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, 2007

 

o                                 Transition report pursuant to Section 13 or 15(d) of the Exchange Act for the transition period from        to

 

Commission File No. 000-28344

 

FIRST COMMUNITY CORPORATION

(Exact name of registrant as specified in its charter)

 

 

5455 Sunset Boulevard, Lexington, South Carolina 29072

(Address of Principal Executive Offices)

 

(803) 951-2265

(Registrant’s Telephone Number, Including Area Code)

 

N/A

(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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

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 equity, as of the latest practicable date:  On October 31, 2007, 3,222,923 shares of the issuer’s common stock, par value $1.00 per share, were issued and outstanding.

 

 

TABLE OF CONTENTS

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Shareholders’ Equity and Comprehensive Income (loss)

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Item 4. Controls and Procedures

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

Item 1A. Risk Factors

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information

Item 6. Exhibits

INDEX TO EXHIBITS

SIGNATURES

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

 

3

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED BALANCE SHEETS

 

		September 30, 2007			December 31, 2006
		(Unaudited)
ASSETS
Cash and due from banks		$	10,492,919		$	10,021,781
Interest-bearing bank balances		166,384			47,786
Federal funds sold and securities purchased under agreements to resell		10,239,079			17,745,404
Investment securities - available for sale		172,983,980			165,826,684
Investment securities - held to maturity (market value of $6,334,359 and $6,509,148 at September 30, 2007 and December 31, 2006, respectively)		6,322,433			6,488,796
Investment securities, at fair value		2,978,441			—
Other investments, at cost		5,156,595			4,207,794
Loans		302,828,777			275,188,567
Less, allowance for loan losses		3,525,495			3,214,624
Net loans		299,303,282			271,973,943
Property, furniture and equipment - net		20,266,788			20,960,332
Bank owned life insurance		9,904,548			9,606,657
Goodwill		27,761,219			27,761,219
Intangible assets		2,150,690			2,652,917
Other assets		10,024,431			10,762,430
Total assets		$	577,750,789		$	548,055,743
LIABILITIES
Deposits:
Non-interest bearing demand		$	80,001,452		$	73,676,415
NOW and money market accounts		86,768,003			114,842,382
Savings		28,178,024			26,134,834
Time deposits less than $100,000		121,873,671			119,082,462
Time deposits $100,000 and over		96,479,828			81,205,314
Total deposits		413,300,978			414,941,407
Securities sold under agreements to repurchase		26,699,400			19,472,580
Federal Home Loan Bank Advances		51,416,383			29,757,545
Federal Home Loan Bank Advances, at fair value		1,519,799			—
Junior subordinated debentures		15,464,000			15,464,000
Other borrowed money		124,014			148,886
Other liabilities		5,054,552			5,063,674
Total liabilities		513,579,126			484,848,092
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 3,222,923 and; 3,264,608 September 30, 2007 and December 31, 2006, respectively		3,222,923			3,264,608
Additional paid in capital		48,796,418			49,695,346
Retained earnings		13,591,833			12,033,065
Accumulated other comprehensive income (loss)		(1,439,511		)	(1,785,368		)
Total shareholders’ equity		64,171,663			63,207,651
Total liabilities and shareholders’ equity		$	577,750,789		$	548,055,743

 

4

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

 

		Nine Months Ended September 30, 2007			Nine Months Ended September 30, 2006
		(Unaudited)			(Unaudited)
Interest income:
Loans, including fees		$	16,493,118		$	13,360,784
Taxable securities		5,695,640			5,595,882
Non-taxable securities		325,252			226,806
Federal funds sold and securities purchased under resale agreements		290,251			523,768
Other		31,706			56,107
Total interest income		22,835,967			19,763,347
Interest expense:
Deposits		8,773,646			6,991,422
Federal funds sold and securities sold under agreement to repurchase		853,140			528,804
Other borrowed money		1,923,836			1,695,081
Total interest expense		11,550,622			9,215,307
Net interest income		11,285,345			10,548,040
Provision for loan losses		359,975			388,724
Net interest income after provision for loan losses		10,925,370			10,159,316
Non-interest income:
Deposit service charges		1,971,559			1,774,796
Mortgage origination fees		258,193			379,497
Commission on sale of non deposit products		218,699			260,800
Gain (loss) on sale of securities		73,694			(69,040		)
Gain on early extinguishment of debt		—			159,416
Fair value gain (loss) adjustments		45,793			89,618
Other		1,038,090			759,193
Total non-interest income		3,606,028			3,354,280
Non-interest expense:
Salaries and employee benefits		5,448,125			5,145,212
Occupancy		911,578			688,936
Equipment		949,280			895,502
Marketing and public relations		375,643			248,688
Amortization of intangibles		502,228			469,121
Other		2,425,930			2,311,469
Total non-interest expense		10,612,784			9,758,928
Income before taxes		3,918,614			3,754,668
Income taxes		1,151,852			1,114,155
Net income		$	2,766,762		$	2,640,513
Basic earnings per common share		$	0.85		$	0.87
Diluted earnings per common share		$	0.84		$	0.84

