News Column

GREER BANCSHARES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

August 12, 2014

CRITICAL ACCOUNTING POLICIES

General - The financial condition and results of operations presented in the consolidated financial statements, the accompanying notes to the consolidated financial statements and this section are, to a large degree, dependent upon the Company's accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change. Those accounting policies that are believed to be the most important to the portrayal and understanding of the Company's financial condition and results of operations are discussed below. These critical accounting policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of a materially different financial condition or results of operations is a reasonable likelihood. Income Taxes - The calculation of the provision for federal income taxes is complex and requires the use of estimates and judgments. There are two accruals for income taxes: 1) The income tax receivable (or payable) represents the estimated amount currently due from (or due to) the federal government and is reported (as appropriate) as a component of "other assets" or "other liabilities" in the consolidated balance sheet; 2) the deferred federal income tax asset or liability represents the estimated impact of temporary differences between how assets and liabilities are recognized under GAAP, and how such assets and liabilities are recognized under the federal tax code. The effective tax rate is based in part on interpretation of the relevant current tax laws. The Company has reviewed all transactions for appropriate tax treatment taking into consideration statutory, judicial and regulatory guidance in the context of our tax positions. In addition, reliance is placed on various tax positions, recent tax audits and historical experience. Deferred Tax Asset - In considering whether a valuation allowance on deferred tax assets is needed, management considers all available evidence, including the length of time tax net operating loss carryforwards are available, the existence of available reversing temporary differences, the ability to generate future taxable income and available tax planning strategies.. The Company anticipates that it will generate income before income taxes at a sufficient level in the future to fully utilize all of its net operating loss carry forwards and therefore does not believe a valuation allowance is required; however, there can be no assurance to this effect, because of the risks described in Part I, Item 1A in the Company's Annual Report on Form 10-K for the 2013 calendar year, under the heading "Forward Looking and Cautionary Statements" in this report below and possibly other risks of which the Company is currently unaware. Allowance for Loan Losses - The allowance for loan losses is based on management's ongoing evaluation of the loan portfolio and reflects an amount that, based on management's judgment, is adequate to absorb inherent probable losses in the existing portfolio. Additions to the allowance for loan losses are provided by charges to earnings. Loan losses are charged against the allowance when we determine the ultimate uncollectability of the loan balance. Subsequent recoveries, if any, are credited to the allowance. Management evaluates the allowance for loan losses on a monthly basis. The evaluation includes the periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower's ability to repay, estimated value of any underlying collateral and related impairment and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision. Due to improved bank credit quality metrics, net recoveries during the period, and a reduction in the loan portfolio size, the Bank determined that the loan loss allowance was overstated and reversed $700,000 of previous provisions during the first quarter of 2014. Management did not change the methodology used in determining the loan loss allowance. Management believes that the allowance for loan losses as of June 30, 2014 is adequate. While management uses available information to 27

-------------------------------------------------------------------------------- recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. In addition, regulatory agencies, as an integral part of the examination process, periodically review the allowance for loan losses. Such agencies may require additions to the allowance based on their judgments about information available to them at the time of their examination. A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and/or insignificant payment shortfalls generally are not classified as impaired. Impairment is measured on a loan by loan basis for commercial and commercial real estate loans by the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, individual consumer and residential loans are not separately identified for impairment. Other Real Estate Owned - The Company values OREO that is acquired in settlement of loans at the net realizable value at the time of foreclosure. Management obtains updated appraisals on such properties as necessary, and reduces those values for estimated selling costs. While management uses the best information available at the time of the preparation of the financial statements in valuing the OREO, it is possible that in future periods the Company will be required to recognize reductions in estimated fair values of these properties. RESULTS OF OPERATIONS Overview The following discussion describes and analyzes our results of operations and financial condition for the quarter ended June 30, 2014 as compared to the quarter ended June 30, 2013 as well as the results for the six months ended June 30, 2014 as compared to the six months ended June 30, 2013. You are encouraged to read this discussion and analysis in conjunction with the financial statements and the related notes included in this report. Throughout this discussion, amounts are rounded to the nearest thousand, except per share data or percentages. Like many community banks, most of our income is derived from interest received on loans and investments. The primary source of funds for making these loans and investments is deposits, most of which are interest-bearing. Consequently, one of the key measures of our success is net interest income, or the difference between the income on interest-earning assets, such as loans and investments, and the expense on interest-bearing liabilities, such as deposits and FHLB advances. Another key measure is the spread between the yield earned on interest-earning assets and the rate paid on interest-bearing liabilities. Of course, there are risks inherent in all loans, so an allowance for loan losses is maintained to absorb probable losses inherent in the loan portfolio. This allowance is established and maintained by charging a provision for loan losses against current operating earnings. There was no provision for loan losses during the quarters ended June 30, 2014 or June 30, 2013. (See "Provision for Loan Losses" for a detailed discussion of this process.) Due to improved credit quality bank metrics, a net recovery of previously charged off amounts, and a reduction in the loan portfolio size, the Bank determined that the loan loss allowance was overstated and reversed $700,000 of previous provisions during the first quarter of 2014 and $1,700,000 during the second quarter of 2013. In addition to earning interest on loans and investments, income is also earned through fees and other charges to the Bank's customers. The various components of this noninterest income, as well as noninterest expense, are described in the following discussion. The Company reported consolidated net income of $434,000 available to common shareholders, or $.17 per diluted common share, for the quarter ended June 30, 2014, compared to consolidated net income of $6,285,000 available to common shareholders, or $2.53 per diluted common share, for the quarter ended June 30, 2013. For the six months ended June 30, 2014, the Company reported consolidated net income of $1,587,000 attributed to common shareholders, or $.64 per diluted common share, compared to a consolidated net income attributed to common shareholders of $6,926,000, or $2.79 per diluted common share, for the six months ended June 30, 2013. The results for the first six months of 2014 were positively impacted by the non-cash reversal of $700,000 in loan loss provision as well as $579,000 in securities gains. The results for the first six months of 2013 were positively impacted by the non-cash reversal of $1,700,000 in loan loss provision as well as the non-cash reversal of the deferred tax asset valuation allowance resulting in a tax benefit of $3,910,000. 28

