SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
Quarterly Report Pursuant to Section 13 or 15(D) of the
Securities Exchange Act of 1934
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For the Quarterly Period Ended September 30, 1999 Commission file number 333-49459
New South Bancshares, Inc.
(Exact name of registrant as specified in its charter)
- --------------------------------------------------------------------------------
Delaware
(State or other jurisdiction of 63-1132716
incorporation or organization) (I.R.S. Employer Identification No.)
1900 Crestwood Boulevard
Birmingham, Alabama 35210
(Address of Principal Executive Officers) (Zip Code)
(205) 951-4000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
NEW SOUTH BANCSHARES, INC.
FORM 10-Q
INDEX
Part I. Financial Information Page
Item 1. Financial Statements
Consolidated Balance Sheets - September 30, 1999 (unaudited) and
December 31, 1998..................................................... 2
Consolidated Income Statements (unaudited) - For the
three and nine months ended September 30, 1999 and 1998............... 3
Consolidated Statements of Cash Flows (unaudited) - For the
nine months ended September 30, 1999 and 1998......................... 4
Notes to Consolidated Financial Statements............................... 5
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations................................... 10
Part II. Other Information
Item 1. Legal Proceedings........................................................ 17
Item 6. Exhibits and Reports on Form 8-K......................................... 17
Signatures................................................................................. 18
Exhibit Index.............................................................................. 19
Part I. Financial Information
Item 1. Financial Statements
NEW SOUTH BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
1999 1998
--------------------- -------------------
(Unaudited)
(In thousands)
ASSETS
Cash and due from banks $ 44,013 $ 66,905
Time deposits in other banks 105 105
Investment securities available for sale 131,996 116,962
Loans held for sale 67,875 115,279
Loans, net of unearned income 877,587 812,877
Allowance for loan losses (10,279) (9,107)
----------- -----------
Net loans 867,308 803,770
Premises and equipment, net 9,919 7,860
Other assets 43,827 31,741
----------- -----------
Total Assets $ 1,165,043 $ 1,142,622
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest bearing $ 86,242 $ 73,873
Interest bearing 739,767 701,575
----------- -----------
Total deposits 826,009 775,448
Federal funds purchased and securities sold under
agreements to repurchase 72,571 68,800
Federal Home Loan Bank advances 163,417 198,418
Notes payable 7,790 --
Guaranteed preferred beneficial interests in the Company's
subordinated debentures 34,500 34,500
Accrued expenses, deferred revenue, and other liabilities 9,000 17,016
----------- -----------
Total Liabilities 1,113,287 1,094,182
Shareholders' Equity:
Common stock of $1.00 par value (authorized: 1.5 million shares;
issued and outstanding: 1,255,537.1 at September 30, 1999 and
1,250,189.5 at December 31, 1998) 1,256 1,250
Surplus 29,475 29,230
Retained earnings 23,229 17,909
Other comprehensive (loss)/income (2,204) 51
----------- -----------
Total Shareholders' Equity 51,756 48,440
----------- -----------
Total Liabilities and Shareholders' Equity $ 1,165,043 $ 1,142,622
=========== ===========
See accompanying notes to consolidated financial statements.
3
NEW SOUTH BANCSHARES, INC.
CONSOLIDATED INCOME STATEMENTS
(Unaudited)
Nine Months Ended Three Months Ended
September 30, September 30,
-------------------------- --------------------------
1999 1998 1999 1998
------------ ------------ ----------- ------------
(In thousands, except for per share data)
Interest Income:
Interest on securities available for sale $ 5,294 $ 10,048 $ 1,653 $ 2,671
Interest on loans 56,278 51,551 18,556 18,638
Interest on other short-term investments 692 358 108 113
-------- -------- -------- --------
Total Interest Income 62,264 61,957 20,317 21,422
Interest Expense:
Interest on deposits 29,448 28,654 9,266 9,490
Interest on federal funds purchased and securities sold
under agreements to repurchase 574 1,792 258 518
Interest on Federal Home Loan Bank advances 6,152 6,684 1,783 2,292
Interest on notes payable 102 366 40 --
Interest expense on guaranteed preferred beneficial interests in
the Company's subordinated debentures 2,199 839 732 733
-------- -------- -------- --------
Total Interest Expense 38,475 38,335 12,079 13,033
Net Interest Income 23,789 23,622 8,238 8,389
Provision for loan losses 2,674 3,067 1,241 1,543
-------- -------- -------- --------
Net Interest Income After Provision for Loan Losses 21,115 20,555 6,997 6,846
Noninterest Income:
Loan administration income 8,813 4,855 4,382 1,677
Origination fees 7,619 8,085 2,309 2,709
Gain/(loss) on sale of investment securities available for sale (10) (90) 721 167
Gain/(loss) on sale of loans 12,033 8,362 2,062 3,338
Other income 3,274 3,614 989 1,301
-------- -------- -------- --------
Total Noninterest Income 31,729 24,826 10,463 9,192
Noninterest Expense:
Salaries and benefits 25,938 18,944 8,812 6,540
Net occupancy and equipment expense 4,326 2,818 1,761 1,055
Loan servicing fees paid to affiliates 259 3,193 89 1,188
Loss/(gain) on loans serviced 248 614 144 168
Federal Deposit Insurance Corporation premiums 342 332 116 111
Other expense 14,815 9,561 5,411 3,045
-------- -------- -------- --------
Total Noninterest Expense 45,928 35,462 16,333 12,107
-------- -------- -------- --------
Income Before Income Taxes 6,916 9,919 1,127 3,931
Income tax expense 1,596 4,135 (436) 1,662
-------- -------- -------- --------
Net Income $ 5,320 $ 5,784 $ 1,563 $ 2,269
======== ======== ======== ========
Weighted average shares outstanding 1,256 1,360 1,256 1,327
Earnings per share $ 4.24 $ 4.25 $ 1.24 $ 1.71
See accompanying notes to consolidated financial statements.
