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 June 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
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 August 1, 2003 was 46,979,991.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30,
---------------------------
RESTATED
2003 2002 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2002
----------- ----------- ----
Assets
Cash and due from banks $ 212,445 $ 137,925 $ 201,333
Interest-bearing bank balances 64,738 40,532 58,703
Federal funds sold 50,000 - 31,293
Securities
Trading 2,197 2,244 350
Available for sale 3,513,173 1,575,324 2,488,944
Held to maturity (market value $71,410, $81,585 and $85,371,
respectively) 68,495 79,671 82,892
----------- ---------- ----------
Total securities 3,583,865 1,657,239 2,572,186
----------- ---------- ----------
Loans
Loans held for sale 60,661 19,636 67,218
Loans held for investment 4,688,591 3,914,789 4,434,011
Allowance for loan losses (64,152) (46,985) (70,275)
----------- ---------- ----------
Net loans 4,685,100 3,887,440 4,430,954
----------- ---------- ----------
Premises and equipment, net 132,966 112,992 137,501
Accrued interest receivable 41,828 38,242 37,080
Intangible assets 245,007 95,255 242,182
Other assets 241,900 193,962 229,778
----------- ----------- ----------
$ 9,257,849 $ 6,163,587 $7,941,010
=========== =========== ==========
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing $ 814,945 $ 553,579 $ 743,174
Interest-bearing 4,306,394 3,170,038 3,849,336
----------- ----------- ----------
Total deposits 5,121,339 3,723,617 4,592,510
Federal funds purchased and repurchase agreements 702,792 1,199,898 1,110,840
Other short-term borrowings 42,452 73,852 81,653
Long-term debt 2,287,784 502,866 1,221,511
Debt associated with trust preferred securities 95,500 31,000 95,500
Accrued interest payable 21,799 23,882 20,945
Other liabilities 239,343 50,544 84,840
----------- ----------- ----------
Total liabilities 8,511,009 5,605,659 7,207,799
----------- ----------- ----------
Minority interest in consolidated subsidiary 86,616 86,471 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 46,896,994, 40,341,762 and
47,347,375 shares, respectively 46,897 40,342 47,347
Surplus 412,608 290,685 427,448
Retained earnings 180,601 132,060 150,948
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (2,937) (1,624) (3,094)
Common stock held in trust for deferred compensation (147) - -
Deferred compensation payable in common stock 147 - -
Accumulated other comprehensive income, net of tax 23,055 9,994 24,150
----------- ----------- ----------
Total shareholders' equity 660,224 471,457 646,799
----------- ----------- ----------
$ 9,257,849 $ 6,163,587 $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 SIX MONTHS ENDED
JUNE 30, JUNE 30,
RESTATED RESTATED
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Interest and fees on loans $ 68,325 $ 64,198 $ 135,658 $ 126,358
Interest and dividends on securities
Taxable 30,937 21,217 61,236 42,784
Exempt from Federal income taxes 1,105 1,064 2,326 2,155
-------- -------- --------- ---------
Total interest and dividends on securities 32,042 22,281 63,562 44,939
Interest on short-term investments 212 218 330 687
-------- -------- --------- ---------
Total interest income 100,579 86,697 199,550 171,984
-------- -------- --------- ---------
Interest expense
Interest on deposits 18,335 21,253 36,334 42,829
Interest on borrowed funds 16,072 12,847 31,573 25,166
-------- -------- --------- ---------
Total interest expense 34,407 34,100 67,907 67,995
-------- -------- --------- ---------
Net interest income 66,172 52,597 131,643 103,989
Provision for loan losses 5,200 6,244 10,700 12,482
-------- -------- --------- ---------
Net interest income after provision for loan losses 60,972 46,353 120,943 91,507
Noninterest income 23,975 13,422 43,861 25,060
Noninterest expenses 50,095 35,792 98,985 70,644
