Attached files

file filename
EX-32 - CERTIFICATIONS PURSUANT TO SECTION 906 - PALMETTO BANCSHARES INCdex32.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 - PALMETTO BANCSHARES INCdex311.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 - PALMETTO BANCSHARES INCdex312.htm
Table of Contents

 

 

U. S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 0-26016

PALMETTO BANCSHARES, INC.

(Exact name of registrant as specified in its charter)

 

South Carolina   74-2235055
(State or other jurisdiction of incorporation or organization)   (IRS Employer Identification No.)
306 East North Street, Greenville, South Carolina   29601
(Address of principal executive offices)   (Zip Code)

(800) 725–2265

(Registrant’s telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨    Smaller reporting company  ¨

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at July 30, 2010

Common stock, $5.00 par value   6,495,130

 

 

 


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Table of Contents

 

               Page

PART I - FINANCIAL INFORMATION

   1
   Item 1.   

Financial Statements

   1
   Item 2.   

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   27
   Item 3.   

Quantitative and Qualitative Disclosures about Market Risk

   71
   Item 4.   

Controls and Procedures

   71

PART II - OTHER INFORMATION

   73
   Item 1.   

Legal Proceedings

   73
   Item 1A.   

Risk Factors

   73
   Item 2.   

Unregistered Sales of Equity Securities and Use of Proceeds

   73
   Item 3.   

Defaults Upon Senior Securities

   74
   Item 4.   

(Removed and Reserved)

   74
   Item 5.   

Other Information

   74
   Item 6.   

Exhibits

   74

SIGNATURES

   75


Table of Contents

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(dollars in thousands, except per share data)

 

     June 30,
2010
    December 31,
2009
 
     (unaudited)        

Assets

    

Cash and cash equivalents

    

Cash and due from banks

   $ 236,029      $ 188,084   
                

Total cash and cash equivalents

     236,029        188,084   

Federal Home Loan Bank (“FHLB”) stock, at cost

     7,010        7,010   

Investment securities available for sale, at fair value

     112,316        119,986   

Mortgage loans held for sale

     1,898        3,884   

Loans, gross

     967,244        1,040,312   

Less: allowance for loan losses

     (28,383     (24,079
                

Loans, net

     938,861        1,016,233   

Premises and equipment, net

     29,344        29,605   

Goodwill, net

     3,691        3,691   

Accrued interest receivable

     4,222        4,322   

Real estate acquired in settlement of loans

     26,521        27,826   

Income tax refund receivable

     4,721        20,869   

Other

     23,308        14,440   
                

Total assets

   $ 1,387,921      $ 1,435,950   
                

Liabilities and shareholders’ equity

    

Liabilities

    

Deposits

    

Noninterest-bearing

   $ 143,223      $ 142,609   

Interest-bearing

     1,048,152        1,072,305   
                

Total deposits

     1,191,375        1,214,914   

Retail repurchase agreements

     24,674        15,545   

Commercial paper (Master notes)

     —          19,061   

FHLB borrowings

     96,000        101,000   

Convertible debt

     380        —     

Accrued interest payable

     1,695        2,020   

Other

     11,154        8,395   
                

Total liabilities

     1,325,278        1,360,935   
                

Shareholders’ equity

    

Preferred stock - par value $0.01 per share; authorized 2,500,000 at both June 30, 2010 and December 31, 2009; none issued and outstanding at both June 30, 2010 and December 31, 2009

     —          —     

Common stock - par value $5.00 per share; authorized 25,000,000 shares at both June 30, 2010 and December 31, 2009; 6,495,130 issued and outstanding at both June 30, 2010 and December 31, 2009

     32,309        32,282   

Capital surplus

     2,758        2,599   

Retained earnings

     33,269        47,094   

Accumulated other comprehensive loss, net of tax

     (5,693     (6,960
                

Total shareholders’ equity

     62,643        75,015   
                

Total liabilities and shareholders’ equity

   $ 1,387,921      $ 1,435,950   
                

See Notes to Consolidated Financial Statements

 

1


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

(dollars in thousands, except per share data) (unaudited)

 

     For the three month  periods
ended June 30,
 
     2010     2009  

Interest income

    

Interest earned on cash and cash equivalents

   $ 88      $ 32   

Dividends paid on FHLB stock

     5        —     

Interest earned on investment securities available for sale

    

U.S. Treasury and federal agencies (taxable)

     7        —     

State and municipal (nontaxable)

     364        410   

Collateralized mortgage obligations (taxable)

     276        823   

Other mortgage-backed (taxable)

     139        248   

Interest and fees earned on loans

     13,571        14,377   
                

Total interest income

     14,450        15,890   

Interest expense

    

Interest paid on deposits

     3,274        5,203   

Interest paid on retail repurchase agreements

     13        14   

Interest paid on commercial paper

     11        14   

Interest paid on other short-term borrowings

     —          11   

Interest paid on FHLB borrowings

     408        380   

Other

     10        —     
                

Total interest expense

     3,716        5,622   
                

Net interest income

     10,734        10,268   

Provision for loan losses

     12,750        30,000   
                

Net interest expense after provision for loan losses

     (2,016     (19,732
                

Noninterest income

    

Service charges on deposit accounts, net

     2,027        2,073   

Fees for trust and investment management and brokerage services

     735        576   

Mortgage-banking

     377        1,244   

Automatic teller machine

     321        335   

Merchant services

     101        273   

Other

     500        602   
                

Total noninterest income

     4,061        5,103   

Noninterest expense

    

Salaries and other personnel

     6,302        6,215   

Occupancy

     1,148        1,155   

Furniture and equipment

     927        892   

Loss on disposition of premises and equipment

     3        21   

Federal Deposit Insurance Corporation (“FDIC”) deposit insurance assessment

     981        1,372   

Mortgage-servicing rights portfolio amortization and impairment

     197        336   

Marketing

     450        316   

Real estate acquired in settlement of loans writedowns and expenses

     2,550        45   

Other

     2,813        2,791   
                

Total noninterest expense

     15,371        13,143   
                

Net loss before benefit for income taxes

     (13,326     (27,772

Benefit for income taxes

     (4,793     (9,921
                

Net loss

   $ (8,533   $ (17,851
                

Common and per share data

    

Net loss - basic

   $ (1.32   $ (2.77

Net loss - diluted

     (1.32     (2.77

Cash dividends

     —          —     

Book value

     9.64        15.45   

Weighted average common shares outstanding - basic

     6,455,598        6,450,090   

Weighted average common shares outstanding - diluted

     6,455,598        6,450,090   

See Notes to Consolidated Financial Statements

 

2


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

(dollars in thousands, except per share data) (unaudited)

 

     For the six month periods
ended June 30,
 
     2010     2009  

Interest income

    

Interest earned on cash and cash equivalents

   $ 155      $ 38   

Dividends paid on FHLB stock

     9        —     

Interest earned on investment securities available for sale

    

U.S. Treasury and federal agencies (taxable)

     14        —     

State and municipal (nontaxable)

     749        839   

Collateralized mortgage obligations (taxable)

     889        1,664   

Other mortgage-backed (taxable)

     337        511   

Interest and fees earned on loans

     27,176        30,404   
                

Total interest income

     29,329        33,456   

Interest expense

    

Interest paid on deposits

     6,837        9,915   

Interest paid on retail repurchase agreements

     27        27   

Interest paid on commercial paper

     21        29   

Interest paid on other short-term borrowings

     —          30   

Interest paid on FHLB borrowings

     901        809   

Other

     10        —     
                

Total interest expense

     7,796        10,810   
                

Net interest income

     21,533        22,646   

Provision for loan losses

     23,500        32,175   
                

Net interest expense after provision for loan losses

     (1,967     (9,529
                

Noninterest income

    

Service charges on deposit accounts, net

     3,977        3,956   

Fees for trust and investment management and brokerage services

     1,386        1,110   

Mortgage-banking

     997        2,110   

Automatic teller machine

     624        635   

Merchant services

     895        551   

Investment securities gains

     8        2   

Other

     1,114        1,170   
                

Total noninterest income

     9,001        9,534   

Noninterest expense

    

Salaries and other personnel

     12,439        12,134   

Occupancy

     2,319        2,071   

Furniture and equipment

     1,894        1,775   

Loss on disposition of premises and equipment

     8        76   

FDIC deposit insurance assessment

     1,696        1,826   

Mortgage-servicing rights portfolio amortization and impairment

     388        750   

Marketing

     745        685   

Real estate acquired in settlement of loans writedowns and expenses

     3,562        74   

Other

     5,643        5,269   
                

Total noninterest expense

     28,694        24,660   
                

Net loss before benefit for income taxes

     (21,660     (24,655

Benefit for income taxes

     (7,835     (8,798
                

Net loss

   $ (13,825   $ (15,857
                

Common and per share data

    

Net loss - basic

   $ (2.14   $ (2.46

Net loss - diluted

     (2.14     (2.46

Cash dividends

     —          0.06   

Book value

     9.64        15.45   

Weighted average common shares outstanding - basic

     6,455,598        6,449,383   

Weighted average common shares outstanding - diluted

     6,455,598        6,449,383   

See Notes to Consolidated Financial Statements

 

3


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss)

(dollars in thousands, except per share data) (unaudited)

 

     Shares of
common
stock
   Common
stock
   Capital
surplus
   Retained
earnings
    Accumulated
other
comprehensive
income (loss), net
    Total  

Balance at December 31, 2008

   6,446,090    $ 32,230    $ 2,095    $ 87,568      $ (6,117   $ 115,776   

Net loss

              (15,857       (15,857

Other comprehensive income (loss), net of tax

               

Investment securities available for sale

               

Change in unrealized position during the period, net of tax impact of $122

                199     

Reclassification adjustment included in net income, net of tax impact of $1

                (1  
                     

Net unrealized gain on investment securities available for sale

                  198   
                     

Comprehensive loss

                  (15,659

Cash dividend declared and paid ($0.06 per share)

              (389       (389

Compensation expense related to stock option plan

           31          31   

Excess tax benefit from equity-based awards

           107          107   

Common stock issued pursuant to stock option plan

   4,000      20      86          106   

Common stock issued pursuant to restricted stock plan

   27,540      14      102          116   
                                           

Balance at June 30, 2009

   6,477,630    $ 32,264    $ 2,421    $ 71,322      $ (5,919   $ 100,088   
                                           

Balance at December 31, 2009

   6,495,130    $ 32,282    $ 2,599    $ 47,094      $ (6,960   $ 75,015   

Net loss

              (13,825       (13,825

Other comprehensive income (loss), net of tax

               

Investment securities available for sale

               

Change in unrealized position during the period, net of tax impact of $778

                1,272     

Reclassification adjustment included in net income, net of tax impact of $3

                (5  
                     

Net unrealized gain on investment securities available for sale

                  1,267   
                     

Comprehensive loss

                  (12,558

Cash dividend declared and paid ($0.00 per share)

              —            —     

Compensation expense related to stock option plan

           15          15   

Common stock issued pursuant to restricted stock plan

   —        27      144          171   
                                           

Balance at June 30, 2010

   6,495,130    $ 32,309    $ 2,758    $ 33,269      $ (5,693   $ 62,643   
                                           

See Notes to Consolidated Financial Statements

 

4


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(in thousands) (unaudited)

 

     For the six month
periods ended June 30,
 
      2010     2009  

OPERATING ACTIVITIES

    

Net loss

   $ (13,825   $ (15,857

Adjustments to reconcile net loss to net cash provided by operating activities

    

Depreciation

     1,067        1,093   

Amortization of unearned discounts / premiums on investment securities available for sale, net

     367        11   

Provision for loan losses

     23,500        32,175   

Gains on sales of mortgage loans held for sale, net

     (501     (1,075

Loss on disposition of premises and equipment

     8        76   

Writedowns, gains, and losses on real estate acquired in settlement of loans

     3,101        42   

Investment securities gains

     (8     (2

Originations of mortgage loans held for sale

     (25,051     (100,862

Proceeds from sale of mortgage loans held for sale

     27,538        97,032   

Compensation expense related to stock options granted

     15        31   

Income tax benefits from exercises of nonqualified stock options in excess of amount previously provided

     —          107   

Decrease (increase) in other assets, net

     7,380        (6,561

Increase (decrease) in other liabilities, net

     2,039        (4,588
                

Net cash provided by operating activities

     25,630        1,622   
                

INVESTING ACTIVITIES

    