4
NEW SOUTH BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended
September 30,
-----------------------------
1999 1998
-------------- ------------
(In thousands)
Operating Activities:
Net income $ 5,320 $ 5,784
Adjustments to reconcile net income to net cash (used in) provided by operations:
Accretion of discounts and fees (304) (136)
Provision for loan losses 2,674 3,067
Depreciation 1,654 680
Loss on sale of investment securities available for sale 10 90
Purchase of mortgage loans held for sale (54,703) (2,484)
Originations of mortgage loans held for sale (572,884) (680,998)
Proceeds from the sale of mortgage loans held for sale 421,838 258,423
Gain on sale of loans (12,033) (8,362)
Increase in other assets (9,812) (8,578)
Increase (Decrease) in accrued expenses, deferred
revenue and other liabilities (8,016) 5,382
--------- ---------
Net Cash Used in Operating Activities (226,256) (427,132)
Investing Activities:
Net decrease in time deposits in other banks -- 95
Proceeds from sales of investment securities available for sale 215,527 557,154
Proceeds from maturities and calls of investment securities
available for sale 47,831 62,627
Purchases of investment securities available for sale (15,606) (19,806)
Net increase in loan portfolio (65,908) (188,897)
Purchases of premises and equipment (3,875) (1,781)
Proceeds from sale of premises and equipment 162 42
Net investment in real estate owned (2,139) (666)
--------- ---------
Net Cash Provided by Investing Activities 175,992 408,768
Financing Activities:
Net increase in noninterest bearing deposits 12,369 5,189
Net increase in interest bearing deposits 38,192 59,833
Net increase (decrease) in federal funds purchased and securities
sold under agreements to repurchase 3,771 (6,000)
Net increase (decrease) in notes payable 7,790 (10,000)
Proceeds from the issuance of guaranteed preferred beneficial
interests in the Company's subordinated debentures -- 34,500
Repayments of Federal Home Loan Bank Advances (35,001) (56,001)
Net proceeds from the issuance of common stock 251 --
Repurchase and retirement of common stock -- (9,793)
--------- ---------
Net Cash Provided in Financing Activities 27,372 27,521
--------- ---------
Net decrease in cash and cash equivalents (22,892) 9,157
Cash and cash equivalents at beginning of period 66,905 16,943
--------- ---------
Cash and Cash Equivalents at End of Period $ 44,013 $ 26,100
========= =========
Supplemental information:
Interest paid $ 36,741 $ 37,623
Income taxes paid $ 178 $ 1,654
See accompanying notes to consolidated financial statements.
5
NEW SOUTH BANCSHARES, INC.
Notes to Consolidated Financial Statements
(Unaudited)
Nine Months Ended September 30, 1999 and 1998
1. General
The consolidated financial statements conform to generally accepted
accounting principles. The accompanying interim financial statements are
unaudited; however, in the opinion of management, all adjustments necessary for
the fair presentation of the consolidated financial statements have been
included. All such adjustments are of a normal recurring nature. Certain
amounts in the prior year financial statements have been reclassified to conform
with the 1999 presentation. These reclassifications had no effect on net income
and were not material to New South Bancshares, Inc.'s (the "Company" or "New
South") balance sheet. The Company is the holding company of New South Federal
Savings Bank (the "Bank"). These financial statements should be read in
conjunction with the consolidated financial statements and notes thereto
contained in the Annual Report on Form 10-K for the year ended December 31,
1998.
2. Recent Accounting Pronouncements
Start-up Costs
The AICPA has issued Statement of Position (SOP) 98-5 Reporting on the
Costs of Start-up Activities. This SOP provides guidance on the financial
reporting of start-up costs and organization costs. It requires costs of start-
up activities and organization costs to be expensed as incurred and the initial
application of this SOP should be reported as the cumulative effect of a change
in accounting principle. This SOP is effective for financial statements for
fiscal years which began after December 15, 1998. The adoption of this
statement did not have an effect on the consolidated financial position or
results of operations.
Derivative Instruments
In September 1999, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 137, Accounting for
Derivative Instruments and Hedging Activities - Deferral of the Effective Date
of FASB Statement No. 133. SFAS No. 137 defers the effective date of the
adoption of SFAS No. 133, from fiscal years beginning after September 15, 1999
to fiscal years beginning after September 15, 2000, with earlier application
encouraged.
Management does not believe that the adoption of either of these statements
will have a material impact on the presentation of the Company's financial
condition or results of operations.
3. S Corporation Election
Effective January 1, 1999, the Company elected S corporation status.
Corporations which elect to be taxed under the provisions of Subchapter S of the
Internal Revenue Code are generally not subject to corporate taxation. Profits
and losses flow through to the S corporation shareholders directly in proportion
to their per share ownership in the entity. Accordingly, shareholders are
required to include profits and losses from the Company in their individual
income tax returns for federal, state and local, if
6
applicable, income tax purposes. Due to the S corporation election, the Company
charged off $1,189,000 in deferred tax assets in the first quarter of 1999.
