UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
R Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended December 31, 2010.
Or
£ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from _______________ to ______________
Commission File Number 000-17122
FIRST FINANCIAL HOLDINGS, INC.
(Exact name of Registrant as specified in its charter)
Delaware | 57-0866076 | |
(State or other jurisdiction of | I.R.S. Employer | |
Incorporation or organization | Identification No.) | |
2440 Mall Drive, Charleston, South Carolina | 29406 | |
(Address of principal executive offices) | (Zip Code) |
(843) 529-5933 |
Registrant’s telephone number, including area code |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes £ No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “and smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer £ | Accelerated filer R | Non-accelerated filer £ | Smaller reporting company £ |
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act). Yes £ No R
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
Class | Outstanding at January 31, 2011 | |
Common Stock, $0.01 par value | 16,526,752 |
FIRST FINANCIAL HOLDINGS, INC.
Index to Form 10-Q
Part I – Financial Information | ||
Item 1. Financial Statements (unaudited) | ||
Consolidated Balance Sheets | 3 | |
Consolidated Statements of Operations | 4 | |
Consolidated Statements of Changes in Shareholders’ Equity | 5 | |
Consolidated Statements of Cash Flows | 6 | |
Notes to Consolidated Financial Statements | 7 | |
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations | 26 | |
Item 3. Quantitative and Qualitative Disclosures About Market Risk | 42 | |
Item 4. Controls and Procedures | 42 | |
Part II – Other Information | ||
Item 1. Legal Proceedings | 42 | |
Item 1A. Risk Factors | 42 | |
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds | 42 | |
Item 3. Defaults Upon Senior Securities | 42 | |
Item 4. Reserved | 43 | |
Item 5. Other Information | 43 | |
Item 6. Exhibits | 43 | |
Signatures | 44 |
2
FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, | September 30, | December 31, | ||||||||||
2010 | 2010 | 2009 | ||||||||||
(in thousands, except share data) | (Unaudited) | (Unaudited) | ||||||||||
ASSETS | ||||||||||||
Cash and due from banks | $ | 48,521 | $ | 49,821 | $ | 58,241 | ||||||
Interest-bearing deposits with banks | 7,905 | 10,726 | 8,188 | |||||||||
Total cash and cash equivalents | 56,426 | 60,547 | 66,429 | |||||||||
Investment securities: | ||||||||||||
Securities available for sale, at fair value | 372,277 | 407,976 | 478,768 | |||||||||
Securities held to maturity, at amortized cost , approximate fair value $22,495, $24,878, and $24,118, respectively | 21,948 | 22,529 | 22,481 | |||||||||
Nonmarketable securities - FHLB stock | 41,273 | 42,867 | 46,141 | |||||||||
Total investment securities | 435,498 | 473,372 | 547,390 | |||||||||
Loans | 2,583,367 | 2,564,348 | 2,644,202 | |||||||||
Less: Allowance for loan losses | 88,349 | 86,871 | 73,534 | |||||||||
Net loans | 2,495,018 | 2,477,477 | 2,570,668 | |||||||||
Loans held for sale | 28,528 | 28,400 | 22,903 | |||||||||
Premises and equipment, net | 82,847 | 83,413 | 80,113 | |||||||||
Goodwill | 28,260 | 28,260 | 28,025 | |||||||||
Other intangible assets, net | 9,515 | 9,754 | 10,470 | |||||||||
FDIC indemnification asset, net | 68,326 | 67,583 | 64,130 | |||||||||
Other assets | 96,920 | 94,209 | 86,020 | |||||||||
Total assets | $ | 3,301,338 | $ | 3,323,015 | $ | 3,476,148 | ||||||
LIABILITIES | ||||||||||||
Deposits: | ||||||||||||
Noninterest-bearing | $ | 220,861 | $ | 223,915 | $ | 216,221 | ||||||
Interest-bearing | 2,188,751 | 2,191,148 | 2,077,206 | |||||||||
Total deposits | 2,409,612 | 2,415,063 | 2,293,427 | |||||||||
Advances from FHLB | 497,106 | 508,235 | 565,622 | |||||||||
Other short-term borrowings | 812 | 812 | 181,812 | |||||||||
