10-Q 1 form10q-09302002.txt FOR PERIOD ENDING SEPTEMBER 30, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ----- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 TRANSACTION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES ----- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ______ TO _____ Commission file number 0-15083 THE SOUTH FINANCIAL GROUP, INC. (Exact name of registrant as specified in its charter) SOUTH CAROLINA 57-0824914 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 102 SOUTH MAIN STREET, GREENVILLE, SOUTH CAROLINA 29601 (Address of principal executive offices) (ZIP Code) Registrant's telephone number, including area code (864) 255-7900 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- The number of outstanding shares of the issuer's $1.00 par value common stock as of November 5, 2002 was 44,111,530.
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) SEPTEMBER 30, -------------------------------- 2002 2001 DECEMBER 31, (UNAUDITED) (UNAUDITED) 2001 ----------- ----------- ---- ASSETS Cash and due from banks $ 175,315 $ 121,391 $ 149,170 Interest-bearing bank balances 41,849 45,162 91,497 Federal funds sold 10,022 - - Securities Trading 3,473 6,334 1,577 Available for sale 1,854,165 1,092,878 1,560,986 Held to maturity (market value $84,790, $73,457 and $81,878, respectively) 82,086 71,783 80,832 ---------- ---------- ---------- Total securities 1,939,724 1,170,995 1,643,395 ---------- ---------- ---------- Loans Loans held for sale 62,699 16,691 6,513 Loans held for investment 4,152,054 3,739,620 3,730,250 Allowance for loan losses (50,011) (43,944) (44,587) ---------- ---------- ---------- Net loans 4,164,742 3,712,367 3,692,176 ---------- ---------- ---------- Premises and equipment, net 126,928 114,168 114,224 Accrued interest receivable 32,730 32,278 38,241 Intangible assets 176,802 98,480 97,140 Other assets 217,856 198,536 203,599 ---------- ---------- ---------- $6,885,968 $5,493,377 $6,029,442 ========== ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Liabilities Deposits Noninterest-bearing $ 678,899 $ 496,353 $ 524,437 Interest-bearing 3,514,780 3,138,304 3,080,818 ---------- ---------- ---------- Total deposits 4,193,679 3,634,657 3,605,255 ---------- ---------- ---------- Federal funds purchased and repurchase agreements 1,219,149 680,179 1,269,538 Other borrowed funds 662,793 533,756 523,912 Subordinated notes 11,000 37,344 37,344 Trust preferred debt 73,500 - 31,000 Accrued interest payable 23,179 31,104 20,337 Other liabilities 61,762 63,250 46,859 ---------- ---------- ---------- Total liabilities 6,245,062 4,980,290 5,534,245 ---------- ---------- ---------- Minority interest in consolidated subsidiary 86,339 37,023 37,023 ---------- ---------- ---------- Shareholders' equity Preferred stock - no par value; authorized 10,000,000 shares; issued and outstanding none - - - Common stock - par value $1 per share; authorized 100,000,000 shares; issued and outstanding 43,588,415, 41,300,221 and 41,228,976 shares, respectively 43,588 41,300 41,229 Surplus 355,545 312,607 311,305 Retained earnings 140,336 105,495 113,288 Guarantee of employee stock ownership plan debt and nonvested restricted stock (3,308) (1,766) (1,544) Accumulated other comprehensive income (loss), net of tax 18,406 18,428 (6,104) ---------- ---------- ---------- Total shareholders' equity 554,567 476,064 458,174 ---------- ---------- ---------- $6,885,968 $5,493,377 $6,029,442 ========== ========== ========== See accompanying notes to consolidated financial statements.
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THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, 2002 2001 2002 2001 ---- ---- ---- ---- Interest income Interest and fees on loans $ 67,751 $ 76,432 $199,680 $242,253 Interest and dividends on securities: Taxable 22,011 16,799 64,795 45,966 Exempt from Federal income taxes 1,084 1,002 3,239 2,966 -------- -------- -------- -------- Total interest and dividends on securities 23,095 17,801 68,034 48,932 Interest on short-term investments 252 213 939 1,181 -------- -------- -------- -------- Total interest income 91,098 94,446 268,653 292,366 -------- -------- -------- -------- INTEREST EXPENSE Interest on deposits 20,493 33,668 63,322 118,656 Interest on borrowed funds 14,115 13,918 40,805 39,943 -------- -------- -------- -------- Total interest expense 34,608 47,586 104,127 158,599 -------- -------- -------- -------- NET INTEREST INCOME 56,490 46,860 164,526 133,767 PROVISION FOR LOAN LOSSES 5,567 5,476 18,049 15,584 -------- -------- -------- -------- Net interest income after provision for loan losses 50,923 41,384 146,477 118,183 NONINTEREST INCOME 17,119 12,664 42,394 38,704 NONINTEREST EXPENSES 46,253 36,417 122,067 110,868 -------- -------- -------- -------- Income before income taxes, minority interest, and cumulative effect of change in accounting principle 21,789 17,631 66,804 46,019 Income taxes 6,645 6,128 21,235 16,120 -------- -------- -------- -------- Income before minority interest and cumulative effect of change in accounting principle 15,144 11,503 45,569 29,899 Minority interest in consolidated subsidiary, net of tax (1,033) (503) (2,219) (905) -------- -------- -------- -------- Income before cumulative effect of change in accounting principle 14,111 11,000 43,350 28,994 Cumulative effect of change in accounting principle, net of tax - - (1,406) 282 -------- -------- -------- -------- NET INCOME $ 14,111 $ 11,000 $ 41,944 $ 29,276 ======== ======== ======== ======== AVERAGE COMMON SHARES OUTSTANDING, BASIC 41,507,843 42,340,019 40,969,925 42,407,504 AVERAGE COMMON SHARES OUTSTANDING, DILUTED 42,504,741 43,091,562 41,933,995 43,129,348 PER COMMON SHARE, BASIC: Net income before cumulative effect of change in accounting principle $ 0.34 $ 0.26 $ 1.06 $ 0.68 Cumulative effect of change in accounting principle, net of tax - - (0.04) 0.01 ------ ------ ------ ------ Net income $ 0.34 $ 0.26 $ 1.02 $ 0.69 ====== ====== ====== ====== PER COMMON SHARE, DILUTED: Net income before cumulative effect of change in accounting principle $ 0.33 $ 0.26 $ 1.03 $ 0.67 Cumulative effect of change in accounting principle, net of tax - - (0.03) 0.01 ------ ------ ------ ------ Net income $ 0.33 $ 0.26 $ 1.00 $ 0.68 ====== ====== ====== ====== CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.12 $ 0.11 $ 0.36 $ 0.33 ====== ====== ====== ====== See accompanying notes to consolidated financial statements.
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THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME (DOLLARS IN THOUSANDS, EXCEPT SHARE DATA) (UNAUDITED) RETAINED ACCUMULATED SHARES OF EARNINGS OTHER COMMON COMMON AND COMPREHENSIVE STOCK STOCK SURPLUS OTHER* INCOME (LOSS) TOTAL ----- ----- ------- ----- ------------- ----- Balance, December 31, 2000 42,460,358 $ 42,460 $ 332,095 $ 87,538 $6,560 $ 468,653 Net income - - - 29,276 - 29,276 Other comprehensive income, net of tax of $5,499 - - - - 11,868 11,868 --------- Comprehensive income - - - - - 41,144 --------- Cash dividends declared ($0.33 per common share) - - - (13,912) - (13,912) Common stock activity: Repurchase of stock (1,450,000) (1,450) (21,668) - - (23,118) Acquisitions 15,270 15 135 - - 150 Dividend reinvestment plan 121,091 121 1,697 - - 1,818 Employee stock purchase plan 11,245 11 159 - - 170 Restricted stock plan (1,378) (1) (15) 561 - 545 Exercise of stock options 143,635 144 217 - - 361 Miscellaneous - - (13) 266 - 253 ---------- -------- --------- --------- ------- --------- Balance, September 30, 2001 41,300,221 $ 41,300 $ 312,607 $ 103,729 $18,428 $ 476,064 ========== ======== ========= ========= ======= ========= Balance, December 31, 2001 41,228,976 $ 41,229 $ 311,305 $ 111,744 $ (6,104) $ 458,174 Net income - - - 41,944 - 41,944 Other comprehensive income, net of tax of $11,348 - - - - 24,510 24,510 --------- Comprehensive income - - - - - 66,454 --------- Cash dividends declared ($0.36 per common share) - - - (14,893) - (14,893) Common stock activity: Acquisitions 4,174,599 4,175 85,825 (1,926) - 88,074 Repurchase of stock (2,141,907) (2,142) (46,341) - - (48,483) Dividend reinvestment plan 70,012 70 1,312 - - 1,382 Employee stock purchase plan 8,094 8 148 - - 156 Restricted stock plan 59,096 59 1,698 (87) - 1,670 Exercise of stock options 194,545 194 1,670 - - 1,864 Cancellation of stock (5,000) (5) (108) - - (113) Miscellaneous - - 36 246 - 282 ---------- -------- --------- --------- ------- --------- Balance, September 30, 2002 43,588,415 $ 43,588 $ 355,545 $ 137,028 $18,406 $ 554,567 ========== ======== ========= ========= ======= ========= * Other includes guarantee of employee stock ownership plan debt and nonvested restricted stock. See accompanying notes to consolidated financial statements.
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THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------ 2002 2001 ---- ---- CASH FLOWS FROM OPERATING ACTIVITIES Net income $ 41,944 $ 29,276 Adjustments to reconcile net income to net cash provided by operating activities Depreciation, amortization, and accretion, net 23,247 22,365 Provision for loan losses 18,049 15,584 Gain on sale of available for sale securities (1,005) (1,539) (Gain) loss on trading securities 267 (207) Gain on equity investments (3,388) (1,019) Loss on disposition of assets and liabilities - 1,251 Gain on sale of loans (1,671) (3,057) Gain on disposition of premises and equipment (55) (266) Loss on disposition of other real estate owned 762 386 Impairment loss from write-down of assets - 391 Impairment loss from write-down of mortgage servicing rights 592 509 Loss on early extinguishment of debt 354 1,093 Loss on changes in fair value of hedges 228 114 Minority interest in consolidated subsidiary 2,219 905 Cumulative effect of change in accounting principle 1,406 (282) Trading account assets, net 206,000 (1,122) Originations of mortgage loans held for sale (325,259) (280,832) Sale of mortgage loans held for sale 296,655 353,175 Other assets, net 5,098 11,861 Other liabilities, net 728 17,038 -------- -------- Net cash provided by operating activities 266,171 165,624 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Sale of securities available for sale 629,343 264,233 Maturity or call of securities available for sale 1,054,079 304,522 Maturity or call of securities held to maturity 6,787 11,756 Purchase of securities available for sale (2,021,568) (712,322) Purchase of securities held to maturity (8,156) (5,897) Purchase of bank-owned life insurance - (25,000) Origination of loans held for investment, net (160,955) (230,247) Sale of loans held for investment 11,961 - Sale of other real estate owned 4,224 5,666 Sale of premises and equipment 1,443 785 Capital expenditures (10,565) (4,598) Disposition of assets and liabilities, net - (40,382) Cash equivalents acquired, net of payment for purchase acquisition 29,227 - -------- -------- Net cash used for investing activities (464,180) (431,484) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Deposits, net 163,246 (216,615) Borrowed funds, net 19,615 464,480 Redemption of subordinated notes (26,344) - Prepayment penalty on early extinguishment of debt - (1,093) Issuance of minority interest stock, net 49,247 37,023 Issuance of trust preferred debt, net 41,176 - Cash dividends paid (14,622) (14,002) Cash dividends paid on minority interest (2,878) (921) Repurchase of common stock (48,483) (23,118) Other common stock activity 3,571 2,752 -------- -------- Net cash provided by financing activities 184,528 248,506 -------- -------- Net change in cash and due from banks (13,481) (17,354) Cash and cash equivalents at beginning of year 240,667 183,907 -------- -------- Cash and cash equivalents at end of period $227,186 $166,553 ======== ======== See accompanying notes to consolidated financial statements.
