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, 2002
TRANSACTION 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
incorporation or organization) Identification No.)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code (864) 255-7900
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
--- ---
The number of outstanding shares of the issuer's $1.00 par value common stock as
of November 5, 2002 was 44,111,530.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30,
--------------------------------
2002 2001 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2001
----------- ----------- ----
ASSETS
Cash and due from banks $ 175,315 $ 121,391 $ 149,170
Interest-bearing bank balances 41,849 45,162 91,497
Federal funds sold 10,022 - -
Securities
Trading 3,473 6,334 1,577
Available for sale 1,854,165 1,092,878 1,560,986
Held to maturity (market value $84,790, $73,457 and
$81,878, respectively) 82,086 71,783 80,832
---------- ---------- ----------
Total securities 1,939,724 1,170,995 1,643,395
---------- ---------- ----------
Loans
Loans held for sale 62,699 16,691 6,513
Loans held for investment 4,152,054 3,739,620 3,730,250
Allowance for loan losses (50,011) (43,944) (44,587)
---------- ---------- ----------
Net loans 4,164,742 3,712,367 3,692,176
---------- ---------- ----------
Premises and equipment, net 126,928 114,168 114,224
Accrued interest receivable 32,730 32,278 38,241
Intangible assets 176,802 98,480 97,140
Other assets 217,856 198,536 203,599
---------- ---------- ----------
$6,885,968 $5,493,377 $6,029,442
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 678,899 $ 496,353 $ 524,437
Interest-bearing 3,514,780 3,138,304 3,080,818
---------- ---------- ----------
Total deposits 4,193,679 3,634,657 3,605,255
---------- ---------- ----------
Federal funds purchased and repurchase agreements 1,219,149 680,179 1,269,538
Other borrowed funds 662,793 533,756 523,912
Subordinated notes 11,000 37,344 37,344
Trust preferred debt 73,500 - 31,000
Accrued interest payable 23,179 31,104 20,337
Other liabilities 61,762 63,250 46,859
---------- ---------- ----------
Total liabilities 6,245,062 4,980,290 5,534,245
---------- ---------- ----------
Minority interest in consolidated subsidiary 86,339 37,023 37,023
---------- ---------- ----------
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 43,588,415,
41,300,221 and 41,228,976 shares, respectively 43,588 41,300 41,229
Surplus 355,545 312,607 311,305
Retained earnings 140,336 105,495 113,288
Guarantee of employee stock ownership plan debt and
nonvested restricted stock (3,308) (1,766) (1,544)
Accumulated other comprehensive income (loss), net of tax 18,406 18,428 (6,104)
---------- ---------- ----------
Total shareholders' equity 554,567 476,064 458,174
---------- ---------- ----------
$6,885,968 $5,493,377 $6,029,442
========== ========== ==========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2002 2001 2002 2001
---- ---- ---- ----
Interest income
Interest and fees on loans $ 67,751 $ 76,432 $199,680 $242,253
Interest and dividends on securities:
Taxable 22,011 16,799 64,795 45,966
Exempt from Federal income taxes 1,084 1,002 3,239 2,966
-------- -------- -------- --------
Total interest and dividends on securities 23,095 17,801 68,034 48,932
Interest on short-term investments 252 213 939 1,181
-------- -------- -------- --------
Total interest income 91,098 94,446 268,653 292,366
-------- -------- -------- --------
INTEREST EXPENSE
Interest on deposits 20,493 33,668 63,322 118,656
Interest on borrowed funds 14,115 13,918 40,805 39,943
-------- -------- -------- --------
Total interest expense 34,608 47,586 104,127 158,599
-------- -------- -------- --------
NET INTEREST INCOME 56,490 46,860 164,526 133,767
PROVISION FOR LOAN LOSSES 5,567 5,476 18,049 15,584
-------- -------- -------- --------
Net interest income after provision for loan losses 50,923 41,384 146,477 118,183
NONINTEREST INCOME 17,119 12,664 42,394 38,704
NONINTEREST EXPENSES 46,253 36,417 122,067 110,868
-------- -------- -------- --------
Income before income taxes, minority interest, and
cumulative effect of change in accounting principle 21,789 17,631 66,804 46,019
Income taxes 6,645 6,128 21,235 16,120
-------- -------- -------- --------
Income before minority interest and cumulative
effect of change in accounting principle 15,144 11,503 45,569 29,899
Minority interest in consolidated subsidiary, net of tax (1,033) (503) (2,219) (905)
-------- -------- -------- --------
Income before cumulative effect of change in
accounting principle 14,111 11,000 43,350 28,994
Cumulative effect of change in accounting principle,
net of tax - - (1,406) 282
-------- -------- -------- --------
NET INCOME $ 14,111 $ 11,000 $ 41,944 $ 29,276
======== ======== ======== ========
AVERAGE COMMON SHARES OUTSTANDING, BASIC 41,507,843 42,340,019 40,969,925 42,407,504
AVERAGE COMMON SHARES OUTSTANDING, DILUTED 42,504,741 43,091,562 41,933,995 43,129,348
PER COMMON SHARE, BASIC:
Net income before cumulative effect of change in
accounting principle $ 0.34 $ 0.26 $ 1.06 $ 0.68
Cumulative effect of change in accounting principle,
net of tax - - (0.04) 0.01
------ ------ ------ ------
Net income $ 0.34 $ 0.26 $ 1.02 $ 0.69
====== ====== ====== ======
PER COMMON SHARE, DILUTED:
Net income before cumulative effect of change in
accounting principle $ 0.33 $ 0.26 $ 1.03 $ 0.67
Cumulative effect of change in accounting principle,
net of tax - - (0.03) 0.01
------ ------ ------ ------
Net income $ 0.33 $ 0.26 $ 1.00 $ 0.68
====== ====== ====== ======
CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.12 $ 0.11 $ 0.36 $ 0.33
====== ====== ====== ======
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP 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, 2000 42,460,358 $ 42,460 $ 332,095 $ 87,538 $6,560 $ 468,653
Net income - - - 29,276 - 29,276
Other comprehensive income,
net of tax of $5,499 - - - - 11,868 11,868
---------
Comprehensive income - - - - - 41,144
---------
Cash dividends declared
($0.33 per common share) - - - (13,912) - (13,912)
Common stock activity:
Repurchase of stock (1,450,000) (1,450) (21,668) - - (23,118)
Acquisitions 15,270 15 135 - - 150
Dividend reinvestment plan 121,091 121 1,697 - - 1,818
Employee stock purchase plan 11,245 11 159 - - 170
Restricted stock plan (1,378) (1) (15) 561 - 545
Exercise of stock options 143,635 144 217 - - 361
Miscellaneous - - (13) 266 - 253
---------- -------- --------- --------- ------- ---------
Balance, September 30, 2001 41,300,221 $ 41,300 $ 312,607 $ 103,729 $18,428 $ 476,064
========== ======== ========= ========= ======= =========
Balance, December 31, 2001 41,228,976 $ 41,229 $ 311,305 $ 111,744 $ (6,104) $ 458,174
Net income - - - 41,944 - 41,944
Other comprehensive income,
net of tax of $11,348 - - - - 24,510 24,510
---------
Comprehensive income - - - - - 66,454
---------
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 43,588,415 $ 43,588 $ 355,545 $ 137,028 $18,406 $ 554,567
========== ======== ========= ========= ======= =========
* Other includes guarantee of employee stock ownership plan debt and nonvested restricted stock.
See accompanying notes to consolidated financial statements.
3
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------
2002 2001
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 41,944 $ 29,276
Adjustments to reconcile net income to net cash provided
by operating activities
Depreciation, amortization, and accretion, net 23,247 22,365
Provision for loan losses 18,049 15,584
Gain on sale of available for sale securities (1,005) (1,539)
(Gain) loss on trading securities 267 (207)
Gain on equity investments (3,388) (1,019)
Loss on disposition of assets and liabilities - 1,251
Gain on sale of loans (1,671) (3,057)
Gain on disposition of premises and equipment (55) (266)
Loss on disposition of other real estate owned 762 386
Impairment loss from write-down of assets - 391
Impairment loss from write-down of mortgage servicing rights 592 509
Loss on early extinguishment of debt 354 1,093
Loss on changes in fair value of hedges 228 114
Minority interest in consolidated subsidiary 2,219 905
Cumulative effect of change in accounting principle 1,406 (282)
Trading account assets, net 206,000 (1,122)
Originations of mortgage loans held for sale (325,259) (280,832)
Sale of mortgage loans held for sale 296,655 353,175
Other assets, net 5,098 11,861
Other liabilities, net 728 17,038
-------- --------
Net cash provided by operating activities 266,171 165,624
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of securities available for sale 629,343 264,233
Maturity or call of securities available for sale 1,054,079 304,522
Maturity or call of securities held to maturity 6,787 11,756
Purchase of securities available for sale (2,021,568) (712,322)
Purchase of securities held to maturity (8,156) (5,897)
Purchase of bank-owned life insurance - (25,000)
Origination of loans held for investment, net (160,955) (230,247)
Sale of loans held for investment 11,961 -
Sale of other real estate owned 4,224 5,666
Sale of premises and equipment 1,443 785
Capital expenditures (10,565) (4,598)
Disposition of assets and liabilities, net - (40,382)
Cash equivalents acquired, net of payment for purchase acquisition 29,227 -
-------- --------
Net cash used for investing activities (464,180) (431,484)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits, net 163,246 (216,615)
Borrowed funds, net 19,615 464,480
Redemption of subordinated notes (26,344) -
Prepayment penalty on early extinguishment of debt - (1,093)
Issuance of minority interest stock, net 49,247 37,023
Issuance of trust preferred debt, net 41,176 -
Cash dividends paid (14,622) (14,002)
Cash dividends paid on minority interest (2,878) (921)
Repurchase of common stock (48,483) (23,118)
Other common stock activity 3,571 2,752
-------- --------
Net cash provided by financing activities 184,528 248,506
-------- --------
Net change in cash and due from banks (13,481) (17,354)
Cash and cash equivalents at beginning of year 240,667 183,907
-------- --------
Cash and cash equivalents at end of period $227,186 $166,553
======== ========
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP 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 (collectively, "TSFG,"
except where the context requires otherwise). All significant intercompany
accounts and transactions are 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 2002
presentations.
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 2001 Annual Report on Form 10-K should be referred to in
connection with the reading of these unaudited interim consolidated financial
statements.
ACCOUNTING ESTIMATES AND ASSUMPTIONS
Certain policies require management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ significantly from these
estimates and assumptions.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146
applies to costs associated with an exit activity that does not involve an
entity newly acquired in a business combination or with a disposal activity
covered by SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." Those costs include, but are not limited to, the following:
a) termination benefits provided to current employees that are involuntarily
terminated under the terms of a benefit arrangement that, in substance, is not
an ongoing benefit arrangement or an individual deferred compensation contract
(hereinafter referred to as one-time termination benefits), b) costs to
terminate a contract that is not a capital lease, and c) costs to consolidate
facilities or relocate employees. This Statement does not apply to costs
associated with the retirement of a long-lived asset covered by SFAS No. 143,
"Accounting for Asset Retirement Obligations." A liability for a cost associated
with an exit or disposal activity shall be recognized and measured initially at
its fair value in the period in which the liability is incurred. A liability for
a cost associated with an exit or disposal activity is incurred when the
definition of a liability is met in accordance with FASB Concepts Statements No.
6, "Elements of Financial Statements." The provisions of this Statement are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The impact of adoption on TSFG, if any,
is not known at this time.
See Note 5 for new accounting pronouncements that TSFG adopted in 2002.
5
(2) SUPPLEMENTAL FINANCIAL INFORMATION
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,
---------------------------- ------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Noninterest income:
Service charges on deposit accounts $ 6,108 $ 4,568 $ 16,436 $ 13,748
Fees for investment services 1,359 1,462 4,639 4,204
Mortgage banking income 850 927 3,397 5,250
Bank-owned life insurance 1,877 1,845 5,486 5,397
Merchant processing income 1,778 1,657 4,741 4,618
Gain on sale of available for sale securities 790 1,134 1,005 1,539
Gain (loss) on trading securities (330) 67 (267) 207
Gain on equity investments 3,527 17 3,388 1,019
Loss on disposition of assets and liabilities - (19) - (1,251)
Other 1,160 1,006 3,569 3,973
-------- -------- ------- -------
Total noninterest income $ 17,119 $ 12,664 $ 42,394 $ 38,704
======== ======== ======== ========
Noninterest expenses:
Salaries and wages $ 18,594 $ 14,101 $ 50,951 $ 43,195
Employee benefits 3,538 3,369 11,841 10,776
Furniture and equipment 3,993 3,366 11,072 10,097
Occupancy 3,919 3,626 11,150 10,830
Professional fees 1,343 1,369 3,859 4,002
Merchant processing expense 1,381 1,436 3,798 3,771
Amortization of intangibles 352 1,423 831 4,425
Impairment loss from write-down of assets - 176 - 391
Merger-related costs (recoveries) 4,465 (89) 4,465 (502)
Loss on early extinguishment of debt 354 1,093 354 1,093
Other 8,314 6,547 23,746 22,790
-------- -------- -------- --------
Total noninterest expenses $ 46,253 $ 36,417 $122,067 $110,868
======== ======== ======== ========
6
CONSOLIDATED STATEMENTS OF CASH FLOW
The following summarizes supplemental cash flow data (in thousands) for the nine
months ended September 30:
2002 2001
---- ----
Interest paid $100,080 $162,663
Income taxes paid (refunded) 25,278 (9,150)
Significant non-cash investing and financing transactions are summarized as follows:
Available for sale securities transferred to trading securities and subsequently sold 208,163 -
Loans securitized and reclassed to available for sale securities - 112,174
Loans held for investment transferred to loans held for sale - 75,000
Change in unrealized gain on available for sale securities 35,526 18,321
Loans transferred to other real estate owned 9,336 8,623
Business combinations:
Fair value of assets acquired (includes cash and cash equivalents) 613,440 -
Fair value of common stock issued and stock options recognized (88,074) -
Cash paid (32,406) -
-------- --------
Liabilities assumed 492,960 -
(3) OTHER COMPREHENSIVE INCOME
The following summarizes other comprehensive income, net of tax (in thousands)
for the nine months ended September 30:
2002 2001
---- ----
Unrealized gains on securities:
Unrealized holding gains arising during the period $ 39,919 $20,270
Income tax expense (12,763) (6,531)
Less: Reclassification adjustment for gains included in net income (4,393) (1,949)
Income tax expense 1,538 679
Unrealized gains (losses) on cash flow hedges:
Cumulative effect of change in accounting principle - (70)
Income tax benefit - 26
Unrealized gain (loss) on change in fair values 332 (884)
Income tax (expense) benefit (123) 327
-------- -------
$ 24,510 $11,868
======== =======
(4) BUSINESS COMBINATIONS
GULF WEST
On August 31, 2002, TSFG completed the merger with 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
fifteen locations in the greater Tampa Bay area. This merger represents TSFG's
first banking locations in the Tampa Bay area and advances TSFG's strategy to
expand in markets with favorable population and per capita income growth
7
prospects. Upon acquiring Gulf West, TSFG combined all of its Florida operations
under the Mercantile Bank name. TSFG acquired all the outstanding common shares
of Gulf West in exchange for 3,925,588 shares of TSFG common stock and $32.4
million in cash.
The Gulf West transaction has been accounted for using the purchase method of
accounting, and accordingly, the assets and liabilities of Gulf West were
recorded at their estimated fair values as of the merger date. The fair values
are preliminary and are subject to adjustment as information relative to the
fair values as of August 31, 2002 becomes available. TSFG uses an allocation
period, not to exceed one year, to identify and quantify the fair value of the
assets acquired and liabilities assumed in business combinations accounted for
as purchases. The consolidated financial statements include the results of Gulf
West's operations since the August 31, 2002 merger date.
The following summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of merger based on information currently
available (in thousands):
AUGUST 31,
2002
ASSETS
Cash and due from banks $ 23,377
Interest-bearing bank balances 37,471
Securities 125,473
Loans
Loans held for sale 25,966
Loans held for investment 286,645
Allowance for loan losses (2,877)
--------
Net loans 309,734
--------
Premises and equipment, net 12,383
Accrued interest receivable 2,147
Intangible assets 79,502
Other assets 19,644
--------
Total assets acquired 609,731
--------
LIABILITIES
Deposits 418,933
Other borrowed funds 67,901
Accrued interest payable 372
Other liabilities 5,299
--------
Total liabilities assumed 492,505
--------
NET ASSETS ACQUIRED $117,226
========
The aggregate purchase price was $117.2 million, including $32.4 million of
cash, 3,925,588 shares of TSFG common stock valued at $78.2 million, outstanding
employee stock options valued at $6.5 million, and shares issuable under
employee stock purchase plan valued at $98,000.
The merger agreement provided each Gulf West shareholder the right to elect to
convert their Gulf West common stock into cash, shares of TSFG common stock, or
a mixture of both, subject to allocation procedures. The per share stock
consideration was 0.6921 shares of TSFG common stock for each Gulf West share.
The per share cash consideration was $13.7942 for each Gulf West share.
