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Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
 
FORM 10-Q
 
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
or
     
o   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 001-35032
(PARKSTERLING LCORPORATION LOGO)
PARK STERLING CORPORATION
(Exact name of registrant as specified in its charter)
 
     
NORTH CAROLINA   27-4107242
     
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
1043 E. Morehead Street, Suite 201    
Charlotte, North Carolina   28204
     
(Address of principal executive offices)   (Zip Code)
(704) 716-2134
(Registrant’s telephone number, including area code)
 
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 þ No o
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 þ No o
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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated Filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
As of November 10, 2011, the registrant had outstanding 32,643,627 shares of common stock, $1.00 par value per share.
 
 


 

PARK STERLING CORPORATION
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 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT

 

 


Table of Contents

PARK STERLING CORPORATION
Part I. FINANCIAL INFORMATION
Item 1.   Financial Statements
CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)
(Dollars in thousands)
                 
    September 30,     December 31,  
    2011     2010 *  
ASSETS
               
 
               
Cash and due from banks
  $ 14,962     $ 2,433  
Interest-earning balances at banks
    36,311       5,040  
Federal funds sold
    5,295       57,905  
Investment securities available-for-sale, at fair value
    130,667       140,590  
Loans held for sale
    1,559        
Loans
    367,412       399,829  
Allowance for loan losses
    (9,833 )     (12,424 )
 
           
Net loans
    357,579       387,405  
 
           
 
               
Federal Home Loan Bank stock
    1,866       1,757  
Premises and equipment, net
    5,335       4,477  
Accrued interest receivable
    1,441       1,640  
Other real estate owned
    5,691       1,246  
Bank-owned life insurance
    8,052        
Other assets
    13,625       13,615  
 
           
 
               
Total assets
  $ 582,383     $ 616,108  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
 
               
Deposits:
               
Noninterest-bearing demand deposits
  $ 42,890     $ 36,333  
Money market, NOW and savings deposits
    120,017       71,666  
Time deposits of less than $100,000
    50,220       78,242  
Time deposits of $100,000 through $250,000
    54,240       79,020  
Time deposits of more than $250,000
    107,625       142,559  
 
           
Total deposits
    374,992       407,820  
 
               
Short-term borrowings
    1,083       874  
FHLB advances
    20,000       20,000  
Subordinated debt
    6,895       6,895  
Accrued interest payable
    109       290  
Accrued expenses and other liabilities
    4,687       3,128  
 
           
Total liabilities
    407,766       439,007  
 
               
Shareholders’ equity:
               
Preferred stock, no par value 5,000,000 shares authorized; -0- issued and outstanding at September 30, 2011 and December 31, 2010
           
Common stock, $1.00 par value 200,000,000 shares authorized at September 30, 2011 and December 31, 2010; 28,619,358 and 28,051,098 shares issued and outstanding at September 30, 2011 and December 31, 2010, respectively
    28,619       28,051  
Additional paid-in capital
    160,368       159,489  
Accumulated deficit
    (16,878 )     (9,501 )
Accumulated other comprehensive income (loss)
    2,508       (938 )
 
           
Total shareholders’ equity
    174,617       177,101  
 
           
 
               
Total liabilities and shareholders’ equity
  $ 582,383     $ 616,108  
 
           
 
     
*   Derived from audited financial statements.
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

PARK STERLING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF LOSS (Unaudited)
(Dollars in thousands, except per share data)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Interest income
                               
Loans, including fees
  $ 4,283     $ 4,963     $ 13,491     $ 15,275  
Federal funds sold
    22       42       85       60  
Taxable investment securities
    681       370       2,046       981  
Tax-exempt investment securities
    181       161       533       481  
Interest on deposits at banks
    44       23       69       51  
 
                       
Total interest income
    5,211       5,559       16,224       16,848  
 
                       
 
                               
Interest expense
                               
Money market, NOW and savings deposits
    158       104       475       276  
Time deposits
    868       1,490       3,174       4,434  
Short-term borrowings
    1       1       2       9  
FHLB advances
    140       144       422       423  
Subordinated debt
    190       190       569       569  
 
                       
Total interest expense
    1,357       1,929       4,642       5,711  
 
                       
Net interest income
    3,854       3,630       11,582       11,137  
 
                               
Provision for loan losses
    568       6,143       8,275       8,768  
 
                       
Net interest income (loss) after provision for loan losses
    3,286       (2,513 )     3,307       2,369  
 
                               
Noninterest income
                               
Service charges on deposit accounts
    23       18       74       47  
Gain on sale of securities available-for-sale
                20       19  
Other noninterest income
    88       8       133       22  
 
                       
Total noninterest income
    111       26       227       88  
 
                       
 
                               
Noninterest expense
                               
Salaries and employee benefits
    3,051       1,777       8,533       4,328  
Occupancy and equipment
    369       236       926       666  
Advertising and promotion
    115       84       240       237  
Legal and professional fees
    721       78       2,233       237  
Deposit charges and FDIC insurance
    134       184       617       543  
Data processing and outside service fees
    142       109       393       302  
Director fees
    45       164       131       211  
Net cost of operation of other real estate
    101       120       429       395  
Loan and collection expense
    180       82       375       161  
Shareholder reporting expense
    36       8       194       24  
Other noninterest expense
    322       148       853       406  
 
                       
Total noninterest expense
    5,216       2,990       14,924       7,510  
 
                       
 
                               
Loss before income taxes
    (1,819 )     (5,477 )     (11,390 )     (5,053 )
 
                               
Income tax benefit
    (443 )     (1,809 )     (4,013 )     (1,714 )
 
                       
 
                               
Net loss
  $ (1,376 )   $ (3,668 )   $ (7,377 )   $ (3,339 )
 
                       
 
                               
Basic loss per common share
  $ (0.05 )   $ (0.23 )   $ (0.26 )   $ (0.38 )
 
                       
 
                               
Diluted loss per common share
  $ (0.05 )   $ (0.23 )   $ (0.26 )   $ (0.38 )
 
                       
 
                               
Weighted-average common shares outstanding
                               
Basic
    28,051,098       15,998,924       28,051,098       8,674,175  
 
                       
Diluted
    28,051,098       15,998,924       28,051,098       8,674,175  
 
                       
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

PARK STERLING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
Nine Months Ended September 30, 2011 and 2010
(Dollars in thousands)
                                                 
                                    Accumulated        
                    Additional             Other     Total  
    Common Stock     Paid-In     Accumulated     Comprehensive     Shareholders’  
    Shares     Amount     Capital     Deficit     Income (Loss)     Equity  
 
                                               
Balance at December 31, 2009
    4,951,098     $ 23,023     $ 23,496     $ (1,642 )   $ 1,218     $ 46,095  
 
                                               
Issuance of common stock net of costs
    23,100,000       107,415       32,796                   140,211  
 
                                               
Share-based compensation expense
                486                   486  
 
                                               
Comprehensive income (loss):
                                               
Net loss
                      (3,339 )           (3,339 )
Unrealized holding gains on available-for-sale securities, net of taxes
                            888       888  
Unrealized holding losses on interest rate swaps, net of taxes
                            (494 )     (494 )
 
                                             
 
                                               
Total comprehensive income (loss)
                                  (2,945 )
 
                                   
 
                                               
Balance at September 30, 2010
    28,051,098     $ 130,438     $ 56,778     $ (4,981 )   $ 1,612     $ 183,847  
 
                                   
 
                                               
Balance at December 31, 2010
    28,051,098     $ 28,051     $ 159,489     $ (9,501 )   $ (938 )   $ 177,101  
 
                                               
Issuance of restricted stock grants
    568,260       568       (568 )                  
 
                                               
Share-based compensation expense
                1,447                   1,447  
 
                                               
Comprehensive income (loss):
                                               
Net loss
                      (7,377 )           (7,377 )
Unrealized holding gains on available-for-sale securities, net of taxes
                            3,728       3,728  
Unrealized holding losses on interest rate swaps, net of taxes
                            (282 )     (282 )
 
                                             
 
                                               
Total comprehensive income (loss)
                                  (3,931 )
 
                                   
 
                                               
Balance at September 30, 2011
    28,619,358     $ 28,619     $ 160,368     $ (16,878 )   $ 2,508     $ 174,617  
 
                                   
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

PARK STERLING CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
(Dollars in thousands)
                 
    Nine Months Ended  
    September 30,  
    2011     2010  
Cash flows from operating activities
               
Net income (loss)
  $ (7,377 )   $ (3,339 )
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Depreciation and amortization
    1,221       443  
Provision for loan losses
    8,275       8,768  
Share-based compensation expense
    1,447       486  
Income on termination of swap
          (353 )
Deferred income taxes
    (4,062 )     576  
Gain on sales of investment securities available-for-sale
    (20 )     (19 )
(Gain) loss on sales of other real estate
    (59 )     342  
Writedowns to other real estate
    374        
Income from bank owned life insurance
    (52 )      
Change in assets and liabilities:
               
Decrease (increase) in accrued interest receivable
    199       (118 )
Decrease (increase) in other assets
    1,433       (2,296 )
Decrease in accrued interest payable
    (181 )     (154 )
Increase in accrued expenses and other liabilities
    1,559       2,552  
 
           
Net cash provided by operating activities
    2,757       6,888  
 
               
Cash flows from investing activities
               
Net decrease (increase) in loans
    12,978       (5,963 )
Purchases of bank premises and equipment
    (1,168 )     (169 )
Purchases of investment securities available-for-sale
    (46,940 )     (81,268 )
Proceeds from sales of investment securities available-for-sale
    24,316       2,155  
Proceeds from maturities and call of investment securities available-for-sale
    37,871       7,590  
Proceeds from sale of other real estate
    2,104       2,724  
Improvements to other real estate
          (93 )
(Purchase) redemption of Federal Home Loan Bank stock
    (109 )     71  
Purchase of bank owned life insurance
    (8,000 )      
 
           
Net cash provided by (used in) investing activities
    21,052       (74,953 )
 
               
Cash flows from financing activities
               
Net (decrease) increase in deposits
    (32,828 )     24,516  
Increase (decrease) in short-term borrowings
    209       (5,889 )
Proceeds from issuance of common stock, net of costs
          140,211  
 
           
Net cash (used by) provided by financing activities
    (32,619 )     158,838  
 
           
 
               
Net (decrease) increase in cash and cash equivalents
    (8,810 )     90,773  
 
               
Cash and cash equivalents, beginning
    65,378       23,237  
 
           
 
               
Cash and cash equivalents, ending
  $ 56,568     $ 114,010  
 
           
 
               
Supplemental disclosures of cash flow information:
               
Cash paid for interest
  $ 4,823     $ 5,865  
Cash paid for income taxes
          950  
 
               
Supplemental disclosure of noncash investing and financing activities:
               
Change in unrealized gain on available-for-sale securities, net of tax
  $ 3,728     $ 888  
Change in unrealized loss on swap, net of tax
    (282 )     (494 )
Loans transferred to other real estate owned
    6,864       2,864  
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 

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Table of Contents

PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 1 — Basis of Presentation
Park Sterling Corporation (the “Company”) was formed on October 6, 2010 to serve as the holding company for Park Sterling Bank (the “Bank”) and is a bank holding company registered with the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) under the Bank Holding Company Act. On January 1, 2011, the Company acquired all of the outstanding stock of the Bank in a statutory exchange transaction (the “Reorganization”). Prior to January 1, 2011, the Company conducted no operations other than obtaining regulatory approval for the Reorganization. The information in the unaudited condensed consolidated financial statements and accompanying notes for all periods prior to January 1, 2011 is that of the Bank on a stand-alone basis.
The Bank was incorporated on September 8, 2006, as a North Carolina-chartered commercial bank and began operations in October 2006. The Bank’s primary focus is to provide banking services to small and mid-sized businesses, owner-occupied and income producing real estate owners, professionals and other customers doing business or residing within its target markets. The Bank operates under the banking laws of North Carolina and the rules and regulations of the Federal Deposit Insurance Corporation (the “FDIC”) and the North Carolina Office of the Commissioner of Banks. The Bank undergoes periodic examinations by those regulatory authorities.
On November 1, 2011, Community Capital Corporation (“Community Capital”) was merged with and into the Company, with the Company as the surviving legal entity, in accordance with an Agreement and Plan of Merger dated as of March 30, 2011. Under the terms of the merger agreement, Community Capital shareholders will receive either $3.30 in cash or 0.6667 of a share of the Company’s common stock, par value $1.00 (“Common Stock”) for each share of Community Capital common stock they owned immediately prior to the merger, subject to the limitation that the total consideration would consist of 40.0% in cash and 60.0% in Common Stock. The merger was structured to be tax-free to Community Capital shareholders with respect to the shares of Common Stock received in the merger and taxable with respect to the cash received in the merger. Cash was paid in lieu of fractional shares. The aggregate merger consideration consisted of 4,024,269 shares of Common Stock and approximately $13.3 million in cash. The final transaction value was $28.8 million based on the $3.85 per share closing price of the Common Stock on October 31, 2011.
The accompanying unaudited condensed consolidated financial statements and notes have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information or footnotes necessary for a complete presentation of financial position, results of operations and cash flows in conformity with GAAP. Because the accompanying unaudited condensed consolidated financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the Company’s audited consolidated financial statements and accompanying footnotes (the “2010 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010 filed with the Securities and Exchange Commission (“SEC”) on March 31, 2011 (the “2010 Form 10-K”).
In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all normal, recurring adjustments necessary to present fairly the financial position of the Company as of September 30, 2011, and the results of its operations and cash flows for the three- and nine-months ended September 30, 2011 and 2010. Operating results for the nine-month period ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year or for other interim periods.
Tabular information, other than share and per share data, is presented in thousands of dollars.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the unaudited condensed consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Material estimates that are susceptible to significant change in the near term are the valuation of the allowance for loan losses, determination of the need for a deferred tax asset valuation allowance and the fair value of financial instruments and other accounts.
Certain amounts reported in prior periods have been reclassified to conform to the current period presentation.

 

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Table of Contents

PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 2 — Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurement (“ASU No. 2010-06”). ASU No. 2010-06 requires some new disclosures and clarifies some existing disclosure requirements about fair value measurement as set forth in FASB Accounting Standards Codification (“ASC”) Subtopic 820-10. The FASB’s objective is to improve these disclosures and, thus, increase transparency in financial reporting.
Specifically, ASU No. 2010-06 amends Codification Subtopic 820-10 to now require that: (1) a reporting entity disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers; and (2) a reporting entity present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). In addition, ASU No. 2010-06 clarifies the requirements for purposes of reporting fair value measurement for each class of assets and liabilities, and that a reporting entity needs to use judgment in determining the appropriate classes of assets and liabilities and should provide disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements. ASU No. 2010-06 became effective for interim and annual reporting periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements which are effective for fiscal years beginning after December 15, 2010, and for interim periods within those fiscal years. The Company adopted the fair value disclosures guidance on January 1, 2010, except for the gross presentation of the Level 3 rollforward information, which was adopted by the Company on January 1, 2011. The adoption of the gross presentation disclosures did not have an impact on the Company’s financial condition or results of operations.
In July 2010, the FASB issued ASU No. 2010-20, Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses (Topic 310) (“ASU No. 2010-20”). ASU No. 2010-20 required the Company to provide a greater level of disaggregated information about the credit quality of the Company’s loans and the Allowance for Loan Losses (the “Allowance”). ASU No. 2010-20 requires the Company to disclose additional information related to credit quality indicators, past due information, and information related to loans modified in a troubled debt restructuring. The provisions of ASU No. 2010-20 were effective for the Company’s reporting period ending December 31, 2010. As this ASU amends only the disclosure requirements for loans and the Allowance, the adoption had no material impact on the Company’s financial condition or results of operations.
In April 2011, the FASB issued ASU No. 2011-02, A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring (Topic 310) (“ASU No. 2011-02”). ASU No. 2011-02 provides greater clarity and guidance to assist creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The provisions of ASU No. 2011-02 were effective for the Company’s reporting period ending September 30, 2011. The adoption had no material impact on the Company’s financial condition or results of operations.
In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS (“ASU No. 2011-04”). ASU No. 2011-04 results in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. ASU 2011-04 is effective for interim and annual reporting periods beginning after December 15, 2011. Adoption of ASU 2011-04 is not expected to have a significant impact on the Company’s financial statement disclosures.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU No. 2011-05”). ASU No. 2011-05 requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2011, with early adoption permitted. Management is evaluating the impact of this ASU on the Company’s consolidated financial statements.
In September 2011, the FASB issued ASU No 2011-08, Intangibles — Goodwill and Other (Topic 350) (“ASU No. 2011-08”). ASU 2011-08 allows companies to waive comparing the fair value of a reporting unit to its carrying amount in assessing the recoverability of goodwill if, based on qualitative factors, it is not more likely than not that the fair value of a reporting unit is less than its carrying amount. ASU 2011-08 will be effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Management is evaluating the impact of this ASU on the Company’s consolidated financial statements.
Note 3 — Shareholders’ Equity
Common Stock
On May 4, 2010, the Bank’s shareholders approved an amendment to the Articles of Incorporation of the Bank to increase the number of authorized shares of common stock to 200,000,000.
On August 18, 2010, in connection with its public offering of common stock (the “Public Offering”), the Bank consummated the issuance and sale of 23,100,000 shares of Common Stock at $6.50 per share, for a gross aggregate offering price of $150.2 million. The Bank incurred underwriting fees of $6.0 million and related expenses of $0.9 million resulting in net proceeds of $143.2 million being received by the Bank of which $140.2 was recorded in shareholders’ equity. Additional underwriting fees equal to $3.0 million will be payable in the future if the Common Stock price closes at a price equal to or above 125% of the offering price, or $8.125 per share, for a period of 30 consecutive days. A liability for the $3.0 million contingent underwriting fee has been accrued and is included in other liabilities in the accompanying balance sheet at September 30, 2011.
On January 1, 2011, in conjunction with the Company’s acquisition of the Bank in a statutory exchange transaction, the par value of authorized common stock of the Company, which was established in the Company’s Articles of Incorporation at $1.00 per share, replaced the previously reported par value of $4.65 per share of common stock of the Bank. This transaction was given retroactive effect in the financial statements. As such, the par value of the common stock reflected in the consolidated balance sheet as of December 31, 2010 reflects a $102.4 million reclassification from common stock to additional paid-in capital as a result of the Reorganization.
Share-Based Plans
The Company may grant share-based compensation to employees and non-employee directors in the form of stock options, restricted stock or other stock-based awards. Share-based compensation expense is measured based on the fair value of the award at the date of grant and is charged to earnings on a straight-line basis over the requisite service period, which is currently up to seven years. The fair value of stock options is estimated at the date of grant using a Black-Scholes option-pricing model and related assumptions and expensed over each option’s vesting period. The amortization of share-based compensation reflects estimated forfeitures, adjusted for actual forfeiture experience. The fair value of restricted stock awards, subject to share price performance vesting requirements, is estimated using a Monte Carlo simulation and related estimated assumptions for volatility and a risk free interest rate.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company maintains share-based compensation plans for directors and employees. During 2010, the Board of Directors of the Bank adopted and shareholders approved the Park Sterling Bank 2010 Stock Option Plan for Directors and the Park Sterling Bank 2010 Employee Stock Option Plan (the “2010 Plans”). The 2010 Plans are substantially similar to the Bank’s 2006 option plans for directors and employees, which provided for an aggregate of 990,000 of common shares reserved for options. The 2010 Plans provided for an aggregate of 1,859,550 of common shares reserved for options. Upon effectiveness of the Reorganization, the Company assumed all outstanding options under the 2010 plans and the 2006 plans, and the Company’s Common Stock was substituted as the stock issuable upon the exercise of options under these plans. As a result, there will be no further awards granted under the 2010 Plans.
Also during 2010, the Board of Directors of the Company adopted and shareholders approved the Park Sterling Corporation 2010 Long-Term Incentive Plan for directors and employees (the “LTIP”), which was effective upon the Reorganization and replaced the 2010 Plans. The LTIP provides for an aggregate of 1,016,400 of common shares reserved for issuance to employees and directors in connection with stock options, stock appreciation rights and other stock-based awards (including, without limitation, restricted stock awards).
Activity in the Company’s share-based plans is summarized in the following table:
                                                                 
            Outstanding Options     Nonvested Restricted Shares  
    Shares             Weighted     Weighted                     Weighted        
    Available             Average     Average                     Average     Aggregate  
    for Future     Number     Exercise     Contractual     Intrinsic     Number     Grant Date     Intrinsic  
    Grants     Outstanding     Price     Term (Years)     Value     Outstanding     Fair Value     Value  
 
                                                               
At December 31, 2010
    525,918       2,323,632     $ 7.83       8.50     $           $     $  
Replacement of 2010 Plans
    (525,918 )                                          
Approved for issuance
    1,016,400                                            
Options Granted
    (115,840 )     115,840       5.51                                
Restricted Shares Granted
    (568,260 )                             568,260       3.91       1,943,449  
Exercised
                                                 
Expired and forfeited
          (242,908 )     7.21                                
 
                                               
 
                                                               
At September 30, 2011
    332,300       2,196,564     $ 7.77       7.84     $       568,260     $ 3.91     $ 1,943,449  
 
