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FCCO > SEC Filings for FCCO > Form 10-K on 21-Mar-2014All Recent SEC Filings

Show all filings for FIRST COMMUNITY CORP /SC/



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.


The Company is headquartered in Lexington, South Carolina and the bank holding company for the Bank. We operate from our main office in Lexington, South Carolina, and our 13 full-service offices located in Lexington (two), Forest Acres, Irmo, Cayce-West Columbia, Gilbert, Chapin, Northeast Columbia, Prosperity, Newberry, Camden, and Aiken, South Carolina and Augusta, Georgia. During the second quarter of 2006, we completed our acquisition of DeKalb Bankshares, Inc., the holding company for The Bank of Camden. The merger added one office in Kershaw County located in the Midlands of South Carolina. During the fourth quarter of 2004, we completed our first acquisition when we merged with DutchFork Bancshares, Inc., the holding company for Newberry Federal Savings Bank. The merger added three offices in Newberry County. In 2007, our College Street office in Newberry was consolidated with our Wilson Road Office in Newberry. On September 15, 2008, the Company completed the acquisition of two financial planning and investment advisory firms, EAH Financial Group and Pooled Resources, LLC. In addition, the Bank expanded its residential mortgage business unit with the acquisition of the assets of Palmetto South, effective July 31, 2011. Palmetto South, which operates as a division of the Bank, offers mortgage loan products for home purchase or refinance in the South Carolina market area. On February 1, 2014 we closed our merger with Savannah River Financial Corporation (Savannah River), the holding company for Savannah River Banking Company (See recent developments below). This acquisition added two branches to our existing branch network, one located in Aiken, SC and one located in Augusta, GA. We engage in a general commercial and retail banking business characterized by personalized service and local decision making, emphasizing the banking needs of small to medium-sized businesses, professional concerns and individuals.

The following discussion describes our results of operations for 2013, as compared to 2012 and 2011, and also analyzes our financial condition as of December 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. A 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.

We have included a number of tables to assist in our description of these measures. For example, the "Average Balances" table shows the average balance during 2013, 2012 and 2011 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. 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 intend to channel a substantial percentage of our earning assets into our loan portfolio. Similarly, the "Rate/Volume Analysis" table helps demonstrate the impact of changing interest rates and changing volume of assets and liabilities during the years shown. We also track the sensitivity of our various categories of assets and liabilities to changes in interest rates, and we have included a "Sensitivity Analysis Table" to help explain this. Finally, we have included a number of tables that provide detail about our investment securities, our loans, and our deposits and other borrowings.

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 detailed 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 noninterest income, as well as our noninterest expense, in the following discussion. The 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 the financial statements and the related notes and the other statistical information also included in this report.

Recent Developments

On February 1, 2014, we completed our acquisition of Savannah River and its wholly-owned subsidiary, Savannah River Banking Company. Under the terms of the Agreement and Plan of Merger, Savannah River shareholders received either $11.00 in cash or 1.0618 shares of the Company's common stock, or a combination thereof, for each Savannah River share they owned immediately prior to the merger, subject to the limitation that 60% of the outstanding shares of Savannah River common stock were exchanged for cash and 40% of the outstanding shares of Savannah River common stock were exchanged for shares of the Company's common stock. The Company issued 1,274,200 shares of common stock in the merger.

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 notes to our consolidated financial statements in this report.

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.

Income taxes are provided for the tax effects of the transactions reported in our consolidated financial statements and consist of taxes currently due plus deferred taxes related to differences between the tax basis and accounting basis of certain assets and liabilities, including available-for-sale securities, allowance for loan losses, write downs of OREO properties, accumulated depreciation, net operating loss carry forwards, accretion income, deferred compensation, intangible assets, and pension plan and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is recorded when it is "more likely than not" that a deferred tax asset will not be realized. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. We file a consolidated federal income tax return for our subsidiary bank. At December 31, 2013, we are in a net deferred tax asset position.

We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the outlook for receiving the contractual cash flows of the investments, (4) the anticipated outlook for changes in the general level of interest rates, and (5) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that the Company will be required to sell the debt security prior to recovering its fair value (See Note 4 to the Consolidated Financial Statements).

Results of Operations

Our net income available to common shareholders was $4.1 million, or $0.78 diluted earnings per common share, for the year ended December 31, 2013, as compared to net income available to common shareholders of $3.3 million, or $0.79 diluted earnings per common share, for the year ended December 31, 2012. During 2013, we continued to reduce our overall cost of funds by reducing funding from certificates of deposits. The decline in certificate of deposit balances was more than offset by a 16.3% increase in transaction, money market and savings account balances. We were able to grow loans (excluding loans held for sale) by $15.5 million from December 31, 2012 to December 31, 2013 despite the continued slow economic environment. Average loan balances increased during 2013 to $344.1 million compared to $331.6 million in 2012.

