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GRBS > SEC Filings for GRBS > Form 10-Q on 13-Aug-2013All Recent SEC Filings

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

Form 10-Q for GREER BANCSHARES INC


13-Aug-2013

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. In 2009 the Company recorded a full valuation allowance on its net deferred tax assets because of its preceding poor earnings history and the inability to reasonably predict future taxable income caused by the volatility in the loan portfolio. Because of substantial improvement in the Company's earnings and the quality of the Company's loan portfolio over the past seven fiscal quarters, the Company does not believe a valuation allowance is now required. The Company is three years cumulatively profitable and has been profitable for the last seven quarters. The Company anticipates that it will generate income before income taxes at a sufficient level in the future to fully utilize all of its net operating loss carry forwards; however, there can be no assurance to this effect, because of the risks described in Part I, Item 1A in the Company's Annual Report on Form 10-K for the 2012 calendar year, under the heading "Forward Looking and Cautionary Statements" in this report below and possibly other risks of which the Company is currently unaware.

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. Due to improved bank metrics and a reduction in the loan portfolio size, the bank determined that the loan loss allowance was overstated and reversed $1,700,000 of previous provisions during the second quarter of 2013. Management did not change the methodology used in determining the loan loss allowance. Management believes that the allowance for loan losses as of June 30, 2013 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/or insignificant 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 June 30, 2013 as compared to the quarter ended June 30, 2012 as well as results for the six months ended June 30, 2013 as compared to the six months ended June 30, 2012. 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 FHLB 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. There was no provision for loan losses during the quarters ended June 30, 2013 or June 30, 2012. (See "Provision for Loan Losses" for a detailed discussion of this process.) Due to improved bank metrics and a reduction in the loan portfolio size, the bank determined that the loan loss allowance was overstated and reversed $1,700,000 of previous provisions during the second quarter of 2013.

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 $7,761,000 available to common shareholders, or $3.12 per diluted common share, for the quarter ended June 30, 2013, compared to consolidated net income of $1,119,000, or $.45 per diluted common share, for the quarter ended June 30, 2012. The results for the second quarter of 2013 were positively impacted by the reversal of $1,700,000 in loan loss provision as well as the reversal of the deferred tax asset valuation allowance of $5,544,000. For the six months ended June 30, 2013, the Company reported consolidated net income of $8,402,000 attributed to common shareholders, or $3.38 per diluted common share, compared to a consolidated net income attributed to common shareholders of $2,786,000 or $1.12 per diluted common share for the six months ended June 30, 2012. The results for the first six months of 2013 were positively impacted by the non-cash reversal of $1,700,000 in loan loss provision as well as the non-cash reversal of the deferred tax asset valuation allowance of $5,544,000.


Interest Income, Interest Expense and Net Interest Income

The Company's total interest income for the quarter ended June 30, 2013 was $3,186,000, compared to $3,680,000 for the quarter ended June 30, 2012, a decrease of $494,000, or 13.4%. Total interest income for the six months ended June 30, 2013 was $6,459,000, compared to $7,568,000 for the six months ended June 30, 2012, a decrease of $1,109,000, or 14.7%. Interest and fees on loans is the largest component of total interest income and decreased $360,000, or 13.0% to $2,413,000 for the quarter ended June 30, 2013, compared to $2,773,000 for the quarter ended June 30, 2012 and to $4,962,000 for the six months ended June 30, 2013 compared to $5,802,000 for the six months ended June 30, 2012. The decrease in interest and fees on loans was primarily the result of reductions of $19,928,000 in average loan balances for the three months ended June 30, 2013, compared to the same period in 2012 and a reduction of $23,821,000 in average loan balances for the six months ended June 30, 2013 compared to the same period in 2012. The Company has intentionally decreased its loan portfolio in efforts to boost regulatory capital levels. Average yields on the Company's loan portfolio were 5.10% and 5.37% for the quarter ended June 30, 2013 and June 30, 2012, respectively, and 5.20% and 5.39% for the six months ended June 30, 2013 and June 30, 2012, respectively.

Interest income on investment securities decreased by $130,000 in the three month period ended June 30, 2013, compared to the three month period ended June 30, 2012. The decrease was due to a decrease in the tax equivalent investment yields from 2.78% to 2.32%. The average balance of investments increased slightly from $141,041,000 to $141,127,000 for the three month periods ended June 30, 2012 and June 30, 2013, respectively. The yield decline is primarily the result of falling market rates caused by the portfolio turnover, which was a result of the bank selling securities at a gain.

