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THFF > SEC Filings for THFF > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for FIRST FINANCIAL CORP /IN/


15-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as disclosures found elsewhere in this report are based upon First Financial Corporation's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, securities valuation and goodwill. Actual results could differ from those estimates.

Allowance for loan losses. The allowance for loan losses represents management's estimate of probable incurred losses in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for loan losses is determined based on management's assessment of several factors: reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current economic and nonperforming loans. Loans are considered impaired if, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest according to the contractual terms of the loan agreement. When a loan is deemed impaired, impairment is measured by using the fair value of underlying collateral,for loans deemed to be collateral dependent, the present value of the future cash flows discounted at the effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses assumptions (e.g., discount rate) and methodologies (e.g., comparison to the recent selling price of similar assets) consistent with those that would be utilized by unrelated third parties.

Changes in the financial condition of individual borrowers, economic conditions, historical loss experience, or the condition of the various markets in which collateral may be sold may affect the required level of the allowance for loan losses and the associated provision for loan losses. Should cash flow assumptions or market conditions change, a different amount may be recorded for the allowance for loan losses and the associated provision for loan losses.

Securities valuation and potential impairment. Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in accumulated other comprehensive income (loss), net of tax. The Corporation obtains market values from a third party on a monthly basis in order to adjust the securities to fair value. Equity securities that do not have readily determinable fair values are carried at cost. Additionally, all securities are required to be evaluated for other than temporary impairment (OTTI). In determining whether a market value decline is other than temporary, management considers the reason for the decline, the extent of the decline, the duration of the decline and whether the Corporation intends to sell a security or is more likely than not to be required to sell a security before recovery of its amortized cost. If an entity intends to sell or it is more likely than not it will be required to sell the security before recovery of its amortized cost basis, the OTTI shall be recognized in earnings equal to the entire difference between the investment's amortized cost basis and its fair value at the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis less any current-period loss, the OTTI shall be separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings.

Changes in credit ratings, financial condition of underlying debtors, default experience and market liquidity affect the conclusions on whether securities are other-than-temporarily impaired. Additional losses may be recorded through earnings for other than temporary impairment, should there be an adverse change in the expected cash flows for these investments.

Goodwill. The carrying value of goodwill requires management to use estimates and assumptions about the fair value of the reporting unit compared to its book value. An impairment analysis is prepared on an annual basis. Fair values of the reporting units are determined by an analysis which considers cash flows streams, profitability and estimated market values of the reporting unit. The majority of the Corporation's goodwill is recorded at First Financial Bank, N.
A.

Management believes the accounting estimates related to the allowance for loan losses, valuation of investment securities and the valuation of goodwill are "critical accounting estimates" because: (1) the estimates are highly susceptible to change from period to period because they require management to make assumptions concerning, among other factors, the changes in the types and volumes of the portfolios, valuation assumptions, and economic conditions, and
(2) the impact of recognizing an impairment or loan loss could have a material effect on the Corporation's assets reported on the balance sheet as well as net income.

RESULTS OF OPERATIONS - SUMMARY FOR 2012

COMPARISON OF 2012 TO 2011

Net income for 2012 was $32.8 million, or $2.48 per share. This represents a 11.8% decrease in net income and a 12.4% decrease in earnings per share, compared to 2011. Return on assets at December 31, 2012 decreased 24.2% to 1.13% compared to 1.49% at December 31, 2011.

The primary components of income and expense affecting net income are discussed in the following analysis. 2012 includes income and expense associated with the purchase of Freestar Bank on December 30, 2011 that were not part of the results for 2011.

NET INTEREST INCOME

The principal source of the Corporation's earnings is net interest income, which represents the difference between interest earned on loans and investments and the interest cost associated with deposits and other sources of funding .Net interest income increased in 2012 to $108.9 million compared to $99.2 million in 2011. Total average interest earning assets increased to $2.67 billion in 2012 from $2.33 billion in 2011. The tax-equivalent yield on these assets decreased to 4.80% in 2012 from 5.23% in 2011. Total average interest-bearing liabilities increased to $2.02 billion in 2012 from $1.76 billion in 2011. The average cost of these interest-bearing liabilities decreased to 0.66% in 2012 from 0.98% in 2011.