Net interest income increased $475 thousand from $17.6 million in 2012 to $18.0 million in 2013. The increase in net interest income is primarily due to the increase in average earning assets. The net interest margin, on a tax equivalent basis, during 2013 was 3.18% as compared to 3.22% during 2012. See below under "Net Interest Income" and "Market Risk and Interest Rate Sensitivity" for a further discussion about the effect of the change in net interest margin. Net interest spread, the difference between the yield on earning assets and the rate paid on interest-bearing liabilities, was 2.94% in 2013 as compared to 2.95% in 2012. The provision for loan losses was $528 thousand in 2013 as compared to $496 thousand in 2012. Although the provision for loan losses increased slightly in 2013 from 2012, our credit quality measures have improved overall during the last two years as evidenced by the decrease in provision for loan losses from $1.4 million in 2011. Non-interest income was $8.2 million in 2013 as compared to $8.0 million in 2012. This increase was primarily due to increased income from investment advisory fees and no OTTI recorded for 2013. This was offset by a slowdown in mortgage banking income as a result of rising mortgage loan rates, particularly in the last half of 2013. Non-interest expense increased to $20.4 million in 2013 as compared to $19.4 million in 2012. The increase includes $539 thousand in merger related expenses related to the previously discussed acquisition of Savannah River which closed on February 1, 2014. In addition, salary and employee benefit expense increased by $861 thousand in 2013 as compared to 2012. Offsetting these increases in non-interest expense was a decrease in other real estate expenses of $502 thousand in 2013 as compared to 2012.

Net interest income decreased $743 thousand in 2012 from $18.3 million in 2011. The decrease in net interest income was a result of continued historically low interest rates throughout 2011 and 2012. The modest growth in our earning asset levels between the two periods was not enough to offset the lower interest rate environment. The net interest margin, on a tax equivalent basis, during 2012 was 3.22% as compared to 3.33% during 2011. Net interest spread was 2.95% in 2012 as compared to 3.11% in 2011. The provision for loan losses was $496 thousand in 2012 as compared to $1.4 million in 2011. The reduction in the provision for loan losses reflects lower net charge-offs and the previously stated improvement in credit quality measures in 2012. Non-interest income was $8.0 million in 2012 as compared to $6.3 million in 2011. This increase was primarily due to increased mortgage origination fees as a result of the expansion of this business through the acquisition of Palmetto South in the second half of 2011. Non-interest expense increased to $19.4 million in 2012 as compared to $18.4 million in 2011. As discussed below under "Non-interest income and expense," the increase is primarily attributable to increases in salary and benefits of $1.6 million in 2012 as compared to 2011.

Net Interest Income

Net interest income is our primary source of revenue. Net interest income is the difference between income earned on assets and interest paid on deposits and borrowings used to support such assets. Net interest income is determined by the rates earned on our interest-earning assets and the rates paid on our interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, and the degree of mismatch and the maturity and repricing characteristics of its interest-earning assets and interest-bearing liabilities.

Net interest income totaled $18.0 million in 2013, $17.6 million in 2012 and $18.3 million in 2011. The yield on earning assets was 3.75%, 4.15%, and 4.64% in 2013, 2012 and 2011, respectively. The rate paid on interest-bearing liabilities was 0.81%, 1.20%, and 1.53% in 2013, 2012, and 2011, respectively. The fully taxable equivalent net interest margin was 3.18% in 2013, 3.22% in 2012 and 3.33% in 2011. Our loan to deposit ratio on average during 2013 was 69.2%, as compared to 70.3% during 2012 and 70.6% during 2011. Loans typically provide a higher yield than other types of earning assets, and, thus, one of our goals continues to grow the loan portfolio as a percentage of earning assets in order to improve the overall yield on earning assets and the net interest margin. At December 31, 2013, the loan (including held for sale) to deposit ratio was 70.7%.

