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Table of Contents

 

 

 

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 March 31, 2010

 

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)

 

South Carolina

 

57-1010751

(State of Incorporation)

 

(I.R.S. Employer Identification)

 

5455 Sunset Boulevard, Lexington, South Carolina 29072

(Address of Principal Executive Offices)

 

(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).     o 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 equity, as of the latest practicable date:  On May 13, 2010, 3,257,490 shares of the issuer’s common stock, par value $1.00 per share, were issued and outstanding.

 

 

 



Table of Contents

 

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 Changes in Shareholders’ Equity and Comprehensive Income (Loss)

5

Consolidated Statements of Cash Flows

6

Notes to Consolidated Financial Statements

7

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

20

Item 3. Quantitative and Qualitative Disclosures About Market Risk

36

Item 4. Controls and Procedures

36

 

 

PART II – OTHER INFORMATION

37

Item 1. Legal Proceedings

37

Item 1A. Risk Factors

37

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

37

Item 3. Defaults Upon Senior Securities

37

Item 4. (Removed and Reserved)

37

Item 5. Other Information

37

Item 6. Exhibits

37

 

 

INDEX TO EXHIBITS

38

SIGNATURES

38

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



Table of Contents

 

PART I

FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED BALANCE SHEETS

 

(Dollars in thousands, except par value)

 

March 31, 2010
(Unaudited)

 

December 31,
2009

 

ASSETS

 

 

 

 

 

Cash and due from banks

 

$

8,283

 

$

6,752

 

Interest-bearing bank balances

 

26,973

 

13,635

 

Federal funds sold and securities purchased under agreements to resell

 

478

 

457

 

Investment securities - available for sale

 

131,966

 

131,836

 

Investment securities - held to maturity (market value of $48,469 and $49,092 at March 31, 2010 and December 31, 2009, respectively)

 

53,685

 

56,104

 

Other investments, at cost

 

7,904

 

7,904

 

Loans

 

342,203

 

344,187

 

Less, allowance for loan losses

 

4,868

 

4,854

 

Net loans

 

337,335

 

339,333

 

Property, furniture and equipment - net

 

18,509

 

18,666

 

Bank owned life insurance

 

10,627

 

10,551

 

Other real estate owned

 

4,926

 

3,167

 

Intangible assets

 

1,347

 

1,502

 

Other assets

 

15,449

 

15,920

 

Total assets

 

$

617,482

 

$

605,827

 

LIABILITIES

 

 

 

 

 

Deposits:

 

 

 

 

 

Non-interest bearing demand

 

$

77,678

 

$

72,656

 

NOW and money market accounts

 

113,234

 

104,659

 

Savings

 

28,408

 

25,757

 

Time deposits less than $100,000

 

158,451

 

156,422

 

Time deposits $100,000 and over

 

87,429

 

90,082

 

Total deposits

 

465,200

 

449,576

 

Securities sold under agreements to repurchase

 

19,453

 

20,676

 

Federal Home Loan Bank advances

 

70,072

 

73,326

 

Junior subordinated debt

 

15,464

 

15,464

 

Other borrowed money

 

137

 

164

 

Other liabilities

 

4,791

 

5,181

 

Total liabilities

 

575,117

 

564,387

 

SHAREHOLDERS’ EQUITY

 

 

 

 

 

Preferred stock, par value $1.00 per share, 10,000,000 shares authorized; 11,350 issued and outstanding

 

10,963

 

10,939

 

Common stock, par value $1.00 per share; 10,000,000 shares authorized; issued and outstanding 3,257,490 at March 31, 2010 and 3,252,358 at December 31, 2009

 

3,258

 

3,252

 

Common stock warrants issued

 

509

 

509

 

Nonvested restricted stock

 

(53

)

(79

)

Additional paid in capital

 

48,897

 

48,873

 

Retained earnings (deficit)

 

(20,109

)

(20,401

)

Accumulated other comprehensive income (loss)

 

(1,100

)

(1,653

)

Total shareholders’ equity

 

42,365

 

41,440

 

Total liabilities and shareholders’ equity

 

$

617,482

 

$

605,827

 

 

3



Table of Contents

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

 

 

 

Three Months ended March 31,

 

(Dollars in thousands, except per share amounts)

 

2010

 

2009

 

Interest and dividend income:

 

 

 

 

 

Loans, including fees

 

$

5,050

 

$

4,963

 

Taxable securities

 

2,016

 

2,851

 

Non-taxable securities

 

71

 

90

 

Federal funds sold and securities purchased under resale agreements

 

9

 

5

 

Other

 

9

 

10

 

Total interest income

 

7,155

 

7,919

 

Interest expense:

 

 

 

 

 

Deposits

 

1,671

 

2,476

 

Federal funds sold and securities sold under agreement to repurchase

 

21

 

29

 

Other borrowed money

 

756

 

1,104

 

Total interest expense

 

2,448

 

3,609

 

Net interest income

 

4,707

 

4,310

 

Provision for loan losses

 

550

 

451

 

Net interest income after provision for loan losses

 

4,157

 

3,859

 

Non-interest income:

 

 

 

 

 

Deposit service charges

 

485

 

556

 

Mortgage origination fees

 

124

 

217

 

Commissions on sale of non-deposit investment products

 

174

 

149

 

Gain (loss) on sale of securities

 

2

 

354

 

Other-than-temporary-impairment write-down on securities

 

(143

)

(657

)

Fair value adjustment gains (losses)

 

(196

)

21

 

Other

 

376

 

408

 

Total non-interest income

 

822

 

1,048

 

Non-interest expense:

 

 

 

 

 

Salaries and employee benefits

 

2,127

 

2,013

 

Occupancy

 

314

 

300

 

Equipment

 

288

 

319

 

Marketing and public relations

 

91

 

107

 

FDIC Assessment

 

204

 

121

 

Amortization of intangibles

 

155

 

155

 

Other

 

1,007

 

1,009

 

Total non-interest expense

 

4,186

 

4,024

 

Net income before tax

 

793

 

883

 

Income taxes

 

204

 

311

 

Net income

 

$

589

 

$

572

 

Preferred stock dividends, including discount accretion

 

166

 

164

 

Net income available to common shareholders

 

$

423

 

$

408

 

 

 

 

 

 

 

Basic earnings per common share

 

$

0.13

 

$

0.13

 

Diluted earnings per common share

 

$

0.13

 

$

0.13

 

Dividends declared per common share

 

$

0.04

 

$

0.08

 

 

4


 


Table of Contents

 

FIRST COMMUNITY CORPORATION

Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income

Three Months ended March 31, 2010 and March 31, 2009

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Common

 

 

 

Common

 

Additional

 

Nonvested

 

Retained

 

Other

 

 

 

 

 

Preferred

 

Shares

 

Common

 

Stock

 

Paid-in

 

Restricted

 

Earnings

 

Comprehensive

 

 

 

(Dollars in thousands)

 

Stock

 

Issued

 

Stock

 

Warrants

 

Capital

 

Stock

 

(Deficit)

 

Income (loss)

 

Total

 

Balance December 31, 2009

 

$

10,939

 

3,252

 

$

3,252

 

$

509

 

$

48,873

 

$

(79

)

$

(20,401

)

$

(1,653

)

$

41,440

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

589

 

 

 

589

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain arising during period on available-for-sale securities net of tax expense of $259

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

480

 

 

 

Reclassification adjustment for Other-than-temporary-Impairment included in income net of tax benefit of $39

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

73

 

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

553

 

553

 

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,142

 

Amortization of compensation on restricted stock

 

 

