0001469134-14-000006.txt : 20140320 0001469134-14-000006.hdr.sgml : 20140320 20140320170259 ACCESSION NUMBER: 0001469134-14-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 13 CONFORMED PERIOD OF REPORT: 20131231 FILED AS OF DATE: 20140320 DATE AS OF CHANGE: 20140320 FILER: COMPANY DATA: COMPANY CONFORMED NAME: First Community Financial Partners, Inc. CENTRAL INDEX KEY: 0001469134 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 204718752 STATE OF INCORPORATION: IL FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 333-185044 FILM NUMBER: 14707344 BUSINESS ADDRESS: STREET 1: 2801 BLACK ROAD CITY: JOLIET STATE: IL ZIP: 60435 BUSINESS PHONE: 815-725-0123 MAIL ADDRESS: STREET 1: 2801 BLACK ROAD CITY: JOLIET STATE: IL ZIP: 60435 10-K 1 a122013fcfp10-k.htm 12 2013 FCFP 10K 12 2013 FCFP 10-K


 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
FORM 10-K
 
(Mark One)
 
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2013
 
OR
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                          to                         
 

333-185041
333-185043
333-185044
Commission file number

FIRST COMMUNITY FINANCIAL PARTNERS, INC.
(Exact name of registrant as specified in its charter)
 
Illinois
 
20-4718752
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
2801 Black Road, Joliet, IL
 
60435
(Address of Principal Executive Offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code:  (815) 725-0123

Securities registered pursuant to Section 12(b) of the Act:
 
None
(Title of Class)

 
Securities registered pursuant to Section 12(g) of the Act:
 
None
(Title of Class)
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o No x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o No x
 




Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is (§ 229.405) not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer o
 
Accelerated filer o
 
 
 
Non-accelerated filer o
(Do not check if a smaller reporting company)
 
Smaller reporting company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o No x
 
The aggregate market value of the voting shares held by non-affiliates of the Registrant was approximately $45,579,601 as of June 30, 2013, the last business day of the Registrant’s most recently completed second fiscal quarter.  Solely for the purpose of this computation, it has been assumed that executive officers and directors of the Registrant are “affiliates,” and the Registrant is not bound by this determination for any other purpose.

There were issued and outstanding 16,540,313 shares of the Registrant’s common stock as of March 13, 2014.
 






FIRST COMMUNITY FINANCIAL PARTNERS, INC.

FORM 10-K

December 31, 2013
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





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PART I

Item 1. Business

First Community

First Community Financial Partners, Inc. (“First Community” or the “Company”) was formed as a bank holding company in 2006 to focus on organizing de novo banks. First Community is headquartered in Joliet, Illinois. First Community has one banking subsidiary, First Community Financial Bank (the “Bank”). The Bank is the result of the Consolidation of our four prior banking subsidiaries and affiliates (the “Consolidation”) and is discussed in more detail below.
    
As of December 31, 2013, on a consolidated basis, First Community had total assets of $867.6 million, total deposits of $725.4 million and total stockholders’ equity of $91.6 million. For the Company’s complete financial information as of December 31, 2013 and 2012 and for each of the years then ended, see Item 8. Financial Statements and Supplementary Data.

The Consolidation
Prior to the closing of the Consolidation on March 12, 2013, First Community had an ownership interest in four banking subsidiaries and affiliates: First Community Bank of Joliet (“FCB Joliet”), First Community Bank of Plainfield (“FCB Plainfield”), First Community Bank of of Homer Glen & Lockport (“FCB Homer Glen”), and Burr Ridge Bank and Trust (“Burr Ridge”), as follows:

Bank
Common Stock Ownership Percentage
Preferred Stock Ownership Percentage
FCB Joliet
100%
n/a
FCB Plainfield
78.19%
96.97%
FCB Homer Glen
60.94%
100%
Burr Ridge
53.09%
n/a

On August 27, 2012, First Community entered into definitive merger agreements that resulted in the merger of our four prior baking subsidiaries and affiliates into the Bank, an Illinois chartered banking institution that is wholly owned by First Community. Specifically, the Consolidation consisted of the following mergers: (1) the merger of Interim First Community Bank of Plainfield, an interim Illinois state banking organized for the purpose of carrying out the Consolidation, with and into FCB Plainfield, which resulted in FCB Plainfield becoming a wholly owned subsidiary of First Community, (2) the merger of FCB Homer Glen with and into FCB Joliet, which resulted in the independent banking business of FCB Homer Glen ceasing and its business becoming part of FCB Joliet’s banking business, (3) the merger of Burr Ridge with and into FCB Joliet, which resulted in the independent banking business of Burr Ridge ceasing and its business becoming part of FCB Joliet’s banking business and (4) immediately following the consummation of the three mergers described above, the merger of FCB Joliet with and into FCB Plainfield, both of which were wholly owned by First Community at such time, which resulted in FCB Plainfield becoming the sole surviving bank following the Consolidation and wholly owned by First Community. Upon the closing of the Consolidation, FCB Plainfield was named “First Community Financial Bank”.
In each of the mergers included in the Consolidation, excluding the last step merger of the two then wholly owned banks, FCB Joliet and FCB Plainfield, the consideration paid by First Community to the stockholders of FCB Plainfield, FCB Homer Glen and Burr Ridge (other than shares held in any such bank's treasury or owned by any such bank's subsidiary, First Community or any First Community subsidiary) consisted of common stock of First Community registered with the Securities and Exchange Commission (the “SEC”) pursuant to Registration Statements on Form S-4. Specifically, each such share of FCB Plainfield common stock was converted into the right to receive 2.30 shares of First Community common stock, each such share of FCB Plainfield preferred stock was converted into the right to receive 305.9 shares of First Community common stock, each such share of FCB Homer common stock was converted into the right to receive 1.20 shares of First Community common stock, and each such share of Burr Ridge common stock was converted into the right to receive 2.81 shares of First Community stock. This resulted in the issuance of approximately 4,000,525 shares of First Community common stock. Pursuant to the terms of the Consolidation, all existing FCB Plainfield, FCB Homer Glen and Burr Ridge stock options outstanding as of the

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time immediately prior to the effective time of the Consolidation terminated in their entirety and were replaced with restricted stock unit awards issued under First Community’s 2008 Equity Incentive Plan.  
The Bank
The Bank is a full-service community bank principally engaged in the business of commercial, family and personal banking, and offers customers a broad range of loan, deposit, and other financial products and services through six full-service banking offices and one loan production office located in Cook, DuPage, and Will Counties, Illinois.
The Bank’s primary business is making loans and accepting deposits. The Bank also offers customers a variety of financial products and services that are related or ancillary to loans and deposits, including cash management, funds transfers, bill payment and other online banking transactions, automated teller machines, and safe deposit boxes.
The Bank’s primary lending area consists of the counties where its banking offices are located, and contiguous counties in the State of Illinois. The Bank derives the most significant portion of its revenues from these geographic areas.
The Bank originates deposits predominantly from the areas where its banking offices are located. The Bank relies on its favorable locations, customer service, competitive pricing, Internet access and related deposit services, such as cash management, to attract and retain deposits. While the Bank accepts certificates of deposit in excess of FDIC deposit insurance limits, the Bank generally does not solicit such deposits because they are more difficult to retain than core deposits and at times are more costly than wholesale deposits.
Lending Activities
The Bank’s loan portfolio consists primarily of non-residential real estate loans (owner occupied commercial real estate and investor commercial real estate, multi-family, construction and land development loans), which represented 59.38% of the total loan portfolio of $652.5 million at December 31, 2013. At December 31, 2013, $21.9 million, or 3.36% of the total loan portfolio, consisted of multi-family mortgage loans; $344.8 million, or 52.84% of the total loan portfolio, consisted of other commercial real estate loans; $159.4 million, or 24.44% of the total loan portfolio, consisted of commercial loans; $20.7 million, or 3.18%, of the total loan portfolio, consisted of construction and land loans; and $86.8 million, or 13.30% of the total loan portfolio, consisted of one-to-four family residential mortgage loans, including home equity loans and lines of credit. In addition, the Bank had farm and agricultural loans totalling $8.5 million, or 1.30% and consumer and other loans totalling $10.3 million, or 1.60% of the total portfolio as of December 31, 2013.
Deposit Activities
The Bank’s deposit accounts consist principally of savings accounts, NOW accounts, checking accounts, money market accounts, certificates of deposit, and IRAs and other qualified plan accounts. The Bank also provides commercial checking accounts and related services such as cash management, as well as provide low-cost checking account services.
At December 31, 2013, the Bank’s deposits totaled $725.4 million; interest bearing deposits totaled $613.4 million; non-interest bearing demand deposits totaled $112.0 million; savings, money market and NOW account deposits totaled $264.9 million; and certificates of deposit totaled 348.5 million.
Competition
First Community and the Bank face significant competition in both originating loans and attracting deposits. The Chicago metropolitan area has a high concentration of financial institutions, many of which are significantly larger institutions that have greater financial resources than we have, and many of which are our competitors to varying degrees. Our competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, the U.S. government, credit unions, leasing companies, insurance companies, real estate conduits and other companies that provide financial services to businesses and individuals. Our most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional competition for deposits from Internet-based financial institutions and non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies.
We seek to meet this competition by emphasizing personalized service and efficient decision-making tailored to individual needs. In addition, we reward long-standing relationships with preferred rates and terms on deposit products based on existing and prospective lending business. We do not rely on any individual, group or entity for a material portion of our loans or our deposits.
Employees
At December 31, 2013, First Community and the Bank had 101 full-time employees and 8 part-time employees. The employees are not represented by a collective bargaining unit and we consider our working relationship with our employees to be good.
Internet Website

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We maintain a website with the address www.fcbankgroup.com. The information contained on our website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor’s own Internet access charges, we make available free of charge through our website our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after we have electronically filed such material with, or furnished such material to, the SEC.

Supervision and Regulation
General
Financial institutions, their holding companies and their affiliates are extensively regulated under federal and state law. As a result, the growth and earnings performance of First Community may be affected not only by management decisions and general economic conditions, but also by the requirements of federal and state statutes and by the regulations and policies of various bank regulatory agencies, including the Illinois Department of Financial and Professional Regulation (the “IDFPR”), the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Federal Deposit Insurance Corporation (the “FDIC”) and the recently created Bureau of Consumer Financial Protection (the “CFPB”). Furthermore, taxation laws administered by the Internal Revenue Service and state taxing authorities, accounting rules developed by the Financial Accounting Standards Board (the “FASB”) and securities laws administered by the SEC and state securities authorities have an impact on the business of First Community. The effect of these statutes, regulations, regulatory policies and accounting rules are significant to the operations and results of First Community and the Bank, and the nature and extent of future legislative, regulatory or other changes affecting financial institutions are impossible to predict with any certainty.
Federal and state banking laws impose a comprehensive system of supervision, regulation and enforcement on the operations of financial institutions, their holding companies and affiliates that is intended primarily for the protection of the FDIC-insured deposits and depositors of banks, rather than shareholders. These federal and state laws, and the regulations of the bank regulatory agencies issued under them, affect, among other things, the scope of business, the kinds and amounts of investments banks may make, reserve requirements, capital levels relative to operations, the nature and amount of collateral for loans, the establishment of branches, the ability to merge, consolidate and acquire, dealings with insiders and affiliates and the payment of dividends. Moreover, turmoil in the credit markets in recent years prompted the enactment of unprecedented legislation that has allowed the U.S. Department of the Treasury (the “Treasury”) to make equity capital available to qualifying financial institutions to help restore confidence and stability in the U.S. financial markets, which imposes additional requirements on institutions in which the Treasury has an investment.
This supervisory and regulatory framework subjects banks and bank holding companies to regular examination by their respective regulatory agencies, which results in examination reports and ratings that are not publicly available and that can impact the conduct and growth of their business. These examinations consider not only compliance with applicable laws and regulations, but also capital levels, asset quality and risk, management ability and performance, earnings, liquidity, and various other factors. The regulatory agencies generally have broad discretion to impose restrictions and limitations on the operations of a regulated entity where the agencies determine, among other things, that such operations are unsafe or unsound, fail to comply with applicable law or are otherwise inconsistent with laws and regulations or with the supervisory policies of these agencies.  
The following is a summary of the material elements of the supervisory and regulatory framework applicable to First Community and the Bank. It does not describe all of the statutes, regulations and regulatory policies that apply, nor does it restate all of the requirements of those that are described. The descriptions are qualified in their entirety by reference to the particular statutory and regulatory provision.
Financial Regulatory Reform
On July 21, 2010, President Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) into law. The Dodd-Frank Act represents a sweeping reform of the U.S. supervisory and regulatory framework applicable to financial institutions and capital markets in the wake of the global financial crisis, certain aspects of which are described below in more detail. In particular, and among other things, the Dodd-Frank Act: created a Financial Stability Oversight Council as part of a regulatory structure for identifying emerging systemic risks and improving interagency cooperation; created the CFPB, which is authorized to regulate providers of consumer credit, savings, payment and other consumer financial products and services; narrowed the scope of federal preemption of state consumer laws enjoyed by national banks and federal savings associations and expanded the authority of state attorneys general to bring actions to enforce federal consumer protection legislation; imposed more stringent capital requirements on bank holding companies and subjected certain activities, including interstate mergers and acquisitions, to heightened capital conditions; with respect to mortgage lending, (i) significantly expanded requirements applicable to loans secured by 1-4 family residential real property, (ii) imposed strict rules on mortgage servicing, and (iii) required the originator of a securitized loan, or the sponsor of a securitization, to retain at least 5% of the credit risk of securitized exposures unless the underlying exposures are qualified residential mortgages or meet certain underwriting standards; repealed the prohibition on the payment of interest on business checking accounts; restricted the interchange fees payable on debit card transactions for issuers with $10 billion in assets or greater; in the so-called “Volcker Rule,” subject to numerous exceptions, prohibited depository institutions and affiliates from certain investments in, and sponsorship of, hedge funds and private equity

6



funds and from engaging in proprietary trading; provided for enhanced regulation of advisers to private funds and of the derivatives markets; enhanced oversight of credit rating agencies; and prohibited banking agency requirements tied to credit ratings. These statutory changes shifted the regulatory framework for financial institutions, impacted the way in which they do business and have the potential to constrain revenues.
Numerous provisions of the Dodd-Frank Act are required to be implemented through rulemaking by the appropriate federal regulatory agencies. Many of the required regulations have been issued and others have been released for public comment, but there remain a number that have yet to be released in any form. Furthermore, while the reforms primarily target systemically important financial service providers, their influence is expected to filter down in varying degrees to smaller institutions over time. Our management will continue to evaluate the effect of the Dodd-Frank Act changes; however, in many respects, the ultimate impact of the Dodd-Frank Act will not be fully known for years, and no current assurance may be given that the Dodd-Frank Act, or any other new legislative changes, will not have a negative impact on our results of operations and financial condition.
The Increasing Regulatory Emphasis on Capital
Regulatory capital represents the net assets of a financial institution available to absorb losses. Because of the risks attendant to their business, depository institutions are generally required to hold more capital than other businesses, which directly affects earnings capabilities. While capital has historically been one of the key measures of the financial health of both bank holding companies and banks, its role is becoming fundamentally more important in the wake of the global financial crisis, as the banking regulators recognized that the amount and quality of capital held by banks prior to the crisis was insufficient to absorb losses during periods of severe stress. Certain provisions of the Dodd-Frank Act and Basel III, discussed below, establish strengthened capital standards for banks and bank holding companies, require more capital to be held in the form of common stock and disallow certain funds from being included in capital determinations. Once fully implemented, these standards will represent regulatory capital requirements that are meaningfully more stringent than those in place currently and historically.
First Community and Bank Required Capital Levels. Bank holding companies have historically had to comply with less stringent capital standards than their bank subsidiaries and were able to raise capital with hybrid instruments such as trust preferred securities. The Dodd-Frank Act mandated the Federal Reserve to establish minimum capital levels for bank holding companies on a consolidated basis that are as stringent as those required for insured depository institutions. As a consequence, the components of holding company permanent capital known as “Tier 1 Capital” are being restricted to capital instruments that are considered to be Tier 1 Capital for insured depository institutions. We did not issue hybrid capital instruments subject to this rule; however, as a result of it, we will not be able to raise capital in the future through these instruments that were popular for bank capital-raising purposes in the past.
Under current federal regulations, the Bank is subject to the following minimum capital standards:
A leverage requirement, consisting of a minimum ratio of Tier 1 Capital to total adjusted book assets of 3% for the most highly-rated banks with a minimum requirement of at least 4% for all others, and
A risk-based capital requirement, consisting of a minimum ratio of Total Capital to total risk-weighted assets of 8% and a minimum ratio of Tier 1 Capital to total risk-weighted assets of 4%.
For this purpose, “Tier 1 Capital” consists primarily of common stock, noncumulative perpetual preferred stock and related surplus less intangible assets (other than certain loan servicing rights and purchased credit card relationships). Total Capital consists primarily of Tier 1 Capital plus “Tier 2 Capital,” which includes other non-permanent capital items, such as certain other debt and equity instruments that do not qualify as Tier 1 Capital, and a portion of the Bank’s allowance for loan and lease losses.
Further, risk-weighted assets for the purposes of the risk-weighted ratio calculations are balance sheet assets and off-balance sheet exposures to which required risk weightings of 0% to 100% are applied.  

