United Community Banks, Inc.
Q2 2008 Earnings Call Transcript

Published: 28 Jul 2008

[Operator:]

Good morning, and welcome to United Community Bank's second quarter conference call. Hosting the call today are President and Chief Executive Officer, Jimmy Tallent, Chief Financial Officer, Rex Schuette, and Chief Risk Officer, David Shearrow. Also participating this morning is Gary Guthrie, President of Atlanta's Residential Construction. United's presentation today includes references to operating earnings and other non-GAAP financial information. United has provided a reconciliation of these measures to GAAP in the financial highlights section of the news release included on its Web site at ucbi.com. A copy of today's earnings release was 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 about United Community Bank. Any forward-looking statement 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 Web site. At this time, we'll begin the conference call with Jimmy Tallent.

[Jimmy Tallent:]

Good morning, everyone, and thank you for joining us today for our discussion of the second quarter of 2008. Today, I will cover with you our key financial results for the quarter. Our primary focus throughout our discussion today will be on asset quality, liquidity and capital. I'll be followed by David, who will provide you with details about our loan portfolio and our credit metrics. Rex will then provide more details about the financials, our margin, and the strength of our capital. Now, turning to the quarter, our second quarter earnings were $7.1 million, or $0.15 per diluted share. This is down from $0.46 per share a year ago. The principal factors for the decline were higher credit costs and narrower margin. Our loan portfolio decreased $35 million this quarter. Our residential construction portfolio continued to decrease ending the quarter at $1.7 billion and representing 29% of total loans. This is a decrease of $268 million from last year and $46 million from last quarter. Commercial loans continued to grow increasing 6% from last year. We're pleased with the changes in both loan categories as they positively contribute to rebalancing our loan portfolio. Customer deposits increased $148 million from a year ago and $417 million from last quarter. We completed very successful promotion during the second quarter for customer time deposits that added $407 million to liquidity. Even with a strong focus on our promotion, we also saw modest growth in other core deposits. Now, let me discuss the areas that have our most intense focus. Our net interest margin declined by 23 basis points to 3.32 on a linked quarter. The decline was primarily due to continued competitive deposit pricing and a higher level of NPAs. Non-performing assets increased to $152 million and charge-offs were 14.3 million while we provided 15.5 million for the quarter. This significant rise in NPAs is coming out of the migration process that we've discussed previously. Performing classified assets for prior quarters have moved to non-performing status in the current quarter. While NPAs were up sharply, we did not see many surprises as most of these loans were already classified in the prior quarters. Total classified loans were flat compared to last quarter. Capital remains strong with all the regulatory capital ratios above the well-capitalized level and improved from the first quarter. While we were certainly challenged this quarter, our solid earnings engine supported by experienced management and locations in growing markets continues to sustain the company and keep a position to manage through the current cycle. Our goal today is to provide you with a clear picture of where our business now stands as well as share more detail information on capital strength, loan loss reserve, credit quality, and credit cost. Now I'll turn the call over to David.

[David Shearrow:]

