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GRBS > SEC Filings for GRBS > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for GREER BANCSHARES INC

Form 10-Q for GREER BANCSHARES INC


14-Nov-2012

Quarterly Report


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

CRITICAL ACCOUNTING POLICIES

General - The financial condition and results of operations presented in the consolidated financial statements, the accompanying notes to the consolidated financial statements and this section are, to a large degree, dependent upon the Company's accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change. Those accounting policies that are believed to be the most important to the portrayal and understanding of the Company's financial condition and results of operations are discussed below. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition or results of operations is a reasonable likelihood.

Income Taxes - The calculation of the provision for federal income taxes is complex and requires the use of estimates and judgments. There are two accruals for income taxes: 1) The income tax receivable (or payable) represents the estimated amount currently due from (or due to) the federal government and is reported (as appropriate) as a component of "other assets" or "other liabilities" in the consolidated balance sheet; 2) the deferred federal income tax asset or liability represents the estimated impact of temporary differences between how assets and liabilities are recognized under GAAP, and how such assets and liabilities are recognized under the federal tax code. The effective tax rate is based in part on interpretation of the relevant current tax laws. The Company has reviewed all transactions for appropriate tax treatment taking into consideration statutory, judicial and regulatory guidance in the context of our tax positions. In addition, reliance is placed on various tax positions, recent tax audits and historical experience.

Deferred Tax Asset - In considering whether a valuation allowance on deferred tax assets is needed, management considers all available evidence, including the length of time tax net operating loss carryforwards are available, the existence of available reversing temporary differences, the ability to generate future taxable income and available tax planning strategies. Primarily as the result of recent earnings history and the inability to reasonably predict future taxable income caused by the volatility in the loan portfolio, the Company has recorded a full valuation allowance on the net deferred tax assets. It is possible that management may conclude in future periods that it may have the ability to generate income before income taxes at a sufficient level, which may allow the Company to reverse a portion, or all of the valuation allowance.

Allowance for Loan Losses - The allowance for loan losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount that, based on management's judgment, is adequate to absorb inherent probable losses in the existing portfolio. Additions to the allowance for loan losses are provided by charges to earnings. Loan losses are charged against the allowance when the ultimate uncollectability of the loan balance is determined. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a monthly basis by management. The evaluation includes the periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and related impairment and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of the examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination. A loan is considered impaired when, based on current information and events, it is probable that the Bank will


be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and commercial real estate loans by the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, individual consumer and residential loans are not separately identified for impairment.

Other Real Estate Owned - The Company values OREO that is acquired in settlement of loans at the net realizable value at the time of foreclosure. Management obtains updated appraisals on such properties as necessary, and reduces those values for estimated selling costs. While management uses the best information available at the time of the preparation of the financial statements in valuing the OREO, it is possible that in future periods the Company will be required to recognize reductions in estimated fair values of these properties.

RESULTS OF OPERATIONS

Overview

The following discussion describes and analyzes our results of operations and financial condition for the quarter ended September 30, 2012 as compared to the quarter ended September 30, 2011 as well as results for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. You are encouraged to read this discussion and analysis in conjunction with the financial statements and the related notes included in this report. Throughout this discussion, amounts are rounded to the nearest thousand, except per share data or percentages.

Like most community banks, most of our income is derived from interest received on loans and investments. The primary source of funds for making these loans and investments is deposits, most of which are interest-bearing. Consequently, one of the key measures of our success is net interest income, or the difference between the income on interest-earning assets, such as loans and investments, and the expense on interest-bearing liabilities, such as deposits and Federal Home Loan Bank advances. Another key measure is the spread between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities.

Of course, there are risks inherent in all loans, so an allowance for loan losses is maintained to absorb probable losses inherent in the loan portfolio. This allowance is established and maintained by charging a provision for loan losses against current operating earnings. (See "Provision for Loan Losses" for a detailed discussion of this process.)

