# First Community Bankshares Inc: Form 10-Q for the period ended Mar 31, 2013

- Company: [First Community Bankshares Inc](/companies/fcbc.md) (CIK 859070)
- Form: 10-Q
- Filed: 2013-05-10
- Accepted by EDGAR: May 10, 2013, 16:48 ET
- Period: 2013-03-31
- Accession: 0001193125-13-214409
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/859070/000119312513214409/d518792d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/859070/000119312513214409/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2013-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2013-01-01 to 2013-03-31 | $4.6m | us-gaap:InterestExpense |
| Income tax | 3 months, 2013-01-01 to 2013-03-31 | $3.4m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2013-01-01 to 2013-03-31 | $7.1m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2013-01-01 to 2013-03-31 | $0.33 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2013-01-01 to 2013-03-31 | $0.34 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2013-01-01 to 2013-03-31 | 21,394,066 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2013-01-01 to 2013-03-31 | $5.5m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2013-01-01 to 2013-03-31 | $1.2m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2013-01-01 to 2013-03-31 | $2.4m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 3 months, 2013-01-01 to 2013-03-31 | $1.1m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2013-03-31 | $167.0m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2013-03-31 | $2.72bn | us-gaap:Assets |
| Total liabilities | at 2013-03-31 | $2.36bn | us-gaap:Liabilities |
| Shareholders' equity | at 2013-03-31 | $358.7m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 52,064 characters.

Unless the context suggests otherwise, the terms “First Community,” “Company,” “we,” “our,” and “us” refer to First Community Bancshares, Inc. and its subsidiaries as a consolidated entity. The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide information that will enhance understanding of our Company’s financial condition, changes in financial condition, and results of operations. This MD&A contains forward-looking statements and should be read in conjunction with our 2012 Annual Report on Form 10-K (the “2012 Form 10-K”) and the other financial information included in this report.

### Forward-Looking Statements

We may make forward-looking statements in filings with the Securities and Exchange Commission (the “SEC”) including this Annual Report on Form 10-K and the Exhibits hereto and thereto in our reports to shareholders and other communications that are made in good faith by our Company pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, among others, statements with respect to our beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates, and intentions that are subject to significant risks and uncertainties and are subject to change based on various factors, many of which are beyond our control. The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” and other similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause our financial performance to differ materially from that expressed in such forward-looking statements:

- the strength of the United States economy in general and the strength of the local economies in which we conduct operations;
- the effects of, and changes in, trade, monetary, and fiscal policies and laws, including interest rate policies of the Federal Reserve Board;
- inflation, interest rate, market and monetary fluctuations;
- our timely development of competitive new products and services and the acceptance of these products and services by new and existing customers;
- the willingness of customers to substitute competitors’ products and services for our products and services and vice versa;
- the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities, and insurance) and the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”);
- the impact of the federal banking regulators’ continued implementation of a number of programs to address capital and liquidity in the banking system; further, future and proposed rules, including those that are part of the Basel III process, which are expected to increase minimum acceptable levels of capital for the industry;
- technological changes;
- the effect of acquisitions, including, without limitation, the failure to achieve the expected revenue growth and/or expense savings from such acquisitions;
- the growth and profitability of our noninterest, or fee, income being less than expected;
- unanticipated regulatory or judicial proceedings;
- changes in consumer spending and saving habits; and
- our success at managing the risks involved in the foregoing.

We caution that the foregoing list of important factors is not all-inclusive. If one or more of the factors affecting these forward-looking statements proves incorrect, then our actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking statements contained in this Quarterly Report on Form 10-Q and other reports we filed with the SEC. Therefore, we caution you not to place undue reliance on our forward-looking information and statements. We do not intend to update any forward-looking statements, whether written or oral, to reflect change. All forward-looking statements attributable to our Company are expressly qualified by these cautionary statements. These factors and other risks and uncertainties are discussed in Part II, Item 1A, “Risk Factors,” herein, and Part I, Item 1A, “Risk Factors,” of our 2012 Form 10-K.

### Company Overview

Our Company is a financial holding company headquartered in Bluefield, Virginia. We operate through our community bank subsidiary, First Community Bank (the “Bank”), which provides financial, trust, and investment advisory services to individuals and commercial customers through seventy-two locations in Virginia, West Virginia, North Carolina, South Carolina, and Tennessee. Our Company is also the parent company of Greenpoint Insurance Group, Inc. (“Greenpoint”), headquartered in High Point, North Carolina, a full-service insurance agency offering commercial and personal lines of insurance through five locations in Virginia, West Virginia, and North Carolina. The Bank is the parent of First Community Wealth Management, a registered investment advisory firm that offers wealth management and investment advice with $906 million in aggregate assets under management as of March 31, 2013. These assets are not assets of our Company, but are managed under various fee-based arrangements as fiduciary or agent. We reported total assets of $2.72 billion as of March 31, 2013. Our Common Stock is traded on the NASDAQ Global Select Market under the symbol, “FCBC.”

We fund our lending and investing activities primarily through the retail deposit operations of our branch banking network. Retail and wholesale repurchase agreements and borrowings from the Federal Home Loan Bank (“FHLB”) provide additional funding. We invest our funds primarily in loans to retail and commercial customers. In addition to loans, we invest a portion of our funds in various debt securities, including those of United States and its agencies, municipals, and certain corporate notes, debt instruments, and equity securities. We also maintain overnight interest-bearing balances with the Federal Reserve and other correspondent banks. The difference between interest earned on assets and interest paid on liabilities is our primary source of earnings. Our net interest income is supplemented by fees for services, commissions on sales, and various deposit service charges.

### Critical Accounting Estimates

We prepare our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) and conform to general practices within the banking industry. Our financial position and results of operations require management to make judgments and estimates to develop the amounts reflected and disclosed in the consolidated financial statements. Different assumptions in the application of these estimates could result in material changes to our consolidated financial position and consolidated results of operations. Estimates, assumptions, and judgments are continually evaluated and based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Our accounting estimates are fundamental to understanding MD&A and the disclosures presented in the Notes to Condensed Consolidated Financial Statements and in MD&A provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Our critical accounting estimates are described in detail in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” of our 2012 Form 10-K.

