South State Corp - 10-Q quarterly report FY

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 nine months ended September 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 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.

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 Company contributed $189,000 and $567,000, respectively, to the pension plan for the three and nine months ended September 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 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 nine months ended September 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 43,545 with a range in exercise price of $34.65 to $39.74 for the three months ended September 30, 2007.  The number of shares in this category was 41,445 with a range in exercise price of $37.70 to $39.74 for the nine months ended September 30, 2007.  There were no outstanding stock options in this category for the three months ended September 30, 2006.  The number of shares in this category was 2,000 with an exercise price of $36.38 for the nine months ended September 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:

As of September 30, 2007, there was $2.2 million 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 2.62 years.  The total fair value of shares vested during the nine months ended September 30, 2007 was $821,000.

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 September 30, 2007, commitments to extend credit and standby letters of credit totaled $420.6 million.  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.  SCBT Financial Corporation does not engage in any significant operations other than the ownership of these banking subsidiaries.

At September 30, 2007, we had approximately $2.3 billion in assets and approximately 667 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 September 30, 2007 as compared to the quarter ended September 30, 2006 as well as results for the nine months ended September 30, 2007 and 2006, and also analyzes our financial condition as of September 30, 2007 as compared to December 31, 2006 and September 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 August 2007, we converted a South Carolina Bank and Trust limited-service branch into a nearby full-service branch location in Lexington, SC.

We measure our progress based on the results of soundness, profitability, and growth.  Our banks achieved solid results during the third 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.  While 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.

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 third quarter of 2006, maintained exceptional credit quality, and continued to make growth investments for the future.  The following key operating highlights for the third quarter of 2007 are outlined below:

Our consolidated earnings growth reflected the continued strong profitability of our bank subsidiaries during the third 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 $837,000 during this period.

We have been able to increase non-taxable equivalent (“non-TE”) net interest income despite the relatively flat yield curve.  We actually experienced net margin expansion compared to the second 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 8 basis points from the third quarter of 2006.  We believe that our net interest margin has stabilized and should remain near current levels through the end of 2007.

Non-taxable equivalent net interest income increased 8.2% in the third quarter of 2007 compared to the same period in 2006.  For the nine months ended September 30, 2007 compared to September 30, 2006, non-taxable equivalent net interest income increased 6.7%.  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 exclude mortgage loans held for sale.  Total loans grew 9.5% from the balance at September 30, 2006 and 4.6% 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 footnote 4 (Loans and Allowance for Loan Losses) to the consolidated financial statements also includes owner occupied commercial real estate not reflected in the percentage above.  Consumer construction and development loans represent 10.3% of our total loan portfolio.  Consumer construction and development loans are comprised of $135.8 million in lot loans and $53.3 in construction loans which represent 7.4% and 2.9%, respectively, of our total loan portfolio.  Loans outstanding (excluding loans held for sale) at September 30, 2007 were $1.8 billion compared to $1.7 billion at September 30, 2006.  Loans outstanding include unearned income.

Interest earned on investment securities increased 14.7% in the third quarter of 2007 compared to the third quarter of 2006, and increased 18.3% for the nine months ended September 30, 2007 compared to September 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 21.5% in the third quarter of 2007 compared to the third quarter of 2006, driven largely by increases in savings deposits, certificates of deposit (“CD”) and federal funds purchased.  In addition, we experienced a 33 basis point increase in the average rate on all interest-bearing liabilities with increases in every category.  On a year-to-date basis, interest expense increased 31.9%, 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 60 basis points on a year-to-date basis.  Some key highlights are outlined below:

The provision for loan losses as a percent of total loans reflects a slight increase in our allowance for loan losses due to an increase in net charge-offs and a modest increase in our nonperforming assets during the third quarter of 2007 compared to the third quarter of 2006.  On a year-to-date basis, the provision for loan losses as a percent of total loans has decreased due to the following:  (1) a decrease in net charge-offs (2) a slight increase in our nonperforming assets since December 31, 2006 and (3) slower loan growth this year versus last.

The table below summarized nonperforming assets (“NPAs”).

In the table above, other nonperforming assets consist of non real estate such as vehicles repossessed and OREO includes certain real estate acquired as a result of foreclosure and property not intended for bank use.

Overall, the Company’s loan portfolio remains well within the historical trends in terms of charge offs and NPAs as a percentage of total loans.  To this point, our commercial real estate portfolio remains steady in terms of past dues, despite the rise in credit costs at other institutions.  We continue to monitor and review frequently the overall asset quality within this portfolio.