Long-term debt | 46,392 | 46,392 | 46,392 | |||||||||
Other liabilities | 32,094 | 34,323 | 34,441 | |||||||||
Total liabilities | 2,986,016 | 3,004,825 | 3,121,694 | |||||||||
SHAREHOLDERS' EQUITY | ||||||||||||
Preferred stock, Series A, $.01 par value, authorized 3,000,000 shares, issued 65,000 shares at December 31, 2010, September 30, 2010 and December 31, 2009, respectively (Redemption value $65,000) | 1 | 1 | 1 | |||||||||
Common stock, $.01 par value, authorized 24,000,000 shares, issued 21,465,163 shares at December 31, 2010, September 30, 2010 and December 31, 2009, respectively | 215 | 215 | 214 | |||||||||
Additional paid-in capital | 195,090 | 194,767 | 194,654 | |||||||||
Treasury stock at cost, 4,938,411 shares at December 31, 2010, September 30, 2010 and December 31, 2009 | (103,563 | ) | (103,563 | ) | (103,563 | ) | ||||||
Retained earnings | 221,304 | 221,920 | 259,511 | |||||||||
Accumulated other comprehensive income | 2,275 | 4,850 | 3,637 | |||||||||
Total shareholders' equity | 315,322 | 318,190 | 354,454 | |||||||||
Total liabilities and shareholders' equity | $ | 3,301,338 | $ | 3,323,015 | $ | 3,476,148 |
3
FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Ended | ||||||||
December 31, | ||||||||
(in thousands, except per share data) | 2010 | 2009 | ||||||
INTEREST INCOME | ||||||||
Interest and fees on loans | $ | 36,366 | $ | 40,018 | ||||
Interest and dividends on investments | 5,023 | 6,964 | ||||||
Other | 695 | 1,118 | ||||||
Total interest income | 42,084 | 48,100 | ||||||
INTEREST EXPENSE | ||||||||
Interest on deposits | 7,600 | 8,718 | ||||||
Interest on borrowed money | 4,224 | 6,494 | ||||||
Total interest expense | 11,824 | 15,212 | ||||||
NET INTEREST INCOME | 30,260 | 32,888 | ||||||
Provision for loan losses | 10,483 | 25,327 | ||||||
Net interest income after provision for loan losses | 19,777 | 7,561 | ||||||
NONINTEREST INCOME | ||||||||
Service charges and fees on deposit accounts | 6,278 | 6,300 | ||||||
Insurance | 5,291 | 5,429 | ||||||
Mortgage and other loan income | 2,636 | 2,439 | ||||||
Trust and plan administration | 1,177 | 1,269 | ||||||
Brokerage fees | 514 | 496 | ||||||
Other | 476 | 1,698 | ||||||
Impairment losses on investment securities: | ||||||||
Total other-than-temporary-impairment losses | (534 | ) | (494 | ) | ||||
Less: Noncredit-related losses(gains) recognized in other comprehensive income before taxes | — | — | ||||||
Net impairment losses reconized in earnings | (534 | ) | (494 | ) | ||||
Total noninterest income | 15,838 | 17,137 | ||||||
NONINTEREST EXPENSE | ||||||||
Salaries and employee benefits | 19,287 | 17,780 | ||||||
Occupancy costs | 2,370 | 2,447 | ||||||
Furniture and equipment | 2,003 | 2,139 | ||||||
Real estate owned expenses, net | 1,254 | 1,560 | ||||||
FDIC insurance and regulatory fees | 1,180 | 941 | ||||||
Professional services | 1,567 | 767 | ||||||
Advertising and marketing | 612 | 786 | ||||||
Other loan expense | 773 | 417 | ||||||
Intangible asset amortization | 239 | 243 | ||||||
Other expense | 4,507 | 5,514 | ||||||
Total noninterest expense | 33,792 | 32,594 | ||||||
Income (loss) before income taxes | 1,823 | (7,896 | ) | |||||
Income tax expense (benefit) | 656 | (3,364 | ) | |||||
NET INCOME (LOSS) | $ | 1,167 | $ | (4,532 | ) | |||
Preferred stock dividends | 813 | 813 | ||||||
Accretion on preferred stock discount | 144 | 136 | ||||||
NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS | $ | 210 | $ | (5,481 | ) | |||
Net income (loss) per common share: | ||||||||
Basic | $ | 0.01 | $ | (0.33 | ) | |||
Diluted | $ | 0.01 | $ | (0.33 | ) | |||
Average common shares outstanding: | ||||||||
Basic | 16,527 | 16,464 | ||||||
Diluted | 16,529 | 16,464 |
4
FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
Accumulated | ||||||||||||||||||||||||||||||||||||
Additional | Treasury | Other | ||||||||||||||||||||||||||||||||||