### Dodd-Frank Wall Street Reform and Consumer Protection Act

On July 21, 2010, sweeping financial regulatory reform legislation entitled the Dodd-Frank Act was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things:

- Centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the “CFPB”), responsible for implementing, examining and enforcing compliance with federal consumer financial laws.
- Requires financial holding companies, such as our Company, to be well capitalized and well managed as of July 21, 2011. Bank holding companies and banks must also be well capitalized and well managed to engage in interstate bank acquisitions.
- Imposes comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institutions themselves.
- Implements corporate governance revisions, including with regard to executive compensation and proxy access by shareholders.
- Makes permanent the $250 thousand limit for federal deposit insurance.
- Repeals the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.
- Amends the Electronic Fund Transfer Act to, among other things, give the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and enforces a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.
- Increases the authority of the Federal Reserve Board to examine bank holding companies, such as our Company, and their nonbank subsidiaries.

Another section of the Dodd-Frank Act, the Mortgage Reform and Anti-Predatory Lending Act (the “Mortgage Reform Act”), contains new underwriting and servicing standards for the mortgage industry, as well as restrictions on compensation for mortgage originators. In addition, the Mortgage Reform Act grants broad discretionary regulatory authority to the CFPB to prohibit or condition terms, acts, or practices relating to residential mortgage loans that the CFPB finds abusive, unfair, deceptive, or predatory, as well as to take other actions that the CFPB finds are necessary or proper to ensure that responsible affordable mortgage credit remains available to consumers. The Dodd-Frank Act also contains laws affecting the securitization of mortgages, and other assets, with requirements for risk retention by securitizers and requirements for regulating credit rating agencies. Many aspects of the Dodd-Frank Act continue to be subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on our Company, our customers, or the general financial industry. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits, and interchange fees could increase costs associated with deposits, as well as place limitations on certain revenues those deposits may generate.

### Recent Business Combinations

On June 8, 2012, the Company entered into a purchase and assumption agreement with loss share arrangements with the Federal Deposit Insurance Corporation (“FDIC”) to purchase certain assets and assume substantially all of the customer deposits and certain liabilities of Waccamaw Bank (“Waccamaw”). Waccamaw, a full service community bank headquartered in Whiteville, North Carolina, operated sixteen branches throughout North and South Carolina. At acquisition, Waccamaw had total assets of approximately $500.64 million, loans of approximately $318.35 million, and deposits of approximately $414.13 million. As a result of the acquisition and the preliminary purchase price allocation, approximately $10.90 million was recorded as goodwill, which represents the excess of the value of the consideration transferred over the fair value of the net assets acquired including indentified intangibles. Under the Single-Family Shared-Loss Agreement and the Commercial Shared-Loss Agreement with the FDIC, the FDIC has agreed to cover 80% of most loan and foreclosed real estate losses. All assets acquired and liabilities assumed are recorded at estimated fair value on the date of acquisition. These fair value estimates are considered preliminary, and are subject to change for up to one year after the closing date of the acquisition as additional information relative to closing date fair values may become available. After the initial acquisition, the Company agreed to purchase four properties totaling $1.80 million from the FDIC.

On May 31, 2012, the Company completed the acquisition of Peoples Bank of Virginia (“Peoples”), based in Richmond, Virginia. Peoples, a full service community bank, operated four branches throughout the Richmond area. At acquisition, Peoples had total assets of approximately $275.76 million, loans of approximately $184.84 million, and deposits of approximately $232.75 million. Under the terms of the merger agreement, shares of Peoples were exchanged for $6.08 in cash and 1.07 shares of the Company’s common stock, resulting in a purchase price of approximately $40.28 million. As a result of the acquisition and the preliminary purchase price allocation, approximately $10.21 million was recorded as goodwill, which represents the excess of the value of the consideration transferred over the fair market value of the net assets acquired including indentified intangibles. These fair value estimates are considered preliminary, and are subject to change for up to one year after the closing date of the acquisition as additional information relative to closing date fair values may become available.

### Results Of Operations

### Overview

The following list includes significant developments regarding our Company and operations during the first quarter of 2013:

- Tax equivalent net interest margin increased 24 basis points to 4.15% for the first quarter of 2013 compared with the first quarter of 2012.
- Net interest income was $23.36 million, an increase of $5.39 million, or 29.95%, compared with the first quarter of 2012.
- Total assets grew $517.02 million, or 23.47%, compared with the first quarter of 2012, which includes the Peoples and Waccamaw acquisitions that occurred during the second quarter of 2012.
- Total stockholders’ equity increased $48.55 million, or 15.65% compared with the first quarter of 2012, which includes the stock issued during the Peoples acquisition.

### Net Income

Net income increased $1.14 million, or 19.00%, to $7.14 million for the first quarter of 2013 compared with $6.00 million for the first quarter of 2012. Net income available to common shareholders increased $1.17 million, or 20.37%, to $6.88 million for the first quarter of 2013 compared with $5.72 million for the first quarter of 2012. The increase was largely attributed to the substantial growth in earning assets as a result of the Peoples and Waccamaw acquisitions. Basic and diluted earnings per common share for the first quarter of 2013 were $0.34 and $0.33, respectively, compared to basic and diluted earnings per common share for the first quarter of 2012 of $0.32 and $0.31, respectively.

### Net Interest Income – Quarterly Comparison (See Table I)

For purposes of this discussion, net interest income is presented on a tax equivalent basis to provide a comparison among all types of interest earning assets. The tax equivalent basis adjusts for the tax-favored status of income from certain loans and investments. Although this is a non-GAAP measure, management believes this measure is more widely used within the financial services industry and provides better comparability of net interest income arising from taxable and tax-exempt sources. The Company uses this measure to monitor net interest income performance and to manage its balance sheet composition.

Net interest income, the largest contributor to earnings, increased $5.39 million, or 29.95%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. Tax equivalent net interest income increased $5.40 million, or 28.92%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. The increase in tax equivalent net interest income was primarily due to growth in average earning assets resulting from the Peoples and Waccamaw acquisitions and reductions in the rates paid on interest-bearing deposits resulting from the sustained low rate environment.

Average earning assets increased $432.32 million and average interest-bearing liabilities increased $382.11 million for the quarter ended March 31, 2013, compared with the same quarter of 2012. The yield on average earning assets increased 5 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. The average rate paid on interest-bearing liabilities decreased 23 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. Average balances and interest yield/rate changes for earning assets and interest-bearing liabilities resulted in a net interest rate spread that was 28 basis points higher for the first quarter of 2013 compared with the first quarter of 2012. Our net interest margin increased 24 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012.

