UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- ----- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2001
TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO _______
Commission file number 0-15083
THE SOUTH FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA 57-0824914
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code (864) 255-7900
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
The number of outstanding shares of the issuer's $1.00 par value common stock as
of November 5, 2001 was 41,316,024.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30,
2001 2000 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2000
------------- ----------- ------------
ASSETS
Cash and due from banks $ 121,391 $ 127,707 $ 156,711
Interest-bearing bank balances 45,162 61,206 26,721
Federal funds sold - 425 475
Securities
Trading 6,334 4,918 5,004
Available for sale 1,092,878 832,902 816,773
Held for investment (market value $73,457, $65,609 and
$78,376, respectively) 71,783 66,339 77,767
-------------- --------------- ----------------
Total securities 1,170,995 904,159 899,544
-------------- --------------- ----------------
Loans
Loans held for sale 16,691 9,098 12,630
Loans held for investment 3,740,141 3,667,895 3,724,088
Less unearned income 521 2,190 1,536
Less allowance for loan losses 43,944 42,847 43,024
-------------- --------------- ----------------
Net loans 3,712,367 3,631,956 3,692,158
-------------- --------------- ----------------
Premises and equipment, net 107,438 119,615 112,863
Accrued interest receivable 32,278 35,251 36,879
Intangible assets 98,485 108,962 107,254
Other assets 204,763 138,834 187,949
-------------- --------------- ----------------
$ 5,492,879 $ 5,128,115 $ 5,220,554
============== =============== ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Deposits
Noninterest-bearing $ 496,353 $ 498,885 $ 491,109
Interest-bearing 3,138,304 3,260,072 3,403,553
-------------- --------------- ----------------
Total deposits 3,634,657 3,758,957 3,894,662
Borrowed funds 1,213,935 800,089 748,715
Subordinated notes 36,846 36,790 36,728
Accrued interest payable 31,104 33,755 35,168
Other liabilities 63,250 21,607 36,628
-------------- --------------- ----------------
Total liabilities 4,979,792 4,651,198 4,751,901
-------------- --------------- ----------------
Minority interest in consolidated subsidiary 37,023 - -
-------------- --------------- ----------------
Shareholders' equity
Preferred stock-no par value; authorized 10,000,000 shares;
issued and outstanding none - - -
Common stock-par value $1 per share; authorized 100,000,000
shares; issued and outstanding 41,300,221, 43,134,578
and 42,460,358 shares, respectively 41,300 43,135 42,460
Surplus 312,607 340,349 332,095
Retained earnings 105,495 86,232 90,131
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (1,766) (3,823) (2,593)
Accumulated other comprehensive income, net of tax 18,428 11,024 6,560
-------------- --------------- ----------------
Total shareholders' equity 476,064 476,917 468,653
-------------- --------------- ----------------
$ 5,492,879 $ 5,128,115 $ 5,220,554
============== =============== ================
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------ ------------------------------
2001 2000 2001 2000
---- ---- ---- ----
INTEREST INCOME
Interest and fees on loans $ 76,432 $ 85,564 $ 242,253 $ 242,217
Interest and dividends on securities:
Taxable 16,799 13,376 45,966 40,506
Exempt from Federal income taxes 1,002 1,241 2,966 3,158
-------------- ------------- -------------- -------------
Total interest and dividends on securities 17,801 14,617 48,932 43,664
Interest on short-term investments 213 528 1,181 1,560
-------------- ------------- -------------- -------------
Total interest income 94,446 100,709 292,366 287,441
-------------- ------------- -------------- -------------
INTEREST EXPENSE
Interest on deposits 33,668 43,306 118,656 116,716
Interest on borrowed funds 13,918 13,459 39,943 37,006
-------------- ------------- -------------- -------------
Total interest expense 47,586 56,765 158,599 153,722
-------------- ------------- -------------- -------------
Net interest income 46,860 43,944 133,767 133,719
PROVISION FOR LOAN LOSSES 5,476 6,709 15,584 19,136
-------------- ------------- -------------- -------------
Net interest income after provision for loan losses 41,384 37,235 118,183 114,583
NONINTEREST INCOME 12,664 6,397 38,704 29,741
NONINTEREST EXPENSES 35,324 50,326 109,775 145,343
-------------- ------------- -------------- -------------
Income (loss) before income taxes, minority
interest, extraordinary item and cumulative effect
of change in accounting principle 18,724 (6,694) 47,112 (1,019)
Income tax expense (benefit) 6,532 (3,612) 16,524 609
-------------- ------------- -------------- -------------
Income (loss) before minority interest, extraordinary
item and cumulative effect of change in
accounting principle 12,192 (3,082) 30,588 (1,628)
Minority interest in consolidated subsidiary, net of tax (503) - (905) -
-------------- ------------- -------------- -------------
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle 11,689 (3,082) 29,683 (1,628)
Extraordinary item, net of tax (689) - (689) -
Cumulative effect of change in accounting principle,
net of tax - - 282 -
-------------- ------------- -------------- -------------
NET INCOME (LOSS) $ 11,000 $ (3,082) $ 29,276 $ (1,628)
============== ============= ============== =============
AVERAGE COMMON SHARES OUTSTANDING, BASIC 42,340,019 42,901,829 42,407,504 42,896,266
AVERAGE COMMON SHARES OUTSTANDING, DILUTED 43,091,562 43,577,447 43,129,348 43,579,040
PER COMMON SHARE - BASIC:
Net income (loss) before extraordinary item and
cumulative effect of change in accounting principle $ 0.28 $ (0.07) $ 0.70 $ (0.04)
Extraordinary item (0.02) - (0.02) -
Cumulative effect of change in accounting principle - - 0.01 -
-------------- ------------- -------------- -------------
Net income (loss) $ 0.26 $ (0.07) $ 0.69 $ (0.04)
============== ============= ============== =============
PER COMMON SHARE - DILUTED:
Net income (loss) before extraordinary item and
cumulative effect of change in accounting principle $ 0.27 $ (0.07) $ 0.69 $ (0.04)
Extraordinary item (0.01) - (0.01) -
Cumulative effect of change in accounting principle - - - -
-------------- ------------- -------------- -------------
Net income (loss) $ 0.26 $ (0.07) $ 0.68 $ (0.04)
============== ============= ============== =============
CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.11 $ 0.10 $ 0.33 $ 0.30
============== ============= ============== =============
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(dollars in thousands, except share data) (Unaudited)
RETAINED ACCUMULATED
SHARES OF EARNINGS OTHER
COMMON COMMON AND COMPREHENSIVE
STOCK STOCK SURPLUS OTHER* INCOME TOTAL
----- ----- ------- ----- ------ -----
Balance, December 31, 1999 43,326,754 $ 43,327 $ 345,309 $ 95,853 $ 16,101 $ 500,590
Net loss - - - (1,628) - (1,628)
Other comprehensive loss, net of
tax of $3,648 - - - - (5,077) (5,077)
------------
Comprehensive loss - - - - - (6,705)
------------
Cash dividends declared
($0.30 per common share) - - - (12,457) - (12,457)
Common stock activity:
Repurchase of stock (524,600) (525) (7,783) - - (8,308)
Dividend reinvestment plan 102,504 103 1,310 - - 1,413
Employee stock purchase plan 13,885 14 176 - - 190
Restricted stock plan 89,792 90 1,269 (1,359) - -
Exercise of stock options and
stock warrants 126,277 126 404 - - 530
Miscellaneous (34) - (336) 2,000 - 1,664
--------------- ------------ ------------- ------------ --------------- ------------
Balance, September 30, 2000 43,134,578 $ 43,135 $ 340,349 $ 82,409 $ 11,024 $ 476,917
=============== ============ ============= ============ =============== ============
Balance, December 31, 2000 42,460,358 $ 42,460 $ 332,095 $ 87,538 $ 6,560 $ 468,653
Net income - - - 29,276 - 29,276
Other comprehensive income,
net of tax of $5,499 - - - - 11,868 11,868
------------
Comprehensive income - - - - - 41,144
------------
Cash dividends declared ($0.33 per
common share) - - - (13,912) - (13,912)
Common stock activity:
Repurchase of stock (1,450,000) (1,450) (21,668) - - (23,118)
Acquisitions 15,270 15 135 150
Dividend reinvestment plan 121,091 121 1,697 - - 1,818
Employee stock purchase plan 11,245 11 159 - - 170
Restricted stock plan (1,378) (1) (15) 561 - 545
Exercise of stock options 143,635 144 217 - - 361
Miscellaneous - - (13) 266 - 253
--------------- ------------ ------------- ------------ --------------- ------------
Balance, September 30, 2001 41,300,221 $ 41,300 $ 312,607 $ 103,729 $ 18,428 $ 476,064
=============== ============ ============= ============ =============== ============
* Other includes guarantee of employee stock ownership plan debt and nonvested restricted stock.
See accompanying notes to consolidated financial statements.
3
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2001 2000
---- ----
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ 29,276 $ (1,628)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities
Depreciation and amortization 11,681 11,219
Provision for loan losses 15,584 19,136
Impairment loss from write-down of assets 391 3,869
Impairment loss from write-down of mortgage servicing rights 510 -
Loss on changes in fair value of hedges 114 -
Loss (gain) on disposition of assets and liabilities 1,251 (2,119)
(Gain) loss on sale of securities (1,746) 5,164
Gain on equity investments (1,019) (2,133)
Gain on sale of loans (2,385) (180)
Loss on sale of other real estate owned 386 53
Loss on sale of premises and equipment 358 34
Minority interest in consolidated subsidiary 905 -
Extraordinary item 689 -
Cumulative effect of change in accounting principle (282) -
Trading account assets, net (1,122) (18)
Originations of mortgage loans held for sale (280,832) (242,652)
Sale of mortgage loans held for sale 353,175 279,190
Other assets, net (9,405) 1,800
Other liabilities, net 17,442 3,762
----------- -----------
Net cash provided by operating activities 134,971 75,497
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES
Sale of securities available for sale 262,880 106,263
Maturity or call of securities available for sale 304,522 73,215
Maturity or call of securities held for investment 11,881 14,086
Purchase of securities available for sale (711,315) (141,346)
Purchase of securities held for investment (5,897) (8,665)
Origination of loans, net (226,989) (461,014)
Sale of credit cards - 5,483
Disposition of equity investments 1,353 6,495
Sale of other real estate owned 5,666 1,401
Sale of premises and equipment 922 155
Capital expenditures (4,355) (46,088)
Disposition of assets and liabilities, net (40,880) (17,690)
----------- -----------
Net cash used for investing activities (402,212) (467,705)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES
Deposits, net (216,519) 321,493
Borrowed funds, net 465,220 103,853
Prepayment penalty on early extinguishment of debt (1,093) -
Net proceeds from issuance of minority interest stock 37,023 -
Cash dividends paid (14,002) (10,715)
Cash dividends paid on minority interest (921) -
Repurchase of common stock (23,118) (8,308)
Other common stock activity 3,297 3,797
----------- -----------
Net cash provided by financing activities 249,887 410,120
----------- -----------
Net change in cash and due from banks (17,354) 17,912
Cash and cash equivalents at beginning of year 183,907 171,426
----------- -----------
Cash and cash equivalents at end of period $ 166,553 $ 189,338
=========== ===========
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL
The foregoing unaudited consolidated financial statements include the accounts
of The South Financial Group, Inc. ("The South Group") and all of its
subsidiaries. All significant intercompany accounts and transactions are
eliminated in consolidation, and all adjustments considered necessary for a fair
presentation of the results for interim periods presented have been included
(such adjustments are normal and recurring in nature). All prior period
financial information has been restated to include historical information for
companies acquired in transactions accounted for as poolings-of-interest.
Certain prior year amounts have been reclassified to conform to 2001
presentations.
These consolidated financial statements should be read in conjunction with the
audited consolidated financial statements and notes thereto included in The
South Group's Annual Report on Form 10-K for the year ended December 31, 2000.
(2) COMPREHENSIVE INCOME
Comprehensive income is the change in The South Group's equity during the period
from transactions and other events and circumstances from non-owner sources.
Total comprehensive income consists of net income and other comprehensive
income. The South Group's other comprehensive income and accumulated other
comprehensive income are comprised of unrealized gains and losses on certain
investments in debt, equity securities, and derivatives that qualify as cash
flow hedges to the extent that the hedge is effective.