Proceeds from sales of securities available for sale

     40,191        2   

Proceeds from maturities of investment securities available for sale

     27,284        3,308   

Purchases of investment securities available for sale

     (64,555     (1,494

Repayments on investment securities available for sale

     6,433        10,743   

Purchases of FHLB stock

     —          (1,592

Redemptions of FHLB stock

     —          2,003   

Decrease (increase) in loans, net

     45,775        (229

Proceeds on sale of real estate acquired in settlement of loans

     6,301        288   

Proceeds on sale of premises and equipment held for sale

     308        1,643   

Purchases of premises and equipment, net

     (1,122     (4,416
                

Net cash provided by investing activities

     60,615        10,256   
                

CASH FLOW FROM FINANCING ACTIVITIES

    

Increase (decrease) in transaction, money market, and savings deposit accounts, net

     18,585        (19,630

Increase (decrease) in time deposit accounts, net

     (42,124     178,152   

Increase in retail repurchase agreements, net

     9,129        7,563   

Decrease in commercial paper, net

     (19,061     (6,149

Decrease in other short-term borrowings

     —          (79,785

Proceeds from FHLB borrowings

     —          30,000   

Repayment of FHLB borrowings

     (5,000     —     

Other common stock activity

     171        222   

Cash dividends paid on common stock

     —          (389
                

Net cash provided by (used in) financing activities

     (38,300     109,984   
                

Net change in cash and cash equivalents

     47,945        121,862   

Cash and cash equivalents, beginning of period

     188,084        29,305   
                

Cash and cash equivalents, end of period

   $ 236,029      $ 151,167   
                

Supplemental cash flow disclosures

    

Cash paid (received) during the period for:

    

Interest expense

   $ 8,121      $ 10,612   
                

Income taxes paid (refunds received, net)

     (20,272     2,880   
                

Significant noncash activities

    

Net unrealized gain on investment securities available for sale, net of tax

   $ 1,267      $ 198   
                

Loans transferred to real estate acquired in settlement of loans, at fair value

     8,097        10,987   
                

See Notes to Consolidated Financial Statements

 

5


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements

 

1. Summary of Significant Accounting Policies

Nature of Operations

Palmetto Bancshares, Inc. (the “Company,” which may be referred to as “we,” “us,” or “our”) is a regional bank holding company organized in 1982 under the laws of South Carolina and is headquartered in Greenville, South Carolina. Through the Company’s subsidiary, The Palmetto Bank (the “Bank”), which began operations in 1904, and the Bank’s wholly-owned subsidiary, Palmetto Capital, we provide a broad array of commercial banking, consumer banking, trust and investment management, and brokerage services throughout our primary market area of northwest South Carolina.

Principles of Consolidation / Basis of Presentation

The accompanying Consolidated Financial Statements include the accounts of the Company, which includes our wholly-owned subsidiary, the Bank, and the Bank’s wholly-owned subsidiary, Palmetto Capital, and other subsidiaries of the Bank. In management’s opinion, all significant intercompany accounts and transactions have been eliminated in consolidation, and all adjustments necessary for a fair presentation of the financial condition and results of operations for periods presented have been included. Any such adjustments are of a normal and recurring nature. Assets held by the Company or its subsidiary in a fiduciary or agency capacity for customers are not included in the Company’s Consolidated Financial Statements because those items do not represent assets of the Company or its subsidiary. The accounting and financial reporting policies of the Company conform, in all material respects, to accounting principles generally accepted in the United States of America (“GAAP”) and to general practices within the financial services industry.

The Consolidated Financial Statements as of and for the three and six month periods ended June 30, 2010 and 2009 contained in this Quarterly Report on Form 10-Q have not been audited by our independent registered public accounting firm. The Consolidated Financial Statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (the “SEC”). Accordingly, the Consolidated Financial Statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the Consolidated Financial Statements, and notes thereto, for the year ended December 31, 2009, included in our Annual Report on Form 10-K.

Subsequent Events

We have evaluated the effects of subsequent events that have occurred subsequent to the period ended June 30, 2010. All material events that require recognition in the accompanying Consolidated Financial Statements or disclosure in the Notes to Consolidated Financial Statements have been included herein.

Business Segments

Operating segments are components of an enterprise about which separate financial information is available that are evaluated regularly by the chief operating decision makers in deciding how to allocate resources and assess performance. As of and since June 30, 2010, we have made no changes to our determination in the Annual Report on Form 10-K for the year ended December 31, 2009 that we had one reportable operating segment, banking.

Use of Estimates

In preparing our Consolidated Financial Statements, the Company’s management makes estimates and assumptions that impact the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities as of the date of the Consolidated Financial Statements for the years presented. Actual results could differ from these estimates and assumptions. Therefore, the results of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results of operations that may be expected in future periods.

 

6


Table of Contents

Reclassifications

Certain amounts previously presented in our Consolidated Financial Statements for prior periods have been reclassified to conform to current classifications. All such reclassifications had no impact on the prior periods’ net loss or shareholders’ equity as previously reported.

Risk and Uncertainties

In the normal course of business, the Company encounters two significant types of risk: economic and regulatory. There are three main components of economic risk: credit risk, market risk, and concentration of credit risk. Credit risk is the risk of default on the Company’s loan portfolio that results from borrowers’ inability or unwillingness to make contractually required payments. Market risk includes primarily interest rate risk. The Company is exposed to interest rate risk to the degree that our interest-bearing liabilities mature or reprice at different speeds, or different bases, than our interest-earning assets. Market risk also reflects the risk of declines in the valuation of assets and liabilities and in the value of the collateral underlying loans and the value of real estate held by the Company. Concentration of credit risk refers to the risk that, if the Company extends a significant portion of our total outstanding credit to borrowers in a specific geographical area or industry or on the security of a specific form of collateral, the Company may experience disproportionately high levels of defaults and losses if those borrowers, or the value of such type of collateral, are adversely impacted by economic or other factors that are particularly applicable to such borrowers or collateral. Concentration of credit risk is also similarly applicable to the investment securities portfolio.

The Bank is subject to the regulations of various government agencies. These regulations may change significantly from period to period. The Bank also undergoes periodic examinations by regulatory agencies, which may subject the Bank to changes with respect to asset valuations, amount of required allowance for loan losses, lending requirements, capital levels, or operating restrictions.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Recently Adopted / Issued Accounting Pronouncements

Certain accounting standards required additional disclosures for the three and six month periods ended June 30, 2010, and such disclosures are included herein. The following is a summary of other applicable accounting pronouncements adopted by the Company during the three month period ended June 30, 2010 that required accounting changes beyond mere disclosures.

In March 2010, guidance related to derivatives and hedging was amended to exempt embedded credit derivative features related to the transfer of credit risk from potential bifurcation and separate accounting. Embedded features related to other types of risk and other embedded credit derivative features were not exempt from potential bifurcation and separate accounting. The amendments were effective for the Company on July 1, 2010. The Company does not expect these amendments to have a material impact on our financial position, results of operations, or cash flows.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations, or cash flows.

Accumulated Other Comprehensive Income (Loss)

We report comprehensive income (loss) in accordance with GAAP, which establishes standards for the reporting and presentation of comprehensive income (loss) and its components in financial statements. In accordance with this guidance, we elected to disclose changes in comprehensive income in our Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss). Comprehensive income (loss) includes all changes in shareholders’ equity during a period except those resulting from transactions with shareholders.

 

7


Table of Contents

The following table summarizes the components of accumulated other comprehensive income (loss), net of tax impact, at the dates and for the periods indicated (in thousands).

 

     Impact of FASB
ASC 715
    Impact of
curtailment
   Total impact
of defined
benefit
pension plan
    Impact of
investment
securities
available  for

sale
    Total  

Accumulated other comprehensive income (loss), after income tax impact, December 31, 2008

   $ (6,126   $ 1,630    $ (4,496   $ (1,621   $ (6,117

Accumulated other comprehensive income, before income tax impact

     —          —        —          321        321   

Income tax expense

     —          —        —          (123     (123
                                       

Accumulated other comprehensive income, after income tax impact

     —          —        —          198        198   
                                       

Accumulated other comprehensive income (loss), after income tax impact, June 30, 2009

   $ (6,126   $ 1,630    $ (4,496   $ (1,423   $ (5,919
                                       

Accumulated other comprehensive income (loss), after income tax impact, December 31, 2009

   $ (8,896   $ 1,630    $ (7,266   $ 306      $ (6,960

Accumulated other comprehensive income, before income tax impact

     —          —        —          2,042        2,042   

Income tax expense

     —          —        —          (775     (775
                                       

Accumulated other comprehensive income, after income tax impact

     —          —        —          1,267        1,267   
                                       

Accumulated other comprehensive income (loss), after income tax impact, June 30, 2010

   $ (8,896   $ 1,630    $ (7,266   $ 1,573      $ (5,693
                                       

The market value of pension plan assets is assessed and adjusted through accumulated other comprehensive income (loss) annually, if necessary.

 

2. Cash and Cash Equivalents

Required Reserve Balances

The Federal Reserve Act requires each depository institution to maintain reserves against its reservable liabilities as prescribed by regulations of the Board of Governors of the Federal Reserve (the “Federal Reserve”). The Bank reports our reservable liabilities to the Federal Reserve on a weekly basis. Weekly reporting institutions maintain reserves on their reservable liabilities with a 30-day lag. For the maintenance period ended on July 14, 2010, based on reservable liabilities from June 1, 2010 through June 14, 2010, the Federal Reserve required the Bank to maintain reserves of $11.4 million. After taking into consideration our levels of vault cash, reserves of $3.0 million were required to be maintained with the Federal Reserve.

Concentrations and Restrictions

In an effort to manage our associated risks, we generally do not sell federal funds to other financial institutions because they are essentially uncollateralized loans. Management regularly evaluates the risk associated with the counterparties to these potential transactions to ensure that we would not expose ourselves to any significant risks with regard to our cash and cash equivalent balances.

Cash and cash equivalents restricted to secure a letter of credit totaled $250 thousand (0.1%) and $512 thousand (0.3%) as of June 30, 2010 and December 31, 2009, respectively. In addition, $836 thousand (0.4%) of the balance of cash and cash equivalents was restricted as of June 30, 2010 and December 31, 2009 under our merchant credit card agreement.

 

3. Investment Securities Available for Sale

The following tables summarize the amortized cost, gross unrealized gains, gross unrealized losses, and fair values of investment securities available for sale at the dates indicated (in thousands).

 

8


Table of Contents
     June 30, 2010
     Amortized
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Fair value

U.S. Treasury and federal agencies

   $ 16,320    $ 2    $ —        $ 16,322

State and municipal

     40,486      1,869      —          42,355

Collateralized mortgage obligations

     42,187      186      (362     42,011

Other mortgage-backed (federal agencies)

     10,788      840      —          11,628
                            

Total investment securities available for sale

   $ 109,781    $ 2,897    $ (362   $ 112,316
                            
     December 31, 2009
     Amortized
cost
   Gross
unrealized
gains
   Gross
unrealized
losses
    Fair value

U.S. Treasury and federal agencies

   $ 16,294    $ 3    $ —        $ 16,297

State and municipal

     44,908      1,880      (3     46,785

Collateralized mortgage obligations

     42,508      168      (2,358     40,318

Other mortgage-backed (federal agencies)

     15,783      838      (35     16,586
                            

Total investment securities available for sale

   $ 119,493    $ 2,889    $ (2,396   $ 119,986
                            

We use prices from third party pricing services and, to a lesser extent, indicative (non-binding) quotes from third party brokers, to measure fair value of our investment securities. For securities priced by third party pricing services, management determines the most appropriate and relevant pricing service for each security class and has that pricing service provide the price for each security in the class. We record the unadjusted value provided by the third party pricing service / broker in our Consolidated Financial Statements, subject to our internal price verification procedures.

Other-Than-Temporary Impairment

The following tables summarize the number of securities in each category of investment securities available for sale, the fair value, and the gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated (dollars in thousands).

