UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from ___________ to ___________
Commission file number 0-21656
UNITED COMMUNITY BANKS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Georgia 58-180-7304
- - ------------------------ ------------------------------------
(State of incorporation) (I.R.S. Employer Identification No.)
P.O. Box 398, 59 Highway 515
Blairsville, Georgia 30512
- - ------------------------------- ----------
(Address of principal executive (Zip Code)
Offices)
(706 ) 745-2151
------------------
(Telephone number)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
YES /XX/ NO / /
Common stock, par value $1 per share: 7,393,605 shares
outstanding as of November 16, 1998
PART I Financial Information
Item 1. Financial Statements
UNITED COMMUNITY BANKS, INC. & SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
September 30, December 31,
1998 1997
------------- ------------
(In Thousands)
ASSETS
Cash and due from banks $ 42,313 $ 60,414
Federal funds sold 13,585 8,420
----------- -----------
Cash and cash equivalents 55,898 68,834
----------- -----------
Securities held to maturity (estimated fair value of $ 63,443 and $70,845) 61,590 69,559
Securities available for sale (amortized cost of $208,964 and $145,522) 208,917 143,894
Mortgage loans held for sale 6,296 3,962
Loans, net of unearned income 941,643 823,324
Less: Allowance for loan losses (11,536) (10,352)
----------- -----------
Loans, net 930,107 812,972
----------- -----------
Premises and equipment, net 35,787 27,737
Accrued interest receivable 12,872 10,985
Other assets 15,104 15,424
----------- -----------
$ 1,326,571 $ 1,153,367
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 134,941 109,210
Interest bearing 984,587 867,869
----------- -----------
Total deposits 1,119,528 977,079
Accrued expenses and other liabilities 10,000 7,274
Federal funds purchased - 33,011
Federal Home Loan Bank advances 87,024 43,321
Long-term debt and other borrowings 4,774 17,569
Company obligated manditorily redeemable capital
securities of subsidiary trust holding solely junior
subordinated debentures of the Company 21,000 -
----------- -----------
Total liabilities 1,242,326 1,078,254
----------- -----------
Stockholders' equity:
Preferred Stock
Common stock, $1 par value; 10,000,000 shares authorized; - -
7,393,605 and 7,385,105 shares issued and outstanding 7,394 7,385
Capital surplus 24,808 24,699
Retained earnings 50,057 42,198
Accumulated other comprehensive income 1,986 831
----------- -----------
Total stockholders' equity 84,245 75,113
----------- -----------
$ 1,326,571 $ 1,153,367
============ ===========
See accompanying notes to consolidated fiancial statements.
UNITED COMMUNITY BANKS, INC. & SUBSIDIARIES
Consolidated Statements of Income
(Unaudited)
For the Three Months Ended, For the Nine Months Ended,
September 30, September 30,
-------------------------- --------------------------
1998 1997 1998 1997
------- ------- ------- -------
(In Thousands Except Share and Per Share Data)
INTEREST INCOME:
Interest and fees on loans $ 24,186 $ 19,841 $ 68,280 $ 55,435
Interest on federal funds sold 507 797 1,202 1,581
Interest on investment securities 803 1,098 2,630 2,954
Interest on investment securities available for sale 2,712 1,715 7,592 5,337
---------- ---------- ---------- ----------
Total interest income 28,208 23,451 79,704 65,307
---------- ---------- ---------- ----------
INTEREST EXPENSE:
Interest on deposits 12,875 11,479 37,246 31,341
Interest on Federal Home Loan Bank advances 1,325 661 2,850 1,800
Interest on long-term debt and other borrowings 169 273 918 873
Interest on Company obligated manditorily redeemable
capital securities of subsidiary trust holding solely
junior subordinated debentures of the Company 344 - 344 -
---------- ---------- ---------- ----------
Total interest expense 14,713 12,413 41,358 34,014
---------- ---------- ---------- ----------
Net interest income 13,495 11,038 38,346 31,293
Provision for loan losses 567 768 1,605 2,066
---------- ---------- ---------- ----------
Net interest income after provision for loan losses 12,928 10,270 36,741 29,227
---------- ---------- ---------- ----------
NONINTEREST INCOME:
Service charges and fees 1,300 1,158 3,777 3,190
Securities gains, net 43 250 214 558
Mortgage loan and related fees 462 263 1,342 814
Other noninterest income 228 69 621 445
---------- ---------- ---------- ----------
Total noninterest income 2,033 1,740 5,954 5,007
---------- ---------- ---------- ----------
NONINTEREST EXPENSE:
Salaries and employee benefits 5,800 4,485 16,795 12,789
Occupancy 1,663 1,312 4,655 3,561
Other noninterest expense 2,787 2,035 8,164 6,535
---------- ---------- ---------- ----------
Total noninterest expense 10,250 7,832 29,614 22,885
---------- ---------- ---------- ----------
Earnings before income taxes 4,711 4,178 13,081 11,349
Income taxes 1,563 1,322 4,391 3,611
---------- ---------- ---------- ----------
NET INCOME $ 3,148 $ 2,856 $ 8,690 $ 7,738
========== ========== ========== ==========
Basic earnings per share $ 0.43 $ 0.39 $ 1.18 $ 1.06
Diluted earnings per share $ 0.42 $ 0.38 $ 1.16 $ 1.06
Dividends declared per common share $ 0.0375 $ 0.025 $ 0.113 $ 0.075
Average shares outstanding 7,394 7,385 7,391 7,272
Diluted average shares outstanding 7,632 7,580 7,619 7,452
/TABLE
UNITED COMMUNITY BANKS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
For the Three Months Ended For the Nine Months Ended,
September 30, September 30,
--------------------------- --------------------------
1998 1997 1998 1997
----- ----- ------ ------
NET INCOME $ 3,148 $ 2,856 $ 8,690 $ 7,738
OTHER COMPREHENSIVE INCOME, BEFORE TAX:
Unrealized holding gains (losses) on investment securities 1,976 1,219 2,077 1,598
Less reclassification adjustment for gains (losses) on
securities available for sale 43 250 214 558
------- ------- -------- -------
Total other comprehensive income, before tax 1,933 969 1,863 1,040
INCOME TAX EXPENSE (BENEFIT) RELATED TO OTHER
COMPREHENSIVE INCOME
Unrealized holding gains (losses) on investment securities 751 463 789 607
Less reclassification adjustment for gains (losses) on
securities available for sale 16 95 81 212
------- ------- -------- -------
Total income tax expense (benefit) related to other
comprehensive income 735 368 708 395
Total other comprehensive income, net of tax 1,198 601 1,155 645
------- ------- -------- -------
Total comprehensive income $ 4,346 $ 3,457 $ 9,845 $ 8,383
======= ======= ======== =======
UNITED COMMUNITY BANKS, INC. & SUBSIDIARIES
Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended
September 30,
1998 1997
---------- ----------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 8,690 $ 7,738
Adjustments to reconcile net income to net cash
provided (used) by operating activities:
Depreciation, amortization and accretion 1,849 1,663
Provision for loan losses 1,605 2,066
Loss (gain) on sale of investment securities (214) (558)
Change in assets and liabilities:
Interest receivable (1,887) (2,047)
Interest payable 260 1,041
Other assets (306) 861
Accrued expenses and other liabilities 2,466 (938)
Change in mortgage loans held for sale (2,334) 2,395
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 10,129 12,221
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from maturities and calls of securities held to maturity 21,020 13,258
Purchases of securities held to maturity (13,095) (9,614)
Proceeds from sales of securities available for sale 13,865 21,194
Proceeds from maturities and calls of securities available for sale 33,830 15,226
Purchases of securities available for sale (110,476) (92,310)
Net increase in loans (118,740) (148,076)
Proceeds from sale of other real estate 113 -
Purchase of bank premises and equipment (9,428) (5,650)
------------ ------------
NET CASH USED IN INVESTING ACTIVITIES (182,911) (205,972)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand and savings deposits 98,277 32,190
Net increase in time deposits 44,172 139,809
Net change in federal funds purchased (33,011) 8,100
Net change in FHLB advances 43,703 3,684
Net change in long-term debt and other borrowings (12,795) 179
Net proceeds from issuance of Capital Securities (1) 20,120 -
Net proceeds from sale of common stock 119 6,476
Dividends paid (739) (501)
------------ ------------
Net cash provided by financing activities 159,846 189,937
------------ ------------
Net increase (decrease) in cash and cash equivalents (12,936) (3,814)
Cash and cash equivalents at beginning of period 68,834 52,666
------------ ------------
Cash and cash equivalents at end of period $ 55,898 $ 48,852
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 41,098 $ 34,628
Income Taxes $ 3,975 $ 3,985
(1) See note 2 of Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SIGNIFICANT ACCOUNTING POLICIES
The accounting and financial reporting policies of United Community
Banks, Inc. (the Company) and its subsidiaries conform to generally
accepted accounting principles and general banking industry practices.
