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FCCO > SEC Filings for FCCO > Form 10-Q on 13-Nov-2012All Recent SEC Filings

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Quarterly Report

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

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, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words "may," "would," "could," "should," "will," "expect," "anticipate," "predict," "project," "potential," "continue," "assume," "believe," "intend," "plan," "forecast," "goal," and "estimate," as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading "Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2011 as filed with the Securities and Exchange Commission (the "SEC") and the following:

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

the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market;

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;

reduced earnings due to higher other-than-temporary impairment charges resulting from additional decline in the value of our securities portfolio, specifically as a result of increasing default rates, and loss severities on the underlying real estate collateral;

the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;

results of examinations by our regulatory authorities, including the possibility that the regulatory authorities

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may, among other things, require us to increase our allowance for loan losses or write-down assets;

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

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

changes in political conditions or the legislative or regulatory environment, including, but not limited to, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") and regulations adopted thereunder, changes in federal and/or state tax laws or interpretations thereof by taxing authorities, including potential negative economic developments that may occur if certain federal tax reductions expire and spending cuts go into effect as currently scheduled, and other governmental initiatives affecting the financial services industry;

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;

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

               changes in deposit flows;

               changes in technology;

               changes in monetary and tax policies, including confirmation of

the income tax refund claims received by the Internal Revenue Service ("IRS");

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

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

              the rate of loan growth in recent years and the lack of seasoning
of a portion of our loan portfolio;

               our ability to maintain appropriate levels of capital and to
comply with our higher individual minimum capital ratios;

               our ability to attract and retain key personnel;

               our ability to retain our existing clients, including our
deposit relationships;

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

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

               other risks and uncertainties detailed from time to time in our
filings with the SEC.

These risks are exacerbated by the developments since 2008 in national and international financial markets, and we are unable to predict what effect continued uncertainty in market conditions will have on the 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 Board of Governors of the Federal Reserve System (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 of the past few years will not further materially and adversely affect our business, financial condition and results of operations.

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.


The following discussion describes our results of operations for the nine months and three months ended September 30, 2012 as compared to the nine month and three month periods ended September 30, 2011 and also analyzes our financial condition as of September 30, 2012 as compared to December 31, 2011. Like most community banks, we derive most of our income from interest we receive 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. 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.

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 establish and maintain this allowance by charging a provision for loan losses

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against our operating earnings. In the following section we have included a discussion of this process, as well as several tables describing our allowance for loan losses and the allocation of this allowance among our various categories of loans.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.

During the third quarter of 2012 and October 2012, we finalized the following significant four events:

On July 27, 2012, the Company closed its public offering of common stock. The offering resulted in the issuance of a total of 1.875 million shares of common stock at $8.00 per share, resulting in gross proceeds of $15 million, as compared to our original target of $12.5 million, and net proceeds of approximately $13.8 million. The investors in the offering consisted of a blend of institutional and retail investors. The offering was over-subscribed and priced at the closing price of our stock on the day of the pricing of the offering. We believe that this offering represents the only successfully executed underwritten public offering of common stock in a capital raising offering by a bank in the Carolinas with $1 billion or less in total assets in more than five years.

On August 29, 2012, we repurchased $3.78 million of our Series T preferred stock from the U.S. Treasury through a modified Dutch auction process. This represented 3,780 shares of the original 11,350 shares of preferred stock sold to the U.S. Treasury in November 2008 pursuant to the TARP Capital Purchase Program. The remaining 7,570 shares of Series T preferred stock were purchased in this same auction by third party investors unrelated to the Company. The auction price was $982.83 per share, which we believe was the highest price paid through that date for a company's shares in the Treasury's TARP preferred stock auctions. As of October 8, 2012, we have repurchased or redeemed the remaining shares of Series T preferred stock from the third party investors. The financial results reported for the third quarter include non-recurring expenses related to this matter in the amount of $119 thousand including attorney costs, CPA costs, and U.S. Treasury underwriter costs. In addition, we recorded a charge for the remaining discount accretion of approximately $159 thousand.

In addition, effective October 1, 2012, we completed a planned conversion from a national bank charter to a state bank charter as a non-member bank. The conversion will reduce certain regulatory examination cost in the future.

On October 25, 2012, the U.S. Treasury accepted our bid to repurchase the warrant to purchase 195,915 shares of our common stock issued to the U.S. Treasury pursuant to the TARP Capital Purchase Program. The repurchase price agreed upon was $297,500. The repurchase transaction was completed on November 1, 2012. The repurchase of the warrant, from the U.S. Treasury has completely eliminated its equity stake in the Company through the TARP Capital Purchase Program.

In addition to the events described above, the following discussion and analysis 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 the financial statements and the related notes and the other statistical information also included in this report.