 

     June 30, 2010
     Less than 12 months    12 months or longer    Total
     #    Fair value    Gross
unrealized
losses
   #    Fair value    Gross
unrealized
losses
   #    Fair value    Gross
unrealized
losses

U.S. Treasury and federal agencies

   —      $ —      $ —      —      $ —      $ —      —      $ —      $ —  

State and municipal

   —        —        —      —        —        —      —        —        —  

Collateralized mortgage obligations

   8      32,058      362    —        —        —      8      32,058      362

Other mortgage-backed (federal agencies)

   —        —        —      —        —        —      —        —        —  
                                                        

Total investment securities available for sale

   8    $ 32,058    $ 362    —      $ —      $ —      8    $ 32,058    $ 362
                                                        
     December 31, 2009
     Less than 12 months    12 months or longer    Total
     #    Fair value    Gross
unrealized
losses
   #    Fair value    Gross
unrealized
losses
   #    Fair value    Gross
unrealized
losses

U.S. Treasury and federal agencies

   1    $ 300    $ —      —      $ —      $ —      1    $ 300    $ —  

State and municipal

   2      662      3    —        —        —      2      662      3

Collateralized mortgage obligations

   3      10,323      412    6      16,624      1,946    9      26,947      2,358

Other mortgage-backed (federal agencies)

   2      1,444      35    —        —        —      2      1,444      35
                                                        

Total investment securities available for sale

   8    $ 12,729    $ 450    6    $ 16,624    $ 1,946    14    $ 29,353    $ 2,396
                                                        

Based on our other-than-temporary impairment analysis as of June 30, 2010, we concluded that gross unrealized losses detailed in the preceding table were not other-than-temporarily impaired as of that date.

Ratings

The following table summarizes Moody’s ratings, by segment, of the investment securities available for sale based on fair value, at June 30, 2010. An AAA rating is based not only on the credit of the issuer, but may also include consideration of the structure of the securities and the credit quality of the collateral.

 

9


Table of Contents
     U.S. Treasury
and federal
agencies
    State
and
municipal
    Collateralized
mortgage
obligations
    Other
mortgage-backed
(federal agencies)
 

Aaa

   100   3   100   100

Aa1-A3

   —        75      —        —     

Baa1

   —        13      —        —     

Not rated or withdrawn rating

   —        9      —        —     
                        

Total

   100   100   100   100
                        

Of the state and municipal investment securities not rated or with withdrawn ratings by Moody’s at June 30, 2010, 15% were rated AA+ by Standard and Poor’s ratings, 52% were rated AA, 19% were rated AA-, and 14%, or $565 thousand, were not rated by Standard and Poor’s ratings.

Maturities

The following table summarizes the amortized cost and estimated fair value of investment securities available for sale at June 30, 2010 by contractual maturity (in thousands). Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations. Collateralized mortgage obligations and other mortgage-backed securities are shown separately since they are not due at a single maturity date.

 

     Amortized cost    Fair value

Due in one year or less

   $ 20,784    $ 20,838

Due after one year through five years

     26,358      27,657

Due after five year through ten years

     9,139      9,600

Due after ten years

     525      582

Collateralized mortgage obligations

     42,187      42,011

Other mortgage-backed securities (federal agencies)

     10,788      11,628
             

Total investment securities available for sale

   $ 109,781    $ 112,316
             

The weighted average contractual life of investment securities available for sale was 3.7 years at June 30, 2010. Since 48%, based on amortized cost, of the portfolio is collateralized mortgage obligations or other mortgage-backed securities, the expected remaining maturity may differ from contractual maturity because borrowers generally have the right to prepay obligations before the underlying mortgages mature.

Pledged

At June 30, 2010 and December 31, 2009, 61% of the portfolio was pledged to secure public deposits, including retail repurchase agreements, and trust assets. Of the $69.0 million and $73.2 million pledged at June 30, 2010 and December 31, 2009, respectively, $47.9 million and $56.3 million, respectively, of the portfolio was securing public deposits and trust assets.

At June 30, 2010 and December 31, 2009, $6.3 million (6%) and $6.3 million (5%), respectively, of the portfolio was pledged to secure federal funds funding from a correspondent bank.

At June 30, 2010 and December 31, 2009, $24.8 million (22%) and $29.8 million (25%), respectively, of the portfolio was pledged to collateralize FHLB advances and letters of credit, of which $23.9 million and $26.8 million, respectively, was available as lendable collateral.

On July 1, 2010, investment securities with a market value of $21.5 million were purchased and pledged to collateralize FHLB advances and letters of credit.

Concentrations

Four state and municipal security issuers issued securities with fair values ranging from 2.0% to 3.6% of total shareholders’ equity at June 30, 2010. Twenty state and municipal security issuers issued securities with fair values ranging from 1.0% to 1.9% of total shareholders’ equity at June 30, 2010.

Two collateralized mortgage obligation issuers issued securities with fair values of 1.3 and 4.1%, respectively, of total shareholders’ equity at June 30, 2010. Nine collateralized mortgage obligations, issued by the Government National Mortgage Association (“GNMA”), had an aggregate fair value of $38.6 million (61.7% of shareholders’ equity) and an amortized cost of $38.8 million at June 30, 2010.

 

10


Table of Contents

The following table summarizes issuer concentrations of other mortgage-backed investment securities at fair value at June 30, 2010 (dollars in thousands).

 

     Federal
National
Mortgage
Association
(“FNMA”)
    Federal Home
Loan Mortgage
Corporation
(“FHLMC”)
    Government
National
Mortgage
Association
(“GNMA”)
    Total  

Other mortgage-backed (federal agencies)

   $ 8,384      $ 1,762      $ 1,482      $ 11,628   

As a percentage of shareholders’ equity

     13.4     2.8     2.4     18.6

Realized Gains and Losses

The following table summarizes the gross realized gains and losses on investment securities available for sale for the periods indicated (in thousands).

 

     For the three month periods
ended June 30,
   For the six month periods
ended June 30,
     2010    2009    2010     2009

Realized gains

   $ —      $ —      $ 1,147      $ 2

Realized losses

     —        —        (1,139     —  
                            

Net realized gains

   $ —      $ —      $ 8      $ 2
                            

 

4. Loans

Composition

The following table summarizes gross loans, categorized by FDIC code, at the dates indicated (dollars in thousands).

 

     June 30, 2010     December 31, 2009  
     Total    % of total     Total    % of total  

Secured by real estate

          

Construction, land development, and other land loans

   $ 178,297    18.4   $ 205,465    19.8

Farmland

     2,891    0.3        466    —     

Single-family residential

     194,808    20.1        203,330    19.6   

Multifamily residential

     28,927    3.0        30,668    3.0   

Nonfarm nonresidential

     432,085    44.7        459,130    44.1   

Commercial and industrial

     55,581    5.8        61,788    5.9   

Obligations of states and political subdivisions of the U.S.

     1,059    0.1        1,418    0.1   

General consumer

     52,461    5.4        57,581    5.5   

Credit line

     4,739    0.5        5,501    0.5   

Bankcards

     12,433    1.3        13,214    1.3   

Others

     3,963    0.4        1,751    0.2   
                          

Loans, gross

   $ 967,244    100.0   $ 1,040,312    100.0
                          

Loans included in the preceding loan composition table are net of participations sold. Participations sold totaled $12.5 million at June 30, 2010 and December 31, 2009.

Mortgage loans serviced for the benefit of others amounted to $426.7 million and $426.6 million at June 30, 2010 and December 31, 2009, respectively, and are not included in our Consolidated Balance Sheets.

Pledged

To borrow from the FHLB, members must pledge collateral to secure advances and letters of credit. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. $339.5 million and $407.0 million of gross loans were pledged to collateralize FHLB advances and letters of credit at June 30, 2010 and December 31, 2009, respectively, of which $145.3 million and $162.0 million, respectively, was available as lendable collateral.

On June 30, 2010, $15.8 million of loans was pledged as collateral for potential borrowings from the Federal Reserve Discount Window.

 

11


Table of Contents

Concentrations

The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at June 30, 2010 (dollars in thousands).

 

     Total    % of gross
loans
    % of Bank’s
total regulatory
capital
 

Secured by commercial real estate

       

Construction, land development, and other land loans

   $ 178,297    18.4   244.5

Multifamily residential

     28,927    3.0      39.7   

Nonfarm nonresidential

     432,085    44.7      592.4   
                   

Total loans secured by commercial real estate

   $ 639,309    66.1   876.6
                   

The following table further categorizes loans secured by commercial real estate, categorized by FDIC code, at June 30, 2010 (dollars in thousands).

 

     Total    % of gross
loans
    % of Bank’s
total regulatory
capital
 

Development commercial real estate loans

       

Secured by:

       

Land - unimproved (commercial or residential)

   $ 61,395    6.4   84.2

Land development - commercial

     16,925    1.8      23.2   

Land development - residential

     59,876    6.2      82.1   

Commercial construction:

       

Hotel / motel

     189    —        0.3   

Retail

     4,448    0.5      6.1   

Office

     244    —        0.3   

Multifamily

     2,617    0.3      3.6   

Industrial and warehouse

     7,140    0.7      9.8   

Healthcare

     4,916    0.5      6.7   

Miscellaneous commercial

     3,362    0.3      4.6   
                   

Total development commercial real estate loans

     161,112    16.7      220.9   

Existing and other commercial real estate loans

       

Secured by:

       

Hotel / motel

     104,155    10.8      142.8   

Retail

     27,070    2.8      37.1   

Office

     27,428    2.8      37.6   

Multifamily

     28,927    3.0      39.7   

Industrial and warehouse

     17,302    1.8      23.7   

Healthcare

     11,232    1.1      15.4   

Miscellaneous commercial

     127,493    13.2      174.8   

Residential construction - speculative

     7,059    0.7      9.7   
                   

Total existing and other commercial real estate loans

     350,666    36.2      480.8   

Commercial real estate owner occupied and residential loans

       

Secured by:

       

Commercial - owner occupied

     117,199    12.1      160.7   

Commercial construction - owner occupied

     5,064    0.5      7.0   

Residential construction - contract

     5,268    0.6      7.2   
                   

Total commercial real estate owner occupied and residential loans

     127,531    13.2      174.9   
                   

Total loans secured by commercial real estate

   $ 639,309    66.1   876.6
                   

Asset Quality

Nonaccrual Loans and Loans Past Due 90 Days and Still Accruing. The following table summarizes nonaccrual loans and loans past due 90 days and still accruing interest at the dates indicated (in thousands).

 

     June 30,
2010
   December 31,
2009

Nonaccrual loans

   $ 91,653    $ 96,936

Loans past due 90 days and still accruing

     20      —  
             
   $ 91,673    $ 96,936
             

No interest income was recorded during the three and six month periods ended June 30, 2010 on loans classified as nonaccrual, as payments collected on nonaccrual loans are applied to the principal balance of the loan. Additional interest income of $999 thousand and $1.8 million would have been reported during the three and six month periods, respectively, ended June 30, 2010 had these loans performed in accordance with their contractual terms. As a result, our earnings did not include this interest income.

 

12


Table of Contents

Troubled Debt Restructurings. At June 30, 2010 and December 31, 2009, the principal balance of troubled debt restructurings totaled $27.8 million and $14.6 million, respectively.

Allowance for Loan Losses

The following table summarizes the activity impacting the allowance for loan losses at the dates and for the periods indicated (in thousands).

 

     At and for the three month  periods
ended June 30,
    At and for the six month  periods
ended June 30,
 
     2010     2009     2010     2009  

Allowance for loan losses, beginning of period

   $ 28,426      $ 12,606      $ 24,079      $ 11,000   

Provision for loan losses

     12,750        30,000        23,500        32,175   

Loans charged-off

     (13,078     (20,686     (20,320     (21,301

Loan recoveries

     285        45        1,124        91   
                                

Net loans charged-off

     (12,793     (20,641     (19,196     (21,210
                                

Allowance for loan losses, end of period

   $ 28,383      $ 21,965      $ 28,383      $ 21,965   
                                

Impaired Loans. The following table summarizes information relative to impaired loans at the dates and for the periods indicated (in thousands).

 

     June 30,
2010
   December 31,
2009

Impaired loans for which there is a related allowance for loan losses determined in accordance with FASB ASC 310

   $ 30,353    $ 11,253

Other impaired loans

     68,354      85,583
             

Total impaired loans

   $ 98,707    $ 96,836
             

Average impaired loans calculated using a simple average

   $ 100,981    $ 82,471

Related allowance for loan losses

     6,825      5,250

 

5. Premises and Equipment, Net

The following table summarizes the premises and equipment balances, net at the dates indicated (in thousands).