The net interest margin decreased from 4.50% in 2011 to 4.30% in 2012. This decrease is primarily the result of the decreased income provided by earning assets. Earning asset yields decreased 43 basis points while the rate on interest-bearing liabilities decreased by 32 basis points.

CONSOLIDATED BALANCE SHEET - AVERAGE BALANCES AND INTEREST RATES

                                                                                           December 31,
                                                  2012                                         2011                                         2010
                                  Average                       Yield/         Average                       Yield/         Average                       Yield/
(Dollar amounts in thousands)     Balance       Interest         Rate          Balance       Interest         Rate          Balance       Interest         Rate
ASSETS
Interest-earning assets:
Loans (1) (2)                   $ 1,863,014       100,083           5.37 %   $ 1,637,471        92,167           5.63 %   $ 1,636,254        96,786           5.92 %
Taxable investment securities       498,509        13,541           2.72 %       460,811        16,161           3.51 %       469,945        18,597           3.96 %
Tax-exempt investments (2)          243,070        14,651           6.03 %       204,921        13,465           6.57 %       194,011        13,415           6.91 %
Federal funds sold                   67,240            44           0.07 %        25,117            36           0.14 %        40,934            59           0.14 %
Total interest-earning assets     2,671,833       128,319           4.80 %     2,328,320       121,829           5.23 %     2,341,144       128,857           5.50 %

Non-interest earning assets:
Cash and due from banks              65,445                                       58,030                                       57,940
Premises and equipment, net          43,594                                       34,054                                       35,001
Other assets                        138,462                                       99,861                                      102,780
Less allowance for loan
losses                              (20,134 )                                    (22,154 )                                    (20,083 )
TOTALS                          $ 2,899,200                                  $ 2,498,111                                  $ 2,516,782

LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest-bearing liabilities:
Transaction accounts            $ 1,176,403         1,736           0.15 %   $   974,275         1,501           0.15 %   $   870,538         1,856           0.21 %
Time deposits                       653,089         6,784           1.04 %       616,164        10,626           1.72 %       697,560        14,450           2.07 %
Short-term borrowings                50,451           140           0.28 %        43,040           187           0.43 %        42,795           325           0.76 %
Other borrowings                    136,281         4,733           3.47 %       125,102         4,833           3.86 %       224,501        10,335           4.60 %
Total interest-bearing
liabilities:                      2,016,224        13,393           0.66 %     1,758,581        17,147           0.98 %     1,835,394        26,966           1.47 %

Non interest-bearing
liabilities:
Demand deposits                     439,206                                      336,038                                      300,760
Other                                79,894                                       61,693                                       59,461
                                  2,535,324                                    2,156,312                                    2,195,615

Shareholders' equity                363,876                                      341,799                                      321,167
TOTALS                          $ 2,899,200                                  $ 2,498,111                                  $ 2,516,782

Net interest earnings                           $ 114,926                                    $ 104,682                                    $ 101,891

Net yield on interest-
earning assets                                                      4.30 %                                       4.50 %                                       4.35 %

(1) For purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding.

(2) Interest income includes the effect of tax equivalent adjustments using a federal tax rate of 35%.

The following table sets forth the components of net interest income due to changes in volume and rate. The table information compares 2012 to 2011 and 2011 to 2010.

                                        2012 Compared to 2011 Increase                       2011 Compared to 2010 Increase
                                               (Decrease) Due to                                   (Decrease) Due to
                                                          Volume/                                              Volume/
(Dollar amounts in thousands)    Volume        Rate         Rate        Total        Volume        Rate         Rate         Total
Interest earned on
interest-earning assets:
Loans (1) (2)                   $ 12,695     $ (4,201 )   $   (579 )   $  7,915     $     72     $ (4,688 )   $      (3 )   $ (4,619 )
Taxable investment securities      1,322       (3,644 )       (298 )     (2,620 )       (361 )     (2,116 )          41       (2,436 )
Tax-exempt investment
securities (2)                     2,507       (1,113 )       (207 )      1,187          754         (668 )         (38 )         48
Federal funds sold                    60          (20 )        (33 )          7          (23 )          0             0          (23 )
Total interest income           $ 16,584     $ (8,978 )   $ (1,117 )   $  6,489     $    442     $ (7,472 )   $       0     $ (7,030 )