The tax equivalent yield on loans increased 32 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. Tax equivalent loan interest income increased $5.48 million, or 28.24%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. Interest on loans for the first quarter of 2013 also includes accretion related to the Peoples and Waccamaw acquisitions of $831 thousand and $3.01 million, respectively. The Company expects the purchase accounting interest accretion to decline in future periods based on acquired portfolio attrition.

The tax equivalent yield on available-for-sale securities decreased 46 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. This decrease was primarily due to the reinvestment of proceeds from sales, maturities, prepayments, and cash in lower yielding securities. The average balance of held-to-maturity securities continued to decline as securities were called or matured and were not replaced.

The tax equivalent yield on interest-bearing deposits with banks decreased 10 basis points for the first quarter of 2013 compared with the first quarter of 2012. Interest-bearing deposits with banks are comprised primarily of excess liquidity kept at the Federal Reserve that bears overnight market rates.

The average balance of interest-bearing demand deposits increased $70.79 million, or 25.02%, and the average rate paid on those deposits increased 2 basis points for the first quarter of 2013 compared with the first quarter of 2012. The average balance of savings deposits increased $110.33 million, or 27.89%, and the average rate paid on those deposits increased 1 basis point for the quarter ended March 31, 2013, compared with the same quarter of 2012. The average balance of time deposits increased $181.67 million, or 28.64%, and the average rate paid on those deposits decreased 37 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. The average balance of noninterest-bearing demand deposits increased $93.32 million, or 39.07%, for the first quarter of 2013 compared with the third quarter of 2012.

There were no federal funds purchased on average for the first quarter of 2013, compared to $1.97 million for the first quarter of 2012. The average balance of retail repurchase agreements, including collateralized retail deposits and commercial treasury accounts, increased $3.58 million, or 4.96%, and the average rate paid on those funds decreased 8 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. The average balance of wholesale repurchase agreements increased $7.65 million, or 15.29%, and the average rate paid on those funds decreased 42 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. The average balance of FHLB and other borrowings increased $10.06 million, or 6.07%, and the average rate paid on those funds decreased 24 basis points for the quarter ended March 31, 2013, compared with the same quarter of 2012. The changes in the average balances and costs of wholesale repurchase agreements and FHLB advances were primarily due to the Waccamaw acquisition.

*(Amounts in thousands)*

| Table I Assets Earning assets | Average Balance Sheets and Net Interest Income Analysis Three Months Ended March 31, 2013 Average Balance | Interest (1) | Average Yield/ Rate (1) | 2012 Average Balance | Interest (1) | Average Yield/ Rate (1) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans (2) | $1,706,296 | $24,887 | 5.92% | $1,394,246 | $19,407 | 5.60% |
| Securities available-for-sale | 544,681 | 3,728 | 2.78% | 478,358 | 3,857 | 3.24% |
| Securities held-to-maturity | 816 | 17 | 8.45% | 3,237 | 62 | 7.70% |
| Interest-bearing deposits | 98,893 | 66 | 0.27% | 42,525 | 39 | 0.37% |
| Total earning assets | 2,350,686 | 28,698 | 4.95% | 1,918,366 | 23,365 | 4.90% |
| Other assets | 352,343 |  |  | 255,638 |  |  |
| Total assets | $2,703,029 |  |  | $2,174,004 |  |  |
| Liabilities |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Demand deposits | $353,677 | $56 | 0.06% | $282,887 | $31 | 0.04% |
| Savings deposits | 505,917 | 155 | 0.12% | 395,588 | 110 | 0.11% |
| Time deposits | 816,060 | 2,151 | 1.07% | 634,390 | 2,264 | 1.44% |
| Total interest-bearing deposits | 1,675,654 | 2,362 | 0.57% | 1,312,865 | 2,405 | 0.74% |
| Borrowings |  |  |  |  |  |  |
| Federal funds purchased | — | — | — | 1,970 | 2 | 0.00% |
| Retail repurchase agreements | 75,751 | 105 | 0.56% | 72,171 | 115 | 0.64% |
| Wholesale repurchase agreements | 57,645 | 475 | 3.34% | 50,000 | 468 | 3.76% |
| FHLB advances and other borrowings | 175,937 | 1,699 | 3.92% | 165,874 | 1,715 | 4.16% |
| Total borrowings | 309,333 | 2,279 | 2.99% | 290,015 | 2,300 | 3.19% |
| Total interest-bearing liabilities | 1,984,987 | 4,641 | 0.95% | 1,602,880 | 4,705 | 1.18% |
| Noninterest-bearing demand deposits | 332,186 |  |  | 238,863 |  |  |
| Other liabilities | 24,307 |  |  | 21,466 |  |  |
| Total liabilities | 2,341,480 |  |  | 1,863,209 |  |  |
| Stockholders’ equity | 361,549 |  |  | 310,795 |  |  |
| Total liabilities and stockholders’ equity | $2,703,029 |  |  | $2,174,004 |  |  |
| Net interest income, tax equivalent |  | $24,057 |  |  | $18,660 |  |
| Net interest rate spread (3) |  |  | 4.00% |  |  | 3.72% |
| Net interest margin (4) |  |  | 4.15% |  |  | 3.91% |

(1) Fully taxable equivalent at the rate of 35% (“FTE”). The FTE basis adjusts for the tax benefits of income on certain tax exempt loans and investments using the federal statutory rate of 35% for each period presented. The Company believes this measure to be the preferred industry measurement of net interest income and provides relevant comparison between taxable and nontaxable amounts.

(2) Nonaccrual loans are included in average balances outstanding but with no related interest income during the period of nonaccrual.

(3) Represents the difference between the yield on earning assets and cost of funds.

(4) Represents tax equivalent net interest income divided by average earning assets.