                                               
 
                                                               
Exercisable at September 30, 2011
            1,099,333     $ 9.14       6.68     $                          
The following weighted-average assumptions were used in valuing options issued during the nine months ended September 30, 2011.
Assumptions in Estimating Option Values
         
Weighted-average volatility
    29.38 %
Expected dividend yield
    0 %
Risk-free interest rate
    3.86 %
Expected life
  7 years
Approximately 380,000 options vested during the nine months ended September 30, 2011; no options vested for the nine months ended September 30, 2010. The compensation expense for stock option plans was $319 thousand and $295 thousand for the three months ended September 30, 2011 and 2010, respectively, and $884 thousand and $486 thousand for the nine months ended September 30, 2011 and 2010, respectively. At September 30, 2011, unrecognized compensation cost related to nonvested stock options of $2.4 million is expected to be recognized over a weighted-average period of 1.33 years.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
No shares of restricted stock vested during the nine months ended September 30, 2011. The compensation expense for restricted shares was $160 thousand and $563 thousand for the three and nine months ended September 30, 2011, respectively. At September 30, 2011, unrecognized compensation cost related to nonvested restricted shares of $1.8 million is expected to be recognized over a weighted-average period of 2.98 years. There were no shares of restricted stock outstanding as of September 30, 2010.
Note 4 — Investment Securities
The amortized cost, unrealized gains and losses, and estimated fair value of securities available-for-sale at September 30, 2011 and December 31, 2010 are as follows:
Amortized Cost and Fair Value of Investment Portfolio
                                 
            Gross     Gross        
    Amortized     Unrealized     Unrealized     Fair  
    Cost     Gains     Losses     Value  
 
                               
September 30, 2011
                               
Securities available-for-sale:
                               
U.S. Government agencies
  $ 524     $ 66     $     $ 590  
Residential mortgage-backed securities
    56,598       1,658             58,256  
Collateralized agency mortgage obligations
    53,457       1,397             54,854  
Municipal securities
    15,508       1,059             16,567  
Corporate and other securities
    500             (100 )     400  
 
                       
Total investment securities
  $ 126,587     $ 4,180     $ (100 )   $ 130,667  
 
                       
 
                               
December 31, 2010
                               
Securities available-for-sale:
                               
U.S. Government agencies
  $ 13,075     $ 181     $ (96 )   $ 13,160  
Residential mortgage-backed securities
    52,342       495       (438 )     52,399  
Collateralized agency mortgage obligations
    60,711       111       (2,103 )     58,719  
Municipal securities
    13,771       183       (146 )     13,808  
Corporate and other securities
    2,675       5       (176 )     2,504  
 
                       
Total investment securities
  $ 142,574     $ 975     $ (2,959 )   $ 140,590  
 
                       
The amortized cost and fair values of securities available-for-sale at September 30, 2011 by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. All of the Company’s residential mortgage-backed securities are backed by an agency of the U.S. government. The Company did not own any commercial mortgage-backed securities as of September 30, 2011 or December 31, 2010.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Maturities of Investment Portfolio
                 
    September 30, 2011  
    Amortized     Fair  
    Cost     Value  
 
               
U.S. Government agencies
               
Due after one year through five years
  $ 524     $ 590  
Residential mortgage-backed securities
               
Due after five years through ten years
    1,127       1,161  
Due after ten years
    55,471       57,095  
Collateralized agency mortgage obligations
               
Due after ten years
    53,457       54,854  
Municipal securities
               
Due after ten years
    15,508       16,567  
Corporate and other securities
               
Due after five years through ten years
    500       400  
Due after ten years
           
 
           
Total investment securites
  $ 126,587     $ 130,667  
 
           
Management periodically evaluates each investment security for other than temporary impairment, relying primarily on industry analyst reports, observation of market conditions and interest rate fluctuations. The following table shows gross unrealized losses and fair value, aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position, for investment securities with unrealized losses at September 30, 2011 and December 31, 2010. The unrealized losses relate to debt securities that have incurred fair value reductions due to market volatility and uncertainty since the securities were purchased. Management believes that the unrealized losses are more likely than not to reverse as confidence returns to investment markets. Since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, and it is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost basis, none of the securities are deemed to be other than temporarily impaired. One corporate debt security has been in a continuous loss position for twelve months or more at September 30, 2011. At December 31, 2010, two corporate debt securities were in a continuous loss position for twelve months or more.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Investment Portfolio Gross Unrealized Losses and Fair Value
                                                 
    Less Than 12 Months     12 Months or More     Total  
    Fair     Unrealized     Fair     Unrealized     Fair     Unrealized  
    Value     Losses     Value     Losses     Value     Losses  
 
September 30, 2011
                                               
Securities available-for-sale:
                                               
Corporate and other securities
  $     $     $ 400     $ (100 )   $ 400     $ (100 )
 
                                   
 
                                               
Total temporarily impaired securities
  $     $     $ 400     $ (100 )   $ 400     $ (100 )
 
                                   
 
                                               
December 31, 2010
                                               
Securities available-for-sale:
                                               
U.S. Government agencies
  $ 9,904     $ (96 )   $     $     $ 9,904     $ (96 )
Residential Mortgage-backed securities
    37,052       (438 )                 37,052       (438 )
Collateralized mortgage obligations
    53,232       (2,103 )                 53,232       (2,103 )
Municipal securities
    6,215       (146 )                 6,215       (146 )
Corporate and other securities
                1,475       (176 )     1,475       (176 )
 
                                   
 
                                               
Total temporarily impaired securities
  $ 106,403     $ (2,783 )   $ 1,475     $ (176 )   $ 107,878     $ (2,959 )
 
                                   
Securities with a fair value of $4.1 million and $4.2 million at September 30, 2011 and December 31, 2010, respectively, were pledged to secure an interest rate swap and securities sold under agreements to repurchase. During the nine months ended September 30, 2011, the Company sold $24.3 million of securities available-for-sale, resulting in a gross gain of $0.02 million. Securities available-for-sale with a book value of $2.2 million were sold in the nine months ended September 30, 2010, resulting in a gross gain of $0.02 million.
The aggregate cost of the Company’s cost method investments totaled $2.4 million at September 30, 2011 and $2.3 million at December 31, 2010. Cost method investments at September 30, 2011 included $1.9 million in Federal Home Loan Bank (“FHLB”) stock and $0.5 million of other investments which are included in other assets. Cost method investments at December 31, 2010 included $1.8 million in FHLB stock and $0.5 million of other investments which are included in other assets. All cost method investments were evaluated for impairment as of September 30, 2011 and December 31, 2010. The following factors have been considered in determining the carrying amount of FHLB stock: (1) management’s current belief that the Company has sufficient liquidity to meet all operational needs in the foreseeable future and would not need to dispose of the stock below recorded amounts, (2) management’s belief that the FHLB has the ability to absorb economic losses given the expectation that the FHLB has a high degree of government support and (3) redemptions and purchases of the stock are at the discretion of the FHLB. At September 30, 2011 and December 31, 2010, the Company estimated that the fair values of cost method investments equaled or exceeded the cost of each of these investments, and, therefore, the investments were not impaired.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 5 — Loans and Allowance for Loan Losses
The following is a summary of the loan portfolio at September 30, 2011 and December 31, 2010:
                 
    September 30,     December 31,  
    2011     2010  
Commercial:
               
Commercial and industrial
  $ 44,939     $ 48,401  
Commercial real estate — owner-occupied
    66,979       55,089  
Commercial real estate — investor income producing
    108,558       110,407  
Acquisition, construction and development
    51,522       87,846  
Other commercial
    7,763       3,225  
 
           
Total commercial loans
    279,761       304,968  
 
           
 
               
Consumer:
               
Residential mortgage
    19,816       21,716  
Home equity lines of credit
    56,787       56,968  
Residential construction
    4,787       9,051  
Other loans to individuals
    6,530       7,245  
 
           
Total consumer loans
    87,920       94,980  
 
           
Total loans
    367,681       399,948  
Deferred fees
    (269 )     (119 )
 
           
Total loans, net of deferred fees
  $ 367,412     $ 399,829  
 
           
At September 30, 2011 and December 31, 2010, the carrying value of loans pledged as collateral on FHLB borrowings totaled $56.5 million and $43.8 million, respectively.
Concentrations of Credit - Loans are primarily made in the Charlotte, Research Triangle and Wilmington regions of North Carolina, and the Charleston and Greenville/Spartanburg regions of South Carolina. Real estate loans can be affected by the condition of the local real estate market. Commercial and industrial loans can be affected by the local economic conditions. The commercial loan portfolio has concentrations in business loans secured by real estate and real estate development loans. Primary concentrations in the consumer loan portfolio include home equity lines of credit and residential mortgages. At September 30, 2011 and December 31, 2010, the Company had no loans outstanding with non-U.S. entities.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Allowance for Loan Losses - The following table presents, by portfolio segment, the activity in the allowance for loan losses for the three and nine months ended September 30, 2011. The following table also presents, by portfolio segment, the balance in the allowance for loan losses disaggregated based on the Company’s impairment measurement method and the related recorded investment in loans at September 30, 2011 and December 31, 2010.
                                 
    Commercial     Consumer     Unallocated     Total  
For the three months ended September 30, 2011
                               
Allowance for Loan Losses:
                               
Balance, beginning of period
  $ 8,036     $ 1,378     $ 1,863     $ 11,277  
Provision for loan losses
    104       587       (123 )     568  
Charge-offs
    (2,113 )                 (2,113 )
Recoveries
    86       15             101  
 
                       
Net charge-offs
    (2,027 )     15             (2,012 )
 
                       
Ending balance
  $ 6,113     $ 1,980     $ 1,740     $ 9,833  
 
                       
 
                               
For the nine months ended September 30, 2011
                               
Allowance for Loan Losses:
                               
Balance, beginning of period
  $ 9,165     $ 1,375     $ 1,884     $ 12,424  
Provision for loan losses
    5,947       2,472       (144 )     8,275  
Charge-offs
    (9,894 )     (1,895 )           (11,789 )
Recoveries
    895       28             923  
 
                       
Net charge-offs
    (8,999 )     (1,867 )           (10,866 )
 
                       
Ending balance
  $ 6,113     $ 1,980     $ 1,740     $ 9,833  
 
                       
 
                               
At September 30, 2011
                               
Allowance for Loan Losses:
                               
Individually evaluated for impairment
  $ 375     $ 670     $     $ 1,045  
Collectively evaluated for impairment
    5,738       1,310       1,740       8,788  
 
                       
Total
  $ 6,113     $ 1,980     $ 1,740     $ 9,833  
 
                       
 
                               
Recorded Investment in Loans:
                               
Individually evaluated for impairment
  $ 17,863     $ 1,585     $     $ 19,448  
Collectively evaluated for impairment
    261,898       86,335             348,233  
 
                       
Total
  $ 279,761     $ 87,920     $     $ 367,681  
 
                       
 
                               
At December 31, 2010
                               
Allowance for Loan Losses:
                               
Individually evaluated for impairment
  $ 4,092     $ 115     $     $ 4,207  
Collectively evaluated for impairment
    5,073       1,260       1,884       8,217  
 
                       
Total
  $ 9,165     $ 1,375     $ 1,884     $ 12,424  
 
                       
 
                               
Recorded Investment in Loans:
                               
Individually evaluated for impairment
  $ 37,451     $ 3,460     $     $ 40,911  
Collectively evaluated for impairment
    267,517       91,520             359,037  
 
                       
Total
  $ 304,968     $ 94,980     $     $ 399,948  
 
                       
A summary of the activity in the allowance for loan losses for the three- and nine-month periods ended September 30, 2011 and 2010 follows:
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Balance, beginning of period
  $ 11,277     $ 8,974     $ 12,424     $ 7,402  
Provision for loan losses
    568       6,143       8,275       8,768  
 
                               
Charge-offs
    (2,113 )     (1,986 )     (11,789 )     (3,042 )
Recoveries
    101       19       923       22  
 
                       
Net charge-offs
    (2,012 )     (1,967 )     (10,866 )     (3,020 )
 
                       
 
                               
Balance, end of period
  $ 9,833     $ 13,150     $ 9,833     $ 13,150  
 
                       

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company’s loan loss allowance methodology includes a comprehensive qualitative component. Qualitative reserves represent an estimate of the amount for which it is probable that environmental factors will cause the quantitatively determined loss contingency estimate to differ from historical results or other assumptions. The Company has identified six environmental factors for inclusion in its allowance methodology at this time, aggregating $1.7 million at September 30, 2011 and $1.9 million at December 31, 2010, including (i) portfolio trends, (ii) portfolio concentrations, (iii) economic and market trends, (iv) changes in lending practices, (v) regulatory environment, and (vi) other factors. The first three factors are believed by management to present the most significant risk to the portfolio, and are therefore associated with both higher absolute and range of potential reserve percentages. The reserve percentages for each of the six factors are derived from available portfolio, industry and economic information combined with management judgment. The Company may consider both trends and absolute levels of such factors, if applicable.
The Company evaluates and estimates off-balance sheet credit exposure at the same time it estimates credit losses for loans by a similar process. These estimated credit losses are not recorded as part of the allowance for loan losses, but are recorded to a separate liability account by a charge to income, if material. Loan commitments, unused lines of credit and standby letters of credit make up the off-balance sheet items reviewed for potential credit losses. These estimated credit losses were not material at September 30, 2011 and December 31, 2010.
Credit Quality Indicators - The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicator is an internal credit risk rating system that categorizes loans into pass, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes that comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes that comprise the consumer portfolio segment.
The following are the definitions of the Company’s credit quality indicators:
Pass:   Loans in classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes there is a low likelihood of loss related to those loans that are considered pass.
Special
Mention:
  Loans in classes that comprise the commercial and consumer portfolio segments that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. Management believes there is a moderate likelihood of some loss related to those loans that are considered special mention.
Classified:   Loans in the classes that comprise the commercial portfolio segment that are inadequately protected by the sound worth and paying capacity of the borrower or of the collateral pledged, if any. Management believes that there is a distinct possibility that the Company will sustain some loss if the deficiencies related to classified loans are not corrected in a timely manner.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company’s credit quality indicators are periodically updated on a case-by-case basis. The following tables present the recorded investment in the Company’s loans as of September 30, 2011 and December 31, 2010, by loan class and by credit quality indicator.
                                                 
    As of September 30, 2011  
            Commercial                          
    Commercial     Real Estate     CRE-Investor     Acquisition,              
    and     (CRE)-Owner     Income     Construction     Other     Total  
    Industrial     Occupied     Producing     and Development     Commercial     Commercial  
Pass
  $ 43,244     $ 61,626     $ 96,555     $ 23,541     $ 7,763     $ 232,729  
Special mention
    984       772       4,443       9,807             16,006  
Classified
    711       4,581       7,560       18,174             31,026  
 
                                   
Total
  $ 44,939     $ 66,979     $ 108,558     $ 51,522     $ 7,763     $ 279,761  
 
                                   
                                                 
    Residential     Home Equity     Residential     Other Loans to             Total  
    Mortgage     Lines of Credit     Construction     Individuals             Consumer  
Pass
  $ 17,378     $ 53,633     $ 3,985     $ 6,414             $ 81,410  
Special mention
    2,035       1,269       708                     4,012  
Classified
    403       1,885       94       116               2,498  
 
                                   
Total
  $ 19,816     $ 56,787     $ 4,787     $ 6,530             $ 87,920  
 
                                     
 
                                               
Total Recorded Investment in Loans
                                    $ 367,681  
 
                                             
                                                 
    As of December 31, 2010  
            Commercial                          
    Commercial     Real Estate     CRE-Investor     Acquisition,              
    and     (CRE)-Owner     Income     Construction     Other     Total  
    Industrial     Occupied     Producing     and Development     Commercial     Commercial  
Pass
  $ 46,888     $ 52,746     $ 98,195     $ 37,435     $ 3,225     $ 238,489  
Special mention
    262             9,520       14,289             24,071  
Classified
    1,251       2,343       2,692       36,122             42,408  
 
                                   
Total
  $ 48,401     $ 55,089     $ 110,407     $ 87,846     $ 3,225     $ 304,968  
 
                                   
                                                 
    Residential     Home Equity     Residential     Other Loans to             Total  
    Mortgage     Lines of Credit     Construction     Individuals             Consumer  
Pass
  $ 19,160     $ 53,839     $ 7,951     $ 7,245             $ 88,195  
Special mention
    1,359       1,607                           2,966  
Classified
    1,197       1,522       1,100                     3,819  
 
                                   
Total
  $ 21,716     $ 56,968     $ 9,051     $ 7,245             $ 94,980  
 
                                     
 
                                               
Total Recorded Investment in Loans
                                    $ 399,948  
 
                                             

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Aging Analysis of Accruing and Non-Accruing Loans - The Company considers a loan to be past due or delinquent when the terms of the contractual obligation are not met by the borrower. The following presents by class, an aging analysis of the Company’s accruing and non-accruing loans as of September 30, 2011 and December 31, 2010.
                                         
    30-59     60-89     Past Due              
    Days     Days     90 Days              
    Past Due     Past Due     or More     Current     Total Loans  
As of September 30, 2011
                                       
Commercial:
                                       
Commercial and industrial
  $ 217     $ 5     $     $ 44,717     $ 44,939  
Commercial real estate — owner-occupied
    155                   66,824       66,979  
Commercial real estate — investor income producing
    196             825       107,537       108,558  
Acquisition, construction and development
    587       3,551       4,511       42,873       51,522  
Other commercial
                      7,763       7,763  
 
                             
Total commercial loans
    1,155       3,556       5,336       269,714       279,761  
 
                             
 
                                       
Consumer:
                                       
Residential mortgage
                403       19,413       19,816  
Home equity lines of credit
                      56,787       56,787  
Residential construction
                95       4,692       4,787  
Other loans to individuals
                      6,530       6,530  
 
                             
Total consumer loans
                498       87,422       87,920  
 
                             
Total loans
  $ 1,155     $ 3,556     $ 5,834     $ 357,136     $ 367,681  
 
                             
 
                                       
As of December 31, 2010
                                       
Commercial:
                                       
Commercial and industrial
  $     $ 593     $ 111     $ 47,697     $ 48,401  
Commercial real estate — owner-occupied
    717                   54,372       55,089  
Commercial real estate — investor income producing
                261       110,146       110,407  
Acquisition, construction and development
    4,025       4,188       5,676       73,957       87,846  
Other commercial
                      3,225       3,225  
 
                             
Total commercial loans
    4,742       4,781       6,048       289,397       304,968  
 
                             
 
                                       
Consumer:
                                       
Residential mortgage
                374       21,342       21,716  
Home equity lines of credit
    1,000                   55,968       56,968  
Residential construction
          1,000             8,051       9,051  
Other loans to individuals
                      7,245       7,245  
 
                             
Total consumer loans
    1,000       1,000       374       92,606       94,980  
 
                             
Total loans
  $ 5,742     $ 5,781     $ 6,422     $ 382,003     $ 399,948  
 
                             
Impaired Loans - All classes of loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impaired loans may include all classes of nonaccruing loans and loans modified in a troubled debt restructuring (“TDR”). If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Information for impaired loans, none of which are accruing interest, at and for the three- and nine-month periods ended September 30, 2011 is set forth in the following table:
                                                         
                            Three Months Ended     Nine Months Ended  
                            September 30, 2011     September 30, 2011  
            Unpaid     Related     Average     Interest     Average     Interest  
    Recorded     Principal     Allowance For     Recorded     Income     Recorded     Income  
    Investment     Balance     Loan Losses     Investment     Recognized     Investment     Recognized  
Impaired Loans with No Related Allowance Recorded:
                                                       
Commercial:
                                                       
Commercial and industrial
  $ 229     $ 1,307     $     $ 531     $     $ 683     $  
CRE — owner-occupied
    155       213             23             291        
CRE — investor income producing
    519       746             474             809        
Acquisition, construction and development
    15,406       24,769             18,569             25,407        
Other commercial
                                         
 
                                         
Total commercial loans
    16,309       27,035             19,597             27,190        
 
                                         
Consumer:
                                                       
Residential mortgage
                                  1,160        
Home equity lines of credit
          1,700                         218        
Residential construction
    95       380             95             682        
Other loans to individuals
          10                                
 
                                         
Total consumer loans
    95       2,090             95             2,060        
 
                                         
Total impaired loans with no related allowance recorded
  $ 16,404     $ 29,125     $     $ 19,692     $     $ 29,250     $  
 
                                         
 
                                                       
Impaired Loans with an Allowance Recorded:
                                                       
Commercial:
                                                       
Commercial and industrial
  $ 63     $ 63     $ 63     $     $     $     $  
CRE — owner-occupied
                                         
CRE — investor income producing
    443       460       112       448             464        
Acquisition, construction and development
    1,048       1,080       200       1,065             763        
Other commercial
                                         
 
                                         
Total commercial loans
    1,554       1,603       375       1,513             1,227        
 
                                         
Consumer:
                                                       
Residential mortgage
    403       407       10       404             182        
Home equity lines of credit
    1,087       1,089       660       368             124        
Residential construction
                                         
Other loans to individuals
                                         
 
                                         