The following consolidated financial statements have not been audited
and all material intercompany balances and transactions have been
eliminated. A more detailed description of the company's accounting
policies is included in the 1997 annual report filed on form 10-K.
In management's opinion, all accounting adjustments necessary to
accurately reflect the financial position and results of operations on
the accompanying financial statements have been made. These
adjustments are considered normal and recurring accruals considered
necessary for a fair and accurate presentation. The results for
interim periods are not necessarily indicative of results for the full
year or any other interim periods.
NOTE 2 - CAPITAL SECURITIES
In July, 1998, a statutory business trust ("United Community Capital
Trust") was created by the Company which in July, 1998, issued
guaranteed preferred beneficial interests in the Company's junior
subordinated preferrable interest debentures ("Capital Securities") to
institutional investors in the amount of $21 million. This issuance
represented the guaranteed preferred beneficial interests in $21
million in junior subordinated deferrable interest debentures
("Subordinated Debentures") issued by the Company to United Community
Capital Trust. For regulatory purposes, the Capital Securities will
be treated as Tier I capital of the Company. The subordinated
debentures are the sole assets of United Community Capital Trust and
bear an interest rate of 8.125% with a maturity date of July 15, 2028,
which may be shortened to a date not earlier than January 15, 2008.
If the subordinated debentures are redeemed in part or in whole prior
to January 15, 2008, the redemption price of the Subordinated Debentures
and the Capital Securities will include a premium ranging from 4.06%
in 2008 to 0.41% in 2017.
Note 3 - Earnings Per Share
Three Months Ended Nine Months Ended
September 30 September 30
--------------------- ----------------------
1998 1997 1998 1997
---- ---- ---- ----
(In thousands, except per share data)
-------------------------------------
(Unaudited)
------------
Basic earnings per share:
Weighted average shares outstanding $ 7,394 $ 7,385 $ 7,391 $ 7,272
Net income 3,148 2,856 8,690 7,738
Basic earnings per share 0.43 0.39 1.18 1.06
Diluted earnings per share:
Weighted average shares outstanding 7,394 7,385 7,391 7,272
Net effect of the assumed exercise of
stock options based on the treasury
stock method using average market
price for the period 98 55 88 40
Effect of conversion of subordinated debt 140 140 140 140
------- ------- ------- -------
Total weighted average shares and common
stock equivalents outstanding 7,632 7,580 7,619 7,452
Net income, as reported 3,148 2,856 8,690 7,738
Income effect of conversion of subordinated
debt, net of tax 47 47 142 142
------- ------- ------- -------
Net income, adjusted for effect of conversion
of subordinated debt, net of tax $ 3,195 $ 2,903 $ 8,832 $ 7,880
Diluted earnings per share 0.42 0.38 1.16 1.06
NOTE 4 - RECENTLY ISSUED ACCOUNTING STANDARDS
During 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (SFAS 130). SFAS 130 became effective in the
first quarter of 1998 and requires a disclosure of comprehensive
income in a full set of general-purpose financial statements. In
addition to net income, comprehensive income includes all other
changes in stockholders' equity during the reporting period except
those resulting from investments from or distributions to
stockholders. The company is presenting a consolidated statement of
comprehensive income in order to comply with this disclosure
requirement.
During June 1998, the FASB issued Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS No. 133). SFAS No. 133 standardizes
the accounting for derivative instruments, including certain
derivative instruments imbedded in other contracts. Under this new
standard, companies are required to carry all derivative instruments
in the statement of financial position at market value. The Company
must adopt SFAS 133 by January 1, 2000, although the FASB will permit
earlier adoption. Once adopted, the provisions of SFAS must be
applied prospectively.
The Company does not anticipate that adoption of SFAS 133 will have a
material impact on the financial statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This discussion contains forward-looking statements under the Private
Securities Litigation Reform Act of 1995 that involve risks and
uncertainties. Although the Company believes that the assumptions
underlying the forward-looking statements contained in the discussion
are reasonable, any of the assumptions could be inaccurate, and
therefore, no assurance can be made that any of the forward-looking
statements included in this discussion will be accurate. Factors
that could cause actual results to differ from results discussed in
forward-looking statements include, but are not limited to: economic
conditions (both generally and in the markets where the Company
operates); competition from other providers of financial services
offered by the Company; government regulation and legislation;
changes in interest rates; material unforeseen changes in the
financial stability and liquidity of the Company's credit customers;
material unforeseen complications related to the Year 2000 issues for
the Company, its suppliers, customers and governmental agencies; and
other risks detailed in the Company's filings with the Securities and
Exchange Commission, all of which are difficult to predict and which
may be beyond the control of the Company. The Company undertakes no
obligation to revise forward-looking statements to reflect events or
changes after the date of this discussion or to reflect the occurrence
of unanticipated events.
OVERVIEW
United Community Banks, Inc. (the "Company") is a bank holding
company registered under the Bank Holding Company Act of 1956. The
company has six commercial bank subsidiaries that operate primarily in
North Georgia and Western North Carolina. As of September 30, 1998,
the Company had 26 bank branches in operation. Total assets at
September 30, 1998 were $1.3 billion, compared to $1.2 billion at
December 31, 1997. This increase represents annualized growth of
approximately 20%.
