First Financial Corporation — 2016 Form 10-K
Business and period: Annual reporting period ended December 31, 2016. First Financial is an Indiana-based financial holding company operating primarily in west-central Indiana and east-central Illinois through its banking and other subsidiaries. It reported 846 full-time-equivalent employees and 71 branches.
Financial results and position
- Earnings: Net income was $38.4 million, up 27.2% from $30.2 million in 2015; diluted EPS was $3.12 versus $2.35. Return on average assets rose to 1.30% from 1.01%; return on average equity was 9.26% versus 7.46%.
- Net interest income and margin: Net interest income increased to $105.0 million from $104.5 million. Net interest margin was unchanged at 4.04%. Average interest-earning assets were $2.75 billion, with a 4.21% tax-equivalent yield.
- Other income and expenses: Non-interest income rose to $46.9 million from $39.2 million, including a $12.8 million gain on the sale of insurance brokerage assets and liabilities. Non-interest expense fell to $90.3 million from $98.4 million, partly reflecting lower pension costs and the insurance operation sale.
- Taxes and unusual item: The effective tax rate increased to 34.1% from 25.6%, primarily because $5.1 million of goodwill eliminated in the insurance sale was not tax-deductible. The sale produced a reported after-tax gain of $5.75 million in the first quarter.
- Balance sheet: Total assets were $2.99 billion, up 0.3%; loans were $1.84 billion, up about $75 million; deposits were $2.43 billion, down $13.8 million. Shareholders’ equity increased to $414.4 million from $410.3 million.
- Funding and liquidity: Borrowings rose to $81.1 million from $46.5 million, mainly as short-term borrowings increased. Year-end cash and due from banks was $75.0 million, down $13.7 million. Operating cash flow was $41.2 million; investing cash flow was negative $44.1 million and financing cash flow negative $10.8 million. Management cited securities cash flows and borrowing capacity as additional liquidity sources.
- Credit quality: Provision for loan losses decreased to $3.3 million from $4.7 million, while net charge-offs increased to $4.5 million from $3.6 million. Nonperforming loans declined to $22.7 million from $25.5 million. The allowance was $18.8 million, or 1.02% of loans, compared with 1.13% a year earlier.
- Capital and shareholder returns: Corporation regulatory ratios were 17.43% CET1, 18.26% total capital and 13.39% leverage; management said the banks were well capitalized. The annual dividend was $1.00 per share, and the company repurchased $19.4 million of stock during 2016.
Changes, outlook and risks
- Results improved from 2015, but the insurance brokerage disposal gain was a significant nonrecurring contributor; the filing does not provide a comparable adjusted earnings measure excluding it.
- Loans grew while deposits edged down and borrowings increased. The securities portfolio declined to $853.7 million from $891.1 million; unrealized losses increased to $14.4 million from $6.7 million, which management attributed mainly to interest-rate and market factors rather than issuer credit deterioration.
- Management described the company as asset-sensitive. Its model estimated that a 100-basis-point rate increase would raise net interest income 3.41% over 12 months, while a 100-basis-point decline would reduce it 0.30%; these are model estimates dependent on assumptions.
- No specific earnings or revenue guidance was provided. Management expected regular cash dividends to continue, subject to earnings, capital needs and regulatory restrictions.
- Key risks include geographic concentration, borrower and collateral deterioration, interest-rate exposure, competition and FinTech disruption, cybersecurity and third-party vendor risks, regulatory change, and uncertainty in allowance and valuation estimates. Management anticipated that adoption of the expected-credit-loss standard would increase the allowance, but said the amount was uncertain.
- The company reported no material pending legal proceedings beyond routine business litigation. The independent auditor gave an unqualified opinion on the financial statements and internal control over financial reporting; management also concluded controls were effective.
Important facts for investors to verify
- Assess earnings excluding the $12.8 million pretax insurance-sale gain and related tax effects, and determine how much of the lower expense base is sustainable.
- Review loan growth, consumer charge-offs, commercial credit trends, nonperforming assets and allowance adequacy, including the potential effects of local economic conditions.
- Confirm the drivers and durability of deposit trends, increased short-term borrowings, and the company’s available liquidity and contingent funding capacity.
- Evaluate securities valuation and interest-rate sensitivity assumptions, including the remaining collateralized debt obligation exposure and the reported $3.1 million call in the first quarter of 2017.
- Reconcile the MD&A’s impaired-loan comparison, which appears to reverse the 2016 and 2015 dates, with the detailed loan tables and financial-statement notes.