Such forward-looking statements speak only as of the date on which such statements are made and shall be deemed to be updated by any future filings made by TSFG with the SEC. 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 SEC, in press releases, and in oral and written statements made by or with the approval of TSFG, which are not statements of historical fact, constitute forward-looking statements.
This report also contains financial information determined by methods other than in accordance with Generally Accepted Accounting Principles (“GAAP”). TSFG’s management uses these non-GAAP measures to analyze TSFG’s performance. In particular, TSFG presents certain designated net interest income amounts on a tax-equivalent basis (in accordance with common industry practice). Management believes that these presentations of tax-equivalent net interest income aid in the comparability of net interest income arising from both taxable and tax-exempt sources over the periods presented. TSFG also presents loan and deposit growth, excluding loans/deposits acquired net of dispositions (referred to herein as “organic growth”). In discussing its deposits, TSFG presents “core deposits,” which are defined by TSFG as noninterest-bearing, interest-bearing checking, money market accounts, and savings accounts, “customer deposits,” which are defined by TSFG as total deposits less brokered deposits, and “customer funding,” which is defined by TSFG as total deposits less brokered deposits plus customer sweeps. Wholesale borrowings include short-term and long-term borrowings less customer sweeps plus brokered deposits. In addition, TSFG provides data eliminating intangibles in order to present data on a “tangible” basis. The limitations associated with operating measures are the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. Management compensates for these limitations by providing detailed reconciliations between GAAP and operating measures. These disclosures should not be viewed as a substitute for GAAP measures, and furthermore, TSFG’s non-GAAP measures may not necessarily be comparable to non-GAAP performance measures of other companies.
The South Financial Group is a financial holding company, headquartered in Greenville, South Carolina, with $14.2 billion in total assets and 170 branch offices in South Carolina, Florida, and North Carolina at March 31, 2007. Founded in 1986, TSFG focuses on fast-growing banking markets in the Southeast and concentrates its growth in metropolitan statistical areas. TSFG operates primarily through:
At March 31, 2007, approximately 47% of TSFG’s customer deposits (total deposits less brokered deposits) were in South Carolina, 39% were in Florida, and 14% were in North Carolina. (See “Noninterest Expenses” for a discussion of the planned merger of TSFG’s two bank subsidiaries subsequent to quarter-end.)
TSFG uses a super-community bank strategy and targets small and middle market businesses and retail customers. As a super-community bank, TSFG combines personalized customer service and local decision-making, typical of community banks, with a full range of financial services normally found at larger regional institutions.
TSFG reported net income of $20.5 million, or $0.27 per diluted share, for the first three months of 2007, compared with $27.8 million, or $0.37 per diluted share, for the first three months of 2006. Average diluted shares outstanding decreased 0.1% to 75.2 million shares, principally as a result of TSFG’s repurchase of 1 million shares at the end of January 2007, partially offset by shares issued pursuant to the exercise of stock options.
TSFG continues to focus on improving its balance sheet mix by increasing the relative level and mix of customer assets and liabilities. On the asset side, average loans as a percentage of average earning assets increased to 77.8% for first quarter 2007 from 75.0% for first quarter 2006. On the funding side, average customer funding (which includes deposits less brokered deposits plus customer sweeps) as a percentage of average total funding increased to 67.3% for first quarter 2007, up from 63.4% for first quarter 2006.
Using period-end balances, TSFG’s loans held for investment at March 31, 2007 increased 1.8% from a year ago, and total deposit balances grew 8.4%. Customer funding (deposits less brokered deposits plus customer sweeps) increased 4.5% since March 31, 2006. Since March 2006, TSFG sold $359.6 million of indirect auto loans, as well as $2.6 million of loans and $27.9 million of deposits in connection with the sale of the Mullins branch. Excluding these amounts, growth in loans held for investment totaled 5.5% from March 31, 2006 to March 31, 2007.
Tax-equivalent net interest income was $96.2 million for the first three months of 2007, an $8.5 million decrease from $104.7 million for the first three months of 2006. The net interest margin decreased to 3.08% for the first three months of 2007 from 3.29% for the first three months of 2006. This margin compression reflects an ongoing change in customer preference for higher-cost deposit categories, higher wholesale borrowing costs, and actions by management to reduce interest rate risk and optionality on the balance sheet. Most recently, the net interest margin declined 4 basis points to 3.08% for the first three months of 2007 from 3.12% for fourth quarter 2006.
Noninterest income increased 5.2% to $30.8 million for the first three months of 2007 compared to $29.3 million for the first three months of 2006. Noninterest income reflected growth in wealth management, mortgage banking, and merchant processing income, offset by a decrease in service charges on deposits.
Noninterest expenses totaled $85.4 million for the first three months of 2007, compared to $79.8 million for the first three months of 2006, an increase of 6.9%. Salaries, wages and employee benefits (excluding contract buyouts and severance), which account for 52.5% of total noninterest expenses for the first three months of 2007, increased 10.7% to $44.8 million. The increase in noninterest expenses included higher incentive expense, higher salaries attributable to annual salary increases and TSFG’s expansion of its management team, higher occupancy expense, and higher merchant processing expense. Noninterest expenses for the first three months of 2007 declined to $85.4 million from $93.6 million for fourth quarter 2006, primarily from TSFG’s expense reduction initiatives implemented during the first quarter of 2007 as well as a $3.2 million decline in employment contract buyouts and severance.
At March 31, 2007, nonperforming assets as a percentage of loans held for investment and foreclosed property increased to 0.47% from 0.46% at March 31, 2006. For the three months ended March 31, 2007 and 2006, annualized net loan charge-offs were 0.29% of average loans held for investment. TSFG’s provision for credit losses decreased to $9.0 million for the first three months of 2007 from $9.9 million for the first three months of 2006, primarily as a result of slower loan growth. The allowance for loan loss coverage of nonperforming loans at March 31, 2007 decreased to 2.63 times, compared with 3.11 times at March 31, 2006.
TSFG’s tangible equity to tangible asset ratio totaled 6.52% at March 31, 2007, up from 5.77% at March 31, 2006, primarily as a result of retention of earnings, the continued runoff of the securities portfolio (which decreased tangible assets), and a decrease in net unrealized losses on available for sale securities. At March 31, 2007, the after-tax net unrealized loss on available for sale securities totaled $37.6 million, down from $66.1 million at March 31, 2006.
Critical Accounting Policies and Estimates
TSFG’s accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry. TSFG makes a number of judgmental estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during periods presented. Material
15
estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and reserve for unfunded lending commitments; the effectiveness of derivatives and other hedging activities; the fair value of certain financial instruments (loans held for sale, securities, derivatives, and privately held investments); income tax assets or liabilities; share-based compensation; and accounting for acquisitions, including the fair value determinations, the analysis of goodwill for impairment and the analysis of valuation allowances in the initial accounting of loans acquired. To a lesser extent, significant estimates are also associated with the determination of contingent liabilities, discretionary compensation, and other employee benefit agreements. Different assumptions in the application of these policies could result in material changes in TSFG’s Consolidated Financial Statements. Accordingly, as this information changes, the Consolidated Financial Statements could reflect the use of different estimates, assumptions, and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions, and judgments, and as such have a greater possibility of producing results that could be materially different than originally reported. TSFG has procedures and processes in place to facilitate making these judgments.
For additional information regarding critical accounting policies, refer to the Annual Report of TSFG on Form 10-K for the year ended December 31, 2006, specifically Item 8, Note 1 – Summary of Significant Accounting Policies in the notes to the Consolidated Financial Statements and the section captioned “Critical Accounting Policies and Estimates” in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Expanded Corporate Facilities
During 2005, TSFG initiated plans for a “corporate campus” to meet current and future facility needs and serve as the primary headquarters for its banking operations, including legal, human resources, accounting, finance, certain loan operations, credit, treasury, internal audit, risk management, and other support and administrative functions. The initial phase of the plans included the purchase of approximately 68 acres of land in Greenville County, South Carolina, for an aggregate investment of $10.4 million in early 2006. While the Company is still finalizing details of the campus, it expects to make additional investments of approximately $90 million between now and 2011, with the first phase being completed and occupied during the first half of 2009. The Company believes assimilating the workforce at one location will provide certain efficiencies through greater interaction and communication as well as an increased ability to attract and retain employees.
In connection with this project, the applicable state, county, and city governments and other sources will provide the Company's banking subsidiary certain tax and economic incentives based on, among other things, a total investment of approximately $100 million and the location of approximately 600 new positions at the campus by December 31, 2011. The requisite new positions must be in addition to the approximately 325 current Greenville-based positions that will be relocated from existing leased facilities to the campus beginning in early 2009. The current estimated range of incentives has a value totaling between $55 and $60 million ($30 to $35 million on a present value basis) assuming the minimum investment and job creation requirements are achieved. A significant portion of the incentives require one or both of the investment and job creation requirements.
The new positions to be located at the campus will be derived from (i) the management and consolidation of existing positions, including relocating some functions currently located outside of South Carolina; (ii) growth and expansion of current and future business lines; and (iii) future acquisitions (if any).
Prior to 2009, TSFG does not expect to recognize any significant expenses associated with the project due to the capitalization of costs during the construction period. However, upon completion of certain infrastructure elements (roads, sidewalks, etc.), the Company will contribute its net investment in those improvements to the City of Greenville in 2008 or early 2009 (currently estimated at $3 million to $5 million, net of certain economic grants). Additionally, the Company currently estimates it will incur one-time charges totaling $3 million to $5 million after-tax related to lease terminations and impairment of leasehold improvements.
Assuming all incentives are earned, TSFG does not currently expect the incremental occupancy costs to be significant in future periods. Although not finalized, the Company is also pursuing other incentives as well as managing the overall timing of the additional investments through 2011.
16
Balance Sheet Review
Loans
TSFG focuses its lending activities on small and middle market businesses and individuals in its geographic markets. At March 31, 2007, outstanding loans totaled $9.9 billion, which equaled 99.8% of total deposits (124.6% of customer deposits) and 70.1% of total assets. The major components of the loan portfolio were commercial loans, commercial real estate loans, and consumer loans (including both direct and indirect loans). Substantially all loans were to borrowers located in TSFG’s market areas in South Carolina, Florida, and North Carolina. At March 31, 2007, approximately 8% of the portfolio was unsecured.
