South State Corp - 10-Q quarterly report FY

WASHINGTON, D.C. 20549

[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2007

OR

[    ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 001-12669

(Exact name of registrant as specified in its charter)

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed

by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months

(or for such shorter period that the registrant was required to file such reports)

and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [  ]

Indicate by check mark whether the registrant is 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.)

Large accelerated filer [  ]  Accelerated filer [X]  Non-accelerated filer [  ]

Indicate by check mark whether the registrant is a shell company

Indicate the number of shares outstanding of each of issuer’s classes of common stock, as of the latest practicable date:

 

 

 

 

 

The Accompanying Notes are an Integral Part of the Financial Statements.

 

 

The Accompanying Notes are an Integral Part of the Financial Statements.

 

The Accompanying Notes are an Integral Part of the Financial Statements

 

 

The Accompanying Notes are an Integral Part of the Financial Statements.

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  Certain prior period information has been reclassified to conform to the current period presentation.  Operating results for the six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

The condensed consolidated balance sheet at December 31, 2006, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

The information contained in the consolidated financial statements and accompanying footnotes included in the SCBT Financial Corporation’s (the “Company”) annual report on Form 10-K for the year ended December 31, 2006 should be referenced when reading these unaudited condensed consolidated financial statements.

In February 2007, the Financial Accounting Standards Board (“FASB”) issued Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, which permits all entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value.  The fair value option may be elected for an individual item without electing it for other identical items.  Unrealized gains and losses on eligible items measured at fair value must be reported in current earnings.  Upfront costs and fees related to such items must also be recognized in current earnings as incurred.  Early adoption is permitted subject to certain conditions.  The statement will be effective as of the start of the first fiscal year beginning after November 15, 2007 and may not be applied retrospectively to prior fiscal years.  The Company does not anticipate that the statement will have a material effect on its financial statements when the statement becomes effective.

On January 1, 2007, the Company adopted the provisions of FASB Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109. The adoption of FIN 48 had no significant impact on the Company’s financial statements.  It is the Company’s policy to recognize interest and penalties accrued relative to unrecognized tax benefits in its respective federal or state income taxes accounts.  As of January 1, 2007, there were no interest and penalties.  The Company and its subsidiaries file a consolidated United States federal income tax return, as well as income tax returns for its subsidiaries in the state of South Carolina.  The Company’s filed income tax returns are no longer subject to examination by taxing authorities for years before 2003.

In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans—an amendment of FASB Statements No. 87, 88, 106, and 132(R), which revises the reporting of assets and liabilities for pensions and other post-retirement benefits.  The new standard requires an employer to recognize the overfunded or underfunded status of a defined benefit pension and other postretirement plan (other than a multi-employer plan) as an asset or liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through other comprehensive income.  This statement requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions.  The Company adopted Statement 158 for the year ended December 31, 2006, except for the requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position which will be effective for fiscal years ending after December 15, 2008.  Before adoption, the Company recognized a prepaid pension cost in other assets for its pension retirement plan and an accrued pension cost for its post-retirement benefits plan.  After adoption, the Company recognizes an accrued pension cost in other liabilities for its pension retirement plan and an increase in the accrued pension cost for its post-retirement benefits plan.  The accrued pension cost is the equivalent of the underfunded status on a projected benefit obligation (“PBO”) basis for its retirement plan and post-retirement benefit plan as of the plans’ measurement date of October 31, 2006.

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements, which provides a common definition of fair value and a framework for measuring assets and liabilities at fair values when a particular standard prescribes it.  In addition, the statement prescribes a more enhanced disclosure of fair value measures, and requires a more expanded disclosure when non-market data is used to assess fair values.  The statement will be effective January 1, 2008.  The Company does not anticipate that the statement will have a material effect on its financial statements when the statement becomes effective.

