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GRBS > SEC Filings for GRBS > Form 10-K on 19-Mar-2013All Recent SEC Filings

Show all filings for GREER BANCSHARES INC | Request a Trial to NEW EDGAR Online Pro

Form 10-K for GREER BANCSHARES INC


19-Mar-2013

Annual Report


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

Description of the Company's Business

Greer State Bank (the "Bank") was organized under a state banking charter in August 1988, and commenced operations on January 3, 1989. Greer Bancshares Incorporated is a South Carolina corporation formed in July 2001, primarily to hold all of the capital stock of the Bank. Greer Bancshares Incorporated and the Bank, its wholly-owned subsidiary, are herein collectively referred to as the "Company." Sometimes, Greer Bancshares Incorporated is also referred to as the "Company". In October 2004 and December 2006, Greer Capital Trust I and Greer Capital Trust II (the "Trusts") were formed, respectively. The Trusts were formed as part of the process of the issuance of trust preferred securities. The Bank engages in commercial and retail banking, emphasizing the needs of small to medium businesses, professional concerns and individuals, primarily in Greer and surrounding areas in the upstate of South Carolina. Greer Bancshares Incorporated currently engages in no business other than owning and managing the Bank. Greer Financial Services, a division of the Bank, provides financial management services and non-deposit product sales.


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 and Deferred Tax Asset

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 represents the estimated amount currently due from the federal government and is reported as a component of "other assets" in the consolidated balance sheet; 2) the deferred federal income tax asset or liability represents the estimated tax 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. Appropriate tax treatment is reviewed of all transactions taking into consideration statutory, judicial and regulatory guidance in the context of our tax positions. In addition, reliance is placed on various tax opinions, recent tax audits and historical experience.

Deferred Tax Asset - At December 31, 2012, the federal deferred tax asset was $6,004,000 with a valuation allowance of $5,691,000. The need for a valuation allowance is considered when it is determined that it is more likely than not that a deferred tax asset will not be realized. In making this determination, management considers all available evidence, including the existence of available reversing temporary differences, the ability to generate future taxable income and available tax planning strategies. In deciding whether a valuation allowance was required, management considered recent pretax losses as significant negative evidence over its ability to realize its net deferred tax assets.

It is possible that the Company's management may conclude in future periods that it may have the ability to generate income before 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 uncollectibility 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, 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 construction loans by either 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 other real estate owned 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 selling costs. While management uses the best information available at the time of the preparation of the financial statements in valuing the other real estate owned, it is possible that in future periods the Company will be required to recognize reductions in estimated fair values of these properties. Additional information about our other real estate owned, including our estimates of fair value as of December 31, 2012 and 2011 is included in Note 17 of our financial statements included in Item 8 below, which information is incorporated herein by reference.

Recent Developments

Consent Order

Effective March 1, 2011, the Bank entered into a Stipulation to the Issuance of a Consent Order (the "Stipulation") agreeing to the issuance of a Consent Order (the "Consent Order") with the FDIC and the Commissioner of Banking on behalf of the South Carolina Board of Financial Institutions (the "Commissioner"). The Consent Order replaced the previously disclosed Memorandum of Understanding effective September 8, 2010 with the FDIC and the Commissioner.

The Consent Order is based on findings of the FDIC and the Commissioner during their joint examination in August 2010 (the "Examination"). Since the completion of the Examination, our Board of Directors has aggressively taken an active role in working to address the findings contained in the Examination and to improve the condition of the Bank. Our Board and management proactively took steps to comply with the requirements of the Consent Order prior to its effectiveness, including the formation of a special Compliance Committee of nonemployee directors to assist our Board in overseeing compliance efforts. The initiatives put in place by our Board and management were expected to achieve, and as of December 31, 2012 have achieved, compliance with all of the requirements contained in the Consent Order.

The Consent Order requires the Bank to undertake a number of actions:

Our Board must enhance its supervision of the Bank's activities, and oversee the efforts of the Bank's management in complying with the Consent Order.

The Bank must develop and approve a written analysis and independent assessment of the Bank's management and staffing needs in order to assure that the Bank has and will retain qualified management.

The Bank must notify the FDIC and the Commissioner (collectively, the "Regulators") of the resignation or termination of any of the Bank's directors or senior executive officers and notify the Regulators and receive their approval prior to appointing any new such director or senior executive officer.

Within 150 days of March 1, 2011, the Bank must achieve and maintain Tier 1 capital at least equal to 8% of total assets and Total Risk-Based capital equal to at least 10% of total risk-weighted assets.