As part of its portfolio and balance sheet management strategies, TSFG reviews its loans held for investment and determines whether its intent for specific loans or classes of loans has changed. If management changes its intent from held for investment to held for sale, the loans are transferred to the held for sale portfolio and recorded at the lower of cost basis or fair value.
Loans held for investment increased $177.2 million, or 1.8%, to $9.9 billion at March 31, 2007 from $9.7 billion at March 31, 2006. Excluding the sale of indirect auto loans in the second quarter of 2006 ($359.6 million) and the third quarter 2006 sale of the Mullins branch ($2.6 million), loan growth was 5.5% since March 31, 2006.
TSFG generally sells a majority of its residential mortgage loans in the secondary market. TSFG also retains certain of its mortgage loans, based on predetermined criteria, in its held for investment portfolio as part of its overall balance sheet management strategy. Loans held for sale increased to $33.5 million at March 31, 2007 from $28.6 million at December 31, 2006 and $23.5 million at March 31, 2006, partly due to TSFG’s decision to hold fewer mortgage loans in its held for investment portfolio.
Table 1 summarizes outstanding loans by collateral type for real estate secured loans and by borrower type for all other loans. Collateral type represents the underlying assets securing the loan, rather than the purpose of the loan.
|
Table 1 |
|
Loan Portfolio Composition |
|
(dollars in thousands) |
| | | | | | | | | | |
| | | | | | | | | | |
| | March 31, | | December 31, | |
| |
| | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Commercial, financial and agricultural | | $ | 2,231,572 | | $ | 1,986,588 | | $ | 2,152,375 | |
Real estate - construction(1) | | | 1,718,783 | | | 1,478,931 | | | 1,630,366 | |
Real estate - residential mortgages (1-4 family) | | | 1,369,196 | | | 1,524,957 | | | 1,416,005 | |
Commercial secured by real estate(1) | | | 3,797,868 | | | 3,658,755 | | | 3,727,316 | |
Consumer | | | 780,715 | | | 1,071,660 | | | 775,805 | |
| |
|
| |
|
| |
|
| |
Loans held for investment | | $ | 9,898,134 | | $ | 9,720,891 | | $ | 9,701,867 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Percentage of Loans Held for Investment | | | | | | | | | | |
Commercial, financial and agricultural | | | 22.5 | % | | 20.5 | % | | 22.2 | % |
Real estate - construction(1) | | | 17.4 | | | 15.2 | | | 16.8 | |
Real estate - residential mortgages (1-4 family) | | | 13.8 | | | 15.7 | | | 14.6 | |
Commercial secured by real estate(1) | | | 38.4 | | | 37.6 | | | 38.4 | |
Consumer | | | 7.9 | | | 11.0 | | | 8.0 | |
| |
|
| |
|
| |
|
| |
Total | | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| |
|
| |
|
| |
|
| |
| |
(1) | These categories include loans to businesses other than real estate companies where owner-occupied real estate is pledged on loans to finance operations, equipment, and facilities. |
17
Table 2 provides a stratification of the loan portfolio by loan purpose. This presentation differs from that in Table 1, which stratifies the portfolio by collateral type and borrower type. Certain prior period amounts have been reclassified to conform to current period presentation.
|
Table 2 |
|
Loan Portfolio Composition Based on Loan Purpose |
|
(dollars in thousands) |
| | | | | | | | | | |
| | March 31, | | December 31, | |
| |
| | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Commercial Loans | | | | | | | | | | |
Commercial and industrial | | $ | 2,596,705 | | $ | 2,371,946 | | $ | 2,491,210 | |
Owner - occupied real estate(1) | | | 883,738 | | | 754,229 | | | 830,179 | |
Commercial real estate | | | 4,209,149 | | | 4,090,130 | | | 4,171,631 | |
| |
|
| |
|
| |
|
| |
| | | 7,689,592 | | | 7,216,305 | | | 7,493,020 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Consumer Loans | | | | | | | | | | |
Indirect - sales finance | | | 666,801 | | | 928,633 | | | 660,401 | |
Direct retail | | | 283,461 | | | 333,773 | | | 292,993 | |
Home equity | | | 531,922 | | | 561,964 | | | 528,909 | |
| |
|
| |
|
| |
|
| |
| | | 1,482,184 | | | 1,824,370 | | | 1,482,303 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Mortgage Loans | | | 726,358 | | | 680,216 | | | 726,544 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Total loans held for investment | | $ | 9,898,134 | | $ | 9,720,891 | | $ | 9,701,867 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Percentage of Loans Held for Investment | | | | | | | | | | |
Commercial and industrial | | | 26.2 | % | | 24.4 | % | | 25.7 | % |
Owner - occupied real estate(1) | | | 8.9 | | | 7.7 | | | 8.6 | |
Commercial real estate | | | 42.5 | | | 42.1 | | | 43.0 | |
Consumer | | | 15.0 | | | 18.8 | | | 15.2 | |
Mortgage | | | 7.4 | | | 7.0 | | | 7.5 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Total | | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| |
|
| |
|
| |
|
| |
| |
(1) | 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. |
Commercial and industrial loans are loans to finance short-term and intermediate-term cash needs of businesses. Typical needs include the need to finance seasonal or other temporary cash flow imbalances, growth in working assets created by sales growth, and purchases of equipment and vehicles. Credit is extended in the form of short-term single payment loans, lines of credit for periods up to a year, revolving credit facilities for periods up to five years, and amortizing term loans for periods up to ten years.
Owner - - occupied real estate loans are loans to finance the purchase or expansion of operating facilities used by businesses not engaged in the real estate business. Typical loans are loans to finance offices, manufacturing plants, warehouse facilities, and retail shops. Depending on the property type and the borrower’s cash flows, amortization terms vary from ten years up to 20 years. Although secured by mortgages on the properties financed, these loans are underwritten based on the cash flows generated by operations of the businesses they house.
Commercial real estate loans are loans to finance real properties that are acquired, developed, or constructed for sale or lease to parties unrelated to the borrower. Included are loans to acquire land for development, land development loans, construction loans, mini-perms for cash flow stabilization periods, and permanent loans in situations where access to the secondary market is limited due to loan size.
Indirect - - sales finance loans are loans to individuals to finance the purchase of motor vehicles. They are closed at the auto dealership but approved in advance by TSFG for immediate purchase. Loans are extended on new and used
18
motor vehicles with terms varying from two years to six years. During the second quarter of 2006, TSFG sold $359.6 million of indirect auto loans.
Direct retail consumer loans are loans to individuals to finance personal, family, or household needs. Typical loans are loans to finance auto purchases, home repairs and additions, and purchases of residential lots.
Home equity loans are loans to homeowners, secured primarily by junior mortgages on their primary residences, to finance personal, family, or household needs. These loans may be in the form of amortizing loans or lines of credit with terms up to 15 years.
Mortgage loans are loans to individuals, secured by first or second mortgages on single-family residences, generally to finance the acquisition or construction of those residences. TSFG generally sells a majority of its residential mortgage loans at origination in the secondary market. TSFG also retains certain of its mortgage loans, based on predetermined criteria, in its held for investment portfolio as part of its overall balance sheet management strategy.
Table 3 sorts the commercial real estate portfolio by geography and property type. The portfolio’s most significant concentration is in commercial real estate loans. Real estate development and construction are major components of the economic activity that occurs in TSFG’s markets. By product type, commercial construction and development loans, the largest component of commercial real estate loans, represent 41.1% of the total commercial real estate loans at March 31, 2007, up from 39.4% at December 31, 2006. The risk attributable to the concentration in commercial real estate loans is managed by focusing our lending on markets with which we are familiar and on borrowers with proven track records whom we believe possess the financial means to weather adverse market conditions. Consequently, although the analysis of reserve adequacy includes an adjustment to account for the risk inherent in this concentration, management believes the loss potential in its commercial real estate loans is not materially greater than that of any other segment of the portfolio. In addition, management believes that diversification by geography, property type, and borrower partially mitigates the risk of loss in its commercial real estate loan portfolio.
19
|
Table 3 |
|
Commercial Real Estate Loans |
|
(dollars in thousands) |
| | | | | | | | | | | | | |
| | March 31, 2007 | | December 31, 2006 | |
| |
| |
| |
| | Balance | | % of
Total | | Balance | | % of
Total | |
| |
| |
| |
| |
| |
Commercial Real Estate Loans by Geographic Diversification | | | | | | | | | | | | | |
Western North Carolina (Hendersonville/Asheville) | | $ | 904,448 | | | 21.5 | % | $ | 913,742 | | | 21.9 | % |
Tampa Bay Florida | | | 561,538 | | | 13.3 | | | 562,905 | | | 13.5 | |
North Coastal South Carolina (Myrtle Beach) | | | 349,638 | | | 8.3 | | | 274,548 | | | 6.6 | |
Midlands South Carolina (Columbia) | | | 346,870 | | | 8.2 | | | 381,810 | | | 9.2 | |
Northeast Florida (Jacksonville) | | | 344,404 | | | 8.2 | | | 354,372 | | | 8.5 | |
Upstate South Carolina (Greenville) | | | 337,518 | | | 8.0 | | | 338,576 | | | 8.1 | |
North Central Florida | | | 323,369 | | | 7.7 | | | 313,009 | | | 7.5 | |
Central Florida (Orlando) | | | 289,034 | | | 6.9 | | | 279,922 | | | 6.7 | |
South Florida (Ft. Lauderdale) | | | 243,457 | | | 5.8 | | | 263,807 | | | 6.3 | |
South Coastal South Carolina (Charleston) | | | 224,676 | | | 5.3 | | | 233,834 | | | 5.6 | |
Marion County, Florida (Ocala) | | | 143,175 | | | 3.4 | | | 147,098 | | | 3.5 | |
Greater South Charlotte South Carolina (Rock Hill) | | | 141,022 | | | 3.4 | | | 108,008 | | | 2.6 | |
| |
|
| |
|
| |
|
| |
|
| |
Total commercial real estate loans | | $ | 4,209,149 | | | 100.0 | % | $ | 4,171,631 | | | 100.0 | % |
| |
|
| |
|
| |
|
| |
|
| |
|
Commercial Real Estate Loans by Product Type | | | | | | | | | | | | | |
Commercial construction/development | | $ | 1,727,974 | | | 41.1 | % | $ | 1,642,221 | | | 39.4 | % |
Mixed use | | | 437,039 | | | 10.4 | | | 441,853 | | | 10.6 | |
Other real estate structures | | | 307,436 | | | 7.3 | | | 315,785 | | | 7.6 | |
Residential construction | | | 296,209 | | | 7.0 | | | 266,779 | | | 6.4 | |
1-4 family residential investment property | | | 282,581 | | | 6.7 | | | 302,883 | | | 7.2 | |
Retail | | | 270,424 | | | 6.4 | | | 280,817 | | | 6.7 | |
Undeveloped land | | | 248,203 | | | 5.9 | | | 253,706 | | | 6.1 | |
Multi-family residential | | | 239,863 | | | 5.7 | | | 233,094 | | | 5.6 | |
Hotel/motel | | | 164,507 | | | 3.9 | | | 178,845 | | | 4.3 | |
Other(1) | | | 234,913 | | | 5.6 | | | 255,648 | | | 6.1 | |
| |
|
| |
|
| |
|
| |
|
| |
Total commercial real estate loans | | $ | 4,209,149 | | | 100.0 | % | $ | 4,171,631 | | | 100.0 | % |
| |
|
| |
|
| |
|
| |
|
| |
| |
(1) | Other includes all loans in categories smaller than the lowest percentages shown above. |
|
| Note: At March 31, 2007 and December 31, 2006, average loan size for commercial real estate loans totaled $501,000 and $478,000, respectively. |
Portfolio risk is also managed by maintaining a “house” lending limit at a level significantly lower than the legal lending limit of both Carolina First Bank and Mercantile Bank and by requiring Board of Director approval to exceed this house limit. At March 31, 2007, TSFG’s house lending limit was $35 million, and five credit relationships totaling $201.6 million were in excess of the house lending limit (but not the legal lending limit). The 20 largest credit relationships had an aggregate outstanding principal balance of $416.7 million, or 4.2% of total loans held for investment at March 31, 2007, up from 3.2% of total loans held for investment at March 31, 2006.
