DBRS Comments on Q2 Earnings of The South Financial Group - Senior at BBB (low): Negative Trend

DBRS has today commented on the Q2 2008 earnings of The South Financial Group, Inc. (The South or the Company), given continuing negative pressure on asset quality and disruptions in the financial markets. For Q2 2008, The South reported a loss of $16.8 million, which was much improved from the $201 million loss reported for Q1 2008 and down from net income of $17.9 million for Q2 2007.

On a sequential quarter basis, the Q2 2008 net loss was down significantly due to the substantial $188 million non-cash goodwill impairment charge taken during Q1 2008, a substantive 13% decrease in credit costs and widening of the Company’s net interest margin (NIM). DBRS comments that roughly 27% of the Q2 2008 provision was for reserve build. On an annual quarterly basis, results were negatively impacted by the 2.7 times increase in provisions and higher noninterest expenses, slightly offset by the Company’s widening NIM. DBRS notes that negative ratings pressure could occur if sustained outsized credit costs and unforeseen charges significantly invade capital. Notwithstanding the severely strained credit fundamentals, outsized credit costs and earnings volatility, The South’s ratings – BBB (low) for Issuer & Senior Debt and Negative trend – were unaffected by the Q2 results.

At June 30, 2008, nonperforming assets (NPAs) were relatively stable at 2.30% of loans held for investment versus 2.26% at March 31, 2008, and up significantly from 0.45% at June 30, 2007. The bulk of the increase was spurred by deteriorating residential development and construction loans, most of which were originated out of the Company’s Florida footprint. The Company’s Q2 2008 net chargeoffs (NCOs) increased to a high 1.81% of average loans held for investment, up from 0.98% for Q1 2008 and 0.21% for Q2 2007. A portion of the elevated Q2 2008 NCOs was related to the sale of approximately $40 million of problematic loans, including three of The South’s seven largest nonperforming loans.

Net interest margin (NIM) widened to 3.24%, from 3.07% for Q1 2008 and 3.12% for Q2 2007, as decreasing funding costs outpaced decreasing asset yields. During Q2 2008, the widening NIM in conjunction with loan growth led to increased net interest income over the prior and year ago quarters. On a sequential quarter basis, the Company’s noninterest income increased due to higher deposit and mortgage banking fees.

DBRS comments that The South’s capital metrics were strengthened considerably by the May 2008 issuance of $250 million of convertible preferred stock. At June 30, 2008 the Company’s tangible equity to tangible asset, Tier 1 and Total capital ratios were 7.9%, 11.05% and 12.59%, respectively. The Company’s liquidity position remains acceptable, given its core deposit base – which represents 78% (at March 31, 2008) of net loans – and moderately sized good quality securities portfolio. Furthermore DBRS notes that the Company left over $100 million of the proceeds from the preferred stock issuance at the parent, which provides several years of debt service coverage without relying on dividends from the bank subsidiary.

On April 23, 2008, DBRS confirmed the ratings of The South Financial Group, Inc. at BBB (low) and changed the trend on all ratings to Negative from Stable. The trend change reflects DBRS’s concerns with The South’s weakened Florida commercial real estate portfolio, which has been negatively impacted by the severe downturn in the housing and mortgage markets. DBRS further notes concern with the higher risk nature of the Company’s commercial real estate concentration primarily due to accelerating asset quality deterioration. DBRS notes that negative ratings pressure could occur if sustained outsized credit costs and unforeseen charges significantly invade capital. Conversely, re-establishing meaningful and sustained earnings and the absence of significant future credit costs could result in the restoration of the trend to Stable.

Note:
All figures are in U.S. dollars unless otherwise noted.