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 MARCH 31, 2002
TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _____ TO _____
Commission file number 0-15083
THE SOUTH FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
SOUTH CAROLINA 57-0824914
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
Registrant's telephone number, including area code (864) 255-7900
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No ____
The number of outstanding shares of the issuer's $1.00 par value common stock as
of May 6, 2002 was 40,275,096.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
MARCH 31,
----------------------------
2002 2001 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2001
----------- ----------- ------------
Assets
Cash and due from banks $ 120,439 $ 133,884 $ 149,170
Interest-bearing bank balances 68,753 31,248 91,497
Securities
Trading 3,942 1,439 1,577
Available for sale 1,571,565 891,626 1,560,986
Held to maturity (market value $80,556, $72,634 and
$81,878, respectively) 79,679 71,473 80,832
---------- --------- ----------
Total securities 1,655,186 964,538 1,643,395
---------- --------- ----------
Loans
Loans held for sale 29,900 17,974 6,513
Loans held for investment 3,780,154 3,717,522 3,730,598
Less unearned income 231 1,072 348
Less allowance for loan losses 45,208 43,741 44,587
---------- --------- ---------
Net loans 3,764,615 3,690,683 3,692,176
---------- --------- ---------
Premises and equipment, net 112,005 117,372 114,224
Accrued interest receivable 32,861 36,938 38,241
Intangible assets 96,835 105,501 97,145
Other assets 207,304 197,588 203,594
---------- ---------- ----------
$6,057,998 $5,277,752 $6,029,442
========== ========== ==========
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing $ 527,629 $ 470,420 $ 524,437
Interest-bearing 3,113,875 3,345,960 3,080,818
---------- ---------- ----------
Total deposits 3,641,504 3,816,380 3,605,255
---------- ---------- ----------
Federal funds purchased and repurchase agreements 1,379,340 358,227 1,269,538
Other borrowed funds 429,992 487,684 523,912
Subordinated notes 37,344 36,767 37,344
Trust preferred debt 31,000 - 31,000
Accrued interest payable 25,125 41,945 20,337
Other liabilities 41,666 46,084 46,859
---------- ---------- ----------
Total liabilities 5,585,971 4,787,087 5,534,245
---------- ---------- ----------
Minority interest in consolidated subsidiary 37,023 12,673 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 40,261,842, 42,526,005
and 41,228,976 shares, respectively 40,262 42,526 41,229
Surplus 289,331 330,882 311,305
Retained earnings 122,578 94,087 113,288
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (1,752) (2,281) (1,544)
Accumulated other comprehensive income (loss), net of tax (15,415) 12,778 (6,104)
---------- ---------- ----------
Total shareholders' equity 435,004 477,992 458,174
---------- ---------- ----------
$6,057,998 $5,277,752 $6,029,442
========== ========== ==========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
2002 2001
---- ----
Interest income
Interest and fees on loans $ 64,880 $ 85,406
Interest and dividends on securities:
Taxable 21,567 13,497
Exempt from Federal income taxes 1,091 1,010
-------- --------
Total interest and dividends on securities 22,658 14,507
Interest on short-term investments 469 608
-------- --------
Total interest income 88,007 100,521
-------- --------
Interest expense
Interest on deposits 21,576 44,906
Interest on borrowed funds 13,025 12,669
-------- --------
Total interest expense 34,601 57,575
-------- --------
Net interest income 53,406 42,946
Provision for loan losses 6,238 4,508
-------- --------
Net interest income after provision for loan losses 47,168 38,438
Noninterest income 11,760 12,915
Noninterest expenses 37,524 38,158
-------- --------
Income before income taxes, minority interest, and cumulative effect of
change in accounting principle 21,404 13,195
Income taxes 6,850 4,750
-------- --------
Income before minority interest and cumulative effect of change in
accounting principle 14,554 8,445
Minority interest in consolidated subsidiary, net of tax (428) (95)
-------- --------
Income before cumulative effect of change in accounting principle 14,126 8,350
Cumulative effect of change in accounting principle, net of tax - 282
-------- --------
Net income $ 14,126 $ 8,632
======== ========
Average common shares outstanding, basic 41,180,460 42,424,190
Average common shares outstanding, diluted 42,059,462 43,117,270
Per common share, basic:
Net income before cumulative effect of change in accounting principle $ 0.34 $ 0.19
Cumulative effect of change in accounting principle - 0.01
------ ------
Net income $ 0.34 $ 0.20
====== ======
Per common share, diluted:
Net income before cumulative effect of change in accounting principle $ 0.34 $ 0.19
Cumulative effect of change in accounting principle - 0.01
------ ------
Net income $ 0.34 $ 0.20
====== ======
Cash dividends declared per common share $ 0.12 $ 0.11
====== ======
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME
(dollars in thousands, except share data) (Unaudited)
RETAINED ACCUMULATED
SHARES OF EARNINGS OTHER
COMMON COMMON AND COMPREHENSIVE
STOCK STOCK SURPLUS OTHER* INCOME (LOSS) TOTAL
--------- ------- ------- -------- ------------- -----
Balance, December 31, 2000 42,460,358 $ 42,460 $ 332,095 $ 87,538 $ 6,560 $ 468,653
Net income - - - 8,632 - 8,632
Other comprehensive income, net of
tax of $3,018 - - - - 6,218 6,218
---------
Comprehensive income - - - - - 14,850
---------
Cash dividends declared
($0.11 per common share) - - - (4,677) - (4,677)
Common stock activity:
Repurchase of stock (60,000) (60) (1,872) - - (1,932)
Dividend reinvestment plan 55,144 55 681 - - 736
Employee stock purchase plan 4,432 5 54 - - 59
Restricted stock plan (2,711) (3) (38) 230 - 189
Exercise of stock options 68,782 69 (25) - - 44
Miscellaneous - - (13) 83 - 70
---------- -------- ---------- -------- -------- ---------
Balance, March 31, 2001 42,526,005 $ 42,526 $ 330,882 $ 91,806 $ 12,778 $ 477,992
========== ======== ========= ======== ======== =========
Balance, December 31, 2001 41,228,976 $ 41,229 $ 311,305 $ 111,744 $ (6,104) $ 458,174
Net income - - - 14,126 - 14,126
Other comprehensive loss,
net of tax of $3,967 - - - - (9,311) (9,311)
---------
Comprehensive income - - - - - 4,815
---------
Cash dividends declared
($0.12 per common share) - - - (4,836) - (4,836)
Common stock activity:
Repurchase of stock (1,135,600) (1,136) (24,181) - - (25,317)
Dividend reinvestment plan 1,485 2 (25) - - (23)
Employee stock purchase plan 2,849 3 48 - - 51
Restricted stock plan 59,096 59 1,281 (291) - 1,049
Exercise of stock options 105,036 105 892 - - 997
Miscellaneous - - 11 83 - 94
---------- -------- --------- --------- -------- ---------
Balance, March 31, 2002 40,261,842 $ 40,262 $ 289,331 $ 120,826 $(15,415) $ 435,004
========== ======== ========= ========= ======== =========
* 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)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2002 2001
---- ----
Cash flows from operating activities
Net income $ 14,126 $ 8,632
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization 3,325 4,401
Provision for loan losses 6,238 4,508
Gain on sale of securities (59) (482)
Gain on equity investments (11) (821)
Loss on disposition of assets and liabilities - 262
Gain on sale of loans (224) (1,951)
(Gain) loss on disposition of premises and equipment (39) 31
Loss on disposition of other real estate owned 168 195
Impairment loss from write-down of assets - 215
Impairment recovery on mortgage servicing rights (200) -
Loss on changes in fair value of hedges 13 97
Minority interest in consolidated subsidiary 428 95
Cumulative effect of change in accounting principle - (282)
Trading account assets, net (2,335) 3,643
Originations of mortgage loans held for sale (137,284) (79,510)
Sale of mortgage loans held for sale 114,121 74,278
Other assets, net 3,504 (15,016)
Other liabilities, net 4,521 12,466
-------- ---------
Net cash provided by operating activities 6,292 10,761
-------- ---------
Cash flows from investing activities
Sale of securities available for sale 211,626 136,732
Maturity or call of securities available for sale 462,473 129,049
Maturity or call of securities held to maturity 4,081 6,294
Purchase of securities available for sale (698,206) (217,281)
Purchase of securities held to maturity (2,928) -
Origination of loans, net (58,677) (111,011)
Disposition of equity investments 68 85
Sale of other real estate owned 1,010 604
Sale of premises and equipment 1,132 239
Capital expenditures (1,844) (860)
Disposition of assets and liabilities, net - 498
-------- ---------
Net cash used for investing activities (81,265) (55,651)
-------- ---------
Cash flows from financing activities
Deposits, net 37,162 (78,550)
Borrowed funds, net 15,882 97,196
Issuance of minority interest stock, net - 12,673
Cash dividends paid (5,693) (4,671)
Cash dividends paid on minority interest (704) 301
Repurchase of common stock (25,317) (1,932)
Other common stock activity 2,168 1,098
--------- ---------
Net cash provided by financing activities 23,498 26,115
--------- ---------
Net change in cash and due from banks (51,475) (18,775)
Cash and cash equivalents at beginning of year 240,667 183,907
--------- ---------
Cash and cash equivalents at end of period $ 189,192 $ 165,132
========= =========
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) GENERAL
The foregoing unaudited consolidated financial statements include the accounts
of The South Financial Group, Inc. and subsidiaries (collectively defined as
"TSFG," except where the context requires otherwise). All significant
intercompany accounts and transactions are eliminated in consolidation, and all
adjustments considered necessary for a fair presentation of the results for
interim periods presented have been included. (Such adjustments are normal and
recurring in nature.) Certain prior year amounts have been reclassified to
conform to 2002 presentations.
The consolidated financial statements and notes are presented in accordance with
the instructions for Form 10-Q. The information contained in the footnotes
included in TSFG's 2001 Annual Report on Form 10-K should be referred to in
connection with the reading of these unaudited interim consolidated financial
statements.
ACCOUNTING ESTIMATES AND ASSUMPTIONS
Certain policies require management to make estimates and assumptions that
affect the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ significantly from these
estimates and assumptions.
