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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Quarterly Report Pursuant to Section 13 or 15(D) of the
Securities Exchange Act of 1934

For the Quarterly Period Ended September 30, 2002

Commission file number 333-49459

New South Bancshares, Inc.
(Exact name of registrant as specified in its charter)

(205) 951-4000
(Registrant’s telephone number, including area code)

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 x No o

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NEW SOUTH BANCSHARES, INC.
FORM 10-Q
INDEX

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NEW SOUTH BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements

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NEW SOUTH BANCSHARES, INC.
CONSOLIDATED INCOME STATEMENTS
(Unaudited)

See accompanying notes to consolidated financial statements

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See accompanying notes to consolidated financial statements

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NEW SOUTH BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

See accompanying notes to consolidated financial statements.

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NEW SOUTH BANCSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)

Nine Months Ended September 30, 2002

1. General

         The consolidated financial statements have been prepared using generally accepted accounting principles. The accompanying interim financial statements are unaudited; however, in the opinion of management, all adjustments necessary for the fair presentation of the consolidated financial statements have been included, and are of a normal recurring nature. Certain amounts in the prior year financial statements have been reclassified to conform with the 2002 presentation. These reclassifications had no effect on net income and were not material to the financial statements. These financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Annual Report on Form 10-K for the year ended December 31, 2001.

         New South Bancshares, Inc. (“Bancshares” or the “Company”) is a unitary thrift holding company formed in 1994. The Company has three wholly owned subsidiaries, New South Federal Savings Bank (“New South” or the “Bank”), Collateral Agency of Texas, Inc., and New South Management Services, LLC. New South has four subsidiaries, Avondale Funding.com, inc. (“Avondale”), New South Agency, Inc., New South Real Estate, LLC, and New South DIL, LLC and significant interests in four joint ventures (the “New South Joint Ventures”). The consolidated financial statements presented primarily represent the accounts of Bancshares and New South. Two of the New South Joint Ventures are consolidated with their minority interests included in other accrued expenses, deferred revenues, and other liabilities. Two New South Joint Ventures are accounted for under the equity method. All significant intercompany accounts or transactions have been eliminated upon consolidation.

2. Derivative Instruments and Hedging Activities

         In September 1998, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS No. 133”). In September 2000, the FASB issued SFAS No. 138, Accounting for Certain Derivative Instruments and Hedging Activities – an Amendment of SFAS No. 133. SFAS No. 133, as amended, replaces existing pronouncements and practices with a single, integrated accounting framework for derivatives and hedging activities requiring companies to formally record at fair value all derivatives and to document, designate, and assess the effectiveness of transactions that receive hedge accounting. See “Interest Sensitivity and Market Risk” section for a more detailed discussion of the Company’s utilization of derivative instruments and hedging activities.

         The Company adopted SFAS No. 133 effective January 1, 2001 and recognized a cumulative-effect transition adjustment of approximately $1.1 million to decrease net income for the effect of the change in the accounting principle relating to derivatives that did not receive hedge accounting treatment. Additionally, the Company recognized a cumulative effect transition adjustment to reduce accumulated other comprehensive income (“OCI”) by $3.2 million on a pre-tax basis. The transition adjustment to OCI represented net unrealized losses on derivative instruments that qualified as cash flow hedges.

         The Company utilizes certain derivatives in its operations that do not qualify as hedges for accounting purposes, as described above, under SFAS No. 133. The following summarizes the impact on earnings, in thousands, from valuation adjustments relating to these derivatives for the periods indicated:

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         During 2001, certain forward contracts relating to loans available for sale initially designated as cash flow hedges were redesignated as fair value hedges resulting in the reclassification of $.4 million into gain on the sale of loans and mortgage servicing rights. OCI was decreased by $.3 million and $.1 million during the nine months ended September 30, 2002 and 2001, respectively from reclassification into earnings resulting from hedge ineffectiveness. Hedge ineffectiveness decreased OCI by $.2 million during the quarter ended September 30, 2002 and increased OCI by $.1 million during the quarter ended September 30, 2001. The extent of hedge ineffectiveness is influenced by a number of factors including future interest rate volatility, hedge performance and correlation.

