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PSTB > SEC Filings for PSTB > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for PARK STERLING CORP

Form 10-Q for PARK STERLING CORP


9-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The purpose of this discussion and analysis is to focus on significant changes in our financial condition as of and results of operations during the three- and nine-month periods ended September 30, 2012. This discussion and analysis highlights and supplements information contained elsewhere in this Quarterly Report on Form 10-Q, particularly the preceding unaudited condensed consolidated financial statements and accompanying notes (the "Unaudited Financial Statements").

Executive Overview

Park Sterling Corporation (the "Company") reported net income of $3.0 million, or $0.09 per share, for the nine months ended September 30, 2012 compared to a net loss of $7.4 million, or $0.21 per share, for the nine months ended September 30, 2011. Net interest income increased $20.2 million, or 174%, to $31.8 million as a result of higher earning assets and improved margins resulting from the acquisition of Community Capital Corporation ("Community Capital") on November 1, 2011 and the Company's growth initiatives. Provision expense decreased $7.2 million, or 88%, to $1.0 million as a result of improved asset quality. Noninterest income increased from $214,000 for the nine months ended September 30, 2011 to $7.8 million for the nine months ended September 30, 2012 as a result of new product capabilities following the acquisition of Community Capital. Noninterest expense increased from $14.9 million for the nine months ended September 30, 2011 to $34.0 million for the nine months ended September 30, 2012 due to the merger with Community Capital, the Company's growth initiatives and increased other real estate owned ("OREO") expenses.

Asset quality continues to improve during 2012, reflecting stabilizing economic conditions in the Company's markets, continued management focus on problem assets and continued discipline in the origination of new loans. Nonperforming assets decreased $5.5 million, or 15%, during the nine month period, to $30.7 million at September 30, 2012 and represented 2.74% of total assets. This compares to 3.25% of total assets at December 31, 2011. Within nonperforming assets, OREO decreased $1.4 million, or 11%, from $14.4 million at December 31, 2011 to $13.0 million at September 30, 2012 as sales of properties outpaced new foreclosures. Troubled debt restructurings increased $3.4 million, or 85%, to $7.4 million at September 30, 2012, primarily due to the inclusion of a new $3.6 million restructured commercial real estate loan.

Total assets remained flat at $1.1 billion at both September 30, 2012 and December 31, 2011. Cash and equivalents increased $78.0 million, or 273%, as funds were generated from a $23.5 million, or 11%, decrease in investments and a $50.8 million, or 7%, decrease in loans at compared to the year-end period. Loan mix improved over the nine months, with exposure to acquisition, construction and development loans declining from 12.2% of total loans at December 31, 2011 to 11.4% of total loans at September 30, 2012. Over this same nine month period, the combination of commercial and industrial and owner-occupied real estate decreased slightly from 33.0% to 32.7%, residential mortgage decreased from 10.5% to 8.2% of total loans, and home equity lines of credit ("HELOCs") decreased from 11.9% to 11.7% of total loans.

Total deposits decreased $15.0 million, or 2%, to $831.7 million at September 30, 2012, compared to $846.6 million at December 31, 2011 with improved deposit mix and lower funding needs. Shareholders' equity increased $5.8 million, or 3%, to $195.8 million at September 30, 2012. Tangible common equity as a percentage of tangible assets remained very strong at 17.31%. Tier 1 leverage ratio also remained very strong at 15.39%. Tangible common equity and tangible assets, and related ratios, are non-GAAP financial measures. For reconciliations to the most comparable GAAP measure, see "Non-GAAP Financial Measures" below.

Business Overview

The Company, a North Carolina corporation, was formed in October 2010 to serve as the holding company for Park Sterling Bank ( the "Bank") and is a bank holding company registered with the Federal Reserve Board. The Bank was incorporated in September 2006 as a North Carolina-chartered commercial nonmember bank. On January 1, 2011, the Company acquired all of the outstanding common stock of the Bank, on a one-for-one basis, in a statutory share exchange transaction effected under North Carolina law. Prior to January 1, 2011, the Company conducted no operations other than obtaining regulatory approval for the holding company reorganization.


