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PSTB > SEC Filings for PSTB > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for PARK STERLING CORP


15-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following is a discussion of our financial position and results of operations and should be read in conjunction with the information set forth in
Part I, Item 1A. "Risk Factors" and the Consolidated Financial Statements.

Executive Overview

The year ended December 31, 2012 represented continued progress toward the Company's vision of creating a regional-sized community bank in the Carolinas and Virginia. In October 2012, we completed our merger with Citizens South and we merged Citizens South Bank with and into the Bank. This acquisition followed the November 2011 completion of our merger with Community Capital and December 2011 merger of CapitalBank with and into the Bank.

The Bank is now the largest community bank headquartered in the Charlotte-Gastonia-Rock Hill MSA, with a strong deposit franchise extending through the Upstate region of South Carolina and into North Georgia, and an expanding presence in the important growth markets of Raleigh and Wilmington, North Carolina, and Greenville and Charleston, South Carolina. Our asset-based lending and residential construction groups offer specialized avenues to originate attractive risk-return loans in this highly competitive environment. Further, our treasury management, wealth management and mortgage banking capabilities provide significant opportunities to diversify revenues away from traditional lending activities.

The Company reported net income available to common shareholders of $4.3 million, or $0.12 per share, for the twelve months ended December 31, 2012, compared to a net loss of $8.4 million, or $0.29 per share, for the twelve months ended December 31, 2011. Excluding merger-related expenses and gain on sale of securities, the Company reported net income available to common shareholders of $7.5 million, or $0.21 per share, for the twelve months ended December 31, 2012 compared to a net loss of $5.9 million, or $(0.21) per share, for the twelve months ended December 31, 2011. Merger-related expenses totaled $5.9 million in 2012 compared to $3.8 million in 2011, and gain on sale of securities totaled $1.5 million in 2012 compared to $20 thousand in 2011. Results for 2012 included three months of operations from the merger with Citizens South and a full year of operations from the merger with Community Capital. Results for 2011 included two months of operations from the merger with Community Capital.

Overall asset quality continued to improve during 2012. Nonperforming loans decreased $2.4 million, or 12%, from $20.2 million, or 2.66% of total loans, at December 31, 2011 to $17.8 million, or 1.31% of total loans, at December 31, 2012, due both to the continued resolution of problem assets and to higher total loan balances from the merger with Citizens South. Nonperforming assets increased by $7.0 million, or 19%, from $36.2 million at December 31, 2011 to $43.2 million at December 31, 2012 due to the inclusion of $14.7 million of OREO acquired in the merger with Citizens South (of which $6.7 million is covered under FDIC loss share agreements). However, nonperforming assets decreased to 2.13% of total assets from 3.25% of total assets as a result of higher total asset balances from the merger. Loans past due 30-89 days and still accruing decreased $2.6 million, or 78%, from $3.3 million, or 0.44% of total loans, at December 31, 2011 to $728 thousand, or 0.05% of total loans, at December 31, 2012. Net charge-offs decreased $10.1 million, or 86%, from $11.7 million, or 1.54% of total loans, for the twelve months ended December 31, 2011 to $1.6 million, or 0.12% of total loans, for the twelve months ended December 31, 2012.

Total assets increased $919.4 million, or 83%, to $2.0 billion at December 31, 2012, compared to $1.1 billion at December 31, 2011, primarily due to the merger with Citizens South. Total loans, which exclude loans held for sale, increased $598.0 million, or 79%, to $1.4 billion, including $101.7 million in covered loans associated with the two failed bank transactions acquired as a result of the merger with Citizens South. The merger resulted in a more balanced loan mix at December 31, 2012 when compared to December 31, 2011. Over the twelve month period, the combination of commercial and industrial ("C&I") and owner occupied real estate loans decreased from 33% to 31% of total loans; acquisition, development and construction ("AC&D") loans decreased from 12% to 10% of total loans; investor owned real estate loans increased from 26% to 27% of total loans; and total consumer loans increased from 27% to 31% of total loans. New loan origination remains somewhat tempered as a result of aggressive competition in the market with respect to term structure and interest rates, and continued general softness in the economy.

Total deposits increased $785.4 million, or 93%, to $1.6 billion at December 31, 2012 compared to $846.6 million at December 31, 2011, due both to organic growth and the merger with Citizens South. The merger resulted in a shift in deposit mix at December 31, 2012 when compared to December 31, 2011. Noninterest bearing demand deposits decreased from 17% to 15% of total deposits; MMDA, NOW and savings accounts increased from 39% to 46% of total deposits; time deposits increased from 29% to 32% of total deposits; and brokered time deposits decreased from 15% to 7% of total deposits. Our core deposits, which exclude brokered deposits and time deposits greater than $250,000, represented 90.3% of total deposits at December 31, 2012 compared with 81.8% of total deposits at December 31, 2011.

The Company remained well capitalized at December 31, 2012. Tangible common equity as a percentage of tangible assets remained strong at 12.14%. Tier 1 leverage ratio also remained strong at 11.25%.