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our unaudited consolidated financial statements as of September 30, 2012 and our notes included in the consolidated financial statements in our 2011 Annual Report on Form 10-K as filed with the SEC.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers,

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the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management's estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

The evaluation and recognition of OTTI on certain investments, including our private label MBSs and other corporate debt security holdings, requires significant judgment and estimates. Some of the more critical judgments supporting the evaluation of OTTI include projected cash flows including prepayment assumptions, default rates and severities of losses on the underlying collateral within the security. Under different conditions or utilizing different assumptions, the actual OTTI recognized by us may be different from the actual amounts recognized in our consolidated financial statements. See Note 3 to the financial statements for the disclosure of certain assumptions used as well as OTTI recognized in the financial statements during the nine and three months ended September 30, 2012 and 2011.

Recent Regulatory Developments

As described above, effective October 1, 2012, the Bank converted from a national bank charter to a South Carolina state bank charter and changed its name from First Community Bank, N.A. to First Community Bank. As a national bank, the Bank's primary regulator was the Office of the Comptroller of the Currency (the "OCC"). As a South Carolina state chartered bank, the Bank's primary federal regulator is now the Federal Deposit Insurance Corporation (the "FDIC").

Following a recent on-site examination of the Bank, the OCC notified the Bank that, effective June 28, 2012, the Bank is no longer subject to the Formal Written Agreement that it entered into with the OCC on April 6, 2010 (the "Formal Agreement"). The Formal Agreement was based on the findings of the OCC during a 2009 on-site examination of the Bank. As reflected in the Formal Agreement, the OCC's primary concern with the Bank was driven by the rating agencies downgrades of non-agency MBSs in its investment portfolio. These securities, purchased in 2004 through 2008, were all rated AAA by the rating agencies at the time of purchase; however, they were impacted by the economic recession and the stress on the residential housing sector and were subsequently downgraded, many to below investment grade. As of September 30, 2012, the Bank had reduced the non-agency MBSs in its investment portfolio that are rated below investment grade to $1.6 million.

The OCC also notified the Bank that, effective June 28, 2012, it is no longer subject to the Individual Minimum Capital Ratios established for the Bank on February 24, 2010, which had required the Bank to maintain a Tier 1 leverage capital ratio of at least 8.00%, a Tier 1 risk-based capital ratio of at least 10.00%, and a total risk-based capital ratio of at least 12.00%. The general regulatory minimums to be well-capitalized are a Tier 1 leverage capital ratio of at least 5.00%, a Tier 1 risk-based capital ratio of at least 6.00%, and a total risk-based capital ratio of at least 10.00%. These regulatory capital ratios for the Bank were 10.08%, 17.13% and 18.39%, respectively, as of September 30, 2012. The Bank is well-capitalized for regulatory purposes.

In addition, the Federal Reserve notified the Company that, effective July 10, 2012, the Company is no longer subject to the MOU.

Comparison of Results of Operations for Nine Months Ended September 30, 2012 to the Nine Months Ended September 30, 2011

Net Income

Our net income for the nine months ended September 30, 2012 was $2.9 million, or $0.60 diluted earnings per common share, as compared to $2.3 million, or $0.53 diluted earnings per common share, for the nine months ended September 30, 2011. The increase in net income between the two periods is primarily due to a lower provision for loan losses and an increase of $1.3 million in non-interest income. These were partially offset by a decrease of $412 thousand in net-interest income and a $577 thousand increase in non- interest expense during the nine months ended September 30, 2012 as compared to the same period in 2011. Average earning assets increased by $2.4 million in the first nine months of 2012 as compared to the same period in 2011. Average earning assets were $552.5 million during the nine months ended September 30, 2012 as compared to $550.1 million during the nine months ended September 30, 2011. The slight increase in average earning assets was primarily a result of the inclusion of the common stock offering proceeds in average earning assets during part of this period prior to redeeming the Series T preferred stock noted above.

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Net Interest Income

Please refer to the table at the end of this Item 2 for the yield and rate data for interest-bearing balance sheet components during the nine month periods ended September 30, 2012 and 2011, along with average balances and the related interest income and interest expense amounts.