8
The Gulf West purchase price and the amount of the purchase price allocated to
goodwill and other intangible assets are presented below (in thousands):
AUGUST 31,
2002
Purchase price $117,226
Gulf West tangible shareholders' equity 44,275
--------
Excess of purchase price over carrying value of
net tangible assets acquired 72,951
Fair value adjustments (1,776)
Direct acquisition costs 4,561
Deferred income taxes 3,766
--------
Total intangible assets 79,502
Core deposit premiums 8,424
--------
Goodwill $ 71,078
========
The core deposit premium intangible asset is amortized over 10 years on an
accelerated basis until the straight-line amortization method is greater at
which time the straight-line method is used. The core deposit premium valuation
and amortization method are based upon a historical study of the deposits
acquired. All of the Gulf West intangible assets were assigned to the Mercantile
Bank segment. The goodwill will not be amortized but will be tested at least
annually for impairment in accordance with SFAS No. 142, "Goodwill and Other
Intangible Assets." The total amount of goodwill expected to be deductible for
income tax purposes is $2.3 million.
The following unaudited pro forma financial information presents the combined
results of operations of TSFG and Gulf West as if the merger had occurred as of
the beginning of the period for each period presented, after giving effect to
certain adjustments, including amortization of core deposit premium intangible
asset and related income tax effects (in thousands, except per common share).
The pro forma financial information does not necessarily reflect the results of
operations that would have occurred had TSFG and Gulf West constituted a single
entity during such periods.
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------
2002 2001
---- ----
Net interest income $ 60,128 $ 51,695
Noninterest income 17,650 13,633
Net income 14,376 12,025
Per common share:
Net income, basic 0.32 0.26
Net income, diluted 0.31 0.26
9
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------
2002 2001
---- ----
Net interest income $ 178,712 $ 147,166
Noninterest income 44,803 41,427
Income before cumulative effect of change in
accounting principle 45,993 31,354
Net income 44,587 31,636
Per common share:
Net income, basic 0.99 0.68
Net income, diluted 0.97 0.67
In connection with the Gulf West merger, TSFG recorded pre-tax merger-related
costs of $4.5 million, included in noninterest expenses, and direct acquisition
costs of $4.6 million, 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, 2002:
TOTAL AMOUNTS REMAINING
COSTS PAID ACCRUAL
----- ---- -------
Merger-related costs:
Compensation-related expenses $ 2,448 $ 1,205 $ 1,243
System conversion costs 614 317 297
Travel 464 438 26
Personnel training 219 79 140
Advertising 148 148 -
Other 572 295 277
------- ------- -------
$ 4,465 $ 2,482 $ 1,983
======= ======= =======
TOTAL AMOUNTS REMAINING
COSTS PAID ACCRUAL
----- ---- -------
Direct acquisition costs:
Investment banking and professional fees $ 3,958 $ 3,012 $ 946
Contract and lease terminations 330 320 10
Severance 273 - 273
------- ------- -------
$ 4,561 $ 3,332 $ 1,229
======= ======= =======
Severance charges are associated with the involuntary termination of
approximately 59 former Gulf West employees who were notified that their
positions were redundant within the combined organization. These positions were
primarily in centralized corporate support and data processing areas. The
contract termination costs are primarily comprised of payments required to be
made to certain executives of Gulf West pursuant to their employment contracts.
The lease termination costs were for buyouts on Gulf West leased facilities.
GARDNER ASSOCIATES, INC.
On September 20, 2002, TSFG acquired Gardner Associates, Inc., an independent
insurance agency based in Columbia, South Carolina. This acquisition was
accounted for using the purchase method of accounting, and accordingly, the
assets and liabilities of Gardner Associates, Inc. were recorded at their
estimated fair values as of the merger date. The fair values are preliminary and
are subject to refinement as information relative to the fair values as of
September 20, 2002 becomes available. TSFG issued 156,426 shares of common stock
10
valued at $3.3 million, acquired tangible assets totaling $1.3 million, assumed
liabilities totaling $455,000, recorded a non-compete agreement intangible asset
of $663,000, recorded goodwill of $876,000, and recorded a customer list
intangible asset of $858,000. The non-compete agreement intangible is amortized
on a straight-line basis over its estimated useful life of 2 years. The customer
list intangible is amortized on a straight-line basis over its estimated useful
life of 10 years. In addition, the principals of Gardner Associates have the
right to receive a maximum of 92,585 shares of TSFG common stock under earnout
provisions based on Gardner Associates' annual and five-year financial
performance.
ROCK HILL BANK AND TRUST
On October 31, 2002, TSFG completed its asset sale agreement to acquire
substantially all of the assets and deposits of Rock Hill Bank & Trust ("Rock
Hill"), which is the wholly-owned banking subsidiary of RHBT Financial
Corporation ("RHBT"). At September 30, 2002, Rock Hill operated 3 branches in
York County, South Carolina, and had deposits of $184.9 million. Under the asset
sale agreement, Rock Hill received 430,017 shares of TSFG common stock, valued
at $9.3 million, plus the right to receive a cash earnout essentially equal to
30% of the net improvement in the aggregate charge-offs and reserves in the
entire designated loan pool and 50% of net amounts recovered under RHBT's
blanket bond insurance policy with respect to such loans. TSFG also agreed to
repurchase such number of these 430,017 shares as are not distributed to RHBT
shareholders in RHBT's pending liquidation. TSFG has identified a potential
liability related to certain Rock Hill trust accounts. Any liability recorded
would increase the goodwill recorded.
TSFG owns 382,500 shares, or approximately 22% of RHBT outstanding stock, which
is included in available for sale securities. During the third quarter, TSFG
wrote-down its investment in RHBT by $1.2 million to its September 30, 2002
estimated fair value of approximately $1.9 million, or $5.00 per share. The
Board of Directors of RHBT presently plans to distribute most, but not
necessarily all, of the 430,017 shares of TSFG common stock received by Rock
Hill to RHBT shareholders after closing of the sale of assets. Upon the
distribution of the TSFG common stock to RHBT shareholders, TSFG will cancel any
TSFG shares received.
CENTRAL BANK OF TAMPA
In October 2002, TSFG signed a definitive agreement to acquire Central Bank of
Tampa ("CBT"), a closely held community bank headquartered in Tampa, Florida. At
September 30, 2002, CBT operated through 5 branches in Tampa and had total
assets of $215.4 million. TSFG will issue common stock equal to $68.0 million in
exchange for all the outstanding common shares of CBT. Such TSFG common stock
will be valued at the average closing price on the ten trading days ending on
the second trading day prior to closing (except that the value will never be
deemed less than $15.00 or greater than $25.00). This transaction, which is
expected to close in the fourth quarter of 2002, will be accounted for using the
purchase method of accounting and is subject to receipt of CBT shareholder and
regulatory approval.
(5) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, TSFG adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"). It requires that goodwill
and intangible assets with indefinite useful lives no longer be amortized, but
instead tested for impairment at least annually in accordance with the
provisions of SFAS 142. SFAS 142 also requires that intangible assets with
definite useful lives be amortized over their respective estimated useful lives
to their estimated residual values and reviewed for impairment in accordance
with SFAS No. 121, "Accounting for the Impairment or Disposal of Long-Lived
Assets" ("SFAS 144").
In connection with the transitional goodwill, SFAS 142 requires TSFG to perform
an assessment of whether there is an indication that goodwill is impaired as of
January 1, 2002. To accomplish this, TSFG had to identify its reporting units
and determine the carrying value of each reporting unit by assigning the assets
and liabilities, including the existing goodwill and intangible assets, to those
11
reporting units as of the date of adoption. TSFG had until June 30, 2002 to
determine the fair value of each reporting unit and compare it to the reporting
unit's carrying amount. To the extent a reporting unit's carrying amount exceeds
its fair value, an indication exists that the reporting unit's goodwill may be
impaired, and the second step of the transitional impairment test must be
performed. In the second step, the implied fair value of the reporting unit's
goodwill, determined by allocating the reporting unit's fair value to all of it
assets (recognized and unrecognized) and liabilities in a manner similar to a
purchase price allocation in accordance with SFAS 141, "Business Combinations,"
is compared to its carrying amount, both of which would be measured as of
January 1, 2002.
TSFG has completed its analysis of the fair value of its intangible assets,
using a discounted cash flow method, and determined that the goodwill associated
with Carolina First Mortgage Company was impaired. TSFG recorded a transitional
impairment loss of $1.4 million. This transitional impairment loss was
recognized as the cumulative effect of a change in accounting principle in the
consolidated statements of income for the nine months ended September 30, 2002
(although it was not reflected in the third quarter 2002 results since the
impairment is reflected as of January 1, 2002).
As of the January 1, 2002 adoption of SFAS 142, TSFG had unamortized goodwill in
the amount of $89.1 million, unamortized identifiable intangible assets in the
amount of $5.5 million, and unamortized unidentifiable intangible assets in the
amount of $2.5 million related to branch purchases. Under SFAS 142, the
amortization of goodwill ceased effective January 1, 2002. The amortization of
goodwill approximated $4.2 million pre-tax (or $4.1 million after tax) during
2001 and $3.2 million pre-tax (or $3.1 million after-tax) during the nine months
ended September 30, 2001. TSFG continues to amortize the identifiable intangible
assets, which relate to core deposit premiums and customer lists. Also, see
Notes 6 and 7 for additional financial statement disclosure requirements under
SFAS 142.
The following presents the details for goodwill amortization expense and net
income (in thousands, except share data):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income $ 14,111 $11,000 $ 41,944 $29,276
Amortization of goodwill, net of tax - 999 - 3,095
-------- ------- -------- -------
Adjusted net income $ 14,111 $11,999 $ 41,944 $32,371
======== ======= ======== =======
Net income per common share, basic $ 0.34 $ 0.26 $ 1.02 $ 0.69
Amortization of goodwill, net of tax - 0.02 - 0.07
------ ------ ------ ------
Adjusted net income per common share, basic $ 0.34 $ 0.28 $ 1.02 $ 0.76
====== ====== ====== ======
Net income per common share, diluted $ 0.33 $ 0.26 $ 1.00 $ 0.68
Amortization of goodwill, net of tax - 0.02 - 0.07
------ ------ ------ ------
Adjusted net income per common share, diluted $ 0.33 $ 0.28 $ 1.00 $ 0.75
====== ====== ====== ======
RECLASSIFICATION OF LOSSES ON EARLY EXTINGUISHMENT OF DEBT
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishments of Debt" ("SFAS 4"), and an amendment of SFAS 4, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145
requires that gains and losses from extinguishment of debt should be classified
12
as an extraordinary item only if they meet the criteria of FASB Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" ("FASB Opinion 30"). Applying the provisions of FASB
Opinion 30 will distinguish transactions that are part of an entity's recurring
operations from those that are unusual or infrequent or that meet the criteria
for classification as an extraordinary item.
The provisions of SFAS 145 are effective for financial statements issued for
fiscal years beginning after May 15, 2002 and interim periods within those
fiscal years, and early adoption is encouraged. Any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods presented that does not meet the criteria in FASB Opinion 30 for
classification as an extraordinary item will be reclassified.
TSFG adopted SFAS 145 effective July 1, 2002. In connection with this adoption,
TSFG reclassified losses on the early extinguishment of debt, which were
incurred in the second half of 2001 and totaled $3.1 million pre-tax, to
noninterest expenses.
UNIDENTIFIABLE INTANGIBLE ASSETS FROM BRANCH PURCHASES
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9" ("SFAS 147"). SFAS 147 removes acquisitions of financial
institutions from the scope of both FASB Statements No. 72 ("SFAS 72") and FASB
Interpretation No. 9 and requires that those transactions be accounted for in
accordance with FASB Statements No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets," except for transactions between two or
more mutual enterprises. Thus, the requirement in SFAS 72 to recognize (and
subsequently amortize) any excess of the fair value of liabilities assumed over
the fair value of tangible and identifiable assets acquired as an unidentifiable
intangible asset no longer applies to acquisitions within the scope of the scope
of SFAS 72. In addition, SFAS 147 amends FASB Statement No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), to include in its
scope long-term customer-relationship intangible assets of financial
institutions such as depositor- and borrower-relationship intangible assets and
credit cardholder intangible assets. Consequently, those intangible assets are
subject to the same undiscounted cash flow recoverability test and impairment
loss recognition and measurement provisions that SFAS 144 requires for other
long-lived assets that are held and used. The provisions of SFAS 147 are
effective for financial statements issued on or after October 1, 2002, and early
adoption is permitted.
In the third quarter, TSFG adopted SFAS 147 effective as of January 1, 2002. The
unamortized unidentifiable intangible assets related to branch purchases, which
totaled $2.5 million net of accumulated amortization as of January 1, 2002, were
reclassified as goodwill. In connection with this adoption, TSFG reversed
pre-tax amortization of intangibles totaling $112,000, which was recorded in the
first half of 2002.
13
(6) INTANGIBLE ASSETS
Intangible assets are summarized as follows (in thousands):
SEPTEMBER 30, DECEMBER 31,
---------------------------
2002 2001 2001
---- ---- ----
Goodwill $162,148 $92,699 $91,600
Core deposit premiums 22,970 14,546 14,546
Less accumulated amortization (9,832) (8,765) (9,006)
-------- ------- -------
13,138 5,781 5,540
-------- ------- -------
Customer list intangible 858 - -
Less accumulated amortization (1) - -
-------- ------- -------
857 - -
Non-compete agreement intangible 663 - -
Less accumulated amortization (4) - -
-------- ------- -------
659 - -
-------- ------- -------
$176,802 $98,480 $97,140
======== ======= =======
The following summarizes the changes in the carrying amount of goodwill related
to each of TSFG's business segments (in thousands) for the nine months ended
September 30, 2002:
CAROLINA MERCANTILE
FIRST BANK BANK OTHER TOTAL
---------- ---- ----- -----
Balance, December 31, 2001 $90,194 $ - $ 1,406 $ 91,600
Goodwill acquired during year 876 71,078 - 71,954
Impairment losses - - (1,406) (1,406)
------- -------- ------- --------
Balance, September 30, 2002 $91,070 $ 71,078 $ - $162,148
======= ======== ======= ========
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. Amortization of intangibles
totaled $1.0 million for core deposit premiums, $210,000 for unidentifiable
intangible assets from branch purchases, and $3.2 million for goodwill for the
nine months ended September 30, 2001. Under SFAS 142, the amortization of
goodwill ceased effective January 1, 2002. Under SFAS 147, the amortization of
unidentifiable intangible assets from branch purchases ceased effective January
1, 2002. See Note 5.
The estimated amortization expense for core deposit premiums for the years ended
December 31 is as follows: $1.4 million for 2002, $2.1 million for 2003, $1.7
million for 2004, $1.5 million for 2005, $1.3 million for 2006, and an aggregate
of $5.9 million for all the years thereafter. The estimated amortization expense
for customer list intangibles is $24,000 for the year ended December 31, 2002
and $86,000 for the years ended December 31, 2003 to 2006 and an aggregate of
$490,000 for all the years thereafter. The estimated amortization expense for
non-compete agreement intangibles for the years ended December 31 is as follows:
$92,000 for 2002, $332,000 for 2003, and $239,000 for 2004.
(7) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs") totaled $5.6 million, $8.9
million, and $10.8 million at September 30, 2002, December 31, 2001, and
September 30, 2001, respectively. Amortization expense for MSRs totaled $2.7
14
million and $3.3 million for the nine months ended September 30, 2002 and 2001,
respectively.
The estimated amortization expense for MSRs for the years ended December 31 is
as follows: $3.5 million for 2002, $3.1 million for 2003, $1.7 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) DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
In accordance with SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities" ("SFAS 133"), TSFG records derivatives at fair value, as
either assets or liabilities, on the consolidated balance sheets. At September
30, 2002, the fair value of derivative assets totaled $6.7 million and was
related to derivatives with no hedging designation and fair value hedges. At
September 30, 2002, the fair value of derivative liabilities totaled $541,000
for cash flow hedges and $208,000 for futures, options, and other derivatives,
which do not qualify for hedge accounting under SFAS 133.
Derivative transactions are measured in terms of the notional amount, but this
amount is not recorded on the consolidated balance sheets. The notional amounts
related to TSFG's derivatives at September 30, 2002, which are not recognized on
the consolidated balance sheets, totaled $283.0 million for the derivative
assets and $417.9 million for the derivative liabilities.
(9) REDEMPTION OF SUBORDINATED NOTES
TSFG redeemed its 9.00% Subordinated Notes Due 2005 (the "Notes") on August 31,
2002. This constituted a full redemption of all of the outstanding Notes, which
had a principal balance of $26.3 million. The Notes were redeemed at their par
value. The associated unamortized issuance costs, which had a balance of
$354,000 at August 31, 2002, were written off on the redemption date and
included in noninterest expenses.
(10) TRUST PREFERRED DEBT
On July 11, 2002, TSFG Capital Trust 2002-A (the "Capital Trust 2002-A"), a
wholly-owned subsidiary of TSFG, issued and sold floating rate securities having
an aggregate liquidation amount of $25.0 million (the "Capital Securities
2002-A") to institutional buyers in a pooled trust preferred issue. The Capital
Securities 2002-A generated gross proceeds of $25.0 million. The Capital Trust
2002-A loaned these proceeds to the parent company to use for general corporate
purposes. Issuance costs from the July 11, 2002 sale totaled $750,000. The trust
preferred debt qualifies as tier 1 capital under Federal Reserve Board
guidelines.