The capital standards described above are minimum requirements and will be increased under Basel III, as discussed below. Bank regulatory agencies are uniformly encouraging banks and bank holding companies to be “well-capitalized” and, to that end, federal law and regulations provide various incentives for banking organizations to maintain regulatory capital at levels in excess of minimum regulatory requirements. For example, a banking organization that is “well-capitalized” may: (i) qualify for exemptions from prior notice or application requirements otherwise applicable to certain types of activities; (ii) qualify for expedited processing of other required notices or applications; and (iii) accept brokered deposits. Under the capital regulations of the FDIC and Federal Reserve, in order to be “well‑capitalized,” a banking organization, under current federal regulations, must maintain:
A leverage ratio of Tier 1 Capital to total assets of 5% or greater,
A ratio of Tier 1 Capital to total risk-weighted assets of 6% or greater, and
A ratio of Total Capital to total risk-weighted assets of 10% or greater.


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The FDIC and Federal Reserve guidelines also provide that banks and bank holding companies experiencing internal growth or making acquisitions will be expected to maintain capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the agencies will continue to consider a “tangible Tier 1 leverage ratio” (deducting all intangibles) in evaluating proposals for expansion or to engage in new activities.
Higher capital levels may also be required if warranted by the particular circumstances or risk profiles of individual banking organizations. For example, the Federal Reserve’s capital guidelines contemplate that additional capital may be required to take adequate account of, among other things, interest rate risk, or the risks posed by concentrations of credit, nontraditional activities or securities trading activities. Further, any banking organization experiencing or anticipating significant growth would be expected to maintain capital ratios, including tangible capital positions (i.e., Tier 1 Capital less all intangible assets), well above the minimum levels.
Prompt Corrective Action. A banking organization’s capital plays an important role in connection with regulatory enforcement as well. Federal law provides the federal banking regulators with broad power to take prompt corrective action to resolve the problems of undercapitalized institutions. The extent of the regulators’ powers depends on whether the institution in question is “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized,” in each case as defined by regulation. Depending upon the capital category to which an institution is assigned, the regulators’ corrective powers include: (i) requiring the institution to submit a capital restoration plan; (ii) limiting the institution’s asset growth and restricting its activities; (iii) requiring the institution to issue additional capital stock (including additional voting stock) or to sell itself; (iv) restricting transactions between the institution and its affiliates; (v) restricting the interest rate that the institution may pay on deposits; (vi) ordering a new election of directors of the institution; (vii) requiring that senior executive officers or directors be dismissed; (viii) prohibiting the institution from accepting deposits from correspondent banks; (ix) requiring the institution to divest certain subsidiaries; (x) prohibiting the payment of principal or interest on subordinated debt; and (xi) ultimately, appointing a receiver for the institution.
As of December 31, 2013, (i) the Bank was not subject to a directive from the FDIC to increase its capital to an amount in excess of the minimum regulatory capital requirements; and (ii) the Bank was “well capitalized,” as defined by FDIC regulations. As of December 31, 2013, First Community had regulatory capital in excess of the Federal Reserve’s requirements and met the Dodd-Frank Act requirements.
The Basel International Capital Accords. The current risk-based capital guidelines described above, which apply to the Bank and are being phased in for First Community, are based upon the 1988 capital accord known as “Basel I” adopted by the international Basel Committee on Banking Supervision, a committee of central banks and bank supervisors, as implemented by the U.S. federal banking regulators on an interagency basis. In 2008, the banking agencies collaboratively began to phase-in capital standards based on a second capital accord, referred to as “Basel II,” for large or “core” international banks (generally defined for United States’ purposes as having total assets of $250 billion or more, or consolidated foreign exposures of $10 billion or more). Basel II emphasized internal assessment of credit, market and operational risk, as well as supervisory assessment and market discipline in determining minimum capital requirements.
On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, announced agreement on a strengthened set of capital requirements for banking organizations around the world, known as Basel III, to address deficiencies recognized in connection with the global financial crisis.  Basel III was intended to be effective globally on January 1, 2013, with phase-in of certain elements continuing until January 1, 2019, and it is currently effective in many countries.
U.S. Implementation of Basel III. After an extended rulemaking process that included a prolonged comment period, in July 2013, the U.S. federal banking agencies approved the implementation of the Basel III regulatory capital reforms in pertinent part, and, at the same time, promulgated rules effecting certain changes required by the Dodd-Frank Act (the “Basel III Rule”). In contrast to capital requirements historically, which were in the form of guidelines, Basel III was released in the form of regulations by each of the agencies. The Basel III Rule is applicable to all U.S. banks that are subject to minimum capital requirements, including federal and state banks and savings and loan associations, as well as to bank and savings and loan holding companies other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $500 million).
The Basel III Rule not only increases most of the required minimum capital ratios, but it introduces the concept of Common Equity Tier 1 Capital, which consists primarily of common stock, related surplus (net of Treasury stock), retained earnings, and Common Equity Tier 1 minority interests subject to certain regulatory adjustments. The Basel III Rule also expanded the definition of capital as in effect currently by establishing more stringent criteria that instruments must meet to be considered Additional Tier 1 Capital (Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now qualify as Tier 1 Capital will not qualify, or their qualifications will change. For example, cumulative preferred stock and certain hybrid capital instruments, including trust preferred securities, will no longer qualify as Tier 1 Capital of any kind, with the exception, subject to certain restrictions, of such instruments issued before May 10, 2010, by bank holding companies with total consolidated assets of less than $15 billion as of December 31, 2009. For those institutions, trust preferred securities and other nonqualifying capital

8



instruments currently included in consolidated Tier 1 Capital are permanently grandfathered under the Basel III Rule, subject to certain restrictions. Noncumulative perpetual preferred stock, which now qualifies as simple Tier 1 Capital, will not qualify as Common Equity Tier 1 Capital, but will qualify as Additional Tier 1 Capital. The Basel III Rule also constrains the inclusion of minority interests, mortgage-servicing assets, and deferred tax assets in capital and requires deductions from Common Equity Tier 1 Capital in the event such assets exceed a certain percentage of a bank’s Common Equity Tier 1 Capital.
The Basel III Rule requires:
A new required ratio of minimum Common Equity Tier 1 equal to 4.5% of risk-weighted assets;
An increase in the minimum required amount of Tier 1 Capital from the current level of 4% of total assets to 6% of risk-weighted assets;
A continuation of the current minimum required amount of Total Capital (Tier 1 plus Tier 2) at 8% of risk-weighted assets; and
A minimum leverage ratio of Tier 1 Capital to total assets equal to 4% in all circumstances.

In addition, institutions that seek the freedom to make capital distributions (including for dividends and repurchases of stock) and pay discretionary bonuses to executive officers without restriction must also maintain 2.5% in Common Equity Tier 1 attributable to a capital conservation buffer to be phased in over three years beginning in 2016. The purpose of the conservation buffer is to ensure that banks maintain a buffer of capital that can be used to absorb losses during periods of financial and economic stress. Factoring in the fully phased-in conservation buffer increases the minimum ratios depicted above to 7% for Common Equity Tier 1, 8.5% for Tier 1 Capital and 10.5% for Total Capital.

The Basel III Rule maintained the general structure of the current prompt corrective action framework, while incorporating the increased requirements. The prompt corrective action guidelines were also revised to add the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution under the new regime, a bank and holding company must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10% or more; and a leverage ratio of 5% or more. It is possible under the Basel III Rule to be well-capitalized while remaining out of compliance with the capital conservation buffer discussed above.
The Basel III Rule revises a number of the risk weightings (or their methodologies) for bank assets that are used to determine the capital ratios. For nearly every class of assets, the Basel III Rule requires a more complex, detailed and calibrated assessment of credit risk and calculation of risk weightings. While Basel III would have changed the risk weighting for residential mortgage loans based on loan-to-value ratios and certain product and underwriting characteristics, there was concern in the United States that the proposed methodology for risk weighting residential mortgage exposures and the higher risk weightings for certain types of mortgage products would increase costs to consumers and reduce their access to mortgage credit. As a result, the Basel III Rule did not effect this change, and banks will continue to apply a risk weight of 50% or 100% to their exposure from residential mortgages, with the risk weighting depending on, among other things, whether the mortgage was a prudently underwritten first lien mortgage.
Furthermore, there was significant concern noted by the financial industry in connection with the Basel III rulemaking as to the proposed treatment of accumulated other comprehensive income (“AOCI”). Basel III requires unrealized gains and losses on available-for-sale securities to flow through to regulatory capital as opposed to the current treatment, which neutralizes such effects. Recognizing the problem for community banks, the U.S. bank regulatory agencies adopted the Basel III Rule with a one-time election for smaller institutions like First Community and the Bank to opt out of including most elements of AOCI in regulatory capital. This opt-out, which must be made in the first quarter of 2015, would exclude from regulatory capital both unrealized gains and losses on available-for-sale debt securities and accumulated net gains and losses on cash-flow hedges and amounts attributable to defined benefit post-retirement plans. We are currently evaluating whether First Community will make the opt-out election. Generally, financial institutions (except for large, internationally active financial institutions) become subject to the new rules on January 1, 2015. However, there will be separate phase-in/phase-out periods for: (i) the capital conservation buffer; (ii) regulatory capital adjustments and deductions; (iii) nonqualifying capital instruments; and (iv) changes to the prompt corrective action rules. The phase-in periods commence on January 1, 2016 and extend until 2019.
First Community
General. As the sole shareholder of the Bank, First Community is a bank holding company. As a bank holding company, we are registered with, and are subject to regulation by, the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”). In accordance with Federal Reserve policy, and as now codified by the Dodd-Frank Act, we are legally obligated to act as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where we might not otherwise do so. Under the BHCA, we are subject to periodic examination by the Federal Reserve. We are required to file with the Federal Reserve periodic reports of our operations and such additional information regarding First Community and the Bank as the Federal Reserve may require.

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Acquisitions, Activities and Change in Control. The primary purpose of a bank holding company is to control and manage banks. The BHCA generally requires the prior approval of the Federal Reserve for any merger involving a bank holding company or any acquisition by a bank holding company of another bank or bank holding company. Subject to certain conditions (including deposit concentration limits established by the BHCA and the Dodd-Frank Act), the Federal Reserve may allow a bank holding company to acquire banks located in any state of the United States. In approving interstate acquisitions, the Federal Reserve is required to give effect to applicable state law limitations on the aggregate amount of deposits that may be held by the acquiring bank holding company and its insured depository institution affiliates in the state in which the target bank is located (provided that those limits do not discriminate against out-of-state depository institutions or their holding companies) and state laws that require that the target bank have been in existence for a minimum period of time (not to exceed five years) before being acquired by an out-of-state bank holding company. Furthermore, in accordance with the Dodd-Frank Act, bank holding companies must be well-capitalized and well-managed in order to effect interstate mergers or acquisitions. For a discussion of the capital requirements, see “The Increasing Regulatory Emphasis on Capital” above.
The BHCA generally prohibits bank holding companies from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to banks and their subsidiaries. This general prohibition is subject to a number of exceptions. The principal exception allows bank holding companies to engage in, and to own shares of companies engaged in, certain businesses found by the Federal Reserve prior to November 11, 1999 to be “so closely related to banking ... as to be a proper incident thereto.” This authority would permit us to engage in a variety of banking-related businesses, including the ownership and operation of a savings association, or any entity engaged in consumer finance, equipment leasing, the operation of a computer service bureau (including software development) and mortgage banking and brokerage. The BHCA generally does not place territorial restrictions on the domestic activities of non-bank subsidiaries of bank holding companies.
Additionally, bank holding companies that meet certain eligibility requirements prescribed by the BHCA and elect to operate as financial holding companies may engage in, or own shares in companies engaged in, a wider range of nonbanking activities, including securities and insurance underwriting and sales, merchant banking and any other activity that the Federal Reserve, in consultation with the Secretary of the Treasury, determines by regulation or order is financial in nature or incidental to any such financial activity or that the Federal Reserve determines by order to be complementary to any such financial activity and does not pose a substantial risk to the safety or soundness of depository institutions or the financial system generally. We do not currently operate as a financial holding company.
Federal law also prohibits any person or company from acquiring “control” of an FDIC-insured depository institution or its holding company without prior notice to the appropriate federal bank regulator. “Control” is conclusively presumed to exist upon the acquisition of 25% or more of the outstanding voting securities of a bank or bank holding company, but may arise under certain circumstances between 10% and 24.99% ownership.
Capital Requirements. Bank holding companies are required to maintain capital in accordance with Federal Reserve capital adequacy requirements, as affected by the Dodd-Frank Act and Basel III. For a discussion of capital requirements, see “-The Increasing Regulatory Emphasis on Capital” above.
U.S. Government Investment in Bank Holding Companies. Events in the United States and global financial markets leading up to the global financial crisis, including deterioration of the worldwide credit markets, created significant challenges for financial institutions throughout the country beginning in 2008. In response to this crisis affecting the U.S. banking system and financial markets, on October 3, 2008, the U.S. Congress passed, and the President signed into law, the Emergency Economic Stabilization Act of 2008 (the “EESA”). The EESA authorized the Secretary of the Treasury to implement various temporary emergency programs designed to strengthen the capital positions of financial institutions and stimulate the availability of credit within the U.S. financial system. Financial institutions participating in certain of the programs established under the EESA are required to adopt the Treasury’s standards for executive compensation and corporate governance.
On October 14, 2008, the Treasury announced a program that provided Tier 1 Capital (in the form of perpetual preferred stock and common stock warrants) to eligible financial institutions. This program, known as the TARP Capital Purchase Program (the “CPP”), allocated $250 billion from the $700 billion authorized by EESA to the Treasury for the purchase of senior preferred shares from qualifying financial institutions. Eligible institutions were able to sell equity interests to the Treasury in amounts equal to between 1% and 3% of the institution’s risk-weighted assets.
As part of this program, on December 11, 2009, we participated in this program by issuing 22,000 shares of First Community’s Fixed Rate Cumulative Perpetual Preferred Stock, Series B (the “Series B Preferred Stock”) to the Treasury for a purchase price of $22.0 million in cash and issued warrants that were immediately exercised by the Treasury for 1,100 shares of First Community’s Fixed Rate Cummulative Perpetual Preferred Stock, Series C (the “Series C Preferred Stock”). The Series B Preferred Stock is non-voting and pays dividends at the rate of 5% per annum from the date of the transaction until the first dividend payment date after the fifth anniversary of the transaction, and thereafter at a rate of 9% per annum. The Series C Preferred Stock is also non-voting and pays dividends at the rate of 9% per annum from the date of the transaction.

