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 September 30, 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
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 November 12, 2003 was 58,999,595.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30,
------------------------------
Restated
2003 2002 December 31,
(Unaudited) (Unaudited) 2002
Assets
Cash and due from banks $ 186,069 $ 175,315 $ 201,333
Interest-bearing bank balances 7,958 41,849 58,703
Federal funds sold - 10,022 31,293
Securities
Trading 954 3,473 350
Available for sale 3,439,226 1,854,165 2,488,944
Held to maturity (market value $72,922, $84,790 and
$85,371, respectively) 70,485 82,086 82,892
---------- ---------- ----------
Total securities 3,510,665 1,939,724 2,572,186
---------- ---------- ----------
Loans
Loans held for sale 45,817 62,699 67,218
Loans held for investment 4,857,154 4,151,493 4,434,011
Allowance for loan losses (63,000) (50,011) (70,275)
---------- ---------- ----------
Net loans 4,839,971 4,164,181 4,430,954
---------- ---------- ----------
Premises and equipment, net 132,137 126,928 137,501
Accrued interest receivable 39,958 32,730 37,080
Intangible assets 245,791 176,802 242,182
Other assets 253,813 217,856 229,778
---------- ---------- ----------
$9,216,362 $6,885,407 $7,941,010
========== ========== ==========
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing $ 811,919 $ 678,899 $ 743,174
Interest-bearing 4,454,096 3,514,780 3,849,336
---------- ---------- ----------
Total deposits 5,266,015 4,193,679 4,592,510
Federal funds purchased and repurchase agreements 718,641 1,019,149 1,110,840
Other short-term borrowings 49,749 76,471 81,653
Long-term debt 2,235,460 797,322 1,221,511
Debt associated with trust preferred securities 95,500 73,500 95,500
Accrued interest payable 19,266 20,753 20,945
Other liabilities 88,317 62,349 84,840
---------- ---------- ----------
Total liabilities 8,472,948 6,243,223 7,207,799
---------- ---------- ----------
Minority interest in consolidated subsidiary 86,748 86,339 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 47,073,578, 43,588,415 and 47,347,375
shares, respectively 47,074 43,588 47,347
Surplus 414,973 355,545 427,448
Retained earnings 197,895 141,614 150,948
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (2,723) (3,308) (3,094)
Common stock held in trust for deferred compensation (150) - -
Deferred compensation payable in common stock 150 - -
Accumulated other comprehensive income (loss), net of tax (553) 18,406 24,150
---------- ---------- ----------
Total shareholders' equity 656,666 555,845 646,799
---------- ---------- ----------
$9,216,362 $6,885,407 $7,941,010
========== ========== ==========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share data) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Interest and fees on loans $ 66,936 $ 65,593 $ 202,594 $ 191,951
Interest and dividends on securities
Taxable 29,177 22,011 90,413 64,795
Exempt from Federal income taxes 1,200 1,084 3,526 3,239
-------- -------- --------- ---------
Total interest and dividends on securities 30,377 23,095 93,939 68,034
Interest on short-term investments 103 252 433 939
-------- -------- --------- ---------
Total interest income 97,416 88,940 296,966 260,924
-------- -------- --------- ---------
Interest expense
Interest on deposits 18,796 20,493 55,130 63,322
Interest on borrowed funds 14,671 13,215 46,244 38,381
-------- -------- --------- ---------
Total interest expense 33,467 33,708 101,374 101,703
-------- -------- --------- ---------
Net interest income 63,949 55,232 195,592 159,221
Provision for loan losses 5,591 5,567 16,291 18,049
-------- -------- --------- ---------
Net interest income after provision for loan losses 58,358 49,665 179,301 141,172
Noninterest income 27,730 16,806 71,591 41,866
Noninterest expenses 50,541 43,725 149,526 114,369
-------- -------- --------- ---------
Income before income taxes, minority interest, and
cumulative effect of change in accounting principle 35,547 22,746 101,366 68,669
Income taxes 10,664 6,937 31,727 21,822
-------- -------- --------- ---------
Income before minority interest and cumulative
effect of change in accounting principle 24,883 15,809 69,639 46,847
Minority interest in consolidated subsidiary, net of tax (990) (1,033) (3,002) (2,219)
-------- -------- --------- ---------
Income before cumulative effect of change in
accounting principle 23,893 14,776 66,637 44,628
Cumulative effect of change in accounting principle, net of tax - - - (1,406)
-------- -------- --------- ---------
Net income $ 23,893 $ 14,776 $ 66,637 $ 43,222
======== ======== ========= =========
Average common shares outstanding, basic 46,955,200 41,507,843 46,968,749 40,969,925
Average common shares outstanding, diluted 47,992,601 42,504,741 48,002,656 41,933,995
Per common share, basic:
Income before cumulative effect of change in accounting principle $ 0.51 $ 0.36 $ 1.42 $ 1.08
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
------ ------ ------ ------
Net income $ 0.51 $ 0.36 $ 1.42 $ 1.05
====== ====== ====== ======
Per common share, diluted:
Income before cumulative effect of change in accounting principle $ 0.50 $ 0.35 $ 1.39 $ 1.06
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
------ ------ ------ ------
Net income $ 0.50 $ 0.35 $ 1.39 $ 1.03
====== ====== ====== ======
Cash dividends declared per common share $ 0.14 $ 0.12 $ 0.42 $ 0.36
====== ====== ====== ======
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
(in thousands, except share and per 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) - - - 43,222 - 43,222
Other comprehensive gain,
net of tax of $11,348 - - - - 24,510 24,510
---------
Comprehensive income - - - - - 67,732
---------
Cash dividends declared
($0.36 per common share) - - - (14,893) - (14,893)
Common stock activity:
Acquisitions 4,174,599 4,175 85,825 (1,926) 88,074
Repurchase of stock (2,141,907) (2,142) (46,341) - - (48,483)
Dividend reinvestment plan 70,012 70 1,312 - - 1,382
Employee stock purchase plan 8,094 8 148 - - 156
Restricted stock plan 59,096 59 1,698 (87) - 1,670
Exercise of stock options 194,545 194 1,670 - - 1,864
Cancellation of stock (5,000) (5) (108) (113)
Miscellaneous - - 36 246 - 282
---------- ------- --------- --------- -------- ---------
Balance, September 30, 2002 (restated) 43,588,415 $43,588 $ 355,545 $ 138,306 $ 18,406 $ 555,845
========== ======= ========= ========= ======== =========
Balance, December 31, 2002 47,347,375 $47,347 $ 427,448 $ 147,854 $ 24,150 $ 646,799
Net income - - - 66,637 - 66,637
Other comprehensive loss,
net of tax of $12,355 - - - - (24,703) (24,703)
---------
Comprehensive income - - - - - 41,934
---------
Cash dividends declared
($0.42 per common share) - - - (19,689) - (19,689)
Common stock activity:
Repurchase of stock (1,274,808) (1,274) (27,283) - - (28,557)
Acquisitions 149,173 149 3,411 454 - 4,014
Dividend reinvestment plan 105,184 105 2,197 - - 2,302
Employee stock purchase plan 20,666 21 306 - - 327
Restricted stock plan 67,023 67 3,187 (167) - 3,087
Exercise of stock options 658,965 659 5,635 - - 6,294
Common stock purchased by trust
for deferred compensation - - - (150) - (150)
Deferred compensation payable in
common stock - - - 150 - 150
Miscellaneous - - 72 83 - 155
---------- ------- --------- --------- ------ ---------
Balance, September 30, 2003 47,073,578 $47,074 $ 414,973 $ 195,172 $ (553) $ 656,666
========== ======= ========= ========= ====== =========
* 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)
Nine Months Ended September 30,
--------------------------------------
Restated
2003 2002
---- ----
Cash flows from operating activities
Net income $ 66,637 $ 43,222
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, amortization, and accretion, net 41,290 22,955
Provision for loan losses 16,291 18,049
Gain on sale of available for sale securities (8,681) (1,005)
Gain on equity investments (3,330) (3,388)
(Gain) loss on trading and derivative activities (2,057) 494
Gain on disposition of assets and liabilities (601) -
Gain on sale of loans (6,410) (1,671)
Gain on disposition of premises and equipment (66) (55)
Loss on disposition of other real estate owned 432 762
Impairment loss from write-down of assets 449 -
Impairment loss from write-down of mortgage servicing rights 96 592
Loss on early extinguishment of debt 2,699 354
Minority interest in consolidated subsidiary 3,002 2,219
Cumulative effect of change in accounting principle - 1,406
Trading account assets, net (1,721) 206,000
Origination of loans held for sale (533,115) (325,259)
Sale of loans held for sale and principal repayments 553,474 296,655
Other assets, net (29,876) 5,099
Other liabilities, net 5,786 (1,180)
---------- --------
Net cash provided by operating activities 104,299 265,249
---------- --------
Cash flows from investing activities
Sale of securities available for sale 1,364,390 629,343
Maturity, redemption, call, or principal repayments of securities
available for sale 2,074,597 1,054,079
Maturity, redemption, call, or principal repayments of securities
held to maturity 35,024 6,787
Purchase of available for sale securities (4,433,634) (2,021,568)
Purchase of securities held to maturity (22,735) (8,156)
Origination of loans held for investment, net of principal repayments
and recoveries (451,122) (160,033)
Sale of loans held for investment - 11,961
Sale of other real estate owned 9,708 4,224
Sale of premises and equipment 2,579 1,443
Purchase of premises and equipment (10,561) (10,565)
Disposition of assets and liabilities, net (5,738) -
Cash equivalents acquired, net of payment for purchase acquisitions (595) 29,227
---------- --------
Net cash used for investing activities (1,438,087) (463,258)
---------- --------
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands) (Unaudited)
Nine Months Ended September 30,
-------------------------------------
Restated
2003 2002
Cash flows from financing activities
Deposits, net 687,024 163,246
Federal funds purchased and repurchase agreements, net (391,991) (297,134)
Short-term borrowings, net (32,770) (74,469)
Issuance of long-term debt 1,085,295 400,000
Payment of long-term debt (64,674) (35,126)
Prepayment penalty on early extinguishment of debt (2,699) -
Issuance of preferred stock associated with minority interest, net - 49,247
Issuance of debt associated with trust preferred securities, net - 41,176
Cash dividends paid on common stock (19,728) (14,622)
Cash dividends paid on minority interest (4,492) (2,878)
Repurchase of common stock (28,557) (48,483)
Other common stock activity 9,078 3,571
---------- ---------
Net cash provided by financing activities 1,236,486 184,528
---------- ---------
Net change in cash and cash equivalents (97,302) (13,481)
Cash and cash equivalents at beginning of year 291,329 240,667
---------- ---------
Cash and cash equivalents at end of period $ 194,027 $ 227,186
========== =========
Supplemental cash flow data
Interest paid $ 104,032 $ 100,080
Income taxes paid 28,250 25,278
Significant non-cash investing and financing transactions:
Available for sale securities transferred to trading and subsequently sold - 208,163
Unrealized gain (loss) on available for sale securities (38,483) 35,526
Loans transferred to other real estate owned 9,338 9,336
Premises and equipment, net transferred to long-lived assets held for sale 2,639 -
Business combinations:
Fair value of assets acquired (includes cash and cash equivalents) 9,448 613,440
Fair value of common stock issued and stock options recognized (4,014) (88,074)
Cash paid for common shares - (32,406)
---------- ---------
Liabilities assumed 5,434 492,960
---------- ---------
See accompanying notes to consolidated financial statements.
5
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 Annual Report on Form 10-K for the year ended
December 31, 2002 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 income taxes.
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 nine months of 2002, which restated the financial results for the
period, was to increase net income by $1.3 million, or $0.03 per diluted share.
By quarter, net income increased $316,000, $297,000, and $665,000 for the first,
second, and third quarters of 2002, respectively.
For a summary of the quarterly financial data for the first nine months
of 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"). SFAS 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. 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. The initial adoption of this standard did not have an impact on the
financial condition or results of operations of TSFG.
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
6
nature of the guarantee; (b) the maximum potential amount of future payments
under the guarantee; (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 fair value of the obligations it has undertaken
in issuing the guarantee at its inception. No contingent liability was
determined to be necessary relating to TSFG's obligation to perform as a
guarantor.
Accounting for Derivative Instruments and Hedging Activities
Effective July 1, 2003, TSFG adopted SFAS No. 149, ("SFAS 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities,"
which amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristics of a derivative, clarifies when
a derivative contains a financing component, amends the definition of an
underlying to conform it to language used in FIN 45, and amends certain other
existing pronouncements. Those changes will result in more consistent reporting
of contracts as either derivatives or hybrid instruments. The adoption of this
standard did not have a material impact on the financial condition or results of
operations of TSFG.