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Interest Income, Interest Expense and Net Interest Income

The Company's total interest income for the quarter ended June 30, 2014 was $3,291,000, compared to $3,186,000 for the quarter ended June 30, 2013, an increase of $105,000, or 3.3%. Total interest income for the six months ended June 30, 2014 was $6,514,000, compared to $6,459,000 for the six months ended June 30, 2013, an increase of $55,000, or 0.9%. Interest and fees on loans is the largest component of total interest income and decreased $91,000, or 3.8%, to $2,322,000 for the quarter ended June 30, 2014, compared to $2,413,000 for the quarter ended June 30, 2013, and decreased $377,000, or 7.6%, to $4,585,000 for the six months ended June 30, 2014, compared to $4,962,000 for the six months ended June 30, 2013. The decrease in interest and fees on loans for the quarterly comparison was the result of reductions of $2,163,000 in average loan balances for the three months ended June 30, 2014, compared to the same period in 2013 and reductions in average yields on the Company's loan portfolio from 5.10% for the quarter ended June 30, 2013 to 4.96% for the quarter ended June 30, 2014. The decrease in interest and fees on loans for the six month comparison was the result of reductions of $5,088,000 in average loan balances for the six months ended June 30, 2014, compared to the same period in 2013, and reductions in average yields on the Company's loan portfolio from 5.20% for the six months ended June 30, 2013 to 4.93% for the six months ended June 30, 2014.The decrease in loan volume and loan yield is attributed to an overall market decrease in loan demand. Interest income on investment securities increased by $195,000 in the three month period ended June 30, 2014, compared to the three month period ended June 30, 2013. The increase was due to an increase in the tax equivalent investment yields from 2.32% to 2.81% as well as an increase in the average balance of investments from $141,127,000 to $146,796,000 for the three month periods ended June 30, 2013 and June 30, 2014, respectively. Interest income on investment securities increased by $433,000 in the six month period ended June 30, 2014, compared to the six month period ended June 30, 2013. The increase was due to an increase in the tax equivalent investment yields from 2.26% to 2.80% as well as an increase in the average balance of investments from $139,724,000 to $146,062,000 for the six month periods ended June 30, 2013 and June 30, 2014, respectively. The Company's total interest expense declined for the three months ended June 30, 2014 by $70,000, or 9.9%, compared to the same period in 2013. The largest component of the Company's interest expense is interest expense on deposits. Deposit interest expense declined due to decreases in average interest rates from 0.50% to 0.37% for the three month periods ended June 30, 2013 and June 30, 2014, respectively, and a reduction due to normal fluctuations of average interest bearing deposits of $3,403,000 during the three month period ended June 30, 2014, compared to the three month period ended June 30, 2013. The Company's total interest expense declined for the six months ended June 30, 2014 by $167,000, or 11.5%, compared to the same period in 2013. Deposit interest expense declined due to decreases in average interest rates from 0.54% to 0.38% for the six month periods ended June 30, 2013 and June 30, 2014, respectively, and a reduction due to normal fluctuations of average interest bearing deposits of $4,294,000 during the six month period ended June 30, 2014, compared to the six month period ended June 30, 2013. Interest on long term borrowings increased slightly to $430,000 from $ $426,000 for the three month period ended June 30, 2014 compared to June 30, 2013. Average long term borrowings outstanding increased by $444,000 for the quarter ended June 30, 2014 compared to the same period in 2013. Average rates on long term borrowings decreased to 3.03% from 3.12% for the three months ended June 30, 2014 compared to the same period in 2013. The long term borrowing rate decrease for the three month period ended June 30, 2014 compared to the three month period ended June 30, 2013 was the result of market repricing upon the maturity of FHLB borrowings. Interest on long term borrowings increased $13,000, or 1.5% for the six month period ended June 30, 2014 compared to the same period in 2013. The increase in long term interest expense for the six months ended June 30, 2014 compared to the same period in 2013 was the result of a decrease in average yields on long term borrowings combined with a slight increase in average long term borrowings outstanding. Average long term borrowings outstanding increased by $228,000 for the six months ended June 30, 2014 compared to the same period in 2013. Average rates on long term borrowings decreased to 3.09% from 3.13% for the six months ended June 30, 2014 compared to the same period in 2013. The long term borrowing rate decrease for the six month period ended June 30, 2014 compared to the six month period ended June 30, 2013 was the result of market repricing upon the maturity of FHLB borrowings. Net interest income, which is the difference between interest earned on assets and the interest paid for the liabilities used to fund those assets, measures the spread earned on lending and investing activities and generally is the primary contributor to the Company's earnings. Net interest income before provision for loan losses increased $181,000, or 7.3%, for the quarter ended June 30, 2014, compared to the same period in 2013. Net interest income before provision for loan losses increased $228,000, or 4.6%, for the six months ended June 30, 2014, compared to the same period in 2013. 29

