Filed by The South Financial Group, Inc.
Pursuant to Rule 425 under the
Securities Act of 1933, as amended,
and deemed filed pursuant to Rule 14a-12
under the Securities Exchange Act of 1934.
Subject Company: The South Financial Group, Inc.
Commission File No. 0-15083
SOUTH FINANCIAL GROUP (TSFG)
Q2 2003 FINANCIAL RELEASE CONFERENCE CALL
Tuesday, July 15, 2003 10:00 am
OPERATOR
Good morning and welcome to The South Financial Group second quarter earnings
release conference call. All participants will be on a listen-only mode until
the question and answer session of the call. This conference is being recorded
at the request of the South Financial Group. If you have any objections, you may
disconnect. At this time I'd like to introduce your conference host Mary Gentry,
director of investor relations of The South Financial Group. Ms. Gentry, you may
begin.
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MARY GENTRY
Good morning, thank you for joining The South Financial Group's second quarter
conference call and web cast. Mack Whittle, our CEO will begin the call with
highlights for the quarter. Then, Bill Hummers, our principal financial officer,
will review the financial results and provide assumptions for the last two
quarters of 2003. Next Mike Sperry, our chief credit officer, will discuss
credit quality. Mack will then finish up by commenting on the fundamentals that
are driving our performance.
We will follow these remarks with an analyst question-and-answer session.
Presentation slides which accompany this morning's remarks are available with
our web cast or in the investor relations section of our Web site under
presentation. Our quarterly financial data supplement, which includes the
reconciliation of GAAP results and non-GAAP performance measures is also
available on our Web site. Before we begin I want to remind you that a number of
our comments today constitute forward-looking statements, and are subject to
risks and uncertainties. We disclaim any obligation to update such
forward-looking statements to reflect events or circumstances that occur after
today. Our actual results may differ materially from those set forth in these
forward-looking statements. Please refer to our reports filed with the
Securities & Exchange Commission for discussion of factors that may cause such
differences to occur.
In addition, I would point out that our presentation today contains non-GAAP
financial information, which management uses in its analysis of TSFG's
performance. In particular, a number of measures presented adjust GAAP
information to present cash basis performance measures, and to exclude the
effects of non operating items, such as merger-related costs, gains or losses on
asset sales, and other non-operating expenses. We believe that the presentation
of non-GAAP financial measures provides useful supplemental information and
better reflects our core operating activities. However, these measures shouldn't
be viewed as a substitute for GAAP operating results and furthermore, our
non-GAAP measures may not necessarily be comparable to non-GAAP performance
measures of other companies. .
Now, I'd like to turn the presentation over to our president and CEO, Mack
Whittle.
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MACK WHITTLE
Thanks Mary, and good morning everyone. We are very pleased to report record
earnings in our ninth consecutive quarter of operating earnings per share
growth. During the last nine quarters we've increased our operating EPS at a 41%
annualized rate. We've delivered another quarter of solid financial results,
another quarter of outstanding earnings progress, and another quarter of meeting
our financial projections. We're executing our business plan and delivered the
results we promised you last quarter.
Let me go over the highlights as we see them for this quarter. Our net income
per share increased to record levels, up 48% versus second quarter of 2002. Our
operating EPS increased to record levels and represented the ninth consecutive
quarter of growth. Top line operating revenue driven by non-interest income grew
31% over the second quarter of last year, and 5% over first quarter of this
year. We successfully increased fee income with non interest income making up
over 23% of total operating revenue. We continued our favorable credit quality
trends with a decline in non performing asset ratio and in charge offs.
As expected, quarter-to-date annualized loan growth exceeded 15%. I'll discuss
this in a little more detail later. Core deposits increased at a 22% annualized
growth rate, driven principally by a money market account. We increased net
income over the first quarter of 2003 despite challenging interest rate
environments. And we announced a pending acquisition of Mountain Bank Financial
Corporation. With this acquisition we will be one of the 50th largest financial
institutions in the U.S. Last quarter, our EPS growth rate of 35% placed us
among top performing banks in the U.S. The American Banker prepares a list of
publicly traded banking companies and ranks them by EPS growth rate. Last
quarter, we ranked 21st on this list. This quarter, our GAAP EPS growth rate is
even higher at 48%. These results demonstrate our discipline and our focus on
achieving superior financial performance and building long-term value for our
shareholders. With this overview, I'd like to now turn the presentation over to
Bill Hummers, for a further review of our financial results.
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WILLIAM HUMMERS
Thank you, Mack. We're pleased to announce another excellent quarter with net
income for the second quarter of 2003 of $22.7 million or 48 cents per diluted
share. This represents a 48% increase over our second quarter 2002 net income of
$15.3 million or 37 cents per diluted share. For the six months ended June 30,
2003, we recorded a 50% increase in net income. For these six months, our net
income was $42.7 million or 89 cents per diluted share compared to $28.4 million
or 68 cents per diluted share for the comparable period in 2002.
