UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the quarterly period ended September 30, 2003
___ Transition report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the transition period from____ to____
Commission file number 0-15083
THE SOUTH FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA 57-0824914
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
(864) 255-7900
Registrant's telephone number, including area code
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
--- ---
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
--- ---
The number of outstanding shares of the issuer's $1.00 par value common stock as
of November 12, 2003 was 58,999,595.
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
September 30,
------------------------------
Restated
2003 2002 December 31,
(Unaudited) (Unaudited) 2002
Assets
Cash and due from banks $ 186,069 $ 175,315 $ 201,333
Interest-bearing bank balances 7,958 41,849 58,703
Federal funds sold - 10,022 31,293
Securities
Trading 954 3,473 350
Available for sale 3,439,226 1,854,165 2,488,944
Held to maturity (market value $72,922, $84,790 and
$85,371, respectively) 70,485 82,086 82,892
---------- ---------- ----------
Total securities 3,510,665 1,939,724 2,572,186
---------- ---------- ----------
Loans
Loans held for sale 45,817 62,699 67,218
Loans held for investment 4,857,154 4,151,493 4,434,011
Allowance for loan losses (63,000) (50,011) (70,275)
---------- ---------- ----------
Net loans 4,839,971 4,164,181 4,430,954
---------- ---------- ----------
Premises and equipment, net 132,137 126,928 137,501
Accrued interest receivable 39,958 32,730 37,080
Intangible assets 245,791 176,802 242,182
Other assets 253,813 217,856 229,778
---------- ---------- ----------
$9,216,362 $6,885,407 $7,941,010
========== ========== ==========
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing $ 811,919 $ 678,899 $ 743,174
Interest-bearing 4,454,096 3,514,780 3,849,336
---------- ---------- ----------
Total deposits 5,266,015 4,193,679 4,592,510
Federal funds purchased and repurchase agreements 718,641 1,019,149 1,110,840
Other short-term borrowings 49,749 76,471 81,653
Long-term debt 2,235,460 797,322 1,221,511
Debt associated with trust preferred securities 95,500 73,500 95,500
Accrued interest payable 19,266 20,753 20,945
Other liabilities 88,317 62,349 84,840
---------- ---------- ----------
Total liabilities 8,472,948 6,243,223 7,207,799
---------- ---------- ----------
Minority interest in consolidated subsidiary 86,748 86,339 86,412
---------- ---------- ----------
Shareholders' equity
Preferred stock-no par value; authorized 10,000,000 shares;
issued and outstanding - none - - -
Common stock-par value $1 per share; authorized 100,000,000 shares;
issued and outstanding 47,073,578, 43,588,415 and 47,347,375
shares, respectively 47,074 43,588 47,347
Surplus 414,973 355,545 427,448
Retained earnings 197,895 141,614 150,948
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (2,723) (3,308) (3,094)
Common stock held in trust for deferred compensation (150) - -
Deferred compensation payable in common stock 150 - -
Accumulated other comprehensive income (loss), net of tax (553) 18,406 24,150
---------- ---------- ----------
Total shareholders' equity 656,666 555,845 646,799
---------- ---------- ----------
$9,216,362 $6,885,407 $7,941,010
========== ========== ==========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(in thousands, except share and per share data) (Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Interest and fees on loans $ 66,936 $ 65,593 $ 202,594 $ 191,951
Interest and dividends on securities
Taxable 29,177 22,011 90,413 64,795
Exempt from Federal income taxes 1,200 1,084 3,526 3,239
-------- -------- --------- ---------
Total interest and dividends on securities 30,377 23,095 93,939 68,034
Interest on short-term investments 103 252 433 939
-------- -------- --------- ---------
Total interest income 97,416 88,940 296,966 260,924
-------- -------- --------- ---------
Interest expense
Interest on deposits 18,796 20,493 55,130 63,322
Interest on borrowed funds 14,671 13,215 46,244 38,381
-------- -------- --------- ---------
Total interest expense 33,467 33,708 101,374 101,703
-------- -------- --------- ---------
Net interest income 63,949 55,232 195,592 159,221
Provision for loan losses 5,591 5,567 16,291 18,049
-------- -------- --------- ---------
Net interest income after provision for loan losses 58,358 49,665 179,301 141,172
Noninterest income 27,730 16,806 71,591 41,866
Noninterest expenses 50,541 43,725 149,526 114,369
-------- -------- --------- ---------
Income before income taxes, minority interest, and
cumulative effect of change in accounting principle 35,547 22,746 101,366 68,669
Income taxes 10,664 6,937 31,727 21,822
-------- -------- --------- ---------
Income before minority interest and cumulative
effect of change in accounting principle 24,883 15,809 69,639 46,847
Minority interest in consolidated subsidiary, net of tax (990) (1,033) (3,002) (2,219)
-------- -------- --------- ---------
Income before cumulative effect of change in
accounting principle 23,893 14,776 66,637 44,628
Cumulative effect of change in accounting principle, net of tax - - - (1,406)
-------- -------- --------- ---------
Net income $ 23,893 $ 14,776 $ 66,637 $ 43,222
======== ======== ========= =========
Average common shares outstanding, basic 46,955,200 41,507,843 46,968,749 40,969,925
Average common shares outstanding, diluted 47,992,601 42,504,741 48,002,656 41,933,995
Per common share, basic:
Income before cumulative effect of change in accounting principle $ 0.51 $ 0.36 $ 1.42 $ 1.08
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
------ ------ ------ ------
Net income $ 0.51 $ 0.36 $ 1.42 $ 1.05
====== ====== ====== ======
Per common share, diluted:
Income before cumulative effect of change in accounting principle $ 0.50 $ 0.35 $ 1.39 $ 1.06
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
------ ------ ------ ------
Net income $ 0.50 $ 0.35 $ 1.39 $ 1.03
====== ====== ====== ======
Cash dividends declared per common share $ 0.14 $ 0.12 $ 0.42 $ 0.36
====== ====== ====== ======
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(in thousands, except share and per share data) (Unaudited)
Retained Accumulated
Shares of Earnings Other
Common Common and Comprehensive
Stock Stock Surplus Other* Income (Loss) Total
----- ----- ------- ----- ------------ -----
Balance, December 31, 2001 41,228,976 $41,229 $ 311,305 $ 111,744 $(6,104) $ 458,174
Net income (restated) - - - 43,222 - 43,222
Other comprehensive gain,
net of tax of $11,348 - - - - 24,510 24,510
---------
Comprehensive income - - - - - 67,732
---------
Cash dividends declared
($0.36 per common share) - - - (14,893) - (14,893)
Common stock activity:
Acquisitions 4,174,599 4,175 85,825 (1,926) 88,074
Repurchase of stock (2,141,907) (2,142) (46,341) - - (48,483)
Dividend reinvestment plan 70,012 70 1,312 - - 1,382
Employee stock purchase plan 8,094 8 148 - - 156
Restricted stock plan 59,096 59 1,698 (87) - 1,670
Exercise of stock options 194,545 194 1,670 - - 1,864
Cancellation of stock (5,000) (5) (108) (113)
Miscellaneous - - 36 246 - 282
---------- ------- --------- --------- -------- ---------
Balance, September 30, 2002 (restated) 43,588,415 $43,588 $ 355,545 $ 138,306 $ 18,406 $ 555,845
========== ======= ========= ========= ======== =========
Balance, December 31, 2002 47,347,375 $47,347 $ 427,448 $ 147,854 $ 24,150 $ 646,799
Net income - - - 66,637 - 66,637
Other comprehensive loss,
net of tax of $12,355 - - - - (24,703) (24,703)
---------
Comprehensive income - - - - - 41,934
---------
Cash dividends declared
($0.42 per common share) - - - (19,689) - (19,689)
Common stock activity:
Repurchase of stock (1,274,808) (1,274) (27,283) - - (28,557)
Acquisitions 149,173 149 3,411 454 - 4,014
Dividend reinvestment plan 105,184 105 2,197 - - 2,302
Employee stock purchase plan 20,666 21 306 - - 327
Restricted stock plan 67,023 67 3,187 (167) - 3,087
Exercise of stock options 658,965 659 5,635 - - 6,294
Common stock purchased by trust
for deferred compensation - - - (150) - (150)
Deferred compensation payable in
common stock - - - 150 - 150
Miscellaneous - - 72 83 - 155
---------- ------- --------- --------- ------ ---------
Balance, September 30, 2003 47,073,578 $47,074 $ 414,973 $ 195,172 $ (553) $ 656,666
========== ======= ========= ========= ====== =========
* Other includes guarantee of employee stock ownership plan debt, nonvested restricted stock and deferred compensation.