-------- -------- --------- ---------
Income before income taxes, minority interest, and
cumulative effect of change in accounting principle 34,852 23,983 65,819 45,923
Income taxes 11,153 7,886 21,063 14,885
-------- -------- --------- ---------
Income before minority interest and cumulative
effect of change in accounting principle 23,699 16,097 44,756 31,038
Minority interest in consolidated subsidiary, net of tax (1,000) (758) (2,012) (1,186)
-------- -------- --------- ---------
Income before cumulative effect of change in
accounting principle 22,699 15,339 42,744 29,852
Cumulative effect of change in accounting principle, net of tax - - - (1,406)
-------- -------- --------- ---------
Net income $ 22,699 $ 15,339 $ 42,744 $ 28,446
======== ======== ========= =========
Average common shares outstanding, basic 46,629,666 40,217,873 46,975,635 40,699,166
Average common shares outstanding, diluted 47,760,781 41,232,890 48,007,767 41,646,176
Per common share, basic:
Net income before cumulative effect of change in accounting principle $ 0.49 $ 0.38 $ 0.91 $ 0.73
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
-------- -------- --------- ---------
Net income $ 0.49 $ 0.38 $ 0.91 $ 0.70
======== ======== ========= =========
Per common share, diluted:
Net income before cumulative effect of change in accounting principle $ 0.48 $ 0.37 $ 0.89 $ 0.71
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
-------- -------- --------- ---------
Net income $ 0.48 $ 0.37 $ 0.89 $ 0.68
======== ======== ========= =========
Cash dividends declared per common share $ 0.14 $ 0.12 $ 0.28 $ 0.24
======== ======== ========= =========
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) - - - 28,446 - 28,446
Other comprehensive gain,
net of tax of $7,766 - - - - 16,098 16,098
Comprehensive income - - - - - 44,544
Cash dividends declared
($0.24 per common share) - - - (9,674) - (9,674)
Common stock activity:
Repurchase of stock (1,135,600) (1,136) (24,181) - - (25,317)
Dividend reinvestment plan 34,244 34 648 - - 682
Employee stock purchase plan 5,331 6 98 - - 104
Restricted stock plan 59,096 59 1,583 (246) - 1,396
Exercise of stock options 149,715 150 1,196 - - 1,346
Miscellaneous - - 36 166 - 202
---------- ------- --------- --------- ------- ---------
Balance, June 30, 2002 (restated) 40,341,762 $40,342 $ 290,685 $ 130,436 $ 9,994 $ 471,457
========== ======= ========= ========= ======= =========
Balance, December 31, 2002 47,347,375 $47,347 $ 427,448 $ 147,854 $24,150 $ 646,799
Net income - - - 42,744 - 42,744
Other comprehensive loss,
net of tax of $1,472 - - - - (1,095) (1,095)
Comprehensive income - - - - - 41,649
Cash dividends declared
($0.28 per common share) - - - (13,091) - (13,091)
Common stock activity:
Repurchase of stock (1,272,805) (1,273) (27,285) - - (28,558)
Acquisitions 146,808 147 3,353 454 - 3,954
Dividend reinvestment plan 70,428 71 1,408 - - 1,479
Employee stock purchase plan 20,011 20 289 - - 309
Restricted stock plan 67,023 67 3,806 (317) - 3,556
Exercise of stock options 518,154 518 3,555 - - 4,073
Common stock purchased by trust
for deferred compensation - - - (147) - (147)
Deferred compensation payable in
common stock - - - 147 - 147
Miscellaneous - - 34 20 - 54
---------- ------- --------- --------- ------- ---------
Balance, June 30, 2003 46,896,994 $46,897 $ 412,608 $ 177,664 $ 23,055 $ 660,224
========== ======= ========= ========= ======= =========
* 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)
SIX MONTHS ENDED JUNE 30,
------------------------------------
2003 2002
---- ----
Cash flows from operating activities
Net income $ 42,744 $ 28,446
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, amortization, and accretion, net 26,824 15,068
Provision for loan losses 10,700 12,482
Gain on sale of available for sale securities (4,183) (215)
Gain on trading securities (96) (63)
(Gain) loss on equity investments (1,875) 139
Gain on disposition of assets and liabilities (601) -
