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| • | deposit growth, change in the mix or type of deposit products, and cost of deposits; |
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| • | loss of deposits due to perceived capital weakness or otherwise; |
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| • | availability of wholesale funding; |
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| • | adequacy of capital and future capital needs; |
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| • | fluctuations in consumer spending; |
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| • | competition in the banking industry and demand for our products and services; |
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| • | continued availability of senior management; |
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| • | technological changes; |
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| • | ability to increase market share; |
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| • | income and expense projections, ability to control expenses, and expense reduction initiatives; |
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| • | changes in the compensation, benefit, and incentive plans, including compensation accruals; |
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| • | risks associated with income taxes, including the potential for adverse adjustments; |
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| • | acquisitions, greater than expected deposit attrition or customer loss, inaccuracy of related cost savings estimates, inaccuracy of estimates of financial results, and unanticipated integration issues; |
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| • | valuation of goodwill and intangibles and any potential future impairment; |
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| • | significant delay or inability to execute strategic initiatives designed to grow revenues; |
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| • | changes in management’s assessment of and strategies for lines of business, asset, and deposit categories; |
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| • | changes in accounting policies and practices; |
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| • | changes in the evaluation of the effectiveness of our hedging strategies; |
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| • | changes in regulatory actions, including the potential for adverse adjustments; |
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| • | changes, costs, and effects of litigation, and environmental remediation; and |
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| • | recently-enacted or proposed legislation. |
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. In discussing its deposits, TSFG presents information summarizing its funding generated by customers using the following definitions: “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 sweep accounts. TSFG also discusses its funding generated from non-customer sources using the following definition: “wholesale borrowings,” which are defined by TSFG as short-term and long-term borrowings less customer sweep accounts plus brokered deposits. Management believes that these presentations of “customer deposits,” “customer funding,” and “wholesale borrowings” aid in the identification of funding generated by its lines of business versus its treasury department. 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 bank holding company, headquartered in Greenville, South Carolina, with $13.7 billion in total assets and 180 branch offices in South Carolina, Florida, and North Carolina at September 30, 2008.
Founded in 1986, TSFG focuses on attractive Southeastern banking markets with long-term growth potential. TSFG operates Carolina First Bank, which conducts banking operations in North Carolina and South Carolina (as Carolina First Bank), in Florida (as Mercantile Bank), and on the Internet (as Bank Caroline). At September 30, 2008, approximately 45% of TSFG’s customer deposits (total deposits less brokered deposits) were in South Carolina, 41% were in Florida, and 14% were in North Carolina.
TSFG uses a super-community bank strategy and targets small business, middle market companies and retail consumers. As a super-community bank, TSFG strives to combine 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 a net loss of $237.2 million, or $3.43 per diluted share, for the first nine months of 2008, compared with net income of $64.3 million, or $0.86 per diluted share, for the first nine months of 2007. The net loss was primarily due to a $221.7 million provision for credit losses resulting from continued credit deterioration, particularly in the Florida market, and a $188.4 million goodwill impairment charge resulting from a decrease in value of the Florida banking segment.
At September 30, 2008, nonperforming assets as a percentage of loans and foreclosed property increased to 2.83% from 0.88% at December 31, 2007 and 0.58% at September 30, 2007. The increase in nonperforming assets was primarily attributable to accelerating deterioration in residential construction and development-related loans, principally in Florida markets. For the nine months ended September 30, 2008, annualized net loan charge-offs totaled 1.90% of average loans held for investment, compared to 0.53% for the year ended December 31, 2007, and 0.39% for the nine months ended September 30, 2007. TSFG’s provision for credit losses increased to $221.7 million for the first nine months of 2008 compared to $36.6 million for the first nine months of 2007.
In order to strengthen its capital and liquidity position, TSFG issued $250.0 million of mandatory convertible non-cumulative preferred stock (“Preferred Stock”) on May 8, 2008, with net proceeds of $239.0 million. The preferred securities pay dividends at an annual rate of 10%, have a conversion price of $6.50 per common share, and the remaining outstanding shares (249,000 at September 30, 2008) will convert into approximately 38.3 million common shares on or before May 1, 2011. (See Note 11 to the Consolidated Financial Statements for additional details regarding the Preferred Stock.)
TSFG’s tangible equity to tangible asset ratio increased to 7.94% at September 30, 2008, from 6.61% at December 31, 2007, due primarily to the issuance of Preferred Stock. In addition, all regulatory capital ratios exceeded well-capitalized minimums.
Tax-equivalent net interest income was $292.6 million for both the first nine months of 2008 and 2007. The net interest margin for the first nine months of 2008 was 3.13%, compared with 3.11% for the first nine months of 2007. This margin improvement is partly due to the decline in funding costs outpacing the decline in earning asset yields, and the issuance of preferred stock. Federal Reserve actions to reduce the targeted fed funds rate by 225 basis points during the first nine months of 2008 led to decreased earning asset yields and a decline in average funding costs. Noninterest income totaled $91.0 million for the first nine months of 2008, compared to $84.6 million for the first nine months of 2007. The increase in noninterest income was largely attributable to a gain on mandatory partial redemption of shares received in the Visa IPO of $1.9 million and a net gain on securities of $1.6 million in the first nine months of 2008 versus a $3.3 million net loss during the first nine months of 2007. In addition, for the first nine months of 2008, gain on certain derivative activities totaled $49,000 versus a loss of $1.2 million for the first nine months of 2007. TSFG’s debit card income (net) and merchant processing income (net) for the first nine months of 2008 increased over the prior year amounts, but were offset by decreases in most other noninterest income categories.
Noninterest expenses totaled $449.2 million for the first nine months of 2008, compared to $240.4 for the nine months ended September 30, 2007. This increase was primarily due to the $188.4 million goodwill impairment charge in the first quarter of 2008. The increase in noninterest expenses also included higher employment contract and severance expense related to the retirement of TSFG’s CEO, higher advertising and business development expenses, higher regulatory assessments, higher loan collection and monitoring expenses, and branch acquisition and conversion costs related to the acquisition of five branches in Orlando, partially offset by declines in professional fees.
Using period-end balances, TSFG’s loans held for investment at September 30, 2008 increased 0.84% from December 31, 2007, and total deposit balances increased 2.2%. Customer funding (deposits less brokered deposits plus customer sweep accounts) decreased 2.3% from December 31, 2007 to September 30, 2008.
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On September 2, 2008, the Board of Directors and Mack I. Whittle, the Company’s Chairman, President, and Chief Executive Officer, entered into a severance agreement pursuant to which Whittle would receive certain retirement benefits and retire on or before December 30, 2008 (at the Board’s election). Those benefits include, among others, a lump sum cash payment of $4.1 million, vesting of all equity awards, service credit under the Supplemental Executive Retirement Plan through age 65 (incremental expense of $4.1 million, of which approximately $2 million relates to service credit through age 65) which provides an annual retirement payment commencing at retirement date, vested benefits under other Company plans, continued welfare and fringe benefits for three years, and three years of continued life insurance coverage. The incremental expense related to these benefits is approximately $12 million, of which $4.6 million was recognized in third quarter 2008, with the remaining expense to be recognized in fourth quarter 2008. Subsequent to quarter-end, the Executive Committee, on behalf of the Board, specified that Whittle’s retirement would be effective October 27, 2008.
The Board has appointed a Succession Committee to oversee a nationwide search for a replacement for Whittle. In the interim, John C.B. Smith, Jr., the Company’s former Lead Independent Director and now Chairman (see below), will lead the Board of Directors and oversee management until such time as a principal executive officer is named. In addition, TSFG’s three-person operating council, consisting of the Chief Financial Officer, Chief Commercial Banking Officer, and Chief Retail Banking Officer will guide the Company through this transition period, acting as the principal executive officers for purposes of filings. As alluded to above, on November 3, 2008, the Board amended TSFG’s Bylaws to consolidate the roles and responsibilities of the Chairman and Lead Independent Director into a single Chairman position. It named John C. B. Smith, Jr. as Chairman, and William R. Timmons III as Vice Chairman.
Recent Market Developments
The global and U.S. economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of residential-related loans and mortgage-backed securities, but spreading to credit default swaps and other derivative securities have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.
Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The availability of credit, confidence in the financial sector, and level of volatility in the financial markets have been significantly adversely affected as a result. In recent weeks, volatility and disruption in the capital and credit markets has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law on October 3, 2008. Pursuant to the EESA, the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
On October 3, 2008, the FDIC increased its insurance coverage limits on all deposits from $100,000 to $250,000 per account until December 31, 2009.
On October 14, 2008, Secretary Paulson, after consulting with the Federal Reserve and the FDIC, announced that the Department of the Treasury will purchase equity stakes in certain banks and thrifts. Under this program, known as the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”), the Treasury will make $250 billion of capital available to U.S. financial institutions in the form of preferred stock (from the $700 billion authorized by the EESA). In conjunction with the purchase of preferred stock, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the TARP Capital Purchase Program. Secretary Paulson also announced that nine large financial institutions agreed to participate in the TARP Capital Purchase Program.
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Also on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, Secretary Paulson signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily provide a 100% guarantee of the senior unsecured debt of all FDIC-insured institutions and their holding companies, as well as deposits in noninterest-bearing transaction deposit accounts under a Temporary Liquidity Guarantee Program through December 31, 2009. Coverage under the Temporary Liquidity Guarantee Program is available for 30 days without charge (subsequently extended to December 5, 2008) and thereafter at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for noninterest-bearing transaction deposits.
TSFG has decided to pursue capital under the TARP Capital Purchase Program, which based on the program guidelines, would range from $115 to $347 million; however, no assurance can be given that TSFG will be approved under those guidelines. Additionally, TSFG has decided to proceed with the Temporary Liquidity Guarantee Program related to noninterest-bearing deposit accounts after the initial period of November 12, 2008; however, TSFG continues to evaluate whether it will participate in the Temporary Liquidity Guarantee Program relative to the guarantee of applicable unsecured obligations.
It is not clear at this time what impact the EESA, the TARP Capital Purchase Program, the Temporary Liquidity Guarantee Program, or other liquidity and funding initiatives will have on the financial markets and the other difficulties described above, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. and global economies. Further adverse effects could have an adverse effect on the Company and its business.
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 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, privately held investments, impaired loans); 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.
Allowance for Loan Losses and Reserve for Unfunded Lending Commitments
The allowance for loan losses (“Allowance”) represents management’s estimate of probable incurred losses in the lending portfolio. Management’s ongoing evaluation of the adequacy of the Allowance considers both impaired and unimpaired loans and takes into consideration TSFG’s past loan loss experience, known and inherent risks in the portfolio, existing adverse situations that may affect the borrowers’ ability to repay, estimated value of any underlying collateral, an analysis of guarantees and an analysis of current economic factors and existing conditions.
Assessing the adequacy of the Allowance is a process that requires considerable judgment. Management considers the period-end Allowance appropriate and adequate to cover probable incurred losses in the loan portfolio. However, management’s judgment is based upon a number of assumptions about current events, which are believed to be reasonable, but which may or may not prove 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.
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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 described above, adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.
A more detailed discussion of TSFG’s Allowance and reserve for unfunded lending commitments is included in the “Balance Sheet Review – Allowance for Loan Losses and Reserve for Unfunded Lending Commitments” section.
Derivatives and Hedging Activities
TSFG uses derivative financial instruments to reduce exposure to changes in interest rates and market prices for financial instruments. The application of hedge accounting requires judgment in the assessment of hedge effectiveness, identification of similarly hedged item groupings, and measurement of changes in the fair value of derivatives and related hedged items. TSFG believes that its methods for addressing these judgmental areas are reasonable and in accordance with generally accepted accounting principles in the United States. See “Derivative Financial Instruments” and “Fair Value of Certain Financial Instruments” for additional information regarding derivatives.
Fair Value of Certain Financial Instruments
Effective January 1, 2008, TSFG adopted SFAS No. 157 (“SFAS 157”), “Fair Value Measurements” for its financial assets and liabilities and SFAS No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities” with no significant impact on its Consolidated Financial Statements. These standards define fair value, establish guidelines for measuring fair value, and allow an irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis.
SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Fair value is based on quoted market prices for the same or similar instruments, adjusted for any differences in terms. If market values are not readily available, then the fair value is estimated. For example, when TSFG has an investment in a privately held company, TSFG’s management evaluates the fair value of these investments based on the entity’s ability to generate cash through its operations, obtain alternative financing, and subjective factors. Modeling techniques, such as discounted cash flow analyses, which use assumptions for interest rates, credit losses, prepayments, and discount rates, are also used to estimate fair value if market values are not readily available.
TSFG carries its available for sale securities, mortgage loans held for sale, and derivatives at fair value. The unrealized gains or losses, net of income tax effect, on available for sale securities and the effective component of derivatives qualifying as cash flow hedges are included in accumulated other comprehensive income (loss), a separate component of shareholders’ equity. The fair value adjustments for mortgage loans held for sale and derivative financial instruments not qualifying as cash flow hedges are included in earnings. In addition, for hedged items in a fair value hedge, changes in the hedged item’s fair value attributable to the hedged risk are also included in noninterest income. No fair value adjustment is allowed for the related hedged asset or liability in circumstances where the derivatives do not meet the requirements for hedge accounting under SFAS No. 133 (“SFAS 133”), “Accounting for Derivative Instruments and Hedging Activities.”
TSFG periodically evaluates its investment securities portfolio for other-than-temporary impairment. If a security is considered to be other-than-temporarily impaired, the related unrealized loss is charged to operations, and a new cost basis is established. Factors considered include the reasons for the impairment, the severity and duration of the impairment, changes in value subsequent to period-end, and forecasted performance of the security issuer. Impairment is considered other-than-temporary unless TSFG has both the intent and ability to hold the security until the fair value recovers and evidence supporting the recovery outweighs evidence to the contrary. However, for equity securities, which typically do not have a contractual maturity with a specified cash flow on which to rely, the ability to hold an equity security indefinitely, by itself, does not allow for avoidance of other-than-temporary impairment.
The fair values of TSFG’s investments in privately held limited partnerships, corporations and LLCs are not readily available. These investments are accounted for using either the cost or the equity method of accounting. The accounting treatment depends upon TSFG’s percentage ownership and degree of management influence. TSFG’s
28
management evaluates its investments in limited partnerships and LLCs quarterly for impairment based on the investee’s ability to generate cash through its operations, obtain alternative financing, and subjective factors. There are inherent risks associated with TSFG’s investments in privately held limited partnerships, corporations and LLCs, which may result in income statement volatility in future periods.
The process for valuing financial instruments, particularly those with little or no liquidity, is subjective and involves a high degree of judgment. Small changes in assumptions can result in significant changes in
valuation. Valuations are subject to change as a result of external factors beyond our control that have a substantial degree of uncertainty. The inherent risks associated with determining the fair value of a financial instrument may result in income statement volatility in future periods.
We may be required, from time to time, to measure certain other assets at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from write-downs of individual assets. For example, nonrecurring fair value adjustments to loans held for investment reflect full or partial write-downs that are based on the loan’s observable fair value or the fair value of the underlying collateral in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” Nonrecurring fair value adjustments to loans held for sale (other than mortgage loans held for sale) reflect the application of the principle of lower of cost or fair value.
See Note 14 to the Consolidated Financial Statements for more information on fair value measurements for the three and nine months ended September 30, 2008.
Income Taxes
Management uses certain assumptions and estimates in determining income taxes payable or refundable, deferred income tax liabilities and assets for events recognized differently in its financial statements and income tax returns, and income tax expense. Determining these amounts requires analysis of certain transactions and interpretation of tax laws and regulations. Management exercises considerable judgment in evaluating the amount and timing of recognition of the resulting income tax liabilities and assets. These judgments and estimates are re-evaluated on a continual basis as regulatory and business factors change.
No assurance can be given that either the tax returns submitted by management or the income tax reported on the Consolidated Financial Statements will not be adjusted by either adverse rulings by the U.S. Tax Court, changes in the tax code, or assessments made by the Internal Revenue Service (“IRS”). TSFG is subject to potential adverse adjustments, including but not limited to: an increase in the statutory federal or state income tax rates, the permanent nondeductibility of amounts currently considered deductible either now or in future periods, and the dependency on the generation of future taxable income, including capital gains, in order to ultimately realize deferred income tax assets.
TSFG adopted FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes,” on January 1, 2007. Under FIN 48, TSFG will only include the current and deferred tax impact of its tax positions in the financial statements when it is more likely than not (likelihood of greater than 50%) that such positions will be sustained by taxing authorities, with full knowledge of relevant information, based on the technical merits of the tax position. While TSFG supports its tax positions by unambiguous tax law, prior experience with the taxing authority, and analysis that considers all relevant facts, circumstances and regulations, management must still rely on assumptions and estimates to determine the overall likelihood of success and proper quantification of a given tax position.