Thank you, Jimmy, and good morning. I want to talk about the second quarter increase in our non-performing assets, charge-offs, and loan loss provision. I'll also discuss how the economic environment is affecting our loan portfolio as well as the aggressive stance we have taken on addressing problem loans in the portfolio and managing through this environment. I also want to mention that our earnings release for this quarter includes a more granular presentation of our loan portfolio, NPAs, and charge-offs, which we hope you will find useful. The current economic cycle continues to impact our credit quality, particularly within the Atlanta residential construction portfolio. As a result, in the second quarter, we made a provision of 15.5 million and took 14.3 million charge-off. As Jimmy noted, in the second quarter, we saw a rise in non-performing asset to 152.2 million which compared to 89.9 million last quarter. Non-performing assets included 123.8 million in non-accrual loans and 28.4 million in OREO. We did not have any loans accruing that were 90 days past due. The ratio of non-performing assets to total assets was 184. This compares to 107 basis points last quarter and 54 basis points, a year ago. Our largest non-performing loans were 9.4, 8.8 and $8.2 million. Each loan was to a separate residential construction customer in Atlanta and the collateral consists primarily of a mix of houses and finished lots. We had four exposures in OREO greater than a million dollars. The largest were 2.9, 2.4, 1.3 and $1.3 million. And each loan was to a residential construction customer. Segmenting our NPAs, the largest market concentration at quarter end was the Atlanta MSA at 69%. The largest loan category concentration was residential construction loans at 74%. Both of these concentrations are consistent with what we've seen in the last few quarters. Net charge-offs were 14.3 million for the quarter compared to 7.1 million for the first quarter 2008 and 2.1 million for the second quarter of 2007. The ratio of net charge-offs to average loans was 97, 48 and 15 basis points, respectively. This continues to be driven by deterioration in the residential construction and housing markets primarily concentrated in the Atlanta MSA. Atlanta comprised 75% of our total second quarter charge-off, up slightly from last quarter. Now, let me provide you with updated information on our residential construction portfolio in Atlanta. Of our $1.7 billion residential construction portfolio, the Atlanta MSA represents 728 million which is down 33 million from last quarter and down 238 million from a year ago. We expect this trend to continue. Of the 728 million, we had 329 million in houses under construction that includes 58 million in pre-sold and 271 million in spec. The balance was dirt loans of 399 million. That includes 232 million in acquisition and development loans, 117 million in finished lots, and 50 million in land loans. In terms of our risk management process, we continue to aggressively manage the entire loan portfolio. We are constantly reviewing our portfolio, carefully assessing all the different categories and segments within risk ratings, past dues, non-watch credits, and the like. On top of our internal reviews, we have also continued our intensified independent credit review examination process to include more targeted reviews in the Atlanta region and a lower dollar threshold of loans. Our entire senior management team remains intently focused on credit quality and doing all that we can to quickly and accurately identify problem credits and move them off our books. We did have a few bright spots in this quarter with the flattening of our watch and classified loans. And our past due loans at quarter-end were 1.10% of total loans as compared to 1.39% last quarter. Residential construction loans were 1.83% past due, down from 2.11% last quarter and accounted for 48% of total past due loans. Now, let me address the loan loss reserve. Based on an extensive portfolio review, we strengthened our allowance at year-end in anticipation of softness in the residential construction portfolio during early 2008. We've seen the fulfillment of our expectations this year as many of the loans we identified and reserved for previously were moved from performing classified to non-performing classified loan status. As our reserve methodology requires, each of our non-performing loans greater than $500,000 was provided a specific reserve based on an expected liquidation value of our collateral less cost to liquidate. The specific reserve may result in an amount greater or less than the amount that was previously reserved in performing status. However, given the flattening of our watch and classified loans, we did not have a significant rise overall in our required allowance. Therefore, we added $15.5 million to the allowance in the second quarter which slightly increased our allowance to 1.53% of loans. In summary, with NPAs at $152 million, a flattening of our watch and classified loans, and the prior reserving against these new non-performers, we believe our allowance is adequate to cover any losses in the portfolio at quarter end. In terms of credit outlook, we expect continued challenges over the next couple of quarters. The housing slowdown continues to create a difficult environment for builders and developers and this continues to have an impact on our credit quality. Given the rise in non-performing loans this quarter, and our aggressive stance on problem resolution, we expect a significant rise in foreclosure activities and charge-offs over the next two quarters. As we move these non-performing loans to OREO, we will continue to write them down to liquidation value less expected selling cost which in most cases, we feel is close to the reserve already assigned in the allowance for loan losses. In addition, we are actively seeking alternative methods for disposing of loans. Recently, we've seen more interest in buying our notes and at somewhat more favorable prices. As a result, we are considering more of these offers which will be yet another way of meeting our goal of aggressively moving problem credits off our books. In summary, because of the amount of foreclosed properties and our commitment to aggressively move them off our books, we will experience higher charge-offs over the next two quarters. Furthermore, we have concerns about the volume of supply of foreclosed properties coming on the market from other banks. How that may contribute to deterioration in pricing? This could lead to additional charge-offs for us in the coming quarters. With regard to NPAs, the market challenges and legal delays that come from bankruptcy will likely drive continued volatility and upward pressure on the level of NPAs for the remainder of 2008. Nevertheless, our plan has not changed. We will continue to recognize our losses and work these problem assets off the books as quickly as possible. With that, I'll turn the call over to Rex.

[Rex Schuette:]