-------------------------------------------------------------------------------- The Company monitors and manages the pricing and maturity of its assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on net interest income and economic value of equity. The principal monitoring technique employed by the Company is the use of an interest rate risk management model which measures the effect that movements in interest rates will have on net interest income and the present value of equity. Scenarios are prepared to analyze market interest rate changes from a 400 basis point decline to a 400 basis point increase. The Company's interest rate risk model currently projects an increase in net interest income in all rising rate scenarios. The Company's present value of equity model shows a decline in the net present value of equity in all rising rate scenarios, primarily caused by market declines in investments. Interest rate sensitivity can be managed by repricing assets or liabilities, replacing an asset or liability at maturity, or adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact of rising or falling interest rates on net interest income. Provision for Loan Losses The Company has developed policies and procedures for evaluating the overall quality of its credit portfolio and the timely identification of potential problem credits. On a quarterly basis, the Bank's Board of Directors reviews and approves the appropriate level for the allowance for loan losses based upon management's recommendations and the results of the internal monitoring and reporting system. Management also monitors historical statistical data for both the Bank and other financial institutions. The adequacy of the allowance for loan losses and the effectiveness of the monitoring and analysis system are also reviewed by the Bank's regulators and the Company's internal auditor. The Bank's allowance for loan losses is based upon judgments and assumptions of risk elements in the portfolio, economic conditions and other factors affecting borrowers. The process includes identification and analysis of loss inherent in various portfolio segments utilizing a credit risk grading process and specific reviews and evaluations of significant problem credits. In addition, management monitors the overall portfolio quality through observable trends in delinquencies, charge-offs and general conditions in the Company's market area. There was no provision for loan losses during the six months ended June 30, 2014 or June 30, 2013. The amount of provision is based on the results of the loan loss model. Due to improved bank credit quality metrics (historical loss calculations in particular), net recovery of previously charged-off amounts, and a reduction in our loan portfolio size, the Bank determined that the loan loss allowance was overstated and made a non-cash reversal of $700,000 of previous provisions in the first quarter of 2014 and $1,700,000 in the second quarter of 2013. Non-performing assets have decreased from $7,071,000 for the quarter ended June 30, 2013 to $3,354,000 for the quarter ended June 30, 2014. Also, the Bank experienced net recoveries during the six month period ended June 30, 2014 of $378,000. See the discussion below under "Allowance for Loan Losses." Noninterest Income Noninterest income remained stable with a slight decrease of $13,000 for the quarter ended June 30, 2014 compared to the quarter ended June 30, 2013. Noninterest income increased $330,000 for the six months ended June 30, 2014 compared to the six months ended June 30, 2013. The increase was primarily due to an increase of $459,000 in securities gains.



Noninterest Expenses

Total noninterest expenses increased $125,000, or 5.4%, for the quarter ended June 30, 2014, to $2,436,000 compared to $2,311,000 for the quarter ended June 30, 2013. Salaries and employee benefits, the largest component of noninterest expenses, increased $54,000 for the three months ended June 30, 2014 compared to the same period in 2013. This increase was due to normal wage increases along with increases in staff. Professional expenses increased $34,000 primarily due to legal costs associated with the Company's subordinated debt offering. OREO and foreclosure expenses increased $20,000 primarily as a result of reduced net gains on sales which were offset by decreased expenses overall due to the reduction in volume of OREO. The three months ended June 30, 2013 had $193,000 in net OREO gains on sale compared to $55,000 in the three months ended June 30, 2014. Total noninterest expenses increased $33,000, or 0.7%, for the six months ended June 30, 2014, to $4,729,000 compared to $4,696,000 for the six months ended June 30, 2013. Salaries and employee benefits, the largest component of noninterest expenses, increased $75,000 for the six months ended June 30, 2014 compared to the same period in 2013. This increase was due to normal wage increases along with increases in staff. Occupancy and Equipment expenses increased $24,000 due to new equipment purchases. Professional expenses increased $30,000 primarily due to legal costs associated with the Company's subordinated debt offering. OREO and foreclosure expenses decreased $155,000 primarily as a result of decreased valuation adjustments on properties held for sale. The six months ended June 30, 2013 had $288,000 in OREO valuation adjustments on properties compared to $109,000 in the six months ended June 30, 2014. 30