Net income excluding merger-related expenses and gain on sale of securities, and related per share measures, as well as 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 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 in exchange for shares of the Company's Common Stock, on a one-for-one basis, in a statutory share exchange transaction effected under North Carolina law pursuant to which the Company became the bank holding company for the Bank. Prior to January 1, 2011, the Company conducted no operations other than obtaining regulatory approval for the holding company reorganization. The Consolidated Financial Statements, the discussions of those financial statements included in this Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as market data and all other operating information presented herein for periods prior to January 1, 2011, are those of the Bank on a stand-alone basis.

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, in November 2011 the Company acquired Community Capital, the parent company of Greenwood, South Carolina-based CapitalBank. As a result of the merger of Community Capital into the Company, CapitalBank, which operated 18 branches in the Upstate and Midlands areas of South Carolina, became a wholly owned subsidiary of the Company and thereafter was merged into the Bank. The aggregate merger consideration consisted of 4,024,269 shares of Common Stock and $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. Community Capital contributed approximately $612.4 million in total assets, $388.2 million in total loans (including loans held for sale), $4.7 million in goodwill and intangibles, and $467.0 million in total deposits to the Company, after acquisition accounting fair market value adjustments.

In addition, in October 2012, the Company acquired Citizens South , the parent company of Citizens South Bank. As a result of the merger of Citizens South into the Company, Citizens South Bank, which operated 20 branches in North Carolina, South Carolina and Georgia, became a wholly-owned subsidiary of the Company and thereafter was merged into the Bank. The aggregate merger consideration consisted of 11,857,226 shares of Common Stock and $24.3 million in cash. The final transaction value was approximately $82.8 million based on the $4.94 per share closing price of the Common Stock on September 28, 2012. In addition, in connection with the merger, the preferred stock previously issued by Citizens South to the Treasury in connection with Citizens South's participation in the SBLF was converted into 20,500 shares of a substantially identical newly created series of our preferred stock, the Series C Preferred Stock. Citizens South contributed approximately $931.0 million in total assets, $683.5 million in total loans (including loans held for sale), $28.7 million in goodwill and intangibles, and $828.3 million in total deposits to the Company, after acquisition accounting fair market value adjustments.

The Company provides a full array of retail and commercial banking services, including wealth management, through its offices located in North Carolina, South Carolina, and Georgia. 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.

Recent Accounting Pronouncements

See Note 2 - Summary of Significant Accounting Policies to the Consolidated 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 accounting principles generally accepted in the United States 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 Consolidated Financial Statements. While all of these policies are important to understanding the Consolidated 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 (PCI) 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 internal risk grade, 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 specific credit review of certain loans, quantitative credit risk, interest rate risk and prepayment risk models, and qualitative economic and environmental assessments, each of which incorporated 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 and is available to absorb future charge-offs.

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 and Citizens South that were deemed credit impaired. PCI loans that were classified as nonperforming loans by Community Capital or Citizens South are no longer classified as nonperforming so long as, at acquisition and quarterly re-estimation periods, 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 and market conditions, independent loan reviews performed periodically by third parties, portfolio trends and concentrations, delinquency information, management's internal review of the loan portfolio, internal historical loss rates 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, other than the portion related to PCI loans, is available to absorb further loan losses in any segment. Further information regarding our policies and methodology used to estimate the allowance for possible loan losses is presented in Note 5 - Loans to the Consolidated Financial Statements.

FDIC Indemnification Asset. In accordance with Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 805, the FDIC indemnification asset was initially recorded at its fair value, and is measured separately from the loan assets and foreclosed assets because the loss sharing agreements are not contractually embedded in them or transferrable with them in the event of disposal. The FDIC indemnification asset is measured at carrying value subsequent to initial measurement. Improved cash flows of the underlying covered assets will result in impairment of the FDIC indemnification asset and negative accretion through non-interest income will result. Impairment of the underlying covered assets will increase the cash flows of the FDIC indemnification asset and a credit to the provision for loan losses for acquired loans will result.

The purchase and assumption agreements between the Bank and the FDIC, as discussed in Note 6 - FDIC Loss Share Agreements to the Consolidated Financial Statements, each contain a provision that obligates us to make a "true-up" payment to the FDIC if the realized losses of each of the applicable acquired banks are less than expected. Any such "true-up" payment that is materially higher than current estimates could have a negative effect on our business, financial condition and results of operations.

Income Taxes. Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of deferred tax assets ("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 December 31, 2012 and 2011, we had a net DTA in the amount of approximately $41.8 million and $31.2 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 considered it appropriate not to establish a DTA valuation allowance at either December 31, 2012 or 2011.

Further 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 12 -Income Taxes to the Consolidated Financial Statements.


Non-GAAP Financial Measures

In addition to traditional capital measures, management uses net income available to common shareholders excluding merger-related expenses and gain on sale of securities, noninterest income excluding gain on sale of securities, noninterest expense excluding merger-related expenses, tangible assets, tangible common equity, adjusted allowance for loan losses to loans, 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 (i) tangible assets and tangible common equity and related ratios to evaluate the adequacy of shareholders' equity and to facilitate comparisons with peers; (ii) adjusted allowance for loan losses to loans to evaluate both its asset quality and asset quality trends, and to facilitate comparisons with peers; and (iii) net income available to common shareholders excluding merger-related expenses and gain on sale of securities, noninterest income excluding gain on sale of securities, noninterest expense excluding merger-related expenses and net interest margin excluding accelerated mark accretion to evaluate its core earnings and to facilitate comparisons with peers.