RECENT DEVELOPMENTS
The Company opened a de novo branch in Etowah, North Carolina
during July, 1998, and is planing to open a de novo branch in
Cherokee, North Carolina by the end of 1998. In addition, a de
novo branch is currently under construction in Murrayville, Georgia,
with a scheduled opening date of April, 1999.
INCOME SUMMARY
For the nine months ended September 30, 1998, the Company reported
net income of $8.7 million, or $1.16 per diluted share, compared to
$7.7 million, or $1.06 per diluted share, for the same period in 1997.
The year-to-date results for 1998 result in an annualized return on
assets and equity of .94% and 14.68%, respectively, compared to 1.04%
and 15.95%, respectively, for the same period in 1997. Net income for
the three months ended September 30, 1998 was $3.1 million, or $.42
per diluted share, compared to $2.9 million, or $.38 per diluted
share, for the same period last year.
Net income for the nine months ended September 30, 1998 increased
12% compared to the same period in 1997. This increase was the
result of an increase in net interest income of $7.0 million, or 23%,
a reduction in provision for loan loss of $461 thousand, or 22%, an
increase in non-interest income of $947 thousand, or 19%, an increase
in non-interest expense of $6.7 million, or 29%, and an increase in
income taxes of $780 thousand, or 22%.
NET INTEREST INCOME
Net interest income is the largest source of the Company's operating
income. Net interest income on a tax-equivalent basis was $39.2
million for the nine months ended September 30, 1998, compared to
$31.9 million for the same period in 1997, an increase of 23%. The
increase in net interest income is primarily attributable to increases
in outstanding average loans of $169 million, or 24%, and average
securities of $48 million, or 26%, for the nine months ended September 30,
1998 as compared to the prior year. These increases in average interest
earning assets were funded primarily with increased average deposit
balances of $184 million, or 21%, and increased average borrowed
funds of $34 million, or 63%.
Net interest income on a tax-equivalent basis for the quarter
ended September 30, 1998 was $13.8 million, an increase of $2.5
million, or 23%, from the third quarter of 1997. This increase is
primarily attributed to increases in outstanding average loans of $172
million, or 23%, and average securities of $55 million, or 27%, for
the third quarter of 1998 as compared to the same period in 1997.
For the nine months ended September 30, 1998, the net interest
margin (net interest income as a percentage of average interest
earning assets) on a tax-equivalent basis was 4.59%, unchanged from
the same period in 1997. The net interest margin for the quarter
ended September 30, 1998 was 4.51%, a 2 basis point improvement over
the same period in 1997.
The following tables show the relative impact of changes in average
balances of interest earning assets and interest bearing liabilities,
and interest rates earned (on a fully-tax equivalent basis) and paid
by the company on those assets and liabilities, for the nine and six
month periods ended September 30, 1998 and 1997.
AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST ANALYSIS
(UNAUDITED)
In thousands
Nine Months Ended Nine Months Ended
Average Average Average Average
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ------- -------- -------
ASSETS:
Interest-earning assets:
Loans, net of unearned income $ 879,132 $ 68,328 10.39% $ 710,248 $ 55,503 10.45%
Securities 234,376 11,038 6.30% 186,731 8,878 6.36%
Federal funds sold
and other interest income 27,615 1,202 5.82% 33,300 1,581 6.35%
----------- -------- --------- --------
TOTAL INTEREST-EARNING ASSETS /
INTEREST INCOME 1,141,123 80,569 9.44% 930,279 65,962 9.48%
-------- --------
NON-INTEREST-EARNING ASSETS:
Cash and due from banks 38,439 26,641
Premises and equipment 31,730 21,888
Other assets 20,846 12,506
----------- ---------
TOTAL ASSETS $ 1,232,138 $ 991,314
============ =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits:
Interest-bearing demand (NOW) $ 190,244 $ 5,919 4.16% $ 137,966 $ 4,039 3.91%
Savings deposits 50,874 1,068 2.81% 42,764 883 2.76%
Money market accounts 36,889 960 3.48% 35,952 902 3.35%
Certificates of deposit 654,432 29,299 5.99% 563,582 25,518 6.05%
Individual Retirement Accounts ----------- -------- --------- --------
Total interest-bearing deposits 932,439 37,246 5.34% 780,264 31,342 5.37%
Federal Home Loan Bank
advances 66,360 2,850 5.74% 39,689 1,800 6.06%
Long-term debt and other borrowing <F1> 20,828 1,262 8.10% 13,879 872 8.40%
----------- -------- --------- --------
Total borrowed funds 87,188 4,112 6.31% 53,568 2,672 6.67%
----------- -------- --------- --------
TOTAL INTEREST-BEARING LIABILITIES /
INTEREST EXPENSE $ 1,019,627 $ 41,358 5.42% $ 833,832 $ 34,014 5.45%
NON-INTEREST-BEARING LIABILITIES:
Non-interest-bearing deposits 122,143 90,302
Other liabilities 7,972 6,484
------------ ---------
Total liabilities 1,149,742 930,618
Shareholders' equity 82,396 $ 60,696
----------- ---------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $ 1,232,138 $ 991,314
=========== =========
Net interest-rate spread 4.02% 4.03%
Impact of non-interest bearing
sources and other changes in
balance sheet composition 0.57% 0.56%
------ -----
NET INTEREST INCOME /
MARGIN ON INTEREST-EARNING ASSETS $ 39,211 4.59% $ 31,948 4.59%
========= ====== ======== =====
<FN>
<F1> Includes Capital Trust Securities
</FN>
/TABLE
Nine Months Ended September 30, 1998
Compared to 1997
-------------------------------------
Increase (decrease)
in interest income and expense
due to changes in:
Volume Rate Total
------ ------ ------
Interest-earning assets:
Loans $13,128 $ (303) $12,825
Securities 2,245 (84) 2,161
Mortgage loans held for sale
Federal funds sold
and other interest income (255) (124) (379)
------- ------- -------
TOTAL INTEREST-EARNING ASSETS 15,118 (511) 14,607
INTEREST-BEARING LIABILITIES:
Interest-bearing demand (NOW) 1,613 267 1,880
Savings deposits 170 15 185
Money market accounts 24 34 58
Certificates of deposit 4,070 (289) 3,781
Brokered certificates of deposit
Other time deposits
------- ------- -------
Total interest-bearing deposits 5,877 27 5,904
Federal funds purchased
and repurchase agreements 1,150 (100) 1,050
Long-term debt and other borrowing <F1> 422 (32) 390
------- ------- -------
Total borrowed funds 1,572 (132) 1,440
------- ------- -------
TOTAL INTEREST-BEARING LIABILITIES 7,449 (105) 7,344
------- ------- -------
INCREASE (DECREASE)
IN NET INTEREST INCOME $ 7,669 $ (406) $ 7,263
======= ======= =======
<FN>
<F1> Includes Capital Trust Securities
</FN>
/TABLE
AVERAGE CONSOLIDATED BALANCE
(UNAUDITED)
In thousands
Three Months Ended Three Months Ended
September 30, 1998 September 30, 1997
Average Average Average Average
Balance Interest Rate Balance Interest Rate
------------ ---------- ------- ------------ --------- -------
ASSETS:
Interest-earning assets:
Loans, net of unearned income $ 922,558 $ 24,203 10.41% $ 750,635 $ 19,866 10.50%
Securities 257,434 3,809 5.87% 202,759 3,021 5.91%
