First Financial Corporation — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. First Financial is a banking company reporting one segment. Unless noted otherwise, figures below are in millions of dollars.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Interest income | $32.9 | $28.1 | $62.3 | $56.0 |
| Net interest income | $30.7 | $26.6 | $58.2 | $53.1 |
| Net interest margin | 4.58% | 4.05% | 4.32% | 4.05% |
| Non-interest income | $13.0 | $8.1 | $21.1 | $19.2 |
| Non-interest expense | $22.7 | $22.1 | $45.9 | $44.7 |
| Provision for loan losses | $1.4 | $1.0 | $2.8 | $2.6 |
| Net income | $15.3 | $8.4 | $24.2 | $17.7 |
| Basic and diluted EPS | $1.25 | $0.68 | $1.98 | $1.45 |
Q2 return on assets and return on equity were 2.05% and 14.53%, respectively, compared with 1.12% and 7.75% a year earlier. Six-month figures were 1.63% and 11.61%, versus 1.19% and 8.26%.
Results included a $4.2 million recovery of previously recorded impairment on a collateralized debt obligation, recognized in non-interest income, and $2.4 million of interest income associated with the security call. Management also reported a $2.4 million recovery of fees on nonaccrual loans in Q2 interest income. These items materially contributed to reported earnings.
Financial position, cash flow and credit
- At June 30, total assets were $2.968 billion, down from $3.001 billion at December 31, 2017. Net loans were $1.909 billion; gross loans were $1.926 billion. Management reported net loans up $72 million year over year.
- Deposits were $2.454 billion, compared with $2.459 billion at year-end 2017. Short-term borrowings were $32.6 million, down from $57.7 million; FHLB advances were $1.4 million. Total shareholders’ equity was $419.7 million, compared with $413.6 million at year-end.
- Six-month operating cash flow was $22.5 million, investing cash flow was negative $5.6 million, and financing cash flow was negative $40.9 million. Cash and due from banks declined $24.0 million to $50.1 million.
- The allowance for loan losses was $20.1 million, or 106.4% of nonperforming loans, versus 91.8% at year-end. Nonperforming loans totaled $18.9 million, down from $21.7 million at year-end. Six-month net charge-offs were $2.7 million, up $0.9 million from the prior-year period.
- Regulatory capital ratios remained strong: First Financial Bank’s common equity Tier 1 ratio was 17.38%, total risk-based capital 18.11%, Tier 1 risk-based capital 17.38%, and Tier 1 leverage 13.42% at June 30.
Changes, outlook and risks
- Net interest income and margin increased year over year, reflecting higher loan interest income; deposit interest expense also rose. Net income gains were amplified by the unusual security recovery and nonaccrual-fee recovery.
- Available-for-sale securities had $19.8 million of gross unrealized losses at June 30, up from $9.5 million at year-end. Management attributed most losses to higher market interest rates rather than issuer credit concerns and stated it did not intend, and was not more likely than not required, to sell before recovery.
- Management said liquidity was adequate, citing expected security maturities, mortgage-backed security principal payments, expected calls, and unused borrowing capacity. It judged the loan-loss allowance adequate. The filing provides no formal earnings or margin guidance.
- Interest-rate sensitivity modeling estimated that a 100-basis-point rate increase would raise net interest income 2.30% over 12 months and 5.40% over 24 months; a 100-basis-point decrease would reduce it 1.57% and 2.95%, respectively. These are model estimates assuming an immediate parallel rate change and no management response.
- Management expects adoption of the CECL credit-loss standard to increase the allowance, but said the amount is uncertain. It did not expect the upcoming lease standard to have a significant impact. No material changes to previously disclosed risk factors or material pending legal proceedings were reported.
- Management identified credit-loss estimation, goodwill valuation, and investment-security valuation as critical accounting judgments. For certain Level 3 collateralized debt obligations, the cited Standard & Poor’s price was 86.26 versus Moody’s 21.40, highlighting substantial valuation uncertainty.
Important facts for investors to verify
- How much of the earnings increase persists after excluding the security and nonaccrual-fee recoveries.
- Whether higher rates continue to improve net interest margin or instead increase deposit funding costs and pressure securities values.
- Trends in charge-offs, past-due loans, nonperforming loans, and allowance adequacy, particularly as consumer charge-offs increased.
- The valuation assumptions and eventual cash realization for Level 3 securities, including the called obligation and remaining unrealized securities losses.
- The eventual CECL allowance impact and the basis for management’s liquidity and interest-rate sensitivity estimates.