First Financial Bancorp. (FFBC) 10-K2008 FY Annual report

In these unprecedented times, First Financial remains focused on growth. While many other banks are regrouping, we are using our resources to focus on acquiring new client relationships and continue on our path to greater success. In 2008, First Financial grew average commercial loans by 15 percent, maintained strong capital levels, entered a new market, and opened new banking centers in growth markets.

Our strong capital level has earned First Financial the classification of “well capitalized” by banking regulatory agencies. The strength and dedication of our associates was also a key contributor to profitably managing the company in 2008. Associates continue to work diligently to build new relationships, serve clients, and reinforce our favorable reputation in the communities we serve.

Our proven stability and dependability is well known to clients in our market areas. We are also attracting new clients who have heard about First Financial’s reputation from independent ratings that compare banks across the country. A multi-million dollar company in Columbus, Indiana, recently sought out our services when they realized they needed a bank with a stronger financial position.

When the opportunity came in 2008 to increase our FDIC coverage, we believed it was the right thing to take on this added expense in order to provide greater safety, security, and peace of mind for our clients. Throughout the year, we carefully managed our balance sheet, maintained reasonable product pricing, and focused our energy and resources on our core business.

As we see it, the silver lining in the current economic climate is the opportunity to acquire great clients who are looking for a better banking relationship and to improve our prospects for hiring some notable talent to enhance our success. We look forward to growing our franchise, expanding our network, and increasing our service offerings in 2009.

Unprecedented events affected the banking industry and the U.S. economy in 2008. At First Financial, the foundation we laid over the past several years provided a layer of protection that enabled us to carry out our strategic growth initiatives amid the turmoil in the capital and credit markets.

Our capital position is strong and our liquidity sources are deep, and those strengths are reflected in the publications of various national ratings of financial institutions:

Because First Financial is one of the country’s healthy banks, the U. S. Treasury invited us to participate in its voluntary Capital Purchase Program that was established in 2008 to restore liquidity and stability in the U.S. financial system. This is not a bailout, but an investment by the Treasury that First Financial will repay. We issued $80 million in perpetual preferred securities to the U.S. Treasury in December on which we will pay the Treasury a five percent return in each of the first five years.

Throughout 2008, we took a variety of measures to position our company more effectively for uncertain economic conditions. These actions enabled us to perform above our peers in return on equity. First Financial achieved 8.21 percent compared to the peer average of 3.84 percent.

We continued to invest in our franchise and our future. Our most extensive project in 2008 was the new Kettering Business Center (shown in the photo above right) that opened in October with a full-service banking center and space for our commercial-relationship managers who serve business clients across Dayton, Ohio, and beyond. Our commercial portfolio is growing in Dayton, and we expect this new facility to attract additional clients and bolster our presence in the market.

Our first banking center using our full, new prototype design opened in Crown Point, Indiana, at the end of 2008. This is our second banking center in the growing community of Crown Point, where our sales team is aggressively seeking new clients and building retail traffic.

New merchandising graphics and elements of our new prototype design are now evident in the 11 banking centers that we renovated in 2008, creating a lighter, brighter, more contemporary banking experience for our clients. Additional remodeling and refreshing of banking centers will continue in 2009 as we further strengthen our brand and add consistency to our properties.

Metropolitan market development advanced in 2008 as we formalized our presence in Indianapolis. A team led by our highly experienced Indianapolis market president is making advances in developing the market and adding to our existing base of commercial clients there.

Also in 2008, our Wealth Resource Group welcomed Alfred Shepard as the new chief investment officer for First Financial Capital Advisors. He and his team of portfolio managers are working to grow and broaden our company’s already strong wealth-management business.

2009 is certain to be a year of challenge, but we expect to find a balance between leveraging our growth opportunities with carefully managing our business and the inherent risks due to the difficult economic conditions.

With a renewed focus on deposit growth and commercial loan development, we are retooling our retail sales process with higher expectations for acquiring new clients and expanding our relationships with current clients. Our associates are looking for every opportunity to bring additional value to client relationships while carefully managing expenses and credit quality.

As we continue to pursue our multi-year facilities improvement plan, we have these new initiatives underway:

To underscore our ongoing commitment to a higher level of service quality for our clients, we have assembled a team of highly qualified officers to identify and recommend meaningful process enhancements that can result in significant service improvement for First Financial’s clients in 2009 and improved efficiency.

In order to meet the challenges of 2009, our company and our people are stretching to meet high-performance goals for every aspect of our business. Every day, we carry out our mission, live our brand, and apply our values as we help our clients on their paths to success.

This annual report contains forward-looking statements. See Page 18 for further information on the risks and uncertainties associated with forward-looking statements.

The following discussion and analysis is presented to facilitate the understanding of the financial position and results of operations of First Financial Bancorp (First Financial or the Company). It identifies trends and material changes that occurred during the reporting periods and should be read in conjunction with the statistical data, Consolidated Financial Statements, and accompanying Notes on Pages 26 through 45.