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Participating financial institutions were required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury held equity issued under the CPP. These requirements were no longer applicable to First Community effective September 21, 2012, the date Treasury completed the sale its ownership of the Series B Preferred Stock and the Series C Preferred Stock to third parties.
Dividend Payments. Our ability to pay dividends to our shareholders may be affected by both general corporate law considerations and policies of the Federal Reserve applicable to bank holding companies. As an Illinois corporation, we are subject to the Illinois Business Corporation Act, as amended, which prohibits us from paying a dividend if, after giving effect to the dividend: (i) First Community would be insolvent; (ii) the net assets of First Community would be less than zero; or (iii) the net assets of First Community would be less than the maximum amount then payable to shareholders of First Community who would have preferential distribution rights if we were liquidated.
As a general matter, the Federal Reserve has indicated that the board of directors of a bank holding company should eliminate, defer or significantly reduce dividends to shareholders if: (i) the company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (ii) the prospective rate of earnings retention is inconsistent with the company’s capital needs and overall current and prospective financial condition; or (iii) the company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. The Federal Reserve also possesses enforcement powers over bank holding companies and their non-bank subsidiaries to prevent or remedy actions that represent unsafe or unsound practices or violations of applicable statutes and regulations. Among these powers is the ability to proscribe the payment of dividends by banks and bank holding companies.
Federal Securities Regulation. Our common stock is registered with the SEC under the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Consequently, we are subject to the information, proxy solicitation, insider trading and other restrictions and requirements of the SEC under the Exchange Act.
Corporate Governance. The Dodd-Frank Act addresses many investor protection, corporate governance and executive compensation matters that will affect most U.S. publicly traded companies. The Dodd-Frank Act will increase stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments, and authorizing the SEC to promulgate rules that would allow stockholders to nominate and solicit voters for their own candidates using a company’s proxy materials. The legislation also directs the Federal Reserve to promulgate rules prohibiting excessive compensation paid to executives of bank holding companies, regardless of whether such companies are publicly traded.
The Bank
General. The Bank is an Illinois-chartered bank. The deposit accounts of the Bank are insured by the FDIC’s Deposit Insurance Fund (“DIF”) to the maximum extent provided under federal law and FDIC regulations. As an Illinois-chartered FDIC-insured bank, the Bank is subject to the examination, supervision, reporting and enforcement requirements of the IDFPR, the chartering authority for Illinois banks, and the FDIC, designated by federal law as the primary federal regulator of insured state banks that, like the Bank, are not members of the Federal Reserve System (“nonmember banks”).
Capital Requirements. Banks are generally required to maintain capital levels in excess of other businesses. For a discussion of capital requirements, see “The Increasing Regulatory Emphasis on Capital” above.
Continuing De Novo Bank Requirements The Bank, which was known as FCB Plainfield prior to the Consolidation, remains subject to certain of the FDIC’s de novo bank requirements until the Bank has been chartered for a period longer than seven years or October 28, 2015. Until then, the Bank is required, among other items, to obtain FDIC approval for any material change to its business plan and to maintain a Tier 1 Leverage Capital Ratio of at least 8%.
Deposit Insurance. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the FDIC.  The FDIC has adopted a risk-based assessment system whereby FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification.  An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators.  
On November 12, 2009, the FDIC adopted a final rule that required insured depository institutions to prepay on December 30, 2009, their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. As such, on December 31, 2009, the Bank prepaid its assessments based on its actual September 30, 2009 assessment base, adjusted quarterly by an estimated 5% annual growth rate through the end of 2012. The FDIC also used the institution’s total base assessment rate in effect on September 30, 2009, increasing it by an annualized three basis points beginning in 2011. The FDIC began to offset prepaid assessments on March 30, 2010, representing payment of the regular quarterly risk-based deposit insurance assessment for the fourth quarter of 2009. Any prepaid assessment not exhausted after collection of the amount due on June 30, 2013, was returned to the institution and normal quarterly payments resumed.

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Amendments to the Federal Deposit Insurance Act also revise the assessment base against which an insured depository institution’s deposit insurance premiums paid to the DIF will be calculated.  Under the amendments, the assessment base will no longer be the institution’s deposit base, but rather its average consolidated total assets less its average tangible equity.  This may shift the burden of deposit insurance premiums toward those large depository institutions that rely on funding sources other than U.S. deposits.  Additionally, the Dodd-Frank Act makes changes to the minimum designated reserve ratio of the DIF, increasing the minimum from 1.15% to 1.35% of the estimated amount of total insured deposits, and eliminating the requirement that the FDIC pay dividends to depository institutions when the reserve ratio exceeds certain thresholds.  The FDIC has until September 3, 2020 to meet the 1.35% reserve ratio target. Several of these provisions could increase the Bank’s FDIC deposit insurance premiums. 
The Dodd-Frank Act permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per insured depositor, retroactive to January 1, 2009. Although the legislation provided that non-interest bearing transaction accounts had unlimited deposit insurance coverage, that program expired on December 31, 2012.
FICO Assessments.   The Financing Corporation (“FICO”) is a mixed-ownership governmental corporation chartered by the former Federal Home Loan Bank Board pursuant to the Competitive Equality Banking Act of 1987 to function as a financing vehicle for the recapitalization of the former Federal Savings and Loan Insurance Corporation. FICO issued 30-year noncallable bonds of approximately $8.1 billion that mature in 2017 through 2019. FICO’s authority to issue bonds ended on December 12, 1991. Since 1996, federal legislation has required that all FDIC-insured depository institutions pay assessments to cover interest payments on FICO’s outstanding obligations. These FICO assessments are in addition to amounts assessed by the FDIC for deposit insurance. The FICO assessment rate is adjusted quarterly and for the fourth quarter of 2013 was approximately 0.0064%.
Supervisory Assessments. Illinois-chartered banks are required to pay supervisory assessments to the IDFPR to fund its operations. The amount of the assessment paid by an Illinois bank to the IDFPR is calculated on the basis of the institution’s total assets, including consolidated subsidiaries, as reported to the IDFPR. During the year ended December 31, 2013, the Bank paid supervisory assessments to the IDFPR totaling $64,500.
Dividend Payments. The primary source of funds for First Community is dividends from the Bank. Under the Illinois Banking Act, the Bank generally may not pay dividends in excess of its net profits. As of December 31, 2013, the Bank was unable to pay dividends due to having negative retained earnings or an accumulated deficit.
The payment of dividends by any financial institution is affected by the requirement to maintain adequate capital pursuant to applicable capital adequacy guidelines and regulations, and a financial institution generally is prohibited from paying any dividends if, following payment thereof, the institution would be undercapitalized. As described above, the Bank exceeded its minimum capital requirements under applicable guidelines as of December 31, 2013. Notwithstanding the availability of funds for dividends, however, the FDIC and IDFPR may prohibit the payment of dividends by the Bank if it determines such payment would constitute an unsafe or unsound practice.
Insider Transactions. The Bank is subject to certain restrictions imposed by federal law on “covered transactions” between the Bank and its “affiliates.” We are an affiliate of the Bank for purposes of these restrictions, and covered transactions subject to the restrictions include extensions of credit to us, investments in our stock or other securities and the acceptance of our stock or other securities as collateral for loans made by the Bank. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates as of July 21, 2011, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.
Certain limitations and reporting requirements are also placed on extensions of credit by the Bank to its directors and officers, to directors and officers of First Community and its subsidiaries, to principal shareholders of First Community and to “related interests” of such directors, officers and principal shareholders. In addition, federal law and regulations may affect the terms upon which any person who is a director or officer of First Community or the Bank, or a principal shareholder of First Community, may obtain credit from banks with which the Bank maintains a correspondent relationship.
Safety and Soundness Standards/Risk Management. The federal banking agencies have adopted guidelines that establish operational and managerial standards to promote the safety and soundness of federally insured depository institutions. The guidelines set forth standards for internal controls, information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, compensation, fees and benefits, asset quality and earnings.
In general, the safety and soundness guidelines prescribe the goals to be achieved in each area, and each institution is responsible for establishing its own procedures to achieve those goals. If an institution fails to comply with any of the standards set forth in the guidelines, the institution’s primary federal regulator may require the institution to submit a plan for achieving and maintaining compliance. If an institution fails to submit an acceptable compliance plan, or fails in any material respect to implement a compliance plan that has been accepted by its primary federal regulator, the regulator is required to issue an order directing the institution to cure the deficiency. Until the deficiency cited in the regulator’s order is cured, the regulator may restrict the institution’s rate of growth, require the institution to increase its capital, restrict the rates the institution pays on deposits or require the institution

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to take any action the regulator deems appropriate under the circumstances. Noncompliance with the standards established by the safety and soundness guidelines may also constitute grounds for other enforcement action by the federal banking regulators, including cease and desist orders and civil money penalty assessments.
During the past decade, the bank regulatory agencies have increasingly emphasized the importance of sound risk management processes and strong internal controls when evaluating the activities of the institutions they supervise.  Properly managing risks has been identified as critical to the conduct of safe and sound banking activities and has become even more important as new technologies, product innovation, and the size and speed of financial transactions have changed the nature of banking markets.  The agencies have identified a spectrum of risks facing a banking institution including, but not limited to, credit, market, liquidity, operational, legal, and reputational risk. In particular, recent regulatory pronouncements have focused on operational risk, which arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses. The Bank is expected to have active board and senior management oversight; adequate policies, procedures, and limits; adequate risk measurement, monitoring, and management information systems; and comprehensive internal controls.
Branching Authority. Illinois banks, such as the Bank, have the authority under Illinois law to establish branches anywhere in the State of Illinois, subject to receipt of all required regulatory approvals.
Federal law permits state and national banks to merge with banks in other states subject to: (i) regulatory approval; (ii) federal and state deposit concentration limits; and (iii) state law limitations requiring the merging bank to have been in existence for a minimum period of time (not to exceed five years) prior to the merger. The establishment of new interstate branches or the acquisition of individual branches of a bank in another state (rather than the acquisition of an out-of-state bank in its entirety) has historically been permitted only in those states the laws of which expressly authorize such expansion. However, the Dodd-Frank Act permits well-capitalized and well-managed banks to establish new branches across state lines without these impediments.
State Bank Investments and Activities. The Bank is permitted to make investments and engage in activities directly or through subsidiaries as authorized by Illinois law. However, under federal law, FDIC-insured state banks are prohibited, subject to certain exceptions, from making or retaining equity investments of a type, or in an amount, that are not permissible for a national bank. Federal law also prohibits FDIC-insured state banks and their subsidiaries, subject to certain exceptions, from engaging as principal in any activity that is not permitted for a national bank unless the bank meets, and continues to meet, its minimum regulatory capital requirements and the FDIC determines that the activity would not pose a significant risk to the DIF. These restrictions have not had, and are not currently expected to have, a material impact on the operations of the Bank.
Transaction Account Reserves. Federal Reserve regulations require depository institutions to maintain reserves against their transaction accounts (primarily NOW and regular checking accounts). For 2014: the first $13.3 million of otherwise reservable balances are exempt from the reserve requirements; for transaction accounts aggregating more than $13.3 million to $89.0 million, the reserve requirement is 3% of total transaction accounts; and for net transaction accounts in excess of $89.0 million, the reserve requirement is $2,271,000 plus 10% of the aggregate amount of total transaction accounts in excess of $89.0 million. These reserve requirements are subject to annual adjustment by the Federal Reserve. The Bank is in compliance with the foregoing requirements.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of Chicago (the “FHLB”), which serves as a central credit facility for its members. The FHLB is funded primarily from proceeds from the sale of obligations of the FHLB system. It makes loans to member banks in the form of FHLB advances. All advances from the FHLB are required to be fully collateralized as determined by the FHLB.
Community Reinvestment Act Requirements. The Community Reinvestment Act requires the Bank to have a continuing and affirmative obligation in a safe and sound manner to help meet the credit needs of its entire community, including low- and moderate-income neighborhoods. Federal regulators regularly assess the Bank’s record of meeting the credit needs of its communities. Applications for additional acquisitions would be affected by the evaluation of the Bank’s effectiveness in meeting its Community Reinvestment Act requirements.
Anti-Money Laundering. The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “Patriot Act”) is designed to deny terrorists and criminals the ability to obtain access to the U.S. financial system and has significant implications for depository institutions, brokers, dealers and other businesses involved in the transfer of money. The Patriot Act mandates financial services companies to have policies and procedures with respect to measures designed to address any or all of the following matters: (i) customer identification programs; (ii) money laundering; (iii) terrorist financing; (iv) identifying and reporting suspicious activities and currency transactions; (v) currency crimes; and (vi) cooperation between financial institutions and law enforcement authorities.
Commercial Real Estate Guidance. The interagency Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices guidance (“CRE Guidance”) provides supervisory criteria, including the following numerical indicators, to assist bank examiners in identifying banks with potentially significant commercial real estate loan concentrations that may warrant greater supervisory scrutiny: (i) commercial real estate loans exceeding 300% of capital and increasing 50% or more in

