UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934 for the quarterly period ended March 31, 2003
Transition report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934 for the transition period from ____ to ____
Commission file number 0-15083
THE SOUTH FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA 57-0824914
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
(864) 255-7900
Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE NONE
(Title of Each Class) (Name of each exchange on which registered)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $1.00 PAR VALUE
COMMON STOCK PURCHASE RIGHTS
(Title of Class)
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
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
----- -----
The number of outstanding shares of the issuer's $1.00 par value common stock as
of May 1, 2003 was 46,644,784.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31,
---------------------------
RESTATED
2003 2002 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2002
----------- ----------- ----
ASSETS
Cash and due from banks $ 181,495 $ 120,439 $ 201,333
Interest-bearing bank balances 59,515 68,753 58,703
Federal funds sold - - 31,293
Securities
Trading 1,418 3,942 350
Available for sale 3,360,107 1,571,565 2,488,944
Held to maturity (market value $63,789, $80,556 and $85,371,
respectively) 61,403 79,679 82,892
----------- ----------- -----------
Total securities 3,422,928 1,655,186 2,572,186
----------- ----------- -----------
Loans
Loans held for sale 60,202 29,900 67,218
Loans held for investment 4,515,133 3,779,682 4,434,011
Allowance for loan losses (66,133) (45,208) (70,275)
----------- ----------- -----------
Net loans 4,509,202 3,764,374 4,430,954
----------- ----------- -----------
Premises and equipment, net 133,261 112,005 137,501
Accrued interest receivable 49,253 32,861 37,080
Intangible assets 242,420 95,495 242,182
Other assets 367,137 207,309 229,778
----------- ----------- -----------
$ 8,965,211 $ 6,056,422 $ 7,941,010
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 757,149 $ 527,629 $ 743,174
Interest-bearing 3,978,566 3,113,875 3,849,336
----------- ----------- -----------
Total deposits 4,735,715 3,641,504 4,592,510
Federal funds purchased and repurchase agreements 956,709 1,279,340 1,110,840
Other short-term borrowings 43,664 63,610 81,653
Long-term debt 2,118,810 503,726 1,221,511
Debt associated with trust preferred securities 95,500 31,000 95,500
Accrued interest payable 22,926 24,419 20,945
Other liabilities 270,403 41,815 84,840
----------- ----------- -----------
Total liabilities 8,243,727 5,585,414 7,207,799
----------- ----------- -----------
Minority interest in consolidated subsidiary 86,484 37,023 86,412
----------- ----------- -----------
Shareholders' equity
Preferred stock-no par value; authorized 10,000,000 shares;
issued and outstanding none - - -
Common stock-par value $1 per share; authorized 100,000,000 shares;
issued and outstanding 46,405,600, 40,261,842 and 47,347,375 shares,
respectively 46,406 40,262 47,347
Surplus 406,839 289,331 427,448
Retained earnings 164,463 121,559 150,948
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (3,035) (1,752) (3,094)
Common stock held in trust for deferred compensation (147) - -
Deferred compensation payable in common stock 147 - -
Accumulated other comprehensive income (loss), net of tax 20,327 (15,415) 24,150
----------- ----------- -----------
Total shareholders' equity 635,000 433,985 646,799
----------- ----------- -----------
$ 8,965,211 $ 6,056,422 $ 7,941,010
=========== =========== ===========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------
RESTATED
2003 2002
---- ----
Interest income
Interest and fees on loans $ 67,333 $ 62,160
Interest and dividends on securities:
Taxable 30,299 21,567
Exempt from Federal income taxes 1,221 1,091
-------- --------
Total interest and dividends on securities 31,520 22,658
Interest on short-term investments 118 469
-------- --------
Total interest income 98,971 85,287
-------- --------
INTEREST EXPENSE
Interest on deposits 17,999 21,576
Interest on borrowed funds 15,501 12,319
-------- --------
Total interest expense 33,500 33,895
-------- --------
NET INTEREST INCOME 65,471 51,392
PROVISION FOR LOAN LOSSES 5,500 6,238
-------- --------
Net interest income after provision for loan losses 59,971 45,154
NONINTEREST INCOME 19,886 11,638
NONINTEREST EXPENSES 48,890 34,852
-------- --------
Income before income taxes, minority interest, and cumulative effect of
change in accounting principle 30,967 21,940
Income taxes 9,910 6,999
-------- --------
Income before minority interest and cumulative effect of change in
accounting principle 21,057 14,941
Minority interest in consolidated subsidiary, net of tax (1,012) (428)
-------- --------
Income before cumulative effect of change in accounting principle 20,045 14,513
Cumulative effect of change in accounting principle, net of tax - (1,406)
-------- --------
NET INCOME $ 20,045 $ 13,107
======== ========
AVERAGE COMMON SHARES OUTSTANDING, BASIC 47,325,448 41,180,460
AVERAGE COMMON SHARES OUTSTANDING, DILUTED 48,257,498 42,059,462
PER COMMON SHARE, BASIC:
Net income before cumulative effect of change in accounting principle $ 0.42 $ 0.35
Cumulative effect of change in accounting principle, net of tax - (0.03)
------ ------
Net income $ 0.42 $ 0.32
====== ======
PER COMMON SHARE, DILUTED:
Net income before cumulative effect of change in accounting principle $ 0.42 $ 0.34
Cumulative effect of change in accounting principle, net of tax - (0.03)
Net income $ 0.42 $ 0.31
====== ======
CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.14 $ 0.12
====== ======
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
RETAINED ACCUMULATED
SHARES OF EARNINGS OTHER
COMMON COMMON AND COMPREHENSIVE
STOCK STOCK SURPLUS OTHER* INCOME (LOSS) TOTAL
----- ----- ------- ----- ------------- -----
Balance, December 31, 2001 41,228,976 $41,229 $ 311,305 $ 111,744 $(6,104) $ 458,174
Net income (restated) - - - 13,107 - 13,107
Other comprehensive loss,
net of tax of $3,967 - - - - (9,311) (9,311)
---------
Comprehensive income - - - - - 3,796
---------
Cash dividends declared
($0.12 per common share) - - - (4,836) - (4,836)
Common stock activity:
Repurchase of stock (1,135,600) (1,136) (24,181) - - (25,317)
Dividend reinvestment plan 1,485 2 (25) - - (23)
Employee stock purchase plan 2,849 3 48 - - 51
Restricted stock plan 59,096 59 1,281 (291) - 1,049
Exercise of stock options 105,036 105 892 - - 997
Miscellaneous - - 11 83 - 94
---------- ------- --------- --------- -------- ---------
Balance, March 31, 2002 (restated) 40,261,842 $40,262 $ 289,331 $ 119,807 $(15,415) $ 433,985
========== ======= ========= ========= ======== =========
Balance, December 31, 2002 47,347,375 $47,347 $ 427,448 $ 147,854 $ 24,150 $ 646,799
Net income - - - 20,045 - 20,045
Other comprehensive loss,
net of tax of $37 - - - - (3,823) (3,823)
---------
Comprehensive income - - - - - 16,222
---------
Cash dividends declared
($0.14 per common share) - - - (6,529) - (6,529)
Common stock activity:
Repurchase of stock (1,266,308) (1,266) (24,981) - - (26,247)
Acquisitions - - - 453 - 453
Dividend reinvestment plan 39,339 39 721 - - 760
Employee stock purchase plan 13,960 14 263 - - 277
Restricted stock plan 68,793 69 2,179 (478) - 1,770
Exercise of stock options 202,441 203 1,188 - - 1,391
Common stock purchased by trust
for deferred compensation - - - (147) - (147)
Deferred compensation payable in
common stock - - - 147 - 147
Miscellaneous - - 21 83 - 104
---------- ------- --------- --------- -------- ---------
Balance, March 31, 2003 46,405,600 $46,406 $ 406,839 $ 161,428 $ 20,327 $ 635,000
========== ======= ========= ========= ======== =========
* Other includes guarantee of employee stock ownership plan debt, nonvested
restricted stock and deferred compensation.
See accompanying notes to consolidated financial statements.
3
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
-------------------------------------
2003 2002
---- ----
Cash flows from operating activities
Net income $ 20,045 $ 13,107
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, amortization, and accretion, net 12,596 8,109
Provision for loan losses 5,500 6,238
Gain on sale of available for sale securities (986) (29)
Loss on trading securities (72) (30)
Gain on equity investments (1,875) (11)
Gain on sale of loans (1,635) (224)
Gain on disposition of premises and equipment (32) (39)
Loss on disposition of other real estate owned 167 168
Impairment loss from write-down of assets 198 -
Impairment loss (recovery) from write-down of mortgage servicing rights 262 (200)
Loss on changes in fair value of hedges 192 13
Minority interest in consolidated subsidiary 1,012 428
Cumulative effect of change in accounting principle - 1,406
Trading account assets, net (996) (2,335)
Originations of mortgage loans held for sale (146,097) (137,284)
Sale proceeds and principal repayments from mortgage loans held for sale 154,706 114,121
Other assets, net (18,368) 2,375
Other liabilities, net 5,291 3,964
--------- ---------
Net cash provided by operating activities 29,908 9,777
--------- ---------
Cash flows from investing activities
Sale of securities available for sale 692,924 211,694
Maturity, call, or principal repayments from securities available for sale 546,448 461,452
Maturity or call of securities held to maturity 28,265 4,040
Purchase of available for sale securities (2,064,141) (698,206)
Purchase of securities held to maturity (6,814) (2,928)
Origination of loans held for investment, net (94,671) (59,664)
Sale of other real estate owned 3,604 1,010
Sale of premises and equipment 37 1,132
Capital expenditures (1,779) (1,844)
Payment for purchase acquisitions (385) -
--------- ---------
Net cash used for investing activities (896,512) (83,314)
--------- ---------
Cash flows from financing activities
Deposits, net 143,134 37,073
Federal funds purchased and repurchase agreements, net (154,040) 9,802
Short-term borrowings, net (38,288) (86,650)
Issuance of long-term debt 899,800 100,000
Payments of long-term debt (2,397) (7,568)
Cash dividends paid (6,656) (5,693)
Cash dividends paid on minority interest (1,553) (704)
Repurchase of common stock (26,247) (25,317)
Other common stock activity 2,532 1,119
--------- ---------
Net cash provided by financing activities 816,285 22,062
--------- ---------
Net change in cash and due from banks (50,319) (51,475)
Cash and cash equivalents at beginning of year 291,329 240,667
--------- ---------
Cash and cash equivalents at end of period $ 241,010 $ 189,192
========= =========
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL
The foregoing unaudited consolidated financial statements include the
accounts of The South Financial Group, Inc. and subsidiaries. "TSFG" refers to
The South Financial Group, Inc. and subsidiaries, except where the context
requires otherwise. All significant intercompany accounts and transactions have
been eliminated in consolidation, and all adjustments considered necessary for a
fair presentation of the results for interim periods presented have been
included. (Such adjustments are normal and recurring in nature.) Certain prior
year amounts have been reclassified to conform to the 2003 presentations. TSFG
has no interests in non-consolidated special purpose entities.
The consolidated financial statements and notes are presented in
accordance with the instructions for Form 10-Q. The information contained in the
footnotes included in TSFG's 2002 Annual Report on Form 10-K should be referred
to in connection with the reading of these unaudited interim Consolidated
Financial Statements.
ACCOUNTING ESTIMATES AND ASSUMPTIONS
Certain policies require management to make estimates and assumptions
that affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ significantly from these
estimates and assumptions. Material estimates that are particularly susceptible
to significant change relate to the determination of the allowance for loan
losses and deferred income tax assets or liabilities.
RESTATEMENT OF 2002 QUARTERLY FINANCIAL DATA
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 91,
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" ("SFAS 91"), which reduced
interest income, noninterest income and noninterest expenses. Income taxes
increased as a result of the restatement. The net impact of these adjustments
for the first quarter of 2002, which restated the financial results for the
quarter, was to increase net income by $316,000, or $0.01 per diluted share.
During the third quarter 2002, TSFG, in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), recognized a $1.4 million
impairment loss on the cumulative effect of a change in accounting principle as
of January 1, 2002. The first quarter 2002, as restated, includes this
impairment loss. In addition, in connection with its adoption of SFAS No. 147,
"Acquisitions of Certain Financial Institutions an amendment of FASB Statements
No. 72 and 144 and FASB Interpretation No. 9" ("SFAS 147") during the third
quarter 2002, effective as of January 1, 2002, TSFG reversed amortization of
intangibles, which increased net income by $71,000 for the first quarter of
2002.
For a summary of the quarterly financial data for first quarter 2002,
as restated and as reported, see Note 36 to the Consolidated Financial
Statements in TSFG's 2002 Annual Report on Form 10-K.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Accounting for Exit or Disposal Activities
Effective January 1, 2003, TSFG adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which 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 146
applies to costs associated with an exit activity that does not involve an
entity newly acquired in a business combination or with a disposal activity
covered by SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." Those costs include, but are not limited to, the following:
a) termination benefits provided to current employees that are involuntarily
terminated under the terms of a benefit arrangement that, in substance, is not
an ongoing benefit arrangement or an individual deferred compensation contract
(hereinafter referred to as one-time termination benefits), b) costs to
terminate a contract that is not a capital lease, and c) costs to consolidate
5
facilities or relocate employees. This Statement does not apply to costs
associated with the retirement of a long-lived asset covered by SFAS No. 143,
"Accounting for Asset Retirement Obligations." A liability for a cost associated
with an exit or disposal activity shall be recognized and measured initially at
its fair value in the period in which the liability is incurred. A liability for
a cost associated with an exit or disposal activity is incurred when the
definition of a liability is met in accordance with FASB Concepts Statements No.
6, "Elements of Financial Statements."
Accounting for Guarantees
Effective January 1, 2003, TSFG adopted the initial recognition and
initial measurement provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
TSFG adopted the disclosure requirements effective as of December 31, 2002. FIN
45 elaborates on the disclosure to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the
nature of the guarantee; (b) the maximum potential amount of future payments
under the grantee; (c) the carrying amount of the liability; and (d) the nature
and extent of any recourse provisions or available collateral that would enable
the guarantor to recover the amounts paid under the guarantee. FIN 45 also
clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the obligations it has undertaken in issuing the
guarantee at its inception. At March 31, 2003, TSFG recorded a liability of
$25,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Accounting for Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46, ("FIN
46"), "Consolidation of Variable Interest Entities", which addresses
consolidation by business enterprises of variable interest entities. Under FIN
46, an enterprise that holds significant variable interest in a variable
interest entity but is not the primary beneficiary is required to disclose the
nature, purpose, size, and activities of the variable interest entity, its
exposure to loss as a result of the variable interest holder's involvement with
the entity, and the nature of its involvement with the entity and date when the
involvement began. The primary beneficiary of a variable interest entity is
required to disclose the nature, purpose, size, and activities of the variable
interest entity, the carrying amount and classification of consolidated assets
that are collateral for the variable interest entity's obligations, and any lack
of recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general creditors (or beneficial interest
holders) of a consolidated variable interest entity to the general creditor of
the primary beneficiary. FIN 46 is effective for the first fiscal year or
interim period beginning after June 15, 2003. The impact to TSFG upon adoption
is currently not known.
