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 June 30, 2003
Transition 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 Identification No.)
incorporation or organization)
102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601
(Address of principal executive offices) (ZIP Code)
(864) 255-7900
Registrant's telephone number, including area code
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NONE NONE
(Title of Each Class) (Name of each exchange on which registered)
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
COMMON STOCK, $1.00 PAR VALUE
COMMON STOCK PURCHASE RIGHTS
(Title of Class)
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
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes X No
The number of outstanding shares of the issuer's $1.00 par value common stock as
of August 1, 2003 was 46,979,991.
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA)
JUNE 30,
---------------------------
RESTATED
2003 2002 DECEMBER 31,
(UNAUDITED) (UNAUDITED) 2002
----------- ----------- ----
Assets
Cash and due from banks $ 212,445 $ 137,925 $ 201,333
Interest-bearing bank balances 64,738 40,532 58,703
Federal funds sold 50,000 - 31,293
Securities
Trading 2,197 2,244 350
Available for sale 3,513,173 1,575,324 2,488,944
Held to maturity (market value $71,410, $81,585 and $85,371,
respectively) 68,495 79,671 82,892
----------- ---------- ----------
Total securities 3,583,865 1,657,239 2,572,186
----------- ---------- ----------
Loans
Loans held for sale 60,661 19,636 67,218
Loans held for investment 4,688,591 3,914,789 4,434,011
Allowance for loan losses (64,152) (46,985) (70,275)
----------- ---------- ----------
Net loans 4,685,100 3,887,440 4,430,954
----------- ---------- ----------
Premises and equipment, net 132,966 112,992 137,501
Accrued interest receivable 41,828 38,242 37,080
Intangible assets 245,007 95,255 242,182
Other assets 241,900 193,962 229,778
----------- ----------- ----------
$ 9,257,849 $ 6,163,587 $7,941,010
=========== =========== ==========
Liabilities and shareholders' equity
Liabilities
Deposits
Noninterest-bearing $ 814,945 $ 553,579 $ 743,174
Interest-bearing 4,306,394 3,170,038 3,849,336
----------- ----------- ----------
Total deposits 5,121,339 3,723,617 4,592,510
Federal funds purchased and repurchase agreements 702,792 1,199,898 1,110,840
Other short-term borrowings 42,452 73,852 81,653
Long-term debt 2,287,784 502,866 1,221,511
Debt associated with trust preferred securities 95,500 31,000 95,500
Accrued interest payable 21,799 23,882 20,945
Other liabilities 239,343 50,544 84,840
----------- ----------- ----------
Total liabilities 8,511,009 5,605,659 7,207,799
----------- ----------- ----------
Minority interest in consolidated subsidiary 86,616 86,471 86,412
----------- ----------- ----------
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 46,896,994, 40,341,762 and
47,347,375 shares, respectively 46,897 40,342 47,347
Surplus 412,608 290,685 427,448
Retained earnings 180,601 132,060 150,948
Guarantee of employee stock ownership plan debt and nonvested
restricted stock (2,937) (1,624) (3,094)
Common stock held in trust for deferred compensation (147) - -
Deferred compensation payable in common stock 147 - -
Accumulated other comprehensive income, net of tax 23,055 9,994 24,150
----------- ----------- ----------
Total shareholders' equity 660,224 471,457 646,799
----------- ----------- ----------
$ 9,257,849 $ 6,163,587 $7,941,010
=========== =========== ==========
See accompanying notes to consolidated financial statements.
1
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
RESTATED RESTATED
2003 2002 2003 2002
---- ---- ---- ----
Interest income
Interest and fees on loans $ 68,325 $ 64,198 $ 135,658 $ 126,358
Interest and dividends on securities
Taxable 30,937 21,217 61,236 42,784
Exempt from Federal income taxes 1,105 1,064 2,326 2,155
-------- -------- --------- ---------
Total interest and dividends on securities 32,042 22,281 63,562 44,939
Interest on short-term investments 212 218 330 687
-------- -------- --------- ---------
Total interest income 100,579 86,697 199,550 171,984
-------- -------- --------- ---------
Interest expense
Interest on deposits 18,335 21,253 36,334 42,829
Interest on borrowed funds 16,072 12,847 31,573 25,166
-------- -------- --------- ---------
Total interest expense 34,407 34,100 67,907 67,995
-------- -------- --------- ---------
Net interest income 66,172 52,597 131,643 103,989
Provision for loan losses 5,200 6,244 10,700 12,482
-------- -------- --------- ---------
Net interest income after provision for loan losses 60,972 46,353 120,943 91,507
Noninterest income 23,975 13,422 43,861 25,060
Noninterest expenses 50,095 35,792 98,985 70,644
-------- -------- --------- ---------
Income before income taxes, minority interest, and
cumulative effect of change in accounting principle 34,852 23,983 65,819 45,923
Income taxes 11,153 7,886 21,063 14,885
-------- -------- --------- ---------
Income before minority interest and cumulative
effect of change in accounting principle 23,699 16,097 44,756 31,038
Minority interest in consolidated subsidiary, net of tax (1,000) (758) (2,012) (1,186)
-------- -------- --------- ---------
Income before cumulative effect of change in
accounting principle 22,699 15,339 42,744 29,852
Cumulative effect of change in accounting principle, net of tax - - - (1,406)
-------- -------- --------- ---------
Net income $ 22,699 $ 15,339 $ 42,744 $ 28,446
======== ======== ========= =========
Average common shares outstanding, basic 46,629,666 40,217,873 46,975,635 40,699,166
Average common shares outstanding, diluted 47,760,781 41,232,890 48,007,767 41,646,176
Per common share, basic:
Net income before cumulative effect of change in accounting principle $ 0.49 $ 0.38 $ 0.91 $ 0.73
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
-------- -------- --------- ---------
Net income $ 0.49 $ 0.38 $ 0.91 $ 0.70
======== ======== ========= =========
Per common share, diluted:
Net income before cumulative effect of change in accounting principle $ 0.48 $ 0.37 $ 0.89 $ 0.71
Cumulative effect of change in accounting principle, net of tax - - - (0.03)
-------- -------- --------- ---------
Net income $ 0.48 $ 0.37 $ 0.89 $ 0.68
======== ======== ========= =========
Cash dividends declared per common share $ 0.14 $ 0.12 $ 0.28 $ 0.24
======== ======== ========= =========
See accompanying notes to consolidated financial statements.
2
THE SOUTH FINANCIAL GROUP, INC. 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, 2001 41,228,976 $41,229 $ 311,305 $ 111,744 $(6,104) $ 458,174
Net income (restated) - - - 28,446 - 28,446
Other comprehensive gain,
net of tax of $7,766 - - - - 16,098 16,098
Comprehensive income - - - - - 44,544
Cash dividends declared
($0.24 per common share) - - - (9,674) - (9,674)
Common stock activity:
Repurchase of stock (1,135,600) (1,136) (24,181) - - (25,317)
Dividend reinvestment plan 34,244 34 648 - - 682
Employee stock purchase plan 5,331 6 98 - - 104
Restricted stock plan 59,096 59 1,583 (246) - 1,396
Exercise of stock options 149,715 150 1,196 - - 1,346
Miscellaneous - - 36 166 - 202
---------- ------- --------- --------- ------- ---------
Balance, June 30, 2002 (restated) 40,341,762 $40,342 $ 290,685 $ 130,436 $ 9,994 $ 471,457
========== ======= ========= ========= ======= =========
Balance, December 31, 2002 47,347,375 $47,347 $ 427,448 $ 147,854 $24,150 $ 646,799
Net income - - - 42,744 - 42,744
Other comprehensive loss,
net of tax of $1,472 - - - - (1,095) (1,095)
Comprehensive income - - - - - 41,649
Cash dividends declared
($0.28 per common share) - - - (13,091) - (13,091)
Common stock activity:
Repurchase of stock (1,272,805) (1,273) (27,285) - - (28,558)
Acquisitions 146,808 147 3,353 454 - 3,954
Dividend reinvestment plan 70,428 71 1,408 - - 1,479
Employee stock purchase plan 20,011 20 289 - - 309
Restricted stock plan 67,023 67 3,806 (317) - 3,556
Exercise of stock options 518,154 518 3,555 - - 4,073
Common stock purchased by trust
for deferred compensation - - - (147) - (147)
Deferred compensation payable in
common stock - - - 147 - 147
Miscellaneous - - 34 20 - 54
---------- ------- --------- --------- ------- ---------
Balance, June 30, 2003 46,896,994 $46,897 $ 412,608 $ 177,664 $ 23,055 $ 660,224
========== ======= ========= ========= ======= =========
* Other includes guarantee of employee stock ownership plan debt, nonvested
restricted stock and deferred compensation.
See accompanying notes to consolidated financial statements.
3
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30,
------------------------------------
2003 2002
---- ----
Cash flows from operating activities
Net income $ 42,744 $ 28,446
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation, amortization, and accretion, net 26,824 15,068
Provision for loan losses 10,700 12,482
Gain on sale of available for sale securities (4,183) (215)
Gain on trading securities (96) (63)
(Gain) loss on equity investments (1,875) 139
Gain on disposition of assets and liabilities (601) -
Gain on sale of loans (4,065) (860)
Gain on disposition of premises and equipment (53) (40)
Loss on disposition of other real estate owned 351 405
Impairment loss from write-down of assets 449 -
Impairment loss (recovery) from write-down of mortgage servicing rights 496 (177)
(Gain) loss on derivative contracts (1,011) 37
Minority interest in consolidated subsidiary 2,012 1,186
Cumulative effect of change in accounting principle - 1,406
Trading account assets, net (1,751) (604)
Originations of loans held for sale (323,989) (222,152)
Sale proceeds and principal repayments from loans held for sale 327,159 209,909
Other assets, net (20,744) (4,401)
Other liabilities, net (3,750) 1,481
---------- --------
Net cash provided by operating activities 48,617 42,047
---------- --------
Cash flows from investing activities
Sale of securities available for sale 999,929 307,363
Maturity, call, or principal repayments from securities available for sale 1,440,730 670,869
Maturity or call of securities held to maturity 34,117 6,428
Purchase of available for sale securities (3,311,534) (971,207)
Purchase of securities held to maturity (19,797) (5,345)
Origination of loans held for investment, net (270,250) (198,586)
Sale of loans held for investment - 11,349
Sale of other real estate owned 7,788 2,874
Sale of premises and equipment 2,564 1,134
Capital expenditures (7,874) (5,660)
Disposition of assets and liabilities, net (5,738) -
Payment for purchase acquisitions (471) -
---------- --------
Net cash used for investing activities (1,130,536) (180,781)
---------- --------
See accompanying notes to consolidated financial statements.
4
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
(IN THOUSANDS) (UNAUDITED)
SIX MONTHS ENDED JUNE 30,
------------------------------------
2003 2002
---- ----
Cash flows from financing activities
Deposits, net 537,782 116,024
Federal funds purchased and repurchase agreements, net (407,884) (69,640)
Short-term borrowings, net (39,787) (76,741)
Issuance of long-term debt 1,085,295 100,000
Payments of long-term debt (18,814) (8,428)
Issuance of minority interest stock, net - 49,448
Cash dividends paid (13,162) (9,780)
Cash dividends paid on minority interest (3,014) (1,376)
Repurchase of common stock (28,558) (25,317)
Other common stock activity 5,915 2,334
---------- ---------
Net cash provided by financing activities 1,117,773 76,524
---------- ---------
Net change in cash and cash equivalents 35,854 (62,210)
Cash and cash equivalents at beginning of year 291,329 240,667
---------- ---------
Cash and cash equivalents at end of period $ 327,183 $ 178,457
========== =========
Supplemental cash flow data
Interest paid $ 67,971 $ 63,587
Income taxes paid 19,431 16,894
Significant non-cash investing and financing transactions:
Security purchases settled subsequent to quarter-end (156,190) -
Unrealized gain (loss) on available for sale securities (248) 23,650
Loans transferred to other real estate owned 5,370 6,006
Premises and equipment, net transferred to long-lived assets held for sale 2,639 -
See accompanying notes to consolidated financial statements.
5
THE SOUTH FINANCIAL GROUP, INC. 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. "TSFG" refers to
The South Financial Group, Inc. and subsidiaries, except where the context
requires otherwise. All significant intercompany accounts and transactions have
been 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 the 2003 presentations. TSFG
has no interests in non-consolidated special purpose entities.
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 Annual Report on Form 10-K for the year ended
December 31, 2002 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. Material estimates that are particularly susceptible
to significant change relate to the determination of the allowance for loan
losses and income taxes.
RESTATEMENT OF 2002 QUARTERLY FINANCIAL DATA
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 91,
"Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases" ("SFAS 91"), which reduced
interest income, noninterest income and noninterest expenses. Income taxes
increased as a result of the restatement. The net impact of these adjustments
for the first six months of 2002, which restated the financial results for the
period, was to increase net income by $613,000, or $0.01 per diluted share. By
quarter, net income increased $316,000 and $297,000 for the first and second
quarters of 2002, respectively.
During the third quarter 2002, TSFG, in accordance with SFAS No. 142,
"Goodwill and Other Intangible Assets" ("SFAS 142"), recognized a $1.4 million
impairment loss on the cumulative effect of a change in accounting principle as
of January 1, 2002. The first six months 2002, as restated, includes this
impairment loss. In addition, in connection with its adoption of SFAS No. 147,
"Acquisitions of Certain Financial Institutions an amendment of FASB Statements
No. 72 and 144 and FASB Interpretation No. 9" ("SFAS 147") during the third
quarter 2002, effective as of January 1, 2002, TSFG reversed amortization of
intangibles, which increased net income by $71,000 and $41,000 for the first and
second quarters of 2002, respectively.
For a summary of the quarterly financial data for first six months
2002, as restated and as reported, see Note 36 to the Consolidated Financial
Statements in TSFG's 2002 Annual Report on Form 10-K.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Accounting for Exit or Disposal Activities
Effective January 1, 2003, TSFG adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. Those
costs include, but are not limited to, the following: a) termination benefits
provided to current employees that are involuntarily terminated under the terms
of a benefit arrangement that, in substance, is not an ongoing benefit
arrangement or an individual deferred compensation contract (hereinafter
referred to as one-time termination benefits), b) costs to terminate a contract
that is not a capital lease, and c) costs to consolidate facilities or relocate
employees. The initial adoption of this standard did not have an impact on the
financial condition or results of operations of TSFG.
6
Accounting for Guarantees
Effective January 1, 2003, TSFG adopted the initial recognition and
initial measurement provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
TSFG adopted the disclosure requirements effective as of December 31, 2002. FIN
45 elaborates on the disclosure to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the
nature of the guarantee; (b) the maximum potential amount of future payments
under the guarantee; (c) the carrying amount of the liability; and (d) the
nature and extent of any recourse provisions or available collateral that would
enable the guarantor to recover the amounts paid under the guarantee. FIN 45
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the obligations it has undertaken in issuing the
guarantee at its inception. At June 30, 2003, TSFG recorded a liability of
$100,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor.
Accounting for Derivative Instruments and Hedging Activities
Effective July 1, 2003, TSFG adopted SFAS No. 149, ("SFAS 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities,"
which amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristics of a derivative, clarifies when
a derivative contains a financing component, amends the definition of an
underlying to conform it to language used in FIN 45, and amends certain other
existing pronouncements. Those changes will result in more consistent reporting
of contracts as either derivatives or hybrid instruments. Management does not
believe the provisions of this standard will have a material impact on results
of future operations.