The following table summarizes the changes in tax equivalent interest earned and paid detailing the amounts attributable to (i) changes in volume (change in the average volume times the prior year’s average rate), (ii) changes in rate (changes in the average rate times the prior year’s average volume), and (iii) changes in rate/volume (change in the average volume column times the change in average rate):

*(Amounts in thousands)*

| Interest earned on: | Three Months Ended March 31, 2013 Compared to 2012 Dollar Increase (Decrease) due to Volume | Rate | Rate/ Volume | Total |
| --- | ---: | ---: | ---: | ---: |
| Loans (FTE) | $4,344 | $1,089 | $47 | $5,480 |
| Securities available-for-sale (FTE) | 535 | (551) | (113) | (129) |
| Securities held-to-maturity (FTE) | (46) | 6 | (5) | (45) |
| Interest-bearing deposits with other banks | 51 | (10) | (14) | 27 |
| Total interest earning assets | 4,884 | 534 | (85) | 5,333 |
| Interest paid on: |  |  |  |  |
| Demand deposits | 8 | 14 | 3 | 25 |
| Savings deposits | 31 | 12 | 2 | 45 |
| Time deposits | 648 | (573) | (188) | (113) |
| Federal funds purchased | — | — | (2) | (2) |
| Retail repurchase agreements | 6 | (14) | (2) | (10) |
| Wholesale repurchase agreements | 71 | (52) | (12) | 7 |
| FHLB advances and other borrowings | 103 | (99) | (20) | (16) |
| Total interest-bearing liabilities | 867 | (712) | (219) | (64) |
| Change in net interest income, tax equivalent | $4,017 | 1,246 | 134 | 5,397 |

### Provision for Loan Losses

The provision for loan losses is determined by management as the amount to be added to the allowance for loan losses after net charge-offs have been deducted to bring the allowance to a level which, in management’s best estimate, is necessary to absorb probable losses within the existing loan portfolio. The provision for loan losses was increased $220 thousand for the first quarter of 2013 compared with the first quarter of 2012. We incurred net charge-offs of $2.06 million for the quarter ended March 31, 2013, compared with $1.33 million for the same quarter of 2012. Annualized net charge-offs as a percentage of average non-covered loans were 0.56% for the quarter ended March 31, 2013, compared with 0.38% for the same quarter of 2012. Non-covered loans exclude loans acquired in the Waccamaw transaction that are covered under the FDIC loss share agreements.

### Noninterest Income

Noninterest income, consisting of all revenues not included in interest and fee income related to earning assets, decreased $130 thousand, or 1.63%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. Exclusive of the impact of gains on the sale of securities and prepaid borrowings, as well as the change in the indemnification asset, noninterest income increased $1.05 million, or 13.19%, to $8.99 million for the quarter ended March 31, 2013, compared with $7.94 million for the same quarter of 2012.

Wealth management revenues, including fees and commissions for trust services and investment advisory services, decreased $48 thousand, or 5.37%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. Service charges on deposit accounts increased $155 thousand, or 5.14%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. Other service charges, commissions, and fees increased $201 thousand, or 12.68%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. Insurance commissions increased $90 thousand, or 5.71%, for the quarter ended March 31, 2013, compared with the same quarter of 2012.

Other operating income increased $945 thousand for the quarter ended March 31, 2013, compared with the same quarter of 2012. The increase was primarily due to a $300 thousand increase in secondary market income and $296 thousand gain on the prepayment of borrowings. We incurred a net gain on sale of securities of $117 thousand for the quarter ended March 31, 2013, which was a $66 thousand increase from the same quarter of 2012. During the first quarter of 2013, the change in the FDIC indemnification asset totaled $1.54 million, including $1.57 million resulting from negative accretion.

### Noninterest Expense

Noninterest expense increased $3.35 million, or 20.69%, for the first quarter of 2013 compared with the first quarter of 2012. Salaries and employee benefits increased $1.89 million, or 22.96%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. The Peoples and Waccamaw acquisitions completed during the second quarter of 2012 accounted for an increase in salaries and employee benefits of $1.25 million during the first quarter of 2013. At March 31, 2013, we had 746 full-time equivalent employees compared to 619 at March 31, 2012. The Peoples and Waccamaw acquisitions resulted in the addition of 100 full-time equivalent employees for the period ended March 31, 2013.

Occupancy, furniture, and equipment expense increased $861 thousand, or 36.84%, to $3.20 million for the quarter ended March 31, 2013, compared with $2.34 million for the same quarter of 2012 as a result of the Peoples and Waccamaw acquisitions. FDIC premiums and assessments increased $150 thousand, or 46.58%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. We incurred $49 thousand in merger related costs for the quarter ended March 31, 2013, in connection with the Peoples and Waccamaw acquisitions. Other operating expense increased $620 thousand, or 12.61%, for the quarter ended March 31, 2013, compared with the same quarter of 2012. The increase in other operating expense was primarily due to our expanded branch network. These increases were offset by a $196 thousand decrease in expenses and net losses associated with other real estate owned (“OREO”) to $625 thousand for the first quarter of 2013, compared with $821 thousand for the first quarter of 2012.

### Income Tax Expense

Income tax as a percentage of pretax income may vary significantly from statutory rates due to permanent differences, which are items of income and expense excluded by law from the calculation of taxable income. Our most significant permanent differences include income on municipal securities, which are exempt from federal income tax; certain dividend payments, which are deductible; and increases in the cash surrender value of life insurance policies. Consolidated income taxes were $3.40 million for the first quarter of 2013 compared to $2.85 million for the first quarter of 2012. The effective tax expense rates for the quarters ended March 31, 2013 and 2012 were 32.23% and 32.22%, respectively.

### Financial Condition

Total assets were $2.72 billion as of March 31, 2013, a decrease of $8.58 million, or 0.31%, compared with $2.73 billion at December 31, 2012. Total liabilities were $2.36 billion as of March 31, 2013, a decrease of $10.92 million, or 0.46%, compared with $2.37 billion at December 31, 2012. As of March 31, 2013, our book value per as-converted common share was $16.93, an increase of $0.17, compared with December 31, 2012.

### Investment Securities

#### Available-for-Sale Securities

Available-for-sale securities as of March 31, 2013, increased $3.15 million, or 0.59%, compared with December 31, 2012. The market value of securities available-for-sale as a percentage of amortized cost was 99.65% at March 31, 2013, compared with 99.92% at December 31, 2012.

During the first quarters of 2013 and 2012, we recognized no other-than-temporary impairment (“OTTI”) charges in earnings related to nonbeneficial interest debt securities. We incurred no OTTI charges on equity securities during the three months ended March 31, 2013 and 2012. See Note 2, “Investment Securities,” of the Notes to Condensed Consolidated Financial Statements in Item 1, “Financial Statements,” herein for additional information.