The Capital Securities 2002-A accrue and pay distributions quarterly at a rate
per annum equal to three-month LIBOR plus 365 basis points. This rate may not
exceed 12.5% through July 2007. The distributions payable on the Capital
Securities 2002-A are cumulative and payable quarterly in arrears. TSFG has the
right, subject to events of default, to defer payments of interest on the
Capital Securities 2002-A for a period not to exceed 20 consecutive quarters,
provided that no extension period may extend beyond the maturity date of October
7, 2032. TSFG has no current intention to exercise its right to defer payments
of interest on the Capital Securities 2002-A.
The Capital Securities 2002-A are mandatorily redeemable upon maturity on
October 7, 2032. TSFG has the right to redeem the Capital Securities 2002-A in
whole or in part, on or after July 7, 2007. If the Capital Securities 2002-A are
redeemed on or after July 7, 2007, the redemption price will be 100% of the
principal amount plus accrued and unpaid interest. In addition, TSFG may redeem
the Capital Securities 2002-A in whole (but not in part) at any time within 90
days following the occurrence of a tax event, an investment company event, or a
capital treatment event at a special redemption price (as defined in the
indenture).
15
On July 30, 2002, South Financial Capital Trust II (the "Capital Trust II"), a
wholly-owned subsidiary of TSFG, issued and sold floating rate securities having
an aggregate liquidation amount of $17.5 million (the "Capital Securities II")
to institutional buyers in a pooled trust preferred issue. The Capital
Securities II generated gross proceeds of $17.5 million. The Capital Trust II
loaned these proceeds to the parent company to use for general corporate
purposes. Issuance costs from the July 30, 2002 sale totaled $574,000. The trust
preferred debt qualifies as tier 1 capital under Federal Reserve Board
guidelines.
The Capital Securities II accrue and pay distributions semi-annually at a rate
per annum equal to six-month LIBOR plus 362.5 basis points. This rate may not
exceed 12.0% through July 30, 2007. The distributions payable on the Capital
Securities II are cumulative and payable quarterly in arrears. TSFG has the
right, subject to events of default, to defer payments of interest on the
Capital Securities II for a period not to exceed 20 consecutive quarters,
provided that no extension period may extend beyond the maturity date of July
30, 2032. TSFG has no current intention to exercise its right to defer payments
of interest on the Capital Securities II.
The Capital Securities II are mandatorily redeemable upon maturity on July 30,
2032. TSFG has the right to redeem the Capital Securities II in whole or in
part, on or after July 30, 2007. If the Capital Securities II are redeemed on or
after July 30, 2007, the redemption price will be 100% of the principal amount
plus accrued and unpaid interest. In addition, TSFG may redeem the Capital
Securities II in whole (but not in part) at any time within 90 days following
the occurrence of a tax event, an investment company event, or a capital
treatment event at a special redemption price (as defined in the indenture).
(11) MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY
Carolina First Mortgage Loan Trust (the "REIT") is a majority-owned subsidiary
of SCOREIT, Inc., which is a wholly-owned subsidiary of Carolina First Bank,
that holds real estate-related assets, including mortgage loans. Carolina First
Bank is a wholly-owned banking subsidiary of TSFG. SCOREIT, Inc.'s ownership in
the REIT is evidenced by common and preferred equity. On June 11, 2002, Carolina
First Bank sold 131 shares of the REIT's Series 2000A Cumulative Fixed Rate
Preferred Shares (the "Series A Trust Preferred Stock") and 385 shares of the
REIT's Series 2002C Cumulative Floating Rate Preferred Shares (the "Series C
Trust Preferred Stock") to institutional buyers. The Series A Trust Preferred
Stock and Series C Trust Preferred Stock have a stated value of $100,000 per
share. Proceeds to Carolina First Bank from these sales totaled approximately
$49.2 million, net of issuance costs totaling $2.4 million, and are reported as
minority interest in consolidated subsidiary on the consolidated balance sheet.
The minority interest in consolidated subsidiary qualifies as capital under
Federal Reserve Board guidelines.
In 2001, Carolina First Bank sold 132 shares of Series A Trust Preferred Stock
and 250 shares of the REIT's Series 2000B Cumulative Floating Rate Preferred
Shares (the "Series B Trust Preferred Stock") to institutional buyers. For
details on the Series A Trust Preferred Stock and Series B Trust Preferred
Stock, see TSFG's Annual Report on Form 10-K for the year ended December 31,
2001.
Dividends on the Series C Trust Preferred Stock are cumulative, and will accrue
whether or not the REIT has earnings, whether or not there are funds legally
available for the payment of such dividends, and whether or not such dividends
are declared. The dividends for the Series C Trust Preferred Stock are computed
at a rate per annum equal to three month LIBOR plus 350 basis points of the
stated value and are payable quarterly.
The shares of Series C Trust Preferred Stock are mandatorily redeemable on May
31, 2012, or upon earlier redemption as provided in the terms of the Series C
Trust Preferred Stock. TSFG has the right to redeem the Series C Trust Preferred
Stock in whole or in part, on or after May 31, 2007, on any quarterly dividend
payment date, at redemption price equal to the liquidation value ($100,000 per
share). After the occurrence of a tax event or capital event (as defined in the
terms of the Series C Trust Preferred Stock), TSFG may redeem all or a portion
of the Series C Trust Preferred Stock at a redemption price equal to 101% of the
liquidation value if the redemption is prior to May 31, 2007 or 100% of the
liquidation value thereafter.
16
The dividends earned by institutional holders of the Series A Trust Preferred
Stock, the Series B Trust Preferred Stock, and the Series C Trust Preferred
Stock for the nine months ended September 30, 2002 amounted to $2.2 million (net
of related income taxes of $1.3 million). These dividends and the amortization
of issuance costs, which totaled $69,000 pre-tax for the nine months ended
September 30, 2002, are expensed on TSFG's consolidated statement of income as
minority interest in consolidated subsidiary.
(12) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common shares
outstanding.
THREE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------
2002 2001
---- ----
Basic:
Average common shares outstanding (denominator) 41,507,843 42,340,019
========== ==========
DILUTED:
Average common shares outstanding 41,507,843 42,340,019
Dilutive potential common shares 996,898 751,543
---------- ----------
Average diluted shares outstanding (denominator) 42,504,741 43,091,562
========== ==========
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------
2002 2001
---- ----
Basic:
Average common shares outstanding (denominator) 40,969,925 42,407,504
========== ==========
DILUTED:
Average common shares outstanding 40,969,925 42,407,504
Dilutive potential common shares 964,070 721,844
---------- ----------
Average diluted shares outstanding (denominator) 41,933,995 43,129,348
========== ==========
NUMBER RANGE OF
OF SHARES EXERCISE PRICES
--------- ---------------
For the three months ended
September 30, 2002 977,672 $21.03 to $31.26
September 30, 2001 1,353,857 $17.93 to $31.26
For the nine months ended
September 30, 2002 977,672 $21.03 to $31.26
September 30, 2001 1,561,080 $16.64 to $31.26
(13) 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.
17
TSFG has identified a potential liability related to certain Rock Hill trust
accounts. Any liability recorded would increase the goodwill recorded.
On November 4, 1996, a derivative shareholder action was filed in the South
Carolina Circuit Court for Greenville County against TSFG and several of its
officers. The complaint was subsequently amended several times. The amended
complaint names as additional defendants the majority of the directors of TSFG
and Carolina First Bank. The named plaintiffs in the amended complaints are
TSFG, pursuant to Section 33-7-400 of the South Carolina Code of Laws, by and
through several named minority shareholders. Plaintiffs allege four causes of
action based generally on the payment to the defendant officers of a bonus in
stock held by TSFG in Affinity Technology Group, Inc. ("Affinity") as a reward
for their efforts in connection with the Affinity investment, and other matters.
The complaint seeks damages for the benefit of TSFG in the amount of
approximately $32 million. TSFG believes that this lawsuit is without merit and
has defended it vigorously. The trial court granted the Company's motion to
dismiss the lawsuit on November 26, 1997. The plaintiffs appealed. On November
1, 2000, the South Carolina Court of Appeals affirmed the dismissal of the
lawsuit. The plaintiffs have sought further review by the South Carolina Supreme
Court. That appeal is currently pending before the state Supreme Court.
(14) BUSINESS SEGMENTS
TSFG has three principal operating subsidiaries, which are evaluated regularly
by the chief operating decision maker in deciding how to allocate resources and
assess performance. Two of these subsidiaries, by virtue of exceeding certain
quantitative thresholds, are reportable segments. The reportable segments,
Carolina First Bank and Mercantile Bank, engage in general banking business
focusing on commercial, consumer and mortgage lending to small and middle market
businesses and consumers in their market areas. The reportable segments also
provide demand transaction accounts and time deposit accounts to businesses and
individuals. Carolina First Bank offers products and services primarily to
customers in South Carolina, coastal North Carolina and on the Internet.
Mercantile Bank offers products and services primarily to customers in its
market areas in northern and central Florida. Revenues for Carolina First Bank
and Mercantile Bank are derived primarily from interest and fees on loans,
interest on investment securities, service charges on deposits and other
customer service fees. No single customer accounts for a significant amount of
the revenues of either reportable segment.
TSFG evaluates performance based on budget to actual comparisons and segment
profits. The accounting policies of the reportable segments are the same as
those described in TSFG's Annual Report on Form 10-K for the year ended December
31, 2001.
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.
18
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
THREE MONTHS ENDED SEPTEMBER 30, 2002:
Net interest income $ 48,011 $10,092 $ (1,613) $ - $ 56,490
Provision for loan losses 3,865 1,718 (16) - 5,567
Noninterest income 10,380 1,441 17,376 (12,078) 17,119
Noninterest expenses 30,945 11,565 15,821 (12,078) 46,253
Amortization of intangibles (a) 246 106 - - 352
Merger-related costs (a) - 4,465 - - 4,465
Income tax expense 7,666 (560) (461) - 6,645
Minority interest in consolidated
subsidiary, net of tax (1,033) - - - (1,033)
Net income 14,882 (1,190) 419 - 14,111
THREE MONTHS ENDED SEPTEMBER 30, 2001:
Net interest income $ 40,903 $ 6,781 $ (824) $ - $ 46,860
Provision for loan losses 4,168 1,325 (17) - 5,476
Noninterest income 9,522 1,077 14,267 (12,202) 12,664
Noninterest expenses 31,170 4,947 12,502 (12,202) 36,417
Amortization of intangibles (a) 1,370 - 53 - 1,423
Merger-related recoveries (a) (89) - - - (89)
Income tax expense 5,217 545 366 - 6,128
Minority interest in consolidated
subsidiary, net of tax (503) - - - (503)
Net income 9,367 1,041 592 - 11,000
NINE MONTHS ENDED SEPTEMBER 30, 2002:
Net interest income $ 143,929 $24,986 $ (4,389) $ - $ 164,526
Provision for loan losses 12,305 5,765 (21) - 18,049
Noninterest income 30,448 3,544 47,451 (39,049) 42,394
Noninterest expenses 92,472 22,061 46,583 (39,049) 122,067
Amortization of intangibles (a) 725 106 - - 831
Merger-related costs (a) - 4,465 - - 4,465
Income tax expense 22,369 223 (1,357) - 21,235
Minority interest in consolidated
subsidiary, net of tax (2,219) - - - (2,219)
Cumulative effect of change in
accounting principal, net of tax - - (1,406) - (1,406)
Net income 45,012 481 (3,549) - 41,944
(a) Included in noninterest expenses.
19
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- -------
NINE MONTHS ENDED SEPTEMBER 30, 2001:
Net interest income $ 117,990 $ 18,166 $ (2,389) $ - $ 133,767
Provision for loan losses 11,107 4,269 208 - 15,584
Noninterest income 28,500 2,485 46,233 (38,514) 38,704
Noninterest expenses 95,171 14,357 39,854 (38,514) 110,868
Amortization of intangibles (a) 4,267 - 158 - 4,425
Merger-related recoveries (a) (502) - - - (502)
Income tax expense 14,585 701 834 - 16,120
Minority interest in consolidated
subsidiary, net of tax (905) - - - (905)
Cumulative effect of change in
accounting principal, net of tax - - 282 - 282
Net income 24,722 1,324 3,230 - 29,276
(a) Included in noninterest expenses.
SEPTEMBER 30, 2002:
Total assets $ 5,492,340 $1,461,921 $812,770 $ (881,063) $ 6,885,968
Loans 3,188,032 1,060,628 78,388 (112,295) 4,214,753
Deposits 3,139,876 1,074,644 - (20,841) 4,193,679
SEPTEMBER 30, 2001:
Total assets $ 4,796,168 $ 746,567 $599,933 $ (649,291) $ 5,493,377
Loans 3,137,723 613,734 4,854 - 3,756,311
Deposits 3,105,502 554,969 - (25,814) 3,634,657
(15) SUBSEQUENT EVENTS
On October 29, 2002, South Financial Capital Trust III (the "Capital Trust
III"), a wholly-owned subsidiary of TSFG, issued and sold floating rate
securities having an aggregate liquidation amount of $22.0 million (the "Capital
Securities III") to institutional buyers in a pooled trust preferred issue. The
Capital Securities III generated gross proceeds of $22.0 million. The Capital
Trust III loaned these proceeds to the parent company to use for general
corporate purposes. The trust preferred debt qualifies as tier 1 capital under
Federal Reserve Board guidelines. Issuance costs from the October 29, 2002 sale
totaled $680,000.
The Capital Securities III accrue and pay distributions semi-annually at a rate
per annum equal to 90-day LIBOR plus 345 basis points. This rate may not exceed
12.0% through October 29, 2007. The distributions payable on the Capital
Securities III are cumulative and payable quarterly in arrears. TSFG has the
right, subject to events of default, to defer payments of interest on the
Capital Securities III for a period not to exceed 20 consecutive quarters,
provided that no extension period may extend beyond the maturity date of October
29, 2032. TSFG has no current intention to exercise its right to defer payments
of interest on the Capital Securities III.
The Capital Securities III are mandatorily redeemable upon maturity on October
29, 2032. TSFG has the right to redeem the Capital Securities III in whole or in
part, on or after October 29, 2007. If the Capital Securities III are redeemed
on or after October 29, 2007, the redemption price will be 100% of the principal
amount plus accrued and unpaid interest. In addition, TSFG may redeem the
Capital Securities III in whole (but not in part) at any time within 90 days
following the occurrence of a tax event, an investment company event, or a
capital treatment event at a special redemption price (as defined in the
indenture).
20
(16) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, except for the
consolidated balance sheet at December 31, 2001, 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.
21
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 ("TSFG", which also may be referred to as "we", "us",
or "our", except where the context requires otherwise). This discussion should
be read in conjunction with the consolidated financial statements and related
notes and with the statistical information and financial data appearing in this
report as well as the Annual Report of TSFG on Form 10-K for the year ended
December 31, 2001. Results of operations for the three and nine month periods
ended September 30, 2002 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 conducted business through 70 locations in South Carolina, 5 locations
in North Carolina and 31 locations in northern and central Florida as of
September 30, 2002. TSFG operates through two wholly-owned subsidiary banks:
Carolina First Bank, a South Carolina state-chartered commercial bank, and
Mercantile Bank, a Florida state-chartered commercial bank (which are
collectively referred to as the "Subsidiary Banks"). Upon acquiring Gulf West,
TSFG combined all of its Florida operations, formerly known as Citrus Bank,
under the Mercantile Bank name. Through our subsidiaries, we provide a full
range of financial services, including asset management, investments, insurance,
and trust services, designed to meet substantially all of the financial needs of
our customers.
FORWARD-LOOKING STATEMENTS
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, and the
assessment of problem loans;
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, and expected financial results;
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
22
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.
MERGERS
The following table summarizes TSFG's mergers completed during 2002. All of
these 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 merger date.
TABLE 1
- --------------------------------------------------------------------------------
SUMMARY OF COMPLETED ACQUISITIONS
- --------------------------------------------------------------------------------
IDENTIFIABLE
ACQUISITION TOTAL SHARES CASH INTANGIBLE
DATE ASSETS (1) ISSUED PAID ASSETS GOODWILL
---- ---------- ------ ---- ------ --------
Gulf West Banks, Inc.
St. Petersburg, FL 08/31/02 $526.9 million 3,925,588 $32.4 million $8.4 million $71.1 million
Gardner Associates, Inc.
Columbia, SC 09/20/02 $ 1.3 million 249,011(2) none $1.5 million $ 0.9 million
Closed subsequent to 9/30/02
- ----------------------------
Rock Hill Bank and Trust
Rock Hill, SC 10/31/02 430,017(3) none(3)
(1) The most recent quarter end prior to acquisition date.
(2) Of this amount, up to 92,585 of these shares are subject to forfeiture back
to TSFG if certain annual and five-year financial performance targets are
not met.
(3) TSFG agreed to pay a cash earnout based on collection and recoveries with
respect to certain loans. TSFG also agreed to repurchase such number of
these 430,017 shares as are not distributed to RHBT shareholders in RHBT's
pending liquidation.