Accounting for Variable Interest Entities
Effective July 1, 2003, TSFG adopted FASB Interpretation No. 46, ("FIN
46"), "Consolidation of Variable Interest Entities," which addresses
consolidation by business enterprises of variable interest entities. Under FIN
46, an enterprise that holds significant variable interest in a variable
interest entity but is not the primary beneficiary is required to disclose the
nature, purpose, size, and activities of the variable interest entity, its
exposure to loss as a result of the variable interest holder's involvement with
the entity, and the nature of its involvement with the entity and date when the
involvement began. The primary beneficiary of a variable interest entity is
required to disclose the nature, purpose, size, and activities of the variable
interest entity, the carrying amount and classification of consolidated assets
that are collateral for the variable interest entity's obligations, and any lack
of recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general creditors (or beneficial interest
holders) of a consolidated variable interest entity to the general creditor of
the primary beneficiary. TSFG had no impact upon adoption since it had no
interests in entities, which it considers to be included within the scope of FIN
46.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
Effective July 1, 2003, TSFG adopted SFAS No. 150, ("SFAS 150"),
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity," which establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. SFAS 150 requires an issuer to classify certain
financial instruments that include certain obligations, such as mandatory
redemption, repurchase of the issuer's equity, or settlement by issuing equity,
as liabilities or assets in some circumstance. Forward contracts to repurchase
an issuer's equity shares that require physical settlement in exchange for cash
are initially measured at the fair value of the shares at inception, adjusted
for any consideration or unstated rights or privileges, which is the same as the
amount that would be paid under the conditions specified in the contract if
settlement occurred immediately. Those contracts and mandatorily redeemable
financial instruments are subsequently measured at the present value of the
amount to be paid at settlement, if both the amount of cash and the settlement
date are fixed, or, otherwise, at the amount that would be paid under the
conditions specified in the contract if settlement occurred at the reporting
date. Other financial instruments are initially and subsequently measured at
fair value, unless required by SFAS 150 or other generally accepted accounting
principles to be measured differently. TSFG had no impact upon adoption since it
had no financial instruments, which it considers to be included within the scope
of SFAS 150.
7
WEBSITE AVAILABILITY OF REPORTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION
Through its website, www.thesouthgroup.com, TSFG makes available, free
of charge, various reports that it files with, or furnishes to, the Securities
and Exchange Commission, including its Annual Report on Form 10-K, Quarterly
Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those
reports. These reports are made available as soon as reasonably practicable
after these reports are filed with, or furnished to the Securities and Exchange
Commission.
(2) SUPPLEMENTAL FINANCIAL INFORMATION TO CONSOLIDATED STATEMENTS OF INCOME
The following presents the details for noninterest income and
noninterest expense (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
------------------------- -------------------------
Restated Restated
2003 2002 2003 2002
---- ---- ---- ----
Noninterest income
Service charges on deposit accounts $ 7,581 $ 5,421 $ 14,541 $ 10,328
Mortgage banking income 2,561 1,289 4,733 2,370
Fees for investment services 2,142 1,853 4,633 3,280
Bank-owned life insurance 1,933 1,803 3,881 3,609
Merchant processing income 2,071 1,715 3,407 2,963
Gain (loss) on derivative contracts 1,203 (24) 1,011 (37)
Gain on sale of available for sale securities 3,197 186 4,183 215
Gain on trading securities 24 33 96 63
Gain (loss) on equity investments - (150) 1,875 (139)
Gain on disposition of assets and liabilities 601 - 601 -
Other 2,662 1,296 4,900 2,408
-------- -------- -------- --------
Total noninterest income $ 23,975 $ 13,422 $ 43,861 $ 25,060
======== ======== ======== ========
Noninterest expenses
Salaries and wages $ 20,319 $ 13,589 $ 39,597 $ 27,225
Employee benefits 5,419 3,925 10,735 8,303
Occupancy 4,668 3,686 9,282 7,231
Furniture and equipment 4,211 3,483 8,805 7,079
Professional fees 1,822 1,150 3,360 2,516
Merchant processing expense 1,607 1,373 2,656 2,417
Telecommunications 1,168 886 2,238 1,569
Amortization of intangibles 724 240 1,429 479
Merger-related costs 382 - 1,879 -
Impairment loss from the write-down of assets 268 - 268 -
Other 9,507 7,460 18,736 13,825
-------- -------- -------- --------
Total noninterest expenses $ 50,095 $ 35,792 $ 98,985 $ 70,644
======== ======== ======== ========
8
(3) Other Comprehensive Income
The following summarizes accumulated other comprehensive income, net of
tax (in thousands) for the six months ended June 30:
2003 2002
---- ----
Unrealized gains on available for sale securities
Balance at beginning of year $ 24,382 $ (5,554)
Other comprehensive gain (loss):
Unrealized holding gains arising during the year 5,810 23,726
Income tax expense (3,445) (7,712)
Less: Reclassification adjustment for gains included in net income (6,058) (76)
Income tax expense 2,204 25
-------- --------
(1,489) 15,963
-------- --------
Balance at end of period 22,893 10,409
-------- --------
Unrealized gains (losses) on cash flow hedges
Balance at beginning of year (232) (550)
Other comprehensive income:
Unrealized gain on change in fair values 625 214
Income tax expense (231) (79)
-------- --------
394 135
-------- --------
Balance at end of period 162 (415)
-------- --------
$ 23,055 $ 9,994
======== ========
During the first six months of 2003, TSFG adjusted its income tax rate
used (on a cumulative basis) on the net unrealized gain recorded for available
for sale securities, which is included in accumulated other comprehensive
income, to the blended statutory federal and state income tax rate of 36.94%.
However, in certain cases where TSFG has loss carryforwards for state income tax
purposes, an income tax rate of 35% is used. At December 31, 2002, TSFG used a
32.5% income tax rate on the net unrealized gain recorded for available for sale
securities.
(4) Business Combinations
MOUNTAINBANK FINANCIAL CORPORATION
In May 2003, TSFG signed a definitive agreement to acquire MountainBank
Financial Corporation ("MBFC"), headquartered in Hendersonville, North Carolina.
At June 30, 2003, MBFC operated primarily through 19 branches in western North
Carolina and had total assets of $959.1 million. At closing, TSFG will issue
shares of common stock in exchange for all the common stock, preferred stock,
and stock obligations of MBFC. This transaction, which is expected to close in
October 2003, will be accounted for using the purchase method of accounting and
is subject to regulatory and MBFC shareholder approvals.
AMERICAN PENSIONS, INC.
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. This
acquisition was accounted for using the purchase method of accounting, and
accordingly, the assets and liabilities of API were recorded at their estimated
fair values as of the acquisition date. TSFG issued 146,808 shares of common
stock valued at $3.5 million, acquired tangible assets totaling $348,000,
assumed liabilities totaling $369,000, recorded a deferred tax liability
totaling $368,000, recorded a non-compete agreement intangible asset of
$350,000, recorded goodwill of $2.8 million, and recorded a customer list
intangible asset of $700,000. The non-compete agreement intangible is amortized
on a straight-line basis over its estimated useful life of 7 years. The customer
list intangible is amortized on a straight-line basis over its estimated useful
life of 10 years. In addition, the shareholders of API have the right to receive
common stock with a maximum value of approximately $2.2 million under earnout
provisions based on API's five-year financial performance, which would increase
goodwill.
9
AMORTIZATION OF PREMIUMS AND DISCOUNTS
Premiums and discounts that resulted from recording the assets and
liabilities acquired through acquisition (Central Bank of Tampa ("CBT"), Rock
Hill Bank & Trust ("Rock Hill Bank"), and Gulf West Banks, Inc. ("Gulf West"))
at their respective fair values are being amortized and accreted using methods
that result in a constant effective yield over the life of the assets and
liabilities. This net amortization decreased net income before income taxes by
$598,000 and $928,000 for the three and six months ended June 30, 2003,
respectively.
(5) DISPOSITION OF ASSETS AND LIABILITIES
In June 2003, Carolina First Bank completed the sale of its branch
office in Powdersville, South Carolina. In connection with the sale of this
branch, TSFG recorded a gain of approximately $601,000 and transferred deposits
of $6.4 million.
(6) INTANGIBLE ASSETS
Intangible assets, net of accumulated amortization, are summarized as
follows (in thousands):
June 30,
--------------------------- December 31,
2003 2002 2002
---- ---- ----
Goodwill $ 227,520 $ 90,194 $ 224,312
Core deposit premiums 26,869 14,546 26,873
Less accumulated amortization (11,715) (9,485) (10,409)
--------- -------- ---------
15,154 5,061 16,464
--------- -------- ---------
Customer list intangible 1,558 - 858
Less accumulated amortization (78) - (24)
--------- -------- ---------
1,480 - 834
--------- -------- ---------
Non-compete agreement intangible 1,013 - 663
Less accumulated amortization (160) - (91)
--------- -------- ---------
853 - 572
--------- -------- ---------
$ 245,007 $ 95,255 $ 242,182
========= ======== =========
At June 30, 2003, TSFG had two reporting units with goodwill, Carolina
First Bank and Mercantile Bank. The following summarizes the changes in the
carrying amount of goodwill related to each of TSFG's reporting units (in
thousands) for the six months ended June 30, 2003:
CAROLINA MERCANTILE
FIRST BANK BANK OTHER TOTAL
---------- ---- ----- -----
Balance, December 31, 2002 $ 116,279 $ 108,033 $ - $ 224,312
Purchase accounting adjustments 1,447 (1,078) 2,839 3,208
--------- --------- ------- ---------
Balance, June 30, 2003 $ 117,726 $ 106,955 $ 2,839 $ 227,520
========= ========= ======= =========
The goodwill for each reporting unit was tested for impairment as of
June 30, 2003 in accordance with SFAS No. 142, "Goodwill and Other Intangible
Assets." TSFG will update this testing annually as of June 30th each year. The
fair value of each reporting unit was estimated using a cash flow approach based
upon the expected present value of future cash flows and a market approach based
upon recent purchase transactions and public company market values. These
valuations indicated that no impairment charge was required as of the June 30,
2003 test date.
Amortization of intangibles totaled $1.3 million for core deposit
premiums, $54,000 for customer list intangibles, and $69,000 for non-compete
agreement intangibles for the six months ended June 30, 2003. Amortization of
intangibles totaled $479,000 for core deposit premiums for the six months ended
June 30, 2002.
The estimated amortization expense for core deposit premiums for the
years ended December 31 is as follows: $2.6 million for 2003, $2.2 million for
2004, $1.9 million for 2005, $1.7 million for 2006, $1.6 million for 2007, and
an aggregate of $6.5 million for all the years thereafter. The estimated
amortization expense for customer list intangibles is $133,000 for 2003,
$156,000 for the years ended December 31, 2004 to 2007 and an aggregate of
10
$777,000 for all the years thereafter. The estimated amortization expense for
non-compete agreement intangibles is $153,000 for 2003, $170,000 for the years
ended December 31, 2004 to 2006, $142,000 for 2007 and an aggregate of $117,000
for all the years thereafter.
(7) MORTGAGE SERVICING RIGHTS
Capitalized mortgage servicing rights ("MSRs"), net of the valuation
allowance, totaled $2.2 million, $4.4 million, and $7.3 million at June 30,
2003, December 31, 2002, and June 30, 2002, respectively. Amortization expense
for MSRs totaled $1.7 million and $1.8 million for the six months ended June 30,
2003 and 2002, respectively. At June 30, 2003 and 2002, the valuation allowance
for capitalized MSRs totaled $2.3 million and $891,000, respectively. In the
first six months of 2003 and 2002, TSFG recorded a $496,000 impairment loss and
$177,000 impairment recovery from the valuation of MSRs, respectively.
The estimated amortization expense for MSRs for the years ended
December 31 is as follows: $3.4 million for 2003, $485,000 for 2004, and none
for all the years 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 economic factors.
(8) GUARANTEES
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customers to perform under the terms
of an underlying contract with the third party or obligate TSFG to guarantee or
stand as surety for the benefit of the third party. The underlying contract may
entail either financial or nonfinancial obligations and may involve such things
as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or repayment of an obligation. Under the terms of a
standby letter, drafts will generally be drawn only when the underlying event
fails to occur as intended. TSFG can seek recovery of the amounts paid from the
borrower. In addition, some of these standby letters of credit are
collateralized. The collateral is generally cash or other assets, although
existing lines of credit are sometimes used. Commitments under standby letters
of credit are usually for one year or less. At June 30, 2003, TSFG recorded a
liability of $100,000 for deferred fees received on standby letters of credit,
which was the estimated fair value for the current carrying amount of the
obligation to perform as a guarantor. No contingent liability was determined to
be necessary relating to TSFG's obligation to perform as a guarantor. The
maximum potential amount of undiscounted future payments related to standby
letters of credit at June 30, 2003 was $81.3 million.
(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.
At the purchase date, TSFG identified a potential contingent liability
related to certain Rock Hill Bank trust accounts. Any liability recorded would
increase the goodwill recorded.
(10) DEFERRED COMPENSATION HELD IN TRUST
Beginning on January 1, 2003, under TSFG's Executive Deferred
Compensation Plan for certain officers, TSFG common stock was added as an
investment option for deferral of up to 100% of a participant's annual bonus
compensation, net of withholdings for social security and Medicare taxes. The
common stock purchased by TSFG for this deferred compensation plan is maintained
in a rabbi trust (the "Trust"), on behalf of the participants. The assets of the
Trust are subject to the claims of general creditors of TSFG. Dividends payable
on the common shares held by the Trust will be reinvested in additional shares
of common stock of TSFG on behalf of the participants. The deferred compensation
obligation in the Trust is classified as a component of shareholders' equity,
and the common stock held by the Trust is classified as a reduction of
shareholders' equity. The obligations of TSFG under this investment option of
the deferred compensation plan, and the shares held by the Trust, have no net
effect on outstanding shares. Subsequent changes in the fair value of the common
stock are not reflected in earnings or shareholders' equity.
11
(11) AVERAGE SHARE INFORMATION
The following is a summary of the basic and diluted average common
shares outstanding:
THREE MONTHS ENDED JUNE 30,
----------------------------------------
2003 2002
---- ----
BASIC:
Average common shares outstanding (denominator) 46,629,666 40,217,873
========== ==========
Diluted:
Average common shares outstanding 46,629,666 40,217,873
Dilutive potential common shares 1,131,115 1,015,017
---------- ----------
Average diluted shares outstanding (denominator) 47,760,781 41,232,890
========== ==========
SIX MONTHS ENDED JUNE 30,
----------------------------------------
2003 2002
---- ----
Basic:
Average common shares outstanding (denominator) 46,975,635 40,699,166
========== ==========
Diluted:
Average common shares outstanding 46,975,635 40,699,166
Dilutive potential common shares 1,032,132 947,010
---------- ----------
Average diluted shares outstanding (denominator) 48,007,767 41,646,176
========== ==========
The following options were outstanding at the period end presented but
were excluded from the calculation of diluted earnings per share because the
exercise price was greater than the average market price of the common shares:
NUMBER RANGE OF
OF SHARES EXERCISE PRICES
--------- ---------------
For the three months ended
June 30, 2003 388,297 $24.10 to $31.26
June 30, 2002 760,594 $22.34 to $31.26
For the six months ended
June 30, 2003 763,200 $22.34 to $31.26
June 30, 2002 942,437 $21.06 to $31.26
(12) STOCK-BASED COMPENSATION
At June 30, 2003, TSFG has two stock-based employee compensation option
plans, which are described more fully in Note 30 to the Consolidated Financial
Statements in TSFG's Annual Report on Form 10-K for the year ended December 31,
2002. TSFG accounts for its option plans under the recognition and measurement
principles of APB Opinion 25, "Accounting for Stock Issued to Employees," and
related Interpretations ("APB Opinion 25"). No stock-based employee compensation
cost is reflected in net income related to these plans, as all options granted
under those plans had an exercise price equal to or greater than the market
value of the underlying common stock on the date of grant. The following table
illustrates the effect on net income and earnings per share as if TSFG had
applied the fair value recognition provisions of SFAS No. 123, "Accounting for
Stock Based Compensation" ("SFAS 123") to stock-based employee compensation
option plans (dollars in thousands, except share data).
