First Community Corporation: Q2 2017 Form 10-Q Summary
Business context and reporting period
First Community Corporation is a South Carolina bank holding company whose principal activities include commercial and retail banking, mortgage banking, investment advisory and non-deposit services. This unaudited Form 10-Q covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods, and financial position at June 30, 2017 compared with December 31, 2016. Dollar amounts are in thousands unless otherwise noted.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Net interest income | $7,049 | $6,677 | $14,110 | $13,014 |
| Provision for loan losses | $78 | $217 | $194 | $357 |
| Non-interest income | $2,644 | $2,264 | $4,622 | $4,353 |
| Non-interest expense | $7,370 | $6,333 | $14,090 | $12,675 |
| Net income | $1,664 | $1,745 | $3,420 | $3,213 |
| Diluted EPS | $0.24 | $0.26 | $0.50 | $0.47 |
| Tax-equivalent net interest margin | 3.49% | 3.43% | 3.51% | 3.38% |
- Six-month average earning assets increased to $836.2 million from $800.6 million, while the tax-equivalent net interest margin expanded 13 basis points to 3.51%.
- Mortgage banking income increased to $1.9 million for the first six months, compared with $1.6 million in 2016. Mortgage production was $55.0 million versus $43.9 million.
- Total assets were $915.5 million, broadly unchanged from $914.8 million at year-end 2016. Gross loans increased to $553.4 million from $546.7 million, driven primarily by commercial mortgage loans.
- Investment securities declined to $256.5 million, including held-to-maturity and available-for-sale securities, from $270.6 million at December 31, 2016.
- Deposits increased to $773.1 million from $766.6 million. The loan-to-deposit ratio was 72.4%, compared with 72.1% at year-end.
- Allowance for loan losses was $5.5 million, or 0.99% of loans, versus $5.2 million, or 0.97%, at year-end. Six-month net recoveries were $82 thousand, compared with net charge-offs of $76 thousand in 2016.
- Non-performing assets declined to $3.9 million, or approximately 0.43% of total assets, from $5.2 million, or 0.59%, at year-end. Nonaccrual loans were $3.0 million; no loans were more than 90 days past due and still accruing.
- Cash and cash equivalents increased to $34.5 million from $22.0 million at the beginning of the year. Six-month operating cash flow was $10.2 million, investing cash flow was $5.8 million, and financing cash flow was negative $3.5 million.
- Shareholders’ equity was $85.1 million, or 9.3% of total assets, compared with $81.9 million, or 8.9%, at year-end.
- Debt at June 30 comprised $18.0 million of Federal Home Loan Bank advances, $17.3 million of repurchase agreements and $15.0 million of junior subordinated debt. The company prepaid $9.8 million of FHLB advances and recorded $281 thousand of prepayment penalties.
- The Bank’s June 30 regulatory ratios were 9.9% leverage, 14.3% Tier 1 risk-based, 15.2% total risk-based and 14.3% CET1. Management stated that the Company and Bank met fully phased-in capital requirements and expected to remain well capitalized for at least the next 12 months.
Material changes versus the prior comparable period
- Six-month net income increased 6.4%, but second-quarter net income decreased 4.6%, primarily because of higher operating costs, core-processing conversion expenses and merger-related costs.
- Six-month net interest income increased 8.4%, supported by loan growth, higher average earning assets and lower funding costs. The cost of interest-bearing liabilities fell to 0.44% from 0.51%.
- Six-month non-interest income rose 6.2%, mainly from mortgage banking and securities-sale gains. Non-interest expense increased 11.2% to $14.1 million.
- Salary and benefits expense increased $763 thousand, reflecting staffing, compensation, medical premiums, higher mortgage production and core-processing conversion costs. The company had 200 full-time equivalent employees versus 187 a year earlier.
- Reported expenses included approximately $98 thousand of Cornerstone merger costs and approximately $281 thousand of FHLB prepayment penalties. Management indicated that certain core-conversion costs were not expected to recur.
- Commercial mortgage loans increased to $394.5 million from $371.1 million, while construction loans declined to $34.5 million from $45.7 million.
Guidance, outlook, risks and unusual items
- The company expected its effective tax rate to be approximately 27% to 28% for the remainder of 2017. A first-quarter share-based compensation tax benefit reduced six-month tax expense by approximately $115 thousand and may create future volatility.
- Management stated that liquidity was adequate. Interest-bearing bank balances, federal funds sold and available-for-sale securities represented 28.6% of total assets. The company also had $20.0 million of federal funds purchased lines and access to an FHLB line of up to 25% of Bank assets, subject to collateral requirements.
- Outstanding commitments to extend credit were $86.4 million, including $34.9 million of unused home-equity lines. These commitments expose the company to additional credit and funding risk.
- On April 11, 2017, First Community agreed to acquire Cornerstone Bancorp and merge Cornerstone National Bank into the Bank. Based on June 30 shares outstanding, consideration was estimated at approximately 877,000 First Community shares and $7.7 million of cash. Closing was expected in early fourth quarter 2017, subject to shareholder and regulatory approvals.
- Key risks include real-estate concentration, credit losses, asset-quality deterioration, interest-rate and funding changes, regulatory capital requirements, cybersecurity, deposit outflows, competition and the ability to complete and integrate the Cornerstone transaction.
- Approximately 91.1% of the loan portfolio was collateralized by real estate. Management identified one current $1.0 million relationship as a potential problem loan and maintained a substantial unallocated allowance because recent loss experience did not cover a full economic cycle.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. No material pending legal proceedings were disclosed.
Important facts for investors to verify
- Confirm the final status, consideration, regulatory approvals, closing date and integration results of the Cornerstone merger.
- Assess whether the increase in non-interest expense, including core-conversion, staffing, audit and merger costs, normalizes after 2017.
- Monitor commercial real-estate concentration, the $1.0 million potential problem relationship, nonaccrual loans and adequacy of the $5.5 million allowance.
- Evaluate sustainability of mortgage banking production and securities-sale gains relative to recurring banking revenue.
- Review sensitivity to interest-rate changes, deposit mix, FHLB funding and the $86.4 million of unfunded lending commitments.
- Reconcile reported regulatory capital ratios after any merger-related cash payment, share issuance or purchase accounting adjustments.