(2) COMPREHENSIVE INCOME
The following summarizes other comprehensive income (loss), net of tax (in
thousands) for the three months ended March 31:
2002 2001
---- ----
Unrealized gains (losses) on securities:
Unrealized holding gains (losses) arising during the year $(13,460) $10,163
Income tax (expense) benefit 4,036 (3,356)
Less: Reclassification adjustment for gains included in net income (40) (467)
Income tax expense 13 168
Unrealized losses on cash flow hedges:
Cumulative effect of change in accounting principle - (70)
Income tax benefit - 26
Unrealized gain (loss) on change in fair values 222 (390)
Income tax (expense) benefit (82) 144
------- -------
$(9,311) $ 6,218
======= =======
5
(3) SUPPLEMENTAL FINANCIAL INFORMATION
CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for noninterest income and noninterest
expense (in thousands) for the three months ended March 31:
2002 2001
---- ----
Noninterest income:
Service charges on deposit accounts $ 4,907 $ 4,368
Fees for investment services 1,427 1,243
Mortgage banking income 1,190 2,419
Bank-owned life insurance 1,806 1,395
Merchant processing income 1,248 1,214
Gain on sale of securities 59 482
Gain on equity investments 11 821
Loss on disposition of assets and liabilities - (262)
Other 1,112 1,235
-------- --------
Total noninterest income $ 11,760 $ 12,915
======== ========
Noninterest expenses:
Salaries and wages $ 16,224 $ 14,614
Employee benefits 4,378 4,080
Furniture and equipment 3,596 3,398
Occupancy 3,545 3,663
Professional fees 1,327 1,312
Merchant processing expense 1,044 829
Amortization of intangibles 310 1,570
Impairment loss from write-down of assets - 215
Restructuring and merger-related recoveries - (413)
Other 7,100 8,890
-------- --------
Total noninterest expenses $ 37,524 $ 38,158
======== ========
CONSOLIDATED STATEMENTS OF CASH FLOW
The following summarizes supplemental cash flow data (in thousands) for the
three months ended March 31:
2002 2001
---- ----
Interest paid $ 29,813 $ 50,798
Income taxes paid (refunded) 3,251 (5,826)
Significant non-cash investing and financing transactions are summarized as follows:
Loans securitized and reclassed to available for sale securities - 112,174
Change in unrealized gain (loss) on available for sale securities (13,500) 9,696
Loans transferred to other real estate owned 3,353 2,129
6
(4) BUSINESS COMBINATIONS
In March 2002, TSFG signed a definitive agreement to acquire Gulf West Banks,
Inc. ("Gulf West"), headquartered in St. Petersburg, Florida. At March 31, 2002,
Gulf West operated through 15 branches in the greater Tampa Bay area of Florida
through its subsidiary, Mercantile Bank, and had total assets of $524.9 million.
In the merger, TSFG will issue 4,465,141 shares of common stock and pay
$32,400,178 in cash in exchange for all the shares of Gulf West common stock
outstanding at closing, calculated on a fully diluted basis. This transaction,
which is expected to close in the third quarter of 2002, will be accounted for
using the purchase method of accounting and is subject to regulatory approvals
as well as the approval of Gulf West shareholders.
(5) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, TSFG adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets"
("SFAS 142"). It requires that goodwill and intangible assets with indefinite
useful lives no longer be amortized, but instead tested for impairment at least
annually in accordance with the provisions of SFAS 142. SFAS 142 also requires
that intangible assets with definite useful lives be amortized over their
respective estimated useful lives to their estimated residual values and
reviewed for impairment in accordance with SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS 121").
In connection with the transitional goodwill, SFAS 142 requires TSFG to perform
an assessment of whether there is an indication that goodwill is impaired as of
January 1, 2002. To accomplish this, TSFG 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. TSFG will then have until June 30,
2002 to determine the fair value of each reporting unit and compare it to the
reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the second step of the transitional impairment test
must be performed. In the second step, the implied fair value of the reporting
unit's goodwill, determined by allocating the reporting unit's fair value to all
of it assets (recognized and unrecognized) and liabilities in a manner similar
to a purchase price allocation in accordance with SFAS 141, "Business
Combinations," is compared to its carrying amount, both of which would be
measured as of January 1, 2002. This second step is required to be completed as
soon as possible, but no later than the end of 2002. Any transitional impairment
loss will be recognized as the cumulative effect of a change in accounting
principle in the consolidated statements of income.
As of the January 1, 2002 adoption of SFAS 142, TSFG had unamortized goodwill in
the amount of $89.1 million, unamortized identifiable intangible assets in the
amount of $5.5 million, and unamortized unidentifiable intangible assets in the
amount of $2.5 million related to branch purchases. Under SFAS 142, the
amortization of goodwill ceased effective January 1, 2002. The amortization of
goodwill approximated $4.2 million pre-tax (or $4.1 million after tax) during
2001 and $1.2 million pre-tax (or $1.1 million after-tax) during the first
quarter ended March 31, 2001. TSFG will continue to amortize the identifiable
intangible assets, which relate to core deposit premiums, and unidentifiable
intangible assets from branch purchases, which fall under the provisions of SFAS
Statement No. 72, "Accounting for Certain Acquisitions of Banking or Thrift
Institutions". TSFG will complete its analysis of the fair value of its
intangible assets and provide for any transitional impairment losses as the
cumulative effect of a change in accounting principle by December 31, 2002. TSFG
has not yet determined whether any transitional impairment losses will be
recognized as the cumulative effect of a change in accounting principle in 2002.
There was no change in the carrying amount of goodwill at March 31, 2002
compared to December 31, 2001. Also, see Notes 6 and 7 for additional financial
statement disclosure requirements under SFAS 142.
7
The following presents the details for goodwill amortization expense and net
income (in thousands, except share data) for the three months ended March 31:
2002 2001
---- ----
Net income $ 14,126 $ 8,632
Amortization of goodwill, net of tax - 1,097
-------- -------
Adjusted net income $ 14,126 $ 9,729
======== =======
Net income per common share, basic $ 0.34 $ 0.20
Amortization of goodwill, net of tax - 0.03
-------- -------
Adjusted net income per common share, basic $ 0.34 $ 0.23
======== =======
Net income per common share, diluted $ 0.34 $ 0.20
Amortization of goodwill, net of tax - 0.03
-------- -------
Adjusted net income per common share, diluted $ 0.34 $ 0.23
======== =======
(6) INTANGIBLE ASSETS
Intangible assets are summarized as follows (in thousands):
March 31, December 31,
-------------------------
2002 2001 2001
---- ---- ----
Goodwill $ 89,063 $ 95,342 $ 89,063
Core deposit premium 15,159 16,429 15,159
Less accumulated amortization (9,858) (9,653) (9,619)
-------- -------- --------
5,301 6,776 5,540
-------- -------- --------
Unidentifiable intangible assets from branch purchases 5,683 6,945 5,683
Less accumulated amortization (3,212) (3,562) (3,141)
-------- -------- --------
2,471 3,383 2,542
-------- -------- --------
$ 96,835 $105,501 $ 97,145
======== ======== ========
Amortization of intangibles totaled $239,000 for core deposit premiums and
$71,000 for unidentifiable intangible assets from branch purchases for the three
months ended March 31, 2002. Amortization of intangibles totaled $375,000 for
core deposit premium, $79,000 for unidentifiable intangible assets from branch
purchases and $1.1 million for goodwill for the three months ended March 31,
2001. Under SFAS 142, the amortization of goodwill ceased effective January 1,
2002. See Note 5.
The estimated amortization expense for core deposit premium for the years ended
December 31 are as follows: $959,000 for 2002, $879,000 for 2003, $759,000 for
2004, $660,000 for 2005, $555,000 for 2006, and $1.7 million thereafter. The
estimated amortization expense for unidentifiable intangible assets from branch
purchases for the years ended December 31, 2002, 2003, 2004, and 2005 is
$263,000, $206,000 for the year ended December 31, 2006 and $1.3 million
thereafter.
8
(7) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs") totaled $8.0 million, $8.9
million and $9.9 million at March 31, 2002, December 31, 2001, and March 31,
2001, respectively. Amortization expense for MSRs totaled $1.0 million and $1.4
million for the three months ended March 31, 2002 and 2001, respectively.
The estimated amortization expense for MSRs for the years ended December 31, are
as follows: $4.1 million for 2002, $2.4 million for 2003, $1.6 million for 2004,
$1.0 million for 2005, and none thereafter. The estimated amortization expense
is based on current information regarding loan payments and prepayments.
Amortization expense could change in future periods based on changes in the
volume of prepayments and other environmental factors.
(8) PER SHARE INFORMATION
The following is a summary of the basic and diluted average common shares
outstanding for the three months ended March 31:
2002 2001
---- ----
Basic:
Average common shares outstanding (denominator) 41,180,460 42,424,190
========== ==========
Diluted:
Average common shares outstanding 41,180,460 42,424,190
Dilutive potential common shares 879,002 693,080
---------- ----------
Average diluted shares outstanding (denominator) 42,059,462 43,117,270
========== ==========
(9) COMMITMENTS AND CONTINGENT LIABILITIES
TSFG is currently subject to various legal proceedings and claims that have
arisen in the ordinary course of its business. In the opinion of management
based on consultation with external legal counsel, any reasonably foreseeable
outcome of such current litigation would not materially affect TSFG's
consolidated financial position or results of operations.
On November 4, 1996, a derivative shareholder action was filed in the South
Carolina Circuit Court for Greenville County against TSFG and several of its
officers. The complaint was subsequently amended several times. The amended
complaint names as additional defendants the majority of the directors of TSFG
and Carolina First Bank. The named plaintiffs in the amended complaints are
TSFG, pursuant to Section 33-7-400 of the South Carolina Code of Laws, by and
through several named minority shareholders. Plaintiffs allege four causes of
action based generally on the payment to the defendant officers of a bonus in
stock held by TSFG in Affinity Technology Group, Inc. ("Affinity") as a reward
for their efforts in connection with the Affinity investment, and other matters.
The complaint seeks damages for the benefit of TSFG in the amount of $32
million. TSFG believes that this lawsuit is without merit and has defended it
vigorously. The trial court granted the Company's motion to dismiss the lawsuit
on November 26, 1997. The plaintiffs appealed. On November 1, 2000, the South
Carolina Court of Appeals affirmed the dismissal of the lawsuit. The plaintiffs
have sought further review by the South Carolina Supreme Court. That appeal is
currently pending before the state Supreme Court.
9
(10) BUSINESS SEGMENTS
TSFG has three 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, service charges on deposits and other customer service
fees. No single customer accounts for a significant amount of the revenues of
either reportable segment.
TSFG evaluates performance based on budget to actual comparisons and segment
profits. The accounting policies of the reportable segments are the same as
those described in TSFG's Annual Report on Form 10-K for the year ended December
31, 2001.
Segment information 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.