12
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- --------------------------
RESTATED RESTATED
2003 2002 2003 2002
---- ---- ---- ----
Net income
Net income, as reported $ 22,699 $ 15,339 $ 42,744 $ 28,446
Deduct:
Total stock-based employee compensation expense
determined under fair value based method for
all option awards, net of related income tax effect 84 452 613 777
-------- -------- -------- --------
Pro forma net income $ 22,615 $ 14,887 $ 42,131 $ 27,669
======== ======== ======== ========
Basic earnings per share
As reported $ 0.49 $ 0.38 $ 0.91 $ 0.70
Pro forma 0.48 0.37 0.90 0.68
Diluted earnings per share
As reported $ 0.48 $ 0.37 $ 0.89 $ 0.68
Pro forma 0.47 0.36 0.88 0.66
(13) MERGER-RELATED AND DIRECT ACQUISITION COSTS
In connection with the acquisitions in 2002 and the API acquisition in
2003, for the six months ended June 30, 2003, TSFG recorded pre-tax
merger-related costs of $1.9 million, included in noninterest expenses, and
direct acquisition costs of $223,000, included in goodwill. The merger-related
and acquisition costs were recorded as incurred. The following summarizes these
charges (in thousands) at and for the six months ended June 30, 2003:
TOTAL AMOUNTS REMAINING
COSTS PAID ACCRUAL
----- ---- -------
Merger-related costs
Compensation-related expenses $ 585 $ 516 $ 69
System conversion costs 574 574 -
Impairment loss from write-down of assets 181 181 -
Travel 49 49 -
Advertising 30 30 -
Other 460 460 -
------- ------- ----
$ 1,879 $ 1,810 $ 69
======= ======= ====
Direct acquisition costs
Investment banking and professional fees $ 114 $ 114 $ -
Severance 109 109 -
----- ----- ---
$ 223 $ 223 $ -
===== ===== ===
At June 30, 2003, the accrual of merger-related costs, which included
$69,000 for charges incurred during the six months ended June 30, 2003, totaled
$753,000. This accrual is for compensation-related and other expenses incurred
in connection with the CBT, Rock Hill Bank, and Gulf West acquisitions. At June
30, 2003, the accrual of direct acquisition costs totaled $528,000. This accrual
is for professional fees and severance in connection with the CBT, Rock Hill
Bank, and Gulf West acquisitions.
(14) BUSINESS SEGMENTS
TSFG has two principal operating subsidiaries, Carolina First Bank and
Mercantile Bank, which are evaluated regularly by the chief operating decision
maker in deciding how to allocate resources and assess performance. Both of
these subsidiaries are reportable segments by virtue of exceeding certain
13
quantitative thresholds. Carolina First Bank and Mercantile 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. Mercantile Bank offers products and services primarily to
customers in its market areas in northern and central Florida. Revenues for
Carolina First Bank and Mercantile Bank are derived primarily from interest and
fees on loans, interest on investment securities, service charges on deposits,
mortgage banking income, fees for investment services, 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, 2002.
Segment information (in thousands) is shown in the table 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.
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
Three Months Ended June 30, 2003
Net interest income $ 50,955 $ 16,731 $ (1,514) $ - $ 66,172
Provision for loan losses 3,892 1,318 (10) - 5,200
Noninterest income 17,950 5,700 15,679 (15,354) 23,975
Noninterest expenses 34,823 12,898 17,728 (15,354) 50,095
Amortization of intangibles (a) 315 389 20 - 724
Merger-related costs (a) 108 254 20 - 382
Income tax expense 9,662 2,629 (1,138) - 11,153
Minority interest in consolidated
subsidiary, net of tax (1,000) - - - (1,000)
Net income 19,528 5,586 (2,415) - 22,699
Six Months Ended June 30, 2003
Net interest income $ 102,979 $ 31,718 $ (3,054) $ - $ 131,643
Provision for loan losses 7,390 3,308 2 - 10,700
Noninterest income 32,995 8,631 30,897 (28,662) 43,861
Noninterest expenses 67,443 25,903 34,301 (28,662) 98,985
Amortization of intangibles (a) 630 779 20 - 1,429
Merger-related costs (a) 431 1,428 20 - 1,879
Income tax expense 19,797 3,566 (2,300) - 21,063
Minority interest in consolidated
subsidiary, net of tax (2,012) - - - (2,012)
Net income 39,332 7,572 (4,160) - 42,744
June 30, 2003
Total assets $ 7,125,070 $2,147,670 $ 964,574 $ (979,465) $ 9,257,849
Loans 3,534,484 1,249,366 100,028 (134,626) 4,749,252
Deposits 3,740,847 1,406,221 - (25,729) 5,121,339
(a) Included in noninterest expenses.
14
CAROLINA MERCANTILE ELIMINATING
FIRST BANK BANK OTHER ENTRIES TOTAL
---------- ---- ----- ------- -----
Three Months Ended June 30, 2002
Net interest income $ 46,930 $ 7,110 $ (1,443) $ - $ 52,597
Provision for loan losses 4,290 1,968 (14) - 6,244
Noninterest income 10,848 1,160 15,485 (14,071) 13,422
Noninterest expenses 29,864 5,041 14,958 (14,071) 35,792
Amortization of intangibles (a) 240 - - - 240
Income tax expense 7,677 287 (78) - 7,886
Minority interest in consolidated
subsidiary, net of tax (758) - - - (758)
Cumulative effect of change in accounting
principal, net of tax - - - - -
Net income 15,189 974 (824) - 15,339
Six Months Ended June 30, 2002
Net interest income $ 93,185 $ 13,580 $ (2,776) $ - $ 103,989
Provision for loan losses 8,440 4,047 (5) - 12,482
Noninterest income 19,854 2,102 30,075 (26,971) 25,060
Noninterest expenses 57,292 9,561 30,762 (26,971) 70,644
Amortization of intangibles (a) 479 - - - 479
Income tax expense 15,122 659 (896) - 14,885
Minority interest in consolidated
subsidiary, net of tax (1,186) - - - (1,186)
Cumulative effect of change in accounting
principal, net of tax - - (1,406) - (1,406)
Net income 30,999 1,415 (3,968) - 28,446
June 30, 2002
Total assets $ 5,404,874 $ 874,915 $ 664,639 $ (780,841) $ 6,163,587
Loans 3,238,192 729,172 35,540 (68,479) 3,934,425
Deposits 3,141,045 616,528 - (33,956) 3,723,617
(a) Included in noninterest expenses.
(15) MANAGEMENT'S OPINION
The financial statements in this report are unaudited, except for the
consolidated balance sheet at December 31, 2002, 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.
15
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 (collectively, "TSFG"). TSFG may also
be referred to herein as "we", "us", or "our", except where the context requires
otherwise. This discussion should be read in conjunction with the consolidated
financial statements and the supplemental financial data appearing in this
report as well as the Annual Report of TSFG on Form 10-K for the year ended
December 31, 2002. Results of operations for the six months ended June 30, 2003
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 at June 30, 2003 conducted business through 75 locations in
South Carolina, 5 locations in North Carolina and 34 locations in northern and
central Florida. TSFG operates principally through two wholly-owned subsidiary
banks: Carolina First Bank, a South Carolina chartered commercial bank, and
Mercantile Bank, a Florida chartered commercial bank (which are collectively
referred to as the "Subsidiary Banks"). TSFG's subsidiaries provide a full range
of financial services, including asset management, investments, insurance,
mortgage, and trust services, designed to meet substantially all of the
financial needs of its customers.
FORWARD-LOOKING STATEMENTS AND NON-GAAP FINANCIAL INFORMATION
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, the
assessment of problem loans, and the performance of the Rock Hill Bank
& Trust "workout loans";
o level, composition, and repricing characteristics of the securities
portfolio;
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 risks associated with income taxes, including the potential for
adverse adjustments;
o acquisitions, related cost savings, expected financial results, and
unanticipated integration issues;
o significant delay or inability to execute strategic initiatives
designed to grow revenues;
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
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.
This report also contains financial information determined by methods
other than in accordance with Generally Accepted Accounting Principles ("GAAP").
TSFG's management uses these non-GAAP measures to analyze TSFG's performance. In
particular, a number of credit quality measures presented adjust GAAP
16
information to exclude the effects of certain identified problem loans purchased
from Rock Hill Bank & Trust (the "Rock Hill Workout Loans"). Management believes
presentations of credit quality measures excluding the Rock Hill Workout Loans
assist in identifying core credit quality measures and trends. These disclosures
should not be viewed as a substitute for GAAP credit quality measures, and
furthermore, TSFG's non-GAAP measures may not necessarily be comparable to
non-GAAP performance measures of other companies.
CRITICAL ACCOUNTING POLICIES
TSFG's accounting policies are in accordance with accounting principles
generally accepted in the United States and with general practice within the
banking industry. The more critical accounting policies include TSFG's
accounting for securities, loans, allowance for loan losses, intangibles, and
income taxes. In particular, TSFG considers its policies regarding the allowance
for loan losses and income taxes to be its most critical accounting policies due
to the significant degree of management judgment. Different assumptions in the
application of these policies could result in material changes in TSFG's
consolidated financial statements. For additional discussion concerning TSFG's
allowance for loan losses and related matters, see "Balance Sheet Review -
Allowance for Loan Losses."
ACQUISITIONS
The following table summarizes TSFG's acquisitions completed during the
past two years. All of the transactions were accounted for using the purchase
method of accounting, and accordingly, the assets and liabilities were recorded
at their estimated fair values, which are subject to adjustment, as of the
acquisition date. TSFG's consolidated financial statements include the results
of the acquired company's operations since the acquisition date.
TABLE 1
- --------------------------------------------------------------------------------------------------------------------
SUMMARY OF COMPLETED ACQUISITIONS
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
PURCHASE IDENTIFIABLE
ACQUISITION TOTAL SHARES PRICE PAID INTANGIBLE
DATE ASSETS ISSUED IN CASH ASSETS GOODWILL
---- ------ ------ ------- ------ --------
Bank acquisitions
Central Bank of Tampa
Tampa, Florida 12/31/02 $ 223,223(1) 3,241,737 $ - $ 2,700 $ 36,095
Rock Hill Bank and Trust
Rock Hill, South Carolina 10/31/02 204,815(1) 430,017 -(2) 1,204 25,597
Gulf West Banks, Inc.
St. Petersburg, Florida 08/31/02 530,296(1) 3,925,588 32,400 8,424 70,861
Insurance agency/other acquisitions
American Pensions, Inc.
Mount Pleasant, South Carolina 04/30/03 (1) 146,808(3) - 1,050 2,839
Gardner Associates, Inc.
Columbia, South Carolina 09/20/02 1,312(1) 249,011(4) - 1,521 1,934
(1) Book value at the acquisition date.
(2) TSFG agreed to pay a cash earnout based on collection and recoveries with
respect to certain loans.
(3) Former shareholders of API have the right to receive common stock with a
maximum value of approximately $2.2 million under earnout provisions based
on API's five-year financial performance.
(4) Of this amount, up to 70,779 of these shares are subject to forfeiture back
to TSFG if certain five-year financial performance targets are not met.
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. API
services over 250 corporate accounts and manages in excess of $200 million in
plan assets.
17
On December 31, 2002, TSFG acquired Central Bank of Tampa ("CBT"), a
community bank headquartered in Tampa, Florida. CBT operated through 5 branches
in Tampa. This merger advances TSFG's strategy to expand in markets with
relatively high population and per capita income growth prospects.
On October 31, 2002, TSFG acquired substantially all of the assets and
deposits of Rock Hill Bank & Trust ("Rock Hill Bank"), which was a wholly-owned
banking subsidiary of RHBT Financial Corporation ("RHBT"). Rock Hill Bank
operated 3 branches in York County, South Carolina. Under the asset sale
agreement, Rock Hill Bank received 430,017 shares of TSFG common stock, plus the
right to receive a cash earnout essentially equal to 30% of the net improvement
in the aggregate charge-offs and reserves in a specified loan pool and 50% of
net amounts recovered under RHBT's blanket bond insurance policy with respect to
such loans. TSFG owned approximately 22% of RHBT's outstanding stock. In
connection with the distribution of TSFG common stock to RHBT shareholders, TSFG
received 95,575 shares, which were immediately cancelled.
On September 20, 2002, TSFG acquired Gardner Associates, Inc. ("Gardner
Associates"), an independent insurance agency based in Columbia, South Carolina.
TSFG intends to use Gardner Associates to build its insurance operations in the
Midlands area of South Carolina. As of June 30, 2003, TSFG issued 156,426 shares
of TSFG common stock to acquire Gardner Associates and 21,806 shares under an
earnout provision. In addition, the principals of Gardner Associates have the
right to receive a maximum of 70,779 shares of TSFG common stock, which has been
issued and deposited in an escrow account, under earnout provisions based on
Gardner Associates' five-year financial performance.
On August 31, 2002, TSFG acquired Gulf West Banks, Inc. ("Gulf West"),
a bank holding company headquartered in St. Petersburg, Florida. Gulf West
operated through Mercantile Bank, a Florida-chartered, non-member bank with 15
locations in the Tampa Bay area of Florida. This merger represents TSFG's first
banking locations in the Tampa Bay area and advances TSFG's strategy to expand
in markets with relatively high population and per capita income growth
prospects. Upon acquiring Gulf West, TSFG combined all of its Florida operations
under the Mercantile Bank name.
Pending Acquisition
In May 2003, TSFG signed a definitive agreement to acquire MountainBank
Financial Corporation ("MBFC"), headquartered in Hendersonville, North Carolina.
At June 30, 2003, MBFC operated primarily through 19 branches in western North
Carolina and had total assets of $959.1 million. At closing, TSFG will issue
shares of common stock in exchange for all the common stock, preferred stock,
and stock obligations of MBFC. This acquisition extends the TSFG franchise into
contiguous Western North Carolina markets. This transaction, which is expected
to close in October 2003, will be accounted for using the purchase method of
accounting and is subject to regulatory and MBFC shareholder approvals. TSFG
received the necessary approvals of the Federal Reserve on August 7, 2003 and
expects to receive the approvals of North Carolina State Banking Commission and
the FDIC on or before the end of August 2003 and the South Carolina State Board
of Financial Institutions in early September 2003.
OVERVIEW
Net income for the six months ended June 30, 2003 totaled $42.7
million, an increase of 50.3% compared with $28.4 million for the six months
ended June 30, 2002. Earnings per diluted share for the first six months of 2003
totaled $0.89, a 30.9% increase from $0.68 per diluted share in the first six
months of 2002. Higher net interest income, fee income initiatives, a lower
provision for loan losses, and gains on sales of securities and equity
investments contributed to the increases in net income and earnings per diluted
share. Net interest income increased from 39.0% growth in average earning
assets. Key factors responsible for TSFG's results of operations are discussed
throughout Management's Discussion and Analysis below.
Noninterest income for the six months ended June 30, 2003 and 2002
included pre-tax gains on asset sales of $6.7 million and $76,000, respectively.
Gains on asset sales include gains on available for sale securities and equity
investments and a gain on the sale of a branch office. Mortgage banking income,
a component of noninterest income, includes gains and losses on the sale of
mortgage loans and charges for the write-down in the value of capitalized
mortgage servicing rights. See "Earnings Review - Noninterest Income" for
details. Noninterest expenses for the first six months of 2003 included $1.9
million in pre-tax merger-related costs and $268,000 in impairment loss from
write-down of assets.
In the third quarter 2002, TSFG recorded a $1.4 million charge, net of
tax, related to impairment of goodwill associated with Carolina First Mortgage
Company, which is shown as a cumulative effect of change in accounting
18
principle. In accordance with the accounting rules, this change was recorded as
of January 1, 2002 and therefore is shown in the first six months of 2002.
During the fourth quarter 2002, TSFG adjusted and reclassified certain
prior 2002 quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income. The net
impact of these adjustments for the first six months of 2002, which restated the
financial results for the first half of the year, was to increase net income by
$613,000, or $0.01 per diluted share.
Average common shares outstanding on a diluted basis were 48.0 million
in the first six months of 2003, up 15.3% from 41.6 million for the first six
months of 2002, due to shares issued for acquisitions completed in 2002. In
connection with share repurchase programs, TSFG repurchased and cancelled
1,272,805 shares during the first six months of 2003.
At June 30, 2003, TSFG had $9.3 billion in assets, $4.7 billion in
loans, $5.1 billion in deposits, and $660.2 million in shareholders' equity. For
the six months ended June 30, 2003, TSFG's average assets totaled $8.6 billion,
an increase of $2.5 billion, or 40.7%, compared with the first six months 2002
average of $6.1 billion.