See accompanying notes to consolidated financial statements.
3
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands) (Unaudited)
Nine Months Ended September 30,
--------------------------------------
Restated
2003 2002
---- ----
Cash flows from operating activities
Net income $ 66,637 $ 43,222
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, amortization, and accretion, net 41,290 22,955
Provision for loan losses 16,291 18,049
Gain on sale of available for sale securities (8,681) (1,005)
Gain on equity investments (3,330) (3,388)
(Gain) loss on trading and derivative activities (2,057) 494
Gain on disposition of assets and liabilities (601) -
Gain on sale of loans (6,410) (1,671)
Gain on disposition of premises and equipment (66) (55)
Loss on disposition of other real estate owned 432 762
Impairment loss from write-down of assets 449 -
Impairment loss from write-down of mortgage servicing rights 96 592
Loss on early extinguishment of debt 2,699 354
Minority interest in consolidated subsidiary 3,002 2,219
Cumulative effect of change in accounting principle - 1,406
Trading account assets, net (1,721) 206,000
Origination of loans held for sale (533,115) (325,259)
Sale of loans held for sale and principal repayments 553,474 296,655
Other assets, net (29,876) 5,099
Other liabilities, net 5,786 (1,180)
---------- --------
Net cash provided by operating activities 104,299 265,249
---------- --------
Cash flows from investing activities
Sale of securities available for sale 1,364,390 629,343
Maturity, redemption, call, or principal repayments of securities
available for sale 2,074,597 1,054,079
Maturity, redemption, call, or principal repayments of securities
held to maturity 35,024 6,787
Purchase of available for sale securities (4,433,634) (2,021,568)
Purchase of securities held to maturity (22,735) (8,156)
Origination of loans held for investment, net of principal repayments
and recoveries (451,122) (160,033)
Sale of loans held for investment - 11,961
Sale of other real estate owned 9,708 4,224
Sale of premises and equipment 2,579 1,443
Purchase of premises and equipment (10,561) (10,565)
Disposition of assets and liabilities, net (5,738) -
Cash equivalents acquired, net of payment for purchase acquisitions (595) 29,227
---------- --------
Net cash used for investing activities (1,438,087) (463,258)
---------- --------
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(in thousands) (Unaudited)
Nine Months Ended September 30,
-------------------------------------
Restated
2003 2002
Cash flows from financing activities
Deposits, net 687,024 163,246
Federal funds purchased and repurchase agreements, net (391,991) (297,134)
Short-term borrowings, net (32,770) (74,469)
Issuance of long-term debt 1,085,295 400,000
Payment of long-term debt (64,674) (35,126)
Prepayment penalty on early extinguishment of debt (2,699) -
Issuance of preferred stock associated with minority interest, net - 49,247
Issuance of debt associated with trust preferred securities, net - 41,176
Cash dividends paid on common stock (19,728) (14,622)
Cash dividends paid on minority interest (4,492) (2,878)
Repurchase of common stock (28,557) (48,483)
Other common stock activity 9,078 3,571
---------- ---------
Net cash provided by financing activities 1,236,486 184,528
---------- ---------
Net change in cash and cash equivalents (97,302) (13,481)
Cash and cash equivalents at beginning of year 291,329 240,667
---------- ---------
Cash and cash equivalents at end of period $ 194,027 $ 227,186
========== =========
Supplemental cash flow data
Interest paid $ 104,032 $ 100,080
Income taxes paid 28,250 25,278
Significant non-cash investing and financing transactions:
Available for sale securities transferred to trading and subsequently sold - 208,163
Unrealized gain (loss) on available for sale securities (38,483) 35,526
Loans transferred to other real estate owned 9,338 9,336
Premises and equipment, net transferred to long-lived assets held for sale 2,639 -
Business combinations:
Fair value of assets acquired (includes cash and cash equivalents) 9,448 613,440
Fair value of common stock issued and stock options recognized (4,014) (88,074)
Cash paid for common shares - (32,406)
---------- ---------
Liabilities assumed 5,434 492,960
---------- ---------
See accompanying notes to consolidated financial statements.
5
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL
The foregoing unaudited consolidated financial statements include the
accounts of The South Financial Group, Inc. and subsidiaries. "TSFG" refers to
The South Financial Group, Inc. and subsidiaries, except where the context
requires otherwise. All significant intercompany accounts and transactions have
been eliminated in consolidation, and all adjustments considered necessary for a
fair presentation of the results for interim periods presented have been
included. Such adjustments are normal and recurring in nature. Certain prior
year amounts have been reclassified to conform to the 2003 presentations. TSFG
has no interests in non-consolidated special purpose entities.
The consolidated financial statements and notes are presented in
accordance with the instructions for Form 10-Q. The information contained in the
footnotes included in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2002 should be referred to in connection with the reading of these
unaudited interim Consolidated Financial Statements.
ACCOUNTING ESTIMATES AND ASSUMPTIONS
Certain policies require management to make estimates and assumptions
that affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ significantly from these
estimates and assumptions. Material estimates that are particularly susceptible
to significant change relate to the determination of the allowance for loan
losses and income taxes.
RESTATEMENT OF 2002 QUARTERLY FINANCIAL DATA
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 91,
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" ("SFAS 91"), which reduced
interest income, noninterest income and noninterest expenses. Income taxes
increased as a result of the restatement. The net impact of these adjustments
for the first nine months of 2002, which restated the financial results for the
period, was to increase net income by $1.3 million, or $0.03 per diluted share.
By quarter, net income increased $316,000, $297,000, and $665,000 for the first,
second, and third quarters of 2002, respectively.
For a summary of the quarterly financial data for the first nine months
of 2002, as restated and as reported, see Note 36 to the Consolidated Financial
Statements in TSFG's 2002 Annual Report on Form 10-K.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Accounting for Exit or Disposal Activities
Effective January 1, 2003, TSFG adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. Those
costs include, but are not limited to, the following: a) termination benefits
provided to current employees that are involuntarily terminated under the terms
of a benefit arrangement that, in substance, is not an ongoing benefit
arrangement or an individual deferred compensation contract (hereinafter
referred to as one-time termination benefits), b) costs to terminate a contract
that is not a capital lease, and c) costs to consolidate facilities or relocate
employees. The initial adoption of this standard did not have an impact on the
financial condition or results of operations of TSFG.
Accounting for Guarantees
Effective January 1, 2003, TSFG adopted the initial recognition and
initial measurement provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
TSFG adopted the disclosure requirements effective as of December 31, 2002. FIN
45 elaborates on the disclosure to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the
6
nature of the guarantee; (b) the maximum potential amount of future payments
under the guarantee; (c) the carrying amount of the liability; and (d) the
nature and extent of any recourse provisions or available collateral that would
enable the guarantor to recover the amounts paid under the guarantee. FIN 45
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the fair value of the obligations it has undertaken
in issuing the guarantee at its inception. No contingent liability was
determined to be necessary relating to TSFG's obligation to perform as a
guarantor.
Accounting for Derivative Instruments and Hedging Activities
Effective July 1, 2003, TSFG adopted SFAS No. 149, ("SFAS 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities,"
which amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristics of a derivative, clarifies when
a derivative contains a financing component, amends the definition of an
underlying to conform it to language used in FIN 45, and amends certain other
existing pronouncements. Those changes will result in more consistent reporting
of contracts as either derivatives or hybrid instruments. The adoption of this
standard did not have a material impact on the financial condition or results of
operations of TSFG.
Accounting for Variable Interest Entities
Effective July 1, 2003, TSFG adopted FASB Interpretation No. 46, ("FIN
46"), "Consolidation of Variable Interest Entities," which addresses
consolidation by business enterprises of variable interest entities. Under FIN
46, an enterprise that holds significant variable interest in a variable
interest entity but is not the primary beneficiary is required to disclose the
nature, purpose, size, and activities of the variable interest entity, its
exposure to loss as a result of the variable interest holder's involvement with
the entity, and the nature of its involvement with the entity and date when the
involvement began. The primary beneficiary of a variable interest entity is
required to disclose the nature, purpose, size, and activities of the variable
interest entity, the carrying amount and classification of consolidated assets
that are collateral for the variable interest entity's obligations, and any lack
of recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general credit of the primary beneficiary. TSFG
had no impact upon adoption since it had no interests in entities, which it
considers to be included within the scope of FIN 46.