Typically S corporations declare dividends to shareholders in an amount
sufficient to enable shareholders to pay the tax on any S corporation income
included in the shareholders' individual income tax returns. These dividends
are generally not subject to tax since they result from S corporation income on
which shareholders have previously been taxed. While the Company presently
intends to declare dividends in an amount sufficient to enable shareholders to
pay income tax at the highest marginal federal, state and local income tax rate
of any shareholder of the Company for the applicable period, since the Company
is dependent on dividends from the Bank, there is no assurance that dividends to
shareholders can be timely made. The Bank also presently intends to declare
dividends in an amount sufficient to pay such dividends to shareholders of the
Company; however, the Bank is subject to strict regulatory and legal guidelines
regarding capital adequacy, dividend policies and other restrictions and rules
designed to ensure the safety and soundness of the Bank and the Company.
Presently, the Company has not yet quantified the impact that election of S
corporation status will have on the consolidated financial statements of the
Company.
4. Servicing Transfer
Effective January 1, 1999, the residential mortgage servicing operations,
and all of the related employees of Collateral Mortgage, Ltd. ("Collateral"), an
affiliate, were transferred to the Bank (the "Transfer"). As a result of this
Transfer, the Bank assumed responsibility for a $2.6 billion loan servicing
portfolio, of which the Bank owns the servicing rights for $1.4 billion of this
portfolio. Under the terms of the Transfer, the Bank also purchased the net
fixed assets related to the servicing operations at net book value, which
totaled approximately $220,000.
5. Avondale Funding.com, inc.
On February 17, 1999, the Bank entered into an Asset Purchase Agreement
(the "Agreement") to acquire the assets associated with the national mortgage
origination activities of Avondale Federal Savings Bank ("AFSB"). Among other
activities, AFSB originated first and second lien residential mortgages and home
equity lines of credit through an established network of brokers and
correspondents, where the application and approval process occurred primarily
over the Internet through the use of customized loan underwriting software.
Under the terms of the Agreement, the Bank issued a promissory note (the
"Note") in the amount of $1,947,000 to AFSB as consideration for the purchased
assets. The Note was subsequently reduced by $127,500 due to a refund from a
software vendor which was negotiated after closing. Interest on the note
accrues at 6% annually. Under the terms of the Note, the Bank is to make
quarterly payments of principal and interest to AFSB equal to 20 basis points of
both the aggregate original principal balance of all mortgage loans originated
and the outstanding balance of all home equity lines of credit originated
through the purchased systems subsequent to the purchase by the Bank. Payments
are to be made on the tenth day of April, July, October, and January, with the
first payment beginning on April 10, 1999, and, unless the Note is repaid in
full earlier, the final balance outstanding is to be paid on January 10, 2000.
Total payments made by the Bank for the production for the first three quarters
of 1999 amounted to approximately $272,000. During the first year of the Note,
the obligation to pay is without recourse to the Bank. In accordance with the
Agreement, the Bank was assigned the rights and obligations of all outstanding
contracts, leases, software license agreements, and all other contractual
agreements in existence at the purchase date relating to the purchased assets.
7
Concurrent with the purchase of the assets, New South organized a wholly-
owned subsidiary, Avondale Funding Corporation, to hold the purchased assets and
continue to operate the national mortgage origination business. During July
1999, Avondale Funding Corporation changed its name to Avondale Funding.com,
inc. ("Avondale").
6. Comprehensive Income
The Company has classified all of its securities as available for sale in
accordance with SFAS No. 115. As of September 30, 1999, the net unrealized loss
on these securities was $2.4 million compared to a net unrealized gain of
$206,000 at September 30, 1998. Pursuant to Statement No. 115, any unrealized
gain or loss activity of available for sale securities is to be recorded as an
adjustment to a separate component of shareholders' equity, net of income tax
effect. Accordingly, for the three and nine month periods ended September 30,
1999 and 1998, the Company recognized a corresponding adjustment as a component
of equity. Since comprehensive income is a measure of all changes in equity of
an enterprise that result from transactions and other economic events of the
period, this change in unrealized loss/gain serves to increase or decrease
comprehensive income. The following table represents comprehensive income for
the three and nine month periods ended September 30, 1999 and 1998.
For the Three Months Ended For the Nine Months Ended
September 30, 1999 September 30, 1999
--------------------------- ----------------------------
Before Before
Tax Tax After Tax Tax Tax After Tax
Amount Effect Amount Amount Effect Amount
------ ------ --------- ------ ------ ---------
(In thousands) (In thousands)
Unrealized gains (losses) arising during the period $ 184 $ 11 $ 173 $(2,358) $(141) $(2,217)
Less reclassification adjustment for (gains)
losses included in net income (771) (46) (725) (40) (2) (38)
----- ----- ----- ------- ----- -------
Net unrealized gain (loss) on securities $(587) $ (35) $(552) $(2,398) $(143) $(2,255)
===== ===== ===== ======= ===== =======
For the Three Months Ended For the Nine Months Ended
September 30, 1998 September 30, 1998
---------------------------- ----------------------------
Before Before
Tax Tax After Tax Tax Tax After Tax
Amount Effect Amount Amount Effect Amount
------ ------ --------- ------ ------ ---------
(In thousands) (In thousands)
Unrealized gains (losses) arising during the period $(140) $ (52) $ (88) $(1,142) $(423) $ (719)
Less reclassification adjustment for (gains)
losses included in net income (167) (62) (105) 90 33 57
----- ----- ----- ------- ----- --------
Net unrealized gain (loss) on securities $(307) $(114) $(193) $(1,052) $(390) $ (662)
===== ===== ===== ======= ===== ========
8
7. Trust Preferred Securities
In June 1998, the Company sold $34,500,000 of 8.5% cumulative preferred
securities issued by New South Capital Trust I (the "Trust"). These preferred
securities are collateralized by subordinated debentures issued by the Company,
and are presented on the balance sheet as a separate line entitled "Guaranteed
preferred beneficial interests in the Company's subordinated debentures." The
debentures have a stated maturity of September 30, 2028 and are subject to early
redemption after September 30, 2003.
