Quarterly Report (10-q)

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”). At September 30, 2016 and December 31, 2015, the Company’s primary operations and business were that of owning the Bank.

 

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 “2015 Audited Financial Statements”) included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 filed with the Securities and Exchange Commission (“SEC”) on March 6, 2016 (the “2015 Form 10-K”).

 

In management’s opinion, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which consist of normal, recurring adjustments, necessary to present fairly the financial position of the Company as of September 30, 2016 and December 31, 2015, the results of its operations for the three and nine months ended September 30, 2016 and 2015, and cash flows for the nine months ended September 30, 2016 and 2015. Operating results for the nine-month period ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year or for other interim periods.

 

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 purchased credit-impaired (“PCI”) loans, the valuation of the allowance for loan losses, the determination of the need for a deferred tax asset valuation allowance, the fair value of financial instruments and other accounts and the fair value of assets and liabilities acquired in the acquisition of First Capital Bancorp, Inc. (“First Capital”).

 

Tabular information, other than share and per share data, is presented in thousands of dollars. Certain amounts reported in prior periods have been reclassified to conform to the current period presentation.

Note 2 - Recent Accounting Pronouncements

 

During the first quarter of 2016, the Company adopted Accounting Standards Update (“ASU”) 2015-16, “Simplifying the Accounting for Measurement Period Adjustments” (“ASU 2015-16”). ASU 2015-16 simplifies the accounting for adjustments made to provisional amounts recognized in a business combination by eliminating the requirement to retrospectively account for those adjustments. The amendments in ASU 2015-16 were effective for fiscal years beginning after December 15, 2015. This guidance did not have a material effect on the Company’s financial statements.

 

During the first quarter of 2016, the Company also adopted ASU 2015-03, “Interest- Imputation of Interest (Subtopic 835-300: Simplifying the Presentation of Debt Issuance Costs)” (“ASU 2015-03”). The amendments in this ASU require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability, consistent with debt discounts. The guidance was effective for fiscal years beginning after December 31, 2015 and interim periods within that year. This guidance did not have a material effect on the Company’s financial statements.

 

On January 5, 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-01, “Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”). Changes to the current GAAP model primarily affect the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The guidance will be effective in fiscal years beginning after December 15, 2017, including interim periods within that fiscal year. The Company is evaluating the impact of this update on its financial statements.

 

 

PARK STERLING CORPORATION

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Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 

In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”), which is intended to improve financial reporting about leasing transactions. ASU 2016-02 will require organizations (“lessees”) that lease assets with lease terms of more than twelve months to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Financial reporting for organizations that own the assets leased by lessees (“lessors”) will remain largely unchanged from current GAAP. In addition, the ASU will require disclosures to help investors and other financial statement users better understand the amount, timing and uncertainty of cash flows arising from leases. The effective date of this ASU is for fiscal years beginning after December 31, 2018 and interim periods within that year. The Company is evaluating the impact of this standard on its financial statements.

 

In February 2016, the FASB issued ASU 2016-09, “Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”), which is intended to improve accounting for share-based payment award transactions. ASU 2016-09 will simplify share-based transactions including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. The effective date of this ASU is for fiscal years beginning after December 31, 2016, including interim periods within those fiscal years. The Company is evaluating the impact of this update on its financial statements.

 

In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”) as part of its project on financial instruments. ASU 2016-13 introduces an approach based on expected losses to estimate credit losses on certain types of financial instruments. It also modifies the impairment model for available-for-sale (AFS) debt securities and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The effective date of this ASU is for reporting periods beginning after December 15, 2019. The implementation of ASU 2016-13 will have a significant impact on both the method of estimating credit losses as well as the amount of credit losses reflected in the Company’s financial statements. The Company is currently in a planning phase for implementation of the new standard and its expected impact on its financial statements.

 

In August 2016, the FASB issued Accounting Standards Update ASU No. 2016-15,  Statement of Cash Flows (Topic 230):  Classification of Certain Cash Receipts and Cash Payments:  (“ASU 2016-15”).  ASU 2016-15 addresses eight classification issues related to the statement of cash flows.  The updated guidance is effective for interim and annual reporting periods beginning after December 15, 2017, including interim periods within those fiscal years.  Early adoption is permitted.  Entities will apply the standard's provisions using a retrospective transition method to each period presented.  The Company does not believe this guidance will have a material impact on the Company’s consolidated financial statements.

Note 3– Business Combinations and Goodwill

 

Business Combinations

 

Generally, acquisitions are accounted for under the acquisition method of accounting in accordance with Accounting Standards Codification (“ASC”) 805, Business Combinations . Both the purchased assets and liabilities assumed are recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, especially the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate estimated fair values. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available.

