# First Community Bankshares Inc: Form 10-Q for the period ended Mar 31, 2014

- Company: [First Community Bankshares Inc](/companies/fcbc.md) (CIK 859070)
- Form: 10-Q
- Filed: 2014-05-09
- Accepted by EDGAR: May 9, 2014, 16:35 ET
- Period: 2014-03-31
- Accession: 0001193125-14-192577
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/859070/000119312514192577/d719666d10q.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/859070/000119312514192577/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2014-03-31.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Interest expense | 3 months, 2014-01-01 to 2014-03-31 | $4.1m | us-gaap:InterestExpense |
| Income tax | 3 months, 2014-01-01 to 2014-03-31 | $2.6m | us-gaap:IncomeTaxExpenseBenefit |
| Net income | 3 months, 2014-01-01 to 2014-03-31 | $5.7m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2014-01-01 to 2014-03-31 | $0.29 | us-gaap:EarningsPerShareDiluted |
| Basic EPS | 3 months, 2014-01-01 to 2014-03-31 | $0.30 | us-gaap:EarningsPerShareBasic |
| Diluted shares (weighted) | 3 months, 2014-01-01 to 2014-03-31 | 19,506,647 shares | us-gaap:WeightedAverageNumberOfDilutedSharesOutstanding |
| Operating cash flow | 3 months, 2014-01-01 to 2014-03-31 | $13.0m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 3 months, 2014-01-01 to 2014-03-31 | $204.0k | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Dividends paid | 3 months, 2014-01-01 to 2014-03-31 | $2.2m | us-gaap:PaymentsOfDividendsCommonStock |
| Share repurchases | 3 months, 2014-01-01 to 2014-03-31 | $2.1m | us-gaap:PaymentsForRepurchaseOfCommonStock |
| Cash and equivalents | at 2014-03-31 | $79.0m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Total assets | at 2014-03-31 | $2.61bn | us-gaap:Assets |
| Total liabilities | at 2014-03-31 | $2.28bn | us-gaap:Liabilities |
| Shareholders' equity | at 2014-03-31 | $333.9m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 53,518 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 help the reader understand our financial condition, changes in financial condition, and results of operations. MD&A contains forward-looking statements and should be read in conjunction with our consolidated financial statements, accompanying notes, and other financial information included in this Quarterly Report on Form 10-Q and our 2013 Annual Report on Form 10-K (the “2013 Form 10-K”).

### Cautionary Statement Regarding 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, filings incorporated by reference, reports to our shareholders, and other communications that we make in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements represent our beliefs, plans, objectives, goals, guidelines, expectations, anticipations, estimates, and intentions. Such statements are subject to significant risks, uncertainties, and 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 U.S. 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 System;
- 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 impact of the U.S. Department of the Treasury and federal banking regulators’ continued implementation of programs to address capital and liquidity in the banking system; further, future and proposed rules, including those that are part of the process outlined in the International Basel Committee on Banking Supervision’s “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems,” which are expected to require banking institutions to increase levels of capital;
- 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, our actual results, performance, or achievements could differ materially from those expressed in, or implied by, forward-looking statements contained in this Annual Report on Form 10-K 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 changes. All forward-looking statements attributable to our Company are expressly qualified by these cautionary statements. See Part II, Item 1A, “Risk Factors,” of this report and Part I, Item 1A, “Risk Factors,” of our 2013 Form 10-K.

### Company Overview

First Community Bancshares, Inc. (“the Company”) is a financial holding company, headquartered in Bluefield, Virginia, that provides commercial banking services through its wholly-owned subsidiary First Community Bank (the “Bank”). The Bank operates sixty-eight locations under the name First Community Bank in West Virginia, Virginia, and North Carolina and under the trade name Peoples Community Bank, a Division of First Community Bank, in Tennessee and South Carolina. The Bank offers wealth management and investment advice through its wholly-owned subsidiary First Community Wealth Management (“FCWM”) and the Bank’s Trust Division, which reported combined assets under management of $697 million as of March 31, 2014. These assets are not our assets, but are managed under various fee-based arrangements as fiduciary or agent. The Company provides insurance services through its wholly-owned subsidiary Greenpoint Insurance Group, Inc. (“Greenpoint”), headquartered in High Point, North Carolina, which operates nine locations under the Greenpoint name and under the trade names First Community Insurance Services (“FCIS”) and Carolina Insurers Associates in North Carolina, Carr & Hyde Insurance and FCIS in Virginia, and FCIS in West Virginia. We reported total assets of $2.61 billion as of March 31, 2014. 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, with additional funding provided by retail and wholesale repurchase agreements and borrowings from the Federal Home Loan Bank (“FHLB”). 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 the 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 generally accepted accounting principles (“GAAP”) in the United States 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 based on historical experience and other factors including expectations of future events believed to be reasonable under the circumstances that are periodically evaluated. These estimates are generally necessary when assets and liabilities are required to be recorded at estimated fair value, a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or establishment of a valuation reserve, or an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. Fair values and information used to record valuation adjustments for certain assets and liabilities are based either on quoted market prices or, when available, are provided by third-party sources. When third-party information is not available, valuation adjustments are estimated by management primarily through the use of financial modeling techniques and appraisal estimates. Our accounting policies are fundamental in understanding MD&A and the disclosures presented in the notes to consolidated statements. Our critical accounting estimates are described in detail in the “Critical Accounting Estimates” section in Part II, Item 7 of our 2013 Form 10-K.

