Attached files

file filename
EX-31.1 - SECTION 302 CEO CERTIFICATION - PALMETTO BANCSHARES INCdex311.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - PALMETTO BANCSHARES INCdex312.htm
EX-32 - SECTION 906 CEO AND CFO CERTIFICATION - PALMETTO BANCSHARES INCdex32.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 March 31, 2011

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   ¨
Non-accelerated filer   ¨    Smaller reporting company   x

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 April 26, 2011

Common stock, $0.01 par value   50,513,722

 

 

 


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Table of Contents

 

          Page  
PART I - FINANCIAL INFORMATION      3   

Item 1.

   Financial Statements      3   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      34   

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk      80   

Item 4.

   Controls and Procedures      81   
PART II - OTHER INFORMATION      82   

Item 1.

   Legal Proceedings      82   

Item 1A.

   Risk Factors      82   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      82   

Item 3.

   Defaults Upon Senior Securities      82   

Item 4.

   (Removed and Reserved)      82   

Item 5.

   Other Information      82   

Item 6.

   Exhibits      82   
SIGNATURES      83   

 

2


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)

 

     March 31,
2011
    December 31,
2010
 
     (unaudited)        

Assets

    

Cash and cash equivalents

    

Cash and due from banks

   $ 188,545      $ 223,017   
                

Total cash and cash equivalents

     188,545        223,017   

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

     6,785        6,785   

Investment securities available for sale, at fair value

     274,103        218,775   

Mortgage loans held for sale

     279        4,793   

Commercial loans held for sale

     60,346        66,157   

Loans, gross

     764,227        793,426   

Less: allowance for loan losses

     (26,954     (26,934
                

Loans, net

     737,273        766,492   

Premises and equipment, net

     28,072        28,109   

Accrued interest receivable

     5,017        4,702   

Foreclosed real estate

     16,244        19,983   

Income tax refund receivable

     7,436        7,436   

Other

     9,111        8,998   
                

Total assets

   $ 1,333,211      $ 1,355,247   
                

Liabilities and shareholders’ equity

    

Liabilities

    

Deposits

    

Noninterest-bearing

   $ 156,323      $ 141,281   

Interest-bearing

     1,021,367        1,032,081   
                

Total deposits

     1,177,690        1,173,362   

Retail repurchase agreements

     23,641        20,720   

FHLB borrowings

     5,000        35,000   

Accrued interest payable

     955        1,187   

Other

     10,080        11,079   
                

Total liabilities

     1,217,366        1,241,348   
                

Shareholders’ equity

    

Preferred stock - par value $0.01 per share; authorized 2,500,000 shares; none issued and outstanding

     —          —     

Common stock - par value $0.01 per share; authorized 75,000,000 shares; 50,513,722 and 47,409,078 issued and outstanding at March 31, 2011 and December 31, 2010

     505        474   

Capital surplus

     141,194        133,112   

Retained earnings (deficit)

     (19,188     (13,108

Accumulated other comprehensive loss, net of tax

     (6,666     (6,579
                

Total shareholders’ equity

     115,845        113,899   
                

Total liabilities and shareholders’ equity

   $ 1,333,211      $ 1,355,247   
                

See Notes to Consolidated Financial Statements

 

3


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

(in thousands, except per share date) (unaudited)

 

     For the three months ended
March 31,
 
     2011     2010  

Interest income

    

Interest earned on cash and cash equivalents

   $ 105      $ 67   

Dividends received on FHLB stock

     14        4   

Interest earned on investment securities available for sale

    

U.S. Treasury and federal agencies (taxable)

     6        7   

State and municipal (nontaxable)

     545        385   

Collateralized mortgage obligations (taxable)

     555        613   

Other mortgage-backed (taxable)

     200        198   

Interest and fees earned on loans

     11,569        13,605   
                

Total interest income

     12,994        14,879   

Interest expense

    

Interest paid on deposits

     2,676        3,563   

Interest paid on retail repurchase agreements

     11        14   

Interest paid on commercial paper

     —          10   

Interest paid on FHLB borrowings

     49        493   
                

Total interest expense

     2,736        4,080   
                

Net interest income

     10,258        10,799   

Provision for loan losses

     5,500        10,750   
                

Net interest income after provision for loan losses

     4,758        49   
                

Noninterest income

    

Service charges on deposit accounts, net

     1,762        1,950   

Fees for trust and investment management and brokerage services

     691        651   

Mortgage-banking

     376        429   

Automatic teller machine

     232        231   

Merchant services

     10        794   

Bankcard services

     76        156   

Investment securities gains, net

     —          8   

Other

     425        278   
                

Total noninterest income

     3,572        4,497   

Noninterest expense

    

Salaries and other personnel

     6,551        6,137   

Occupancy

     1,183        1,171   

Furniture and equipment

     985        967   

Professional services

     510        547   

FDIC deposit insurance assessment

     958        715   

Marketing

     414        295   

Foreclosed real estate writedowns and expenses

     833        1,012   

Loss on commercial loans held for sale

     1,151        —     

Other

     1,773        2,036   
                

Total noninterest expense

     14,358        12,880   
                

Net loss before provision (benefit) for income taxes

     (6,028     (8,334

Provision (benefit) for income taxes

     52        (3,042
                

Net loss

   $ (6,080   $ (5,292
                

Common and per share data

    

Net loss - basic

   $ (0.12   $ (0.82

Net loss - diluted

     (0.12     (0.82

Cash dividends

     —          —     

Book value

     2.29        10.93   

Weighted average common shares outstanding - basic

     49,453,501        6,455,598   

Weighted average common shares outstanding - diluted

     49,453,501        6,455,598   

See Notes to Consolidated Financial Statements

 

4


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
(deficit)
    Accumulated
other
comprehensive
income (loss), net
    Total  

Balance at December 31, 2009

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

Net loss

              (5,292       (5,292

Other comprehensive income (loss), net of tax

               

Investment securities available for sale

               

Change in unrealized position during the period, net of tax impact of $715

                1,169     

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

                (5  
                     

Net unrealized gain on investment securities available for sale

                  1,164   
                     

Comprehensive loss

                  (4,128

Compensation expense related to stock option plan

           7             7   

Common stock issued pursuant to restricted stock plan

     —           13         71             84   
                                                   

Balance at March 31, 2010

     6,495,130       $ 32,295       $ 2,677       $ 41,802      $ (5,796   $ 70,978   
                                                   

Balance at December 31, 2010

     47,409,078       $ 474       $ 133,112       $ (13,108   $ (6,579   $ 113,899   

Net loss

              (6,080       (6,080

Other comprehensive income (loss), net of tax

               

Investment securities available for sale

               

Change in unrealized position during the period, net of tax impact of $53

                (87  

Reclassification adjustment included in net income, net of tax impact of $0

                —       
                     

Net unrealized loss on investment securities available for sale

                  (87
                     

Comprehensive loss

                  (6,167

Common stock issued pursuant to restricted stock plan

     34,614         —           162             162   

Common stock issued pursuant to Follow-On Offering

     3,070,030         31         7,920             7,951   
                                                   

Balance at March 31, 2011

     50,513,722       $ 505       $ 141,194       $ (19,188   $ (6,666   $ 115,845   
                                                   

See Notes to Consolidated Financial Statements

 

5


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows

(in thousands) (unaudited)

 

     For the three months
ended March 31,
 
Operating Activities    2011     2010  

Net loss

   $ (6,080   $ (5,292

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

    

Depreciation

     598        625   

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

     1,327        31   

Decrease in income tax refunds receivable

     —          20,131   

Provision for loan losses

     5,500        10,750   

Gain on sales of mortgage loans held for sale, net

     (300     (343

Loss on commercial loans held for sale

     1,151        —     

Writedowns, gains and losses of sales of foreclosed real estate

     515        799   

Loss on prepayment of FHLB advances

     136        —     

Investment securities gains

     —          (8

Originations of mortgage loans held for sale

     (11,410     (15,008

Proceeds from sale of mortgage loans held for sale

     16,224        18,114   

Compensation expense related to stock options granted

     —          7   

Restricted stock compensation expense

     162        84   

Increase in interest receivable and other assets, net

     (374     (3,364

Increase (decrease) in interest payable and other liabilities, net

     (1,231     1,000   
                

Net cash provided by operating activities

     6,218        27,526   
                

Investing Activities

    

Proceeds from sales of investment securities available for sale

     —          40,191   

Proceeds from maturities of investment securities available for sale

     38,870        13,245   

Purchases of investment securities available for sale

     (107,031     (51,233

Repayments on mortgage-backed investment securities available for sale

     11,365        3,743   

Proceeds from sale of commercial loans held for sale

     2,132        —     

Repayments on commercial loans held for sale

     596        —     

Decreases in loans, net

     21,887        19,769   

Proceeds on sale of foreclosed real estate

     6,988        2,053   

Purchases of premises and equipment, net

     (561     (1,245
                

Net cash (used for) provided by investing activities

     (25,754     26,523   
                

Financing Activities

    

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

     31,418        (584

Decrease in time deposit accounts, net

     (27,090     (85,717

Increase in retail repurchase agreements, net

     2,921        5,872   

Decrease in commercial paper, net

     —          (113

Repayment of FHLB borrowings

     (30,136     (5,000

Proceeds from issuance of common stock, net

     7,951        —     

Proceeds from issuance of convertible debt

     —          380   
                

Net cash used for financing activities

     (14,936     (85,162
                

Net change in cash and due from banks

     (34,472     (31,113

Cash and due from banks at beginning of period

     223,017        188,073   
                

Cash and due from banks at end of period

   $ 188,545      $ 156,960   
                

Supplemental cash flow disclosures

    

Cash paid (received) during the period for:

    

Interest expense

   $ 2,968      $ 4,572   

Income tax refunds received, net

     —          20,933   

Significant noncash activities

    

Change in net unrealized gain (loss) on investment securities available for sale, net of tax

     (87     1,164   

Loans transferred from gross loans to commercial loans held for sale

     1,224        —     

Commercial loans held for sale transferred to foreclosed real estate

     3,156        —     

Gross loans transferred to foreclosed real estate, at fair value

     608        3,893   

See Notes to Consolidated Financial Statements

 

6


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 in this Quarterly Report on Form 10-Q 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 months ended March 31, 2011 and 2010 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 GAAP for complete financial statements and should be read in conjunction with the Consolidated Financial Statements, and notes thereto, for the year ended December 31, 2010, included in our Annual Report on Form 10-K filed with the SEC on February 28, 2011.

Subsequent Events

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements. Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date. The Company has reviewed events occurring through the date of this filing and no subsequent events have occurred requiring accrual or disclosure in these financial statements in addition to any included herein.

Business Segments

Operating segments are components of an enterprise about which separate financial information is available and are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and assess performance. Public enterprises are required to report a measure of segment profit or loss, certain specific revenue and expense items for each segment, segment assets, and information about the way that the operating segments were determined, among other items.

The Company considers business segments by analyzing distinguishable components that are engaged in providing individual products, services, or groups of related products or services and that are subject to risks and returns that are different from those of other business segments. When determining whether products and services are related, the Company considers the nature of the products or services, the nature of the production processes, the type or class of customer for which the products or services are designed, and the methods used to distribute the products or provide the services.

 

7


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

During 2009 and 2010, the Company realigned its organizational structure and began the process of more specifically delineating its businesses. However, at this time the Company does not yet have in place a reporting structure to separately report and evaluate various lines of businesses. Accordingly, at March 31, 2011 the Company had one reportable operating segment.

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 periods presented. Actual results could differ from these estimates and assumptions. Therefore, the results of operations for the three months ended March 31, 2011 are not necessarily indicative of the results of operations that may be expected in future periods or for the year ended December 31, 2011.

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 overall 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 resulting from borrowers’ inability or unwillingness to make contractually required payments, or default on repayment of investment securities. Market risk primarily includes interest rate risk. The Company is exposed to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or different bases, than its interest-earning assets. Market risk also reflects the risk of declines in the valuation of loans held for sale, 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 its 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 default and losses if those borrowers, or the value of such type of collateral, is 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 Company and the Bank are subject to the regulations of various government agencies. These regulations can and do change significantly from period to period. The Company and the Bank also undergo periodic examinations by regulatory agencies, which may subject them to changes with respect to asset valuations, amount of required allowance for loan loss, capital levels or operating restrictions.

Recently Adopted / Issued Accounting Pronouncements

In April 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2011-02 Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (“ASU 2011-02”). ASU 2011-02 amends Topic 310 of the FASB Accounting Standards Codification to clarify when creditors should classify loan modifications as troubled debt restructurings. As amended, Topic 310 states that a troubled debt restructuring occurs when a creditor, for economic or legal reasons related to a debtor’s financial difficulties, grants a concession to the debtor that it wouldn’t otherwise consider. For public entities, the amendments promulgated by ASU 2011-02 are effective for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The provisions of ASU 2011-02 could result in more loan modifications being classified as troubled debt restructurings, which could affect the aggregate amount of the Company’s TDRs and therefore the calculation of the allowance for loan losses, and increase disclosures. The Company is in the process of evaluating the impact of ASU 2011-02 on its financial position, results of operations and cash flows.

 

8


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

In July 2010, the FASB issued Accounting Standards Update No. 2010-20 Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (“ASU 2010-20”). ASU 2010-20 expanded disclosures related to allowance for credit losses and the credit quality of financing receivables. The update requires the allowance and other credit quality disclosures to be provided on a disaggregated basis. The Company adopted the period-end disclosure provisions of this update as of December 31, 2010. Accordingly, the Company adopted the activity-based disclosure provisions of this amendment during the first quarter 2011.

Other accounting standards that have been recently 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)

The Company discloses changes in comprehensive income in the 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.

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

 

     For the three months ended
March 31,
 
     2011     2010  

Net unrealized Gains on Investment Securities Available for Sale

    

Balance, beginning of period

   $ 1,264      $ 306   

Other comprehensive income (loss):

    

Unrealized holding gains (losses) arising during the period

     (140     1,884   

Income tax (expense) benefit

     53        (715

Less: Reclassification adjustment for gains included in net loss

     —          (8

Income tax expense (benefit)

     —          3   
                
     (87     1,164   
                

Balance, end of period

     1,177        1,470   
                

Net unrealized Losses on Impact of Defined Benefit Pension Plan

    

Balance, beginning of period

     (7,843     (7,266

Other comprehensive loss:

    

Impact of FASB ASC 715

     —          —     

Income tax benefit

     —          —     
                
     —          —     
                

Balance, end of period

     (7,843     (7,266
                
   $ (6,666   $ (5,796
                

Total other comprehensive income (loss), end of period

   $ (87   $ 1,164   

Net loss

     (6,080     (5,292
                

Comprehensive loss

   $ (6,167   $ (4,128
                

The Company made a $1.3 million contribution to the pension plan during March 2011; however, the market value of pension plan assets is only assessed and adjusted through accumulated other comprehensive income (loss) annually, if necessary.

 

2. Cash and Cash Equivalents

Noninterest-Earning Deposits with Financial Institutions

There were no noninterest-earning deposits with financial institutions included in the Cash and due from banks line item in the Consolidated Balance Sheets at March 31, 2011 and December 31, 2010.

Required Reserve Balances

The Federal Reserve Act requires each depository institution to maintain reserves against certain liabilities as prescribed by regulations of the Board of Governors of the Federal Reserve (the “Federal Reserve”). The Bank reports these liabilities to the Federal Reserve on a weekly basis. Weekly reporting institutions maintain reserves on these liabilities with a 30-day lag. For the maintenance period ended on April 20, 2011, based on reported liabilities from March 8, 2011 through March 21, 2011, the Federal Reserve required the Bank to maintain reserves of $12.3 million. After taking into consideration the Company’s levels of vault cash, reserves of $2.5 million were required to be maintained with the Federal Reserve.

Concentrations and Restrictions

 

9


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

In an effort to manage counterparty risk, the Company generally does not sell federal funds to other financial institutions. Federal funds are essentially uncollateralized overnight loans. The Company regularly evaluates the risk associated with the counterparties to these potential transactions to ensure that it would not be exposed to any significant risks with regard to cash and cash equivalent balances.

Cash and cash equivalents pledged as collateral and therefore restricted at the dates indicated are as follows (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Merchant credit card agreements

   $ 452       $ 451   

Contractually restricted balances for check clearing

     1,929         1,929   
                 

Total

   $ 2,381       $ 2,380   
                 

In April 2011, $1.0 million of the contractually restricted balances for check clearing were freed of restriction and returned to the Company.

 

3. Investment Securities Available for Sale

The following tables summarize the amortized cost, gross unrealized gains and losses included in accumulated other comprehensive income, and fair values of investment securities available for sale at the dates indicated (in thousands). At March 31, 2011 and December 31, 2010 the Company did not have any investment securities classified as held to maturity.

 

     March 31, 2011  
     Amortized
cost
     Gross
unrealized
gains
     Gross
unrealized
losses
    Fair value  

State and municipal

   $ 104,288       $ 1,695       $ (324   $ 105,659   

Collateralized mortgage obligations

     148,480         973         (918     148,535   

Other mortgage-backed (federal agencies)

     19,439         596         (126     19,909   
                                  

Total investment securities available for sale

   $ 272,207       $ 3,264       $ (1,368   $ 274,103   
                                  
     December 31, 2010  
     Amortized
cost
     Gross
unrealized
gains
     Gross
unrealized
losses
    Fair value  

U.S. Treasury and federal agencies

   $ 37,430       $ 2       $ (6   $ 37,426   

State and municipal

     51,243         1,687         (468     52,462   

Collateralized mortgage obligations

     107,876         671         (376     108,171   

Other mortgage-backed (federal agencies)

     20,189         647         (120     20,716   
                                  

Total investment securities available for sale

   $ 216,738       $ 3,007       $ (970   $ 218,775   
                                  

In April 2011, the Company purchased additional mortgage-backed and state and municipal investment securities aggregating approximately $12.4 million and sold its remaining private-table CMO for $2.3 million, recognizing a $56 thousand gain.

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).

 

10


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     March 31, 2011  
     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

     24         16,021         324         —           —           —           24         16,021         324   

Collateralized mortgage obligations

     20         72,738         842         3         7,261         76         23         79,999         918   

Other mortgage-backed (federal agencies)

     3         6,600         126         —           —           —           3         6,600         126   
                                                                                

Total investment securities available for sale

     47       $ 95,359       $ 1,292         3       $ 7,261       $ 76         50       $ 102,620       $ 1,368   
                                                                                
     December 31, 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

     2       $ 21,428       $ 6         —         $ —         $ —           2       $ 21,428       $ 6   

State and municipal

     12         7,211         468         —           —           —           12         7,211         468   

Collateralized mortgage obligations

     10         38,295         376         —           —           —           10         38,295         376   

Other mortgage-backed (federal agencies)

     3         6,861         120         —           —           —           3         6,861         120   
                                                                                

Total investment securities available for sale

     27       $ 73,795       $ 970         —         $ —         $ —           27       $ 73,795       $ 970   
                                                                                

Other-Than-Temporary Impairment

Based on its other-than-temporary impairment analysis at March 31, 2011, the Company 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 March 31, 2011. 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.

 

     State
and
municipal
    Collateralized
mortgage
obligations
    Other
mortgage-backed
(federal agencies)
 

Aaa

     14     100     100

Aa1-A3

     56        —          —     

Baa1

     5        —          —     

Not rated or withdrawn rating

     25        —          —     
                        

Total

     100     100     100
                        

The following table summarizes by Standard and Poor’s ratings, by segment, of the investment securities available for sale based on fair value, at March 31, 2011.

 

     State
and
municipal
    Collateralized
mortgage
obligations
    Other
mortgage-backed
(federal agencies)
 

Aaa

     18     100     100

Aa+-A

     53        —          —     

Not rated or withdrawn rating

     29        —          —     
                        

Total

     100     100     100
                        

One state and municipal security totaling $203 thousand was not rated by either Moody’s or Standard and Poor’s.

Maturities

The following table summarizes the amortized cost and estimated fair value of investment securities available for sale at March 31, 2011 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.

 

11


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     Amortized cost      Fair value  

Due in one year or less

   $ 3,500       $ 3,549   

Due after one year through five years

     23,538         24,634   

Due after five year through ten years

     38,227         38,693   

Due after ten years

     39,023         38,783   

Collateralized mortgage obligations

     148,480         148,535   

Other mortgage-backed securities (federal agencies)

     19,439         19,909   
                 

Total investment securities available for sale

   $ 272,207       $ 274,103   
                 

The weighted average life of investment securities available for sale was 4.5 years, based on expected prepayment activity, at March 31, 2011. Since 62% of the portfolio, based on amortized cost, consists of 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

Investment securities were pledged as collateral for the following at the dates indicated (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Public funds deposits

   $ 97,531       $ 67,260   

FHLB advances and line of credit

     24,654         48,344   
                 

Total

   $ 122,185       $ 115,604   
                 

Concentrations

The following table summarizes issuer concentrations of collateralized mortgage obligations whose aggregate book values exceed 10% of shareholders’ equity at March 31, 2011 (dollars in thousands).

 

Issuer

   Aggregate
fair value
     Aggregate
amortized cost
     Amortized cost as a % of
shareholders’ equity
 

Freddie Mac

   $ 48,389       $ 48,357         41.7

Fannie Mae

     39,506         39,381         34.0

Ginnie Mae

     55,769         56,038         48.4

The following table summarizes issuer concentrations of other mortgage-backed investment securities whose book values exceed 10% of shareholders’ equity at March 31, 2011 (dollars in thousands).

 

Issuer

   Aggregate
fair value
     Aggregate
amortized cost
     Amortized cost as a % of
shareholders’ equity
 

Fannie Mae

   $ 14,772       $ 14,300         12.3

Although there are no state and municipal investment securities with state issuer concentrations whose aggregate book values exceed 10% of shareholders’ equity at March 31, 2011, three state issuers, Michigan, Texas, and South Carolina, exceeded 9% of shareholders’ equity at March 31, 2011. These securities represented 31.6% of the total state and municipal portfolio and 12.2% of the total investment securities portfolio at March 31, 2011.

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 months

ended March 31,

 
     2011      2010  

Realized gains

   $ —         $ 1,147   

Realized losses

     —           (1,139
                 

Net realized gains

   $ —         $ 8   
                 

 

4. Loans

 

12


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

The tabular disclosures in this Note include amounts related to commercial loans held for sale, which are reported separately from the Company’s gross loan portfolio on the Consolidated Balance Sheets and are subject to different accounting and reporting requirements. Inclusion of commercial loans held for sale with the related disclosures for loans held for investment provides a more accurate and relevant picture of the Company’s loan exposures based on the characteristics of commercial loans held for sale.

Composition

The following table summarizes gross loans and commercial loans held for sale, categorized by portfolio segment, at the dates indicated (dollars in thousands).

 

     March 31, 2011     December 31, 2010  
     Total     % of total     Total     % of total  

Commercial real estate

   $ 543,683        65.9   $ 573,822        66.8

Single-family residential

     175,332        21.3        178,980        20.8   

Commercial and industrial

     48,624        5.9        47,812        5.6   

Consumer

     50,884        6.2        52,652        6.1   

Other

     6,050        0.7        6,317        0.7   
                                

Total loans

   $ 824,573        100.0   $ 859,583        100.0
                    

Less: Commercial loans held for sale

     (60,346       (66,157  
                    

Loans, gross

   $ 764,227        $ 793,426     
                    

Loans included in the preceding table are net of participations sold, unearned income, charge-offs, and unamortized deferred fees and costs on originated loans. Participations sold totaled $12.3 million and $12.5 million at March 31, 2011 and December 31, 2010, respectively. Unearned income, deferred fees and costs, and discounts and premiums totaled $279 thousand and $299 thousand at March 31, 2011 and December 31, 2010, respectively.

Pledged

To borrow from the Federal Home Loan Bank (the “FHLB”), members must pledge collateral. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and qualifying commercial loans. At March 31, 2011 and December 31, 2010, $362.9 million and $393.7 million of gross loans, respectively, were pledged to collateralize FHLB advances and letters of credit of which $87.0 million and $92.5 million, respectively, was available as lendable collateral.

At March 31, 2011 and December 31, 2010, $10.8 million and $10.9 million, respectively, of loans were pledged as collateral to cover the various Federal Reserve System services that are available for use by the Company. Effective March 11, 2011, the Company may borrow from the FHLB for terms up to 3 years, subject to availability of collateral. Previously from January 2010 to March 2011, the maximum maturity for potential borrowings was overnight. Any future potential borrowings from the Federal Reserve Discount Window would be at the secondary credit rate and must be used for operational issues. The Federal Reserve has the discretion to deny approval of borrowing requests.

Concentrations

The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at March 31, 2011 (dollars in thousands). Of the aggregate balance of commercial loans held for sale, 99.4% are commercial real estate loans based on FDIC code.

 

13


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

    Commercial
real  estate
included in
gross loans
    Commercial
real estate
included in

commercial
loans held

for sale
    Total
commercial
real estate
loans
    % of gross loans
and commercial
loans held for sale
    % of Bank’s
total  regulatory
capital
 

Secured by commercial real estate

         

Construction, land development, and other land loans

  $ 112,579      $ 8,884      $ 121,463        14.7     91.8

Multifamily residential

    18,143        7,475        25,618        3.1        19.4   

Nonfarm nonresidential

    352,977        43,625        396,602        48.1        299.8   
                                       

Total loans secured by commercial real estate

  $ 483,699      $ 59,984      $ 543,683        65.9     411.0
                                       

The following table further categorizes loans secured by commercial real estate at March 31, 2011 (dollars in thousands).

 

    Commercial
real  estate
included in
gross loans
    Commercial
real  estate
included in
commercial
loans  held
for sale
    Total
commercial
real estate
loans
    % of gross loans
and  commercial
loans held for
sale
    % of Bank’s
total  regulatory
capital
 

Development commercial real estate loans

         

Secured by:

         

Land - unimproved (commercial or residential)

  $ 43,714      $ 1,161      $ 44,875        5.4     33.9

Land development - commercial

    12,515        463        12,978        1.6        9.8   

Land development - residential

    41,541        7,260        48,801        5.9        36.9   

Commercial construction:

         

Retail

    4,420        —          4,420        0.5        3.3   

Office

    239        —          239        0.0        0.2   

Multifamily

    1,250        —          1,250        0.2        1.0   

Industrial and warehouse

    930        —          930        0.1        0.7   

Miscellaneous commercial

    3,312        —          3,312        0.4        2.5   
                                       

Total development commercial real estate loans

    107,921        8,884        116,805        14.1        88.3   

Existing and other commercial real estate loans

         

Secured by:

         

Hotel / motel

    18,143        7,475        25,618        3.1        19.4   

Retail

    55,764        33,378        89,142        10.8        67.4   

Office

    15,735        4,313        20,048        2.4        15.2   

Multifamily

    23,270        1,409        24,679        3.0        18.7   

Industrial and warehouse

    11,945        1,489        13,434        1.6        10.2   

Healthcare

    12,891        —          12,891        1.6        9.7   

Miscellaneous commercial

    115,207        2,570        117,777        14.3        89.0   

Residential construction - speculative

    863        —          863        0.1        0.6   
                                       

Total existing and other commercial real estate loans

    253,818        50,634        304,452        36.9        230.2   

Commercial real estate owner occupied and residential loans

         

Secured by:

         

Commercial - owner occupied

    118,165        466        118,631        14.4        89.7   

Commercial construction - owner occupied

    1,711        —          1,711        0.2        1.3   

Residential construction - contract

    2,084        —          2,084        0.3        1.5   
                                       

Total commercial real estate owner occupied and residential loans

    121,960        466        122,426        14.9        92.5   
                                       

Total loans secured by commercial real estate

  $ 483,699      $ 59,984      $ 543,683        65.9     411.0
                                       

Asset Quality

Credit Quality Indicators. The Company regularly monitors the credit quality of its loan portfolio. Credit quality refers to the current and expected ability of borrowers to repay their obligations according to the contractual terms of such loans. Credit quality is evaluated through assignment of individual loan grades, as well as past-due and performing status analysis. Credit quality indicators allow the Company to assess the inherent loss on certain individual and pools of loans. See Note 4 of the Company’s Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2010, as filed with the SEC on February 28, 2011, for a more detailed discussion of loan grading criteria and other credit quality indicators.

