THFF

Business Context and Reporting Period

Company: First Financial Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: The Corporation operates as a single-segment banking entity headquartered in Terre Haute, Indiana. As of August 1, 2007, there were 1,304,145 shares of common stock outstanding.

Key Financial Metrics

All figures in thousands, except per share data.

Material Changes vs. Prior Period

• Net Income: Net income for the three months ended June 30, 2007, was $6.413 million, essentially flat compared to $6.425 million in the same period in 2006. For the six-month period, net income increased to $12.836 million from $11.934 million.
• Net Interest Income: Increased slightly to $18.565 million (Q2 2007) from $18.511 million (Q2 2006), driven by an increase in earning assets. However, the Net Interest Margin (NIM) declined to 3.87% from 3.90% due to funding costs rising faster than yields on earning assets.
• Non-Interest Income: Rose to $7.529 million in Q2 2007 from $7.215 million in Q2 2006. Growth was primarily driven by increased gains on the sale of mortgage loans, insurance commissions, and other service fees.
• Non-Interest Expense: Decreased by $103,000 (0.6%) in Q2 2007 compared to the prior year. Salaries and employee benefits were reduced by $689,000 due to the consolidation of bank subsidiaries and a reduction in full-time equivalent employees.
• Provision for Loan Losses: Increased to $1.240 million in Q2 2007 from $645,000 in Q2 2006. Net charge-offs increased by $362,000 for the quarter and $1.0 million for the six-month period compared to 2006.
• Asset Quality: Non-performing loans decreased to $12.596 million (June 30, 2007) from $14.636 million (Dec 31, 2006). The allowance for loan losses as a percentage of non-performing loans improved to 122% from 110%.

Outlook, Risks, and Management Commentary

• Capital Adequacy: The Corporation and its subsidiary banks are categorized as "well capitalized" by regulatory agencies. Total risk-based capital ratio for the Corporation was 17.85% as of June 30, 2007.
• Interest Rate Risk: Management identifies interest rate risk as the most significant market risk. Sensitivity analysis indicates that a 100 basis point increase in rates would decrease net interest income by 3.46% over the next 12 months, while a 100 basis point decrease would increase it by 1.73%.
• Liquidity: The Corporation maintains adequate liquidity through liquid assets and core deposits. It anticipates $65.7 million in principal payments from mortgage-backed securities and $13.2 million in securities to be called within the next 12 months.
• Accounting Changes: The Company adopted FASB Interpretation No. 48 (FIN 48) on January 1, 2007, resulting in a cumulative effect adjustment that reduced retained earnings by $86,000. The Company is currently under IRS audit for the 2004 and 2005 tax years.
• Share Repurchases: The Company purchased 64,500 shares of common stock during the quarter at an average price of $29.66 per share. There is no formal public repurchase program.

Investor Verification Checklist

• Net Charge-Offs: Verify the trend in net charge-offs, which increased by $1.0 million year-to-date, and assess the adequacy of the allowance for loan losses despite the improved coverage ratio.
• Net Interest Margin Compression: Monitor the spread between funding costs and asset yields, as the NIM has declined for two consecutive periods (3.90% to 3.87% in Q2; 3.92% to 3.89% YTD).
• Interest Rate Sensitivity: Review the asset-liability management strategy given the negative sensitivity to rising interest rates (projected 3.46% income drop on a 100bps hike).
• Tax Audit Status: Track the outcome of the ongoing IRS audit for 2004 and 2005 tax years and any potential adjustments to unrecognized tax benefits.
• Employee Consolidation: Confirm the sustainability of cost savings from the reduction in full-time equivalent employees following the consolidation of bank subsidiaries.