South Financial Group 10-Q 2007
Commission file number 0-15083
South Financial Group, Inc.
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 o.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check One):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x.
The number of outstanding shares of the issuers $1.00 par value common stock as of May 7, 2007 was 74,151,226.
PART I. FINANCIAL INFORMATION
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
See notes to consolidated financial statements (unaudited), which are an integral part of these statements.
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
See notes to consolidated financial statements (unaudited), which are an integral part of these statements.
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
See notes to consolidated financial statements (unaudited), which are an integral part of these statements.
THE SOUTH FINANCIAL GROUP, INC. AND SUBSIDIARIES
THE SOUTH FINANCIAL GROUP, INC. AND
Note 1 General
The foregoing unaudited Consolidated Financial Statements and Notes are presented in accordance with the instructions for the Securities and Exchange Commission Quarterly Report on Form 10-Q. TSFG refers to The South Financial Group, Inc. and subsidiaries, except where the context requires otherwise. The information contained in the Notes to Consolidated Financial Statements included in TSFGs Annual Report on Form 10-K for the year ended December 31, 2006 should be referred to in connection with the reading of these unaudited interim Consolidated Financial Statements. The Consolidated Balance Sheet at December 31, 2006 is derived from TSFGs Consolidated Audited Financial Statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. 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.
Nature of Operations
TSFG is a financial holding company headquartered in Greenville, South Carolina that offers a broad range of financial products and services, including banking, treasury services, merchant processing, mortgage, and wealth management (which consists of insurance, retail investment, benefits administration, and trust and investment management). It has two bank subsidiaries, Carolina First Bank, a South Carolina banking corporation headquartered in Greenville, South Carolina, and Mercantile Bank, a Florida banking corporation headquartered in Jacksonville, Florida. It also owns several non-bank subsidiaries. At March 31, 2007, TSFG operated through 78 branch offices in South Carolina, 66 in Florida, and 26 in North Carolina. In South Carolina, the branches are primarily located in the states largest metropolitan areas. The Florida operations are principally concentrated in the Jacksonville, Orlando, Tampa Bay, Southeast Florida, and Gainesville areas. The North Carolina branches are primarily located in the Hendersonville and Asheville areas of western North Carolina and in the Wilmington area of eastern North Carolina.
Accounting Estimates and Assumptions
The preparation of the Consolidated Financial Statements and accompanying notes requires management of TSFG to make a number of 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 the period. Actual results could differ significantly from these estimates and assumptions.
Principles of Consolidation
The Consolidated Financial Statements include the accounts of The South Financial Group, Inc. and all other entities in which it has a controlling financial interest. All significant intercompany balances and transactions have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the 2007 presentations.
Recently Adopted Accounting Pronouncements
Accounting for Uncertainty in Income Taxes
In July 2006, the FASB released FASB Interpretation No. 48 (FIN 48), Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 clarifies the accounting and reporting for uncertainties in income tax law. This Interpretation prescribes a comprehensive model for the financial statement recognition, measurement, presentation and disclosure of uncertain tax positions taken or expected to be taken in income tax returns. TSFG adopted FIN 48 effective January 1, 2007. As a result, the Company recognized a $488,000 increase to reserves for uncertain tax positions. This increase was accounted for as an adjustment to the beginning balance of retained earnings; therefore, prior period results have not been restated. At the beginning of 2007, TSFG had approximately $13.2 million of total gross unrecognized tax benefits. Of this total, $3.6 million represents the amount of unrecognized tax benefits that, if recognized, would favorably affect the effective income tax rate in any future periods. During the first quarter 2007, unrecognized tax benefits were reduced by approximately $4.7 million related to payments
THE SOUTH FINANCIAL GROUP, INC. AND
due on settlements with South Carolina and the Internal Revenue Service during 2006. As of March 31, 2007, the Company does not expect a significant increase or decrease in unrecognized tax benefits in the next 12 months.
TSFG and its subsidiaries are subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. The Company has substantially concluded all U.S. federal income tax matters for years through 2003. The Companys 2005 federal income tax return is currently under examination. In addition, the Company is subject to state and local income tax examinations for the tax years 2001 through 2006.
TSFGs continuing practice is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had approximately $1.1 million accrued for interest and penalties at January 1, 2007.