TSFG recognizes deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. Management regularly reviews the Company’s deferred tax assets for recoverability based on history of earnings, expectations for future earnings and expected timing of reversals of temporary differences. Realization of the deferred tax asset in accordance with GAAP ultimately depends on the existence of sufficient taxable income available under tax law, including future reversals of existing temporary differences, future taxable income exclusive of reversing differences, taxable income in prior carryback years, and tax planning strategies.
Although realization is not assured, management believes the recorded deferred tax assets, beyond the REIT capital loss and the South Carolina non-bank net operating loss (which currently have a valuation allowance recorded as reported in Note 16 to the Consolidated Financial Statements included in TSFG’s Annual Report on Form 10-K for the year ended December 31, 2007), are fully recoverable based on forecasts of future income and current forecasts for the periods through which losses may be carried back and/or forward. Should the assumptions of future profitability change
29
significantly beyond the carryback period, a valuation allowance may be established if management believes any portion of the deferred tax asset will not be realized.
Share-Based Compensation
TSFG measures compensation cost for share-based awards at fair value and recognizes compensation over the service period for awards expected to vest. The fair value of restricted stock and restricted stock units is based on the number of shares granted and the quoted price of our common stock, the fair value of service-based stock options is determined using the Black-Scholes valuation model, and the fair value of market-based stock options is determined using a Monte Carlo simulation. Both the Black-Scholes model and the Monte Carlo simulation require the input of subjective assumptions, changes to which can materially affect the fair value estimate. In addition, the estimation of share-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. TSFG considers many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Actual results, and future changes in estimates, may differ substantially from our current estimates. For performance-based awards, TSFG estimates the degree to which performance conditions will be met to determine the number of shares which will vest and the related compensation expense prior to the vesting date.
Accounting for Acquisitions
TSFG has grown its operations, in part, through bank and non-bank acquisitions. Since 2000, and in accordance with SFAS No. 141, “Business Combinations,” and No. 142, “Goodwill and Other Intangible Assets,” TSFG has used the purchase method of accounting to account for acquisitions. Under this method, TSFG is required to record assets acquired and liabilities assumed at their fair value, which in many instances involves estimates based on third party, internal, or other valuation techniques. These estimates also include the establishment of various accruals for planned facilities dispositions and employee benefit related considerations, among other acquisition-related items. In addition, purchase acquisitions typically result in goodwill or other intangible assets, which are subject to periodic impairment tests, on an annual basis, or more often, if events or circumstances indicate that there may be impairment. These tests, which TSFG performed annually as of June 30th since 2002, use estimates such as projected cash flows, discount rates, time periods, and comparable market values in their calculations. Furthermore, the determination of which intangible assets have finite lives is subjective, as well as the determination of the amortization period for such intangible assets.
TSFG evaluates goodwill for impairment by determining the fair value for each reporting unit and comparing it to the carrying amount. If the carrying amount exceeds its fair value, the potential for impairment exists, and a second step of impairment testing is required. In the second step, the implied fair value of the reporting unit’s goodwill is determined by allocating the reporting unit’s fair value to all of its assets (recognized and unrecognized) and liabilities as if the reporting unit had been acquired in a business combination at the date of the impairment test. If the implied fair value of reporting unit goodwill is lower than its carrying amount, goodwill is impaired and is written down to its implied fair value.
During first quarter 2008, the acceleration of credit deterioration in Florida prompted TSFG to perform an updated interim impairment evaluation of a significant portion of the recorded goodwill as of March 31, 2008. As a result of this evaluation, during first quarter 2008, TSFG recognized goodwill impairment in the Florida banking segment primarily due to increased projected credit costs and a related decrease in projected loan growth, as well as changes in the measurement of segment profitability. See “Goodwill” for additional discussion of management’s process and the assumptions and judgments applied. The annual evaluation performed as of June 30, 2008 and a subsequent interim evaluation performed as of September 30, 2008 indicated that no additional impairment charge was required as of those dates.
For several previous acquisitions, TSFG has agreed to issue contingent earn-out payments based on the achievement of certain performance targets. Upon paying the additional consideration, TSFG would record additional goodwill.
TSFG’s other intangible assets have an estimated finite useful life and are amortized over that life in a manner that reflects the estimated decline in the economic value of the identified intangible asset. TSFG periodically reviews its other intangible assets to determine whether there have been any events or circumstances which indicate the recorded amount is not recoverable from projected undiscounted cash flows. If the projected undiscounted net operating cash flows are less than the carrying amount, a loss is recognized to reduce the carrying amount to fair value, and when appropriate, the amortization period is also reduced.
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Expanded Corporate Facilities
During 2007, TSFG started construction on its Expanded Corporate Facilities. Through September 30, 2008, TSFG had invested approximately $55 million in the project (which has been capitalized in premises and equipment on the consolidated balance sheet as construction in progress) and had entered into additional contractual commitments of approximately $37 million. The initial phase of the facilities is expected to be placed in service during mid-2009.
Balance Sheet Review
Loans
TSFG focuses its lending activities on small and middle market businesses and individuals in its geographic markets. At September 30, 2008, outstanding loans totaled $10.3 billion, which equaled 103.3% of total deposits (139.0% of customer deposits) and 75.5% of total assets. Loans held for investment increased $86.2 million, or 0.84%, from $10.2 billion at December 31, 2007. 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 September 30, 2008, approximately 6% 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.
During the three and nine months ended September 30, 2008, TSFG transferred commercial real estate loans with an unpaid principal balance totaling $71.7 million and $111.7 million, respectively, from the held for investment portfolio to the held for sale portfolio, and charged-off $28.1 million and $49.8 million, respectively, of these loans against the allowance for loan losses. Of these loans, $38.7 million (net of charge-offs) were sold, leaving $23.2 million (net of charge-offs) on the balance sheet in loans held for sale at September 30, 2008, of which $22.6 million are considered nonperforming loans.
TSFG generally sells a majority of its residential mortgage loans in the secondary market. TSFG also retains certain of its mortgage loans in its held for investment portfolio as part of its overall balance sheet management strategy. Mortgage loans held for sale decreased $3.5 million to $14.3 million at September 30, 2008, from $17.9 million at December 31, 2007, primarily due to lower mortgage loan volume and timing of mortgage sales. Effective January 1, 2008, TSFG elected to account for its mortgage loans held for sale at fair value pursuant to SFAS 159.
Table 1 summarizes outstanding loans held for investment by collateral type for real estate secured loans and by borrower type for all other loans. Collateral type represents the underlying assets securing the loan, rather than the purpose of the loan. Table 2 provides a stratification of the loan portfolio held for investment by loan purpose, which is more meaningful in terms of portfolio management. This presentation differs from that in Table 1, which stratifies the portfolio by collateral type and borrower type, consistent with external regulatory reporting.
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|
Table 1 |
|
Loan Portfolio Composition Based on Collateral Type or Borrower Type |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | December 31,
2007 | |
| |
| | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Commercial, financial and agricultural | | $ | 2,333,390 | | $ | 2,289,016 | | $ | 2,309,294 | |
Real estate - construction (1) | | | 1,710,837 | | | 2,160,125 | | | 1,763,365 | |
Real estate - residential mortgages (1-4 family) | | | 1,538,160 | | | 1,376,716 | | | 1,390,729 | |
Commercial secured by real estate (1) | | | 3,941,121 | | | 3,533,700 | | | 3,946,440 | |
Consumer | | | 776,132 | | | 813,680 | | | 803,592 | |
| |
|
| |
|
| |
|
| |
Loans held for investment | | $ | 10,299,640 | | $ | 10,173,237 | | $ | 10,213,420 | |
| |
|
| |
|
| |
|
| |
| |
(1) | These categories include loans to businesses other than real estate companies where owner-occupied real estate is pledged on loans to finance operations, equipment, and facilities. |
|
Table 2 |
|
Loan Portfolio Composition Based on Loan Purpose |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | December 31,
2007 | |
| |
| | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Commercial Loans | | | | | | | | | | |
Commercial and industrial (1) | | $ | 2,824,117 | | $ | 2,693,973 | | $ | 2,742,863 | |
Owner - occupied real estate (2) | | | 1,206,597 | | | 1,042,131 | | | 1,070,376 | |
Commercial real estate (3) | | | 4,094,164 | | | 4,178,653 | | | 4,158,384 | |
| |
|
| |
|
| |
|
| |
| | | 8,124,878 | | | 7,914,757 | | | 7,971,623 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Consumer Loans | | | | | | | | | | |
Indirect - sales finance | | | 680,413 | | | 707,819 | | | 699,014 | |
Consumer lot loans | | | 249,062 | | | 334,971 | | | 311,386 | |
Direct retail (1) | | | 100,257 | | | 109,883 | | | 107,827 | |
Home equity (1) | | | 784,357 | | | 746,253 | | | 754,158 | |
| |
|
| |
|
| |
|
| |
| | | 1,814,089 | | | 1,898,926 | | | 1,872,385 | |
| |
|
| |
|
| |
|
| |
|
Mortgage Loans (1) | | | 360,673 | | | 359,554 | | | 369,412 | |
| |
|
| |
|
| |
|
| |
|
Total loans held for investment | | $ | 10,299,640 | | $ | 10,173,237 | | $ | 10,213,420 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Percentage of Loans Held for Investment | | | | | | | | | | |
Commercial and industrial | | | 27.4 | % | | 26.5 | % | | 26.9 | % |
Owner - occupied real estate (2) | | | 11.7 | | | 10.2 | | | 10.5 | |
Commercial real estate | | | 39.8 | | | 41.1 | | | 40.7 | |
Consumer | | | 17.6 | | | 18.7 | | | 18.3 | |
Mortgage | | | 3.5 | | | 3.5 | | | 3.6 | |
| |
|
| |
|
| |
|
| |
|
Total | | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| |
|
| |
|
| |
|
| |
| |
(1) | In second quarter 2008, TSFG reclassified certain loan balances. Amounts presented for prior periods have been reclassified to conform to the current presentation. |
| |
(2) | In Table 1, 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. |
| |
(3) | See “Commercial Real Estate Concentration,” “Credit Quality,” and “Allowance for Loan Losses and Reserve for Unfunded Lending Commitments” for more detail on commercial real estate loans. |
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 single32
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 (“CRE”) loans are loans to finance real properties that are acquired, developed, or constructed for sale or lease to parties unrelated to the borrower. Our CRE products fall into four primary categories including land, acquisition and development, construction, and income property. See “Commercial Real Estate Concentration” below for further details.
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 motor vehicles with terms varying from two years to six years. During second quarter 2008, TSFG ceased originating indirect loans in Florida, and plans to allow this portion of the portfolio to run off over its remaining life. At September 30, 2008, this portfolio of Florida indirect loans totaled $428.6 million.
Consumer lot loans are loans to individuals to finance the purchase of residential lots.
Direct retail consumer loans are loans to individuals to finance personal, family, or household needs. Typical loans are loans to finance auto purchases or home repairs and additions.
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. TSFG’s home equity portfolio consists of loans to direct customers, with no brokered loans.
Mortgage loans are loans to individuals, secured by first 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 in its held for investment portfolio as part of its overall balance sheet management strategy. TSFG’s mortgage portfolio is bank-customer related, with minimal brokered loans or subprime exposure.
Portfolio risk is partially managed by maintaining a “house” lending limit at a level significantly lower than the legal lending limit of Carolina First Bank and by requiring approval by the Risk Committee of the Board of Directors to exceed this house limit. At September 30, 2008, TSFG’s house lending limit was $35 million, and 10 credit relationships totaling $441.2 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 $477.8 million, or 4.6% of total loans held for investment at September 30, 2008, compared to 4.2% of total loans held for investment at December 31, 2007.
TSFG, through its Corporate Banking group, participates in “shared national credits” (multi-bank credit facilities of $20 million or more, or “SNCs”), primarily to borrowers who are headquartered or conduct business in or near our markets. At September 30, 2008, the loan portfolio included commitments totaling $1.2 billion in SNCs. Outstanding borrowings under these commitments totaled $701.6 million at September 30, 2008, increasing from $660.7 million at December 31, 2007. The largest commitment was $40.0 million and the largest outstanding balance was $30.6 million at September 30, 2008. In addition to internal limits that control our credit exposure to individual borrowers, we have established limits on the size of the overall SNC portfolio, and have established a sub-limit for total credit exposure to borrowers located outside of our markets. All of our SNC relationships are underwritten and managed in a centralized Corporate Banking Group staffed with experienced bankers. Our strategy targets borrowers whose management teams are well known to us and whose risk profile is above average. Our ongoing strategic plan is to maintain diversity in our portfolio and expand the profitability of our relationships through the sale of non-credit products. Going forward, we expect to reduce the percentage of our portfolio invested in SNCs.
Commercial Real Estate Concentration
The portfolio’s largest 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. We attempt to manage the risk attributable
33
to the concentration in commercial real estate loans 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. Also, management believes that diversification by geography, property type, and borrower partially diversifies the risk of loss in its commercial real estate loan portfolio.
TSFG’s commercial real estate products include the following:
| | |
CRE Product | | Description |
| |
|
Completed income property | | Loans to finance a variety of income producing properties, including apartments, retail centers, hotels, office buildings and industrial facilities |
| | |
Residential A&D | | Loans to develop land into residential lots |
| | |
Commercial A&D | | Loans to finance the development of raw land into sellable commercial lots |
| | |
Commercial construction | | Loans to finance the construction of various types of income property |
| | |
Residential construction | | Loans to construct single family housing; primarily to residential builders |
| | |
Residential condo | | Loans to construct or convert residential condominiums |
| | |
Undeveloped land | | Loans to acquire land for resale or future development |
Underwriting policies dictate the loan-to-value (“LTV”) limitations for commercial real estate loans. Table 3 presents selected characteristics of commercial real estate loans by product type.
|
Table 3 |
|
Selected Characteristics of Commercial Real Estate Loans |
|
(dollars in thousands) |
| | | | | | | | | | | | | |
| | September 30, 2008 | |
| |
| |
| | Policy LTV | | Weighted Average
Time to Maturity
(in months) | | Weighted
Average
Loan Size | | Largest
Ten
Total O/S | |
| |
| |
| |
| |
| |
Completed income property | | 85 | % | | 44.7 | | | $ | 488 | | $ | 134,029 | |
Residential A&D | | 75 | | | 10.7 | | | | 672 | | | 109,616 | |
Commercial A&D | | 75 | | | 11.2 | | | | 1,000 | | | 98,939 | |
Commercial construction | | 80 | | | 28.1 | | | | 2,325 | | | 142,340 | |
Residential construction | | 80 | | | 12.5 | | | | 329 | | | 69,544 | |
Residential condo | | 80 | | | 10.1 | | | | 1,567 | | | 138,747 | |
Undeveloped land | | 65 | | | 11.2 | | | | 709 | | | 81,813 | |
|
Overall | | | | | 29.7 | | | $ | 597 | | $ | 775,028 | |
In addition to LTV limitations, other commercial real estate management processes are as follows:
Project Hold Limits. TSFG has implemented project hold limits (which represent the maximum amount that TSFG will hold in its portfolio by project) tiered by the underlying risk. These project limits act to encourage the appropriate amount of borrower and geographic granularity within the portfolio. Since the project limits vary by grade, TSFG attempts to reduce the exposure in correlation to the amount of assigned risk inherent in the project.
Construction Advances. TSFG monitors construction advances on all new construction projects and existing or renewed construction projects over set thresholds to ensure inspections are properly obtained and advances are consistent with the construction budget. The appropriateness of the construction budget is part of the underwriting package and considered during the approval process. The monitoring is administered by the centralized Construction Loan Administration department on an ongoing basis.
Quarterly Project Reviews. On a quarterly basis, each commercial real estate loan greater than $5 million is reviewed as part of a large project review process. Risk Management and the Relationship Manager discuss recent sales activity, local market absorption rates and the progress of each transaction in order to ensure proper internal risk rating and borrower strategy.
Appraisal Policies. It is TSFG’s policy to comply with Interagency Appraisal and Evaluation Guidelines as issued by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of Thrift Supervision (the “Agencies”). These guidelines address
34
supervisory matters relating to real estate appraisals and evaluations used to support real estate-related financial transactions and provide guidance to both examiners and regulated institutions about prudent appraisal and evaluation programs. Under the Agencies’ appraisal regulations, the appraiser is selected and engaged directly by TSFG or its agent. Additionally, because the appraisal and evaluation process is an integral component of the credit underwriting process, these processes should be isolated from influence by our loan production process. TSFG orders and reviews all appraisals for loans over a set threshold through a centralized review function.
Although the Agencies’ appraisal regulations exempt certain categories of real estate-related financial transactions from the appraisal requirements, most real estate transactions over $250,000 are considered federally regulated transactions and thus require appraisals. The Agencies allow us to use an existing appraisal or evaluation to support a subsequent transaction, if we document that the existing estimate of value remains valid. Criteria for determining whether an existing appraisal or evaluation remains valid will vary depending upon the condition of the property and the marketplace, and the nature of any subsequent transaction. Factors that could cause changes to originally reported values include: the passage of time; the volatility of the local market; the availability of financing; the inventory of competing properties; improvement to, or lack of maintenance of, the subject property or competing surrounding properties; changes in zoning; or environmental contamination.