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the preceding three years; or (ii) construction and land development loans exceeding 100% of capital. The CRE Guidance does not limit banks’ levels of commercial real estate lending activities, but rather guides institutions in developing risk management practices and levels of capital that are commensurate with the level and nature of their commercial real estate concentrations. Although the Bank’s loan portfolio consists primarily of business and commercial real estate loans, the Bank is in compliance with these guidelines and we do not expect the CRE Guidance to adversely affect our operations.
Consumer Financial Services
There are numerous developments in federal and state laws regarding consumer financial products and services that impact the Bank’s business. Importantly, the current structure of federal consumer protection regulation applicable to all providers of consumer financial products and services changed significantly on July 21, 2011, when the CFPB commenced operations to supervise and enforce consumer protection laws. The CFPB has broad rulemaking authority for a wide range of consumer protection laws that apply to all providers of consumer products and services, including the Bank, as well as the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over providers with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in assets, like the Bank, will continue to be examined by their applicable bank regulators. Below are additional recent regulatory developments relating to consumer mortgage lending activities. We do not currently expect these provisions to have a significant impact on Bank operations; however, additional compliance resources will be needed to monitor changes.
Ability-to-Repay Requirement and Qualified Mortgage Rule. The Dodd-Frank Act contains additional provisions that affect consumer mortgage lending. First, it significantly expands underwriting requirements applicable to loans secured by 1-4 family residential real property and augments federal law combating predatory lending practices. In addition to numerous new disclosure requirements, the Dodd‑Frank Act imposes new standards for mortgage loan originations on all lenders, including banks and savings associations, in an effort to strongly encourage lenders to verify a borrower’s ability to repay, while also establishing a presumption of compliance for certain “qualified mortgages.” In addition, the Dodd-Frank Act generally requires lenders or securitizers to retain an economic interest in the credit risk relating to loans that the lender sells, and other asset‑backed securities that the securitizer issues, if the loans have not complied with the ability-to-repay standards. The risk retention requirement generally will be 5%, but could be increased or decreased by regulation.
On January 10, 2013, the CFPB issued a final rule, effective January 10, 2014, that implements the Dodd-Frank Act’s ability-to-repay requirements and clarifies the presumption of compliance for “qualified mortgages.” In assessing a borrower’s ability to repay a mortgage-related obligation, lenders generally must consider eight underwriting factors: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) monthly payment on the subject transaction; (iv) monthly payment on any simultaneous loan; (v) monthly payment for all mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) monthly debt-to-income ratio or residual income; and (viii) credit history. The final rule also includes guidance regarding the application of, and methodology for evaluating, these factors.
Further, the final rule also clarifies that qualified mortgages do not include “no-doc” loans and loans with negative amortization, interest-only payments, balloon payments, terms in excess of 30 years, or points and fees paid by the borrower that exceed 3% of the loan amount, subject to certain exceptions. In addition, for qualified mortgages, the monthly payment must be calculated on the highest payment that will occur in the first five years of the loan, and the borrower’s total debt-to-income ratio generally may not be more than 43%. The final rule also provides that certain mortgages that satisfy the general product feature requirements for qualified mortgages and that also satisfy the underwriting requirements of Fannie Mae and Freddie Mac (while they operate under federal conservatorship or receivership), or the U.S. Department of Housing and Urban Development, Department of Veterans Affairs, or Department of Agriculture or Rural Housing Service, are also considered to be qualified mortgages. This second category of qualified mortgages will phase out as the aforementioned federal agencies issue their own rules regarding qualified mortgages, the conservatorship of Fannie Mae and Freddie Mac ends, and, in any event, after seven years.
As set forth in the Dodd-Frank Act, subprime (or higher-priced) mortgage loans are subject to the ability-to-repay requirement, and the final rule provides for a rebuttable presumption of lender compliance for those loans. The final rule also applies the ability-to-repay requirement to prime loans, while also providing a conclusive presumption of compliance (i.e., a safe harbor) for prime loans that are also qualified mortgages. Additionally, the final rule generally prohibits prepayment penalties (subject to certain exceptions) and sets forth a 3-year record retention period with respect to documenting and demonstrating the ability-to-repay requirement and other provisions.
Changes to Mortgage Loan Originator Compensation. Effective April 2, 2011, previously existing regulations concerning the compensation of mortgage loan originators were amended. As a result of these amendments, mortgage loan originators may not receive compensation based on a mortgage transaction’s terms or conditions other than the amount of credit extended under the mortgage loan. Further, the new standards limit the total points and fees that a bank and/or a broker may charge on conforming and jumbo loans to 3% of the total loan amount. Mortgage loan originators may receive compensation from a consumer or from a lender, but not both. These rules contain requirements designed to prohibit mortgage loan originators from

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“steering” consumers to loans that provide mortgage loan originators with greater compensation. In addition, the rules contain other requirements concerning recordkeeping.
Servicing. On January 17, 2013, the CFPB announced rules to implement certain provisions of the Dodd-Frank Act relating to mortgage servicing. The new servicing rules require servicers to meet certain benchmarks for loan servicing and customer service in general. Servicers must provide periodic billing statements and certain required notices and acknowledgments, promptly credit borrowers’ accounts for payments received and promptly investigate complaints by borrowers and are required to take additional steps before purchasing insurance to protect the lender’s interest in the property. The new servicing rules also call for additional notice, review and timing requirements with respect to delinquent borrowers, including early intervention, ongoing access to servicer personnel and specific loss mitigation and foreclosure procedures. The rules provide for an exemption from most of these requirements for “small servicers.” A small servicer is defined as a loan servicer that services 5,000 or fewer mortgage loans and services only mortgage loans that they or an affiliate originated or own. The new servicing rules took effect on January 10, 2014. We do not expect these rules to impact the Bank’s business.
Foreclosure and Loan Modifications. Federal and state laws further impact foreclosures and loan modifications, with many of such laws having the effect of delaying or impeding the foreclosure process on real estate secured loans in default. Mortgages on commercial property can be modified, such as by reducing the principal amount of the loan or the interest rate, or by extending the term of the loan, through plans confirmed under Chapter 11 of the Bankruptcy Code. In recent years, legislation has been introduced in the U.S. Congress that would amend the Bankruptcy Code to permit the modification of mortgages secured by residences, although at this time the enactment of such legislation is not presently proposed. The scope, duration and terms of potential future legislation with similar effect continue to be discussed. We cannot predict whether any such legislation will be passed or the impact, if any, it would have on our business.
Additional Constraints on First Community and Bank
Monetary Policy. The monetary policy of the Federal Reserve has a significant effect on the operating results of financial or bank holding companies and their subsidiaries. Among the tools available to the Federal Reserve to affect the money supply are open market transactions in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits, and their use may affect interest rates charged on loans or paid on deposits.
The Volcker Rule. In addition to other implications of the Dodd-Frank Act discussed above, the act amends the BHC Act to require the federal regulatory agencies to adopt rules that prohibit banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (defined as hedge funds and private equity funds). This statutory provision is commonly called the “Volcker Rule.” On December 10, 2013, the federal regulatory agencies issued final rules to implement the prohibitions required by the Volcker Rule. Thereafter, in reaction to industry concern over the adverse impact to community banks of the treatment of certain collateralized debt instruments in the final rule, the federal regulatory agencies approved an interim final rule to permit banking entities to retain interests in collateralized debt obligations backed primarily by trust preferred securities (“TruPS CDOs”) from the investment prohibitions contained in the final rule. Under the interim final rule, the agencies permit the retention of an interest in or sponsorship of covered funds by banking entities under $15 billion in assets if the following qualifications are met:
The TruPS CDO was established, and the interest was issued, before May 19, 2010;
The banking entity reasonably believes that the offering proceeds received by the TruPS CDO were invested primarily in qualifying TruPS collateral; and
The banking entity’s interest in the TruPS CDO was acquired on or before December 10, 2013.
Although the Volcker Rule has significant implications for many large financial institutions, we do not currently anticipate that the Volcker Rule will have a material effect on our operations. First Community may incur costs if it is required to adopt additional policies and systems to ensure compliance with the Volcker Rule, but any such costs are not expected to be material. Until the application of the final rules is fully understood, the precise financial impact of the rule on First Community, the Bank, its customers or the financial industry more generally, cannot be determined.




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Item 1A. Risk Factors

RISK FACTORS

Various risks and uncertainties, some of which are difficult to predict and beyond First Community’s control, could negatively impact First Community or the Bank. As financial institutions, First Community and the Bank are exposed to interest rate risk, liquidity risk, credit risk, operational risk, risks from economic or market conditions, and general business risks among others. Adverse experience with these or other risks could have a material impact on the financial condition and results of operations of First Community or the Bank, as well as the value of First Community common stock.
Our business may be adversely affected by the highly regulated environment in which we operate.
The Company and the Bank are subject to extensive federal and state regulation, supervision and examination. Banking regulations are primarily intended to protect depositors’ funds, FDIC funds, customers and the banking system as a whole, rather than stockholders. These regulations affect the Company’s lending practices, capital structure, investment practices, dividend policy and growth, among other things.
As a bank holding company, we are subject to regulation and supervision primarily by the Federal Reserve. The Bank, as an Illinois-chartered bank, is subject to regulation and supervision by both the IDFPR and the FDIC. We and the Bank undergo periodic examinations by these regulators, which have extensive discretion and authority to prevent or remedy unsafe or unsound practices or violations of law by banks and bank holding companies.
The primary federal and state banking laws and regulations that affect us are described in this annual report under the section captioned “Supervision and Regulation.” These laws, regulations, rules, standards, policies and interpretations are constantly evolving and may change significantly over time. For example, on July 21, 2010, the Dodd-Frank Act was signed into law, which significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act, together with the regulations to be developed thereunder, includes provisions affecting large and small financial institutions alike, including several provisions that will affect how community banks will be regulated in the future. In addition, the Federal Reserve has adopted numerous new regulations addressing banks’ overdraft and mortgage lending practices. Further, the CFPB was recently established, with broad powers to supervise and enforce consumer protection laws, and additional consumer protection legislation and regulatory activity is anticipated in the near future.

In July 2013, the U.S. federal banking authorities approved the implementation of the Basel III Rule. The Basel III Rule is applicable to all U.S. banks that are subject to minimum capital requirements as well as to bank and saving and loan holding companies, other than “small bank holding companies” (generally bank holding companies with consolidated assets of less than $500 million). The Basel III Rule not only increases most of the required minimum regulatory capital ratios, it introduces a new Common Equity Tier 1 Capital ratio and the concept of a capital conservation buffer. The Basel III Rule also expands the current definition of capital by establishing additional criteria that capital instruments must meet to be considered Additional Tier 1 Capital (i.e., Tier 1 Capital in addition to Common Equity) and Tier 2 Capital. A number of instruments that now generally qualify as Tier 1 Capital will not qualify, or their qualifications will change when the Basel III Rule is fully implemented. However, the Basel III Rule permits banking organizations with less than $15 billion in assets to retain, through a one-time election, the existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Basel III Rule has maintained the general structure of the current prompt corrective action thresholds while incorporating the increased requirements, including the Common Equity Tier 1 Capital ratio. In order to be a “well-capitalized” depository institution under the new regime, an institution must maintain a Common Equity Tier 1 Capital ratio of 6.5% or more; a Tier 1 Capital ratio of 8% or more; a Total Capital ratio of 10.0% or more; and a leverage ratio of 5.0% or more. Institutions must also maintain a capital conservation buffer consisting of Common Equity Tier 1 Capital to avoid certain restrictions on dividends and compensation. Generally, financial institutions will become subject to the Basel III Rule on January 1, 2015 with a phase-in period through 2019 for many of the changes.
Such changes, including changes regarding interpretations and implementation, could affect the Company in substantial and unpredictable ways and could have a material adverse effect on the Company’s business, financial condition and results of operations. Further, such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with applicable laws, regulations or policies could result in sanctions by regulatory agencies, civil monetary penalties, and/or damage to the Company’s reputation, which could have a material adverse effect on the Company’s business, financial condition and results of operations.

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The policies of the Federal Reserve also have a significant impact on us. Among other things, the Federal Reserve’s monetary policies directly and indirectly influence the rate of interest earned on loans and paid on borrowings and interest-bearing deposits, and can also affect the value of financial instruments we hold and the ability of borrowers to repay their loans, which could have a material adverse effect on our business, financial condition and results of operations.
Competition from financial institutions and other financial services providers may adversely affect our growth and profitability and have a material adverse effect on us.
We operate in a highly competitive industry and experience intense competition from other financial institutions in our market. We compete with these institutions in making loans, attracting deposits and recruiting and retaining talented people. We also compete with nonbank financial service providers, including mortgage companies, finance companies, mutual funds and credit unions. Many of these competitors are not subject to the same regulatory restrictions that we are and may be able to compete more effectively as a result. We have observed that the competition in our market for making commercial loans has resulted in more competitive pricing and credit structure, as well as intense competition for qualified commercial lending officers. We also may face a competitive disadvantage as a result of our smaller size, limited branch network, narrower product offerings and lack of geographic diversification as compared to some of our larger competitors. Although our competitive strategy is to provide a distinctly superior customer and employee experience, this strategy could be unsuccessful. Our growth and profitability depend on our continued ability to compete effectively within our market area and our inability to do so could have a material adverse effect on us.
Our business is subject to the conditions of the local economy in which we operate and continued weakness in the local economy and the real estate markets may materially and adversely affect us.
Our success is dependent to a large extent upon the general economic conditions in the Illinois and Chicago area where the Bank provides banking and financial services. Accordingly, the local economic conditions in Chicago have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources.
Our operating results have been negatively impacted by the historically high level of nonperforming loans in our commercial loan portfolio. Continued weakness in the Illinois and Chicago area economy has had and may continue to have a material adverse affect on us, including higher provisions for loan losses and net loan charge-offs, lower net interest income caused by an increase in nonaccrual loans, and higher legal and collection costs. In addition, we may be required to continue to devote substantial additional attention and resources to nonperforming asset management rather than focusing on business growth activities. Continued adverse conditions in the local economy could also reduce demand for new loans and other financial services and impair our ability to attract and retain deposits.
Our business is subject to economic conditions and other factors, many of which are beyond our control and could materially and adversely affect us.
From December 2007 through June 2009, the United States economy was in recession. Business activity across a wide range of industries and regions in the United States was greatly reduced. Although general economic conditions have improved, certain sectors remain weak, and unemployment remains at high levels, including within the Chicago area, where most of our customers are located. In addition, local governments and many businesses continue to experience serious difficulty due to lower consumer spending and decreased liquidity in the credit markets.
Market conditions also led to the failure or merger of several prominent financial institutions and numerous regional and community-based financial institutions. These failures, as well as projected future failures, have had a significant negative impact on the capitalization level of the deposit insurance fund of the FDIC, which, in turn, has led to a significant increase in deposit insurance premiums paid by financial institutions.
The Company’s financial performance generally, and in particular the ability of customers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers, is highly dependent upon the business environment in the markets where the Company operates, in the state of Illinois generally and in the United States as a whole. A favorable business environment is generally characterized by, among other factors: economic growth; efficient capital markets; low inflation; low unemployment; high business and investor confidence; and strong business earnings. Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, business activity or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; high unemployment; natural disasters; or a combination of these or other factors.
Overall, although showing signs of improvement, the business environment was unfavorable for many households and businesses in the United States. While economic conditions in the Chicago area, the state of Illinois and the United States have

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generally improved since the recession, improvement may not continue or occur at a meaningful rate. Such conditions could materially and adversely affect us.
The preparation of our consolidated financial statements requires us to make estimates and judgments, which are subject to an inherent degree of uncertainty and which may differ from actual results.
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles and general reporting practices within the financial services industry, which require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Some accounting policies, such as those pertaining to our allowance for loan loss and deferred tax assets and the necessity of any related valuation allowance, require the application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their nature, these estimates and judgments are subject to an inherent degree of uncertainty and actual results may differ from these estimates and judgments under different assumptions or conditions, which may have a material adverse effect on our financial condition or results of operations in subsequent periods.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio, which could have a material adverse effect on us.
Making loans is a substantial part of our business, and every loan we make is subject to the risk that it will not be repaid or that any underlying collateral in the case of secured loans will not be sufficient to assure full repayment. Among other things, the risk of non-payment is affected by:
 
 
Ÿ
 
changes in economic, market and industry conditions,
 
Ÿ
 
the credit risks associated with the particular borrower and type of loan,
 
Ÿ
 
cash flow of the borrower and/or the project being financed,
 
Ÿ
 
the duration of the loan, and
 
Ÿ
 
opportunities to identify potential loan repayment issues when remedial action may be most effective.
We maintain an allowance for loan losses, which is established through an accounting reserve established through a provision for loan losses charged to expense, which we believe is adequate to provide for probable losses inherent in our loan portfolio as of the corresponding balance sheet date. The determination of the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which are subject to material changes. Continuing deterioration in or stagnation of economic conditions affecting borrowers, new information regarding existing loans and any underlying collateral, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance for loan losses.
In addition, our federal and state regulators periodically review our allowance for loan losses and, based on judgments that differ from those of our management, may require an increase in our provision for loan losses or the recognition of further loan charge-offs. Further, if loan charge-offs in future periods exceed our allowance for loan losses, we will need additional provisions to increase the allowance. Any increases in our allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on us.
We are subject to interest rate risk, including interest rate fluctuations, that could have a material adverse effect on us.
Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond the Company’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Open Market Committee of the Federal Reserve.
Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but such changes could also affect:
 
Ÿ
 
the Company’s ability to originate loans and obtain deposits,
 
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the fair value of the Company’s financial assets and liabilities, and
 
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the average duration of the Company’s securities portfolio.