4 THE SOUTH FINANCIAL GROUP AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) GENERAL The foregoing unaudited consolidated financial statements include the accounts of The South Financial Group, Inc. and subsidiaries (collectively, "TSFG," except where the context requires otherwise). All significant intercompany accounts and transactions are eliminated in consolidation, and all adjustments considered necessary for a fair presentation of the results for interim periods presented have been included. (Such adjustments are normal and recurring in nature.) Certain prior year amounts have been reclassified to conform to 2002 presentations. The consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q. The information contained in the footnotes included in TSFG's 2001 Annual Report on Form 10-K should be referred to in connection with the reading of these unaudited interim consolidated financial statements. ACCOUNTING ESTIMATES AND ASSUMPTIONS Certain policies require management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ significantly from these estimates and assumptions. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In June 2002, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." 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. This Statement does not apply to costs associated with the retirement of a long-lived asset covered by SFAS No. 143, "Accounting for Asset Retirement Obligations." A liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred. A liability for a cost associated with an exit or disposal activity is incurred when the definition of a liability is met in accordance with FASB Concepts Statements No. 6, "Elements of Financial Statements." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The impact of adoption on TSFG, if any, is not known at this time. See Note 5 for new accounting pronouncements that TSFG adopted in 2002. 5 (2) SUPPLEMENTAL FINANCIAL INFORMATION CONSOLIDATED STATEMENTS OF INCOME The following presents the details for noninterest income and noninterest expense (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ------------------------------ 2002 2001 2002 2001 ---- ---- ---- ---- Noninterest income: Service charges on deposit accounts $ 6,108 $ 4,568 $ 16,436 $ 13,748 Fees for investment services 1,359 1,462 4,639 4,204 Mortgage banking income 850 927 3,397 5,250 Bank-owned life insurance 1,877 1,845 5,486 5,397 Merchant processing income 1,778 1,657 4,741 4,618 Gain on sale of available for sale securities 790 1,134 1,005 1,539 Gain (loss) on trading securities (330) 67 (267) 207 Gain on equity investments 3,527 17 3,388 1,019 Loss on disposition of assets and liabilities - (19) - (1,251) Other 1,160 1,006 3,569 3,973 -------- -------- ------- ------- Total noninterest income $ 17,119 $ 12,664 $ 42,394 $ 38,704 ======== ======== ======== ======== Noninterest expenses: Salaries and wages $ 18,594 $ 14,101 $ 50,951 $ 43,195 Employee benefits 3,538 3,369 11,841 10,776 Furniture and equipment 3,993 3,366 11,072 10,097 Occupancy 3,919 3,626 11,150 10,830 Professional fees 1,343 1,369 3,859 4,002 Merchant processing expense 1,381 1,436 3,798 3,771 Amortization of intangibles 352 1,423 831 4,425 Impairment loss from write-down of assets - 176 - 391 Merger-related costs (recoveries) 4,465 (89) 4,465 (502) Loss on early extinguishment of debt 354 1,093 354 1,093 Other 8,314 6,547 23,746 22,790 -------- -------- -------- -------- Total noninterest expenses $ 46,253 $ 36,417 $122,067 $110,868 ======== ======== ======== ========
6 CONSOLIDATED STATEMENTS OF CASH FLOW The following summarizes supplemental cash flow data (in thousands) for the nine months ended September 30:
2002 2001 ---- ---- Interest paid $100,080 $162,663 Income taxes paid (refunded) 25,278 (9,150) Significant non-cash investing and financing transactions are summarized as follows: Available for sale securities transferred to trading securities and subsequently sold 208,163 - Loans securitized and reclassed to available for sale securities - 112,174 Loans held for investment transferred to loans held for sale - 75,000 Change in unrealized gain on available for sale securities 35,526 18,321 Loans transferred to other real estate owned 9,336 8,623 Business combinations: Fair value of assets acquired (includes cash and cash equivalents) 613,440 - Fair value of common stock issued and stock options recognized (88,074) - Cash paid (32,406) - -------- -------- Liabilities assumed 492,960 - (3) OTHER COMPREHENSIVE INCOME The following summarizes other comprehensive income, net of tax (in thousands) for the nine months ended September 30: 2002 2001 ---- ---- Unrealized gains on securities: Unrealized holding gains arising during the period $ 39,919 $20,270 Income tax expense (12,763) (6,531) Less: Reclassification adjustment for gains included in net income (4,393) (1,949) Income tax expense 1,538 679 Unrealized gains (losses) on cash flow hedges: Cumulative effect of change in accounting principle - (70) Income tax benefit - 26 Unrealized gain (loss) on change in fair values 332 (884) Income tax (expense) benefit (123) 327 -------- ------- $ 24,510 $11,868 ======== =======
(4) BUSINESS COMBINATIONS GULF WEST On August 31, 2002, TSFG completed the merger with 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 fifteen locations in the greater Tampa Bay area. This merger represents TSFG's first banking locations in the Tampa Bay area and advances TSFG's strategy to expand in markets with favorable population and per capita income growth 7 prospects. Upon acquiring Gulf West, TSFG combined all of its Florida operations under the Mercantile Bank name. TSFG acquired all the outstanding common shares of Gulf West in exchange for 3,925,588 shares of TSFG common stock and $32.4 million in cash. The Gulf West transaction has been accounted for using the purchase method of accounting, and accordingly, the assets and liabilities of Gulf West were recorded at their estimated fair values as of the merger date. The fair values are preliminary and are subject to adjustment as information relative to the fair values as of August 31, 2002 becomes available. TSFG uses an allocation period, not to exceed one year, to identify and quantify the fair value of the assets acquired and liabilities assumed in business combinations accounted for as purchases. The consolidated financial statements include the results of Gulf West's operations since the August 31, 2002 merger date. The following summarizes the estimated fair values of the assets acquired and liabilities assumed at the date of merger based on information currently available (in thousands): AUGUST 31, 2002 ASSETS Cash and due from banks $ 23,377 Interest-bearing bank balances 37,471 Securities 125,473 Loans Loans held for sale 25,966 Loans held for investment 286,645 Allowance for loan losses (2,877) -------- Net loans 309,734 -------- Premises and equipment, net 12,383 Accrued interest receivable 2,147 Intangible assets 79,502 Other assets 19,644 -------- Total assets acquired 609,731 -------- LIABILITIES Deposits 418,933 Other borrowed funds 67,901 Accrued interest payable 372 Other liabilities 5,299 -------- Total liabilities assumed 492,505 -------- NET ASSETS ACQUIRED $117,226 ======== The aggregate purchase price was $117.2 million, including $32.4 million of cash, 3,925,588 shares of TSFG common stock valued at $78.2 million, outstanding employee stock options valued at $6.5 million, and shares issuable under employee stock purchase plan valued at $98,000. The merger agreement provided each Gulf West shareholder the right to elect to convert their Gulf West common stock into cash, shares of TSFG common stock, or a mixture of both, subject to allocation procedures. The per share stock consideration was 0.6921 shares of TSFG common stock for each Gulf West share. The per share cash consideration was $13.7942 for each Gulf West share. 8 The Gulf West purchase price and the amount of the purchase price allocated to goodwill and other intangible assets are presented below (in thousands): AUGUST 31, 2002 Purchase price $117,226 Gulf West tangible shareholders' equity 44,275 -------- Excess of purchase price over carrying value of net tangible assets acquired 72,951 Fair value adjustments (1,776) Direct acquisition costs 4,561 Deferred income taxes 3,766 -------- Total intangible assets 79,502 Core deposit premiums 8,424 -------- Goodwill $ 71,078 ======== The core deposit premium intangible asset is amortized over 10 years on an accelerated basis until the straight-line amortization method is greater at which time the straight-line method is used. The core deposit premium valuation and amortization method are based upon a historical study of the deposits acquired. All of the Gulf West intangible assets were assigned to the Mercantile Bank segment. The goodwill will not be amortized but will be tested at least annually for impairment in accordance with SFAS No. 142, "Goodwill and Other Intangible Assets." The total amount of goodwill expected to be deductible for income tax purposes is $2.3 million. The following unaudited pro forma financial information presents the combined results of operations of TSFG and Gulf West as if the merger had occurred as of the beginning of the period for each period presented, after giving effect to certain adjustments, including amortization of core deposit premium intangible asset and related income tax effects (in thousands, except per common share). The pro forma financial information does not necessarily reflect the results of operations that would have occurred had TSFG and Gulf West constituted a single entity during such periods. THREE MONTHS ENDED SEPTEMBER 30, ------------------------------------------- 2002 2001 ---- ---- Net interest income $ 60,128 $ 51,695 Noninterest income 17,650 13,633 Net income 14,376 12,025 Per common share: Net income, basic 0.32 0.26 Net income, diluted 0.31 0.26 9
NINE MONTHS ENDED SEPTEMBER 30, -------------------------------------------- 2002 2001 ---- ---- Net interest income $ 178,712 $ 147,166 Noninterest income 44,803 41,427 Income before cumulative effect of change in accounting principle 45,993 31,354 Net income 44,587 31,636 Per common share: Net income, basic 0.99 0.68 Net income, diluted 0.97 0.67
In connection with the Gulf West merger, TSFG recorded pre-tax merger-related costs of $4.5 million, included in noninterest expenses, and direct acquisition costs of $4.6 million, included in goodwill. The merger-related and acquisition costs were recorded as incurred. The following summarizes these charges (in thousands) at and for the nine months ended September 30, 2002:
TOTAL AMOUNTS REMAINING COSTS PAID ACCRUAL ----- ---- ------- Merger-related costs: Compensation-related expenses $ 2,448 $ 1,205 $ 1,243 System conversion costs 614 317 297 Travel 464 438 26 Personnel training 219 79 140 Advertising 148 148 - Other 572 295 277 ------- ------- ------- $ 4,465 $ 2,482 $ 1,983 ======= ======= ======= TOTAL AMOUNTS REMAINING COSTS PAID ACCRUAL ----- ---- ------- Direct acquisition costs: Investment banking and professional fees $ 3,958 $ 3,012 $ 946 Contract and lease terminations 330 320 10 Severance 273 - 273 ------- ------- ------- $ 4,561 $ 3,332 $ 1,229 ======= ======= =======
Severance charges are associated with the involuntary termination of approximately 59 former Gulf West employees who were notified that their positions were redundant within the combined organization. These positions were primarily in centralized corporate support and data processing areas. The contract termination costs are primarily comprised of payments required to be made to certain executives of Gulf West pursuant to their employment contracts. The lease termination costs were for buyouts on Gulf West leased facilities. GARDNER ASSOCIATES, INC. On September 20, 2002, TSFG acquired Gardner Associates, Inc., an independent insurance agency based in Columbia, South Carolina. This acquisition was accounted for using the purchase method of accounting, and accordingly, the assets and liabilities of Gardner Associates, Inc. were recorded at their estimated fair values as of the merger date. The fair values are preliminary and are subject to refinement as information relative to the fair values as of September 20, 2002 becomes available. TSFG issued 156,426 shares of common stock 10 valued at $3.3 million, acquired tangible assets totaling $1.3 million, assumed liabilities totaling $455,000, recorded a non-compete agreement intangible asset of $663,000, recorded goodwill of $876,000, and recorded a customer list intangible asset of $858,000. The non-compete agreement intangible is amortized on a straight-line basis over its estimated useful life of 2 years. The customer list intangible is amortized on a straight-line basis over its estimated useful life of 10 years. In addition, the principals of Gardner Associates have the right to receive a maximum of 92,585 shares of TSFG common stock under earnout provisions based on Gardner Associates' annual and five-year financial performance. ROCK HILL BANK AND TRUST On October 31, 2002, TSFG completed its asset sale agreement to acquire substantially all of the assets and deposits of Rock Hill Bank & Trust ("Rock Hill"), which is the wholly-owned banking subsidiary of RHBT Financial Corporation ("RHBT"). At September 30, 2002, Rock Hill operated 3 branches in York County, South Carolina, and had deposits of $184.9 million. Under the asset sale agreement, Rock Hill received 430,017 shares of TSFG common stock, valued at $9.3 million, plus the right to receive a cash earnout essentially equal to 30% of the net improvement in the aggregate charge-offs and reserves in the entire designated loan pool and 50% of net amounts recovered under RHBT's blanket bond insurance policy with respect to such loans. TSFG also agreed to repurchase such number of these 430,017 shares as are not distributed to RHBT shareholders in RHBT's pending liquidation. TSFG has identified a potential liability related to certain Rock Hill trust accounts. Any liability recorded would increase the goodwill recorded. TSFG owns 382,500 shares, or approximately 22% of RHBT outstanding stock, which is included in available for sale securities. During the third quarter, TSFG wrote-down its investment in RHBT by $1.2 million to its September 30, 2002 estimated fair value of approximately $1.9 million, or $5.00 per share. The Board of Directors of RHBT presently plans to distribute most, but not necessarily all, of the 430,017 shares of TSFG common stock received by Rock Hill to RHBT shareholders after closing of the sale of assets. Upon the distribution of the TSFG common stock to RHBT shareholders, TSFG will cancel any TSFG shares received. CENTRAL BANK OF TAMPA In October 2002, TSFG signed a definitive agreement to acquire Central Bank of Tampa ("CBT"), a closely held community bank headquartered in Tampa, Florida. At September 30, 2002, CBT operated through 5 branches in Tampa and had total assets of $215.4 million. TSFG will issue common stock equal to $68.0 million in exchange for all the outstanding common shares of CBT. Such TSFG common stock will be valued at the average closing price on the ten trading days ending on the second trading day prior to closing (except that the value will never be deemed less than $15.00 or greater than $25.00). This transaction, which is expected to close in the fourth quarter of 2002, will be accounted for using the purchase method of accounting and is subject to receipt of CBT shareholder and regulatory approval. (5) ADOPTION OF NEW ACCOUNTING PRONOUNCEMENTS GOODWILL AND OTHER INTANGIBLE ASSETS Effective January 1, 2002, TSFG adopted the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). It requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). In connection with the transitional goodwill, SFAS 142 requires TSFG to perform an assessment of whether there is an indication that goodwill is impaired as of January 1, 2002. To accomplish this, TSFG had to identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those 11 reporting units as of the date of adoption. TSFG had until June 30, 2002 to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired, and the second step of the transitional impairment test must be performed. In the second step, the implied fair value of the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of it assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS 141, "Business Combinations," is compared to its carrying amount, both of which would be measured as of January 1, 2002. TSFG has completed its analysis of the fair value of its intangible assets, using a discounted cash flow method, and determined that the goodwill associated with Carolina First Mortgage Company was impaired. TSFG recorded a transitional impairment loss of $1.4 million. This transitional impairment loss was recognized as the cumulative effect of a change in accounting principle in the consolidated statements of income for the nine months ended September 30, 2002 (although it was not reflected in the third quarter 2002 results since the impairment is reflected as of January 1, 2002). As of the January 1, 2002 adoption of SFAS 142, TSFG had unamortized goodwill in the amount of $89.1 million, unamortized identifiable intangible assets in the amount of $5.5 million, and unamortized unidentifiable intangible assets in the amount of $2.5 million related to branch purchases. Under SFAS 142, the amortization of goodwill ceased effective January 1, 2002. The amortization of goodwill approximated $4.2 million pre-tax (or $4.1 million after tax) during 2001 and $3.2 million pre-tax (or $3.1 million after-tax) during the nine months ended September 30, 2001. TSFG continues to amortize the identifiable intangible assets, which relate to core deposit premiums and customer lists. Also, see Notes 6 and 7 for additional financial statement disclosure requirements under SFAS 142. The following presents the details for goodwill amortization expense and net income (in thousands, except share data):
THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- --------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Net income $ 14,111 $11,000 $ 41,944 $29,276 Amortization of goodwill, net of tax - 999 - 3,095 -------- ------- -------- ------- Adjusted net income $ 14,111 $11,999 $ 41,944 $32,371 ======== ======= ======== ======= Net income per common share, basic $ 0.34 $ 0.26 $ 1.02 $ 0.69 Amortization of goodwill, net of tax - 0.02 - 0.07 ------ ------ ------ ------ Adjusted net income per common share, basic $ 0.34 $ 0.28 $ 1.02 $ 0.76 ====== ====== ====== ====== Net income per common share, diluted $ 0.33 $ 0.26 $ 1.00 $ 0.68 Amortization of goodwill, net of tax - 0.02 - 0.07 ------ ------ ------ ------ Adjusted net income per common share, diluted $ 0.33 $ 0.28 $ 1.00 $ 0.75 ====== ====== ====== ======
