UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended: SEPTEMBER 30, 1996 Commission file number: 1-10853 SOUTHERN NATIONAL CORPORATION (Exact name of registrant as specified in its charter) <TABLE> <S> <C> NORTH CAROLINA 56-0939887 (State of Incorporation) (I.R.S. Employer Identification No.) 200 WEST SECOND STREET WINSTON-SALEM, NORTH CAROLINA 27101 (Address of Principal Executive Offices) (Zip Code) </TABLE> (910) 733-2000 (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 (Check Mark) No__ At October 31, 1996, 109,113,999 shares of the registrant's common stock, $5 par value, were outstanding. This Form 10-Q has 21 pages. The Exhibit Index is included on page 19.
SOUTHERN NATIONAL CORPORATION FORM 10-Q SEPTEMBER 30, 1996 INDEX <TABLE> <CAPTION> PAGE NO. <S> <C> Part I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited).......................................................................... 3 Consolidated Financial Statements......................................................................... 3 Notes to Consolidated Financial Statements................................................................ 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 9 Analysis of Financial Condition........................................................................... 9 Asset/Liability Management................................................................................ 11 Capital Adequacy and Resources............................................................................ 12 Analysis of Results of Operations......................................................................... 13 Part II. OTHER INFORMATION Item 1. Legal Proceedings......................................................................................... 19 Item 6. Exhibits and Reports on Form 8-K.......................................................................... 19 SIGNATURES.......................................................................................................... 20 EXHIBIT 2 Agreement and Plan of Reorganization between Southern National Corporation and United Carolina Bancshares Corporation, dated November 1, 1996, and exhibits thereto: a) Stock Option Agreement between Southern National Corporation and United Carolina Bancshares Corporation and b) Stock Option Agreement between United Carolina Bancshares Corporation and Southern National Corporation. EXHIBIT 11 Computation of Earnings Per Share EXHIBIT 27 Financial Data Schedule -- Included with electronically-filed document only. ...... </TABLE> 2
PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS SOUTHERN NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) <TABLE> <CAPTION> SEPTEMBER 30, DECEMBER 31, 1996 1995 <S> <C> <C> (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) ASSETS Cash and due from banks...................................................................... $ 656,632 $ 585,527 Interest-bearing deposits with banks......................................................... 429 1,172 Federal funds sold and securities purchased under resale agreements or similar arrangements.............................................................................. 7,433 118,977 Securities available for sale................................................................ 5,489,878 5,201,344 Securities held to maturity (market value: $130,291 at September 30, 1996, and $159,886 at December 31, 1995)........................................................................ 126,848 153,969 Loans held for sale.......................................................................... 178,582 245,280 Loans and leases, net of unearned income..................................................... 13,932,414 13,706,711 Allowance for loan and lease losses....................................................... (184,203) (175,588) Loans and leases, net................................................................... 13,748,211 13,531,123 Premises and equipment, net.................................................................. 314,406 313,858 Other assets................................................................................. 574,138 485,180 TOTAL ASSETS............................................................................ $21,096,557 $ 20,636,430 LIABILITIES AND SHAREHOLDERS' EQUITY Noninterest-bearing demand deposits.......................................................... $ 2,039,356 $ 1,885,725 Savings and interest checking................................................................ 1,380,011 1,591,488 Money rate savings........................................................................... 3,204,789 3,049,810 Other time deposits.......................................................................... 8,394,256 8,157,033 Total deposits.......................................................................... 15,018,412 14,684,056 Short-term borrowed funds.................................................................... 2,095,282 2,595,416 Long-term debt............................................................................... 2,050,211 1,383,935 Accounts payable and other liabilities....................................................... 275,846 261,681 TOTAL LIABILITIES....................................................................... 19,439,751 18,925,088 SHAREHOLDERS' EQUITY: Preferred stock, $5 par, 5,000,000 shares authorized, none issued and outstanding at September 30, 1996, and 733,869 at December 31, 1995...................................... -- 3,669 Common stock, $5 par, 300,000,000 shares authorized, 109,112,010 issued and outstanding at September 30, 1996, and 109,151,655 at December 31, 1995.................................. 545,560 545,758 Paid-in capital.............................................................................. 137,974 269,404 Retained earnings............................................................................ 987,979 865,658 Loan to employee stock ownership plan and unvested restricted stock.......................... (2,971) (4,314) Net unrealized (depreciation) appreciation on securities available for sale.................. (11,736) 31,167 TOTAL SHAREHOLDERS' EQUITY.............................................................. 1,656,806 1,711,342 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............................................. $21,096,557 $ 20,636,430 </TABLE> See accompanying notes to consolidated financial statements. 3
SOUTHERN NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) <TABLE> <CAPTION> FOR THE NINE MONTHS FOR THE THREE MONTHS ENDED ENDED SEPTEMBER 30, SEPTEMBER 30, 1996 1995 1996 1995 <S> <C> <C> <C> <C> (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) INTEREST INCOME Interest and fees on loans and leases............................ $320,498 $321,808 $ 957,961 $ 938,187 Interest and dividends on securities............................. 84,796 79,528 236,117 233,814 Interest on short-term investments............................... 208 401 584 1,790 Total interest income......................................... 405,502 401,737 1,194,662 1,173,791 INTEREST EXPENSE Interest on deposits............................................. 144,489 142,779 421,847 415,093 Interest on short-term borrowed funds............................ 24,594 48,688 81,602 141,748 Interest on long-term debt....................................... 28,842 20,384 76,678 49,768 Total interest expense........................................ 197,925 211,851 580,127 606,609 NET INTEREST INCOME................................................ 207,577 189,886 614,535 567,182 Provision for loan and lease losses.............................. 13,500 7,933 38,161 23,315 NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES...... 194,077 181,953 576,374 543,867 NONINTEREST INCOME Service charges on deposit accounts.............................. 27,340 22,381 79,358 66,162 Mortgage banking activities...................................... 6,992 9,019 24,834 18,581 Trust income..................................................... 5,963 4,483 16,803 13,478 Agency insurance commissions..................................... 5,549 3,479 16,315 11,757 Other insurance commissions...................................... 2,943 2,195 8,117 8,095 Other nondeposit fees and commissions............................ 17,780 14,233 50,894 40,977 Securities gains (losses), net................................... 705 1,114 543 (18,731) Other noninterest income......................................... 7,650 5,821 20,131 28,597 Total noninterest income...................................... 74,922 62,725 216,995 168,916 NONINTEREST EXPENSE Personnel expense................................................ 74,599 74,300 225,297 275,693 Occupancy and equipment expense.................................. 26,750 25,621 76,965 83,243 Foreclosed property expense...................................... 214 524 1,306 2,258 Federal deposit insurance expense................................ 36,293 2,901 42,820 18,881 Other noninterest expense........................................ 49,878 43,775 144,461 159,835 Total noninterest expense..................................... 187,734 147,121 490,849 539,910 EARNINGS Income before income taxes....................................... 81,265 97,557 302,520 172,873 Income tax expense............................................... 25,299 32,971 98,536 58,813 Net income....................................................... 55,966 64,586 203,984 114,060 Preferred dividend requirements............................... -- 1,255 610 3,843 Income applicable to common shares............................ $ 55,966 $ 63,331 $ 203,374 $ 110,217 PER COMMON SHARE Net income: Primary....................................................... $ .50 $ .57 $ 1.85 $ 1.01 Fully diluted................................................. $ .50 $ .56 $ 1.83 $ 1.00 Cash dividends declared....................................... $ .27 $ .23 $ .73 $ .63 AVERAGE SHARES OUTSTANDING Primary.......................................................... 110,841,221 110,162,172 110,071,975 109,489,491 Fully diluted.................................................... 111,013,052 114,996,393 111,722,834 114,782,862 </TABLE> See accompanying notes to consolidated financial statements. 4