 

 

PARK STERLING CORPORATION

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Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 

First Capital

 

On January 1, 2016, the Company acquired First Capital pursuant to the merger agreement dated September 30, 2015. Upon completion of the merger, First Capital common shareholders received either $5.54 in cash or 0.7748 Park Sterling shares for each First Capital share they held, subject to the limitation that the total consideration for shareholders consisted of 30.0% in cash and 70.0% in Park Sterling shares; First Capital warrant holders received either $1.77 in cash or 0.24755 Park Sterling shares for each First Capital warrant they held, subject to the limitation that the total consideration for warrant holders consisted of 30.0% in cash and 70.0% in Park Sterling shares; and each outstanding option to purchase shares of First Capital common stock was converted into the right to receive cash equal to the product of (a) $5.54 minus the per share exercise price of such option, and (b) the number of shares of First Capital common stock subject to the option. After application of the elections made by the holders of First Capital’s common stock and warrants and the allocation procedures contained in the merger agreement, the aggregate merger consideration consisted of approximately 8,376,094 shares of the Company’s common stock and approximately $25.8 million in cash. Based upon the $7.32 per share closing price of the Company’s common stock on December 31, 2015, the transaction value was approximately $87.1 million.

 

The assets acquired and liabilities assumed from First Capital were recorded at their fair value as of the closing date of the merger. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition as additional information regarding the closing date fair values becomes available. Goodwill of $34.5 million was initially recorded at the time of the acquisition. As a result of refinements to the fair value mark on nonmarketable equity securities, deferred tax asset, other assets and other liabilities, goodwill as indicated below is $0.7 million less than the goodwill estimated at the time of acquisition; these refinements had no impact on the statement of income. The following table summarizes the consideration paid by the Company in the merger with First Capital and the amounts of the assets acquired and liabilities assumed recognized at the acquisition date:

 

		As Recorded				Fair Value and Other
		by				Merger Related				As Recorded
		First Capital				Adjustments				by the Company
Consideration Paid
Cash										$	25,834
Common shares issued											61,313
Fair Value of Total Consideration Transferred										$	87,147
Recognized amounts of identifiable assets acquired and liabilities assumed:
Cash and cash equivalents		$	13,767			$	-			$	13,767
Securities			77,404				69				77,473
Nonmarketable equity securities			4,161				27				4,188
Loans, net of allowance			500,265				(56	)			500,209
Premises and equipment			11,699				(393	)			11,306
Core deposit intangibles			-				3,700				3,700
Interest receivable			1,856				-				1,856
Bank owned life insurance			10,216				-				10,216
Deferred tax asset			3,956				(706	)			3,250
Other assets			2,962				(123	)			2,839
Total assets acquired			626,286				2,518				628,804
Deposits			506,060				1,683				507,743
Federal Home Loan Bank advances			45,000				503				45,503
Junior Subordinated Debt			9,963				(1,372	)			8,591
Short term borrowings			7,621				-				7,621
Other liabilities			5,994				38				6,032
Total liabilities assumed		$	574,638			$	852			$	575,490
Total net identifiable assets		$	51,648			$	1,666			$	53,314
Goodwill resulting from acquisition										$	33,833

 

 

PARK STERLING CORPORATION

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Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 

The following table presents certain proforma information as if First Capital had been acquired on January 1, 2015. These results combine the historical results of First Capital in the Company’s consolidated statement of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2015. Acquisition-related costs of $7.9 million are included in the Company’s consolidated statements of income for the nine months ended September 30, 2016 and are not included in the proforma information below. In particular, no adjustments have been made to eliminate the amount of First Capital recovery of loan losses of $145 thousand for the nine months ended September 30, 2015. Furthermore, additional expenses related to systems conversions and other costs of integration are expected to be recorded during 2016. Additionally, the Company expects to achieve further operating cost savings and other business synergies as a result of the acquisition which are not reflected in the proforma amounts below:

 

		Proforma Results for the												Actual Results
		Nine Months Ended September 30, 2015												Nine Months Ended
		Park Sterling				First Capital				Combined				September 30, 2016
Total revenues (net interest income plus noninterest income)		$	75,126			$	16,871			$	91,997			$	94,019
Net income			12,831				3,508				16,339				14,617
Basic earnings per common share		$	0.29			$	0.28			$	0.31			$	0.28

 

Note 4 – Investment Securities

 

The amortized cost, unrealized gains and losses, and estimated fair value of securities available-for-sale at September 30, 2016 and December 31, 2015 are as follows:

 

Amortized Cost and Fair Value of Investment Portfolio

 