 

     June 30,
2010
    December 31,
2009
 

Land

   $ 6,534      $ 6,534   

Buildings

     19,772        19,904   

Leasehold improvements

     5,245        5,313   

Furniture and equipment

     20,741        20,908   

Software

     4,037        3,719   

Bank automobiles

     137        820   

Capital lease asset

     1,244        420   
                

Premises and equipment, gross

     57,710        57,618   

Accumulated depreciation

     (28,366     (28,013
                

Premises and equipment, net

   $ 29,344      $ 29,605   
                

 

6. Goodwill, net

Goodwill of $3.7 million at June 30, 2010 and December 31, 2009 resulted from past business combinations from 1988 through 1999. We perform our annual impairment testing as of June 30. Due to the overall adverse economic environment and the negative impact on the banking industry as a whole, including the impact to the Company resulting in net losses and a decline in market capitalization based on our common stock price, we also performed an impairment test of our goodwill at December 31, 2009. No impairment loss was recognized during the three or six month periods ended June 30, 2010 or 2009 or at December 31, 2009.

 

13


Table of Contents
7. Mortgage-Banking Activities

Mortgage loans serviced for the benefit of others amounted to $426.7 million and $426.6 million at June 30, 2010 and December 31, 2009, respectively, and are excluded from our Consolidated Balance Sheets.

The book value of mortgage-servicing rights at June 30, 2010 and December 31, 2009 was $2.9 million and $3.0 million, respectively. Mortgage-servicing rights are included within the Other assets financial statement line item of the Consolidated Balance Sheets. The fair value of mortgage-servicing rights at June 30, 2010 and December 31, 2009 was $3.4 million and $3.6 million, respectively.

Mortgage-Servicing Rights Activity

The following table summarizes the changes in the mortgage-servicing rights portfolio at the dates and for the periods indicated (in thousands).

 

     At and for the three month
periods ended June 30,
    At and for the six month
periods ended June 30,
 
     2010     2009     2010     2009  

Mortgage-servicing rights portfolio, net of valuation allowance, beginning of period

   $ 3,014      $ 2,993      $ 3,039      $ 2,932   

Capitalized mortgage-servicing rights

     107        408        273        883   

Mortgage-servicing rights portfolio amortization and impairment

     (197     (336     (388     (750
                                

Mortgage-servicing rights portfolio, net of valuation allowance, end of period

   $ 2,924      $ 3,065      $ 2,924      $ 3,065   
                                

Valuation Allowance

The following table summarizes the activity impacting the valuation allowance for impairment of the mortgage-servicing rights portfolio for the periods indicated (in thousands).

 

     For the three month
periods ended June 30,
    For the six month
periods ended June 30,
     2010    2009     2010    2009

Valuation allowance, beginning of period

   $ 38    $ 39      $ 40    $ 30

Additions charged to and (reductions credited from) operations

     3      (1     1      8
                            

Valuation allowance, end of period

   $ 41    $ 38      $ 41    $ 38
                            

 

8. Real Estate and Personal Property Acquired in Settlement of Loans

Composition

The following table summarizes real estate acquired in settlement of loans and personal property acquired in settlement of loans, the latter of which is included within the Other assets financial statement line item on the Consolidated Balance Sheets at the dates indicated (in thousands).

 

     June 30,
2010
   December 31,
2009

Real estate acquired in settlement of loans

   $ 26,521    $ 27,826

Personal property acquired in settlement of loans

     106      188
             

Total property acquired in settlement of loans

   $ 26,627    $ 28,014
             

Real Estate Acquired in Settlement of Loans Activity

The following table summarizes the changes in real estate acquired in settlement of loans at the dates and for the periods indicated (in thousands).

 

14


Table of Contents
     At and for the three  month
period ended June 30, 2010
    At and for the six month
period ended June 30,  2010
 

Real estate acquired in settlement of loans, beginning of period

   $ 28,867      $ 27,826   

Plus: New real estate acquired in settlement of loans

     4,204        8,097   

Less: Proceeds from sale of real estate acquired in settlement of loans

     (4,248     (6,301

Less: Gain / (loss) on sale on real estate acquired in settlement of loans

     14        285   

Less: Provision charged to expense

     (2,316     (3,386
                

Real estate acquired in settlement of loans, end of period

   $ 26,521      $ 26,521   
                

Subsequent to June 30, 2010, three properties with an aggregate net carrying amount of $4.7 million were sold at a gain of $282 thousand. At July 28, 2010, nine additional assets with an aggregate net carrying amount of $1.3 million were under contract for sale scheduled to close in the third quarter of 2010.

 

9. Deposits

Composition

The following table summarizes traditional deposit composition at the dates indicated (in thousands).

 

     June 30,
2010
   December 31,
2009

Transaction deposit accounts

   $ 431,040    $ 449,867

Money market deposit accounts

     150,053      119,082

Savings deposit accounts

     46,776      40,335

Time deposit accounts $100,000 and greater

     238,299      263,664

Time deposit accounts less than $100,000

     325,207      341,966
             

Total traditional deposit accounts

   $ 1,191,375    $ 1,214,914
             

At June 30, 2010 and December 31, 2009, $810 thousand and $542 thousand, respectively, of overdrawn transaction deposit accounts were reclassified to loans.

Interest Expense on Deposit Accounts

The following table summarizes interest paid on traditional deposit accounts for the periods indicated (in thousands).

 

     For the three month
periods ended June 30,
   For the six month
periods ended June 30,
     2010    2009    2010    2009

Transaction deposit accounts

   $ 67    $ 141    $ 128    $ 386

Money market deposit accounts

     174      139      334      307

Savings deposit accounts

     37      35      69      66

Time deposit accounts

     2,996      4,888      6,306      9,156
                           

Total interest expense on traditional deposit accounts

   $ 3,274    $ 5,203    $ 6,837    $ 9,915
                           

 

10. Borrowings

Federal Funds Accommodations

At June 30, 2010, we had access to federal funds funding, secured by U.S. Treasury and federal agency securities, from a correspondent bank. The following table summarizes our federal funds funding utilization and availability at the dates indicated (in thousands).

 

     June 30,
2010
   December 31,
2009

Authorized federal funds funding accomodations

   $ 5,000    $ 5,000

Utilized federal funds funding accomodations

     —        —  
             

Available federal funds funding accomodations

   $ 5,000    $ 5,000
             

This federal funds funding source may be canceled at any time at the correspondent bank’s discretion.

FHLB Borrowings

 

15


Table of Contents

As disclosed in Notes 3 and 4, we pledge investment securities and loans to collateralize FHLB advances and letters of credit. Additionally, we may pledge cash and cash equivalents. In order to compute lendable collateral amounts, the market value of pledged securities and loans balances is reduced by a collateral discount factor. This amount is then adjusted by the institution assigned collateral maintenance level factor. Among other things, the collateral maintenance level factor takes into account our collateral credit score determined by the FHLB. Cash and cash equivalents, if pledged, are not subject to the collateralization maintenance level.

The following table summarizes FHLB borrowed funds utilization and availability at the dates indicated (in thousands).

 

     June 30,
2010
    December 31,
2009
 

Available lendable loan collateral value to serve against FHLB advances and letters of credit

   $ 145,302      $ 162,014   

Available lendable investment security collateral value to serve against FHLB advances and letters of credit

     23,909        26,791   

Advances and letters of credit

    

FHLB advances

   $ (96,000   $ (101,000

Letters of credit

     (50,000     (50,000

Excess / (deficiency)

   $ (9,015   $ 55   

On July 1, 2010, investment securities with a market value of $21.5 million were pledged to cover the deficiency at June 30, 2010.

The following table summarizes FHLB borrowings at June 30, 2010 (dollars in thousands). Our FHLB advances do not have embedded call options.

 

                                   Total  

Borrowing balance

   $ 19,000      $ 30,000      $ 30,000      $ 5,000      $ 12,000      $ 96,000   

Interest rate

     0.63     1.34     2.89     3.61     0.43     1.69

Maturity date

     1/7/2011        1/18/2011        3/7/2011        4/2/2013        4/4/2011     

In January 2010, we were notified by the FHLB that it will not allow incremental borrowings until our financial condition improves.

Federal Reserve Discount Window

On June 30, 2010, $15.8 million of loans were pledged as collateral to cover the various Federal Reserve System services that are being utilized by the Company. The maximum maturity for borrowings is overnight. Any future potential borrowings from the Federal Reserve Discount Window are at the secondary credit rate and must be used for operational issues, and the Federal Reserve has the discretion to deny approval of borrowing requests.

We had no outstanding borrowings from the Federal Reserve at June 30, 2010 or December 31, 2009.

Convertible Debt

The Company has outstanding unsecured convertible promissory notes in an aggregate principal amount of $380 thousand to members of the Company’s Board of Directors. The notes bear interest at 10% per year payable quarterly, have a stated maturity of March 31, 2015, may be prepaid by the Company at any time, and are mandatorily convertible into stock of the Company at the same terms and conditions as other investors that participate in the Company’s next stock offering. The proceeds from the issuance of the notes were contributed to the Bank as a capital contribution. As of June 30, 2010, interest of $10 thousand has been accrued but not paid.

 

11. Employee Benefit Plans

401(k) Plan

During the three month periods ended June 30, 2010 and 2009, matching contributions made in conjunction with our employee 401(k) plan totaled $101 thousand and $94 thousand, respectively. During the six month periods ended June 30, 2010 and 2009, matching contributions made in conjunction with our employee 401(k) plan totaled $199 thousand and $203 thousand, respectively.

 

16


Table of Contents

Defined Benefit Pension Plan

Historically, we have offered a noncontributory, defined benefit pension plan that covered all full-time employees having at least twelve months of continuous service and having attained age 21. The plan was frozen on December 31, 2007; accordingly, effective January 1, 2008, we ceased accruing pension benefits under the plan. Although no previously accrued benefits were lost, employees no longer accrue benefits for service subsequent to 2007.

The Company recognizes the funded status of our defined benefit postretirement plan in our Consolidated Balance Sheet. Gains and losses, prior service costs and credits, and any remaining transition amounts that had not yet been recognized through net periodic benefit cost as of December 31, 2007 are recognized in accumulated other comprehensive income, net of tax impacts, until they are amortized as a component of net periodic cost.

The Company recognized an accrued pension liability, net at June 30, 2010 and December 31, 2009, which was included in the Other liabilities financial statement line item on the Consolidated Balance Sheets, of $4.0 million and $3.7 million, respectively.

The fair value of plan assets totaled $12.7 million and $13.2 million at June 30, 2010 and December 31, 2009, respectively.

Cost of Defined Benefit Pension Plan. The following table summarizes the net periodic (income) expense components for the Company’s defined benefit pension plan, which is included in Salaries and other personnel expense on the Consolidated Statements of Income (Loss), for the periods indicated (in thousands).

 

     For the three month
period ended June 30, 2010
    For the six month
period ended June 30, 2010
 

Interest cost

   $ 256      $ 482   

Expected return on plan assets

     (258     (485

Amortization of net actuarial loss

     178        337   
                

Net periodic pension expense

   $ 176      $ 334   
                

No expense was recorded during the three and six month periods ended June 30, 2009.

Contributions. Employer contributions in the amount of at least $78 thousand will be made during 2010. Additional contributions may be made depending on the funded status of the plan.

 

12. Equity Based Compensation

Stock Option Plan

Stock option awards have been granted under the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan with various expiration dates through December 31, 2016. Of these, 132,810 stock option awards remained outstanding at June 30, 2010 with exercise prices ranging from $13.50 to $30.40. All stock option awards granted have a vesting term of five years and an exercise period of ten years.

The compensation cost that was charged against pretax net income (loss) for previously granted stock option awards that vested during the three month periods ended June 30, 2010 and 2009 was $8 thousand and $16 thousand, respectively. During the six month periods ended June 30, 2010 and 2009, such compensation expense was $15 and $31 thousand, respectively.

At June 30, 2010, based on stock option awards outstanding at that time, the total pretax compensation cost related to nonvested stock option awards granted under the stock option plan but not yet recognized was $16 thousand. Stock option compensation expense is recognized on a straight-line basis over the stock option award vesting period. Remaining stock option compensation expense is expected to be recognized through 2011.

The following table summarizes stock option activity for the 1997 Stock Compensation Plan at the dates and for the periods indicated.

 

17


Table of Contents
     Stock options
outstanding
    Weighted-
average
exercise price

Outstanding at December 31, 2008

   169,330      $ 20.98

Exercised

   (4,000     26.60
            

Outstanding at June 30, 2009

   165,330      $ 20.84
            

Outstanding at December 31, 2009

   147,210      $ 21.80

Forfeited

   (14,400     15.00
            

Outstanding at June 30, 2010

   132,810      $ 22.54
            

The following table summarizes information regarding stock option awards outstanding and exercisable at June 30, 2010.