During the three months ended June 30, 2003, we incurred several items we could
historically consider to be non operational. These items included merger related
costs of $382,000 associated with the prior year acquisitions, gain on the sale
of available for sale securities of $3.2 million, impairment on a fixed asset of
$268,000, and a gain on the sale of deposits of $601,000. After adjusting the
results for these non-operating items, including the related income tax effect,
we reported operating income of $20.6 million or .43 cents per diluted share for
the quarter. Net interest income increased by $701,000 from the first quarter of
2003, due to a 26% annualized increase of average turning assets. The net
interest margin of 3.32% for the second quarter was down from the 3.54% for the
first quarter. This decline was largely attributable to higher investment
security balances, which generally have a lower yield than loans.
The total average loans outstanding during the second quarter were 12% higher on
an annualized basis than the average for the previous quarter, while average
deposits during the second quarter were 21% higher on an annualized basis
compared to the first quarter. We continue to see solid growth in our freedom
money market accounts, which is priced at 50% of the current. This account while
currently at the upper end of money market rates position us well for when
interest rates are increased.
We continue to see meaningful improvement in our non-interest income. Our total
non-interest income for the quarter was $24 million, which represents a 4.1% or
21% increase over the previous quarter, and is an increase of 10.6% or 79% over
the 2002 comparable quarter. This increase is made up of several key components.
Service charges on deposit accounts have increased from $5.4 million in the
second quarter of 2002, to $7.6 million in the second quarter of 2003, an
increase of 40%. Mortgage banking incomes doubled from $1.3 million in the
second quarter of 2002 to $2.6 million in the second quarter of 2003.
Additional increases came from almost all of our other sources of fee income.
Non interest expense totaled $50.1 million during the second quarter of 2003,
which represents a $14.3 million or 40% increase from the second quarter of
2002, and a $1.2 million increase over the first quarter or 2.5%. This increase
over the second quarter of 2002 is due primarily to the additional non-interest
expenses associated with the 2002 mergers, which occurred during the second half
of the year.
The increase over the first quarter is largely from higher personnel costs
associated with our April acquisition of an employee benefit plan administration
company and higher incentive compensation payable from Elevate and commercial
loan lending incentives. The remaining expenses excluding merger related costs
were relatively flat except for merchant processing expense, which was offset by
our related revenue increases and higher professional fees related to deposit
pricing and fee incentives.
The provision for loan losses was $5.2 million for the second quarter, compared
to $5.5 million from the previous quarter and $6.2 million for the second
quarter 2002. As you will recall, we acquired loans in October 2002 from the
Rock Hill Bank & Trust and segregated certain identified problem loans into a
separately managed portfolio. In our press release we include two sets of credit
quality measures: one including and one excluding the Rock Hill workout loan.
Mike Sperry will address credit quality in more detail in a few minutes. But
first I want to update you on the progress of our merger transactions as well as
provide an update on our capital levels and our earnings outlook.
On April 30th, we acquired an employee benefit plan administrator for an initial
purchase price of $3.5 to $5.7 million in stock, depending upon whether the five
year goals are met. We anticipate pursuing additional similar small
acquisitions, which are designed to enhance non-interest income in future
quarters.
On May 14th we announced our proposed acquisition of Mountain Bank Financial
Corporation in an all-stock transaction valued at approximately $137 million.
Mountain Bank, the largest community bank headquartered in west North Carolina,
operates 19 branch offices in 11 counties in western North Carolina and has
approximately $960 million in assets as of June 30. The transaction is subject
to regulatory and Mountain Bank shareholder approvals. The regulatory
applications for the approval of the merger transaction have been filed. The
transaction is going as anticipated and we expect to close it in October 2003.
We anticipate incurring $11 million in direct acquisition costs, $1.5 million in
non-compete agreement costs and $4.5 million in merge-related expenses. Goodwill
is expected to increase by approximately $82 million as a result of this
transaction. Mountain Bank shareholders will receive $32.50 per Mountain Bank
common share, payable in TSFG common stock.
The TSFG common stock will be valued based on a ten-day trading average
immediately subsequent to the Federal Reserve consent subject to pricing costs.
We believe that we can achieve cost savings of approximately 20% related to this
acquisition and anticipate the merger will be slightly accretive in the first
full year. This estimate does not include any anticipated revenue enhancements.
In June we filed a universal shelf statement with the SEC to provide additional
flexibility to the company in managing our capital levels, both in terms of debt
and equity.
Now I'd like to provide you with a brief update regarding the assumptions that
we've been using in our estimates for the remainder of 2003. First, we
anticipate a stable economic outlook for 2003 with no additional changes in
interest rates. We expect low double-digit loan growth to continue. Except for
the addition of Mountain Bank, total earning assets will be lower in the low
single digits as we begin to replace securities with loans.
We expect third quarter net interest margin to be relatively unchanged from the
second quarter, as high-yielding loans will offset the margin pressure from
lower interest rates. The provision for loan losses is expected to range from $5
to $6 million a quarter in the third quarter and from $6 to $7 million in the
fourth quarter including the impact from the Mountain Bank acquisition.
Annualized net loan charge offs are anticipated to be between 40 and 45 basis
points for the remainder of the year.
Total non-interest income is expected to be approximately $21.5 to $22.5 million
in the third quarter, increasing to approximately $25 to $26 million in the
fourth quarter including the Mountain Bank acquisition. Quarterly non interest
expenses before merger costs should remain flat at approximately $50 to $51
million in the third quarter, increasing to approximately $55 to $56 million in
the fourth quarter due to the Mountain Bank acquisition. The dividends to
minority interest and consolidated subsidiaries are expected to continue at
approximately $1 million per quarter net of tax. The effective tax rate is
anticipated to remain at approximately 32% for the remainder of 2003. Now I'd
like to turn the discussion over to Mike Sperry to provide additional
information on our credit quality.
