DBRS Downgrades The South Financial Group, Inc to B; Under Review with Negative Implications

DBRS has today downgraded the ratings for The South Financial Group, Inc. (The South or the Company) and its related entities, including its Issuer & Senior Debt rating to B from BB. At the same time, DBRS downgraded The South’s banking subsidiary’s Deposit & Senior debt rating to BB (low) from BB (high) and maintained its Short-term Instruments rating at R-4. All ratings were placed Under Review with Negative Implications.

The downgrade follows a much larger than expected $341 million quarterly net loss available to common shareholders, which reflected higher credit costs and the negative impact of a sizeable $200 million valuation allowance against its $203 million deferred tax assets. DBRS notes that the results are preliminary and the loss could increase following the completion of the Company’s on-going goodwill impairment analysis, which should be completed in early November.

The downgrade reflects The South’s weakened tangible common equity position, severe asset quality deterioration, moderate core earnings capacity, and DBRS’s expectation of sustained elevated credit costs and expenses over the near term. The significant Q3 2009 quarterly (preliminary) loss negatively impacted The South’s capital position. Indeed, the significant decrease of tangible common equity more than overshadowed the moderate decline in regulatory capital, as regulatory capital already largely excluded deferred tax assets as of Q4 2008 and was not impacted by the sizeable valuation allowance. DBRS believes that The South’s lower tangible common equity position further reduces its financial flexibility. DBRS notes that further material contraction in the Company’s tangible common equity position will likely result in negative rating actions. DBRS comments that the Company’s asset quality deterioration remains steep, and credit costs high. Although there appears to be some indication of stabilization in the credit metrics, it is DBRS’s perception that substantial amounts of potential losses remain embedded in the Company’s loan portfolios, especially given still declining real estate valuations and rising unemployment. Finally, the Company’s core earnings capacity (income before provisions and taxes), provides only a moderate level of loss absorption capacity, especially when compared to recent quarterly net charge-offs, and are likely to remain pressured over the near term, due to high credit expenses.

DBRS’s review will focus on The South’s ability to raise additional capital to offset anticipated near term credit costs and expenses. DBRS notes that the quarter’s results place considerable strain on the Company’s financial flexibility, and perhaps its ability to raise future capital. DBRS notes that the inability of the Company to strengthen its capital position over the near term, could result in further rating actions.

The South’s Florida exposures, especially its acquisition, construction and development portfolio, represent the bulk of its troubled loans. During Q3 2009, NPAs on an absolute basis contracted by $16 million; however, the Company’s NPA ratio increased to a high 6.05% of loans versus 5.94% at June 30, 2009, reflecting a 4.6% decrease in period end loans. Meanwhile, NCOs for Q3 2009 increased to a high 7.31% of average loans, from 4.91% for the prior quarter. DBRS notes that the large increase in The South’s NCOs reflects a $60 million charge related to the sale of $163 million of problematic loans. Reflecting the steep decline in the housing markets, roughly 49% of net charge-offs were CRE related, the majority of which were Florida and South Carolina based residential acquisition and development loans. Meanwhile, 67% of Q3 2009 nonaccrual loans were CRE, of which 55% were in Florida. DBRS comments that The South’s CRE portfolio represents a challenging concentration, constituting approximately 42% (excluding owner-occupied loans) of total loans and 5.9 times (x) tangible common equity. DBRS comments that the Company’s reserves to non-performing assets improved, yet were still relatively moderate at 62%.

Reflecting the loss for the quarter, the Company’s tangible common equity ratio narrowed to 5.25%, from 6.07% at June 30, 2009, indicating the reduction in the common equity resources available to absorb elevated losses. The Company’s estimated Tier 1 and Total risk based capital ratios were 11.19% and 12.49%, respectively, down from 12.36% and 13.65%, respectively, at June 30, 2009, and includes $347 million in TARP capital.

DBRS notes that the Company’s liquidity position is adequate, yet remains pressured by its large wholesale funding reliance of 43% (as of June 30, 2009). The South’s sound securities portfolio, which represents 18% of total assets, access to the FHLB and Federal Reserve Discount Window, round out its liquidity profile. Furthermore, The South’s parent’s fundamentals remain solid, punctuated by a sizeable cash position.

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

The applicable methodologies are Rating Banks and Bank Holding Companies Operating in the United States, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.