Federal funds sold
and other interest income 33,696 507 5.97% 42,484 797 7.44%
------------ --------- ------------ ---------
TOTAL INTEREST-EARNING ASSETS /
INTEREST INCOME $ 1,213,688 28,520 9.32% 995,878 23,683 9.43%
--------- ---------
NON-INTEREST-EARNING ASSETS:
Cash and due from banks 40,349 28,207
Premises and equipment 33,542 23,649
Other assets 26,528 12,274
------------ ------------
TOTAL ASSETS $ 1,314,107 $ 1,060,007
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest-bearing liabilities:
Interest-bearing deposits:
Interest-bearing demand (NOW) $ 207,592 $ 2,169 4.15% 145,365 $ 1,433 3.91%
Savings deposits 53,729 386 2.85% 43,838 305 2.76%
Money market accounts 40,462 349 3.42% 36,182 309 3.39%
Certificates of deposit 663,454 9,971 5.96% 612,989 9,432 6.10%
------------ --------- ------------ ---------
Total interest-bearing deposits 965,237 12,875 5.29% 838,375 11,479 5.43%
Federal Home Loan Bank
advances 92,768 1,325 5.67% 42,418 661 6.18%
Long-term debt and other borrowing <F1> 23,515 513 8.66% 13,635 273 7.94%
------------ --------- ------------ ---------
Total borrowed funds 116,284 1,838 6.27% 56,053 934 6.61%
------------ --------- ------------ ---------
TOTAL INTEREST-BEARING LIABILITIES /
INTEREST EXPENSE $ 1,081,521 $ 14,713 5.40% $ 894,428 $ 12,413 5.51%
NON-INTEREST-BEARING LIABILITIES:
Non-interest-bearing deposits 132,210 99,140
Other liabilities 8,745 6,944
------------ -----------
Total liabilities 1,222,476 1,000,512
Shareholders' equity 91,631 $ 59,496
------------ -----------
TOTAL LIABILITIES
AND SHAREHOLDERS' EQUITY $ 1,314,107 $ 1,060,007
============ ===========
Net interest-rate spread 3.92% 3.92%
Impact of non-interest bearing
sources and other changes in
balance sheet composition 0.59% 0.57%
------ ------
NET INTEREST INCOME /
MARGIN ON INTEREST-EARNING ASSETS $ 13,807 4.51% $ 11,270 4.49%
========= ======= ======== =======
<FN>
<F1> Includes Capital Trust
/TABLE
Three Months Ended September 30, 1998
Compared to 1997
------------------------------------
Increase (decrease)
in interest income and expense
due to changes in:
Volume Rate Total
------ ------- -------
INTEREST-EARNING ASSETS:
Loans $4,512 $ (174) $4,338
Securities 809 (20) 789
Mortgage loans held for sale
Federal funds sold
and other interest income (148) (142) (290)
------ -------- ------
TOTAL INTEREST-EARNING ASSETS 5,173 (336) 4,837
INTEREST-BEARING LIABILITIES:
Interest-bearing demand (NOW) 646 90 736
Savings deposits 71 10 81
Money market accounts 37 3 40
Certificates of deposit 762 (223) 539
Brokered certificates of deposit
Other time deposits
------ -------- ------
Total interest-bearing deposits 1,516 (120) 1,396
Federal funds purchased
and repurchase agreements 723 (59) 664
Long-term debt and other borrowing (1) 214 26 240
------ -------- ------
Total borrowed funds 937 (33) 904
------ -------- ------
TOTAL INTEREST-BEARING LIABILITIES 2,453 (153) 2,300
------ -------- ------
INCREASE (DECREASE)
IN NET INTEREST INCOME $2,720 $ (183) $2,537
====== ======== ======
PROVISION FOR LOAN LOSS
The provision for loan losses was $1.6 million, or .24% of
average loans on an annualized basis, for the nine months ended
September 30, 1998, compared to $2.1 million, or .39% of average
loans, for the same period in 1997. Net loan charge-offs for the
nine months ended September 30, 1998 were $421 thousand, or .06% of
average loans on an annualized basis, compared to $204 thousand, or
.04% of average loans on an annualized basis, for the same period in
1997. The provision for loan losses and allowance for loan losses
reflect management's consideration of the various risks in the loan
portfolio. Additional discussion of loan quality and the allowance
for loan losses in provided in the Asset Quality discussion section of
this report.
NON-INTEREST INCOME
Non-interest income for the nine months ended September 30, 1998
was $6.0 million, an increase of $947 thousand, or 19%, over the
comparable 1997 period. Excluding net gains on the sale of
securities, non-interest income was $5.7 million for the nine months
ended September 30, 1998, and increase of $1.3 million, or 29%,
compared to the same period in 1997. The increase of $1.3 million
is primarily attributed to an increase in service charges on deposit
accounts of $587 thousand resulting from an increase in the number and
volume of transaction deposit accounts, an improvement in mortgage
banking fees of $528 thousand resulting from significantly higher
level of refinance originations due to historically low mortgage
rates, and increased trust and brokerage fees of $153 thousand, or
75%, resulting from an initiative to grow trust assets under
management.
NON-INTEREST EXPENSE
For the nine months ended September 30, 1998, non-interest
expense totaled $29.6 million, an increase of $6.7 million, or 29%,
from the same period in 1997. The largest component of non-interest
expense is employee salaries and benefits, which totaled $16.8 million
for the nine months ended September 30, 1998, an increase of $4.0
million, or 31%, compared to the same period in 1997. The
efficiency ratio, which is a measure of operating expenses as a
percentage of operating revenues excluding securities gains, was 67.2%
for the nine months ended September 30, 1998, compared to 64.0% for
the same period in 1997. The increase in non-interest expense and
the efficiency ratio are primarily attributed to the Company's recent
internal growth, which included the construction of new branch
offices. Comparing the nine month period ended September 30, 1998
with the same period in 1997, compensation and benefit expense
increased $4.0 million, or 31%; total occupancy expense (which
includes equipment expense) increased $1.1 million, or 31%; and, total
other operating expense increased $1.6 million, or 25%. Significant
increases in the other operating expense category for the nine months
ended September 30, 1998 as compared to the same period in 1997
include: ATM expenses of $108 thousand, or 42%; postage and supply
expense of $407 thousand, or 34%; advertising expense of $152
thousand, or 14%; and, goodwill and core deposit amortization expense
of $108 thousand, or 35%.
The Company has recently undertaken a program aimed at improving
operating efficiencies, primarily by centralizing certain back-office
functions that are currently performed at various locations that do
not have a direct impact on customer contact. Examples of functions
being centralized include deposit operations, wire transfers and
accounts payable. This program is currently in the development
stage and implementation will be done in phases throughout 1999.
Management does not anticipate any forced reductions in staffing
levels, since affected employees will be offered comparable positions
at the Company's operating headquarters; however, management
anticipates some level of attrition for which replacement will not be
necessary. Overall, management expects the Company's future growth
will not require proportionate increases in operational costs which
should result in improved operating efficiencies.