The Bank must submit to the Regulators a written capital plan detailing the steps it will take to achieve the capital requirements. Such capital plan must include a contingency plan to sell or merge the Bank in the event it fails to meet the capital requirements.

The Bank must adopt and implement a written plan addressing liquidity, contingency funding and asset liability management.

The Bank must charge off certain classified assets identified in the Examination.

The Bank must formulate a written plan to reduce the Bank's risk exposure in relationships with certain classified assets in excess of $500,000. Such plan must progressively effect the reduction of such classified assets over 180, 360, 540 and 720 days.

The Bank must generally refrain from extending additional credit to troubled borrowers.

The Bank must prepare a written strategic plan.

The Bank must revise and fully implement its written lending and collection policies.


The Bank must perform a risk segmentation analysis, and our Board must develop a plan to reduce any segment of the loan portfolio which the Regulators deem to be an undue concentration of credit.

Our Board must review the adequacy of the Banks' allowance for loan losses and establish a comprehensive policy for determining its adequacy.

The Bank must formulate and implement a written plan to improve and sustain Bank earnings, and annually revise such plan.

The Bank must develop and implement a written policy for managing interest rate risk, in compliance with regulatory requirements.

The Bank must correct all violations of regulations described in the Examination.

While the Consent Order is in effect, the Bank may not declare or pay dividends or bonuses without the prior written approval of the Regulators, nor make any distributions of interest, principal or other sums on subordinated debentures.

While the Consent Order is in effect, the Bank generally may not accept, renew or roll over any brokered deposits. The Bank must submit to the Regulators a written plan for eliminating its reliance on brokered deposits.

While the Consent Order is in effect, the Bank must limit asset growth to no more than 5% per calendar year.

The Bank must provide quarterly progress reports to the Regulators.

The plans, policies and procedures which the Bank is required to prepare under the Consent Order are generally subject to approval by the Regulators before implementation.

The Consent Order will remain in effect until modified or terminated by the FDIC and the Commissioner. Our Board and management are striving to cause the Bank to comply with the Consent Order. However, meeting some requirements may be difficult, and there can be no assurance that the Bank will be able to comply fully with all of the Consent Order's provisions. Failure to meet these requirements could result in additional regulatory action, which could lead to the Bank being taken into receivership by the FDIC.

A copy of the Stipulation and the Consent Order are attached collectively as Exhibit 10.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on March 7, 2011. The brief description of the material terms of the Stipulation and the Consent Order set forth above does not purport to be complete and is qualified by reference to the full text of the Stipulation and the Consent Order.

As of December 31, 2012, the Bank was compliant with all of the Consent Order requirements. The Tier One Capital Ratio was 9.08% and the Total Risk Based Capital Ratio was 15.14% as of December 31, 2012.

On July 7, 2011, the Company entered into a Written Agreement (the "Written Agreement") with the FRB. The Written Agreement is intended to enhance the ability of the Company to serve as a source of strength to the Bank. The Written Agreement's requirements are in addition to those of the Consent Order entered into by the Bank with the FDIC and the Commissioner.

Pursuant to the Written Agreement, the Company is, in general, required to:

take steps to ensure that the Bank complies with the Consent Order (described above);

not, without the prior written approval of the FRB, (i) declare or pay any dividends, (ii) receive dividends or any form of payment from the Bank representing a reduction in capital, (iii) make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities, (iv) incur, increase or guarantee any debt, or (v) purchase or redeem any shares of its stock;

within 60 days of July 7, 2011, submit to the FRB a written statement of planned sources and uses of cash (which the Company has timely submitted);

comply with notice provisions of laws and regulations regarding the appointment of any new directors or senior executive officers;

comply with certain banking laws and regulations restricting indemnification of and severance payments to executives and employees; and

submit quarterly progress reports to the FRB.

Given its strategy of seeking to improve the Company's and Bank's capital positions, as well as complying with the capital requirements and restrictions contained in the Consent Order, the Company has no plans to pay dividends or engage in any of the other restricted capital and financing activities described above. As previously disclosed, the Boards and management of the Company and the Bank have proactively taken steps to comply with the requirements of the Consent Order. The


Company and the Bank believe that these steps will help the Company and the Bank address the concerns underlying the Consent Order and the Written Agreement.

Management does not believe that the Written Agreement will have a significant impact on the Bank's lending and deposit operations, which will continue to be conducted in the usual and customary manner. As of December 31, 2012, the Company was compliant with all of the Written Agreement requirements.

