Business Context and Reporting Period
First Community Corporation is a South Carolina bank holding company whose principal subsidiary provides commercial and retail banking, mortgage banking, investment advisory, and non-deposit services. This unaudited Form 10-Q covers the three and nine months ended September 30, 2017, compared with the corresponding 2016 periods; balance-sheet comparisons are primarily with December 31, 2016. The company had 6,706,406 common shares outstanding as of November 6, 2017.
Key Financial Metrics
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net income | $1.893 million | $1.677 million | $5.313 million | $4.890 million |
| Diluted EPS | $0.28 | $0.25 | $0.78 | $0.72 |
| Net interest income | $7.227 million | $6.651 million | $21.336 million | $19.665 million |
| Provision for loan losses | $166 thousand | $179 thousand | $360 thousand | $536 thousand |
| Non-interest income | $2.422 million | $2.387 million | $7.045 million | $6.740 million |
| Non-interest expense | $6.894 million | $6.583 million | $20.984 million | $19.258 million |
| Tax-equivalent net interest margin | 3.52% | 3.29% | 3.51% | 3.35% |
For the nine months, net income increased approximately 8.7%, while diluted EPS increased approximately 8.3%. Q3 net income increased approximately 12.9% and diluted EPS increased approximately 12.0%.
- Total assets were $914.2 million at September 30, 2017, broadly unchanged from $914.8 million at December 31, 2016.
- Gross loans increased 4.0% to $568.5 million from $546.7 million. Commercial mortgage loans increased to $398.8 million from $371.1 million and represented 70.1% of gross loans.
- Deposits increased to $770.1 million from $766.6 million. Non-interest-bearing deposits increased to $195.3 million, while time deposits declined to $164.5 million.
- Investment securities declined to $246.1 million, including held-to-maturity and available-for-sale securities, from $270.6 million at year-end.
- Shareholders’ equity increased to $86.6 million from $81.9 million, and represented 9.7% of total assets versus 8.9% at December 31, 2016.
- Cash and cash equivalents were $27.1 million at September 30, 2017, compared with $22.0 million at December 31, 2016.
- Net cash provided by operating activities was $13.2 million; investing activities used $0.3 million; financing activities used $7.8 million.
- Outstanding borrowings included $17.3 million of Federal Home Loan Bank advances, $17.5 million of repurchase obligations, and $15.0 million of junior subordinated debt.
- The loan-to-deposit ratio was 74.6%, compared with 72.1% at December 31, 2016.
Material Changes Versus Prior Comparable Period
- Net interest income benefited from higher average earning assets, a greater proportion of loans, lower funding costs, and a higher net interest margin. Average earning assets increased to $837.0 million from $810.4 million for the nine-month comparison.
- Mortgage banking income increased to $3.0 million from $2.5 million for the nine months; mortgage loan production was $83.4 million versus $77.2 million.
- Investment advisory and non-deposit fees increased to $908 thousand from $871 thousand. Assets under management increased to $254.0 million from $195.1 million at September 30, 2016.
- Non-interest expense increased 9.0% for the nine months, primarily from higher salaries and benefits, data-processing and professional costs, core-processing conversion costs, and Cornerstone merger expenses.
- The allowance for loan losses increased to $5.7 million from $5.2 million, but the provision declined to $360 thousand from $536 thousand. Net loan recoveries were $82 thousand for the nine months, compared with $85 thousand of net charge-offs in 2016.
- Non-performing assets declined to $3.7 million, or 0.41% of assets, from $5.2 million, or 0.59%. Non-accrual loans declined to $2.9 million from $4.1 million, while impaired loans declined to $4.6 million from $5.8 million.
- Available-for-sale securities declined to $229.1 million from $253.4 million. The company reported $2.3 million of unrealized losses on available-for-sale securities at September 30, 2017, but did not consider the securities other-than-temporarily impaired.
- The company prepaid approximately $13.0 million of FHLB advances and incurred a $446 thousand early-extinguishment charge during the nine months.
Guidance, Outlook, Risks, Contingencies and Unusual Items
- Management stated that liquidity and capital are adequate for operating and lending requirements and expects the company and bank to remain well capitalized for at least the next 12 months.
- Management expected the effective tax rate to be approximately 27% to 28% for the remainder of 2017. A first-quarter accounting change for share-based compensation reduced tax expense by approximately $115 thousand and may increase future tax-rate volatility.
- Management anticipated approximately $325 thousand of additional Cornerstone-related expenses in the fourth quarter of 2017. The Cornerstone merger closed on October 20, 2017, after the reporting date, with consideration consisting of cash, company shares, or a combination, subject to specified allocation limits.
- The company completed a core-processing conversion during the first nine months of 2017. Management indicated that certain overtime and temporary-help costs were nonrecurring, while other technology and processing costs shifted among expense categories.
- Approximately 90.7% of the loan portfolio was collateralized by real estate. Key credit risks include declining real-estate values, higher interest rates, unemployment, borrower payment deterioration, loan-growth seasoning, and the adequacy of the allowance.
- Other risks include interest-rate and funding risk, deposit outflows, regulatory restrictions, merger integration and customer-retention risk, cybersecurity, competition, economic weakness, severe weather, and changes in accounting or tax rules.
- The company had $93.2 million of commitments to extend credit, including $35.3 million of unused home-equity lines. These commitments are subject to customary underwriting and collateral requirements.
- The company disclosed no material pending legal proceedings and stated that disclosure controls were effective as of September 30, 2017.
- Interest-rate sensitivity modeling estimated that a parallel 200-basis-point increase would reduce projected net interest income by 1.77%, while a 200-basis-point decrease would reduce it by 6.90%, subject to the model’s assumptions.
Investor Verification Priorities
- Verify the accounting, purchase consideration, pro forma impact, and integration costs of the October 20, 2017 Cornerstone merger.
- Monitor commercial real-estate concentration, classified loans, non-accrual loans, delinquency trends, and whether the $5.7 million allowance remains adequate.
- Assess sustainability of loan growth and the 3.51% tax-equivalent net interest margin as interest rates and deposit funding costs change.
- Separate recurring earnings from securities gains, debt-prepayment penalties, merger expenses, core-processing conversion costs, and share-based compensation tax effects.
- Review liquidity sources, FHLB borrowing capacity, deposit mix, uninsured or large time deposits, and the $93.2 million of unfunded credit commitments.
- Confirm that post-merger capital ratios remain above regulatory minimums and that dividend capacity is not constrained by regulatory or bank-level requirements.