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FCCO > SEC Filings for FCCO > Form 10-Q on 14-May-2013All 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, 2012 as filed with the Securities and Exchange Commission (the "SEC") and the following:

credit losses as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, 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;

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

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;

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;

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 governmental initiatives affecting the financial services industry;

general economic conditions resulting in, among other things, a deterioration in credit quality;

changes occurring in business conditions and inflation;

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changes in access to funding or increased regulatory requirements with regard to funding;

increased cybersecurity risk, including potential business disruptions or financial losses;

changes in deposit flows;

changes in technology;

changes in monetary and tax policies;

changes in accounting policies and practices;

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;

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; and

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 2013, the capital and credit markets have experienced severe levels of volatility. During the first three months of 2013, 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, the economic and monetary policy statements by the Board of Governors of the Federal Reserve System (the "Federal Reserve"), and other variables, 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.

If any of these risks or uncertainties materialize, or if any of the assumptions underlying our forward-looking statements proves to be incorrect, our results could differ materially from those expressed in, implied or projected by, such forward-looking statements. Forward-looking statements in this Form 10-Q speak as of the date of this document, and we do not intend, and assume no obligation, to update such forward-looking statements or to update the reasons why actual results could differ from those expressed in, or implied or projected by, the forward-looking statements.


The following discussion describes our results of operations for the three months ended March 31, 2013 as compared to the three month period ended March 31, 2012 and also analyzes our financial condition as of March 31, 2013 as compared to December 31, 2012. 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

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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 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.

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 March 31, 2013 and our notes included in the consolidated financial statements in our 2012 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, 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 MBS 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 of the assumptions used as well as OTTI recognized in the financial statements during the three months ended March 31, 2012.

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Comparison of Results of Operations for Three Months Ended March 31, 2013 to the Three Months Ended March 31, 2012

Net Income

Our net income for the three months ended March 31, 2013 was $1.0 million or $0.20 diluted earnings per common share, as compared to $799 thousand or $0.19 diluted earnings per common share, for the three months ended March 31, 2012. The increase in net income between the two periods is primarily due to a decrease of $80 thousand in the provision for loan losses and an increase of $620 thousand in non-interest income in the three months ended March 31, 2013 as compared to the same period in 2012. The factors resulting in increased net income were partially offset by a decrease of $230 thousand in net interest income and a $195 thousand increase in non-interest expense during the three months ended March 31, 2013. Average earning assets increased by $19.0 million in the first quarter of 2013 as compared to the same period in 2012. Average earning assets were $562.1 million during the three months ended March 31, 2013 as compared to $543.1 million during the three months ended March 31, 2012. The increase in earning assets was offset by a 21 basis point decrease in our net interest margin on a tax equivalent basis.

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 three-month periods ended March 31, 2013 and 2012, along with average balances and the related interest income and interest expense amounts.

Net interest income was $4.3 million and $4.5 million for the three months ended March 31, 2013 and 2012. Our tax equivalent net interest margin decreased by 21 basis points from 3.36% at March 31, 2012 to 3.15% at March 31, 2013. The yield on earning assets for the three months ended March 31, 2013 and 2012 was 3.81% and 4.48%, respectively. The cost of interest-bearing liabilities during the first three months of 2013 was 0.90% as compared to 1.36% in the same period of 2012. Throughout 2012 and during the three months ended March 31, 2013, interest rates continued to remain at historically low levels. For the three months ended March 31, 2013, loans averaged 60.1% of average earning assets as compared to 60.5% in the same period of 2012. The lower average loan balances as well as reinvesting cash flows from maturing loans and investments at interest rates that remain at historical lows over the last year have resulted in the 67 basis point decline in the yield on earning assets during the two periods. Our cost of funds declined 46 basis points, on average, in the first quarter of 2013 as compared to the same period of 2012. Interest-bearing transaction accounts, money market accounts and savings deposits, which are typically our lower costing funds, represented 44.1% of our average interest bearing liabilities during the first quarter of 2013 as compared to 37.8% in the same period of 2012. Time deposits and borrowed funds, typically the higher costing funds, represented 55.9% of our average interest-bearing funds in the first quarter of 2013 as compared to 62.2% during the same period in 2012. The continued improvement in the overall mix of our funding sources resulted in a reduction of our cost of funds during the first quarter of 2013.

Provision and Allowance for Loan Losses

At March 31, 2013 and December 31, 2012, the allowance for loan losses was $4.5 million, or 1.36%, and $4.6 million, or 1.39%, of total loans, respectively. Our provision for loan losses was $150 thousand for the three months ended March 31, 2013, as compared to $230 thousand for the three months ended March 31, 2012. 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.

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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 ratings of loans within the portfolio. The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses. There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. The allowance is also subject to examination and testing for adequacy by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions. Such regulatory agencies could require us to adjust our allowance based on information available to them at the time of their examination.