### Performance Overview

Highlights of our results of operations for the quarter ended March 31, 2014, and financial condition as of March 31, 2014, include the following:

- The non-covered loan portfolio increased $29.66 million compared to year-end 2013 and $94.46 million compared to the first quarter of 2013. The increase from March 31, 2013, is primarily attributed to new commercial real estate volume in Southern West Virginia and Central North Carolina. This marks the fourth consecutive quarter non-covered loan growth has exceeded covered loan declines.
- Annualized growth in the non-covered loan portfolio was 7.71% during the quarter.
- Non-covered delinquent loans as a percentage of total non-covered loans experienced a significant decrease of 104 basis points, or 36.78%, to 1.79% compared to the first quarter of 2013. The decrease is attributed to declines in both past due and nonaccrual loans.
- The Company repurchased 131,500 shares during the quarter.
- The Company significantly exceeds regulatory “well capitalized” targets as of March 31, 2014, with a total risk-based capital ratio of 16.24%, a Tier 1 risk-based capital ratio of 14.98%, and a Tier 1 leverage ratio of 10.13%.

### Results of Operations

#### Net Income

The following table presents our net income and related information in the periods indicated:

*(Amounts in thousands, except per share data)*

|  | Three Months Ended March 31, 2014 | 2013 | Three Months Ended Increase (Decrease) | % Change |
| --- | ---: | ---: | ---: | ---: |
| Net income | $5,725 | $7,141 | $(1,416) | -19.83% |
| Net income available to common shareholders | 5,497 | 6,883 | (1,386) | -20.14% |
| Basic earnings per common share | 0.30 | 0.34 | (0.04) | -11.76% |
| Diluted earings per common share | 0.29 | 0.34 | (0.05) | -14.71% |
| Return on average assets | 0.86% | 1.03% | -0.17% | -16.50% |
| Return on average common equity | 7.02% | 8.11% | -1.09% | -13.44% |

*Three Month Comparison.* Net income decreased in the first quarter of 2014 compared to the same quarter of the prior year primarily due to the decrease in interest earned on loans as the average loan yield decreased 52 basis points, or 8.63% in the first quarter of 2014 compared to the same quarter of the prior year.

#### Net Interest Income

Net interest income, our largest contributor to earnings, comprised 75.28% of total net interest and noninterest income in the first quarter of 2014 compared to 74.82% in the same quarter of 2013. For the following 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 non-GAAP, management believes this financial measure is more widely used in the financial services industry and provides better comparability of net interest income arising from taxable and tax-exempt sources. We use this non-GAAP financial measure to monitor net interest income performance and manage the composition of our balance sheet. The following table presents our average consolidated balance sheets in the periods indicated:

*(Amounts in thousands)*

| Assets Earning assets | Three Months Ended March 31, 2014 Average Balance | Interest(1) | Average Yield/ Rate(1) | 2013 Average Balance | Interest(1) | Average Yield/ Rate(1) |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Loans(2) | $1,717,908 | $22,893 | 5.40% | $1,706,296 | $24,888 | 5.92% |
| Securities available-for-sale | 499,851 | 3,808 | 3.09% | 544,681 | 3,728 | 2.78% |
| Securities held-to-maturity | 1,367 | 15 | 4.45% | 816 | 17 | 8.45% |
| Interest-bearing deposits | 26,395 | 30 | 0.46% | 98,893 | 66 | 0.27% |
| Total earning assets | 2,245,521 | 26,746 | 4.83% | 2,350,686 | 28,699 | 4.95% |
| Other assets | 346,019 |  |  | 352,343 |  |  |
| Total assets | $2,591,540 |  |  | $2,703,029 |  |  |
| Liabilities |  |  |  |  |  |  |
| Interest-bearing deposits |  |  |  |  |  |  |
| Demand deposits | $370,021 | $54 | 0.06% | $353,677 | $56 | 0.06% |
| Savings deposits | 530,031 | 137 | 0.10% | 505,917 | 155 | 0.12% |
| Time deposits | 714,402 | 1,697 | 0.96% | 816,060 | 2,151 | 1.07% |
| Total interest-bearing deposits | 1,614,454 | 1,888 | 0.47% | 1,675,654 | 2,362 | 0.57% |
| Borrowings |  |  |  |  |  |  |
| Federal funds purchased | 3,547 | 3 | 0.34% | — | — | — |
| Retail repurchase agreements | 67,356 | 26 | 0.16% | 75,751 | 105 | 0.56% |
| Wholesale repurchase agreements | 50,000 | 463 | 3.76% | 57,645 | 475 | 3.34% |
| FHLB advances and other borrowings | 166,087 | 1,678 | 4.10% | 175,937 | 1,700 | 3.92% |
| Total borrowings | 286,990 | 2,170 | 3.07% | 309,333 | 2,280 | 2.99% |
| Total interest-bearing liabilities | 1,901,444 | 4,058 | 0.87% | 1,984,987 | 4,642 | 0.95% |
| Noninterest-bearing demand deposits | 336,573 |  |  | 332,186 |  |  |
| Other liabilities | 20,918 |  |  | 24,307 |  |  |
| Total liabilities | 2,258,935 |  |  | 2,341,480 |  |  |
| Stockholders’ equity | 332,605 |  |  | 361,549 |  |  |
| Total liabilities and stockholders’ equity | $2,591,540 |  |  | $2,703,029 |  |  |
| Net interest income, tax equivalent |  | $22,688 |  |  | $24,057 |  |
| Net interest rate spread(3) |  |  | 3.96% |  |  | 4.00% |
| Net interest margin(4) |  |  | 4.10% |  |  | 4.15% |

(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 presents the impact on tax equivalent net interest income resulting from changes in volume, the average volume times the prior year’s average rate; rate, the average rate times the prior year’s average volume; and rate/volume, the average volume column times the change in average rate, in the periods indicated:

*(Amounts in thousands)*

| Interest earned on: | Three Months Ended March 31, 2014 Compared to 2013 Dollar Increase (Decrease) due to Volume | Rate | Rate/ Volume | Total |
| --- | ---: | ---: | ---: | ---: |
| Loans (FTE) | $169 | $(2,150) | $(14) | $(1,995) |
| Securities available-for-sale (FTE) | (307) | 422 | (35) | 80 |
| Securities held-to-maturity (FTE) | 11 | (8) | (5) | (2) |
| Interest-bearing deposits with other banks | (48) | 46 | (34) | (36) |
| Total interest earning assets | (175) | (1,690) | (88) | (1,953) |
| Interest paid on: |  |  |  |  |
| Demand deposits | 3 | (4) | (1) | (2) |
| Savings deposits | 7 | (24) | (1) | (18) |
| Time deposits | (268) | (213) | 27 | (454) |
| Federal funds purchased | — | — | 3 | 3 |
| Retail repurchase agreements | (12) | (76) | 9 | (79) |
| Wholesale repurchase agreements | (63) | 59 | (8) | (12) |
| FHLB advances and other borrowings | (95) | 78 | (5) | (22) |
| Total interest-bearing liabilities | (428) | (180) | 24 | (584) |
| Change in net interest income, tax equivalent | $253 | $(1,510) | $(112) | $(1,369) |

The following table reconciles the differences between net interest income under GAAP and net interest income on a tax equivalent basis in the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2014 | 2013 |
| --- | ---: | ---: |
| Net interest income, GAAP basis | $22,025 | $23,362 |
| Tax equivalent adjustment(1) | 663 | 695 |
| Net interest income, tax equivalent | $22,688 | $24,057 |

(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.

Interest and yield on loans include accretion income from the Peoples and Waccamaw acquired loan portfolios. We expect the purchase accounting interest accretion to continue to decline in future periods due to acquired portfolio attrition. The following table presents net interest margin and related average balance sheet information excluding the impact of purchase accounting accretion in the periods indicated:

*(Amounts in thousands)*

| Earning assets | Three Months Ended March 31, 2014 Interest(1) | Average Yield/ Rate(1) | 2013 Interest(1) | Average Yield/ Rate(1) |
| --- | ---: | ---: | ---: | ---: |
| Loans(2) | $22,893 | 5.40% | $24,888 | 5.92% |
| Accretion income | 3,122 |  | 3,842 |  |
| Less: cash accretion income | 600 |  | 1,782 |  |
| Non-cash accretion income | 2,522 |  | 2,060 |  |
| Loans, excluding non-cash accretion | 20,371 | 4.81% | 22,828 | 5.43% |
| Other earning assets | 3,853 | 2.96% | 3,811 | 2.40% |
| Total earning assets | 24,224 | 4.38% | 26,639 | 4.60% |
| Total interest-bearing liabilities | 4,058 | 0.87% | 4,642 | 0.95% |
| Net interest income, tax equivalent | $20,166 |  | $21,997 |  |
| Net interest rate spread(3), less non-cash accretion |  | 3.51% |  | 3.65% |
| Net interest margin(4), less non-cash accretion |  | 3.64% |  | 3.80% |

(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.

*Three Month Comparison*. Net interest income under GAAP decreased $1.34 million, or 5.72%, and tax equivalent net interest income decreased $1.37 million, or 5.69%, in the first quarter of 2014 compared to the same quarter of the prior year. Changes in the average balances of and yields/rates on earning assets and interest-bearing liabilities resulted in a 4 basis point decrease in the net interest rate spread and a 5 basis point decrease in the net interest margin.

Loan interest accretion stemming from the Peoples and Waccamaw acquisitions totaled $3.12 million in the first quarter of 2014, of which $600 thousand was received in cash, and $3.84 million in the same quarter of the prior year, of which $1.78 million was received in cash. Excluding non-cash accretion income, the yield on loans decreased 62 basis points, which compares to a decrease of 52 basis points under GAAP. Excluding non-cash accretion income, the net interest margin decreased 16 basis points, which compares to a decrease of 5 basis points under GAAP. We expect the effect of accretion income on acquired loans to continue to be lessened in future periods.

Average earning assets decreased $105.17 million, or 4.47%, in the first quarter of 2014 compared to the same quarter of the prior year primarily due to decreases in interest-bearing deposits with banks, which are primarily comprised of excess liquidity kept at the Federal Reserve Bank (“FRB”) of Richmond bearing overnight market rates, and securities available for sale. The yield on earning assets decreased 12 basis points, which was largely due to a 52 basis point decrease in the yield on loans, a result of the continued low rate environment, and a 400 basis point decrease in the yield on held-to-maturity securities, due to new investments in lower yielding securities. During the first quarter of 2014, we purchased medium-term bonds in the held-to-maturity category to provide for the funding necessary to extinguish certain wholesale borrowings as they come due.

As of March 31, 2014, interest-bearing liabilities included interest-bearing deposits; retail repurchase agreements, consisting of collateralized retail deposits and commercial treasury accounts; wholesale repurchase agreements; Federal Home Loan Bank (“FHLB”) advances; and other borrowings. Average interest-bearing liabilities decreased $83.54 million, or 4.21%, in the first quarter of 2014 compared to the same quarter of the prior year, primarily due to declines in average time deposit balances. The yield on interest-bearing liabilities decreased 8 basis points, which was largely due to a 10 basis point decrease in the rate on interest-bearing deposits. Average interest-bearing deposits decreased $61.20 million, or 3.65% which was driven by a $101.66 million, or 12.46%, decrease in average time deposits, partially offset by increases in average interest-bearing demand deposits of $16.34 million, or 4.62%, and average savings deposits, which include money market and savings accounts, of $24.11 million, or 4.77%. Average borrowings decreased $22.34 million, or 7.22%, largely due to the prepayment of certain borrowings acquired from Waccamaw totaling $19.62 million during the first quarter of 2013.