In September 2006, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements and 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.  EITF 06-4 requires that policyholders recognize a liability for the postretirement benefits provided through endorsement split-dollar life insurance.  The liability to recognize is dependent upon whether the Company is deemed to have promised a death benefit to the participant or to maintain the split-dollar arrangement for the participant’s benefit.  EITF 06-5 provides guidance for calculating policy amounts that could be realized and recognized as assets on the policyholder’s balance sheet.  Both EITF 06-4 and 06-5 will be effective for fiscal years beginning after December 15, 2007.  The Company does not anticipate that these Issues will have a material effect on its financial statements.

In March 2006, the FASB issued Statement No. 156, Accounting for Servicing of Financial Assets. Statement No. 156, which is an amendment to Statement No. 140, simplifies the accounting for servicing assets and liabilities, such as those common with mortgage securitization activities.  The new standard clarifies when an obligation to service financial assets should be separately recognized as a servicing asset or a servicing liability; requires that a separately recognized servicing asset or servicing liability be initially measured at fair value, if practicable; and permits an entity with a separately recognized servicing asset or servicing liability to choose either the amortization method or fair value method for subsequent measurement.  Statement No. 156 is effective for separately recognized servicing assets and liabilities acquired or issued after the beginning of an entity’s fiscal year that begins after September 15, 2006, with early adoption permitted.  Adoption of this statement did not have a material effect on the Company’s results of operations or financial condition.

In February 2006, the FASB issued Statement No. 155, Accounting for Certain Hybrid Instruments, which is an amendment of Statements No. 133 and 140.  Statement No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis.  The statement also clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement No. 133; establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and amends Statement No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.  Statement No. 155 is effective for all financial instruments acquired or issued after the beginning of an entity’s first fiscal year that begins after September 15, 2006.  Adoption of this statement did not have a material effect on the Company’s results of operations or financial condition.

 

 

The Company's loan portfolio is comprised of the following:

An analysis of the changes in the allowance for loan losses is as follows:

 

The Company's total deposits are comprised of the following:

The aggregate amount of time deposits in denominations of $100,000 or more at June 30, 2007, December 31, 2006, and June 30, 2006 was $369,052,000, $371,517,000 and $298,829,000, respectively.

The Company and its subsidiaries provide certain retirement benefits to their employees in the form of a non-contributory defined benefit pension plan and an employees’ savings plan.

The non-contributory defined benefit pension plan covers all employees hired on or before December 31, 2005, who have attained age 21, and who have completed one year of eligible service.  Effective January 1, 2006, amendments were made to the Company’s pension plan.  On this date, a new benefit formula applies only to participants who have not attained age 45 or who do not have five years of service.

The components of net periodic pension expense recognized during the three and six months ended June 30 are as follows:

 

The Company contributed $189,000 and $378,000, respectively, to the pension plan for the three and six months ended June 30, 2007 and anticipates making similar additional contributions during the remainder of the year.

Electing employees are eligible to participate in the employees’ savings plan, under the provisions of Internal Revenue Code Section 401(k), after attaining age 21.  Plan participants elect to contribute portions of their annual base compensation as a before tax contribution.  The Company matches 50% of these contributions up to a 6% employee contribution for employees hired before January 1, 2006 who were age 45 and higher with five or more vesting years of service.  The Company matches 100% of these contributions up to a 6% employee contribution for current employees under age 45 or with less than five years of service.  Employees hired on January 1, 2006 or thereafter will not participate in the defined benefit pension plan, but will receive the Company’s 100% matching of their 401(k) plan contributions, up to 6% of salary.

Employees can enter the savings plan on or after the first day of each month.  If an employee does not elect to defer at least 2% of his or her salary by the election date, the Company will automatically enroll the employee and defer 2% of his or her salary within the savings plan.  If the employee does not elect an investment allocation, the plan administrator will select a retirement-based portfolio according to the employee’s number of years until normal retirement age.  The employee may terminate participation if the employee affirmatively elects to do so.  The plan’s investment valuations are now generally provided on a daily basis.