On October 31, 2003, the FASB proposed a modification and
interpretation of FIN 46. Evaluation of the impact of FIN 46 and SFAS No. 150,
("SFAS 150"), "Accounting for Certain Financial Instruments with Characteristics
of both Liabilities and Equity," on the treatment of debt associated with trust
preferred securities is in process. TSFG currently consolidates the trusts,
which issued TSFG's trust preferred securities, in its consolidated financial
statements and reports the related debt instruments, referred to as debt
associated with trust preferred securities, as a liability on its consolidated
balance sheet. Under one potential interpretation of FIN 46, TSFG's trusts,
which have issued TSFG's trust preferred securities, would no longer be included
in TSFG's consolidated financial statements. Conversely, SFAS 150 requires the
consolidation of these subsidiaries and the presentation of the related debt
instruments as a liability.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
Effective July 1, 2003, TSFG adopted SFAS 150, which establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. SFAS 150
requires an issuer to classify certain financial instruments that include
certain obligations, such as mandatory redemption, repurchase of the issuer's
equity, or settlement by issuing equity, as liabilities or assets in some
circumstances. Forward contracts to repurchase an issuer's equity shares that
require physical settlement in exchange for cash are initially measured at the
fair value of the shares at inception, adjusted for any consideration or
unstated rights or privileges, which is the same as the amount that would be
paid under the conditions specified in the contract if settlement occurred
immediately. Those contracts and mandatorily redeemable financial instruments
are subsequently measured at the present value of the amount to be paid at
settlement, if both the amount of cash and the settlement date are fixed, or,
otherwise, at the amount that would be paid under the conditions specified in
the contract if settlement occurred at the reporting date. Other financial
instruments are initially and subsequently measured at fair value, unless
required by SFAS 150 or other generally accepted accounting principles to be
measured differently. TSFG had no impact upon adoption since it had no financial
instruments, which it considers to be included within the scope of SFAS 150.
7
WEBSITE AVAILABILITY OF REPORTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION
Through its website, www.thesouthgroup.com, TSFG makes available, free
of charge, various reports that it files with, or furnishes to, the Securities
and Exchange Commission, including its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports. These reports are made available as soon as reasonably practicable
after these reports are filed with, or furnished to the Securities and Exchange
Commission.
(2) SUPPLEMENTAL FINANCIAL INFORMATION TO CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for noninterest income and
noninterest expense (in thousands):
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ---------------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Noninterest income
Service charges on deposit accounts $ 7,613 $ 6,108 $ 22,154 $ 16,436
Mortgage banking income 3,804 727 8,537 3,097
Fees for investment services 1,946 1,359 6,579 4,639
Bank-owned life insurance 2,063 1,877 5,944 5,486
Merchant processing income 2,161 1,778 5,568 4,741
Insurance income 1,118 254 2,675 636
Gain on sale of available for sale securities 4,498 790 8,681 1,005
Gain on equity investments 1,455 3,527 3,330 3,388
Gain (loss) on trading and derivative activities 950 (520) 2,057 (494)
Gain on disposition of assets and liabilities - - 601 -
Other 2,122 906 5,465 2,932
-------- -------- -------- --------
Total noninterest income $ 27,730 $ 16,806 $ 71,591 $ 41,866
======== ======== ======== ========
Noninterest expenses
Salaries and wages $ 17,972 $ 16,256 $ 57,569 $ 43,481
Employee benefits 5,709 3,538 16,444 11,841
Occupancy 4,699 3,919 13,981 11,150
Furniture and equipment 4,466 3,993 13,271 11,072
Professional fees 1,348 1,343 4,708 3,859
Merchant processing expense 1,686 1,381 4,342 3,798
Telecommunications 1,239 967 3,477 2,536
Amortization of intangibles 730 352 2,159 831
Merger-related costs 345 4,465 2,224 4,465
Impairment loss from the write-down of assets - - 268 -
Loss on early extinguishment of debt 2,699 354 2,699 354
Other 9,648 7,157 28,384 20,982
-------- -------- -------- --------
Total noninterest expenses $ 50,541 $ 43,725 $149,526 $114,369
======== ======== ======== ========
8
(3) OTHER COMPREHENSIVE INCOME
The following summarizes accumulated other comprehensive income, net of
tax (in thousands) for the nine months ended September 30:
2003 2002
---- ----
Unrealized gains (losses) on available for sale securities
Balance at beginning of year $ 24,382 $ (5,554)
Other comprehensive gain (loss):
Unrealized holding gains (losses) arising during the year (26,472) 39,919
Income tax benefit (expense) 8,505 (12,763)
Less: Reclassification adjustment for gains included in net income (12,011) (4,393)
Income tax expense 4,377 1,538
-------- --------
(25,601) 24,301
-------- --------
Balance at end of period (1,219) 18,747
-------- --------
Unrealized gains (losses) on cash flow hedges
Balance at beginning of year (232) (550)
Other comprehensive income:
Unrealized gain on change in fair values 1,425 332
Income tax expense (527) (123)
-------- --------
898 209
-------- --------
Balance at end of period 666 (341)
-------- --------
$ (553) $ 18,406
======== ========
During the first nine months of 2003, TSFG adjusted its income tax rate
used (on a cumulative basis) on the net unrealized gain recorded for available
for sale securities, which is included in accumulated other comprehensive
income, to the blended statutory federal and state income tax rate of 36.94%.
However, in certain cases where TSFG has loss carryforwards for state income tax
purposes, an income tax rate of 35% is used. At December 31, 2002, TSFG used a
32.5% income tax rate on the net unrealized gain recorded for available for sale
securities.
(4) BUSINESS COMBINATIONS
ALLIED ASSURANCE
On September 22, 2003, TSFG acquired Allied Assurance ("Allied"), an
independent insurance agency based in Columbia, South Carolina. TSFG issued
2,365 shares of common stock valued at $60,000 and recorded goodwill of
approximately $60,000. TSFG agreed to issue annual earnout shares, valued at
approximately $45,000, for each of August 31, 2004, 2005, 2006, and 2007, based
on revenue retention. TSFG intends to use Allied to further its insurance
operations in the Midlands of South Carolina.
AMERICAN PENSIONS, INC.
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. This
acquisition was accounted for using the purchase method of accounting, and
accordingly, the assets and liabilities of API were recorded at their estimated
fair values as of the acquisition date. TSFG issued 146,808 shares of common
stock valued at $3.5 million, acquired tangible assets totaling $348,000,
assumed liabilities totaling $369,000, recorded a deferred tax liability
totaling $386,000, recorded a non-compete agreement intangible asset of
$350,000, recorded goodwill of $2.9 million, and recorded a customer list
intangible asset of $700,000. The non-compete agreement intangible is amortized
on a straight-line basis over its estimated useful life of 7 years. The customer
list intangible is amortized on a straight-line basis over its estimated useful
life of 10 years. In addition, the shareholders of API have the right to receive
common stock with a maximum value of approximately $2.2 million under earnout
provisions based on API's five-year financial performance, which would increase
goodwill.
9
GARDNER ASSOCIATES, INC.
During the nine months ended September 30, 2003, TSFG recorded an
increase in goodwill for the fair value of 21,806 shares earned by the
principals of Gardner Associates, Inc. ("Gardner Associates"), which totaled
$454,000, in accordance with earnout provisions.
AMORTIZATION OF PREMIUMS AND DISCOUNTS
Premiums and discounts that resulted from recording the assets and
liabilities acquired through acquisition (Central Bank of Tampa ("CBT"), Rock
Hill Bank & Trust ("Rock Hill Bank"), and Gulf West Banks, Inc. ("Gulf West"))
at their respective fair values are being amortized and accreted using methods
that approximate a constant effective yield over the life of the assets and
liabilities. This net amortization decreased net income before income taxes by
$799,000 and $1.7 million for the three and nine months ended September 30,
2003, respectively.
(5) DISPOSITION OF ASSETS AND LIABILITIES
In June 2003, Carolina First Bank completed the sale of its branch
office in Powdersville, South Carolina. In connection with the sale of this
branch, TSFG recorded a gain of $601,000 and transferred deposits of $6.4
million.
