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THFF > SEC Filings for THFF > Form 10-K on 14-Mar-2014All Recent SEC Filings

Show all filings for FIRST FINANCIAL CORP /IN/

Form 10-K for FIRST FINANCIAL CORP /IN/


14-Mar-2014

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 2013

COMPARISON OF 2013 TO 2012

Net income for 2013 was $31.5 million, or $2.37 per share. This represents a 3.9% decrease in net income and a 4.4% decrease in earnings per share, compared to 2012. Return on assets at December 31, 2013 decreased 6.2% to 1.06% compared to 1.13% at December 31, 2012.

The primary components of income and expense affecting net income are discussed in the following analysis.

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 decreased in 2013 to $107.3 million compared to $108.9 million in 2012. Total average interest earning assets increased to $2.73 billion in 2013 from $2.67 billion in 2012. The tax-equivalent yield on these assets decreased to 4.46% in 2013 from 4.80% in 2012. Total average interest-bearing liabilities increased to $2.04 billion in 2013 from $2.02 billion in 2012. The average cost of these interest-bearing liabilities decreased to 0.44% in 2013 from 0.66% in 2012.

The net interest margin decreased from 4.30% in 2012 to 4.13% in 2013. This decrease is primarily the result of the decreased income provided by earning assets. Earning asset yields decreased 34 basis points while the rate on interest-bearing liabilities decreased by 22 basis points.


CONSOLIDATED BALANCE SHEET - AVERAGE BALANCES AND INTEREST RATES
                                                                                       December 31,
                                                 2013                                      2012                                      2011
                                   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)                   $ 1,807,599        92,207        5.10 %   $ 1,863,014       100,083        5.37 %   $ 1,637,471        92,167        5.63 %
Taxable investment securities       641,383        16,157        2.52 %       498,509        13,541        2.72 %       460,811        16,161        3.51 %
Tax-exempt investments (2)          242,484        13,523        5.58 %       243,070        14,651        6.03 %       204,921        13,465        6.57 %
Federal funds sold                   42,460            32        0.08 %        67,240            44        0.07 %        25,117            36        0.14 %
Total interest-earning assets     2,733,926       121,919        4.46 %     2,671,833       128,319        4.80 %     2,328,320       121,829        5.23 %
Non-interest earning assets:
Cash and due from banks              75,945                                    65,445                                    58,030
Premises and equipment, net          48,625                                    43,594                                    34,054
Other assets                        140,227                                   138,462                                    99,861
Less allowance for loan
losses                              (22,623 )                                 (20,134 )                                 (22,154 )
TOTALS                          $ 2,976,100                               $ 2,899,200                               $ 2,498,111

LIABILITIES AND SHAREHOLDERS'
EQUITY
Interest-bearing liabilities:
Transaction accounts            $ 1,321,848         1,374        0.10 %   $ 1,176,403         1,736        0.15 %   $   974,275         1,501        0.15 %
Time deposits                       579,815         4,512        0.78 %       653,089         6,784        1.04 %       616,164        10,626        1.72 %
Short-term borrowings                37,968            78        0.21 %        50,451           140        0.28 %        43,040           187        0.43 %
Other borrowings                    105,161         2,997        2.85 %       136,281         4,733        3.47 %       125,102         4,833        3.86 %
Total interest-bearing
liabilities:                      2,044,792         8,961        0.44 %     2,016,224        13,393        0.66 %     1,758,581        17,147        0.98 %
Non interest-bearing
liabilities:
Demand deposits                     479,659                                   439,206                                   336,038
Other                                73,963                                    79,894                                    61,693
                                  2,598,414                                 2,535,324                                 2,156,312
Shareholders' equity                377,686                                   363,876                                   341,799
TOTALS                          $ 2,976,100                               $ 2,899,200                               $ 2,498,111
Net interest earnings                           $ 112,958                                 $ 114,926                                 $ 104,682
Net yield on interest-
earning assets                                                   4.13 %                                    4.30 %                                    4.50 %

(1)For purposes of these computations, non-accruing 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 2013 to 2012 and 2012 to 2011.