6
(2) SUPPLEMENTAL FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for noninterest income and
noninterest expense (in thousands):
Three Months Ended
March 31,
-------------------------
Restated
2003 2002
---- ----
Noninterest income
Service charges on deposit accounts $ 6,960 $ 4,907
Fees for investment services 2,491 1,427
Mortgage banking income 2,172 1,081
Bank-owned life insurance 1,948 1,806
Merchant processing income 1,336 1,248
Gain on sale of available for sale securities 986 29
Gain on trading securities 72 30
Gain on equity investments 1,875 11
Other 2,046 1,099
-------- --------
Total noninterest income $ 19,886 $ 11,638
======== ========
Noninterest expenses
Salaries and wages $ 19,278 $ 13,636
Employee benefits 5,316 4,378
Occupancy 4,614 3,545
Furniture and equipment 4,594 3,596
Professional fees 1,538 1,327
Telecommunications 1,070 683
Merchant processing expense 1,049 1,044
Amortization of intangibles 705 239
Merger-related costs 1,497 -
Other 9,229 6,404
-------- --------
Total noninterest expenses $ 48,890 $ 34,852
======== ========
CONSOLIDATED STATEMENTS OF CASH FLOW
The following summarizes supplemental cash flow data (in thousands) for
the three months ended March 31:
2003 2002
---- ----
Interest paid $ 32,168 $ 29,813
Income taxes paid 1,044 3,251
Significant non-cash investing and financing transactions are summarized as follows:
Security sales settled subsequent to quarter-end 129,972 -
Security purchases settled subsequent to quarter-end (181,377) -
Unrealized loss on available for sale securities (4,061) (13,500)
Loans transferred to other real estate owned 4,011 3,353
Premises and equipment, net transferred to long-lived assets held for sale 2,639 -
7
(3) OTHER COMPREHENSIVE INCOME
The following summarizes accumulated other comprehensive income (loss),
net of tax (in thousands) for the three months ended March 31:
2003 2002
---- ----
Unrealized gains (losses) on available for sale securities
Balance at beginning of year $ 24,382 $ (5,554)
Other comprehensive loss:
Unrealized holding losses arising during the year (1,200) (13,460)
Income tax (expense) benefit (910) 4,036
Less: Reclassification adjustment for gains included in net income (2,861) (40)
Income tax expense 1,021 13
-------- --------
(3,950) (9,451)
-------- --------
Balance at end of period 20,432 (15,005)
-------- --------
Unrealized losses on cash flow hedges
Balance at beginning of year (232) (550)
Other comprehensive income:
Unrealized gain on change in fair values 201 222
Income tax expense (74) (82)
-------- --------
127 140
-------- --------
Balance at end of period (105) (410)
-------- --------
$ 20,327 $ (15,415)
======== =========
During the first quarter 2003, TSFG adjusted its income tax rate used
(on a cumulative basis) on the net unrealized gain recorded for available for
sale securities, which is included in accumulated other comprehensive income, to
the blended statutory federal and state income tax rate of 36.94%. However, in
certain cases where TSFG has capital loss carryforwards for state income tax
purposes, an income tax rate of 35% is used. At December 31, 2002, TSFG used a
32.5% income tax rate on the net unrealized gain recorded for available for sale
securities.
(4) BUSINESS COMBINATIONS
CENTRAL BANK OF TAMPA
On December 31, 2002, TSFG acquired Central Bank of Tampa ("CBT"), a
community bank headquartered in Tampa, Florida. CBT operated through 5 branches
in Tampa. This acquisition added to TSFG's growing presence in the Tampa Bay
area and advanced TSFG's strategy to expand in markets with favorable population
and per capita income growth prospects.
The aggregate purchase price was $66.2 million, which consisted of
3,241,737 shares of TSFG common stock and $2,000 of cash paid in lieu of
fractional shares. The TSFG common stock issued was valued at the average
closing price on the ten trading days ending on the second trading day prior to
closing. CBT shareholders received 9.850 shares of TSFG common stock for each
share of CBT common stock.
The CBT purchase price and the amount of the purchase price allocated
to goodwill and other intangible assets are presented below (in thousands). The
estimated fair values of the assets acquired and the liabilities assumed at the
purchase date are subject to adjustment as fair value information becomes
available. The allocation of the CBT purchase price was adjusted in the first
quarter of 2003 to reflect third-party valuations of certain assets and
liabilities.
8
Purchase price $ 66,224
CBT tangible shareholders' equity 28,943
---------
Excess of purchase price over carrying value of net tangible assets acquired 37,281
Fair value adjustments (1,642)
Direct acquisition costs 1,526
Deferred income taxes 1,616
---------
Total intangible assets 38,781
Core deposit premiums 2,700
---------
Goodwill $ 36,081
=========
The core deposit premium intangible asset is amortized over 10 years on
an accelerated basis until the straight-line amortization method is greater at
which time the straight-line method is used. The core deposit premium valuation
and amortization method are based upon a historical study of the deposits
acquired. All of the CBT intangible assets were assigned to the Mercantile Bank
segment. The goodwill will not be amortized but will be tested at least annually
for impairment in accordance with SFAS 142. The total amount of goodwill
expected to be deductible for income tax purposes is $356,000.
AMORTIZATION OF PREMIUMS AND DISCOUNTS
Premiums and discounts that resulted from recording the assets and
liabilities acquired through acquisition (CBT, Rock Hill Bank & Trust, and Gulf
West Banks, Inc.) at their respective fair values are being amortized and
accreted using methods that result in a constant effective yield over the life
of the assets and liabilities. This net amortization decreased net income before
income taxes by $330,000 in the first three months of 2003.
(5) INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, are summarized as
follows (in thousands):
MARCH 31,
---------------------------- DECEMBER 31,
2003 2002 2002
---- ---- ----
Goodwill $ 225,255 $ 90,194 $ 224,312
Core deposit premiums 26,873 14,546 26,873
Less accumulated amortization (11,063) (9,245) (10,409)
--------- -------- ---------
15,810 5,301 16,464
--------- -------- ---------
Customer list intangible 858 - 858
Less accumulated amortization (45) - (24)
--------- -------- ---------
813 - 834
--------- -------- ---------
Non-compete agreement intangible 663 - 663
Less accumulated amortization (121) - (91)
--------- -------- ---------
542 - 572
--------- -------- ---------
$ 242,420 $ 95,495 $ 242,182
========= ======== =========
The following summarizes the changes in the carrying amount of goodwill
related to each of TSFG's business segments (in thousands) for the three months
ended March 31, 2003:
CAROLINA MERCANTILE
FIRST BANK BANK TOTAL
---------- ---- -----
Balance, December 31, 2002 $ 116,279 $ 108,033 $ 224,312
Purchase accounting adjustments 1,420 (477) 943
--------- --------- ---------
Balance, March 31, 2003 $ 117,699 $ 107,556 $ 225,255
========= ========= =========
9
Amortization of intangibles totaled $654,000 for core deposit premiums,
$21,000 for customer list intangibles, and $30,000 for non-compete agreement
intangibles for the three months ended March 31, 2003. Amortization of
intangibles totaled $239,000 for core deposit premiums for the three months
ended March 31, 2002.
The estimated amortization expense for core deposit premiums for the
years ended December 31 is as follows: $2.6 million for 2003, $2.2 million for
2004, $1.9 million for 2005, $1.7 million for 2006, $1.7 million for 2007, and
an aggregate of $6.4 million for all the years thereafter. The estimated
amortization expense for customer list intangibles is $86,000 for the years
ended December 31, 2003 to 2007 and an aggregate of $404,000 for all the years
thereafter. The estimated amortization expense for non-compete agreement
intangibles is $120,000 for the years ended December 31, 2003 to 2006 and
$92,000 for 2007.
(6) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs"), net of the valuation
allowance, totaled $3.2 million, $4.4 million, and $8.0 million at March 31,
2003, December 31, 2002, and March 31, 2002, respectively. Amortization expense
for MSRs totaled $909,000 and $1.0 million for the three months ended March 31,
2003 and 2002, respectively. At March 31, 2003 and 2002, the valuation allowance
for capitalized MSRs totaled $2.0 million and $869,000, respectively. In the
first three months of 2003 and 2002, TSFG recorded a $262,000 impairment loss
and $200,000 impairment recovery from the valuation of MSRs, respectively.
The estimated amortization expense for MSRs for the years ended
December 31 is as follows: $3.6 million for 2003, $487,000 for 2004, and none
for all the years thereafter. The estimated amortization expense is based on
current information regarding loan payments and prepayments. Amortization
expense could change in future periods based on changes in the volume of
prepayments and economic factors.
(7) GUARANTEES
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customer to perform under the terms
of an underlying contract with the third party or obligates TSFG to guarantee or
stand as surety for the benefit of the third party. The underlying contract may
entail either financial or nonfinancial obligations and may involve such things
as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or repayment of an obligation. Under the terms of a
standby letter, drafts will generally be drawn only when the underlying event
fails to occur as intended. TSFG can seek recovery of the amounts paid from the
borrower. In addition, some of these standby letters of credit are
collateralized. The collateral is generally cash, although existing lines of
credit are sometimes used. Commitments under standby letters of credit are
usually for one year or less. At March 31, 2003, TSFG recorded a liability of
$25,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor. The maximum potential
amount of undiscounted future payments related to standby letters of credit at
March 31, 2003 was $58.3 million.
(8) COMMITMENTS AND CONTINGENT LIABILITIES
TSFG is currently subject to various legal proceedings and claims that
have arisen in the ordinary course of its business. In the opinion of management
based on consultation with external legal counsel, any reasonably foreseeable
outcome of such current litigation would not materially affect TSFG's
consolidated financial position or results of operations.
At the purchase date, TSFG identified a potential contingent liability
related to certain Rock Hill Bank & Trust trust accounts. Any liability recorded
would increase the goodwill recorded.
(9) DEFERRED COMPENSATION HELD IN TRUST
Beginning on January 1, 2003, under TSFG's Executive Deferred
Compensation Plan for certain officers, TSFG common stock was added as an
investment option for deferral of up to 100% of a participant's annual bonus
compensation, net of withholdings for social security and Medicare taxes. The
common stock purchased by TSFG for this deferred compensation plan is maintained
in a Rabbi Trust (the "Trust"), on behalf of the participants. The assets of the
Trust are subject to the claims of general creditors of TSFG. Dividends payable
on the common shares held by the Trust will be reinvested in additional shares
of common stock of TSFG on behalf of the participants. The deferred compensation
obligation in the Trust is classified as a component of shareholders' equity,
and the common stock held by the Trust is classified as a reduction of
10
shareholders' equity. The obligations of TSFG under this investment option of
the deferred compensation plan, and the shares held by the Trust, have no net
effect on outstanding shares. Subsequent changes in the fair value of the common
stock are not reflected in earnings or shareholders' equity.
(10) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common
shares outstanding:
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 47,325,448 41,180,460
========== ==========
Diluted:
Average common shares outstanding 47,325,448 41,180,460
Dilutive potential common shares 932,050 879,002
---------- ----------
Average diluted shares outstanding (denominator) 48,257,498 42,059,462
========== ==========
The following options were outstanding at the period end presented but
were excluded from the calculation of diluted earnings per share because the
exercise price was greater than the average market price of the common shares:
NUMBER RANGE OF
OF SHARES EXERCISE PRICES
--------- ---------------
For the three months ended
March 31, 2003 1,539,803 $21.00 to $31.26
March 31, 2002 1,065,168 $19.47 to $31.26
(11) STOCK-BASED COMPENSATION
At March 31, 2003, TSFG has two stock-based employee compensation
option plans, which are described more fully in Note 30 to the Consolidated
Financial Statements in TSFG's 2002 Annual Report on Form 10-K. TSFG accounts
for its option plans under the recognition and measurement principles of APB
Opinion 25, "Accounting for Stock Issued to Employees," and related
Interpretations ("APB Opinion 25"). No stock-based employee compensation cost is
reflected in net income related to these plans, as all options granted under
those plans had an exercise price equal to or greater than the market value of
the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share as if TSFG had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock Based Compensation" ("SFAS 123") to stock-based employee compensation
option plans for the three months ended March 31 (dollars in thousands, except
share data).
2003 2002
---- ----
Net income
Net income, as reported $ 20,045 $ 13,107
Deduct:
Total stock-based employee compensation expense determined under fair
value based method for all option awards, net of related tax effect 392 382
-------- --------
Pro forma net income $ 19,653 $ 12,725
======== ========
Basic earnings per share
As reported $ 0.42 $ 0.32
Pro forma 0.42 0.31
Diluted earnings per share
As reported $ 0.42 $ 0.31
Pro forma 0.41 0.30
11
(12) MERGER-RELATED AND DIRECT ACQUISITION COSTS
In connection with the CBT, Rock Hill Bank, and Gulf West acquisitions,
TSFG recorded pre-tax merger-related costs of $1.5 million, included in
noninterest expenses, and direct acquisition costs of $197,000, included in
goodwill during the first quarter 2003. The merger-related and acquisition costs
were recorded as incurred. The following summarizes these charges (in thousands)
at and for the three months ended March 31, 2003:
TOTAL AMOUNTS REMAINING
COSTS PAID ACCRUAL
----- ---- -------
MERGER-RELATED COSTS
Compensation-related expenses $ 511 $ 215 $ 296
System conversion costs 461 281 180
Fixed asset impairment 198 198 -
Travel 33 33 -
Advertising 30 30 -
Other 264 256 8
------ ------ -----
$1,497 $1,013 $ 484
====== ====== =====
DIRECT ACQUISITION COSTS
Investment banking and professional fees $ 88 $ 88 $ -
Severance 109 109 -
------ ------ -----
$ 197 $ 197 $ -
====== ====== =====
At March 31, 2003, the accrual of merger-related costs, which included
$484,000 for charges incurred during the three months ended March 31, 2003,
totaled $1.1 million. This accrual is for compensation-related and other
expenses incurred in connection with the CBT, Rock Hill Bank, and Gulf West
acquisitions. At March 31, 2003, the accrual of direct acquisition costs totaled
$569,000. This accrual is for professional fees and severance in connection with
the purchase of assets and deposits from Rock Hill Bank.
(13) BUSINESS SEGMENTS
TSFG has two principal operating subsidiaries, Carolina First Bank and
Mercantile Bank, which are evaluated regularly by the chief operating decision
maker in deciding how to allocate resources and assess performance. Both of
these subsidiaries are reportable segments by virtue of exceeding certain
quantitative thresholds. Carolina First Bank and Mercantile Bank engage in
general banking business focusing on commercial, consumer, and mortgage lending
to small and middle market businesses and consumers in their market areas. The
reportable segments also provide demand transaction accounts and time deposit
accounts to businesses and individuals. Carolina First Bank offers products and
services primarily to customers in South Carolina, coastal North Carolina and on
the Internet. Mercantile Bank offers products and services primarily to
customers in its market areas in northern and central Florida. Revenues for
Carolina First Bank and Mercantile Bank are derived primarily from interest and
fees on loans, interest on investment securities, service charges on deposits
and other customer service fees. No single customer accounts for a significant
amount of the revenues of either reportable segment.
TSFG evaluates performance based on budget to actual comparisons and
segment profits. The accounting policies of the reportable segments are the same
as those described in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2002.
Segment information (in thousands) is shown in the table below. The
"Other" column includes all other business activities that did not meet the
quantitative thresholds and therefore are not shown as a reportable segment.