(6) INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, are summarized as
follows (in thousands):
September 30,
--------------------------- December 31,
2003 2002 2002
---- ---- ----
Goodwill $ 229,034 $ 162,148 $ 224,312
Core deposit premiums 26,869 22,970 26,873
Less accumulated amortization (12,364) (9,832) (10,409)
--------- --------- ---------
14,505 13,138 16,464
--------- --------- ---------
Customer list intangible 1,558 858 858
Less accumulated amortization (117) (1) (24)
--------- --------- ---------
1,441 857 834
--------- --------- ---------
Non-compete agreement intangible 1,013 663 663
Less accumulated amortization (202) (4) (91)
--------- --------- ---------
811 659 572
--------- --------- ---------
$ 245,791 $ 176,802 $ 242,182
========= ========= =========
At September 30, 2003, TSFG had two reportable segments with goodwill,
Carolina First Bank and Mercantile Bank. The following summarizes the changes in
the carrying amount of goodwill related to each of TSFG's reporting units (in
thousands) for the nine months ended September 30, 2003:
Carolina Mercantile
First Bank Bank Other Total
---------- ---- ----- -----
Balance, December 31, 2002 $ 116,279 $ 108,033 $ - $ 224,312
Purchase accounting adjustments 2,453 (603) 2,872 4,722
--------- --------- ------- ---------
Balance, September 30, 2003 $ 118,732 $ 107,430 $ 2,872 $ 229,034
========= ========= ======= =========
The goodwill for each reporting unit was tested for impairment as of
June 30, 2003 in accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets." TSFG will update this testing annually as of June 30th each year. The
fair value of each reporting unit was estimated using a cash flow approach based
upon the expected present value of future cash flows and a market approach based
upon recent purchase transactions and public company market values. These
valuations indicated that no impairment charge was required as of the June 30,
2003 test date.
Amortization of intangibles totaled $2.0 million for core deposit
premiums, $93,000 for customer list intangibles, and $111,000 for non-compete
10
agreement intangibles for the nine months ended September 30, 2003. Amortization
of intangibles totaled $826,000 for core deposit premiums, $4,000 for
non-compete agreement intangibles, and $1,000 for customer list intangibles for
the nine months ended September 30, 2002.
The estimates provided below exclude amortization expense for
intangible assets related to TSFG's acquisition of MBFC, which closed October 3,
2003. The estimated amortization expense for core deposit premiums for the years
ended December 31 is as follows: $2.6 million for 2003, $2.2 million for 2004,
$1.9 million for 2005, $1.7 million for 2006, $1.6 million for 2007, and an
aggregate of $6.5 million for all the years thereafter. The estimated
amortization expense for customer list intangibles is $133,000 for 2003,
$156,000 for the years ended December 31, 2004 to 2007 and an aggregate of
$777,000 for all the years thereafter. The estimated amortization expense for
non-compete agreement intangibles is $153,000 for 2003, $170,000 for the years
ended December 31, 2004 to 2006, $142,000 for 2007 and an aggregate of $117,000
for all the years thereafter.
(7) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs"), net of the valuation
allowance, totaled $2.0 million, $4.4 million, and $5.6 million at September 30,
2003, December 31, 2002, and September 30, 2002, respectively. Amortization
expense for MSRs totaled $2.3 million and $2.7 million for the nine months ended
September 30, 2003 and 2002, respectively. At September 30, 2003 and 2002, the
valuation allowance for capitalized MSRs totaled $1.9 million and $1.7 million,
respectively. In the first nine months of 2003 and 2002, TSFG recorded a $96,000
and $592,000 impairment loss from the valuation of MSRs, respectively.
The estimated amortization expense for MSRs for the years ended
December 31 is as follows: $3.0 million for 2003, $1.3 million for 2004, and
none for all the years thereafter. The estimated amortization expense is based
on current information regarding loan payments and prepayments. Amortization
expense could change in future periods based on changes in the volume of
prepayments and economic factors.
(8) GUARANTEES
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customers to perform under the terms
of an underlying contract with the third party or obligate TSFG to guarantee or
stand as surety for the benefit of the third party. The underlying contract may
entail either financial or nonfinancial obligations and may involve such things
as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or repayment of an obligation. Under the terms of a
standby letter, drafts will generally be drawn only when the underlying event
fails to occur as intended. TSFG can seek recovery of the amounts paid from the
borrower. In addition, some of these standby letters of credit are
collateralized. Commitments under standby letters of credit are usually for one
year or less. At September 30, 2003, TSFG recorded a liability of $100,000 for
deferred fees received on standby letters of credit, which was the estimated
fair value of the obligation to perform as a guarantor. No contingent liability
was determined to be necessary relating to TSFG's obligation to perform as a
guarantor. The maximum potential amount of undiscounted future payments related
to standby letters of credit at September 30, 2003 was $86.7 million. In
addition, TSFG guarantees a portion of the debt of a company in which it has an
equity investment. The fair value of this guarantee is not deemed significant at
September 30, 2003. TSFG occasionally provides a guarantee for the issuance of
consumer credit cards for certain of its customers. The total of such guarantees
at September 30, 2003 was approximately $200,000, and the fair value is not
deemed significant.
(9) COMMITMENTS AND CONTINGENT LIABILITIES
TSFG is currently subject to various legal proceedings and claims that
have arisen in the ordinary course of its business. In the opinion of management
based on consultation with external legal counsel, any reasonably foreseeable
outcome of such current litigation would not materially affect TSFG's
consolidated financial position or results of operations.
TSFG acquired the former Beacon Manufacturing Company facility in
Swannanoa, North Carolina on October 3, 2003 as part of its acquisition of
MountainBank Financial Corporation ("MBFC"). MBFC had acquired this facility
through a foreclosure proceeding. In September 2003, a fire and apparent
vandalism resulted in a release of fuel oil and other materials. Clean-up of the
oil spill, including releases to the adjacent Swannanoa River, has been
substantially completed. TSFG intends to investigate, and if necessary
remediate, any related environmental impacts and soil and groundwater
contamination attributable to historical practices at the facility, as well as
to stabilize the site and remove waste materials. Based on available
information, MBFC established a net reserve of $2.4 million. This reserve
consisted of a $4.4 million environmental remediation contingent liability,
offset by $1.0 million for the estimated net realizable value of the other real
estate owned and $1.0 million estimated for potential insurance recovery for
11
building damage, debris removal, and environmental remediation on this property.
TSFG continues to evaluate the reserve level and may make purchase accounting
adjustments, which would be treated as goodwill adjustments in the MBFC
transaction. There can be no guarantee that any liability or costs arising out
of this matter will not exceed any established reserves.
(10) DEFERRED COMPENSATION HELD IN TRUST
Beginning on January 1, 2003, under TSFG's Executive Deferred
Compensation Plan for certain officers, TSFG common stock was added as an
investment option for deferral of up to 100% of a participant's annual cash
bonus compensation, net of withholdings for social security and Medicare taxes.
The common stock purchased by TSFG for this deferred compensation plan is
maintained in a rabbi trust (the "Trust"), on behalf of the participants. The
assets of the Trust are subject to the claims of general creditors of TSFG.
Dividends payable on the common shares held by the Trust will be reinvested in
additional shares of common stock of TSFG on behalf of the participants. The
deferred compensation obligation in the Trust is classified as a component of
shareholders' equity, and the common stock held by the Trust is classified as a
reduction of shareholders' equity. The obligations of TSFG under this investment
option of the deferred compensation plan, and the shares held by the Trust, have
no net effect on outstanding shares. Subsequent changes in the fair value of the
common stock are not reflected in earnings or shareholders' equity.