INCOME TAXES
Income tax expense increased by $780 thousand, or 22%, during the
first nine months of 1998 as compared to the same period in 1997.
The effective tax rate for the nine months ended September 30, 1998
was 33.6%, compared to 31.8% for comparable 1997 period. This
increase is primarily attributed to the Company moving into a higher
federal income tax bracket associated with taxable income amounts
greater that $10 million.
LOANS
The Company experienced annualized loan growth of 19.2% for the
nine month period ended September 30, 1998. Outstanding loans, net
of unearned income, totaled $942 million at September 30, 1998,
compared to $823 million at December 31, 1997. The loan growth
experienced during the first nine months of 1998 is attributed to
continued robust economic conditions in the Company's market area and
corresponding strong demand for residential construction, residential
mortgage, consumer and commercial loans. Average loans for the nine
months ended September 30, 1998 were $879 million compared to $710
million for the comparable 1997 period, representing an increase of
24%. The average tax-equivalent yield on loans for the nine months
ended September 30, 1998 was 10.39%, compared to 10.45% for the same
period in 1997. This decline is primarily attributed to the
increased competitive pressures on loan pricing.
Asset Quality
Non-performing assets, which is comprised of non-accrual loans,
loans past-due 90 days or more and still accruing interest and other
real estate owned totaled $1.6 million, compared to $1.4 million at
December 31 1997. Non-performing loans at September 30, 1998
consist primarily of loans secured by real estate, which comprise $710,000
or 91%, or total non-performing loans. These loans are
generally well secured and in the process of collection. Other real
estate owned at September 30, 1998 totaled $781 thousand, compared to
$386 thousand at December 31, 1998, and was comprised of six
properties.
Management classifies loans as non-accrual when principal or
interest is 90 days or more past due and the loan is not sufficiently
collateralized and in the process of collection. Once a loan is
classified as non-accrual, it cannot be reclassified as an accruing
loan until all principal and interest payments are brought current and
the prospects for future payments in accordance with the loan
agreement appear relatively certain. Foreclosed properties held as
other real estate owned are recorded at the lower of the Company's
recorded investment in the loan or market value.
The following table presents information about the Company's non-
performing assets, including asset quality ratios.
NON-PERFORMING ASSETS
(unaudited)
In thousands
September 30, December 31,
1998 1997
------------- ------------
Non-accrual loans $ 515 $ 536
Loans past due 90 days or more
and still accruing 264 515
---------- ---------
Total non-performing loans 779 1,051
Other real estate owned 781 386
---------- ---------
Total non-performing assets $ 1,560 $ 1,437
========== =========
Total non-performing loans as a percentage
of total loans 0.08% 0.13%
Total non-performing assets as a percentage
of total assets 0.12% 0.12%
Allowance as a percentage of total loans 1.23% 1.26%
Allowance for loan losses as a percentage
of non-peforming loans 1481% 985%
Allowance for loan losses as a percentage
of non-perfoming assets 739% 720%
As of September 30, 1998 the Company had $4.8 million of
outstanding loans that were not included in the past-due or non-
accrual categories, but for which management had knowledge that the
borrowers were having financial difficulties. Although these
difficulties are serious enough for management to be uncertain of the
borrowers' ability to comply original repayment terms of the loans, no
losses are anticipated at this time in connection with them based on
current market conditions, cash flow generation and collateral values.
These loans are subject to routine management review and are
considered in determining the adequacy of the allowance for loan
losses.
The allowance for loan losses at September 30, 1998 totaled $11.5
million, and increase of $1.2 million from December 31, 1997. This
provides a ratio of allowance to total loans at September 30, 1998 of
1.23%, compared to 1.26% at December 31, 1997. At September 30,
1998 and December 31, 1997 the ratio of allowance for loan losses to
total non-performing loans was 1481% and 985%, respectively.
Management believes that the allowance for loan losses at
September 30, 1998 is sufficient to absorb losses inherent in the loan
portfolio. This assessment is based upon the best available
information and does involve a degree of uncertainty and matters of
judgement. Accordingly, the adequacy of the loan loss reserve
cannot be determined with precision and could be susceptible to
significant change in future periods. Further discussion of the
allowance for loan losses is included in the Year 2000 section of this
discussion.
The following table provides an analysis of the changes in the
Company's allowance for loan losses for the nine month periods ended
September 30, 1998 and 1997.
Allowance for Loan Losses
(unaudited)
In thousands
Nine Months Ended
September 30,
1998 1997
-----------------------
Balance beginning of period $10,352 $8,125
Provision for loan losses 1,605 2,066
Loans charged-off (787) (535)
Charge-off recoveries 366 331
-----------------------
Net charge-offs (421) (204)
-----------------------
Balance end of period $11,536 $9,987
=======================
Net charge-offs as a percentage 0.06% 0.04%
of average loans (annualized)
DEPOSITS AND BORROWED FUNDS
Total average non-interest bearing deposits for the nine months
ended September 30, 1998 were $122.1 million, an increase of $32
million, or 35%, from the same period in 1997. For the three months
ended September 30, 1998, total average non-interest bearing deposits
were $132.2 million, an increase of $33.1 million, or 33%, from the
comparable 1997 period. These increases are the result of
management's efforts to increase to level of deposits used to fund
earning assets.
Total average borrowed funds for the nine months ended September 30,
1998 were $87.2 million, an increase of $33.6 million, or 63%,
from the comparable 1997 period. For the three months ended
September 30, 1998, total average borrowed funds were $116.2 million,
an increase of $60.2 million, or 108%, from the third quarter of
1997. Most of the increase for both the nine and three month
periods is attributed to increased net borrowings from the Federal
Home Loan Bank ("FHLB"), which were used to fund loan growth and the
purchase of investment securities classified as available for sale.
At September 30, 1998, the Company had aggregate FHLB borrowings of
approximately $87 million.
ASSET/LIABILITY MANAGEMENT
The Company's financial performance is largely dependent upon its
ability to manage market interest rate risk, which can be further
defined as the exposure of the Company's net interest income to
fluctuations in interest rates. Since net interest income is the
largest component of the Company's earnings, management of interest
rate risk is a top priority. The Company's risk management program
includes a coordinated approach to managing interest rate risk and is
governed by policies established the Asset/Liability Management
Committee ("ALCO"), which is comprised of members of the Company's
senior management team. The ALCO meets regularly to evaluate the
impact of market interest rates on the assets, liabilities, net
interest margin, capital and liquidity of the Company and to determine
the appropriate strategic plans to address the impact of these
factors.
The Company's balance sheet structure is primarily short-term
with most assets and liabilities either repricing or maturing in five
years or less. Management monitors the sensitivity of net interest
income to changes in market interest rates by utilizing a dynamic
simulation model. This model measures net interest income
sensitivity and volatility to interest rate changes based on
assumptions which management believes are reasonable. Factors
considered in the simulation model include actual maturities,
estimated cash flows, repricing characteristics, deposit growth and
the relative sensitivity of assets and liabilities to changes in
market interest rates. The simulation model considers other factors
that can impact net interest income, including the mix or earning
assets and liabilities, yield curve relationships, customer
preferences and general market conditions. Utilizing the simulation
model, management can project the impact of changes in interest rates
on net interest income.