12
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
Three Months Ended March 31, 2003
Net interest income $ 52,024 $ 14,987 $ (1,540) $ - $ 65,471
Provision for loan losses 3,498 1,990 12 - 5,500
Noninterest income 15,045 2,931 15,218 (13,308) 19,886
Noninterest expenses 32,620 13,005 16,573 (13,308) 48,890
Amortization of intangibles (a) 315 390 - - 705
Merger-related costs (a) 323 1,174 - - 1,497
Income tax expense 10,135 937 (1,162) - 9,910
Minority interest in consolidated
subsidiary, net of tax (1,012) - - - (1,012)
Net income 19,804 1,986 (1,745) - 20,045
MARCH 31, 2003
Total assets $ 6,875,479 $2,109,116 $ 933,540 $ (952,924) $ 8,965,211
Loans 3,426,218 1,183,564 100,029 (134,476) 4,575,335
Deposits 3,475,736 1,281,489 - (21,510) 4,735,715
THREE MONTHS ENDED MARCH 31, 2002
Net interest income $ 46,255 $ 6,470 $ (1,333) $ - $ 51,392
Provision for loan losses 4,150 2,079 9 - 6,238
Noninterest income 9,006 942 14,590 (12,900) 11,638
Noninterest expenses 27,428 4,520 15,804 (12,900) 34,852
Amortization of intangibles (a) 239 - - - 239
Income tax expense 7,445 372 (818) - 6,999
Minority interest in consolidated
subsidiary, net of tax (428) - - - (428)
Cumulative effect of change in accounting
principal, net of tax - - (1,406) - (1,406)
Net income 15,810 441 (3,144) - 13,107
MARCH 31, 2002
Total assets $ 5,337,437 $ 804,553 $ 627,213 $ (712,781) $ 6,056,422
Loans 3,169,152 672,594 37,315 (69,479) 3,809,582
Deposits 3,095,611 565,053 - (19,160) 3,641,504
(a) Included in noninterest expenses.
(14) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, except for the
consolidated balance sheet at December 31, 2002, which is derived from TSFG's
consolidated audited financial statements. In the opinion of management, all
adjustments necessary to present a fair statement of the results for the interim
periods have been made. All such adjustments are of a normal, recurring nature.
13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis are presented to assist in
understanding the financial condition and results of operations of The South
Financial Group, Inc. and its subsidiaries (collectively, "TSFG"). TSFG may also
be referred to herein as "we", "us", or "our", except where the context requires
otherwise. This discussion should be read in conjunction with the consolidated
financial statements and the supplemental financial data appearing in this
report as well as the Annual Report of TSFG on Form 10-K for the year ended
December 31, 2002. Results of operations for the three months ended March 31,
2003 are not necessarily indicative of results that may be attained for any
other period. Percentage calculations contained herein have been calculated
based upon actual, not rounded, results.
TSFG, a South Carolina corporation headquartered in Greenville, South
Carolina, is a financial holding company, which commenced banking operations in
December 1986, and at March 31, 2003 conducted business through 76 locations in
South Carolina, 5 locations in North Carolina and 34 locations in northern and
central Florida. TSFG operates principally through two wholly-owned subsidiary
banks: Carolina First Bank, a South Carolina chartered commercial bank, and
Mercantile Bank, a Florida chartered commercial bank (which are collectively
referred to as the "Subsidiary Banks"). TSFG's subsidiaries provide a full range
of financial services, including asset management, investments, insurance,
mortgage, and trust services, designed to meet substantially all of the
financial needs of its customers.
FORWARD-LOOKING STATEMENTS AND NON-GAAP FINANCIAL INFORMATION
This report contains certain forward-looking statements (as defined in
the Private Securities Litigation Reform Act of 1995) to assist in the
understanding of anticipated future operating and financial performance, growth
opportunities, growth rates, and other similar forecasts and statements of
expectations. These forward-looking statements reflect current views, but are
based on assumptions and are subject to risks, uncertainties, and other factors,
which may cause actual results to differ materially from those in such
statements. These factors include, but are not limited to, the following:
o risks from changes in economic, monetary policy, and industry
conditions;
o changes in interest rates, deposit rates, the net interest margin, and
funding sources;
o market risk and inflation;
o risks inherent in making loans including repayment risks and value of
collateral;
o loan growth, the adequacy of the allowance for loan losses, the
assessment of problem loans, and the Rock Hill Bank & Trust Workout
loans;
o level, composition, and repricing characteristics of the securities
portfolio;
o fluctuations in consumer spending;
o competition in the banking industry and demand for our products and
services;
o dependence on senior management;
o technological changes;
o ability to increase market share;
o expense projections;
o risks associated with income taxes, including the potential for
adverse adjustments;
o acquisitions, related cost savings, expected financial results, and
unanticipated integration issues;
o significant delay or inability to execute strategic initiatives
designed to grow revenues;
o changes in accounting policies and practices;
o costs and effects of litigation; and
o recently-enacted or proposed legislation.
Such forward-looking statements speak only as of the date on which such
statements are made. We undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made to reflect the occurrence of unanticipated events. In
addition, certain statements in future filings by TSFG with the Securities and
Exchange Commission, in press releases, and in oral and written statements made
by or with the approval of TSFG, which are not statements of historical fact,
constitute forward-looking statements.
This report also contains financial information determined by methods
other than in accordance with Generally Accepted Accounting Principles ("GAAP").
TSFG's management uses these non-GAAP measures in their analysis of TSFG's
performance. In particular, a number of credit quality measures presented adjust
14
GAAP information to exclude the effects of certain identified problems loans
purchased from Rock Hill Bank & Trust (the "Rock Hill Workout Loans").
Management believes presentations of credit quality measures excluding the Rock
Hill Workout Loans assist in identifying core credit quality measures and
trends. These disclosures should not be viewed as a substitute for GAAP
operating results, and furthermore, TSFG's non-GAAP measures may not necessarily
be comparable to non-GAAP performance measures of other companies.
CRITICAL ACCOUNTING POLICIES
TSFG's accounting policies are in accordance with accounting principles
generally accepted in the United States and with general practice within the
banking industry. The more critical accounting policies include TSFG's
accounting for securities, loans, allowance for loan losses, intangibles, and
income taxes. In particular, TSFG considers its policies regarding the allowance
for loan losses and income taxes to be its most critical accounting policies due
to the significant degree of management judgment. Different assumptions in the
application of these policies could result in material changes in TSFG's
consolidated financial statements. For additional discussion concerning TSFG's
allowance for loan losses and related matters, see "Balance Sheet Review -
Allowance for Loan Losses."
ACQUISITIONS
The following table summarizes TSFG's acquisitions completed during the
past two years. All the acquisitions, except for Gardner Associates, Inc., an
insurance agency, were bank acquisitions. All of the transactions were accounted
for using the purchase method of accounting, and accordingly, the assets and
liabilities were recorded at their estimated fair values, which are subject to
adjustment, as of the acquisition date. TSFG's consolidated financial statements
include the results of the acquired company's operations since the acquisition
date.
TABLE 1
- --------------------------------------------------------------------------------------------------------------------
SUMMARY OF COMPLETED ACQUISITIONS
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
PURCHASE IDENTIFIABLE
ACQUISITION TOTAL SHARES PRICE PAID INTANGIBLE
DATE ASSETS ISSUED IN CASH ASSETS GOODWILL
---- ------ ------ ------- ------ --------
Central Bank of Tampa
Tampa, Florida 12/31/02 $ 223,223 (1) 3,241,737 $ - $ 2,700 - $ 36,081
Rock Hill Bank and Trust
Rock Hill, South Carolina 10/31/02 204,815 (1) 430,017 - (2) 1,204 25,571
Gardner Associates, Inc.
Columbia, South Carolina 09/20/02 1,312 (1) 249,011 (3) - 1,521 1,934
Gulf West Banks, Inc.
St. Petersburg, Florida 08/31/02 530,296 (1) 3,925,588 32,400 8,424 71,475
(1) Book value at the acquisition date.
(2) TSFG agreed to pay a cash earnout based on collection and recoveries with
respect to certain loans.
(3) Of this amount, up to 70,779 of these shares are subject to forfeiture back
to TSFG if certain five-year financial performance targets are not met.
On December 31, 2002, TSFG acquired Central Bank of Tampa ("CBT"), a
community bank headquartered in Tampa, Florida. CBT operated through 5 branches
in Tampa. This merger advances TSFG's strategy to expand in markets with
relatively high population and per capita income growth prospects.
On October 31, 2002, TSFG acquired substantially all of the assets and
deposits of Rock Hill Bank & Trust ("Rock Hill Bank"), which was a wholly-owned
banking subsidiary of RHBT Financial Corporation ("RHBT"). Rock Hill Bank
operated 3 branches in York County, South Carolina. Under the asset sale
agreement, Rock Hill Bank received 430,017 shares of TSFG common stock, plus the
right to receive a cash earnout essentially equal to 30% of the net improvement
15
in the aggregate charge-offs and reserves in a specified loan pool and 50% of
net amounts recovered under RHBT's blanket bond insurance policy with respect to
such loans. TSFG owned approximately 22% of RHBT's outstanding stock. In
connection with the distribution of TSFG common stock to RHBT shareholders, TSFG
received 95,575 shares, which were immediately cancelled.
On September 20, 2002, TSFG acquired Gardner Associates, Inc. ("Gardner
Associates"), an independent insurance agency based in Columbia, South Carolina.
TSFG intends to use Gardner Associates to build its insurance operations in the
Midlands area of South Carolina. As of March 31, 2003, TSFG issued 156,426
shares of TSFG common stock to acquire Gardner Associates and 21,806 shares
under an earnout provision. In addition, the principals of Gardner Associates
have the right to receive a maximum of 70,779 shares of TSFG common stock, which
has been issued and deposited in an escrow account, under earnout provisions
based on Gardner Associates' five-year financial performance.
On August 31, 2002, TSFG acquired Gulf West Banks, Inc. ("Gulf West"), a
bank holding company headquartered in St. Petersburg, Florida. Gulf West
operated through Mercantile Bank, a Florida-chartered, non-member bank with 15
locations in the Tampa Bay area of Florida. This merger represents TSFG's first
banking locations in the Tampa Bay area and advances TSFG's strategy to expand
in markets with relatively high population and per capita income growth
prospects. Upon acquiring Gulf West, TSFG combined all of its Florida operations
under the Mercantile Bank name.
Acquisition Completed Subsequent to Quarter-End
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. API
services over 250 corporate accounts and manages in excess of $200 million in
plan assets. Net assets of API at April 30, 2003 totaled $56,000, and total
revenues for the year ended December 31, 2002 were $1.9 million. TSFG issued
146,808 shares of common stock valued at approximately $3.5 million at closing.
In addition, the shareholders of API have the right to receive common stock with
a maximum value of approximately $2.2 million under earnout provisions based on
API's five-year financial performance. This transaction was accounted for using
the purchase method of accounting.
OVERVIEW
Net income for the three months ended March 31, 2003 totaled $20.0
million, an increase of 52.9% compared with $13.1 million for the three months
ended March 31, 2002. Earnings per diluted share for the first three months of
2003 totaled $0.42, a 35.5% increase from $0.31 per diluted share in the first
three months of 2002. Higher net interest income, fee income initiatives, a
lower provision for loan losses, and gains on sales of securities and equity
investments contributed to the increases in net income and earnings per diluted
share. Net interest income increased from 34.6% growth in average earning
assets. Key factors responsible for TSFG's results of operations are discussed
throughout Management's Discussion and Analysis below.
Noninterest income for the three months ended March 31, 2003 and 2002
included pre-tax gains on asset sales of $2.9 million and $40,000, respectively.
Gains on asset sales include gains on available for sale securities and equity
investments. Mortgage banking income, a component of noninterest income,
includes gains and losses on the sale of mortgage loans and charges for the
write-down in the value of capitalized mortgage servicing rights. See "Earnings
Review - Noninterest Income" for details. Noninterest expenses for the first
three months of 2003 included $1.5 million in pre-tax merger-related costs.
In the third quarter 2002, TSFG recorded a $1.4 million charge related
to impairment of goodwill associated with Carolina First Mortgage Company, which
is shown as a cumulative effect of change in accounting principle. In accordance
with the accounting rules, this change was recorded as of January 1, 2002 and
therefore is shown in the first quarter 2002.
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income. The net
impact of these adjustments for the first quarter 2002, which restated the
financial results for the quarter, was to increase net income by $316,000, or
$0.01 per diluted share.
Average common shares outstanding on a diluted basis were 48.3 million
in the first three months of 2003, up 14.7% from 42.1 million for the first
three months of 2002, due to shares issued for acquisitions completed in 2002.
In connection with share repurchase programs, TSFG repurchased and cancelled
1,266,308 shares during the first three months of 2003.
16
At March 31, 2003, TSFG had $9.0 billion in assets, $4.6 billion in
loans, $4.7 billion in deposits, and $635.0 million in shareholders' equity. For
the three months ended March 31, 2003, TSFG's average assets totaled $8.4
billion, an increase of $2.3 billion, or 36.7%, compared with the first quarter
2002 average of $6.1 billion.
BALANCE SHEET REVIEW
Loans
TSFG focuses its lending activities on small and middle market
businesses and individuals in its geographic markets. At March 31, 2003,
outstanding loans totaled $4.6 billion, which equaled 96.6% of total deposits
and 51.0% of total assets. The major components of the loan portfolio were
commercial loans, commercial real estate loans, consumer loans (including both
direct and indirect loans), and one-to-four family residential mortgage loans.
Substantially all loans were to borrowers located in TSFG's South Carolina,
North Carolina, and Florida market areas. The portfolio contains no "highly
leveraged transactions," as defined by regulatory authorities.
Loans held for investment increased $735.5 million, or 19.5%, to $4.5
billion at March 31, 2003 from $3.8 billion at March 31, 2002. In 2002, $582.8
million in loans held for investment were acquired in mergers with CBT, Rock
Hill Bank, and Gulf West, accounting for approximately 80% of the increase.
During the first three months of 2003, loans held for investment increased $81.1
million, or 1.8%. The majority of the first quarter 2003 loan growth, annualized
at 7.3%, was in commercial, home equity and indirect consumer loans. While
originations of residential mortgage loans increased, most of these loans were
sold at origination in the secondary market.
Loans held for sale increased $30.3 million to $60.2 million at March
31, 2003 from $29.9 million at March 31, 2002. Mortgage loan originations were
higher in the current period, which increased the inventory of loans in process.
Also, certain commercial real estate loans acquired from Gulf West, which
totaled $8.9 million at March 31, 2003, were designated for sale at acquisition.
During the first three months of 2003, loans held for sale decreased $8.8
million, primarily from the sale of two commercial real estate loans acquired
from Gulf West.
Table 2 summarizes outstanding loans by collateral type for real estate
secured loans and by borrower type for all other loans. Collateral type
represents the underlying assets securing the loan, rather than the purpose of
the loan.
17
TABLE 2
- -----------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- -----------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial, financial and agricultural $ 952,877 $ 778,257 $ 913,368
Real estate - construction (1) 558,406 543,358 570,265
Real estate - residential mortgages (1-4 family) 657,509 515,593 643,941
Commercial secured by real estate (1) 1,792,969 1,418,954 1,765,103
Consumer 553,267 523,173 541,210
Lease financing receivables 105 347 124
----------- ----------- -----------
Loans held for investment 4,515,133 3,779,682 4,434,011
Loans held for sale 60,202 29,900 67,218
Less: allowance for loan losses 66,133 45,208 70,275
----------- ----------- -----------
Total net loans $ 4,509,202 $ 3,764,374 $ 4,430,954
=========== =========== ===========
Percentage of loans held for investment
Commercial, financial and agricultural 21.1 % 20.6 % 20.6 %
Real estate - construction (1) 12.4 14.4 12.9
Real estate - residential mortgages (1-4 family) 14.6 13.6 14.5
Commercial secured by real estate (1) 39.6 37.6 39.8
Consumer 12.3 13.8 12.2
Lease financing receivables - - -
------ ------ ------
Total 100.0 % 100.0 % 100.0 %
====== ====== =======
(1) These categories include loans to businesses other than real estate
companies where owner-occupied real estate is pledged on loans to finance
operations, equipment, and facilities.