 

    Options outstanding   Options exercisable
Exercise price or range of
exercise prices
  Number of stock
options
outstanding at
6/30/10
  Weighted-
average
remaining
contractual life
(years)
  Weighted-
average exercise
price
  Number of stock
options
exercisable at
6/30/10
  Weighted-
average exercise
price
$13.50       7,800   0.50   $ 13.50   7,800   $ 13.50
$15.00   to   $20.00   40,010   2.06     17.75   40,010     17.75
$23.30   to   $26.60   51,200   3.87     24.47   51,200     24.47
$27.30   to   $30.40   33,800   5.53     27.37   26,480     27.36
                 
Total       132,810   3.55     22.54   125,490     22.26
                 

At June 30, 2010, we determined the fair value of our common stock based on the average of the last five trades reported through our Private Trading System. At June 30, 2010, the fair value of our common stock did not exceed the exercise price of any options outstanding and exercisable. Cash received from stock option exercises under the stock option plan during the three and six month periods ended June 30, 2009 was $106 thousand. The total intrinsic value of stock options exercised during the three and six month period ended June 30, 2009 was $62 thousand. There were no stock options exercised during the three and six month periods ended June 30, 2010.

Restricted Stock Plan

250,000 shares of common stock have been reserved for issuance under the Palmetto Bancshares, Inc. 2008 Restricted Stock Plan, which provides for the grant of common stock awards to the Company’s employees, officers, and directors. The first awards were granted under the Plan during 2009. The following table summarizes restricted stock activity at the dates and for the periods indicated.

 

     Restricted stock
outstanding
    Weighted-
average grant
price

Outstanding at December 31, 2008

   —        $ —  
            

Granted

   37,540        42.00

Forfeited

   (10,000     42.00
            

Outstanding at June 30, 2009

   27,540        42.00
            

Granted

   17,500        21.95

Vested

   (5,508     42.00
            

Outstanding at December 31, 2009

   39,532        33.12
            

Granted

   —          —  
            

Outstanding at June 30, 2010

   39,532      $ 33.12
            

The value of the restricted stock awarded is established as the fair value of the stock at the time of the grant. We measure compensation cost for restricted stock awards at fair value and recognize compensation expense over the service period. As such, expense relative to 2009 grants is recognized ratably over the five year vesting period of the stock award grants. Of the restricted stock shares outstanding at June 30, 2010, 39% perform their annual vesting on July 1 and 61% perform their annual vesting on December 31. The compensation cost that was charged against pretax income during the three month periods ended June 30, 2010 and June 30, 2009 for restricted stock awards was $85 thousand and $37 thousand, respectively. The total income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation cost was $30 thousand and $13 thousand, for the same periods, respectively. The compensation cost that was charged against pretax income during the six month periods ended June 30, 2010 and June 30, 2009 for restricted stock awards was $170 thousand and $116 thousand, respectively. The total income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation cost was $60 thousand and $41 thousand, for the same periods, respectively. Forfeitures are accounted for by eliminating compensation expense for unvested shares as forfeitures occur. At June 30, 2010, based on restricted stock awards outstanding at that time, the total pretax compensation cost related to nonvested restricted stock awards granted under the restricted stock plan but not yet recognized was $1.1 million. This cost is expected to be recognized over a remaining period through 2014. The estimation of restricted stock awards that will ultimately vest requires judgment and, to the extent actual results or updated estimates differ from current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised.

 

18


Table of Contents

At June 30, 2010, there was no intrinsic value associated with the restricted stock as the fair value did not exceed the fair value on the date of grant. At June 30, 2010, 204,960 shares were available for issuance under the plan.

Shares of restricted stock granted to employees under the 2008 Restricted Stock Plan are subject to prorata restrictions as to continuous employment for a specified time period following the date of grant, currently five years. During this period, the holder is entitled to full voting rights and dividends.

 

13. Shareholders’ Equity and Average Share Information

Private Placement

On May 25, 2010, as amended on June 8, 2010, the Company entered into a Stock Purchase Agreement and Registration Rights Agreement and Amendment No. 1 to Stock Purchase Agreement and Registration Rights Agreement (“Amendment No. 1” and together with the Stock Purchase Agreement and the Registration Rights Agreement, the “Investment Agreements”) with institutional investors pursuant to which the investors committed to purchase approximately $103 million of shares of the Company’s common stock at $2.60 per share (the “Private Placement”).

Pursuant to the Investment Agreements, the Company has agreed to, among other things, nominate and appoint three designees of the investors to the Company’s and the Bank’s Board of Directors. In addition, the investors will have preemptive rights with respect to public or private offerings of the Company’s common stock (or rights to purchase, or securities convertible into or exercisable for, common stock) during a 24-month period after the closing of the Private Placement to enable the investors to maintain their percentage interests of the Company’s common stock beneficially owned, subject to certain exceptions, including an exception that permits the Company to conduct a common stock offering following the closing of the Private Placement of up to $10 million directed to the Company’s current shareholders.

The Private Placement is conditioned upon, among other things, the Company’s shareholders’ approval of an amendment to the Company’s Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock from 25,000,000 shares to 75,000,000 shares and reduce the par value of the common stock from $5.00 per share to $0.01 per share, the Company’s representations and warranties contained in the Investment Agreements being true and correct in all material respects on the closing date, and the investors receiving all required regulatory approvals and determinations. The Investment Agreements may be terminated by the Company or an investor under certain circumstances, including that the Company or an investor, with respect to its investment, may terminate if the closing of the Private Placement has not occurred by December 31, 2010.

The Company’s annual shareholder meeting, at which time the shareholders will vote on the proposals described above, is scheduled for August 6, 2010.

Cash Dividends

The Board of Directors has not declared or paid a dividend on our common stock since the quarter ended March 31, 2009. The Company and the Bank are subject to regulatory policies and requirements relating to the payment of dividends. Since our total risk-based capital ratio was below the well-capitalized regulatory minimum threshold at June 30, 2010, payment of a dividend on our common stock would have required prior notification and non-objection from the FDIC.

Average Share Information

 

19


Table of Contents

The following table summarizes our reconciliation of the numerators and denominators of the basic and diluted net income (loss) per common share computations for the periods indicated.

 

     For the three month
periods ended June 30,
   For the six month
periods ended June 30,
     2010    2009    2010    2009

Weighted average common shares outstanding - basic

   6,455,598    6,450,090    6,455,598    6,449,383

Dilutive impact resulting from potential common share issuances

   —      —      —      —  
                   

Weighted average common shares outstanding - diluted

   6,455,598    6,450,090    6,455,598    6,449,383
                   

Basic net income (loss) per share is computed by dividing net income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding during the period. For diluted net income per share, the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. If dilutive, common stock equivalents are calculated for stock options and restricted stock shares using the treasury stock method. No potential common shares were included in the computation of the diluted per share amount for the three and six month periods ended June 30, 2010 and 2009 as inclusion would be antidilutive given our net loss during the periods.

 

14. Income Taxes

During 2009, the U.S. Congress extended the net operating loss carryback period from two years to five years for qualifying institutions. As a result of our net operating loss in 2009, the Company filed income tax refund claims and recorded receivables related to carrybacks from 2004 through 2007 and federal and state tax refund claims for estimated taxes paid in 2009 totaling $20.9 million, all of which were received during the three month period ended March 31, 2010, reduced by $661 thousand as a result of the filing of an amended 2009 federal income tax return in June 2010.

Our income tax receivable of $4.7 million recorded at June 30, 2010 was primarily the result of our taxable net operating loss for the six month period ended June 30, 2010 which was carried back to 2008. Effective January 1, 2010, the available carryback years for net operating losses under the Internal Revenue Code rules reverted from five years back to two years. At June 30, 2010, the Company has additional carryback capacity in 2010 to recapture up to $3.2 million of taxes paid in 2008.

As of June 30, 2010, net deferred income tax assets totaling $8.7 million are recorded in the Company’s Consolidated Balance Sheet. As of that date, we determined that $3.2 million of our net deferred income tax assets are realizable based primarily on an available refund from net operating loss carryback against income taxes previously paid in 2008, and $5.5 million is supported by tax planning strategies and projections of future taxable income. Accordingly, no valuation allowance is recorded against net deferred income tax assets as of June 30, 2010.

 

15. Commitments, Guarantees, and Other Contingencies

Lending Commitments and Standby Letters of Credit

Unused lending commitments to customers are not recorded in our Consolidated Balance Sheets until funds are advanced. For commercial customers, lending commitments generally take the form of unused revolving credit arrangements to finance customers’ working capital requirements. For retail customers, lending commitments are generally unused lines of credit secured by residential property.

The following table summarizes the contractual amounts of our unused lending commitments relating to extension of credit with off-balance sheet risk at June 30, 2010 (in thousands).

 

20


Table of Contents

Commitments to extend credit:

  

Revolving, open-end lines secured by single-family residential properties

   $ 49,347

Bankcardlines

     40,820

Commercial real estate, construction, and land development loans secured by real estate

  

Single-family residential construction loan commitments

     3,370

Commercial real estate, other construction loan, and land development loan commitments

     14,727

Other

     51,013
      

Total commitments to extend credit

   $ 159,277
      

Commitments to fund “other” loans are comprised primarily of overdraft protection lines and lines related to commercial and industrial loans.

Standby letters of credit are issued for customers in connection with contracts between the customers and third parties. Letters of credit are conditional commitments issued by us to guarantee the performance of a customer to a third party. The maximum potential amount of undiscounted future payments related to letters of credit was $3.3 million and $4.6 million at June 30, 2010 and December 31, 2009, respectively.

The reserve for unfunded commitments at June 30, 2010 and December 31, 2009 was $98 thousand and $128 thousand, respectively, and is recorded in the Other liabilities financial statement line item in the Consolidated Balance Sheet.

Loan Participations

With regard to participations sold aggregating $23.0 million at June 30, 2010 ($12.5 million of which related to gross loan balances and $10.5 million of which related to the contractual loan balances of real estate acquired in settlement of loans), we serve as the lead bank and are therefore responsible for certain administration and other management functions as agent to the participating banks. The participation agreements include certain standard representations and warranties related to our duties to the participating banks.

Derivatives

See Note 16 for further discussion regarding our off-balance sheet arrangements and commitments related to our derivative loan commitments and freestanding derivatives.

Real Property Operating Lease Obligations

We lease certain of our office facilities and real estate related to banking services under operating leases. There has been no significant change in future minimum lease payments payable as reported in our Annual Report on Form 10-K for the year ended December 31, 2009.

Legal Proceedings

We are subject to actual and threatened legal proceedings and other claims against us arising out of the conduct of our business. Some of these suits and proceedings seek damages, fines, or penalties. These suits and proceedings are being defended by, or contested on behalf of, us. On the basis of information presently available, we do not believe that existing proceedings and claims will have a material impact on our financial position or results of operations.

 

16. Derivative Financial Instruments and Hedging Activities

At June 30, 2010 and December 31, 2009, our only derivative instruments related to our residential mortgage lending activities. We are required to recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. Changes in the fair value of those derivatives are reported in current earnings or other comprehensive income depending on the purpose for which the derivative is held and whether the derivative qualifies for hedge accounting.

We originate certain residential loans with the intention of selling these loans. Between the time that we enter into an interest rate lock commitment to originate a residential loan with a potential borrower and the time the closed loan is sold, we are subject to variability in market prices related to these commitments. We also enter into forward sale agreements of “to be issued” loans. The commitments to originate residential loans and forward sales commitments are freestanding derivative instruments and are recorded on the Consolidated Balance Sheets at fair value. They do not qualify for hedge accounting treatment. Fair value adjustments are recorded within the Mortgage-banking financial statement line item of the Consolidated Statements of Income (Loss).

 

21


Table of Contents

At June 30, 2010, commitments to originate conforming loans totaled $7.9 million. At June 30, 2010, these derivative loan commitments had positive fair values, included within the Other assets financial statement line item of the Consolidated Balance Sheets, totaling $250 thousand and no negative fair values. At December 31, 2009, commitments to originate conforming loans totaled $7.0 million. At December 31, 2009, these derivative loan commitments had positive fair values, included within the Other assets financial statement line item of the Consolidated Balance Sheets, totaling $52 thousand, and negative fair values, included within the Other liabilities financial statement line item of the Consolidated Balance Sheets, totaling $11 thousand. The net change in derivative loan commitment fair values during the three and six month periods ended June 30, 2010 resulted in net derivative loan commitment income of $157 thousand and $209 thousand, respectively. Net derivative loan commitment income was $95 thousand for the three and six month periods ended June 30, 2009.