The sole assets of the Trust are $35,567,010 in subordinated debentures,
which have the same interest rate, and maturity characteristics as the trust
preferred securities. The Company owns all of the common securities of the
Trust, which amounted to $1,067,010.
8. Segment Reporting
The Company's reportable segments consist of Residential Mortgage Banking,
Automobile Lending, and Portfolio Management.
Residential Mortgage Banking originates and services single-family mortgage
loans. These loans are originated through the Company's network of retail loan
origination offices and through brokers and correspondents. Automobile Lending
consists of originating and servicing loans on automobiles. These loans are
primarily acquired on an indirect basis through automobile dealers. Portfolio
management oversees the Company's overall portfolio of marketable assets as well
as the Bank's funding needs. Residential Mortgage Banking and Automobile
Lending sell permanent, marketable loans to Portfolio Management at market-based
prices. Portfolio Management then sells, securitizes, or retains the loans
based on the Company's needs and market conditions. Certain short-term and
floating rate loans are retained by the originating unit, which is credited with
the interest income generated by those loans. The originating unit pays a
market-based funds-use charge to Portfolio Management. The segment results also
include certain other overhead allocations. The results for the three
reportable segments of the Company are included in the following table.
For the Nine Months Ended September 30, 1999
---------------------------------------------------------------
Residential
Mortgage Automobile Portfolio
Banking Lending Management Other Consolidated
----------- ---------- ---------- ------- ------------
(In thousands)
Interest income $ 13,652 $ 158 $ 46,457 $ 1,997 $ 62,264
Interest expense 167 31 38,207 70 38,475
Intra-Company funds/use (charge)/credit (8,463) (100) 8,768 (205) 0
Provision for loan losses 41 0 2,009 624 2,674
Noninterest income 30,472 766 (1,495) 1,986 31,729
Noninterest expense 27,021 4,375 3,478 11,054 45,928
Intra-company loan service fees 1,292 556 (1,848) 0 0
Effects of intra-company loan sales (250) 926 (676) 0 0
-------- ------- -------- ------- ----------
Net income before income taxes 9,474 (2,100) 7,512 (7,970) 6,916
Provision for income taxes 2,186 (485) 1,734 (1,839) 1,596
-------- ------- -------- ------- ----------
Net Income $ 7,288 $(1,615) $ 5,778 $(6,131) $ 5,320
======== ======= ======== ======= ==========
Depreciation and amortization, net $ 2,187 $ 215 $ 395 $ 351 $ 3,148
Total assets 240,753 10,284 852,660 61,346 1,165,043
Capital expenditures 1,078 59 9 2,808 3,954
9
8. Segment Reporting (cont.)
For the Three Months Ended September 30, 1999
------------------------------------------------------------------
Residential
Mortgage Automobile Portfolio
Banking Lending Management Other Consolidated
----------- ---------- ---------- ------- ------------
(In thousands)
Interest income $ 7,430 $ 55 $ 11,633 $ 1,199 $ 20,317
Interest expense 16 10 11,988 65 12,079
Intra-Company funds/use (charge)/credit (2,913) (56) 3,044 (75) 0
Provision for loan losses 41 0 737 463 1,241
Noninterest income 9,130 179 189 965 10,463
Noninterest expense 9,164 1,496 1,379 4,294 16,333
Intra-company loan service fees 369 299 (668) 0 0
Effects of intra-company loan sales (1,837) 443 1,394 0 0
-------- ------- -------- ------- ----------
Net income before income taxes 2,958 (586) 1,488 (2,733) 1,127
Provision for income taxes (1,144) 227 (576) 1,057 (436)
-------- ------- -------- ------- ----------
Net Income $ 4,102 $ (813) $ 2,064 $(3,790) $ 1,563
======== ======= ======== ======= ==========
Depreciation and amortization, net $ 904 $ 72 $ 262 $ 137 $ 1,375
Total assets 240,753 10,284 852,860 61,346 1,165,043
Capital expenditures 310 4 9 318 641
Due to information system constraints, presentation of comparable
information for the three and nine month periods ended September 30, 1998 is not
practicable.
9. Sale of Servicing Rights
On September 30, 1999, the Company sold its servicing rights on
approximately 1,600 loans with total outstanding principal balances of $171.8
million from its servicing portfolio. The related amount of the servicing asset
reported in the accompanying consolidated financial statements associated with
the loans included in this sale totaled $2.2 million. The resulting gain on the
sale of the Company's servicing rights totaled $460,000, which is included in
the gain on loans caption in the accompanying consolidated financial statements.
10
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Basis of Presentation
The following discussion should be read in conjunction with the Company's
Consolidated Financial Statements and Notes thereto and the other financial data
included elsewhere in this document. The financial information provided below
has been rounded in order to simplify its presentation. However, the ratios and
percentages provided below are calculated using the detailed financial
information contained in the Consolidated Financial Statements, the Notes
thereto, and the other financial data included elsewhere in this document
The purpose of this discussion is to provide an analysis of significant
changes in the Company's assets, liabilities, and capital at September 30, 1999
as compared to December 31, 1998, in addition to including an analysis of income
for the three and nine months ended September 30, 1999 as compared to the same
periods ended September 30, 1998.