Table 3 provides a stratification of the loan portfolio by loan purpose.
This presentation differs from that in Table 2, which stratifies the portfolio
by collateral type and borrower type.
18
TABLE 3
- -----------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION BASED ON LOAN PURPOSE
- -----------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial loans
Commercial and industrial $ 1,188,782 $ 1,013,706 $ 1,178,955
Owner - occupied real estate 724,685 633,003 733,819
Commercial real estate 1,463,330 1,167,532 1,420,252
----------- ----------- -----------
3,376,797 2,814,241 3,333,026
----------- ----------- -----------
CONSUMER LOANS
Indirect - sales finance 448,253 363,197 420,294
Direct retail 274,290 300,515 273,419
Home equity 261,311 174,854 243,648
----------- ----------- -----------
983,854 838,566 937,361
----------- ----------- -----------
MORTGAGE LOANS 154,482 126,875 163,624
----------- ----------- -----------
Total loans held for investment $ 4,515,133 $ 3,779,682 $ 4,434,011
=========== =========== ===========
PERCENTAGE OF LOANS HELD FOR INVESTMENT
Commercial and industrial 26.3 % 26.8 % 26.6 %
Owner - occupied real estate 16.1 16.7 16.6
Commercial real estate 32.4 30.9 32.0
Consumer 21.8 22.2 21.1
Mortgage 3.4 3.4 3.7
------ ------ ------
Total 100.0 % 100.0 % 100.0 %
====== ====== ======
Commercial and industrial loans are loans to finance short-term and
intermediate-term cash needs of businesses. Typical needs include the need to
finance seasonal or other temporary cash flow imbalances, growth in working
assets created by sales growth, and purchases of equipment and vehicles. Credit
is extended in the form of short-term single payment loans, lines of credit for
periods up to a year, revolving credit facilities for periods up to five years,
and amortizing term loans for periods up to ten years.
Owner-occupied real estate loans are loans to finance the purchase or
expansion of operating facilities used by businesses not engaged in the real
estate business. Typical loans are loans to finance offices, manufacturing
plants, warehouse facilities, and retail shops. Depending on the property type
and the borrower's cash flows, amortization terms vary from 10 years up to 20
years. Although secured by mortgages on the properties financed, these loans are
underwritten based on the cash flows generated by operations of the businesses
they house.
Commercial real estate loans are loans to finance real properties that
are acquired, developed, or constructed for sale or lease to parties unrelated
to the borrower. Included are loans to acquire land for development, land
development loans, construction loans, mini-perms for cash flow stabilization
periods, and permanent loans in situations where access to the secondary market
is limited due to loan size.
Indirect sales finance loans are loans to individuals to finance the
purchase of automobiles. They are closed at the auto dealership but approved in
advance by TSFG for immediate purchase. Loans are extended on new and used autos
with terms varying from 2 years up to 5 years.
Direct consumer loans are loans to individuals to finance personal,
family, or household needs. Typical loans are loans to finance auto purchases,
home repairs and additions, and home purchases. These loans are made by TSFG
employees in its branches.
19
Home equity loans are loans to home-owners, secured by junior mortgages
on their primary residences, to finance personal, family, or household needs.
These loans may be in the form of amortizing loans or lines of credit with terms
up to 15 years.
Mortgage loans are loans to individuals, secured by first mortgages on
single family residences, to finance the acquisition of those residences. These
loans, originated by TSFG's mortgage lending division, do not qualify for
immediate sale but are judged to be sellable with seasoning. They are
underwritten to secondary market standards and are sold, from time to time, as
they become sellable to secondary market investors.
The portfolio's only significant industry concentration is in commercial
real estate loans. All other industry concentrations are less than 10% of total
loans. Commercial real estate loans were 32.4% of loans held for investment at
March 31, 2003. Due to sustained strong population growth and household income
growth, real estate development and construction are major components of the
economic activity in TSFG's markets. The risk attributable to this concentration
is managed by lending in our markets, where we are familiar with real estate
market conditions, to borrowers we know well, who have proven track records and
possess the financial means to weather reverses in this industry. TSFG does not
make loans without recourse to the borrower, loans without personal guarantees
from the owners, or loans to cash out equity in commercial properties.
Consequently, although the analysis of reserve adequacy includes an adjustment
to account for the risk inherent in this concentration, management believes the
risk of loss in its commercial real estate loans is not materially greater than
the risk of loss in any other segment of the portfolio.
At March 31, 2003, the loan portfolio included commitments totaling
$138.0 million in "shared national credits" (multi-bank credit facilities of $20
million or more). Outstandings under these commitments totaled $79.6 million. By
policy, we participate in shared national credits only if the borrower is
headquartered in our market, the borrower is in an industry familiar to us, we
meet directly with the borrower to conduct our analysis, and the borrower agrees
to establish an ongoing banking relationship with us. One of these credits, in
which our commitment totals $1.1 million, is on our internal watch list;
however, none of these credit facilities were classified in the most recent
shared national credits examinations conducted by the regulatory agencies.
Credit Quality
A willingness to take credit risk is inherent in the decision to grant
credit. Prudent risk-taking requires a credit risk management system based on
sound policies and control processes that ensure compliance with those policies.
TSFG's credit risk management system is defined by policies approved by the
Board of Directors that govern the risk underwriting, portfolio monitoring, and
problem loan administration processes. Adherence to underwriting standards is
managed through a multi-layered credit approval process and immediate
after-the-fact review by credit risk management of loans approved by lenders.
Through daily review by credit risk managers, monthly reviews of exception
reports, and ongoing analysis of asset quality trends, compliance with
underwriting and loan monitoring policies is closely supervised. The
administration of problem loans is driven by policies that require written plans
for resolution and quarterly meetings with credit risk management to review
progress. Credit risk management activities are monitored by Credit Committees
of each banking subsidiary's Board of Directors, which meet monthly to review
credit quality trends, new large credits, loans to insiders, large problem
credits, credit policy changes, and reports on independent credit audits of
branch offices.
To facilitate comparisons, Table 4 presents credit quality indicators
two ways: one that includes all loans and one that excludes the Rock Hill
Workout Loans. On October 31, 2002, loans totaling $191.3 million were acquired
from Rock Hill Bank. Prior to the closing and in connection with identified
problem loans, Rock Hill Bank had charged off a significant portion of its loan
portfolio and established additional reserves. At closing, TSFG segregated
certain identified problem loans into a separately-managed portfolio, referred
to as the "Rock Hill Workout Loans." At March 31, 2003, this portfolio totaled
$63.6 million, down from $72.4 million at December 31, 2002, with an allowance
for loan losses of $11.6 million. Nonperforming assets for the Rock Hill Workout
Loans at March 31, 2003 were $32.8 million. Net loan charge-offs for the first
quarter 2003, which were included in the allowance for loan losses as of
December 31, 2002, totaled $4.1 million. TSFG expects nonperforming assets and
the allowance for loan losses to decline as the Rock Hill Workout Loans are
liquidated or otherwise resolved. Where appropriate, TSFG has provided credit
quality measures excluding the Rock Hill Workout Loans to identify core credit
quality measures and trends.
Table 4 presents information pertaining to nonperforming assets.
20
TABLE 4
- -------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Nonaccrual loans - commercial $ 58,114 $ 40,521 $ 61,206
Nonaccrual loans - consumer 2,865 2,965 2,384
Restructured loans - - -
Total nonperforming loans 60,979 43,486 63,590
Other real estate owned 10,836 7,143 10,596
---------- ----------- ----------
Total nonperforming assets $ 71,815 $ 50,629 $ 74,186
========== =========== ==========
Loans past due 90 days still accruing interest (1) $ 3,652 $ 9,532 $ 5,414
========== =========== ==========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 1.59 % 1.34 % 1.67 %
========== =========== ==========
Allowance for loan losses as a percentage of nonperforming loans 1.08 x 1.04 x 1.11 x
========== =========== ==========
EXCLUDING THE ROCK HILL WORKOUT LOANS
Loans held for investment $4,451,498 $ 3,779,682 $ 4,361,658
Allowance for loan losses 54,514 45,208 53,979
Total nonperforming loans 28,254 43,486 34,596
Other real estate owned 10,751 7,143 10,422
---------- ----------- ----------
Total nonperforming assets $ 39,005 $ 50,629 $ 45,018
========== =========== ==========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 0.87 % 1.34 % 1.03 %
========== =========== ==========
Allowance for loan losses as a percentage of nonperforming loans 1.93 x 1.04 x 1.56 x
========== =========== ==========
(1) All of these loans are consumer and residential mortgage loans.
(2) Calculated using loans held for investment.
Note: Nonperforming assets exclude personal property repossessions, which
totaled $1.0 million, $1.2 million, and $1.3 million, at March 31, 2003, March
31, 2002, and December 31, 2002, respectively.
CREDIT QUALITY INCLUDING ROCK HILL WORKOUT LOANS. Nonperforming assets
declined to 1.59% of loans and other real estate owned at March 31, 2003 from
1.67% at December 31, 2002. Net loan charge-offs increased to 0.85% of average
loans for the first quarter 2003 from 0.37% for the fourth quarter 2002,
primarily due to the disposition of fully-reserved Rock Hill Workout Loans and
the liquidation of fully-reserved nonperforming loans. As anticipated, the
allowance for loan losses declined to 1.46% of period-end loans at March 31,
2003 from 1.58% at December 31, 2002.
CREDIT QUALITY EXCLUDING ROCK HILL WORKOUT LOANS. Core nonperforming
assets (which exclude the Rock Hill Workout Loans) declined 13% to 0.87% of
loans and other real estate owned at March 31, 2003 from 1.03% at December 31,
2002. This ratio has declined every quarter-end since its peak of 1.34% at March
31, 2002. Net loan charge-offs increased from $4.4 million for the fourth
quarter 2002 to $5.5 million for the first quarter 2003, or from 0.41% to 0.50%
of average loans, as write-downs of $1.5 million were incurred to liquidate
nonperforming loans with allocated reserves of $2.1 million. The allowance for
loan losses declined slightly as a percent of loans held for investment, from
1.24% at December 31, 2002 to 1.22% at March 31, 2003, but increased from 1.56
times to 1.93 times nonperforming loans for the quarter-ends. Loans past due 90
days and still accruing interest showed continued improvement during the first
quarter 2003.
Certain of the Rock Hill Workout Loans are defined as "designated
loans" under the Rock Hill Bank purchase agreement ("Designated Loans") and are
subject to earnout provisions. The total principal amount owed by the borrowers
for Designated Loans was $45.2 million, of which $19.5 million had been charged
off or reserved prior to acquisition by TSFG. To the extent that principal
collections on these Designated Loans exceed $25.7 million through the
termination date of the earnout agreement, TSFG will pay the RHBT shareholders
21
30% of such excess. The net effect is to pay RHBT shareholders 30% of the net
recoveries on these loans from charge-off collections and reserve reductions.
Through March 31, 2003, total charge-offs and reserves on the Designated loans
exceeded the amount that would require a payment under the earnout agreement.
Future credit quality trends depend primarily on the direction of the
economy, and current economic data do not provide a clear signal of that
direction. Until the business climate improves, we expect portfolio quality
indicators to remain volatile, nonperforming asset levels to fluctuate, and
charge-offs to be higher than historical norms. Management believes, however,
that loss exposure in its loan portfolio is identified, adequately reserved for
in a timely manner, and closely monitored to ensure that changes are promptly
addressed in its analysis of allowance for loan loss adequacy. Accordingly,
management believes the allowance for loan losses as of March 31, 2003 was
adequate, based on its assessment of probable losses, and available facts and
circumstances then prevailing.
The following summarizes information on impaired loans (in thousands),
all of which are in nonaccrual status, at and for the three months ended March
31. All impaired loans are commercial loans.
2003 2002
---- -----
Impaired loans $ 58,114 $ 40,521
Impaired loans, excluding the Rock Hill Workout Loans 25,389 40,521
Average investment in impaired loans 61,585 40,219
Related allowance 14,751 4,409
Related allowance, excluding the Rock Hill Workout Loans 6,176 4,409
Recognized interest income - 120
Foregone interest 1,361 892
Allowance for Loan Losses
The adequacy of the allowance for loan losses (the "Allowance") is
analyzed quarterly. For purposes of this analysis, adequacy is defined as a
level sufficient to absorb probable losses in the portfolio. The methodology
employed for this analysis is discussed below.
The portfolio is segregated into risk-similar segments for which
historical loss ratios are calculated and adjusted for identified changes in
current portfolio characteristics. Historical loss ratios are calculated by
product type for consumer loans (direct installment, indirect installment,
revolving, and mortgage) and by credit risk grade for performing commercial
loans. Nonperforming commercial loans are individually assessed for impairment
under SFAS 114 and assigned specific allocations. To allow for modeling error, a
range of probable loss ratios (from 95% to 105% of the adjusted historical loss
ratio) is then derived for each segment. The resulting percentages are then
applied to the dollar amounts of loans in each segment to arrive at each
segment's range of probable loss levels.
The Allowance for each portfolio segment is set at an amount within its
range that reflects management's best judgment of the extent to which historical
loss levels are more or less accurate indicators of current losses in the
portfolio. Management's judgments evolve from an assessment of various issues,
including but not limited to the pace of loan growth, emerging portfolio
concentrations, risk management system changes, entry into new markets, new
product offerings, loan portfolio quality trends, and uncertainty in current
economic and business conditions.
The Allowance is then segregated into allocated and unallocated
components. The allocated component is the sum of the loss estimates at the
lower end of the probable loss range for each category. The unallocated
component is the sum of the amounts by which final loss estimates exceed the
lower end estimates for each category. The unallocated component of the
Allowance represents probable losses inherent in the portfolio based on our
analysis that are not fully captured in the allocated component. Allocation of
the Allowance to respective loan portfolio components is not necessarily
indicative of future losses or future allocations. The entire Allowance is
available to absorb losses in the loan portfolio.
Assessing the adequacy of the Allowance is a process that requires
considerable judgment. Management's judgments are based on numerous assumptions
about current events, which we believe to be reasonable, but which may or may
not be valid. Thus, there can be no assurance that loan losses in future periods
will not exceed the current Allowance amount or that future increases in the
Allowance will not be required. No assurance can be given that management's
ongoing evaluation of the loan portfolio in light of changing economic
22
conditions and other relevant circumstances will not require significant future
additions to the Allowance, thus adversely affecting the operating results of
TSFG.
The Allowance is also subject to examination and adequacy testing by
regulatory agencies, which may consider such factors as the methodology used to
determine adequacy and the size of the Allowance relative to that of peer
institutions, and other adequacy tests. In addition, such regulatory agencies
could require us to adjust our Allowance based on information available to them
at the time of their examination.
