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GRBS > SEC Filings for GRBS > Form 10-K on 18-Mar-2014All Recent SEC Filings

Show all filings for GREER BANCSHARES INC

Form 10-K for GREER BANCSHARES INC


18-Mar-2014

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; and 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 of all transactions is reviewed 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, 2013, our federal deferred tax asset was $6,628,000 with no valuation allowance. 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 nine 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 nine 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.

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, 2013 and 2012 is included in Note 17 of our financial statements included in Item 8 below, which information is incorporated herein by reference.

Recent Developments

Memorandum of Understanding

On March 1, 2011, the Bank entered into the Consent Order with the FDIC and the S.C. Bank Board. The Consent Order required the Bank to take specific steps regarding, among other things, its management, capital levels, asset quality, lending practices, liquidity and profitability in order to improve the safety and soundness of the Bank's operations, each as described and set forth in the Consent Order.


As of March 20, 2013, the FDIC and S.C. Bank Board terminated the Consent Order and replaced it with the Memorandum of Understanding ("FDIC MOU"), which became effective on January 31, 2013. The FDIC MOU is based on the findings of the FDIC during their on-site examination of the Bank as of October 15, 2012. The FDIC MOU is a step down in corrective action requirements as compared to the Consent Order. The FDIC MOU requires the Bank, among other things, to (i) prepare and submit annual, comprehensive budgets; (ii) maintain a minimum 8% Tier one leverage capital ratio and a minimum 10% Total Risk based capital ratio; (iii) take various specified actions to continue to reduce classified assets; (iv) obtain the written consent of its supervisory authorities prior to paying any cash dividends; and (v) submit periodic reports to the FDIC regarding various aspects of the foregoing actions. The minimum capital ratios established by the FDIC in the FDIC MOU are higher than the minimum and well-capitalized ratios generally applicable to all banks. However, the Bank will be deemed "well-capitalized" as long as it maintains its capital over the above noted required capital levels. As of December 31, 2013, the Bank's Tier One Capital Ratio was 10.78% and Total Risk Based Capital Ratio was 17.61%, thus exceeding the levels required by the FDIC MOU. In addition, as of December 31, 2013, the Bank was in compliance with all of the FDIC MOU requirements.

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.

A copy of the FDIC MOU is attached as exhibit 10.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on March 25, 2013. The brief description of the material terms of the FDIC MOU set forth above does not purport to be complete and is qualified by reference to the full text of the FDIC MOU.

On July 7, 2011, the Company entered into the Written Agreement with the FRB. The Written Agreement was intended to enhance the ability of the Company to serve as a source of strength to the Bank. The Written Agreement's requirements were in addition to those of the Bank's Consent Order (which, as discussed above, has been terminated and replaced with the FDIC MOU) and required the Company to take specific steps regarding, among other things, compliance with the supervisory actions of its regulators, appointment of directors and senior executive officers, indemnification and severance payments to executive officers and employees, payment of debt or dividends and quarterly reporting.

As of May 3, 2013, as a result of the steps the Company took in complying with the Written Agreement and improvement in the overall condition of the Company, the FRB terminated the Written Agreement and replaced it with the FRB MOU, which became effective May 29, 2013, after approval by the Company's Board of Directors and upon final execution by the FRB. The FRB MOU is a step down in corrective action requirements as compared to the Written Agreement and reflects an improvement in the overall condition of the Company from "troubled" to "less than satisfactory". The FRB MOU requires the Company, among other things, to (i) preserve its cash; (ii) obtain the written consent of its supervisory authorities prior to paying any dividends with respect to its common or preferred stock or trust preferred securities, purchasing or redeeming any shares of its stock or incurring, increasing or guaranteeing any debt; and (iii) submit quarterly reports to the FRB regarding the Company's actions to comply with the requirements of the FRB MOU. As of December 31, 2013 the Company was in compliance with all of the FRB MOU requirements.

Given its strategy of seeking to improve the Company's and Bank's capital positions, as well as the capital requirements and restrictions contained in the FRB MOU, the Company has no plans to pay dividends or engage in any of the other restricted capital and financing activities described above.