BALANCE SHEET REVIEW
Loans
TSFG focuses its lending activities on small and middle market
businesses and individuals in its geographic markets. At June 30, 2003,
outstanding loans totaled $4.7 billion, which equaled 92.7% of total deposits
and 51.3% of total assets. The major components of the loan portfolio were
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 were to borrowers located in TSFG's South Carolina,
North Carolina, and Florida market areas. Less than 5% of the portfolio is
unsecured. The portfolio contains no "highly leveraged transactions," as defined
by regulatory authorities.
Loans held for investment increased $773.8 million, or 19.8%, to $4.7
billion at June 30, 2003 from $3.9 billion at June 30, 2002. In 2002, $585.3
million in loans held for investment were acquired in mergers with Gulf West,
Rock Hill Bank, and CBT, accounting for approximately 75% of the increase.
During the first six months of 2003, loans held for investment increased $254.6
million, or 5.7%. The majority of the first six months of 2003 loan growth,
annualized at 11.6%, was in commercial, indirect consumer and home equity loans.
While originations of residential mortgage loans increased, most of these loans
were sold at origination in the secondary market.
Loans held for sale increased $41.0 million to $60.7 million at June
30, 2003 from $19.6 million at June 30, 2002. Mortgage loan originations were
higher in the current period, which increased the inventory of loans in process.
Loan held for sale at June 30, 2003 included no loans acquired from Gulf West.
During the first six months of 2003, loans held for sale acquired from Gulf West
decreased $17.7 million, primarily from the sale of two commercial real estate
loans and the transfer to loans held for investment.
Table 2 summarizes outstanding loans by collateral type for real estate
secured loans and by borrower type for all other loans. Collateral type
represents the underlying assets securing the loan, rather than the purpose of
the loan.
19
TABLE 2
- --------------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
JUNE 30,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial, financial and agricultural $ 982,947 $ 783,494 $ 913,368
Real estate - construction (1) 573,468 565,040 570,265
Real estate - residential mortgages (1-4 family) 675,018 564,286 643,941
Commercial secured by real estate (1) 1,878,573 1,463,678 1,765,103
Consumer 578,491 538,072 541,210
Lease financing receivables 94 219 124
----------- ----------- -----------
Loans held for investment 4,688,591 3,914,789 4,434,011
Loans held for sale 60,661 19,636 67,218
Less: allowance for loan losses 64,152 46,985 70,275
----------- ----------- -----------
Total net loans $ 4,685,100 $ 3,887,440 $ 4,430,954
=========== =========== ===========
Percentage of loans held for investment
Commercial, financial and agricultural 21.0 % 20.0 % 20.6 %
Real estate - construction (1) 12.2 14.4 12.9
Real estate - residential mortgages (1-4 family) 14.4 14.4 14.5
Commercial secured by real estate (1) 40.1 37.5 39.8
Consumer 12.3 13.7 12.2
Lease financing receivables - - -
----- ----- -----
Total 100.0 % 100.0 % 100.0 %
===== ===== =====
(1) These categories include loans to businesses other than real estate
companies where owner-occupied real estate is pledged on loans to finance
operations, equipment, and facilities.
Table 2 provides a stratification of the portfolio by collateral type
and borrower type. Table 3 provides a stratification of the loan portfolio by
loan purpose.
20
TABLE 3
- --------------------------------------------------------------------------------------------------------------------------
LOAN PORTFOLIO COMPOSITION BASED ON LOAN PURPOSE
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
JUNE 30,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Commercial loans
Commercial and industrial $ 1,265,383 $ 1,023,955 $ 1,178,955
Owner - occupied real estate 725,735 642,475 733,819
Commercial real estate 1,518,286 1,208,425 1,420,252
----------- ----------- -----------
3,509,404 2,874,855 3,333,026
----------- ----------- -----------
Consumer loans
Indirect - sales finance 479,616 391,392 420,294
Direct retail 265,913 290,372 273,419
Home equity 287,087 205,020 243,648
----------- ----------- -----------
1,032,616 886,784 937,361
----------- ----------- -----------
Mortgage loans 146,571 153,150 163,624
----------- ----------- -----------
Total loans held for investment $ 4,688,591 $ 3,914,789 $ 4,434,011
=========== =========== ===========
Percentage of loans held for investment
Commercial and industrial 27.0 % 26.2 % 26.6 %
Owner - occupied real estate 15.5 16.4 16.6
Commercial real estate 32.4 30.9 32.0
Consumer 22.0 22.7 21.1
Mortgage 3.1 3.9 3.7
----- ----- -----
Total 100.0 % 100.0 % 100.0 %
===== ===== =====
Commercial and industrial loans are loans to finance short-term and
intermediate-term cash needs of businesses. Typical needs include the need to
finance seasonal or other temporary cash flow imbalances, growth in working
assets created by sales growth, and purchases of equipment and vehicles. Credit
is extended in the form of short-term single payment loans, lines of credit for
periods up to a year, revolving credit facilities for periods up to five years,
and amortizing term loans for periods up to ten years.
Owner-occupied real estate loans are loans to finance the purchase or
expansion of operating facilities used by businesses not engaged in the real
estate business. Typical loans are loans to finance offices, manufacturing
plants, warehouse facilities, and retail shops. Depending on the property type
and the borrower's cash flows, amortization terms vary from ten years up to 20
years. Although secured by mortgages on the properties financed, these loans are
underwritten based on the cash flows generated by operations of the businesses
they house.
Commercial real estate loans are loans to finance real properties that
are acquired, developed, or constructed for sale or lease to parties unrelated
to the borrower. Included are loans to acquire land for development, land
development loans, construction loans, mini-perms for cash flow stabilization
periods, and permanent loans in situations where access to the secondary market
is limited due to loan size.
Indirect - sales finance loans are loans to individuals to finance the
purchase of automobiles. They are closed at the auto dealership but approved in
advance by TSFG for immediate purchase. Loans are extended on new and used autos
with terms varying from two years up to five years.
Direct retail consumer loans are loans to individuals to finance
personal, family, or household needs. Typical loans are loans to finance auto
purchases, home repairs and additions, and home purchases. These loans are made
by TSFG employees in its branches.
21
Home equity loans are loans to home-owners, secured by junior mortgages
on their primary residences, to finance personal, family, or household needs.
These loans may be in the form of amortizing loans or lines of credit with terms
up to 15 years.
Mortgage loans are loans to individuals, secured by first mortgages on
single family residences, to finance the acquisition of those residences. These
loans, originated by TSFG's mortgage lending division, do not qualify for
immediate sale but are judged to be sellable with seasoning. They are
underwritten to secondary market standards and are sold, from time to time, as
they become sellable to secondary market investors.
The portfolio's only significant industry concentration is in
commercial real estate loans. All other industry concentrations are less than
10% of total loans. Commercial real estate loans were 32.4% of loans held for
investment at June 30, 2003. Due to sustained strong population growth and
household income growth, real estate development and construction are major
components of the economic activity in TSFG's markets. The risk attributable to
this concentration is managed by confining our lending to markets we are
familiar with and to borrowers who have proven track records and the financial
means to weather adverse market conditions. In its commercial real estate
lending, TSFG does not make loans without recourse to the borrower, loans
without personal guarantees from the owners, or loans to cash out equity in
commercial properties. Consequently, although the analysis of reserve adequacy
includes an adjustment to account for the risk inherent in this concentration,
management believes the risk of loss in its commercial real estate loans is not
materially greater than the risk of loss in any other segment of the portfolio.
At June 30, 2003, the loan portfolio included commitments totaling
$126.1 million in "shared national credits" (multi-bank credit facilities of $20
million or more). Outstanding balances under these commitments totaled $73.9
million. By policy, we participate in shared national credits only if the
borrower is headquartered in our market, the borrower is in an industry familiar
to us, we meet directly with the borrower to conduct our analysis, and the
borrower agrees to establish an ongoing banking relationship with us. None of
these credit facilities were classified in the most recent report on shared
national credits prepared by the regulatory agencies.
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
underwriting and loan monitoring policies is closely supervised. 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 are monitored by Credit Committees
of each banking subsidiary's Board of Directors, which meet monthly to review
credit quality trends, new large credits, loans to insiders, large problem
credits, credit policy changes, and reports on independent credit audits of
branch offices.
To facilitate comparisons, Table 4 presents credit quality indicators
two ways: one that includes all loans and one that excludes the Rock Hill
Workout Loans. On October 31, 2002, loans totaling $191.3 million were acquired
from Rock Hill Bank. Prior to the closing and in connection with identified
problem loans, Rock Hill Bank had charged off a significant portion of its loan
portfolio and established additional reserves. At closing, TSFG segregated
certain identified problem loans into a separately-managed portfolio, referred
to as the "Rock Hill Workout Loans." At June 30, 2003, this portfolio totaled
$50.6 million, down from $72.4 million at December 31, 2002, with an allowance
for loan losses of $8.4 million. Nonperforming assets for the Rock Hill Workout
Loans at June 30, 2003 were $25.6 million, down from $29.2 million at December
31, 2002. Net loan charge-offs for the first six months of 2003, which were
provided for in the allowance for loan losses as of December 31, 2002, totaled
$6.8 million. TSFG expects nonperforming assets and the allowance for loan
losses to decline as the Rock Hill Workout Loans are liquidated, moved to
performing status or otherwise resolved. Where appropriate, TSFG has provided
credit quality measures excluding the Rock Hill Workout Loans to identify core
credit quality measures and trends.
Table 4 presents information pertaining to nonperforming assets.
22
TABLE 4
- ----------------------------------------------------------------------------------------------------------------------------
NONPERFORMING ASSETS
- ----------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
JUNE 30,
--------------------------------
RESTATED DECEMBER 31,
2003 2002 2002
---- ---- ----
Nonperforming Assets Including the Rock Hill Workout Loans
Loans held for investment $ 4,688,591 $ 3,914,789 $ 4,434,011
Allowance for loan losses 64,152 46,985 70,275
Nonaccrual loans - commercial 54,306 35,477 61,206
Nonaccrual loans - consumer 2,928 3,519 2,384
Restructured loans - - -
Total nonperforming loans 57,234 38,996 63,590
Other real estate owned 7,827 7,696 10,596
----------- ----------- -----------
Total nonperforming assets $ 65,061 $ 46,692 $ 74,186
=========== =========== ===========
Loans past due 90 days still accruing interest (1) $ 5,456 $ 6,951 $ 5,414
=========== =========== ===========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 1.39 % 1.19 % 1.67 %
==== ==== ====
Allowance for loan losses as a percentage of nonperforming loans 1.12 x 1.20 x 1.11 x
==== ==== ====
Nonperforming Assets Excluding the Rock Hill Workout Loans
Loans held for investment $ 4,637,959 $ 3,914,789 $ 4,361,658
Allowance for loan losses 55,798 46,985 53,979
Total nonperforming loans 31,675 38,996 34,596
Other real estate owned 7,827 7,696 10,422
----------- ----------- -----------
Total nonperforming assets $ 39,502 $ 46,692 $ 45,018
=========== =========== ===========
Total nonperforming assets as a percentage of loans and other
real estate owned (2) 0.85 % 1.19 % 1.03 %
==== ==== ====
Allowance for loan losses as a percentage of nonperforming loans 1.76 x 1.20 x 1.56 x
==== ==== ====
(1) All of these loans are consumer and residential mortgage loans. (2)
Calculated using loans held for investment.
Note: Nonperforming assets exclude personal property repossessions, which
totaled $1.3 million, $982,000, and $1.3 million, at June 30, 2003, June
30, 2002, and December 31, 2002, respectively.
CREDIT QUALITY INCLUDING ROCK HILL WORKOUT LOANS. Nonperforming assets
declined to 1.39% of loans and other real estate owned at June 30, 2003 from
1.67% at December 31, 2002. Net loan charge-offs increased to 0.73% of average
loans for the first six months of 2003 from 0.53% for the first half 2002,
primarily due to the disposition of fully-reserved Rock Hill Workout Loans and
the liquidation of fully-reserved nonperforming loans. As anticipated, the
allowance for loan losses declined to 1.37% of period-end loans at June 30, 2003
from 1.58% at December 31, 2002.
CREDIT QUALITY EXCLUDING ROCK HILL WORKOUT LOANS. Core nonperforming
assets (which exclude the Rock Hill Workout Loans) declined 15.4% to 0.85% of
loans and other real estate owned at June 30, 2003 from 1.19% at June 30, 2002.
This ratio has declined every quarter-end since its peak of 1.34% at March 31,
2002. Net loan charge-offs totaled $10.1 million, or 0.44% of average loans for
the first half of 2003, down from $10.1 million, or 0.53% of average loans for
the first half of 2002. The allowance for loan losses declined slightly as a
percent of loans held for investment, from 1.24% at December 31, 2002 to 1.20%
at June 30, 2003, but increased from 1.56 times to 1.76 times nonperforming
loans.
Certain of the Rock Hill Workout Loans are defined as "designated
loans" under the Rock Hill Bank purchase agreement ("Designated Loans") and are
subject to earnout provisions. The total principal amount owed by the borrowers
for Designated Loans was $45.2 million, of which $19.5 million had been charged
off or reserved prior to acquisition by TSFG. To the extent that principal
23
collections on these Designated Loans exceed $25.7 million through the
termination date of the earnout agreement, TSFG will pay the RHBT shareholders
30% of such excess. The net effect is to pay RHBT shareholders 30% of the net
recoveries on these loans from charge-off collections and reserve reductions.
Through June 30, 2003, total charge-offs and reserves on the Designated loans
exceeded the amount that would require a payment under the earnout agreement.
Future credit quality trends depend primarily on the direction of the
economy, and current economic data do not provide a clear signal of that
direction. Until the business climate improves, TSFG expects portfolio quality
indicators to remain volatile, nonperforming asset levels to fluctuate, and
charge-offs to be higher than historical norms. Management believes, however,
that loss exposure in its loan portfolio is identified, adequately reserved for
in a timely manner, and closely monitored to ensure that changes are promptly
addressed in its analysis of allowance for loan loss adequacy. Accordingly,
management believes the allowance for loan losses as of June 30, 2003 was
adequate, based on its assessment of probable losses, and available facts and
circumstances then prevailing.
Table 5 summarizes information on impaired loans (in thousands), all of
which are in nonaccrual status. All impaired loans are commercial loans.
TABLE 5
- -------------------------------------------------------------------------------------------------------------------------
IMPAIRED LOANS
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
AT AND FOR AT AND FOR
THE SIX MONTHS THE YEAR ENDED
ENDED JUNE 30, DECEMBER 31,
---------------------------
2003 2002 2002
---- ---- ----
Impaired loans $ 54,306 $ 35,477 $ 61,206
Impaired loans, excluding the Rock Hill Workout Loans 28,747 35,477 32,212
Average investment in impaired loans 59,283 40,178 42,258
Related allowance 11,937 4,259 22,016
Related allowance, excluding the Rock Hill Workout Loans 5,549 4,259 9,429
Recognized interest income - 72 125
Foregone interest 1,802 1,568 2,973
Allowance for Loan Losses
The adequacy of the allowance for loan losses (the "Allowance") is
analyzed quarterly. For purposes of this analysis, adequacy is defined as a
level sufficient to absorb probable losses in the portfolio as of the balance
sheet date presented. The methodology employed for this analysis is discussed
below.
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
24
analysis that are not fully captured in the allocated component. Allocation of
the Allowance to respective loan portfolio components is 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 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 $64.2 million, or 1.37% of loans held for
investment, at June 30, 2003, a significant increase from $47.0 million, or
1.20%, at June 30, 2002. Nonperforming loans totaled $57.2 million at June 30,
2003, an increase of $18.2 million from $39.0 million at June 30, 2002. These
increases were the result of the acquisition of loans from Rock Hill Bank,
partially offset by lower core nonperforming loans. Excluding the $25.6 million
of nonperforming loans related to the Rock Hill Workout Loans, nonperforming
loans declined to $31.7 million at June 30, 2003 from $39.0 million at June 30,
2002 (to 0.68% from 1.00% of loans held for investment), and the Allowance
increased to $55.8 million at June 30, 2003 from $47.0 million at June 30, 2002
(1.20% of loans held for investment at both June 30, 2003 and 2002). See "Credit
Quality."