The following table summarizes the Company’s internal credit quality indicators on gross loans and commercial loans held for sale, by class, at March 31, 2011 (in thousands).

 

14


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

    Construction,  land
development

and other land
loans
    Multifamily
residential
    Nonfarm
nonresidential
    Commercial
real estate
in  commercial
loans held

for sale
    Total
commercial
real estate
 

Grade 1

  $ —        $ —        $ —        $ —        $ —     

Grade 2

    —          —          813        —          813   

Grade 3

    9,748        3,685        124,399        —          137,832   

Grade 4

    10,075        543        101,119        —          111,737   

Grade W

    7,482        1,069        21,854        —          30,405   

Grade 5

    7,232        11,068        41,341        4,060        63,701   

Grade 6

    35,894        1,754        59,655        38,314        135,617   

Grade 7

    17,837        —          3,252        17,610        38,699   

Not risk rated*

    24,312        24        543        —          24,879   
                                       
  $ 112,580      $ 18,143      $ 352,976      $ 59,984      $ 543,683   
                                 

Less: Commercial real estate included in commercial loans held for sale

            (59,984
               

Total

          $ 483,699   
               

* -Consumer real estate loans of $24.3 million, included within construction, land development, and other land loans, are not risk rated, in accordance with our policy

 

     Commercial and
industrial
 

Grade 1

   $ 1,916   

Grade 2

     433   

Grade 3

     16,659   

Grade 4

     16,837   

Grade W

     4,123   

Grade 5

     1,212   

Grade 6

     5,251   

Grade 7

     1,242   

Not graded **

     951   
        

Total

   $ 48,624   
        

** - Primarily represents indirect auto loans underwritten as consumer loans but classified as commercial and industrial since loans were made to the customer’s business. These loans were subsequently rated as Grade 3 credits in April 2011.

 

    Single-family
residential revolving,
open end loans
    Single-family
residential closed end,
first lien
    Single-family
residential closed end,
junior lien
    Single-family
residential loans in
commercial loans held

for sale
    Total  single-family
residential loans
 

Performing

  $ 57,433      $ 100,620      $ 8,041      $ —        $ 166,094   

Nonperforming

    875        7,395        606        362        9,238   
                                       

Total

  $ 58,308      $ 108,015      $ 8,647      $ 362      $ 175,332   
                                 

Less: Single-family residential loans included in commercial loans held for sale

            (362
               

Total

          $ 174,970   
               

 

     Credit cards      Consumer-other      Total Consumer  

Performing

   $ —         $ 50,380       $ 50,380   

Nonperforming

     26         478         504   
                          

Total

   $ 26       $ 50,858       $ 50,884   
                          

 

     Other  

Performing

   $ 6,050   

Nonperforming

     —     
        

Total

   $ 6,050   
        

The following table summarizes the Company’s internal credit quality indicators on gross loans and commercial loans held for sale, by class, at December 31, 2010 (in thousands).

 

15


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

    Construction,  land
development

and other land
loans
    Multifamily
residential
    Nonfarm
nonresidential
    Commercial
real estate
in  commercial
loans held

for sale
    Total
commercial
real estate
 

Grade 1

  $ 53      $ —        $ —        $ —        $ 53   

Grade 2

    —          —          834        —          834   

Grade 3

    13,188        3,728        131,695        —          148,611   

Grade 4

    9,146        549        99,182        —          108,877   

Grade W

    10,654        1,085        28,268        —          40,007   

Grade 5

    7,550        11,168        41,046        4,114        63,878   

Grade 6

    34,157        1,769        59,440        42,450        137,816   

Grade 7

    21,071        —          3,622        18,661        43,354   

Not risk rated*

    29,512        28        852        —          30,392   
                                       
  $ 125,331      $ 18,327      $ 364,939      $ 65,225      $ 573,822   
                                 

Less: Commercial real estate included in commercial loans held for sale

            (65,225
               

Total

          $ 508,597   
               

* -Consumer real estate loans of $29.5 million, included within construction, land development, and other land loans, are not risk rated, in accordance with our policy

 

     Commercial and
industrial
 

Grade 1

   $ 1,932   

Grade 2

     487   

Grade 3

     22,027   

Grade 4

     10,534   

Grade W

     3,778   

Grade 5

     1,171   

Grade 6

     5,779   

Grade 7

     1,736   

Not graded

     368   
        

Total

   $ 47,812   
        

 

    Single-family
residential  revolving,

open end loans
    Single-family
residential closed end,
first lien
    Single-family
residential closed end,

junior lien
    Single-family
residential loans in

commercial loans held
for sale
    Total single-family
residential loans
 

Performing

  $ 58,874      $ 101,414      $ 8,289      $ —        $ 168,577   

Nonperforming

    998        7,607        866        932        10,403   
                                       

Total

  $ 59,872      $ 109,021      $ 9,155      $ 932      $ 178,980   
                                 

Less: Single-family residential loans included in commercial loans held for sale

            (932
               

Total

          $ 178,048   
               

 

     Credit cards      Consumer-other      Total Consumer  

Performing

   $ 126       $ 52,041       $ 52,167   

Nonperforming

     26         459         485   
                          

Total

   $ 152       $ 52,500       $ 52,652   
                          

 

     Other  

Performing

   $ 6,317   

Nonperforming

     —     
        

Total

   $ 6,317   
        

The following table summarizes delinquencies, by class, at March 31, 2011 (in thousands).

 

16


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     30-89 Days
Past Due
     Greater than
90 Days Past
Due

on Nonaccrual
    Recorded
Investment > 90

Days
and Accruing
     Total
Past  Due
    Current     Total loans  

Construction, land development and other land loans

   $ 2,415       $ 52,386      $ —         $ 54,801      $ 66,662      $ 121,463   

Multifamily residential

     —           7,475        —           7,475        18,143        25,618   

Nonfarm nonresidential

     1,271         14,063        —           15,334        381,268        396,602   
                                                  

Total commercial real estate

     3,686         73,924        —           77,610        466,073        543,683   
                                                  

Single-family real estate, revolving, open end loans

     559         875        10         1,444        56,864        58,308   

Single-family real estate, closed end, first lien

     2,634         7,395        187         10,216        98,161        108,377   

Single-family real estate, closed end, junior lien

     159         606        —           765        7,882        8,647   
                                                  

Total single-family residential

     3,352         8,876        197         12,425        162,907        175,332   
                                                  

Commercial and industrial

     416         1,795        —           2,211        46,413        48,624   

Credit cards

     —           26        —           26        —          26   

All other consumer

     512         478        —           990        49,868        50,858   
                                                  

Total consumer

     512         504        —           1,016        49,868        50,884   
                                                  

Farmland

     521         —          —           521        3,036        3,557   

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

     —           —          —           —          961        961   

Other

     —           —          —           —          1,532        1,532   
                                                  

Total

     8,487         85,099        197         93,783        730,790        824,573   

Less: Commercial loans held for sale

     —           (22,662     —           (22,662     (37,684     (60,346
                                                  

Total gross loans

   $ 8,487       $ 62,437      $ 197       $ 71,121      $ 693,106      $ 764,227   
                                                  

The following table summarizes delinquencies, by class, at December 31, 2010 (in thousands).

 

     30-89 Days
Past Due
     Greater than
90 Days Past

Due
on Nonaccrual
    Recorded
Investment > 90

Days
and Accruing
     Total
Past  Due
    Current     Total loans  

Construction, land development and other land loans

   $ 7,240       $ 52,528      $ —         $ 59,768      $ 76,686      $ 136,454   

Multifamily residential

     —           7,943        —           7,943        18,327        26,270   

Nonfarm nonresidential

     2,566         18,781        —           21,347        389,751        411,098   
                                                  

Total commercial real estate

     9,806         79,252        —           89,058        484,764        573,822   
                                                  

Single-family real estate, revolving, open end loans

     687         998        —           1,685        58,187        59,872   

Single-family real estate, closed end, first lien

     3,004         7,607        —           10,611        99,342        109,953   

Single-family real estate, closed end, junior lien

     280         866        —           1,146        8,009        9,155   
                                                  

Total single-family residential

     3,971         9,471        —           13,442        165,538        178,980   
                                                  

Commercial and industrial

     371         2,197        68         2,636        45,176        47,812   

Credit cards

     —           26        —           26        126        152   

All other consumer

     937         459        —           1,396        51,104        52,500   
                                                  

Total consumer

     937         485        —           1,422        51,230        52,652   
                                                  

Farmland

     —           —          —           —          3,667        3,667   

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

     —           —          —           —          990        990   

Other

     —           —          —           —          1,660        1,660   
                                                  

Total

     15,085         91,405        68         106,558        753,025        859,583   

Less: Commercial loans held for sale

     —           (27,940     —           (27,940     (38,217     (66,157
                                                  

Total gross loans

   $ 15,085       $ 63,465      $ 68       $ 78,618      $ 714,808      $ 793,426   
                                                  

While a loan is in nonaccrual status, cash received is applied to the principal balance. Additional interest income of $550 thousand would have been reported during the three months ended March 31, 2011 had loans classified as nonaccrual during the period performed in accordance with their original terms. As a result, the Company’s earnings did not include this interest income.

Troubled Debt Restructurings. At March 31, 2011, the principal balance of troubled debt restructurings totaled $53.3 million, of which loans totaling $18.2 million are classified as commercial loans held for sale.

 

17


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

In addition, at March 31, 2011, $3.4 million troubled debt restructurings were also in nonaccrual status. During the three months ended March 31, 2011, one troubled debt restructuring of $876 thousand was removed from this classification as it was performing in accordance with its restructured terms. At December 31, 2010, the principal balance of troubled debt restructurings totaled $44.9 million, of which loans totaling $17.2 million are classified as commercial loans held for sale.

Impaired Loans. The following table summarizes the composition of and information relative to impaired loans, by class, at March 31, 2011 (in thousands).

 

     Gross Loans      Commercial Loans Held for Sale      Total Loans  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
     Unpaid
Principal
Balance
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

                       

Construction, land development and other land loans

   $ 35,123       $ 54,143          $ 8,884       $ 21,699       $ 44,007       $ 75,842      

Multifamily residential

     —           —              7,475         13,543         7,475         13,543      

Nonfarm nonresidential

     4,343         8,006            18,985         28,584         23,328         36,590      
                                                           

Total commercial real estate

     39,466         62,149            35,344         63,826         74,810         125,975      
                                                           

Single-family real estate, revolving, open end loans

     —           —              —           —           —           —        

Single-family real estate, closed end, first lien

     2,292         7,161            362         482         2,654         7,643      

Single-family real estate, closed end, junior lien

     —           —              —           —           —           —        
                                                           

Total single-family residential

     2,292         7,161            362         482         2,654         7,643      
                                                           

Commercial and industrial

     93         3,106            —           —           93         3,106      
                                                           

Total impaired loans with no related allowance recorded

   $ 41,851       $ 72,416          $ 35,706       $ 64,308       $ 77,557       $ 136,724      
                                                           

With an allowance recorded:

                       

Construction, land development and other land loans

   $ 9,805       $ 9,805       $ 3,911             $ 9,805       $ 9,805       $ 3,911   

Multifamily residential

     —           —           —                 —           —           —     

Nonfarm nonresidential

     17,457         21,684         2,340               17,457         21,684         2,340   
                                                           

Total commercial real estate

     27,262         31,489         6,251               27,262         31,489         6,251   
                                                           

Single-family real estate, revolving, open end loans

     —           —           —                 —           —           —     

Single-family real estate, closed end, first lien

     1,791         1,791         147               1,791         1,791         147   

Single-family real estate, closed end, junior lien

     162         162         55               162         162         55   
                                                           

Total single-family residential

     1,953         1,953         202               1,953         1,953         202   
                                                           

Commercial and industrial

     1,367         1,436         796               1,367         1,436         796   
                                                           

Total impaired loans with an allowance recorded

   $ 30,582       $ 34,878       $ 7,249             $ 30,582       $ 34,878       $ 7,249   
                                                           

Total:

                       

Construction, land development and other land loans

   $ 44,928       $ 63,948       $ 3,911       $ 8,884       $ 21,699       $ 53,812       $ 85,647       $ 3,911   

Multifamily residential

     —           —           —           7,475         13,543         7,475         13,543         —     

Nonfarm nonresidential

     21,800         29,690         2,340         18,985         28,584         40,785         58,274         2,340   
                                                                       

Total commercial real estate

     66,728         93,638         6,251         35,344         63,826         102,072         157,464         6,251   
                                                                       

Single-family real estate, revolving, open end loans

     —           —           —           —           —           —           —           —     

Single-family real estate, closed end, first lien

     4,083         8,952         147         362         482         4,445         9,434         147   

Single-family real estate, closed end, junior lien

     162         162         55         —           —           162         162         55   
                                                                       

Total single-family residential

     4,245         9,114         202         362         482         4,607         9,596         202   
                                                                       

Commercial and industrial

     1,460         4,542         796         —           —           1,460         4,542         796   
                                                                       

Total impaired loans

   $ 72,433       $ 107,294       $ 7,249       $ 35,706       $ 64,308       $ 108,139       $ 171,602       $ 7,249   
                                                                       

The following table summarizes the composition of and information relative to impaired loans, by class, at December 31, 2010 (in thousands).

 

18


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     Gross Loans      Commercial Loans Held for Sale      Total Loans  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
     Unpaid
Principal
Balance
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

                       

Construction, land development and other land loans

   $ 29,183       $ 39,953          $ 11,123       $ 25,303       $ 40,306       $ 65,256      

Multifamily residential

     —           —              7,943         14,010         7,943         14,010      

Nonfarm nonresidential

     11,504         17,099            19,674         30,367         31,178         47,466      
                                                           

Total commercial real estate

     40,687         57,052            38,740         69,680         79,427         126,732      
                                                           

Single-family real estate, revolving, open end loans

     —           —              —           —           —           —        

Single-family real estate, closed end, first lien

     2,567         6,233            595         1,374         3,162         7,607      

Single-family real estate, closed end, junior lien

     —           —              —           —           —           —        
                                                           

Total single-family residential

     2,567         6,233            595         1,374         3,162         7,607      
                                                           

Commercial and industrial

     117         117            —           —           117         117      
                                                           

Total impaired loans with no related allowance recorded

   $ 43,371       $ 63,402          $ 39,335       $ 71,054       $ 82,706       $ 134,456      
                                                           

With an allowance recorded:

                       

Construction, land development and other land loans

   $ 11,164       $ 17,527       $ 3,103             $ 11,164       $ 17,527       $ 3,103   

Multifamily residential

     —           —           —                 —           —           —     

Nonfarm nonresidential

     10,936         10,936         2,273               10,936         10,936         2,273   
                                                           

Total commercial real estate

     22,100         28,463         5,376               22,100         28,463         5,376   
                                                           

Single-family real estate, revolving, open end loans

     —           —           —                 —           —           —     

Single-family real estate, closed end, first lien

     1,300         1,300         94               1,300         1,300         94   

Single-family real estate, closed end, junior lien

     165         165         57               165         165         57   
                                                           

Total single-family residential

     1,465         1,465         151               1,465         1,465         151   
                                                           

Commercial and industrial

     1,381         1,450         819               1,381         1,450         819   
                                                           

Total impaired loans with an allowance recorded

   $ 24,946       $ 31,378       $ 6,346             $ 24,946       $ 31,378       $ 6,346   
                                                           

Total:

                       

Construction, land development and other land loans

   $ 40,347       $ 57,480       $ 3,103       $ 11,123       $ 25,303       $ 51,470       $ 82,783       $ 3,103   

Multifamily residential

     —           —           —           7,943         14,010         7,943         14,010         —     

Nonfarm nonresidential

     22,440         28,035         2,273         19,674         30,367         42,114         58,402         2,273   
                                                                       

Total commercial real estate

     62,787         85,515         5,376         38,740         69,680         101,527         155,195         5,376   
                                                                       

Single-family real estate, revolving, open end loans

     —           —           —           —           —           —           —           —     

Single-family real estate, closed end, first lien

     3,867         7,533         94         595         1,374         4,462         8,907         94   

Single-family real estate, closed end, junior lien

     165         165         57         —           —           165         165         57   
                                                                       

Total single-family residential

     4,032         7,698         151         595         1,374         4,627         9,072         151   
                                                                       

Commercial and industrial

     1,498         1,567         819         —           —           1,498         1,567         819   
                                                                       

Total impaired loans

   $ 68,317       $ 94,780       $ 6,346       $ 39,335       $ 71,054       $ 107,652       $ 165,834       $ 6,346   
                                                                       

Interest income recognized on impaired loans during the three months ended March 31, 2011 was $621 thousand. The average balance of total impaired loans was $107.9 million for the same period.

Allowance for Loan Losses

The following table summarizes the allowance for loan losses and recorded investment in gross loans, by portfolio segment, at and for the periods indicated (in thousands).

 

19


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     At and for the three months ended March 31, 2011      At and for the
three months ended

March 31, 2010
Total
 
     Commercial
Real Estate
     Single-family
Residential
     Commercial and
Industrial
     Consumer      Other      Total     

Allowance for loan losses:

                    

Allowance for loan losses, beginning of period

   $ 18,979       $ 4,061       $ 2,492       $ 1,375       $ 27       $ 26,934       $ 24,079   

Provision for loan losses

     3,983         936         479         57         45         5,500         10,750   

Loan charge-offs

     4,145         856         435         170         183         5,789         7,242   

Loan recoveries

     35         50         30         56         138         309         839   
                                                              

Net loans charged-off

     4,110         806         405         114         45         5,480         6,403   
                                                              

Allowance for loan losses, end of period

   $ 18,852       $ 4,191       $ 2,566       $ 1,318       $ 27       $ 26,954       $ 28,426   
                                                              

Individually evaluated for impairment

   $ 6,251       $ 202       $ 796       $ —         $ —         $ 7,249       $ 6,997   

Collectively evaluated for impairment

     12,601         3,989         1,770         1,318         27         19,705         21,429   
                                                              

Allowance for loan losses, end of period

   $ 18,852       $ 4,191       $ 2,566       $ 1,318       $ 27       $ 26,954       $ 28,426   
                                                              

Gross loans, end of period:

                    

Individually evaluated for impairment

   $ 66,728       $ 4,245       $ 1,460       $ —         $ —         $ 72,433       $ 107,399   

Collectively evaluated for impairment

     416,971         170,725         47,164         50,884         6,050         691,794         902,848   
                                                              

Total gross loans

   $ 483,699       $ 174,970       $ 48,624       $ 50,884       $ 6,050       $ 764,227       $ 1,010,247   
                                                              

 

5. Commercial Loans Held for Sale and Valuation Allowance

In September 2010, the Company began to market for sale a pool of specifically identified commercial loans. Through March 31, 2011 ten of these loans with a gross book value of $12.4 million were sold, of which $2.0 million were closed in the three months ended March 31, 2011.

The Company is continuing its efforts to market and sell the remaining commercial loans held for sale. At March 31, 2011, commercial loans held for sale totaled $60.3 million. Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these loans to their fair value less estimated costs to sell based on updated valuations.

 

6. Premises and Equipment, net

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

 

     March 31,
2011
    December 31,
2010
 

Land

   $ 6,534      $ 6,534   

Buildings

     19,396        19,386   

Leasehold improvements

     5,208        5,200   

Furniture and equipment

     12,646        12,571   

Software

     4,061        3,562   

Bank automobiles

     106        137   

Capital lease asset

     1,378        1,085   
                

Premises and equipment, gross

     49,329        48,475   

Accumulated depreciation

     (21,257     (20,366
                

Premises and equipment, net

   $ 28,072      $ 28,109   
                

Depreciation expense for the three months ended March 31, 2011 and 2010 was $598 thousand and $625 thousand, respectively.

At March 31, 2011, a vacant bank-owned branch facility with a net book value of $235 thousand is under contract for sale and included in Other assets in the Consolidated Balance Sheets, and in April 2011 the Company began marketing for sale a piece of vacant land with a book value of $728 thousand.

 

20


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

7. Mortgage-Banking Activities

Mortgage loans serviced for the benefit of others amounted to $424.0 million and $423.6 million at March 31, 2011 and December 31, 2010, respectively, and are excluded from the Consolidated Balance Sheets.

The book value of mortgage-servicing rights was $2.9 million at both March 31, 2011 and December 31, 2010. Mortgage-servicing rights are included within Other assets in the Consolidated Balance Sheets. The fair value of mortgage-servicing rights at March 31, 2011 and December 31, 2010 was $3.5 million and $3.6 million, respectively.

Mortgage-Servicing Rights Activity

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

 

     For the three months
ended March 31,
 
     2011     2010  

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

   $ 2,896      $ 3,039   

Capitalized mortgage-servicing rights

     170        166   

Mortgage-servicing rights portfolio amortization and impairment

     (212     (191
                

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

   $ 2,854      $ 3,014   
                

Valuation Allowance

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

 

     For the three months
ended March 31,
 
     2011      2010  

Valuation allowance, beginning of period

   $ 39       $ 40   

Additions charged to and (reduction credited from) operations

     2         (2
                 

Valuation allowance, end of period

   $ 41       $ 38   
                 

 

8. Foreclosed Real Estate and Repossessed Personal Property

Composition

The following table summarizes foreclosed real estate and repossessed personal property at the dates indicated (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Foreclosed real estate

   $ 16,244       $ 19,983   

Repossessed personal property

     141         104   
                 

Total foreclosed real estate and repossessed personal property

   $ 16,385       $ 20,087   
                 

Foreclosed Real Estate Activity

The following table summarizes the changes in the foreclosed real estate portfolio at the dates and for the periods indicated (in thousands). Foreclosed real estate is net of participations sold of $3.3 million and $8.2 million at March 31, 2011 and March 31, 2010, respectively.

 

21


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     At and for the three
months ended
March 31,
 
     2011     2010  

Foreclosed real estate, beginning of period

   $ 19,983      $ 27,826   

Plus: New foreclosed real estate

     3,764        3,893   

Less: Proceeds from sale of foreclosed real estate

     (6,988     (2,053

Less: Gain on sale of foreclosed real estate

     81        271   

Less: Provision charged to expense

     (596     (1,070
                

Foreclosed real estate, end of period

   $ 16,244      $ 28,867   
                

Subsequent to March 31, 2011, 7 properties with an aggregate net carrying amount of $174 thousand were sold at an immaterial loss. At April 26, 2011, 9 additional properties with an aggregate net carrying amount of $2.0 million were under contract for sale to close in the second quarter of 2011.

 

9. Deposits

Composition

The following table summarizes the composition of deposits at the dates indicated (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Transaction deposit accounts

   $ 453,080       $ 434,108   

Money market deposit accounts

     149,902         143,143   

Savings deposit accounts

     55,159         49,472   

Time deposit accounts $100,000 and greater

     244,303         247,169   

Time deposit accounts less than $100,000

     275,246         299,470   
                 

Total deposits

   $ 1,177,690       $ 1,173,362   
                 

At March 31, 2011, $664 thousand of overdrawn transaction deposit accounts were reclassified to loans, compared with $692 thousand at December 31, 2010. The Company had no brokered deposits at March 31, 2011 or December 31, 2010.

Interest Expense on Deposit Accounts

The following table summarizes interest expense on deposits for the periods indicated (in thousands).

 

     For the three months
ended March 31,
 
     2011      2010  

Transaction deposit accounts

   $ 49       $ 61   

Money market deposit accounts

     81         161   

Savings deposit accounts

     16         32   

Time deposit accounts

     2,530         3,309   
                 

Total interest expense on total deposits

   $ 2,676       $ 3,563   
                 

 

10. Borrowings

Correspondent Bank Line of Credit

At March 31, 2011, the Company had access to an unsecured line of credit from a correspondent bank. The following table summarizes the Company’s line of credit funding utilization and availability at the dates indicated (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Correspondent bank line of credit accomodations

   $ 5,000       $ 5,000   

Utilized correspondent bank line of credit accomodations

     —           —     
                 

Available correspondent bank line of credit accomodations

   $ 5,000       $ 5,000   
                 

In April 2011, we obtained an uncommitted overnight variable rate line of credit from a correspondent bank totaling $25 million. If drawn upon, the

 

22


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

Company will be required to pledge investment securities with a fair vale equal to approximately 110% of the amount borrowed. These correspondent bank lines of credit funding source may be canceled at any time at the correspondent bank’s discretion.

FHLB Borrowings

As disclosed in Note 3, Investment Securities Available for Sale, and Note 4, Loans, the Company pledges investment securities and loans to collateralize FHLB advances and letters of credit. Additionally, the Company may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages, as calculated by the FHLB.

The Company is a member of the FHLB of Atlanta, which is one of twelve regional FHLBs that administer home financing credit for depository institutions. As an FHLB member, the Company is required to purchase and maintain stock in the FHLB. No ready market exists for FHLB stock, and this stock has no quoted market value. Purchases and redemptions are normally transacted each quarter to adjust the Company’s investment to an amount based on the FHLB requirements, which are generally based on the amount of borrowings the Company has outstanding with the FHLB. Requests for redemptions of FHLB stock are met at the discretion of the FHLB. The carrying value of this stock was $6.8 million at both March 31, 2011 and December 31, 2010, respectively. In April 2011 the FHLB of Atlanta repurchased $727 thousand of the FHLB stock owned by the Company. The stock was repurchased at book value therefore no gain or loss was recognized.

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

 

     March 31,
2011
    December 31,
2010
 

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

   $ 86,977      $ 92,464   

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

     23,273        46,275   

Advances and letters of credit

    

FHLB advances

     (5,000     (35,000

Letters of credit

     (50,000     (50,000

Excess

     54,985        53,303   

At March 31, 2011, the Company had one outstanding FHLB advance totaling $5 million. The advance bears interest at a fixed rate of 3.61% and matures in April 2013. The FHLB advance is subject to a prepayment fee in the event of full or partial repayment prior to maturity. In January 2011, the Company prepaid $30.0 million of FHLB advances resulting in a prepayment penalty of $136 thousand.

Federal Reserve Discount Window

At March 31, 2011 and December 31, 2010, $10.8 million and $10.9 million, respectively, of loans were pledged as collateral to cover the various Federal Reserve System services that are available for use by the Company. Primary credit is available through the Discount Window to generally sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee target rate for federal funds. The Company’s maximum maturity for potential borrowings is overnight. Although the Company has not drawn on this availability since its establishment in 2009, any potential borrowings from the Federal Reserve Discount Window would be 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.

 

11. Shareholders’ Equity

Authorized Common Shares

The Company has authorized common stock of 75.0 million shares. In October 2010, the Company issued 39,975,980 shares of common stock to a group of institutional investors in a private placement (the “Private Placement”). An additional 1,230,029 shares were issued in December 2010 and January 2011 to legacy shareholders as of October 6, 2010, and 2,616,124 shares were issued to the institutional investors in the first quarter 2011 in a follow-on offering related to the Private Placement. In connection these share issuances,

 

23


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

the Company received gross proceeds of $106 million and $8 million in the fourth quarter 2010 and first quarter 2011, respectively. Of the proceeds received, $96 million and $8 million were contributed to the Bank in fourth quarter 2010 and first quarter 2011, respectively.