10
INCOME STATEMENT SEGMENT DATA (IN THOUSANDS)
CAROLINA CITRUS ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ------ ----- ----------- -----
Three Months Ended March 31, 2002:
Net interest income $ 47,693 $ 7,046 $ (1,333) $ - $ 53,406
Provision for loan losses 4,150 2,079 9 - 6,238
Noninterest income 9,114 956 14,590 (12,900) 11,760
Noninterest expense 29,592 5,028 15,804 (12,900) 37,524
Amortization 310 - - - 310
Income tax expense 7,270 398 (818) - 6,850
Minority interest in consolidated
subsidiary, net of tax (428) - - - (428)
Net income 15,367 497 (1,738) - 14,126
Three Months Ended March 31, 2001:
Net interest income $ 38,348 $ 5,406 $ (808) $ - $ 42,946
Provision for loan losses 3,436 960 112 - 4,508
Noninterest income 9,490 534 16,725 (13,834) 12,915
Noninterest expense 32,844 4,647 14,501 (13,834) 38,158
Amortization 1,517 - 53 - 1,570
Income tax expense 4,032 119 599 - 4,750
Minority interest in consolidated
subsidiary, net of tax (95) - - - (95)
Cumulative effect of change in
accounting principal, net of tax - - 282 - 282
Net income 7,431 214 987 - 8,632
BALANCE SHEET SEGMENT DATA (IN THOUSANDS)
Carolina Citrus Eliminating
First Bank Bank Other Entries Total
---------- ------ ----- -----------
March 31, 2002:
Total assets $ 5,337,525 $ 804,635 $ 628,619 $ (712,781) $ 6,057,998
Loans - net of unearned income 3,169,311 672,676 37,315 (69,479) 3,809,823
Deposits 3,095,611 565,053 - (19,160) 3,641,504
March 31, 2001:
Total assets $ 4,693,994 $ 620,223 $ 584,270 $ (620,735) $ 5,277,752
Loans - net of unearned income 3,242,411 485,214 6,799 - 3,734,424
Deposits 3,343,133 485,704 - (12,457) 3,816,380
11
(11) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, except for the
consolidated balance sheet at December 31, 2001, which is derived from TSFG's
consolidated audited financial statements. In the opinion of management, all
adjustments necessary to present a fair statement of the results for the interim
periods have been made. All such adjustments are of a normal, recurring nature.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis are presented to assist in understanding
the financial condition and results of operations of The South Financial Group,
Inc. and its subsidiaries ("TSFG", which also may be referred to as "we", "us",
or "our", except where the context requires otherwise). This discussion should
be read in conjunction with the consolidated financial statements and related
notes and with the statistical information and financial data appearing in this
report as well as the Annual Report of TSFG on Form 10-K for the year ended
December 31, 2001. Results of operations for the three month period ended March
31, 2002 are not necessarily indicative of results that may be attained for any
other period. Percentage calculations contained herein have been calculated
based upon actual, not rounded, results.
TSFG, a South Carolina corporation headquartered in Greenville, South Carolina,
is a financial holding company, which commenced banking operations in December
1986, and conducted business through 69 locations in South Carolina, 5 locations
in North Carolina and 16 locations in northern and central Florida as of March
31, 2002. TSFG operates through two wholly-owned subsidiary banks: Carolina
First Bank, a South Carolina state-chartered commercial bank, and Citrus Bank, a
Florida state-chartered commercial bank (which are collectively referred to as
the "Subsidiary Banks"). Through our subsidiaries, we provide a full range of
financial services, including asset management, investments, insurance, and
trust services, designed to meet substantially all of the financial needs of our
customers.
FORWARD-LOOKING STATEMENTS
This report contains certain forward-looking statements (as defined in the
Private Securities Litigation Reform Act of 1995) to assist in the understanding
of anticipated future operating and financial performance, growth opportunities,
growth rates, and other similar forecasts and statements of expectations. These
forward-looking statements reflect current views, but are based on assumptions
and are subject to risks, uncertainties, and other factors, which may cause
actual results to differ materially from those in such statements. These factors
include, but are not limited to, the following:
o risks from changes in economic, monetary policy and industry conditions;
o changes in interest rates, deposit rates, the net interest margin and
funding sources;
o market risk and inflation;
o risks inherent in making loans including repayment risks and value of
collateral;
o loan growth, the adequacy of the allowance for loan losses and the
assessment of problem loans;
o fluctuations in consumer spending;
o competition in the banking industry and demand for our products and
services;
o dependence on senior management;
o technological changes;
o ability to increase market share;
o expense projections;
o acquisitions, related cost savings and expected financial results;
o changes in accounting policies and practices;
o costs and effects of litigation; and
o recently-enacted or proposed legislation.
Such forward-looking statements speak only as of the date on which such
statements are made. We undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such
statement is made to reflect the occurrence of unanticipated events. In
addition, certain statements in future filings by TSFG with the Securities and
13
Exchange Commission, in press releases and in oral and written statements made
by or with the approval of TSFG, which are not statements of historical fact,
constitute forward-looking statements.
PENDING MERGER
In March 2002, TSFG signed a definitive agreement to acquire Gulf West Banks,
Inc. ("Gulf West"), headquartered in St. Petersburg, Florida. At March 31, 2002,
Gulf West operated through 15 branches in the greater Tampa Bay area of Florida
through its subsidiary, Mercantile Bank, and had total assets of $524.9 million.
In the merger, TSFG will issue 4,465,141 shares of common stock and pay
$32,400,178 in cash in exchange for all the shares of Gulf West common stock
outstanding at closing, calculated on a fully diluted basis. This transaction,
which is expected to close in the third quarter of 2002, will be accounted for
using the purchase method of accounting and is subject to regulatory approvals,
as well as the approval of Gulf West shareholders.
EARNINGS REVIEW
OVERVIEW
Net income for the three months ended March 31, 2002 totaled $14.1 million, up
63.6% compared with $8.6 million for the first quarter 2001. Earnings per
diluted share for the first quarter 2002 were $0.34, a 70.0% increase from $0.20
per diluted share in the first quarter 2001. Key factors responsible for TSFG's
results of operations are discussed throughout Management's Discussion and
Analysis below.
Average common shares outstanding on a diluted basis were 42.1 million in the
first quarter 2002, down 2.5% from 43.1 million for first quarter 2001. In
connection with share repurchase programs, TSFG repurchased and cancelled
1,135,600 shares during the first quarter of 2002.
Noninterest income for the three months ended March 31, 2002 and 2001 included
pre-tax gains on asset sales of $40,000 and $1.0 million, respectively. Gains on
asset sales include gains on available for sale securities, disposition of
assets and liabilities, and equity investments. See "Earnings Review -
Noninterest Income" for details. Noninterest expenses for the first quarter 2002
included no pre-tax other items. For the first quarter 2001, noninterest
expenses included the following pre-tax other items: $413,000 recovery of
merger-related costs related to the sale of real estate and $215,000 impairment
loss from the write-down of assets. For the first three months of 2001, net
income included a $434,000 pre-tax gain from the cumulative effect of adopting a
new accounting principle for derivatives.
At March 31, 2002, TSFG had approximately $6.1 billion in assets, $3.8 billion
in loans, $3.6 billion in deposits, and $435.0 million in shareholders' equity.
At March 31, 2002, the ratio of nonperforming assets to loans and other real
estate owned was 1.34%.
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 months
ended March 31, 2002 and 2001.
14
TABLE 1
- ----------------------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- ----------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------------------------------
2002 2001
------------------------------------ ------------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
ASSETS
Earning assets
Loans, net of unearned income (1) $ 3,774,882 $ 64,880 6.97 % $ 3,749,320 $ 85,406 9.24 %
Investment securities, taxable (2) 1,643,790 21,567 5.25 808,914 13,497 6.77
Investment securities, nontaxable (3) 91,662 1,679 7.33 84,611 1,554 7.45
Federal funds sold - - - 370 5 5.48
Interest-bearing bank balances 110,742 469 1.72 39,381 603 6.21
----------- ------- ----------- --------
Total earning assets 5,621,076 88,595 6.39 4,682,596 101,065 8.75
------- --------
Non-earning assets 513,164 534,886
----------- -----------
Total assets $ 6,134,240 $ 5,217,482
=========== ===========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 594,706 $ 1,810 1.23 $ 569,458 $ 4,383 3.12
Savings 114,724 214 0.76 115,214 688 2.42
Money market 733,534 2,915 1.61 735,069 8,421 4.65
Time deposits 1,677,119 16,637 4.02 1,944,469 31,414 6.55
--------- ------- --------- -------
Total interest-bearing deposits 3,120,083 21,576 2.80 3,364,210 44,906 5.41
Borrowings 1,949,994 13,025 2.71 858,764 12,669 5.98
--------- ------ --------- ------
Total interest-bearing liabilities 5,070,077 34,601 2.77 4,222,974 57,575 5.53
------ ------
Noninterest-bearing liabilities
Noninterest-bearing deposits 495,511 438,251
Other noninterest-bearing liabilities 103,384 74,930
--------- ---------
Total liabilities 5,668,972 4,736,155
Shareholders' equity 465,268 481,327
--------- ---------
Total liabilities and shareholders' $6,134,240 $ 5,217,482
equity ========== ===========
Net interest margin $ 53,994 3.90 % $ 43,490 3.77 %
======== ========
Tax-equivalent adjustment (3) $ 588 $ 544
======== ========
(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.
15
Fully tax-equivalent net interest income for the first three months of 2002
increased $10.5 million, or 24.2%, to $54.0 million from $43.5 million in the
first three months of 2001. The net interest margin increased to 3.90% in the
first quarter of 2002 from 3.77% in the first quarter of 2001 and equaled the
fourth quarter 2001 net interest margin. These increases were due to the
increase in average earning assets and the prompt repricing of funding sources
as the Federal Reserve lowered rates during 2001.
Average earning assets grew $938.5 million, or 20.0%, to $5.6 billion in the
first quarter of 2002 from $4.7 billion in the first quarter of 2001, primarily
from internally generated loan growth and investment securities. Average loans
were $3.8 billion during the first quarter of 2002 compared with $3.7 billion
during the first quarter of 2001. Average investment securities, excluding the
average net unrealized securities gains, increased from $893.5 million in the
first quarter of 2001 to $1.7 billion in the first quarter of 2002. During 2001,
prepayments of mortgage-backed securities accelerated. TSFG increased the U.S.
Treasury security portfolio by $520 million during the fourth quarter of 2001,
largely in anticipation of additional prepayments. TSFG purchased these
securities to leverage the capital position (which takes advantage of
opportunities to increase net interest income) and to manage interest rate risk.
During 2001, the Federal Reserve reduced the target for the federal funds rate
11 times for a total of 475 basis points. Eight of these reductions occurred in
the last nine months of the year for a total of 325 basis points. The majority
of our variable rate loans, which constitute approximately 50% of the loan
portfolio, reprice immediately following changes in interest rates by the
Federal Reserve. During the last three-quarters of 2001, the net interest margin
improved, primarily from repricing certificates of deposits at significantly
lower rates and prepaying higher-cost Federal Home Loan Bank ("FHLB") advances.
Accordingly, as TSFG reduced its interest rates during the year, the decline in
the funding source rate outpaced the decline in the earning asset yield. From
the first quarter 2001 to the first quarter 2002, the earning asset yield
declined 236 basis points to 6.39%, whereas the funding source rate declined 276
basis points to 2.77%.
