 million at year end 1996. It is the general policy of the Banks to stop accruing interest income and place the recognition of interest on a cash basis when a loan is placed on nonaccrual status and any interest previously accrued but not collected is reversed against current income unless the collateral for the loan is sufficient to cover the accrued interest or a guarantor assures payment of interest. Loans made by the Banks to facilitate the sale of other real estate are made on terms comparable to loans of similar risk. An adequate investment by the buyer is required prior to the removal of other real estate from non-performing assets. There were no commitments to lend additional funds on nonaccrual loans at December 31, 1997. Table 7 summarizes United's non-performing assets for each of the last five years. Table 7 - Risk Elements (dollars in thousands) December 31, ------------ 1997 1996 1995 1994 1993 ---- ---- ---- ---- ---- Loans on nonaccrual $ 515 984 2,017 569 585 Loans 90 days past due 536 487 291 102 219 Other real estate 386 210 65 -- -- ------ ----- ----- ----- ----- Total non-performing assets $1,437 1,681 2,373 671 804 ====== ===== ===== ===== ===== Total non-performing loans as a percentage of loans 0.13% 0.23% 0.49% 0.19% 0.28% Loans 90 days past due as a percentage of loans 0.07% 0.08% 0.06% 0.03% 0.08% Risk Elements There may be additional loans within United's portfolio that may become classified as conditions dictate; however, management was not aware of any such loans that are material in amount at December 31, 1997. At December 31, 1997, management was unaware of any known trends, events or uncertainties that will have, or that are reasonably likely to have a material effect on United's liquidity, capital resources or operations. Deposits All major categories of average interest bearing deposits increased during 1997. The largest dollar increase in average interest bearing deposits was in the time deposit category, rising over $168.7 million or 41% during 1997 as compared to 1996 followed by the increase in average interest bearing demand deposits of $6.2 million or 4%. Average non-interest bearing demand deposits increased $22.4 million or 31% after increasing 36% during 1996. The increases were primarily a result of internally generated growth, as well as the previously discussed expansions. Savings deposits, interest bearing demand deposits and non-interest bearing demand deposits comprised 35% of total average deposits during 1997. For 1996, these lower cost deposits comprised 41% of total average deposits. The maturities of time deposits of $100,000 or more issued by the Banks at December 31, 1997, are summarized in the following table: Table 8 - Maturities of Time Deposits Over $100,000 (dollars in thousands) Three months or less $ 49,895 Over three months through six months 41,867 Over six months through twelve months 36,577 Over twelve months 28,464 -------- $156,803 ======== At December 31, 1997, five of the Banks were shareholders in the Federal Home Loan Bank of Atlanta. Through this affiliation, advances totaling $43.3 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 and provide competitive, long-term fixed rate loans to its customers. 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. During 1997 and 1996, United used derivative financial instruments to a limited extent in its interest rate risk management. Interest rate swap contracts with an aggregate notional amount of $35 million extending through various dates in 1998 and 1999 were executed to effectively convert certain fixed rate liabilities to variable rates. From October 1, 1996, through December 1997, United converted the effective interest rate of certain deposit liabilities from 7.25% to 6.46% with the execution of the swap agreements. Additionally, United entered into an interest rate floor contract for the notional amount of $50 million extending through January 1998. For a one time premium upon the execution of the contract, the floor agreement reduces United's interest rate risk in the event of rate declines below a predetermined level. Notional amounts of the swap and floor contracts only represent the basis for exchange of the cash flows and do not represent credit risk. Credit risk is limited to the positive market value of the derivative at a given date. United anticipates continued use of derivative interest rate contracts when appropriate in its asset-liability rate management. 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 effect of interest rate movements 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. Table 9 shows interest sensitivity gaps for these different intervals as of December 31, 1997. Table 9 - Interest Rate Sensitivity Analysis (dollars in thousands) December 31, 1997 ----------------- 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 $ 8,420 -- -- -- -- 8,420 Investment securities -- 6,464 21,334 115,965 69,690 213,453 Mortgage loans held for sale -- 3,962 -- -- -- 3,962 Loans -- 355,427 309,540 135,157 23,200 823,324 -------- ------- ------- ------- ------- --------- Total interest earning assets 8,420 365,853 330,874 251,122 92,890 1,049,159 -------- ------- ------- ------- ------- --------- Interest bearing liabilities: Deposits: Demand -- 189,280 -- -- -- 189,280 Savings -- -- 45,280 -- -- 45,280 Time -- 191,524 321,404 120,381 -- 633,309 FHLB advances 31,736 72 2,386 7,855 1,272 43,321 Notes payable 12,722 352 995 -- -- 14,069 Convertible subordinate debentures -- -- -- -- 3,500 3,500 -------- ------- ------- ------- ------- --------- Total interest bearing liabilities 44,458 381,228 370,065 128,236 4,772 928,759 -------- ------- ------- ------- ------- --------- Noninterest bearing sources of funds - net -- -- -- -- 109,210 109,210 -------- ------- ------- ------- ------- --------- Interest sensitivity gap (36,038) (15,375) (39,191) 122,886 (21,092) 11,190 -------- ------- ------- ------- ------- --------- Cumulative interest sensitivity gap $(36,038) (51,413) (90,604) 32,282 11,190 -- ======== ======= ======= ======= ======= ========= As seen in the preceding table, for the first 365 days 86% of earning liabilities funding sources will reprice compared to 67% of all interest earning assets. Changes in the mix of earning assets or supporting liabilities can 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 which are not reflected in the interest rate sensitivity analysis report. These prepayments may have significant effects on United's net interest margin. Because of these factors an interest sensitivity gap report may not provide a complete assessment of United's exposure to changes in interest rates. Table 9 indicates United is in a liability sensitive or negative gap position at 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. 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 required to produce an optimal net interest margin. Also see "Quantitative and Qualitative Disclosures about Market Risk" included elsewhere herein. Table 10 represents the expected maturity of the total investment securities by maturity date and average yields based on amortized cost (for all obligations on a fully taxable basis assuming a 34% tax rate) at December 31, 1997. It should be noted that the composition and maturity/repricing distribution of the investment portfolio is subject to change depending on rate sensitivity, capital needs, and liquidity needs. Table 10 - Expected Maturity of Investment Securities (dollars in thousands) After One But After Five But Within One Year Within Five Years Within Ten Years After Ten Years ---------------- ----------------- ---------------- --------------- Amount Yield Amount Yield Amount Yield Amount Yield Totals ------ ----- ------ ----- ------ ----- ------ ----- ------- Securities held to maturity: U.S. Treasury securities $ 500 7.12% -- -- -- -- -- -- 500 U.S. Government Agencies 17,817 5.57% 4,544 6.11% -- -- -- -- 22,361 State and political subdivisions 1,739 8.20% 17,132 7.37% 18,819 7.56% 4,640 8.11% 42,330 Mortgage backed securities 621 5.11% 1,721 6.65% 860 6.16% 1,166 7.89% 4,368 ------- ---- ------ ---- ------ ---- ----- ---- ------ 