First Financial Corporation — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; this is an annual report, not a standalone fourth-quarter filing. First Financial is a community-focused financial holding company operating primarily in west-central Indiana and east-central Illinois.
Financial performance and condition
| Metric | 2018 | 2017 |
|---|---|---|
| Net income | $46.6 million | $29.1 million |
| Diluted earnings per share | $3.80 | $2.38 |
| Net interest income | $116.6 million | $107.9 million |
| Net interest margin, tax-equivalent | 4.32% | 4.11% |
| Provision for loan losses | $5.8 million | $5.3 million |
| Net charge-offs | $5.2 million | $4.2 million |
| Total assets at year-end | $3.009 billion | $3.001 billion |
| Loans, net, at year-end | $1.934 billion | $1.887 billion |
| Deposits at year-end | $2.437 billion | $2.459 billion |
| Short-term borrowings at year-end | $69.7 million | $57.7 million |
Return on average assets was 1.57%, versus 0.98%; return on average shareholders’ equity was 10.98%, versus 6.69%. Cash from operating activities was $57.4 million; cash and due from banks ended the year at $74.4 million. Shareholders’ equity was $442.7 million, up from $413.6 million. The 2018 dividend was $1.02 per share.
Nonperforming loans declined to $16.6 million from $21.7 million, and allowance coverage of nonperforming loans rose to 123% from 92%. The allowance for loan losses was $20.4 million, or 1.05% of loans. Approximately 60% of the loan portfolio was commercial and commercial real estate lending.
At December 31, the Corporation’s CET1, total risk-based capital, and leverage ratios were 18.48%, 19.36%, and 14.59%, respectively. The Bank’s corresponding ratios were 17.99%, 18.71%, and 14.19%; management reported both banking subsidiaries as well capitalized.
Material changes and unusual items
- Net income increased substantially, but 2018 included a recovery of a previously impaired security: $2.4 million of pretax interest income and $4.5 million of pretax non-interest income. This is an unusual contributor to results.
- Net interest income rose as loan growth and higher asset yields more than offset increased funding costs. Average interest-bearing liability cost increased to 0.47% from 0.31%.
- 2017 results included a $6.3 million non-cash tax expense from remeasurement of deferred tax balances after federal tax reform. The effective tax rate was 19.3% in 2018 versus 41.5% in 2017, reflecting that prior-year charge and the lower federal tax rate.
- Loans increased while deposits fell by $21.9 million; short-term borrowings increased by $12.0 million. Available-for-sale securities declined by $30.0 million, and shareholders’ accumulated other comprehensive loss widened to $23.5 million from $14.7 million, largely reflecting securities valuation changes.
- In 2018, First Financial early adopted an accounting standard permitting certain tax effects to be reclassified from accumulated other comprehensive income to retained earnings, moving $2.4 million between those accounts with no change to total equity.
Outlook, risks, and contingencies
- Acquisition: On January 7, 2019, the Corporation signed an agreement to acquire HopFed Bancorp, parent of Heritage Bank USA. The transaction was expected to close in the second quarter of 2019, subject to regulatory and shareholder approvals. Pro forma assets were approximately $3.9 billion as of September 30, 2018. Integration, execution, credit, and cost-savings risks are disclosed; no quantified synergy or earnings guidance is provided.
- Interest rates and liquidity: Management identifies interest-rate risk as its most significant market risk. Its model estimates net interest income would rise 2.06% over 12 months after a 100-basis-point increase and fall 2.94% after a 100-basis-point decrease; results depend on assumptions and exclude management responses. Liquidity sources include securities cash flows and secured or unsecured borrowing capacity.
- Credit and geographic concentration: Commercial and commercial real estate exposure, borrower cash flows, collateral values, and local economic conditions are key risks. In February 2019, $9 million of loans were downgraded from special mention to substandard; the filing says the allowance impact was not material.
- Accounting and market exposures: Management expected adoption of the CECL credit-loss standard, then scheduled for 2020, to increase the allowance, but the amount was uncertain. The Corporation also has LIBOR-linked instruments and disclosed uncertainty around the transition from LIBOR.
- Other: The filing cites competition, cybersecurity and vendor risks, regulatory requirements, deposit funding and rising funding costs, pension obligations, and potential acquisition dilution. No material pending legal proceedings were reported. The auditor gave unqualified opinions on the financial statements and internal control; management also concluded controls were effective.
Key facts for investors to verify
- How much of 2018’s earnings increase is repeatable after excluding the security recovery and comparing against 2017’s tax-remeasurement charge.
- Whether loan and deposit trends, funding costs, and net interest margin remain favorable as rates and competition change.
- Credit quality and allowance adequacy, especially for commercial and commercial real estate loans, including the subsequent $9 million downgrade.
- Completion terms, purchase accounting, integration costs, capital effects, and realized benefits of the HopFed acquisition.
- The effect of CECL adoption, securities valuation changes, and LIBOR transition on future earnings, capital, and liquidity.