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Income Tax Expense

The Company has a net operating loss carry-forward for federal tax purposes for the three months ended June 30, 2014 and June 30, 2013. Also, the Bank had state tax expense in the three months ended June 30, 2014 and June 30, 2013 due to net income at the Bank level. See "Critical Accounting Policies - Income Taxes" and "Critical Accounting Policies - Deferred Tax Asset" above. In evaluating whether the full benefit of the net deferred tax asset will be realized, management considered both positive and negative evidence including recent earnings trends, projected earnings and asset quality. As of June 30, 2014, management concluded that the positive evidence outweighed the negative evidence in determining realization of any deferred tax temporary differences. The Company is three years cumulatively profitable and has been profitable for the last eleven quarters. The Bank is deemed to be "well capitalized" with Tier one leverage and Total risk based capital ratios of 9.92% and 16.61%, respectively. The Company will continue to monitor deferred tax assets closely to evaluate future realization of the full benefit of the net deferred tax asset and the potential need to establish a valuation allowance. BALANCE SHEET REVIEW Loans The Company's outstanding loans represented the largest component of earning assets at 55.5% of total earning assets as of June 30, 2014. The Company's gross loans totaled $189,186,000 as of June 30, 2014, an increase of $2,027,000, or 1.1%, from gross loans of $187,159,000 as of December 31, 2013. Adjustable rate loans totaled 46.8% of the Company's loan portfolio as of June 30, 2014, which allows the Company to be in a favorable position as interest rates rise. The Company's loan portfolio consists primarily of real estate mortgage loans, commercial loans and consumer loans with concentrations in commercial real estate, including construction and land development loans. Substantially all of these loans are to borrowers located in South Carolina, with the majority located in the Company's local market area. Although our asset and credit quality trends continue to improve, management continues to work aggressively to identify and quantify potential losses and execute plans to reduce problem assets. The Company uses internal and external loan review analysis performed by loan officers, credit administration and an external loan review firm that require detailed, written summaries of the loans reviewed to determine risk rating, accrual status and collateral valuation.



Allowance for Loan Losses

The Company's allowance for loan losses at June 30, 2014 was $2,938,000, or 1.55% of gross loans outstanding, compared to $3,260,000 or 1.74% of gross loans outstanding at December 31, 2013. The net decrease of 0.19% in the allowance ratio was a result of a reduced loan portfolio size and improved loan credit quality metrics, in particular, historical loan loss experience and net recoveries during 2014 that warranted a non-cash provision reversal of $700,000 during the first quarter of 2014. The allowance at June 30, 2014 included an allocation of $91,000 related to specifically identified impaired loans compared to an allocation of $113,000 related to specifically identified impaired loans at December 31, 2013. Internal reviews and evaluations of the Company's loan portfolio for the purpose of identifying potential problem loans, external reviews by federal and state banking examiners, management's consideration of current economic conditions, historical loan losses and other relevant risk factors are used in evaluating the adequacy of the allowance for loan losses. The level of loan loss reserves is monitored on an on-going basis. The evaluation is inherently subjective as it requires estimates that are susceptible to significant change. Despite the Company's efforts to provide accurate estimates, actual losses will undoubtedly vary from the estimates. Also, there is a possibility that charge-offs in future periods will exceed the allowance for loan losses as estimated at any point in time. If delinquencies and defaults increase, additional loan loss provisions may be required which would adversely affect the Company's results of operations and financial condition. At June 30, 2014, the Company had $3,354,000 in non-performing assets, comprised of non-accruing loans of $1,622,000 and $1,732,000 in OREO. This compares to $4,827,000 in non-performing assets, comprised of $2,552,000 in non-accruing loans and $2,275,000 in OREO at December 31, 2013. All of the non-performing loans were real estate loans at June 30, 2014. All nonperforming real estate loans have annual appraisals to support the loan balances. The Company had a net recovery of charge-offs of $378,000 and $187,000 for the first six months of 2014 and 2013, respectively. The allowance for loan losses as a percentage of non-performing loans was 181.1% and 127.7% as of June 30, 2014 and December 31, 2013, respectively. Troubled debt restructured loans ("TDRs"), which are included in the impaired loan totals, were $2,858,000 and $2,937,000 at June 30, 2014 and December 31, 2013, respectively. TDRs on non-accrual were $1,543,000 and $1,635,000 at June 30, 2014 and December 31, 2013, respectively. This decrease in TDRs was a result of principal reductions through payments. 31

-------------------------------------------------------------------------------- The Company's potential problem loans, which are not included in non-performing or impaired loans, amounted to $10,264,000, or 5.4% of total loans outstanding at June 30, 2014 compared to $12,025,000, or 6.4% of totals loans outstanding at December 31, 2013. Potential problem loans represent those loans with a well-defined weakness and those loans where information about possible credit problems of borrowers or the performance of construction or development projects has caused management to have concerns about the borrower's ability to comply with present repayment terms.