Management does not believe that the FRB MOU 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.

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, 2013, the Company had accrued and owed a total of $885,000 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 accumulate and compound when not paid. As of December 31, 2013, the outstanding principal amount of the TARP Preferred was approximately $10.5 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, 2013 the Company has failed to pay twelve 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, 2013 there was $1,772,000 in non-declared TARP dividends and the related accrued interest 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, the U.S. 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. The U.S. 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, the U.S. Treasury informed the Company that the U.S. Treasury was considering including the Company's TARP preferred stock as part of a series of pooled auctions. The U.S. 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 at that time. By letter dated as of January 18, 2013, the U.S. Treasury informed the Company that it was extending the opt-out process and that the Company had until April 30, 2013 to submit a bid. The Company submitted its own bid to repurchase all its outstanding TARP securities on April 18, 2013, but subsequently withdrew its bid. If the Company's TARP preferred stock is sold by the U.S. 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 the U.S. 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 Company is continuing to explore options for eliminating some or all of the TARP Preferred, including but not limited to options for raising capital to finance the purchase and retirement of the TARP Preferred.

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 2013 as compared to 2012 and 2012 compared to 2011. The Company's financial condition as of December 31, 2013 as compared to December 31, 2012 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 85 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 2013, 2012 and 2011 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, 2013 compared with year ended December 31, 2012

The Company recorded net income attributable to common shareholders of $8,209,000 for the year ended December 31, 2013, compared to net income attributable to common shareholders of $4,186,000 for the year ended December 31, 2012. Income per diluted common share for the year ended December 31, 2013 was $3.30, compared to income per diluted common share of $1.68 for the year ended December 31, 2012. The net income in 2013 was aided significantly by a credit to the loan loss provision for $1,700,000, as well as a net tax benefit of $3,801,000. The net tax benefit was a result of $1,890,000 in taxes being offset by a non-cash reversal of the deferred tax asset valuation allowance of $5,691,000. The non-cash reversal of the loan loss provision was reflective of a reduced loan portfolio size and improved loan portfolio credit quality metrics. The 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 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 did not necessarily indicate a trend that continued. Net interest income decreased to $10,223,000 for the year ended December 31, 2013 compared to the year ended December 31, 2012. Noninterest income decreased $2,693,000 or 49.8%, in 2013 compared to 2012 primarily as a result of decreased gains on sale of investments of $2,669,000. Noninterest expenses decreased by $1,310,000, or 24.2%, in 2013 compared to 2012 primarily as the result of a decrease in real estate owned expenses and FDIC insurance assessments.

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 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 $10,505,000 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 $2,533,000, or 19.0%, in 2012 compared to 2011 primarily as the result of a decrease in real estate owned expenses.

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 $10,223,000 for the year ended December 31, 2013 compared to 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 $14.6 million, or 4.1%, during 2013. 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 $1,440,000, or 10.0%. Interest income was also negatively impacted by foregone interest on non-accrual loans. Foregone interest reduced net interest income by $163,000 in 2013 which was a slight increase over the 2012 amount of foregone interest of $131,000. The Bank's interest bearing liabilities decreased, and interest expense declined by $1,158,000, or 29.2% compared to 2012. The yield on average interest earning assets declined by 28 basis points in 2013. However, the yield paid on interest bearing liabilities decreased by 31 basis points. The decline in interest expense, while offset by a decline in interest income, resulted in a higher net interest spread and net interest yield, and was primarily the result of lower market interest rates in 2013.

Net interest income decreased to $10,505,000 for the year ended December 31, 2012 compared to the year ended December 31, 2011 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 in 2012 by $2,233,000, or 36.0% compared to 2011. The yield on average interest earning assets declined by 32 basis points in 2012 compared to 2011. However, the yield paid on interest bearing liabilities decreased by 44 basis points during the same period. The decline in interest expense, while offset by a decline in interest income, resulted in a higher net interest spread and net interest yield, and was primarily the result of lower market interest rates in 2012.


The following table sets forth for the periods indicated, the weighted-average yields earned, the weighted-average yields paid, the net interest spread and the net interest margin on earning assets. The table also indicates the average . . .

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