As a result of the share issuances noted above, remaining authorized but unissued common shares were 24,486,278 at April 26, 2011.

During August 2010, the Company’s shareholders’ approved an amendment to the Company’s Amended and Restated Articles of Incorporation to increase the number of authorized shares of common stock from 25.0 million shares to 75.0 million shares and reduce the par value of the common stock from $5.00 per share to $0.01 per share.

As disclosed in Note 14, Equity Based Compensation, as of April 26, 2011 the Company has reserved a total of 274,656 shares for future issuance under various equity incentive plans.

Authorized Preferred Shares

The Company has authorized preferred stock of 2.5 million shares with such preferences, limitations and relative rights, within legal limits, of the class, or one or more series within the class, as are set by the Board of Directors. To date, the Company has not issued any preferred shares.

Cash Dividends

The Board of Directors has not declared or paid a dividend on our common stock since the first quarter 2009. Under the terms of a Consent Order the Bank entered into with the regulatory agencies in June 2010 (the “Consent Order”), payment of common dividends requires prior notification to and non-objection from the applicable banking regulators.

Recapitalization

In connection with the Private Placement, the Company evaluated the appropriate accounting for the transaction by analyzing investor ownership, independence, risk, solicitation and collaboration considerations. Based on the analysis of these factors, the Company concluded that the Private Placement transaction resulted in a recapitalization of the Company’s ownership for which push-down accounting was not required.

 

12. Income Taxes

During 2009, the U.S. Congress extended the net operating loss carryback period from two years to five years for qualifying institutions. 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 December 31, 2010, the Company had additional carryback capacity to recapture up to $7.4 million of taxes paid in 2008. Accordingly, the Company’s income tax receivable of $7.4 million at December 31, 2010 was primarily the result of its taxable net operating loss for the year ended December 31, 2010 which was carried back to 2008. In March 2011, after filing its 2010 federal income tax return, the Company filed a request for refund for this amount and the refund was received in April 2011.

As of March 31, 2011, net deferred tax assets, before any valuation allowance, of $22.9 million are recorded in the Company’s Consolidated Balance Sheets. The net deferred tax asset is fully offset by a valuation allowance of $22.9 million as a result of uncertainty surrounding the ultimate realization of these tax benefits. Based on the Company’s projections of future taxable income over the next three years, cumulative tax losses over the previous two years, net operating loss carry forward limitations as discussed below and available tax planning strategies, the Company initially recorded a valuation allowance against the net deferred tax asset in December 2010. The Company’s ongoing analysis indicates that a full valuation allowance is appropriate at March 31, 2011 as well. The Private Placement consummated in October 2010 was considered a change in control under the Internal Revenue Service rules. Accordingly, the Company was required to evaluate potential limitation or deferral of its ability to carry forward pre-acquisition net operating losses and to determine the amount of net unrealized pre-acquisition built-in losses, which also limits the amount of net operating losses that may be used in the future. As a result of the analysis, the Company currently estimates that future utilization of net operating loss carry forwards and built-in losses of $46 million generated prior to October 7, 2010 will be limited to $1.1 million per year.

Provision for income taxes was $52 thousand in the first quarter 2011. The provision for income taxes in the first quarter 2011 reflects the additional valuation allowance in excess of the tax benefit generated in the current period that is necessary to fully offset the net deferred tax asset of $22.9 million at March 31, 2011.

 

13. Employee Benefit Plans

401(k) Plan

 

24


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

During the three months ended March 31, 2011 and 2010, the Company made matching contributions to the employee 401(k) plan totaling $98 thousand and $98 thousand, respectively.

Defined Benefit Pension Plan

Historically, the Company has 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. In 2007, the Company notified employees that it would cease accruing pension benefits for employees with regard to the noncontributory, defined benefit pension 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 the defined benefit postretirement plan in the Consolidated Balance Sheets. 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’s net accrued liability is included in Other liabilities in the Consolidated Balance Sheets and totaled $4.1 million and $5.2 million at March 31, 2011 and December 31, 2010, respectively.

The fair value of plan assets totaled $15.5 million and $13.9 million at March 31, 2011 and December 31, 2010, respectively.

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

 

     For the three months ended
March 31,
 
     2011     2010  

Interest cost

   $ 251      $ 227   

Expected return on plan assets

     (274     (227

Amortization of net actuarial loss

     197        158   
                

Net periodic pension expense

   $ 174      $ 158   
                

As a result of the Company’s decision to curtail the plan effective on January 1, 2008, no costs relative to service costs have been necessary since that date as employees no longer accrue benefits for services rendered.

Current and Future Expected Contributions. The Pension Protection Act of 2006 imposed a number of burdens on pension plans with an asset to liability ratio of less than 80% with additional burdens imposed if the asset to liability ratio falls below 60%. Due primarily to the utilization of a lower discount rate for determining the present value of the liabilities (provided by the IRS based on the 24 month average of bond yields), the Company’s plan was 73% funded at January 1, 2011 and, as a result, in March 2011, the Company contributed $1.3 million to the pension plan. This contribution increased the Company’s asset to liability ratio to the 80% threshold level. The Company anticipates additional employer contributions in the amount of $374 thousand will be made for the 2011 plan year.

 

14. Equity Based Compensation

Stock Option Plan

General. Stock option awards have been granted under the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan. The Plan terminated in 2007 and no options have been granted under the Plan since then. However, the termination did not impact options previously granted under the Plan. All outstanding options expire at various dates through December 31, 2016. Of these, 120,010 stock option awards remained outstanding at March 31, 2011 with exercise prices ranging from $15.00 to $30.40 per share. All stock option awards granted have a vesting term of five years and an exercise period of ten years.

 

25


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

Stock Option Compensation Expense. The compensation expense for stock options charged against pretax income during the three months ended March 31, 2011 was less than $1 thousand. There was no income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation expense. The compensation expense that was charged against pretax income during the same period of 2010 for stock options was $7 thousand. The total income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation expense was $1 thousand. Estimates of forfeitures are made at the time of grant and were not expected to be significant; therefore, compensation expense is being recognized for all equity based awards.

At March 31, 2011 and December 31, 2010, based on options outstanding at that time, the total compensation expense related to unvested stock option awards granted under the Company’s stock option plan but not yet recognized was less than $1 thousand and $1 thousand, respectively, before the impact of income taxes. Stock option compensation expense is recognized on a straight-line basis over the vesting period of the option. This remaining compensation expense related to unvested stock option awards is expected to be fully recognized during 2011.

Stock Option Activity. The following table summarizes stock option activity for the Palmetto Bancshares, Inc. 1997 Stock Compensation Plan for the periods indicated.

 

     Stock options
outstanding
    Weighted-
average

exercise  price
 

Outstanding at December 31, 2009

     147,210      $ 21.80   

Exercised

     (14,400     15.00   
                

Outstanding at March 31, 2010

     132,810      $ 22.54   
                

Outstanding at December 31, 2010

     120,010      $ 22.93   

Forfeited

     —          —     
                

Outstanding at March 31, 2011

     120,010      $ 22.93   
                

The following table summarizes information regarding stock options outstanding and exercisable at March 31, 2011.

 

     Options outstanding      Options exercisable  

Exercise price or range of exercise prices

   Number of stock
options
outstanding at
3/31/11
     Weighted-
average
remaining
contractual life
(years)
     Weighted-
average exercise
price
     Number of stock
options
exercisable at
3/31/11
     Weighted-
average exercise
price
 

$15.00 to $20.00

     40,010         1.31       $ 17.75         40,010       $ 17.75   

$23.30 to $26.60

     51,200         3.12         24.47         51,200         24.47   

$27.30 to $30.40

     28,800         4.79         27.39         28,640         27.37   
                          

Total

     120,010         2.91         22.93         119,850         22.92   
                          

At March 31, 2011, the fair value of the Company’s common stock did not exceed the exercise price of any options outstanding and exercisable, and therefore the stock options had no intrinsic value.

Restricted Stock Plan

Under the 2008 Restricted Stock Plan, 250,000 shares of common stock have been reserved for issuance subject to its anti-dilution provisions. Forfeitures are returned to the available pool of common stock for future issuance. The following table summarizes restricted stock activity at the date and for the periods indicated.

 

26


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     Shares of
restricted stock
    Weighted-
average grant
price
 

Shares available for issuance under the 2008 Restricted Stock Plan

     250,000     

2009 Grants

     (55,040   $ 35.63   

2009 Forfeitures

     10,000        42.00   

2010 Grants

     (18,500     2.60   

2010 Forfeitures

     2,800        42.00   

2011 Grants

     (34,614     2.60   

2011 Forfeitures

     —          —     
          

Remaining shares available for issuance at March 31, 2011

     154,646     
          

January 2011, 34,614 shares of restricted stock with a total value of $90 thousand were granted to the nine non-management directors of the Company as compensation for their annual Board retainers. These restricted stock awards were fully vested at the date of grant.

The value of the restricted stock awarded is established as the fair value of the stock at the time of the grant. The Company measures compensation expense for restricted stock awards at fair value and recognizes compensation expense over the service period for grants that have time / service-based vesting provisions. The compensation expense that was charged against pretax income during the three months ended March 31, 2011 for restricted stock awards granted prior to the first quarter 2011 was $72 thousand. There was no income tax benefit recognized in the Consolidated Statements of Income (Loss) with regard to the deductible portion of this compensation expense. For the three months ended March 31, 2010, compensation expense for restricted stock awards was $84 thousand and the income tax benefit with regard to the deductible portion of this compensation expense was $30 thousand. Forfeitures are accounted for by eliminating compensation expense for unvested shares as forfeitures occur. At March 31, 2011, based on restricted stock awards outstanding at that time, the total pretax compensation expense related to unvested restricted stock awards granted under the restricted stock plan but not yet recognized was $848 thousand. This expense is expected to be recognized through 2015.

With the exception of the restricted stock awards granted to directors in January 2011, shares of restricted stock granted to employees and directors under the Plan are subject to pro rata restrictions as to continuous employment and service as a director, respectively, 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.

Palmetto Bancshares, Inc. 2011 Stock Plan

In February 2011, the Board of Directors approved the Palmetto Bancshares, Inc. 2011 Stock Plan (the “2011 Plan”) to further support the alignment of management and shareholder interests. The 2011 Plan allows for the Board of Directors to grant a total of 2 million stock options and / or restricted stock awards to employees and directors. The Board is seeking shareholder approval for the 2011 Plan, and the Company has included a proposal for approval of the 2011 Plan in the definitive proxy statement for the annual shareholders meeting scheduled for May 19, 2011.

 

15. Average Share Information

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

 

     For the three months ended
March 31,
 
     2011     2010  

Weighted average common shares outstanding - basic

     49,453,501        6,455,598   

Dilutive impact resulting from potential common share issuances

     —          —     
                

Weighted average common shares outstanding - diluted

     49,453,501        6,455,598   
                

Per Share Data

    

Net loss - basic

   $ (0.12   $ (0.82

Net loss - diluted

     (0.12     (0.82

Basic net income (loss) per share is computed by dividing net income (loss) available to common

 

27


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

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 loss per share amount for the three months ended March 31, 2011 and 2010 as inclusion would be anti-dilutive given the Company’s net loss during the respective periods.

 

16. Commitments, Guarantees, and Other Contingencies

Lending Commitments and Standby Letters of Credit

Unused lending commitments to customers are not recorded in the 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 Company routinely extends lending commitments for both floating and fixed rate loans.

The following table summarizes the contractual amounts of the Company’s unused lending commitments relating to extension of credit with off-balance sheet risk at March 31, 2011 (in thousands).

 

Commitments to extend credit:

  

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

   $ 48,110   

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

  

Single-family residential construction loan commitments

     1,954   

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

     12,072   

Commercial and industrial loan commitments

     14,479   

Overdraft protection line commitments

     28,986   

Other

     6,671   
        

Total commitments to extend credit

   $ 112,272   
        

Standby letters of credit are issued for customers in connection with contracts between customers and third parties. Letters of credit are conditional commitments issued by the Company 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 $3.1 million and $2.7 million at March 31, 2011 and December 31, 2010, respectively.

The reserve for unfunded commitments at March 31, 2011 and December 31, 2010 was $150 thousand and $99 thousand, respectively, and is recorded in Other liabilities in the Consolidated Balance Sheets.

Loan Participations

With regard to participations sold disclosed in Note 4, Loans, and Note 8, Foreclosed Real Estate and Repossessed Personal Property, the Company serves as the lead bank and is 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 the Company’s duties to the participating banks.

Derivatives

See Note 17, Derivative Financial Instruments and Hedging Activities, for further discussion regarding the Company’s off-balance sheet arrangements and commitments related to its derivative loan commitments and freestanding derivatives.

Long-Term Contractual Obligations

In addition to the contractual commitments and arrangements previously described, the Company enters into other contractual obligations in the ordinary course of business. The following table summarizes these contractual obligations at March 31, 2011 (in thousands) except obligations for employee benefit plans as these obligations are paid from separately identified assets. See Note 13, Employee Benefit Plans, for discussion regarding employee benefit plans.

 

28


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

Other contractual obligations

   Less than
one year
     Over one
through
three years
     Over three
through five
years
     Over five
years
     Total  

Time deposit accounts

   $ 333,876       $ 181,849       $ 3,789       $ 35       $ 519,549   

There have been no other significant changes in future real property operating lease obligations or FHLB advances as reported in our Annual Report on Form 10-K for the year ended December 31, 2010.

Recourse Liability on Credit Card Accounts

In connection with the sale of the credit card portfolio in December 2010, the Company is subject to a recourse obligation on certain credit card accounts with outstanding balances of $329 thousand at March 31, 2011. The Company has a reserve of $61 thousand established to absorb estimated losses in connection with these accounts.

Legal Proceedings

The Company is subject to actual and threatened legal proceedings and other claims arising out of the conduct of its business. Some of these suits and proceedings seek damages, fines, or penalties. These suits and proceedings are being defended by or contested on the Company’s behalf. On the basis of information presently available, the Company does not believe that existing proceedings and claims will have a material effect on its financial position or results of operations.

 

17. Derivative Financial Instruments and Hedging Activities

At March 31, 2011 and December 31, 2010, the Company’s only derivative instruments related to residential mortgage lending activities. The Company originates certain residential loans with the intention of selling these loans. Between the time the Company enters into an interest rate lock commitment to originate a residential loan with a potential borrower and the time the closed loan is sold, the Company is subject to variability in market prices related to these commitments. The Company also enters 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 Mortgage-banking in the Consolidated Statements of Income (Loss).

At March 31, 2011, commitments to originate conforming loans totaled $7.0 million. At March 31, 2011, these derivative loan commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $122 thousand. At December 31, 2010, commitments to originate conforming loans totaled $12.2 million. At December 31, 2010, these derivative loan commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $103 thousand and negative fair values, included with Other liabilities in the Consolidated Balance Sheets, totaling $40 thousand. The net change in derivative loan commitment fair values during the three months ended March 31, 2011 and 2010 resulted in net derivative loan commitment income of $59 thousand and $51 thousand, respectively.

Forward sales commitments totaled $4.9 million at March 31, 2011. At March 31, 2011, forward sales commitments had positive fair values, included within Other assets in the Consolidated Balance Sheets, totaling $22 thousand and negative fair values, included within Other liabilities in the Consolidated Balance Sheets, totaling $17 thousand. Forward sales commitments totaled $19.6 million at December 31, 2010. At December 31, 2010, forward sales commitments had positive fair values, included with Other assets in the Consolidated Balance Sheets, totaling $175 thousand and negative fair values, included within Other liabilities in the Consolidated Balance Sheets, totaling $96 thousand. The net change in forward sales commitment fair values during the three months ended March 31, 2011 and 2010, resulted in a loss of $75 thousand and $76 thousand, respectively.

 

18. Disclosures Regarding Fair Value

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table summarizes 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).

 

29


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     March 31, 2011  
     Level 1      Level 2      Level 3      Total  

Assets

           

Investment securities available for sale

           

State and municipal

   $ 40,640       $ 65,019       $ —         $ 105,659   

Collateralized mortgage obligations

     12,634         135,901         —           148,535   

Other mortgage-backed (federal agencies)

     —           19,909         —           19,909   

Derivative financial instruments

     —           144         —           144   
                                   

Total assets measured at fair value on a recurring basis

   $ 53,274       $ 220,973       $ —         $ 274,247   
                                   

Liabilities

           

Derivative financial instruments

   $ —         $ 17       $ —         $ 17   
                                   
     December 31, 2010  
     Level 1      Level 2      Level 3      Total  

Assets

           

Investment securities available for sale

           

U.S. Treasury and federal agencies

   $ —         $ 37,426       $ —         $ 37,426   

State and municipal

     7,530         44,932         —           52,462   

Collateralized mortgage obligations

     25,992         82,179         —           108,171   

Other mortgage-backed (federal agencies)

     —           20,716         —           20,716   

Derivative financial instruments

     —           278         —           278   
                                   

Total assets measured at fair value on a recurring basis

   $ 33,522       $ 185,531       $ —         $ 219,053   
                                   

Liabilities

           

Derivative financial instruments

   $ —         $ 136       $ —         $ 136   
                                   

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

For financial assets measured at fair value on a nonrecurring basis that were reflected in the balance sheet, the following tables summarize the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets as of the periods indicated (in thousands).

 

     March 31, 2011  
     Level 1      Level 2      Level 3      Total  

Assets

           

Mortgage loans held for sale

   $ —         $ 279       $ —         $ 279   

Commercial loans held for sale

     —           22,483         37,863         60,346   

Impaired loans in gross loans

     —           46,722         4,863         51,585   

Foreclosed real estate and repossessed personal property

     1,543         14,403         439         16,385   
                                   

Total assets measured at fair value on a nonrecurring basis

   $ 1,543       $ 83,887       $ 43,165       $ 128,595   
                                   
     December 31, 2010  
     Level 1      Level 2      Level 3      Total  

Assets

           

Mortgage loans held for sale

   $ —         $ 4,793       $ —         $ 4,793   

Commercial loans held for sale

     1,303         21,231         43,623         66,157   

Impaired loans in gross loans

     —           43,920         6,649         50,569   

Foreclosed real estate and repossessed personal property

     5,999         13,939         149         20,087   
                                   

Total assets measured at fair value on a nonrecurring basis

   $ 7,302       $ 83,883       $ 50,421       $ 141,606   
                                   

Carrying Amounts and Estimated Fair Value Financial Assets and Liabilities Not Measured at Fair Value

The following table summarizes the carrying amount and fair values for other financial instruments included in the Consolidated Balance Sheets at the dates indicated (in thousands). The methodologies used to determine fair value are disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010. The Company has used management’s best estimate of fair value based on those methodologies. Thus, the fair values presented may not be the amounts which could be realized in an immediate sale or settlement of the instrument. In addition, any income taxes or other expenses, which would be incurred in an actual sale or settlement, are not taken into consideration in the fair values presented.

 

30


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

     March 31, 2011      December 31, 2010  
     Carrying
amount
     Fair value      Carrying
amount
     Fair value  

Assets

           

Loans (1)

   $ 685,688       $ 676,645       $ 715,923       $ 709,018   
                                   

Total assets

   $ 685,688       $ 676,645       $ 715,923       $ 709,018   
                                   

Liabilities

           

Deposits

   $ 1,177,690       $ 1,185,496       $ 1,173,362       $ 1,178,905   

FHLB advances

     5,000         5,107         35,000         35,224   
                                   

Total liabilities

   $ 1,182,690       $ 1,190,603       $ 1,208,362       $ 1,214,129   
                                   

 

(1) Includes Loans, net less impaired loans valued based on the fair value of underlying collateral.

 

19. Regulatory Capital Requirements and Dividend Restrictions

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). The Company and the Bank were classified in the well-capitalized category at March 31, 2011 and December 31, 2010. In connection with the Consent Order, the Bank is subject to a minimum Tier 1 leverage ratio of 8.00%, which is higher than the statutory well-capitalized minimum ratio of 5.00%.

Since March 31, 2011, no conditions or events have occurred, of which the Company is aware, that have resulted in a material change in the Company’s or the Bank’s risk 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 March 31, 2011

               

Total capital to risk-weighted assets

               

Company

   $ 133,867         15.00   $ 71,418         8.00     n/a         n/a   

Bank

     132,274         14.80        71,489         8.00      $ 89,361         10.00

Tier 1 capital to risk-weighted assets

               

Company

     122,511         13.72        35,709         4.00        n/a         n/a   

Bank

     120,907         13.53        35,744         4.00        53,616         6.00   

Tier 1 leverage ratio

               

Company

     122,511         9.26        52,931         4.00        n/a         n/a   

Bank

     120,907         9.13        52,972         4.00        66,215         5.00   

At December 31, 2010

               

Total capital to risk-weighted assets

               

Company

   $ 132,118         14.43   $ 73,261         8.00     n/a         n/a   

Bank

     130,632         14.25        73,339         8.00      $ 91,674         10.00

Tier 1 capital to risk-weighted assets

               

Company

     120,478         13.16        36,631         4.00        n/a         n/a   

Bank

     118,981         12.98        36,669         4.00        55,004         6.00   

Tier 1 leverage ratio

               

Company

     120,478         8.22        58,634         4.00        n/a         n/a   

Bank

     118,981         8.12        58,624         4.00        73,280         5.00   

Recent Regulatory Developments

The Company and the Bank are subject to periodic examination by various regulatory agencies. In November 2009, the FDIC and the State Board (collectively, the “Supervisory Authorities”) 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 the FDIC to receive

 

31


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

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. 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 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;

 

32


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Notes To Consolidated Financial Statements—(Continued)

 

   

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 it operates 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 its geographic areas. The FDIC informed the Company that this high-rate determination is also effective for calendar year 2011; 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 Bank 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 the Bank has 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 the Bank’s compliance will be made by the FDIC and the State Board. However, the Bank believes it is currently in compliance with all provisions of the Consent Order except for the requirement to reduce the total amount of its criticized assets at September 30, 2009 by a total of 75% by May 30, 2012. The Consent Order requires a reduction in criticized assets by specified percentages by certain dates, with the first date being December 7, 2010 when a 25% ($56.7 million) reduction in criticized assets was required. The Bank reduced its criticized assets by more than the amount necessary to meet the December 7, 2010 deadline. The Bank’s next incremental deadline, June 5, 2011, stipulates a 45% ($102.0 million) reduction in criticized assets from the September 30, 2009 balances. As of April 26, 2011, the Bank has reduced its criticized assets by 60.4% ($130.7 million). 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. In addition, the Supervisory Authorities may amend the Consent Order based on the results of their ongoing examinations.

 

33


Table of Contents

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

The following discussion and analysis presents the more significant factors impacting our financial condition as of March 31, 2011 and results of operations and cash flows for the three months ended March 31, 2011. This discussion should be read in conjunction with, and is intended to supplement, all of the other Items presented in this Quarterly Report on Form 10-Q and our Consolidated Financial Statements and the notes thereto for the year ended December 31, 2010 included in our Annual Report on Form 10-K and 10 K/A for that period. Results for the three months ended March 31, 2011 are not necessarily indicative of the results for the year ended December 31, 2011 or any future period. Percentage calculations contained herein have been calculated based on actual not rounded results.

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 ability to complete the sale of our commercial loans held for sale, specifically at values equal or above the currently recorded loan balances which would not result in additional writedowns,

 

   

Our ability to maintain appropriate levels of capital, including the potential that the regulatory agencies may require higher levels of capital above the standard regulatory-mandated minimums,

 

   

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

 

   

Our ability to attract and 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 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,

 

   

Changes in availability of wholesale funding sources, including increases in collateral margin requirements,

 

   

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, including the effect of the recent financial reform legislation on the banking and financial services industries,

 

   

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,

 

34


Table of Contents
   

Changes in deposit flows,

 

   

Changes in monetary and tax policies, including confirmation of the income tax refund claims received by the Internal Revenue Service,

 

   

Changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board and the Financial Accounting Standards Board,

 

   

Potential limitations on our ability to utilize net operating loss carryforwards and net unrealized built in losses for income tax purposes due to the change in control resulting from the Private Placement transaction,

 

   

Risks associated with income taxes, including the potential for adverse adjustments and the inability to reverse valuation allowances on deferred tax assets,

 

   

Changes in accounting principles, policies, or guidelines,

 

   

Our ability to maintain effective internal control over financial reporting,

 

   

Our reliance on available secondary funding sources such as Federal Home Loan Bank (“FHLB”) advances, Federal Reserve Discount Window borrowings, sales of securities and loans, and lines of credit from correspondent banks to meet our liquidity needs,

 

   

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

 

   

The value of our stock price, including our ability to become listed on a national stock exchange and the resulting impact on our stock price as a result of such listing,

 

   

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 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 state of 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 continued to impact the Company in 2010 and 2011. 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 maintain sufficient 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.

 

35


Table of Contents

Selected Financial Data

The following consolidated selected 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).