On August 31, 2002, TSFG completed the merger with 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
fifteen locations in the greater Tampa Bay area of Florida. This merger
represents TSFG's first banking locations in the greater 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. TSFG's
consolidated financial statements include the results of Gulf West's operations
since the August 31, 2002 merger date.
On September 20, 2002, TSFG acquired Gardner Associates, Inc. ("Gardner
Associates"), an independent insurance agency based in Columbia, South Carolina,
which TSFG will use to build its insurance operations in the Midlands area of
South Carolina.
Subsequent to quarter end, on October 31, 2002, TSFG completed the acquisition
of substantially all of the assets and deposits of Rock Hill Bank & Trust ("Rock
Hill"), which is the wholly-owned banking subsidiary of RHBT Financial
Corporation ("RHBT"). Rock Hill operated 3 branches in York County, South
Carolina. Under the asset sale agreement, Rock Hill 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 the
entire designated loan pool and 50% of net amounts recovered under RHBT's
blanket bond insurance policy with respect to such loans.
23
In connection with improper activities and bad lending practices by a former
executive officer with respect to a large number of Rock Hill's loans, Rock Hill
had to charge off or establish additional reserves for a material portion of its
loan portfolio, prior to closing of the merger. Accordingly, related to the
loans acquired from Rock Hill, TSFG expects its allowance for loan losses and
nonaccrual loans to increase to above historical levels. The ultimate impact is
not currently known.
TSFG owns 382,500 shares, or approximately 22% of RHBT outstanding stock, which
is included in available for sale securities. During the third quarter, TSFG
wrote-down its investment in RHBT by $1.2 million to its September 30, 2002
estimated fair value of approximately $1.9 million, or $5.00 per share. The
Board of Directors of RHBT presently plans to distribute most, but not
necessarily all, of the 430,017 shares of TSFG common stock received by Rock
Hill to RHBT shareholders shortly after closing of the sale of assets. Upon the
distribution of the TSFG common stock to RHBT shareholders, TSFG will cancel any
TSFG shares received.
PENDING MERGER
In October 2002, TSFG signed a definitive agreement to acquire Central Bank of
Tampa ("CBT"), a closely held community bank headquartered in Tampa, Florida. At
September 30, 2002, CBT operated through 5 branches in Tampa and had total
assets of $215.4 million. TSFG will issue common stock equal to $68.0 million in
exchange for all the outstanding common shares of CBT. Such TSFG common stock
will be valued at the average closing price on the ten trading days ending on
the second trading day prior to closing (except that the value will never be
deemed less than $15.00 or greater than $25.00). This transaction, which is
expected to close in the fourth quarter of 2002, will be accounted for using the
purchase method of accounting and is subject to receipt of CBT shareholder and
regulatory approval.
EARNINGS REVIEW
OVERVIEW
Net income for the nine months ended September 30, 2002 totaled $41.9 million,
up 43.3% compared with $29.3 million for the nine months ended September 30,
2001. Earnings per diluted share for the first nine months of 2002 were $1.00, a
47.1% increase from $0.68 per diluted share in the first nine months of 2001.
Higher net interest income, efficiency improvements, and a more favorable
effective tax rate contributed to the increases in net income and earnings per
diluted share. Net interest income increased from a higher net interest margin
and 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, 2002 and 2001
included pre-tax gains on asset sales of $4.4 million and $1.3 million,
respectively. For the nine months ended September 30, 2002, TSFG recognized a
$4.7 million gain on the sale of NetBank, Inc. common stock, which was partially
offset by a $1.2 million write-down on its investment in RHBT. See "Earnings
Review - Noninterest Income" for details on the gain on asset sales. Noninterest
expenses for the first nine months of 2002 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 from previous
mergers, and a $354,000 loss on early extinguishment of debt. For the first nine
months of 2001, noninterest expenses included the following pre-tax other items:
$1.1 million loss on early extinguishment of debt, $502,000 recovery of
merger-related costs related to the sale of real estate, and $391,000 impairment
loss from the write-down of assets.
On January 1, 2002, TSFG adopted SFAS 142 and ceased amortization of goodwill.
Amortization of intangibles that are not amortized in 2002 totaled $3.4 million
for the nine months ended September 30, 2001. In the third quarter 2002, TSFG
recorded a $1.4 million charge related to impairment of goodwill associated with
Carolina First Mortgage Company, which is shown as a cumulative effect of change
in accounting principle. In accordance with the accounting rules, this change
was recorded as of January 1, 2002 and therefore is reflected in the
year-to-date income, but not the quarter.
24
Average common shares outstanding on a diluted basis were 41.9 million in the
first nine months of 2002, down 2.8% from 43.1 million for first nine months of
2001. In connection with share repurchase programs, TSFG repurchased and
cancelled 2,141,907 shares during the first nine months of 2002.
At September 30, 2002, TSFG had approximately $6.9 billion in assets, $4.2
billion in loans, $4.2 billion in deposits, and $554.6 million in shareholders'
equity. At September 30, 2002, the ratio of nonperforming assets to loans and
other real estate owned was 1.07%.
NET INTEREST INCOME
Net interest income is the difference between the interest earned on assets and
the interest paid for the liabilities to support such assets as well as such
items as loan fees and dividend income. The net interest margin measures how
effectively a company manages the difference between the yield on earning assets
and the rate paid on funds to support those assets. Fully tax-equivalent net
interest income adjusts the yield for assets earning tax-exempt income to a
comparable yield on a taxable basis. Table 2 presents average balance sheets and
a net interest income analysis on a tax equivalent basis for the three and nine
months ended September 30, 2002 and 2001.
25
TABLE 2
- ------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- ------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 30,
-----------------------------------------------------------
2002 2001
---------------------------- ----------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- ---- ------- ------- ----
Assets
Earning assets
Loans (1) $4,018,965 $67,751 6.69% $ 3,741,496 $76,432 8.10 %
Investment securities (taxable) (2) 1,707,479 22,011 5.16 1,046,714 16,799 6.37
Investment securities (nontaxable) (3) 93,301 1,669 7.16 84,243 1,541 7.26
Federal funds sold 7,214 26 1.43 968 8 3.28
Interest-bearing bank balances 50,154 226 1.79 36,819 205 2.21
----------- ------- ----------- -------
Total earning assets 5,877,113 91,683 6.19 4,910,240 94,985 7.67
----------- ------- ----------- -------
Non-earning assets 592,822 525,510
---------- -----------
Total assets $6,469,935 $ 5,435,750
========== ===========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 592,622 $ 1,731 1.16 $ 587,151 $ 3,472 2.35
Savings 124,611 224 0.71 114,016 570 1.98
Money market 834,111 3,725 1.77 772,515 6,798 3.49
Time deposits 1,744,858 14,813 3.37 1,626,509 22,828 5.57
---------- ------- ---------- -------
Total interest-bearing deposits 3,296,202 20,493 2.47 3,100,191 33,668 4.31
Borrowings 1,924,197 14,115 2.91 1,219,802 13,918 4.53
---------- ------- ---------- -------
Total interest-bearing liabilities 5,220,399 34,608 2.63 4,319,993 47,586 4.37
------- -------
Noninterest-bearing liabilities
Noninterest-bearing deposits 570,508 494,911
Other noninterest-bearing liabilities 80,410 92,510
---------- ----------
Total liabilities 5,871,317 4,907,414
Minority interest in consolidated
subsidiary 86,429 37,027
Shareholders' equity 512,189 491,309
---------- ----------
Total liabilities and shareholders'
equity $6,469,935 $5,435,750
========== ==========
Net interest margin $57,075 3.85% $47,399 3.83 %
======= =======
Tax-equivalent adjustment (3) $ 585 $ 539
======= =======
(1) Nonaccrual loans are included in average balances for yield computations.
(2) The average balances for investment securities exclude the unrealized gain
recorded for available for sale securities.
(3) The tax-equivalent adjustment to net interest income adjusts the yield for
assets earning tax-exempt income to a comparable yield on a taxable basis.
(4) The minority interest in consolidated subsidiary pertains to the REIT
preferred stock, which qualifies as regulatory capital and pays cumulative
dividends.
Note: Average balances are derived from daily balances.
26
TABLE 2 (CONTINUED)
- -----------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- -----------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------
2002 2001
------------------------------ ------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
Assets
Earning assets
Loans (1) $3,894,325 $199,680 6.86 % $3,754,478 $242,253 8.63 %
Investment securities (taxable) (2) 1,650,010 64,795 5.24 938,807 45,966 6.55
Investment securities (nontaxable) (3) 92,218 4,984 7.21 82,833 4,563 7.37
Federal funds sold 2,431 26 1.43 446 13 3.90
Interest-bearing bank balances 69,851 913 1.75 33,458 1,168 4.67
---------- -------- ---------- --------
Total earning assets 5,708,835 270,398 6.33 4,810,022 293,963 8.17
-------- --------
Non-earning assets 537,398 533,726
---------- ----------
Total assets $6,246,233 $5,343,748
========== ==========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 590,902 $ 5,332 1.21 $ 580,509 $ 11,686 2.69
Savings 118,909 654 0.74 114,421 1,887 2.20
Money market 756,348 9,538 1.69 744,836 22,302 4.00
Time deposits 1,715,167 47,798 3.73 1,801,287 82,781 6.14
---------- -------- ---------- --------
Total interest-bearing deposits 3,181,326 63,322 2.66 3,241,053 118,656 4.89
Borrowings 1,928,727 40,805 2.83 1,044,276 39,943 5.11
---------- -------- ---------- --------
Total interest-bearing liabilities 5,110,053 104,127 2.72 4,285,329 158,599 4.95
---------- -------- ---------- --------
Noninterest-bearing liabilities
Noninterest-bearing deposits 530,737 469,053
Other noninterest-bearing liabilities 73,843 83,911
---------- ----------
Total liabilities 5,714,633 4,838,293
Minority interest in consolidated
subsidiary (4) 454,232 20,358
Shareholders' equity 477,368 485,097
---------- ----------
Total liabilities and shareholders'
equity $6,246,233 $5,343,748
========== ===========
Net interest margin $166,271 3.89 % $135,364 3.76 %
======== ========
Tax-equivalent adjustment (3) $ 1,745 $ 1,597
======== ========
(1) Nonaccrual loans are included in average balances for yield computations.
(2) The average balances for investment securities exclude the unrealized gain
recorded for available for sale securities.
(3) The tax-equivalent adjustment to net interest income adjusts the yield for
assets earning tax-exempt income to a comparable yield on a taxable basis.
(4) The minority interest in consolidated subsidiary pertains to the REIT
preferred stock, which qualifies as regulatory capital and pays cumulative
dividends.
Note: Average balances are derived from daily balances.
27
Fully tax-equivalent net interest income for the first nine months of 2002
increased $30.9 million, or 22.8%, to $166.3 million from $135.4 million in the
first nine months of 2001. The net interest margin increased to 3.89% in the
first nine months of 2002 from 3.76% in the first nine months of 2001. These
increases were due to the increase in average earning assets, the prompt
repricing of funding sources as the Federal Reserve lowered rates during 2001,
and repricing maturing certificates of deposit at significantly lower rates.
Average earning assets grew $898.8 million, or 18.7%, to $5.7 billion in the
first nine months of 2002 from $4.8 billion in the first nine months of 2001,
primarily from higher investment securities. The Gulf West merger, which closed
August 31, 2002, added $475.6 million in earning assets, which are included for
the month of September. The Gulf West merger accounted for approximately $53
million of the increase in average earning assets for the first nine months of
2002. Average loans increased $139.8 million, unadjusted for the December 2001
sale of $79.5 million of residential mortgage loans from the held for investment
portfolio, to $3.9 billion in the first nine months of 2002 from $3.8 billion in
the first nine months of 2001. Average investment securities, excluding the
average net unrealized securities gains, increased from $1.0 billion in the
first nine months of 2001 to $1.7 billion in the first nine months of 2002. TSFG
increased the U.S. Treasury security portfolio by $520.1 million during the
fourth quarter of 2001, largely in anticipation of prepayments of
mortgage-backed securities. TSFG purchased these securities to leverage the
capital position, take advantage of opportunities to increase net interest
income, and manage interest rate risk. The acceleration of prepayments of
mortgage-backed securities reduces interest income due to the related write-off
of any associated purchased premium.
During 2001, the Federal Reserve reduced the target for the federal funds rate
11 times for a total of 475 basis points. Three of these reductions occurred in
the last three months of the year for a total of 125 basis points. A large
portion of our adjustable rate loans, which constitute 54.1% of the loan
portfolio, repriced immediately following changes in interest rates by the
Federal Reserve. In addition, certificates of deposits were repriced at
significantly lower rates and higher-cost Federal Home Loan Bank ("FHLB")
advances were prepaid. Accordingly, as TSFG reduced its interest rates during
the year, the decline in the funding source rate outpaced the decline in the
earning asset yield. For the first nine months of 2001 compared with the first
nine months of 2002, the earning asset yield declined 184 basis points to 6.33%,
whereas the funding source rate declined 223 basis points to 2.72%. TSFG expects
certificates of deposit to continue to reprice downward in the last quarter of
2002, although with a significantly smaller benefit than that realized in 2001
and the first three quarters of 2002. As a result of the significant decline in
interest rates in 2001, the current market rates for similar certificates of
deposits are significantly lower.
Average total deposits remained constant at $3.7 billion during the first nine
months of both 2002 and 2001. These balances stayed flat due to the competitive
nature of the deposit markets. TSFG has elected to reduce deposit rate-driven
promotions. Average borrowings increased to $1.9 billion during the nine months
ended September 30, 2002 from $1.0 billion during the nine months ended
September 30, 2001 due to increases in repurchase agreements and fed funds
purchased to fund the growth in earning assets. Repurchase agreements, which
increased in connection with TSFG's purchases of securities to leverage the
capital position, accounted for the majority of this increase.
In the third quarter 2002, TSFG repositioned its investment portfolio by selling
approximately $450 million of 10-year U.S. Treasury securities and purchasing
approximately $412 million of adjustable rate mortgage-backed securities. This
repositioning may reduce net interest income, while better positioning TSFG for
increasing interest rates.
Deposits generated through Bank CaroLine, an Internet banking division of
Carolina First Bank, generally pay higher rates than those offered by our branch
locations. During the first nine months of 2002, TSFG priced the Bank CaroLine
deposits less aggressively than it did in 2001 in an effort to lower the overall
cost of funds. Bank CaroLine deposits totaled $34.1 million as of September 30,
2002 compared with $55.3 million and $91.6 million as of December 31, 2001 and
September 30, 2001, respectively.
28
On August 31, 2002, TSFG redeemed $26.3 million of 9.00% Subordinated Notes Due
2005. In connection with the redemption, TSFG recorded a $354,000 loss on early
extinguishment of debt. During 2001, TSFG recorded a $3.1 million loss
associated with the early extinguishment of approximately $54.3 million in FHLB
advances. TSFG engaged in these transactions to take advantage of the
opportunity to reinvest the proceeds and refinance the borrowings at more
favorable rates, thereby enhancing net interest income. TSFG continues to
evaluate the relative cost and benefit of incurring additional prepayment
penalties from the early extinguishment of debt. See "Borrowed Funds."
PROVISION FOR LOAN LOSSES
The provision for loan losses is recorded in amounts sufficient to bring the
allowance for loan and lease losses (the "Allowance") to a level deemed
appropriate by management based on factors discussed in "Balance Sheet Review -
Allowance for Loan Losses" and "Credit Quality." The provision for loan losses
was $18.0 million and $15.6 million for the first nine months of 2002 and 2001,
respectively. The increase was attributable to continued loan growth, higher
loan losses, and uncertain economic conditions.
The Allowance equaled 1.20% and 1.18% of loans held for investment as of
September 30, 2002 and 2001, respectively. Based on management's analysis of
impairment as defined in Statement of Financial Accounting Standards ("SFAS")
114, specific reserves allocated to impaired loans totaled $6.2 million, or
19.3% of impaired loans at September 30, 2002, compared with $4.2 million and
13.1% of impaired loans at September 30, 2001. See "Allowance for Loan Losses"
and "Credit Quality."
NONINTEREST INCOME
Noninterest income totaled $42.4 million in the first nine months of 2002,
compared with $38.7 million in the first nine months of 2001. The increase in
noninterest income was primarily the result of a $2.7 million increase in
service charges on deposit accounts and a $2.4 million increase in gain on
equity investments. This increase was partially offset by a $1.9 million
decrease in mortgage banking income (see Table 4, Components of Mortgage Banking
Income for details). Table 3 shows the components of noninterest income for the
three and nine months ended September 30, 2002 and 2001.