 

5

 

		Three Months Ended September 30, 2007			Three Months Ended September 30, 2006
		(Unaudited)			(Unaudited)
Interest income:
Loans, including fees		$	5,754,554		$	5,011,246
Taxable securities		2,000,203			2,034,786
Non-taxable securities		107,948			95,028
Federal funds sold and securities purchased under resale agreements		119,862			127,693
Other		14,014			19,709
Total interest income		7,996,581			7,288,462
Interest expense:
Deposits		3,090,112			2,700,583
Federal funds sold and securities sold under agreement to repurchase		290,817			236,882
Other borrowed money		706,658			600,375
Total interest expense		4,087,587			3,537,840
Net interest income		3,908,994			3,750,622
Provision for loan losses		134,475			140,395
Net interest income after provision for loan losses		3,774,519			3,610,227
Non-interest income:
Deposit service charges		714,242			652,230
Mortgage origination fees		76,955			132,916
Commission on sale of non deposit products		75,266			54,170
Gain on sale of investments		—			342
Fair value gain (loss) adjustments		138,161			(47,266		)
Other		358,658			283,340
Total non-interest income		1,363,282			1,075,732
Non-interest expense:
Salaries and employee benefits		1,838,619			1,764,918
Occupancy		340,246			276,534
Equipment		316,610			320,449
Marketing and public relations		96,817			101,733
Amortization of intangibles		167,409			167,398
Other		713,416			776,341
Total non-interest expense		3,473,117			3,407,373
Income before tax		1,664,684			1,278,586
Income tax		516,588			375,680
Net income		$	1,148,096		$	902,906
Basic earnings per common share		$	0.35		$	0.28
Diluted earnings per common share		$	0.35		$	0.27

 

6

 

FIRST COMMUNITY CORPORATION

Statement of Changes in Shareholder’s Equity and Comprehensive Income

Nine Months ended September 30, 2007 and September 30, 2006

 

		Shares Issued		Common Stock			Additional Paid-in Capital			Retained Earnings			Accumulated Other Comprehensive Income (loss)			Total
Balance, December 31, 2005		2,848,627		$	2,848,627		$	42,352,205		$	9,240,088		$	(3,674,135	)	$	50,766,785
Comprehensive Income:
Net income
Accumulated other										2,640,513						2,640,513
comprehensive income net of income tax benefit of $667,600													1,192,865
Add: reclassification adjustment for loss included in net income, net of tax of $24,284													45,098
Other comprehensive loss													1,237,963			1,237,963
Total comprehensive income																3,878,476
Dividends paid ($0.17 per share)										(512,582		)				(512,582		)
Stock issued in acquisition		364,034		364,034			7,212,859									7,576,893
Common stock repurchased		(54,600	)	(54,600		)	(919,261		)							(973,861		)
Options exercised		98,438		98,438			745,477									843,915
Dividend reinvestment plan		6,562		6,562			107,634									114,196
Balance, September 30, 2006		3,263,061		$	3,263,061		$	49,498,914		$	11,368,019		$	(2,436,172	)	$	61,693,822
Balance, December 31, 2006		3,264,608		$	3,264,608		$	49,695,346		$	12,033,065		$	(1,785,368	)	$	63,207,651
Comprehensive Income:
Net income										2,766,762						2,766,762
Cumulative adjustment to initially apply FASB Statement No. 159										(559,678		)	559,678
Accumulated other comprehensive loss net of income tax benefit of $89,300													(165,920		)
Less: reclassification
adjustment for gains included in net income, net of tax of $25,793													(47,901		)
Other comprehensive loss													(213,821		)	(213,821		)
Total comprehensive income																2,552,941
Dividends paid ($0.20 per share)										(648,316		)				(648,316		)
Common stock repurchased		(104,513	)	(104,513		)	(1,686,948		)							(1,791,461		)
Options exercised		54,230		54,230			660,692									714,922
Dividend reinvestment plan		8,598		8,598			127,328									135,926
Balance, September 30, 2007		3,222,923		$	3,222,923		$	48,796,418		$	13,591,833		$	(1,439,511	)	$	64,171,663