 

    At and for the three months ended           At and for the
year ended
 
    March 31,
2011
    December 31,
2010
    September 30,
2010
    June 30,
2010
    March 31,
2010
          December 31,
2010
 

STATEMENTS OF INCOME (LOSS)

             

Interest income

  $ 12,994      $ 13,442      $ 13,856      $ 14,450      $ 14,879        $ 56,627   

Interest expense

    2,736        3,682        3,888        3,716        4,080          15,366   
                                                 

Net interest income

    10,258        9,760        9,968        10,734        10,799          41,261   

Provision for loan losses

    5,500        10,500        13,100        12,750        10,750          47,100   
                                                 

Net interest income (expense) after provision for loan losses

    4,758        (740     (3,132     (2,016     49          (5,839

Noninterest income

    3,572        4,370        4,270        3,730        4,497          16,867   

Noninterest expense

    14,358        22,155        22,497        15,040        12,880          72,572   
                                                 

Net loss before provision (benefit) for income taxes

    (6,028     (18,525     (21,359     (13,326     (8,334       (61,544

Provision (benefit) for income taxes

    52        14,073        (7,580     (4,793     (3,042       (1,342
                                                 

Net loss

  $ (6,080   $ (32,598   $ (13,779   $ (8,533   $ (5,292     $ (60,202
                                                 
 

COMMON AND PER SHARE DATA

             

Net loss per common share:

             

Basic

  $ (0.12   $ (0.74   $ (2.13   $ (1.32   $ (0.82     $ (3.78

Diluted

    (0.12     (0.74     (2.13     (1.32     (0.82       (3.78

Cash dividends per common share

    —          —          —          —          —            —     

Book value per common share

    2.29        2.40        7.60        9.64        10.93          2.40   

Outstanding common shares

    50,513,722        47,409,078        6,495,130        6,495,130        6,495,130          47,409,078   

Weighted average common shares outstanding—basic

    49,453,501        43,973,313        6,455,598        6,455,598        6,455,598          15,913,000   

Weighted average common shares outstanding—diluted

    49,453,501        43,973,313        6,455,598        6,455,598        6,455,598          15,913,000   

Dividend payout ratio

    n/a     n/a     n/a     n/a     n/a       n/a
                                                 
 

PERIOD-END BALANCES

             

Assets

  $ 1,333,211      $ 1,355,247      $ 1,379,632      $ 1,386,959      $ 1,347,564        $ 1,355,247   

Investment securities available for sale, at fair value

    274,103        218,775        129,571        112,316        115,893          218,775   

Total loans

    824,852        864,376        919,844        969,142        1,011,368          864,376   

Deposits (including traditional and nontraditional)

    1,201,331        1,194,082        1,220,673        1,216,049        1,168,978          1,194,082   

FHLB borrowings

    5,000        35,000        96,000        96,000        96,000          35,000   

Convertible debt

    —          —          380        380        380          —     

Shareholders' equity

    115,845        113,899        49,374        62,643        70,978          113,899   
                                                 
 

AVERAGE BALANCES

             

Assets

  $ 1,322,690      $ 1,464,771      $ 1,392,873      $ 1,371,747      $ 1,367,982        $ 1,399,592   

Interest-earning assets

    1,269,221        1,393,765        1,320,359        1,304,274        1,283,045          1,325,651   

Investment securities available for sale, at fair value

    231,176        175,715        132,223        115,274        117,702          135,379   

Total loans

    846,823        901,564        945,312        994,587        1,031,740          967,882   

Deposits (including traditional and nontraditional)

    1,184,624        1,223,542        1,221,131        1,192,535        1,181,492          1,204,835   

Other short-term borrowings

    1        1        1        —          2          1   

FHLB borrowings

    5,666        89,367        95,997        95,998        99,666          95,231   

Convertible debt

    —          29        380        380        4          199   

Shareholders' equity

    120,042        139,250        62,832        70,705        76,648          87,463   
                                                 
 

SELECT PERFORMANCE RATIOS

             

Return on average assets

    (1.86 )%      (8.83 )%      (3.92 )%      (2.50 )%      (1.57 )%        (4.30 )% 

Return on average shareholders' equity

    (20.54     (92.88     (87.00     (48.41     (28.00       (68.83

Net interest margin

    3.28        2.78        3.00        3.30        3.41          3.11   
                                                 
 

CAPITAL RATIOS

             

Average shareholders' equity as a percentage of average assets

    9.08     9.51     4.51     5.15     5.60       6.25

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

    8.69        8.40        3.58        4.52        5.27          8.40   

Tier 1 risk-based capital

    13.72        13.16        4.35        5.81        6.82          13.16   

Total risk-based capital

    15.00        14.43        5.63        7.08        8.09          14.43   

Tier 1 leverage ratio

    9.26        8.22        3.03        4.34        5.30          8.22   
                                                 
 

ASSET QUALITY INFORMATION

             

Allowance for loan losses

  $ 26,954      $ 26,934      $ 29,339      $ 28,383      $ 28,426        $ 26,934   

Nonaccrual loans

    85,099        91,405        90,773        91,653        113,181          91,405   

Nonperforming assets

    101,484        111,492        113,411        118,280        142,161          111,492   

Net loans charged-off

    5,480        12,453        9,786        12,793        6,403          41,435   

Allowance for loan losses as a percentage of gross loans

    3.53     3.39     3.55     2.93     2.81       3.39

Nonaccrual loans as a percentage of gross loans, commercial loans held

             

for sale, and foreclosed assets

    10.12        10.39        9.67        9.22        10.89          10.39   

Nonperforming assets as a percentage of assets

    7.61        8.23        8.22        8.53        10.55          8.23   

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

    2.85        6.09        4.12        5.17        2.53          4.39   
                                                 

 

 

36


Table of Contents

Executive Summary of First Quarter 2011 Financial Results

Context for the Three Months Ended March 31, 2011 and the Company

The Palmetto Bank has been operating since 1906 and the Bank’s holding company, Palmetto Bancshares, Inc., was incorporated in 1982. Given the Company’s 104 year history, the Company has developed long-standing relationships with customers in the communities in which we operate and a recognizable name, which has resulted in a well-established branch network and loyal deposit base. As a result, the Company has historically had a lower cost of deposits than its peers due to a higher core deposit mix.

The Company operated under the same executive management team for more than 30 years until 2009. During that time, the Company grew to become the fifth largest banking institution headquartered in South Carolina and one of the most profitable banking franchises in the Carolinas. From 1999 to 2008, the Company averaged a return on average assets and return on average equity of 1.25% and 15.2%, respectively, and the Company’s net interest margin averaged 4.78%. In addition, over the same time period, noninterest income to average assets averaged 1.60%.

As a result of the challenges that developed in 2008, the Company accelerated its management succession plan and in early 2009 the board of directors hired a new Chief Executive Officer and Chief Operating Officer. As the impact of the recession worsened, the Company’s new management team quickly developed and implemented a comprehensive Strategic Project Plan to address all areas of the Company with an immediate emphasis on aggressively resolving the Company’s asset quality issues, including through the hiring in July 2009 of a new Chief Credit Officer who brought over 25 years of credit experience to the Company.

Both 2009 and 2010 were very challenging years for the Company, the banking industry, and the U.S. economy in general. In relation to the Company, the overall economic context for our financial condition and results of operations include the following:

 

   

Ongoing financial stress in the overall U.S. economy that generally started with an economic crisis in August 2008 and continued into 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 resulting in significant governmental financial assistance to many financial institutions, extensive regulatory and congressional scrutiny, and new comprehensive reform legislation, including unknown regulations to be adopted as a result.

 

   

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 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, which have begun to improve but for which uncertainty continues about whether the trend will continue 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 which 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 developing 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.”

 

37


Table of Contents
   

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), effective July 1, 2009 the Company named Samuel L. Erwin as Chief Executive Officer and President of the Bank and Lee S. 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 as the Chief Financial Officer of the Company and the Bank from July 1, 2010 to February 2, 2011. 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.

 

   

During 2009 and 2010, we realigned our organizational structure and began the process of more specifically delineating our businesses. Additional organizational and senior management changes included designating an internal executive to be responsible for our Commercial Bank in August 2009 and another internal executive to be responsible for our Wealth Management business in October 2010. In addition, the Company hired a new Chief Credit Officer in July 2009, a new Retail Banking Executive in October 2010, a new Chief Financial Officer in November 2010, and a new Chief Information Officer to start in May 2011.

 

   

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. Asset quality challenges continued in 2010 and into 2011; primarily as a result of these credit losses we also incurred net losses in 2010 and for the three months ended March 31, 2011.

 

   

Increased regulatory scrutiny given declining asset quality, financial results and capital position, which resulted in the Bank agreeing to the issuance of a Consent Order with its primary bank regulatory agencies in June 2010.

 

   

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 federal funds purchased, FHLB advances, and higher priced certificates of deposit used to fund loan growth during that period. Loans (including commercial loans held for sale) decreased $331.8 million from March 31, 2009 (peak quarter end loans) to March 31, 2011. Borrowings and certificates of deposits also decreased $200.0 million from June 30, 2009 (peak quarter end borrowings).

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 and raising additional capital

   June 2009 – October 2010
Annual Strategic Plans   

•  Strategic planning at the corporate and department level for calendar years 2010 and 2011 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-capital raise and post-recession environment

   Calendar years 2010 and 2011

 

38


Table of Contents
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 distribution channels to meet their expectations

 

•  Adapting to the rapidly changing financial services landscape, including lower earnings due to the low interest rate environment, potential regulatory restrictions on historical sources of income, and higher compliance costs

 

•  Intended listing of common stock on the NASDAQ stock exchange

 

•  Preparing for growth through organic growth given banking market disruption in our geographic markets and the potential for growth through mergers and acquisitions

   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, 2010 and into 2011 with the overall objectives being: 1) to aggressively deal with our credit quality, earnings and capital 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 the National Bureau of Economic Research concluded that the recession officially ended in June 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.

The consummation of the Private Placement in October 2010 and subsequent follow-on offering in which the Company received $113.9 million of gross proceeds is a significant step forward in the implementation of these strategic initiatives. The Private Placement resulted in the Company’s and the Bank’s capital adequacy ratios exceeding the well-capitalized minimums. In addition, while financial challenges remain, the completion of the Private Placement repositioned the Company from a defensive posture to a more offensive oriented posture in terms of balance sheet management, market presence, customer retention, and new customer acquisition.

As summarized in more detail below, we are continuing our keen focus on improving credit quality and earnings. Overall, with the completion of the Private Placement, we are in the process of repositioning the balance sheet as part of our balance sheet management efforts to utilize our excess cash more effectively to improve our net interest margin. This includes investing in higher yielding investment securities until loan growth resumes, as well as paying down higher priced funding such as FHLB advances and maturing CDs. We are also continuing to adapt our organizational structure to fit the current and future size and scope of our business activities and operations. Such efforts include hiring management personnel with specialized industry experience, more specifically delineating our businesses, preparing “go to market” strategies with relevant products and services and marketing plans by business, and process improvement and automation to reduce our recurring operating expenses.

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. In South Carolina, unemployment rose significantly throughout 2009 and into 2010 and is higher than the national average. In addition, 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 2009, 2010 and through the first three months of 2011 were significantly impacted by the following in comparison to our historical financial results.

 

   

Provision for loan losses totaling $5.5 million in first quarter 2011 and $47.1 million and $73.4 million in 2010 and 2009, respectively, compared to $5.6 million in 2008.

 

   

Loss on commercial loans held for sale totaling $1.2 million in first quarter 2011 and $7.6 million in 2010 compared to none in 2009 and 2008.

 

   

Net loss from writedowns, expenses, operations, and sales of foreclosed real estate totaling $833 thousand in first quarter 2011 and $11.7 million and $3.2 million in 2010 and 2009, respectively, compared to $516 thousand in 2008.

 

39


Table of Contents
   

Foregone interest of $860 thousand in first quarter 2011 and $4.7 million and $3.7 million 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 2.29%, 2.75% and 4.75%, respectively.

 

   

Higher FDIC deposit insurance assessments totaling $1.0 million in first quarter 2011 and $4.5 million and $3.3 million in 2010 and 2009, respectively, compared to $786 thousand in 2008 due to industry wide increases in general assessment rates, our voluntary participation in the FDIC’s Transaction Account Guarantee Program, our capital classification being below well-capitalized throughout most of 2010, and an industry-wide special assessment in 2009.

 

   

Goodwill impairment totaling $3.7 million in 2010.

 

   

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

 

   

Full valuation allowance recorded against deferred tax assets in December 2010 and March 2011 resulting in the elimination or deferral of tax benefits that would have otherwise been available to reduce our net losses in first quarter 2011 and the year ended December 31, 2010.

In total, the above events impacted pretax earnings by $9.3 million during the three months ended March 31, 2011. Compared to the same periods of 2008, the above events reduced our pretax earnings by approximately $72.3 million and $76.7 million for the years ended December 31, 2010, and 2009, respectively. In addition, the valuation allowance recorded against the net deferred tax asset reduced after-tax earnings by $20.5 million in 2010. We believe consummation of the Private Placement and successful completion of the Strategic Project Plan will result in significant improvement to our earnings going forward.

The credit-related costs associated with the recession are significant for banks. Beginning in the fourth quarter of 2008 and continuing throughout 2009, 2010 and into 2011, construction, acquisition and development real estate projects have slowed down, guarantors are financially stressed, and increasing credit losses have surfaced. During 2009 and into 2010, 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 has manifested itself in our borrowers in several ways: decreases in cash flows from underlying properties supporting the loans (e.g., slower property sales for development type projects or lower occupancy rates or rental rates for operating properties), decreases in cash flows from the borrowers themselves, increased pressure on guarantors due to illiquid and diminished personal balance sheets resulting from investing additional personal capital in the projects, and declines in fair values of real estate related assets, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers are no longer willing to sell the assets at such deep discounts.

This resulted in a significant increase in the level of nonperforming assets through March 31, 2010, with a continued elevated level of such assets through March 31, 2011. While nonperforming assets are still high, we have now experienced four consecutive quarters of a reduction with an overall reduction of 28.6% since the peak at March 31, 2010. In addition, the migration of loans into nonaccrual status declined in the first quarter 2011.

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 selling costs with the fair values determined primarily based on third party appraisals. During 2009 and 2010, appraised values decreased significantly and continue to be depressed in 2011, even in comparison to appraisals received when the loans were originated in 2006 to 2009, and upon reappraisal since origination. As a result, our evaluation of our loan portfolio and foreclosed assets in 2009, 2010 and through the first three months of 2011 resulted in significant credit losses.

Regulatory Consent Order

As a result of these circumstances and the examination of the Supervisory Authorities in November 2009, the Bank agreed to the issuance of the Consent Order with the Supervisory Authorities effective on June 10, 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    We believe we have complied with this provision of the Consent Order.

 

40


Table of Contents
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.    Based on current capital levels, this provision of the Consent Order has not been applicable.
   
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 believe we have complied with this provision of the Consent Order.
   
Notify the supervisory authorities in writing of the resignation or termination of any of the Bank’s directors or senior executive officers.    We believe we have complied with this provision of the Consent Order.
   
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.”    We believe we have complied with 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.    We believe we have complied with this provision of the Consent Order.
   
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”.    To date, we believe we have complied with this provision of the Consent Order. The Supervisory Authorities may also amend the requirements of the Consent Order based on the results of their ongoing examinations.
   
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.    We believe we have complied with this provision of the Consent Order.

 

41


Table of Contents
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.    We believe we have complied with this provision of the Consent Order.
   
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.    As part of our Strategic Project Plan summarized below, we have performed a risk segmentation analysis of our concentrations of credit and developed a plan to reduce our concentration in commercial real estate. We continue to monitor our concentrations and, in particular, are working aggressively to reduce our concentrations in commercial real estate. We submitted our plan to the Supervisory Authorities in August 2010.
   
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.    We believe we have complied with this provision of the Consent Order.
   
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.    We believe we have complied with this provision of the Consent Order.
   
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 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.    We have prepared annual budgets for 2010 and 2011 that were approved by the Bank’s Board of Directors. We submitted the budgets to the Supervisory Authorities in August 2010.
   
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.    We believe we have complied with this provision of the Consent Order.
   
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    We believe we have complied with this provision of the Consent Order.

 

42


Table of Contents
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).    Prior to and at March 31, 2011, the Bank did not have any brokered deposits.
   
Limit asset growth to 10% per annum.    We believe we have complied with this provision of the Consent Order.
   
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.    We believe we have complied with this provision of the Consent Order.
   
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.    We believe we have complied with this provision of the Consent Order.
   
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.    We believe we have complied with this provision of the Consent Order, and we have submitted the required progress reports to the Supervisory Authorities.

We intend to take all actions necessary to enable the Bank to comply with the requirements of the Consent Order, and, as noted above, as of the date hereof we have submitted all documentation required thus far to the Supervisory Authorities. 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 Supervisory Authorities. However, we believe we are currently in compliance with all provisions of the Consent Order except for the requirement to reduce the total amount of our criticized assets at September 30, 2009 by a total of 75% by May 30, 2012. The Consent Order requires a reduction in criticized assets by specified percentages by certain dates, with the first date being December 7, 2010 when a 25% ($56.7 million) reduction in criticized assets was required. We reduced our criticized assets by more than the amount necessary to meet the December 7, 2010 deadline. Our next incremental deadline, June 5, 2011, stipulates a 45% ($102.0 million) reduction in criticized assets from the September 30, 2009 balances. As of April 26, 2011, we have reduced our criticized assets by 60.4% ($130.7 million). 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. In addition, the Supervisory Authorities may amend the Consent Order based on the results of their ongoing examinations.

Strategic Project Plan

In response to the challenging economic environment and our negative financial results and in preparation for a potential formal agreement from the banking regulatory agencies, in June 2009 the Board of Directors and management adopted and began executing a proactive and aggressive Strategic Project Plan (the “Plan”) to address the issues related to credit quality, liquidity, earnings, and capital. Execution of the Plan is being overseen by the special Regulatory Oversight and Risk Management Committee of the Board of Directors, and we utilized external expertise to assist with its initial implementation. The Plan contemplated substantially all of the requirements of the Consent Order and therefore we believe we have already made substantial progress towards complying with the requirements of the Consent Order. However, certain provision of the Consent Order required us to submit written plans to the Supervisory Authorities for their review and / or approval, and all provisions of the Consent Order are subject to examination by the Supervisory Authorities in subsequent examinations.

Since June 2009, we have been, and continue to be, keenly focused on executing the Plan, which now also reflects the requirements of the Consent Order. No one can predict the ongoing impact of the recession given its length and severity. However, it is our expectation that our hard work, the eventual improvement in the economy and the real estate markets, and raising additional capital, will help our borrowers and us weather this storm and continue our road to recovery and return to profitability.

Credit Quality. Given the negative asset quality trends within our loan portfolio, which began in 2008, accelerated during 2009, and continued throughout 2010 and into 2011, we have worked aggressively to

 

43


Table of Contents

identify and quantify potential losses and execute plans to reduce problem assets. The credit quality plan includes, among other things:

 

 

Performing detailed loan reviews of our loan portfolio in 2009, 2010 and into 2011. The loan reviews were performed by management as well as by an independent loan review firm that reported their results directly to the Board of Directors. These internal and independent loan reviews will continue during 2011.

 

 

For identified problem loans, we prepared written workout plans that are borrower specific to determine how best to resolve the loans which could include restructuring the loans, requesting additional collateral, demanding payment from guarantors, sale of the loans, or foreclosure and sale of the collateral.

 

 

We also increased our monitoring of borrower and industry sector concentrations and are limiting additional credit exposure to these concentrations.

 

 

In July 2009, we hired a new Chief Credit Officer and reevaluated our lending policies and procedures and credit administration function and implemented significant enhancements. Among other changes, we reorganized our credit administration function, hired additional internal resources and external consulting assistance, and reorganized our line of business lending roles and responsibilities including separate designation of a commercial lending business with more direct oversight and clearer accountability.

 

 

In 2010, we hired additional personnel with expertise in problem asset workout and disposition, and in June 2010 we hired a seasoned department manager for our Special Assets Department, which is now comprised of five individuals.

 

 

We are actively marketing problem assets for sale. Nonperforming assets declined $10.0 million (9.0%) during the first quarter 2011, and by 28.6% since the peak at March 31, 2010. The decline during the first quarter 2011 was the fourth consecutive quarterly decline in nonperforming assets.

 

 

In September 2010, we began marketing for sale a pool of commercial loans. Through March 31, 2011, we sold ten loans with a gross book value of $12.4 million. We are continuing our efforts to sell the remaining loans held for sale. At March 31, 2011, we had commercial loans held for sale aggregating $60.3 million.

Credit quality indicators improved in the first quarter 2011 as we experienced reductions in charge-offs, and in migration of loans to nonaccrual status, and reductions in past dues and nonperforming assets at March 31, 2011. We continue to monitor our loan portfolio very carefully and are aggressively working to reduce our problem assets.

Liquidity. In June 2009, we implemented a forward-looking liquidity plan and increased our liquidity monitoring. The liquidity plan includes, among other things:

 

   

Implementing proactive customer deposit retention initiatives specific to large deposit customers and our deposit customers in general.

 

   

Executing targeted deposit growth and retention campaigns. Since June 30, 2010, our deposits have remained stable through our normal growth and retention efforts, and therefore we have not utilized any special campaigns. In addition, given our cash position, beginning in the fourth quarter 2010 and continuing into the first quarter 2011, we reduced our deposit pricing to allow our higher priced certificates of deposit to roll off as they mature.

 

   

Evaluating our sources of available financing and identifying additional collateral for pledging for FHLB, Federal Reserve and other secured borrowings. In April 2011, we entered into a Master Repurchase Agreement resulting in a new line of credit from a correspondent bank totaling $25 million.

 

   

Accelerating the filing of our income tax refund claims resulting in refunds received totaling $27.6 million in 2010 and 2011.

 

   

During 2009 and most of 2010, maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in other earning assets. Maintaining this cash balance reduced our interest income when compared with investing these funds at the average yield on our investment securities. Following the consummation of our Private Placement in October 2010, we have redeployed, through March 31, 2011, $208.5 million of this cash into investment securities and prepaid $91 million of FHLB advances which were scheduled to mature in January through April 2011. We will continue to monitor the level of cash balances in relation to expected liquidity needs and may make further purchases of investment securities during 2011.

 

44


Table of Contents

At April 26, 2011, funding sources included cash invested at the Federal Reserve totaling $163.9 million, approximately $2.9 million in available retail repurchase agreement capacity, $80.4 million from the FHLB, and our correspondent bank lines of credit totaling $30.0 million.

Capital. At March 31, 2011, as a result of the consummation of the Private Placement in October 2010, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds and the requirements of the Consent Order. In addition, to preserve our capital, we have:

 

   

Not paid a dividend on our common stock since the first quarter of 2009.

 

   

Reduced our loan portfolio (including commercial loans held for sale) by $331.8 million and total assets by $68.9 million since March 31, 2009.

 

   

Evaluated other capital saving alternatives such as asset sales and reducing outstanding credit commitments.

 

   

Issued unsecured convertible debt from the Company in March 2010 of $380 thousand, the proceeds of which were contributed to the Bank as a capital contribution. In October 2010, as a result of the Private Placement, these notes were converted into common stock of the Company.

 

   

As a condition of the Private Placement, conducted a $10 million follow-on common stock offering to our legacy shareholders as of October 6, 2010 and institutional investors in the Private Placement. The follow-on offering was fully subscribed resulting in the issuance of common stock for gross proceeds of $10.0 million in December 2010 and the first quarter 2011. The net proceeds of the offering were invested in the Bank.

Earnings. We have been implementing an earnings plan that is focused on improvement through a combination of revenue increases and expense reductions, including assistance from external consulting firms to review our current and potential new products and services and related rates and fees, and to identify process and efficiency improvements.

 

   

With respect to net interest income, we implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain criteria. At March 31, 2011, loans aggregating $218.8 million had interest rate floors, of which $199.4 million had floors greater than or equal to 5%. In 2010 and again in March 2011, we introduced loan specials intended to generate additional loan volume for residential mortgage, auto, credit card, consumer, and commercial loans. In light of the current low interest rate environment, we have also reduced the interest rates paid on our deposit accounts. Given expectations for rising interest rates, during 2010 we also borrowed longer-term advances from the FHLB, and extended maturities on certain CD specials to lock in the low interest rates at the time of the specials. In December 2010 and January 2011, we used excess cash earning 25 basis points to prepay $91.0 million of FHLB advances bearing interest at an average rate of 1.58%.

 

   

We are evaluating additional sources of noninterest income. For example, in March 2010, we introduced a new checking account, MyPal checking, and a new savings account, Smart Savings, both of which provide noninterest income resulting from service charges or debit card transactions. We also evaluated the profitability of all of our pre-existing checking accounts and in October 2010 upgraded a large number of unprofitable checking accounts to the MyPal account. In addition, we revised our existing fees and implemented new fees, with various implementation dates generally between October 1, 2010 and March 1, 2011. We also anticipate increases to fee structures during 2011 related to other services.

 

   

We identified specific opportunities for noninterest expense reductions and are continuing to review other expense areas for additional reductions. These expense reductions have been and will continue to be partially offset by the higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of nonperforming assets.

 

   

We continue to critically evaluate each of our businesses to determine their contribution to our financial performance and their relative risk / return relationship. Based on the evaluation to date, we sold two product lines during 2010. In March 2010, we sold our merchant services business and entered into a referral and services agreement with Global Direct Payments, Inc. (“Global Direct”) related to our merchant services business which resulted in a net gain of $587 thousand. Similarly, in December 2010, we sold our credit card portfolio and entered into a joint marketing agreement with Elan Financial Services, Inc., which resulted in a net gain of $1.2 million.

Summary

In summary, during the three months ended March 31, 2011, we continued to be impacted by the negative financial conditions of our borrowers, further deterioration in real estate values and the economy in general;

 

45


Table of Contents

however we have also made substantial progress on the execution of the Strategic Project Plan adopted in June 2009. We believe that raising capital, combined with an improving economy and our continued focus on credit quality and earnings improvements, will accelerate our return to profitability in the post-recession environment. We believe that we may return to profitability, on a quarterly basis, at some point during 2012. However, as discussed in this report, our performance is subject to numerous risks and uncertainties, many of which are beyond our control, and we can provide no assurances regarding when or if we will return to profitability.

Critical Accounting Policies and Estimates

Our significant accounting policies are fundamental to understanding our financial condition and results of operations because some accounting policies require the use of estimates and assumptions that may impact the value of assets or liabilities and financial results. Accounting for these critical areas requires subjective and complex judgments and could be subject to revision as new information becomes available. Our policies governing the accounting for our allowance for loan losses and the related reserve for unfunded commitments, commercial loans held for sale and the related valuation allowance, mortgage-servicing rights portfolio, goodwill, foreclosed real estate, the realization of our net deferred tax asset, defined benefit pension plan, the valuation of our common stock, and the determination of fair value of financial instruments were determined to be critical. On an annual basis, management, in conjunction with our independent registered public accounting firm, discusses the critical accounting estimates with the Audit Committee of our Board of Directors. For additional information regarding our critical accounting policies and estimates, refer to our Annual Report on Form 10-K/A for the year ended December 31, 2010.

Financial Condition

During 2009 and 2010, we realigned our organizational structure and began the process of more specifically delineating our businesses. However, at this time we do not yet have in place a reporting structure to separately report and evaluate our various lines of businesses. Our organization structure delineation and more granular line of business management reporting efforts have continued in 2011. Accordingly, the discussion and analysis of our financial condition and results of operations herein is provided on a consolidated basis, with commentary on business specific implications if more granular information is available.

Overview

 

46


Table of Contents

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Balance Sheets

(dollars in thousands)

 

     March 31,
2011
    December 31,
2010
    Dollar
variance
    Percent
variance
 

Assets

    
(unaudited)
  
     

Cash and cash equivalents

        

Cash and due from banks

   $ 188,545      $ 223,017      $ (34,472     (15.5 )% 
                                

Total cash and cash equivalents

     188,545        223,017        (34,472     (15.5

FHLB stock, at cost

     6,785        6,785        —          —     

Investment securities available for sale, at fair value

     274,103        218,775        55,328        25.3   

Mortgage loans held for sale

     279        4,793        (4,514     (94.2

Commercial loans held for sale

     60,346        66,157        (5,811     (8.8

Loans, gross

     764,227        793,426        (29,199     (3.7

Less: allowance for loan losses

     (26,954     (26,934     (20     0.1   
                                

Loans, net

     737,273        766,492        (29,219     (3.8

Premises and equipment, net

     28,072        28,109        (37     (0.1

Accrued interest receivable

     5,017        4,702        315        6.7   

Foreclosed real estate

     16,244        19,983        (3,739     (18.7

Income tax refund receivable

     7,436        7,436        —          —     

Other

     9,111        8,998        113        1.3   
                                

Total assets

   $ 1,333,211      $ 1,355,247      $ (22,036     (1.6 )% 
                                

Liabilities and shareholders’ equity

        

Liabilities

        

Deposits

        

Noninterest-bearing

   $ 156,323      $ 141,281      $ 15,042        10.6

Interest-bearing

     1,021,367        1,032,081        (10,714     (1.0
                                

Total deposits

     1,177,690        1,173,362        4,328        0.4   

Retail repurchase agreements

     23,641        20,720        2,921        14.1   

FHLB borrowings

     5,000        35,000        (30,000     (85.7

Accrued interest payable

     955        1,187        (232     (19.5

Other

     10,080        11,079        (999     (9.0
                                

Total liabilities

     1,217,366        1,241,348        (23,982     (1.9
                                

Shareholders’ equity

        

Preferred stock

     —          —          —          —     

Common stock

     505        474        31        6.5   

Capital surplus

     141,194        133,112        8,082        6.1   

Retained earnings (deficit)

     (19,188     (13,108     (6,080     46.4   

Accumulated other comprehensive loss, net of tax

     (6,666     (6,579     (87     1.3   
                                

Total shareholders’ equity

     115,845        113,899        1,946        1.7   
                                

Total liabilities and shareholders’ equity

   $ 1,333,211      $ 1,355,247      $ (22,036     (1.6 )% 
                                

Cash and Cash Equivalents

Cash and cash equivalents decreased $34.5 million at March 31, 2011 from December 31, 2010 primarily as a result of reinvestment of excess liquidity into higher-yielding investment securities and repayment of FHLB advances in January 2011. Carrying excess cash has a negative impact on our interest income since we only earn 25 basis points on our deposits with the Federal Reserve versus investing this cash in higher earning assets. Accordingly, since consummation of the Private Placement in October 2010, we began redeploying this cash by investing $101.5 million in investment securities in the fourth quarter 2010 and $107.0 million in the first quarter 2011, prepaying $91.0 million of FHLB advances in December 2010 and January 2011, and not pursuing retention of higher priced certificates of deposits that matured in the fourth quarter 2010 and first quarter 2011. Redeploying our excess cash resulted in an improvement in our net interest margin to 3.28% in the first quarter 2011 compared to 2.78% in the fourth quarter 2010.