#### Held-to-Maturity Securities

Held-to-maturity securities as of March 31, 2013, remained constant at $816 thousand compared with December 31, 2012. The market value of securities held-to-maturity as a percentage of amortized cost was 100.96% at March 31, 2013, compared with 101.96% at December 31, 2012.

### Loan Portfolio

#### Loans Held for Sale

Loans held for sale as of March 31, 2013, decreased $3.88 million, or 58.12% compared with December 31, 2012. Loans held for sale consist of mortgage loans sold on a best efforts basis into the secondary loan market; accordingly, we do not retain the interest rate risk involved in these long-term commitments. The gross notional amount of outstanding commitments related to secondary market mortgage loans at March 31, 2013, was $14.10 million for 79 loans compared to $14.84 million for 88 loans at December 31, 2012.

#### Loans Held for Investment

Loans held for investment as of March 31, 2013, decreased $35.36 million, or 2.05%, compared with December 31, 2012, and increased $302.77 million, or 21.84%, compared with March 31, 2012. The significant increase between the first quarter of 2013 and first quarter of 2012 was primarily due to the Peoples and Waccamaw acquisitions that occurred during the second quarter of 2012. The average loan to deposit ratio was 84.98% for the first quarter of 2013 compared to 85.71% for the fourth quarter of 2012, and 89.85% for the first quarter of 2012. The held for investment portfolio continues to be diversified among loan types and industry segments. The following table details the loan portfolio for the dates indicated:

*(Amounts in thousands)*

|  | March 31, 2013 Amount | Percent | December 31, 2012 Amount | Percent | March 31, 2012 Amount | Percent |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Covered loans | $195,060 | 11.55% | $207,106 | 12.01% | $— | 0.00% |
| Non-covered loans |  |  |  |  |  |  |
| Commercial loans |  |  |  |  |  |  |
| Construction, development, and other land | 55,220 | 3.27% | 57,434 | 3.38% | 45,736 | 3.29% |
| Commercial and industrial | 91,666 | 5.43% | 88,738 | 5.15% | 80,637 | 5.82% |
| Multi-family residential | 63,929 | 3.78% | 65,694 | 3.81% | 78,815 | 5.68% |
| Single family non-owner occupied | 136,334 | 8.07% | 135,912 | 7.88% | 108,247 | 7.81% |
| Non-farm, non-residential | 440,226 | 26.06% | 448,810 | 26.02% | 356,029 | 25.68% |
| Agricultural | 2,117 | 0.12% | 1,709 | 0.10% | 1,607 | 0.12% |
| Farmland | 33,930 | 2.01% | 34,570 | 2.00% | 37,751 | 2.72% |
| Total commercial loans | 823,422 | 48.74% | 832,867 | 48.29% | 708,822 | 51.12% |
| Consumer real estate loans |  |  |  |  |  |  |
| Home equity lines | 108,385 | 6.42% | 111,081 | 6.44% | 109,751 | 7.91% |
| Single family owner occupied | 470,437 | 27.85% | 473,547 | 27.46% | 479,411 | 34.58% |
| Owner occupied construction | 19,760 | 1.17% | 16,223 | 0.94% | 17,995 | 1.30% |
| Total consumer real estate loans | 598,582 | 35.44% | 600,851 | 34.84% | 607,157 | 43.79% |
| Consumer and other loans |  |  |  |  |  |  |
| Consumer loans | 68,625 | 4.06% | 78,163 | 4.53% | 65,036 | 4.69% |
| Other | 3,603 | 0.21% | 5,666 | 0.33% | 5,510 | 0.40% |
| Total consumer and other loans | 72,228 | 4.27% | 83,829 | 4.86% | 70,546 | 5.09% |
| Total non-covered loans | 1,494,232 | 88.45% | 1,517,547 | 87.99% | 1,386,525 | 100.00% |
| Total loans held for investment | $1,689,292 | 100.00% | $1,724,653 | 100.00% | $1,386,525 | 100.00% |
| Loans held for sale | $2,794 |  | $6,672 |  | $3,522 |  |

### Allowance for Loan Losses

The allowance for loan losses is maintained at a level management deems sufficient to absorb probable loan losses inherent in the loan portfolio. The allowance is increased by charges to earnings in the form of provisions for loan losses and recoveries of prior loan charge-offs and decreased by loans charged off. The determination of the allowance requires management to make various assumptions and judgments. As a result, actual loan losses may differ materially from management’s determination if actual conditions differ significantly from the assumptions utilized. The ultimate adequacy of the allowance for loan losses is dependent upon a variety of factors beyond our control including, among other things, the economy, changes in interest rates, and the view of regulatory authorities toward loan classifications. Management considers the allowance to be adequate based upon analysis of the portfolio as of March 31, 2013; however, no assurance can be made that additions to the allowance for loan losses will not be required in future periods.

Qualitative risk factors for the loan portfolio remain relatively high which reflect the elevated risk of loan losses due to high unemployment, effects of the recent recession, and devaluations of various categories of collateral. Significant stress continues in commercial and residential real estate markets, resulting in significant declines in real estate valuations. Decreases in real estate values adversely affect the value of property used as collateral for loans, including loans we originated. In addition, adverse changes in the economy, particularly continued high rates of unemployment, may have a negative effect on the ability of our borrowers to make timely loan payments. A further increase in loan delinquencies could adversely impact loan loss experience, causing potential increases in the provision and allowance for loan losses.

Our allowance for loan losses totaled $24.85 million at March 31, 2013, $25.77 million at December 31, 2012, and $25.80 million at March 31, 2012. The allowance for loan losses as a percentage of non-covered loans held for investment was 1.66% at March 31, 2013, 1.70% at December 31, 2012, and 1.86% at March 31, 2012. The decrease between March 31, 2013, and March 31, 2012, was largely due to the addition of Peoples loans at fair value with no corresponding allowance for loan losses. The cash flow analysis performed for the first quarter of 2013 identified three of the Company’s seven purchased credit impaired loan pools as impaired with a combined impairment of $276 thousand at March 31, 2013. The portfolio will continue to be monitored for deterioration in credit, which may result in the need to record an allowance for loan losses in a future period. As a result of stable credit metrics and the general downward trend in net charge-offs over recent quarters, management deemed the reduced allowance and provision for loan losses as adequate and directionally consistent.

The following table details the allowance for loan loss activity and related information for the three months ended March 31, 2013 and 2012.