The following summarizes other comprehensive income (loss), net of tax (in
thousands) for the periods indicated:
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2001 2000
---- ----
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the year $20,270 $ (10,187)
Income tax (expense) benefit (6,531) 4,204
Less: Reclassification adjustment for (gains) losses included in net income (1,949) 1,462
Income tax expense (benefit) 679 (556)
Unrealized losses on cash flow hedges:
Cumulative effect of change in accounting principle (70) -
Income tax benefit 26 -
Unrealized loss on change in fair values (884) -
Income tax benefit 327 -
-------------- ---------------
$11,868 $ (5,077)
============== ===============
5
(3) SUPPLEMENTAL FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for other noninterest income and other
noninterest expense (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ------------------------------
2001 2000 2001 2000
---- ---- ---- ----
Other noninterest income:
Service charges on deposit accounts $ 4,568 $ 4,759 $ 13,748 $ 13,401
Mortgage banking income 927 953 5,250 3,965
Fees for investment services 1,462 1,257 4,204 4,063
Bank-owned life insurance 1,691 851 5,042 2,483
Merchant processing fees 1,657 818 4,618 2,035
Gain (loss) on sale of securities 1,201 (5,327) 1,746 (5,164)
Gain (loss) on disposition of assets and liabilities (19) 2,013 (1,251) 2,119
Gain (loss) on equity investments 17 (332) 1,019 2,133
Other 1,160 1,405 4,328 4,706
------------- ------------- -------------- --------------
Total other noninterest income $ 12,664 $ 6,397 $ 38,704 $ 29,741
============= ============= ============== ==============
Other noninterest expenses:
Personnel expense $ 17,470 $ 18,290 $ 53,971 $ 56,290
Occupancy 3,626 4,039 10,830 11,474
Furniture and equipment 3,366 3,352 10,097 8,988
Amortization of intangibles 1,423 1,600 4,425 4,824
Impairment loss from write-down of assets 176 3,869 391 3,869
Restructuring and merger-related costs
(recoveries) (89) 7,851 (502) 27,775
System conversion costs - 987 - 1,826
Other 9,352 10,338 30,563 30,297
------------- ------------- -------------- --------------
Total other noninterest expenses $ 35,324 $ 50,326 $ 109,775 $ 145,343
============= ============= ============== ==============
6
CONSOLIDATED STATEMENTS OF CASH FLOW
For purposes of reporting cash flows, cash equivalents include due from banks,
interest-bearing bank balances and Federal funds sold.
The following summarizes supplemental cash flow data (in thousands) for the
periods indicated:
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
2001 2000
---- ----
Interest paid $ 162,663 $ 143,075
Income taxes paid (refunded) (9,150) 17,391
Significant non-cash transactions are summarized as follows:
Securitization of mortgage loans 112,174 -
Loans held for investment transferred to loans held for sale 75,000 -
Loans transferred to other real estate owned 8,623 868
(4) IMPAIRMENT OF ASSETS
Based on The South Group's acquisition activity, internal growth, and
realignment plans, certain properties will not be used for future growth.
Accordingly, The South Group reviewed for impairment long-lived assets related
to abandoned properties at Carolina First Bank. As a result of this review, in
the third quarter of 2000, The South Group recorded a pre-tax impairment loss
from the write-down of assets totaling $3,869,000. The impaired assets were
written down to their net realizable value and classified as assets held for
disposal. During the nine months ended September 30, 2001, The South Group
recorded an additional impairment loss of $391,000 to update the estimated net
realizable value for the impaired assets, which were not sold as of September
30, 2001. The impairment loss included $82,000 for the write-down of land to
fair value, $176,000 for the loss associated with subletting office space at
less than the contractual lease rate and $133,000 for adjustments related to
lease termination fees for four abandoned locations. As of September 30, 2001,
assets held for sale totaled $1,181,000.
(5) MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY
Carolina First Mortgage Loan Trust (the "REIT) is a majority-owned subsidiary of
Carolina First Bank that holds real estate-related assets, including mortgage
loans. Carolina First Bank is a wholly-owned banking subsidiary of The South
Group. Carolina First Bank's ownership in the REIT is evidenced by common and
preferred equity. On February 22, 2001, Carolina First Bank sold 132 shares of
the REIT's Series 2000A Cumulative Fixed Rate Preferred Shares (the "Series A
Trust Preferred Stock") to an institutional buyer. On June 8, 2001, Carolina
First Bank sold 250 shares of the REIT's Series 2000B Cumulative Floating Rate
Preferred Shares (the "Series B Trust Preferred Stock") to an institutional
buyer. The Series A Trust Preferred Stock and Series B Trust Preferred Stock
have a stated value of $100,000 per share. Proceeds to Carolina First Bank from
these sales totaled approximately $37.0 million, net of issuance costs. This net
amount is reported as minority interest in consolidated subsidiary on the
consolidated balance sheet.
Dividends on the Series A Trust Preferred Stock and Series B Trust Preferred
Stock are cumulative, and will accrue whether or not the Carolina First Mortgage
Loan Trust has earnings, whether or not there are funds legally available for
the payment of such dividends, and whether or not such dividends are declared.
The dividends for the Series A Trust Preferred Stock are computed at a rate per
7
annum equal to 11.125% of the stated value and are payable quarterly. The
dividends for the Series B Trust Preferred Stock are computed at a rate per
annum equal to three month LIBOR plus 300 basis points of the stated value and
are payable quarterly.
The dividends earned by institutional holders of the Series A Trust Preferred
Stock and the Series B Trust Preferred Stock from February 22, 2001 to September
30, 2001 amounted to $905,000 (net of related income taxes of $542,000) and have
been expensed on The South Group's consolidated statement of income as minority
interest in consolidated subsidiary.
(6) EXTRAORDINARY ITEM
In the third quarter of 2001, The South Group recognized an extraordinary loss
on the early extinguishment of debt in the amount of $689,000 (net of related
income taxes of $404,000). This loss related to prepayment penalties for Federal
Home Loan Bank advances totaling $23.0 million with fixed interest rates ranging
from 5.41% to 5.53% due in 2008.
(7) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENT
Effective January 1, 2001, The South Group adopted the provisions of Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("SFAS 133") as amended by SFAS No. 137 and
138, which establishes accounting and reporting standards for derivatives and
hedging activities. It requires an entity to recognize all derivatives as either
assets or liabilities in the balance sheet, and measure those instruments at
fair value. Changes in the fair value of those derivatives are reported in
current earnings or other comprehensive income depending on the purpose for
which the derivative is held and whether the derivative qualifies for hedge
accounting.
At January 1, 2001, upon the adoption of SFAS 133, The South Group had the
following derivative instruments which were recorded on The South Group's
consolidated balance sheet: a warrant to purchase shares of common stock of
Affinity Technology Group, Inc. ("Affinity Warrant"), interest rate swap
agreements and fixed rate conforming residential mortgage loan commitments. The
South Group identified no embedded derivative instruments requiring separate
accounting treatment.
The cumulative effect of adopting SFAS 133 resulted in a gain of $282,000 (net
of related income taxes of $152,000) reported in the consolidated statement of
income. This gain was associated with recording the Affinity Warrant on the
consolidated balance sheet at its fair value of $434,000 on January 1, 2001. The
fair value of interest rate swap agreements that qualify as cash flow hedges,
which amounted to a loss of $70,000 as of January 1, 2001, was recorded on the
consolidated balance sheet as a charge of $44,000 (net of related taxes of
$26,000) to other comprehensive income. The fair value of interest rate swap
agreements that qualify as fair value hedges, which totaled $101,000 as of
January 1, 2001, was recorded on the consolidated balance sheet as a derivative
asset, included in other assets, with a corresponding adjustment to deposits.
The fair value of loan commitments was not significant at January 1, 2001. See
Note 8 herein for additional disclosures related to derivative financial
instruments and hedging activities.
(8) DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES
The South Group uses derivatives, classified as fair value hedges or cash flow
hedges, as part of its interest rate management activities. Fair value hedges
are associated with a recognized fixed rate asset or liability. Cash flow hedges
hedge the variability of forecasted transactions or future cash flows of a
recognized variable rate asset or liability.
8
All derivatives are recognized on the consolidated balance sheet at their fair
value. On the date the derivative contract is entered into, The South Group
designates the derivative as (1) a hedge of the fair value of a recognized asset
or liability or of an unrecognized firm commitment ("fair value hedge"), (2) a
hedge of a forecasted transaction or of the variability of cash flows to be
received or paid related to a recognized asset or liability ("cash flow hedge"),
or (3) an instrument with no hedging designation. Changes in fair value for
derivatives that qualify as fair value hedges are recorded through the
consolidated statements of income. Changes in fair value for derivatives that
qualify as cash flow hedges are recorded through other comprehensive income (net
of tax) in shareholders' equity to the extent that the hedge is effective. Any
ineffective portion of the cash flow hedges is recorded through the consolidated
statements of income. Changes in the fair value of derivative instruments with
no hedging designation are recorded through the consolidated statements of
income.
At the inception of a hedge transaction, The South Group formally documents all
relationships between hedging instruments and hedged items, as well as its
risk-management objective and strategy for undertaking the hedge. This process
includes identification of the hedging instrument, hedged item, risk being
hedged and the methodology for measuring both effectiveness and ineffectiveness.
In addition, The South Group assesses, both at the inception of the hedge and on
an ongoing quarterly basis, whether the derivative used in the hedging
transaction is highly effective in offsetting changes in fair value or cash
flows of the hedged item.
The South Group discontinues hedge accounting in accordance with SFAS 133 when:
the derivative is no longer effective in offsetting changes in the fair value or
cash flows of a hedged item; the derivative expires or is sold, terminated or
exercised; the derivative is dedesignated as a hedge instrument, because it is
unlikely that a forecasted transaction will occur; or management determines that
designation of the derivative as a hedge instrument is no longer appropriate.
On February 27, 2001, The South Group exercised the Affinity Warrant and
reclassified the derivative asset as securities available for sale based on the
fair value as of the exercise date. For the three and nine months ended
September 30, 2001, losses of $16,000 and $114,000, respectively, were
recognized in noninterest expenses for changes in fair value related to the
Affinity Warrant and derivatives with no hedging designation.
For the three and nine months ended September 30, 2001, changes in the fair
value for interest rate swaps that qualify as cash flow hedges totaled a loss of
$286,000 (net of related income tax benefit of $168,000) and $884,000 (net of
related income tax benefit of $327,000), respectively, which were recorded
through other comprehensive income. The ineffective portion was not significant
for the three and nine months ended September 30, 2001.
At September 30, 2001, the fair value of derivative assets totaled $1.9 million
and was related to derivatives with no hedging designation and fair value
hedges. At September 30, 2001, the fair value of derivative liabilities totaled
$953,000 and was attributable to cash flow hedges and fair value hedges.
9
(9) PER SHARE INFORMATION
Basic and diluted earnings per share have been computed based upon net income in
the accompanying consolidated statements of income divided by the weighted
average common shares outstanding or assumed to be outstanding as summarized
below:
THREE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------
2001 2000
---- ----
BASIC:
Average common shares outstanding (denominator) 42,340,019 42,901,829
================ ===============
DILUTED:
Average common shares outstanding (denominator) 42,340,019 42,901,829
Dilutive common stock options and warrants 751,543 675,618
---------------- ---------------
Average diluted shares outstanding 43,091,562 43,577,447
================ ===============
NINE MONTHS ENDED SEPTEMBER 30,
------------------------------------------------
2001 2000
BASIC:
Average common shares outstanding (denominator) 42,407,504 42,896,266
================ ===============
DILUTED:
Average common shares outstanding (denominator) 42,407,504 42,896,266
Dilutive common stock options and warrants 721,844 682,774
---------------- ---------------
Average diluted shares outstanding 43,129,348 43,579,040
================ ===============
(10) COMMITMENTS AND CONTINGENT LIABILITIES
The South Group is currently subject to various legal proceedings and claims
that have arisen in the ordinary course of its business. In the opinion of
management based on consultation with external legal counsel, any reasonably
foreseeable outcome of such current litigation would not materially affect The
South Group's consolidated financial position or results of operations.
On February 28, 2000, plaintiff John W. Dickens filed a breach of contract
lawsuit in the Court of Common Pleas for the Fifth Judicial Circuit against
Anchor Financial, prior to its acquisition by The South Group. The plaintiff's
amended complaint based primarily on an employment agreement sought
compensation, other benefits, and actual and punitive damages for defamation,
fraud in the inducement, negligent representation, detrimental reliance, and
alleged violations of the South Carolina Payment of Wages Act in excess of $5
million. The plaintiff was an employee of Bailey Financial Corporation, which
merged with Anchor Financial on April 9, 1999. Following the merger, the
plaintiff worked for Anchor Financial until the termination of his employment on
December 16, 1999. The South Group filed counterclaims denying the allegations
and citing parachute payment limitations as specified in Section 280G of the
Internal Revenue Code. The parties have agreed to settle the lawsuit, and The
South Group's expected payments were fully accrued for as of September 30, 2001.