In addition to earning interest on loans and investments, income is also earned through fees and other charges to the Bank's customers. The various components of this noninterest income, as well as noninterest expense, are described in the following discussion.

The Company reported consolidated net income of $777,000 available to common shareholders, or $.31 per diluted common share, for the quarter ended September 30, 2012, compared to consolidated net loss of $806,000, or ($.32) per diluted common share, for the quarter ended September 30, 2011. The results for the third quarter of 2012 were positively impacted by an investment transaction of $378,000 comprised of a gain on sale of securities of $878,000 partially offset by $500,000 in prepayment fees on FHLB advances. For the nine months ended September 30, 2012, the Company reported consolidated net income of $3,563,000 attributed to common shareholders, or $1.43 per diluted common share, compared to a consolidated net loss attributed to common shareholders of $2,912,000 or $(1.17) per diluted common share for the nine months ended September 30, 2011.

Interest Income, Interest Expense and Net Interest Income

The Company's total interest income for the quarter ended September 30, 2012 was $3,507,000, compared to $4,266,000 for the quarter ended September 30, 2011, a decrease of $759,000, or 17.8%. Total interest income for the nine months ended September 30, 2012 was $11,075,000, compared to $13,226,000 for the nine months ended September 30, 2011, a decrease of $2,151,000, or 16.3%. Interest and fees on loans is the largest component of total interest income and decreased $495,000, or 15.5% to $2,700,000 for the quarter ended September 30, 2012, compared to $3,195,000 for the quarter ended September 30, 2011 and to $8,502,000 for the nine months ended September 30, 2012 compared to $9,986,000 for the nine months ended September 30, 2011. The decrease in interest and fees on loans was primarily the result of reductions of $39,287,000 in average loan balances for the three months ended September 30, 2012, compared to the same period in 2011 and a reduction of $41,166,000 in average loan balances for the nine months ended September 30, 2012 compared to the same period in 2011. The Company has intentionally decreased its loan portfolio in efforts to boost regulatory capital levels. Average yields on the Company's loan portfolio were 5.37% and 5.30% for the quarter ended September 30, 2012 and September 30, 2011, respectively, and 5.38% and 5.30% for the nine months ended September 30, 2012 and September 30, 2011, respectively. The


loan portfolio yield for the three and nine month periods ended September 30, 2011 was adversely affected by non-accrual loans which comprised a larger percentage of the loan portfolio as compared to the percentage in the current year periods.

Interest income on investment securities decreased by $261,000 in the three month period ended September 30, 2012, compared to the three month period ended September 30, 2011. The decrease was due to a decrease in the tax equivalent investment yields from 3.66% to 2.47% offset by an increase in the average balance of investments from $133,312,000 to $139,207,000 for the three month periods ended September 30, 2011 and September 30, 2012, respectively. The yield decline is primarily the result of falling market rates caused by the portfolio turnover, which was a result of the bank intentionally selling securities to recognize gains.

Interest income on investment securities decreased by $645,000 in the nine month period ended September 30, 2012, compared to the nine month period ended September 30, 2011. The decrease was due primarily to a decrease in investment yields from 3.62% to 2.75% for the nine month periods ended September 30, 2012 and September 30, 2011, respectively, offset slightly by an increase in the average balance of investments from $135,048,000 to $137,078,000 for the periods ended September 30, 2012 and September 30, 2011, respectively. The yield decline is primarily the result of falling market rates caused by the portfolio turnover, which was a result of the bank intentionally selling securities to recognize gains.

The Company's total interest expense declined for the three months ended September 30, 2012 by $547,000 or 37.2% compared to the same period in 2011. The largest component of the Company's interest expense is interest expense on deposits. Deposit interest expense declined due to rate decreases from 1.25% to 0.70% for the three month periods ended September 30, 2011 and September 30, 2012, respectively, and a reduction of average interest bearing deposits of $27,373,000.