While the Agencies’ appraisal regulations generally allow appropriate evaluations of real estate collateral in lieu of an appraisal for loan renewals and refinancing, in certain situations an appraisal is required. If new funds are advanced over reasonable closing costs, we would be expected to obtain a new appraisal for the renewal of an existing transaction when there is a material change in market conditions or the physical aspects of the property that threatens our real estate collateral protection.
A reappraisal would not be required when we advance funds to protect our interest in a property, such as to repair damaged property, because these funds should be used to restore the damaged property to its original condition. If a loan workout involves modification of the terms and conditions of an existing credit, including acceptance of new or additional real estate collateral, which facilitates the orderly collection of the credit or reduces our risk of loss, a reappraisal or reevaluation may be prudent, even if it is obtained after the modification occurs.
TSFG’s policy is to order new appraisals in the following circumstances:
| | |
| • | Funds are being advanced to increase the loan above the originally committed loan amount and the appraisal is more than 18 months old; |
| | |
| • | Loan is downgraded to substandard or worse, and the appraisal is more than three years old or significant adverse changes have occurred in the market where the property is located; |
| | |
| • | Loan is downgraded to watch, and the appraisal is more than five years old or significant adverse changes have occurred in the market where the property is located; |
| | |
| • | Loan is restructured to advance additional funds or extend the original amortization term, and the appraisal is over three years old or significant adverse changes have occurred in the market where the property is located; |
| | |
| • | Property is being cross-pledged to another loan (other than an abundance of caution), and the appraisal is over three years old or significant adverse changes have occurred in the market where the property is located. |
Credit Officers and Special Assets Officers make the final determination of whether an updated appraisal is required and the timing of the updated appraisal, as part of their approval and portfolio management responsibilities.
Stress Testing. TSFG has implemented a Dual Risk Rating system with nine risk scorecards. The Risk Rating system was launched in December 2007, and fully implemented by March 31, 2008. TSFG expects to begin stressing historical risk ratings following proper validation of assignments and migration studies.
Late in first quarter 2008, the land portfolio in Florida began to exhibit indicators of distress which prompted additional analysis of the existing portfolio and potential losses based on existing loan to value ratios and anticipated default probabilities. This analysis is further discussed in “Allowance for Loan Losses and Reserve for Unfunded Lending Commitments” below. The allowance for loan losses was increased by approximately $26 million during the first nine months of 2008 as a result of this analysis.
35
Table 4 presents the commercial real estate portfolio by geography, while Table 5 presents the commercial real estate portfolio by geography and property type. Commercial real estate nonaccruals, past dues, and net charge-offs are presented in Tables 7, 8, and 12, respectively. TSFG monitors trends in these categories in order to evaluate the possibility of higher credit risk in its commercial real estate portfolio.
|
Table 4 |
|
Commercial Real Estate Loans by Geographic Diversification (1) |
|
(dollars in thousands) |
| | | | | | | | | | | | | |
| | September 30, 2008 | | December 31, 2007 | |
| |
| |
| |
| | Balance | | % of
Total CRE | | Balance | | % of
Total CRE | |
| |
| |
| |
| |
| |
South Carolina, exluding Coastal: | | | | | | | | | | | | | |
Upstate South Carolina (Greenville) | | $ | 451,735 | | | 11.0 | % | $ | 400,936 | | | 9.6 | % |
Midlands South Carolina (Columbia) | | | 248,121 | | | 6.1 | | | 300,414 | | | 7.2 | |
Greater South Charlotte South Carolina (Rock Hill) | | | 155,565 | | | 3.8 | | | 134,166 | | | 3.2 | |
Coastal South Carolina: | | | | | | | | | | | | | |
North Coastal South Carolina (Myrtle Beach) | | | 324,300 | | | 7.9 | | | 297,075 | | | 7.2 | |
South Coastal South Carolina (Charleston) | | | 305,943 | | | 7.5 | | | 231,881 | | | 5.6 | |
Western North Carolina (Hendersonville/Asheville) | | | 832,527 | | | 20.3 | | | 868,226 | | | 20.9 | |
Central Florida: | | | | | | | | | | | | | |
Central Florida (Orlando) | | | 265,675 | | | 6.5 | | | 278,416 | | | 6.7 | |
Marion County, Florida (Ocala) | | | 165,836 | | | 4.1 | | | 168,054 | | | 4.0 | |
North Florida: | | | | | | | | | | | | | |
Northeast Florida (Jacksonville) | | | 299,139 | | | 7.3 | | | 327,877 | | | 7.9 | |
North Central Florida | | | 318,909 | | | 7.8 | | | 301,485 | | | 7.3 | |
South Florida (Ft. Lauderdale) | | | 249,901 | | | 6.1 | | | 283,937 | | | 6.8 | |
Tampa Bay Florida | | | 476,513 | | | 11.6 | | | 565,917 | | | 13.6 | |
| |
|
| |
|
| |
|
| |
|
| |
Total commercial real estate loans | | $ | 4,094,164 | | | 100.0 | % | $ | 4,158,384 | | | 100.0 | % |
| |
|
| |
|
| |
|
| |
|
| |
| |
(1) | Geography is primarily determined by the originating operating geographic market and not necessarily the ultimate location of the underlying collateral.
Note: At September 30, 2008 and December 31, 2007, average loan size for commercial real estate loans totaled $597,000 and $557,000, respectively. |
|
Table 5 |
|
Commercial Real Estate Loans by Geography and Product Type |
|
(dollars in thousands) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2008 Commercial Real Estate Loans by Geography | |
| |
| |
| | SC, Excl
Coastal | | Coastal
SC | | Western
NC | | Central
FL | | North
FL | | South
FL | | Tampa
Bay | | Total
CRE | | % of
LHFI | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
Commercial Real Estate Loans by Product Type | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Completed income property | | $ | 427,767 | | $ | 286,122 | | $ | 457,476 | | $ | 194,794 | | $ | 358,517 | | $ | 152,861 | | $ | 206,409 | | $ | 2,083,946 | | | 20.3 | % |
Residential A&D | | | 111,484 | | | 76,460 | | | 171,628 | | | 55,919 | | | 81,290 | | | 4,048 | | | 54,523 | | | 555,352 | | | 5.4 | |
Commercial A&D | | | 45,634 | | | 31,050 | | | 42,321 | | | 25,380 | | | 10,295 | | | 12,932 | | | 72,455 | | | 240,067 | | | 2.3 | |
Commercial construction | | | 162,072 | | | 47,627 | | | 26,659 | | | 35,988 | | | 47,940 | | | 11,005 | | | 29,068 | | | 360,359 | | | 3.5 | |
Residential construction | | | 49,514 | | | 32,329 | | | 53,988 | | | 29,018 | | | 34,171 | | | 11,265 | | | 15,270 | | | 225,555 | | | 2.2 | |
Residential condo | | | 23,928 | | | 109,938 | | | 10,295 | | | 9,223 | | | 17,541 | | | 17,484 | | | 20,111 | | | 208,520 | | | 2.0 | |
Undeveloped land | | | 35,022 | | | 46,717 | | | 70,160 | | | 81,189 | | | 68,294 | | | 40,306 | | | 78,677 | | | 420,365 | | | 4.1 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total CRE Loans | | $ | 855,421 | | $ | 630,243 | | $ | 832,527 | | $ | 431,511 | | $ | 618,048 | | $ | 249,901 | | $ | 476,513 | | $ | 4,094,164 | | | 39.8 | % |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
CRE Loans as % of Total Loans HFI | | | 8.3 | % | | 6.1 | % | | 8.1 | % | | 4.2 | % | | 6.0 | % | | 2.4 | % | | 4.7 | % | | 39.8 | % | | | |
See “Credit Quality” for additional commercial real estate information.
36
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 periodic meetings with credit risk management to review progress. Credit risk management activities are monitored by the Risk Committee of the Board, which meets periodically to review credit quality trends, new large credits, loans to insiders, large problem credits, credit policy changes, and reports on independent credit reviews.
For TSFG’s policy regarding impairment on loans, nonaccruals, charge-offs, and foreclosed property, refer to Item 8, Note 1 – Summary of Significant Accounting Policies in the notes to the Consolidated Financial Statements in the Annual Report on Form 10-K for year ended December 31, 2007.
Table 6 presents our credit quality indicators.
|
Table 6 |
|
Credit Quality Indicators |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | December 31,
2007 | |
| |
| | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Loans held for investment | | $ | 10,299,640 | | $ | 10,173,237 | | $ | 10,213,420 | |
Allowance for loan losses | | | 200,748 | | | 118,861 | | | 126,427 | |
Allowance for credit losses (1) | | | 203,000 | | | 120,424 | | | 128,695 | |
Nonaccrual loans - commercial and industrial (2)(3) | | | 28,309 | | | 18,056 | | | 22,963 | |
Nonaccrual loans - owner - occupied real estate (2) | | | 6,951 | | | 3,738 | | | 4,085 | |
Nonaccrual loans - commercial real estate (2) | | | 160,479 | | | 13,972 | | | 36,634 | |
Nonaccrual loans - consumer (3) | | | 21,184 | | | 13,397 | | | 11,606 | |
Nonaccrual loans - mortgage (3) | | | 20,889 | | | 2,646 | | | 4,903 | |
Restructured loans accruing interest | | | 2,279 | | | 1,448 | | | 1,440 | |
| |
|
| |
|
| |
|
| |
Total nonperforming loans held for investment | | | 240,091 | | | 53,257 | | | 81,631 | |
Nonperforming loans held for sale - commercial real estate | | | 22,576 | | | — | | | — | |
Foreclosed property (other real estate owned and personal property repossessions) | | | 30,503 | | | 5,658 | | | 8,276 | |
| |
|
| |
|
| |
|
| |
Total nonperforming assets | | $ | 293,170 | | $ | 58,915 | | $ | 89,907 | |
| |
|
| |
|
| |
|
| |
Loans past due 90 days or more (mortgage and consumer with interest accruing) | | $ | 12,899 | | $ | 2,629 | | $ | 5,349 | |
| |
|
| |
|
| |
|
| |
Total nonperforming assets as a percentage of loans and foreclosed property | | | 2.83 | % | | 0.58 | % | | 0.88 | % |
| |
|
| |
|
| |
|
| |
Allowance for loan losses to nonperforming loans HFI | | | 0.84 | x | | 2.23 | x | | 1.55 | 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 September 30, 2008, December 31, 2007, and September 30, 2007, commercial nonaccrual loans included $157,000, $218,000, and $403,000, respectively, in restructured loans. |
| |
(3) | In second quarter 2008, TSFG reclassified certain loan balances. Amounts presented for prior periods have been reclassified to conform to the current presentation. |
TSFG’s nonperforming asset ratio (nonperforming assets as a percentage of loans and foreclosed property) increased to 2.83% at September 30, 2008 from 0.88% at December 31, 2007 and 0.58% at September 30, 2007. The
37
increase in nonperforming assets was primarily attributable to accelerating market deterioration in residential housing and development-related loans, principally in Florida markets.
During the three and nine months ended September 30, 2008, TSFG transferred loans with an unpaid principal balance totaling $71.7 million and $111.7 million, respectively, from the held for investment portfolio to the held for sale portfolio, and charged-off $28.1 million and $49.8 million, respectively, of these loans against the allowance for loan losses. Of these loans, $38.7 million (net of charge-offs) were sold, leaving $23.2 million (net of charge-offs) on the balance sheet in loans held for sale at September 30, 2008, of which $22.6 million are considered nonperforming loans.
Table 7 presents CRE nonaccrual loans by geography and product type. At September 30, 2008, there were no CRE loans past due 90 days still accruing interest.
|
Table 7 |
|
Commercial Real Estate Nonaccrual Loans |
|
(dollars in thousands) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | September 30, 2008 CRE Nonaccrual Loans HFI (“NAL”) by Geography | |
| |
| |
| | SC, Excl
Coastal | | Coastal
SC | | Western
NC | | Central
FL | | North
FL | | South
FL | | Tampa
Bay | | Total
CRE NAL | | % of
NAL (1) | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
CRE Nonaccrual Loans by Product Type | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Completed income property | | $ | 1,830 | | $ | 1,771 | | $ | 6,043 | | $ | 6,775 | | $ | 1,761 | | $ | 3,027 | | $ | 637 | | $ | 21,844 | | | 9.2 | % |
Residential A&D | | | 2,313 | | | 2,588 | | | 14,695 | | | 7,884 | | | 3,530 | | | 250 | | | 26,917 | | | 58,177 | | | 24.5 | |
Commercial A&D | | | 396 | | | 7,050 | | | 579 | | | 152 | | | — | | | — | | | — | | | 8,177 | | | 3.4 | |
Commercial construction | | | — | | | — | | | 1,424 | | | — | | | — | | | 1,658 | | | — | | | 3,082 | | | 1.3 | |
Residential construction | | | 1,288 | | | 1,859 | | | 5,608 | | | 9,503 | | | 1,537 | | | 11 | | | — | | | 19,806 | | | 8.3 | |
Residential condo | | | — | | | 2,349 | | | — | | | 1,712 | | | — | | | 8,811 | | | 6,934 | | | 19,806 | | | 8.3 | |
Undeveloped land | | | 147 | | | — | | | 860 | | | 440 | | | 3,764 | | | 15,880 | | | 8,496 | | | 29,587 | | | 12.5 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total CRE Nonaccrual Loans | | $ | 5,974 | | $ | 15,617 | | $ | 29,209 | | $ | 26,466 | | $ | 10,592 | | $ | 29,637 | | $ | 42,984 | | $ | 160,479 | | | 67.5 | % |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
CRE Nonaccrual Loans as % of Total Nonaccrual Loans (1) | | | 2.5 | % | | 6.6 | % | | 12.3 | % | | 11.1 | % | | 4.4 | % | | 12.5 | % | | 18.1 | % | | 67.5 | % | | | |
| |
(1) | Calculated as a percent of nonaccrual loans held for investment, which totaled $237.8 million at September 30, 2008. Excludes nonaccrual loans held for sale, which totaled $22.6 million at September 30, 2008. |
Table 8 provides detail regarding commercial real estate loans past due 30 days or more.
|
Table 8 |
|
Commercial Real Estate Loans Past Due 30 Days or More (excluding nonaccruals) |
|
(dollars in thousands) |
| | | | | | | | | | | | | |
| | September 30, 2008 | | December 31, 2007 | |
| |
| |
| |
| | Balance | | % of CRE | | Balance | | % of CRE | |
| |
| |
| |
| |
| |
North Carolina | | $ | 14,418 | | | 0.35 | % | $ | 10,029 | | | 0.24 | % |
South Carolina | | | 11,720 | | | 0.29 | | | 1,889 | | | 0.05 | |
Florida | | | 24,886 | | | 0.61 | | | 14,383 | | | 0.34 | |
| |
|
| |
|
| |
|
| |
|
| |
Total CRE loans past due 30 days or more | | $ | 51,024 | | | 1.25 | % | $ | 26,301 | | | 0.63 | % |
| |
|
| |
|
| |
|
| |
|
| |
In accordance with SFAS No. 114 (“SFAS 114”), “Accounting by Creditors for Impairment of a Loan,” loans are considered to be impaired when, in management’s judgment and based on current information, the full collection of principal and interest becomes doubtful. A loan is also considered impaired if its terms are modified in a troubled debt restructuring. Table 9 summarizes information on impaired loans.
38
|
Table 9 |
|
Impaired Loans |
|
(dollars in thousands) |
| | | | | | | | | | |
| | At and For the
Nine Months
Ended September 30, | | At and For the
Year Ended
December 31,
2007 | |
| |
| | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Impaired loans | | $ | 198,018 | | $ | 38,060 | | $ | 68,102 | |
Average investment in impaired loans | | | 182,475 | | | 35,251 | | | 40,360 | |
Related allowance | | | 29,911 | | | 11,010 | | | 11,340 | |
Foregone interest | | | 11,416 | | | 2,142 | | | 3,437 | |
Potential problem loans consist of commercial loans that are performing in accordance with contractual terms but for which management has concerns about the ability of an obligor to continue to comply with repayment terms because of the obligor’s potential operating or financial difficulties. These loans are identified through our internal risk grading processes. Management monitors these loans closely and reviews their performance on a regular basis. Table 10 provides additional detail regarding potential problem loans.
|
Table 10 |
|
Potential Problem Loans |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, 2008 | |
| |
| |
| | | | | Outstanding Principal Balance | |
| | | | |
| |
| | Number of
Loans | | Amount | | Percentage of
Loans Held for
Investment | |
| |
| |
| |
| |
Large potential problem loans ($5 million or more) | | | 17 | | $ | 169,799 | | | 1.65 | % |
Small potential problem loans (less than $5 million) | | | 811 | | | 272,087 | | | 2.64 | |
| |
|
| |
|
| |
|
| |
Total potential problem loans (1) | | | 828 | | $ | 441,886 | | | 4.29 | % |
| |
|
| |
|
| |
|
| |
| |
(1) | Includes commercial and industrial, commercial real estate, and owner-occupied real estate. |
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.
