United Community Banks, Inc.

Copies of today's earnings release and investor presentation for the third quarter were filed on Form 8-K with the SEC, and a replay of this call will be available on the company's Investor Relations page at ucbi.com.

Please be aware that during this call, forward-looking statements may be made by United Community Banks. Any forward-looking statements should be considered in light of risks and uncertainties described on Page 4 of the company's Form 10-K, and other information provided by the company in its filings with the SEC and included on its website.

At this time, we will begin the conference call with Jimmy Tallent.

Good morning, everyone, and thank you for joining us for our earnings call. Our results mark another quarter of positive earnings and momentum.

We continued our progress, improving operating efficiency and reducing problem assets. And for the first time since the credit cycle began, we had positive year-over-year loan growth.

We believe we're on the right track.

I'll share some highlights in a moment, but first, let me comment about the format of our call this morning. We're going to try something a little different.

Rather than have David and Rex comment on their respective areas, I'm going to cover all of our prepared remarks, and then we'll open the call for your questions. We're hoping this will give you the information that you need, and perhaps be more respectful of your time.

I also want to take a moment to introduce you to another participant in our call today. You may know that Lynn Harton has joined our team as Chief Operating Officer.

Lynn is no stranger to most of you, and we're excited to have him on the United team. He will join David, Rex and me to answer your questions following my prepared remarks.

Some of those remarks will refer to pages in our third quarter investor presentation, which is available in the Investor Relations section of our website.

With that said, let's move on to some highlights from the quarter. These items are among those covered in the investor presentation.

Core pretax, pre-credit earnings were $29.9 million, up by $1.6 million from the second quarter and up $3.4 million from the third quarter of 2011. Net income was $10.6 million or $0.13 per share.

Severance charges, which are excluded from core earnings, decreased net income by $400,000 or almost $0.01 per share. That was offset by $478,000 release of income tax reserves that related to the roll-off of an open state tax year.

Core operating expenses continue to decline as a result of our ongoing improvement in operating efficiencies.

Loans were up, both linked-quarter and year-to-date. This is a first year-over-year positive loan growth since the first quarter of 2008.

Our provision for loan losses was $15.5 million, down $2.5 million from last quarter. Total credit cost, which include $3.7 million in OREO expense, were down $645,000 from the second quarter.

Net charge-offs of $20.6 million were up slightly from second quarter due to losses from the sale of $13 million in performing classified loans that had $3.6 million in specific reserves at the end of the second quarter. Losses on the sold loans account for most of the difference between our provision and charge-offs for the quarter.

Our allowance for loan losses remain strong at 2.6% of loans. Non-performing assets at quarter end were $142 million, down $3.8 million from the previous quarter and represented 2.1% of total assets.

Core transaction deposits grew by $72 million, bringing year-to-date growth to $236 million. The annualized growth rate was 9% for the quarter and 11% year-to-date.

Our net interest margin was 3.6%, up 17 basis points from the second quarter. The increase was due primarily to our second quarter balance sheet restructuring and the resulting smaller balance sheet.

Our margin was also positively impacted by higher yield on our securities portfolio, resulting from a change in the time period over which we're amortizing premiums on agency pass-through securities. This benefit was mostly offset by lower loan pricing, which resulted in a 7 basis points decrease in our loan yield.

And all of our capital ratios strengthened this quarter.

With positive loan growth and strong core deposit growth, and with improvements in credit metrics and operating efficiency, we're pleased with the third quarter results and the overall direction that we're heading.

Now for other key drivers of our third quarter performance. I'm pleased to report growth in our loan portfolio.

Our focus on growing owner-occupied, commercial real estate and small business loans continues to gain traction. We've also achieved success growing our consumer and residential mortgage portfolios, which is helping to achieve a more favorable business mix.

We funded $137 million in new loans during the quarter, mostly small business, owner-occupied commercial real estate and residential real estate, compared with $87 million in the second quarter. Much of our loan growth is the result of our investment in new lenders last year and new retail product offerings.

We continue to add new lenders to build momentum in our markets and to extend our footprint. In the third quarter, we added a very seasoned lender in Greenville, South Carolina.

Consistent with our efforts to leverage our retail banking platform, we recently added Ray Skinner to lead our retail banking efforts. Ray brings a strong retail banking background that is a perfect complement to our high service business model.

Competition for new loans and defensive measures to keep the loans that we have are putting pressure on loan pricing that will cause some margin compression going forward. Our plan for dealing with the margin compression is to continue with balanced loan growth and to improve our deposit mix.