In August 2010, the Bank conducted the Public Offering, which raised gross proceeds of $150.2 million to facilitate a change in its business plan from primarily organic growth at a moderate pace over the next few years to seeking accelerated organic growth and to acquire regional and community banks in the Carolinas and Virginia. As part of the Bank's change in strategy, immediately following the Public Offering, the Bank reduced the size of its board of directors from thirteen members to six members, maintaining two of the sitting directors, and adding four new directors. The Bank also reorganized its management team following the Public Offering, adding three new executive officers.

Consistent with our growth strategy, during 2011 the Bank opened a full-service branch in Charleston, South Carolina and loan production offices in Raleigh, North Carolina and Greenville, South Carolina, and subsequently opened full-service branches in Greenville and Raleigh in the first quarter of 2012. The Bank currently anticipates that it will open additional branch offices and/or loan production offices in its target markets in the future.

As part of our growth strategy, Community Capital was merged with and into the Company in November 2011. The aggregate merger consideration consisted of 4,024,269 shares of Common Stock and approximately $13.3 million in cash. The final transaction value was approximately $28.8 million based on the $3.85 per share closing price of the Common Stock on October 31, 2011.

In addition, on October 1, 2012, Citizens South was merged with and into us, with the Company as the surviving legal entity, in accordance with an Agreement and Plan of Merger dated as of May 13, 2012. Under the terms of the Citizens South merger agreement, Citizens South stockholders received either $7.00 in cash or 1.4799 shares of Common Stock for each Citizens South share they owned immediately prior to the merger, subject to the limitation that the total consideration paid in the merger would consist of 30.0% in cash and 70.0% in Common Stock. The Citizens South merger was structured to be tax-free to Citizens South stockholders with respect to the shares of Common Stock received in the merger and taxable with respect to the cash received in the merger. Cash was paid in lieu of fractional shares. The aggregate merger consideration consisted of approximately 11,857,226 shares of Common Stock and approximately $24.2 million in cash. Based on the $4.94 per share closing price of the Common Stock on September 28, 2012, the transaction value was approximately $82.8 million. In addition, in connection with the merger, the preferred stock previously issued by Citizens South to the United States Department of the Treasury in connection with Citizens South's participation in the Small Business Lending Fund program ("SBLF") was converted into 20,500 shares of a substantially identical newly created series of our preferred stock. In connection with the merger, the book value of assets acquired was $941 million and liabilities assumed was $861 million. The calculations to determine fair values were incomplete at the time of filing of this Current Report on Form 10-Q. Until the determination of the fair values is complete, it is impractical to include disclosures related to the fair value of the assets acquired and liabilities assumed as required by the accounting guidance.

The Company provides a full array of retail and commercial banking services, including wealth management, through its 44 offices located in North Carolina, South Carolina, and Georgia, including those locations acquired in the Citizens South merger. Our objective since inception has been to provide the strength and product diversity of a larger bank and the service and relationship attention that characterizes a community bank. We strive to develop a personal relationship with our customers so that we are positioned to anticipate and address their financial needs.

Non-GAAP Financial Measures

In addition to traditional capital measures, management uses tangible assets, tangible common equity, asset quality measures excluding acquisitions, and related ratios and per-share measures, as well as net interest margin excluding accelerated accretion, each of which is a non-GAAP financial measure. Management uses tangible assets and tangible common equity and related ratios to evaluate the adequacy of shareholders' equity and to facilitate comparisons with peers. Management uses asset quality measures excluding acquisitions to evaluate both its asset quality and asset quality trends, and to facilitate comparisons with peers. Management uses net interest margin excluding accelerated accretion to evaluate its core earnings.