Management’s ongoing evaluation of the adequacy of the Allowance considers both impaired and unimpaired loans and takes into consideration TSFG’s past loan loss experience, known and inherent risks in the portfolio, existing adverse situations that may affect the borrowers’ ability to repay, estimated value of any underlying collateral, an analysis of guarantees and an analysis of current economic factors and existing conditions.
TSFG, through its lending and credit functions, continuously reviews its loan portfolio for credit risk. TSFG employs an independent credit review area that reviews the lending and credit functions and processes to validate that credit risks are appropriately identified and addressed and reflected in the risk ratings. Using input from the credit risk identification process, the Company’s credit risk management area analyzes and validates the Company’s Allowance calculations. The analysis includes four basic components: general allowances for loan pools segmented based on similar risk characteristics, specific allowances for individually impaired loans, subjective and judgmental qualitative adjustments based on identified economic factors and existing conditions and other risk factors, and the unallocated component of the Allowance (which is determined based on the overall Allowance level and the determination of a range given the inherent imprecision of calculating the Allowance).
39
Management reviews the methodology, calculations and results and ensures that the calculations are appropriate and that all material risk elements have been assessed in order to determine the appropriate level of Allowance for the inherent losses in the loan portfolio at each quarter end. The Allowance for Credit Losses Committee is in place to ensure that the process is systematic and consistently applied.
The following chart reflects the various levels of reserves included in the Allowance:
| |
Level I | General allowance calculated based upon historical losses |
| |
Level II | Specific reserves for individually impaired loans |
| |
Level III | Subjective/judgmental adjustments for economic and other risk factors |
| |
Unfunded | Reserves for off-balance sheet (unadvanced) exposure |
| |
Unallocated | Represents the imprecision inherent in the previous calculations |
| |
Total | Represents summation of all reserves |
Level I Reserves. The first reserve component is the general allowance for loan pools segmented based on similar risk characteristics that are determined by applying adjusted historical loss factors to each loan pool. This part of the methodology is governed by SFAS No. 5, “Accounting for Contingencies.” The general allowance factors are based upon recent and historical charge-off experience and are applied to the outstanding portfolio by loan type and internal risk rating. Historical loss analyses of the previous 12 quarters provide the basis for factors used for homogenous pools of smaller loans, such as indirect auto and other consumer loan categories which generally are not evaluated based on individual risk ratings but almost entirely based on historical losses. The loss factors used in the Level I analyses are adjusted quarterly based on loss trends and risk rating migrations.
TSFG generates historical loss ratios from actual loss history for eight subsets of the loan portfolio over a 12 quarter period (3 years). Commercial loans are sorted by risk rating into four pools—Pass, Special Mention, Substandard, and Doubtful. Consumer loans are sorted into four pools by product type—Direct, Indirect, Revolving, and Mortgage.
The adjusted loss ratio for each pool is multiplied by the dollar amount of loans in the pool in order to create a range. We then add and subtract five percent (5.0%) to and from this amount to create the upper and lower boundaries of the range. The upper and lower boundary amounts for each pool are summed to establish the total range. Although TSFG generally uses the actual historical loss rate, on occasion management may decide to select a higher or lower boundary based on known market trends or internal behaviors that would impact the performance of a specific portfolio grouping. The Level I reserves totaled $64.7 million at September 30, 2008, based on the portfolio historical loss rates, compared to $48.7 million at December 31, 2007.
Level II Reserves. The second component of the Allowance involves the calculation of specific allowances for each individually impaired loan in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan.” In situations where a loan is determined to be impaired (primarily because it is probable that all principal and interest amounts due according to the terms of the note will not be collected as scheduled), a specific reserve may or may not be warranted. Upon examination of the collateral and other factors, it may be determined that TSFG reasonably expects to collect all amounts due; therefore, no specific reserve is warranted. Any loan determined to be impaired (whether a specific reserve is assigned or not) is excluded from the Level I calculations described above.
TSFG tests a broad group of loans for impairment each quarter (this includes all loans over $500,000 that have been placed in nonaccrual status). Once a loan is identified as impaired, reserves are based on a thorough analysis of the most probable source of repayment which is normally the liquidation of collateral, but may also include discounted future cash flows or the market value of the loan itself. Generally, for collateral dependent loans, current market appraisals are utilized for larger credits; however, in situations where a current market appraisal is not available, management uses the best available information (including appraisals for similar properties, communications with qualified real estate professionals, information contained in reputable publications and other observable market data) to estimate the current fair value (less cost to sell) of the subject property. TSFG had Level II reserves of $29.9 million at September 30, 2008, compared to $11.3 million at December 31, 2007.
Level III Reserves. The third component of the Allowance represents subjective and judgmental adjustments determined by management to account for the effect of risks or losses that are not fully captured elsewhere. This part of the methodology is calculated in accordance with SFAS 5 and reflects adjustments to historical loss experience to incorporate current economic conditions and other factors which impact the inherent losses in the portfolio. This component includes amounts for new loan products or portfolio categories which are deemed to have risks not included
40
in the other reserve elements as well as macroeconomic and other factors. The qualitative risk factors of this third allowance level are more subjective and require a high degree of management judgment. Currently, Level III Reserves include additional reserves for current economic conditions, the commercial real estate concentration in the portfolio, and an additional adjustment to represent declining land values in Florida.
During first quarter 2008, undeveloped land loans were experiencing distressed default rates, and higher loss severities were expected. TSFG performed two separate analyses to determine an accurate adjustment to this category. Both analyses concluded that an adjustment to the allowance of $23.8 million was appropriate. This adjustment was added to the Allowance in the Florida Bank segment for the first time during first quarter 2008. This analysis was updated during third quarter 2008 with updated loan balances on this subportfolio using an adjusted appraisal discount, which resulted in the new Level III allowance component increasing to $25.9 million.
TSFG also experienced an increase in losses in the indirect portfolio, as $9.1 million was charged-off during the first nine months of 2008, compared to $3.8 million in the first nine months of 2007. As a result of that recognizable increase, an adjustment was made to the component of economic conditions increasing that portion of the Allowance by $10.5 million.
As a result of the two areas mentioned above, the Level III Reserves increased to $102.6 million at September 30, 2008, from $66.4 million at December 31, 2007.
Reserve for Unfunded Commitments. At September 30, 2008 and December 31, 2007, the reserve for unfunded commitments was $2.3 million. This reserve is determined by formula; historical loss ratios are multiplied by potential usage levels (i.e., the difference between actual usage levels and the second highest historical usage level).
Unallocated Reserves. The calculated Level I, II and III reserves are 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 ranges, and is distributed to the loan categories based on the mix of loans in each category. The unallocated portion is calculated as the sum of the differences between the actual calculated Allowance and the lower boundary amounts for each category in our model. The sum of these differences at September 30, 2008 was $11.6 million, up from $7.7 million at June 30, 2008 and $6.0 million at December 31, 2007. The unallocated Allowance is the result of management’s best estimate of risks inherent in the portfolio, economic uncertainties and other subjective factors, including industry trends, as well as the imprecision inherent in estimates used for the allocated portions of the Allowance. Management reviews the overall level of the Allowance as well as the unallocated component and considers the level of both amounts in determining the appropriate level of reserves for the overall inherent risk in TSFG’s total loan portfolio.
Changes in the Level II reserves (and the overall Allowance) may not correlate to the relative change in impaired loans depending on a number of factors including whether the impaired loans are secured, the collateral type, and the estimated loss severity on individual loans. Specifically, impaired loans increased to $198.0 million at September 30, 2008 from $68.1 million at December 31, 2007, primarily attributable to commercial real estate loans in Florida. Most of the loans contributing to the increase were over $500,000 and were evaluated for whether a specific reserve was warranted based on the analysis of the most probable source of repayment including liquidation of the collateral. Based on this analysis, the Level II Reserves increased 164% compared to the 191% increase in impaired loans.
Changes in the other components of the Allowance (reserves for Level I, Level III, unallocated, and unfunded commitments) are not related to specific loans but reflect changes in loss experience and subjective and judgmental adjustments made by management. For example, due to indicators of stress on the land portfolio in Florida and other credit quality indicators, these reserves were increased by $26 million during the first nine months of 2008.
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.
41
Table 11 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 11 |
|
Summary of Loan and Credit Loss Experience |
|
(dollars in thousands) |
| | | | | | | | | | |
| | At and For the
Nine Months
Ended September 30, | | At and For the
Year Ended
December 31,
2007 | |
| | | |
| | | |
| |
| | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Allowance for loan losses, beginning of year | | $ | 126,427 | | $ | 111,663 | | $ | 111,663 | |
Net charge-offs: | | | | | | | | | | |
Loans charged-off | | | (152,664 | ) | | (34,159 | ) | | (59,408 | ) |
Loans recovered | | | 5,306 | | | 5,253 | | | 6,847 | |
| |
|
| |
|
| |
|
| |
| | | (147,358 | ) | | (28,906 | ) | | (52,561 | ) |
Additions to allowance through provision expense | | | 221,679 | | | 36,104 | | | 67,325 | |
| |
|
| |
|
| |
|
| |
Allowance for loan losses, end of period | | $ | 200,748 | | $ | 118,861 | | $ | 126,427 | |
| |
|
| |
|
| |
|
| |
|
Reserve for unfunded lending commitments, beginning of year | | $ | 2,268 | | $ | 1,025 | | $ | 1,025 | |
Provision for unfunded lending commitments | | | (16 | ) | | 538 | | | 1,243 | |
| |
|
| |
|
| |
|
| |
Reserve for unfunded lending commitments, end of period | | $ | 2,252 | | $ | 1,563 | | $ | 2,268 | |
| |
|
| |
|
| |
|
| |
|
Allowance for credit losses, beginning of year | | $ | 128,695 | | $ | 112,688 | | $ | 112,688 | |
Net charge-offs: | | | | | | | | | | |
Loans charged-off | | | (152,664 | ) | | (34,159 | ) | | (59,408 | ) |
Loans recovered | | | 5,306 | | | 5,253 | | | 6,847 | |
| |
|
| |
|
| |
|
| |
| | | (147,358 | ) | | (28,906 | ) | | (52,561 | ) |
Additions to allowance through provision expense | | | 221,663 | | | 36,642 | | | 68,568 | |
| |
|
| |
|
| |
|
| |
Allowance for credit losses, end of period | | $ | 203,000 | | $ | 120,424 | | $ | 128,695 | |
| |
|
| |
|
| |
|
| |
|
Average loans held for investment | | $ | 10,366,359 | | $ | 9,925,410 | | $ | 9,985,751 | |
Loans held for investment, end of period | | | 10,299,640 | | | 10,173,237 | | | 10,213,420 | |
Net charge-offs as a percentage of average loans held for investment (annualized) | | | 1.90 | % | | 0.39 | % | | 0.53 | % |
Allowance for loan losses as a percentage of loans held for investment | | | 1.95 | | | 1.17 | | | 1.24 | |
Allowance for credit losses as a percentage of loans held for investment | | | 1.97 | | | 1.18 | | | 1.26 | |
Allowance for loan losses to nonperforming loans held for investment | | | 0.84 | x | | 2.23 | x | | 1.55 | x |
| | | | | | | | | | |
The provision for credit losses for the first nine months of 2008 totaled $221.7 million, which exceeded net loan charge-offs by $74.3 million. The higher provision largely reflected credit deterioration due to continued weakness in housing markets, particularly in Florida. The allowance for credit losses as a percentage of loans held for investment increased to 1.97% at September 30, 2008 from 1.26% at December 31, 2007 and 1.18% at September 30, 2007. Table 12 provides additional detail for net charge-offs.
42
|
Table 12 |
|
Net Charge-Offs by Product Type |
|
(dollars in thousands) |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | Nine Months Ended
September 30, 2008 | |
| | | | | | | | | | | | | | | | | | | | | | |
| |
| | | | | | | | | | | | | | | | | | | | | | | Amount | | % of
NCO | |
| | | | | | | | | | | | | | | | | | | | | | |
| |
| |
Commercial and industrial | | | | | | | | | | | | | | | | | | | $ | 24,516 | | | 16.6 | % |
Owner-occupied real estate | | | | | | | | | | | | | | | | | | | | 1,742 | | | 1.2 | |
Commercial real estate | | | | | | | | | | | | | | | | | | | | 95,474 | | | 64.8 | |
Indirect - sales finance | | | | | | | | | | | | | | | | | | | | 9,137 | | | 6.2 | |
Home equity | | | | | | | | | | | | | | | | | | | | 3,612 | | | 2.5 | |
Mortgage and consumer lot | | | | | | | | | | | | | | | | | | | | 11,920 | | | 8.1 | |
Direct retail | | | | | | | | | | | | | | | | | | | | 957 | | | 0.6 | |
| | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
Total Net Charge-Offs | | | | | | | | | | | | | | | | | | | $ | 147,358 | | | 100.0 | % |
| | | | | | | | | | | | | | | | | | | | | | |
|
| |
|
| |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, 2008 CRE Net Charge-Offs (“NCO”) by Geography | |
| |
| |
| | SC, Excl
Coastal | | Coastal
SC | | Western
NC | | Central
FL | | North
FL | | South
FL | | Tampa
Bay | | Total
CRE NCO | | % of
NCO | |
| |
| |
| |
| |
| |
| |
| |
| |
| |
| |
CRE Net Charge-Offs by Product Type | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Completed income property | | $ | 542 | | $ | 219 | | $ | 2,153 | | $ | 1,052 | | $ | 388 | | $ | — | | $ | 533 | | $ | 4,887 | | | 3.3 | % |
Residential A&D | | | 497 | | | 234 | | | 1,859 | | | 10,409 | | | 11,124 | | | — | | | 6,134 | | | 30,257 | | | 20.5 | |
Commercial A&D | | | 245 | | | — | | | 211 | | | 150 | | | — | | | 625 | | | 8,425 | | | 9,656 | | | 6.6 | |
Commercial construction | | | — | | | — | | | (45 | ) | | — | | | — | | | 2,856 | | | — | | | 2,811 | | | 1.9 | |
Residential construction | | | 928 | | | 670 | | | 949 | | | 1,174 | | | 2,292 | | | — | | | — | | | 6,013 | | | 4.1 | |
Residential condo | | | — | | | 1,000 | | | 185 | | | 465 | | | 140 | | | 4,209 | | | 16,972 | | | 22,971 | | | 15.6 | |
Undeveloped land | | | 150 | | | — | | | 1,426 | | | 621 | | | 10,153 | | | 5,849 | | | 680 | | | 18,879 | | | 12.8 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total CRE Net Charge-Offs | | $ | 2,362 | | $ | 2,123 | | $ | 6,738 | | $ | 13,871 | | $ | 24,097 | | $ | 13,539 | | $ | 32,744 | | $ | 95,474 | | | 64.8 | % |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
|
| |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | |
CRE Net Charge-Offs as % of Total Net Charge-Offs | | | 1.6 | % | | 1.4 | % | | 4.6 | % | | 9.4 | % | | 16.4 | % | | 9.2 | % | | 22.2 | % | | 64.8 | % | | | |
Securities
TSFG uses the investment securities portfolio for several purposes. It serves as a vehicle to manage interest rate 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. 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. Table 13 shows the carrying values of the investment securities portfolio.
43
|
Table 13 |
|
Investment Securities Portfolio Composition |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | | | |
| |
| | December 31, | |
| | 2008 | | 2007 | | 2007 | |
| |
| |
| |
| |
Available for Sale (at fair value) | | | | | | | | | | |
U.S. Treasury | | $ | 28,084 | | $ | 168,614 | | $ | 27,592 | |
U.S. Government agencies | | | 327,933 | | | 659,681 | | | 503,571 | |
Agency mortgage-backed securities | | | 1,312,116 | | | 1,119,547 | | | 1,088,427 | |
Private label mortgage-backed securities | | | 15,152 | | | — | | | — | |
State and municipal | | | 260,532 | | | 303,388 | | | 302,586 | |
Other investments: | | | | | | | | | | |
Corporate bonds | | | 9,855 | | | 20,680 | | | 20,380 | |
Federal Home Loan Bank (“FHLB”) stock | | | 38,478 | | | 43,060 | | | 35,333 | |
Community bank stocks | | | 1,555 | | | 4,789 | | | 4,988 | |
Other equity investments | | | 1,976 | | | 3,482 | | | 3,335 | |
| |
|
| |
|
| |
|
| |
| | | 1,995,681 | | | 2,323,241 | | | 1,986,212 | |
| |
|
| |
|
| |
|
| |
Held to Maturity (at amortized cost) | | | | | | | | | | |
State and municipal | | | 24,418 | | | 40,934 | | | 39,451 | |
Other investments | | | 100 | | | 240 | | | 240 | |
| |
|
| |
|
| |
|
| |
| | | 24,518 | | | 41,174 | | | 39,691 | |
| |
|
| |
|
| |
|
| |
Total | | $ | 2,020,199 | | $ | 2,364,415 | | $ | 2,025,903 | |
| |
|
| |
|
| |
|
| |
|
Total securities as a percentage of total assets | | | 14.8 | % | | 16.8 | % | | 14.6 | % |
| |
|
| |
|
| |
|
| |
|
Percentage of Total Securities Portfolio | | | | | | | | | | |
U.S. Treasury | | | 1.4 | % | | 7.1 | % | | 1.4 | % |
U.S. Government agencies | | | 16.2 | | | 27.9 | | | 24.8 | |
Agency mortgage-backed securities | | | 64.9 | | | 47.3 | | | 53.7 | |
Private label mortgage-backed securities | | | 0.8 | | | — | | | — | |
State and municipal | | | 14.1 | | | 14.6 | | | 16.9 | |
Other investments | | | 2.6 | | | 3.1 | | | 3.2 | |
| |
|
| |
|
| |
|
| |
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 $2.1 billion in the first nine months of 2008, 20.8% below the average for the corresponding period in 2007 of $2.6 billion.