A formal consummation of the settlement agreement is expected in the near
future.
10
On March 2, 1998, plaintiff Charlesetta Crockett filed a lawsuit in the South
Carolina Circuit Court for Saluda County, alleging that her son and two former
officers of Midlands National Bank, prior to its merger with Carolina First
Bank, placed mortgages on her property without her knowledge or consent. The
plaintiff complains that Carolina First Bank later learned that the mortgages
were forged but did not cancel the mortgages, and instead conveyed them to the
two former Midlands National Bank officers. The plaintiff seeks to have the
mortgages set aside and to quiet her title to the property; she also seeks
actual and punitive damages and statutory penalties in unspecified amounts.
Carolina First Bank filed its Answer on October 30, 1998, denying any liability
to the plaintiff, and has defended the suit vigorously. The case is still in the
discovery phase and has not been set for trial.
On November 4, 1996, a derivative shareholder action was filed in the South
Carolina Circuit Court for Greenville County against The South Group and several
of its officers. The complaint was subsequently amended several times. The
amended complaint names as additional defendants the majority of the directors
of The South Group and Carolina First Bank. The named plaintiffs in the amended
complaints are The South Group, pursuant to Section 33-7-400 of the South
Carolina Code of Laws, by and through several named minority shareholders.
Plaintiffs allege four causes of action based generally on the payment to the
defendant officers of a bonus in stock held by The South Group in Affinity
Technology Group, Inc. ("Affinity") as a reward for their efforts in connection
with the Affinity investment, and other matters. The complaint seeks damages for
the benefit of The South Group in the amount of $32 million. The South Group
believes that this lawsuit is without merit and has defended it vigorously. The
trial court granted the Company's motion to dismiss the lawsuit on November 26,
1997. The plaintiffs appealed. On November 1, 2000, the South Carolina Court of
Appeals affirmed the dismissal of the lawsuit. The plaintiffs have sought
further review by the South Carolina Supreme Court.
(11) BUSINESS SEGMENTS
The South Group has four wholly-owned operating subsidiaries, which are
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and assess performance. Two of these subsidiaries, by virtue
of exceeding certain quantitative thresholds, are reportable segments. The
reportable segments, Carolina First Bank and Citrus Bank, engage in general
banking business focusing on commercial, consumer and mortgage lending to small
and middle market businesses and consumers in their market areas. The reportable
segments also provide demand transaction accounts and time deposit accounts to
businesses and individuals. Carolina First Bank offers products and services
primarily to customers in South Carolina, coastal North Carolina and on the
Internet. Citrus Bank offers products and services primarily to customers in its
market areas in northern and central Florida. Revenues for Carolina First Bank
and Citrus Bank are derived primarily from interest and fees on loans, interest
on investment securities and service charges on deposits. No single customer
accounts for a significant amount of the revenues of either reportable segment.
The South Group evaluates performance based on budget to actual comparisons and
segment profits. The accounting policies of the reportable segments are the same
as those described in The South Group's Annual Report on Form 10-K for the year
ended December 31, 2000.
Segment information is shown in the tables below. The "Other" column includes
all other business activities that did not meet the quantitative thresholds and
therefore are not shown as a reportable segment.
11
INCOME STATEMENT SEGMENT DATA (IN THOUSANDS)
CAROLINA CITRUS ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
THREE MONTHS ENDED SEPTEMBER 30, 2001:
Net interest income $ 40,903 $ 6,781 $ (824) $ - $ 46,860
Provision for loan losses 4,168 1,325 (17) - 5,476
Noninterest income 9,522 1,077 14,224 (12,159) 12,664
Noninterest expense 30,077 4,947 12,459 (12,159) 35,324
Amortization 1,370 - 53 - 1,423
Income tax expense 5,621 545 366 - 6,532
Minority interest in consolidated
subsidiary, net of tax (503) - - - (503)
Extraordinary item, net of tax (689) - - - (689)
Net income 9,367 1,041 592 - 11,000
THREE MONTHS ENDED SEPTEMBER 30, 2000:
Net interest income $ 38,028 $ 5,993 $ (109) $ 32 $ 43,944
Provision for loan losses 5,816 541 352 - 6,709
Noninterest income 4,309 392 14,857 (13,161) 6,397
Noninterest expense 44,081 4,966 14,408 (13,129) 50,326
Amortization 1,548 - 52 - 1,600
Income tax expense (benefit) (2,085) 308 (1,835) - (3,612)
Net income (loss) (5,475) 570 1,823 - (3,082)
NINE MONTHS ENDED SEPTEMBER 30, 2001:
Net interest income $117,990 $18,166 $(2,389) $ - $ 133,767
Provision for loan losses 11,107 4,269 208 - 15,584
Noninterest income 28,500 2,485 46,233 (38,514) 38,704
Noninterest expense 94,078 14,357 39,854 (38,514) 109,775
Amortization 4,267 - 158 - 4,425
Income tax expense 14,989 701 834 - 16,524
Minority interest in consolidated
subsidiary, net of tax (905) - - - (905)
Extraordinary item, net of tax (689) - - - (689)
Cumulative effect of change in
accounting principal, net of tax - - 282 - 282
Net income 24,722 1,324 3,230 - 29,276
12
CAROLINA CITRUS ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
NINE MONTHS ENDED SEPTEMBER 30, 2000:
Net interest income $ 117,047 $16,774 $ (102) $ - $ 133,719
Provision for loan losses 15,981 1,771 1,384 - 19,136
Noninterest income 20,357 1,234 39,215 (31,065) 29,741
Noninterest expense 126,315 14,203 35,890 (31,065) 145,343
Amortization 4,657 - 167 - 4,824
Income tax expense 409 716 (516) - 609
Net income (loss) (5,301) 1,318 2,355 - (1,628)
BALANCE SHEET SEGMENT DATA (IN THOUSANDS)
CAROLINA CITRUS ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
SEPTEMBER 30, 2001:
Total assets $ 4,795,670 $ 746,567 $ 599,933 $ (649,291) $ 5,492,879
Loans - net of unearned income 3,137,723 613,734 4,854 - 3,756,311
Deposits 3,105,502 554,969 - (25,814) 3,634,657
SEPTEMBER 30, 2000:
Total assets $ 4,592,314 $ 505,727 $ 578,333 $ (548,259) $ 5,128,115
Loans - net of unearned income 3,225,579 437,799 11,425 - 3,674,803
Deposits 3,341,818 425,053 - (7,914) 3,758,957
(12) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, except for the
consolidated balance sheet at December 31, 2000. In the opinion of management,
all adjustments necessary to present a fair statement of the results for the
interim periods have been made. All such adjustments are of a normal, recurring
nature.
13
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
consolidated financial statements and related notes and with the statistical
information and financial data appearing in this report as well as the Annual
Report of The South Financial Group, Inc. ("The South Group", "we", "us", or
"our") on Form 10-K for the year ended December 31, 2000. Results of operations
for the three and nine month periods ended September 30, 2001 are not
necessarily indicative of results that may be attained for any other period.
The South Group, a South Carolina corporation headquartered in Greenville, South
Carolina, is a financial holding company, which commenced banking operations in
December 1986, and conducted business through 69 locations in South Carolina, 5
locations in North Carolina and 15 locations in northern and central Florida as
of September 30, 2001. The South Group operates through the following principal
subsidiaries: Carolina First Bank, a South Carolina state-chartered commercial
bank; Citrus Bank, a Florida state-chartered commercial bank; and Carolina First
Mortgage Company ("CF Mortgage"), a mortgage banking company. Through our
subsidiaries, we provide a full range of banking services, including mortgage,
trust and investment services, designed to meet substantially all of the
financial needs of our customers.
Prior year amounts, except cash dividends declared per common share, have been
restated to reflect prior acquisitions, including the June 6, 2000 merger with
Anchor Financial Corporation ("Anchor Financial"). The merger was accounted for
as a pooling-of-interests. Percentage calculations contained herein have been
calculated based upon actual, not rounded, results.
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements (as defined in the
Private Securities Litigation Reform Act of 1995) to assist in the understanding
of anticipated future operating and financial performance, growth opportunities,
growth rates, and other similar forecasts and statements of expectations. These
forward-looking statements reflect current views, but are based on assumptions
and are subject to risks, uncertainties and other factors, which may cause
actual results to differ materially from those in such statements. These factors
include, but are not limited to, the following: risks from changes in economic,
monetary policy and industry conditions; changes in interest rates, deposit
rates, the net interest margin and funding sources; market risk; inflation;
risks inherent in making loans including repayment risks and value of
collateral; loan growth; adequacy of the allowance for loan losses and the
assessment of problem loans; fluctuations in consumer spending; the demand for
our products and services; dependence on senior management; technological
changes; ability to increase market share; expense projections; estimates of
impairment loss; acquisitions; risks, realization of costs savings and total
financial performance associated with our merger with Anchor Financial; changes
in accounting policies and practices; costs and effects of litigation; and
recently-enacted or proposed legislation.
Such forward-looking statements speak only as of the date on which such
statements are made. We undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made to reflect the occurrence of unanticipated events. In
addition, certain statements in future filings by us with the Securities and
Exchange Commission, in press releases and in oral and written statements made
by or with the approval of The South Group which are not statements of
historical fact constitute forward-looking statements.
14
EARNINGS REVIEW
OVERVIEW
Net income for the nine months ended September 30, 2001 was $29.3 million, or
$0.68 per diluted share. The South Group reported a net loss of $1.6 million, or
$0.04 per diluted share, for the nine months ended September 30, 2000.
Restructuring and merger-related costs related to the June 2000 merger with
Anchor Financial, which totaled $27.8 for the nine months ended September 30,
2000, had a significant impact on the 2000 results.
Net income for the nine months ended September 30, 2001 included the following
pre-tax other items: $1.5 million gain on sale of available for sale securities,
$1.3 million loss on disposition of assets and liabilities, $1.1 million
extraordinary loss on the early extinguishment of debt, $1.0 million gain on
equity investments, $502,000 recovery of merger-related costs related to the
sale of real estate, $434,000 cumulative effect of adopting SFAS 133 and
$391,000 impairment loss from write-down of assets. For the first nine months of
2000, net income included the following pre-tax other items: $27.8 million for
restructuring and merger-related costs, $5.4 million loss on sale of available
for sale securities primarily from restructuring the investment portfolio
following the Anchor Financial merger, $3.9 million impairment loss from
write-down of assets, $3.0 million loan loss provision to apply the reserve
analysis methodology to Anchor Financial's loan portfolio, $2.1 million gain on
equity investments, $2.1 million gain on disposition of assets and liabilities
and $1.8 million for system conversion costs. Other key factors responsible for
The South Group's results of operations are discussed throughout Management's
Discussion and Analysis below.
At September 30, 2001, The South Group had approximately $5.5 billion in assets,
$3.7 billion in loans, $3.6 billion in deposits and $476.1 million in
shareholders' equity. At September 30, 2001, the ratio of nonperforming assets
to loans and other real estate owned was 1.07%.
NET INTEREST INCOME
Net interest income is the difference between the interest earned on assets and
the interest paid for the liabilities to support such assets as well as such
items as loan fees and dividend income. The net interest margin measures how
effectively a company manages the difference between the yield on earning assets
and the rate paid on funds to support those assets. Fully tax-equivalent net
interest income adjusts the yield for assets earning tax-exempt income to a
comparable yield on a taxable basis. Table 1 presents average balance sheets and
a net interest income analysis on a tax equivalent basis for the three and nine
months ended September 30, 2001 and 2000.
