10-Q 1 d10q.txt FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20052 ---------------------------------------------------------- FORM 10-Q [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 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 4,288,228 ------------------------------- ------------------------------- (Class) (Outstanding at March 31, 2001) SouthBanc Shares, Inc. and Subsidiaries FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2001 TABLE OF CONTENTS Part I Financial Information Item 1. Financial Statements Consolidated Balance Sheets as of March 31, 2001 and September 30, 2000 (unaudited)........................................ 3 Consolidated Statements of Income for the Three Months Ended March 31, 2001, and the Three Months Ended March 31, 2000, and the Six Months Ended March 31, 2001, and the Six Months Ended March 31, 2000 (unaudited)............................................ 4 Consolidated Statements of Stockholders' Equity for the Year Ended September 30, 2000 and the Six Months Ended March 31, 2001 (unaudited)....................... 5 Consolidated Statements of Cash Flows for the Six Months Ended March 31, 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 and Six Months Ended March 31, 2001 and 2000......................................................... 10 Liquidity and Capital Resources.......................................... 15 Capital Compliance....................................................... 15 Impact of New Accounting Pronouncements.................................. 16 Effect of Inflation and Changing Prices.................................. 16 Item 3. Quantitative and Qualitative Disclosures about Market Risk............... 16 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 Security Holders.................. 19 5. Other Information.................................................... 18 6. Exhibits and Reports on Form 8-K..................................... 19 Signatures............................................................... 20

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

See accompanying notes to consolidated financial statements. 3 SouthBanc Shares, Inc. and Subsidiaries Consolidated Statements of Income (Unaudited)

See accompanying notes to consolidated financial statements. 4 SouthBanc Shares, Inc. and Subsidiaries Consolidated Statements of Stockholders' Equity Year Ended September 30, 2000 and Six Months Ended March 31, 2001 (Unaudited)

See accompanying notes to consolidated financial statements. 5 SouthBanc Shares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Six Months Ended March 31, 2001 and 2000 (Unaudited)

Continued 6 SouthBanc Shares, Inc. and Subsidiaries Consolidated Statements of Cash Flows Six Months Ended March 31, 2001 and 2000 (Unaudited)

See accompanying notes to consolidated financial statements. 7 SouthBanc Shares, Inc. and Subsidiaries 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 three and six month periods ended March 31, 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, Perpetual Bank, A Federal Savings Bank, ("Perpetual Bank"), Heritage Federal Bank ("Heritage Federal") (collectively the "Banks") and Perpetual Bank's wholly owned subsidiaries, Mortgage First Service Corporation and United Service Corporation, and United Service Corporation's wholly owned subsidiary, United Investment Services. At March 31, 2001, United Service Corporation had assets of $2.3 million. United Service Corporation 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 Banks to pay dividends to the Company. The payment of dividends by the Banks is subject to regulation by the Office of Thrift Supervision ("OTS"). The Banks may not declare or pay a cash dividend if the effect thereof would cause the capital of the Banks to be reduced below regulatory capital requirements imposed by the OTS or below the liquidation account established by the Banks in connection with their respective conversions from the mutual to stock form of organization. The Company's Board of Directors declared a cash dividend of $0.15 per share to its shareholders during the quarter ended December 31, 2000, payable to shareholders of record as of January 2, 2001, and a cash dividend of $0.15 per share during the quarter ended March 31, 2001 payable to shareholders of record as of April 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:

9 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 $1.3 million at March 31, 2001 to $671.2 million at March 31, 2001 from $672.5 million at September 30, 2000, primarily as a result of a decrease in loans receivable and other assets. Loans receivable decreased 2.9% or $14.9 million to $501.4 million at March 31, 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 not currently holding fixed rate loans originated in its portfolio due to the Company's estimates of expected changes in market interest rates. Mortgage-backed securities available-for-sale decreased 3.5% or $2.5 million to $70.1 at March 31, 2001 from $72.6 million at September 30, 2000. Principal repayments on mortgage-backed securities were $4.2 million during the six months ended March 31, 2001. Investment securities available for sale increased 82.7% or $12.1 million to $26.8 million at March 31, 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 the 2001 quarter the Banks purchased securities of $15.2 million with available funds, including $13.7 million of municipal bonds and $1.5 million of a trust preferred bond. These investments were purchased in an effort to balance fixed and adjustable rate investments within the Bank's portfolio and to minimize prepayment risk. Cash and cash equivalents increased 5.74% or $1.2 million to $23.0 at March 31, 2001 from $21.8 million at September 30, 2000. At March 31, 2001, $10.2 million was invested in interest-bearing overnight investment accounts yielding 5.33%. Real estate held for development decreased slightly to $2.1 million at March 31, 2001. The Company is presently developing two single-family residential subdivisions and two commercial real estate development projects. Four lots were sold during the quarter in the single-family residential subdivisions. Development costs of $34,000 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 March 31, 2001. Cash surrender value of life insurance was $16.6 million at March 31, 2001, an increase of $8.3 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 Heritage Federal during the quarter ended December 31, 2000. Deposits increased $40,000 to $452.0 million at March 31, 2001 from $451.9 million at September 30, 2000. Non-interest bearing checking accounts increased 2.01% or $300,000 to $15.2 million at March 31, 2001, from $14.9 million at September 30, 2000. Interest bearing checking accounts increased 11.61% or $5.2 million to $50.0 million at March 31, 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 6.76% or $3.4 million to $53.7 million at March 31, 2001 from $50.3 million at September 30, 2000. Certificates of deposit decreased 2.60% or $8.9 million to $333.0 million at March 31, 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 were $20.4 million at March 31, 2001 and 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 6.66%, with a maturity date of May 12, 2001. Advances from the Federal Home Loan Bank increased $7.1 million to $105.4 million at March 31, 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. Stockholders equity decreased $361,000 to $79.7 million at March 31, 2001 from $80.1 million at September 30, 2000. Retained earnings was increased by net income of $4.8 million for the six months ended March 31, 2001, and decreased by dividends paid in the 10 amount of $1.3 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 six months of fiscal 2001, the Company repurchased 238,602 shares at an average cost of $18.56 per share and a total cost of $4.4 million. Accumulated other comprehensive income, net, increased $393,000 to $2.3 million at March 31, 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 $44,000 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 March 31, 2001, and 2000 Net Income ---------- Net income for the three months ended March 31, 2001, increased to $2.0 million or $0.46 basic earnings per share and $0.45 diluted earnings per share, compared to $1.3 million or $0.44 basic earnings per share and $0.42 diluted earnings per share for the same three 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. Net Interest Income ------------------- Net interest income was $5.0 million for the three months ended March 31, 2001 and $3.0 million for the three months ended March 31, 2000. Heritage Federal added approximately $248 million in total loans in 2000. Total interest income increased 88.3% or $5.9 million to $12.5 million for the three months ended March 31, 2001, from $6.6 million for the three months ended March 31, 2000, due primarily to a higher average balance of outstanding loans which increased $239.3 million or 89.0% to an average of $508.1 million yielding 8.33% for the three months ended March 31, 2001, from $268.8 million yielding 8.04% for the three months ended March 31, 2000. Interest income on mortgage-backed securities increased 68.5% or $530,000 to $1.3 million for the three months ended March 31, 2001, as the average balance increased $24.4 million to $71.3 million for the three months ended March 31, 2001 from $46.9 million for the three months ended March 31, 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 $8.8 million of mortgage-backed securities were on Heritage Federal's balance sheet at March 31, 2000. In addition, as loans decreased during the quarter, investable funds were used to purchase investment and mortgage-backed securities. Interest income on other investments increased 32.7% or $150,000 due primarily to a higher balance of investment securities and interest