(11) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common
shares outstanding:
Three Months Ended September 30,
--------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 46,955,200 41,507,843
========== ==========
Diluted:
Average common shares outstanding 46,955,200 41,507,843
Dilutive potential common shares 1,037,401 996,898
---------- ----------
Average diluted shares outstanding (denominator) 47,992,601 42,504,741
========== ==========
Nine Months Ended September 30,
--------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 46,968,749 40,969,925
========== ==========
Diluted:
Average common shares outstanding 46,968,749 40,969,925
Dilutive potential common shares 1,033,907 964,070
---------- ----------
Average diluted shares outstanding (denominator) 48,002,656 41,933,995
========== ==========
The following options were outstanding at the period end presented but
were excluded from the calculation of diluted earnings per share because the
exercise price was greater than the average market price of the common shares:
Number Range of
of Shares Exercise Prices
--------- ---------------
For the three months ended
September 30, 2003 297,362 $24.79 to $31.26
September 30, 2002 977,672 $21.03 to $31.26
For the nine months ended
September 30, 2003 532,915 $23.05 to $31.26
September 30, 2002 977,672 $21.03 to $31.26
12
(12) STOCK-BASED COMPENSATION
At September 30, 2003, TSFG had two stock-based employee compensation
option plans, which are described more fully in Note 30 to the Consolidated
Financial Statements in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2002. TSFG accounts for its option plans under the recognition and
measurement principles of APB Opinion 25, "Accounting for Stock Issued to
Employees," and related Interpretations ("APB Opinion 25"). No stock-based
employee compensation cost is reflected in net income related to these plans, as
all options granted under those plans had an exercise price equal to or greater
than the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share as
if TSFG had applied the fair value recognition provisions of SFAS No. 123,
"Accounting for Stock Based Compensation" ("SFAS 123") to stock-based employee
compensation option plans (dollars in thousands, except share data).
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Net income
Net income, as reported $ 23,893 $ 14,776 $ 66,637 $ 43,222
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for
all option awards, net of related income tax effect 799 880 1,401 1,643
-------- -------- -------- --------
Pro forma net income $ 23,094 $ 13,896 $ 65,236 $ 41,579
======== ======== ======== ========
Basic earnings per share
As reported $ 0.51 $ 0.36 $ 1.42 $ 1.05
Pro forma 0.49 0.33 1.39 1.01
Diluted earnings per share
As reported $ 0.50 $ 0.35 $ 1.39 $ 1.03
Pro forma 0.48 0.33 1.36 0.99
(13) MERGER-RELATED AND DIRECT ACQUISITION COSTS
In connection with the acquisitions in 2002 and the API acquisition in
2003, for the nine months ended September 30, 2003, TSFG recorded pre-tax
merger-related costs of $2.2 million, included in noninterest expenses, and
direct acquisition costs of $313,000, included in goodwill. The merger-related
and acquisition costs were recorded as incurred. The following summarizes these
charges (in thousands) at and for the nine months ended September 30, 2003:
Total Amounts Remaining
Costs Paid Accrual
----- ---- -------
Merger-related costs
Compensation-related expenses $ 598 $ 563 $ 35
System conversion costs 600 600 -
Impairment loss from write-down of assets 181 181 -
Travel 54 54 -
Advertising 30 30 -
Other 761 761 -
------- ------- ----
$ 2,224 $ 2,189 $ 35
======= ======= ====
Direct acquisition costs
Investment banking and professional fees $ 204 $ 184 $ 20
Severance 109 109 -
------- ------- ----
$ 313 $ 293 $ 20
======= ======= ====
13
At September 30, 2003, the accrual of merger-related costs, which included
$35,000 for charges incurred during the nine months ended September 30, 2003,
totaled $755,000. This accrual is for compensation-related and other expenses
incurred in connection with the CBT, Rock Hill Bank, and Gulf West acquisitions.
At September 30, 2003, the accrual of direct acquisition costs, which included
$20,000 for charges incurred during the nine months ended September 30, 2003,
totaled $545,000. This accrual is for professional fees and severance in
connection with the CBT, Rock Hill Bank, and Gulf West acquisitions.
(14) BUSINESS SEGMENTS
TSFG has two principal operating subsidiaries, Carolina First Bank and
Mercantile Bank, which are evaluated regularly by the chief operating decision
maker in deciding how to allocate resources and assess performance. Both of
these subsidiaries are reportable segments by virtue of exceeding certain
quantitative thresholds. Carolina First Bank and Mercantile Bank engage in
general banking business focusing on commercial, consumer, and mortgage lending
to small and middle market businesses and consumers in their market areas. The
reportable segments also provide demand transaction accounts and time deposit
accounts to businesses and individuals. Carolina First Bank offers products and
services primarily to customers in South Carolina, North Carolina and on the
Internet. Mercantile Bank offers products and services primarily to customers in
its market areas in northern and central Florida. Revenues for Carolina First
Bank and Mercantile Bank are derived primarily from interest and fees on loans,
interest on investment securities, service charges on deposits, mortgage banking
income, fees for investment services, and other customer service fees. No single
customer accounts for a significant amount of the revenues of either reportable
segment.
TSFG evaluates performance based on budget to actual comparisons and
segment profits. The accounting policies of the reportable segments are the same
as those described in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2002.
Segment information (in thousands) is shown in the table below. The "Other"
column includes all other business activities that did not meet the quantitative
thresholds and therefore are not shown as a reportable segment.
Carolina Mercantile Eliminating
First Bank Bank Other Entries Total
---------- ---- ----- ------- -----
Three Months Ended September 30, 2003
Net interest income $ 49,514 $ 15,918 $ (1,483) $ - $ 63,949
Provision for loan losses 3,723 1,884 (16) - 5,591
Noninterest income 22,126 3,870 17,760 (16,026) 27,730
Noninterest expenses 37,766 12,829 15,972 (16,026) 50,541
Amortization of intangibles (a) 310 390 30 - 730
Merger-related costs (a) 185 136 24 - 345
Income tax expense 9,038 1,522 104 - 10,664
Minority interest in consolidated
subsidiary, net of tax (990) - - - (990)
Net income 20,123 3,553 217 - 23,893
Nine Months Ended September 30, 2003
Net interest income $ 152,493 $ 47,636 $ (4,537) $ - $ 195,592
Provision for loan losses 11,113 5,192 (14) - 16,291
Noninterest income 55,121 12,501 48,657 (44,688) 71,591
Noninterest expenses 105,209 38,732 50,273 (44,688) 149,526
Amortization of intangibles (a) 940 1,169 50 - 2,159
Merger-related costs (a) 616 1,564 44 - 2,224
Income tax expense 28,835 5,088 (2,196) - 31,727
Minority interest in consolidated
subsidiary, net of tax (3,002) - - - (3,002)
Net income 59,455 11,125 (3,943) - 66,637
(a) Included in noninterest expenses.
14
Carolina Mercantile Eliminating
First Bank Bank Other Entries Total
---------- ---- ----- ------- -----
September 30, 2003
Total assets $ 7,193,820 $2,179,590 $ 966,685 $ (1,123,733) $ 9,216,362
Loans 3,600,913 1,336,809 99,521 (134,272) 4,902,971
Deposits 3,835,269 1,453,226 - (22,480) 5,266,015
Three Months Ended September 30, 2002
Net interest income $ 47,233 $ 9,612 $ (1,613) $ - $ 55,232
Provision for loan losses 3,865 1,718 (16) - 5,567
Noninterest income 10,051 1,457 17,376 (12,078) 16,806
Noninterest expenses 28,741 11,241 15,821 (12,078) 43,725
Amortization of intangibles (a) 246 106 - - 352
Merger-related costs (a) - 4,465 - - 4,465
Income tax expense 8,000 (602) (461) - 6,937
Minority interest in consolidated
subsidiary, net of tax (1,033) - - - (1,033)
Cumulative effect of change in accounting
principle, net of tax - - - - -
Net income 15,645 (1,288) 419 - 14,776
Nine Months Ended September 30, 2002
Net interest income $ 140,418 $ 23,192 $ (4,389) $ - $ 159,221
Provision for loan losses 12,305 5,765 (21) - 18,049
Noninterest income 29,943 3,521 47,451 (39,049) 41,866
Noninterest expenses 86,071 20,764 46,583 (39,049) 114,369
Amortization of intangibles (a) 725 106 - - 831
Merger-related costs (a) - 4,465 - - 4,465
Income tax expense 23,122 57 (1,357) - 21,822
Minority interest in consolidated
subsidiary, net of tax (2,219) - - - (2,219)
Cumulative effect of change in accounting
principle, net of tax - - (1,406) - (1,406)
Net income 46,644 127 (3,549) - 43,222
September 30, 2002
Total assets $ 5,492,298 $1,461,402 $ 812,770 $ (881,063) $ 6,885,407
Loans 3,187,990 1,060,109 78,388 (112,295) 4,214,192
Deposits 3,139,876 1,074,644 - (20,841) 4,193,679
(a) Included in noninterest expenses.
