UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934 for the quarterly period ended March 31, 2003
Transition report pursuant to Section 13 or 15(d) of the Securities
--- Exchange Act of 1934 for the transition period from ____ to ____
Commission file number 0-15083
THE SOUTH FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA 57-0824914
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
(864) 255-7900
Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE NONE
(Title of Each Class) (Name of each exchange on which registered)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $1.00 PAR VALUE
COMMON STOCK PURCHASE RIGHTS
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
----- -----
The number of outstanding shares of the issuer's $1.00 par value common stock as
of May 1, 2003 was 46,644,784.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31,
---------------------------
RESTATED
2003 2002 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2002
----------- ----------- ----
ASSETS
Cash and due from banks $ 181,495 $ 120,439 $ 201,333
Interest-bearing bank balances 59,515 68,753 58,703
Federal funds sold - - 31,293
Securities
Trading 1,418 3,942 350
Available for sale 3,360,107 1,571,565 2,488,944
Held to maturity (market value $63,789, $80,556 and $85,371,
respectively) 61,403 79,679 82,892
----------- ----------- -----------
Total securities 3,422,928 1,655,186 2,572,186
----------- ----------- -----------
Loans
Loans held for sale 60,202 29,900 67,218
Loans held for investment 4,515,133 3,779,682 4,434,011
Allowance for loan losses (66,133) (45,208) (70,275)
----------- ----------- -----------
Net loans 4,509,202 3,764,374 4,430,954
----------- ----------- -----------
Premises and equipment, net 133,261 112,005 137,501
Accrued interest receivable 49,253 32,861 37,080
Intangible assets 242,420 95,495 242,182
Other assets 367,137 207,309 229,778
----------- ----------- -----------
$ 8,965,211 $ 6,056,422 $ 7,941,010
=========== =========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 757,149 $ 527,629 $ 743,174
Interest-bearing 3,978,566 3,113,875 3,849,336
----------- ----------- -----------
Total deposits 4,735,715 3,641,504 4,592,510
Federal funds purchased and repurchase agreements 956,709 1,279,340 1,110,840
Other short-term borrowings 43,664 63,610 81,653
Long-term debt 2,118,810 503,726 1,221,511
Debt associated with trust preferred securities 95,500 31,000 95,500
Accrued interest payable 22,926 24,419 20,945
Other liabilities 270,403 41,815 84,840
----------- ----------- -----------
Total liabilities 8,243,727 5,585,414 7,207,799
----------- ----------- -----------
Minority interest in consolidated subsidiary 86,484 37,023 86,412
----------- ----------- -----------
Shareholders' equity
Preferred stock-no par value; authorized 10,000,000 shares;
issued and outstanding none - - -
Common stock-par value $1 per share; authorized 100,000,000 shares;
issued and outstanding 46,405,600, 40,261,842 and 47,347,375 shares,
respectively 46,406 40,262 47,347
Surplus 406,839 289,331 427,448
Retained earnings 164,463 121,559 150,948
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (3,035) (1,752) (3,094)
Common stock held in trust for deferred compensation (147) - -
Deferred compensation payable in common stock 147 - -
Accumulated other comprehensive income (loss), net of tax 20,327 (15,415) 24,150
----------- ----------- -----------
Total shareholders' equity 635,000 433,985 646,799
----------- ----------- -----------
$ 8,965,211 $ 6,056,422 $ 7,941,010
=========== =========== ===========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
----------------------
RESTATED
2003 2002
---- ----
Interest income
Interest and fees on loans $ 67,333 $ 62,160
Interest and dividends on securities:
Taxable 30,299 21,567
Exempt from Federal income taxes 1,221 1,091
-------- --------
Total interest and dividends on securities 31,520 22,658
Interest on short-term investments 118 469
-------- --------
Total interest income 98,971 85,287
-------- --------
INTEREST EXPENSE
Interest on deposits 17,999 21,576
Interest on borrowed funds 15,501 12,319
-------- --------
Total interest expense 33,500 33,895
-------- --------
NET INTEREST INCOME 65,471 51,392
PROVISION FOR LOAN LOSSES 5,500 6,238
-------- --------
Net interest income after provision for loan losses 59,971 45,154
NONINTEREST INCOME 19,886 11,638
NONINTEREST EXPENSES 48,890 34,852
-------- --------
Income before income taxes, minority interest, and cumulative effect of
change in accounting principle 30,967 21,940
Income taxes 9,910 6,999
-------- --------
Income before minority interest and cumulative effect of change in
accounting principle 21,057 14,941
Minority interest in consolidated subsidiary, net of tax (1,012) (428)
-------- --------
Income before cumulative effect of change in accounting principle 20,045 14,513
Cumulative effect of change in accounting principle, net of tax - (1,406)
-------- --------
NET INCOME $ 20,045 $ 13,107
======== ========
AVERAGE COMMON SHARES OUTSTANDING, BASIC 47,325,448 41,180,460
AVERAGE COMMON SHARES OUTSTANDING, DILUTED 48,257,498 42,059,462
PER COMMON SHARE, BASIC:
Net income before cumulative effect of change in accounting principle $ 0.42 $ 0.35
Cumulative effect of change in accounting principle, net of tax - (0.03)
------ ------
Net income $ 0.42 $ 0.32
====== ======
PER COMMON SHARE, DILUTED:
Net income before cumulative effect of change in accounting principle $ 0.42 $ 0.34
Cumulative effect of change in accounting principle, net of tax - (0.03)
Net income $ 0.42 $ 0.31
====== ======
CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.14 $ 0.12
====== ======
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
RETAINED ACCUMULATED
SHARES OF EARNINGS OTHER
COMMON COMMON AND COMPREHENSIVE
STOCK STOCK SURPLUS OTHER* INCOME (LOSS) TOTAL
----- ----- ------- ----- ------------- -----
Balance, December 31, 2001 41,228,976 $41,229 $ 311,305 $ 111,744 $(6,104) $ 458,174
Net income (restated) - - - 13,107 - 13,107
Other comprehensive loss,
net of tax of $3,967 - - - - (9,311) (9,311)
---------
Comprehensive income - - - - - 3,796
---------
Cash dividends declared
($0.12 per common share) - - - (4,836) - (4,836)
Common stock activity:
Repurchase of stock (1,135,600) (1,136) (24,181) - - (25,317)
Dividend reinvestment plan 1,485 2 (25) - - (23)
Employee stock purchase plan 2,849 3 48 - - 51
Restricted stock plan 59,096 59 1,281 (291) - 1,049
Exercise of stock options 105,036 105 892 - - 997
Miscellaneous - - 11 83 - 94
---------- ------- --------- --------- -------- ---------
Balance, March 31, 2002 (restated) 40,261,842 $40,262 $ 289,331 $ 119,807 $(15,415) $ 433,985
========== ======= ========= ========= ======== =========
Balance, December 31, 2002 47,347,375 $47,347 $ 427,448 $ 147,854 $ 24,150 $ 646,799
Net income - - - 20,045 - 20,045
Other comprehensive loss,
net of tax of $37 - - - - (3,823) (3,823)
---------
Comprehensive income - - - - - 16,222
---------
Cash dividends declared
($0.14 per common share) - - - (6,529) - (6,529)
Common stock activity:
Repurchase of stock (1,266,308) (1,266) (24,981) - - (26,247)
Acquisitions - - - 453 - 453
Dividend reinvestment plan 39,339 39 721 - - 760
Employee stock purchase plan 13,960 14 263 - - 277
Restricted stock plan 68,793 69 2,179 (478) - 1,770
Exercise of stock options 202,441 203 1,188 - - 1,391
Common stock purchased by trust
for deferred compensation - - - (147) - (147)
Deferred compensation payable in
common stock - - - 147 - 147
Miscellaneous - - 21 83 - 104
---------- ------- --------- --------- -------- ---------
Balance, March 31, 2003 46,405,600 $46,406 $ 406,839 $ 161,428 $ 20,327 $ 635,000
========== ======= ========= ========= ======== =========
* Other includes guarantee of employee stock ownership plan debt, nonvested
restricted stock and deferred compensation.