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2013 | 2012 |
| --- | ---: | ---: |
| Beginning balance | $25,770 | $26,205 |
| Provision for loan losses | 1,142 | 922 |
| Charge-offs | (2,759) | (1,562) |
| Recoveries | 697 | 235 |
| Net charge-offs | (2,062) | (1,327) |
| Ending balance | $24,850 | $25,800 |
| **Non-covered loans** |  |  |
| Annualized net charge-offs to average loans | 0.56% | 0.38% |
| Allowance for loan losses to total loans | 1.66% | 1.86% |

46

### Risk Elements

Nonperforming assets consist of loans accounted for on a nonaccrual basis, accruing loans contractually past due 90 days or more, unseasoned troubled debt restructurings (“TDRs”), and OREO. Loans acquired with credit deterioration through business combinations, for which a discount exists, are not considered to be nonaccrual as a result of the accretion of the discount based on the expected cash flow of the loans. The following table summarizes the components of nonperforming assets and presents additional detail for nonperforming and restructured loans for the periods indicated:

*(Amounts in thousands)*

| Non-covered loans | March 31, 2013 | December 31, 2012 | March 31, 2012 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans | $30,076 | $23,931 | $24,617 |
| Accruing loans past due 90 days or more | — | — | — |
| TDRs (1) | 1,596 | 6,009 | 2,668 |
| Total nonperforming loans | 31,672 | 29,940 | 27,285 |
| OREO not covered under FDIC loss share agreements | 4,439 | 5,749 | 3,829 |
| Total nonperforming assets | $36,111 | $35,689 | $31,114 |
| **Covered loans** |  |  |  |
| Nonaccrual loans | $4,567 | $4,323 | $— |
| Accruing loans past due 90 days or more | — | — | — |
| Total nonperforming loans | 4,567 | 4,323 | — |
| OREO covered under FDIC loss share agreements | 6,911 | 3,255 | — |
| Total nonperforming assets | $11,478 | $7,578 | $— |
| **Total loans** |  |  |  |
| Nonaccrual loans | $34,643 | $28,254 | $24,617 |
| Accruing loans past due 90 days or more | — | — | — |
| TDRs (1) | 1,596 | 6,009 | 2,668 |
| Total nonperforming loans | 36,239 | 34,263 | 27,285 |
| OREO | 11,350 | 9,004 | 3,829 |
| Total nonperforming assets | $47,589 | $43,267 | $31,114 |
| Performing TDRs (2) | $10,272 | $6,038 | $7,052 |
| Total TDRs (3) | $11,868 | 12,047 | $9,720 |
| **Non-covered loans** |  |  |  |
| Nonperforming loans to total loans | 2.12% | 1.97% | 1.97% |
| Nonperforming assets to total assets | 1.43% | 1.42% | 1.41% |
| Allowance for loan losses to nonperforming loans | 78.46% | 86.07% | 94.56% |
| **Total loans (includes covered assets)** |  |  |  |
| Nonperforming loans to total loans | 2.15% | 1.99% | 1.97% |
| Nonperforming assets to total assets | 1.75% | 1.59% | 1.41% |
| Allowance for loan losses to nonperforming loans | 68.57% | 75.21% | 94.56% |

(1) TDRs restructured within the past six months or nonperforming, excluding nonaccrual TDRs of $675 thousand , $3.04 million, and $2.81 million at March 31, 2013, December 31, 2012, and March 31, 2012, respectively.

(2) TDRs with six months or more of satisfactory payment performance, excluding nonaccrual TDRs of $1.67 million, $792 thousand, and $24 thousand at March 31, 2013, December 31, 2012, and March 31, 2012, respectively.

(3) Perfoming and nonperforming TDRs, excluding nonaccrual TDRs of $2.34 million, $3.83 million, and $2.83 million at March 31, 2013, December 31, 2012, and March 31, 2012, respectively.

Non-covered loans exclude loans acquired in the Waccamaw transaction that are covered under the FDIC loss share agreements. Non-covered nonperforming assets totaled $36.11 million at March 31, 2013, a $422 thousand increase over December 31, 2012, and a $5.00 million increase over March 31, 2012. Non-covered nonperforming assets as a percentage of total non-covered assets were 1.43% at March 31, 2013, 1.42% at December 31, 2012, and 1.41% at March 31, 2012.

Non-covered nonaccrual loans totaled $30.08 million at March 31, 2013, $23.93 million at December 31, 2012, and $24.62 million at March 31, 2012. As of March 31, 2013, non-covered nonaccrual loans were largely attributed to the following loan classes: commercial construction (22.75%); single family owner occupied (19.53%); non-farm, non-residential (18.76%); commercial and industrial (17.90%); and single family non-owner occupied (15.30%). The increase in non-covered nonaccrual loans during the first quarter of 2013 was primarily due to one commercial loan relationship totaling $6.40 million. Approximately $5.66 million, or 18.81%, of non-covered nonaccrual loans were attributed to loans acquired in business combinations. Certain loans included in the nonaccrual category have been written down to the estimated realizable value or assigned specific reserves within the allowance for loan losses based upon management’s estimate of loss at ultimate resolution.

When restructuring loans for borrowers experiencing financial difficulty, we generally make concessions in interest rates, loan terms, and/or amortization terms. Certain TDRs are classified as nonperforming at time of restructuring and are returned to performing status after six months of satisfactory payment performance; however, these loans remain identified as impaired until full payment or other satisfaction of the obligation occurs. Accruing TDRs totaled $11.87 million at March 31, 2013, $12.05 million at December 31, 2012, and $9.72 million at March 31, 2012. Accruing nonperforming TDRs amounted to $1.60 million, or 13.45%, of total accruing TDRs as of March 31, 2013, as compared to 49.88% of accruing TDRs at December 31, 2012, and 27.45% of accruing TDRs at March 31, 2012. The allowance for loan losses attributed to TDRs totaled $1.65 million at March 31, 2013, $1.87 million at December 31, 2012, and $675 thousand at March 31, 2012.

Ongoing activity within the classification and categories of nonperforming loans include collections on delinquencies, foreclosures, loan restructurings, and movements into or out of the nonperforming classification as a result of changing economic conditions, borrower financial capacity, or resolution efforts. There were no accruing loans contractually past due 90 days or more as of March 31, 2013.