TSFG expects certificates of deposit to continue to reprice downward in 2002,
although with a lesser benefit than that realized in 2001. TSFG's certificates
of deposit include approximately $273 million that presently pay an annualized
percentage yield equal to or slightly higher than 7%, which mature during the
last three quarters of 2002. As a result of the significant decline in interest
rates in 2001, the current market rates for similar certificates of deposits are
significantly lower. Excluding these 7% certificates of deposit, the magnitude
of additional downward repricing opportunities related to certificates of
deposit and other interest-bearing deposits is limited.
Average total deposits declined from $3.8 billion during the first quarter of
2001 to $3.6 billion during the first quarter of 2002. These balances declined
due to the competitive nature of the deposit markets. In 2001 and in the first
quarter of 2002, TSFG decided to keep the deposit rates offered on par with
competitors and reduce deposit rate-driven promotions. Average borrowings
increased to $1.9 billion in the first quarter of 2002 from $858.8 million
during the first quarter of 2001 due to repurchase agreements and the use of
other funding sources, such as FHLB advances, to fund the growth in earning
assets. Repurchase agreements, which increased in connection with TSFG's
purchases of securities to leverage the capital position, accounted for the
majority of this increase.
Deposits generated through Bank CaroLine, an Internet banking division of
Carolina First Bank, generally pay higher rates than those offered by our branch
locations. During the first three months of 2002, TSFG priced the Bank CaroLine
deposits less aggressively than it did in 2001 in an effort to lower the overall
cost of funds. Bank CaroLine deposits totaled $45.6 million as of March 31, 2002
compared with $55.3 million and $191.8 million as of December 31, 2001 and March
31, 2001, respectively.
16
During the last half of 2001, TSFG sold available for sale investment securities
resulting in a $3.1 million pre-tax gain. In addition, TSFG recorded a $3.1
million pre-tax loss associated with the early extinguishment of approximately
$54.3 million in FHLB advances, 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. TSFG 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 $6.2 million and $4.5 million for the first
three months of 2002 and 2001, respectively. The increase was attributable to
continued loan growth, higher loan losses, and uncertain economic conditions.
The allowance for loan and lease losses (the "Allowance") equaled 1.20% and
1.18% of loans held for investment as of March 31, 2002 and 2001, respectively.
Although nonperforming loans increased by $23.3 million over this period,
specific reserves allocated to impaired loans, which consist of commercial
nonaccrual loans, did not increase proportionately. Based on management's
analysis of impairment as defined in Statement of Financial Accounting Standards
("SFAS") 114, specific reserves allocated to impaired loans totaled $4.4
million, or 10.9% of impaired loans at March 31, 2002, compared with $5.1
million and 27.7% of impaired loans at March 31, 2001.
Net charge-offs totaled $5.6 million, or 0.60% of average loans for the first
quarter of 2002, up from $3.7 million and 0.39% in the first quarter of 2001.
This increase is largely related to higher consumer loan charge-offs. While
uncertainty in the current economic outlook makes future loss levels less
predictable, management expects charge-offs as a percentage of average loans to
be comparable to the percentage for the first quarter 2002 over the next several
quarters.
NONINTEREST INCOME
Noninterest income totaled $11.8 million in the first three months of 2002,
compared with $12.9 million in the first three months of 2001. Table 2 shows the
components of noninterest income for the three months ended March 31, 2002 and
2001.
17
TABLE 2
- -------------------------------------------------------------------------------------------------------------------------
COMPONENTS OF NONINTEREST INCOME
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED
MARCH 31,
--------------------------
2002 2001
---- ----
Service charges on deposit accounts $ 4,907 $ 4,368
Fees for investment services 1,427 1,243
Mortgage banking income 1,190 2,419
Bank-owned life insurance 1,806 1,395
Merchant processing fees 1,248 1,214
Other 1,142 1,314
------ ------
Noninterest income, excluding gains on asset sales 11,720 11,953
------ ------
Gain on available for sale securities 29 403
Gain on equity investments 11 821
Loss on disposition of assets and liabilities - (262)
------ ------
Gains on asset sales 40 962
------ ------
Total noninterest income $11,760 $12,915
======= =======
Noninterest income included gains on asset sales of $40,000 and $1.0 million in
the first quarter of 2002 and 2001, respectively. Excluding gains on asset
sales, noninterest income was $11.7 million for the first quarter 2002, down
from $12.0 million in the first quarter 2001. Increases in service charges on
deposit accounts and fees for investment services of 12.3% and 14.8%,
respectively, partially offset the decline in mortgage banking income. Mortgage
banking income declined $1.2 million, as net gains of $1.3 million related to
the securitization of mortgage loans and sale of mortgage servicing rights were
realized during the first quarter 2001.
In the first quarter of 2001, the gain on equity investments included $758,000
from the exchange of Star Systems, Inc. stock for stock of Concord EFS, Inc., a
publicly-traded company, and a $63,000 gain from the sale of common stock of
Affinity Technology Group, Inc. During the first three months of 2001, the loss
on disposition of assets and liabilities related to the sale-leaseback of a
branch office.
Service charges on deposit accounts, the largest contributor to noninterest
income, rose 12.3% to $4.9 million in the first three months of 2002 from $4.4
million for the same period in 2001. The increase was attributable to attracting
new transaction accounts, improving collection of fees, and revising fee
structures to reflect competitive pricing. Average balances for deposit
transaction accounts, which impact service charges, increased approximately 4.3%
for the same period.
Fees for investment services, which include trust and brokerage income, for the
first three months of 2002 and 2001 were approximately $1.4 million and $1.2
million, respectively. During this period, brokerage income increased $104,000,
and trust income increased $80,000. At March 31, 2002 and 2001, the market value
of assets administered by the trust department totaled approximately $711
million and $718 million, respectively.
Mortgage banking income includes origination fees, servicing fees (net of the
related amortization for the mortgage-servicing rights and subservicing
payments), gains and losses on sales of mortgage loans (both current production
18
and portfolio loans), gains and losses on sales of mortgage servicing rights,
and losses and recoveries related to the impairment of mortgage-servicing
rights. Mortgage banking income in the first three months of 2002 decreased $1.2
million to $1.2 million from $2.4 million in the first three months of 2001. In
March 2001, TSFG securitized $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 in the first quarter 2001. This
gain, which was partially offset by a $352,000 loss on the sale of mortgage
servicing rights in the first quarter 2001, accounts for the decrease in
mortgage banking income.
TSFG realigned its mortgage banking strategy to place more emphasis on mortgage
originations. In connection with these efforts, TSFG securitized mortgage loans,
sold mortgage loans, and sold mortgage-servicing rights in 2001. In September
2001, TSFG entered into contracts with non-affiliated companies to service
mortgage loans for TSFG's affiliates. These servicing contracts, which began in
December 2001, pertain to portfolio mortgage loans and mortgage loans for which
Carolina First Bank owns the rights to subservice. Beginning in 2002, TSFG
expects its mortgage banking income to decrease as a result of the declining
servicing portfolio and the outsourcing of servicing to outside, third party
servicers.
Mortgage loans originated by TSFG originators totaled approximately $109 million
and $77 million in the first three months of 2002 and 2001, respectively.
Mortgage origination volumes by TSFG originators increased in the first quarter
2002 due to lower mortgage loan rates and the hiring of additional mortgage
originators. First quarter 2001 mortgage loan originations also included $67
million attributable to correspondent relationships. TSFG discontinued its
correspondent relationships in the second quarter of 2001. With the realignment
of the mortgage banking strategy in 2001, the benefit associated with
correspondent orginations, which were principally related to increasing the
servicing volumes, diminished.
CF Mortgage's total servicing portfolio includes mortgage loans owned by
Carolina First Bank, mortgage loans owned by Citrus Bank, and other mortgage
loans for which Carolina First Bank owns the rights to service. At March 31,
2002, CF Mortgage's servicing portfolio included 7,701 loans having an aggregate
principal balance of approximately $659.7 million. At March 31, 2001, the
aggregate principal balance for CF Mortgage's servicing portfolio totaled $1.9
billion, significantly higher than March 31, 2002 due to sales of mortgage
servicing rights and mortgage portfolio loans during 2001. Fees related to
servicing other loans, for which Carolina First Bank owns the rights to service,
are offset by the related amortization of mortgage servicing rights.
First quarter 2002 mortgage banking income also included a $393,000 downward
adjustment to the gain associated with the fourth quarter 2001 sale of portfolio
mortgage loans. In addition, TSFG recorded a $200,000 recovery of impairment
from the valuation of mortgage servicing rights.
Bank-owned life insurance income increased to $1.8 million in the first three
months of 2002 from $1.4 million in the same period in 2001 due to additional
purchases of life insurance and increases in cash values. Merchant processing
fees remained relatively constant at $1.2 million for both the first quarters of
2002 and 2001.
Other noninterest income totaled $1.1 million in the first quarter of 2002,
compared with $1.3 million in the first quarter of 2001. Other noninterest
income included income related to credit and debit cards, insurance commissions,
international banking services, and other fee-based services.
NONINTEREST EXPENSES
Noninterest expenses decreased to $37.5 million in the first three months of
2002 from $38.2 million in the first three months of 2001. Noninterest expenses
in the first quarter of 2001 included a $413,000 recovery of restructuring and
19
merger-related costs (which related to the sale of real estate at prices higher
than estimated) and a $215,000 impairment loss from the write down of assets
(which was primarily related to lease termination fees for abandoned locations).
Excluding these other charges, noninterest expenses decreased $832,000, or 2.2%,
to $37.5 million for the first quarter 2002 from $38.4 million for the first
quarter 2001. TSFG decreased noninterest expenses by effectively managing
overhead expenses and ceasing goodwill amortization.
Salaries, wages, and employee benefits increased to $20.6 million in the first
three months of 2002 from $18.7 million in the first three months of 2001.
Full-time equivalent employees declined to 1,332 at March 31, 2002 from 1,361 at
March 31, 2001. The increase in personnel expense was attributable to adding
revenue-producing associates, at a higher cost per full-time equivalent
employee, and recording higher levels of incentive pay. Restricted stock plan
awards, which are expensed to salaries and wages, increased to $1.0 million in
the first quarter of 2002 from $189,000 in the first quarter of 2001.
Occupancy and furniture and equipment expenses remained relatively constant at
$7.1 million in the first three months of 2002 and 2001. Professional fees
remained at $1.3 million for both the first quarters 2002 and 2001. Merchant
processing fee expenses increased $215,000 to $1.0 million for the first three
months of 2002, compared with $829,000 in the same period for 2001. This
increase was the result of increased volume in merchant processing activity.
Amortization of intangibles decreased to $310,000 for the three months ended
March 31, 2002 from $1.6 million for the three months ended March 31, 2001. This
decrease was primarily attributable to the January 1, 2002 adoption of SFAS No.