See accompanying notes to consolidated financial statements.
3
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED MARCH 31,
-------------------------------------
2003 2002
---- ----
Cash flows from operating activities
Net income $ 20,045 $ 13,107
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, amortization, and accretion, net 12,596 8,109
Provision for loan losses 5,500 6,238
Gain on sale of available for sale securities (986) (29)
Loss on trading securities (72) (30)
Gain on equity investments (1,875) (11)
Gain on sale of loans (1,635) (224)
Gain on disposition of premises and equipment (32) (39)
Loss on disposition of other real estate owned 167 168
Impairment loss from write-down of assets 198 -
Impairment loss (recovery) from write-down of mortgage servicing rights 262 (200)
Loss on changes in fair value of hedges 192 13
Minority interest in consolidated subsidiary 1,012 428
Cumulative effect of change in accounting principle - 1,406
Trading account assets, net (996) (2,335)
Originations of mortgage loans held for sale (146,097) (137,284)
Sale proceeds and principal repayments from mortgage loans held for sale 154,706 114,121
Other assets, net (18,368) 2,375
Other liabilities, net 5,291 3,964
--------- ---------
Net cash provided by operating activities 29,908 9,777
--------- ---------
Cash flows from investing activities
Sale of securities available for sale 692,924 211,694
Maturity, call, or principal repayments from securities available for sale 546,448 461,452
Maturity or call of securities held to maturity 28,265 4,040
Purchase of available for sale securities (2,064,141) (698,206)
Purchase of securities held to maturity (6,814) (2,928)
Origination of loans held for investment, net (94,671) (59,664)
Sale of other real estate owned 3,604 1,010
Sale of premises and equipment 37 1,132
Capital expenditures (1,779) (1,844)
Payment for purchase acquisitions (385) -
--------- ---------
Net cash used for investing activities (896,512) (83,314)
--------- ---------
Cash flows from financing activities
Deposits, net 143,134 37,073
Federal funds purchased and repurchase agreements, net (154,040) 9,802
Short-term borrowings, net (38,288) (86,650)
Issuance of long-term debt 899,800 100,000
Payments of long-term debt (2,397) (7,568)
Cash dividends paid (6,656) (5,693)
Cash dividends paid on minority interest (1,553) (704)
Repurchase of common stock (26,247) (25,317)
Other common stock activity 2,532 1,119
--------- ---------
Net cash provided by financing activities 816,285 22,062
--------- ---------
Net change in cash and due from banks (50,319) (51,475)
Cash and cash equivalents at beginning of year 291,329 240,667
--------- ---------
Cash and cash equivalents at end of period $ 241,010 $ 189,192
========= =========
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL
The foregoing unaudited consolidated financial statements include the
accounts of The South Financial Group, Inc. and subsidiaries. "TSFG" refers to
The South Financial Group, Inc. and subsidiaries, except where the context
requires otherwise. All significant intercompany accounts and transactions have
been eliminated in consolidation, and all adjustments considered necessary for a
fair presentation of the results for interim periods presented have been
included. (Such adjustments are normal and recurring in nature.) Certain prior
year amounts have been reclassified to conform to the 2003 presentations. TSFG
has no interests in non-consolidated special purpose entities.
The consolidated financial statements and notes are presented in
accordance with the instructions for Form 10-Q. The information contained in the
footnotes included in TSFG's 2002 Annual Report on Form 10-K should be referred
to in connection with the reading of these unaudited interim Consolidated
Financial Statements.
ACCOUNTING ESTIMATES AND ASSUMPTIONS
Certain policies require management to make estimates and assumptions
that affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ significantly from these
estimates and assumptions. Material estimates that are particularly susceptible
to significant change relate to the determination of the allowance for loan
losses and deferred income tax assets or liabilities.
RESTATEMENT OF 2002 QUARTERLY FINANCIAL DATA
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 91,
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" ("SFAS 91"), which reduced
interest income, noninterest income and noninterest expenses. Income taxes
increased as a result of the restatement. The net impact of these adjustments
for the first quarter of 2002, which restated the financial results for the
quarter, was to increase net income by $316,000, or $0.01 per diluted share.
During the third quarter 2002, TSFG, in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), recognized a $1.4 million
impairment loss on the cumulative effect of a change in accounting principle as
of January 1, 2002. The first quarter 2002, as restated, includes this
impairment loss. In addition, in connection with its adoption of SFAS No. 147,
"Acquisitions of Certain Financial Institutions an amendment of FASB Statements
No. 72 and 144 and FASB Interpretation No. 9" ("SFAS 147") during the third
quarter 2002, effective as of January 1, 2002, TSFG reversed amortization of
intangibles, which increased net income by $71,000 for the first quarter of
2002.
For a summary of the quarterly financial data for first quarter 2002,
as restated and as reported, see Note 36 to the Consolidated Financial
Statements in TSFG's 2002 Annual Report on Form 10-K.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Accounting for Exit or Disposal Activities
Effective January 1, 2003, TSFG adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146
applies to costs associated with an exit activity that does not involve an
entity newly acquired in a business combination or with a disposal activity
covered by SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." Those costs include, but are not limited to, the following:
a) termination benefits provided to current employees that are involuntarily
terminated under the terms of a benefit arrangement that, in substance, is not
an ongoing benefit arrangement or an individual deferred compensation contract
(hereinafter referred to as one-time termination benefits), b) costs to
terminate a contract that is not a capital lease, and c) costs to consolidate
5
facilities or relocate employees. This Statement does not apply to costs
associated with the retirement of a long-lived asset covered by SFAS No. 143,
"Accounting for Asset Retirement Obligations." A liability for a cost associated
with an exit or disposal activity shall be recognized and measured initially at
its fair value in the period in which the liability is incurred. A liability for
a cost associated with an exit or disposal activity is incurred when the
definition of a liability is met in accordance with FASB Concepts Statements No.
6, "Elements of Financial Statements."
Accounting for Guarantees
Effective January 1, 2003, TSFG adopted the initial recognition and
initial measurement provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
TSFG adopted the disclosure requirements effective as of December 31, 2002. FIN
45 elaborates on the disclosure to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the
nature of the guarantee; (b) the maximum potential amount of future payments
under the grantee; (c) the carrying amount of the liability; and (d) the nature
and extent of any recourse provisions or available collateral that would enable
the guarantor to recover the amounts paid under the guarantee. FIN 45 also
clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the obligations it has undertaken in issuing the
guarantee at its inception. At March 31, 2003, TSFG recorded a liability of
$25,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
Accounting for Variable Interest Entities
In January 2003, the FASB issued FASB Interpretation No. 46, ("FIN
46"), "Consolidation of Variable Interest Entities", which addresses
consolidation by business enterprises of variable interest entities. Under FIN
46, an enterprise that holds significant variable interest in a variable
interest entity but is not the primary beneficiary is required to disclose the
nature, purpose, size, and activities of the variable interest entity, its
exposure to loss as a result of the variable interest holder's involvement with
the entity, and the nature of its involvement with the entity and date when the
involvement began. The primary beneficiary of a variable interest entity is
required to disclose the nature, purpose, size, and activities of the variable
interest entity, the carrying amount and classification of consolidated assets
that are collateral for the variable interest entity's obligations, and any lack
of recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general creditors (or beneficial interest
holders) of a consolidated variable interest entity to the general creditor of
the primary beneficiary. FIN 46 is effective for the first fiscal year or
interim period beginning after June 15, 2003. The impact to TSFG upon adoption
is currently not known.