 

 

 

 

 

 

 

 

26

 

 

 

 

 

26

 

Dividends: Common  ($0.04 per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

(131

)

 

 

(131

)

Preferred

 

24

 

 

 

 

 

 

 

 

 

 

 

(166

)

 

 

(142

)

Dividend reinvestment plan

 

 

 

6

 

6

 

 

 

24

 

 

 

 

 

 

 

30

 

Balance, March  31, 2010

 

$

10,963

 

3,258

 

$

3,258

 

$

509

 

$

48,897

 

$

(53

)

$

(20,109

)

$

(1,100

)

42,365

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, December 31, 2008

 

$

10,850

 

3,227

 

$

3,227

 

$

509

 

$

48,732

 

$

(186

)

$

6,263

 

$

(1,239

)

$

68,156

 

Comprehensive Income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

 

 

 

 

 

 

 

 

 

 

 

572

 

 

 

572

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain arising during period on available-for-sale securities net of tax expense of $143

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

264

 

 

 

Unrealized market loss on held-to-maturity securities (net of $404 tax benefit)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(750

)

 

 

Less: reclassification adjustment for gain included in net income, net of tax expense of $65

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(125

)

 

 

Other comprehensive loss

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(611

)

(611

)

Comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(39

)

Amortization of compensation on restricted stock

 

 

 

 

 

 

 

 

 

 

26

 

 

 

 

 

26

 

Dividends: Common  ($0.08 per share)

 

 

 

 

 

 

 

 

 

 

 

 

 

(258

)

 

 

(258

)

Preferred

 

22

 

 

 

 

 

 

 

 

 

 

 

(164

)

 

 

(142

)

Dividend reinvestment plan

 

 

 

9

 

9

 

 

 

46

 

 

 

 

 

 

 

55

 

Balance, March  31, 2009

 

$

10,872

 

3,236

 

$

3,236

 

$

509

 

$

48,778

 

$

(160

)

$

6,413

 

$

(1,850

)

67,798

 

 

5



Table of Contents

 

FIRST COMMUNITY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

 

Three Months ended March 31,

 

(Dollars in thousands)

 

2010

 

2009

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

589

 

$

572

 

Adjustments to reconcile net income to net cash provided (used) in operating activities:

 

 

 

 

 

Depreciation

 

229

 

249

 

Premium amortization (discount accretion)

 

272

 

(43

)

Provision for loan losses

 

550

 

451

 

Amortization of intangibles

 

155

 

155

 

Gain on sale of securities

 

(2

)

(354

)

Other-than-temporary-impairment on securities

 

143

 

657

 

Net (increase) decrease in fair value option instruments and derivatives

 

196

 

(21

)

(Increase) decrease in other assets

 

116

 

428

 

Increase (decrease) in other liabilities

 

(390

)

(304

)

Net cash provided in operating activities

 

1,858

 

1,790

 

Cash flows from investing activities:

 

 

 

 

 

Purchase of investment securities available-for-sale

 

(13,746

)

(17,424

)

Maturity of investment securities available-for-sale

 

14,148

 

16,115

 

Proceeds from sale of securities available-for-sale

 

2

 

11,187

 

Maturity of investment securities held-to-maturity

 

2,381

 

2,972

 

Maturity of securities held-for-trading

 

 

166

 

Decrease (increase) in loans

 

(520

)

1,097

 

Purchase of property and equipment

 

(72

)

(175

)

Net cash provided in investing activities

 

2,193

 

13,938

 

Cash flows provided from financing activities:

 

 

 

 

 

Increase in deposit accounts

 

15,610

 

9,426

 

Increase (decrease) in securities sold under agreements to repurchase

 

(1,223

)

175

 

Decrease in other borrowings

 

(27

)

(31

)

Advances from the FHLB

 

 

4,000

 

Repayment of advances FHLB

 

(3,254

)

(9,254

)

Dividends paid: Common Stock

 

(131

)

(258

)

Preferred Stock

 

(166

)

(142

)

Dividend reinvestment plan

 

30

 

55

 

Net cash provided from financing activities

 

10,839

 

3,971

 

Net increase in cash and cash equivalents

 

14,890

 

19,699

 

Cash and cash equivalents at beginning of period

 

20,844

 

12,367

 

Cash and cash equivalents at end of period

 

35,734

 

32,066

 

Supplemental disclosure:

 

 

 

 

 

Cash paid during the period for:

 

 

 

 

 

Interest

 

$

2,602

 

$

3,695

 

Income taxes

 

$

 

$

350

 

Non-cash investing and financing activities:

 

 

 

 

 

Unrealized gain (loss) on securities

 

$

554

 

$

(925

)

Transfer of loans to foreclosed property

 

$

1,972

 

$

681

 

 

6



Table of Contents

 

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 March 31, 2010 and December 31, 2009, the Company’s results of operations for the three months ended March 31, 2010 and 2009, and the Company’s cash flows for the three months ended March 31, 2010 and 2009. The results of operations for the three months ended March 31, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010.

 

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 2009 Annual Report on Form 10-K should be referred to in connection with these unaudited interim financial statements.

 

Note 2 — Earnings Per Share

 

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

 

(In thousands except average market price)

 

 

 

Three months

 

 

 

ended March 31,

 

 

 

2010

 

2009

 

Numerator (Net income available to common shareholders)

 

$

423

 

$

408

 

Denominator

 

 

 

 

 

Weighted average common shares outstanding for:

 

 

 

 

 

Basic earnings per share

 

3,238

 

3,231

 

Dilutive securities:

 

 

 

 

 

Stock options — Treasury stock method

 

 

 

Diluted earnings per share

 

3,238

 

3,231

 

The average market price used in calculating assumed number of shares

 

$

6.19

 

$

6.56

 

 

At March 31, 2010 there were 190,256 outstanding options at an average exercise price of $13.28 and warrants for 196,000 shares at $8.69.  None of the options or warrants have an exercise price below the average market price of $6.19 for the three-month period ended March 31, 2010 and therefore are not deemed to be dilutive.

 

Note 3 —Assets and Liabilities Measured at Fair Value

 

In connection with the adoption of the Fair Value Option, the company adopted the requirements of the FASB ASC Fair Value Measurement Topic which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  Fair value is defined 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. The Fair Value Measurement Topic 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:

 

7



Table of Contents

 

Note 3 —Assets and Liabilities Measured at Fair Value - continued

 

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.

 

Following is a description of valuation methodologies used for assets and liabilities recorded at fair value on a recurring basis:

 

Investment Securities Available for Sale: 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 or by dealers or brokers in active over-the-counter markets.  Level 2 securities include mortgage-backed securities issued both issued by government sponsored enterprises and private label mortgage-backed securities.  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.

 

Investment Securities Held-to-Maturity: Investment securities that are held-to-maturity and considered other-than-temporarily-impaired are recorded at fair value in accordance with the FASB ASC Topic on “Investments- Debt and Equity Securities” on a non recurring basis.  If the Company does not expect to recover the entire amortized cost basis of the security, other-than-temporary-impairment (OTTI) is considered to have occurred.  See Note 4 for determining allocation between current earnings and comprehensive income.  Measurement is 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 2 securities include private label mortgage-backed securities.  Generally these fair values are priced from established pricing models.