The following table presents these non-GAAP financial measures and provides a reconciliation of these non-GAAP measures to the most directly comparable GAAP measure reported in the unaudited condensed consolidated financial statements:

                 Reconciliation of Non-GAAP Financial Measures



                                         September 30,
                                             2012
                                          (Unaudited)
                                          (dollars in
                                       thousands, except
                                           per share
                                           amounts)
Tangible common equity to tangible
assets
Total assets                           $       1,110,188
Less: intangible assets                            4,337
Tangible assets                        $       1,105,851

Total common equity                    $         195,804
Less: intangible assets                            4,337
Tangible common equity                 $         191,467

Tangible common equity                           191,467
Divided by: tangible assets                    1,105,851
Tangible common equity to tangible
assets                                             17.31 %

                                                                              Nine months
                                               Three months ended                ended
                                                                               September
                                         September 30,         June 30,           30,
                                             2012                2012             2012
                                          (Unaudited)        (Unaudited)      (Unaudited)
Net interest margin excluding
accelerated mark accretion
Net interest income                    $           9,971     $     10,099     $     31,792
Less: accelerated mark accretion                      17             (277 )         (1,729 )
Net interest income excluding
accelerated mark accretion                         9,988            9,822           30,063
Divided by: average earning assets               998,669        1,012,579        1,008,300
Multiplied by: annualization factor                 3.98             4.02             1.34
Net interest margin excluding
accelerated mark accretion                          3.98 %           3.90 %           3.98 %

                                         September 30,         June 30,       December 31,
                                             2012                2012            2011*
                                          (Unaudited)        (Unaudited)
                                        (dollars in thousands, except per share amounts)
Asset quality measures and loan
information excluding acquisition
Total loans                            $         708,283     $    712,506     $    759,047
Less: PCI loans acquired with
Community Capital                                (42,823 )        (48,045 )        (63,818 )
Purchased performing loans acquired
with Community Capital                          (246,267 )       (262,104 )       (299,682 )
Loans excluding acquired loans
(originated loans)                     $         419,193     $    402,357     $    395,547

Allowance for loan losses              $           9,207     $      9,431     $     10,154
Less: allowance related to acquired
PCI loans                                           (291 )           (254 )              -
Allowance for loan losses excluding
allowance related to PCI loans                     8,916            9,177           10,154
Less: allowance related to acquired
purchased performing loans                          (345 )           (345 )              -
Allowance for loan losses related to
nonacquired loans                      $           8,571     $      8,832     $     10,154
Divided by: loans excluding
acquisition                                      419,193          402,357          395,547
Allowance for loan losses to loans
excluding acquisition                               2.04 %           2.20 %           2.57 %

Allowance for loan losses related to
acquired purchased performing loans                  345              345                -
Divided by: purchased performing
loans                                            246,267          262,104          299,682
Allowance for loan losses related to
acquired purchased performing loans
to purchased performing loans                       0.14 %           0.13 %           0.00 %

Recent Accounting Pronouncements

See Note 2 to the Unaudited Financial Statements for a description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.


Critical Accounting Policies and Estimates

In the preparation of our financial statements, we have adopted various accounting policies that govern the application of GAAP and in accordance with general practices within the banking industry. Our significant accounting policies are described in Note 2 - Summary of Significant Accounting Policies to the Company's audited consolidated financial statements and accompanying notes (the "2011 Audited Financial Statement") included in the 2011 Form 10-K. While all of these policies are important to understanding our financial statements, certain accounting policies described below involve significant judgment and assumptions by management that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and assumptions that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

Purchased Credit-Impaired Loans. Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered credit impaired. Evidence of credit quality deterioration as of the purchase date may include statistics such as past due and nonaccrual status, recent borrower credit scores and recent loan-to-value ("LTV") percentages. PCI loans are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, the associated allowance for credit losses related to these loans is not carried over at the acquisition date. We estimated the cash flows expected to be collected at acquisition using our internal credit risk, interest rate risk, prepayment risk assumptions and a third-party valuation model, which incorporate our best estimate of current key relevant factors, such as property values, default rates, loss severity and prepayment speeds.