6
(2) SUPPLEMENTAL FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for noninterest income and
noninterest expense (in thousands):
Three Months Ended
March 31,
-------------------------
Restated
2003 2002
---- ----
Noninterest income
Service charges on deposit accounts $ 6,960 $ 4,907
Fees for investment services 2,491 1,427
Mortgage banking income 2,172 1,081
Bank-owned life insurance 1,948 1,806
Merchant processing income 1,336 1,248
Gain on sale of available for sale securities 986 29
Gain on trading securities 72 30
Gain on equity investments 1,875 11
Other 2,046 1,099
-------- --------
Total noninterest income $ 19,886 $ 11,638
======== ========
Noninterest expenses
Salaries and wages $ 19,278 $ 13,636
Employee benefits 5,316 4,378
Occupancy 4,614 3,545
Furniture and equipment 4,594 3,596
Professional fees 1,538 1,327
Telecommunications 1,070 683
Merchant processing expense 1,049 1,044
Amortization of intangibles 705 239
Merger-related costs 1,497 -
Other 9,229 6,404
-------- --------
Total noninterest expenses $ 48,890 $ 34,852
======== ========
CONSOLIDATED STATEMENTS OF CASH FLOW
The following summarizes supplemental cash flow data (in thousands) for
the three months ended March 31:
2003 2002
---- ----
Interest paid $ 32,168 $ 29,813
Income taxes paid 1,044 3,251
Significant non-cash investing and financing transactions are summarized as follows:
Security sales settled subsequent to quarter-end 129,972 -
Security purchases settled subsequent to quarter-end (181,377) -
Unrealized loss on available for sale securities (4,061) (13,500)
Loans transferred to other real estate owned 4,011 3,353
Premises and equipment, net transferred to long-lived assets held for sale 2,639 -
7
(3) OTHER COMPREHENSIVE INCOME
The following summarizes accumulated other comprehensive income (loss),
net of tax (in thousands) for the three months ended March 31:
2003 2002
---- ----
Unrealized gains (losses) on available for sale securities
Balance at beginning of year $ 24,382 $ (5,554)
Other comprehensive loss:
Unrealized holding losses arising during the year (1,200) (13,460)
Income tax (expense) benefit (910) 4,036
Less: Reclassification adjustment for gains included in net income (2,861) (40)
Income tax expense 1,021 13
-------- --------
(3,950) (9,451)
-------- --------
Balance at end of period 20,432 (15,005)
-------- --------
Unrealized losses on cash flow hedges
Balance at beginning of year (232) (550)
Other comprehensive income:
Unrealized gain on change in fair values 201 222
Income tax expense (74) (82)
-------- --------
127 140
-------- --------
Balance at end of period (105) (410)
-------- --------
$ 20,327 $ (15,415)
======== =========
During the first quarter 2003, TSFG adjusted its income tax rate used
(on a cumulative basis) on the net unrealized gain recorded for available for
sale securities, which is included in accumulated other comprehensive income, to
the blended statutory federal and state income tax rate of 36.94%. However, in
certain cases where TSFG has capital loss carryforwards for state income tax
purposes, an income tax rate of 35% is used. At December 31, 2002, TSFG used a
32.5% income tax rate on the net unrealized gain recorded for available for sale
securities.
(4) BUSINESS COMBINATIONS
CENTRAL BANK OF TAMPA
On December 31, 2002, TSFG acquired Central Bank of Tampa ("CBT"), a
community bank headquartered in Tampa, Florida. CBT operated through 5 branches
in Tampa. This acquisition added to TSFG's growing presence in the Tampa Bay
area and advanced TSFG's strategy to expand in markets with favorable population
and per capita income growth prospects.
The aggregate purchase price was $66.2 million, which consisted of
3,241,737 shares of TSFG common stock and $2,000 of cash paid in lieu of
fractional shares. The TSFG common stock issued was valued at the average
closing price on the ten trading days ending on the second trading day prior to
closing. CBT shareholders received 9.850 shares of TSFG common stock for each
share of CBT common stock.
The CBT purchase price and the amount of the purchase price allocated
to goodwill and other intangible assets are presented below (in thousands). The
estimated fair values of the assets acquired and the liabilities assumed at the
purchase date are subject to adjustment as fair value information becomes
available. The allocation of the CBT purchase price was adjusted in the first
quarter of 2003 to reflect third-party valuations of certain assets and
liabilities.
8
Purchase price $ 66,224
CBT tangible shareholders' equity 28,943
---------
Excess of purchase price over carrying value of net tangible assets acquired 37,281
Fair value adjustments (1,642)
Direct acquisition costs 1,526
Deferred income taxes 1,616
---------
Total intangible assets 38,781
Core deposit premiums 2,700
---------
Goodwill $ 36,081
=========
The core deposit premium intangible asset is amortized over 10 years on
an accelerated basis until the straight-line amortization method is greater at
which time the straight-line method is used. The core deposit premium valuation
and amortization method are based upon a historical study of the deposits
acquired. All of the CBT intangible assets were assigned to the Mercantile Bank
segment. The goodwill will not be amortized but will be tested at least annually
for impairment in accordance with SFAS 142. The total amount of goodwill
expected to be deductible for income tax purposes is $356,000.
AMORTIZATION OF PREMIUMS AND DISCOUNTS
Premiums and discounts that resulted from recording the assets and
liabilities acquired through acquisition (CBT, Rock Hill Bank & Trust, and Gulf
West Banks, Inc.) at their respective fair values are being amortized and
accreted using methods that result in a constant effective yield over the life
of the assets and liabilities. This net amortization decreased net income before
income taxes by $330,000 in the first three months of 2003.
(5) INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, are summarized as
follows (in thousands):
MARCH 31,
---------------------------- DECEMBER 31,
2003 2002 2002
---- ---- ----
Goodwill $ 225,255 $ 90,194 $ 224,312
Core deposit premiums 26,873 14,546 26,873
Less accumulated amortization (11,063) (9,245) (10,409)
--------- -------- ---------
15,810 5,301 16,464
--------- -------- ---------
Customer list intangible 858 - 858
Less accumulated amortization (45) - (24)
--------- -------- ---------
813 - 834
--------- -------- ---------
Non-compete agreement intangible 663 - 663
Less accumulated amortization (121) - (91)
--------- -------- ---------
542 - 572
--------- -------- ---------
$ 242,420 $ 95,495 $ 242,182
========= ======== =========
The following summarizes the changes in the carrying amount of goodwill
related to each of TSFG's business segments (in thousands) for the three months
ended March 31, 2003:
CAROLINA MERCANTILE
FIRST BANK BANK TOTAL
---------- ---- -----
Balance, December 31, 2002 $ 116,279 $ 108,033 $ 224,312
Purchase accounting adjustments 1,420 (477) 943
--------- --------- ---------
Balance, March 31, 2003 $ 117,699 $ 107,556 $ 225,255
========= ========= =========
9
Amortization of intangibles totaled $654,000 for core deposit premiums,
$21,000 for customer list intangibles, and $30,000 for non-compete agreement
intangibles for the three months ended March 31, 2003. Amortization of
intangibles totaled $239,000 for core deposit premiums for the three months
ended March 31, 2002.
The estimated amortization expense for core deposit premiums for the
years ended December 31 is as follows: $2.6 million for 2003, $2.2 million for
2004, $1.9 million for 2005, $1.7 million for 2006, $1.7 million for 2007, and
an aggregate of $6.4 million for all the years thereafter. The estimated
amortization expense for customer list intangibles is $86,000 for the years
ended December 31, 2003 to 2007 and an aggregate of $404,000 for all the years
thereafter. The estimated amortization expense for non-compete agreement
intangibles is $120,000 for the years ended December 31, 2003 to 2006 and
$92,000 for 2007.
(6) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs"), net of the valuation
allowance, totaled $3.2 million, $4.4 million, and $8.0 million at March 31,
2003, December 31, 2002, and March 31, 2002, respectively. Amortization expense
for MSRs totaled $909,000 and $1.0 million for the three months ended March 31,
2003 and 2002, respectively. At March 31, 2003 and 2002, the valuation allowance
for capitalized MSRs totaled $2.0 million and $869,000, respectively. In the
first three months of 2003 and 2002, TSFG recorded a $262,000 impairment loss
and $200,000 impairment recovery from the valuation of MSRs, respectively.
The estimated amortization expense for MSRs for the years ended
December 31 is as follows: $3.6 million for 2003, $487,000 for 2004, and none
for all the years thereafter. The estimated amortization expense is based on
current information regarding loan payments and prepayments. Amortization
expense could change in future periods based on changes in the volume of
prepayments and economic factors.