TSFG participates in “shared national credits” (multi-bank credit facilities of $20 million or more), primarily to borrowers who are headquartered or conduct business in or near our markets. At March 31, 2007, the loan portfolio included commitments totaling $1.0 billion in shared national credits. Outstanding borrowings under these commitments totaled $468.2 million at March 31, 2007, increasing from $413.2 million at December 31, 2006 and $237.3 million at March 31, 2006.
20
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 after-the-fact review by credit risk management of loans approved by lenders. Through daily review by credit risk managers, monthly reviews of exception reports, and ongoing analysis of asset quality trends, compliance with underwriting and loan monitoring policies is closely supervised. The administration of problem loans is driven by policies that require written plans for resolution and quarterly meetings with credit risk management to review progress. Credit risk management activities are monitored by Credit Committees of each banking subsidiary’s Board of Directors, which meet monthly to review credit quality trends, new large credits, loans to insiders, large problem credits, credit policy changes, and reports on independent credit reviews of branch offices.
Table 4 presents our credit quality indicators.
|
Table 4 |
|
Credit Quality Indicators |
|
(dollars in thousands) |
| | | | | | | | | | |
| | March 31, | | | |
| |
| | December 31, | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Loans held for investment | | $ | 9,898,134 | | $ | 9,720,891 | | $ | 9,701,867 | |
Allowance for loan losses | | | 113,736 | | | 111,219 | | | 111,663 | |
Allowance for credit losses(1) | | | 114,822 | | | 112,454 | | | 112,688 | |
| | | | | | | | | | |
Nonaccrual loans - commercial(2) | | | 36,403 | | | 28,367 | | | 28,733 | |
Nonaccrual loans - consumer | | | 4,195 | | | 3,818 | | | 5,250 | |
Nonaccrual loans - mortgage | | | 2,624 | | | 3,537 | | | 3,185 | |
Restructured loans(2) | | | — | | | — | | | — | |
| |
|
| |
|
| |
|
| |
Total nonperforming loans | | | 43,222 | | | 35,722 | | | 37,168 | |
| | | | | | | | | | |
Foreclosed property (other real estate owned and personal property repossessions) | | | 3,572 | | | 9,323 | | | 4,341 | |
| |
|
| |
|
| |
|
| |
Total nonperforming assets | | $ | 46,794 | | $ | 45,045 | | $ | 41,509 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Loans past due 90 days or more (mortgage and consumer with interest accruing)(3) | | $ | 193 | | $ | 2,369 | | $ | 3,129 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Total nonperforming assets as a percentage of loans held for investment and foreclosed property | | | 0.47 | % | | 0.46 | % | | 0.43 | % |
| |
|
| |
|
| |
|
| |
Allowance for loan losses to nonperforming loans | | | 2.63 | x | | 3.11 | x | | 3.00 | x |
| |
|
| |
|
| |
|
| |
| |
(1) | The allowance for credit losses is the sum of the allowance for loan losses and the reserve for unfunded lending commitments. |
| |
(2) | At March 31, 2007, December 31, 2006, and March 31, 2006, nonaccrual loans – commercial included $1.9 million, $500,000, and $693,000, respectively, in restructured loans. |
| |
(3) | At March 31, 2007, there were no mortgage loans past due 90 days or more still accruing interest. |
TSFG’s nonperforming asset ratio (nonperforming assets as a percentage of loans held for investment and foreclosed property) increased to 0.47% at March 31, 2007 from 0.43% at December 31, 2006 and 0.46% at March 31, 2006. Geographically, South Carolina and North Carolina nonaccrual loans increased since year-end, while Florida nonaccrual loans declined modestly since year-end.
Table 5 summarizes information on impaired loans, all of which are in nonaccrual status. All impaired loans are commercial loans. There was no recognized interest income on impaired loans.
21
|
Table 5 |
|
Impaired Loans |
|
(dollars in thousands) |
| | | | | | | | | | | | |
| | At and For the
Three Months
Ended March 31, | | At and For the
Year Ended
December 31, | |
| |
| | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Impaired loans(1) | | $ | 36,403 | | $ | 22,055 | | $ | | 28,733 | |
Average investment in impaired loans | | | 35,445 | | | 20,506 | | | | 26,331 | |
Related allowance | | | 7,716 | | | 4,904 | | | | 6,686 | |
Foregone interest | | | 882 | | | 269 | | | | 1,665 | |
| |
(1) | In second quarter 2006, TSFG enhanced its policy to include nonaccruing loans that are fully protected by collateral as impaired loans. This change increased impaired loans by $9.3 million and $6.0 million, respectively, at March 31, 2007 and December 31, 2006. |
Allowance for Loan Losses and Reserve for Unfunded Lending Commitments
The allowance for loan losses represents management’s estimate of probable incurred losses inherent in the lending portfolio. The adequacy of the allowance for loan losses (the “Allowance”) is analyzed quarterly. For purposes of this analysis, adequacy is defined as a level sufficient to absorb probable incurred losses in the portfolio as of the balance sheet date presented. 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 reviewed for impairment and impairment is measured in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan, an amendment of FASB Statements No. 5 and 15” (“SFAS 114”), and assigned specific reserves. To allow for modeling margin for imprecision, 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, loans acquired from acquisitions, 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 incurred losses inherent in the portfolio based on our analysis that are not fully captured in the allocated component. Allocation of the Allowance to respective loan portfolio components is not necessarily indicative of future losses or future allocations. The entire Allowance is available to absorb probable incurred losses in the loan portfolio.
Assessing the adequacy of the Allowance is a process that requires considerable judgment. Management’s judgments are based on numerous assumptions about current events, which we believe to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current Allowance amount or that future increases in the Allowance will not be required. No assurance can be given that management’s ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the Allowance, thus adversely affecting the operating results of TSFG.
The Allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the Allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require us to adjust our Allowance based on information available to them at the time of their examination.
22
The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to that used to determine the allowance for loan losses described above, adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.
Table 6 summarizes the changes in the allowance for loan losses, reserve for unfunded lending commitments, and allowance for credit losses and provides certain related ratios.
|
Table 6 |
|
Summary of Loan and Credit Loss Experience |
|
(dollars in thousands) |
| | | | | | | | | | |
| | At and For the
Three Months
Ended March 31, | | At and For the
Year Ended
December 31, | |
| |
| | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Allowance for loan losses, beginning of year | | $ | 111,663 | | $ | 107,767 | | $ | 107,767 | |
Allowance adjustment for loans sold | | | — | | | — | | | (3,089 | ) |
Net charge-offs: | | | | | | | | | | |
Loans charged-off | | | (8,611 | ) | | (8,873 | ) | | (36,623 | ) |
Loans recovered | | | 1,732 | | | 2,066 | | | 10,261 | |
| |
|
| |
|
| |
|
| |
| | | (6,879 | ) | | (6,807 | ) | | (26,362 | ) |
Additions to allowance through provision expense | | | 8,952 | | | 10,259 | | | 33,347 | |
| |
|
| |
|
| |
|
| |
Allowance for loan losses, end of period | | $ | 113,736 | | $ | 111,219 | | $ | 111,663 | |
| |
|
| |
|
| |
|
| |
Reserve for unfunded lending commitments, beginning of year | | $ | 1,025 | | $ | 1,583 | | $ | 1,583 | |
Provision for unfunded lending commitments | | | 61 | | | (348 | ) | | (558 | ) |
| |
|
| |
|
| |
|
| |
Reserve for unfunded lending commitments, end of period | | $ | 1,086 | | $ | 1,235 | | $ | 1,025 | |
| |
|
| |
|
| |
|
| |
Allowance for credit losses, beginning of year | | $ | 112,688 | | $ | 109,350 | | $ | 109,350 | |
Allowance adjustment for loans sold | | | — | | | — | | | (3,089 | ) |
Net charge-offs: | | | | | | | | | | |
Loans charged-off | | | (8,611 | ) | | (8,873 | ) | | (36,623 | ) |
Loans recovered | | | 1,732 | | | 2,066 | | | 10,261 | |
| |
|
| |
|
| |
|
| |
| | | (6,879 | ) | | (6,807 | ) | | (26,362 | ) |
Additions to allowance through provision expense | | | 9,013 | | | 9,911 | | | 32,789 | |
| |
|
| |
|
| |
|
| |
Allowance for credit losses, end of period | | $ | 114,822 | | $ | 112,454 | | $ | 112,688 | |
| |
|
| |
|
| |
|
| |
|
Average loans held for investment | | $ | 9,783,328 | | $ | 9,606,556 | | $ | 9,581,602 | |
Loans held for investment, end of period | | | 9,898,134 | | | 9,720,891 | | | 9,701,867 | |
Net charge-offs as a percentage of average loans held for investment (annualized) | | | 0.29 | % | | 0.29 | % | | 0.28 | % |
Allowance for loan losses as a percentage of loans held for investment | | | 1.15 | | | 1.14 | | | 1.15 | |
Allowance for credit losses as a percentage of loans held for investment | | | 1.16 | | | 1.16 | | | 1.16 | |
Allowance for loan losses to nonperforming loans | | | 2.63 | x | | 3.11 | x | | 3.00 | x |
Securities
TSFG uses the investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate and prepayment risk, to generate interest and dividend income, to provide liquidity to meet funding requirements, and to provide collateral for pledges on public deposits, FHLB advances, and securities sold under repurchase agreements. Table 7 shows the carrying values of the investment securities portfolio.