 

7

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

		Nine months ended September 30,
		2007			2006
Cash flows from operating activities:
Net income		$	2,766,762		$	2,640,513
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation		825,828			724,118
Premium amortization (Discount accretion)		(533,987		)	(346,216		)
Amortization of intangibles		502,228			469,133
Provision for loan losses		359,975			388,724
(Gain) loss on sale of securities		(73,694		)	69,040
Gain on extinguishment of debt		—			(159,416		)
Net (increase) decrease in fair value option instruments and derivatives		(45,793		)	(89,618		)
Increase (decrease) in other assets		601,698			419,668
(Increase) Decrease in other liabilities		(9,121		)	263,886
Net cash provided by operating activities		4,393,896			4,379,832
Cash flows form investing activities:
Purchase of investment securities available-for-sale		(41,271,466		)	(33,659,888		)
Maturity of investment securities available-for-sale		23,159,061			20,941,877
Proceeds from sale of securities available-for-sale		6,356,924			21,310,446
Maturity of investment securities held-to-maturity		148,686			—
Purchase of securities held-for-trading		(3,098,097		)	—
Maturity of securities-held-for-trading		156,166			—
Proceeds from sale of securities held-for-trading		3,463,665			—
Increase in loans		(27,552,782		)	(21,627,480		)
Net cash disbursed in business combination		—			(1,229,598		)
Purchase of Bank Owned Life Insurance		—			(3,500,000		)
Purchase of property and equipment		(132,284		)	(3,270,783		)
Net cash used in investing activities		(38,770,127		)	(21,035,426		)
Cash flows from financing activities:
Increase (decrease) in deposit accounts		(1,640,429		)	22,288,205
Increase in securities sold under agreements to repurchase		7,226,820			4,527,350
Decrease in other borrowings		(24,872		)	(53,687
Advances from the Federal Home Loan Bank		45,000,000			9,000,000
Repayment of Advances from the Federal Home Loan Bank		(23,012,948		)	(18,091,649		)
Advances from FHLB, fair value option		1,500,000			—
Proceeds from exercise of stock options		714,922			843,915
Cash dividends paid		(648,316		)	(512,582		)
Purchase of common stock		(1,791,461		)	(973,861		)
Dividend reinvestment plan		135,926			114,196
Net cash provided from financing activities		27,459,642			17,141,887
Net increase (decrease) in cash and cash equivalents		(6,916,589		)	486,293
Cash and cash equivalents at beginning of period		27,814,971			12,864,146
Cash and cash equivalents at end of period		$	20,898,382		$	13,350,439
Supplemental disclosure:
Cash paid during the period for:
Interest		$	10,673,161		$	8,527,288
Taxes		$	250,000		$	472,647
Non-cash investing and financing activities:
Unrealized gain (loss) on securities available-for-sale		$	337,868		$	1,925,786

 

8

 

Notes to Consolidated Financial Statements

 

Note 1 - Basis of Presentation

 

In the opinion of management, the accompanying unaudited consolidated balance sheets, the consolidated statements of income, the consolidated statements of changes in shareholders’ equity, and the consolidated statements of cash flows of First Community Corporation (“the Company”) present fairly in all material respects the Company’s financial position at September 30, 2007 and December 31, 2006, the Company’s results of operations for the nine and three months ended September 30, 2007 and 2006, and the Company’s cash flows for the nine and  three months ended September 30, 2007 and 2006. The results of operations for the nine and three months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.

 

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 2006 Annual Report on Form 10-K should be referred to in connection with these unaudited interim financial statements.

 

The Company is not an accelerated filer as defined in Rule 12b-2 of the Exchange Act.  As a result, the Company qualifies for the extended compliance period with respect to the accountants report on management’s assessment of internal control over financial reporting and management’s annual report on internal control over financial reporting required by PCAOB Auditing Standards No. 5.

 

Note 2 – Earnings Per Share

 

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

 

		Nine months ended September 30,						Three months ended September 30,
		2007			2006			2007			2006
Numerator (Included in basic and diluted earnings per share)		$	2,766,762		$	2,640,513		$	1,148,096		$	902,906
Denominator
Weighted average common shares
Outstanding for:
Basic earnings per share		3,240,665			3,041,824			3,237,183			3,267,820
Dilutive securities:
Stock options - Treasury
Stock method		54,061			96,075			44,574			94,097
Diluted earnings per share		3,294,726			3,137,899			3,281,757			3,361,917
The average market price used in calculating assumed number of Shares		$	16.65		$	18.06		$	15.94		$	17.99

 

Note 3 –SFAS No. 159 (“SFAS 159”) “The Fair Value Option for Financial assets and Financial Liabilities”

 

The Company adopted the provisions of SFAS 159 effective January 1, 2007 which became effective in February 2007. SFAS 159 generally permits the measurement of selected eligible financial instruments at fair value at specified election dates. This election can generally be applied on an instrument by instrument basis. As a result of adopting SFAS 159, the Company reduced retained earnings and accumulated other comprehensive loss as of January 1, 2007 by $559,678. This amount represents the unrealized loss net of tax on the securities that were reclassified from “available for sale” to “trading” securities under SFAS 159.