142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which requires TSFG to
cease the amortization of goodwill. See Item 1, Note 5 to the Consolidated
Financial Statements.
Other noninterest expenses decreased $1.8 million to $7.1 million in the first
quarter of 2002 from $8.9 million in the first quarter of 2001. The overall
decrease in other noninterest expenses was principally attributable to decreases
in business development, insurance, telecommunications, outside service fees and
advertising.
INCOME TAXES
Income tax expense attributable to income from continuing operations increased
to $6.9 million for the first three months of 2002 from $4.8 million for the
first three months of 2001. The effective income tax rate as a percentage of
pretax income was 32.0% for the first quarter of 2002 and 36.0% for the first
quarter of 2001. The effective income tax rate declined in connection with
ceasing the amortization of goodwill and increases in bank-owned life insurance.
The incremental statutory income tax rate was 36.94% for both of these periods.
TSFG's effective income tax rates take into consideration certain assumptions
and estimates by management. No assurance can be given that either the tax
returns submitted by management or the income tax reported on the consolidated
financial statements will not be adjusted by either adverse rulings by the U.S.
Tax Court, changes in the tax code, or assessments made by the Internal Revenue
Service. TSFG is subject to potential adverse adjustments, including but not
limited to: an increase in the statutory federal or state income tax rates, the
permanent nondeductibility of amounts currently considered deductible either now
or in future periods, and the dependency on the generation of future taxable
income in order to ultimately realize deferred tax assets. Tax returns for 1998
and subsequent years are exposed to examination by taxing authorities.
20
BALANCE SHEET REVIEW
LOANS
At March 31, 2002, TSFG had total loans outstanding of $3.8 billion, which
equaled 105% of total deposits and 63% of total assets. Loans are the largest
category of earning assets and generally produce the highest yields. The loan
portfolio consists principally of commercial loans, commercial real estate
loans, consumer loans (including both direct and indirect loans), and
one-to-four family residential mortgage loans. Substantially all loans are to
borrowers domiciled in our market areas in South Carolina, North Carolina, and
Florida. The portfolio does not contain any foreign loans or any Highly
Leveraged Transactions, as defined by regulatory authorities.
TSFG's only significant industry concentration is commercial real estate loans
(loans to finance real properties for sale or lease to unrelated third parties),
which totaled $1.2 billion, or 30.9% of total loans, at March 31, 2002. In Table
3, these loans are included in "Real estate - construction" and "Commercial
secured by real estate," categories that also include loans to non-real estate
industry borrowers. All other industry concentrations represented less than 10%
of total loans.
Table 3 summarizes outstanding loans by collateral type with the percentage of
loans in each category.
21
TABLE 3
- -------------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31, DECEMBER 31,
---------------------------------
2002 2001 2001
---- ---- ----
Commercial, financial and agricultural $ 778,315 $ 610,618 $ 742,218
Real estate - construction 543,358 445,952 532,037
Real estate - residential mortgages (1-4 family) 515,631 804,398 551,119
Commercial secured by real estate (1) 1,419,060 1,355,124 1,400,466
Consumer 523,423 498,819 504,222
Lease financing receivables 367 2,611 536
---------- ---------- ----------
Loans held for investment 3,780,154 3,717,522 3,730,598
Less: unearned income 231 1,072 348
---------- ---------- ----------
Loans held for investment, net of unearned income 3,779,923 3,716,450 3,730,250
Loans held for sale 29,900 17,974 6,513
Less: allowance for loan losses 45,208 43,741 44,587
---------- ---------- ----------
Total net loans $3,764,615 $3,690,683 $3,692,176
========== ========== ==========
- -------------------------------------------------------------------------------------------------------------------------
PERCENTAGE OF LOANS HELD FOR INVESTMENT IN CATEGORY
- -------------------------------------------------------------------------------------------------------------------------
MARCH 31, DECEMBER 31,
---------------------------------
2002 2001 2001
---- ---- ----
Commercial, financial and agricultural 20.59 % 16.43 % 19.90 %
Real estate - construction 14.37 12.00 14.26
Real estate - residential mortgages (1-4 family) 13.64 21.64 14.77
Commercial secured by real estate (1) 37.54 36.44 37.54
Consumer 13.85 13.42 13.52
Lease financing receivables 0.01 0.07 0.01
------ ------ ------
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 March 31, 2002, such loans were approximately
56% of the category total.
Loans held for investment, net of unearned income, increased $63.5 million, or
1.7%, to approximately $3.8 billion at March 31, 2002 from $3.7 million at March
31, 2001. Adjusting for sales of mortgage loans, loans held for investment
increased approximately $213.8 million, or 6.0%, from March 31, 2001. Commercial
loans led this growth with an overall increase of 9.3% and increases of 5.3% and
33.9% for Carolina First Bank and Citrus Bank, respectively.
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.
22
The portfolio is segregated into risk-similar segments for which historical loss
ratios are calculated and adjusted for identified changes in current portfolio
characteristics. Historical loss ratios are calculated by product type for
consumer loans (direct installment, indirect installment, revolving, and
mortgage) and by credit risk grade for performing commercial loans.
Nonperforming commercial loans are individually assessed for impairment under
SFAS 114 and assigned specific allocations. To allow for modeling error, a range
of probable loss ratios (from 95% to 105% of the adjusted historical loss ratio)
is then derived for each segment. The resulting percentages are then applied to
the dollar amounts of loans in each segment to arrive at each segment's range of
probable loss levels.
The Allowance for each portfolio segment is set at an amount within its range
that reflects management's best judgment of the extent to which historical loss
levels are more or less accurate indicators of current losses in the portfolio.
Management's judgments evolve from an assessment of various issues, including
but not limited to the pace of loan growth, emerging portfolio concentrations,
risk management system changes, entry into new markets, new product offerings,
loan portfolio quality trends, and uncertainty in current economic and business
conditions.
The Allowance is then segregated into allocated and unallocated components. The
allocated component is the sum of the loss estimates at the lower end of the
probable loss range for each category. The unallocated component is the sum of
the amounts by which final loss estimates exceed the lower end estimates for
each category. The unallocated component of the Allowance represents probable
losses inherent in the portfolio based on our analysis that are not fully
captured in the allocated component. Allocations of the Allowance to respective
loan portfolio components are not necessarily indicative of future losses or
future allocations. The entire Allowance is available to absorb losses in the
loan portfolio.
Assessing the adequacy of the Allowance is a process that requires considerable
judgment. Management's judgments are based on numerous assumptions about current
events, which we believe to be reasonable, but which may or may not be valid.
Thus, there can be no assurance that loan losses in future periods will not
exceed the current Allowance amount or that future increases in the Allowance
will not be required. No assurance can be given that management's ongoing
evaluation of the loan portfolio in light of changing economic conditions and
other relevant circumstances will not require significant future additions to
the Allowance, thus adversely affecting the operating results of TSFG.
The Allowance is also subject to examination and adequacy testing by regulatory
agencies, which may consider such factors as the methodology used to determine
the adequacy and the size of the Allowance relative to that of peer
institutions, and other adequacy tests. In addition, such regulatory agencies
could require us to adjust our Allowance based on information available to them
at the time of their examination.
The Allowance totaled $45.2 million, or 1.20% of loans held for investment, net
of unearned income at March 31, 2002, compared with $43.7 million, or 1.18%, at
March 31, 2001. The Allowance to nonperforming loans ratio was 1.04 times and
2.17 times at March 31, 2002 and 2001, respectively. Nonperforming loans
increased to $43.5 million at March 31, 2002 from $20.2 million at March 31,
2001. See "Credit Quality." Our analysis of Allowance adequacy includes an
impairment analysis for each nonperforming commercial loan.
Table 4 summarizes the changes in the Allowance. Net charge-offs increased in
2001, particularly in consumer and real estate-related commercial loans,
primarily due to the unfavorable economic conditions that prevailed. Until the
economy improves, charge-off levels are expected to remain above historical
levels. Assuming that economic conditions do not significantly worsen,
management expects charge-offs to remain at the level for first quarter 2002
over the next several quarters.
23
TABLE 4
- -------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
AT AND FOR AT AND FOR
THE THREE MONTHS THE YEAR ENDED
ENDED MARCH 31, DECEMBER 31,
----------------------------------
2002 2001 2001
---- ---- ----
Loan loss reserve at beginning of year $ 44,587 $ 43,024 $ 43,024
Allowance adjustment for loans sold - (101) (230)
Net charge-offs:
Loans charged-off (6,384) (4,177) (23,154)
Loans recovered 767 487 2,902
---------- ---------- ----------
(5,617) (3,690) (20,252)
Additions to reserve through provision expense 6,238 4,508 22,045
---------- ---------- ----------
Loan loss reserve at end of period $ 45,208 $ 43,741 $ 44,587
---------- ---------- ----------
Average loans $3,774,882 $3,749,320 $3,769,358
Loans held for investment, net of unearned
income (period end) 3,779,923 3,716,450 3,730,250
Net charge-offs as a percentage of average
loans (annualized) 0.60 % 0.39 % 0.54 %
Allowance for loan losses as a percentage of loans
held for investment, net of unearned income 1.20 1.18 1.20
The following summarizes impaired loan information (in thousands), all of which
are on nonaccrual, at and for the three months ended March 31:
2002 2001
---- ----
Impaired loans $ 40,521 $ 18,453
Average investment in impaired loans 40,219 17,135
Related allowance 4,409 5,111
Recognized interest income 120 16
Foregone interest 892 228
Nonaccrual loans were $43.5 million and $20.2 million as of March 31, 2002 and
2001, respectively. Interest income recognized on nonaccrual loans totaled
approximately $136,000 and $22,000 for the three months ended March 31, 2002 and
2001, respectively.
SECURITIES
At March 31, 2002, TSFG's investment portfolio totaled $1.66 billion, up $690.6
million from $964.5 million invested as of March 31, 2001 and relatively
unchanged from the $1.64 billion invested as of December 31, 2001. The majority
of this increase occurred in the fourth quarter 2001, when TSFG increased its
24
U.S. Treasury security portfolio by approximately $520 million. During 2001, as
a result of declining interest rates, U.S. government agency securities were
called prior to the stated maturities, and prepayments associated with
mortgage-backed securities accelerated. TSFG increased the available for sale
portfolio balances to provide a quality investment alternative, in preparation
for additional prepayments of mortgage-backed securities, and to increase net
interest income by leveraging available capital. During 2002, TSFG may elect to
sell investment securities depending on its need for liquidity to fund loan
demand and the general level of interest rates.
