First Financial Corporation — Q1 2012 Form 10-Q
Business context and reporting period
Unaudited consolidated results for the three months ended March 31, 2012; First Financial reports one segment, banking. The quarter includes the effects of its December 30, 2011 acquisition of Freestar Bank, which expanded its presence in several Illinois markets. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and condition
- Profit: Net income was $7.44 million versus $8.80 million a year earlier; diluted EPS was $0.56 versus $0.67. Return on assets was 1.02% (1.42% in Q1 2011) and return on equity was 8.46% (10.76%).
- Interest income and margin: Net interest income was $27.17 million versus $24.76 million. Net interest margin was 4.26%, compared with 4.51%; management attributed margin pressure to earning-asset yields falling more than funding costs. The MD&A says net interest income increased $1.2 million, which does not reconcile with the statements’ $2.41 million increase; verify this discrepancy.
- Other income and expenses: Non-interest income rose to $9.51 million from $8.30 million, helped by mortgage-loan sale gains ($0.93 million versus $0.34 million). Non-interest expense increased to $23.42 million from $18.95 million. Management attributed $2.8 million of the increase to Freestar, including about $0.65 million of one-time conversion costs; post-retirement benefit expense also rose $0.79 million.
- Credit costs: The loan-loss provision was $2.96 million versus $1.18 million. Net charge-offs increased by $1.8 million year over year. The allowance was $18.31 million, or 0.99% of gross loans, versus $22.14 million and 1.37% at March 31, 2011; management said it considered the allowance adequate.
- Credit quality: Non-performing loans totaled $56.17 million, broadly stable against $56.42 million at December 31, 2011. The allowance equaled 32.6% of non-performing loans, versus 34.1% at year-end. Other real estate owned rose to $7.16 million from $4.96 million.
- Balance sheet and funding: Total assets were $2.92 billion, down from $2.95 billion at year-end. Net loans were $1.83 billion versus $1.87 billion; deposits were $2.28 billion versus $2.27 billion. Compared with March 2011, management reported loans up 14.8% and deposits up 17.3%, primarily due to Freestar.
- Liquidity and cash flow: Cash and due from banks were $62.98 million, with federal funds sold of $108.13 million. Operating cash flow was $22.73 million; investing cash outflow was $57.52 million and financing cash outflow was $36.52 million. Cash and due from banks declined $71.30 million during the quarter. Management anticipated adequate liquidity, citing deposit and repayment sources, expected security cash flows, and unused borrowing capacity.
- Debt and capital: Short-term borrowings declined to $64.97 million from $100.02 million; other borrowings were $146.27 million. The subsidiary bank was categorized as well capitalized. At March 31, First Financial Bank’s total risk-based, Tier I risk-based, and Tier I leverage capital ratios were 14.91%, 14.20%, and 10.94%, respectively.
Material changes, outlook, and risks
- Freestar acquisition-related growth lifted loans, deposits, and net interest income, while acquisition costs contributed to higher operating expenses. Shareholders’ equity was $354.94 million, up from $346.96 million at year-end.
- No specific earnings or revenue guidance was provided. Interest-rate sensitivity modeling estimated that a 100-basis-point rate increase would raise net interest income 3.53% over 12 months, while a 100-basis-point decrease would reduce it 1.10%; management cautioned that these models rely on assumptions and do not reflect management actions.
- Management identified credit-loss estimation, goodwill valuation, and investment-security valuation as critical accounting judgments. Available-for-sale securities included $9.90 million of gross unrealized losses, principally associated with collateralized debt obligations (CDOs). Four CDOs had previously been determined to be other-than-temporarily impaired; no additional impairment was identified in Q1. Management said it did not intend, and did not expect to be required, to sell the securities before recovery. CDO valuations rely in part on illiquid-market pricing and significant estimates.
- Forward-looking risks include economic and financial-market conditions, interest rates, competition, regulation, litigation, borrower losses, and execution of business plans. The filing reported no material change to previously disclosed risk factors and no material pending litigation beyond routine matters. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.
Important facts for investors to verify
- Reconcile the MD&A’s stated $1.2 million increase in net interest income with the financial statements’ $2.41 million increase.
- Assess loan-loss provisioning and trends in charge-offs, non-performing loans, troubled restructurings, and foreclosed real estate, including the effect of acquired loans.
- Review the valuation assumptions, liquidity, and potential credit exposure associated with the impaired CDOs and other Level 3 assets.
- Track Freestar integration costs and subsequent loan, deposit, margin, and expense trends; the filing provides no specific forward earnings guidance.
- Monitor liquidity, funding mix, and capital ratios, including the quarter’s decline in cash and short-term borrowings.