The average tax-equivalent portfolio yield decreased for the nine months ended September 30, 2008 to 4.67% from 4.81% for the nine months ended September 30, 2007.
The expected duration of the debt securities portfolio was approximately 4.0 years at September 30, 2008, an increase from approximately 3.3 years at December 31, 2007. If interest rates rise, the duration of the debt securities portfolio may extend. Conversely, if interest rates fall, the duration of the debt securities portfolio may decline. Since total securities include callable bonds and mortgage-backed securities, security paydowns are likely to accelerate if interest rates fall or decline if interest rates rise. Changes in interest rates and related prepayment activity impact yields and fair values of TSFG’s securities.
The available for sale portfolio constituted 98.8% of total securities at September 30, 2008. 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 62% of mortgage-backed securities (“MBS”) are collateralized mortgage obligations (“CMOs”) with an average duration of 5.3 years. The majority of these securities are government agency securities. At September 30,
44
2008, approximately 14% 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 one to ten years.
In second quarter 2008, TSFG recorded $927,000 in other-than-temporary impairment on its corporate bond portfolio due to a change in intent to hold the securities until a recovery in value based on a change in investment strategy. In third quarter 2008, TSFG sold approximately $8.4 million of corporate bonds and recognized a gain on sale of approximately $129,000. In addition, in third quarter 2008, TSFG recorded $1.8 million in other-than-temporary impairment on certain community bank-related investments included in the equity investment portfolio due to the severity and/or duration of the impairment. In the nine months ended September 30, 2007, TSFG recorded $2.9 million in other-than-temporary impairment on its corporate bond portfolio. In third quarter 2007, TSFG sold approximately $70 million of corporate bonds.
At September 30, 2008, TSFG had equity investments in four community banks located in the Southeast with a fair value of $1.6 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. As mentioned above, in third quarter 2008, TSFG recorded $1.8 million in other-than-temporary impairment on certain of these investments and certain community bank-related investments included in other equity investments.
The net unrealized loss on securities available for sale (pre-tax) totaled $48.1 million at September 30, 2008, compared with a $48.8 million loss at December 31, 2007. If interest rates increase, credit spreads continue to widen, and/or market illiquidity worsens, TSFG expects its net unrealized loss on securities available for sale to increase. See Item 1, Note 5 to the Consolidated Financial Statements for information about TSFG’s securities in unrealized loss positions.
Table 14 shows the credit risk profile of the securities portfolio.
45
|
Table 14 |
|
Investment Securities Portfolio Credit Risk Profile |
|
(dollars in thousands) |
| | | | | | | | | | | | | |
| | September 30, 2008 | | December 31, 2007 | |
| |
| |
| |
| | Balance | | % of Total | | Balance | | % of Total | |
| |
| |
| |
| |
| |
Government and agency | | | | | | | | | | | | | |
U.S. Treasury | | $ | 28,084 | | | 1.4 | % | $ | 27,592 | | | 1.4 | % |
U.S. Government agencies (1) | | | 327,933 | | | 16.2 | | | 503,571 | | | 24.9 | |
Agency mortgage-backed securities (MBS) (1)(2) | | | 1,312,116 | | | 64.9 | | | 1,088,427 | | | 53.7 | |
Federal Home Loan Bank Stock | | | 38,478 | | | 1.9 | | | 35,333 | | | 1.7 | |
| |
|
| |
|
| |
|
| |
|
| |
Total government and agency | | | 1,706,611 | | | 84.4 | | | 1,654,923 | | | 81.7 | |
| |
|
| |
|
| |
|
| |
|
| |
State and municipal (3)(4)(5) | | | | | | | | | | | | | |
Pre-funded with collateral or AAA-rated backed by Texas Permanent School Fund | | | 187,635 | | | 9.3 | | | 214,675 | | | 10.6 | |
Underlying issuer or collateral rated A or better (including South Carolina State Aid) | | | 80,740 | | | 4.0 | | | 102,187 | | | 5.1 | |
Underlying issuer or collateral rated BBB | | | 7,331 | | | 0.4 | | | 12,930 | | | 0.6 | |
Non-rated | | | 9,244 | | | 0.4 | | | 12,245 | | | 0.6 | |
| |
|
| |
|
| |
|
| |
|
| |
Total state and municipal | | | 284,950 | | | 14.1 | | | 342,037 | | | 16.9 | |
| |
|
| |
|
| |
|
| |
|
| |
Corporate bonds | | | | | | | | | | | | | |
AA or A-rated | | | 9,855 | | | 0.5 | | | 17,068 | | | 0.8 | |
BBB-rated | | | — | | | — | | | 3,312 | | | 0.2 | |
| |
|
| |
|
| |
|
| |
|
| |
Total corporate bonds | | | 9,855 | | | 0.5 | | | 20,380 | | | 1.0 | |
| |
|
| |
|
| |
|
| |
|
| |
Private label mortgage-backed securities AAA-rated (2) | | | 15,152 | | | 0.8 | | | — | | | — | |
| |
|
| |
|
| |
|
| |
|
| |
Community bank stocks and other | | | 3,631 | | | 0.2 | | | 8,563 | | | 0.4 | |
| |
|
| |
|
| |
|
| |
|
| |
Total securities | | $ | 2,020,199 | | | 100.0 | % | $ | 2,025,903 | | | 100.0 | % |
| |
|
| |
|
| |
|
| |
|
| |
Percent of total securities: (4) | | | | | | | | | | | | | |
Rated A or higher | | | | | | 99.0 | % | | | | | 98.2 | % |
Investment grade | | | | | | 99.4 | | | | | | 99.0 | |
| |
(1) | At September 30, 2008, these numbers include, in the aggregate, $169.7 million and $1.3 billion related to senior debt and MBS, respectively, issued by FNMA and FHLMC. |
| |
(2) | Current policies restrict MBS/CMO purchases to agency-backed and a small percent of private-label securities and prohibit securities collateralized by sub-prime assets. |
| |
(3) | At September 30, 2008 and December 31, 2007, state and municipal securities include $24.4 million and $39.5 million, respectively, of securities held to maturity at amortized cost. |
| |
(4) | Ratings shown above do not reflect the benefit of guarantees by bond insurers. At September 30, 2008, $34.5 million of municipal bonds are guaranteed by bond insurers. At December 31, 2007, $43.5 million of municipal bonds are guaranteed by bond insurers. |
| |
(5) | At September 30, 2008, the breakdown by current bond rating is as follows: $187.6 million pre-funded with collateral or AAA-rated backed by Texas Permanent School Fund, $8.9 million AAA-rated, $83.5 million AA or A-rated, $600,000 BBB-rated, and $4.3 million non-rated. |
| |
Note: | Within each category, securities are ordered based on risk assessment from lowest to highest. TSFG holds no collateralized debt obligations, or subordinated debt or equity investments in FNMA or FHLMC. |
Investments Included in Other Assets. TSFG also invests in limited partnerships, limited liability companies (“LLCs”) and other privately held companies. These investments are included in other assets. During the first nine months of 2008, TSFG sold $1.9 million of such investments for a net gain of $4.1 million and recorded $589,000 in other-than-temporary impairment on these investments. At September 30, 2008, TSFG’s investment in these entities totaled $16.9 million, of which $4.5 million were accounted for under the cost method and $12.4 million were accounted for under the equity method.
46
Goodwill
In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), TSFG evaluates its goodwill annually for each reporting unit as of June 30th. However, the acceleration of credit deterioration in Florida prompted TSFG to perform an interim impairment evaluation of a significant portion of the recorded goodwill as of March 31, 2008. As a result of this evaluation, during first quarter 2008, TSFG recognized goodwill impairment in the Florida banking segment primarily due to increased projected credit costs and a related decrease in projected loan growth. In addition, during first quarter 2008, TSFG refined its methodology for allocating certain previously unallocated noninterest expenses to its banking segments, which resulted in higher allocated expenses to each of those segments; such costs were then utilized in the discounted cash flow analysis to determine the fair value of the Florida banking segment. The goodwill impairment charge of $188.4 million was recorded in noninterest expense in the consolidated statements of income. The fair value of the Florida reporting unit tested for impairment was determined primarily using discounted cash flow models based on internal forecasts and, to a lesser extent, market-based trading and transaction multiples. Internal forecasts include certain assumptions made by management, including expectations about growth in earning assets, credit losses, and expenses.
The goodwill impairment analysis is performed on the Company’s reporting units and closely follows its operating segments. These reporting units, as well as the assumptions and forecasts used in the discounted cash flow model and the market approach, have varying degrees of subjectivity and may not be comparable to the reporting units, assumptions, and forecasts used by other companies in evaluating their goodwill for impairment.
The annual impairment evaluation as of June 30, 2008 and a subsequent interim evaluation as of September 30, 2008 indicated that no additional impairment charge was required, and there have been no events or circumstances since quarter-end indicating impairment. Management will continue to update its analysis as circumstances change, and as market conditions continue to be volatile and unpredictable. Additional impairment charges could result in the future if continued credit deterioration occurs, if fair values continue to decline in the current environment, or if management reduces its expectations for segment cash flows.
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 trading and customer hedging programs. See Note 9 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 trading derivatives, economic hedges, and customer hedging programs are included in Other Derivatives in the table in Note 9.
In the three and nine months ended September 30, 2008, noninterest income included a loss of $199,000 and a gain of $49,000, 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.
Credit Risk of Derivative Financial Instruments. Entering into derivative financial contracts creates credit risk for potential amounts contractually due to TSFG from the derivative counterparties. Derivative credit risk is generally measured as the net replacement cost to TSFG in the event that a counterparty to a contract in a gain position to TSFG completely fails to perform under the terms of the contract. Derivative credit risk related to existing bank customers (in the case of “customer loan swaps” and foreign exchange contracts) is monitored through existing credit policies and procedures. The effects of changes in interest rates or foreign exchange rates are evaluated across a range of possible options to limit the maximum exposures to individual customers. Customer loan swaps are generally cross-collateralized with the related loan. In addition, customers may also be required to provide margin collateral to further limit TSFG’s derivative credit risk.
Counterparty credit risk with other derivative counterparties (generally money-center and super-regional financial institutions) is evaluated through existing policies and procedures. This evaluation considers the total relationship between TSFG and each of the counterparties. Individual limits are established by management and
47
approved by the credit department. Institutional counterparties must have an investment grade credit rating and be approved by TSFG’s Asset/Liability Management Committee and Executive Credit Committee.
A deterioration of the credit standing of one or more of the counterparties to these contracts may result in the related hedging relationships being deemed ineffective or in TSFG not achieving its desired economic hedging outcome.
During third quarter 2008, TSFG terminated swaps with a counterparty that was experiencing financial difficulty and replaced those swaps with a different counterparty. In addition, credit deterioration of another swap counterparty negatively affected the valuation of certain swaps during third quarter 2008, and moved the value of these swaps from Level 2 to Level 3 in the SFAS 157 hierarchy (see Note 14 to the Consolidated Financial Statements).
Deposits
Deposits remain TSFG’s primary source of funds. Average customer deposits equaled 62.0% of average total funding in the first nine months of 2008. TSFG faces 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, Federal Reserve borrowings, brokered CDs, and FHLB advances to fund a portion of loan demand and, if appropriate, any increases in investment securities.
Table 15 shows the breakdown of total deposits by type of deposit and the respective percentage of total deposits, while Table 16 shows the breakdown of customer funding by type.
|
Table 15 |
|
Type of Deposits |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | | |
| |
| | December 31,
2007 | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Noninterest-bearing demand deposits | | $ | 1,022,632 | | $ | 1,164,312 | | $ | 1,127,657 | |
Interest-bearing checking | | | 1,090,874 | | | 1,100,428 | | | 1,117,850 | |
Money market accounts | | | 1,806,143 | | | 2,184,822 | | | 2,188,261 | |
Savings accounts | | | 150,150 | | | 169,091 | | | 158,092 | |
Time deposits under $100,000 | | | 1,840,363 | | | 1,384,094 | | | 1,442,030 | |
Time deposits of $100,000 or more | | | 1,524,813 | | | 1,515,417 | | | 1,496,270 | |
| |
|
| |
|
| |
|
| |
Customer deposits (1) | | | 7,434,975 | | | 7,518,164 | | | 7,530,160 | |
Brokered deposits | | | 2,573,833 | | | 1,983,505 | | | 2,258,408 | |
| |
|
| |
|
| |
|
| |
Total deposits | | $ | 10,008,808 | | $ | 9,501,669 | | $ | 9,788,568 | |
| |
|
| |
|
| |
|
| |
Percentage of Deposits | | | | | | | | | | |
Noninterest-bearing demand deposits | | | 10.2 | % | | 12.2 | % | | 11.5 | % |
Interest-bearing checking | | | 10.9 | | | 11.6 | | | 11.4 | |
Money market accounts | | | 18.1 | | | 23.0 | | | 22.4 | |
Savings accounts | | | 1.5 | | | 1.8 | | | 1.6 | |
Time deposits under $100,000 | | | 18.4 | | | 14.6 | | | 14.7 | |
Time deposits of $100,000 or more | | | 15.2 | | | 15.9 | | | 15.3 | |
| |
|
| |
|
| |
|
| |
Customer deposits (1) | | | 74.3 | | | 79.1 | | | 76.9 | |
Brokered deposits | | | 25.7 | | | 20.9 | | | 23.1 | |
| |
|
| |
|
| |
|
| |
Total deposits | | | 100.0 | % | | 100.0 | % | | 100.0 | % |
| |
|
| |
|
| |
|
| |
| |
(1) | TSFG defines customer deposits as total deposits less brokered deposits. |
48
|
Table 16 |
|
Type of Customer Funding |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | | |
| |
| | December 31,
2007 | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Customer deposits (1) | | $ | 7,434,975 | | $ | 7,518,164 | | $ | 7,530,160 | |
Customer sweep accounts(2) | | | 551,559 | | | 599,021 | | | 648,311 | |
| |
|
| |
|
| |
|
| |
Customer funding | | $ | 7,986,534 | | $ | 8,117,185 | | $ | 8,178,471 | |
| |
|
| |
|
| |
|
| |
| |
(1) | TSFG defines customer deposits as total deposits less brokered deposits. |
| |
(2) | TSFG includes customer sweep accounts in short-term borrowings on its consolidated balance sheet. |
At September 30, 2008, period-end customer funding decreased $191.9 million, or 2.3%, from December 31, 2007, as increases in time deposits due to several promotions during the quarter were more than offset by decreases in all other customer deposit categories and customer sweeps. Public deposits totaled approximately $627 million at September 30, 2008, compared to $582 million at December 31, 2007. This increase was more than offset by a decrease in commercial deposits at September 30, 2008 relative to December 31, 2007 due in part to lower overall liquidity from commercial customers and customers seeking diversification among banks to avoid deposit levels in excess of FDIC insurance limits (which increased to $250,000 in October 2008).
TSFG plans to participate in the Temporary Liquidity Guarantee Program’s full coverage of noninterest-bearing deposit transaction accounts regardless of dollar amount through December 31, 2009 (see “Recent Market Developments”). In addition, subsequent to quarter-end, TSFG began participating in Certificate of Deposit Account Registry Services (“CDARS”), a program that allows TSFG’s customers the ability to benefit from full FDIC insurance on CD investments of up to $50 million.
While reported in short-term borrowings on the consolidated balance sheet, customer sweep accounts represent excess overnight cash from commercial customer operating accounts and are a source of funding for TSFG. Currently, sweep balances are generated through two products: 1) collateralized customer repurchase agreements ($468.4 million at September 30, 2008) and 2) uninsured Eurodollar deposits ($83.1 million at September 30, 2008). These balances are tied directly to commercial customer checking accounts, and these sweep accounts generate treasury services noninterest income.
TSFG uses brokered deposits and other borrowed funds 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 December 31, 2007 as TSFG replaced certain customer funding and other wholesale funding sources with brokered deposits.
