Business Context and Reporting Period
First Community Corporation is a South Carolina bank holding company for First Community Bank, serving small-to-medium businesses, professionals and consumers through 18 full-service offices in South Carolina and Georgia, plus loan-production offices. This Form 10-K covers the fiscal year ended December 31, 2017; fourth-quarter information is unaudited.
On October 20, 2017, the Company acquired Cornerstone Bancorp and Cornerstone National Bank for approximately $27.1 million, consisting of $7.8 million in cash and 877,364 shares of Company common stock. The acquisition added approximately $145.4 million of assets, $126.6 million of deposits and three branches. Results include Cornerstone for the 72 days after acquisition.
Financial Performance and Condition
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total assets | $1,050.7 million | $914.8 million | 14.9% |
| Loans, excluding loans held for sale | $646.8 million | $546.7 million | 18.3% |
| Deposits | $888.3 million | $766.6 million | 15.9% |
| Net interest income | $29.4 million | $26.5 million | 11.1% |
| Non-interest income | $9.6 million | $8.9 million | 7.8% |
| Provision for loan losses | $0.5 million | $0.8 million | Lower by $0.2 million |
| Non-interest expense | $29.4 million | $25.8 million | 13.9% |
| Net income | $5.8 million | $6.7 million | (13.0%) |
| Diluted EPS | $0.83 | $0.98 | (15.3%) |
Net interest margin on a fully taxable-equivalent basis improved to 3.52% from 3.35%; net interest spread increased to 3.31% from 3.13%. The yield on earning assets increased to 3.74%, while the rate paid on interest-bearing liabilities declined to 0.43%.
Returns and operating metrics weakened despite revenue growth: return on average assets was 0.62% versus 0.75%, return on average common equity was 6.56% versus 8.08%, and the efficiency ratio was 74.34% versus 72.27%.
Cash and cash equivalents increased to $30.6 million from $22.0 million. Operating activities generated $18.4 million of cash, investing activities generated $9.0 million, and financing activities used $18.8 million. The Company reported adequate liquidity, supported by core deposits, $30.0 million of unused short-term credit lines and FHLB borrowing capacity of up to 25% of Bank assets.
Total debt-like borrowings at year-end included $19.3 million of repurchase agreements, $14.3 million of FHLB advances and $15.0 million of junior subordinated debt. FHLB advances declined from $24.0 million in 2016. The average loan-to-deposit ratio increased to 73.1% from 69.6%; the year-end ratio, including loans held for sale, was 73.4%.
Capital remained strong. The Bank was considered well capitalized, with a 13.4% Tier 1 risk-based capital ratio, 14.2% total risk-based capital ratio, 13.4% CET1 ratio and 9.7% Tier 1 leverage ratio. Company ratios were 14.0%, 14.8%, 12.1% and 10.1%, respectively.
Fourth-Quarter 2017 Results
| Metric | Q4 2017 | Q4 2016 |
|---|---|---|
| Interest income | $8.7 million | $7.5 million |
| Net interest income | $8.1 million | $6.8 million |
| Provision for loan losses | $0.2 million | $0.2 million |
| Income before taxes | $2.1 million | $2.2 million |
| Net income | $0.5 million | $1.8 million |
| Diluted EPS | $0.07 | $0.26 |
Fourth-quarter earnings were materially reduced by the Tax Cuts and Jobs Act deferred-tax remeasurement and by Cornerstone-related costs.
Material Changes Versus the Prior Period
- Loan growth included approximately $60.1 million from Cornerstone and approximately $40.2 million of organic growth, or 7.3%, from December 31, 2016.
- Commercial mortgage loans increased 24.0% to $460.3 million and represented 71.2% of loans, increasing concentration in commercial real estate.
- Deposits increased $121.7 million, including approximately $126.1 million acquired from Cornerstone. Organic core deposits grew, while organic time deposits declined.
- Net interest income increased $2.9 million from improved margin and higher earning assets. Non-interest income increased $0.7 million, supported by mortgage banking and investment advisory activity.
- Non-interest expense increased $3.6 million, including approximately $0.9 million of merger expenses and approximately $0.4 million associated with conversion to an outsourced core processing system.
- Income tax expense increased to $3.3 million from $2.2 million. The Tax Act generated an approximately $1.2 million fourth-quarter charge, primarily from remeasuring deferred tax assets; management expected the benefit of the lower tax rate to be realized over approximately twelve months.
- Asset quality improved overall: non-performing assets declined to 0.51% of assets from 0.57%, non-performing loans declined to 0.52% of loans from 0.75%, and net charge-offs were a recovery of $53 thousand compared with net charge-offs of $156 thousand in 2016.
Outlook, Risks, Contingencies and Unusual Items
Management expected a 2018 effective tax rate of approximately 19% to 20% and expected the Bank to remain well capitalized for at least the following 12 months. No formal revenue or earnings guidance was provided.
- Credit risk is concentrated in commercial real estate and other real-estate-secured lending. Approximately 76.0% of total loans were commercial real estate loans, and 90.4% of loans had real estate as a primary or secondary component of collateral.
- Non-owner-occupied commercial real estate loans equaled approximately 249% of Bank risk-based capital, below the regulatory supervisory indicator of 300%, but subject to heightened regulatory scrutiny.
- The allowance for loan losses was $5.8 million, or 0.89% of loans, compared with 0.94% in 2016. Management cautioned that future charge-offs or regulatory reviews could require additional provisions.
- Interest-rate risk remains significant. Modeling indicated a potential 2.26% decline in 12-month net interest income under a 200-basis-point rate increase and a 7.71% decline under a 200-basis-point decrease.
- The Company identified cybersecurity, technology conversion, competition, deposit retention, regulatory changes, acquisition integration, funding access and capital requirements as material risks.
- Adoption of the Current Expected Credit Loss model was expected to materially affect the allowance for loan losses and could increase earnings volatility; the filing states that implementation was expected in 2019.
- Commitments to extend credit, including lines of credit, totaled $107.6 million at December 31, 2017, compared with $87.3 million in 2016. Management stated that litigation was incidental to ordinary operations and was not expected to have a material effect.
- Management and the auditor reported effective internal control over financial reporting, and the independent auditor issued unqualified opinions on the financial statements and internal controls.
Most Important Facts to Verify
- Confirm the full-year and fourth-quarter earnings impact of the $1.2 million Tax Act deferred-tax charge and whether the expected 19% to 20% 2018 tax rate was achieved.
- Reconcile reported loan and deposit growth between organic growth and the Cornerstone acquisition.
- Monitor commercial real estate concentration, criticized loans, nonaccrual loans, TDRs and allowance coverage as the acquired portfolio seasons.
- Review the effect of rising or falling interest rates on net interest margin, deposit pricing and modeled net interest income sensitivity.
- Assess whether merger and core-processing conversion costs were nonrecurring and whether operating efficiency improved after integration.
- Verify the timing and balance-sheet impact of CECL adoption, including any required increase in the allowance for loan losses.
- Confirm liquidity availability, FHLB collateral capacity, maturity of borrowings and the regulatory limitations affecting future dividends.