Accounting for Purchases of Life Insurance
In September 2006, the FASB ratified the consensus reached by the EITF on Issue No. 06-5, Accounting for Purchases of Life Insurance -- Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.FASB Technical Bulletin No. 85-4 requires that the amount that could be realized under the insurance contract as of the date of the statement of financial position should be reported as an asset. Since the issuance of FASB Technical Bulletin No. 85-4, there has been diversity in practice in the calculation of the amount that could be realized under insurance contracts. Issue No. 06-5, which was effective January 1, 2007, concludes that the Company should consider any additional amounts (e.g., cash stabilization reserves and deferred acquisition cost taxes) included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized in accordance with FASB Technical Bulletin No. 85-4. The adoption of this standard did not have a significant impact on TSFGs shareholders equity or results of operations.
Accounting for Certain Hybrid Financial Instruments
In February 2006, the FASB issued SFAS No. 155 (SFAS 155), Accounting for Certain Hybrid Financial Instruments an amendment of FASB Statements No. 133 and 140. SFAS 155 permits an entity to measure at fair value any financial instrument that contains an embedded derivative that otherwise would require bifurcation. In December 2006, the FASB issued a narrow exception to SFAS 155 in the form of a Derivative Implementation Guide that would exempt most securitized financial instruments that are subject to prepayment from the bifurcation requirements of SFAS 155 and SFAS 133. The Company adopted this standard in the first quarter of 2007 with no significant impact on its shareholders equity or results of operations.
Recently Issued Accounting Pronouncements
Fair Value Option for Financial Assets and Financial Liabilities
On February 15, 2007, the FASB issued SFAS No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities, which allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. Subsequent changes in fair value of these financial assets and liabilities would be recognized in earnings when they occur. SFAS 159 further establishes certain additional disclosure requirements. SFAS 159 is effective for TSFGs financial statements for the year beginning on January 1, 2008. The Company is currently evaluating the effect of adopting this standard on its Consolidated Financial Statements.
Fair Value Measurements
In September 2006, the FASB issued SFAS No. 157 (SFAS 157), Fair Value Measurements, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. The Company is currently evaluating the effect of adopting this standard on its Consolidated Financial Statements.
THE SOUTH FINANCIAL GROUP, INC. AND
Note 2 Supplemental Financial Information to Consolidated Statements of Income
The following presents the details for noninterest income and noninterest expense (in thousands):
Note 3 Accumulated Other Comprehensive Income (Loss)
The following summarizes accumulated other comprehensive loss, net of tax (in thousands):
Note 4 Gross Unrealized Losses on Investment Securities
Gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in an unrealized loss position, were as follows (in thousands):
At March 31, 2007, TSFG had 1,111 individual investments that were in an unrealized loss position. The unrealized losses on investments summarized above, except for equity investments, were attributable to increases in interest rates, rather than deterioration in credit quality. The majority of these securities are government or agency securities and, therefore, pose minimal credit risk. TSFG believes it has the ability and intent to hold its debt securities until a market price recovery or maturity. Therefore, at March 31, 2007, these investments are not considered impaired on an other-than-temporary basis.
At March 31, 2007, TSFGs equity investments with unrealized losses are not considered impaired on an other-than-temporary basis due to the lack of severity of the impairment.
Note 5 Derivative Financial Instruments and Hedging Activities
The fair value of TSFGs derivative assets and liabilities and their related notional amounts (in thousands) are presented below.
For the three months ended March 31, 2007 and 2006, noninterest income included a gain of $97,000 and a loss of $1.1 million, respectively, for derivative activities. These amounts include the following: the change in fair value of derivatives that do not qualify for hedge accounting under SFAS 133, as well as the net cash settlement from these interest rate swaps; hedge ineffectiveness for fair value hedges, which totaled $140,000 and $451,000, respectively, for the three months ended March 31, 2007 and 2006; and other miscellaneous items.
Note 6 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 be expected to materially affect TSFGs consolidated financial position or results of operations.