Securities (i.e., securities held to maturity, securities available for sale,
and trading securities) averaged $1.7 billion in the first three months of 2002,
up significantly from the $893.5 million average in the first three months of
2001. The majority of the increase was attributable to purchases of securities
to leverage available capital. The average portfolio yield decreased in the
first quarter of 2002 to 5.36% from 6.83% in the first quarter of 2001. The
securities yield decreased due to a lower level of general interest rates and
the addition of lower-yielding securities. The composition of the investment
portfolio as of March 31, 2002 follows: mortgage-backed securities 44%,
treasuries 34%, agencies 11%, state and municipalities 6%, and other securities
5% (which included equity investments described below).
During the first quarter 2002, the gross unrealized loss on securities (pre-tax)
increased to $21.1 million at March 31, 2002 from $7.6 million at December 31,
2001. The increase was primarily associated with the U.S. Treasury security
portfolio, partially offset by an increase in the gross unrealized gain from
TSFG's investment in Net.B@nk, Inc. ("Net.B@nk").
EQUITY INVESTMENTS
Investment in Net.B@nk, Inc. At March 31, 2002, TSFG owned 1,175,000 shares of
Net.B@nk, Inc. ("Net.B@nk") common stock, or approximately 2% 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.
TSFG'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 $19.9 million as of March 31, 2002. TSFG'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 March 31, 2002, TSFG, 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. TSFG'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 $463,000 as of March 31, 2002. TSFG's shares in
Affinity are "restricted" securities, as that term is defined in federal
securities law.
Investments in Banks. As of March 31, 2002, TSFG had equity investments in
fourteen community banks located in the Southeast. In each case, TSFG owns less
than 5% of the community bank's outstanding common stock. TSFG has made these
investments to develop correspondent banking relationships and to promote
community banking in the Southeast. As of March 31, 2002, equity investments in
the community banks, included in securities available for sale with a basis of
approximately $9.8 million, were recorded at their pre-tax market value of
approximately $10.3 million. TSFG also has an investment in Nexity Financial
Corporation, an Internet bank, which is recorded at its cost basis of $500,000.
As a result of our merger with Anchor Financial Corporation in 2000, TSFG has 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 $5.0 million as of March
31, 2002.
25
CF Investment Company. CF Investment Company is a wholly-owned Small Business
Investment Company, licensed through the Small Business Administration. Its
principal focus is to invest in companies that have a bank-related technology or
service that TSFG and its subsidiaries can use. As of March 31, 2002, CF
Investment Company had invested approximately $1.4 million in a company
specializing in electronic document management and Internet-related services.
CF Investment Company's loans and equity investments represent a higher risk to
TSFG due to the start-up nature of this company. CF Investment Company is
largely inactive and has not made a new investment since second quarter 2000.
INTANGIBLE ASSETS AND OTHER ASSETS
The intangible assets balance at March 31, 2002 of $96.8 million was
attributable to goodwill of $91.5 million and core deposit balance premiums of
$5.3 million. The intangible assets balance at March 31, 2001 of $105.5 million
consisted of goodwill of $98.7 million and core deposit balance premiums of $6.8
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. TSFG adopted SFAS 142 effective January 1, 2002 and
is required to test its intangible assets for impairment in accordance with the
provisions of SFAS 142. See Item 1, Notes 5 and 6 to the Consolidated Financial
Statements.
Other assets increased $9.7 million to $207.3 million at March 31, 2002 from
$197.6 million at March 31, 2001. This was largely attributable to increases in
the value of bank-owned life insurance, which increased $6.6 million to $121.2
million at March 31, 2002. Mortgage servicing rights totaled $8.0 million and
$9.9 million at March 31, 2002 and 2001, respectively. The balance for mortgage
servicing rights declined primarily due to the amortization of rights, which
accelerated in the first quarter of 2002 due to higher mortgage prepayments.
DEPOSITS
Deposits remain TSFG's primary source of funds for loans and investments.
Deposits provided funding for 64% and 81% of average earning assets for the
three months ended March 31, 2002 and 2001, respectively. Carolina First Bank
and Citrus Bank face stiff competition from other banking and financial services
companies in gathering deposits. The percentage of funding provided by deposits
has declined, and accordingly, we have developed other sources, such as FHLB
advances and short-term borrowings, to fund loan demand and increases in
investment securities. In addition, we have increased the use of brokered
certificates of deposits, which are included in deposits.
At March 31, 2002, deposits totaled $3.6 billion, down 5% from the prior year
balance and up 1% from December 31, 2001. Average deposits decreased 5% to $3.6
billion for the three months ended March 31, 2002 from $3.8 billion for the
three months ended March 31, 2001. Deposit pricing remains very competitive, and
we expect this pricing environment to continue. In 2001 and the first quarter
2002, TSFG decide to keep deposit rates offered on par with competitors and
reduced deposit rate-driven promotions, which resulted in lower deposit
balances.
Table 1 in "EARNINGS REVIEW--Net Interest Income" details average balances for
the deposit portfolio for the three months ended March 31, 2002 and 2001. On
average, time deposits decreased $267.4 million, or 13.7%. Increases in the
average balances for other types of deposits, including noninterest-bearing of
$57.3 million and interest checking of $25.2 million, partially offset this
decrease. As part of its overall funding strategy, TSFG focuses on the mix of
deposits and, in particular, increasing the level of transaction accounts (i.e.,
noninterest-bearing, interest checking, money market, and savings accounts). For
26
the three months ended March 31, 2002, transaction accounts made up 54% of
average deposits, compared with 49% for the three months ended March 31, 2001.
These trends reflect TSFG's efforts to enhance its deposit mix by working to
attract lower-cost transaction accounts.
The decline in time deposits was largely attributable to fewer certificate of
deposit promotions, maturities of certificates of deposits from promotions held
in 2000, and lower rates at Bank CaroLine. At March 31, 2002, total deposits for
Bank CaroLine, an Internet bank, totaled $45.6 million, down from $191.8 million
as of March 31, 2001. Deposits for Bank CaroLine declined significantly, due to
offering less aggressive interest rates in an effort to lower the overall cost
of funds. At March 31, 2002, TSFG had $246.6 million in brokered certificates of
deposit under $100,000, compared with $109.2 million at March 31, 2001. 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% of total deposits at both
March 31, 2002 and 2001. TSFG's larger denomination time deposits are generally
from customers within the local market areas of its banks and, therefore, have a
greater degree of stability than is typically associated with this source of
funds.
BORROWED FUNDS
TSFG's short-term borrowings consist of federal funds purchased and repurchase
agreements, FHLB advances (with maturities less than one year when made),
commercial paper, and other short-term borrowings. The long-term borrowings
consist primarily of subordinated notes, trust preferred debt, and FHLB
borrowings with maturities greater than one year when made. In the first three
months of 2002, average borrowings totaled $1.9 billion compared with $858.8
million for the same period in 2001. This increase was primarily attributable to
an increased reliance on short-term borrowings to support earning asset growth
and to fund increases in investment securities.
Federal funds purchased and repurchase agreements are used to satisfy daily
funding needs and, when advantageous, for rate arbitrage. Federal funds
purchased and repurchase agreements totaled $1.4 billion and $358.2 million at
March 31, 2002 and 2001, respectively. The higher balances are primarily
associated with higher balances in investment securities available for sale.
Balances in these accounts can fluctuate on a day-to-day basis.
At March 31, 2002 and 2001, FHLB advances totaled $386.8 million and $461.4
million, respectively. FHLB advances are a source of funding which TSFG uses
depending on the current level of deposits, management's willingness to raise
deposits through market promotions, the Subsidiary Banks' unused FHLB borrowing
capacity, and the availability of collateral to secure FHLB borrowings.
TSFG plans to increase long-term borrowings in 2002 to provide more stable
funding while borrowing rates remain relatively low. For example, in February
and April 2002, TSFG entered into ten-year repurchase agreements for $200
million.
CAPITAL RESOURCES AND DIVIDENDS
Total shareholders' equity amounted to $435.0 million, or 7.2% of total assets,
at March 31, 2002, compared with $478.0 million, or 9.1% of total assets, at
March 31, 2001. At December 31, 2001, total shareholders' equity was $458.2
million, or 7.6% of total assets. Shareholders' equity declined primarily from
TSFG's stock repurchase program, cash dividends paid, and the unrealized losses
in the investment securities available for sale portfolio. Retention of earnings
partially offset these decreases.
27
In December 2000, we initiated a stock repurchase program for up to two million
shares, which we expanded to three million shares in September 2001. In February
2002, we added an additional one million shares to the program, bringing the
total to four million shares, or approximately 10% of our outstanding shares. In
connection with the program, TSFG has repurchased 3,529,383 shares, including
1,135,600 shares purchased during the first three months of 2002. We may
continue to repurchase shares depending upon current market conditions and
available cash.
TSFG's unrealized loss on securities, which is included in accumulated other
comprehensive loss, was $15.0 million as of March 31, 2002 as compared to an
unrealized gain of $13.1 million as of March 31, 2001 and an unrealized loss of
$5.6 million as of December 31, 2001. The decline was associated with 2001 sales
of available for sale securities for a net gain of approximately $3.5 million
and unrealized losses associated with U.S. Treasury securities purchased in the
fourth quarter of 2001.
Book value per share at March 31, 2002 and 2001 was $10.80 and $11.24,
respectively. Tangible book value per share at March 31, 2002 and 2001 was $8.40
and $8.76, respectively. Tangible book value was below book value as a result of
the purchase premiums associated with branch purchases and acquisitions
accounted for as purchases.
TSFG and its Subsidiary Banks continue to maintain higher capital ratios than
required under regulatory guidelines and exceeded the well-capitalized
requirements at March 31, 2002. Table 5 sets forth various capital ratios for
TSFG and its Subsidiary Banks.
TABLE 5
- --------------------------------------------------------------------------------------------------------------------------
CAPITAL RATIOS
- --------------------------------------------------------------------------------------------------------------------------
WELL ADEQUATELY
MARCH 31, CAPITALIZED CAPITALIZED
2002 REQUIREMENT REQUIREMENT
The South Group:
Total risk-based capital 10.90 % n/a n/a
Tier 1 risk-based capital 8.87 n/a n/a
Leverage ratio 6.56 n/a n/a
Carolina First Bank:
Total risk-based capital 11.35 % 10.00 % 8.00 %
Tier 1 risk-based capital 9.40 6.00 4.00
Leverage ratio 6.61 5.00 4.00
Citrus Bank:
Total risk-based capital 14.47 % 10.00 % 8.00 %
Tier 1 risk-based capital 8.88 6.00 4.00
Leverage ratio 8.40 5.00 4.00
TSFG and its Subsidiary Banks are subject to certain regulatory restrictions on
the amount of dividends they are permitted to pay. We have paid a cash dividend
each quarter since the initiation of cash dividends on February 1, 1994. TSFG
presently intends to pay a quarterly cash dividend on its Common Stock; however,
28
future dividends will depend upon our financial performance and capital
requirements.
MARKET RISK AND ASSET/LIABILITY MANAGEMENT
Market risk is the risk of loss from adverse changes in market prices and rates.