Entering new markets, adding lenders to our existing markets and renewing our focus on retail services supports our efforts in growing loans and net interest revenue.

Now turning to credit quality. I am pleased with the overall improvement in our credit measures.

The inflow of non-performing loans was basically flat with the second quarter at approximately $30 million, and our loans past due, 30 to 89 days, also remain flat at 68 basis points, while non-performing assets decreased by $3.8 million from the second quarter.

One of the things I was most encouraged by was the sharp decrease in performing classified loans. They were down $41 million or nearly 13% from the second quarter.

That puts our quarter end ratio of classified assets to Tier 1 capital and allowance at 55% compared with 62% 3 months earlier. Included in this number are accruing TDRs, which also declined for the first half.

We also saw an $8 million decrease in our watch loans. The levels of classified and watch loans are leading indicators of future non-performing loan inflows, so these trends are encouraging.

And now, the fee revenue. You will find the trends shown on Page 8 of our investor presentation.

We had good core fee revenue growth in the third quarter compared to both the second quarter and a year ago. Mortgage fees are the main contributor, as we closed $108 million in loans in the third quarter.

That compares with $80 million in the second quarter and $57 million a year ago. While refinancing activities certainly gave us a third quarter lift, we have been adding lenders to ensure that we get a larger share of this business.

Deposit service charges are up from last year due to new service fees that we rolled out at the beginning of the year. We've seen some decrease in those fees, as customers avoided them by maintaining higher account balances.

We also experienced some minor account attrition with customers that kept small balances. The new fees have now begun to stabilize and in a more predictable and even pace.

Our core operating expenses are presented on Page 9 of our investor presentation. Our core expenses are down in nearly every category, reflecting our efforts to improve operating efficiency.

Salaries and employee benefit expenses are down almost $800,000 from the second quarter, and down $3.3 million from a year ago. We've reduced headcount by 22 from the second quarter and by 170 from last year.

We have a number of efficiency projects currently underway which will be completed throughout 2013, all of which will help us to continue to reduce cost and operate more efficiently. The critical focus on process improvement is becoming firmly embedded in our corporate culture, and I believe that is a positive development for this organization.

Our capital continues to grow and strengthen with each profitable quarter. At quarter end, our Tier 1 leverage ratio was 9.8%, our Tier 1 common risk-based ratio was 8.8% and our tangible common equity-to-assets ratio was 5.7%.

Reversal of our deferred tax valuation allowance would increase the tangible common ratio to approximately 9.4%.

Before I close, I want to talk about a couple of items that I'm sure are on your mind. The first of which is our deferred tax asset.

At the end of the quarter, our valuation allowance was $272 million. That represents about $4.70 per share.

The question on everyone's mind is, "When are we going to reverse the allowance and put that back on our books?" I wish I have an absolute answer for you.

We continue to evaluate the positive and negative evidence, which includes earnings trends, credit quality measures, forecasting and a host of other factors. With each profitable quarter that passes and with credit measures continuing to move in the right direction, the weight of the positive evidence is shifting in our favor.

At this point, our expectation is the reversal of our DTA allowance could occur mid to late 2013.

The second thing I want to address is our recent announcement about our change in auditors in 2013. As most of you know, we have a long-standing relationship with Porter Keadle Moore that has lasted for decades.

Our relationship began when our company was a small, single-office community bank with only $40 million in assets. Over the years, Porter Keadle Moore has served us exceptionally well by staffing our engagements with top-notch talent and responding to our changing needs as we grew in size and complexity from that single-office bank many years ago.

The decision to make this change is not the result of any disagreement over accounting practices, disclosure issues or dissatisfaction with service. Nothing could be farther from the truth.

Our Audit Committee and the Board of Directors simply believe that it is in our shareholders' best interest to use a Big 4 firm in view of our expected future growth.

At the beginning of the year, we committed to improve the core pretax, pre-credit earnings run rate by $10 million annually, or $2.5 million per quarter by the fourth quarter of 2012. We set as our base the fourth quarter of 2011 when pretax, pre-credit earnings were $26.6 million.

In 3 quarters, we've made tremendous progress. Third quarter core fee revenue is up $1.6 million from the fourth quarter of 2011, and third quarter core operating expenses are down $3.3 million from the fourth quarter of 2011.

In fact, expenses alone are favorable by $13 million on an annualized basis. Our people have done a truly outstanding job.

