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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

  (Mark One)  
      
  x   Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the quarterly period ended September 30, 2014  
      
  oTransition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the transition period from _____ to _____  

 

Commission File No. 000-28344

 

 

 

 

FIRST COMMUNITY CORPORATION
(Exact name of registrant as specified in its charter)
 
South Carolina 57-1010751

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

 

5455 Sunset Boulevard, Lexington, South Carolina 29072

(Address of principal executive offices) (Zip Code)

 

 

(803) 951-2265

(Registrant’s telephone number, including area code)

 

 

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). x Yes o No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o Accelerated filer o Non-accelerated filer o Smaller reporting company x

 

Indicate by check mark whether the registrant is shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: On November 13, 2014, 6,660,466 shares of the issuer’s common stock, par value $1.00 per share, were issued and outstanding.

 
 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION 3
Item 1. Financial Statements 3
Consolidated Balance Sheets 3
Consolidated Statements of Income 4
Consolidated Statements of Comprehensive Income (Loss) 6
Consolidated Statements of Changes in Shareholders’ Equity 7
Consolidated Statements of Cash Flows 8
Notes to Consolidated Financial Statements 9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 39
Item 3. Quantitative and Qualitative Disclosures About Market Risk 56
Item 4. Controls and Procedures 56
 
PART II – OTHER INFORMATION 57
Item 1. Legal Proceedings 57
Item 1A. Risk Factors 57
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 57
Item 3. Defaults Upon Senior Securities 57
Item 4. Mine Safety Disclosures 57
Item 5. Other Information 57
Item 6. Exhibits 57
   
SIGNATURES 58
INDEX TO EXHIBITS 59
EX-31.1 RULE 13A-14(A) CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER  
EX-31.2 RULE 13A-14(A) CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER  
EX-32 SECTION 1350 CERTIFICATIONS  
2
 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED BALANCE SHEETS

        
(Dollars in thousands, except par value)  September 30,
2014
   December 31, 
   (Unaudited)   2013 
ASSETS          
Cash and due from banks  $12,474   $8,239 
Interest-bearing bank balances   43,010    5,668 
Federal funds sold and securities purchased under agreements to resell   644    259 
Investment securities – available-for-sale   260,412    224,355 
Investment securities – held-to-maturity   1,352     
Other investments, at cost   2,160    2,674 
Loans held for sale   3,404    3,790 
Loans   448,556    347,597 
Less,  allowance for loan losses   4,156    4,219 
Net loans   444,400    343,378 
Property, furniture and equipment – net   29,532    19,444 
Bank owned life insurance   14,538    11,072 
Other real estate owned   3,014    3,370 
Intangible assets   1,918     
Goodwill   4,390    571 
Other assets   9,669    10,489 
Total assets  $830,917   $633,309 
LIABILITIES          
Deposits:          
Non-interest bearing demand  $146,826   $111,198 
NOW and money market accounts   288,864    174,224 
Savings   53,176    51,134 
Time deposits less than $100,000   110,275    96,096 
Time deposits $100,000 and over   87,830    64,419 
Total deposits   686,971    497,071 
Securities sold under agreements to repurchase   17,650    18,634 
Federal Home Loan Bank advances   32,312    43,325 
Junior subordinated debt   15,464    15,464 
Other liabilities   5,957    6,144 
Total liabilities   758,354    580,638 
            SHAREHOLDERS’ EQUITY          
Preferred stock, par value $1.00 per share, 10,000,000 shares authorized; none issued and outstanding        
Common stock, par value $1.00 per share; 10,000,000 shares authorized; issued and outstanding 6,660,466 at September 30, 2014 5,302,674 at December 31, 2013   6,660    5,303 
Common stock warrants issued   48    48 
Additional paid in capital   75,467    62,214 
Restricted stock   (819)   (444)
Accumulated deficit   (9,402)   (11,923)
Accumulated other comprehensive income (loss)   609    (2,527)
Total shareholders’ equity   72,563    52,671 
Total liabilities and shareholders’ equity  $830,917   $633,309 

See Notes to Consolidated Financial Statements

3
 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

 
   Nine   Nine 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2014   2013 
(Dollars in thousands, except per share data)  (Unaudited)   (Unaudited) 
Interest income:          
Loans, including fees  $16,277   $13,202 
Taxable securities   2,936    2,096 
Nontaxable securities   933    780 
Federal funds sold and securities purchased under resale agreements   25    24 
Other   49    25 
Total interest income   20,220    16,127 
Interest expense:          
Deposits   1,272    1,395 
Federal funds sold and securities sold under agreement to repurchase   28    27 
Other borrowed money   1,381    1,433 
Total interest expense   2,681    2,855 
Net interest income   17,539    13,272 
Provision for loan losses   702    379 
Net interest income after provision for loan losses   16,837    12,893 
Non-interest income:          
Deposit service charges   1,145    1,115 
Mortgage banking income   2,337    2,968 
Investment advisory fees and non-deposit commissions   722    695 
Gain on sale of securities   102    152 
Gain (loss) on sale of other assets   (2)   7 
Fair value loss adjustments       (2)
Loss on early extinguishment of debt   (67)   (141)
Other   1,837    1,525 
Total non-interest income   6,074    6,319 
Non-interest expense:          
Salaries and employee benefits   10,198    8,934 
Occupancy   1,367    1,023 
Equipment   1,128    907 
Marketing and public relations   591    311 
FDIC assessments   393    309 
Other real estate expense   360    395 
Amortization of intangibles   169    128 
Merger and acquisition expense   474    33 
Other   3,191    2,679 
Total non-interest expense   17,871    14,719 
Net income before tax   5,040    4,493 
Income taxes   1,425    1,206 
Net income  $3,615   $3,287 
           
Basic earnings per common share  $0.56   $0.62 
Diluted earnings per common share  $0.55   $0.62 

See Notes to Consolidated Financial Statements

4
 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

 
   Three   Three 
   Months Ended   Months Ended 
   September 30,   September 30, 
   2014   2013 
(Dollars in thousands, except per share data)  (Unaudited)   (Unaudited) 
         
Interest income:          
Loans, including fees  $5,615   $4,379 
Taxable securities   987    784 
Nontaxable securities   339    294 
Federal funds sold and securities purchased under resale agreements   8    9 
Other   19    8 
Total interest income   6,968    5,474 
Interest expense:          
Deposits   415    425 
Federal funds sold and securities sold under agreement to repurchase   9    9 
Other borrowed money   448    470 
Total interest expense   872    904 
Net interest income   6,096    4,570 
Provision for loan losses   152    129 
Net interest income after provision for loan losses   5,944    4,441 
Non-interest income:          
Deposit service charges   400    387 
Mortgage banking income   1,016    770 
Investment advisory fees and non-deposit commissions   267    279 
Gain on sale of securities   16    4 
Gain (loss) on sale of other assets   10    (23)
Other   591    524 
Total non-interest income   2,300    1,941 
Non-interest expense:          
Salaries and employee benefits   3,502    2,948 
Occupancy   489    343 
Equipment   414    310 
Marketing and public relations   218    106 
FDIC assessment   138    108 
Other real estate expense   105    189 
Amortization of intangibles   64    32 
Merger and acquisition expense   39    33 
Other   1,091    888 
Total non-interest expense   6,060    4,957 
Net income before tax   2,184    1,425 
Income taxes   632    379 
Net income  $1,552   $1,046 
           
Basic earnings per common share  $0.23   $0.20 
Diluted earnings per common share  $0.23   $0.20 

 

See Notes to Consolidated Financial Statements

5
 

FIRST COMMUNITY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)  

 

(Dollars in thousands)  Nine months ended September 30, 
   2014   2013 
         
Net income  $3,615   $3,287 
           
Other comprehensive income:          
Unrealized gain (loss) during the period on available-for-sale securities, net of taxes of $1,699 and $2,027, respectively   3,203    (3,936)
           
Less: Reclassification adjustment for (gain) loss included in net income, net of taxes of $35 and $52, respectively   (67)   (100)
           
Other comprehensive income (loss)   3,136    (4,036)
Comprehensive income (loss)  $6,751   $(749)

 

(Dollars in thousands)  Three months ended September 30, 
   2014   2013 
         
Net income  $1,552   $1,046 
           
Other comprehensive income:          
Unrealized gain (loss) during the period on available-for-sale securities, net of taxes of $118 and $411, respectively.   229    (795)
           
Less: Reclassification adjustment for (gain) loss included in net income, net of taxes of $5 and $1, respectively.   (11)   (3)
           
Other comprehensive income (loss)   218    (798)
Comprehensive income  $1,770   $248 

 

See Notes to Consolidated Financial Statements

6
 

FIRST COMMUNITY CORPORATION

Consolidated Statements of Changes in Shareholders’ Equity

Nine Months ended September 30, 2014 and September 30, 2013

(Unaudited)

 

(Dollars and shares in thousands)               Accumulated     
           Common   Additional   Nonvested       Other     
   Shares   Common   Stock   Paid-in   Restricted   Accumulated   Comprehensive     
   Issued   Stock   Warrants   Capital   Stock   Deficit   Income (Loss)   Total 
                                 
Balance, December 31, 2012   5,227   $5,227   $50   $61,615   $(152)  $(14,915)  $2,358   $54,183 
Net income                            3,287         3,287 
Other comprehensive loss net of tax benefit of $1,975                                 (4,036)   (4,036)
Issuance of restricted stock   60    60         493    (553)              
Amortization compensation restricted stock                       187              187 
Dividends: Common ($0.17 per share)                            (832)        (832)
Dividend reinvestment plan   9    9         71                   80 
Balance, September 30, 2013   5,296   $5,296   $50   $62,179   $(518)  $(12,460)  $(1,678)  52,869 
                                         
Balance, December 31, 2013   5,303   $5,303   $48   $62,214   $(444)  $(11,923)  $(2,527)  $52,671 
Net income                            3,615         3,615 
Other comprehensive income net of tax of $1,664                                 3,136    3,136 
Issuance of restricted stock   71    71         697    (768)              
Amortization compensation restricted stock                       393              393 
Issuance of common stock   1,274    1,274         12,436                   13,710 
Dividends: Common ($0.18 per share)                            (1,094)        (1,094)
Dividend reinvestment plan   12    12         120                   132 
Balance, September 30, 2014   6,660   $6,660   $48   $75,467   $(819)  $(9,402)  $609   $72,563 

 

See Notes to Consolidated Financial Statements

7
 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 
   Nine months ended September 30, 
(Dollars in thousands)  2014   2013 
Cash flows from operating activities:          
Net income  $3,615   $3,287 
Adjustments to reconcile net income to net cash provided in operating activities:          
Depreciation   827    655 
Premium amortization   2,680    3,239 
Provision for loan losses   702    379 
Write downs of other real estate owned   146    41 
Loss (gain) on sale of other real estate owned   2    (7)
Sale of loans held-for-sale   66,548    107,432 
Originations of loans held-for-sale   (66,161)   (100,303)
Amortization of intangibles   169    128 
Gain on sale of securities   (102)   (152)
Net decrease in fair value option instruments and derivatives       2 
Loss on early extinguishment of debt   67    141 
Write down of land       109 
Decrease in other assets   1,297    1,572 
Increase (decrease) in other liabilities   (572)   1,541 
Net cash provided from operating activities   9,218    18,064 
Cash flows from investing activities:          
Purchase of investment securities available-for-sale and other investments   (82,322)   (80,972)
Purchase of investment securities held-to-maturity   (1,352)    
Maturity of investment securities available-for-sale   28,302    40,653 
Proceeds from sale of securities available-for-sale   43,589    6,306 
Proceeds from sale of other investments   513    257 
Decrease (increase)  in loans   11,775    (14,744)
Net cash disbursed in business combination   (11,354)    
Purchase of  loans   (8,705)    
Proceeds from sale of other real estate owned   1,742    1,476 
Purchase of property and equipment   (2,746)   (682)
Net cash used in investing activities   (20,558)   (47,706)
Cash flows from financing activities:          
Increase in deposit accounts   35,552    33,615 
Increase (decrease) in securities sold under agreements to repurchase   (984)   1,176 
Advances from the Federal Home Loan Bank   38,100    16,500 
Repayment of advances from FHLB   (57,886)   (18,655)
Purchase of deposit accounts   39,482     
Dividends paid: Common Stock   (1,094)   (832)
Dividend reinvestment plan   132    80 
Net cash provided from financing activities   53,302    31,884 
Net increase in cash and cash equivalents   41,962    2,242 
Cash and cash equivalents at beginning of period   14,166    18,708 
Cash and cash equivalents at end of period  $56,128   $20,950 
Supplemental disclosure:          
Cash paid during the period for:          
Interest  $2,666   $3,212 
Income taxes  $860   $210 
Non-cash investing and financing activities:          
Unrealized gain (loss) on securities  $3,136   $(4,036)
Transfer of loans to foreclosed property  $1,574   $1,135 

 

See Notes to Consolidated Financial Statements

8
 

First Community Corporation

Notes to Consolidated Financial Statements

 

Note 1 - Basis of Presentation

 

In the opinion of management, the accompanying unaudited consolidated balance sheets, and the consolidated statements of income, comprehensive income (loss), changes in shareholders’ equity, and the cash flows of First Community Corporation (“the Company”), present fairly in all material respects the Company’s financial position at September 30, 2014 and December 31, 2013, and the Company’s results of operations and cash flows for the three and nine months ended September 30, 2014 and 2013. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.