The Company's total interest expense declined for the nine months ended September 30, 2012 by $1,773,000 or 35.7% compared to the same period in 2011. Deposit interest expense declined due to rate decreases from 1.38% to .83% for the nine month periods ended September 30, 2011 and September 30, 2012, respectively, and a decrease in average interest bearing deposits of $30,204,000.

Interest on long term borrowings declined $133,000, or 20.6% and $461,000, or 21.6% for the three and nine month periods ended September 30, 2012, respectively, compared to the same periods in 2011. The decline in long term interest expense was the result of decreases in average long term borrowings outstanding more than offsetting the increase in average yields on long term borrowings for the three and nine months ended September 30, 2012 compared to the same periods in 2011. Average long term borrowings outstanding declined by $13,568,000 for the quarter ended September 30, 2012 compared to the same period in 2011. Average long term borrowings outstanding declined by $24,423,000 for the nine months ended September 30, 2012 compared to the same period in 2011. Average rates on long term borrowings increased to 3.15% from 2.99% for the nine months ended September 30, 2012 compared to the same period in 2011. Average rates on long term borrowings decreased to 2.95% from 3.09% for the three months ended September 30, 2012 compared to the same period in 2011. The long term borrowings rate increase for the nine month period ended September 30, 2012 compared to the nine month period ended September 30, 2011 was the result of the elimination of lower rate FHLB borrowings due to the maturity of the borrowings. The long term borrowing rate decrease for the three month period ended September 30, 2012 compared to the three month period ended September 30, 2011 was the result of the elimination, by prepayment, of certain remaining high rate FHLB borrowings at the beginning of the third quarter of 2012.

Net interest income, which is the difference between interest earned on assets and the interest paid for the liabilities used to fund those assets, measures the spread earned on lending and investing activities and is the primary contributor to the Company's earnings. Net interest income before provision for loan losses decreased $212,000, or 7.6%, for the quarter ended September 30, 2012, compared to the same period in 2011. Net interest income before provision for loan losses decreased $378,000, or 4.6%, for the nine months ended September 30, 2012, compared to the same period in 2011.

The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on net interest income. The principal monitoring technique employed by the Company is the use of an interest rate risk management model which measures the effects that movements in interest rates will have on net interest income and the present value of equity. Included in the interest rate risk management reports generated by the model is a report that measures interest sensitivity "gap," which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Balance sheets that are asset sensitive typically produce more earnings as interest rates rise and likewise, earnings decrease as interest rates fall. Balance sheets that are liability sensitive typically produce less earnings as interest rates rise and likewise, more earnings as interest rates fall. The Company's balance sheet was liability sensitive in the up to twelve months gap analysis as of September 30, 2012. Interest rate sensitivity can be managed by repricing assets or liabilities, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.


Provision for Loan Losses

The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and the timely identification of potential problem credits. On a quarterly basis, the Bank's Board of Directors reviews and approves the appropriate level for the allowance for loan losses based upon management's recommendations and the results of the internal monitoring and reporting system. Management also monitors historical statistical data for both the Bank and other financial institutions. The adequacy of the allowance for loan losses and the effectiveness of the monitoring and analysis system are also reviewed by the Bank's regulators and the Company's internal auditor.

The Bank's allowance for loan losses is based upon judgments and assumptions of risk elements in the portfolio, economic conditions and other factors affecting borrowers. The process includes identification and analysis of loss inherent in various portfolio segments utilizing a credit risk grading process and specific reviews and evaluations of significant problem credits. In addition, management monitors the overall portfolio quality through observable trends in delinquencies, charge-offs and general conditions in the Company's market area.

There was no provision for loan losses during the quarter ended September 30, 2012 compared to $1,197,000, for the same period in 2011. There was no provision for loan losses during the nine months ended September 30, 2012 compared to $3,292,000, for the same period in 2011. While the credit market has not improved greatly since the third quarter of 2011, it does not appear to be deteriorating compared to the prior year. The amount of provision is based on the results of the loan loss model. Due to improved bank metrics and a reduction in the loan portfolio size, the model did not require a provision for the quarter ended September 30, 2012. Non-performing assets have decreased from $18.2 million for the quarter ended September 30, 2011 to $11.4 million for the quarter ended September 30, 2012. In addition, we have seen a significant decline in past due loans since December 31, 2011 as the bank has focused on collection efforts as well as charge-off resolution of certain past due loans. Also see the discussion below under "Allowance for Loan Losses."