Accounting for Variable Interest Entities
Effective July 1, 2003, TSFG adopted 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 credit of the primary beneficiary. TSFG
had no impact upon adoption since it had no interests in entities, which it
considers to be included within the scope of FIN 46.
On October 31, 2003, the FASB proposed a modification and
interpretation of FIN 46. Evaluation of the impact of FIN 46 and SFAS No. 150,
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity," on the treatment of debt associated with trust
preferred securities is in process. TSFG currently consolidates the trusts,
which issued TSFG's trust preferred securities, in its consolidated financial
statements and reports the related debt instruments, referred to as debt
associated with trust preferred securities, as a liability on its consolidated
balance sheet. Under one potential interpretation of FIN 46, TSFG's trusts,
which have issued TSFG's trust preferred securities, would no longer be included
in TSFG's consolidated financial statements. Conversely, SFAS 150 requires the
consolidation of these subsidiaries and the presentation of the related debt
instruments as a liability.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
Effective July 1, 2003, TSFG adopted SFAS 150, which establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. SFAS 150
requires an issuer to classify certain financial instruments that include
certain obligations, such as mandatory redemption, repurchase of the issuer's
equity, or settlement by issuing equity, as liabilities or assets in some
circumstances. Forward contracts to repurchase an issuer's equity shares that
require physical settlement in exchange for cash are initially measured at the
fair value of the shares at inception, adjusted for any consideration or
unstated rights or privileges, which is the same as the amount that would be
paid under the conditions specified in the contract if settlement occurred
immediately. Those contracts and mandatorily redeemable financial instruments
are subsequently measured at the present value of the amount to be paid at
settlement, if both the amount of cash and the settlement date are fixed, or,
otherwise, at the amount that would be paid under the conditions specified in
the contract if settlement occurred at the reporting date. Other financial
instruments are initially and subsequently measured at fair value, unless
required by SFAS 150 or other generally accepted accounting principles to be
measured differently. TSFG had no impact upon adoption since it had no financial
instruments, which it considers to be included within the scope of SFAS 150.
7
WEBSITE AVAILABILITY OF REPORTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION
Through its website, www.thesouthgroup.com, TSFG makes available, free
of charge, various reports that it files with, or furnishes to, the Securities
and Exchange Commission, including its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports. These reports are made available as soon as reasonably practicable
after these reports are filed with, or furnished to the Securities and Exchange
Commission.
(2) SUPPLEMENTAL FINANCIAL INFORMATION TO CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for noninterest income and
noninterest expense (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ---------------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Noninterest income
Service charges on deposit accounts $ 7,613 $ 6,108 $ 22,154 $ 16,436
Mortgage banking income 3,804 727 8,537 3,097
Fees for investment services 1,946 1,359 6,579 4,639
Bank-owned life insurance 2,063 1,877 5,944 5,486
Merchant processing income 2,161 1,778 5,568 4,741
Insurance income 1,118 254 2,675 636
Gain on sale of available for sale securities 4,498 790 8,681 1,005
Gain on equity investments 1,455 3,527 3,330 3,388
Gain (loss) on trading and derivative activities 950 (520) 2,057 (494)
Gain on disposition of assets and liabilities - - 601 -
Other 2,122 906 5,465 2,932
-------- -------- -------- --------
Total noninterest income $ 27,730 $ 16,806 $ 71,591 $ 41,866
======== ======== ======== ========
Noninterest expenses
Salaries and wages $ 17,972 $ 16,256 $ 57,569 $ 43,481
Employee benefits 5,709 3,538 16,444 11,841
Occupancy 4,699 3,919 13,981 11,150
Furniture and equipment 4,466 3,993 13,271 11,072
Professional fees 1,348 1,343 4,708 3,859
Merchant processing expense 1,686 1,381 4,342 3,798
Telecommunications 1,239 967 3,477 2,536
Amortization of intangibles 730 352 2,159 831
Merger-related costs 345 4,465 2,224 4,465
Impairment loss from the write-down of assets - - 268 -
Loss on early extinguishment of debt 2,699 354 2,699 354
Other 9,648 7,157 28,384 20,982
-------- -------- -------- --------
Total noninterest expenses $ 50,541 $ 43,725 $149,526 $114,369
======== ======== ======== ========
8
(3) OTHER COMPREHENSIVE INCOME
The following summarizes accumulated other comprehensive income, net of
tax (in thousands) for the nine months ended September 30:
2003 2002
---- ----
Unrealized gains (losses) on available for sale securities
Balance at beginning of year $ 24,382 $ (5,554)
Other comprehensive gain (loss):
Unrealized holding gains (losses) arising during the year (26,472) 39,919
Income tax benefit (expense) 8,505 (12,763)
Less: Reclassification adjustment for gains included in net income (12,011) (4,393)
Income tax expense 4,377 1,538
-------- --------
(25,601) 24,301
-------- --------
Balance at end of period (1,219) 18,747
-------- --------
Unrealized gains (losses) on cash flow hedges
Balance at beginning of year (232) (550)
Other comprehensive income:
Unrealized gain on change in fair values 1,425 332
Income tax expense (527) (123)
-------- --------
898 209
-------- --------
Balance at end of period 666 (341)
-------- --------
$ (553) $ 18,406
======== ========
During the first nine months of 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 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
ALLIED ASSURANCE
On September 22, 2003, TSFG acquired Allied Assurance ("Allied"), an
independent insurance agency based in Columbia, South Carolina. TSFG issued
2,365 shares of common stock valued at $60,000 and recorded goodwill of
approximately $60,000. TSFG agreed to issue annual earnout shares, valued at
approximately $45,000, for each of August 31, 2004, 2005, 2006, and 2007, based
on revenue retention. TSFG intends to use Allied to further its insurance
operations in the Midlands of South Carolina.
AMERICAN PENSIONS, INC.
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. This
acquisition was accounted for using the purchase method of accounting, and
accordingly, the assets and liabilities of API were recorded at their estimated
fair values as of the acquisition date. TSFG issued 146,808 shares of common
stock valued at $3.5 million, acquired tangible assets totaling $348,000,
assumed liabilities totaling $369,000, recorded a deferred tax liability
totaling $386,000, recorded a non-compete agreement intangible asset of
$350,000, recorded goodwill of $2.9 million, and recorded a customer list
intangible asset of $700,000. The non-compete agreement intangible is amortized
on a straight-line basis over its estimated useful life of 7 years. The customer
list intangible is amortized on a straight-line basis over its estimated useful
life of 10 years. 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, which would increase
goodwill.
9
GARDNER ASSOCIATES, INC.
During the nine months ended September 30, 2003, TSFG recorded an
increase in goodwill for the fair value of 21,806 shares earned by the
principals of Gardner Associates, Inc. ("Gardner Associates"), which totaled
$454,000, in accordance with earnout provisions.
AMORTIZATION OF PREMIUMS AND DISCOUNTS
Premiums and discounts that resulted from recording the assets and
liabilities acquired through acquisition (Central Bank of Tampa ("CBT"), Rock
Hill Bank & Trust ("Rock Hill Bank"), and Gulf West Banks, Inc. ("Gulf West"))
at their respective fair values are being amortized and accreted using methods
that approximate a constant effective yield over the life of the assets and
liabilities. This net amortization decreased net income before income taxes by
$799,000 and $1.7 million for the three and nine months ended September 30,
2003, respectively.
(5) DISPOSITION OF ASSETS AND LIABILITIES
In June 2003, Carolina First Bank completed the sale of its branch
office in Powdersville, South Carolina. In connection with the sale of this
branch, TSFG recorded a gain of $601,000 and transferred deposits of $6.4
million.
(6) INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, are summarized as
follows (in thousands):
September 30,
--------------------------- December 31,
2003 2002 2002
---- ---- ----
Goodwill $ 229,034 $ 162,148 $ 224,312
Core deposit premiums 26,869 22,970 26,873
Less accumulated amortization (12,364) (9,832) (10,409)
--------- --------- ---------
14,505 13,138 16,464
--------- --------- ---------
Customer list intangible 1,558 858 858
Less accumulated amortization (117) (1) (24)
--------- --------- ---------
1,441 857 834
--------- --------- ---------
Non-compete agreement intangible 1,013 663 663
Less accumulated amortization (202) (4) (91)
--------- --------- ---------
811 659 572
--------- --------- ---------
$ 245,791 $ 176,802 $ 242,182
========= ========= =========
At September 30, 2003, TSFG had two reportable segments with goodwill,
Carolina First Bank and Mercantile Bank. The following summarizes the changes in
the carrying amount of goodwill related to each of TSFG's reporting units (in
thousands) for the nine months ended September 30, 2003:
Carolina Mercantile
First Bank Bank Other Total
---------- ---- ----- -----
Balance, December 31, 2002 $ 116,279 $ 108,033 $ - $ 224,312
Purchase accounting adjustments 2,453 (603) 2,872 4,722
--------- --------- ------- ---------
Balance, September 30, 2003 $ 118,732 $ 107,430 $ 2,872 $ 229,034
========= ========= ======= =========
The goodwill for each reporting unit was tested for impairment as of
June 30, 2003 in accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets." TSFG will update this testing annually as of June 30th each year. The
fair value of each reporting unit was estimated using a cash flow approach based
upon the expected present value of future cash flows and a market approach based
upon recent purchase transactions and public company market values. These
valuations indicated that no impairment charge was required as of the June 30,
2003 test date.
Amortization of intangibles totaled $2.0 million for core deposit
premiums, $93,000 for customer list intangibles, and $111,000 for non-compete
10
agreement intangibles for the nine months ended September 30, 2003. Amortization
of intangibles totaled $826,000 for core deposit premiums, $4,000 for
non-compete agreement intangibles, and $1,000 for customer list intangibles for
the nine months ended September 30, 2002.
The estimates provided below exclude amortization expense for
intangible assets related to TSFG's acquisition of MBFC, which closed October 3,
2003. 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, $1.6 million for 2007, and an
aggregate of $6.5 million for all the years thereafter. The estimated
amortization expense for customer list intangibles is $133,000 for 2003,
$156,000 for the years ended December 31, 2004 to 2007 and an aggregate of
$777,000 for all the years thereafter. The estimated amortization expense for
non-compete agreement intangibles is $153,000 for 2003, $170,000 for the years
ended December 31, 2004 to 2006, $142,000 for 2007 and an aggregate of $117,000
for all the years thereafter.
(7) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs"), net of the valuation
allowance, totaled $2.0 million, $4.4 million, and $5.6 million at September 30,
2003, December 31, 2002, and September 30, 2002, respectively. Amortization
expense for MSRs totaled $2.3 million and $2.7 million for the nine months ended
September 30, 2003 and 2002, respectively. At September 30, 2003 and 2002, the
valuation allowance for capitalized MSRs totaled $1.9 million and $1.7 million,
respectively. In the first nine months of 2003 and 2002, TSFG recorded a $96,000
and $592,000 impairment loss from the valuation of MSRs, respectively.
The estimated amortization expense for MSRs for the years ended
December 31 is as follows: $3.0 million for 2003, $1.3 million 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.
(8) GUARANTEES
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customers to perform under the terms
of an underlying contract with the third party or obligate 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. Commitments under standby letters of credit are usually for one
year or less. At September 30, 2003, TSFG recorded a liability of $100,000 for
deferred fees received on standby letters of credit, which was the estimated
fair value 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 September 30, 2003 was $86.7 million. In
addition, TSFG guarantees a portion of the debt of a company in which it has an
equity investment. The fair value of this guarantee is not deemed significant at
September 30, 2003. TSFG occasionally provides a guarantee for the issuance of
consumer credit cards for certain of its customers. The total of such guarantees
at September 30, 2003 was approximately $200,000, and the fair value is not
deemed significant.
(9) 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.
TSFG acquired the former Beacon Manufacturing Company facility in
Swannanoa, North Carolina on October 3, 2003 as part of its acquisition of
MountainBank Financial Corporation ("MBFC"). MBFC had acquired this facility
through a foreclosure proceeding. In September 2003, a fire and apparent
vandalism resulted in a release of fuel oil and other materials. Clean-up of the
oil spill, including releases to the adjacent Swannanoa River, has been
substantially completed. TSFG intends to investigate, and if necessary
remediate, any related environmental impacts and soil and groundwater
contamination attributable to historical practices at the facility, as well as
to stabilize the site and remove waste materials. Based on available
information, MBFC established a net reserve of $2.4 million. This reserve
consisted of a $4.4 million environmental remediation contingent liability,
offset by $1.0 million for the estimated net realizable value of the other real
estate owned and $1.0 million estimated for potential insurance recovery for
11
building damage, debris removal, and environmental remediation on this property.
TSFG continues to evaluate the reserve level and may make purchase accounting
adjustments, which would be treated as goodwill adjustments in the MBFC
transaction. There can be no guarantee that any liability or costs arising out
of this matter will not exceed any established reserves.
(10) 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 cash
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 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.