#### Provision for Loan Losses

The provision for loan losses is the amount added to the allowance for loan losses after net charge-offs have been deducted in order to bring the allowance to a level management determines necessary to absorb probable losses in the existing loan portfolio. The provision charged to operations was increased by $651 thousand in the first quarter of 2014 compared to the same quarter of the prior year due to an increase in specific reserves on loans identified as impaired during the quarter and growth in the non-covered loan portfolio. A net recovery of $262 thousand was attributed to the provision for purchased credit impaired (“PCI”) loans in the first quarter of 2014 due to better than expected performance in the Waccamaw PCI loan portfolio, of which $59 thousand was credited to operations and $203 thousand was recorded through the FDIC indemnification asset to reflect the indemnified portion of the post-acquisition exposure. There was no provision attributed to PCI loans prior to the second quarter of 2013. See “Allowance for Loan Losses” in the “Financial Condition” section below.

#### Noninterest Income

Noninterest income consists of all revenues not included in interest and fee income related to earning assets. Noninterest income comprised 24.72% of total net interest and noninterest income in the first quarter of 2014 compared to 25.18% in the same quarter of the prior year. The following table presents the components of, and changes in, noninterest income in the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2014 | 2013 | Three Months Ended Increase (Decrease) | % Change |
| --- | ---: | ---: | ---: | ---: |
| Wealth management | $1,008 | $846 | $162 | 19.15% |
| Service charges on deposit accounts | 3,070 | 3,168 | (98) | -3.09% |
| Other service charges and fees | 1,771 | 1,786 | (15) | -0.84% |
| Insurance commissions | 1,964 | 1,666 | 298 | 17.89% |
| Net impairment loss | (264) | — | (264) | 0.00% |
| Net gain on sale of securities | 45 | 117 | (72) | -61.54% |
| Net FDIC indemnification asset amortization | (1,134) | (1,539) | 405 | -26.32% |
| Other operating income | 774 | 1,817 | (1,043) | -57.40% |
| Noninterest income | $7,234 | $7,861 | $(627) | -7.98% |

*Three Month Comparison*. Noninterest income decreased $627 thousand, or 7.98%, in the first quarter of 2014 compared to the same quarter of the prior year. Wealth management revenues, which include fees and commissions for trust and investment advisory services, increased as a result of the recognition of estate settlement fees. Service charges on deposit accounts and other charges and fees decreased primarily from a reduction in non-sufficient funds and interchange fee income. Insurance commissions increased largely due to increased levels of contingent profit-sharing commissions and a general increase in premium commissions. In the first quarter of 2014, we incurred OTTI charges of $264 thousand related to a non-Agency mortgage-backed security (“MBS”) and certain equity holdings and realized a net gain of $45 thousand on the sale of securities. See Note 2, “Investment Securities,” to the Condensed Consolidated Financial Statements in Item 1 of this report. We recorded net amortization related to the FDIC indemnification asset of $1.13 million as a result of improved loss estimates in the covered Waccamaw loan portfolio. Other operating income decreased primarily due to a $301 thousand decrease in secondary market income, a $296 thousand decrease in income from bank owned life insurance policies, and a $392 thousand decrease in gains recognized in 2013 from debt prepayments.

Excluding the impact from OTTI charges, the sale of securities, and the net amortization on the FDIC indemnification asset, noninterest income decreased $696 thousand, or 7.50%, to $8.59 million in the first quarter of 2014, compared with $9.28 million in the same quarter of the prior year.

#### Noninterest Expense

The following table presents the components of, and changes in, noninterest expense in the periods indicated:

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2014 | 2013 | Three Months Ended Increase (Decrease) | % Change |
| --- | ---: | ---: | ---: | ---: |
| Salaries and employee benefits | $9,905 | $10,110 | $(205) | -2.03% |
| Occupancy of bank premises | 1,778 | 1,855 | (77) | -4.15% |
| Furniture and equipment | 1,194 | 1,343 | (149) | -11.09% |
| Amortization of intangible assets | 175 | 179 | (4) | -2.23% |
| FDIC premiums and assessments | 434 | 472 | (38) | -8.05% |
| Merger related expense | — | 49 | (49) | -100.00% |
| Other operating expense | 5,694 | 5,536 | 158 | 2.85% |
| Total noninterest expense | $19,180 | $19,544 | $(364) | -1.86% |

*Three Month Comparison*. Noninterest expense decreased $364 thousand, or 1.86%, in the first quarter of 2014 compared to the same quarter of the prior year. Full-time equivalent employees, calculated using the number of hours worked, decreased to 706 as of March 31, 2014, from 746 as of March 31, 2013. The reduction in full-time equivalent employees was seen throughout our corporate and branch network. Occupancy, furniture, and equipment expense decreased $226 thousand, or 7.07%, in the first quarter of 2014, which included a $76 thousand decrease in property taxes and a $71 thousand decrease in depreciation costs. The increase in other operating expense included a net loss on sales and expenses on OREO of $857 thousand in the first quarter of 2014 compared to $625 thousand in the same period of the prior year 2012, as well as an increase in ATM processing expense of $171 thousand.

#### 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 generally include interest income on municipal securities and increases in the cash surrender value of officers’ life insurance policies, which are both exempt from federal income tax. Income tax expense decreased $835 thousand, or 24.59%, and the effective rate decreased 132 basis points to 30.91% in the first quarter of 2014 compared to the same quarter of the prior year. The decrease in the effective tax rate was largely due to a decrease in taxable revenues as a percent of net earnings.

### Financial Condition

Total assets were $2.61 billion as of March 31, 2014, an increase of $7.83 million, or 0.30%, compared with $2.60 billion as of December 31, 2013. Total liabilities were $2.28 billion as of March 31, 2014, an increase of $2.53 million, or 0.11%, compared with $2.27 billion as of December 31, 2013. Our book value per as-converted common share was $17.18 as of March 31, 2014, an increase of $0.39, compared to December 31, 2013.