Financial Results for the Three and Nine Months Ended September 30, 1999
New South reported net income of $5.3 million for the nine months ended
September 30, 1999, an 8.0% decrease as compared to net income of $5.8 million
for the same period in 1998. On a per share basis, earnings were $4.24 and
$4.25, respectively, for the same periods. Year-to-date earnings resulted in an
annualized return on average assets (ROA) of .65% and an annualized return on
average equity (ROE) of 14.16% compared to .75 % and 14.39%, respectively, for
the first three quarters of 1998. New South's operating efficiency ratio
increased from 78.14% at September 30, 1998 to 86.91% at September 30, 1999, due
to additional expenses related to the acquisition and operation of Avondale and
an increase in the Bank's full time equivalent employees in the residential
mortgage production and servicing operations, installment lending, and
manufactured housing operations, which were offset by a decrease in the loan
servicing fees paid to Affiliates due to the Transfer of the residential
mortgage servicing operations from Collateral to the Bank.
Net income for the third quarter of 1999 was $1.6 million, or $1.24 per
share, compared to $2.3 million, or $1.71 per share, for the same period of
1998. ROA and ROE for the second quarter of 1999 were .61 % and 12.30%,
respectively, compared to .88 % and 18.16%, respectively, for the third quarter
of 1998. The decreases in ROA and ROE are due to the decline in interest income
on a lower average balance in mortgage-backed securities as compared to the same
period in 1998, the $436 million loan securitization completed in May 1999, and
additional expenses related to the acquisition and operation of Avondale.
Net Interest Income
Net interest income for the nine months ended September 30, 1999 was $23.8
million, a .7% increase over the same period in 1998. The Company's increase in
interest income is primarily attributable to an increase in the average balance
in the loan portfolio, offset by the decline in interest income on a lower
average balance in mortgage-backed securities, the $436 million loan
securitization completed in May 1999, and an increase in the interest expense
related to the Company's issuance of subordinated debentures at the end of the
second quarter of 1998.
Net interest income increased by $151,000 for the nine months ended
September 30, 1999, as compared to the same period in 1998. This majority of
this increase is due to a $4.7 million increase in interest income on loans
which was caused by an increase in loan production, in addition to a $334,000
11
increase in interest income on other short term investments. This increase was
offset by a $4.8 million decrease in interest income on securities available for
sale which was primarily attributable to principal paydowns received on mortgage
backed securities, in addition to the maturities of other specific securities,
which were not replaced with new security issues.
The cost of interest bearing liabilities increased by $140,000 during the
nine months ended September 30, 1999, as compared to the same period in 1998,
due to a $1.4 million increase in interest expense related to the Company's
subordinated debentures, which were issued at the end of the second quarter of
1998, and a $794,000 increase in interest expense on deposits, offset by a $1.2
million decrease in interest expense on federal funds purchased and securities
sold under agreements to repurchase, a $532,000 decrease in interest expense on
Federal Home Loan Bank (FHLB) Advances, and a $264,000 decrease in interest
expense on notes payable.
Net interest income for the three months ended September 30, 1999 was $8.2
million, a 1.8% decrease over the same period in 1998. The Company's decrease
in interest income for the three months ended September 30, 1999 is primarily
attributable to a $1.0 million decline in interest income on the lower average
balance in mortgage-backed securities, as noted above, and a decrease in the
interest expense related to the Company's lower average balance for the quarter
in FHLB Advances, federal funds purchased and securities sold under agreements
to repurchase, and deposits, as compared to the same period in 1998.
The cost of interest bearing liabilities decreased by $954,000 or 7.3%
during the three months ended September 30, 1999, as compared to the same period
in 1998. The decrease is primarily attributable to a $509,000, $260,000 and a
$224,000 decrease in interest expense related to a decrease in the outstanding
average balances of FHLB Advances, federal funds purchased and securities sold
under agreements to repurchase, and deposits, respectively.
Noninterest Income and Noninterest Expenses
Noninterest income for the nine months ended September 30, 1999 totaled
$31.7 million at September 30, 1999 compared to $24.8 million for the same
period in the prior year. Significant factors contributing to the increase
include an increase in the gain recognized on the sale of loans of approximately
$3.7 million, of which $3.2 million was attributable to the May 1999 loan
securitization, and an increase in loan administration income of $4.0 million
due to the Transfer of the residential mortgage servicing portfolio from
Collateral.
Noninterest income for the third quarter of 1999 was $10.5 million compared
to $9.2 million for the same period of the prior year. Significant factors
contributing to the $1.3 million increase was a $2.7 million increase in loan
administration income, offset by a $1.3 million decrease in the gain recognized
on the sale of loans during the quarter, as compared to the same period in 1998.
Noninterest expenses for the nine months ended September 30, 1999 totaled
$45.9 million compared to $35.5 million for the same period in 1998. The
increase is primarily attributable to increases in salaries and benefits
expense, occupancy and equipment expense, and other expense of $7.0 million,
$1.5 million and $5.3 million, respectively, from September 1998 to September
1999. These increases are related to additional expenses associated with the
acquisition and operation of Avondale, increased loan production volumes, and an
increase in the Bank's full time equivalent employees in the residential
mortgage production and servicing operations, automobile lending, and
manufactured housing operations, which were offset by a $2.9 million decrease in
the loan servicing fees paid to Affiliates due to the Transfer of the
residential mortgage servicing operations from Collateral.