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

The following table summarizes cash and cash equivalents pledged as collateral and therefore restricted at the dates indicated (in thousands).

 

47


Table of Contents
     March 31,
2011
     December 31,
2010
 

Merchant credit card agreements

   $ 452       $ 451   

Contractually restricted balances for check clearing

     1,929         1,929   
                 

Total

   $ 2,381       $ 2,380   
                 

In April 2011, $1.0 million of the contractually restricted balances for check clearing were freed of restriction and returned to the Company.

Investment Activities

General. Our primary objective in managing the investment portfolio is to maintain a portfolio of high quality, highly liquid investments yielding competitive returns. We are required under federal regulations to maintain adequate liquidity to ensure safe and sound operations. We maintain investment balances based on a continuing assessment of cash flows, the level of current and expected loan production, current interest rate risk strategies, and the assessment of the potential future direction of market interest rate changes. Investment securities differ in terms of default, interest rate, liquidity, and expected rate of return risk.

Composition. The following table summarizes the composition of our investment securities available for sale portfolio at the dates indicated (dollars in thousands).

 

     March 31, 2011     December 31, 2010  
     Total      % of total     Total      % of total  

U.S. Treasury and federal agencies

   $ —           —     $ 37,426         17.1

State and municipal

     105,659         38.5        52,462         24.0   

Collateralized mortgage obligations

     148,535         54.2        108,171         49.4   

Other mortgage-backed (federal agencies)

     19,909         7.3        20,716         9.5   
                                  

Total investment securities available for sale

   $ 274,103         100.0   $ 218,775         100.0
                                  

Average balances of investment securities available for sale increased to $231.2 million during the three months ended March 31, 2011 from $175.7 million during the three months ended December 31, 2010 and $117.7 million during the three months ended March 31, 2010. This increase was the result of purchases in the third quarter 2010 of U.S. Treasury and federal agencies to provide additional securities to pledge as collateral for FHLB borrowings, as well as reinvestment of our excess cash into securities during the fourth quarter 2010 and first quarter 2011. Investments in the fourth quarter 2010 and first quarter 2011 consisted primarily of government and agency CMOs at an average yield of 1.30%, and AA or better rated municipal securities at an average yield of 3.10%, which was more favorable than other investment securities of comparable credit quality and duration at that time. At March 31, 2011, municipal securities issued in Michigan, Texas and South Carolina represented 31.6% of the total state and municipal portfolio and 12.2% of the total investment securities portfolio. The most recent Company purchase of a municipal security from Michigan was in 2007.

The fair value of the investment securities available for sale portfolio represented 20.6% of total assets at March 31, 2011 and 16.1% of total assets at December 31, 2010.

Subsequent to March 31, 2011, in April 2011, we purchased additional mortgage-backed and state and municipal investment securities aggregating approximately $12.4 million. We also sold our remaining private-label CMO for $2.3 million, recognizing a gain of $56 thousand.

Unrealized Position. The following table summarizes the amortized cost and fair value composition of our investment securities available for sale portfolio at the dates indicated (dollars in thousands).

 

     March 31, 2011      December 31, 2010  
     Amortized
cost
     Fair
value
     Amortized
cost
     Fair
value
 

U.S. Treasury and federal agencies

   $ —         $ —         $ 37,430       $ 37,426   

State and municipal

     104,288         105,659         51,243         52,462   

Collateralized mortgage obligations

     148,480         148,535         107,876         108,171   

Other mortgage-backed (federal agencies)

     19,439         19,909         20,189         20,716   
                                   

Total investment securities available for sale

   $ 272,207       $ 274,103       $ 216,738       $ 218,775   
                                   

Pledged. Public depositors from state and local municipalities typically require that the Bank pledge investment grade securities to the accounts to ensure repayment. Although the funds are usually a low cost,

 

48


Table of Contents

relatively stable source of funding for the Bank, availability depends on the particular government’s fiscal policies and cash flow needs.

Investments securities were pledged as collateral for the following at the dates indicated (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Public funds deposits

   $ 97,531       $ 67,260   

FHLB advances and line of credit

     24,654         48,344   
                 

Total

   $ 122,185       $ 115,604   
                 

In April 2011, the Company obtained a $25 million secured overnight line of credit with another bank. This line of credit, if drawn upon, will require the pledge of investment securities with a fair value equal to approximately 110% of the amount borrowed.

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).

 

    March 31, 2011  
    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

    24        16,021        324        —          —          —          24        16,021        324   

Collateralized mortgage obligations

    20        72,738        842        3        7,261        76        23        79,999        918   

Other mortgage-backed (federal agencies)

    3        6,600        126        —          —          —          3        6,600        126   
                                                                       

Total investment securities available for sale

    47      $ 95,359      $ 1,292        3      $ 7,261      $ 76        50      $ 102,620      $ 1,368   
                                                                       
    December 31, 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

    2      $ 21,428      $ 6        —        $ —        $ —          2      $ 21,428      $ 6   

State and municipal

    12        7,211        468        —          —          —          12        7,211        468   

Collateralized mortgage obligations

    10        38,295        376        —          —          —          10        38,295        376   

Other mortgage-backed (federal agencies)

    3        6,861        120        —          —          —          3        6,861        120   
                                                                       

Total investment securities available for sale

    27      $ 73,795      $ 970        —        $ —        $ —          27      $ 73,795      $ 970   
                                                                       

Gross unrealized losses increased $498 thousand from December 31, 2010 to March 31, 2011, primarily within the collateralized mortgage obligation sector of the investment securities portfolio as a result of an increase in treasury yields over the periods presented. Based on our other-than-temporary impairment analysis at March 31, 2011 and December 31, 2010, we concluded that gross unrealized losses detailed in the preceding table were not other-than-temporarily impaired as of that date.

Fair values of securities in the investment securities portfolio could decline in the future if the underlying performance of the collateral for collateralized mortgage obligations or other securities deteriorates and the levels do not provide sufficient protection for contractual principal and interest. As a result, there is risk that other-than-temporary impairments may occur in the future particularly in light of the current economic environment.

Ratings. The following table summarizes Moody’s Investors Service’s (“Moody’s”) ratings, by segment, of investment securities available for sale based on fair value, at March 31, 2011. 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.

 

49


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

Aaa

     14     100     100

Aa1-A3

     56        —          —     

Baa1

     5        —          —     

Not rated or withdrawn rating

     25        —          —     
                        

Total

     100     100     100
                        

The following table summarizes by Standard and Poor’s ratings, by segment, of the investment securities available for sale based on fair value, at March 31, 2011.

 

     State
and
municipal
    Collateralized
mortgage
obligations
    Other
mortgage-backed
(federal agencies)
 

Aaa

     18     100     100

Aa+-A

     53        —          —     

Not rated or withdrawn rating

     29        —          —     
                        

Total

     100     100     100
                        

One state and municipal security totaling $203 thousand was not rated by Moody’s or Standard and Poor’s.

Maturities. The weighted average life of investment securities available for sale was 4.5 years, based on expected prepayment activity, at March 31, 2011. Since 62% of the portfolio, based on amortized cost, 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. Given the general expectation of a rising interest rate environment, we are intentionally investing in shorter-term duration securities to minimize our interest rate risk if interest rates begin to rise.

Concentrations. The following table summarizes issuer concentrations of collateralized mortgage obligations whose aggregate book values exceed 10% of shareholders’ equity at March 31, 2011 (dollars in thousands).

 

Issuer

   Aggregate
fair  value
     Aggregate
amortized  cost
     Amortized cost as a % of
shareholders’ equity
 

Freddie Mac

   $ 48,389       $ 48,357         41.7

Fannie Mae

     39,506         39,381         34.0

Ginnie Mae

     55,769         56,038         48.4

The following table summarizes issuer concentrations of other mortgage-backed investment securities whose book values exceed 10% of shareholders’ equity at March 31, 2011 (dollars in thousands).

 

Issuer

   Aggregate
fair  value
     Aggregate
amortized  cost
     Amortized cost as a % of
shareholders’ equity
 

Fannie Mae

   $ 14,772       $ 14,300         12.3

Although there are no state and municipal investment securities with state issuer concentrations whose aggregate book values exceed 10% of shareholders’ equity at March 31, 2011, three state issuers, Michigan, Texas, and South Carolina, exceeded 9% of shareholders’ equity at March 31, 2011. These securities represented 31.6% of the total state and municipal portfolio and 12.2% of the total investment securities portfolio at March 31, 2011.

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 months

ended March 31,

 
     2011      2010  

Realized gains

   $ —         $ 1,147   

Realized losses

     —           (1,139
                 

Net realized gains

   $ —         $ 8   
                 

Lending Activities

 

50


Table of Contents

General. Loans continue to be the largest component of our assets. During the three months ended March 31, 2011, gross loans declined approximately $29.2 million (3.7%) as a result of repayments, sales and charge-offs. In addition, commercial loans held for sale declined $5.8 million (8.8%) as we continue to actively seek to reduce our commercial real estate loan portfolio to improve our credit quality and reduce our concentration in commercial real estate. Based on our risk assessment of borrowers, during 2010, we also implemented risk-based loan pricing and interest rate floors, or minimum interest rates, both at origination and renewal. In addition, we are proactively addressing the reduction of our nonperforming assets through restructurings, charge-offs, and sales. Overall, the demand for new loans from credit-worthy borrowers is weak such that repayments are outpacing new loans originated.

Commercial Loans Held for Sale. In September 2010, we began marketing for sale a pool of specifically identified commercial loans. Our marketing efforts continued through the first quarter 2011 and are expected to continue through 2011. We are evaluating the bids received on a loan-by-loan basis and are balancing the desire to reduce problem loans with preservation of capital. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking industry in general and our Company in particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year-end. While bid prices on certain assets improved in the first quarter 2011, such prices continue to reflect heavy discounting. In many cases, we have not accepted certain discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order. To date, we have sold commercial loans held for sale with a gross book value of $12.4 million.

We are continuing our efforts to sell the remaining loans held for sale. At March 31, 2011, we had commercial loans held for sale aggregating $60.3 million. These loans are carried at the lower of cost or fair value, and a valuation allowance of $853 thousand was recorded against the loans held for sale resulting in a net carrying amount in the Consolidated Balance Sheets of $60.3 million. Of the aggregate balance of commercial loans held for sale, 99.4% are commercial real estate loans based on FDIC code. Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these assets to fair value, which was based on updated appraisals received during the first quarter or internal valuations, less estimated costs to sell. There can be no assurances that the loans will be sold, or that bids will be offered, at the currently recorded balances. Accordingly, to the extent we accept bids for these loans, we may receive less than the current net carrying amount of the loans and incur a corresponding incremental loss on any such loan sales.

Loan Composition. Disclosure guidance related to a company’s allowance for loan losses and the credit quality of its financing receivables require the loans and allowance for loan losses disclosures to be provided on a disaggregated basis. This disaggregated basis has been defined as portfolio segments, the level at which we develop and document our methodology to determine our allowance for loan losses, and classes, a level of information below the portfolio segment that provides an understanding as to the nature and extent of exposure in our loan portfolio. For reporting purposes, loan classes are based on FDIC code, and portfolio segments are an aggregation of those classes based on the way we develop and document our allowance for loan losses. FDIC codes are based on the underlying loan collateral.

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

 

     March 31, 2011     December 31, 2010  
     Total     % of total     Total     % of total  

Commercial real estate

   $ 543,683        65.9   $ 573,822        66.8

Single-family residential

     175,332        21.3        178,980        20.8   

Commercial and industrial

     48,624        5.9        47,812        5.6   

Consumer

     50,884        6.2        52,652        6.1   

Other

     6,050        0.7        6,317        0.7   
                                

Total loans

   $ 824,573        100.0   $ 859,583        100.0
                    

Less: Commercial loans held for sale

     (60,346       (66,157  
                    

Loans, gross

   $ 764,227        $ 793,426     
                    

Loans included in the preceding loan composition table are net of participations sold. Participations sold reflect two loans totaling $12.3 million at March 31, 2011 and $12.5 million at December 31, 2010. With regard to participations sold, we serve as the lead bank and are therefore responsible for certain

 

51


Table of Contents

administration and other management functions as agent to the participating banks. We are in active discussions with the participating banks to keep them informed of the status of these loans and determine loan workout plans.

Mortgage loans serviced for the benefit of others amounted to $424.0 million and $423.6 million at March 31, 2011 and December 31, 2010, respectively, and are not included in our Consolidated Balance Sheets.

Pledged. To borrow from the FHLB, members must pledge collateral. Acceptable collateral includes, among other types of collateral, a variety of residential, multifamily, home equity lines and second mortgages, and commercial loans. At March 31, 2011 and December 31, 2010, $362.9 million and $393.7 million of gross loans, respectively, were pledged to collateralize FHLB advances and letters of credit, of which $87.0 million and $92.5 million, respectively, was available as lendable collateral.

At March 31, 2011 and December 31, 2010, $10.8 million and $10.9 million, respectively, of loans were pledged as collateral to cover the various Federal Reserve System services that we utilize.

Concentrations. General. During 2009, 2010 and continuing into 2011, we increased our monitoring of borrower and industry sector concentrations and are limiting additional credit exposure to these concentrations, in particular the segments of our loan portfolio secured by commercial real estate. In addition, we are proactively executing loan workout plans with a particular focus on reducing our concentrations in these segments. In addition, we are evaluating the potential sale, individually or in bulk, of performing and nonperforming commercial loans. In September 2010, we began marketing for sale commercial loans to reduce our nonperforming assets and concentration in commercial real estate.

Loan Type / Industry Concentration. The following table summarizes loans secured by commercial real estate, categorized by FDIC code, at March 31, 2011 (dollars in thousands).

 

     Commercial
real estate
included in
gross loans
     Commercial
real estate
included in
commercial
loans held
for sale
     Total
commercial
real estate
loans
     % of gross
loans and
commercial
loans held
for sale
    % of
Bank’s
total
regulatory
capital
 

Secured by commercial real estate

             

Construction, land development, and other land loans

   $ 112,579       $ 8,884       $ 121,463         14.7     91.8

Multifamily residential

     18,143         7,475         25,618         3.1        19.4   

Nonfarm nonresidential

     352,977         43,625         396,602         48.1        299.8   
                                           

Total loans secured by commercial real estate

   $ 483,699       $ 59,984       $ 543,683         65.9     411.0
                                           

The following table further categorizes loans secured by commercial real estate at March 31, 2011 (dollars in thousands).

 

52


Table of Contents
     Commercial
real estate
included in
gross loans
     Commercial
real estate
included in
commercial
loans held
for sale
     Total
commercial
real estate
loans
     % of gross
loans and
commercial
loans held
for sale
    % of
Bank’s
total
regulatory
capital
 

Development commercial real estate loans

             

Secured by:

             

Land - unimproved (commercial or residential)

   $ 43,714       $ 1,161       $ 44,875         5.4     33.9

Land development - commercial

     12,515         463         12,978         1.6        9.8   

Land development - residential

     41,541         7,260         48,801         5.9        36.9   

Commercial construction:

     —                

Retail

     4,420         —           4,420         0.5        3.3   

Office

     239         —           239         0.0        0.2   

Multifamily

     1,250         —           1,250         0.2        1.0   

Industrial and warehouse

     930         —           930         0.1        0.7   

Miscellaneous commercial

     3,312         —           3,312         0.4        2.5   
                                           

Total development commercial real estate loans

     107,921         8,884         116,805         14.1        88.3   

Existing and other commercial real estate loans

             

Secured by:

             

Hotel / motel

     18,143         7,475         25,618         3.1        19.4   

Retail

     55,764         33,378         89,142         10.8        67.4   

Office

     15,735         4,313         20,048         2.4        15.2   

Multifamily

     23,270         1,409         24,679         3.0        18.7   

Industrial and warehouse

     11,945         1,489         13,434         1.6        10.2   

Healthcare

     12,891         —           12,891         1.6        9.7   

Miscellaneous commercial

     115,207         2,570         117,777         14.3        89.0   

Residential construction - speculative

     863         —           863         0.1        0.6   
                                           

Total existing and other commercial real estate loans

     253,818         50,634         304,452         36.9        230.2   

Commercial real estate owner occupied and residential loans

             

Secured by:

             

Commercial - owner occupied

     118,165         466         118,631         14.4        89.7   

Commercial construction - owner occupied

     1,711         —           1,711         0.2        1.3   

Residential construction - contract

     2,084         —           2,084         0.3        1.5   
                                           

Total commercial real estate owner occupied and residential loans

     121,960         466         122,426         14.9        92.5   
                                           

Total loans secured by commercial real estate

   $ 483,699       $ 59,984       $ 543,683         65.9     411.0
                                           

Asset Quality. Given the negative credit quality trends that began in 2008, accelerated during 2009, and continued through 2010 and into 2011, we have performed extensive analysis of our non-consumer loan portfolio, with particular focus on commercial real estate loans. The analyses included internal and external loan reviews that required detailed, written analyses for the loans reviewed and vetting of the risk rating, accrual status, and collateral valuation of the loans by the loan officers, our senior management team, external consultants, and an external loan review firm. Of particular significance is that these reviews have currently identified 30 specifically identified borrower relationships (43 individual loans) that have resulted in $73.6 million (62%) of the $118.9 million of net loan charge-offs, writedowns on loans held for sale, and writedowns on foreclosed assets recorded in the past nine quarters. In general, these loans have one or more of the following common characteristics:

 

   

Individually larger commercial real estate loans originated in 2004 through 2008 that were larger and more complex loans than we historically originated.

 

   

Out-of-market loans, participated loans purchased from other banks, or brokered loans brought to us by loan brokers, which were generally to non-customers for whom we generally had no pre-existing banking relationship.

 

   

Concentrated originations in commercial real estate, including acquisition development and construction loans, by loan officers who did not have the level of specialized expertise necessary to more effectively underwrite and manage these types of loans.

In general, our entire commercial real estate loan portfolio has been negatively impacted by the challenging economic environment that began in 2008. However, this pool of loans is the primary contributor to our deteriorated asset quality, charge-offs, and resulting net loss over the past nine quarters. In addition, this pool of loans has exhibited a loss given default much higher than the remainder of the loan portfolio that is comprised of in-market loans to our ongoing customers that were underwritten by loan officers using our normal credit underwriting standards. Accordingly, as we evaluate the credit quality of the remaining loan portfolio, we do not currently believe that the higher loss rate incurred on this particular pool of loans is indicative of the loss rate to be incurred on the remainder of the loan portfolio.

As part of the credit quality plan, to continue addressing the impact of the economic environment on our loan portfolio, we are continuing our detailed review of the loan portfolio and are focused on executing detailed loan workout plans for all of our problem loans led by a team of seasoned commercial lenders and

 

53


Table of Contents

using external loan workout consulting expertise. It is clear that some of our borrowers are continuing to face financial stress manifesting itself in the following ways:

 

   

Decreased cash flows from the underlying properties supporting the loans,

 

   

Personal cash flows from the borrowers themselves and guarantors under pressure due to illiquid and diminished personal balance sheets resulting from investing additional personal capital in the projects, and

 

   

Declining fair values of real estate related assets, resulting in lower cash proceeds from sales or fair values declining to the point that borrowers are no longer willing to sell the assets at such deep discounts.

We also continue to review our lending policies and procedures and credit administration function. To this end, during 2009, 2010, and thus far in 2011 we implemented several enhancements as follows:

 

   

Construction draws: In 2009, we centralized the oversight and disbursement of construction draws to contractors working for borrowers, and hired a construction draw manager to review advance requests before funds are advanced to borrowers.

 

   

Loan Policy: In 2009, 2010 and 2011, we amended our loan policy to, among other changes, adjust lending limit approval authorities, prohibit out-of-market loans to borrowers for which we do not have a previously existing relationship, prohibit brokered loans and update for new regulatory appraisal guidelines.

 

   

Credit Administration: In 2009, we hired a new Chief Credit Officer who brings over 25 years of credit administration, loan review, and credit policy experience to the Company; we reassigned two commercial lenders to credit analysts in the Credit Administration department; and we hired an additional Credit Administration executive.

 

   

Special Assets: In 2009 and 2010, we engaged two external workout consultants (who have since completed their engagements); reassigned a commercial lender; hired two experienced special assets professionals, and we hired a seasoned department leader to manage our Special Assets Department. This department is currently comprised of five people and these internal personnel and external consultants have been focused exclusively on accelerated resolution of our problem assets.

 

   

Training: During 2010 and 2011, we conducted additional training including external specialists in the areas of problem loan workout and negotiating skills, analysis of personal financial statements and business tax returns, cash flow analysis, perfecting security interests in collateral, appraisals, Small Business Administration programs and credit underwriting.

At March 31, 2011, nonperforming assets decreased $10.0 million (9.0%) from December 31, 2010, representing a total decline of 28.6% from the peak at March 31, 2010 and the fourth consecutive quarterly decline. However, we continue to have a high-risk loan portfolio given the concentration in commercial real estate and the number of individually large criticized loans.

The following table summarizes nonperforming assets, by class, at the dates indicated (dollars in thousands).

 

54


Table of Contents
     March 31,
2011
    December 31,
2010
    September 30,
2010
    June 30,
2010
    March 31,
2010
    December 31,
2009
 

Construction, land development and other land loans

   $ 52,386      $ 52,528      $ 42,914      $ 37,733      $ 54,347      $ 47,901   

Multifamily residential

     7,475        7,943        8,022        9,352        9,827        9,844   

Nonfarm nonresidential

     14,063        18,781        25,787        28,200        31,910        23,330   

Single-family real estate, revolving, open end loans

     875        998        987        535        279        127   

Single-family real estate, closed end, first lien

     7,395        7,607        6,473        7,991        7,801        7,079   

Single-family real estate, closed end, junior lien

     606        866        969        633        392        446   

Commercial and industrial

     1,795        2,197        4,776        6,330        7,917        7,475   

Credit cards

     26        26        400        398        298        372   

All other consumer

     478        459        445        433        362        312   

Farmland

     —          —          —          48        48        50   
                                                

Total nonaccrual loans

     85,099        91,405        90,773        91,653        113,181        96,936   

Real estate acquired in settlement of loans

     16,244        19,983        22,508        26,521        28,867        27,826   

Repossessed automobiles acquired in settlement of loans

     141        104        130        106        113        188   
                                                

Total foreclosed assets

     16,385        20,087        22,638        26,627        28,980        28,014   
                                                

Total nonperforming assets

   $ 101,484      $ 111,492      $ 113,411      $ 118,280      $ 142,161      $ 124,950   
                                                

Less: Nonaccrual commercial loans held for sale

     (22,654     (27,940     (47,957     —          —          —     
                                                

Adjusted nonperforming assets

   $ 78,830      $ 83,552      $ 65,454      $ 118,280      $ 142,161      $ 124,950   
                                                

Loans*

   $ 824,573      $ 859,583      $ 916,128      $ 967,244      $ 1,010,247      $ 1,040,312   

Total assets

     1,333,211        1,355,247        1,379,632        1,386,959        1,347,564        1,435,763   

Total nonaccrual loans as a percentage of:

            

loans* and foreclosed assets

     10.12     10.39     9.67     9.22     10.89     9.07

total assets

     6.38        6.74        6.58        6.61        8.40        6.75   

Total nonperforming assets as a percentage of:

            

loans* and foreclosed assets

     12.07     12.67     12.08     11.90     13.68     11.70

total assets

     7.61        8.23        8.22        8.53        10.55        8.70   

 

* includes gross loans and commercial loans held for sale

Loans placed in nonaccrual status during the three months ended March 31, 2011 resulted from loans becoming delinquent on contractual payments due to deterioration in the financial condition of the borrowers or guarantors such that full payment of principal or interest was not expected due to personal cash flows from the borrowers and guarantors being inadequate to service the loans, interest reserves on the loans being depleted, a decrease in operating cash flows from the underlying properties supporting the loans, or a decline in fair values of the collateral resulting in lower cash proceeds from property sales. Loans migrating into nonaccrual status in the first quarter 2011 totaled $10.1 million compared to an average of $27 million the previous seven quarters.

Nineteen loans with a balance greater than $1 million comprised approximately 59% of our nonaccrual loans at March 31, 2011. The following table summarizes the composition of these loans by collateral type (dollars in thousands).

 

     Total nonaccrual loans >
$1 million
     % of total nonaccrual
loans
 

Residential / residential lots / golf course development

   $ 37,442         44

Multifamily residential

     6,995         8   

Real estate for commercial use

     4,367         5   

Marina

     1,198         2   
                 

Total nonaccrual loans > $1 million secured by commercial real estate

   $ 50,002         59
                 

Additionally, five of these loans (25% based on the principal balance at March 31, 2011) were purchased participations and six of these loans (26% based on the principal balance at March 31, 2011) are out-of-market loans. In 2009, we amended our loan policy to preclude originating any new loans of these kinds.

 

55


Table of Contents

While a loan is in nonaccrual status, cash received is applied to the principal balance. Additional interest income of $500 thousand would have been reported during the three months ended March 31, 2011 had loans classified as nonaccrual during the period performed in accordance with their original terms. As a result, our earnings did not include this interest income.

The following table summarizes the changes in the Foreclosed real estate portfolio at the dates and for the periods indicated (in thousands). Foreclosed real estate is net of participations sold of $3.3 million (two properties) at March 31, 2011.

 

    

At and for the three

months ended

March 31,

 
     2011     2010  

Foreclosed real estate, beginning of period

   $ 19,983      $ 27,826   

Plus: New foreclosed real estate

     3,764        3,893   

Less: Proceeds from sale of foreclosed real estate

     (6,988     (2,053

Less: Gain on sale of foreclosed real estate

     81        271   

Less: Provision charged to expense

     (596     (1,070
                

Foreclosed real estate, end of period

   $ 16,244      $ 28,867   
                

The following table summarizes the Foreclosed real estate portfolio, by FDIC code, at March 31, 2011 (in thousands).

 

Construction, land development, and other land loans

   $ 6,320   

Single-family residential

     1,826   

Nonfarm, nonresidential

     8,098   
        

Total real estate acquired in settlement of loans

   $ 16,244   
        

Four individual properties greater than $1 million comprised approximately 42% of our foreclosed real estate portfolio at March 31, 2011. Of these properties, 45% were mixed used retail / office, 17% were retail offices, 23% were residential lots, and 15% were commercial lots. Additionally, none of these properties were participations. One of the four was the result of out-of-market loans.

These properties are being actively marketed with the primary objective of liquidating the collateral at a level that most accurately approximates fair value and allows recovery of as much of the unpaid principal balance as possible upon the sale of the property in a reasonable period of time. As a result, loan charge-offs were recorded prior to or upon foreclosure to writedown the loans to fair value less estimated costs to sell. For some assets, additional writedowns have been taken based on receipt of updated third party appraisals for which appraised values continue to decline, although the rate of decline appears to be slowing. Based on currently available valuation information, the carrying value of these assets is believed to be representative of their fair value less estimated costs to sell although there can be no assurance that the ultimate proceeds from the sale of these assets will be equal to or greater than the carrying values particularly in the current real estate environment and the continued downward trend in third party appraised values.