Table 6, which summarizes the changes in the Allowance, provides
additional information with respect to the activity in the Allowance. While
uncertainty in the current economic outlook makes future charge-off levels less
predictable, management does not expect losses to increase significantly over
the next several quarters. As a percentage of average loans, losses in 2003,
excluding the Rock Hill Workout Loans, are expected to be slightly lower than
2002 losses. However, the economic outlook remains highly uncertain, and future
charge-off levels may therefore fluctuate above or below that average from
quarter to quarter.
25
TABLE 6
- -------------------------------------------------------------------------------------------------------------------------
SUMMARY OF LOAN LOSS EXPERIENCE
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
AT AND FOR AT AND FOR
THE SIX MONTHS THE YEAR ENDED
ENDED JUNE 30, DECEMBER 31,
----------------------------
RESTATED
2003 2002 2002
---- ---- ----
Allowance for loan losses, beginning of year $ 70,275 $ 44,587 $ 44,587
Purchase accounting adjustments - - 22,973
Allowance adjustment for loans sold - - (12)
Net charge-offs:
Loans charged-off (19,125) (12,100) (23,556)
Loans recovered 2,302 2,016 4,017
----------- ----------- -----------
(16,823) (10,084) (19,539)
Additions to reserve through provision expense 10,700 12,482 22,266
----------- ----------- -----------
Allowance for loan losses, end of period $ 64,152 $ 46,985 $ 70,275
=========== =========== ===========
Average loans $ 4,589,087 $ 3,830,696 $ 4,008,094
Loans held for investment 4,688,591 3,914,789 4,434,011
Net charge-offs as a percentage of average loans (annualized) 0.73 % 0.53 % 0.49 %
Allowance for loan losses as a percentage of loans held
for investment 1.37 1.20 1.58
Excluding the Rock Hill Workout Loans:
Net loan charge-offs $ 10,056 $ 10,084 $ 19,906
Net charge-offs as a percentage of average loans (annualized) 0.44 % 0.53 % 0.50 %
Allowance for loan losses as a percentage of loans held
for investment 1.20 1.20 1.24
Securities
TSFG uses the investment securities portfolio for several purposes. It
serves as a vehicle to manage interest rate and prepayment risk, to leverage
capital through generating interest and dividend income from the investment of
excess funds, to provide liquidity to meet liquidity requirements, and to
provide collateral for pledges on public deposits and securities sold under
repurchase agreements.
At June 30, 2003, TSFG's investment portfolio totaled $3.6 billion, up
$1.9 billion from the $1.7 billion invested as of June 30, 2002, and up $1.0
billion from the $2.6 billion invested as of December 31, 2002. The majority of
the increase since December 31, 2002 was attributable to the purchase of U.S.
Government agency and mortgage-backed securities in the available for sale
portfolio. In the first six months of 2003, TSFG bought these securities to
leverage capital and take advantage of the opportunity to increase net interest
income. In addition, TSFG has engaged in, and expects to continue to engage in,
hedging activities to reduce interest rate risk associated with the investment
securities. Also, in 2002, TSFG acquired $210.8 million in available for sale
securities from the acquisitions completed in 2002. During the remainder of
2003, TSFG expects that purchases of investment securities will primarily occur
to replace pre-paying, called, or maturing securities. TSFG's security portfolio
experienced average prepayments of approximately $100 million per month and
average calls of approximately $130 million per month during the first half of
the year. TSFG expects loan growth to continue and to replace some securities
balances with new loans. Accordingly, if strong loan demand continues, TSFG
expects investment securities to decline during the second half of 2003.
Securities (i.e., trading securities, securities available for sale,
and securities held to maturity) excluding the unrealized gain recorded for
available for sale securities averaged $3.2 billion in the first six months of
2003, 85.4% above the average of the first six months of 2002 of $1.7 billion.
The majority of the increase was attributable to securities purchased to
leverage available capital, or to offset anticipated paydowns of mortgage-backed
securities and calls of U.S. Government agency securities. The average portfolio
26
yield decreased in the first six months of 2003 to 4.12% from 5.43% in the first
six months of 2002. The securities yield decreased due to a lower level of
general interest rates and the addition of lower-yielding, shorter duration
securities.
The duration of the portfolio declined to approximately 4.4 years at
June 30, 2003 from 7.2 years at June 30, 2002. The securities portfolio
currently reprices within a 2.8 year pricing horizon, which is significantly
faster than indicated by the duration.
The composition of the investment portfolio as of June 30, 2003 was as
follows: mortgage-backed securities ("MBS") 66.3%, U.S. Government agencies
14.8%, U.S. Treasuries 7.2%, state and municipalities 3.4%, and other securities
8.3% (see other investments described below). Mortgage-backed securities have
increased from 46.4% of the portfolio at December 31, 2002, due to the first
quarter 2003 purchases to leverage available capital. Collateralized mortgage
obligations ("CMOs"), the majority of which are short-term, represent
approximately 15% of the securities portfolio. At June 30, 2003, variable-rate
MBS, constituted approximately 40% of total MBS. TSFG manages the MBS portfolio
to maintain a short duration and repricing horizon. This strategy provides
significant cash flow to proactively manage as market conditions change. TSFG
may use this cash to reinvest in securities at current market rates, fund future
loan growth, or pay off borrowed funds.
The available for sale portfolio constituted 98.0% of total securities
at June 30, 2003. Management believes that the high concentration of available
for sale securities provides greater flexibility in the management of the
overall investment portfolio.
The net unrealized gain on available for sale securities (pre-tax)
increased to $36.0 million at June 30, 2003 from a $16.1 million gain at June
30, 2002. The increase in the net unrealized gain was primarily associated with
U.S. Treasury securities, which had unrealized losses at June 30, 2002 and were
sold in the third quarter 2002. At December 31, 2002, the net unrealized gain on
available for sale securities (pre-tax) totaled $36.3 million. Long-term
interest rates rose suddenly in July 2003, which resulted in a net unrealized
loss on available for sale securities (pre-tax) of $6.8 million at July 31,
2003.
Other Investments
INVESTMENT IN NETBANK, INC. At June 30, 2003, TSFG owned 517,904 shares
of NetBank common stock. NetBank owns and operates NetBank, F.S.B., an
FDIC-insured federal savings bank that provides banking services to consumers
utilizing the Internet. TSFG's investment in NetBank, which is included in
securities available for sale with a basis of $144,000, was recorded at its
pre-tax market value of approximately $6.8 million at June 30, 2003. During the
six months ended June 30, 2003, TSFG sold 207,096 shares of NetBank for a
pre-tax gain of $1.9 million.
INVESTMENTS IN BANKS. At June 30, 2003, 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. These investments in community banks, which
are included in securities available for sale with a basis of $16.7 million,
were recorded at their pre-tax market value of approximately $20.3 million at
June 30, 2003.
TSFG also has an investment in Nexity Financial Corporation, an
Internet bank, which was recorded at its cost basis of $500,000.
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. CF Investment
Company's loans and equity investments represent a higher risk to TSFG due to
the start-up nature of such companies. As of June 30, 2003, CF Investment
Company had invested approximately $1.2 million (or 49% interest in common
stock) in a company specializing in electronic document management services and
$502,000 (or 15% interest in common stock) in a paycard company. The estimated
fair value of these investments is deemed to approximate the cost basis. TSFG
may incur impairment losses in the future depending on the performance of CF
Investment Company's investments.
OTHER INVESTMENTS NOT SPECIFIED ABOVE. In addition to the investments
described in the preceding paragraphs, other investments in available for sale
securities at June 30, 2003, which are carried at market value, included
corporate bonds of $161.3 million, Fannie Mae preferred stock of $51.7 million,
FHLB stock of $49.4 million, and other equity securities of $4.9 million. Other
equity securities include TSFG's investment in Affinity Technology Group, Inc.
("Affinity"). At June 30, 2003, TSFG owned 4,876,340 shares of common stock of
Affinity, or approximately 12% of the outstanding shares. TSFG's investment in
Affinity has a basis of $433,000 and was recorded at its June 30, 2003 pre-tax
27
market value of approximately $780,000. At June 30, 2003, the aggregate market
value for these other investments, which are not specified in the preceding
paragraphs, totaled $267.3 million with a cost basis of $265.9 million.
Intangible Assets
The intangible assets balance at June 30, 2003 of $245.0 million
consisted of goodwill of $227.5 million, core deposit premiums of $15.2 million,
customer list intangibles of $1.5 million, and non-compete agreement intangibles
of $853,000. The intangible assets balance at June 30, 2002 of $95.3 million
consisted of goodwill of $90.2 million and core deposit premiums of $5.1
million. The increase in goodwill was primarily due to the $134.1 million of
goodwill acquired during 2002 from the acquisitions of CBT, Rock Hill Bank,
Gardner Associates, and Gulf West, subsequent adjustments in 2003 totaling
$369,000, and $2.8 million of goodwill acquired during 2003 from the acquisition
of API. The increase in core deposit premiums was due to adding $2.7 million
from the CBT merger, $1.2 million from the Rock Hill Bank merger, and $8.4
million from the Gulf West merger. The customer list intangibles and non-compete
agreement intangibles were added with the acquisitions of Gardner Associates and
API.
Deposits
Deposits remain TSFG's primary source of funds for loans and
investments. Average deposits provided funding for 60.3% of average earning
assets in the first six months of 2003 and 64.6% in the first six months of
2002. Carolina First Bank and Mercantile 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, TSFG has
developed other sources, such as FHLB advances, short-term borrowings, and
long-term structured repurchase agreements, to fund a portion of loan demand and
increases in investment securities. In addition, TSFG has increased the use of
brokered certificates of deposit, which are included in deposits.
At June 30, 2003, deposits totaled $5.1 billion, up $1.4 billion from
June 30, 2002. In 2002, TSFG acquired $783.8 million in deposits from its
mergers with CBT, Rock Hill Bank, and Gulf West, which accounted for
approximately 56% of the increase. In addition, TSFG increased deposits,
particularly transaction accounts, through increased sales referrals and
targeted deposit promotions. The increase in deposits also includes a $119.7
million increase in brokered certificates of deposit. At June 30, 2003, TSFG had
$529.8 million in brokered certificates of deposit, compared with $410.1 million
at June 30, 2002. We consider these funds as an attractive alternative funding
source available to use while continuing our efforts to maintain and grow our
local deposit base.
Table 8 in "Results of Operations - Net Interest Income" details
average balances for the deposit portfolio for both the six months ended June
30, 2003 and 2002. Average money market accounts increased $512.5 million, or
71.5%, and average noninterest demand deposits increased $211.0 million, or
41.3%. On average, time deposits increased $258.7 million, or 15.2%, which
includes a $249.7 million increase in average brokered certificates of deposit.
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-bearing checking, money market, and savings
accounts). For the six months ended June 30, 2003, transaction accounts made up
58.4% of average deposits, compared with 53.2% for the six months ended June 30,
2002. These trends reflect TSFG's efforts to enhance its deposit mix by working
to attract lower-cost transaction accounts. TSFG's customer-centered sales
process, Elevate, is an integral part of achieving this goal. In addition, TSFG
held deposit campaigns, based on employee referrals, to raise transaction
accounts and offered an attractive money market account, priced at 50% of the
prime interest rate.
At June 30, 2003, total deposits for Bank CaroLine, an Internet bank,
totaled $25.1 million, down from $38.7 million as of June 30, 2002. Deposits for
Bank CaroLine declined significantly, due to offering less aggressive interest
rates in an effort to lower the overall cost of funds.
Time deposits of $100,000 or more represented 12.0% of total deposits
at June 30, 2003 and 12.5% at June 30, 2002. 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 at other financial institutions.
During the second quarter 2003, TSFG sold the deposits at its
Powdersville, South Carolina branch office to an unrelated financial
institution. TSFG sold $6.4 million in deposits and recorded a gain associated
with the sale totaling $601,000.
28
Borrowed Funds
TSFG uses both short-term and long-term borrowings to fund growth of
earning assets in excess of deposit growth. 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,
FHLB advances, and repurchase agreements with maturities greater than one year
when made. In the first six months of 2003, average borrowings totaled $3.1
billion, compared with $1.9 billion for the same period in 2002. This increase
was primarily attributable to an increased reliance on short-term borrowings to
support earning asset growth, including increases in investment securities.
TSFG's long-term borrowings totaled $2.3 billion at June 30, 2003, up
from $502.9 million as of June 30, 2002, primarily from the increase in
repurchase agreements and FHLB advances. TSFG increased long-term borrowings to
provide longer-term liquidity at historically-low interest rates.
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 $2.0 billion at June 30, 2003,
including $1.3 billion in long-term repurchase agreements, and $1.3 billion at
June 30, 2002, including $100.0 million in long-term repurchase agreements.
These balances are primarily to finance higher balances in investment securities
available for sale and to support earning asset growth. Balances in these
accounts can fluctuate on a day-to-day basis.
The FHLB advances were $979.3 million, all long-term advances, at June
30, 2003 and $386.0 million, including $363.0 million in long-term advances, at
June 30, 2002. 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 continues to
evaluate the relative cost and benefit of incurring prepayment penalties from
the early extinguishment of debt.
Capital Resources and Dividends
Total shareholders' equity amounted to $660.2 million, or 7.1% of total
assets, at June 30, 2003, compared with $471.5 million, or 7.6% of total assets,
at June 30, 2002. At December 31, 2002, total shareholders' equity was $646.8
million, or 8.1% of total assets. The increase in shareholders' equity, when
comparing June 30, 2003 to the same period in 2002, is primarily from the
issuance of common stock for the 2002 mergers, retention of earnings, and the
unrealized gains in the available for sale investment portfolio. TSFG's stock
repurchase program and cash dividends paid partially offset these increases.
TSFG has a stock repurchase program and, in February 2003, expanded its
program by one million shares in connection with the CBT merger. In May 2003,
TSFG added an additional one million shares. During 2003, TSFG repurchased
1,272,805 shares and has approximately 1.3 million shares remaining under its
stock repurchase authorization. TSFG may continue to repurchase shares depending
upon current market conditions, available cash, and capital levels.
TSFG's unrealized gain on securities, net of tax, which is included in
accumulated other comprehensive income, was $22.9 million as of June 30, 2003 as
compared to $10.4 million as of June 30, 2002 and $24.4 million as of December
31, 2002. The increase in the unrealized gain (net of deferred income tax) from
June 30, 2002 to June 30, 2003 was comprised of increases in: U.S. Treasury
securities $14.5 million, U.S. Government agencies $1.1 million, mortgage-backed
securities $481,000, and state and municipalities $421,000. This increase was
partially offset by a decrease in other securities of $4.0 million, principally
from the sale of NetBank common stock and the write-down and subsequent
cancellation of TSFG's shares in RHBT due to TSFG's acquisition of substantially
all the assets and deposits of Rock Hill Bank, which was the wholly-owned
banking subsidiary of RHBT.
Book value per share at June 30, 2003 and 2002 was $14.08 and $11.69,
respectively. Tangible book value per share at June 30, 2003 and 2002 was $8.85
and $9.33, respectively. Tangible book value was below book value as a result of
the purchase premiums associated with acquisitions of entities and assets
accounted for as purchases.
TSFG and its Subsidiary Banks exceeded the well-capitalized regulatory
requirements at June 30, 2003. Table 7 sets forth various capital ratios for
TSFG and its Subsidiary Banks.