TABLE 3
- --------------------------------------------------------------------------------------------------------------------------
COMPONENTS OF NONINTEREST INCOME
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- -------------------------
2002 2001 2002 2001
---- ---- ---- ----
Service charges on deposit accounts $ 6,108 $ 4,568 $16,436 $13,748
Fees for investment services 1,359 1,462 4,639 4,204
Mortgage banking income 850 927 3,397 5,250
Bank-owned life insurance 1,877 1,845 5,486 5,397
Merchant processing income 1,778 1,657 4,741 4,618
Other 830 1,073 3,302 4,180
------- ------- ------- -------
Noninterest income, excluding gain (loss) on asset sales 12,802 11,532 38,001 37,397
------- ------- ------- -------
Gain on sale of available for sale securities 790 1,134 1,005 1,539
Gain on equity investments, net 3,527 17 3,388 1,019
Loss on disposition of assets and liabilities - (19) - (1,251)
------- ------- ------- -------
Gain on asset sales, net 4,317 1,132 4,393 1,307
------- ------- ------- -------
Total noninterest income $17,119 $12,664 $42,394 $38,704
======= ======= ======= =======
29
Noninterest income included gains on asset sales of $4.4 million and $1.3
million in the first nine months of 2002 and 2001, respectively. During the
first nine months of 2002, the gain on equity investment included a $4.7 million
gain on the sale of 450,000 shares of NetBank, Inc. common stock. This gain was
partially offset by a $1.2 million write-down on RHBT common stock and a
$150,000 write-off of an investment in a technology company. During the nine
months ended September 30, 2001, the gain on equity investments included $1.1
million from the exchange of Star Systems, Inc. stock for stock of Concord EFS,
Inc. (a publicly-traded company) and the subsequent sale of the investment in
Concord EFS, Inc., as well as a $63,000 gain from the sale of common stock of
Affinity Technology Group, Inc. These gains were partially offset by a $200,000
loss associated with the write-down of an Internet-related investment. During
the first nine months of 2001, the loss on disposition of assets and liabilities
related to a $1.0 million loss associated with the sale of four branch office
locations, which closed in July 2001, and a $262,000 loss associated with the
sale-leaseback of a branch office.
Service charges on deposit accounts, the largest contributor to noninterest
income, rose 19.6% to $16.4 million in the first nine months of 2002 from $13.7
million for the same period in 2001. The increase was attributable to attracting
new transaction accounts, improving collection of fees, and revising fee
structures to reflect competitive pricing. Average balances for deposit
transaction accounts, which impact service charges, increased approximately 4.6%
for the same period.
Fees for investment services, which include trust and brokerage income, for the
first nine months of 2002 and 2001 were approximately $4.6 million and $4.2
million, respectively. During this period, brokerage income increased $575,000,
and trust income decreased $140,000, partially related to the decline in market
value of assets administered. At September 30, 2002 and 2001, the market value
of assets administered by the trust department totaled $621.7 million and $735.4
million, respectively.
Mortgage banking income includes origination income and secondary marketing
operations (related to current production), servicing fees (net of the related
amortization for the mortgage-servicing rights and subservicing payments), gains
and losses on sales of portfolio mortgage loans, gains and losses on sales of
mortgage servicing rights, and losses and recoveries related to the impairment
of mortgage-servicing rights. Mortgage banking income in the first nine months
of 2002 decreased $1.9 million to $3.4 million from $5.3 million in the first
nine months of 2001. Table 4 shows the components of mortgage banking income for
the three and nine months ended September 30, 2002 and 2001.
TABLE 4
- --------------------------------------------------------------------------------------------------------------------------
COMPONENTS OF MORTGAGE BANKING INCOME
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- -------------------------
2002 2001 2002 2001
---- ---- ---- ----
Origination income and secondary marketing operations $1,991 $1,413 $5,345 $4,446
Net mortgage servicing income (372) (118) (963) 418
Impairment on mortgage servicing rights (769) (229) (592) (509)
Gain (loss) on sale of portfolio mortgage loans - (80) (393) 1,500
Loss on sale of mortgage servicing rights - (59) - (605)
------ ------ ------ ------
Total mortgage banking income $ 850 $ 927 $3,397 $5,250
====== ====== ====== ======
TSFG realigned its mortgage banking strategy to place more emphasis on mortgage
originations. For the first nine months of 2002, origination income and
secondary marketing increased 20.2% to $5.3 million from $4.4 million for the
first nine months of 2001. Mortgage loans held for sale originated by TSFG
originators totaled $325.3 million and $191.6 million in the first nine months
of 2002 and 2001, respectively. Mortgage origination volumes by TSFG originators
increased in the first nine months of 2002 due to lower mortgage loan rates and
the hiring of additional mortgage originators. Mortgage loan originations, for
30
the nine months ended September 30, 2001, also included $89.2 million
attributable to correspondent relationships. TSFG discontinued its correspondent
relationships in the second quarter of 2001. The benefit associated with
correspondent originations, which were principally related to increasing the
servicing volumes (which TSFG began outsourcing in December 2001), diminished.
In connection with the realignment of its mortgage banking strategy, TSFG
securitized mortgage loans, sold mortgage loans, and sold mortgage-servicing
rights in 2001. These sales resulted in a $393,000 loss and an $895,000 net gain
during the first nine months of 2002 and 2001, respectively. Beginning in
December 2001, TSFG contracted with non-affiliated companies to service mortgage
loans for TSFG's affiliates. Net servicing income declined to a $963,000 loss
for the nine months ended September 30, 2002 from a $418,000 gain for the nine
months ended September 30, 2001. This decline resulted from a smaller servicing
portfolio, the outsourcing of servicing to third party servicers, and higher
mortgage servicing rights amortization due to declining interest rates.
CF Mortgage's total servicing portfolio includes mortgage loans owned by
Carolina First Bank, mortgage loans owned by Mercantile Bank, and other mortgage
loans for which Carolina First Bank owns the rights to service. At September 30,
2002, CF Mortgage's servicing portfolio included 6,726 loans having an aggregate
principal balance of $560.2 million. At September 30, 2001, the aggregate
principal balance for CF Mortgage's servicing portfolio totaled $1.1 billion,
significantly higher than September 30, 2002 due to sales of mortgage servicing
rights and mortgage portfolio loans during 2001. Mortgage servicing rights, net
of the valuation allowance totaled $5.6 million and $10.8 million at September
30, 2002 and 2001, respectively. Fees related to servicing other loans, for
which Carolina First Bank owns the rights to service, are offset by the related
amortization of mortgage servicing rights.
For the nine months ended September 30, 2002, TSFG recorded a $592,000 charge
for impairment, net of recoveries, from the valuation of mortgage servicing
rights, which included $769,000 recorded for the third quarter. In the first
nine months of 2001, TSFG recorded a $509,000 charge for impairment from the
valuation of mortgage servicing rights. At September 30, 2002, the valuation
allowance for capitalized mortgage servicing rights totaled $1.7 million.
Bank-owned life insurance income remained relatively constant at $5.5 million
for the first nine months of 2002 and $5.4 million for the first nine months of
2001. Merchant processing income also remained relatively constant at $4.7
million and $4.6 million for the nine months ended September 30, 2002 and 2001,
respectively.
Other noninterest income totaled $3.3 million for the first nine months of 2002,
compared with $4.2 million for the first nine months of 2001. This decrease was
primarily the result of $267,000 in losses on trading securities for the first
nine months of 2002, compared with $207,000 in gains for the corresponding
period in 2001, and $762,000 in losses on the sale of real estate acquired in
partial or total satisfaction of problem loans for the first nine months of
2002, compared with $386,000 in losses for the corresponding period in 2001.
Other noninterest income includes income related to customer service fees, debit
cards, insurance commissions, and international banking services. Total income
from these fee income sources increased over the prior year (in aggregate) and
the preceding quarter, due in part to TSFG's rollout of Elevate, a
customer-centered sales process.
NONINTEREST EXPENSES
Noninterest expenses increased to $122.1 million in the first nine months of
2002 from $110.9 million in the first nine months of 2001. Noninterest expenses
for the nine months ended September 30, 2002 included $4.5 million in
merger-related expenses, $1.6 million in salary and wages related to the
settlement of certain employment agreements from previous mergers, and a
$354,000 loss on the early extinguishment of debt. Noninterest expenses in the
first nine months of 2001 included a $1.1 million loss on the early
extinguishment of debt, a $502,000 recovery of merger-related costs (which
31
related to the sale of real estate at prices higher than estimated), and a
$391,000 impairment loss from the write down of assets (which was primarily
related to lease termination fees for abandoned locations). Excluding these
other charges, noninterest expenses increased $5.8 million, or 5.3%, to $115.7
million for the first nine months of 2002 from $109.9 million for the first nine
months of 2001. Increases in salaries, wages, and employee benefits, which in
part reflects expenses related to Gulf West, were partially offset by lower
amortization of intangibles from ceasing goodwill amortization.
Salaries, wages, and employee benefits increased to $62.8 million in the first
nine months of 2002 from $54.0 million in the first nine months of 2001.
Full-time equivalent employees increased to 1,593 from 1,357 as of September 30,
2002 and 2001, respectively. The increase in personnel expense was attributable
to adding Gulf West for the month of September, hiring new revenue-producing
associates (at a higher cost per full-time equivalent employee), and recording
higher levels of incentive pay. Restricted stock plan awards, which are expensed
to salaries and wages, increased to $1.7 million in the first nine months of
2002 from $545,000 in the first nine months of 2001.
Occupancy and furniture and equipment expenses increased to $22.2 million for
the nine months ended September 30, 2002 from $20.9 million for the
corresponding period from 2001, primarily from the addition of branch offices,
principally from Gulf West, and higher data processing costs. Professional fees
and merchant processing expenses remained relatively constant for the first nine
months of 2002 and 2001.
Amortization of intangibles decreased to $831,000 for the nine months ended
September 30, 2002 from $4.4 million for the nine months ended September 30,
2001. This decrease was primarily attributable to the January 1, 2002 adoption
of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which
requires TSFG to cease the amortization of goodwill.
Other noninterest expenses increased $956,000 to $23.7 million in the first nine
months of 2002 from $22.8 million in the first nine months of 2001. The overall
increase in other noninterest expenses was principally attributable to increases
in loan collection expense and sundry losses.
MERGER-RELATED COSTS
In connection with the August 31, 2002 merger of Gulf West, TSFG incurred
pre-tax merger-related costs of approximately $4.5 million for the nine months
ended September 30, 2002. For the nine months ended September 30, 2001, TSFG had
a $502,000 recovery of merger-related costs. This recovery related to the sale
of properties acquired in the June 2000 merger of Anchor Financial Corporation
at prices higher than estimated when a reserve for their disposition was
established in 2000. At September 30, 2002, the accrual for merger-related costs
totaled $2.0 million, which included $1.2 million for compensation-related
expenses. See Item 1, Note 4 to the Consolidated Financial Statements.
During the fourth quarter 2002, TSFG expects to record merger-related costs in
connection with the asset sale agreement with Rock Hill (which closed October
31, 2002), the merger with CBT (expected to close in the fourth quarter 2002),
and additional costs, which are expected to be insignificant, associated with
Gulf West.
INCOME TAXES
The effective income tax rate as a percentage of pretax income was 31.8% for the
first nine months of 2002 and 35.0% for the first nine months of 2001. The
effective income tax rate declined in connection with the company's ability to
utilize a capital tax loss carry forward to offset gains realized on equity
investments in third quarter 2002 and ceasing the amortization of goodwill. The
write-off of goodwill associated with the sale of four branch office locations
that was not deductible for tax purposes increased the effective rate for the
nine months ended September 30, 2001. The blended statutory income tax rate was
36.94% for both of these periods.
32
TSFG's effective income tax rates take into consideration certain assumptions
and estimates by management. No assurance can be given that either the tax
returns submitted by management or the income tax reported on the consolidated
financial statements will not be adjusted by either adverse rulings by the U.S.
Tax Court, changes in the tax code, or assessments made by the Internal Revenue
Service. TSFG is subject to potential adverse adjustments, including but not
limited to: an increase in the statutory federal or state income tax rates, the
permanent nondeductibility of amounts currently considered deductible either now
or in future periods, and the dependency on the generation of future taxable
income, including capital gains, in order to ultimately realize deferred tax
assets. Tax returns for 1998 and subsequent years are exposed to examination by
taxing authorities.
THIRD QUARTER RESULTS
Net income for the three months ended September 30, 2002 totaled $14.1 million,
up 28.3% compared with $11.0 million for the three months ended September 30,
2001. Earnings per diluted share for the three months ended September 30, 2002
were $0.33, a 26.9% increase from earnings per diluted share of $0.26 for the
three months ended September 30, 2001. Higher net interest income, service
charges on deposits accounts, gains on asset sales, and a more favorable tax
rate contributed to the growth in earnings. This earnings growth was partially
offset by merger-related costs, higher noninterest expenses, and a higher
provision for loan losses.
Fully tax-equivalent net interest income totaled $57.1 million, an increase of
$9.7 million, or 20.4%, compared with the third quarter of 2001. Net interest
income increased from a stable net interest margin and 19.7% growth in average
earning assets, principally from investment securities. The net interest margin
was 3.85% for the third quarter 2002, up slightly from 3.83% for the third
quarter 2001.
Noninterest income for the three months ended September 30, 2002 and 2001
included pre-tax gains on asset sales of $4.3 million and $1.1 million,
respectively. For the third quarter 2002, the largest item was a $4.7 million
gain from the sale of NetBank common stock, partially offset by a $1.2 million
write-down on the investment in RHBT. See "Earnings Review - Noninterest Income"
for details on the gains on asset sales. Noninterest income, excluding the gains
on asset sales, increased 11.0% to $12.8 million for the third quarter of 2002
compared with $11.5 million for the third quarter of 2001. Mortgage banking
income for the third quarter 2002 included a $769,000 impairment write-down on
the value of mortgage servicing rights due to the decline in interest rates,
compared with $229,000 for the third quarter 2001. The noninterest income
increase came principally from fee income increases from service charge on
deposit accounts, mortgage banking income excluding impairment on mortgage
servicing rights, brokerage income, merchant processing income, debit card
income, and insurance income.
For the third quarter 2002, noninterest expenses included the following pre-tax
other items: $4.5 million in merger-related expenses, $1.6 million in salary and
wages related to the settlement of certain employment agreements from previous
mergers, and a $354,000 loss on the early extinguishment of debt. For the third
quarter 2001, noninterest expenses included the following pre-tax other items:
$1.1 million loss on the early extinguishment of debt, a $176,000 write-down of
an impaired asset, and the recovery of $89,000 of restructuring and
merger-related costs. Noninterest expenses, excluding the other items, increased
13.1% to $39.9 million for the third quarter of 2002 from $35.2 million for the
third quarter of 2001, which in part reflects expenses related to Gulf West.
Increases in noninterest expenses were partially offset by lower amortization of
intangibles from ceasing goodwill amortization. Amortization of intangibles that
are not amortized in 2002 totaled $1.1 million for the three months ended
September 30, 2001.
BALANCE SHEET REVIEW
LOANS
Loans are the largest category of earning assets and generally produce the
highest yields. TSFG concentrates on lending to small and middle market
businesses and retail consumers. At September 30, 2002, outstanding loans
totaled $4.2 billion, which equaled 100.5% of total deposits and 61.2% of total
33
assets. The loan portfolio consisted principally of 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 domiciled in TSFG's market areas in South Carolina, North Carolina,
and Florida. The portfolio did not contain any foreign loans or any "highly
leveraged transactions," as defined by regulatory authorities.
TSFG's only significant industry concentration is commercial real estate loans
(loans to finance real properties for sale or lease to unrelated third parties),
which totaled $1.3 billion, or 32.4.% of loans held for investment, at September
30, 2002. In Table 3, these loans are included in the "Real estate -
construction" and "Commercial secured by real estate" categories, which also
include loans to non-real estate industry borrowers. All other industry
concentrations represented less than 10% of total loans.
Table 5 summarizes outstanding loans by collateral type for real estate secured
loans and by borrower type for all other loans.
TABLE 5
- -------------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
---------------------------------
2002 2001 2001
---- ---- ----
Commercial, financial and agricultural $ 820,421 $ 722,220 $ 742,218
Real estate - construction (1) 545,896 507,587 532,037
Real estate - residential mortgages (1-4 family) 603,822 708,338 551,119
Commercial secured by real estate (1) 1,633,775 1,289,154 1,400,466
Consumer 547,932 511,349 503,900
Lease financing receivables 208 972 510
---------- ---------- ----------
Loans held for investment 4,152,054 3,739,620 3,730,250
Loans held for sale 62,699 16,691 6,513
Less: allowance for loan losses 50,011 43,944 44,587
----------- ---------- ----------
Total net loans $4,164,742 $3,712,367 $3,692,176
========== ========== ==========
- -------------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF LOANS HELD FOR INVESTMENT IN CATEGORY
- -------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, DECEMBER 31,
--------------------------------
2002 2001 2001
---- ---- ----
Commercial, financial and agricultural 19.76 % 19.31 % 19.90 %
Real estate - construction (1) 13.15 13.57 14.26
Real estate - residential mortgages (1-4 family) 14.54 18.94 14.77
Commercial secured by real estate (1) 39.34 34.47 37.54
Consumer 13.20 13.68 13.52
Lease financing receivables 0.01 0.03 0.01
------ ------ ------
Total 100.00 % 100.00 % 100.00 %
====== ====== ======
(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. At September 30, 2002, such loans
were approximately 51.2% of these category totals.