15
TABLE 1
- -------------------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- -------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED SEPTEMBER 30,
--------------------------------------------------------------------
2001 2000
-------------------------------- --------------------------------
AVERAGE/ INCOME/ YIELD/ AVERAGE/ INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- ---- ------- ------- ----
ASSETS
Earning assets
Loans (net of unearned income) (1) $3,741,496 $76,432 8.10 % $3,627,125 $85,564 9.38 %
Investment securities (taxable) (2) 1,046,714 16,799 6.00 763,924 13,376 6.97
Investment securities (nontaxable) (3) 84,243 1,541 7.26 83,103 1,613 7.72
Federal funds sold 968 8 3.28 14,121 62 1.75
Interest-bearing bank balances 36,819 205 2.21 33,130 466 5.60
------------- -------------
---------- ----------
Total earning assets 4,910,240 94,985 7.67 4,521,403 101,081 8.89
---------- ----------
Non-earning assets 525,510 555,792
------------- -------------
Total assets $5,435,750 $5,077,195
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 587,151 $ 3,472 2.35 $ 542,059 $4,177 3.07
Savings 114,016 570 1.98 124,522 859 2.74
Money market 772,515 6,798 3.49 714,042 9,712 5.41
Time deposits 1,626,509 22,828 5.57 1,835,139 28,558 6.19
------------- ---------- ------------- ----------
Total interest-bearing deposits 3,100,191 33,668 4.31 3,215,762 43,306 5.36
Borrowings 1,219,802 13,918 4.53 802,154 13,459 6.67
------------- ---------- ------------- ----------
Total interest-bearing liabilities 4,319,993 47,586 4.37 4,017,916 56,765 5.62
---------- ----------
Noninterest-bearing liabilities
Noninterest-bearing deposits 494,911 543,550
Other noninterest liabilities 129,537 46,971
------------- -------------
Total liabilities 4,944,441 4,608,437
Shareholders' equity 491,309 468,758
------------- -------------
Total liabilities and shareholders' equity $5,435,750 $5,077,195
============= =============
Net interest margin $47,399 3.83 % $44,316 3.90 %
========== ==========
Tax-equivalent adjustment (3) $ 539 $ 372
========== ==========
(1) Nonaccrual loans are included in average balances for yield computations.
(2) The average balances for investment securities exclude the unrealized gain or 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.
Note: Average balances are derived from daily balances.
16
TABLE 1 (CONTINUED)
- ---------------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- ---------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
NINE MONTHS ENDED SEPTEMBER 30,
-------------------------------------------------------------------
2001 2000
-------------------------------- --------------------------------
AVERAGE/ INCOME/ YIELD/ AVERAGE/ INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
------- ------- ---- ------- ------- ----
ASSETS
Earning assets
Loans (net of unearned income) (1) $ 3,754,478 $ 242,253 8.63 % $ 3,490,325 $ 242,217 9.30 %
Investment securities (taxable) (2) 938,807 45,966 6.55 785,387 40,506 6.91
Investment securities (nontaxable) (3) 82,833 4,563 7.37 88,542 4,842 7.33
Federal funds sold 446 13 3.90 12,587 342 3.65
Interest-bearing bank balances 33,458 1,168 4.67 24,068 1,218 6.78
------------ ----------- ------------ ----------
Total earning assets 4,810,022 293,963 8.17 4,400,909 289,125 8.81
----------- ----------
Non-earning assets 533,726 541,278
------------ ------------
Total assets $ 5,343,748 $ 4,942,187
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 580,509 $ 11,686 2.69 $ 575,344 $ 12,600 2.94
Savings 114,421 1,887 2.20 138,503 2,757 2.67
Money market 744,836 22,302 4.00 671,983 25,831 5.15
Time deposits 1,801,287 82,781 6.14 1,719,235 75,528 5.89
------------ ----------- ------------ ----------
Total interest-bearing deposits 3,241,053 118,656 4.89 3,105,065 116,716 5.04
Borrowings 1,044,276 39,943 5.11 777,610 37,006 6.38
------------ ----------- ------------ ----------
Total interest-bearing liabilities 4,285,329 158,599 4.95 3,882,675 153,722 5.31
----------- ----------
Noninterest-bearing liabilities
Noninterest-bearing deposits 469,053 534,537
Other noninterest liabilities 104,269 47,570
------------ ------------
Total liabilities 4,858,651 4,464,782
Shareholders' equity 485,097 477,405
------------ ------------
Total liabilities and shareholders' $ 5,343,748 $ 4,942,187
euity ============ ============
Net interest margin $ 135,364 3.76 % $ 135,403 4.12 %
=========== ==========
Tax-equivalent adjustment (3) $ 1,597 $ 1,684
=========== ==========
(1) Nonaccrual loans are included in average balances for yield computations.
(2) The average balances for investment securities exclude the unrealized gain or 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.
Note: Average balances are derived from daily balances.
17
Compared to 2000, fully tax-equivalent net interest income for the first nine
months of 2001 remained constant at $135.4 million while the net interest margin
declined to 3.76% from 4.12%. In the first nine months of 2001, the Federal
Reserve reduced interest rates a total of 350 basis points. As The South Group
reduced its interest rates, the decline in the earning asset yield outpaced the
decline in the funding source rate. The earning asset yield declined 64 basis
points to 8.17% for the nine months ended September 30, 2001 whereas the funding
source rate declined only 36 basis points to 4.95% for the nine months ended
September 30, 2000. The smaller decline in the funding source rate resulted
primarily from the inability to reprice immediately certificates of deposit,
which have defined maturity dates. Earning asset growth, however, offset the
decline in net interest income from interest rate reductions. Average earning
assets grew $409.1 million, or 9.3%, to $4.8 billion in the first nine months of
2001 from $4.4 billion in the first nine months of 2000, primarily from
internally generated loan growth and investment securities.
During 2000, Carolina First Bank and Citrus Bank held certificate of deposit
promotions designed to build customer loyalty and expand our customer base.
Also, in the fall of 2000, Carolina First Bank held a deposit promotion in its
coastal markets to ensure retention of customers following the Anchor Financial
merger. This promotion generated approximately $200 million of one-year
certificates of deposit with an annualized percentage yield of 7.50%. Of the
$200 million raised in this promotion, $26 million matured in September 2001
with the remaining $174 million maturing during the fourth quarter 2001. Citrus
Bank's promotions generated approximately $80 million in certificates of deposit
with an average annualized percentage yield of 7.44%. As a result of the 350
basis point decline in interest rates in the first nine months of 2001, the
current market rates for similar certificates of deposits are significantly
lower than these promotional rates. Accordingly, we expect our net interest
margin to benefit from the maturity of these certificates of deposit, which is
concentrated in the fourth quarter of 2001.
Deposits generated through Bank CaroLine, an Internet bank, generally pay higher
rates than those offered by our branch locations. During the first nine months
of 2001, The South Group priced the Bank CaroLine deposits less aggressively
than it did in 2000 in an effort to lower the overall cost of funds. Bank
CaroLine deposits totaled $91.6 million as of September 30, 2001 compared with
$221.2 million and $223.0 million as of December 31, 2000 and September 30,
2000, respectively.
The net interest margin increased from the second quarter of 2001 to the third
quarter of 2001 with margins of 3.69% and 3.83%, respectively. This increase
primarily resulted from The South Group's continuing efforts to reduce funding
source rates in order to minimize the impact of reductions in earning asset
yields resulting from Federal Reserve actions. The higher net interest margin in
the third quarter of 2001 also reflected the repricing of certificates of
deposit at significantly lower rates.
As the Federal Reserve continued to lower interest rates during the second
quarter of 2001, the majority of our variable rate loans, which constitute
approximately 45% of the loan portfolio, repriced downward immediately. While we
continued with our prompt downward repricing of interest-bearing deposits in the
third quarter, the magnitude of the repricing going forward may not completely
compensate for the declines in the earning asset yield. Continued declines in
interest rates would put pressure on The South Group's net interest margin due
to competitive deposit markets and some deposit rates having reached what
management considers to be their lower limit.
During the third quarter 2001, The South Group sold available for sale
investment securities resulting in a $1.1 million pre-tax gain. In addition, The
South Group recorded a $1.1 million pre-tax loss associated with the early
extinguishment of debt, which was recorded as an extraordinary item. By
reinvesting the proceeds and refinancing the borrowings at more favorable rates,
these transactions are expected to enhance net interest income. In October 2001,
18
The South Group prepaid approximately $31.2 million in FHLB advances and
incurred an extraordinary loss on the early extinguishment of debt of
approximately $2.0 million pre-tax. The South Group continues to evaluate the
relative cost and benefit of incurring additional prepayment penalties from the
early extinguishment of debt and may continue to engage in such transactions.
PROVISION FOR LOAN LOSSES
The provision for loan losses was $15.6 million and $19.1 million for the first
nine months of 2001 and 2000, respectively. The provision for loan losses in
2000 included $3.0 million made during the second quarter when The South Group's
reserve analysis methodology was employed to determine reserve requirements for
Anchor Financial's loan portfolio.
The allowance for loan and lease losses (the "Allowance") equaled 1.18% and
1.17% of loans held for investment as of September 30, 2001 and 2000,
respectively. Although nonperforming loans increased by $14.4 million over this
period, specific reserves allocated to these loans did not increase
proportionately. Based on management's analysis of impairment as defined in SFAS
114, specific reserves allocated to nonperforming loans totaled $4.2 million and
13.1% of the total on September 30, 2001, compared with $4.3 million and 24.3%
of the total on September 30, 2000.
Net charge-offs totaled $14.5 million for the first nine months of 2001, $4.5
million higher than the $10.0 million charged off during the first nine months
of 2000. As an annualized percentage of average loans, net charge-offs were
0.52% for the first nine months of 2001, up from 0.38% for the comparable period
in 2000. Given the current unfavorable economic outlook, management expects
charge-offs to remain at 2001's higher levels, and possibly increase slightly,
over the next several quarters.
NONINTEREST INCOME
Noninterest income increased to $38.7 million in the first nine months of 2001
from $29.7 million in the first nine months of 2000. Noninterest income included
gains and losses on asset sales in the first nine months of 2001 and 2000.
During the nine months ended September 30, 2001, noninterest income included a
$1.5 million gain on the sale of available for sale securities, $1.3 million
loss on disposition of assets and liabilities and $1.0 million gain on equity
investments. The loss on the disposition of assets and liabilities related to a
$1.0 million loss associated with the sale of four branch office locations,
which closed in July 2001, and a $262,000 loss associated with the
sale-leaseback of a branch office. The gain on equity investments included $1.1
million from the marking to estimated fair value and subsequent sale of an
investment in Concord EFS Inc. and $63,000 gain from the sale of Affinity
Technology Group, Inc. ("Affinity") common stock. These gains were partially
offset by a $200,000 loss associated with the write-down of an Internet-related
investment. In the first nine months of 2000, we recognized a $2.1 million net
gain from equity investments and a $2.1 million gain from the sale of three
branch offices. These gains were offset by losses of approximately $5.4 million
on the sale of available for sale securities principally from restructuring the
combined investment portfolio following completion of the Anchor Financial
merger. Excluding the net gain or loss on asset sales from both periods,
noninterest income increased $6.5 million, or 21%, to $37.4 million for the
first nine months of 2001 from $30.9 million for the first nine months of 2000.
Service charges on deposit accounts, the largest contributor to noninterest
income, rose 3% to $13.7 million in the first nine months of 2001 from $13.4
million for the same period in 2000. Average deposits, which impact service
19
charges, increased approximately 2% for the same period. The increase in service
charges was attributable to attracting new transaction accounts, improving
collection of fees and adjusting fees upward to reflect competitive pricing.
Mortgage banking income includes origination fees, gains from the sale or
securitization of loans, losses from the sale and valuation of mortgage
servicing rights and servicing fees (net of the related amortization for the
mortgage servicing rights and subservicing payments). Mortgage banking income in
the first nine months of 2001 increased $1.3 million to $5.3 million from $4.0
million in the first nine months of 2000.
Mortgage originations totaled approximately $281 million and $243 million in the
first nine months of 2001 and 2000, respectively. Mortgage originations are net
of mortgage loans acquired through acquisition. Mortgage origination volumes
increased in the first nine months of 2001 due to lower mortgage loan rates and
the hiring of additional mortgage originators.
In 2001, The South Group continued its efforts to realign its mortgage banking
strategy to place more emphasis on mortgage originations. In connection with
these on-going efforts, The South Group has securitized mortgage loans, sold
mortgage loans and sold mortgage-servicing rights. In September 2001, The South
Group entered into contracts with non-affiliated companies to service mortgage
loans for The South Group's affiliates. These servicing contracts, which will
begin in December 2001, pertain to portfolio mortgage loans and mortgage loans
for which Carolina First Bank owns the rights to subservice.