Unfortunately, margin compression has absorbed 1/3 of the benefit of their hard work, leaving the third quarter net interest revenue down $1.7 million from the fourth quarter of 2011. Further margin compression is the greatest uncertainty to achieving our goal.

In the fourth quarter, in addition to the expected margin compression resulting from loan repricing pressures, our margin and net interest revenue will be impacted by the cost of our recently issued senior notes. Those notes were issued at the beginning of the quarter, while the subordinated debt they replace does not mature until mid-December, causing an overlap.

We also expect our securities yield to continue its downward trend, as we replace future runoffs at lower yields, and we plan to continue to reinvest these proceeds, primarily in floating-rate securities, to minimize interest rate sensitivity and duration risk. Currently, floating-rate securities make up 39% of our investment portfolio.

We expect these factors to pull our margin down into the mid- to high-340 range for the fourth quarter.

These headwinds will remain for some time, but we are up to the challenge. Positive momentum continues to build, credit quality measures are improving, especially lower classified assets and our TDRs.

We expect this trend to continue. Also, we are achieving year-over-year loan growth in a weak economy, and that is no small feat.

Our people continue to pursue new business relationships. We're reducing expenses and improving operating efficiency.

We are well-positioned with the right people, strategy, products and business model to be the financial services leader in our markets.

And now, Lynn, Rex, David and I will be pleased to answer any questions.

I wanted to ask you about the loan growth. It was good to see the ending balances higher.

Can you just talk about what is -- what pieces are growing and what pieces are shrinking? And how do you think that's going to net out over the next 12 months?

David?

Sure, yes. Jeff, this is David.

We're seeing some growth in the categories that we've been targeting, which is in a lot of commercial area, particularly on business loans. We're seeing a little bit of an increase in C&I.

And we're certainly, from an origination standpoint, continuing to get traction on owner-occupied commercial real estate. We also have had some success more recently on the retail side, where we've tried to put a good bit more emphasis in growing, both kind of HELOC product that we've introduced and we've had good success with.

It's really -- we're proud of the results so far. We've been -- we've got an average credit score on these of 775, and a loan-to-value, even in this environment of 55%.

So we're real pleased with the growth we're getting there, and then, we're also getting some growth in our consumer book as well. So it's really focusing primarily on that core business customer, and then also trying to expand and build on that retail delivery as well.

All right. If you think about the next 12 months, you think that the growth in those 5 or 6 categories can offset your targeted shrinkage in land or construction or whatever else you have?

Yes, we're really -- we've been trying to shift the mix consistently as we've gone through the cycle. We really need to continue to drive down the land exposure in both the residential construction and commercial construction books predominantly.

We're not doing much in the way of new residential construction, no there's a little bit of building occurring for individuals building their own homes. And then on the commercial construction side, while we're not targeting that heavily, there are some good investment-grade opportunities out there that we may look at from time to time, but I think it'll be a fairly small part of our portfolio.

Question on net charge-offs for David. They've still kind of lingered in the mid to high ones for the last few quarters.

Do you have any expectation about where you think they'll trend over the next 3 to 5 quarters? And how much positive leverage you can get there?

Sure, Jennifer. I think, right now, first, keep in mind, I think this quarter, as Jimmy mentioned in his comments, the charge-offs were up a little bit because we accelerated a couple of performing classified loans, and we're able -- about $13 million worth have moved off the books, and that was about I think $3.6 million of our charge-off this quarter.

But I really think over the next, probably 2 to 3 quarters, net charge-offs will be somewhere in the high-teens, 15 to high-teens range. And then I would expect some decline towards the -- in the second half of next year.

I think -- on the other hand, the provisioning, I think you'll see us continue to be able to under provide by some amount, and I'd kind of expect near terms next couple of quarters to be in the, say, the $14 million to $16 million range of the provision. The offset of both of those numbers really would be, again, if we were able to move off performing classified, that could bump up your -- the charge-offs in a given quarter.

But generally, that's what I would expect. And then hopefully some tailing off as we go into the second half of next year.

You may have covered this already, Jimmy, but if you can, just I heard the margin guidance, if you can just kind of put it in terms for NII, dollars of NII, what you're looking at? I understand NII is going to get impacted by the added cost of those senior notes as well.

But do you -- as you look at the trajectory of NII, do you think it goes down next quarter, settles and starts to grow again? And I guess, securities balances and loan growth used to offset the lower margin, and just how we should think about that?

Kevin, let me just ask Rex to address that, and then I may add some to it. Rex?

