First Community Corporation: 2018 Form 10-K Summary
Business context and reporting period
First Community Corporation is a South Carolina bank holding company for First Community Bank, serving commercial and retail customers through 20 full-service offices and a mortgage production office in South Carolina and Georgia. The filing covers the fiscal year ended December 31, 2018, with quarterly data provided for the fourth quarter.
The 2018 results include a full year of operations from the October 2017 acquisition of Cornerstone Bancorp, compared with approximately 72 days of Cornerstone contribution in 2017.
Financial performance and key metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Total assets | $1.092 billion | $1.051 billion |
| Loans | $718.5 million | $646.8 million |
| Deposits | $925.5 million | $888.3 million |
| Shareholders’ equity | $112.5 million | $105.7 million |
| Net interest income | $35.7 million | $29.4 million |
| Non-interest income | $10.6 million | $9.6 million |
| Net income | $11.2 million | $5.8 million |
| Diluted EPS | $1.45 | $0.83 |
| Net interest margin, tax equivalent | 3.69% | 3.52% |
| Efficiency ratio | 68.06% | 74.34% |
| Return on average assets | 1.04% | 0.62% |
| Return on average common equity | 10.48% | 6.56% |
Loan growth was primarily organic: loans increased 11.1% year over year, excluding loans held for sale. Commercial mortgage loans represented 71.5% of total loans, while commercial real estate and commercial construction loans together represented approximately 78.1% of the portfolio.
Asset quality improved overall. Non-performing assets declined to $4.0 million, or 0.37% of assets, from $5.3 million, or 0.51%, in 2017. Nonaccrual loans declined to $2.5 million from $3.3 million. The allowance for loan losses increased to $6.3 million, or 0.87% of loans, from $5.8 million, or 0.89%.
Cash flow, debt and liquidity
- Net cash provided by operating activities was $20.2 million, compared with $18.4 million in 2017.
- Investing activities used $47.8 million, primarily reflecting $71.3 million of net loan growth and net investment-security purchases.
- Financing activities provided $29.3 million, including $37.3 million of deposit growth and an $8.8 million increase in securities sold under repurchase agreements, partly offset by net FHLB repayments.
- Cash and cash equivalents increased to $32.3 million from $30.6 million.
- Year-end borrowings included $28.0 million of repurchase agreements, $0.2 million of FHLB advances and $15.0 million of junior subordinated debt.
- The Bank had $30.0 million of unused short-term credit lines and an FHLB borrowing line of up to 25% of assets, subject to collateral requirements.
- Management stated that liquidity was adequate and expected the Bank to remain well capitalized for at least the following 12 months.
Fourth-quarter results
Fourth-quarter 2018 net income was $2.7 million, or $0.35 diluted EPS, compared with $0.5 million, or $0.07 diluted EPS, in the fourth quarter of 2017. Fourth-quarter net interest income was $9.4 million, provision for loan losses was $94 thousand, and income before taxes was $3.4 million. The quarter included a $332 thousand loss on securities sales.
Material changes versus the prior comparable period
- Net income increased approximately 93%, primarily because 2017 included a $1.2 million deferred-tax remeasurement charge related to the Tax Cuts and Jobs Act, approximately $903 thousand of Cornerstone merger expenses and approximately $300 thousand of core-system conversion costs.
- Net interest income increased $6.4 million as average earning assets expanded and the net interest margin improved. The Federal Reserve increased short-term rates four times during 2018, benefiting variable-rate asset yields but increasing funding costs.
- Non-interest expense increased to $32.1 million from $29.4 million, primarily due to a full year of Cornerstone operating costs, higher salaries and benefits, occupancy expense and outsourced data-processing costs.
- Non-interest income increased to $10.6 million from $9.6 million, supported by deposit-service charges, mortgage banking, investment advisory fees and ATM/debit-card income. Securities results shifted from a $400 thousand gain in 2017 to a $342 thousand loss in 2018.
- Deposits increased 4.2%, with core deposits increasing and time deposits declining. FHLB advances declined substantially from $14.3 million to $0.2 million.
- The Bank remained well capitalized, although its total risk-based capital ratio declined to 14.0% from 14.2% and its leverage ratio increased to 10.0% from 9.7%.
Guidance, outlook, risks and unusual items
The filing does not provide formal earnings or revenue guidance. Management emphasized continued quality loan growth, growth in core deposits, expense management, liquidity management and monitoring of interest-rate exposure. Management expected an effective tax rate of approximately 20.5% to 21.0% assuming the corporate tax rate remained unchanged.
- Commercial real estate concentration is a principal risk. Non-owner-occupied commercial real estate was approximately 260% of Bank risk-based capital, below the regulatory screening threshold of 300%, but subject to heightened supervisory attention.
- Approximately 91.1% of loans had real estate as a primary or secondary source of collateral, increasing sensitivity to local real estate values, economic conditions and natural disasters.
- The loan portfolio has interest-rate and concentration risk, while a flattening yield curve could pressure future net interest margins. Management’s model estimated that a parallel 200-basis-point rate increase would reduce next-12-month net interest income by 3.54%.
- Future credit losses could exceed the allowance, and regulators may require additional provisions or charge-offs.
- The Current Expected Credit Loss standard was scheduled to become applicable in 2020 and could materially increase the allowance for loan losses and introduce greater earnings volatility.
- Other risks include cybersecurity and third-party vendor failures, competition, regulatory changes, deposit outflows, loss of key personnel, acquisition integration risk and restrictions on dividends or capital distributions.
- The company reported no material pending legal proceeding, no material subsequent event requiring disclosure and effective disclosure controls and internal control over financial reporting. The independent auditor issued unqualified opinions.
Most important facts for an investor to verify
- Whether strong 2018 earnings growth is sustainable after the 2017 tax charge, merger costs and other unusual items are excluded.
- Future performance of the heavily concentrated commercial real estate portfolio, including delinquency, nonaccrual and charge-off trends.
- The adequacy of the $6.3 million allowance for loan losses before and after CECL adoption.
- The effect of deposit pricing, further interest-rate changes and yield-curve movements on the 3.69% net interest margin.
- Liquidity under stress, including reliance on repurchase agreements, FHLB capacity and uninsured or rate-sensitive deposits.
- Capital levels and dividend capacity after the fully phased-in Basel III capital conservation buffer.
- Whether the new Augusta and expanded Upstate operations generate sufficient deposits, loans and fee income to offset their operating costs.