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If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore, earnings and cash flows, could be adversely affected. Earnings and cash flows could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.
Although management believes it has implemented effective asset and liability management strategies, including the use of derivatives as hedging instruments, to reduce the potential effects of changes in interest rates on the Company’s results of operations, if these strategies prove ineffective, or if any substantial, unexpected and prolonged change in market interest rates occurs, such events could have a material adverse effect on us.
We have counterparty risk and therefore we may be materially and adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding and other transactions could be materially and negatively affected by the actions and the soundness of other financial institutions. Financial services institutions are generally interrelated as a result of trading, clearing, counterparty, credit or other relationships. We have exposure to many different industries and counterparties and regularly engage in transactions with counterparties in the financial services industry, including commercial banks, brokers and dealers, investment banks and other institutional customers. Many of these transactions may expose us to credit or other risks if another financial institution experiences adverse circumstances. In certain circumstances, the collateral that we hold may be insufficient to fully cover the risk that a counterparty defaults on its obligations, which may cause us to experience losses that could have a material adverse affect on us.
We are subject to certain operational risks, including, but not limited to, data processing system failures and errors and customer or employee fraud. First Community’s controls and procedures may fail or be circumvented.
There have been a number of highly publicized cases involving fraud or other misconduct by employees of financial services firms in recent years. Misconduct by our employees could include hiding unauthorized activities from us, improper or unauthorized activities on behalf of our customers or improper use of confidential information. Employee fraud, errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. It is not always possible to prevent employee errors and misconduct, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors could also subject us to civil claims for negligence.
We maintain a system of internal controls and procedures designed to reduce the risk of loss from employee or customer fraud or misconduct, employee errors and operational risks, including data processing system failures and errors and customer or employee fraud. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on us.
We are dependent upon outside third parties for processing and handling of our records and data.
We rely on software developed by third party vendors to process various Company transactions. In some cases, we have contracted with third parties to run their proprietary software on behalf of the Company. These systems include, but are not limited to, general ledger, payroll, employee benefits, loan and deposit processing, and securities portfolio management. While the Company performs a review of controls instituted by the applicable vendor over these programs in accordance with industry standards and performs its own testing of user controls, we must rely on the continued maintenance of controls by these third party vendors, including safeguards over the security of customer data. In addition, the Company maintains, or contracts with third parties to maintain, backups of key processing output daily in the event of a failure on the part of any of these systems. Nonetheless, we may incur a temporary disruption in its ability to conduct its business or process its transactions, or incur damage to its reputation if the third party vendor fails to adequately maintain internal controls or institute necessary changes to systems. Such disruption or a breach of security may have a material adverse effect on us.
System failure or breaches of our network security, including with respect to our Internet banking activities, could subject us to increased operating costs as well as litigation and other liabilities.
The computer systems and network infrastructure we use in our operations and Internet banking activities could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Computer break-ins, “phishing” and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, as well as that of our customers engaging in Internet banking activities. In addition, advances in computer capabilities or other developments could result in a compromise or breach of our systems designed to protect customer data. Although we have procedures in place to prevent or limit the effects of any of these potential

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problems and intend to continue to implement security technology and establish operational procedures to mitigate the risk of such occurrences, these measures could be unsuccessful. Any interruption in, or breach in security of, our computer systems and network infrastructure, or that of our Internet banking customers, could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on us.
We are subject to lending concentration risks.
We have focused on repositioning our portfolio to reduce our exposure to industries and sectors that we no longer consider economically desirable. As of December 31, 2013, 85.12% of the Bank’s loan portfolio consisted of commercial loans, of which approximately 56.20% were commercial real estate loans. Our commercial loans are typically larger in amount than loans to individual consumers and, therefore, have the potential for higher losses on an individual loan basis. Credit quality issues on larger commercial loans, if they were to occur, could cause greater volatility in reported credit quality performance measures, such as total impaired or non-performing loans, and the amount of charge-offs and recoveries between periods. The deterioration of any one or a few of these loans may cause a significant increase in uncollectible loans, which would have a material adverse impact on us.
The problems that have occurred in the residential real estate and mortgage markets throughout much of the United States also affected the commercial real estate market. In our market areas, we have generally experienced a downturn in credit performance by our commercial real estate loan customers, and in light of the uncertainty that exists in the economy and credit markets, there can be no guarantee that we will not experience further deterioration in the performance of commercial real estate and other real estate loans in the future. In such case, we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could cause us to increase our provision for loan losses and materially and adversely affect our operating results, financial condition or capital levels.
We may not be able to access sufficient and cost-effective sources of liquidity.
Liquidity is essential to our business and drives our ability to make new loans or invest in securities. In addition, the Company requires liquidity to meet its deposit and debt obligations as they come due. Our access to funding sources in amounts adequate to finance our activities or on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or the economy generally. Factors that could reduce our access to liquidity sources include a downturn in the Chicago area market, difficult credit markets or adverse regulatory actions against us.
 
As part of our liquidity management, we use a number of funding sources in addition to what is provided by in-market deposit and repayments and maturities of loans and investments. Although we have increased our funding from our core customers to reduce our reliance on wholesale funding, we continue to use brokered money market accounts and certificates of deposits, out-of-local-market certificates of deposit, broker/dealer repurchase agreements, federal funds purchased and FHLB and Federal Reserve Bank (“FRB”) advances as a source of liquidity.
Under FDIC regulations, only “well-capitalized” institutions may issue brokered certificates of deposit (“CDs”) without prior regulatory approval. The Bank is currently categorized as “well-capitalized” and, therefore, may continue to utilize this funding source. Brokered CD distributors may use other criteria in determining which banks to allow to issue brokered CDs through their distribution network. If our access to the brokered CD market were reduced in any material respect, it could lead to an inability to replace brokered deposits at maturity, which would result in higher costs to, or reduced asset levels at, the Bank.
Our liquidity position is affected by the amount of cash and other liquid assets on hand, payment of interest and dividends on our outstanding debt and equity instruments, capital we inject into the Bank, redemption of our previously issued debt, proceeds we raise through the issuance of debt and equity instruments, and dividends received from the Bank (if permitted). Our future liquidity position may be materially adversely affected if, in the future, one or a combination of the following events occur:
 
 
Ÿ
 
the Bank reports net losses or its earnings are weak relative to our cash flow needs as a holding company,
 
Ÿ
 
we deem it advisable or are required by our regulators to use cash at the holding company level to support loan growth of the Bank or address other capital needs of the Bank through downstream capital injections, or
 
Ÿ
 
we have difficulty raising cash at the holding company level through the issuance of debt or equity securities or accessing additional sources of credit.
Our usual liquidity management challenges include responding to potential volatility in our customers’ deposit balances. We primarily use advances from the FHLB, broker/dealer repurchase agreements and federal funds purchased to meet our immediate liquidity needs. We maintain stable client deposits, which allows us to not heavily rely on wholesale funding

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sources. However, our recent level of client deposits may not continue, our client deposits may not remain at current levels and we may not be able to maintain the recent reduced reliance on wholesale deposits. Increased customer confidence in general economic conditions, higher expected rates of return on other investments (including a rise in interest rates) or additional restrictions on the availability of FDIC coverage could each cause our customers to move all or a portion of their deposits to other investment options, thus causing a reduction in our deposits and increasing our reliance on wholesale or other funding sources.
Given the losses recorded by the prior bank subsidiaries and affiliates from 2008 through 2011 and the negative retained earnings at the Bank as of December 31, 2013, and the resulting limitations on the ability of the Bank to pay dividends to First Community, we have been dependent upon our current cash position and cash proceeds generated by capital raises to meet liquidity needs at the holding company level. If we foresee that we face diminished liquidity, we may, to the extent possible, seek to issue additional debt or securities which could cause ownership or economic dilution to our current shareholders.
The recent repeal of federal prohibitions on payment of interest on business demand deposits could increase the Company’s interest expense and have a material adverse effect on us.
All federal prohibitions on the ability of financial institutions to pay interest on business demand deposit accounts were repealed as part of the Dodd-Frank Act. As a result, some financial institutions have commenced offering interest on these demand deposits to compete for customers. If competitive pressures require the Company to pay interest on these demand deposits to attract and retain business customers, its interest expense would increase and its net interest margin would decrease. This could have a material adverse effect on us. Further, the effect of the repeal of the prohibition could be more significant in a higher interest rate environment as business customers would have a greater incentive to seek interest on demand deposits.
Changes in our credit ratings could increase our financing costs or make it more difficult for us to obtain funding or capital on commercially acceptable terms.
We are rated by several different rating agencies, including International Data Corporation and Bankrate.com. Many factors, both within and out of our control, may cause these agencies to downgrade their ratings related to the Company, which could subject us to negative publicity, adversely impact our ability to acquire or retain deposits and increase our cost of borrowing or limit our asset growth. Also, our credit ratings are an important factor to the institutions that provide our sources of liquidity, and reductions in our credit ratings could adversely affect our liquidity, increase our borrowing costs, limit our access to the capital markets or trigger unfavorable contractual obligations.
The Company is a bank holding company and its sources of funds are limited.
The Company is a bank holding company, and its operations are primarily conducted by the Bank, which is subject to significant federal and state regulation. The Company’s ability to receive dividends or loans from the Bank is restricted and therefore the ability to pay dividends to shareholders is restricted. Currently the Bank is unable to pay dividends due to negative retained earnings. Dividend payments by the Bank to the Company in the future will require generation of future earnings by the Bank and could require regulatory approval if any proposed dividends are in excess of prescribed guidelines. Further, as a structural matter, the Company’s right to participate in the assets of the Bank in the event of a liquidation or reorganization of the Bank would be subject to the claims of the Bank’s creditors, including depositors, which would take priority except to the extent the Company may be a creditor with a recognized claim. As of December 31, 2013, the Bank had deposits and other liabilities of approximately $776.0 million.
Our business strategy is dependent on our continued ability to attract, develop and retain highly qualified and experienced personnel in senior management and customer relationship positions.
We believe our future success is dependent, in part, on our ability to attract and retain highly qualified and experienced personnel in key senior management and other positions. Our competitive strategy is to provide each of our commercial customers with a highly qualified relationship manager that will serve as the customer’s key point of contact with us. Achieving the status of a “trusted advisor” for our customers also requires that we minimize relationship manager turnover and provide stability to our customer relationships. Competition for experienced personnel in our industry is intense, and we may not be able to successfully attract and retain such personnel.
Our reputation could be damaged by negative publicity.
Reputational risk, or the risk to us from negative publicity, is inherent in our business. Negative publicity can result from actual or alleged conduct in a number of areas, including legal and regulatory compliance, lending practices, corporate governance, litigation, inadequate protection of customer data, ethical behavior of our employees, and from actions taken by regulators, ratings agencies and others as a result of that conduct. Damage to our reputation could impact our ability to attract new or maintain existing loan and deposit customers, employees and business relationships.

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New lines of business or new products and services may subject us to certain additional risks.
From time to time, we will consider and may enter into new lines of business or offer new products or services. These activities can involve a number of uncertainties, risks and expenses, including the investment of significant time and resources, and our projected price and profitability targets may not be attainable or our efforts may not be successful. These initiatives have required and will continue to require us to enter geographical markets that are new to us. In addition, new lines of business and new products and services could significantly impact the effectiveness of our system of internal controls, and present requirements for legal compliance with which we were previously unfamiliar. Failure to successfully manage these risks could have a material adverse affect on us.
We may experience difficulties in managing our future growth.
Our future success, in part, depends on our achieving growth in commercial banking relationships that results in increased commercial loans at yields that are profitable to us. Achieving our growth targets requires us to attract customers who currently bank at other financial institutions in our market, thereby increasing our share of the market. Although we believe that we have the necessary resources in place to successfully manage our future growth, our growth strategy exposes us to certain risks and expenses, including adversely affecting our results of operations and placing a significant strain on our management, personnel, systems and resources. In addition, maintaining credit quality while growing our loan portfolio is critical to achieving and sustaining profitable growth. We may not be able to manage our growth effectively. If we fail to do so, we would be materially harmed.
In furtherance of our growth strategy, we may also seek to further reorganize or consolidate our corporate structure or acquire other financial institutions or parts of those institutions in the future, and we may engage in banking center expansion. In connection with future reorganizations, consolidations or acquisitions, we may issue equity securities which could cause ownership and economic dilution to our current shareholders. Moreover, our regulators will need to formally approve our implementation of a reorganization, consolidation or acquisition strategy. Furthermore, following any future reorganization, consolidation, merger or acquisition, our integration efforts may not be successful or, after giving effect to the acquisition, we may not achieve a level of profitability that will justify the investment that we made in any such acquisition.
 
The Company and the Bank are subject to changes in federal and state tax laws and changes in interpretation of existing laws.
The Company’s financial performance is impacted by federal and state tax laws. Given the current economic and political environment, and ongoing federal and state budgetary pressures, the enactment of new federal or state tax legislation may occur. For example, in January 2011, the State of Illinois passed an income tax increase for both individuals and corporations, which increased our state income tax rate. The further enactment of such legislation, or changes in the interpretation of existing law, including provisions impacting tax rates, apportionment, consolidation or combination, income, expenses, and credits, may have a material adverse effect on us.
Regulatory requirements, growth plans or operating results may require us to raise additional capital, which may not be available on favorable terms or at all.
We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. At December 31, 2013, the Bank was categorized as “well-capitalized” under the applicable regulatory capital framework. To the extent regulatory requirements change, our future operating results erode capital or we seek to expand through loan growth or acquisitions, we may be required to raise additional capital. Our ability to raise capital in any such event would depend on conditions in the capital markets, which are outside of our control, and on our financial condition and performance. Accordingly, our ability to raise capital when needed or on favorable terms is uncertain. The inability to attract new capital investment, or to attract capital on terms acceptable to us, could have a material adverse impact on us.
We have not paid a dividend on our common stock since the Company’s formation in 2006. In addition, regulatory restrictions and liquidity constraints at the holding company level could impair our ability to make distributions on our outstanding securities.

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Historically, our primary source of funds at the holding company level has been debt and equity issuances. The Bank and its predecessor banks have not paid dividends to the Company, and the Company has not paid dividends to our common shareholders, since the Company’s formation in 2006. Current and future liquidity constraints at the holding company level could continue to impair our ability to declare and pay dividends on our common or preferred stock or pay interest on our outstanding debt securities in the future. If we are unable to pay dividends or interest on our outstanding securities in the future, the market value of such securities may be materially adversely affected.

We are an emerging growth company and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors. In addition, our election not to opt out of JOBS Act extended accounting transition period may make our financial statements less easily comparable to the financial statements of other companies.
We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and shareholder approval of any golden parachute payments not previously approved. We will remain an emerging growth company for up to five years, though we may cease to be an emerging growth company earlier under certain circumstances, including if, before the end of such five years, we are deemed to be a large accelerated filer under the rules of the SEC (which depends on, among other things, having a market value of common stock held by non-affiliates in excess of $700 million). We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
Further, Section 102(b)(1) of the JOBS Act exempts emerging growth companies from being required to comply with new or revised financial accounting standards until private companies (that is, those that have not had a Securities Act registration statement declared effective or do not have a class of securities registered under the Exchange Act) are required to comply with the new or revised financial accounting standards. The JOBS Act provides that a company can elect to opt out of the extended transition period and comply with the requirements that apply to non-emerging growth companies but any such an election to opt out is irrevocable. We have elected not to opt out of such extended transition period which means that when a standard is issued or revised and it has different application dates for public or private companies, we, as an emerging growth company, can adopt the new or revised standard at the time private companies adopt the new or revised standard. This may make comparison of our financial statements with another public company which is neither an emerging growth company nor an emerging growth company which has opted out of using the extended transition period difficult or impossible because of the potential differences in accountant standards used.

The utilization of our tax losses could be substantially limited if we experienced an ownership change as defined in the Code.