                                         2013 Compared to 2012 Increase                      2012 Compared to 2011 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)                   $ (2,977 )   $ (5,049 )   $    150     $ (7,876 )   $ 12,695     $ (4,201 )   $   (579 )   $  7,915
Taxable investment securities      3,881         (983 )       (282 )      2,616        1,322       (3,644 )       (298 )     (2,620 )
Tax-exempt investment
securities (2)                       (35 )     (1,096 )          3       (1,128 )      2,507       (1,113 )       (207 )      1,187
Federal funds sold                   (17 )          7           (2 )        (12 )         60          (20 )        (33 )          7
Total interest income           $    852     $ (7,121 )   $   (131 )   $ (6,400 )   $ 16,584     $ (8,978 )   $ (1,117 )   $  6,489
Interest paid on
interest-bearing liabilities:
Transaction accounts                 215         (514 )        (63 )       (362 )        311          (63 )        (13 )        235
Time deposits                       (761 )     (1,702 )        191       (2,272 )        637       (4,227 )       (253 )     (3,843 )
Short-term borrowings                (35 )        (36 )          9          (62 )         32          (68 )        (12 )        (48 )
Other borrowings                  (1,081 )       (849 )        194       (1,736 )        432         (488 )        (44 )       (100 )
Total interest expense            (1,662 )     (3,101 )        331       (4,432 )      1,412       (4,846 )       (322 )     (3,756 )
Net interest income             $  2,514     $ (4,020 )   $   (462 )   $ (1,968 )   $ 15,172     $ (4,132 )   $   (795 )   $ 10,245

(1)For purposes of these computations, non-accruing 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, 2013, the provision for loan losses was $7.9 million net, a decrease of $913 thousand, or 10.4%, compared to 2012. The 2013 provision includes $1.4 million related to a decrease in the FDIC indemnification asset. Pursuant to its accounting policy, the Corporation reflects changes in the FDIC indemnification asset related to actual or expected losses in indemnified loans as offsets or additions to the provision for loan losses.

Net charge-offs for 2013 were $8.4 million as compared to $8.3 million for 2012 and $9.0 million for 2011. Non-accrual loans decreased to $19.8 million at December 31, 2013 from $36.8 million at December 31, 2012. Loans past due 90 days and still on accrual decreased to $2.1 million compared to $3.4 million at December 31, 2012.

NON-INTEREST INCOME

Non-interest income of $40.5 million increased $1.0 million from the $39.5 million earned in 2012. Increases in electronic banking fees, trust fees, deposit fees and insurance income offset reduced income from the sale of mortgage loans.

NON-INTEREST EXPENSES

Non-interest expenses increased to $94.6 million for 2013 from $93.1 million for 2012. Much of the increase in expenses was related to the increase in occupancy and equipment expenses as the Corporation added 5 locations to banking business. Salaries increased $945 thousand while benefits decreased $2.1 million. The benefits expense decrease of $2.1 million was primarily driven by a decrease in pension expense of $3.3 million. The pension plan was frozen for most employees at the end of 2012. Increased costs of the 401K plan reduced the benefit of the freezing of the pension plan benefit.

INCOME TAXES

The Corporation's federal income tax provision was $13.8 million in 2013 and 2012. The overall effective tax rate in 2013 of 30.4% increased as compared to a 2012 effective rate of 29.6%.


COMPARISON OF 2012 TO 2011

Net income for 2012 was $32.8 million or $2.48 per share compared to $37.2 million in 2011 or $2.83 per share. This decrease in net income was driven by the increased non-interest expense from the acquisition of Freestar combined with reduced net interest margin of 20 basis points from 4.50% to 4.30%.

Net interest income increased $9.7 million in 2012 compared to 2011 as total average interest-earning assets increased. This increase was primarily the result of increasing the earning assets with the acquisition of the Freestar bank at the end of 2011. The provision for loan losses increased $3.0 million from $5.8 million in 2011 to $8.8 million in 2012. Net non-interest income and expense increased $11.7 million from 2011 to 2012. Non-interest expenses increased $17.9 million while non-interest income increased $6.2 million. The increase in non-interest income resulted primarily from electronic banking fees and gain on sale of mortgage loans. The increase in non-interest expense was primarily salaries and benefits associated with the acquisition of the Freestar bank at the end of 2011and an increase in pension expense.
The provision for income taxes decreased $0.6 million from 2011 to 2012 and the effective tax rate increased 1.7% in 2012 from 2011.

COMPARISON AND DISCUSSION OF 2013 BALANCE SHEET TO 2012

The Corporation's total assets increased 4.3% or $123.3 million at December 31, 2013, from a year earlier. Available-for-sale securities increased $223.6 million at December 31, 2013, from the previous year. Loans, net of unearned income, decreased by $60.2 million to $1.79 billion. Deposits increased by $182.7 million while borrowings decreased by $42.4 million. In August 2013, the Corporation acquired a number of branch facilities in central and southern Illinois and assumed approximately $189 million in customer deposits. Total shareholders' equity increased $14.1 million to $386.2 million at December 31, 2013. Net income was partially offset by higher dividends. There were also 35,531 shares from the treasury with a value of $1.22 million that were contributed to the ESOP plan in 2013 compared to 49,825 shares with a value of $1.44 million in 2012.
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 2013 the portfolio's balance increased
by 32.4%. The average life of the portfolio increased from 4.2 years in 2012 to
4.7 years in 2013. The portfolio structure will continue to provide cash flows
to be reinvested during 2014.