TSFG's market risk arises principally from interest rate risk inherent in its
core banking activities. Interest rate risk is the risk to net income
represented by the impact of higher or lower interest rates. TSFG has risk
management policies to monitor and limit exposure to interest rate risk.
As of March 31, 2002, there have been no material changes from the market risk
sensitivity analysis in TSFG's annual report on Form 10-K. The disclosures
related to the market risk of TSFG should be read in conjunction with TSFG's
audited consolidated financial statements, related notes and management's
discussion and analysis of financial condition and results of operations
included in TSFG's Annual Report on Form 10-K for the year ended December 31,
2001.
We attempt to manage exposure to fluctuations in interest rates through policies
established by our Asset/Liability Committee ("ALCO") and approved by the Board
of Directors. The primary goal of TSFG's ALCO is to achieve consistent growth in
net interest income while managing interest rate risk. We attempt to control the
mix and maturities of assets and liabilities to achieve consistent growth in net
interest income despite changes in market interest rates while maintaining
adequate liquidity and capital. Our asset/liability mix is sufficiently balanced
so that the effect of interest rates moving in either direction is not expected
to have a significant impact on net interest income over time.
TSFG uses several tools to monitor and manage interest rate risk. One of the
primary tools is a simulation model which is used to analyze earnings at risk
and the interest sensitivity gap (the difference between the amount of rate
sensitive assets maturing or repricing within a specific time period and the
amount of rate sensitive liabilities maturing or repricing within the same time
period). The model takes into account interest rate changes as well as changes
in the mix and volume of assets and liabilities. The model's inputs (such as
interest rates and levels of loans and deposits) are updated on a regular basis.
Interest sensitivity gap ("GAP position") measures the difference between rate
sensitive assets and rate sensitive liabilities during a given time frame.
TSFG's GAP position, while not a complete measure of interest sensitivity, is
reviewed periodically to provide insights related to the static repricing
structure of assets and liabilities. At March 31, 2002, on a cumulative basis
through twelve months, rate-sensitive liabilities exceeded rate-sensitive
assets, resulting in a liability sensitive position of $251.9 million. At March
31, 2002, TSFG's static gap position indicates that net interest income on a
cumulative basis through twelve months would benefit from decreases in market
interest rates. The static gap position is limited because it does not take into
account changes in interest rates or changes in management's expectations or
intentions, including any potential sales of assets or liabilities that TSFG
might contemplate depending upon variations in the markets. In addition,
indications of the impact of interest rates changes using the static gap
position may differ from the simulation model estimates. As of year end 2001,
TSFG's GAP position was a $256.3 million liability sensitive position.
The forecast used for earnings at risk analysis simulates our consolidated
balance sheet and consolidated statements of income under several different rate
scenarios over a twelve-month period. It reports a case in which interest rates
remain flat and reports variations that occur when rates gradually increase and
decrease 200 basis points over the next twelve-month period. Computation of
prospective effects of hypothetical interest rate changes are based on numerous
29
assumptions, including relative levels of market interest rates and loan
prepayments, and should not be relied upon as indicative of actual results.
Further, the computations do not contemplate any activities TSFG could undertake
in response to changes in interest rates.
TSFG models a gradual increase/decrease in rates rather than an immediate
change. According to the model as of March 31, 2002, TSFG is positioned so that
net interest income will decrease $2.3 million in the next twelve months if
interest rates rise 200 basis points and will increase $1.4 million in the next
twelve months if interest rates decline 200 basis points. The inverse
relationship between interest rates and net interest income is related to the
liability sensitive position of TSFG at March 31, 2002. In both the increasing
and decreasing rate scenarios, more interest-bearing liabilities reprice within
the next twelve months than earning assets. In the increasing rate scenario,
this means that the increase in interest expense is greater than the increase in
interest income resulting in a decline in net interest income. The explanation
is the opposite in the declining rate scenario resulting in an increase in net
interest income. In addition, due to the interest rate cuts that occurred during
2001 and the prompt repricing of interest-bearing deposits, some of our deposit
rates are nearing what management considers to be an acceptable lower limit.
Accordingly, in the declining rate scenario, the model assumes that certificate
of deposit rates will not decline below 0.50% thus limiting the interest expense
reduction from repricing certificates of deposit by the entire 200 basis points.
The overall interest rate risk position of TSFG continues to fall within the
interest rate risk guidelines established by ALCO.
In addition to the standard scenarios used to analyze earnings at risk, TSFG's
ALCO analyzes the potential impact of other scenarios. The starting point for
these "what-if" scenarios is our base forecast. This base forecast consolidates
all balance sheet information that we are presently aware of with our "most
likely" interest rate projections. The "what-if" scenarios are then used to
gauge the impact of changes in interest rates and/or balance sheet items on the
earnings of TSFG compared to the base forecast. Strategies can be formulated
based on the information provided by the earnings simulation if a scenario
either seems likely to occur or we choose to undertake the proposed transaction.
TSFG updates its base forecast quarterly based on economic changes that occurred
during the past quarter as well as changes in the economic outlook for the
coming year.
Derivatives and Hedging Activities. TSFG uses derivative instruments as part of
its interest rate risk management activities to reduce risks associated with its
lending, deposit taking, and borrowing activities. Derivatives used for interest
rate risk management include various interest rate swaps and options with
indices that relate to the pricing of specific on-balance sheet instruments and
forecasted transactions.
TSFG has interest rate swap agreements that qualify as fair value hedges and
those that qualify as cash flow hedges. Fair value hedges are used to hedge
fixed rate deposits. TSFG uses cash flow hedges to hedge interest rate risk
associated with variable rate borrowings.
In connection with its interest rate management activities, TSFG may use options
and other derivatives as economic hedges of on-balance sheet assets and
liabilities or forecasted transactions which do not qualify for hedge accounting
under SFAS 133. Accordingly, these derivatives are reported at fair value on the
consolidated balance sheet with realized gains and losses included in earnings.
By using derivative instruments, TSFG is exposed to credit and market risk.
Credit risk, which is the risk that a counterparty to a derivative instrument
will fail to perform, is equal to the extent of the fair value gain in a
derivative. Credit risk is created when the fair value of a derivative contract
is positive, since this generally indicates that the counterparty owes us. When
the fair value of a derivative is negative, no credit risk exists since TSFG
would owe the counterparty. TSFG minimizes the credit risk in derivative
instruments by entering into transactions with high-quality counterparties as
evaluated by management. Market risk is the adverse effect on the value of a
30
financial instrument from a change in interest rates or implied volatility of
rates. We manage the market risk associated with interest rate contracts by
establishing and monitoring limits as to the types and degree of risk that may
be undertaken. The market risk associated with derivatives used for interest
rate risk management activity is fully incorporated into our market risk
sensitivity analysis.
At March 31, 2002, the fair value of derivative assets totaled $356,000 and was
related to fair value hedges and derivatives with no hedging designation. At
March 31, 2002, the fair value of derivative liabilities totaled $974,000 and
was attributable to cash flow hedges.
OFF-BALANCE SHEET ARRANGEMENTS
In the normal course of operations, TSFG engages in a variety of financial
transactions that, in accordance with generally accepted accounting principles,
are not recorded in the financial statements, or are recorded in amounts that
differ from the notional amounts. These transactions involve, to varying
degrees, elements of credit, interest rate, and liquidity risk. Such
transactions are used by TSFG for general corporate purposes or for customer
needs. Corporate purpose transactions are used to help manage credit, interest
rate, and liquidity risk or to optimize capital. Customer transactions are used
to manage customers' requests for funding.
TSFG's off-balance sheet arrangements, which principally include lending
commitments, derivatives, and stock-related agreements, are described below. At
March 31, 2002 and 2001, TSFG had no interests in non-consolidated special
purpose entities.
Lending Commitments. Lending commitments include loan commitments, standby
letters of credit, unused business credit card lines, and documentary letters of
credit. These instruments are not recorded in the consolidated balance sheet
until funds are advanced under the commitments. TSFG provides these lending
commitments to customers in the normal course of business.
For commercial customers, loan commitments generally take the form of revolving
credit arrangements to finance customers' working capital requirements. For
retail customers, loan commitments are generally lines of credit secured by
residential property. At March 31, 2002, commercial and retail loan commitments
totaled $686.4 million. Standby letters of credit are conditional commitments to
guarantee performance, typically contract or financial integrity, of a customer
to a third party and totaled $53.7 million at March 31, 2002. Documentary
letters of credit are typically issued in connection with customers' trade
financing requirements and totaled $16.5 million at March 31, 2002. Unused
business credit card lines, which totaled $16.2 million at March 31, 2002, are
generally for short-term borrowings.
TSFG applies essentially the same credit policies and standards as it does in
the lending process when making these commitments.
Derivatives. In accordance with SFAS No. 133, TSFG records derivatives at fair
value, as either assets or liabilities, on the consolidated balance sheet.
Derivative transactions are measured in terms of the notional amount, but this
amount is not recorded on the balance sheets and is not, when viewed in
isolation, a meaningful measure of the risk profile of the instrument. The
notional amount is not exchanged, but is used only as the basis upon which
interest and other payments are calculated.
At March 31, 2002, the fair value of derivative assets and liabilities totaled
$356,000 and $974,000, respectively, which was reported on the consolidated
balance sheets. The related notional amounts, which are not recorded on the
consolidated balance sheets, totaled $3.0 million for the derivative assets and
$128.5 million for the derivative liabilities.
31
Stock-Related Agreements. In March 2002, TSFG entered into an accelerated share
repurchase contract with an unaffiliated company to repurchase 1 million shares
of TSFG common stock over the next six months and to settle the contract in
stock. The contract is appropriately reflected as a reduction in shareholder's
equity and in the earnings per share calculation.
LIQUIDITY
Liquidity management ensures that adequate funds are available to meet deposit
withdrawals, fund loan and capital expenditure commitments, maintain reserve
requirements, pay operating expenses, provide funds for dividends and debt
service, and manage operations on an ongoing basis. Funds are primarily provided
by the Subsidiary Banks through customers' deposits, principal and interest
payments on loans, loan sales or securitizations, securities available for sale,
maturities of securities, temporary investments, and earnings.
Proper liquidity management is crucial to ensure that TSFG is able to take
advantage of new business opportunities as well as meet the demands of its
customers. In this process, we focus on assets and liabilities and on the manner
in which they combine to provide adequate liquidity to meet our needs.
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 TSFG. Liquidity is also enhanced by the ability
to acquire new deposits through the Subsidiary Banks' established branch network
of 90 branches in South Carolina, North Carolina, and Florida. In addition, TSFG
can raise deposits on the Internet through Bank CaroLine. Liquidity needs are a
factor in developing the Subsidiary Banks' deposit pricing structure, which may
be altered to retain or grow deposits if deemed necessary.
