Business Context and Reporting Period
First Financial Corporation is an Indiana-based financial holding company providing banking, lending, trust and insurance services, primarily in west-central Indiana and east-central Illinois. This Form 10-K covers the year ended December 31, 2011; figures are annual unless otherwise noted.
On December 30, 2011, the Bank acquired Freestar Bank for $47 million in cash and assumed approximately $8.2 million of liabilities. The transaction added approximately $414 million of assets, including $245 million of loans and $361 million of deposits, and recorded $29.8 million of goodwill. Because it closed at year-end, the acquisition chiefly affected the balance sheet rather than 2011 operating results.
Key Financial Metrics
| Metric | 2011 | 2010 |
|---|---|---|
| Total assets, year-end | $2.954 billion | $2.451 billion |
| Net interest income | $99.2 million | $96.6 million |
| Net interest margin | 4.50% | 4.35% |
| Non-interest income | $33.3 million | $29.8 million |
| Net income | $37.2 million | $28.0 million |
| Diluted earnings per share | $2.83 | $2.14 |
| Return on average assets | 1.49% | 1.11% |
| Deposits, year-end | $2.274 billion | $1.903 billion |
| Borrowings, year-end | $246.4 million | $159.9 million |
| Shareholders’ equity, year-end | $347.0 million | $321.7 million |
| Cash and cash equivalents, year-end | $134.3 million | $58.5 million |
2011 net cash provided by operating activities was $40.6 million; investing activities provided $4.5 million and financing activities provided $30.7 million. The allowance for loan losses was $19.2 million, down from $22.3 million. Net charge-offs were $9.0 million, or 0.55% of average loans, versus $8.0 million, or 0.49%, in 2010.
Regulatory capital remained strong: the Corporation reported Tier 1 risk-based capital of 14.21%, total risk-based capital of 15.08% and a Tier 1 leverage ratio of 12.73%. The Bank was classified as well capitalized.
Material Changes Versus 2010
- Net income rose 32.6%, while diluted EPS increased 32.2%.
- Net interest income increased $2.6 million as funding costs fell faster than asset yields: average interest-bearing liability cost declined to 0.98% from 1.47%, while earning-asset yield fell to 5.23% from 5.50%.
- Provision for loan losses fell to $5.8 million from $9.2 million, although net charge-offs increased. Nonperforming loans declined to $56.4 million from $58.8 million.
- Non-interest income grew $3.5 million, primarily because impairment losses on securities were substantially lower. Non-interest expense fell $2.0 million, including lower FDIC and incentive costs.
- Year-end assets increased 20.5%, with approximately $414 million of the increase attributable to Freestar. Loans rose to $1.895 billion and deposits to $2.274 billion.
- Cash dividends were $0.94 per share for 2011, compared with $0.92 in 2010.
Outlook, Risks and Unusual Items
Management anticipated moderate growth opportunities in 2012 and gradual improvement in labor markets and retail sales, but did not provide quantified earnings or revenue guidance. It did not expect labor conditions to improve dramatically. Management described the company as asset-sensitive; modeled net interest income rose 1.55% over 12 months with a 100-basis-point rate increase and fell 2.47% with a 100-basis-point decrease, assuming an immediate parallel rate shift and no management response.
Key risks include local economic weakness, credit deterioration—particularly in commercial and real estate lending—interest-rate changes, competition, regulatory costs and operational or information-security failures. The filing also highlights uncertainty from Dodd-Frank and prospective Basel III rules. The company’s investment portfolio included collateralized debt obligations with $9.4 million of unrealized losses at year-end; four CDOs had previously recognized cumulative impairment charges, and fair values are sensitive to illiquid-market assumptions.
The pension plan was underfunded by $31.0 million at year-end, compared with $18.5 million in 2010. The filing reports no material pending litigation beyond ordinary routine matters. The independent auditor gave unqualified opinions on the consolidated financial statements and internal control; however, Freestar, acquired on December 30, was excluded from the internal-control assessment and audit scope.
Important Facts for Investors to Verify
- Freestar’s final acquisition-date fair values, goodwill and subsequent earnings contribution; management said certain valuation estimates remained preliminary.
- Credit quality and reserve adequacy, including the acquired and purchased-credit-impaired loan portfolios, nonperforming assets and charge-off trends.
- Valuation and expected cash flows of the CDO holdings, including the judgments used for illiquid securities.
- Funding and liquidity developments following the increase in borrowings, and the maturity schedule for deposits and other borrowings.
- Effects of pension assumptions and funding requirements, as well as potential regulatory changes and interest-rate movements.