3. S Corporation Election

         The Company is an S Corporation, and as such generally is not subject to Federal corporate taxation. Certain states, however, do not recognize S Corporation status; therefore, the Company incurs state income taxes for those jurisdictions. Profits and losses flow through to the S Corporation shareholders directly in proportion to their per share ownership in the entity. Accordingly, shareholders will be required to include profits and losses from the Company on their individual income tax returns for federal, and state and local, if applicable, income tax purposes.

         Typically, S Corporations declare dividends to shareholders in an amount sufficient to enable shareholders to pay the tax on any S Corporation income included in the shareholder’s individual income. The Company paid dividends totaling $7.0 million during the nine months ended September 30, 2002. Generally, such dividends are not subject to tax since they result from S Corporation income on which shareholders have previously been taxed.

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4. Comprehensive Income

         Comprehensive income is the change in equity during a period from transactions and other events and circumstances from nonowner sources. For New South and the Company, nonowner transactions consist of changes in unrealized gains and losses on securities available for sale and changes relating to cash flow hedges under SFAS No. 133. The following table represents, in thousands, comprehensive income for the periods indicated.

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5. Segment Reporting

         Reportable segments consist of Residential Mortgage Banking, Commercial Real Estate Lending, Automobile Lending, and Portfolio Management.

         Residential Mortgage Banking originates and services single-family mortgage loans. These loans are originated through the Company’s network of retail loan origination offices and through brokers and correspondents. Commercial Real Estate Lending consists of loans secured primarily by multi-family housing. Automobile Lending consists of the origination and servicing of loans secured by automobiles, light trucks, and vans. These loans are primarily acquired on an indirect basis through automobile dealers. Portfolio Management oversees the Company’s overall portfolio of marketable assets as well as New South’s funding needs. Other includes unallocated corporate overhead. Residential Mortgage Banking, Commercial Real Estate Lending, and Automobile Lending retain the assets generated by each unit, and are credited with the interest income generated by those assets unless they are actually sold in the secondary market with the results of such sales being attributed to each unit. Each unit pays a market-based funds-use charge to Portfolio Management. The segment results include certain other overhead allocations. The results for the reportable segments of the Company for the three and nine months ended September 30, 2002 and 2001, in thousands, are included in the following tables.

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6. Recent Accounting Pronouncements

         In June 2001, the FASB issued SFAS No. 141, Business Combinations (“SFAS No. 141”) and SFAS No. 142, Goodwill and Other Intangible Assets (“SFAS No. 142”). These statements revise the standards of accounting for business combinations and related goodwill and other intangible assets. SFAS No. 141 was generally effective for business combinations after July 1, 2001 and SFAS No. 142 was effective for fiscal years beginning after December 15, 2001 with certain provisions effective earlier. The adoption of SFAS No. 142 on January 1, 2002 did not have a significant impact on the financial statements.

         In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). This statement revises the standards of accounting for the accounting and reporting for the impairment or disposal of long-lived assets. SFAS No. 144 was effective for fiscal years beginning after December 15, 2001. The adoption of SFAS No. 144 on January 1, 2002 did not have a significant impact on the financial statements.

         In April 2002, the FASB issued SFAS No. 145, Rescission of SFAS No. 4, 44, and 64, Amendment of SFAS No. 13, and Technical Corrections (“SFAS No. 145”). This statement rescinded SFAS No. 4, 44, and 64, the provisions of which are either addressed in other pronouncements or no longer applicable. SFAS No. 13 was amended to address the accounting for certain lease modifications. Adoption of SFAS No. 145 on January 1, 2002 did not have a significant impact on the financial statements.

         In June 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with Exit or Disposal Activities (“SFAS No. 146”). This statement addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146 requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. The provisions of this statement are effective for exit or disposal activities

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that are initiated after December 31, 2002, with early application encouraged. The impact of the statement on the Company’s consolidated financial position and results of operations is not expected to be material.