RECLASSIFICATION OF LOSSES ON EARLY EXTINGUISHMENT OF DEBT In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishments of Debt" ("SFAS 4"), and an amendment of SFAS 4, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 requires that gains and losses from extinguishment of debt should be classified 12 as an extraordinary item only if they meet the criteria of FASB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("FASB Opinion 30"). Applying the provisions of FASB Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. The provisions of SFAS 145 are effective for financial statements issued for fiscal years beginning after May 15, 2002 and interim periods within those fiscal years, and early adoption is encouraged. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in FASB Opinion 30 for classification as an extraordinary item will be reclassified. TSFG adopted SFAS 145 effective July 1, 2002. In connection with this adoption, TSFG reclassified losses on the early extinguishment of debt, which were incurred in the second half of 2001 and totaled $3.1 million pre-tax, to noninterest expenses. UNIDENTIFIABLE INTANGIBLE ASSETS FROM BRANCH PURCHASES In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9" ("SFAS 147"). SFAS 147 removes acquisitions of financial institutions from the scope of both FASB Statements No. 72 ("SFAS 72") and FASB Interpretation No. 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets," except for transactions between two or more mutual enterprises. Thus, the requirement in SFAS 72 to recognize (and subsequently amortize) any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable assets acquired as an unidentifiable intangible asset no longer applies to acquisitions within the scope of the scope of SFAS 72. In addition, SFAS 147 amends FASB Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that SFAS 144 requires for other long-lived assets that are held and used. The provisions of SFAS 147 are effective for financial statements issued on or after October 1, 2002, and early adoption is permitted. In the third quarter, TSFG adopted SFAS 147 effective as of January 1, 2002. The unamortized unidentifiable intangible assets related to branch purchases, which totaled $2.5 million net of accumulated amortization as of January 1, 2002, were reclassified as goodwill. In connection with this adoption, TSFG reversed pre-tax amortization of intangibles totaling $112,000, which was recorded in the first half of 2002. 13 (6) INTANGIBLE ASSETS Intangible assets are summarized as follows (in thousands):
SEPTEMBER 30, DECEMBER 31, --------------------------- 2002 2001 2001 ---- ---- ---- Goodwill $162,148 $92,699 $91,600 Core deposit premiums 22,970 14,546 14,546 Less accumulated amortization (9,832) (8,765) (9,006) -------- ------- ------- 13,138 5,781 5,540 -------- ------- ------- Customer list intangible 858 - - Less accumulated amortization (1) - - -------- ------- ------- 857 - - Non-compete agreement intangible 663 - - Less accumulated amortization (4) - - -------- ------- ------- 659 - - -------- ------- ------- $176,802 $98,480 $97,140 ======== ======= =======
The following summarizes the changes in the carrying amount of goodwill related to each of TSFG's business segments (in thousands) for the nine months ended September 30, 2002:
CAROLINA MERCANTILE FIRST BANK BANK OTHER TOTAL ---------- ---- ----- ----- Balance, December 31, 2001 $90,194 $ - $ 1,406 $ 91,600 Goodwill acquired during year 876 71,078 - 71,954 Impairment losses - - (1,406) (1,406) ------- -------- ------- -------- Balance, September 30, 2002 $91,070 $ 71,078 $ - $162,148 ======= ======== ======= ========
Amortization of intangibles totaled $826,000 for core deposit premiums, $4,000 for non-compete agreement intangibles, and $1,000 for customer list intangibles for the nine months ended September 30, 2002. Amortization of intangibles totaled $1.0 million for core deposit premiums, $210,000 for unidentifiable intangible assets from branch purchases, and $3.2 million for goodwill for the nine months ended September 30, 2001. Under SFAS 142, the amortization of goodwill ceased effective January 1, 2002. Under SFAS 147, the amortization of unidentifiable intangible assets from branch purchases ceased effective January 1, 2002. See Note 5. The estimated amortization expense for core deposit premiums for the years ended December 31 is as follows: $1.4 million for 2002, $2.1 million for 2003, $1.7 million for 2004, $1.5 million for 2005, $1.3 million for 2006, and an aggregate of $5.9 million for all the years thereafter. The estimated amortization expense for customer list intangibles is $24,000 for the year ended December 31, 2002 and $86,000 for the years ended December 31, 2003 to 2006 and an aggregate of $490,000 for all the years thereafter. The estimated amortization expense for non-compete agreement intangibles for the years ended December 31 is as follows: $92,000 for 2002, $332,000 for 2003, and $239,000 for 2004. (7) MORTGAGE SERVICING RIGHTS Capitalized mortgage servicing rights ("MSRs") totaled $5.6 million, $8.9 million, and $10.8 million at September 30, 2002, December 31, 2001, and September 30, 2001, respectively. Amortization expense for MSRs totaled $2.7 14 million and $3.3 million for the nine months ended September 30, 2002 and 2001, respectively. The estimated amortization expense for MSRs for the years ended December 31 is as follows: $3.5 million for 2002, $3.1 million for 2003, $1.7 million 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) DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES In accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS 133"), TSFG records derivatives at fair value, as either assets or liabilities, on the consolidated balance sheets. At September 30, 2002, the fair value of derivative assets totaled $6.7 million and was related to derivatives with no hedging designation and fair value hedges. At September 30, 2002, the fair value of derivative liabilities totaled $541,000 for cash flow hedges and $208,000 for futures, options, and other derivatives, which do not qualify for hedge accounting under SFAS 133. Derivative transactions are measured in terms of the notional amount, but this amount is not recorded on the consolidated balance sheets. The notional amounts related to TSFG's derivatives at September 30, 2002, which are not recognized on the consolidated balance sheets, totaled $283.0 million for the derivative assets and $417.9 million for the derivative liabilities. (9) REDEMPTION OF SUBORDINATED NOTES TSFG redeemed its 9.00% Subordinated Notes Due 2005 (the "Notes") on August 31, 2002. This constituted a full redemption of all of the outstanding Notes, which had a principal balance of $26.3 million. The Notes were redeemed at their par value. The associated unamortized issuance costs, which had a balance of $354,000 at August 31, 2002, were written off on the redemption date and included in noninterest expenses. (10) TRUST PREFERRED DEBT On July 11, 2002, TSFG Capital Trust 2002-A (the "Capital Trust 2002-A"), a wholly-owned subsidiary of TSFG, issued and sold floating rate securities having an aggregate liquidation amount of $25.0 million (the "Capital Securities 2002-A") to institutional buyers in a pooled trust preferred issue. The Capital Securities 2002-A generated gross proceeds of $25.0 million. The Capital Trust 2002-A loaned these proceeds to the parent company to use for general corporate purposes. Issuance costs from the July 11, 2002 sale totaled $750,000. The trust preferred debt qualifies as tier 1 capital under Federal Reserve Board guidelines. The Capital Securities 2002-A accrue and pay distributions quarterly at a rate per annum equal to three-month LIBOR plus 365 basis points. This rate may not exceed 12.5% through July 2007. The distributions payable on the Capital Securities 2002-A are cumulative and payable quarterly in arrears. TSFG has the right, subject to events of default, to defer payments of interest on the Capital Securities 2002-A for a period not to exceed 20 consecutive quarters, provided that no extension period may extend beyond the maturity date of October 7, 2032. TSFG has no current intention to exercise its right to defer payments of interest on the Capital Securities 2002-A. The Capital Securities 2002-A are mandatorily redeemable upon maturity on October 7, 2032. TSFG has the right to redeem the Capital Securities 2002-A in whole or in part, on or after July 7, 2007. If the Capital Securities 2002-A are redeemed on or after July 7, 2007, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, TSFG may redeem the Capital Securities 2002-A in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the indenture). 15 On July 30, 2002, South Financial Capital Trust II (the "Capital Trust II"), a wholly-owned subsidiary of TSFG, issued and sold floating rate securities having an aggregate liquidation amount of $17.5 million (the "Capital Securities II") to institutional buyers in a pooled trust preferred issue. The Capital Securities II generated gross proceeds of $17.5 million. The Capital Trust II loaned these proceeds to the parent company to use for general corporate purposes. Issuance costs from the July 30, 2002 sale totaled $574,000. The trust preferred debt qualifies as tier 1 capital under Federal Reserve Board guidelines. The Capital Securities II accrue and pay distributions semi-annually at a rate per annum equal to six-month LIBOR plus 362.5 basis points. This rate may not exceed 12.0% through July 30, 2007. The distributions payable on the Capital Securities II are cumulative and payable quarterly in arrears. TSFG has the right, subject to events of default, to defer payments of interest on the Capital Securities II for a period not to exceed 20 consecutive quarters, provided that no extension period may extend beyond the maturity date of July 30, 2032. TSFG has no current intention to exercise its right to defer payments of interest on the Capital Securities II. The Capital Securities II are mandatorily redeemable upon maturity on July 30, 2032. TSFG has the right to redeem the Capital Securities II in whole or in part, on or after July 30, 2007. If the Capital Securities II are redeemed on or after July 30, 2007, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, TSFG may redeem the Capital Securities II in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the indenture). (11) MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY Carolina First Mortgage Loan Trust (the "REIT") is a majority-owned subsidiary of SCOREIT, Inc., which is a wholly-owned subsidiary of Carolina First Bank, that holds real estate-related assets, including mortgage loans. Carolina First Bank is a wholly-owned banking subsidiary of TSFG. SCOREIT, Inc.'s ownership in the REIT is evidenced by common and preferred equity. On June 11, 2002, Carolina First Bank sold 131 shares of the REIT's Series 2000A Cumulative Fixed Rate Preferred Shares (the "Series A Trust Preferred Stock") and 385 shares of the REIT's Series 2002C Cumulative Floating Rate Preferred Shares (the "Series C Trust Preferred Stock") to institutional buyers. The Series A Trust Preferred Stock and Series C Trust Preferred Stock have a stated value of $100,000 per share. Proceeds to Carolina First Bank from these sales totaled approximately $49.2 million, net of issuance costs totaling $2.4 million, and are reported as minority interest in consolidated subsidiary on the consolidated balance sheet. The minority interest in consolidated subsidiary qualifies as capital under Federal Reserve Board guidelines. In 2001, Carolina First Bank sold 132 shares of Series A Trust Preferred Stock and 250 shares of the REIT's Series 2000B Cumulative Floating Rate Preferred Shares (the "Series B Trust Preferred Stock") to institutional buyers. For details on the Series A Trust Preferred Stock and Series B Trust Preferred Stock, see TSFG's Annual Report on Form 10-K for the year ended December 31, 2001. Dividends on the Series C Trust Preferred Stock are cumulative, and will accrue whether or not the REIT has earnings, whether or not there are funds legally available for the payment of such dividends, and whether or not such dividends are declared. The dividends for the Series C Trust Preferred Stock are computed at a rate per annum equal to three month LIBOR plus 350 basis points of the stated value and are payable quarterly. The shares of Series C Trust Preferred Stock are mandatorily redeemable on May 31, 2012, or upon earlier redemption as provided in the terms of the Series C Trust Preferred Stock. TSFG has the right to redeem the Series C Trust Preferred Stock in whole or in part, on or after May 31, 2007, on any quarterly dividend payment date, at redemption price equal to the liquidation value ($100,000 per share). After the occurrence of a tax event or capital event (as defined in the terms of the Series C Trust Preferred Stock), TSFG may redeem all or a portion of the Series C Trust Preferred Stock at a redemption price equal to 101% of the liquidation value if the redemption is prior to May 31, 2007 or 100% of the liquidation value thereafter. 16 The dividends earned by institutional holders of the Series A Trust Preferred Stock, the Series B Trust Preferred Stock, and the Series C Trust Preferred Stock for the nine months ended September 30, 2002 amounted to $2.2 million (net of related income taxes of $1.3 million). These dividends and the amortization of issuance costs, which totaled $69,000 pre-tax for the nine months ended September 30, 2002, are expensed on TSFG's consolidated statement of income as minority interest in consolidated subsidiary. (12) AVERAGE SHARE INFORMATION The following is a summary of the basic and diluted average common shares outstanding.
THREE MONTHS ENDED SEPTEMBER 30, ------------------------------------------- 2002 2001 ---- ---- Basic: Average common shares outstanding (denominator) 41,507,843 42,340,019 ========== ========== DILUTED: Average common shares outstanding 41,507,843 42,340,019 Dilutive potential common shares 996,898 751,543 ---------- ---------- Average diluted shares outstanding (denominator) 42,504,741 43,091,562 ========== ========== NINE MONTHS ENDED SEPTEMBER 30, ------------------------------------------- 2002 2001 ---- ---- Basic: Average common shares outstanding (denominator) 40,969,925 42,407,504 ========== ========== DILUTED: Average common shares outstanding 40,969,925 42,407,504 Dilutive potential common shares 964,070 721,844 ---------- ---------- Average diluted shares outstanding (denominator) 41,933,995 43,129,348 ========== ==========
NUMBER RANGE OF OF SHARES EXERCISE PRICES --------- --------------- For the three months ended September 30, 2002 977,672 $21.03 to $31.26 September 30, 2001 1,353,857 $17.93 to $31.26 For the nine months ended September 30, 2002 977,672 $21.03 to $31.26 September 30, 2001 1,561,080 $16.64 to $31.26
(13) 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. 17 TSFG has identified a potential liability related to certain Rock Hill trust accounts. Any liability recorded would increase the goodwill recorded. On November 4, 1996, a derivative shareholder action was filed in the South Carolina Circuit Court for Greenville County against TSFG and several of its officers. The complaint was subsequently amended several times. The amended complaint names as additional defendants the majority of the directors of TSFG and Carolina First Bank. The named plaintiffs in the amended complaints are TSFG, pursuant to Section 33-7-400 of the South Carolina Code of Laws, by and through several named minority shareholders. Plaintiffs allege four causes of action based generally on the payment to the defendant officers of a bonus in stock held by TSFG in Affinity Technology Group, Inc. ("Affinity") as a reward for their efforts in connection with the Affinity investment, and other matters. The complaint seeks damages for the benefit of TSFG in the amount of approximately $32 million. TSFG believes that this lawsuit is without merit and has defended it vigorously. The trial court granted the Company's motion to dismiss the lawsuit on November 26, 1997. The plaintiffs appealed. On November 1, 2000, the South Carolina Court of Appeals affirmed the dismissal of the lawsuit. The plaintiffs have sought further review by the South Carolina Supreme Court. That appeal is currently pending before the state Supreme Court. (14) BUSINESS SEGMENTS TSFG has three principal operating subsidiaries, which are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. Two of these subsidiaries, by virtue of exceeding certain quantitative thresholds, are reportable segments. The reportable segments, Carolina First Bank and 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 and other customer service fees. No single customer accounts for a significant amount of the revenues of either reportable segment. TSFG evaluates performance based on budget to actual comparisons and segment profits. The accounting policies of the reportable segments are the same as those described in TSFG's Annual Report on Form 10-K for the year ended December 31, 2001. Segment information (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. 18
CAROLINA MERCANTILE ELIMINATING FIRST BANK BANK OTHER ENTRIES TOTAL ---------- ---- ----- ------- ----- THREE MONTHS ENDED SEPTEMBER 30, 2002: Net interest income $ 48,011 $10,092 $ (1,613) $ - $ 56,490 Provision for loan losses 3,865 1,718 (16) - 5,567 Noninterest income 10,380 1,441 17,376 (12,078) 17,119 Noninterest expenses 30,945 11,565 15,821 (12,078) 46,253 Amortization of intangibles (a) 246 106 - - 352 Merger-related costs (a) - 4,465 - - 4,465 Income tax expense 7,666 (560) (461) - 6,645 Minority interest in consolidated subsidiary, net of tax (1,033) - - - (1,033) Net income 14,882 (1,190) 419 - 14,111 THREE MONTHS ENDED SEPTEMBER 30, 2001: Net interest income $ 40,903 $ 6,781 $ (824) $ - $ 46,860 Provision for loan losses 4,168 1,325 (17) - 5,476 Noninterest income 9,522 1,077 14,267 (12,202) 12,664 Noninterest expenses 31,170 4,947 12,502 (12,202) 36,417 Amortization of intangibles (a) 1,370 - 53 - 1,423 Merger-related recoveries (a) (89) - - - (89) Income tax expense 5,217 545 366 - 6,128 Minority interest in consolidated subsidiary, net of tax (503) - - - (503) Net income 9,367 1,041 592 - 11,000 NINE MONTHS ENDED SEPTEMBER 30, 2002: Net interest income $ 143,929 $24,986 $ (4,389) $ - $ 164,526 Provision for loan losses 12,305 5,765 (21) - 18,049 Noninterest income 30,448 3,544 47,451 (39,049) 42,394 Noninterest expenses 92,472 22,061 46,583 (39,049) 122,067 Amortization of intangibles (a) 725 106 - - 831 Merger-related costs (a) - 4,465 - - 4,465 Income tax expense 22,369 223 (1,357) - 21,235 Minority interest in consolidated subsidiary, net of tax (2,219) - - - (2,219) Cumulative effect of change in accounting principal, net of tax - - (1,406) - (1,406) Net income 45,012 481 (3,549) - 41,944 (a) Included in noninterest expenses.
