First Financial Corporation — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Unaudited consolidated results; dollar figures below are in millions unless noted. The company reports one segment: banking.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net interest income | $27.4 | $24.9 | $82.2 | $74.8 |
| Net interest margin | 4.55% | 4.50% | Not stated | Not stated |
| Noninterest income | $9.7 | $8.9 | $29.0 | $25.1 |
| Noninterest expense | $23.0 | $18.6 | $69.5 | $56.9 |
| Provision for loan losses | $2.6 | $1.4 | $7.3 | $3.9 |
| Net income | $8.1 | $9.8 | $24.2 | $27.0 |
| Diluted EPS | $0.61 | $0.75 | $1.83 | $2.06 |
Q3 return on assets was 1.16% and return on equity 9.35%, versus 1.57% and 11.32% a year earlier. Nine-month figures were 1.12% and 9.06%, versus 1.44% and 10.65%.
Financial position, cash flow and capital
- At September 30, total assets were $2.879 billion, net loans $1.837 billion, deposits $2.260 billion and shareholders’ equity $368.8 million. Assets and net loans declined from December 31, 2011; equity rose from $347.0 million.
- Period-end short-term borrowings were $44.0 million, down from $100.0 million at year-end; other borrowings were $125.9 million, down from $146.4 million. Total liabilities were $2.510 billion.
- For the first nine months, operating cash flow was $39.6 million; investing cash flow was negative $5.7 million and financing cash flow negative $104.5 million. Cash and due from banks ended at $63.6 million, down $70.6 million from year-start. Federal funds sold and short-term investments were $55.8 million at quarter-end.
- The bank was categorized as well capitalized. First Financial Bank’s total risk-based, Tier I risk-based and Tier I leverage ratios were 15.71%, 14.85% and 11.88%, respectively.
Changes versus comparable periods
- Q3 net interest income increased $2.5 million, with management attributing margin improvement to lower funding costs. Nine-month net interest income rose 9.9%.
- Net income fell 17.6% in Q3 and 10.3% year to date. Higher loan-loss provision and noninterest expense more than offset stronger net interest and fee income.
- Q3 noninterest expense increased $4.4 million year over year; salaries and benefits accounted for most of the increase. Nine-month expense rose $12.6 million, including higher personnel costs related in part to the Freestar acquisition and $3.7 million of increased fringe-benefit expense, primarily pension costs.
- Mortgage-loan sale gains increased $0.8 million in Q3 and $1.8 million year to date. The first nine months of 2012 include Freestar Bank results, acquired December 30, 2011, unlike the 2011 comparison.
- Nonperforming loans increased to $65.7 million from $56.4 million at year-end. The allowance for loan losses increased to $21.5 million from $19.2 million, while allowance coverage of nonperforming loans declined to 32.6% from 34.1%.
Outlook, risks and unusual items
- No specific earnings or financial guidance is provided. Management said it anticipates adequate liquidity, citing expected security principal repayments and calls and available unused borrowing capacity.
- Interest-rate simulations estimate that a 100-basis-point rate increase would raise net interest income 4.64% over 12 months and a 100-basis-point decrease would reduce it 1.34%. The filing cautions that these are model estimates assuming immediate rate changes and no management response.
- Credit quality warrants attention: nine-month net charge-offs were $6.1 million versus $4.3 million, and impaired-loan volume and specific allocations increased. Management considers the allowance adequate, based on its analysis.
- Available-for-sale securities included $8.9 million of gross unrealized losses, mostly associated with collateralized debt obligations (CDOs). Three CDOs had cumulative impairment charges of $14.9 million recognized in earnings and $8.0 million in other comprehensive income; management cited illiquidity as a major source of non-credit valuation loss and said it did not intend, and was not more likely than not required, to sell the securities before recovery. CDO valuations rely on third-party pricing and are sensitive to assumptions.
- Other real estate owned rose to $8.7 million from $5.0 million at year-end. Management identifies loan-loss allowance, goodwill valuation and investment-security valuation as critical accounting judgments.
- The filing lists economic and financial-market conditions, interest rates, competition, regulation, litigation and execution of business plans among risks. No material changes to previously disclosed risk factors or material pending legal proceedings were reported. Disclosure controls were assessed as effective.
Investor verification points
- Review the loan portfolio’s deterioration, nonperforming-loan mix, charge-offs and adequacy of the $21.5 million allowance.
- Assess CDO exposure, valuation inputs, impairment judgments and the potential effect of illiquid markets or further credit deterioration.
- Separate Freestar acquisition effects from underlying year-over-year expense, deposit and loan trends.
- Reconcile falling cash balances and financing outflows with management’s liquidity assessment and available borrowing capacity.
- Monitor pension-related expense and the sensitivity of earnings to interest-rate movements.