         In October 2002, the FASB issued SFAS No. 147, Acquisitions of Certain Financial Institutions (“SFAS No. 147”). This statement amends SFAS No. 72, Accounting for Certain Acquisitions of Banking or Thrift Institutions (“SFAS No. 72”) and SFAS No. 144 and FASB Interpretation No. 9, Applying APB Opinions No. 16 and 17, When a Savings and Loan Association or a Similar Institution is Acquired in a Business Combination Accounted for by the Purchase Method (“Interpretation No. 9”). Except for transactions between two or more mutual enterprises, SFAS No. 147 removes acquisitions of financial institutions from the scope of both SFAS No. 72 and Interpretation No. 9 and requires that those transactions be accounted for in accordance with SFAS No. 141 and 142. In addition, this statement amends SFAS No. 144 to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor and borrower relationship intangible assets and credit cardholder intangible assets. SFAS No. 147 is effective after September 30, 2002 and will not have a material impact on the Company’s consolidated financial position or results of operations.

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Basis of Presentation

         The following discussion should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto and the other financial data included elsewhere in this document. The Company’s accounting policies are integral to the financial results discussed herein. The significant accounting policies of the Company are contained in Footnote 1 to the Consolidated Financial Statements filed in the Company’s Form 10K for the year ended December 31, 2001. The financial information provided below has been rounded in order to simplify its presentation. However, the ratios and percentages provided below are calculated using the detailed financial information contained in the Consolidated Financial Statements, the Notes thereto, and the other financial data included elsewhere in this document. All tables and financial statements included in this report should be considered an integral part of this analysis.

         The purpose of this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is to provide an analysis of significant changes in the Company’s assets, liabilities, and capital at September 30, 2002 as compared to December 31, 2001, in addition to including an analysis of income for the quarter ended September 30, 2002 (“Third Quarter 2002”) and nine months ended September 30, 2002 (“YTD 2002”) as compared to the quarter ended September 30, 2001 (“Third Quarter 2001”) and nine months ended September 30, 2001 (“YTD 2001”).

Forward Looking Statements

         This management discussion and analysis contains certain forward looking information with respect to the financial condition, results of operations, and business of the Company, including the Notes to Consolidated Financial Statements and statements contained in this discussion with respect to security maturities, loan maturities, loan growth, expectations for and the impact of interest rate changes, the adequacy of the allowance for loan losses, expected loan losses, and the impact of inflation, unknown trends, or regulatory action. The Company cautions readers that forward looking statements, including without limitation those noted above, are subject to risks and uncertainties that could cause actual results to differ materially from those indicated in the forward looking statements. Factors that may cause actual results to differ materially from those contemplated include, among others, the stability of interest rates, the rate of growth of the economy in the Company’s market area, the success of the Company’s marketing efforts, the ability to expand into new segments of the market area, competition, changes in technology, the strength of the consumer and commercial credit sectors, levels of consumer confidence, the impact of regulation applicable to the Company, and the performance of stock and bond markets.

Net Income and Key Performance Ratios

         The Company reported net income of $3.2 million for both Third Quarter 2002 and Third Quarter 2001. On a per share basis, net earnings were $2.53 and $2.57, respectively, for each period. During Third Quarter 2002 the annualized return on average assets was 0.88% and the annualized return on average equity was 19.97% compared to 1.08% and 23.03%, respectively, for Third Quarter 2001.

         Net income totaled $9.0 million for YTD 2002, a 2.7% increase from net income of $8.8 million for same period in 2001. On a per share basis, net earnings were $7.19 and $7.00, respectively, for the same periods. YTD 2001 results of operations included a transition adjustment relating to the cumulative effect of a change in accounting principle for derivative instruments and hedging activities of $1.1 million, or $.89 per share and the securitization gain discussed in the following paragraph. During YTD 2002 the annualized return on average assets was 0.88% and the annualized return on average equity was 19.23% compared to 0.99% and 20.57%, respectively, for YTD 2001.