19
CAROLINA MERCANTILE ELIMINATING FIRST BANK BANK OTHER ENTRIES TOTAL ---------- ---- ----- ------- NINE MONTHS ENDED SEPTEMBER 30, 2001: Net interest income $ 117,990 $ 18,166 $ (2,389) $ - $ 133,767 Provision for loan losses 11,107 4,269 208 - 15,584 Noninterest income 28,500 2,485 46,233 (38,514) 38,704 Noninterest expenses 95,171 14,357 39,854 (38,514) 110,868 Amortization of intangibles (a) 4,267 - 158 - 4,425 Merger-related recoveries (a) (502) - - - (502) Income tax expense 14,585 701 834 - 16,120 Minority interest in consolidated subsidiary, net of tax (905) - - - (905) Cumulative effect of change in accounting principal, net of tax - - 282 - 282 Net income 24,722 1,324 3,230 - 29,276 (a) Included in noninterest expenses. SEPTEMBER 30, 2002: Total assets $ 5,492,340 $1,461,921 $812,770 $ (881,063) $ 6,885,968 Loans 3,188,032 1,060,628 78,388 (112,295) 4,214,753 Deposits 3,139,876 1,074,644 - (20,841) 4,193,679 SEPTEMBER 30, 2001: Total assets $ 4,796,168 $ 746,567 $599,933 $ (649,291) $ 5,493,377 Loans 3,137,723 613,734 4,854 - 3,756,311 Deposits 3,105,502 554,969 - (25,814) 3,634,657
(15) SUBSEQUENT EVENTS On October 29, 2002, South Financial Capital Trust III (the "Capital Trust III"), a wholly-owned subsidiary of TSFG, issued and sold floating rate securities having an aggregate liquidation amount of $22.0 million (the "Capital Securities III") to institutional buyers in a pooled trust preferred issue. The Capital Securities III generated gross proceeds of $22.0 million. The Capital Trust III loaned these proceeds to the parent company to use for general corporate purposes. The trust preferred debt qualifies as tier 1 capital under Federal Reserve Board guidelines. Issuance costs from the October 29, 2002 sale totaled $680,000. The Capital Securities III accrue and pay distributions semi-annually at a rate per annum equal to 90-day LIBOR plus 345 basis points. This rate may not exceed 12.0% through October 29, 2007. The distributions payable on the Capital Securities III are cumulative and payable quarterly in arrears. TSFG has the right, subject to events of default, to defer payments of interest on the Capital Securities III for a period not to exceed 20 consecutive quarters, provided that no extension period may extend beyond the maturity date of October 29, 2032. TSFG has no current intention to exercise its right to defer payments of interest on the Capital Securities III. The Capital Securities III are mandatorily redeemable upon maturity on October 29, 2032. TSFG has the right to redeem the Capital Securities III in whole or in part, on or after October 29, 2007. If the Capital Securities III are redeemed on or after October 29, 2007, the redemption price will be 100% of the principal amount plus accrued and unpaid interest. In addition, TSFG may redeem the Capital Securities III in whole (but not in part) at any time within 90 days following the occurrence of a tax event, an investment company event, or a capital treatment event at a special redemption price (as defined in the indenture). 20 (16) MANAGEMENT'S OPINION The financial statements in this report are unaudited, except for the consolidated balance sheet at December 31, 2001, which is derived from TSFG's consolidated audited financial statements. In the opinion of management, all adjustments necessary to present a fair statement of the results for the interim periods have been made. All such adjustments are of a normal, recurring nature. 21 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis are presented to assist in understanding the financial condition and results of operations of The South Financial Group, Inc. and its subsidiaries ("TSFG", which also may be referred to as "we", "us", or "our", except where the context requires otherwise). This discussion should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this report as well as the Annual Report of TSFG on Form 10-K for the year ended December 31, 2001. Results of operations for the three and nine month periods ended September 30, 2002 are not necessarily indicative of results that may be attained for any other period. Percentage calculations contained herein have been calculated based upon actual, not rounded, results. TSFG, a South Carolina corporation headquartered in Greenville, South Carolina, is a financial holding company, which commenced banking operations in December 1986, and conducted business through 70 locations in South Carolina, 5 locations in North Carolina and 31 locations in northern and central Florida as of September 30, 2002. TSFG operates through two wholly-owned subsidiary banks: Carolina First Bank, a South Carolina state-chartered commercial bank, and Mercantile Bank, a Florida state-chartered commercial bank (which are collectively referred to as the "Subsidiary Banks"). Upon acquiring Gulf West, TSFG combined all of its Florida operations, formerly known as Citrus Bank, under the Mercantile Bank name. Through our subsidiaries, we provide a full range of financial services, including asset management, investments, insurance, and trust services, designed to meet substantially all of the financial needs of our customers. FORWARD-LOOKING STATEMENTS This report contains certain forward-looking statements (as defined in the Private Securities Litigation Reform Act of 1995) to assist in the understanding of anticipated future operating and financial performance, growth opportunities, growth rates, and other similar forecasts and statements of expectations. These forward-looking statements reflect current views, but are based on assumptions and are subject to risks, uncertainties, and other factors, which may cause actual results to differ materially from those in such statements. These factors include, but are not limited to, the following: o risks from changes in economic, monetary policy, and industry conditions; o changes in interest rates, deposit rates, the net interest margin, and funding sources; o market risk and inflation; o risks inherent in making loans including repayment risks and value of collateral; o loan growth, the adequacy of the allowance for loan losses, and the assessment of problem loans; o fluctuations in consumer spending; o competition in the banking industry and demand for our products and services; o dependence on senior management; o technological changes; o ability to increase market share; o expense projections; o risks associated with income taxes, including the potential for adverse adjustments; o acquisitions, related cost savings, and expected financial results; o changes in accounting policies and practices; o costs and effects of litigation; and o recently-enacted or proposed legislation. Such forward-looking statements speak only as of the date on which such statements are made. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made to reflect the occurrence of unanticipated events. In addition, certain statements in future filings by TSFG with the Securities and 22 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. MERGERS The following table summarizes TSFG's mergers completed during 2002. All of these 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 merger date. TABLE 1 -------------------------------------------------------------------------------- SUMMARY OF COMPLETED ACQUISITIONS --------------------------------------------------------------------------------
IDENTIFIABLE ACQUISITION TOTAL SHARES CASH INTANGIBLE DATE ASSETS (1) ISSUED PAID ASSETS GOODWILL ---- ---------- ------ ---- ------ -------- Gulf West Banks, Inc. St. Petersburg, FL 08/31/02 $526.9 million 3,925,588 $32.4 million $8.4 million $71.1 million Gardner Associates, Inc. Columbia, SC 09/20/02 $ 1.3 million 249,011(2) none $1.5 million $ 0.9 million Closed subsequent to 9/30/02 ---------------------------- Rock Hill Bank and Trust Rock Hill, SC 10/31/02 430,017(3) none(3)
(1) The most recent quarter end prior to acquisition date. (2) Of this amount, up to 92,585 of these shares are subject to forfeiture back to TSFG if certain annual and five-year financial performance targets are not met. (3) TSFG agreed to pay a cash earnout based on collection and recoveries with respect to certain loans. TSFG also agreed to repurchase such number of these 430,017 shares as are not distributed to RHBT shareholders in RHBT's pending liquidation. On August 31, 2002, TSFG completed the merger with 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 fifteen locations in the greater Tampa Bay area of Florida. This merger represents TSFG's first banking locations in the greater 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. TSFG's consolidated financial statements include the results of Gulf West's operations since the August 31, 2002 merger date. On September 20, 2002, TSFG acquired Gardner Associates, Inc. ("Gardner Associates"), an independent insurance agency based in Columbia, South Carolina, which TSFG will use to build its insurance operations in the Midlands area of South Carolina. Subsequent to quarter end, on October 31, 2002, TSFG completed the acquisition of substantially all of the assets and deposits of Rock Hill Bank & Trust ("Rock Hill"), which is the wholly-owned banking subsidiary of RHBT Financial Corporation ("RHBT"). Rock Hill operated 3 branches in York County, South Carolina. Under the asset sale agreement, Rock Hill 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 the entire designated loan pool and 50% of net amounts recovered under RHBT's blanket bond insurance policy with respect to such loans. 23 In connection with improper activities and bad lending practices by a former executive officer with respect to a large number of Rock Hill's loans, Rock Hill had to charge off or establish additional reserves for a material portion of its loan portfolio, prior to closing of the merger. Accordingly, related to the loans acquired from Rock Hill, TSFG expects its allowance for loan losses and nonaccrual loans to increase to above historical levels. The ultimate impact is not currently known. TSFG owns 382,500 shares, or approximately 22% of RHBT outstanding stock, which is included in available for sale securities. During the third quarter, TSFG wrote-down its investment in RHBT by $1.2 million to its September 30, 2002 estimated fair value of approximately $1.9 million, or $5.00 per share. The Board of Directors of RHBT presently plans to distribute most, but not necessarily all, of the 430,017 shares of TSFG common stock received by Rock Hill to RHBT shareholders shortly after closing of the sale of assets. Upon the distribution of the TSFG common stock to RHBT shareholders, TSFG will cancel any TSFG shares received. PENDING MERGER In October 2002, TSFG signed a definitive agreement to acquire Central Bank of Tampa ("CBT"), a closely held community bank headquartered in Tampa, Florida. At September 30, 2002, CBT operated through 5 branches in Tampa and had total assets of $215.4 million. TSFG will issue common stock equal to $68.0 million in exchange for all the outstanding common shares of CBT. Such TSFG common stock will be valued at the average closing price on the ten trading days ending on the second trading day prior to closing (except that the value will never be deemed less than $15.00 or greater than $25.00). This transaction, which is expected to close in the fourth quarter of 2002, will be accounted for using the purchase method of accounting and is subject to receipt of CBT shareholder and regulatory approval. EARNINGS REVIEW OVERVIEW Net income for the nine months ended September 30, 2002 totaled $41.9 million, up 43.3% compared with $29.3 million for the nine months ended September 30, 2001. Earnings per diluted share for the first nine months of 2002 were $1.00, a 47.1% increase from $0.68 per diluted share in the first nine months of 2001. Higher net interest income, efficiency improvements, and a more favorable effective tax rate contributed to the increases in net income and earnings per diluted share. Net interest income increased from a higher net interest margin and 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 nine months ended September 30, 2002 and 2001 included pre-tax gains on asset sales of $4.4 million and $1.3 million, respectively. For the nine months ended September 30, 2002, TSFG recognized a $4.7 million gain on the sale of NetBank, Inc. common stock, which was partially offset by a $1.2 million write-down on its investment in RHBT. See "Earnings Review - Noninterest Income" for details on the gain on asset sales. Noninterest expenses for the first nine months of 2002 included the following pre-tax other items: $4.5 million in merger-related costs, $1.6 million of personnel expense related to the settlement of certain employment agreements from previous mergers, and a $354,000 loss on early extinguishment of debt. For the first nine months of 2001, noninterest expenses included the following pre-tax other items: $1.1 million loss on early extinguishment of debt, $502,000 recovery of merger-related costs related to the sale of real estate, and $391,000 impairment loss from the write-down of assets. On January 1, 2002, TSFG adopted SFAS 142 and ceased amortization of goodwill. Amortization of intangibles that are not amortized in 2002 totaled $3.4 million for the nine months ended September 30, 2001. In the third quarter 2002, TSFG recorded a $1.4 million charge related to impairment of goodwill associated with Carolina First Mortgage Company, which is shown as a cumulative effect of change in accounting principle. In accordance with the accounting rules, this change was recorded as of January 1, 2002 and therefore is reflected in the year-to-date income, but not the quarter. 24 Average common shares outstanding on a diluted basis were 41.9 million in the first nine months of 2002, down 2.8% from 43.1 million for first nine months of 2001. In connection with share repurchase programs, TSFG repurchased and cancelled 2,141,907 shares during the first nine months of 2002. At September 30, 2002, TSFG had approximately $6.9 billion in assets, $4.2 billion in loans, $4.2 billion in deposits, and $554.6 million in shareholders' equity. At September 30, 2002, the ratio of nonperforming assets to loans and other real estate owned was 1.07%. NET INTEREST INCOME Net interest income is the difference between the interest earned on assets and the interest paid for the liabilities to support such assets as well as such items as loan fees and dividend income. The net interest margin measures how effectively a company manages the difference between the yield on earning assets and the rate paid on funds to support those assets. Fully tax-equivalent net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis. Table 2 presents average balance sheets and a net interest income analysis on a tax equivalent basis for the three and nine months ended September 30, 2002 and 2001. 25
TABLE 2 ------------------------------------------------------------------------------------------------------ COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS ------------------------------------------------------------------------------------------------------ (DOLLARS IN THOUSANDS) THREE MONTHS ENDED SEPTEMBER 30, ----------------------------------------------------------- 2002 2001 ---------------------------- ---------------------------- AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ BALANCE EXPENSE RATE BALANCE EXPENSE RATE ------- ------- ---- ------- ------- ---- Assets Earning assets Loans (1) $4,018,965 $67,751 6.69% $ 3,741,496 $76,432 8.10 % Investment securities (taxable) (2) 1,707,479 22,011 5.16 1,046,714 16,799 6.37 Investment securities (nontaxable) (3) 93,301 1,669 7.16 84,243 1,541 7.26 Federal funds sold 7,214 26 1.43 968 8 3.28 Interest-bearing bank balances 50,154 226 1.79 36,819 205 2.21 ----------- ------- ----------- ------- Total earning assets 5,877,113 91,683 6.19 4,910,240 94,985 7.67 ----------- ------- ----------- ------- Non-earning assets 592,822 525,510 ---------- ----------- Total assets $6,469,935 $ 5,435,750 ========== =========== Liabilities and shareholders' equity Liabilities Interest-bearing liabilities Interest-bearing deposits Interest checking $ 592,622 $ 1,731 1.16 $ 587,151 $ 3,472 2.35 Savings 124,611 224 0.71 114,016 570 1.98 Money market 834,111 3,725 1.77 772,515 6,798 3.49 Time deposits 1,744,858 14,813 3.37 1,626,509 22,828 5.57 ---------- ------- ---------- ------- Total interest-bearing deposits 3,296,202 20,493 2.47 3,100,191 33,668 4.31 Borrowings 1,924,197 14,115 2.91 1,219,802 13,918 4.53 ---------- ------- ---------- ------- Total interest-bearing liabilities 5,220,399 34,608 2.63 4,319,993 47,586 4.37 ------- ------- Noninterest-bearing liabilities Noninterest-bearing deposits 570,508 494,911 Other noninterest-bearing liabilities 80,410 92,510 ---------- ---------- Total liabilities 5,871,317 4,907,414 Minority interest in consolidated subsidiary 86,429 37,027 Shareholders' equity 512,189 491,309 ---------- ---------- Total liabilities and shareholders' equity $6,469,935 $5,435,750 ========== ========== Net interest margin $57,075 3.85% $47,399 3.83 % ======= ======= Tax-equivalent adjustment (3) $ 585 $ 539 ======= ======= (1) Nonaccrual loans are included in average balances for yield computations. (2) The average balances for investment securities exclude the unrealized gain 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.
26
TABLE 2 (CONTINUED) ----------------------------------------------------------------------------------------------------------- COMPARATIVE AVERAGE BALANCES - YIELDS AND COSTS ----------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) NINE MONTHS ENDED SEPTEMBER 30, -------------------------------------------------------------- 2002 2001 ------------------------------ ------------------------------ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ BALANCE EXPENSE RATE BALANCE EXPENSE RATE Assets Earning assets Loans (1) $3,894,325 $199,680 6.86 % $3,754,478 $242,253 8.63 % Investment securities (taxable) (2) 1,650,010 64,795 5.24 938,807 45,966 6.55 Investment securities (nontaxable) (3) 92,218 4,984 7.21 82,833 4,563 7.37 Federal funds sold 2,431 26 1.43 446 13 3.90 Interest-bearing bank balances 69,851 913 1.75 33,458 1,168 4.67 ---------- -------- ---------- -------- Total earning assets 5,708,835 270,398 6.33 4,810,022 293,963 8.17 -------- -------- Non-earning assets 537,398 533,726 ---------- ---------- Total assets $6,246,233 $5,343,748 ========== ========== Liabilities and shareholders' equity Liabilities Interest-bearing liabilities Interest-bearing deposits Interest checking $ 590,902 $ 5,332 1.21 $ 580,509 $ 11,686 2.69 Savings 118,909 654 0.74 114,421 1,887 2.20 Money market 756,348 9,538 1.69 744,836 22,302 4.00 Time deposits 1,715,167 47,798 3.73 1,801,287 82,781 6.14 ---------- -------- ---------- -------- Total interest-bearing deposits 3,181,326 63,322 2.66 3,241,053 118,656 4.89 Borrowings 1,928,727 40,805 2.83 1,044,276 39,943 5.11 ---------- -------- ---------- -------- Total interest-bearing liabilities 5,110,053 104,127 2.72 4,285,329 158,599 4.95 ---------- -------- ---------- -------- Noninterest-bearing liabilities Noninterest-bearing deposits 530,737 469,053 Other noninterest-bearing liabilities 73,843 83,911 ---------- ---------- Total liabilities 5,714,633 4,838,293 Minority interest in consolidated subsidiary (4) 454,232 20,358 Shareholders' equity 477,368 485,097 ---------- ---------- Total liabilities and shareholders' equity $6,246,233 $5,343,748 ========== =========== Net interest margin $166,271 3.89 % $135,364 3.76 % ======== ======== Tax-equivalent adjustment (3) $ 1,745 $ 1,597 ======== ======== (1) Nonaccrual loans are included in average balances for yield computations. (2) The average balances for investment securities exclude the unrealized gain 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.