29
TABLE 7
- --------------------------------------------------------------------------------------------------
CAPITAL RATIOS
- --------------------------------------------------------------------------------------------------
WELL
CAPITALIZED
JUNE 30, 2003 REQUIREMENT
------------- -----------
TSFG
Total risk-based capital 10.57 % n/a
Tier 1 risk-based capital 8.44 n/a
Leverage ratio 5.95 n/a
Carolina First Bank
Total risk-based capital 10.62 % 10.00 %
Tier 1 risk-based capital 7.63 6.00
Leverage ratio 5.18 5.00
Mercantile Bank
Total risk-based capital 12.11 % 10.00 %
Tier 1 risk-based capital 8.88 6.00
Leverage ratio 6.93 5.00
On June 27, 2003, TSFG filed a "universal shelf" registration statement
registering up to $200.0 million of securities to provide additional flexibility
in managing capital levels, both in terms of debt and equity.
TSFG and its subsidiaries are subject to certain regulatory
restrictions on the amount of dividends they are permitted to pay. TSFG has 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, future dividends will depend upon TSFG's financial performance
and capital requirements.
In July and October 2002, TSFG, through three wholly-owned trust
subsidiaries, issued and sold floating rate securities to institutional buyers
in three pooled trust preferred issues. These securities generated proceeds to
TSFG of $62.5 million, net of issuance costs totaling $2.0 million, which
qualifies as tier 1 capital under Federal Reserve Board guidelines.
EARNINGS REVIEW
Net Interest Income
Net interest income is TSFG's primary source of revenue. Net interest
income is the difference between the interest earned on assets, including loan
fees and security dividends, and the interest paid for the liabilities to
support such assets. The net interest margin measures how effectively a company
manages the difference between the yield on earning assets and the rate paid on
funds used to support those assets. Fully tax-equivalent net interest income
adjusts the yield for assets earning tax-exempt income to a comparable yield on
a taxable basis. Table 8 presents average balance sheets and a net interest
income analysis on a tax equivalent basis for the three and six months ended
June 30, 2003 and 2002.
30
TABLE 8
- ---------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- ---------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED JUNE 30,
------------------------------------------------------------
2003 2002 (RESTATED)
------------------------------ ---------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
ASSETS
Earning assets
Loans (1) $ 4,656,461 $ 68,325 5.89% $ 3,886,016 $ 64,198 6.63 %
Investment securities (taxable)(2) 3,232,492 30,937 3.83 1,598,062 21,217 5.31
Investment securities (nontaxable)(3) 106,979 1,700 6.36 91,674 1,636 7.14
Federal funds sold 2,321 9 1.56 - - -
Interest-bearing bank balances 68,759 203 1.18 49,324 218 1.77
----------- -------- ----------- --------
Total earning assets 8,067,012 101,174 5.03 5,625,076 87,269 6.22
----------- -------- ----------- --------
Non-earning assets 796,326 505,330
----------- -----------
Total assets $ 8,863,338 $ 6,130,406
=========== ===========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 637,989 $ 1,001 0.63 $ 585,400 $ 1,791 1.23
Savings 151,611 160 0.42 117,284 216 0.74
Money market 1,347,476 5,742 1.71 700,293 2,898 1.66
Time deposits 1,961,550 11,432 2.34 1,722,779 16,348 3.81
---------- ------- ----------- -------
Total interest-bearing deposits 4,098,626 18,335 1.79 3,125,756 21,253 2.73
Borrowings 3,181,191 16,072 2.03 1,912,274 12,847 2.69
---------- ------- ----------- -------
Total interest-bearing liabilities 7,279,817 34,407 1.90 5,038,030 34,100 2.71
------- -------
Noninterest-bearing liabilities
Noninterest-bearing deposits 736,084 525,368
Other noninterest-bearing
liabilities 111,463 73,713
---------- ----------
Total liabilities 8,127,364 5,637,111
Minority interest in consolidated
subsidiary(4) 86,563 38,701
Shareholders' equity 649,411 454,594
---------- ----------
Total liabilities and
shareholders' equity $ 8,863,338 $ 6,130,406
=========== ===========
Net interest margin $66,767 3.32% $53,169 3.79 %
======= =======
Tax-equivalent adjustment (3) $ 595 $ 572
======= =======
(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.
(4) The minority interest in consolidated subsidiary pertains to the REIT
preferred stock, which qualifies as regulatory capital and pays cumulative
dividends.
Note: Average balances are derived from daily balances.
31
TABLE 8 (CONTINUED)
- --------------------------------------------------------------------------------------------------------------------
COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS
- --------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
FOR THE SIX MONTHS ENDED JUNE 30,
-------------------------------------------------------------------
2003 2002 (RESTATED)
-------------------------------- -----------------------------------
AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/
BALANCE EXPENSE RATE BALANCE EXPENSE RATE
ASSETS
Earning assets
Loans (1) $ 4,589,087 $ 135,658 5.96 % $ 3,830,696 $ 126,358 6.65 %
Investment securities, taxable (2) 3,064,496 61,236 4.00 1,620,800 42,784 5.28
Investment securities, nontaxable (3) 110,871 3,578 6.45 91,668 3,315 7.23
Federal funds sold 2,340 17 1.47 - - -
Interest-bearing bank balances 51,169 313 1.23 79,863 687 1.73
----------- --------- ----------- ---------
Total earning assets 7,817,963 200,802 5.18 5,623,027 173,144 6.21
--------- ---------
Non-earning assets 812,057 509,227
----------- -----------
Total assets $ 8,630,020 $ 6,132,254
=========== ===========
Liabilities and shareholders' equity
Liabilities
Interest-bearing liabilities
Interest-bearing deposits
Interest checking $ 649,844 $ 2,070 0.64 % $ 590,027 $ 3,601 1.23 %
Savings 153,865 354 0.46 116,011 430 0.75
Money market 1,229,362 10,000 1.64 716,822 5,813 1.64
Time deposits 1,958,745 23,910 2.46 1,700,075 32,985 3.91
----------- --------- ----------- --------
Total interest-bearing deposits 3,991,816 36,334 1.84 3,122,935 42,829 2.77
Borrowings 3,072,392 31,573 2.07 1,931,030 25,166 2.63
----------- --------- ----------- --------
Total interest-bearing liabilities 7,064,208 67,907 1.94 5,053,965 67,995 2.71
--------- --------
Noninterest-bearing liabilities
Noninterest-bearing deposits 721,525 510,522
Other noninterest-bearing liabilities 106,533 69,921
----------- -----------
Total liabilities 7,892,266 5,634,408
Minority interest in consolidated
subsidiary (4) 86,506 37,866
Shareholders' equity 651,248 459,980
----------- -----------
Total liabilities and shareholders' equity $ 8,630,020 $ 6,132,254
=========== ===========
Net interest margin $ 132,895 3.43 % $ 105,149 3.77 %
========= =========
Tax-equivalent adjustment (3) $ 1,252 $ 1,160
========= =========
(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.
(4) The minority interest in consolidated subsidiary pertains to the REIT
preferred stock, which qualifies as regulatory capital and pays cumulative
dividends.
Note: Averages balances are derived from daily balances.
32
Fully tax-equivalent net interest income for the first six months of
2003 increased $27.7 million, or 26.4%, to $132.9 million from $105.1 million in
the first six months of 2002. This increase was attributable to a 39.0% increase
in average earning assets, partially offset by a decline in the net interest
margin. The net interest margin declined to 3.43% in the first six months of
2003 from 3.77% in the first six months of 2002. This decrease in the net
interest margin was largely attributable to higher investment securities (which
generally have a lower yield than loans), downward pricing of fixed rate
commercial loans, and deposit rates approaching lower limits due to
historically-low interest rates. In addition, TSFG has experienced solid growth
in money market accounts, principally from a product priced at 50% of the prime
interest rate. If interest rates rise, TSFG will benefit from the relatively
slower increase for these accounts, which are currently at the upper end of
money market rates.
Interest rates are presently at historically low levels. During 2003,
the Federal Reserve lowered the federal funds target rate 25 basis points at the
end of June, which followed one decline in 2002 and eleven downward adjustments
in 2001. The 2003 reduction had minimal impact on the net interest margin during
the first half of the year (as it occurred so late in the second quarter). A
large portion of TSFG's adjustable rate loans, which constitute 56.6% of the
loan portfolio, reprice immediately following an interest rate change by the
Federal Reserve. The funding source changes take more time to filter into the
net interest margin, primarily because of the timed maturities of certificates
of deposit and borrowings. A large portion of deposits and borrowings had
repriced by the end of 2002 while new and maturing loans and investments
continue to be made at lower rates.
Downward pressure on the net interest margin is expected to continue
for the remainder of 2003. In addition, continued declines in interest rates
would put additional pressure on the net interest margin because some deposit
rates are reaching what management considers their lower limit. TSFG expects
certificates of deposit to continue to mature and reprice downward in 2003,
although with a significantly smaller benefit than that realized during the past
two years.
During the fourth quarter of 2002, TSFG adjusted and reclassified
certain prior quarter amounts to account for an overaccrual of interest expense
related to repurchase agreements and the deferral of loan fee income. In the
first six months of 2002, the over accrual of interest expense related to
repurchase agreements overstated interest expense by $1.5 million, which was
corrected in the fourth quarter of 2002. The additional deferral of loan fee
income decreased net interest income by $5.6 million in the first six months of
2002. A related deferral of salaries, wages and employee benefits substantially
offset the decrease in the deferral of loan fee income. See "Overview."
Average earning assets grew $2.2 billion, or 39.0%, to $7.8 billion in
the first six months of 2003 from $5.6 billion in the first six months of 2002,
primarily from acquisitions and the purchase of investment securities. The Gulf
West merger, which closed August 31, 2002, the asset purchase with Rock Hill
Bank, which closed on October 31, 2002, and the Central Bank of Tampa merger,
which closed on December 31, 2002, added approximately $903.8 million in earning
assets. Average loans increased $758.4 million to $4.6 billion in the first six
months of 2003 from $3.8 billion in the first six months of 2002. Average
investment securities, excluding the average net unrealized securities gains,
increased to $3.2 billion in the first six months of 2003 from $1.7 billion in
the first six months of 2002. The increase in the investment portfolio occurred
in order to leverage available capital and take advantage of the opportunity to
increase net interest income. During the remainder of 2003, TSFG expects that
purchases of investment securities will primarily occur to replace pre-paying,
called or maturing securities. TSFG's security portfolio experienced average
prepayments of approximately $100 million per month and average calls of
approximately $130 million per month during the first half of the year. TSFG
expects loan growth to continue and to replace some securities balances with new
loans. Accordingly, if strong loan demand continues, TSFG expects investment
securities to decline during the second half of 2003.
Average total deposits increased by $1.1 billion, or 29.7%, to $4.7
billion during the first six months of 2003 from $3.6 billion in the first six
months of 2002. The majority of the increase was attributable to the deposits
acquired from Gulf West, Rock Hill Bank, and CBT in the second half of 2002.
During the second quarter 2003, deposit growth accelerated with average deposits
increasing at a 21.3% annualized rate over the first quarter 2003, driven by
growth in money market and noninterest-bearing deposits. Average borrowings
increased to $3.1 billion during the six months ended June 30, 2003 from $1.9
billion during the six months ended June 30, 2002 due to increases in repurchase
agreements and FHLB advances. These borrowings were used to fund the growth in
earning assets.
Deposits generated through Bank CaroLine, an Internet banking division
of Carolina First Bank, generally receive higher rates than those offered by our
branch locations as a result of the less expensive Internet delivery channel.
Bank CaroLine deposits totaled $25.1 million as of June 30, 2003 compared with
$29.6 million and $38.7 million as of December 31, 2002 and June 30, 2002,
respectively.
33
Provision for Loan Losses
The provision for loan losses is recorded in amounts sufficient to
bring the allowance for loan losses to a level deemed appropriate by management.
Management determines this amount based upon many factors, including its
assessment of loan portfolio quality, loan growth, changes in loan portfolio
composition, net loan charge-off levels, and expected economic conditions. The
provision for loan losses was $10.7 million and $12.5 million in the first six
months of 2003 and 2002, respectively. The lower provision for loan losses was
primarily attributable to the liquidation of nonperforming loans on which
allocated reserves exceeded net losses incurred.
Net loan charge-offs were $16.8 million, or 0.73% of average loans, for
the first six months of 2003, compared with $10.1 million, or 0.53% of average
loans, for the first six months 2002. Loan charge-offs in the first six months
of 2003 included losses of $6.8 million on Rock Hill Workout Loans, which were
provided for in the allowance for loan losses at year-end. Therefore, the
allowance for loan losses declined, and these charge-offs had no impact on the
first six months of 2003 provision for loan losses. The allowance for loan
losses equaled 1.37%, 1.58%, and 1.20% of loans held for investment as of June
30, 2003, December 31, 2002, and June 30, 2002, respectively. The significant
increase from June 2002 to December 2002 was attributable to the Rock Hill
Workout Loans. See "Loans." Excluding the Rock Hill Workout Loans, the allowance
for loan losses was 1.20% of loans held for investment as of June 30, 2003.
Noninterest Income
Noninterest income totaled $43.9 million in the first six months of
2003, compared with $25.1 million in the first six months of 2002. The increase
in noninterest income was primarily composed of a $4.2 million increase in
deposit service charges, a $4.0 gain on sale of available for sale securities, a
$2.4 million increase in mortgage banking income, a $2.0 million increase in
gain on equity investments, a $1.4 million increase in fees for investment
services, and a $2.5 increase in other, which was largely due to increases in
insurance commissions, debit card income, and customer service fees. Table 9
shows the components of noninterest income for the six months ended June 30,
2003 and 2002.
TABLE 9
- --------------------------------------------------------------------------------------------------------------------------
COMPONENTS OF NONINTEREST INCOME
- --------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Service charges on deposit accounts $ 7,581 $ 5,421 $ 14,541 $ 10,328
Mortgage banking income 2,561 1,289 4,733 2,370
Fees for investment services 2,142 1,853 4,633 3,280
Bank-owned life insurance 1,933 1,803 3,881 3,609
Merchant processing income 2,071 1,715 3,407 2,963
Gain (loss) on derivative contracts 1,203 (24) 1,011 (37)
Other 2,686 1,329 4,996 2,471
-------- -------- -------- --------
Noninterest income, excluding gain on asset sales 20,177 13,386 37,202 24,984
-------- -------- -------- --------
Gain on sale of available for sale securities 3,197 186 4,183 215
Gain on equity investments, net - (150) 1,875 (139)
Gain on disposition of assets and liabilities 601 - 601 -
-------- -------- -------- --------
Gain on asset sales, net 3,798 36 6,659 76
-------- -------- -------- --------
Total noninterest income $ 23,975 $ 13,422 $ 43,861 $ 25,060
======== ======== ======== ========
Noninterest income included gains on asset sales for both the six
months ended June 30, 2003 and 2002. Excluding these net gains on asset sales,
noninterest income increased $12.2 million, or 48.9%, in the first six months of
2003 to $37.2 million from $25.0 million for the corresponding period in 2002.
During the first six months of 2003, the gain on equity investment
totaling $1.9 million was from the sale of 207,096 shares of NetBank, Inc.
common stock. During the six months ended June 30, 2002, the loss on equity
investments totaling $139,000 included a $150,000 write-off of an investment in
a technology company and was partially offset by an $11,000 gain on the sale of
an equity investment in a community bank.
34
Service charges on deposit accounts, the largest contributor to
noninterest income, rose 40.8% to $14.5 million in the first six months of 2003
from $10.3 million for the same period in 2002. The increase was attributable to
increasing 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 42.5% for the same
period.
Mortgage banking income includes origination income and secondary
marketing operations (related to current production), mortgage servicing income
(net of the related amortization for the mortgage servicing rights and
subservicing payments), losses and recoveries related to the impairment of
mortgage servicing rights, and gains and losses on sales of portfolio mortgage
loans. Mortgage banking income in the first six months of 2003 increased $2.4
million to $4.7 million from $2.4 million in the first six months of 2002. Table
10 shows the components of mortgage banking income for the six months ended June
30, 2003 and 2002.