Interest income on investment securities decreased by $263,000 in the six month period ended June 30, 2013, compared to the six month period ended June 30, 2012. The decrease was due primarily to a decrease in investment yields from 2.90% to 2.26% for the six month periods ended June 30, 2013 and June 30, 2012, respectively, offset slightly by an increase in the average balance of investments from $136,013,000 to $139,724,000 for the periods ended June 30, 2012 and June 30, 2013, 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 at a gain and then reinvesting available funds.

The Company's total interest expense declined for the three months ended June 30, 2013 by $387,000 or 35.4% compared to the same period in 2012. The largest component of the Company's interest expense is interest expense on deposits. Deposit interest expense declined due to decreases in average interest rates from 0.85% to 0.50% for the three month periods ended June 30, 2012 and June 30, 2013, respectively, and a reduction of average interest bearing deposits of $24,214,000.

The Company's total interest expense declined for the six months ended June 30, 2013 by $791,000 or 35.3% compared to the same period in 2012. Deposit interest expense declined due to decreases in average interest rates from 0.87% to 0.54% for the six month periods ended June 30, 2012 and June 30, 2013, respectively, and a decrease in average interest bearing deposits of $24,788,000.

Interest on long term borrowings declined $143,000, or 25.2% and $311,000, or 26.8% for the three and six month periods ended June 30, 2013, respectively, compared to the same periods in 2012. The decline in long term interest expense was the result of decreases in average long term borrowings outstanding and the decrease in average yields on long term borrowings for the three and six months ended June 30, 2013 compared to the same periods in 2012. Average long term borrowings outstanding declined by $7,749,000 for the quarter ended June 30, 2013 compared to the same period in 2012. Average long term borrowings outstanding declined by $7,169,000 for the six months ended June 30, 2013 compared to the same period in 2012. Average rates on long term borrowings decreased to 2.76% from 3.29% for the three months ended June 30, 2013 compared to the same period in 2012. Average rates on long term borrowings decreased to 2.65% from 3.25% for the six months ended June 30, 2013 compared to the same period in 2012. The long term borrowing rate decrease for the three and six month periods ended June 30, 2013 compared to the three and six month periods ended June 30, 2012 was the result of the elimination of certain remaining high rate FHLB borrowings during 2012 due to factors noted above.

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 $107,000, or 4.1%, for the quarter ended June 30, 2013, compared to the same period in 2012. Net interest income before provision for loan losses decreased $318,000, or 6.0%, for the six months ended June 30, 2013, compared to the same period in 2012.

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 June 30, 2013. 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 quarters ended June 30, 2013 or June 30, 2012 or for the six months ended June 30, 2013 or June 30, 2012. The amount of provision is based on the results of the loan loss model. Due to improved bank metrics (historical loss calculations in particular) and a reduction in our loan portfolio size, there was a negative provision for the second quarter of 2013. The bank determined, based on the model, that the loan loss allowance was overstated and made a non-cash reversal of $1,700,000 of previous provisions. Non-performing assets have decreased from $13.6 million for the quarter ended June 30, 2012 to $7.1 million for the quarter ended June 30, 2013. Also, the bank experienced net recoveries during the three and six month periods ended June 30, 2013. See the discussion below under "Allowance for Loan Losses."

Noninterest Income

Noninterest income decreased $602,000 for the quarter ended June 30, 2013 compared to the quarter ended June 30, 2012. The decrease is primarily due to a decrease of $611,000 in securities gains. Noninterest income decreased $1,750,000 for the six months ended June 30, 2013 compared to the same period in 2012. The decrease is primarily due to a decrease of $1,792,000 in gains on sale of investment securities.

Noninterest Expenses

Total noninterest expenses decreased $139,000, or 5.7%, for the quarter ended June 30, 2013, to $2,311,000 compared to $2,450,000 for the quarter ended June 30, 2012. The primary cause of decreased noninterest expense for the three months ended June 30, 2013 relates to a decrease in OREO and foreclosure expenses. Salaries and employee benefits, the largest component of noninterest expenses, increased $53,000 for the three months ended June 30, 2013 compared to the same period in 2012. This is primarily due to lifting a wage freeze and re-establishing the Company's 401(k) match that was suspended as of January 1, 2011. Professional expenses and postage and supplies have all declined as the result of continued budget control. OREO and foreclosure expenses decreased $138,000 primarily as a result of reduced valuation adjustments. The three months ended June 30, 2012 had $165,000 in valuation adjustments compared to $97,000 in the three months ended June 30, 2013.