Securities

The Company's investment portfolio is an important contributor to the earnings of the Company. The Company strives to maintain a portfolio that provides necessary liquidity for the Company while maximizing income consistent with the ability of the Company's capital structure to accept nominal amounts of investment risk. During years when loan demand has not been strong, the Company has utilized the investment portfolio as a means for investing "excess" funds for higher yields, instead of accepting low overnight investment rates. The investment portfolio also provides securities that can be pledged against borrowings as a source of funding for loans. However, it is management's intent to maintain a significant percentage of the Company's earning assets in the loan portfolio as loan demand allows. As of June 30, 2014, investment securities totaled $144,523,000 or 43.1% of total earning assets. Investment securities as of June 30, 2014 increased $1,571,000, or 1.1%, from $142,952,000 as of December 31, 2013, due to the purchase of $4,998,000 in municipal securities and $14,472,000 in U.S. government and other agency obligations, offset by the call or maturity of two securities totaling $1,250,000, the sale, net of gains and losses, of thirteen securities totaling $17,395,000, cash inflows from principal payments on mortgage backed securities of $2,171,000, premium amortization on securities of $653,000, and a decrease in unrealized losses of $3,570,000.



Cash and Cash Equivalents

The Company's cash and cash equivalents were $9,781,000 at June 30, 2014, compared to $5,929,000 at December 31, 2013, an increase of $3,852,000. This is a normal fluctuation. Balances due from bank accounts vary depending on the settlement of cash letters and other transactions.

Deposits

The Company receives its primary source of funding for loans and investments from its deposit accounts. The Company takes into consideration liquidity needs, direction and level of interest rates and market conditions when pricing deposits. At June 30, 2014 and December 31, 2013, interest bearing deposits comprised 83.0% and 84.8% of total deposits, respectively. Total deposits increased to $262,185,000 as of June 30, 2014 compared to $253,388,000 as of December 31, 2013. An increase of $5,857,000 in demand deposits and $9,174,000 in savings and negotiable order of withdrawal accounts was offset by a decrease of $6,234,000 in retail certificates of deposit. Total core deposits, defined as all deposits excluding time deposits of $100,000 or more and brokered deposits have increased by $11,943,000 in the six months ended June 30, 2014. The increase in core deposits as well as total deposits is seasonal due to several public agency accounts that increase due to tax revenue in the first quarter and then subsequently decline in the second through the fourth quarters.



Borrowings

The Company's borrowings are comprised of federal funds purchased, repurchase agreements, long-term advances from the FHLB of Atlanta, and subordinated debentures. At June 30, 2014, total borrowings were $72,571,000, compared with $74,341,000 as of December 31, 2013. At June 30, 2014 and December 31, 2013, long term repurchase agreements were $15,000,000. Notes payable to the FHLB of Atlanta totaled $44,250,000 and $48,000,000 as of June 30, 2014 and December 31, 2013, respectively. The weighted average rate of interest for the Company's portfolio of FHLB of Atlanta advances was 2.05% and 1.91% as of June 30, 2014 and December 31, 2013, respectively. The weighted average remaining maturity for FHLB of Atlanta advances was 0.98 years as of June 30, 2014 and 1.26 years as of December 31, 2013. In October 2004 and December 2006, the Company issued $6,186,000 and $5,155,000 of junior subordinated debentures to its wholly-owned capital trusts, Greer Capital Trust I and Greer Capital Trust II (collectively, the "Trusts"), respectively, to fully and unconditionally guarantee the trust preferred securities issued by the capital trusts. The junior subordinated debentures issued in October 2004 mature in October 2034. Interest payments are due quarterly to Greer Capital Trust I at the three-month LIBOR plus 220 basis points. The junior subordinated debentures issued in December 2006 mature in December 2036. Interest payments are due quarterly to Greer Capital Trust II at the three-month LIBOR plus 173 basis points. On January 3, 2011, the Company elected to defer interest payments on the two junior subordinated debentures beginning with the January 2011 payments. On February 14, 2014, after receiving regulatory approval, the Company gave notice to the trustees that it was ending its deferral of interest and paid all $970,422 of deferred interest amounts due. In accordance with relevant accounting guidance, the Trusts are not consolidated with the Company. Accordingly, the Company does not report the securities issued 32

-------------------------------------------------------------------------------- by the Trusts as liabilities, and instead reports as liabilities the junior subordinated debentures issued by the Company and held by each Trust. However, the Company has fully and unconditionally guaranteed the repayment of the variable rate trust preferred securities. These trust preferred securities currently qualify as Tier 1 capital for the regulatory capital requirements of the Company. On June 11, 2014 the Company issued $1,980,000 of Series A 5% Subordinated Notes due June 30, 2022 (the "Series A Notes") in a private placement. The Series A Notes initially accrue interest at a rate of 5% payable at the end of each calendar quarter. The interest rate increases to 7% effective July 1, 2017. The Company may prepay all or any part of the outstanding principal amount of the Series A Notes at any time after June 30, 2016. The Series A Notes are not convertible into the common stock or any other securities of the Company and are not secured by any collateral, guaranty, insurance, sinking fund or other form of security.