Forward sales commitments totaled $9.0 million at June 30, 2010. At June 30, 2010, forward sales commitments had no positive fair values, and negative fair values, included within the Other liabilities financial statement line item of the Consolidated Balance Sheets, totaling $240 thousand. At December 31, 2009, forward sales commitments totaled $10.0 million. At December 31, 2009, these forward sales commitments had positive fair values, included within the Other assets financial statement line item of the Consolidated Balance Sheets, totaling $92 thousand, and negative fair values, included within the Other liabilities financial statement line item of the Consolidated Balance Sheets, totaling $1 thousand. The net change in forward sales commitment fair values during the three and six month periods ended June 30, 2010 resulted in net forward sales commitment expense of $255 thousand and $331 thousand, respectively. Net forward sales commitment income was $245 thousand for the three and six month periods ended June 30, 2009.

 

17. Disclosures Regarding Fair Value

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following tables summarize our assets and liabilities measured at fair value on a recurring basis at the dates indicated, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).

 

     June 30, 2010
     Level 1    Level 2    Level 3    Total

Assets

           

Investment securities available for sale

   $ 16,322    $ 53,983    $ 42,011    $ 112,316

Derivative financial instruments

     —        250      —        250
                           

Total assets measured at fair value on a recurring basis

   $ 16,322    $ 54,233    $ 42,011    $ 112,566
                           

Liabitites

           

Derivative financial instruments

   $ —      $ 240    $ —      $ 240
                           
     December 31, 2009
     Level 1    Level 2    Level 3    Total

Assets

           

Investment securities available for sale

   $ 16,297    $ 63,371    $ 40,318    $ 119,986

Derivative financial instruments

     —        144      —        144
                           

Total assets measured at fair value on a recurring basis

   $ 16,297    $ 63,515    $ 40,318    $ 120,130
                           

Liabitites

           

Derivative financial instruments

   $ —      $ 12    $ —      $ 12
                           

The following tables summarize the detail of investment securities available for sale fair value measurements from brokers or third party pricing services by level at the dates indicated (in thousands).

 

22


Table of Contents
     June 30, 2010
     Level 1    Level 2    Level 3    Total

Brokers

   $ —      $ —      $ 42,011    $ 42,011

Third party pricing services

     16,322      53,983      —        70,305
                           

Total

   $ 16,322    $ 53,983    $ 42,011    $ 112,316
                           
     December 31, 2009
     Level 1    Level 2    Level 3    Total

Brokers

   $ —      $ —      $ 40,318    $ 40,318

Third party pricing services

     16,297      63,371      —        79,668
                           

Total

   $ 16,297    $ 63,371    $ 40,318    $ 119,986
                           

The following table reconciles the beginning and ending balances of investment securities available for sale fair value measurements using significant unobservable inputs on a recurring basis at the dates and for the period indicated (in thousands).

 

     Level 3  

Balance, December 31, 2009

   $ 40,318   

Total gains / losses (realized / unrealized) included in:

  

Net income / loss

     (371

Accumulated other comprehensive income

     54   

Purchases, sales, issuances, and settlements, net

     2,010   

Transfers in and (out) of level three

     —     
        

Balance, June 30, 2010

   $ 42,011   
        

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The following tables summarize our assets measured at fair value on a nonrecurring basis at the dates indicated, aggregated by the level in the fair value hierarchy within which those measurements fall (in thousands).

 

     June 30, 2010
     Level 1    Level 2    Level 3    Total

Assets

           

Impaired loans, net

   $ —      $ 65,398    $ 26,484    $ 91,882

Real estate and personal property acquired in settlement of loans

     —        13,133      13,494      26,627
                           

Total assets measured at fair value on a nonrecurring basis

   $ —      $ 78,531    $ 39,978    $ 118,509
                           
     December 31, 2009
     Level 1    Level 2    Level 3    Total

Assets

           

Impaired loans, net

   $ —      $ 75,209    $ 16,377    $ 91,586

Real estate and personal property acquired in settlement of loans

     —        25,522      2,492      28,014
                           

Total assets measured at fair value on a nonrecurring basis

   $ —      $ 100,731    $ 18,869    $ 119,600
                           

Carrying Amounts and Estimated Fair Value of Principal Financial Assets and Liabilities

The following table summarizes the carrying amount and fair values for other financial instruments included in our Consolidated Balance Sheets at the dates indicated (in thousands).

 

23


Table of Contents
     June 30, 2010    December 31, 2009
     Carrying
amount
   Fair value    Carrying
amount
   Fair value

Assets

           

Loans, gross

   $ 868,537    $ 846,979    $ 943,476    $ 924,647
                           

Total assets

   $ 868,537    $ 846,979    $ 943,476    $ 924,647
                           

Liabilities

           

Deposits

   $ 1,191,375    $ 1,183,474    $ 1,214,914    $ 1,206,857

FHLB borrowings

     96,000      95,692      101,000      100,119
                           

Total liabilities

   $ 1,287,375    $ 1,279,166    $ 1,315,914    $ 1,306,976
                           

 

18. Regulatory Capital Requirements

The following table summarizes the Company’s and the Bank’s actual and required capital ratios at the dates indicated (dollars in thousands). Although our Tier 1 leverage ratio and Tier 1 risk-based capital ratio were above the well-capitalized regulatory minimum threshold of 5% and 6%, respectively, at December 31, 2009, these ratios are in the adequately-capitalized category at June 30, 2010. Our total risk-based capital ratio was below the well-capitalized regulatory minimum threshold of 10% at June 30, 2010 and December 31, 2009. As a result, we were classified in the undercapitalized category at June 30, 2010 and the adequately-capitalized category at December 31, 2009.

Since June 30, 2010, no conditions or events have occurred, of which we are aware, that have resulted in a material change in the Company’s or the Bank’s category other than as reported in this Quarterly Report on Form 10-Q.

 

     Actual     For capital adequacy
purposes
    To be “well capitalized”  under
prompt corrective action
provisions
 
     amount    ratio     amount    ratio     amount    ratio  

At June 30, 2010

               

Total capital to risk-weighted assets

               

Company

   $ 72,050    7.08   $ 81,375    8.00     n/a    n/a   

Bank

     72,931    7.17        81,420    8.00      $ 101,775    10.00

Tier 1 capital to risk-weighted assets

               

Company

     59,141    5.81        40,687    4.00        n/a    n/a   

Bank

     60,015    5.90        40,710    4.00        61,065    6.00   

Tier 1 leverage ratio

               

Company

     59,141    4.34        54,505    4.00        n/a    n/a   

Bank

     60,015    4.40        54,597    4.00        68,246    5.00   

At December 31, 2009

               

Total capital to risk-weighted assets

               

Company

   $ 93,298    8.25   $ 90,426    8.00     n/a    n/a   

Bank

     93,013    8.22        90,518    8.00      $ 113,147    10.00

Tier 1 capital to risk-weighted assets

               

Company

     79,046    6.99        45,213    4.00        n/a    n/a   

Bank

     78,745    6.96        45,259    4.00        67,888    6.00   

Tier 1 leverage ratio

               

Company

     79,046    5.55        56,951    4.00        n/a    n/a   

Bank

     78,745    5.52        57,042    4.00        71,302    5.00   

Private Placement

As disclosed in Note 13, on May 25, 2010, as amended on June 8, 2010, the Company entered into Investment Agreements with institutional investors, pursuant to which the investors committed to purchase approximately $103 million of shares of the Company’s common stock. The net proceeds of the Private Placement, after estimated direct expenses of $8.5 million, are expected to be approximately $94.5 million of which approximately $1.5 million will be retained by the Company and approximately $93.0 million will be contributed to the Bank as a capital contribution. Successful completion of the Private Placement will result in the Company’s and the Bank’s capital levels being above the amounts necessary to be categorized as well-capitalized.

 

24


Table of Contents

Recent Regulatory Developments

The Company and the Bank are subject to periodic examination by various regulatory agencies. In November 2009, the FDIC and the South Carolina State Board of Financial Institutions (the “State Board”) conducted their annual joint examination of the Bank. Beginning in October 2009, the Company’s Board of Directors and the Regulatory Oversight Committee of the Board of Directors met periodically with these regulatory agencies to receive status reports on their examination, and the Board received the final report of examination in April 2010. Effective June 10, 2010, the Bank agreed to the issuance of a Consent Order with the FDIC and the State Board (the “Consent Order”). The Consent Order includes requirements regarding the Bank’s capital position and other requirements, including that the Bank:

 

   

Achieve and maintain, within 120 days from the effective date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets;

 

   

Determine, within 30 days of the last day of the calendar quarter, its capital ratios. If any capital measure falls below the established minimum, within 30 days provide a written plan to the supervisory authorities describing the means and timing by which the Bank shall increase such ratios to or in excess of the established minimums;

 

   

Establish, within 30 days from the effective date of the Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored by the Bank’s Board of Directors;

 

   

Develop, within 60 days from the effective date of the Consent Order, a written analysis and assessment of the Bank’s management and staffing needs;

 

   

Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers;

 

   

Eliminate, within 10 days from the effective date of the Consent Order, by charge-off or collection, all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful”;

 

   

Review and update, within 60 days from the effective date of the Consent Order, its policy to ensure the adequacy of the Bank’s allowance for loan and lease losses, which must provide for a review of the Bank’s allowance for loan and lease losses at least once each calendar quarter;

 

   

Submit, within 60 days from the effective date of the Consent Order, a written plan to reduce classified assets, which shall include, among other things, a reduction of the Bank’s risk exposure in relationships with assets in excess of $1,000,000 which are criticized as “Substandard,” “Doubtful,” or “Special Mention”;

 

   

Revise, within 60 days from the effective date of the Consent Order, its policies and procedures for managing the Bank’s Adversely Classified Other Real Estate Owned;

 

   

Not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, in whole or in part, “Loss” or “Doubtful” and is uncollected. In addition, the Bank may not extend any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been criticized, in whole or in part, “Substandard” or “Special Mention” and is uncollected, unless the Bank’s board of directors determines that failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank;

 

   

Perform, within 90 days from the effective date of the Consent Order, a risk segmentation analysis with respect to the Bank’s Concentrations of Credit and develop a written plan to systematically reduce any segment of the portfolio that is an undue concentration of credit;

 

   

Review, within 60 days from the effective date of the Consent Order and annually thereafter, the Bank’s loan policies and procedures for adequacy and, based upon this review, make all appropriate revisions to the policies and procedures necessary to enhance the Bank’s lending functions and ensure their implementation;

 

   

Adopt, within 60 days from the effective date of the Consent Order, an effective internal loan review and grading system to provide for the periodic review of the Bank’s loan portfolio in order to identify and categorize the Bank’s loans, and other extensions of credit which are carried on the Bank’s books as loans, on the basis of credit quality;

 

   

Review and update, within 60 days from the effective date of the Consent Order, its written profit plan to ensure the Bank has a realistic, comprehensive budget for all categories of income and expense, which must address, at minimum, goals and strategies for improving and sustaining the earnings of the

 

25


Table of Contents
 

Bank, the major areas in and means by which the Bank will seek to improve the Bank’s operating performance, realistic and comprehensive budgets, a budget review process to monitor income and expenses of the Bank to compare actual figure with budgetary projections, the operating assumptions that form the basis for and adequately support major projected income and expense components of the plan, and coordination of the Bank’s loan, investment, and operating policies and budget and profit planning with the funds management policy;

 

   

Review and update, within 60 days from the effective date of the Consent Order, its written plan addressing liquidity, contingent funding, and asset liability management;

 

   

Eliminate, within 30 days from the effective date of the Consent Order, all violations of law and regulation or contraventions of policy set forth in the FDIC’s safety and soundness examination of the Bank in November 2009;

 

   

Not accept, renew, or rollover any brokered deposits unless it is in compliance with the requirements of 12 C.F.R. § 337.6(b);

 

   

Limit asset growth to 10% per annum;

 

   

Not declare or pay any dividends or bonuses or make any distributions of interest, principal, or other sums on subordinated debentures without the prior approval of the supervisory authorities;

 

   

Not offer an effective yield on deposits of more than 75 basis points over the national rates published by the FDIC weekly on its website unless otherwise specifically permitted by the FDIC. On April 1, 2010 the Bank was notified by the FDIC that it had determined that the geographic areas in which we operate were considered high-rate areas. Accordingly, the Bank is able to offer interest rates on deposits up to 75 basis points over the prevailing interest rates in our geographic areas; and

 

   

Furnish, by within 30 days from the effective date of the Consent Order and within 30 days of the end of each quarter thereafter, written progress reports to the supervisory authorities detailing the form and manner of any actions taken to secure compliance with the Consent Order.