As part of its acquisition of Florida Banks, Inc. (Florida Banks), TSFG acquired a recourse reserve associated with loans previously sold from Florida Banks wholesale mortgage operation. This recourse requires the repurchase of loans at par plus accrued interest from the buyer, upon the occurrence of certain events. At March 31, 2007, the estimated recourse reserve liability, included in other liabilities, totaled $6.1 million. TSFG will continue to evaluate the reserve level and may make adjustments through earnings as more information becomes known. There can be no guarantee that any liability or cost arising out of this matter will not exceed any established reserves.
TSFG is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, commercial letters of credit, and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.
TSFGs exposure to credit loss is represented by the contractual amount of these instruments. TSFG uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
Commitments to extend credit are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since certain of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. TSFG evaluates each customers creditworthiness on a case-by-case basis. The amount of the collateral obtained, if deemed necessary by TSFG upon extension of credit, is based on TSFGs credit evaluation of the borrower.
Commercial letters of credit and standby letters of credit are conditional commitments issued by TSFG to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in making loans to customers. TSFG generally holds collateral supporting those commitments if deemed necessary. A summary of the contractual amounts of TSFGs financial instruments relating to extension of credit with off-balance-sheet risk follows (in thousands):
Note 7 Share Information
The following is a summary of the basic and diluted average common shares outstanding and earnings per share calculations (in thousands, except share and per share data):
The following options were outstanding at the period end presented but were excluded from the calculation of diluted earnings per share because the exercise price was greater than the average market price of the common shares:
On December 14, 2006, TSFGs Board of Directors authorized a stock repurchase program of up to 4 million shares. This authorization replaced TSFGs existing stock repurchase authorization. In first quarter 2007, TSFG repurchased 1 million shares in connection with the aforementioned authorization, under an accelerated share repurchase agreement. Subsequent to quarter-end, TSFG repurchased an additional 1 million shares.
Note 8 Business Segments
South Carolina Bank, North Carolina Bank, and Florida Bank are TSFGs primary reportable segments for management financial reporting. Effective January 1, 2007,TSFG changed its segment methodology from a legal entity structure (i.e., Carolina First Bank and Mercantile Bank) to a business segment structure along geographic lines to maintain consistency with the way management internally reviews financial information and allocates resources. Results for prior periods have been restated for comparability. Each regional bank segment consists of commercial and consumer lending and full service branches in its geographic region with its own management team. The branches provide a full range of traditional banking products as well as treasury services, merchant services, wealth management and mortgage banking services. The Other column includes the investment securities portfolio, indirect lending, treasury, parent company activities, bank-owned life insurance, net intercompany eliminations, various nonbank subsidiaries, equity investments, and certain other activities not currently allocated to the aforementioned segments.
The results for these segments are based on TSFGs management reporting process, which assigns balance sheet and income statement items to each segment. Unlike financial reporting there is no authoritative guidance for management reporting equivalent to generally accepted accounting principles. The Company uses an internal funding methodology to assign funding costs to assets and earning credits to liabilities with an offset in Other. The management reporting process measures the performance of the defined segments based on TSFGs management structure and is not necessarily comparable with similar information for other financial services companies or representative of results that would be achieved if the segments operated as stand-alone entities. If the management
structure and/or allocation process changes, allocations, transfers and assignments may change. Segment information (in thousands) is shown in the table below.
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 consolidated financial statements appearing in this report as well as the Annual Report of TSFG on Form 10-K for the year ended December 31, 2006. Results of operations for the three months ended March 31, 2007 are not necessarily indicative of results that may be attained for any other period.
TSFG primarily operates through Carolina First Bank and Mercantile Bank, which are collectively referred to as the Subsidiary Banks.
Index to Item 2, Managements Discussion and Analysis of Financial Condition and Results of Operations
All of TSFGs electronic filings with the Securities and Exchange Commission (SEC), including its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are made available at no cost on TSFGs web site, www.thesouthgroup.com, through the Investor Relations link. TSFGs SEC filings are also available through the SECs web site at www.sec.gov.
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 may affect the operations, performance, business strategy and results of TSFG including, but not limited to, the following:
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 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.
This report also contains financial information determined by methods other than in accordance with Generally Accepted Accounting Principles (GAAP). TSFGs management uses these non-GAAP measures to analyze TSFGs 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. TSFG also presents loan and deposit growth, excluding loans/deposits acquired net of dispositions (referred to herein as organic growth). In discussing its deposits, TSFG presents core deposits, which are defined by TSFG as noninterest-bearing, interest-bearing checking, money market accounts, and savings accounts, 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 sweeps. Wholesale borrowings include short-term and long-term borrowings less customer sweeps plus brokered deposits. 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, TSFGs non-GAAP measures may not necessarily be comparable to non-GAAP performance measures of other companies.