34
Loans held for investment increased $412.4 million, or 11.0%, to approximately
$4.2 billion at September 30, 2002 from $3.7 billion at September 30, 2001. In
December 2001, TSFG sold $79.5 million of residential mortgage loans from the
held for investment portfolio. On August 31, 2002, TSFG acquired $286.6 million
in loans held for investment from its merger with Gulf West, which accounted for
more than half of the increase. The majority of the loan growth was in
commercial loans at both Carolina First Bank and Mercantile Bank, although
commercial loan growth slowed during the third quarter 2002. Indirect auto loans
(loans purchased from car dealers) and home equity loans also increased,
partially offset by a decline in direct consumer loans.
The composition of the loans held for investment portfolio is similar to that as
of December 31, 2001, following the December 2001 sale of residential mortgage
loans. While TSFG originations of residential mortgage loans have increased,
TSFG sells most of its residential mortgage loans in the secondary market. Loans
held for sale increased principally from the addition of approximately $26.0
million of commercial real estate loans acquired from Gulf West, which are
primarily related to the hospitality sector. TSFG has not yet received final
appraisals on these properties and expects to record a market valuation
adjustment in the fourth quarter 2002.
TSFG's corporate lending group focuses on relationship-based lending to larger
regional companies headquartered in its markets. At September 30, 2002, the
outstanding balance of loans identified as shared national credits totaled $55.8
million.
ALLOWANCE FOR LOAN LOSSES
The adequacy of the Allowance is analyzed quarterly. For purposes of this
analysis, adequacy is defined as a level sufficient to absorb probable losses in
the portfolio. The methodology employed for this analysis is as follows.
The portfolio is segregated into risk-similar segments for which historical loss
ratios are calculated and adjusted for identified changes in current portfolio
characteristics. Historical loss ratios are calculated by product type for
consumer loans (direct installment, indirect installment, revolving, and
mortgage) and by credit risk grade for performing commercial loans.
Nonperforming commercial loans are individually assessed for impairment under
SFAS 114 and assigned specific allocations. To allow for modeling error, a range
of probable loss ratios (from 95% to 105% of the adjusted historical loss ratio)
is then derived for each segment. The resulting percentages are then applied to
the dollar amounts of loans in each segment to arrive at each segment's range of
probable loss levels.
The Allowance for each portfolio segment is set at an amount within its range
that reflects management's best judgment of the extent to which historical loss
levels are more or less accurate indicators of current losses in the portfolio.
Management's judgments evolve from an assessment of various issues, including
but not limited to the pace of loan growth, emerging portfolio concentrations,
risk management system changes, entry into new markets, new product offerings,
loan portfolio quality trends, and uncertainty in current economic and business
conditions.
The Allowance is then segregated into allocated and unallocated components. The
allocated component is the sum of the loss estimates at the lower end of the
probable loss range for each category. The unallocated component is the sum of
the amounts by which final loss estimates exceed the lower end estimates for
each category. The unallocated component of the Allowance represents probable
losses inherent in the portfolio based on our analysis that are not fully
captured in the allocated component. Allocations of the Allowance to respective
loan portfolio components are not necessarily indicative of future losses or
future allocations. The entire Allowance is available to absorb losses in the
loan portfolio.
Assessing the adequacy of the Allowance is a process that requires considerable
judgment. Management's judgments are based on numerous assumptions about current
events, which we believe to be reasonable, but which may or may not be valid.
Thus, there can be no assurance that loan losses in future periods will not
35
exceed the current Allowance amount or that future increases in the Allowance
will not be required. No assurance can be given that management's ongoing
evaluation of the loan portfolio in light of changing economic conditions and
other relevant circumstances will not require significant future additions to
the Allowance, thus adversely affecting the operating results of TSFG.
The Allowance is also subject to examination and adequacy testing by regulatory
agencies, which may consider such factors as the methodology used to determine
the adequacy and the size of the Allowance relative to that of peer
institutions, and other adequacy tests. In addition, such regulatory agencies
could require us to adjust our Allowance based on information available to them
at the time of their examination.
The Allowance totaled $50.0 million, or 1.20% of loans held for investment at
September 30, 2002, compared with $43.9 million, or 1.18%, at September 30,
2001. The Allowance was 1.42 times and 1.28 times nonperforming loans at
September 30, 2002 and 2001, respectively. Nonperforming loans were $35.2
million at September 30, 2002, compared with $34.2 million at September 30,
2001. See "Credit Quality."
Table 6 summarizes the changes in the Allowance. Net charge-offs totaled $15.5
million, or 0.53% of average loans for the first nine months of 2002, up from
$14.5 million and 0.52% in the first nine months of 2001. This increase is
largely related to higher consumer loan charge-offs in the first quarter 2002.
Net loan charge-offs in the third quarter 2002 were $5.4 million, or 0.54% of
average loans, consistent with the 0.53% year-to-date 2002 average. While
uncertainty in the current economic outlook makes future charge-off levels less
predictable, management does not expect losses to increase significantly over
the next several quarters. As a percentage of average loans, losses are expected
to be comparable to the year-to-date average for 2002.
TABLE 6
- -------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
AT AND FOR AT AND FOR
THE NINE MONTHS THE YEAR ENDED
ENDED SEPTEMBER 30, DECEMBER 31,
-------------------------------------
2002 2001 2001
---- ---- ----
Loan loss reserve at beginning of year $ 44,587 $ 43,024 $ 43,024
Purchase accounting adjustments 2,877 - -
Allowance adjustment for loans sold (12) (162) (230)
Net charge-offs:
Loans charged-off (18,377) (16,971) (23,154)
Loans recovered 2,887 2,469 2,902
---------- ---------- ----------
(15,490) (14,502) (20,252)
Additions to reserve through provision expense 18,049 15,584 22,045
---------- ---------- ----------
Loan loss reserve at end of period $ 50,011 $ 43,944 $ 44,587
========== ========== ==========
Average loans $3,894,325 $3,754,478 $3,769,358
Loans held for investment 4,152,054 3,739,620 3,730,250
Net charge-offs as a percentage of average
loans (annualized) 0.53 % 0.52 % 0.54 %
Allowance for loan losses as a percentage of loans
held for investment 1.20 1.18 1.20
36
SECURITIES
At September 30, 2002, TSFG's investment portfolio totaled $1.9 billion, up
$768.7 million from $1.2 billion invested as of September 30, 2001 and up $296.3
million from the $1.6 billion invested as of December 31, 2001. The majority of
this increase occurred in the fourth quarter 2001, when TSFG increased its U.S.
Treasury security portfolio by approximately $520 million. In addition, on
August 31, 2002, TSFG added $125.5 million in available for sale securities from
its merger with Gulf West. During 2001, as a result of declining interest rates,
U.S. government agency securities were called prior to the stated maturities,
and prepayments associated with mortgage-backed securities accelerated. TSFG
increased the available for sale portfolio balances in preparation for
additional prepayments of mortgage-backed securities and to increase net
interest income by leveraging available capital. TSFG may elect to sell
investment securities depending on its need for liquidity to fund loan demand
and the general level of interest rates. In addition, TSFG has engaged in, and
expects to continue to engage in, hedging activities to reduce interest rate
risk associated with the investment securities.
Securities (i.e., securities held to maturity, securities available for sale,
and trading securities) excluding the unrealized gain recorded for available for
sale securities averaged $1.7 billion in the first nine months of 2002, up
significantly from the $1.0 billion average in the first nine months of 2001.
The majority of the increase was attributable to purchases of securities to
leverage available capital, anticipate accelerated paydowns of mortgage-backed
securities, and provide for increased calls of U.S. agency securities. The
average portfolio yield decreased in the first nine months of 2002 to 5.34% from
6.59% in the first nine months of 2001. The securities yield decreased due to a
lower level of general interest rates and the addition of lower-yielding
securities.
The composition of the investment portfolio as of September 30, 2002 follows:
mortgage-backed securities 63.8%, treasuries 12.5%, agencies 11.2%, state and
municipalities 5.1%, and other securities 7.4% (which includes equity
investments described below). To better position the securities portfolio for
increasing interest rates, TSFG sold approximately $450 million of 10-year U.S.
Treasury securities and purchased approximately $412 million of adjustable rate
mortgage-backed securities during the third quarter 2002. This repositioning
shifted the investment portfolio composition to 63.8% mortgage-backed securities
and 12.5% treasuries as of September 30, 2002 from 42.4% and 31.8%,
respectively, as of June 30, 2002.
During the first nine months of 2002, the gross unrealized gain on securities
(pre-tax) increased to $27.9 million at September 30, 2002 from a $7.6 million
loss at December 31, 2001. The increase in the gross unrealized gain for the
nine months ended September 30, 2002 was primarily associated with U.S. Treasury
securities, which increased $29.0 million, and was the result of a change in the
level of longer-term interest rates.
During the third quarter, TSFG transferred $208.2 million of U.S. treasury
securities from available for sale securities to trading securities at fair
value and recognized a $1.6 million unrealized gain at the time of transfer.
Also, during the third quarter, TSFG purchased an additional $363.0 million of
U.S. Treasury securities, which were classified as trading, and
contemporaneously hedged the purchase of these securities with futures
contracts. Prior to September 30, 2002, TSFG sold the $571.2 million of U.S.
Treasury securities and settled the futures contracts for a net loss of
$364,000, which includes the $1.6 million gain recorded upon transferring the
securities to trading securities.
EQUITY INVESTMENTS
Investment in NetBank, Inc. At September 30, 2002, TSFG owned 725,000 shares of
NetBank, Inc. ("NetBank") common stock. NetBank owns and operates NetBank,
F.S.B., an FDIC-insured federal savings bank that provides banking services to
consumers utilizing the Internet. TSFG's investment in NetBank, which is
included in securities available for sale and has a cost basis of approximately
$201,000, was recorded at its pre-tax market value of approximately $7.5 million
as of September 30, 2002. During 2002, TSFG sold 450,000 shares of NetBank for a
pre-tax gain of $4.7 million.
37
Investment in Affinity Technology Group, Inc. At September 30, 2002, TSFG,
through its subsidiary Blue Ridge Finance Company, Inc. ("Blue Ridge"), owned
4,876,340 shares of common stock of Affinity, or approximately 11% of the
outstanding shares. TSFG's investment in Affinity, which is included in
securities available for sale and has a cost basis of approximately $433,000,
was recorded at its pre-tax market value of approximately $293,000 as of
September 30, 2002.
Investments in Banks. As of September 30, 2002, TSFG had equity investments in
sixteen community banks located in the Southeast. With one exception (RHBT which
is discussed below), TSFG owns less than 5% of the community bank's outstanding
common stock. TSFG has made these investments to develop correspondent banking
relationships and to promote community banking in the Southeast. As of September
30, 2002, equity investments in these community banks (excluding RHBT) were
included in securities available for sale with a cost basis of approximately
$10.2 million and were recorded at their pre-tax market value of $11.2 million.
As a result of TSFG's acquisition of Anchor Financial Corporation in 2000
("Anchor"), TSFG acquired 382,500 shares, or 22% of the outstanding shares, of
RHBT (which were owned by Anchor). TSFG continues to hold these shares. The RHBT
investment is included in securities available for sale. On October 31, 2002,
TSFG completed the acquisition of substantially all the assets and deposits of
Rock Hill, which is the wholly-owned banking subsidiary of RHBT. See "Mergers."
During the third quarter, TSFG wrote-down its investment in RHBT by $1.2 million
from $3.1 million to its September 30, 2002 estimated fair value of
approximately $1.9 million, or $5.00 per share. The Board of Directors of RHBT
presently plans to distribute most, but not necessarily all, of the 430,017
shares of TSFG common stock received by Rock Hill to RHBT shareholders after
closing of the sale of assets. Upon the distribution of the TSFG common stock to
RHBT shareholders, TSFG will cancel any TSFG shares received.
TSFG also has an investment in Nexity Financial Corporation, an Internet bank,
which is recorded at its cost basis of $500,000.
CF Investment Company. CF Investment Company is a wholly-owned Small Business
Investment Company, licensed through the Small Business Administration. Its
principal focus is to invest in companies that have a bank-related technology or
service that TSFG and its subsidiaries can use. CF Investment Company's loans
and equity investments represent a higher risk to TSFG due to the start-up
nature of such companies. As of September 30, 2002, CF Investment Company had
invested approximately $1.2 million in a company specializing in electronic
document management and $502,000 in a paycard company.
Other Equity Investments. In addition to the equity investments described in the
preceding paragraphs, equity investments in available for sale securities at
September 30, 2002, which are carried at market value, included corporate bonds
of $84.2 million, FHLB stock of $31.1 million, and corporate common and
preferred stocks of $4.3 million. At September 30, 2002, the aggregate market
value for these other equity investments totaled $119.6 million with a cost
basis of $118.5 million.
INTANGIBLE ASSETS
The intangible assets balance at September 30, 2002 of $176.8 million was
attributable to goodwill of $162.1 million, core deposit premiums of $13.1
million, customer list intangibles of $857,000, and non-compete agreement
intangibles of $659,000. The intangible assets balance at September 30, 2001 of
$98.5 million consisted of goodwill of $92.7 million and core deposit premiums
of $5.8 million. The increase in goodwill was primarily due to the $71.1 million
of goodwill acquired during 2002 from the Gulf West merger and $876,000 of
goodwill acquired from the acquisition of Gardner Associates. The increase was
partially offset by the transitional impairment loss of $1.4 million in
connection with goodwill recorded for Carolina First Mortgage Company. TSFG was
required to test its intangible assets for impairment in accordance with the
provisions of SFAS 142, which TSFG adopted effective January 1, 2002. See Item
1, Notes 5 and 6 to the Consolidated Financial Statements. The increase in core
deposit premiums was due to adding $8.4 million from the Gulf West merger. The
customer list intangibles and non-compete agreement intangibles were added with
the acquisition of Gardner Associates, an independent insurance agency.
38
DEPOSITS
Deposits remain TSFG's primary source of funds for loans and investments.
Deposits provided funding for 65.0% and 77.1% of average earning assets for the
nine months ended September 30, 2002 and 2001, respectively. Carolina First Bank
and Mercantile Bank face stiff competition from other banking and financial
services companies in gathering deposits. The percentage of funding provided by
deposits has declined, and accordingly, we have developed other sources, such as
FHLB advances and short-term borrowings, to fund a portion of loan demand and
increases in investment securities. In addition, we have increased the use of
brokered certificates of deposits, which are included in deposits.
At September 30, 2002, deposits totaled $4.2 billion, up $559.0 million from
September 30, 2001. On August 31, 2002, TSFG acquired $418.9 million in deposits
from its merger with Gulf West, which accounted for the majority of the
increase. In addition, this increase includes a $323.7 million increase in
brokered certificates of deposit. At September 30, 2002, TSFG had $453.6 million
in brokered certificates of deposit under $100,000, compared with $129.9 million
at September 30, 2001. We consider these funds as an attractive alternative
funding source available to use while continuing our efforts to maintain and
grow our local deposit base.
Average deposits remained relatively constant at $3.7 billion for both the nine
months ended September 30, 2002 and 2001. Deposit pricing remains very
competitive, and we expect this pricing environment to continue. In 2001 and the
first nine months of 2002, TSFG decided to keep deposit rates offered on par
with competitors and reduced deposit rate-driven promotions, which resulted in
lower deposit balances. Deposits acquired from Gulf West offset this decrease.
Table 2 in "EARNINGS REVIEW--Net Interest Income" details average balances for
the deposit portfolio for the nine months ended September 30, 2002 and 2001. On
average, time deposits decreased $86.1 million, or 4.8%, which includes a $219.3
million increase in average brokered certificates of deposit. The decline in
time deposits was largely attributable to fewer certificate of deposit
promotions and maturities of certificates of deposits from promotions held in
2000. Increases in the average balances for other types of deposits, including
noninterest-bearing of $61.7 million, money market accounts of $11.5 million,
and interest checking of $10.4 million, offset this decrease.
As part of its overall funding strategy, TSFG focuses on the mix of deposits
and, in particular, increasing the level of transaction accounts (i.e.,
noninterest-bearing, interest checking, money market, and savings accounts). For
the nine months ended September 30, 2002, transaction accounts made up 53.8% of
average deposits, compared with 51.4% for the nine months ended September 30,
2001. The transaction account percentage increased to 54.9% for the third
quarter of 2002. These trends reflect TSFG's efforts to enhance its deposit mix
by working to attract lower-cost transaction accounts. TSFG's customer-centered
sales process, Elevate, is an integral part of achieving this goal. In addition,
in the summer of 2002, TSFG held a deposit campaign, based on employee
referrals, to raise transaction accounts.
At September 30, 2002, total deposits for Bank CaroLine, an Internet bank,
totaled $34.1 million, down from $91.6 million as of September 30, 2001.
Deposits for Bank CaroLine declined significantly, due to offering less
aggressive interest rates in an effort to lower the overall cost of funds.
Time deposits of $100,000 or more represented 11.8% of total deposits at
September 30, 2002 and 14.0% at September 30, 2001. TSFG's larger denomination
time deposits are generally from customers within the local market areas of its
banks and, therefore, have a greater degree of stability than is typically
associated with this source of funds at other financial institutions.
BORROWED FUNDS
TSFG's short-term borrowings consist of federal funds purchased and repurchase
agreements, FHLB advances (with maturities less than one year when made),
commercial paper, and other short-term borrowings. The long-term borrowings
39
consist primarily of subordinated notes, trust preferred debt, and FHLB
borrowings and repurchase agreements with maturities greater than one year when
made. In the first nine months of 2002, average borrowings totaled $1.9 billion
compared with $1.0 billion for the same period in 2001. This increase was
primarily attributable to an increased reliance on short-term borrowings to
support earning asset growth and to fund increases in investment securities.