27 Fully tax-equivalent net interest income for the first nine months of 2002 increased $30.9 million, or 22.8%, to $166.3 million from $135.4 million in the first nine months of 2001. The net interest margin increased to 3.89% in the first nine months of 2002 from 3.76% in the first nine months of 2001. These increases were due to the increase in average earning assets, the prompt repricing of funding sources as the Federal Reserve lowered rates during 2001, and repricing maturing certificates of deposit at significantly lower rates. Average earning assets grew $898.8 million, or 18.7%, to $5.7 billion in the first nine months of 2002 from $4.8 billion in the first nine months of 2001, primarily from higher investment securities. The Gulf West merger, which closed August 31, 2002, added $475.6 million in earning assets, which are included for the month of September. The Gulf West merger accounted for approximately $53 million of the increase in average earning assets for the first nine months of 2002. Average loans increased $139.8 million, unadjusted for the December 2001 sale of $79.5 million of residential mortgage loans from the held for investment portfolio, to $3.9 billion in the first nine months of 2002 from $3.8 billion in the first nine months of 2001. Average investment securities, excluding the average net unrealized securities gains, increased from $1.0 billion in the first nine months of 2001 to $1.7 billion in the first nine months of 2002. TSFG increased the U.S. Treasury security portfolio by $520.1 million during the fourth quarter of 2001, largely in anticipation of prepayments of mortgage-backed securities. TSFG purchased these securities to leverage the capital position, take advantage of opportunities to increase net interest income, and manage interest rate risk. The acceleration of prepayments of mortgage-backed securities reduces interest income due to the related write-off of any associated purchased premium. During 2001, the Federal Reserve reduced the target for the federal funds rate 11 times for a total of 475 basis points. Three of these reductions occurred in the last three months of the year for a total of 125 basis points. A large portion of our adjustable rate loans, which constitute 54.1% of the loan portfolio, repriced immediately following changes in interest rates by the Federal Reserve. In addition, certificates of deposits were repriced at significantly lower rates and higher-cost Federal Home Loan Bank ("FHLB") advances were prepaid. Accordingly, as TSFG reduced its interest rates during the year, the decline in the funding source rate outpaced the decline in the earning asset yield. For the first nine months of 2001 compared with the first nine months of 2002, the earning asset yield declined 184 basis points to 6.33%, whereas the funding source rate declined 223 basis points to 2.72%. TSFG expects certificates of deposit to continue to reprice downward in the last quarter of 2002, although with a significantly smaller benefit than that realized in 2001 and the first three quarters of 2002. As a result of the significant decline in interest rates in 2001, the current market rates for similar certificates of deposits are significantly lower. Average total deposits remained constant at $3.7 billion during the first nine months of both 2002 and 2001. These balances stayed flat due to the competitive nature of the deposit markets. TSFG has elected to reduce deposit rate-driven promotions. Average borrowings increased to $1.9 billion during the nine months ended September 30, 2002 from $1.0 billion during the nine months ended September 30, 2001 due to increases in repurchase agreements and fed funds purchased to fund the growth in earning assets. Repurchase agreements, which increased in connection with TSFG's purchases of securities to leverage the capital position, accounted for the majority of this increase. In the third quarter 2002, TSFG repositioned its investment portfolio by selling approximately $450 million of 10-year U.S. Treasury securities and purchasing approximately $412 million of adjustable rate mortgage-backed securities. This repositioning may reduce net interest income, while better positioning TSFG for increasing interest rates. Deposits generated through Bank CaroLine, an Internet banking division of Carolina First Bank, generally pay higher rates than those offered by our branch locations. During the first nine months of 2002, TSFG priced the Bank CaroLine deposits less aggressively than it did in 2001 in an effort to lower the overall cost of funds. Bank CaroLine deposits totaled $34.1 million as of September 30, 2002 compared with $55.3 million and $91.6 million as of December 31, 2001 and September 30, 2001, respectively. 28 On August 31, 2002, TSFG redeemed $26.3 million of 9.00% Subordinated Notes Due 2005. In connection with the redemption, TSFG recorded a $354,000 loss on early extinguishment of debt. During 2001, TSFG recorded a $3.1 million loss associated with the early extinguishment of approximately $54.3 million in FHLB advances. TSFG engaged in these transactions to take advantage of the opportunity to reinvest the proceeds and refinance the borrowings at more favorable rates, thereby enhancing net interest income. TSFG continues to evaluate the relative cost and benefit of incurring additional prepayment penalties from the early extinguishment of debt. See "Borrowed Funds." PROVISION FOR LOAN LOSSES The provision for loan losses is recorded in amounts sufficient to bring the allowance for loan and lease losses (the "Allowance") to a level deemed appropriate by management based on factors discussed in "Balance Sheet Review - Allowance for Loan Losses" and "Credit Quality." The provision for loan losses was $18.0 million and $15.6 million for the first nine months of 2002 and 2001, respectively. The increase was attributable to continued loan growth, higher loan losses, and uncertain economic conditions. The Allowance equaled 1.20% and 1.18% of loans held for investment as of September 30, 2002 and 2001, respectively. Based on management's analysis of impairment as defined in Statement of Financial Accounting Standards ("SFAS") 114, specific reserves allocated to impaired loans totaled $6.2 million, or 19.3% of impaired loans at September 30, 2002, compared with $4.2 million and 13.1% of impaired loans at September 30, 2001. See "Allowance for Loan Losses" and "Credit Quality." NONINTEREST INCOME Noninterest income totaled $42.4 million in the first nine months of 2002, compared with $38.7 million in the first nine months of 2001. The increase in noninterest income was primarily the result of a $2.7 million increase in service charges on deposit accounts and a $2.4 million increase in gain on equity investments. This increase was partially offset by a $1.9 million decrease in mortgage banking income (see Table 4, Components of Mortgage Banking Income for details). Table 3 shows the components of noninterest income for the three and nine months ended September 30, 2002 and 2001.
TABLE 3 -------------------------------------------------------------------------------------------------------------------------- COMPONENTS OF NONINTEREST INCOME -------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, ---------------------------- ------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Service charges on deposit accounts $ 6,108 $ 4,568 $16,436 $13,748 Fees for investment services 1,359 1,462 4,639 4,204 Mortgage banking income 850 927 3,397 5,250 Bank-owned life insurance 1,877 1,845 5,486 5,397 Merchant processing income 1,778 1,657 4,741 4,618 Other 830 1,073 3,302 4,180 ------- ------- ------- ------- Noninterest income, excluding gain (loss) on asset sales 12,802 11,532 38,001 37,397 ------- ------- ------- ------- Gain on sale of available for sale securities 790 1,134 1,005 1,539 Gain on equity investments, net 3,527 17 3,388 1,019 Loss on disposition of assets and liabilities - (19) - (1,251) ------- ------- ------- ------- Gain on asset sales, net 4,317 1,132 4,393 1,307 ------- ------- ------- ------- Total noninterest income $17,119 $12,664 $42,394 $38,704 ======= ======= ======= =======
29 Noninterest income included gains on asset sales of $4.4 million and $1.3 million in the first nine months of 2002 and 2001, respectively. During the first nine months of 2002, the gain on equity investment included a $4.7 million gain on the sale of 450,000 shares of NetBank, Inc. common stock. This gain was partially offset by a $1.2 million write-down on RHBT common stock and a $150,000 write-off of an investment in a technology company. During the nine months ended September 30, 2001, the gain on equity investments included $1.1 million from the exchange of Star Systems, Inc. stock for stock of Concord EFS, Inc. (a publicly-traded company) and the subsequent sale of the investment in Concord EFS, Inc., as well as a $63,000 gain from the sale of common stock of Affinity Technology Group, Inc. These gains were partially offset by a $200,000 loss associated with the write-down of an Internet-related investment. During the first nine months of 2001, the loss on disposition of assets and liabilities related to a $1.0 million loss associated with the sale of four branch office locations, which closed in July 2001, and a $262,000 loss associated with the sale-leaseback of a branch office. Service charges on deposit accounts, the largest contributor to noninterest income, rose 19.6% to $16.4 million in the first nine months of 2002 from $13.7 million for the same period in 2001. The increase was attributable to attracting new transaction accounts, improving collection of fees, and revising fee structures to reflect competitive pricing. Average balances for deposit transaction accounts, which impact service charges, increased approximately 4.6% for the same period. Fees for investment services, which include trust and brokerage income, for the first nine months of 2002 and 2001 were approximately $4.6 million and $4.2 million, respectively. During this period, brokerage income increased $575,000, and trust income decreased $140,000, partially related to the decline in market value of assets administered. At September 30, 2002 and 2001, the market value of assets administered by the trust department totaled $621.7 million and $735.4 million, respectively. Mortgage banking income includes origination income and secondary marketing operations (related to current production), servicing fees (net of the related amortization for the mortgage-servicing rights and subservicing payments), gains and losses on sales of portfolio mortgage loans, gains and losses on sales of mortgage servicing rights, and losses and recoveries related to the impairment of mortgage-servicing rights. Mortgage banking income in the first nine months of 2002 decreased $1.9 million to $3.4 million from $5.3 million in the first nine months of 2001. Table 4 shows the components of mortgage banking income for the three and nine months ended September 30, 2002 and 2001.
TABLE 4 -------------------------------------------------------------------------------------------------------------------------- COMPONENTS OF MORTGAGE BANKING INCOME -------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) THREE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER 30, SEPTEMBER 30, --------------------------- ------------------------- 2002 2001 2002 2001 ---- ---- ---- ---- Origination income and secondary marketing operations $1,991 $1,413 $5,345 $4,446 Net mortgage servicing income (372) (118) (963) 418 Impairment on mortgage servicing rights (769) (229) (592) (509) Gain (loss) on sale of portfolio mortgage loans - (80) (393) 1,500 Loss on sale of mortgage servicing rights - (59) - (605) ------ ------ ------ ------ Total mortgage banking income $ 850 $ 927 $3,397 $5,250 ====== ====== ====== ======
TSFG realigned its mortgage banking strategy to place more emphasis on mortgage originations. For the first nine months of 2002, origination income and secondary marketing increased 20.2% to $5.3 million from $4.4 million for the first nine months of 2001. Mortgage loans held for sale originated by TSFG originators totaled $325.3 million and $191.6 million in the first nine months of 2002 and 2001, respectively. Mortgage origination volumes by TSFG originators increased in the first nine months of 2002 due to lower mortgage loan rates and the hiring of additional mortgage originators. Mortgage loan originations, for 30 the nine months ended September 30, 2001, also included $89.2 million attributable to correspondent relationships. TSFG discontinued its correspondent relationships in the second quarter of 2001. The benefit associated with correspondent originations, which were principally related to increasing the servicing volumes (which TSFG began outsourcing in December 2001), diminished. In connection with the realignment of its mortgage banking strategy, TSFG securitized mortgage loans, sold mortgage loans, and sold mortgage-servicing rights in 2001. These sales resulted in a $393,000 loss and an $895,000 net gain during the first nine months of 2002 and 2001, respectively. Beginning in December 2001, TSFG contracted with non-affiliated companies to service mortgage loans for TSFG's affiliates. Net servicing income declined to a $963,000 loss for the nine months ended September 30, 2002 from a $418,000 gain for the nine months ended September 30, 2001. This decline resulted from a smaller servicing portfolio, the outsourcing of servicing to third party servicers, and higher mortgage servicing rights amortization due to declining interest rates. CF Mortgage's total servicing portfolio includes mortgage loans owned by Carolina First Bank, mortgage loans owned by Mercantile Bank, and other mortgage loans for which Carolina First Bank owns the rights to service. At September 30, 2002, CF Mortgage's servicing portfolio included 6,726 loans having an aggregate principal balance of $560.2 million. At September 30, 2001, the aggregate principal balance for CF Mortgage's servicing portfolio totaled $1.1 billion, significantly higher than September 30, 2002 due to sales of mortgage servicing rights and mortgage portfolio loans during 2001. Mortgage servicing rights, net of the valuation allowance totaled $5.6 million and $10.8 million at September 30, 2002 and 2001, respectively. 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. For the nine months ended September 30, 2002, TSFG recorded a $592,000 charge for impairment, net of recoveries, from the valuation of mortgage servicing rights, which included $769,000 recorded for the third quarter. In the first nine months of 2001, TSFG recorded a $509,000 charge for impairment from the valuation of mortgage servicing rights. At September 30, 2002, the valuation allowance for capitalized mortgage servicing rights totaled $1.7 million. Bank-owned life insurance income remained relatively constant at $5.5 million for the first nine months of 2002 and $5.4 million for the first nine months of 2001. Merchant processing income also remained relatively constant at $4.7 million and $4.6 million for the nine months ended September 30, 2002 and 2001, respectively. Other noninterest income totaled $3.3 million for the first nine months of 2002, compared with $4.2 million for the first nine months of 2001. This decrease was primarily the result of $267,000 in losses on trading securities for the first nine months of 2002, compared with $207,000 in gains for the corresponding period in 2001, and $762,000 in losses on the sale of real estate acquired in partial or total satisfaction of problem loans for the first nine months of 2002, compared with $386,000 in losses for the corresponding period in 2001. Other noninterest income includes income related to customer service fees, debit cards, insurance commissions, and international banking services. Total income from these fee income sources increased over the prior year (in aggregate) and the preceding quarter, due in part to TSFG's rollout of Elevate, a customer-centered sales process. NONINTEREST EXPENSES Noninterest expenses increased to $122.1 million in the first nine months of 2002 from $110.9 million in the first nine months of 2001. Noninterest expenses for the nine months ended September 30, 2002 included $4.5 million in merger-related expenses, $1.6 million in salary and wages related to the settlement of certain employment agreements from previous mergers, and a $354,000 loss on the early extinguishment of debt. Noninterest expenses in the first nine months of 2001 included a $1.1 million loss on the early extinguishment of debt, a $502,000 recovery of merger-related costs (which 31 related to the sale of real estate at prices higher than estimated), and a $391,000 impairment loss from the write down of assets (which was primarily related to lease termination fees for abandoned locations). Excluding these other charges, noninterest expenses increased $5.8 million, or 5.3%, to $115.7 million for the first nine months of 2002 from $109.9 million for the first nine months of 2001. Increases in salaries, wages, and employee benefits, which in part reflects expenses related to Gulf West, were partially offset by lower amortization of intangibles from ceasing goodwill amortization. Salaries, wages, and employee benefits increased to $62.8 million in the first nine months of 2002 from $54.0 million in the first nine months of 2001. Full-time equivalent employees increased to 1,593 from 1,357 as of September 30, 2002 and 2001, respectively. The increase in personnel expense was attributable to adding Gulf West for the month of September, 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 $1.7 million in the first nine months of 2002 from $545,000 in the first nine months of 2001. Occupancy and furniture and equipment expenses increased to $22.2 million for the nine months ended September 30, 2002 from $20.9 million for the corresponding period from 2001, primarily from the addition of branch offices, principally from Gulf West, and higher data processing costs. Professional fees and merchant processing expenses remained relatively constant for the first nine months of 2002 and 2001. Amortization of intangibles decreased to $831,000 for the nine months ended September 30, 2002 from $4.4 million for the nine months ended September 30, 2001. This decrease was primarily attributable to the January 1, 2002 adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"), which requires TSFG to cease the amortization of goodwill. Other noninterest expenses increased $956,000 to $23.7 million in the first nine months of 2002 from $22.8 million in the first nine months of 2001. The overall increase in other noninterest expenses was principally attributable to increases in loan collection expense and sundry losses. MERGER-RELATED COSTS In connection with the August 31, 2002 merger of Gulf West, TSFG incurred pre-tax merger-related costs of approximately $4.5 million for the nine months ended September 30, 2002. For the nine months ended September 30, 2001, TSFG had a $502,000 recovery of merger-related costs. This recovery related to the sale of properties acquired in the June 2000 merger of Anchor Financial Corporation at prices higher than estimated when a reserve for their disposition was established in 2000. At September 30, 2002, the accrual for merger-related costs totaled $2.0 million, which included $1.2 million for compensation-related expenses. See Item 1, Note 4 to the Consolidated Financial Statements. During the fourth quarter 2002, TSFG expects to record merger-related costs in connection with the asset sale agreement with Rock Hill (which closed October 31, 2002), the merger with CBT (expected to close in the fourth quarter 2002), and additional costs, which are expected to be insignificant, associated with Gulf West. INCOME TAXES The effective income tax rate as a percentage of pretax income was 31.8% for the first nine months of 2002 and 35.0% for the first nine months of 2001. The effective income tax rate declined in connection with the company's ability to utilize a capital tax loss carry forward to offset gains realized on equity investments in third quarter 2002 and ceasing the amortization of goodwill. The write-off of goodwill associated with the sale of four branch office locations that was not deductible for tax purposes increased the effective rate for the nine months ended September 30, 2001. The blended statutory income tax rate was 36.94% for both of these periods. 32 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 tax assets. Tax returns for 1998 and subsequent years are exposed to examination by taxing authorities. THIRD QUARTER RESULTS Net income for the three months ended September 30, 2002 totaled $14.1 million, up 28.3% compared with $11.0 million for the three months ended September 30, 2001. Earnings per diluted share for the three months ended September 30, 2002 were $0.33, a 26.9% increase from earnings per diluted share of $0.26 for the three months ended September 30, 2001. Higher net interest income, service charges on deposits accounts, gains on asset sales, and a more favorable tax rate contributed to the growth in earnings. This earnings growth was partially offset by merger-related costs, higher noninterest expenses, and a higher provision for loan losses. Fully tax-equivalent net interest income totaled $57.1 million, an increase of $9.7 million, or 20.4%, compared with the third quarter of 2001. Net interest income increased from a stable net interest margin and 19.7% growth in average earning assets, principally from investment securities. The net interest margin was 3.85% for the third quarter 2002, up slightly from 3.83% for the third quarter 2001. Noninterest income for the three months ended September 30, 2002 and 2001 included pre-tax gains on asset sales of $4.3 million and $1.1 million, respectively. For the third quarter 2002, the largest item was a $4.7 million gain from the sale of NetBank common stock, partially offset by a $1.2 million write-down on the investment in RHBT. See "Earnings Review - Noninterest Income" for details on the gains on asset sales. Noninterest income, excluding the gains on asset sales, increased 11.0% to $12.8 million for the third quarter of 2002 compared with $11.5 million for the third quarter of 2001. Mortgage banking income for the third quarter 2002 included a $769,000 impairment write-down on the value of mortgage servicing rights due to the decline in interest rates, compared with $229,000 for the third quarter 2001. The noninterest income increase came principally from fee income increases from service charge on deposit accounts, mortgage banking income excluding impairment on mortgage servicing rights, brokerage income, merchant processing income, debit card income, and insurance income. For the third quarter 2002, noninterest expenses included the following pre-tax other items: $4.5 million in merger-related expenses, $1.6 million in salary and wages related to the settlement of certain employment agreements from previous mergers, and a $354,000 loss on the early extinguishment of debt. For the third quarter 2001, noninterest expenses included the following pre-tax other items: $1.1 million loss on the early extinguishment of debt, a $176,000 write-down of an impaired asset, and the recovery of $89,000 of restructuring and merger-related costs. Noninterest expenses, excluding the other items, increased 13.1% to $39.9 million for the third quarter of 2002 from $35.2 million for the third quarter of 2001, which in part reflects expenses related to Gulf West. Increases in noninterest expenses were partially offset by lower amortization of intangibles from ceasing goodwill amortization. Amortization of intangibles that are not amortized in 2002 totaled $1.1 million for the three months ended September 30, 2001. BALANCE SHEET REVIEW LOANS Loans are the largest category of earning assets and generally produce the highest yields. TSFG concentrates on lending to small and middle market businesses and retail consumers. At September 30, 2002, outstanding loans totaled $4.2 billion, which equaled 100.5% of total deposits and 61.2% of total 33 assets. The loan portfolio consisted principally of commercial loans, commercial real estate loans, consumer loans (including both direct and indirect loans), and one-to-four family residential mortgage loans. Substantially all loans were to borrowers domiciled in TSFG's market areas in South Carolina, North Carolina, and Florida. The portfolio did not contain any foreign loans or any "highly leveraged transactions," as defined by regulatory authorities. TSFG's only significant industry concentration is commercial real estate loans (loans to finance real properties for sale or lease to unrelated third parties), which totaled $1.3 billion, or 32.4.% of loans held for investment, at September 30, 2002. In Table 3, these loans are included in the "Real estate - construction" and "Commercial secured by real estate" categories, which also include loans to non-real estate industry borrowers. All other industry concentrations represented less than 10% of total loans. Table 5 summarizes outstanding loans by collateral type for real estate secured loans and by borrower type for all other loans.