During the three months ended March 31, 2011, we sold 14 properties with an aggregate net carrying amount of $5.9 million in total foreclosed real estate sales at a net gain of $81 thousand.

Subsequent to March 31, 2011, 7 properties with an aggregate net carrying amount of $174 thousand were sold at an immaterial loss. At April 26, 2011, 9 additional properties with an aggregate net carrying amount of $2.0 million were under contract for sale scheduled to close in the second quarter of 2011.

We are actively addressing the elevated level of nonperforming assets and will continue to be aggressive in working to resolve these issues as quickly as possible. For problem assets identified, we prepared written workout plans that are borrower-specific to determine how best to resolve the loans which could include restructuring the loans, requesting additional collateral, demanding payment from guarantors, sale of the loans, or foreclosure and sale of the collateral. We are also actively marketing for sale certain commercial loans. However, given the nature of the projects related to such loans and the distressed values within the real estate market, immediate resolution in all cases is not expected. Therefore, it is reasonable to expect that current negative asset quality trends may continue for coming periods when compared to historical periods. The carrying values of these assets may require additional adjustment for further declines in estimated fair values.

 

56


Table of Contents

Troubled Debt Restructurings. Troubled debt restructurings are loans that have undergone concessionary adjustments and were restructured from their original contractual terms due to financial difficulty of the borrower, for example, reduction in the contractual interest rate below that at which the borrower could obtain new credit from another lender. As part of our proactive actions to resolve problem loans and the resulting determination of our individual loan workout plans, we may restructure loans to assist borrowers facing cash flow challenges in the current economic environment to facilitate ultimate repayment of the loan. At March 31, 2011, the principal balance of troubled debt restructurings, in gross loans and commercial loans held for sale, totaled $53.3 million, of which loans totaling $18.2 million are classified as commercial loans held for sale. In addition, at March 31, 2011, $3.4 million troubled debt restructurings were also in nonaccrual status.

Historically, we have not split loans into two legally separate loans. However, at March 31, 2011, we had four loans that had been legally split into separate loans (commonly referred to as an A/B loan structure), with both the A and B loans accounted for as troubled debt restructures. Restructuring these loans into legally separate loans resulted in charge-offs of $381 thousand of the B loans during the three months ended March 31, 2011. Additionally, an additional charge-off of $181 thousand was taken during the first quarter of 2011 related to a loan that had been legally split during 2010. All of the A loans are currently performing in accordance with their terms. The aggregate balances of the A and B loans at March 31, 2011 were $8.2 million and $11.2 million, respectively.

Fourteen individual loans greater than $1 million comprised $41.4 million (78%) of our troubled debt restructurings, including commercial loans held for sale, at March 31, 2011. Two of the loans experienced rate concessions, two experienced term concessions, six experienced rate and term concessions, and four experienced a reduction in required principal paydowns. At March 31, 2011, 13 of the loans totaling $39.9 million are performing as expected under the new terms.

A troubled debt restructuring can be removed from this classification in years after the restructuring if both of the following conditions exist: the restructuring agreement specifies an interest rate equal to or greater than the rate that the creditor was willing to accept at the time of the restructuring for a new loan with comparable risk, and the loan is not impaired based on the terms specified by the restructuring agreement. For the three months ended March 31, 2011, one troubled debt restructuring of $876 thousand was removed from troubled debt restructuring status as it was performing in accordance with its restructured terms.

In April 2011, the FASB issued ASU 2011-02. We are currently evaluating the potential impact of this new standard on our loan portfolio and allowance for loan losses.

Potential Problem Loans. Potential problem loans consist of commercial loans not already classified as nonaccrual for which questions exist as to the current sound worth and paying capacity of the borrower or of the collateral pledged, if any, have a well-defined weakness or weaknesses that jeopardize the liquidation of the loan, and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. We monitor these loans closely and review performance on a regular basis. As of March 31, 2011, total potential problem loans (loans classified as substandard and doubtful) totaled $112.9 million, of which $33.6 million were in commercial loans held for sale. Total potential problem loans decreased 23.2% from their peak of $147.5 million at June 30, 2010.

Allowance for Loan Losses. The allowance for loan losses represents an amount that we believe will be adequate to absorb probable losses inherent in our loan portfolio as of the balance sheet date. Assessing the adequacy of the allowance for loan losses is a process that requires considerable judgment. Our judgment in determining the adequacy of the allowance is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions that may impact the overall loan portfolio or an individual borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and borrower and collateral specific considerations for loans individually evaluated for impairment.

The allowance for loan losses remained relatively flat at $27.0 million, or 3.53% of gross loans, at March 31, 2011, compared to $26.9 million, or 3.39%, at December 31, 2010. The increasing coverage percentage is a function of a decreasing loan portfolio. We believed it was appropriate for the provision for loan losses to cover net charge-offs in the first quarter 2011 as we continue to have high levels of classified and criticized assets and nonperforming loans. While we have been actively deleveraging our commercial real estate portfolio since 2009, we still maintain a heavy concentration in commercial real estate loans. In addition,

 

57


Table of Contents

appraised values on commercial real estate may be starting to stabilize, although it is too soon to conclude that the values have hit bottom.

The March 31, 2011 allowance for loan losses, and, therefore indirectly the provision for loan losses for the three months ended March 31, 2011, was determined based on the following specific factors, though not intended to be an all inclusive list:

 

   

The impact of the ongoing depressed overall economic environment, including within our geographic market,

 

   

The cumulative impact of the extended duration of this economic deterioration on our borrowers, in particular commercial real estate loans for which we have a heavy concentration,

 

   

The level of real estate development loans, in which the majority of our losses have occurred, although such loans have decreased to 14.7% of the loan portfolio, including commercial loans held for sale, at March 31, 2011 from 15.9% at December 31, 2010,

 

   

The asset quality trends in our loan portfolio, including a high level of nonperforming assets at March 31, 2011, which while still at an elevated level, decreased for the past four consecutive quarters,

 

   

The trend in our criticized and classified loans, which while still at an elevated level, decreased 4.6% and 6.4%, respectively, from the previous quarter and represents the fourth consecutive quarterly decline,

 

   

The trend and elevated level of the historical loan loss rates within our loan portfolio,

 

   

The results of our internal and external loan reviews, and

 

   

Our individual impaired loan analysis which identified:

 

   

Continued stress on borrowers given increasing lack of liquidity and limited bank financing and credit availability, and

 

   

Depressed appraised values and market assumptions used to value real estate dependent loans.

The following table summarizes activity within our allowance for loan losses, by portfolio segment, at the dates and for the periods indicated (dollars in thousands). Loans charged-off and recovered are charged or credited to the allowance for loan losses at the time realized.

 

     At and for the three months
ended March 31,
    At and for the year
ended December 31,
 
     2011     2010     2010  

Allowance for loan losses, beginning of period

   $ 26,934      $ 24,079      $ 24,079   

Provision for loan losses

     5,500        10,750        47,100   

Less: Allowance reclassified as commercial loans held for sale valuation allowance

     —          —          2,358   

Less: Allowance reclassified in credit card portfolio sale

     —          —          452   

Loan charged-off

      

Commercial real estate

     4,145        5,270        33,481   

Single-family residential

     856        1,176        4,214   

Commercial and industrial

     435        282        3,135   

Consumer

     170        514        1,483   

Other

     183        —          647   
                        

Total loans charged-off

     5,789        7,242        42,960   

Recoveries

      

Commercial real estate

     35        363        544   

Single-family residential

     50        66        98   

Commercial and industrial

     30        145        154   

Consumer

     56        265        729   

Other

     138        —          —     
                        

Total loans recovered

     309        839        1,525   
                        

Net loans charged-off

     5,480        6,403        41,435   
                        

Allowance for loan losses, end of period

   $ 26,954      $ 28,426      $ 26,934   
                        

Average gross loans

   $ 779,306      $ 1,028,302      $ 943,101   

Ending gross loans

     764,227        1,010,247        793,426   

Nonaccrual loans

     85,099        113,181        91,405   

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

     2.85     2.53     4.39

Allowance for loan losses as a percentage of ending gross loans

     3.53        2.81        3.39   

Allowance for loan losses as a percentage of nonaccrual loans

     31.67        25.12        29.47   

 

58


Table of Contents

In addition to loans charged-off in their entirety in the ordinary course of business, included within loans charged-off for the three months ended March 31, 2011 were $4.3 million in gross loan charge-offs relating to loans individually evaluated for impairment. The determination was made to take partial charge-offs on certain collateral dependent loans based on the status of the underlying real estate projects or our expectation that these loans would be foreclosed on and we would take possession of the collateral. The loan charge-offs were recorded to writedown the loans to the fair value of the collateral less estimated costs to sell, which are generally based on fair values from third party appraisals.

We analyze individual loans within the portfolio and make allocations to the allowance for loan losses based on each individual loan’s specific factors and other circumstances that impact the collectability of the loan. The population of loans evaluated to be potential impaired loans includes all troubled debt restructurings and all loans with interest reserves, as well as significant individual loans classified as doubtful or on nonaccrual status. At March 31, 2011, we had one loan totaling $3.0 million with a Bank-funded interest reserve. Based on its performance, this loan was not considered impaired.

In situations where a loan is determined to be impaired because it is probable that all principal and interest due according to the terms of the loan agreement will not be collected as scheduled, the loan is excluded from the general reserve calculation described below and is evaluated individually for impairment. The impairment analysis is based on the determination of the most probable source of repayment, which is typically liquidation of the underlying collateral but may also include discounted future cash flows or, in rare cases, the market value of the loan itself. At March 31, 2011, $79.1 million of our loans evaluated individually for impairment, including commercial loans held for sale, were valued based on collateral value, $27.4 million were valued based on discounted future cash flows and $1.6 million were valued based on a loan’s observable market price.

Generally, for larger impaired loans valued based on the value of the collateral, current appraisals performed by approved third party appraisers are the basis for estimating the current fair value of the collateral. However, in situations where a current appraisal is not available, we use the best available information (including recent appraisals for similar properties, communications with qualified real estate professionals, information contained in reputable trade publications, and other observable market data) to estimate the current fair value. The estimated costs to sell the property, if not already included in the appraisal, are then deducted from the appraised value to arrive at the net realizable value of the loan used to calculate the loan’s specific reserve.

The following table summarizes the composition of and information relative to impaired loans, by class, at March 31, 2011 (in thousands).

 

59


Table of Contents
     Gross Loans      Commercial Loans
Held for Sale
     Total Loans  
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Recorded
Investment
     Unpaid
Principal
Balance
     Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

With no related allowance recorded:

                       

Construction, land development and other land loans

   $ 35,123       $ 54,143          $ 8,884       $ 21,699       $ 44,007       $ 75,842      

Multifamily residential

     —           —              7,475         13,543         7,475         13,543      

Nonfarm nonresidential

     4,343         8,006            18,985         28,584         23,328         36,590      
                                                           

Total commercial real estate

     39,466         62,149            35,344         63,826         74,810         125,975      
                                                           

Single-family real estate, revolving, open end loans

     —           —              —           —           —           —        

Single-family real estate, closed end, first lien

     2,292         7,161            362         482         2,654         7,643      

Single-family real estate, closed end, junior lien

     —           —              —           —           —           —        
                                                           

Total single-family residential

     2,292         7,161            362         482         2,654         7,643      
                                                           

Commercial and industrial

     93         3,106            —           —           93         3,106      
                                                           

Total impaired loans with no related allowance recorded

   $ 41,851       $ 72,416          $ 35,706       $ 64,308       $ 77,557       $ 136,724      
                                                           

With an allowance recorded:

                       

Construction, land development and other land loans

   $ 9,805       $ 9,805       $ 3,911             $ 9,805       $ 9,805       $ 3,911   

Multifamily residential

     —           —           —                 —           —           —     

Nonfarm nonresidential

     17,457         21,684         2,340               17,457         21,684         2,340   
                                                           

Total commercial real estate

     27,262         31,489         6,251               27,262         31,489         6,251   
                                                           

Single-family real estate, revolving, open end loans

     —           —           —                 —           —           —     

Single-family real estate, closed end, first lien

     1,791         1,791         147               1,791         1,791         147   

Single-family real estate, closed end, junior lien

     162         162         55               162         162         55   
                                                           

Total single-family residential

     1,953         1,953         202               1,953         1,953         202   
                                                           

Commercial and industrial

     1,367         1,436         796               1,367         1,436         796   
                                                           

Total impaired loans with an allowance recorded

   $ 30,582       $ 34,878       $ 7,249             $ 30,582       $ 34,878       $ 7,249   
                                                           

Total:

                       

Construction, land development and other land loans

   $ 44,928       $ 63,948       $ 3,911       $ 8,884       $ 21,699       $ 53,812       $ 85,647       $ 3,911   

Multifamily residential

     —           —           —           7,475         13,543         7,475         13,543         —     

Nonfarm nonresidential

     21,800         29,690         2,340         18,985         28,584         40,785         58,274         2,340   
                                                                       

Total commercial real estate

     66,728         93,638         6,251         35,344         63,826         102,072         157,464         6,251   
                                                                       

Single-family real estate, revolving, open end loans

     —           —           —           —           —           —           —           —     

Single-family real estate, closed end, first lien

     4,083         8,952         147         362         482         4,445         9,434         147   

Single-family real estate, closed end, junior lien

     162         162         55         —           —           162         162         55   
                                                                       

Total single-family residential

     4,245         9,114         202         362         482         4,607         9,596         202   
                                                                       

Commercial and industrial

     1,460         4,542         796         —           —           1,460         4,542         796   
                                                                       

Total impaired loans

   $ 72,433       $ 107,294       $ 7,249       $ 35,706       $ 64,308       $ 108,139       $ 171,602       $ 7,249   
                                                                       

Interest income recognized on impaired loans during the three months ended March 31, 2011 was $621 thousand. The average balance of total impaired loans was $107.9 million for the same period.

At December 31, 2010, the balance of impaired loans, including commercial loans held for sale, was $107.7 million. Of that balance, $24.9 million of the impaired loans had a related allowance for loan losses of $6.3 million. The average balance of impaired loans was $105.7 million for the year ended December 31, 2010 and $102.1 million for the three months ended March 31, 2010.

We calculate our general allowance by applying our historical loss factors to each sector of the loan portfolio. For consistency of comparison on a quarterly basis, we utilize a five-year look-back period when computing historical loss rates. However, given the increase in charge-offs beginning in 2009, during 2010 and 2011 we also used a three-year look-back period for computing historical loss rates as another reference point in determining the allowance for loan losses.

We adjust these historical loss percentages for qualitative environmental factors derived from macroeconomic indicators and other factors. Qualitative factors we considered in the determination of the March 31, 2011 allowance for loan losses include pervasive factors that generally impact borrowers across the loan portfolio (such as unemployment and consumer price index) and factors that have specific implications to particular loan portfolios (such as residential home sales or commercial development). Factors evaluated may include changes in delinquent, nonaccrual and troubled debt restructured loan trends, trends in risk ratings and net loans charged-off, concentrations of credit, competition and legal and regulatory requirements, trends in the nature and volume of the loan portfolio, national and local economic and business conditions, collateral valuations, the experience and depth of lending management, lending

 

60


Table of Contents

policies and procedures, underwriting standards and practices, the quality of loan review systems and degree of oversight by the Board of Directors, peer comparisons, and other external factors. The general reserve calculated using the historical loss rates and qualitative factors is then combined with the specific allowance on loans individually evaluated for impairment to determine the total allowance for loan losses.

The following table summarizes the allocation of the allowance for loan losses, by portfolio segment, at March 31, 2011 (in thousands).

 

     Commercial
Real Estate
     Single-family
Residential
     Commercial and
Industrial
     Consumer      Other      Total  

Allowance for loan losses:

                 

Allowance for loan losses, beginning of period

   $ 18,979       $ 4,061       $ 2,492       $ 1,375       $ 27       $ 26,934   

Provision for loan losses

     3,983         936         479         57         45         5,500   

Loan charge-offs

     4,145         856         435         170         183         5,789   

Loan recoveries

     35         50         30         56         138         309   
                                                     

Net loans charged-off

     4,110         806         405         114         45         5,480   
                                                     

Allowance for loan losses, end of period

   $ 18,852       $ 4,191       $ 2,566       $ 1,318       $ 27       $ 26,954   
                                                     

Individually evaluated for impairment

   $ 6,251       $ 202       $ 796       $ —         $ —         $ 7,249   

Collectively evaluated for impairment

     12,601         3,989         1,770         1,318         27         19,705   
                                                     

Allowance for loan losses, end of period

   $ 18,852       $ 4,191       $ 2,566       $ 1,318       $ 27       $ 26,954   
                                                     

Gross loans, end of period:

                 

Individually evaluated for impairment

   $ 66,728       $ 4,245       $ 1,460       $ —         $ —         $ 72,433   

Collectively evaluated for impairment

     416,971         170,725         47,164         50,884         6,050         691,794   
                                                     

Total gross loans

   $ 483,699       $ 174,970       $ 48,624       $ 50,884       $ 6,050       $ 764,227   
                                                     

Portions of the allowance for loan losses may be allocated for specific loans or portfolio segments. However, the entire allowance for loan losses is available for any loan that, in our judgment, should be charged-off. While we utilize the best judgment and information available to it, the ultimate adequacy of the allowance for loan losses depends on a variety of factors beyond our control, including the performance of our loan portfolio, the economy, changes in interest rates, and the view of the regulatory authorities toward loan classifications.

In addition to our portfolio review process, various regulatory agencies periodically review our allowance for loan losses. These agencies may require us to recognize additions to the allowance for loan losses based on their judgments and information available to them at the time of their examinations. While we use available information to recognize inherent losses on loans, future adjustments to the allowance for loan losses may be necessary based on changes in economic conditions and other factors and the impact of such changes and other factors on our borrowers.

We believe that the allowance for loan losses at March 31, 2011 is appropriate and adequate to cover probable inherent losses in the loan portfolio. However, underlying assumptions may be impacted in future periods by changes in economic conditions, the impact of regulatory examinations, and the discovery of information with respect to borrowers that was not known to us at the time of the issuance of our Consolidated Financial Statements. Therefore, our assumptions may or may not prove valid. Thus, there can be no assurance that loan losses in future periods, including potential incremental losses resulting from the sale of the commercial loans held for sale, will not exceed the current allowance for loan losses amount or that future increases in the allowance for loan losses will not be required. Additionally, no assurance can be given that our ongoing evaluation of the loan portfolio, in light of changing economic conditions and other relevant factors, will not require significant future additions to the allowance for loan losses, thus adversely impacting our business, financial condition, results of operations, and cash flows.

Commercial Loans Held for Sale Valuation Allowance. At March 31, 2011, commercial loans held for sale are carried at the lower of cost or fair value, and reflect a valuation allowance of $853 thousand recorded against the loans held for sale resulting in a net carrying amount in the Consolidated Balance Sheets of $60.3

 

61


Table of Contents

million. A valuation allowance is recorded against the loans held for sale for the excess of the recorded investment in the loan over the fair value less estimated selling costs.

In September 2010, we began marketing for sale a pool of specifically identified commercial loans. Our marketing efforts continued through the first quarter 2011 and are expected to continue through 2011. We are evaluating the bids received on a loan-by-loan basis and are balancing the desire to reduce problem loans with preservation of capital. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking industry in general and our Company in particular to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year-end. While bid prices on certain assets improved in the first quarter 2011, such prices continue to reflect heavy discounting. In many cases, we have not accepted such discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order.

Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these assets to fair value, which was based on updated appraisals received during the first quarter, less estimated costs to sell, or internal valuations, as applicable.

The following table summarizes activity within commercial loans held for sale and the related valuation allowance, at the dates and for the periods indicated (in thousands).

 

     Commercial loans held
for sale, prior to
valuation allowance
     Valuation allowance
on commercial loans
held for sale
 

Beginning balance at December 31, 2010

   $ 68,491       $ 2,334   

Additions:

     

Loans held for investment transferred to loans held for sale

     1,224         —     

Net recovery of valuation for ending loans held for sale

     —           (36
                 

Total additions

     1,224         (36
                 

Reductions:

     

Loans held for sale sold

     1,974         —     

Transfers to foreclosed real estate

     3,319         163   

Direct writedowns on loans held for sale

     2,624         1,282   

Net paydowns

     598         —     
                 

Total reductions

     8,515         1,445   
                 

Ending balance at March 31, 2011

   $ 61,200       $ 853   
                 

Premises and Equipment, net

Premises and equipment, net decreased by $37 thousand (0.1%) during the three months ended March 31, 2011.

At March 31, 2011, a vacant bank-owned branch facility with a net book value of $235 thousand is under contract for sale and included in Other assets in the Consolidated Balance Sheets, and in April 2011 the Company began marketing for sale vacant land with a book value of $728 thousand.

Deferred Tax Asset, net

As of December 31, 2010, prior to any valuation allowance, gross deferred tax assets totaling $25.9 million and gross deferred tax liabilities totaling $5.4 million were recorded in the Company’s Consolidated Balance Sheets. Based on our projections of future taxable income over the next three years, cumulative tax losses over the previous three years, limitations on future utilization of various deferred tax assets under the Internal Revenue Code, and available tax planning strategies, we recorded a valuation allowance against the net deferred tax asset in the amount of $20.5 million through a charge against income tax expense (benefit) at December 31, 2010. At March 31, 2011, as a result of the first quarter loss, gross deferred tax assets increased to $28.2 million while gross deferred tax liabilities declined to $5.3 million. Based on a continued evaluation of the factors considered at December 31, 2010, including the limitation on the future utilization of net operating losses as discussed below, we recorded an additional valuation allowance against the net deferred tax asset to fully offset the income tax benefit that otherwise would have been recorded.

 

62


Table of Contents

The Private Placement that was consummated on October 7, 2010 was considered a change in control under the Internal Revenue Code. Accordingly, we were required to determine the potential limitation or deferral of our ability to carry forward pre-acquisition net operating losses and to determine the amount of net unrealized built-in losses as of October 7, 2010, which also limits the amount of net operating losses that may be used in the future. As a result of our analysis, we currently estimate that future utilization of net operating loss carry forwards and built-in losses of $46 million generated prior to October 7, 2010 will be limited to $1.1 million per year.

Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for financial reporting purposes at March 31, 2011 and December 31, 2010, the net operating losses are able to be carried forward for income tax purposes up to twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the future, we will be able to utilize some of the net operating losses for income tax purposes and reverse a portion of the valuation allowance for financial reporting purposes. The determination of how much of the net operating losses we will be able to utilize and therefore how much of the valuation allowance that may be reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.

Deposit Activities

Traditional deposit accounts have historically been the primary source of funds for the Company and a competitive strength of our Company. Traditional deposit accounts also provide a customer base for the sale of additional financial products and services and fee income through service charges. We set targets for growth in deposit accounts annually in an effort to increase the number of products per banking relationship. Deposits are attractive sources of funding because of their stability and generally low cost as compared with other funding sources.

The following table summarizes our composition of deposits at the dates indicated (dollars in thousands).

 

     March 31,
2011
    December 31,
2010
 
     Total      % of
total
    Total      % of
total
 

Noninterest-bearing transaction deposit accounts

   $ 156,323         13.3   $ 141,281         12.0

Interest-bearing transaction deposit accounts

     296,757         25.2        292,827         25.0   
                                  

Transaction deposit accounts

     453,080         38.5        434,108         37.0   

Money market deposit accounts

     149,902         12.7        143,143         12.2   

Savings deposit accounts

     55,159         4.7        49,472         4.2   

Time deposit accounts

     519,549         44.1        546,639         46.6   
                                  

Total deposits

   $ 1,177,690         100.0   $ 1,173,362         100.0
                                  

In March 2010, we introduced a new checking account, MyPal checking, and a new savings account, Smart Savings. These accounts combine traditional banking features and nonbanking features and are expected to be a source of both additional deposits and noninterest income resulting primarily from service charges or debit card transactions.

The MyPal checking account includes a monthly fee of $5, which is reduced by $0.50 each time an account holder uses their debit card. Thus, ten debit card transactions per month results in no monthly fee to the account holder. However, the Company earns a per transaction fee from the merchant each time the debit cards are used. In addition, the MyPal checking account includes a competitive interest rate, free checks, free identity theft protection and safety deposit rental for a period of time, and comes with a membership rewards program that provides purchase discounts to the account holders for items such as airfare, car rental and hotel, and every day savings at a wide variety of national and local retailers and entertainment companies.

The Smart Savings account can be linked to any of our checking accounts and results in $1 being transferred from the account holder’s checking account to the Smart Saving account each time the account holder uses their debit card. The Company initially matched each $1 transfer with $1 for the first six months. Effective October 1, 2010, the match was reduced to $0.10 per each $1 transfer. The maximum match is $250 per year. The Smart Savings account is also interest-bearing.

 

63


Table of Contents

We also evaluated the profitability of all of our pre-existing checking accounts and in October 2010 upgraded a large number of unprofitable checking accounts to the MyPal account. We are also revising our existing fees (some increases and some decreases) and eliminating existing fees or implementing new fees based on our analysis of our fee structure in relation to our costs and competitor fees, with various implementation dates generally between October 1, 2010 and March 1, 2011.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was signed into law on July 21, 2010, calls for new limits on interchange transaction fees that banks receive from merchants via card networks like Visa, Inc. and MasterCard, Inc. when a customer uses a debit card. In December 2010, the Federal Reserve issued a proposal to implement a provision in the Dodd-Frank Act that requires the Federal Reserve to set debit-card interchange fees. The proposed rule, if implemented in its current form, would result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates. The results of this proposed legislation may impact our interchange income from debit card transactions in the future.

As a result of the Private Placement in October 2010, we did not pursue retention of higher priced certificates of deposits that matured in the fourth quarter 2010 and first quarter 2011.

At March 31, 2011, traditional deposit accounts as a percentage of liabilities were 96.7% compared with 94.5% at December 31, 2010. Interest-bearing deposits decreased $10.7 million during the three months ended March 31, 2011, primarily due to higher priced time deposit accounts not being retained at maturity as part of our balance sheet management efforts. Noninterest-bearing deposits increased $15.0 million during the same period, primarily as a result of focused efforts to grow core deposits and seasonal increases in balances. Traditional deposit accounts continue to be our primary source of funding, and, as part of our liquidity plan, we are proactively pursuing deposit retention initiatives with our deposit customers. We are also pursuing strategies to increase our transaction deposit accounts as a proportion of our total deposits.

The Dodd-Frank Act also permanently raises the current standard maximum deposit insurance amount to $250,000. The standard maximum insurance amount of $100,000 had been temporarily raised to $250,000 until December 31, 2013. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category. In addition, the FDIC provides unlimited deposit insurance coverage for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts. We elected to voluntarily participate in the FDIC’s Transaction Account Guarantee Program (the “TAGP”) through December 31, 2010. Throughout 2010, participating institutions paid fees of 15 to 25 basis points (annualized), depending on the Risk Category assigned to the institution, on the balance of each covered account in excess of $250,000. Coverage under the program was in addition to and separate from the basic coverage available under the FDIC’s general deposit insurance rules. We believe participation in the program enhanced our ability to retain customer deposits. As a result of the Dodd-Frank Act, the voluntary TAGP program ended on December 31, 2010, and all institutions were required to provide full deposit insurance on noninterest-bearing transaction accounts until December 31, 2012. There is not a separate assessment for this as there was for institutions participating in the TAGP program.

Borrowing Activities

Borrowings as a percentage of total liabilities decreased from 4.5% at December 31, 2010 to 2.4% at March 31, 2011. The decrease was due to less reliance on such borrowed funding sources as liquidity was provided through core deposit growth, and cash retention of proceeds from loan payments and maturing securities. We also utilized excess cash balances in January 2011 to prepay $30.0 million of FHLB advances.