12
Noninterest expenses for the second quarter of 1999 were $16.3 million
compared to $12.1 million for the same period of the prior year. Significant
increases and decreases were experienced in the same categories as discussed
above in the year-to-date analysis.
Provision and Allowance for Loan Losses
Management establishes allowances for the purpose of absorbing losses that
are inherent within the loan portfolio and that are expected to occur based on
management's review of historical losses, underwriting standards, changes in the
composition of the loan portfolio, changes in the economy, and other factors.
The allowance for loan losses is maintained at a level considered adequate to
provide for losses as determined by management's continuing review and
evaluation of the loans and its judgment as to the impact of economic conditions
on the portfolio. Charges are made to the allowance for loans that are charged
off during the year while recoveries of these amounts are credited to the
account. The Company follows a policy of charging off loans determined to be
uncollectible by management.
Additions to the allowance for loan losses, which are expensed as the
provision for loan losses on the Company's income statement, are made
periodically to maintain the allowance at an appropriate level based on
management's analysis of the inherent risk in the loan portfolio. The amount of
the provision is a function of the level of loans outstanding, the mix of the
outstanding loan portfolio, the levels of classified assets and nonperforming
loans, and current and anticipated economic conditions.
The Company's allowance for loan losses is based upon management's judgment
and assumptions regarding risk elements in the portfolio, future economic
conditions, and other factors affecting borrowers. The evaluation of the
allowance for loan losses includes management's identification and analysis of
loss inherent in various portfolio segments using a credit grading process and
specific reviews and evaluations of certain significant problem credits. In
addition, management monitors the overall portfolio quality through observable
trends in delinquencies, charge-offs, and general economic conditions in the
service area with residential mortgage and automobile loan portfolios each being
evaluated collectively for impairment. The adequacy of the allowance for loan
losses and the effectiveness of the Company's monitoring and analysis system are
also reviewed periodically by the OTS and the Company's independent auditors.
Based on present information and an ongoing evaluation, management
considers the allowance for loan losses to be adequate to meet presently known
and inherent risks in the loan portfolio. Management's judgment as to the
adequacy of the allowance is based upon a number of assumptions about future
events, which it believes to be reasonable but which may or may not be valid.
Thus, there can be no assurance that charge-offs in future periods will not
exceed the allowance for loan losses or that additional increases in the
allowance for loan losses will not be required.
At September 30, 1999, the allowance for loan losses was $10.3 million, a
12.9% increase compared to $9.1 million at December 31, 1998. The $1.2 million
increase in the allowance for loan losses during the period is primarily
attributable to the Company's increased emphasis on different types of lending
markets with higher inherent risks including manufactured housing, residential
construction lending, and home equity lines of credit through Avondale.
Interest Sensitivity
Through policies established by the Asset/Liability Management Committee
formed by the Bank's Board of Directors, the Company monitors and manages the
repricing and maturity of its assets and liabilities in order to diminish the
potential adverse impact that changes in interest rates could have on its net
interest income. The Asset/Liability Management Committee uses a combination of
traditional
13
gap analysis, which compares the repricings, maturities, and prepayments, as
applicable, of New South's interest-earning assets, interest-bearing liabilities
and off balance sheet instruments, and interest rate sensitivity analysis to
manage interest rate risk.
The Company's interest rate sensitivity analysis evaluates interest rate
risk based on the impact on the net interest income and market value of
portfolio equity ("MVPE") of various interest rate scenarios. The MVPE analysis
is required quarterly by the Office of Thrift Supervision ("OTS") by virtue of
the Company's asset size. The Company also uses an earnings simulation model to
determine the effect of several interest rate scenarios on the Company's net
interest income. New South's Asset/Liability Management Committee meets semi-
monthly to monitor and evaluate the interest rate risk position of New South,
and to formulate and implement strategies for increasing and protecting the
interest rate margin and net income.
Brokered deposits are considered to be highly interest-sensitive and are
reflected in interest rate risk analyses reviewed by the Asset/Liability
Management Committee. Additionally, both the Asset/Liability Management
Committee and the Bank's Board of Directors are apprised of the level of
brokered deposits on an ongoing basis.
For relatively short-term rate changes, New South can be characterized as
being in a well-hedged, or neutral, position. As of September 30, 1999, the
Company's interest rate risk management model indicated that projected net
interest income would decrease by 10.55% assuming an instantaneous increase in
interest rates of 200 basis points, or increase by 5.56%, assuming an
instantaneous decrease of 200 basis points. All measurements of interest rate
risk sensitivity fall within guidelines established by the Bank's Board of
Directors.
The Company uses interest rate contracts, primarily interest rate swaps and
caps, to reduce or modify interest rate risk. The impact of these instruments is
incorporated into the interest rate risk management model. The Company manages
the credit risk of its interest rate swaps, caps, and forward contracts through
(i) a review of creditworthiness of the counterparties to such contracts, (ii)
Board established credit limits for each counterparty, and (iii) monitoring by
the Asset/Liability Management Committee.
At September 30, 1999, the Bank had interest rate swap contracts with
notional amounts totaling $150 million. Of these, $115 million were
variable-for-fixed swap contracts designated as hedges against New South's loan
portfolio. These contracts effectively convert $115 million in variable rate
funding to a fixed rate, thus reducing the impact of an upward movement in
interest rates on the net interest margin.
Additionally, the Bank has entered into $35 million in fixed-for-variable
swaps concurrent with the issuance of $35 million in brokered certificates of
deposit. These swaps reduce the current cost of these liabilities, and convert
them to an adjustable rate. These swaps are callable at the option of the
counterparty. If called, the Bank has the right to call the certificates of
deposit.