Table 19 in “Earnings Review - Net Interest Income” details average balances for the deposit portfolio for the three and nine months ended September 30, 2008 and 2007. Comparing the nine months ended September 30, 2008 and 2007, average customer funding decreased $155.3 million, or 1.9%. Within customer funding, the mix continues to shift toward higher cost products, with increases in average time deposits and customer sweep accounts more than offset by a decrease in noninterest-bearing deposits, interest checking, savings and money markets. Average brokered deposits increased $189.3 million, or 9.4%.
Average customer funding equaled 66.9% of average total funding in the first nine months of 2008 compared to 67.1% in the first nine months of 2007. As part of its overall funding strategy, TSFG expects to continue its focus on lowering its funding costs by trying to improve the customer funding level, mix, and rate paid. TSFG attempts to enhance its deposit mix by working to attract lower-cost transaction accounts through actions such as new transaction account opening goals, new checking products, 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, together with customer behavior driving the mix towards higher rate deposit products—money markets and CDs.
Borrowed Funds
Table 17 shows the breakdown of borrowed funds by type.
49
|
Table 17 |
|
Type of Borrowed Funds |
|
(dollars in thousands) |
| | | | | | | | | | |
| | September 30, | | | |
| |
| | December 31,
2007 | |
| | 2008 | | 2007 | | |
| |
| |
| |
| |
Short-Term Borrowings | | | | | | | | | | |
Federal funds purchased and repurchase agreements | | $ | 137,927 | | $ | 595,272 | | $ | 206,216 | |
Customer sweep accounts | | | 551,559 | | | 599,021 | | | 648,311 | |
Federal Reserve borrowings | | | 30,000 | | | — | | | — | |
FHLB advances | | | — | | | 175,000 | | | — | |
Commercial paper | | | 19,068 | | | 32,601 | | | 30,828 | |
Treasury, tax and loan note | | | 450,375 | | | 668,687 | | | 752,195 | |
| |
|
| |
|
| |
|
| |
Total short-term borrowings | | | 1,188,929 | | | 2,070,581 | | | 1,637,550 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Long-Term Borrowings | | | | | | | | | | |
Repurchase agreements | | | 200,000 | | | 200,000 | | | 200,000 | |
FHLB advances | | | 298,119 | | | 223,093 | | | 223,087 | |
Subordinated notes | | | 216,704 | | | 242,478 | | | 216,704 | |
Mandatorily redeemable preferred stock of subsidiary | | | 56,800 | | | 64,800 | | | 56,800 | |
Note payable | | | 779 | | | 797 | | | 786 | |
Employee stock ownership plan note payable | | | — | | | — | | | — | |
Purchase accounting premiums, net of amortization | | | 707 | | | 1,035 | | | 963 | |
| |
|
| |
|
| |
|
| |
Total long term borrowings | | | 773,109 | | | 732,203 | | | 698,340 | |
| |
|
| |
|
| |
|
| |
Total borrowings | | | 1,962,038 | | | 2,802,784 | | | 2,335,890 | |
Less: Customer sweep accounts | | | (551,559 | ) | | (599,021 | ) | | (648,311 | ) |
Add: Brokered deposits (1) | | | 2,573,833 | | | 1,983,505 | | | 2,258,408 | |
| |
|
| |
|
| |
|
| |
Total wholesale borrowings | | $ | 3,984,312 | | $ | 4,187,268 | | $ | 3,945,987 | |
| |
|
| |
|
| |
|
| |
| | | | | | | | | | |
Wholesale borrowings as a % of total assets | | | 29.1 | % | | 29.7 | % | | 28.4 | % |
| |
(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 nine months of 2008, average borrowings totaled $2.4 billion, compared with $2.5 billion for the same period in 2007.
Period-end wholesale borrowings increased to $4.0 billion at September 30, 2008, compared to $3.9 billion at December 31, 2007 as TSFG replaced certain customer funding with brokered deposits. Average wholesale borrowings totaled $4.0 billion in the first nine months of 2008 and 2007. TSFG plans to continue efforts to lower its reliance on wholesale borrowings, principally by growth in customer funding.
Daily funding needs are met through federal funds purchased and short-term brokered CDs, term treasury, tax and loan notes (“TT&L”), repurchase agreements, Federal Reserve borrowings, and FHLB advances. Balances in these accounts can fluctuate on a day-to-day basis based on availability and overall funding needs.
In December 2007, the Federal Reserve announced the establishment of a temporary Term Auction Facility (“TAF”) in which the Federal Reserve would auction term funds to depository institutions. The program is similar to term TT&L auctions in that institutions place bids for the borrowing and the rate on the awarded amount is based on the results of the auction. The collateral used to secure the borrowings is the same that is currently held at the Discount Window (see “Liquidity”).
FHLB advances are a source of funding that TSFG uses depending on the current level of deposits and the availability of collateral to secure FHLB borrowings. At September 30, 2008, TSFG had $633.3 million of unused borrowing capacity from the FHLB. See “Liquidity” for further discussion.
50
During the first nine months of 2008, TSFG recognized a net loss on early extinguishment of debt of $339,000, primarily due to prepayment penalties for FHLB advances partially offset by gains on calls of interest rate swaps hedging brokered CDs.
Capital Resources and Dividends
Total shareholders’ equity totaled $1.5 billion, or 11.2% of total assets, at September 30, 2008 and December 31, 2007. Shareholders’ equity remained basically flat as the net loss for the first nine months of 2008 (which includes the $188.4 million goodwill impairment charge) and cash dividends paid were largely offset by the net proceeds from the issuance of Preferred Stock.
On May 8, 2008, TSFG issued $250.0 million of mandatory convertible non-cumulative preferred stock, with net proceeds of $239.0 million. The preferred securities pay dividends at an annual rate of 10%, have a conversion price of $6.50 per common share, and the remaining outstanding shares (249,000 at September 30, 2008) will convert into approximately 38.3 million common shares by May 1, 2011. Although this issuance strengthened TSFG’s overall capital and liquidity position and regulatory capital ratios, it had a dilutive effect on book value per share and tangible book value per share and will have a dilutive effect on earnings per share. (For the three and nine months ended September 30, 2008, the Preferred Stock is antidilutive and, as such, is excluded from the calculation of earnings per share.)
During third quarter 2008, 1,000 shares of Preferred Stock were converted into approximately 154,000 common shares. Subsequent to quarter-end, 5,750 shares of Preferred Stock were converted into approximately 885,000 common shares.
Common book value per common share at September 30, 2008 (assuming conversion of the Preferred Stock) and December 31, 2007 was $13.78 and $21.40, respectively. Common tangible book value per common share at September 30, 2008 (assuming conversion of the Preferred Stock) and December 31, 2007 was $9.42 and $12.04, respectively. Tangible book value was below book value as a result of goodwill and intangibles associated with acquisitions of entities and assets accounted for as purchases. Since TSFG’s net loss for the nine months ended September 30, 2008 was largely due to the $188.4 million goodwill impairment charge which was reported in first quarter 2008, book value per share decreased much more than tangible book value per share. At September 30, 2008, goodwill totaled $461.5 million, or $6.32 per share ($4.15 per share assuming conversion of the Preferred Stock), and is not being amortized, while other intangibles totaled $23.1 million and will continue to be amortized.
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 Carolina First Bank exceeded the well-capitalized regulatory requirements at September 30, 2008. 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 18 sets forth various capital ratios for TSFG and Carolina First Bank. Under current regulatory guidelines, debt associated with trust preferred securities qualifies for tier 1 capital treatment. At September 30, 2008, trust preferred securities included in tier 1 capital totaled $200.5 million.
51
| | | | | | | |
| | September 30, 2008 | | Well
Capitalized
Requirement | |
| |
| |
| |
TSFG | | | | | | | |
Total risk-based capital | | 12.68 | % | | n/a | | |
Tier 1 risk-based capital | | 11.18 | | | n/a | | |
Leverage ratio | | 9.70 | | | n/a | | |
|
Carolina First Bank | | | | | | | |
Total risk-based capital | | 11.59 | % | | 10.00 | % | |
Tier 1 risk-based capital | | 9.86 | | | 6.00 | | |
Leverage ratio | | 8.54 | | | 5.00 | | |
| | | | | | | |
The regulatory agencies have proposed rules to reduce the risk-weighting for FNMA and FHLMC securities (excluding preferred or common stock) from 20% to 10%, and to reduce the amount of the goodwill deducted from tier 1 capital by any associated deferred tax liability. If approved, management expects TSFG’s tier 1 and total capital ratios to improve. In addition, TSFG has decided to pursue capital under the TARP Capital Purchase Program (see “Recent Market Developments”), which based on the program guidelines, would range from $115 to $347 million; however, no assurance can be given that TSFG will be approved under those guidelines.
At September 30, 2008, TSFG’s tangible equity to tangible asset ratio totaled 7.94%, an increase from 6.61% at December 31, 2007, due primarily to the issuance of Preferred Stock.
Carolina First Bank is subject to certain regulatory restrictions on the amount of dividends it is permitted to pay. Currently, Carolina First Bank may not pay a dividend to TSFG without regulatory approval. TSFG presently intends to pay a quarterly cash dividend on its common stock; however, future dividends will depend upon a number of factors, including payment of the Preferred Stock dividend, financial performance, capital requirements and assessment of capital needs. On May 2, 2008, TSFG announced a reduction in its quarterly common stock cash dividend to $0.01 per share.
TSFG, through a real estate investment trust subsidiary, had 568 mandatorily redeemable preferred shares outstanding at September 30, 2008 with a stated value of $100,000 per share. At September 30, 2008, these preferred shares, which are reported as long-term debt on the consolidated balance sheet, totaled $56.8 million. Under Federal Reserve Board guidelines, $26.3 million qualified as tier 1 capital, and $18.3 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 its real estate trust subsidiary from paying dividends to Carolina First Bank, which in turn may limit its ability to pay dividends to TSFG.
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 19 presents average balance sheets and a net interest income analysis on a tax-equivalent basis for the three and nine months ended September 30, 2008 and 2007.
52
|
Table 19 |
|
Comparative Average Balances - Yields and Costs |
|
(dollars in thousands) |
| | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | |
| |
| |
| | 2008 | | 2007 | |
| |
| |
| |
| | Average
Balance | | Income/
Expense | | Yield/
Rate | | Average
Balance | | Income/
Expense | | Yield/
Rate | |
| |
| |
| |
| |
| |
| |
| |
Assets | | | | | | | | | | | | | | | | | | | |
Earning assets | | | | | | | | | | | | | | | | | | | |
Loans (1) | | $ | 10,458,765 | | $ | 155,433 | | | 5.91 | % | $ | 10,065,454 | | $ | 195,393 | | | 7.70 | % |
Investment securities, taxable (2) | | | 1,768,461 | | | 20,186 | | | 4.57 | | | 2,121,044 | | | 25,390 | | | 4.79 | |
Investment securities,
nontaxable (2) (3) | | | 290,431 | | | 3,726 | | | 5.13 | | | 351,584 | | | 4,394 | | | 5.00 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total investment securities | | | 2,058,892 | | | 23,912 | | | 4.65 | | | 2,472,628 | | | 29,784 | | | 4.82 | |
Federal funds sold and interest-bearing bank balances | | | 37,149 | | | 197 | | | 2.11 | | | 6,574 | | | 100 | | | 6.03 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total earning assets | | | 12,554,806 | | $ | 179,542 | | | 5.69 | | | 12,544,656 | | $ | 225,277 | | | 7.13 | |
| | | | |
|
| | | | | | | |
|
| | | | |
Non-earning assets | | | 1,281,130 | | | | | | | | | 1,477,862 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total assets | | $ | 13,835,936 | | | | | | | | $ | 14,022,518 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders’ Equity | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits | | | | | | | | | | | | | | | | | | | |
Interest-bearing checking | | $ | 1,130,079 | | $ | 2,481 | | | 0.87 | | $ | 1,122,793 | | $ | 5,571 | | | 1.97 | |
Savings | | | 143,014 | | | 255 | | | 0.71 | | | 172,110 | | | 697 | | | 1.61 | |
Money market | | | 1,949,001 | | | 11,293 | | | 2.31 | | | 2,236,493 | | | 22,390 | | | 3.97 | |
Time deposits, excluding brokered deposits | | | 3,259,783 | | | 30,522 | | | 3.72 | | | 2,905,426 | | | 36,594 | | | 5.00 | |
Brokered deposits | | | 2,574,430 | | | 24,520 | | | 3.79 | | | 2,208,381 | | | 29,245 | | | 5.25 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total interest-bearing deposits | | | 9,056,307 | | | 69,071 | | | 3.03 | | | 8,645,203 | | | 94,497 | | | 4.34 | |
Customer sweep accounts | | | 536,526 | | | 2,251 | | | 1.67 | | | 559,906 | | | 6,237 | | | 4.42 | |
Other borrowings (4) | | | 1,453,196 | | | 11,297 | | | 3.09 | | | 1,858,800 | | | 26,231 | | | 5.60 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total interest-bearing liabilities | | | 11,046,029 | | $ | 82,619 | | | 2.98 | | | 11,063,909 | | $ | 126,965 | | | 4.55 | |
| | | | |
|
| | | | | | | |
|
| | | | |
Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing deposits | | | 1,059,565 | | | | | | | | | 1,198,350 | | | | | | | |
Other noninterest-bearing liabilities | | | 177,735 | | | | | | | | | 240,771 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total liabilities | | | 12,283,329 | | | | | | | | | 12,503,030 | | | | | | | |
Shareholders’ equity | | | 1,552,607 | | | | | | | | | 1,519,488 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total liabilities and shareholders’ equity | | $ | 13,835,936 | | | | | | | | $ | 14,022,518 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Net interest income (tax-equivalent) | | | | | $ | 96,923 | | | 3.08 | % | | | | $ | 98,312 | | | 3.12 | % |
Less: tax-equivalent adjustment (3) | | | | | | 1,304 | | | | | | | | | 1,538 | | | | |
| | | | |
|
| | | | | | | |
|
| | | | |
Net interest income | | | | | $ | 95,619 | | | | | | | | $ | 96,774 | | | | |
| | | | |
|
| | | | | | | |
|
| | | | |
| | | | | | | | | | | | | | | | | | | |
Supplemental data: | | | | | | | | | | | | | | | | | | | |
Customer funding (5) | | $ | 8,077,968 | | $ | 46,802 | | | 2.30 | % | $ | 8,195,078 | | $ | 71,489 | | | 3.46 | % |
Wholesale
borrowings (6) | | | 4,027,626 | | | 35,817 | | | 3.54 | | | 4,067,181 | | | 55,476 | | | 5.41 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total funding (7) | | $ | 12,105,594 | | $ | 82,619 | | | 2.72 | % | $ | 12,262,259 | | $ | 126,965 | | | 4.11 | % |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
| |
(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) | During the three months ended September 30, 2008 and 2007, TSFG capitalized $424,000 and $188,000, respectively, of interest in conjunction with the construction of its expanded corporate facilities. |
| |
(5) | Customer funding includes total deposits (total interest-bearing plus noninterest-bearing deposits) less brokered deposits plus customer sweep accounts. |
| |
(6) | Wholesale borrowings include borrowings less customer sweep accounts plus brokered deposits. For purposes of this table, wholesale borrowings equal the sum of other borrowings and brokered deposits, as customer sweep accounts are presented separately. |
| |
(7) | Total funding includes customer funding and wholesale borrowings. |
| |
Note: Average balances are derived from daily balances. |
53
|
Table 19 (continued) |
|
Comparative Average Balances - Yields and Costs |
|
(dollars in thousands) |
| | | | | | | | | | | | | | | | | | | |
| | Nine Months Ended September 30, | |
| |
| |
| | 2008 | | 2007 | |
| |
| |
| |
| | Average
Balance | | Income/
Expense | | Yield/
Rate | | Average
Balance | | Income/
Expense | | Yield/
Rate | |
| |
| |
| |
| |
| |
| |
| |
Assets | | | | | | | | | | | | | | | | | | | |
Earning assets | | | | | | | | | | | | | | | | | | | |
Loans (1) | | $ | 10,384,557 | | $ | 484,677 | | | 6.23 | % | $ | 9,955,125 | | $ | 573,982 | | | 7.71 | % |
Investment securities, taxable (2) | | | 1,772,581 | | | 61,169 | | | 4.60 | | | 2,259,935 | | | 81,094 | | | 4.79 | |
Investment securities,
nontaxable (2) (3) | | | 305,312 | | | 11,683 | | | 5.10 | | | 364,692 | | | 13,526 | | | 4.95 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total investment securities | | | 2,077,893 | | | 72,852 | | | 4.67 | | | 2,624,627 | | | 94,620 | | | 4.81 | |
Federal funds sold and interest-bearing bank balances | | | 22,095 | | | 375 | | | 2.27 | | | 7,087 | | | 338 | | | 6.38 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total earning assets | | | 12,484,545 | | $ | 557,904 | | | 5.97 | | | 12,586,839 | | $ | 668,940 | | | 7.10 | |
| | | | |
|
| | | | | | | |
|
| | | | |