 

Loans: Loans that are considered impaired are recorded at fair value on a non-recurring basis.  Once a loan is considered impaired measurement is based upon FASB ASC 310-10-35 “Loan Impairment”.  The fair value is estimated using one of several methods, including collateral liquidation value, market value of similar debt and discounted cash flows.  Those impaired loans not requiring a specific charge against the allowance represent loans for which the fair value of the expected repayments or collateral meet or exceed the recorded investment in the loan.  At March 31, 2010, substantially all of the total impaired loans were evaluated based on the fair value of the underlying collateral.  When the Company records the fair value based upon a current appraisal the fair value measurement is considered when a current appraisal is not available or there is estimated further impairment the measurement is considered a Level 3 measurement.

 

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.  When the OREO value is based upon a current appraisal or when a current appraisal is not available or there is estimated further impairment the measurement is considered a Level 3 measurement.

 

Derivative Financial Instruments:  Interest rate swaps and interest rate caps are carried at fair value and measured on a recurring basis. The measurement is based on valuation techniques including discounted cash flows analysis for each derivative.  The analysis reflects the contractual remaining term of derivative, interest rates,

 

8



Table of Contents

 

Note 3 —Assets and Liabilities Measured at Fair Value - continued

 

volatility and expected cash payments.  The measurement of the interest rate swap and cap are considered to be a Level 3 measurement.

 

Goodwill and Other Intangible Assets:  Goodwill and other intangible assets are measured for impairment on an annual basis, as of September 30th, or more frequently if there is a change in circumstances.  If the goodwill or other intangibles exceed the fair value, an impairment charge is recorded in an amount equal to the excess.  Impairment is tested utilizing accepted valuation techniques utilizing discounted cash flows of the business unit, and implied fair value based on a multiple of earnings and tangible book value for merger transactions.  The measurement of these fair values is considered a Level 3 measurement.  The goodwill impairment test as of September 30, 2009, reflected impairment in the amount of $27.8 million, and, as a result, the balance of goodwill was written off as of that date.

 

Federal Home Loan Bank Advances:  Certain Federal Home Loan Bank advances are accounted for in accordance with the provisions of the Fair Value Option Topic.  The fair value is calculated on a recurring basis using a discounted cash flow model based on current rate for advances with similar remaining terms.  The measurement of these advances is considered Level 3 measurement.

 

The following tables reflect the changes in fair values for the three-month periods ended March 31, 2010 and 2009 and where these changes are included in the income statement:

 

(Dollars in thousands)

March 31, 2010

 

Description

 

Non-interest income:
Fair value
adjustment
gain (loss)

 

Total

 

Interest rate cap/swap

 

$

(196

)

$

(196

)

Total

 

$

(196

)

$

(196

)

 

(Dollars in thousands)

March 31, 2009

 

Description

 

Non-interest income:
Fair value
adjustment
gain (loss)

 

Total

 

Trading securities

 

$

21

 

$

21

 

Interest rate cap/floor

 

(11

)

(11

)

Federal Home Loan Bank Advance

 

11

 

11

 

Total

 

$

21

 

$

21

 

 

9



Table of Contents

 

Note 3 —Assets and Liabilities Measured at Fair Value - continued

 

The following table summarizes quantitative disclosures about the fair value for each category of assets carried at fair value as of March 31, 2010 and December 31, 2009 that are measured on a recurring basis.

 

(Dollars in thousands)

 

Description

 

March 31,
2010

 

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

 

5,540

 

 

 

5,540

 

 

 

Mortgage backed securities

 

88,323

 

 

 

88,323

 

 

 

Small Business Administration securities

 

17,285

 

 

 

17,285

 

 

 

State and local government

 

8,234

 

 

 

8,234

 

 

 

Corporate and other securities

 

12,584

 

1,266

 

5,538

 

5,780

 

 

 

131,966

 

1,266

 

124,920

 

5,780

 

 

 

 

 

 

 

 

 

 

 

Interest rate cap/swap

 

(643

)

 

 

(643

)

Total

 

$

131,323

 

$

1,266

 

$

124,920

 

$

5,137

 

 

(Dollars in thousands)

 

Description

 

December
31, 2009

 

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

 

7,718

 

 

 

7,718

 

 

 

Mortgage backed securities

 

94,124

 

 

 

94,124

 

 

 

Small Business Administration securities

 

9,408

 

 

 

9,408

 

 

 

State and local government

 

8,179

 

 

 

8,179

 

 

 

Corporate and other securities

 

12,407

 

1,215

 

5,412

 

5,780

 

 

 

131,836

 

1,215

 

124,841

 

5,780

 

 

 

 

 

 

 

 

 

 

 

Interest rate cap/floor

 

(535

)

 

 

(535

)

Total

 

$

131,301

 

$

1,215

 

$

124,841

 

$

5,245

 

 

10



Table of Contents

 

Note 3 —Assets and Liabilities Measured at Fair Value - continued

 

The following table reconciles the changes in Level 3 financial instruments for the three months ended March 31, 2010, that are measured on a recurring basis.

 

 

 

Available
for
Sale
securities

 

Interest rate
Cap/Floor

 

Beginning Balance, December 31, 2009

 

$

5,780

 

$

(535

)

 

 

 

 

 

 

 

 

Gain (loss) recognized

 

 

 

(196

)

Payment

 

 

88

 

Ending Balance, March 31, 2010

 

$

5,780

 

$

(643

)

 

The following table summarizes quantitative disclosures about the fair value for each category of assets carried at fair value as of March 31, 2010 that are measured on a non-recurring basis.  Other intangible assets are measured on a non-recurring basis at least annually.  The valuation is performed each year at September 30.

 

(Dollars in thousands)

 

Description

 

March
31, 2010

 

Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Impaired loans

 

$

5,602

 

$

 

$

5,602

 

 

Held-to-Maturity securities (OTTI)

 

2,396

 

 

2,396

 

 

Other real estate owned

 

4,926

 

 

4,926

 

 

Total

 

$

12,924

 

$

 

$

12,924

 

 

 

11



Table of Contents

 

Note 4—Investment Securities

 

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

 

HELD-TO-MATURITY:

 

(Dollars in thousands)

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

March 31, 2010:

 

 

 

 

 

 

 

 

 

State and local government

 

$

2,711

 

$

84

 

$

 

$

2,795

 

Mortgage-backed securities

 

50,914

 

399

 

5,698

 

45,615

 

Other

 

60

 

 

1

 

59

 

 

 

$

53,685

 

$

483

 

$

5,699

 

$

48,469

 

 

(Dollars in thousands)

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

December 31, 2009:

 

 

 

 

 

 

 

 

 

State and local government

 

$

2,711

 

$

94

 

$

 

$

2,805

 

Mortgage-backed securities

 

53,333

 

389

 

7,492

 

46,230

 

Other

 

60

 

 

3-

 

57

 

 

 

$

56,104

 

$

483

 

$

7,495

 

$

49,092

 

 

AVAILABLE-FOR-SALE:

 

(Dollars in thousands)

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

March 31, 2010:

 

 

 

 

 

 

 

 

 

Government sponsored enterprises

 

5,500

 

40

 

 

5,540

 

Small business Administration pools

 

17,189

 

121

 

25

 

17,285

 

Mortgage-backed securities

 

86,997

 

2,405

 

1,079

 

88,323

 

State and local government

 

8,103

 

157

 

26

 

8,234

 

Corporate and other securities

 

14,258

 

457

 

2,131

 

12,584

 

 

 

$

132,047

 

$

3,180

 

$

3,261

 

$

131,966

 

 

(Dollars in thousands)

 

Amortized
Cost

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

December 31, 2009:

 

 

 

 

 

 

 

 

 

Government sponsored enterprises

 

7,682

 

50

 

14

 

7,718

 

Small business Administration pools

 

9,354

 

74

 

20

 

9,408

 

Mortgage-backed securities

 

93,131

 

2,096

 

1,103

 

94,124

 

State and local government

 

8,106

 

123

 

50

 

8,179

 

Corporate and other securities

 

14,495

 

361

 

2,449

 

12,407

 

 

 

$

132,768

 

$

2,704

 

$

3,636

 

$

131,836

 

 

During the three months ended March 31, 2010 and March 31, 2009, the Company received proceeds of $2,000 and $11,187, respectively, from the sale of investment securities available-for-sale, amounting to gains of $2,000 and $354,000 in earnings for each respective period.