SOUTHERN NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED) <TABLE> <CAPTION> RETAINED SHARES OF EARNINGS COMMON PREFERRED COMMON PAID-IN AND STOCK STOCK STOCK CAPITAL OTHER* TOTAL <S> <C> <C> <C> <C> <C> <C> (DOLLARS IN THOUSANDS) BALANCE, DECEMBER 31, 1994, AS PREVIOUSLY REPORTED...................................... 102,215,032 $ 3,850 $511,075 $285,599 $695,953 $1,496,477 Merger with Regional Acceptance Corporation accounted for under the pooling of interests method of accounting............. 5,794,215 -- 28,971 (9,800) 9,900 29,071 BALANCE, DECEMBER 31, 1994, AS RESTATED......... 108,009,247 3,850 540,046 275,799 705,853 1,525,548 Add (Deduct) Net income.................................... -- -- -- -- 114,060 114,060 Common stock issued........................... 2,478,754 -- 12,393 24,821 -- 37,214 Redemption of common stock.................... (1,436,550) -- (7,183) (25,674) -- (32,857) Net appreciation on securities available for sale....................................... -- -- -- -- 80,905 80,905 Preferred stock cancellations and conversions................................ 66,447 (148) 332 (2,555) -- (2,371) Cash dividends declared: Common stock............................... -- -- -- -- (77,593) (77,593) Preferred stock............................ -- -- -- -- (3,811) (3,811) Amortization of unearned stock compensation... -- -- -- -- 1,141 1,141 BALANCE, SEPTEMBER 30, 1995..................... 109,117,898 $ 3,702 $545,588 $272,391 $820,555 $1,642,236 </TABLE> <TABLE> <S> <C> <C> <C> <C> <C> <C> BALANCE, DECEMBER 31, 1995, AS PREVIOUSLY REPORTED...................................... 103,357,440 $ 3,669 $516,787 $279,204 $874,403 $1,674,063 Merger with Regional Acceptance Corporation accounted for under the pooling of interests method of accounting............. 5,794,215 -- 28,971 (9,800) 18,108 37,279 BALANCE, DECEMBER 31, 1995, AS RESTATED......... 109,151,655 3,669 545,758 269,404 892,511 1,711,342 Add (Deduct) Net income.................................... -- -- -- -- 203,984 203,984 Common stock issued........................... 1,804,663 -- 9,023 36,070 -- 45,093 Redemption of common stock.................... (6,179,000) -- (30,895) (149,495) -- (180,390) Net depreciation on securities available for sale....................................... -- -- -- -- (42,903) (42,903) Preferred stock cancellations and conversions................................ 4,334,692 (3,669) 21,674 (18,005) -- -- Cash dividends declared: Common stock............................... -- -- -- -- (81,053) (81,053) Preferred stock............................ -- -- -- -- (610) (610) Amortization of unearned stock compensation... -- -- -- -- 1,343 1,343 BALANCE, SEPTEMBER 30, 1996..................... 109,112,010 $ -- $545,560 $137,974 $973,272 $1,656,806 </TABLE> * Includes net unrealized appreciation (depreciation) on securities available for sale, unvested restricted stock and loan to employee stock ownership plan. See accompanying notes to consolidated financial statements. 5
SOUTHERN NATIONAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 (UNAUDITED) <TABLE> <CAPTION> 1996 1995 <S> <C> <C> (DOLLARS IN THOUSANDS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income........................................................................................... $ 203,984 $ 114,060 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan and lease losses................................................................ 38,161 23,315 Depreciation of premises and equipment............................................................. 29,403 24,469 Amortization of intangibles........................................................................ 5,364 8,740 Accretion of negative goodwill..................................................................... (4,678) (4,751) Amortization of unearned stock compensation........................................................ 1,343 1,141 Discount accretion and premium amortization on securities, net..................................... 2,052 3,144 Loss (gain) on sales of trading account securities, net............................................ 2 (31) Loss (gain) on sales of securities, net............................................................ (543) 18,731 Loss (gain) on sales of loans, net................................................................. (6,127) (3,366) Loss (gain) on disposals of premises and equipment, net............................................ (220) (6,476) Loss (gain) on foreclosed property and other real estate, net...................................... 2,066 1,353 Proceeds from sales of trading account securities, net of purchases................................ (2) 31 Proceeds from sales of loans held for sale......................................................... 1,107,666 380,443 Purchases of loans held for sale................................................................... (309,600) (180,180) Origination of loans held for sale, net of principal collected..................................... (725,241) (406,631) Decrease (increase) in: Accrued interest receivable...................................................................... 24,115 (26,239) Other assets..................................................................................... (112,874) 28,240 Increase (decrease) in: Accrued interest payable......................................................................... 2,526 18,961 Accounts payable and other liabilities........................................................... 34,088 97,733 Net cash provided by operating activities...................................................... 291,485 92,687 CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of securities available for sale................................................. 315,067 1,145,702 Proceeds from maturities of securities available for sale............................................ 1,631,600 688,757 Purchases of securities available for sale........................................................... (1,487,678) (1,826,599) Proceeds from maturities of securities held to maturity.............................................. 29,024 155,549 Purchases of securities held to maturity............................................................. (2,034) (43,544) Leases made to customers............................................................................. (53,082) (33,842) Principal collected on leases........................................................................ 35,419 34,401 Loan originations, net of principal collected........................................................ (988,710) (827,178) Purchases of loans................................................................................... (79,344) (5,382) Proceeds from disposals of premises and equipment.................................................... 2,426 12,605 Purchases of premises and equipment.................................................................. (40,213) (61,250) Proceeds from sales of foreclosed property........................................................... 10,730 8,107 Proceeds from sales of other real estate held for development or sale................................ 5,672 11,447 Other, net........................................................................................... -- (9,177) Net cash used in investing activities.......................................................... (621,123) (750,404) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits............................................................................. 334,356 120,886 Net (decrease) increase in short-term borrowed funds................................................. (500,134) 125,410 Proceeds from long-term debt......................................................................... 1,236,758 1,046,358 Repayments of long-term debt......................................................................... (570,482) (651,831) Net proceeds from common stock issued................................................................ 45,004 37,214 Redemption of common stock........................................................................... (180,390) (32,857) Preferred stock cancellations and conversions........................................................ -- (2,371) Cash dividends paid on common and preferred stock.................................................... (76,656) (57,770) Net cash provided by financing activities...................................................... 288,456 585,039 Net Decrease in Cash and Cash Equivalents.............................................................. (41,182) (72,678) CASH AND CASH EQUIVALENTS at beginning of period....................................................... 705,676 671,777 CASH AND CASH EQUIVALENTS at end of period............................................................. $ 664,494 $ 599,099 SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the year for: Interest........................................................................................... $ 578,174 $ 587,914 Income taxes....................................................................................... 112,108 78,933 Noncash financing and investing activities: Transfer of loans to foreclosed property........................................................... 13,200 6,438 Transfer of fixed assets to other real estate owned................................................ 8,416 21,846 Common stock issued upon conversion of debentures.................................................. -- 4,896 Restricted stock issued............................................................................ 88 -- Securitization of mortgage loans................................................................... 817,268 53,540 </TABLE> See accompanying notes to consolidated financial statements. 6
SOUTHERN NATIONAL CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1996 (Unaudited) A. BASIS OF PRESENTATION In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the consolidated balance sheets of Southern National Corporation and subsidiaries ("Southern National" or "SNC") as of September 30, 1996 and December 31, 1995; the consolidated statements of income for the three months and nine months ended September 30, 1996 and 1995; and the consolidated statements of cash flows for the nine months ended September 30, 1996 and 1995. The consolidated financial statements and notes are presented in accordance with the instructions for Form 10-Q. The information contained in the footnotes included in Southern National's latest annual report on Form 10-K should be referred to in connection with the reading of these unaudited interim consolidated financial statements. Certain 1995 amounts have been reclassified to conform with statement presentations for 1996. The reclassifications have no effect on shareholders' equity or net income as previously reported. The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. B. NATURE OF OPERATIONS Southern National is a multi-bank holding company headquartered in Winston-Salem, North Carolina. Southern National conducts its operations in North Carolina, South Carolina and Virginia primarily through its commercial banking subsidiaries and, to a lesser extent, through its other subsidiaries. The commercial banking subsidiaries, Branch Banking and Trust Company ("BB&T"), Branch Banking and Trust Company of South Carolina ("BB&T-SC") and Branch Banking and Trust Company of Virginia ("BB&T-VA"), provide a wide range of traditional banking services for retail and commercial customers, including small and mid-size businesses, public agencies and local governments, trust companies and individuals. Substantially all of Southern National's loans are to businesses and individuals in the Carolinas and Virginia. Subsidiaries of the commercial banks offer lease financing to commercial businesses and municipal governments; investment alternatives, including discount brokerage services, annuities, mutual funds and government and municipal bonds; life and property and casualty insurance on an agency basis; and insurance premium financing. C. NEW ACCOUNTING PRONOUNCEMENTS During 1995, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." This statement establishes accounting standards for long-lived assets, certain identifiable intangibles and goodwill related to those assets to be held and to be disposed of. The statement requires such assets to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Any resulting impairment loss is required to be reported in the period in which the recognition criteria are first applied and met. Southern National adopted the provisions of the statement on January 1, 1996. The implementation did not have a material impact on the consolidated financial position or consolidated results of operations. In May 1995, the FASB issued SFAS No. 122, "Accounting for Mortgage Servicing Rights," which amends SFAS No. 65, "Accounting for Certain Mortgage Banking Activities." SFAS No. 122 requires that mortgage banking enterprises recognize, as separate assets, rights to service mortgage loans for others, however those servicing rights are acquired. The statement further requires mortgage banking enterprises to assess their capitalized mortgage servicing rights for impairment based on the fair value of those rights. Southern National elected, in the third quarter of 1995, to adopt this statement effective as of January 1, 1995. The impact of the adoption of this statement resulted in additional mortgage banking income of $2.5 million, before taxes, or $.02 per fully diluted share, after taxes, during the first nine months of 1995. SFAS No. 122 prohibits retroactive application to prior years. In October of 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based Compensation," which establishes financial accounting and reporting standards for stock-based compensation plans. The statement defines a fair value based method of accounting for an employee stock option or similar equity instrument and encourages the adoption of 7
that method of accounting. However, the statement also allows entities to continue to account for such plans under Accounting Principles Board ("APB") Opinion No. 25. Entities electing to account for such plans in accordance with APB Opinion No. 25 must make pro forma disclosures of net income and earnings per share as if the fair value based method of accounting defined in the statement had been applied. Southern National adopted the statement effective January 1, 1996 and elected to continue to account for stock-based compensation plans under the provisions of APB Opinion No. 25. Therefore, the implementation of the statement did not have an impact on Southern National's consolidated financial position or consolidated results of operations. Southern National will make the required pro forma disclosures of net income and earnings per share using accounting methods prescribed by SFAS No. 123 in the Form 10-K for the year ending December 31, 1996. In June of 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities." The statement, which becomes effective for transactions occurring after December 31, 1996, provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities based on the financial components approach that focuses on control. Under this approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, derecognizes all assets it does not control and derecognizes liabilities when extinguished. The statement also provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. Management does not anticipate that the implementation of the statement will have a material impact on the consolidated financial position or consolidated results of operations of Southern National. D. MERGERS AND ACQUISITIONS On August 22, 1996, Southern National announced plans to acquire Fidelity Financial Bankshares Corporation ("Fidelity") of Richmond, Va. Under the terms of the agreement, Fidelity shareholders will receive .7931 shares of Southern National common stock for each share of Fidelity common stock held. The deal is valued at $24.68 per Fidelity share. The exchange ratio is fixed between Southern National stock prices of $26.50 and $31.50. Outside this collar, the exchange ratio is variable based on Southern National's common stock price and will fall within a range of .7137 and .8758. The transaction will be accounted for under the purchase method of accounting. Fidelity, with $321 million in assets, operates seven branches in the Richmond metropolitan area through its banking subsidiary, Fidelity Federal Savings Bank, which will merge into BB&T-VA. On September 1, 1996, Southern National completed the acquisition of Regional Acceptance Corporation of Greenville, N.C. ("Regional") in a stock transaction accounted for under the pooling-of-interests method of accounting. Accordingly, the consolidated financial statements and supplemental financial information contained herein has been restated to reflect Regional's financial condition and results of operations. Regional's shareholders received .3861 shares of Southern National stock in exchange for each share of Regional stock held. Pursuant to the acquisition, Southern National issued approximately 5.85 million shares of common stock. Regional will continue to operate as an independent subsidiary of Southern National Corporation. Regional, which specializes in indirect financing for consumer purchases of mid-model and late-model used automobiles, operates 28 branch offices in North Carolina, South Carolina, Tennessee and Virginia. On September 9, 1996, Southern National announced plans to acquire Boyle-Vaughan Associates, Inc., an independent insurance agency based in Columbia, S.C. On October 1, 1996, Southern National announced an agreement to acquire the William Goldsmith Agency Inc. and the C. Dan Joyner Insurance Agency, both based in Greenville, S.C. These insurance agencies will be accounted for as purchase transactions. On November 4, 1996, Southern National announced plans to acquire United Carolina Bancshares Corporation ("UCB") of Whiteville, N.C. in a stock transaction to be accounted for as a pooling of interests. Under the terms of the agreement, UCB shareholders will receive 1.135 shares of Southern National common stock in exchange for each share of UCB common stock held. The transaction, which will be structured as a tax-free exchange, is valued at $985 million, or $40.01 per UCB common share, based on the November 1, 1996 closing price of Southern National common stock of $35.25. The exchange ratio is subject to renegotiation if Southern National's stock price declines 20% compared to the stock price on the agreement date or declines 15% relative to an index of peer bank stocks. UCB, which conducts business primarily through its commercial banking subsidiaries, has $4.4 billion in assets and operates 153 branch offices in North and South Carolina. 8
E. SUPPLEMENTAL CASH FLOW INFORMATION During the first quarter of 1996, Southern National redeemed all outstanding shares of Convertible Preferred Stock. This transaction, a noncash financing activity, resulted in the conversion of 733,869 shares of preferred stock into 4,334,692 shares of common stock. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This report includes statements which are based on current expectations. These statements are forward looking and actual results may differ materially from those contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations". Factors affecting the ultimate outcomes of these expectations include business conditions in the commercial banking industry, overall economic conditions, competitive factors with other financial institutions and with non-bank financial service companies, fluctuations in interest rates and other factors. ANALYSIS OF FINANCIAL CONDITION Southern National's total assets at September 30, 1996 were $21.1 billion, a $460.1 million increase from the balance at December 31, 1995. The primary components of the increase were securities, which increased $261.4 million, and loans and leases, which grew $159.0 million. These increases were offset by declines in other earning assets of $112.3 million. Growth in loans was affected by securitizations. During 1996 and 1995, Southern National has transferred $1.2 billion in mortgage loans from the mortgage portfolio to the securities portfolio. During the third quarter of 1996, Southern National securitized $307.1 million of loans. This is designed to provide Southern National with additional liquidity and flexibility in managing mortgage loan assets. The resulting mortgage-backed securities are being used to replace lower-yielding U.S. Treasuries in the securities portfolio as they mature, thereby improving margin. Management intends to hold the mortgage-backed securities in the available for sale portfolio for the foreseeable future. Annualized loan growth, excluding the impact of these securitizations, was 9.1% comparing end of period loans at September 30, 1996 and December 31, 1995. Average loans, excluding the impact of $974.8 million of securitized loans, increased at an annualized rate of 7.4% comparing the quarters ended September 30, 1996 and 1995. Growth in average loans has been healthy in all categories comparing the quarterly averages for the third quarters of 1996 and 1995. Mortgage loans, excluding the impact of the loan securitizations, grew at a rate of 5.5%, average commercial loans increased 8.3% over the same time frame and average consumer loans grew at a rate of 8.2%. The trends in lending have been improving since the completion of the merger of equals and momentum has particularly increased in recent quarters. At September 30, 1996, securities available for sale had unrealized depreciation, after tax, of $11.7 million compared to unrealized appreciation, after tax, of $31.2 million at December 31, 1995. The taxable equivalent yield on the securities portfolio during the third quarter was 6.74%, up from 6.32% for the fourth quarter of 1995 and up from 6.23% for the third quarter of the prior year. During the fourth quarter of 1995, Southern National began to restructure the balance sheet by changing the mix of investments held. The primary result of this strategy has been a reduction of holdings in U.S. Treasuries, as such investments have been replaced with securitized mortgage loans from Southern National's mortgage loan portfolio. The change in mix was undertaken to improve the overall investment yield of the securities portfolio, as reflected in these improved quarterly yields. On the liability side of the balance sheet, long-term debt rose $666.3 million compared to December 31, 1995, primarily as a result of the issuance of $225.0 million of senior bank notes and $250.0 million of subordinated notes during 1996. This growth was offset by a $500.1 million reduction in short-term borrowed funds compared to year end 1995. Total deposits increased by $334.4 million from the balance at December 31, 1995. Southern National, as well as many other financial institutions, has been experiencing a trend of slower deposit growth because of competition for deposits from various non-financial institution sources. However, through an increased emphasis on demand deposits, which composed 46% of the increase in total deposits, Southern National has experienced stronger growth during 1996. Noninterest-bearing demand deposits increased $153.6 million, or 8.1%, during the first nine months of 1996. Slower deposit growth during 1995 caused management to rely more heavily on nondeposit funding sources, such as Federal Home Loan Bank advances and Federal funds purchased. The improved deposit growth during 1996 also contributed to the reduction in short-term borrowed funds. Less reliance on short-term borrowed funds should provide more stability for the net interest margin. 9
ASSET QUALITY Nonperforming assets were $78.9 million at September 30, 1996, compared to $79.9 million at December 31, 1995. The allowance for losses as a percentage of loans and leases was 1.31% compared to 1.26% nine months earlier, and nonperforming assets as a percentage of loan-related assets were .56% at September 30, 1996 compared to .57% at December 31, 1995. Loans 90 days or more past due and still accruing interest totaled $28.2 million compared to a prior year-end balance of $29.1 million. Southern National has experienced higher levels of net charge-offs during 1996, particularly in the credit card category of consumer loans. This trend is consistent with other institutions; however, Southern National's credit card portfolio is small compared to our peers and the trend is not expected to have a significant impact on overall credit quality. Southern National's asset quality indicators remain at or above historic rates and management does not anticipate a material change in asset quality levels during the remainder of 1996. The provision for loan and lease losses for the first nine months of 1996 was $38.2 million compared to $23.3 million in the first nine months of 1995. The increase in the provision reflects higher net charge-offs during 1996 and continued growth in loans. Regional, Southern National's nonstandard automobile finance subsidiary, affects Southern National's credit quality through higher net charge-offs and nonperforming assets. This results from the cyclical nature of Regional's business and rapid growth of the subsidiary through expansion. The higher charge-offs are not expected to have a significant effect on Southern National's overall credit quality. Asset quality statistics relevant to the last five calendar quarters are presented in the accompanying table. ASSET QUALITY ANALYSIS <TABLE> <CAPTION> 9/30/96 6/30/96 3/31/96 12/31/95 9/30/95 <S> <C> <C> <C> <C> <C> (DOLLARS IN THOUSANDS) ALLOWANCE FOR LOAN & LEASE LOSSES Beginning balance.............................................. $181,269 $178,885 $175,588 $177,149 $178,929 Provision for loan and lease losses............................ 13,500 13,261 11,400 11,317 7,933 Net charge-offs................................................ (10,566) (10,877) (8,103) (12,878) (9,713) Ending balance.............................................. $184,203 $181,269 $178,885 $175,588 $177,149 RISK ASSETS Nonaccrual loans and leases.................................... $ 63,088 $ 68,014 $ 69,473 $ 66,198 $ 65,807 Foreclosed real estate......................................... 7,166 4,926 4,938 6,868 6,981 Other foreclosed property...................................... 8,609 7,426 6,336 6,784 5,914 Nonperforming assets........................................ $ 78,863 $ 80,366 $ 80,747 $ 79,850 $ 78,702 Loans 90 days or more past due and still accruing.............. $ 28,222 $ 18,025 $ 28,249 $ 29,094 $ 26,909 ASSET QUALITY RATIOS Nonaccrual loans and leases as a percentage of total loans and leases......................................................... .45% .48% .49% .47% .46% Nonperforming assets as a percentage of: Total assets................................................... .37 .39 .40 .39 .38 Loans and leases plus foreclosed property...................... .56 .57 .57 .57 .55 Net charge-offs as a percentage of average loans and leases...... .30 .31 .23 .36 .27 Allowance for loan and lease losses as a percentage of loans and leases......................................................... 1.31 1.28 1.26 1.26 1.25 Ratio of allowance for loan and lease losses to: Net charge-offs................................................ 4.38X 4.19x 5.49x 3.44x 4.60x Nonaccrual loans and leases.................................... 2.92 2.67 2.57 2.65 2.69 </TABLE> All items referring to loans and leases include loans held for sale and are net of unearned income. Applicable ratios are annualized. 10
ASSET/LIABILITY MANAGEMENT Asset/liability management activities are designed to assure liquidity and, through the management of Southern National's interest sensitivity position, to manage the impact of interest rate fluctuations on net interest income. It is the responsibility of the Asset/Liability Management Committee ("ALCO") to set policy guidelines and to establish long-term strategies with respect to interest rate exposure and liquidity. The ALCO meets regularly to review Southern National's interest rate and liquidity risk exposures in relation to present and prospective market and business conditions, and adopts funding and balance sheet management strategies that are intended to assure that the potential impact on earnings and liquidity is within established parameters. A prime objective in interest rate risk management is the avoidance of wide fluctuations in net interest income through balancing the impact of changes in interest rates on interest-sensitive assets and interest-sensitive liabilities. Management uses Interest Sensitivity Simulation Analysis to measure the interest rate sensitivity of earnings. Balance sheet repositioning is the most cost-effective means of managing interest rate risk and is accomplished through strategic pricing of asset and liability accounts. The expected result of strategic pricing is the development of appropriate maturity and repricing streams in those accounts to produce consistent net income during adverse interest rate environments. The ALCO monitors loan, investment and liability portfolios to ensure comprehensive management of interest rate risk on the balance sheet. These portfolios are analyzed for proper fixed-rate and variable-rate "mixes" given a specific interest rate outlook. Management has established parameters for asset/liability management which prescribe a maximum impact on net interest income of 3% for a 150 basis point change over nine months, for the most likely interest rate scenario, and a maximum of 6% for a 300 basis point change over 12 months. It is management's on-going objective to effectively manage the impact of changes in interest rates and minimize the resulting effect on earnings. At September 30, 1996, fluctuations in interest rate scenarios of this magnitude would not have a significant impact on Southern National's earnings. Future strategies for managing the balance sheet include maintaining an equity to asset ratio of 7.0% to 8.0%. The current equity ratio, at 7.9%, allows Southern National flexibility in making decisions affecting equity because current balances are at the top of the target range. Southern National recently announced plans to repurchase shares of its common stock for reissue in connection with the proposed acquisition of Fidelity. Repurchase of the shares should allow Southern National to manage its capital position more effectively. Management also intends to continue to eliminate low margin assets on the balance sheet. The securitizations, referred to earlier, have improved securities yields by moving $1.2 billion in mortgage loans to the securities portfolio where they have been used to replace lower yielding U.S. Treasuries as these investments have matured. This strategy will continue into the foreseeable future. Management is also considering non-certificate core funding strategies, as certificate accounts are not always the most cost-effective source of funding. DERIVATIVES AND OFF-BALANCE SHEET FINANCIAL INSTRUMENTS Interest rate volatility often increases to the point that balance sheet repositioning through the use of account repricing and other on-balance sheet strategies cannot occur rapidly enough to avoid adverse net income effects. At those times, off-balance sheet or synthetic hedges are utilized. Management uses interest rate swaps, caps and floors to supplement balance sheet repositioning. These financial instruments are designed to move the interest sensitivity of Southern National toward a neutral position. Interest rate swaps are contractual agreements between two parties to exchange a series of cash flows representing interest payments. A swap allows both parties to transform the repricing characteristics of an asset or liability from a fixed to a floating rate, a floating rate to a fixed rate, or one floating rate to another floating rate. The underlying principal positions are not affected. Swap terms generally range from one year to ten years depending on need. At September 30, 1996, interest rate swaps and floors with a total notional value of $1.1 billion, and terms of up to seven years, were outstanding. 11
The following tables set forth certain information concerning Southern National's interest rate swaps and floors at September 30, 1996: INTEREST RATE SWAPS AND FLOORS SEPTEMBER 30, 1996 <TABLE> <CAPTION> NOTIONAL RECEIVE PAY UNREALIZED TYPE AMOUNT RATE RATE GAINS (LOSSES) <S> <C> <C> <C> <C> (DOLLARS IN THOUSANDS) Receive fixed swaps.................................................. $ 485,000 6.60% 5.51% $ 2,306 Pay fixed swaps...................................................... 304,610 5.56 5.47 35 Basis swaps.......................................................... 250,000 5.69 5.51 (1,718) Floors............................................................... 105,000 -- -- 284 Total................................................................ $ 1,144,610 6.08% 5.50% $ 907 <CAPTION> RECEIVE PAY FIXED BASIS SWAPS YEAR-TO-DATE ACTIVITY FIXED SWAPS SWAPS AND FLOORS TOTAL <S> <C> <C> <C> <C> Balance, December 31, 1995........................................... $ 140,000 $ 353,413 $ 250,000 $ 743,413 Additions............................................................ 450,000 -- 105,000 555,000 Maturities/amortizations............................................. (105,000) (48,803) -- (153,803) Terminations......................................................... -- -- -- -- Balance, September 30, 1996.......................................... $ 485,000 $ 304,610 $ 355,000 $1,144,610 <CAPTION> ONE YEAR ONE TO FIVE AFTER FIVE MATURITY SCHEDULE* OR LESS YEARS YEARS TOTAL <S> <C> <C> <C> <C> Receive fixed swaps.................................................. $ 35,000 $ 200,000 $ 250,000 $ 485,000 Pay fixed swaps...................................................... 15,604 284,620 4,386 304,610 Basis swaps.......................................................... -- 250,000 -- 250,000 Floors............................................................... -- 105,000 -- 105,000 Total................................................................ $ 50,604 $ 839,620 $ 254,386 $1,144,610 </TABLE> *Maturities are based on full contract extensions. CAPITAL ADEQUACY AND RESOURCES The maintenance of appropriate levels of capital is a management priority. Capital adequacy is monitored on an on-going basis by management. Southern National's principal capital planning goals are to provide an adequate return to shareholders while retaining a sufficient base from which to provide future growth and compliance with all regulatory standards. Total shareholders' equity was $1.7 billion at September 30, 1996 and December 31, 1995. As a percentage of total assets, total shareholders' equity was 7.9% at September 30, 1996, down from 8.3% at December 31, 1995. Southern National's book value per common share at September 30, 1996 was $15.18, versus $15.04 at December 31, 1995. Average shareholders' equity as a percentage of average assets was 7.9% for the quarter ended September 30, 1996 and 8.2% for the three months ended December 31, 1995. Tier 1 and total risk-based capital ratios at September 30, 1996 were 11.3% and 14.3%, respectively. The leverage ratio was 7.9% at the end of the third quarter. The comparable ratios at the end of 1995 were 13.2%, 14.4% and 7.9%, respectively. These capital ratios measure the capital to risk-weighted assets and off-balance sheet items as defined by Federal Reserve Board ("FRB") guidelines. An 8.00% minimum of total capital to risk-weighted assets is required. One-half of the 8.00% minimum must consist of tangible common shareholders' equity (Tier 1 capital) under regulatory guidelines. The leverage ratio, established by the FRB, measures Tier 1 capital to average total assets less goodwill and must be maintained in conjunction with the risk-based capital standards. The regulatory minimum for the leverage ratio is 3.00%. The declines in certain capital ratios reflect the impact of a common stock repurchase plan which was undertaken to facilitate the conversion of all of Southern National's preferred stock outstanding. The preferred stock was redeemed on 12
March 29, 1996, at the price of $104.05 per share. Each share of preferred stock was convertible into 5.9068 shares of common stock. CAPITAL ADEQUACY RATIOS <TABLE> <CAPTION> 1996 1995 THIRD SECOND FIRST FOURTH THIRD QUARTER QUARTER QUARTER QUARTER QUARTER <S> <C> <C> <C> <C> <C> Average equity to average assets............................................. 7.93% 8.00% 8.20% 8.17% 7.83% Equity to assets at period end............................................... 7.85 7.81 7.88 8.29 7.89 Risk-based capital ratios: Tier 1 capital............................................................. 11.3 11.9 12.3 13.2 12.1 Total capital.............................................................. 14.3 15.0 13.5 14.4 13.4 Leverage ratio............................................................... 7.9 7.9 7.7 7.9 7.7 </TABLE> ANALYSIS OF RESULTS OF OPERATIONS Southern National had net income for the first nine months of 1996 totaling $204.0 million, compared to $114.1 million during the first nine months of 1995. On a fully diluted per share basis, earnings for the nine months ended September 30, 1996 were $1.83, compared to $1.00 for the same period in 1995. For the third quarter, net income totaled $56.0 million, or $.50 per fully diluted share. This represents a 13.3% decrease from third quarter 1995 net income of $64.6 million, or $.56 per fully diluted share. The 1996 earnings reflect the impact of a one-time assessment levied by the Federal Deposit Insurance Corporation ("FDIC") totaling approximately $33 million on a pre-tax basis. The purpose of the assessment was to recapitalize the Savings Association Insurance Fund ("SAIF") and was levied on all institutions with SAIF-insured deposits. Southern National was significantly affected by the assessment because of its past thrift acquisitions. Excluding the impact of this assessment, Southern National earned $225.3 million for the first nine months of 1996, or $2.02 per fully diluted share. The significant increase from the prior year earnings resulted from $76.3 million in after-tax nonrecurring charges and securities losses related to the merger between Southern National and BB&T Financial Corporation ("BB&T FC") which were recorded in the first nine months of 1995. Excluding nonrecurring items from the prior year and the impact of the assessment recorded in the third quarter of 1996, Southern National's net income would have increased 18.3%, or $34.9 million. For the third quarter, net income totaled $77.2 million on a recurring basis compared to $68.3 million recorded for the third quarter of 1995, an increase of $9.0 million, or 13.2%. On a fully diluted per share basis, recurring net income for the quarter was $.70, a 18.6% increase over the $.59 earned on a recurring basis in the third quarter of 1995. Southern National's growth in recurring earnings resulted from three factors. First, net interest margin improved from 4.13% for the first nine months of 1995 to 4.43% for the first nine months of 1996. Second, following the merger of Southern National and BB&T FC, management targeted a growth rate in noninterest income of 20%. The 22.7% growth in recurring noninterest income for the nine months ended September 30, 1996 compared to the same period in 1995 exceeds this goal and demonstrates progress in achieving the revenue enhancements which were expected to be a strength of the combined bank. Third, Southern National has controlled noninterest expenses following the merger as shown by the improvement in the efficiency ratio to 53.3% from 56.4% for the nine months ended September 30, 1996 and 1995, respectively. Southern National's market area continues to grow at a healthy, sustainable rate. The core business has shown positive trends each of the six quarters since the Southern National / BB&T FC merger. Southern National's operations were somewhat affected by Hurricane Fran during the quarter. The hurricane caused significant damage to portions of BB&T's market area, as well as damaging certain banking offices and interrupting business in those offices. Management does not believe, however, that the hurricane caused any material impact on Southern National's consolidated financial condition or consolidated results of operations. NET INTEREST INCOME Net interest income on a fully taxable equivalent ("FTE") basis was $639.4 million for the first nine months of 1996 compared to $591.1 million for the same period in 1995, a 8.2% increase. For the nine months ended September 30, 1996 and 13
1995, average interest-earning assets increased $107.4 million, or .6%, to $19.3 billion, while average interest-bearing liabilities decreased by $120.0 million. As mentioned previously, Southern National also experienced substantial positive development in the net interest margin. The 30 basis point increase in margin was primarily rate driven, rather than volume driven. The increase was caused primarily by a 43 basis point increase in yields from securities, combined with a 53 basis point decrease in rates paid on savings, interest checking and MRS sweeps, a 64 basis point decline in rates paid on short-term borrowed funds and a 52 basis point decrease in rates paid on long-term debt. These fluctuations reflect the restructuring of the securities portfolio, as well as other categories of the balance sheet, which has slowed growth in total assets, thus reducing Southern National's dependence on costly nondeposit funding sources. The improvement in margin also reflects a change in management focus from pricing strategies to quality strategies. Loans and deposits were very competitively priced following the merger of Southern National and BB&T FC to protect current market positions and retain customer relationships. The net interest margin was 4.42% for the third quarter, down from 4.49% for the second quarter of 1996. The reduction for the current quarter reflects the impact of prepayment penalties associated with changing the funding strategy for the recently-acquired Regional. Southern National paid off Regional's existing borrowings because Southern National has greater access to more cost-effective funding sources than were being utilized by Regional. Management anticipates improved net interest margins for Regional because of the changes made in funding. The following table demonstrates fluctuations in net interest income and the related yields, and details the portions of these changes caused by changes in rates versus changes in volumes. 14
NET INTEREST INCOME AND RATE/VOLUME ANALYSIS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 <TABLE> <CAPTION> CHANGE AVERAGE BALANCES YIELD/RATE INCOME/EXPENSE INCREASE DUE TO FULLY TAXABLE EQUIVALENT 1996 1995 1996 1995 1996 1995 (DECREASE) RATE <S> <C> <C> <C> <C> <C> <C> <C> <C> (DOLLARS IN THOUSANDS) ASSETS Securities (1): U.S. Treasury, government and other (5).............. $ 4,943,840 $ 5,261,508 6.54% 6.08% $ 242,473 $ 239,945 $ 2,528 $ 17,474 States and political subdivisions............... 152,762 172,660 9.04 8.92 10,356 11,540 (1,184) 160 Total securities (5)....... 5,096,602 5,434,168 6.61 6.18 252,829 251,485 1,344 17,634 Other earning assets (2)....... 14,443 41,744 5.71 5.76 617 1,799 (1,182) (16) Loans and leases, net of unearned income (1)(3)(4)(5). 14,145,508 13,673,281 9.12 9.23 966,078 944,431 21,647 (11,577) Total Earnings assets...... 19,256,553 19,149,193 8.45 8.36 1,219,524 1,197,715 21,809 6,041 Non-earning assets......... 1,163,799 1,195,379 TOTAL ASSETS............. $20,420,352 $20,344,572 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Savings, interest-checking and MRS sweeps................. $ 3,141,071 $ 3,231,733 1.75 2.28 41,045 55,200 (14,155) (12,695) Money market deposits........ 1,398,939 1,634,222 3.55 3.53 37,211 43,110 (5,899) 357 Time deposits................ 8,323,308 7,697,780 5.51 5.50 343,591 316,783 26,808 696 Total interest-bearing deposits................. 12,863,318 12,563,735 4.38 4.42 421,847 415,093 6,754 (11,642) Short-term borrowed funds...... 2,055,123 3,188,018 5.30 5.94 81,602 141,748 (60,146) (13,898) Long-term debt................. 1,756,915 1,043,602 5.86 6.38 76,678 49,768 26,910 (4,592) Total interest-bearing liabilities.............. 16,675,356 16,795,355 4.65 4.83 580,127 606,609 (26,482) (30,132) Demand deposits............ 1,833,456 1,697,375 Other liabilities.......... 268,845 274,959 Shareholders' equity....... 1,642,695 1,576,883 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..... $20,420,352 $20,344,572 Average interest rate spread... 3.80 3.53 Net yield on earning assets.... 4.43% 4.13% $ 639,397 $ 591,106 $ 48,291 $ 36,173 Taxable equivalent adjustment.. $ 24,862 $ 23,924 <CAPTION> FULLY TAXABLE EQUIVALENT VOLUME <S> <C> ASSETS Securities (1): U.S. Treasury, government and other (5).............. $(14,946) States and political subdivisions............... (1,344) Total securities (5)....... (16,290) Other earning assets (2)....... (1,166) Loans and leases, net of unearned income (1)(3)(4)(5). 33,224 Total Earnings assets...... 15,768 Non-earning assets......... TOTAL ASSETS............. LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Savings, interest-checking and MRS sweeps................. (1,460) Money market deposits........ (6,256) Time deposits................ 26,112 Total interest-bearing deposits................. 18,396 Short-term borrowed funds...... (46,248) Long-term debt................. 31,502 Total interest-bearing liabilities.............. 3,650 Demand deposits............ Other liabilities.......... Shareholders' equity....... TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..... Average interest rate spread... Net yield on earning assets.... $ 12,118 Taxable equivalent adjustment.. </TABLE> (1) Yields related to securities, loans and leases exempt from both federal and state income taxes, federal income taxes only or state income taxes only are stated on a taxable equivalent basis using statutory tax rates in effect for the periods presented. (2) Includes federal funds sold and securities purchased under resale agreements or similar arrangements. (3) Loan fees, which are not material for the periods shown, are included for rate calculation purposes. (4) Nonaccrual loans have been included in the average balances. (5) Includes assets which were held for sale or available for sale at amortized cost. 15
Net interest income FTE for the third quarter of 1996 was $215.9 million, up from $198.4 million for the third quarter of 1995. The higher level of net interest income reflects a significant increase in the net interest margin, from 4.04% to 4.42% comparing the third quarters. The average yield earned on earning assets increased 11 basis points. However, the rates paid on interest-bearing liabilities declined by 26 basis points, with reductions in rates paid on deposits, short-term borrowed funds and long-term debt. Hedging strategies have been used in the past and will be utilized in the future to reduce sensitivity to interest rate movements. See "ASSET/LIABILITY MANAGEMENT" for additional discussion of hedging strategies. NONINTEREST INCOME Noninterest income for the nine months ended September 30, 1996 was $217.0 million, compared to $168.9 million for the same period in 1995. Securities losses of $19.8 million recorded in the first quarter of 1995 were a major contributing factor to the increase in noninterest income. These securities losses resulted from a restructuring of the securities portfolio done in connection with the merger of Southern National and BB&T FC. However, Southern National also experienced positive development in core noninterest income. Service charges on deposits, mortgage banking activities, general and other insurance commissions and trust income all showed strong gains during the period. The percentage of total revenues, calculated as net interest income plus noninterest income excluding securities gains or losses, derived from noninterest (fee-based) income for the nine months ended September 30, 1996 was 26.0%, up from 24.9% for the first nine months of 1995. Management anticipates continued growth in noninterest income, with an ultimate target ratio of noninterest income to total revenues of 30%. Service charges on deposits grew for the first nine months in 1996 compared to 1995, increasing by $13.2 million, or 19.9%. The primary factor contributing to the significant growth in service charges on deposits was increased fees during 1996. For the third quarter, service charges increased $5.0 million, or 22.2%, over the same quarter last year. The greatest increases involved commercial account analysis income and overdraft charges. Looking forward, management anticipates new fees on automated teller machines ("ATMs") to provide an additional $6 million in fee income on an annual basis with very little related expense. As part of Southern National's emphasis on alternative delivery systems, management anticipates the addition of 75 new ATMs in existing branches and an additional 200 ATMs in non-branch locations. Trust income grew $3.3 million, or 24.7%, for the nine months ended September 30,1996 compared to the same period in 1995. For the third quarter of 1996, trust services income totaled $6.0 million, an increase of $1.5 million over the third quarter of 1995. Southern National also realized substantial growth in agency insurance commissions, up $4.6 million, or 38.8%, compared to the first nine months of 1995. The growth in agency insurance commissions resulted primarily from unusually large contingency commissions and earnings from sales of life insurance contracts. Comparing the third quarters of 1996 and 1995, agency insurance commissions grew at a rate of 59.5%. With the announced acquisitions of Boyle-Vaughan Associates, Inc., William Goldsmith Agency Inc. and the C. Dan Joyner Insurance Agency, all in South Carolina, Southern National has assembled the largest independent agency system in the Carolinas. Management anticipates continued growth in agency insurance commissions and will continue to pursue acquisitions of quality independent agencies. Mortgage banking activities increased 33.7%, or $6.3 million, for the nine months ended September 30, 1996 compared to the same period in 1995. For the third quarter of 1996, mortgage banking activities decreased $2.0 million, or 22.5%. The increase in the year-to-date balances resulted from increased net gains on higher volumes of sales of mortgage loans and higher fees during the first nine months of 1996. The reduction in the quarter reflects larger losses from loan sales recorded for the three months ended September 30, 1996. Other nondeposit fees and commissions increased by $9.9 million to a level of $50.9 million in 1996 compared with $41.0 million for the first nine months of 1995. The primary component generating the increase in nondeposit fees and commissions was investment services, which increased $5.7 million. For the third quarter of 1996, other nondeposit fees and commissions increased $3.5 million compared to the prior year, also driven by investment services. Other income decreased $8.5 million for the first nine months of 1996 because of a premium totaling $12.3 million relating to a divestiture of deposits recorded in 1995. This divestiture was necessary in order to comply with anti-trust laws following the merger of Southern National and BB&T FC. For the third quarter, other income increased $1.8 million compared with the third quarter of 1995. 16
NET INTEREST INCOME AND RATE/VOLUME ANALYSIS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995 <TABLE> <CAPTION> CHANGE AVERAGE BALANCES YIELD/RATE INCOME/EXPENSE INCREASE DUE TO FULLY TAXABLE EQUIVALENT 1996 1995 1996 1995 1996 1995 (DECREASE) RATE <S> <C> <C> <C> <C> <C> <C> <C> <C> (DOLLARS IN THOUSANDS) ASSETS Securities (1): U.S. Treasury, government and other (5).................. $ 5,210,191 $ 5,286,634 6.69% 6.20% $ 87,080 $ 81,904 $ 5,176 $ 6,385 States and political subdivisions............... 143,615 166,290 8.88 9.03 3,189 3,753 (564) (55) Total securities (5)....... 5,353,806 5,452,924 6.74 6.23 90,269 85,657 4,612 6,330 Other earning assets (2)....... 14,983 31,033 5.79 5.13 218 401 (183) 46 Loans and leases, net of unearned income (1)(3)(4)(5)................. 14,145,593 14,020,701 9.10 9.17 323,363 324,193 (830) (2,819) Total earning assets....... 19,514,382 19,504,658 8.45 8.34 413,850 410,251 3,599 3,557 Non-earning assets......... 1,188,691 1,240,632 TOTAL ASSETS............. $20,703,073 $20,745,290 LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Savings, interest-checking and MRS sweeps............. $ 3,105,541 $ 3,268,889 1.62 2.22 12,630 18,314 (5,684) (4,773) Money market deposits........ 1,437,753 1,514,249 3.63 3.40 13,132 12,974 158 833 Time deposits................ 8,596,251 7,722,931 5.49 5.73 118,727 111,491 7,236 (4,669) Total interest-bearing deposits................. 13,139,545 12,506,069 4.37 4.53 144,489 142,779 1,710 (8,609) Short-term borrowed funds...... 1,823,310 3,297,130 5.37 5.86 24,594 48,688 (24,094) (3,870) Long-term debt................. 1,977,109 1,309,932 5.80 6.17 28,842 20,384 8,458 (1,288) Total interest-bearing liabilities.............. 16,939,964 17,113,131 4.65 4.91 197,925 211,851 (13,926) (13,767) Demand deposits............ 1,853,529 1,705,197 Other liabilities.......... 266,860 303,285 Shareholders' equity....... 1,642,720 1,623,677 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..... $20,703,073 $20,745,290 Average interest rate spread... 3.80 3.43 Net yield on earning assets.... 4.42% 4.04% $215,925 $198,400 $ 17,525 $ 17,324 Taxable equivalent adjustment................... $ 8,348 $ 8,514 <CAPTION> FULLY TAXABLE EQUIVALENT VOLUME <S> <C> ASSETS Securities (1): U.S. Treasury, government and other (5).................. $ (1,209) States and political subdivisions............... (509) Total securities (5)....... (1,718) Other earning assets (2)....... (229) Loans and leases, net of unearned income (1)(3)(4)(5)................. 1,989 Total earning assets....... 42 Non-earning assets......... TOTAL ASSETS............. LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing deposits: Savings, interest-checking and MRS sweeps............. (911) Money market deposits........ (675) Time deposits................ 11,905 Total interest-bearing deposits................. 10,319 Short-term borrowed funds...... (20,224) Long-term debt................. 9,746 Total interest-bearing liabilities.............. (159) Demand deposits............ Other liabilities.......... Shareholders' equity....... TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY..... Average interest rate spread... Net yield on earning assets.... $ 201 Taxable equivalent adjustment................... </TABLE> (1) Yields related to securities, loans and leases exempt from both federal and state income taxes, federal income taxes only or state income taxes only are stated on a taxable equivalent basis using statutory tax rates in effect for the periods presented. (2) Includes federal funds sold and securities purchased under resale agreements or similar arrangements. (3) Loan fees, which are not material for the periods shown are included for rate calculation purposes. (4) Nonaccrual loans have been included in the average balances. Only the interest collected on such loans is included as income. (5) Includes assets held for sale or available for sale at amortized cost. NONINTEREST EXPENSE Noninterest expense was $490.8 million for the first nine months of 1996 compared to $539.9 million for the same period a year ago. Merger-related accruals and expenses led to an elevated level of noninterest expense in the first nine months of 1995. These items included $104.8 million of pretax nonrecurring charges which primarily affected personnel expense, occupancy and equipment expense and other noninterest expense. Excluding nonrecurring charges, personnel expense, the largest component of noninterest expense, increased from $217.5 million for the first nine months of 1995 to $225.3 million for the same period in 1996. This modest increase of 3.6% reflects efficiencies of scale accomplished as a result of the Southern National/BB&T FC merger. The only component of 17
personnel expense currently increasing is incentive compensation because of increased sales and higher productivity in many areas. The nonrecurring charges discussed above contributed $58.2 million to total personnel costs during the first nine months of 1995 in the form of severance pay, termination of employment contracts, early retirement packages and related benefits. For the third quarter of 1996, personnel expense totaled $74.6 million, a increase of $3.2 million from the $71.4 million recorded in the third quarter of 1995 on a recurring basis. This increase reflects additional incentive compensation, as discussed above. Occupancy and equipment expense, excluding nonrecurring charges, for the nine months ended September 30, 1996 increased $4.0 million, or 5.5%, compared to 1995. On-going depreciation of property and equipment purchased in connection with implementing the merger is a major component of the increase. The $10.3 million in nonrecurring charges relating to branch closings and the consolidation of bank operations and systems associated with the merger had a significant impact on the total occupancy and equipment expense in the prior year. For the third quarter of 1996, occupancy and equipment expense totaled $26.8 million, up slightly from the $25.9 million incurred on a recurring basis in the prior year. Federal deposit insurance expense increased $23.9 million, or 126.8%, for the nine months ended September 30, 1996, compared to the same period in the prior year, as a result of the recording of a one-time assessment by the FDIC on SAIF-insured deposits, as discussed above. During 1995 and 1996, significant legislation was passed affecting deposit insurance premiums. During the third quarter of 1995, the FDIC reduced the rates paid from $.23 per $100 to $.04 on deposits insured by the Bank Insurance Fund ("BIF"). Effective January 1, 1996, insurance premiums charged on BIF-insured deposits were eliminated because of the recapitalization of the BIF. Southern National continued to pay insurance premiums on SAIF-insured deposits during 1996 through the third quarter, when the one-time assessment was levied. The assessment recapitalized the SAIF, and, therefore, future insurance premiums on SAIF-insured deposits were eliminated. Effective January 1, 1997, Southern National will pay $.0644 per $100 of SAIF-insured deposits and $.0129 per $100 of BIF-insured deposits to service the Financing Corporation ("FICO") bonds. Southern National anticipates a reduction in FDIC-related expense in the fourth quarter of 1996 of $3.0 million and an annual cost savings of approximately $8.8 million. The one-time SAIF assessment eliminates a cost disadvantage Southern National had with some competitors who did not have SAIF-insured deposits. Southern National incurred Federal deposit insurance expense of $36.3 million during the third quarter of 1996, up from $2.9 million recorded in the prior year. The increase reflects the SAIF assessment, which totaled approximately $33 million, before tax, and was recorded during the third quarter. Excluding $36.3 million in nonrecurring charges which were recorded in the first nine months of last year, other noninterest expenses increased $20.9 million, or 16.9%. This increase was driven by increases in advertising, up $2.7 million and loan and lease expenses, up $5.3 million. The increased advertising costs are related to a marketing program to increase BB&T's brand identity. While it is difficult to measure the impact of advertising costs, and any program takes time to be effective, studies have noted an increase in BB&T's brand identity and in the "switch preference" of customers of competitors. Additional loan and lease expenses resulted from a home equity loan incentive program. For the third quarter, other expenses totaled $49.9 million, up from the $40.4 million recorded in the third quarter of 1995 on a recurring basis. This increase reflects higher levels of advertising and promotional expenditures made during the third quarter of 1996. Southern National's efficiency ratio, excluding the impact of the SAIF assessment, improved to 53.3% for the first nine months of 1996 compared to 56.4%, excluding nonrecurring charges, for the same period in 1995. PROVISION FOR INCOME TAXES The provision for income taxes increased to $98.5 million for the first nine months of 1996 compared to $58.8 million recorded in the first nine months of 1995. Excluding the impact of the nonrecurring charges recorded in 1995, the income tax provision for the prior year totaled $95.2 million. Comparing the recurring balances, the provision for income taxes increased $15.0 million, or 15.8%, because of higher pretax income. Effective tax rates were 32.9% and 33.3% for the nine months ended September 30, 1996 and 1995, respectively. For the third quarter of 1996, the provision for income taxes totaled $37.0 million, excluding the impact of the assessment, up $1.6 million, or 4.6%, compared to the third quarter 1995 balance. The effective tax rates for the three months ended September 30, 1996 and 1995 were 32.4% and 34.2%, respectively. PROFITABILITY MEASURES <TABLE> <CAPTION> 1996 1995 THIRD SECOND FIRST FOURTH THIRD QUARTER QUARTER QUARTER QUARTER QUARTER <S> <C> <C> <C> <C> <C> Return on average assets..................................................... 1.08% 1.50% 1.43% 1.39% 1.24% Return on average common equity.............................................. 13.55 18.77 17.99 17.50 16.19 Net interest margin.......................................................... 4.42 4.49 4.38 4.17 4.04 Efficiency ratio (taxable equivalent)*....................................... 53.3 53.0 53.8 51.8 54.0 </TABLE> * Excludes securities gains (losses), foreclosed property expense and nonrecurring items for all periods. 18
PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS The nature of the business of Southern National's banking subsidiaries ordinarily results in a certain amount of litigation. The subsidiaries of Southern National are involved in various legal proceedings, all of which are considered incidental to the normal conduct of business. Management believes that the liabilities arising from these proceedings will not have a materially adverse effect on the consolidated financial position or consolidated results of operations of Southern National. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit 2 -- Agreement and Plan of Reorganization between Southern National Corporation and United Carolina Bancshares Corporation, dated November 1, 1996 and exhibits thereto: a) Stock Option Agreement between Southern National Corporation and United Carolina Bancshares Corporation and b) Stock Option Agreement between United Carolina Bancshares Corporation and Southern National Corporation. Exhibit 11 -- "Computation of Earnings Per Share" is included herein. Exhibit 27 -- "Financial Data Schedule" is included in the electronically-filed document as required. (b) Southern National filed a Form 8-K under Item 5 on April 15, 1996 to report the results of operations and financial condition as of March 31, 1996. Southern National filed a Form 8-K under Item 5 on May 3, 1996 to report plans to acquire Regional Acceptance Corporation of Greenville, N.C. Southern National filed a Form 8-K under Item 5 on July 12, 1996 to report the results of operations and financial condition as of June 30, 1996. Southern National filed a Form 8-K under Item 5 on August 27, 1996 to report plans to acquire Fidelity Financial Bankshares Corporation of Richmond, Va. Southern National filed a Form 8-K under Item 5 on September 3, 1996 to report that the acquisition of Regional Acceptance Corporation had been completed through the issuance of 5.85 million shares of common stock. Southern National filed a Form 8-K under Item 5 on October 11, 1996 to report the results of operations and financial condition as of September 30, 1996. Southern National filed a Form 8-K under Item 5 on October 11, 1996 to report plans to purchase a number of common shares equal to the amount issued in the Fidelity Financial Bankshares Corporation transaction. Southern National also reported that the transaction would be accounted for as a purchase, instead of a pooling of interests, which was originally planned. Southern National filed an 8-K under Item 5 on November 4, 1996 to report plans to acquire United Carolina Bancshares Corporation of Whiteville, N.C. 19
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SOUTHERN NATIONAL CORPORATION (Registrant) Date: November 14, 1996 By: /s/ SCOTT E. REED SCOTT E. REED, SENIOR EXECUTIVE VICE PRESIDENT AND CHIEF FINANCIAL OFFICER Date: November 14, 1996 By: /s/ SHERRY A. KELLETT SHERRY A. KELLETT, EXECUTIVE VICE PRESIDENT AND CONTROLLER (PRINCIPAL ACCOUNTING OFFICER) 20