Off-Balance Sheet Financial Instruments

The Company has certain off-balance-sheet instruments in the form of contractual commitments to extend credit to customers and standby letters of credit. The commitments to extend credit are legally binding and have set expiration dates and are at predetermined interest rates. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party, which are issued primarily to support public and private borrowing arrangements. The underwriting criteria for these commitments are the same as for loans in the loan portfolio. Collateral is also obtained, if necessary, based on the credit evaluation of each borrower. Although many of the commitments will expire unused, management believes there are adequate resources to fund these commitments. Contractual commitments to extend credit to customers and standby letters of credit are commonly needed by commercial banking customers and are offered by the Bank to serve its commercial customer base. At June 30, 2014 and December 31, 2013, the Company's commitments to extend credit totaled $35,836,000 and $31,324,000, respectively.



LIQUIDITY AND CAPITAL RESOURCES

Liquidity - Bank

Liquidity represents the ability of a company to quickly convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring sources and uses of funds to meet day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities in our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control. Liquidity is also a measure of the Bank's ability to provide funds to meet the needs of depositors and borrowers. The Bank's primary goal is to meet these needs at all times. In addition to these basic cash needs, the Bank must meet liquidity requirements created by daily operations and regulatory requirements. Liquidity requirements of the Bank are met primarily through two categories of funding: core deposits and borrowings. In the first six months of 2014, liquidity needs were met through maintaining core deposits and borrowings. Core deposits, which are generally the result of stable consumer and commercial banking relationships, are considered to be a relatively stable component of the Bank's mix of liabilities. At June 30, 2014, core deposits totaled $217,659,000, or 83.0%, of the Bank's total deposits, compared to $205,756,000, or 81.2%, of the Bank's total deposits as of December 31, 2013. Unsecured lines of credit with correspondent banks are also sources of liquidity. The Bank had unsecured federal funds lines of credit with correspondent banks totaling $19,500,000 and $16,000,000 available for use as of June 30, 2014 and December 31, 2013, respectively. The Bank also has a collateralized borrowing capacity of 25% of total assets from the FHLB. Outstanding FHLB borrowings totaled $44,250,000 and $48,000,000 at June 30, 2014 and December 31, 2013, respectively. Unused available FHLB borrowings totaled $46,100,000 and $43,020,000 at June 30, 2014 and December 31, 2013, respectively, and were subject to collateral availability. The Bank has additional borrowing capacity through the Federal Reserve Bank "discount window" and has pledged a portion of its consumer and commercial loan portfolio as collateral for $13,044,000 in unused available credit as of June 30, 2014.



The Bank's liquidity ratio (cash, federal funds and unpledged securities available for sale divided by total deposits) has decreased from 35.6% to 33.9% from December 31, 2013 to June 30, 2014 primarily as a result of the Bank's increased pledging of securities for certain deposits.

In addition to the primary funding sources discussed above, secondary sources of liquidity include sales of investment securities which are not held for pledging purposes. 33

-------------------------------------------------------------------------------- Management believes that the Bank's available borrowing capacity and efforts to grow deposits are adequate to provide the necessary funding for its banking operations for the remainder of 2014 and for the foreseeable future thereafter. However, management is prepared to take other actions, including potential asset sales, if necessary to maintain appropriate liquidity.



Liquidity - Parent Holding Company

Greer Bancshares Incorporated, the Bank's parent holding company (the "Company") generally has liquidity needs to pay limited operating expenses and dividends. These liquidity needs include interest on junior subordinated debt and dividends on preferred stock issued as a part of the Troubled Asset Relief Program. Any cash dividends paid to shareholders, as well as the Company's other liquidity needs, are typically funded by dividends from the Bank and rental income of land leased to the Bank. The Company had $60,000 in cash as of June 30, 2014 to meet short term liquidity needs. The Company will require funding from the Bank in the following quarter due to scheduled payments for subordinated debt interest and preferred stock dividends as discussed below. In October 2004 and December 2006, the Company issued two different series of "Trust Preferred" securities to raise capital. In these offerings, the Company issued $6,186,000 and $5,155,000, respectively, of junior subordinated debentures to its wholly-owned capital Trusts, Greer Capital Trust I and Greer Capital Trust II (collectively, the "Trusts"), respectively, and fully and unconditionally guaranteed corresponding principal amounts of the trust preferred securities issued by the Trusts. On January 3, 2011, the Company elected to defer interest payments on the two junior subordinated debentures beginning with the January 2011 payments. On February 14, 2014, after receiving regulatory approval, the Company gave notice to the trustees that it was ending its deferral of interest and paid $970,422, which included both deferred interest and interest due through the April 2014 due dates. The funds for this payment were provided by dividends from the Bank. On January 6, 2011, the Company gave notice to the U.S. Treasury Department that the Company was suspending the payment of regular quarterly cash dividends on the TARP cumulative perpetual preferred stock, beginning with the February 15, 2011 dividend. The decision to elect the deferral of interest payments and to suspend the dividend payments was made in consultation with the FRB. The terms of the TARP cumulative perpetual preferred stock prohibited the Company from paying any dividends on its common stock while payments on the TARP Preferred Stock were in arrears. On March 4, 2014, after receiving regulatory approval, the Company resumed the payment of regular quarterly cash dividends on its TARP Preferred Stock issued to the U.S. Treasury and paid all $1,928,247 of deferred dividend amounts due. The funds for this payment were provided by dividends from the Bank. On March 19, 2014, after receiving regulatory approval, the Company repurchased $3,150,000 of principal of the TARP Preferred Stock. The funds for this payment were provided by dividends from the Bank. On June 11, 2014, after receiving regulatory approval, the Company repurchased $1,980,000 of principal of the TARP Preferred Stock. The funds for this payment were provided by subordinated debt issued as described above in Note 8 to the Financial Statements. On July 23, 2014, after receiving regulatory approval, the Company repurchased the remaining $5,363,000 of principal of the TARP Preferred Stock and paid all of the $91,171 of accrued but previously unpaid dividends on the TARP Preferred Stock. The funds for this payment were provided by $1,479,171 of dividends from the Bank and $3,975,000 in principal amount of subordinated debt issued as described above in Note 8 to the Financial Statements.