Interest paid on
interest-bearing liabilities:
Transaction accounts                 311          (63 )        (13 )        235          221         (515 )         (61 )       (355 )
Time deposits                        637       (4,227 )       (253 )     (3,843 )     (1,686 )     (2,418 )         282       (3,822 )
Short-term borrowings                 32          (68 )        (12 )        (48 )          2         (139 )          (1 )       (138 )
Other borrowings                     432         (488 )        (44 )       (100 )     (4,576 )     (1,662 )         736       (5,502 )
Total interest expense             1,412       (4,846 )       (322 )     (3,756 )     (6,039 )     (4,734 )         956       (9,817 )
Net interest income             $ 15,172     $ (4,132 )   $   (795 )   $ 10,245     $  6,481     $ (2,738 )   $    (956 )   $  2,787

(1) For purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding.

(2) Interest income includes the effect of tax equivalent adjustments using a federal tax rate of 35%.

PROVISION FOR LOAN LOSSES

The provision for loan losses charged to expense is based upon credit loss experience and the results of a detailed analysis estimating an appropriate and adequate allowance for loan losses. The analysis includes the evaluation of impaired loans as prescribed under Accounting Standards Codification (ASC-310), pooled loans as prescribed under ASC 450-10, and economic and other risk factors as outlined in various Joint Interagency Statements issued by the bank regulatory agencies. For the year ended December 31, 2012, the provision for loan losses was $8.8 million net, an increase of $3.0 million, or 52.4%, compared to 2011. The 2012 provision was reduced by $2.2 million for the offset of loans identified in the analysis of potential loan losses that are subject to the loss share agreement with the FDIC. Of those anticipated losses, 80% can be reimbursed by the FDIC and the FDIC indemnification asset has a corresponding increase of $2.2 million for those anticipated losses. The decrease was the result of several components related to the analysis of the Corporation's Allowance for Loan and Lease Losses.

Net charge-offs for 2012 were $8.3 million as compared to $9.0 million for 2011 and $8.0 million for 2010. Non-accrual loans decreased to $35.8 million at December 31, 2012 from $38.1 million at December 31, 2011. The decrease occurred despite a $4.7 million increase in non-accruals from the acquisition of Freestar Bank on December 30, 2011. Loans past due 90 days and still on accrual increased to $3.4 million compared to $2.0 million at December 31, 2011.

NON-INTEREST INCOME

Non-interest income of $39.5 million increased $6.2 million from the $33.3 million earned in 2011. Electronic banking fees and gains from the sale of mortgage loans were the primary drivers of this increase.

NON-INTEREST EXPENSES

Non-interest expenses increased to $93.1 million for 2012 from $75.2 million for 2011. The largest increase was in salaries and benefits at $ 10.8 million. Salaries increased $5.6 million while benefits increased $5.2 million. The salaries relate to the acquisition of Freestar and staffing for the four new branch locations acquired from the FDIC. Those were expenses not in the financial statement of previous years. The benefits expense increase of $5.2 million was primarily driven by an increase in pension expense of $3.3 million. The pension plan was frozen for most employees during 2012. Other expenses were up $4.9 million from 2011. Over $1 million of these were one-time costs associated with the acquisition and integration of Freestar Bank.

INCOME TAXES

The Corporation's federal income tax provision was $13.8 million in 2012 compared to a provision of $14.4 million in 2011. The overall effective tax rate in 2012 of 29.6% increased as compared to a 2011 effective rate of 27.9%.

COMPARISON OF 2011 TO 2010

Net income for 2011 was $37.2 million or $2.83 per share compared to $28.0 million in 2010 or $2.14 per share. This increase in net income was primarily driven by the improved net interest margin of 15 basis points from 4.35% to 4.50%.

Net interest income increased $2.6 million in 2011 compared to 2010 as total average interest-earning assets remained stable. This increase was primarily the result of the cost of funding declining at a faster pace than the decline in the earnings on earning assets. The provision for loan losses decreased $3.4 million from $9.2 million in 2010 to $5.8 million in 2011. Net non-interest income and expense decreased $5.6 million from 2010 to 2011. Non-interest expenses decreased $2.0 million while non-interest income increased $3.5 million. The increase in non-interest income resulted primarily from reduced impairment losses and lower non-interest expense resulted from reduced FDIC expense and reduced incentive expense.

