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SFST > SEC Filings for SFST > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for SOUTHERN FIRST BANCSHARES INC

Form 10-Q for SOUTHERN FIRST BANCSHARES INC


7-Nov-2012

Quarterly Report


Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion reviews our results of operations for the three and nine month periods ended September 30, 2012 as compared to the three and nine month periods ended September 30, 2011 and assesses our financial condition as of September 30, 2012 as compared to December 31, 2011. You should read the following discussion and analysis in conjunction with the accompanying consolidated financial statements and the related notes and the consolidated financial statements and the related notes for the year ended December 31, 2011 included in our Annual Report on Form 10-K for that period. Results for the three and nine month periods ended September 30, 2012 are not necessarily indicative of the results for the year ending December 31, 2012 or any future period.

Discussion of forward-looking statements

This report, including information included or incorporated by reference in this report, contains statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to our financial condition, results of operation, plans, objectives, or future performance. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words "may," "would," "could," "should," "will," "expect," "anticipate," "predict," "project," "potential," "believe," "continue," "assume," "intend," "plan," and "estimate," as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ from those anticipated in any forward-looking statements include, but are not limited to, those described under Item 1A- Risk Factors of our Annual Report on Form 10-K for the year ended December 31, 2011, as well as the following:

changes in political conditions and the legislative or regulatory environment, including the effect of the recent financial reform legislation on the banking and financial services industries;

general economic conditions in the U.S., including the possibility of a prolonged period of limited economic growth; disruptions to the credit and financial markets; and contractions or limited growth in consumer spending or consumer credit;

reduced earnings due to higher credit losses, including losses in the sectors of our loan portfolio secured by real estate, may be greater than expected due to economic factors, including, but not limited to, declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior or other factors;

reduced earnings due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;

the high concentration of our real estate-based loans collateralized by real estate in a weak commercial real estate market;

our ability to comply with our Formal Agreement and potential regulatory actions if we fail to comply;

results of examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets;

restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals, including the potential that the regulatory agencies may require higher levels of capital above the current standard regulatory-mandated minimums, including the impact of the proposed capital rules under Basel III;

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

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

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

general economic conditions, either nationally or regionally and especially in our primary service area, being less favorable than expected, resulting in, among other things, a deterioration in credit quality;

changes occurring in business conditions and inflation;

changes in deposit flows;

changes in technology;

changes in monetary and tax policies;

adequacy of the level of our allowance for loan losses;

the rate of delinquencies and amount of loans charged-off;



the rate of loan growth;

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

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

changes in the securities markets; and

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

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

These risks are exacerbated by the developments over the last three plus years in local, national and international financial markets, and we are unable to predict what effect these uncertain market conditions will continue to have on our Company. Beginning in 2008 and continuing into 2012, the capital and credit markets have experienced severe levels of volatility and disruption. During the first nine months of 2012, economic conditions, while slow by historical standards and still fluctuating on a day-to-day basis, have shown general signs of stabilization. However, as a result of U.S. government fiscal challenges, continued volatility in European sovereign and bank debt, slow improvement in domestic employment conditions and the economic and monetary policy statements by the Federal Reserve, it is difficult to predict if this stabilization is indicative of a lasting trend. There can be no assurance that these challenging developments will not materially and adversely affect our business, financial condition and results of operations.

OVERVIEW

We are a bank holding company headquartered in Greenville, South Carolina, and were incorporated in March 1999 under the laws of South Carolina. We provide a wide range of banking services and products to our clients through our wholly-owned bank subsidiary, Southern First Bank, N.A., formerly known as Greenville First Bank, N.A. In July of 2007, we changed the name of our Company and Bank to Southern First Bancshares, Inc. and Southern First Bank, N.A., respectively. We do not engage in any significant operations other than the ownership of our banking subsidiary.

We currently have six offices located in Greenville and Lexington Counties of South Carolina. On July 16, 2012, we announced our pending expansion into Charleston, South Carolina with the hiring of Mr. Lenwood Howell as Executive Vice President and Charleston Regional Executive. We expect to open a Charleston office during the fourth quarter of 2012 at 480 East Bay Street, Charleston, South Carolina. In addition, we are currently in the process of constructing a third full-service office in Columbia, South Carolina, which is also expected to open in the fourth quarter of 2012.

Our business model continues to be client-focused, utilizing relationship teams to provide our clients with a specific banker contact and support team responsible for all of their banking needs. The purpose of this structure is to provide a consistent and superior level of professional service, and we believe it provides us with a distinct competitive advantage. We consider exceptional client service to be a critical part of our culture, which we refer to as "ClientFIRST."