Basic earnings per share are calculated by dividing net income by the weighted-average shares of common stock outstanding during each period.  The Company’s diluted earnings per share are based on the weighted-average shares of common stock outstanding during each period plus the maximum dilutive effect of common stock issuable upon exercise of stock options.  The weighted-average number of shares and equivalents are determined after giving retroactive effect to stock dividends and stock splits.

The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended June 30:

 

The calculation of diluted earnings per share excludes outstanding stock options that have exercise prices greater than the average market price of the common shares.  The number of shares in this category was 41,445 with a range in exercise price of $37.70 to $39.74 for the three and six months ended June 30, 2007.  The number of shares in this category was 7,000 with an exercise price of $34.46 for the three and six months ended June 30, 2006.

Dividends per share are calculated using the current number of common shares issued and outstanding at the record date for any dividends paid during the reported periods.

The Company’s 1999 and 2004 stock option programs are long-term retention programs intended to attract, retain, and provide incentives for key employees and non-employee directors in the form of incentive and non-qualified stock options and restricted stock.  With the exception of non-qualified options granted to directors under the 1999 and 2004 plans, which in some cases may be exercised at any time prior to expiration and in some other cases may be exercised at intervals less than one year following the grant date, incentive stock options granted under the plans may not be exercised in whole or in part within one year following the date of the grant, as these incentive stock options become exercisable in 25% increments ratably over the four year period following the grant date.  The options are granted at an exercise price at least equal to the fair value of the common stock at the date of grant and have terms of ten years.  No options were granted under the 1999 plan after January 2, 2004, and the plan is closed other than for any options still unexercised and outstanding.  The 2004 plan is the only plan from which new share-based compensation grants may be issued.  It is the Company’s policy to grant options out of the 661,500 shares registered under the 2004 plan.

Activity in the Company’s stock option plans is summarized in the following table.  All information has been retroactively adjusted for stock dividends and stock splits.

The fair value of options is estimated at the date of grant using the Black-Scholes option pricing model and expensed over the options’ vesting periods.  The following weighted-average assumptions were used in valuing options issued:

 

The Company from time-to-time also grants shares of restricted stock to key employees and non-employee directors.  These awards help align the interests of these employees and directors with the interests of the Company’s shareholders by providing economic value directly related to increases in the value of the Company’s stock.  The value of the stock awarded is established as the fair market value of the stock at the time of the grant.  The Company recognizes expenses, equal to the total value of such awards, ratably over the vesting period of the stock grants.  Grants to employees have typically vested over a 48-month period either ratably or all at once.  Grants to non-employee directors typically vest within a 12-month period.

Nonvested restricted stock for the six months ended June 30, 2007 is summarized in the following table.  All information has been retroactively adjusted for stock dividends and stock splits.

 

As of June 30, 2007, there was $2,792,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the plans.  This cost is expected to be recognized over a weighted-average period of 2.72 years.  The total fair value of shares vested during the six months ended June 30, 2007 was $797,000.

In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities, which are not reflected in the accompanying financial statements.  The commitments and contingent liabilities include guarantees, commitments to extend credit, and standby letters of credit.  At June 30, 2007, commitments to extend credit and standby letters of credit totaled $411,370,000.  The Company does not anticipate any material losses as a result of these transactions.

 

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations relates to the financial statements contained in this quarterly report beginning on page 1.  For further information, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in the Annual Report on Form 10-K for the year ended December 31, 2006.

SCBT Financial Corporation, headquartered in Columbia, South Carolina, is a bank holding company incorporated under the laws of South Carolina in 1985.  We provide a wide range of banking services and products to our customers through our wholly-owned subsidiaries:  South Carolina Bank and Trust, N.A. and South Carolina Bank and Trust of the Piedmont, N.A., both national banks that opened for business in 1934 and 1996, respectively.  We engage in no significant operations other than the ownership of these banking subsidiaries.

At June 30, 2007, we had approximately $2.3 billion in assets and approximately 650 full-time equivalent employees.  Through our banking subsidiaries we provide our customers with checking accounts, NOW accounts, savings and time deposits of various types, brokerage services and alternative investment products such as annuities and mutual funds, trust and asset management services, business loans, agriculture loans, real estate loans, personal use loans, home improvement loans, automobile loans, credit cards, letters of credit, home equity lines of credit, safe deposit boxes, bank money orders, wire transfer services, correspondent banking services, and use of ATM facilities.