bearing deposits which increased 34.4% or $8.8 million, to an average balance of $34.4 million yielding 5.73% for the three months ended March 31, 2001, from $25.6 million yielding 7.16% for the three months ended March 31, 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 139.1% or $3.2 million as the average outstanding balance increased 97.1% or $218.0 million to $442.5 million at an average cost of 5.00% for the three months ended March 31, 2001, from $224.5 million at an average cost of 4.12% for the three months ended March 31, 2000. Heritage Federal added over $200 million of deposits at the time of the merger in July 2000. In addition, interest rates were higher during the 2001 quarter than in the 2000 quarter. Interest on borrowings increased $598,000 to $1.9 million for the three months ended March 31, 2001, from $1.3 million for the three months ended March 31, 2000, as the average borrowings increased 44.0% or $40.7 million to $133.1 million at an average cost of 5.83% for the three months ended March 31, 2001, from $92.4 million at an average cost of 5.14% for the three months ended March 31, 2000. The total cost of average interest bearing liabilities for the quarter ended March 31, 2001 was 5.19%. 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 decreased 61.9% or $130,000 to $80,000 for the three months ended March 31, 2001, from $210,000 for the three months ended March 31, 2000 due to a decrease in non-performing assets during the quarter ended March 31, 2001. Non- 11 performing assets represented 1.58% of total assets at March 31, 2001. The allowance for loan losses was 1.22% of total loans at March 31, 2001 and 1.28% at September 31, 2000. Non-performing assets at March 31, 2001 were $10.6 million consisting of $3.0 million of residential mortgage construction loans, $2.0 million of real estate acquired in settlement of loans, $4.7 million of single family residential loans, $845,000 of commercial real estate loans, and $28,000 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. The allowance for loan losses to total net loans was 1.22% March 31, 2001, and 1.28% at September 30, 2000. Other Income ------------ Total other income increased 8.79% or $128,000 to $1.6 million for the three months ended March 31, 2001, from $1.5 million for the three months ended March 31, 2000. Loan and deposit service charges increased $153,000 to $1.1 million from $948,000 for the three months ended March 31, 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 $337,500 for the three months ended March 31, 2001. There was no gain or loss on the sale of investments for the three months ended March 31, 2000. Gain (loss) on real estate acquired in settlement of loans was a loss of $307,500 for the three months ended March 31, 2001, compared to a gain of $10,000 for the three months ended March 31, 2000. During the second quarter of 2001 certain properties acquired in settlement of loans were written down to net realizable value following new appraisals of the properties. There was a $3,000 gain on sale of loans for the three months ended March 31, 2001. There was no gain or loss for the three months ended March 31, 2000. Gain on sale of real estate held for development was negligible for the three months ended March 31, 2001. United Service Corporation sold four lots in The Meadows residential subdivision earning as gain of $30,000 for the three months ended March 31, 2000. Earnings on bank owned life insurance increased 84.9% or $107,000 to $233,000 for the three months ended March 31, 2001 from $126,000 for the three months ended March 31, 2000, due to the purchase of $8.0 million of additional officers life insurance for Heritage Federal in the first fiscal quarter of 2001. Other income decreased $127,000 to $211,000 for the three months ended March 31, 2001, compared to $338,000 for the three months ended March 31, 2000. Other income in 2000 included a positive change in the market value of the Company's investment in limited partnership. The 2001 quarter included increases from United Investments and Mortgage First subsidiaries, but did not include any positive changes in the limited partnership investment's market value. General and Administrative Expense ---------------------------------- Salaries and employee benefits increased 46.4% or $596,000 to $1.9 million for the three months ended March 31, 2001, from $1.3 million for the three months ended March 31, 2000. The Company increased the number of employees as a result of the merger, increasing by 65 full time equivalent employees to 180 at March 31, 2001 from 115 at March 31, 2000. Office occupancy increased 33.5% or $49,000 to $197,000 for the three months ended March 31, 2001, from $148,000 for the three months ended March 31, 2000, due to an increase in office building depreciation expense and property taxes. Furniture and equipment expenses increased 60.2% or $164,000 to $436,000 for the three months ended March 31, 2001, from $272,000 for the three months ended March 31, 2000. The Company owned six office buildings in March 2000 and ten office buildings in 2001. Advertising increased 223.1% or $86,000 to $125,000 for the three months ended March 31, 2001, from $39,000 for the three months ended March 31, 2000 due to the free checking program promotion that began at Heritage Federal in October 2000. Data processing increased 58.1% or $72,000 to $197,000 for the three months ended March 31, 2001, from $125,000 for the three months ended March 31, 