TABLE 5 ------------------------------------------------------------------------------------------------------------------------- LOAN PORTFOLIO COMPOSITION ------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER 30, DECEMBER 31, --------------------------------- 2002 2001 2001 ---- ---- ---- Commercial, financial and agricultural $ 820,421 $ 722,220 $ 742,218 Real estate - construction (1) 545,896 507,587 532,037 Real estate - residential mortgages (1-4 family) 603,822 708,338 551,119 Commercial secured by real estate (1) 1,633,775 1,289,154 1,400,466 Consumer 547,932 511,349 503,900 Lease financing receivables 208 972 510 ---------- ---------- ---------- Loans held for investment 4,152,054 3,739,620 3,730,250 Loans held for sale 62,699 16,691 6,513 Less: allowance for loan losses 50,011 43,944 44,587 ----------- ---------- ---------- Total net loans $4,164,742 $3,712,367 $3,692,176 ========== ========== ========== ------------------------------------------------------------------------------------------------------------------------- PERCENTAGE OF LOANS HELD FOR INVESTMENT IN CATEGORY ------------------------------------------------------------------------------------------------------------------------- SEPTEMBER 30, DECEMBER 31, -------------------------------- 2002 2001 2001 ---- ---- ---- Commercial, financial and agricultural 19.76 % 19.31 % 19.90 % Real estate - construction (1) 13.15 13.57 14.26 Real estate - residential mortgages (1-4 family) 14.54 18.94 14.77 Commercial secured by real estate (1) 39.34 34.47 37.54 Consumer 13.20 13.68 13.52 Lease financing receivables 0.01 0.03 0.01 ------ ------ ------ Total 100.00 % 100.00 % 100.00 % ====== ====== ======
(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. At September 30, 2002, such loans were approximately 51.2% of these category totals. 34 Loans held for investment increased $412.4 million, or 11.0%, to approximately $4.2 billion at September 30, 2002 from $3.7 billion at September 30, 2001. In December 2001, TSFG sold $79.5 million of residential mortgage loans from the held for investment portfolio. On August 31, 2002, TSFG acquired $286.6 million in loans held for investment from its merger with Gulf West, which accounted for more than half of the increase. The majority of the loan growth was in commercial loans at both Carolina First Bank and Mercantile Bank, although commercial loan growth slowed during the third quarter 2002. Indirect auto loans (loans purchased from car dealers) and home equity loans also increased, partially offset by a decline in direct consumer loans. The composition of the loans held for investment portfolio is similar to that as of December 31, 2001, following the December 2001 sale of residential mortgage loans. While TSFG originations of residential mortgage loans have increased, TSFG sells most of its residential mortgage loans in the secondary market. Loans held for sale increased principally from the addition of approximately $26.0 million of commercial real estate loans acquired from Gulf West, which are primarily related to the hospitality sector. TSFG has not yet received final appraisals on these properties and expects to record a market valuation adjustment in the fourth quarter 2002. TSFG's corporate lending group focuses on relationship-based lending to larger regional companies headquartered in its markets. At September 30, 2002, the outstanding balance of loans identified as shared national credits totaled $55.8 million. ALLOWANCE FOR LOAN LOSSES The adequacy of the Allowance is analyzed quarterly. For purposes of this analysis, adequacy is defined as a level sufficient to absorb probable losses in the portfolio. The methodology employed for this analysis is as follows. The portfolio is segregated into risk-similar segments for which historical loss ratios are calculated and adjusted for identified changes in current portfolio characteristics. Historical loss ratios are calculated by product type for consumer loans (direct installment, indirect installment, revolving, and mortgage) and by credit risk grade for performing commercial loans. Nonperforming commercial loans are individually assessed for impairment under SFAS 114 and assigned specific allocations. To allow for modeling error, a range of probable loss ratios (from 95% to 105% of the adjusted historical loss ratio) is then derived for each segment. The resulting percentages are then applied to the dollar amounts of loans in each segment to arrive at each segment's range of probable loss levels. The Allowance for each portfolio segment is set at an amount within its range that reflects management's best judgment of the extent to which historical loss levels are more or less accurate indicators of current losses in the portfolio. Management's judgments evolve from an assessment of various issues, including but not limited to the pace of loan growth, emerging portfolio concentrations, risk management system changes, entry into new markets, new product offerings, loan portfolio quality trends, and uncertainty in current economic and business conditions. The Allowance is then segregated into allocated and unallocated components. The allocated component is the sum of the loss estimates at the lower end of the probable loss range for each category. The unallocated component is the sum of the amounts by which final loss estimates exceed the lower end estimates for each category. The unallocated component of the Allowance represents probable losses inherent in the portfolio based on our analysis that are not fully captured in the allocated component. Allocations of the Allowance to respective loan portfolio components are not necessarily indicative of future losses or future allocations. The entire Allowance is available to absorb losses in the loan portfolio. Assessing the adequacy of the Allowance is a process that requires considerable judgment. Management's judgments are based on numerous assumptions about current events, which we believe to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not 35 exceed the current Allowance amount or that future increases in the Allowance will not be required. No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the Allowance, thus adversely affecting the operating results of TSFG. The Allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine the adequacy and the size of the Allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require us to adjust our Allowance based on information available to them at the time of their examination. The Allowance totaled $50.0 million, or 1.20% of loans held for investment at September 30, 2002, compared with $43.9 million, or 1.18%, at September 30, 2001. The Allowance was 1.42 times and 1.28 times nonperforming loans at September 30, 2002 and 2001, respectively. Nonperforming loans were $35.2 million at September 30, 2002, compared with $34.2 million at September 30, 2001. See "Credit Quality." Table 6 summarizes the changes in the Allowance. Net charge-offs totaled $15.5 million, or 0.53% of average loans for the first nine months of 2002, up from $14.5 million and 0.52% in the first nine months of 2001. This increase is largely related to higher consumer loan charge-offs in the first quarter 2002. Net loan charge-offs in the third quarter 2002 were $5.4 million, or 0.54% of average loans, consistent with the 0.53% year-to-date 2002 average. 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 are expected to be comparable to the year-to-date average for 2002.
TABLE 6 ------------------------------------------------------------------------------------------------------------------------- SUMMARY OF LOAN LOSS EXPERIENCE ------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) AT AND FOR AT AND FOR THE NINE MONTHS THE YEAR ENDED ENDED SEPTEMBER 30, DECEMBER 31, ------------------------------------- 2002 2001 2001 ---- ---- ---- Loan loss reserve at beginning of year $ 44,587 $ 43,024 $ 43,024 Purchase accounting adjustments 2,877 - - Allowance adjustment for loans sold (12) (162) (230) Net charge-offs: Loans charged-off (18,377) (16,971) (23,154) Loans recovered 2,887 2,469 2,902 ---------- ---------- ---------- (15,490) (14,502) (20,252) Additions to reserve through provision expense 18,049 15,584 22,045 ---------- ---------- ---------- Loan loss reserve at end of period $ 50,011 $ 43,944 $ 44,587 ========== ========== ========== Average loans $3,894,325 $3,754,478 $3,769,358 Loans held for investment 4,152,054 3,739,620 3,730,250 Net charge-offs as a percentage of average loans (annualized) 0.53 % 0.52 % 0.54 % Allowance for loan losses as a percentage of loans held for investment 1.20 1.18 1.20
36 SECURITIES At September 30, 2002, TSFG's investment portfolio totaled $1.9 billion, up $768.7 million from $1.2 billion invested as of September 30, 2001 and up $296.3 million from the $1.6 billion invested as of December 31, 2001. The majority of this increase occurred in the fourth quarter 2001, when TSFG increased its U.S. Treasury security portfolio by approximately $520 million. In addition, on August 31, 2002, TSFG added $125.5 million in available for sale securities from its merger with Gulf West. During 2001, as a result of declining interest rates, U.S. government agency securities were called prior to the stated maturities, and prepayments associated with mortgage-backed securities accelerated. TSFG increased the available for sale portfolio balances in preparation for additional prepayments of mortgage-backed securities and to increase net interest income by leveraging available capital. TSFG may elect to sell investment securities depending on its need for liquidity to fund loan demand and the general level of interest rates. 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. Securities (i.e., securities held to maturity, securities available for sale, and trading securities) excluding the unrealized gain recorded for available for sale securities averaged $1.7 billion in the first nine months of 2002, up significantly from the $1.0 billion average in the first nine months of 2001. The majority of the increase was attributable to purchases of securities to leverage available capital, anticipate accelerated paydowns of mortgage-backed securities, and provide for increased calls of U.S. agency securities. The average portfolio yield decreased in the first nine months of 2002 to 5.34% from 6.59% in the first nine months of 2001. The securities yield decreased due to a lower level of general interest rates and the addition of lower-yielding securities. The composition of the investment portfolio as of September 30, 2002 follows: mortgage-backed securities 63.8%, treasuries 12.5%, agencies 11.2%, state and municipalities 5.1%, and other securities 7.4% (which includes equity investments described below). To better position the securities portfolio for increasing interest rates, TSFG sold approximately $450 million of 10-year U.S. Treasury securities and purchased approximately $412 million of adjustable rate mortgage-backed securities during the third quarter 2002. This repositioning shifted the investment portfolio composition to 63.8% mortgage-backed securities and 12.5% treasuries as of September 30, 2002 from 42.4% and 31.8%, respectively, as of June 30, 2002. During the first nine months of 2002, the gross unrealized gain on securities (pre-tax) increased to $27.9 million at September 30, 2002 from a $7.6 million loss at December 31, 2001. The increase in the gross unrealized gain for the nine months ended September 30, 2002 was primarily associated with U.S. Treasury securities, which increased $29.0 million, and was the result of a change in the level of longer-term interest rates. During the third quarter, TSFG transferred $208.2 million of U.S. treasury securities from available for sale securities to trading securities at fair value and recognized a $1.6 million unrealized gain at the time of transfer. Also, during the third quarter, TSFG purchased an additional $363.0 million of U.S. Treasury securities, which were classified as trading, and contemporaneously hedged the purchase of these securities with futures contracts. Prior to September 30, 2002, TSFG sold the $571.2 million of U.S. Treasury securities and settled the futures contracts for a net loss of $364,000, which includes the $1.6 million gain recorded upon transferring the securities to trading securities. EQUITY INVESTMENTS Investment in NetBank, Inc. At September 30, 2002, TSFG owned 725,000 shares of NetBank, Inc. ("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 and has a cost basis of approximately $201,000, was recorded at its pre-tax market value of approximately $7.5 million as of September 30, 2002. During 2002, TSFG sold 450,000 shares of NetBank for a pre-tax gain of $4.7 million. 37 Investment in Affinity Technology Group, Inc. At September 30, 2002, TSFG, through its subsidiary Blue Ridge Finance Company, Inc. ("Blue Ridge"), owned 4,876,340 shares of common stock of Affinity, or approximately 11% of the outstanding shares. TSFG's investment in Affinity, which is included in securities available for sale and has a cost basis of approximately $433,000, was recorded at its pre-tax market value of approximately $293,000 as of September 30, 2002. Investments in Banks. As of September 30, 2002, TSFG had equity investments in sixteen community banks located in the Southeast. With one exception (RHBT which is discussed below), TSFG owns less than 5% of the community bank's outstanding common stock. TSFG has made these investments to develop correspondent banking relationships and to promote community banking in the Southeast. As of September 30, 2002, equity investments in these community banks (excluding RHBT) were included in securities available for sale with a cost basis of approximately $10.2 million and were recorded at their pre-tax market value of $11.2 million. As a result of TSFG's acquisition of Anchor Financial Corporation in 2000 ("Anchor"), TSFG acquired 382,500 shares, or 22% of the outstanding shares, of RHBT (which were owned by Anchor). TSFG continues to hold these shares. The RHBT investment is included in securities available for sale. On October 31, 2002, TSFG completed the acquisition of substantially all the assets and deposits of Rock Hill, which is the wholly-owned banking subsidiary of RHBT. See "Mergers." During the third quarter, TSFG wrote-down its investment in RHBT by $1.2 million from $3.1 million to its September 30, 2002 estimated fair value of approximately $1.9 million, or $5.00 per share. The Board of Directors of RHBT presently plans to distribute most, but not necessarily all, of the 430,017 shares of TSFG common stock received by Rock Hill to RHBT shareholders after closing of the sale of assets. Upon the distribution of the TSFG common stock to RHBT shareholders, TSFG will cancel any TSFG shares received. TSFG also has an investment in Nexity Financial Corporation, an Internet bank, which is 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 September 30, 2002, CF Investment Company had invested approximately $1.2 million in a company specializing in electronic document management and $502,000 in a paycard company. Other Equity Investments. In addition to the equity investments described in the preceding paragraphs, equity investments in available for sale securities at September 30, 2002, which are carried at market value, included corporate bonds of $84.2 million, FHLB stock of $31.1 million, and corporate common and preferred stocks of $4.3 million. At September 30, 2002, the aggregate market value for these other equity investments totaled $119.6 million with a cost basis of $118.5 million. INTANGIBLE ASSETS The intangible assets balance at September 30, 2002 of $176.8 million was attributable to goodwill of $162.1 million, core deposit premiums of $13.1 million, customer list intangibles of $857,000, and non-compete agreement intangibles of $659,000. The intangible assets balance at September 30, 2001 of $98.5 million consisted of goodwill of $92.7 million and core deposit premiums of $5.8 million. The increase in goodwill was primarily due to the $71.1 million of goodwill acquired during 2002 from the Gulf West merger and $876,000 of goodwill acquired from the acquisition of Gardner Associates. The increase was partially offset by the transitional impairment loss of $1.4 million in connection with goodwill recorded for Carolina First Mortgage Company. TSFG was required to test its intangible assets for impairment in accordance with the provisions of SFAS 142, which TSFG adopted effective January 1, 2002. See Item 1, Notes 5 and 6 to the Consolidated Financial Statements. The increase in core deposit premiums was due to adding $8.4 million from the Gulf West merger. The customer list intangibles and non-compete agreement intangibles were added with the acquisition of Gardner Associates, an independent insurance agency. 38 DEPOSITS Deposits remain TSFG's primary source of funds for loans and investments. Deposits provided funding for 65.0% and 77.1% of average earning assets for the nine months ended September 30, 2002 and 2001, respectively. 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, we have developed other sources, such as FHLB advances and short-term borrowings, to fund a portion of loan demand and increases in investment securities. In addition, we have increased the use of brokered certificates of deposits, which are included in deposits. At September 30, 2002, deposits totaled $4.2 billion, up $559.0 million from September 30, 2001. On August 31, 2002, TSFG acquired $418.9 million in deposits from its merger with Gulf West, which accounted for the majority of the increase. In addition, this increase includes a $323.7 million increase in brokered certificates of deposit. At September 30, 2002, TSFG had $453.6 million in brokered certificates of deposit under $100,000, compared with $129.9 million at September 30, 2001. 