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MICHAEL SPERRY
Thank you Bill. Good morning. To facilitate analysis of our credit quality
trends we provided as Bill mentioned in addition to our GAAP numbers, credit
quality data that exclude the Rock Hill workout loans. I'm going to focus on
these core numbers, and discuss the workout loans separately. I will also
briefly address Mountain Bank, specifically its potential impact on our credit
quality trends.
Our core ratios continue to reflect improvement. At quarter end, loans past dues
30 days or more were 1.32% of loans, one basis point higher than at last quarter
end. Commercial and consumer past dues at 1.14% and 1.17%, respectively were
both lower for the third consecutive quarter end but mortgage loans
delinquencies jumped from 4.93% in March to 6.54% in June. While this increase
is a concern, mortgage loans were only 3.2% of total loans at quarter end.
That's $146 million. Year to date losses in this portfolio are tracking below
last year's level and we really don't anticipate material problems in this
portfolio.
For the fifth consecutive quarter, non performing assets declined as a
percentage of loans plus foreclosed property, from 0.87% in March to 0.85% in
June. The dollar total increased slightly about $497,000 but would have declined
had scheduled closings on two loans totaling $2.6 million not slipped into the
third quarter. Core charge offs were 39 basis points on average loans, a
significant improvement from last quarter's 50 basis points. While we expected
improvement we did better than we thought because we had higher than expected
commercial recoveries. In the last half of the year we expect our non-performing
asset ratio to continue declining and we think our net charge off ratio will be
comparable to that of the second quarter. We do not anticipate dramatic
improvement in either ratio, unless the economic climate improves significantly
and that does not appear likely in my view.
As anticipated last quarter, significant improvement occurred in the Rock Hill
workout loan pool. Non-performing assets declined to $7.1 million from $32.7
million at the end of March to $25.6 million at the end of June. Charge offs for
the quarter were $2.7 million down from $4.1 million last quarter and were again
fully absorbed by preexisting reserves.
Total outstanding declined $13 million ending the quarter at $50.6 million. We
had charge offs of $2.7 million, payoffs of $2.9 million and we transferred $7.4
million in performing loans out of the pool. We expect continued improvement in
the workout pool over the remainder of the year. We're off to a real good run in
this quarter.
Regarding Mountain Bank, if you've seen their second quarter press release you
know that they reported significant improvement in loss levels and delinquency
levels. Non-performing assets rose slightly but most of the increase was the
reclassification of a former branch site to OREO. Non-performing loans and
foreclosed properties were essentially flat. These results are encouraging and
we think may signal the beginning of improved trends.
We reviewed Mountain Bank's credit policies and loan administration process
during our due diligence review. Those systems were installed approximately 18
months ago. We were pleased to discover that the current underwriting standards
and credit approval process of Mountain Bank are very similar to ours. Its
problem loan management system is not as robust, but its problem assets are not
large, are typically real secured, and have minimal loss exposure. Our
preliminary test of reserve adequacy tended to substantiate current reserve
levels, which are higher than ours at 1.62% of loans. We are now in the process
of assigning our risk ratings to the bank's portfolio and confirming this
finding. In short, we are not concerned that Mountain Bank's portfolio contained
abnormally high levels of problems or loss exposures.
So in sum, we had another good quarter. We anticipate continued progress this
year, and Mountain Bank should not adversely impact our credit quality trends.
The wild card, of course, is the economy. It continues to resist efforts to
reinvigorate it, and we continue to caution against concluding that we are
immune to this reality. As we've discussed in the past, changes in our watch
loan levels have proven to be a reliable indicator of changes in the business
climate in our markets.
In the first quarter, our watch loan levels subsided for the first time in
several quarters, suggesting that the environment may be improving. But it
swelled again in the second quarter, not back to the 2002 year-end level but up
nonetheless. The question is, is it racketing down or is it beginning new growth
rate? It is too soon to predict, but one thing is clear. The longer the economy
remains in the doldrums, the greater the risk to our credit quality trends. Now
back to Mack.
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MACK WHITTLE
As you've heard we're building strong fundamentals and benefiting from operating
in superior southeastern banking market. We have outstanding people running our
markets and our functional areas. Our team is in place and focused on achieving
superior financial performance. This quarter we demonstrated that by realizing
15% loan growth, better-than-expected non interest income growth, and continued
favorable credit quality trends.
First on loan growth. We expected our loan growth to be strong this quarter, and
it was. We operate in some of the best markets in the Southeast and are gaining
business in all of our markets. We continue to move market share from several
large competitors including those going through system and customer conversions.
We are also leveraging our Florida markets and capturing additional business
from existing customers due to higher post-merger lending limits. We continue to
redefine and develop our Elevate sales process as a way to manage our lines of
business. For example, we recently held a one-day business to business call
blitz and generated over $100 million in loan opportunities during that one day.
Call blitzes have become a part of the Elevate process and a part of our
culture, and typically generate over 400 calls in a single day.