23
|
Table 7 |
|
Investment Securities Portfolio Composition |
|
(dollars in thousands) |
| | | | | | | | | | |
| | March 31, | | | |
| |
| | December 31, | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Available for Sale(at fair value) | | | | | | | | | | |
U.S. Treasury | | $ | 167,295 | | $ | 178,864 | | $ | 166,719 | |
U.S. Government agencies | | | 657,708 | | | 648,264 | | | 653,034 | |
Mortgage-backed securities | | | 1,246,384 | | | 1,603,090 | | | 1,400,288 | |
State and municipal | | | 315,372 | | | 356,057 | | | 341,488 | |
Other investments: | | | | | | | | | | |
Corporate bonds | | | 98,454 | | | 114,241 | | | 113,365 | |
Federal Home Loan Bank (“FHLB”) stock | | | 44,119 | | | 67,504 | | | 52,246 | |
Community bank stocks | | | 12,210 | | | 10,577 | | | 12,406 | |
Other equity investments | | | 4,505 | | | 3,977 | | | 3,910 | |
| |
|
| |
|
| |
|
| |
| | | 2,546,047 | | | 2,982,574 | | | 2,743,456 | |
| |
|
| |
|
| |
|
| |
Held to Maturity(at amortized cost) | | | | | | | | | | |
State and municipal | | | 46,117 | | | 57,408 | | | 52,208 | |
Other investments | | | 100 | | | 100 | | | 100 | |
| |
|
| |
|
| |
|
| |
| | | 46,217 | | | 57,508 | | | 52,308 | |
| |
|
| |
|
| |
|
| |
Total | | $ | 2,592,264 | | $ | 3,040,082 | | $ | 2,795,764 | |
| |
|
| |
|
| |
|
| |
Total securities as a percentage of total assets | | | 18.3 | % | | 21.2 | % | | 19.7 | % |
| |
|
| |
|
| |
|
| |
Percentage of Total Securities Portfolio | | | | | | | | | | |
U.S. Treasury | | | 6.5 | % | | 5.9 | % | | 6.0 | % |
U.S. Government agencies | | | 25.4 | | | 21.3 | | | 23.3 | |
Mortgage-backed securities | | | 48.1 | | | 52.7 | | | 50.1 | |
State and municipal | | | 13.9 | | | 13.6 | | | 14.1 | |
Other investments | | | 6.1 | | | 6.5 | | | 6.5 | |
| |
|
| |
|
| |
|
| |
Total | | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| |
|
| |
|
| |
|
| |
Securities (i.e., securities available for sale and securities held to maturity) excluding the unrealized loss on securities available for sale averaged $2.8 billion in the first three months of 2007, 12.2% below the average for the corresponding period in 2006 of $3.2 billion. TSFG has continued to decrease securities by not reinvesting maturing investments and principal paydowns in an effort to lower its interest rate risk in a rising rate and inverted yield curve environment and to reduce its reliance on wholesale borrowings. In addition, in first quarter 2007, TSFG sold approximately $116 million of securities available for sale to manage interest rate risk as determined by our new asset/liability management model.
The average tax-equivalent portfolio yield increased for the three months ended March 31, 2007 to 4.79% from 4.73% in the first three months of 2006.
TSFG strives to provide adequate flexibility to proactively manage cash flow as market conditions change. Cash flow may be used to pay-off borrowings, to fund loan growth, or to reinvest in securities at then current market rates.
The expected duration of the debt securities portfolio was approximately 3.8 years at March 31, 2007 and December 31, 2006, a decrease from approximately 4.3 years at March 31, 2006. If interest rates rise, the duration of the debt securities portfolio may extend. Since total securities include some callable bonds and mortgage-backed securities, security paydowns are likely to accelerate if interest rates fall.
The available for sale portfolio constituted 98.2% of total securities at March 31, 2007. Management believes that maintaining most of its securities in the available for sale category provides greater flexibility in the management of the overall investment portfolio. The majority of these securities are government or agency securities and, therefore, pose minimal credit risk. Approximately 71% of MBS are collateralized mortgage obligations (“CMOs”) with an average duration
24
of 5.5 years. At March 31, 2007, approximately 19.5% of the MBS portfolio was variable rate or hybrid variable rate, where the rate adjusts on an annual basis after a specified fixed rate period, generally ranging from three to ten years.
Changes in interest rates and related prepayment activity impact yields and fair values of TSFG’s securities. Based on the current investment portfolio composition, in a rising interest rate environment, related prepayment activity should decrease.
The net unrealized loss on securities available for sale (pre-tax) totaled $59.8 million at March 31, 2007, compared with a $75.3 million loss at December 31, 2006 and a $105.1 million loss at March 31, 2006 as long term interest rates decreased during this period and the runoff of the securities portfolio continued. If interest rates increase, TSFG expects its net unrealized loss on securities available for sale to increase. See Item 1, Note 4 to the Consolidated Financial Statements for information about TSFG’s securities in unrealized loss positions.
Community Bank Stocks. At March 31, 2007, TSFG had equity investments in 10 community banks located in the Southeast with a cost basis of $9.6 million and a market value of $12.2 million. In each case, TSFG owns less than 5% of the community bank’s outstanding common stock. These investments in community banks are included in securities available for sale.
Derivative Financial Instruments
Derivative financial instruments used by TSFG may include interest rate swaps, caps, collars, floors, options, futures and forward contracts. Derivative contracts are primarily used to hedge identified risks and also to provide risk-management products to customers. TSFG has derivatives that qualify for hedge accounting under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), derivatives that do not qualify for hedge accounting under SFAS 133 but otherwise achieve economic hedging goals (“economic hedges”), as well as derivatives that are used in customer hedging programs. See Note 5 to the Consolidated Financial Statements for disclosure of the fair value of TSFG’s derivative assets and liabilities (which are included in other assets and other liabilities, respectively, in the Consolidated Financial Statements) and their related notional amounts. TSFG’s economic hedges and customer hedging programs are included in Other Derivatives in the table in Note 5.
In the three months ended March 31, 2007 and 2006, noninterest income included a gain of $97,000 and a loss of $1.1 million, respectively, for derivative activities. These amounts include the following: the change in fair value of derivatives that do not qualify for hedge accounting under SFAS 133, as well as the net cash settlement from these interest rate swaps; hedge ineffectiveness; and other miscellaneous items.
Deposits
Deposits remain TSFG’s primary source of funds. Carolina First Bank and Mercantile Bank face strong competition from other banking and financial services companies in gathering deposits. TSFG also maintains short and long term wholesale sources including federal funds, repurchase agreements, brokered CDs, and FHLB advances to fund a portion of loan demand and, if appropriate, any increases in investment securities.
Table 8 shows the breakdown of total deposits by type of deposit and the respective percentage of total deposits.
25
|
Table 8 |
|
Type of Deposits |
|
(dollars in thousands) |
| | | | | | | | | | |
| | March 31, | | | |
| |
| | December 31, | |
| | 2007 | | 2006 | | 2006 | |
| |
| |
| |
| |
Noninterest-bearing demand deposits | | $ | 1,286,800 | | $ | 1,468,825 | | $ | 1,280,908 | |
Interest-bearing checking | | | 1,198,714 | | | 1,188,449 | | | 1,208,125 | |
Money market accounts | | | 2,374,242 | | | 2,261,672 | | | 2,435,413 | |
Savings accounts | | | 184,283 | | | 191,449 | | | 181,192 | |
| |
|
| |
|
| |
|
| |
Total core deposits | | | 5,044,039 | | | 5,110,395 | | | 5,105,638 | |
Time deposits under $100,000 | | | 1,797,170 | | | 1,381,468 | | | 1,680,878 | |
Time deposits of $100,000 or more | | | 1,132,510 | | | 1,285,048 | | | 1,105,793 | |
| |
|
| |
|
| |
|
| |
Customer deposits(1) | | | 7,973,719 | | | 7,776,911 | | | 7,892,309 | |
Brokered deposits | | | 1,977,489 | | | 1,401,771 | | | 1,624,431 | |
| |
|
| |
|
| |
|
| |
Total deposits | | | 9,951,208 | | | 9,178,682 | | | 9,516,740 | |
Less: Brokered deposits | | | (1,977,489 | ) | | (1,401,771 | ) | | (1,624,431 | ) |
Add: Customer sweeps | | | 479,698 | | | 311,992 | | | 500,288 | |
| |
|
| |
|
| |
|
| |
Customer funding(2) | | $ | 8,453,417 | | $ | 8,088,903 | | $ | 8,392,597 | |
| |
|
| |
|
| |
|
| |
Percentage of Deposits | | | | | | | | | | |
Noninterest-bearing demand deposits | | | 12.9 | % | | 16.0 | % | | 13.4 | % |
Interest-bearing checking | | | 12.0 | | | 12.9 | | | 12.7 | |
Money market accounts | | | 23.9 | | | 24.6 | | | 25.6 | |
Savings accounts | | | 1.8 | | | 2.1 | | | 1.9 | |
| |
|
| |
|
| |
|
| |
Core deposits | | | 50.6 | | | 55.6 | | | 53.6 | |
Time deposits under $100,000 | | | 18.1 | | | 15.1 | | | 17.7 | |
Time deposits of $100,000 or more | | | 11.4 | | | 14.0 | | | 11.6 | |
| |
|
| |
|
| |
|
| |
Customer deposits(1) | | | 80.1 | | | 84.7 | | | 82.9 | |
Brokered deposits | | | 19.9 | | | 15.3 | | | 17.1 | |
| |
|
| |
|
| |
|
| |
Total deposits | | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| |
|
| |
|
| |
|
| |
| |
(1) | TSFG defines customer deposits as total deposits less brokered deposits. |
|
(2) | TSFG defines customer funding as total deposits less brokered deposits plus customer sweeps. |
At March 31, 2007, period-end customer funding increased $364.5 million, or 4.5%, from March 31, 2006, primarily due to increases in time deposits and customer sweeps partially offset by a decrease in core deposits, as TSFG’s deposit mix continued to shift into higher-cost deposit categories.