 

As prescribed by FASB ASC 320-10-35 for the quarter ended March 31, 2010, the Company recognized the credit component of an other-than-temporary impairment (OTTI) of its debt securities in earnings and the non-credit component in other comprehensive income (OCI) for those securities in which the Company does not intend to sell the security and it is more likely than not the Company will not be required to sell the securities prior to recovery.

 

12



Table of Contents

 

Note 4—Investment Securities — continued

 

At March 31, 2010 corporate and other securities available-for-sale included the following at fair value: corporate bonds at $6.5 million, corporate debt obligations (“CDOs”) of $4.8 million, mutual funds at $878,000 and Federal Home Loan Mortgage Corporation preferred stock of $388,000.  At December 31, 2009 corporate and other securities available-for-sale included the following at fair value: corporate bonds at $6.3 million, CDOs of $4.9 million, mutual funds at $865,000 and Federal Home Loan Mortgage Corporation preferred stock of $348,000.

 

During the three months ended March 31, 2010 and March 31, 2009, the Company recorded other-than-temporary impairment losses on held-to-maturity and available-for-sale securities as follows:

 

(Dollars in thousands)

 

 

 

Three months ended March 31,
2010

 

Three months ended March 31,
2009

 

 

 

Held-to-
maturity
mortgage-
backed
securities

 

Available-
for-sale
securities

 

Total

 

Held-to-
maturity
mortgage-
backed
securities

 

Available-
for-sale
securities

 

Total

 

Total OTTI charge realized and unrealized

 

$

28

 

$

115

 

$

143

 

$

1,301

 

$

510

 

$

1,811

 

OTTI recognized in other comprehensive income (non-credit component)

 

 

 

 

 

$

1,154

 

 

$

1,154

 

Net impairment losses recognized in earnings (credit component)

 

$

28

 

$

115

 

$

143

 

$

147

 

$

510

 

$

657

 

 

During 2010, an other than temporary impairment occurred of which only a portion was attributed to credit loss and recognized in earnings.  The remainder was reported in other comprehensive income.  The following is an analysis of amounts relating to credit losses on debt securities recognized in earnings during the three months ended March 31, 2010 and March 31, 2009.

 

(Dollars in thousands)

 

 

 

2010

 

2009

 

 

 

Available for

 

Held to

 

Held to

 

 

 

Sale

 

maturity

 

maturity

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

$

165

 

$

326

 

 

 

 

 

 

 

 

 

 

Other-than-temporary-impairment not previously recognized

 

115

 

 

147

 

 

 

 

 

 

 

 

 

Additional increase for which an other-than-temporary impairment was previously recognized related to credit losses

 

 

28

 

 

Realized losses during the period

 

(73

)

 

 

Balance related to credit losses on debt securities at end of period

 

$

207

 

$

354

 

$

147

 

 

13



Table of Contents

 

Note 4—Investment Securities - continued

 

As of March 31, 2010, those debt securities with OTTI in which only the amount of loss related to credit was recognized in earnings consisted of two non-agency mortgage backed securities.  The Company uses a third party to obtain information about the structure in order to determine how the underlying cash flows will be distributed to each security.  Relevant assumptions such as prepayment rate, default rate and loss severity on a loan level basis are used in determining the expected recovery of the remaining unrealized losses.  The average prepayment rate, default rate and severity used in the valuations were approximately 11%, 5%, and 53%, respectively.

 

The following table shows 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 March 31, 2010 and December 31, 2009.

 

March 31, 2010

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

(Dollars in thousands)

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

US Treasury and Government sponsored enterprises

 

$

 

$

 

$

 

$

 

$

 

$

 

Government Sponsored Enterprise mortgage-backed securities

 

5,802

 

40

 

 

 

5,802

 

40

 

Small Business Administration Pools

 

2,481

 

25

 

 

 

 

 

2,481

 

25

 

Non-agency mortgage-backed securities

 

862

 

224

 

7054

 

815

 

7,916

 

1,039

 

Corporate bonds

 

780

 

49

 

7,210

 

2,082

 

7,990

 

2,131

 

State and local government

 

1,003

 

26

 

 

 

1,003

 

26

 

 

 

10,928

 

364

 

14,264

 

2,897

 

25,192

 

3,261

 

Held-to-maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-agency mortgage-backed securities

 

2,110

 

484

 

40,535

 

5,214

 

42,645

 

5,698

 

Other

 

50

 

1

 

 

 

50

 

1

 

 

 

2,160

 

485

 

40,535

 

5,214

 

42,695

 

5,699

 

Total

 

$

13,088

 

$

849

 

$

54,799

 

$

8,111

 

$

67,887

 

$

8,960

 

 

December 31, 2009

 

 

 

Less than 12 months

 

12 months or more

 

Total

 

(Dollars in thousands)

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Fair Value

 

Unrealized
Loss

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

US Treasury and Government sponsored enterprises

 

$

1,486

 

$

14

 

$

 

$

 

$

1,486

 

$

14

 

Government Sponsored Enterprise mortgage-backed securities

 

16,577

 

142

 

 

 

16,577

 

142

 

Small Business Administration pools

 

3,430

 

20

 

 

 

3,430

 

20

 

Non-agency mortgage-backed securities

 

472

 

130

 

7,880

 

831

 

8,352

 

961

 

Corporate bonds and other

 

2,033

 

247

 

8,191

 

2,202

 

10,224

 

2,449

 

State and local government

 

3,626

 

50

 

 

 

3,626

 

50

 

 

 

27,624

 

603

 

16,071

 

3,033

 

43,695

 

3,636

 

Held-to-maturity securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-agency mortgage-backed securities

 

5,135

 

1,364

 

35,882

 

6,128

 

41,017

 

7,492

 

Other

 

57

 

3

 

 

 

57

 

3

 

 

 

5,192

 

1,367

 

35,882

 

6,128

 

41,074

 

7,495

 

Total

 

$

32,816

 

$

1,970

 

$

51,953

 

$

9,161

 

$

84,769

 

$

11,131

 

 

14



Table of Contents

 

Note 4—Investment Securities — continued

 

Government Sponsored Enterprise, Mortgage-Backed Securities: Beginning in 2008 and continuing through 2009 and into 2010 the bond markets and many institutional holders of bonds have come under a great deal of stress partially as a result of increasing delinquencies in the sub-prime mortgage lending market. At March 31, 2010, First Community Bank, N.A. (the “Bank”) owns mortgage-backed securities (MBSs) including collateralized mortgage obligations (CMOs) with a book value of $77.0 million and approximate fair value of $79.4 million issued by government sponsored entities (GSEs). Current economic conditions have impacted MBSs issued by GSEs such as FHLMC and FNMA. These entities have experienced increasing delinquencies in the underlying loans that make up the MBSs and CMOs. As of March 31, 2010 and December 31, 2009, all of the MBSs issued by GSEs are classified as “Available for Sale“. Unrealized losses on 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 has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2010.