 

9

 

The following summarizes the effect of reclassifying the securities as of January 1, 2007.

 

		Amortized Cost			Unrealized Loss			Fair Value
Available-for-sale securities (1)		$	4,258,774		$	861,044		$	3,397,730
Deferred tax effect of unrealized loss					$	301,366
Cumulative effect adjustment (reclassification from accumulated other comprehensive loss and charge to retained earnings)					$	559,678

 

(1)

The investments were carried at fair value, in the available-for-sale portfolio, on the balance sheet prior to adoption. Therefore, there was no effect on the net carrying value at January 1, 2007.

 

Following the initial measurement date, ongoing unrealized gains or losses on these securities as well as other financial instruments for which fair value reporting is elected are reported in earnings at each subsequent reporting date. The securities selected to be accounted for under the fair value option were all of the Company’s structured corporate bonds that did not contain an interest rate floor. These securities were selected as the coupons on these bonds had decreased to a minimal level. By reclassifying these securities the Company is positioned to improve net interest income and the net interest margin on this segment of its investment portfolio.

 

In connection with the adoption of SFAS 159, the Company was required to adopt SFAS No. 157, “Fair Value Measurement” (“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The following table summarizes quantitative disclosures about the fair value measurement for each category of assets and liabilities carried at fair value as of September 30, 2007.

 

Description		September  30, 2007			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Trading securities		$	2,978,441		$	—		$	2,978,441		$	—
Available for sale securities		172,983,980			933,937			171,540,756			509,287
Interest rate cap/floor		343,471			—			—			343,471
Federal Home Loan Bank Advance		(1,519,799		)	—						(1,519,799		)
Total		$	174,786,093		$	933,937		$	174,519,197		$	(667,041	)

 

10

 

The following tables reflect the changes in fair values for the nine and three month periods ended September 30, 2007 and where these changes are included in the income statement.

 

		Changes in Fair Values for the nine month period ended, September 30, 2007
Description		Gain (loss) on sale of securities			Non-interest income - Other			Total changes in Fair Values included in current earnings
Trading securities		$	69,405		$	28,047		$	97,452
Interest rate cap/floor					37,544			37,544
Federal Home Loan Bank Advance					(19,798		)	(19,798		)
Total		$	69,405		$	45,793		$	115,198

 

		Changes in Fair Values for the three month period ended, September 30, 2007
Description		Gain (loss) on sale of securities			Non-interest income - Other			Total changes in Fair Values included in current earnings
Trading securities		$	—		$	64,991		$	64,991
Interest rate cap/floor					92,008			92,008
Federal Home Loan Bank Advance					(18,838		)	(18,838		)
Total		$	—		$	138,161		$	138,161

 

Note 4 - Recently Issued Accounting Pronouncements

 

The following is a summary of recent authoritative pronouncements that could impact the accounting, reporting, and or disclosure of financial information by the Company.

 

In July 2006, the FASB issued FASB Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in enterprises’ financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company’s adoption of FIN 48, effective January 1, 2007, did not a material impact on its financial position, results of operations or cash flows.

 

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.”  SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This standard does not require any new fair value measurements, but rather eliminates inconsistencies found in various prior pronouncements. SFAS 157 is effective for the Company on January 1, 2008. In conjunction with the early adoption of SFAS 159 described below the Company adopted the provisions of SFAS 157 effective January 1, 2007. The adoption of this pronouncement is not expected to have a significant impact on the Company’s financial statements.

 

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” (“SFAS 158”), which amends SFAS 87 and SFAS 106 to require recognition of the over funded or under funded status of pension and other postretirement benefit plans on the balance sheet. Under SFAS 158, gains and losses, prior service costs and credits, and any remaining transition amounts under SFAS 87 and SFAS 106 that have not yet been recognized through net periodic benefit cost will be recognized in accumulated other comprehensive income, net of tax effects, until they are amortized as a component of net periodic cost. The measurement date — the date at which the benefit obligation and plan assets are measured — is required to be the company’s fiscal year end. SFAS 158 is effective for publicly held companies for fiscal years ending after December 15, 2006, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. The Company does not have a defined benefit pension plan.