Thank you, David, and good morning to everyone. As Jimmy indicated in his opening comments, the key items I will cover this morning are financial highlights, margin, liquidity and capital. During the second quarter, net operating income totaled $7.1 million and diluted operating earnings per share was $0.15. Both measures were down from last year and the prior quarter principally due to margin compression and higher credit costs. The trends in fee revenue and operating expenses were commented on in our earnings release and the schedule showed the changes by category. My comments today are focused on some of the key trend items. Fee revenue of $15.1 million was down 1.4 million from the second quarter 2007 and reflective of our current run rate. Most of the increase from last year was from non-recurring items and other fee revenue as well as the decrease in mortgage loan fees as the demand for mortgage loans continue to (inaudible). Looking at operating expenses, they totaled 49.8 million for the quarter. This was an increase of 2.2 million over the first quarter 2008 and an increase of 2.1 million from the second quarter of 2007. Higher OREO costs accounted for the majority of the increase from last year and the prior quarter. The OREO costs were reflected in the other expense category which totaled $7.6 million for the second quarter and was 3.5 million higher than a year ago. The increase was due to write-downs and related costs of our closed properties of 2.5 million and an increase in FDIC insurance premiums of 900,000. We are controlling costs across all categories with many categories down from last quarter. A key driver of our costs is staffing, and over the past 12 months, total staff was up only two people. Turning to our margin, for the second quarter tax equivalent net interest revenue was 61.8 million, down 6.2 million or 9% from the second quarter of 2007. Net interest margin for the first quarter was 3.32% compared to 3.55 for the first quarter of 2008 and 3.94, a year ago. The key factors impacting our margin were competitive deposit pricing in our markets and the full impact of last quarter's actions by the Fed to lower interest rates by 200 basis points. Our net interest spread of 2.97% was down 30 basis points from the fourth quarter 2007, driven by loan yields dropping 151 basis points while deposit pricing dropped only 76 basis points during the same time period. Competitive pricing cost over half of the 23 basis point decline in our margin this quarter compared to the first quarter. The other key factors included the higher level of non-performing assets that lowered the margin by 4 basis points and 6 basis points for the decline in the rate earned on our non-interest-bearing funds. As rates decrease, earnings on these balances decrease also. We are focused on improving our margin through better pricing for credit risks and deposits. We expect slight margin compression to continue in the short-term with a focus on moving the margin back to the 350 to 370 range by next year. Our credit environment and liquidity are key factors to getting there. With a focus on improving liquidity, we executed a very successful strategy this quarter ahead of our competition which resulted in increasing our customer time deposits by $407 million. This time deposit promotion was a key part of our program that enabled us to reduce our wholesale borrowing and significantly improve the level of our liquidity. We increased our wholesale funding capacity by $700 million to 2.9 billion at quarter end. While raising these deposits added a little to our funding costs in the short-term, it was a prudent decision in this environment. We continue to manage our balance sheet to a more neutral, interest sensitive position. At quarter-end, our interest rate sensitivity reflects a 120 basis point increase in net interest revenue over the next 12 months based on a 200 basis point ramp up of interest rates. We are at a more neutral position compared to prior quarters’ interest sensitivity and down 70 basis points from last quarter and 50 basis points from last year. The effective duration of our investment securities portfolio was 3.8 years at quarter-end, up from 2.6 years at March 2008 and up from 2.7 years at June 2007. The increase in duration this quarter was due to $125 million of short-term securities called during the quarter and a rise in mortgage rates that extended lines. Within our investment securities portfolio, we do not have any common or preferred stock of Freddy Mac or Fannie Mae. Now, to discuss capital, we know that maintaining a strong capital position is important, especially during these uncertain times. All of our regulatory capital ratios continue to be strong. At June 30th our estimated tier-one ratio was 9.17%, leverage was 7.03%, and total risk base was 11.40%. Also, our tangible equity to asset ratio was 6.77%. In analyzing our capital for loss absorption at quarter-end, our tier-one capital was $160 million over the well-capitalized level, and our total risk base capital was 85 million above the well-capitalized level. At this level, we could immediately absorb 130 million in credit costs and still remain well-capitalized and keep our allowance for loan losses at its present level. With our solid earnings base, strong capital levels, and well-reserved allowance to loan ratio of 1.53%, we have ample room to absorb potential credit losses as we work our way through this current environment. As part of our capital planning process, we run a capital model with various stress scenarios to determine the (inaudible) of our capital. We continually update these stress scenarios and I would like to share with you some of the results. The key element to our stress model are the levels of capital, allowance, and core earnings to sustain credit losses. Next is severity and frequency. We look at the potential levels of net charge-offs and provision and then consider what time periods or quarters these losses are most likely to occur. We target our capital rejections to maintain our ratios of 100 basis points above the regulatory well-capitalized level and a tangible equity to asset ratio above 550. Starting with our regulatory capital base and conservative pre-tax, pre-provision earnings estimates, we stressed our model by the following levels. We used 100 million of net charge-off and provision over the next two quarters, taking us through year-end 2008, then we add an additional 100 million of charge-offs in the first two quarters of next year taking us through June 2009. Finally, for our (inaudible) model, we add 100 million more for a total of 300 million of charge-offs over the next 10 quarters taking us through year-end 2010. Our results indicate that for the first two scenarios of 200 million of cumulative losses, all of our regulatory capital ratios remain above the 100 basis point guideline and tangible equity to asset stays above 550 with one exception. Our total risk based capital ratio fell below our guideline, which we would resolve by issuing 60 million of sub debt or trust preferred securities. For the third scenario of 300 million of cumulative losses over the next ten quarters, we would require 80 million of sub debt or trust preferred, only 20 million over the prior scenarios and our tangible equity to assets would still be above 550. I would like to note that we do not perceive losses at the levels we include in our stress (inaudible). That said, the point we want to reinforce today is that we have a strong capital position as well as a solid base of core earnings and allowance to work through this cycle. Even in the burn down scenario, we can add a small amount of sub debt to maintain our capital ratios of 100 basis points above well-capitalized and not have to issue common stock. Now, I'll turn the call back to Jimmy.

[Jimmy Tallent:]

Thanks, Rex. We cover a lot of information in a short period of time. Let me recap three key points that I feel are important for you to take away from this call. First, our core earnings remain solid. If you pill away all of the credit issues you still have a thriving business that has a tremendous value. It's easy to lose sight of this with all the credit costs that we've incurred, but when the credit cycle recovers, our business will be strong again. Several temporary factors continue to suppress our earnings, specifically, the carrying costs of our NPAs, abnormally high credit cost, higher loan workout expense and margin compression caused by the deposit pricing environment. My point is despite these pressures the company remains solid and in a very strong position to manage through the current economic cycle. Second, credit costs will continue to rise for the next two quarters. Our goal is to be at the front of the pack of those companies that get their credit problems behind them. To that end, we're going to hold steady in our commitment to moving problem credits off of our books as quickly as possible. As David outlined previously, the commitment to dispose of these assets aggressively while it makes the best business sense will likely cause our credit costs to rise over the next two quarters. We expect a significant volume of foreclosure activity and we will price properties to move quickly. However, given the large number of foreclosures from all banks today, our sales included, this will add inventory to an already saturated market. We're concerned about the impact of this increased supply of our closed properties on liquidation values. Therefore, I can tell you with certainty that our foreclosure activity will be on the rise for the next two quarters as we move non-performing loans to OREO, and it will cause an increase in charge-offs. Regardless, we remain committed to aggressively disposing of problem credits. And my third point is that capital remains solid. Clearly, we are in an environment where we cannot have too much capital. We plan to add regulatory capital in a non-dilutive manner. This will likely occur in the third quarter. In the meantime, as Rex explained earlier, at our current capital levels with conservative estimates of pre-tax, pre-provision earnings, we can sustain significant credit costs outwards of $300 million over the next ten quarters and maintain our well-capitalized levels with the addition of a moderate amount of sub debt. Now, let me be perfectly clear about this $300 million credit cost. This is a stress test, not our expectation. In fact, let me put some additional perspective on the $300 million. If you add up all of our non-performing loans, all of our OREO, and all of our loans, 30 days or more past due, and charge every one of them off to zero with no recovery, that is still $100 million less than the burn down scenario that Rex shared with you earlier. In conclusion, we continue to have great faith in our business model, more strongly than ever. We remain a very sound company, one that is led by seasoned bankers who are using all of their expertise to guide us through this volatile operating environment. We remain committed who we are and how we do business. This means our people continue to do a wonderful job of delivering outstanding service, a key factor in keeping our customers loyal and continuing to bring their business to us. With that, I will ask the operator to open the call to questions.