#### Investment Securities

Available-for-sale securities as of March 31, 2014, decreased $35.96 million, or 6.92%, compared to December 31, 2013. The market value of securities available-for-sale as a percentage of amortized cost was 96.91% as of March 31, 2014, compared to 95.97% as of December 31, 2013.

Held-to-maturity securities as of March 31, 2014, increased $7.59 million compared to $568 thousand as of December 31, 2013, due to the purchase of medium-term bonds to provide funding to extinguish certain wholesale borrowings when due. Investment securities classified as held to maturity are comprised primarily of U.S. Agency securities and high grade municipal bonds. The market value of securities held to maturity as a percentage of amortized cost was 99.84% as of March 31, 2014, compared with 101.94% as of December 31, 2013.

We recognized credit-related OTTI charges in earnings associated with debt securities beneficially owned of $232 thousand for the three months ended March 31, 2014, and no charges for the three months ended March 31, 2013. These charges were related to a non-Agency MBS. Temporary impairment on the non-Agency MBS is primarily related to changes in interest rates. We recognized OTTI charges in earnings associated with certain equity securities of $32 thousand for the three months ended March 31, 2014, and no charges for the three months ended March 31, 2013. See Note 2, “Investment Securities,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

#### Loans Held for Sale

Loans held for sale as of March 31, 2014, increased $860 thousand, or 97.40%, compared to December 31, 2013. 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 as of March 31, 2014, was $2.04 million for 10 loans compared to $3.68 million for 19 loans as of December 31, 2013.

#### Loans Held for Investment

Loans held for investment as of March 31, 2014, increased $21.14 million, or 1.24%, compared to December 31, 2013. The increase was primarily due to increased draw activity related to existing construction loans coupled with continued growth in commercial real estate originations. The non-covered loan portfolio increased $29.66 million, or 1.90%, compared to December 31, 2013. The average loan to deposit ratio was 88.05% for the three months ended March 31, 2014, compared to 84.98% for the same period of 2013. Our loans held for investment are grouped into three segments (commercial loans, consumer real estate loans, and consumer and other loans) with each segment divided into various classes. Covered loans are defined as loans acquired in FDIC-assisted transactions that are covered by loss share agreements. See Note 3, “Loans,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table presents loans, net of unearned income with non-covered loans disaggregated by class, as of the periods indicated.

*(Amounts in thousands)*

| Non-covered loans held for investment Commercial loans | March 31, 2014 Amount | Percent | December 31, 2013 Amount | Percent | March 31, 2013 Amount | Percent |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Construction, development, and other land | $45,661 | 2.64% | $35,255 | 2.06% | $55,220 | 3.27% |
| Commercial and industrial | 94,403 | 5.45% | 95,455 | 5.58% | 91,666 | 5.43% |
| Multi-family residential | 75,594 | 4.36% | 70,197 | 4.10% | 63,929 | 3.78% |
| Single family non-owner occupied | 137,969 | 7.97% | 135,559 | 7.92% | 136,334 | 8.07% |
| Non-farm, non-residential | 484,361 | 27.97% | 475,911 | 27.82% | 440,226 | 26.06% |
| Agricultural | 2,093 | 0.12% | 2,324 | 0.14% | 2,117 | 0.12% |
| Farmland | 32,410 | 1.87% | 32,614 | 1.91% | 33,930 | 2.01% |
| Total commercial loans | 872,491 | 50.38% | 847,315 | 49.53% | 823,422 | 48.74% |
| Consumer real estate loans |  |  |  |  |  |  |
| Home equity lines | 113,137 | 6.53% | 111,770 | 6.53% | 108,385 | 6.42% |
| Single family owner occupied | 492,627 | 28.45% | 496,012 | 28.99% | 470,437 | 27.85% |
| Owner occupied construction | 34,360 | 1.98% | 28,703 | 1.68% | 19,760 | 1.17% |
| Total consumer real estate loans | 640,124 | 36.96% | 636,485 | 37.20% | 598,582 | 35.44% |
| Consumer and other loans |  |  |  |  |  |  |
| Consumer loans | 72,111 | 4.16% | 71,313 | 4.17% | 68,625 | 4.06% |
| Other | 3,968 | 0.23% | 3,926 | 0.23% | 3,603 | 0.21% |
| Total consumer and other loans | 76,079 | 4.39% | 75,239 | 4.40% | 72,228 | 4.27% |
| Non-covered loans held for investment | 1,588,694 | 91.73% | 1,559,039 | 91.13% | 1,494,232 | 88.45% |
| Covered loans | 143,170 | 8.27% | 151,682 | 8.87% | 195,060 | 11.55% |
| Less unearned income | — | — | — |  | — |  |
| Total loans held for investment | 1,731,864 | 100.00% | 1,710,721 | 100.00% | 1,689,292 | 100.00% |
| Allowance for loan losses | 23,798 |  | 24,077 |  | 24,850 |  |
| Total loans held for investment, less allowance | 1,708,066 |  | 1,686,644 |  | 1,664,442 |  |
| Loans held for sale | $1,743 |  | $883 |  | $2,794 |  |

48

#### 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 with a discount continue to accrue interest based on expected cash flows; therefore, PCI loans are generally not considered nonaccrual. See Note 5, “Credit Quality,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

The following table summarizes the components of nonperforming assets and presents additional details for nonperforming and restructured loans as of the periods indicated:

*(Amounts in thousands)*

| Non-covered nonperforming | March 31, 2014 | December 31, 2013 | March 31, 2013 |
| --- | ---: | ---: | ---: |
| Nonaccrual loans | $20,909 | $19,161 | $30,076 |
| Accruing loans past due 90 days or more | — | — | — |
| TDRs(1) | 1,775 | 1,311 | 1,596 |
| Total nonperforming loans | 22,684 | 20,472 | 31,672 |
| Non-covered OREO | 5,923 | 7,318 | 4,439 |
| Total nonperforming assets | $28,607 | $27,790 | $36,111 |
| **Covered nonperforming** |  |  |  |
| Nonaccrual loans | $1,261 | $3,353 | $4,567 |
| Accruing loans past due 90 days or more | 109 | 86 | — |
| Total nonperforming loans | 1,370 | 3,439 | 4,567 |
| Covered OREO | 8,705 | 7,541 | 6,911 |
| Total nonperforming assets | $10,075 | $10,980 | $11,478 |
| **Total nonperforming** |  |  |  |
| Nonaccrual loans | $22,170 | $22,514 | $34,643 |
| Accruing loans past due 90 days or more | 109 | 86 | — |
| TDRs(1) | 1,775 | 1,311 | 1,596 |
| Total nonperforming loans | 24,054 | 23,911 | 36,239 |
| OREO | 14,628 | 14,859 | 11,350 |
| Total nonperforming assets | $38,682 | $38,770 | $47,589 |
| **Additional Information** |  |  |  |
| Performing TDRs(2) | $11,193 | $10,900 | $10,272 |
| Total TDRs(3) | 12,968 | 12,211 | 11,868 |
| **Non-covered ratios** |  |  |  |
| Nonperforming loans to total loans | 1.43% | 1.31% | 2.12% |
| Nonperforming assets to total assets | 1.16% | 1.14% | 1.43% |
| Non-PCI allowance to nonperforming loans | 102.74% | 113.92% | 78.46% |
| Non-PCI allowance to total loans | 1.47% | 1.50% | 1.66% |
| **Total ratios** |  |  |  |
| Nonperforming loans to total loans | 1.39% | 1.40% | 2.15% |
| Nonperforming assets to total assets | 1.48% | 1.49% | 1.75% |
| Allowance for loan losses to nonperforming loans | 98.94% | 100.69% | 68.57% |
| Allowance for loan losses to total loans | 1.37% | 1.41% | 1.47% |

(1) TDRs restructured within the past six months, excludes nonaccrual TDRs of $722 thousand, $734 thousand, and $675 thousand for the periods ended March 31, 2014, December 31, 2013, and March 31, 2013, respectively.

(2) TDRs with six months or more of satisfactory payment performance, excludes nonaccrual TDRs of $1.41 million, $1.47 million, and $1.67 million for the periods ended March 31, 2014, December 31, 2013, and March 31, 2013, respectively.

(3) Perfoming and nonperforming TDRs, excludes nonaccrual TDRs of $2.13 million, $2.20 million, and $2.34 million for the periods ended March 31, 2014, December 31, 2013, and March 31, 2013, respectively.

Non-covered nonperforming assets totaled $28.61 million as of March 31, 2014, an $817 thousand increase over December 31, 2013, and a $7.50 million decrease from March 31, 2013. Non-covered nonperforming assets as a percentage of total non-covered assets were 1.16% as of March 31, 2014, 1.14% as of December 31, 2013, and 1.43% as of March 31, 2013.

Non-covered nonaccrual loans totaled $20.91 million as of March 31, 2014, $19.16 million as of December 31, 2013, and $30.08 million as of March 31, 2013. As of March 31, 2014, non-covered nonaccrual loans were largely attributed to the following loan classes: single family owner occupied (37.74%); commercial and industrial (25.66%); non-farm, non-residential (14.22%); and single family nonowner occupied (11.51%). As of March 31, 2014, approximately $2.65 million, or 12.67%, of non-covered nonaccrual loans were attributed to performing 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 $12.97 million as of March 31, 2014, $12.21 million as of December 31, 2013, and $11.87 million as of March 31, 2013. Nonperforming accruing TDRs totaled $1.78 million, or 13.69%, of total accruing TDRs as of March 31, 2014, as compared to 10.74% of accruing TDRs as of December 31, 2013, and 13.45% of accruing TDRs as of March 31, 2013. The allowance for loan losses attributed to TDRs totaled $1.83 million as of March 31, 2014, $1.84 million as of December 31, 2013, and $1.65 million as of March 31, 2013.

Ongoing activity in 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. Covered accruing loans contractually past due 90 days or more totaled $109 thousand as of March 31, 2014, compared to $86 thousand as of December 31, 2013, and none as of March 31, 2013.

Non-covered OREO, which is carried at the lesser of estimated net realizable value or cost, totaled $5.92 million as of March 31, 2014, a decrease of $1.40 million, or 19.06%, compared with December 31, 2013. As of March 31, 2014, non-covered OREO consisted of 55 properties with an average holding period of 8 months. The net loss on the sale of OREO totaled $714 thousand in the first quarter of 2014 and $400 thousand in the same quarter of the prior year. Pursuant to FDIC loss share agreements, covered OREO is presented net of the related fair value discount. The following tables detail 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 |
| 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 |
| Beginning balance, January 1, 2014 | $7,318 | $7,541 | $14,859 |
| Additions | 533 | 2,160 | 2,693 |
| Disposals | (1,469) | (382) | (1,851) |
| Valuation adjustments | (459) | (614) | (1,073) |
| Ending balance, March 31, 2014 | $5,923 | $8,705 | $14,628 |

Non-covered delinquent loans, comprised of loans 30 days or more past due and nonaccrual loans, totaled $28.41 million as of March 31, 2014, a decrease of $2.46 million, or 7.96%, compared with December 31, 2013. Non-covered delinquent loans as a percentage of total non-covered loans measured 1.79% as of March 31, 2014, which is attributed to loans 30 to 89 days past due of 0.47% and nonaccrual loans of 1.32%. Non-covered nonperforming loans, comprised of nonaccrual loans, nonperforming TDRs, and unseasoned TDRs, as a percentage of total non-covered loans were 1.43% as of March 31, 2014, 1.31% at December 31, 2013, and 2.12% at March 31, 2013.