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 Company's Consolidated Financial Statements at December 31:

                 Reconciliation of Non-GAAP Financial Measures

                                                      2012                     2011                     2010
Tangible assets:                                     (Dollars in thousands, except share and per share data)
Total assets                                   $        2,032,633       $        1,113,222       $          616,108
Less: intangible assets                                    32,772                    4,644                        -
Tangible assets                                $        1,999,861       $        1,108,578       $          616,108

Tangible common equity:
Total common equity                            $          255,041       $          190,054       $          177,101
Less: intangible assets                                    32,772                    4,644                        -
Tangible common equity                         $          222,269       $          185,410       $          177,101

Tangible common equity to tangible assets:
Tangible common equity                         $          222,269       $          185,410       $          177,101
Divided by: tangible assets                             1,999,861                1,108,578                  616,108
Tangible common equity to tangible assets                   11.11 %                  16.73 %                  28.75 %

Tangible book value per share:
Issued and outstanding shares                          44,575,853               32,643,627               28,051,098
Add: dilutive stock options                                19,640                        -                        -
Less: nondilutive restricted awards                      (568,260 )               (568,260 )                      -
Period end dilutive shares                             44,027,233               32,075,367               28,051,098

Tangible common equity                         $          222,269       $          185,410       $          177,101
Divided by: dilutive common shares
outstanding (1)                                        44,014,415               32,075,367               28,051,098
Tangible common book value per share           $             5.05       $             5.78       $             6.31

Adjusted allowance for loan losses:
Allowance for loan losses                      $           10,591       $           10,154       $           14,424
Plus: acquisition accounting net FMV
adjustments to acquired loans                              53,593                   35,146                        -
Adjusted allowance for loan losses             $           64,184       $           45,300       $           14,424
Divided by: total loans (excluding LHFS)                1,356,833                  758,822                  399,829
Adjusted allowance for loan losses to total
loans                                                        4.73 %                   5.97 %                   3.61 %

Adjusted net income (loss):
Pretax income (loss) (as reported)             $            6,649       $          (13,303 )     $          (12,897 )
Plus: merger-related expenses                               5,895                    3,812                        -
Less: gain on sale of securities                           (1,478 )                    (20 )                      -
Pretax income (loss)                                       11,066                   (9,511 )                (12,897 )
Tax expense (benefit)                                       3,558                   (3,604 )                 (5,038 )
Adjusted net income (loss)                                  7,508                   (5,907 )                 (7,859 )
Preferred dividends                                            51                        -                        -
Adjusted net income (loss) available to
common shareholders                            $            7,457       $           (5,907 )     $           (7,859 )

Adjusted net income (loss) available to
common shareholders per share                  $             0.21       $            (0.21 )     $            (0.58 )
Divided by: weighted average diluted shares            35,108,229               28,723,647               13,558,221

Adjusted noninterest income:
Noninterest income (as reported)               $           11,609       $            1,647       $              126
Less: gain on sale of securities                           (1,478 )                    (20 )                      -
Adjusted noninterest income                    $           10,131       $            1,627       $              126

Adjusted noninterest expense:
Noninterest expense (as reported)              $           54,261       $           24,960       $           11,053
Less: merger-related expenses                              (5,895 )                 (3,812 )                      -
Adjusted noninterest income                    $           48,366       $           21,148       $           11,053

(1) As contemplated during the Public Offering, the Company awarded certain performance-based restricted shares to officers and directors following the holding company reorganization. These 568,260 shares vest one-third each when the Company's stock price per share reaches the following performance thresholds for 30 consecutive trading days: (i) 125% of offer price ($8.13); (ii) 140% of offer price ($9.10); and (iii) 160% of offer price ($10.40). These anti-dilutive restricted shares are issued (and thereby have voting rights), but are not included in earnings per share or tangible book value per share calculations until they vest (and thereby have economic rights).


Results of Operations

Summary. The Company recorded net income of $4.3 million, or $0.12 per diluted share, for the year ended December 31, 2012, compared to a net loss of $8.4 million, or $(0.29) per diluted common share, for the year ended December 31, 2011 and a net loss of $7.9 million, or $(0.58) per diluted common share, for the year ended December 31, 2010.

Excluding merger-related expenses and gain on sale of securities, the Company reported net income available to common shareholders of $7.5 million, or $0.21 per share, for the year ended December 31, 2012 compared to a net loss of $5.9 million, or $(0.21) per share, for the year ended December 31, 2011. Merger-related expenses totaled $5.9 million in 2012 compared to $3.8 million in 2011, and gain on sale of securities totaled $1.5 million in 2012 compared to $20 thousand in 2011. Results for 2012 included three months of operations from the merger with Citizens South and a full year of operations from the merger . . .

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