 

In the opinion of management, all adjustments necessary to fairly present the consolidated financial position and consolidated results of operations have been made. All such adjustments are of a normal, recurring nature. All significant intercompany accounts and transactions have been eliminated in consolidation. The consolidated financial statements and notes thereto are presented in accordance with the instructions for Form 10-Q. The information included in the Company’s 2013 Annual Report on Form 10-K should be referred to in connection with these unaudited interim financial statements.   

9
 

Note 2 – Earnings Per Common Share

 

The following reconciles the numerator and denominator of the basic and diluted earnings per common share computation:

 

(In thousands except average market price)

   Nine months   Three months 
   Ended September 30,   Ended September 30, 
   2014   2013   2014   2013 
Numerator (Net income available to  common shareholders)  $3,615   $3,287   $1,552   $1,046 
Denominator                    
Weighted average common shares outstanding for:                    
Basic earnings per share   6,496    5,281    6,659    5,295 
Dilutive securities:                    
Deferred compensation   23        22     
Warrants – Treasury stock method   46    41    46    46 
Diluted earnings per share   6,565    5,322    6,727    5,341 
The average market price used in calculating assumed number of shares  $10.82   $9.50   $10.73   $10.33 

 

At September 30, 2014, there were 69,903 outstanding options at an average exercise price of $20.15. None of these options has an exercise price below the average market price of $10.73 for the three-month period ended September 30, 2014 or $10.82 for the nine-month period ended September 30, 2014, and, therefore they are not deemed to be dilutive. At September 30, 2013, there were 73,022 outstanding options at an average exercise price of $20.23. None of these options has an exercise price below the average market price of $10.33 for the three-month period ended September 30, 2013 or $9.50 for the nine-month period ended September 30, 2013, and, therefore they are not deemed to be dilutive. In the fourth quarter of 2011, we issued $2.5 million in 8.75% subordinated notes maturing on December 16, 2019. On November 15, 2012, the subordinated notes were redeemed in full at par. Warrants for 107,500 shares of common stock at $5.90 per share were issued in connection with the issuance of the subordinated debt. These warrants expire December 16, 2019 and are included in dilutive securities in the table above.

10
 

Note 3 – Investment Securities

The amortized cost and estimated fair values of investment securities are summarized below:

 

AVAILABLE-FOR-SALE:
(Dollars in thousands)
  Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
September 30, 2014:                    
Government sponsored enterprises   $3,399   $24   $38   $3,385 
Mortgage-backed securities    151,185    905    1,072    151,018 
Small Business Administration pools    52,667    376    477    52,566 
State and local government    51,009    1,343    223    52,129 
Corporate and other securities    1,349        35    1,314 
   $259,609   $2,648   $1,845   $260,412 
December 31, 2013:                    
Government sponsored enterprises   $3,388   $1   $143   $3,246 
Mortgage-backed securities    120,925    757    2,006    119,676 
Small Business Administration pools    56,595    376    851    56,120 
State and local government    45,048    96    2,146    42,998 
Corporate and other securities    2,348    21    54    2,315 
   $228,304   $1,251   $5,200   $224,355 
                    
HELD-TO-MATURITY
(Dollars in thousands)
  Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair Value 
September 30, 2014:                    
State and local government    1,352            1,352 
   $1,352   $   $   $1,352 
December 31, 2013:                    
State and local government                 
   $   $   $   $ 

During the nine months ended September 30, 2014 and September 30, 2013, the Company received proceeds of $43.6 million and $6.3 million, respectively, from the sale of investment securities available-for-sale.  Gross realized gains amounted to $205 thousand and gross realized losses amounted to $103 thousand for the nine months ended September 30, 2014.  For the nine months ended September 30, 2013, gross realized gains totaled $238 thousand and gross realized losses totaled $86 thousand.   During the three months ended September 30, 2014 and September 30, 2013, the Company received proceeds of $7.2 million and $2.8 million, respectively, from the sale of investment securities available-for-sale. For the three months ended September 30, 2014, gross realized gains amounted to $57 thousand and gross realized losses amounted to $40 thousand.  Gross realized gains totaled $90 thousand and gross realized losses totaled $86 thousand for the three months ended September 30, 2013.  The Company did not sell any investment securities held-to-maturity for the three and nine month periods ended September 30, 2014 or September 30, 2013.

At September 30, 2014, other securities available-for-sale included the following at fair value: mutual funds at $837.2 thousand, foreign debt of $60.2 thousand, and Corporate preferred stock in the amount of $416.8 thousand. At December 31, 2013, corporate and other securities available-for-sale included the following at fair value: corporate bonds at $1.0 million, mutual funds at $817.8 thousand, foreign debt of $59.7 thousand, and corporate preferred stock in the amount of $416.8 thousand.

Other investments, at cost, include Federal Home Loan Bank (“FHLB”) stock in the amount of $2.2 million and $2.7 million at September 30, 2014 and December 31, 2013 respectively.

11
 

Note 3 – Investment Securities – continued

There were no other than temporary impairment (“OTTI”) losses recorded on securities for the quarters ended September 30, 2014 and September 30, 2013.

The following is an analysis of amounts relating to credit losses on debt securities recognized in earnings during the nine months ended September 30, 2014 and September 30, 2013.

 

(Dollars in thousands)  2014  2013 
   Available   Available 
   for Sale   for Sale 
         
Balance at beginning of period  $   $271 
           
Other-than-temporary-impairment not previously recognized        
           
Additional increase for which an other-than-temporary impairment was previously recognized related to credit losses        
Other-than-temporary-impairment previously recognized on securities sold        
Realized losses during the period       (57)
Balance related to credit losses on debt securities at end of period  $   $214 

 

As of September 30, 2014 and December 31, 2013 there were no non-agency mortgage-backed securities (“MBSs”) rated below investment grade.

12
 

Note 3 – Investment Securities - continued

The following tables show gross unrealized losses and fair values, aggregated by investment category and length of time that individual securities have been in a continuous loss position, at September 30, 2014 and December 31, 2013. There were no unrealized losses for held-to-maturity securities at September 30, 2014 and December 31, 2013.

   Less than 12 months   12 months or more   Total 
September 30, 2014
(Dollars in thousands)
  Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
Available-for-sale securities:                              
Government Sponsored Enterprises   $   $   $1,462   $38   $1,462   $38 
Government Sponsored Enterprise mortgage-backed securities    49,615    355    30,150    714    79,765    1,069 
Small Business Administration pools    8,261    31    21,840    446    30,101    477 
Non-agency mortgage-backed securities    265    3            265    3 
State and local government    2,328    8    8,302    215    10,630    223 
Corporate bonds and other            887    35    887    35 
Total   $60,469   $397   $62,641   $1,448   $123,110   $1,845 

 

   Less than 12 months   12 months or more   Total 
December 31, 2013
(Dollars in thousands)
  Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
   Fair
Value
   Unrealized
Loss
 
Available-for-sale securities:                              
Government Sponsored Enterprises   $3,230   $143   $   $   $3,230   $143 
Government Sponsored Enterprise mortgage-backed securities    74,251    1,814    6,354    184    80,605    1,998 
Small Business Administration pools    19,150    628    9,294    223    28,444    851 
Non-agency mortgage-backed securities    716    8            716    8 
State and local government    33,257    1,856    3,337    290    36,594    2,146 
Corporate bonds and other    872    53    50    1    922    54 
Total   $131,476   $4,502   $19,035   $698   $150,511   $5,200 

 

Government Sponsored Enterprise, Mortgage-Backed Securities: At September 30, 2014, the Company owns MBSs, including collateralized mortgage obligations (“CMOs”), with an amortized cost of $150.4 million and approximate fair value of $150.2 million, issued by government sponsored enterprises (“GSEs”). At December 31, 2013, the Company owned MBSs, including CMOs with an amortized cost of $120.9 million and approximate fair value of $119.7 million, issued by GSEs. As of September 30, 2014 and December 31, 2013, all of the MBSs issued by GSEs were classified as “Available for Sale.” Unrealized losses on certain of these investments are not considered to be “other than temporary,” and we have the intent and ability to hold these until they mature or recover the current book value. The contractual cash flows of the investments are guaranteed by the GSE. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Company’s investment. Because the Company does not intend to sell these securities and it is more likely than not the Company will not be required to sell these securities before a recovery of its amortized cost, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at September 30, 2014.

Non-agency Mortgage-Backed Securities: The Company also holds private label MBSs (“PLMBSs”), including CMOs, at September 30, 2014 with an amortized cost of $796.9 thousand and approximate fair value of $813.5 thousand. The Company held PLMBSs, including CMOs, at December 31, 2013 with an amortized cost of $954.2 thousand and approximate fair value of $949.0 thousand. Management monitors each of these securities on a quarterly basis to identify any deterioration in the credit quality, collateral values and credit support underlying the investments. There were no PLMBSs rated below investment grade as of September 30, 2014.

13
 

Note 3 – Investment Securities - continued

Corporate Bonds: Corporate bonds held by the Company are reviewed on a quarterly basis to identify downgrades by rating agencies as well as deterioration of the underlying collateral or the issuer’s ability to service the debt obligation. As of September 30, 2014, the Company does not own any corporate bonds.

State and Local Governments and Other: Management monitors these securities on a quarterly basis to identify any deterioration in the credit quality. Included in the monitoring is a review of the credit rating, a financial analysis and certain demographic data on the underlying issuer. The Company does not consider these securities to be OTTI at September 30, 2014.

The amortized cost and fair value of investment securities at September 30, 2014, by expected maturity, follow. Expected maturities differ from contractual maturities because borrowers may have the right to call or prepay the obligations with or without prepayment penalties. Mortgage-backed securities are included in the year corresponding with the remaining expected life.

   Available-for-sale   Held-to-maturity 
(Dollars in thousands)  Amortized
Cost
   Fair
Value
   Amortized Cost   Fair
Value
 
Due in one year or less   $7,930   $7,976   $   $ 
Due after one year through five years    127,481    127,437         
Due after five years through ten years    109,019    110,047    1,352    1,352 
Due after ten years    15,179    14,952         
   $259,609   $260,412   $1,352   $1,352 

 

Note 4 – Loans

 

Loans summarized by category as of September 30, 2014, December 31, 2013 and September 30, 2013 are as follows:

   September 30,   December 31,   September 30, 
(Dollars in thousands)  2014   2013   2013 
Commercial, financial and agricultural   $33,147   $19,925   $19,940 
Real estate:               
Construction    22,738    18,933    16,110 
Mortgage-residential   47,369    37,579    37,506 
Mortgage-commercial   305,013    237,701    237,934 
Consumer:               
Home equity    32,435    25,659    26,011 
Other    7,854    7,800    7,563 
Total  $448,556   $347,597   $345,064 
14
 

Note 4 – Loans-continued

The detailed activity in the allowance for loan losses and the recorded investment in loans receivable as of and for the nine months ended September 30, 2014 and September 30, 2013 and for the year ended December 31, 2013 is as follows:

(Dollars in thousands)                                
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
2014                                        
                                         
Allowance for loan losses:                                        
Beginning balance
December 31, 2013
  $233   $26   $291   $1,117   $112   $80   $2,360   $4,219 
                                         
Charge-offs   2        39    689        95        825 
                                         
Recoveries   32        15            13        60 
                                         
Provisions   (116)   12    (101)   1,171        65    (329)   702 
Ending balance
September 30, 2014
  $147   $38   $166   $1,599   $112   $63   $2,031   $4,156 
                                         
Ending balances:                                        
Individually evaluated  for impairment  $   $   $4   $   $   $   $   $4 
                                        
Collectively evaluated  for impairment   147    38    162    1,599    112    63    2,031    4,152 
                                         
Loans receivable:                                        
Ending balance-total  $33,147   $22,738   $47,369   $305,013   $32,435   $7,854   $   $448,556 
                                         
Ending balances:                                        
                                          
Individually evaluated for impairment   58        1,038    6,152    93    5        7,346 
                                         
Collectively evaluated  for impairment  $33,089   $22,738   $46,331   $298,861   $32,342   $7,849   $   $441,210 
15
 

Note 4 – Loans-continued

(Dollars in thousands)                         
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
2013                                        
                                         
Allowance for loan losses:                                        
Beginning balance
December 31, 2012
  $338   $   $235   $1,322   $400   $17   $2,309   $4,621 
                                         
Charge-offs   29        44    604    67    64        808 
                                         
Recoveries   31        64        3    33        131 
                                         
Provisions   (136)   27    65    578    (188)   119    (86)   379 
Ending balance
September 30, 2013
  $204   $27   $320   $1,296   $148   $105   $2,223   $4,323 
                                         
Ending balances:                                        
Individually evaluated for impairment  $   $   $4   $165   $   $   $   $169 
                                         
Collectively evaluated for impairment   204    27    316    1,131    148    105    2,223    4,154 
                                         
Loans receivable:                                        
Ending balance-total  $19,940   $16,110   $37,506   $237,934   $26,011   $7,563   $   $345,064 
                                         
Ending balances:                                        
Individually evaluated for impairment   80        872    4,679        5        5,636 
                                        
Collectively evaluated for impairment  $19,860   $16,110   $36,634   $233,255   $26,011   $7,558   $   $339,428 
16
 

Note 4 – Loans-continued

(Dollars in thousands)                         
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
December 31, 2013                                        
                                         
Allowance for loan losses:                                        
Beginning balance
January 1, 2013
  $338   $   $235   $1,322   $400   $17   $2,309   $4,621 
                                         
Charge-offs           (47)   (897)   (67)   (79)       (1,090)
                                         
Recoveries   47        72            41        160 
                                         
Provisions   (152)   26    31    692    (221)   101    51    528 
Ending balance
December 31, 2013
  $233   $26   $291   $1,117   $112   $80   $2,360   $4,219 
                                         
Ending balances:                                        
Individually evaluated  for impairment  $   $   $4   $   $   $   $   $4 
                                         
Collectively evaluated for impairment   233    26    287    1,117    112    80    2,360    4,215 
                                         
Loans receivable:                                        
Ending balance-total  $19,925   $18,933   $37,579   $237,701   $25,659   $7,800   $   $347,597 
                                         
Ending balances:                                        
Individually evaluated  for impairment   76        951    4,834    109    12        5,982 
                                         
Collectively evaluated  for impairment  $19,849   $18,933   $36,628   $232,867   $25,550   $7,788       $341,615 

Loans outstanding to bank directors, executive officers and their related business interests amounted to $10.6 million and $9.5 million at September 30, 2014 and September 30, 2013, respectively. Repayments on these loans during the nine months ended September 30, 2014 were $1.1 million and loans made totaled $1.4 million. Repayments on these loans during the nine months ended September 30, 2013 were $1.8 million and loans made totaled $500 thousand. Related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons and generally do not involve more than the normal risk of collectability.