Total consumer loans
    1,490       1,496       670       772             306        
 
                                         
Total impaired loans with an allowance recorded
  $ 3,044     $ 3,099     $ 1,045     $ 2,285     $     $ 1,533     $  
 
                                         
 
                                                       
Impaired Loans:
                                                       
Commercial
  $ 17,863     $ 28,638     $ 375     $ 21,110     $     $ 28,417     $  
Consumer
    1,585       3,586       670       867             2,366        
 
                                         
Total impaired loans
  $ 19,448     $ 32,224     $ 1,045     $ 21,977     $     $ 30,783     $  
 
                                         

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Information for impaired loans, none of which are accruing interest, at and for the year ended December 31, 2010 is set forth in the following table:
                                         
            Unpaid     Related     Average     Interest  
    Recorded     Principal     Allowance For     Recorded     Income  
    Investment     Balance     Loan Losses     Investment     Recognized  
Impaired Loans with No Related Allowance Recorded:
                                       
Commercial:
                                       
Commercial and industrial
  $ 722     $ 913     $     $ 69     $  
CRE — owner-occupied
                             
CRE — investor income producing
    583       841             15        
Acquisition, construction and development
    19,054       25,909             3,753        
Other commercial
                             
 
                             
Total commercial loans
    20,359       27,663             3,837        
 
                             
Consumer:
                                       
Residential mortgage
    1,197       1,255             111        
Home equity lines of credit
    164       165             3        
Residential construction
    1,100       2,174             27        
Other loans to individuals
                               
 
                             
Total consumer loans
    2,461       3,594             141        
 
                             
Total impaired loans with no related allowance recorded
  $ 22,820     $ 31,257     $     $ 3,978     $  
 
                             
 
                                       
Impaired Loans with an Allowance Recorded:
                                       
Commercial:
                                       
Commercial and industrial
  $ 437     $ 437     $ 280     $ 2     $  
CRE — owner-occupied
    717       741       136       393        
CRE — investor income producing
    1,119       1,209       277       404        
Acquisition, construction and development
    14,818       14,828       3,399       328        
Other commercial
                               
 
                             
Total commercial loans
    17,091       17,215       4,092       1,127        
 
                             
Consumer:
                                       
Residential mortgage
                             
Home equity lines of credit
    1,000       1,000       115       22        
Residential construction
                             
Other loans to individuals
                             
 
                             
Total consumer loans
    1,000       1,000       115       22        
 
                             
Total impaired loans with an allowance recorded
  $ 18,091     $ 18,215     $ 4,207     $ 1,149     $  
 
                             
 
                                       
Impaired Loans:
                                       
Commercial
  $ 37,450     $ 44,878     $ 4,092     $ 4,964     $  
Consumer
    3,461       4,594       115       163        
 
                             
Total impaired loans
  $ 40,911     $ 49,472     $ 4,207     $ 5,127     $  
 
                             
During the three and nine months ended September 30, 2011 and 2010, the Company did not recognize any interest income, including interest income recognized on a cash basis, within the period that loans were impaired.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Nonaccrual and Past Due Loans - It is the general policy of the Company to stop accruing interest income when a loan is placed on nonaccrual status and any interest previously accrued but not collected is reversed against current income. Generally, a loan is placed on nonaccrual status when there is probable loss or when there is reasonable doubt that all principal will be collected, or when it is over 90 days past due. At September 30, 2011 and December 31, 2010, there were no loans 90 days or more past due and accruing interest. The recorded investment in nonaccrual loans at September 30, 2011 and December 31, 2010 follows:
                 
    September 30,     December 31,  
    2011     2010  
Commercial:
               
Commercial and industrial
  $ 292     $ 1,159  
CRE — owner-occupied
    155       717  
CRE — investor income producing
    962       1,702  
Acquisition, construction and development
    16,454       33,872  
Other commercial
           
 
           
Total commercial loans
    17,863       37,450  
 
           
Consumer:
               
Residential mortgage
    403       1,197  
Home equity lines of credit
    1,087       1,164  
Residential construction
    95       1,100  
Other loans to individuals
           
 
           
Total consumer loans
    1,585       3,461  
 
           
Total nonaccrual loans
  $ 19,448     $ 40,911  
 
           
Approximately 53.6% and 56.1% of nonaccrual loans were current at September 30, 2011 and December 31, 2010, respectively.
Troubled Debt Restructuring - In situations where, for economic or legal reasons related to a borrower’s financial difficulties, management may grant a concession for other than an insignificant period of time to the borrower that would not otherwise be considered, the related loan is classified as a TDR. Management strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms. These modified terms may include rate reductions, principal forgiveness, payment forbearance and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. All loan modifications are made on a case-by-case basis.
As of September 30, 2011, the Company had 13 TDR loans totaling $10.0 million of which $8.0 million are nonaccrual loans. All of the nonaccrual TDR loans are in the acquisition, construction and development portfolio and the $2.0 million of accruing TDR loans are in the residential mortgage portfolio. There was no specific allowance for these loans as of September 30, 2011. Nonaccrual loans at December 31, 2010 include $24.9 million of TDR loans of which $23.7 million is in the acquisition, construction and development portfolio. The December 31, 2010 recorded allowance for these loans was $2.4 million.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
For the three and nine months ended September 30, 2011, the following table presents a breakdown of the types of concessions made by loan class:
                                                 
    Three months ended     Nine months ended  
    September 30, 2011     September 30, 2011  
            Pre-Modification     Post-Modification             Pre-Modification     Post-Modification  
            Outstanding     Outstanding             Outstanding     Outstanding  
    Number of     Recorded     Recorded     Number of     Recorded     Recorded  
    loans     Investment     Investment     loans     Investment     Investment  
Below market interest rate
                                               
Acquisition, construction and development
        $     $       2     $ 3,120     $ 689  
 
                                   
 
                      2       3,120       689  
 
                                   
 
                                               
Forgiveness of principal
                                               
CRE — investor income producing
                      1       208        
Acquisition, construction and development
                      7       3,578       200  
Residential mortgage
                      2       722       38  
 
                                   
 
                      10       4,508       238  
 
                                   
 
                                               
Total
        $     $       12     $ 7,628     $ 927  
 
                                   
The following table presents loans that were modified as TDRs within the 12 months ended September 30, 2011 and for which there was a payment default during the three and nine months ended September 30, 2011.
                                 
    Three months ended     Nine months ended  
    September 30, 2011     September 30, 2011  
    Number of             Number of        
    loans     Recorded Investment     loans     Recorded Investment  
Below market interest rate
                               
Acquisition, construction and development
        $       4     $ 634  
 
                       
 
                4       634  
 
                       
 
                               
Forgiveness of principal
                               
Commercial real estate — owner-occupied
                1        
Acquisition, construction and development
                6        
Residential mortgage
                1        
 
                       
 
                8        
 
                       
 
                               
Total
        $       12     $ 634  
 
                       

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company does not deem a TDR to be successful until it has been re-established as an accruing loan. Therefore, all TDRs are disclosed as nonaccrual in the table below. The following table presents the successes and failures of the types of modifications within the previous 12 months as of September 30, 2011:
                                                 
    Paying as restructured     Nonaccrual     Foreclosure/Default  
    Number of     Recorded     Number of     Recorded     Number of     Recorded  
    loans     Investment     loans     Investment     loans     Investment  
 
                                               
Below market interest rate
    1     $ 803       4     $ 1,323       2     $  
Forgiveness of principal
                2       238       8        
 
                                   
Total
    1     $ 803       6     $ 1,561       10     $  
 
                                   
There were no loans identified as a result of adopting ASU 2011-02, that were previously measured under a general allowance for loan loss methodology.
Related Party Loans - From time to time, the Company engages in loan transactions with its directors, executive officers and their related interests (collectively referred to as “related parties”). Such loans are made in the ordinary course of business and on substantially the same terms and collateral as those for comparable transactions prevailing at the time and do not involve more than the normal risk of collectability or present other unfavorable features. A summary of activity in loans to related parties is as follows:
         
    Nine Months Ended  
    September 30,  
    2011  
 
       
Beginning balance
  $ 5,075  
Disbursements
    574  
Repayments
    (1,317 )
 
     
Ending balance
  $ 4,332  
 
     
At September 30, 2011 and December 31, 2010, the Company had pre-approved but unused lines of credit totaling $3.5 million to related parties.
Note 6 — Income Taxes
Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of deferred tax assets (DTAs) and liabilities for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. In general, the Company records a DTA when the event giving rise to the tax benefit has been recognized in the consolidated financial statements.
As of September 30, 2011 and December 31, 2010, the Company had a DTA in the amount of approximately $10.9 million and $7.4 million, respectively. The Company evaluates the carrying amount of its DTA on a quarterly basis in accordance with the guidance provided in FASB ASC Topic 740 (“ASC 740”), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon the Company generating a sufficient level of taxable income in future periods, which can be difficult to predict. If the Company’s forecast of taxable income within the carryforward periods available under applicable law is not sufficient to cover the amount of net deferred assets, such assets may be impaired. Based on the weight of available evidence, the Company has determined, as of September 30, 2011 and December 31, 2010, that it is more likely than not that it will be able to fully realize the existing DTA and therefore considers it appropriate not to establish a DTA valuation allowance at either September 30, 2011 or December 31, 2010.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company considers all available evidence, positive and negative, to determine whether a DTA allowance is appropriate. In conducting the DTA analysis, the Company believes it is essential to differentiate between the unique characteristics of each industry or business. In particular, characteristics such as business model, level of capital and reserves held by financial institutions and their ability to absorb potential losses are important distinctions to be considered for bank holding companies like the Company.
Negative Evidence. Park Sterling considered the following five areas of potential negative evidence identified in ASC 740 as part of its DTA analysis:
  1.   Rolling twelve-quarter cumulative loss.
The Company commenced operations in late 2006, attained profitability in the third quarter of 2008 and remained profitable through the second quarter of 2010 before its business was materially impacted by the recent significant economic downturn. As a result, the Company moved into a rolling twelve-quarter cumulative pre-tax loss position during the third quarter of 2010. ASC 740 states that a cumulative loss in recent years is a significant piece of negative evidence that is difficult to overcome. However, the Company evaluates the circumstances behind those losses and considers them in the context of the current economic environment and the significant changes it has made over the past year to address the circumstances underlying the losses.
As of September 30, 2011, the Company’s cumulative pre-tax loss position was $23.4 million and was driven, in large part, by rolling twelve-quarter cumulative provision expenses of $29.2 million. This high level of provision expense reflects the negative impact on the Company’s loan portfolio from the effects of the extended economic downturn. The risk of loan loss is inherent to the banking industry. The Company considered the special circumstances of the economic environment of the last few years, which led to these high historical provision levels and currently believes they are unlikely to be repeated going forward, given changes in the Company’s lending practices, business strategy, risk tolerance, capital levels and operating practices.
Based on current internal loss data analysis, approximately 80% of the Company’s rolling twelve-quarter cumulative provision expense of $29.5 million is associated with construction & development (“C&D”) lending (which was impacted the most by the economic downturn), of which at least 70% is related to residential-oriented exposures. Prior to the Public Offering in August 2010, the Company had allowed an excessive concentration to build in C&D exposures, which peaked at $159 million, or 43% of total loans, in the fourth quarter of 2008. Shortly prior to the Public Offering in the second quarter of 2010, C&D exposures were $124 million, or 31% of total loans. Following the Public Offering, Park Sterling reconstituted its executive management team with significant new hires, immediately curtailed originating new residential C&D exposures and significantly tightened standards for all other types of C&D lending. These changes reflect both the Company’s new business strategies and risk tolerance, which include building a more diversified loan portfolio both by geography and product type. As of September 30, 2011, C&D exposures had been reduced to $56.3 million, or 15% of total loans.
The Company has also significantly strengthened its lending practices since the Public Offering including the additions of a new chief risk officer, chief credit officer, head of special assets, manager of credit underwriting and additional credit underwriters. The Company currently believes it has remediated many of the circumstances that led to the rolling twelve-quarter cumulative pre-tax loss position and does not expect these losses to continue in the future.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
  2.   History of operating loss or tax credit carryforwards expiring unused.
 
      The Company has no history of operating loss or tax carryforwards expiring unused.
  3.   Losses expected in early future years.
 
      The Company currently expects to be profitable in early future years, as described in detail below.
  4.   Unsettled circumstances that would adversely affect future operations and profit levels.
The Company is not currently aware of any unsettled circumstances that, if unfavorably resolved, would adversely affect future operations and profit levels on a continuing basis in future years.
  5.   Carryback or carryforward period that is so brief it would limit realization of tax benefits.
The earliest expiration date for the Company’s net operating loss carryforwards is December 31, 2030, leaving over nineteen years for recognition.
Positive Evidence. The Company considered the following sources of future taxable income identified in ASC 740 as positive evidence to weigh against the negative evidence described above.
  1.   Future reversals of existing taxable temporary differences and carryforwards.
The Company’s largest future reversal relates to its allowance for loan losses, which totaled $9.8 million as of September 30, 2011. Current tax, accounting and regulatory treatment of the allowance generally results in substantial taxable temporary differences for financial institutions engaged in lending activities. The following is a brief description of the Company’s current expectations regarding recognition or reversal of the major components of the allowance:
    Specific reserves, which totaled $1.0 million at September 30, 2011, relate to identified impairments and are based on individual loan-collectability analyses. The Company currently estimates that specific reserves will generally reverse within two quarters of establishment, and currently believes these reserves are very unlikely to remain unaddressed after three quarters of establishment. To be conservative, specific reserves are currently assumed to reverse within one year.
    Quantitative reserves, which totaled $7.0 million at September 30, 2011, are based on model-driven estimates of inherent loss content in the performing loan portfolio. The Company currently estimates that the average life of the underlying loan pool is approximately three years and quantitative reserves are currently assumed to reverse within approximately three years.
    Qualitative reserves, which totaled $1.7 million at September 30, 2011, are based on framework-driven estimates of inherent loss content in the performing loan portfolio not captured by the quantitative reserves identified above. The Company currently estimates that the average life of the underlying loan pool is approximately three years and qualitative reserves are currently assumed to reverse within approximately three years.
Given these assumptions, the Company currently expects the full allowance-driven component of its DTA to reverse within approximately three years, meaning either (i) the Company will generate sufficient taxable income to fully utilize these reversals through reduced tax payments or (ii) these reversals will shift to net operating loss carryforwards with an expected 20-year life, which would be utilized as the Company generates sufficient taxable income over that period.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
  2.   Future taxable income, exclusive of reversing temporary differences and carryforwards.
Projecting future taxable income requires estimates and judgments about future events that may be predictable, but that are less certain than past events that can be objectively measured. In projecting future taxable income, the Company considered the significant change in its strategy that occurred in mid-2010, from previously growing organically at a moderate pace to creating a regional bank across Virginia and the Carolinas through a combination of mergers and acquisitions and accelerated organic growth. This transition was facilitated by the completion of its $150.2 million Public Offering in August 2010 and the addition of new executive management and additional independent board members. The Company is focused on long-term results and has taken actions to achieve this objective, including:
    Addressing legacy problem assets, particularly C&D-related exposures, to move more rapidly through the cycle;
    Consummating the merger with Community Capital to expand its market into South Carolina and to enter into new business lines, such as wealth management;
    Hiring experienced bankers and opening de novo offices in three new markets (Charleston, South Carolina, the Upstate region of South Carolina and the Research Triangle region of North Carolina);
    Hiring bankers to begin a new asset-based lending line of business; and
    Significantly strengthening the leadership team with the addition of a new chief credit officer, head of special assets, head of managerial reporting, chief accounting officer and other positions.
The progress already made indicates that the new strategy is well on track to achieve its intended objectives. Management presents, generally on a monthly basis, a financial forecast to the board of directors that incorporates current assumptions and timelines regarding the Company’s baseline activities, including assumptions regarding loan and deposit growth. These assumptions and timelines are periodically evaluated both in terms of their historical trends and absolute levels. Prior to the consummation of the merger with Community Capital, the forecast was presented on both a stand-alone Company and combined Company-and-Community-Capital basis, including adjustments for certain merger related items. Under each scenario, the Company currently expects its pre-tax profitability to build to levels sufficient to fully absorb the existing DTA over approximately three years.
  3.   Tax-planning strategies that could, if necessary, be implemented.
As provided by ASC 740, the Company considers certain prudent and feasible tax-planning strategies that, if implemented, could prevent an operating loss or tax credit carryforward from expiring unused and could result in realization of the existing DTA. These strategies include increasing assets by leveraging existing capital held in excess of regulatory requirements and redeployment of existing assets into either higher yielding or taxable instruments. The Company currently expects that these tax-planning strategies could generate pre-tax profitability at levels sufficient to fully absorb the existing DTA over approximately three years. The Company has no present intention to implement such strategies.
Based on the weight of available evidence, the Company has determined that it is more likely than not that it will be able to fully realize the existing DTA. Specifically, the negative evidence is tempered by the unusual and temporary circumstances created by the recent significant economic downturn and significant changes in the Company’s lending practices, management, capital levels, growth strategy, risk tolerance, and operating practices. The implementation of such changes has already led to improved asset quality measures since the fourth quarter of 2010. Further, the positive evidence currently indicates that the Company has opportunities through various means to generate income at a sufficient enough level to fully absorb the DTA within approximately three years, which is well within the life of the existing DTA, portions of which expire at the earliest in 2030.
Management, in conjunction with the board of directors, will continue to evaluate the carrying value of the Company’s DTA on a quarterly basis, in accordance with ASC 740, and will determine any need for a valuation allowance based upon circumstances and expectations then in existence.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 7 — Per Share Results
Basic and diluted net loss per common share are computed based on the weighted-average number of shares outstanding during each period. Diluted net loss per common share reflect the potential dilution that could occur if all dilutive stock options were exercised and all restricted shares were vested.
Basic and diluted net loss per common share have been computed based upon net loss as presented in the accompanying consolidated statements of loss divided by the weighted-average number of common shares outstanding or assumed to be outstanding as summarized below:
Weighted-Average Shares for Earnings Per Share Calculation
                                 
    Three Months Ended     Nine Months Ended  
    September 30     September 30  
    2011     2010     2011     2010  
 
                               
Weighted-average number of common shares outstanding
    28,051,098       4,951,098       28,051,098       4,951,098  
 
                               
Effect of dilutive stock options and restricted shares
                       
 
                       
 
                               
Weighted-average number of common shares and dilutive potential common shares outstanding
    28,051,098       4,951,098       28,051,098       4,951,098  
 
                       
There were 2,196,564 outstanding stock options that were anti-dilutive for each of the three- and nine-month periods ended September 30, 2011. For the three- and nine-month periods ended September 30, 2010, 2,097,252 outstanding stock options were anti-dilutive. In all periods, the anti-dilution was due to the net loss for the periods and all such options were omitted from the calculation of diluted earnings per share for their respective periods.
There were 568,260 outstanding restricted shares that were anti-dilutive for each of the three- and nine-month periods ended September 30, 2011, due to the vesting price exceeding the average market price for the period, and were omitted from the calculation. One third of the restricted shares will vest when the Company’s share price meets or exceeds each of $8.125, $9.10 and $10.40 for 30 consecutive trading days.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 8 — Total Comprehensive Income (Loss)
The components of comprehensive income (loss) and related tax effects during the three- and nine-month periods ended September 30, 2011 and 2010 are as follows:
Comprehensive Income (Loss)
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
Net income (loss)
    (1,376 )     (3,668 )     (7,377 )     (3,339 )
 
                               
Unrealized holding gains on available-for-sale securities
  $ 3,141     $ 683     $ 6,084     $ 1,465  
Tax effect
    (1,210 )     (264 )     (2,344 )     (565 )
Reclassification of gain recognized in net income
                (20 )     (19 )
Tax effect
                8       7  
 
                       
 
    1,931       419       3,728       888  
 
                       
 
                               
Unrealized holding loss on swaps
          (164 )     (458 )     (453 )
Tax effect
          63       176       (41 )
 
                       
 
          (101 )     (282 )     (494 )
 
                       
 
                               
Total comprehensive income (loss)
  $ 555     $ (3,350 )   $ (3,931 )   $ (2,945 )
 
                       
Note 9 — Derivative Financial Instruments and Hedging Activities
During May 2008, the Company entered into an interest rate swap agreement with a notional amount of $40.0 million that matured on May 16, 2011. The derivative instrument was used to protect certain designated variable rate loans from the downward effects of their repricing in the event of a decreasing rate environment. It had been accounted for as a cash flow hedge and the Company recognized no additional gain as a result of this maturity. The fair market value of this swap at December 31, 2010 was $0.5 million. Changes in fair value of the swap that are deemed effective are recorded in other comprehensive income net of tax. Changes in fair value for the ineffective portion of the swap are recorded in interest income; such amounts were insignificant for each of the three and nine months ended September 30, 2010. Due to the maturity of the swap agreement, there was no interest income recorded in the three months ended September 30, 2011. The Company recorded interest income on the swap of $0.4 million in the nine months ended September 30, 2011, and $0.3 million and $0.9 million in each of the three and nine months ended September 30, 2010, respectively.
At September 30, 2011, the Company had seven loan swaps, including one forward-starting swap. The fair value mark on that swap, which was $(0.2) million as of September 30, 2011, will be offset when the associated loan closes and is marked to fair value in the fourth quarter of 2011. The total original notional amount of these loan swaps was $17.4 million. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans and are accounted for as fair value hedges. The derivative instruments are used to convert these fixed rate loans to an effective floating rate. If the LIBOR rate is below the stated fixed rate of the loan for a given period, the Company will owe the floating rate payer the notional amount times the difference between LIBOR and the stated fixed rate. If LIBOR is above the stated rate for any given period during the term of the contract, the Company will receive payments based on the notional amount times the difference between LIBOR and the stated fixed rate. These derivative instruments are carried at a fair market value of $(0.7) and $(0.5) million and are included in loans at September 30, 2011 and December 31, 2010, respectively. The loans being hedged are also recorded at fair value. The Company recorded interest expense on these loan swaps of $0.2 million and $0.4 million in each of the three and nine months ended September 30, 2011, respectively, and $0.1 million and $0.3 million in each of the three and nine months ended September 30, 2010, respectively.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The table below presents information regarding the individual loan swaps at September 30, 2011:
Individual Loan Swap Information
                                         