The decrease in the provision for loan losses for the first three months of 2013 as compared to the same period in 2012 is a result of a continuation of moderating levels of classified and non-performing loans as well as continued moderate improvement in economic conditions, including 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, and 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 $9.0 million (1.45% of total assets) at March 31, 2013 as compared to $8.8 million (1.45% of total assets) at December 31, 2012. While we believe these ratios are favorable in comparison to current industry results (both nationally and locally), we continue to be concerned about the impact of this economic environment on our customer base of local businesses and professionals. There were 28 loans, totaling $5.7 million, included in non-performing status (non-accrual loans and loans past due 90 days and still accruing) at March 31, 2013. 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 27 loans is approximately $161 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 March 31, 2013, we had one loan delinquent more than 90 days and still accruing interest in the amount of $325 thousand. Loans totaling $3.3 million were delinquent 30 days to 89 days representing 1.01% of total loans.

Our management continuously monitors non-performing, classified and past due loans, to identify deterioration regarding the condition of these loans. We have identified two loan relationships in the aggregate amount of $1.8 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.

The following table summarizes the activity related to our allowance for loan losses:

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Allowance for Loan Losses

                                                              Three Month Ended
                                                                  March 31,
(Dollars in thousands)                                        2013        2012
Average loans outstanding (including loans held for sale)   $ 337,923   $ 328,604
Loans outstanding at period end                             $ 333,720   $ 331,090
Non-performing assets:
Nonaccrual loans                                            $   5,388   $   5,416
Loans 90 days past due still accruing                             325           -
Foreclosed real estate                                          3,317       5,383
Repossessed-other                                                  17           2
Total non-performing assets                                 $   9,047   $  10,801

Beginning balance of allowance                              $   4,621   $   4,699
Loans charged-off:
Construction and development                                        -           -
1-4 family residential mortgage                                     4         120
Non-residential real estate                                       235          71
Home equity                                                        42           -
Commercial                                                          7           -
Installment & credit card                                          26          21
Total loans charged-off                                           314         212
1-4 family residential mortgage                                    61           7
Non-residential real estate                                         -           -
Home equity                                                         -           2
Commercial                                                         11          12
Installment & credit card                                           5           7
Total recoveries                                                   77          28
Net loan charge offs (recoveries)                                 237         184
Provision for loan losses                                         150         230
Balance at period end                                       $   4,534   $   4,745

Net charge -offs to average loans                                 .07 %       .06 %
Allowance as percent of total loans                              1.36 %      1.43 %
Non-performing assets as % of total assets                       1.45 %      1.80 %
Allowance as % of non-performing loans                           79.4 %      87.6 %

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The following allocation of the allowance to specific components is not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses in the portfolio.

Composition of the Allowance for Loan Losses

                                           March 31, 2013      December 31, 2012
                                                     % of                   % of
                                                   loans in               loans in
(Dollars in thousands)                   Amount    Category    Amount     Category
Commercial, Financial and Agricultural   $   409        6.3 % $     338        6.3 %
Real Estate - Construction                    21        3.6 %         -        3.9 %
Real Estate Mortgage:
Commercial                                 1,075       69.1 %     1,322       68.2 %
Residential                                  199       11.5 %       235       11.7 %
Home Equity                                  236        7.9 %       400        8.2 %
Other                                         78        1.6 %        17        1.7 %
Unallocated                                2,516        N/A       2,309        N/A
Total                                    $ 4,534      100.0 % $   4,621      100.0 %

Accrual of interest is discontinued on loans when management believes, after considering economic and business conditions and collection efforts that a borrower's financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed in nonaccrual status when it becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest, which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.

Non-interest Income and Non-interest Expense

Non-interest income during the first quarter of 2013 was $2.1 million as compared to $1.5 million during the same period in 2012. Deposit service charges decreased $28 thousand. Mortgage origination fees increased $292 thousand. The decrease in deposit service charges is primarily a result of lower overdraft protection fees due to a continued decrease in the number of items being presented on insufficient funds accounts during the first quarter of 2013 as compared to the same period in 2012. The historically low interest rate environment as well as our continued focus on mortgage origination fee revenues resulted in the increase to $1.0 million in mortgage origination fees in the first quarter of 2013 as compared to $700 thousand in the same period of 2012. OTTI charges of $200 thousand (credit component) on two private label mortgage backed securities were recognized during the first three months of 2012 (see Note 3 to financial statements). There were no OTTI charges in the first quarter of 2013. As a result of the reduction in the balance of below investment grade securities in our portfolio in 2011 and 2012, the exposure to future OTTI credit charges on the securities held in our investment portfolio has been greatly reduced (see "Financial Position" discussion). Nevertheless, management continues to monitor the investment portfolio with a high degree of scrutiny. There can be no assurance that we will not conclude in future periods that conditions existing at that time indicate some of the securities are other-than temporarily impaired, which would require a charge to earnings in such period. During the three months ended March 31, 2012, we repaid $4.0 million in a FHLB advance that was to mature in January 2013. The loss on early extinguishment of this debt was $121 thousand. There were no losses incurred as a result of early extinguishment of debt during the first quarter of 2013.

Total non-interest expense increased by $195 thousand, or 4.2%, during the first quarter of 2013 as compared to the same quarter in 2012. Salary and benefit expense increased $434 thousand from $2.6 million in the first quarter of 2012 to $3.0 million in the first quarter of 2013. At March 31, 2013, we had 163 . . .

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