2000. Office supplies increased 82.7% or $62,000 to $138,000 for the three months ended March 31, 2001, from $75,000 for the three months ended March 31, 2000, due to the addition of Heritage Federal to the consolidated results. There was no profit improvement program expense for the three months ended March 31, 2001 compared to $24,000 for the three months ended March 31, 2000. The profit improvement program included consultant fees for sales training, staff realignment, and product fee enhancement. Other operating expenses increased 78.2% or $246,000 to $561,000 for the three months ended March 31, 2001, from $315,000 for the three months ended March 31, 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 $41,000, transfer agent expenses of $46,000, consultant expenses for a human resources project of $50,000, an increase in directors and officers liability insurance of $31,000, telephone expenses of $16,000, postage of $18,000 and expenses related to real estate acquired in foreclosure of $20,000. Income Taxes ------------ Income taxes increased 58.9% or $361,000 to $974,000 for the three months ended March 31, 2001, from $613,000 for the three months ended March 31, 2000. This was due to an increase in income before taxes of 53.8% or $1.1 million to $3.0 million from $1.9 million for the three months ended March 31, 2001, and 2000, respectively, primarily due to the merger with Heritage Bancorp in July 2000. 12 Comparison of Operating Results for the Six Months Ended March 31, 2001, and 2000 Net Income ---------- Net income for the six months ended March 31, 2001, increased to $4.8 million or $1.09 basic earnings per share and $1.06 diluted earnings per share, compared to $2.7 million or $0.88 basic earnings per share and $0.83 diluted earnings per share for the same six 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. Net Interest Income ------------------- Net interest income was $10.1 million for the six months ended March 31, 2001 and $6.1 million for the six 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 90.8% or $12.1 million to $25.4 million for the six months ended March 31, 2001, from $13.3 million for the six months ended March 31, 2000, due primarily to a higher average balance of outstanding loans which increased $247.5 million or 93.8% to an average of $511.3 million yielding 8.44% for the six months ended March 31, 2001, from $263.8 million yielding 8.05% for the six months ended March 31, 2000. Interest income on mortgage- backed securities increased 54.1% or $915,000 to $2.6 million for the six months ended March 31, 2001, as the average balance increased $22.5 million to $71.8 million for the six months ended March 31, 2000 from $49.3 million for the six months ended March 31, 2000. Much of the increase in average balances is due to the addition of Heritage Federal to the consolidated Company. Approximately $14.0 million of mortgage-backed securities were on Heritage Federal's balance sheet at March 31, 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 17.8% or $175,000 due primarily to a higher balance of investment securities and interest bearing deposits which increased 10.4% or $10.4 million, to an average balance of $38.2 million yielding 6.0% for the six months ended March 31, 2001 from $27.8 million yielding 7.05% for the six months ended March 31, 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 149.2% or $6.7 million as the average outstanding balance increased 99.0% or $220.1 million to $442.4 million at an average cost of 5.06% for the six months ended March 31, 2001, from $222.3 million at an average cost of 4.04% for the six months ended March 31, 2000. Heritage Federal added over $200 million of deposits at the time of the merger in July 2000. In addition, interest rates on time deposits were higher during the 2001 quarter than in the 2000 quarter. Average rates of interest paid on certificates of deposit during the first six months of fiscal 2001 were 6.02% compared to 5.34% paid on certificates of deposit during the first six months of fiscal 2000. Interest on borrowings increased $1.4 million to $4.1 million for the six months ended March 31, 2001, from $2.7 million for the six months ended March 31, 2000, as the average borrowings increased 40.0% or $37.4 million to $130.8 million at an average cost of 6.28% for the six months ended March 31, 2001, from $93.4 million at an average cost of 5.71% for the six months ended March 31, 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 decreased 65.8% or $237,000 to $123,000 for the six months ended March 31, 2001, from $360,000 for the six months ended March 31, 2000, due to a decrease in non-performing assets during the six months ended March 31, 2000. Non-performing assets at March 31, 2001, were $10.6 million consisting of $3.0 million of residential mortgage construction loans, $2.0 million of real estate acquired in settlement of loans, $4.7 million of single family residential loans, $845,000 of commercial real estate loans, and $28,000 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. As these non- 13 performing assets have decreased, the Company has been able to provide lower levels of provision for loan losses. Year to date charge-offs total $458,000 as of March 31, 2001. The allowance for loan losses to total loans was 1.22% at March 31, 2001 and 1.27% at September 30, 2000. Other Income ------------ Total other income increased 57.7% or $1.6 million to $4.4 million for the six months ended March 