(7) GUARANTEES
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customer to perform under the terms
of an underlying contract with the third party or obligates TSFG to guarantee or
stand as surety for the benefit of the third party. The underlying contract may
entail either financial or nonfinancial obligations and may involve such things
as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or repayment of an obligation. Under the terms of a
standby letter, drafts will generally be drawn only when the underlying event
fails to occur as intended. TSFG can seek recovery of the amounts paid from the
borrower. In addition, some of these standby letters of credit are
collateralized. The collateral is generally cash, although existing lines of
credit are sometimes used. Commitments under standby letters of credit are
usually for one year or less. At March 31, 2003, TSFG recorded a liability of
$25,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor. The maximum potential
amount of undiscounted future payments related to standby letters of credit at
March 31, 2003 was $58.3 million.
(8) COMMITMENTS AND CONTINGENT LIABILITIES
TSFG is currently subject to various legal proceedings and claims that
have arisen in the ordinary course of its business. In the opinion of management
based on consultation with external legal counsel, any reasonably foreseeable
outcome of such current litigation would not materially affect TSFG's
consolidated financial position or results of operations.
At the purchase date, TSFG identified a potential contingent liability
related to certain Rock Hill Bank & Trust trust accounts. Any liability recorded
would increase the goodwill recorded.
(9) DEFERRED COMPENSATION HELD IN TRUST
Beginning on January 1, 2003, under TSFG's Executive Deferred
Compensation Plan for certain officers, TSFG common stock was added as an
investment option for deferral of up to 100% of a participant's annual bonus
compensation, net of withholdings for social security and Medicare taxes. The
common stock purchased by TSFG for this deferred compensation plan is maintained
in a Rabbi Trust (the "Trust"), on behalf of the participants. The assets of the
Trust are subject to the claims of general creditors of TSFG. Dividends payable
on the common shares held by the Trust will be reinvested in additional shares
of common stock of TSFG on behalf of the participants. The deferred compensation
obligation in the Trust is classified as a component of shareholders' equity,
and the common stock held by the Trust is classified as a reduction of
10
shareholders' equity. The obligations of TSFG under this investment option of
the deferred compensation plan, and the shares held by the Trust, have no net
effect on outstanding shares. Subsequent changes in the fair value of the common
stock are not reflected in earnings or shareholders' equity.
(10) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common
shares outstanding:
THREE MONTHS ENDED MARCH 31,
----------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 47,325,448 41,180,460
========== ==========
Diluted:
Average common shares outstanding 47,325,448 41,180,460
Dilutive potential common shares 932,050 879,002
---------- ----------
Average diluted shares outstanding (denominator) 48,257,498 42,059,462
========== ==========
The following options were outstanding at the period end presented but
were excluded from the calculation of diluted earnings per share because the
exercise price was greater than the average market price of the common shares:
NUMBER RANGE OF
OF SHARES EXERCISE PRICES
--------- ---------------
For the three months ended
March 31, 2003 1,539,803 $21.00 to $31.26
March 31, 2002 1,065,168 $19.47 to $31.26
(11) STOCK-BASED COMPENSATION
At March 31, 2003, TSFG has two stock-based employee compensation
option plans, which are described more fully in Note 30 to the Consolidated
Financial Statements in TSFG's 2002 Annual Report on Form 10-K. TSFG accounts
for its option plans under the recognition and measurement principles of APB
Opinion 25, "Accounting for Stock Issued to Employees," and related
Interpretations ("APB Opinion 25"). No stock-based employee compensation cost is
reflected in net income related to these plans, as all options granted under
those plans had an exercise price equal to or greater than the market value of
the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share as if TSFG had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock Based Compensation" ("SFAS 123") to stock-based employee compensation
option plans for the three months ended March 31 (dollars in thousands, except
share data).
2003 2002
---- ----
Net income
Net income, as reported $ 20,045 $ 13,107
Deduct:
Total stock-based employee compensation expense determined under fair
value based method for all option awards, net of related tax effect 392 382
-------- --------
Pro forma net income $ 19,653 $ 12,725
======== ========
Basic earnings per share
As reported $ 0.42 $ 0.32
Pro forma 0.42 0.31
Diluted earnings per share
As reported $ 0.42 $ 0.31
Pro forma 0.41 0.30
11
(12) MERGER-RELATED AND DIRECT ACQUISITION COSTS
In connection with the CBT, Rock Hill Bank, and Gulf West acquisitions,
TSFG recorded pre-tax merger-related costs of $1.5 million, included in
noninterest expenses, and direct acquisition costs of $197,000, included in
goodwill during the first quarter 2003. The merger-related and acquisition costs
were recorded as incurred. The following summarizes these charges (in thousands)
at and for the three months ended March 31, 2003:
TOTAL AMOUNTS REMAINING
COSTS PAID ACCRUAL
----- ---- -------
MERGER-RELATED COSTS
Compensation-related expenses $ 511 $ 215 $ 296
System conversion costs 461 281 180
Fixed asset impairment 198 198 -
Travel 33 33 -
Advertising 30 30 -
Other 264 256 8
------ ------ -----
$1,497 $1,013 $ 484
====== ====== =====
DIRECT ACQUISITION COSTS
Investment banking and professional fees $ 88 $ 88 $ -
Severance 109 109 -
------ ------ -----
$ 197 $ 197 $ -
====== ====== =====
At March 31, 2003, the accrual of merger-related costs, which included
$484,000 for charges incurred during the three months ended March 31, 2003,
totaled $1.1 million. This accrual is for compensation-related and other
expenses incurred in connection with the CBT, Rock Hill Bank, and Gulf West
acquisitions. At March 31, 2003, the accrual of direct acquisition costs totaled
$569,000. This accrual is for professional fees and severance in connection with
the purchase of assets and deposits from Rock Hill Bank.
(13) BUSINESS SEGMENTS
TSFG has two principal operating subsidiaries, Carolina First Bank and
Mercantile Bank, which are evaluated regularly by the chief operating decision
maker in deciding how to allocate resources and assess performance. Both of
these subsidiaries are reportable segments by virtue of exceeding certain
quantitative thresholds. Carolina First Bank and Mercantile Bank engage in
general banking business focusing on commercial, consumer, and mortgage lending
to small and middle market businesses and consumers in their market areas. The
reportable segments also provide demand transaction accounts and time deposit
accounts to businesses and individuals. Carolina First Bank offers products and
services primarily to customers in South Carolina, coastal North Carolina and on
the Internet. Mercantile Bank offers products and services primarily to
customers in its market areas in northern and central Florida. Revenues for
Carolina First Bank and Mercantile Bank are derived primarily from interest and
fees on loans, interest on investment securities, service charges on deposits
and other customer service fees. No single customer accounts for a significant
amount of the revenues of either reportable segment.
TSFG evaluates performance based on budget to actual comparisons and
segment profits. The accounting policies of the reportable segments are the same
as those described in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2002.
Segment information (in thousands) is shown in the table below. The
"Other" column includes all other business activities that did not meet the
quantitative thresholds and therefore are not shown as a reportable segment.