(11) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common
shares outstanding:
Three Months Ended September 30,
--------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 46,955,200 41,507,843
========== ==========
Diluted:
Average common shares outstanding 46,955,200 41,507,843
Dilutive potential common shares 1,037,401 996,898
---------- ----------
Average diluted shares outstanding (denominator) 47,992,601 42,504,741
========== ==========
Nine Months Ended September 30,
--------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 46,968,749 40,969,925
========== ==========
Diluted:
Average common shares outstanding 46,968,749 40,969,925
Dilutive potential common shares 1,033,907 964,070
---------- ----------
Average diluted shares outstanding (denominator) 48,002,656 41,933,995
========== ==========
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
September 30, 2003 297,362 $24.79 to $31.26
September 30, 2002 977,672 $21.03 to $31.26
For the nine months ended
September 30, 2003 532,915 $23.05 to $31.26
September 30, 2002 977,672 $21.03 to $31.26
12
(12) STOCK-BASED COMPENSATION
At September 30, 2003, TSFG had two stock-based employee compensation
option plans, which are described more fully in Note 30 to the Consolidated
Financial Statements in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2002. 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 (dollars in thousands, except share data).
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Net income
Net income, as reported $ 23,893 $ 14,776 $ 66,637 $ 43,222
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for
all option awards, net of related income tax effect 799 880 1,401 1,643
-------- -------- -------- --------
Pro forma net income $ 23,094 $ 13,896 $ 65,236 $ 41,579
======== ======== ======== ========
Basic earnings per share
As reported $ 0.51 $ 0.36 $ 1.42 $ 1.05
Pro forma 0.49 0.33 1.39 1.01
Diluted earnings per share
As reported $ 0.50 $ 0.35 $ 1.39 $ 1.03
Pro forma 0.48 0.33 1.36 0.99
(13) MERGER-RELATED AND DIRECT ACQUISITION COSTS
In connection with the acquisitions in 2002 and the API acquisition in
2003, for the nine months ended September 30, 2003, TSFG recorded pre-tax
merger-related costs of $2.2 million, included in noninterest expenses, and
direct acquisition costs of $313,000, included in goodwill. The merger-related
and acquisition costs were recorded as incurred. The following summarizes these
charges (in thousands) at and for the nine months ended September 30, 2003:
Total Amounts Remaining
Costs Paid Accrual
----- ---- -------
Merger-related costs
Compensation-related expenses $ 598 $ 563 $ 35
System conversion costs 600 600 -
Impairment loss from write-down of assets 181 181 -
Travel 54 54 -
Advertising 30 30 -
Other 761 761 -
------- ------- ----
$ 2,224 $ 2,189 $ 35
======= ======= ====
Direct acquisition costs
Investment banking and professional fees $ 204 $ 184 $ 20
Severance 109 109 -
------- ------- ----
$ 313 $ 293 $ 20
======= ======= ====
13
At September 30, 2003, the accrual of merger-related costs, which included
$35,000 for charges incurred during the nine months ended September 30, 2003,
totaled $755,000. This accrual is for compensation-related and other expenses
incurred in connection with the CBT, Rock Hill Bank, and Gulf West acquisitions.
At September 30, 2003, the accrual of direct acquisition costs, which included
$20,000 for charges incurred during the nine months ended September 30, 2003,
totaled $545,000. This accrual is for professional fees and severance in
connection with the CBT, Rock Hill Bank, and Gulf West acquisitions.
(14) 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, 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, mortgage banking
income, fees for investment services, 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.
Carolina Mercantile Eliminating
First Bank Bank Other Entries Total
---------- ---- ----- ------- -----
Three Months Ended September 30, 2003
Net interest income $ 49,514 $ 15,918 $ (1,483) $ - $ 63,949
Provision for loan losses 3,723 1,884 (16) - 5,591
Noninterest income 22,126 3,870 17,760 (16,026) 27,730
Noninterest expenses 37,766 12,829 15,972 (16,026) 50,541
Amortization of intangibles (a) 310 390 30 - 730
Merger-related costs (a) 185 136 24 - 345
Income tax expense 9,038 1,522 104 - 10,664
Minority interest in consolidated
subsidiary, net of tax (990) - - - (990)
Net income 20,123 3,553 217 - 23,893
Nine Months Ended September 30, 2003
Net interest income $ 152,493 $ 47,636 $ (4,537) $ - $ 195,592
Provision for loan losses 11,113 5,192 (14) - 16,291
Noninterest income 55,121 12,501 48,657 (44,688) 71,591
Noninterest expenses 105,209 38,732 50,273 (44,688) 149,526
Amortization of intangibles (a) 940 1,169 50 - 2,159
Merger-related costs (a) 616 1,564 44 - 2,224
Income tax expense 28,835 5,088 (2,196) - 31,727
Minority interest in consolidated
subsidiary, net of tax (3,002) - - - (3,002)
Net income 59,455 11,125 (3,943) - 66,637
(a) Included in noninterest expenses.
14
Carolina Mercantile Eliminating
First Bank Bank Other Entries Total
---------- ---- ----- ------- -----
September 30, 2003
Total assets $ 7,193,820 $2,179,590 $ 966,685 $ (1,123,733) $ 9,216,362
Loans 3,600,913 1,336,809 99,521 (134,272) 4,902,971
Deposits 3,835,269 1,453,226 - (22,480) 5,266,015
Three Months Ended September 30, 2002
Net interest income $ 47,233 $ 9,612 $ (1,613) $ - $ 55,232
Provision for loan losses 3,865 1,718 (16) - 5,567
Noninterest income 10,051 1,457 17,376 (12,078) 16,806
Noninterest expenses 28,741 11,241 15,821 (12,078) 43,725
Amortization of intangibles (a) 246 106 - - 352
Merger-related costs (a) - 4,465 - - 4,465
Income tax expense 8,000 (602) (461) - 6,937
Minority interest in consolidated
subsidiary, net of tax (1,033) - - - (1,033)
Cumulative effect of change in accounting
principle, net of tax - - - - -
Net income 15,645 (1,288) 419 - 14,776
Nine Months Ended September 30, 2002
Net interest income $ 140,418 $ 23,192 $ (4,389) $ - $ 159,221
Provision for loan losses 12,305 5,765 (21) - 18,049
Noninterest income 29,943 3,521 47,451 (39,049) 41,866
Noninterest expenses 86,071 20,764 46,583 (39,049) 114,369
Amortization of intangibles (a) 725 106 - - 831
Merger-related costs (a) - 4,465 - - 4,465
Income tax expense 23,122 57 (1,357) - 21,822
Minority interest in consolidated
subsidiary, net of tax (2,219) - - - (2,219)
Cumulative effect of change in accounting
principle, net of tax - - (1,406) - (1,406)
Net income 46,644 127 (3,549) - 43,222
September 30, 2002
Total assets $ 5,492,298 $1,461,402 $ 812,770 $ (881,063) $ 6,885,407
Loans 3,187,990 1,060,109 78,388 (112,295) 4,214,192
Deposits 3,139,876 1,074,644 - (20,841) 4,193,679
(a) Included in noninterest expenses.
(15) SUBSEQUENT EVENTS
MountainBank Financial Corporation
On October 3, 2003, TSFG acquired MBFC, a bank holding company
headquartered in Hendersonville, North Carolina. At September 30, 2003, MBFC
operated primarily through 19 branches in western North Carolina and had total
assets of $952.0 million. The aggregate purchase price was $140.7 million, which
consisted of 5,485,298 shares of TSFG common stock valued at $135.6 million,
$24,000 of cash paid in lieu of fractional shares and outstanding employee stock
options valued at $5.0 million. This acquisition adds markets to TSFG's
geographic footprint, advancing TSFG's strategy to expand in markets with
favorable population and per capita income growth prospects.
15
TSFG accounted for MBFC using the purchase method of accounting, and
accordingly, TSFG's consolidated financial statements will include the results
of operations of MBFC beginning on the October 3, 2003 acquisition date.
OFFERING OF COMMON STOCK
On October 22, 2003, TSFG filed a preliminary prospectus supplement
with the Securities and Exchange Commission relating to its proposed offering of
6,325,000 shares (including the underwriters' over-allotment option with respect
to 825,000 shares). On November 12, 2003, TSFG completed the offering, selling
6,325,000 shares at a gross offering price of $27.00 per share. The offering
generated proceeds to TSFG of approximately $161 million, net issuance costs for
underwriting and expenses.
(16) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, and the
consolidated balance sheet at December 31, 2002 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.
16
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 nine months ended September 30,
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 currently conducts business through 76 locations in South
Carolina, 24 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 may be identified by the use of
such words as: "estimate", "anticipate", "expect", "believe", "intend", "plan",
or words of similar meaning, or future or conditional verbs such as "may",
"intend", "could", "will", or "should". 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 (including loans acquired via
acquisition), and the performance of 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 changes in regulatory actions, including the potential for adverse
adjustments;
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.
17
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 to analyze TSFG's performance. In
particular, a number of credit quality measures presented adjust GAAP
information to exclude the effects of certain identified problem 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. In addition,
certain designated net interest income amounts are presented on a tax-equivalent
basis. Management believes that the presentation of net interest income on a
tax-equivalent basis aids in the comparability of net interest income arising
from both taxable and tax-exempt sources. These disclosures should not be viewed
as a substitute for GAAP measures, 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
two years ending September 30, 2003. 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
---- ------ ------ ------- ------ --------
Bank acquisitions
Central Bank of Tampa
Tampa, Florida 12/31/02 $ 223,223 (1) 3,241,737 $ - $ 2,700 $ 36,168
Rock Hill Bank and Trust
Rock Hill, South Carolina 10/31/02 204,815 (1) 430,017 - (2) 1,204 26,543
Gulf West Banks, Inc.
St. Petersburg, Florida 08/31/02 530,296 (1) 3,925,588 32,400 8,424 71,263
Insurance agency/other acquisitions
Allied Assurance
Columbia, South Carolina 09/22/03 95 (1) 2,365 (3) - - 60
American Pensions, Inc.
Mount Pleasant, South Carolina 04/30/03 (1) 146,808 (4) - 1,050 2,872
Gardner Associates, Inc.
Columbia, South Carolina 09/20/02 1,312 (1) 249,011 (5) - 1,521 1,934
(1) Book value at the acquisition date.
(2) TSFG acquired substantially all of the assets and deposits. TSFG agreed to
pay a cash earnout based on recoveries with respect to certain loans.
18
(3) TSFG agreed to issue annual earnout shares, valued at approximately
$45,000, for each of August 31, 2004, 2005, 2006, and 2007, based on
revenue retention.
(4) Former 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.
(5) 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 September 22, 2003, TSFG acquired Allied Assurance ("Allied"), an
independent insurance agency based in Columbia, South Carolina. TSFG intends to
use Allied to further its insurance operations in the Midlands of South
Carolina.
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.
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
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 owns 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. In September 2003,
TSFG established a reserve of $1.5 million for a contingent liability related to
certain Rock Hill Bank trust accounts. The recording of this liability increased
the goodwill recorded.
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 September 30, 2003, TSFG issued 156,426
shares of TSFG common stock to acquire Gardner Associates and 21,806 shares
under an earnout provision. During the nine months ended September 30, 2003,
TSFG recorded an increase in goodwill for the fair value of the 21,806 shares,
which totaled $454,000. 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 October 3, 2003, TSFG acquired MountainBank Financial Corporation
("MBFC"), a bank holding company headquartered in Hendersonville, North
Carolina. At September 30, 2003, MBFC operated primarily through 19 branches in
western North Carolina and had total assets of $952.0 million, loans of $775.0
million, securities of $80.8 million, and deposits of $779.3 million. TSFG's
composition of loans, securities, and deposits remained similar, after adding
MBFC balances. In connection with the acquisition, MBFC was merged into Carolina
First Bank. MBFC also operated Community National Bank, a national bank
headquartered in Pulaski, Virginia with approximately $69 million in assets at
September 30, 2003. Community National Bank remains a stand-alone subsidiary of
TSFG. TSFG expects to sell Community National Bank in the first quarter 2004.
19
This acquisition adds two of North Carolina's attractive growth
markets, Asheville and Hendersonville, to TSFG's geographic footprint advancing
TSFG's strategy to expand in markets with favorable population and per capita
income growth prospects. The aggregate purchase price was $140.7 million, which
consisted of 5,485,298 shares of TSFG common stock valued at $135.6 million,
$24,000 of cash paid in lieu of fractional shares and outstanding employee stock
options valued at $5.0 million. TSFG expects to record approximately $100
million of intangible assets, including goodwill. TSFG anticipates pre-tax
merger-related costs between approximately $4 million and $4.5 million, included
in noninterest expenses, largely in the fourth quarter 2003.