Memorandum of Understanding - Bank

On March 1, 2011, the Bank entered into the Consent Order with the FDIC and the S.C. Bank Board. The Consent Order required the Bank to take specific steps regarding, among other things, its management, capital levels, asset quality, lending practices, liquidity and profitability in order to improve the safety and soundness of the Bank's operations, each as described and set forth in the Consent Order. Effective March 20, 2013, the FDIC and S.C. Bank Board terminated the Consent Order and replaced it with the MOU, which became effective on January 31, 2013. The MOU was based on the findings of the FDIC during their on-site examination of the Bank as of October 15, 2012. The MOU was a step down in corrective action requirements as compared to the Consent Order. The MOU required the Bank, among other things, to (i) prepare and submit annual, comprehensive budgets; (ii) maintain a minimum 8% Tier one leverage capital ratio and a minimum 10% Total Risk based capital ratio; (iii) take various specified actions to continue to reduce classified assets; (iv) obtain the written consent of its supervisory authorities prior to paying any cash dividends; and (v) submit periodic reports to the FDIC regarding various aspects of the foregoing actions. On April 21, 2014, the Company received notice that effective April 17, 2014, the MOU was terminated entirely. 34

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Memorandum of Understanding with Federal Reserve - Company

On July 7, 2011, the Company entered into the Written Agreement with the FRB. The Written Agreement was intended to enhance the ability of the Company to serve as a source of strength to the Bank. The Written Agreement's requirements were in addition to those of the Bank's Consent Order (which, as discussed above, has been terminated) and required the Company to take specific steps regarding, among other things, compliance with the supervisory actions of its regulators, appointment of directors and senior executive officers, indemnification and severance payments to executive officers and employees, payment of debt or dividends and quarterly reporting. Effective May 3, 2013, as a result of the steps the Company took in complying with the Written Agreement and improvement in the overall condition of the Company, the FRB terminated the Written Agreement and replaced it with the FRB MOU, which became effective May 29, 2013, after approval by the Company's Board of Directors and upon final execution by the FRB. The FRB MOU was a step down in corrective action requirements as compared to the Written Agreement and reflected an improvement in the overall condition of the Company from "troubled" to "less than satisfactory". The FRB MOU required the Company, among other things, to (i) preserve its cash; (ii) obtain the written consent of its supervisory authorities prior to paying any dividends with respect to its common or preferred stock or trust preferred securities, purchasing or redeeming any shares of its stock or incurring, increasing or guaranteeing any debt; and (iii) submit quarterly reports to the FRB regarding the Company's actions to comply with the requirements of the FRB MOU. On June 2, 2014, the Company received notice that effective May 30, 2014, the FRB MOU was terminated entirely.



Dividends - Bank

Under South Carolina banking law, the Bank is authorized to pay cash dividends up to 100% of net income in any calendar year without obtaining the prior approval of the S.C. Bank Board provided that the Bank received a composite rating of one or two at the last federal or state regulatory examination. Otherwise, the Bank must obtain approval from the S.C. Bank Board prior to the payment of any cash dividends. In addition, under the FDIC Improvement Act, the Bank may not pay a dividend if, after paying the dividend, the Bank would be undercapitalized. Dividends - Company On February 14, 2014, after receiving regulatory approval, the Company gave notice to the trustees of the trust preferred subordinated debt that it was ending its deferral of interest and paid $970,422, which included both deferred interest and interest due through the April 2014 due dates. The funds for this payment were provided by dividends from the Bank. In addition, on March 4, 2014, after receiving regulatory approval, the Company resumed the payment of regular quarterly cash dividends on its preferred stock issued to the U.S. Treasury and paid all $1,928,247 of deferred dividend amounts due. The funds for this payment were provided by dividends from the Bank.