First Financial is a $3.7 billion bank holding company headquartered in Cincinnati, Ohio. As of December 31, 2008, First Financial, through its subsidiaries, operated in western Ohio, Indiana, and northern Kentucky. These subsidiaries include a commercial bank, First Financial Bank, N.A. (Bank), with 81 banking centers and 98 ATMs, and a registered investment advisor, First Financial Capital Advisors LLC (Capital Advisors). Within these two subsidiaries, First Financial conducts two primary activities: banking and wealth management. The Bank operates in nine distinct markets under the First Financial Bank name and provides lending products, deposit accounts, cash management, and other services to commercial and retail clients. The wealth management activities include a full range of services including trust services, brokerage, private banking, investment, and other related services.

In the first quarter of 2008, First Financial's corporate headquarters was relocated to its existing Cincinnati market offices in Cincinnati, Ohio. The Bank subsidiary remains headquartered in Hamilton, Ohio.

First Financial's return on average shareholders' equity for 2008 was 8.21%, which compares to 12.73% and 7.13% for 2007 and 2006, respectively. First Financial's return on average assets for 2008 was 0.67%. This compares to return on average assets of 1.08% and 0.62% for 2007 and 2006, respectively.

The major components of First Financial's operating results for the past five years are summarized in Table 1 — Financial Summary and discussed in greater detail on subsequent pages.

First Financial serves a combination of metropolitan and non-metropolitan markets through its full-service banking centers. Market selection is based upon a number of factors, but markets are primarily chosen for their potential for growth, and long-term profitability. First Financial's goal is to develop a competitive advantage utilizing a local market focus; building long-term relationships with clients and helping them reach greater levels of success in their financial life. To help achieve its goals of superior service to an increasing number of clients, First Financial opened two new banking centers in its metropolitan markets in 2008, including a new market headquarters for its Dayton-Middletown metropolitan market and a new banking center in Crown Point, Indiana. Additionally, First Financial added a commercial lending team in the Indianapolis metropolitan market. First Financial intends to continue to concentrate future growth plans and capital investments in its metropolitan markets. Smaller markets have historically provided stable, low-cost funding sources to First Financial and they remain an important part of its funding base. First Financial believes its historical strength in these markets should enable it to retain or improve its market share.

The primary source of First Financial's revenue is net interest income, the excess of interest received from earning assets over interest paid on interest-bearing liabilities, and the fees for financial services provided to clients. First Financial's business results tend to be influenced by overall economic factors and conditions, including market interest rates, price competition within the marketplace, business spending, and consumer confidence.

Net interest income in 2008 declined 1.9% from 2007, compared to a 5.3% decline from 2006 to 2007. The decline in 2008 was primarily due to the impact from declining market interest rates throughout the year. From September 2007 through December 2008, the Federal Reserve decreased the targeted federal funds rate 10 times from 5.25% to 0.25%, which led to a decline in most market interest rates and negatively impacted the company's asset sensitive balance sheet. The impact from lower interest rates was partially offset by the continued shift in the mix of deposits from higher-cost certificates of deposit to lower-cost transaction-based accounts and a $124.2 million, or 4.1%, increase in average earning assets during 2008. The net interest margin was 3.71% for 2008, compared with 3.94% in 2007, and 4.01% in 2006.

Loan growth during 2008 was primarily driven by First Financial's continued efforts to expand its commercial lending sales force and deepen its market presence, primarily in metropolitan markets. The mix shift from certain lower yielding consumer loans to higher yielding commercial loans continues, as period-end commercial, commercial real estate, and construction loans increased from $1.64 billion in the fourth quarter of 2007 to $1.89 billion in the fourth quarter of 2008, an increase of $244.4 million or 14.9%.

In October of 2007, First Financial announced the formation of a long-term exclusive marketing agreement and the sale of its merchant payment processing portfolio to its historical merchant processing technology provider. Under the terms of the agreement, the buyer will continue to provide merchant processing services to existing clients of First Financial, and First Financial will jointly market with them merchant processing services to prospective clients.

The competitive landscape remained intense during 2008 and was made even more difficult by the increased liquidity pressure being exhibited by a number of banks in our markets. During 2008, First Financial initiated a deposit pricing strategy aimed at maximizing the net interest margin in a very competitive deposit gathering landscape. The strategy has been successful as outflows of time deposits have been replaced with less expensive wholesale funding that was used to help fund asset generation. Average total deposits declined by $31.5 million or 1.1% from 2007 to 2008, however, average transaction and savings deposits increased $17.2 million, or 1.1%, during this time.

Noninterest income was negatively impacted by a number of factors, primarily driven by lower trust and wealth management fees and lower service charges on deposits in 2008 as compared with 2007. Noninterest income in 2008 included a $3.7 million loss related to the decline in market value of equity securities of the Federal Home Loan Mortgage Corporation (FHLMC). Noninterest expense has continued to improve as a direct result of the successful reorganization of First Financial's corporate structure, resulting in a reduction in noninterest expense of $5.6 million or 4.6% for 2008 compared with 2007.