OVERVIEW
Net income for the nine months ended September 30, 2003 totaled $66.6
million, an increase of 54.2% compared with $43.2 million for the nine months
ended September 30, 2002. Earnings per diluted share for the first nine months
of 2003 totaled $1.39, a 35.0% increase from $1.03 per diluted share in the
first nine 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 39.9% 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 nine months ended September 30, 2003 and
2002 included pre-tax gains on asset sales of $12.6 million and $4.4 million,
respectively. Gains on asset sales include gains on available for sale
securities and equity investments and a gain on the sale of a branch office.
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 nine months of 2003 included the
following pre-tax other items: a $2.7 million loss on early extinguishment of
debt, $2.2 million in merger-related costs, and $268,000 in impairment loss from
write-down of assets. For the first nine months of 2002 noninterest expenses
included the following pre-tax other items: $4.5 million in merger-related
costs, $1.6 million of personnel expense related to the settlement of certain
employment agreements, and a $354,000 loss on early extinguishment of debt. In
the third quarter 2002, TSFG recorded a $1.4 million charge, net of tax, related
to impairment of goodwill associated with Carolina First Mortgage Company, which
is shown as a cumulative effect of change in accounting principle.
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 nine months of 2002, which restated
the financial results for the first nine months of the year, was to increase net
income by $1.3 million, or $0.03 per diluted share.
Average common shares outstanding on a diluted basis were 48.0 million
in the first nine months of 2003, up 14.5% from 41.9 million for the first nine
months of 2002, due to shares issued for acquisitions completed in the fourth
quarter of 2002. In connection with share repurchase programs, TSFG repurchased
and cancelled 1,274,808 shares during the first nine months of 2003.
At September 30, 2003, TSFG had $9.2 billion in assets, $4.9 billion in
loans, $5.3 billion in deposits, and $656.7 million in shareholders' equity. For
the nine months ended September 30, 2003, TSFG's average assets totaled $8.8
billion, an increase of $2.5 billion, or 40.7%, compared with the first nine
months 2002 average of $6.2 billion.
BALANCE SHEET REVIEW
Loans
TSFG focuses its lending activities on small and middle market
businesses and individuals in its geographic markets. At September 30, 2003,
outstanding loans totaled $4.9 billion, which equaled 93.1% of total deposits
and 53.2% 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. Less than 5% of the portfolio is
unsecured. The portfolio contains no "highly leveraged transactions," as defined
by regulatory authorities.
Loans held for investment increased $705.7 million, or 17.0%, to $4.9
billion at September 30, 2003 from $4.2 billion at September 30, 2002. In the
fourth quarter of 2002, $295.7 million in loans held for investment were
acquired in mergers with Rock Hill Bank and CBT, accounting for approximately
20
42% of the increase. During the first nine months of 2003, loans held for
investment increased $423.1 million, or 9.5%. The majority of the growth,
annualized at 12.8%, was in commercial, indirect consumer and home equity loans.
While originations of residential mortgage loans increased, most of these loans
were sold at origination in the secondary market.
Loans held for sale decreased $16.9 million to $45.8 million at
September 30, 2003 from $62.7 million at September 30, 2002. Loans held for sale
at September 30, 2003 included no loans acquired from Gulf West. During the
first nine months of 2003, loans held for sale acquired from Gulf West decreased
$17.7 million, primarily from the sale of two commercial real estate loans and
the transfer to loans held for investment.
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.
Table 2
- ------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- ------------------------------------------------------------------------------------------------------------
(dollars in thousands)
September 30,
--------------------------------
Restated December 31,
2003 2002 2002
---- ---- ----
Commercial, financial and agricultural $985,892 $820,294 $913,368
Real estate - construction (1) 550,306 545,896 570,265
Real estate - residential mortgages (1-4 family) 717,915 603,728 643,941
Commercial secured by real estate (1) 1,995,295 1,633,520 1,765,103
Consumer 607,746 547,847 541,210
Lease financing receivables - 208 124
---------- ---------- ----------
Loans held for investment 4,857,154 4,151,493 4,434,011
Loans held for sale 45,817 62,699 67,218
Allowance for loan losses (63,000) (50,011) (70,275)
---------- ---------- ----------
Total net loans $4,839,971 $4,164,181 $4,430,954
========== ========== ==========
Percentage of loans held for investment
Commercial, financial and agricultural 20.3 % 19.8 % 20.6 %
Real estate - construction (1) 11.3 13.1 12.9
Real estate - residential mortgages (1-4 family) 14.8 14.5 14.5
Commercial secured by real estate (1) 41.1 39.4 39.8
Consumer 12.5 13.2 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 2 provides a stratification of the portfolio by collateral type
and borrower type. Table 3 provides a stratification of the loan portfolio by
loan purpose.
21
Table 3
- -----------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION BASED ON LOAN PURPOSE
- -----------------------------------------------------------------------------------------------------
(dollars in thousands)
September 30,
--------------------------------
Restated December 31,
2003 2002 2002
---- ---- ----
Commercial loans
Commercial and industrial $1,347,854 $1,046,947 $1,178,955
Owner - occupied real estate 617,386 696,794 733,819
Commercial real estate 1,673,598 1,327,577 1,420,252
---------- ---------- ----------
3,638,838 3,071,318 3,333,026
---------- ---------- ----------
Consumer loans
Indirect - sales finance 543,585 414,894 420,294
Direct retail 231,076 280,580 273,419
Home equity 307,518 223,078 243,648
---------- ---------- ----------
1,082,179 918,552 937,361
---------- ---------- ----------
Mortgage loans 136,137 161,623 163,624
---------- ---------- ----------
Total loans held for investment $4,857,154 $4,151,493 $4,434,011
========== ========== ==========
Percentage of loans held for investment
Commercial and industrial 27.7 % 25.2 % 26.6 %
Owner - occupied real estate 12.7 16.8 16.6
Commercial real estate 34.5 32.0 32.0
Consumer 22.3 22.1 21.1
Mortgage 2.8 3.9 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 ten 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 two years up to five years.
Direct retail 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.
22
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 34.5% of loans held for
investment at September 30, 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 confining our lending to markets we are
familiar with and to borrowers who have proven track records and the financial
means to weather adverse market conditions. In its commercial real estate
lending, 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 September 30, 2003, the loan portfolio included commitments totaling
$185.0 million in "shared national credits" (multi-bank credit facilities of $20
million or more). Outstanding balances under these commitments totaled $75.2
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. None of
these credit facilities were classified in the most recent report on shared
national credits prepared 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 September 30, 2003, this portfolio
totaled $41.7 million, down from $72.4 million at December 31, 2002, with an
allowance for loan losses of $6.1 million. Nonperforming assets for the Rock
Hill Workout Loans at September 30, 2003 were $22.3 million, down from $29.2
million at December 31, 2002. Net loan charge-offs for the first nine months of
2003 totaled $8.7 million, the majority of which were provided for in the
allowance for loan losses as of December 31, 2002. TSFG expects nonperforming
assets and the allowance for loan losses to decline as the Rock Hill Workout
Loans are liquidated, moved to performing status, 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.
23
Table 4
- ------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS
- ------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
September 30,
--------------------------------
Restated December 31,
2003 2002 2002
---- ---- ----
Nonperforming Assets Including the Rock Hill Workout Loans
Loans held for investment $ 4,857,154 $ 4,151,493 $ 4,434,011
Allowance for loan losses 63,000 50,011 70,275
Nonaccrual loans - commercial 52,341 32,306 61,206
Nonaccrual loans - consumer 2,876 2,850 2,384
Restructured loans - - -
----------- ----------- -----------
Total nonperforming loans 55,217 35,156 63,590
Other real estate owned 9,695 9,318 10,596
----------- ----------- -----------
Total nonperforming assets $ 64,912 $ 44,474 $ 74,186
=========== =========== ===========
Loans past due 90 days still accruing interest (1) $ 5,634 $ 5,744 $ 5,414
=========== =========== ===========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 1.33 % 1.07 % 1.67 %
==== ==== ====
Allowance for loan losses to nonperforming loans 1.14 x 1.42 x 1.11 x
==== ==== ====
Nonperforming Assets Excluding the Rock Hill Workout Loans
Loans held for investment $ 4,815,481 $ 4,151,493 $ 4,361,658
Allowance for loan losses 56,889 50,011 53,979
Total nonperforming loans 34,274 35,156 34,596
Other real estate owned 8,336 9,318 10,422
----------- ----------- -----------
Total nonperforming assets $ 42,610 $ 44,474 $ 45,018
=========== =========== ===========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 0.88 % 1.07 % 1.03 %
==== ==== ====
Allowance for loan losses to nonperforming loans 1.66 x 1.42 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 $1.1 million, $1.1 million, and $1.3 million, at September 30,
2003, September 30, 2002, and December 31, 2002, respectively.
Credit Quality Including Rock Hill Workout Loans. Nonperforming assets
declined to 1.33% of loans and other real estate owned at September 30, 2003
from 1.67% at December 31, 2002. Net loan charge-offs increased to 0.69% of
average loans held for investment for the first nine months of 2003 from 0.54%
for the first nine months of 2002, primarily due to the disposition of Rock Hill
Workout Loans. As anticipated, the allowance for loan losses declined to 1.30%
of period-end loans held for investment at September 30, 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 4.2% to 0.88% of
loans and other real estate owned at September 30, 2003 from 1.07% at September
30, 2002. Net loan charge-offs totaled $14.9 million, or 0.44% of average loans
held for investment for the first nine months of 2003, down from $15.5 million,
or 0.54% of average loans held for investment for the first nine months of 2002.
The allowance for loan losses declined slightly as a percent of loans held for
investment, from 1.24% at December 31, 2002 to 1.18% at September 30, 2003, but
increased from 1.56 times to 1.66 times nonperforming loans.
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
24
termination date of the earnout agreement, TSFG will pay the RHBT shareholders
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 September 30, 2003, principal collections and reserve reduction did not
exceed 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, TSFG expects portfolio quality
indicators to remain volatile and nonperforming asset levels to fluctuate.
TSFG's core credit quality measures remained stable in the third quarter 2003.
Immediately prior to filing this periodic report, events occurred relating to an
$8.6 million problem loan that increased the probability of it becoming a
nonaccrual loan. TSFG expects its nonperforming asset ratio to be comparable to
or lower than its September 30, 2003 ratio, depending on the status of this loan
and the overall business climate. Management believes 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 September 30, 2003 was adequate, based on its
assessment of probable losses, and available facts and circumstances then
prevailing.
Table 5 summarizes information on impaired loans (in thousands), all of
which are in nonaccrual status. All impaired loans are commercial loans.
Table 5
- ---------------------------------------------------------------------------------------------------------------
IMPAIRED LOANS
- ---------------------------------------------------------------------------------------------------------------
(dollars in thousands)
At and For
The Nine Months At and For
Ended September 30, The Year Ended
-------------------------------- December 31,
2003 2002 2002
---- ---- ----
Impaired loans $ 52,341 $ 32,306 $ 61,206
Impaired loans, excluding the Rock Hill Workout Loans 31,398 32,306 32,212
Average investment in impaired loans 57,534 38,342 42,258
Related allowance 12,222 6,248 22,016
Related allowance, excluding the Rock Hill Workout Loans 6,931 6,248 9,429
Recognized interest income - - 125
Foregone interest 2,612 1,469 2,973
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 as of the balance
sheet date presented. 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
25
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
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 $63.0 million, or 1.30% of loans held for
investment, at September 30, 2003, a significant increase from $50.0 million, or
1.20%, at September 30, 2002. Nonperforming loans totaled $55.2 million at
September 30, 2003, an increase of $20.1 million from $35.2 million at September
30, 2002. These increases were the result of the acquisition of loans from Rock
Hill Bank, partially offset by lower core nonperforming loans. Excluding the
$20.9 million of nonperforming loans related to the Rock Hill Workout Loans,
nonperforming loans declined to $34.3 million at September 30, 2003 from $35.2
million at September 30, 2002 (to 0.71% from 0.85% of loans held for
investment), and the Allowance increased to $56.9 million at September 30, 2003
from $50.0 million at September 30, 2002 (1.18% and 1.20% of loans held for
investment at both September 30, 2003 and 2002, respectively). See "Credit
Quality."
Table 6, 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,
excluding the Rock Hill Workout Loans, are expected to be slightly lower than
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.
