First Financial Corporation — Q3 2011 Form 10-Q
Business context and period: Indiana-based bank holding company reporting one segment, banking. This unaudited filing covers the quarter and nine months ended September 30, 2011; income and cash-flow comparisons are with the corresponding 2010 periods. Balance-sheet comparisons are with December 31, 2010 unless stated otherwise. Dollar figures below are in millions except per-share data and ratios.
Financial performance and condition
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net interest income | $24.9 | $24.7 | $74.8 | $72.0 |
| Net interest margin | 4.50% | 4.39% | Not clearly provided | Not clearly provided |
| Provision for loan losses | $1.4 | $2.4 | $3.9 | $7.0 |
| Non-interest income | $8.9 | $7.3 | $25.1 | $20.2 |
| Non-interest expense | $18.6 | $20.6 | $56.9 | $57.6 |
| Net income | $9.8 | $6.3 | $27.0 | $19.7 |
| Basic and diluted EPS | $0.75 | $0.48 | $2.06 | $1.50 |
- Management reported Q3 return on assets of 1.57% and return on equity of 11.32%, compared with 0.99% and 7.79%, respectively, a year earlier.
- At September 30, total assets were $2,511.3; loans net of unearned income and allowance were $1,635.5; deposits were $1,927.0; and shareholders’ equity was $356.6. Versus year-end 2010, assets rose $60.2, net loans rose $17.7, deposits rose $23.9, and equity rose $34.9.
- Cash and due from banks were $57.2, with no federal funds sold or short-term investments at period-end. Short-term borrowings were $40.6 and FHLB advances were $124.2, for total borrowings of about $164.8. The filing reports no liquidity shortfall and says management expects adequate liquidity.
- Nine-month operating cash flow was $27.4, investing cash flow was negative $45.2, and financing cash flow was $16.6. Cash and cash equivalents ended at $57.2, down $1.3 from year-end.
- The allowance for loan losses was $22.1, or 1.33% of loans, versus 1.22% at September 30, 2010. Reported non-performing loans were $61.4, up from $58.8 at year-end 2010; the allowance equaled 36% of non-performing loans, versus 38%.
- All three reported regulatory capital ratios for the lead bank exceeded “well capitalized” thresholds: total risk-based 18.40% versus 10.00% minimum, Tier 1 risk-based 17.38% versus 6.00%, and Tier 1 leverage 13.38% versus 5.00%.
Material changes versus comparable periods
- Q3 net income increased to $9.8 from $6.3; nine-month net income increased to $27.0 from $19.7. Net interest income rose modestly in both comparisons as funding costs declined faster than asset yields.
- Q3 non-interest income increased $1.6, including a $0.9 gain from exchanging bank-owned life insurance policies and lower securities impairment losses than in Q3 2010. Nine-month non-interest income also benefited from substantially lower impairment losses.
- Q3 non-interest expense declined $2.0 year over year. Management attributed $0.6 of the reduction to lower FDIC insurance expense and described differences in the timing and accrual of incentive costs between years.
- Nine-month provision for loan losses declined to $3.9 from $7.0; management said net charge-offs also decreased. Non-accrual loans increased to $42.2 from $38.5 at year-end, while restructured loans and accruing loans over 90 days past due declined.
- Available-for-sale securities increased to $610.9 from $560.8 at year-end. Unrealized losses declined to $7.4 from $14.6, largely due to improved fair values; the portfolio still includes illiquid collateralized debt obligations (CDOs).
Outlook, commentary, risks and unusual items
- No earnings or revenue guidance is provided. Management expects adequate liquidity, citing $6.5 of securities maturities, $97.5 of anticipated mortgage-backed-security principal payments, and $10.8 of expected security calls over the next 12 months.
- Interest-rate simulations estimate that a 100-basis-point increase would raise net interest income 1.21% over 12 months and 4.20% over 24 months; a 100-basis-point decrease would reduce it 1.08% and 3.20%, respectively. The filing cautions that the models rely on assumptions and do not reflect management responses.
- Management judged the allowance adequate, while noting a modest increase in impaired and non-accrual loans, primarily smaller-balance non-accrual loans. Allowance adequacy, goodwill valuation, and investment-security valuation are identified as critical accounting judgments.
- CDOs had $7.4 fair value and $7.4 of gross unrealized losses at quarter-end; the filing describes material market illiquidity and Level 3 valuation inputs. Management states most unrealized losses reflect market illiquidity rather than issuer credit deterioration and does not expect or intend to sell the securities before recovery. Equity-security impairment charges included $0.1 in Q2 and an additional $0.013 in Q3 2011.
- On October 11, 2011, after quarter-end, the company agreed to acquire Freestar Bank and certain PNB Holding liabilities for $47.0 cash plus assumption of approximately $8.2 of liabilities. Freestar had approximately $400 of assets and 13 offices. Closing was expected by December 31, 2011, subject to regulatory, shareholder, and other approvals; the purchase price may adjust based on tangible book value.
- The company’s FDIC loss-sharing agreement related to the 2009 Danville bank acquisition produced a $3.8 indemnification asset at quarter-end. Forward-looking risks include economic and market conditions, interest rates, competition, regulation, litigation, borrower losses, and accounting changes. The filing reports no material change in previously disclosed risk factors and no material pending legal proceedings beyond routine litigation.
Important facts for investors to verify
- Reconcile non-performing-loan disclosures: the MD&A reports $61.4 total, including $16.3 restructured and $2.8 accruing over 90 days, while the note tables show $17.1 restructured and $3.0 accruing over 90 days. The filing text does not clearly explain the differences.
- Reconcile nine-month dividends: the shareholders’ equity statement reports $6.2 of cash dividends, while the cash-flow statement reports $12.2 of dividends paid.
- Review CDO credit and valuation assumptions, Level 3 pricing uncertainty, and the sensitivity of the portfolio to liquidity and further credit deterioration.
- Assess trends in non-accrual and impaired loans, charge-offs, restructuring activity, and allowance coverage, including the effects of the FDIC-covered loan portfolio.
- Confirm the Freestar/PNB transaction’s final terms, approvals, purchase-price adjustment, and impact on capital, liquidity, and integration costs.