The Allowance totaled $66.1 million, or 1.46% of loans held for
investment, at March 31, 2003, a significant increase from $45.2 million, or
1.20%, at March 31, 2002. Nonperforming loans totaled $61.0 million at March 31,
2003, an increase of $17.5 million from $43.5 million at March 31, 2002. These
increases were the result of the acquisition of loans from Rock Hill Bank,
partially offset by lower core nonperforming loans. Excluding the $32.7 million
of nonperforming loans related to the Rock Hill Workout Loans, nonperforming
loans declined to $28.3 million at March 31, 2003 from $43.5 million at March
31, 2002 (to 0.63% from 1.15% of loans held for investment), and the Allowance
increased to $54.5 million at March 31, 2003 from $45.2 million at March 31,
2002 (to 1.22% from 1.20% of loans held for investment). See "Credit Quality."
Table 5, which summarizes the changes in the Allowance, provides
additional information with respect to the activity in the Allowance. While
uncertainty in the current economic outlook makes future charge-off levels less
predictable, management does not expect losses to increase significantly over
the next several quarters. As a percentage of average loans, losses in 2003 are
expected to be comparable to 2002 losses. However, the economic outlook remains
highly uncertain, and future charge-off levels may therefore fluctuate above or
below that average from quarter to quarter.
TABLE 5
- -------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
AT AND FOR
THE THREE MONTHS AT AND FOR
ENDED MARCH 31, THE YEAR ENDED
-------------------------------- DECEMBER 31,
2003 2002 2002
---- ---- ----
Allowance for loan losses, beginning of year $ 70,275 $ 44,587 $ 44,587
Purchase accounting adjustments - - 22,973
Allowance adjustment for loans sold - - (12)
Net charge-offs:
Loans charged-off (10,308) (6,384) (23,556)
Loans recovered 666 767 4,017
----------- ----------- -----------
(9,642) (5,617) (19,539)
Additions to reserve through provision expense 5,500 6,238 22,266
----------- ----------- -----------
Allowance for loan losses, end of period $ 66,133 $ 45,208 $ 70,275
=========== =========== ===========
Average loans $ 4,520,965 $ 3,774,762 $ 4,008,094
Loans held for investment 4,515,133 3,779,682 4,434,011
Net charge-offs as a percentage of average loans (annualized) 0.85 % 0.60 % 0.49 %
Allowance for loan losses as a percentage of loans held
for investment 1.46 1.20 1.58
Excluding the Rock Hill Workout Loans:
Net loan charge-offs $ 5,533 $ 5,617 $ 19,906
Net charge-offs as a percentage of average loans (annualized) 0.50 % 0.60 % 0.50 %
Allowance for loan losses as a percentage of loans held
for investment, excluding Rock Hill Workout Loans 1.22 1.20 1.24
23
Securities
TSFG uses the investment securities portfolio for several purposes. It
serves as a vehicle to manage interest rate and prepayment risk, generates
interest and dividend income from the investment of excess funds depending on
loan demand, provides appropriate level of liquidity to meet liquidity
requirements, and is used as collateral for pledges on public deposits and
securities sold under repurchase agreements.
At March 31, 2003, TSFG's investment portfolio totaled $3.4 billion, up
$1.8 billion from the $1.7 billion invested as of March 31, 2002, and up $850.7
million from the $2.6 billion invested as of December 31, 2002. The majority of
the increase since December 31, 2002 was attributable to the purchase of U.S.
Government agency and mortgage-backed securities in the available for sale
portfolio. In the first quarter 2003, TSFG bought these securities to leverage
capital and take advantage of the opportunity to increase net interest income.
In addition, TSFG has engaged in, and expects to continue to engage in, hedging
activities to reduce interest rate risk associated with the investment
securities. Also, in 2002, TSFG acquired $210.8 million in available for sale
securities from the acquisitions completed in 2002. During 2003, TSFG expects to
sell investment securities as loan growth increases, depending on the general
level of interest rates.
Securities (i.e., trading securities, securities available for sale,
and securities held to maturity) excluding the unrealized gain recorded for
available for sale securities averaged $3.0 billion in the first quarter of
2003, 73.4% above the first quarter of 2002 average of $1.7 billion. The
majority of the increase was attributable to purchases of securities to leverage
available capital, anticipate accelerated paydowns of mortgage-backed
securities, and provide for increased calls of U.S. Government agency
securities. The average portfolio yield decreased in the first three months of
2003 to 4.28% from 5.36% in the first three months of 2002. The securities yield
decreased due to a lower level of general interest rates and the addition of
lower-yielding, shorter duration securities.
The duration of the portfolio declined to approximately 4.9 years at
March 31, 2003 from 7.2 years at March 31, 2002. The securities portfolio
currently reprices within a two and a half-year pricing horizon, which is
significantly faster than indicated by the duration.
The composition of the investment portfolio as of March 31, 2003 was as
follows: mortgage-backed securities 57.1%, U.S. Government agencies 27.6%, U.S.
Treasuries 7.4%, state and municipalities 3.4%, and other securities 4.5% (which
includes equity investments described below). Mortgage-backed securities have
increased from 46.4% of the portfolio at December 31, 2002, due to the first
quarter 2003 purchase to leverage available capital. Collateralized mortgage
obligations, the majority of which are short-term, represent less than 15% of
the securities portfolio.
The available for sale portfolio constituted 98.2% of total securities
at March 31, 2003. Management believes that the high concentration of available
for sale securities provides greater flexibility in the management of the
overall investment portfolio.
During the first quarter 2003, the net unrealized gain on available for
sale securities (pre-tax) increased to $32.2 million at March 31, 2003 from a
$21.1 million loss at March 31, 2002. The increase in the net unrealized gain
was primarily associated with U.S. Treasury securities, which had unrealized
losses at March 31, 2002 and were sold in the third quarter 2002. At December
31, 2002, the net unrealized gain on available for sale securities (pre-tax)
totaled $36.3 million.
Other Investments
INVESTMENT IN NETBANK, INC. At March 31, 2003, TSFG owned 517,904
shares of NetBank common stock. NetBank owns and operates NetBank, F.S.B., an
FDIC-insured federal savings bank that provides banking services to consumers
utilizing the Internet. TSFG's investment in NetBank, which is included in
securities available for sale with a basis of $144,000, was recorded at its
pre-tax market value of approximately $4.8 million at March 31, 2003. During the
three months ended March 31, 2003, TSFG sold 207,096 shares of NetBank for a
pre-tax gain of $1.9 million.
INVESTMENTS IN BANKS. At March 31, 2003, TSFG had equity investments in
fourteen community banks located in the Southeast. In each case, TSFG owns less
than 5% of the community bank's outstanding common stock. TSFG has made these
investments to develop correspondent banking relationships and to promote
community banking in the Southeast. These investments in community banks, which
are included in securities available for sale with a basis of approximately
$16.7 million, were recorded at their pre-tax market value of approximately
$19.2 million at March 31, 2003.
TSFG also has an investment in Nexity Financial Corporation, an
Internet bank, which was recorded at its cost basis of $500,000.
24
CF INVESTMENT COMPANY. CF Investment Company is a wholly-owned Small
Business Investment Company, licensed through the Small Business Administration.
Its principal focus is to invest in companies that have a bank-related
technology or service that TSFG and its subsidiaries can use. CF Investment
Company's loans and equity investments represent a higher risk to TSFG due to
the start-up nature of such companies. As of March 31, 2003, CF Investment
Company had invested approximately $1.2 million (or 49% interest in common
stock) in a company specializing in electronic document management services and
$502,000 (or 15% interest in common stock) in a paycard company. The estimated
fair value of these investments is deemed to approximate the cost basis. TSFG
may incur impairment losses in the future depending on the performance of CF
Investment Company's investments.
OTHER INVESTMENTS NOT SPECIFIED ABOVE. In addition to the investments
described in the preceding paragraphs, other investments in available for sale
securities at March 31, 2003, which are carried at market value, included
corporate bonds of $70.7 million, FHLB stock of $50.7 million, and other equity
securities of $5.3 million. Other equity securities include TSFG's investment in
Affinity Technology Group, Inc. ("Affinity"). At March 31, 2003, TSFG owned
4,876,340 shares of common stock of Affinity, or approximately 12% of the
outstanding shares. TSFG's investment in Affinity has a basis of $433,000 and
was recorded at its March 31, 2003 pre-tax market value of approximately
$878,000. At March 31, 2003, the aggregate market value for these other
investments, which are not specified in the preceding paragraphs, totaled $126.7
million with a cost basis of $125.3 million.
Intangible Assets
The intangible assets balance at March 31, 2003 of $242.4 million
consisted of goodwill of $225.3 million, core deposit premiums of $15.8 million,
customer list intangibles of $813,000, and non-compete agreement intangibles of
$542,000. The intangible assets balance at March 31, 2002 of $95.5 million
consisted of goodwill of $90.2 million and core deposit premiums of $5.3
million. The increase in goodwill was primarily due to the $134.1 million of
goodwill acquired during 2002 from the mergers with CBT, Rock Hill Bank, Gardner
Associates, and Gulf West and subsequent adjustments in 2003 totaling $943,000.
The increase in core deposit premiums was due to adding $2.7 million from the
CBT merger, $1.2 million from the Rock Hill Bank merger, and $8.4 million from
the Gulf West merger. The customer list intangibles and non-compete agreement
intangibles were added with the acquisition of Gardner Associates.
Deposits
Deposits remain TSFG's primary source of funds for loans and
investments. Average deposits provided funding for 60.7% of average earning
assets in the first quarter 2003 and 64.3% in the first quarter 2002. Carolina
First Bank and Mercantile Bank face stiff competition from other banking and
financial services companies in gathering deposits. The percentage of funding
provided by deposits has declined, and accordingly, TSFG has developed other
sources, such as FHLB advances, short-term borrowings, and long-term structured
repurchase agreements, to fund a portion of loan demand and increases in
investment securities. In addition, TSFG has increased the use of brokered
certificates of deposit, which are included in deposits.
At March 31, 2003, deposits totaled $4.7 billion, up $1.1 billion from
March 31, 2002. In 2002, TSFG acquired $783.8 million in deposits from its
merger with CBT, Rock Hill Bank, and Gulf West, which accounted for 72% of the
increase. In addition, this increase includes a $273.9 million increase in
brokered certificates of deposit. At March 31, 2003, TSFG had $520.2 million in
brokered certificates of deposit, compared with $246.3 million at March 31,
2002. We consider these funds as an attractive alternative funding source
available to use while continuing our efforts to maintain and grow our local
deposit base.
Deposit pricing remains very competitive, and we expect this pricing
environment to continue. During the past two years, TSFG decided to keep deposit
rates offered on par with competitors and reduced deposit rate-driven
promotions, which resulted in lower deposit balances. Deposits acquired in 2002
mergers offset this decrease.
Table 7 in "Results of Operations - Net Interest Income" details
average balances for the deposit portfolio for both the three months ended March
31, 2003 and 2002. Average money market accounts increased $376.4 million, or
51.3%, and average noninterest demand deposits increased $211.3 million, or
42.6%. On average, time deposits increased $278.8 million, or 16.6%, which
includes a $310.4 increase in average brokered certificates of deposit.
As part of its overall funding strategy, TSFG focuses on the mix of
deposits and, in particular, increasing the level of transaction accounts (i.e.,
noninterest-bearing, interest-bearing checking, money market, and savings
accounts). For the three months ended March 31, 2003, transaction accounts made
up 57.4% of average deposits, compared with 53.6% for the three months ended
March 31, 2002. These trends reflect TSFG's efforts to enhance its deposit mix
25
by working to attract lower-cost transaction accounts. TSFG's customer-centered
sales process, Elevate, is an integral part of achieving this goal. In addition,
in the summer of 2002 and the first quarter of 2003, TSFG held deposit
campaigns, based on employee referrals, to raise transaction accounts.
At March 31, 2003, total deposits for Bank CaroLine, an Internet bank,
totaled $27.3 million, down from $45.6 million as of March 31, 2002. Deposits
for Bank CaroLine declined significantly, due to offering less aggressive
interest rates in an effort to lower the overall cost of funds.
Time deposits of $100,000 or more represented 13.3% of total deposits
at March 31, 2003 and 14.6% at March 31, 2002. TSFG's larger denomination time
deposits are generally from customers within the local market areas of its banks
and, therefore, have a greater degree of stability than is typically associated
with this source of funds at other financial institutions.
In March 2003, TSFG entered into an agreement with an unrelated
financial institution to sell the deposits at its Powdersville, South Carolina
branch office. TSFG expects to complete the sale in June 2003 and close the
office subsequent to the sale. TSFG expects to sell approximately $8 million in
deposits and record a gain associated with the sale.
Borrowed Funds
TSFG uses both short-term and long-term borrowings to fund growth of
earning assets in excess of deposit growth. TSFG's short-term borrowings consist
of federal funds purchased and repurchase agreements, FHLB advances (with
maturities less than one year when made), commercial paper, and other short-term
borrowings. The long-term borrowings consist primarily of subordinated notes,
FHLB advances, and repurchase agreements with maturities greater than one year
when made. In the first three months of 2003, average borrowings totaled $3.0
billion, compared with $1.9 billion for the same period in 2002. This increase
was primarily attributable to an increased reliance on short-term borrowings to
support earning asset growth, including increases in investment securities.
TSFG's long-term borrowings totaled $2.1 billion at March 31, 2003, up
from $503.7 million as of March 31, 2002, primarily from the increase in
repurchase agreements and FHLB advances. TSFG increased long-term borrowings in
2002 and first quarter 2003 to provide longer-term liquidity at historically-low
interest rates.
Federal funds purchased and repurchase agreements are used to satisfy
daily funding needs and, when advantageous, for rate arbitrage. Federal funds
purchased and repurchase agreements totaled $2.1 billion at March 31, 2003,
including $1.1 billion in long-term repurchase agreements, and $1.4 billion at
March 31, 2002, including $100.0 million in long-term repurchase agreements.
These balances are primarily to finance higher balances in investment securities
available for sale and to support earning asset growth. Balances in these
accounts can fluctuate on a day-to-day basis.
The FHLB advances were $1.0 billion, including $994.6 million in
long-term advances, at March 31, 2003 and $386.8 million, including $23.0
million in long-term advances, at March 31, 2002. FHLB advances are a source of
funding which TSFG uses depending on the current level of deposits, management's
willingness to raise deposits through market promotions, the Subsidiary Banks'
unused FHLB borrowing capacity, and the availability of collateral to secure
FHLB borrowings.
Capital Resources and Dividends
Total shareholders' equity amounted to $635.0 million, or 7.1% of total
assets, at March 31, 2003, compared with $434.0 million, or 7.2% of total
assets, at March 31, 2002. At December 31, 2002, total shareholders' equity was
$646.8 million, or 8.1% of total assets. The increase in shareholders' equity,
when comparing March 31, 2003 to the same period in 2002, is primarily from the
issuance of common stock for the 2002 mergers, the unrealized gains in the
available for sale investment portfolio, and retention of earnings. TSFG's stock
repurchase program and cash dividends paid partially offset these increases.
TSFG has a stock repurchase program and, in February 2003, expanded its
program by one million shares in connection with the CBT merger. During 2003,
TSFG repurchased 1,266,308 shares and has approximately 298,000 shares remaining
under its stock repurchase authorization. TSFG may continue to repurchase shares
depending upon current market conditions and available cash.