26
Table 6
- -------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
At and For
The Nine Months
Ended September 30, At and For
-------------------------------- The Year Ended
Restated December 31,
2003 2002 2002
---- ---- ----
Allowance for loan losses, beginning of year $ 70,275 $ 44,587 $ 44,587
Purchase accounting adjustments - 2,877 22,973
Allowance adjustment for loans sold - (12) (12)
Net charge-offs:
Loans charged-off (26,422) (18,377) (23,556)
Loans recovered 2,856 2,887 4,017
---------- ---------- ----------
(23,566) (15,490) (19,539)
Additions to reserve through provision expense 16,291 18,049 22,266
---------- ---------- ----------
Allowance for loan losses, end of period $ 63,000 $ 50,011 $ 70,275
========== ========== ==========
Average loans held for investment $4,598,980 $3,865,951 $3,969,786
Loans held for investment 4,857,154 4,151,493 4,434,011
Net charge-offs as a percentage of average loans held for
investment (annualized) 0.69 % 0.54 % 0.49 %
Allowance for loan losses as a percentage of loans held
for investment 1.30 1.20 1.58
Excluding the Rock Hill Workout Loans:
Net loan charge-offs $ 14,852 $ 15,490 $ 19,906
Allowance for loan losses, end of period 56,889 50,011 53,979
Average loans held for investment 4,541,966 3,865,951 3,951,550
Loans held for investment 4,815,481 4,151,493 4,361,658
Net charge-offs as a percentage of average loans held for
investment (annualized) 0.44 % 0.54 % 0.50 %
Allowance for loan losses as a percentage of loans held
for investment 1.18 1.20 1.24
Securities
TSFG uses the investment securities portfolio for several purposes. It
serves as a vehicle to manage interest rate and prepayment risk, to leverage
capital through generating interest and dividend income from the investment of
funds, to provide liquidity to meet liquidity requirements, and to provide
collateral for pledges on public deposits and securities sold under repurchase
agreements. 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.
At September 30, 2003, TSFG's investment portfolio totaled $3.5
billion, up $1.6 billion from the $1.9 billion invested as of September 30,
2002, and up $938.5 million from the $2.6 billion invested as of December 31,
2002. In 2002, TSFG acquired $85.3 million in available for sale securities from
the acquisitions completed in the fourth quarter of 2002. The majority of the
increase since December 31, 2002 was attributable to the purchase of U.S.
Government agency and mortgage-backed securities ("MBS") in the available for
sale portfolio. TSFG bought these securities to leverage capital and take
advantage of the opportunity to increase net interest income. Subsequent to the
end of the third quarter of 2003, TSFG purchased $662.7 million in MBS, U.S.
Government agency securities, and municipal securities. TSFG expects to reduce
the level of its securities portfolio as a percentage of total assets, as loan
growth replaces some securities balance with new loans.
27
TSFG's security portfolio experienced average prepayments of
approximately $107 million per month and average calls of approximately $104
million per month during the first nine months of the year. TSFG expects the
investment portfolio to continue generating approximately $75 million per month
in cash flow through maturities and prepayments, which should be sufficient to
fund anticipated loan growth.
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 $3.3 billion in the first nine months of
2003, 88.4% above the average of the first nine months of 2002 of $1.7 billion.
The majority of the increase was attributable to securities purchased to
leverage available capital or to offset anticipated paydowns of MBS and calls of
U.S. Government agency securities. The average portfolio yield decreased in the
first nine months of 2003 to 3.90% from 5.35% in the first nine 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 5.0 years at
September 30, 2003 from 7.5 years at September 30, 2002. The securities
portfolio currently reprices within a 3.6 year pricing horizon, which is
significantly faster than indicated by the duration. TSFG manages the portfolio
to maintain a short repricing horizon and provide cash flow to fund loan growth.
This strategy provides significant cash flow to proactively manage as market
conditions change. TSFG may use this cash to reinvest in securities at current
market rates, fund future loan growth, or pay off borrowed funds.
The composition of the investment portfolio as of September 30, 2003
was as follows: MBS 59.3%, U.S. Government agencies 20.9%, U.S. Treasuries 7.1%,
state and municipalities 4.5%, and other securities 8.2% (see other investments
described below). MBS have increased from 46.4% of the portfolio at December 31,
2002, due to the first quarter 2003 purchases to leverage available capital.
Approximately one-third of MBS are collateralized mortgage obligations ("CMOs"),
the majority of which are short-term. TSFG manages the MBS portfolio to maintain
a short duration and repricing horizon. Approximately 40% of MBS are variable
rate.
The available for sale portfolio constituted 98.0% of total securities
at September 30, 2003. Management believes that the high concentration of
available for sale securities provides greater flexibility in the management of
the overall investment portfolio.
The net unrealized loss on available for sale securities (pre-tax)
totaled $2.2 million at September 30, 2003 compared to a $27.9 million gain at
September 30, 2002. This decrease was primarily associated with MBS, which
decreased $22.4 million. At December 31, 2002, the net unrealized gain on
available for sale securities (pre-tax) totaled $36.3 million. Long-term
interest rates rose in October 2003, which resulted in an increase in net
unrealized loss on available for sale securities. The net unrealized loss on
available for sale securities (pre-tax) totaled $23.4 million at October 31,
2003.
Other Investments
Investment in NetBank, Inc. At September 30, 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 $6.5 million at September 30, 2003. During
the nine months ended September 30, 2003, TSFG sold 207,096 shares of NetBank
for a pre-tax gain of $1.9 million.
Investments in Banks. At September 30, 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 $15.2
million, were recorded at their pre-tax market value of approximately $19.2
million at September 30, 2003. During the nine months ended September 30, 2003,
TSFG sold a community bank investment for a pre-tax gain of $1.2 million.
TSFG also has an investment in Nexity Financial Corporation, an
Internet bank, which was recorded at its cost basis of $500,000.
Other Investments Not Specified Above. In addition to the investments
described in the preceding paragraphs, other investments in available for sale
securities at September 30, 2003, which are carried at market value, included
corporate bonds of $149.7 million, Fannie Mae preferred stock of $61.8 million,
FHLB stock of $47.4 million, and other equity securities of $3.6 million. Other
equity securities include TSFG's investment in Affinity Technology Group, Inc.
28
("Affinity") as well as several other limited partnerships and small business
investments. At September 30, 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 September 30, 2003
pre-tax market value of approximately $927,000. At September 30, 2003, the
aggregate market value for these other investments, which are not specified in
the preceding paragraphs, totaled $262.5 million with a cost basis of $267.1
million.
Intangible Assets
The intangible assets balance at September 30, 2003 of $245.8 million
consisted of goodwill of $229.0 million, core deposit premiums of $14.5 million,
customer list intangibles of $1.4 million, and non-compete agreement intangibles
of $811,000. The intangible assets balance at September 30, 2002 of $176.8
million consisted of goodwill of $162.1 million, core deposit premiums of $13.1
million, customer list intangibles of $857,000, and non-compete agreement
intangibles of $659,000. The increase in goodwill was primarily due to the $62.2
million of goodwill acquired during the fourth quarter 2002 from the
acquisitions of CBT and Rock Hill Bank and adjustments for the Gulf West
acquisition, subsequent adjustments in 2003 totaling $1.8 million, $2.9 million
of goodwill acquired during 2003 from the acquisition of API, and $60,000
acquired during 2003 from the acquisition of Allied. The increase in core
deposit premiums was due to adding $2.7 million from the CBT merger and $1.2
million from the Rock Hill Bank merger. The customer list intangibles and
non-compete agreement intangibles were added with the acquisition of API. In the
fourth quarter 2003, TSFG expects to record approximately $100 million of
intangible assets, including goodwill, in connection with the MBFC acquisition.
Deposits
Deposits remain TSFG's primary source of funds for loans and
investments. Average deposits provided funding for 60.8% of average earning
assets in the first nine months of 2003 and 65.0% in the first nine months of
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 September 30, 2003, deposits totaled $5.3 billion, up $1.1 billion
from September 30, 2002. In the fourth quarter of 2002, TSFG acquired $364.9
million in deposits from its mergers with CBT and Rock Hill Bank, which
accounted for approximately 34% of the increase. In addition, TSFG increased
deposits, particularly transaction accounts, through increased sales referrals
and targeted deposit promotions. The increase in deposits also includes a $109.0
million increase in brokered certificates of deposit. At September 30, 2003,
TSFG had $569.2 million in brokered certificates of deposit, compared with
$460.2 million at September 30, 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.
Table 8 in "Results of Operations - Net Interest Income" details
average balances for the deposit portfolio for both the nine months ended
September 30, 2003 and 2002. Average money market accounts increased $651.1
million, or 86.1%, and average noninterest demand deposits increased $210.0
million, or 39.6%. On average, time deposits increased $204.3 million, or 11.9%,
which includes a $203.8 million 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 nine months ended September 30, 2003, transaction accounts
made up 60.5% of average deposits, compared with 53.8% for the nine months ended
September 30, 2002. These trends reflect TSFG's efforts to enhance its deposit
mix 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, TSFG held deposit campaigns, based on employee referrals, to
raise transaction accounts and offered an attractive money market account,
priced as a percentage of the prime interest rate.
At September 30, 2003, total deposits for Bank CaroLine, the Internet
banking division of Carolina First Bank, totaled $24.7 million, down from $34.1
million as of September 30, 2002. Deposits for Bank CaroLine declined, 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 9.5% of total deposits at
September 30, 2003 and 11.8% at September 30, 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.
29
During the second quarter 2003, TSFG sold the deposits at its
Powdersville, South Carolina branch office to an unrelated financial
institution. TSFG sold $6.4 million in deposits and recorded a gain associated
with the sale totaling $601,000.
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 nine months of 2003, average borrowings totaled $3.1
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 $2.2 billion at September 30, 2003,
up from $797.3 million as of September 30, 2002, primarily from the increase in
repurchase agreements and FHLB advances. TSFG increased long-term borrowings 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 $2.0 billion at September 30, 2003,
including $1.3 billion in long-term repurchase agreements, and totaled $1.2
billion at September 30, 2002, including $200.0 million in long-term repurchase
agreements. These balances are primarily to finance higher balances in available
for sale investment securities and to support earning asset growth. Balances in
these accounts can fluctuate on a day-to-day basis. Subsequent to quarter end,
TSFG increased federal funds purchased and repurchase agreements by $493.9
million to fund the purchase of securities (see "Securities").
The FHLB advances were $927.6 million, all long-term advances, at
September 30, 2003 and $606.9 million, including $583.9 million in long-term
advances, at September 30, 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. TSFG continues to evaluate the relative cost and benefit of
incurring prepayment penalties from the early extinguishment of debt.
Capital Resources and Dividends
Total shareholders' equity amounted to $656.7 million, or 7.1% of total
assets, at September 30, 2003, compared with $555.8 million, or 8.1% of total
assets, at September 30, 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 September 30, 2003 to the same period in 2002, is
primarily from the issuance of common stock for the fourth quarter 2002 mergers
and retention of earnings. TSFG's stock repurchase program, cash dividends paid,
and the unrealized losses in the available for sale investment portfolio
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. In May 2003,
TSFG added an additional one million shares. During 2003, TSFG repurchased
1,274,808 shares and has approximately 1.3 million shares remaining under its
stock repurchase authorization. TSFG may continue to repurchase shares depending
upon current market conditions, available cash, and capital levels.
TSFG's unrealized loss on securities, net of tax, which is included in
accumulated other comprehensive income, was $1.2 million as of September 30,
2003 as compared to a unrealized gain of $18.7 million as of September 30, 2002
and $24.4 million as of December 31, 2002. This decrease to an unrealized loss
(net of deferred income tax) from September 30, 2002 to September 30, 2003 was
comprised of decreases in: MBS $14.8 million, other securities $2.6 million,
U.S. Government agencies $1.4 million, U.S. Treasury securities $837,000, and
state and municipalities $397,000. The decline in all categories except for
other securities is due to rises in long-term interest rates in the third
quarter. The decrease in other securities was 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. Long-term interest rates rose in October 2003, which resulted in an
increased unrealized loss on securities. TSFG's unrealized loss on securities,
net of tax totaled $14.5 million at October 31, 2003.
30
Book value per share at September 30, 2003 and 2002 was $13.95 and
$12.75, respectively. Tangible book value per share at September 30, 2003 and
2002 was $8.73 and $8.70, respectively. Tangible book value was below book value
as a result of the purchase premiums associated with acquisitions of entities
and assets accounted for as purchases.
TSFG is subject to the risk based capital guidelines administered by
bank regulatory agencies. The guidelines are designed to make regulatory capital
requirements more sensitive to differences in risk profiles among banks and bank
holding companies, to account for off-balance sheet exposure and to minimize
disincentives for holding liquid assets. Under these guidelines, assets and
certain off-balance sheet items are assigned to broad risk categories, each with
appropriate weights. The resulting capital ratios represent capital as a
percentage of total risk weighted assets and certain off-balance sheet items.
TSFG and its Subsidiary Banks exceeded the well-capitalized regulatory
requirements at September 30, 2003. Failure to meet minimum capital requirements
can initiate certain mandatory, and possibly additional discretionary actions by
regulators, that, if undertaken, could have a direct material effect on our
consolidated financial statements. Table 7 sets fourth various capital ratios
for TSFG and its Subsidiary Banks.