#### 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 and recoveries of prior loan charge-offs and decreased by loans charged off. The provision for loan losses is calculated and charged to expense to bring the allowance to an appropriate level using a systematic process of measurement that requires significant judgments and estimates.

Management performs quarterly assessments to determine the appropriate level of the allowance for loan losses. The allowance for loan losses includes specific allocations to significant individual loans and credit relationships and general reserves to the remaining loans that have been deemed impaired. Loans not specifically identified are grouped into pools based on similar risk characteristics. Management’s general reserve allocations are based on judgments of qualitative and quantitative factors about macro and micro economic conditions reflected in the loan portfolio and the economy. For loans acquired in business combinations, a provision is recorded for any credit deterioration after the acquisition. Loans identified with credit impairment at acquisition are grouped into pools and evaluated separately from the non-PCI portfolio. The provision calculated for PCI loans is offset by an adjustment to the FDIC indemnification asset to reflect the indemnified portion of the post-acquisition exposure. See “Critical Accounting Estimates” above, as well as “Significant Accounting Policies” in Note 1, “General,” and Note 6, “Allowance for Loan Losses,” to the Condensed Consolidated Financial Statements in Item 1 of this report.

Our allowance for loan losses, excluding PCI loans, as a percentage of non-covered loans declined during the first quarter of 2014. Our qualitative risk factors reflected a reduced risk of loan losses due to improvements in unemployment trends, general economic conditions, and asset quality metrics. As of March 31, 2014, management considered the allowance to be adequate based upon analysis of the portfolio; however, no assurance can be made that additions to the allowance will not be required in future periods. Net charge-offs decreased $193 thousand, or 9.36%, in the first quarter of 2014 compared to the same quarter of the prior year.

Our allowance for loan losses totaled $23.80 million as of March 31, 2014, $24.08 million as of December 31, 2013, and $24.85 million as of March 31, 2013. The allowance attributed to non-PCI loans as a percentage of non-covered loans held for investment was 1.47% as of March 31, 2014, 1.50% at December 31, 2013, and 1.66% at March 31, 2013. The cash flow analysis performed for the first quarter of 2014 identified three of our seven PCI loan pools as impaired with a cumulative impairment of $485 thousand at March 31, 2014. 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.

The following table presents activity in our allowance for loan losses for the periods indicated.

*(Amounts in thousands)*

|  | Three Months Ended March 31, 2014 Non-acquired Impaired | Acquired Impaired | Total | 2013 Non-acquired Impaired | Acquired Impaired | Total |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Beginning balance | $23,322 | $755 | $24,077 | $25,762 | $8 | $25,770 |
| Provision for loan losses | 1,852 | (262) | 1,590 | 1,142 | — | 1,142 |
| Benefit attributable to the FDIC indemnification asset | — | 203 | 203 | — | — | — |
| Provision for loan losses charged to operations | 1,852 | (59) | 1,793 | 1,142 | — | 1,142 |
| Provision for loan losses recorded through the FDIC indemnification asset | — | (203) | (203) | — | — | — |
| Charge-offs | (2,216) | — | (2,216) | (2,759) | — | (2,759) |
| Recoveries | 347 | — | 347 | 697 | — | 697 |
| Net charge-offs | (1,869) | — | (1,869) | (2,062) | — | (2,062) |
| Ending balance | $23,305 | $493 | $23,798 | $24,842 | $8 | $24,850 |

#### Deposits

Total deposits as of March 31, 2014, increased $23.95 million, or 1.23%, compared to December 31, 2013. Noninterest-bearing deposits increased $13.46 million, interest-bearing deposits increased $20.93 million, and savings deposits, which include money market and savings accounts, increased $7.09 million as of March 31, 2014, compared to December 31, 2013. Time deposits decreased $17.53 million as of March 31, 2014, compared to December 31, 2013.

#### Borrowings

Total borrowings as of March 31, 2014, decreased $21.97 million, or 7.31%, compared to December 31, 2013. Short-term borrowings consist of federal funds purchased and retail repurchase agreements. No federal funds were purchased as of March 31, 2014, compared to $16.00 million as of December 31, 2013. The balance of retail repurchase agreements decreased $5.97 million, or 5.05%, as of March 31, 2014, compared to December 31, 2013. Long-term borrowings consist of wholesale repurchase agreements; FHLB borrowings, including convertible and callable advances; and other obligations. The balance and weighted average rate of wholesale repurchase agreements remained constant at $50.00 million and 3.71%, respectively, as of March 31, 2014, compared to December 31, 2013. As of March 31, 2014, wholesale repurchase agreements had contractual maturities between two and five years. The balance and weighted average rate of FHLB borrowings remained unchanged at $150.00 million and 4.12%, respectively, as of March 31, 2014, compared to December 31, 2013. As of March 31, 2014, FHLB borrowings had contractual maturities between three and seven years.

#### Stockholders’ Equity

Total stockholders’ equity increased $5.30 million, or 1.61%, from $328.61 million as of December 31, 2013, to $333.91 million as of March 31, 2014. The change in stockholders’ equity was impacted by net income of $5.73 million, dividends declared on our common and Series A Noncumulative Convertible Preferred Stock of $2.44 million, repurchases of 131,500 shares of our common stock totaling $2.15 million, and other comprehensive income (“OCI”) of $4.05 million. OCI was driven by unrealized gains on available-for-sale securities.