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. Average deposits remained relatively constant at $3.7 billion for both the nine months ended September 30, 2002 and 2001. Deposit pricing remains very competitive, and we expect this pricing environment to continue. In 2001 and the first nine months of 2002, TSFG decided to keep deposit rates offered on par with competitors and reduced deposit rate-driven promotions, which resulted in lower deposit balances. Deposits acquired from Gulf West offset this decrease. Table 2 in "EARNINGS REVIEW--Net Interest Income" details average balances for the deposit portfolio for the nine months ended September 30, 2002 and 2001. On average, time deposits decreased $86.1 million, or 4.8%, which includes a $219.3 million increase in average brokered certificates of deposit. The decline in time deposits was largely attributable to fewer certificate of deposit promotions and maturities of certificates of deposits from promotions held in 2000. Increases in the average balances for other types of deposits, including noninterest-bearing of $61.7 million, money market accounts of $11.5 million, and interest checking of $10.4 million, offset this decrease. As part of its overall funding strategy, TSFG focuses on the mix of deposits and, in particular, increasing the level of transaction accounts (i.e., noninterest-bearing, interest checking, money market, and savings accounts). For the nine months ended September 30, 2002, transaction accounts made up 53.8% of average deposits, compared with 51.4% for the nine months ended September 30, 2001. The transaction account percentage increased to 54.9% for the third quarter of 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, in the summer of 2002, TSFG held a deposit campaign, based on employee referrals, to raise transaction accounts. At September 30, 2002, total deposits for Bank CaroLine, an Internet bank, totaled $34.1 million, down from $91.6 million as of September 30, 2001. 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 11.8% of total deposits at September 30, 2002 and 14.0% at September 30, 2001. TSFG's larger denomination time deposits are generally from customers within the local market areas of its banks and, therefore, have a greater degree of stability than is typically associated with this source of funds at other financial institutions. BORROWED FUNDS TSFG's short-term borrowings consist of federal funds purchased and repurchase agreements, FHLB advances (with maturities less than one year when made), commercial paper, and other short-term borrowings. The long-term borrowings 39 consist primarily of subordinated notes, trust preferred debt, and FHLB borrowings and repurchase agreements with maturities greater than one year when made. In the first nine months of 2002, average borrowings totaled $1.9 billion compared with $1.0 billion for the same period in 2001. This increase was primarily attributable to an increased reliance on short-term borrowings to support earning asset growth and to fund increases in investment securities. Federal funds purchased and repurchase agreements are used to satisfy daily funding needs and, when advantageous, for rate arbitrage. Federal funds purchased and repurchase agreements totaled $1.2 billion and $680.2 million at September 30, 2002 and 2001, respectively. The higher balances are primarily associated with the financing of 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. At September 30, 2002 and 2001, FHLB advances totaled $605.7 million and $479.3 million, respectively. FHLB advances are a source of funding which TSFG uses depending on the current level of deposits, management's willingness to raise deposits through market promotions, the Subsidiary Banks' unused FHLB borrowing capacity, and the availability of collateral to secure FHLB borrowings. TSFG increased long-term borrowings in 2002 to provide longer-term liquidity. For example, in February and April 2002, TSFG entered into ten-year repurchase agreements for a total of approximately $200 million. In July 2002, TSFG, through two wholly-owned trust subsidiaries, issued and sold floating rate securities to institutional buyers in two pooled trust preferred issues. These securities generated net proceeds to TSFG of $41.2 million. Debt issuance costs totaled $1.3 million. The trust preferred debt qualifies as tier 1 capital under Federal Reserve Board guidelines. See Item 1, Note 10 to the Consolidated Financial Statements for the terms of the trust preferred debt. On August 31, 2002, TSFG redeemed $26.3 million of 9.00% Subordinated Notes Due 2005. In connection with the redemption, TSFG recorded a $354,000 loss on early extinguishment of debt. On October 29, 2002, through a wholly-owned trust subsidiaries, issued and sold floating rate securities to institutional buyers in a pooled trust preferred issues. These securities generated gross proceeds to TSFG of $22.0 million. Debt issuance costs totaled $680,000. The trust preferred debt qualifies as tier 1 capital under Federal Reserve Board guidelines. See Item 1, Note 15 to the Consolidated Financial Statements for the terms of the trust preferred debt. CAPITAL RESOURCES AND DIVIDENDS TSFG is committed to managing capital for maximum shareholder benefit and maintaining strong protection for depositors, creditors, and its employees. Total shareholders' equity amounted to $554.6 million, or 8.1% of total assets, at September 30, 2002, compared with $476.1 million, or 8.7% of total assets, at September 30, 2001. At December 31, 2001, total shareholders' equity was $458.2 million, or 7.6% of total assets. Shareholders' equity increased since December 31, 2001 primarily from retention of earnings, the unrealized gains in the investment securities available for sale portfolio, and the issuance of common stock for the Gulf West merger. TSFG's stock repurchase program and cash dividends paid partially offset these increases. In December 2000, we initiated a stock repurchase program for up to two million shares, which we expanded to three million shares in September 2001. In February 2002, we added an additional one million shares and in August 2002, we added an additional 1.1 million shares, in connection with the Gulf West merger, bringing the total to 5.1 million shares. In connection with the program, TSFG has repurchased 4,535,690 shares, including 2,141,907 shares purchased during the first nine months of 2002. We may continue to repurchase shares depending upon current market conditions and available cash. 40 TSFG's unrealized gain on securities, which is included in accumulated other comprehensive income, was $18.7 million as of September 30, 2002 as compared to an unrealized gain of $19.0 million as of September 30, 2001 and an unrealized loss of $5.6 million as of December 31, 2001. The increase in the unrealized gain (net of deferred income tax) for the nine months ended September 30, 2002 was comprised of increases in: U.S. Treasury securities $19.8 million, mortgage-backed securities $3.9 million, agencies $3.2 million, and state and municipalities $441,000. This increase was partially offset by a decrease in other securities of $3.0 million, principally from the decline in the value of RHBT. Book value per share at September 30, 2002 and 2001 was $12.72 and $11.53, respectively. Tangible book value per share at September 30, 2002 and 2001 was $8.68 and $9.14, respectively. Tangible book value was below book value as a result of the purchase premiums associated with branch purchases and acquisitions accounted for as purchases. TSFG and its Subsidiary Banks exceeded the well-capitalized regulatory requirements at September 30, 2002. Table 7 sets forth various capital ratios for TSFG and its Subsidiary Banks.
TABLE 7 -------------------------------------------------------------------------------------------------------------------------- CAPITAL RATIOS -------------------------------------------------------------------------------------------------------------------------- WELL ADEQUATELY SEPTEMBER 30, CAPITALIZED CAPITALIZED 2002 REQUIREMENT REQUIREMENT ---- ----------- ----------- THE SOUTH GROUP: Total risk-based capital 11.45 % n/a n/a Tier 1 risk-based capital 9.12 n/a n/a Leverage ratio 7.22 n/a n/a CAROLINA FIRST BANK: Total risk-based capital 12.09 % 10.00 % 8.00 % Tier 1 risk-based capital 8.91 6.00 4.00 Leverage ratio 6.48 5.00 4.00 MERCANTILE BANK: Total risk-based capital 12.65 % 10.00 % 8.00 % Tier 1 risk-based capital 8.60 6.00 4.00 Leverage ratio 10.13 5.00 4.00
TSFG and its Subsidiary Banks are subject to certain regulatory restrictions on the amount of dividends they are permitted to pay. We have paid a cash dividend each quarter since the initiation of cash dividends on February 1, 1994. TSFG presently intends to pay a quarterly cash dividend on its Common Stock; however, future dividends will depend upon our financial performance and capital requirements. On June 11, 2002, Carolina First Bank sold 131 shares of the Carolina First Mortgage Loan Trust's Series 2000A Cumulative Fixed Rate Preferred Shares (the "Series A Trust Preferred Stock") and 385 shares of Carolina First Mortgage Loan Trust's Series 2002C Cumulative Floating Rate Preferred Shares (the "Series C Trust Preferred Stock") to institutional buyers. Proceeds to Carolina First Bank from these sales totaled approximately $49.2 million, net of issuance costs totaling $2.4 million, and are reported as minority interest in consolidated subsidiary on the consolidated balance sheet. The minority interest in consolidated subsidiary qualifies as tier 1 capital (in the case of Series A Trust Preferred Stock) and tier 2 capital (in the case of Series C Trust Preferred Stock) under Federal Reserve Board guidelines. See Item 1, Note 11 to the Consolidated Financial Statements. 41 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 net proceeds to TSFG of $62.5 million, which qualifies as tier 1 capital under Federal Reserve Board guidelines. See Item 1, Notes 10 and 15 to the Consolidated Financial Statements. MARKET RISK AND ASSET/LIABILITY MANAGEMENT Market risk is the risk of loss from adverse changes in market prices and rates. TSFG's market risk arises principally from interest rate risk inherent in its core banking activities. Interest rate risk is the risk to net income represented by the impact of higher or lower interest rates. TSFG has risk management policies to monitor and limit exposure to interest rate risk. The disclosures related to the market risk of TSFG should be read in conjunction with TSFG's audited consolidated financial statements, related notes, and management's discussion and analysis of financial condition and results of operations included in TSFG's Annual Report on Form 10-K for the year ended December 31, 2001. We attempt to manage exposure to fluctuations in interest rates through policies established by our Asset/Liability Committee ("ALCO") and approved by the Board of Directors. The primary goal of TSFG's ALCO is to achieve consistent growth in net interest income while managing interest rate risk. We attempt to control the mix and maturities of assets and liabilities to achieve consistent growth in net interest income despite changes in market interest rates while maintaining adequate liquidity and capital. Our asset/liability mix is sufficiently balanced so that the effect of interest rates moving in either direction is not expected to have a significant impact on net interest income over time. TSFG uses several tools to monitor and manage interest rate risk. One of the primary tools is a simulation model which is used to analyze earnings at risk and the interest sensitivity gap (the difference between the amount of rate sensitive assets maturing or repricing within a specific time period and the amount of rate sensitive liabilities maturing or repricing within the same time period). The model takes into account interest rate changes as well as changes in the mix and volume of assets and liabilities. The model's inputs (such as interest rates and levels of loans and deposits) are updated on a regular basis. Interest sensitivity gap ("GAP position") measures the difference between rate sensitive assets and rate sensitive liabilities during a given time frame. TSFG's GAP position, while not a complete measure of interest sensitivity, is reviewed periodically to provide insights related to the static repricing structure of assets and liabilities. At September 30, 2002, on a cumulative basis through twelve months, rate-sensitive assets exceeded rate-sensitive liabilities, resulting in an asset sensitive position of $510.2 million. This asset sensitivity increased from the June 30, 2002 figure of $30.2 million primarily as a result of anticipated accelerated prepayment speeds on mortgage-backed securities, sales of 10-year U.S. Treasury securities, and purchases of adjustable rate mortgage-backed securities that reprice within a year. At September 30, 2002, TSFG's static gap position indicates that net interest income on a cumulative basis through twelve months would benefit from increases in market interest rates. The static gap position is limited because it does not take into account the effect of changes in interest rates or changes in management's expectations or intentions, including any potential sales of assets or liabilities that TSFG might contemplate depending upon variations in the markets. In addition, indications of the impact of interest rate changes using the static gap position may differ from the simulation model estimates. As of year end 2001, TSFG's GAP position was a $256.3 million liability sensitive position. The forecast used for earnings at risk analysis simulates our consolidated balance sheet and consolidated statements of income under several different rate scenarios over a twelve-month period. It reports a case in which interest rates remain flat and reports variations that occur when rates gradually increase and decrease 200 basis points over the next twelve-month period. These rates assume a parallel shift in the treasury yield curve, except for lower limits in the 42 declining rate scenario 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 activities TSFG could undertake in response to changes in interest rates. According to the model as of September 30, 2002, TSFG is positioned so that net interest income will increase $10.7 million, or 4.6%, in the next twelve months if interest rates rise 200 basis points and will decrease $3.7 million, or -1.6%, in the next twelve months if interest rates decline 200 basis points. In the increasing rate scenario, the prepayment speeds are reduced on the mortgage-backed securities, which leads to a higher level of earning assets and higher interest income. The decrease in net interest income in the declining rate scenario is limited due to assumptions related to both earning asset and interest-bearing liability repricings. 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 200 basis points. The floors placed on these key rates restrict the reduction in both interest income and expense. In addition, many deposit rates are reaching what management believes to be an acceptable lower limit. For example, the model assumes that certificate of deposit rates will not decline below 0.50% thus limiting the interest expense reduction from repricing certificates of deposit by the entire 200 basis points. The overall interest rate risk position of TSFG continues to fall within the interest rate risk guidelines established by ALCO. In addition to the standard scenarios used to analyze earnings at risk, TSFG's ALCO analyzes the potential impact of other scenarios. The starting point for these "what-if" scenarios is our base forecast. This base forecast consolidates all balance sheet information that we are presently aware of with our "most likely" interest rate projections. The "what-if" scenarios are then used to gauge the impact of changes in interest rates and/or balance sheet items on the earnings of TSFG compared to the base forecast. Strategies can be formulated based on the information provided by the earnings simulation if a scenario either seems likely to occur or we choose to undertake the proposed transaction. TSFG updates its base forecast quarterly based on economic changes that occurred during the past quarter as well as changes in the economic outlook. 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 with indices that relate to the pricing of specific on-balance sheet instruments and forecasted transactions, and futures contracts. 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. Beginning in the second quarter 2002, TSFG began using futures contracts to hedge interest rate risk associated with investment securities. As such, the investment securities, subsequently classified as trading securities, and the related futures contracts are recorded at fair value. Any ineffectiveness resulting from differences between the changes in fair value of the investment securities and futures contracts will be recognized in the consolidated statements of income as gains or losses in trading securities. TSFG increased its hedging activities associated with investment securities in the third quarter 2002. Such activities may result in increased volatility in realized gains and losses on trading activities. See "Securities." 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. TSFG's use of these instruments increased in the third quarter 2002. 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 43 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. We manage the market risk associated with interest rate contracts by establishing and monitoring limits as to the types and degree of risk that may be undertaken. The market risk associated with derivatives used for interest rate risk management activity is fully incorporated into our market risk sensitivity analysis. In accordance with SFAS 133, TSFG records derivatives at fair value, as either assets or liabilities, on the consolidated balance sheets. At September 30, 2002, the fair value of derivative assets totaled $6.7 million and was related to derivatives with no hedging designation and fair value hedges. At September 30, 2002, the fair value of derivative liabilities totaled $541,000 for cash flow hedges and $208,000 for futures, options, and other derivatives, which do not qualify for hedge accounting under SFAS 133. 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 September 30, 2002 and 2001, TSFG had no interests in non-consolidated special purpose entities. Lending Commitments. Lending commitments include loan commitments, standby letters of credit, unused business credit card lines, and documentary letters of credit. These instruments are not recorded in the consolidated balance sheet until funds are advanced under the commitments. TSFG provides these lending commitments to customers in the normal course of business. For commercial customers, loan commitments generally take the form of revolving credit arrangements to finance customers' working capital requirements. For retail customers, loan commitments are generally lines of credit secured by residential property. At September 30, 2002, commercial and retail loan commitments totaled $819.9 million. These commitments increased from $698.4 million at June 30, 2002, due primarily to the addition of approximately $80 million from Gulf West and increases in home equity loan commitments. Standby letters of credit are conditional commitments to guarantee performance, typically contract or financial integrity, of a customer to a third party and totaled $45.2 million at September 30, 2002. Documentary letters of credit are typically issued in connection with customers' trade financing requirements and totaled $27.4 million at September 30, 2002. Unused business credit card lines, which totaled $16.4 million at September 30, 2002, are generally for short-term borrowings. TSFG applies essentially the same credit policies and standards as it does in the lending process when making these commitments. Derivatives. In accordance with SFAS 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. 