 

11

 

Therefore, SFAS 158 will not have an effect on the Company’s financial conditions or results of operations.

 

In September, 2006, The FASB ratified the consensuses reached by the FASB’s Emerging Issues Task Force (“EITF”) relating to EITF 06-4 “Accounting for the Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. EITF 06-4 addresses employer accounting for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods should recognize a liability for future benefits in accordance with SFAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions”, or Accounting Principles Board (“APB”) Opinion No. 12, “Omnibus Opinion—1967”. EITF 06-4 is effective for fiscal years beginning after December 15, 2007. Entities should recognize the effects of applying this Issue through either (a) a change in accounting principle through a cumulative-effect adjustment to retained earnings or to other components of equity or net assets in the statement of financial position as of the beginning of the year of adoption or (b) a change in accounting principle through retrospective application to all prior periods. The Company has reviewed the impact of EITF 06-4 and will adopt as of January 1, 2008 through a cumulative effect adjustment to retained earnings. The cumulative effect adjustment is estimated to be approximately $400,000.

 

In September 2006, the FASB ratified the consensus reached related to EITF 06-5, “Accounting for Purchases of Life Insurance—Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, Accounting for Purchases of Life Insurance.”  EITF 06-5 states that a policyholder should consider any additional amounts included in the contractual terms of the insurance policy other than the cash surrender value in determining the amount that could be realized under the insurance contract.  EITF 06-5 also states that a policyholder should determine the amount that could be realized under the life insurance contract assuming the surrender of an individual-life by individual-life policy (or certificate by certificate in a group policy). EITF 06-5 is effective for fiscal years beginning after December 15, 2006.  The adoption of EITF 06-5 does not have a material impact on its financial position, results of operations and cash flows.

 

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB Statement No. 115.”  This statement permits, but does not require, entities to measure many financial instruments at fair value.  The objective is to provide entities with an opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions.  Entities electing this option will apply it when the entity first recognizes an eligible instrument and will report unrealized gains and losses on such instruments in current earnings. This statement (1) applies to all entities, (2) specifies certain election dates, (3) can be applied on an instrument-by-instrument basis with some exceptions, (4) is irrevocable, and (5) applies only to entire instruments.  One exception is demand deposit liabilities which are explicitly excluded as qualifying for fair value.  With respect to SFAS 115, available-for-sale and held-to-maturity securities at the effective date are eligible for the fair value option at that date.  The cumulative unrealized gains and losses on those securities at the date of adoption are to be included in the cumulative-effect adjustment and thereafter, such securities are accounted for as trading securities.  SFAS 159 is effective for the Company on January 1, 2008.  Earlier adoption is permitted in 2007 if the Company also elects to apply the provisions of SFAS 157, “Fair Value Measurement.”  As of January 1, 2007, the Company elected early adoption of the provisions of SFAS 159. See Note 3 for the effect of adopting SFAS 159.

 

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 and cash flows.

 

12

 

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. These statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those projected 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,” “will,” “expect,” “anticipate,” “believe,” “intend,” “plan,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties include, but are not limited to, those described under the heading “Risk Factors” in our 2006 Annual Report on Form 10-K and the following:

•                  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;

•                  general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;

•                  changes occurring in business conditions and inflation;

•                  changes in technology;

•                  changes in deposit flows;

•                  the level of allowance for loan loss;

•                  the rate of delinquencies and amounts of charge-offs;

•                  the rates of loan growth;

•                  adverse changes in asset quality and resulting credit risk-related losses and expenses;

•                  changes in monetary and tax policies;

•                  loss of consumer confidence and economic disruptions resulting from terrorist activities;

•                  changes in the securities markets; and

•                  other risks and uncertainties detailed from time to time in our filings with the Securities and Exchange Commission.

 

We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.

 

Overview

 

The following discussion describes our results of operations for the three and nine month periods ended September 30, 2007 as compared to the three and nine month periods ended September 30, 2006 and also analyzes our financial condition as of September 30, 2007 as compared to December 31, 2006. 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.

 

Of course, 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 detailed discussion of this process.

 

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 also 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.

 

13

 

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 notes to our unaudited consolidated financial statements as of September 30, 2007 in this report and our notes included in the consolidated financial statements in our 2006 Annual Report on Form 10-K as filed with the Securities and Exchange Commission.

 

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.

 

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.