In March 2001, The South Group securitized approximately $112.2 million of
mortgage portfolio loans and subsequently sold $80.4 million of these
mortgage-backed securities. This transaction resulted in a $1.6 million gain,
which included $634,000 associated with recording the related mortgage-servicing
asset. In July 2001, we sold approximately $71.9 million of mortgage loans for a
loss of $80,000. In the first nine months of 2001, The South Group recorded
$605,000 in losses from the sale of mortgage servicing rights related to
approximately $949 million in mortgage loans. The South Group also recorded
$510,000 in charges for the write-down in the value of capitalized mortgage
servicing rights due to falling interest rates.
The servicing operations of CF Mortgage consist of servicing mortgage loans that
are owned by Carolina First Bank or Citrus Bank and subservicing loans, to which
the rights to service are owned by Carolina First Bank or other non-affiliated
financial institutions. At September 30, 2001, CF Mortgage was servicing or
subservicing 11,916 loans having an aggregate principal balance of approximately
$1.1 billion. Fees related to the servicing portfolio from non-affiliated
companies are offset by the related amortization for the mortgage servicing
rights and subservicing payments. Servicing income does not include the benefit
of interest-free escrow balances related to mortgage loan-servicing activities.
Fees for investment services, which include trust and brokerage income, in the
first nine months of 2001 and 2000 were approximately $4.2 million and $4.1
million, respectively. During this period, trust income declined approximately
$100,000, and brokerage income increased approximately $241,000. At September
30, 2001 and 2000, the market value of assets administered by the trust
department totaled approximately $735 million and $746 million, respectively.
Bank-owned life insurance increased to $5.0 million in the first nine months of
2001 from $2.5 million in the first nine months of 2000 due to increases in the
cash value of life insurance policies. Merchant processing fees increased to
$4.6 million in the first nine months of 2001 from $2.0 million in the first
nine months of 2000 from repricing the fee schedule and attracting several new
large merchants.
20
Other noninterest income totaled $4.3 million in the first nine months of 2001,
compared with $4.7 million in the first nine months of 2000. Other noninterest
income included income related to credit and debit cards, insurance commissions,
international banking services and other fee-based services. The decrease in
other noninterest income was largely due to $744,000 in losses on the sale of
fixed assets and real estate in 2001.
In the first quarter of 2001, Carolina First Bank entered into an agreement to
sell branch offices in Bennettsville, Lugoff, Liberty and McColl, South
Carolina. This transaction closed in July 2001, and a loss on disposition of
assets and liabilities of $970,000 was recognized during the second quarter 2001
to record the assets at their net realizable value. The loss was related to the
write-off of intangible assets associated with the branches sold. The sale of
branch offices in less populated and slower-growing markets is part of The South
Group's goal to increase the average deposits per branch.
NONINTEREST EXPENSES
Noninterest expenses decreased to $109.8 million in the first nine months of
2001 from $145.3 million in the first nine months of 2000. Noninterest expenses
in the first nine months of 2001 included $502,000 in restructuring and
merger-related recoveries, which related to the sale of real estate at prices
higher than estimated, and a $391,000 impairment loss from the write-down of
assets, which was primarily related to lease termination fees for abandoned
locations and the loss associated with subletting office space at less than the
contractual lease rate. Noninterest expenses in the first nine months of 2000
included $27.8 million in restructuring and merger-related costs, a $3.9 million
impairment loss from the write-down of assets, which was primarily related to
leasehold improvements associated with the former operations center, $1.8
million in system conversion costs and $877,000 in other charges related to the
Anchor Financial merger. Excluding these other items, noninterest expenses
decreased $1.1 million, or 1%, to $109.9 million for the first nine months of
2001 from $111.0 million for the first nine months of 2000.
Personnel expense decreased to $54.0 million in the first nine months of 2001
from $56.3 million in the first nine months of 2000. Full-time equivalent
employees increased to 1,357 at September 30, 2001 from 1,348 at September 30,
2000. The decline in personnel expense was largely attributable to cost savings
associated with the Anchor Financial merger.
Occupancy and furniture and equipment expenses increased $465,000 to $20.9
million in the first nine months of 2001 from $20.5 million in the first nine
months of 2000. This increase resulted principally from higher computer
equipment fees and capitalized software amortization associated with the new
core operating system. The South Group continues to dispose of real estate in
connection with the Anchor Financial merger. Occupancy expenses have declined
primarily from the elimination of rent and maintenance agreements associated
with disposed properties.
Other noninterest expenses increased $266,000 to $30.6 million in the first nine
months of 2001 from $30.3 million in the first nine months of 2000. The overall
increase in other noninterest expenses was principally attributable to the
overhead and operating expenses associated with increased lending and deposit
activities. The largest items of other noninterest expense were
telecommunications, advertising, professional and outside service fees,
stationery, supplies and printing.
SYSTEM CONVERSION COSTS
From March 2000 to July 2000, The South Group and its subsidiaries converted
their operating systems to the Fiserv Comprehensive Banking System.
21
During 2000, as a result of the system conversion process, and the related
training involved with learning a new system, certain outstanding items on the
general ledger, including loan funding and demand deposit account
reconciliations, were not resolved in a timely manner. While the majority of the
outstanding items have been resolved, The South Group has $115,000 remaining as
of September 30, 2001 from the accrual to cover estimated potential charge-offs
associated with the remaining outstanding items. At this time, we do not
anticipate any further material changes to our consolidated financial position
or results of operations related to these reconciliations.
During the first nine months of 2001, The South Group charged $585,000, against
the $700,000 accrual, related to reconciliations associated with the system
conversion. The South Group expects the remaining $115,000 of accrued expenses
to be sufficient to cover any additional charge-offs in 2001.
INCOME TAX EXPENSE
Income tax expense for the nine months ended September 30, 2001 and 2000 was
$16.5 million and $609,000, respectively. This increase was attributable to the
increase in income before income taxes, minority interest, extraordinary item
and cumulative effect of change in accounting principle ("pretax income" or
"pretax loss").
The South Group's statutory federal and state income tax rates remained
relatively consistent for both the nine months ended September 30, 2001 and the
corresponding period in 2000. In spite of this, income tax expense was not
proportionate to pretax income or pretax loss when comparing the periods. For
the nine months ended September 30, 2000, certain significant charges relating
to the merger with Anchor Financial were expensed for book purposes but were not
deductible for tax purposes. These and other permanent book to tax differences,
which are also not subject to deferred income taxes, were added back to our
insignificant pretax loss, and resulted in taxable income. Consequently, a
disproportionate provision for income tax expense exists, when comparing the
nine months ended September 30, 2000 to the nine months ended September 30,
2001.
THIRD QUARTER RESULTS
Net income for the three months ended September 30, 2001 was $11.0 million, or
$0.26 per diluted share. For the three months ended September 30, 2000, The
South Group reported a net loss of $3.1 million, or $0.07 per diluted share,
which included significant restructuring and merger-related charges, a loss from
restructuring the combined investment portfolio following the Anchor Financial
merger and impairment loss from write-down of assets.
Net income for the three months ended September 30, 2001 included the following
pre-tax other items: $1.1 million gain on the sale of available for sale
securities and $1.1 million extraordinary loss on the early extinguishment of
debt. The third quarter 2001 net income also included the recovery of $89,000 of
restructuring and merger-related costs and a $176,000 write-down of an impaired
asset. For the three months ended September 30, 2000, the net loss included the
following pre-tax other items: $7.9 million for restructuring and merger-related
costs, $5.4 million loss on the sale of available for sale securities primarily
from restructuring the combined investment portfolio following the Anchor
Financial merger, $3.9 million impairment loss from the write-down of assets
primarily related to leasehold improvements associated with the former
operations center in Columbia, $2.0 million gain on the sale of two branch
offices, $1.0 million in system conversion costs, $877,000 in other charges
associated with the Anchor Financial merger and a $332,000 net loss on equity
investments.
22
Net interest income increased $2.9 million to $46.9 million for the three months
ended September 30, 2001 from $43.9 million for the comparable period in 2000.
The third quarter 2001 net interest margin decreased to 3.83% compared with
3.90% for the third quarter of 2000. The decline was related to higher rates
paid on certain certificates of deposit from targeted deposit promotions,
increased reliance on borrowings to fund earning asset growth and lower
noninterest-bearing deposit balances. A higher level of average earning assets,
which increased 9% to $4.9 billion for the third quarter of 2001 from $4.5
billion for the third quarter of 2000, partially offset the decline.
Noninterest income, excluding the net gains on asset sales described above,
increased 14% to $11.5 million for the third quarter of 2001 compared with $10.1
million for the third quarter of 2000. Fees for investment services, merchant
processing fees and increases in cash value related to bank-owned life insurance
contributed to this increase, which was partially offset by a $590,000 loss on
the write-down and sale of real estate.
Noninterest expenses, excluding the other items described above, declined 4% to
$35.2 million for the third quarter of 2001 from $36.7 million for the third
quarter 2000. This decline reflected on-going efforts to control expenses and
the achievement of cost savings, particularly related to personnel expenses and
occupancy, from the June 2000 merger with Anchor Financial.
BALANCE SHEET REVIEW
LOANS
At September 30, 2001, The South Group had total loans outstanding of $3.7
billion, which equaled 102% of our total deposits and 68% of our total assets.
Loans are the largest category of earning assets and produce the highest yields.
The loan portfolio consists principally of commercial real estate loans,
commercial loans, consumer loans (including both direct and indirect loans) and
one-to-four family residential mortgage loans. Substantially all loans are to
borrowers domiciled in our market areas in South Carolina, Florida and North
Carolina. The portfolio does not contain any foreign loans or any Highly
Leveraged Transactions, as defined by regulatory authorities.
Table 2 summarizes loans outstanding and percentage of loans in each category,
showing the composition sorted by collateral type.
23
TABLE 2
- -------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- -------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
SEPTEMBER 30,
----------------------------------- DECEMBER 31,
2001 2000 2000
---- ---- ----
Commercial, financial and agricultural $ 722,220 $ 530,706 $ 561,360
Real estate - construction 507,587 529,699 458,577
Real estate - residential mortgages
(1-4 family) 708,338 878,196 890,693
Commercial secured by real estate (1) 1,289,154 1,252,159 1,348,604
Consumer 511,832 457,806 460,668
Credit cards - 13,512 -
Lease financing receivables 1,010 5,817 4,186
------------------ ----------------- -----------------
Loans held for investment 3,740,141 3,667,895 3,724,088
Loans held for sale 16,691 9,098 12,630
------------------ ----------------- -----------------
Total gross loans 3,756,832 3,676,993 3,736,718
Unearned income 521 2,190 1,536
Allowance for loan losses 43,944 42,847 43,024
------------------ ----------------- -----------------
Total net loans $ 3,712,367 $ 3,631,956 $ 3,692,158
================== ================= =================
- -------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF LOANS HELD FOR INVESTMENT IN CATEGORY
- -------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30,
---------------------------------------- DECEMBER 31,
2001 2000 2000
---- ---- ----
Commercial, financial and agricultural 19.31 % 14.47 % 15.07 %
Real estate - construction 13.57 14.44 12.31
Real estate - residential mortgages
(1-4 family) 18.94 23.94 23.92
Commercial secured by real estate (1) 34.47 34.14 36.22
Consumer 13.68 12.48 12.37
Credit cards - 0.37 -
Lease financing receivables 0.03 0.16 0.11
------------------ ----------------- -----------------
Total 100.00 % 100.00 % 100.00 %
================== ================= =================
(1) This category includes loans to businesses other than real estate companies where owner-occupied real estate is pledged on loans
to finance operations, equipment and facilities. At September 30, 2001, such loans were approximately half of the category
total.
From December 31, 2000 to September 30, 2001, commercial, financial and
agricultural loans grew 29%, primarily from diversification strategies designed
to reduce the relative portfolio concentration in commercial real estate loans.
The consumer loan growth of 11% was primarily in indirect auto loans (loans
purchased from car dealers) at Citrus Bank. The construction
24
growth of 11% was primarily composed of single-family residential development
and construction loans at Citrus Bank. The decline in residential mortgage loans
reflects the securitization or sale of $184.1 million of mortgage loans in the
first nine months of 2001.
In March 2001, The South Group securitized approximately $112.2 million of
residential mortgage loans from the held for investment portfolio and
subsequently sold $80.4 million of these mortgage-backed securities. The
remaining $31.8 million of mortgage-backed securities was included in our
securities available for sale. In connection with this transaction, we recorded
a $1.6 million gain, which was included in mortgage banking income. In July
2001, The South Group sold $71.9 million of residential mortgage loans,
previously transferred from the held for investment portfolio to loans held for
sale, for a nominal loss.