12
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
Three Months Ended March 31, 2003
Net interest income $ 52,024 $ 14,987 $ (1,540) $ - $ 65,471
Provision for loan losses 3,498 1,990 12 - 5,500
Noninterest income 15,045 2,931 15,218 (13,308) 19,886
Noninterest expenses 32,620 13,005 16,573 (13,308) 48,890
Amortization of intangibles (a) 315 390 - - 705
Merger-related costs (a) 323 1,174 - - 1,497
Income tax expense 10,135 937 (1,162) - 9,910
Minority interest in consolidated
subsidiary, net of tax (1,012) - - - (1,012)
Net income 19,804 1,986 (1,745) - 20,045
MARCH 31, 2003
Total assets $ 6,875,479 $2,109,116 $ 933,540 $ (952,924) $ 8,965,211
Loans 3,426,218 1,183,564 100,029 (134,476) 4,575,335
Deposits 3,475,736 1,281,489 - (21,510) 4,735,715
THREE MONTHS ENDED MARCH 31, 2002
Net interest income $ 46,255 $ 6,470 $ (1,333) $ - $ 51,392
Provision for loan losses 4,150 2,079 9 - 6,238
Noninterest income 9,006 942 14,590 (12,900) 11,638
Noninterest expenses 27,428 4,520 15,804 (12,900) 34,852
Amortization of intangibles (a) 239 - - - 239
Income tax expense 7,445 372 (818) - 6,999
Minority interest in consolidated
subsidiary, net of tax (428) - - - (428)
Cumulative effect of change in accounting
principal, net of tax - - (1,406) - (1,406)
Net income 15,810 441 (3,144) - 13,107
MARCH 31, 2002
Total assets $ 5,337,437 $ 804,553 $ 627,213 $ (712,781) $ 6,056,422
Loans 3,169,152 672,594 37,315 (69,479) 3,809,582
Deposits 3,095,611 565,053 - (19,160) 3,641,504
(a) Included in noninterest expenses.
(14) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, except for the
consolidated balance sheet at December 31, 2002, which is derived from TSFG's
consolidated audited financial statements. In the opinion of management, all
adjustments necessary to present a fair statement of the results for the interim
periods have been made. All such adjustments are of a normal, recurring nature.
13
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis are presented to assist in
understanding the financial condition and results of operations of The South
Financial Group, Inc. and its subsidiaries (collectively, "TSFG"). TSFG may also
be referred to herein as "we", "us", or "our", except where the context requires
otherwise. This discussion should be read in conjunction with the consolidated
financial statements and the supplemental financial data appearing in this
report as well as the Annual Report of TSFG on Form 10-K for the year ended
December 31, 2002. Results of operations for the three months ended March 31,
2003 are not necessarily indicative of results that may be attained for any
other period. Percentage calculations contained herein have been calculated
based upon actual, not rounded, results.
TSFG, a South Carolina corporation headquartered in Greenville, South
Carolina, is a financial holding company, which commenced banking operations in
December 1986, and at March 31, 2003 conducted business through 76 locations in
South Carolina, 5 locations in North Carolina and 34 locations in northern and
central Florida. TSFG operates principally through two wholly-owned subsidiary
banks: Carolina First Bank, a South Carolina chartered commercial bank, and
Mercantile Bank, a Florida chartered commercial bank (which are collectively
referred to as the "Subsidiary Banks"). TSFG's subsidiaries provide a full range
of financial services, including asset management, investments, insurance,
mortgage, and trust services, designed to meet substantially all of the
financial needs of its customers.
FORWARD-LOOKING STATEMENTS AND NON-GAAP FINANCIAL INFORMATION
This report contains certain forward-looking statements (as defined in
the Private Securities Litigation Reform Act of 1995) to assist in the
understanding of anticipated future operating and financial performance, growth
opportunities, growth rates, and other similar forecasts and statements of
expectations. These forward-looking statements reflect current views, but are
based on assumptions and are subject to risks, uncertainties, and other factors,
which may cause actual results to differ materially from those in such
statements. These factors include, but are not limited to, the following:
o risks from changes in economic, monetary policy, and industry
conditions;
o changes in interest rates, deposit rates, the net interest margin, and
funding sources;
o market risk and inflation;
o risks inherent in making loans including repayment risks and value of
collateral;
o loan growth, the adequacy of the allowance for loan losses, the
assessment of problem loans, and the Rock Hill Bank & Trust Workout
loans;
o level, composition, and repricing characteristics of the securities
portfolio;
o fluctuations in consumer spending;
o competition in the banking industry and demand for our products and
services;
o dependence on senior management;
o technological changes;
o ability to increase market share;
o expense projections;
o risks associated with income taxes, including the potential for
adverse adjustments;
o acquisitions, related cost savings, expected financial results, and
unanticipated integration issues;
o significant delay or inability to execute strategic initiatives
designed to grow revenues;
o changes in accounting policies and practices;
o costs and effects of litigation; and
o recently-enacted or proposed legislation.
Such forward-looking statements speak only as of the date on which such
statements are made. We undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made to reflect the occurrence of unanticipated events. In
addition, certain statements in future filings by TSFG with the Securities and
Exchange Commission, in press releases, and in oral and written statements made
by or with the approval of TSFG, which are not statements of historical fact,
constitute forward-looking statements.
This report also contains financial information determined by methods
other than in accordance with Generally Accepted Accounting Principles ("GAAP").
TSFG's management uses these non-GAAP measures in their analysis of TSFG's
performance. In particular, a number of credit quality measures presented adjust
14
GAAP information to exclude the effects of certain identified problems loans
purchased from Rock Hill Bank & Trust (the "Rock Hill Workout Loans").
Management believes presentations of credit quality measures excluding the Rock
Hill Workout Loans assist in identifying core credit quality measures and
trends. These disclosures should not be viewed as a substitute for GAAP
operating results, and furthermore, TSFG's non-GAAP measures may not necessarily
be comparable to non-GAAP performance measures of other companies.
CRITICAL ACCOUNTING POLICIES
TSFG's accounting policies are in accordance with accounting principles
generally accepted in the United States and with general practice within the
banking industry. The more critical accounting policies include TSFG's
accounting for securities, loans, allowance for loan losses, intangibles, and
income taxes. In particular, TSFG considers its policies regarding the allowance
for loan losses and income taxes to be its most critical accounting policies due
to the significant degree of management judgment. Different assumptions in the
application of these policies could result in material changes in TSFG's
consolidated financial statements. For additional discussion concerning TSFG's
allowance for loan losses and related matters, see "Balance Sheet Review -
Allowance for Loan Losses."
ACQUISITIONS
The following table summarizes TSFG's acquisitions completed during the
past two years. All the acquisitions, except for Gardner Associates, Inc., an
insurance agency, were bank acquisitions. All of the transactions were accounted
for using the purchase method of accounting, and accordingly, the assets and
liabilities were recorded at their estimated fair values, which are subject to
adjustment, as of the acquisition date. TSFG's consolidated financial statements
include the results of the acquired company's operations since the acquisition
date.
TABLE 1
- --------------------------------------------------------------------------------------------------------------------
SUMMARY OF COMPLETED ACQUISITIONS
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
PURCHASE IDENTIFIABLE
ACQUISITION TOTAL SHARES PRICE PAID INTANGIBLE
DATE ASSETS ISSUED IN CASH ASSETS GOODWILL
---- ------ ------ ------- ------ --------
Central Bank of Tampa
Tampa, Florida 12/31/02 $ 223,223 (1) 3,241,737 $ - $ 2,700 - $ 36,081
Rock Hill Bank and Trust
Rock Hill, South Carolina 10/31/02 204,815 (1) 430,017 - (2) 1,204 25,571
Gardner Associates, Inc.
Columbia, South Carolina 09/20/02 1,312 (1) 249,011 (3) - 1,521 1,934
Gulf West Banks, Inc.
St. Petersburg, Florida 08/31/02 530,296 (1) 3,925,588 32,400 8,424 71,475
(1) Book value at the acquisition date.
(2) TSFG agreed to pay a cash earnout based on collection and recoveries with
respect to certain loans.
(3) Of this amount, up to 70,779 of these shares are subject to forfeiture back
to TSFG if certain five-year financial performance targets are not met.
On December 31, 2002, TSFG acquired Central Bank of Tampa ("CBT"), a
community bank headquartered in Tampa, Florida. CBT operated through 5 branches
in Tampa. This merger advances TSFG's strategy to expand in markets with
relatively high population and per capita income growth prospects.
On October 31, 2002, TSFG acquired substantially all of the assets and
deposits of Rock Hill Bank & Trust ("Rock Hill Bank"), which was a wholly-owned
banking subsidiary of RHBT Financial Corporation ("RHBT"). Rock Hill Bank
operated 3 branches in York County, South Carolina. Under the asset sale
agreement, Rock Hill Bank received 430,017 shares of TSFG common stock, plus the
right to receive a cash earnout essentially equal to 30% of the net improvement
15
in the aggregate charge-offs and reserves in a specified loan pool and 50% of
net amounts recovered under RHBT's blanket bond insurance policy with respect to
such loans. TSFG owned approximately 22% of RHBT's outstanding stock. In
connection with the distribution of TSFG common stock to RHBT shareholders, TSFG
received 95,575 shares, which were immediately cancelled.