 

Merger Completed on June 9, 2006

 

On June 9, 2006 we consummated our acquisition of DeKalb Bankshares, Inc. (“DeKalb”), the parent company of The Bank of Camden. In addition, The Bank of Camden was merged with and into our wholly owned banking subsidiary, First Community Bank, NA, and the Camden office now operates as a branch of First Community Bank. Pursuant to the merger, we issued 364,034 shares of our common stock valued at $7.6 million and paid $2.4 million in cash to shareholders of DeKalb. Other costs related to the merger included stock options valued at $585,000 and direct acquisition cost of $277,000. Periods prior to June 9, 2006 do not include the effect of the merger and, as a result, the discussion of the three months and nine months ended June 30, 2006 reflects results from the former DeKalb after June 9, 2006. All of the information technology and operating systems for the former The Bank of Camden have subsequently been successfully integrated into the First Community Bank systems.

 

Comparison of Results of Operations for Nine Months Ended September 30, 2007 to the Nine Months Ended September 30, 2006:

 

Net Income

 

Our net income for the nine months ended September 30, 2007 was $2.8 million, or $.84 diluted earnings per share, as compared to $2.6 million, or $.84 diluted earnings per share, for the nine months ended September 30, 2006. The increase in net income is primarily due to increased net interest income as a result of an increase in the average earning assets between the two periods. Non-interest income also increased as a result of increased deposit service charges. These increases were somewhat offset by an increase in non-interest expense of  $854,000 for the nine month period ended September 30, 2007, as compared to the same period in 2006. The non-interest expense increase results primarily from several initiatives, as discussed below, in the fourth quarter of 2006 and first and third quarter of 2007. The increase in net interest income resulted from earning assets increasing on average by $38.3 million in the first nine months of 2007 as compared to the same period in 2006. Average earning assets were $430.9 million during the nine months ended September 30, 2006 as compared to $469.2 million during the nine months ended September 30, 2007. The increase in average earning assets resulted in an increase in net interest income of $737,000 in the first nine months of 2007 as compared to the first nine months of 2006. Non-interest income increased $252,000 in the first nine months of 2007 as compared to the first nine months of 2006.

 

14

 

 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, 2007 and 2006, along with average balances and the related interest income and interest expense amounts.

 

Net interest income was $11.3 million for the nine months ended September 30, 2007 as compared to $10.5 million for the nine months ended September 30, 2006. This increase was primarily due to an increase in the level of earning assets. The yield on earning assets increased by 38 basis points. We continue to make progress in changing the mix of our earning asset portfolios. The investment portfolio and short term investments represented 37.5% of the average interest earning assets in the nine months ended September 30, 2007 as compared to 43.8% during the comparable period in 2006. Since the consummation of the merger with DutchFork Bankshares in October 2004, our objective has been to increase the percentage of earning assets in the loan portfolio as compared to other earning assets. This began by restructuring the investment portfolio in late 2004 and early 2005 in order to shorten the maturity and purchase investments that provided ongoing cash flow. Yields on loans are typically higher than yields on other types of earning assets and thus one of our goals continues to be to grow the loan portfolio as a percentage of earning assets.

 

The yield on earning assets for the nine months ended September 30, 2007 and 2006 was 6.51% and 6.13%, respectively. The cost of interest-bearing liabilities during the first nine months of 2007 was 3.80% as compared to 3.23% in the same period of 2006. This increase in the yield on interest earning assets of 38 basis points while the cost of interest bearing liabilities increased 57 basis points resulted in a decrease of our net interest margin of 5 basis points. The net interest margin was 3.22% for the nine months ended September 30, 2007 as compared to 3.27% for the nine months ended September 30, 2006. On a fully taxable equivalent (“FTE”) basis, the net interest margin was 3.30% and 3.36% for the nine months ended September 30, 2007 and 2006, respectively. During much of 2006 and continuing into 2007 the yield curve was inverted. The yield curve as well as a very competitive deposit and lending environment continue to be significant contributors to the decline in the net interest margin. The higher increase in the cost of funds as compared to yield on interest earning assets is primarily due to a significant increase in our funding cost on time deposits during the two periods. Approximately 85.0% of our time deposits reprice within 12 months and as a result of increases in short term interest rates during the first six to nine months of 2006 the cost of these deposits increased 73 basis points in the first nine months of 2007 as compared to the same period in 2006. The average cost of time deposits was 4.76% in the nine months ended September 30, 2007 as compared to 4.03 % during the same period in 2006.