17
 

Note 4 – Loans-continued

The detailed activity in the allowance for loan losses as of and for the three months ended September 30, 2014 and the three months ended September 30, 2013 is as follows:

(Dollars in thousands)                         
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
2014                                        
                                         
Allowance for loan losses:                                        
Beginning balance
June 30, 2014
  $180   $109   $206   $1,317   $118   $52   $2,084   $4,066 
                                         
Charge-offs   2        4            75        81 
                                         
Recoveries   8        6            5        19 
                                         
Provisions   (39)   (71)   (42)   282    (6)   81    (53)   152 
Ending balance
September 30, 2014
  $147   $38   $166   $1,599   $112   $63   $2,031   $4,156 

 

(Dollars in thousands)                         
           Real estate   Real estate                 
       Real estate   Mortgage   Mortgage   Consumer   Consumer         
   Commercial   Construction   Residential   Commercial   Home equity   Other   Unallocated   Total 
2013                                        
                                         
Allowance for loan losses:                                        
Beginning balance
June 30, 2013
  $264   $25   $319   $1,082   $226   $96   $2,427   $4,439 
                                         
Charge-offs   22        8    207    23    25        285 
                                         
Recoveries   11        2        2    25        40 
                                         
Provisions   (49)   2    7    421    (57)   9    (204)   129 
Ending balance
September 30, 2013
  $204   $27   $320   $1,296   $148   $105   $2,223   $4,323 
18
 

Note 4 – Loans-continued

The following table presents at September 30, 2014 and December 31, 2013 loans individually evaluated and considered impaired under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310 “Accounting by Creditors for Impairment of a Loan.” Impairment includes performing troubled debt restructurings (“TDRs”).

(Dollars in thousands)  September 30,   December 31, 
   2014   2013 
Total loans considered impaired   $7,346   $5,982 
Loans considered impaired for which there is a related allowance for loan loss:          
Outstanding loan balance    53    55 
Related allowance    4    4 
Loans considered impaired and previously written down to fair value    7,293    5,927 
Average impaired loans    8,827    7,637 
19
 

Note 4 – Loans-continued

The following tables are by loan category and present at September 30, 2014, September 30, 2013 and December 31, 2013 loans individually evaluated and considered impaired under FASB ASC 310 “Accounting by Creditors for Impairment of a Loan.” Impairment includes performing TDRs.

(Dollars in thousands)              Nine months ended   Three months ended 
       Unpaid       Average   Interest   Average   Interest 
September 30, 2014  Recorded   Principal   Related   Recorded   Income   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized   Investment   Recognized 
With no allowance recorded:                                   
Commercial  $58   $115   $   $133   $   $131   $0 
Real estate:                                   
Construction                            
Mortgage-residential   985    1,344        1,227    5    1,221     
Mortgage-commercial   6,152    7,381        7,326    39    7,236    9 
Consumer:                                   
Home Equity   93    97        79        86     
Other   5    5        8        6      
                                    
With an allowance recorded:                                   
Commercial                            
Real estate:                                   
Construction                            
Mortgage-residential   53    53    4    54    2    54    1 
Mortgage-commercial                            
Consumer:                                   
Home Equity                            
Other                            
                                    
Total:                                   
Commercial  $58   $115   $   $133   $   $131   $ 
Real estate:                                   
Construction                            
Mortgage-residential   1,038    1,397    4    1,281    7    1,275    1 
Mortgage-commercial   6,152    7,381        7,326    39    7,236    9 
Consumer:                                   
Home Equity   93    97        79        86     
Other   5    5        8        6      
   $7,346   $8,995   $4   $8,827   $46   $8,734   $10 
20
 

Note 4 – Loans-continued

(Dollars in thousands)              Nine months ended   Three months ended 
       Unpaid       Average   Interest   Average   Interest 
September 30, 2013  Recorded   Principal   Related   Recorded   Income   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized   Investment   Recognized 
With no allowance recorded:                                   
Commercial  $80   $80   $   $147   $8   $144   $0 
Real estate:                                   
Construction                             
Mortgage-residential   816    831        973    21    976    3 
Mortgage-commercial   4,514    5,104        5,708    80    5,713    13 
Consumer:                                   
Home Equity                            
Other   5    6        17        16      
                                    
With an allowance recorded:                                   
Commercial                            
Real estate:                                   
Construction                            
Mortgage-residential   56    56    4    57    8    57    1 
Mortgage-commercial   165    285    165    294        291     
Consumer:                                   
Home Equity                            
Other                            
                                    
Total:                                   
Commercial  $80   $80   $   $147   $8   $144   $0 
Real estate:                                   
Construction                             
Mortgage-residential   872    887    4    1,030    29    1,033    4 
Mortgage-commercial   4,679    5,389    165    6,002    80    6,004    13 
Consumer:                                   
Home Equity                            
Other   5    6        17        16      
   $5,636   $6,362   $169   $7,196   $117   $7,197   $17 
21
 

Note 4 – Loans-continued

(Dollars in thousands)              Year ended 
December 31, 2013      Unpaid       Average   Interest 
   Recorded   Principal   Related   Recorded   Income 
   Investment   Balance   Allowance   Investment   Recognized 
With no allowance recorded:                         
Commercial   $76   $76   $   $146   $8 
Real estate:                         
Construction                     
Mortgage-residential    896    998        1,096    121 
Mortgage-commercial    4,834    5,447        6,204    27 
Consumer:                          
Home Equity    109    109        109    4 
Other    12    13        26    1 
                          
With an allowance recorded:                         
Commercial                     
Real estate:                         
Construction                     
Mortgage-residential    55    55    4    56    9 
Mortgage-commercial                     
Consumer:                         
Home Equity                     
Other                     
                          
Total:                         
Commercial    76    76        146    8 
Real estate:                         
Construction                     
Mortgage-residential    951    1,053    4    1,152    130 
Mortgage-commercial    4,834    5,447        6,204    27 
Consumer:                         
Home Equity    109    109        109    4 
Other    12    13        26    1 
   $5,982   $6,698   $4   $7,637   $170 

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, including: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis is performed on a monthly basis. The Company uses the following definitions for risk ratings:

 

Special Mention. Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. Special mention assets are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

22
 

Note 4 – Loans-continued

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered as pass rated loans. As of September 30, 2014 and December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is shown in the table below. As of September 30, 2014 and December 31, 2013, no loans were classified as doubtful.

 

(Dollars in thousands)                    
September 30, 2014      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Commercial, financial & agricultural   $32,179   $893   $75   $   $33,147 
Real estate:                         
Construction    21,515    1,223            22,738 
Mortgage – residential    44,907    1,117    1,345        47,369 
Mortgage – commercial    282,097    8,948    13,968        305,013 
Consumer:                         
Home Equity    31,412    757    266        32,435 
Other    7,677    101    76        7,854 
Total   $419,787   $13,039   $15,730   $   $448,556 

 

(Dollars in thousands)                    
December 31, 2013      Special             
   Pass   Mention   Substandard   Doubtful   Total 
Commercial, financial & agricultural   $19,627   $218   $80   $   $19,925 
Real estate:                         
Construction    15,341    3,592            18,933 
Mortgage – residential    36,614    229    736        37,579 
Mortgage – commercial    223,110    5,813    8,778        237,701 
Consumer:                         
Home Equity    23,800    855    1,004        25,659 
Other    7,788        12        7,800 
Total   $326,280   $10,707   $10,610   $   $347,597 

At September 30, 2014 and December 31, 2013, non-accrual loans totaled $6.8 million and $5.4 million, respectively.

TDRs that are still accruing and included in impaired loans at September 30, 2014 and December 31, 2013 amounted to $551 thousand and $576 thousand, respectively. TDRs in nonaccrual status at September 30, 2014 and December 31, 2013 amounted to $3.9 million and $2.2 million, respectively.

Loans greater than ninety days delinquent and still accruing interest at September 30, 2014 and December 31, 2013 amounted to $95 thousand and $2 thousand, respectively.

23
 

Note 4 – Loans-continued

We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

 

Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality and are initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.

 

Purchase credit impaired (“PCI”) loans acquired totaled $4.2 million at estimated fair value, and acquired performing loans totaling $102.3 million at estimated fair value were not credit impaired. The gross contractual amount receivable for PCI loans and acquired performing loans was approximately $5.7 million and $116.0 million, respectively, as of the acquisition date. For the acquired performing loans, the best estimate at acquisition date of contractual cash flows not expected to be collected is $825.0 thousand. Determining the fair value of PCI loans at acquisition required the Company to estimate cash flows expected to result from those loans and to discount those cash flows at appropriate rates of interest. For such loans, the excess of cash flows expected to be collected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans and is called the accretable yield. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and is called the nonaccretable difference. In accordance with GAAP, there was no carry-over of previously established allowance for credit losses from the acquired company.

 

In conjunction with the acquisition of Savannah River Financial Corporation (“Savannah River”) on February 1, 2014, the acquired PCI loan portfolio was accounted for at fair value as follows: 

(Dollars in thousands)  February 1, 2014 
      
Contractual principal and interest at acquisition  $5,717 
Nonaccretable difference   (1,205)
Expected cash flows at acquisition   4,512 
Accretable yield   (272)
Basis in PCI loans at acquisition – estimated fair value  $4,240 

No changes have been made to the initial assumptions used in determining the original basis of PCI loans acquired.

24
 

Note 4 – Loans-continued

A summary of changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2014 follows (in thousands): 

   Three Months
Ended
September 30,
2014
   Nine Months
Ended
September 30,
2014
 
         
Accretable yield, beginning of period  $164      $272 
           
Accretion   (49)   (132)
           
Reclassification of nonaccretable difference due to improvement in expected cash flows       (25) 
Accretable yield, end of period  $115   $115 

 

The following tables are by loan category and present loans past due and on non-accrual status as of September 30, 2014 and December 31, 2013:

(Dollars in thousands)
 
September 30, 2014
  30-59
Days
Past Due
   60-89 Days
Past Due
   Greater than 90
Days and
Accruing
   Nonaccrual   Total Past
Due
   Current   Total
Loans
 
Commercial   $1   $   $86   $58   $145   $33,002   $33,147 
Real estate:                                   
Construction                        22,738    22,738 
Mortgage-residential    301        9    984    1,294    46,075    47,369 
Mortgage-commercial    468    1,066        5,654    7,188    297,825    305,013 
Consumer:                                   
Home equity    19    17        94    130    32,305    32,435 
Other    6    3        5    14    7,840    7,854 
Total   $795   $1,086   $95   $6,795   $8,771   $439,785   $448,556 

 

(Dollars in thousands)
 
December 31, 2013
  30-59
Days
Past Due
   60-89 Days
Past Due
   Greater than 90
Days and
Accruing
   Nonaccrual   Total Past
Due
   Current   Total
Loans
 
Commercial   $   $8   $2   $76   $86   $19,839   $19,925 
Real estate:                                   
Construction                        18,933    18,933 
Mortgage-residential    331    277        895    1,503    36,076    37,579 
Mortgage-commercial    54    908        4,314    5,276    232,425    237,701 
Consumer:                                   
Home equity    40            109    149    25,510    25,659 
Other    8            12    20    7,780    7,800 
Total   $433   $1,193   $2   $5,406   $7,034   $340,563   $347,597 
25
 

Note 4 – Loans-continued

As a result of adopting the amendments in Accounting Standards Update (“ASU”) 2011-02 (Receivables-Topic 310), the Company reassessed all restructurings that occurred on or after the beginning of the fiscal year of adoption (January 1, 2011) to determine whether they are considered TDRs under the amended guidance. The Company identified as TDRs certain loans for which the allowance for loan losses had previously been measured under a general allowance methodology. Upon identifying those loans as TDRs, the Company identified them as impaired under the guidance in ASC 310-10-35. The amendments in ASU 2011-02 require prospective application of the impairment measurement guidance in ASC 310-10-35 for those loans newly identified as impaired.

 

The following tables, by loan category, present loans determined to be TDRs during the nine month periods ended September 30, 2014 and September 30, 2013. There were no loans determined to be TDRs during the three month periods ended September 30, 2014 and September 30, 2013.

 

Troubled Debt Restructurings  For the nine months ended September 30, 2014 
(Dollars in thousands)            
       Pre-Modification   Post-Modification 
       Outstanding   Outstanding 
   Number   Recorded   Recorded 
   of Contracts   Investment   Investment 
Nonaccrual               
Mortgage-Commercial   1   $1,730   $1,730 
                
Mortgage-Residential   1   $180   $180 
                
Total TDRs   2   $1,910   $1,910 

 

As shown in the table above, two loans were determined to be TDRs during the nine months ended September 30, 2014. The interest rate was lowered on both of these loans.