Gain on sale of loans (4,065) (860)
Gain on disposition of premises and equipment (53) (40)
Loss on disposition of other real estate owned 351 405
Impairment loss from write-down of assets 449 -
Impairment loss (recovery) from write-down of mortgage servicing rights 496 (177)
(Gain) loss on derivative contracts (1,011) 37
Minority interest in consolidated subsidiary 2,012 1,186
Cumulative effect of change in accounting principle - 1,406
Trading account assets, net (1,751) (604)
Originations of loans held for sale (323,989) (222,152)
Sale proceeds and principal repayments from loans held for sale 327,159 209,909
Other assets, net (20,744) (4,401)
Other liabilities, net (3,750) 1,481
---------- --------
Net cash provided by operating activities 48,617 42,047
---------- --------
Cash flows from investing activities
Sale of securities available for sale 999,929 307,363
Maturity, call, or principal repayments from securities available for sale 1,440,730 670,869
Maturity or call of securities held to maturity 34,117 6,428
Purchase of available for sale securities (3,311,534) (971,207)
Purchase of securities held to maturity (19,797) (5,345)
Origination of loans held for investment, net (270,250) (198,586)
Sale of loans held for investment - 11,349
Sale of other real estate owned 7,788 2,874
Sale of premises and equipment 2,564 1,134
Capital expenditures (7,874) (5,660)
Disposition of assets and liabilities, net (5,738) -
Payment for purchase acquisitions (471) -
---------- --------
Net cash used for investing activities (1,130,536) (180,781)
---------- --------
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30,
------------------------------------
2003 2002
---- ----
Cash flows from financing activities
Deposits, net 537,782 116,024
Federal funds purchased and repurchase agreements, net (407,884) (69,640)
Short-term borrowings, net (39,787) (76,741)
Issuance of long-term debt 1,085,295 100,000
Payments of long-term debt (18,814) (8,428)
Issuance of minority interest stock, net - 49,448
Cash dividends paid (13,162) (9,780)
Cash dividends paid on minority interest (3,014) (1,376)
Repurchase of common stock (28,558) (25,317)
Other common stock activity 5,915 2,334
---------- ---------
Net cash provided by financing activities 1,117,773 76,524
---------- ---------
Net change in cash and cash equivalents 35,854 (62,210)
Cash and cash equivalents at beginning of year 291,329 240,667
---------- ---------
Cash and cash equivalents at end of period $ 327,183 $ 178,457
========== =========
Supplemental cash flow data
Interest paid $ 67,971 $ 63,587
Income taxes paid 19,431 16,894
Significant non-cash investing and financing transactions:
Security purchases settled subsequent to quarter-end (156,190) -
Unrealized gain (loss) on available for sale securities (248) 23,650
Loans transferred to other real estate owned 5,370 6,006
Premises and equipment, net transferred to long-lived assets held for sale 2,639 -
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 six months of 2002, which restated the financial results for the
period, was to increase net income by $613,000, or $0.01 per diluted share. By
quarter, net income increased $316,000 and $297,000 for the first and second
quarters of 2002, respectively.
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 six months 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 and $41,000 for the first and
second quarters of 2002, respectively.
For a summary of the quarterly financial data for first six months
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.
6
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. At June 30, 2003, TSFG recorded a liability of
$100,000 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.
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. Management does not
believe the provisions of this standard will have a material impact on results
of future operations.