31, 2001, from $2.8 million for the six months ended March 31, 2000. Loan and deposit service charges increased $339,000 to $2.3 million from $2.0 million for the six months ended March 31, 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 $1.5 million for the six months ended March 31, 20001 compared to a loss of $95,000 for the six months ended March 31, 2000. The gain resulted from the sale of equity investments. Gain (loss) on real estate acquired in settlement of loans was a loss of $307,000 for the six months ended March 31, 2001, compared to a gain of $5,000 for the six months ended March 31, 2000. There was a loss on sale of loans of $2,400 for the six months ended March 31, 2001, compared to no loss for the six months ended March 31, 2000. Gain on sale of real estate held for development was $17,000 for the six months ended March 31, 2001, as eight residential lots were sold by the United Service Corporation in The Meadows residential subdivision compared to $83,000 for the six months ended March 31, 2000, as seven residential lots were sold in The Meadows. Earnings on bank owned life insurance increased 66.6% or $157,000 to $390,000 for the six months ended March 31, 2001 from $234,000 for the six months ended March 31, 2000 due to the purchase of $8.0 million of additional officers life insurance for Heritage Federal during the first quarter of fiscal 2001. Other income decreased $125,000 to $460,000 for the six months ended March 31, 2001, compared to $586,000 for the six months ended March 31, 2000. Other income in 2000 included a positive change in the market value of the Company's investment in limited partnership. The 2001 period included increases from United Investments and Mortgage First subsidiaries, but did not include any positive changes in the limited partnership investment's market value. General and Administrative Expense ---------------------------------- Salaries and employee benefits increased 42.4% or $1.0 million to $3.6 million for the six months ended March 31, 2001, from $2.6 million for the six months ended March 31, 2000. The Company increased the number of employees as a result of the merger, increasing by 65 full time equivalent employees to 180 at March 31, 2001 from 115 at March 31, 2000. Office occupancy increased 40.7% or $112,000 to $388,000 for the six months ended March 31, 2001, from $276,000 for the six months ended March 31, 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 March 31, 2000 and ten office buildings for the same period in 2001. Furniture and equipment expenses increased 71.1% or $366,000 to $881,000 for the six months ended March 31, 2001, from $515,000 for the six months ended March 31, 2000. Advertising increased 166.6% or $142,000 to $228,000 for the six months ended March 31, 2001, from $85,000 for the six months ended March 31, 2000. Advertising costs increased as a result of the merger due to the fact that Heritage began a new free checking product campaign during the months immediately following the merger. Data processing increased 49.4% or $124,000 to $376,000 for the six months ended March 31, 2001, from $252,000 for the six months ended March 31, 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 73.4% or $132,000 to $311,000 for the six months ended March 31, 2001, from $179,000 for the six months ended March 31, 2000, due to the addition of Heritage Federal. There was no profit improvement program expense for the six months ended March 31,2001 compared to $94,000 for the six months ended March 31, 2000. The profit improvement program included consultant fees for sales training, staff realignment, and product fee enhancement. Other operating expenses increased 94.1% or $567,000 to $1.2 million for the six months ended March 31, 2001, from $602,000 for the six months ended March 31, 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 $103,000, 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 $54,000, telephone expenses of $25,000, postage of $40,000 and expenses related to real estate acquired in foreclosure of $65,000. Income Taxes ------------ Income taxes increased 95.1% or $1.2 million to $2.5 million for the six months ended March 31, 2001, from $1.3 million for the six months ended March 31, 2000. This was due to an increase in income before taxes of 84.7% or $3.3 million to $7.3 million from $3.9 million for the six months ended March 31, 2001, and 2000, respectively, primarily due to the merger with Heritage Bancorp in July 2000. 14 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 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 March 31, 2001, the Company originated $23.4 million of loans and $400,000 of loans were sold. The Company also purchased $1.6 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 March 31, 2001, the Company had outstanding commitments to originate loans of approximately $84.7 million. Certificates of deposit scheduled to mature in one year or less at March 31, 2001, totaled $278.2 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. Capital Compliance ------------------ The Company is not subject to any regulatory capital requirements. The Banks' 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 December 31, 2000, the most recent notification from the OTS categorized the Banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Banks 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 Banks' category. Perpetual Bank, A Federal Savings Bank --------------------------------------