 

Troubled Debt Restructurings  For the nine months ended September 30, 2013 
(Dollars in thousands)            
       Pre-Modification   Post-Modification 
       Outstanding   Outstanding 
   Number   Recorded   Recorded 
   of Contracts   Investment   Investment 
Nonaccrual               
Mortgage-Commercial   1   $257   $257 
                
Total TDRs   1   $257   $257 

 

As shown in the table above, one loan was determined to be a TDR during the nine months ended September 30, 2013. The loan was modified to extend the terms outside the Company’s guidelines.

 

During the three month periods ended September 30, 2014 and September 30, 2013, there were no loans determined to be TDRs in the previous twelve months that had payment defaults. Any payment that is past due greater than 30 days is considered to be a payment default.

26
 

Note 4 – Loans-continued

In the determination of the allowance for loan losses, all TDRs are reviewed to ensure that one of the three proper valuation methods (fair market value of the collateral, present value of cash flows, or observable market price) is adhered to. All nonaccrual loans are written down to their corresponding collateral value. All troubled TDR accruing loans that have a loan balance that exceeds the present value of cash flows will have a specific allocation. All nonaccrual loans are considered impaired. Under ASC 310-10, a loan is impaired when it is probable that the Company will be unable to collect all amounts due including both principal and interest according to the contractual terms of the loan agreement.

 

Note 5 – Recently Issued Accounting Pronouncements

 

The following is a summary of recent authoritative pronouncements:

 

In February 2013, the FASB amended the Liabilities topic of the Accounting Standards Codification to address obligations resulting from joint and several liability arrangements. The guidance addresses recognition of financial commitments arising from joint and several liability arrangements. Specifically, the amendments require recognition of financial commitments arising from loans, contracts, and legal rulings if the Company can be held liable for the entire claim. The amendments were effective for the Company for reporting periods beginning after December 15, 2013. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2014, the FASB amended the Equity Method and Joint Ventures topic of the Accounting Standards Codification. The amendments provide criteria that must be met in order to apply a proportional amortization method to Low-Income Housing Tax Credit investments and provide guidance on the method used to amortize the investment, the impairment approach, and the eligibility criteria for entities that have other arrangements (e.g., loans) with the limited liability entity. The amendments will be effective for the Company for new investments in qualified affordable housing projects for interim and annual periods beginning after December 15, 2014. For existing investments in qualified affordable housing projects, the Company will apply the proportional amortization method retrospectively. The Company intends to continue using the effective yield method for existing investments in qualified affordable housing projects. The Company does not expect these amendments to have a material effect on its financial statements.

In January 2014, the FASB amended Receivables topic of the Accounting Standards Codification. The amendments are intended to resolve diversity in practice with respect to when a creditor should reclassify a collateralized consumer mortgage loan to other real estate owned (OREO). In addition, the amendments require a creditor reclassify a collateralized consumer mortgage loan to OREO upon obtaining legal title to the real estate collateral, or the borrower voluntarily conveying all interest in the real estate property to the lender to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement. The amendments will be effective for the Company for annual periods, and interim periods within those annual periods beginning after December 15, 2014, with early implementation of the guidance permitted. In implementing this guidance, assets that are reclassified from real estate to loans are measured at the carrying value of the real estate at the date of adoption. Assets reclassified from loans to real estate are measured at the lower of the net amount of the loan receivable or the fair value of the real estate less costs to sell at the date of adoption. The Company will apply the amendments prospectively. The Company does not expect these amendments to have a material effect on its financial statements.

In May 2014, the FASB issued guidance to change the recognition of revenue from contracts with customers. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration the entity receives or expects to receive. The guidance will be effective for the Company for reporting periods beginning after December 15, 2016. The Company will apply the guidance using a full retrospective approach. The Company does not expect these amendments to have a material effect on its financial statements.

In June 2014, the FASB issued guidance which makes limited amendments to the guidance on accounting for certain repurchase agreements. The new guidance (1) requires entities to account for repurchase-to-maturity transactions as secured borrowings (rather than as sales with forward repurchase agreements), (2) eliminates accounting guidance on linked repurchase financing transactions, and (3) expands disclosure requirements related to certain transfers of financial assets that are accounted for as sales and certain transfers (specifically, repos, securities lending transactions, and repurchase-to-maturity transactions) accounted for as secured borrowings. The amendments will be effective for the Company for the first interim or annual period beginning after December 15, 2014. The Company will apply the guidance by making a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. The Company does not expect these amendments to have a material effect on its financial statements.

27
 

Note 5 – Recently Issued Accounting Pronouncement-continued

In June 2014, the FASB issued guidance which clarifies that performance targets associated with stock compensation should be treated as a performance condition and should not be reflected in the grant date fair value of the stock award. The amendments will be effective for the Company for fiscal years that begin after December 15, 2015. The Company will apply the guidance to all stock awards granted or modified after the amendments are effective, stock awards with performance targets that are outstanding at the start of the first fiscal year in the financial statements and to all stock awards that are granted or modified after the effective date. The Company does not expect these amendments to have a material effect on its financial statements.

In August 2014, the FASB issued guidance that is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. In connection with preparing financial statements, management will need to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the organization’s ability to continue as a going concern within one year after the date that the financial statements are issued. The amendments will be effective for the Company for annual period ending after December 15, 2016, and for annual periods and interim periods thereafter. The Company does not expect these amendments to have a material effect on its financial statements.

 

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

 

Note 6 – Fair Value of Financial Instruments

 

The Company adopted FASB ASC Fair Value Measurement Topic 820, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level l

Quoted prices in active markets for identical assets or liabilities.

   
Level 2

Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

   
Level 3 Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

FASB ASC 825-10-50 “Disclosure about Fair Value of Financial Instruments”, requires the Company to disclose estimated fair values for its financial instruments. Fair value estimates, methods, and assumptions are set forth below.

Cash and short term investments—The carrying amount of these financial instruments (cash and due from banks, interest-bearing bank balances, federal funds sold and securities purchased under agreements to resell) approximates fair value. All mature within 90 days and do not present unanticipated credit concerns and are classified as Level 1.

28
 

Note 6 – Fair Value of Financial Instruments - continued

Investment Securities—Measurement is on a recurring basis based upon quoted market prices, if available. If quoted market prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for prepayment assumptions, projected credit losses, and liquidity. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, or by dealers or brokers in active over-the-counter markets. Level 2 securities include MBSs issued both by government sponsored enterprises and PLMBSs. Generally these fair values are priced from established pricing models. Level 3 securities include corporate debt obligations and asset–backed securities that are less liquid or for which there is an inactive market.

Loans Held for Sale— The Company originates fixed rate residential loans on a servicing released basis in the secondary market. Loans closed but not yet settled with an investor, are carried in the Company’s loans held for sale portfolio. These loans are fixed rate residential loans that have been originated in the Company’s name and have closed. Virtually all of these loans have commitments to be purchased by investors at a locked in price with the investors on the same day that the loan was locked in with the company’s customers. Therefore, these loans present very little market risk for the Company and are classified as Level 2. The carrying amount of these loans approximates fair value.

Loans—The fair value of loans are estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities and are classified as Level 2. As discount rates are based on current loan rates as well as management estimates, the fair values presented may not be indicative of the value negotiated in an actual sale. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair value of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be Level 3 inputs.

Other Real Estate Owned (“OREO”) — OREO is carried at the lower of carrying value or fair value on a non-recurring basis. Fair value is based upon independent appraisals or management’s estimation of the collateral and is considered a Level 3 measurement.

 

Accrued Interest Receivable—The fair value approximates the carrying value and is classified as Level 1.

Interest rate swap—The fair value approximates the carrying value and is classified as Level 3.

Deposits—The fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed-maturity certificates of deposits is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturities. Deposits are classified as Level 2.

Federal Home Loan Bank Advances—Fair value is estimated based on discounted cash flows using current market rates for borrowings with similar terms and are classified as Level 2.

Short Term Borrowings—The carrying value of short term borrowings (securities sold under agreements to repurchase and demand notes to the Treasury) approximates fair value. These are classified as Level 2.

Junior Subordinated Debentures—The fair values of junior subordinated debentures is estimated by using discounted cash flow analyses based on incremental borrowing rates for similar types of instruments. These are classified as Level 2.

Accrued Interest Payable—The fair value approximates the carrying value and is classified as Level 1.

Commitments to Extend Credit—The fair value of these commitments is immaterial because their underlying interest rates approximate market.

29
 

Note 6 – Fair Value of Financial Instruments - continued

 

The carrying amount and estimated fair value by classification Level of the Company’s financial instruments as of September 30, 2014 and December 31, 2013 are as follows:

 

   September 30, 2014 
       Fair Value 
(Dollars in thousands)  Carrying
Amount
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and short term investments   $56,128   $56,128   $56,128   $   $ 
Held-to-maturity securities   1,352    1,352    1,352         
Available-for-sale securities    260,412    260,412    837    259,158    417 
Other investments, at cost    2,160    2,160            2,160 
Loans held for sale    3,404    3,404        3,404     
Net loans receivable    444,400    447,116        439,774    7,342 
Accrued interest    2,449    2,449    2,449         
Financial liabilities:                         
Non-interest bearing demand   $146,826   $146,826   $   $146,826   $ 
NOW and money market accounts    288,864    288,864        288,864     
Savings    53,176    53,176        53,176     
Time deposits    198,105    198,875        198,875     
Total deposits    686,971    687,741        687,741     
Federal Home Loan Bank Advances    32,312    34,602        34,602     
Short term borrowings    17,650    17,650        17,650     
Junior subordinated debentures    15,464    15,443        15,443     
Accrued interest payable    709    709    709         

 

   December 31, 2013 
       Fair Value 
(Dollars in thousands)  Carrying
Amount
   Total   Level 1   Level 2   Level 3 
Financial Assets:                         
Cash and short term investments   $14,166   $14,166   $14,166   $   $ 
Available-for-sale securities    224,355    224,355    818    223,120    417 
Other investments, at cost    2,674    2,674            2,674 
Loans held for sale    3,790    3,790        3,790     
Net loans receivable    343,378    345,262        339,284    5,978 
Accrued interest    2,267    2,267    2,267         
Financial liabilities:                         
Non-interest bearing demand   $111,198   $111,198   $   $111,198   $ 
NOW and money market accounts    174,224    174,224        174,224     
Savings    51,134    51,134        51,134     
Time deposits    160,515    161,623        161,623     
Total deposits    497,071    498,179        498,179     
Federal Home Loan Bank Advances    43,325    47,011        47,011     
Short term borrowings    18,634    18,634        18,634     
Junior subordinated debentures    15,464    15,464        15,464     
Accrued interest payable    694    694    694         
30
 

Note 6 – Fair Value of Financial Instruments - continued

 

The following tables summarize quantitative disclosures about the fair value for each category of assets carried at fair value as of September 30, 2014 and December 31, 2013 that are measured on a recurring basis. There were no liabilities carried at fair value as of September 30, 2014 or December 31, 2013 that are measured on a recurring basis.

 

Description  September
30, 2014
   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Available-for-sale securities                    
Government sponsored enterprises   $3,385   $   $3,385   $ 
Mortgage-backed securities    151,018        151,018     
Small Business Administration securities    52,566        52,566     
State and local government    52,129        52,129     
Corporate and other securities    1,314    837    60    417 
Total   $260,412   $837   $259,158   $417 

 

Description  December 31, 2013   Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Available-for-sale securities                    
Government sponsored enterprises   $3,246   $   $3,246   $ 
Mortgage-backed securities    119,676        119,676     
Small Business Administration securities    56,120        56,120     
State and local government    42,998        42,998     
Corporate and other securities    2,315    818    1,080    417 
Total   $224,355   $818   $223,120   $417 
31
 

Note 6 – Fair Value of Financial Instruments - continued

 

The following tables reconcile the changes in Level 3 financial instruments for the nine and three months ended September 30, 2014 that are measured on a recurring basis.

 

(Dollars in thousands)  Corporate Preferred
Stock
 
Beginning Balance December 31, 2013  $417 
Total gains or losses (realized/unrealized)     
      
Included in earnings    
      
Included in other comprehensive income    
      
Purchases, issuances, and settlements    
      
Transfers in and/or out of Level 3    
Ending Balance September 30, 2014  $417 

 

(Dollars in thousands)  Corporate Preferred
Stock
 
Beginning Balance June 30, 2014  $417 
Total gains or losses (realized/unrealized)     
      
Included in earnings    
      
Included in other comprehensive income    
      
Purchases, issuances, and settlements    
      
Transfers in and/or out of Level 3    
Ending Balance September 30, 2014  $417 
32
 

Note 6 – Fair Value of Financial Instruments - continued

 

The following tables reconcile the changes in Level 3 financial instruments for the nine and three months ended September 30, 2013 that are measured on a recurring basis.

 

(Dollars in thousands)  Interest rate Swap   Corporate Preferred
Stock
 
Beginning Balance December 31, 2012  $(338)       $417 
Total gains or losses (realized/unrealized)          
           
Included in earnings   (2)    
           
Included in other comprehensive income        
           
Purchases, issuances, and settlements   253     
           
Transfers in and/or out of Level 3        
Ending Balance September 30, 2013  $(87)  $417 

 

(Dollars in thousands)  Interest rate Swap   Corporate Preferred
Stock
 
Beginning Balance June 30, 2013  $(172)       $417 
Total gains or losses (realized/unrealized)          
           
Included in earnings        
           
Included in other comprehensive income        
           
Purchases, issuances, and settlements   85     
           
Transfers in and/or out of Level 3        
Ending Balance September 30, 2013  $(87)  $417 
33
 

Note 6 – Fair Value of Financial Instruments – continued

 

The following tables summarize quantitative disclosures about the fair value for each category of assets carried at fair value as of September 30, 2014 and December 31, 2013 that are measured on a non-recurring basis.

