Business Context and Reporting Period
First Community Corporation is a South Carolina bank holding company for First Community Bank, serving small and mid-sized businesses, professionals and consumers in South Carolina and Georgia. The Bank operated 15 full-service offices, a Greenville loan production office and a mortgage production office as of December 31, 2016. This Form 10-K covers the fiscal year ended December 31, 2016; fourth-quarter data is also presented.
Financial Performance and Condition
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Total assets | $914.8 million | $862.7 million | +$52.1 million |
| Loans, excluding held for sale | $546.7 million | $489.2 million | +11.8% |
| Deposits | $766.6 million | $716.2 million | +$50.4 million |
| Net interest income | $26.5 million | $25.3 million | +$1.2 million |
| Net income | $6.7 million | $6.1 million | +9.1% |
| Diluted EPS | $0.98 | $0.91 | +$0.07 |
| Net interest margin, tax equivalent | 3.35% | 3.38% | -3 basis points |
| Return on average assets | 0.75% | 0.73% | +2 basis points |
| Return on average common equity | 8.08% | 7.94% | +14 basis points |
| Efficiency ratio | 72.27% | 71.25% | Higher expenses relative to revenue |
Fourth-quarter 2016 net income was $1.8 million, or $0.26 diluted EPS, compared with $1.6 million, or $0.24 diluted EPS, in the fourth quarter of 2015.
- Interest income increased to $29.5 million from $28.6 million, driven primarily by higher average earning assets. Average earning assets increased $46.3 million.
- Provision for loan losses declined to $774,000 from $1.1 million. Net charge-offs were $156,000, or 0.03% of average loans and loans held for sale.
- Non-interest income was $8.9 million versus $9.0 million. Securities gains increased to $601,000 from $355,000, while mortgage banking income and investment advisory fees declined modestly.
- Non-interest expense increased to $25.8 million from $24.7 million, primarily due to higher salaries and benefits, staffing for the Greenville loan production office, technology and debit-card processing costs.
- The effective tax rate declined to 24.5% from 27.1%, aided by a $200,000 South Carolina tax credit and increased bank-owned life insurance income.
Balance Sheet, Credit, Debt and Liquidity
- Loan growth was funded primarily by deposits. The year-end loan-to-deposit ratio increased to 72.1% from 68.7%.
- Commercial mortgage loans were $371.1 million, or 67.9% of loans, and commercial real estate plus construction loans totaled approximately $406.0 million. Management identified real estate and commercial real estate concentration as material credit risks.
- Non-performing assets were approximately $7.3 million, or 0.57% of total assets, versus 0.85% in the selected financial data presentation for 2015; non-accrual loans declined to $4.0 million from $4.8 million. The filing contains differing presentation references for certain asset-quality percentages, which should be reconciled to the audited notes.
- The allowance for loan losses increased to $5.2 million, or 0.95% of loans, from $4.6 million, or 0.94%. Allowance coverage of non-performing loans improved to 127.1% from 95.0%.
- Cash and cash equivalents were $22.0 million at year-end, compared with $22.9 million in 2015. Management stated that liquidity was adequate, supported by core deposits, $20.0 million of unused short-term credit lines, and FHLB borrowing capacity of up to 25% of Bank assets subject to collateral requirements.
- FHLB advances declined to $24.0 million from $24.8 million; repurchase borrowings declined to $19.5 million from $21.0 million. Junior subordinated debt remained $15.0 million, with a carrying value of $15.0 million and a stated maturity in 2034.
- Shareholders’ equity increased to $81.9 million from $79.0 million. The company paid $0.32 per common share in dividends during 2016, up from $0.28 in 2015.
- The Bank was classified as well capitalized. At December 31, 2016, Bank ratios were 13.8% Tier 1 risk-based capital, 14.7% total risk-based capital, 13.8% CET1 and 9.8% Tier 1 leverage. The Company’s corresponding ratios were 14.5%, 15.3%, 12.2% and 10.2%.
Cash Flow and Material Changes
- Operating activities provided $5.1 million of cash, down from $14.5 million, primarily reflecting working-capital and other-asset changes.
- Investing activities used $51.5 million, including $57.5 million of net loan growth and purchases of investment securities.
- Financing activities provided $45.5 million, principally from a $50.4 million increase in deposits, partly offset by net FHLB repayments and $2.1 million of common dividends.
- Organic loan production, excluding loans originated for sale, increased to approximately $164.5 million from $116.5 million.
- The securities portfolio declined to approximately $270.6 million from $283.8 million. Management reported no securities below investment grade and no other-than-temporary impairment charges.
- The Bank’s 2015 FDIC consent order concerning Bank Secrecy Act and anti-money-laundering controls was terminated on January 28, 2016 after corrective actions.
Guidance, Outlook, Risks and Unusual Items
- Management expected the 2017 effective tax rate to be between 27% and 30%, expected the Bank to remain well capitalized for at least the next 12 months, and stated that liquidity was adequate for operating and loan-funding needs.
- The company was converting its core processing and electronic banking systems to a third-party platform, with conversion planned for June 2017. Execution failures could cause disruptions, customer attrition, losses or regulatory consequences.
- Interest-rate risk is material. The company described itself as asset sensitive; modeled 12-month net interest income changes at December 31, 2016 were +0.37% for a 100-basis-point increase, +0.08% for a 200-basis-point increase, and negative 2.81% and 7.69% for 100- and 200-basis-point decreases.
- Key risks include concentration in commercial real estate and real estate-secured loans, deterioration in local economic or property conditions, higher credit losses, interest-rate changes, deposit outflows, competition, cybersecurity, regulatory changes, capital requirements and the ability to retain key personnel.
- Unusual or non-recurring items included $459,000 of FHLB prepayment penalties, $601,000 of securities gains, a $200,000 state tax credit, debit-card reissuance and fraud costs, and increased legal and professional costs related to internal-control audit requirements.
- Management reported no material pending litigation, no material subsequent events requiring accrual or disclosure, and unqualified audit opinions on the consolidated financial statements and internal control over financial reporting.
Investor Verification Priorities
- Reconcile the filing’s inconsistent presentation of 2015 non-performing asset ratios and the MD&A wording that reverses the years for net interest income.
- Assess the sustainability of 11.8% loan growth, particularly the $406.0 million commercial real estate and construction exposure.
- Review allowance methodology, acquired-loan credit marks, impaired loans, TDRs and the impact of commercial real estate concentration on future provisions.
- Verify the effect of further Federal Reserve rate increases on the 3.35% net interest margin and modeled interest-rate sensitivity.
- Monitor deposit growth, uninsured time deposits, FHLB advances, overnight borrowings and available liquidity capacity.
- Confirm successful completion and cost of the June 2017 core-system conversion and continued compliance following termination of the BSA consent order.
- Evaluate dividend sustainability in light of regulatory restrictions, capital conservation requirements and the Company’s dependence on dividends from the Bank.