Under the accounting guidance for PCI loans, the excess of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and is recognized in interest income over the remaining life of the loan, or pool of loans, in situations where there is a reasonable expectation about the timing and amount of cash flows to be collected. The difference between the contractually required payments and the cash flows expected to be collected at acquisition, considering the impact of prepayments, is referred to as the nonaccretable difference.

In addition, subsequent to acquisition, we periodically evaluate our estimate of cash flows expected to be collected. These evaluations, performed quarterly, require the continued usage of key assumptions and estimates, similar to the initial estimate of fair value. In the current economic environment, estimates of cash flows for PCI loans require significant judgment given the impact of home price and property value changes, changing loss severities, prepayment speeds and other relevant factors. Decreases in the expected cash flows will generally result in a charge to the provision for credit losses resulting in an increase to the allowance for loan losses. Significant increases in the expected cash flows will generally result in an increase in interest income over the remaining life of the loan, or pool of loans. Disposals of loans, which may include sales of loans to third parties, receipt of payments in full or part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

PCI loans currently represent loans acquired from Community Capital that were deemed credit impaired. PCI loans that were classified as nonperforming loans by Community Capital are no longer classified as nonperforming because, at acquisition, we believe we will fully collect the new carrying value of these loans. It is important to note that judgment regarding the timing and amount of cash flows to be collected is required to classify PCI loans as performing, even if the loan is contractually past due.

Allowance for Loan Losses. The allowance for loan losses is based upon management's ongoing evaluation of the loan portfolio and reflects an amount considered by management to be its best estimate of known and inherent losses in the portfolio as of the balance sheet date. The determination of the allowance for loan losses involves a high degree of judgment and complexity. In making the evaluation of the adequacy of the allowance for loan losses, management considers current economic conditions, independent loan reviews performed periodically by third parties, delinquency information, management's internal review of the loan portfolio, and other relevant factors. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require us to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Although provisions have been established by loan segments based upon management's assessment of their differing inherent loss characteristics, the entire allowance for losses on loans is available to absorb further loan losses in any segment. Additional information regarding our policies and methodology used to estimate the allowance for possible loan losses is presented in Note 5 - Loans to the 2011 Audited Financial Statements, and Note 6 - Loans and Allowance for Loan Losses to the Unaudited Financial Statements included in this form 10-Q.


Income Taxes. Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of DTAs and liabilities for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. In general, we record a DTA when the event giving rise to the tax benefit has been recognized in the consolidated financial statements.

As of September 30, 2012 and December 31, 2011, we had a net DTA in the amount of approximately $29.1 million and $31.1 million, respectively. We evaluate the carrying amount of our DTA quarterly in accordance with the guidance provided in FASB ASC Topic 740 ("ASC 740"), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon the Company generating a sufficient level of taxable income in future periods, which can be difficult to predict. If our forecast of taxable income within the carry forward periods available under applicable law is not sufficient to cover the amount of net deferred assets, such assets may be impaired. Based on the weight of available evidence, we have determined that it is more likely than not that we will be able to fully realize the existing DTA. Accordingly, we consider it appropriate not to establish a DTA valuation allowance at either September 30, 2012 or December 31, 2011.

In evaluating whether we will realize the full benefit of our net DTA, we considered projected earnings, asset quality, liquidity, capital position (which will enable us to deploy capital to generate taxable income), growth plans, and similar factors. In addition, we considered the previous twelve quarters of income (loss) before income taxes in determining the need for a valuation allowance, which is called the cumulative loss test. For the year ended 2011, we incurred a loss, primarily because of the increased provision for loan losses, which resulted in the failure of the cumulative loss test. Significant negative trends in credit quality, losses from operations, and similar factors could affect the realizability of the DTA in the future.

Additional information regarding our income taxes, including the methodology used to determine the need for a valuation allowance for the existing DTA, if any, is presented in Note 7 -Income Taxes to the Unaudited Financial Statements.