 

(Dollars in thousands)                
Description  September 30,
2014
   Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans:                    
Commercial & Industrial   $58   $   $   $58 
Real estate:                    
Mortgage-residential    1,034            1,034 
Mortgage-commercial    6,152            6,152 
Consumer:                    
Home equity    93            93 
Other    5            5 
Total impaired    7,342            7,342 
Other real estate owned:                    
Construction    424            424 
Mortgage-residential    220            220 
Mortgage-commercial    2,370            2,370 
Total other real estate owned    3,014            3,014 
Total   $10,356   $   $   $10,356 
34
 

Note 6 – Fair Value of Financial Instruments - continued

 

(Dollars in thousands)                
Description  December 31,
2013
   Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)
 
Impaired loans:                    
Commercial & Industrial   $76   $   $   $76 
Real estate:                    
Mortgage-residential    947            947 
Mortgage-commercial    4,834            4,834 
Consumer:                    
Home equity    109            109 
Other    12            12 
Total impaired    5,978            5,978 
Other real estate owned:                    
Construction    301            301 
Mortgage-residential    168            168 
Mortgage-commercial    2,901            2,901 
Total other real estate owned    3,370            3,370 
Total   $9,348   $   $   $9,348 

 

The Company has a large percentage of loans with real estate serving as collateral. Loans which are deemed to be impaired are primarily valued on a nonrecurring basis at the fair value of the underlying real estate collateral. Such fair values are obtained using independent appraisals, which the Company considers to be Level 3 inputs. Third party appraisals are generally obtained when a loan is identified as being impaired or at the time it is transferred to OREO. This internal process consists of evaluating the underlying collateral to independently obtained comparable properties. With respect to less complex or smaller credits, an internal evaluation may be performed. Generally the independent and internal evaluations are updated annually. Factors considered in determining the fair value include geographic sales trends, the value of comparable surrounding properties as well as the condition of the property. The aggregate amount of impaired loans was $7.4 million and $6.0 million as of September 30, 2014 and December 31, 2013, respectively.

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Note 6 – Fair Value of Financial Instruments - continued

For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of September 30, 2014 and December 31, 2013, the significant unobservable inputs used in the fair value measurements were as follows:

 

(Dollars in thousands)  Fair Value as
of September
30, 2014
   Valuation Technique  Significant
Observable Inputs
  Significant
Unobservable
Inputs
Preferred stock   $417   Estimation based on comparable non-listed securities  Comparable transactions  n/a
OREO   $3,014   Appraisal Value/Comparison Sales/Other estimates  Appraisals and or sales of comparable properties  Appraisals discounted 6% to 16% for sales commissions and other holding cost
Impaired loans   $7,342   Appraisal Value  Appraisals and or sales of comparable properties  Appraisals discounted 6% to 16% for sales commissions and other holding cost

  

(Dollars in thousands)  Fair Value as
of December
31, 2013
   Valuation Technique  Significant
Observable Inputs
  Significant
Unobservable
Inputs
Preferred stock   $417   Estimation based on comparable non-listed securities  Comparable transactions  n/a
OREO   $3,370   Appraisal Value/Comparison Sales/Other estimates  Appraisals and or sales of comparable properties  Appraisals discounted 6% to 16% for sales commissions and other holding cost
Impaired loans   $5,978   Appraisal Value  Appraisals and or sales of comparable properties  Appraisals discounted 6% to 16% for sales commissions and other holding cost

 

Note 7 – Mergers and Acquisitions – Savannah River Financial Corporation

 

On February 1, 2014, the Company acquired all of the outstanding common stock of Savannah River Financial Corporation of Augusta, Georgia (“Savannah River”), the bank holding company for Savannah River Banking Company (“SRBC”), in a cash and stock transaction. The total purchase price was approximately $33.5 million, consisting of $19.8 million in cash and 1,274,200 shares of our common stock valued at $13.7 million based on a provision in the merger agreement that 60% of the outstanding shares of Savannah River common stock be exchanged for cash and 40% of the outstanding shares of Savannah River common stock be exchanged for shares of the Company’s common stock. The value of the Company’s common stock issued was determined based on the closing price of the common stock on January 31, 2014 as reported by NASDAQ, which was $10.76. Savannah River common shareholders received 1.0618 shares of the Company’s common stock in exchange for each share of Savannah River common stock, or $11.00 per share, subject to the limitations discussed above. The Company issued 1,274,200 shares of its common stock in connection with the merger.

 

The Savannah River transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed and consideration exchanged were recorded at estimated fair value on the acquisition date based on a third party valuation of significant accounts. Fair values are subject to refinement for up to a year.

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Note 7 – Mergers and Acquisitions-continued

 

The following table presents the assets acquired and liabilities assumed as of February 1, 2014 as recorded by the Company on the acquisition date and initial fair value adjustments.

 

   As Recorded by   Fair Value   As Recorded 
(Dollars in thousands, except per share data)  Savannah River   Adjustments   by the Company 
Assets               
Cash and cash equivalents  $8,451   $   $8,451 
Investment securities   23,014    126(a)   23,140 
Loans   109,532    (3,016)(b)   106,516 
Premises and equipment   7,695    473(c)   8,168 
Intangible assets       1,182(d)   1,182 
Bank owned life insurance   3,158        3,158 
Other assets   1,839    (248)(e)   1,591 
Total assets  $153,689   $(1,483)  $152,206 
                
Liabilities               
Deposits:               
Noninterest-bearing  $11,045   $   $11,045 
Interest-bearing   102,891    211(f)   103,102 
Total deposits   113,936    211    114,147 
FHLB advances   8,684    22(g)   8,706 
Other liabilities   345        345 
Total liabilities   122,965    233    123,198 
Net identifiable assets acquired over (under) liabilities assumed   30,724    (1,716)   29,008 
Goodwill       4,507    4,507 
Net assets acquired over liabilities assumed  $30,724   $2,791   $33,515 
                
Consideration:               
First Community Corporation common shares issued   1,274,200           
Purchase price per share of the Company’s common stock  $10.76           
   $13,710           
Cash exchanged for stock and fractional shares   19,805           
Fair value of total consideration transferred  $33,515           

 

 

Explanation of fair value adjustments

(a)—Adjustment reflects marking the securities portfolio to fair value as of the acquisition date.

(b)—Adjustment reflects the fair value adjustments based on the Company’s evaluation of the acquired loan portfolio. and excludes the allowance for loan losses recorded by Savannah River.

(c)—Adjustment reflects the fair value adjustments based on the Company’s evaluation of the acquired premises and equipment.

(d)—Adjustment reflects the recording of the core deposit intangible on the acquired deposit accounts.

(e)—Adjustment reflects the deferred tax adjustment related to fair value adjustments at 34%.

(f)—Adjustment reflects the fair value adjustment on interest-bearing deposits.

(g)—Adjustment reflects the fair value adjustment on FHLB Advances which was equal to the prepayment fee paid to pay-off the FHLB Advances upon consummation of the merger.

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Note 7 – Mergers and Acquisitions-continued

 

The operating results of the Company for the period ended September 30, 2014 include the operating results of the acquired assets and assumed liabilities for the 242 days subsequent to the acquisition date of February 1, 2014. Merger-related charges related to the Savannah River acquisition of $435 thousand are recorded in the consolidated statement of income and include incremental costs related to closing the acquisition, including legal, accounting and auditing, investment banker, travel, printing, supplies and other costs. Additional merger related costs of $539 thousand were included in the consolidated statement of income of the Company for the year ended December 31, 2013.

 

The following table discloses the impact of the merger with Savannah River (excluding the impact of merger-related expenses) since the acquisition on February 1, 2014 through September 30, 2014. The table also presents certain pro forma information as if Savannah River had been acquired on January 1, 2014 and January 1, 2013. These results combine the historical results of Savannah River in the Company’s consolidated statement of income and, while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2014 or January 1, 2013.

 

   Actual since         
   Acquisition   Pro Forma   Pro Forma 
   (February 1, 2014 through   Nine Months Ended   Nine Months Ended 
(Dollars in thousands)    September 30, 2014)       September 30, 2014        September 30, 2013 
                
Total revenues (net interest income plus noninterest income)  $21,377   $24,132   $21,423 
Net income  $3,553   $3,760   $3,617 

 

On September 26, 2014, First Community Bank (the “Bank”), the wholly-owned subsidiary of the Company, completed the acquisition of approximately $40 million in deposits and $8.7 million in loans from First South Bank (“First South”). This represented all of the deposits and a portion of the loans at First South’s Columbia, South Carolina banking office located at 1333 Main Street. The Bank paid a premium of $714 thousand for the deposits and loans acquired. The deposits and loans from First South have been consolidated into the Bank’s branch located at 1213 Lady Street, Columbia, South Carolina. The premium paid of $714 thousand plus fair value adjustments recorded on loans and deposits acquired resulted in a core deposit intangible of $365.9 thousand and other identifiable intangible assets in the amount of $538.6 thousand being recorded related to this transaction and is reflected on the consolidated balance sheet at September 30, 2014.

 

Note 8 – Subsequent Events

 

Subsequent events are events or transactions that occur after the balance sheet date but before financial statements are issued. Recognized subsequent events are events or transactions that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements.  Nonrecognized subsequent events are events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.  Management has reviewed events occurring through the date the financial statements were issued and no subsequent events occurred requiring accrual or disclosure.

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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations.

This report contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements may relate to, among other matters, the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013 as filed with the Securities and Exchange Commission (the “SEC”) and the following:

·credit losses as a result of, among other potential factors, declining real estate values, increasing interest rates, increasing unemployment, changes in payment behavior or other factors;
·the amount of our loan portfolio collateralized by real estate and weaknesses in the real estate market;
·restrictions or conditions imposed by our regulators on our operations;
·the adequacy of the level of our allowance for loan losses and the amount of loan loss provisions required in future periods;
·expected revenue synergies and cost savings from the acquisition of Savannah River may not be fully realized;
·examinations by our regulatory authorities, including the possibility that the regulatory authorities may, among other things, require us to increase our allowance for loan losses or write-down assets;
·reduced earnings due to higher other-than-temporary impairment charges resulting from additional decline in the value of our securities portfolio, specifically as a result of increasing default rates, and loss severities on the underlying real estate collateral;
·increases in competitive pressure in the banking and financial services industries;
·changes in the interest rate environment which could reduce anticipated or actual margins;
·changes in political conditions or the legislative or regulatory environment, including governmental initiatives affecting the financial services industry;
·general economic conditions resulting in, among other things, a deterioration in credit quality;
·changes occurring in business conditions and inflation;
·changes in access to funding or increased regulatory requirements with regard to funding;
·cybersecurity risks, including potential business disruptions or financial losses;
·changes in deposit flows;
·changes in technology;
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·changes in monetary and tax policies;
·changes in accounting policies and practices;
·the rate of delinquencies and amounts of loans charged-off;
·the rate of loan growth in recent years and the lack of seasoning of a portion of our loan portfolio;
·our ability to maintain appropriate levels of capital, including levels of capital required under the capital rules implementing Basel III;
·our ability to attract and retain key personnel;
·our ability to retain our existing clients, including our deposit relationships;
·adverse changes in asset quality and resulting credit risk-related losses and expenses;
·loss of consumer confidence and economic disruptions resulting from terrorist activities; and
·other risks and uncertainties detailed from time to time in our filings with the SEC.

If any of these risks or uncertainties materialize, or if any of the assumptions underlying such forward-looking statements proves to be incorrect, our results could differ materially from those expressed, implied or projected by us in such forward-looking statements. For additional information with respect to factors that could cause actual results to differ from the expectations stated in the forward-looking statements, see “Risk Factors” under Part I, Item 1A of our 2013 Annual Report on Form 10-K. We urge investors to consider all of these factors carefully in evaluating the forward-looking statements contained in this Quarterly Report on Form 10-Q. We make these forward-looking statements as of the date of this document and we do not intend, and assume no obligation, to update the forward-looking statements or to update the reasons why actual results could differ from those expressed, implied or projected by the forward-looking statements.

Overview

The following discussion describes our results of operations for the nine months and three months ended September 30, 2014 as compared to the nine months and three month period ended September 30, 2013 and also analyzes our financial condition as of September 30, 2014 as compared to December 31, 2013. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.

There are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section we have included a discussion of this process, as well as several tables describing our allowance for loan losses and the allocation of this allowance among our various categories of loans.

In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this non-interest income, as well as our non-interest expense, in the following discussion.

The following discussion and analysis identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.

40
 

Recent Events

 

On February 1, 2014, we completed our acquisition of Savannah River and its wholly-owned subsidiary, SRBC. Under the terms of the merger agreement, Savannah River shareholders received either $11.00 in cash or 1.0618 shares of the Company’s common stock, or a combination thereof, for each Savannah River share they owned immediately prior to the merger, subject to the limitation that 60% of the outstanding shares of Savannah River common stock were exchanged for cash and 40% of the outstanding shares of Savannah River common stock were exchanged for shares of the Company’s common stock. The Company issued 1,274,200 shares of common stock in connection with the merger. Total intangibles, including goodwill of $3.8 million and a core deposit premium of $1.2 million, were recorded in conjunction with the acquisition (See Note 7 “Mergers and Acquisitions” to the consolidated financial statements).

 

On September 26, 2014, the Bank completed its acquisition of approximately $40 million in deposits and $8.7 million in loans from First South. This represented all of the deposits and a portion of the loans at First South’s Columbia, South Carolina banking office located at 1333 Main Street. The Bank paid a premium of $714 thousand, for the deposits and loans acquired. The deposits and loans from First South have been consolidated into the Bank’s branch located at 1213 Lady Street, Columbia, South Carolina.