The following table summarizes our borrowings composition at the dates indicated (dollars in thousands).

 

     March 31, 2011     December 31, 2010  
     Total      % of total     Total      % of total  

Retail repurchase agreements

   $ 23,641         82.5   $ 20,720         37.2

FHLB advances

     5,000         17.5        35,000         62.8   
                                  

Total borrowed funds

   $ 28,641         100.0   $ 55,720         100.0
                                  

 

64


Table of Contents

Retail Repurchase Agreements. We offer retail repurchase agreements as an alternative investment tool to conventional savings deposits. The investor buys an interest in a pool of U.S. government or agency securities. Funds are swept daily between the customer and the Bank. Retail repurchase agreements are securities transactions, not insured deposits.

Wholesale Funding. Wholesale funding options include lines of credit from correspondent banks, FHLB advances, and the Federal Reserve Discount Window. Such funding provides us with the ability to access the type of funding needed at the time and amount needed at market rates. This provides us with the flexibility to tailor borrowings to our specific needs. Interest rates on such borrowings vary from time to time in response to general economic conditions.

Correspondent Bank Line of Credit. At March 31, 2011, the Company had access to an unsecured line of credit from a correspondent bank. The following table summarizes the Company’s line of credit funding utilization and availability at the dates indicated (in thousands).

 

     March 31,
2011
     December 31,
2010
 

Correspondent bank line of credit accomodations

   $ 5,000       $ 5,000   

Utilized correspondent bank line of credit accomodations

     —           —     
                 

Available correspondent bank line of credit accomodations

   $ 5,000       $ 5,000   
                 

In April 2011, we obtained an uncommitted overnight variable rate line of credit from a correspondent bank totaling $25 million. If drawn upon, the Company will be require to pledge investment securities with a fair vale equal to approximately 110% of the amount borrowed. These correspondent bank lines of credit funding source may be canceled at any time at the correspondent bank’s discretion.

FHLB Borrowings. We pledge investment securities and loans to collateralize FHLB advances and letters of credit. Additionally, we may pledge cash and cash equivalents. The amount that can be borrowed is based on the balance of the type of asset pledged as collateral multiplied by lendable collateral value percentages, as calculated by the FHLB. Effective March 2011, we may borrow from the FHLB for terms up to 3 years, subject to availability of collateral. Previously, from January 2010 to March 2011 the maximum maturity for potential borrowings was overnight.

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

 

     March 31,
2011
    December 31,
2010
 

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

   $ 86,977      $ 92,464   

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

     23,273        46,275   

Advances and letters of credit

    

FHLB advances

     (5,000     (35,000

Letters of credit

     (50,000     (50,000

Excess

     54,985        53,303   

At March 31, 2011, the Company had one outstanding FHLB advance totaling $5 million. The advance bears interest at a fixed rate of 3.61% and matures in April 2013. This FHLB advance is subject to a prepayment fee in the event of full or partial repayment prior to maturity.

In January 2011, as part of our overall balance sheet management efforts to utilize our excess cash and reduce our overall borrowing cost, we prepaid $30.0 million of FHLB advances.

Federal Reserve Discount Window. We have established a borrowing relationship with the Federal Reserve through its Discount Window. Through the Discount Window, primary credit is available to generally sound depository institutions on a very short-term basis, typically overnight, at a rate above the Federal Open Market Committee target rate for federal funds. Our maximum maturity for potential borrowings is overnight. Although we have not drawn on this availability since established in 2009, any potential borrowings from the Federal Reserve Discount Window would be at the secondary credit rate and must be used for operational issues. Further, the Federal Reserve has the discretion to deny approval of borrowing requests.

 

65


Table of Contents

Capital

At March 31, 2011, as a result of the consummation of the Private Placement in October 2010, all of our capital ratios exceeded the well-capitalized regulatory minimum thresholds as well as the minimum capital ratios established in the Consent Order.

The following table summarizes key performance indicators related to capital at the dates and for the periods indicated (dollars in thousands, except per share data).

 

     At and for the three months
ended March 31,
 
     2011     2010  

Total shareholders’ equity

   $ 115,845      $ 70,978   

Average shareholders’ equity

     120,042        76,648   

Shareholders’ equity as a percentage of assets

     8.69     5.27

Average shareholders’ equity as a percentage of average assets

     9.08        5.60   

Cash dividends per common share

   $ —        $ —     

Dividend payout ratio

     n/a     n/a

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

 

     For the three month periods ended
March 31,
 
     2011     2010  

Net Unrealized Gains on Investment Securities Available for Sale

    

Balance, beginning of period

   $ 1,264      $ 306   

Other comprehensive income (loss):

    

Unrealized holding gains (losses) arising during the period

     (140     1,884   

Income tax (expense) benefit

     53        (715

Less: Reclassification adjustment for (gains) losses included in net (loss) income

     —          (8

Income tax expense (benefit)

     —          3   
                
     (87     1,164   
                

Balance, end of period

     1,177        1,470   
                

Net Unrealized Gains on Impact of Defined Benefit Pension Plan

    

Balance, beginning of period

     (7,843     (7,266

Other comprehensive loss:

    

Impact of FASB ASC 715

     —          —     

Income tax benefit

     —          —     
                
     —          —     
                

Balance, end of period

     (7,843     (7,266
                
   $ (6,666   $ (5,796
                

Total other comprehensive income (loss), end of period

   $ (87   $ 1,164   

Net loss

     (6,080     (5,292
                

Comprehensive loss

   $ (6,167   $ (4,128
                

 

66


Table of Contents

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

Dividends, The Company and the Bank are subject to regulatory policies and requirements relating to the payment of dividends. In an effort to retain capital during this period of economic uncertainty, the Board of Directors reduced the quarterly dividend for the first quarter of 2009 and has not declared or paid a quarterly common stock dividend since that date. The Board of Directors believes that suspension of the dividend was prudent to protect our capital base. In addition, given the Bank’s recent losses and the restrictions imposed by the Consent Order with the Supervisory Authorities, we are subject to regulatory policies and requirements relating to the payment of dividends, including requirements to seek regulatory approval prior to paying dividends and to maintain adequate capital above regulatory minimums. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and if future dividends will be reinstated, and at what level, because they are dependent on our financial condition, results of operations, and / or cash flows, as well as capital and dividend regulations from the FDIC and others.

Basel III. Internationally, both the Basel Committee and the Financial Stability Board (established in April 2009 by the G-20 Finance Ministers and Central Bank Governors to take action to strengthen regulation and supervision of the financial system with greater international consistency, cooperation, and transparency) have committed to raise capital standards and liquidity buffers within the banking system through Basel III. In September 2010, the Group of Governors and Heads of Supervision agreed to the calibration and phase-in of the Basel III minimum capital requirements (raising the minimum Tier 1 common equity ratio to 4.5% and minimum Tier 1 equity ratio to 6.0%, with full implementation by January 2015) and introducing a capital conservation buffer of common equity of an additional 2.5% with implementation by January 2019. The U.S. federal banking agencies support this agreement. In December 2010, the Basel Committee issued the Basel III rules text that outlines the details and time-lines of global regulatory standards on bank capital adequacy and liquidity. According to the Basel Committee, the Framework sets out higher and better-quality capital, better risk coverage, the introduction of a leverage ratio as a backstop to the risk-based requirement, measures to promote the build-up of capital that can be drawn down in periods of stress, and the introduction of two global liquidity standards.

Private Placement. In October 2010 we consummated a private placement in which institutional investors purchased $103.9 million of shares of the Company’s common stock at $2.60 per share. As a result, the Company’s and the Bank’s capital adequacy ratios exceed the minimum capital adequacy ratios to be categorized as “well-capitalized” and those required by the Consent Order for the Bank.

In addition, the investors 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 shareholders as of the close of business on October 6, 2010. With respect to our legacy shareholders, at December 31, 2010, we had issued 776,123 shares of common stock for proceeds of $2.0 million, and in January 2011 we issued an additional 453,906 shares for proceeds of $1.2 million. Under the terms of the Private Placement, the institutional investors who participated in the Private Placement had the right to purchase any unsubscribed shares from the follow-on offering to the legacy shareholders. As a result, in the first quarter 2011, we issued to these institutional investors 2,616,124 shares of common stock at $2.60 per share for net proceeds of $6.8 million, resulting in the $10 million offering being fully subscribed. The net proceeds of the offerings were contributed to the Bank as an additional capital contribution.

Regulatory Capital and Other Requirements. The Company and the Bank are required to meet regulatory capital requirements that include several measures of capital. Under regulatory capital requirements, accumulated other comprehensive income (loss) amounts do not increase or decrease regulatory capital and are not included in the calculation of risk-based capital and leverage ratios.

Due to the Consent Order we may not accept brokered deposits unless the FDIC grants a waiver. Although we currently do not utilize brokered deposits as a funding source, if we were to seek to begin using such a funding source, there is no assurance that the FDIC will grant us the approval when requested. These restrictions could have a substantial negative impact on our liquidity. Additionally, we would normally be restricted from offering an effective yield on deposits of more than 75 basis points over the national rates

 

67


Table of Contents

published by the FDIC weekly on their website. However, on April 1, 2010, the FDIC notified us that they had determined that the geographic areas in which we operate were considered high-rate areas. Accordingly, we are able to offer interest rates on deposits up to 75 basis points over the prevailing interest rates in our geographic areas. The FDIC has informed us that this high-rate determination is also effective for 2011.

The balance of gross deferred income taxes at March 31, 2011 represented deferred tax assets and liabilities arising from temporary differences between the financial reporting and income tax bases of various items as of that date. As of December 31, 2010, we determined that it was not more likely than not that the net deferred tax asset could be supported as realizable, given the financial results for the year and change in control resulting from the Private Placement that was consummated in October 2010. Based on this determination, as described in more detail in Financial Condition - Deferred Tax Asset, we recorded a valuation allowance for financial reporting purposes at December 31, 2010. Based on our evaluation of the deferred tax asset at March 31, 2011, we recorded an incremental valuation allowance to fully offset our deferred tax asset at March 31, 2011.

Additionally, for regulatory capital purposes, deferred tax assets are limited to the assets which can be realized through (i) carryback to prior years or (ii) taxable income in the next twelve months. At March 31, 2011, all of our net deferred tax asset was excluded from Tier 1 and total capital based on these criteria. We will continue to evaluate the realizability of our deferred tax asset on a quarterly basis for both financial reporting and regulatory capital purposes. The evaluation may result in the inclusion of some of the deferred tax asset in regulatory capital in future periods.

Since March 31, 2011, 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 regulatory capital category other than as reported in this Quarterly Report on Form 10-Q.

Equity. We have authorized common stock and preferred stock of 75 million and 2.5 million shares, respectively. In the Private Placement, 39,975,980 shares of common stock were issued in October 2010, 1,230,029 shares were issued in connection with the follow-on offering to legacy shareholders as of October 6, 2010, and 2,616,124 shares were issued to the institutional investors in the Private Placement in the first quarter 2011, resulting in remaining authorized but unissued common shares of 24,486,278 at April 26, 2011. To date, we have not issued any shares of preferred stock.

Government Financing. We did not participate in the U.S. Treasury’s Capital Purchase Program offered in 2008 based on our evaluation of the merits of the program at that time.

In September 2010, the U.S. President signed into law the Small Business Jobs Act of 2010 (the “SBLF”). The SBLF, which was enacted as part of the Act, a $30 billion fund that encourages lending to small businesses by providing Tier 1 capital to qualified community banks with assets of less than $10 billion. On December 21, 2010, the U.S. Treasury published the application form, term sheet and their guidance for participation in the SBLF. Under the terms of the SBLF, the Treasury will purchase shares of senior preferred stock from banks, bank holding companies, and other financial institutions that will qualify as Tier 1 capital for regulatory purposes and rank senior to a participating institution’s common stock. The application deadline for participating in the SBLF is March 31, 2011. Based on the program criteria, we decided not to participate in the SBLF.

With respect to any other potential government assistance programs in the future, we will evaluate the merits of the programs, including the terms of the financing, the Company’s capital position, the cost to the Company of alternative capital, and the Company’s strategy for the use of additional capital, to determine whether it is prudent to participate.

Private Trading System. On June 26, 2009, we implemented a Private Trading System on our website (www.palmettobank.com). The Private Trading System is a passive mechanism created to assist buyers and sellers in facilitating trades in our common stock. On June 30, 2009, the Company mailed a letter and related materials to shareholders regarding the Private Trading System and elected to furnish this information as an exhibit to a Current Report on Form 8-K filed with the SEC on July 2, 2009 which can be accessed through the SEC’s website (www.sec.gov).

One of the requirements of the Private Placement is that the Company will use its reasonable best efforts to list the shares of our common stock on NASDAQ or another national securities exchange within nine months of the closing date of the Private Placement on October 7, 2010. While we intend to list our

 

68


Table of Contents

common stock on NASDAQ, no assurances can be provided at this time that we will meet such listing requirements or be granted approval by the NASDAQ to be listed.

Derivative Activities

See Part I – Financial Information, Item 1. Financial Statements, Note 17 for disclosures regarding our derivative financial instruments and hedging activities.

Liquidity

General

Liquidity measures our ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to accommodate possible outflows in deposit accounts, meet loan requests and commitments, maintain reserve requirements, pay operating expenses, provide funds for dividends and debt service, manage operations on an ongoing basis, capitalize on new business opportunities, and take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining a level of liquid funds through proactive balance sheet management.

Asset liquidity is provided by liquid assets which are readily convertible into cash, are pledgeable or which will mature in the near future. Our liquid assets may include cash, interest-bearing deposits in banks, investment securities available for sale, and federal funds sold. Liability liquidity is provided by access to funding sources, which include deposits and borrowed funds. We may also issue equity securities although our common and preferred stock are not listed on a national exchange or quoted on the OTC Bulletin Board. Each of the Company’s sources of liquidity is subject to various factors beyond our control.

Liquidity resources and balances at March 31, 2011, contained herein, are an accurate depiction of our activity during the period and, except as noted, have not materially changed to date.

In June 2009, we implemented a forward-looking liquidity plan and increased our liquidity monitoring. The liquidity plan includes, among other things:

 

   

Implementing proactive customer deposit retention initiatives specific to large deposit customers and our deposit customers in general.

 

   

Executing targeted deposit growth and retention campaigns, resulting in retained and new certificates of deposit through June 30, 2010. Since June 30, 2010, our deposits have remained stable through our normal growth and retention efforts, and therefore we have not utilized any special campaigns. In addition, given our cash position, beginning in the fourth quarter 2010 and continuing into the first quarter 2011, we are not pursuing special CD campaigns and have reduced our deposit pricing to allow our higher priced CDs to roll off as they mature.

 

   

Evaluating our sources of available financing and identifying additional collateral for pledging for FHLB, Federal Reserve and other secured borrowings. In April 2011, we entered into a Master Repurchase Agreement resulting in a new line of credit from a correspondent bank totaling $25 million.

 

   

Accelerating the filing of income tax refund claims resulting in refunds received totaling $27.6 million in 2010 and 2011.

 

   

During 2009 and most of 2010, maintaining cash received primarily from loan and security repayments invested in cash rather than being reinvested in other earning assets. Following the consummation of our Private Placement in October 2010, we have redeployed, through March 31, 2011, $208.5 million of this cash into investment securities and prepaid $91 million of FHLB advances which were scheduled to mature in January through April 2011. We will continue to monitor the level of cash balances in relation to expected liquidity needs and may make further purchases of investment securities during 2011.

Cash Flow Needs

In the normal course of business, we enter into various transactions, some of which, in accordance with accounting principles generally accepted in the U.S., are not recorded in our Consolidated Balance Sheets.

 

69


Table of Contents

These transactions may involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the Consolidated Balance Sheets, if any.

Lending Commitments and Standby Letters of Credit. See Part I – Financial Information, Item 1. Financial Statements, Note 16 contained herein for disclosures regarding our commitments, guarantees, and other contingencies.

Derivatives. See Derivative Activities, included elsewhere in this item, for discussion regarding the Company’s off-balance sheet arrangements and commitments related to our derivative loan commitments and freestanding derivatives.

Dividend Obligations. The holders of the Company’s common stock are entitled to receive dividends, when and if declared by the Company’s Board of Directors, out of funds legally available for such dividends. The Company is a legal entity separate and distinct from the Bank and depends on the payment of dividends from the Bank. The Company and the Bank are subject to regulatory policies and requirements relating to the payment of dividends, including requirements to maintain adequate capital above regulatory minimums. The appropriate federal regulatory authorities are authorized to determine under certain circumstances that the payment of dividends by a bank holding company or a bank would be an unsafe or unsound practice and to prohibit payment of those dividends. The appropriate federal regulatory authorities have indicated that banking organizations should generally pay dividends only out of current income. In addition, as a South Carolina chartered bank, the Bank is subject to legal limitations on the amount of dividends it is permitted to pay.

In an effort to retain capital during this period of economic uncertainty, the Board of Directors reduced the quarterly dividend for the first quarter of 2009. Subsequent to the first quarter 2009, the Board of Directors suspended the quarterly common stock dividend. The Board of Directors believes that suspension of the dividend was prudent to protect our capital base. In addition, payment of a dividend on our common stock requires prior notification to and non-objection from the applicable banking regulators. Our Board of Directors will continue to evaluate dividend payment opportunities on a quarterly basis. There can be no assurance as to when and if future dividends will be reinstated, and at what level, because they are dependent on our financial condition, results of operations, and / or cash flows, as well as capital and dividend regulations from the FDIC and others.

Long-Term Contractual Obligations. In addition to the contractual commitments and arrangements previously described, the Company enters into other contractual obligations in the ordinary course of business. The following table summarizes these contractual obligations at March 31, 2011 (in thousands) except obligations for employee benefit plans as these obligations are paid from separately identified assets. See Note 13, Employee Benefit Plans, for discussion regarding these employee benefit plans.

 

Other contractual obligations

   Less than
one year
     Over one
through
three  years
     Over three
through five
years
     Over five
years
     Total  

Time deposit accounts

   $ 333,876       $ 181,849       $ 3,789       $ 35       $ 519,549   

There have been no other significant changes in future real property operating lease obligations or FHLB advances as reported in our Annual Report on Form 10-K and Form 10-K/A for the year ended December 31, 2010.

Short-Term Contractual and Noncontractual Obligations. There have been no significant changes in short-term contractual or noncontractual obligations as reported in our Annual Report on Form 10-K and Form 10-K/A for the year ended December 31, 2010.

 

70


Table of Contents

First Quarter 2011 Earnings Review

Overview

PALMETTO BANCSHARES, INC. AND SUBSIDIARY

Consolidated Statements of Income (Loss)

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

 

    

For the three months

ended March 31,

             
       Dollar
variance
    Percent
variance
 
     2011     2010      

Interest income

        

Interest earned on cash and cash equivalents

   $ 105      $ 67      $ 38        56.7

Dividends received on FHLB stock

     14        4        10        250.0   

Interest earned on investment securities available for sale

     1,306        1,203        103        8.6   

Interest and fees earned on loans

     11,569        13,605        (2,036     (15.0
                                

Total interest income

     12,994        14,879        (1,885     (12.7

Interest expense

        

Interest paid on deposits

     2,676        3,563        (887     (24.9

Interest paid on retail repurchase agreements

     11        14        (3     (21.4

Interest paid on commercial paper

     —          10        (10     (100.0

Interest paid on FHLB borrowings

     49        493        (444     (90.1
                                

Total interest expense

     2,736        4,080        (1,344     (32.9
                                

Net interest income

     10,258        10,799        (541     (5.0

Provision for loan losses

     5,500        10,750        (5,250     (48.8
                                

Net interest income after provision for loan losses

     4,758        49        4,709        9,610.2   
                                

Noninterest income

        

Service charges on deposit accounts, net

     1,762        1,950        (188     (9.6

Fees for trust and investment management and brokerage services

     691        651        40        6.1   

Mortgage-banking

     376        429        (53     (12.4

Automatic teller machine

     232        231        1        0.4   

Merchant services

     10        794        (784     (98.7

Bankcard services

     76        156        (80     (51.3

Investment securities gains, net

     —          8        (8     (100.0

Other

     425        278        147        52.9   
                                

Total noninterest income

     3,572        4,497        (925     (20.6

Noninterest expense

        

Salaries and other personnel

     6,551        6,137        414        6.7   

Occupancy

     1,183        1,171        12        1.0   

Furniture and equipment

     985        967        18        1.9   

Professional services

     510        547        (37     (6.8

FDIC deposit insurance assessment

     958        715        243        34.0   

Marketing

     414        295        119        40.3   

Foreclosed real estate writedowns and expenses

     833        1,012        (179     (17.7

Loss on commercial loans held for sale

     1,151        —          1,151        100.0   

Other

     1,773        2,036        (263     (12.9
                                

Total noninterest expense

     14,358        12,880        1,478        11.5   
                                

Net loss before provision (benefit) for income taxes

     (6,028     (8,334     2,306        (27.7

Provision (benefit) for income taxes

     52        (3,042     3,094        (101.7
                                

Net loss

   $ (6,080   $ (5,292   $ (788     14.9
                                

Common and per share data

        

Net loss - basic

   $ (0.12   $ (0.82   $ 0.70        (85.4 )% 

Net loss - diluted

     (0.12     (0.82     0.70        (85.4

Cash dividends

     —          —          —          —     

Book value

     2.29        10.93        (8.64     (79.0

Weighted average common shares outstanding - basic

     49,453,501        6,455,598       

Weighted average common shares outstanding - diluted

     49,453,501        6,455,598       

Summary

Historically, our earnings were driven primarily by a high net interest margin, which allowed for a higher expense base related primarily to personnel and facilities. However, given the narrowing of our net interest margin due to the reduction of 500 to 525 basis points in interest rates by the Federal Reserve in 2007 and 2008, we have become much more focused on increasing our noninterest income and managing expenses. In addition, we are realigning our lending focus to originate higher yielding loan portfolio segments with lower historical loss rates. To further accelerate efforts to improve our earnings, we engaged external strategic

 

71


Table of Contents

consulting firms in 2010 that specialize in assessment of banking products and services, revenue enhancements, and efficiency reviews.

One of the components of our Strategic Project Plan is an earnings plan that is focused on earnings improvement through a combination of revenue increases and expense reductions. In summary, to date:

 

 

With respect to net interest income, we implemented risk-based loan pricing and interest rate floors on renewed and new loans meeting certain criteria. At March 31, 2011, loans aggregating $218.8 million had interest rate floors, of which $199.4 million had floors greater than or equal to 5%. In 2010 and into 2011, we introduced loan specials intended to generate additional loan volume for residential mortgage, auto, credit card, consumer, and commercial loans. In light of the current low interest rate environment, we have also reduced the interest rates paid on our deposit accounts. Given expectations for rising interest rates, during 2010 we also borrowed longer-term advances from the FHLB, and extended maturities on certain CD specials to lock in the low interest rates at the time of the specials. In December 2010 and January 2011, we used excess cash earning 25 basis points to prepay $91.0 million of FHLB advances bearing interest at an average rate of 1.58%.

 

 

Regarding noninterest income, we are evaluating other noninterest sources of income. For example, in March 2010, we introduced a new checking account, MyPal checking, and a new savings account, Smart Savings, both of which provide noninterest income resulting from service charges or debit card transactions. We evaluated the profitability of all of our pre-existing checking accounts and in October 2010 upgraded a large number of unprofitable checking accounts to the MyPal account. We also revised our existing fees and implemented new fees, with various implementation dates generally between October 1, 2010 and March 1, 2011. We anticipate further fee increases related to other Company-provided services during 2011.

 

 

Regarding noninterest expenses, we identified specific noninterest expense reductions and are continuing to review other expense areas for additional reductions. These expense reductions have been and will be partially offset by the higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of nonperforming assets.

 

 

We continue to critically evaluate each of our businesses to determine their contribution to our financial performance and their relative risk / return relationship. Based on the evaluation to date, we sold two product lines during 2010. In March 2010, we sold our merchant services product line and entered into a referral and services agreement with Global Direct, which resulted in a net gain of $587 thousand. Similarly, in December 2010 we sold our credit card portfolio and entered into a joint marketing agreement with Elan Financial Services, Inc., resulting in a net gain of $1.2 million.

We are continuing our keen focus on improving credit quality and earnings. Overall, with the completion of the Private Placement in October 2010, we are in the process of repositioning the balance sheet as part of our balance sheet management efforts to utilize our excess cash more effectively to improve our net interest margin. This includes investing in higher yielding investment securities until loan growth resumes, as well as paying down higher priced funding such as FHLB advances and maturing CDs. We are also continuing to adapt our organizational structure to fit the current and future size and scope of our business activities and operations. Such efforts include hiring management personnel with specialized industry experience, more specifically delineating our businesses, and preparing “go to market” strategies with relevant products and services and marketing plans by business.

Net Interest Income

General. Net interest income is the difference between interest income earned on interest-earning assets, primarily loans and investment securities, and interest expense paid on interest-bearing deposits and other interest-bearing liabilities. This measure represents the largest component of income for us. The net interest margin measures how effectively we manage the difference between the interest income earned on interest-earning assets and the interest expense paid for funds to support those assets. Changes in interest rates earned on interest-earning assets and interest rates paid on interest-bearing liabilities, the rate of growth of the interest-earning assets and interest-bearing liabilities base, the ratio of interest-earning assets to interest-bearing liabilities, and the management of interest rate sensitivity factor into fluctuations within net interest income.

During the second half of 2008 and continuing through 2011, the financial markets experienced significant volatility resulting from the continued fallout of subprime lending and the global liquidity crisis. A multitude of government initiatives along with interest rate cuts by the Federal Reserve have been designed to improve liquidity for the distressed financial markets and stabilize the banking system. The relationship

 

72


Table of Contents

between declining interest-earning asset yields and more slowly declining interest-bearing liability costs has caused, and may continue to cause, net interest margin compression. Net interest margin compression may also continue to be impacted by continued deterioration of assets resulting in further interest income adjustments.

Net interest income totaled $10.3 million for the three months ended March 31, 2011 compared with $10.8 million for the three months ended March 31, 2010. Overall, interest income for the three months ended March 31, 2011 was negatively impacted by the following:

 

   

Reduction in interest rates by the Federal Reserve by 500 to 525 basis points throughout 2007 and 2008 and a continuation of this low rate environment into 2011. In response, taking into consideration the yields earned and rates paid, we have refined the type of loan and deposit products we prefer to pursue and are exercising more discipline in our loan and deposit interest rate levels. We have also implemented interest rate floors on loans. At March 31, 2011, loans aggregating $218.8 million had interest rate floors, of which $199.4 million had floors greater than or equal to 5%.

 

   

Foregone interest on nonaccrual loans for the three months ended March 31, 2011 totaled $500 thousand.

 

   

Maintaining historically high levels of cash as a result of loan and security repayments, deposit growth and funds received in the Private Placement and related follow-on offerings. Maintaining this cash balance has reduced our interest income by $860 thousand for the three months ended March 31, 2011 when compared with investing these funds at the average yield of 2.29% on our investment securities, since we are retaining a higher level of cash instead of reinvesting this cash in higher yielding assets. Given the consummation of our Private Placement in October 2010, we have begun redeploying this cash balance into investment securities and also prepaid $91 million of FHLB advances in December 2010 and January 2011 that were scheduled to mature in January through April 2011.

 

   

Reduction of $35.0 million in gross loans and commercial loans held for sale during the three months ended March 31, 2011 as repayments, sales and charge-offs outpaced new loan originations given limited loan demand from credit-worthy borrowers.