                                    Floating  
Original     Current                         Rate  
Notional     Notional     Termination   Fixed     Floating     Payer  
Amount     Amount     Date   Rate     Rate     Spread  
$ 2,670     $ 2,406    
04/10/13
    5.85 %   USD-LIBOR-BBA     2.38 %
  1,800       430    
04/09/13
    5.80 %   USD-LIBOR-BBA     2.33 %
  1,100       993    
03/10/13
    6.04 %   USD-LIBOR-BBA     2.27 %
  3,775       3,512    
02/15/13
    5.90 %   USD-LIBOR-BBA     2.20 %
  1,870       1,561    
02/15/13
    5.85 %   USD-LIBOR-BBA     2.25 %
  2,555       2,555    
10/10/15
    5.50 %   USD-LIBOR-BBA     2.88 %
  3,595       3,541    
04/27/17
    5.25 %   USD-LIBOR-BBA     2.73 %
           
 
                       
$ 17,365     $ 14,998    
 
                       
           
 
                       
Note 10 — Fair Value Measurements
The Company is required to disclose the estimated fair value of financial instruments, both assets and liabilities on and off the balance sheet, for which it is practicable to estimate fair value. These fair value estimates are made at each balance sheet date, based on relevant market information and information about the financial instruments. Fair value estimates are intended to represent the price at which an asset could be sold or the price for which a liability could be settled in an orderly transaction between market participants at the measurement date. However, given there is no active market or observable market transactions for many of the Company’s financial instruments, the Company has made estimates of many of these fair values which are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimated values. The methodologies used for estimating the fair value of financial assets and financial liabilities are discussed below:
      Cash and Cash Equivalents
      The carrying amounts of cash and short-term instruments including due from banks and Federal funds sold approximate their fair value.
Investment Securities
      Fair value for investment securities is based on the quoted market price if such information is available. If a quoted market price is not available, fair values are based on quoted market prices of comparable instruments.
      Loan Held for Sale
      The fair value of loans held for sale is determined, when possible, using quoted secondary market prices. If no such quoted prices exist, the fair value of the loan is determined using quoted prices for a similar loan or loans, adjusted for the specific attributes of the loan.
      FHLB Stock
      The Bank, as a member of the FHLB, is required to maintain an investment in FHLB capital stock and the carrying amount is estimated to be fair value.
Loans, net of allowance
      For certain homogenous categories of loans, such as residential mortgages, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Further adjustments are made to reflect current market conditions. There is no discount for liquidity included in the expected cash flow assumptions.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Accrued Interest Receivable
      The carrying amount is a reasonable estimate of fair value.
Deposits
      The fair value of deposits that have no stated maturities, including demand deposits, savings, money market and NOW accounts, is the amount payable on demand at the reporting date. The fair value of deposits that have stated maturity dates, primarily time deposits, is estimated by discounting expected cash flows using the rates currently offered for instruments of similar remaining maturities.
Borrowings
      The fair values of short-term and long-term borrowings are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements.
Accrued Interest Payable
      The carrying amount is a reasonable estimate of fair value.
Derivative Instruments
      Derivative instruments, including interest rate swaps and swap fair value hedges, are recorded at fair value on a recurring basis. Fair value measurement is based on discounted cash flow models. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.
Financial Instruments with Off-Balance Sheet Risk
      With regard to financial instruments with off-balance sheet risk discussed in Note K of the 2010 Audited Financial Statements, it is not practicable to estimate the fair value of future financing commitments.
The carrying amounts and estimated fair values of the Company’s financial instruments, none of which are held for trading purposes, at September 30, 2011 and December 31, 2010 are as follows:
Financial Instruments Carrying Amounts and Estimated Fair Values
                                 
    September 30, 2011     December 31, 2010  
    Carrying     Estimated     Carrying     Estimated  
    Amount     Fair Value     Amount     Fair Value  
Financial assets:
                               
Cash and cash equivalents
  $ 56,568     $ 56,568     $ 65,378     $ 65,378  
Investment securities
    130,667       130,667       140,590       140,590  
Loans held for sale
    1,559       1,559              
Loans, net of allowance
    357,579       352,979       387,405       382,854  
FHLB stock
    1,866       1,866       1,757       1,757  
Interest rate swap
                459       459  
Accrued interest receivable
    1,441       1,441       1,640       1,640  
Bank owned life insurance
    8,052       8,052              
 
                               
Financial liabilities:
                               
Deposits with no stated maturity
  $ 162,907     $ 162,907     $ 107,999     $ 107,999  
Deposits with stated maturities
    212,085       212,878       299,821       300,393  
Swap fair value hedge
    738       738       569       569  
Borrowings
    27,978       27,382       27,769       26,913  
Accrued interest payable
    109       109       290       290  

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
The Company utilizes fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. Securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value on a nonrecurring basis. These nonrecurring fair value adjustments typically involve application of lower of cost or market accounting or write-downs of individual assets.
The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
  Level 1     Valuation is based upon quoted prices for identical instruments traded in active markets.
  Level 2     Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
  Level 3    Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques may include the use of option pricing models, discounted cash flow models and similar techniques.
The following is a description of valuation methodologies used for assets and liabilities recorded at fair value:
      Investment Securities Available-for-Sale
      Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include mortgage-backed securities issued by government-sponsored entities, municipal bonds and corporate debt securities that are valued using quoted prices for similar instruments in active markets. Securities classified as Level 3 include a corporate debt security in a less liquid market whose value is determined by reference to the going rate of a similar debt security if it were to enter the market at period end. The derived market value requires significant management judgment and is further substantiated by discounted cash flow methodologies.
      Derivative Instruments
      Derivative instruments held or issued by the Company for risk management purposes are traded in over-the-counter markets where quoted market prices are not readily available. For those derivatives, the Company uses a third party to measure the fair value. The Company classifies derivatives instruments held or issued for risk management purposes as Level 2. As of September 30, 2011 and December 31, 2010, the Company’s derivative instruments consist of interest rate swaps and swap fair value hedges.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
      Loans
      Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures it for the estimated impairment. The fair value of impaired loans is estimated using one of several methods, including collateral value, a loan’s observable market price and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value exceeds the recorded investments in such loans. Impaired loans where a specific allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value for identical collateral, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available for identical collateral or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price for the collateral, the Company records the impaired loan as nonrecurring Level 3.
      At September 30, 2011 and December 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the collateral. The Company recorded the six loans involved in fair value hedges at fair market value on a recurring basis. The Company does not record other loans at fair value on a recurring basis.
Loans held for sale
      Loans held for sale are adjusted to fair value upon transfer from the loan portfolio to loans held for sale. Subsequently, loans held for sale are carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral, management’s estimation of the value of the collateral or commitments on hand from investors within the secondary market for loans with similar characteristics. The fair value adjustments for loans held for sale are recorded as nonrecurring Level 2.
Other real estate owned
      Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value for identical collateral, the Company records the foreclosed asset as nonrecurring Level 3. When an appraised value is not available for identical collateral or management determines the fair value of the collateral is further impaired below the appraised value and there is not an observable market price for the collateral, the Company records the OREO as nonrecurring Level 3.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The table below presents, by level, the recorded amount of assets and liabilities at September 30, 2011 and December 31, 2010 measured at fair value on a recurring basis:
Fair Value on a Recurring Basis
                                 
    Quoted Prices in     Significant              
    Active Markets for     Other     Significant        
    Identical Assets     Observable Inputs     Unobservable Inputs     Assets/(Liabilities)  
Description   (Level 1)     (Level 2)     (Level 3)     at Fair Value  
 
                               
September 30, 2011
                               
U.S. Government agencies
  $     $ 590     $     $ 590  
Residential mortgage-backed securities
          58,256             58,256  
Collateralized agency mortgage obligations
          54,854             54,854  
Municipal securities
          16,567             16,567  
Debt Securities
                400       400  
Loans held for sale
          1,559             1,559  
Fair value loans
          13,181             13,181  
Swap fair value hedge
          (738 )           (738 )
 
                               
December 31, 2010
                               
U.S. Government agencies
  $     $ 13,160     $     $ 13,160  
Residential mortgage-backed securities
          52,399             52,399  
Collateralized agency mortgage obligations
          58,719             58,719  
Municipal securities
          13,808             13,808  
Debt Securities
                350       350  
Corporate and other Securities
          2,154             2,154  
Interest rate swap
          459             459  
Fair value loans
          9,702             9,702  
Swap fair value hedge
          (569 )             (569 )
There were no transfers between valuation levels during the three or nine months ended September 30, 2011 or September 30, 2010.
The following are reconciliations of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the three and nine months ended September 30, 2011 and September 30, 2010.
Level 3 Assets Reconciliation
                                 
    Three Months Ended     Nine Months Ended  
    September 30,     September 30,  
    2011     2010     2011     2010  
 
                               
Debt Securities:
                               
Balance, beginning of period
  $ 400     $ 408     $ 350     $ 400  
(Increase) decrease in unrealized loss
          (13 )     50       (5 )
 
                       
Balance, end of period
  $ 400     $ 395     $ 400     $ 395  
 
                       

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Assets Recorded at Fair Value on a Nonrecurring Basis
Upon further review of the classification of assets recorded at fair value on a nonrecurring basis within the fair value hierarchy, the Company determined that OREO that was previously classified as Level 2 assets given that estimated fair value was based on current appraisals should be considered Level 3 assets rather than Level 2 assets. Therefore, $5.7 million in OREO has been reclassified from Level 2 to Level 3 as of September 30, 2011 and $1.2 million in OREO from Level 2 to Level 3 as of December 31, 2010. The table below presents, by level, the recorded amounts of assets at September 30, 2011 and December 31, 2010 measured at fair value on a nonrecurring basis:
Fair Value on a Nonrecurring Basis
                                 
    Quoted Prices                    
    in Active     Significant              
    Markets for     Other     Significant        
    Identical     Observable     Unobservable     Assets/  
    Assets     Inputs     Inputs     (Liabilities)  
Description   (Level 1)     (Level 2)     (Level 3)     at Fair Value  
 
                               
September 30, 2011
                               
OREO
  $     $     $ 5,691     $ 5,691  
Impaired loans:
                               
CRE — investor income producing
                331       331  
Acquisition, construction and development
                848       848  
Residential mortgage
                393       393  
Home equity lines of credit
                427       427  
 
                               
December 31, 2010
                               
OREO
  $     $     $ 1,246     $ 1,246  
Impaired loans:
                               
Commercial and industrial
                157       157  
CRE — owner-occupied
                581       581  
CRE — investor income producing
                842       842  
Acquisition, construction and development
                11,419       11,419  
Home equity lines of credit
                885       885  
The carrying value of OREO is periodically reviewed and written down to fair value and any loss is included in earnings. During the nine months ended September 30, 2011, OREO with a carrying value of $1.4 million was written down by $0.4 million to $1.0 million. There were no write downs of OREO during the nine months ended September 30, 2010.
There were no transfers between valuation levels for any accounts for the three and nine months ended September 30, 2011 and September 30, 2010. If different valuation techniques are deemed necessary, the Company would consider those transfers to occur at the end of the period that the accounts are valued.

 

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PARK STERLING CORPORATION
Notes to Condensed Consolidated Financial Statements (Unaudited)
Note 11 — Commitments and Contingencies
In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the accompanying unaudited condensed consolidated financial statements. At September 30, 2011, the Company had $31.8 million of loan commitments outstanding, $69.1 million of pre-approved but unused lines of credit and $3.7 million of standby letters of credit and financial guarantees. At December 31, 2010, the Company had $3.8 million of loan commitments outstanding, $69.6 million of pre-approved but unused lines of credit and $2.9 million of standby letters of credit and financial guarantees. In management’s opinion, these commitments represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity.
As of September 30, 2011 and December 31, 2010, the Company has a commitment to fund $0.6 million related to an agreement with the Small Business Investment Corporation.
Note 12 — Subsequent Event
Business Combinations
On November 1, 2011, the Company acquired 100% of the common stock outstanding of Community Capital. Community Capital, based in Greenwood, South Carolina, was the bank holding company of CapitalBank, which is located throughout the Upstate and central region of South Carolina.
Under the terms of the merger agreement, Community Capital shareholders could elect to receive either $3.30 in cash or 0.6667 of a share of Common Stock for each share of Community Capital they owned immediately prior to the merger, subject to the limitation that the total consideration would consist of 40.0% in cash and 60.0% in Common Stock. This share consideration resulted in the issuance of 4,024,269 shares of Common Stock. The final transaction value was $28.8 million based on the $3.85 per share closing price of the Common Stock on October 31, 2011.
The Community Capital acquisition will be accounted for under the acquisition method of accounting with the Company treated as the acquirer. Under the acquisition method of accounting, the assets and liabilities of Community Capital, as of November 1, 2011, will be recorded by the Company at their respective fair values and the excess of the merger consideration over the fair value of Community Capital’s net assets will be allocated to goodwill. The calculations to determine fair values were incomplete at the time of filing of this Current Report on Form 10-Q. Until the determination of the fair values is complete, it is impractical to include disclosures related to the fair value of the assets acquired and liabilities assumed as required by the accounting guidance.

 

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CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
This report contains, and Park Sterling Corporation (the “Company”) and its management may make, certain statements that constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements can be identified by the fact that they do not relate strictly to historical or current facts and often use words such as “may,” “plan,” “contemplate,” “anticipate,” “believe,” “intend,” “continue,” “expect,” “project,” “predict,” “estimate,” “could,” “should,” “would,” “will,” “goal,” “target” and similar expressions. These forward-looking statements express management’s current expectations, plans or forecasts of future events, results and condition, including financial and other estimates and expectations regarding the proposed merger with Community Capital Corporation (“Community Capital”), the general business strategy of engaging in bank mergers, organic growth and anticipated asset size, additional branch openings, expansion of product capabilities, anticipated loan growth, refinement of the loan loss allowance methodology, recruiting of key leadership positions, decreases in construction and development loans and other changes in loan mix, changes in deposit mix, capital and liquidity levels, emerging regulatory expectations and measures, net interest income, credit trends and conditions, including loan losses, allowance, charge-offs, delinquency trends and nonperforming loan and asset levels, residential sales activity, valuation of the deferred tax asset and other similar matters. These statements are not guarantees of future results or performance and by their nature involve certain risks and uncertainties that are based on management’s beliefs and assumptions and on the information available to management at the time that these disclosures were prepared. Actual outcomes and results may differ materially from those expressed in, or implied by, any of these forward-looking statements.
You should not place undue reliance on any forward-looking statement and should consider all of the following uncertainties and risks, as well as those more fully discussed in the 2010 Form 10-K, the Company’s Quarterly Reports on Form 10-Q for the quarters ended March 31, 2011 and June 30, 2011 and in any of the Company’s subsequent filings with the SEC: failure to realize synergies and other financial benefits from the Community Capital merger within the expected time frame; increases in expected costs or difficulties related to integration of the Community Capital merger; inability to successfully open new branches or loan production offices, including the Company’s inability to attract and maintain customers; inability to identify and successfully negotiate and complete additional combinations with potential merger partners or to successfully integrate such businesses into the Company, including the Company’s ability to realize the benefits and cost savings from and limit any unexpected liabilities acquired as a result of any such business combination; the impact of deterioration of the United States credit standing; the effects of negative economic conditions, including stress in the commercial real estate markets or delay or failure of recovery in the residential real estate markets; changes in consumer and investor confidence and the related impact on financial markets and institutions; changes in interest rates; failure of assumptions underlying the establishment of its allowance; deterioration in the credit quality of its loan portfolios or in the value of the collateral securing those loans or in the value of guarantor support for those loans, where applicable; deterioration in the value of securities held in its investment securities portfolio; failure of assumptions underlying the utilization of the Company’s deferred tax asset, legal and regulatory developments; increased competition from both banks and nonbanks; changes in accounting standards, rules and interpretations, inaccurate estimates or assumptions in accounting and the impact on the Company’s financial statements; the Company’s ability to attract new employees; and management’s ability to effectively manage credit risk, market risk, operational risk, legal risk, and regulatory and compliance risk.
Forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made.

 

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
The purpose of this discussion and analysis is to focus on significant changes in the financial condition as of and results of operations of Park Sterling Corporation (“the Company”) during the three- and nine-month periods ended September 30, 2011. This discussion and analysis highlights and supplements information contained elsewhere in this Quarterly Report on Form 10-Q, particularly the preceding unaudited condensed consolidated financial statements and accompanying notes.
Executive Overview
The Company reported a $1.4 million loss, or $(0.05) per share, for the three months ended September 30, 2011, compared to a $3.1 million loss, or $(0.11) per share, for the three months ended June 30, 2011. Net interest income increased by $82,000, or 2%, from the prior quarter as a 9 basis point improvement in net interest margin, to 2.69%, more than offset a 2% decline in average interest-earning assets during the period. The provision for loan losses decreased from $3.2 million in the second quarter of 2011 to $568,000 in the third quarter of 2011 as a result of continuing improvement in asset quality and a decrease in total loans. Noninterest income more than doubled from $44,000 to $111,000, primarily as a result of earnings from the Company’s purchase of bank-owned life insurance during the third quarter of 2011. Noninterest expense decreased by $258,000, or 5%, from $5.5 million in the second quarter of 2011 to $5.2 million in the third quarter of 2011, as lower legal and professional fees, primarily associated with the Company’s merger with Community Capital, more than offset increases in personnel, occupancy and loan collection expenses.
Average interest-earning assets declined by $13.4 million, or 2%, from June 30, 2011 to September 30, 2011, driven by two ongoing management initiatives. First, the Company continued to allow lower-yielding cash and investments to contract to fund a managed run-off of brokered deposits and higher-priced time deposits. This action helped both to produce a more attractive deposit mix and to eliminate negative-carry, which, in turn, contributed to an improved net interest margin. Second, the Company continued to reduce its exposure to residential construction and development (“C&D”) loans, which contributed to an improvement in both loan mix and asset quality. Total C&D loans decreased to 15.3% of total loans at September 30, 2011, compared to 18.6% at June 30, 2011 and 27.4% at September 30, 2010. Commercial and industrial (“C&I”) loans and owner-occupied commercial real estate loans together increased 5% compared to the second quarter of 2011. C&I and owner-occupied loans represented 30.4% of total loans at September 30, 2011, compared to 28.1% at June 30, 2011 and 24.9% at September 30, 2011. Non-owner-occupied commercial real estate loans and 1-4 family loans remained fairly steady compared to the second quarter of 2011 at 29.5% and 5.4% of total loans, respectively. Home equity lines of credit (“HELOC”) increased slightly from 14.8% to 15.4% of total loans on a linked-quarter basis.
Asset quality continued to improve in the third quarter. Nonperforming loans, which include $2.0 million in successfully remediated troubled debt restructurings (“TDRs”), decreased 22%, to $21.4 million, or 5.84% of total loans, compared to $27.6 million, or 7.25% of total loans, as of June 30, 2011. Nonperforming assets, which included $1.6 million in loans held for sale, decreased 12%, to $28.7 million, or 4.93% of total assets, down from $32.6 million, or 5.34% of total assets, as of June 30, 2011. Net charge-offs decreased $1.7 million, or 46%, to $2.0 million, representing 2.19% of average loans on an annualized basis, compared to $3.7 million, or 3.87% of average loans (annualized) in the prior quarter. The allowance for loan losses was $9.8 million, or 2.68% of total loans, at September 30, 2011, a decrease from $11.3 million, or 2.96% of total loans, at June 30, 2011. This decrease in the allowance resulted both from positive credit quality trends in the loan portfolio and from the recognition of losses on previously identified impaired loans and a related reduction in specific reserves.
Total deposits decreased $28.9 million, or 7%, compared to the second quarter of 2011, but improved in mix. The decrease was primarily due to the previously mentioned managed contraction in brokered and higher-priced time deposits. This decrease was partially offset by continued growth in money market, NOW and savings deposits, which increased by 8% in the period, and demand deposits, which increased by 2%. Compared to the third quarter of 2010, total deposits decreased $42.4 million, or 10%, resulting from a 32% decrease in time deposits, offset by a 65% increase in money market, NOW and savings deposits, and a 41% increase in demand deposits. Core deposits, which exclude brokered deposits, as a percentage of total deposits were 77%, compared to 76% in the first quarter of 2011 and 72% in the third quarter of 2010.