TSFG's unrealized gain on securities, net of tax, which is included in
accumulated other comprehensive income, was $20.4 million as of March 31, 2003
as compared to an unrealized loss of $15.0 million as of March 31, 2002 and an
unrealized gain of $24.4 million as of December 31, 2002. The increase in the
26
unrealized gain (net of deferred income tax) from March 31, 2002 to March 31,
2003 was comprised of increases in: U.S. Treasury securities $30.6 million,
mortgage-backed securities $8.1 million, U.S. Government agencies $5.4 million,
and state and municipalities $753,000. This increase was partially offset by a
decrease in other securities of $9.4 million, principally from the sale of
NetBank common stock and the write-down and subsequent cancellation of TSFG's
shares in RHBT due to TSFG's acquisition of substantially all the assets and
deposits of Rock Hill Bank, which was the wholly-owned banking subsidiary of
RHBT.
Book value per share at March 31, 2003 and 2002 was $13.68 and $10.78,
respectively. Tangible book value per share at March 31, 2003 and 2002 was $8.46
and $8.41, respectively. Tangible book value was below book value as a result of
the purchase premiums associated with acquisitions accounted for as purchases
and branch purchases.
TSFG and its Subsidiary Banks exceeded the well-capitalized regulatory
requirements at March 31, 2003. Table 6 sets forth various capital ratios for
TSFG and its Subsidiary Banks.
TABLE 6
- ---------------------------------------------------------------------------------------------------
CAPITAL RATIOS
- ---------------------------------------------------------------------------------------------------
WELL
CAPITALIZED
MARCH 31, 2003 REQUIREMENT
-------------- -----------
TSFG
Total risk-based capital 10.71 % n/a
Tier 1 risk-based capital 8.46 n/a
Leverage ratio 6.04 n/a
CAROLINA FIRST BANK
Total risk-based capital 10.89 % 10.00 %
Tier 1 risk-based capital 7.76 6.00
Leverage ratio 5.26 5.00
MERCANTILE BANK
Total risk-based capital 12.64 % 10.00 %
Tier 1 risk-based capital 9.14 6.00
Leverage ratio 7.71 5.00
TSFG is actively considering filing a "universal shelf" so that it
might more readily access the capital markets.
TSFG and its subsidiaries are subject to certain regulatory
restrictions on the amount of dividends they are permitted to pay. TSFG has paid
a cash dividend each quarter since the initiation of cash dividends on February
1, 1994. At the December 2002 meeting, the Board of Directors approved a regular
quarterly cash dividend of $0.14 per common share, which represents an effective
annual increase of 16.7%. TSFG presently intends to pay a quarterly cash
dividend on its common stock; however, future dividends will depend upon TSFG's
financial performance and capital requirements.
In July and October 2002, TSFG, through three wholly-owned trust
subsidiaries, issued and sold floating rate securities to institutional buyers
in three pooled trust preferred issues. These securities generated proceeds to
TSFG of $62.5 million, net of issuance costs totaling $2.0 million, which
qualifies as tier 1 capital under Federal Reserve Board guidelines.
In June 2002, Carolina First Bank sold 131 shares of the Carolina First
Mortgage Loan Trust's Series 2000A Cumulative Fixed Rate Preferred Shares (the
"Series A REIT Preferred Stock") and 385 shares of Carolina First Mortgage Loan
Trust's Series 2002C Cumulative Floating Rate Preferred Shares (the "Series C
REIT Preferred Stock") to institutional buyers. Proceeds to Carolina First Bank
from these sales totaled approximately $49.2 million, net of issuance costs
totaling $2.4 million, and are reported as minority interest in consolidated
subsidiary on the consolidated balance sheet. The minority interest in
consolidated subsidiary qualifies as tier 1 capital (in the case of Series A
REIT Preferred Stock) and tier 2 capital (in the case of Series C REIT Preferred
Stock) under Federal Reserve Board guidelines.
27
EARNINGS REVIEW
Net Interest Income
Net interest income is TSFG's primary source of revenue. Net interest
income is the difference between the interest earned on assets, including loan
fees and security dividends, and the interest paid for the liabilities to
support such assets. The net interest margin measures how effectively a company
manages the difference between the yield on earning assets and the rate paid on
funds used to support those assets. Fully tax-equivalent net interest income
adjusts the yield for assets earning tax-exempt income to a comparable yield on
a taxable basis. Table 7 presents average balance sheets and a net interest
income analysis on a tax equivalent basis for the three months ended March 31,
2003 and 2002.
28
TABLE 7
- --------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- --------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
--------------------------------------------------------------
2003 2002 (RESTATED)
-------------------------- ---------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
Assets
Earning assets
Loans (1) $4,520,965 $ 67,333 6.04% $3,774,762 $62,160 6.68 %
Investment securities (taxable)(2) 2,894,634 30,299 4.19 1,643,790 21,567 5.25
Investment securities (nontaxable)(3) 114,807 1,878 6.54 91,662 1,679 7.33
Federal funds sold 2,359 8 1.38 - - -
Interest-bearing bank balances 33,384 110 1.34 110,742 469 1.72
----------- ------- ---------- -------
Total earning assets 7,566,149 99,628 5.34 5,620,956 85,875 6.20
------- -------
Non-earning assets 821,681 513,163
----------- ----------
Total assets $ 8,387,830 $6,134,119
=========== ==========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 661,831 $ 1,069 0.66 $ 594,706 $ 1,810 1.23
Savings 156,145 194 0.50 114,724 214 0.76
Money market 1,109,935 4,258 1.56 733,534 2,915 1.61
Time deposits 1,955,910 12,478 2.59 1,677,119 16,637 4.02
---------- ------- ---------- -------
Total interest-bearing deposit 3,883,821 17,999 1.88 3,120,083 21,576 2.80
Borrowings 2,962,384 15,501 2.12 1,949,994 12,319 2.56
---------- ------- ---------- -------
Total interest-bearing liabiliti 6,846,205 33,500 1.98 5,070,077 33,895 2.71
------- -------
Noninterest-bearing liabilities
Noninterest-bearing deposits 706,804 495,511
Other noninterest-bearing 101,544 66,082
liabilities
---------- ----------
Total liabilities 7,654,553 5,631,670
Minority interest in consolidated 86,449(4) 37,023
subsidiary (4)
Shareholders' equity 646,828 465,426
---------- ----------
Total liabilities and shareholders $8,387,830 $6,134,119
========== ==========
Net interest margin $ 66,128 3.54% $51,980 3.75 %
======== =======
Tax-equivalent adjustment (3) $ 657 $ 588
======== =======
(1) Nonaccrual loans are included in average balances for yield computations.
(2) The average balances for investment securities exclude the unrealized gain
or loss recorded for available for sale securities.
(3) The tax-equivalent adjustment to net interest income adjusts the yield for
assets earning tax-exempt income to a comparable yield on a taxable basis.
(4) The minority interest in consolidated subsidiary pertains to the REIT
preferred stock, which qualifies as regulatory capital and pays cumulative
dividends.
Note: Average balances are derived from daily balances.
29
Fully tax-equivalent net interest income for the first three months of
2003 increased $14.1 million, or 27.2%, to $66.1 million from $52.0 million in
the first three months of 2002. The net interest margin declined to 3.54% in the
first three months of 2003 from 3.75% in the first three months of 2002. This
decrease in the net interest margin was largely attributable to downward
repricing of fixed rate commercial loans, higher investment securities (which
generally have a lower yield than loans), and deposit rates approaching lower
limits due to historically-low interest rates.
During the fourth quarter of 2002, TSFG adjusted and reclassified
certain prior quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income. In the
first quarter of 2002, the over accrual of interest expense related to
repurchase agreements overstated interest expense by $706,000, which was
corrected in the fourth quarter of 2002. The additional deferral of loan fee
income decreased net interest income by $2.7 million in the first quarter of
2002. A related deferral of salaries, wages and employee benefits substantially
offset the decrease in the deferral of loan fee income. See "Overview."
Average earning assets grew $1.9 billion, or 34.6%, to $7.6 billion in
the first three months of 2003 from $5.6 billion in the first three months of
2002, primarily from the purchase of investment securities and acquisitions. The
Gulf West merger, which closed August 31, 2002, the asset purchase with Rock
Hill Bank, which closed on October 31, 2002, and the Central Bank of Tampa
merger, which closed on December 31, 2002, added approximately $903.8 million in
earning assets. Average loans increased $746.2 million, to $4.5 billion in the
first three months of 2003 from $3.8 billion in the first three months of 2002.
Average investment securities, excluding the average net unrealized securities
gains, increased from $1.7 billion in the first three months of 2002 to $3.0
billion in the first three months of 2003. In the first quarter of 2003, TSFG
purchased approximately $1.1 billion in adjustable rate U.S. government agencies
and mortgage-backed securities. These purchases leveraged available capital and
took advantage of the opportunity to increase net interest income. As the
economy improves, TSFG expects loan growth to increase and to replace some
securities balances with new loans. In addition, during 2003, TSFG expects that
purchases of investment securities will primarily occur to replace pre-paying or
maturing securities. Accordingly, TSFG expects investment securities to decline
during the second half of 2003.
Interest rates are presently at historically low levels. During 2002,
the Federal Reserve lowered the Federal funds target rate one time in November
by 50 basis points. TSFG's interest sensitive assets reprice more quickly than
its interest-bearing liabilities. A large portion of TSFG's adjustable rate
loans, which constitute 54.6% of the loan portfolio, reprice immediately
following an interest rate change by the Federal Reserve. The funding source
changes take more time to filter into the net interest margin, primarily because
of the timed maturities of certificates of deposit and borrowings. A large
portion of deposits and borrowings had repriced by the end of 2002 while new and
maturing loans and investments continue to be made at lower rates.
Downward pressure on the net interest margin is expected to continue
for the remainder of 2003. In addition, continued declines in interest rates
would put additional pressure on the net interest margin because some deposit
rates are reaching what management considers to be their lower limit. TSFG
expects certificates of deposit to continue to mature and reprice downward in
2003, although with a significantly smaller benefit than that realized during
the past two years.
Average total deposits increased by $975.0 million, or 27.1%, to $4.6
billion during the first three months of 2003 from $3.6 billion in the first
three months of 2002. Excluding the impact of the Gulf West, Rock Hill Bank and
Central Bank of Tampa mergers, these balances remained flat due to the
competitive nature of the deposit markets. During the past two years, TSFG
decided to keep deposit rates on par with competitors and reduce deposit
rate-driven promotions. Average borrowings increased to $3.0 billion during the
three months ended March 31, 2003 from $2.0 billion during the three months
ended March 31, 2002 due to increases in fed funds purchased, repurchase
agreements, and FHLB advances. These borrowings were used to fund the growth in
earning assets.
Deposits generated through Bank CaroLine, an Internet banking division
of Carolina First Bank, generally receive higher rates than those offered by our
branch locations as a result of the less expensive Internet delivery channel.
During the last two years, TSFG priced Bank CaroLine deposits less aggressively
than it did in 2000 in an effort to lower the overall cost of funds. Bank
CaroLine deposits totaled $27.3 million as of March 31, 2003 compared with $29.6
million and $45.6 million as of December 31, 2002 and March 31, 2002,
respectively.
Provision for Loan Losses
The provision for loan losses is recorded in amounts sufficient to
bring the allowance for loan losses to a level deemed appropriate by management.
Management determines this amount based upon many factors, including its
assessment of loan portfolio quality, loan growth, changes in loan portfolio
30
composition, net loan charge-off levels, and expected economic conditions. The
provision for loan losses was $5.5 million and $6.2 million in the first three
months of 2003 and 2002, respectively. The lower provision for loan losses was
primarily attributable to the liquidation of nonperforming loans on which
allocated reserves exceeded net losses incurred.
Net loan charge-offs were $9.6 million, or 0.85% of average loans, for
the first quarter 2003, compared with $5.6 million, or 0.60% of average loans,
for the first quarter 2002. Loan charge-offs in the first quarter of 2003
included losses of $4.1 million of Rock Hill Workout Loans, which were included
in the allowance for loan losses at the prior quarter-end. Therefore, the
allowance for loan losses declined, and these charge-offs had no impact on the
first quarter 2003 provision for loan losses. The allowance for loan losses
equaled 1.46%, 1.58%, and 1.20% of loans held for investment as of March 31,
2003, December 31, 2002, and March 31, 2002, respectively. The significant
increase from March 2002 to December 2002 was attributable to the Rock Hill
Workout Loans. See "Loans." Excluding the Rock Hill Workout Loans, the allowance
for loan losses was 1.22% of loans held for investment as of March 31, 2003.
Noninterest Income
Noninterest income totaled $19.9 million in the first three months of
2003, compared with $11.6 million in the first three months of 2002. The
increase in noninterest income was primarily the result of a $2.1 million
increase in service charges on deposit accounts, a $1.9 million increase in gain
on equity investments, a $1.1 million increase in fees for investment services,
a $1.1 million increase in mortgage banking income, a $957,000 increase in gain
on sale of available for sale securities, and a $989,000 increase in other,
which was largely due to increases in insurance commissions and debit card
income. Table 8 shows the components of noninterest income for the three months
ended March 31, 2003 and 2002.
TABLE 8
- -------------------------------------------------------------------------------------
COMPONENTS OF NONINTEREST INCOME
- -------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2003 2002
---- ----
Service charges on deposit accounts $ 6,960 $ 4,907
Fees for investment services 2,491 1,427
Mortgage banking income 2,172 1,081
Bank-owned life insurance 1,948 1,806
Merchant processing income 1,336 1,248
Other 2,118 1,129
-------- --------
Noninterest income, excluding gain on asset sales 17,025 11,598
-------- --------
Gain on sale of available for sale securities 986 29
Gain on equity investments, net 1,875 11
-------- --------
Gain on asset sales, net 2,861 40
-------- --------
Total noninterest income $ 19,886 $ 11,638
======== ========
Noninterest income included gains on asset sales for both the three
months ended March 31, 2003 and 2002. Excluding these net gains on asset sales,
noninterest income increased $5.4 million, or 46.8%, in the first quarter 2003
to $17.0 million from $11.6 million for the corresponding period in 2002. TSFG
is striving to increase its revenues from noninterest income sources.
During the first three months of 2003, the gain on equity investment
totaling $1.9 million was from the sale of 207,096 shares of NetBank, Inc.
common stock. During the three months ended March 31, 2002, the gain on equity
investments totaling $11,000 was from the sale of an equity investment in a
community bank.
Service charges on deposit accounts, the largest contributor to
noninterest income, rose 41.8% to $7.0 million in the first three months of 2003
from $4.9 million for the same period in 2002. The increase was attributable to
increasing transaction accounts, improving collection of fees, and revising fee
structures to reflect competitive pricing. Average balances for deposit
transaction accounts, which impact service charges, increased approximately
36.0% for the same period.
31
Fees for investment services, which include trust and brokerage income,
for the first three months of 2003 and 2002, were $2.5 million and $1.4 million,
respectively. During this period, brokerage income increased $1.0 million, and
trust income increased $22,000. Brokerage income increased primarily from the
addition of brokers. At March 31, 2003 and 2002, the market value of assets
administered by the trust department totaled $627.8 million and $711.0 million,
respectively.
Mortgage banking income includes origination income and secondary
marketing operations (related to current production), mortgage servicing income
(net of the related amortization for the mortgage servicing rights and
subservicing payments), losses and recoveries related to the impairment of
mortgage servicing rights, and gains and losses on sales of portfolio mortgage
loans. Mortgage banking income in the first three months of 2003 increased $1.1
million to $2.2 million from $1.1 million in the first three months of 2002.
Table 9 shows the components of mortgage banking income for the three months
ended March 31, 2003 and 2002.
TABLE 9
- --------------------------------------------------------------------------------------------------
COMPONENTS OF MORTGAGE BANKING INCOME
- --------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
-----------------------
2003 2002
---- ----
Origination income and secondary marketing operations $ 2,944 $ 1,679
Net mortgage servicing loss (510) (405)
(Impairment) recoveries on mortgage servicing rights (262) 200
Loss on sale of portfolio mortgage loans - (393)
------- -------
Total mortgage banking income $ 2,172 $ 1,081
======= =======
For the first three months of 2003, origination income and secondary
marketing increased 75.3% to $2.9 million from $1.7 million for the first three
months of 2002. Mortgage loans originated by TSFG originators totaled $161.5
million and $109.0 million in the first three months of 2003 and 2002,
respectively. Mortgage origination volumes by TSFG originators increased in the
first three months of 2003 due to lower mortgage loan rates and the hiring of
additional mortgage originators.
TSFG's total servicing portfolio includes mortgage loans owned by
Carolina First Bank, mortgage loans owned by Mercantile Bank, and other mortgage
loans for which Carolina First Bank owns the rights to service. At March 31,
2003, TSFG's servicing portfolio included 5,180 loans having an aggregate
principal balance of $399.2 million. At March 31, 2002, the aggregate principal
balance for TSFG's servicing portfolio totaled $659.7 million, significantly
higher than March 31, 2003 due to prepayments of loans from increased
refinancings as a result of lower interest rates. Fees related to servicing
other loans, for which Carolina First Bank owns the rights to service, are
offset by the related amortization of mortgage servicing rights. TSFG expects
its total servicing portfolio to continue to decline since the emphasis of its
mortgage banking strategy is on mortgage originations. TSFG sells most of the
loans it originates in the secondary market with servicing rights released.
Mortgage servicing rights, net of the valuation allowance, totaled $3.2
million and $8.0 million at March 31, 2003 and 2002, respectively. For the three
months ended March 31, 2003, TSFG recorded a $262,000 charge for impairment from
the valuation of mortgage servicing rights. In the first three months of 2002,
TSFG had a impairment recovery of $200,000 from the valuation of mortgage
servicing rights. At March 31, 2003, the valuation allowance for capitalized
mortgage servicing rights totaled $2.0 million.
Bank-owned life insurance income increased to $1.9 million for the
first three months of 2003 from $1.8 million for the first three months of 2002
due to increases in cash values. Merchant processing income increased 7.1% to
$1.3 million for the three months ended March 31, 2003 from $1.2 million for the
three months ended 2002 from attracting new merchants.
Other noninterest income totaled $2.1 million for the first three
months of 2003, compared with $1.1 million for the first three months of 2002.
Other noninterest income includes income related to debit cards, insurance
commissions, customer service fees, international banking services, and other
fee-based services. Total income from these fee income sources increased over
the prior year due in part to TSFG's rollout of Elevate, a customer-centered
sales process. The increase in other noninterest income was largely due to
increases in insurance commissions, which increased $621,000, and debit card
income, which increased $302,000.
32
Noninterest Expenses
Noninterest expenses increased to $48.9 million in the first three
months of 2003 from $34.9 million in the first three months of 2002. Noninterest
expenses for the three months ended March 31, 2003 included $1.5 million in
merger-related costs. Excluding these merger-related costs, noninterest expenses
increased $12.5 million, or 36.0%, to $47.4 million for the first three months
of 2003 from $34.9 million for the first three months of 2002.
Salaries, wages, and employee benefits increased to $24.6 million in
the first three months of 2003 from $18.0 million in the first three months of
2002. Full-time equivalent employees increased to 1,647 from 1,332 as of March
31, 2003 and 2002, respectively. The increase in personnel expense was
attributable to the 2002 acquisitions that closed in the third and fourth
quarters, hiring new revenue-producing associates (at a higher cost per
full-time equivalent employee), and recording higher levels of incentive pay.
Restricted stock plan awards, which are expensed to salaries and wages,
increased to $1.8 million in the first three months of 2003 from $1.0 million in
the first three months of 2002.
Occupancy expense increased to $4.6 million for the three months ended
March 31, 2003 from $3.5 million for the corresponding period from 2002,
primarily from the addition of branch offices from the 2002 acquisitions.
Furniture and equipment increased $1.0 million to $4.6 million for the first
quarter 2003 from $3.6 million for the same period in 2002. The increase in
furniture and equipment expense was primarily attributable to increases in
depreciation and additional maintenance agreements principally from the
acquisitions in the last four months of 2002.
Professional fees increased to $1.5 million for the first quarter 2003
from $1.3 million for the first quarter 2002. Telecommunication expense
increased $387,000 to $1.1 million for the first three months of 2003 from
$683,000 in the first three months of 2002. Merchant processing expense remained
relatively constant for the first three months of 2003 and 2002.
Amortization of intangibles increased to $705,000 for the three months
ended March 31, 2003 from $239,000 for the three months ended March 31, 2002.
This increase was primarily attributable to the addition of core deposit
premiums in the third and fourth quarters of 2002 for the CBT, Rock Hill Bank,
and Gulf West acquisitions, which totaled $12.3 million. In addition, in the
third quarter 2002, TSFG added $858,000 in customer list intangibles and
$663,000 in non-compete agreement intangibles with the acquisition of Gardner
Associates.
In connection with the 2002 acquisitions of CBT, Rock Hill Bank, and
Gulf West, TSFG incurred pre-tax merger-related costs of $1.5 million in the
first quarter 2003. See Part I, Item 1, Note 12 to the Consolidated Financial
Statements.
Other noninterest expenses increased $2.8 million to $9.2 million in
the first three months of 2003 from $6.4 million in the first three months of
2002. The overall increase in other noninterest expenses was principally
attributable to increases in loan collection, advertising, debit card, and
insurance expenses.
Income Taxes
The effective income tax rate as a percentage of pretax income remained
relatively constant at 32.0% for the first three months of 2003 and 31.9% for
the first three months of 2002. The blended statutory federal and state income
tax rate was 36.94% for both of these periods.
TSFG's effective income tax rates take into consideration certain
assumptions and estimates by management. No assurance can be given that either
the tax returns submitted by management or the income tax reported on the
consolidated financial statements will not be adjusted by either adverse rulings
by the U.S. Tax Court, changes in the tax code, or assessments made by the
Internal Revenue Service. TSFG is subject to potential adverse adjustments,
including but not limited to: an increase in the statutory federal or state
income tax rates, the permanent nondeductibility of amounts currently considered
deductible either now or in future periods, and the dependency on the generation
of future taxable income, including capital gains, in order to ultimately
realize deferred income tax assets. Tax returns for 1999 and subsequent years
are exposed to examination by taxing authorities.
33
MARKET RISK AND ASSET/LIABILITY MANAGEMENT
Market risk is the risk of loss from adverse changes in market prices
and rates. TSFG's market risk arises principally from interest rate risk
inherent in its core banking activities. Interest rate risk is the risk to net
income represented by the impact of higher or lower interest rates. TSFG has
risk management policies and systems to monitor and limit exposure to interest
rate risk.
TSFG attempts to manage exposure to fluctuations in interest rates
through policies established by our Asset/Liability Committee ("ALCO") and
approved by the Board of Directors. The primary goal of TSFG's ALCO is to
achieve consistent growth in net interest income through implementation of
strategies to improve balance sheet positioning and/or earnings while managing
interest rate risk. TSFG attempts to control the mix and maturities of assets
and liabilities to achieve consistent growth in net interest income despite
changes in market interest rates while maintaining adequate liquidity and
capital. TSFG's asset/liability mix is sufficiently balanced so that the effect
of interest rates moving in either direction is not expected to have a
significant impact on net interest income over time. The overall interest rate
risk position of TSFG continues to fall within the interest rate risk guidelines
established by ALCO.
TSFG uses several tools to monitor and manage interest rate risk. One
of the primary tools is a simulation model, which is used to analyze earnings at
risk and the interest sensitivity gap (the difference between the amount of rate
sensitive assets maturing or repricing within a specific time period and the
amount of rate sensitive liabilities maturing or repricing within the same time
period). The model takes into account interest rate changes as well as changes
in the mix and volume of assets and liabilities. The model's inputs (such as
interest rates and levels of loans and deposits) are updated on a regular basis.
Interest sensitivity gap ("GAP position") measures the difference
between rate sensitive assets and rate sensitive liabilities maturing or whose
rates are subject to change during a given time frame. TSFG's GAP position,
while not a complete measure of interest sensitivity, is reviewed periodically
to provide insights related to the static repricing structure of assets and
liabilities. In general, an asset sensitive position would indicate that net
interest income would benefit from increases in market interest rates.
Conversely, a liability sensitive position generally indicates that net interest
income would benefit from decreases in market interest rates. The static gap
position is limited because it does not take into account changes in interest
rates or changes in management's expectations or intentions. In addition, it is
not necessarily indicative of positions on other dates.
Table 10 shows TSFG's financial instruments that are sensitive to
changes in interest rates as well as TSFG's interest sensitivity gap at March
31, 2003. The carrying amounts of rate-sensitive assets and liabilities are
presented in the periods in which they next reprice to market rates or mature.
For assets, projected repayments, anticipated principal prepayments, and
potential calls are taken into account. To reflect anticipated prepayments,
certain asset categories are shown in Table 10 using estimated cash flows rather
than contractual cash flows. For core deposits without contractual maturities
(i.e., interest checking, savings, money market, and noninterest-bearing deposit
accounts), Table 10 presents principal cash flows based on management's judgment
concerning their most likely runoff. The actual maturities and runoff could vary
substantially if future prepayments, runoff, and calls differ from TSFG's
historical experience and management's judgment.
34
TABLE 10
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY GAP ANALYSIS
- ---------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
0-3 4-12 ONE TO AFTER
MONTHS MONTHS THREE YEARS THREE YEARS TOTAL
------ ------ ----------- ----------- -----
Interest-sensitive assets
Earning assets
Loans $2,684,724 $ 770,778 $ 926,788 $ 193,045 $4,575,335
Investment securities (1) 359,659 793,565 767,931 1,469,584 3,390,739
Interest-bearing balances with other banks 58,515 500 500 - 59,515
----------- ----------- ----------- ----------- -----------
Total earning assets $3,102,898 $1,564,843 $1,695,219 $1,662,629 $8,025,589
========== =========== =========== ========== =========
INTEREST-SENSITIVE LIABILITIES
Liabilities
Interest-sensitive liabilities
Interest-bearing deposits
Interest checking $ - $ 199,626 $ 232,988 $ 232,988 $ 665,602
Savings - 15,572 77,860 62,288 155,720
Money market 836,736 144,313 103,080 103,080 1,187,209
Certificates of deposit 444,881 935,417 502,046 87,691 1,970,035
----------- ----------- ----------- ----------- -----------
Total interest-bearing deposits 1,281,617 1,294,928 915,974 486,047 3,978,566
Other deposits (2) - 75,714 378,575 302,860 757,149
Borrowings 1,430,445 1,213,602 227,359 343,277 3,214,683
----------- ----------- ----------- ----------- -----------
Total interest-sensitive liabilities 2,712,062 2,584,244 1,521,908 1,132,184 7,950,398
Periodic interest-sensitive gap 390,836 (1,019,401) 173,311 530,445 75,191
Notional amount of interest rate swaps (324,500) 179,500 55,000 90,000 -
----------- ----------- ----------- ----------- -----------
Periodic interest-sensitive gap after interest
rate swaps $ 66,336 $ (839,901) $ 228,311 $ 620,445 $ 75,191
========== ========== ========== ========== ========
Cumulative interest-sensitive gap $ 66,336 $ (773,565) $(545,254) $ 75,191 $ -
========== ========== ========== ========== ========
(1) Investment securities exclude the unrealized gain on the sale of securities
of $32.2 million.
(2) Other deposits consist of noninterest-bearing deposits, which respond in
part to changes in interest rates.
As indicated in Table 10, as of March 31, 2003, on a cumulative basis
through twelve months, rate-sensitive liabilities exceeded rate-sensitive
assets, resulting in a liability-sensitive position of $773.6 million, or 8.6%
of total assets. This static gap liability sensitive position resulted primarily
from the increase in the Freedom Money Market, which reprices immediately
following changes in the prime rate, and from funding some of the securities
purchased during the first quarter 2003 with repurchase agreements that reprice
within one year.
The forecast used for earnings at risk analysis simulates TSFG's
consolidated balance sheet and consolidated statements of income under several
different rate scenarios over a twelve-month period. It reports a case in which
interest rates remain flat and reports variations that occur when rates
gradually increase and decrease 100 and 200 basis points over the next
twelve-month period. These rates assume a parallel shift in the treasury yield
curve, except for lower limits in the declining rate scenarios as discussed
below. Computation of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates and loan prepayments, and should not be relied upon as indicative of
35
actual results. Further, the computations do not contemplate any additional
actions TSFG could undertake in response to changes in interest rates. Table 11
shows the effect that the indicated changes in interest rates would have on net
interest income as projected for the next twelve months using the "most likely"
projected balance sheet.
TABLE 11
EARNINGS AT RISK ANALYSIS
ANNUALIZED HYPOTHETICAL PERCENTAGE CHANGE IN
INTEREST RATE SCENARIO NET INTEREST INCOME
---------------------- -------------------
2.00% 1.90%
1.00 1.11
Flat -
(1.00) (0.10)
(2.00) (2.61)
As indicated in Table 11, although TSFG has a static gap liability
sensitive position, the earnings at risk analysis indicates that TSFG will
benefit from an increase in interest rates. This situation is due to the
reduction of the prepayment speeds on the mortgage-backed securities in the
increasing rate scenarios resulting in a higher level of earning assets and
higher interest income.
Although net interest income declines in the declining rate scenarios,
lower limits are in place, which limit these rate declines and the impact on net
interest income. Due to the low level of current interest rates, many of the key
rates (such as Federal Funds and three month LIBOR), which the majority of the
balance sheet items are indexed to in the model, cannot be lowered the full 100
and 200 basis points. The floors placed on these key rates restrict the
reduction in both interest income and expense in the declining rate scenario. In
addition, many deposit rates are reaching what management believes to be an
acceptable lower limit thus limiting the interest expense reduction from
repricing deposits by the entire 100 and 200 basis points.
In addition to the standard scenarios used to analyze earnings at risk,
TSFG's ALCO analyzes the potential impact of other scenarios. The starting point
for these "what-if" scenarios is our base forecast. This base forecast
consolidates all balance sheet information that we are presently aware of with
our "most likely" interest rate projections. The "what-if" scenarios are then
used to gauge the impact of changes in interest rates and/or balance sheet items
on the earnings of TSFG compared to the base forecast. Strategies can be
formulated based on the information provided by the earnings simulation if a
scenario either seems likely to occur or we choose to undertake the proposed
transaction. TSFG updates its base forecast quarterly based on economic changes
that occurred during the past quarter as well as changes in the economic outlook
for the coming year.
Derivatives and Hedging Activities. TSFG uses derivative instruments as
part of its interest rate risk management activities to reduce risks associated
with its lending, investment, deposit taking, and borrowing activities.
Derivatives used for interest rate risk management include various interest rate
swaps, options with indices that relate to the pricing of specific on-balance
sheet instruments and forecasted transactions, and futures contracts.
TSFG has interest rate swap agreements that qualify as fair value
hedges and those that qualify as cash flow hedges. Fair value hedges are used to
hedge fixed rate deposits. TSFG uses cash flow hedges to hedge interest rate
risk associated with variable rate borrowings.