Regulatory Capital - Bank and Company

The Federal Reserve Board and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance-sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the risk-based standard, capital is classified into two tiers. Tier 1 capital of the Company consists of equity minus unrealized gains plus unrealized losses on securities available for sale and less a disallowed portion of our deferred tax assets. In addition to Tier 1 capital requirements, Tier 2 capital consists of the allowance for loan losses subject to certain limitations. A bank holding company's qualifying capital base for purposes of its risk-based capital ratio consists of the sum of its Tier 1 and Tier 2 capital. The regulatory minimum requirements are 4% for Tier 1 and 8% for total risk-based capital. The Company and the Bank are also required to maintain capital at a minimum level based on average assets, which is known as the leverage ratio. Only the strongest bank holding companies and banks are allowed to maintain capital at the minimum requirement, which is 4%. All others are subject to maintaining ratios 100 to 200 basis points above the minimum requirement. 35

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The Bank exceeded minimum regulatory capital requirements at June 30, 2014 as set forth in the following table:

(Dollars in thousands) To meet For Capital the requirements Adequacy Purposes of the MOU Bank: Actual Minimum Minimum Amount Ratio Amount Ratio Amount Ratio As of June 30, 2014 Total risk-based capital (to risk-weighted assets) $ 37,706 16.61 % $ 18,165 8.0 % N/A N/A Tier 1 capital (to risk-weighted assets) $ 35,429 15.60 % $ 9,082 4.0 % N/A N/A Tier 1 capital (leverage) (to average assets) $ 35,429 9.92 % $ 14,392 4.0 % N/A N/A As of December 31, 2013 Total risk-based capital (to risk-weighted assets) $ 41,446 17.61 % $ 18,831 8.0 % $ 23,539 10.0 % Tier 1 capital (to risk-weighted assets) $ 38,500 16.36 % $ 9.416 4.0 % N/A N/A Tier 1 capital (leverage) (to average assets) $ 38,500 10.78 % $ 14.418 4.0 % $ 28,837 8.0 % The Company is also subject to certain capital requirements as noted above. At June 30, 2014, the Company's Tier 1 risk-based capital ratio, Tier 1 capital (leverage) ratio and the total risk-based capital ratio were 13.87%, 8.76% and 16.32%, respectively. At December 31, 2013, the Company's Tier 1 risk-based capital ratio, Tier 1 capital ratio and the total risk-based capital ratio were 15.72%, 10.28% and 17.66%, respectively.



Board Involvement

The Company's Board of Directors (the "Board") continues to be very active in providing oversight and supervision to the management of the Bank. In addition to the regular monthly Board meetings, the Board committees are active with the Corporate Governance and Loan Committee meeting monthly, Audit Committee meeting quarterly, and Human Resources meeting as needed but usually quarterly.



Forward-looking and Cautionary Statements

This report contains "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Such statements relate to, among other things, future economic performance, plans and objectives of management for future operations, and projections of revenues and other financial items that are based on the beliefs of management, as well as assumptions made by, and information currently available to, management. Words such as "may," "will," "anticipate," "should," "would," "believe," "contemplate," "expect," "estimate," "continue," "may," "appear," and "intend," as well as other similar words and expressions, are intended to identify forward-looking statements. Actual results may differ materially from the results discussed in the forward-looking statements. The Company's operating performance is subject to various risks and uncertainties including, without limitation: -



significant increases in competitive pressure in the banking and financial services industries;

-



reduced earnings due to higher credit losses owing to economic factors, including declining home values, increasing interest rates, increasing unemployment, or changes in payment behavior or other causes;

-



the concentration of our portfolio in real estate based loans and the weakness in the commercial real estate market;

-



increased funding costs due to market illiquidity, increased competition for funding or other regulatory requirements;

- market risk and inflation; -



level, composition and re-pricing characteristics of our securities portfolios;

-



availability of wholesale funding;

-



adequacy of capital and future capital needs;

- our reliance on secondary sources of liquidity such as FHLB advances, federal funds lines of credit from correspondent banks and brokered time deposits, to meet our liquidity needs; -



changes in the interest rate environment which could reduce anticipated or actual margins;

36

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changes in political conditions or the legislative or regulatory environment, including recently enacted and proposed legislation;

-



adequacy of the level of our allowance for loan losses;

-



the rate of delinquencies and amounts of charge-offs;

- the rates of loan growth; -



adverse changes in asset quality and resulting credit risk-related losses and expenses;

-



general economic conditions, either nationally or regionally and especially in our primary service area,

-



becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

-



changes occurring in business conditions and inflation;

- changes in technology; -



changes in monetary and tax policies;

-



loss of consumer confidence and economic disruptions resulting from terrorist activities;

-



changes in the securities markets;

-



ability to generate future taxable income to realize deferred tax assets;

-



ability to have sufficient liquidity at the parent holding company level to pay preferred stock dividends and

-



interest expense on junior subordinated debt; and

-



other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

For a description of risk factors which may cause actual results to differ materially from such forward-looking statements, see the Company's Annual Report on Form 10-K for the year ended December 31, 2013, and other reports from time to time filed with or furnished to the Securities and Exchange Commission. Investors are cautioned not to place undue reliance on any forward-looking statements as these statements speak only as of the date when made. The Company undertakes no obligation to update any forward-looking statements made in this report.


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Source: Edgar Glimpses


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