(15) SUBSEQUENT EVENTS
MountainBank Financial Corporation
On October 3, 2003, TSFG acquired MBFC, a bank holding company
headquartered in Hendersonville, North Carolina. At September 30, 2003, MBFC
operated primarily through 19 branches in western North Carolina and had total
assets of $952.0 million. The aggregate purchase price was $140.7 million, which
consisted of 5,485,298 shares of TSFG common stock valued at $135.6 million,
$24,000 of cash paid in lieu of fractional shares and outstanding employee stock
options valued at $5.0 million. This acquisition adds markets to TSFG's
geographic footprint, advancing TSFG's strategy to expand in markets with
favorable population and per capita income growth prospects.
15
TSFG accounted for MBFC using the purchase method of accounting, and
accordingly, TSFG's consolidated financial statements will include the results
of operations of MBFC beginning on the October 3, 2003 acquisition date.
OFFERING OF COMMON STOCK
On October 22, 2003, TSFG filed a preliminary prospectus supplement
with the Securities and Exchange Commission relating to its proposed offering of
6,325,000 shares (including the underwriters' over-allotment option with respect
to 825,000 shares). On November 12, 2003, TSFG completed the offering, selling
6,325,000 shares at a gross offering price of $27.00 per share. The offering
generated proceeds to TSFG of approximately $161 million, net issuance costs for
underwriting and expenses.
(16) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, and the
consolidated balance sheet at December 31, 2002 is derived from TSFG's
consolidated audited financial statements. In the opinion of management, all
adjustments necessary to present a fair statement of the results for the interim
periods have been made. All such adjustments are of a normal, recurring nature.
16
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis are presented to assist in
understanding the financial condition and results of operations of The South
Financial Group, Inc. and its subsidiaries (collectively, "TSFG"). TSFG may also
be referred to herein as "we", "us", or "our", except where the context requires
otherwise. This discussion should be read in conjunction with the consolidated
financial statements and the supplemental financial data appearing in this
report as well as the Annual Report of TSFG on Form 10-K for the year ended
December 31, 2002. Results of operations for the nine months ended September 30,
2003 are not necessarily indicative of results that may be attained for any
other period. Percentage calculations contained herein have been calculated
based upon actual, not rounded, results.
TSFG, a South Carolina corporation headquartered in Greenville, South
Carolina, is a financial holding company, which commenced banking operations in
December 1986, and currently conducts business through 76 locations in South
Carolina, 24 locations in North Carolina and 34 locations in northern and
central Florida. TSFG operates principally through two wholly-owned subsidiary
banks: Carolina First Bank, a South Carolina chartered commercial bank, and
Mercantile Bank, a Florida chartered commercial bank (which are collectively
referred to as the "Subsidiary Banks"). TSFG's subsidiaries provide a full range
of financial services, including asset management, investments, insurance,
mortgage, and trust services, designed to meet substantially all of the
financial needs of its customers.
FORWARD-LOOKING STATEMENTS AND NON-GAAP FINANCIAL INFORMATION
This report contains certain forward-looking statements (as defined in
the Private Securities Litigation Reform Act of 1995) to assist in the
understanding of anticipated future operating and financial performance, growth
opportunities, growth rates, and other similar forecasts and statements of
expectations. These forward-looking statements may be identified by the use of
such words as: "estimate", "anticipate", "expect", "believe", "intend", "plan",
or words of similar meaning, or future or conditional verbs such as "may",
"intend", "could", "will", or "should". These forward-looking statements reflect
current views, but are based on assumptions and are subject to risks,
uncertainties, and other factors, which may cause actual results to differ
materially from those in such statements. These factors include, but are not
limited to, the following:
o risks from changes in economic, monetary policy, and industry
conditions;
o changes in interest rates, deposit rates, the net interest margin, and
funding sources;
o market risk and inflation;
o risks inherent in making loans including repayment risks and value of
collateral;
o loan growth, the adequacy of the allowance for loan losses, the
assessment of problem loans (including loans acquired via
acquisition), and the performance of the Rock Hill Bank & Trust
"workout loans";
o level, composition, and repricing characteristics of the securities
portfolio;
o fluctuations in consumer spending;
o competition in the banking industry and demand for our products and
services;
o dependence on senior management;
o technological changes;
o ability to increase market share;
o expense projections;
o risks associated with income taxes, including the potential for
adverse adjustments;
o acquisitions, related cost savings, expected financial results, and
unanticipated integration issues;
o significant delay or inability to execute strategic initiatives
designed to grow revenues;
o changes in accounting policies and practices;
o changes in regulatory actions, including the potential for adverse
adjustments;
o costs and effects of litigation; and
o recently-enacted or proposed legislation.
Such forward-looking statements speak only as of the date on which such
statements are made. We undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made to reflect the occurrence of unanticipated events. In
addition, certain statements in future filings by TSFG with the Securities and
Exchange Commission, in press releases, and in oral and written statements made
by or with the approval of TSFG, which are not statements of historical fact,
constitute forward-looking statements.
17
This report also contains financial information determined by methods
other than in accordance with Generally Accepted Accounting Principles ("GAAP").
TSFG's management uses these non-GAAP measures to analyze TSFG's performance. In
particular, a number of credit quality measures presented adjust GAAP
information to exclude the effects of certain identified problem loans purchased
from Rock Hill Bank & Trust (the "Rock Hill Workout Loans"). Management believes
presentations of credit quality measures excluding the Rock Hill Workout Loans
assist in identifying core credit quality measures and trends. In addition,
certain designated net interest income amounts are presented on a tax-equivalent
basis. Management believes that the presentation of net interest income on a
tax-equivalent basis aids in the comparability of net interest income arising
from both taxable and tax-exempt sources. These disclosures should not be viewed
as a substitute for GAAP measures, and furthermore, TSFG's non-GAAP measures may
not necessarily be comparable to non-GAAP performance measures of other
companies.
CRITICAL ACCOUNTING POLICIES
TSFG's accounting policies are in accordance with accounting principles
generally accepted in the United States and with general practice within the
banking industry. The more critical accounting policies include TSFG's
accounting for securities, loans, allowance for loan losses, intangibles, and
income taxes. In particular, TSFG considers its policies regarding the allowance
for loan losses and income taxes to be its most critical accounting policies due
to the significant degree of management judgment. Different assumptions in the
application of these policies could result in material changes in TSFG's
consolidated financial statements. For additional discussion concerning TSFG's
allowance for loan losses and related matters, see "Balance Sheet Review -
Allowance for Loan Losses."
ACQUISITIONS
The following table summarizes TSFG's acquisitions completed during the
two years ending September 30, 2003. All of the transactions were accounted for
using the purchase method of accounting, and accordingly, the assets and
liabilities were recorded at their estimated fair values, which are subject to
adjustment, as of the acquisition date. TSFG's consolidated financial statements
include the results of the acquired company's operations since the acquisition
date.
Table 1
- --------------------------------------------------------------------------------------------------------------------
SUMMARY OF COMPLETED ACQUISITIONS
- --------------------------------------------------------------------------------------------------------------------
(dollars in thousands)
Purchase Identifiable
Acquisition Total Shares Price Paid Intangible
Date Assets Issued in Cash Assets Goodwill
---- ------ ------ ------- ------ --------
Bank acquisitions
Central Bank of Tampa
Tampa, Florida 12/31/02 $ 223,223 (1) 3,241,737 $ - $ 2,700 $ 36,168
Rock Hill Bank and Trust
Rock Hill, South Carolina 10/31/02 204,815 (1) 430,017 - (2) 1,204 26,543
Gulf West Banks, Inc.
St. Petersburg, Florida 08/31/02 530,296 (1) 3,925,588 32,400 8,424 71,263
Insurance agency/other acquisitions
Allied Assurance
Columbia, South Carolina 09/22/03 95 (1) 2,365 (3) - - 60
American Pensions, Inc.
Mount Pleasant, South Carolina 04/30/03 (1) 146,808 (4) - 1,050 2,872
Gardner Associates, Inc.
Columbia, South Carolina 09/20/02 1,312 (1) 249,011 (5) - 1,521 1,934
(1) Book value at the acquisition date.
(2) TSFG acquired substantially all of the assets and deposits. TSFG agreed to
pay a cash earnout based on recoveries with respect to certain loans.
18
(3) TSFG agreed to issue annual earnout shares, valued at approximately
$45,000, for each of August 31, 2004, 2005, 2006, and 2007, based on
revenue retention.