 

Non-agency mortgage —backed securities: The Company also holds private label mortgage-backed securities (PLMBSs) including CMOs at March 31, 2010 with an amortized cost of $62.6 million and approximate fair value of $54.6 million. Although these are not classified as sub-prime obligations or considered the “high risk” tranches, the majority of “structured” investments within all credit markets have been impacted by volatility and credit concerns and economic stresses throughout 2008 and continuing into 2009 and 2010. The result has been that the market for these investments has become less liquid and the spread as compared to alternative investments has widened dramatically. During the second quarter of 2008, the Company implemented a leverage strategy whereby we acquired approximately $63.2 million in certain non-agency MBSs and CMOs. All of the mortgage assets acquired in this transaction were classified as prime or ALT-A securities and represented the senior or super-senior tranches of the securities. The assets acquired as part of this strategy were classified as held-to-maturity in the investment portfolio. Due to the significant spreads on these securities they were all purchased at discounts. A detailed analysis of each of the CMO pools included in this leverage transaction as well as privately held CMOs held previously in the available-for-sale portfolio have been analyzed by reviewing underlying loan delinquencies, collateral value and resulting credit support. These securities have continued to experience increasing delinquencies in the underlying loans that make up the MBSs and CMOs. Management monitors each of these pools on a quarterly basis to identify any deterioration in the credit quality, collateral values and credit support underlying the investments.

 

During the quarter ended March 31, 2010, the Company identified four PLMBS with a fair value of $3.3 million that it considers other-than-temporarily-impaired.  As prescribed by FASB ASC 320-10-65, the Company has recognized an impairment charge in earnings of $75,500 and no impairment charge during the first quarter of 2010 through other comprehensive income.  The $75,500 represents the estimated credit losses on these securities for the quarter ended March 31, 2010.  The credit losses were estimated by projecting the expected cash flows estimating prepayment speeds, increasing defaults and collateral loss severities.  The credit loss portion of the impairment charge represents the difference between the present value of the expected cash flows and the amortized cost basis of the securities.    The Company does not intend to sell these securities and it is more likely than not that the Company will not be required to sell these securities before recovery of its amortized cost.

 

It is expected that the PLMBS portfolio will not be settled at a price less than the amortized cost of the Company’s investment. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider the remaining balance of these investments to be other-than-temporarily impaired at March 31, 2010.

 

15



Table of Contents

 

Note 4—Investment Securities - continued

 

The following table summarizes as of March 31, 2010 the number of CUSIPs, par value, carrying value and fair value of the non-agency mortgage-backed/CMOs securities by credit rating. The credit rating reflects the lowest credit rating by any major rating agency.  All non-agency mortgage-backed /CMO securities are in the super senior or senior tranche.

 

(Dollars in thousands)

 

Credit
Rating

 

Number
of
CUSIPs

 

Par
Value

 

Amortized
Cost

 

Fair
Value

 

AAA

 

17

 

$

9,732

 

$

9,120

 

$

9,131

 

AA1

 

1

 

2,694

 

2,595

 

2,110

 

AA

 

2

 

4,848

 

4,678

 

4,559

 

A1

 

1

 

3,873

 

3,642

 

3,523

 

A3

 

1

 

414

 

414

 

411

 

BAA1

 

1

 

466

 

583

 

466

 

Below Investment Grade

 

19

 

45,469

 

41,556

 

34,363

 

Total

 

42

 

$

67,496

 

$

62,588

 

$

54,563

 

 

Corporate Bonds: The Company’s unrealized loss on investments in corporate bonds relates to bonds with eight different issuers. The economic conditions throughout 2008, 2009 and 2010 have had a significant impact on all corporate debt obligations. As a result, the spreads on all of the securities have widened dramatically and the liquidity of many of these investments has been negatively impacted. Each of these bonds is rated BBB (investment grade) or better with the exception of four bonds downgraded below investment grade as of March 31, 2010. The first is rated C by Fitch and Ca by Moody and is a preferred term security with a par value of $2.0 million, book value of $1.90 million and fair value of $941,000 (PRETSL XIII B class).  During the quarter ended March 31, 2010, the Company identified this bond as other-than-temporarily-impaired and recognized an impairment charge for the credit component in earnings of $67,000.  The second bond was downgraded in 2009 and is a collateralized debt obligation (CDO ACE 2005-15 3A), rated CCC- by S&P, with a carrying value of $998,000 and fair value of $905,000. This bond matures in December 2010 and it is anticipated that we will receive the par value of the bond at maturity. The third bond is also a CDO, (ACE 2005—12AI) rated CCC+ by S&P and B3 by Moody’s with a carrying value of $4.9 million and a fair value of $3.93 million and matures in July 2014. The fourth bond is rated Ba1 by Moody and BBB- S&P (SLMA O) with a carrying value of $998,000 and a fair value of $780,000 and matures in July 2014.  All of the 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. Because the Company has the ability and it is more likely than not the Company can hold these investments until a recovery of fair value, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2010, except to the extent OTTI has been previously recognized on the PRETSL XIII noted above.

 

Small Business Administration Pools: These pools are guaranteed pass-thru with the full faith and credit of the United States government.  Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2010.

 

State and Local Governments and Other: The unrealized losses on these investments are attributable to increases in interest rates, rather than credit quality. Because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be maturity, the Company does not consider the investments to be other-than-temporarily impaired at March 31, 2010.

 

16


 


Table of Contents

 

Note 4—Investment Securities - continued

 

The amortized cost and fair value of investment securities at March 31, 2010 by contractual 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 based on average life at estimated prepayment speeds.

 

 

 

Held-to-maturity

 

Available-for-sale

 

(Dollars in thousands)

 

Amortized
Cost

 

Fair
Value

 

Amortized
Cost

 

Fair
Value

 

Due in one year or less

 

$

3,595

 

$

3,589

 

$

15,900

 

$

14,834

 

Due after one year through five years

 

17,361

 

15,340

 

64,636

 

65,089

 

Due after five years through ten years

 

23,817

 

20,437

 

35,956

 

35,301

 

Due after ten years

 

8,912

 

9,103

 

15,555

 

16,742

 

 

 

$

53,685

 

$

48,469

 

$

132,047

 

$

131,966

 

 

Note 5 - 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 January 2010, compensation guidance was updated to reflect the SEC’s views of when escrowed share arrangements are considered to be compensatory.  Historically, the SEC staff has expressed the view that an escrowed share arrangement involving the release of shares to certain shareholders based on performance-related criteria is presumed to be compensatory.  Facts and circumstances may indicate that the arrangement is an incentive made to facilitate a transaction on behalf of the company if the escrowed shares will be released or canceled without regard to continued employment. In such cases, the SEC staff generally believes that the arrangement should be recognized and measured according to its nature and reflected as a reduction of the proceeds allocated to the newly issued securities.  The SEC staff believes that an escrowed share arrangement in which the shares are automatically forfeited if employment is terminated is compensation. The guidance is effective upon issuance and had no impact on the Company’s financial statements.

 

In January 2010, fair value guidance was amended to require disclosures for significant amounts transferred in and out of Levels 1 and 2 and the reasons for such transfers and to require that gross amounts of purchases, sales, issuances and settlements be provided in the Level 3 reconciliation.  The new disclosures are effective for the Company for the current quarter and have been reflected in the Fair Value footnote.

 

Guidance related to subsequent events was amended in February 2010 to remove the requirement for an SEC filer to disclose the date through which subsequent events were evaluated.  The amendments were effective upon issuance and had no significant impact on the Company’s financial statements.