Our net deferred tax asset totaled $16.8 million as of December 31, 2013. The ultimate realization of a deferred tax asset is dependent upon the generation of future taxable income during the periods prior to the expiration of the related net operating losses and the limitations of Section 382 of the Code.  Section 382 of the Code contains rules that limit the ability of a company that undergoes an ownership change to utilize its net operating loss carryforwards and certain built-in losses recognized in years after the ownership change. Under the rules, such an ownership change is generally any change in ownership of more than 50% of its stock within a rolling three-year period, as calculated in accordance with the rules. The rules generally operate by focusing on changes in ownership among stockholders considered by the rules as owning directly or indirectly 5% or more of the stock of the company and any change in ownership arising from new issuances of stock by the company.  If we undergo an ownership change for purposes of Section 382 as a result of future transactions involving our common stock, our ability to use any of our net operating loss carryforwards, tax credit carryforwards or net unrealized built-in losses at the time of ownership change would be subject to the limitations of Section 382 on their use against future taxable income. The limitation may affect the amount of our deferred income tax asset and, depending on the limitation, a portion of our built-in losses, any net operating loss carryforwards or tax credit carryforwards could expire before we would be able to use them. This could adversely affect our financial position, results of operations and cash flow.

The integration of our prior banking subsidiaries and affiliates with First Community following the Consolidation may present significant challenges.
    

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First Community may face significant challenges in combining its four prior banking subsidiaries and affiliates operations in a timely and efficient manner, and in retaining key personnel. The failure to integrate successfully and to manage successfully the challenges presented by the integration process may result in First Community not achieving the anticipated benefits of the Consolidation, including operational and financial synergies.
We have a substantial amount of preferred stock and debt outstanding and may incur additional indebtedness in the future, which could restrict our operations.
As of December 31, 2013, we had $6.1 million of preferred stock and $19.3 million of subordinated debt outstanding. We currently expect our dividend and interest expense to be approximately $592,000 in fiscal year 2014. We may not generate sufficient revenues to service our preferred stock or to service or repay our debt, and have sufficient funds left over to achieve or sustain profitability in our operations, meet our working capital and capital expenditure needs, and to pay dividends to our common shareholders.
The degree to which we are leveraged could have important consequences for our shareholders, including:
limiting our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;
making it more difficult for us to satisfy its debt and other obligations;
limiting our ability to borrow additional funds, or to sell assets to raise funds, if needed, for working capital, capital expenditures, acquisitions or other purposes;
increasing our vulnerability to general adverse economic and industry conditions, including changes in interest rates; and
placing us at a competitive disadvantage compared to our competitors that have less preferred stock or debt.

If for any reason we are unable to meet our debt service and repayment obligations under any note representing our currently outstanding subordinated debt, we would be in default under the terms of such note, which would allow the holder thereof to declare the principal amount of the note and any accrued but unpaid dividends to be due and payable. If the amounts outstanding under our subordinated notes were to be accelerated, we may not have cash sufficient to repay in full the money owed to our debt holders.
The Consolidation may not be accretive and may cause dilution to our earnings per share, which may negatively affect the price of our common stock following completion of the Consolidation.
We currently anticipate that the Consolidation will be accretive to the earnings per share of the combined company during the 2015 calendar year. This expectation is based on preliminary estimates and assumes certain synergies expected to be realized by the combined Bank during such time. Such estimates and assumptions could materially change due to additional transaction-related costs, the failure to realize any or all of the benefits expected in the merger or other factors beyond the control of First Community or the Bank. All of these factors could delay, decrease or eliminate the expected accretive effect of the Consolidation and cause resulting dilution to the First Community’s earnings per share or to the price of First Community common stock.
The market price of our common stock may be volatile, which could cause the value of an investment in our common stock to decline.
The market price of our common stock may fluctuate substantially due to a variety of factors, many of which are beyond our control, including:
Ÿ
general market conditions;
Ÿ
domestic and international economic factors unrelated to our performance;
Ÿ
actual or anticipated fluctuations in our quarterly operating results;
Ÿ
changes in or failure to meet publicly disclosed expectations as to our future financial performance;
Ÿ
downgrades in any securities analysts’ estimates of our financial performance or lack of research and reports by industry analysts;
Ÿ
changes in market valuations or earnings of similar companies;
Ÿ
any future sales of our common stock or other securities; and
Ÿ
additions or departures of key personnel.
The stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of particular companies. These types of broad market fluctuations may adversely affect the trading price of our common stock. In the past, shareholders have sometimes instituted securities class action litigation against companies

24



following periods of volatility in the market price of their securities. Any similar litigation against us could result in substantial costs, divert management’s attention and resources and harm our business or results of operations.
Our stock is relatively thinly traded.
Although our common stock is traded on the OTCQB marketplace, the average daily trading volume of our common stock is relatively small compared to many public companies. The desired market characteristics of depth, liquidity, and orderliness require the substantial presence of willing buyers and sellers in the marketplace at any given time. In our case, this presence depends on the individual decisions of a relatively small number of investors and general economic and market conditions over which we have no control. Due to the relatively small trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause the stock price to fall more than would be justified by the inherent worth of the Company. Conversely, attempts to purchase a significant amount of our stock could cause the market price to rise above the reasonable inherent worth of the Company.


Item 1B. Unresolved Staff Comments

Not applicable.



25



Item 2. Properties    

As of December 31, 2013 the net book value of our properties was $16.4 million. The following is a list of our offices:
Location
Address
Ownership
Square Footage
Joliet Branch
2801 Black Road, Joliet, Illinois, 60435
Owned
11,048

Channahon Branch
25407 South Bell Road, Channahon, Illinois 60410
Leased
8,880

Naperville Branch
24 West Gartner Road, Suite 104, Naperville, Illinois 60540
Leased
4,100

Naperville Loan Production Office
64 S. Washington, Suite 300, Naperville, Illinois 60540
Leased
2,825

Plainfield Branch
14150 S. Rt. 30, Plainfield, Illinois 60544
Owned
12,000

Homer Glen Branch
13901 S. Bell Road, Homer Glen, Illinois 60491
Owned
4,000

Burr Ridge Branch
7020 County Line Road, Burr Ridge, Illinois 60527
Owned
18,863




Item 3. Legal Proceedings

The Company is involved from time to time in various legal actions arising in the normal course of business. While the outcome of the pending proceedings cannot be predicted with certainty, it is the opinion of management that the resolution of these proceedings should not have a material adverse effect on our consolidated financial position or results of operation.


Item 4. Mine Safety Disclosures

Not applicable.


26




PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

First Community’s common stock is traded on the OTCQB marketplace under the symbol “FCMP.” There were approximately 1009 holders of record of our common stock as of March 13, 2014.
The following table presents quarterly high and low bid prices per share information for our common stock for 2013 and 2012. These quotations represent inter-dealer prices without retail mark-ups, mark-downs or commissions and may not necessarily represent actual transactions.
 
Market Price Range
 
High
 
Low
2013
 
 
 
Quarter ended December 31
$
4.63

 
$
3.60

Quarter ended September 30
4.00

 
2.58

Quarter ended June 30
4.00

 
3.00

Quarter ended March 31
4.25

 
3.50

2012
 
 
 
Quarter ended December 31
$
3.00

 
$
2.40

Quarter ended September 30
3.10

 
2.25

Quarter ended June 30
4.00

 
2.00

Quarter ended March 31
4.00

 
1.60

The timing and amount of cash dividends paid on our common stock depends on our earnings, capital requirements, financial condition and other relevant factors including the ability of the Bank to repay dividends to the Company. In addition, regulatory policies restrict the ability of the Bank to pay dividends due to its negative retained earnings. See Item 1. Business above and Note 14 to our Consolidated Financial Statements contained in Item 8 Financial Statements and Supplementary Data.
First Community has not paid cash dividends on its common stock since its formation in 2006.




27



Item 6.     Selected Financial Data

Not applicable.


    

28



Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our financial statements and related notes thereto included elsewhere in this report. This report may contain certain forward-looking statements, such as discussions of the Company’s pricing and fee trends, credit quality and outlook, liquidity, new business results, expansion plans, anticipated expenses and planned schedules. The Company intends such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies and expectations of the Company, are identified by use of the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “project,” or similar expressions. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many risks and uncertainties, including those described in Item 1A. “Risk Factors” and other sections of this Annual Report on Form 10-K and the Company’s other filings with the SEC, and other risks and uncertainties, including changes in interest rates, general economic conditions and those in the Company’s market area, legislative/regulatory changes, including the rules recently adopted by the U.S. federal banking authorities to implement the Basel III capital accords, monetary and fiscal policies of the U.S. government, including policies of the Treasury and the Federal Reserve, the Company’s success in raising capital, demand for loan products, deposit flows, competition, demand for financial services in the Company’s market area and accounting principles, policies and guidelines. Furthermore, forward-looking statements speak only as of the date they are made. Except as required under the federal securities laws or the rules and regulations of the SEC, we do not undertake any obligation to update or review any forward-looking information, whether as a result of new information, future events or otherwise.

Overview

Highlighted operational data includes:

Net income available to common shareholders increased $20.5 million to $20.6 million for the year ended December 31, 2013 compared to $104,000 for the year ended December 31, 2012.
Book value per common share increased $1.10 to $5.24 at December 31, 2013, compared to $4.14 at December 31, 2012.
First Community repurchased $16.8 million of its outstanding $22.0 million Series B Preferred Stock, during 2013. The 16,824 preferred shares, with a liquidation preference of $1,000 per share, were repurchased at a cost of $11.9 million resulting in a gain attributable to common shareholders of $4.9 million.
Loan growth before loan sales and chargeoffs was $43.7 million during 2013 which included $15.0 million of loan growth in commercial and residential 1-4 family loans.
Non-performing loans decreased $4.7 million to $23.2 million or 3.56% of total loans at December 31, 2013, compared with $27.9 million or 4.39% of total loans at December 31, 2012. Current year asset sales, charge-offs and a continued focus on asset quality contributed to the improvement in 2013.
Total special mention, substandard and doubtful loans decreased $41.5 million to $57.0 million at December 31, 2013.
Non-interest expense continued to improve as a result of the Consolidation and overall improved operating performance. Non-interest expense for the year was $20.2 million which was a $1.6 million improvement over $21.8 million in the prior year.

Results of Operations
Net Interest Income
Net interest income is the largest component of our income, and is affected by the interest rate environment and the volume and the composition of interest earning assets and interest-bearing liabilities. Our interest earning assets include loans, interest bearing deposits in other banks, investment securities, and federal funds sold. Our interest bearing liabilities include deposits, advances from the FHLB, subordinated debentures, repurchase agreements and other short-term borrowings.
The following table reflects the components of net interest income for the years ended December 31, 2013, 2012 and 2011:

29



 
Years ended December 31,
 
2013
2012
2011
(Dollars in thousands)
Average
Balances
Income/
Expense
Average Yields/
Rates
Average
Balances
Income/
Expense
Average Yields/
Rates
Average
Balances
Income/
Expense
Average Yields/
Rates
Assets
 
 
 
 
 
 
 
 
 
Loans (1)
$
659,140

$
32,664

4.96
%
$
659,139

$
36,626

5.56
%
$
755,625

$
43,888

5.81
%
Investment securities (2)
103,596

2,056

1.98

102,627

1,648

1.61

71,252

1,274

1.79

Federal funds sold
17,049

11

0.06

17,048

53

0.31

19,143

64

0.33

Interest bearing deposits with other banks
72,721

167

0.23

71,579

195

0.27

63,372

230

0.36

Total earning assets
$
852,506

$
34,898

4.09
%
$
850,393

$
38,522

4.53
%
$
909,392

$
45,456

5.00
%
 
 
 
 
 
 
 
 
 
 
Other assets
28,490

 
 
28,980

 
 
22,843

 
 
Total assets
$
880,996

 
 
$
879,373

 
 
$
932,235

 
 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
NOW accounts
$
64,858

$
152

0.23
%
$
64,858

$
234

0.36
%
$
60,444

$
313

0.52
%
Money market accounts
158,505

459

0.29

154,017

590

0.38

155,464

903

0.58

Savings accounts
23,505

47

0.20

23,505

64

0.27

23,598

98

0.42

Time deposits
412,258

4,278

1.04

412,257

7,006

1.70

479,356

10,538

2.20

Total interest bearing deposits
659,126

4,936

0.75
%
654,637

7,894

1.21
%
718,862

11,852

1.65
%
Securities sold under agreements to repurchase
23,992

33

0.14
%
23,993

33

0.14
%
21,258

93

0.44
%
Mortgage payable
779

47

6.03

779

47

6.03




FHLB Advances






9,534

117

1.23

Subordinated debentures
13,340

1,190

8.92

4,060

325

8.00

4,060

325

8.00

Total interest bearing liabilities
697,237

6,206

0.89
%
683,469

8,299

1.22
%
753,714

12,387

1.64
%
Non-interest bearing deposits
99,613

 
 
101,031

 
 
85,696

 
 
Other liabilities
5,361

 
 
5,436

 
 
4,531

 
 
Total liabilities
$
802,211

 
 
$
789,936

 
 
$
843,941

 
 
 
 
 
 
 
 
 
 
 
 
Total shareholders' equity
$
78,755

 
 
$
89,437

 
 
$
88,294

 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and equity
$
880,966

 
 
$
879,373

 
 
$
932,235

 
 
 
 
 
 
 
 
 
 
 
 
Net interest income
 
$
28,692

 
 
$
30,223

 
 
$
33,069

 
Interest rate spread
 
 
3.20
%
 
 
3.31
%
 
 
3.36
%
Net interest margin
 
 
3.37
%


 
3.55
%
 
 
3.64
%
Footnotes:
(1) Average loans include non-performing loans.
(2) No tax-equivalent adjustments were made, as the effect thereof was not material.

Net interest income was $28.7 million for the year ended December 31, 2013, a decrease of $1.5 million or 5.07%, from $30.2 million for the same period in the prior year. The net interest margin was 3.37% for this period in 2013 and 3.55% for 2012. The net interest income and margin decrease from the prior year was due to a decrease in our loan yields partially offset by an improvement in our average cost of funds as a result of an improved deposit mix and downward repricing of interest bearing deposits. Interest expense decreased in 2013 as certificates of deposits were either not renewed or repriced at lower rates.

 

30



Rate/Volume Analysis

The following table sets forth certain information regarding changes in our interest income and interest expense for the years noted (dollars in thousands):
 
Year Ended December 31,
 
2013 Compared to 2012
 
2012 Compared to 2011
 
Volume
Rate
Mix
Net Increase (Decrease)
 
Volume
Rate
Mix
Net Increase (Decrease)
 
 
 
 
 
 
 
 
 
 
Interest Income
 
 
 
 
 
 
 
 
 
Loans (1)
$

$
(3,962
)
$

$
(3,962
)
 
$
(5,604
)
$
(1,901
)
$
243

$
(7,262
)
Investment securities (2)
16

388

4

408

 
561

(130
)
(57
)
374

Federal funds sold

(42
)

(42
)
 
(7
)
(4
)

(11
)
Interest bearing deposits with other banks

(28
)

(28
)
 
30

(57
)
(8
)
(35
)
Total interest income
16

(3,644
)
4

(3,624
)
 
(5,020
)
(2,092
)
178

(6,934
)
 
 
 
 
 
 
 
 
 
 
Interest expense
 
 
 
 
 
 
 
 
 
NOW accounts
$

$
(82
)
$

$
(82
)
 
$
23

$
(95
)
$
(7
)
$
(79
)
Money market accounts
17

(144
)
(4
)
(131
)
 
(8
)
(307
)
2

(313
)
Savings accounts

(17
)

(17
)
 

(34
)

(34
)
Time deposits

(2,728
)

(2,728
)
 
(1,476
)
(2,391
)
335

(3,532
)
Securities sold under agreements to repurchase




 
12

(22
)
(3
)
(13
)
Mortgage payable




 




FHLB advances




 
(117
)
(117
)
117

(117
)
Subordinated debentures
742

38

85

865

 




Total interest expense
$
759

$
(2,933
)
$
81

$
(2,093
)
 
$
(1,566
)
$
(2,966
)
$
444

$
(4,088
)
 
 
 
 
 
 
 
 
 
 
Change in net interest income
$
(743
)
$
(711
)
$
(77
)
$
(1,531
)
 
$
(3,454
)
$
874

$
(266
)
$
(2,846
)
Footnotes:
(1) Average loans include non-performing loans.
(2) No tax-equivalent adjustments were made, as the effect thereof was not material.