 

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Shareholders’ equity increased $1.0 million to $174.6 million compared to $173.6 million at June 30, 2011, as an increase in accumulated other comprehensive income offset the third quarter 2011 net loss of $1,376,000. Shareholders’ equity decreased $9.2 million compared to the third quarter of 2010 as a result of $11.9 million in accumulated net losses. Tangible common equity as a percentage of tangible assets remains strong, posting a slight increase to 29.98% from 28.43% at June 30, 2011 and from 29.06% at September 30, 2010. Tier 1 leverage ratio also remains strong at 27.13%, a slight increase from 27.07% at June 30, 2011.
Tangible common equity and tangible assets are non-GAAP financial measures. Management uses these measures and related ratios to evaluate to the adequacy of shareholders’ equity and to facilitate comparisons with peers. The following table provides a reconciliation of these non-GAAP measures to the most directly comparable GAAP measures.
Reconciliation of Non-GAAP Financial Measures
                         
    Three months ended  
    September 30,     June 30,     September 30,  
    2011     2011     2010  
Tangible Assets (1)
                       
Total Assets
  $ 582,383     $ 610,668     $ 632,630  
Less: Intangible assets
                 
 
                 
 
                       
Tangible Assets
  $ 582,383     $ 610,668     $ 632,630  
 
                 
 
                       
Tangible Common Equity (2)
                       
Total Common Equity
  $ 174,617     $ 173,584     $ 183,847  
Less: Intangible assets
                 
 
                 
 
                       
Tangible Assets
  $ 174,617     $ 173,584     $ 183,847  
 
                 
     
(1)   Tangible assets equals period end total assets less intangible assets.
 
(2)   Tangible common equity equals period end common shareholders’ equity less intangible assets.
Business Overview
The Company was formed on October 6, 2010 to serve as the holding company for Park Sterling Bank (the “Bank”) and is a bank holding company registered with the Federal Reserve Board under the Bank Holding Company Act. On January 1, 2011, the Company acquired all of the outstanding stock of the Bank in a statutory exchange transaction (the “Reorganization”). At September 30, 2011, the Company’s primary operations and business were that of owning the Bank, its sole subsidiary with its main office in Charlotte, North Carolina. On November 1, 2011, the Company completed its merger with Community Capital Corporation (“Community Capital”), pursuant to which CapitalBank, with its main office in Greenwood, South Carolina, became a wholly owned subsidiary of the Company (the “Merger”). The Company’s offices are located at 1043 E. Morehead Street, Suite 201, Charlotte, North Carolina, 28204 and its phone number is (704) 716-2134.
The Bank was incorporated on September 8, 2006 as a North Carolina-chartered commercial bank and is a wholly owned subsidiary of the Company. The Bank opened for business on October 25, 2006 at 1043 E. Morehead Street, Suite 201, Charlotte, North Carolina. The Bank opened a branch in Wilmington, North Carolina, in October 2007, in the SouthPark neighborhood of Charlotte in July 2008 and in Charleston, South Carolina in June 2011. Also in June 2011, the Company opened loan production offices in Raleigh, North Carolina and Greenville, South Carolina. In September 2011, the Bank received regulatory approval to open full service branches in Greenville, South Carolina and Raleigh, North Carolina. The Bank currently anticipates that it will open additional branch offices and/or loan production offices in its target markets in the future.
On January 1, 2011, the Company acquired all of the outstanding common stock of the Bank in the Reorganization, which was effected under North Carolina law and in accordance with the terms of an Agreement and Plan of Reorganization and Share Exchange dated October 22, 2010. This agreement and the Reorganization were approved by the Bank’s shareholders at a special meeting of the Bank’s shareholders held on November 23, 2010. Pursuant to the Reorganization, shares of the Bank’s common stock were exchanged for shares of the Company’s common stock on a one-for-one basis. As a result, the Bank became the sole subsidiary of the Company, the Company became the holding company for the Bank and the shareholders of the Bank became shareholders of the Company. The unaudited condensed consolidated financial statements, discussions of those statements, market data and all other operating data presented herein for periods prior to January 1, 2011 are those of the Bank on a stand-alone basis.

 

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In August 2010, the Bank conducted an equity raise (the “Public Offering”), which raised gross proceeds of $150.2 million to facilitate a change in its business plan from primarily organic growth at a moderate pace over the next few years to seeking to acquire regional and community banks in the Carolinas and Virginia. The Company intends to become a regional-sized multi-state banking franchise through acquisitions and organic growth, seeking to reach a consolidated asset size of between $8 billion and $10 billion over the next several years. The Company expects that typically it would fund any such acquisitions through a combination of the issuance of stock and cash as payment of the consideration in such acquisition. Depending on the timing and magnitude of any particular future acquisition, the Company anticipates that in the future it likely will seek additional equity capital or issue indebtedness at some point to fund its growth strategy, although it currently has no plans with respect to any such issuance. As part of its operations, the Company regularly evaluates the potential acquisition of, and holds discussions with, various financial institutions eligible for bank holding company ownership or control. As a general rule, the Company expects to publicly announce material transactions when a definitive agreement has been reached.
As part of the Bank’s change in strategy, immediately following the Public Offering, the Bank reduced the size of its board of directors from thirteen members to six members, maintaining two of the sitting directors, Larry W. Carroll and Thomas B. Henson, and adding four new directors, Walter C. Ayers, Leslie M. (Bud) Baker, James C. Cherry and Jeffrey S. Kane. Mr. Baker was named Chairman of the board of directors upon becoming a member. In March 2011, the board of directors of the Company, which mirrors that of the Bank, approved expanding its membership to seven and appointed Jean E. Davis as a director.
The Bank also reorganized its management team following the Public Offering. The new executive management team includes James C. Cherry, who became the Chief Executive Officer; David L. Gaines, who became the Chief Financial Officer; Nancy J. Foster, who became the Chief Risk Officer; and Bryan F. Kennedy, III, who was the President and Chief Executive Officer and remains the President.
On November 1, 2011, Community Capital Corporation (“Community Capital”) was merged with and into the Company, with the Company as the surviving legal entity, in accordance with an Agreement and Plan of Merger dated as of March 30, 2011. Under the terms of the merger agreement, Community Capital shareholders will receive either $3.30 in cash or 0.6667 of a share of the Company’s common stock, par value $1.00 (“Common Stock”) for each share of Community Capital common stock they owned immediately prior to the merger, subject to the limitation that the total consideration would consist of 40.0% in cash and 60.0% in Common Stock. The merger was structured to be tax-free to Community Capital shareholders with respect to the shares of Common Stock received in the merger and taxable with respect to the cash received in the merger. Cash was paid in lieu of fractional shares. The aggregate merger consideration consisted of 4,024,269 shares of Common Stock and approximately $13.3 million in cash. The final transaction value was $28.8 million based on the $3.85 per share closing price of Common Stock on October 31, 2011.
In connection with the Merger, in November 2011, the board of directors of the Company was expanded to eight members and Patricia C. Hartung (formerly the Chairperson of the board of directors of Community Capital) was appointed as a director.
Market Area
The Bank provides banking services to small and mid-sized businesses, owner-occupied and income producing real estate owners, real estate developers and builders, professionals and consumers doing business or residing within its target markets. Through its branches, the Bank provides a wide range of banking products, including personal and business checking accounts, individual retirement accounts, business and personal money market accounts, certificates of deposit, overdraft protection, safe deposit boxes and online banking. The Bank lending activities include a range of short to medium-term commercial, real estate, residential mortgage and home equity and personal loans. Its objective since inception has been to provide the strength and product diversity of a larger bank and the service and relationship attention that characterizes a community bank. The Bank strives to develop a personal relationship with its customers while at the same time offering traditional deposit and loan banking services.
The Bank’s primary market areas consists of the Charlotte and Wilmington, North Carolina metropolitan statistical areas (“MSAs”). The Bank also operates a branch office in Charleston, South Carolina and loan production offices in Raleigh, North Carolina and Greenville, South Carolina. Additional information regarding each of these locations is provided below.

 

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Charlotte. Charlotte, the largest city in North or South Carolina, anchors an MSA with a total population of approximately 1.8 million in 2010, according to the Charlotte Chamber of Commerce. According to the U.S. Census Bureau, the population for the Charlotte-Gastonia-Rock Hill MSA increased 34.8% from 2000 to 2010. This population is expected to grow 14.8% between 2010 and 2015. Charlotte is a significant financial center and is currently home to nine Fortune 500 companies. Charlotte also has concentrations in the transportation, utilities, education, professional services and construction sectors. The 2010 median household income for the Charlotte MSA was $62,215 and is projected to grow 13.2% over the next five years.
Wilmington. Wilmington, a historic seaport and the largest city on the coast of North Carolina, anchors a metropolitan area covering New Hanover, Brunswick and Pender counties with a 2010 population of 367,101. The U.S. Census Bureau estimates that Wilmington’s MSA is expected to grow 13.2% from 2010 to 2015. Wilmington’s economy is diversified and includes tourism, shipping, pharmaceutical development, chemical and aircraft component manufacturing, and fiber optic industries. Wilmington is also a regional retail and medical center, with the New Hanover Regional Medical Center/Cape Fear Hospital ranking in the top ten largest medical facilities in the state. The median household income in 2010 for the Wilmington MSA was $49,403 and is projected to increase 13.2% over the next five years.
Charleston. Charleston, the second largest city in South Carolina, is located on the state’s coastline. According to the U.S. Census Bureau, the population for the Charleston-North Charleston-Summerville MSA was 671,833, a 22.3% increase since 2000. The area’s population is projected to grow 10.3% from 2010 to 2015. Charleston is the largest business and financial center for the southeastern section of South Carolina. The city is a popular tourist destination, with a large number of restaurants, hotels and retail stores. The manufacturing, shipping and medical industries are also key economic sectors in Charleston. The 2010 median household income for the Charleston MSA was $51,065 and is expected to grow 12.6% from 2010 to 2015.
Raleigh. Raleigh, the capital city of North Carolina, is located in the metropolitan area covering Wake, Johnston, and Franklin counties. The Raleigh-Cary MSA had a total population of approximately 1.2 million in 2010, and is expected to grow 19.4% over the next five years. Raleigh is part of North Carolina’s Research Triangle, an eight-county region that is home to numerous high-tech companies and enterprises. Other industries present in the economy include banking/financial services, electrical and medical equipment, wholesale distribution, and pharmaceuticals. The median household income in 2010 for the Raleigh-Cary MSA was $68,373 and is projected to increase 15.4% over the next five years.
Greenville. Greenville, located within the largest county in South Carolina, is on the Interstate 85 corridor, approximately halfway between Atlanta and Charlotte. According to the U.S. Census Bureau, the population for the Greenville-Mauldin-Easley MSA was 644,096, a 15.0% increase since 2000. The area’s population is projected to grow 7.4% between 2010 and 2015. Greenville’s economy, formerly based largely around textiles, is now dominated by the manufacturing, automotive research, and healthcare industries. The city is the home of Michelin’s North American headquarters. The 2010 median household income for the Greenville MSA was $50,114 and is expected to grow 11.4% by 2015.
Competition
The Company competes for deposits in its banking markets with other commercial banks, savings banks and other thrift institutions, credit unions, agencies issuing U.S. government securities and all other organizations and institutions engaged in money market transactions. In its lending activities, the Company competes with all other financial institutions, as well as consumer finance companies, mortgage companies and other. Commercial banking in its markets is extremely competitive.

 

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Interest rates, both on loans and deposits, and prices of fee-based services, are significant competitive factors among financial institutions generally. Other important competitive factors include office location, office hours, the quality of customer service, community reputation, continuity of personnel and services, and in the case of larger commercial customers, relative lending limits and the ability to offer sophisticated cash management and other commercial banking services. Many of the Bank’s competitors have greater resources, broader geographic markets and higher lending limits than the Bank does, and they can offer more products and services and can better afford and make more effective use of media advertising, support services and electronic technology than can the Bank. To counter these competitive disadvantages, the Bank depends on its reputation as a community bank in its local markets, its direct customer contact, its ability to make credit and other business decisions locally, and its personalized customer service.
In recent years, Federal and state legislation has heightened the competitive environment in which all financial institutions conduct their business, and the potential for competition among financial institutions of all types has increased significantly. Additionally, with the elimination of restrictions on interstate banking, a North Carolina commercial bank may be required to compete not only with other North Carolina-based financial institutions, but also with out-of-state financial institutions which may acquire North Carolina institutions, establish or acquire branch offices in North Carolina, or otherwise offer financial services across state lines, thereby adding to the competitive atmosphere of the industry in general. In terms of assets, the Bank is currently one of the smaller commercial banks in North Carolina.
Recent Accounting Pronouncements
See Note 2 to the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for a description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.
Critical Accounting Policies and Estimates
In the preparation of its financial statements, the Company has adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and in accordance with general practices within the banking industry. The Company’s significant accounting policies are described in Note B — Summary of Significant Accounting Policies to the Company’s audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2010, filed with the Securities and Exchange Commission on March 31, 2011 (the “2010 Audited Financial Statements”). While all of these policies are important to understanding the Company’s financial statements, certain accounting policies described below involve significant judgment and assumptions by management of the Company that have a material impact on the carrying value of certain assets and liabilities. The Company considers these accounting policies to be critical accounting policies. The judgment and assumptions the Company uses are based on historical experience and other factors, which it believes to be reasonable under the circumstances. Because of the nature of the judgment and assumptions the Company makes, actual results could differ from these judgments and assumptions that could have a material impact on the carrying values of its assets and liabilities and its results of operations.
Allowance for Loan Losses. The allowance for loan losses is based upon management’s ongoing evaluation of the loan portfolio and reflects an amount considered by management to be its best estimate of known and inherent losses in the portfolio as of the balance sheet date. The determination of the allowance for loan losses involves a high degree of judgment and complexity. In making the evaluation of the adequacy of the allowance for loan losses, management considers current economic conditions, statutory examinations of the loan portfolio by regulatory agencies, independent loan reviews performed periodically by third parties, delinquency information, management’s internal review of the loan portfolio, and other relevant factors. While management uses the best information available to make evaluations, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, regulatory examiners may require the Company to recognize changes to the allowance for loan losses based on their judgments about information available to them at the time of their examination. Although provisions have been established by loan segment, based upon management’s assessment of their differing inherent loss characteristics, the entire allowance for losses on loans is available to absorb further loan losses in any segment. Further information regarding the Company’s policies and methodology used to estimate the allowance for possible loan losses is presented in Note D —Loans to the 2010 Audited Financial Statements.

 

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Income Taxes. — Income taxes are provided based on the asset-liability method of accounting, which includes the recognition of deferred tax assets (“DTAs”) and liabilities for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. In general, the Company records a DTA when the event giving rise to the tax benefit has been recognized in the consolidated financial statements.
As of September 30, 2011 and December 31, 2010, the Company had a DTA in the amounts of approximately $10.8 million and $7.4 million, respectively. The Company evaluates the carrying amount of its DTA on a quarterly basis in accordance with the guidance provided in Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 740 (ASC 740), in particular, applying the criteria set forth therein to determine whether it is more likely than not (i.e., a likelihood of more than 50%) that some portion, or all, of the DTA will not be realized within its life cycle, based on the weight of available evidence. In most cases, the realization of the DTA is dependent upon the Company generating a sufficient level of taxable income in future periods, which can be difficult to predict. If the Company’s forecast of taxable income within the carryforward periods available under applicable law is not sufficient to cover the amount of net deferred assets, such assets may be impaired. Based on the weight of available evidence, the Company has determined that it is more likely than not that it will be able to fully realize the existing DTA within approximately three years and therefore considers it appropriate not to establish a DTA valuation allowance at either September 30, 2011 or December 31, 2010.
Further information regarding the Company’s income taxes, including the methodology used to determine the need for a valuation allowance for the existing DTA, if any, is presented in Note 6 —Income Taxes to the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.
Fair Value Measurements. As a financial services company, the carrying value of certain financial assets and liabilities is impacted by the application of fair value measurements, either directly or indirectly. In certain cases, an asset or liability is measured and reported at fair value on a recurring basis, such as available-for-sale investment securities. In other cases, management must rely on estimates or judgments to determine if an asset or liability not measured at fair value warrants an impairment write-down or whether a valuation reserve should be established. Given the inherent volatility, the use of fair value measurements may have a significant impact on the carrying value of assets or liabilities, or result in material changes to the financial statements, from period to period.
Detailed information regarding fair value measurements can be found in Note M —Fair Value of Financial Instruments to the Company’s 2010 Audited Financial Statements. The following is a summary of those assets that may be affected by fair value measurements, as well as a brief description of the current accounting practices and valuation methodologies employed by the Company:
Available-for-Sale Investment Securities. Investment securities classified as available-for-sale are measured and reported at fair value on a recurring basis. For most securities, the fair value is based upon quoted market prices or determined by pricing models that consider observable market data. However, the fair value of certain investment securities must be based upon unobservable market data, such as nonbinding broker quotes and discounted cash flow analysis or similar models, due to the absence of an active market for these securities. As a result, management’s determination of fair value for these securities is highly dependent on subjective or complex judgments, estimates and assumptions, which could change materially between periods.
Impaired Loans. For loans considered impaired, the amount of impairment loss recognized is determined based on a discounted cash flow analysis or the fair value of the underlying collateral if repayment is expected solely from the sale of the collateral. The vast majority of the collateral securing impaired loans is real estate, although it may also include accounts receivable and equipment, inventory or similar personal property.

 

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Financial Condition at September 30, 2011 and December 31, 2010
Total assets declined by $33.7 million, or 5.5%, from $616.1 million at December 31, 2010 to $582.4 million at September 30, 2011. At September 30, 2011, interest-earning assets were $549.3 million, which included $367.4 million in gross loans, $130.7 million in investment securities available-for-sale, $36.3 million in interest-bearing deposits in other banks, $8.0 million of bank-owned life insurance, (comprised of $4.0 million of general account life insurance and $4.0 million of hybrid account life insurance), $5.3 million in overnight investments and $1.6 million in loans held for sale. Interest-earning assets at December 31, 2010 totaled $603.3 million and consisted of $399.8 million in gross loans, $140.6 million in investment securities available-for-sale, $57.9 million in overnight investments and $5.0 million in interest-bearing deposits in other banks.
Shareholders’ equity equaled $174.6 million at September 30, 2011 compared to $177.1 million at December 31, 2010. This decrease of $2.5 million was a result of the year-to-date loss of $7.4 million, offset by a $3.5 million increase, net of taxes, in accumulated other comprehensive income relating to unrealized gains on investments available-for-sale and swaps and $1.4 million of additional paid in capital relating to the share-based compensation expense.
The following table reflects selected ratios for the Company for the nine months ended September 30, 2011 and 2010 and for the year ended December 31, 2010:
Selected Ratios
                         
    Nine months ended        
    September 30,     For the year  
    (annualized and unaudited)     ended December 31,  
    2011     2010     2010*  
Return on Average Assets
    -1.60 %     -0.88 %     -2.81 %
 
                       
Return on Average Equity
    -5.61 %     -6.39 %     -9.75 %
 
                       
Period End Equity to Total Assets
    29.98 %     29.06 %     28.75 %
*   Derived from audited financial statements.
Investments and Other Interest-earning Assets
The Company’s investment portfolio consists of U.S. government agency securities, residential mortgage-backed securities, municipal securities and other debt instruments. All of the residential mortgage-backed securities held by the Company are backed by an agency of the U.S. government. All of the Company’s investment securities are categorized as available-for-sale. Securities available-for-sale are carried at market value, with unrealized holding gains and losses reported in other comprehensive income, net of tax. Investment securities were $130.7 million at September 30, 2011. This was a $9.9 million decrease from the $140.6 million balance at December 31, 2010 and is a result of the net maturities and sales of $16.0 million of securities available for sale and a $6.1 million improvement in the fair market value of the portfolio.
At the end of the third quarter of 2011, the Company’s portfolio had a net unrealized gain of $4.1 million compared to a $2.0 million net unrealized loss at December 31, 2010. The Company had no securities with an unrealized loss deemed to be other than temporary at September 30, 2011 or December 31, 2010.
At September 30, 2011, the Company had $5.3 million in Federal funds sold, and $36.3 million in interest-bearing deposits with other FDIC-insured financial institutions. This compares with $57.9 million in Federal funds and $5.0 million in interest-bearing deposits at other FDIC-insured financial institutions at December 31, 2010.
Loans
The Company considers asset quality to be of primary importance, and employs a formal internal loan review process to ensure adherence to the lending policy as approved by its board of directors. Since its inception, the Company has promoted the separation of loan underwriting from the loan production staff through its credit department. Currently, credit administration analysts are responsible for underwriting and assigning proper risk grades for all loans with a total exposure in excess of $500,000.