 

Critical Accounting Policies

We have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States and with general practices within the banking industry in the preparation of our financial statements. Our significant accounting policies are described in the footnotes to our unaudited consolidated financial statements as of September 30, 2014 and our notes included in the consolidated financial statements in our 2013 Annual Report on Form 10-K as filed with the SEC.

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgment and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Because of the nature of the judgment and assumptions we make, actual results could differ from these judgments and estimates that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

Allowance for Loan Losses

We believe the allowance for loan losses is the critical accounting policy that requires the most significant judgment and estimates used in preparation of our consolidated financial statements. Some of the more critical judgments supporting the amount of our allowance for loan losses include judgments about the credit worthiness of borrowers, the estimated value of the underlying collateral, the assumptions about cash flow, determination of loss factors for estimating credit losses, the impact of current events, and conditions, and other factors impacting the level of probable inherent losses. Under different conditions or using different assumptions, the actual amount of credit losses incurred by us may be different from management’s estimates provided in our consolidated financial statements. Refer to the portion of this discussion that addresses our allowance for loan losses for a more complete discussion of our processes and methodology for determining our allowance for loan losses.

Goodwill and Other Intangibles

 

Goodwill represents the excess of the purchase price over the sum of the estimated fair values of the tangible and identifiable intangible assets acquired less the estimated fair value of the liabilities assumed. As of September 30, 2014 and December 31, 2013, the balance of goodwill was $4.4 million and $571 thousand, respectively. This increase in goodwill was due to the acquisition of Savannah River in the first quarter of 2014 which added $3.8 million in additional goodwill. Goodwill has an indefinite useful life and is evaluated for impairment annually or more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss is recognized to the extent that the carrying amount exceeds the asset’s fair value. Qualitative factors are assessed to first determine if it is more likely than not (more than 50%) that the carrying value of goodwill is less than fair value. These qualitative factors include, but are not limited to, overall deterioration in general economic conditions, industry and market conditions, and overall financial performance. If determined that it is more likely than not that there has been a deterioration in the fair value of the carrying value than the first of a two-step process would be performed. The first step, used to identify potential impairment, involves comparing each reporting unit’s estimated fair value to its carrying value, including goodwill. If the estimated fair value of a reporting unit exceeds its carrying value, goodwill is considered not to be impaired. If the carrying value exceeds estimated fair value, there is an indication of potential impairment and the second step is performed to measure the amount of impairment.

41
 

If required, the second step involves calculating an implied fair value of goodwill for each reporting unit for which the first step indicated impairment. The implied fair value of goodwill is determined in a manner similar to the amount of goodwill calculated in a business combination, by measuring the excess of the estimated fair value of the reporting unit, as determined in the first step, over the aggregate estimated fair values of the individual assets, liabilities and identifiable intangibles as if the reporting unit was being acquired in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment charge is recorded for the excess. An impairment loss cannot exceed the carrying value of goodwill assigned to a reporting unit, and the loss establishes a new basis in the goodwill. Subsequent reversal of goodwill impairment losses is not permitted. Management has determined that the Company has one reporting unit.

 

Core deposit intangibles consist of costs that resulted from the acquisition of deposits from Savannah River as well as the assumption of deposits from First South in the third quarter of 2014. Core deposit intangibles represent the estimated value of long-term deposit relationships acquired in this transaction. These costs are amortized over the estimated useful lives of the deposit accounts acquired on a method that we believe reasonably approximates the anticipated benefit stream from the accounts. The estimated useful lives are periodically reviewed for reasonableness.

 

Income Taxes and Deferred Tax Assets and Liabilities

Income taxes are provided for the tax effects of the transactions reported in our consolidated financial statements and consist of taxes currently due plus deferred taxes related to differences between the tax basis and accounting basis of certain assets and liabilities, including available-for-sale securities, allowance for loan losses, write downs of OREO properties, accumulated depreciation, net operating loss carry forwards, accretion income, deferred compensation, intangible assets, and pension plan and post-retirement benefits. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. A valuation allowance is recorded when it is “more likely than not” that a deferred tax asset will not be realized. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. We file a consolidated federal income tax return for the Bank. At September 30, 2014 and December 31, 2013, we were in a net deferred tax asset position.

Other-Than-Temporary Impairment

We evaluate securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) the outlook for receiving the contractual cash flows of the investments, (4) the anticipated outlook for changes in the general level of interest rates, and (5) our intent and ability to retain our investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value or for a debt security whether it is more-likely-than-not that the Company will be required to sell the debt security prior to recovering its fair value (See Note 3 to the Consolidated Financial Statements).

Business Combinations, Method of Accounting for Loans Acquired

 

We account for acquisitions under FASB ASC Topic 805, Business Combinations, which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No allowance for loan losses related to the acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk.

 

Acquired credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality, found in FASB ASC Topic 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality. and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loans. Loans acquired in business combinations with evidence of credit deterioration are considered impaired. Loans acquired through business combinations that do not meet the specific criteria of FASB ASC Topic 310-30, but for which a discount is attributable, at least in part to credit quality, are also accounted for under this guidance. Certain acquired loans, including performing loans and revolving lines of credit (consumer and commercial), are accounted for in accordance with FASB ASC Topic 310-20, where the discount is accreted through earnings based on estimated cash flows over the estimated life of the loan.

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Comparison of Results of Operations for Nine Months Ended September 30, 2014 to the Nine Months Ended September 30, 2013

 

Net Income

 

As noted above, our acquisition of Savannah River was closed on February 1, 2014. Therefore, the results for the nine months ended September 30, 2014 include the impact of this acquisition from February 1, 2014 through September 30, 2014. The purchase of loans and assumption of deposits from First South closed on September 26, 2014 and, therefore, this transaction did not have a significant impact on the results of operations for the period ended September 30, 2014. Our net income for the nine months ended September 30, 2014 was $3.6 million or $0.55 diluted earnings per common share, as compared to $3.3 million or $0.62 diluted earnings per common share for the nine months ended September 30, 2013. Diluted earnings per share in the nine months ended September 30, 2014 reflect the additional shares issued in connection with the Savannah River acquisition. The increase in net income between the two periods is primarily due to increased net interest income as result of a higher level of earning assets as well as a 27 basis point improvement in our net interest margin. This was partially offset by an increase in non-interest expense including $474 thousand in merger and acquisition expenses related to our acquisition of Savannah River and the loans and deposits acquired from First South. In addition, mortgage banking income decreased by $631 thousand in the nine months ended September 30, 2014 as compared to the same period in 2013. Net interest income increased $4.3 million for the nine months ended September 30, 2014 as compared to the same period 2013. Non-interest expense in the nine months ended September 30, 2014 increased $3.2 million as compared to the same period in 2013. Both of these fluctuations are primarily a result of the impact of the Savannah River acquisition. Average earning assets increased by $124.7 million in the first nine months of 2014 as compared to the same period in 2013. Average earning assets were $701.7 million during the nine months ended September 30, 2014 as compared to $576.9 million during the nine months ended September 30, 2013. The net interest margin on a tax equivalent basis increased to 3.42% during the first nine months of 2014 as compared to 3.15% during the first nine months of 2013.

Net Interest Income

 

Please refer to the table at the end of this Item 2 for the yield and rate data for interest-bearing balance sheet components during the nine-month periods ended September 30, 2014 and 2013, along with average balances and the related interest income and interest expense amounts.

 

Net interest income was $17.5 million for the nine months ended September 30, 2014 as compared to $13.3 million for the nine months ended September 30, 2013. The increase in average earning assets as a result of the Savannah River merger contributed to the overall $4.2 million increase in net interest income in the nine months ended September 30, 2014 as compared to the same period in 2013. Interest rates over the last several years have remained at historically low levels and have continued this trend throughout the first nine months of 2014. Our net interest margin on a tax equivalent basis increased 27 basis points, from 3.15% for the nine months ended September 30, 2013 to 3.42% for the same period in 2014. The yield on earning assets increased by 11 basis points in the first nine months of 2014 as compared to the same period in 2013. The yield on earning assets for the nine months ended September 30, 2014 and 2013 was 3.85% and 3.74%, respectively. Loans comprised 62.0% of average earning assets in the first nine months of 2014 as compared to 59.3% in the same period of 2013. The yield on our loan portfolio decreased 16 basis points in the nine month period ended September 30, 2014 to 5.00% as compared to 5.16% during the same period in 2013. This was partially offset by an increase on the yield on securities of 33 basis points in comparing the same two periods. The overall yield on securities increased due to a slowdown in prepayment rates in the MBS portfolio in the first nine months of 2014. As a result, the related premiums on these securities are amortized over a longer time period. The average balance of our securities portfolio was $249.6 million for the nine month period ended September 30, 2014 as compared to $220.7 million for the same period of 2013. The cost of interest-bearing liabilities during the first nine months of 2014 was 0.63% as compared to 0.83% in the same period of 2013, reflecting a 20 basis point decrease. The continued focus and resulting shift in our deposit funding mix has continued to allow us to lower our overall cost of funds. Interest-bearing transaction accounts, money market accounts and savings deposits, which are typically our lower costing funds, represented 56.5% of our average interest bearing liabilities during the first nine months of 2014 as compared to 47.4% in the same period of 2013. Time deposits and borrowed funds, typically the higher costing funds, represent 43.5% of our average interest-bearing funds in the first nine months of 2014 as compared to 52.6% during the same period in 2013.

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Provision and Allowance for Loan Losses

At September 30, 2014 and December 31, 2013, the allowance for loan losses was $4.1 and $4.2 million, respectively. This represented 0.92% and 1.21% of total loans at September 30, 2014 and December 31, 2013, respectively. No allowance for loan losses related to the Savannah River acquired loans is recorded on the acquisition date because the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired were recorded at the acquisition date fair value, which was based on expected cash flows and included an estimation of expected future loan losses for the purchased credit-impaired loans, including principal and interest. Under current accounting principles, information regarding our estimate of loan fair values may be adjusted for a period of up to one year as we continue to refine our estimate of expected future cash flows in the acquired portfolio. There were no adjustments in the third quarter of 2014 to the original assumptions. At September 30, 2014, the allowance for loan losses plus the fair value adjustment related to credit as a percentage of total loans (excluding loans held for sale) was 1.33%. Our provision for loan losses was $702 thousand for the nine months ended September 30, 2014 as compared to $379 thousand for the nine months ended September 30, 2013. This provision is made based on our assessment of general loan loss risk and asset quality. The allowance for loan losses represents an amount which we believe will be adequate to absorb probable losses on existing loans that may become uncollectible. Our judgment as to the adequacy of the allowance for loan losses is based on a number of assumptions about future events, which we believe to be reasonable, but which may or may not prove to be accurate. Our determination of the allowance for loan losses is based on evaluations of the collectability of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, the experience ability and depth of lending personnel, economic conditions (local and national) that may affect the borrower’s ability to repay, the amount and quality of collateral securing the loans, our historical loan loss experience, and a review of specific problem loans. We also consider subjective issues such as changes in the lending policies and procedures, changes in the local/national economy, changes in volume or type of credits, changes in volume/severity of problem loans, quality of loan review and board of director oversight, and concentrations of credit. Periodically, we adjust the amount of the allowance based on changing circumstances. We charge recognized losses to the allowance and add subsequent recoveries back to the allowance for loan losses.

 

Our loan portfolio consists of a large percentage of real estate secured loans. Real estate values continue to be adversely impacted as a result of the economic downturn over the last several years. Impaired values of the underlying real estate collateral as well as lower historical residential and commercial real estate sales impacts our ability to sell collateral upon foreclosure. There is a risk that this trend will continue.  The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended.  If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses.  If during a period of reduced real estate values we are required to liquidate the property collateralizing a loan to satisfy the debt or to increase the allowance for loan losses, it could materially reduce our profitability and adversely affect our financial condition.  

 

Non-performing assets were $9.9 million (1.19% of total assets) at September 30, 2014 as compared to $8.7 million (1.39% of total assets) and $8.8 million (1.39% of total assets) at September 30, 2013 and December 31, 2013, respectively. The increase in non-performing assets between December 31, 2013 and September 30, 2014 results primarily from one credit that had previously been identified as a potential problem loan being placed in non-accrual status. This $1.7 million loan is secured by a residential subdivision and commercial real estate which has been written down to the estimated fair value of the underlying collateral. While we believe these non-performing ratios are favorable in comparison to current industry results, we continue to be concerned about the impact of this economic environment on our customer base of local businesses and professionals. There were 47 loans, totaling $6.8 million, that were included in non-performing status (non-accrual loans and loans past due 90 days and still accruing) at September 30, 2014. The average balance of the remaining 46 loans, which excludes the previously mentioned $1.7 million non-performing loan, is approximately $113.8 thousand and the majority of these loans are secured by first mortgage liens. At the time the loans are placed in non-accrual status, we typically obtain an updated appraisal and, if the loan balance exceeds fair value, write the balance down to the fair value. At September 30, 2014, we had two loans delinquent more than 90 days and still accruing interest with a current balances totaling $95 thousand. At September 30, 2014, we had loans totaling $1.9 million that were delinquent 30 days to 89 days which represented 0.42% of total loans.

44
 

Our management continuously monitors non-performing, classified and past due loans, to identify deterioration regarding the condition of these loans. We have identified one loan relationship in the amount of $754 thousand that is current as to principal and interest and not included in non-performing assets that could represent a potential problem loan. This balance is included as substandard loans in Note 4 of the financial statements.