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 creditors (or beneficial interest
holders) of a consolidated variable interest entity to the general creditor 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.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
Effective July 1, 2003, TSFG adopted SFAS No. 150, ("SFAS 150"),
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity," 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 circumstance. 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 Six Months Ended
June 30, June 30,
------------------------- -------------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Noninterest income
Service charges on deposit accounts $ 7,581 $ 5,421 $ 14,541 $ 10,328
Mortgage banking income 2,561 1,289 4,733 2,370
Fees for investment services 2,142 1,853 4,633 3,280
Bank-owned life insurance 1,933 1,803 3,881 3,609
Merchant processing income 2,071 1,715 3,407 2,963
Gain (loss) on derivative contracts 1,203 (24) 1,011 (37)
Gain on sale of available for sale securities 3,197 186 4,183 215
Gain on trading securities 24 33 96 63
Gain (loss) on equity investments - (150) 1,875 (139)
Gain on disposition of assets and liabilities 601 - 601 -
Other 2,662 1,296 4,900 2,408
-------- -------- -------- --------
Total noninterest income $ 23,975 $ 13,422 $ 43,861 $ 25,060
======== ======== ======== ========
Noninterest expenses
Salaries and wages $ 20,319 $ 13,589 $ 39,597 $ 27,225
Employee benefits 5,419 3,925 10,735 8,303
Occupancy 4,668 3,686 9,282 7,231
Furniture and equipment 4,211 3,483 8,805 7,079
Professional fees 1,822 1,150 3,360 2,516
Merchant processing expense 1,607 1,373 2,656 2,417
Telecommunications 1,168 886 2,238 1,569
Amortization of intangibles 724 240 1,429 479
Merger-related costs 382 - 1,879 -
Impairment loss from the write-down of assets 268 - 268 -
Other 9,507 7,460 18,736 13,825
-------- -------- -------- --------
Total noninterest expenses $ 50,095 $ 35,792 $ 98,985 $ 70,644
======== ======== ======== ========
8
(3) Other Comprehensive Income
The following summarizes accumulated other comprehensive income, net of
tax (in thousands) for the six months ended June 30:
2003 2002
---- ----
Unrealized gains on available for sale securities
Balance at beginning of year $ 24,382 $ (5,554)
Other comprehensive gain (loss):
Unrealized holding gains arising during the year 5,810 23,726
Income tax expense (3,445) (7,712)
Less: Reclassification adjustment for gains included in net income (6,058) (76)
Income tax expense 2,204 25
-------- --------
(1,489) 15,963
-------- --------
Balance at end of period 22,893 10,409
-------- --------
Unrealized gains (losses) on cash flow hedges
Balance at beginning of year (232) (550)
Other comprehensive income:
Unrealized gain on change in fair values 625 214
Income tax expense (231) (79)
-------- --------
394 135
-------- --------
Balance at end of period 162 (415)
-------- --------
$ 23,055 $ 9,994
======== ========
During the first six 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
MOUNTAINBANK FINANCIAL CORPORATION
In May 2003, TSFG signed a definitive agreement to acquire MountainBank
Financial Corporation ("MBFC"), headquartered in Hendersonville, North Carolina.
At June 30, 2003, MBFC operated primarily through 19 branches in western North
Carolina and had total assets of $959.1 million. At closing, TSFG will issue
shares of common stock in exchange for all the common stock, preferred stock,
and stock obligations of MBFC. This transaction, which is expected to close in
October 2003, will be accounted for using the purchase method of accounting and
is subject to regulatory and MBFC shareholder approvals.
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 $368,000, recorded a non-compete agreement intangible asset of
$350,000, recorded goodwill of $2.8 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
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 result in a constant effective yield over the life of the assets and
liabilities. This net amortization decreased net income before income taxes by
$598,000 and $928,000 for the three and six months ended June 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 approximately $601,000 and transferred deposits
of $6.4 million.
(6) INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, are summarized as
follows (in thousands):
June 30,
--------------------------- December 31,
2003 2002 2002
---- ---- ----
Goodwill $ 227,520 $ 90,194 $ 224,312
Core deposit premiums 26,869 14,546 26,873
Less accumulated amortization (11,715) (9,485) (10,409)
--------- -------- ---------
15,154 5,061 16,464
--------- -------- ---------
Customer list intangible 1,558 - 858
Less accumulated amortization (78) - (24)
--------- -------- ---------
1,480 - 834
--------- -------- ---------
Non-compete agreement intangible 1,013 - 663
Less accumulated amortization (160) - (91)
--------- -------- ---------
853 - 572
--------- -------- ---------
$ 245,007 $ 95,255 $ 242,182
========= ======== =========
At June 30, 2003, TSFG had two reporting units 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 six months ended June 30, 2003:
CAROLINA MERCANTILE
FIRST BANK BANK OTHER TOTAL
---------- ---- ----- -----
Balance, December 31, 2002 $ 116,279 $ 108,033 $ - $ 224,312
Purchase accounting adjustments 1,447 (1,078) 2,839 3,208
--------- --------- ------- ---------
Balance, June 30, 2003 $ 117,726 $ 106,955 $ 2,839 $ 227,520
========= ========= ======= =========
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 $1.3 million for core deposit
premiums, $54,000 for customer list intangibles, and $69,000 for non-compete
agreement intangibles for the six months ended June 30, 2003. Amortization of
intangibles totaled $479,000 for core deposit premiums for the six months ended
June 30, 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, $1.6 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
10
$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 $2.2 million, $4.4 million, and $7.3 million at June 30,
2003, December 31, 2002, and June 30, 2002, respectively. Amortization expense
for MSRs totaled $1.7 million and $1.8 million for the six months ended June 30,
2003 and 2002, respectively. At June 30, 2003 and 2002, the valuation allowance
for capitalized MSRs totaled $2.3 million and $891,000, respectively. In the
first six months of 2003 and 2002, TSFG recorded a $496,000 impairment loss and
$177,000 impairment recovery from the valuation of MSRs, respectively.