Our non-interest income growth, we set aggressive non-interest income goals for
the second quarter, and we exceeded them. Our service charges on deposit
accounts were up 9% from the first quarter, and 40% from last year. This was
from significant transaction account growth, fee increases, and expanded cash
management services that we talked about last quarter.
Our strategy of focusing on mortgage originations and adding mortgage
originators was well-timed. We had another quarter of strong mortgage banking
income, up 18% from the first quarter, and double second quarter of last year.
We added 16 additional originators in the second quarter, continued
re-financings, and had limited impairments on servicing rights. Our Elevate
sales process that is both retail and business is working and provides a
foundation for the evolving and sustainable sales culture.
Our fee income growth including insurance income, debit card income, customer
service fees, transaction account growth, and loan growth demonstrate that
significant progress. When we introduced Elevate, as many of you remember, in
November of 2001, we sold a little over one product per sales FTE per day. We
now sell close to 3 products per sales FTE per day, and our goal is 4 by the end
of this year. As well, we have products sold per household of 3.5. This has had
a direct impact on our non-interest income as you might well imagine. For the
quarter, non-interest income growth represents over 23% of total revenue. We are
approaching our goal of 25% of total revenue and encouraged by this progress.
Now let me spend a few minutes and talk about our acquisition strategy. We have
a disciplined acquisition approach with three well-defined goals as we look at
potential candidates. First, the acquisition must strategically enhance our
franchise and be in one of our identified high-growth Southeastern banking
markets. We expect all acquisitions to be accretive to cash EPS and stated
financial goals within 12 months. And we only look at companies with similar
banking cultures and shared super-community banking objectives.
This quarter, we announced the pending merger of Mountain Bank Financial
Corporation. This merger meets all of those goals. Mountain Bank operates in
very attractive western North Carolina markets, including Hendersonville and
Asheville, which were targeted for expansion by us for many years. It is a
logical expansion of our franchise into a neighboring community of Greenville
which shares our upstate media market.
We expect an accretive financial impact based on 20% cost savings, and excluding
any revenue enhancements. And our companies share a common community bank
operating philosophy that focuses on taking care of our customers. In addition,
we have a proven integration methodology, and an experienced team to deliver
that. We demonstrated that successfully in our recent integrations of Gulf West,
Rock Hill, and Central Bank of Tampa. Our team is already assembled and is
already working on another seamless integration with Mountain Bank.
In addition, with our strategy to grow non-interest income to peer levels, we're
also looking at acquiring insurance agencies, similar to our acquisition of
Gardner Associates last fall. During this quarter, as Bill pointed out, we
purchased American Pensions Inc., a benefit plan administrator. Also a few weeks
ago we announced the establishment of an investment management firm to manage
assets for our customers. These initiatives are working out very well and are
part of our efforts to leverage our customer base and realize non-interest
income opportunities.
Setting multiple year financial goals has proven to be a very effective
management tool and an effective way to focus our team. As we have said before,
management's current three-year strategic goals are a 14.50% ROE and a 1.25% ROA
by the end of 2003. We believe we are on track to be at or very near these
goals. As we near the end of this current three-year period, we are very pleased
with what we've accomplished. And based on our stock price performance, it
appears that the market is pleased as well. However, as we have said before,
this three-year period is not the end. It is merely the first stage. Our team is
currently developing another three-year plan that will set goals based on a new
peer group that is high performing banks. This is all a part of our continuing
focus on profitability and achieving above peer group returns. We plan to
rollout this new plan, this new three-year strategic plan, sometime in this
third quarter.
During the past year we completed four acquisitions, announced one other
acquisition. Acquisitions as you know generate intangible assets. Therefore, in
analyzing returns we find it useful to examine cash returns when comparing our
returns to our peers. Our cash return on tangible equity for the second quarter
of 20.8% exceeds our peer group average of 17% for the previous quarter. We
expect to end 2003 with cash returns on tangible equity above our peer group
average. As we go forward, we will look closely at our performance measures on a
cash basis, which is something we believe the investment community is already
doing.
In summary, we had an outstanding quarter. For the ninth consecutive quarter,
operating EPS increased. Our annualized EPS growth during this period exceeded
40%. Year-to-date loan growth met our double-digit growth projections. We are
increasing our non-interest income stream and approaching the goals we've set of
25% of total revenue. And we continue to report favorable credit quality trends.
Our financial performance demonstrates the successful execution of our plan and
the focus of our management team. And with that, I'd like to open it back up for
questions.
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OPERATOR
Thank you sir. At this time, if you would like to ask a question please press
star then 1 on your touch-tone keypad. If you are using speaker equipment, you
may need to lift your handset prior to pressing star 1. To withdraw your
question or if your question has already been answered, please press star 2.
Once again, that's star 1 if you would like to ask a question and star 2 to
cancel. One moment please, while the questions register. Our first question is
from Jeff Davis of FTN Financial Securities.
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JEFF DAVIS
Good morning. Good quarter, gentlemen. Two-part question. Mack, first part to
you. Could you comment on what you're seeing with regards to Wachovia within
South Carolina, any change in their operation? I know you're pulling a little
bit of market share from those guys, but color there, and then to the extent you
could provide it in Florida. And then let me go ahead and just do the second
part. And it relates to margin. Margin guidance is flat or I assume roughly flat
for the coming quarter. And I would assume the securities portfolio yield give
up is close to over with the yield this quarter at 3.8%. But the Fed just cut
rates 25 bps and you've gotten your cost of funds down nicely. What are the
dynamics that hold the margin here?