In addition, the Bank had $250 million in interest rate cap contracts
outstanding at September 30, 1999. As discussed above, the Company is exposed
to rising liability costs due to the relatively short-term nature of its
liability portfolio. The interest rate cap contracts serve as hedges against
increases in costs of liabilities.
Earning Assets
14
Loans
Loans are the single largest category of earning assets and typically
provide higher yields than other categories. Total loans net of unearned income
increased $64.6 million, or 8.0%, from $812.9 million at December 31, 1998 to
$877.6 million at September 30, 1999. Total loan originations for the nine
months ended September 30, 1999 were $1.0 billion. The Bank sells a substantial
portion of its originated loans into the secondary market, primarily by
securitizing pools of loans and through sales to private investors. Such loan
sales totaled $984.4 million for the nine months ended September 30, 1999, of
which $436 million related to the loan securitization completed in May 1999.
Investment Securities
Investment securities are a significant component of the Company's total
earning assets. Total investment securities were $132.0 million at September 30,
1999, a 12.9% increase compared to $117.0 million at December 31, 1998. The
increase is primarily attributable to additional purchases of mortgage-backed
securities for liquidity management purposes and the pledging of securities for
the Company's interest rate swap and repurchase agreement transactions late in
the third quarter. At September 30, 1999, all investment securities were
classified as available for sale and recorded at market value. The Company
elected to classify its entire securities portfolio as available for sale in
order to maximize flexibility in meeting funding requirements.
Funding Sources
Deposits are the Bank's largest source of funds used to support earning
assets. The Bank has been able to attract deposits by offering nationally
competitive rates. The Bank's deposits increased $50.6 million, or 6.5%, from
$775.4 million at December 31, 1998 to $826.0 million at September 30, 1999.
This increase in deposits was primarily due to an increase in brokered
certificates of deposit and a general emphasis on building the Bank's deposit
base, in order to support and fund the overall increase in loan production
volume.
The Bank also uses FHLB Advances as an alternative low-cost funding source.
FHLB Advances are secured by a pledge of most of the Company's residential
mortgage portfolio. These Advances were $163.4 million at September 30, 1999, a
17.6% decrease compared to $198.4 million at December 31, 1998. The decrease at
September 30, 1999 is primarily attributable to the Company's application of the
proceeds from the sale of $70.7 million in consumer mortgage loans during March
1999, offset by additional draws of $25 million initiated late in the third
quarter to support and fund the Bank's continued increase in loan production
volume.
Capital
At September 30, 1999 shareholders' equity of the Company totaled $51.8
million, or 4.4% of total assets, compared to $48.4 million, or 4.2% of total
assets at December 31, 1998. The increase is primarily attributable to the net
income of $5.3 million earned during the period, offset by a $2.3 million
increase in the unrealized loss on investment securities available for sale,
included in other comprehensive income (loss) in the accompanying financial
statements.
The OTS requires thrift financial institutions to maintain capital at
adequate levels based on a percentage of assets and off-balance sheet exposures,
adjusted for risk weights ranging from 0% to 100%. Under the risk-based
standard, capital is classified into two tiers. Tier 1 capital of the Bank
consists of common stockholders' equity, excluding the unrealized gain (loss) on
securities available-for-sale, minus certain intangible assets. The Bank's Tier
2 capital consists of the general reserve for loan
15
losses subject to certain limitations. Consolidated regulatory capital
requirements do not apply to thrift holding companies. The following table sets
forth the Bank's specific capital amounts and ratios for the indicated periods.
As of As of
September 30, December 31,
Analysis of Capital 1999 1998
------------- ------------
(Dollars in thousands)
Tier 1 capital $ 91,067 $ 79,891
Tier 2 capital 4,953 3,430
-------- --------
Total qualifying capital $ 96,020 $ 83,321
======== ========
Total risk-weighted assets $854,192 $802,409
======== ========
Tier 1 leverage ratio 7.81% 7.00%
Total risk-based capital ratio 11.24% 10.38%
Tier 1 risk-based capital ratio 10.23% 9.96%
The Bank has consistently exceeded regulatory minimum guidelines and it is
the intention of management to continue to monitor these ratios to ensure
regulatory compliance and maintain adequate capital for the Bank. The Bank's
current capital ratios place it in the "well capitalized" category.
Year 2000 Project
The Year 2000 issue, which is common to most organizations, concerns the
inability of certain computer and operational systems to properly perform
calculations and process information containing four-digit date fields. New
South has developed and implemented an enterprise-wide strategy to address and
mitigate potential risks resulting from the Year 2000 issue, which encompasses
the following components. The Company's Year 2000 plan includes all
subsidiaries.
. awareness of the Year 2000 issue and communication/education of key personnel
on the approach for addressing potential problems;
. identification of significant systems, including both system hardware and
software, and interfaces to and from these systems;
. inventory and assessment of personal computers and shadow systems;
. assessment of potentially affected operational systems;
. establishment of a testing plan to test key internal systems and a
remediation plan to address any problems identified;
. evaluation, and testing when applicable, of the Year 2000 efforts of
significant vendors and outside service organizations providing processing
for the Company; and,
. development of contingency plans, where necessary, to address potential
unidentified problems in both significant internal and external systems.