In order to assist in achieving a desired level of interest rate
sensitivity, the Company has entered into off-balance sheet contracts
that are considered derivative financial instruments. Derivative
financial instruments can be a cost and capital effective means of
modifying the repricing characteristics of on-balance sheet assets and
liabilities. These contracts include interest rate swaps in which the
Company pays a variable rate and receives a fixed rate on a notional
amount and interest rate cap contracts for which the Company pays an
up-front premium in exchange for a variable cash flow if interest
rates exceed the cap rate. As of September 30, 1998, the Company
had three swap contracts with a combined notional amount of $25
million; maturity dates for these contracts range from December, 1998
through January, 1999. In addition, the Company had one cap
contract as of September 30, 1998 with a notional amount of $10
million that matures in September, 2003. In order to minimize the
credit risk of derivative financial instruments, the Company requires
that all contract counterparties have an investment grade or better
credit rating.
The Company requires all derivative financial instruments be used
only for asset/liability management or hedging specific transactions
or positions, and not for trading or speculative purposes.
Management believes that the risk associated with using derivative
financial instruments to mitigate interest rate sensitivity is minimal
and should not have any material unintended impact on the Company's
financial condition or results of operations. An explanation of a
recently issued accounting standard that applies to use of derivative
financial instruments is included in the Notes to Consolidated
Financial Statements section of this report.
CAPITAL RESOURCES AND LIQUIDITY
The following table shows the Company's capital ratios, as
calculated under regulatory guidelines, compared to the regulatory
minimum capital ratio and the regulatory minimum capital ratio needed
to qualify as a "well-capitalized" institution at September 30, 1998
and December 31, 1997:
September 30, December 31,
1998 1997
-------------- ------------
Leverage ratio 6.76% 5.76%
Regulatory minimum 3.00 3.00
Well-capitalized minimum 5.00 5.00
Tier I risk-based capital 10.63 8.59
Regulatory minimum 3.00 3.00
Well-capitalized minimum 5.00 5.00
Total risk-based capital 12.26 10.28
Regulatory minimum 8.00 8.00
Well-capitalized minimum 10.00 10.00
The improvement in the leverage ratio over the prior period shown
in the table above is primarily due to the continued growth in net
income and the Company's current dividend policy, which is allowing
the Company to retain approximately 85% of net earnings. The
company is currently paying dividends on a quarterly basis and expects
to continue making such distributions in the future if results from
operations and capital levels are sufficient. Effective with the
first quarter of 1998, the quarterly dividend was increased by 50%, to
$.0375 from $.0250. For the nine months ended September 30, 1998
the Company paid dividends of $.1125 per common share, compared to
$.075 per common share for the same period in 1997.
Improvement in the Tier I and Total risk-based capital ratios is
attributed to the growth in net income retained by the Company and the
issuance of $21 million of 8.125% Company obligated mandatorily
redeemable capital securities of subsidiary trust holding solely
junior subordinated debentures of the Company ("Capital Securities")
of July 15, 1998 which, under current regulatory guidelines, qualify
as Tier I capital.
Liquidity measures the ability to meet current and future cash
flow needs as they become due. Maintaining an adequate level of
liquid funds, at the most economical cost, is an important component
of the Company's asset and liability management program. The
Company has several sources of available funding to provide the
required level of liquidity. The Company, like most banking
organizations, relies primarily upon cash inflows from financing
activities (deposit gathering, short-term borrowing and issuance of
long-term debt) in order to fund its investing activities (loan
origination and securities purchases). The financing activity cash
inflows such as loan payments and securities sales and prepayments are
also a significant component of liquidity.
YEAR 2000
OVERVIEW
The "Year 2000" issue refers to potential problems that may
result from the improper processing of dates and date-dependent
calculations by computers and other microchip-embedded technology
(like an alarm or telephone system). In simple terms, problems with
Year 2000 can result from a computer's inability to recognize a two-
digit date field (00) as representing year 2000 and, incorrectly,
recognize the year as 1900. Failure to identify and correct this
problem could result in system processing errors that would disrupt
the Company's normal business operations. In recognition of the
seriousness of this issue, and in accordance with directives on Year
2000 issued by banking regulatory agencies, the Company established a
Year 2000 Committee in January, 1998. This committee is chaired by
the Company's Chief Information Officer and reports directly to the
Company's board of directors on a quarterly basis.
STATE OF READINESS
The Company has adopted a seven-phase action plan to address Year
2000 issues and expects to address all aspects of the action plan in a
timely manner and to be prepared for the impact Year 2000 will have on
the Company, its systems, vendors and customers. The seven phases
are:
1. AWARENESS - The Year 2000 committee and committee chairman were
appointed and authorized to develop an overall strategy for
addressing the Year 2000 issue. An on-going awareness
program has been developed to keep directors, employees and
customers informed about the Year 2000 issue and apprised of
the Company's progress in addressing it.
2. INVENTORY - Entails completion of a specific, detailed
inventory of all hardware, software and other microchip-
embedded products used by the Company. Procedures are
established to ensure that any new purchases are properly
analyzed for Year 2000 compliance and then inventoried.
Vendors and suppliers are contacted to ascertain Year 2000
compliance status and efforts to remediate potential problems.
3. ASSESSMENT - Mission critical areas are identified and testing
to identify potential problem areas begins. Budgets are
developed for expected expenses and other resources needed to
adequately address potential problems. The potential risk
exposure posed by credit customers and large depositors is
also evaluated.
4. RENOVATION/ANALYSIS - Vendors that supply system applications
are requested to provided certification that their product
used by the Company is Year 2000 compliant. Non-compliant
systems are renovated or replaced.
5. TESTING - All replaced or upgraded systems are tested to
ensure full correction of any Year 2000 issues and then review
by a third party for validation of corrective action.
Contingency plans are tested for effectiveness.
6. IMPLEMENTATION - A final review of all systems after the
renovation of problematic areas is completed. Management and
system users will carefully assess the status of corrective
action.
7. POST-IMPLEMENTATION - Utilizing the contingency plans, the Year
2000 committee will continue to refine backup processes and
procedures to be used in a worst-case scenario.
This seven-phase program applies to both information technology ("IT")
and non-information technology ("non-IT") systems that are affected by
Year 2000 that have been designated by the Year 2000 Committee as
"mission critical." For purposes of the Year 2000 project, mission
critical systems are defined as any technology element that, if not
able to function properly, could result in financial liability, loss
of revenue, significant customer service/support problems and damage
to the Company's reputation.
The following table identifies some, but not all, IT and non-IT
mission critical systems and elements:
IT Non-IT
Mainframe hardware Security systems
Mainframe software HVAC systems
ATMs Vault doors
PC network hardware Printed forms
PC network software Phone systems
As of September 30, 1998, the awareness and inventory phases of the
Year 2000 project have been completed for both IT and non-IT systems.
