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| TSFG > SEC Filings for TSFG > Form 10-K on 3-Mar-2009 | All Recent SEC Filings |
3-Mar-2009
Annual Report
The following discussion and analysis are presented to assist in understanding the financial condition, changes in financial condition, results of operations, and cash flows of The South Financial Group, Inc. and its subsidiaries (collectively, "TSFG"), except where the context requires otherwise. TSFG may also be referred to herein as "we", "us", or "our." This discussion should be read in conjunction with the audited Consolidated Financial Statements and accompanying Notes presented in Item 8 of this report and the supplemental financial data appearing throughout this report. Percentage calculations contained herein have been calculated based upon actual, not rounded, results.
TSFG primarily operates through its subsidiary bank, Carolina First Bank, which conducts operations in South Carolina and North Carolina (as Carolina First) and in Florida (as Mercantile).
Index to Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations
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 may be identified by the use of such words as:
"estimate", "anticipate", "expect", "believe", "intend", "plan", or words of
similar meaning, or future or conditional verbs such as "may", "intend",
"could", "will", or "should". 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. A variety of factors, some of which are discussed in more
detail in Item 1A - Risk Factors, may affect the operations, performance,
business strategy and results of TSFG including, but not limited to, the
following:
• risks from changes in economic, monetary policy, regulatory, governmental, and industry conditions;
• changes in interest rates, shape of the yield curve, deposit rates, the net interest margin, and funding sources;
• market risk (including net interest income at risk analysis and economic value of equity risk analysis) and inflation;
• risks inherent in making loans including repayment risks and changes in the value of collateral;
• loan growth, loan sales, the adequacy of the allowance for credit losses, provision for credit losses, and the assessment of problem loans (including loans acquired via acquisition);
• continued deterioration in the overall credit environment;
• level, composition, and repricing characteristics of the securities portfolio;
• deposit growth, change in the mix or type of deposit products and cost of deposits;
• loss of deposits due to perceived financial condition or otherwise;
• availability of wholesale funding;
• adequacy of capital and future capital needs;
• fluctuations in consumer spending;
• competition in the banking industry and demand for our products and services;
• continued availability of senior management;
• technological changes;
• ability to increase market share;
• income and expense projections, ability to control expenses, and expense reduction initiatives;
• changes in the compensation, benefit, and incentive plans, including compensation accruals;
• risks associated with income taxes, including the potential for adverse adjustments and realization of deferred taxes;
• acquisitions, greater than expected deposit attrition or customer loss, inaccuracy of related cost savings estimates, inaccuracy of estimates of financial results, and unanticipated integration issues;
• valuation of goodwill and intangibles and any potential future impairment;
• significant delay or inability to execute strategic initiatives designed to grow revenues;
• changes in management's assessment of and strategies for lines of business, asset, and deposit categories;
• changes in accounting policies and practices;
• changes in the evaluation of the effectiveness of our hedging strategies;
• changes in regulatory actions, including the potential for adverse
• adjustments;
changes, costs, and effects of litigation, and environmental
remediation; and
• recently-enacted or proposed legislation.
Such forward-looking statements speak only as of the date on which such statements are made and shall be deemed to be updated by any future filings made by TSFG with the Securities and Exchange Commission ("SEC"). 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 SEC, 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.
Non-GAAP Financial Information
This report also contains financial information determined by methods other than in accordance with Generally Accepted Accounting Principles ("GAAP"). TSFG's management uses these non-GAAP measures to analyze TSFG's performance. In particular, TSFG presents certain designated net interest income amounts on a tax-equivalent basis (in accordance with common industry practice). Management believes that these presentations of tax-equivalent net interest income aid in the comparability of net interest income arising from both taxable and tax-exempt sources over the periods presented. In discussing its deposits, TSFG presents information summarizing its funding generated by customers using the following definitions: "customer deposits," which are defined by TSFG as total deposits less brokered deposits, and "customer funding," which is defined by TSFG as total deposits less brokered deposits plus customer sweep accounts. TSFG also discusses its funding generated from non-customer sources using the following definition: "wholesale borrowings" which are defined by TSFG as short-term and long-term borrowings less customer sweep accounts plus brokered deposits. Management believes that these presentations of "customer deposits," "customer funding," and "wholesale borrowings" aid in the identification of funding generated by its lines of business versus its treasury department. In addition, TSFG provides data eliminating intangibles in order to present data on a "tangible" basis. The limitations associated with operating measures are the risk that persons might disagree as to the appropriateness of items comprising these measures and that different companies might calculate these measures differently. Management compensates for these limitations by providing detailed reconciliations between GAAP and operating measures. These disclosures should not be viewed as a substitute for GAAP measures, and furthermore, TSFG's non-GAAP measures may not necessarily be comparable to non-GAAP performance measures of other companies.