						Gross				Gross
		Amortized				Unrealized				Unrealized				Fair
		Cost				Gains				Losses				Value
September 30, 2016
Securities available-for-sale:
Municipal securities		$	12,728			$	836			$	-			$	13,564
Residential agency pass-through securities			188,991				4,295				-				193,286
Residential collateralized mortgage obligations			98,096				1,873				-				99,969
Asset-backed securities			95,140				800				(385	)			95,555
Corporate and other securities			1,475				-				(95	)			1,380
Equity securities			1,250				6				-				1,256
Total securities available-for-sale		$	397,680			$	7,810			$	(480	)		$	405,010
Securities held-to-maturity:
Residential agency pass-through securities		$	36,361			$	1,516			$	-			$	37,877
Residential collateralized mortgage obligations			6,990				255				-				7,245
Commercial mortgage-backed obligations			51,633				2,556				-				54,189
Asset-backed securities			4,431				-				(18	)			4,413
Total securities held-to-maturity		$	99,415			$	4,327			$	(18	)		$	103,724
December 31, 2015
Securities available-for-sale:
U.S. Government agencies		$	503			$	11			$	-			$	514
Municipal securities			14,049				747				-				14,796
Residential agency pass-through securities			130,041				1,500				(81	)			131,460
Residential collateralized mortgage obligations			151,928				646				(943	)			151,631
Commercial mortgage-backed securities			4,856				-				(100	)			4,756
Asset-backed securities			79,941				104				(925	)			79,120
Corporate and other securities			1,463				37				-				1,500
Equity securities			1,250				-				(93	)			1,157
Total securities available-for-sale		$	384,031			$	3,045			$	(2,142	)		$	384,934
Securities held-to-maturity:
Residential agency pass-through securities		$	41,012			$	831			$	(53	)		$	41,790
Residential collateralized mortgage obligations			7,723				69				-				7,792
Commercial mortgage-backed obligations			52,329				-				332				52,661
Asset-backed securities			5,394				-				(8	)			5,386
Total securities held-to-maturity		$	106,458			$	900			$	271			$	107,629

 

 

PARK STERLING CORPORATION

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Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 

In the second quarter of 2014, commercial mortgage-backed securities (“MBS”) with a fair market value of $58.5 million were transferred from available-for-sale to held-to-maturity. These securities had an aggregate unrealized loss of $2.2 million ($1.5 million, net of tax) on the date of transfer. The net unamortized, unrealized loss on the transferred securities included in accumulated other comprehensive income in the accompanying balance sheet as of September 30, 2016 and December 31, 2015 totaled $1.5 million and $1.7 million, respectively. This amount will be amortized out of accumulated other comprehensive income over the remaining life of the underlying securities as an adjustment of the yield on those securities. As a result, the amortized cost of these investments of $53.1 million is higher than the $51.6 million carrying value of the securities as of September 30, 2016. There were no transfers of securities from available-for-sale to held-to-maturity during the three and nine months ended September 30, 2016 or 2015.

 

At September 30, 2016 and December 31, 2015, investment securities with a fair market value of $172.9 million and $154.9 million, respectively, were pledged to secure public and trust deposits, to secure interest rate swaps, and for other purposes as required and permitted by law.

 

At September 30, 2016 and December 31, 2015, commercial MBS include $45.6 million and $51.1 million, respectively, of delegated underwriting and servicing (“DUS”) bonds collateralized by multi-family properties and backed by an agency of the U.S. government, and $6.0 million of private-label securities collateralized by commercial properties.

 

At September 30, 2016 and December 31, 2015, asset-backed securities include a $4.8 million security that is approximately 45% collateralized by the Federal family education loan program and 55% collateralized by a private student loan program.

 

The amortized cost and fair value of investment securities available-for-sale and held-to-maturity at September 30, 2016 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 agency pass-through securities and residential collateralized mortgage obligations are backed by an agency of the United States government. None of our residential agency pass-through securities or residential collateralized mortgage obligations are private-label securities.

 

 

PARK STERLING CORPORATION

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Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 

		September 30, 2016
		Amortized				Fair
		Cost				Value
Securities available-for-sale:
Municipal securities
Due after five years through ten years			5,825				6,152
Due after ten years			6,903				7,412
Residential agency pass-through securities
Due after five years through ten years			7,217				7,575
Due after ten years			181,774				185,711
Residential collateralized mortgage obligations
Due after five years through ten years			15,140				15,509
Due after ten years			82,956				84,460
Asset-backed securities
Due after five years through ten years			71,721				69,003
Due after ten years			23,419				26,552
Corporate and other securities
Due after ten years			1,475				1,380
Equity securities
No maturity			1,250				1,256
Total securities available-for-sale		$	397,680			$	405,010
Securities held-to-maturity:
Residential agency pass-through securities
Due after ten years		$	36,361			$	37,877
Residential collateralized mortgage obligations
Due after ten years			6,990				7,245
Commercial mortgage-backed obligations
Due after five years through ten years			51,633				54,189
Asset-backed securities
Due after ten years			4,431				4,413
Total securities held-to-maturity		$	99,415			$	103,724