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MACK WHITTLE
Jeff, this is Mack. We are, you know, one of the things that we've been able to
do in South Carolina, primarily because of our size and now we've got a very
robust treasury services area, and we picked up some of the corporate services
that we didn't have before, most of that is a function of our increased size.
We've also picked up a number of the old SCN Wachovia now new Wachovia corporate
employees who have really helped us boost our loan business with the local South
Carolina companies that we were not banking. So we are seeing a substantial
amount of growth in South Carolina. And in the markets that we're in South
Carolina have continued to do well, you know, in these downward economic times,
we still have seen pretty good growth in those markets that we're in South
Carolina.
As we look at Florida, you need to remember that this time last year, we weren't
in Tampa. And today we've got a billion dollars in assets in Tampa. And a
franchise that basically covers the whole Tampa/St. Pete market. So our ability
to not only make larger loans by putting those two banks together and leveraging
off the whole franchise, we're also able to go after some of that market and
many people don't realize that Tampa really is the second largest market in the
southeast. It's, you know, right behind Atlanta and a lot of the things that
they do. They have the second highest number of Fortune 500 companies. So it is
a great market for us and we have good market coverage and presence there.
On the margin, I'll address that and let Jim Monroe and Bill Hummers who are
here as well. Our loan growth really started in the early part of the second
quarter. We really didn't get the Florida franchise geared up and going until
the second quarter, and many of those loans closed in the latter part of the
second quarter. We still see an incredible pipeline of loans, many of which we
hope it would close in June, but really spilled over into July as Mike pointed
out. So the loan growth there, we still see that fairly strong. And as those
loans come on, then you'll begin to see the securities begin to come off. So I
think the guidance we've given is that the earning asset base will be fairly
flat. But there will be a replacement in earning assets from securities to
loans. We're probably a half a quarter late on that strategy coming out, but it
is fully in effect now, and I think you'll begin to see that securities
portfolio come down nicely as we move into the third and fourth quarter. Bill,
you or Jim want to comment?
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WILLIAM HUMMERS
I think what Mack said was fine. We're about a half a quarter behind in
executing our strategy of replacing securities with loans. So since loan growth
has picked up, we'll be - the investment portfolio will be starting to shrink to
be replaced with loans.
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JEFF DAVIS
OK. And then Bill, within rough parameters, assuming the Fed doesn't cut again
and the curve doesn't flatten from the long end, has the margin then come close
to finding a floor here, and I should know off the top of my head, but I can't
remember what Mountain Bank's margin is, we'll get a little delta from that.
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WILLIAM HUMMERS
There will be a little change from Mountain Bank's margin. Their margins are a
little bit higher than ours but overall we'll absorb them in. We think the
margin, as we said in our guidance, the margin over the remaining part of the
year will be essentially flat.
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JEFF DAVIS
OK. All right, very good, thank you.
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WILLIAM HUMMERS
Thank you.
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OPERATOR
Our next question is from Gary Tenner from Sun Trust Robinson.
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GARY TENNER
Good morning. Quick question, you mentioned about [$2.6] million of
non-performers did not close in the second quarter. Should we assume that those
have closed already in the third quarter?
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MIKE SPERRY
You can assume they will close. As it turns out they have not yet but they were
not scheduled to yet, but they will go out in the third quarter.
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GARY TENNER
OK, great. And just I wonder, Mack, if you could give some comments on what
you're seeing on the acquisition front down in Florida as far as pricing and
expectations?
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MACK WHITTLE
Well, first, let me say this. You know, our goal is to try to have two clean
quarters between acquisitions. So what we want to make sure we demonstrate to
the market is discipline in what we do and the acquisitions we make, but then we
think it's important to show that we did in fact integrate it properly and we
did in fact get the accretion that we talk about so we think it's - our
preference is two to three quarters, clean quarters between acquisitions. That
is not always the case but that should be the case more often than not. Having
said that, you know, there are not a lot of banks really that are of any size
that are in our footprint in Florida. You know, maybe a handful, five or six.
We have continuing conversations with all of them in various stages of where
they are and where they want to be. We're just trying to position ourselves so
that when they do make that decision that we're able to move forward. I think
that the FNB transaction is an interesting transaction. I think that as well as
the Provident pricing, really should speak to the recent sell of the Provident
branches, should really speak to what we're doing with the value of the
franchise by growing Florida. Because Florida truly is a premium market or at
least the banking environment thinks that it is a premium market. And I think
it's demonstrated by the price Provident got for the deposits that they sold
there as well as the way this FNB transaction has unfolded. Gary, does that
answer your question?
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GARY TENNER
Yes, it sure does. You know, I just wonder if you could comment on what you're
seeing as far as what expectations are on the seller's side. Do they continue, I
imagine they continue to be quite high based on recent transactions but is there
any change?