The Company intends to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and as of the date hereof we have submitted all documentation required as of this date to the FDIC and State Board. There can be no assurance that the Bank will be able to comply fully with the provisions of the Consent Order, and the determination of our compliance will be made by the FDIC and the State Board. However, we believe we are currently in compliance with all provisions of the Consent Order except for the requirements to raise additional capital and to reduce our criticized assets by the specified percentages by certain dates, with the first date being December 6, 2010. Failure to meet the requirements of the Consent Order could result in additional regulatory requirements, which could ultimately lead to the Bank being taken into receivership by the FDIC.

 

26


Table of Contents
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis presents factors impacting our financial condition as of June 30, 2010 and results of operations and cash flows for the three and six month periods ended June 30, 2010. This discussion should be read in conjunction with our Consolidated Financial Statements and the notes thereto included in this Quarterly Report on Form 10-Q and our Consolidated Financial Statements and the notes thereto for the year ended December 31, 2009 included in our Annual Report on Form 10-K for that period. Results for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results for the year ending December 31, 2010 or any future period. Percentage calculations contained herein have been calculated based on actual not rounded results presented herein.

Forward-Looking Statements

This report, including information included or incorporated by reference in this document, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements relate to the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements as they will depend on many factors about which we are unsure including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate” as well as similar expressions are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, but are not limited to, the following:

 

   

Greater than expected losses could occur due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors,

 

   

Greater than expected losses could occur due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral,

 

   

The rate of delinquencies and amounts of loans charged-off,

 

   

The adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods,

 

   

Our efforts to raise capital or otherwise increase our regulatory capital ratios,

 

   

Risks and uncertainties associated with the closing of our private placement, including the risk that we are unable to consummate the private placement,

 

   

Our ability to comply with our Consent Order and potential regulatory actions if we fail to comply,

 

   

Our ability to retain key personnel,

 

   

Our ability to retain our existing customers, including our deposit relationships,

 

   

The rates of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio,

 

   

The amount of our loan portfolio collateralized by real estate, and the weakness in the real estate market,

 

   

Increased funding costs due to market illiquidity, increased competition for funding, and / or increased regulatory requirements with regard to funding,

 

   

Significant increases in competitive pressure in the banking and financial services industries,

 

   

Changes in the interest rate environment which could reduce anticipated or actual margins,

 

   

Changes in political conditions and the legislative or regulatory environment,

 

   

General economic conditions, either nationally or regionally and especially in our primary service areas, becoming less favorable than expected, resulting in, among other things, a further deterioration in credit quality,

 

   

Changes occurring in business conditions and inflation,

 

   

Changes in technology,

 

   

Changes in deposit flows,

 

   

Changes in monetary and tax policies,

 

   

Changes in accounting principles, policies, or guidelines,

 

   

Our ability to maintain effective internal control over financial reporting,

 

27


Table of Contents
   

Our reliance on available secondary funding sources such as FHLB advances, Federal Reserve Discount Window borrowings, sales of securities and loans, and federal funds lines of credit from correspondent banks to meet our liquidity needs,

 

   

Adverse changes in asset quality and resulting credit risk-related losses and expenses,

 

   

Loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions,

 

   

Changes in the securities markets, and / or

 

   

Other risks and uncertainties detailed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2009, in Part II, Item 1A of this Quarterly Report on Form 10-Q, and from time to time in our other filings with the SEC.

These risks are exacerbated by the recent developments in national and international financial markets, and we are unable to predict what impact these uncertain market conditions will have on us. During 2008 and 2009, the capital and credit markets experienced extended volatility and disruption which continue to impact the Company in 2010. There can be no assurance that these unprecedented developments will not continue to materially and adversely impact our business, financial condition, and results of operations, as well as our ability to raise capital or other funding for liquidity and business purposes.

We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements whether as a result of new information, future events, or otherwise.

 

28


Table of Contents

Selected Financial Data

The following consolidated financial data should be read in conjunction with Item 1. Financial Statements and Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (dollars in thousands, except per share data) (unaudited).

 

    For the six
month
period ended
June 30,
2010
    For the six
month
period ended
June 30,
2009
             For the three
month
period ended
June 30,
2010
    For the three
month
period ended
March 31,
2010
    For the three
month

period ended
December 31,
2009
    For the three
month

period ended
September 30,
2009
    For the three
month
period ended
June 30,
2009
    For the year
ended
December 31,
2009
 

STATEMENTS OF INCOME (LOSS)

                     

Interest income

  $ 29,329      $ 33,456            $ 14,450      $ 14,879      $ 15,708      $ 17,046      $ 15,890      $ 66,210   

Interest expense

    7,796        10,810              3,716        4,080        5,099        5,530        5,622        21,439   
                                                                     

Net interest income

    21,533        22,646              10,734        10,799        10,609        11,516        10,268        44,771   

Provision for loan losses

    23,500        32,175              12,750        10,750        17,225        24,000        30,000        73,400   
                                                                     

Net interest income (loss) after provision for loan losses

    (1,967     (9,529           (2,016     49        (6,616     (12,484     (19,732     (28,629

Noninterest income

    9,001        9,534              4,061        4,940        4,625        4,543        5,103        18,702   

Noninterest expense

    28,694        24,660              15,371        13,323        13,628        13,998        13,143        52,286   
                                                                     

Net loss before benefit for income taxes

    (21,660     (24,655           (13,326     (8,334     (15,619     (21,939     (27,772     (62,213

Benefit for income taxes

    (7,835     (8,798           (4,793     (3,042     (5,566     (7,764     (9,921     (22,128
                                                                     

Net loss

  $ (13,825   $ (15,857         $ (8,533   $ (5,292   $ (10,053   $ (14,175   $ (17,851   $ (40,085
                                                                     

COMMON AND PER SHARE DATA

                     

Net loss per common share:

                     

Basic

  $ (2.14   $ (2.46         $ (1.32   $ (0.82   $ (1.55   $ (2.20   $ (2.77   $ (6.21

Diluted

    (2.14     (2.46           (1.32     (0.82     (1.55     (2.20     (2.77     (6.21

Cash dividends per common share

    —          —                —          —          —          —          —          0.06   

Book value per common share

    9.64        15.45              9.64        10.93        11.55        13.63        15.45        11.55   

Outstanding common shares

    6,495,130        6,477,630              6,495,130        6,495,130        6,495,130        6,477,630        6,477,630        6,495,130   

Weighted average common shares outstanding - basic

    6,455,598        6,449,383              6,455,598        6,455,598        6,450,150        6,450,090        6,450,090        6,449,754   

Weighted average common shares outstanding - diluted

    6,455,598        6,449,383              6,455,598        6,455,598        6,450,150        6,450,090        6,450,090        6,449,754   

Dividend payout ratio

    n/a     (2.45 ) %            n/a     n/a     n/a     n/a     n/a     n/a
                                                                     

PERIOD-END BALANCES

                     

Assets

  $ 1,387,921      $ 1,465,529            $ 1,387,921      $ 1,348,463      $ 1,435,950      $ 1,425,455      $ 1,465,529      $ 1,435,950   

Investment securities available for sale, at fair value

    112,316        113,347              112,316        115,893        119,986        121,027        113,347        119,986   

Total loans

    969,142        1,138,832              969,142        1,011,368        1,044,196        1,082,313        1,138,832        1,044,196   

Deposits (including traditional and nontraditional)

    1,216,049        1,275,744              1,216,049        1,168,978        1,249,520        1,247,850        1,275,744        1,249,520   

FHLB borrowings

    96,000        82,000              96,000        96,000        101,000        82,000        82,000        101,000   

Convertible debt

    380        —                380        380        —          —          —          —     

Shareholders’ equity

    62,643        100,088              62,643        70,978        75,015        88,266        100,088        75,015   
                                                                     

AVERAGE BALANCES

                     

Assets

  $ 1,370,438      $ 1,414,629            $ 1,372,608      $ 1,368,244      $ 1,431,639      $ 1,462,846      $ 1,441,610      $ 1,430,271   

Interest-earning assets

    1,293,718        1,356,912              1,304,274        1,283,045        1,332,232        1,385,232        1,386,300        1,352,956   

Investment securities available for sale, at fair value

    116,481        120,505              115,274        117,702        120,606        115,377        117,532        119,238   

Total loans

    1,013,061        1,163,551              994,587        1,031,740        1,070,390        1,126,812        1,162,453        1,130,809   

Deposits (including traditional and nontraditional)

    1,187,044        1,204,990              1,192,535        1,181,492        1,248,568        1,270,659        1,255,242        1,232,526   

Other short-term borrowings

    1        9,997              —          2        112        1,386        6,605        15,447   

FHLB borrowings

    97,822        73,220              95,998        99,666        84,063        82,000        53,647        68,054   

Convertible debt

    193        —                380        4        —          —          —          —     

Shareholders’ equity

    73,660        118,411              70,705        76,648        88,879        102,298        118,922        106,906   
                                                                     

SELECT PERFORMANCE RATIOS

                     

Return on average assets

    (2.03 ) %      (2.26 ) %            (2.49 ) %      (1.57 ) %      (2.79 ) %      (3.84 ) %      (4.97 ) %      (2.80 ) % 

Return on average shareholders’ equity

    (37.85     (27.00           (48.41     (28.00     (44.87     (54.97     (60.21     (37.50

Net interest margin

    3.36        3.37              3.30        3.41        3.16        3.30        2.97        3.31   
                                                                     

CAPITAL RATIOS

                     

Average shareholders’ equity as a percentage of average assets

    5.37     8.37           5.15     5.60     6.21     6.99     8.25     7.47

Shareholders’ equity as a percentage of assets, at period end

    4.51        6.83              4.51        5.26        5.22        6.19        6.83        5.22   

Tier 1 risk-based capital

    5.81        8.46              5.81        6.82        6.99        7.50        8.46        6.99   

Total risk-based capital

    7.08        9.71              7.08        8.09        8.25        8.76        9.71        8.25   

Tier 1 leverage ratio

    4.34        7.17              4.34        5.30        5.55        5.99        7.17        5.55   
                                                                     

ASSET QUALITY INFORMATION

                     

Allowance for loan losses

  $ 28,383      $ 21,965            $ 28,383      $ 28,426      $ 24,079      $ 22,548      $ 21,965      $ 24,079   

Nonaccrual loans

    91,653        95,549              91,653        113,181        96,936        92,532        95,549        96,936   

Nonperforming assets

    118,280        113,413              118,280        142,161        124,950        120,297        113,413        124,950   

Net loans charged-off

    19,196        21,210              12,793        6,403        15,694        23,417        20,641        60,321   

Allowance for loan losses as a percentage of gross loans

    2.93     1.95           2.93     2.81     2.31     2.09     1.95     2.31

Nonaccrual loans as a percentage of gross loans and foreclosed assets

    9.22        8.35              9.22        10.89        9.07        8.35        8.35        9.07   

Nonperforming assets as a percentage of assets

    8.52        7.74              8.52        10.54        8.70        8.44        7.74        8.70   

Net loans charged-off as a percentage of average gross loans

    3.83        3.70              5.17        2.53        5.83        8.28        7.18        5.36   
                                                                     

 

29


Table of Contents

Executive Summary of Second Quarter 2010 Financial Results

Context for the Three Month Period Ended June 30, 2010 and the Company

2009 was a very challenging year for the Company, the banking industry, and the U.S. economy in general, and these challenges have continued into 2010. In relation to the Company, the overall economic context for our financial condition and results of operations include the following:

 

   

Ongoing financial crisis in the overall U.S. economy that generally started in August 2008 and continued in 2009, for which the banking industry and the Company continue to be adversely affected.

 

   

Volatile equity markets that declined significantly during the first half of 2009 and have since begun to improve although daily volatility continues.

 

   

Significant stress on the banking industry with significant financial assistance to many financial institutions, extensive regulatory and congressional scrutiny, and new regulatory rules and requirements.