Overview
The South Financial Group is a bank holding company, headquartered in Greenville, South Carolina, with $13.6 billion in total assets and 180 branch offices in South Carolina, Florida, and North Carolina at December 31, 2008. Founded in 1986, TSFG focuses on attractive Southeastern banking markets which have historically experienced long-term growth. TSFG operates Carolina First Bank, which conducts banking operations in South Carolina and North Carolina (as Carolina First), in Florida (as Mercantile), and on the Internet (as Bank CaroLine). At December 31, 2008, approximately 45% of TSFG's customer deposits (total deposits less brokered deposits) were in South Carolina, 41% were in Florida, and 14% were in North Carolina.
TSFG targets small business, middle market companies, and retail consumers. TSFG strives to combine personalized customer service and local decision-making, typical of community banks, with a full range of financial services normally found at larger regional institutions.
TSFG reported a net loss available to common shareholders of $568.6 million, or $(7.77) per diluted share, for 2008, compared with net income of $73.3 million or $0.99 per diluted share for 2007. The net loss was primarily due to a $426.0 million goodwill impairment charge resulting from a decrease in the value of the Mercantile banking segment and a $344.6 million provision for credit losses resulting from continued credit deterioration, particularly in the Florida market.
At December 31, 2008, nonperforming assets as a percentage of loans and foreclosed property increased to 4.10% from 0.88% at December 31, 2007. The increase in nonperforming assets was primarily attributable to accelerating deterioration in residential construction and development-related loans (which are included in commercial real estate loans), principally in Florida markets. For 2008, annualized net loan charge-offs totaled 2.16% of average loans held for investment, compared to 0.53% for the year ended December 31, 2007. TSFG's provision for credit losses increased to $344.6 million for 2008 compared to $68.6 million for 2007.
In order to strengthen its capital and liquidity position, TSFG issued a total of $597.0 million of preferred stock and warrants during 2008, with net proceeds of $585.0 million. Of this amount, $347.0 million of perpetual preferred stock and warrants were issued to the U.S. Treasury Department under the Troubled Asset Relief Program Capital Purchase Program (the "CPP") and $250.0 million of mandatorily convertible preferred stock (with net proceeds of $238.0 million) was issued to investors. The CPP preferred stock pays cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. The convertible preferred securities pay dividends at an annual rate of 10%, have a conversion price of $6.50 per common share, and the remaining outstanding shares (238,700 at December 31, 2008) will convert into approximately 36.7 million common shares on or before May 1, 2011. Subsequent to year-end, 48,674 shares of convertible preferred stock were converted into approximately 10.0 million common shares, which included 2.5 million shares issued as an inducement to convert. (See "Capital Resources and Dividends" under "Balance Sheet Review" and Note 19 to the Consolidated Financial Statements for additional details regarding preferred stock.)
TSFG's tangible equity to tangible asset ratio increased to 10.29% at December 31, 2008, from 6.61% at December 31, 2007, due primarily to the issuance of preferred stock. Tangible common equity to tangible assets was 6.05% at December 31, 2008 compared to 6.61% at December 31, 2007. Tangible common equity to tangible assets, assuming conversion of the mandatorily convertible preferred stock, was 7.84% at December 31, 2008. In addition, all regulatory capital ratios exceeded well-capitalized minimums.
Tax-equivalent net interest income was $385.5 million for 2008, a $3.5 million decrease from $389.0 million in 2007. The net interest margin decreased to 3.09% in 2008 from 3.10% for 2007, primarily due to increased nonperforming asset levels partially offset by the issuance of preferred stock. Federal Reserve actions to reduce the targeted fed funds rate by 400 basis points during 2008 led to decreased earning asset yields and a decline in average funding costs.
Noninterest income totaled $121.7 million for 2008, compared to $113.7 million for 2007. The increase in noninterest income was largely attributable to a gain on mandatory partial redemption of shares received in the Visa IPO of $1.9 million and a net gain on securities of $3.1 million in 2008 versus a $4.6 million net loss on securities in 2007. In addition, the change in noninterest income included a $990,000 positive swing from the loss associated with derivative activities. TSFG's debit card income (net) and trust and investment management income in 2008 increased over the prior year amounts, but were offset by decreases in most other noninterest income categories.