Provision for Loan Losses
The provision for loan losses was $8.0 million for the year ended December 31, 2013, compared to $7.1 million for the same period in 2012. Net charge-offs increased to $15.1 million for the year ended December 31, 2013 compared to $11.2 million for the year ended December 31, 2012. Non-performing loans decreased from December 31, 2012 to December 31, 2013 by 17.0% to $23.2 million from $27.9 million. During the year ended December 31, 2013, the Company sold approximately $10.3 million in non-performing loans for approximately $7.1 million resulting in charge-offs related to the sales of approximately $3.2 million. Management determined that selling the assets to a third party helped to effectively reduce non-performing assets and helped to avoid the carrying costs related to foreclosure.

31



Non-interest Income
    
Non-interest income for the year ended December 31, 2013 decreased slightly from the year ended December 31, 2012. During the third quarter of 2013, First Community added three additional mortgage loan staff members to its residential mortgage loan operation with the goal of increasing future mortgage fee income. The following table sets forth the components of non-interest income for the periods indicated:    
 
For year ended December 31,
(Dollars in thousands)
2013
2012
Service charges on deposit accounts
$
436

$
455

Gain on sale of loans
353

339

Gain on sale of securities
4

17

Mortgage fee income
368

288

Other
478

551

Total non-interest income
$
1,639

$
1,650


Non-interest Expense

Non-interest expense decreased for the year ended December 31, 2013 compared to the year ended December 31, 2012. Salaries and employee benefits increased for the year ended December 31, 2013 compared to the the year ended December 31, 2012 as a result of increased incentive compensation during 2013 commensurate with the improvements in the Company’s operating results. In addition, during the third quarter of 2013, First Community added three additional staff members to its residential mortgage loan operation, contributing to the increase in salary and benefits expense. Data processing fees improved from 2012 due to a renegotiation of our core processing contract in the first quarter of 2013. Professional fees are normalizing as we completed the Consolidation and incurred the costs related to the transaction in 2012 and the first three months of 2013. Other expenses were slightly higher in 2013 compared to 2012, which was primarily the result of the issuance of stock incentive awards which were immediately vested. These were offset by reductions in FDIC insurance as a result of the decrease in total assets of the Bank and the lifting of the Bank’s Memoranda of Understanding during the third quarter of 2013. The following table sets forth the components of non-interest expense for the periods indicated:
 
For year ended December 31,
(Dollars in thousands)
2013
2012
Salaries and employee benefits
10,666

9,805

Occupancy and equipment expense
2,229

2,421

Data processing
860

1,179

Professional fees
1,424

2,975

Advertising and business development
654

405

Loan workout
180

(43
)
Loss on sale of foreclosed assets, net
168

936

Foreclosed assets, net of rental income
250

380

Other expense
3,816

3,779

Total non-interest expense
$
20,247

$
21,837




32



Income Taxes
    
Prior to the Consolidation, the Company filed four tax returns, one consolidated return for First Community and FCB Joliet and one for each other prior banking subsidiary. Because of multiple returns, we separately calculated income tax expense, established deferred tax assets and determined valuation allowances.   Subsequent to the Consolidation, the Company now calculates income tax expense on a consolidated basis.           

Under U.S. GAAP, (“Generally Accepted Accounting Principles”) a valuation allowance against a net deferred tax asset is required to be recognized if it is more-likely-than-not that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax asset is highly subjective and dependent upon judgment concerning management’s evaluation of both positive and negative evidence, forecasts of future income, applicable tax planning strategies and assessments of current and future economic and business conditions.
Prior to the Consolidation of its four prior bank subsidiaries in 2013, the Company determined a valuation allowance was necessary for two of those banks as of December 31, 2012, largely based on negative evidence including cumulative losses caused by credit losses in its loan portfolio and general uncertainty surrounding future economic and business conditions.
The Company evaluates the need for a deferred tax asset valuation allowance on an ongoing basis, considering both positive and negative evidence. As of September 30, 2013, positive evidence included seven consecutive quarters of income, continued improvement in asset quality ratios, termination of our Memoranda of Understanding with our banking regulators, completion of our Consolidation in March 2013 and the prospect that other key drivers of profitability will continue in the future. Negative evidence included no available taxes paid in open carryback years, no significant tax planning opportunities to accelerate taxable income and that 2013 will be the first year of taxable income since 2007. Based on the Company’s assessment of all available evidence, management determined that it was more-likely-than-not that the deferred tax asset would be realized. Therefore, at September 30, 2013, the Company released its $15.6 million valuation allowance against the net deferred tax assets resulting in a credit to income tax (benefit) expense.
The Company realized income tax benefits of $14.6 million and $341,000 of income tax expense for the year ended December 31, 2013 and 2012, respectively. The income taxes in 2012 were related to the income taxes for Burr Ridge which had taxable income and no longer had a valuation allowance against its net deferred tax asset prior to the Consolidation. The decline in income taxes for the year ended December 31, 2013 compared to the year ended December 31, 2012 was a result of the new tax structure and the release of the deferred tax valuation allowance during the third quarter of 2013. We now expect normalized income tax expense in future periods.

Financial Condition
Our assets totaled $867.6 million and $902.6 million at December 31, 2013 and December 31, 2012, respectively. Total loans at December 31, 2013 and December 31, 2012 were $652.5 million and $637.4 million, respectively. Total deposits were $725.4 million and $780.7 million at December 31, 2013 and December 31, 2012, respectively. We continue to see decreases in time deposit accounts as we have continued to lower our rates in an effort to lower our overall cost of funding. The decrease in total assets was due to decreases in cash on hand related to decreases in deposits from 2012, in addition to the funding of new loans, and investments in available for sale securities in an effort to deploy additional liquidity. Borrowed funds, consisting of securities sold under agreements to repurchase and a mortgage note payable, totaled $25.6 million and $25.7 million at December 31, 2013 and December 31, 2012, respectively. In addition, $15.5 million in subordinated debt was raised during 2013.
Total shareholders’ equity was $91.6 million and $87.9 million at December 31, 2013 and December 31, 2012, respectively. The increase was as a result of the net income available to common shareholders for the year ended December 31, 2013 partially offset by the repurchase of preferred shares.

33



Loans
The loan portfolio consists principally of loans to individuals and small- and medium-sized businesses within our primary market area. The table below shows our loan portfolio composition (dollars in thousands):
 
December 31,
 
2013
 
2012
 
2011
 
2010
 
2009
 
Amount
% of Total
 
Amount
% of Total
 
Amount
% of Total
 
Amount
% of Total
 
Amount
% of Total
Construction and Land Development
$
20,745

3
%
 
$
30,494

5
%
 
$
41,946

6
%
 
$
54,507

7
%
 
$
83,931

11
%
Farmland and Agricultural Production
8,505

1

 
7,211

1

 
12,761

2

 
11,161

1

 
11,661

2

Residential 1-4 Family
86,770

13

 
77,567

12

 
86,703

13

 
85,112

11

 
77,866

11

Commercial Real Estate
366,689

56

 
366,901

58

 
379,881

55

 
429,823

55

 
381,076

51

Commercial
159,427

25

 
140,895

22

 
147,184

21

 
184,204

23

 
151,827

20

Consumer and other
10,315

2

 
14,361

2

 
23,385

3

 
26,108

3

 
35,128

5

Total Loans
$
652,451

100
%
 
$
637,429

100
%
 
$
691,860

100
%
 
$
790,915

100
%
 
$
741,489

100
%
 Total loans increased by $15.0 million during the year ended December 31, 2013 as a result of new loan originations. New loans originated during the 2013 were primarily in the residential real estate and commercial loan categories which is in line with our current strategy for loan growth.
The contractual maturity distributions of our loan portfolio as of December 31, 2013 are indicated in the tables below:
 
Loans Maturities December 31, 2013
(Dollars in thousands)
Within One Year
One Year to Five Years
After Five Years
Total
Construction and Land Development
$
11,483

$
961

$
8,301

$
20,745

Farmland and Agricultural Production
2,452


6,053

8,505

Residential 1-4 Family
23,072

8,328

55,370

86,770

Commercial Real Estate
53,573

89,336

223,780

366,689

Commercial
87,528

9,541

62,358

159,427

Consumer and other
2,255

108

7,952

10,315

      Total
$
180,363

$
108,274

$
363,814

$
652,451

 
December 31, 2013
(Dollars in thousands)
Due After One Year
Loans with:
 
Predetermined interest rates
$
144,046

Floating or adjustable rates
328,042

 
$
472,088

Allowance for Loan Losses

Management reviews the level of the allowance for loan losses on a quarterly basis. The methodology used to assess the adequacy of the allowance includes the allocation of specific and general reserves. The specific component relates to loans that are impaired. For such loans that are classified as impaired, an allowance is established when the collateral value, discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan. The general component is established for non-impaired loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors include local economic trends, concentrations, management experience, and other elements of the Company’s lending operations.

At December 31, 2013 and December 31, 2012, the allowance for loan losses was $15.8 million and $22.9 million, respectively, with a resulting allowance to total loans ratio of 2.42% and 3.59%. Net charge-offs amounted to $15.1 million for the year ended December 31, 2013, compared to $11.2 million for the same period in 2012. Charge-offs and recoveries for each major loan category are shown in the table below:

34



 
Year ended December 31,
(Dollars in thousands)
2013
2012
2011
2010
2009
Balance at beginning of period
$
22,878

$
26,991

$
24,799

$
16,516

$
11,109

Charge-offs:
 
 
 
 
 
Construction and Land Development
1,295

1,762

8,397

6,197

3,238

Farmland and Agricultural Production

1,353




Residential 1-4 Family
1,192

946

1,744

2,625

515

Commercial Real Estate
8,511

8,027

4,697

12,638

266

Commercial
6,229

1,452

2,005

1,446

2,780

Consumer and other
604


35

92

70

Total charge-offs
$
17,831

$
13,540

$
16,878

$
22,998

$
6,869

Recoveries:
 
 
 
 
 
Construction and Land Development
1,470

605

503

62


Farmland and Agricultural Production
5





Residential 1-4 Family
266

84

78



Commercial Real Estate
394

1,123

878



Commercial
627

547

162

230


Consumer and other
9

6

2

1

18

Total recoveries
$
2,771

$
2,365

$
1,623

$
293

$
18

Net charge-offs
15,060

11,175

15,255

22,705

6,851

Provision for loan losses
8,002

7,062

17,447

30,988

12,258

Allowance for loan losses at end of period
$
15,820

$
22,878

$
26,991

$
24,799

$
16,516

Selected loan quality ratios:
 
 
 
 
 
Net charge-offs to average loans
2.28
%
1.70
%
2.02
%
2.91
%
1.08
%
Allowance to total loans
2.42
%
3.59
%
3.90
%
3.14
%
2.23
%
Allowance to non-performing loans
68.21
%
81.88
%
80.07
%
53.56
%
119.80
%

The following table provides additional detail of the balance of the allowance for loan losses by portfolio segment (dollars in thousands):
 
At December 31,
 
2013
2012
 
2011
 
2010
 
2009
Balance at end of period applicable to:
Amount
% of Total Loans
 
Amount
% of Total Loans
 
Amount
% of Total Loans
 
Amount
% of Total Loans
 
Amount
% of Total Loans
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and Land Development
$
2,711

17
%
 
$
4,755

5
%
 
$
6,252

6
%
 
$
8,610

7
%
 
$
3,328

11
%
Farmland and Agricultural Production
427

3

 
472

1

 
1,595

2

 
58

1

 
188

2

Residential 1-4 Family
1,440

9

 
2,562

12

 
2,408

13

 
3,084

11

 
1,249

11

Commercial Real Estate
7,909

50

 
11,864

58

 
11,438

55

 
8,877

54

 
6,945

51

Commercial
3,183

20

 
3,075

22

 
4,337

21

 
3,927

23

 
3,752

20

Consumer and other
150

1

 
150

2

 
280

3

 
215

3

 
903

5

Unallocated


 


 
681


 
28


 
151


Total
$
15,820

100
%
 
$
22,878

100
%
 
$
26,991

100
%
 
$
24,799

100
%
 
$
16,516

100
%


35



Impaired Loans
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining the impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment shortfalls on a case by case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis using the fair value of collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate, or the loan’s obtainable market price due to financial difficulties of the borrower.
Residential 1-4 family and consumer loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer loans for impairment disclosures, unless such loans are the subject of a restructuring agreement.
There were approximately $23.2 million in non-performing loans at December 31, 2013 which was down from $27.9 million at December 31, 2012. Loan sales in the amount of $10.3 million resulting in $3.2 million of charge-offs took place during 2013, which contributed to the reduction in non-performing loans from prior year. In addition, the decrease was the result of current year charge-offs, paydowns, and loans moved to foreclosed assets. One non-performing loan was moved to held for sale as the pending sale is anticipated to close in the first quarter of 2014.
Impaired loans were $28.6 million and $40.2 million at December 31, 2013 and December 31, 2012, respectively. Included in impaired loans at December 31, 2013 were $9.9 million in loans with valuation allowances totaling $2.4 million, and $18.7 million in loans without a valuation allowance. Included in impaired loans at December 31, 2012 were $5.0 million in loans with valuation allowances totaling $1.3 million, and $35.2 million in loans without a valuation allowance.
The following presents the recorded investment in non-accrual loans and loans past due over 90 days and still accruing as of:
 
At December 31,
 
2013
2012
2011
2010
2009
Total non-accrual loans
$
22,843

$
27,941

$
38,234

$
45,684

$
13,655

Accruing loans delinquent 90 days or more
351



620

131

Total non-performing loans
23,194

27,941

38,234

46,304

13,786

Troubled debt restructuring accruing
3,167

12,817

4,500

2,500



We define potential problem loans as loans rated substandard which are still accruing interest.  We do not necessarily expect to realize losses on all potential problem loans, but we recognize potential problem loans carry a higher probability of default and require additional attention by management.  The aggregate principal amounts of potential problem loans as of December 31, 2013 and December 31, 2012 were approximately $3.8 million and $15.1 million, respectively.  Management believes it has established an appropriate allowance for loan losses under U.S. GAAP.

The gross interest income that would have been recorded if non-accrual loans and performing troubled debt restructurings had been current in accordance with their original terms was $1.4 million and $1.6 million, respectively, for the years ended December 31, 2013 and 2012, respectively. The amount of interest collected on non-accrual loans and performing troubled debt restructurings that was included in interest income was $101,000 and $586,000 for the years ended December 31, 2013 and 2012, respectively.