Noninterest Income

Noninterest income decreased $136,000 for the quarter ended September 30, 2012 compared to the quarter ended September 30, 2011. The decrease is primarily due to a decrease of $153,000 in brokerage revenue. Noninterest income increased $1,487,000 for the nine months ended September 30, 2012 compared to the same period in 2011. The increase is primarily due to an increase of $1,713,000 in gains on sale of investment securities which were sold to recognize the gain.

Noninterest Expenses

Total noninterest expenses decreased $794,000, or 20.1%, for the quarter ended September 30, 2012, to $3,151,000 compared to $3,945,000 for the quarter ended September 30, 2011. The primary cause of decreased noninterest expense for the three months ended September 30, 2012 relates to a decrease in OREO and foreclosure expenses. Salaries and employee benefits, the largest component of noninterest expenses, decreased $21,000 for the three months ended September 30, 2012 compared to the same period in 2011. This is primarily due to the reduction in certain employee benefit expenses including stock option expense. Professional expenses, director's fees, postage and supplies have all declined as the result of continued budget control. OREO and foreclosure expenses decreased $945,000 primarily as a result of reduced valuation adjustments. The three months ended September 30, 201 had $1,203,000 in valuation adjustments compared to $91,000 in the three months ended September 30, 2012.

Total noninterest expenses decreased $2,263,000, or 21.4%, for the nine months ended September 30, 2012, to $8,327,000 compared to $10,590,000 for the nine months ended September 30, 2011. The primary cause of decreased noninterest expense for the nine months ended September 30, 2012 relates to a decrease in OREO and foreclosure expenses. Salaries and employee benefits, the largest component of noninterest expenses, decreased $47,000 for the nine months ended September 30, 2012 compared to the same period in 2011. This is due to the reduction in certain employee benefit expenses including stock option expense. Professional expenses, director's fees, postage and supplies and marketing expenses have all declined as the result of continued budget control. OREO and foreclosure expenses decreased $2,341,000 primarily as a result of reduced valuation adjustments. The nine months ended September 30, 2011 had $2,327,000 in valuation adjustments compared to $171,000 in the nine months ended September 30, 2012. There were $641,000 and $274,000 of Federal Home Loan bank prepayment penalties in the nine months ended September 30, 2012 and September 30, 2011, respectively, that were incurred as part of security sales and balance sheet restructuring transactions.

Income Tax Expense

The Company has a net operating loss carry-forward for federal tax purposes and therefore there was no federal income tax expense for the three and nine months ended September 30, 2012 or during the same period in 2011. The Bank, however, does have state tax expense in the three and nine months ended September 30, 2012 due to net income at the bank level. See "- Critical Accounting Policies - Deferred Tax Asset" above. In evaluating whether the full benefit of the net deferred tax asset will be realized, both positive and negative evidence was considered including recent earnings trends, projected earnings and


asset quality. As of September 30, 2012, management concluded that the negative evidence outweighed any positive evidence in determining realization of any deferred tax temporary differences and has recorded a full valuation allowance in the amount of $5.8 million on its net deferred tax assets. The Company will continue to monitor deferred tax assets closely to evaluate future realization of the full benefit of the net deferred tax asset and the potential need to reduce the valuation allowance. Significant positive trends in credit quality and pre-tax income from operations could impact the level of valuation allowances deemed necessary on deferred tax assets in the future.