The estimated amortization expense for MSRs for the years ended
December 31 is as follows: $3.4 million for 2003, $485,000 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.
(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. The collateral is generally cash or other assets, although
existing lines of credit are sometimes used. Commitments under standby letters
of credit are usually for one year or less. At June 30, 2003, TSFG recorded a
liability of $100,000 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 June 30, 2003 was $81.3 million.
(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.
At the purchase date, TSFG identified a potential contingent liability
related to certain Rock Hill Bank trust accounts. Any liability recorded would
increase the goodwill recorded.
(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 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
(11) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common
shares outstanding:
THREE MONTHS ENDED JUNE 30,
----------------------------------------
2003 2002
---- ----
BASIC:
Average common shares outstanding (denominator) 46,629,666 40,217,873
========== ==========
Diluted:
Average common shares outstanding 46,629,666 40,217,873
Dilutive potential common shares 1,131,115 1,015,017
---------- ----------
Average diluted shares outstanding (denominator) 47,760,781 41,232,890
========== ==========
SIX MONTHS ENDED JUNE 30,
----------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 46,975,635 40,699,166
========== ==========
Diluted:
Average common shares outstanding 46,975,635 40,699,166
Dilutive potential common shares 1,032,132 947,010
---------- ----------
Average diluted shares outstanding (denominator) 48,007,767 41,646,176
========== ==========
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
June 30, 2003 388,297 $24.10 to $31.26
June 30, 2002 760,594 $22.34 to $31.26
For the six months ended
June 30, 2003 763,200 $22.34 to $31.26
June 30, 2002 942,437 $21.06 to $31.26
(12) STOCK-BASED COMPENSATION
At June 30, 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 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).
12
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- --------------------------
RESTATED RESTATED
2003 2002 2003 2002
---- ---- ---- ----
Net income
Net income, as reported $ 22,699 $ 15,339 $ 42,744 $ 28,446
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for
all option awards, net of related income tax effect 84 452 613 777
-------- -------- -------- --------
Pro forma net income $ 22,615 $ 14,887 $ 42,131 $ 27,669
======== ======== ======== ========
Basic earnings per share
As reported $ 0.49 $ 0.38 $ 0.91 $ 0.70
Pro forma 0.48 0.37 0.90 0.68
Diluted earnings per share
As reported $ 0.48 $ 0.37 $ 0.89 $ 0.68
Pro forma 0.47 0.36 0.88 0.66
(13) MERGER-RELATED AND DIRECT ACQUISITION COSTS
In connection with the acquisitions in 2002 and the API acquisition in
2003, for the six months ended June 30, 2003, TSFG recorded pre-tax
merger-related costs of $1.9 million, included in noninterest expenses, and
direct acquisition costs of $223,000, included in goodwill. The merger-related
and acquisition costs were recorded as incurred. The following summarizes these
charges (in thousands) at and for the six months ended June 30, 2003:
TOTAL AMOUNTS REMAINING
COSTS PAID ACCRUAL
----- ---- -------
Merger-related costs
Compensation-related expenses $ 585 $ 516 $ 69
System conversion costs 574 574 -
Impairment loss from write-down of assets 181 181 -
Travel 49 49 -
Advertising 30 30 -
Other 460 460 -
------- ------- ----
$ 1,879 $ 1,810 $ 69
======= ======= ====
Direct acquisition costs
Investment banking and professional fees $ 114 $ 114 $ -
Severance 109 109 -
----- ----- ---
$ 223 $ 223 $ -
===== ===== ===
At June 30, 2003, the accrual of merger-related costs, which included
$69,000 for charges incurred during the six months ended June 30, 2003, totaled