The South Group's loans held for investment, net of unearned income increased
$73.9 million, or 2.0%, to approximately $3.74 billion at September 30, 2001
from $3.67 billion at September 30, 2000. After adjusting for the securitization
or sale of mortgage loans, loans held for investment, net of unearned income
increased approximately $258.0 million, or 7.1%, from September 30, 2000. The
majority of the loan growth was from commercial and consumer loans, primarily in
our Florida markets.
The tragic events of September 11th prompted immediate banking industry concerns
surrounding credit exposure to the airline, insurance and tourism industries.
The South Group's loan portfolio has limited exposure to the airline and
insurance industries. Tourism is an important component of the economy in Myrtle
Beach and Orlando, two of our key markets. Myrtle Beach is a seasonal market
that winds down in September and is a "drive-to" rather than "fly-to"
destination. Consequently, the impact on this market has been relatively minor.
Tourism has slowed in Orlando, and hotel occupancy rates have fallen. As of
September 30, 2001, The South Group's Orlando hotel or motel loan exposure was
limited to nine loans, which totaled approximately $32.1 million.
ALLOWANCE FOR LOAN LOSSES
The adequacy of the Allowance is analyzed on a quarterly basis. For purposes of
this analysis, adequacy is defined as a level sufficient to absorb probable
losses in the portfolio. The methodology employed for this analysis is as
follows.
The portfolio is segregated into risk-similar segments for which historical loss
ratios are calculated and adjusted for identified changes in current portfolio
characteristics. Loss ratios are calculated by product type for consumer loans
and by risk grade for commercial loans. Large problem commercial loans are
individually assessed for impairment under SFAS 114. To allow for modeling
error, a range of probable loss ratios is then derived for each segment at plus
and minus five percent of the adjusted historical loss ratio. The resulting
percentages are then applied to the dollar amounts of loans in each segment to
arrive at each segment's range of probable loss levels.
The Allowance for each portfolio segment is set at an amount within its range
that reflects management's best judgment of the extent to which historical loss
levels are more or less accurate indicators of current losses in the portfolio.
Management's judgments evolve from an assessment of various issues, including
but not limited to the pace of loan growth, emerging portfolio concentrations,
risk management system changes, entry into new markets, new product offerings,
loan portfolio quality trends, and uncertainty in current economic and business
conditions.
25
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 it believes 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 Allowance 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 The South Group.
The Allowance is also subject to examination and adequacy testing by regulatory
agencies, which may consider such factors as the methodology used to determine
the adequacy and the size of the Allowance relative to that of peer
institutions, and other adequacy tests. In addition, such regulatory agencies
could require us to adjust our Allowance based on information available to them
at the time of their examination.
As of September 30, 2001 and September 30, 2000, the Allowance totaled $43.9
million and $42.8 million, respectively, or 1.18% and 1.17%, respectively, of
loans held for investment, net of unearned income. During the first nine months
of 2001, the Allowance was reduced $162,000 as a consequence of the
securitization or sale of residential mortgage loans. The Allowance to
nonperforming loans ratio was 1.28 times and 2.16 times at September 30, 2001
and 2000, respectively. Nonperforming loans increased to $34.2 million as of
September 30, 2001 from $19.8 million as of September 30, 2000. See "Credit
Quality." Our analysis of Allowance adequacy includes an impairment analysis for
each nonperforming commercial loan.
Table 3 summarizes the changes in the Allowance.
- ------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- ------------------------------------------------------------------------------------------------------------------------
AT AND FOR
THE NINE MONTHS AT AND FOR
ENDED SEPTEMBER 30, THE YEAR ENDED
-------------------------------------- DECEMBER 31,
2001 2000 2000
---- ---- ----
Loan loss reserve at beginning of year $ 43,024 $ 33,756 $ 33,756
Allowance adjustment for loans sold (162) (82) (252)
Net charge-offs:
Loans charged-off (16,971) (11,672) (16,073)
Loans recovered 2,469 1,709 2,215
---------------- ---------------- --------------------
(14,502) (9,963) (13,858)
Additions to reserve through provision
expense 15,584 19,136 23,378
---------------- ---------------- --------------------
Loan loss reserve at end of period $ 43,944 $ 42,847 $ 43,024
================ ================ ====================
Average loans $ 3,754,478 $ 3,490,325 $ 3,545,336
Loans held for investment, net of
unearned income (period end) 3,739,620 3,665,705 3,722,552
Net charge-offs as a percentage of
average loans (annualized) 0.52 % 0.38 % 0.39 %
Allowance for loan losses as a percentage
of loans excluding loans held for sale 1.18 1.17 1.16
The following summarizes impaired loan information (in thousands), all of which
are on nonaccrual, at and for the nine months ended September 30:
2001 2000
---- ----
Impaired loans $31,946 $ 17,699
Average investment in impaired loans 26,730 14,500
Related allowance 4,178 4,306
Recognized interest income 296 829
Foregone interest 1,739 525
Nonaccrual loans were $34.2 million and $19.8 million as of September 30, 2001
and 2000, respectively. Interest income recognized on nonaccrual loans totaled
approximately $297,000 and $902,000 for the nine months ended September 30, 2001
and 2000, respectively.
27
SECURITIES
At September 30, 2001, The South Group's investment portfolio totaled $1.2
billion, up $266.8 million from the $904.2 million invested as of September 30,
2000 and up $271.5 million from the $899.5 million invested as of December 31,
2000. Securities (i.e., securities held for investment, securities available for
sale, and trading securities) averaged $1.0 billion in the first nine months of
2001, up 17% from the $873.9 million average in the first nine months of 2000. A
significant portion of the increase was attributable to the purchase of
securities to match fund against additional borrowings. The South Group expects
an increase in such transactions during the fourth quarter.
The average portfolio yield decreased in the first nine months of 2001 to 6.61%
from 6.93% in the first nine months of 2000. The securities yield decreased due
to a lower level of general interest rates. During the first nine months of
2001, due to the declining interest rate environment, U.S. government agencies
were called prior to the stated maturities, and prepayments associated with
mortgage-backed securities accelerated. The agency securities, which were called
during the first nine months of 2001, were replaced primarily with
mortgage-backed securities to further enhance portfolio yields. The composition
of the investment portfolio as of September 30, 2001 follows: mortgage-backed
securities 76%, treasuries and agencies 6%, state and municipalities 7%, and
other securities 11% (which included equity investments described below).
EQUITY INVESTMENTS
Investment in Net.B@nk, Inc. At September 30, 2001, The South Group owned
1,175,000 shares of Net.B@nk, Inc. ("Net.B@nk") common stock, or approximately
4% of the outstanding shares. Net.B@nk owns and operates Net.B@nk, F.S.B., an
FDIC-insured federal savings bank that provides banking services to consumers
utilizing the Internet. The South Group's investment in Net.B@nk, which is
included in securities available for sale and has a basis of approximately
$326,000, was recorded at its pre-tax market value of approximately $9.8 million
as of September 30, 2001. The South Group's shares of Net.B@nk common stock are
"restricted" securities, as that term is defined in federal securities law.
Investment in Affinity Technology Group, Inc. At September 30, 2001, The South
Group, through its subsidiary Blue Ridge Finance Company, Inc. ("Blue Ridge"),
owned 4,876,340 shares of common stock of Affinity, or approximately 12% of the
outstanding shares. The South Group's investment in Affinity, which is included
in securities available for sale and has a basis of approximately $433,000, was
recorded at its pre-tax market value of approximately $293,000 as of September
30, 2001. During the first nine months of 2001, The South Group sold
approximately 348,000 shares of Affinity common stock for a pre-tax gain of
$63,000. The South Group's shares in Affinity are "restricted" securities, as
that term is defined in federal securities law.
At December 31, 2000, The South Group owned a warrant to purchase 3,471,340
shares of Affinity common stock for approximately $0.0001 per share ("Affinity
Warrant"). On January 1, 2001, effective with the adoption of SFAS 133 for
derivative activities, The South Group recorded the Affinity Warrant on the
consolidated balance sheet at its fair value of $434,000. Under accounting
principles as of December 31, 2000, the Affinity Warrant was not recorded on the
consolidated balance sheet. On February 27, 2001, we exercised the Affinity
Warrant and reclassified the asset as securities available for sale based on the
fair value as of the exercise date.
Investments in Banks and Transaction Processing Company. As of September 30,
2001, The South Group had equity investments in fourteen community banks located
in the Southeast. In each case, we own less than 5% of the community bank's
28
outstanding common stock. The South Group has made these investments to develop
correspondent banking relationships and to promote community banking in the
Southeast. As of September 30, 2001, equity investments in the community banks,
included in securities available for sale with a basis of approximately $9.1
million, were recorded at their pre-tax market value of approximately $8.5
million.
As a result of our merger with Anchor Financial, we have an investment in Rock
Hill Bank & Trust. The investment, which is included in securities available for
sale and has a basis of approximately $3.1 million, was recorded at its pre-tax
market value of approximately $4.6 million as of September 30, 2001. The South
Group also has an investment in Nexity Financial Corporation, an Internet bank,
which is recorded at its basis of $500,000.
The South Group owned 24,103 shares of Concord EFS Inc., a transaction
processing company, following its February 2001 acquisition of Star Systems,
Inc., an electronic payment network. During the first quarter 2001, we
recognized a $758,000 gain associated with marking our investment to estimated
fair value as of the Concord EFS Inc. acquisition date. In June 2001, we sold
all 24,103 shares of Concord EFS Inc. for an additional $360,000 gain.
CF Investment Company. CF Investment Company is a Small Business Investment
Company, licensed through the Small Business Administration. Its principal focus
is to invest in companies that have a bank-related technology or service The
South Group and its subsidiaries can use. As of September 30, 2001, CF
Investment Company had invested approximately $1.5 million (principally in the
form of loans) in companies specializing in electronic document management and
Internet-related services.
CF Investment Company's loans represent a higher credit risk to us due to the
start-up nature of these companies. During the second quarter of 2001, The South
Group incurred a $200,000 loss related to the write-down of an investment in an
Internet-related company.
INTANGIBLE ASSETS AND OTHER ASSETS
The intangible assets balance at September 30, 2001 of $98.5 million consisted
of goodwill of $92.7 million and core deposit balance premiums of $5.8 million.
The intangible assets balance at September 30, 2000 of $109.0 million consisted
of goodwill of $101.5 million and core deposit balance premiums of $7.5 million.
The decline in the intangible assets balances was attributable to the
amortization of intangibles and the write-off of intangible assets associated
with the sale of branches.
Other assets increased $65.9 million to $204.8 million at September 30, 2001
from $138.8 million at September 30, 2000. This increase was largely
attributable to balances for bank-owned life insurance, which increased $54.0
million to $107.7 million at September 30, 2001. Mortgage servicing rights
totaled $10.8 million and $26.7 million at September 30, 2001 and 2000,
respectively. The balance for mortgage servicing rights declined primarily due
to the fourth quarter 2000 and first quarter 2001 sales of rights.
DEPOSITS
The South Group's primary source of funds for loans and investments is its
deposits that are gathered through the branch networks of Carolina First Bank
and Citrus Bank and on the Internet through Bank CaroLine. Deposits provided
funding for 77% and 83% of average earning assets for the nine months ended
September 30, 2001 and 2000, respectively. Carolina First Bank and Citrus Bank
face stiff competition from other banking and financial services companies in
29
gathering deposits. The percentage of funding provided by deposits has declined,
and accordingly, we have developed other sources, such as FHLB advances, to fund
loan demand.
At September 30, 2001, deposits totaled $3.6 billion, down 3% from the prior
year balance and 7% from December 31, 2000. Average deposits increased 2% to
$3.7 billion for the nine months ended September 30, 2001 from $3.6 billion for
the nine months ended September 30, 2000. During the nine months ended September
30, 2001, total interest-bearing deposits averaged $3.2 billion with a rate of
4.89%, compared with $3.1 billion with a rate of 5.04% for the corresponding
period in 2000. Deposit pricing remains very competitive, and we expect this
pricing environment to continue. In addition, we have experienced higher deposit
costs associated with targeted deposit promotions to attract and retain
customers in connection with mergers, new markets and new products. With the
maturity of higher rate certificates of deposit, The South Group may elect to
rechannel some of these balances to lower cost funding sources, thereby
decreasing deposits and increasing borrowings.