 

Provision and Allowance for Loan Losses

 

At September 30, 2007, the allowance for loan losses was $3.5 million, or 1.16% of total loans, as compared to $3.2 million, or 1.17% of total loans, at December 31, 2006. Our provision for loan losses was $360,000 for the nine months ended September 30, 2007, as compared to $389,000 for the nine months ended September 30, 2006. This provision is made based on our assessment of general loan loss risk and asset quality. The allowance for loan losses represent 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 collectibility of loans, including consideration of factors such as the balance of impaired loans, the quality, mix, and size of our overall loan portfolio, economic conditions 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.

 

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. 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. 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.

 

15

 

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.

 

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.

 

At September 30, 2007, we had $542,000 in loans delinquent more than 90 days and still accruing interest, and loans totaling $629,000 that were delinquent 30 days to 89 days. Due to the current loan to collateral values or other factors it is anticipated that all of the principal and interest will be collected on those loans greater than 90 days or more delinquent and still accruing interest. We had six loans in a nonaccrual status in the amount of $557,000 at September 30, 2007. Our management continuously monitors non-performing, classified and past due loans, to identify deterioration regarding the condition of these loans. We identified four loans in the amount of $188,000 that are current as to principal and interest and not included in non-performing assets that could be potential problem loans.

 

Allowance for Loan Losses		Nine Month Ended September 30,
(Dollars in thousands)		2007			2006
Average loans outstanding		$	293,478		$	242,263
Loans outstanding at period end		$	302,829		$	269,773
Non-performing assets:
Nonaccrual loans		$	557		$	46
Loans 90 days past due still accruing		542			51
Foreclosed real estate		63			50
Total non-performing loans		$	1,162		$	147
Beginning balance of allowance		$	3,215		$	2,701
Loans charged-off:
1-4 family residential mortgage		148			67
Non-residential real estate		—
Home equity		32			—
Commercial		22			44
Installment & credit card		160			127
Total loans charged-off		362			238
Recoveries:
1-4 family residential mortgage		23			2
Non-residential real estate		54			7
Home equity		4			—
Commercial		167			40
Installment & credit card		64			31
Total recoveries		312			80
Net loan charge offs		50			158
Acquired in business combination		—			320
Provision for loan losses		360			389
Balance at period end		$	3,525		$	3,252
Net charge -offs to average loans		.02		%	0.07		%
Allowance as percent of total loans		1.16		%	1.21		%
Non-performing assets as % of total assets		0.20		%	0.03		%
Allowance as % of non-performing loans		303.36		%	3,352.6		%

 

16

 

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

 

		September 30, 2007					December 31, 2006
					% of loans in					% of loans in
(Dollars in thousands)		Amount			Category		Amount			Category
Commercial, Financial and Agricultural		$	128		8.2	%	$	83		8.6	%
Real Estate – Construction		337			11.6	%	884			11.4	%
Real Estate Mortgage:
Commercial		2,238			52.6	%	1,692			50.5	%
Residential		399			17.4	%	323			17.4	%
Consumer		186			10.2	%	133			12.1	%
Unallocated		237			N/A		100			N/A
Total		$	3,525		100.0	%	$	3,215		100.0	%

 

Non-interest Income and Non-interest Expense

 

Non-interest income during the first nine months of 2007 was $3.6 million as compared to $3.4 million during the same period in 2006. During the first nine months of 2006, we realized losses on the sale of securities in the amount of $69,000. The proceeds from the sale of securities in the first quarter of 2006 were used to pay down approximately $5.0 million in a Federal Home Loan Bank advance, which resulted in a gain on the early extinguishment of debt of $159,000. These advances were acquired in the DutchFork Bankshares merger. During the first nine months of 2007, we realized gains on sale of securities in the amount of $74,000. Deposit service charges increased $197,000, or  11.1%, in the first nine months of 2007 as compared to the same period in 2006. This increase is a result of an increase in the average transaction deposit accounts between the two periods as well as adjustments in certain deposit fees in the first half of 2007. Commissions on the sale of non-deposit investment products and mortgage origination fees decreased $42,000 and $121,000 respectively. The decision to portfolio certain mortgage loans during the first nine months of 2007 accounted for approximately $75,000 in the decline in mortgage origination fees. In addition, there has been a softening of the new home sales and refinancing activity in the market during the first nine months of 2007. The fees related to the loans included in the portfolio are deferred and amortized over the life of the loans. The decline in commissions on sale of non-deposit investment products is believed to be a result of the timing and closing of transactions. Other non-interest income increased $279,000 in the first nine months of 2007 as compared to the same period in 2006. This was primarily a result of increases in  ATM/Debit card surcharge and exchange fees of approximately $145,000, increased earning on bank owned life insurance of $58,000.