TSFG uses brokered deposits as an alternative funding source while continuing its efforts to maintain and grow its local customer funding base. Brokered deposits increased as a percentage of total deposits since March 31, 2006 as TSFG replaced certain puttable funding with brokered deposits.
Table 11 in “Earnings Review - Net Interest Income” details average balances for the deposit portfolio for the three months ended March 31, 2007 and 2006. Comparing the three months ending March 31, 2007 and 2006, average customer funding increased $264.7 million, or 3.3%. As stated above, within customer funding, the mix continues to shift toward higher cost products, with increases in average money market accounts and time deposits partially offset by a decrease in noninterest-bearing deposits.
Average customer funding equaled 67.3% of average total funding in the first three months of 2007 and 63.4% in the first three months of 2006. As part of its overall funding strategy, TSFG expects to continue its focus on lowering its funding costs by trying to improve the level and mix of customer funding. TSFG attempts to enhance its deposit mix by working to attract lower-cost transaction accounts through actions such as new transaction account opening goals, differentiating pricing for promotions and specific markets, and changing incentive plans to place a greater emphasis on lower-cost customer deposit growth. Deposit pricing is very competitive, and we expect this pricing environment to continue.
26
Time deposits of $100,000 or more are generally from customers within our local markets and include public deposits. Since the first quarter of 2006, time deposits of $100,000 or more decreased $152.5 million, or 11.9%, to $1.1 billion. TSFG generally elected not to price its larger certificates of deposit aggressively, instead focusing on its smaller time deposits in an attempt to attract and retain longer-term relationships.
Borrowed Funds
Table 9 shows the breakdown of total wholesale borrowings by type.
| | | | | | | | | | |
Table 9 | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
Type of Borrowings | | | | | | | | | | |
|
|
|
|
|
|
|
|
|
|
|
(dollars in thousands) | | | | | | | | | | |
| | March 31, | | | | |
| |
| | | December 31, | |
| | 2007 | | 2006 | | 2006 | |
| |
|
| |
|
| |
|
| |
Short-Term Borrowings | | | | | | | | | | |
Federal funds purchased and repurchase agreements | | $ | 1,016,470 | | $ | 1,222,688 | | $ | 920,811 | |
Customer sweeps | | | 479,698 | | | 311,992 | | | 500,288 | |
FHLB advances | | | 75,000 | | | — | | | 175,000 | |
Commercial paper | | | 35,584 | | | 35,210 | | | 32,631 | |
Treasury, tax and loan note | | | 781 | | | 1,146 | | | 139,989 | |
| |
|
| |
|
| |
|
| |
Total short-term borrowings | | | 1,607,533 | | | 1,571,036 | | | 1,768,719 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Long-Term Borrowings | | | | | | | | | | |
Repurchase agreements | | | 200,000 | | | 821,000 | | | 521,000 | |
FHLB advances | | | 328,107 | | | 842,134 | | | 328,113 | |
Subordinated notes | | | 188,871 | | | 155,695 | | | 188,871 | |
Mandatorily redeemable preferred stock of subsidiary | | | 89,800 | | | 89,800 | | | 89,800 | |
Note payable | | | 818 | | | 856 | | | 828 | |
Employee stock ownership plan note payable | | | 125 | | | 425 | | | 200 | |
Purchase accounting premiums, net of amortization | | | 1,569 | | | 2,019 | | | 1,663 | |
| |
|
| |
|
| |
|
| |
Total long term borrowings | | | 809,290 | | | 1,911,929 | | | 1,130,475 | |
| |
|
| |
|
| |
|
| |
Total borrowings | | | 2,416,823 | | | 3,482,965 | | | 2,899,194 | |
Less: Customer sweeps | | | (479,698 | ) | | (311,992 | ) | | (500,288 | ) |
Add: Brokered deposits(1) | | | 1,977,489 | | | 1,401,771 | | | 1,624,431 | |
| |
|
| |
|
| |
|
| |
Total wholesale borrowings | | $ | 3,914,614 | | $ | 4,572,744 | | $ | 4,023,337 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Wholesale borrowings as a % of total assets | | | 27.6 | % | | 31.8 | % | | 28.3 | % |
| |
(1) | TSFG includes brokered deposits in total deposits on its consolidated balance sheet. |
TSFG uses both short-term and long-term borrowings to fund growth of earning assets in excess of deposit growth. In the first three months of 2007, average borrowings totaled $2.7 billion, compared with $3.6 billion for the same period in 2006. Average wholesale borrowings totaled $4.0 billion in the first three months of 2007, compared with $4.6 billion in the first three months of 2006. TSFG continues to reduce its reliance on wholesale borrowings by growth in customer funding and reductions in securities.
Sources including federal funds purchased and short-term brokered CDs, repurchase agreements and FHLB advances are used to satisfy daily funding needs. Balances in these accounts can fluctuate on a day-to-day basis.
FHLB advances are a source of funding that TSFG uses depending on the current level of deposits, its ability to raise deposits through market promotions, and the availability of collateral to secure FHLB borrowings.
Beginning in mid-2006, the FHLB and certain structured repurchase agreement counterparties exercised options to put certain borrowings back to TSFG. The termination of these borrowings was offset by 3 to 5-year
27
brokered certificates of deposit combined with growth in customer funding. While the decision to issue brokered CDs rather than reissue similar puttable funding increased TSFG’s current funding cost, removing the related funding optionality reduced future interest rate risk exposure. Given the current rate outlook, TSFG expects another $105 million of funding to be put back by mid-2007 and is evaluating alternatives to replace.
TSFG plans to replace approximately $120 million of trust and real estate investment trust preferred securities, which are callable during the last nine months of 2007, with more efficient sources of capital. These securities are priced at approximately 300 to 350 basis points above LIBOR. The write-off of the associated debt issuance costs, which total approximately $2 million, would offset the majority of the benefit for 2007. Subsequent to quarter-end, TSFG redeemed $29.0 million of the trust and real estate investment trust preferred shares.
Capital Resources and Dividends
Total shareholders’ equity totaled $1.6 billion, or 11.0% of total assets, at March 31, 2007 and December 31, 2006, compared with $1.5 billion, or 10.3% of total assets, at March 31, 2006. Shareholders’ equity increased from the retention of earnings and the decrease in the net unrealized loss on securities available for sale, partially offset by cash dividends paid and TSFG’s repurchase of 1 million shares in first quarter 2007. At March 31, 2007, TSFG had 3 million shares remaining under its stock repurchase authorization. Subsequent to quarter-end, TSFG repurchased an additional 1 million shares in the open market.
TSFG’s unrealized loss on securities available for sale, net of income tax, which is included in accumulated other comprehensive loss, was $37.6 million at March 31, 2007, compared with a $47.4 million loss at December 31, 2006 and a $66.1 million loss at March 31, 2006 due primarily to a decrease in long-term interest rates.
Book value per share at March 31, 2007 and 2006 was $20.91 and $19.77, respectively. Tangible book value per share at March 31, 2007 and 2006 was $11.76 and $10.54, respectively. Tangible book value was below book value as a result of the purchase premiums associated with acquisitions of entities and assets accounted for as purchases.
TSFG is subject to the risk-based capital guidelines administered by bank regulatory agencies. The guidelines are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance sheet exposure and to minimize disincentives for holding liquid assets. Under these guidelines, assets and certain off-balance sheet items are assigned to broad risk categories, each with appropriate weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and certain off-balance sheet items. TSFG and its Subsidiary Banks exceeded the well-capitalized regulatory requirements at March 31, 2007. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary actions by regulators, that, if undertaken, could have a direct material effect on our Consolidated Financial Statements.
Table 10 sets forth various capital ratios for TSFG and its Subsidiary Banks. Under current regulatory guidelines, debt associated with trust preferred securities qualifies for tier 1 capital treatment. At March 31, 2007, trust preferred securities included in tier 1 capital totaled $173.5 million, of which $4.0 million was called subsequent to quarter-end.
28
| | | | | | | |
| | March 31, 2007 | | Well
Capitalized
Requirement | |
| |
| |
| |
TSFG | | | | | | | |
Total risk-based capital | | 11.31 | % | | n/a | | |
Tier 1 risk-based capital | | 9.76 | | | n/a | | |
Leverage ratio | | 8.28 | | | n/a | | |
| | | | | | | |
Carolina First Bank | | | | | | | |
Total risk-based capital | | 11.43 | % | | 10.00 | % | |
Tier 1 risk-based capital | | 9.11 | | | 6.00 | | |
Leverage ratio | | 7.57 | | | 5.00 | | |
| | | | | | | |
Mercantile Bank | | | | | | | |
Total risk-based capital | | 12.29 | % | | 10.00 | % | |
Tier 1 risk-based capital | | 9.37 | | | 6.00 | | |
Leverage ratio | | 8.18 | | | 5.00 | | |
Subsequent to quarter-end, TSFG began the process of merging Mercantile Bank into Carolina First Bank (see “Noninterest Expenses” for further discussion). The combined bank’s capital ratios exceeded the well-capitalized regulatory requirements at March 31, 2007 on a pro-forma basis.
At March 31, 2007, TSFG’s tangible equity to tangible asset ratio totaled 6.52%, an increase from 5.77% at March 31, 2006, due primarily to a decrease in tangible assets attributable to the continued runoff of securities since first quarter 2006, as well as a decrease in the unrealized loss on securities available for sale. If interest rates increase, TSFG expects its unrealized loss on securities available for sale to increase, leading to a lower tangible equity to tangible asset ratio.
TSFG’s Subsidiary Banks are subject to certain regulatory restrictions on the amount of dividends they are permitted to pay. TSFG has paid a cash dividend each quarter since the initiation of cash dividends on February 1, 1994. TSFG presently intends to pay a quarterly cash dividend on its common stock; however, future dividends will depend upon TSFG’s financial performance and capital requirements.