On September 20, 2002, TSFG acquired Gardner Associates, Inc. ("Gardner
Associates"), an independent insurance agency based in Columbia, South Carolina.
TSFG intends to use Gardner Associates to build its insurance operations in the
Midlands area of South Carolina. As of March 31, 2003, TSFG issued 156,426
shares of TSFG common stock to acquire Gardner Associates and 21,806 shares
under an earnout provision. In addition, the principals of Gardner Associates
have the right to receive a maximum of 70,779 shares of TSFG common stock, which
has been issued and deposited in an escrow account, under earnout provisions
based on Gardner Associates' five-year financial performance.
On August 31, 2002, TSFG acquired Gulf West Banks, Inc. ("Gulf West"), a
bank holding company headquartered in St. Petersburg, Florida. Gulf West
operated through Mercantile Bank, a Florida-chartered, non-member bank with 15
locations in the Tampa Bay area of Florida. This merger represents TSFG's first
banking locations in the Tampa Bay area and advances TSFG's strategy to expand
in markets with relatively high population and per capita income growth
prospects. Upon acquiring Gulf West, TSFG combined all of its Florida operations
under the Mercantile Bank name.
Acquisition Completed Subsequent to Quarter-End
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. API
services over 250 corporate accounts and manages in excess of $200 million in
plan assets. Net assets of API at April 30, 2003 totaled $56,000, and total
revenues for the year ended December 31, 2002 were $1.9 million. TSFG issued
146,808 shares of common stock valued at approximately $3.5 million at closing.
In addition, the shareholders of API have the right to receive common stock with
a maximum value of approximately $2.2 million under earnout provisions based on
API's five-year financial performance. This transaction was accounted for using
the purchase method of accounting.
OVERVIEW
Net income for the three months ended March 31, 2003 totaled $20.0
million, an increase of 52.9% compared with $13.1 million for the three months
ended March 31, 2002. Earnings per diluted share for the first three months of
2003 totaled $0.42, a 35.5% increase from $0.31 per diluted share in the first
three months of 2002. Higher net interest income, fee income initiatives, a
lower provision for loan losses, and gains on sales of securities and equity
investments contributed to the increases in net income and earnings per diluted
share. Net interest income increased from 34.6% growth in average earning
assets. Key factors responsible for TSFG's results of operations are discussed
throughout Management's Discussion and Analysis below.
Noninterest income for the three months ended March 31, 2003 and 2002
included pre-tax gains on asset sales of $2.9 million and $40,000, respectively.
Gains on asset sales include gains on available for sale securities and equity
investments. Mortgage banking income, a component of noninterest income,
includes gains and losses on the sale of mortgage loans and charges for the
write-down in the value of capitalized mortgage servicing rights. See "Earnings
Review - Noninterest Income" for details. Noninterest expenses for the first
three months of 2003 included $1.5 million in pre-tax merger-related costs.
In the third quarter 2002, TSFG recorded a $1.4 million charge related
to impairment of goodwill associated with Carolina First Mortgage Company, which
is shown as a cumulative effect of change in accounting principle. In accordance
with the accounting rules, this change was recorded as of January 1, 2002 and
therefore is shown in the first quarter 2002.
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income. The net
impact of these adjustments for the first quarter 2002, which restated the
financial results for the quarter, was to increase net income by $316,000, or
$0.01 per diluted share.
Average common shares outstanding on a diluted basis were 48.3 million
in the first three months of 2003, up 14.7% from 42.1 million for the first
three months of 2002, due to shares issued for acquisitions completed in 2002.
In connection with share repurchase programs, TSFG repurchased and cancelled
1,266,308 shares during the first three months of 2003.
16
At March 31, 2003, TSFG had $9.0 billion in assets, $4.6 billion in
loans, $4.7 billion in deposits, and $635.0 million in shareholders' equity. For
the three months ended March 31, 2003, TSFG's average assets totaled $8.4
billion, an increase of $2.3 billion, or 36.7%, compared with the first quarter
2002 average of $6.1 billion.
BALANCE SHEET REVIEW
Loans
TSFG focuses its lending activities on small and middle market
businesses and individuals in its geographic markets. At March 31, 2003,
outstanding loans totaled $4.6 billion, which equaled 96.6% of total deposits
and 51.0% of total assets. The major components of the loan portfolio were
commercial loans, commercial real estate loans, consumer loans (including both
direct and indirect loans), and one-to-four family residential mortgage loans.
Substantially all loans were to borrowers located in TSFG's South Carolina,
North Carolina, and Florida market areas. The portfolio contains no "highly
leveraged transactions," as defined by regulatory authorities.
Loans held for investment increased $735.5 million, or 19.5%, to $4.5
billion at March 31, 2003 from $3.8 billion at March 31, 2002. In 2002, $582.8
million in loans held for investment were acquired in mergers with CBT, Rock
Hill Bank, and Gulf West, accounting for approximately 80% of the increase.
During the first three months of 2003, loans held for investment increased $81.1
million, or 1.8%. The majority of the first quarter 2003 loan growth, annualized
at 7.3%, was in commercial, home equity and indirect consumer loans. While
originations of residential mortgage loans increased, most of these loans were
sold at origination in the secondary market.
Loans held for sale increased $30.3 million to $60.2 million at March
31, 2003 from $29.9 million at March 31, 2002. Mortgage loan originations were
higher in the current period, which increased the inventory of loans in process.
Also, certain commercial real estate loans acquired from Gulf West, which
totaled $8.9 million at March 31, 2003, were designated for sale at acquisition.
During the first three months of 2003, loans held for sale decreased $8.8
million, primarily from the sale of two commercial real estate loans acquired
from Gulf West.
Table 2 summarizes outstanding loans by collateral type for real estate
secured loans and by borrower type for all other loans. Collateral type
represents the underlying assets securing the loan, rather than the purpose of
the loan.
17
TABLE 2
- -----------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- -----------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial, financial and agricultural $ 952,877 $ 778,257 $ 913,368
Real estate - construction (1) 558,406 543,358 570,265
Real estate - residential mortgages (1-4 family) 657,509 515,593 643,941
Commercial secured by real estate (1) 1,792,969 1,418,954 1,765,103
Consumer 553,267 523,173 541,210
Lease financing receivables 105 347 124
----------- ----------- -----------
Loans held for investment 4,515,133 3,779,682 4,434,011
Loans held for sale 60,202 29,900 67,218
Less: allowance for loan losses 66,133 45,208 70,275
----------- ----------- -----------
Total net loans $ 4,509,202 $ 3,764,374 $ 4,430,954
=========== =========== ===========
Percentage of loans held for investment
Commercial, financial and agricultural 21.1 % 20.6 % 20.6 %
Real estate - construction (1) 12.4 14.4 12.9
Real estate - residential mortgages (1-4 family) 14.6 13.6 14.5
Commercial secured by real estate (1) 39.6 37.6 39.8
Consumer 12.3 13.8 12.2
Lease financing receivables - - -
------ ------ ------
Total 100.0 % 100.0 % 100.0 %
====== ====== =======
(1) These categories include loans to businesses other than real estate
companies where owner-occupied real estate is pledged on loans to finance
operations, equipment, and facilities.
Table 3 provides a stratification of the loan portfolio by loan purpose.
This presentation differs from that in Table 2, which stratifies the portfolio
by collateral type and borrower type.