Kevin, I think your thoughts are right in line with what we're looking at. You will see the net interest revenue decline, as Jimmy indicated, with the overlap of the senior notes for 1 quarter.

That's about $800,000 impact in Q4. Additionally, we have some securities repricing within the portfolio that probably have another $300,000 to $400,000 impact in Q4, going from fixed to floating.

As we look ahead, we'll pick up the double count of the sub-debt coming off in Q1, so you'll pick up $500,000 of that in Q1. That's basically in Q4.

And again, we are looking to try and level that off and bring it back up again. As you noted through -- as David indicated, I'm sure the loan growth, net loan growth, in 2013, as well as rebalancing the security portfolio a little bit.

So it should be dropping down in Q4, then coming back up some in Q1, and again, gradually through the balance of the year. But again, as I indicated, the margin will come down because of the items relating to the double dip of the senior notes this next quarter, additionally with the repricing of securities.

And again, we still see this, as Jimmy indicated, some further margin compression again with the loan pricing. In the past, that's been offset almost entirely with our deposit pricing done with the mix of deposits that's less than the impact of it.

We don't have as much deposits on the CDs repricing compared to last year.

Right, okay. Great One just follow-on question on credit.

I know this is kind of a long situation, but just from time to time, we have to ask about it. Fletcher, has there been any developments, or should we expect any developments that will impact that from your guys standpoint?

Well we -- Kevin, as you know, we're still-- that's our largest relationship has. We've had it on non-accrual really since the third quarter a year ago and took a big charge.

So we're carrying about $47 million at the end of this past quarter on the relationship. The relationship continues to perform at the present time, so it's a performing nonperformer.

We still have cash collateral supporting the ongoing performance. If there weren't significant asset sales or if the borrower were not to contribute additional cash to support the credit, he would probably -- we'd be looking at the fall, my guess would be kind of, towards the end of the first quarter, if that were to occur, and then we'd have to deal with that if that were to occur, but at the moment the credit continues to perform.

And in terms of the legal proceedings, though, for their bankruptcy proceedings, there's no change -- perceived change, in how that impacts you, guys?

No, there's not. The structure of the loans was they were set up in what are effectively bankruptcy remote entities, single-purpose entities, just hold the assets that they purchase, with no other obligations outside of the obligations to the bank.

So I don't envision, really, any direct impact from any of their broader issues at their holding company at this point in time. And so there's been no, no impact there.

Jimmy, I just want to shift gears and talk a little bit about overhead expenses, and as next year shapes up, are there some additional opportunities for you to get more efficient or maybe just bring us up-to-date the kind of where you're thinking is after this huge progress?

Chris, we have a number of initiatives that are currently underway, as well as others that are planned that we believe that we will see -- continue to see benefit with the operating cost. And also, just the basic operating expenses that we're constantly addressing.

I'm really pleased with the progress that we have made, our people have made among over the last year. I don't expect a reduction equal to that.

I do expect a continued downward trend, probably a little slower pace. But also, too, we will be adding people from time to time, principally revenue producers that will be able to help drive that side of the ledger.

But -- so the answer is, we will see some reduction, not at the speed that we've seen over the last 12 months, but I would almost view that as an investment into -- as far as any increase in revenue production.

Okay. Great.

And then just a follow-up for David. Is there any interest in bulk sales?

And I'm just asking from a pricing standpoint, has pricing improved or, at all, attracted to you to do faster or reckless positions than you've done?

Chris, we're always looking at any option. When you say bulk, I don't envision any kind of a massive sale in that sense.

Could we put a few credits together and sell? Yes, possibly.

In a given quarter, we might do that. With regard to pricing, there's been a little bit of an uptick based on the people I talked to in the residential mortgage piece.

If you wanted to package a little bit of that, the land and the CRE, really not a lot of change there. It's pretty much in the same range where it has been for the last several quarters.

There's still a fair amount of interest out in the market. So anyway, that's kind of it.

I don't -- we don't envision right now any large bulk sales, but obviously, we're always looking at different options as we go along.

Thank you, operator. We want to thank everyone for being on the call this morning.

Once again, we invite you, if you have additional questions to please not hesitate to call Lynn, David, Rex or myself. Also, we want to thank our people once again for the wonderful job that they continue to do day after day.

I feel very, very good as to where we are and the progress that we're making. That progress is totally attributable to our wonderful people.

Thanks again for being on the call, and we look forward to talking with you soon.