$753,000. This accrual is for compensation-related and other expenses incurred
in connection with the CBT, Rock Hill Bank, and Gulf West acquisitions. At June
30, 2003, the accrual of direct acquisition costs totaled $528,000. 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
13
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,
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 June 30, 2003
Net interest income $ 50,955 $ 16,731 $ (1,514) $ - $ 66,172
Provision for loan losses 3,892 1,318 (10) - 5,200
Noninterest income 17,950 5,700 15,679 (15,354) 23,975
Noninterest expenses 34,823 12,898 17,728 (15,354) 50,095
Amortization of intangibles (a) 315 389 20 - 724
Merger-related costs (a) 108 254 20 - 382
Income tax expense 9,662 2,629 (1,138) - 11,153
Minority interest in consolidated
subsidiary, net of tax (1,000) - - - (1,000)
Net income 19,528 5,586 (2,415) - 22,699
Six Months Ended June 30, 2003
Net interest income $ 102,979 $ 31,718 $ (3,054) $ - $ 131,643
Provision for loan losses 7,390 3,308 2 - 10,700
Noninterest income 32,995 8,631 30,897 (28,662) 43,861
Noninterest expenses 67,443 25,903 34,301 (28,662) 98,985
Amortization of intangibles (a) 630 779 20 - 1,429
Merger-related costs (a) 431 1,428 20 - 1,879
Income tax expense 19,797 3,566 (2,300) - 21,063
Minority interest in consolidated
subsidiary, net of tax (2,012) - - - (2,012)
Net income 39,332 7,572 (4,160) - 42,744
June 30, 2003
Total assets $ 7,125,070 $2,147,670 $ 964,574 $ (979,465) $ 9,257,849
Loans 3,534,484 1,249,366 100,028 (134,626) 4,749,252
Deposits 3,740,847 1,406,221 - (25,729) 5,121,339
(a) Included in noninterest expenses.
14
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
Three Months Ended June 30, 2002
Net interest income $ 46,930 $ 7,110 $ (1,443) $ - $ 52,597
Provision for loan losses 4,290 1,968 (14) - 6,244
Noninterest income 10,848 1,160 15,485 (14,071) 13,422
Noninterest expenses 29,864 5,041 14,958 (14,071) 35,792
Amortization of intangibles (a) 240 - - - 240
Income tax expense 7,677 287 (78) - 7,886
Minority interest in consolidated
subsidiary, net of tax (758) - - - (758)
Cumulative effect of change in accounting
principal, net of tax - - - - -
Net income 15,189 974 (824) - 15,339
Six Months Ended June 30, 2002
Net interest income $ 93,185 $ 13,580 $ (2,776) $ - $ 103,989
Provision for loan losses 8,440 4,047 (5) - 12,482
Noninterest income 19,854 2,102 30,075 (26,971) 25,060
Noninterest expenses 57,292 9,561 30,762 (26,971) 70,644
Amortization of intangibles (a) 479 - - - 479
Income tax expense 15,122 659 (896) - 14,885
Minority interest in consolidated
subsidiary, net of tax (1,186) - - - (1,186)
Cumulative effect of change in accounting
principal, net of tax - - (1,406) - (1,406)
Net income 30,999 1,415 (3,968) - 28,446
June 30, 2002
Total assets $ 5,404,874 $ 874,915 $ 664,639 $ (780,841) $ 6,163,587
Loans 3,238,192 729,172 35,540 (68,479) 3,934,425
Deposits 3,141,045 616,528 - (33,956) 3,723,617
(a) Included in noninterest expenses.
(15) 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.
15
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 six months ended June 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 at June 30, 2003 conducted business through 75 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 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 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 to analyze TSFG's performance. In
particular, a number of credit quality measures presented adjust GAAP
16
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. These disclosures
should not be viewed as a substitute for GAAP credit quality 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
past two years. 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 $ 36,095
Rock Hill Bank and Trust
Rock Hill, South Carolina 10/31/02 204,815(1) 430,017 -(2) 1,204 25,597
Gulf West Banks, Inc.