The Federal Financial Institutions Examination Council
(FFIEC) issued a statement entitled "Year 2000 Project Management
Awareness" in May, 1997. This statement established key milestones
that banks and other financial institutions must meet with regard to
Year 2000 testing and remediation.
The following table sets forth each deadline of this statement
and where the Company stands, as of September 30, 1998, with respect
to meeting each deadline.
Date Task Company's Status
- - -------------- --------------------------------- ----------------
June 30, 1998 Complete development of all Completed
written testing strategies, plans
and policies; due diligence to
determine Year 2000 risk posed
by customers implemented.
September 1, 1998 Commence testing of internal Completed
Mission-critical systems; assessment
of customers' Year 2000 preparedness
and potential impact on the Company
substantially complete.
December 31, 1998 Testing of internal mission-critical Testing cannot commence until a
systems substantially complete year-end 1998 data file of all
accounts is available; expect to
be substantially complete by
January 31, 1999
March 31, 1999 External testing with material third Scheduled for completion by
parties begins March 31, 1999
June 30, 1999 Testing of all mission-critical systems Scheduled for completion by
completed and corrective actions June 30, 1999
substantively completed.
The FFIEC has, under its bank supervisory authority, developed a
multi-phase examination process to determine if banks are complying
with the provisions of the awareness statement described above. The
Company intends to comply with all regulatory requirements established
by banking regulatory agencies and the Securities and Exchange
Commission.
As is the case with many financial institutions, the Company is
dependent upon third parties to provide systems used in daily
operations. Examples include, but are not limited to, firms that
provide both mainframe and desktop computer hardware, bank processing
software that tracks loans and deposits in an automated manner,
telecommunications services, check clearing and electrical utilities.
Even though many providers of these products have advised that they
are Year 2000 compliant, the Company is performing an independent
testing and validation that will attempt to confirm that this is the
case for each product as it is installed and used in the Company's
operations. Generally speaking, the Company utilizes hardware and software
providers that are registered under the Securities and Exchange Act of
1934; the Commission filings for each provider are being reviewed by
management to determine if any significant disclosures with regard to
the Year 2000 are made. In addition, the Company has requested all
providers of hardware, software, processing services and other systems
that are date-sensitive to provide written certification of the Year
2000 status for their product or service. The following table sets
forth the Company's significant material relationships with third
parties that, in the opinion of management, could potentially result
in business interruption if the product or service provided is not
Year 2000 compliant. This table is not intended to itemize all
relationships with third-party service providers.
Product/Service Year 2000 Assessment Status
--------------- ---------------------------
Bank processing system Certified compliant by manufacturer; being
tested internally
Mainframe In final phase of internal testing
Telecommunications services Testing scheduled for first quarter of 1999
Wire transfers Certified compliant by proxy
Check clearing Certified compliant by proxy
EXPECTED COSTS ASSOCIATED WITH ADDRESSING YEAR 2000
As part of the Company's initiative to assess its state of
readiness with regard to Year 2000, a budget was developed by the Year
2000 Committee. The budget is divided into five distinct
categories:
Consulting - costs incurred with the engagement of third-party
consultants and solution providers to assist with
management of the Year 2000 project, to review and
negotiate contracts and insurance coverage and
to perform audits of the Company's state of readi-
ness for the Year 2000.
Inventory - costs associated with the initial inventory and
review of all of the Company's systems, including
hardware, software and any other micro-chip
embedded products.
Testing - cost associated with running tests on the
company's systems, both individually and
collectively, to determine if processing is
affected by any of the potential problem dates
associated with the Year 2000 and documenting
the results of the tests. These costs may also
include costs to upgrade the Company's computer
systems to provide sufficient system resources to
perform the tests.
Remediation - costs incurred to repair, upgrade or replace
hardware, software or other micro-chip embedded
technology that is not Year 2000 compliant.
Resources - costs associated with staff training and customer
awareness with regard to the Year 2000 issue.
Examples of this type of cost are fees for an
employee to attend a seminar on Year 2000 or
costs to produce a pamphlet on Year 2000 for the
Company's customers.
The following table sets for the Company's budget for the Year 2000
issue and actual amounts expended as of September 30, 1998. All
amounts shown are pre-tax. In addition, the table indicates the
percentage of each budget line item (as described above) that is
expected to be recognized as current period expense and the percentage
that is expected to be recorded as a new asset with expense recognized
over the useful life of the asset through charges to depreciation
expense. Management intends to provide an update of this table in
periodic reports with the Securities and Exchange Commission on Forms
10-K and 10-Q.
Year 2000 Budget
(unaudited)
In thousands
Actual Costs % of Budget
% of Total Incurred as of Expended as of % of Budget
Budget Budget 30-Sep-98 30-Sep-98 Expensed Amortized
---------------------------------------------------------- --------------------------
Consulting $ 175 9% $ 13 7% 100% 0%
Inventory 70 4% 60 86% 100% 0%
Testing 82 4% 23 28% 100% 0%
Remediation 1,520 80% 1,259 83% 15% 85%
Resources 53 3% 16 30% 100% 0%
---------------------------------------------------------- --------------------------
Total $1,900 100.0% $1,371 72% 12% 88%
In accordance with recently issued accounting guidelines on how
Year 2000 costs should be recognized for financial statement purposes
(EITF 96-14), the Company intends to recognize as current period
expense all costs associated with the consulting, inventory, testing
and resources components of the Year 2000 budget. The costs
associated with remediation, which comprise approximately 80% of the
Year 2000 budget, are primarily related to the installation of a new
wide-area desktop computer network (WAN) that will replace virtually
all of the desktop computers, file servers and peripheral equipment
currently in use. In addition to being expected to be Year 2000 compliant,
the new WAN will provide the Company with a uniform standard desktop
computer configuration, internal and external e-mail capability,
internet access and savings on telephone communication costs
through utilization of the WAN communications backbone for voice
communication. The Company intends to leverage this new WAN
technology to increase the levels of employee productivity and improve
the operating efficiency. The costs of the WAN component of the
Year 2000 remediation budget will be recognized over a useful life of
three years at a cost of approximately $450,000 per year starting in
the first quarter of 1999. This annual cost does not include any of
the anticipated savings that the Company expects to achieve through
improved operating efficiency and reduced telecommunications cost
over the next three years. Approximately 8%, or $150 thousand, of
the remediation budget will be recognized as expense for the write-off
of any desktop computer network equipment that will be functionally
obsolete after the new WAN is installed.
The Company expects to fund the costs associated with preparing
for Year 2000 out of its normal operating cash flows. No major
information technology initiatives have been postponed as a result of
Year 2000 preparation that would have a material impact on the
Company's financial condition or results of operations.
