First Financial Bancorp. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011. Financial statements are unaudited. First Financial is a bank holding company operating in Ohio, Indiana, and Kentucky; it reported total assets of $6.04 billion.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $65.9 million | $67.7 million | $133.2 million | $139.8 million |
| Noninterest income | $41.1 million | $40.5 million | $84.8 million | $67.4 million |
| Provision for loan and lease losses | $29.7 million | $25.1 million | $56.3 million | $46.0 million |
| Net income | $16.0 million | $17.8 million | $33.2 million | $29.4 million |
| Diluted earnings per common share | $0.27 | $0.30 | $0.57 | $0.48 |
| Net interest margin | 4.61% | 4.53% | 4.67% | 4.71% |
Q2 net income declined year over year, while first-half net income and diluted EPS increased. First-half 2010 net income available to common shareholders was $27.5 million after $1.9 million of preferred dividends; no preferred dividends were reported in 2011. Q2 return on average assets was 1.03% and return on average equity was 9.05%.
- Revenue and expenses: Q2 total noninterest income rose modestly year over year, mainly due to higher FDIC loss-sharing income, partly offset by lower accelerated discount income on covered loans. First-half noninterest income increased 25.8%, primarily reflecting $22.3 million more FDIC loss-sharing income. Excluding FDIC loss-sharing and accelerated covered-loan income, first-half noninterest income was $29.2 million versus $31.2 million. First-half noninterest expense fell to $110.3 million from $116.1 million.
- Cash flow: First-half operating cash flow was $127.0 million; investing activities provided $57.3 million and financing activities used $186.2 million. Cash and due from banks ended the period at $104.2 million, down $1.8 million from year-end.
- Loans and credit: Uncovered loans were $2.79 billion, down 1.0% from December 31, 2010; covered loans were $1.24 billion, down 16.1%. The uncovered-loan allowance was $53.7 million (1.92% of loans), compared with $57.2 million at year-end. Covered-loan allowance increased to $51.0 million from $16.5 million, reflecting updated expected cash flows and impairment provisions. First-half provision expense was $6.4 million on uncovered loans and $49.9 million on covered loans.
- Asset quality: Excluding covered assets, nonperforming loans were $74.0 million and nonperforming assets were $90.3 million, both lower than at year-end. First-half uncovered net charge-offs were $10.0 million, or 0.72% annualized. Management said weakness persisted in commercial and consumer sectors despite isolated improvement.
- Deposits, debt, and liquidity: Deposits were $4.97 billion, down 3.3% from year-end. Borrowed funds totaled $207.5 million, including $102.3 million of long-term debt. The company reported $251.3 million of on-hand liquidity and approximately $2.1 billion of unused overnight wholesale funding capacity; remaining FHLB borrowing capacity was $238.8 million.
- Capital and shareholder returns: Shareholders’ equity was $721.8 million. The company reported consolidated regulatory ratios of 11.01% leverage, 20.15% Tier 1 risk-based, and 21.43% total capital, and stated it exceeded well-capitalized thresholds. It declared $0.24 per share in dividends for the first half. The $20.6 million trust preferred debt was redeemed June 30.
Material changes and management commentary
- Net interest income declined year over year as acquired covered-loan balances ran off and the yield on the FDIC indemnification asset fell; lower funding costs and higher investment income partly offset the decline. The company invested liquidity in securities amid muted loan demand.
- First Financial exited five banking centers in Michigan and Louisville during Q1, shifting resources toward core markets. It expects to dissolve First Financial Capital Advisors later in 2011.
- In Q2, the company agreed to acquire Liberty Savings Bank’s 16 Ohio branches, with approximately $350 million of deposits at March 31, 2011, plus about $150 million of performing loans. Closing was expected in Q3, subject to regulatory approval and customary conditions.
- Management provided no specific earnings guidance. It said covered-loan balances should continue to decline absent additional acquisitions and warned that covered-loan cash-flow re-estimates can cause earnings volatility. Interest-rate sensitivity modeling indicated projected net interest income changes of -10.54% under a 200-basis-point decline and +4.85% under a 200-basis-point increase; results depend on modeling assumptions.
Risks, contingencies, and unusual items
- Covered loans represented about 31% of total loans and depend on FDIC loss-sharing agreements. Reimbursement eligibility depends on compliance with servicing and reporting requirements; improvement in expected covered-loan cash flows is generally recognized prospectively, while deterioration can trigger current-period provision expense.
- A July 2011 lawsuit related to mortgage-backed securities alleged claims involving former Irwin entities. Plaintiffs alleged approximately $20.4 million of investment related to IHE Funding; the filing said potential responsibility could not yet be reasonably estimated and no reserve was established. First Financial expects to seek FDIC indemnification.
- Irwin Mortgage Corporation filed for Chapter 11 bankruptcy on July 8, 2011. Its results and balance sheet were deconsolidated at the end of Q2; the filing said the bankruptcy’s impact could not be predicted.
- Other risks include continued economic weakness, loan quality and loss estimates, interest-rate changes, liquidity access, regulatory changes, litigation, and possible disputes or delays in obtaining FDIC indemnification. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether covered-loan credit estimates, FDIC reimbursements, and the indemnification asset remain supportable as acquired loans run off.
- Trends in uncovered delinquencies, charge-offs, classified assets, and the allowance, particularly in commercial real estate and construction.
- Actual liquidity and deposit trends, including reliance on wholesale funding and the pace of time-deposit runoff.
- Regulatory approval, closing terms, and integration effects of the proposed Liberty branch and loan acquisition.
- Developments in the Irwin-related litigation and IMC bankruptcy, including the scope and timing of any FDIC indemnification.