[Operator:]

(Operator instructions) We'll go first to Kevin Fitzsimmons with Sandler O'Neill.

[Kevin Fitzsimmons:]

Hey guys, good morning.

[Jimmy Tallent:]

Hello, Kevin.

[David Shearrow:]

Good morning.

[Kevin Fitzsimmons:]

Couple things. First, you mentioned you're willing to be more aggressive in terms of sales and disposing of the problem loans off the balance sheet, can you give us a little more color, David, on what kind of pricing you're seeing out there right now, and where you think that's going? Just in terms of what kind of cents on the dollar it's looking at? And then secondly, Jimmy, if you can – I understand the kind of capital scenarios you were laying out, and one thing I think didn't mentioned at all was the dividend. And I just want to get a feel for where that falls in your thinking? Why not include that as a potential lever, and what your thinking on that is? Thanks.

[David Shearrow:]

All right, Kevin, let me address the credit question first, and then we'll pass it off. In terms of severity of losses we've been experiencing to-date, Kevin, on the housing front, our typical on a liquidation anywhere from zero to say 15% to 16% on housing – and our actual average is probably in Atlanta, just on completed housing is closer to 15%. On the finished lot side, obviously, it depends as how they on location, but we're averaging between 30% and 40% haircuts when we're liquidating completed finished lots.

[Jimmy Tallent:]

Kevin, in regards to the dividend, and I think it's a really good question. First, I think we would look at the amount of our dividends relative to other banks, and it's always been fairly small, about $4.25 million per quarter now. That's not small obviously in this environment. We're very sensitive to the needs of our retail base because a high percentage of ownership of the company is to the retail. But at the end of the day, if we have to choose what we believe is the right thing for our investors would be certainly a lower dividend payment and we feel that, that certainly is more advantageous than running the risk of dilution to our shareholders through issuing of common stock. But, let me be clear. Nothing is off the table in this environment.

[Kevin Fitzsimmons:]

Is Jimmy just as a follow-up to that, you just said nothing's off the table, is – have you gotten a chance to look at, or are you beginning to look at, anything else in terms of not just your ongoing approach to getting – working down resi construction, but also is there anything non-core that you can look at kind of disposing or selling, or a more severe approach to expenses, anything that might increase what is needed to absorb the credit losses?

[Jimmy Tallent:]

Sure, Kevin, we look at everything on the balance sheet. We really just don't have anything that is of substance relative to being non-core. Basically, our balance sheet is to real customers. And just really don't have anything that that we see that you could actually sell off if that was a choice. Certainly, when you look at the total business you have BRAINTECH, but at this point we have no plans of doing anything there. Looking at the expense base, certainly, we are in the middle of looking at that and certainly at all options. Our folks have done a very good job when you look at over the last 12 months and the overall expense base, particularly, on the people, but I think any good company and any good management team certainly at this point with the economy, ought to take a deep dive to explore the expense base and see what we can do. That will certainly be accomplished with our company and we're in the middle of that presently as well.

[Kevin Fitzsimmons:]

Okay. All right. Thank you very much, guys.

[Operator:]

And we'll go next to Jennifer Demba with SunTrust Robinson Humphrey.

[Jennifer Demba:]

Thank you. I'm wondering if what kind of expectation you have in terms of contracting the loan portfolio further. What kind of rate of decline can we expect maybe over the next two to four quarters?

[Jimmy Tallent:]

David, do you want to take that?

[David Shearrow:]

Yeah, I mean right now, Jennifer, we've been fairly flattish obviously, my expectation is as the residential construction is going to continue to burn off much in the fashion it has this past quarter, I don't see strong drivers currently out in the market. We are getting some, little bit of activity on the commercial real estate front. If I had to kind of look at our overall portfolio really for the rest of the year I think my expectation is a fairly flat environment.

[Jennifer Demba:]

Okay. And can you, Jimmy, give me an idea of what you're seeing out there in terms of the tone from your customers? Have they been concerned with the IndyMac failure? Seems like customers are a lot more concerned about safety. Have you seen any impact from your customer base there?