The net interest margin decreased in 2013 as compared to 2012. Since early 2008, interest rates have been at historic lows. The yield on earning assets decreased by 40 basis points and our cost of funds decreased by 39 basis points in 2013 as compared to 2012. Continued historically low interest rates have impacted our ability to reduce funding cost in relation to the decline in earning asset yields. During 2013, we continued to control the growth of our balance sheet and shift the mix of funding to lower cost sources (non-interest bearing transaction accounts, interest-bearing transaction accounts, money-market accounts and savings deposits). During 2013, the average balance in these accounts increased by $53.0 million as compared to 2012. During the same period, our funding from time deposits decreased by $27.0 million. Our average borrowings, which are typically a higher cost funding source, decreased $2.9 million in 2013 as compared to 2012. The change in the mix of funding sources has lessened the impact of the significant decline in our yield on earning assets. Throughout 2013, time deposits and borrowed funds represented 51.9% of our total interest bearing funding sources, and, in 2012, these balances represented 59.9% of our interest bearing funding sources.

The net interest margin decreased in 2012 as compared to 2011. The yield on earning assets decreased by 49 basis points and our cost of funds decreased by 33 basis points in 2012 as compared to 2011. This resulted in a decrease in our net interest spread of 16 basis points in 2012 as compared to 2011. During 2012, the average balance in lower cost sources of funding, as described above, increased by $26.0 million as compared to 2011. The change in the mix of funding sources lessened the impact of the significant decline in our yield on earning assets between 2012 and 2011. Our average borrowings and time deposits decreased $36.9 million in 2012 as compared to 2011. Throughout 2012, time deposits and borrowed funds represented 59.9% of our total interest bearing funding sources, and, in 2011, these balances represented 65.1% of our interest bearing funding sources.

Average Balances, Income Expenses and Rates. The following table depicts, for the periods indicated, certain information related to our average balance sheet and our average yields on assets and average costs of liabilities. Such yields are derived by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been derived from daily averages.

                                                                         Year ended December 31,
                                            2013                                  2012                                  2011
                               Average      Income/      Yield/      Average      Income/      Yield/      Average      Income/      Yield/
(Dollars in thousands)         Balance      Expense       Rate       Balance      Expense       Rate       Balance      Expense       Rate
Earning assets
Loans(1)                     $ 344,110     $ 17,581       5.11 %   $ 331,564     $ 18,361       5.54 %   $ 329,534     $ 19,110       5.80 %
Securities                     223,540        4,136       1.85 %     204,926        4,557       2.22 %     205,744        6,342       3.08 %
Other short-term
investments(2)                  13,649           66       0.48 %      17,234           84       0.49 %      15,178           74       0.49 %
Total earning assets           581,299       21,783       3.75 %     553,724       23,002       4.15 %     550,456       25,526       4.64 %
Cash and due from banks          8,546                                 8,643                                 7,992
Premises and equipment          17,509                                17,388                                17,759
Intangible assets                  641                                   832                                   740
Other assets                    22,290                                25,556                                31,791
Allowance for loan losses       (4,483 )                              (4,843 )                              (4,823 )
Total assets                 $ 625,802                             $ 601,300                             $ 603,915
transaction accounts           100,808          111       0.11 %   $  89,734          151       0.17 %   $  83,625          270       0.32 %
Money market accounts           74,514          171       0.23 %      52,575          153       0.29 %      48,802          209       0.43 %
Savings deposits                47,296           53       0.11 %      39,020           49       0.13 %      32,093           48       0.15 %
Time deposits                  171,436        1,458       0.85 %     198,392        2,769       1.40 %     219,737        4,046       1.84 %
Other borrowings                69,022        1,941       2.81 %      71,926        2,306       3.21 %      87,460        2,636       3.01 %
Total interest-bearing
liabilities                    463,076        3,734       0.81 %     451,647        5,428       1.20 %     471,717        7,209       1.53 %
Demand deposits                103,467                                91,737                                82,572
Other liabilities                5,422                                 5,469                                 5,286
Shareholders' equity            53,837                                52,447                                44,340
Total liabilities and
shareholders' equity         $ 625,802                             $ 601,300                             $ 603,915
Net interest spread                                       2.94 %                                2.95 %                                3.11 %
Net interest income/margin                 $ 18,049       3.10 %                 $ 17,574       3.17 %                 $ 18,317       3.33 %
Net interest margin (tax
equivalent)(3)                                            3.18 %                                3.22 %                                3.33 %

(1) All loans and deposits are domestic. Average loan balances include non-accrual loans and loans held for sale.

(2) The computation includes federal funds sold, securities purchased under agreement to resell and interest bearing deposits.

(3) Based on 32.5% marginal tax rate.

The following table presents the dollar amount of changes in interest income and interest expense attributable to changes in volume and the amount attributable to changes in rate. The combined effect in both volume and rate, which cannot be separately identified, has been allocated proportionately to the change due to volume and due to rate.