The Subsidiary Banks have access to borrowing from the FHLB and maintain
short-term lines of credit from unrelated banks. FHLB advances, outstanding as
of March 31, 2002, totaled $386.8 million. At March 31, 2002, the Subsidiary
Banks had approximately $326 million of unused borrowing capacity from the FHLB.
This capacity was unavailable at March 31, 2002 because the Subsidiary Banks had
no available FHLB-qualifying collateral. At March 31, 2002, the Subsidiary Banks
had $18.5 million in cash as FHLB collateral, which is classified as restricted
cash and earns a market interest rate. Until the Subsidiary Banks have available
collateral (other than cash) to secure additional FHLB advances, TSFG will fund
its short-term needs principally with deposits, including brokered certificates
of deposit, federal funds purchased, repurchase agreements, and the sale of
securities available for sale. At March 31, 2002, the Subsidiary Banks had
unused short-term lines of credit totaling approximately $170.8 million (which
are withdrawable at the lender's option).
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 TSFG elects to repurchase additional shares through
its share repurchase program or in connection with its pending merger with Gulf
West, such purchases will reduce liquidity at the parent company level.
In the normal course of business, to meet the financial needs of its customers,
TSFG, principally through the Subsidiary Banks, enters into agreement to extend
credit. For amounts and types of such agreements at March 31, 2002, see
"Off-Balance Sheet Arrangements." Increased demand for funds under these
agreements would reduce TSFG's liquidity and could require additional sources of
liquidity.
32
CREDIT QUALITY
A willingness to take credit risk is inherent in the decision to grant credit.
Prudent risk-taking requires a credit risk management system based on sound
policies and control processes that ensure compliance with those policies.
TSFG's credit risk management system is defined by policies approved by the
Board of Directors that govern the risk underwriting, portfolio monitoring, and
problem loan administration processes. Adherence to underwriting standards is
managed through a multi-layered credit approval process and immediate
after-the-fact review by credit risk management of loans approved by lenders.
Through daily review by credit risk managers, monthly reviews of exception
reports, and ongoing analysis of asset quality trends, compliance with loan
monitoring policies is managed. The administration of problem loans is driven by
policies that require written plans for resolution and quarterly meetings with
credit risk management to review progress. Credit risk management activities,
including specific reviews of new large credits, are reviewed by the Directors'
Credit Committees of each banking subsidiary, which meet monthly. The results of
a comprehensive independent review of compliance with credit policy, which focus
on testing for compliance with credit policies and procedures both at the city
office level and at the credit risk management level, is reported to the
Directors' Credit Committees of each banking subsidiary.
Table 6 presents information pertaining to nonperforming assets.
TABLE 6
- -------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS AND PAST DUE LOANS
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
MARCH 31, DECEMBER 31,
------------------------------
2002 2001 2001
---- ---- ----
Nonaccrual loans - commercial $ 40,521 $ 18,453 $ 35,245
Nonaccrual loans - consumer 2,965 1,703 3,643
Restructured loans - - -
--------- --------- ---------
Total nonperforming loans 43,486 20,156 38,888
Other real estate owned 7,143 4,421 4,969
--------- --------- ---------
Total nonperforming assets $ 50,629 $ 24,577 $ 43,857
========= ========= =========
Loans past due 90 days still accruing interest (1) $ 12,496 $ 11,780 $ 14,125
========= ========= =========
Total nonperforming assets as a percentage
of loans and other real estate owned (2) 1.34 % 0.66 % 1.17 %
==== ==== ====
Allowance for loan losses as a
percentage of nonperforming loans 1.04 x 2.17 x 1.15 x
==== ==== ====
(1) Substantially all of these loans are consumer and residential mortgage loans.
(2) Calculated using loans held for investment, net of unearned income.
As a percentage of loans and other real estate owned, nonperforming assets were
1.34% at March 31, 2002, compared with 1.17% at December 31, 2001 and 0.66% at
March 31, 2001. This increase was attributable to the economic decline that
began in the first half of 2001 and accelerated after the events of September
11th. At March 31, 2002, nonperforming loans were concentrated in nine credit
relationships, which accounted for 57.0% of the nonperforming loan balance. Our
estimated loss exposure for these nine relationships was $1.0 million as of
March 31, 2002. Total estimated impairment on all commercial nonaccrual loans
totaled $4.4 million and $5.1 million as of March 31, 2002 and 2001,
respectively.
33
Until the economy improves, credit quality indicators will remain volatile.
Charge-off and nonperforming asset levels will remain above historical norms.
While current economic data seem to be signaling improvement, the outlook
remains uncertain. Management believes, however, that loss exposure in its loan
portfolio is identified, adequately reserved in a timely manner, and closely
monitored to ensure that changes are promptly addressed in its analysis of
Allowance adequacy. Accordingly, management believes the Allowance as of March
31, 2002 is adequate, based on its assessment of probable losses, and available
facts and circumstances then prevailing.
CURRENT ACCOUNTING ISSUES
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141,
"Business Combinations" ("SFAS 141"), and SFAS No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). SFAS 141 requires that the purchase method of
accounting be used for all business combinations initiated after June 30, 2001,
as well as all purchase method business combinations completed after June 30,
2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase
method business combination must meet to be recognized and reported apart from
goodwill, noting that any purchase price allocable to assembled workforce may
not be accounted for separately. SFAS 142 requires that goodwill and intangible
assets with indefinite useful lives no longer be amortized, but instead tested
for impairment at least annually in accordance with the provisions of SFAS 142.
SFAS 142 also requires that intangible assets with definite useful lives be
amortized over their respective estimated useful lives to their estimated
residual values, and reviewed for impairment in accordance with SFAS 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" ("SFAS 121"). TSFG adopted the provisions of SFAS 141, as of the
date of issuance, and SFAS 142, effective January 1, 2002. See Note 5 to the
Consolidated Financial Statements for the financial impact from the January 1,
2002 adoption of SFAS 142.
In connection with the transitional goodwill, SFAS 142 requires TSFG to perform
an assessment of whether there is an indication that goodwill is impaired as of
January 1, 2002. To accomplish this, TSFG 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. TSFG will then have until June 30,
2002 to determine the fair value of each reporting unit and compare it to the
reporting unit's carrying amount. To the extent a reporting unit's carrying
amount exceeds its fair value, an indication exists that the reporting unit's
goodwill may be impaired and the second step of the transitional impairment test
must be performed. In the second step, the implied fair value of the reporting
unit's goodwill, determined by allocating the reporting unit's fair value to all
of it assets (recognized and unrecognized) and liabilities in a manner similar
to a purchase price allocation in accordance with SFAS 141, is compared to its
carrying amount, both of which would be measured as of January 1, 2002. This
second step is required to be completed as soon as possible, but no later than
the end of 2002. Any transitional impairment loss will be recognized as the
cumulative effect of a change in accounting principle in the consolidated
statements of income.
In August 2001, the Financial Accounting Standards Board issued SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"),
which addresses the financial accounting and reporting for the impairment or
disposal of long-lived assets. SFAS 144 supersedes SFAS No. 121, "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of"
("SFAS 121"), and 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. SFAS 144
retains the fundamental provisions of SFAS 121 for recognizing and measuring
impairment losses on long lived assets held for use and long lived assets to be
34
disposed of by sale and resolves significant implementation issues associated
with SFAS 121. Unlike SFAS 121, an impairment assessment under SFAS 144 will not
result in a write down of goodwill. Rather, goodwill is evaluated for impairment
under SFAS 142, as described above.
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. TSFG adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144
for long lived assets held for use did not have a material impact on our
consolidated financial statements. The provisions of SFAS 144 for assets held
for sale or other disposal generally are required to be applied prospectively
after the adoption date to newly initiated disposal activities.
35
PART II. OTHER INFORMATION
ITEM 1 LEGAL PROCEEDINGS
See Note 9 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
Annual Meeting of Shareholders
On April 30, 2002, the Company held its 2002 Annual Meeting of
Shareholders. The results of the 2002 Annual Meeting of Shareholders
follow.
PROPOSAL #1 - ELECTION OF DIRECTORS
The shareholders approved setting the number of Company directors at 17
persons. The following persons were elected as Directors with the votes
indicated.
Voting shares in favor Withheld
# % Authority
---------- ----- ---------
William S. Hummers III 28,363,891 95.2% 1,439,690
Charles B. Schooler 29,512,021 99.0% 290,560
Edward J. Sebastian 28,691,983 96.3% 1,110,598
Eugene E. Stone IV 29,450,628 98.8% 351,953
William R. Timmons III 28,694,969 96.3% 1,107,612
Mack I. Whittle, Jr. 26,748,327 89.8% 3,054,254
William P. Brant, Judd B. Farr, C. Claymon Grimes, Jr., M. Dexter
Hagy, W. Gairy Nichols III, Thomas J. Rogers, H. Earle Russell, Jr.,
John C.B. Smith, Jr., William R. Timmons, Jr., Samuel H. Vickers, and
David C. Wakefield III continued in their present terms as directors.
PROPOSAL #2 - APPROVAL OF AMENDED AND RESTATED LONG-TERM INCENTIVE PLAN
The shareholders approved TSFG's Amended and Restated Long-Term
Incentive Plan with 27,768,005 shares, or 93.2%, voting in favor,
1,562,666 shares voting against, and 471,910 shares abstaining.
PROPOSAL #3 - AMENDMENT TO AMENDED AND RESTATED STOCK OPTION PLAN
The shareholders approved an amendment to TSFG's Amended and Restated
Stock Option Plan to increase the shares available for issuance by
1,200,000 shares with 27,695,798 shares, or 92.9%, voting in favor,
1,613,900 shares voting against, and 492,883 shares abstaining.
36
PROPOSAL #4 - AMENDMENT TO AMENDED AND RESTATED RESTRICTED STOCK
AGREEMENT PLAN
The shareholders approved an amendment to TSFG's Amended and Restated
Restricted Stock Agreement Plan to increase the shares available for
issuance by 250,000 shares with 26,777,781 shares, or 89.9%, voting in
favor, 2,529,753 shares voting against, and 495,047 shares abstaining.
PROPOSAL #5 - RATIFICATION OF AUDITORS
The shareholders approved a proposal to ratify the appointment of KPMG
LLP as independent auditors of TSFG for fiscal year 2002 with
28,987,095 shares, or 97.3%, voting in favor, 541,640 shares voting
against, and 273,846 shares abstaining.
ITEM 5 OTHER INFORMATION
None.
ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Agreement and Plan of Merger by and between TSFG and Gulf West Banks,
Inc. dated March 21, 2002.
(b) Reports on Form 8-K
TSFG filed Current Reports on Form 8-K dated March 21, 2002.
37
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, TSFG has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
The South Financial Group, Inc.
/s/ William S. Hummers III
----------------------------------
William S. Hummers III
Executive Vice President
38