[Jimmy Tallent:]

Well, we've not seen anything, Jennifer, in regards to dollars. But certainly, the concern from our depositors has risen probably as high as I've ever seen. And I suspect that will do nothing, but intensify over the next few months. We have designed actually two quarters ago, a pretty extensive training program for people to be able to explain to our customers, talk with them very intelligently about the FDIC insurance. We've also added the Cedars program to our offerings so that we can insure some of the larger depositors. And we have been very proactive, quite candidly, Jennifer, in reaching out to our customer base and trying to make sure that they are put to as much ease as possible. It's somewhat interesting when you hear of the IndyMac all the way on the West Coast, my concern is if and when we have a failure on the East Coast.

[Jennifer Demba:]

Right. When you said you proactively reached out, would that be through advertisement or personal contact from the bankers?

[Jimmy Tallent:]

Both.

[Jennifer Demba:]

Okay. One other question, Rex. You mentioned you thought the margin pressure would continue over the near-term and then perhaps move back up to 350-ish, can you kind of give us some more color around that, and what gives you that comfort?

[Rex Schuette:]

Sure, Jennifer. As I indicated in the call, if you look at the quarter, and I talked about some of the decreases, I was talking about it in the context of our link quarter bringing us down from 355 to 332. And again, the key items underneath that were our deposit pricing, you had 200 basis point decline in the first quarter, another 25 in Q2, impacting that we were not able to lower our deposit pricing as quickly. The other major component on is that to keep in mind is the NPAs and the load on our margin right now. The four basis points was a link quarter. If you look at it compared to a year ago, it's about 23 basis points. And again, as we look at that, you're going to have some NPA carry cost even going in the next year, but it's had its kind of peak I think coming through right now with the height of the volume. And if we take 80% of that, that's roughly 18 basis points improvement as we go into next year or later this year from our 332 moving it up to about 350. And the balance of it, we see that coming back through our loan CD spread. That squeezed as we had the rates come down fast. We're actually seeing an improvement in our loan pricing even in the third quarter. If you look at the balance of the year in Q3 and Q4 we have 250 million of CDs on average a month maturing in Q3 and just under 200 million for Q4, and both those quarters are about a 435 rate. And we're putting on CDs today probably in the 350, 360 range. So, I think underneath it, the reason I had some caution is again getting through this next quarter in particular with NPAs, we'll have some drag here, but I really see it flattening out and seeing some improvement come in the near-term.

[Jennifer Demba:]

Thank you.

[Operator:]

And we'll go next to Adam Barkstrom with Sterne Agee.

[Adam Barkstrom:]

Hey, guys. Good morning. I wanted to follow up on Kevin's question talking about the loan sales and you guys had mentioned in your press release that you continued to push some of your non-performing (inaudible). Did you already talk about this? What was actually sold in the quarter? How much?

[David Shearrow:]

Yeah, Adam, if you look at kind of what happened on our NPA activity, we moved – we had a little over 100 million in new NPAs come on. We had approximately 50 moved out of that, included in that 50 number is 14 in charge-offs, so, kind of actual, between the actual sale of assets, and we did have some that went back on performing status, actual sold was probably about 28 million. So you had 14 charge-offs, the balance would be credits that get reworked and became performing credits.

[Adam Barkstrom:]

All right. So you sold, just I'm clear, you sold $28 million in the quarter, and most of that was residence or almost all that was residential real estate construction?

[David Shearrow:]

That's correct.

[Adam Barkstrom:]

Okay. Okay. Thank you. And then, hey Rex, I was curious if you give us a little more color on the – one thing I was just wondering about you talk about the margin, and the margin being under pressure and the competitive deposit pricing, and I was just curious why the aggressive deposit campaign when such competitive on – such a competitive time on deposit rates? Could you give us some more color on that, obviously that funded the pay down of the borrow income, I was curious if you guys are seeing a little pressure on that side of the balance sheet?

[Rex Schuette:]

As Jimmy indicated, I think the key point with it in coming into the second quarter, Adam, was to make sure that we took a good, hard look at liquidity and wanting to expand it, and again developed a program in a fairly short time period – and this was all internal, on a word of mouth back to the customer, not through promotion out there, and I think executed a very good program to add over 400 million of liquidity in the second quarter. Again, it was at a slightly higher rate, but again the other side it was at a longer maturity. So, we had it at 15 months versus an average of 10 that we've been putting on previously. So it helped, I think, to get us well into next year, if there's concerns again about liquidity or again concerns on customer deposits in our markets. So, I think it made a lot of very good business sense to put that on at this time, and it had again a small impact in the margin, but I think well worth it at this time.

[Adam Barkstrom:]

Okay. And then that product, you're saying that was primarily a 15 month type of product?

[Rex Schuette:]

Yes.

[Adam Barkstrom:]

Can you share what kind of rate you're paying on that?

[Rex Schuette:]

The rate was basically about 416, stated rate on it.

[Adam Barkstrom:]

416.

[Jimmy Tallent:]

Adam, this is Jimmy. One of the other thought processes behind that certainly is to have as much of the liquidity as we possibly can as early. Goes back to a question of what Jennifer asked relative to the FDIC insurance, and with the uncertainty there on how the customer base will react, not just with us, but everywhere, we felt that made good business sense. The other thing too I would point out and I just happened to notice early this morning in the Atlanta paper, two very, very large banks are now paying more than what we offered for a much shorter term.

[Adam Barkstrom:]

Jimmy, do you remember what – do you remember exactly what the terms were just roughly?

[Jimmy Tallent:]

Seven months, 4.25.

[Adam Barkstrom:]

Okay, gentlemen, thank you.

