First Financial Corporation — Q2 2017 Form 10-Q
Business context and period: The company is a one-segment banking business. This unaudited report covers the three and six months ended June 30, 2017, compared with the corresponding 2016 periods; balance-sheet comparisons are to December 31, 2016. Dollar amounts below are in millions unless noted.
Financial performance and condition
| Metric | Q2 / June 30, 2017 | Comparable period / prior date |
|---|---|---|
| Net interest income | $26.56 Q2; $53.07 first half | $26.06 Q2 2016; $52.22 first half 2016 |
| Net interest margin | 4.05% Q2 and first half | 4.04% Q2 2016; 4.05% first half 2016 |
| Net income | $8.35 Q2; $17.72 first half | $8.23 Q2 2016; $21.91 first half 2016 |
| EPS, basic and diluted | $0.68 Q2; $1.45 first half | $0.68 Q2 2016; $1.76 first half 2016 |
| Loans, net | $1,837.4 | $1,820.4 at Dec. 31, 2016 |
| Deposits | $2,427.7 | $2,428.5 at Dec. 31, 2016 |
| Total assets / shareholders’ equity | $2,974.7 / $434.5 | $2,988.5 / $414.4 at Dec. 31, 2016 |
| Short-term borrowings / FHLB advances | $51.9 / $0.1 | $81.0 / $0.1 at Dec. 31, 2016 |
- Q2 net income increased modestly year over year, while first-half net income fell. The company attributes the first-half comparison primarily to the $13.0 million pretax gain from the 2016 sale of its insurance brokerage operation.
- Q2 net interest income rose about $0.5 million year over year. First-half noninterest income was $19.2 million versus $30.6 million; the 2016 insurance-sale gain was the main difference. A $3.1 million cash recovery on a previously written-down security boosted 2017 first-quarter noninterest income.
- First-half noninterest expense declined to $44.7 million from $46.1 million, including savings associated with the insurance operation’s sale. The loan-loss provision rose to $2.64 million from $1.27 million; first-half net charge-offs were approximately $1.73 million, broadly comparable with 2016.
- Operating cash flow was $17.0 million for the first half, versus $11.9 million in 2016. Investing activities used $0.1 million and financing activities used $36.5 million; cash and due from banks decreased $19.6 million to $55.4 million.
- Allowance for loan losses was $19.68 million, or 96.7% of reported nonperforming loans. Nonperforming loans were $20.36 million, down from $22.67 million at year-end 2016. A $2.8 million loan was placed on nonaccrual after June 30 and is not included in the quarter-end figures.
- Regulatory capital ratios exceeded the disclosed minimums. At June 30, the bank’s common equity Tier 1, total risk-based, Tier 1 risk-based and Tier 1 leverage ratios were 17.14%, 17.88%, 17.14% and 13.14%, respectively.
Changes, outlook and risks
- Loans increased from year-end while deposits were essentially unchanged. The deposit mix shifted: non-interest-bearing deposits fell to $415.9 million from $564.1 million, while other interest-bearing deposits rose to $1,969.0 million from $1,820.7 million.
- Management reported adequate liquidity, citing deposits, loan and securities repayments, $7.4 million of securities maturities, anticipated mortgage-backed security principal payments of $111.7 million and unused borrowing capacity. These anticipated cash flows are estimates, not committed funding.
- Interest-rate simulation estimated that a 100-basis-point increase would raise net interest income 1.92% over 12 months; a 100-basis-point decrease would reduce it 2.64%. The filing cautions that rate-shock models rely on assumptions and do not reflect management actions.
- No earnings guidance is provided. Management said it considers the allowance adequate. It expects CECL adoption to increase the allowance, but the amount is uncertain. Management did not expect material effects from several other pending accounting standards described in the filing.
- Key exposures include credit quality, interest-rate and liquidity risk, economic and competitive conditions, regulatory or accounting changes, and litigation. The company reported no material change in risk factors from its 2016 Form 10-K and no material pending legal proceedings beyond routine litigation.
- Management described securities unrealized losses as primarily interest-rate-related and did not consider the portfolio other-than-temporarily impaired. Certain collateralized debt obligations and municipal securities use Level 3 valuation inputs; the filing notes a wide range among available third-party CDO pricing estimates.
Important facts for investors to verify
- Impact and collectability of the $2.8 million post-quarter-end nonaccrual loan, and subsequent movement in nonperforming loans and the allowance.
- Whether deposit mix changes affect funding costs and the 4.05% net interest margin as rates change.
- Quality and sustainability of earnings excluding the 2016 insurance-sale gain and the 2017 one-time $3.1 million security recovery.
- Assumptions behind expected liquidity inflows and the interest-rate sensitivity model, including available borrowing capacity.
- Valuation support and potential credit exposure for Level 3 securities, and the expected allowance effect when CECL is adopted.