First Financial Corporation — Q2 2012 Form 10-Q
Business context and reporting period. First Financial Corporation is a bank holding company reporting one segment, banking. This unaudited quarterly filing covers the three and six months ended June 30, 2012; balance-sheet comparisons are primarily to December 31, 2011. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q2 2012 / June 30, 2012 | Comparable period / prior date |
|---|---|---|
| Net income | $8.7; diluted EPS $0.66 | Q2 2011: $8.4; $0.64 per share |
| Six-month net income | $16.1; EPS $1.22 | First half 2011: $17.2; EPS $1.31 |
| Net interest income | Q2: $27.7; first half: $54.8 | Q2 2011: $25.2; first half 2011: $49.9 |
| Net interest margin | Q2: 4.42% | Q2 2011: 4.55% |
| Non-interest income / expense | Q2: $9.8 / $23.1; first half: $19.3 / $46.5 | Q2 2011: $7.9 / $19.4; first half 2011: $16.2 / $38.4 |
| Provision for loan losses | Q2: $1.8; first half: $4.7 | Q2 2011: $1.4; first half 2011: $2.5 |
| Total assets / net loans | $2,891.7 / $1,857.6 | December 31, 2011: $2,954.8 / $1,874.4 |
| Deposits / borrowings | $2,253.2 / $193.2 total | December 31, 2011: $2,274.5 / $246.4 total |
| Cash and cash equivalents | $84.7 | $134.3 at December 31, 2011 |
| Shareholders’ equity | $358.3 | $347.0 at December 31, 2011 |
Cash flow and liquidity. First-half operating cash flow was $28.3 million, investing cash flow was $3.3 million, and financing cash flow was negative $81.2 million, resulting in a $49.6 million reduction in cash and cash equivalents. Financing outflows included a $52.9 million reduction in short-term borrowings and $22.0 million net deposit outflow. Management cited expected security maturities, mortgage-backed-security principal payments, calls, and unused FHLB and correspondent-bank capacity as liquidity sources, and anticipated adequate liquidity.
Margins, returns, and capital. Q2 return on assets and return on equity were 1.20% and 9.43%, respectively, versus 1.35% and 9.93% a year earlier. First-half ratios were 1.11% and 8.96%, versus 1.38% and 10.34%. At June 30, the subsidiary bank’s total risk-based, Tier I risk-based, and Tier I leverage capital ratios were 14.96%, 14.18%, and 11.18%, above the stated well-capitalized thresholds. The company reported that its subsidiary banks remained well capitalized.
Material changes and operating drivers
- Q2 net income and EPS improved modestly year over year, but first-half net income and EPS declined. Higher net interest income and non-interest income were offset by higher operating expenses and loan-loss provisioning.
- Q2 net interest income rose $2.5 million year over year, while net interest margin fell 0.13 percentage point. Management attributed the margin decline to earning-asset income declining more than funding costs.
- First-half non-interest expense increased $8.2 million year over year. Salaries and benefits, including higher pension expense, were major contributors. Management said some other expenses included Freestar acquisition costs that would not recur.
- First-half loan balances were higher than in the first half of 2011, and deposits also increased year over year, according to management. Against year-end 2011, however, period-end total loans and deposits were lower.
- Short-term borrowings declined $52.9 million from year-end; total period-end borrowings were $193.2 million versus $246.4 million.
Credit, investments, outlook, and risks
- Credit quality: The allowance for loan losses was $20.1 million, up from $19.2 million at year-end. First-half net charge-offs were $4.8 million versus $3.1 million a year earlier. Management considered the allowance adequate based on its portfolio analysis.
- Management reported non-performing loans of $59.6 million, up from $56.4 million at year-end; the allowance equaled 33.7% of that amount. Accruing loans more than 90 days past due rose to $8.0 million from $2.0 million, primarily due to one $5.5 million multifamily loan. The loan remained on accrual because management considered collateral sufficient. The filing’s detailed loan tables use a different restructured-loan total than the MD&A summary.
- Investment valuation: Available-for-sale securities had a $658.8 million fair value. Gross unrealized losses were $9.5 million, including $9.4 million on collateralized debt obligations (CDOs). Management said most losses reflected market illiquidity rather than issuer credit deterioration and stated it did not intend, and was not more likely than not required, to sell the securities before recovery. Three CDOs had previously recorded cumulative impairment charges; no new impairment was identified in the first half of 2012. CDO valuations rely on third-party pricing amid a wide range of market estimates.
- Interest-rate sensitivity: Management’s model estimated that a 100-basis-point rate increase would raise net interest income 3.71% over 12 months and 6.55% over 24 months; a 100-basis-point decrease would reduce it 1.10% and 3.05%, respectively. These scenarios assume immediate rate changes and no management response; actual outcomes may differ.
- Acquisition and contingencies: The December 2011 Freestar Bank acquisition expanded the company into Illinois markets; purchase accounting was finalized during Q2. The legacy Danville acquisition remains subject to an FDIC loss-sharing agreement. No material pending legal proceedings were reported, and the filing reported no material change in previously disclosed risk factors.
- Outlook: The filing provides no specific earnings or revenue guidance. Management’s stated liquidity expectation and modeled interest-rate scenarios are not guarantees. Forward-looking results are subject to economic and market conditions, interest rates, competition, regulatory changes, litigation, and execution risks.
Important facts for investors to verify
- Whether elevated past-due loans, especially the $5.5 million multifamily credit, cure, migrate to nonaccrual, or require additional reserves.
- How allowance levels and charge-offs evolve as impaired loans and specific allocations increase.
- The support for CDO fair values and expected cash flows, including the sensitivity of Level 3 valuation inputs to illiquid markets and underlying issuer credit performance.
- Whether higher pension and other operating costs persist, and how much acquisition-related expense is genuinely nonrecurring.
- Whether liquidity, deposit trends, and capital ratios remain adequate under changing funding needs and interest-rate conditions.