St. Petersburg, Florida 08/31/02 530,296(1) 3,925,588 32,400 8,424 70,861
Insurance agency/other acquisitions
American Pensions, Inc.
Mount Pleasant, South Carolina 04/30/03 (1) 146,808(3) - 1,050 2,839
Gardner Associates, Inc.
Columbia, South Carolina 09/20/02 1,312(1) 249,011(4) - 1,521 1,934
(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) 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.
(4) 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 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.
17
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 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 June 30, 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.
Pending Acquisition
In May 2003, TSFG signed a definitive agreement to acquire MountainBank
Financial Corporation ("MBFC"), headquartered in Hendersonville, North Carolina.
At June 30, 2003, MBFC operated primarily through 19 branches in western North
Carolina and had total assets of $959.1 million. At closing, TSFG will issue
shares of common stock in exchange for all the common stock, preferred stock,
and stock obligations of MBFC. This acquisition extends the TSFG franchise into
contiguous Western North Carolina markets. This transaction, which is expected
to close in October 2003, will be accounted for using the purchase method of
accounting and is subject to regulatory and MBFC shareholder approvals. TSFG
received the necessary approvals of the Federal Reserve on August 7, 2003 and
expects to receive the approvals of North Carolina State Banking Commission and
the FDIC on or before the end of August 2003 and the South Carolina State Board
of Financial Institutions in early September 2003.
OVERVIEW
Net income for the six months ended June 30, 2003 totaled $42.7
million, an increase of 50.3% compared with $28.4 million for the six months
ended June 30, 2002. Earnings per diluted share for the first six months of 2003
totaled $0.89, a 30.9% increase from $0.68 per diluted share in the first six
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 39.0% 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 six months ended June 30, 2003 and 2002
included pre-tax gains on asset sales of $6.7 million and $76,000, 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 six months of 2003 included $1.9
million in pre-tax merger-related costs and $268,000 in impairment loss from
write-down of assets.
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
18
principle. In accordance with the accounting rules, this change was recorded as
of January 1, 2002 and therefore is shown in the first six months of 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 six months of 2002, which restated the
financial results for the first half of the year, was to increase net income by
$613,000, or $0.01 per diluted share.
Average common shares outstanding on a diluted basis were 48.0 million
in the first six months of 2003, up 15.3% from 41.6 million for the first six
months of 2002, due to shares issued for acquisitions completed in 2002. In
connection with share repurchase programs, TSFG repurchased and cancelled
1,272,805 shares during the first six months of 2003.
At June 30, 2003, TSFG had $9.3 billion in assets, $4.7 billion in
loans, $5.1 billion in deposits, and $660.2 million in shareholders' equity. For
the six months ended June 30, 2003, TSFG's average assets totaled $8.6 billion,
an increase of $2.5 billion, or 40.7%, compared with the first six months 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 June 30, 2003,
outstanding loans totaled $4.7 billion, which equaled 92.7% of total deposits
and 51.3% 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 $773.8 million, or 19.8%, to $4.7
billion at June 30, 2003 from $3.9 billion at June 30, 2002. In 2002, $585.3
million in loans held for investment were acquired in mergers with Gulf West,
Rock Hill Bank, and CBT, accounting for approximately 75% of the increase.
During the first six months of 2003, loans held for investment increased $254.6
million, or 5.7%. The majority of the first six months of 2003 loan growth,
annualized at 11.6%, 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 increased $41.0 million to $60.7 million at June
30, 2003 from $19.6 million at June 30, 2002. Mortgage loan originations were
higher in the current period, which increased the inventory of loans in process.
Loan held for sale at June 30, 2003 included no loans acquired from Gulf West.
During the first six 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.