#### Liquidity and Capital Resources

We maintain a liquidity risk management policy and contingency funding policy (the “Liquidity Plan”) that is designed to detect potential liquidity issues in order to protect depositors, creditors, and shareholders. The Liquidity Plan includes various internal and external indicators that are reviewed on a recurring basis by our Asset/Liability Management Committee (“ALCO”) and the Board of Directors. ALCO is responsible for reviewing liquidity risk exposure and policies related to liquidity management and ensuring that systems and internal controls are consistent with liquidity policies and provide accurate reports regarding liquidity needs, sources, and compliance.

As of March 31, 2014, we maintained liquidity in the form of unencumbered cash on hand and deposits with other financial institutions of $79.00 million, availability on federal funds lines with correspondent banks of $105.00 million, credit available from the FRB’s discount window of $9.09 million, unused borrowing capacity with the FHLB of $362.35 million, and unpledged available-for-sale securities of $199.27 million. Cash on hand and deposits with other financial institutions, as well as lines of credit extended from correspondent banks and the FHLB, are immediately available to satisfy deposit withdrawals, customer credit needs, and our operations. Available-for-sale securities represent a secondary source of liquidity upon conversion to a liquid asset. Our approved lines of credit with correspondent banks are available as backup liquidity sources.

As a holding company, the Company does not conduct significant operations. The Company’s primary sources of liquidity are dividends received from the Bank and borrowings. Dividends paid by the Bank are subject to certain regulatory limitations. As of March 31, 2014, the Company’s liquid assets consisted of cash and investment securities totaling $24.21 million. The Company’s cash reserves and investments provide adequate working capital to meet obligations and projected dividends to shareholders for the next twelve months. The Company maintains a $15.00 million unsecured, committed line of credit with an unrelated financial institution. As of March 31, 2014, there was no outstanding balance on the line.

#### Capital Resources

Risk-based capital guidelines, promulgated by state and federal banking agencies, include balance sheet assets and off-balance sheet arrangements weighted by the risks inherent in the specific asset type. As of March 31, 2014, and December 31, 2013, the Company and the Bank were deemed “well capitalized” under regulatory capital adequacy standards. The following table presents our capital ratios as of the dates indicated:

| Total risk-based capital ratio | March 31, 2014 | December 31, 2013 |
| --- | ---: | ---: |
| First Community Bancshares, Inc. | 16.24% | 16.44% |
| First Community Bank | 14.38% | 14.55% |
| Tier 1 risk-based capital ratio |  |  |
| First Community Bancshares, Inc. | 14.98% | 15.19% |
| First Community Bank | 13.12% | 13.30% |
| Tier 1 leverage ratio |  |  |
| First Community Bancshares, Inc. | 10.13% | 9.95% |
| First Community Bank | 8.81% | 8.63% |

52

#### Off-Balance Sheet Arrangements

We extend contractual commitments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. Our exposure to credit loss in the event of nonperformance by other parties to financial instruments is the same as the contractual amount of the instrument. The following table presents the Company’s off-balance sheet financial instruments as of the dates indicated:

*(Amounts in thousands)*

|  | March 31, 2014 | December 31, 2013 |
| --- | ---: | ---: |
| Commitments to extend credit | $226,031 | $216,179 |
| Commitments related to secondary market mortgage loans | 2,039 | 3,677 |
| Standby letters of credit and financial guarantees | 4,233 | 4,193 |
| Total off-balance sheet risk | $232,303 | $224,049 |
| Reserve for unfunded commitments | $326 | $326 |

#### Impact of Inflation and Changing Prices

Our consolidated financial statements and related notes are presented in accordance with GAAP, which requires the measurement of results of operations and financial position in terms of historical dollars. Inflation may cause a rise in price levels and changes in the relative purchasing power of money. These inflationary effects are not reflected in historical dollar measurements. The primary effect of inflation on our operations is increased operating costs. In management’s opinion, interest rates have a greater impact on our financial performance than inflation. Interest rates do not necessarily fluctuate in the same direction, or to the same extent, as the price of goods and services; therefore, the effect of inflation on financial institutions is generally not as significant as the effect on businesses with large investments in property, plant, and inventory. The U.S. inflation rate continues to be relatively stable, and management believes that any changes in inflation will not have a material impact on our financial performance.

## Market risk

As filed, 5,556 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, 2014, 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, 2014 Change in Net Interest Income | Percent Change | December 31, 2013 Change in Net Interest Income | Percent Change |
| ---: | ---: | ---: | ---: | ---: |
| 300 | $1,047 | 1.2 | $2,649 | 3.1 |
| 200 | 535 | 0.6 | 1,517 | 1.8 |
| 100 | 60 | 0.1 | 454 | 0.5 |
| (100) | 11 | 0.0 | 497 | 0.6 |

## Controls and procedures

As filed, 2,577 characters.

### Evaluation of Disclosure Controls and Procedures

In connection with this report, 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, 2014, our disclosure controls and procedures were effective.

Disclosure controls and procedures are our Company’s 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, 2014, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 873 characters.

A description of the Company’s risk factors is included in Part I, Item 1A, “Risk Factors,” of our 2013 Form 10-K. Our risk factors discuss potential events, trends, or other circumstances that could adversely affect our business, financial condition, results of operations, cash flows, liquidity, access to capital resources, and, consequently, cause the market value of our common stock to decline. These risks could cause our future results to differ materially from historical results and expectations of future financial performance. There may be risks and uncertainties that we have not identified or that we have deemed immaterial that could adversely affect our business; therefore, our risk factors are not intended to be an exhaustive list of all risks we face. There have been no material changes from the risk factors previously disclosed in our 2013 Form 10-K.

Filed May 9, 2014.
Source: SEC EDGAR, the filing index for accession 0001193125-14-192577. Last ingested by Listed: Nov 6, 2026, 14:30 ET. No prices; not investment advice.