TSFG, through a real estate investment trust subsidiary, had 898 mandatorily redeemable preferred shares outstanding at March 31, 2007 with a stated value of $100,000 per share. At March 31, 2007, these preferred shares, which are reported as long-term debt on the consolidated balance sheet, totaled $89.9 million. Under Federal Reserve Board guidelines, $26.3 million qualified as tier 1 capital, and $53.5 million qualified as tier 2 capital. The terms for the preferred shares include certain asset coverage and cash flow tests, which if not satisfied, may prohibit TSFG’s real estate trust subsidiary from paying dividends to Carolina First Bank, which in turn may limit its ability to pay dividends to TSFG. Subsequent to quarter-end, TSFG redeemed $25.0 million of the preferred shares.
Earnings Review
Net Interest Income
Net interest income is TSFG’s primary source of revenue. Net interest income is the difference between the interest earned on assets, including loan fees and dividends on investment securities, and the interest incurred for the liabilities to support such assets. The net interest margin measures how effectively a company manages the difference between the yield on earning assets and the rate incurred on funds used to support those assets. Fully tax-equivalent net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis based on a 35% marginal federal income tax rate. Table 11 presents average balance sheets and a net interest income analysis on a tax-equivalent basis for the three months ended March 31, 2007 and 2006.
29
| | | | | | | | | | | | | | | | | | | |
Table 11 |
|
Comparative Average Balances - Yields and Costs |
|
(dollars in thousands) | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended March 31, | |
| |
| |
| | 2007 | | 2006 | |
| |
| |
| |
| | Average | | Income/ | | Yield/ | | Average | | Income/ | | Yield/ | |
| | Balance | | Expense | | Rate | | Balance | | Expense | | Rate | |
| |
| |
| |
| |
| |
| |
| |
Assets | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Earning assets | | | | | | | | | | | | | | | | | | | |
Loans(1) | | $ | 9,813,010 | | $ | 186,628 | | | 7.71 | % | $ | 9,630,573 | | $ | 169,188 | | | 7.12 | % |
Investment securities, taxable(2) | | | 2,414,896 | | | 28,825 | | | 4.78 | | | 2,752,345 | | | 32,543 | | | 4.73 | |
Investment securities,
nontaxable(2) (3) | | | 383,804 | | | 4,689 | | | 4.89 | | | 434,980 | | | 5,145 | | | 4.73 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total investment securities | | | 2,798,700 | | | 33,514 | | | 4.79 | | | 3,187,325 | | | 37,688 | | | 4.73 | |
Federal funds sold and interest-bearing bank balances | | | 8,331 | | | 141 | | | 6.86 | | | 21,509 | | | 292 | | | 5.51 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total earning assets | | | 12,620,041 | | $ | 220,283 | | | 7.06 | | | 12,839,407 | | $ | 207,168 | | | 6.53 | |
| | | | |
|
| | | | | | | |
|
| | | | |
Non-earning assets | | | 1,528,013 | | | | | | | | | 1,527,849 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total assets | | $ | 14,148,054 | | | | | | | | $ | 14,367,256 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders’ Equity | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits | | | | | | | | | | | | | | | | | | | |
Interest-bearing checking | | $ | 1,187,239 | | $ | 5,935 | | | 2.03 | | $ | 1,140,738 | | $ | 4,406 | | | 1.57 | |
Savings | | | 178,940 | | | 706 | | | 1.60 | | | 191,613 | | | 308 | | | 0.65 | |
Money market | | | 2,377,771 | | | 23,537 | | | 4.01 | | | 2,215,043 | | | 16,345 | | | 2.99 | |
Time deposits, excluding brokered deposits | | | 2,893,638 | | | 35,581 | | | 4.99 | | | 2,778,587 | | | 26,031 | | | 3.80 | |
Brokered deposits | | | 1,771,081 | | | 22,720 | | | 5.20 | | | 1,373,199 | | | 15,389 | | | 4.54 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total interest-bearing deposits | | | 8,408,669 | | | 88,479 | | | 4.27 | | | 7,699,180 | | | 62,479 | | | 3.29 | |
Customer sweeps | | | 453,928 | | | 4,981 | | | 4.45 | | | 299,894 | | | 2,889 | | | 3.91 | |
Other borrowings | | | 2,270,120 | | | 30,644 | | | 5.47 | | | 3,272,395 | | | 37,087 | | | 4.60 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total interest-bearing liabilities | | | 11,132,717 | | $ | 124,104 | | | 4.52 | | | 11,271,469 | | $ | 102,455 | | | 3.69 | |
| | | | |
|
| | | | | | | |
|
| | | | |
Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing deposits | | | 1,230,320 | | | | | | | | | 1,431,304 | | | | | | | |
Other noninterest-bearing liabilities | | | 233,248 | | | | | | | | | 176,487 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total liabilities | | | 12,596,285 | | | | | | | | | 12,879,260 | | | | | | | |
Shareholders’ equity | | | 1,551,769 | | | | | | | | | 1,487,996 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total liabilities and shareholders’ equity | | $ | 14,148,054 | | | | | | | | $ | 14,367,256 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Net interest income (tax-equivalent) | | | | | $ | 96,179 | | | 3.08 | % | | | | $ | 104,713 | | | 3.29 | % |
Less: tax-equivalent adjustment(3) | | | | | | 1,641 | | | | | | | | | 1,801 | | | | |
| | | | |
|
| | | | | | | |
|
| | | | |
Net interest income | | | | | $ | 94,538 | | | | | | | | $ | 102,912 | | | | |
| | | | |
|
| | | | | | | |
|
| | | | |
| | | | | | | | | | | | | | | | | | | |
Supplemental data: | | | | | | | | | | | | | | | | | | | |
Customer funding (4) | | $ | 8,321,836 | | $ | 70,740 | | | 3.45 | % | $ | 8,057,179 | | $ | 49,979 | | | 2.52 | % |
Wholesale borrowings (5) | | | 4,041,201 | | | 53,364 | | | 5.36 | | | 4,645,594 | | | 52,476 | | | 4.58 | |
Total funding (6) | | | 12,363,037 | | | 124,104 | | | 4.07 | | | 12,702,773 | | | 102,455 | | | 3.27 | |
| |
(1) | Nonaccrual loans are included in average balances for yield computations. |
|
(2) | The average balances for investment securities exclude the unrealized loss recorded for available for sale securities. |
|
(3) | The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. |
| |
(4) | Customer funding includes total deposits (total interest-bearing plus noninterest-bearing deposits) less brokered deposits plus customer sweeps. |
| |
(5) | Wholesale borrowings include borrowings less customer sweeps plus brokered deposits. For purposes of this table, wholesale borrowings equal the sum of other borrowings and brokered deposits, as customer sweeps are presented separately. |
| |
(6) | Total funding includes customer funding and wholesale borrowings. |
| |
Note: Average balances are derived from daily balances. |
30
Fully tax-equivalent net interest income decreased 8.1% to $96.2 million for the first three months of 2007 from $104.7 million for the first three months of 2006. TSFG’s average earning assets declined 1.7% to $12.6 billion for first quarter 2007 from $12.8 billion for first quarter 2006 due primarily to the continued securities runoff and the second quarter 2006 sale of indirect loans, partially offset by organic loan growth. As a result, average loans as a percentage of average earning assets increased to 77.8% for first quarter 2007, up from 75.0% for first quarter 2006, improving the earning asset mix. At March 31, 2007, approximately 61% of TSFG’s accruing loans were variable rate loans, the majority of which are tied to the prime rate. TSFG has entered into receive-fixed interest rate swaps to hedge the forecasted interest income from certain prime-based commercial loans as part of its overall interest rate risk management. TSFG also has an interest rate floor that is designated as a hedge of commercial loans and is intended to mitigate earnings exposure to falling interest rates.
The net interest margin for first quarter 2007 was 3.08%, compared with 3.29% for first quarter 2006. The yield on average earning assets increased 53 basis points, aided by improved loan yields, which were up 59 basis points. However, the improved yield on earning assets was more than offset by an 80 basis point increase in the average cost of funding. This margin compression reflects an ongoing change in industry trends, including customer preferences for higher-cost deposit categories, higher wholesale borrowing costs, and a continued challenging interest rate environment, as well as TSFG’s decision to replace puttable funding since mid-2006 with higher-cost short-term borrowings and brokered deposits.
Provision for Credit Losses
The provision for credit losses is recorded in amounts sufficient to bring the allowance for loan losses and the reserve for unfunded lending commitments to a level deemed appropriate by management. Management determines this amount based upon many factors, including its assessment of loan portfolio quality, loan growth, changes in loan portfolio composition, net loan charge-off levels, and expected economic conditions. The provision for credit losses was $9.0 million and $9.9 million in the first three months of 2007 and 2006, respectively. The lower provision for credit losses was primarily attributable to slower loan growth.
Net loan charge-offs were $6.9 million, or 0.29% of average loans held for investment, for the first three months of 2007, compared with $6.8 million, or 0.29% of average loans held for investment, for the first three months of 2006. The allowance for credit losses equaled 1.16% of loans held for investment as of March 31, 2007, December 31, 2006, and March 31, 2006. See “Loans,” “Credit Quality,” and “Allowance for Loan Losses and Reserve for Unfunded Lending Commitments.”
31
Noninterest Income
Table 12 shows the components of noninterest income.
|
Table 12 |
|
Components of Noninterest Income |
|
(dollars in thousands) |
| | | | | | | |
| | Three Months Ended
March 31, | |
| |
| |
| | 2007 | | 2006 | |
| |
| |
| |
Service charges on deposit accounts | | $ | 10,613 | | $ | 11,288 | |
Debit card income | | | 2,177 | | | 1,921 | |
Customer service fee income | | | 1,291 | | | 1,009 | |
| |
|
| |
|
| |
Total customer fee income | | | 14,081 | | | 14,218 | |
| |
|
| |
|
| |
| | | | | | | |
Insurance income | | | 3,297 | | | 2,977 | |
Retail investment services | | | 1,958 | | | 2,023 | |
Trust and investment management income | | | 1,594 | | | 1,457 | |
Benefits administration fees | | | 742 | | | 667 | |
| |
|
| |
|
| |
Total wealth management income | | | 7,591 | | | 7,124 | |
| |
|
| |
|
| |
| | | | | | | |
Merchant processing income | | | 3,755 | | | 2,686 | |
Bank-owned life insurance income | | | 2,851 | | | 2,819 | |
Mortgage banking income | | | 2,069 | | | 1,884 | |
Gain (loss) on certain derivative activities | | | 97 | | | (1,125 | ) |
(Loss) gain on sale of securities available for sale | | | (1,385 | ) | | 675 | |
Other | | | 1,785 | | | 1,039 | |
| |
|
| |
|
| |
Total noninterest income | | $ | 30,844 | | $ | 29,320 | |
| |
|
| |
|
| |
Total customer fee income decreased 1.0% in the first three months of 2007 compared to the same period in 2006. Service charges on deposit accounts, the largest component of customer fee income, decreased 6.0% during the first three months of 2007 compared to the first three months of 2006 due primarily to lower nonsufficient funds charges and returned check fees. This decrease was driven by lower service chargeable balances and customer convenience initiatives, including longer branch hours and all day deposit credit.