 

We perform an analysis quarterly to assess the risk within the loan portfolio. The portfolio is segregated into similar risk components for which historical loss ratios are calculated and adjusted for identified changes in current portfolio characteristics. Historical loss ratios are calculated by product type and by regulatory credit risk classification (See Note 4– Loans). The allowance consists of an allocated and unallocated allowance. The allocated portion is determined by types and ratings of loans within the portfolio. The unallocated portion of the allowance is established for losses that exist in the remainder of the portfolio and compensates for uncertainty in estimating the loan losses. The annualized weighted average loss ratios over the 24 month period ended September 30, 2014 for loans classified substandard, special mention and pass have been approximately 4.08%, 3.79% and 0.053%, respectively. The allocated portion of the allowance is based on historical loss experience as well as certain qualitative factors as explained above. The qualitative factors have been established based on certain assumptions made as a result of the current economic conditions and as conditions change are adjusted to be directionally consistent with these changes.

 

There can be no assurance that charge-offs of loans in future periods will not exceed the allowance for loan losses as estimated at any point in time or that provisions for loan losses will not be significant to a particular accounting period. The allowance is also subject to examination and testing for adequacy by regulatory agencies, which may consider such factors as the methodology used to determine adequacy and the size of the allowance relative to that of peer institutions. Such regulatory agencies could require us to adjust our allowance based on information available to them at the time of their examination.

45
 

The following table summarizes the activity related to our allowance for loan losses:

Allowance for Loan Losses

 

(Dollars in thousands)  Nine months Ended
September 30,
 
   2014   2013 
Average loans outstanding (including loans held for sale)  $     435,076   $     342,183 
Loans outstanding at period end  $448,556          $345,064 
Non-performing assets:          
Nonaccrual loans  $6,795   $5,052 
Loans 90 days past due still accruing   95    54 
Foreclosed real estate   3,014    3,607 
Total non-performing assets  $9,904   $8,713 
           
Beginning balance of allowance  $4,219   $4,621 
Loans charged-off:          
Construction and development        
1-4 family residential mortgage   39    44 
Multi-family residential        
Non-residential real estate   689    604 
Home equity       67 
Commercial   2    29 
Installment & credit card   95    64 
Total loans charged-off   825    808 
Recoveries:          
1-4 family residential mortgage   15    64 
Non-residential real estate        
Home equity       3 
Commercial   32    31 
Installment & credit card   13    33 
Total recoveries   60    131 
Net loan charge offs   765    677 
Provision for loan losses   702    379 
Balance at period end  $4,156   $4,323 
           
Net charge -offs to average loans   0.18%   0.20%
Allowance as percent of total loans   0.93%   1.25%
Non-performing assets as % of total assets   1.19%   1.37%
Allowance as % of non-performing assets   41.96%   49.62%
46
 

The following allocation of the allowance to specific components is not necessarily indicative of future losses or future allocations. The entire allowance is available to absorb losses in the portfolio.

 

Composition of the Allowance for Loan Losses

(Dollars in thousands)  September 30,  2014   December 31, 2013 
       % of
loans in
       % of
   loans in
 
   Amount   Category   Amount   Category 
Commercial, Financial and Agricultural  $147    7.4%  $233    5.7%
Real Estate – Construction   38    5.1%   26    5.5%
Real Estate Mortgage:                    
Commercial   1,599    68.0%   1,117    68.4%
Residential   166    10.6%   291    10.8%
Consumer:                    
Home Equity   112    7.2%   112    7.4%
Other   63    1.7%   80    2.2%
Unallocated   2,031          N/A    2,360    N/A 
Total  $4,156    100.0%  $4,219    100.0%

 

Accrual of interest is discontinued on loans when management believes, after considering economic and business conditions and collection efforts that a borrower’s financial condition is such that the collection of interest is doubtful. A delinquent loan is generally placed in nonaccrual status when it becomes 90 days or more past due. At the time a loan is placed in nonaccrual status, all interest, which has been accrued on the loan but remains unpaid is reversed and deducted from earnings as a reduction of reported interest income. No additional interest is accrued on the loan balance until the collection of both principal and interest becomes reasonably certain.

 

Non-interest Income and Non-interest Expense

 

Non-interest income during the first nine months of 2014 was $6.1 million as compared to $6.3 million during the same period in 2013. Mortgage banking income decreased $631 thousand during the first nine months of 2014, which was a result of a slowdown in mortgage loan activity that began in the second half of 2013. The slowdown resulted from an increase in mortgage loan interest rates during this period that impacted refinancing activity, and the slowdown in refinancing activity has carried into 2014. Although the level of purchase money activity has increased as a percentage of total production, it has not been enough to offset the decline in refinancing activity. Investment advisory fees and non-deposit commissions increased by $27 thousand in the first nine months of 2014 as compared to the same period in 2013. We added one new investment advisor in the fourth quarter of 2013 and another in the second quarter of 2014 to our financial planning unit. During the nine months ended September 30, 2014, we sold investment securities for a net gain of $102 thousand. At the same time we prepaid $2.0 million in FHLB advances scheduled to mature in 2015 and incurred a loss on the extinguishment of the debt of $67 thousand. During the first nine months of 2013, we realized gains on the sale of securities of $152 thousand and incurred a loss on extinguishment of debt in the amount of $141 thousand. Non-interest income “Other” increased $312 thousand in the first nine months of 2014 as compared to the same period in 2013. This is a result of an increase in debit card fee income of approximately $82 thousand as well as increases in other miscellaneous fee income sources as a result of our overall increase in asset size in the first nine months of 2014 as compared to the same period in 2013.

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Total non-interest expense increased by $3.2 million, or 21.4%, during the first nine months of 2014 as compared to the same period in 2013. Salary and benefit expense increased $1.3 million from $8.9 million in the first nine months of 2013 to $10.2 million in the same period of 2014. At September 30, 2014, we had 188 full time equivalent employees as compared to 166 at September 30, 2013. This increase in salary and benefit expense and number of full time equivalent employees results from the employees that were added in connection with the acquisition of Savannah River. Occupancy expense and equipment expense increased $344 thousand and $221 thousand, respectively, for the nine months ended September 30, 2014, as compared to the first nine months of 2013, and both are a direct result of the Savannah River merger. Marketing and public relations expense was $591 thousand in the first nine months of 2014 as compared to $311 thousand in the same period of 2013. The timing of a media campaign in the first nine months of 2014 resulted in the increased marketing cost as compared to the same period of 2013. For the nine months ended September 30, 2014, we incurred merger and acquisition related expenses of $474 thousand. Of this amount $420 thousand was related to the Savannah River acquisition and $54 thousand was related to cost associated with the deposit assumption and loan acquisition from First South. There were $33 thousand in merger related expenses incurred during the first nine months of 2013. Amortization of intangible expense in the nine months ended September 30, 2014 was $169 thousand as compared to $128 thousand in the same period of 2013. The amortization expense in 2014 represents expense recognition of the Savannah River core deposit premium. The 2013 amortization expense relates to intangibles related to previous acquisitions that were fully written off in 2013. Non-interest expense “Other” increased $512 thousand in the first nine months of 2014 to $3.2 million as compared to $2.7 million in the same period of 2013. As noted in the table below, substantially all components of this expense category reflected increases. These increases are primarily a result of the acquisition of Savannah River.

 

The following is a summary of the components of other non-interest expense:

 

(Dollars in thousands)  Nine months ended 
   September 30, 
   2014          2013 
Data processing  $   422   $   327 
Supplies   118    77 
Telephone   281    242 
Correspondent services   142    131 
Subscriptions and publications   117    85 
Loss on limited partnership interest   140    156 
Insurance   211    186 
Postage   141    133 
Legal and Professional fees   566    389 
Director fees   272    224 
Shareholder expenses   132    155 
Other Miscellaneous   649    574 
   $3,191   $2,679 

 

Income Tax Expense

 

Our effective tax rate was 28.3% and 26.8% in the first nine months of 2014 and 2013, respectively. As a result of our current level of tax exempt securities in our investment portfolio, our effective tax rate is expected to remain at 27.5% to 30.0% throughout the remainder of 2014.

 

Comparison of Results of Operations for Three Months Ended September 30, 2014 to the Three Months Ended September 30, 2013:

 

Net Income

 

Please refer to the table “Yields on Average Earning Assets and Rates on Average Interest-Bearing Liabilities” appearing at the end of this Item for the yield and rate data for interest-bearing balance sheet components during the three-month periods ended September 30, 2014 and 2013, along with average balances and the related interest income and interest expense amounts.

48
 

Our net income for the third quarter of 2014 was $1.6 million, or $0.23 diluted earnings per common share, as compared to $1.0 million, or $0.20 diluted earnings per common share, in the same period of 2013. Diluted earnings per share in the three months ended September 30, 2014 reflect the additional shares issued in connection with the Savannah River acquisition. Net interest income increased by $1.5 million for the three months ended September 30, 2014 compared to the same period in 2013. Our taxable equivalent net interest margin in the third quarter of 2014 increased to 3.48% compared to 3.18% in the same period of 2013. The yield on average earning assets increased to 3.88% in the third quarter of 2014 from 3.71% in the third quarter of 2013. The cost of interest bearing liabilities also decreased to 0.61% in the third quarter of 2014 as compared to 0.77% in the third quarter of 2013. Average earning assets were $713.9 million during the third quarter of 2014 as compared to $585.4 million during the third quarter of 2013. As previously discussed, our continued focus and resulting shift in our deposit funding mix has allowed us to lower our overall cost of funds. Interest-bearing transaction accounts, money market accounts and savings deposits, which are typically our lower costing funds, represented 58.5% of our average interest bearing liabilities during the third quarter of 2014 as compared to 49.9% in the same period of 2013. Time deposits and borrowed funds, typically the higher costing funds, represent 41.5% of our average interest-bearing funds in the third quarter of 2014 as compared to 50.1% during the same period in 2013.

 

Provision for Loan Losses

The provision for loan losses for the three months ended September 30, 2014 was $152 thousand as compared to $129 thousand for the three months ended September 30, 2013. As previously discussed, the provision is made based on our assessment of general loan loss risk and asset quality, historical loss experience and various other qualitative factors.

Non-interest Income and Non-interest Expense

 

For the three months ended September 30, 2014, we had non-interest income of $2.3 million as compared to non-interest income of $1.9 million in the same period of 2013. Mortgage banking income increased $246 thousand during the third quarter of 2014 as compared to the same period in 2013. As noted previously, an increase in interest rates during the second half of 2013 resulted in a slowdown in mortgage refinancing activity that continued to impact the first half of 2014. Mortgage lending activity is cyclical with the third quarter typically having a higher level of activity. We realized an increase in activity during the three months ended September 30, 2014, but we anticipate it to slow down somewhat in the fourth quarter of 2014. We continue to focus on this source of revenue and have added two new mortgage loan originators in 2014, one in the Midlands market and the other in the Augusta market. Non-interest income “Other” increased $67 thousand during the three months ended September 30, 2014 as compared to the same period in 2013. As previously discussed under the nine month results, this increase reflects an increase in various fees, including debit card fees, as result of the increase in the overall asset size subsequent to the Savannah River merger.

 

Total non-interest expense increased $1.1 million in the third quarter of 2014, compared to the same period of 2013. Salaries and benefits increased $554 thousand in the third quarter of 2014 as compared to the same period in 2013. This increase is a result of the addition of the Savannah River employees as well as normal salary adjustments. The increases between the two periods of $146 thousand and $104 thousand in occupancy and equipment expenses, respectively, are primarily a result of the Savannah River acquisition and the addition of their two branch offices. Our FDIC insurance assessment increased $30 thousand in the third quarter of 2014, as compared to the same period in 2013. This increase reflects the larger asset base used to calculate the quarterly assessments. Non-interest expense “Other”, increased $203 thousand in the three months ended September 30, 2014 as compared to the same period of 2013. As noted in the discussion of the nine months results, all components of this expense category reflected increases which are primarily a result of the acquisition of Savannah River.

 

Financial Position

 

Assets totaled $830.9 million at September 30, 2014 as compared to $633.3 million at December 31, 2013, an increase of $197.6 million. The acquisition of Savannah River added $152.2 million in total assets at fair value during the first quarter of 2014. In addition, the closing of the loan and deposit acquisition from First South on September 26, 2014 added approximately $40.2 million in total assets at the end of the third quarter of 2014. Loans (excluding loans held for sale) at September 30, 2014 were $448.6 million as compared to $347.6 million at December 31, 2013. Organic loans (loans not acquired from the Savannah River acquisition and the First South loan acquisition) decreased by approximately $14.2 million during the nine months ended September 30, 2014. Although organic loan production was $49.2 million during the first nine months of 2014, this did not overcome some anticipated and significant loan payoffs. Total loans at fair value acquired in the acquisition of Savannah River and First South amounted to $106.5 million and $8.7 million, respectively. At September 30, 2014 and December 31, 2013, loans (excluding loans held for sale) accounted for 59.1% and 58.9% of earning assets, respectively. The loan-to-deposit ratio at September 30, 2014 was 65.8% as compared to 70.7% at December 31, 2013. Investment securities increased to $263.9 million at September 30, 2014 from $227.0 million at December 31, 2013. We acquired $23.1 million in securities at fair value as result of the Savannah River acquisition. Most of these securities were sold subsequent to the closing of the transaction. The increase in interest bearing bank balances to $43.0 million at September 30, 2014 from $5.7 million at December 31, 2013 primarily reflects the net cash received from the First South transaction that closed on September 26, 2014. The increase in the investment portfolio during the first nine months of 2014 was primarily funded by an organic increase in deposits of approximately $35.7 million. Deposits were $687.0 million at September 30, 2014 as compared to $497.1 million at December 31, 2013. One of our goals as a community bank has been, and continues to be, to grow our assets through quality loan growth by providing credit to small and mid-size businesses and individuals within the markets we serve. Loan production and portfolio growth rates continue to be impacted by the current economic cycle as borrowers continue to be less inclined to leverage their corporate and personal balance sheets. However, we remain committed to meeting the credit needs of our local markets. A continuation of the slow recovery from recessionary national and local economic conditions as well as deterioration of asset quality within our Company could significantly impact our ability to grow our loan portfolio.