44 At September 30, 2002, the fair value of derivative assets totaled $6.7 million and was related to derivatives with no hedging designation and fair value hedges. At September 30, 2002, the fair value of derivative liabilities totaled $541,000 for cash flow hedges and $208,000 for futures, options, and other derivatives, which do not qualify for hedge accounting under SFAS 133. The related notional amounts, which are not recorded on the consolidated balance sheets, totaled $283.0 million for the derivative assets and $417.9 million for the derivative liabilities. 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 September 30, 2002, CFGRL had in force insurance not recorded on the consolidated balance sheets of $31.6 million. A loss reserve, determined based on reported and past loss experience of in force policies, of $176,000 was included in other liabilities at September 30, 2002. 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 September 2002, TSFG settled its existing accelerated share repurchase contract by issuing 93,693 shares and entered into a new accelerated share repurchase contract with an unaffiliated company to repurchase 1.1 million shares of TSFG common stock (subject to blackout periods at TSFG's option, which may extend the contract period) and to settle the contract in stock. TSFG expects the counterparty's purchases of shares under this contract to continue into the first quarter 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, we focus 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 of 106 branches in South Carolina, North Carolina, and Florida. In addition, TSFG can raise deposits on the Internet through Bank CaroLine. Liquidity needs are a factor in developing the Subsidiary Banks' deposit pricing structure, which may be altered to retain or grow deposits if deemed necessary. The Subsidiary Banks have access to borrowing from the FHLB and maintain short-term lines of credit from unrelated banks. FHLB advances, outstanding as of September 30, 2002, totaled $605.7 million. At September 30, 2002, the Subsidiary Banks had approximately $327.5 million of unused borrowing capacity from the FHLB. At September 30, 2002, $286.8 million of this excess capacity was 45 unavailable because the Subsidiary Banks had no available FHLB-qualifying collateral. 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 September 30, 2002, the Subsidiary Banks had unused short-term lines of credit totaling approximately $320.8 million (which are withdrawable at the lender's option). The Federal Reserve Bank provides back-up funding for commercial banks. Borrowing relationships with both the Federal Reserve Bank of Richmond and the Federal Reserve Bank of Atlanta are being put in place for the Subsidiary Banks so that emergency funding needs can be met. Liquidity at the parent company level is provided through cash dividends from the Subsidiary Banks and the capacity of the parent company to raise additional borrowed funds or sell capital securities as needed. In October 2002, a trust subsidiary of TSFG issued and sold floating rate securities to institutional buyers in a pooled trust preferred issue, which generated net proceeds to the parent company of $21.3 million. See Item 1, Note 15 to the consolidated Financial Statements. If TSFG elects to repurchase additional shares through its share repurchase program, such purchases will reduce liquidity at the parent company level. At September 30, 2002, the parent company had unused short-term lines of credit totaling approximately $10.0 million (which are withdrawable at the lender's option). In the normal course of business, to meet the financial needs of its customers, TSFG, principally through the Subsidiary Banks, enters into agreement to extend credit. For amounts and types of such agreements at September 30, 2002, see "Off-Balance Sheet Arrangements." Increased demand for funds under these agreements would reduce TSFG's liquidity and could require additional sources of liquidity. CREDIT QUALITY A willingness to take credit risk is inherent in the decision to grant credit. Prudent risk-taking requires a credit risk management system based on sound policies and control processes that ensure compliance with those policies. TSFG's credit risk management system is defined by policies approved by the Board of Directors that govern the risk underwriting, portfolio monitoring, and problem loan administration processes. Adherence to underwriting standards is managed through a multi-layered credit approval process and immediate after-the-fact review by credit risk management of loans approved by lenders. Through daily review by credit risk managers, monthly reviews of exception reports, and ongoing analysis of asset quality trends, compliance with loan monitoring policies is managed. The administration of problem loans is driven by policies that require written plans for resolution and quarterly meetings with credit risk management to review progress. Credit risk management activities are monitored by the Directors' Credit Committees of each banking subsidiary, which meet monthly to review credit quality trends, new large credits, insider loans, large problem credits, credit policy changes, and reports on independent credit audits of city offices. Table 8 presents information pertaining to nonperforming assets. 46
TABLE 8 ------------------------------------------------------------------------------------------------------------------------- NONPERFORMING ASSETS AND PAST DUE LOANS ------------------------------------------------------------------------------------------------------------------------- (DOLLARS IN THOUSANDS) SEPTEMBER 30, DECEMBER 31, ------------------------------ 2002 2001 2001 ---- ---- ---- Nonaccrual loans - commercial $ 32,306 $ 31,946 $ 35,245 Nonaccrual loans - consumer 2,850 2,276 3,643 Restructured loans - - - --------- -------- -------- Total nonperforming loans 35,156 34,222 38,888 Other real estate owned 9,318 5,846 4,969 --------- -------- -------- Total nonperforming assets $ 44,474 $ 40,068 $ 43,857 ========= ======== ======== Loans past due 90 days still accruing interest (1) $ 5,744 $ 9,380 $ 10,482 ========= ======== ======== Total nonperforming assets as a percentage of loans and other real estate owned (2) 1.07 % 1.07 % 1.17 % ==== ==== ==== Allowance for loan losses as a percentage of nonperforming loans 1.42 x 1.28 x 1.15 x ==== ==== ====
(1) Substantially all of these loans are consumer and residential mortgage loans. (2) Calculated using loans held for investment, net of unearned income. Note: Nonperforming assets exclude repossessions, which totaled $1.4 million at September 30, 2002. Nonperforming assets were 1.07% of loans plus other real estate owned at September 30, 2002, compared with 1.17% at December 31, 2001 and 1.07% at September 30, 2001. Nonperforming loans have declined for the last two quarters. The third quarter 2002 decline reflected the payout of TSFG's largest nonaccrual loan, which totaled approximately $7.7 million. Approximately $179,000 of interest income was recorded in the third quarter 2002 in connection with this payout. Nonperforming loans at September 30, 2002 include the addition of $3.3 million from Gulf West. The following summarizes information on impaired loans (in thousands), all of which are in nonaccrual status, at and for the nine months ended September 30. All impaired loans are commercial loans. 2002 2001 ---- ---- Impaired loans $ 32,306 $ 31,946 Average investment in impaired loans 38,342 26,730 Related allowance 6,248 4,178 Recognized interest income - 296 Foregone interest 1,469 1,739 Nonaccrual loans were $35.2 million and $34.2 million on September 30, 2002 and 2001, respectively. Interest income recognized on nonaccrual loans totaled none and $297,000 for the nine months ended September 30, 2002 and 2001, respectively. Nonaccrual loans, concentrated in six credit relationships, accounted for 47.7% of the nonperforming loan balance. Estimated loss exposure for these six relationships totaled $1.3 million as of September 30, 2002. Total estimated impairment on all commercial nonaccrual loans totaled $6.2 million and $4.2 million as of September 30, 2002 and 2001, respectively. 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, portfolio quality indicators will remain volatile, nonperforming asset levels may fluctuate, and charge-offs will tend to be higher than historical norms. Management believes, however, that loss exposure in its loan portfolio is identified, adequately reserved for in a 47 timely manner, and closely monitored to ensure that changes are promptly addressed in its analysis of Allowance adequacy. Accordingly, management believes the Allowance as of September 30, 2002 was adequate, based on its assessment of probable losses, and available facts and circumstances then prevailing. CURRENT ACCOUNTING ISSUES In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" ("SFAS 141"), and SFAS No. 142, "Goodwill and Other Intangible Assets" ("SFAS 142"). SFAS 141 requires that the purchase method of accounting be used for all business combinations initiated after September 30, 2001, as well as all purchase method business combinations completed after September 30, 2001. SFAS 141 also specifies criteria intangible assets acquired in a purchase method business combination must meet to be recognized and reported apart from goodwill, noting that any purchase price allocable to assembled workforce may not be accounted for separately. SFAS 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead tested for impairment at least annually in accordance with the provisions of SFAS 142. SFAS 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS 121, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"). TSFG adopted the provisions of SFAS 141, as of the date of issuance, and SFAS 142, effective January 1, 2002. See Note 5 to the Consolidated Financial Statements for the financial impact from the January 1, 2002 adoption of SFAS 142. In connection with the transitional goodwill, SFAS 142 requires TSFG to perform an assessment of whether there is an indication that goodwill is impaired as of January 1, 2002. To accomplish this, TSFG had to identify its reporting units and determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets, to those reporting units as of the date of adoption. TSFG had until June 30, 2002 to determine the fair value of each reporting unit and compare it to the reporting unit's carrying amount. To the extent a reporting unit's carrying amount exceeds its fair value, an indication exists that the reporting unit's goodwill may be impaired, and the second step of the transitional impairment test must be performed. In the second step, the implied fair value of the reporting unit's goodwill, determined by allocating the reporting unit's fair value to all of it assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation in accordance with SFAS 141, "Business Combinations," is compared to its carrying amount, both of which would be measured as of January 1, 2002. TSFG has completed its analysis of the fair value of its intangible assets and determined that the goodwill associated with Carolina First Mortgage Company was impaired. TSFG recorded a transitional impairment loss of $1.4 million. This transitional impairment loss was recognized as the cumulative effect of a change in accounting principle in the consolidated statements of income for the nine months ended September 30, 2002 (although it was not reflected in the third quarter 2002 results since the impairment is reflected as of January 1, 2002). In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections" ("SFAS 145"). SFAS 145 rescinds SFAS No. 4, "Reporting Gains and Losses from Extinguishments of Debt" ("SFAS 4"), and an amendment of SFAS 4, SFAS No. 64, "Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements." SFAS 145 requires that gains and losses from extinguishment of debt should be classified as an extraordinary item only if they meet the criteria of FASB Opinion No. 30, "Reporting the Results of Operations-Reporting the Effects of Disposal of a Segment of Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions" ("FASB Opinion 30"). Applying the provisions of FASB Opinion 30 will distinguish transactions that are part of an entity's recurring operations from those that are unusual or infrequent or that meet the criteria for classification as an extraordinary item. 48 The provisions of SFAS 145 are effective for financial statements issued for fiscal years beginning after May 15, 2002 and interim periods within those fiscal years, and early adoption is encouraged. Any gain or loss on extinguishment of debt that was classified as an extraordinary item in prior periods presented that does not meet the criteria in FASB Opinion 30 for classification as an extraordinary item will be reclassified. TSFG adopted SFAS 145 effective July 1, 2002. In connection with this adoption, TSFG reclassified losses on the early extinguishment of debt, which were incurred in the second half of 2001 and totaled $3.1 million pre-tax, as noninterest expenses. In September 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities" ("SFAS 146"), which addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)." SFAS 146 applies to costs associated with an exit activity that does not involve an entity newly acquired in a business combination or with a disposal activity covered by SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." 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. This Statement does not apply to costs associated with the retirement of a long-lived asset covered by SFAS No. 143, "Accounting for Asset Retirement Obligations." A liability for a cost associated with an exit or disposal activity shall be recognized and measured initially at its fair value in the period in which the liability is incurred. A liability for a cost associated with an exit or disposal activity is incurred when the definition of a liability is met in accordance with FASB Concepts Statements No. 6, "Elements of Financial Statements." The provisions of this Statement are effective for exit or disposal activities that are initiated after December 31, 2002, with early application encouraged. The impact of adoption on the Corporation is not known at this time. In October 2002, the FASB issued SFAS No. 147, "Acquisitions of Certain Financial Institutions an amendment of FASB Statements No. 72 and 144 and FASB Interpretation No. 9" ("SFAS 147"). SFAS 147 removes acquisitions of financial institutions from the scope of both FASB Statements No. 72 ("SFAS 72") and FASB Interpretation No. 9 and requires that those transactions be accounted for in accordance with FASB Statements No. 141, "Business Combinations," and No. 142, "Goodwill and Other Intangible Assets," except for transactions between two or more mutual enterprises. Thus, the requirement in SFAS 72 to recognize (and subsequently amortize) any excess of the fair value of liabilities assumed over the fair value of tangible and identifiable assets acquired as an unidentifiable intangible asset no longer applies to acquisitions within the scope of the scope of SFAS 72. In addition, SFAS 147 amends FASB Statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), to include in its scope long-term customer-relationship intangible assets of financial institutions such as depositor- and borrower-relationship intangible assets and credit cardholder intangible assets. Consequently, those intangible assets are subject to the same undiscounted cash flow recoverability test and impairment loss recognition and measurement provisions that SFAS 144 requires for other long-lived assets that are held and used. The provisions of SFAS 147 are effective for financial statements issued on or after October 1, 2002 and early adoption is permitted. In the third quarter, TSFG adopted SFAS 147 effective as of January 1, 2002. With the third quarter adoption of SFAS 147, the unamortized unidentifiable intangible assets related to branch purchases, which totaled $2.5 million, net of accumulated amortization, as of September 30, 2002, were reclassified as goodwill. In connection with this adoption, TSFG reversed $112,000 pre-tax of amortization of intangibles, which were recorded in the first half of 2002. 49 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 (a) Evaluation of Disclosure Controls and Procedures TSFG's Executive Officer and Principal Financial Officer have evaluated TSFG's disclosure controls and procedures as of November 4, 2002, and they concluded that these controls and procedures are effective. (b) Changes in Internal Controls There are no significant changes in internal controls or in other factors that could significantly affect these controls subsequent to November 4, 2002. 50 PART II. OTHER INFORMATION ITEM 1 LEGAL PROCEEDINGS See Note 13 to the Consolidated Financial Statements for a discussion of legal proceedings. ITEM 2 CHANGE IN SECURITIES None. ITEM 3 DEFAULTS UPON SENIOR SECURITIES None. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None. ITEM 5 OTHER INFORMATION None. ITEM 6 EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 10.1 Amendment 5 to The South Financial Group Amended and Restated Stock Option Plan. 99.1 Certificates filed pursuant to Section 906 of the Sarbanes Oxley Act of 2002. (b) Reports on Form 8-K The South Group filed Current Reports on Form 8-K dated July 11, 2002, July 25, 2002, August 6, 2002, August 26, 2002, and August 31, 2002. 51 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, TSFG has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. The South Financial Group, Inc. /s/ William S. Hummers III ------------------------------------ William S. Hummers III Executive Vice President 52 CERTIFICATION I, Mack I. Whittle, Jr., certify that: 1. I have reviewed this quarterly report on Form 10-Q of The South Financial Group, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ Mack I. Whittle, Jr. ------------------------ Mack I. Whittle, Jr. Chief Executive Officer 53 CERTIFICATION I, William S. Hummers III, certify that: 1. I have reviewed this quarterly report on Form 10-Q of The South Financial Group, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/ William S. Hummers III -------------------------- William S. Hummers III Executive Vice President (principal financial officer) 54