BALANCE SHEET REVIEW

Loans

Outstanding loans represented the largest component of earning assets at 57.6% of total earning assets as of September 30, 2012. Gross loans totaled $199,711,000 as of September 30, 2012, a decline of $27,091,000, or 11.9%, from gross loans of $226,802,000 as of December 31, 2011. As a result of the adverse economic environment and a desire to improve capital ratios, management has intentionally slowed loan growth and enhanced underwriting requirements. Adjustable rate loans totaled 60.1% of the Company's loan portfolio as of September 30, 2012, which allows the Company to be in a favorable position as interest rates rise. The Company's loan portfolio consists primarily of real estate mortgage loans, commercial loans and consumer loans with concentrations in commercial real estate, including construction and land development loans. Substantially all of these loans are to borrowers located in South Carolina, with the majority being in the Company's local market area.

Given the negative asset and credit quality trends within the loan portfolio since 2008, management continues to work aggressively to identify and quantify potential losses and execute plans to reduce problem assets. The analyses included internal and external loan reviews that required detailed, written summaries of the loans reviewed and vetting of the risk rating, accrual status and collateral valuation of the loans by the loan officers, credit administration and an external loan review firm.

Allowance for Loan Losses

The allowance for loan losses at September 30, 2012 was $4,513,000, or 2.26% of gross loans outstanding, compared to $6,747,000 or 2.97% of gross loans outstanding at December 31, 2011. The net decrease of .71% in the allowance ratio was primarily a result of the reduction in specific allowances due to charge-offs. The allowance at September 30, 2012 included an allocation of $115,000 related to specifically identified impaired loans compared to $2,168,000 at December 31, 2011.

Internal reviews and evaluations of the Company's loan portfolio for the purpose of identifying potential problem loans, external reviews by federal and state banking examiners, management's consideration of current economic conditions, historical loan losses and other relevant risk factors are used in evaluating the adequacy of the allowance for loan losses. The level of loan loss reserves is monitored on an on-going basis. The evaluation is inherently subjective as it requires estimates that are susceptible to significant change. Despite the Company's efforts to provide accurate estimates. actual losses will undoubtedly vary from the estimates. Also, there is a possibility that charge-offs in future periods will exceed the allowance for loan losses as estimated at any point in time. If delinquencies and defaults increase, additional loan loss provisions may be required which would adversely affect the Company's results of operations and financial condition.

At September 30, 2012, the Company had $11,413,000 in non-performing assets, comprised of non-accruing loans of $6,945,000 and $4,468,000 in OREO. This compares to $10,449,000 in non-accruing loans and $6,469,000 in OREO at December 31, 2011. Non-performing loans consisted of $6,750,000 in real estate loans and $195,000 in commercial loans at September 30, 2012. The nonperforming real estate loans have had appraisals within the past twelve months to support the loan balances.

Net charge-offs for the first nine months of 2012 and 2011 were approximately $2,234,000 and $4,416,000, respectively. The allowance for loan losses as a percentage of non-performing loans was 65.0% and 64.6% as of September 30, 2012 and December 31, 2011, respectively.

Troubled debt restructured loans ("TDRs"), which are included in the impaired loan totals, were $7,032,000 and $12,050,000 at September 30, 2012 and December 31, 2011, respectively. TDRs on non-accrual were $4,457,000 and $6,975,000 at September 30, 2012 and December 31, 2011, respectively. This decrease in TDRs was a result of principal reductions through payments, charge-offs and transfers to OREO.

Potential problem loans, which are not included in non-performing or impaired loans, amounted to approximately $21,085,000, or 10.6% of total loans outstanding at September 30, 2012 compared to $24,314,000, or 10.7% of totals loans outstanding at December 31, 2011. Potential problem loans represent those loans with a well-defined weakness and those loans where information about possible credit problems of borrowers or the performance of construction or development projects has caused management to have concerns about the borrower's ability to comply with present repayment terms.


Securities

The Company's investment portfolio is an important contributor to the earnings of the Company. The Company strives to maintain a portfolio that provides necessary liquidity for the Company while maximizing income consistent with the ability of the Company's capital structure to accept nominal amounts of investment risk. During years when loan demand has not been strong, the Company has utilized the investment portfolio as a means for investing "excess" funds . . .

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