(4) Former shareholders of API have the right to receive common stock with a
maximum value of approximately $2.2 million under earnout provisions based
on API's five-year financial performance.
(5) Of this amount, up to 70,779 of these shares are subject to forfeiture back
to TSFG if certain five-year financial performance targets are not met.
On September 22, 2003, TSFG acquired Allied Assurance ("Allied"), an
independent insurance agency based in Columbia, South Carolina. TSFG intends to
use Allied to further its insurance operations in the Midlands of South
Carolina.
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. API
services over 250 corporate accounts and manages in excess of $200 million in
plan assets.
On December 31, 2002, TSFG acquired Central Bank of Tampa ("CBT"), a
community bank headquartered in Tampa, Florida. CBT operated through 5 branches
in Tampa. This merger advances TSFG's strategy to expand in markets with
relatively high population and per capita income growth prospects.
On October 31, 2002, TSFG acquired substantially all of the assets and
deposits of Rock Hill Bank & Trust ("Rock Hill Bank"), which was a wholly-owned
banking subsidiary of RHBT Financial Corporation ("RHBT"). Rock Hill Bank
operated 3 branches in York County, South Carolina. Under the asset sale
agreement, Rock Hill Bank received 430,017 shares of TSFG common stock, plus the
right to receive a cash earnout essentially equal to 30% of the net improvement
in the aggregate charge-offs and reserves in a specified loan pool and 50% of
net amounts recovered under RHBT's blanket bond insurance policy with respect to
such loans. TSFG owns approximately 22% of RHBT's outstanding stock. In
connection with the distribution of TSFG common stock to RHBT shareholders, TSFG
received 95,575 shares, which were immediately cancelled. In September 2003,
TSFG established a reserve of $1.5 million for a contingent liability related to
certain Rock Hill Bank trust accounts. The recording of this liability increased
the goodwill recorded.
On September 20, 2002, TSFG acquired Gardner Associates, Inc. ("Gardner
Associates"), an independent insurance agency based in Columbia, South Carolina.
TSFG intends to use Gardner Associates to build its insurance operations in the
Midlands area of South Carolina. As of September 30, 2003, TSFG issued 156,426
shares of TSFG common stock to acquire Gardner Associates and 21,806 shares
under an earnout provision. During the nine months ended September 30, 2003,
TSFG recorded an increase in goodwill for the fair value of the 21,806 shares,
which totaled $454,000. In addition, the principals of Gardner Associates have
the right to receive a maximum of 70,779 shares of TSFG common stock, which has
been issued and deposited in an escrow account, under earnout provisions based
on Gardner Associates' five-year financial performance.
On August 31, 2002, TSFG acquired Gulf West Banks, Inc. ("Gulf West"),
a bank holding company headquartered in St. Petersburg, Florida. Gulf West
operated through Mercantile Bank, a Florida-chartered, non-member bank with 15
locations in the Tampa Bay area of Florida. This merger represents TSFG's first
banking locations in the Tampa Bay area and advances TSFG's strategy to expand
in markets with relatively high population and per capita income growth
prospects. Upon acquiring Gulf West, TSFG combined all of its Florida operations
under the Mercantile Bank name.
Acquisition Completed Subsequent to Quarter End
On October 3, 2003, TSFG acquired MountainBank Financial Corporation
("MBFC"), a bank holding company headquartered in Hendersonville, North
Carolina. At September 30, 2003, MBFC operated primarily through 19 branches in
western North Carolina and had total assets of $952.0 million, loans of $775.0
million, securities of $80.8 million, and deposits of $779.3 million. TSFG's
composition of loans, securities, and deposits remained similar, after adding
MBFC balances. In connection with the acquisition, MBFC was merged into Carolina
First Bank. MBFC also operated Community National Bank, a national bank
headquartered in Pulaski, Virginia with approximately $69 million in assets at
September 30, 2003. Community National Bank remains a stand-alone subsidiary of
TSFG. TSFG expects to sell Community National Bank in the first quarter 2004.
19
This acquisition adds two of North Carolina's attractive growth
markets, Asheville and Hendersonville, to TSFG's geographic footprint advancing
TSFG's strategy to expand in markets with favorable population and per capita
income growth prospects. The aggregate purchase price was $140.7 million, which
consisted of 5,485,298 shares of TSFG common stock valued at $135.6 million,
$24,000 of cash paid in lieu of fractional shares and outstanding employee stock
options valued at $5.0 million. TSFG expects to record approximately $100
million of intangible assets, including goodwill. TSFG anticipates pre-tax
merger-related costs between approximately $4 million and $4.5 million, included
in noninterest expenses, largely in the fourth quarter 2003.
OVERVIEW
Net income for the nine months ended September 30, 2003 totaled $66.6
million, an increase of 54.2% compared with $43.2 million for the nine months
ended September 30, 2002. Earnings per diluted share for the first nine months
of 2003 totaled $1.39, a 35.0% increase from $1.03 per diluted share in the
first nine months of 2002. Higher net interest income, fee income initiatives, a
lower provision for loan losses, and gains on sales of securities and equity
investments contributed to the increases in net income and earnings per diluted
share. Net interest income increased from 39.9% growth in average earning
assets. Key factors responsible for TSFG's results of operations are discussed
throughout Management's Discussion and Analysis below.
Noninterest income for the nine months ended September 30, 2003 and
2002 included pre-tax gains on asset sales of $12.6 million and $4.4 million,
respectively. Gains on asset sales include gains on available for sale
securities and equity investments and a gain on the sale of a branch office.
Mortgage banking income, a component of noninterest income, includes gains and
losses on the sale of mortgage loans and charges for the write-down in the value
of capitalized mortgage servicing rights. See "Earnings Review - Noninterest
Income" for details.
Noninterest expenses for the first nine months of 2003 included the
following pre-tax other items: a $2.7 million loss on early extinguishment of
debt, $2.2 million in merger-related costs, and $268,000 in impairment loss from
write-down of assets. For the first nine months of 2002 noninterest expenses
included the following pre-tax other items: $4.5 million in merger-related
costs, $1.6 million of personnel expense related to the settlement of certain
employment agreements, and a $354,000 loss on early extinguishment of debt. In
the third quarter 2002, TSFG recorded a $1.4 million charge, net of tax, related
to impairment of goodwill associated with Carolina First Mortgage Company, which
is shown as a cumulative effect of change in accounting principle.
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income. The net
impact of these adjustments for the first nine months of 2002, which restated
the financial results for the first nine months of the year, was to increase net
income by $1.3 million, or $0.03 per diluted share.
Average common shares outstanding on a diluted basis were 48.0 million
in the first nine months of 2003, up 14.5% from 41.9 million for the first nine
months of 2002, due to shares issued for acquisitions completed in the fourth
quarter of 2002. In connection with share repurchase programs, TSFG repurchased
and cancelled 1,274,808 shares during the first nine months of 2003.
At September 30, 2003, TSFG had $9.2 billion in assets, $4.9 billion in
loans, $5.3 billion in deposits, and $656.7 million in shareholders' equity. For
the nine months ended September 30, 2003, TSFG's average assets totaled $8.8
billion, an increase of $2.5 billion, or 40.7%, compared with the first nine
months 2002 average of $6.2 billion.
BALANCE SHEET REVIEW
Loans
TSFG focuses its lending activities on small and middle market
businesses and individuals in its geographic markets. At September 30, 2003,
outstanding loans totaled $4.9 billion, which equaled 93.1% of total deposits
and 53.2% of total assets. The major components of the loan portfolio were
commercial loans, commercial real estate loans, consumer loans (including both
direct and indirect loans), and one-to-four family residential mortgage loans.
Substantially all loans were to borrowers located in TSFG's South Carolina,
North Carolina, and Florida market areas. Less than 5% of the portfolio is
unsecured. The portfolio contains no "highly leveraged transactions," as defined
by regulatory authorities.
Loans held for investment increased $705.7 million, or 17.0%, to $4.9
billion at September 30, 2003 from $4.2 billion at September 30, 2002. In the
fourth quarter of 2002, $295.7 million in loans held for investment were
acquired in mergers with Rock Hill Bank and CBT, accounting for approximately
20
42% of the increase. During the first nine months of 2003, loans held for
investment increased $423.1 million, or 9.5%. The majority of the growth,
annualized at 12.8%, was in commercial, indirect consumer and home equity loans.