[Jimmy Tallent:]

Yeah.

[David Shearrow:]

Thank you, Adam.

[Operator:]

And we'll go next to Christopher Marinac with FIG Partners.

[Christopher Marinac:]

Thanks. Good morning. Rex, I just want to reconcile the comment you made about the 130 million credit costs that you sort of able to take, I want to compare that with the tier-one as well as the risk-based excess that you mentioned?

[Rex Schuette:]

Right. The 130 million is really based on the total risk – that I mentioned was 85 million and looking at that on a pre-tax basis, what that's equivalent to. So it's 85 million in excess of our 10% for well-capitalized, looking at quarter-end.

[Christopher Marinac:]

So it's 85 million tax adjusted?

[Rex Schuette:]

85 million tax adjusted.

[Christopher Marinac:]

Perfect. Okay. And then on the deposit growth this quarter just noticing that only about 20% of it – of the deposits were coming from the core area. I was curious to what extent you're having any success on the NOW accounts, I know that those were positive versus the money market down, I was just curious if you can kind of relate what customers want on the NOW side and the money markets compared to the growth that you and others are seeing on CDs?

[Jimmy Tallent:]

Chris, this is Jimmy. It's really, it's really somewhat of an unusual time. Seems like the large part of the deposit base today are very, very sensitive and focused on the insurance. Our people are dealing with that multiple times every single day. I don't know that there's any specific reason that the NOW account had a different type of activity. I would tell you though conceptually from the company's standpoint, we have a number of initiatives in place to acquire core deposit accounts. And we're beginning to get some traction on it. I'm hopeful that we will see that portfolio composition mix continue to change closer to the core deposit base. But really, that's certainly where we're focused at. The CD promotion was really just to build liquidity.

[Christopher Marinac:]

Okay. And then one other question back to credit quality for David or whomever is just can you contrast any changes either good or bad outside of Atlanta within your footprint whether that's in the Georgia coast or in North Carolina or Tennessee?

[David Shearrow:]

Yeah. Chris, I have to say that the story continues to be Atlanta-centered, but having said that, we have seen little more slowness in our other markets. We had a couple irons move in the coast, overall – relative to overall, they're not substantial. There's one or two credits down there, but we are also getting more reports of more softness. I think they've been lagging Atlanta on the slowdown. So we're seeing a little bit more slowness down there. The North Georgia is seeing a little bit more slowness, but it's holding in there, still very well relative to Atlanta. So, I guess the answer is, yeah, we're seeing more slowness, we're not surprised by that because of what's going on in the general economy, but the story is still an Atlanta story at this point.

[Christopher Marinac:]

Great. Thank you, David. Appreciate it.

[David Shearrow:]

Okay.

[Operator:]

And we'll go next to Kevin Reynolds with Janney Montgomery Scott.

[Kevin Reynolds:]

Good morning, guys.

[Rex Schuette:]

Good morning.

[Jimmy Tallent:]

Hey, Kevin.

[David Shearrow:]

Good morning.

[Kevin Reynolds:]

Most of my questions I think have been answered. The one question I had you'd talked about a flattening out, David, in past dues and total classified loans, could you run back through that again, just give me sort of some numbers, maybe percentages as well as dollar levels?

[David Shearrow:]

We don't provide our level of watch and classified out to the market, but what I'll tell you on that front is, they are relatively flat from first to second quarter, in fact, actually they were down somewhat. We're not viewing that as a victory in any sense at this point in time, and not sure that that's going to be the case looking over the next two quarters, but that's just a fact where we were at the end of the quarter. On the past dues, we actually were down from 1.39% down to 1.10% at the end of the quarter and that frankly was a very pleasant surprise, and so, it is a bright spot. And we saw improvements in most all categories including residential construction. So, these are two encouraging signs, but obviously we're – if you look at the general market particularly Atlanta, we don't see any substantial market improvements down there. So we're not – we're still very cautious about where we are in this whole cycle at this point in time.

[Jimmy Tallent:]

Kevin, this is Jim. Let me add on to that too in regards to that overall watch list as we refer to. There has been a number of continued exercises within the last 30 days, an extensive review of not just the classified assets, but all the way down to any development over a million dollars in the Atlanta market. But, it has been extended out all across the company. And really, we felt pretty good once we again went through that, and we're doing it every 30 to 45 days. But, that's absolutely not to declare victory at this point in time. What I would want to emphasize is our intent focus on early identification, and once we do identify that weak credit, we work very, very quickly to get it resolved.

[Kevin Reynolds:]

Okay. And then I know this is sort of been asked a little bit, but I'm going to ask it a different way perhaps. The CD campaign this quarter for liquidity purposes, why so much, why now, and perhaps without naming names, could you – it sounds to me as if you're sort of preparing for some real market uncertainty to pick up on the part of the retail depositors out there, are there some things you're either seeing or hearing that lead you to believe that we may have some issues to deal with, with other institutions in the current quarter or say, maybe before year-end?

[Jimmy Tallent:]

Sure, Kevin. The question is why now which really was in the earlier to mid part of the second quarter. We felt, number one, that we ought to build liquidity now because of the uncertainty over the next quarter or two, particularly with the health of some of the banks. We truly feel that the insurance is going to become a bigger issue in the near-term if other banks were to fail. Also, we felt that we were at a time point that maybe we were at that cusp of the pricing that if we went in now could be well be cheaper now than later simply because of other banks piling on and trying to build liquidity. That's what we're seeing. We made a very conscious decision knowing that it would be a little bit expensive on the short-term, but over the 15-month period, we think it would certainly be to our advantage. And then, literally in the last 45 days, we've seen two very large banks paying high rates for shorter term.