Financial Condition at September 30, 2012 and December 31, 2011

Total assets of $1.1 billion at September 30, 2012 were flat compared to December 31, 2011. During the nine months, cash, interest-earning balances and Federal funds sold increased $78.0 million, or 273%, and investment securities available-for-sale decreased $23.3 million, or 11%, while loans decreased $51.0 million, or 7%, and non-marketable equity securities decreased $3.9 million, or 46%.

Total liabilities at September 30, 2012 were $914.4 million, a decrease of $8.8 million, or 1.0%, over total liabilities of $923.2 million at December 31, 2011. Total deposits decreased $15.0 million, or 1.8% and total borrowings increased $6.7 million, or 10.7%, during the first nine months of 2012. Total borrowings included $6.9 million in Tier 2-eligible subordinated debt at September 30, 2012 and December 31, 2011, and $5.7 million and $5.4 million of Tier 1-eligible subordinated debt (after acquisition accounting fair market value adjustments) at September 30, 2012 and December 31, 2011, respectively.

Total shareholders' equity increased $5.8 million, or 3%, during the first nine months to $195.8 million at September 30, 2012. This increase resulted from net income for the nine months ended September 30, 2012 of $3.0 million, $1.2 million in accumulated other comprehensive income from unrealized securities gains, and $1.5 million of share-based compensation expense.


The following table reflects selected ratios for the Company for the nine months ended September 30, 2012 and 2011 and for the year ended December 31, 2011:

                                Selected Ratios





                                      Nine months ended         Twelve months
                                        September 30,               ended
                                         (annualized)           December 31,
                                       2012         2011            2011*
Return on Average Assets                  0.36 %     -1.95 %             -1.20 %

Return on Average Equity                  2.08 %     -6.82 %             -4.69 %

Period End Equity to Total Assets        17.64 %     29.98 %             17.07 %

* Derived from audited financial statements.

Investments and Other Interest-earning Assets

Investment securities decreased $23.3 million, or 11.1%, to $186.8 million at September 30, 2012, from $210.1 million at December 31, 2011. These securities were sold to provide the necessary cash consideration for the merger with Citizens South. Purchases of investment securities available-for-sale were $51.7 million for the nine months ended September 30, 2012. Proceeds from the sales, calls, and maturities of investment securities available-for-sale totaled $77.5 million for the nine months ended September 30, 2012, resulting in gains on the sale of securities available-for-sale of $1.5 million. Our investment portfolio consists of U.S. government agency securities, residential mortgage-backed securities, municipal securities and other debt instruments. At September 30, 2012, our investment portfolio had a net unrealized gain of $6.6 million compared to a $4.7 million net unrealized gain at December 31, 2011. There were no securities with an unrealized loss deemed to be other than temporary at September 30, 2012 or December 31, 2011.

At September 30, 2012, we had $22.2 million in federal funds sold, and $37.3 million in interest-bearing deposits with other FDIC-insured financial institutions. This compares with no federal funds sold and $10.1 million in interest-bearing deposits at other FDIC-insured financial institutions at December 31, 2011.

Loans

We consider asset quality to be of primary importance, and we employ a formal internal loan review process to ensure adherence to lending policies as approved by our board of directors. Since inception, we have promoted the separation of loan underwriting from the loan production staff through our credit department. Currently, credit administration analysts are responsible for underwriting and assigning proper risk grades for all loans with an individual, or relationship, exposure in excess of $500 thousand. Underwriting is completed on standardized forms including a loan approval form and separate credit memorandum. The credit memorandum includes a summary of the loan's structure and a detailed analysis of loan purpose, borrower strength (including individual and global cash flow worksheets), repayment sources and, when applicable, collateral positions and guarantor strength. The credit memorandum further identifies exceptions to policy and/or regulatory limits, total exposure, LTV, risk grades and other relevant credit information. Loans are approved or denied by varying levels of signature authority based on total exposure. A management-level loan committee is responsible for approving all credits with $1 million or greater in cumulative related exposure.

Our loan underwriting policy contains LTV limits that are at or below levels required under regulatory guidance, when such guidance is available, including . . .

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