Deferral of Preferred Dividends and Trust Preferred Interest

On January 3, 2011, the Company gave notice of its election pursuant to the terms of its two issues of trust preferred securities, to defer payments of interest on such securities beginning in January 2011. The outstanding trust preferred securities total $11.3 million. The Company is permitted to defer paying such interest for up to twenty consecutive quarters. As of December 31, 2012, the Company had accrued and owed a total of $608,000 of interest payments on the two junior subordinated debentures As a condition to deferring payments of interest, the Company is generally prohibited from paying any dividends on its capital stock until deferred interest has been paid. Accordingly, so long as trust preferred interest is deferred, the Company is prohibited from paying dividends on its common stock or the Company's preferred stock issued to the U.S. Treasury Department as part of the Troubled Assets Relief Program (the "TARP Preferred").

On January 6, 2011, the Company also gave notice to the U.S. Treasury Department that the Company is suspending the payment of regular quarterly cash dividends on the TARP Preferred. Dividends under the TARP Preferred cumulate and compound when not paid. As of December 31, 2012, the outstanding principal amount of the TARP Preferred was approximately $10.4 million. The Company's failure to pay a total of six such dividends, whether or not consecutive, gives the U.S. Treasury Department the right to elect two directors to the Company's Board of Directors. That right would continue until the Company pays all due but unpaid dividends. As of December 31, 2012 the Company has failed to pay eight such dividends. As a result, the U.S. Treasury Department has the right to elect two of the Company's directors; however, the U.S. Treasury Department has not acted upon their right to elect two directors. As of December 31, 2012 there was $1,089,300 in non-declared TARP dividends as well as $68,081 in declared but not paid TARP dividends. Also, the terms of the TARP Preferred prohibit the Company from paying any dividends on its common stock while payments on the TARP Preferred are in arrears.

On May 3, 2012, Treasury announced additional details on its strategy for winding down the remaining bank and bank holding company investments made through TARP, and one such strategy is utilizing an auction to sell pools of several recipient companies' TARP securities to third parties. Treasury has indicated that it expects a single winning bidder to purchase all of the TARP securities included in a pool. By letter dated as of June 19, 2012, Treasury informed the Company that Treasury is considering including the Company's TARP preferred stock as part of a series of pooled auctions. Treasury has also indicated that a TARP recipient may, with regulatory approval, opt out of the pool auction process and either make its own bid to repurchase all of its remaining TARP securities or designate a single outside investor (or single group of investors) to make such a bid. TARP recipients that received an extension of the original August 6, 2012 deadline (as the Company did) had until October 9, 2012 to submit a bid. The Company did not submit a bid. If the Company's TARP preferred stock is sold by Treasury to a third party investor, the Company's understanding is that a purchaser of the Company's TARP preferred stock would assume the right, which Treasury currently possesses, to elect two directors to the Company's Board of Directors until the Company pays all due but unpaid quarterly dividends on the TARP preferred stock.

The decision to elect deferral of interest payments under the Company's trust preferred securities and to suspend dividend payments on the TARP Preferred was made in consultation with the Federal Reserve Bank of Richmond.

Results of Operations

This discussion and analysis is intended to assist the reader in understanding the financial condition and results of operations of the Company and its wholly-owned subsidiary, the Bank. The commentary should be read in conjunction with the consolidated financial statements and the related notes and the other statistical information in this report.

The following discussion describes our results of operations for 2012 as compared to 2011 and 2011 compared to 2010. The Company's financial condition as of December 31, 2012 as compared to December 31, 2011 is also analyzed. Like most community banks, the Bank derives most of its income from interest received on loans and investments. The primary source of funds for making these loans and investments is deposits, on which interest is paid on 83 percent of the accounts. The Bank also utilizes Federal Home Loan Bank ("FHLB") advances, the Federal Reserve discount window, federal funds purchased and repurchase agreements for funding loans and investments. One of the key measures of success is net interest margin, 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 other borrowings as a percentage of interest-earning assets. Another key measure is the spread between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities.

A number of tables have been included to assist in the description of these measures. For example, the "Average Balances" table shows the average balances during 2012, 2011 and 2010 of each category of assets and liabilities, as well as the yield earned or the rate paid with respect to each category. A review of this table shows that loans typically provide higher interest yields than do other types of interest earning assets, resulting in management's intent to channel a substantial percentage of funding sources into the loan portfolio. Similarly, the "Analysis of Changes in Net Interest Income" table demonstrates the impact of changing interest rates and the changing volume of assets and liabilities during the years shown. Finally, a number of tables have been included that provide detail about the Company's investment securities, loans, deposits and other borrowings.