Federal funds purchased and repurchase agreements are used to satisfy daily
funding needs and, when advantageous, for rate arbitrage. Federal funds
purchased and repurchase agreements totaled $1.2 billion and $680.2 million at
September 30, 2002 and 2001, respectively. The higher balances are primarily
associated with the financing of higher balances in investment securities
available for sale and to support earning asset growth. Balances in these
accounts can fluctuate on a day-to-day basis.
At September 30, 2002 and 2001, FHLB advances totaled $605.7 million and $479.3
million, respectively. FHLB advances are a source of funding which TSFG uses
depending on the current level of deposits, management's willingness to raise
deposits through market promotions, the Subsidiary Banks' unused FHLB borrowing
capacity, and the availability of collateral to secure FHLB borrowings.
TSFG increased long-term borrowings in 2002 to provide longer-term liquidity.
For example, in February and April 2002, TSFG entered into ten-year repurchase
agreements for a total of approximately $200 million.
In July 2002, TSFG, through two wholly-owned trust subsidiaries, issued and sold
floating rate securities to institutional buyers in two pooled trust preferred
issues. These securities generated net proceeds to TSFG of $41.2 million. Debt
issuance costs totaled $1.3 million. The trust preferred debt qualifies as tier
1 capital under Federal Reserve Board guidelines. See Item 1, Note 10 to the
Consolidated Financial Statements for the terms of the trust preferred debt.
On August 31, 2002, TSFG redeemed $26.3 million of 9.00% Subordinated Notes Due
2005. In connection with the redemption, TSFG recorded a $354,000 loss on early
extinguishment of debt.
On October 29, 2002, through a wholly-owned trust subsidiaries, issued and sold
floating rate securities to institutional buyers in a pooled trust preferred
issues. These securities generated gross proceeds to TSFG of $22.0 million. Debt
issuance costs totaled $680,000. The trust preferred debt qualifies as tier 1
capital under Federal Reserve Board guidelines. See Item 1, Note 15 to the
Consolidated Financial Statements for the terms of the trust preferred debt.
CAPITAL RESOURCES AND DIVIDENDS
TSFG is committed to managing capital for maximum shareholder benefit and
maintaining strong protection for depositors, creditors, and its employees.
Total shareholders' equity amounted to $554.6 million, or 8.1% of total assets,
at September 30, 2002, compared with $476.1 million, or 8.7% of total assets, at
September 30, 2001. At December 31, 2001, total shareholders' equity was $458.2
million, or 7.6% of total assets. Shareholders' equity increased since December
31, 2001 primarily from retention of earnings, the unrealized gains in the
investment securities available for sale portfolio, and the issuance of common
stock for the Gulf West merger. TSFG's stock repurchase program and cash
dividends paid partially offset these increases.
In December 2000, we initiated a stock repurchase program for up to two million
shares, which we expanded to three million shares in September 2001. In February
2002, we added an additional one million shares and in August 2002, we added an
additional 1.1 million shares, in connection with the Gulf West merger, bringing
the total to 5.1 million shares. In connection with the program, TSFG has
repurchased 4,535,690 shares, including 2,141,907 shares purchased during the
first nine months of 2002. We may continue to repurchase shares depending upon
current market conditions and available cash.
40
TSFG's unrealized gain on securities, which is included in accumulated other
comprehensive income, was $18.7 million as of September 30, 2002 as compared to
an unrealized gain of $19.0 million as of September 30, 2001 and an unrealized
loss of $5.6 million as of December 31, 2001. The increase in the unrealized
gain (net of deferred income tax) for the nine months ended September 30, 2002
was comprised of increases in: U.S. Treasury securities $19.8 million,
mortgage-backed securities $3.9 million, agencies $3.2 million, and state and
municipalities $441,000. This increase was partially offset by a decrease in
other securities of $3.0 million, principally from the decline in the value of
RHBT.
Book value per share at September 30, 2002 and 2001 was $12.72 and $11.53,
respectively. Tangible book value per share at September 30, 2002 and 2001 was
$8.68 and $9.14, respectively. Tangible book value was below book value as a
result of the purchase premiums associated with branch purchases and
acquisitions accounted for as purchases.
TSFG and its Subsidiary Banks exceeded the well-capitalized regulatory
requirements at September 30, 2002. Table 7 sets forth various capital ratios
for TSFG and its Subsidiary Banks.
TABLE 7
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CAPITAL RATIOS
- --------------------------------------------------------------------------------------------------------------------------
WELL ADEQUATELY
SEPTEMBER 30, CAPITALIZED CAPITALIZED
2002 REQUIREMENT REQUIREMENT
---- ----------- -----------
THE SOUTH GROUP:
Total risk-based capital 11.45 % n/a n/a
Tier 1 risk-based capital 9.12 n/a n/a
Leverage ratio 7.22 n/a n/a
CAROLINA FIRST BANK:
Total risk-based capital 12.09 % 10.00 % 8.00 %
Tier 1 risk-based capital 8.91 6.00 4.00
Leverage ratio 6.48 5.00 4.00
MERCANTILE BANK:
Total risk-based capital 12.65 % 10.00 % 8.00 %
Tier 1 risk-based capital 8.60 6.00 4.00
Leverage ratio 10.13 5.00 4.00
TSFG and its Subsidiary Banks are subject to certain regulatory restrictions on
the amount of dividends they are permitted to pay. We have paid a cash dividend
each quarter since the initiation of cash dividends on February 1, 1994. TSFG
presently intends to pay a quarterly cash dividend on its Common Stock; however,
future dividends will depend upon our financial performance and capital
requirements.
On June 11, 2002, Carolina First Bank sold 131 shares of the Carolina First
Mortgage Loan Trust's Series 2000A Cumulative Fixed Rate Preferred Shares (the
"Series A Trust Preferred Stock") and 385 shares of Carolina First Mortgage Loan
Trust's Series 2002C Cumulative Floating Rate Preferred Shares (the "Series C
Trust Preferred Stock") to institutional buyers. Proceeds to Carolina First Bank
from these sales totaled approximately $49.2 million, net of issuance costs
totaling $2.4 million, and are reported as minority interest in consolidated
subsidiary on the consolidated balance sheet. The minority interest in
consolidated subsidiary qualifies as tier 1 capital (in the case of Series A
Trust Preferred Stock) and tier 2 capital (in the case of Series C Trust
Preferred Stock) under Federal Reserve Board guidelines. See Item 1, Note 11 to
the Consolidated Financial Statements.
41
In July and October 2002, TSFG, through three wholly-owned trust subsidiaries,
issued and sold floating rate securities to institutional buyers in three pooled
trust preferred issues. These securities generated net proceeds to TSFG of $62.5
million, which qualifies as tier 1 capital under Federal Reserve Board
guidelines. See Item 1, Notes 10 and 15 to the Consolidated Financial
Statements.
MARKET RISK AND ASSET/LIABILITY MANAGEMENT
Market risk is the risk of loss from adverse changes in market prices and rates.
TSFG's market risk arises principally from interest rate risk inherent in its
core banking activities. Interest rate risk is the risk to net income
represented by the impact of higher or lower interest rates. TSFG has risk
management policies to monitor and limit exposure to interest rate risk.
The disclosures related to the market risk of TSFG should be read in conjunction
with TSFG's audited consolidated financial statements, related notes, and
management's discussion and analysis of financial condition and results of
operations included in TSFG's Annual Report on Form 10-K for the year ended
December 31, 2001.
We attempt to manage exposure to fluctuations in interest rates through policies
established by our Asset/Liability Committee ("ALCO") and approved by the Board
of Directors. The primary goal of TSFG's ALCO is to achieve consistent growth in
net interest income while managing interest rate risk. We attempt to control the
mix and maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates while maintaining
adequate liquidity and capital. Our asset/liability mix is sufficiently balanced
so that the effect of interest rates moving in either direction is not expected
to have a significant impact on net interest income over time.
TSFG uses several tools to monitor and manage interest rate risk. One of the
primary tools is a simulation model which is used to analyze earnings at risk
and the interest sensitivity gap (the difference between the amount of rate
sensitive assets maturing or repricing within a specific time period and the
amount of rate sensitive liabilities maturing or repricing within the same time
period). The model takes into account interest rate changes as well as changes
in the mix and volume of assets and liabilities. The model's inputs (such as
interest rates and levels of loans and deposits) are updated on a regular basis.
Interest sensitivity gap ("GAP position") measures the difference between rate
sensitive assets and rate sensitive liabilities during a given time frame.
TSFG's GAP position, while not a complete measure of interest sensitivity, is
reviewed periodically to provide insights related to the static repricing
structure of assets and liabilities. At September 30, 2002, on a cumulative
basis through twelve months, rate-sensitive assets exceeded rate-sensitive
liabilities, resulting in an asset sensitive position of $510.2 million. This
asset sensitivity increased from the June 30, 2002 figure of $30.2 million
primarily as a result of anticipated accelerated prepayment speeds on
mortgage-backed securities, sales of 10-year U.S. Treasury securities, and
purchases of adjustable rate mortgage-backed securities that reprice within a
year. At September 30, 2002, TSFG's static gap position indicates that net
interest income on a cumulative basis through twelve months would benefit from
increases in market interest rates. The static gap position is limited because
it does not take into account the effect of changes in interest rates or changes
in management's expectations or intentions, including any potential sales of
assets or liabilities that TSFG might contemplate depending upon variations in
the markets. In addition, indications of the impact of interest rate changes
using the static gap position may differ from the simulation model estimates. As
of year end 2001, TSFG's GAP position was a $256.3 million liability sensitive
position.
The forecast used for earnings at risk analysis simulates our consolidated
balance sheet and consolidated statements of income under several different rate
scenarios over a twelve-month period. It reports a case in which interest rates
remain flat and reports variations that occur when rates gradually increase and
decrease 200 basis points over the next twelve-month period. These rates assume
a parallel shift in the treasury yield curve, except for lower limits in the
42
declining rate scenario as discussed below. Computation of prospective effects
of hypothetical interest rate changes are based on numerous assumptions,
including relative levels of market interest rates and loan prepayments, and
should not be relied upon as indicative of actual results. Further, the
computations do not contemplate any activities TSFG could undertake in response
to changes in interest rates.
According to the model as of September 30, 2002, TSFG is positioned so
that net interest income will increase $10.7 million, or 4.6%, in the next
twelve months if interest rates rise 200 basis points and will decrease $3.7
million, or -1.6%, in the next twelve months if interest rates decline 200 basis
points. In the increasing rate scenario, the prepayment speeds are reduced on
the mortgage-backed securities, which leads to a higher level of earning assets
and higher interest income. The decrease in net interest income in the declining
rate scenario is limited due to assumptions related to both earning asset and
interest-bearing liability repricings. Due to the low level of current interest
rates, many of the key rates (such as Federal Funds and three month LIBOR),
which the majority of the balance sheet items are indexed to in the model,
cannot be lowered the full 200 basis points. The floors placed on these key
rates restrict the reduction in both interest income and expense. In addition,
many deposit rates are reaching what management believes to be an acceptable
lower limit. For example, the model assumes that certificate of deposit rates
will not decline below 0.50% thus limiting the interest expense reduction from
repricing certificates of deposit by the entire 200 basis points. The overall
interest rate risk position of TSFG continues to fall within the interest rate
risk guidelines established by ALCO.
In addition to the standard scenarios used to analyze earnings at risk, TSFG's
ALCO analyzes the potential impact of other scenarios. The starting point for
these "what-if" scenarios is our base forecast. This base forecast consolidates
all balance sheet information that we are presently aware of with our "most
likely" interest rate projections. The "what-if" scenarios are then used to
gauge the impact of changes in interest rates and/or balance sheet items on the
earnings of TSFG compared to the base forecast. Strategies can be formulated
based on the information provided by the earnings simulation if a scenario
either seems likely to occur or we choose to undertake the proposed transaction.
TSFG updates its base forecast quarterly based on economic changes that occurred
during the past quarter as well as changes in the economic outlook.
Derivatives and Hedging Activities. TSFG uses derivative instruments as part of
its interest rate risk management activities to reduce risks associated with its
lending, investment, deposit taking, and borrowing activities. Derivatives used
for interest rate risk management include various interest rate swaps, options
with indices that relate to the pricing of specific on-balance sheet instruments
and forecasted transactions, and futures contracts.
TSFG has interest rate swap agreements that qualify as fair value hedges and
those that qualify as cash flow hedges. Fair value hedges are used to hedge
fixed rate deposits. TSFG uses cash flow hedges to hedge interest rate risk
associated with variable rate borrowings.
Beginning in the second quarter 2002, TSFG began using futures contracts to
hedge interest rate risk associated with investment securities. As such, the
investment securities, subsequently classified as trading securities, and the
related futures contracts are recorded at fair value. Any ineffectiveness
resulting from differences between the changes in fair value of the investment
securities and futures contracts will be recognized in the consolidated
statements of income as gains or losses in trading securities. TSFG increased
its hedging activities associated with investment securities in the third
quarter 2002. Such activities may result in increased volatility in realized
gains and losses on trading activities. See "Securities."
In connection with its interest rate management activities, TSFG uses futures,
options, and other derivatives as economic hedges of on-balance sheet assets and
liabilities or forecasted transactions, which do not qualify for hedge
accounting under SFAS 133. Accordingly, these derivatives are reported at fair
value on the consolidated balance sheet with realized gains and losses included
in earnings. Such activities may result in increased volatility in realized
gains and losses on trading activities. TSFG's use of these instruments
increased in the third quarter 2002.
By using derivative instruments, TSFG is exposed to credit and market risk.
Credit risk, which is the risk that a counterparty to a derivative instrument
will fail to perform, is equal to the extent of the fair value gain in a
43
derivative. Credit risk is created when the fair value of a derivative contract
is positive, since this generally indicates that the counterparty owes us. When
the fair value of a derivative is negative, no credit risk exists since TSFG
would owe the counterparty. TSFG minimizes the credit risk in derivative
instruments by entering into transactions with high-quality counterparties as
evaluated by management. Market risk is the adverse effect on the value of a
financial instrument from a change in interest rates or implied volatility of
rates. We manage the market risk associated with interest rate contracts by
establishing and monitoring limits as to the types and degree of risk that may
be undertaken. The market risk associated with derivatives used for interest
rate risk management activity is fully incorporated into our market risk
sensitivity analysis.
In accordance with SFAS 133, TSFG records derivatives at fair value, as either
assets or liabilities, on the consolidated balance sheets. At September 30,
2002, the fair value of derivative assets totaled $6.7 million and was related
to derivatives with no hedging designation and fair value hedges. At September
30, 2002, the fair value of derivative liabilities totaled $541,000 for cash
flow hedges and $208,000 for futures, options, and other derivatives, which do
not qualify for hedge accounting under SFAS 133.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, TSFG engages in a variety of financial
transactions that, in accordance with generally accepted accounting principles,
are not recorded in the financial statements, or are recorded in amounts that
differ from the notional amounts. These transactions involve, to varying
degrees, elements of credit, interest rate, and liquidity risk. Such
transactions are used by TSFG for general corporate purposes or for customer
needs. Corporate purpose transactions are used to help manage credit, interest
rate, and liquidity risk or to optimize capital. Customer transactions are used
to manage customers' requests for funding.
TSFG's off-balance sheet arrangements, which principally include lending
commitments, derivatives, and stock-related agreements, are described below. At
September 30, 2002 and 2001, TSFG had no interests in non-consolidated special
purpose entities.
Lending Commitments. Lending commitments include loan commitments, standby
letters of credit, unused business credit card lines, and documentary letters of
credit. These instruments are not recorded in the consolidated balance sheet
until funds are advanced under the commitments. TSFG provides these lending
commitments to customers in the normal course of business.
For commercial customers, loan commitments generally take the form of revolving
credit arrangements to finance customers' working capital requirements. For
retail customers, loan commitments are generally lines of credit secured by
residential property. At September 30, 2002, commercial and retail loan
commitments totaled $819.9 million. These commitments increased from $698.4
million at June 30, 2002, due primarily to the addition of approximately $80
million from Gulf West and increases in home equity loan commitments. Standby
letters of credit are conditional commitments to guarantee performance,
typically contract or financial integrity, of a customer to a third party and
totaled $45.2 million at September 30, 2002. Documentary letters of credit are
typically issued in connection with customers' trade financing requirements and
totaled $27.4 million at September 30, 2002. Unused business credit card lines,
which totaled $16.4 million at September 30, 2002, are generally for short-term
borrowings.
TSFG applies essentially the same credit policies and standards as it does in
the lending process when making these commitments.
Derivatives. In accordance with SFAS 133, TSFG records derivatives at fair
value, as either assets or liabilities, on the consolidated balance sheet.
Derivative transactions are measured in terms of the notional amount, but this
amount is not recorded on the balance sheets and is not, when viewed in
isolation, a meaningful measure of the risk profile of the instrument. The
notional amount is not exchanged, but is used only as the basis upon which
interest and other payments are calculated.