In the first three months of 2007 compared with the corresponding period in 2006, wealth management income increased $467,000, or 6.6%, primarily due to an increase in insurance income driven by higher contingency fee income, which is generally earned during the first the quarter of the year.
Noninterest income also included a gain on derivative activities of $97,000 in the first three months of 2007 compared with a loss of $1.1 million in the first quarter of 2006.
For first quarter 2007, mortgage banking income increased 9.8%, compared with the same period in 2006. The year over year comparison was positively affected by the second quarter 2006 sale of the mortgage servicing rights portfolio, which had a $208,000 loss in first quarter 2006. Mortgage loans originated by TSFG originators totaled $152.7 million and $189.0 million in first quarter 2007 and 2006, respectively.
Merchant processing income increased 39.8% in the first three months of 2007 compared to the same period in 2006 as a result of increased transactions. (See “Noninterest Expenses” for merchant processing expense, which increased 39.5%.)
Net losses on securities totaled $1.4 million for first quarter 2007 compared to a net gain of $675,000 for first quarter 2006. In first quarter 2007, TSFG sold approximately $116 million of securities available for sale to manage interest rate risk as determined by our new asset/liability management model.
32
Noninterest Expenses
Table 13 shows the components of noninterest expenses.
|
Table 13 |
|
Components of Noninterest Expenses |
|
(dollars in thousands) |
| | | | | | | |
| | Three Months Ended
March 31, | |
| |
| |
| | 2007 | | 2006 | |
| |
| |
| |
Salaries and wages, excluding contract buyouts and severance | | $ | 35,072 | | $ | 31,456 | |
Employment contract buyouts and severance | | | 1,760 | | | 598 | |
| |
|
| |
|
| |
Total salaries and wages | | | 36,832 | | | 32,054 | |
| |
|
| |
|
| |
Employee benefits | | | 9,759 | | | 9,029 | |
Occupancy | | | 8,608 | | | 7,313 | |
Furniture and equipment | | | 6,462 | | | 5,952 | |
Professional services | | | 4,103 | | | 5,779 | |
Merchant processing expense | | | 3,020 | | | 2,165 | |
Amortization of intangibles | | | 2,001 | | | 2,207 | |
Advertising and business development | | | 1,931 | | | 2,506 | |
Telecommunications | | | 1,393 | | | 1,418 | |
Other | | | 11,242 | | | 11,411 | |
| |
|
| |
|
| |
Total noninterest expenses | | $ | 85,351 | | $ | 79,834 | |
| |
|
| |
|
| |
In first quarter 2007, TSFG implemented an expense reduction initiative, the goal of which is to reduce annual expenses by approximately $20 million from the fourth quarter 2006 run rate. Although many of these initiatives were in place at the end of first quarter 2007, certain staff reductions which were effective in late February and early March had less than one complete month of impact on the first quarter 2007 results.
On May 9, 2007, Carolina First Bank filed an application with the FDIC and the South Carolina Department of Banking to merge Mercantile Bank into Carolina First Bank. It is contemplated that the former operations of Mercantile Bank will continue to operate under the brand name Mercantile Bank in Florida, albeit as a division of Carolina First Bank. The merger is expected to close at the end of the second quarter 2007. The merger was considered in TSFG’s expense reduction initiative; however, TSFG does not expect to realize the full benefit of the merger until system conversion and full integration are accomplished in late 2007 or early 2008.
Salaries and wages (excluding contract buyouts and severance) and employee benefits increased $4.3 million, or 10.7%, in the first three months of 2007 compared with the same period in 2006, despite the fact that full-time equivalent employees as of March 31, 2007 decreased slightly to 2,516 from 2,526 at March 31, 2006. In addition to normal annual salary increases, TSFG has invested in several key hires in an effort to strengthen its management team and has incurred additional salary expense in order to attract and retain this talent. The increase in personnel expense was also affected by higher incentive expense under TSFG’s LTIP as a result of service awards approved by the board of directors during the second and third quarters of 2006. The discretionary nature of certain incentive plans and accruals may result in increased volatility in personnel expense in future periods, based on management’s assessment of the probability that certain performance targets will be met.
Occupancy and furniture and equipment expense increased 13.6% for the first three months of 2007 compared with the corresponding period in 2006 due primarily to increased rent expense. The increase in merchant processing expense of 39.5% was in line with the increase in merchant processing income. Professional services decreased by 29.0% for first quarter of 2007 compared with first quarter of 2006. In first quarter of 2006, professional services included outsourcing costs for internal audit projects which are now handled by TSFG’s staff. In addition, advertising and business development and telecommunications decreased for the first three months of 2007 compared to the first three months of 2006 due to the aforementioned expense reduction initiatives implemented in first quarter of 2007.
33
Income Taxes
The effective income tax rate as a percentage of pretax income was 33.9% for the first three months of 2007 and 34.6% for the first three months of 2006. The blended statutory federal and state income tax rate was approximately 37% for both of these periods.
Enterprise Risk Management
There have been no significant changes to the discussion of Enterprise Risk Management, including Market Risk and Asset/Liability Management, Derivatives and Hedging Activities, Economic Risk, Credit Risk, Liquidity Risks, Operational Risk, and Compliance and Litigation Risks, as presented in pages 55 through 60 of TSFG’s Annual Report on Form 10-K for the year ended December 31, 2006.
Interest Sensitivity Analysis. As discussed on page 56 of TSFG’s 2006 Form 10-K, TSFG uses a simulation model to analyze various interest rate scenarios in order to monitor interest rate risk. The information presented in Tables 14 and 15 are not projections, and are presented with static balance sheet positions. This methodology allows for an analysis of our inherent risk associated with changes in interest rates. There are some similar assumptions used in both Table 14 and 15. These include, but are not limited to, the following:
| | |
| • | interest rate scenarios that assume an instantaneous and parallel change in interest rates along the entire yield curve; |
| | |
| • | a static balance sheet for net income analysis; |
| | |
| • | as assets and liabilities mature or reprice they are reinvested at current rates and keep the same characteristics (i.e., remain as either variable or fixed rate) for net income analysis; |
| | |
| • | mortgage backed securities prepayments are based on historical industry data; |
| | |
| • | loan prepayments are based upon historical bank-specific analysis and historical industry data; |
| | |
| • | deposit retention and average lives are based on historical bank-specific analysis; |
| | |
| • | whether callable/puttable assets and liabilities are called/put are based on the implied forward yield curve for each interest rate scenario; and |
| | |
| • | management takes no action to counter any change. |
Table 14 reflects the sensitivity of net income to changes in interest rates. It shows the effect that the indicated changes in interest rates would have on net income over the next 12 months compared with the base case or flat interest rate scenario. The base case or flat scenario assumes interest rates stay at March 31, 2007 and 2006 levels, respectively.
|
Table 14 |
|
Net Income at Risk Analysis |
|
| | | | | | | | | | | | |
| | | Annualized Hypothetical Percentage Change in
Net Income | |
| | |
| |
Interest Rate Scenario | | | Gradual Rate Change
March 31, | | Immediate Rate Change
March 31, | |
| |
| |
|
|
|
| |
| | | 2007 | | | 2007 | | 2006 | |
| | |
| |
|
| |
| |
| 2.00%(1) | | (0.8 | ) % | | | (6.0 | ) % | | 5.5 | % | |
| 1.00 (1) | | (0.3 | ) | | | (2.2 | ) | | 3.2 | | |
| Flat | | — | | | | — | | | — | | |
| (1.00) (1) | | 0.7 | | | | 0.1 | | | (4.8 | ) | |
| (2.00) (1) | | 1.4 | | | | (3.9 | ) | | (20.0 | ) | |
| |
(1) | For March 31, 2006, the rising 100 and 200 basis points and falling 100 and 200 basis points interest rate scenarios assume an immediate and parallel change in interest rates along the entire yield curve. For March 31, 2007, net income sensitivity is shown for both immediate and gradual rate shifts over a 12 month period. For future periods, management’s primary focus regarding net income sensitivity will be on gradual rate shifts, which TSFG views as providing a more realistic assessment of potential risk exposures. |
34
Table 15 reflects the sensitivity of the economic value of equity (“EVE”) to changes in interest rates. EVE is a measurement of the inherent, long-term balance sheet-related economic value of TSFG (defined as the fair value of all assets minus the fair value of all liabilities and their associated off balance sheet amounts) at a given point in time. Table 15 shows the effect that the indicated changes in interest rates would have on the fair value of net assets at March 31, 2007 and 2006, respectively, compared with the base case or flat interest rate scenario. The base case scenario assumes interest rates stay at March 31, 2007 and 2006 levels, respectively.
|
Table 15 |
|
Economic Value of Equity Risk Analysis |
|
| | | | | | | | |
Interest Rate Scenario | | | Annualized Hypothetical Percentage Change in
Economic Value of Equity
March 31, | |
| | |
|
|
| |
| | 2007 | | 2006 | |
| |
| |
| |
| 2.00%(1) | | (11.8 | ) % | | (5.9 | ) % | |
| 1.00%(1) | | (5.3 | ) | | (1.9 | ) | |
| Flat | | — | | | — | | |
| (1.00)%(1) | | 1.4 | | | (2.7 | ) | |
| (2.00)%(1) | | (3.4 | ) | | (11.8 | ) | |
| |
(1) | The rising 100 and 200 basis point and falling 100 and 200 basis point interest rate scenarios assume an instantaneous and parallel change in interest rates along the entire yield curve. |
The improved net income at risk profile over the past year is due primarily to the reduction in investment securities and wholesale borrowings during the fourth quarter 2005, continued securities runoff in 2006, the replacement of recently terminated puttable funding with non-puttable borrowings, and a 2006 interest rate floor purchase. During fourth quarter 2006, we successfully converted to a more advanced asset/liability management system, which will enhance our ability to measure and manage interest rate risk and liquidity risk. In addition, TSFG continually refines the modeling process through the use of more precise model assumptions. Since March 31, 2006, assumptions related to such areas as loan prepayments and average non-maturity deposit lives were updated.