There are risks inherent in all loans. Therefore, an allowance for loan losses is maintained to absorb inherent probable losses on existing loans that may become uncollectible. The allowance is established and maintained by charging a provision for loan losses against operating earnings. A detailed discussion of this process is included, as well as tables, describing the allowance for loan losses.

In addition to earning interest on loans and investments, income is earned through fees and other charges collected for services provided to customers. Various components of this noninterest income, as well as noninterest expense, are described in the following discussion.

The following discussion and analysis also identifies significant factors that have affected the financial position and operating results during the periods included in the accompanying financial statements. Therefore, this discussion and analysis should be read in conjunction with the consolidated financial statements and the related notes and the other statistical information also included in this report. All dollars are rounded to the nearest thousand.

Year ended December 31, 2012 compared with year ended December 31, 2011

The Company recorded net income attributable to common shareholders of $4,186,000 for the year ended December 31, 2012, compared to a net loss attributable to common shareholders of $2,794,000 for the year ended December 31, 2011. Income per diluted common share for the year ended December 31, 2012 was $1.68, compared to loss per diluted common share of $1.12 for the year ended December 31, 2011. The net income in 2012 was aided significantly by a net gain on investment transactions of $2,147,000, which included $2,789,000 of gains on securities offset with $642,000 of FHLB prepayment penalties. These gains were the result of market conditions in 2012 and do not necessarily indicate a trend that will continue into 2013 or beyond. The Company also did not incur any loan loss provision in 2012. This was due to a reduction in the size of the loan portfolio along with significant reductions in non-accrual loans, impaired loans and delinquent loans. The net loss in 2011 was due primarily to the loan loss provision, real estate owned expenses and FDIC deposit insurance assessments, partially offset by gain on sale of investment securities. Net interest income decreased to $10,438,000 for the year ended December 31, 2012. Noninterest income increased $1,527,000 or 39.3%, in 2012 compared to 2011 primarily as a result of increased gains on sale of investments of $1,709,000. Noninterest expenses decreased by $2,532,000, or 19.1%, in 2012 compared to 2011 primarily as the result of a decrease in real estate owned expenses.

Year ended December 31, 2011 compared with year ended December 31, 2010

The Company recorded a net loss attributable to common shareholders of $2,794,000 for the year ended December 31, 2011, compared to a net loss attributable to common shareholders of $7,938,000 for the year ended December 31, 2010. The loss per diluted common share for the year ended December 31, 2011 was $1.12, compared to loss per diluted common share of $3.19 for the year ended December 31, 2010. The net loss in 2011 was due primarily to the loan loss provision, real estate owned expenses and FDIC deposit insurance assessments, partially offset by gain on sale of investment securities. Net interest income decreased slightly to $10,949,000 for the year ended December 31, 2011. Noninterest income decreased $1,352,000 or 25.8%, in 2011 compared to 2010 primarily as a result of reduced gains on sale of investments of $1,129,000. Noninterest expenses increased slightly by $459,000, or 3.6%, in 2011 compared to 2010 primarily as the result of an increase in professional fees and FDIC insurance assessments.

Net Interest Income

Net interest income, the difference between interest earned and interest paid, is the largest component of the Company's earnings. Therefore, changes in that area have a significant impact on net income. Variations in the volume and mix of assets and liabilities and their relative sensitivity to interest rate movements determine changes in net interest income. Interest rate spread


and net interest margin are two significant elements in analyzing net interest income. Interest rate spread is the difference between the yield on average earning assets and the rate on average interest bearing liabilities. Net interest margin is calculated as net interest income divided by average earning assets.

Net interest income decreased to $10,438,000 for the year ended December 31, 2012 primarily as the result of decreases in the volume of interest earning assets. The Bank's average earning assets decreased by $43.2 million, or 10.9%, during 2012. This reduction in earning assets resulted from our intentional restructuring of our balance sheet that was intended to increase our capital ratios. Interest income on earning assets decreased by $2,745,000, or 15.9%. Interest income was also negatively impacted by foregone interest on non-accrual loans. While the foregone interest reduced net interest income by $131,000 in 2012, this was actually an improvement over the 2011 amount of foregone interest of $705,000. The Bank's interest bearing liabilities decreased, and interest expense declined by $2,234,000, or 35.7% compared to 2011. The yield on average interest earning assets declined by 32 basis points in 2012. However, the yield paid on interest bearing liabilities decreased by 44 basis points. The decline . . .

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