In connection with its interest rate management activities, TSFG uses
futures, options, and other derivatives as economic hedges of on-balance sheet
assets and liabilities or forecasted transactions, which do not qualify for
hedge accounting under SFAS 133. Accordingly, these derivatives are reported at
fair value on the consolidated balance sheet with realized gains and losses
included in earnings. Such activities may result in increased volatility in
realized gains and losses on trading activities.
By using derivative instruments, TSFG is exposed to credit and market
risk. Credit risk, which is the risk that a counterparty to a derivative
instrument will fail to perform, is equal to the extent of the fair value gain
in a derivative. Credit risk is created when the fair value of a derivative
contract is positive, since this generally indicates that the counterparty owes
us. When the fair value of a derivative is negative, no credit risk exists since
TSFG would owe the counterparty. TSFG minimizes the credit risk in derivative
instruments by entering into transactions with high-quality counterparties as
evaluated by management. Market risk is the adverse effect on the value of a
financial instrument from a change in interest rates or implied volatility of
rates. TSFG manages the market risk associated with interest rate contracts by
establishing and monitoring limits as to the types and degree of risk that may
be undertaken. The market risk associated with derivatives used for interest
rate risk management activity is fully incorporated into our market risk
sensitivity analysis.
36
In accordance with SFAS 133, TSFG records derivatives at fair value, as
either assets or liabilities, on the consolidated balance sheets. At March 31,
2003, the fair value of derivative assets totaled $4.3 million and was related
to fair value hedges and derivatives with no hedging designation. At March 31,
2003, the fair value of derivative liabilities totaled $167,000 and was related
to cash flow hedges.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, TSFG engages in a variety of
financial transactions that, in accordance with generally accepted accounting
principles, are not recorded in the financial statements, or are recorded in
amounts that differ from the notional amounts. These transactions involve, to
varying degrees, elements of credit, interest rate, and liquidity risk. Such
transactions are used by TSFG for general corporate purposes or for customer
needs. Corporate purpose transactions are used to help manage credit, interest
rate, and liquidity risk or to optimize capital. Customer transactions are used
to manage customers' requests for funding.
TSFG's off-balance sheet arrangements, which principally include
lending commitments, derivatives, and stock-related agreements, are described
below. At March 31, 2003 and 2002, TSFG had no interests in non-consolidated
special purpose entities.
Lending Commitments. Lending commitments include loan commitments,
standby letters of credit, unused business credit card lines, and documentary
letters of credit. These instruments are not recorded in the consolidated
balance sheet until funds are advanced under the commitments. TSFG provides
these lending commitments to customers in the normal course of business.
For commercial customers, loan commitments generally take the form of
revolving credit arrangements to finance customers' working capital
requirements. For retail customers, loan commitments are generally lines of
credit secured by residential property. At March 31, 2003, commercial and retail
loan commitments totaled $846.6 million. Documentary letters of credit are
typically issued in connection with customers' trade financing requirements and
totaled $11.7 million at March 31, 2003. Unused business credit card lines,
which totaled $15.2 million at March 31, 2003, are generally for short-term
borrowings.
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customer to perform under the terms
of an underlying contract with the third party or obligates TSFG to guarantee or
stand as surety for the benefit of the third party. The underlying contract may
entail either financial or nonfinancial obligations and may involve such things
as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or repayment of an obligation. Under the terms of a
standby letter, drafts will generally be drawn only when the underlying event
fails to occur as intended. TSFG can seek recovery of the amounts paid from the
borrower. In addition, some of these standby letters of credit are
collateralized. The collateral is generally cash, although existing lines of
credit are sometimes used. Commitments under standby letters of credit are
usually for one year or less. At March 31, 2003, TSFG recorded a liability of
$25,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor. The maximum potential
amount of undiscounted future payments related to standby letters of credit at
March 31, 2003 was $58.3 million.
TSFG applies essentially the same credit policies and standards as it
does in the lending process when making these commitments.
Derivatives. In accordance with SFAS 133, TSFG records derivatives at
fair value, as either assets or liabilities, on the consolidated balance sheet.
Derivative transactions are measured in terms of the notional amount, but this
amount is not recorded on the balance sheets and is not, when viewed in
isolation, a meaningful measure of the risk profile of the instrument. The
notional amount is not exchanged, but is used only as the basis upon which
interest and other payments are calculated.
At March 31, 2003, the fair value of derivative assets totaled $4.3
million and was related to derivatives with no hedging designation and fair
value hedges. At March 31, 2003, the fair value of derivative liabilities
totaled $167,000 and was related to cash flow hedges. The related notional
amounts, which are not recorded on the consolidated balance sheets, totaled
$437.5 million for the derivative assets and $14.7 million for the derivative
liabilities.
37
Credit Life & Disability Insurance. Carolina First Guaranty
Reinsurance, Ltd. ("CFGRL"), a wholly-owned subsidiary of TSFG, offers credit
life and disability insurance up to a single policy limit of $100,000 to
customers of the Subsidiary Banks. As of March 31, 2003, CFGRL had in force
insurance not recorded on the consolidated balance sheets of $31.3 million. A
loss reserve, determined based on reported and past loss experience of in force
policies, of $206,000 was included in other liabilities at March 31, 2003.
Stock-Related Agreements. In connection with stock repurchases, TSFG
has, from time to time, entered into "accelerated share repurchase" contracts.
Under these accelerated share repurchase contracts, an unaffiliated investment
bank (the "counterparty") "borrows" the requisite number of shares from
unaffiliated third parties, and delivers these shares to TSFG in exchange for
cash (such that these shares are immediately removed from TSFG's outstanding
shares). Over a period of time subsequent to the entry into the accelerated
share repurchase contract, the counterparty purchases TSFG shares in the open
market to cover their borrowed position. After the counterparty has covered this
position, TSFG settles with the counterparty for any gains or losses associated
with changes in TSFG's stock price during the period of time that stock was
being purchased. This settlement may be made in cash or in TSFG common stock.
These contracts are reflected as a reduction in shareholders' equity and
outstanding shares (used in the earnings per share calculation).
In March 2003, TSFG settled its existing accelerated contract by
receiving and canceling 6,308 shares. Also, in March 2003, TSFG entered into a
new accelerated share repurchase contract with an unaffiliated company to
repurchase one million shares of TSFG common stock and to settle the contract in
stock. TSFG expects the counterparty's purchases of shares under this contract
to continue through May 2003.
LIQUIDITY
Liquidity management ensures that adequate funds are available to meet
deposit withdrawals, fund loan and capital expenditure commitments, maintain
reserve requirements, pay operating expenses, provide funds for dividends and
debt service, and manage operations on an ongoing basis. Funds are primarily
provided by the Subsidiary Banks through customers' deposits, principal and
interest payments on loans, loan sales or securitizations, securities available
for sale, maturities of securities, temporary investments, and earnings.
Securities classified as available for sale, which are not pledged, may be sold
in response to changes in interest rates or liquidity needs. A substantial
majority of TSFG's securities are pledged.
Proper liquidity management is crucial to ensure that TSFG is able to
take advantage of new business opportunities as well as meet the demands of its
customers. In this process, TSFG focuses on assets and liabilities and on the
manner in which they combine to provide adequate liquidity to meet our needs.
Net cash provided by operations and deposits from customers have been
the primary sources of liquidity for TSFG. Liquidity is also enhanced by the
ability to acquire new deposits through the Subsidiary Banks' established branch
network. In addition, TSFG can raise deposits on the Internet through Bank
CaroLine. Liquidity needs are a factor in developing the Subsidiary Banks'
deposit pricing structure, which may be altered to retain or grow deposits if
deemed necessary.
The Subsidiary Banks have access to borrowing from the FHLB and
maintain short-term lines of credit from unrelated banks. FHLB advances,
outstanding as of March 31, 2003, totaled $1.0 billion. At March 31, 2003, the
Subsidiary Banks had approximately $473.6 million of unused borrowing capacity
from the FHLB. This capacity may be used when the Subsidiary Banks have
available collateral to pledge. Until the Subsidiary Banks make collateral
available (other than cash) to secure additional FHLB advances, TSFG will fund
its short-term needs principally with deposits, including brokered certificates
of deposit, federal funds purchased, repurchase agreements, and the sale of
securities available for sale. In addition, the Subsidiary Banks may purchase
securities or may repay repurchase agreements to provide additional
FHLB-qualifying collateral. At March 31, 2003, the Subsidiary Banks had unused
short-term lines of credit totaling approximately $313.3 million (which are
withdrawable at the lender's option).
The Federal Reserve Bank provides back-up funding for commercial banks.
Collateralized borrowing relationships with the Federal Reserve Banks of
Richmond and Atlanta are in place for the Subsidiary Banks to meet emergency
funding needs. At March 31, 2003, the Subsidiary Banks had qualifying collateral
to secure advances up to $494.9 million, of which none was outstanding.
At March 31, 2003, the parent company had an unused short-term line of
credit totaling $10.0 million (which is withdrawable at the lender's option and
matures June 30, 2003).
38
In the normal course of business, to meet the financial needs of its
customers, TSFG, principally through the Subsidiary Banks, enters into
agreements to extend credit. For amounts and types of such agreements at March
31, 2003, see "Off-Balance Sheet Arrangements." Increased demand for funds under
these agreements would reduce TSFG's liquidity and could require additional
sources of liquidity.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Accounting for Exit or Disposal Activities
Effective January 1, 2003, TSFG adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which 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 146
applies to costs associated with an exit activity that does not involve an
entity newly acquired in a business combination or with a disposal activity
covered by SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." Those costs include, but are not limited to, the following:
a) termination benefits provided to current employees that are involuntarily
terminated under the terms of a benefit arrangement that, in substance, is not
an ongoing benefit arrangement or an individual deferred compensation contract
(hereinafter referred to as one-time termination benefits), b) costs to
terminate a contract that is not a capital lease, and c) costs to consolidate
facilities or relocate employees. This Statement does not apply to costs
associated with the retirement of a long-lived asset covered by SFAS No. 143,
"Accounting for Asset Retirement Obligations." A liability for a cost associated
with an exit or disposal activity shall be recognized and measured initially at
its fair value in the period in which the liability is incurred. A liability for
a cost associated with an exit or disposal activity is incurred when the
definition of a liability is met in accordance with FASB Concepts Statements No.
6, "Elements of Financial Statements."
Accounting for Guarantees
Effective January 1, 2003, TSFG adopted the initial recognition and
initial measurement provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
TSFG adopted the disclosure requirements effective as of December 31, 2002. FIN
45 elaborates on the disclosure to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the
nature of the guarantee; (b) the maximum potential amount of future payments
under the grantee; (c) the carrying amount of the liability; and (d) the nature
and extent of any recourse provisions or available collateral that would enable
the guarantor to recover the amounts paid under the guarantee. FIN 45 also
clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the obligations it has undertaken in issuing the
guarantee at its inception. At March 31, 2003, TSFG recorded a liability of
$25,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Accounting for Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46, ("FIN
46"), "Consolidation of Variable Interest Entities", which addresses
consolidation by business enterprises of variable interest entities. Under FIN
46, an enterprise that holds significant variable interest in a variable
interest entity but is not the primary beneficiary is required to disclose the
nature, purpose, size, and activities of the variable interest entity, its
exposure to loss as a result of the variable interest holder's involvement with
the entity, and the nature of its involvement with the entity and date when the
involvement began. The primary beneficiary of a variable interest entity is
required to disclose the nature, purpose, size, and activities of the variable
interest entity, the carrying amount and classification of consolidated assets
that are collateral for the variable interest entity's obligations, and any lack
of recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general creditors (or beneficial interest
holders) of a consolidated variable interest entity to the general creditor of
the primary beneficiary. FIN 46 is effective for the first fiscal year or
interim period beginning after June 15, 2003. The impact to TSFG upon adoption
is currently not known.
39
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk and Asset/Liability Management" in Item 2, Management
Discussion and Analysis of Financial Condition and Results of Operations for
quantitative and qualitative disclosures about market risk, which information is
incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
TSFG's Chief Executive Officer and Principal Financial Officer have
evaluated TSFG's disclosure controls and procedures within 90 days of the
filing of this quarterly report ("Evaluation Date"), and they concluded
that these controls and procedures are effective.
(b) Changes in Internal Controls
There have been no significant changes in internal controls or in other
factors, including any corrective actions with regard to significant
deficiencies and material weaknesses that could significantly affect these
controls subsequent to the Evaluation Date.
40
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
See Note 8 to the Consolidated Financial Statements for a discussion of
legal proceedings.
ITEM 2 CHANGE IN SECURITIES AND USE OF PROCEEDS
The following information is provided in response to Item 2(c) of Form
10-Q and Item 701 of Regulation S-K:
(a) On April 30, 2003, we issued 146,807 shares of our common stock (the
"Shares").
(b) We issued the Shares to the shareholders of American Pensions, Inc. ("API")
in connection with our acquisition of API, which was effected through the merger
of API into Company subsidiary formed to facilitate the transaction.
(c) We issued the Shares to API's shareholders in a merger transaction, after
which we owned 100% of the surviving company (API's successor). Additional
shares may become issuable in the future, depending upon whether earnout targets
are met.
(d) We offered and sold the Shares in reliance on Section 4(2) of the Securities
Act of 1933. Neither we nor anyone on our behalf engaged in any public
solicitation or public advertisement in connection with the offer and sale of
the Shares. API had a total of three shareholders, each of which is a
sophisticated investor. We provided API's shareholders with access to
information sufficient to enable API's shareholders to make an informed
investment decision. API's shareholders acquired the Shares with an intent not
to resell or distribute the Shares except in accordance with an applicable
exemption from registration or an effective registration statement under the
Securities Act.
(e) The Shares are not convertible into or exchangeable or otherwise exercisable
for other equity securities.
(f) The requirement of Item 701(f) regarding the use of proceeds is not
applicable.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Asset Sale Agreement entered into as of September 3, 2002 by
and among TSFG, Carolina First Bank, and Rock Hill Bank &
Trust. Incorporated by reference to Exhibit 2.1 of TSFG's
Registration Statement on Form S-4, Commission File No.
333-100100.
10.1 The South Financial Group Second Amended and Restated Stock
Option Plan.
99.1 Additional Exhibit under Item 99 of Item 601(b) of Regulation
S-K. Certificates accompanying quarterly report pursuant to
Section 906 of the Sarbanes Oxley Act of 2002. A signed
original of this written statement required by Section 906 has
been provided to The South Financial Group, Inc. and will be
retained and furnished to the Securities and Exchange
Commission or its staff upon request.
41
(b) Reports on Form 8-K
TSFG filed Current Reports on Form 8-K dated January 3, 2003 and April
15, 2003.
42
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, TSFG has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
The South Financial Group, Inc.
/s/ William S. Hummers III
-----------------------------------------------
William S. Hummers III
Vice Chairman and Executive Vice President
(Principal Accounting and Principal Financial
Officer)
43
CERTIFICATION
I, Mack I. Whittle, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of The South
Financial Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 8, 2003
/s/ Mack I. Whittle, Jr.
------------------------
Mack I. Whittle, Jr.
President and Chief Executive Officer
44
CERTIFICATION
I, William S. Hummers III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The South
Financial Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: May 8, 2003
/s/ William S. Hummers III
--------------------------
William S. Hummers III
Vice Chairman, Executive Vice President,
and Principal Financial Officer
45