TABLE 10
- -------------------------------------------------------------------------------------------------------------------------
COMPONENTS OF MORTGAGE BANKING INCOME
- -------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------- -----------------------
2003 2002 2003 2002
---- ---- ---- ----
Origination income and secondary marketing operations $ 3,271 $ 1,498 $ 6,215 $ 3,177
Net mortgage servicing loss (476) (186) (986) (591)
(Impairment) recoveries on mortgage servicing rights (234) (23) (496) 177
Loss on sale of portfolio mortgage loans - - - (393)
------- ------- ------- -------
Total mortgage banking income $ 2,561 $ 1,289 $ 4,733 $ 2,370
======= ======= ======= =======
For the first six months of 2003, origination income and secondary
marketing increased 95.6% to $6.2 million from $3.2 million for the first six
months of 2002. Mortgage loans originated by TSFG originators totaled $354.9
million and $212.1 million in the first six months of 2003 and 2002,
respectively. Mortgage origination volumes by TSFG originators increased in the
first six months of 2003 due to lower mortgage loan rates and the hiring of
additional mortgage originators.
TSFG's total servicing portfolio includes mortgage loans owned by
Carolina First Bank and Mercantile Bank, and other mortgage loans for which
Carolina First Bank owns the rights to service. At June 30, 2003, TSFG's
servicing portfolio included 4,394 loans having an aggregate principal balance
of $320.8 million. At June 30, 2002, the aggregate principal balance for TSFG's
servicing portfolio totaled $619.3 million, significantly higher than June 30,
2003 due to prepayments of loans from increased refinancings as a result of
lower interest rates. 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. TSFG expects its total servicing portfolio to
continue to decline since the emphasis of its mortgage banking strategy is on
mortgage originations. TSFG sells most of the loans it originates in the
secondary market with servicing rights released.
Mortgage servicing rights, net of the valuation allowance, totaled $2.2
million and $7.3 million at June 30, 2003 and 2002, respectively. For the six
months ended June 30, 2003, TSFG recorded a $496,000 charge for impairment from
the valuation of mortgage servicing rights. In the first six months of 2002,
TSFG had an impairment recovery of $177,000 from the valuation of mortgage
servicing rights. At June 30, 2003 and 2002, the valuation allowance for
capitalized mortgage servicing rights totaled $2.3 million and $891,000,
respectively.
Fees for investment services, which include trust and brokerage income,
for the first six months of 2003 and 2002, were $4.6 million and $3.3 million,
respectively. Brokerage income increased $1.3 million to $2.8 million, primarily
from the addition of brokers and improved equity market conditions. Trust income
remained relatively constant at $1.8 million. At June 30, 2003 and 2002, the
market value of assets administered by the trust department totaled $674.4
million and $676.2 million, respectively.
Bank-owned life insurance income increased to $3.9 million for the
first six months of 2003 from $3.6 million for the first six months of 2002 due
to increases in cash values. Merchant processing income increased 15.0% to $3.4
million for the six months ended June 30, 2003 from $3.0 million for the six
months ended June 30, 2002 from attracting new merchants.
35
During the first six months of 2003, gain on derivative contracts
totaled $1.0 million, compared with a $37,000 loss for the first six months of
2002. In 2003, TSFG increased its use of derivatives as economic hedges of
on-balance sheet assets and liabilities or forecasted transactions, which result
in realized gains and losses included in earnings. Such activities may result in
increased volatility in realized gains and losses on trading activities. See
"Market Risk and Asset/Liability Management - Derivatives and Hedging
Activities."
Other noninterest income totaled $5.0 million for the first six months
of 2003, compared with $2.5 million for the first six months of 2002. Other
noninterest income includes income related to insurance commissions, debit
cards, customer service fees, international banking services, and other
fee-based services. Total income from these fee income sources increased over
the prior year due in part to TSFG's rollout of Elevate, a customer-centered
sales process. The increase in other noninterest income was largely from
increases in insurance commissions, which increased $1.2 million, and debit card
income, which increased $582,000. As a result of recent VISA/MasterCard legal
settlements, effective August 1, 2003, TSFG anticipates a reduction in debit
card interchange income of approximately 30%. TSFG expects to substantially
offset this reduction by continued growth in consumer debit card penetration,
introduction of a small business debit card product, and a modest reduction in
debit card expense.
Noninterest Expenses
Noninterest expenses increased to $99.0 million in the first six months
of 2003 from $70.6 million in the first six months of 2002. Noninterest expenses
for the six months ended June 30, 2003 included $1.9 million in merger-related
costs and a $268,000 impairment loss from write-down of assets.
Salaries, wages, and employee benefits increased to $50.3 million in
the first six months of 2003 from $35.5 million in the first six months of 2002.
Full-time equivalent employees increased to 1,718 from 1,379 as of June 30, 2003
and 2002, respectively. The increase in personnel expense was primarily
attributable to the 2002 acquisitions (which occurred during the second half of
the year), the API acquisition in 2003, hiring new 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 $3.6 million in the first six months of 2003
from $1.4 million in the first six months of 2002.
Occupancy expense increased to $9.3 million for the six months ended
June 30, 2003 from $7.2 million for the corresponding period of 2002, primarily
from the addition of branch offices from the 2002 acquisitions. Furniture and
equipment increased $1.7 million to $8.8 million for the first six months of
2003 from $7.1 million for the same period in 2002. The increase in furniture
and equipment expense was primarily attributable to increases in depreciation
and additional maintenance agreements principally from the acquisitions in the
last four months of 2002.
The increase in professional fees to $3.4 million for the first six
months of 2003 from $2.5 million for the first six months of 2002 was partially
related to deposit pricing and fee initiatives. The increase in merchant
processing expense to $2.7 million for the first six months of 2003 from $2.4
million for the first six months of 2002 was offset by related revenue
increases. Telecommunication expense increased $669,000 to $2.2 million for the
first six months of 2003 from $1.6 million in the first six months of 2002.
Amortization of intangibles increased to $1.4 million for the six
months ended June 30, 2003 from $479,000 for the six months ended June 30, 2002.
This increase was primarily attributable to the addition of core deposit
premiums in the third and fourth quarters of 2002 for the CBT, Rock Hill Bank,
and Gulf West acquisitions, which totaled $12.3 million. In addition, TSFG added
customer list intangibles and non-compete agreement intangibles with the
acquisitions of Gardner Associates and API.
TSFG incurred pre-tax merger-related costs of $1.9 million in the first
six months of 2003 in connection with the 2002 acquisitions of CBT, Rock Hill
Bank, and Gulf West, and the 2003 acquisition of API. See Part I, Item 1, Note
13 to the Consolidated Financial Statements.
Other noninterest expenses increased $4.9 million to $18.7 million in
the first six months of 2003 from $13.8 million in the first six months of 2002.
The overall increase in other noninterest expenses was principally attributable
to increases in loan collection, advertising, debit card, and insurance
expenses.
Income Taxes
The effective income tax rate as a percentage of pretax income remained
relatively constant at 32.0% for the first six months of 2003 and 32.4% for the
first six months of 2002. TSFG expects the effective income tax rate for the
36
balance of 2003 to remain at 32% or decline slightly. The blended statutory
federal and state 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, including capital gains, in order to ultimately
realize deferred income tax assets. Tax returns for 1999 and subsequent years
are exposed to examination by taxing authorities.
Second Quarter Results
Net income for the three months ended June 30, 2003 totaled $22.7
million, up 48.0% compared with $15.3 million for the three months ended June
30, 2002. Earnings per diluted share for the three months ended June 30, 2003
were $0.48, a 29.7% increase from earnings per diluted share of $0.37 for the
three months ended June 30, 2002. Higher net interest income, fee income
initiatives, a lower provision for loan losses, and gains on sales of available
for sale securities contributed to the increases in net income and earnings per
diluted share. This earnings growth was partially offset by higher noninterest
expenses.
Fully tax-equivalent net interest income totaled $66.8 million, an
increase of $13.6 million, or 25.6%, compared with the second quarter of 2002.
Net interest income increased from 43.4% growth in average earning assets,
partially offset by a decline in the net interest margin. The net interest
margin declined to 3.32% in the second quarter 2003 from 3.79% in the same
period in 2002. The decrease in the net interest margin was largely attributable
to higher investment securities (which generally have a lower yield than loans),
downward repricing of fixed rate commercial loans, and deposit rates approaching
lower limits due to historically-low interest rates.
Noninterest income for the three months ended June 30, 2003 and 2002
included pre-tax gains on asset sales of $3.8 million and $36,000, respectively.
See "Earnings Review - Noninterest Income" for details on the gains on asset
sales. Noninterest income, excluding the gains on asset sales, increased 50.7%
to $20.2 million for the second quarter of 2003 compared with $13.4 million for
the second quarter of 2002. The increase in noninterest income, excluding the
gains on asset sales, was primarily the result of a $2.2 million increase in
deposit service charges, a $1.3 increase in mortgage banking income, a $1.2
million increase in gain on derivative contracts, and a $1.4 million increase in
other, which was largely due to increases in insurance commissions, benefit
administration fees (due to the API acquisition), debit card income, and
customer service fees. For the three months ended June 30, 2003, TSFG recorded a
$234,000 charge for impairment from the value of mortgage servicing rights,
compared to $23,000 for the corresponding period in 2002.
For the second quarter 2003, noninterest expenses included the
following pre-tax other items: $382,000 in merger-related costs and a $268,000
impairment loss from write-down of assets. Noninterest expenses, excluding other
items, increased 38.1% to $49.4 million for the second quarter 2003 from $35.8
million for the second quarter 2002, which is primarily attributable to the 2002
acquisitions (which occurred during the second half of the year) and increased
personnel expense from hiring new revenue-producing associates (at a higher cost
per full-time equivalent employee) and recording higher levels of incentive pay.
MARKET RISK AND ASSET/LIABILITY MANAGEMENT
Market risk is the risk of loss from adverse changes in market prices
and interest 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 changes in market interest rates. TSFG
has risk management policies and systems to monitor and limit exposure to
interest rate risk.
TSFG attempts 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 through implementation of
strategies to improve balance sheet positioning and/or earnings while managing
interest rate risk. TSFG attempts 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. TSFG's asset/liability mix is sufficiently balanced so that the effect
of interest rates moving in either direction is not expected to have a
37
significant impact on net interest income over time. The overall interest rate
risk position of TSFG continues to fall within the interest rate risk guidelines
established by ALCO.
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 maturing or whose
rates are subject to change 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. In general, an asset sensitive position would indicate that net
interest income would benefit from increases in market interest rates.
Conversely, a liability sensitive position generally indicates that net interest
income would benefit from decreases in market interest rates. The static gap
position is limited because it does not take into account a number of important
factors, such as the degree of changes in interest rates, the timing of the
implementation of such changes, or changes in management's expectations or
intentions. In addition, it is not necessarily indicative of positions on other
dates.
Table 11 shows TSFG's financial instruments that are sensitive to
changes in interest rates as well as TSFG's interest sensitivity gap at June 30,
2003. The carrying amounts of rate-sensitive assets and liabilities are
presented in the periods in which they next reprice to market rates or mature.
For assets, projected repayments, anticipated principal prepayments, and
potential calls are taken into account. To reflect anticipated prepayments,
certain asset categories are shown in Table 11 using estimated cash flows rather
than contractual cash flows. For core deposits without contractual maturities
(i.e., interest checking, savings, money market, and noninterest-bearing deposit
accounts), Table 11 presents principal cash flows based on management's judgment
concerning their most likely runoff. The actual maturities and runoff could vary
substantially if future prepayments, runoff, and calls differ from TSFG's
historical experience and management's judgment.
38
TABLE 11
- ---------------------------------------------------------------------------------------------------------------------------
INTEREST RATE SENSITIVITY GAP ANALYSIS
- ---------------------------------------------------------------------------------------------------------------------------
(DOLLARS IN THOUSANDS)
0-3 4-12 ONE TO AFTER
MONTHS MONTHS THREE YEARS THREE YEARS TOTAL
------ ------ ----------- ----------- -----
Interest-sensitive assets
Earning assets
Loans $ 2,855,986 $ 751,562 $ 943,587 $ 198,117 $ 4,749,252
Investment securities (1) 825,799 822,292 835,877 1,063,897 3,547,865
Fed funds sold 50,000 - - - 50,000
Interest-bearing balances with other banks 63,738 1,000 - - 64,738
----------- ----------- ----------- ----------- -----------
Total earning assets $ 3,795,523 $ 1,574,854 $ 1,779,464 $ 1,262,014 $ 8,411,855
=========== =========== =========== =========== ===========
Interest-sensitive liabilities
Liabilities
Interest-sensitive liabilities
Interest-bearing deposits
Interest checking $ - $ 201,611 $ 235,213 $ 235,213 $ 672,037
Savings - 14,756 73,780 59,024 147,560
Money market 1,268,382 128,059 91,471 91,471 1,579,383
Certificates of deposit 460,223 981,145 391,972 74,074 1,907,414
----------- ----------- ----------- ----------- -----------
Total interest-bearing deposits 1,728,605 1,325,571 792,436 459,782 4,306,394
Other deposits (2) - 81,494 407,472 325,979 814,945
Borrowings 1,357,660 1,060,431 342,361 368,076 3,128,528
----------- ----------- ----------- ----------- -----------
Total interest-sensitive liabilities 3,086,265 2,467,496 1,542,269 1,153,837 8,249,867
Periodic interest-sensitive gap 709,258 (892,642) 237,195 108,177 161,988
Notional amount of interest rate swaps (534,500) 228,500 75,000 231,000 -
----------- ----------- ----------- ----------- -----------
Periodic interest-sensitive gap after interest
rate swaps $ 174,758 $ (664,142) $ 312,195 $ 339,177 $ 161,988
=========== =========== =========== =========== ===========
Cumulative interest-sensitive gap $ 174,758 $ (489,384) $ (177,189) $ 161,988 $ -
=========== =========== =========== =========== ===========
(1) Investment securities exclude the unrealized gain on the sale of securities
of $36.0 million.
(2) Other deposits consist of noninterest-bearing deposits, which respond in
part to changes in interest rates.
As indicated in Table 11, as of June 30, 2003, on a cumulative basis
through twelve months, rate-sensitive liabilities exceeded rate-sensitive
assets, resulting in a liability-sensitive position of $489.4 million, or 5.3%
of total assets. This static gap liability sensitive position resulted primarily
from the increase in the Freedom Money Market, which reprices immediately
following changes in the prime rate, and from funding some of the securities
purchased during the first six months of 2003 with repurchase agreements that
reprice within one year.
The forecast used for earnings at risk analysis simulates TSFG's
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 100 and 200 basis points over the next
twelve-month period. These rates assume a parallel shift in the treasury yield
curve, except for lower limits in the declining rate scenarios as discussed
below. Computation of prospective effects of hypothetical interest rate changes
are based on numerous assumptions, including relative levels of market interest
rates and loan prepayments, and should not be relied upon as indicative of
actual results. Further, the computations do not contemplate any additional
actions TSFG could undertake in response to changes in interest rates. Table 12
shows the effect that the indicated changes in interest rates would have on net
interest income as projected for the next twelve months using the "most likely"
projected balance sheet.
39
TABLE 12
- -------------------------------------------------------------------------------------------------------------
EARNINGS AT RISK ANALYSIS
- -------------------------------------------------------------------------------------------------------------
ANNUALIZED HYPOTHETICAL PERCENTAGE CHANGE IN
INTEREST RATE SCENARIO NET INTEREST INCOME
---------------------- -------------------
2.00% 2.86%
1.00 2.29
Flat -
(1.00) (0.95)
(2.00) (4.11)
As indicated in Table 12, although TSFG has a static gap liability
sensitive position, the earnings at risk analysis indicates that TSFG will
benefit from an increase in interest rates. This situation is due to the
reduction of the prepayment speeds on the mortgage-backed securities in the
increasing rate scenarios resulting in a higher level of earning assets and
higher interest income.
Although net interest income declines in the declining rate scenarios,
lower limits are in place, which limit these rate declines and the impact on net
interest income. Due to the low level of current interest rates, many of the key
rates (such as Federal Funds and three month LIBOR), which the majority of the
balance sheet items are indexed to in the model, cannot be lowered the full 100
and 200 basis points. The floors placed on these key rates restrict the
reduction in both interest income and expense in the declining rate scenario. In
addition, many deposit rates are reaching what management believes to be an
acceptable lower limit thus limiting the interest expense reduction from
repricing deposits by the entire 100 and 200 basis points.