Non-earning assets | | | 1,365,056 | | | | | | | | | 1,500,585 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total assets | | $ | 13,849,601 | | | | | | | | $ | 14,087,424 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Liabilities and Shareholders’ Equity | | | | | | | | | | | | | | | | | | | |
Liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing liabilities | | | | | | | | | | | | | | | | | | | |
Interest-bearing deposits | | | | | | | | | | | | | | | | | | | |
Interest-bearing checking | | $ | 1,135,385 | | $ | 9,817 | | | 1.15 | | $ | 1,161,835 | | $ | 17,535 | | | 2.02 | |
Savings | | | 150,600 | | | 986 | | | 0.87 | | | 177,381 | | | 2,139 | | | 1.61 | |
Money market | | | 2,081,789 | | | 39,748 | | | 2.55 | | | 2,302,298 | | | 68,455 | | | 3.98 | |
Time deposits, excluding brokered deposits | | | 3,070,785 | | | 93,345 | | | 4.06 | | | 2,903,159 | | | 108,582 | | | 5.00 | |
Brokered deposits | | | 2,198,237 | | | 65,461 | | | 3.98 | | | 2,008,977 | | | 78,331 | | | 5.21 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total interest-bearing deposits | | | 8,636,796 | | | 209,357 | | | 3.24 | | | 8,553,650 | | | 275,042 | | | 4.30 | |
Customer sweep accounts | | | 598,186 | | | 10,344 | | | 2.31 | | | 503,676 | | | 16,746 | | | 4.45 | |
Other borrowings (4) | | | 1,816,963 | | | 45,584 | | | 3.35 | | | 2,037,836 | | | 84,585 | | | 5.55 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total interest-bearing liabilities | | | 11,051,945 | | $ | 265,285 | | | 3.21 | | | 11,095,162 | | $ | 376,373 | | | 4.54 | |
| | | | |
|
| | | | | | | |
|
| | | | |
Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing deposits | | | 1,074,100 | | | | | | | | | 1,217,798 | | | | | | | |
Other noninterest-bearing liabilities | | | 185,846 | | | | | | | | | 235,366 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total liabilities | | | 12,311,891 | | | | | | | | | 12,548,326 | | | | | | | |
Shareholders’ equity | | | 1,537,710 | | | | | | | | | 1,539,098 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
Total liabilities and shareholders’ equity | | $ | 13,849,601 | | | | | | | | $ | 14,087,424 | | | | | | | |
| |
|
| | | | | | | |
|
| | | | | | | |
| | | | | | | | | | | | | | | | | | | |
Net interest income (tax-equivalent) | | | | | $ | 292,619 | | | 3.13 | % | | | | $ | 292,567 | | | 3.11 | % |
Less: tax-equivalent adjustment (3) | | | | | | 4,089 | | | | | | | | | 4,734 | | | | |
| | | | |
|
| | | | | | | |
|
| | | | |
Net interest income | | | | | $ | 288,530 | | | | | | | | $ | 287,833 | | | | |
| | | | |
|
| | | | | | | |
|
| | | | |
| | | | | | | | | | | | | | | | | | | |
Supplemental data: | | | | | | | | | | | | | | | | | | | |
Customer funding (5) | | $ | 8,110,845 | | $ | 154,240 | | | 2.54 | % | $ | 8,266,147 | | $ | 213,457 | | | 3.45 | % |
Wholesale
borrowings (6) | | | 4,015,200 | | | 111,045 | | | 3.69 | | | 4,046,813 | | | 162,916 | | | 5.38 | |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
Total funding (7) | | $ | 12,126,045 | | $ | 265,285 | | | 2.92 | % | $ | 12,312,960 | | $ | 376,373 | | | 4.09 | % |
| |
|
| |
|
| | | | |
|
| |
|
| | | | |
| |
(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) | During the nine months ended September 30, 2008 and 2007, TSFG capitalized $1.1 million and $188,000, respectively, of interest in conjunction with the construction of its expanded corporate facilities. |
| |
(5) | Customer funding includes total deposits (total interest-bearing plus noninterest-bearing deposits) less brokered deposits plus customer sweep accounts. |
| |
(6) | Wholesale borrowings include borrowings less customer sweep accounts plus brokered deposits. For purposes of this table, wholesale borrowings equal the sum of other borrowings and brokered deposits, as customer sweep accounts are presented separately. |
| |
(7) | Total funding includes customer funding and wholesale borrowings. |
| |
Note: Average balances are derived from daily balances. |
54
Fully tax-equivalent net interest income remained constant at $292.6 million for both the first nine months of 2008 and 2007. TSFG’s average earning assets declined 0.8% to $12.5 billion for the first nine months of 2008 from $12.6 billion for the first nine months of 2007 due primarily to the planned reduction of securities which exceeded loan growth. At September 30, 2008, 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. Certain of these swaps with a notional amount of $300 million mature in fourth quarter 2008. TSFG also has an interest rate floor that is designated as a hedge of variable rate commercial loans and is intended to mitigate earnings exposure to falling interest rates.
The net interest margin for the first nine months of 2008 was 3.13%, compared with 3.11% for the first nine months of 2007, partly due to the net proceeds from the Preferred Stock issuance. The yield on average earning assets decreased 113 basis points, primarily due to decreased loan yields, which were down 148 basis points. The decrease in earning asset yields was more than offset by a decrease in the average cost of funding of 117 basis points. The Federal Reserve has decreased the federal funds target rate by 275 basis points through September 30, 2008 since September 30, 2007.
Fully tax-equivalent net interest income for third quarter 2008 totaled $96.9 million, a decrease of $4.6 million from $101.5 million for second quarter 2008 and $1.4 million from $98.3 million for third quarter 2007. The net interest margin for third quarter 2008 was 3.08%, compared to 3.24% for second quarter 2008, and 3.12% for third quarter 2007. This linked-quarter decrease was primarily due to higher funding costs driven by a change in our funding mix (a shift towards longer-term, but more expensive, funding sources) and increased reversals of interest income on loans moving to nonaccrual status. Continued actions by the Federal Reserve to reduce interest rates (together with the fact that the competitive environment may not allow TSFG to lower rates on customer deposits) and the maturity of interest rate swaps on the loan portfolio could negatively affect our net interest margin in fourth quarter 2008. Subsequent to quarter-end, the Federal Reserve has decreased the federal funds target rate by 100 basis points.
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 $221.7 million in the first nine months of 2008, compared to $36.6 million in the first nine months of 2007. The higher provision largely reflected credit deterioration due to continued weakness in housing markets, particularly in Florida, and additional specific reserves for nonperforming loans and the land development portfolios in Florida.
For third quarter 2008, the provision for credit losses totaled $84.6 million, compared to $63.8 million for second quarter 2008 and $10.5 million for third quarter 2007. Third quarter provision exceeded net loan charge-offs by $9.2 million. Management expects the level of charge-offs and provision expense to remain elevated relative to historical trends due to the current credit environment.
Net loan charge-offs were $147.4 million, or 1.90% of average loans held for investment, for the first nine months of 2008, compared with $28.9 million, or 0.39% of average loans held for investment, for the first nine months of 2007. The allowance for credit losses equaled 1.97% of loans held for investment as of September 30, 2008, compared to 1.26% for December 31, 2007 and 1.18% for September 30, 2007. See “Loans,” “Credit Quality,” and “Allowance for Loan Losses and Reserve for Unfunded Lending Commitments.”
55
Noninterest Income
Table 20 shows the components of noninterest income.
| | | | | | | | | | | | | |
Table 20 |
|
Components of Noninterest Income |
|
(dollars in thousands) |
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| |
| |
| |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| |
| |
| |
| |
| |
| | | | | | | | | |
Service charges on deposit accounts | | $ | 11,376 | | $ | 11,213 | | $ | 32,791 | | $ | 33,049 | |
Debit card income, net | | | 2,006 | | | 1,838 | | | 5,938 | | | 5,244 | |
Customer service fee income | | | 1,425 | | | 1,533 | | | 4,114 | | | 4,226 | |
| |
|
| |
|
| |
|
| |
|
| |
Total customer fee income | | | 14,807 | | | 14,584 | | | 42,843 | | | 42,519 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Insurance income | | | 2,368 | | | 2,839 | | | 7,816 | | | 9,123 | |
Retail investment services, net | | | 2,294 | | | 2,064 | | | 5,960 | | | 5,799 | |
Trust and investment management income | | | 1,728 | | | 1,642 | | | 5,251 | | | 4,970 | |
Benefits administration fees | | | 813 | | | 889 | | | 2,303 | | | 2,380 | |
| |
|
| |
|
| |
|
| |
|
| |
Total wealth management income | | | 7,203 | | | 7,434 | | | 21,330 | | | 22,272 | |
| |
|
| |
|
| |
|
| |
|
| |
|
Bank-owned life insurance income | | | 2,881 | | | 2,974 | | | 8,938 | | | 10,279 | |
Mortgage banking income | | | 879 | | | 834 | | | 4,222 | | | 4,780 | |
Gain (loss) on securities | | | (725 | ) | | 287 | | | 1,547 | | | (3,335 | ) |
Gain on Visa IPO share redemption | | | — | | | — | | | 1,904 | | | — | |
Merchant processing income, net | | | 916 | | | 928 | | | 2,582 | | | 2,434 | |
Gain (loss) on certain derivative activities | | | (199 | ) | | 198 | | | 49 | | | (1,202 | ) |
Other | | | 2,138 | | | 2,678 | | | 7,591 | | | 6,823 | |
| |
|
| |
|
| |
|
| |
|
| |
Total noninterest income | | $ | 27,900 | | $ | 29,917 | | $ | 91,006 | | $ | 84,570 | |
| |
|
| |
|
| |
|
| |
|
| |
Noninterest income increased 7.6% to $91.0 million in the first nine months of 2008 due primarily to a gain on mandatory partial redemption of shares received in the Visa IPO of $1.9 million and a net gain on securities of $1.5 million in the first nine months of 2008 compared to a $3.3 million net loss on securities in the first nine months of 2007. The 2008 gain includes other-than-temporary impairment recorded on corporate bonds, community bank-related stock, and other investments (see “Securities”), which was more than offset by other gains on sales. In addition, for the first nine months of 2008, gain on certain derivative activities totaled $49,000 versus a loss of $1.2 million for the first nine months of 2007.
Total customer fee income increased slightly in the first nine months of 2008 compared to the same period in 2007, primarily due to increased debit card usage, and merchant processing income (net of direct processing costs) increased 6.1% in the first nine months of 2008 compared to the same period in 2007 as a result of increased transactions. Bank-owned life insurance decreased in the first nine months of 2008 relative to 2007 due to the receipt of fewer life insurance proceeds.
Mortgage banking income decreased 11.7% in the first nine months of 2008 when compared to the same period in 2007. Mortgage loans originated by TSFG originators totaled $229.7 million and $412.0 million in the first nine months of 2008 and 2007, respectively. The decrease in mortgage banking income was principally the result of lower origination volumes in response to industry conditions.
For third quarter 2008, noninterest income totaled $27.9 million, compared to $32.2 million in second quarter 2008 and $29.9 million in third quarter 2007. The decrease from second quarter 2008 to third quarter 2008 was largely attributable to the swing in gains/losses on securities and lower mortgage banking income, partly offset by modest increases in service charges on deposit accounts (in keeping with seasonal trends), retail investment services, and merchant processing. The increase from third quarter 2007 to third quarter 2008 was primarily due to the swing in gains/losses on securities, derivative activities, and loss on sales of other real estate owned.
56
Noninterest Expenses
Table 21 shows the components of noninterest expenses.
| | | | | | | | | | | | | |
Table 21 |
|
Components of Noninterest Expenses |
|
(dollars in thousands) | | | | | | | | | | | | | |
| | Three Months Ended
September 30, | | Nine Months Ended
September 30, | |
| |
| |
| |
| | 2008 | | 2007 | | 2008 | | 2007 | |
| |
| |
| |
| |
| |
| | | | | | | | | |
Salaries and wages, excluding contracts and severance | | $ | 37,700 | | $ | 34,535 | | $ | 108,689 | | $ | 103,865 | |
Employee benefits | | | 9,252 | | | 8,862 | | | 27,663 | | | 27,866 | |
Occupancy | | | 9,770 | | | 8,723 | | | 27,365 | | | 25,876 | |
Furniture and equipment | | | 6,991 | | | 6,543 | | | 20,107 | | | 19,491 | |
Professional services | | | 4,573 | | | 4,278 | | | 11,679 | | | 13,295 | |
Advertising and business development | | | 2,114 | | | 1,443 | | | 7,316 | | | 5,347 | |
Regulatory assessments | | | 3,020 | | | 300 | | | 7,471 | | | 1,164 | |
Loan collection and monitoring | | | 4,112 | | | 710 | | | 7,249 | | | 1,889 | |
Amortization of intangibles | | | 1,474 | | | 1,907 | | | 4,721 | | | 6,044 | |
Telecommunications | | | 1,628 | | | 1,404 | | | 4,527 | | | 4,215 | |
Employment contracts and severance | | | 4,621 | | | — | | | 6,920 | | | 2,306 | |
Branch acquisition and conversion costs | | | — | | | — | | | 731 | | | — | |
(Gain) loss on early extinguishment of debt | | | (125 | ) | | 1,299 | | | 339 | | | 1,530 | |
Goodwill impairment | | | — | | | — | | | 188,431 | | | — | |
Visa-related litigation | | | — | | | — | | | (863 | ) | | — | |
Other | | | 8,262 | | | 8,735 | | | 26,846 | | | 27,479 | |
| |
|
| |
|
| |
|
| |
|
| |
Total noninterest expenses | | $ | 93,392 | | $ | 78,739 | | $ | 449,191 | | $ | 240,367 | |
| |
|
| |
|
| |
|
| |
|
| |
During first quarter 2008, the acceleration of credit deterioration in Florida prompted TSFG to perform an interim evaluation of the goodwill associated with its Florida banking segment. The evaluation reflected decreases in projected cash flows for the Florida banking segment, and accordingly the estimated fair value of the segment declined. This decline resulted in the recognition of a goodwill impairment charge of $188.4 million. See “Goodwill.”
Salaries and wages (excluding contracts and severance) and employee benefits increased $4.6 million, in the first nine months of 2008 compared with the same period in 2007, partially due to normal salary increases and lower loan origination salary deferrals. In addition, the number of full-time equivalent employees increased to 2,535 at September 30, 2008 from 2,457 at September 30, 2007, partly due to the acquisition of five branch offices in Orlando and three de-novo branch openings.
Employment contracts and severance increased as a result of expenses related to the retirement of Mack Whittle (see “Overview”). The incremental expense related to Whittle’s retirement benefits is approximately $12 million, of which $4.6 million was recognized in third quarter 2008, with the remaining expense to be recognized in fourth quarter 2008.
Advertising and business development increased 36.8% for the first nine months of 2008 compared with the first nine months of 2007, primarily due to costs related to customer funding initiatives. In addition, regulatory assessments increased as the credit which had been offsetting FDIC premiums for all of 2006 and the first three quarters of 2007 was fully utilized in fourth quarter 2007. FDIC insurance premiums are expected to increase based on TSFG’s decision to proceed with the Temporary Liquidity Guarantee Program related to noninterest-bearing deposit accounts (see “Recent Market Developments”) and across-the-board rate increases beginning in 2009 (designed to replenish the FDIC’s Deposit Insurance Fund). Loan collection and monitoring expense increased $5.4 million for the first nine months of 2008 compared with the first nine months of 2007 due to the current credit environment, and may continue to increase.
57
Professional services decreased by 12.2% for the first nine months of 2008 compared with the first nine months of 2007, primarily due to a decrease in legal fees and expenses related to development of TSFG’s strategic initiatives.
During the first nine months of 2008, TSFG recognized a loss on early extinguishment of debt of $339,000, which reflects prepayment penalties on FHLB advances, offset by calls of interest rate swaps hedging brokered CDs, versus a loss of $1.5 million in the first nine months of 2007. See “Borrowed Funds.”
TSFG incurred branch acquisition and conversion costs during the first half of 2008 related to the June 6, 2008 purchase of five retail branch offices in the Orlando area. This transaction also contributed to higher occupancy expense.
Third quarter 2008 noninterest expenses increased $5.8 million from second quarter 2008 and $14.7 million from third quarter 2007 due primarily to salaries and wages, loan collection and monitoring, regulatory assessments, occupancy, and expenses related to Whittle’s retirement.
Income Taxes
The effective income tax rate as a percentage of pretax income was 18.6% for the first nine months of 2008 and 32.6% for the first nine months of 2007. The 2008 tax rate was driven by the impact of the nondeductible goodwill impairment, other nontaxable and nondeductible items, and management’s projections. The effective income tax rate for fourth quarter 2008 could be significantly impacted by variances between management’s projections and actual results. The statutory U.S. federal income tax rate was 35% for both 2008 and 2007.