MATERIAL RISKS ASSOCIATED WITH THE COMPANY'S YEAR 2000 ISSUES
CREDIT RISK - the Company, in the conduct of its ordinary operations,
extends credit to individuals, partnerships and corporations. The
extension of credit to businesses is based upon an evaluation of the
borrower's ability to generate cash flows from operations sufficient
to repay principal and interest, in addition to meeting the operating
needs of the business. Failure of one of the Company's business
borrowers to adequately prepare for the impact a Year 2000 failure
could have on its business could potentially impair its ability
to repay the loan. An example of this would be a loan to a building
supply store that has computer accounting systems that fail to recognize
Year 2000 and, consequently, are unable to calculate and bill accounts
receivable in January 2000. This failure would most likely have a negative
impact on the customer's cash flow and, consequently, its ability to
repay the loan in accordance with its original terms. The Company's exposure
to Year 2000 credit risk is somewhat mitigated by the fact that only 13%
of the $930 million in outstanding loans are to commercial
enterprises. In order to assess the risks of Year 2000 in these
loans, the Company's credit administration department has developed a
risk determination questionnaire to be completed by the loan officer
responsible for a commercial credit, both existing and new requests.
If the questionnaire responses indicate that the customer is not
giving sufficient consideration to the risks of Year 2000 on his or
her company, the loan risk rating of the credit will be adjusted to
reflect increased credit risk and an additional allocation of the
allowance for loan losses will be made. Additional charges to the
provision for loan loss will be made if, in the estimation of
management, the increased risk for loan loss related to Year 2000 is
not adequately provided for in the allowance for loan losses as of any
balance sheet date. As of the date of this report, the initial
questionnaires have been completed and are in the process of being
reviewed by loan review staff and members of the Company's information
technology staff.
LIQUIDITY RISK - is the risk to the Company's earnings and capital
arising from an inability to raise sufficient cash to meet obligations
as they come due. This risk is a very significant one for the
Company since its primary business is banking, which involves taking
deposits, which are generally due upon demand. Since the Company
uses these deposits to fund loans and purchase investment securities,
a dramatic increase in deposit withdrawals because of Year 2000
problems specific to the Company or of a more general nature could
have an adverse impact on the Company. Specifically, the Company
could be forced to liquidate investments under adverse market
conditions (that is, to sell at a loss) in order to fund a
significantly higher level of deposit withdrawal activity. The
Company is assessing its liquidity risk by running various scenarios
of deposit withdrawals coincident with the turn of millenium, ranging
from normal activity to what could be reasonably expected in a panic
situation. As of September 30, 1998, the Company (or its affiliate
banks) has federal funds lines of credit totaling approximately $15
million, unpledged investment securities available for repurchase
agreements of approximately $100 million, secured borrowing
availability at the Federal Home Loan Bank (FHLB) of approximately
$200 million and a secured line of credit for $15 million, all of
which can provide additional liquidity if the lending insitutions (in
the case of borrowings) have funds available to lend at that point in
time. In addition, the Company has secured borrowing facilities for
all affiliate banks with the Federal Reserve that will allow access to
additional borrowed funds, and the Federal Reserve has indicated in
widely published reports that it will provide additional cash to the
banking system through the discount window in order to alleviate
liquidity pressures on financial institutions resulting from the
desire of individuals to hold cash from late 1999 through the turn of
the millenium.
TRANSACTION RISK - is the risk to the Company's earnings and capital
resulting from failure to deliver one of its products or services in a
acceptable manner. An examples of transaction risk related to Year
2000 is the ability of the Company's computer system to properly bill
customers for loan payments due and account for the payments when
received or the ability of a customer to perform a deposit or
withdrawal at an ATM. In both of these examples, the individual
customer is directly affected and the Company is impacted by the
collective impact of all incorrectly processed customer transactions.
Since all of the Company's products and services are processed in some
manner by computer systems, all aspects of product design, delivery
and support are being carefully evaluated in order to determine
potential transaction risks.
The Company's Year 2000 policy also addresses other risks related
to the Year 2000 issue which include, but are not limited to,
strategic risk (adverse impact on business decisions or the
implementation of business decisions, such as acquisitions);
reputational risk (impact of bad publicity on customers and Company
value); and legal risk (risk of litigation related to adverse impact
of Year 2000 issues on the Company).
CONTINGENCY PLANNING FOR YEAR 2000
The Company's Year 2000 committee has presented the board of
directors with a written Business Remediation and Business Resumption
Contingency Policy. The purpose of this policy is to ensure that the
Company is prepared to address any crisis situation(s) that could
result from the failure of any of the Company's systems or third-party
vendors and suppliers to recognize Year 2000 critical dates. The Company's
Year 2000 contingency policy is modeled after the FFIEC interagency
STATEMENT ON CONTINGENCY PLANNING IN CONNECTION WITH YEAR 2000 issued
in May, 1997 and is comprised of four key phases:
1. ORGANIZATIONAL PLANNING - identification of core business
processes and establishment of a timeline
for a Year 2000 contingency plan.
2. BUSINESS IMPACT ANALYSIS - determination of Year 2000
failure risks for all core
business processes and identification of failure
scenarios. The minimal level of
acceptable service in the event of failure is also
determined.
3. DEVELOPMENT OF CONTINGENCY PLANS - identification and
selection of the most reasonable and cost-effective
contingency strategy for each core business process
in the event of failure.
4. Contingency Plan Validation - validation of each plan by a
qualified independent party and final approval by senior
management and the board of directors.
A core business process is, for the purposes of the Company's
Year 2000 contingency planning, defined as a group of interrelated
tasks performed as a basic and integral part of the Company's daily
operation. Examples of core business processes include posting of
payments on loans and processing of checks, both which require a
complex infrastructure of hardware, software, communications and
power. Core business processes are further defined by potential
impact on the Company and its operations. "Mission Critical" core
business processes are those which, if not functioning properly
because of failure to recognize Year 2000, will most likely cause an
immediate loss of revenue and crisis-level customer service problems
that could damage the Company's reputation. The Company's Year 2000
Committee is currently in the process of developing specific
contingency plans that detail precisely how the "most likely worst-
case scenarios" resulting from system failure will be handled. The
objective of contingency planning is not to duplicate the complete
functionality of failed systems, but, rather to identify the most
economical means of resuming a minimally acceptable level of service
in as short a time as possible.
QUANTITATIVE AND QUALITATIVE DISCLOSURES OF MARKET RISK
Information for this items is included under the heading of
Asset/Liability Management in the Management's Discussion and Analysis
section of this report.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
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During the course of ordinary business, the Company and its
subsidiaries are defendants in various legal proceedings. In the
opinion of management, adverse decisions in any currently pending or
threatened proceeding will not result in a material adverse change in
the financial condition or results of operations of the Company.
Item 2. Changes in Securities - None
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Item 3. Defaults Upon Senior Securities - None
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Item 4. Submission of Matters to a Vote of Security Holders - None
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Item 5. Other Information - None
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Item 6. Exhibits and Reports on Form 8-K
--------------------------------
Exhibit 27 - Financial Data Schedule (for SEC use only)
There were no reports on Form 8-K.
UNITED COMMUNITY BANKS, INC. AND SUBSIDIARIES
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned thereunto duly authorized.
UNITED COMMUNITY BANKS, INC.
By: /s/ Jimmy C. Tallent
Jimmy C. Tallent, President
(Principal Executive Officer)
Date: November 13, 1998
By: /s/ Christopher J. Bledsoe
Christopher J. Bledsoe
Chief Financial Officer
(Principal Financial Officer)
Date: November 13, 1998