                                    1 year and less           1 to 5 years            5 to 10 years            Over 10 Years           2013
(Dollar amounts in thousands)     Balance        Rate      Balance       Rate       Balance       Rate       Balance       Rate        Total
U.S. government sponsored
entity mortgage-backed
securities and agencies (1)     $      127       5.29 %   $ 14,149       5.28 %   $  38,461       4.93 %   $ 151,051       5.58 %   $ 203,788
Collateralized mortgage
obligations (1)                          -          - %      3,475       4.48 %       5,780       4.58 %     497,486       2.49 %     506,741
States and political
subdivisions                        10,612       4.25 %     33,389       3.84 %      83,995       3.59 %      66,991       3.71 %     194,987
Corporate obligations                    -          - %          -          - %           -          - %       9,044          - %       9,044
TOTAL                           $   10,739                $ 51,013                $ 128,236                $ 724,572                $ 914,560

(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           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                    -          - %          -          - %           -          - %       6,122          - %       6,122
Total                               12,587       4.20 %     42,139       4.11 %     155,506       4.03 %     480,388       4.11 %     690,620
Equities                                            - %                     - %                      - %         380          - %         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.

LOAN PORTFOLIO

Loans outstanding by major category as of December 31 for each of the last five
years and the maturities at year end 2013 are set forth in the following
analyses.

(Dollar amounts in thousands)       2013            2012            2011            2010            2009
Loan Category
Commercial                      $ 1,042,138     $ 1,088,144     $ 1,099,324     $   896,107     $   870,977
Residential                         482,377         496,237         505,600         437,576         447,379
Consumer                            268,033         268,507         289,717         307,403         314,561
TOTAL                           $ 1,792,548     $ 1,852,888     $ 1,894,641     $ 1,641,086     $ 1,632,917



                                                          After One
                                            Within        But Within       After Five
(Dollar amounts in thousands)              One Year       Five Years         Years            Total
MATURITY DISTRIBUTION
Commercial, financial and agricultural   $  358,025     $    534,143     $    149,970     $ 1,042,138
TOTAL
Residential                                                                                   482,377
Consumer                                                                                      268,033
TOTAL                                                                                     $ 1,792,548
Loans maturing after one year with:
Fixed interest rates                                    $    172,419     $    137,976
Variable interest rates                                      361,724           11,994
TOTAL                                                   $    534,143     $    149,970


ALLOWANCE FOR LOAN LOSSES

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

(Dollar amounts in
thousands)                        2013            2012            2011            2010            2009
Amount of loans outstanding
at December 31,               $ 1,792,548     $ 1,852,888     $ 1,894,641     $ 1,641,086     $ 1,632,917
Average amount of loans by
year                          $ 1,807,599     $ 1,863,014     $ 1,637,471     $ 1,636,254     $ 1,563,274
Allowance for loan losses
at beginning of year          $    21,958     $    19,241     $    22,336     $    19,437     $    16,280
Loans charged off:
Commercial                          4,830           4,176           5,336           7,099           2,997
Residential                         4,942           2,598           2,811             872           1,881
Consumer                            3,615           3,640           2,969           4,503           6,783
Total loans charged off            13,387          10,414          11,116          12,474          11,661
Recoveries of loans
previously charged off:
Commercial                          3,149             644             938           2,319             574
Residential                           472             100              95             258             523
Consumer                            1,401           1,387           1,108           1,934           1,851
Total recoveries                    5,022           2,131           2,141           4,511           2,948
Net loans charged off               8,365           8,283           8,975           7,963           8,713
Provision charged to
expense *                           6,475          11,000           5,880          10,862          11,870
Balance at end of year        $    20,068     $    21,958     $    19,241     $    22,336     $    19,437
Ratio of net charge-offs
during period to average
loans outstanding                    0.46 %          0.44 %          0.55 %          0.49 %          0.56 %

* In 2013 the provision charged to expense was increased by $1.4 million for the decrease to the FDIC indemnification asset. In 2012 and 2011 the provision was reduced with a corresponding increase in the FDIC indemnification asset by $2.2 million and $125 thousand, 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 $1.8 billion of loans outstanding at December 31, 2013 are $19.4 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 loans acquired on December 30, 2011 in the Freestar acquisition. The acquired portfolio includes purchased credit impaired loans with a contractual balance due of $10.8 million and a fair value of $9.2 million.

The analysis of the allowance for loan losses includes the allocation of specific amounts of the allowance to individual impaired 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 portfolios, trends in delinquent and non-performing loans, and economic trends affecting our market. These components are added together and compared to the balance of our allowance at the evaluation date. The allowance for loan losses as a percentage of total loans declined to 1.12% at year end 2013 compared to . . .

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