18
TABLE 3
- -----------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION BASED ON LOAN PURPOSE
- -----------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial loans
Commercial and industrial $ 1,188,782 $ 1,013,706 $ 1,178,955
Owner - occupied real estate 724,685 633,003 733,819
Commercial real estate 1,463,330 1,167,532 1,420,252
----------- ----------- -----------
3,376,797 2,814,241 3,333,026
----------- ----------- -----------
CONSUMER LOANS
Indirect - sales finance 448,253 363,197 420,294
Direct retail 274,290 300,515 273,419
Home equity 261,311 174,854 243,648
----------- ----------- -----------
983,854 838,566 937,361
----------- ----------- -----------
MORTGAGE LOANS 154,482 126,875 163,624
----------- ----------- -----------
Total loans held for investment $ 4,515,133 $ 3,779,682 $ 4,434,011
=========== =========== ===========
PERCENTAGE OF LOANS HELD FOR INVESTMENT
Commercial and industrial 26.3 % 26.8 % 26.6 %
Owner - occupied real estate 16.1 16.7 16.6
Commercial real estate 32.4 30.9 32.0
Consumer 21.8 22.2 21.1
Mortgage 3.4 3.4 3.7
------ ------ ------
Total 100.0 % 100.0 % 100.0 %
====== ====== ======
Commercial and industrial loans are loans to finance short-term and
intermediate-term cash needs of businesses. Typical needs include the need to
finance seasonal or other temporary cash flow imbalances, growth in working
assets created by sales growth, and purchases of equipment and vehicles. Credit
is extended in the form of short-term single payment loans, lines of credit for
periods up to a year, revolving credit facilities for periods up to five years,
and amortizing term loans for periods up to ten years.
Owner-occupied real estate loans are loans to finance the purchase or
expansion of operating facilities used by businesses not engaged in the real
estate business. Typical loans are loans to finance offices, manufacturing
plants, warehouse facilities, and retail shops. Depending on the property type
and the borrower's cash flows, amortization terms vary from 10 years up to 20
years. Although secured by mortgages on the properties financed, these loans are
underwritten based on the cash flows generated by operations of the businesses
they house.
Commercial real estate loans are loans to finance real properties that
are acquired, developed, or constructed for sale or lease to parties unrelated
to the borrower. Included are loans to acquire land for development, land
development loans, construction loans, mini-perms for cash flow stabilization
periods, and permanent loans in situations where access to the secondary market
is limited due to loan size.
Indirect sales finance loans are loans to individuals to finance the
purchase of automobiles. They are closed at the auto dealership but approved in
advance by TSFG for immediate purchase. Loans are extended on new and used autos
with terms varying from 2 years up to 5 years.
Direct consumer loans are loans to individuals to finance personal,
family, or household needs. Typical loans are loans to finance auto purchases,
home repairs and additions, and home purchases. These loans are made by TSFG
employees in its branches.
19
Home equity loans are loans to home-owners, secured by junior mortgages
on their primary residences, to finance personal, family, or household needs.
These loans may be in the form of amortizing loans or lines of credit with terms
up to 15 years.
Mortgage loans are loans to individuals, secured by first mortgages on
single family residences, to finance the acquisition of those residences. These
loans, originated by TSFG's mortgage lending division, do not qualify for
immediate sale but are judged to be sellable with seasoning. They are
underwritten to secondary market standards and are sold, from time to time, as
they become sellable to secondary market investors.
The portfolio's only significant industry concentration is in commercial
real estate loans. All other industry concentrations are less than 10% of total
loans. Commercial real estate loans were 32.4% of loans held for investment at
March 31, 2003. Due to sustained strong population growth and household income
growth, real estate development and construction are major components of the
economic activity in TSFG's markets. The risk attributable to this concentration
is managed by lending in our markets, where we are familiar with real estate
market conditions, to borrowers we know well, who have proven track records and
possess the financial means to weather reverses in this industry. TSFG does not
make loans without recourse to the borrower, loans without personal guarantees
from the owners, or loans to cash out equity in commercial properties.
Consequently, although the analysis of reserve adequacy includes an adjustment
to account for the risk inherent in this concentration, management believes the
risk of loss in its commercial real estate loans is not materially greater than
the risk of loss in any other segment of the portfolio.
At March 31, 2003, the loan portfolio included commitments totaling
$138.0 million in "shared national credits" (multi-bank credit facilities of $20
million or more). Outstandings under these commitments totaled $79.6 million. By
policy, we participate in shared national credits only if the borrower is
headquartered in our market, the borrower is in an industry familiar to us, we
meet directly with the borrower to conduct our analysis, and the borrower agrees
to establish an ongoing banking relationship with us. One of these credits, in
which our commitment totals $1.1 million, is on our internal watch list;
however, none of these credit facilities were classified in the most recent
shared national credits examinations conducted by the regulatory agencies.
Credit Quality
A willingness to take credit risk is inherent in the decision to grant
credit. Prudent risk-taking requires a credit risk management system based on
sound policies and control processes that ensure compliance with those policies.
TSFG's credit risk management system is defined by policies approved by the
Board of Directors that govern the risk underwriting, portfolio monitoring, and
problem loan administration processes. Adherence to underwriting standards is
managed through a multi-layered credit approval process and immediate
after-the-fact review by credit risk management of loans approved by lenders.
Through daily review by credit risk managers, monthly reviews of exception
reports, and ongoing analysis of asset quality trends, compliance with
underwriting and loan monitoring policies is closely supervised. The
administration of problem loans is driven by policies that require written plans
for resolution and quarterly meetings with credit risk management to review
progress. Credit risk management activities are monitored by Credit Committees
of each banking subsidiary's Board of Directors, which meet monthly to review
credit quality trends, new large credits, loans to insiders, large problem
credits, credit policy changes, and reports on independent credit audits of
branch offices.
To facilitate comparisons, Table 4 presents credit quality indicators
two ways: one that includes all loans and one that excludes the Rock Hill
Workout Loans. On October 31, 2002, loans totaling $191.3 million were acquired
from Rock Hill Bank. Prior to the closing and in connection with identified
problem loans, Rock Hill Bank had charged off a significant portion of its loan
portfolio and established additional reserves. At closing, TSFG segregated
certain identified problem loans into a separately-managed portfolio, referred
to as the "Rock Hill Workout Loans." At March 31, 2003, this portfolio totaled
$63.6 million, down from $72.4 million at December 31, 2002, with an allowance
for loan losses of $11.6 million. Nonperforming assets for the Rock Hill Workout
Loans at March 31, 2003 were $32.8 million. Net loan charge-offs for the first
quarter 2003, which were included in the allowance for loan losses as of
December 31, 2002, totaled $4.1 million. TSFG expects nonperforming assets and
the allowance for loan losses to decline as the Rock Hill Workout Loans are
liquidated or otherwise resolved. Where appropriate, TSFG has provided credit
quality measures excluding the Rock Hill Workout Loans to identify core credit
quality measures and trends.
Table 4 presents information pertaining to nonperforming assets.
20
TABLE 4
- -------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Nonaccrual loans - commercial $ 58,114 $ 40,521 $ 61,206
Nonaccrual loans - consumer 2,865 2,965 2,384
Restructured loans - - -
Total nonperforming loans 60,979 43,486 63,590
Other real estate owned 10,836 7,143 10,596
---------- ----------- ----------
Total nonperforming assets $ 71,815 $ 50,629 $ 74,186
========== =========== ==========
Loans past due 90 days still accruing interest (1) $ 3,652 $ 9,532 $ 5,414
========== =========== ==========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 1.59 % 1.34 % 1.67 %
========== =========== ==========
Allowance for loan losses as a percentage of nonperforming loans 1.08 x 1.04 x 1.11 x
========== =========== ==========
EXCLUDING THE ROCK HILL WORKOUT LOANS
Loans held for investment $4,451,498 $ 3,779,682 $ 4,361,658
Allowance for loan losses 54,514 45,208 53,979
Total nonperforming loans 28,254 43,486 34,596
Other real estate owned 10,751 7,143 10,422
---------- ----------- ----------
Total nonperforming assets $ 39,005 $ 50,629 $ 45,018
========== =========== ==========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 0.87 % 1.34 % 1.03 %
========== =========== ==========
Allowance for loan losses as a percentage of nonperforming loans 1.93 x 1.04 x 1.56 x
========== =========== ==========
(1) All of these loans are consumer and residential mortgage loans.