The provision for income taxes increased $2.4 million from 2010 to 2011 and the effective tax rate decreased 2% in 2011 from 2010 as nontaxable income increased.

COMPARISON AND DISCUSSION OF 2012 BALANCE SHEET TO 2011

The Corporation's total assets decreased 2.0% or $58.7 million at December 31, 2012, from a year earlier. Available-for-sale securities increased $24.7 million at December 31, 2012, from the previous year. Loans, net of unearned income, decreased by $41.8 million to $1.85 billion. Deposits increased by $1.6 million while borrowings decreased by $86.2 million. Total shareholders' equity increased $25.2 million to $372.1 million at December 31, 2012. Net income was partially offset by higher dividends. There were also 49,825 shares from the treasury with a value of $1.44 million that were contributed to the ESOP plan in 2012 compared to 46,250 shares with a value of $1.56 million in 2011.

Following is an analysis of the components of the Corporation's balance sheet.

SECURITIES

The Corporation's investment strategy seeks to maximize income from the investment portfolio while using it as a risk management tool and ensuring safety of principal and capital. During 2012 the portfolio's balance increased by 3.7%. The average life of the portfolio increased from 4.0 years in 2011 to 4.2 years in 2012. The portfolio structure will continue to provide cash flows to be reinvested during 2013.

                                   1 year and less             1 to 5 years              5 to 10 years              Over 10 Years            2012
(Dollar amounts in thousands)    Balance        Rate       Balance        Rate        Balance        Rate        Balance        Rate         Total
U.S. government sponsored
entity mortgage-backed
securities and agencies (1)     $   1,382         4.78 %   $  3,261         6.06 %   $  62,178         4.60 %   $ 184,872         5.75 %   $ 251,693
Collateralized mortgage
obligations (1)                        40         3.70 %      1,096         4.87 %      11,789         3.94 %     220,395         2.92 %     233,320
States and political
subdivisions                       11,165         4.13 %     37,782         3.92 %      81,539         3.61 %      68,999         3.87 %     199,485
Corporate obligations                   -         0.00 %          -         0.00 %           -         0.00 %       6,122         0.00 %       6,122
Total                              12,587         4.20 %     42,139         4.11 %     155,506         4.03 %     480,388         4.11 %     690,620
Equities                                          0.00 %                    0.00 %                     0.00 %         380         0.00 %         380
TOTAL                           $  12,587                  $ 42,139                  $ 155,506                  $ 480,768                  $ 691,000

(1) Distribution of maturities is based on the estimated life of the asset.

                                   1 year and less             1 to 5 years              5 to 10 years              Over 10 Years            2011
(Dollar amounts in thousands)    Balance        Rate       Balance        Rate        Balance        Rate        Balance        Rate         Total
U.S. government sponsored
entity mortgage-backed
securities and agencies (1)     $       2         7.50 %   $ 11,287         4.01 %   $  83,897         4.44 %   $ 220,716         4.37 %   $ 315,902
Collateralized mortgage
obligations (1)                         -         0.00 %      2,384         5.20 %      19,438         4.39 %     126,125         4.17 %     147,947
States and political
subdivisions                        8,465         7.22 %     42,309         6.17 %      71,071         5.40 %      73,736         6.03 %     195,581
Corporate obligations                   -         0.00 %          -         0.00 %           -         0.00 %       4,771         1.94 %       4,771
Total                               8,467         7.22 %     55,980         5.69 %     174,406         4.83 %     425,348         4.57 %     664,201
Equities                                          0.00 %                    0.00 %                     0.00 %       2,086         0.00 %       2,086
TOTAL                           $   8,467                  $ 55,980                  $ 174,406                  $ 427,434                  $ 666,287

(1) Distribution of maturities is based on the estimated life of the asset.

LOAN PORTFOLIO



Loans outstanding by major category as of December 31 for each of the last five
years and the maturities at year end 2012 are set forth in the following
analyses.