The following discussion describes our results of operations for the quarter ended June 30, 2007 as compared to the quarter ended June 30, 2006 as well as results for the six months ended June 30, 2007 and 2006, and also analyzes our financial condition as of June 30, 2007 as compared to December 31, 2006 and June 30, 2006.    Like most financial institutions, we derive most of our income from interest we receive on our loans and investments.  Our primary source of funds for making these loans and investments is our deposits, on which we may pay interest.  Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits.  Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance by charging a provision for loan losses against our operating earnings.  In the following section, we have included a detailed discussion of this process.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers.  We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.

The following section also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements.  We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

In April 2007, we moved a South Carolina Bank and Trust limited-service branch to a full-service branch location on Broad Street in Charleston, SC.

We measure our progress based on the results of soundness, profitability, and growth.  Our banks achieved record results during the second quarter of 2007.  These results were achieved as the banking industry continues to experience ongoing challenges in a difficult interest rate environment, in a slowing economy, and with a rise in credit costs.  We are very proud of the results our team produced despite these challenges.  Our company achieved an increase in consolidated net income compared to the second quarter of 2006, maintained exceptional credit quality, and continued to make growth investments for the future.  The following key operating highlights for the second quarter of 2007 are outlined below:

 

 

Our consolidated earnings growth reflected the continued strong profitability of our bank subsidiaries during the second quarter of 2007.  South Carolina Bank and Trust had net income of $5.3 million and South Carolina Bank and Trust of the Piedmont had net income of $722,000 during this period.

We have been able to increase non-taxable equivalent (“non-TE”) net interest income despite the flat to slightly inverted yield curve.  We actually experienced net margin expansion compared to the first quarter of 2007 by 7 basis points.  While rates on interest-bearing liabilities increased generally more than asset yields, growth in interest-earning assets contributed to higher net interest income for the quarter.  Taxable equivalent (“TE”) net interest margin decreased 22 basis points from the second quarter of 2006, but increased 5 basis points compared to the first quarter of 2007.  We believe that we will continue to experience a slowing in the secular trend of net interest margin compression.

 

Non-taxable equivalent net interest income increased 4.9% in the second quarter of 2007 compared to the same period in 2006.  For the six months ended June 30, 2007 compared to June 30, 2006, non-taxable equivalent net interest income increased 6.0%.  Some key highlights are outlined below:

 

Growth in commercial real estate and commercial non-real estate drove the increase in total loans from the comparable period in 2006.  Total loans grew 9.7% from the balance at June 30, 2006 and 2.6% from the balance at December 31, 2006.  Loans are our largest category of earning assets and commercial real estate loans represent approximately 38.0% of our total loans.  Commercial real estate in the footnotes to the consolidated financial statements also includes owner occupied commercial real estate not reflected in the percentage above.  Consumer construction and development loans represent 11.2% of our total loan portfolio.  Consumer construction and development loans are comprised of $148.9 million in lot loans and $52.6 in construction loans which represent 8.2% and 2.9%, respectively, of our total loan portfolio.  Loans outstanding (excluding loans held for sale) at June 30, 2007 were $1.8 billion compared to $1.6 billion at June 30, 2006.  Loans outstanding include unearned income.

 

Interest earned on loans increased 14.3% in the second quarter of 2007 compared to the second quarter of 2006, and increased 17.5% for the six months ended June 30, 2007 compared to June 30, 2006.  Some key highlights are outlined below:

We use investment securities, the second largest category of earning assets, to generate interest income through the employment of excess funds, to provide liquidity, to fund loan demand or deposit liquidation, and to pledge as collateral for public funds deposits and repurchase agreements.  We increased the size of our investment portfolio and kept its composition relatively consistent with a bias towards increasing purchases of US government agency bonds rather than mortgage-backed securities.  We continued our approach of lengthening the average life of the portfolio as interest rates increased and in light of our expectation that the Federal Reserve will not increase its targeted level for the federal funds interest rate.  At June 30, 2007, investment securities were $234.9 million, compared to $210.4 million at December 31, 2006 and $211.0 million at June 30, 2006.