(2) Calculated using loans held for investment.
Note: Nonperforming assets exclude personal property repossessions, which
totaled $1.0 million, $1.2 million, and $1.3 million, at March 31, 2003, March
31, 2002, and December 31, 2002, respectively.
CREDIT QUALITY INCLUDING ROCK HILL WORKOUT LOANS. Nonperforming assets
declined to 1.59% of loans and other real estate owned at March 31, 2003 from
1.67% at December 31, 2002. Net loan charge-offs increased to 0.85% of average
loans for the first quarter 2003 from 0.37% for the fourth quarter 2002,
primarily due to the disposition of fully-reserved Rock Hill Workout Loans and
the liquidation of fully-reserved nonperforming loans. As anticipated, the
allowance for loan losses declined to 1.46% of period-end loans at March 31,
2003 from 1.58% at December 31, 2002.
CREDIT QUALITY EXCLUDING ROCK HILL WORKOUT LOANS. Core nonperforming
assets (which exclude the Rock Hill Workout Loans) declined 13% to 0.87% of
loans and other real estate owned at March 31, 2003 from 1.03% at December 31,
2002. This ratio has declined every quarter-end since its peak of 1.34% at March
31, 2002. Net loan charge-offs increased from $4.4 million for the fourth
quarter 2002 to $5.5 million for the first quarter 2003, or from 0.41% to 0.50%
of average loans, as write-downs of $1.5 million were incurred to liquidate
nonperforming loans with allocated reserves of $2.1 million. The allowance for
loan losses declined slightly as a percent of loans held for investment, from
1.24% at December 31, 2002 to 1.22% at March 31, 2003, but increased from 1.56
times to 1.93 times nonperforming loans for the quarter-ends. Loans past due 90
days and still accruing interest showed continued improvement during the first
quarter 2003.
Certain of the Rock Hill Workout Loans are defined as "designated
loans" under the Rock Hill Bank purchase agreement ("Designated Loans") and are
subject to earnout provisions. The total principal amount owed by the borrowers
for Designated Loans was $45.2 million, of which $19.5 million had been charged
off or reserved prior to acquisition by TSFG. To the extent that principal
collections on these Designated Loans exceed $25.7 million through the
termination date of the earnout agreement, TSFG will pay the RHBT shareholders
21
30% of such excess. The net effect is to pay RHBT shareholders 30% of the net
recoveries on these loans from charge-off collections and reserve reductions.
Through March 31, 2003, total charge-offs and reserves on the Designated loans
exceeded the amount that would require a payment under the earnout agreement.
Future credit quality trends depend primarily on the direction of the
economy, and current economic data do not provide a clear signal of that
direction. Until the business climate improves, we expect portfolio quality
indicators to remain volatile, nonperforming asset levels to fluctuate, and
charge-offs to be higher than historical norms. Management believes, however,
that loss exposure in its loan portfolio is identified, adequately reserved for
in a timely manner, and closely monitored to ensure that changes are promptly
addressed in its analysis of allowance for loan loss adequacy. Accordingly,
management believes the allowance for loan losses as of March 31, 2003 was
adequate, based on its assessment of probable losses, and available facts and
circumstances then prevailing.
The following summarizes information on impaired loans (in thousands),
all of which are in nonaccrual status, at and for the three months ended March
31. All impaired loans are commercial loans.
2003 2002
---- -----
Impaired loans $ 58,114 $ 40,521
Impaired loans, excluding the Rock Hill Workout Loans 25,389 40,521
Average investment in impaired loans 61,585 40,219
Related allowance 14,751 4,409
Related allowance, excluding the Rock Hill Workout Loans 6,176 4,409
Recognized interest income - 120
Foregone interest 1,361 892
Allowance for Loan Losses
The adequacy of the allowance for loan losses (the "Allowance") is
analyzed quarterly. For purposes of this analysis, adequacy is defined as a
level sufficient to absorb probable losses in the portfolio. The methodology
employed for this analysis is discussed below.
The portfolio is segregated into risk-similar segments for which
historical loss ratios are calculated and adjusted for identified changes in
current portfolio characteristics. Historical loss ratios are calculated by
product type for consumer loans (direct installment, indirect installment,
revolving, and mortgage) and by credit risk grade for performing commercial
loans. Nonperforming commercial loans are individually assessed for impairment
under SFAS 114 and assigned specific allocations. To allow for modeling error, a
range of probable loss ratios (from 95% to 105% of the adjusted historical loss
ratio) is then derived for each segment. The resulting percentages are then
applied to the dollar amounts of loans in each segment to arrive at each
segment's range of probable loss levels.
The Allowance for each portfolio segment is set at an amount within its
range that reflects management's best judgment of the extent to which historical
loss levels are more or less accurate indicators of current losses in the
portfolio. Management's judgments evolve from an assessment of various issues,
including but not limited to the pace of loan growth, emerging portfolio
concentrations, risk management system changes, entry into new markets, new
product offerings, loan portfolio quality trends, and uncertainty in current
economic and business conditions.
The Allowance is then segregated into allocated and unallocated
components. The allocated component is the sum of the loss estimates at the
lower end of the probable loss range for each category. The unallocated
component is the sum of the amounts by which final loss estimates exceed the
lower end estimates for each category. The unallocated component of the
Allowance represents probable losses inherent in the portfolio based on our
analysis that are not fully captured in the allocated component. Allocation of
the Allowance to respective loan portfolio components is not necessarily
indicative of future losses or future allocations. The entire Allowance is
available to absorb losses in the loan portfolio.
Assessing the adequacy of the Allowance is a process that requires
considerable judgment. Management's judgments are based on numerous assumptions
about current events, which we believe to be reasonable, but which may or may
not be valid. Thus, there can be no assurance that loan losses in future periods
will not exceed the current Allowance amount or that future increases in the
Allowance will not be required. No assurance can be given that management's
ongoing evaluation of the loan portfolio in light of changing economic
22
conditions and other relevant circumstances will not require significant future
additions to the Allowance, thus adversely affecting the operating results of
TSFG.
The Allowance is also subject to examination and adequacy testing by
regulatory agencies, which may consider such factors as the methodology used to
determine adequacy and the size of the Allowance relative to that of peer
institutions, and other adequacy tests. In addition, such regulatory agencies
could require us to adjust our Allowance based on information available to them
at the time of their examination.
The Allowance totaled $66.1 million, or 1.46% of loans held for
investment, at March 31, 2003, a significant increase from $45.2 million, or
1.20%, at March 31, 2002. Nonperforming loans totaled $61.0 million at March 31,
2003, an increase of $17.5 million from $43.5 million at March 31, 2002. These
increases were the result of the acquisition of loans from Rock Hill Bank,
partially offset by lower core nonperforming loans. Excluding the $32.7 million
of nonperforming loans related to the Rock Hill Workout Loans, nonperforming
loans declined to $28.3 million at March 31, 2003 from $43.5 million at March
31, 2002 (to 0.63% from 1.15% of loans held for investment), and the Allowance
increased to $54.5 million at March 31, 2003 from $45.2 million at March 31,
2002 (to 1.22% from 1.20% of loans held for investment). See "Credit Quality."
Table 5, which summarizes the changes in the Allowance, provides
additional information with respect to the activity in the Allowance. While
uncertainty in the current economic outlook makes future charge-off levels less
predictable, management does not expect losses to increase significantly over
the next several quarters. As a percentage of average loans, losses in 2003 are
expected to be comparable to 2002 losses. However, the economic outlook remains
highly uncertain, and future charge-off levels may therefore fluctuate above or
below that average from quarter to quarter.
TABLE 5
- -------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
AT AND FOR
THE THREE MONTHS AT AND FOR
ENDED MARCH 31, THE YEAR ENDED
-------------------------------- DECEMBER 31,
2003 2002 2002
---- ---- ----
Allowance for loan losses, beginning of year $ 70,275 $ 44,587 $ 44,587
Purchase accounting adjustments - - 22,973
Allowance adjustment for loans sold - - (12)
Net charge-offs:
Loans charged-off (10,308)