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, totaled $4.44 million as of March 31, 2013, a decrease of $1.31 million, or 22.79%, compared with December 31, 2012. As of March 31, 2013, non-covered OREO consisted of 48 properties with an average holding period of 10 months. During the first quarter of 2013 the net loss on OREO totaled $400 thousand. Covered OREO is pursuant to the FDIC Loss Share Agreements and is presented net of the related fair value discount. The following table details activity within OREO for the periods indicated:

*(Amounts in thousands)*

|  | Non-covered | Covered | Total |
| --- | ---: | ---: | ---: |
| Beginning balance, January 1, 2013 | $5,749 | $3,255 | $9,004 |
| Acquired | — | — | — |
| Additions | 2,451 | 4,414 | 6,865 |
| Disposals | (3,378) | (534) | (3,912) |
| Valuation adjustments | (383) | (224) | (607) |
| Ending balance, March 31, 2013 | $4,439 | $6,911 | $11,350 |

*(Amounts in thousands)*

|  | Non-covered | Covered | Total |
| --- | ---: | ---: | ---: |
| Beginning balance, January 1, 2012 | $5,914 | $— | $5,914 |
| Acquired | — | — | — |
| Additions | 1,027 | — | 1,027 |
| Disposals | (2,550) | — | (2,550) |
| Valuation adjustments | (562) | — | (562) |
| Ending balance, March 31, 2012 | $3,829 | $— | $3,829 |

Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $42.26 million as of March 31, 2013, an increase of $3.26 million, or 8.36%, compared with December 31, 2012. Non-covered delinquent loans as a percentage of total non-covered loans measured 2.83% at March 31, 2013, of which loans 30 to 89 days past due comprised 0.82% and nonaccrual loans comprised 2.01%. Non-covered nonperforming loans, comprised of nonaccrual loans, nonperforming TDRs, and unseasoned TDRs, as a percentage of total non-covered loans were 2.12% at March 31, 2013, 1.97% at December 31, 2012, and 1.97% at March 31, 2012.

### Deposits

Total deposits as of March 31, 2013, increased $17.32 million, or 0.85%, compared with December 31, 2012. Noninterest-bearing deposits and interest-bearing demand deposits as of March 31, 2013, increased $12.57 million and $24.12 million, respectively, compared with December 31, 2012. Savings deposits, which include money market accounts and savings accounts, as of March 31, 2013, increased $13.05 million compared with December 31, 2012. Time deposits as of March 31, 2013, decreased $32.41 million compared with December 31, 2012.

### Borrowings

Our borrowings consist primarily of securities sold under agreements to repurchase and FHLB advances. Short-term borrowings consist of overnight federal funds purchased and repurchase agreements. There were no federal funds purchased at March 31, 2013, or December 31, 2012. The balance of retail repurchase agreements decreased $6.42 million, or 8.23%, as of March 31, 2013, compared with December 31, 2012. The balance of wholesale repurchase agreements decreased $8.20 million, or 14.08%, and the weighted average rate increased 37 basis points to 3.71% as of March 31, 2013, compared with December 31, 2012. The balance of FHLB borrowings, including convertible and callable advances and fixed rate credit, decreased $11.56 million, or 7.15%, and the weighted average rate increased 26 basis points to 4.12% as of March 31, 2013, compared with December 31, 2012. As of March 31, 2013, the FHLB borrowings had maturities between four and eight years. During the first quarter of 2013, the Company prepaid $8.15 million of wholesale repurchase agreements and $11.47 million of FHLB borrowings that resulted in gains totaling $296 thousand.

### Stockholders’ Equity

Total stockholders’ equity increased 2.35 million, or 0.66%, from $356.32 million at December 31, 2012, to $358.67 million at March 31, 2013. The change in stockholders’ equity during the first quarter of 2013 was primarily due to net income of $7.14 million, dividends declared on common and preferred stock of $2.67 million, treasury share purchases of $1.08 million, and an increase in accumulated other comprehensive loss of $1.10 million.

### Risk-Based Capital

Risk-based capital guidelines promulgated by state and federal banking agencies weight balance sheet assets and off-balance sheet commitments based on inherent risks associated with the respective asset types. As of March 31, 2013, the Bank was deemed “well capitalized” under regulatory capital adequacy standards. Our Company’s and the Bank’s capital ratios are presented in the following table for the dates indicated.

| Total risk-based capital ratio | March 31, 2013 | December 31, 2012 |
| --- | ---: | ---: |
| First Community Bancshares, Inc. | 17.65% | 16.70% |
| First Community Bank | 16.06% | 15.23% |
| **Tier 1 risk-based capital ratio** |  |  |
| First Community Bancshares, Inc. | 16.40% | 15.44% |
| First Community Bank | 14.81% | 13.97% |
| **Tier 1 leverage ratio** |  |  |
| First Community Bancshares, Inc. | 10.35% | 9.96% |
| First Community Bank | 9.31% | 8.98% |

### Liquidity and Capital Resources

We maintain a liquidity policy as a means to manage liquidity and the associated risk. The policy includes a Liquidity Contingency Plan (the “Liquidity Plan”) that is designed as a tool for us to detect liquidity issues promptly to protect depositors, creditors and shareholders. The Liquidity Plan includes monitoring various internal and external indicators such as changes in core deposits and changes in market conditions. It provides for timely responses to a wide variety of funding scenarios ranging from changes in loan demand to a decline in our quarterly earnings to a decline in the market price of our stock. The Liquidity Plan calls for specific responses designed to meet a wide range of liquidity needs based upon assessments on a recurring basis by our Company and Board of Directors.

As of March 31, 2013, we maintained liquidity in the form of unencumbered cash on hand and deposits with other financial institutions of $167.04 million, unpledged available-for-sale securities of $256.62 million, FHLB unused borrowing capacity of $331.57 million, and federal funds lines availability of $114.51 million. Cash on hand and deposits with other financial institutions, as well as the FHLB, are immediately available for satisfaction of deposit withdrawals, customer credit needs, and our operations. Available-for-sale securities represent a secondary level of liquidity available for conversion to liquid funds in the event of extraordinary needs. Our approved lines of credit with correspondent banks are available as backup liquidity sources.