 

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Underwriting is completed on standardized forms including a loan approval form and separate credit memorandum. The credit memorandum includes a summary of the loan’s structure and a detailed analysis of loan purpose, borrower strength (including individual and global cash flow worksheets), repayment sources, collateral positions and guarantor strength. The memorandum further identifies exceptions to policy and/or regulatory limits, total exposure, loan to value and risk grades. Loans are approved or denied by varying levels of signature authority based on total exposure. Prior to December 31, 2010, the Company employed an approval system consisting of individual signature authorities, dual-signature authorities and a board-level loan committee. The approval structure was revised as of January 1, 2011 to rely more heavily on approvals from a loan committee.
The Company’s loan underwriting policy contains loan-to-value (“LTV’) limits that are at or below levels required under regulatory guidance, when such guidance is available, including limitations for non-real estate collateral, such as accounts receivable, inventory and marketable securities. When applicable, the Company compares LTV with loan-to-cost guidelines and ultimately limits loan amounts to the lower of the two ratios. The Company also considers FICO scores and strives to uphold a high standard when extending loans to individuals. LTV limits have been selectively reduced in response to the recent economic cycle. In particular, loans collateralized with 1-4 family properties have seen a reduction in their maximum LTV. The Company has not underwritten any subprime, hybrid, no-documentation or low-documentation products.
All acquisition, construction and development loans, commercial and consumer, are subject to the Company’s policy, guidelines and procedures specifically designed to properly identify, monitor and mitigate the risk associated with these loans. Loan officers receive and review a cost budget from the borrower at the time a construction and development loan is originated. Loan draws are monitored against the budgeted line items during the development period in order to identify potential cost overruns. Individual draw requests are verified through review of supporting invoices as well as site inspections performed by an external inspector. Additional periodic site inspections are performed by loan officers at times that do not coincide with draw requests in order to keep abreast of ongoing project conditions. Project status is reported to senior management on an ongoing basis via the Company’s monthly C&D and watch meetings. Reports generated regarding acquisition, construction and development loans include status of the project, summary of customer correspondence, site visit update when performed, review of risk grade and impairment analysis, if applicable. As of September 30, 2011, approximately 43% of the Company’s acquisition, construction and development loan portfolio, commercial and consumer, falls under the watch list.
The Company’s second mortgage exposure is primarily attributable to its HELOC portfolio, which totals approximately $57 million as of September 30, 2011, of which approximately 60% is secured by second mortgages and approximately 40% is secured by first mortgages. For HELOCs in North Carolina, which comprise the majority of the portfolio, the Company records a “Request for Copy of Notice of Sale” with the county in which the property is located. All loans are assigned an internal risk grade by the loan officer and monitored by the credit administration function in the same fashion as commercial loans. Aside from loan committee, loan review and watch list meetings, loans are also monitored for delinquency through bi-weekly past due meetings. As of September 30, 2011, there were no accruing delinquent HELOCs in the Company’s portfolio.
At September 30, 2011, total loans were $367.7 million compared to $399.9 million at December 31, 2010. This decrease included a $40.6 million reduction in the construction and development portfolio, consistent with the Company’s general intention and actions over the past year to reduce residential construction and development exposure in its portfolio.

 

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The following table presents a summary of the loan portfolio at September 30, 2011 and at December 31, 2010, 2009, 2008, 2007 and 2006 (dollars in thousands).
Summary of Loans By Segment and Class
                                                                                                 
    September 30,     December 31,  
    2011     %     2010     %     2009     %     2008     %     2007     %     2006*     %  
Commercial:
                                                                                               
Commercial and industrial
  $ 44,939       12 %   $ 48,401       12 %   $ 41,980       11 %   $ 37,266       10 %   $ 23,011       10 %   $ 5,044       12 %
Commercial real estate - owner occupied
    66,979       18 %     55,089       14 %     50,693       13 %     29,734       8 %     7,181       3 %     48       0 %
Commercial real estate - investor income producing
    108,558       30 %     110,407       28 %     112,508       28 %     90,172       24 %     55,759       25 %     11,403       27 %
Acquisition, construction and development
    51,522       14 %     87,846       22 %     100,668       25 %     123,759       33 %     88,666       39 %     17,887       42 %
Other commercial
    7,763       2 %     3,225       1 %     1,115       0 %     257       0 %     6,189       3 %           0 %
 
                                                                       
Total commercial loans
    279,761       76 %     304,968       77 %     306,964       77 %     281,188       75 %     180,806       80 %     34,382       81 %
 
                                                                       
 
                                                                                               
Consumer:
                                                                                               
Residential mortgage
    19,816       5 %     21,716       5 %     20,577       5 %     13,916       4 %     2,490       1 %     522       1 %
Home equity lines of credit
    56,787       16 %     56,968       14 %     52,026       13 %     48,625       13 %     25,829       11 %     6,800       16 %
Residential construction
    4,787       1 %     9,051       2 %     11,639       3 %     19,873       6 %     9,816       4 %     575       1 %
Other loans to individuals
    6,530       2 %     7,245       2 %     6,471       2 %     7,888       2 %     7,809       4 %     392       1 %
 
                                                                       
Total consumer loans
    87,920       24 %     94,980       23 %     90,713       23 %     90,302       25 %     45,944       20 %     8,289       19 %
 
                                                                       
Total loans
    367,681       100 %     399,948       100 %     397,677       100 %     371,490       100 %     226,750       100 %     42,671       100 %
 
                                                                       
Deferred fees
    (269 )     0 %     (119 )     0 %     (113 )     0 %     (218 )     0 %     (209 )     0 %     (24 )     0 %
 
                                                                       
Total loans, net of deferred fees
  $ 367,412       100 %   $ 399,829       100 %   $ 397,564       100 %   $ 371,272       100 %   $ 226,541       100 %   $ 42,647       100 %
 
                                                                       
*   Park Sterling Bank commenced operations on October 25, 2006.
Substantially all of the Company’s loans are to customers in its immediate markets. In the Charlotte market, the Company has a diversified mix of commercial real estate, owner-occupied commercial real estate, commercial and small business loans, and a significant portfolio of HELOCs. The Company’s Wilmington operation has a heavier concentration of real estate related loans with a smaller proportion of construction and development loans than Charlotte. Wilmington, like most coastal markets, is heavily dependent on real estate and tourism to drive its economy. The Company expects future growth in its newer markets of Charleston, Greenville and Raleigh. The Company believes it is not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on its financial condition or results of operations.
Asset Quality and Allowance for Loan Losses
Due to unprecedented asset quality challenges and the global economic recession, the U.S. banking industry has been experiencing significant financial challenges. The Company’s senior management works closely with credit administration and lending staff to ensure that adequate resources are in place to proactively manage through the current slowdown in the real estate market and overall economy. When a problem is identified, management is committed to assessing the situation and moving quickly to minimize losses, while being sensitive to the borrower’s effectiveness as an operator, the long-term viability of the business or project and the borrower’s commitment to working with the Company to achieve an acceptable resolution of the credit.

 

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As a given loan’s credit quality changes, the responsibility for changing the borrower’s risk grade accordingly lies first with the Company’s lending staff, and second with the credit administration department. The process of determining the allowance for loan losses is fundamentally driven by the risk grade system. In determining the allowance for loan losses and any resulting provision to be charged against earnings, particular emphasis is placed on the results of the loan review process. Consideration is also given to the value and adequacy of collateral, economic conditions in the Company’s market areas and other factors.
The Company’s loan loss allowance methodology consists of a comprehensive qualitative component, which evaluates six environmental factors, including portfolio trends, portfolio concentrations, general economic and market trends, changes in lending practices, regulatory environment and other factors. Further details about this component of the Company’s loan loss allowance are outlined below. These factors are intended to help management recognize expected losses that may not be identified through the quantitative analysis of the Company’s historical loss experience. For loans determined to be impaired, the allowance is based on discounted cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. This discounted cash flow analysis is inherently subjective, as it requires material estimates, including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The allowance for loan losses represents management’s estimate of the appropriate level of reserve to provide for the risk inherent in the Company’s loan portfolio. The determination of the allowance for loan losses involves a high degree of judgment and complexity.
The evaluation of the allowance for loan losses, which generally occurs at the end of each quarter, consists of three components, as follows:
1) Specific Reserve Component. Specific reserves represent the current impairment estimate on specific loans, which is an estimate of the amount for which it is probable that the Company will be unable to collect all amounts due on such loans, if any, according to contractual terms based on current information and events. Impairment measurement reflects only a deterioration of credit quality and not changes in market rates that may cause a change in the fair value of the impaired loan. The amount of impairment may be measured in one of three ways, including (i) calculating the present value of expected future cash flows, discounted at the loan’s interest rate and deducting estimated selling costs, if any; (ii) observing quoted market prices for identical or similar instruments traded in active markets, or employing model-based valuation techniques for which all significant assumptions are observable in the market; and (iii) determining the fair value of collateral, for both collateral dependent loans and for loans when foreclosure is probable.
2) Quantitative Reserve Component. Quantitative reserves represent the current loss contingency estimate on pools of loans, which is an estimate of the amount for which it is probable that the Company will be unable to collect all amounts due on homogeneous groups of loans according to contractual terms should one or more events occur, excluding those loans specifically identified above. Given the limited operating history of the Company, this component of the allowance for loan losses is currently based on the historical loss experience of comparable institutions. This comparable institution loss experience was obtained by surveying peer group institutions, which include North Carolina-based community banks that management believes originate similar types of loans to those originated by the Company, as supplemented by discussions with peers and industry professionals. The estimated historical loss rates are grouped into loans with similar risk characteristics by utilizing the Company’s internal risk grades applied on a consistent basis across all loan types. Management is in the process of collecting and evaluating internal loan loss data for the purpose of validating and/or modifying the current quantitative reserve calculation and expects to have completed and implemented revised methodology by the end of 2011.

 

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3) Qualitative Reserve Component. Qualitative reserves represent an estimate of the amount for which it is probable that environmental factors will cause the aforementioned loss contingency estimate to differ from historical results or other assumptions. The Company has identified the following six environmental factors for inclusion in its allowance methodology at this time:
  i.   Portfolio trends, which may relate to such factors as type or level of loan origination activity, changes in asset quality (i.e., past due, special mention, non-performing) and/or changes in collateral values;
  ii.   Portfolio concentrations, which may relate to individual borrowers and/or guarantors, geographic regions, industry sectors, loan types and/or other factors;
  iii.   Economic and market trends, which may relate to trends and/or levels of gross domestic production, unemployment, bankruptcies, foreclosures, housing starts, housing prices, equity prices, competitor activities and/or other factors;
  iv.   Changes in lending practices, which may relate to changes in credit policies, procedures, systems or staff;
  v.   Regulatory environment, which may relate to modification and/or expansion of regulatory requirements or supervisory practices; and
  vi.   Other factors, which is intended to capture environmental factors not specifically identified above.
Management believes that each of the above environmental factors addresses and provides for the additional uncertainty when current conditions are not consistent with the conditions prevailing in the prior periods utilized in the calculation of historical loss estimates. This additional uncertainty may be heightened during periods of unusual market and/or economic volatility, such as exists today.
Each qualitative component is evaluated on at least a quarterly basis by the Company’s Allowance Committee and is ranked as being “Low,” “Moderate,” “High,” or “Very High.” The first three factors — portfolio trends, portfolio concentrations and economic and market trends — are believed by management to present the most significant risk to the portfolio and are therefore associated with both higher absolute and range of potential reserve percentage (from 0.05% to 0.15% of outstanding performing loans). The last three factors — changes in lending practices, regulatory environment and other factors — carry a slightly lower absolute and range of potential reserve percentage (from 0.025% to 0.10% of outstanding performing loans). The reserve percentages for each of the six factors are derived from available industry information combined with management judgment. The Company may consider both trends and absolute levels of such factors, if applicable.
Before 2010, the Company did not include qualitative factors in its allowance model. During the first quarter of 2010, the Company introduced its first qualitative factor by including an estimate of $477,792, reflecting management’s judgment that, given the uncertain economic outlook, historical peer group data did not appropriately recognize loss content in the portfolio, despite an improvement in net charge-offs from the previous quarter. This estimate for environmental factors was reduced to $100,000 in the second quarter of 2010, reflecting management’s assessment that asset quality had stabilized, given two quarters of improvement in net charge-offs, and that the general economic outlook was expected to stabilize or improve over the second half of 2010.
During the third quarter of 2010, the Company introduced refinements to the qualitative components of its allowance model. The aggregate qualitative factor, which was previously $100,000, was increased to 0.475% of nonimpaired loans, or $1.8 million. The following is a breakdown of the ranking of each factor and its contribution to the aggregate qualitative component of the allowance:
    Portfolio Trends — High (0.100%, or $0.4 million).
    Portfolio Concentrations — High (0.100%, or $0.4 million).
    Economic and Market Trends — High (0.100%, or $0.4 million).
    Changes in Lending Practices — Low (0.025%, or $0.1 million).
    Regulatory Environment — High (0.075%, or $0.3 million).
    Other Factors — Moderate (0.075%, or $0.3 million).

 

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During the fourth quarter of 2010, management increased the aggregate estimate for environmental factors to 0.525% of nonimpaired loans, or $1.9 million. This change was driven by a 0.050% increase in the Portfolio Trends factor from a rating of High (0.100%) to a rating of Very High (0.150%). This increase reflected a rise in classified loans from 7.09% to 11.56% of total loans and a concurrent five-fold increase in nonperforming loans to 10.23% of total loans following a detailed portfolio review of all loans except the Company’s HELOC exposures. Uncertainty around the HELOC exposures was the key driver for increasing the Portfolio Trend qualitative factor. All other factors remained unchanged from the prior period. There were no further changes in the Company’s environmental factors during the first nine months of 2011.
Qualitative reserves represented 0.500% of outstanding performing loans as of September 30, 2011, accounting for $1.7 million, or 18%, of the Company’s allowance for loan losses. There was no provision expense related to this component of allowance for the first nine months of 2011 given that outstanding performing loans declined during the period. Qualitative reserves represented 0.525% of outstanding performing loans as of December 31, 2010, accounting for $1.9 million, or 15%, of the Company’s allowance for loan losses.
The Company’s policy regarding past due loans normally requires a loan be placed on nonaccrual status when there is probable loss or when there is a reasonable doubt that all principal will be collected, or when it is over 90 days past due. Charge-off to the allowance for loan losses may ensue following timely collection efforts and a thorough review of payment sources. Further efforts are then pursued through various means available. Loans carried in a nonaccrual status are generally secured by collateral, which is considered in the determination of the allowance for loan losses, through the impaired loan process.
The allowance for loan losses is increased by provisions charged to operations and reduced by loans charged off, net of recoveries. The allowance for loan losses as a percentage of total loans decreased to 2.68% at September 30, 2011 from 3.31% at September 30, 2010. The decrease in the allowance is a result of both improvement in portfolio trends and the recognition of loss on loans. The allowance for loan losses as a percentage of total loans decreased from 3.11% at December 31, 2010, due to improvement in portfolio trends and the recognition of loss on loans. The Company had net charge-offs of $10.9 million in the first nine months of 2011 compared to $1.1 million in the same period of 2010 and $12.0 million for the year ended December 31, 2010.
While management believes that it uses the best information available to determine the allowance for loan losses, and that its allowance for loan losses is maintained at a level appropriate in light of the risk inherent in the Company’s loan portfolio based on an assessment of various factors affecting the loan portfolio, unforeseen market conditions could result in adjustments to the allowance for loan losses, and net income could be significantly affected, if circumstances differ substantially from the assumptions used in making the final determination. The allowance for loan losses to total loans may increase if the Company’s loan portfolio deteriorates due to economic conditions or other factors.

 

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The following table presents a summary of changes in the allowance for loan losses and includes information regarding charge-offs, and selected coverage ratios for the nine-month period ended September 30, 2011 and the years ended December 31, 2010, 2009, 2008, 2007 and 2006 (dollars in thousands):
Allowance for Loan Losses
                                                 
    September 30,     December 31,  
    2011     2010     2009     2008     2007     2006*  
Balance, beginning of period
  $ 12,424     $ 7,402     $ 5,568     $ 3,398     $ 640     $  
Provision for loan losses
    8,275       17,005       3,272       2,544       2,758       640  
 
                                               
Charge-offs:
                                               
Commercial:
                                               
Commercial and industrial
  $ (724 )   $ (1,338 )   $ (8 )   $     $     $  
Commercial real estate — owner-occupied
    (194 )     (105 )                        
Commercial real estate — investor income producing
    (87 )     (840 )                        
Acquisition, construction and development
    (6,760 )     (7,752 )     (631 )     (374 )            
Other commercial
    (2,129 )                              
Consumer:
                                               
Residential mortgage
    (571 )     (154 )     (720 )                  
Home equity lines of credit
    (1,102 )     (1,496 )     (33 )                  
Residential construction
    (222 )     (347 )                        
Other loans to individuals
          (10 )     (46 )                  
 
                                   
 
                                               
Total Charge-offs
    (11,789 )     (12,042 )     (1,438 )     (374 )            
 
                                   
 
                                               
Recoveries:
                                               
Commercial:
                                               
Commercial and industrial
  $ 240     $ 2     $     $     $     $  
Commercial real estate — owner-occupied
    3       16                          
Commercial real estate — investor income producing
    178       1                          
Acquisition, construction and development
    474       35                          
Other commercial
                                   
Consumer:
                                               
Residential mortgage
    5       4                          
Home equity lines of credit
    4       1                          
Residential construction
                                   
Other loans to individuals
    19                                
 
                                   
Total Recoveries
    923       59                          
 
                                   
 
                                               
Net charge-offs
    (10,866 )     (11,983 )     (1,438 )     (374 )            
 
                                   
 
                                               
Balance, end of period
  $ 9,833     $ 12,424     $ 7,402     $ 5,568     $ 3,398     $ 640  
 
                                   
 
                                               
Net charge-offs to total loans
    3.94 %     3.00 %     0.36 %     0.10 %     0.00 %     0.00 %
 
                                               
Allowance for loan losses to total loans
    2.68 %     3.11 %     1.86 %     1.50 %     1.50 %     1.50 %
*   Park Sterling Bank commenced operations on October 25, 2006

 

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Allocation of the Allowance for Loan Losses
                                                                                                 
    September 30,     December 31,  
    2011     %     2010     %     2009     %     2008     %     2007     %     2006     %  
Commercial:
                                                                                               
Commercial and industrial
  $ 687       12 %   $ 896       12 %   $ 529       11 %   $       10 %   $       10 %   $       12 %
Commercial real estate — owner-occupied
    1,453       18 %     1,061       14 %     627       13 %           8 %           3 %           0 %
Commercial real estate — investor income producing
    2,572       30 %     2,105       28 %     1,496       28 %           24 %           25 %           27 %
Acquisition, construction and development
    1,314       14 %     4,695       22 %     3,149       25 %           33 %           39 %           42 %
Other commercial
    87       2 %     408       1 %           0 %           0 %           3 %           0 %
 
                                                                                               
Consumer:
                                                                                               
Residential mortgage
    327       5 %     320       5 %     547       5 %           4 %           1 %           1 %
Home equity lines of credit
    1,477       16 %     871       14 %     835       13 %           13 %           11 %           16 %
Residential construction
    90       1 %     98       2 %     144       3 %           6 %           4 %           1 %
Other loans to individuals
    86       2 %     86       2 %     75       2 %           2 %           4 %           1 %
Unallocated
    1,740       0 %     1,884       0 %           0 %     5,568       0 %     3,398       0 %     640       0 %
 
                                                                       
 
  $ 9,833       100 %   $ 12,424       100 %   $ 7,402       100 %   $ 5,568       100 %   $ 3,398       100 %   $ 640       100 %
 
                                                                       
*   Park Sterling Bank commenced operations on October 25, 2006
Nonperforming Assets
The Company grades loans with a risk grade scale of 1-9, with grades 1-5 representing pass credits, and grades 6, 7, 8, and 9 representing “special mention,” “substandard,” “doubtful,” and “loss” credit grades, respectively. Loans are reviewed on a regular basis internally and at least annually by an external loan review group to ensure loans are graded appropriately. Credits are reviewed for past due trends, declining cash flows, significant decline in collateral value, weakened guarantor financial strength, management concerns, market conditions and other factors that could jeopardize the repayment performance of the loan. Documentation deficiencies, to include collateral perfection and outdated or inadequate financial information, are also considered in grading loans.
All loans graded 6 or worse are included on the Company’s list of “watch loans,” which represent potential problem loans, and are updated and reported to both management and the loan and risk committee of the board of directors on a monthly basis. Additionally, the watch list committee may review other loans with more favorable ratings if there are concerns that the loan may become a problem in the future. Due to unfavorable economic conditions, the Company currently includes a special review of all grade 5 loans greater than $250,000 in its watch list committee. Impairment analysis has been performed on all loans graded “substandard” (risk grade of 7 or worse) and selected other loans as deemed appropriate. At September 30, 2011, the Company maintained “watch loans” totaling $77.9 million, including $24.3 million of grade 5 loans, compared to $102.9 million at December 31, 2010, including $33.6 million of grade 5 loans. Currently all loans on the Company’s watch list carry a risk grade of 5 or worse. The future level of watch loans cannot be predicted, but rather will be determined by several factors, including overall economic conditions in the markets served. It is the general policy of the Company to stop accruing interest income when a loan is placed on nonaccrual status and any interest previously accrued but not collected is reversed against current income. Generally, a loan is placed on nonaccrual status when it is over 90 days past due and there is reasonable doubt that all principal will be collected.