- ---------------------------------------------
MACK WHITTLE
Go back and look at our acquisitions and we have been able to -- we try to look
at deals that are out of the cross hairs of everybody else and we try to offer
some strategic advantages that some of the larger guys can't offer. And you
know, we try to do that. And again, we're going to be disciplined. I mean, we
walked away from at least two acquisitions in Florida last year that were --
that the pricing got beyond what we felt was, would keep us within our financial
parameters. You know, we've got a financial model that we use when we look at
these acquisitions, and we try to use reasonable assumptions in that. And if the
price gets outside of the range of keeping us still on track to meet these
financial objectives that we've stated to all you folks, then we'll back away
from it.
- ---------------------------------------------
GARY TENNER
OK. Great, thank you.
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OPERATOR
Our next question is from Robert Albertson of Sandler O'Neill.
- ---------------------------------------------
ROBERT ALBERTSON
Good morning.
- ---------------------------------------------
MACK WHITTLE
Good morning.
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ROBERT ALBERTSON
Want to just go back quickly to the margin. As you get the richer shift in
earning assets toward loans and the securities decline, what would be the
implications in terms of gains and losses on those securities and your
philosophy? And then secondly, Mack, if rates go up a 100 basis points over the
next 12 months, can you kind of dimension what that would mean for your margin
or more importantly your net interest income?
- ---------------------------------------------
WILLIAM HUMMERS
This is Bill Hummers. I think Jim Monroe, who runs our investment area, may be
able to address that first part of your question better.
- ---------------------------------------------
JIM MONROE
Yeah, the pay downs in the portfolio, just the natural attrition in pay downs
from the mortgage securities we have, represent about 3.5% of the balance a
month. That's around $100 million. So we believe we can more than meet any
monthly loan growth numbers just with natural pay-downs without having to
actually sell any securities.
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MACK WHITTLE
Our loan growth, projected loan growth, and you can see, runs about $50 to $60
million net a month. And the securities are rolling off to the tune of about
$100 plus million a month.
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ROBERT ALBERTSON
OK.
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MACK WHITTLE
And this is, again, this is all by design. This is kind of what we talked about
two and three quarters ago. And this was the plan, as we said we're probably --
the loan growth piece is a little probably half-a-quarter behind where we
thought it would be.
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ROBERT ALBERTSON
Good, thank you. And then, the outlook if rates rise?
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BILL HUMMERS
I would expect our net interest margin to go up if interest rates go up a 100
basis points.
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ROBERT ALBERTSON
Well, but I mean, meaningfully or modestly?
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BILL HUMMERS
Probably modestly.
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ROBERT ALBERTSON
Thank you very much.
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MACK WHITTLE
Most of our loans, probably 60% of our loans Mike, are tied to prime and are
indexed. So you know, we get a nice kick. We don't have a large mortgage
portfolio, as Mike pointed out that's $130 to $140 million. So you know, we see
some very positive things if rates can move, start moving up.
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ROBERT ALBERTSON
Thank you very much.
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OPERATOR
Our next question is from Todd Hagerman of Fox-Pitt.
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TODD HAGERMAN
Good morning.
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MACK WHITTLE
Good morning.
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TODD HAGERMAN
Couple of questions. Just some further clarifications, just in terms of the
margin and some of the dynamics in the quarter. If you could maybe comment a
little bit in terms of the hedging gains that you've recognized this quarter,
the $1.2 million, and you know, what your outlook there is for the next couple
of quarters given the rate environment. And then Mack, maybe if you could
provide a little bit more color in terms of on the deposit side and just looking
at some of the yields, and you mentioned the freedom money market account, I
guess. Just talk a little bit more in terms of the deposit gathering efforts,
and kind of what you're seeing, where it's coming from in terms of new
household, the Elevate program, is it existing household kind of growth, any
color you can add there would be helpful.
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WILLIAM HUMMERS
Why don't we let Jim Monroe talk about the hedging gains and then Mack, if you
want to talk about that.
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JIM MONROE
No problem. The hedging is from the sale of covered calls against securities
that are either already in the portfolio or we've committed to buy into the
portfolio. It's the type of thing that we take what the market gives us. This
was a very good quarter for doing that. Our expectation for the next quarter is
that it would not be quite that high on the order maybe of 50% of what we did
this last quarter. But that's what that revenue represents.
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MACK WHITTLE
On the deposit side, we are, in our approach, and Elevate is a piece of this,
when we have our blitzes, we are leading more with deposits than we are with
loans now. We have a very competitive treasury management, cash management
product now. We have staffed up that cash management area, both in South
Carolina and now in Florida. And we're beginning to realize some very large
deposit accounts from that, as well as some non-interest income. We picked up
some very lucrative non-interest income relative to cash management products and
services. But really, probably, the grass roots aspects of Elevate, the ability
to have and incent everyone in the company to generate deposits has been
incredibly successful. We have numerous campaigns during the course of the year.
We've had one that was tied to basketball. We called it hoops hysteria and we
had everybody in the company involved in it. We generated over $200 million in
net new deposits as a result of that program.
And we paid incentives to our employees for that. Our incentive payout, these
are to non-executive and non-officer employees, these are hourly folks that are
getting these deposits. Our payout this year will exceed $1 million in
incentives related to Elevate, the Elevate program. But it is an incredible
power to have that many people out soliciting business, asking for business,
whether they're at church or the dentist or you know, in their offices
identifying the need of a customer, and soliciting. Again we focus from time to
time on various products. But the deposit piece was driven primarily by this
hoops hysteria.