19
TABLE 2
- --------------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
JUNE 30,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial, financial and agricultural $ 982,947 $ 783,494 $ 913,368
Real estate - construction (1) 573,468 565,040 570,265
Real estate - residential mortgages (1-4 family) 675,018 564,286 643,941
Commercial secured by real estate (1) 1,878,573 1,463,678 1,765,103
Consumer 578,491 538,072 541,210
Lease financing receivables 94 219 124
----------- ----------- -----------
Loans held for investment 4,688,591 3,914,789 4,434,011
Loans held for sale 60,661 19,636 67,218
Less: allowance for loan losses 64,152 46,985 70,275
----------- ----------- -----------
Total net loans $ 4,685,100 $ 3,887,440 $ 4,430,954
=========== =========== ===========
Percentage of loans held for investment
Commercial, financial and agricultural 21.0 % 20.0 % 20.6 %
Real estate - construction (1) 12.2 14.4 12.9
Real estate - residential mortgages (1-4 family) 14.4 14.4 14.5
Commercial secured by real estate (1) 40.1 37.5 39.8
Consumer 12.3 13.7 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.
20
TABLE 3
- --------------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION BASED ON LOAN PURPOSE
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
JUNE 30,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial loans
Commercial and industrial $ 1,265,383 $ 1,023,955 $ 1,178,955
Owner - occupied real estate 725,735 642,475 733,819
Commercial real estate 1,518,286 1,208,425 1,420,252
----------- ----------- -----------
3,509,404 2,874,855 3,333,026
----------- ----------- -----------
Consumer loans
Indirect - sales finance 479,616 391,392 420,294
Direct retail 265,913 290,372 273,419
Home equity 287,087 205,020 243,648
----------- ----------- -----------
1,032,616 886,784 937,361
----------- ----------- -----------
Mortgage loans 146,571 153,150 163,624
----------- ----------- -----------
Total loans held for investment $ 4,688,591 $ 3,914,789 $ 4,434,011
=========== =========== ===========
Percentage of loans held for investment
Commercial and industrial 27.0 % 26.2 % 26.6 %
Owner - occupied real estate 15.5 16.4 16.6
Commercial real estate 32.4 30.9 32.0
Consumer 22.0 22.7 21.1
Mortgage 3.1 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.
21
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 June 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 June 30, 2003, the loan portfolio included commitments totaling
$126.1 million in "shared national credits" (multi-bank credit facilities of $20
million or more). Outstanding balances under these commitments totaled $73.9
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 June 30, 2003, this portfolio totaled
$50.6 million, down from $72.4 million at December 31, 2002, with an allowance
for loan losses of $8.4 million. Nonperforming assets for the Rock Hill Workout
Loans at June 30, 2003 were $25.6 million, down from $29.2 million at December
31, 2002. Net loan charge-offs for the first six months of 2003, which were
provided for in the allowance for loan losses as of December 31, 2002, totaled
$6.8 million. 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.
22
TABLE 4
- ----------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
JUNE 30,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Nonperforming Assets Including the Rock Hill Workout Loans
Loans held for investment $ 4,688,591 $ 3,914,789 $ 4,434,011
Allowance for loan losses 64,152 46,985 70,275
Nonaccrual loans - commercial 54,306 35,477 61,206
Nonaccrual loans - consumer 2,928 3,519 2,384
Restructured loans - - -
Total nonperforming loans 57,234 38,996 63,590
Other real estate owned 7,827 7,696 10,596
----------- ----------- -----------
Total nonperforming assets $ 65,061 $ 46,692 $ 74,186
=========== =========== ===========
Loans past due 90 days still accruing interest (1) $ 5,456 $ 6,951 $ 5,414
=========== =========== ===========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 1.39 % 1.19 % 1.67 %
==== ==== ====
Allowance for loan losses as a percentage of nonperforming loans 1.12 x 1.20 x 1.11 x
==== ==== ====
Nonperforming Assets Excluding the Rock Hill Workout Loans
Loans held for investment $ 4,637,959 $ 3,914,789 $ 4,361,658
Allowance for loan losses 55,798 46,985 53,979
Total nonperforming loans 31,675 38,996 34,596
Other real estate owned 7,827 7,696 10,422
----------- ----------- -----------
Total nonperforming assets $ 39,502 $ 46,692 $ 45,018
=========== =========== ===========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 0.85 % 1.19 % 1.03 %
==== ==== ====
Allowance for loan losses as a percentage of nonperforming loans 1.76 x 1.20 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 per