Like most community banks, we derive the majority of our income from interest received on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits and borrowings. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities, which is called our net interest spread.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We maintain this allowance by charging a provision for loan losses against our operating earnings for each period. We have included a detailed discussion of this process, as well as several tables describing our allowance for loan losses.

In addition to earning interest on our loans and investments, we earn income through fees and other charges to our clients. We have also included a discussion of the various components of this noninterest income, as well as of our noninterest expense.


Economic conditions, competition, and the monetary and fiscal policies of the Federal government significantly affect most financial institutions, including the Bank. Lending and deposit activities and fee income generation are influenced by levels of business spending and investment, consumer income, consumer spending and savings, capital market activities, and competition among financial institutions, as well as customer preferences, interest rate conditions and prevailing market rates on competing products in our market areas.

The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with our financial statements and the other statistical information included in our filings with the SEC.

Effect of Economic Trends

The twelve months ended December 31, 2011 and the first nine months of 2012 continue to reflect the tumultuous economic conditions which have negatively impacted our clients' liquidity and credit quality. Concerns regarding increased credit losses from the weakening economy have negatively affected capital and earnings of most financial institutions. Financial institutions have experienced significant declines in the value of collateral for real estate loans, heightened credit losses, which have resulted in record levels of non-performing assets, charge-offs and foreclosures.

Liquidity in the debt markets remains low in spite of efforts by the Treasury and the Federal Reserve to inject capital into financial institutions. The federal funds rate set by the Federal Reserve has remained at 0.25% since December 2008, following a decline from 4.25% to 0.25% during 2008 through a series of seven rate reductions.

In response to the challenges facing the financial services sector, beginning in 2008 a multitude of new regulatory and governmental actions have been announced, including the Emergency Economic Stabilization Act of 2008 (the "EESA"), the Troubled Asset Relief Program (the "TARP"), the American Recovery and Reinvestment Act of 2009 (the "Recovery Act"), the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and related economic recovery programs. Some of the more recent actions include those described in Part I. Item 1. Business - Supervision and Regulation of our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the SEC.

On April 5, 2012, the U.S. President signed the Jumpstart Our Business Startup Act (the "JOBS Act"), which is intended to stimulate economic growth by helping smaller and emerging growth companies access the U.S. capital markets. The JOBS Act amends various provisions of, and adds new sections to, the Securities Act of 1933 and the Securities Exchange Act of 1934, as well as provisions of the Sarbanes-Oxley Act of 2002. In addition, under the JOBS Act, a bank or bank holding company is permitted to have 2,000 shareholders before being subject to public company requirements and to deregister from the SEC when its shareholder count falls below 1,200. While we do not anticipate that the JOBS Act will have a significant effect on the Company, it is unclear what long term effects this new legislation will have on community banks in general.

In addition, in June 2012, the Federal Reserve approved three notices of proposed rulemaking ("NPRs") to, among other things, implement the Basel III minimum capital requirements and capital conservation buffer. The three NPRs are expected to be published jointly by the Federal Reserve, the FDIC and the OCC after each agency has completed its approval process. The comment period on the NPRs expired on October 22, 2012. If approved in their current form, the NPRs would be effective over a phased-in period from 2013 to 2019. We are in the process of evaluating the impact of the proposed rules on the Company and the Bank.

Future regulations, or enforcement of the terms of programs already in place, may require financial institutions to raise additional. There can be no assurance as to the actual impact of the Dodd-Frank Act, the JOBS Act, Basel III or any other governmental program or regulation on the financial markets.

The weak economic conditions are expected to continue through the remainder of 2012 and into 2013. Certain financial institutions in the Southeast will likely continue to experience heightened credit losses and higher levels of non-performing assets, charge-offs and foreclosures. In light of these conditions, financial institutions also face heightened levels of scrutiny from federal and state regulators. These factors negatively influenced, and likely will continue to negatively influence, earning asset yields at a time when the market for deposits is intensely competitive. As a result, financial institutions experienced, and are expected to continue to experience, pressure on credit costs, loan yields, deposit and other borrowing costs, liquidity, and capital.


EARNINGS REVIEW

Our net income was $1.2 million and $483,000 for the three months ended September 30, 2012 and 2011, respectively, an increase of $743,000. After our dividend payment to our preferred shareholders, net income to common shareholders was $842,000, or diluted earnings per share ("EPS") of $0.21, for the third quarter of 2012 as compared to net income to common shareholders of $197,000, or diluted EPS of $0.05 for the same period in 2011. The increase in net income resulted primarily from increases in net interest income and noninterest income as well as a decrease in the provision for loan losses.