 

Consolidation guidance was amended in February 2010 to defer guidance regarding the analysis of interests in variable interest entities issued in June 2009 for entities having attributes of investment companies or that apply investment company measurement principles.  Disclosure requirements provided in the June 2009 guidance were not deferred.  The amendments were effective January 1, 2010 and had no effect on the Company’s financial statements.

 

In March 2010, guidance related to derivatives and hedging was amended to exempt embedded credit derivative features related to the transfer of credit risk from potential bifurcation and separate accounting.  Embedded features related to other types of risk and other embedded credit derivative features were not exempt from potential bifurcation and separate accounting.  The amendments will be effective for the Company on July 1, 2010 although early adoption is permitted.  The Company does not expect these amendments to have any impact on the 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.

 

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Note 6 — Fair Value of Financial Instruments

 

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, 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.

 

Investment Securities - Fair values are based on quoted market prices, where available.  If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments.

 

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.  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.

 

Accrued Interest Receivable - The fair value approximates the carrying value.

 

Interest rate cap/floor - The fair value approximates the carrying value.

 

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.

 

Federal Home Loan Bank Advances - Fair value is estimated based on discounted cash flows using current market rates for borrowings with similar terms.

 

Short Term Borrowings - The carrying value of short term borrowings (securities sold under agreements to repurchase and demand notes to the U.S. Treasury) approximates fair value.

 

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.

 

Accrued Interest Payable - The fair value approximates the carrying value.

 

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

 

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Note 6 — Fair Value of Financial Instruments - continued

 

The carrying amount and estimated fair value of the Company’s financial instruments are as follows:

 

 

 

March 31, 2010

 

December 31, 2009

 

(Dollars in thousands)

 

Carrying
Amount

 

Fair
Value

 

Carrying
Amount

 

Fair
Value

 

Financial Assets:

 

 

 

 

 

 

 

 

 

Cash and short term investments

 

$

35,734

 

$

35,734

 

$

20,844

 

$

20,844

 

Held-to-maturity securities

 

53,685

 

48,469

 

56,104

 

49,092

 

Available-for-sale securities

 

131,966

 

131,966

 

131,836

 

131,836

 

Other investments, at cost

 

7,904

 

7,904

 

7,904

 

7,904

 

Loans receivable

 

342,203

 

340,827

 

344,187

 

340,505

 

Allowance for loan losses

 

4,868

 

 

4,854

 

 

Net loans

 

337,335

 

340,827

 

339,333

 

340,505

 

Accrued interest

 

2,065

 

2,065

 

2,200

 

2,200

 

Interest rate cap/floor/swap

 

(643

)

(643

)

(535

)

(535

)

 

 

 

 

 

 

 

 

 

 

Financial liabilities:

 

 

 

 

 

 

 

 

 

Non-interest bearing demand

 

$

77,678

 

$

77,678

 

$

72,656

 

$

72,656

 

NOW and money market accounts

 

113,234

 

113,234

 

104,659

 

104,659

 

Savings

 

28,408

 

28,408

 

25,757

 

25,757

 

Time deposits

 

245,880

 

248,003

 

246,504

 

248,473

 

Total deposits

 

465,200

 

467,323

 

449,576

 

451,545

 

Federal Home Loan Bank Advances

 

70,072

 

74,853

 

73,326

 

77,738

 

Short term borrowings

 

19,590

 

19,590

 

20,840

 

20,840

 

Junior subordinated debentures

 

15,464

 

15,464

 

15,464

 

15,464

 

Accrued interest payable

 

2,053

 

2,053

 

2,219

 

2,219

 

 

Note 7 — 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 available to be issued and, with the exception of the two items disclosed below, no additional subsequent events occurred requiring accrual or disclosure.

 

On April 6, 2010, First Community Bank, the subsidiary bank of First Community Corporation entered into a formal written agreement with the Office of the Comptroller of the Currency (OCC), our primary bank regulator.  The Agreement is based on the findings of the OCC during a 2009 on-site examination of the Bank.  As reflected in the Agreement, the OCC’s primary concern with First Community Bank is driven by the rating agencies’ downgrades of non-agency MBSs in its investment portfolio.  These securities, purchased in 2004 through 2008, were all rated AAA by the rating agencies at the time of purchase; however, they have been impacted by the economic recession and the stress on the residential housing sector.  These ratings do not reflect the discounted purchase price paid by the Bank.  They only reflect their analysis of the performance of the security overall, and therefore, a downgrade does not capture the risk of loss to the Bank.  The Agreement did not require any adjustment to the Bank’s balance sheet or income statement; nor did it change the Bank’s “well capitalized” status.  The OCC has separately established the following individual minimum capital ratios for the Bank: a Tier I leverage capital ratio of at least 8.00%, a Tier 1

 

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risk-based capital ratio of at least 10.00%, and a Total risk-based capital ratio of at least 12.00%.  As of March 31, 2010, the Bank exceeds these ratios.  The Board of Directors has appointed an independent compliance committee made up of directors to monitor and report on compliance with the terms of the agreement.  Management has already submitted revisions to certain policies to the OCC and anticipates that all of the revisions will be submitted by the end of May 2010.

 

Subsequent to March 31, 2010, we restructured a portion of our available-for-sale investments. We sold the CDO ACE 2005-12 AI, (see note 4 Corporate Bond section), and realized a loss in the amount of $1.7 million.  Approximately $41.0 million in available-for-sale GSE bonds and MBSs were sold that realized a gain of approximately $1.7 million.  The funds received from this transaction were primarily invested in other securities that have a lower regulatory risk weighting such as GNMA mortgage-backed securities and SBA pools.  Both of these types of securities carry a zero percent regulatory risk weighting and are backed by the full faith and credit of the United States Government.  A significant portion of the proceeds were reinvested into adjustable rate securities.  As a result of this transaction, we believe we have structured the balance sheet to continue to provide for improvement in our net interest margin in a rising interest rate environment, reduced the level of investments rated below investment grade as well as improved our overall regulatory capital ratios.

 

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, 2009 as filed with the Securities and Exchange Commission (the “SEC”) and the following:

 

·                  increases in competitive pressure in the banking and financial services industries;

·                  our ability to comply with the terms of the formal written agreement between the Bank and the OCC within the timeframes specified;;

·                  changes in the interest rate environment which could reduce anticipated or actual margins;

·                  changes in political conditions or the legislative or regulatory environment;

·                  reduced earnings due to higher credit losses generally and specifically potentially because losses in our real estate loan portfolio may be greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;

·                  high concentrations of real estate-based loans collateralized by real estate in a weak commercial real estate market;

·                  general economic conditions, either nationally or regionally and especially in our primary service area, being 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 adequacy of our level of allowance for loan loss;

·                  the rate of delinquencies and amounts of loans charged-off;

·                  the rates of loan growth;

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

·                  the effect of final rules amending Regulation E that prohibit financial institutions from charging consumer fees for paying overdrafts on ATM and one-time debit card transactions, unless the consumer consents or opts-in to the overdraft service for those types of transactions;

·                  changes in monetary and tax policies;

·                  loss of consumer confidence and economic disruptions resulting from terrorist activities or other military actions;

 

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·                  changes in the securities markets; and

·                  other risks and uncertainties detailed from time to time in our filings with the SEC.

 

These risks are exacerbated by the developments over the last 24 months in national and international financial markets, and we are unable to predict what effect these uncertain market conditions will have on the Company.    There can be no assurance that the unprecedented developments experienced over the last 24 months will not materially and adversely affect our business, financial condition and results of operations.