Table 7
- ---------------------------------------------------------------------------
CAPITAL RATIOS
- ---------------------------------------------------------------------------
Well
Capitalized
September 30, 2003 Requirement
------------------ -----------
TSFG
Total risk-based capital 10.43 % n/a
Tier 1 risk-based capital 8.40 n/a
Leverage ratio 6.01 n/a
Carolina First Bank
Total risk-based capital 10.38 % 10.00 %
Tier 1 risk-based capital 7.52 6.00
Leverage ratio 5.14 5.00
Mercantile Bank
Total risk-based capital 11.36 % 10.00 %
Tier 1 risk-based capital 8.31 6.00
Leverage ratio 6.74 5.00
On June 27, 2003, TSFG filed a "universal shelf" registration statement
registering up to $200.0 million of securities to provide additional flexibility
in managing capital levels, both in terms of debt and equity. On October 22,
2003, TSFG filed a preliminary prospectus supplement with the Securities and
Exchange Commission relating to its proposed offering of 6,325,000 shares of
TSFG common stock (including the underwriters' over-allotment option with
respect to 825,000 shares), subject to market and other conditions. On November
12, 2003, TSFG completed the offering, selling 6,325,000 shares at a gross
offering price of $27.00 per share. The offering generated proceeds to TSFG of
approximately $161 million, net issuance costs for underwriting and expenses.
TSFG plans to use the net proceeds to increase the capital at TSFG's subsidiary
banks, to pursue growth opportunities and for general corporate purposes.
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. 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 October 2002, TSFG, through a wholly-owned trust subsidiary, issued
and sold floating rate securities to institutional buyers in a pooled trust
preferred issue. These securities generated proceeds to TSFG of $21.3 million,
net of issuance costs totaling $680,000, which qualifies as tier 1 capital under
Federal Reserve Board guidelines.
Effective July 1, 2003, TSFG adopted both FASB Interpretation No. 46
("FIN 46"), "Consolidation of Variable Interest Entities," and Statement of
Financial Accounting Standard No. 150 ("SFAS 150"), "Accounting for Certain
Financial Instruments with Characteristics of both Liabilities and Equity."
31
Evaluations of the impact of FIN 46 and SFAS 150 on the treatment of debt
associated with trust preferred securities are in process. TSFG currently
consolidates the trusts, which issued TSFG's trust preferred securities, in its
consolidated financial statements and reports the related debt instruments,
referred to as debt associated with trust preferred securities, as a liability
on its consolidated balance sheet. Under one potential interpretation of FIN 46,
TSFG's trusts, which have issued TSFG's trust preferred securities, would no
longer be included in TSFG's consolidated financial statements. Conversely, SFAS
150 requires the consolidation of these subsidiaries and the presentation of the
related debt instruments as a liability. In addition, the Federal Reserve has
issued regulations allowing for the continued inclusion of these instruments in
Tier 1 capital, regardless of FIN 46 interpretation. However, such a
determination could potentially be changed at a later date by the regulators.
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 incurred 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 8 present's average balance sheets and a net interest
income analysis on a tax equivalent basis for the three and nine months ended
September 30, 2003 and 2002.
32
Table 8
- ---------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- ---------------------------------------------------------------------------------------------
(dollars in thousands)
Three Months Ended September 30,
-----------------------------------------------------
2003 2002 (Restated)
------------------------- -------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
Assets
Earning assets
Loans (1) $4,787,522 $ 66,936 5.5% $4,018,375 $ 65,593 6.48 %
Investment securities, taxable (2) 3,354,656 29,177 3.48 1,707,479 22,011 5.16
Investment securities, nontaxable (3) 136,412 1,847 5.42 93,301 1,669 7.16
Federal funds sold and resale agreements 2,283 6 1.04 7,214 26 1.43
Interest-bearing bank balances 37,293 97 1.03 50,154 226 1.79
---------- -------- ---------- --------
Total earning assets 8,318,166 98,063 4.68 5,876,523 89,525 6.04
-------- --------
Non-earning assets 771,241 592,822
---------- ----------
Total assets $9,089,407 $6,469,345
========== ==========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 607,443 $ 883 0.58 $ 592,622 $ 1,731 1.16
Savings 146,596 155 0.42 124,611 224 0.71
Money market 1,757,785 7,571 1.71 834,111 3,725 1.77
Time deposits 1,842,055 10,187 2.19 1,744,858 14,813 3.37
---------- -------- ---------- --------
Total interest-bearing deposits 4,353,879 18,796 1.71 3,296,202 20,493 2.47
Borrowings 3,129,173 14,671 1.86 1,924,197 13,215 2.72
---------- -------- ---------- --------
Total interest-bearing liabilities 7,483,052 33,467 1.77 5,220,399 33,708 2.56
-------- --------
Noninterest-bearing liabilities
Noninterest-bearing deposits 778,652 570,508
Other noninterest-bearing liabilities 92,351 78,876
---------- ----------
Total liabilities 8,354,055 5,869,783
Minority interest in consolidated
subsidiary (4) 86,694 86,429
Shareholders' equity 648,658 513,133
---------- ----------
Total liabilities and shareholders' $9,089,407 $6,469,345
========== ==========
Net interest margin $64,596 3.0% $ 55,817 3.77 %
======= ========
Tax-equivalent adjustment (3) $ 647 $ 585
======= ========
(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.
33
Table 8 (Continued)
- ----------------------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- ----------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
For the Nine Months Ended September 30,
-----------------------------------------------------------------------
2003 2002 (Restated)
---------------------------------- ----------------------------------
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
Assets
Earning assets
Loans (1) $ 4,655,959 $ 202,594 5.82 % $ 3,893,943 $ 191,951 6.59 %
Investment securities, taxable (2) 3,162,279 90,413 3.81 1,650,010 64,795 5.24
Investment securities, nontaxable (3) 119,478 5,425 6.05 92,218 4,984 7.21
Federal funds sold and resale agreements 2,321 23 1.32 2,431 26 1.43
Interest-bearing bank balances 46,493 410 1.18 69,851 913 1.75
----------- --------- ----------- ---------
Total earning assets 7,986,530 298,865 5.00 5,708,453 262,669 6.15
--------- ----------- ---------
Non-earning assets 798,301 537,399
----------- -----------
Total assets $ 8,784,831 $ 6,245,852
=========== ===========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest-bearing checking $ 635,555 $ 2,953 0.62 % $ 590,902 $ 5,332 1.21 %
Savings 151,416 509 0.45 118,909 654 0.74
Money market 1,407,438 17,571 1.67 756,348 9,538 1.69
Time deposits 1,919,421 34,097 2.38 1,715,167 47,798 3.73
----------- --------- ----------- ---------
Total interest-bearing deposits 4,113,830 55,130 1.79 3,181,326 63,322 2.66
Borrowings 3,091,527 46,244 2.00 1,928,727 38,381 2.66
----------- --------- ----------- ---------
Total interest-bearing liabilities 7,205,357 101,374 1.88 5,110,053 101,703 2.66
--------- ---------
Noninterest-bearing liabilities
Noninterest-bearing deposits 740,777 530,737
Other noninterest-bearing liabilities 101,753 72,937
----------- -----------
Total liabilities 8,047,887 5,713,727
Minority interest in consolidated subsidiary (4) 86,569 54,232
Shareholders' equity 650,375 477,893
----------- -----------
Total liabilities and shareholders' equity $ 8,784,831 $ 6,245,852
=========== ===========
Net interest margin $ 197,491 3.31 % $ 160,966 3.77 %
========= =========
Tax-equivalent adjustment (3) $ 1,899 $ 1,745
========= =========
(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.
34
Fully tax-equivalent net interest income for the first nine months of
2003 increased $36.5 million, or 22.7%, to $197.5 million from $161.0 million in
the first nine months of 2002. This increase was attributable to a 39.9%
increase in average earning assets, partially offset by a decline in the net
interest margin. The net interest margin declined to 3.31% in the first nine
months of 2003 from 3.77% in the first nine months of 2002. This decrease in was
largely attributable to higher investment securities (which generally have a
lower yield than loans), accelerated premium amortization for mortgage-backed
securities, declines in the federal funds target rate, and deposit rates
approaching lower limits due to historically low interest rates. In addition,
TSFG has experienced solid growth in money market accounts, principally from a
product priced at a percentage of the prime interest rate. If interest rates
rise, TSFG will benefit from the relatively slower increase for these accounts,
which are currently at the upper end of money market rates.
Interest rates are presently at historically low levels. During 2003,
the Federal Reserve lowered the federal funds target rate 25 basis points at the
end of June, which followed a 50 basis point reduction in November 2002 and
eleven downward adjustments in 2001. A large portion of TSFG's adjustable rate
loans, which constitute 58.2% 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.
Accelerated premium amortization resulting from high levels of
prepayments experienced on mortgage-backed securities had a negative impact on
the net interest margin. Net premium amortization on MBS in the first nine
months of 2003 was $15.0 million compared with $1.2 million during the same
period in 2002. TSFG expects premium amortization for mortgage-backed securities
to slow in the fourth quarter 2003, which would have a positive impact on the
net interest margin.
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 nine months of 2002, the over accrual of interest expense related to
repurchase agreements overstated interest expense by $2.4 million, which was
corrected in the fourth quarter of 2002. The additional deferral of loan fee
income decreased net interest income by $7.7 million in the first nine months 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 $2.3 billion, or 39.9%, to $8.0 billion in
the first nine months of 2003 from $5.7 billion in the first nine months of
2002, primarily from acquisitions, the purchase of investment securities and
internal loan growth. 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 $762.0
million to $4.7 billion in the first nine months of 2003 from $3.9 billion in
the first nine months of 2002, due to adding approximately $585.3 million in
loans acquired in mergers in 2002 and internal loan growth. Average investment
securities, excluding the average net unrealized securities gains, increased to
$3.3 billion in the first nine months of 2003 from $1.7 billion in the first
nine months of 2002. The increase in the investment portfolio occurred in order
to leverage available capital and take advantage of the opportunity to increase
net interest income. Subsequent to the end of the third quarter of 2003, TSFG
purchased $662.7 million in mortgage-backed securities, U.S. government agency
securities, and municipal securities. TSFG expects to reduce the level of its
securities portfolio as a percentage of total assets, as loan growth replaces
some securities balances with new loans.
Average total deposits increased by $1.1 billion, or 30.8%, to $4.9
billion during the first nine months of 2003 from $3.7 billion in the first nine
months of 2002. The majority of the increase was attributable to the $783.8
million in deposits acquired from Gulf West, Rock Hill Bank, and CBT in the
second half of 2002. Average deposits for the third quarter 2003 increased 32.7%
over the prior year third quarter average, driven by growth in money market and
noninterest-bearing deposits. Average borrowings increased to $3.1 billion
during the nine months ended September 30, 2003 from $1.9 billion during the
nine months ended September 30, 2002 due to increases in 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.
Bank CaroLine deposits totaled $24.7 million as of September 30, 2003 compared
with $29.6 million and $34.1 million as of December 31, 2002 and September 30,
2002, respectively.
35
In August 2003, TSFG recorded a $2.7 million loss on the early
extinguishment of approximately $40.0 million in FHLB advances with a fixed rate
of 6.27%, thereby enhancing net interest income. TSFG continues to evaluate the
relative cost and benefit of incurring additional prepayment penalties from the
early extinguishment of debt.
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
composition, net loan charge-off levels, and expected economic conditions. The
provision for loan losses was $16.3 million and $18.0 million in the first nine
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 $23.6 million, or 0.69% of average loans held
for investment, for the first nine months of 2003, compared with $15.5 million,
or 0.54% of average loans held for investment, for the first nine months 2002.
Loan charge-offs in the first nine months of 2003 included losses of $8.7
million on Rock Hill Workout Loans, the majority of which were provided for in
the allowance for loan losses at year-end. Therefore, the allowance for loan
losses declined, and the aforementioned reserved charge-offs had limited impact
on the first nine months of 2003 provision for loan losses. The allowance for
loan losses equaled 1.30%, 1.58%, and 1.20% of loans held for investment as of
September 30, 2003, December 31, 2002, and September 30, 2002, respectively. The
significant increase from September 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 1.18% of loans held for investment as of
September 30, 2003.
Noninterest Income
Noninterest income totaled $71.6 million in the first nine months of
2003, compared with $41.9 million in the first nine months of 2002. The increase
in noninterest income was primarily composed of a $7.7 million increase in gain
on sale of available for sale securities, a $5.7 million increase in deposit
service charges, a $5.4 million increase in mortgage banking income, a $2.6
million increase in gain on trading and derivative activities, a $2.0 million
increase in insurance income, a $1.9 million increase in fees for investment
services, and a $2.5 million increase in other, which was largely due to
increases in benefit administration fees (due to the API acquisition), debit
card income, and other customer fee based services. Table 9 shows the components
of noninterest income for the nine months ended September 30, 2003 and 2002.
