First Financial Bancorp. — Q2 2013 Form 10-Q
Business context and period. The unaudited filing covers the three and six months ended June 30, 2013. First Financial is a Cincinnati-based bank holding company operating primarily in Ohio, Indiana and Kentucky, with commercial banking, retail banking and wealth management businesses. Amounts below are in millions of dollars unless stated otherwise.
Financial performance and condition
| Metric | Q2 2013 / June 30, 2013 | Comparable period / prior balance |
|---|---|---|
| Net interest income | $58.1; net interest margin 4.02% | Q2 2012: $64.8; 4.49% |
| Noninterest income | $11.6 | Q2 2012: $33.5 |
| Noninterest expense | $53.3 | Q2 2012: $57.5 |
| Net income / diluted EPS | $15.8 / $0.27 | Q2 2012: $17.8 / $0.30 |
| Return on average assets / equity | 1.01% / 9.02% | Q2 2012: 1.13% / 9.98% |
| Total assets | $6,274.6 | December 31, 2012: $6,497.0 |
| Total loans, excluding covered loans | $3,382.1 | December 31, 2012: $3,179.1 |
| Deposits | $4,770.6 | December 31, 2012: $4,955.8 |
| Total borrowed funds | $693.9 | December 31, 2012: $699.8 |
| Shareholders’ equity | $695.5 | December 31, 2012: $710.4 |
For the six months ended June 30, net income was $29.7, diluted EPS was $0.51, net interest income was $116.7 and net interest margin was 4.03%. The respective 2012 figures were $34.8, $0.59, $131.5 and 4.50%. Six-month return on average assets was 0.94% versus 1.09%; return on average equity was 8.47% versus 9.83%.
Cash flow and liquidity. First-half operating cash flow was $79.7, investing cash flow was $132.1 and financing cash flow was negative $231.6, resulting in a $19.8 decline in cash and due from banks to $114.7. Cash and interest-bearing deposits with other banks totaled $117.4 at quarter-end. The company reported $391.9 of remaining FHLB borrowing capacity and $2.0 billion of unused, available overnight wholesale funding. Management said liquidity was sufficient for operations and planned capital expenditures.
Credit, capital and distributions. Uncovered nonperforming loans were $74.9 and nonperforming assets $86.7, down from $75.9 and $88.4 at year-end 2012. The uncovered allowance was $47.0, or 1.39% of loans, versus $47.8, or 1.50%. First-half uncovered net charge-offs were $6.2 (0.38% annualized), compared with $13.2 (0.90%) in 2012. Covered loans were $622.3, down from $748.1. The company reported consolidated regulatory capital ratios of 10.12% leverage, 15.41% Tier 1 risk-based and 16.68% total risk-based, and said it remained well-capitalized. It declared regular and variable dividends totaling $0.27 per share for the next payment; the filing says this was to be the last variable dividend. First-half repurchases under the plan totaled 590,400 shares at an average $15.43.
Material changes and management commentary
- Q2 net interest income declined 10.4% year over year, and margin fell 47 basis points. Management attributed the pressure chiefly to runoff of higher-yielding covered loans, a low-rate and competitive lending environment, lower investment yields and a shift toward lower-yielding new loans. Lower deposit costs partly offset these effects; short-term borrowings increased.
- Noninterest income fell 65.4% in Q2, largely because FDIC loss-sharing income was $7.4 negative versus $8.3 positive in Q2 2012, and because 2012 included a $5.0 litigation settlement. First-half noninterest income fell 41.5%; 2013 included $1.7 in securities-sale gains.
- Q2 covered-loan provision was a negative $8.3, reflecting impairment recapture. The company changed its covered-loan valuation methodology, placing greater emphasis on total expected cash flows; the change contributed to a net $8.5 reclassification from accretable to nonaccretable difference and lower yields on certain loan pools. Management also recorded a related reduction in the FDIC indemnification asset.
- Noninterest expense declined 7.3% in Q2, but included $4.3 of pension settlement charges after lump-sum distributions exceeded the plan’s annual accounting threshold. Further distributions may cause additional settlement charges in the remainder of 2013. A 2012 efficiency initiative identified about $17.1 of annualized savings; management reported approximately $15.0 of annualized net savings realized through Q2, subject to execution and business conditions.
- Uncovered loans grew $203.1 since year-end, while deposits decreased $185.2. Management attributed deposit declines partly to reducing higher-cost time deposits and lower public-fund balances. The investment portfolio contracted $243.8 in the first half; rising rates contributed to an after-tax unrealized securities loss of $5.8 at June 30 versus an unrealized gain of $12.8 at year-end.
- Management described interest-rate exposure as risk-neutral to modestly asset-sensitive near term and asset-sensitive over the longer term. Model scenarios showed first-year net interest income changes of negative 5.79% under a 100-basis-point decline, negative 0.30% under a 100-basis-point increase and positive 1.39% under a 200-basis-point increase. These are model estimates, not guidance.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management estimated a normalized future effective tax rate of 34.5% after favorable 2013 tax items, and expected subsequent quarterly dividends to consist only of the regular dividend. Following the end of the variable dividend, the company targeted returning 60%–80% of earnings through regular dividends and repurchases, while maintaining capital above applicable thresholds. Basel III requirements were expected to apply beginning January 1, 2015; preliminary management assessments indicated capital would remain above requirements.
Key risks include sensitivity to interest rates and margin compression; credit quality, collateral values and allowance estimates; deposit runoff and access to funding; the declining covered-loan portfolio and estimates of FDIC reimbursements; execution of cost savings and branch consolidations; regulatory and technology changes; operational or cybersecurity failures; and litigation. Loan commitments were $1.3 billion and letters of credit $14.6 at June 30; commitments may not be fully drawn. The company disclosed ongoing litigation and unresolved claims but said liabilities were not probable or reasonably estimable, where applicable. The Irwin Mortgage bankruptcy plan became effective June 28, 2013 following a global settlement that management said did not materially affect the financial statements.
Management stated disclosure controls were effective at a reasonable assurance level and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether loan growth can offset runoff of covered loans and continued net-interest-margin pressure.
- Underlying credit trends, including growth in TDRs to $32.9, charge-offs, delinquency and the adequacy of both covered and uncovered loan reserves.
- The assumptions, cash-flow estimates and sensitivity of the $89.0 FDIC indemnification asset and related loss-sharing arrangements.
- Deposit retention, funding costs, available borrowing capacity and the effect of rising rates on securities values and liquidity.
- Whether the stated cost savings are sustained, and the extent of additional pension settlement charges in the second half of 2013.
- Capital and shareholder-return plans, including the transition from variable to regular dividends and execution of planned repurchases.