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
either a scenario 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, investment, deposit taking, and borrowing activities.
Derivatives used for interest rate risk management include various interest rate
swaps, options and futures contracts. Options and futures contracts typically
have 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 uses
futures, 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. Such activities may result in increased volatility in
realized gains and losses on trading activities.
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
financial instrument from a change in interest rates or implied volatility of
rates. TSFG manages 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.
40
In accordance with SFAS 133, TSFG records derivatives at fair value, as
either assets or liabilities, on the consolidated balance sheets. At June 30,
2003, the fair value of derivative assets totaled $4.6 million and was related
to fair value hedges, derivatives with no hedging designation, and cash flow
hedges. At June 30, 2003, TSFG had no derivative liabilities.
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 June 30, 2003 and 2002, 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 June 30, 2003, commercial and retail
loan commitments totaled $811.0 million. Documentary letters of credit are
typically issued in connection with customers' trade financing requirements and
totaled $13.3 million at June 30, 2003. Unused business credit card lines, which
totaled $15.5 million at June 30, 2003, are generally for short-term borrowings.
Standby letters of credit represent an obligation of TSFG to a third
party contingent upon the failure of TSFG's customer to perform under the terms
of an underlying contract with the third party or obligates TSFG to guarantee or
stand as surety for the benefit of the third party. The underlying contract may
entail either financial or nonfinancial obligations and may involve such things
as the customer's delivery of merchandise, completion of a construction
contract, release of a lien, or repayment of an obligation. Under the terms of a
standby letter, drafts will generally be drawn only when the underlying event
fails to occur as intended. TSFG can seek recovery of the amounts paid from the
borrower. In addition, some of these standby letters of credit are
collateralized. The collateral is generally cash, although existing lines of
credit are sometimes used. Commitments under standby letters of credit are
usually for one year or less. At June 30, 2003, TSFG had a recorded liability of
$100,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor. The maximum potential
amount of undiscounted future payments related to standby letters of credit at
June 30, 2003 was $81.3 million.
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 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 June 30, 2003, the fair value of derivative assets totaled $4.6
million and was related to derivatives with no hedging designation, fair value
hedges, and cash flow hedges. The related notional amounts, which are not
recorded on the consolidated balance sheets, totaled $672.0 million for the
derivative assets. At June 30, 2003, TSFG had no derivative liabilities.
41
Credit Life & Disability Insurance. Carolina First Guaranty
Reinsurance, Ltd. ("CFGRL"), a wholly-owned subsidiary of TSFG, offers credit
life and disability insurance up to a single policy limit of $100,000 to
customers of the Subsidiary Banks. As of June 30, 2003, CFGRL had in force
insurance not recorded on the consolidated balance sheets of $31.9 million. A
loss reserve, determined based on reported and past loss experience of in force
policies, of $201,000 was included in other liabilities at June 30, 2003.
Stock-Related Agreements. In connection with stock repurchases, TSFG
has, from time to time, entered into "accelerated share repurchase" contracts.
Under these accelerated share repurchase contracts, an unaffiliated investment
bank (the "counterparty") "borrows" the requisite number of shares from
unaffiliated third parties, and delivers these shares to TSFG in exchange for
cash (such that these shares are immediately removed from TSFG's outstanding
shares). Over a period of time subsequent to the entry into the accelerated
share repurchase contract, the counterparty purchases TSFG shares in the open
market to cover their borrowed position. After the counterparty has covered this
position, TSFG settles with the counterparty for any gains or losses associated
with changes in TSFG's stock price during the period of time that stock was
being purchased. This settlement may be made in cash or in TSFG common stock.
These contracts are reflected as a reduction in shareholders' equity and
outstanding shares (used in the earnings per share calculation).
In March 2003, TSFG settled an accelerated contract by receiving and
canceling 6,308 shares. Also, in March 2003, TSFG entered into a new accelerated
share repurchase contract with an unaffiliated company to repurchase one million
shares of TSFG common stock and to settle the contract in stock. In June 2003,
TSFG settled this accelerated contract by issuing 93,253 restricted shares,
adjusted to 91,250 shares when exchanged for registered shares during July 2003.
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.
Securities classified as available for sale, which are not pledged, may be sold
in response to changes in interest rates or liquidity needs. A substantial
majority of TSFG's securities are pledged.
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, TSFG focuses on assets and liabilities and on the
manner in which they combine to provide adequate liquidity to meet our needs.
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. 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 June 30, 2003, totaled $979.3 million. At June 30, 2003, the
Subsidiary Banks had approximately $712.4 million of unused borrowing capacity
from the FHLB. This capacity may be used when the Subsidiary Banks have
available collateral to pledge. Until the Subsidiary Banks make collateral
available (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. In addition, the Subsidiary Banks may purchase
securities or may repay repurchase agreements to provide additional
FHLB-qualifying collateral. At June 30, 2003, the Subsidiary Banks had unused
short-term lines of credit totaling approximately $321 million (which are
withdrawable at the lender's option).
The Federal Reserve Bank provides back-up funding for commercial banks.
Collateralized borrowing relationships with the Federal Reserve Banks of
Richmond and Atlanta are in place for the Subsidiary Banks to meet emergency
funding needs. At June 30, 2003, the Subsidiary Banks had qualifying collateral
to secure advances up to $549.9 million, of which none was outstanding.
At June 30, 2003, the parent company had an unused short-term line of
credit totaling $10.0 million (which is withdrawable at the lender's option and
matures June 30, 2004).
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In the normal course of business, to meet the financial needs of its
customers, TSFG, principally through the Subsidiary Banks, enters into
agreements to extend credit. For amounts and types of such agreements at June
30, 2003, see "Off-Balance Sheet Arrangements." Increased demand for funds under
these agreements would reduce TSFG's liquidity and could require additional
sources of liquidity.
RECENTLY ADOPTED ACCOUNTING PRONOUNCEMENTS
Accounting for Exit or Disposal Activities
Effective January 1, 2003, TSFG adopted SFAS No. 146, "Accounting for
Costs Associated with Exit or Disposal Activities" ("SFAS 146"). SFAS 146
addresses financial accounting and reporting for costs associated with exit or
disposal activities and requires that a liability for a cost associated with an
exit or disposal activity be recognized when the liability is incurred. Those
costs include, but are not limited to, the following: a) termination benefits
provided to current employees that are involuntarily terminated under the terms
of a benefit arrangement that, in substance, is not an ongoing benefit
arrangement or an individual deferred compensation contract (hereinafter
referred to as one-time termination benefits), b) costs to terminate a contract
that is not a capital lease, and c) costs to consolidate facilities or relocate
employees. The initial adoption of this standard did not have an impact on the
financial condition or results of operations of TSFG.
Accounting for Guarantees
Effective January 1, 2003, TSFG adopted the initial recognition and
initial measurement provisions of Financial Accounting Standards Board
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45").
TSFG adopted the disclosure requirements effective as of December 31, 2002. FIN
45 elaborates on the disclosure to be made by a guarantor in its interim and
annual financial statements about its obligations under certain guarantees that
it has issued. FIN 45 clarifies that a guarantor is required to disclose (a) the
nature of the guarantee; (b) the maximum potential amount of future payments
under the guarantee; (c) the carrying amount of the liability; and (d) the
nature and extent of any recourse provisions or available collateral that would
enable the guarantor to recover the amounts paid under the guarantee. FIN 45
also clarifies that a guarantor is required to recognize, at inception of a
guarantee, a liability for the obligations it has undertaken in issuing the
guarantee at its inception. At June 30, 2003, TSFG recorded a liability of
$100,000 for deferred fees received on standby letters of credit, which was the
estimated fair value for the current carrying amount of the obligation to
perform as a guarantor. No contingent liability was determined to be necessary
relating to TSFG's obligation to perform as a guarantor.
Accounting for Derivative Instruments and Hedging Activities
Effective July 1, 2003, TSFG adopted SFAS No. 149, ("SFAS 149"),
"Amendment of Statement 133 on Derivative Instruments and Hedging Activities,"
which amends and clarifies financial accounting and reporting for derivative
instruments, including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for hedging activities
under SFAS No. 133, "Accounting for Derivative Instruments and Hedging
Activities." SFAS 149 clarifies under what circumstances a contract with an
initial net investment meets the characteristics of a derivative, clarifies when
a derivative contains a financing component, amends the definition of an
underlying to conform it to language used in FIN 45, and amends certain other
existing pronouncements. Those changes will result in more consistent reporting
of contracts as either derivatives or hybrid instruments. Management does not
believe the provisions of this standard will have a material impact on results
of future operations.
Accounting for Variable Interest Entities
Effective July 1, 2003, TSFG adopted FASB Interpretation No. 46, ("FIN
46"), "Consolidation of Variable Interest Entities," which addresses
consolidation by business enterprises of variable interest entities. Under FIN
46, an enterprise that holds significant variable interest in a variable
interest entity but is not the primary beneficiary is required to disclose the
nature, purpose, size, and activities of the variable interest entity, its
exposure to loss as a result of the variable interest holder's involvement with
the entity, and the nature of its involvement with the entity and date when the
involvement began. The primary beneficiary of a variable interest entity is
required to disclose the nature, purpose, size, and activities of the variable
interest entity, the carrying amount and classification of consolidated assets
that are collateral for the variable interest entity's obligations, and any lack
of recourse by creditors (or beneficial interest holders) of a consolidated
variable interest entity to the general creditors (or beneficial interest
43
holders) of a consolidated variable interest entity to the general creditor of
the primary beneficiary. TSFG had no impact upon adoption since it had no
interests in entities, which it considers to be included within the scope of FIN
46.
Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity
Effective July 1, 2003, TSFG adopted SFAS No. 150, ("SFAS 150"),
"Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity," which establishes standards for how an issuer
classifies and measures certain financial instruments with characteristics of
both liabilities and equity. SFAS 150 requires an issuer to classify certain
financial instruments that include certain obligations, such as mandatory
redemption, repurchase of the issuer's equity, or settlement by issuing equity,
as liabilities or assets in some circumstance. Forward contracts to repurchase
an issuer's equity shares that require physical settlement in exchange for cash
are initially measured at the fair value of the shares at inception, adjusted
for any consideration or unstated rights or privileges, which is the same as the
amount that would be paid under the conditions specified in the contract if
settlement occurred immediately. Those contracts and mandatorily redeemable
financial instruments are subsequently measured at the present value of the
amount to be paid at settlement, if both the amount of cash and the settlement
date are fixed, or, otherwise, at the amount that would be paid under the
conditions specified in the contract if settlement occurred at the reporting
date. Other financial instruments are initially and subsequently measured at
fair value, unless required by SFAS 150 or other generally accepted accounting
principles to be measured differently. TSFG had no impact upon adoption since it
had no financial instruments, which it considers to be included within the scope
of SFAS 150.
44
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Market Risk and Asset/Liability Management" in Item 2, Management
Discussion and Analysis of Financial Condition and Results of Operations for
quantitative and qualitative disclosures about market risk, which information is
incorporated herein by reference.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the
participation of TSFG's management, including the its chief executive officer
("CEO") and Chief Financial Officer ("CFO"), of the effectiveness of TSFG's
disclosure controls and procedures as of June 30, 2003. Based on that
evaluation, TSFG's management, including the CEO and CFO, has concluded that
TSFG's disclosure controls and procedures are effective. During the second
quarter of 2003, there was no change in TSFG's internal control over financial
reporting that has materially affected, or is reasonably likely to materially
affect, TSFG's internal control over financial reporting.
45
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 AND USE OF PROCEEDS
On April 30, 2003, TSFG acquired American Pensions, Inc. ("API"), a
benefit plan administrator headquartered in Mount Pleasant, South Carolina. In
connection with the acquisition, TSFG issued 146,808 shares of common stock
valued at $3.5 million. In addition, the shareholders of API have the right to
receive common stock with a maximum value of approximately $2.2 million under
earnout provisions based on API's five-year financial performance. This issuance
was exempt under Section 4(2) of the Securities Act of 1933 insofar as API had
only three shareholders.
On June 2, 2003, TSFG issued 93,253 shares of its common stock to UBS
AG, London Branch ("UBS"), an investment banking concern. These shares were
issued in satisfaction of an obligation to pay UBS approximately $2,238,000, of
which approximately $56,000 was underwriting commissions, incurred in connection
with the settlement of an accelerated share repurchase contract. This issuance
was exempt under Section 4(2) of the Securities Act of 1933.
ITEM 3 DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS
Annual Meeting of Shareholders
On April 29, 2003, TSFG held its 2003 Annual Meeting of Shareholders.
The results of the 2003 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
---- --- ---------
Gordon W. Campbell 37,651,825 98.1% 727,274
M. Dexter Hagy 37,767,935 98.4% 611,164
H. Earle Russell, Jr. 37,764,714 98.4% 614,385
John C. B. Smith, Jr. 37,767,696 98.4% 611,403
William R. Timmons, Jr 37,620,672 98.0% 758,427
Samuel H. Vickers 37,647,991 98.1% 731,108
William P. Brant, Judd B. Farr, C. Claymon Grimes, Jr., William S.
Hummers III, Thomas J. Rogers, Charles B. Schooler, Edward J.
Sebastian, Eugene E. Stone IV, William R. Timmons III, David C.
Wakefield III, and Mack I. Whittle, Jr. continued in their present
terms as directors.
PROPOSAL #2 - APPROVAL OF AMENDED AND RESTATED MANAGEMENT INCENTIVE
COMPENSATION PLAN
The shareholders approved TSFG's Amended and Restated Management
Incentive Compensation Plan with 34,318,013 shares, or 89.4%, voting
in favor, 3,552,491 shares voting against, and 508,595 shares
abstaining.
PROPOSAL #3 - APPROVAL OF AMENDMENT TO AMENDED AND RESTATED RESTRICTED
STOCK AGREEMENT PLAN
The shareholders approved an amendment to TSFG's Amended and Restated
Restricted Stock Agreement Plan with 33,633,073 shares, or 87.6%,
voting in favor, 4,256,415 shares voting against, and 489,611 shares
abstaining.
PROPOSAL #4 - APPROVAL OF 2004 LONG-TERM INCENTIVE PLAN
The shareholders approved an amendment to TSFG's 2004 Long-Term
Incentive Plan with 33,685,681 shares, or 87.8%, voting in favor,
4,183,090 shares voting against, and 510,328 shares abstaining.
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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 2003 with
36,881,752 shares, or 96.1%, voting in favor, 1,289,203 shares voting
against, and 208,144 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 between TSFG and MBFC dated May
14, 2003. Incorporated by reference to Exhibit 2.1 of TSFG's
Current Statement on Form 8-K dated May 14, 2003.
10.1 Supplemental Executive Retirement Agreements dated July 15,
2003 between TSFG and each of Mack I. Whittle, Jr., William S.
Hummers III, James W. Terry, Jr., Andrew B. Cheney, and John
C. DuBose.
31.1 Certification of the Principal Executive Officer pursuant
to 15 U.S.C. 78m(a) or 78o(d)(Section 302 of the Sarbanes-
Oxley Act of 2002).
31.2 Certification of the Principal Financial Officer pursuant
to 15 U.S.C. 78m(a) or 78o(d) (Section 302 of the Sarbanes-
Oxley Act of 2002).
32.1 Certification of the Principal Executive Officer pursuant to
18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
32.2 Certification of the Principal Executive Officer pursuant to
18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of
2002).
(b) Reports on Form 8-K
Form 8-K dated April 15, 2003 attaching TSFG's first quarter earnings
release.
Form 8-K dated May 14, 2003 announcing that TSFG had entered into a
merger agreement with MBFC and attaching the merger agreement as an
exhibit.
Form 8-K dated July 15, 2003 attaching TSFG's second quarter earnings
release.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, TSFG has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.
The South Financial Group, Inc.
/s/ William S. Hummers III
-----------------------------------------------
William S. Hummers III
Vice Chairman and Executive Vice President
(Principal Accounting and Principal Financial
Officer)
August 12, 2003
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