20,677 5.81% 23,397 7.07% 19,679 7.50% 5,806 8.07% 69,559 ------- ---- ------ ---- ------ ---- ----- ---- ------ Securities available for sale: U.S. Treasury securities 2,242 6.09% 42,573 6.20% 1,489 6.05% -- -- 46,304 U.S. Government agencies 8,150 5.77% 33,269 6.31% 3,898 6.17% -- -- 45,317 State and political subdivisions 2,569 9.03% 3,019 8.21% 4,103 7.02% 1,984 7.26% 11,675 Mortgage backed securities 2,499 6.93% 15,062 6.46% 7,416 6.24% 7,993 6.48% 32,970 Other -- -- -- -- -- -- 6,256 5.18% 6,256 ------- ---- ------ ---- ------ ---- ----- ---- ------ 15,460 6.55% 93,923 6.35% 16,906 6.40% 16,233 6.07% 142,522 ------- ---- ------ ---- ------ ---- ----- ---- ------ Total $36,137 6.13% 117,320 6.49% 36,585 6.99% 22,039 6.60% 212,081 ======= ==== ======= ==== ====== ==== ====== ==== ======= 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 high level of liquidity in all economic environments. Liquidity is defined as the ability of a company 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 day to day cash flow requirements of the Banks' customers, whether they are depositors wishing to withdraw funds or borrowers requiring funds to meet their credit needs. Without proper liquidity management, United would not be able to perform the primary functions of a financial intermediary and would, therefore, not be able to meet the needs of the communities it serves. The primary function of asset and liability management is not only to assure adequate liquidity in order for United to meet the needs of its customer base, but to maintain an appropriate balance between interest-sensitive assets and interest-sensitive liabilities so that the Company can also meet the investment requirements of its shareholders. Daily monitoring of the sources and use of funds is necessary to maintain an acceptable cash position that meets both requirements. In a banking environment, both assets and liabilities are considered sources of liquidity funding and both are, therefore, monitored on a daily basis. The asset portion of the balance sheet provides liquidity primarily through loan principal repayments, maturities of investment securities and, to a lesser extent, sales of securities. Installment loan payments are becoming an increasingly important source of liquidity for United as this portfolio continues to grow. Mortgage loans held for sale totaled just over $3.9 million at December 31, 1997, and typically turn over every 45 days. Real estate-construction and commercial, financial and agricultural loans that mature in one year or less amounted to $133 million or 16% of the total loan portfolio at December 31, 1997. Investment securities maturing in the same time frame totaled $36 million or 17% of the total investment securities portfolio at year end 1997. Other short-term investments such as federal funds sold and maturing interest bearing deposits with other banks are additional sources of liquidity funding. The liability portion of the balance sheet provides liquidity through various customers' interest bearing and non-interest bearing deposit accounts. Federal funds purchased and securities sold under agreements to repurchase are additional sources of liquidity and basically 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 short-term liquidity needs. As disclosed in United's Consolidated Statements of Cash Flows included elsewhere herein, net cash provided by operating activities was approximately $14.0 million during 1997. The major sources of cash provided by operating activities are net income and changes in other assets and other liabilities. Net cash used in investing activities of $252.2 million consisted primarily of a net increase in loans of $189.1 million and securities purchased of $125.9 million funded largely by sales, maturities and paydowns of investment securities of $72.6 million. These changes resulted from management's continued efforts to reinvest new funds in higher-yielding loans rather than investment securities. Net cash provided by financing activities provided the remainder of funding sources for 1997. The $254.4 million of net cash provided by financing activities consisted primarily of a $203.8 million net increase in deposits coupled with a net increase in Federal Home Loan Bank advances of $8.2 million and federal funds purchases of $33.0 million at year end. Management considers United's liquidity position at December 31, 1997, to be sufficient to meet its foreseeable 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 Stockholders' equity at December 31, 1997, increased 30% from December 31, 1996. Net earnings after dividends for 1997 provided $10.0 million of the increase in stockholders' equity while an offering of 300,000 shares of common stock offering added $6.5 million. Dividends of $699 thousand or $.10 per share were declared on the Common Stock in 1997 and 1996. United has historically retained the majority of its earnings in order to keep pace with the rate at which assets have grown. Average stockholders' equity as a percentage of total average assets is one measure used to determine capital strength. The ratio of average stockholders' equity to average assets for 1997 and 1996 was 6.47% and 6.82%, respectively. United's asset growth has continued to exceed the rate at which capital has been retained. Table 11 summarizes these and other key ratios for United for each of the last three years. Table 11 - Equity Ratios Years Ended December 31, ------------------------ 1997 1996 1995 ---- ---- ---- Return on average assets 1.05% 1.14% 1.10% Return on average equity 16.18% 16.69% 15.84% Dividend payout ratio 6.51% 7.58% 8.82% Average equity to average assets 6.47% 6.82% 6.93% 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 stockholders' equity less goodwill and deposit-based intangibles, amounted to $68.2 million at December 31, 1997. 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 $81.6 million at December 31, 1997. The percentage ratios, as calculated under the guidelines, were 8.59% and 10.28% for Tier I and Total Risk-based Capital, respectively, at December 31, 1997. A minimum leverage ratio is required in addition to the risk-based capital standards and is defined as period end stockholders' equity adjusted for 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 ratio in tandem with the risk-based capital ratios to assess capital adequacy of banks and bank holding companies. United's leverage ratios at December 31, 1997 and 1996 were 5.76% and 5.98%, respectively. Further analysis regarding the actual and required capital ratios of United and the Banks is provided in note 12 to the consolidated financial statements. All three of the capital ratios of United and each bank currently exceed the minimum ratios required in 1997 as defined by federal regulators. United monitors these ratios to ensure that the company and the bank subsidiaries remain within regulatory guidelines. Increased regulatory activity in the financial industry as a whole will continue to impact the structure of the industry; however, management does not anticipate any negative impact on the capital resources or operations of United. Income Tax Expense Income tax expense increased 16% in 1997 as compared to 1996 and 61% in 1996 as compared to 1995. The effective tax rate as a percentage of pretax income was 31% in 1997 and 32% in 1996. These tax rates are lower than the statutory Federal tax rate of 34% primarily due to interest income on tax exempt loans and securities. See United's consolidated financial statements for an analysis of income taxes. Impact of Inflation and Changing Prices. A bank's asset and liability structure is substantially different from that of an industrial company in that primarily all assets and liabilities of a bank are monetary in nature and therefore differ greatly from most commercial and industrial companies that have significant investments in fixed assets or inventories. Inflation does have 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. Cost cutting and cost controlling measures have been implemented, including the constant search for technological advancements in order to improve efficiency and productivity. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK United's net interest income, and the fair value of its financial instruments, are primarily influenced by changes in the level of interest rates. United manages its exposure to fluctuations in interest rates through policies established by its Asset/Liability Management Committee (the "ALCO"). The ALCO meets regularly and has the responsibility for approving asset/liability management policies, formulating and implementing strategies to improve balance sheet positioning and/or earnings and reviewing the interest rate sensitivity of United and the Banks. Management utilizes an interest rate simulation model to estimate the sensitivity of United's net interest income to changes in interest rates. Such estimates are based upon a number of assumptions for each scenario, including the level of balance sheet growth, interest-bearing accounts repricing characteristics and the rate of prepayments. The estimated impact on United's net interest income sensitivity over a one-year time horizon is shown below. Such analysis assumes an immediate and sustained parallel shift in interest rates, no balance sheet growth and United's estimate of how interest-bearing transaction accounts will reprice in each scenario. Principal/Notional Percentage Increase (Decrease) in Amounts of Earning Interest Income/Expense Given Assets, Interest Bearing Immediate and Sustained Liabilities Parallel Interest Rate Shifts and Swaps at Down 100 Up 100 December 31, 1997 Basis Points Basis Points ----------------- ------------ ------------ (in thousands) Assets which reprice in: One year or less 705,147 Over one year 344,012 ---------- $1,049,159 (4.79%) 4.72% ---------- Liabilities which reprice in: One year or less 795,751 Over one year 133,008 ---------- $ 928,759 (7.36%) 7.23% ---------- Non-trading swaps 35,000 102.42% (102.42%) ---------- Net interest income sensitivity (1.51%) 1.52% The ALCO policy, with which United complies, is based on the same assumptions as the above table and provides that a 100 basis point increase or decrease in interest rates should not reduce net interest income by more than five percent (5%). Certain financial instruments have been excluded from the above analysis because of the no-growth assumption, including letters of credit and the commitments to extend credit. United enters into various interest rate contracts to manage United's interest rate sensitivity. Such contracts generally have a fixed notional principal amount and include interest rate swaps where a company typically receives or pays a fixed rate and a counterparty pays or receives a floating rate based on a specific index, generally prime rate or London Interbank Offered Rate ("LIBOR") and interest rate floors purchased where the Company receives interest if the specific index falls below the floor rate. The interest rate risk factor in these contracts is considered in the overall interest management strategy of United's interest risk management program. The income or expense associated with these interest rate derivatives is ultimately reflected as adjustments to interest income or expense. Changes in the estimated fair value of interest rate protection contracts are not reflected in the financial statements until realized. MARKET AND DIVIDEND DATA Stock. There is no established public trading market for United's Common Stock. At December 31, 1997, there were 2,534 holders of record of Common Stock. Dividends. United paid cash dividends of $.10 per share of Common Stock to shareholders of record in 1997 and 1996. United intends to pay cash dividends on a quarterly basis. However, the amount and frequency of dividends will be determined by United's Board of Directors in light of the earnings, capital requirements and the financial condition of United, and no assurance can be given that dividends will be paid in the future. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Consolidated Financial Statements December 31, 1997, 1996 and 1995 (with Independent Accountants' Report thereon) [PORTER KEADLE MOORE, LLP LOGO] 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, 1997 and 1996 and the related statements of earnings, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. 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, 1997 and 1996, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. \s\ PORTER KEADLE MOORE, LLP Atlanta, Georgia March 6, 1998 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 1997 and 1996 Assets 1997 1996 ---- ---- (In Thousands) Cash and due from banks, including reserve requirements of $11,000 and $6,234 $ 60,414 28,085 Federal funds sold 8,420 24,585 ---------- ------ Cash and cash equivalents 68,834 52,670 ---------- ------ Securities held to maturity (estimated fair value of $70,845 and $77,625) 69,559 77,326 Securities available for sale 143,894 81,264 Mortgage loans held for sale 3,962 6,727 Loans 823,324 634,574 Less: Allowance for loan losses 10,352 8,125 ---------- ------- Loans, net 812,972 626,449 ---------- ------- Premises and equipment, net 27,737 20,108 Accrued interest receivable 10,985 8,559 Other assets 15,424 13,000 ---------- ------- $1,153,367 886,103 Liabilities and Stockholders' Equity Deposits: Demand $ 109,210 82,138 Interest-bearing demand 189,280 167,372 Savings 45,280 41,963 Time 476,506 346,838 Time, in excess of $100,000 156,803 134,989 ---------- ------- Total deposits 977,079 773,300 ---------- ------- Accrued expenses and other liabilities 7,274 6,101 Federal funds purchased 33,011 -- FHLB advances 43,321 35,074 Notes payable 14,069 10,453 Convertible subordinated debentures 3,500 3,500 ---------- ------- Total liabilities 1,078,254 828,428 ---------- ------- Commitments Stockholders' equity: Preferred stock -- -- Common stock, $1 par value; 10,000,000 shares authorized; 7,385,105 and 7,084,621 shares issued and outstanding 7,385 7,085 Capital surplus 24,699 18,516 Retained earnings 42,198 32,162 Net unrealized gain (loss) on securities available for sale, net of tax 831 (88) ---------- ------- Total stockholders' equity 75,113 57,675 ---------- ------- $1,153,367 886,103 ========== ======= </TABLE See accompanying notes to consolidated financial statements. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Consolidated Statements of Earnings For the Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995 ---- ---- ---- (In Thousands Except Per Share Data) Interest income: Interest and fees on loans $76,722 57,978 44,626 Interest on deposits with other banks -- 102 4 Interest on federal funds sold 1,642 1,096 1,315 Interest on investment securities: U.S. Treasury & U.S. Government agencies 9,097 6,735 5,354 State and political subdivisions 2,319 1,995 1,910 ------- ------ ------ Total interest income 89,780 67,906 53,209 ------- ------ ------ Interest expense: Interest on deposits: Demand 6,712 5,445 3,833 Savings 1,190 1,147 1,100 Time 34,966 25,569 21,396 ------- ------ ------ 42,868 32,161 26,329 Notes payable, subordinated debentures, federal funds purchased and FHLB advances 3,680 1,930 1,865 ------- ------ ------ Total interest expense 46,548 34,091 28,194 ------- ------ ------ Net interest income 43,232 33,815 25,015 Provision for loan losses 2,634 1,597 1,116 ------- ------ ------ Net interest income after provision for loan losses 40,598 32,218 23,899 Noninterest income: Service charges and fees 3,505 2,990 2,167 Gain (loss) on sales of investment securities 426 (13) 4 Mortgage loan and other related fees 1,157 1,566 1,582 Other noninterest income 1,892 1,123 770 ------- ------ ------ Total noninterest income 6,980 5,666 4,523 ------- ------ ------ Noninterest expense: Salaries and employee benefits 17,695 13,373 10,504 Occupancy 4,726 3,570 2,948 Other noninterest expense 9,656 7,900 5,752 ------- ------ ------ Total noninterest expense 32,077 24,843 19,204 ------- ------ ------ Earnings before income taxes 15,501 13,041 9,218 Income taxes 4,766 4,114 2,549 ------- ------ ------ Net earnings $10,735 8,927 6,669 ======= ====== ====== Earnings per common share $ 1.47 1.29 1.03 ======= ====== ====== Earnings per common share - assuming dilution $ 1.46 1.26 1.01 ======= ====== ====== See accompanying notes to consolidated financial statements. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders' Equity For the Years Ended December 31, 1997, 1996 and 1995 Net Unrealized Gain (Loss) On Securities Available Common Stock Capital Retained for Sale Shares Amount Surplus Earnings Net of Tax Total ------ ------ ------- -------- ---------- ----- (In Thousands Except Share and Per Share Data) Balance, December 31, 1994, as previously reported 5,589,365 $5,589 7,474 17,363 (209) 30,217 Adjustment in connection with pooling of interests 685,240 686 3,550 468 (56) 4,648 --------- ------ ------ ------ ---- ------ Balance, December 31, 1994, as restated 6,274,605 6,275 11,024 17,831 (265) 34,865 Issuance of common shares for bank acquisition 455,400 455 4,828 -- -- 5,283 Proceeds from common stock offering, net of offering cost 215,515 216 2,218 -- -- 2,434 Change in unrealized gain (loss) on securities available for sale, net of tax -- -- -- -- 545 545 Cash dividends declared, ($.08 per share) -- -- -- (588) -- (588) Purchase and retirement of treasury stock of pooled entity (737) (1) (6) -- -- (7) Net earnings -- -- -- 6,669 -- 6,669 --------- ------- ----- ------ ---- ------ Balance, December 31, 1995 6,944,783 6,945 18,064 23,912 280 49,201 Change in unrealized gain (loss) on securities available for sale, net of tax -- -- -- -- (368) (368) Cash dividends declared, ($.10 per share) -- -- -- (677) -- (677) Common stock issued in conversion of debentures 178,568 179 821 -- -- 1,000 Purchase and retirement of treasury stock of pooled entity (38,730) (39) (369) -- -- (408) Net earnings -- -- -- 8,927 -- 8,927 --------- ------- ------ ------ ---- ------ Balance, December 31, 1996 7,084,621 7,085 18,516 32,162 (88) 57,675 Change in unrealized gain (loss) on securities available for sale, net of tax -- -- -- -- 919 919 Cash dividends declared, ($.10 per share) -- -- -- (699) -- (699) Net earnings -- -- -- 10,735 -- 10,735 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 7,385,105 $7,385 24,699 42,198 831 75,113 ========= ====== ====== ====== ==== See accompanying notes to consolidated financial statements. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows For the Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995 ---- ---- ---- (In Thousands) Cash flows from operating activities: Net earnings $ 10,735 8,927 6,669 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation, amortization and accretion 2,448 2,347 1,882 Provision for loan losses 2,634 1,597 1,116 Provision for deferred income tax expense (benefit) (404) 82 (95) (Gain) loss on sale of securities available for sale (426) 13 (4) Change in assets and liabilities, net of effects of purchase acquisitions: Interest receivable (2,426) (1,430) (1,831) Interest payable 1,340 267 1,370 Other assets (2,020) (9) 1,003 Accrued expenses and other liabilities (659) 1,059 (1,335) Change in mortgage loans held for sale 2,765 5,321 347 --------- ------- ------- Net cash provided by operating activities 13,987 18,174 9,122 --------- ------- ------- Cash flows from investing activities, net of effects of purchase acquisitions: Cash acquired from acquisitions and branch purchases -- 2,650 25,867 Proceeds from maturities and calls of securities held to maturity 18,009 21,920 14,317 Purchases of securities held to maturity (10,418) (13,762) (29,075) Proceeds from sales of securities available for sale 32,105 18,065 17,520 Proceeds from maturities and calls of securities available for sale 22,470 32,652 11,299 Purchases of securities available for sale (115,501) (62,631) (64,143) Net increase in loans (189,157) (140,507) (68,874) Purchases of premises and equipment (9,702) (3,143) (2,236) --------- -------- ------- Net cash used in investing activities (252,194) (144,756) (95,325) Cash flows from financing activities, net of effects of purchase acquisitions: Net change in demand and savings deposits 52,297 49,312 23,824 Net change in time deposits 151,482 62,394 92,333 Net change in federal funds purchased 33,011 -- (8,300) Proceeds from convertible subordinated debentures -- 3,500 -- Proceeds from notes payable 4,747 -- 2,539 Proceeds from FHLB advances 15,636 29,375 8,596 Repayments of notes payable (1,131) (856) (630) Repayments of FHLB advances (7,389) (3,302) (11,744) Proceeds from sale of common stock 6,477 -- 2,434 Purchase of treasury stock of pooled entity -- (408) (7) Proceeds from resale of treasury stock of pooled entity 6 -- -- Cash paid for dividends (765) (677) (588) --------- ------- ------- Net cash provided by financing activities 254,371 139,338 108,457 --------- ------- ------- Net change in cash and cash equivalents 16,164 12,756 22,254 Cash and cash equivalents at beginning of period 52,670 39,914 17,660 --------- ------- ------- Cash and cash equivalents at end of period $ 68,834 52,670 39,914 ========= ======= ======= See accompanying notes to consolidated financial statements. 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 or the Company) 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 a six 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 (Carolina), Peoples Bank, Blue Ridge, Georgia (Peoples), Towns County Bank, Hiawassee, Georgia (Towns) White County Bank, Cleveland, Georgia (White) and First Clayton Bank and Trust Company, Clayton, Georgia (Clayton) (collectively, the "Bank Subsidiaries") 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 with the current financial statement presentations. The Bank Subsidiaries are commercial banks which serve markets throughout North Georgia and Western North Carolina and provide a full range of customary banking services. The Bank Subsidiaries are insured and subject to the regulation of the Federal Deposit Insurance Corporation. 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 earnings 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 earnings over the remaining life of the security as an adjustment to yield in a manner consistent with the amortization or accretion of premium or discount on the associated security. 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 earnings 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 earnings 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 earnings of the period in which the change occurs. No market valuation allowances were required at December 31, 1997 or 1996. 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 Bank Subsidiaries had no material amounts of impaired loans at December 31, 1997 or 1996. 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. Management believes that 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 using primarily 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. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued 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 the 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, 1997 and 1996, no valuation allowances were required for United's mortgage servicing rights. United recognized approximately $15,000, $137,000 and $790,000 in servicing assets during 1997, 1996 and 1995, respectively, and recognized amortization expense relating to servicing assets of approximately $144,000, $267,000, and $283,000 during 1997, 1996 and 1995, respectively. During 1996, United sold mortgage loan servicing rights with a net book value of approximately $1,254,000. No such sales occurred during 1997 or 1995. 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. Interest Rate Risk Management As part of United's overall interest rate risk management, interest rate swaps and interest rate floors are utilized. These contracts are designated by United as hedges of interest rate exposures, and interest income or expense derived from these contracts is recorded over the life of the contract as an adjustment to interest income or expense of the instruments hedged. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Recent Accounting Pronouncements In 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 127 "Deferral of the Effective Date of Certain Provisions of SFAS No. 125" ("SFAS 127"), Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130") and Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("SFAS 131"). SFAS 127 simply defers, until January 1, 1998, the effective date of selected provisions of a previously issued accounting and disclosure standard. SFAS 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS 131 specifies the presentation and disclosure of operating segment information reported in the annual report and interim reports issued to stockholders. The provisions of SFAS 130 and 131 are effective for fiscal years beginning after December 15, 1997. The management of the Company believes that the adoption of these statements will not have a material impact on the Company's financial position, results of operations, or liquidity. Earnings Per Common Share SFAS No. 128 "Earnings Per Common Share" ("SFAS 128") became effective for the Company for the year ended December 31, 1997. This new standard specifies the computation, presentation and disclosure requirements for earnings per common share and is designed to simplify previous earnings per common share standards and to make domestic and international practices more compatible. Earnings per common share is based on the weighted average number of common shares outstanding during the period while the effects of potential common shares outstanding during the period are included in earnings per common share-assuming dilution. All earnings per common share amounts have been restated to conform to the provisions of SFAS 128. SFAS 128 requires earnings per common share with and without the dilutive effects of potential common stock issuances from instruments such as options, convertible securities and warrants to be presented on the face of the statements of earnings. Additionally, the new statement requires the reconciliation of the amounts used in the computation of both earnings per common share and earnings per common share-assuming dilution. Earnings per common share amounts for the years ended December 31, 1997, 1996 and 1995 are as follows (dollars in thousands, except for per share data): For the Year Ended December 31, 1997 Weighted Average Net Earnings Common Shares Per Share (Numerator) (Denominator) Amount ------------ ------------- --------- Earnings per common share $10,735 7,300,874 $1.47 ===== Effect of dilutive securities: Stock options -- 46,680 Convertible debentures 189 140,000 ------- --------- Earnings per common share - assuming dilution $10,924 7,487,554 $1.46 ======= ========= ===== UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued Earnings Per Common Share, continued For the Year Ended December 31, 1996 Weighted Average Net Earnings Common Shares Per Share (Numerator) (Denominator) Amount ------------ ------------- ---------- Earnings per common share: $ 8,927 6,919,437 $1.29 ===== Effect of dilutive securities: Stock options -- 30,098 Convertible debentures 56 161,311 ------- --------- Earnings per common share - assuming dilution $ 8,983 7,110,846 $1.26 ======= ========= ===== For the Year Ended December 31, 1995 Weighted Average Net Earnings Common Shares Per Share (Numerator) (Denominator) Amount ------------ ------------- --------- Earnings per common share $ 6,669 6,499,264 $1.03 ===== Effect of dilutive securities: Stock options -- 6,897 Convertible debentures 56 178,568 ------- --------- Earnings per common share - assuming dilution $ 6,725 6,684,729 $1.01 ======= ========= ===== (1) Mergers and Acquisitions Effective September 12, 1997, the Company 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 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, 1995. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (1) Mergers and Acquisitions, continued The following is a reconciliation of the amounts of net interest income and net earnings previously reported with the restated amounts (in thousands): 1997 1996 1995 ---- ---- ---- Net interest income: The Company, as previously reported in 1996 and 1995 $40,288 31,368 22,919 Clayton 2,944 2,447 2,096 ------- ------ ------ As restated $43,232 33,815 25,015 ======= ====== ====== Net earnings: The Company, as previously reported in 1996 and 1995 $ 9,974 8,201 6,051 Clayton 761 726 618 ------- ------ ------ As restated $10,735 8,927 6,669 ======= ====== ====== On September 28, 1996, UCB assumed deposits of $23.7 million and purchased certain assets totaling $33.2 million of a branch in Cornelia, Georgia. On August 31, 1995, United acquired all the outstanding common stock of White County Bancshares, Inc., (White Bancshares) the parent company of White County Bank, Cleveland, Georgia. United issued 455,400 shares of its common stock and approximately $10,000 in cash for fractional shares, in exchange for all the outstanding common shares of White Bancshares. Additionally, United exercised its option to convert the exchangeable payable in kind debenture previously acquired during 1994, and the related accrued interest into a majority interest in White County Bank. At the date of acquisition, White County Bank had total assets of $71 million and liabilities of $63 million. The original purchase price was allocated to assets and liabilities acquired based on their fair values at the date of acquisition. This transaction was accounted for as a purchase and, therefore, is not included in United's results of operations or statements of financial position prior to the date of acquisition. (2) Cash Flows United paid approximately $45 million, $34 million and $27 million in interest on deposits and other liabilities during 1997, 1996 and 1995, respectively. In connection with United's 1995 acquisition of White, assets having a fair value of $71 million were acquired and liabilities totaling $63 million were assumed. For the Years Ended December 31, -------------------------------- 1997 1996 1995 ---- ---- ---- Schedule of noncash investing and financing activities (in thousands): Conversion of subordinated debentures into 178,568 shares of common stock $ -- 1,000 -- Common stock issued and conversion of exchangeable payable in kind debenture in connection with the acquisition of White $ -- -- 8,384 Change in unrealized gain (loss) on securities available for sale, net of tax $ 919 (368) 545 (Decrease) increase in dividends payable $ (66) -- -- UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (3) Investment Securities Investment securities at December 31, 1997 and 1996 are as follows (in thousands): December 31, 1997 ------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ----------- --------- Securities Available for Sale: U.S. Treasuries $ 46,304 642 1 46,945 U.S. Government agencies 45,317 268 33 45,552 State and political subdivisions 11,675 189 4 11,860 Mortgage-backed securities 32,970 387 10 33,347 Other 6,256 -- 66 6,190 -------- ----- --- ------- Total $142,522 1,486 114 143,894 ======== ===== === ======= Securities Held to Maturity: U.S. Treasuries $ 500 6 -- 506 U.S. Government agencies 22,361 35 57 22,339 State and political subdivisions 42,330 1,211 8 43,533 Mortgage-backed securities 4,368 109 10 4,467 -------- ----- --- ------- Total $ 69,559 1,361 75 70,845 ======== ===== === ======= December 31, 1997 ------------------------------------------------------ Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value --------- ---------- ----------- --------- Securities Available for Sale: U.S. Treasuries $ 12,771 71 1 12,841 U.S. Government agencies 39,169 59 275 38,953 State and political subdivisions 6,685 162 14 6,833 Mortgage-backed securities 18,644 46 55 18,635 Other 4,104 -- 102 4,002 -------- ----- ---- ------ Total $ 81,373 338 447 81,264 ======== ===== ==== ====== Securities Held to Maturity: U.S. Treasuries $ 2,368 6 -- 2,374 U.S. Government agencies 34,804 42 301 34,545 State and political subdivisions 33,036 646 173 33,509 Mortgage-backed securities 7,118 103 24 7,197 -------- ----- ---- ------ Total $ 77,326 797 498 77,625 ======== ===== ==== ====== The amortized cost and estimated fair value of the securities portfolio at December 31, 1997, 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. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (3) Investment Securities, continued Securities Held Securities Available to Maturity for Sale December 31, 1997 December 31, 1997 ------------------------ ------------------------- Amortized Estimated Amortized Estimated Cost Fair Value Cost Fair Value --------- ---------- ---------- ---------- U.S. Treasuries: Within 1 year $ 500 506 2,242 2,247 1 to 5 years -- -- 42,573 43,184 5 to 10 years -- -- 1,489 1,514 ------- ------ ------- ------- $ 500 506 46,304 46,945 ======= ====== ======= ======= U.S. Government agencies: Within 1 year $17,817 17,801 8,150 8,150 1 to 5 years 4,544 4,538 33,269 33,495 5 to 10 years -- -- 3,898 3,907 ------- ------ ------- ------- $22,361 22,339 45,317 45,552 ======= ====== ======= ======= State and political subdivisions: Within 1 year $ 1,739 1,753 2,569 2,582 1 to 5 years 17,132 17,516 3,019 3,103 5 to 10 years 18,819 19,452 4,103 4,169 More than 10 years 4,640 4,812 1,984 2,006 ------- ------ ------- ------- $42,330 43,533 11,675 11,860 ======= ====== ======= ======= Other: More than 10 years $ -- -- 6,256 6,190 ======= ====== ======= ======= Total securities other than mortgage-backed securities: Within 1 year $20,056 20,060 12,961 12,979 1 to 5 years 21,676 22,054 78,861 79,782 5 to 10 years 18,819 19,452 9,490 9,590 More than 10 years 4,640 4,812 8,240 8,196 Mortgage-backed securities 4,368 4,467 32,970 33,347 ------- ------ ------- ------- $69,559 70,845 142,522 143,894 ======= ====== ======= ======= There were no sales of securities held to maturity during 1997, 1996 and 1995. Proceeds from sales of securities available for sale during 1997, 1996 and 1995 were $ 32 million, $18 million and $18 million, respectively. Gross gains of $451,000, $53,000 and $113,000 for 1997, 1996 and 1995, respectively, along with gross losses of $25,000, $66,000 and $109,000 for 1997, 1996 and 1995, respectively, were realized on those sales. Securities with a carrying value of $65 million and $52 million at December 31, 1997 and 1996, respectively, were pledged to secure public deposits as required by law. 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, 1997 and 1996 are summarized as follows (in thousands): 1997 1996 ---- ---- Commercial, financial and agricultural $105,462 100,538 Real estate - construction 78,699 51,425 Real estate - mortgage 523,629 380,681 Consumer 115,534 101,930 -------- ------- Total loans 823,324 634,574 Less: Allowance for loan losses 10,352 8,125 -------- ------- Loans, net $812,972 626,449 ======== ======= The Bank Subsidiaries grant loans and extensions of credit to individuals and a variety of firms and corporations located primarily in counties in northern Georgia and western North Carolina. Although the Bank Subsidiaries 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 1997 and 1996, certain executive officers and directors of United and its Bank Subsidiaries, including their immediate families and companies with which they are associated, maintained a variety of banking relationships with the Bank Subsidiaries. Total loans outstanding to these persons at December 31, 1997 and 1996 amounted to $15,811,000 and $13,520,000, respectively. The change from December 31, 1996 to December 31, 1997 reflects payments amounting to $8,408,000 and advances of $10,699,000. 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): 1997 1996 1995 ---- ---- ---- Balance at beginning of year $ 8,125 6,884 4,231 Allowance for loan losses acquired from White -- -- 1,813 Provisions charged to earnings 2,634 1,597 1,116 Loans charged off (797) (695) (701) Recoveries of loans previously charged off 390 339 425 ------- ----- ----- Balance at end of year $10,352 8,125 6,884 ======= ===== ===== United serviced approximately $103.5 and $117.4 million of mortgage loans for others at December 31, 1997 and 1996, respectively. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (5) Premises and Equipment Premises and equipment at December 31, 1997 and 1996 are summarized as follows (in thousands): 1997 1996 ---- ---- Land and land improvements $ 6,102 4,770 Building and improvements 14,001 12,667 Furniture and equipment 15,018 10,771 Construction in progress 2,919 167 ------- ------ 38,040 28,375 Less: Accumulated depreciation 10,303 8,267 ------- ------ $27,737 20,108 ======= ====== Depreciation expense was approximately $2.1 million, $1.6 million and $1.4 million in 1997, 1996 and 1995, respectively. (6) Time Deposits At December 31, 1997, contractual maturities of time deposits are summarized as follows ( in thousands): Maturing In: 1998 $509,837 1999 92,144 2000 15,482 2001 13,394 2002 and thereafter 2,452 -------- $633,309 ======== (7) FHLB Advances The Bank Subsidiaries 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 5.51% to 7.81% at December 31, 1997. The majority of the advances represent draws to fund mortgage loans to customers over payment terms longer than those normally given. The FHLB advances are collateralized by first mortgage loans, FHLB stock and other U.S. agency securities. Advances from FHLB outstanding at December 31, 1997 mature as follows ( in thousands): Year 1998 $24,468 1999 15,033 2000 808 2001 307 2002 1,432 2003 and thereafter 1,273 ------- $43,321 ======= UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (8) Notes Payable Notes payable at December 31, 1997 and 1996 consisted of the following (in thousands): 1997 1996 ---- ---- Note payable, due in quarterly installments of $321,455, plus interest, through January 2005, 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. $12,722 10,453 Commercial paper of Finance, due at maturity during 1998 and unsecured. Interest is from 7.15% to 7.25% and is payable monthly. 1,347 -- ------- ------ $14,069 10,453 ======= ====== Aggregate maturities required on the notes payable at December 31, 1997 are as follows: 1998 $ 2,633 1999 1,286 2000 1,286 2001 1,286 2002 1,286 2003 and thereafter 6,292 ------- $14,069 ======= (9) Convertible Subordinated Debentures On December 31, 1996, the holders of convertible debentures of the Company due July 1, 2000 (the "2000 Debentures"), which bore interest at a fixed rate of 9% per annum, converted the 2000 Debentures into an aggregate of 178,568 shares of common stock in accordance with their terms and pursuant to an additional six month period for conversion extended by the Company in order to comply with certain obligations of the Company to provide the holders with notice of the conversion termination date. On December 31, 1996, United also completed a private placement of convertible subordinated 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, payable in quarterly installments commencing on April 1, 1997. 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 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 $3,025,000 at December 31, 1997 and 1996. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (10) Income Taxes During 1997, 1996 and 1995, United made income tax payments of approximately $5.5 million, $4.0 million and $2.7 million, respectively. The components of income tax expense for the years ended December 31, 1997, 1996 and 1995 are as follows (in thousands): 1997 1996 1995 ---- ---- ---- Current $5,170 4,032 2,644 Deferred (reduction) (404) 82 (95) ------ ----- ----- $4,766 4,114 2,549 ====== ===== ===== The differences between the provision for income taxes and the amount computed by applying the statutory federal income tax rate (34 percent) to earnings before income taxes are as follows (in thousands): 1997 1996 1995 ---- ---- ---- Pretax income at statutory rates $5,270 4,434 3,134 Add (deduct): Tax-exempt interest income (878) (828) (789) Nondeductible interest expense 147 127 130 Other 227 381 74 ------ ----- ----- $4,766 4,114 2,549 ====== ===== ===== The following summarizes the sources and expected tax consequences of future taxable deductions (income) which comprise the net deferred tax asset at December 31, 1997 and 1996 (in thousands): 1997 1996 ---- ---- Deferred tax assets: Allowance for loan losses $3,531 2,549 Net operating loss and credit carryforwards 42 349 Unrealized loss on securities available for sale -- 6 Other 32 172 ------ ----- Gross deferred tax assets 3,605 3,076 ------ ----- Deferred tax liabilities: Premises and equipment (1,326) (1,159) Unrealized gain on securities available for sale (541) -- Other (65) (101) ------ ------ Gross deferred tax liabilities (1,932) (1,260) ------ ------ Net deferred tax asset $1,673 1,816 ====== ====== At December 31, 1997, United has a loss carryforward of approximately $1 million for state income taxes which will begin to expire in 2008. The use of this carryforward is limited to future taxable earnings of United and to annual limitations imposed by the tax code. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (11) 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 $803,000, $583,000 and $566,000 in 1997, 1996, and 1995, respectively. (12) Regulatory Matters The Bank Subsidiaries 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 Bank Subsidiaries' financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank Subsidiaries must meet specific capital guidelines that involve quantitative measures of the Bank Subsidiaries' assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank Subsidiaries' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Bank Subsidiaries 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, 1997, that the Bank Subsidiaries meet all capital adequacy requirements to which they are subject. Minimum ratios required by the Bank Subsidiaries 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 Bank Subsidiaries 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 1997 Adequacy Action Adequacy Action Adequacy Action ---- -------- ---------- -------- ---------- -------- ---------- Consolidated $63,520 N/A 31,777 N/A 47,374 N/A UCB 24,391 30,488 12,195 18,293 15,503 19,379 Carolina 17,213 21,516 8,606 12,910 12,980 16,226 1996 Consolidated $48,893 N/A 24,446 N/A 34,159 N/A UCB 19,746 24,682 9,873 14,809 12,401 15,502 Carolina 11,736 14,670 5,868 8,802 8,870 11,807 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (12) Regulatory Matters, continued Actual capital amounts and ratios for United and its most significant subsidiaries as of December 31, 1997 and 1996 are as follows (in thousands): Actual Actual Actual Total Risk Based Tier 1 Risk Based Tier 1 Leverage ----------------- ------------------ ----------------- Actual Actual Actual 1997 Amount Ratio Amount Ratio Amount Ratio ---- ------ ----- ------ ----- ------ ----- Consolidated $81,614 10.28% 68,184 8.59% 68,184 5.76% UCB 33,303 10.92% 29,733 9.75% 29,733 7.67% Carolina 23,260 10.81% 20,566 9.56% 20,566 6.34% 1996 ---- Consolidated $62,241 10.18% 51,102 8.36% 51,102 5.98% UCB 25,036 10.14% 22,518 9.12% 22,518 7.26% Carolina 17,052 11.62% 15,259 10.40% 15,259 6.88% As of December 31, 1997 and 1996, the most recent notification from the Federal Deposit Insurance Corporation categorized each Bank subsidiary as well capitalized under the regulatory framework for prompt corrective action. (13) Commitments The Bank Subsidiaries 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 sheets. The contract amounts of these instruments reflect the extent of involvement the Bank Subsidiaries 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 and letters of credit and financial guarantees written is represented by the contractual amount of these instruments. The Bank Subsidiaries 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, the contract or notional amount of off-balance sheet instruments (in thousands): 1997 1996 ---- ---- Financial instruments whose contract amounts represent credit risk: Commitments to extend credit $106,040 64,091 Standby letters of credit $ 2,520 1,721 Interest rate contracts: Swap agreements $ 35,000 35,000 Floors purchased $ 50,000 50,000 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 Bank Subsidiaries 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. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (13) Commitments, continued Standby letters of credit and financial guarantees written are conditional commitments issued by the Bank Subsidiaries 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 Bank Subsidiaries 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. Derivative financial instruments include forwards, futures, swaps, options, and other instruments with similar characteristics. In general terms, derivative instruments are contracts or agreements whose value can be derived from interest rates, currency exchange rates and financial indices. The Bank Subsidiaries use interest rate contracts in balance sheet management activities, the objective of which is to minimize the risk inherent in the asset and liability interest rate structure. The Bank Subsidiaries do not use derivative financial instruments for trading purposes. Interest rate contracts include an agreement with a counterparty to exchange cash flow based on the movement of an underlying interest rate included such as the prime rate or the London International Borrowing Rate (LIBOR). A swap agreement involves the exchanges of a series of interest payments, either at a fixed or variable rate, based on a notional amount without the exchange of the underlying principal. An interest rate floor contract allows a party, for a purchase premium, to receive income if a predetermined interest rate falls below a predetermined level. Income or expense on interest rate contracts used by the Bank Subsidiaries to manage interest rate exposure is recorded on an accrual basis as an adjustment to the yield of the related interest earning asset or interest bearing liability over the period covered by the contracts. Amounts accrued relating to such contracts are included in accrued expenses and other liabilities as of the balance sheet date. The Bank Subsidiaries' exposure from these interest rate contracts results from the possibility that one party may default on its contractual obligation (credit risk) or from the movement of interest rates (market risk). Credit risk is limited to the positive market value of the derivative, which is significantly less than its notional value since the notional amount only represents the basis for determining the exchange of the cash flows. Credit risk is minimized by performing credit reviews of the counterparties to the contract or by conducting activities through organized exchanges. (14) 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, 1997 and 1996, there were no preferred shares issued or outstanding. (15) Stockholders' Equity Dividends paid by the Bank Subsidiaries 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 Bank Subsidiaries. At December 31, 1997, approximately $12.9 million of the Bank Subsidiaries' 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 Subsidiary's total capital in relation to its assets, deposits and other such items. Capital adequacy considerations could further limit the availability of dividends from the Bank Subsidiaries. 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 Bank Subsidiaries 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 up to 300,000 shares of United's common stock at a price equal to the fair market value at the date of grant. At December 31, 1997, 128,296 shares were available for grant under this plan. No options were exercised in 1997, 1996 or 1995. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (15) Stockholder's Equity, continued SFAS No. 123, "Accounting for Stock-Based Compensation," became effective for the Company January 1, 1996. This statement 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. The Company has chosen not to adopt the cost recognition principles of this statement. No compensation expense has been recognized in 1997, 1996 or 1995 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 the new statement, the Company's net earnings and earnings per share would have been reduced to the pro forma amounts indicated below (in thousands, except per share data): 1997 1996 1995 ---- ---- ---- Net earnings As reported $10,735 8,927 6,669 Pro forma $10,526 8,893 6,574 Earnings per common share As reported $ 1.47 1.29 1.03 Pro forma $ 1.44 1.29 1.01 Earnings per common share-assuming dilution As reported $ 1.46 1.26 1.01 Pro forma $ 1.43 1.25 .99 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 1997, 1996 and 1995, respectively: dividend yield of 1%, risk free interest rates of 6%, 6% and 5%, and an expected life of 10 years. A summary of activity in the Company'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, 1995 50,000 $10.00 $10.00 Options granted in 1996 42,000 $18.00 $18.00 ------- Options outstanding at December 31, 1996 92,000 $13.65 $10.00 - 18.00 Options granted in 1997 79,704 $22.15 $22.00 - 22.51 ------- Options outstanding at December 31, 1997 171,704 $17.60 $10.00 - 22.51 ======= Options on 102,104 and 58,400 shares were exercisable at December 31, 1997 and 1996, respectively. The weighted average grant-date fair value of options granted in 1997 and 1996 was $7.93 and $6.45, respectively. Such options have a weighted average remaining contractual life of approximately 8 years as of December 31, 1997. (16) Supplemental Financial Data Components of other operating expenses in excess of 1% of total interest and other noninterest income for the years ended December 31, 1997, 1996 and 1995 are as follows (in thousands): 1997 1996 1995 ---- ---- ---- Stationery and supplies $ 831 1,152 512 Advertising 1,486 704 646 UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (17) United Community Banks, Inc. (Parent Company Only) Financial Information Balance Sheets December 31, 1997 and 1996 1997 1996 ---- ---- (In thousands) Assets Cash $ 281 1,550 Investment in subsidiaries 82,902 65,559 Other assets 8,995 5,455 ------- ------ $92,178 72,564 ======= ====== Liabilities and Stockholders' Equity Other liabilities $ 843 936 Notes payable 12,722 10,453 Convertible subordinated debentures 3,500 3,500 Stockholders' equity 75,113 57,675 ------- ------ $92,178 72,564 ======= ====== UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (17) United Community Banks, Inc. (Parent Company Only) Financial Information, continued Statements of Earnings For the Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995 ---- ---- ---- (In thousands) Income: Dividends from Bank Subsidiaries $ 1,150 5,361 1,680 Other 730 87 170 ------- ----- ----- Total income 1,880 5,448 1,850 ------- ----- ----- Expenses: Interest on notes payable and subordinated debentures 1,045 882 910 Other 2,097 1,266 428 ------- ----- ----- Total expense 3,142 2,148 1,338 ------- ----- ----- Earnings (loss) before income tax benefit and equity in undistributed earnings of subsidiaries (1,262) 3,300 512 Income tax benefit 823 739 350 ------- ----- ----- Earnings (loss) before equity in undistributed earnings of subsidiaries (439) 4,039 862 Equity in undistributed earnings of subsidiaries 11,174 4,888 5,807 ------- ----- ----- Net earnings $10,735 8,927 6,669 ======= ===== ===== UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (17) United Community Banks, Inc. (Parent Company Only) Financial Information, continued Statements of Cash Flows For the Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995 ---- ---- ---- (In thousands) Cash flows from operating activities: Net earnings $10,735 8,927 6,669 Adjustments to reconcile net earnings to net cash provided by (used in) operating activities: Equity in undistributed earnings of Bank Subsidiaries (11,174) (4,888) (5,807) Depreciation, amortization and accretion 300 203 185 Change in: Other assets (2,567) (33) (205) Accrued interest payable 27 (39) 39 Other liabilities (54) (263) (18) ------- ------ ------ Net cash provided by (used in) operating activities (2,733) 3,907 863 ------- ------ ------ Cash flows from investing activities: Purchase of premises and equipment (1,273) -- -- Cash paid in lieu of fractional shares -- -- (10) Capital contributions to Bank Subsidiaries (5,250) (4,275) (4,500) ------ ------ ------ Net cash used in investing activities (6,523) (4,275) (4,510) ------ ------ ------ Cash flows from financing activities: Proceeds from convertible subordinated debentures -- 3,500 -- Proceeds from notes payable 3,400 -- 2,539 Repayments of notes payable (1,131) (856) (630) Proceeds from sale of common stock 6,477 -- 2,434 Purchase and retirement of treasury stock of pooled entity -- (408) (7) Proceeds from resale of treasury stock of pooled entity 6 -- -- Dividends paid (765) (677) (588) ------- ------ ------ Net cash provided by financing activities 7,987 1,559 3,748 ------- ------ ------ Net change in cash (1,269) 1,191 101 Cash at beginning of year 1,550 359 258 ------- ------ ------ Cash at end of year $ 281 1,550 359 ======= ====== ====== (18) 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 Bank Subsidiaries, but rather a good-faith estimate of the increase or decrease in value of financial instruments held by United since purchase, origination, or issuance. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (18) Fair Value of Financial Instruments, continued 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. 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 The carrying amount of federal funds purchased is a reasonable estimate of fair value. FHLB 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. Notes Payable and Convertible Subordinated Debentures Notes payable and convertible subordinated debentures are made using variable rates, thus, the carrying amount is a reasonable estimate of fair value. Interest Rate Swaps and Interest Rate Floors The fair value of interest rate swaps and interest rate floors is obtained from dealer quotes. These values represent the estimated amount United would receive 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, the contract value is a reasonable estimate of fair value. 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. UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, continued (18) Fair Value of Financial Instruments, continued The carrying amount and estimated fair values of United's financial instruments at December 31, 1997 and 1996 are as follows (in thousands): December 31, 1997 December 31, 1996 --------------------- --------------------- Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value -------- ---------- ------- ---------- Assets: Cash and cash equivalents $ 68,834 68,834 52,670 52,670 Securities held to maturity 69,559 70,845 77,326 77,625 Securities available for sale 143,894 143,894 81,264 81,264 Mortgage loans held for sale 3,962 3,962 6,727 6,727 Loans, net 812,972 814,855 626,449 629,107 Liabilities: Deposits 977,079 981,580 773,300 778,068 Federal funds purchased 33,011 33,011 -- -- FHLB advances 43,321 43,087 35,074 34,863 Notes payable 14,069 14,070 10,453 10,453 Convertible subordinated debentures 3,500 3,500 3,500 3,500 Unrecognized financial instruments: Commitments to extend credit 106,040 106,040 64,091 64,091 Standby letters of credit 2,520 2,520 1,721 1,721 Swap agreements 12 156 17 97 Floors purchased 3 -- 33 21 [ATTACHMENT - PROXY CARD] COMMON STOCK OF UNITED COMMUNITY BANKS, INC. THIS PROXY IS SOLICITED BY THE BOARD OF DIRECTORS FOR THE 1998 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 April 16, 1998, and any adjournment thereof. 1. [box] FOR all nominees for director listed below (except as indicated to the contrary): Jimmy C. Tallent; Billy M. Decker; Thomas C. Gilliland; Robert L. Head, Jr.; Charles E. Hill; Hoyt O. Holloway; P. Deral Horne; John R. Martin; Clarence W. Mason, Sr.; W. C. Nelson, Jr.; Charles E. Parks (Instruction: To withhold authority to vote for any individual nominee, write that nominee's name on the space provided below) [box] WITHHOLD AUTHORITY to vote for all nominees listed above. 2. In accordance with their best judgment with respect to any other matters that may properly come before the meeting. THE BOARD OF DIRECTORS FAVORS A VOTE "FOR" THE ELECTION AS DIRECTORS OF THE PERSONS NAMED IN THE PROXY AND UNLESS INSTRUCTIONS TO THE CONTRARY ARE INDICATED IN THE SPACE PROVIDED, THIS PROXY WILL BE SO VOTED. Please sign this Proxy exactly as name appears on the Proxy. Note: When signing as an attorney, trustee, administrator or guardian, please give your title as such. In the case of joint tenants, each joint owner must sign. Date: _________________________________