Table 1 in "EARNINGS REVIEW--Net Interest Income" details average balances for
the deposit portfolio for the nine months ended September 30, 2001 and 2000. On
average, time deposits grew $82.1 million, or 5%, and money market accounts
increased $72.9 million, or 11%. This growth was due to certificates of deposit
and money market promotions in select markets and increases in brokered
certificates of deposit. The growth in time deposits and money market accounts
was partially offset by declines in savings accounts of $24.1 million and
noninterest-bearing deposits of $65.5 million.
Although noninterest-bearing deposits declined from the comparable prior year
period, these average balances increased each quarter of 2001 to $494.9 million
for the third quarter 2001 from $474.0 million and $438.3 million for the second
and first quarters of 2001, respectively. In addition, average time deposits
declined each quarter of 2001 to $1.6 billion for the third quarter 2001 from
$1.8 billion and $1.9 billion for the second and first quarters of 2001,
respectively. The decline in time deposit balances was largely attributable to
offering fewer certificate of deposit promotions in 2001 and reducing Bank
CaroLine's certificate of deposit rates.
At September 30, 2001, total deposits for Bank CaroLine, an Internet bank,
totaled $91.6 million, down from $223.0 million as of September 30, 2000 and
$221.2 million as of December 31, 2000. Deposits for Bank CaroLine declined
significantly, due to offering less aggressive interest rates in an effort to
lower the overall cost of funds. At September 30, 2001, The South Group had
$129.9 million in brokered certificates of deposit under $100,000, compared with
$99.2 million at September 30, 2000. We consider these funds as an alternative
funding source available to use while continuing to maintain and grow our local
deposit base.
Time deposits of $100,000 or more represented 15% and 17% of total deposits at
September 30, 2001 and 2000, respectively. Our large denomination time deposits
are generally from customers within the local market areas of its banks and,
therefore, have a greater degree of stability than is typically associated with
this source of funds.
BORROWED FUNDS
The South Group's short-term borrowings consist of federal funds purchased and
repurchase agreements, FHLB advances, commercial paper, and other short-term
borrowings. The long-term borrowings consist primarily of subordinated notes,
FHLB borrowings, an employee stock ownership plan note payable and a mortgage
note payable. In the first nine months of 2001, average borrowings totaled $1.0
billion compared with $777.6 million for the same period in 2000. This increase
30
was primarily attributable to an increased reliance on short-term borrowings,
including FHLB advances, to support earning asset growth and to match fund
increases in investment securities.
Federal funds purchased and repurchase agreements are used to satisfy daily
funding needs and, when advantageous, for rate arbitrage. Federal funds
purchased and repurchase agreements totaled $680.2 million and $235.5 million at
September 30, 2001 and 2000, respectively. Balances in these accounts can
fluctuate on a day-to-day basis. At September 30, 2001 and 2000, FHLB advances
totaled $479.3 million and $547.4 million, respectively. FHLB advances are a
source of funding which The South Group uses depending on the current level of
deposits and management's willingness to raise deposits through market
promotions. In 2001, as a result of the significant decline in interest rates,
The South Group implemented a program of periodically increasing its long-term
FHLB advances to lock in lower borrowing rates. As of September 30, 2001,
long-term FHLB advances totaled $333.6 million (excluding $31.2 million prepaid
in October 2001), up from $276.5 million as of December 31, 2000.
CAPITAL RESOURCES AND DIVIDENDS
Total shareholders' equity amounted to $476.1 million, or 8.7% of total assets,
at September 30, 2001, compared with $476.9 million, or 9.3% of total assets, at
September 30, 2000. At December 31, 2000, total shareholders' equity was $468.7
million, or 9.0% of total assets. The increase in total shareholders' equity
since December 31, 2000 resulted principally from the retention of earnings and
an increase in the net unrealized gain on securities. Cash dividends paid and
the stock repurchase program partially offset these increases.
In December 2000, we initiated a stock repurchase program for up to two million
shares. In September 2001, the stock repurchase program was expanded to up to
three million shares, or approximately 7% of our outstanding shares. In
connection with the program, The South Group has repurchased 2,297,376 shares,
including 1,450,000 shares purchased during the first nine months of 2001. We
may continue to repurchase shares depending upon current market conditions and
available cash.
Book value per share at September 30, 2001 and 2000 was $11.53 and $11.06,
respectively. Tangible book value per share at September 30, 2001 and 2000 was
$9.14 and $8.53, respectively. Tangible book value was below book value as a
result of the purchase premiums associated with branch purchases and
acquisitions accounted for as purchases.
The South Group and its banking subsidiaries exceeded the well-capitalized
requirements at September 30, 2001. Table 4 sets forth various capital ratios
for The South Group and its banking subsidiaries.
31
Table 4
- -------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS
- -------------------------------------------------------------------------------------------------------------------------
WELL ADEQUATELY
SEPTEMBER 30, CAPITALIZED CAPITALIZED
2001 REQUIREMENT REQUIREMENT
---- ----------- -----------
THE SOUTH GROUP:
Total risk-based capital 10.64 % n/a n/a
Tier 1 risk-based capital 8.52 n/a n/a
Leverage ratio 6.94 n/a n/a
CAROLINA FIRST BANK:
Total risk-based capital 10.82 % 10.00 % 8.00 %
Tier 1 risk-based capital 8.84 6.00 4.00
Leverage ratio 6.94 5.00 4.00
CITRUS BANK:
Total risk-based capital 10.65 % 10.00 % 8.00 %
Tier 1 risk-based capital 9.50 6.00 4.00
Leverage ratio 8.69 5.00 4.00
The South Group and its subsidiaries are subject to certain regulatory
restrictions on the amount of dividends they are permitted to pay. We have paid
a cash dividend each quarter since the initiation of cash dividends on February
1, 1994. The South Group presently intends to pay a quarterly cash dividend on
its Common Stock; however, future dividends will depend upon our financial
performance and capital requirements.
Carolina First Mortgage Loan Trust (the "REIT") is a majority-owned subsidiary
of Carolina First Bank that holds real estate-related assets, including mortgage
loans. Carolina First Bank's ownership in the REIT is evidenced by common and
preferred equity. On February 22, 2001, Carolina First Bank sold 132 shares of
the REIT's Series 2000A Cumulative Fixed Rate Preferred Shares to an
institutional buyer. On June 8, 2001, Carolina First Bank sold 250 shares of the
REIT's Series 2000B Cumulative Floating Rate Preferred Shares to an
institutional buyer. Proceeds to Carolina First Bank from these sales totaled
approximately $37.0 million, net of issuance costs.
MARKET RISK AND ASSET/LIABILITY MANAGEMENT
Market risk is the risk of loss from adverse changes in market prices and rates.
Our market risk arises principally from interest rate risk inherent in our
lending, deposit and borrowing activities. Management actively monitors and
manages its interest rate risk exposure. Although we manage other risks, such as
credit quality and liquidity risk, in the normal course of business, management
considers interest rate risk to be its most significant market risk and could
potentially have the largest material effect on The South Group's financial
condition and results of operations. Other types of market risks, such as
commodity price risk, do not arise in the normal course of our business
activities.
32
As of September 30, 2001, there have been no material changes from the market
risk sensitivity analysis in The South Group's Quarterly Report on Form 10-Q for
the quarter ended June 30, 2001. The disclosures related to the market risk of
The South Group should be read in conjunction with The South Group's audited
consolidated financial statements, related notes and management's discussion and
analysis of financial condition and results of operations included in The South
Group's Annual Report on Form 10-K for the year ended December 31, 2000.
We attempt to manage exposure to fluctuations in interest rates through policies
established by our Asset/Liability Committee ("ALCO"). The primary goal of The
South Group's ALCO is to achieve consistent growth in net interest income while
managing our interest rate risk. We attempt to control the mix and maturities of
assets and liabilities to achieve consistent growth in net interest income
despite changes in market interest rates. We seek to accomplish this goal while
maintaining adequate liquidity and capital. Our asset/liability mix is
sufficiently balanced so that the effect of interest rates moving in either
direction is not expected to have a significant impact on net interest income
over time.
The South Group's ALCO uses several tools to monitor and manage interest rate
risk. One of the primary tools is a simulation model which is used to analyze
earnings at risk and interest sensitivity gap (the difference between the amount
of rate sensitive assets maturing or repricing within a specific time period and
the amount of rate sensitive liabilities maturing or repricing within the same
time period). The model takes into account interest rate changes as well as
changes in the mix and volume of assets and liabilities. The model's inputs
(such as interest rates and levels of loans and deposits) are updated on a
regular basis.
The forecast used for earnings at risk analysis simulates our consolidated
balance sheet and consolidated statements of income under several different rate
scenarios over a twelve-month period. It reports a case in which interest rates
remain flat and reports variations that occur when rates gradually increase and
decrease 200 basis points over the next twelve-month period. Computation of
prospective effects of hypothetical interest rate changes are based on numerous
assumptions, including relative levels of market interest rates and loan
prepayments, and should not be relied upon as indicative of actual results.
Further, the computations do not contemplate any actions The South Group could
undertake in response to changes in interest rates.
Beginning in the first quarter of 2001, we began modeling a gradual
increase/decrease in rates rather than an immediate change. This change was made
because rates typically change gradually over time rather than abruptly, and
thus, the information provided is more meaningful. According to the model as of
September 30, 2001, The South Group is positioned so that net interest income
will increase $6.6 million in the next twelve months if interest rates rise 200
basis points and will decrease $2.9 million in the next twelve months if
interest rates decline 200 basis points. The larger increase in net interest
income when interest rates are increased is primarily due to the assumptions
related to mortgage-backed securities. In the increasing interest rate model,
the prepayment speed is slower than in the flat and declining interest rate
models, and, thus, the balances remain at higher levels at the higher rates
assumed in the increasing scenario.
The assumptions related to deposit repricings also influence the changes in net
interest income when interest rates are adjusted. In both the increasing and
decreasing rate scenarios, we assume that deposit rates will not change by the
full 200 basis points. Due to the interest rate cuts that occurred during the
first nine months of 2001 and the prompt repricing of interest-bearing deposits,
some of our deposit rates are nearing what management considers to be an
acceptable lower level. Accordingly, in the declining rate scenario, the model
assumes that certificate of deposit rates will not decline below 1.00% thus
limiting the interest expense reduction from repricing certificates of deposit
by the entire 200 basis points.
33
In addition to the standard scenarios used to analyze earnings at risk, The
South Group's ALCO analyzes the potential impact of other scenarios. The
starting point for these "what-if" scenarios is our base forecast. This base
forecast consolidates all balance sheet information that we are presently aware
of with our "most likely" interest rate projections. The "what-if" scenarios are
then used to gauge the impact of changes in interest rates and/or balance sheet
items on the earnings of The South Group compared to the base forecast.
Strategies can be formulated based on the information provided by the earnings
simulation if a scenario either seems likely to occur or we choose to undertake
the proposed transaction. The South Group updates its base forecast quarterly
based on economic changes that occurred during the past quarter as well as
changes in the economic outlook for the coming year.
We use interest sensitivity gap ("GAP position") analysis to monitor the
relationship between the maturity and repricing of rate sensitive assets and
rate sensitive liabilities during a given time frame. Our GAP position, while
not a complete measure of interest sensitivity, is reviewed periodically to
provide insights related to the static repricing structure of assets and
liabilities. At September 30, 2001, on a cumulative basis through twelve months,
rate-sensitive assets exceeded rate-sensitive liabilities, resulting in an asset
sensitive position of $275.9 million. The majority of this change from the
relatively neutral position at the end of the second quarter related to the
acceleration of prepayments for mortgage-backed securities, which is typical in
a declining rate environment. In addition, assumptions regarding mortgage loan
sales shifted assets from long-term to short-term repricing. The GAP position is
based on The South Group's forecast which holds interest rates at their current
levels for the entire twelve-month period.
Derivatives and Hedging Activities. The South Group uses derivative instruments
as part of its interest rate management activities to reduce risks associated
with its lending, deposit taking and borrowing activities. CF Mortgage enters
into loan sale commitments in connection with its mortgage banking business and
issues commitments to borrowers to lend funds in a secured mortgage transaction.
Effective January 1, 2001, with the adoption of SFAS 133, we began recognizing
all derivatives as either assets or liabilities on the consolidated balance
sheet and reporting these instruments at fair value.
The South Group has interest rate swap agreements that qualify as fair value
hedges and those that qualify as cash flow hedges. Fair value hedges are used to
hedge fixed rate deposits. The South Group uses cash flow hedges to hedge
interest rate risk associated with variable rate borrowings.