[Kevin Reynolds:]

Okay. What about the smaller banks? What are they doing these days?

[Jimmy Tallent:]

They're doing the same thing. They're paying. In my opinion, whatever they have to for funding. I think what we will see over the next quarter or two as some banks get to a point where they're unable to get brokerage CDs, their only alternative in the market is to pay whatever price they have to, to attract CD or deposits. I just see in the next couple of quarters it's just my opinion, we will see a much stronger pressure on the CD pricing.

[David Shearrow:]

Kevin, also, as I indicated before briefly, this gives us I think a significant amount of more flexibility as we get into the latter half of this year, and what we do on wholesale funding at the same time versus not doing it previously. So, we have an opportunity to, I think, utilize some wholesale funding if appropriate later in the year going into next year, since we built up a fairly significant amount of capacity right now.

[Kevin Reynolds:]

Okay. And then just to go back to you, Jimmy, do you think, you think the pressure on local deposit pricing goes higher over the next six months? Do you think we might get some regulatory resolution of such activity in the next six months? Or do you think that these banks survive into 2009?

[Jimmy Tallent:]

Well, that's a good question, Kevin. I think we probably will see the action occur some time in early '09 could be some toward the latter part of '08, but I'm beginning to think it may be the first half of '09.

[Kevin Reynolds:]

Okay. Thank you.

[Operator:]

And we'll go next to Michael Rose with Raymond James.

[Michael Rose:]

Can you talk a little bit about the lot inventory numbers? Is there any change in the trends?

[David Shearrow:]

Yes, in the Atlanta market is where we get that kind of data, Michael. The actual lot inventory was really flat quarter-over-quarter. We're up 400 lots based on a count. So, from we're at 148.7000 lots on the ground in Greater Atlanta right now. The lot supply in terms of months of course is up because starts were soft again. Overall, starts in Atlanta declined from 26,000, down to 20,000 starts in the quarter. So, inventory level is flat, but activity is still very soft. So, that's going to still take some time to work through that. On the housing front, just to address that quickly, housing inventory up slightly from 11 months to 11.7 months. Overall closings in the quarter were 30,200. That was down from 34,200 first quarter. And I guess the kind of one comment I make overall, and Gary may want to add his thoughts too, but we are hoping, I think all the builders were hoping for a stronger spring season than we had, and we got a little bit of a flutter early in the spring, but it really didn't sustain, and so, it's been a little disappointing.

[Gary Guthrie:]

That's true, David. We haven't seen so far any appreciable pickup, and certainly didn't get (inaudible) we hope to have.

[Michael Rose:]

Okay. And Rex, separately, can you talk about your efficiency ratio target, and how the elevated costs from NPAs plays into that, and when you think you might be able to return to that sort of target that 56% to 58% target that you've provided?

[Rex Schuette:]

That is the crystal ball question, Michael. It really is driven entirely on our credit cost and provisioning, and expectation out there. So, it's going to take us to get, as both David and Jimmy indicated earlier, we look to try and get beyond most of this as much as possible this year. And I think then going into next year is where you'd see the improvement in our operating efficiency ratio again as the provisioning number comes down. But, until that number comes down and the impact on our margin really not going to get back to that 56 to 58 or 58 to 60.

[Michael Rose:]

All right. Great. Thank you.

[Operator:]

And we'll go next to Brian Roman with Robeco Investments.

[Brian Roman:]

Thank you for taking my question. A number of questions, but I want to get back to this issue you guys have raised. Basically, you're saying that you anticipate – not anticipate, but you can envision some more banks going the way of IndyMac, are you talking about on a national level, on a local level? Large banks? Little banks? You're the first people I've heard kind of put it this way.

[Jimmy Tallent:]

Brian, this is Jimmy. What we're saying is that what – based on what we hear, certainly there is some of the smaller banks I'm sure under stress. We're not advocating that.

[Brian Roman:]

No, I hope not at least.

[Jimmy Tallent:]

But that's based on what we hear, certainly given the limited ability to raise capital, given the portfolio of a lot of the banks, certainly some of the small ones heavily invested in A&D and construction, and not a lot of core deposits I suspect it's going to be a real challenge. Again, we're not….

[Brian Roman:]

So I'm sorry, I don't want to put words in your mouth, so agree or disagree, but you're sort of looking more locally and looking at some of the smaller construction oriented banks that haven't had access to capital. So you're – you're really in your local – looking in your local markets right now. Is that correct?

[Jimmy Tallent:]

Exactly. That's correct.

[Brian Roman:]

Okay. Couple other – several other questions, goodwill, big item on your balance sheet, any discussion about writing it off, writing some of it off given the outcomes in your loan portfolio?

[David Shearrow:]

We look at the evaluation on a regular basis. There's a little over 320 million of total intangibles, 306 million of goodwill. Obviously, I think the point is coming in from Wachovia and what they did on impairment.

[Brian Roman:]

TSFG down in Florida and there're few others.