On an ongoing basis, TSFG evaluates its deferred tax assets for realizability (see “Critical Accounting Policies and Estimates – Income Taxes”). As of September 30, 2008, management determined that no additional valuation allowance against deferred tax assets was required.
In October 2008, TSFG was awarded a $100 million allocation under the New Markets Tax Credits (“NMTC”) program from the Community Development Financial Institution Fund (“CDFI”) of the Department of the Treasury. This award is in addition to the $100 million allocation which TSFG received in fourth quarter 2007. The program is designed to attract private-sector investment to help finance community development projects, stimulate economic growth and create jobs in lower income communities by providing tax credits to lenders who have an allocation. The NMTC provides tax credits aggregating 39% of the invested amount over seven years, although a portion of the value gained via the tax credits must be used to benefit the respective projects.
Enterprise Risk Management
Pages 51 through 54 of TSFG’s Annual Report on Form 10-K for the year ended December 31, 2007 provides a discussion of overall Enterprise Risk Management, Derivatives and Hedging Activities, Economic Risk, Operational Risk, and Compliance and Litigation Risks.
Credit Risk
Credit risk is the potential for financial loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligation. Credit risk arises in many of TSFG’s business activities, most prominently in its lending activities, derivative activities, ownership of debt securities, and when TSFG acts as an intermediary on behalf of its customers and other third parties. TSFG has a risk management system designed to help ensure compliance with its policies and control processes. See “Critical Accounting Policies and Estimates – Allowance for Loan Losses and Reserve for Unfunded Lending Commitments,” “Credit Quality,” and “Derivative Financial Instruments” for updated credit risk disclosures.
Liquidity Risks
TSFG’s business is also subject to liquidity risk, which arises in the normal course of business. TSFG’s liquidity risk is that we will be unable to meet a financial commitment to a customer, creditor, or investor when due. See “Liquidity” for updated liquidity disclosures.
58
Market Risk and Asset/Liability Management
There has been no significant change to the market risk and asset/liability management methodology as disclosed in TSFG’s 2007 Form 10-K. The interest sensitivity analysis which follows has been updated for September 30, 2008 numbers.
Interest Sensitivity Analysis. As discussed on pages 51 and 52 of TSFG’s 2007 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 22 and 23 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 22 and 23. These include, but are not limited to, the following:
| |
• | a static balance sheet for net interest 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 is based on the implied forward yield curve for each interest rate scenario; and |
| |
• | management takes no action to counter any change. |
Table 22 reflects the sensitivity of net interest income to changes in interest rates. It shows the effect that the indicated changes in interest rates would have on net interest 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 September 30, 2008 and 2007 levels, respectively.
Estimated impacts of interest rate movements are based on sensitivity over the next 12 months assuming a static balance sheet. For shorter periods, the earnings impact may be higher or lower than shown due to timing differences in repricing of assets versus liabilities or differences in timing of new asset versus liability originations.
During October, the Federal Reserve lowered the federal funds target rate by 100 basis points, to a level of 1%. As shown below, we have exposure to declining interest rates, with a 100 gradual rate decline adversely impacting net interest income by an estimated 1.2% over the next year, relative to our base case. The impact of October’s rate reductions could be more adverse to the extent the competitive environment does not allow TSFG to lower rates paid on customer deposits as assumed, in response to decline in wholesale interest rates.
Near-term, the adverse impact of lower rates may be offset by the positive impact of recent widening of spreads between two key short-term market benchmark rates. As a result of volatility in financial markets, short-term LIBOR rates rose sharply in September, with the spread between 1 month LIBOR and the federal funds target rate widening by 250 basis points. Though this spread narrowed by more than 100 basis points in recent weeks, the spread remains wider than normal, which positively impacts TSFG’s net interest income, as we have approximately $2 billion of assets for which pricing is tied to LIBOR versus only $1 billion of funding and interest rate swaps tied to LIBOR.
59
| | | | | | |
Table 22 |
|
Net Interest Income at Risk Analysis |
|
| |
Interest Rate Scenario (1) | Annualized Hypothetical Percentage Change in
Net Interest Income
September 30, |
|
|
| | | 2008 | | 2007 | |
| | |
| |
| |
2.00 | % | | 2.0 | % | (1.4 | )% |
1.00 | | | 1.0 | | (0.7 | ) |
Flat | | | — | | — | |
(1.00 | ) | | (1.2 | ) | 0.3 | |
(2.00 | ) | | n/a | | 0.7 | |
| |
(1) | Net interest income sensitivity is shown for gradual rate shifts over a 12 month period. |
Table 23 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 23 shows the effect that the indicated changes in interest rates would have on the fair value of net assets at September 30, 2008 and 2007, respectively, compared with the base case or flat interest rate scenario. The base case or flat scenario assumes interest rates stay at September 30, 2008 and 2007 levels, respectively.
| | | | | | |
Table 23 |
|
Economic Value of Equity Risk Analysis |
|
| |
Interest Rate Scenario (1) | Annualized Hypothetical Percentage Change in
Economic Value of Equity
September 30, |
|
|
| | | 2008 | | 2007 | |
| | |
| |
| |
2.00 | % | | (7.6 | )% | (10.2 | )% |
1.00 | | | (2.8 | ) | (4.3 | ) |
Flat | | | — | | — | |
(1.00 | ) | | 2.4 | | 1.4 | |
(2.00 | ) | | n/a | | (2.1 | ) |
| |
(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. |
There are material limitations with TSFG’s models presented in Tables 22 and 23, 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 interest income or the fair value of net assets, but rather the risk to net interest 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
60
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 reserve for unfunded lending commitments in other liabilities on the consolidated balance sheet. See Note 10 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 9 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.
Liquidity is managed at two levels. The first is the liquidity of the parent company, which is the holding company that owns Carolina First Bank, the banking subsidiary. The second is the liquidity of the banking subsidiary. The management of liquidity at both levels is essential because the parent company and banking subsidiary each have different funding needs and sources, and each are subject to certain regulatory guidelines and requirements. Through the Asset Liability Committee (“ALCO”), Corporate Treasury is responsible for planning and executing the funding activities and strategy.
TSFG’s liquidity policy strives to ensure a diverse funding base, with limits established by wholesale funding source as well as aggregate wholesale funding. Daily and short-term liquidity needs are principally met with deposits from customers, payments on loans, maturities and paydowns of investment securities, and wholesale borrowings, including brokered CDs, federal funds purchased (as available), repurchase agreements, and, depending on the availability of collateral, treasury tax and loan notes, and borrowings from the Federal Reserve and FHLB. In light of current market conditions, TSFG has reduced its usage of short-term unsecured wholesale borrowings. TSFG is focusing additional efforts aimed at acquiring new deposits from its customer base through its established branch network to enhance liquidity and reduce reliance on wholesale borrowing. Liquidity needs are a factor in developing the deposit pricing structure, which may be altered to retain or grow deposits if deemed necessary.
Longer term funding needs are typically met through a variety of wholesale sources, which have a broader range of maturities than customer deposits and add flexibility in liquidity planning and management. These wholesale sources include advances from the FHLB with longer maturities, brokered CDs, and instruments that qualify as regulatory capital, including trust preferred securities and subordinated debt. In addition, the Company may also issue equity capital to address liquidity or capital needs.
Under normal business conditions, the sources above are adequate to meet both the short-term and longer-term funding needs of the Company; however, TSFG’s contingency funding plan establishes early warning triggers to alert management to potentially negative liquidity trends. The plan provides a framework to manage through various scenarios – including identification of alternative actions and an executive management team to navigate through a crisis. Limits ensure that liquidity is sufficient to manage through crises of various degrees of severity, triggered by TSFG-specific events, such as significant adverse changes to earnings, credit quality or credit ratings, or general industry or market events, such as market instability or rapid adverse changes in the economy. We have no debt for which a downgrade of our credit ratings would trigger additional collateral requirements or early termination. As of September 30, 2008, we had more than $4 billion of secured liquidity reserves in the form of borrowing capacity from the Federal Reserve ($3.6 billion), FHLB ($633.3 million) and unpledged investment securities ($453.1 million), which represent
61
ample liquidity to manage through a severe liquidity scenario. Following a severe liquidity scenario, we would consider various actions to replenish liquidity, including potential asset sales.
In addition to the primary funding sources discussed above, secondary sources of liquidity include sales of investment securities which are not held for pledging purposes and other classes of assets. Securities classified as available for sale which are not pledged may be sold or pledged against new borrowings in response to changes in interest rates or liquidity needs. A significant portion of TSFG’s securities are pledged as collateral for repurchase agreements and public funds deposits, although $453.1 million was unpledged as of September 30, 2008..
Management believes that TSFG’s available borrowing capacity and efforts to grow deposits are sufficient to provide the necessary funding for the remainder of 2008 and 2009. However, management is prepared to take other actions if needed to manage through adverse liquidity conditions.
Regarding the Temporary Liquidity Guarantee Programs offered by the FDIC, TSFG will participate in the program providing full coverage of noninterest-bearing deposit transaction accounts regardless of dollar amount through December 31, 2009, and TSFG is considering participation in the program whereby the FDIC will guarantee new senior unsecured debt issued by the end of June 2009. These programs will further stabilize and strengthen our liquidity position.
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 24 summarizes future contractual obligations based on maturity dates as of September 30, 2008. Table 24 does not include payments which may be required under employment and deferred compensation agreements. In addition, Table 24 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 nine months ended September 30, 2008).
| | | | | | | | | | | | | | | | |
Table 24 |
|
Contractual Obligations |
|
(dollars in thousands) |
| |
| | Payments Due by Period | |
| |
| |
| | Total | | Remainder
of
2008 | | 2009
and
2010 | | 2011
and
2012 | | After
2012 | |
| |
| |
| |
| |
| |
| |
Time deposits | | $ | 5,939,009 | | $ | 1,464,569 | | $ | 3,956,765 | | $ | 277,463 | | $ | 240,212 | |
Short-term borrowings | | | 1,188,929 | | | 1,188,929 | | | — | | | — | | | — | |
Long-term debt | | | 772,402 | | | 41 | | | 69,948 | | | 256,416 | | | 445,997 | |
Operating leases | | | 193,347 | | | 4,831 | | | 37,813 | | | 33,599 | | | 117,104 | |
Expanded corporate facilities contracts | | | 37,252 | | | 9,173 | | | 28,079 | | | — | | | — | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
Total contractual obligations | | $ | 8,130,939 | | $ | 2,667,543 | | $ | 4,092,605 | | $ | 567,478 | | $ | 803,313 | |
| |
|
| |
|
| |
|
| |
|
| |
|
| |
TSFG has the ability to borrow from the FHLB and maintain short-term lines of credit from unrelated banks. FHLB advances outstanding as of September 30, 2008 totaled $298.1 million. At September 30, 2008, TSFG had $633.3 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, Federal Reserve borrowings, treasury tax and loan notes, and the principal run-off of investment securities. At September 30, 2008, TSFG had unused short-term lines of credit totaling $194.2 million (which may be canceled at the lender’s option and which are subject to funds availability at the lender), compared to $1.9 billion at December 31, 2007.
A collateralized borrowing relationship with the Federal Reserve Bank of Richmond is in place for Carolina First Bank. At September 30, 2008, TSFG had qualifying collateral to secure advances up to $3.6 billion, of which $30.0 million was outstanding.
TSFG 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 September 30, 2008, 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.
62
Typically, the primary sources of funding for the parent company include dividends received from its banking subsidiary, proceeds from the issuance of subordinated debt, equity, and commercial paper. Currently, dividends are not payable from Carolina First Bank to the parent without regulatory approval. The primary uses of funds for the parent company include repayment of maturing debt and commercial paper, share repurchases, dividends paid to common and preferred shareholders, and capital contributions to subsidiaries. At September 30, 2008, the parent company had one $10.0 million short-term unused line of credit. During the first nine months of 2008, two of its lines of credit totaling $25.0 million were cancelled.
During second quarter 2008, TSFG issued $250 million of mandatory convertible non-cumulative Preferred Stock (with net proceeds of $239.0 million) and reduced its quarterly common stock cash dividend to $0.01 per share in an effort to strengthen its capital and liquidity position. The parent company contributed $125 million of the preferred capital proceeds to Carolina First Bank during second quarter 2008.
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.
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.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
At September 30, 2008, 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 September 30, 2008, 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 was 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 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 its assessment during the quarter ended September 30, 2008 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
Item 1. Legal Proceedings
See Note 10 to the Consolidated Financial Statements for a discussion of legal proceedings.
Item 1A. Risk Factors
The following are additional risk factors for TSFG, to be read in conjunction with Item 1A (pages 9-11) of TSFG’s Annual Report on Form 10-K for the year ended December 31, 2007.
TSFG may be adversely affected by the soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty, or other relationships. TSFG has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks, and other institutional clients. Many of these transactions expose TSFG to credit risk in the event of a default by a counterparty or client. In addition, TSFG’s credit risk may be exacerbated when the collateral held by the Company cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the credit or derivative exposure due to the Company. Any such losses could have a material adverse affect on TSFG’s financial condition and results of operations.
Recent government actions in response to market conditions may affect TSFG. It is not clear at this time what impact EESA, the TARP Capital Purchase Program, the Temporary Liquidity Guarantee Program, or other liquidity and funding initiatives (or TSFG’s participation or non-participation in any of these) will have on TSFG. There can also be no assurance as to the impact that the above measures will have on the financial markets, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. and global economies. The failure of EESA to help stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit, or the trading price of our common stock.
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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 stock’s underlying value, and applicable regulatory, legal, and accounting matters. The following table presents information about our stock repurchases for the three months ended September 30, 2008.
| | | | | | | | | | | | | |
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 | | Approximate
Dollar Value of
Shares that
May Yet Be
Purchased
Under Plans or
Programs
(in thousands) | |
| |
| |
| |
| |
| |
July 1, 2008 to July 31, 2008 | | | — | | $ | — | | | — | | $ | — | |
August 1, 2008 to August 31, 2008 | | | 204 | (1 ) | | 6.84 | | | — | | | — | |
September 1, 2008 to September 30, 2008 | | | — | | | — | | | — | | | — | |
| |
| |
| |
| |
| |
Total | | | 204 | | $ | 6.84 | | | — | | $ | — | |
| |
| |
| |
| |
| |
| |
(1) | These shares were canceled in connection with exercise of options, vesting of restricted stock, or distribution from the deferred compensation plan. Pursuant to TSFG’s stock option plans, participants may exercise stock options by surrendering shares of TSFG common stock the participants already own or, in some cases, by surrendering fully vested stock options 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. Pursuant to TSFG’s Executive Deferred Compensation Plan, participants may tender shares of stock as payment for taxes due at the time of distribution. Shares surrendered by participants of these plans are repurchased at current market value pursuant to the terms of the applicable stock option, restricted stock, or deferred compensation plan and not pursuant to publicly announced share repurchase programs. |
Item 3. Defaults upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Securities Holders
On July 18, 2008, TSFG held a Special Meeting of Shareholders. The results of the Special Meeting of Shareholders follow.
Proposal #1 – Approve conversion terms and general voting rights of our Mandatory Convertible Non-cumulative Preferred Stock. This Proposal was approved with 40,742,129 shares, or 95.2%, voting in favor, 2,039,554 shares voting against, and 398,388 shares abstaining.
Proposal #2 – Approve adjournment of the special meeting to solicit additional proxies if there are insufficient votes at the time of the Special Meeting to adopt Proposal #1 or a quorum is not present at the time of the Special Meeting. This Proposal was approved with 37,832,623 shares, or 87.6%, voting in favor, 4,859,378 shares voting against, and 488,070 shares abstaining.
65
Item 5. Other Information
Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year
On November 3, 2008, the Board of Directors of The South Financial Group, Inc. amended its bylaws to consolidate into a single “Chairman” position, the rights and responsibilities of the positions of “Lead Independent Director” and “Chairman” set forth in its Bylaws immediately prior to such amendment.
Upon amending its Bylaws, the Board named John C. B. Smith, Jr. as Chairman, and William R. Timmons III as Vice Chairman.
Appointment of Principal Executive Officers
Solely for purposes of the Company’s filings under the Exchange Act, the Audit Committee of the Board of Directors has designated James R. Gordon, H. Lynn Harton and Christopher T. Holmes as the principal executive officers.
Item 6. Exhibits
| |
3.1 | Bylaws of TSFG |
| |
31.1 | Certificate of the Principal Executive Officers 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 |
| |
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 |
| |
32.1+ | Certificate of Principal Executive Officers pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| |
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 September 30, 2008 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.
| | |
| | The South Financial Group, Inc. |
| | |
Date: November 6, 2008 | | /s/ James R. Gordon |
| |
|
| | James R. Gordon |
| | Senior Executive Vice President and |
| | Chief Financial Officer |
| | (Duly Authorized Officer and
Principal Financial Officer) |
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