The South Financial Group is a financial holding company, headquartered in Greenville, South Carolina, with $14.2 billion in total assets and 170 branch offices in South Carolina, Florida, and North Carolina at March 31, 2007. Founded in 1986, TSFG focuses on fast-growing banking markets in the Southeast and concentrates its growth in metropolitan statistical areas. TSFG operates primarily through:
At March 31, 2007, approximately 47% of TSFGs customer deposits (total deposits less brokered deposits) were in South Carolina, 39% were in Florida, and 14% were in North Carolina. (See Noninterest Expenses for a discussion of the planned merger of TSFGs two bank subsidiaries subsequent to quarter-end.)
TSFG uses a super-community bank strategy and targets small and middle market businesses and retail customers. As a super-community bank, TSFG combines 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 net income of $20.5 million, or $0.27 per diluted share, for the first three months of 2007, compared with $27.8 million, or $0.37 per diluted share, for the first three months of 2006. Average diluted shares outstanding decreased 0.1% to 75.2 million shares, principally as a result of TSFGs repurchase of 1 million shares at the end of January 2007, partially offset by shares issued pursuant to the exercise of stock options.
TSFG continues to focus on improving its balance sheet mix by increasing the relative level and mix of customer assets and liabilities. On the asset side, average loans as a percentage of average earning assets increased to 77.8% for first quarter 2007 from 75.0% for first quarter 2006. On the funding side, average customer funding (which includes deposits less brokered deposits plus customer sweeps) as a percentage of average total funding increased to 67.3% for first quarter 2007, up from 63.4% for first quarter 2006.
Using period-end balances, TSFGs loans held for investment at March 31, 2007 increased 1.8% from a year ago, and total deposit balances grew 8.4%. Customer funding (deposits less brokered deposits plus customer sweeps) increased 4.5% since March 31, 2006. Since March 2006, TSFG sold $359.6 million of indirect auto loans, as well as $2.6 million of loans and $27.9 million of deposits in connection with the sale of the Mullins branch. Excluding these amounts, growth in loans held for investment totaled 5.5% from March 31, 2006 to March 31, 2007.
Tax-equivalent net interest income was $96.2 million for the first three months of 2007, an $8.5 million decrease from $104.7 million for the first three months of 2006. The net interest margin decreased to 3.08% for the first three months of 2007 from 3.29% for the first three months of 2006. This margin compression reflects an ongoing change in customer preference for higher-cost deposit categories, higher wholesale borrowing costs, and actions by management to reduce interest rate risk and optionality on the balance sheet. Most recently, the net interest margin declined 4 basis points to 3.08% for the first three months of 2007 from 3.12% for fourth quarter 2006.
Noninterest income increased 5.2% to $30.8 million for the first three months of 2007 compared to $29.3 million for the first three months of 2006. Noninterest income reflected growth in wealth management, mortgage banking, and merchant processing income, offset by a decrease in service charges on deposits.
Noninterest expenses totaled $85.4 million for the first three months of 2007, compared to $79.8 million for the first three months of 2006, an increase of 6.9%. Salaries, wages and employee benefits (excluding contract buyouts and severance), which account for 52.5% of total noninterest expenses for the first three months of 2007, increased 10.7% to $44.8 million. The increase in noninterest expenses included higher incentive expense, higher salaries attributable to annual salary increases and TSFGs expansion of its management team, higher occupancy expense, and higher merchant processing expense. Noninterest expenses for the first three months of 2007 declined to $85.4 million from $93.6 million for fourth quarter 2006, primarily from TSFGs expense reduction initiatives implemented during the first quarter of 2007 as well as a $3.2 million decline in employment contract buyouts and severance.