15 Capital Compliance, Continued ----------------------------- Heritage Federal Bank ---------------------

If the Banks were to fail to meet the minimum capital requirements, they 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 September 2000, the Financial Accounting Standards Board (the "FASB") issued Statement of Financial Accounting Standard ("SFAS") No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement No. 125". This statement will become effective for transfers occurring after March 31, 2001 and for disclosures relating to securitizations and collateral for fiscal years ending after December 15, 2000. In addition to replacing SFAS No. 125, this statement will rescind SFAS No. 127 "Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125". SFAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but will carry over most of the provisions of Statement 125 without reconsideration. The Company anticipates that adoption of the standard will not have a material effect on the Company. Other accounting standards that have been issued or proposed by the Financial Accounting Standards Board 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. 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-earning 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 16 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 sheet 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 time period. At March 31, 2001, there have been no material changes to the market risk information set forth under "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Market Risk and Asset Liability Management" in the Company's 2000 Annual Report to stockholders. For the three month period ended March 31, 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 2.82%. As of the quarter ended December 31, 2000, the interest rate spread was 2.79%. The Company's management believes that the interest rate spread has improved as market interest rates have decreased and liabilities have matured or repriced. The prime rate quoted by major United States ("US") banks as of January 1, 2001 was 9.5%, but had decreased to 8.00% as of April 1, 2001, and the rate on 90 day US treasury bills as of January 1, 2001 was 5.88%, but had decreased to 4.28% as of April 1, 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 Banks from time to time and currently are involved as plaintiff or defendant in various legal actions incident to their business. These actions are not believed to be material, either individually or collectively, to the consolidated financial condition or results of operations of the Banks. 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 -------------------------------------------------------------- On January 17, 2001, the Company held its annual meeting of stockholders for the purpose of the election of Directors to three-year terms, the ratification of the approval of the SouthBanc Shares, Inc. 2001 Stock Option Plan and the ratification of Elliot Davis, LLP as the Company's independent auditors. The number of votes cast at the meeting as to each matter to be acted upon was as follows:

The Directors whose terms continued and the years their terms expire are as follows: Harold A. "Drew" Pickens, Jr. (2002), J. Riley Bailes (2002), Martha C. Clamp (2002), J. Edward Wells (2003) and Richard C. Ballenger (2003).

Item 5. Other Information ---------------------------- None 18 Item 6. Exhibits and Reports on Form 8-K ------------------------------------------- A. Exhibits: --------- 3.1 Certificate of Incorporation of the Company (1) 3.2 Bylaws of the Company (1) 10.1 Employment Agreement between SouthBanc Shares, Inc. and Robert W. Orr (2) 10.2 Employment Agreement between SouthBanc Shares, Inc. and Thomas C. Hall (2) 10.3 Employment Agreement between SouthBanc Shares, Inc. and Barry C. Visioli (2) 10.4 Employment Agreement between Perpetual Bank, A Federal Savings Bank and Robert W. Orr (2) 10.5 Employment Agreement between Perpetual Bank, A Federal Savings Bank and Thomas C. Hall (2) 10.6 Employment Agreement between Perpetual Bank, A Federal Savings Bank and Barry C. Visioli (2) 10.7 1998 Stock Option Plan (3) 10.8 1998 Management Development and Recognition Plan (3) 10.9 Supplemental Executive Retirement Agreement with Robert W. Orr (2) 10.10 Supplemental Executive Retirement Agreement with Thomas C. Hall (2) 10.11 Supplemental Executive Retirement Agreement with Barry C. Visioli (2) 10.12 Employment Agreement between SouthBanc Shares, Inc. and J. Edward Wells (4) 10.13 2001 Stock Option Plan (5) (1) Incorporated by reference to the Company's Registration Statement on Form S-1, as amended (File No. 333-42517). (2) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended September 30, 1999. (3) Incorporated by reference to the Company's Definitive Proxy Statement dated December 18, 1998. (4) Incorporated by reference to the Company's Annual Report on Form 10-K for the year ended September 30, 2000. (5) Incorporated by reference to the Company's Definitive Proxy Statement dated December 14, 2000. B. Reports on Form 8-K ------------------- The Company did not file any reports on Form 8-K during the quarter ended March 31, 2001. 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. SouthBanc Shares, Inc. Date: May 11, 2001 /s/ Robert W. Orr ------------------------------------- Robert W. Orr President and Chief Executive Officer (Duly Authorized Representative) Date: May 11, 2001 /s/ Thomas C. Hall ------------------------------------- Thomas C. Hall Chief Financial Officer 20

SOUTHBANC SHARES INC 10-Q