49
 

The following table shows the composition of the loan portfolio by category:

(In thousands)  September 30,   December 31, 
   2014   2013 
   Amount   Percent   Amount   Percent 
                 
Commercial, financial & agricultural  $33,147    7.4%  $19,925    5.7%
Real estate:                    
Construction   22,738    5.1%   18,933    5.5%
Mortgage – residential   47,369    10.6%   37,579    10.8%
Mortgage – commercial   305,013    68.0%   237,701    68.4%
Consumer:                    
Home Equity   32,435    7.2%   25,659    7.4%
Other   7,854    1.7%   7,800    2.2%
Total gross loans   448,556    100.0%   347,597    100.0%
Allowance for loan losses   (4,156)        (4,219)     
Total net loans  $444,400        $343,378      

 

In the context of this discussion, a real estate mortgage loan is defined as any loan, other than loans for construction purposes and advances on home equity lines of credit, secured by real estate, regardless of the purpose of the loan. Advances on home equity lines of credit are included in consumer loans. We follow the common practice of financial institutions in our market areas of obtaining a security interest in real estate whenever possible, in addition to any other available collateral. This collateral is taken to reinforce the likelihood of the ultimate repayment of the loan and tends to increase the magnitude of the real estate loan components. Generally we limit the loan-to-value ratio to 80%.

 

Market Risk Management

 

The effective management of market risk is essential to achieving our strategic financial objectives. Our most significant market risk is interest rate risk. We have established an Asset/Liability Management Committee (“ALCO”) to monitor and manage interest rate risk. The ALCO monitors and manages the pricing and maturity of assets and liabilities in order to diminish the potential adverse impact that changes in interest rates could have on net interest income. The ALCO has established policy guidelines and strategies with respect to interest rate risk exposure and liquidity.

A monitoring technique employed by the ALCO is the measurement of interest sensitivity “gap,” which is the positive or negative dollar difference between assets and liabilities that are subject to interest rate repricing within a given period of time. Also, asset/liability simulation modeling is performed to assess the impact varying interest rates and balance sheet mix assumptions will have on net interest income. Interest rate sensitivity can be managed by repricing assets or liabilities, selling securities available-for-sale, replacing an asset or liability at maturity or by adjusting the interest rate during the life of an asset or liability. Managing the amount of assets and liabilities repricing in the same time interval helps to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.

We are currently asset sensitive within one year. However, neither the “gap” analysis nor asset/liability modeling is a precise indicator of our interest sensitivity position due to the many factors that affect net interest income, including changes in the volume and mix of earning assets and interest-bearing liabilities. Net interest income is also impacted by other significant factors, including changes in the volume and mix of earning assets and interest-bearing liabilities. Through simulation modeling, we monitor the effect that an immediate and sustained change in interest rates of 100 basis points and 200 basis points up and down will have on net interest income over the next twelve months.

50
 

Based on the many factors and assumptions used in simulating the effect of changes in interest rates, the following table estimates the percentage change in net interest income at September 30, 2014, June 30, 2014, March 31, 2014 and December 31, 2013 over twelve months.

 

Net Interest Income Sensitivity

 

Change in short term interest rates                  Hypothetical
percentage change in
net interest income
 
   September
30, 2014
   June 30,
2014
   March 31,
2014
   December
31, 2013
 
+200bp    +4.52%   +1.62 %   +2.78%   +2.54 %
+100bp    +2.43%   +0.47 %   +1.22%   +1.22 %
Flat                 
-100bp   -5.9%   -5.16%   -5.55%   -6.23%
-200bp   -13.76%   -12.53%   -11.32%   -11.05%

 

The significant decrease in net interest income in a down 200 basis point environment primarily results from the current level of interest rates being paid on our interest bearing transaction accounts as well as money market accounts. The interest rates on these accounts are at a level where they cannot be repriced in proportion to the change in interest rates. The increase and decrease of 100 and 200 basis points assume a simultaneous and parallel change in interest rates along the entire yield curve. At the current historically low interest rate levels, we believe that a downward shift of 200 basis points across the entire yield curve is unlikely.

We also perform a valuation analysis projecting future cash flows from assets and liabilities to determine the Present Value of Equity (“PVE”) over a range of changes in market interest rates. The sensitivity of PVE to changes in interest rates is a measure of the sensitivity of earnings over a longer time horizon. At September 30, 2014, June 30, 2014 and March 31, 2014, the PVE exposure in a plus 200 basis point increase in market interest rates was estimated to be 0.66%, 0.65% and 0.71%, respectively, as compared to (3.3%) at December 31, 2013.

Liquidity and Capital Resources

 

We believe our liquidity remains adequate to meet operating and loan funding requirements. Interest-bearing bank balances, federal funds sold, and investment securities available-for-sale represent 36.7% of total assets at September 30, 2014. We believe that our existing stable base of core deposits along with continued growth in this deposit base will enable us to meet our long-term and short-term liquidity needs successfully. These needs include the ability to respond to short-term demand for funds caused by the withdrawal of deposits, maturity of repurchase agreements, extensions of credit and the payment of operating expenses. Other sources of liquidity, in addition to deposit gathering activities, include maturing loans and investments, purchase of federal funds from other financial institutions and selling securities under agreements to repurchase. We monitor closely the level of large certificates of deposits in amounts of $100 thousand or more as they tend to be more sensitive to interest rate changes and, thus, less reliable sources of funding for liquidity purposes. At September 30, 2014, the amount of certificates of deposits of $100 thousand or more represented 12.8% of total deposits. These deposits are issued to local customers many of whom have other product relationships with the Bank. At September 30, 2014, we had brokered CDs in the amount of $2.8 million which were acquired in the Savannah River acquisition.

 

Through the operations of our Bank, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At September 30, 2014, we had issued commitments to extend credit of $52.5 million, including $29.6 million in unused home equity lines of credit, through various types of lending arrangements. We evaluate each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate. We manage the credit risk on these commitments by subjecting them to normal underwriting and risk management processes.

 

Other than as described elsewhere in this report, we are not aware of any trends, events or uncertainties that we expect to result in a significant adverse effect on our liquidity position. However, no assurances can be given in this regard, as rapid growth, deterioration in loan quality, and poor earnings, or a combination of these factors, could change the liquidity position in a relatively short period of time.

51
 

The Company has generally maintained a high level of liquidity and adequate capital, which along with continued retained earnings, we believe will be sufficient to fund the operations of the Bank for at least the next 12 months. Shareholders’ equity was 8.7% and 8.3% of total assets at September 30, 2014 and December 31, 2013, respectively. The Bank maintains federal funds purchased lines in the total amount of $20.0 million with two financial institutions, although these have not utilized in 2014. In addition, the Bank has a repo line in the amount of $10.0 million with another financial institution. Specific investment securities would be pledged if and when we were to utilize the line. The FHLB of Atlanta has approved a line of credit of up to 25% of the Bank’s assets, which would be collateralized by a pledge against specific investment securities and/or eligible loans. We regularly review the liquidity position of the Company and have implemented internal policies establishing guidelines for sources of asset based liquidity and evaluate and monitor the total amount of purchased funds used to support the balance sheet and funding from noncore sources. We believe that our existing stable base of core deposits along with continued growth in this deposit base will enable us to meet our long term liquidity needs successfully.

 

The Federal Reserve Board and bank regulatory agencies require bank holding companies and financial institutions to maintain capital at adequate levels based on a percentage of assets and off-balance sheet exposures, adjusted for risk weights ranging from 0% to 100%. Under the capital adequacy guidelines, regulatory capital is classified into two tiers. These guidelines require an institution to maintain a certain level of Tier 1 and Tier 2 capital to risk-weighted assets. Tier 1 capital consists of common shareholders’ equity, excluding the unrealized gain or loss on securities available for sale, minus certain intangible assets. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100% based on the risks believed to be inherent in the type of asset. Tier 2 capital consists of Tier 1 capital plus the general reserve for loan losses, subject to certain limitations. We are also required to maintain capital at a minimum level based on total average assets, which is known as the Tier 1 leverage ratio. At both the holding company and bank level, we are subject to various regulatory capital requirements administered by the federal banking agencies. To be considered “well capitalized,” we must maintain total risk-based capital of at least 10%, Tier 1 capital of at least 6%, and a leverage ratio of at least 5%. Generally, to be considered adequately capitalized, the FDIC and Federal Reserve regulatory capital guidelines for Tier 1 capital, total capital and leverage capital ratios are 4.0%, 8.0% and 4.0%, respectively.

 

The Bank’s risk-based capital ratios of leverage ratio, Tier 1, and total capital were 9.9%, 15.1%, and 15.9%, respectively, at September 30, 2014 as compared to 10.3%, 16.8%, and 17.9%, respectively, at December 31, 2013. The Company’s risk-based capital ratios of leverage ratio, Tier 1, and total capital were 10.3%, 15.8%, and 16.6%, respectively at September 30, 2014 as compared to 10.8%, 17.6% and 18.7%, respectively at December 31, 2013. Our management anticipates that the Bank and the Company will remain a well-capitalized institution for at least the next 12 months.

 

Since the Company is a bank holding company, its ability to declare and pay dividends is dependent on certain federal and state regulatory considerations, including the guidelines of the Federal Reserve Board. The Federal Reserve Board has issued a policy statement regarding the payment of dividends by bank holding companies. In general, the Federal Reserve Board’s policies provide that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the bank holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. The Federal Reserve Board’s policies also require that a bank holding company serve as a source of financial strength to its subsidiary banks by standing ready to use available resources to provide adequate capital funds to those banks during periods of financial stress or adversity and by maintaining the financial flexibility and capital-raising capacity to obtain additional resources for assisting its subsidiary banks where necessary. In addition, under the prompt corrective action regulations, the ability of a bank holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. These regulatory policies could affect the ability of the Company to pay dividends or otherwise engage in capital distributions.

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In addition, since the Company is a legal entity separate and distinct from the Bank and does not conduct stand-alone operations, its ability to pay dividends depends on the ability of the Bank to pay dividends to it, which is also subject to regulatory restrictions. As a South Carolina chartered bank, the Bank is subject to limitations on the amount of dividends that it is permitted to pay. Unless otherwise instructed by the South Carolina Board of Financial Institutions, the Bank is generally permitted under South Carolina State banking regulations to pay cash dividends of up to 100% of net income in any calendar year without obtaining the prior approval of the South Carolina Board of Financial Institutions. The FDIC also has the authority under federal law to enjoin a bank from engaging in what in its opinion constitutes an unsafe or unsound practice in conducting its business, including the payment of a dividend under certain circumstances.

 

In July 2013, the Federal Reserve Board and the FDIC approved final rules to implement the Basel III regulatory capital reforms among other changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. The rules will apply to all national and state banks, such as the Bank, and savings associations and most bank holding companies and savings and loan holding companies, such as the Company, which we collectively refer to herein as covered banking organizations. Bank holding companies with less than $500 million in total consolidated assets are not subject to the final rule, nor are savings and loan holding companies substantially engaged in commercial activities or insurance underwriting. The framework requires covered banking organizations to hold more and higher quality capital, which acts as a financial cushion to absorb losses, taking into account the impact of risk. The approved rules include a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% as well as a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets. The rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and include a minimum leverage ratio of 4% for all covered banking institutions. In terms of quality of capital, the final rules emphasize common equity tier 1 capital and implement strict eligibility criteria for regulatory capital instruments. The rules also change the methodology for calculating risk-weighted assets to enhance risk sensitivity. The changes begin to take effect for the Company and the Bank in January 2015. The ultimate impact of the new capital standards on the Company and the Bank is currently being reviewed.

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FIRST COMMUNITY CORPORATION
Yields on Average Earning Assets and Rates
on Average Interest-Bearing Liabilities
                         
   Three months ended September 30, 2014   Three months ended September 30, 2013 
   Average   Interest   Yield/   Average   Interest   Yield/ 
   Balance   Earned/Paid   Rate   Balance   Earned/Paid   Rate 
Assets                              
Earning assets                              
Loans  $445,060   $5,615    5.02%  $344,544   $4,379    5.04%
Securities:   251,893    1,326    2.09%   225,922    1,078    1.89%
Federal funds sold and securities purchased   16,937    27    0.63%   14,953    17    0.45%
Total earning assets   713,890    6,968    3.88%   585,419    5,474    3.71%
Cash and due from banks   10,398              8,781           
Premises and equipment   29,046              17,193           
Other assets   32,316              24,186           
Allowance for loan losses   (4,099)             (4,421)          
Total assets  $781,551             $631,158           
                               
Liabilities                              
Interest-bearing liabilities                              
Interest-bearing transaction accounts  $133,554   $43    0.13%  $104,146   $27    0.10%
Money market accounts   147,916    88    0.24%   80,839    48    0.24%
Savings deposits   52,346    15    0.11%   48,490    14    0.11%
Time deposits   170,889    269    0.63%   167,516    336    0.80%
Other borrowings   65,782    457    2.76%   67,484    479    2.81%
Total interest-bearing liabilities   570,487    872    0.61%   468,475    904    0.77%
Demand deposits   133,891              104,944