At March 31, 2007, nonperforming assets as a percentage of loans held for investment and foreclosed property increased to 0.47% from 0.46% at March 31, 2006. For the three months ended March 31, 2007 and 2006, annualized net loan charge-offs were 0.29% of average loans held for investment. TSFGs provision for credit losses decreased to $9.0 million for the first three months of 2007 from $9.9 million for the first three months of 2006, primarily as a result of slower loan growth. The allowance for loan loss coverage of nonperforming loans at March 31, 2007 decreased to 2.63 times, compared with 3.11 times at March 31, 2006.
TSFGs tangible equity to tangible asset ratio totaled 6.52% at March 31, 2007, up from 5.77% at March 31, 2006, primarily as a result of retention of earnings, the continued runoff of the securities portfolio (which decreased tangible assets), and a decrease in net unrealized losses on available for sale securities. At March 31, 2007, the after-tax net unrealized loss on available for sale securities totaled $37.6 million, down from $66.1 million at March 31, 2006.
TSFGs 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 (loans held for sale, securities, derivatives, and privately held investments); income tax assets or liabilities; share-based compensation; and accounting for acquisitions, including the fair value determinations, the analysis of goodwill for impairment and the analysis of valuation allowances in the initial accounting of loans acquired. 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 TSFGs 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.
For additional information regarding critical accounting policies, refer to the Annual Report of TSFG on Form 10-K for the year ended December 31, 2006, specifically Item 8, Note 1 Summary of Significant Accounting Policies in the notes to the Consolidated Financial Statements and the section captioned Critical Accounting Policies and Estimates in Managements Discussion and Analysis of Financial Condition and Results of Operations.
During 2005, TSFG initiated plans for a corporate campus to meet current and future facility needs and serve as the primary headquarters for its banking operations, including legal, human resources, accounting, finance, certain loan operations, credit, treasury, internal audit, risk management, and other support and administrative functions. The initial phase of the plans included the purchase of approximately 68 acres of land in Greenville County, South Carolina, for an aggregate investment of $10.4 million in early 2006. While the Company is still finalizing details of the campus, it expects to make additional investments of approximately $90 million between now and 2011, with the first phase being completed and occupied during the first half of 2009. The Company believes assimilating the workforce at one location will provide certain efficiencies through greater interaction and communication as well as an increased ability to attract and retain employees.
In connection with this project, the applicable state, county, and city governments and other sources will provide the Company's banking subsidiary certain tax and economic incentives based on, among other things, a total investment of approximately $100 million and the location of approximately 600 new positions at the campus by December 31, 2011. The requisite new positions must be in addition to the approximately 325 current Greenville-based positions that will be relocated from existing leased facilities to the campus beginning in early 2009. The current estimated range of incentives has a value totaling between $55 and $60 million ($30 to $35 million on a present value basis) assuming the minimum investment and job creation requirements are achieved. A significant portion of the incentives require one or both of the investment and job creation requirements.
The new positions to be located at the campus will be derived from (i) the management and consolidation of existing positions, including relocating some functions currently located outside of South Carolina; (ii) growth and expansion of current and future business lines; and (iii) future acquisitions (if any).
Prior to 2009, TSFG does not expect to recognize any significant expenses associated with the project due to the capitalization of costs during the construction period. However, upon completion of certain infrastructure elements (roads, sidewalks, etc.), the Company will contribute its net investment in those improvements to the City of Greenville in 2008 or early 2009 (currently estimated at $3 million to $5 million, net of certain economic grants). Additionally, the Company currently estimates it will incur one-time charges totaling $3 million to $5 million after-tax related to lease terminations and impairment of leasehold improvements.
Assuming all incentives are earned, TSFG does not currently expect the incremental occupancy costs to be significant in future periods. Although not finalized, the Company is also pursuing other incentives as well as managing the overall timing of the additional investments through 2011.
TSFG focuses its lending activities on small and middle market businesses and individuals in its geographic markets. At March 31, 2007, outstanding loans totaled $9.9 billion, which equaled 99.8% of total deposits (124.6% of customer deposits) and 70.1% of total assets. The major components of the loan portfolio were commercial loans, commercial real estate loans, and consumer loans (including both direct and indirect loans). Substantially all loans were to borrowers located in TSFGs market areas in South Carolina, Florida, and North Carolina. At March 31, 2007, approximately 8% of the portfolio was unsecured.