As a holding company, we do not conduct significant operations and our primary sources of liquidity are dividends upstreamed from the Bank and borrowings from outside sources. Banking regulations limit the amount of dividends that may be paid by the Bank. As of March 31, 2013, our liquid assets, including cash and investment securities, totaled $23.27 million. Our cash reserves and investments, as well as management fee arrangements, provide adequate working capital to meet obligations and projected dividends to shareholders for the next twelve months. Additionally, we maintain a $15.00 million unsecured, committed line of credit. There was no balance on the line as of March 31, 2013.

### Off-Balance Sheet Risk

As of March 31, 2013, our off-balance sheet risk included $198.04 million in commitments to extend credit and $5.89 million in standby letters of credit and financial guarantees. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is represented by the contractual amount of those instruments.

## Market risk

As filed, 6,602 characters.

Our profitability is dependent to a large extent upon net interest income, which is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings. Our Company, like other financial institutions, is subject to interest rate risk to the degree that interest-earning assets reprice differently than interest-bearing liabilities. We manage our mix of assets and liabilities with the goal of limiting exposure to interest rate risk, ensuring adequate liquidity, and coordinating sources and uses of funds while maintaining an acceptable level of net interest income given the current interest rate environment.

Our primary component of operational revenue, net interest income, is subject to variation as a result of changes in interest rate environments in conjunction with unbalanced repricing opportunities on earning assets and interest-bearing liabilities. Interest rate risk has four primary components: repricing risk, basis risk, yield curve risk and option risk. Repricing risk occurs when earning assets and paying liabilities reprice at differing times as interest rates change. Basis risk occurs when the underlying rates on the assets and liabilities the institution holds change at different levels or in varying degrees. Yield curve risk is the risk of adverse consequences as a result of unequal changes in the spread between two or more rates for different maturities for the same instrument. Lastly, option risk is due to embedded options, often put or call options, given or sold to holders of financial instruments.

To mitigate the effect of changes in the general level of interest rates, we manage repricing opportunities and thus, our interest rate sensitivity. We seek to control our interest rate risk exposure to insulate net interest income and net earnings from fluctuations in the general level of interest rates. To measure our exposure to interest rate risk, quarterly simulations of net interest income are performed using financial models that project net interest income through a range of possible interest rate environments including rising, declining, most likely and flat rate scenarios. We use a simulation model that captures all earning assets, interest-bearing liabilities, and off-balance sheet financial instruments and combines the various factors affecting rate sensitivity into an earnings outlook for a range of assumed interest rate scenarios. The results of these simulations indicate the existence and severity of interest rate risk in each of those rate environments based upon the current balance sheet position, assumptions as to changes in the volume and mix of interest-earning assets and interest-paying liabilities and our estimate of yields to be attained in those future rate environments and rates that will be paid on various deposit instruments and borrowings. These assumptions are inherently uncertain and, as a result, the model cannot precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and our strategies. However, the earnings simulation model is currently the best tool available to us and the industry for managing interest rate risk.

We have established policy limits for tolerance of interest rate risk in various interest rate scenarios. In addition, the policy addresses exposure limits to changes in the economic value of equity according to predefined policy guidelines. The most recent simulation indicates that current exposure to interest rate risk is within our defined policy limits.

The following table summarizes the impact of immediate and sustained rate shocks in the interest rate environment on net interest income. The model simulates plus 300 to minus 100 basis point changes from the base case rate simulation and illustrates the prospective effects of hypothetical interest rate changes over a twelve-month time period. This modeling technique, although useful, does not take into account all strategies that management might undertake in response to a sudden and sustained rate shock as depicted. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. As of March 31, 2013, the Federal Open Market Committee maintained a target range for federal funds of 0 to 25 basis points, rendering a complete downward shock of 200 basis points meaningless; accordingly, downward rate scenarios are limited to minus 100 basis points. In the downward rate shocks presented, benchmark interest rates are assumed at levels with floors near 0%.

| (Amounts in thousands, except basis points) Increase (Decrease) in Interest Rates/Basis Points | March 31, 2013 Change in Net Interest Income | Percent Change | December 31, 2012 Change in Net Interest Income | Percent Change |
| ---: | ---: | ---: | ---: | ---: |
| 300 | $9,330 | 11.3 | $10,928 | 13.2 |
| 200 | 5,842 | 7.1 | 7,455 | 9.0 |
| 100 | 2,617 | 3.2 | 3,606 | 4.4 |
| (100) | 68 | 0.1 | (35) | — |

During the next twelve months we have more assets than liabilities projected to reprice. As a result, projected net interest income will increase if and when benchmark rates increase. If benchmark interest rates decrease further than current levels, projected net interest income will remain roughly level.

### Impact of Inflation and Changing Prices

The consolidated financial statements and notes thereto presented herein have been prepared in accordance with GAAP, which requires the measurement of financial position and operating results in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The primary effect of inflation on our operations is reflected in increased operating costs. In management’s opinion, interest rates have a greater impact on our consolidated performance than do the effects of general levels of inflation. Interest rates do not necessarily fluctuate in the same direction or to the same extent as the price of goods and services.

## Controls and procedures

As filed, 2,584 characters.

### Evaluation of Disclosure Controls and Procedures

In connection with this report on Form 10-Q, we conducted an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures pursuant to the Securities Exchange Act of 1934 (the “Exchange Act”) Rule 13a-15(b). Based upon that evaluation, the CEO and CFO concluded that, as of March 31, 2013, our disclosure controls and procedures were effective.

Disclosure controls and procedures are Company controls and other procedures that are designed to ensure that information we are required to disclose in the reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information we are required to disclose in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including the CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

Management, including the CEO and CFO, does not expect that our disclosure controls and internal controls will prevent all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our Company have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, collusion of two or more people, or management’s override of the controls.

### Changes in Internal Control over Financial Reporting

We assess the adequacy of our internal control over financial reporting quarterly and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There were no changes in our internal control over financial reporting during the quarter ended March 31, 2013, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 559 characters.

Refer to our 2012 Form 10-K for disclosures with respect to our risk factors which could materially affect our business, financial condition, or future results. The risks described in the 2012 Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also adversely affect our business, financial condition, or operating results. There have been no material changes from the risk factors previously disclosed in Part I, Item 1A, “Risk Factors,” of our 2012 Form 10-K.

Filed May 10, 2013.
Source: SEC EDGAR, the filing index for accession 0001193125-13-214409. Last ingested by Listed: Nov 6, 2026, 14:30 ET. No prices; not investment advice.