 

All forward-looking statements in this report are based on information available to us as of the date of this report.  Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved.  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 quarter ended March 31, 2010 as compared to the quarter ended March 31, 2009 and also analyzes our financial condition as of March 31, 2010 as compared to December 31, 2009.  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 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.

 

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 March 31, 2010 and our notes included in the consolidated financial statements in our 2009 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.

 

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

 

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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.

 

The evaluation and recognition of other-than-temporary impairment (“OTTI”) on certain investments including our private label mortgage-backed securities and other corporate debt security holdings requires significant judgment and estimates.  Some of the more critical judgments supporting the evaluation of OTTI include projected cash flows including prepayment assumptions, default rates and severities of losses on the underlying collateral within the security.  Under different conditions or utilizing different assumptions, the actual OTTI recognized by us may be different from the actual amounts recognized in our consolidated financial statements.  See Note 4 to the financial statements for the disclosure of certain of the assumptions used as well as OTTI recognized in the financial statements during the three months ended March 31, 2010 and 2009.

 

Recent Legislative and Regulatory Initiatives to Address Financial and Economic Crises.

 

The Congress, Treasury and the federal banking regulators, including the FDIC, have taken broad action since early September 2008 to address volatility in the U.S. banking system.

 

In October 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted. The EESA authorizes the Treasury to purchase from financial institutions and their holding companies up to $700 billion in mortgage loans, mortgage-related securities and certain other financial instruments, including debt and equity securities issued by financial institutions and their holding companies in a Troubled Asset Relief Program (“TARP”).  The purpose of TARP is to restore confidence and stability to the U.S. banking system and to encourage financial institutions to increase their lending to customers and to each other.  The Treasury has allocated $250 billion towards the TARP Capital Purchase Program (“CPP”).  Under the CPP, the Treasury will purchase debt or equity securities from participating institutions.  The TARP also will include direct purchases or guarantees of troubled assets of financial institutions. Participants in the CPP are subject to executive compensation limits and are encouraged to expand their lending and mortgage loan modifications.

 

On November 21, 2008 as part of the TARP CPP, First Community Corporation entered into a Letter Agreement and Securities Purchase Agreement (collectively, the “CPP Purchase Agreement”) with the Treasury, pursuant to which First Community sold (i) 11,350 shares of First Community’s Fixed Rate Cumulative Perpetual Preferred Stock, Series T (the “Series T Preferred Stock”) and (ii) a warrant (the “CPP Warrant”) to purchase 195,915 shares of First Community’s common stock for an aggregate purchase price of $11,350,000 in cash.

 

The Series T Preferred Stock qualifies as Tier 1 capital and is entitled to cumulative dividends at a rate of 5% per annum for the first five years, and 9% per annum thereafter.  However, First Community currently must consult with the Federal Reserve before it pays these dividends and must consult with the OCC before it may redeem the Series T Preferred Stock. Contrary to the original restrictions in the EESA, however, it will not necessarily be required to raise additional equity capital in order to redeem this stock.  The CPP Warrant has a 10-year term and is immediately exercisable upon its issuance, with an exercise price, subject to anti-dilution adjustments, equal to $8.69 per share of the common stock. Please see the Form 8-K we filed with the SEC on November 25, 2008, for additional information about the Series T Preferred Stock and the CPP Warrant.

 

EESA also increased FDIC deposit insurance on most accounts from $100,000 to $250,000.  This increase is in place until the end of 2010 and is not covered by deposit insurance premiums paid by the banking industry.

 

Following a systemic risk determination, the FDIC established the TLGP on October 14, 2008.  The TLGP includes the TAGP, which provides unlimited deposit insurance coverage through December 31, 2010 for noninterest-bearing transaction accounts (typically business checking accounts) and certain funds swept into noninterest-bearing savings accounts.  Institutions participating in the TLGP pay a 10 basis points fee (annualized) on the balance of each covered account in excess of $250,000, while the extra deposit insurance is in place.  The TLGP also includes the

 

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Debt Guarantee Program (“DGP”), under which the FDIC guarantees certain senior unsecured debt of FDIC-insured institutions and their holding companies.  The unsecured debt must be issued on or after October 14, 2008 and not later than June 30, 2009, and the guarantee is effective through the earlier of the maturity date or June 30, 2012.  On March 17, 2009, the FDIC adopted an interim rule that extends the DGP and imposes surcharges on existing rates for certain debt issuances.  This extension allows institutions that have issued guaranteed debt before April 1, 2009 to issue guaranteed debt during the extended issuance period that ends on October 31, 2009. For such institutions, the guarantee on debt issued on or after April 1, 2009, will expire no later than December 31, 2012.  The DGP coverage limit is generally 125% of the eligible entity’s eligible debt outstanding on September 30, 2008 and scheduled to mature on or before June 30, 2009 or, for certain insured institutions, 2% of their liabilities as of September 30, 2008.  Depending on the term of the debt maturity, the nonrefundable DGP fee ranges from 60 to 110 basis points (annualized) for covered debt outstanding until the earlier of maturity or June 30, 2012 and 75 to 125 basis points (annualized) for covered debt outstanding until after June 30, 2012.  The TAGP and DGP are in effect for all eligible entities, unless the entity opted out on or before December 5, 2008.   We are participating in the TAGP, but opted out of the DGP.

 

On February 10, 2009, the Treasury announced the Financial Stability Plan, which earmarked $350 billion of the TARP funds authorized under EESA. Among other things, the Financial Stability Plan includes:

 

·                  A capital assistance program that invested in mandatory convertible preferred stock of  certain qualifying institutions determined on a basis and through a process similar to the Capital Purchase Program;

 

·                                          A consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances;

 

·                                          A public-private investment fund that is intended to leverage public and private capital with public financing to purchase up to $500 billion to $1 trillion of legacy “toxic assets” from financial institutions; and

 

·                                          Assistance for homeowners by providing up to $75 billion to reduce mortgage payments and interest rates and establishing loan modification guidelines for government and private programs.

 

On February 17, 2009, the American Recovery and Reinvestment Act (the “Recovery Act”) was signed into law in an effort to, among other things, create jobs and stimulate growth in the United States economy.  The Recovery Act specifies appropriations of approximately $787 billion for a wide range of Federal programs and will increase or extend certain benefits payable under the Medicaid, unemployment compensation, and nutrition assistance programs.  The Recovery Act also reduces individual and corporate income tax collections and makes a variety of other changes to tax laws.  The Recovery Act also imposes certain limitations on compensation paid by participants in the TARP.

 

On March 23, 2009, the Treasury, in conjunction with the FDIC and the Federal Reserve, announced the Public-Private Partnership Investment Program for Legacy Assets which consists of two separate plans, addressing two distinct asset groups:

 

· The first plan is the Legacy Loan Program, which has a primary purpose to facilitate the sale of troubled mortgage loans by eligible institutions, including FDIC-insured federal or state banks and savings associations. Eligible assets are not strictly limited to loans; however, what constitutes an eligible asset will be determined by participating banks, their primary regulators, the FDIC and the Treasury. Under the Legacy Loan Program, the FDIC has sold certain troubled assets out of an FDIC receivership in two separate transactions relating to the failed Illinois bank, Corus Bank, NA, and the failed Texas bank, Franklin Bank, S.S.B. These transactions were completed in September 2009 and October 2009, respectively.