While originations of residential mortgage loans increased, most of these loans
were sold at origination in the secondary market.
Loans held for sale decreased $16.9 million to $45.8 million at
September 30, 2003 from $62.7 million at September 30, 2002. Loans held for sale
at September 30, 2003 included no loans acquired from Gulf West. During the
first nine months of 2003, loans held for sale acquired from Gulf West decreased
$17.7 million, primarily from the sale of two commercial real estate loans and
the transfer to loans held for investment.
Table 2 summarizes outstanding loans by collateral type for real estate
secured loans and by borrower type for all other loans. Collateral type
represents the underlying assets securing the loan, rather than the purpose of
the loan.
Table 2
- ------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- ------------------------------------------------------------------------------------------------------------
(dollars in thousands)
September 30,
--------------------------------
Restated December 31,
2003 2002 2002
---- ---- ----
Commercial, financial and agricultural $985,892 $820,294 $913,368
Real estate - construction (1) 550,306 545,896 570,265
Real estate - residential mortgages (1-4 family) 717,915 603,728 643,941
Commercial secured by real estate (1) 1,995,295 1,633,520 1,765,103
Consumer 607,746 547,847 541,210
Lease financing receivables - 208 124
---------- ---------- ----------
Loans held for investment 4,857,154 4,151,493 4,434,011
Loans held for sale 45,817 62,699 67,218
Allowance for loan losses (63,000) (50,011) (70,275)
---------- ---------- ----------
Total net loans $4,839,971 $4,164,181 $4,430,954
========== ========== ==========
Percentage of loans held for investment
Commercial, financial and agricultural 20.3 % 19.8 % 20.6 %
Real estate - construction (1) 11.3 13.1 12.9
Real estate - residential mortgages (1-4 family) 14.8 14.5 14.5
Commercial secured by real estate (1) 41.1 39.4 39.8
Consumer 12.5 13.2 12.2
Lease financing receivables - - -
----- ----- -----
Total 100.0 % 100.0 % 100.0 %
===== ===== =====
(1) These categories include loans to businesses other than real estate
companies where owner-occupied real estate is pledged on loans to finance
operations, equipment, and facilities.
Table 2 provides a stratification of the portfolio by collateral type
and borrower type. Table 3 provides a stratification of the loan portfolio by
loan purpose.
21
Table 3
- -----------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION BASED ON LOAN PURPOSE
- -----------------------------------------------------------------------------------------------------
(dollars in thousands)
September 30,
--------------------------------
Restated December 31,
2003 2002 2002
---- ---- ----
Commercial loans
Commercial and industrial $1,347,854 $1,046,947 $1,178,955
Owner - occupied real estate 617,386 696,794 733,819
Commercial real estate 1,673,598 1,327,577 1,420,252
---------- ---------- ----------
3,638,838 3,071,318 3,333,026
---------- ---------- ----------
Consumer loans
Indirect - sales finance 543,585 414,894 420,294
Direct retail 231,076 280,580 273,419
Home equity 307,518 223,078 243,648
---------- ---------- ----------
1,082,179 918,552 937,361
---------- ---------- ----------
Mortgage loans 136,137 161,623 163,624
---------- ---------- ----------
Total loans held for investment $4,857,154 $4,151,493 $4,434,011
========== ========== ==========
Percentage of loans held for investment
Commercial and industrial 27.7 % 25.2 % 26.6 %
Owner - occupied real estate 12.7 16.8 16.6
Commercial real estate 34.5 32.0 32.0
Consumer 22.3 22.1 21.1
Mortgage 2.8 3.9 3.7
----- ----- -----
Total 100.0 % 100.0 % 100.0 %
===== ===== =====
Commercial and industrial loans are loans to finance short-term and
intermediate-term cash needs of businesses. Typical needs include the need to
finance seasonal or other temporary cash flow imbalances, growth in working
assets created by sales growth, and purchases of equipment and vehicles. Credit
is extended in the form of short-term single payment loans, lines of credit for
periods up to a year, revolving credit facilities for periods up to five years,
and amortizing term loans for periods up to ten years.
Owner-occupied real estate loans are loans to finance the purchase or
expansion of operating facilities used by businesses not engaged in the real
estate business. Typical loans are loans to finance offices, manufacturing
plants, warehouse facilities, and retail shops. Depending on the property type
and the borrower's cash flows, amortization terms vary from ten years up to 20
years. Although secured by mortgages on the properties financed, these loans are
underwritten based on the cash flows generated by operations of the businesses
they house.
Commercial real estate loans are loans to finance real properties that
are acquired, developed, or constructed for sale or lease to parties unrelated
to the borrower. Included are loans to acquire land for development, land
development loans, construction loans, mini-perms for cash flow stabilization
periods, and permanent loans in situations where access to the secondary market
is limited due to loan size.
Indirect - sales finance loans are loans to individuals to finance the
purchase of automobiles. They are closed at the auto dealership but approved in
advance by TSFG for immediate purchase. Loans are extended on new and used autos
with terms varying from two years up to five years.
Direct retail consumer loans are loans to individuals to finance
personal, family, or household needs. Typical loans are loans to finance auto
purchases, home repairs and additions, and home purchases. These loans are made
by TSFG employees in its branches.
22
Home equity loans are loans to home-owners, secured by junior mortgages
on their primary residences, to finance personal, family, or household needs.
These loans may be in the form of amortizing loans or lines of credit with terms
up to 15 years.
Mortgage loans are loans to individuals, secured by first mortgages on
single family residences, to finance the acquisition of those residences. These
loans, originated by TSFG's mortgage lending division, do not qualify for
immediate sale but are judged to be sellable with seasoning. They are
underwritten to secondary market standards and are sold, from time to time, as
they become sellable to secondary market investors.
The portfolio's only significant industry concentration is in
commercial real estate loans. All other industry concentrations are less than
10% of total loans. Commercial real estate loans were 34.5% of loans held for
investment at September 30, 2003. Due to sustained strong population growth and
household income growth, real estate development and construction are major
components of the economic activity in TSFG's markets. The risk attributable to
this concentration is managed by confining our lending to markets we are
familiar with and to borrowers who have proven track records and the financial
means to weather adverse market conditions. In its commercial real estate
lending, TSFG does not make loans without recourse to the borrower, loans
without personal guarantees from the owners, or loans to cash out equity in
commercial properties. Consequently, although the analysis of reserve adequacy
includes an adjustment to account for the risk inherent in this concentration,
management believes the risk of loss in its commercial real estate loans is not
materially greater than the risk of loss in any other segment of the portfolio.
At September 30, 2003, the loan portfolio included commitments totaling
$185.0 million in "shared national credits" (multi-bank credit facilities of $20
million or more). Outstanding balances under these commitments totaled $75.2
million. By policy, we participate in shared national credits only if the
borrower is headquartered in our market, the borrower is in an industry familiar
to us, we meet directly with the borrower to conduct our analysis, and the
borrower agrees to establish an ongoing banking relationship with us. None of
these credit facilities were classified in the most recent report on shared
national credits prepared by the regulatory agencies.
Credit Quality
A willingness to take credit risk is inherent in the decision to grant
credit. Prudent risk-taking requires a credit risk management system based on
sound policies and control processes that ensure compliance with those policies.
TSFG's credit risk management system is defined by policies approved by the
Board of Directors that govern the risk underwriting, portfolio monitoring, and
problem loan administration processes. Adherence to underwriting standards is
managed through a multi-layered credit approval process and immediate
after-the-fact review by credit risk management of loans approved by lenders.
Through daily review by credit risk managers, monthly reviews of exception
reports, and ongoing analysis of asset quality trends, compliance with
underwriting and loan monitoring policies is closely supervised. The
administration of problem loans is driven by policies that require written plans
for resolution and quarterly meetings with credit risk management to review
progress. Credit risk management activities are monitored by Credit Committees
of each banking subsidiary's Board of Directors, which meet monthly to review
credit quality trends, new large credits, loans to insiders, large problem
credits, credit policy changes, and reports on independent credit audits of
branch offices.
To facilitate comparisons, Table 4 presents credit quality indicators
two ways: one that includes all loans and one that excludes the Rock Hill
Workout Loans. On October 31, 2002, loans totaling $191.3 million were acquired
from Rock Hill Bank. Prior to the closing and in connection with identified
problem loans, Rock Hill Bank had charged off a significant portion of