First Financial Corporation — 2012 Form 10-K
Business context and period. This annual report covers the fiscal year ended December 31, 2012. First Financial is an Indiana-based financial holding company operating primarily in west-central Indiana and east-central Illinois. Its businesses include banking, consumer finance, insurance and trust services. The 2011 acquisition of Freestar Bank expanded its Illinois presence; 2012 results include a full year of Freestar-related activity, limiting direct year-over-year comparability.
Financial performance and condition
- Profitability: Net income was $32.8 million, or $2.48 per diluted share, down 11.8% and 12.4%, respectively, from 2011. Return on average assets fell to 1.13% from 1.49%; return on average equity was 9.02%, versus 10.88%.
- Revenue and margins: Net interest income rose 9.8% to $108.9 million, while net interest margin declined to 4.30% from 4.50%. Non-interest income increased to $39.5 million from $33.3 million, led by electronic banking fees and mortgage-sale gains. Total non-interest expense rose to $93.1 million from $75.2 million, including acquisition/integration expenses and higher salaries, benefits and pension costs.
- Credit costs: Net provision for loan losses was $8.8 million, compared with $5.8 million in 2011; the reported 2012 provision was reduced by $2.2 million for the related FDIC indemnification asset. Net charge-offs were $8.3 million, down from $9.0 million.
- Credit quality: Nonperforming loans totaled $59.8 million, up from $56.4 million. Non-accrual loans decreased to $36.8 million from $38.1 million, but loans past due over 90 days and still accruing increased to $3.4 million from $2.0 million. The allowance was $22.0 million, or 37% of nonperforming loans, versus 34% a year earlier.
- Balance sheet and funding: Total assets were $2.895 billion, down 2.0%. Loans were $1.853 billion versus $1.895 billion; deposits were $2.276 billion, essentially unchanged. Borrowings declined to $160.3 million from $246.4 million, and shareholders’ equity increased to $372.1 million from $347.0 million.
- Cash flow and liquidity: Operating cash flow was $54.7 million. Investing activities used $3.9 million and financing activities used $97.8 million; cash and due from banks ended at $87.2 million, down from $134.3 million. Management cited anticipated 2013 receipts of $111.6 million in mortgage-backed securities principal payments, in addition to scheduled maturities and calls.
- Capital: The Corporation reported Tier 1 risk-based capital of 15.38%, total risk-based capital of 16.37% and a Tier 1 leverage ratio of 11.43%. The Bank was categorized as well capitalized by regulators.
- Shareholder returns: Cash dividends were $0.95 per share for 2012, with a 38.4% payout ratio. The company expected comparable dividends to continue, subject to earnings, capital needs and regulatory limits.
Material changes and notable items
- Net interest income improved as average earning assets expanded and funding costs fell, but lower asset yields outpaced the decline in liability costs, compressing the margin.
- Non-interest expenses increased $17.9 million. Management attributed much of the increase to Freestar-related staffing and operations, higher pension expense, and more than $1 million of one-time acquisition and integration costs.
- Gross loans declined year over year, particularly consumer and residential balances; commercial loans remained the largest portfolio component. Total assets decreased despite higher securities and equity.
- The company redeemed the $6.2 million of trust-preferred-related borrowings assumed with Freestar on December 31, 2012.
- The defined-benefit pension plan was frozen for most employees during 2012. The pension plan had a $29.3 million funded deficit at year-end.
- Three collateralized debt obligations backed largely by trust-preferred securities had cumulative other-than-temporary impairment charges of about $15.0 million recorded through earnings. The portfolio also had $8.2 million of gross unrealized losses at year-end, predominantly attributed by management to market illiquidity rather than issuer credit deterioration.
Outlook, risks and contingencies
Management anticipated moderate growth opportunities in 2013 and gradual improvement in labor markets and retail sales, while not expecting a dramatic near-term improvement in labor conditions. The filing provides no specific earnings or revenue guidance. Management described the local economy as relatively stable compared with broader state and national cycles.
- Key risks include local economic and real-estate weakness, borrower defaults and collateral values, allowance-estimation uncertainty, geographic concentration, competition, and interest-rate, liquidity and operational risks.
- The company characterized itself as asset-sensitive. Its model estimated that a 100-basis-point rate increase would raise net interest income 3.56% over 12 months; a 100-basis-point decrease would reduce it 0.91%. These are model estimates based on assumptions, not forecasts.
- Regulatory changes, including Dodd-Frank requirements and proposed Basel III capital rules, could increase compliance costs or capital and liquidity needs. The filing stated that the timing and final form of Basel III implementation remained uncertain.
- Commitments to extend credit totaled $362.0 million and commercial letters of credit totaled $7.7 million. These may expire undrawn and are not necessarily future cash outflows.
- The company reported no material pending legal proceedings apart from ordinary routine litigation. Management and the auditor concluded that internal control over financial reporting was effective; the auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether the increased 2012 non-interest expense and lower net income reflect largely nonrecurring acquisition and pension items or a continuing cost trend.
- Subsequent trends in nonperforming loans, past-due loans, charge-offs, and allowance coverage, particularly in residential and commercial real-estate exposures.
- The quality, valuation assumptions and potential additional losses associated with the collateralized debt obligations and other securities with unrealized losses.
- Whether deposit funding, cash balances and scheduled borrowing repayments provide adequate liquidity under changing rate and credit conditions.
- How regulatory capital rules, pension obligations and dividend restrictions could affect future capital flexibility and shareholder distributions.
- Progress toward management’s moderate-growth outlook and the integration and performance of the Freestar-expanded markets.