The Company utilizes third party service providers for most of its critical
systems; therefore, much of the Company's remediation effort relates to
monitoring and communicating with those service providers to gain assurance that
they will be able to effectively address the Year 2000 issue. The Company has
actively participated, when possible, in the testing of the software provided by
the third party service providers. When active participation has not been
available, the Company has closely monitored the testing strategy of the
applicable service providers, and has gained assurance that their testing
procedures are adequate.
16
Because of the nature of its operations, the primary external customers of
the Company would be considered its borrowers and depositors. Although there is
a level of inherent risk that a borrower may be unable to meet its obligation to
the Company due to a Year 2000 related problem, this risk is mitigated because
the Company does not have any loans that, by themselves, would materially impact
the Company's loan portfolio. The risk is further diminished by the fact that
the Company's loans are primarily secured by asset-based collateral where the
fair market value of such property is typically equal to or greater than the
outstanding loan balance.
The Company has successfully completed the testing phase of its Year 2000
strategy which included testing of key internal systems and crucial shadow
systems which includes spreadsheets and other underlying systems. Moreover, the
Company has drafted contingency plans in the event of significant unforeseen
Year 2000 problems and/or failures in critical processing areas. These
contingency plans include written documentation of procedures necessary to
minimize losses through implementation of alternate processing procedures in an
expeditious manner. The contingency plans include such information as decision-
making authority (i.e., personnel authorized to declare existing systems
incapable of processing and, if necessary, effect the implementation of
developed contingency procedures), key personnel to be involved if contingency
plans are implemented, contact information of any outside parties to be
involved, detailed procedures necessary to implement alternate processing, and
interim controls which should be implemented while contingency plans are in
place. While contingency plans are in place, in a worst case scenario, however,
it is possible that basic utilities the Company depends on might not be
available for an extended period of time. Should this unlikely event occur, the
Company may experience significant delays in its ability to perform services.
The Company has estimated its total internal costs for the Year 2000
project to be between $1.5 million and $2.0 million, of which $1.1 million was
incurred prior to 1999 and approximately $400,000 has been incurred in fiscal
1999. Given the nature and scope of the project, it is not feasible at this
stage to estimate the degree of success of the project. However, management
believes the Company has a suitable plan in place to address the issue, and the
final outcome is not anticipated to have a material adverse effect on the
operations of the Company.
The foregoing information constitutes a Year 2000 Readiness Disclosure
pursuant to the Year 2000 Information and Readiness Disclosure Act.
Forward Looking Statements
This management discussion and analysis contains certain forward looking
information with respect to the financial condition, results of operations, and
business of the Company, including the Notes to Consolidated Financial
Statements and statements contained in the discussion above with respect to
security maturities, loan maturities, loan growth, expectations for and the
impact of interest rate changes, the adequacy of the allowance for loan losses,
expected loan losses, and the impact of inflation, unknown trends, or regulatory
action. The Company cautions readers that forward looking statements, including
without limitation those noted above, are subject to risks and uncertainties
that could cause actual results to differ materially from those indicated in the
forward looking statements. Factors that may cause actual results to differ
materially from those contemplated include, among others, the stability of
interest rates, the rate of growth of the economy in the Company's market area,
the success of the Company's marketing efforts, the ability to expand into new
segments of the market area, competition, changes in technology, the strength of
the consumer and commercial credit sectors, levels of consumer confidence, the
impact of regulation applicable to the Company, and the performance of stock and
bond markets.
17
Part II
Other Information
Item 1. Legal Proceedings
The Company, in the ordinary course of business, from time to time, has
been named in lawsuits. Certain of these lawsuits are class actions, which
request unspecified or substantial damages. In each case, a class has not yet
been certified. These matters have arisen in the normal course of business and
are related to lending, collections, servicing and other activities and allege
breach of contract, breach of fiduciary duty, and similar tort claims or
violations of federal or state laws. The Company believes that it has
meritorious defenses to these lawsuits. Although the outcome of any such
litigation cannot be predicted with certainty, management is of the opinion that
ultimate resolution of these lawsuits will not have a material adverse effect on
the Company's financial condition or results of operations.
Item 6. Exhibits and Reports on Form 8-K
ITEM 6(A)--EXHIBITS
The exhibits listed in the Exhibit Index at page 19 of this Form 10-Q are
filed herewith or are incorporated by reference herein.
ITEM 6(B)--REPORTS on Form 8-K
No report on Form 8-K was filed by the Company during the period July 1,
1999 to September 30, 1999.
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, New
South Bancshares, Inc. has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
November 12, 1999 By: /s/ ROBERT M. COUCH
---------------------------------
Robert M. Couch
Executive Vice President
November 12, 1999 By: /s/ SUZANNE H. MOORE
---------------------------------
Suzanne H. Moore
Vice President and Controller
19
EXHIBIT INDEX
The following is a list of exhibits including items incorporated by
reference:
*3.1 Certificate of Incorporation of New South Bancshares, Inc.
*3.2 By-Laws of New South Bancshares, Inc.
*4.1 Certificate of Trust of New South Capital Trust I
*4.2 Initial Trust Agreement of New South Capital Trust I
**4.3 Form of Junior Subordinated Indenture between the Company and
Bankers Trust Company, as Debenture Trustee
**10 Material Contracts
****24.1 Power of Attorney
27 Financial Data Schedule
- ----------------
* Filed with Registration Statement on Form S-1, filed April 6, 1998,
registration No. 333-49459
** Filed with Amendment No. 1 to the Registration Statement on Form S-1,
filed May 13, 1998
*** Filed with Amendment No. 2 to the Registration Statement on Form S-1,
filed May 26, 1998
****Filed with Annual Report on Form 10-K, filed April 1, 1999
20