Total noninterest expenses decreased $514,000, or 9.9%, for the six months ended June 30, 2013, to $4,696,000 compared to $5,210,000 for the six months ended June 30, 2012. Salaries and employee benefits, the largest component of noninterest expenses, increased $35,000 for the six months ended June 30, 2013 compared to the same period in 2012. This is due to lifting the wage freeze and re-establishing the Company's 401(k) match that was suspended as of January 1, 2011. Professional expenses and postage and supplies and marketing expenses have all declined as the result of continued budget control. OREO and foreclosure expenses decreased $199,000 primarily as a result of an increase in net gain on sale of OREO. The six months ended June 30, 2012 had $5,000 in net gain on sale of OREO compared to $193,000 in the six months ended June 30, 2013. There were $141,000 of Federal Home Loan bank prepayment penalties in the six months ended June 30, 2012 that were incurred as part of security sales and balance sheet restructuring transactions. There were no Federal Home Loan bank prepayment penalties in the six months ended June 30, 2013. FDIC premiums have declined $177,000 due to the Bank's improved rating upon release from the Consent Order (and the Bank's placement under the MOU) combined with a decrease in asset size.


Income Tax Expense

The Company has a net operating loss carry-forward for federal tax purposes for the six months ended June 30, 2013 and June 30, 2012, but did incur federal alternative minimum tax for the six months ended June 30, 2013. Also, the Bank had state tax expense in the six months ended June 30, 2013 due to net income at the Bank level. See "Critical Accounting Policies - Income Taxes" and "Critical Accounting Policies - Deferred Tax Asset" above. In evaluating whether the full benefit of the net deferred tax asset will be realized, management considered both positive and negative evidence including recent earnings trends, projected earnings and asset quality. As of June 30, 2013, management concluded that the positive evidence outweighed the negative evidence in determining realization of any deferred tax temporary differences and reversed the valuation allowance in the amount of $5.5 million on its net deferred tax assets. This non-cash reversal of the deferred tax asset valuation allowance was reflective of sustained profitability and improved earnings that support the ability to utilize the deferred tax asset in the future. The Company is three years cumulatively profitable and has been profitable for the last seven quarters. The Bank is deemed to be "well capitalized" with Tier one leverage and Total risk based capital ratios of 10.57% and 16.77%, respectively. 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 establish a valuation allowance.

BALANCE SHEET REVIEW

Loans

Outstanding loans represented the largest component of earning assets at 54.5% of total earning assets as of June 30, 2013. Gross loans totaled $187,080,000 as of June 30, 2013, a decline of $9,389,000, or 4.8%, from gross loans of $196,469,000 as of December 31, 2012. 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 57.2% of the Company's loan portfolio as of June 30, 2013, 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 located in the Company's local market area.

Although our asset and credit quality trends continue to improve, management continues to work aggressively to identify and quantify potential losses and execute plans to reduce problem assets. The Company uses internal and external loan review analysis performed by loan officers, credit administration and an external loan review firm that require detailed, written summaries of the loans reviewed to determine risk rating, accrual status and collateral valuation.

Allowance for Loan Losses

The allowance for loan losses at June 30, 2013 was $2,916,000, or 1.56% of gross loans outstanding, compared to $4,429,000 or 2.25% of gross loans outstanding at December 31, 2012. The net decrease of 0.69% in the allowance ratio was a result of improved loan metrics, in particular, historical loan loss experience and net recoveries during 2013 that warranted a non-cash provision reversal of $1,700,000 during the second quarter of 2013. The allowance at June 30, 2013 included an allocation of $112,000 related to specifically identified impaired loans compared to an allocation of $114,000 related to specifically identified impaired loans at December 31, 2012.

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 June 30, 2013, the Company had $7,071,000 in non-performing assets, comprised of non-accruing loans of $3,619,000 and $3,452,000 in OREO. This compares to $8,641,000 in non-performing assets, comprised of $3,934,000 in non-accruing loans and $4,707,000 in OREO at December 31, 2012. Non-performing loans consisted of $3,490,000 in real estate loans, $111,000 in commercial loans and $18,000 in consumer installment loans at June 30, 2013. The nonperforming real estate loans have had appraisals within the past twelve months to support the loan balances.


The first six months of 2013 had a net recovery of charge-offs of $187,000. Net charge-offs for the first six months of 2012 were $432,000. The allowance for loan losses as a percentage of non-performing loans was 80.6% and 112.6% as of June 30, 2013 and December 31, 2012, respectively.

Troubled debt restructured loans ("TDRs"), which are included in the impaired loan totals, were $4,436,000 and $5,254,000 at June 30, 2013 and December 31, 2012, respectively. TDRs on non-accrual were $2,754,000 and $3,160,000 at June 30, 2013 and December 31, 2012, 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 . . .

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