 

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The Company employs one of three potential methods to determine the fair value of impaired loans.
1) Fair value of collateral method. This is the most common method and is used when the loan is collateral dependent. In most cases, the Company will obtain an “as is” appraisal from a third-party appraisal group. The fair value from that appraisal may be adjusted downward for liquidation discounts for foreclosure or quick sale scenarios, as well as any applicable selling costs.
2) Cash flow method. This method is used when the loan is not collateral dependent and involves the calculation of the net present value of the expected future cash flow from the loan, discounted at the nominal interest rate of the loan.
3) Loan market value method. This is the method used least often by the Company. Fair value is based on the offering price from a note buyer, in either the local community or a national loan sale advisor.
With respect to nonaccruing commercial and consumer acquisition, construction and development loans, the Company typically utilizes an “as-is,” or “discounted,” value to determine an appropriate fair value. When appraising projects with an expected cash flow to be received over a period of time, such as acquisition and development/land development loans, fair value is determined using a discounted cash flow methodology. When appropriate, the Company also requests that the appraiser include a three- or six-month liquidation value in order to examine quick sale scenario proceeds. The Company also accounts for expected selling cost when determining an appropriate property value.
Nonperforming loans, which consist of nonaccrual loans, accruing TDRs and accruing loans for which payments are 90 days or more past due, decreased $20.7 million, or 49.1%, to $21.4 million, or 5.84% of total loans at September 30, 2011, compared to $42.1 million, or 10.53%, of total loans at December 31, 2010. Nonperforming assets, which consist of nonperforming loans, OREO and loans held for sale decreased $14.7 million, or 33.9%, to $28.7 million at September 30, 2011 from $43.4 million at December 31, 2010. There were no loans past due 90 days or more and still accruing interest at September 30, 2011 or December 31, 2010.
Nonaccrual loans were $19.4 million at September 30, 2011, a decrease of $21.5 million, or 52.6%, from nonaccrual loans of $40.9 million at December 31, 2010. These nonaccrual loans consisted primarily of loans involving commercial and consumer acquisition, construction and development activity, which totaled $16.5 million, or 84.6%, of total nonaccrual loans at September 30, 2011 compared to $35.0 million, or 85.5%, of total nonaccrual loans at December 31, 2010. Nonaccruing TDRs are included in the nonaccrual loan amounts noted. At September 30, 2011, nonaccruing TDR loans were $8.0 million and had no recorded allowance. At December 31, 2010, nonaccruing TDR loans were $24.9 million and had a recorded allowance of $2.4 million. Accruing TDRs totaled $2.0 million at September 30, 2011, and $1.2 million at December 31, 2010.
Prior to being discontinued in the second half of 2010, the Company’s underwriting policy permitted interest reserves to be partially or fully funded by loan proceeds as a means to support acquisition, construction and development loans. As of September 30, 2011, there were no acquisition, construction and development loans kept current with bank-funded reserves.
At September 30, 2011, OREO totaled $5.7 million all of which is recorded at values based on the Company’s most recent appraisals. At December 31, 2010, OREO was $1.2 million. All OREO properties have been written down to their respective fair values.

 

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The following table summarizes nonperforming assets at September 30, 2011 and December 31, 2010, 2009, 2008, 2007 and 2006 (dollars in thousands):
Nonperforming Assets
                                                 
    September 30,     December 31,  
    2011     2010     2009     2008     2007     2006*  
 
                                               
Nonaccrual loans
  $ 19,448     $ 40,911     $ 2,688     $     $     $  
Past due 90 days or more and accruing
                                   
Troubled debt restructuring
    2,001       1,198                          
 
                                   
Total nonperforming loans
    21,449       42,109       2,688                    
Other real estate owned
    5,691       1,246       1,550       1,431              
Loans held for sale
    1,559                                
 
                                   
Total nonperforming assets
  $ 28,699     $ 43,355     $ 4,238     $ 1,431     $     $  
 
                                   
 
                                               
Nonperforming loans to total loans
    5.84 %     10.53 %     0.68 %     0.00 %     0.00 %     0.00 %
 
                                               
Nonperforming assets to total assets
    4.93 %     7.04 %     0.89 %     0.33 %     0.00 %     0.00 %
 
                                               
Allowance for loan losses to nonperforming assets
    34.26 %     28.66 %     175.00 %     389.00 %     0.00 %     0.00 %
*   Park Sterling Bank commenced operations on October 25, 2006
Deposits and Other Borrowings
The Company offers a broad range of deposit instruments, including personal and business checking accounts, individual retirement accounts, business and personal money market accounts and certificates of deposit at competitive interest rates. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. The Company regularly evaluates the internal cost of funds, surveys rates offered by competing institutions, reviews cash flow requirements for lending and liquidity and executes rate changes when deemed appropriate.
Total deposits decreased by $32.8 million, or 8.0%, from December 31, 2010 to September 30, 2011. Core deposits (excluding brokered time deposits) decreased $12.5 million, or 4.1%, while brokered time deposits decreased by $20.3 million, or 19.2%. The decrease in core deposits resulted from a shift in pricing to reduce interest expense.
Borrowed funds totaled $28.0 million at September 30, 2011, compared to $27.8 million at December 31, 2010.

 

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Results of Operations
The following table summarizes components of income and expense and the changes in those components for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands):
Condensed Consolidated Statements of Loss
                                                                 
    Three Months Ended                     Nine Months Ended        
    September 30,                     September 30,        
    2011     2010     Change     2011     2010     Change  
    (Unaudited)     $     %     (Unaudited)     $     %  
 
                                                               
Gross interest income
  $ 5,211     $ 5,559     $ (348 )     -6.3 %   $ 16,224     $ 16,848     $ (624 )     -3.7 %
Gross interest expense
    1,357       1,929       (572 )     -29.7 %     4,642       5,711       (1,069 )     -18.7 %
 
                                               
Net interest income
    3,854       3,630       224       6.2 %     11,582       11,137       445       4.0 %
 
                                                               
Provision for loan losses
    568       6,143       (5,575 )     -90.8 %     8,275       8,768       (493 )     -5.6 %
 
                                                               
Noninterest income
    111       26       85       326.9 %     227       88       139       158.0 %
Noninterest expense
    5,216       2,990       2,226       74.4 %     14,924       7,510       7,414       98.7 %
 
                                               
Net loss before taxes
    (1,819 )     (5,477 )     3,658       -66.8 %     (11,390 )     (5,053 )     (6,337 )     125.4 %
 
                                                               
Income tax benefit
    (443 )     (1,809 )     1,366       -75.5 %     (4,013 )     (1,714 )     (2,299 )     134.1 %
 
                                               
 
                                                               
Net loss
  $ (1,376 )   $ (3,668 )   $ 2,292       -62.5 %   $ (7,377 )   $ (3,339 )   $ (4,038 )     120.9 %
 
                                               
Net Income (Loss). The net loss for the three months ended September 30, 2011 was $1.4 million compared to net loss of $3.7 million for the same period in 2010. This decrease in net loss of $2.3 million resulted primarily from a $5.6 million decrease in provision for loan losses partially offset by an increase in noninterest expense of $2.2 million and a decrease in tax benefit of $1.4 million. The net loss for the nine months ended September 30, 2011 was $7.4 million compared to net loss of $3.3 million for the same period in 2010. This increase of $4.1 million resulted primarily from a $7.4 million increase in noninterest expense offset by a $2.2 million increase in tax benefits.
Annualized return on average assets decreased during the nine-month period ended September 30, 2011 to (1.60)% from (.88)% for the same period in 2010. Annualized return on average equity increased from (6.39)% for the nine-month period ended September 30, 2010 to (5.61)% for the same period in 2011.
Net Interest Income. The Company’s largest source of earnings is net interest income, which is the difference between interest income on interest-earning assets and interest paid on deposits and other interest-bearing liabilities. The primary factors that affect net interest income are changes in volume and yields of earning assets and interest-bearing liabilities, which are affected, in part, by management’s responses to changes in interest rates through asset/liability management. Net interest income increased modestly to $3.9 million for the three-month periods ended September 30, 2011 from $3.6 million for the same period in 2010. During the nine-month period ended September 30, 2011, net interest income was $11.6 million as compared to $11.1 million for the same period in 2010, an increase of $0.5 million, or 4.0%.
Total average interest-earning assets increased by $29.0 million, or 5.4%, to $568.7 million for the three months ended September 30, 2011 from $539.7 million for the same period in the previous year. The Company experienced significant movement in average balances of interest-earning assets. Average Federal funds sold decreased by $33.9 million driven by lower of levels of deposits. Average loans declined by $32.5 million, a function of maturities, normal amortization and charge-offs, net of production. The declines were offset by $69.9 million increase in investment securities due to the investment of the net proceeds from the Public Offering and a $25.5 million increase in interest-earning balance at banks in preparation for cash needs related to the Community Capital merger.

 

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Average balances of total interest-bearing liabilities decreased by $24.8 million in the third quarter of 2011, with average total interest-bearing deposit balances decreasing by $24.6 million, or 6.5%, to $354.9 million from $379.5 million for the same period in 2010. Average brokered deposits declined by $31.1 million from the previous year as management reduced the Company’s wholesale funding. This decline in brokered deposits was partially offset by an increase in other average deposits of $19.8 million in the third quarter of 2011 as compared to the same period in 2010. This increase in other average deposits included an increase in average noninterest-bearing deposits of $13.3 million, or 43.1%, to $44.1 million at September 30, 2011 and an increase in average savings and money market deposits of $54.9 million, or 105.4%, to $107.1 million at September 30, 2011.
The Company’s net interest margin increased from 2.67% in the three-month period ended September 30, 2010 to 2.69% in the same period in 2011 as a result of lower yields on interest-bearing liabilities declining more than lower yields on interest-earning assets. Interest paid on funding sources for the three months ended September 30, 2011 totaled $1.4 million, reflecting a 1.40% cost of interest-bearing liabilities. For the same period in 2010, interest of $1.9 million was paid at a cost of interest-bearing liabilities of 1.88%.
Total average interest-earning assets increased by $94.3 million, or 19.4%, to $580.4 million for the nine months ended September 30, 2011 from $486.1 million for the same period in the previous year. The Company experienced growth in the average balances of interest-earning assets, specifically investment securities available-for-sale and Federal funds sold due to the investment of the net proceeds from the Public Offering. The average balance of investment securities available-for-sale increased by $84.8 million along with a $14.1 million increase in the average balance of Federal funds sold.
Average balances of total interest-bearing liabilities decreased for the nine months ended September 30, 2011, with average total interest-bearing deposit balances decreasing by $6.8 million, or 1.8%, to $365.1 million in 2011 from $371.9 million for the same period in 2010. Average brokered deposits declined by $31.8 million from the previous year as management reduced the Company’s wholesale funding. This decline in brokered deposits was more than offset by an increase in other average deposits of $36.7 million in the first nine months of 2011 as compared to the same period in 2010. This increase in other average deposits includes an increase in average noninterest-bearing deposits of $11.8 million, or 41.1%, to $40.3 million at September 30, 2011 and an increase in average savings and money market deposits of $44.9 million, or 97.5%, to $90.9 million at September 30, 2011.
The Company’s net interest margin decreased from 3.06% in the nine-month period ended September 30, 2010 to 2.67% in the same period in 2011 as a result of lower yields on investments and the loss of income on nonaccrual loans. Interest paid on funding sources for the nine months ended September 30, 2011 totaled $4.6 million, reflecting a 1.58% cost of interest-bearing liabilities. For the same period in 2010, interest of $5.7 million was paid at a cost of interest-bearing liabilities of 1.89%.

 

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The following tables summarize net interest income and average yields and rates paid for the periods indicated (dollars in thousands):
Average Balance Sheets and Net Interest Analysis
                                                 
    For the Three Months Ended September 30,  
    2011     2010  
    Average     Income/     Yield/     Average     Income/     Yield/  
    Balance     Expense     Rate     Balance     Expense     Rate  
Assets
                                               
Interest-earning assets:
                                               
Loans, including fees (1)
  $ 367,096     $ 4,283       4.63 %   $ 399,580     $ 4,963       4.93 %
Federal funds sold
    36,505       22       0.24 %     70,388       42       0.24 %
Taxable investment securities
    118,445       681       2.30 %     50,216       370       2.95 %
Tax-exempt investment securities
    16,201       181       4.47 %     14,570       161       4.42 %
Other interest-earning assets
    30,496       44       0.57 %     4,971       23       1.84 %
 
                                   
 
                                               
Total interest-earning assets
    568,743       5,211       3.64 %     539,725       5,559       4.09 %
 
                                               
Allowance for loan losses
    (10,698 )                     (9,061 )                
Cash and due from banks
    14,315                       8,061                  
Premises and equipment
    5,087                       4,596                  
Other assets
    29,607                       12,339                  
 
                                           
 
                                               
Total assets
  $ 607,054                     $ 555,660                  
 
                                           
 
                                               
Liabilities and shareholders’ equity
                                               
Interest-bearing liabilities:
                                               
Interest-bearing demand
  $ 12,770     $ 3       0.09 %   $ 9,695     $ 3       0.12 %
Savings and money market
    107,069       155       0.57 %     52,138       101       0.77 %
Time deposits — core
    141,154       487       1.37 %     192,666       909       1.87 %
Time deposits — brokered
    93,906       381       1.61 %     125,007       581       1.84 %
 
                                   
Total interest-bearing deposits
    354,899       1,026       1.15 %     379,506       1,594       1.67 %
Federal Home Loan Bank advances
    20,000       140       2.78 %     20,000       144       2.86 %
Other borrowings
    8,418       191       9.00 %     8,490       191       8.93 %
 
                                   
Total borrowed funds
    28,418       331       4.62 %     28,490       335       4.67 %
 
                                   
 
                                               
Total interest-bearing liabilities
    383,317       1,357       1.40 %     407,996       1,929       1.88 %
 
                                   
 
                                               
Net interest rate spread
            3,854       2.23 %             3,630       2.21 %
 
                                       
 
                                               
Noninterest-bearing demand deposits
    44,130                       30,833                  
Other liabilities
    5,210                       2,168                  
Shareholders’ equity
    174,397                       114,663                  
 
                                           
Total liabilities and shareholders’ equity
  $ 607,054                     $ 555,660                  
 
                                       
Net interest margin
                    2.69 %                     2.67 %
 
                                           
(1)   Average loan balances include nonaccrual loans.

 

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Average Balance Sheets and Net Interest Analysis
                                                 
    For the Nine Months Ended September 30,  
    2011     2010  
    Average     Income/     Yield/     Average     Income/     Yield/  
    Balance     Expense     Rate     Balance     Expense     Rate  
Assets
                                               
Interest-earning assets:
                                               
Loans, including fees (1)
  $ 383,242     $ 13,491       4.71 %   $ 398,381     $ 15,275       5.13 %
Federal funds sold
    48,555       85       0.23 %     34,358       60       0.23 %
Taxable investment securities
    119,084       2,046       2.29 %     35,664       981       3.67 %
Tax-exempt investment securities
    15,634       533       4.55 %     14,304       481       4.48 %
Other interest-earning assets
    13,877       69       0.66 %     3,431       51       1.99 %
 
                                   
 
                                               
Total interest-earning assets
    580,392       16,224       3.74 %     486,138       16,848       4.63 %
 
                                               
Allowance for loan losses
    (11,569 )                     (8,408 )                
Cash and due from banks
    17,424                       7,915                  
Premises and equipment
    4,757                       4,619                  
Other assets
    22,674                       12,847                  
 
                                           
 
                                               
Total assets
  $ 613,678                     $ 503,111                  
 
                                           
 
                                               
Liabilities and shareholders’ equity
                                               
Interest-bearing liabilities:
                                               
Interest-bearing demand
  $ 11,737     $ 11       0.13 %   $ 9,440     $ 6       0.08 %
Savings and money market
    90,918       464       0.68 %     46,039       270       0.78 %
Time deposits — core
    164,059       1,870       1.52 %     186,272       2,718       1.95 %
Time deposits — brokered
    98,356       1,304       1.77 %     130,114       1,716       1.76 %
 
                                   
Total interest-bearing deposits
    365,070       3,649       1.34 %     371,865       4,710       1.69 %
Federal Home Loan Bank advances
    20,000       422       2.82 %     22,820       423       2.48 %
Other borrowings
    8,276       571       9.22 %     8,747       578       8.83 %
 
                                   
Total borrowed funds
    28,276       993       4.70 %     31,567       1,001       4.24 %
 
                                   
 
                                               
Total interest-bearing liabilities
    393,346       4,642       1.58 %     403,432       5,711       1.89 %
 
                                   
 
                                               
Net interest rate spread
            11,582       2.16 %             11,137       2.74 %
 
                                       
 
                                               
Noninterest-bearing demand deposits
    40,322                       28,571                  
Other liabilities
    4,527                       1,475                  
Shareholders’ equity
    175,483                       69,633                  
 
                                           
Total liabilities and shareholders’ equity
  $ 613,678                     $ 503,111                  
 
                                       
Net interest margin
                    2.67 %                     3.06 %
 
                                           
(1)   Average loan balances include nonaccrual loans.

 

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Provision for Loan Losses. The Company’s provision for loan losses decreased $5.6 million, or 90.7%, to $0.6 million during the three months ended September 30, 2011, from $6.1 million during the corresponding period in 2010 and $0.5 million, or 5.6%, to $8.3 million during the nine months ended September 30, 2011, from $8.7 million during the corresponding period in 2010. The decrease in the provision is a result of a reduction in outstanding loans and improvement in the quality of the Company’s loans. The Company had $2.0 million in net charge-offs during the three months ended September 30, 2011 compared to $0.5 million during the corresponding period in 2010. Year-to-date net charge-offs were $10.9 million compared to $1.1 million during the first nine months of 2010.
The ratio of the allowance for loan losses to total loans was 2.68% and 3.11% at September 30, 2011 and December 31, 2010, respectively. Management periodically evaluates its credit policies and procedures to confirm that they effectively manage risk and facilitate appropriate internal controls.
Noninterest Income. Noninterest income has not historically been a major component of the Company’s earnings, being primarily comprised of service charges and gains on sales of securities. During the third quarter, the Company purchased $8 million of bank-owned life insurance to offset the costs of employer provided benefit plans. Noninterest income increased from $26 thousand for the three months ended September 30, 2010 to $111 thousand for the same period in 2011. The growth in non-interest income was primarily related to the increase in the cash surrender value of bank-owned life insurance of $52 thousand and a $25 thousand annual dividend on the Company’s SBIC investment.
Noninterest income increased from $88 thousand for the nine months ended September 30, 2010 to $227 thousand for the same period in 2011. The growth in non-interest income was primarily related to the increase in the cash surrender value of bank-owned life insurance of $52 thousand for the nine months ended September 30, 2011.
Noninterest Expense. The level of noninterest expense substantially affects the Company’s profitability. Total noninterest expense was $5.2 million for the three months ended September 30, 2011 compared to $3.0 million for the same period in 2010. The increase of $2.2 million, or 74.4%, included an increase in salaries and benefits in the amount of $1.3 million as a result of an increase in full time equivalent employees (“FTEs”), reflecting the Company’s change in strategy and expansion into de novo markets. FTEs increased from 82 at June 30, 2011 to 83 at September 30, 2011, compared to an increase of 5 from 49 at June 30, 2010 to 54 at September 30, 2011. The increase in noninterest expense also included a $0.6 million increase in legal and professional fees of which approximately $0.5 million was merger-related.
Total noninterest expense was $14.9 million for the nine months ended September 30, 2011 compared to $7.5 million for the same period in 2010. The increase of $7.4 million, or 98.7%, included an increase in salaries and benefits in the amount of $4.2 million as a result of an increase in FTEs, reflecting the Company’s change in strategy and expansion into de novo markets. FTEs increased from 62 at December 31, 2010 to 83 September 30, 2011, compared to an increase of 11 from 43 at December 31, 2009 to 54 at September 30, 2010. Legal and professional fees also increased by $2.0 million primarily as a result of the Company becoming a public entity. Approximately $1.2 million of these fees was merger-related.