Our net income for the first nine months of 2012 was $2.7 million compared to $1.7 million for the first nine months of 2011. Net income to common shareholders was $1.8 million, or diluted EPS of $0.46, for the nine months ended September 30, 2012, and $793,000, or diluted EPS of $0.20, for the nine months ended September 30, 2011. The increase in net income resulted primarily from increases in net interest income and noninterest income, partially offset by increases in noninterest expense and income tax expense.

Net Interest Income and Margin

Our level of net interest income is determined by the level of earning assets and the management of our net interest margin. For the three month period ended September 30, 2012, our net interest income was $6.7 million, a 12.3% increase over net interest income of $6.0 million for the same period in 2011. In comparison, our average earning assets increased 1.9%, or $13.5 million, during the third quarter of 2012 compared to the third quarter of 2011, while our interest bearing liabilities decreased by $16.8 million during the same period. The increase in average earning assets is primarily related to an increase in average loans, partially offset by a decrease in federal funds sold, while the decrease in average interest-bearing liabilities is a result of a decrease in time deposits, specifically, out-of-market certificates of deposit which decreased $35.0 million, offset in part by an increase in interest-bearing transaction accounts.

We have included a number of tables to assist in our description of various measures of our financial performance. For example, the "Average Balances, Income and Expenses, Yields and Rates" table reflects the average balance of each category of our assets and liabilities as well as the yield we earned or the rate we paid with respect to each category during the three and nine month periods ended September 30, 2012 and 2011. A review of this table shows that our loans typically provide higher interest yields than do other types of interest-earning assets, which is why we direct a substantial percentage of our earning assets into our loan portfolio. Similarly, the "Rate/Volume Analysis" table demonstrates the effect of changing interest rates and changing volume of assets and liabilities on our financial condition during the periods shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included tables to illustrate our interest rate sensitivity with respect to interest-earning accounts and interest-bearing accounts. Finally, we have included various tables that provide detail about our investment securities, our loans, our deposits, and other borrowings.

The following tables set forth information related to our average balance sheets, average yields on assets, and average costs of liabilities. We derived these yields by dividing income or expense by the average balance of the corresponding assets or liabilities. We derived average balances from the daily balances throughout the periods indicated. During the same periods, we had no securities purchased with agreements to resell. All investments owned have an original maturity of over one year. Nonaccrual loans are included in the following tables. Loan yields have been reduced to reflect the negative impact on our earnings of loans on nonaccrual status. The net of capitalized loan costs and fees are amortized into interest income on loans.


Average Balances, Income and Expenses, Yields and Rates

                                                                                   For the Three Months Ended September 30,
                                                                             2012                                      2011
                                                  Average     Income/      Yield/           Average     Income/      Yield/
  (dollars in thousands)                          Balance     Expense     Rate(1)           Balance     Expense     Rate(1)
  Interest-earning assets
  Federal funds sold                            $  22,406   $      13        0.23 %       $  34,786   $      20        0.23 %
  Investment securities, taxable                   54,636         301        2.19 %          78,986         489        2.46 %
  Investment securities, nontaxable (2)            17,935         215        4.76 %          14,607         177        4.82 %
  Loans                                           631,238       8,343        5.26 %         584,312       8,231        5.59 %
  Total interest-earning assets                   726,215       8,872        4.86 %         712,691       8,917        4.96 %
  Noninterest-earning assets                       41,576                                    41,253
  Total assets                                  $ 767,791                                 $ 753,944
  Interest-bearing liabilities
  NOW accounts                                  $ 151,396         208        0.55 %       $ 138,494         330         .95 %
  Savings & money market                          108,669         101        0.37 %         115,071         227        0.78 %
  Time deposits                                   212,049         633        1.19 %         237,013       1,094        1.83 %
  Total interest-bearing deposits                 472,114         942        0.79 %         490,578       1,651        1.34 %
  Note payable and other borrowings               124,363       1,046        3.35 %         122,700       1,140        3.69 %
  Junior subordinated debentures                   13,403          94        2.79 %          13,403          86        2.55 %
  Total interest-bearing liabilities              609,880       2,082        1.36 %         626,681       2,877        1.82 %
  Noninterest-bearing liabilities                  94,226                                    65,112
  Shareholders' equity                             63,685                                    62,151
  Total liabilities and shareholders' equity    $ 767,791                                 $ 753,944
  Net interest spread                                                        3.50 %                                    3.14 %
  Net interest income (tax equivalent) /
  margin                                                    $   6,790        3.72 %                   $   6,040        3.36 %
  Less: tax-equivalent adjustment (2)                              82                                        66
  Net interest income                                       $   6,708                                 $   5,974

(1) Annualized for the three month period.
(2) The tax-equivalent adjustment to net interest income adjusts the yield for assets earning tax-exempt income to a comparable yield on a taxable basis.