Credit quality remained relatively stable throughout most of 2008, however, First Financial began to experience some deterioration within its commercial lending portfolios as borrowers came under increased stress due to the continued economic downturn, eroding real estate values and increasing levels of unemployment.

While credit costs did trend higher towards the end of 2008, First Financial's coverage ratios remained strong. The allowance for loan and lease losses as a percent of nonperforming loans was 197.3% at December 31, 2008, compared with 197.9% at December 31, 2007. First Financial believes that its credit costs in 2008, although higher than previous levels, were favorable relative to industry and peer levels and are a reflection of its strong credit management policies and practices.

On December 23, 2008, First Financial completed the sale of $80.0 million in perpetual preferred securities to the U.S. Treasury under its Capital Purchase Program (CPP), as a component of its Troubled Asset Relief Program (TARP), which represented approximately 3.0% of risk-weighted assets at September 30, 2008. These securities carry a 5.0% annual dividend rate for the first five years and a 9.0% annual rate thereafter. These dividends will result in diluted net income per common share, which is computed by dividing net income applicable to common stock by the weighted average number of shares, nonvested stock, and dilutive common stock equivalents outstanding during the period. First Financial's regulatory capital ratios at December 31, 2008, significantly exceeded the levels necessary to be classified as "well capitalized."

In conjunction with the purchase of the preferred shares, the Treasury received a warrant to purchase 930,233 common shares at an exercise price of $12.90. The warrant has a term of 10 years. The Treasury agreed not to exercise voting power with respect to the common shares that it acquires upon exercise of the warrant.

First Financial has both a short and long-term plan for utilization of the CPP proceeds. In anticipation of the receipt of the $80.0 million in capital, the company began purchasing agency-guaranteed, residential mortgage-backed securities. The investment portfolio specifically designated as the CPP Investment Portfolio totaled approximately $122.5 million at December 31, 2008. The ratio of investments to capital, or leverage on the CPP capital, was 1.5 times the proceeds received. The company has established an internal maximum on the CPP Investment Portfolio not to exceed 5 times.

Although loan growth remained relatively strong throughout 2008, First Financial is evaluating several ways to increase lending volume consistent with the intent of the CPP program. The company is also working with its third-party servicer for residential

For a more detailed discussion of the above topics, please refer to the sections that follow.

First Financial's net interest income for the years 2004 through 2008 is shown in Table 1 — Financial Summary. The amount of net interest income is determined by the volume and mix of earning assets, the rates earned on such earning assets, and the volume, mix, and rates paid for the deposits and borrowed money that support the earning assets. Table 2 — Volume/Rate Analysis describes the extent to which changes in interest rates and changes in volume of earning assets and interest-bearing liabilities have affected First Financial's net interest income on a tax equivalent basis during the years indicated. Table 2 — Volume/Rate Analysis should be read in conjunction with the Statistical Information shown on Page 19.

Interest income on a tax equivalent basis is presented in Table 1 — Financial Summary. The tax equivalent adjustment recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a 35.0% tax rate for all years presented. The tax equivalent net interest margin was 3.77%, 4.01%, and 4.09% for the years 2008, 2007, and 2006, respectively.

Nonaccruing loans and loans held for sale were included in the daily average loan balances used in determining the yields in Table 2 — Volume/Rate Analysis.

Interest foregone on nonaccruing loans is disclosed in Note 8 of the Notes to Consolidated Financial Statements and is not considered to have a material effect on these presentations. The amount of loan fees included in the interest income computation for 2008, 2007, and 2006 was $1.7 million, $1.8 million, and $3.6 million, respectively. The decline in loan fees in 2008 and 2007 is primarily due to First Financial's 2007 decision to sell future residential real estate loan originations to its strategic partner, resulting in all future loan fees associated with residential real estate loans being owned by the new servicer, in conjunction with the sale of the mortgage servicing portfolio in the first quarter of 2007.

(1) Tax equivalent basis was calculated using a 35.00% tax rate.

(2) Includes loans held-for-sale.

(3) Includes investment securities held-to-maturity, investment securities available-for-sale, and other investments.

Net interest income decreased $6.6 million or 5.3% primarily due to a 3.6% net decline in the level of average earning assets, resulting from the third quarter of 2006 sale of ten banking centers and their related loans and deposits. In a series of actions beginning in September of 2007, the Federal Reserve lowered the federal funds rate a total of 100 basis points by December 31, 2007. These actions resulted in the decline of other market interest rates, specifically the prime rate, but created a disproportionate and timing-related impact on asset yields as compared to deposit costs.

Noninterest income and noninterest expenses for 2008, 2007, and 2006 are shown in Table 3 — Noninterest Income and Noninterest Expenses.

Noninterest expense in the fourth quarter of 2007 included $0.5 million associated with First Financial’s proportionate share of the announced Visa Inc. member bank settlement charges and pending litigation. Visa used a portion of the proceeds of their planned initial public offering (IPO) to satisfy such litigation judgments and settlements. Upon the completion of this IPO, First Financial received its proportionate share of proceeds from the offering, offsetting its liability for the litigation.