[David Shearrow:]

Prior quarter. There haven't been many out there that have had impairment charges. As we look at it in our franchise, we do not see any permanent impairment as we look at our franchise right now. As we look at our core earning base as well as – again as I talked about it in the context of looking at our capital planning and what we can absorb, and looking at losses going forward, so we'll keep a view on that, I mean, looking at it, we look at it every quarter and prospectively. So, at this time, we really think it's more temporary with respect to looking at the stock price out there in comparison to your market cap in comparison to tangible equity, and feel comfortable where we're at.

[Brian Roman:]

I'm sure your accountants look at it too, so….

[David Shearrow:]

Absolutely.

[Brian Roman:]

….they let you know. By the way, I appreciate the breakout you guys are putting in the release now. I'm looking at the breakdown of the loan portfolios, and your residential construction 1.745. I love this term, dirt loans, we don't use it up here in New York, but I'm comparing dirt loans to house loans, and house loans seem to be declining at a faster rate than dirt loans, can you explain why that is the case?

[David Shearrow:]

Sure. That's just – that's the normal conversion if you think in terms of what's quickest to convert to cash. Completed house is going to come before a lot. Lot has to be built on before it can be sold typically. And so what you see in a slowdown like this where the sales activity has slowed, the first thing that's going to decline is your completed housing. When new house starts pick up you'll see more of the dirt being absorbed and become construction loans, and then flowing through. So, it's nothing more than what you expect to find in this type of cycle. Is that clear?

[Brian Roman:]

Yeah, that makes sense. So, but then looking forward, we should as investors look at dirt loans staying higher, longer than house loans?

[David Shearrow:]

That's correct, until at some point when you see a reversal in the market, but, in general, yes, that's correct.

[Brian Roman:]

Okay. Last question, (inaudible) the margin declined sequentially, you referenced higher CD rates, you referenced Fed moves in January – I think they moved after that as well. My understanding is that construction loans tend to be higher margin loans, they have a lot of (inaudible) fees that get amortized over the life of the loan. With that part of the portfolio starting to decline, is there any way to quantify what the decline in the residential construction portfolio does to the overall margin? And obviously, you can refute what I – my initial statement if it's not true.

[David Shearrow:]

No, Brian, obviously, there's a mix change in the portfolio with respect to the construction. Portfolio has a slightly higher rate, but the commercial loans we've put on again have deposits with it. And so you might see a yield difference on the loan itself, but again, we're getting other core deposits with that relationship at the same time.

[Brian Roman:]

Point well taken. Yeah.

[David Shearrow:]

The link quarter was a fairly small decrease and you look at 46 million in construction on a $6 billion portfolio, it's not going to have a material impact. But again, the $200 and some million again 238 year-over-year does have an impact in margin overall when you look at the year-over-year margin. Again, we do have slightly, as I mentioned, it's a combination of our loan to CD spread is what is getting compression, and it's a combination of not being able to move down CD as fast, our loans get priced immediately, the prime base, that number has – the prime base is about 3.2 billion of our total portfolio, and it's consistent with last quarter, so, again, there is a little bit of mix in there impacting it. But, on the link quarter, I don't think it's a material number on a link quarter.

[Brian Roman:]

Great. Thank you very much for taking my question.

[Operator:]

And we'll go next to Jefferson Harralson with KBW.

[Jefferson Harralson:]

Hey, thanks, guys.

[Jimmy Tallent:]

Hey, Jefferson.

[Jefferson Harralson:]

You guys mentioned, I think when you were talking about the stress case piece, your capital targets being 100 basis points over the regulatory minimum, is that just for your stress case, or is that your actual capital targets where you would feel uncomfortable bringing them down to, say, 50 basis points over the regulatory minimum?

[David Shearrow:]

No, our guideline has been this for years, Jefferson, is 100 basis points above the regulatory well-capitalized level. So, that is our internal guideline. If we're getting close near slightly going underneath it, we're looking at actions.

[Jefferson Harralson:]

Okay.

[David Shearrow:]

Again to keep it above that target.

[Jefferson Harralson:]

All right, thanks. Do you have in front of you what the total capital ratio is at the bank level? And is it more thin? I guess a broader question is it more thin than the total capital ratio at the holding company level?

[David Shearrow:]

It is slightly under that about 1130 at the bank level on total risk-based capital.

[Jefferson Harralson:]

Okay. If you guys go out and look for sub debt or drop and the rate is unacceptable, what is – do you plan to go without or what is Plan B?

[Jimmy Tallent:]

We would go without, because we're not in a position, Jefferson, that we absolutely have to have that. In times like these it probably would make sense to be able to bolster that. And we have been looking and talking really over the last couple of quarters, and as we all know how the pricing has gotten to be very, very expensive. Sub debt right now what appear to be somewhere in the LIBOR plus 4% range, and I think there's a number of stories that whereby it's a lot more expensive than that. Trust preferred is very, very expensive. Assuming that we went that route we would probably look on a private basis, possibly internally. So, we will be very methodical and disciplined in that process, because we don't want to go out and pay some ridiculous amount when we don't have to do it. Fortunately, we have options available to us today.

[Jefferson Harralson:]

Thanks for the color.

[Operator:]

And there are no other questions at this time. I'd like to turn things back to our speakers for any closing remarks.

[Jimmy Tallent:]

We want to thank all of you for being with us today. Thank you for your support with United Community Bank. We look forward to reviewing with you our third quarter results in October. And we hope all of you have a great day.

[Operator:]

Thank you everyone. That does conclude today's conference. You may now disconnect.