· The second plan is the Securities Program, which is administered by the Treasury and involves the creation of public-private investment funds to target investments in eligible residential mortgage-backed securities and commercial mortgage-backed securities issued before 2009 that originally were rated AAA or the equivalent by two or more nationally recognized statistical rating organizations, without regard to rating enhancements (collectively, “Legacy Securities”). Legacy Securities must be directly secured by actual mortgage loans, leases or other assets, and may be purchased only from financial institutions that meet TARP eligibility requirements. Treasury

 

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received over 100 unique applications to participate in the Legacy Securities PPIP and in July 2009 selected nine public-private investment fund managers.  As of December 31, 2009, public-private investment funds have completed initial and subsequent closings on approximately $6.2 billion of private sector equity capital, which was matched 100% by Treasury, representing $12.4 billion of total equity capital. Treasury has also provided $12.4 billion of debt capital, representing $24.8 billion of total purchasing power. As of December 31, 2009, public-private investment funds have drawn-down approximately $4.3 billion of total capital which has been invested in certain non-agency residential mortgage backed securities and commercial mortgage backed securities and cash equivalents pending investment.

 

On May 22, 2009, the FDIC levied a one-time special assessment on all banks which was paid on September 30, 2009.

 

On November 12, 2009, the FDIC issued a final rule to require banks to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012 and to increase assessment rates effective on January 1, 2011.

 

Although it is likely that further regulatory actions will arise as the Federal government attempts to address the economic situation, we cannot predict the effect that fiscal or monetary policies, economic control, or new federal or state legislation may have on our business and earnings in the future.

 

Insurance of Accounts and Regulation by the FDIC.   The deposits at our bank are insured up to applicable limits by the Deposit Insurance Fund of the FDIC.  The Deposit Insurance Fund is the successor to the Bank Insurance Fund and the Savings Association Insurance Fund, which were merged effective March 31, 2006.  As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC insured institutions.  It also may prohibit any FDIC insured institution from engaging in any activity the FDIC determines by regulation or order to pose a serious risk to the insurance fund.  The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the Office of Thrift Supervision an opportunity to take such action, and may terminate the deposit insurance if it determines that the institution has engaged in unsafe or unsound practices or is in an unsafe or unsound condition.

 

Under regulations effective January 1, 2007, the FDIC adopted a new risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based upon supervisory and capital evaluations.   For deposits held as of March 31, 2010, institutions are assessed at annual rates ranging from 12 to 50 basis points, depending on each institution’s risk of default as measured by regulatory capital ratios and other supervisory measures.   Effective April 1, 2009, assessments take into account each institution’s reliance on secured liabilities and brokered deposits.  This resulted in assessments ranging from 7 to 77.5 basis points.  In May 2009, the FDIC issued a final rule which levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution’s total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits.  This special assessment was part of the FDIC’s efforts to rebuild the Deposit Insurance Fund.  We paid this onetime special assessment in the amount of $300 thousand to the FDIC at the end of the third quarter 2009.

 

In November 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012.  The FDIC also adopted a uniform three-basis point increase in assessment rates effective on January 1, 2011.  In December 2009, we paid $ 2.9 million in prepaid risk-based assessments. At March 31, 2010 remaining $2.5 million in prepaid deposit insurance is included in accrued interest receivable and other assets in the accompanying balance sheet as of March 31, 2010.

 

FDIC insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s.  For the first quarter of 2010, the Financing Corporation assessment equaled 1.14 basis points for domestic deposits.  These assessments, which may be revised based upon the level of deposits, will continue until the bonds mature in the years 2017 through 2019.

 

The FDIC may terminate the deposit insurance of any insured depository institution, including the bank, if it

 

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determines after a hearing that the institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC or the OCC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital.  If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC.  Management of the bank is not aware of any practice, condition or violation that might lead to termination of the bank’s deposit insurance.

 

Comparison of Results of Operations for Three Months Ended March 31, 2010 to the Three Months Ended March 31, 2009

 

Net Income

 

Our net income for the three months ended March 31, 2010 was $589,000, or $0.13 diluted earnings per share, as compared to $572,000 or $0.13 diluted earnings per share, for the three months ended March 31, 2009.  The slight increase in net income between the two periods is primarily due to an increase of $397,000 in net interest income and a lower effective tax rate between the two periods.  The effect of these positive changes were offset by an increase in the provision for loan losses of $99,000, a decrease in non-interest income of $226,000 and an increase in non-interest expense of $162,000 between the two periods.  Average earning assets decreased by $18.3 million in the first quarter of 2010 as compared to the same period in 2009.  Average earning assets were $572.9 million during the three months ended March 31, 2009 as compared to $554.7 million during the three months ended March 31, 2010.  The decrease in average earning assets was a result of prepaying approximately $27.0 million in Federal Home Loan Bank advances late in the fourth quarter of 2009 as well as repaying $3.3 million in maturing advances in the first quarter of 2010. Despite the decrease in average earning assets, we realized an increase in net interest income of $397,000 in the first three months of 2010 as compared to the first three months of 2009 as a result of a 38 basis point increase in our net interest margin on a tax equivalent basis.

 

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 three-month periods ended March 31, 2010 and 2009, along with average balances and the related interest income and interest expense amounts.

 

Net interest income was $4.7 million for the three months ended March 31, 2010 as compared to $4.3 million for the three months ended March 31, 2009.  This increase was due to an increase in our net interest margin.  The net interest margin on a taxable equivalent basis increased by 38 basis points from 3.08% at March 31, 2009 to 3.46% at March 31, 2010.  The yields on earning assets decreased by 38 basis points in the first quarter of 2010 as compared to the same period in 2009. The yield on earning assets for the three months ended March 31, 2010 and 2009 was 5.23% and 5.61%, respectively.  The cost of interest-bearing liabilities during the first three months of 2010 was 2.04% as compared to 2.85% in the same period of 2009, resulting in a 81 basis points decrease.  As a result of the ongoing recessionary economic conditions during 2008, throughout 2009 and thus far in 2010, interest rates continue to remain at historically low levels.  There were three primary contributors to the improvement in the net interest margin.  First, the repricing of time deposits has resulted in the cost of those funds decreasing by 125 basis points during the first quarter of 2010 as compared to the same period in 2009.  Second, during the fourth quarter of 2009, we prepaid $27.0 million in Federal Home Loan Bank advances which contributed to an 18 basis point decrease in cost of other borrowed funds in the first quarter of 2010 as compared to the same period in 2009. Third, the percentage of non-interest bearing deposits supporting our total funding sources increased from 11.5% in the first quarter of 2009 to 13.3% in the same period of 2010.

 

Provision and Allowance for Loan Losses

 

At March 31, 2010 and December 31, 2009, the allowance for loan losses was $4.9 million, or 1.42% and 1.41% of total loans, respectively.  Our provision for loan losses was $550,000 for the three months ended March 31, 2010, as compared to $451,000 for the three months ended March 31, 2009.  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

 

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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.

 

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.  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.

 

The increase in the provision for the first three months of 2010 as compared to the same period in 2009 is a result of the ongoing economic downturn experienced throughout our markets and the country. Real estate values have been dramatically impacted during the current economic cycle.  With our loan portfolio consisting of a large percentage of real estate secured loans, we like most financial institutions, have experienced increasing delinquencies and problem loans.  In some cases, this downturn has resulted in an impairment to the value of our collateral and our ability to sell the 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.

 

The effects of the slowing economy have resulted in some deterioration of our loan portfolio in general as evidenced by the increase in non-performing assets from $8.3 million (1.37% of total assets) at December 31, 2009 to $9.1 million (1.47% of total assets) at March 31, 2010. While we believe these 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 are 33 loans included in non-performing status (non-accrual loans and loans past due 90 days and still accruing). The largest is for $828,000 and is secured by a first lien on a single family residential property.  The average balance of the remaining 32 loans is ap