As part of its portfolio and balance sheet management strategies, TSFG reviews its loans held for investment and determines whether its intent for specific loans or classes of loans has changed. If management changes its intent from held for investment to held for sale, the loans are transferred to the held for sale portfolio and recorded at the lower of cost basis or fair value.
Loans held for investment increased $177.2 million, or 1.8%, to $9.9 billion at March 31, 2007 from $9.7 billion at March 31, 2006. Excluding the sale of indirect auto loans in the second quarter of 2006 ($359.6 million) and the third quarter 2006 sale of the Mullins branch ($2.6 million), loan growth was 5.5% since March 31, 2006.
TSFG generally sells a majority of its residential mortgage loans in the secondary market. TSFG also retains certain of its mortgage loans, based on predetermined criteria, in its held for investment portfolio as part of its overall balance sheet management strategy. Loans held for sale increased to $33.5 million at March 31, 2007 from $28.6 million at December 31, 2006 and $23.5 million at March 31, 2006, partly due to TSFGs decision to hold fewer mortgage loans in its held for investment portfolio.
Table 1 summarizes outstanding loans by collateral type for real estate secured loans and by borrower type for all other loans. Collateral type represents the underlying assets securing the loan, rather than the purpose of the loan.
Table 2 provides a stratification of the loan portfolio by loan purpose. This presentation differs from that in Table 1, which stratifies the portfolio by collateral type and borrower type. Certain prior period amounts have been reclassified to conform to current period presentation.
Commercial and industrial loans are loans to finance short-term and intermediate-term cash needs of businesses. Typical needs include the need to finance seasonal or other temporary cash flow imbalances, growth in working assets created by sales growth, and purchases of equipment and vehicles. Credit is extended in the form of short-term single payment loans, lines of credit for periods up to a year, revolving credit facilities for periods up to five years, and amortizing term loans for periods up to ten years.
Owner - occupied real estate loans are loans to finance the purchase or expansion of operating facilities used by businesses not engaged in the real estate business. Typical loans are loans to finance offices, manufacturing plants, warehouse facilities, and retail shops. Depending on the property type and the borrowers cash flows, amortization terms vary from ten years up to 20 years. Although secured by mortgages on the properties financed, these loans are underwritten based on the cash flows generated by operations of the businesses they house.
Commercial real estate loans are loans to finance real properties that are acquired, developed, or constructed for sale or lease to parties unrelated to the borrower. Included are loans to acquire land for development, land development loans, construction loans, mini-perms for cash flow stabilization periods, and permanent loans in situations where access to the secondary market is limited due to loan size.
Indirect - sales finance loans are loans to individuals to finance the purchase of motor vehicles. They are closed at the auto dealership but approved in advance by TSFG for immediate purchase. Loans are extended on new and used
motor vehicles with terms varying from two years to six years. During the second quarter of 2006, TSFG sold $359.6 million of indirect auto loans.
Direct retail consumer loans are loans to individuals to finance personal, family, or household needs. Typical loans are loans to finance auto purchases, home repairs and additions, and purchases of residential lots.
Home equity loans are loans to homeowners, secured primarily by junior mortgages on their primary residences, to finance personal, family, or household needs. These loans may be in the form of amortizing loans or lines of credit with terms up to 15 years.
Mortgage loans are loans to individuals, secured by first or second mortgages on single-family residences, generally to finance the acquisition or construction of those residences. TSFG generally sells a majority of its residential mortgage loans at origination in the secondary market. TSFG also retains certain of its mortgage loans, based on predetermined criteria, in its held for investment portfolio as part of its overall balance sheet management strategy.
Table 3 sorts the commercial real estate portfolio by geography and property type. The portfolios most significant concentration is in commercial real estate loans. Real estate development and construction are major components of the economic activity that occurs in TSFGs markets. By product type, commercial construction and development loans, the largest component of commercial real estate loans, represent 41.1% of the total commercial real estate loans at March 31, 2007, up from 39.4% at December 31, 2006. The risk attributable to the concentration in commercial real estate loans is managed by focusing our lending on markets with which we are familiar and on borrowers with proven track records whom we believe possess the financial means to weather adverse market conditions. Consequently, although the analysis of reserve adequacy includes an adjustment to account for the risk inherent in this concentration, management believes the loss potential in its commercial real estate loans is not materially greater than that of any other segment of the portfolio. In addition, management believes that diversification by geography, property type, and borrower partially mitigates the risk of loss in its commercial real estate loan portfolio.