We currently got a hot rod 100 program going on where we're promoting HELOCs,
the second mortgage product, and we have set a goal there of $100 million. And
we're well on track to breakthrough that as well. But it is the power of
everybody being engaged in a specific direction after a specific product that is
what's driving the deposit and the loan growth to a large degree.
Now, you know, we've got some competitive ideas and we've got some new markets.
So -- and you got to realize, too, that we're not lead market share in most
markets that we're in, especially in Florida. So the growth potential for us in
Orlando, Tampa and Jacksonville is incredible. The lead market share is
controlled by, you know, SunTrust, Wachovia and Bank of America, and in all
three of those Florida markets together they have over 50% of the share. And
we're at 2% in most of those markets. So our potential, you know, now that we've
got competitive corporate products, and we've got -- we can lend competitively
with these guys, and we have folks that know those markets. We think the ability
to continue to grow from that perspective is great.
- ---------------------------------------------
TODD HAGERMAN
Great, thanks, Mack.
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OPERATOR
Our next question is from John Kline of Sandler O'Neill.
- ---------------------------------------------
JOHN KLINE
Hi guys. Great quarter. I apologize if you might have gone over this before. But
I was just kind of curious, in the, you know, the breakout of your loan growth,
15% really dynamite. Especially, you know, in this market. Just wondering, you
know if you could quantify how much of that you were able to capture from your
competitors, especially Wachovia. And kind of what the distribution is, Florida
versus South Carolina, and was it predominantly commercial, or you know,
consumer-related?
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MICHAEL SPERRY
Do you want me to try to handle that, Mack?
- ---------------------------------------------
MACK WHITTLE
Yes.
- ---------------------------------------------
MICHAEL SPERRY
John, this is Mike Sperry.
- ---------------------------------------------
JOHN KLINE
Hi, Mike.
- ---------------------------------------------
MICHAEL SPERRY
I don't have detailed statistics but I have got a pretty good feel for it. I see
every new loan of over $5 million that comes to the bank comes across to my
desk. Over the last quarter just looking back, one component of the growth has
been our indirect lending in Florida which has been very good. And it has grown
at a pace of 18 to 20% over the quarter just the normal pace of growing indirect
paper from dealers which has done very well. Our delinquencies in that portfolio
are very low, lower than .92%. The industry average is 2%. So, we are real
comfortable with how well that's managed as far as quality paper we're buying.
We are letting it grow because it is a source of growth. Beyond that we have
also had good success with loans to larger companies who need to borrow $50
million, don't want to go through the hassle of the syndication process where a
bank comes in and makes a loan and gets 15 syndicate partners and charges 2%
fees for everybody in it. And maybe another bank like Wachovia or like SunTrust
or South Trust offer to put a club deal together to put two banks together and
we do 15 and they do 35. We found good success in opportunities like that
because the customers are real sick of that syndication stuff and if it's a
local company, owner managed, they like what we call club deals.
So, we've done a considerable amount of that over the last quarter. The third
piece is, now that we have a successful very competitive array of products for
cash management we can handle the treasury services functions of a company
that's got $50 to $100 million a year in revenue. We're going into companies
that in the past we could have loaned money to but since they had their loans
over where the cash management was they just weren't really interested in doing
anything but giving us a loan. We like relationships so we passed on those. Now
we are able to go in and attack with a cash management product and get the
loans.
So, a big part of it has been on the upper middle market component on the
commercial side. The activity in Florida is strong, the population growth is
still outstanding down there, much better in Jacksonville than it is in Orlando
but it is still strong in Orlando. Of course, we are just beginning to know
Tampa and there are a lot of opportunities in Tampa. Lot of good development
loans there, construction loans on condos and in middle market companies, who
are anxious to find a local bank that will do business with them. I'll just give
you one story. There's a company in South Carolina, one of the largest Fortune
500 companies in our part of the country and we have never banked them before,
Sunoco products that's who it is. We got a chance to get in on that credit
facility this year and we frankly didn't think we had much of a chance to get in
it. But when they heard that there was a local South Carolina bank that would
like to be a part of syndicate, they said let's get them in there. They were
excited about that and we were very impressed that they wanted a local bank in
their syndicate. Even really large companies like the idea of a local bank, so
that's kind of where it has been.
- ---------------------------------------------
OPERATOR
Our next question is from Jefferson Harralson of KBW.
- ---------------------------------------------
JEFFERSON HARRALSON
Most of my questions have been answered. Let me just ask you some questions I
may have missed some of this. On the Rock Hill Workout bank is that going
in-line with your expectations or has there been any changes that would surprise
you positively or negatively?
- --------------------------------------------
MICHAEL SPERRY
The Workout bank has gone exactly as we expected, you know, when you plan
something like this you build a graph and say we are going to work through these
loans so you draw a straight line down where it is to zero, but it is never
quite a straight line. And the first 90 days to 120 days, we went backwards
instead of forwards, but in the middle of this last quarter it started to all
come together. You can see the results of this quarter, how it's come down, we
really think, it is going to roll right down to where we had thought it would be
by year end. The best news is that the loss estimate that we built into it
turned out to have been a little bit on the conservative side. Our actual losses
have been less than we anticipated, and we think that will continue. That part
of it has gone well.