 

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The following table presents components of noninterest expense for the three and nine months ended September 30, 2011 and 2010 (dollars in thousands):
Noninterest Expense
                                                                 
    Three months ended                     Nine months ended        
    September 30,                     September 30,        
    2011     2010     Change     2011     2010     Change  
    (Unaudited)     $     %     (Unaudited)     $     %  
 
                                                               
Salaries and employee benefits
  $ 3,051     $ 1,777     $ 1,274       71.7 %   $ 8,533     $ 4,328     $ 4,205       97.2 %
Occupancy and equipment
    369       236       133       56.4 %     926       666       260       39.0 %
Advertising and promotion
    115       84       31       36.9 %     240       237       3       1.3 %
Legal and professional fees
    721       78       643       824.4 %     2,233       237       1,996       842.2 %
Deposit charges and FDIC insurance
    134       184       (50 )     -27.2 %     617       543       74       13.6 %
Data processing and outside service fees
    142       109       33       30.3 %     393       302       91       30.1 %
Director fees
    45       164       (119 )     -72.6 %     131       211       (80 )     -37.9 %
Net cost of operation of other real estate
    101       120       (19 )     -15.8 %     429       395       34       8.6 %
Loan and collection expense
    180       82       98       119.5 %     375       161       214       132.9 %
Shareholder reporting expense
    36       8       28       350.0 %     194       24       170       708.3 %
Other noninterest expense
    322       148       174       117.6 %     853       406       447       110.1 %
 
                                               
 
                                                               
Total noninterest expense
  $ 5,216     $ 2,990     $ 2,226       74.4 %   $ 14,924     $ 7,510     $ 7,414       98.7 %
 
                                               
Income Taxes. The Company generates significant amounts of non-taxable income from tax-exempt investment securities. Accordingly, the level of such income in relation to income before taxes significantly affects the Company’s effective tax rate. For the three months ended September 30, 2011, the Company recognized an income tax benefit of $0.4 million compared to a benefit of $1.8 million for the same period in 2010. For the nine months ended September 30, 2011, the Company recognized an income tax benefit of $4.0 million compared to a benefit of $1.7 million for the same period in 2010. The effective tax rate for the nine months ended September 30, 2011 was 35.22% compared to 33.92% for the same period in 2010.
Liquidity and Capital Resources
Liquidity refers to the ability to manage future cash flows to meet the needs of depositors and borrowers and to fund operations. Management strives to maintain sufficient liquidity to fund future loan demand and to satisfy fluctuations in deposit levels. This is achieved primarily in the form of available lines of credit from various correspondent banks, the FHLB, the Federal Reserve Discount Window, and through an investment portfolio. In addition, the Company occasionally has short-term investments at its primary correspondent bank in the form of Federal funds sold. Liquidity is governed by an asset/liability policy approved by the board of directors and administered by an internal Senior Management Risk Committee (the “Committee”). The Committee reports on a monthly basis asset/liability related matters to the Loan and Risk Committee of the board of directors.

 

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The Company’s internal liquidity ratio was 49.7% at September 30, 2011 compared to 50.5% at December 31, 2010. In addition, at September 30, 2011, the Company had an additional $36.5 million of credit available from the FHLB, $23.9 million from the Federal Reserve Discount Window and available lines of credit totaling $70.0 million from correspondent banks.
At September 30, 2011, the Company had $31.8 million of loan commitments outstanding, $69.1 million of pre-approved but unused lines of credit and $3.7 million of standby letters of credit and financial guarantees. In management’s opinion, these commitments represent no more than normal lending risk to the Company and will be funded from normal sources of liquidity. At December 31, 2010, the Company had $3.8 million of loan commitments outstanding, $69.6 million of pre-approved but unused lines of credit and $2.9 million of standby letters of credit and financial guarantees.
The Company’s capital position is reflected in its shareholders’ equity, subject to certain adjustments for regulatory purposes. Shareholders’ equity, or capital, is a measure of the Company’s net worth, soundness and viability. Shareholders’ equity on September 30, 2011 was $174.6 million compared to the December 31, 2010 balance of $177.1 million. In August 2010, the Company completed its Public Offering of 23,100,000 shares of common stock at an initial purchase price of $6.50 per share for an aggregate offering price of approximately $150.2 million. As a result of the offering, the Company received net proceeds of approximately $140.2 million, after $9.0 million in underwriting fees, including the $3.0 million in contingent fees (described in Note 3 to the unaudited condensed consolidated financial statements included in this Quarterly Report on Form 10-Q), and approximately $0.9 million in related expenses. Remaining proceeds have been invested in accordance with the Company’s investment policies.
Risk-based capital regulations adopted by the Federal Reserve Board and the FDIC require bank holding companies and banks to achieve and maintain specified ratios of capital to risk-weighted assets. The risk-based capital rules are designed to measure “Tier 1” capital (consisting generally of common shareholders’ equity, a limited amount of qualifying perpetual preferred stock and trust preferred securities, and minority interests in consolidated subsidiaries, net of goodwill and other intangible assets and certain other items) and total capital (consisting of Tier 1 capital and Tier 2 capital, which generally includes certain preferred stock, mandatory convertible debt securities and term subordinated debt) in relation to the credit risk of both on- and off-balance sheet items. Under the guidelines, one of four risk weights is applied to the different on-balance sheet items. Off-balance sheet items, such as loan commitments, are also subject to risk weighting after conversion to balance sheet equivalent amounts. All banks must maintain a minimum total capital to total risk weighted assets ratio of 8.00%, at least half of which must be in the form of core, or Tier 1, capital. These guidelines also specify that banks that are experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels. At September 30, 2011, the Company and the Bank satisfied the

 

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respective minimum regulatory capital requirements, and were “well capitalized” within the meaning of Federal regulatory requirements. The Company’s risk-weighted assets at September 30, 2011 and December 31, 2010 were $428.6 million and $431.3 million, respectively. Actual capital levels and minimum levels at September 30, 2011 and December 31, 2010 were (dollars in thousands):
Capital Ratios
                                                 
                                    To Be Well  
                    For Capital     Capitalized Under  
                    Adequacy     Prompt Corrective  
    Actual     Purposes     Actions Provisions  
    Amount     Ratio     Amount     Ratio     Amount     Ratio  
 
                                               
Park Sterling Corporation
                                               
September 30, 2011
                                               
Total Risk-Based Capital Ratio
  $ 174,273       40.66 %   $ 34,288       8.00 %   $ 42,860       10.00 %
 
                                               
Tier 1 Capital Ratio
    161,965       37.79 %     17,144       4.00 %     25,716       6.00 %
 
                                               
Tier 1 Leverage Ratio
    161,965       27.13 %     23,876       4.00 %     29,846       5.00 %
 
                                               
December 31, 2010*
                                               
Total Risk-Based Capital Ratio
  $ 185,768       43.06 %   $ 34,035       8.00 %   $ 42,543       10.00 %
 
                                               
Tier 1 Capital Ratio
    173,395       40.20 %     17,017       4.00 %     25,525       6.00 %
 
                                               
Tier 1 Leverage Ratio
    173,395       27.39 %     22,227       4.00 %     27,784       5.00 %
 
                                               
Park Sterling Bank
                                               
September 30, 2011
                                               
Total Risk-Based Capital Ratio
  $ 98,855       23.80 %   $ 33,225       8.00 %   $ 41,532       10.00 %
 
                                               
Tier 1 Capital Ratio
    86,711       20.88 %     16,613       4.00 %     24,919       6.00 %
 
                                               
Tier 1 Leverage Ratio
    86,711       16.67 %     20,812       4.00 %     26,015       5.00 %
 
                                               
December 31, 2010
                                               
Total Risk-Based Capital Ratio
  $ 185,768       43.06 %   $ 34,035       8.00 %   $ 42,543       10.00 %
 
                                               
Tier 1 Capital Ratio
    173,395       40.20 %     17,017       4.00 %     25,525       6.00 %
 
                                               
Tier 1 Leverage Ratio
    173,395       27.39 %     22,227       4.00 %     27,784       5.00 %
*   The consolidated capital ratios presented herein, as of December 31, 2010, are those of the Bank, prior to the effectiveness of the Reorganization on January 1, 2011.
The Bank has committed to its regulators to maintain a Tier 1 Leverage Ratio of at least 10.00% for the three years following the Public Offering.
Disclosure of Contractual Obligations, Commitments and Off-Balance Sheet Arrangements
In the ordinary course of operations, the Company enters into certain contractual obligations. Such obligations include the funding of operations through debt issuances as well as leases for premises and equipment.
Information about the Company’s off-balance sheet risk exposure is presented in Note K of the 2010 Audited Financial Statements. As part of ongoing business, the Company has not participated in transactions that generate relationships with unconsolidated entities or financial partnerships, such as entities often referred to as special purpose entities (“SPEs”), which are generally established for facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As of September 30, 2011, the Company was not involved in any unconsolidated SPE transactions.

 

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Impact of Inflation and Changing Prices
The Company has an asset and liability make-up that is distinctly different from that of an entity with substantial investments in plant and inventory because the major portions of a commercial bank’s assets are monetary in nature. As a result, the Company’s performance may be significantly influenced by changes in interest rates. Although the Company and the banking industry are more affected by changes in interest rates than by inflation in the prices of goods and services, inflation is a factor that may influence interest rates. However, the frequency and magnitude of interest rate fluctuations do not necessarily coincide with changes in the general inflation rate. Inflation does affect operating expenses in that personnel expenses and the cost of supplies and outside services tend to increase more during periods of high inflation.
Interest Rate Sensitivity
The Committee actively evaluates and manages interest rate risk using a process developed by the Company. The Committee is also responsible for approving the Company’s asset/liability management policies, overseeing the formulation and implementation of strategies to improve balance sheet positioning and earnings, and reviewing the Company’s interest rate sensitivity position.
The primary measures that management uses to evaluate short-term interest rate risk include (i) cumulative gap summary, which measures potential changes in cash flows should interest rates rise or fall; (ii) net interest income at risk, which projects the impact of different interest rate scenarios on net interest income over one-year and two-year time horizons; (iii) net income at risk, which projects the impact of different interest rate scenarios on net income over one-year and two-year time horizons; and (iv) economic value of equity at risk, which measures potential long-term risk in the balance sheet by valuing the Company’s assets and liabilities at “market” under different interest rate scenarios.
These measures have historically been calculated under a simulation model prepared by an independent correspondent bank assuming incremental 100 basis point shocks (or immediate shifts) in interest rates up to a total increase or decrease of 300 basis points. These simulations estimate the impact that various changes in the overall level of interest rates over a one- and two- year time horizon would have on net interest income. The results help the Company develop strategies for managing exposure to interest rate risk. Like any forecasting technique, interest rate simulation modeling is based on a large number of assumptions. In this case, the assumptions relate primarily to loan and deposit growth, asset and liability prepayments, interest rates and balance sheet management strategies. Management believes that the assumptions are reasonable, both individually and in the aggregate. Nevertheless, the simulation modeling process produces only a sophisticated estimate, not a precise calculation of exposure. The overall interest rate risk management process is subject to annual review by an outside professional services firm to ascertain its effectiveness as required by Federal regulations.
The Company’s current guidelines for risk management call for preventive measures if a 300 basis point shock or immediate increase or decrease in short term rates over the next 12 months would affect net interest income over the same period by more than 30.0%. The Company currently operates well within these guidelines. As of September 30, 2011, based on the results of the simulation model, the Company could expect net interest income to decrease by approximately 2.7% over 12 months if short-term interest rates immediately decreased by 300 basis points, which is unlikely based on current rate levels. If short-term interest rates increased by 300 basis points, net interest income could be expected to increase by approximately 6.3% over 12 months. At December 31, 2010, the simulation model results showed that the Company could expect net interest income to decrease by approximately 4.8% over 12 months if short-term interest rates decreased by 300 basis points, and if short-term interest rates increased by 300 basis points, net interest income could be expected to increase by approximately 6.6% over 12 months.

 

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The Company uses multiple interest rate swap agreements, accounted for as either cash flow or fair value hedges, as part of the management of interest rate risk. In May 2011, the Company’s interest rate swap that was accounted for as a cash flow hedge terminated. The swap had a notional amount of $40.0 million that was purchased on May 16, 2008 to protect the Company from falling rates. The Company received 6.22% fixed for a period of three years, and paid prime rate for the same period, currently at 3.25%. As a result of the termination, there was no income recorded in the three months ended September 30, 2011. During the three months ended September 2010, the Company recorded $0.5 million of income from this instrument. During the nine months ended September 30, 2011 and 2010, the Company recorded $0.3 million and $0.9 million of income, respectively, from this instrument.
The Company has entered into seven loan swaps, including one forward-starting swap, accounted for as fair value hedges. The fair value mark on the forward-starting swap will be offset when the associated loan closes and is marked to fair value in the fourth quarter of 2011. The total original notional amount of these swaps was $17.4 million. These derivative instruments are used to protect the Company from interest rate risk caused by changes in the LIBOR curve in relation to certain designated fixed rate loans. These derivative instruments are carried at a fair market value of $(0.7) million at September 30, 2011. The Company recorded interest expense on these loan swaps of $0.2 million and $0.4 million in each of the three and nine months ended September 30, 2011, and $0.1 million and $0.3 million in each of the three and nine months ended September 30, 2010.
For cash flow hedges, the Company uses the dollar-offset method for assessing effectiveness using the cumulative approach. The dollar-offset method compares the dollar amount of the change in anticipated future cash flows of the hedging instrument with the dollar amount of the changes in anticipated future cash flows of the risk being hedged over the assessment period. The cumulative approach involves comparing the cumulative changes in the hedging instrument’s anticipated future cash flows to the cumulative changes in the hedged transaction’s anticipated future cash flows. Because the floating index and reset dates are based on identical terms, management believes that the hedge relationship of the cumulative changes in expected future cash flow from the hedging derivative and the cumulative changes in expected interest cash flows from the hedged exposure will be highly effective.
Consistent with the risk management objective and the hedge accounting designation, management measures the degree of hedge effectiveness by comparing the cumulative change in anticipated interest cash flows from the hedged exposure over the hedging period to the cumulative change in anticipated cash flows from the hedging derivative. Any difference between these two measures will be deemed hedge ineffectiveness and recorded in current earnings. Management utilizes the “Hypothetical Derivative Method” to compute the cumulative change in anticipated interest cash flows from the hedged exposure. To the extent that the cumulative change in anticipated cash flows from the hedging derivative offsets from 80% to 125% of the cumulative change in anticipated interest cash flows from the hedged exposure, the hedge is deemed effective.
For fair value hedges, ASC Topic 815 requires that the method selected for assessing hedge effectiveness must be reasonable, be defined at the inception of the hedging relationship and be applied consistently throughout the hedging relationship. The Company uses the dollar-offset method for assessing effectiveness using the cumulative approach. The dollar-offset method compares the fair value of the hedging derivative with the fair value of the hedged exposure. The cumulative approach involves comparing the cumulative changes in the hedging derivative’s fair value to the cumulative changes in the hedged exposure’s fair value. The calculation of dollar offset is the change in clean fair value of hedging derivative, divided by the change in fair value of the hedged exposure attributable to changes in the LIBOR curve. To the extent that the cumulative change in fair value of the hedging derivative offsets from 80% to 125% of the cumulative change in fair value of the hedged exposure, the hedge will be deemed effective. The change in fair value of the hedging derivative and the change in fair value of the hedged exposure are recorded in earnings. Any hedge ineffectiveness is also reflected in current earnings.
Prime rate swaps (pay floating, received fixed) are recorded on the balance sheet in other assets or liabilities at fair market value. Loan swaps (pay fixed, receive floating) are carried at fair market value and are included in loans. Changes in fair value of the hedged loans have been completely offset by the fair value changes in the derivatives, which are in contra asset accounts included in loans.
See Note L of the 2010 Audited Financial Statements and Note 9 of the Company’s unaudited condensed financial statements included in this Quarterly Report on Form 10-Q for further discussion of the Company’s derivative financial instruments and hedging activities.

 

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Financial institutions are subject to interest rate risk to the degree that their interest-bearing liabilities, primarily deposits, mature or reprice more or less frequently, or on a different basis, than their interest-earning assets, primarily loans and investment securities. The match between the scheduled repricing and maturities of the Company’s interest-earning assets and liabilities within defined periods is referred to as “gap” analysis. At September 30, 2011, the Company’s cumulative one-year gap was a positive, or asset sensitive, $121.8 million, or 20.9% of total assets. The Company’s cumulative one-year gap at December 31, 2010 was $42.9 million, or 7.0%, of total assets.
The following table reflects the Company’s rate sensitive assets and liabilities by maturity as of September 30, 2011 (dollars in thousands). Variable rate loans are shown in the category of due “within three months” because they reprice with changes in the prime lending rate. Fixed rate loans are presented assuming the entire loan matures on the final due date, although payments are actually made at regular intervals and are not reflected in this schedule.

 

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Interest Rate Gap Sensitivity
                                         
    Within     Three     One Year              
    Three     Months to     to Five     After        
    Months     One Year     Years     Five Years     Total  
 
                                       
At September 30, 2011:
                                       
Interest-earning assets:
                                       
Interest-bearing deposits
  $ 36,311     $     $     $     $ 36,311  
Federal funds sold
    5,295                         5,295  
Securities
    6,185       17,280       60,117       47,085       130,667  
Loan held for sale
                      1,559       1,559  
Loans
    207,724       53,348       105,766       574       367,412  
Bank owned life insurance
    8,052                         8,052  
 
                             
Total interest-earning assets
    263,567       70,628       165,883       49,218       549,296  
 
                             
 
                                       
Interest-bearing liabilities:
                                       
Demand deposits
    3,106             7,100       5,328       15,534  
MMDA and savings
    104,483                         104,483  
Time deposits
    29,516       91,046       91,523             212,085  
Short term borrowings
    1,083                         1,083  
Long term borrowings
                20,000       6,895       26,895  
 
                             
Total interest-bearing liabilities
    138,188       91,046       118,623       12,223       360,080  
 
                             
 
                                       
Derivatives
    16,834             (13,238 )     (3,596 )      
 
                             
 
                                       
Interest sensitivity gap
  $ 142,213     $ (20,418 )   $ 34,022     $ 33,399     $ 189,216  
Cummulative interest sensitivity gap
  $ 142,213     $ 121,795     $ 155,817     $ 189,216          
 
                                       
Percentage of total assets
            20.89 %                        
 
                                     
 
                                       
At December 31, 2010:
                                       
Interest-earning assets:
                                       
Interest bearing deposits
  $ 5,040     $     $     $     $ 5,040  
Federal funds sold
    57,905                         57,905  
Securities
                12,590       128,000       140,590  
Loans
    245,364       16,532       133,416       4,517       399,829  
Other interest-earning assets
                      2,275       2,275  
 
                             
Total interest-earning assets
    308,309       16,532       146,006       134,792       605,639  
 
                             
 
                                       
Interest-bearing liabilities:
                                       
Demand deposits
    9,372                         9,372  
MMDA and savings
    62,293                         62,293  
Time deposits
    74,505       145,549       79,767             299,821  
Short term borrowings
    874                         874  
Long term borrowings
                20,000       6,895       26,895  
 
                             
Total interest-bearing liabilities
    147,044       145,549       99,767       6,895       399,255  
 
                             
 
                                       
Derivatives
    (29,316 )     40,000       (7,036 )     (3,648 )      
 
                             
 
                                       
Interest sensitivity gap
  $ 131,949     $ (89,017 )   $ 39,203     $ 124,249     $ 206,384  
Cummulative interest sensitivity gap
  $ 131,949     $ 42,932     $ 82,135     $ 206,384          
 
                                       
Percentage of total assets
            6.97 %                        
 
                                     

 

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Item 3.   Quantitative and Qualitative Disclosures about Market Risk.
See “Interest Rate Sensitivity” in the Management’s Discussion and Analysis of Financial Condition and Results of Operations in Part I, Item 2 for disclosures about market risk.
Item 4.   Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this Quarterly Report on Form 10-Q, the management of the Company, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, carried out an evaluation of the effectiveness of the Company’s disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of such date.
Changes in Internal Control Over Financial Reporting
There was no change in the Company’s internal control over financial reporting that occurred during the third fiscal quarter of 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1.   Legal Proceedings
In the ordinary course of business, the Company may be a party to various legal proceedings from time to time. There are no material pending legal proceedings to which the Company is a party or of which any of its property is subject. In addition, the Company is not aware of any threatened litigation, unasserted claims or assessments that could have a material adverse effect on its business, operating results or financial condition.
Item 1A   Risk Factors
Not applicable.
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds
During the three months ended September 30, 2011, the Company did not have any unregistered sales of equity securities or repurchases of its common stock.
Item 3.   Defaults Upon Senior Securities
Not applicable.
Item 4.   [Removed and Reserved]
Item 5.   Other Information
Not applicable.

 

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Item 6.   Exhibits
The following documents are filed or furnished as exhibits to this report:
         
Exhibit    
Number   Description of Exhibits
       
 
  3.1    
Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
       
 
  3.2    
Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
       
 
  31.1    
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1    
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  32.2    
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  101    
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010; (ii) Condensed Consolidated Statements of Income (Loss) for the three and nine months ended September 30, 2011 and 2010; (iii) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2011 and 2010; (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010; and (v) Notes to Condensed Consolidated Financial Statements*
*   The information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934

 

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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.
         
  PARK STERLING CORPORATION
 
 
Date: November 14, 2011  By:   /s/ James C. Cherry    
    James C. Cherry   
    Chief Executive Officer (authorized officer)   
       
Date: November 14, 2011  By:   /s/ David L. Gaines    
    David L. Gaines   
    Chief Financial Officer (principal financial officer)   
 

 

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Exhibit Index
         
Exhibit    
Number   Description of Exhibits
       
 
  3.1    
Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
       
 
  3.2    
Bylaws of the Company, incorporated by reference to Exhibit 3.2 of the Company’s Current Report on Form 8-K (File No. 001-35032) filed January 13, 2011
       
 
  31.1    
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  31.2    
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
 
  32.1    
Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  32.2    
Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
 
  101    
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010; (ii) Condensed Consolidated Statements of Income (Loss) for the three and nine months ended September 30, 2011 and 2010; (iii) Condensed Consolidated Statements of Changes in Shareholders’ Equity for the nine months ended September 30, 2011 and 2010; (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010; and (v) Notes to Condensed Consolidated Financial Statements*
*   The information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934

 

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