Average Balance Sheets and Net Interest Income / Margin Analysis. The following table summarizes our average balance sheets and net interest income / margin analysis for the periods indicated (dollars in thousands). Our yields on interest-earning assets and rates paid on interest-bearing liabilities shown in the table are derived by dividing interest income and expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively. The following table does not include a tax-equivalent adjustment to net interest income for interest-earning assets earning tax-exempt income to a comparable yield on a taxable basis.

 

73


Table of Contents
     For the three months ended March 31,  
     2011     2010  
     Average
balance
    Income/
expense
     Yield/
rate
    Average
balance
    Income/
expense
     Yield/
rate
 

Assets

              

Interest-earning assets

              

Cash and cash equivalents

   $ 184,437      $ 105         0.23   $ 126,593      $ 67         0.21

FHLB stock

     6,785        14         0.84        7,010        4         0.23   

Investment securities available for sale, taxable (1)

     165,664        761         1.86        71,718        818         4.63   

Investment securities available for sale, nontaxable (1)

     65,512        545         3.37        45,984        385         3.40   

Loans (2)

     846,823        11,569         5.54        1,031,740        13,605         5.35   
                                      

Total interest-earning assets

     1,269,221        12,994         4.15        1,283,045        14,879         4.70   
                          

Noninterest-earning assets

              

Cash and cash equivalents

     13,135             11,711        

Allowance for loan losses

     (26,301          (23,646     

Premises and equipment, net

     28,267             29,909        

Goodwill

     —               3,688        

Accrued interest receivable

     4,555             4,436        

Foreclosed real estate

     17,804             28,864        

Income tax refund receivable

     7,435             15,928        

Deferred tax asset, net

     —               5,358        

Other

     8,574             8,689        
                          

Total noninterest-earning assets

     53,469             84,937        
                          

Total assets

   $ 1,322,690           $ 1,367,982        
                          

Liabilities and Shareholders’ Equity

              

Liabilities

              

Interest-bearing liabilities

              

Transaction deposit accounts

   $ 295,779      $ 49         0.07   $ 299,329      $ 61         0.08

Money market deposit accounts

     142,040        81         0.23        123,741        161         0.53   

Savings deposit accounts

     51,776        16         0.13        41,803        32         0.31   

Time deposit accounts

     525,052        2,530         1.95        536,876        3,309         2.50   
                                      

Total interest-bearing deposits

     1,014,647        2,676         1.07        1,001,749        3,563         1.44   

Retail repurchase agreements

     23,311        11         0.19        22,319        14         0.25   

Commercial paper (Master notes)

     —          —           —          16,671        10         0.24   

Other short-term borrowings

     1        —           —          2        —           —     

FHLB borrowings

     5,666        49         3.51        99,666        493         2.01   

Convertible debt

     —          —           —          4        —           —     
                                      

Total interest-bearing liabilities

     1,043,625        2,736         1.06        1,140,411        4,080         1.45   

Noninterest-bearing liabilities

              

Noninterest-bearing deposits

     146,666             140,753        

Accrued interest payable

     1,204             1,727        

Other

     11,153             8,443        
                          

Total noninterest-bearing liabilities

     159,023             150,923        
                          

Total liabilities

     1,202,648             1,291,334        

Shareholders’ equity

     120,042             76,648        
                          

Total liabilities and shareholders’ equity

   $ 1,322,690           $ 1,367,982        
                          

NET INTEREST INCOME / NET YIELD ON INTEREST-EARNING ASSETS

     $ 10,258         3.28     $ 10,799         3.41
                          

 

(1) The average balances for investment securities include the applicable unrealized gain or loss recorded for available for sale securities.
(2) Calculated including mortgage and commercial loans held for sale, excluding the allowance for loan losses. Nonaccrual loans are included in average balances for yield computations. The impact of foregone interest income as a result of loans on nonaccrual was not considered in the above analysis. All loans and deposits are domestic.

 

74


Table of Contents

Federal Reserve Rate Influences. The Federal Reserve influences the general market rates of interest earned on interest-earning assets and interest paid on interest-bearing liabilities. However, there have been no changes by the Federal Reserve with regard to the targeted federal funds interest rate since December 2008.

Rate / Volume Analysis. The following rate / volume analysis summarizes the dollar amount of changes in interest income and interest expense attributable to changes in volume and the amount attributable to changes in rate when comparing the periods indicated (in thousands). The impact of the combination of rate and volume change has been divided proportionately between the rate change and volume change.

 

     For the three months ended March 31, 2011
compared with  the three months ended
March 31, 2010
 
     Change in
volume
    Change in
rate
    Total
change
 

Assets

      

Interest-earning assets

      

Cash and cash equivalents

   $ 33      $ 5      $ 38   

FHLB stock

     —          10        10   

Investment securities available for sale

     192        (89     103   

Loans

     (2,548     512        (2,036
                        

Total interest income

   $ (2,323   $ 438      $ (1,885

Liabilities and Shareholders’ Equity

      

Interest-bearing liabilities

      

Transaction deposit accounts

   $ (1   $ (11   $ (12

Money market deposit accounts

     29        (109     (80

Savings deposit accounts

     12        (28     (16

Time deposit accounts

     (72     (707     (779
                        

Total interest paid on deposits

     (32     (855     (887

Retail repurchase agreements

     1        (4     (3

Commercial paper (Master notes)

     (5     (5     (10

FHLB borrowings

     (2,151     1,707        (444
                        

Total interest expense

   $ (2,187   $ 843      $ (1,344
                        

Net interest income

   $ (136   $ (405   $ (541
                        

Absent the significant impact of nonaccrual loans during the three months ended March 31, 2011, the change in loans due to volume and the change due to rate for the three month period ended March 31, 2011 compared with the three month period ended March 31, 2010 was ($5.0) million and $2.9 million, respectively.

Provision for Loan Losses

Provision for loan losses decreased from $10.8 million during the three months ended March 31, 2010 to $5.5 million for the three months ended March 31, 2011. The decrease was due primarily to declining charge-offs resulting from lower levels of nonperforming assets and declines in criticized and classified assets. See also Financial Condition – Lending Activities, included elsewhere in this item, for discussion regarding our accounting policies related to, factors impacting, and methodology for analyzing the adequacy of our allowance for loan losses and, therefore, our provision for loan losses.

Noninterest Income

General. The following table summarizes the components of noninterest income for the periods indicated (in thousands).

 

     For the three months
ended March 31,
 
     2011      2010  

Service charges on deposit accounts, net

   $ 1,762       $ 1,950   

Fees for trust and investment management and brokerage services

     691         651   

Mortgage-banking

     376         429   

Automatic teller machine

     232         231   

Merchant services

     10         794   

Bankcard services

     76         156   

Investments securities gains, net

     —           8   

Other

     425         278   
                 

Total noninterest income

   $ 3,572       $ 4,497   
                 

 

75


Table of Contents

Service Charges on Deposit Accounts, Net. Net service charges on deposit accounts comprise a significant component of noninterest income totaling 2.4% of average transaction deposit accounts for the three months ended March 31, 2011 compared with 2.6% of average transaction deposit accounts for the three month period ended March 31, 2010. The decrease in service charges on deposit accounts of $188 thousand, or 9.6%, is attributed primarily to a decrease in NSF fees resulting from a $100 courtesy overdraft line included with the MyPal checking account we began offering in March 2010, changes in customer behavior that have resulted in a reduction in the number of transactions that would otherwise result in overdrafts, and the customers with historical overdraft transactions who did not opt-in to overdraft protection in accordance with Regulation E which went into effect during the third quarter 2010.

In response to competition to retain deposits, institutions in the financial services industry have increasingly been providing services for free in an effort to lure deposits away from competitors and retain existing balances. Services that were initially developed as fee income opportunities, such as Internet banking and bill payment service, are now provided to customers free of charge. Consequently, opportunities to earn additional income from service charges for such services have been more limited. In addition, recent focus on the level of deposit service charges within the banking industry by the media and the U.S. Government may result in future legislation limiting the amount and type of services charges within the banking industry.

The November 2009 amendment to Regulation E of the Electronic Fund Transfer Act, which was effective July 1, 2010 for new customers and August 15, 2010 for existing customers, prohibits financial institutions from charging consumers fees for paying overdrafts on automated teller machine and one-time debit card transactions unless a consumer consents to the overdraft service for those types of transactions. Some industry experts estimated that the impact of the change from Regulation E would result in a reduction of 30% to 40% of such overdraft fees. To continue to have overdraft services available to those customers who desired to have this service, we were proactive in encouraging our deposit customers to opt-in to overdraft protection; however, not all of our customers who have previously utilized overdraft features have opted-in to overdraft protection. In addition, in December 2010, the Federal Reserve issued a proposal to implement a provision in the Dodd-Frank Act that requires the Federal Reserve to set debit-card interchange fees. The proposed rule, if implemented in its current form, would result in a significant reduction in debit-card interchange revenue. Though the rule technically does not apply to institutions with less than $10 billion in assets, such as the Bank, there is concern that the price controls may harm community banks, which could be pressured by the marketplace to lower their own interchange rates. We are still evaluating the guidance and at this time we do not yet know if the guidance and the implementation of Regulation E will result in a sustained reduction in our services charges.

Fees for Trust and Investment Management and Brokerage Services. Fees for trust and investment management and brokerage services represent income associated with wealth management and advisory services provided by the Company. The increase in this category was due to a $27 thousand increase in trust fees while brokerage services increased $13 thousand. The growth in income was due to an increase in assets under management, both from new accounts and the general increase in fair values of the underlying assets against which the fees are calculated.

Mortgage-Banking. Most of the residential mortgage loans that we originate are sold in the secondary market. Normally we retain the servicing rights to maintain the customer relationships related to servicing the loans. Mortgage loans serviced for the benefit of others amounted to $424.0 million and $423.6 million at March 31, 2011 and December 31, 2010, respectively, and are not included in our Consolidated Balance Sheets.

The following table summarizes the components of mortgage-banking income for the periods indicated (dollars in thousands).

 

76


Table of Contents
     For the three months ended March 31,  
     2011     2010  

Mortgage-servicing fees

   $ 258      $ 256   

Gain on sale of mortgage loans held for sale

     300        343   

Mortgage-servicing rights portfolio amortization and impairment

     (212     (191

Derivative loan commitment income

     59        51   

Forward sales commitment loss

     (75     (76

Other

     46        46   
                

Total mortgage-banking income

   $ 376      $ 429   
                

Mortgage-servicing fees as a percentage of average mortgage loans serviced for the benefit of others

     0.25     0.24

Mortgage-banking income decreased $53 thousand (12.4%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. Gains on sales of mortgage loans declined approximately $43 thousand (12.5%) while the expense associated with amortization and impairment of mortgage-servicing rights increased $21 thousand (11.0%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. The decline in gain on sale of mortgage loans was the result of a decline in the volume of loans originated and sold over the periods. Mortgage loans held for sale originated during the three months ended March 31, 2011 and 2010 totaled $11.4 million and $15.0 million, respectively, while sales over the same periods were $16.2 million and $18.1 million, respectively. In March 2011, we completed a review of our mortgage origination and servicing business with the assistance of a third party consultant to identify opportunities to improve the profitability of this business. We are still evaluating the results of this review.

Merchant Services. Merchant services income decreased $784 thousand (98.7%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. As previously described in the Executive Summary of First Quarter 2011 Financial Results, Strategic Project Plan, we are critically evaluating each of our product lines to determine their contribution to our financial performance and their relative risk / return relationship. Based on the evaluation, on March 31, 2010 we sold this product line and entered into a referral and services agreement with Global Direct related to our merchant services business which resulted in a gross payment to the Company of $786 thousand, which is included in Merchant services income in the amount of $559 thousand, net of transaction fees, for the three months ended March 31, 2010. Under the agreement, Global Direct provides services including merchant sales through a dedicated sales person, marketing and advertising within our geographic footprint, credit review and approval and activating new merchant accounts, equipment sales and customer service, transaction authorization service, risk mitigation services, and compliance with applicable laws and card association and payment network rules. Under the terms of the agreement, we now receive referral income when we refer customers that are accepted by Global Direct and a percentage of the ongoing revenues related to merchant services accounts sold to Global Direct.

Bankcard Services. Bankcard services income decreased $80 thousand (51.3%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. In connection with our on-going strategic review of our business, we sold our credit card portfolio and entered into a joint marketing agreement in December 2010 with Elan Financial Services, Inc., resulting in a net gain of $1.2 million. We also entered into an interim servicing agreement to cover the period through the date the accounts are transferred to the third party’s system, a period expected not to exceed nine months from the date of the sale. In connection with the interim servicing agreement, we receive a set servicing fee per active account per month for providing servicing related functions such as payment processing, collections, customer service and billing. Based on the structure of the interim servicing agreement, the servicing fee to be received is considered adequate compensation for the services to be performed and, therefore, no servicing asset or liability was recognized in connection with the sale.

Other. Other noninterest income increased $147 thousand (52.9%) from the three months ended March 31, 2010 to the three months ended March 31, 2011. The increase was primarily due to increased debit card fees resulting primarily from the MyPal checking account ($35 thousand).

Noninterest Expense

General. The earnings component of our Strategic Project Plan includes keen focus on expense management. As part of our earnings plan to improve our overall financial performance, we identified specific noninterest expense reductions realized in 2009 and 2010 and are continuing to review other expense areas for additional reductions. Examples include:

 

77


Table of Contents
   

Freezing most employee salaries effective May 1, 2009 to February 28, 2011 and eliminating the remaining officer cash incentive plan awards under the corporate incentive plan for 2009 and 2010,

 

   

Reducing our Saturday banking hours from 2:00 p.m. to noon in September 2009 and converting some branch office hours on Saturdays to drive thru only in October 2010,

 

   

Reducing marketing expenses and corporate contributions to not-for-profit organizations, and

 

   

Reducing officer perquisites, including elimination in 2010 of all bank-owned automobiles, reduction in coverage for annual physical examinations, elimination in 2010 of Company paid life insurance premiums for certain officers, and termination of officer participation in the Supplemental Executive Retirement Plan.

With the assistance from a third party consulting firm, we also reviewed our Retail Banking network from March through June 2010 and are implementing process improvements and other recommendations that we believe will result in reduced expenses. In September 2010 through January 2011, with assistance from the same consulting firm, we performed a comprehensive review of our lending process that we believe will similarly result in efficiency improvements and cost savings. Savings have also been realized resulting from more fully leveraging existing technology, implementing more advanced technology, and other process improvements. These expense reductions are partially offset by the higher level of credit-related costs incurred due to legal, consulting, and carrying costs related to our higher level of nonperforming assets. We continue to review other expense areas for additional reduction opportunities.

The following table summarizes the components of noninterest expense for the periods indicated (in thousands).

 

     For the three months
ended March 31,
 
     2011      2010  

Salaries and other personnel

   $ 6,551       $ 6,137   

Occupancy

     1,183         1,171   

Furniture and equipment

     985         967   

Professional services

     510         547   

FDIC deposit insurance assessment

     958         715   

Marketing

     414         295   

Foreclosed real estate writedowns and expenses

     833         1,012   

Loss on commercial loans held for sale

     1,151         —     

Other

     1,773         2,036   
                 

Total noninterest expense

   $ 14,358       $ 12,880   
                 

Salaries and Other Personnel. Salaries and other personnel expense increased $414 thousand (6.7%) for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010 as a result of increased use of contract labor, employee raises generally effective February 28, 2011 after a two year salary freeze, and increased incentive compensation accruals paid for new product sales and referrals. Total full-time equivalent employees (“FTE”) at March 31, 2011 and 2010 were 385 and 409, respectively. While total FTEs declined, certain positions that became open were replaced with higher paid employees as part of our plan to recruit personnel with specific industry expertise and experience. In the first quarter 2011, additions to headcount were primarily focused in revenue generating roles such as commercial lending, trust, and retail banking. In connection with the execution of our strategic plan, we have been evaluating the proper alignment of roles and responsibilities within the Company and working to ensure our overall compensation structure remains competitive with the industry as we continue to compete for talent.

Occupancy. Occupancy costs increased slightly ($12 thousand, or 1.0%) for the three months ended March 31, 2011 as compared to the three months ended March 31, 2010. Decreases in maintenance costs were offset by higher repairs expense. During the first quarter 2010, as part of our strategic evaluation of proper alignment of resources, we engaged a property management firm to handle property management functions for all of our facilities. This initiative has resulted in increased efficiencies through a reduction in facilities related vendors, execution of standardized contracts, and volume based pricing.

Furniture and Equipment. Furniture and equipment expense increased $18 thousand, or 1.9%, from the three months ended March 31, 2010 to the three months ended March 31, 2011. The increase was due to increased property taxes on leased equipment that were partially offset by lower depreciation and maintenance costs on bank-owned automobiles resulting from the sale of all Company-provided automobiles in April 2010.

 

78


Table of Contents

Professional Services. Professional services expense decreased $37 thousand, or 6.8%, from the three months ended March 31, 2010. The decline is attributable to lower consulting expenses and accounting fees. To date, and primarily in 2010, we executed nine process improvement engagements across the Company that were facilitated by third party consultants. We expect our consulting expense to decline in 2011 as the last such planned engagement is currently in process.

FDIC Deposit Insurance Assessment. FDIC insurance premiums increased $243 thousand (34.0%) from the three months ended March 31, 2010 to the same period of 2011. The increase in FDIC insurance premiums is attributable to a higher assessment rate in 2011 based on our overall regulatory rating as well as an increase in transaction deposit balances.

In February 2011, the FDIC approved two rules that amend the deposit insurance assessment regulations. The first rule changes the assessment base from one based on domestic deposits to one based on assets. The assessment base changes from adjusted domestic deposits to average consolidated total assets minus average tangible equity. The second rule changes the deposit insurance assessment system for large institutions in conjunction with the guidance given in the Dodd-Frank Act. Since the new base would be much larger than the current base, the FDIC will lower assessment rates, which achieves the FDIC’s goal of not significantly altering the total amount of revenue collected from the industry. Risk categories and debt ratings will be eliminated from the assessment calculation for large banks which will instead use scorecards. The scorecards will include financial measures that are predictive of long-term performance. A large financial institution will continue to be defined as an insured depository institution with at least $10 billion in assets. Both changes in the assessment system became effective as of April 1, 2011 and will be payable at the end of September 2011.

With the consummation of the Private Placement in October 2010 and the resulting change in the Bank’s capital classification to well-capitalized, as well as the changes to the deposit insurance assessment regulations, we project that our FDIC insurance premiums will be reduced by approximately $1.8 million in 2011 when compared with 2010, based on our 2011 budgeted level of deposits and assets.

Marketing. Marketing expense increased $119 thousand (40.3%) from the three month period ended March 31, 2010 to the same period of 2011, primarily due to increased television and radio advertising campaigns designed to increase brand awareness and to promote certain consumer lending programs. Marketing expense in the first quarter 2010 was primarily impacted by promotional efforts related to our new MyPal checking and Smart Savings deposit accounts and increased marketing related to mortgage and small business.

Foreclosed Real Estate Writedowns and Expenses. Foreclosed real estate writedowns and expenses decreased $179 thousand from the three months ended March 31, 2010 to the same period of 2011. The carrying value of these assets is written down to their fair value less estimated selling costs, based on currently available valuation information primarily from third party appraisals. Writedowns on 19 such properties during the first quarter of 2011 resulted in a provision charged to expense of $596 thousand. The continued high level of writedowns is due to receipts of contracts for sale and updated appraisals which continued to show declining values based on lack of property sales activity. The continued high level of expenses is due to payment of legal fees, taxes, insurance, utilities, property management company fees, and other carrying costs on our elevated level of foreclosed properties.

Loss on Commercial Loans Held for Sale. In September 2010, we began marketing for sale a pool of specifically identified commercial loans. Our marketing efforts continued through the first quarter 2011 and are expected to continue through 2011. We are evaluating the bids received on a loan-by-loan basis and are balancing the desire to reduce problem loans with preservation of capital. In general, we believe potential buyers are making bids at heavily discounted prices given the need for the banking industry in general, and our Company in particular, to deleverage commercial real estate assets. We believe this was particularly true in the fourth quarter of 2010 as banks sought to rid themselves of problem assets prior to year-end. While bid prices on certain assets improved in the first quarter 2011, such prices continue to reflect heavy discounting. In many cases, we have not accepted such discounted bids. In certain cases, however, we are making the strategic decision to sell certain assets at amounts less than their recorded book values to continue to reduce our criticized assets and concentration in commercial real estate as required by the Consent Order.

 

79


Table of Contents

Writedowns of $1.1 million were recorded in the first quarter 2011 to reduce the value of these assets to fair value, which was based on updated appraisals received during the first quarter, less estimated costs to sell, or internal valuations, as applicable.

During the first quarter 2011, we closed five loans, representing two relationships, with a gross book value of $2.0 million. At March 31, 2011, we had commercial loans held for sale aggregating $60.3 million.

Other. Other noninterest expense decreased $263 thousand (12.9%) during the three months ended March 31, 2011 over the same period of 2010. Included in this financial statement line item and positively impacting this decline were the following:

 

   

Merchant expenses eliminated during 2010 in conjunction with the sale of the merchant services product line to Global Direct resulting in a decline of $192 thousand over the periods.

 

   

Branch closure expense associated with banking offices previously consolidated or relocated for which leases had not yet expired or properties had not yet been subleased or sold. Two operating leases expired during 2010 resulting in a reduction in branch facilities during the three months ended March 31, 2011 over the same period of 2010 ($89 thousand).

Offsetting these positive impacts was the following:

 

   

During the first quarter of 2011, as part of our overall balance sheet management efforts to utilize our excess cash and reduce our overall borrowing cost, we prepaid $30.0 million of FHLB advances resulting in a prepayment penalty of $136 thousand for the three months ended March 31, 2011. We did not prepay any advances during the three months ended March 31, 2010.

Provision (Benefit) for Income Taxes

Provision for income taxes was $52 thousand in the first quarter 2011 compared to an income tax benefit of $3.0 million in the first quarter 2010. The provision for income taxes in the first quarter 2011 reflects the additional valuation allowance necessary to fully offset the net deferred tax asset of $22.9 million at March 31, 2011. As discussed in Part I – Financial Information, Item 1. Financial Statements, Note 12 and Financial Condition – Deferred Tax Asset, we determined that based on projections of future taxable income, available tax planning strategies and limitations on our ability to utilize net operating loss carryforwards, a valuation allowance on our net deferred tax asset was necessary. Based on projections for the remainder of 2011, we expect to maintain a full allowance against the net deferred tax asset. Additional provisions or benefits may result to the extent of changes in deferred tax liabilities which require adjustments to the valuation allowance to maintain a full allowance against the net deferred tax asset. The first quarter 2010 benefit is related to our ability to utilize operating losses as a carryback to offset income taxes paid in 2008.

Analysis of our ability to realize deferred tax assets requires us to apply significant judgment and is inherently subjective because it requires the future occurrence of circumstances that cannot be predicted with certainty. While we recorded a valuation allowance against our net deferred tax asset for financial reporting purposes at March 31, 2011 and December 31, 2010, the net operating losses are able to be carried forward for income tax purposes up to twenty years. Thus, to the extent we return to profitability and generate sufficient taxable income in the future, we will be able to utilize some of the net operating losses for income tax purposes and reverse a portion of the valuation allowance for financial reporting purposes. The determination of how much of the net operating losses we will be able to utilize and therefore how much of the valuation allowance that may be reversed and the timing is based on our future results of operations and the amount and timing of actual loan charge-offs and asset writedowns.

Recently Issued / Adopted Authoritative Pronouncements

See Item 1. Financial Statements, Note 1, for a discussion regarding recently issued and recently adopted authoritative pronouncements and their expected impact on our business, financial condition, results of operations, and cash flows.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

As of March 31, 2011, the following table summarizes the forecasted impact on net interest income using a base case scenario given upward and downward movements in interest rates of 100, 200 and 300 basis points based on forecasted assumptions of prepayment speeds, nominal interest rates and loan and deposit repricing rates. Estimates are based on current economic conditions, historical interest rate cycles and other factors

 

80


Table of Contents

deemed to be relevant. However, underlying assumptions may be impacted in future periods which were not known to management at the time of the issuance of the Consolidated Financial Statements. Therefore, management’s assumptions may or may not prove valid. No assurance can be given that changing economic conditions and other relevant factors impacting our net interest income will not cause actual occurrences to differ from underlying assumptions.

 

Interest rate scenario (1)

   Percentage
change in net
interest income
from base
 

Up 300 basis points

     8.27

Up 200 basis points

     6.09   

Up 100 basis points

     3.48   

Base

  

Down 100 basis points

     0.87   

Down 200 basis points

     0.56   

Down 300 basis points

     0.36   

 

  (1) The rising and falling 100, 200 and 300 basis point interest rate scenarios assume an immediate and parallel change in interest rates along the entire yield curve. Beginning with the March 31, 2011 analysis, the Company revised certain assumptions with respect to the interest rate sensitivity of its transaction account deposits to be more representative of the long-term nature of these balances and better reflect the interest rate profile of these funding sources.

There are material limitations with the model presented above, which include, but are not limited to:

 

   

It presents the balance sheet in a static position. When assets and liabilities mature or reprice, they do not necessarily keep the same characteristics.

 

   

The computation of prospective impacts of hypothetical interest rate changes are based on numerous assumptions and should not be relied upon as indicative of actual results.

 

   

The computations do not contemplate any additional actions we could undertake in response to changes in interest rates.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

An evaluation of our disclosure controls and procedures (as defined in Sections 13(a)-15(e) and 15(d)-15(e) of the Securities Exchange Act of 1934) was carried out under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer and several other members of senior management as of March 31, 2011, the last day of the period covered by this Quarterly Report. The Company’s Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2011 in ensuring that the information required to be disclosed in the reports we file or submit under the Securities Exchange Act of 1934 is (i) accumulated and communicated to management (including the Company’s Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms.

First Quarter Internal Control Changes

During the first quarter of 2011, we did not make any changes in our internal controls over financial reporting that have materially affected or are reasonably likely to materially affect those controls.

 

81


Table of Contents

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

See Part I – Financial Information, Item 1. Financial Statements, Note 16 contained herein for disclosures required by this item.

Item 1A. Risk Factors

In addition to the other information set forth in this Quarterly Report, you should carefully consider the factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2010 which could materially affect our business, financial condition, results of operations, or cash flows. The risks described in the Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known or currently deemed to be immaterial also may materially and adversely affect our business, financial condition, results of operations or cash flows.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

None

Item 4. (Removed and Reserved)

Item 5. Other Information

None

Item 6. Exhibits

 

10.1    Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Samuel L. Erwin dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011
10.2    Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Lee S. Dixon dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011
10.3    Form of Subscription Agreement: Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 3, 2011
31.1^    Samuel L. Erwin’s Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2^    Roy D. Jones’ Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32^    Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

^ Filed with this Quarterly Report on Form 10-Q

Copies of exhibits are available upon written request to Corporate Secretary, Palmetto Bancshares, Inc., 306 East North Street, Greenville, South Carolina 20601

 

82


Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

PALMETTO BANCSHARES, INC.
By:

/s/ Samuel L. Erwin

Samuel L. Erwin
Chief Executive Officer
Palmetto Bancshares, Inc.

/s/ Roy D. Jones

Roy D. Jones
Chief Financial Officer
Palmetto Bancshares, Inc.

Date: May 2, 2011

 

83


Table of Contents

EXHIBIT INDEX

 

Exhibit
No.

  

Description

10.1    Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Samuel L. Erwin dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011
10.2    Employment Agreement by and between Palmetto Bancshares, Inc., The Palmetto Bank and Lee S. Dixon dated March 17, 2011: Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on April 1, 2011
10.3    Form of Subscription Agreement: Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on February 3, 2011
31.1    Samuel L. Erwin’s Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Roy D. Jones’ Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32    Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

84