- ---------------------------------------------
JEFFERSON HARRALSON
OK, can you comment on the loss rates of indirect auto? Have they been flat or
improved or down?
- ---------------------------------------------
MICHAEL SPERRY
They were low in the fourth quarter of last year, low in the first quarter of
this year, a little higher this quarter, but still not as high as they were in
the first part of 2002. So they are in the 1.1 to 1.15 range, which is, you
know, where we had anticipated they would be.
- ---------------------------------------------
JEFFERSON HARRALSON
Mack, when you talk about your 3-year goals later in the quarter, I guess what
are you going to have goals on? The same ratios you did before or is it going to
be EPS growth goals or are you going to focus on ROE and such?
- ---------------------------------------------
MACK WHITTLE
You know, we are in the early stages of formulating that and we don't want to
paint ourselves in a box with it. But, I think, if you look at what we would
define as high performing banks, they all have different ratios. Some may have
high ROEs and low ROAs and good EPS growth rate but--so, we are going to give
ourselves some flexibility but, I think to look at strong EPS growth rate that
will very definitely be one of the goals. As most of you know we still look at
our earnings on an operating basis and you know we will--we may look at
beginning to convert to cash on some of this but, you know, our financial goals
set three years ago are operating numbers. And as we move forward, I think, you
probably will see an ROE goal that will be part of it. We are looking at the ROA
side of it and what the acquisition strategy, what kind of realistic ROA goal we
could have. You know, obviously credit performance, as we did before, will be a
part of it. We want to see that those non-performers and--in order to get to the
high performing level we will have to have the charge-offs down in the 35 basis
points and the nonperformers down in the 65 to 70 basis point range and make
that work. We will set the same discipline in place that we did here and look at
acquisitions and price acquisitions so that they are accretive to what those
financial goals will be.
- ---------------------------------------------
JEFFERSON HARRALSON
OK, thanks guys.
- ---------------------------------------------
MACK WHITTLE
We've got non-interest income, that's another one, 25% of revenue is the goal we
set for the year. That's still substantially below the average of the peers, so
we, you know, we need to do some things strategically to build that. So, I think
you will continue to see non-interest income as a part of that. You will see it
in a small way a part of our acquisition strategy as we make some small
acquisitions.
- ---------------------------------------------
OPERATOR
Our next question is from Ross Haberman of Haberman.
- ---------------------------------------------
ROSS HABERMAN
How are you gentlemen?
- ---------------------------------------------
MACK WHITTLE
We are doing well, thanks.
- ---------------------------------------------
ROSS HABERMAN
Quick question, Mack. Could you, I guess, touch upon again the acquisitions and
is Florida going to continue to be an emphasis or North Carolina, like the
MountainBank type of deal?
- ---------------------------------------------
MACK WHITTLE
I mean, we would like to stay within our footprint, okay. And within that
Florida footprint there are a handful of banks that are of the size. I think
when we look at our acquisition strategy we don't want to do anything much over
a billion dollars. We think that about 8% to 10% of total assets size is a nice
size for us to properly integrate and do it seamlessly. That could be in one
bank, that could be in multiple banks. So there are not many that are of that
size in Florida, that remain in Florida. There are some that are smaller than
that and we continue, as I said earlier, to look at those, probably stay within
that footprint and that is central Florida to northern Florida footprint. We
don't have any plans to look at south Florida, you know, how the Barnett team
that we put into our team know Florida quite well and really feel like we are
getting into a whole different banking environment, once you get in the southern
part of Florida. So, that is not a part of the strategy. North Carolina is
intriguing; I mean, you know, one of the things that we have--that is the part
of that focus is the markets that we move into and we are not looking at any
market that is not growing faster than the national average and growing faster
than the southeastern average in population growth, household growth, and per
capita household income growth. So there are certain markets in North Carolina
that would address that. I don't have any thing specific that we're working on
but parts of North Carolina would fit within the footprint that we have defined.
Again, North Carolina is an attractive state as is South Carolina. But I think
if you look at the Provident pricing and the FNB transaction, Florida is still
going to demand a premium. So you know, if all things being equal, I think we'd
prefer to expand to Florida, the Florida piece of it. Plus, the scale there, you
know, we've got the branches there, we're in the markets, we'd like to grow
market share in Jacksonville, Orlando and Tampa. We've got 2% of market share in
those markets. And we'd like that to be, you know, closer to 10%. Lot of that
will come organically but you know, if there's an acquisition opportunity to
help us grow that, then we'll do that as well.
- ---------------------------------------------
ROSS HABERMAN
Is de novo branching in Florida part of the equation?
- ---------------------------------------------
MACK WHITTLE
Yes, absolutely. We'll build out probably five to six new branches next year and
a good part of those will be in the Florida market.
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ROSS HABERMAN
Thank you.
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OPERATOR
At this time I'd like to turn the call back over to Ms. Gentry for any closing
remarks.
- ---------------------------------------------
MARY GENTRY
We just want to thank everybody for joining us. And if you have additional
questions or need any additional information, feel free to give us a call. Thank
you.
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OPERATOR
Thank you for participating in today's conference call and have a nice day.
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DISCLAIMER
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