FCCO

Business Context and Reporting Period

Company: First Community Corporation (First Community Bank, NA)

Filing Type: Form 10-Q (Quarterly Report)

Reporting Period: Three months ended March 31, 2007

Overview: The Company is a South Carolina-based bank holding company. The quarter reflects the post-merger integration of DeKalb Bankshares (completed June 2006) and the early adoption of SFAS 159 (Fair Value Option) effective January 1, 2007. The Company focuses on growing its loan portfolio relative to investments to improve yields.

Key Financial Metrics

Material Changes vs. Prior Period

• Net Income Decline: Net income decreased by approximately $110,000 (13.2%) compared to Q1 2006. This was primarily driven by a $457,000 (14.4%) increase in non-interest expenses, partially offset by a $281,000 increase in net interest income.
• Expense Growth: Non-interest expenses rose due to hiring retail bankers, a new television advertising campaign, consulting fees for process improvement, and occupancy costs from a new administrative building and the Camden branch.
• Net Interest Margin Compression: The net interest margin decreased 15 basis points to 3.18%. While the yield on earning assets increased 50 basis points to 6.44%, the cost of interest-bearing liabilities increased 79 basis points to 3.74%, largely due to higher rates on time deposits.
• Asset Mix Shift: Loans grew by $13.0 million, increasing their share of earning assets to 61.3% from 58.6% at year-end 2006. Investment securities decreased by approximately $9.0 million.
• Non-Performing Assets: Non-performing assets increased significantly to $1.123 million (0.20% of total assets) from $101,000 in Q1 2006, driven by $791,000 in nonaccrual loans and $332,000 in loans 90+ days past due still accruing.

Guidance, Outlook, and Risks

• Accounting Changes (SFAS 159): The Company adopted SFAS 159 on January 1, 2007, reclassifying certain structured corporate bonds from "available-for-sale" to "trading." This resulted in a cumulative reduction of retained earnings of $559,678. Future unrealized gains/losses on these instruments will be reported in earnings.
• Strategic Outlook: Management intends to continue shifting assets from the investment portfolio to the higher-yielding loan portfolio. They anticipate advertising expenses will remain approximately 65% above prior-year levels for the remainder of 2007.
• Capital Position: The Company remains "well-capitalized." Tier 1 risk-based capital ratio was 12.5% and total risk-based capital was 13.5% at March 31, 2007, well above regulatory minimums.
• Market Risk: The Company is currently liability-sensitive within one year. Simulation modeling indicates a decline in net interest income in both rising and falling rate environments due to the inverted yield curve and the repricing characteristics of transaction accounts.
• Risks: Key risks include competitive pressure, interest rate volatility, credit quality deterioration, and the impact of the inverted yield curve on margins.

Investor Verification Checklist

• Expense Sustainability: Verify if the 14.4% increase in non-interest expenses (driven by marketing and consulting) is a one-time step-up or a permanent increase in the cost structure.
• Credit Quality Trends: Monitor the $1.123 million in non-performing assets and the $332,000 in loans 90+ days past due to ensure they do not accelerate, given the allowance for loan losses is 297.6% of non-performing loans.
• Margin Pressure: Assess the ability to maintain net interest margins as time deposits reprice higher (84.2% reprice within 12 months) in a competitive deposit environment.
• Stock Repurchases: Note the repurchase of 62,413 shares in Q1 2007 at an average price of $17.70; verify remaining authorization under the 200,000 share plan.
• Accounting Impact: Confirm the ongoing impact of SFAS 159 on earnings volatility due to the fair value measurement of trading securities.