There are material limitations with TSFG’s models presented in Tables 14 and 15, which include, but are not limited to, the following:
| | |
| • | the flat scenarios are base case and are not indicative of historical results; |
| | |
| • | they do not project an increase or decrease in net income or the fair value of net assets, but rather the risk to net income and the fair value of net assets because of changes in interest rates; |
| | |
| • | they present the balance sheet in a static position; however, when assets and liabilities mature or reprice, they do not necessarily keep the same characteristics (e.g., variable or fixed interest rate); |
| | |
| • | the computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results; and |
| | |
| • | the computations do not contemplate any additional actions TSFG could undertake in response to changes in interest rates. |
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.
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. TSFG estimates probable losses related to binding unfunded lending commitments and records a
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reserve for unfunded lending commitments in other liabilities on the consolidated balance sheet. See Note 6 to the Consolidated Financial Statements for disclosure of the amounts of lending commitments.
Derivatives. In accordance with SFAS 133, TSFG records derivatives at fair value, as either assets or liabilities, on the consolidated balance sheets. 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.
See “Derivative Financial Instruments” under “Balance Sheet Review” and Note 5 to the Consolidated Financial Statements for additional information regarding derivatives.
Liquidity
Liquidity management ensures that adequate funds are available to meet deposit withdrawals, fund loan and capital expenditure commitments, maintain reserve requirements, pay operating expenses, provide funds for dividends and debt service, manage operations on an ongoing basis, and capitalize on new business opportunities. Funds are primarily provided by the Subsidiary Banks through customer funding, wholesale borrowings, principal and interest payments on loans, loan sales, sales of securities available for sale, maturities and paydowns of securities, 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 significant portion of TSFG’s securities are pledged as collateral for FHLB borrowings, repurchase agreements and public funds deposits. Management believes that cash flows from investments, in addition to its available borrowing capacity and efforts to grow deposits, are sufficient to provide the necessary funding for the remainder of 2007.
In managing its liquidity needs, TSFG focuses on its existing assets and liabilities, as well as its ability to enter into additional borrowings, and on the manner in which they combine to provide adequate liquidity to meet our needs. Table 16 summarizes future contractual obligations based on maturity dates as of March 31, 2007. Table 16 does not include payments which may be required under employment and deferred compensation agreements. In addition, Table 16 does not include payments required for interest and income taxes (see Item 1, Consolidated Statements of Cash Flows for details on interest and income taxes paid for the three months ended March 31, 2007).
|
Table 16 |
|
Contractual Obligations |
|
(dollars in thousands) |
| | | | | | | | | | | | | | | | |
| | Payments Due by Period | |
| |
| |
| | Total | | Remainder
of
2007 | | 2008
and
2009 | | 2010
and
2011 | | After
2011 | |
| |
| |
| |
| |
| |
| |
Time deposits | | $ | 4,907,169 | | $ | 2,671,660 | | $ | 781,137 | | $ | 612,639 | | $ | 841,733 | |
Short-term borrowings | | | 1,607,533 | | | 1,607,533 | | | — | | | — | | | — | |
Long-term debt | | | 807,721 | | | 177 | | | 182,954 | | | 65,180 | | | 559,410 | |
Operating leases | | | 190,521 | | | 14,184 | | | 36,221 | | | 27,390 | | | 112,726 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total contractual obligations | | $ | 7,512,944 | | $ | 4,293,554 | | $ | 1,000,312 | | $ | 705,209 | | $ | 1,513,869 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Net cash provided by operations and deposits from customers have been the primary sources of liquidity for TSFG. TSFG is focusing additional efforts aimed at acquiring new deposits through the Subsidiary Banks’ established branch network to enhance liquidity and reduce reliance on wholesale borrowing. 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 the ability to borrow from the FHLB and maintain short-term lines of credit from unrelated banks. FHLB advances outstanding as of March 31, 2007 totaled $403.1 million. At March 31, 2007, the Subsidiary Banks had $49.9 million of unused borrowing capacity from the FHLB. TSFG funds its short-term needs principally with deposits, including brokered deposits, federal funds purchased, repurchase agreements, FHLB advances, treasury tax and loan notes, and the principal runoff of investment securities. At March 31, 2007, the Subsidiary Banks had unused short-term lines of credit totaling $1.9 billion (which may be canceled at the lender’s option).
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The Federal Reserve Bank provides back-up funding for commercial banks. Collateralized borrowing relationships with the Federal Reserve Banks of Richmond and Atlanta are in place for the Subsidiary Banks to meet emergency funding needs. At March 31, 2007, the Subsidiary Banks had qualifying collateral to secure advances up to $1.8 billion, of which none was outstanding.
At March 31, 2007, the parent company had three unused short-term lines of credit totaling $35.0 million. These lines of credit mature May 14, 2007 for $15.0 million, June 30, 2007 for $10.0 million, and November 14, 2007 for $10.0 million.
TSFG, principally through the Subsidiary Banks, enters into agreements in the normal course of business to extend credit to meet the financial needs of its customers. For amounts and types of such agreements at March 31, 2007, see “Off-Balance Sheet Arrangements.” Increased demand for funds under these agreements would reduce TSFG’s available liquidity and could require additional sources of liquidity.
Recently Adopted/Issued Accounting Pronouncements
See Note 1 – Recently Adopted Accounting Pronouncements and Recently Issued Accounting Pronouncements in the accompanying Notes to the Consolidated Financial Statements for details of recently adopted and recently issued accounting pronouncements and their expected impact on the Company’s Consolidated Financial Statements.
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Item 3. | Quantitative and Qualitative Disclosures about Market Risk |
See “Enterprise Risk 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.
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Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
At March 31, 2007, TSFG’s management, under the supervision and with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated its disclosure controls and procedures as currently in effect. Based on this evaluation, TSFG’s management concluded that as of March 31, 2007, TSFG’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by TSFG in the reports filed or submitted by it under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by TSFG in such reports is accumulated and communicated to TSFG’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Controls over Financial Reporting
TSFG continually assesses the adequacy of its internal control over financial reporting quarterly and strives to enhance its controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in TSFG’s internal control over financial reporting identified in connection with the evaluation described in the immediately preceding paragraph during the quarter ended March 31, 2007 or through the date of this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, TSFG’s internal control over financial reporting.
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PART II. OTHER INFORMATION
See Note 6 to the Consolidated Financial Statements for a discussion of legal proceedings.
There have been no material changes to the risk factors previously disclosed under Item 1A (pages 10-12) of TSFG’s Annual Report on Form 10-K for the year ended December 31, 2006.
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Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
TSFG has repurchased shares of our common stock in private transactions and open-market purchases, as authorized by our Board. The amount and timing of stock repurchases will be based on factors, including but not limited to, management’s assessment of TSFG’s capital structure and liquidity, the market price of TSFG’s common stock compared to management’s assessment of the stocks underlying value, and applicable regulatory, legal, and accounting matters. The following table presents information about our stock repurchases for the three months ended March 31, 2007.
| | | | | | | | | | | | | |
| | Issuer Purchases of Equity Securities | | | | |
| | | | | | | | | | | | | |
Period | | Total
Number
of Shares
Purchased | | Average
Price
Paid per
Share | | Total
Number of
Shares Purchased
as Part
of Publicly
Announced Plans
or Programs | | Maximum
Number of
Shares that
May Yet Be
Purchased
Under Plans or
Programs (2) | |
| |
| |
| |
| |
| |
January 1, 2007 to January 31, 2007 | | | 1,030,644 | (1) | $ | 26.00 | | | 1,000,000 | | | 3,000,000 | |
February 1, 2007 to February 28, 2007 | | | 487 | (1) | | 26.78 | | | — | | | 3,000,000 | |
March 1, 2007 to March 31, 2007 | | | 837 | (1) | | 25.51 | | | — | | | 3,000,000 | |
| |
|
| |
|
| |
|
| |
|
| |
Total | | | 1,031,968 | | $ | 26.00 | | | 1,000,000 | | | 3,000,000 | |
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|
| |
|
| |
|
| |
|
| |
| |
(1) | Includes 30,644 shares in January, 487 shares in February, and 837 shares in March canceled in connection with exercise of options or vesting of restricted stock. Pursuant to TSFG’s stock option plans, participants may exercise stock options by surrendering shares of TSFG common stock the participants already own as payment of the option exercise price. Pursuant to TSFG’s restricted stock plans, participants may tender shares of vested restricted stock as payment for taxes due at the time of vesting. Shares surrendered by participants of these plans are repurchased pursuant to the terms of the applicable stock option or restricted stock plan and not pursuant to publicly announced share repurchase programs. |
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(2) | In December of 2006, TSFG announced a stock repurchase program authorizing TSFG to repurchase up to 4 million shares of its common stock. This authorization replaced TSFG’s existing stock repurchase authorizations. This stock repurchase program has no expiration date and will expire upon completion of repurchases totaling the amount authorized to repurchase. Subsequent to quarter-end, TSFG repurchased an additional 1 million shares of its common stock in the open market at an average price per share of $23.07. As of the filing of this Form 10-Q, there were 2 million shares remaining under the authorization. |
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Item 3. | Defaults upon Senior Securities |
None.
| |
Item 4. | Submission of Matters to a Vote of Securities Holders |
None.
None.
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| |
Item 6. | Exhibits |
| |
10.1 | Form of Award Agreement for 2007-2009 Period of the TSFG Long Term Incentive Plan |
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31.1 | Certificate of the Principal Executive Officer pursuant to Rule 13a-14a/15(d)-14(a) of Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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31.2 | Certificate of the Principal Financial Officer pursuant to Rule 13a-14a/15(d)-14(a) of Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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32.1+ | Certificate of Chief Executive Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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32.2+ | Certificate of Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
+ This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
Note for non-filed versions of this Form 10-Q
The above exhibits may be found on TSFG’s electronic filing of its March 31, 2007 Quarterly Report on Form 10-Q with the Securities and Exchange Commission (“SEC”) and is accessible at no cost on TSFG’s web site, www.thesouthgroup.com, through the Investor Relations link. TSFG’s SEC filings are also available through the SEC’s web site at www.sec.gov.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, TSFG has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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| The South Financial Group, Inc. |
| |
Date: May 9, 2007 | /s/ James R. Gordon |
|
|
| James R. Gordon |
| Executive Vice President and Chief Financial Officer |
| (Principal Accounting and Financial Officer) |
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