 

 

Interest earned on investment securities increased 17.6% in the second quarter of 2007 compared to the second quarter of 2006, and increased 20.3% for the six months ended June 30, 2007 compared to June 30, 2006.  The increases resulted both from higher average outstanding balances and higher yields.

Although securities classified as available for sale may be sold from time to time to meet liquidity or other needs, it is not our normal practice to trade this segment of the investment securities portfolio. While management generally holds these assets on a long-term basis or until maturity, any short-term investments or securities available for sale could be converted at an earlier point, depending partly on changes in interest rates and alternative investment opportunities.

Interest expense on interest-bearing liabilities increased 32.2% in the second quarter of 2007 compared to the second quarter of 2006, driven largely by increases in savings deposits, certificates of deposit (“CD”) and federal funds purchased.  In addition, we experienced a 62 basis point increase in the average rate on all interest earning liabilities with increases in every category.  On a year-to-date basis, interest expense increased 38.0%, again reflective of increases in the average balances of savings deposits, CDs and federal funds purchased, and reflective of the increase in the average rate on all interest earning liabilities of 72 basis points on a year-to-date basis.  Some key highlights are outlined below:

Deposit growth continued to remain strong in the quarter-to-quarter and the linked-quarter comparison.  We continued to see steady growth in the number of transaction accounts and savings accounts.  Our customers opened approximately 10,000 new demand deposit checking accounts during the first half of 2007, a slight decrease from openings in the number of accounts during the first half of 2006.  Noninterest-bearing deposits grew $10.0 million, or 3.6%, in the second quarter of 2007 compared to the second quarter of 2006.  Compared to the first quarter of 2007, noninterest-bearing deposits grew $12.1 million, or 4.4%, to $285.2 million at June 30, 2007.

 

We have established an allowance for loan losses through a provision for loan losses charged to expense.  The allowance for loan losses represents an amount that we believe will be adequate to absorb probable losses on existing loans that may become uncollectible.  We assess the adequacy of the allowance for loan losses by using an internal risk rating system, independent credit reviews, and regulatory agency examinations—all of which evaluate the quality of the loan portfolio and seek to identify problem loans.  Based on this analysis, management and the board of directors consider the current allowance to be adequate.  Nevertheless, our evaluation is inherently subjective as it requires estimates that are susceptible to significant change.  Actual losses may vary from our estimates, and there is a possibility that charge-offs in future periods could exceed the allowance for loan losses as estimated at any point in time.  We expect loan charge-off levels in 2007 to be approximately in line with prior years.

The provision for loan losses for the quarter ended June 30, 2007 was $800,000 compared to $1.5 million in the comparable period last year and $782,000 in the first quarter of 2007.  The provision reflects a slight increase in our allowance for loan losses due to some new loan growth compared to the first quarter of 2007 and very low net charge-offs during the second quarter of 2007.  Some key highlights regarding the second quarter asset quality are outlined below:

The sub-prime mortgage industry continues to experience credit problems.  We have virtually no participation in this product line and our credit quality remains very strong.

OREO includes certain real estate acquired as a result of foreclosure and property not intended for bank use. As of June 30, 2007, other real estate owned was $771,000, compared with $597,000 at December 31, 2006 and $249,000 at the end of the second quarter of 2006.

 

 

Noninterest income increased 17.0% in the second quarter of 2007 compared to the same period in 2006.  On a year-to-date basis, the increase was 18.8%.  The quarterly increases are the result of the following:

 

Noninterest expense increased 14.1% in the second quarter of 2007 compared to the same period in 2006.  On a year-to-date basis expenses increased 13.8%.  The quarterly increases primarily resulted from the following: