10-Q 1 d10q.txt QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20052 ---------------------------------------------------------- FORM 10-Q QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission File Number 0-23751 ------------------------------------------------------------------------ SouthBanc Shares, Inc. (Exact Name of Registrant as Specified in its Charter) Delaware 58-2361245 ------------------------------------ ---------- (State or other jurisdiction of (I.R.S. employer incorporation or organization) identification no.) 907 N. Main Street Anderson, South Carolina 29621 ------------------------------ (Address of Principal Executive Offices) (Zip Code) (8 6 4 ) 2 2 5 - 0 2 4 1 ------------------------------------------------------------- (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. (1) Yes X No ----- ----- $0.01 par value of common stock 4,247,605 ------------------------------- ------------------ (Class) (Outstanding at June 30, 2001) SouthBanc Shares, Inc. and Subsidiaries FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS Item 1. Financial Statements Consolidated Balance Sheets as of June 30, 2001 and September 30, 2000 (unaudited)................................... 3 Consolidated Statements of Income for the Nine Months Ended June 30, 2001, and the Three Months Ended June 30, 2001 (unaudited)...................................................... 4 Consolidated Statements of Stockholders' Equity for the Year Ended September 30, 2000 and the Nine Months Ended June 30, 2001 (unaudited).................. 5 Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2001 and 2000 (unaudited)......................... 6 Notes to Consolidated Financial Statements (unaudited) 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for the Three Months Ended June 30, 2001 and 2000 and the Nine Months Ended June 30, 2001 and 2000.......... 9 Liquidity and Capital Resources....................................... 15 Capital Compliance.................................................... 16 Impact of New Accounting Pronouncements............................... 16 Effect of Inflation and Changing Prices............................... 16 Item 3. Market Risk Disclosure 17 Part II Other Information Items: 1. Legal Proceedings................................................. 18 2. Changes in Securities and Use of Proceeds......................... 18 3. Defaults Upon Senior Securities................................... 18 4. Submission of Matters to a Vote of Senior Holders................. 18 5. Other Information................................................. 18 6. Exhibits and Reports on Form 8-K.................................. 18 Signatures............................................................ 19

2 SouthBanc Shares, Inc. and Subsidiary Consolidated Balance Sheets (Unaudited) Item I - Financial Statements

See accompanying notes to the consolidated financial statements. 3 SOUTHBANC SHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

See accompanying notes to the consolidated financial statements. 4 SouthBanc Shares, Inc. and Subsidiary Consolidated Statements of Stockholders; Equity Year Ended September 30, 2000 and Nine Months Ended June 30, 2001 (Unaudited)

See accompanying notes to the consolidated financial statements. 5 SouthBanc Shares, Inc. and Subsidiary Consolidated Statements of Cash Flows Nine Months Ended June 30, 2001 and 2000

6 (Continued) (Continued) SouthBanc Shares, Inc. and Subsidiary Consolidated Statements of Cash Flows Nine Months Ended June 30, 2001 and 2000

See accompanying notes to consolidated financial statements. 7 SouthBanc Shares, Inc. and Subsidiary Notes to Consolidated Financial Statements (Unaudited) 1. Basis of Presentation --------------------- The accompanying unaudited consolidated financial statements for SouthBanc Shares, Inc. ("Company") were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. All adjustments, consisting only of normal recurring accruals, which are, in the opinion of management, necessary for fair presentation of the interim consolidated financial statements have been included. The results of operations for the period ended June 30, 2001 are not necessarily indicative of the results that may be expected for the entire year. These consolidated financial statements do not include all disclosures required by generally accepted accounting principles and should be read in conjunction with the Company's audited consolidated financial statements and related notes for the year ended September 30, 2000. 2. Principles of Consolidation --------------------------- The accompanying unaudited consolidated financial statements include the accounts of the Company, SouthBank ("Bank"), and the Bank's wholly owned subsidiaries, Mortgage First Service Corporation and United Service Corporation, and United Service Corporation's wholly owned subsidiary, United Investment Services. Between July 31, 2000 and June 29, 2001, the Company operated two savings banks, Perpetual Bank and Heritage Federal Bank, as separate subsidiaries. As of June 29, 2001 the two banking subsidiaries were combined into one bank, and the name was changed to SouthBank. The consolidated results for the quarter and nine months ended June 30, 2001 include the former Heritage Federal. However, since Heritage was merged into SouthBank as of July 31, 2000, the consolidated results for the three and nine months ended June 30, 2000 do not include Heritage's results. United Service Corporation is a wholly-owned subsidiary of the Bank. At June 30, 2001, United Service had assets of $2.3 million. United Service is involved in two residential and two commercial real estate development projects. All significant intercompany items and transactions have been eliminated in consolidation. 3. Payment of Dividends -------------------- The payment of dividends by the Company depends primarily on the ability of the Bank to pay dividends to the Company. The payment of dividends by the Bank is subject to regulation by the Office of Thrift Supervision ("OTS"). The Bank may not declare or pay a cash dividend if the effect thereof would cause the capital of the Savings Bank to be reduced below regulatory capital requirements imposed by the OTS or below the liquidation account established by the Bank in connection with the conversion of the Bank's former mutual holding company (SouthBanc Shares, M.H.C.) from the mutual to stock form of organization. The Company's Board of Directors declared a cash dividend of $.15 per share to its shareholders during the quarter ended June 30, 2001, payable on July 16, 2001 to shareholders of record as of July 2, 2001. 4. Earnings Per Share ------------------ The Company calculates earnings per share in accordance with SFAS No. 128, "Earnings Per Share." SFAS No. 128 specifies the computation, presentation and disclosure requirements for earnings per share (EPS) for entities with publicly held common stock or potential common stock such as options, warrants, convertible securities or contingent stock agreements if those securities trade in a public market. 8 4. Earnings Per Share (Continued) ----------------------------- This standard specifies computation and presentation requirements for both basic EPS and, for entities with complex capital structures, diluted EPS. Basic earnings per share are computed by dividing net income by the weighted average common shares outstanding. Diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. The dilutive effect of options outstanding under the Company's stock option plan is reflected in diluted earnings per share by application of the treasury stock method. RECONCILIATION OF THE NUMERATORS AND DENOMINATORS OF THE BASIC AND DILUTED EPS COMPUTATIONS:

5. Subsequent Event - Merger with National Commerce Financial Corporation ---------------------------------------------------------------------- On July 15, 2001, the Company signed a definitive agreement to be acquired by National Commerce Financial Corporation ("NCF"). The transaction will be accounted for as a purchase. Each SouthBanc shareholder can elect to receive either $28.00 per share in cash, 1.1142 shares of NCF common stock, or $14.00 per share in cash plus .5571 of a share of NCF common stock as consideration. However, the total merger consideration must be paid 50% in NCF stock and 50% in cash. The transaction is subject to approval by regulators and shareholders, and is expected to close in the fourth calendar quarter of 2001. Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Comparison of Financial Condition at March 31, 2001 and September 30, 2000 -------------------------------------------------------------------------- General ------- Total assets decreased $12.6 million to $659.9 million at June 30, 2001 from $672.5 million at September 30, 2000, primarily as a result of a decrease in loans receivable and other assets. The decreases were offset by an increase in cash surrender value of life insurance. 9 Loans receivable decreased 6.8% or $35.2 million to $481.1 million at June 30, 2001, from $516.3 million at September 30, 2000. The decrease in loans receivable resulted primarily from a decrease in first mortgage residential and construction loans. The Company is currently holding fixed rate loans originated in its portfolio due to the prepayment of residential loans and a decrease in construction loan production. Mortgage-backed securities available-for-sale decreased 7.7% or $5.6 million to $67.1 at June 30, 2001 from $72.7 million at September 30, 2000. Principal repayments on mortgage-backed securities were $7.8 million during the nine months ended June 30, 2001. Investment securities available for sale increased 146.9% or $21.6 million to $36.3 million at June 30, 2001 from $14.7 million at September 30, 2000. Certain securities had been sold following the merger with Heritage Bancorp., Inc. in July 2000 in an effort to balance the investment portfolios of the two banks and to better manage interest rate risk. During 2001 the Bank purchased securities of $26.6 with available funds, including $16.0 million of municipal bonds and $2.6 million of trust preferred bonds, $2.0 million of Federal National Mortgage Association preferred stock, $2.0 million of Federal Home Loan Mortgage Corporation preferred stock, $1.0 million of a U. S. Treasury note and a $3.0 million Federal Home Loan Mortgage Corporation callable note. Cash and cash equivalents increased 20.2% or $4.4 million to $26.2 at June 30, 2001 from $21.8 million at September 30, 2000. At June 30, 2001, $15.7 million was invested in interest-bearing overnight investment accounts yielding 3.76%. Real estate held for development decreased slightly to $2.0 million at June 30, 2001. The Company is presently developing two single-family residential subdivisions and two commercial real estate development projects. Two lots were sold during the quarter in the single-family residential subdivisions and five lots were sold in one of the commercial real estate projects. Development costs of $256,000 were incurred in one of the commercial real estate projects during the quarter. Other assets at September 30, 2000 included accounts receivable related to settlement of security sales prior to September 30, 2000. The sales were settled in October 2000, and no such receivables existed as of June 30, 2001. Cash surrender value of life insurance was $16.9 million at June 30, 2001, an increase of $8.6 million from $8.3 million at September 30, 2000. The Company owns life insurance policies as part of the Supplemental Executive Retirement Agreements maintained on certain key officers of the Company. The Company purchased $8.0 million of cash surrender value of life insurance to cover employee benefit expenses of officers of the former Heritage Federal during the quarter ended December 31, 2000. Deposits decreased $9.5 million to $442.4 at June 30, 2001 from $451.9 million at September 30, 2000. Non-interest bearing checking accounts decreased 7.38% or $1.1 million to $13.8 million at June 30, 2001, from $14.9 million at September 30, 2000. Interest bearing checking accounts increased 6.47% or $2.9 million to $47.7 million at June 30, 2001, from $44.8 million at September 30, 2000, as the Company continues to offer checking products that are more aggressively priced than those offered by competitors. Statement savings accounts increased 10.346% or $5.2 million to $55.5 million at June 30, 2001 from $50.3 million at September 30, 2000. Certificates of deposit decreased 4.83% or $16.5 million to $325.4 at June 30, 2001 from $341.9 million at September 30, 2000, as the Company did not meet higher interest rates offered by local competitors. Borrowings through reverse repurchase agreements decreased 1.47% or $300,000 to $20.1 million at June 30, 2001 from $20.4 million at September 30, 2000. The Company pledged $21.0 million of mortgage-backed securities as collateral for these borrowings. The Company has borrowed $10.0 million at a rate of 6.71% with a call date of February 3, 2002, and a maturity date of February 3, 2005, and $10.0 million at a rate of 3.85%, with a maturity date of December 12, 2001. Advances from the Federal Home Loan Bank increased $9.1 million to $107.4 million at June 30, 2001 from $98.3 million at September 30, 2000. The additional borrowings were used to fund the $8.0 million purchase of cash surrender value of life insurance. 10 Stockholders equity was $80.1 million at June 30, 2001 and at September 30, 2000. Retained earnings was increased by net income of $6.1 for the nine months ended June 30, 2001, and decreased by dividends paid in the amount of $1.9 million. Common stock repurchased through the common stock repurchase programs is recorded on the Company's balance sheet as Treasury Stock, a contra-equity account. During the first nine months of fiscal 2001, the Company repurchased 281,813 shares at an average cost of $18.95 per share and a total cost of $5.3 million. Accumulated other comprehensive income, net, increased $849,000 to $2.8 million at June 30, 2001 from $1.9 million at September 30, 2000 due to an increase in the market value of investment securities available for sale. The Company contributed $67,000 to the employee stock ownership plan reducing the contra-equity account related to the plan's debt. Comparison of Operating Results for the Three Months Ended June 30, 2001, and 2000 Net Income ---------- Net income for the three months ended June 30, 2001, increased to $1.3 million or $0.32 basic earnings per share and $0.31 diluted earnings per share, compared to $1.2 million or $0.42 basic earnings per share and $0.40 diluted earnings per share for the same three months a year ago. The primary reasons for the increase in income was the acquisition of Heritage Federal in July 2000 and the settlement of a lawsuit. See the Company's September 30, 2000 audited consolidated financial statements for a discussion of the merger with Heritage Bancorp, Inc., former parent company of Heritage Federal. The additional net interest income attributable to the merger was offset by an increase in the provision of loan losses. Earnings per share was also impacted by the shares of Company common stock issued in connection with the merger. Net Interest Income ------------------- Net interest income was $4.7 million for the three months ended June 30, 2001 and $2.8 million for the three months ended June 30, 2000. Heritage Federal added approximately $248 million in total loans in 2000. Total interest income increased 70.6% or $4.9 million to $11.8 million for the three months ended June 30, 2001, from $6.9 million for the three months ended June 30, 2000, due primarily to a higher average balance of outstanding loans which increased $217.5 million or 78.5% to an average of $494.5 million yielding 8.01% for the three months ended June 30, 2001, from $277.0 million yielding 8.08% for the three months ended June 30, 2000. Interest income on mortgage-backed securities increased 34.7% or $292,000 to $1.1 million for the three months ended June 30, 2001, as the average balance increased $23.8 million to $69.0 million for the three months ended June 30, 2001 from $45.2 million for the three months ended June 30, 2000. Much of the increase in average balances is due to the addition of Heritage Federal to the consolidated Company and to changes in the relative mix of assets in the combined Company's balance sheet. Approximately $8.5 million of mortgage-backed securities were on Heritage Federal's balance sheet at June 30, 2000. In addition, as loans decreased during the quarter, investable funds were used to purchase investment securities. Interest income on other investments increased 58.87% or $288,000 due primarily to a higher balance of investment securities and interest bearing deposits which increased 107.9% or $27.3 million, to an average balance of $52.6 million yielding 5.92% for the three months ended June 30, 2001, from $25.3 million yielding 7.74% for the three months ended June 30, 2000. The increase in average balances was only partially offset by the decrease in yield on these investments, causing interest income to increase. Interest Expense ---------------- Interest expense on deposits increased 109.8% or $2.8 million as the average outstanding balance increased 96.2% or $223.1 million to $455.1 million at an average cost of 4.69% for the three months ended June 30, 2001, from $232.0 million at an average cost of 4.39% for the three months ended June 30, 2000. The Heritage merger added over $200 million of deposits in July 2000. In addition, weighted average interest rates were higher during the 2001 quarter than in the 2000 quarter. Interest on borrowings increased $181,000 to $1.7 million for the three months ended June 30, 2001, from $1.5 million for the three months ended June 30, 2000, as the average borrowings increased 30.5% or $29.0 million to $124.1 million at an average cost of 5.56% for the three months ended June 30, 2001, from $95.1 million at an average cost of 6.49% for the three months ended June 30, 2000. The total cost of average interest bearing liabilities for the quarter ended June 30, 2001 was 4.88%. 11 Provisions for Loan Losses -------------------------- Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered adequate by management to provide for management's best estimate of inherent loan losses. In determining the adequacy of the allowance for loan losses, management evaluates various factors including the market value of the underlying collateral, growth, and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, loss experience, delinquency trends and economic conditions. Management evaluates the carrying value of loans periodically, and the allowance for loan losses is adjusted accordingly. The provision for loan losses increased $1.8 million to $1.9 million for the three months ended June 30, 2001, from $75,000 for the three months ended June 30, 2000 due to charge-offs of $735,000 for the quarter ended June 30, 2001 compared to $26,000 for the quarter ended June 30, 2000. Charge-offs included residential mortgages of $356,000 consumer loans of $4,000, commercial loans of $82,000 and commercial real estate loans of $293,000. Non-performing assets represented 1.53% of total assets at June 30, 2001. The allowance for loan losses was 1.50% of total loans at June 30, 2001 and 1.28% at September 31, 2000. Non-performing assets at June 30, 2001 were $10.1 million consisting of $3.9 million of residential mortgage construction loans, $1.9 million of real estate acquired in settlement of loans, $3.9 million of single family residential loans, $257,000 of commercial real estate loans, $65,000 of commercial other loans and $9,000 of consumer loans. Non-performing assets at September 30, 2000 were $13.4 million consisting of $5.3 million of residential mortgage construction loans, $1.1 million of real estate acquired in settlement of loans, $5.1 million of single family residential loans, $1.5 million of commercial real estate loans, $354,000 of commercial loans, and $63,000 of consumer loans. Due to a decrease in total loans, the allowance for loan losses has increased as a percentage of total loans at June 30, 2001 compared to previous periods. However, due to the amount of charge-offs and types of non-performing assets held by the Bank, management believes the allowance is adequate as of June 30, 2001. Other Income ------------ Gain on sale of real estate held for development was $43,000 for the three months ended June 30, 2001 as two residential lots were sold by the United Service Corporation in The Meadows residential subdivision and five lots in the North Park Industrial Park compared to $1,500 for the three months ended June 30, 2000 as two residential lots and one residential house were sold. Total other income increased 118.8% or $1.6 million to $3.0 million for the three months ended June 30, 2001, from $1.4 million for the three months ended June 30, 2000. Loan and deposit service charges increased $156,000 to $1.2 million from $995,000 for the three months ended June 30, 2000, as a result of the larger portfolio of accounts held by the Company following the addition of Heritage Federal. Gain (loss) on sale of investments was a gain of $307,500 for the three months ended June 30, 2001. There was no gain or loss on the sale of investments for the three months ended June 30, 2000. Gain (loss) on real estate acquired in settlement of loans was a loss of $312,000 for the three months ended June 30, 2001, compared to a loss of $6,000 for the three months ended June 30, 2000. During the third quarter of 2001 certain properties acquired in settlement of loans were written down to net realizable value following new appraisals of the properties. Earnings on bank owned life insurance increased 117.2% or $129,000 to $239,000 for the three months ended June 30, 2001 from $110,000 for the three months ended June 30, 2000, due to the purchase of $8.0 million of additional officers life insurance for the former officers of Heritage Federal in the first fiscal quarter of 2001. The Company settled a lawsuit during the quarter, receiving $1.4 million, net of attorney's fees. The terms of the settlement are confidential. Other income in 2000 included an increase in the value of the Company's investment in a limited partnership of $90,000. The quarter ended June 30, 2001 included a decrease of $19,000. General and Administrative Expense ---------------------------------- Salaries and employee benefits increased 49.1% or $665,000 to $2.0 million for the three months ended June 30, 2001, from $1.4 million for the three months ended June 30, 2000. The Company increased the number of employees as a result of the merger by 63 full time equivalent employees to 189 at June 30, 2001 from 126 at June 30, 2000. Office occupancy increased 85.8% or $114,000 to $247,000 for the three months ended June 30, 2001, from $133,000 for the three months ended June 30, 2000, due to an increase in office building depreciation expense and building repair and maintenance. Furniture and equipment expenses increased 66.1% or $175,000 to $440,000 for the three months ended June 30, 2001, from $265,000 for the three months ended June 30, 2000. The Company owned six office buildings in June 2000 and eleven office buildings in 2001. Advertising increased 265.9% or $169,000 to $232,000 for the three months ended June 30, 2001, from $63,000 for the three months ended June 30, 2000 12 due to the free checking program promotion that began at Heritage Federal in October 2000 and the promotion of the name change to SouthBank. Data processing increased 30.8% or $45,000 to $191,000 for the three months ended June 30, 2001, from $146,000 for the three months ended June 30, 2000. Office supplies increased 104.8% or $67,000 to $131,000 for the three months ended June 30, 2001, from $64,000 for the three months ended June 30, 2000, due to the addition of the former Heritage Federal to the consolidated results. Other operating expenses increased 91.2% or $338,000 to $708,000 for the three months ended June 30, 2001, from $370,000 for the three months ended June 30, 2000. The increases are primarily due to the acquisition of the former Heritage Federal, and several types of other expenses are affected. The largest increases were in legal expenses of $40,000, transfer agent expenses of $32,000, consultant expenses for a human resources project of $87,000, an increase in directors and officers liability insurance of $26,000, telephone expenses of $60,000, postage of $18,000 and expenses related to real estate acquired in foreclosure of $36,000. Income Taxes ------------ Income taxes increased 9.2% or $50,000 to $598,000 for the three months ended June 30, 2001, from $548,000 for the three months ended June 30, 2000. This was due to an increase in income before taxes of 11.3% or $200,000 to $1.9 million from $1.7 million for the three months ended June 30, 2001, and 2000, respectively, primarily due to the merger with Heritage Bancorp in July 2000. Comparison of Operating Results for the Nine Months Ended June 30, 2001, and 2000 Net Income ---------- Net income for the nine months ended June 30, 2001, increased to $6.1 million or $1.41 basic earnings per share and $1.37 diluted earnings per share, compared to $3.9 million or $1.30 basic earnings per share and $1.23 diluted earnings per share for the same nine months a year ago. The primary reason for the increase was the acquisition of Heritage Federal in July 2000. See the Company's September 30, 2000 audited consolidated financial statements for a discussion of the merger with Heritage Bancorp, Inc., former parent company of Heritage Federal. Another factor in the increased net income was the settlement of a lawsuit in June 2001 in the amount of $1.4 million, net of attorney's fees. The increases in net interest income were partially offset by an increase in the provision for loan losses. Net Interest Income ------------------- Net interest income was $14.8 million for the nine months ended June 30, 2001 and $9.0 million for the nine months ended March 31, 2000. The acquisition of Heritage Federal added approximately $248 million in total loans to the Company's interest earning assets in the fourth quarter of fiscal 2000. Total interest income increased 83.9% or $17.0 million to $37.2 million for the nine months ended June 30, 2001, from $20.2 million for the nine months ended June 30, 2000, due primarily to a higher average balance of outstanding loans which increased $236.7 million or 88.0% to an average of $505.8 million yielding 8.30% for the nine months ended June 30, 2001, from $269.1 million yielding 8.03% for the nine months ended June 30, 2000. Interest income on mortgage-backed securities increased 47.7% or $1.2 million to $3.7 million for the nine months ended June 30, 2001, as the average balance increased $23.0 million to $70.9 million for the nine months ended June 30, 2001 from $47.9 million for the nine months ended June 30, 2000. Much of the increase in average balances is due to the addition of the former Heritage Federal to the consolidated Company. Approximately $8.5 million of mortgage-backed securities were on Heritage Federal's balance sheet at the time of the merger in July, 2000. In addition, since the acquisition of Heritage Federal in the fourth quarter of fiscal 2000, the Company has restructured its investments to manage interest rate risk while maximizing earnings, causing certain investments to be divested and other assets to be purchased. Interest income on other investments increased 31.5% or $463,000 due primarily to a higher balance of investment securities and interest bearing deposits which increased 58.5% or $15.5 million, to an average balance of $42.0 million yielding 6.15% for the nine months ended June 30, 2001 from $26.5 million yielding 7.39% for the nine months ended June 30, 2000. The increase in the balances is mainly due to the merger with Heritage Bancorp. The reason for the decrease in rate is the overall decrease in market interest rates in the second quarter of 2001 and due to changes in the mix of assets among investment securities, interest bearing deposits and FHLB stock. Interest Expense ---------------- Interest expense on deposits increased 134.9% or $9.5 million as the average outstanding balance increased 98.0% or $221.1 million to $446.6 million at an average cost of 4.93% for the nine months ended June 30, 2001, from $225.5 million at an average cost of 4.16% for the nine months ended June 301, 2000. Heritage Federal added over $200 million of deposits at the time of the merger in July 2000. In addition, weighted average interest rates on time deposits in the Bank's portfolio were higher during the 13 2001 quarter than in the 2000 quarter. Average rates of interest paid on certificates of deposit during the first nine months of fiscal 2001 were 5.96% compared to 5.48% paid on certificates of deposit during the first nine months of fiscal 2000. Interest on borrowings increased $1.6 million to $5.8 million for the nine months ended June 30, 2001, from $4.2 million for the nine months ended June 30, 2000, as the average borrowings increased 36.7% or $34.5 million to $128.5 million at an average cost of 6.05% for the nine months ended June 30, 2001, from $94.0 million at an average cost of 5.98% for the nine months ended June 30, 2000. Provisions for Loan Losses -------------------------- Provisions for loan losses are charges to earnings to bring the total allowance for loan losses to a level considered adequate by management to provide for management's best estimate of inherent loan losses. In determining the adequacy of the allowance for loan losses, management evaluates various factors including the market value of the underlying collateral, growth, and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, loss experience, delinquency trends and economic conditions. Management evaluates the carrying value of loans periodically, and the allowance for loan losses is adjusted accordingly. The provision for loan losses increased 354.9% or $1.6 million to $2.0 million for the nine months ended June 30, 2001, from $435,000 for the nine months ended June 30, 2000, due to charge-offs of $1.3 million for the nine months ended June 30, 2001 compared to $176,000 for the nine months ended June 30, 2000. Charge-offs included $582,000 of residential mortgage loans, $39,000 of consumer loans, $278,000 of commercial loans, and $408,000 of commercial real estate loans. Non-performing assets at June 30, 2001, were $10.1 million consisting of $3.9 million of residential mortgage construction loans, $1.9 million of real estate acquired in settlement of loans, $3.9 million of single family residential loans, $257,000 of commercial real estate loans, $65,000 of commercial other loans and $9,000 of consumer loans. Non-performing assets at September 30, 2000 were $13.4 million consisting of $5.3 million of residential mortgage construction loans, $1.1 million of real estate acquired in settlement of loans, $5.1 million of single family residential loans, $1.5 million of commercial real estate loans, $354,000 of commercial loans, and $63,000 of consumer loans. Due to the decrease in overall loans, the allowance as a percentage of total loans has increased. The allowance for loan losses to total loans was 1.50% at June 30, 2001 and 1.28% at September 30, 2000. However, due to the increase in charge-offs in 2001 and due to the current level of non-performing assets, management believes that the higher reserve level is warranted. Other Income ------------ Total other income increased 78.1% or $3.2 million to $7.4 million for the nine months ended June 30, 2001, from $4.2 million for the nine months ended June 30, 2000. Loan and deposit service charges increased $400,000 to $3.4 million from $3.0 million for the nine months ended June 30, 2000, as a result of an increase to the fee structure of deposit accounts and an increase in the number of checking accounts. Gain (loss) on sale of investments was a gain of $1.8 million for the nine months ended June 30, 20001 compared to a loss of $95,000 for the nine months ended June 30, 2000. The gain resulted from the sale of equity investments. Gain (loss) on real estate acquired in settlement of loans was a loss of $619,000 for the nine months ended June 30 2001, compared to a loss of $1,500 for the nine months ended June 30, 2000. Gain on sale of real estate held for development was $60,000 for the nine months ended June 30 2001, as profit was recognized on seven residential lots were sold by the United Service Corporation in The Meadows residential subdivision and six lots in the Northpark Industrial Park compared to $84,000 for the nine months ended June 30, 2000, as profit was recognized on nineteen residential lots in The Meadows and one lot in the Northpark Industrial Park. Earnings on bank owned life insurance increased 83.1% or $286,000 to $630,000 for the nine months ended June 30, 2001 from $344,000 for the nine months ended June 30, 2000 due to the purchase of $8.0 million of additional officers life insurance for the former officers of Heritage Federal during the first quarter of fiscal 2001. Other income also included the settlement of a lawsuit in the amount of $1.4 million, net of attorney's fees. Other income increased $229,000 to $648,000 for the nine months ended June 30, 2001, compared to $897,000 for the nine months ended June 30, 2000. Other income in 2000 included a positive change in the market value of the Company's investment in limited partnership. General and Administrative Expense ---------------------------------- Salaries and employee benefits increased 44.8% or $1.8 million to $5.7 million for the nine months ended June 30, 2001, from $3.9 million for the nine months ended June 30, 2000. The Company increased the number of employees as a result of the merger, increasing by 63 full time equivalent employees to 189 at June 30, 2001 from 126 at June 30, 2000. Office occupancy increased 14 55.7% or $227,000 to $635,000 for the nine months ended June 30, 2001, from $408,000 for the nine months ended June 30, 2000, due to a increase in the number of buildings operated by the consolidated Company. The Company owned six office buildings during the period ended June 30, 2000 and eleven office buildings for the same period in 2001. Furniture and equipment expenses increased 67.4% or $532,000 to $1.3 million for the nine months ended June 30, 2001, from $789,000 for the nine months ended June 30, 2000. Advertising increased 208.9% or $311,000 to $460,000 for the nine months ended June 30, 2001, from $149,000 for the nine months ended June 30, 2000. Advertising costs increased as a result of the merger and due to the free checking product campaign during the months immediately following the merger. Data processing increased 42.4% or $169,000 to $567,000 for the nine months ended June 30, 2001, from $398,000 for the nine months ended June 30, 2000. Data processing expenses increased for the consolidated Company at a rate lower than the increases in other types of expenses due to the fact that both Banks use the same computer software system. The Company experienced an increase in the number of computers used by associates, but was able to discontinue certain types of software maintenance costs incurred by Heritage as a result of the merger. Office supplies increased 81.6% or $199,000 to $442,000 for the nine months ended June 30, 2001, from $243,000 for the nine months ended June 30, 2000, due to the addition of Heritage Federal. There was no profit improvement program expense for the nine months ended June 30, 2001 compared to $94,000 for the nine months ended June 30, 2000. The profit improvement program included consultant fees for sales training, staff realignment, and product fee enhancement. Other operating expenses increased 94.8% or $913,000 to $1.9 million for the nine months ended June 30, 2001, from $963,000 for the nine months ended June 30, 2000. The increases are primarily due to the acquisition of Heritage Federal, and several types of other expenses are affected. The largest increases were in legal expenses of $143,000, transfer agent expense of $56,000, consultant expense for a human resources project of $75,000, an increase in directors and officers liability insurance expense of $81,000, telephone expenses of $85,000, postage of $42,000 and expenses related to real estate acquired in foreclosure of $101,000. Income Taxes ------------ Income taxes increased 69.1% or $1.3 million to $3.1 for the nine months ended June 30, 2001, from $1.8 million for the nine months ended June 30, 2000. This was due to an increase in income before taxes of $3.5 million to $9.2 million from $5.7 million for the nine months ended June 30, 2001, and 2000, respectively, primarily due to the merger with Heritage Bancorp in July 2000. Liquidity and Capital Resources ------------------------------- The Company's primary sources of funds are deposits, repayment of loan principal, and repayment of mortgage backed securities and collateralized mortgage obligations, and, to a lesser extent, maturities of investment securities, and short-term investments and operations. While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan repayments are more influenced by interest rates, general economic conditions, and competition. The Company attempts to price its deposits to meet its asset/liability objectives consistent with local market conditions. Excess balances are invested in overnight funds. In addition, the Company is eligible to borrow funds from the Federal Home Loan Bank ("FHLB") of Atlanta. Recent legislation repealed the OTS's minimum liquidity ratio requirement. OTS regulations now require the Banks to maintain sufficient liquidity to ensure their safe and sound operation. The primary investing activity of the Company is lending. During the three months ended June 30, 2001, the Company originated $41.5 million of loans and no loans were sold. The Company also purchased $1.1 million of loans. Principal repayments of loans, mortgage-backed securities, and collateralized mortgage obligations and Federal Home Loan Bank advances primarily funded the retained originations. Liquidity management is both a short and long-term responsibility of management. The Company adjusts its investments in liquid assets based upon management's assessment of (i) expected loan demand, (ii) projected loan sales, (iii) expected deposit flows, (iv) yields available on interest-bearing deposits, and (v) liquidity of its asset/liability management program. Excess liquidity is generally invested in interest-bearing overnight deposits and other short-term government and agency obligations. If the Company requires funds beyond its ability to generate them internally, it has additional borrowing capacity with the FHLB and collateral eligible for repurchase agreements. The Company anticipates that it will have sufficient funds available through normal loan repayments to meet current loan commitments. At June 30, 2001, the Company had outstanding commitments to originate loans of approximately $80.3 million. Certificates of deposit scheduled to mature in one year or less at June 30, 2001, totaled $205.7 million. Based upon management's experience and familiarity with the customers involved and the Company's pricing policy relative to that of its perceived competitors, management believes that a significant portion of such deposits will remain with the Company. 15 Capital Compliance ------------------ The Company is not subject to any regulatory capital requirements. The Bank's actual capital and ratios as required by the OTS, as well as those required to be considered well capitalized according to the Prompt Corrective Action Provisions are presented in the following table. As of June 30, 2001, the most recent notification from the OTS categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risked-based, and Tier I core ("leverage") ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank's category.

If the Bank were to fail to meet the minimum capital requirements, it will be required to file a written capital restoration plan with regulatory agencies and would be subject to various mandatory and discretionary restrictions on its operations. Impact of New Accounting Pronouncements --------------------------------------- In July 2001, the SEC issued Staff Accounting Bulletin (SAB) No. 101 - Selected Loan Loss Allowance Methodology and Documentation Issues. This staff accounting bulletin clearly defines the required development, documentation, and application of a systematic methodology for determining allowances for loan and lease losses in accordance with generally accepted accounting principles. The Company believes that it is in compliance with SAB 102. In June 2001, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 141 - Business Combinations. This SFAS addresses accounting and reporting for all business combinations and defines the purchase method as the only acceptable method. This statement is effective for all business combinations initiated after June 30, 2001. In June 2001, the FASB issued SFAS No. 142 - Goodwill and other Intangible Assets. This SFAS addresses how goodwill and other intangible assets should be accounted for at their acquisition (except for those acquired in a business combination) and after they have been initially recognized in the financial statements. The statement is effective for all fiscal years beginning after December 15, 2001. The Company believes the effect of this SFAS will not have a material impact on the financial position of the Company. Additional accounting standards that have been issued or proposed by the FASB that do not require adoption until a future date are not expected to have a material impact on the consolidated financial statements upon adoption. Effect of Inflation and Changing Prices --------------------------------------- The Consolidated Financial Statements and related financial data presented herein have been prepared in accordance with Generally Accepted Accounting Principles ("GAAP") which require the measurement of financial position and operating results in terms of historical dollars, without considering the changes in relative purchasing power of money over time due to inflation. The primary impact of inflation on operations of the Company is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution's performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services. 16 ITEM 3 - Quantitative and Qualitative Disclosures about Market Risk ------------------------------------------------------------------- Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises principally from interest rate risk inherent in its lending, investment, deposit and borrowing activities. Management actively monitors and manages its interest rate risk exposure. Although the Company manages other risks such as credit quality and liquidity risk in the normal course of business, management considers interest rate risk to be its most significant market risk that could potentially have the largest material effect on the Company's financial condition and results of operations. Other types of market risks such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company's business activities. The Company's profitability is affected by fluctuations in market interest rates. Management's goal is to maintain a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase or decrease in interest rates may adversely impact the Company's earnings to the extent that the interest rates on interest-bearing assets and interest-bearing liabilities do not change at the same rate, to the same extent or on the same basis. The Company monitors the impact of changes in interest rates on its net interest income using a test that measures the impact on net interest income and net portfolio value of an immediate change in interest rates in 100 basis point increments and by measuring the Banks' interest sensitivity gap ("Gap"). Net portfolio value is defined as the net present value of assets, liabilities and off-balance contracts. Gap is the amount of interest sensitive assets repricing or maturing over the next twelve months compared to the amount of interest sensitive liabilities maturing or repricing in the same period. For the three month period ended June 30, 2001, the Banks interest rate spread, defined as the average yield on interest-bearing assets less the average rate paid on interest bearing liabilities was 2.79%. As of the quarter ended March 31, 2001, the interest rate spread was 2.85%. The Company's management believes that the interest rate spread has decreased as the yield on interest earning assets declined more than the cost of interest bearing liabilities. The prime rate quoted by major United States ("US") banks as of January 1, 2001 was 9.5%, but had decreased to 6.75% as of June 29, 2001, and the rate on 90 day US treasury bills as of January 1, 2001 was 5.88%, but had decreased to 3.57% as of June 29, 2001. The Banks' interest bearing liabilities are currently repricing or maturing at a faster rate than their interest earning assets, and are repricing at lower interest rates, thereby improving the Banks' interest rate spread. 17 PART II Item 1. Legal Proceedings -------------------------- The Company is not a party to any legal proceedings at this time. The Savings Bank from time to time and currently is involved as plaintiff or defendant in various legal actions incident to its business. These actions are not believed to be material, either individually or collectively, to the consolidated financial condition or results of operations of the Savings Bank. Item 2. Changes in Securities and Use of Proceeds --------------------------------------------------- None Item 3. Defaults Upon Senior Securities ---------------------------------------- Not applicable Item 4. Submission of Matters to a Vote of Security Holders ------------------------------------------------------------ None Item 5. Other Information -------------------------- None Item 6. Exhibits and Reports on Form 8-K ----------------------------------------- A. Exhibits: -------- 2 Agreement and Plan of Merger * 3(a) Certificate of Incorporation of the Company ** 3(b) Bylaws of the Company ** 10.1 Employment Agreement between SouthBanc Shares, Inc. and Robert W. Orr *** 10.2 Employment Agreement between SouthBanc Shares, Inc. and Thomas C. Hall *** 10.3 Employment Agreement between SouthBanc Shares, Inc. and Barry C. Visioli *** 10.4 Employment Agreement between Perpetual Bank, A Federal Savings Bank and Robert W. Orr *** 10.5 Employment Agreement between Perpetual Bank, A Federal Savings Bank and Thomas C. Hall *** 10.6 Employment Agreement between Perpetual Bank, A Federal Savings Bank and Barry C. Viosoli *** 10.7 1998 Stock Option Plan **** 10.8 1998 Management Development and Recognition Plan **** 10.9 Supplemental Executive Retirement Agreement with Robert W. Orr *** 10.10 Supplemental Executive Retirement Agreement with Thomas C. Hall *** 10.11 Supplemental Executive Retirement Agreement with Barry C. Visioli *** 27 Financial Data Schedule * Incorporated by reference to the Company's Current Report on Form 8-K filed February 22, 2000 ** Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (File No. 333-42517) 18 *** Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended September 30, 1999. **** Incorporated by reference to the Company's Definitive Proxy Statement dated December 18, 1998. B. Reports on Form 8-K ------------------- None. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this amended report to be signed on its behalf by the undersigned thereunto duly authorized. SouthBanc Shares, Inc. /s/ Robert W. Orr Date: August 14, 2001 ______________________________________ Robert W. Orr President and Managing Officer (Duly Authorized Representative) /s/ Thomas C. Hall Date: August 14, 2001 ______________________________________ Thomas C. Hall Chief Financial Officer 19

SOUTHBANC SHARES INC 10-Q