Table 9
- --------------------------------------------------------------------------------------------------------------
COMPONENTS OF NONINTEREST INCOME
- --------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Service charges on deposit accounts $ 7,613 $ 6,108 $22,154 $16,436
Mortgage banking income 3,804 727 8,537 3,097
Fees for investment services 1,946 1,359 6,579 4,639
Bank-owned life insurance 2,063 1,877 5,944 5,486
Merchant processing income 2,161 1,778 5,568 4,741
Insurance income 1,118 254 2,675 636
Gain (loss) on trading and derivative activities 950 (520) 2,057 (494)
Other 2,122 906 5,465 2,932
------- ------- ------- -------
Noninterest income, excluding gain on asset sales 21,777 12,489 58,979 37,473
------- ------- ------- -------
Gain on sale of available for sale securities 4,498 790 8,681 1,005
Gain on equity investments, net 1,455 3,527 3,330 3,388
Gain on disposition of assets and liabilities - - 601 -
Gain on asset sales, net 5,953 4,317 12,612 4,393
------- ------- ------- -------
Total noninterest income $27,730 $16,806 $71,591 $41,866
======= ======= ======= =======
36
Noninterest income included gains on asset sales for both the nine
months ended September 30, 2003 and 2002. Excluding these net gains on asset
sales, noninterest income increased $21.5 million, or 57.4%, in the first nine
months of 2003 to $59.0 million from $37.5 million for the corresponding period
in 2002.
During the first nine months of 2003, the gain on equity investments
totaling $3.3 million included a $1.9 million gain from the sale of 207,096
shares of NetBank, Inc. common stock and a $1.6 million gain from the sale of
community bank stock and corporate bonds. These gains were partially offset by a
$183,000 loss associated with the write-down of an investment in a venture
capital limited partnership. During the nine months ended September 30, 2002,
the gain on equity investments totaling $3.4 million included a $4.7 million
gain on the sale of 450,000 shares of NetBank, Inc. common stock. This gain was
partially offset by a $1.2 million write-down on RHBT common stock and a
$150,000 write-off of an investment in a technology company.
Service charges on deposit accounts, the largest contributor to
noninterest income, rose 34.8% to $22.2 million in the first nine months of 2003
from $16.4 million for the same period in 2002. The increase was attributable to
increasing transaction accounts including cash management, improving collection
of fees, and revising fee structures to reflect competitive pricing. Average
balances for deposit transaction accounts, which impact service charges,
increased 47.0% for the same period.
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 nine months of 2003 increased $5.4
million to $8.5 million from $3.1 million in the first nine months of 2002.
Table 10 shows the components of mortgage banking income for the nine months
ended September 30, 2003 and 2002.
Table 10
- -------------------------------------------------------------------------------------------------------------------------
COMPONENTS OF MORTGAGE BANKING INCOME
- -------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ---------------------
2003 2002 2003 2002
---- ---- ---- ----
Origination income and secondary marketing operations $ 3,693 $ 1,868 $ 9,908 $ 5,045
Net mortgage servicing loss (289) (372) (1,275) (963)
Impairment on mortgage servicing rights 400 (769) (96) (592)
Loss on sale of portfolio mortgage loans - - - (393)
------- ------- ------- -------
Total mortgage banking income $ 3,804 $ 727 $ 8,537 $ 3,097
======= ======= ======= =======
For the first nine months of 2003, origination income and secondary
marketing increased 96.4% to $9.9 million from $5.0 million for the first nine
months of 2002. Mortgage loans originated by TSFG originators totaled $569.5
million and $325.3 million in the first nine months of 2003 and 2002,
respectively. Mortgage origination volumes by TSFG originators increased in the
first nine 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 and Mercantile Bank, and other mortgage loans for which
Carolina First Bank owns the rights to service. At September 30, 2003, TSFG's
servicing portfolio included 3,677 loans having an aggregate principal balance
of $256.5 million. At September 30, 2002, the aggregate principal balance for
TSFG's servicing portfolio totaled $560.2 million, significantly higher than
September 30, 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 $2.0
million and $5.6 million at September 30, 2003 and 2002, respectively. In the
first nine months of 2003 and 2002, TSFG recorded a $96,000 and $592,000
impairment loss from the valuation of MSRs, respectively. At September 30, 2003
and 2002, the valuation allowance for capitalized mortgage servicing rights
totaled $1.9 million and $1.7 million, respectively.
37
Fees for investment services, which include trust and brokerage income,
for the first nine months of 2003 and 2002, were $6.6 million and $4.6 million,
respectively. Brokerage income increased $1.8 million to $4.0 million, primarily
from the addition of brokers and improved equity market conditions. Trust income
increased $200,000 to $2.5 million. At September 30, 2003 and 2002, the market
value of assets administered by the trust department totaled $685.8 million and
$621.7 million, respectively.
Bank-owned life insurance income increased to $5.9 million for the
first nine months of 2003 from $5.5 million for the first nine months of 2002
due to increases in cash values. At September 30, 2003, the cash surrender value
of bank-owned life insurance totaled $150.1 million. Subsequent to quarter-end,
TSFG purchased an additional $25.0 million of life insurance on certain
officers, which should increase bank-owned life insurance income. Merchant
processing income increased 17.4% to $5.6 million for the nine months ended
September 30, 2003 from $4.7 million for the nine months ended September 30,
2002 from attracting new merchants.
Insurance income increased to $2.7 million for the first nine months of
2003 from $636,000 for the first nine months of 2002, principally from acquiring
agencies and leveraging TSFG's customer base. TSFG acquired Gardner Associates
in September 2002 and Allied Assurance in September 2003.
During the first nine months of 2003, gain on trading and derivative
activities totaled $2.1 million, compared with a $494,000 loss for the first
nine months of 2002. In 2003, TSFG increased its use of derivatives as economic
hedges of on-balance sheet assets and liabilities or forecasted transactions,
which result in realized gains and losses included in earnings. Such activities
may result in increased volatility in realized gains and losses on trading and
derivative activities. See "Market Risk and Asset/Liability Management -
Derivatives and Hedging Activities."
Other noninterest income totaled $5.5 million for the first nine months
of 2003, compared with $2.9 million for the first nine months of 2002. Other
noninterest income includes income related to debit cards, 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 from increases in benefits administration
fees (due to the API acquisition), which increased $867,000, and debit card
income, which increased $794,000. As a result of recent VISA/MasterCard legal
settlements, effective August 1, 2003, debit card interchange income declined by
approximately 30%. TSFG substantially offset this reduction by continued growth
in consumer debit card penetration and a modest reduction in debit card expense.
Noninterest Expenses
Noninterest expenses increased to $150.0 million in the first nine
months of 2003 from $114.4 million in the first nine months of 2002. Noninterest
expenses for the nine months ended September 30, 2003 included a $2.7 million
loss on the early extinguishment of debt, $2.2 million in merger-related costs,
and a $268,000 impairment loss from write-down of assets. For the nine months
ended September 30, 2002, noninterest expenses included $4.5 million in
merger-related costs, $1.6 million in personnel expenses related to the
settlement of certain employment agreements, and a $354,000 loss on the early
extinguishment of debt.
Salaries, wages, and employee benefits increased to $74.0 million in
the first nine months of 2003 from $55.3 million in the first nine months of
2002. Full-time equivalent employees increased to 1,726 from 1,593 as of
September 30, 2003 and 2002, respectively. The increase in personnel expense was
primarily attributable to the 2002 acquisitions (which occurred during the last
four months of the year), the API acquisition in 2003, 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 $3.1 million in
the first nine months of 2003 from $1.7 million in the first nine months of
2002. Salaries, wages, and employee benefits declined to $23.7 million in the
third quarter 2003 from $25.7 million in the second quarter 2003, primarily due
to the reduction of estimated incentive compensation accruals for the year and
changes in vesting schedules.
Occupancy expense increased to $14.0 million for the nine months ended
September 30, 2003 from $11.2 million for the corresponding period of 2002,
primarily from the addition of branch offices from the 2002 acquisitions.
Furniture and equipment increased $2.2 million to $13.3 million for the first
nine months of 2003 from $11.1 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.
The increase in professional fees to $4.7 million for the first nine
months of 2003 from $3.9 million for the first nine months of 2002 was partially
related to deposit pricing and fee initiatives. The increase in merchant
processing expense to $4.3 million for the first nine months of 2003 from $3.8
38
million for the first nine months of 2002 was offset by related revenue
increases. Telecommunication expense increased $941,000 to $3.5 million for the
first nine months of 2003 from $2.5 million in the first nine months of 2002
principally from the acquisitions in the last four months of 2002.
Amortization of intangibles increased to $2.2 million for the nine
months ended September 30, 2003 from $831,000 for the nine months ended
September 30, 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,
TSFG added customer list intangibles and non-compete agreement intangibles with
the acquisitions of Gardner Associates and API.
TSFG incurred pre-tax merger-related costs of $2.2 million in the first
nine months of 2003 in connection with the 2002 acquisitions of CBT, Rock Hill
Bank, Gardner Associates, and Gulf West, and the 2003 acquisition of API. In the
third quarter 2002, TSFG incurred pre-tax merger-related costs of $4.5 million
in connection with the Gulf West acquisition. See Part I, Item 1, Note 13 to the
Consolidated Financial Statements. In connection with the acquisition of MBFC,
TSFG expects to incur between approximately $4 million and $4.5 million in
pre-tax merger-related costs, largely in the fourth quarter 2003.
In August 2003, TSFG recorded a loss on early extinguishment of debt
totaling $2.7 million for prepayment penalties for FHLB advances totaling $40.0
million with a fixed interest rate of 6.27%. In the third quarter 2002, TSFG
recorded a loss on early extinguishment of debt totaling $354,000 for the
unamortized issuance costs associated with redeeming $26.3 million of 9.00%
Subordinated Notes Due 2005.
Other noninterest expenses increased $7.4 million to $28.4 million in
the first nine months of 2003 from $21.0 million in the first nine months of
2002. The overall increase in other noninterest expenses was principally
attributable to increases in loan collection, travel, insurance, advertising,
debit card, and supplies expenses.
Income Taxes
The effective income tax rate as a percentage of pretax income remained
relatively constant at 31.3% for the first nine months of 2003 and 31.8% for the
first nine months of 2002. TSFG expects the effective income tax rate for 2003
to remain at approximately 31% or decline slightly. 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.
Third Quarter Results
Net income for the three months ended September 30, 2003 totaled $23.9
million, up 61.7% compared with $14.8 million for the three months ended
September 30, 2002. Earnings per diluted share for the three months ended
September 30, 2003 were $0.50, a 42.9% increase from earnings per diluted share
of $0.35 for the three months ended September 30, 2002. Higher net interest
income, fee income initiatives, higher mortgage banking income, and gains on
sales of available for sale securities contributed to the increases in net
income and earnings per diluted share. This earnings growth was partially offset
by higher noninterest expenses, including a loss on early extinguishment of
debt.
Fully tax-equivalent net interest income totaled $64.6 million, an
increase of $8.8 million, or 15.7%, compared with the third quarter of 2002. Net
interest income increased from a 41.5% growth in average earning assets,
partially offset by a decline in the net interest margin. The net interest
margin declined to 3.08% in the third quarter 2003 from 3.77% in the same period
in 2002. The decrease in the net interest margin was largely attributable to
higher investment securities (which generally have a lower yield than loans),
downward repricing of fixed rate commercial loans, and deposit rates approaching
lower limits due to historically-low interest rates.
Noninterest income for the three months ended September 30, 2003 and
2002 included pre-tax gains on asset sales of $6.0 million and $4.3 million,
respectively. See "Earnings Review - Noninterest Income" for details on the
gains on asset sales. Noninterest income, excluding the gains on asset sales,
increased 74.4% to $21.8 million for the third quarter of 2003 compared with
39
$12.5 million for the third quarter of 2002. Mortgage banking income, service
charges on deposits, gains on trading and derivative activities, and insurance
income drove the increases in noninterest income. For the three months ended
September 30, 2003, TSFG recorded a $400,000 impairment recovery from the value
of mortgage servicing rights, compared to a $769,000 impairment loss for the
corresponding period in 2002.
For the third quarter 2003, noninterest expenses included the following
pre-tax other items: a $2.7 million loss on the early extinguishment of debt and
$345,000 in merger-related costs. For the three months ended September 30, 2002,
noninterest expenses included the following pre-tax other items: $4.5 million in
merger-related costs, $1.6 million in salary and wages related to the settlement
of certain employment agreements, and a $354,000 loss on the early
extinguishment of debt. Noninterest expenses, excluding other items, increased
27.3% to $47.5 million for the third quarter 2003 from $37.3 million for the
third quarter 2002, which is primarily attributable to the 2002 acquisitions
(which occurred during the last four months of the year) and increased personnel
expense from hiring new revenue-producing associates (at a higher cost per
full-time equivalent employee) and recording higher levels of incentive pay.