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         During 2001, the Company completed the securitization of approximately $254 million of primarily residential nonconforming mortgage loans, $229 million in the first quarter and $25 million in the second quarter 2001 (the “Securitization”), recording a gain of $3.7 million. The nature and timing of the Securitization had a significant impact on the Third Quarter 2001 and YTD 2001 results of operations as well as Third Quarter 2001 and YTD 2001 averages. The residual interest in the amount of $7.9 million associated with the Securitization was sold to an affiliated company at fair market value.

Net Interest Income, Earning Assets and Interest-bearing Liabilities

         Net interest income for Third Quarter 2002 was $10.6 million, a $3.4 million, or 47.2%, increase from $7.2 million for Third Quarter 2001. This increase was primarily attributable to an increase in average earning assets of $214.1 million, to $1,290.3 million during Third Quarter 2002, compared with $1,076.2 million during Third Quarter 2001, reflecting the Securitization. Net interest income was also affected by a decline in the cost of interest-bearing liabilities of 138 basis points compared with a smaller decrease in the yield on interest earning assets of 69 basis points. The larger decline in the cost of interest-bearing liabilities compared with yield on earning assets reflects the repricing characteristics of certain time deposits and the impact of short-term interest rates as more fully discussed below. The impact of the increase in average earning assets was offset with comparable increases in the level of average interest-bearing liabilities of $222.9 million to $1,268.2 million during Third Quarter 2002, compared with $1,045.3 million during Third Quarter 2001. Overall, this movement in volumes and rates resulted in an increase in the net interest rate margin of 60 basis points during the Third Quarter 2002 compared with the same period in 2001. Net interest income increased despite the impact of the Company’s interest rate swap contracts (“Swaps”), which decreased net interest income by $3.1 million during Third Quarter 2002, compared with a decrease of $1.4 million during Third Quarter 2001. See “Interest Sensitivity and Market Risk” section for a more detailed discussion of Swaps.

         As discussed further herein, a significant portion of the Company’s securities sold under agreements to repurchase (“Security Repo Agreements”) have been converted from short term to longer term liabilities through the use of Swaps. The impact of the Swaps on Security Repo Agreements increased their cost for Third Quarter 2002 by 212 basis points verses 64 basis points for Third Quarter 2001. Swaps increased Security Repo Agreements cost for YTD 2002 by 220 basis points compared with 50 basis points for YTD 2001.

         Net interest income for YTD 2002 was $28.8 million, a $7.8 million or 37.2% increase from $21.0 million for YTD 2001. This increase was attributable to an increase in average earning assets of $181.1 million, to $1,256.0 million during YTD 2002, compared with $1,074.9 million during YTD 2001. The impact of the increase in average earning assets was offset with comparable increases in the level of average interest-bearing liabilities of $176.8 million to $1,228.0 million during YTD 2002, compared with $1,051.2 million during YTD 2001. The timing of the Securitization had less impact on the year to date periods than on the quarterly periods discussed above. During YTD 2002, the cost of interest-bearing liabilities declined by 141 basis points compared with a 93 basis point decrease in the yield on interest earning assets. The combined movement in volumes and rates resulted in an increase in the net interest rate margin of 45 basis points during YTD 2002 compared with YTD 2001. The Company’s Swaps decreased net interest income by $9.2 million during YTD 2002, compared with a decrease of $2.5 million during YTD 2001. See “Interest Sensitivity and Market Risk” section for a more detailed discussion of Swaps.

         The significant change in the impact of the Swaps on the net interest rate margin is due to the significant decline in short-term interest rates over the last 24 months. The Federal Reserve Bank has lowered short-term interest rates 11 times since January 1, 2001, resulting in a 475 basis point decrease in the federal funds rate. These decreases have resulted in declining yields or costs on all classes of interest-bearing assets and liabilities. Due to a steepening of the yield curve, the short-term interest-bearing assets and liabilities were significantly impacted as can be seen in the yield on federal funds sold and the cost of other interest-bearing deposits.

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         The following tables set forth, for the periods indicated, certain information related to the Company’s average balance sheet and its average yields on assets and average costs of liabilities. Such yields or costs are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from the daily balances throughout the periods indicated.

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Average Balances, Income, Expense, and Rates

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Average Balances, Income, Expense, and Rates