 

Total non-interest expense increased by $854,000 during the nine months of 2007 as compared to the same period of 2006. During the fourth quarter of 2006 and first quarter 2007, we introduced two initiatives that impacted the results of the nine months ended September 30, 2007. We began to hire additional personnel, specifically retail bankers, in many of our offices to increase our lending capacity and to continue to focus on core deposit growth. In addition, in December 2006, we engaged a consulting firm to assist in identifying process efficiency improvements, expense control opportunities and non-interest income enhancements. From January through May 2007, we expensed these consulting engagement expenses. These two initiatives along with moving into the bank’s new administrative office in July 2006 contributed to the 8.7% increase in non-interest expense in the first nine months of 2007 as compared to the same period of 2006. Salaries and employee benefits increased $303,000 in the first nine months of 2007 as compared to the same period in 2006. This increase primarily relates to the addition of the retail bankers noted above. At September 30, 2007 we had 134 full time equivalent employees as compared to 131 at September 30, 2006. Occupancy expense increased by $223,000 to $912,000 in the first nine months of  2007 as compared to $689,000 during the same period in 2006. This increase results from the addition of the Camden office in June 2006 as well as the move into the new administrative building in July 2006. Equipment expense increased by $54,000

 

17

 

in the first nine months of 2007 as compared to the same period in 2006. This increase relates to the addition of the Camden office in June 2006 as well as the move into the new administrative center in July 2006. Marketing and public relations expense increased 51.1% from $249,000 in 2006 as compared to $376,000 in the nine months ended September 30, 2007. The increase relates to commencing a television advertising campaign during the first quarter of 2007 focusing on our lending products and capacity. The cost of producing the advertising spots was included in the first quarter 2007 results. We anticipate that the television campaign will cause advertising expenses to run approximately 55.0% above the prior year comparable periods throughout the balance of 2007. The increase in amortization of intangibles of $33,000 is a result of the acquisition of DeKalb Bankshares in June of 2006. Other expenses increased by $115,000 in the first nine months of 2007 as compared to the same period in 2006. This increase results primarily from the increase in consulting and professional fees related to the consulting engagement discussed previously. The expenses related to the consulting engagement were incurred through May 2007 and will not impact our results for the balance of 2007.

 

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

 

		Nine months ended
		September 30,
(Dollars in thousands)		2007			2006
ATM/debit card processing		$	251		$	192
Supplies		162			190
Telephone		277			288
Correspondent services		117			128
Insurance		206			187
Postage		146			121
Professional fees		678			565
Other		589			640
		$	2,426		$	2,311

 

Income Tax Expense

 

In the first nine months of 2007, we had an effective tax rate of 29.4%.as compared to 29.7% during the same period of 2006. Our effective tax rate is currently expected to remain 29.0% to 31.0% throughout the remainder of 2007.

 

Comparison of Results of Operations for Three Months Ended September 30, 2007 to the Three Months Ended September 30, 2006:

 

Net Income

 

Our net income for the third quarter of 2007 was $1.1 million or $0.35 per diluted share, as compared to $903,000, or $0.27 per diluted share during the comparable period in 2006. Net interest income increased by $158,000 for the three months ended September 30, 2007 from $3.8 million in 2006 to $3.9 million in 2007. The increase in net interest income is primarily due to an increase in the level of average earning assets. Average earning assets equaled $454.5 million during the third quarter of 2006 as compared to $483.7 million during the third quarter of 2007. 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 three month periods ended September 30, 2007 and 2006, along with average balances and the related interest income and interest expense amounts. The yield on average earning assets increased to 6.56% in the third quarter of 2007 as compared to 6.36% in the third quarter of 2006. The cost of interest bearing liabilities also increased to 3.88% in third quarter of 2007 as compared to 3.46% in the third quarter of 2006. The net interest margin was 3.21% for the three months ended September 30, 2007 and 3.27% for the three months ended September 30, 2006. On an FTE basis, we had a net interest margin of 3.29% and 3.36% for the three months ended September 30, 2007 and 2006, respectively.

 

Non-interest Income and Non-interest Expense

 

We earned $1.4 million and $1.1 million in non-interest income for the three months ended September 30, 2007 and 2006, respectively. An increase in deposit service charges of $62,000 was offset by a $56,000 decrease in mortgage origination fees. There has been a softening of new home sales and refinancing in our market area that has resulted in the lower mortgage origination fees during most recent quarter. Non interest income “Other” increased by $75,000 in the third quarter of 2007 as compared to the same period of 2006. The increase primarily relates an increase of $40,000 in ATM/Debit card surcharge

 

18