 

Securities available-for-sale of $124.4 million were sold in the nine months ended September 30, 2016. No securities available-for-sale were sold during the three months ended September 30, 2016. Gross realized losses on the sale of securities for the nine months ended September 30, 2016 were $187 thousand. Gross realized gains on the sale of securities for the nine months ended September 30, 2016 were $94 thousand. Sales of securities in both the three and nine months ended September 30, 2015 were $3.1 million. The significant amount of sales of securities during the first quarter of 2016 is due to the sale of securities held by First Capital immediately following the acquisition.

 

Management evaluates its investments quarterly 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 securities with unrealized losses at September 30, 2016 and December 31, 2015. None of the securities are deemed to be other than temporarily impaired since none of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations, as all but one of the bonds are issued by United States government agencies with the remaining bond being partially guaranteed by a government agency, and it is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost basis. At September 30, 2016, there were nine securities in a loss position for twelve months or more. At December 31, 2015, there were 18 securities in a loss position for twelve months or more.

 

 

PARK STERLING CORPORATION

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Notes to Condensed Consolidated Financial Statements (Unaudited)

(table amounts in thousands, except share data and per share amounts)

 

Pursuant to the “Volcker Rule” adopted by the federal banking regulatory agencies effective April, 2014, banks and their affiliates are prohibited from engaging in proprietary trading and investing in and sponsoring a covered fund (such as a hedge fund or private equity fund). Banking entities have until July 21, 2017 to conform their activities to the requirements of the rule. At September 30, 2016 and December 31, 2015, the Company held a collateralized loan obligation (“CLO”) with a fair value of $5.0 million, which was included in asset-backed securities, which currently would be prohibited under the Volcker Rule. In October 2016, the Company sold its position in the prohibited security for a loss of $44 thousand. The net unrealized loss of the prohibited CLO was $57 thousand at December 31, 2015.

 

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, 2016
Securities available-for-sale:
Residential agency pass-through securities		$	9,899			$	-			$	-			$	-			$	9,899			$	-
Asset-backed securities			-				-				28,536				(385	)			28,536				(385	)
Corporate and other securities			1,380				(95	)			-				-				1,380				(95	)
Total temporarily impaired available-for-sale securities		$	11,279			$	(95	)		$	28,536			$	(385	)		$	39,815			$	(480	)
Securities held-to-maturity:
Asset-backed securities		$	-			$	-			$	4,413			$	(18	)		$	4,413			$	(18	)
Total temporarily impaired held-to-maturity securities		$	-			$	-			$	4,413			$	(18	)		$	4,413			$	(18	)
December 31, 2015
Securities available-for-sale:
Residential agency pass-through securities		$	14,785			$	(37	)		$	3,489			$	(44	)		$	18,274			$	(81	)
Residential collateralized mortgage obligations			43,563				(306	)			27,718				(637	)			71,281				(943	)
Commercial mortgage-backed securities			4,756				(100	)			-				-				4,756				(100	)
Asset-backed securities			18,651				(190	)			45,263				(735	)			63,914				(925	)
Equity Securities			1,157				(93	)			-				-				1,157				(93	)
Total temporarily impaired available-for-sale securities		$	82,912			$	(726	)		$	76,470			$	(1,416	)		$	159,382			$	(2,142	)
Securities held-to-maturity:
Residential collateralized mortgage obligations		$	4,456			$	(53	)		$	-			$	-			$	4,456			$	(53	)
Commercial mortgage-backed securities			18,736				(370	)			33,925				(997	)			52,661				(1,367	)
Asset-backed securities			-				-				5,386				(8	)			5,386				(8	)
Total temporarily impaired held-to-maturity securities		$	23,192			$	(423	)		$	39,311			$	(1,005	)		$	62,503			$	(1,428	)

 

The Company has nonmarketable equity securities consisting of investments in several unaffiliated financial institutions, as well as investments in five statutory trusts related to trust preferred securities issued by predecessor companies. These investments totaled $16.3 million at September 30, 2016 and $11.4 million at December 31, 2015. Included in these amounts at September 30, 2016 and December 31, 2015 was $14.7 million and $10.0 million, respectively, of Federal Home Loan Bank (“FHLB”) stock. All nonmarketable equity securities were evaluated for impairment as of September 30, 2016 and December 31, 2015. At September 30, 2016 and December 31, 2015, the Company estimated that the fair values of nonmarketable equity securities equaled or exceeded the cost of each of these investments, and, therefore, the investments were not impaired.