36



Investment Securities
Investment securities serve to enhance the overall yield on interest earning assets while supporting interest rate sensitivity and liquidity positions, and as collateral on public funds and securities sold under agreements to repurchase. All securities are classified as available for sale as the Company intends to hold the securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale are reported at fair value with unrealized gains or losses reported as a separate component of other comprehensive income, net of the related deferred tax effect. Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.
The amortized cost and fair value of securities available for sale (in thousands) are as follows:
 
December 31, 2013
 
December 31, 2012
 
December 31, 2011
 
Amortized Cost
Fair Value
 
Amortized Cost
Fair Value
 
Amortized Cost
Fair Value
U.S. government federal agency
$

$

 
$
1,001

$
1,002

 
$
1,002

$
1,004

Government sponsored enterprises
22,185

22,277

 
25,544

25,790

 
23,549

23,740

Residential collateralized mortgage obligations
23,444

23,237

 
20,018

20,344

 
20,087

20,352

Residential mortgage backed securities
27,924

28,006

 
7,486

7,716

 
4,918

5,038

Corporate securities
29,013

29,092

 
12,520

12,721

 
2,163

2,165

State and political subdivisions
38,217

38,704

 
40,190

41,388

 
27,381

28,072

 
$
140,783

$
141,316

 
$
106,759

$
108,961

 
$
79,100

$
80,371

Available for sale securities increased $32.4 million to $141.3 million at December 31, 2013 from $109.0 million December 31, 2012, as excess cash was invested during the year ended December 31, 2013. Overall increases in the treasury yield curve during the second quarter of 2013 allowed the Bank to invest more of its excess cash.     
Securities with a fair value of $41.0 million and $47.1 million were pledged as collateral on public funds, securities sold under agreements and for other purposes as required or permitted by law as of December 31, 2013 and December 31, 2012, respectively.
The amortized cost of debt securities available for sale as of December 31, 2013, by contractual maturity are shown below (in thousands). Maturities may differ from contractual maturities in residential collateralized mortgage obligations and residential mortgage backed securities because the mortgages underlying the securities may be called or repaid without any penalties. Therefore these securities are segregated in the following maturity summary.
 
Within One Year
 
After One Year Within Five Years
 
After Five Years Within Ten Years
 
After Ten Years
 
Other Securities
 
Amount
Yield
 
Amount
Yield
 
Amount
Yield
 
Amount
Yield
 
Amount
Government sponsored enterprises
$
11,029

0.72
%
 
$
9,159

1.13
%
 
$
1,997

2.04
%
 
$

%
 
$

Residential collateralized mortgage obligations and residential mortgage backed securities

%
 

%
 

%
 

%
 
51,368

Corporate securities
3,249

1.02
%
 
25,264

1.26
%
 
500

3.25
%
 

%
 

State and political subdivisions
4,730

1.83
%
 
23,702

2.31
%
 
6,333

2.17
%
 
3,452

6.49
%
 

 
$
19,008

1.05
%
 
$
58,125

1.67
%
 
$
8,830

2.20
%
 
$
3,452

6.49
%
 
$
51,368

No tax-equivalent yield adjustments were made as the effect thereof was not material.
The Company holds securities issued by the State of Illinois, in the amount of $821,000, of which $318,000 are sales tax revenue bonds. In addition, approximately 85% of the state and political subdivisions portfolio consists of securities issued by municipalities in Illinois. Approximately 8% of state and political subdivisions securities are insured and approximately 69% of our state and political subdivisions securities consist of general obligation issues.
Deposits

Deposits, which include non-interest-bearing demand deposits, interest bearing demand deposits, savings deposits and time deposits, are the primary source of the Company’s funds. The Company offers a variety of products designed to attract and

37



retain customers, with a primary focus on building and expanding relationships. The Company continues to focus on establishing comprehensive relationships with business borrowers, seeking deposits as well as lending relationships.

The following table sets forth the composition of our deposits at the dates indicated (dollars in thousands):
 
December 31, 2013
December 31, 2012
 
Amount
Percent
Amount
Percent
Non-interest bearing demand deposits
$
111,955

15.43
%
$
114,116

14.62
%
NOW and money market accounts
240,537

33.16

244,441

31.31

Savings
24,399

3.36

25,411

3.26

Time deposit certificates, $100,000 or more
223,436

30.80

254,268

32.57

Other time deposit certificates
125,074

17.24

142,426

18.24

Total
$
725,401

100.00
%
$
780,662

100.00
%
    
Total deposits decreased $55.3 million to $725.4 million at December 31, 2013, from $780.7 million at December 31, 2012. The decrease related to the following: (i) a commercial client withdrawing deposits, which were deposited temporarily upon the sale of a business, of approximately $26.4 million during the first six months of 2013, (ii) the decrease in time deposit certificates of $48.2 million as we continued to lower our time deposit rates and focus on core funding sources, (iii) the decrease in interest bearing transaction accounts of $3.9 million and (iv) the repurchase of our Series B Preferred Stock totaling $6.5 million with the proceeds of the subordinated debt offering which were held in escrow in a deposit account at the Bank at December 31, 2013.

The following table sets forth our time deposits segmented by months to maturity and deposit amount (dollars in thousands):
 
December 31, 2013
 
Time Deposits $250 and Greater
Time Deposits of $100 - $250
Time Deposits of Less than $100
Total
Months to maturity:
 
 
 
 
Three or less
$
10,731

$
22,877

$
18,212

$
51,820

Over Three to Six
9,581

23,164

20,824

53,569

Over Six to Twelve
18,871

55,393

40,324

114,588

Over Twelve
26,115

56,704

45,714

128,533

Total
$
65,298

$
158,138

$
125,074

$
348,510




38



Liquidity and Capital Resources

Our goal in liquidity management is to satisfy the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. Our Board of Directors has established an Asset/Liability Policy in order to achieve and maintain earnings performance consistent with long-term goals while maintaining acceptable levels of interest rate risk, a “well-capitalized” balance sheet, and adequate levels of liquidity. This policy designates the Bank’s Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO, which includes members of management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions.

Overall deposit levels are monitored on a constant basis as are liquidity policy levels. Primary sources of liquidity include cash and due from banks, short-term investments such as federal funds sold, securities sold under agreements to repurchase, and our investment portfolio, which can also be used as collateral on public funds. Alternative sources of funds include unsecured federal funds lines of credit through correspondent banks, brokered deposits, and FHLB advances. The Bank has established contingency plans in the event of extraordinary fluctuations in cash resources.

The following table reflects the average daily outstanding, year-end outstanding, maximum month-end outstanding and weighted average rates paid for each of the categories of short-term borrowings:
 
December 31,
 
2013
2012
2011
(Dollars in thousands)
 
 
 
Securities sold under agreements to repurchase:
 
 
 
Balance:
 
 
 
Average daily outstanding
$
23,992

$
23,993

$
21,258

Outstanding at end of period
24,896

24,842

18,278

Maximum month-end outstanding
32,431

31,303

24,371

Rate:
 
 
 
Weighted average interest rate during the year
0.14
%
0.14
%
0.44
%
Weighted average interest rate at end of the period
0.11
%
0.14
%
0.22
%
 
 
 
 
FHLB borrowings:
 
 
 
Balance:
 
 
 
Average daily outstanding
$
330

$

$

Outstanding at end of period



Maximum month-end outstanding



Rate:
 
 
 
Weighted average interest rate during the year
0.15
%
%
%
Weighted average interest rate at end of the period
%
%
%

Provisions of the Illinois banking laws place restrictions upon the amount of dividends that can be paid to the Company by the Bank. The availability of dividends may be further limited because of the need to maintain capital ratios satisfactory to applicable regulatory agencies.

The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial results and condition. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies. In addition, the Bank remains subject to certain of the FDIC’s de novo bank requirements until the Bank has been chartered for a period longer than seven years. Until October 28, 2015, the Bank is required, among other items, to obtain FDIC approval for any material change to its business plan.

On March 21, 2012, FCB Joliet entered into a Memorandum of Understanding with the FDIC and the IDFPR. The memorandum was not a “written agreement” for purposes of Section 8 of the Federal Deposit Insurance Act. The memorandum

39



documented an understanding among FCB Joliet, the FDIC and the IDFPR, that, among other things, FCB Joliet maintain its Tier 1 capital ratio at a minimum of 8% for the duration of the memorandum, and maintain its ratio of total capital to risk-weighted assets at a minimum of 12% for the duration of the memorandum.

On April 18, 2012, FCB Homer Glen entered into a Memorandum of Understanding with the FDIC and the IDFPR. The memorandum was not a “written agreement” for purposes of Section 8 of the Federal Deposit Insurance Act. The memorandum documented an understanding among FCB Homer Glen, the FDIC and the IDFPR, that, among other things, FCB Homer Glen maintain its Tier 1 capital ratio at a minimum of 8.5% for the duration of the memorandum, and maintain its ratio of total capital to risk-weighted assets at a minimum of 12.5% for the duration of the memorandum.

As part of its approval of the Consolidation, the FDIC had required that the Bank remain subject to these informal regulatory actions instituted at FCB Joliet and FCB Homer Glen for the duration of the memoranda.

Effective August 12, 2013, the Memorandum of Understanding that each of FCB Joliet and FCB Homer Glen had entered into with the FDIC and the IDFPR was terminated.

Pursuant to a resolution dated October 19, 2011, First Community was required to obtain written approval from the FRB prior to the declaration or payment of dividends by First Community, any increase in indebtedness of First Community or the redemption of First Community stock. On November 14, 2013, the FRB notified the Company that it had no objections to the Company rescinding the board resolution. The resolution was then rescinded by the Board of Directors on November 22, 2013.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the following table) of total and Tier I capital to risk-weighted assets and of Tier I capital to average assets, each as defined in the applicable regulations. Management believes, as of December 31, 2013 and December 31, 2012, the Company and the Bank met all capital adequacy requirements to which they are subject.

As of December 31, 2013, the Bank was well capitalized under the regulatory framework for prompt corrective action. Currently, to be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the following table. Bank regulators can modify capital requirements as part of their examination process. Moreover, the U.S. federal banking authorities’ approval of the Basel III Rules will affect the Company’s and the Bank’s capital requirements. See Note 14 to our Consolidated Financial Statements for more information.


40



The Company and the Bank’s capital amounts and ratios as of the dates noted are presented in the following table (dollar amounts in thousands):
 
Actual
Minimum Capital Requirement
Minimum To Be Well Capitalized under Prompt Corrective Action Provisions
 
Amount
Ratio
Amount
Ratio
Amount
Ratio
December 31, 2013
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
 
 
 
 
 
Consolidated
$
103,635

13.55
%
$
61,177

8.00
%
 N/A
 N/A
First Community Financial Bank
100,758

12.93

62,357

8.00

$
77,947

10.00
%
Tier I Capital (to risk-weighted assets)
 
 
 
 
 
 
Consolidated
74,688

9.77
%
30,588

4.00
%
 N/A
 N/A
First Community Financial Bank
91,116

11.69

31,179

4.00

46,768

6.00
%
Tier I Capital (to average assets)
 
 
 
 
 
 
Consolidated
74,688

8.87
%
33,680

4.00
%
 N/A
 N/A
First Community Financial Bank
91,116

10.81

33,707

4.00

42,133

5.00
%
December 31, 2012
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
 
 
 
 
 
Consolidated
$
99,579

14.46
%
55,079

8.00
%
 N/A
 N/A
FCB Joliet
47,428

13.46

28,181

8.00

$
35,226

10.00
%
FCB Plainfield
18,630

16.40

9,090

8.00

11,363

10.00

FCB Homer Glen
9,878

16.57

4,769

8.00

5,961

10.00

Burr Ridge
22,684

13.90

13,059

8.00

16,324

10.00

Tier I Capital (to risk-weighted assets)
 
 
 
 
 
 
Consolidated
86,733

12.60
%
27,539

4.00
%
 N/A
 N/A
FCB Joliet
42,905

12.18

14,090

4.00

21,135

6.00
%
FCB Plainfield
17,185

15.12

4,545

4.00

6,818

6.00

FCB Homer Glen
9,112

15.29

2,385

4.00

3,577

6.00

Burr Ridge
20,632

12.64

6,530

4.00

9,795

6.00

Tier I Capital (to average assets)
 
 
 
 
 
 
Consolidated
86,733

9.87
%
35,143

4.00
%
 N/A
 N/A
FCB Joliet
42,905

9.04

18,982

4.00

23,727

5.00
%
FCB Plainfield
17,185

12.06

5,698

4.00

7,123

5.00

FCB Homer Glen
9,112

11.97

3,044

4.00

3,805

5.00

Burr Ridge
20,632

11.12

7,418

4.00

9,273

5.00


Off-Balance Sheet Arrangements and Contractual Obligations
The Company is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customer. These financial instruments include commitments to extend credit and standby letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
Our off-balance sheet arrangements and contractual obligations are summarized in the table that follows for the periods noted.
 
December 31,
 
2013
2012
2011
Commitments to extend credit
$
116,572

$
90,368

$
82,393

Standby letters of credit
17,497

12,600

18,369

 
$
134,069

$
102,968

$
100,762


41



Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company, is based on management's evaluation of the party.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements and, generally, have terms of one year or less. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds collateral, which may include accounts receivable, inventory, property and equipment, income producing properties, supporting those commitments if deemed necessary. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments of the Company could be required to make is represented by the contractual amount shown in the summary above. If the commitment were funded, the Company would be entitled to seek recovery from the customer. At December 31, 2013 and 2012, there was $220,000 and $300,000, respectively, recorded as liabilities for the Company's potential obligations under these guarantees.
Critical Accounting Policies and Estimates
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. When establishing the allowance for loan losses, management categorizes loans into risk categories generally based on the nature of the collateral and the basis of repayment.
    
The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses, and may require the Company to recognize adjustments to its allowance based on their judgments of information available to them at the time of their examinations.

The allowance consists of specific and general components. The specific component relates to impaired loans. For loans classified as impaired, an allowance is established when the collateral value, discounted cash flows or observable market price of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical loss experience adjusted for qualitative factors. These qualitative factors consider local economic trends, concentrations, management experience, and other elements of the Company’s lending operations.
    
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining the impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.
    
Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the fair value of collateral if the loan is collateral dependent, the present value of expected future cash flows discounted at the loan’s effective interest rate, or the loan’s obtainable market price due to financial difficulties of the borrower.



42



Foreclosed Assets
Assets acquired through loan foreclosure or other proceedings are initially recorded at fair value less estimated selling costs at the date of foreclosure establishing a new cost basis. After foreclosure, foreclosed assets are held for sale and are carried at the lower of cost or fair value less estimated costs of disposal. Any valuation adjustments required at the date of transfer are charged to the allowance for loan losses. Subsequently, unrealized losses and realized gains and losses on sales are included in other noninterest income. Operating results from foreclosed assets are recorded in other noninterest expense.
Income taxes
Deferred taxes are provided using the liability method. Deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
The Company had adopted the accounting guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions. The adoption of this standard did not have a significant impact on the Company and there are no uncertain tax positions as of December 31, 2013 and 2012.

Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are recognized or sustained upon examination. The term more-likely-than-not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances, and information available at the reporting date and is subject to management’s judgment. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more-likely-than-not that some portion or all of a deferred tax asset will not be realized.
Recent Accounting Pronouncements
Refer to Note 1 of our Consolidated Financial Statements for a description of recent accounting pronouncements including respective dates of adoption and effects on results of operations and financial condition.




43



Item 7A. Quantitative and Qualitative Disclosures about Market Risk

Not applicable.




44



Item 8. Financial Statements and Supplementary Data







FIRST COMMUNITY FINANCIAL PARTNERS, INC.
CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2013 and 2012
INDEX



45




Report of Independent Registered Public Accounting Firm







To the Board of Directors
First Community Financial Partners, Inc.


We have audited the accompanying consolidated balance sheets of First Community Financial Partners, Inc. and Subsidiaries (“the Company”) as of December 31, 2013 and 2012, and the related consolidated statements of operations, comprehensive income, shareholders’ equity and cash flows for the years then ended.  These financial statements are the responsibility of the Company's management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Community Financial Partners, Inc. and Subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.



/s/ McGladrey LLP
Chicago, Illinois
March 20, 2014


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