Our net interest margin, on a tax-equivalent basis, was 3.72% for the three months ended September 30, 2012 compared to 3.36% for the third quarter of 2011. The 36 basis point increase in net interest margin as compared to the same period in 2011, was driven primarily by a 46 basis point reduction in the cost of our interest bearing liabilities.

While our interest-earning assets increased by $13.5 million as compared to the same quarter in 2011, our tax-equivalent interest income decreased by $45,000 or 10 basis points. The decline in yield on our interest earning assets was driven primarily by reduced yields on our investment securities and loan portfolios. Our average loan balances increased by $46.9 million as of the third quarter of 2012, compared to the same period in 2011, while our loan yield decreased by 33 basis points. The decrease in loan yield was driven primarily by loans being originated or renewed at market rates which are lower than those in the past.

Our interest expense also decreased during the third quarter of 2012 as compared to the third quarter of 2011 due to lower rates on our interest-bearing liabilities. While our average interest-bearing liabilities decreased by $16.8 million as of the third quarter of 2012, compared to the same period in 2011, the rate on these liabilities decreased by 46 basis points. In effect, our interest-bearing liabilities continue to reprice downward at a faster rate than our interest-earning assets. In addition, as of September 30, 2012, over half of our FHLB advances were at fixed interest rates, while all of our other borrowings, including notes payable and junior subordinated debt, had variable interest rates.


Our net interest spread was 3.50% for the three months ended September 30, 2012 compared to 3.14% for the same period in 2011. The net interest spread is the difference between the yield we earn on our interest-earning assets and the rate we pay on our interest-bearing liabilities. The 46 basis point reduction in rate on our interest-bearing liabilities, partially offset by an 10 basis point decline in yield on our earning assets, resulted in a 36 basis point increase in our net interest spread for the 2012 period.

                                                                                                 For the Nine Months Ended September 30,
                                                                                   2012                                             2011
                                                  Average     Income/            Yield/                  Average     Income/      Yield/
  (dollars in thousands)                          Balance     Expense           Rate(1)                  Balance     Expense     Rate(1)
  Interest-earning assets
  Federal funds sold                            $  25,291   $      48              0.25 %            $    49,925   $      88        0.24 %
  Investment securities, taxable                   65,166       1,083              2.22 %                 66,699       1,290        2.59 %
  Investment securities, nontaxable (2)            17,961         642              4.77 %                 12,424         485        5.22 %
  Loans                                           614,577      24,351              5.29 %                579,975      24,664        5.69 %
  Total interest-earning assets                   722,995      26,124              4.83 %                709,023      26,527        5.00 %
  Noninterest-earning assets                       42,982                                                 41,399
  Total assets                                  $ 765,977                                            $   750,422
  Interest-bearing liabilities
  NOW accounts                                  $ 153,398         711              0.62 %            $   138,495       1,146        1.11 %
  Savings & money market                          111,849         339              0.40 %                108,187         657        0.81 %
  Time deposits                                   209,847       2,191              1.39 %                246,856       3,670        1.99 %
  Total interest-bearing deposits                 475,094       3,241              0.91 %                493,538       5,473        1.48 %
  Note payable and other borrowings               123,540       3,142              3.40 %                122,700       3,434        3.74 %
  Junior subordinated debentures                   13,403         282              2.81 %                 13,403         259        2.58 %
  Total interest-bearing liabilities              612,037       6,665              1.45 %                629,641       9,166        1.95 %
  Noninterest-bearing liabilities                  90,034                                                 59,736
  Shareholders' equity                             63,906                                                 61,045
  Total liabilities and shareholders' equity    $ 765,977                                            $   750,422
  Net interest spread                                                              3.38 %                                           3.05 %
  Net interest income (tax equivalent) /
  margin                                                    $  19,459              3.60 %                          $  17,361        3.27 %
  Less: tax-equivalent adjustment (2)                             244                                                    184
  Net interest income                                       $  19,215                                              $  17,177

(1) Annualized for the nine month period. . . .

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