(Dollar amounts in thousands)        2012            2011            2010            2009            2008
Loan Category
Commercial                        $ 1,088,144     $ 1,099,324     $   896,107     $   870,977     $   720,281
Residential                           496,237         505,600         437,576         447,379         436,388
Consumer                              268,507         289,717         307,403         314,561         303,123
TOTAL                             $ 1,852,888     $ 1,894,641     $ 1,641,086     $ 1,632,917     $ 1,459,792

Credit card loans held-for-sale   $         -     $         -     $         -     $         -     $    12,800




                                                After One
                                  Within        But Within       After Five
(Dollar amounts in thousands)    One Year       Five Years         Years            Total
MATURITY DISTRIBUTION
Commercial, financial and
agricultural                    $  421,495     $    538,980     $    127,669     $ 1,088,144
TOTAL

Residential                                                                          496,237
Consumer                                                                             268,507
TOTAL                                                                            $ 1,852,888

Loans maturing after one year
with:
Fixed interest rates                           $    167,611     $    114,053
Variable interest rates                             371,369           13,616
TOTAL                                          $    538,980     $    127,669

ALLOWANCE FOR LOAN LOSSES



The activity in the Corporation's allowance for loan losses is shown in the
following analysis:



(Dollar amounts in
thousands)                       2012            2011            2010            2009            2008
Amount of loans outstanding
at December 31,               $ 1,852,888     $ 1,894,641     $ 1,641,086     $ 1,632,917     $ 1,459,792

Average amount of loans by
year                          $ 1,863,014     $ 1,637,471     $ 1,636,254     $ 1,563,274     $ 1,451,911

Allowance for loan losses
at beginning of year          $    19,241     $    22,336     $    19,437     $    16,280     $    15,351
Loans charged off:
Commercial                          4,176           5,336           7,099           2,997           2,406
Residential                         2,598           2,811             872           1,881           1,274
Consumer                            3,640           2,969           4,503           6,783           5,914
Total loans charged off            10,414          11,116          12,474          11,661           9,594

Recoveries of loans
previously charged off:
Commercial                            644             938           2,319             574             704
Residential                           100              95             258             523             101
Consumer                            1,387           1,108           1,934           1,851           1,863
Total recoveries                    2,131           2,141           4,511           2,948           2,668
Net loans charged off               8,283           8,975           7,963           8,713           6,926
Provision charged to
expense *                          11,000           5,880          10,862          11,870           7,855
Balance at end of year        $    21,958     $    19,241     $    22,336     $    19,437     $    16,280
Ratio of net charge-offs
during period to average
loans outstanding                    0.44 %          0.55 %          0.49 %          0.56 %          0.48 %

* In 2012 the provision charged to expense was reduced by $2.2 million for the increase to the FDIC

Indemnification asset. In 2011 and 2010 it was reduced by $125 thousand and $1.7 million, respectively.

The allowance is maintained at an amount management believes sufficient to absorb probable incurred losses in the loan portfolio. Monitoring loan quality and maintaining an adequate allowance is an ongoing process overseen by senior management and the loan review function. On at least a quarterly basis, a formal analysis of the adequacy of the allowance is prepared and reviewed by management and the Board of Directors. This analysis serves as a point in time assessment of the level of the allowance and serves as a basis for provisions for loan losses. The loan quality monitoring process includes assigning loan grades and the use of a watch list to identify loans of concern.

Included in the $1.9 billion of loans outstanding at December 31, 2012 are $27.8 million of covered loans, those loans acquired with the purchase of the First National Bank of Danville from the FDIC that are covered by the loss sharing agreement.

Also included are $245 million of loan acquired on December 30, 2011 in the Freestar acquisition. These acquired loans are recorded at fair value with no carryover of Freestar's allowance for loan losses. The loans acquired had a contractual balance due of $254 million. The acquired portfolio includes purchased credit impaired loans with a contractual balance due of $29 million and a fair value of $20 million.

The analysis of the allowance for loan losses includes the allocation of specific amounts of the allowance to individual problem loans, generally based on an analysis of the collateral securing those loans. Portions of the allowance are also allocated to loan portfolios, based upon a variety of factors including historical loss experience, trends in the type and volume of the loan . . .

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