                                                  2013 versus 2012                       2012 versus 2011
                                             Increase (decrease) due to             Increase (decrease) due to
(In thousands)                            Volume        Rate         Net         Volume        Rate         Net
Earning assets
Loans                                   $    677     $ (1,457 )   $   (780 )   $    117     $   (866 )   $   (749 )
Investment securities                        390         (811 )       (421 )        (25 )     (1,759 )     (1,784 )
Other short-term investments                 (17 )         (1 )        (18 )         10            0           10
Total earning assets                       1,108       (2,327 )     (1,219 )        151       (2,674 )     (2,523 )
Interest-bearing liabilities
Interest-bearing transaction accounts         17          (57 )        (40 )         18         (137 )       (119 )
Money market accounts                         36          (18 )         18           18          (74 )        (56 )
Savings deposits                              10           (6 )          4            9           (8 )          1
Time deposits                               (338 )       (973 )     (1,311 )       (366 )       (911 )     (1,277 )
Other short-term borrowings                  (90 )       (275 )       (365 )       (515 )        186         (329 )
Total interest-bearing liabilities           134       (1,828 )     (1,694 )       (323 )     (1,457 )     (1,780 )
Net interest income                                               $    475                               $   (743 )

Market Risk and Interest Rate Sensitivity

Market risk reflects the risk of economic loss resulting from adverse changes in market prices and interest rates. The risk of loss can be measured in either diminished current market values or reduced current and potential net income. Our primary market risk is interest rate risk. We have established an Asset/Liability Management Committee ("ALCO") to monitor and manage interest rate risk. The ALCO 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 our net interest income. The ALCO has established policy guidelines and strategies with respect to interest rate risk exposure and liquidity.

A monitoring technique employed by us is the measurement of our interest sensitivity "gap," which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Also, asset/liability modeling is performed to assess the impact varying interest rates and balance sheet mix assumptions will have on net interest income. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity or by 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 on net interest income of rising or falling interest rates. Neither the "gap" analysis or asset/liability modeling are precise indicators of our interest sensitivity position due to the many factors that affect net interest income including, the timing, magnitude and frequency of interest rate changes as well as changes in the volume and mix of earning assets and interest-bearing liabilities.

The following table illustrates our interest rate sensitivity at December 31, 2013.

Interest Sensitivity Analysis

                                 Within          One to         Three to         Over
(Dollars in thousands)          One Year      Three Years      Five Years     Five Years       Total
Earning assets
Loans(1)                       $ 116,196     $    106,629     $   92,677     $   26,689     $ 342,191
Loans Held for Sale                3,790               -              -              -          3,790
Securities(2)                     76,255           38,106         23,310         90,633       228,304
Federal funds sold,
securities purchased under
agreements to resell and
other earning assets               8,601               -              -              -          8,601
Total earning assets             204,842          144,735        115,987        117,322       582,886
Interest bearing liabilities
Interest bearing deposits
NOW accounts                      21,417           35,378         14,701         29,403       100,899
Money market accounts             18,331           25,664          7,333         21,997        73,325
Savings deposits                  10,227            7,670          5,114         28,123        51,134
Time deposits                     78,873           53,163         28,468             11       160,515
Total interest-bearing
deposits                         128,848          121,875         55,616         79,534       385,873
Other borrowings                  43,150            2,104         32,106             63        77,423
Total interest-bearing
liabilities                      171,998          123,979         87,722         79,597       463,296
Period gap                     $  32,844     $     20,756     $   28,265     $   37,725     $ 119,590
Cumulative gap                 $  32,844     $     53,600     $   81,865     $  119,590     $ 119,590
Ratio of cumulative gap to
total earning assets                5.64 %           9.20 %        14.05 %        20.52 %       20.52 %

(1) Loans classified as non-accrual as of December 31, 2013 are not included in the balances.

(2) Securities based on amortized cost.

We entered into a five year interest rate swap agreement on October 8, 2008 that expired on October 8, 2013. The swap agreement had a $10.0 million notional amount. We received a variable rate of interest on the notional amount based on a three month LIBOR rate and pay a fixed rate interest of 3.66%. The contract was entered into to protect us from the negative impact of rising interest rates. Our exposure to credit risk was limited to the ability of the counterparty to make potential future payments required pursuant to the agreement. Our exposure to market risk of loss was limited to the changes in the market value of the swap between reporting periods. At December 31, 2012, the . . .

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