Noninterest expenses for 2008 totaled $792.0 million, compared to $321.2 million for 2007. This increase was primarily due to the $426.0 million goodwill impairment charge in 2008. The increase in noninterest expenses also included higher employment contract and severance expense related to the retirement of TSFG's CEO, higher regulatory assessments, higher loan collection and foreclosed asset expenses, and increases in most other noninterest expense categories.
Using period-end balances, TSFG's loans held for investment at December 31, 2008 decreased 0.21% from a year ago, and total deposits, including brokered deposits, decreased 3.9%. Customer funding (deposits less brokered deposits plus customer sweep accounts) decreased 2.3% since December 31, 2007.
On September 2, 2008, the Board of Directors and Mack I. Whittle, the Company's Chairman, President, and Chief Executive Officer, entered into a severance agreement pursuant to which Whittle would receive certain retirement benefits and retire on or before December 30, 2008 (at the Board's election). Subsequently, the Executive Committee, on behalf of the Board, specified that Whittle's retirement would be effective October 27, 2008. Those benefits included, among others, a lump sum cash payment of $4.1 million (subject to a six month delay pursuant to Section 409A of the Internal Revenue Code), vesting of all equity awards, service credit under the Supplemental Executive Retirement Plan through age 65 which provides an annual retirement payment commencing at retirement date, vested benefits under other Company plans, continued welfare and fringe benefits for three years, and three years of continued life insurance coverage. The incremental expense related to these benefits was approximately $12 million, which was recognized in the second half of 2008.
The Board appointed a Succession Committee to oversee a nationwide search for a replacement for Whittle. On November 3, 2008, the Board amended TSFG's Bylaws to consolidate the roles and responsibilities of the Chairman and Lead Independent Director into a single Chairman position. It named John C. B. Smith, Jr. as Chairman, and William R. Timmons III as Vice Chairman. On November 14, 2008, the Board named H. Lynn Harton as Interim President and CEO; subsequent to year-end, on February 9, 2009, the Board named Harton President and CEO and appointed him to the Board.
Recent Market Developments
The global and U.S. economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of residential-related loans and mortgage-backed securities, but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.
Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The availability of credit, confidence in the financial sector, and level of volatility in the financial markets have been significantly adversely affected as a result. In recent weeks, volatility and disruption in the capital and credit markets has reached unprecedented levels.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, the Emergency Economic Stabilization Act of 2008 (the "EESA") was signed into law on October 3, 2008. Pursuant to the EESA, the U.S. Treasury was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The U.S. Treasury has since injected capital into many financial institutions, including TSFG, under the Troubled Asset Relief Program Capital Purchase Program (the "CPP"). On December 5, 2008, TSFG entered into a Securities Purchase Agreement-Standard Terms with the U.S. Treasury pursuant to which, among other things, TSFG sold preferred stock and warrants to the U.S. Treasury for an aggregate purchase price of $347.0 million. Under the terms of the CPP, TSFG is prohibited from increasing dividends on its common stock, and from making certain repurchases of equity securities, including its common stock, without the U.S. Treasury's consent. Furthermore, as long as the preferred stock issued to the U.S. Treasury is outstanding, dividend payments and repurchases or redemptions relating to certain equity securities, including TSFG's common stock, are prohibited until all accrued and unpaid dividends are paid on such preferred stock, subject to certain limited exceptions. See "Balance Sheet Review-Capital Resources and Dividends" and Note 19 - Preferred Stock and Warrants in the accompanying Notes to the Consolidated Financial Statements in Item 8.
On October 3, 2008, the FDIC increased its insurance coverage limits on all deposits from $100,000 to $250,000 per account until December 31, 2009.
On October 14, 2008, the "systemic risk exception" to the FDIC Act was enacted, enabling the FDIC to temporarily provide a 100% guarantee of the senior unsecured debt of all FDIC-insured institutions and their holding companies, as well as deposits in noninterest-bearing transaction deposit accounts and certain interest-bearing checking accounts (for which the rate paid will not exceed 50 basis points) under a Temporary Liquidity Guarantee Program ("TLGP") through December 31, 2009. Coverage under the TLGP is available for 30 days without charge (subsequently extended to December 5, 2008) and thereafter at
a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for noninterest-bearing transaction deposits and certain interest-bearing checking accounts (for which the rate paid will not exceed 50 basis points).
TSFG opted into the TLGP with respect to noninterest-bearing deposit accounts and certain interest-bearing checking accounts (for which the rate paid will not exceed 50 basis points) in December 2008. TSFG currently does not plan to participate in the Temporary Liquidity Guarantee Program with respect to the guarantee of applicable unsecured obligations.