 

   

General anxiety on the part of our customers and the general public.

 

   

Uncertainty about the future and when the economy will return to “normal” and questions about what will be the “new normal.”

 

   

Low and uncertain interest rate environment particularly given the government intervention in the financial markets, with current expectations of rising interest rates although the timing is uncertain.

 

   

High levels of unemployment nationally and in our local markets, and uncertainty about when the trend will begin to improve.

Additional context specific to the Company includes the following:

 

   

Fast growth from 2004 through the first quarter of 2009 growing total assets 57% during that period that resulted in the Company reaching a natural “maturity/life cycle hump” that is typical for banks that reach that asset size. Typical challenges associated with this stage of our life cycle include:

 

   

Stress on our infrastructure requiring investment in the number and expertise of employees and refinement of policies and procedures.

 

   

Required investments in technology to invest in the future, and rationalization of the technology investments versus our historical investment in facilities.

 

   

Adapting products and services and related pricing and fees to remain relevant to our current and evolving customer base and competitiveness in the market place, and development of broader distribution channels for delivery of our products and services.

 

   

Application of a more sophisticated risk management approach, including a comprehensive view of risk, processes and procedures, internal and vendor expertise, and the “way we do business.”

 

   

Executive management succession plan implemented effective July 1, 2009 and resulting organizational changes.

 

   

In planning for the retirement of the former Chief Executive Officer of the Company and the Chief Executive Officer of the Bank (who also served as the President, Chief Operating Officer, and Chief Accounting Officer of the Company), the Company hired Samuel L. Erwin in March 2009 and Lee. S. Dixon in May 2009 as senior executive vice presidents. Effective July 1, 2009, the Company named Mr. Erwin as Chief Executive Officer and President of the Bank and Mr. Dixon as Chief Operating Officer of the Company and the Bank. Subsequently, Mr. Erwin also assumed the title of Chief Executive Officer of the Company on January 1, 2010, and Mr. Dixon assumed additional responsibilities as Chief Risk Officer of the Company and the Bank in October 2009, and, subject to regulatory approval, will also assume the role of Chief Financial Officer as of July 1, 2010.

 

   

Messrs. Erwin and Dixon have proven bank turn around and operational capabilities and rapidly developed and implemented the Company’s Strategic Project Plan in June 2009 as summarized below.

 

   

Significant deterioration in asset quality during 2009 resulting in a net loss for 2009 which was the first annual net loss in the history of the Company since the Great Depression in the 1930s. We also incurred a net loss in the first and second quarters of 2010.

 

   

Increased regulatory scrutiny given declining asset quality, financial results and capital position, which resulted in the Bank entering into a Consent Order with the banking regulatory agencies in June 2010.

 

30


Table of Contents
   

Strategic repositioning and reduction of the balance sheet to reduce commercial real estate loan concentrations and individually larger and more complex loans originated during 2004 through 2008, as well as intentional reduction in the amount of higher priced certificates of deposit accounts used to fund the loan growth during that period. Gross loans have decreased $189.1 million from March 31, 2009 to June 30, 2010. Total traditional and nontraditional deposits increased $3.4 million over the same period through various certificate of deposit and transaction deposit campaigns designed to attract and retain lower priced deposit accounts.

In light of the above, in 2009, management and the Board of Directors reacted quickly and defined three strategic initiatives, which are currently summarized as follows:

 

Component

  

Primary Emphasis

  

Time Horizon

Strategic Project Plan   

•      Manage through the extended recession and volatile economic environment

 

•      Execute the Strategic Project Plan related to credit quality, earnings, liquidity, and capital (the Strategic Project Plan is described in more detail below), including preparation for a potential formal agreement with the bank regulatory agencies

   June 2009 – June 2010
2010 Annual Strategic Plan   

•      Strategic planning at the corporate and department level for calendar year 2010 in the context of the uncertain economic environment

 

•      Acceleration of overcoming the growth hump/life cycle stage of maturity resulting from fast growth reaching a high of $1.5 billion in assets

 

•      Positioning the Bank to return to profitability in the post-recession environment

   Calendar year 2010
Bank of the Future   

•      Reinventing the Bank to be “the bank of the future”

 

•      Determining the “customer of tomorrow” and refining our products, services, and distributions channels to meet their expectations

 

•      Adapting to the rapidly changing financial services landscape

 

•      Potential listing on the NASDAQ stock exchange

   Two to five years

We believe it is critical to focus on all three strategic initiatives simultaneously to optimize long-term shareholder value. As a result, management and the Board of Directors focused a tremendous amount of time and effort on addressing all three initiatives in 2009 and continuing into 2010 with the overall objectives being: 1) to aggressively deal with our credit quality and earnings issues as quickly as possible and 2) to accelerate into a much shorter time frame the “reinvention of The Palmetto Bank” that might otherwise normally take several years to accomplish. While many believe the recession officially ended in 2009, the impact of the recession is continuing to be felt by the banking industry and the Company. Accordingly, our focus has been and continues to be centered on managing through the effects of the recession to position the Company to return to profitability once the economy begins to recover.

Summary Financial Results and Company Response

The national and local economy and the banking industry continue to deal with the effects of the most pronounced recession in decades. Unemployment in South Carolina rose significantly throughout 2009 and into 2010 and is higher than the national average, and residential and commercial real estate projects are depressed with significant deterioration in values. As a result, the impact in our geographic area and to individual borrowers was severe. As a result of the extended recession, our financial results in the second quarters of 2009 and 2010 were significantly impacted by the following in comparison to our historical financial results in the second quarter of 2008:

 

   

Provision for loan losses totaling $12.8 million and $30.0 million, respectively, in 2010 and 2009 compared to $687 thousand for 2008.

 

   

Net loss from writedowns, expenses, operations, and sales of real estate acquired in settlement of loans totaling $2.6 million and $45 thousand in 2010 and 2009, respectively, compared to $38 thousand in 2008.

 

31


Table of Contents
   

Foregone interest of $1.1 million and $940 thousand in 2010 and 2009, respectively, compared to none in 2008 on cash invested at the Federal Reserve at 25 basis points to maintain liquidity versus the average yield on our investment securities of 2.74 and 5.05%, respectively.

 

   

Higher FDIC insurance premiums due to industry wide increases in general assessment rates, our voluntary participation in the FDIC’s Transaction Account Guarantee Program, our capital classification below well-capitalized, and the 2009 special assessment totaling $981 thousand and $1.4 million, respectively, in 2010 and 2009, compared to $183 thousand in 2008.

 

   

Higher credit-related expenses for problem asset workout and other expenses to execute the Strategic Project Plan which were not incurred prior to the second quarter 2009.

In total, the above reduced our earnings by approximately $16.5 million and $31.4 million for the three month periods ended June 30, 2010 and 2009, respectively, compared to the same period of 2008. Accordingly, management believes successful completion of the Strategic Project Plan will result in significant improvement to our earnings.

The credit-related costs for banks associated with the recession are significant. Beginning in the fourth quarter of 2008 and continuing into 2010, we recognized that construction, acquisition and development real estate projects were slowing, guarantors were becoming financially stressed, and increasing credit losses were surfacing. During 2009, delinquencies over 90 days increased resulting in an increase in nonaccrual loans indicating significant credit quality deterioration and probable losses. In particular, loans secured by real estate including acquisition, construction and development projects demonstrated stress given reduced cash flows of individual borrowers, limited bank financing and credit availability, and slow property sales. This deterioration manifested itself in our borrowers in several ways: the cash flows from underlying properties supporting the loans decreased (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties), cash flows from the borrowers themselves and guarantors were under pressure due to illiquid and diminished personal balance sheets resulting from investing additional personal capital in the projects, and fair values of real estate related assets declined, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers were no longer willing to sell the assets at such deep discounts.

The result of the above was a significant increase in the level of nonperforming assets through March 31, 2010, with a continued elevated level of such assets at June 30, 2010. In addition, many of these loans are collateral dependent real estate loans for which we are required to write down the loans to fair value less estimated costs to sell with the fair values determined primarily based on third party appraisals. During 2009 and continuing into 2010, appraised values decreased significantly even in comparison to appraisals received within the past 12 to 48 months. As a result, our evaluation of our loan portfolio and allowance for loan losses at June 30, 2010 resulted in net charge-offs of $12.8 million and a provision for loan losses of $12.8 million during the three month period ended June 30, 2010.

Recent Regulatory Developments

As a result of the above and the examination of the Bank by the FDIC and the State Board (collectively, the “Supervisory Authorities”) in November 2009, effective June 10, 2010, the Bank agreed to the issuance of a Consent Order with the Supervisory Authorities. Beginning in October 2009, the Board of Directors and a newly created committee of the Board of Directors, the Regulatory Oversight Committee, met periodically with these regulatory agencies to receive status reports on their examination, and the Board received the final report of examination in April 2010 and the Consent Order in June 2010. A summary of the requirements of the Consent Order and the Bank’s status on complying with the Consent Order is as follows:

 

Requirements of the Consent Order    Bank’s Compliance Status
Achieve and maintain, within 120 days from the effective date of the Consent Order, Total Risk Based capital at least equal to 10% of risk-weighted assets and Tier 1 capital at least equal to 8% of total assets.    As disclosed in more detail in this report, on May 25, 2010 and amended on June 8, 2010, the Company entered into a Stock Purchase Agreement with institutional investors pursuant to which the investors agreed to purchase approximately $103 million of shares of the Company’s common stock. Substantially all of the net proceeds of the Private Placement will be contributed to the Bank as a capital contribution. Successful completion of the Private Placement will result in the Company’s and the Bank’s capital levels being above the amounts necessary to be categorized as well-capitalized.

 

32


Table of Contents
Determine, within 30 days of the last day of the calendar quarter,
its capital ratios. If any capital measure falls below the established
minimum, within 30 days provide a written plan to the supervisory
authorities describing the means and timing by which the Bank
shall increase such ratios to or in excess of the established
minimums.
   At June 30, 2010, the Bank’s capital ratios were below the
established minimum and we have submitted a written plan to
the Supervisory Authorities describing our capital plan,
including the Private Placement summarized above.
   
Establish, within 30 days from the effective date of the Consent Order, a plan to monitor compliance with the Consent Order, which shall be monitored by the Bank’s Board of Directors.    We have implemented a plan to monitor compliance with the Consent Order.
   
Develop, within 60 days from the effective date of the Consent Order, a written analysis and assessment of the Bank’s management and staffing needs.    We have prepared a written analysis and assessment of the Bank’s management and staffing needs and have submitted the plan to the Supervisory Authorities.
   
Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers.    Effective June 30, 2010, Lauren S. Greer transitioned from her role as Chief Financial Officer of the Bank to the Director of Finance and Accounting. We have notified the Supervisory Authorities, and subject to their approval, effective July 1, 2010, Lee S. Dixon, our current Chief Operating Officer and Chief Risk Officer, will assume the responsibilities as the Chief Financial Officer. Mr. Dixon has substantial banking, regulatory, financial reporting, and risk management expertise from his 22 years of business experience, including as a partner in the Banking and Capital Markets practice of PricewaterhouseCoopers LLP, and has worked with banking clients ranging from small community banks to some of the largest national banks.
   
Eliminate, within 10 days from the effective date of the Consent Order, by charge-off or collection, all assets or portions of assets classified “Loss” and 50% of those assets classified “Doubtful.”    At June 30, 2010, we have complied with this provision and no additional reductions were required by this provision of the Consent Order.
   
Review and update, within 60 days from the effective date of the Consent Order, its policy to ensure the adequacy of the Bank’s allowance for loan and lease losses, which must provide for a review of the Bank’s allowance for loan and lease losses at least once each calendar quarter.    As part of our Strategic Project Plan summarized below, in 2009 we reviewed and updated our policy in June and October to ensure the adequacy of the allowance for loan losses, including a review of the allowance for loan losses each calendar quarter. We have continued to refine our policy in 2010. We have submitted the revised policy to the Supervisory Authorities.
   
Submit, within 60 days from the effective date of the Consent Order, a written plan to reduce classified assets, which shall include, among other things, a reduction of the Bank’s risk exposure in relationships with assets in excess of $1,000,000 which are criticized as “Substandard,” “Doubtful,” or “Special Mention”.    As part of our Strategic Project Plan summarized below, we have developed written loan workout plans to reduce classified assets, and we have submitted our plan to the Supervisory Authorities.