44
At September 30, 2002, the fair value of derivative assets totaled $6.7 million
and was related to derivatives with no hedging designation and fair value
hedges. At September 30, 2002, the fair value of derivative liabilities totaled
$541,000 for cash flow hedges and $208,000 for futures, options, and other
derivatives, which do not qualify for hedge accounting under SFAS 133. The
related notional amounts, which are not recorded on the consolidated balance
sheets, totaled $283.0 million for the derivative assets and $417.9 million for
the derivative liabilities.
Credit Life & Disability Insurance. Carolina First Guaranty Reinsurance, Ltd.
("CFGRL"), a wholly-owned subsidiary of TSFG, offers credit life and disability
insurance up to a single policy limit of $100,000 to customers of the Subsidiary
Banks. As of September 30, 2002, CFGRL had in force insurance not recorded on
the consolidated balance sheets of $31.6 million. A loss reserve, determined
based on reported and past loss experience of in force policies, of $176,000 was
included in other liabilities at September 30, 2002.
Stock-Related Agreements. In connection with stock repurchases, TSFG has, from
time to time, entered into "accelerated share repurchase" contracts. Under these
accelerated share repurchase contracts, an unaffiliated investment bank (the
"counterparty") "borrows" the requisite number of shares from unaffiliated third
parties, and delivers these shares to TSFG in exchange for cash (such that these
shares are immediately removed from TSFG's outstanding shares). Over a period of
time subsequent to the entry into the accelerated share repurchase contract, the
counterparty purchases TSFG shares in the open market to cover their borrowed
position. After the counterparty has covered this position, TSFG settles with
the counterparty for any gains or losses associated with changes in TSFG's stock
price during the period of time that stock was being purchased. This settlement
may be made in cash or in TSFG common stock. These contracts are reflected as a
reduction in shareholders' equity and outstanding shares (used in the earnings
per share calculation).
In September 2002, TSFG settled its existing accelerated share repurchase
contract by issuing 93,693 shares and entered into a new accelerated share
repurchase contract with an unaffiliated company to repurchase 1.1 million
shares of TSFG common stock (subject to blackout periods at TSFG's option, which
may extend the contract period) and to settle the contract in stock. TSFG
expects the counterparty's purchases of shares under this contract to continue
into the first quarter 2003.
LIQUIDITY
Liquidity management ensures that adequate funds are available to meet deposit
withdrawals, fund loan and capital expenditure commitments, maintain reserve
requirements, pay operating expenses, provide funds for dividends and debt
service, and manage operations on an ongoing basis. Funds are primarily provided
by the Subsidiary Banks through customers' deposits, principal and interest
payments on loans, loan sales or securitizations, securities available for sale,
maturities of securities, temporary investments, and earnings. Securities
classified as available for sale, which are not pledged, may be sold in response
to changes in interest rates or liquidity needs. A substantial majority of
TSFG's securities are pledged.
Proper liquidity management is crucial to ensure that TSFG is able to take
advantage of new business opportunities as well as meet the demands of its
customers. In this process, we focus on assets and liabilities and on the manner
in which they combine to provide adequate liquidity to meet our needs.
Net cash provided by operations and deposits from customers have been the
primary sources of liquidity for TSFG. Liquidity is also enhanced by the ability
to acquire new deposits through the Subsidiary Banks' established branch network
of 106 branches in South Carolina, North Carolina, and Florida. In addition,
TSFG can raise deposits on the Internet through Bank CaroLine. Liquidity needs
are a factor in developing the Subsidiary Banks' deposit pricing structure,
which may be altered to retain or grow deposits if deemed necessary.
The Subsidiary Banks have access to borrowing from the FHLB and maintain
short-term lines of credit from unrelated banks. FHLB advances, outstanding as
of September 30, 2002, totaled $605.7 million. At September 30, 2002, the
Subsidiary Banks had approximately $327.5 million of unused borrowing capacity
from the FHLB. At September 30, 2002, $286.8 million of this excess capacity was
45
unavailable because the Subsidiary Banks had no available FHLB-qualifying
collateral. Until the Subsidiary Banks make collateral available (other than
cash) to secure additional FHLB advances, TSFG will fund its short-term needs
principally with deposits, including brokered certificates of deposit, federal
funds purchased, repurchase agreements, and the sale of securities available for
sale. In addition, the Subsidiary Banks may purchase securities or may repay
repurchase agreements to provide additional FHLB-qualifying collateral. At
September 30, 2002, the Subsidiary Banks had unused short-term lines of credit
totaling approximately $320.8 million (which are withdrawable at the lender's
option).
The Federal Reserve Bank provides back-up funding for commercial banks.
Borrowing relationships with both the Federal Reserve Bank of Richmond and the
Federal Reserve Bank of Atlanta are being put in place for the Subsidiary Banks
so that emergency funding needs can be met.
Liquidity at the parent company level is provided through cash dividends from
the Subsidiary Banks and the capacity of the parent company to raise additional
borrowed funds or sell capital securities as needed. In October 2002, a trust
subsidiary of TSFG issued and sold floating rate securities to institutional
buyers in a pooled trust preferred issue, which generated net proceeds to the
parent company of $21.3 million. See Item 1, Note 15 to the consolidated
Financial Statements. If TSFG elects to repurchase additional shares through its
share repurchase program, such purchases will reduce liquidity at the parent
company level. At September 30, 2002, the parent company had unused short-term
lines of credit totaling approximately $10.0 million (which are withdrawable at
the lender's option).
In the normal course of business, to meet the financial needs of its customers,
TSFG, principally through the Subsidiary Banks, enters into agreement to extend
credit. For amounts and types of such agreements at September 30, 2002, see
"Off-Balance Sheet Arrangements." Increased demand for funds under these
agreements would reduce TSFG's liquidity and could require additional sources of
liquidity.
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 loan
monitoring policies is managed. 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 the Directors' Credit Committees of each banking subsidiary, which
meet monthly to review credit quality trends, new large credits, insider loans,
large problem credits, credit policy changes, and reports on independent credit
audits of city offices.
Table 8 presents information pertaining to nonperforming assets.
46
TABLE 8
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NONPERFORMING ASSETS AND PAST DUE LOANS
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
SEPTEMBER 30, DECEMBER 31,
------------------------------
2002 2001 2001
---- ---- ----
Nonaccrual loans - commercial $ 32,306 $ 31,946 $ 35,245
Nonaccrual loans - consumer 2,850 2,276 3,643
Restructured loans - - -
--------- -------- --------
Total nonperforming loans 35,156 34,222 38,888
Other real estate owned 9,318 5,846 4,969
--------- -------- --------
Total nonperforming assets $ 44,474 $ 40,068 $ 43,857
========= ======== ========
Loans past due 90 days still accruing interest (1) $ 5,744 $ 9,380 $ 10,482
========= ======== ========
Total nonperforming assets as a percentage
of loans and other real estate owned (2) 1.07 % 1.07 % 1.17 %
==== ==== ====
Allowance for loan losses as a
percentage of nonperforming loans 1.42 x 1.28 x 1.15 x
==== ==== ====
(1) Substantially all of these loans are consumer and residential mortgage
loans.
(2) Calculated using loans held for investment, net of unearned income.
Note: Nonperforming assets exclude repossessions, which totaled $1.4 million at
September 30, 2002.
Nonperforming assets were 1.07% of loans plus other real estate owned at
September 30, 2002, compared with 1.17% at December 31, 2001 and 1.07% at
September 30, 2001. Nonperforming loans have declined for the last two quarters.
The third quarter 2002 decline reflected the payout of TSFG's largest nonaccrual
loan, which totaled approximately $7.7 million. Approximately $179,000 of
interest income was recorded in the third quarter 2002 in connection with this
payout. Nonperforming loans at September 30, 2002 include the addition of $3.3
million from Gulf West.
The following summarizes information on impaired loans (in thousands), all of
which are in nonaccrual status, at and for the nine months ended September 30.
All impaired loans are commercial loans.
2002 2001
---- ----
Impaired loans $ 32,306 $ 31,946
Average investment in impaired loans 38,342 26,730
Related allowance 6,248 4,178
Recognized interest income - 296
Foregone interest 1,469 1,739
Nonaccrual loans were $35.2 million and $34.2 million on September 30, 2002 and
2001, respectively. Interest income recognized on nonaccrual loans totaled none
and $297,000 for the nine months ended September 30, 2002 and 2001,
respectively. Nonaccrual loans, concentrated in six credit relationships,
accounted for 47.7% of the nonperforming loan balance. Estimated loss exposure
for these six relationships totaled $1.3 million as of September 30, 2002. Total
estimated impairment on all commercial nonaccrual loans totaled $6.2 million and
$4.2 million as of September 30, 2002 and 2001, respectively.
Future credit quality trends depend primarily on the direction of the economy,
and current economic data do not provide a clear signal of that direction. Until
the business climate improves, portfolio quality indicators will remain
volatile, nonperforming asset levels may fluctuate, and charge-offs will tend to
be higher than historical norms. Management believes, however, that loss
exposure in its loan portfolio is identified, adequately reserved for in a
47
timely manner, and closely monitored to ensure that changes are promptly
addressed in its analysis of Allowance adequacy. Accordingly, management
believes the Allowance as of September 30, 2002 was adequate, based on its
assessment of probable losses, and available facts and circumstances then
prevailing.
CURRENT ACCOUNTING ISSUES
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.
141, "Business Combinations" ("SFAS 141"), and SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 141 requires that the purchase method of
accounting be used for all business combinations initiated after September 30,
2001, as well as all purchase method business combinations completed after
September 30, 2001. SFAS 141 also specifies criteria intangible assets acquired
in a purchase method business combination must meet to be recognized and
reported apart from goodwill, noting that any purchase price allocable to
assembled workforce may not be accounted for separately. SFAS 142 requires that
goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead tested for impairment at least annually in accordance
with the provisions of SFAS 142. SFAS 142 also requires that intangible assets
with definite useful lives be amortized over their respective estimated useful
lives to their estimated residual values, and reviewed for impairment in
accordance with SFAS 121, "Accounting for the Impairment or Disposal of
Long-Lived Assets" ("SFAS 144"). TSFG adopted the provisions of SFAS 141, as of
the date of issuance, and SFAS 142, effective January 1, 2002. See Note 5 to the
Consolidated Financial Statements for the financial impact from the January 1,
2002 adoption of SFAS 142.
In connection with the transitional goodwill, SFAS 142 requires TSFG to perform
an assessment of whether there is an indication that goodwill is impaired as of
January 1, 2002. To accomplish this, TSFG had to identify its reporting units
and determine the carrying value of each reporting unit by assigning the assets
and liabilities, including the existing goodwill and intangible assets, to those
reporting units as of the date of adoption. TSFG had until June 30, 2002 to
determine the fair value of each reporting unit and compare it to the reporting
unit's carrying amount. To the extent a reporting unit's carrying amount exceeds
its fair value, an indication exists that the reporting unit's goodwill may be
impaired, and the second step of the transitional impairment test must be
performed. In the second step, the implied fair value of the reporting unit's
goodwill, determined by allocating the reporting unit's fair value to all of it
assets (recognized and unrecognized) and liabilities in a manner similar to a
purchase price allocation in accordance with SFAS 141, "Business Combinations,"
is compared to its carrying amount, both of which would be measured as of
January 1, 2002.
TSFG has completed its analysis of the fair value of its intangible assets and
determined that the goodwill associated with Carolina First Mortgage Company was
impaired. TSFG recorded a transitional impairment loss of $1.4 million. This
transitional impairment loss was recognized as the cumulative effect of a change
in accounting principle in the consolidated statements of income for the nine
months ended September 30, 2002 (although it was not reflected in the third
quarter 2002 results since the impairment is reflected as of January 1, 2002).
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No.
4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections"
("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from
Extinguishments of Debt" ("SFAS 4"), and an amendment of SFAS 4, SFAS No. 64,
"Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145
requires that gains and losses from extinguishment of debt should be classified
as an extraordinary item only if they meet the criteria of FASB Opinion No. 30,
"Reporting the Results of Operations-Reporting the Effects of Disposal of a
Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions" ("FASB Opinion 30"). Applying the provisions of FASB
Opinion 30 will distinguish transactions that are part of an entity's recurring
operations from those that are unusual or infrequent or that meet the criteria
for classification as an extraordinary item.
48
The provisions of SFAS 145 are effective for financial statements issued for
fiscal years beginning after May 15, 2002 and interim periods within those
fiscal years, and early adoption is encouraged. Any gain or loss on
extinguishment of debt that was classified as an extraordinary item in prior
periods presented that does not meet the criteria in FASB Opinion 30 for
classification as an extraordinary item will be reclassified.
TSFG adopted SFAS 145 effective July 1, 2002. In connection with this adoption,
TSFG reclassified losses on the early extinguishment of debt, which were
incurred in the second half of 2001 and totaled $3.1 million pre-tax, as
noninterest expenses.
In September 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146
applies to costs associated with an exit activity that does not involve an
entity newly acquired in a business combination or with a disposal activity
covered by SFAS No. 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets." Those costs include, but are not limited to, the following:
a) termination benefits provided to current employees that are involuntarily
terminated under the terms of a benefit arrangement that, in substance, is not
an ongoing benefit arrangement or an individual deferred compensation contract
(hereinafter referred to as one-time termination benefits), b) costs to
terminate a contract that is not a capital lease, and c) costs to consolidate
facilities or relocate employees. This Statement does not apply to costs
associated with the retirement of a long-lived asset covered by SFAS No. 143,
"Accounting for Asset Retirement Obligations." A liability for a cost associated
with an exit or disposal activity shall be recognized and measured initially at
its fair value in the period in which the liability is incurred. A liability for
a cost associated with an exit or disposal activity is incurred when the
definition of a liability is met in accordance with FASB Concepts Statements No.
6, "Elements of Financial Statements." The provisions of this Statement are
effective for exit or disposal activities that are initiated after December 31,
2002, with early application encouraged. The impact of adoption on the
Corporation is not known at this time.
In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain
Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB
Interpretation No. 9" ("SFAS 147"). SFAS 147 removes acquisitions of financial
institutions from the scope of both FASB Statements No. 72 ("SFAS 72") and FASB
Interpretation No. 9 and requires that those transactions be accounted for in
accordance with FASB Statements No. 141, "Business Combinations," and No. 142,
"Goodwill and Other Intangible Assets," except for transactions between two or
more mutual enterprises. Thus, the requirement in SFAS 72 to recognize (and
subsequently amortize) any excess of the fair value of liabilities assumed over
the fair value of tangible and identifiable assets acquired as an unidentifiable
intangible asset no longer applies to acquisitions within the scope of the scope
of SFAS 72. In addition, SFAS 147 amends FASB Statement No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), to include in its
scope long-term customer-relationship intangible assets of financial
institutions such as depositor- and borrower-relationship intangible assets and
credit cardholder intangible assets. Consequently, those intangible assets are
subject to the same undiscounted cash flow recoverability test and impairment
loss recognition and measurement provisions that SFAS 144 requires for other
long-lived assets that are held and used.
The provisions of SFAS 147 are effective for financial statements issued on or
after October 1, 2002 and early adoption is permitted. In the third quarter,
TSFG adopted SFAS 147 effective as of January 1, 2002.
With the third quarter adoption of SFAS 147, the unamortized unidentifiable
intangible assets related to branch purchases, which totaled $2.5 million, net
of accumulated amortization, as of September 30, 2002, were reclassified as
goodwill. In connection with this adoption, TSFG reversed $112,000 pre-tax of
amortization of intangibles, which were recorded in the first half of 2002.
49
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk and Asset/Liability Management" in ITEM 2, Management
Discussion and Analysis of Financial Condition and Results of Operations for
quantitative and qualitative disclosures about market risk, which information is
incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
TSFG's Executive Officer and Principal Financial Officer have evaluated
TSFG's disclosure controls and procedures as of November 4, 2002, and they
concluded that these controls and procedures are effective.
(b) Changes in Internal Controls
There are no significant changes in internal controls or in other factors
that could significantly affect these controls subsequent to November 4,
2002.
50
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
See Note 13 to the Consolidated Financial Statements for a discussion
of legal proceedings.
ITEM 2 CHANGE IN SECURITIES
None.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 Amendment 5 to The South Financial Group Amended and Restated
Stock Option Plan.
99.1 Certificates filed pursuant to Section 906 of the Sarbanes
Oxley Act of 2002.
(b) Reports on Form 8-K
The South Group filed Current Reports on Form 8-K dated July 11, 2002,
July 25, 2002, August 6, 2002, August 26, 2002, and August 31, 2002.
51
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, TSFG has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
The South Financial Group, Inc.
/s/ William S. Hummers III
------------------------------------
William S. Hummers III
Executive Vice President
52
CERTIFICATION
I, Mack I. Whittle, Jr., certify that:
1. I have reviewed this quarterly report on Form 10-Q of The South
Financial Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Mack I. Whittle, Jr.
------------------------
Mack I. Whittle, Jr.
Chief Executive Officer
53
CERTIFICATION
I, William S. Hummers III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The South
Financial Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact necessary
to make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by this
quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly report
is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about
the effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability
to record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves
management or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ William S. Hummers III
--------------------------
William S. Hummers III
Executive Vice President
(principal financial officer)
54