On February 10, 2009, the U.S. Treasury announced the Financial Stability Plan ("FSP"), which, among other things, proposes to establish a new Capital Assistance Program ("CAP") through which eligible banking institutions will have access to U.S. Treasury capital as a bridge to private capital until market conditions normalize, and extends the TLGP to October 31, 2009. As a complement to the CAP, a new Public-Private Investment Fund on an initial scale of up to $500 billion, with the potential to expand up to $1 trillion, was announced to catalyze the removal of legacy assets from the balance sheets of financial institutions. This proposed fund will combine public and private capital with government financing to help free up capital to support new lending. In addition, the existing Term Asset-Backed Securities Lending Facility ("TALF") would be expanded (up to $1 trillion) in order to reduce credit spreads and restart the securitized credit markets that in recent years supported a substantial portion of lending to households, students, small businesses, and others. Furthermore, the FSP proposes a new framework of governance and oversight to help ensure that banks receiving funds are held responsible for appropriate use of those funds through stronger conditions on lending, dividends and executive compensation along with enhanced reporting to the public.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (the "Stimulus Bill") was signed into law. The Stimulus Bill is intended to provide tax breaks for individuals and businesses, direct aid to distressed states and individuals, and infrastructure spending. The Stimulus Bill also limits executive compensation at companies that have received or will receive CPP funds based on a sliding scale of funds received. Also in February 2009, the U.S. Treasury announced the Homeowner Affordability and Stability Plan ("HASP"), which proposes to provide refinancing for certain homeowners, to support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac, and to establish a Homeowner Stability Initiative to reach at-risk homeowners. Among other things, the Homeowner Stability Initiative would offer monetary incentive to mortgage servicers and mortgage holders for certain modifications of at-risk loans, and would establish an insurance fund designed to reduce foreclosures.
It is not clear at this time what impact the EESA, the CPP, the TLGP, the FSP, the Stimulus Bill, the HASP, or other liquidity and funding initiatives will have on the financial markets and the other difficulties described above, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. and global economies. Failure of these programs to address the issues noted above could have an adverse effect on the Company and its business.
Critical Accounting Policies and Estimates
TSFG's accounting policies are in accordance with accounting principles generally accepted in the United States and with general practice within the banking industry. TSFG makes a number of judgmental estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during periods presented. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and reserve for unfunded lending commitments, the effectiveness of derivatives and other hedging activities, the fair value of certain financial instruments (securities, derivatives, and privately held investments), income tax assets or liabilities, share-based compensation, and accounting for acquisitions, including the fair value determinations and the analysis of goodwill impairment. To a lesser extent, significant estimates are also associated with the determination of contingent liabilities, discretionary compensation, and other employee benefit agreements. Different assumptions in the application of these policies could result in material changes in TSFG's Consolidated Financial Statements. Accordingly, as this information changes, the Consolidated Financial Statements could reflect the use of different estimates, assumptions, and judgments. Certain determinations inherently have a greater reliance on the use of estimates, assumptions, and judgments, and as such have a greater possibility of producing results that could be materially different than originally reported. TSFG has procedures and processes in place to facilitate making these judgments.
The allowance for loan losses ("Allowance") represents management's estimate of probable incurred losses in the lending portfolio. See "Balance Sheet Review - Allowance for Loan Losses" for additional discussion, including the methodology for analyzing the adequacy of the Allowance. This methodology relies upon management's judgment in segregating the portfolio into risk-similar segments, computing specific allocations for impaired loans, and setting the amounts within the probable loss range (from 95% to 105% of the adjusted historical loss ratio). Management's judgments evolve from an assessment of various issues, including but not limited to the pace of loan growth, collateral values, borrower's ability and willingness to repay, 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.
Assessing the adequacy of the Allowance is a process that requires considerable judgment. Management considers the year-end Allowance appropriate and adequate to cover probable incurred losses in the loan portfolio. However, management's judgment is based upon a number of assumptions about current events, which are believed to be reasonable, but which may or may not prove valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current Allowance amount or that future increases in the Allowance will not be required. No assurance can be given that management's ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the Allowance, thus adversely affecting the operating results of TSFG.
The Allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the Allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require TSFG to adjust its Allowance based on information available to them at the time of their examination.
The methodology used to determine the reserve for unfunded lending commitments, which is included in other liabilities, is inherently similar to that used to determine the allowance for loan losses described above, adjusted for factors specific to binding commitments, including the probability of funding and historical loss ratio.
TSFG uses derivative financial instruments to reduce exposure to changes in interest rates and market prices for financial instruments. The application of hedge accounting requires judgment in the assessment of hedge effectiveness, identification of similarly hedged item groupings, and measurement of changes in the fair value of derivatives and related hedged items. TSFG believes that its . . .
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