Portfolio risk is also managed by maintaining a house lending limit at a level significantly lower than the legal lending limit of both Carolina First Bank and Mercantile Bank and by requiring Board of Director approval to exceed this house limit. At March 31, 2007, TSFGs house lending limit was $35 million, and five credit relationships totaling $201.6 million were in excess of the house lending limit (but not the legal lending limit). The 20 largest credit relationships had an aggregate outstanding principal balance of $416.7 million, or 4.2% of total loans held for investment at March 31, 2007, up from 3.2% of total loans held for investment at March 31, 2006.
TSFG participates in shared national credits (multi-bank credit facilities of $20 million or more), primarily to borrowers who are headquartered or conduct business in or near our markets. At March 31, 2007, the loan portfolio included commitments totaling $1.0 billion in shared national credits. Outstanding borrowings under these commitments totaled $468.2 million at March 31, 2007, increasing from $413.2 million at December 31, 2006 and $237.3 million at March 31, 2006.
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. TSFGs 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 after-the-fact review by credit risk management of loans approved by lenders. Through daily review by credit risk managers, monthly reviews of exception reports, and ongoing analysis of asset quality trends, compliance with underwriting and loan monitoring policies is closely supervised. The administration of problem loans is driven by policies that require written plans for resolution and quarterly meetings with credit risk management to review progress. Credit risk management activities are monitored by Credit Committees of each banking subsidiarys Board of Directors, which meet monthly to review credit quality trends, new large credits, loans to insiders, large problem credits, credit policy changes, and reports on independent credit reviews of branch offices.
Table 4 presents our credit quality indicators.
TSFGs nonperforming asset ratio (nonperforming assets as a percentage of loans held for investment and foreclosed property) increased to 0.47% at March 31, 2007 from 0.43% at December 31, 2006 and 0.46% at March 31, 2006. Geographically, South Carolina and North Carolina nonaccrual loans increased since year-end, while Florida nonaccrual loans declined modestly since year-end.
Table 5 summarizes information on impaired loans, all of which are in nonaccrual status. All impaired loans are commercial loans. There was no recognized interest income on impaired loans.
Allowance for Loan Losses and Reserve for Unfunded Lending Commitments
The allowance for loan losses represents managements estimate of probable incurred losses inherent in the lending portfolio. The adequacy of the allowance for loan losses (the Allowance) is analyzed quarterly. For purposes of this analysis, adequacy is defined as a level sufficient to absorb probable incurred losses in the portfolio as of the balance sheet date presented. 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 reviewed for impairment and impairment is measured in accordance with SFAS No. 114, Accounting by Creditors for Impairment of a Loan, an amendment of FASB Statements No. 5 and 15 (SFAS 114), and assigned specific reserves. To allow for modeling margin for imprecision, 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 segments range of probable loss levels.
The Allowance for each portfolio segment is set at an amount within its range that reflects managements best judgment of the extent to which historical loss levels are more or less accurate indicators of current losses in the portfolio. Managements 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, loans acquired from acquisitions, 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 incurred losses inherent in the portfolio based on our analysis that are not fully captured in the allocated component. Allocation of the Allowance to respective loan portfolio components is not necessarily indicative of future losses or future allocations. The entire Allowance is available to absorb probable incurred losses in the loan portfolio.
Assessing the adequacy of the Allowance is a process that requires considerable judgment. Managements judgments are based on numerous assumptions about current events, which we believe to be reasonable, but which may or may not be valid. Thus, there can be no assurance that loan losses in future periods will not exceed the current Allowance amount or that future increases in the Allowance will not be required. No assurance can be given that managements ongoing evaluation of the loan portfolio in light of changing economic conditions and other relevant circumstances will not require significant future additions to the Allowance, thus adversely affecting the operating results of TSFG.
The Allowance is also subject to examination and adequacy testing by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the Allowance relative to that of peer institutions, and other adequacy tests. In addition, such regulatory agencies could require us to adjust our Allowance based on information available to them at the time of their examination.
The 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.
Table 6 summarizes the changes in the allowance for loan losses, reserve for unfunded lending commitments, and allowance for credit losses and provides certain related ratios.