Salaries, wages, and employee benefits declined to $23.7 million in the third
quarter 2003 from $25.7 million in the second quarter 2003, primarily due to the
reduction of estimated incentive compensation accruals for the year and changes
in vesting schedules.
Market Risk and Asset/Liability Management
Market risk is the risk of loss from adverse changes in market prices
and interest 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 changes in market 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 a number of important
factors, such as the degree of changes in interest rates, the timing of the
implementation of such changes, or changes in management's expectations or
intentions. In addition, it is not necessarily indicative of positions on other
dates.
Table 11 shows TSFG's financial instruments that are sensitive to
changes in interest rates as well as TSFG's interest sensitivity gap at
September 30, 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 11 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 11 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.
40
Table 11
- --------------------------------------------------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY GAP ANALYSIS
- --------------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
0-3 4-12 Two to After
Months Months Three Years Three Years Total
------ ------ ----------- ----------- -----
Interest-sensitive assets
Earning assets
Loans $2,984,362 $ 784,452 $ 927,956 $ 206,201 $ 4,902,971
Investment securities (1) 1,033,259 684,103 1,019,495 776,042 3,512,899
Federal funds sold - - - - -
Interest-bearing balances with other banks 7,208 750 - - 7,958
---------- ---------- ---------- --------- -----------
Total earning assets $4,024,829 $1,469,305 $1,947,451 $ 982,243 $ 8,423,828
========== ========== ========== ========= ===========
Interest-sensitive liabilities
Liabilities
Interest-sensitive liabilities
Interest-bearing deposits
Interest checking $ - $ 182,598 $ 213,031 $ 213,031 $ 608,660
Savings - 14,335 71,674 57,339 143,348
Money market 1,625,787 121,614 86,867 86,867 1,921,135
Certificates of deposit 444,157 1,000,566 248,129 88,101 1,780,953
---------- ---------- ---------- --------- -----------
Total interest-bearing deposits 2,069,944 1,319,113 619,701 445,338 4,454,096
Other Deposits (2) - 81,192 405,960 324,767 811,919
Borrowings 1,834,597 660,814 392,362 211,577 3,099,350
---------- ---------- ---------- --------- -----------
Total interest-sensitive liabilities 3,904,541 2,061,119 1,418,023 981,682 8,365,365
Periodic interest-sensitive gap 120,288 (591,814) 529,428 561 58,463
Notional amount of interest rate swaps (506,500) 397,000 155,000 (45,500) -
---------- ---------- ---------- --------- -----------
Periodic interest-sensitive gap after interest
rate swaps $ (386,212) $ (194,814) $ 684,428 $ (44,939) $ 58,463
========== ========== ========== ========= ===========
Cumulative interest -sensitive gap $ (386,212) $ (581,026) $ 103,402 $ 58,463 $ -
========== ========== ========== ========= ===========
(1) Investment securities exclude the unrealized loss on available for sale
securities of $2.2 million.
(2) Other deposits consist of noninterest-bearing deposits, which respond in
part to changes in interest rates.
As indicated in Table 11, as of September 30, 2003, on a cumulative
basis through twelve months, rate-sensitive liabilities exceeded rate-sensitive
assets, resulting in a liability-sensitive position of $581.0 million, or 6.3%
of total assets. This static gap liability sensitive position resulted primarily
from the increase in the money market balances, which reprices immediately
following changes in the prime rate, and from funding some of the securities
purchased during the first nine months of 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 100 and 200 basis points and decrease 100 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 scenario 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 actual results. Further, the computations do not contemplate any
additional actions TSFG could undertake in response to changes in interest
rates. Table 12 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.
41
TABLE 12
EARNINGS AT RISK ANALYSIS
ANNUALIZED HYPOTHETICAL PERCENTAGE CHANGE IN
INTEREST RATE SCENARIO NET INTEREST INCOME
---------------------- -------------------
2.00% 1.83%
1.00 0.78
Flat -
(1.00) (1.55)
As indicated in Table 12, 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 100 basis point declining
rate scenario, lower limits are in place, which limit the 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, are not lowered
the full 100 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 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
either a scenario 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 and futures contracts. Options and futures contracts typically
have indices that relate to the pricing of specific on-balance sheet instruments
and forecasted transactions.
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. In 2003, TSFG increased its use
of derivatives. During the first nine months of 2003, gain on trading and
derivative activities totaled $2.1 million, compared with a $494,000 loss for
the first nine months of 2002. At September 30, 2003, TSFG had no open futures
or options contracts.
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
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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.
In accordance with SFAS 133, TSFG records derivatives at fair value, as
either assets or liabilities, on the consolidated balance sheets. At September
30, 2003, the fair value of derivative assets totaled $1.1 million and was
related to cash flow hedges. At September 30, 2003, the fair value of derivative
liabilities totaled $6.6 million and was related to fair value hedges and
derivatives with no hedging designation.
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 September 30, 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 September 30, 2003, commercial and
retail loan commitments totaled $1.0 billion. Documentary letters of credit are
typically issued in connection with customers' trade financing requirements and
totaled $9.3 million at September 30, 2003. Unused business credit card lines,
which totaled $16.2 million at September 30, 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. Commitments under standby letters of credit are usually for one
year or less. At September 30, 2003, TSFG had a recorded liability of $100,000
for deferred fees received on standby letters of credit, which was the estimated
fair value 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 September 30, 2003 was $86.7 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 September 30, 2003, the fair value of derivative assets totaled $1.1
million and was related to cash flow hedges. At September 30, 2003, the fair
value of derivative liabilities totaled $6.6 million and was related to fair
value hedges and derivatives with no hedging designation. The related notional
amounts, which are not recorded on the consolidated balance sheets, totaled
$96.1 million for the derivative assets and $656.5 million for the derivative
liabilities.
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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 September 30, 2003, CFGRL had in force
insurance not recorded on the consolidated balance sheets of $30.7 million. A
loss reserve, determined based on reported and past loss experience of in force
policies, of $177,000 was included in other liabilities at September 30, 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 an 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. In June 2003,
TSFG settled this accelerated contract by issuing 93,253 restricted shares,
adjusted to 91,250 shares when exchanged for registered shares during July 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, manage operations on an ongoing basis, and capitalize on new
business opportunities. 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 and paydowns
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 September 30, 2003, totaled $927.6 million. At September 30,
2003, the Subsidiary Banks had approximately $813.2 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 September 30, 2003, the Subsidiary Banks had
unused short-term lines of credit totaling approximately $275.8 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 September 30, 2003, the Subsidiary Banks had qualifying
collateral to secure advances up to $628.6 million, of which none was
outstanding.
At September 30, 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, 2004).
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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
September 30, 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"). SFAS 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. 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. The initial adoption of this standard did not have an impact on the
financial condition or results of operations of TSFG.
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 guarantee; (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. No contingent liability was determined to be
necessary relating to TSFG's obligation to perform as a guarantor.
Accounting for Derivative Instruments and Hedging Activities
Effective July 1, 2003, TSFG adopted SFAS No. 149, ("SFAS 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities,"
which amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristics of a derivative, clarifies when
a derivative contains a financing component, amends the definition of an
underlying to conform it to language used in FIN 45, and amends certain other
existing pronouncements. Those changes will result in more consistent reporting
of contracts as either derivatives or hybrid instruments. The initial adoption
of this standard did not have a material impact on the financial condition or
results of operations of TSFG.
Accounting for Variable Interest Entities
Effective July 1, 2003, TSFG adopted FIN 46, 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 credit of the primary beneficiary. TSFG
had no impact upon adoption since it had no interests in entities, which it
considers to be included within the scope of FIN 46.
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On October 31, 2003, the FASB proposed a modification and
interpretation of FIN 46. Evaluations of the impact of FIN 46 and SFAS 150, on
the treatment of debt associated with trust preferred securities is in process.
TSFG currently consolidates the trusts, which issued TSFG's trust preferred
securities, in its consolidated financial statements and reports the related
debt instruments, referred to as debt associated with trust preferred
securities, as a liability on its consolidated balance sheet. Under one
potential interpretation of FIN 46, TSFG's trusts, which have issued TSFG's
trust preferred securities, would no longer be included in TSFG's consolidated
financial statements. Conversely, SFAS 150 requires the consolidation of these
subsidiaries and the presentation of the related debt instruments as a
liability.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
Effective July 1, 2003, TSFG adopted SFAS 150, which establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. SFAS 150
requires an issuer to classify certain financial instruments that include
certain obligations, such as mandatory redemption, repurchase of the issuer's
equity, or settlement by issuing equity, as liabilities or assets in some
circumstances. Forward contracts to repurchase an issuer's equity shares that
require physical settlement in exchange for cash are initially measured at the
fair value of the shares at inception, adjusted for any consideration or
unstated rights or privileges, which is the same as the amount that would be
paid under the conditions specified in the contract if settlement occurred
immediately. Those contracts and mandatorily redeemable financial instruments
are subsequently measured at the present value of the amount to be paid at
settlement, if both the amount of cash and the settlement date are fixed, or,
otherwise, at the amount that would be paid under the conditions specified in
the contract if settlement occurred at the reporting date. Other financial
instruments are initially and subsequently measured at fair value, unless
required by SFAS 150 or other generally accepted accounting principles to be
measured differently. TSFG had no impact upon adoption since it had no financial
instruments, which it considers to be included within the scope of SFAS 150.
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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.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
As of September 30, 2003 and pursuant to Rule 13a-15 of the Securities
Exchange Act of 1934 (the "Exchange Act"), TSFG's management, including the
Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), conducted
an evaluation of the effectiveness and design of TSFG's disclosure controls and
procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) of the
Exchange Act). Based upon that evaluation, TSFG's CEO and CFO concluded, as of
September 30, 2003, that TSFG's disclosure controls and procedures were
effective in recording, processing, summarizing and reporting information
required to be disclosed by TSFG, within the time periods specified in the
Securities and Exchange Commission's rules and forms.
Changes in Internal Controls
In addition and as of September 30, 2003, there have been no changes in
internal control over financial reporting (as defined in Rule 13a-15(f) and
15d-15(f) of the Exchange Act) during the third quarter of 2003 that have
materially affected or is reasonably likely to materially affect, the internal
control over financial reporting.
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PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
See Note 9 to the Consolidated Financial Statements for a discussion of
legal proceedings.
ITEM 2 CHANGE IN SECURITIES AND USE OF PROCEEDS
On September 22, 2003, TSFG acquired 100% of the capital stock of
Allied Assurance, an independent insurance agency headquartered in Columbia,
South Carolina. In connection with the acquisition, TSFG issued 2,365 shares of
common stock. This issuance was exempt under Section 4(2) of the Securities Act
of 1933 insofar as Allied Assurance had only one shareholder.
On October 20, 2003, the Board of Directors of TSFG approved the
redemption of the outstanding Common Stock Purchase Rights under the Amended and
Restated Shareholders Rights Agreement dated December 18, 1996. No action is
required on behalf of shareholders.
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
4.1 Amendment and Termination of Shareholder Rights Agreement
dated October 20, 2003. Incorporated by reference to Exhibit
4.1 of TSFG's Current Statement on Form 8-K dated October 20,
2003.
31.1 Certification of the Principal Executive Officer pursuant
to 15 U.S.C. 78m(a) or 78o(d) (Section 302 of the Sarbanes
-Oxley Act of 2002).
31.2 Certification of the Principal Financial Officer pursuant
to 15 U.S.C. 78m(a) or 78o(d) (Section 302 of the Sarbanes
-Oxley Act of 2002).
32.1 Certification of the Principal Executive Officer pursuant to
18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
32.2 Certification of the Principal Executive Officer pursuant to
18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
(b) Reports on Form 8-K
Form 8-K dated August 22, 2003 announcing under Item 5 that TSFG had
received approval from the Federal Reserve Bank in Richmond, VA to
consummate its acquisition of MBFC.
Form 8-K dated October 3, 2003 announcing under Items 2 and 7 that TSFG
had completed its acquisition of MBFC.
Form 8-K dated October 20, 2003 furnishing under Items 7 and 12 TSFG's
third quarter earnings release and disclosing under Item 5 TSFG's
termination of its exisitng Shareholder Rights Agreement.
48
Form 8-K dated October 22, 2003 furnishing under Item 9 supplemental
forward-looking financial information.
Form 8-K dated November 5, 2003 announcing under Item 5 certain
information regarding offering expenses related to TSFG's shelf
registration statement.
Form 8-K dated November 5, 2003 filing under Items 5 and 7 the
underwriting agreement and certain other exhibits relating to TSFG's
public offering of common stock, and furnishing under Item 9 a press
release regarding such offering.
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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.
Date: November 13, 2003 /s/ William S. Hummers III
---------------------------
William S. Hummers III
Vice Chairman and Executive Vice President
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