Net interest income was $13.3 million for the nine months ended September 30, 2012 as compared to $13.7 million for the nine months ended September 30, 2011. This decrease was primarily due to the decrease in earning assets. The net interest margin on a taxable equivalent basis decreased 7 basis points, from 3.33% as of September 30, 2011 to 3.26% as of September 30, 2012. The yield on earning assets decreased by 45 basis points in the first nine months of 2012 as compared to the same period in 2011. The yield on earning assets for the nine months ended September 30, 2012 and 2011 was 4.24% and 4.69%, respectively. The cost of interest-bearing liabilities during the first nine months of 2012 was 1.25% as compared to 1.58% in the same period of 2011, resulting in a 33 basis points decrease. Continued low loan demand has resulted in loans comprising 59.8% of average earning assets in the first nine months of 2012 as compared to 60.0% in the same period of 2011. The relatively flat level loans as well as reinvesting cash flows from maturing loans and investments at interest rates that have continued to decline over the last year have resulted in the 45 basis point decline in the yield on earning assets during the two periods. Our cost of funds has declined by 33 basis points on average in the first nine months of 2012 as compared to the same period of 2011. Interest-bearing transaction accounts, money market accounts and savings deposits, which are typically our lower costing funds, represent 39.5% of our average interest bearing liabilities during the first nine months of 2012 as compared to 34.2% in the same period of 2011. Time deposits and borrowed funds, typically the higher costing funds, represent 60.5% of our average interest-bearing funds in the first nine months of 2012 as compared to 65.8% during the same period in 2011. Throughout the first nine months of 2012, we continued to focus on controlling the growth of the balance sheet and shifting our funding from higher cost certificates of deposit to "pure deposits" (deposits other than certificates of deposits). The improvement in the overall mix of our funding sources has contributed to the reduction in our cost of funds during the first nine months of 2012 as compared to the same period in 2011.

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Provision and Allowance for Loan Losses

At September 30, 2012 and December 31, 2011, the allowance for loan losses was $4.7 million. This represented 1.45% of total loans at both September 30, 2012 and December 31, 2011. Our provision for loan losses was $416 thousand for the nine months ended September 30, 2012 as compared to $1.1 million for the nine months ended September 30, 2011. This provision is made based on our assessment of general loan loss risk and asset quality. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, the experience ability and depth of lending personnel, economic conditions (local and national) that may affect the borrower's ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, and concentrations of credit. Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses.

The decrease in the provision for loan losses for the first nine months of 2012 as compared to the same period in 2011 is a result of a continuation of moderating levels of classified and non-performing loans as well as some moderate improvement in economic conditions, including stabilizing unemployment levels, in our markets. Our loan portfolio consists of a large percentage of real estate secured loans. Real estate values continue to be adversely impacted as a result of the economic downturn over the last several years. Impaired values of the underlying real estate collateral as well as continued slowdown in both residential and commercial real estate sales impacts our ability to sell collateral upon foreclosure. Although there are signs in our market that this slowdown is moderating, there is a risk that this trend will continue. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses. If during a period of reduced real estate values we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.

Non-performing assets were $10.5 million (1.73% of total assets) at September 30, 2012 as compared to $9.5 million (1.6% of total assets), $10.8 million (1.79% of total assets) and $12.8 million (2.15% of total assets) at June 30, 2012, March 31, 2012 and December 31, 2011, respectively. The net increase of $1.0 million in non-performing assets at September 30, 2012 on a linked quarter basis is primarily attributed to the net effect of the inflow of three new non-accrual loans in the approximate amount of $1.6 million, the movement of another three loans from non-accrual to Other Real Estate Owned ("OREO") status in the amount of $1.0 million, and the sale of OREO properties in the amount of approximately $375 thousand. While we believe these ratios are favorable in comparison to current industry results nationally and specifically in our local markets, we continue to be concerned about the impact of this economic environment on our customer base of local businesses and professionals. There were 26 loans, totaling $4.9 million, included in non-performing status (non-accrual loans and loans past due 90 days and still accruing) at September 30, 2012. The largest with a carrying value of $1.4 million is secured by a first lien on an owner occupied commercial business property located in the midlands of South Carolina. The average balance of the remaining 24 loans is approximately $145 thousand and the majority of these loans are secured by first mortgage liens. At the time the loans are placed in non-accrual status, we typically obtain an updated appraisal and, if the loan balance exceeds fair value, write the balance down to the fair value. At September 30, 2012, we had no loans delinquent more than 90 days and still accruing interest, and loans totaling $3.4 million that were delinquent 30 days to 89 days representing 1.05% of total loans.

Our management continuously monitors non-performing, classified and past due loans, to identify deterioration regarding the condition of these loans. At September 30, 2012, we have identified two loan relationships in the amount of $1.7 million that are current as to principal and interest and not included in non-performing assets that could represent potential problem loans. These balances are included as substandard loans in Note 4 of the financial statements.

We perform an analysis quarterly to assess the risk within the loan portfolio. The portfolio is segregated into similar risk components for which historical loss ratios are calculated and adjusted for identified changes in current portfolio characteristics. Historical loss ratios are calculated by product type and by regulatory credit risk classification. The allowance consists of an allocated and unallocated allowance. The allocated portion is determined by types and

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ratings of loans within the portfolio. This allocated portion of the allowance . . .

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