By using derivative instruments, The South Group is exposed to credit and market
risk. Credit risk, which is the risk that a counterparty to a derivative
instrument will fail to perform, is equal to the extent of the fair value gain
in a derivative. Credit risk is created when the fair value of a derivative
contract is positive, since this generally indicates that the counterparty owes
us. When the fair value of a derivative is negative, no credit risk exists since
we would owe the counterparty. The South Group minimizes the credit risk in
derivative instruments by entering into transactions with high-quality
counterparties as evaluated by our management. Market risk is the adverse effect
on the value of a financial instrument from a change in interest rates or
implied volatility of rates. We manage the market risk associated with interest
rate contracts by establishing and monitoring limits as to the types and degree
of risk that may be undertaken.
At September 30, 2001, the fair value of derivative assets totaled $1.9 million
and was related to fair value hedges and derivatives with no hedging
designation. At September 30, 2001, the fair value of derivative liabilities
totaled $953,000 and was attributable to cash flow hedges. The South Group's
derivative and hedging activities are discussed in further detail in Notes 7 and
8 of the Consolidated Financial Statements.
34
LIQUIDITY
Liquidity management ensures that adequate funds are available to meet deposit
withdrawals, fund loan and capital expenditure commitments, maintain reserve
requirements, pay operating expenses, provide funds for dividends and debt
service and manage operations on an ongoing basis. Funds are primarily provided
by Carolina First Bank and Citrus Bank through customers' deposits, principal
and interest payments on loans, loan sales or securitizations, securities
available for sale, maturities of securities, temporary investments and
earnings. Proper liquidity management is crucial to ensure that The South Group
is able to take advantage of new business opportunities as well as meet the
demands of its customers.
Investment securities are an important tool to our liquidity management.
Securities classified as available for sale may be sold in response to changes
in interest rates, liquidity needs and/or significant prepayment risk.
Net cash provided by operations and deposits from customers have been the
primary sources of liquidity for us. Liquidity is also enhanced by the ability
to acquire new deposits through Carolina First Bank's and Citrus Bank's
established branch network of 89 branches in South Carolina, North Carolina and
Florida. In addition, we can raise deposits on the Internet through Bank
CaroLine. The liquidity needs of Carolina First Bank and Citrus Bank are a
factor in developing their deposit pricing structure; deposit pricing may be
altered to retain or grow deposits if deemed necessary.
Carolina First Bank and Citrus Bank have access to borrowing from the FHLB and
maintain short-term lines of credit from unrelated banks. At September 30, 2001,
unused borrowing capacity from the FHLB totaled approximately $9.8 million with
an outstanding balance of $479.3 million (of which $31.2 million was prepaid in
October 2001). The unused borrowing capacity from the FHLB could increase due to
the ability to borrow against commercial real estate loans. At September 30,
2001, Carolina First Bank and Citrus Bank had unused short-term lines of credit
totaling approximately $261.5 million (which are withdrawable at the lender's
option). Management believes that these sources are adequate to meet its
liquidity needs.
Liquidity at the parent company level is provided through cash dividends from
the subsidiary banks and the capacity of the parent company to raise additional
borrowed funds as needed. If The South Group elects to repurchase additional
shares through its share repurchase program, such purchases will reduce
liquidity at the parent company level.
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. The
South Group's credit risk management system is defined by policies approved by
the Board of Directors that govern the risk underwriting, portfolio monitoring,
and problem loan administration processes. Adherence to underwriting standards
is managed through a multi-layered credit approval process and immediate
after-the-fact review by credit risk management of loans approved by lenders.
Through daily review by credit risk managers, monthly reviews of exception
reports, and ongoing analysis of asset quality trends, compliance with loan
monitoring policies is managed. The administration of problem loans is driven by
policies that require written plans for resolution and quarterly meetings with
35
credit risk management to review progress. Credit risk management activities,
including specific reviews of new large credits, are reviewed by the Directors'
Credit Committee of each banking subsidiary, which meet monthly.
Table 6 presents information pertaining to nonperforming assets.
TABLE 6
- --------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS AND PAST DUE LOANS
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
SEPTEMBER 30,
------------------------------ DECEMBER 31,
2001 2000 2000
---- ---- ----
Nonaccrual loans $ 34,222 $ 19,846 $ 18,413
Restructured loans - - -
------------ ------------ ------------
Total nonperforming loans 34,222 19,846 18,413
Other real estate owned 5,846 2,977 3,101
------------ ------------ ------------
Total nonperforming assets $ 40,068 $ 22,823 $ 21,514
============ ============ ============
Nonperforming assets as a percentage
of loans and other real estate owned (1) 1.07 % 0.62 % 0.58 %
============ ============ ============
Net loan charge-offs as a percentage
of average loans (annualized) 0.52 0.38 0.42
============ ============ ============
Loans past due 90 days still accruing
interest (2) $ 11,656 $ 9,838 $ 10,682
============ ============ ============
Allowance for loan losses as a
percentage of nonperforming loans 1.28 x 2.16 x 2.34 x
============ ============ ============
(1) Calculated using loans held for investment, net of unearned income.
(2) Substantially all of these loans are consumer and residential mortgage loans.
As a percentage of loans and other real estate owned, nonperforming assets were
1.07% at September 30, 2001, compared with 0.58% as of December 31, 2000 and
0.62% as of September 30, 2000. Compared with the preceding quarter end,
nonperforming loans decreased $944,000 to $34.2 million, or 0.92% of loans held
for investment, as of September 30, 2001 from $35.2 million, or 0.95% of loans
held for investment, as of June 30, 2001.
As of September 30, 2001, nonperforming loans were concentrated in seven credit
relationships, which accounted for 56% of the nonperforming loan balance. Our
estimated loss exposure for these seven relationships was $1.5 million as of
September 30, 2001. Total estimated impairment on all commercial nonaccrual
loans totaled $4.2 million as of September 30, 2001, down 38% from $6.8 million
as of June 30, 2001.
Net loan charge-offs totaled $14.5 million and $10.0 million in the first nine
months of 2001 and 2000, respectively, or 0.52% and 0.38%, respectively, as an
annualized percentage of average loans. Uncertainty in the economic outlook has
increased, making charge-off levels in future periods less predictable. In
addition, as the economic climate softens, the flow of loans into nonaccrual
status and other real estate loans increases. However, loss exposure in the
portfolio is identified, reserved, and closely monitored to ensure that changes
are promptly addressed in the analysis of Allowance adequacy. As of September
30, 2001, management believes the Allowance to be adequate, based on
management's assessment of probable losses, including an impairment analysis for
each nonperforming loan.
36
CURRENT ACCOUNTING ISSUES
Statement of Financial Accounting Standards ("SFAS") No. 140, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities"
- - a replacement of FASB No. 125, was issued in September 2000. It revises the
standards for accounting for securitizations and other transfers of financial
assets and collateral and requires certain disclosures but will carry over most
of SFAS 125's provisions without reconsideration. SFAS 140 is effective for
transfers and servicing of financial assets and extinguishment of liabilities
occurring after March 31, 2001. This statement is effective for recognition and
reclassification of collateral and for disclosures related to securitization
transactions and collateral for fiscal years ending after December 15, 2000. The
South Group adopted the provisions of SFAS 140 effective April 1, 2001 with no
material impact.
In July 2001, the Financial Accounting Standards Board issued SFAS 141,
"Business Combinations," and SFAS 142, "Goodwill and Other Intangible Assets."
SFAS 141 requires that the purchase method of accounting be used for all
business combinations initiated after September 30, 2001 as well as all purchase
method business combinations completed after September 30, 2001. SFAS 141 also
specifies criteria intangible assets acquired in a purchase method business
combination must meet to be recognized and reported apart from goodwill. SFAS
142 will require that goodwill and intangible assets with indefinite useful
lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 will also
require that intangible assets with definite useful lives be amortized over
their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
The South Group is required to adopt the provisions of SFAS 141 immediately, and
SFAS 142 effective January 1, 2002. Goodwill and intangible assets acquired in
business combinations completed before July 1, 2001 will continue to be
amortized prior to the adoption of SFAS 142.
SFAS 141 will require upon adoption of SFAS 142, that The South Group evaluate
its existing intangible assets and goodwill that were acquired in prior purchase
business combinations, and make any necessary reclassifications in order to
conform with the new criteria in SFAS 141 for recognition apart from goodwill.
Upon adoption of SFAS 142, The South Group will be required to reassess the
useful lives and residual values of all intangible assets acquired in purchase
business combinations, and make any necessary amortization period adjustments by
the end of the first interim period after adoption. In addition, to the extent
an intangible asset is identified as having an indefinite useful life, The South
Group will be required to test the intangible asset for impairment in accordance
with the provisions of SFAS 142 within the first interim period. Any impairment
loss will be measured as of the date of adoption and recognized as the
cumulative effect of a change in accounting principle in the first interim
period.
In connection with the transitional goodwill impairment evaluation, SFAS 142
will require us to perform an assessment of whether there is an indication that
goodwill is impaired as of the date of adoption. To accomplish this, The South
Group must identify its reporting units and determine the carrying value of each
reporting unit by assigning the assets and liabilities, including the existing
goodwill and intangible assets, to those reporting units as of the date of
adoption. We will then have up to nine months from the date of adoption to
determine the fair value of each reporting unit and compare it to the reporting
unit's carrying amount. To the extent a reporting unit's carrying amount exceeds
its fair value, an indication exists that the reporting unit's goodwill may be
impaired and the second step of the transitional impairment test must be
performed. In the second step, the implied fair value of the reporting unit's
goodwill, determined by allocating the reporting unit's fair value to all of it
assets (recognized and unrecognized) and liabilities in a manner similar to a
purchase price allocation in accordance with SFAS 141, is compared to its
37
carrying amount, both of which would be measured as of the date of adoption.
This second step is required to be completed as soon as possible, but no later
than the end of the year of adoption. Any transitional impairment loss will be
recognized as the cumulative effect of a change in accounting principle, in our
consolidated statements of income.
As of the date of adoption, The South Group expects to have unamortized goodwill
in the amount of $91.6 million and unamortized identifiable intangible assets in
the amount of $5.5 million, which will be subject to the transition provisions
of SFAS 141 and 142. Amortization expense related to goodwill was $4.8 million
pre-tax (or $4.7 million after-tax) and $3.4 million pre-tax (or $3.3 million
after-tax) for the year ended December 31, 2000 and the nine months ended
September 30, 2001, respectively. Because of the extensive effort needed to
comply with adopting SFAS 141 and 142, it is not practicable to reasonably
estimate the impact of adopting these Statements on our financial statements at
the date of this report, including whether any transitional impairment losses
will be required to be recognized as the cumulative effect of a change in
accounting principle.
In August 2001, the Financial Accounting Standards Board issued SFAS 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" which addresses
the financial accounting and reporting for the impairment or disposal of
long-lived assets. While SFAS 144 supersedes SFAS 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," it
retains many of the fundamental provisions of that Statement.
SFAS 144 also supersedes the accounting and reporting provisions of FASB Opinion
No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal
of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring
Events and Transactions," for the disposal of a segment of a business. However,
it retains the requirement in Opinion 30 to report separately discontinued
operations and extends the reporting to a component of an entity that either has
been disposed of (by sale, abandonment, or in a distribution to owners) or is
classified as held for sale. By broadening the presentation of discontinued
operations to include more disposal transactions, the FASB has enhanced
management's ability to provide information that helps financial statement users
to assess the effects of a disposal transactions on the ongoing operations of an
entity.
The provisions of SFAS 144 are effective for financial statements issued for
fiscal years beginning after December 15, 2001, and interim periods within those
fiscal years. The South Group will adopt SFAS 144 on January 1, 2002 and has not
yet determined the impact from adoption.
38
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
See Note 10 to the Consolidated Financial Statements for a discussion
of legal proceedings.
ITEM 2 CHANGE IN SECURITIES
None.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
None.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 First Amendment dated September 19, 2001 to the Noncompetition, Severance and Employment Agreement by and between Stephen
L. Chryst and The South Financial Group, Inc. and Carolina First Bank.
10.2 First Amendment dated September 19, 2001 to the Noncompetition, Severance and Employment Agreement by and between Tommy
E. Looper and The South Financial Group, Inc. and Carolina First Bank.
10.3 Standstill Agreement dated August 16, 2001 by and among The South Financial Group, Inc., Mid-Atlantic Investors, and
Individuals set forth in the Agreement.
(b) Reports on Form 8-K
None.
39
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, The South
Group has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
The South Financial Group, Inc.
/s/ William S. Hummers III
----------------------------------
William S. Hummers III
Executive Vice President
40