Preferred Stock | Common Stock | Paid-in | Stock | Retained | Comprehensive | |||||||||||||||||||||||||||||||
(In thousands, except per share data) | Shares | Amount | Shares | Amount | Capital | At cost | Earnings | Income | Total | |||||||||||||||||||||||||||
Balance at September 30, 2010 | 65 | $ | 1 | 16,527 | $ | 215 | $ | 194,767 | $ | (103,563 | ) | $ | 221,920 | $ | 4,850 | $ | 318,190 | |||||||||||||||||||
Net income | 1,167 | 1,167 | ||||||||||||||||||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||||||||||||||
Unrealized loss on securities available for sale, net of taxes of $1,641 | (2,575 | ) | (2,575 | ) | ||||||||||||||||||||||||||||||||
Total comprehensive loss | (1,408 | ) | ||||||||||||||||||||||||||||||||||
Stock based compensation expense | 179 | 179 | ||||||||||||||||||||||||||||||||||
Accretion of preferred stock | 144 | (144 | ) | — | ||||||||||||||||||||||||||||||||
Cash dividends: | ||||||||||||||||||||||||||||||||||||
Common stock ($0.05 per share) | (826 | ) | (826 | ) | ||||||||||||||||||||||||||||||||
Preferred stock | (813 | ) | (813 | ) | ||||||||||||||||||||||||||||||||
Balance at December 31, 2010 | 65 | $ | 1 | 16,527 | $ | 215 | $ | 195,090 | $ | (103,563 | ) | $ | 221,304 | $ | 2,275 | $ | 315,322 | |||||||||||||||||||
Balance at September 30, 2009 | 65 | $ | 1 | 15,897 | $ | 208 | $ | 185,249 | $ | (103,563 | ) | $ | 265,821 | $ | 3,933 | $ | 351,649 | |||||||||||||||||||
Net loss | (4,532 | ) | (4,532 | ) | ||||||||||||||||||||||||||||||||
Other comprehensive income: | ||||||||||||||||||||||||||||||||||||
Unrealized loss on securities available for sale, net of taxes of $190 | (296 | ) | (296 | ) | ||||||||||||||||||||||||||||||||
Total comprehensive loss | (4,828 | ) | ||||||||||||||||||||||||||||||||||
Stock based compensation expense | 91 | 91 | ||||||||||||||||||||||||||||||||||
Common stock issued pursuant to public offering | 629 | 6 | 9,178 | 9,184 | ||||||||||||||||||||||||||||||||
Accretion of preferred stock | 136 | (136 | ) | — | ||||||||||||||||||||||||||||||||
Cash dividends: | ||||||||||||||||||||||||||||||||||||
Common stock ($0.05 per share) | (829 | ) | (829 | ) | ||||||||||||||||||||||||||||||||
Preferred stock | (813 | ) | (813 | ) | ||||||||||||||||||||||||||||||||
Balance at December 31, 2009 | 65 | $ | 1 | 16,526 | $ | 214 | $ | 194,654 | $ | (103,563 | ) | $ | 259,511 | $ | 3,637 | $ | 354,454 |
5
FIRST FINANCIAL HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended | ||||||||
December 31, | ||||||||
(in thousands) | 2010 | 2009 | ||||||
Operating Activities | ||||||||
Net income (loss) | $ | 1,167 | $ | (4,532 | ) | |||
Adjustments to reconcile net income to net cash provided by operating activities | ||||||||
Provision for loan losses | 10,483 | 25,327 | ||||||
Depreciation | 1,442 | 1,562 | ||||||
Amortization of intangibles | 239 | 243 | ||||||
Net (increase) decrease in current & deferred income tax | (1,216 | ) | (26,761 | ) | ||||
Amortization of mark-to-market adjustments | (3,020 | ) | (2,584 | ) | ||||
Fair market value of adjustments on Other real estate owned | 1,309 | 1,083 | ||||||
Amortization of unearned (discounts) premiums on investments, net | (721 | ) | (1,084 | ) | ||||
Other-than-temporary impairment losses | 534 | 494 | ||||||
Loans originated for sale | (110,455 | ) | (82,258 | ) | ||||
Proceeds from loans held for sale | 112,365 | 86,110 | ||||||
Gain on sale of loans, net | (2,038 | ) | 376 | |||||
Loss (gain) on sale of real estate owned, net | (141 | ) | 497 | |||||
Loss (gain) on sale on disposal of property and equipment, net | — | (1,276 | ) | |||||
Recognition of stock-based compensation expense | 179 | 86 | ||||||
Decrease in prepaid FDIC insurance premium | 950 | — | ||||||
Other | 7,033 | 5,685 | ||||||
Net cash provided by operating activities | 18,110 | 2,968 | ||||||
Investing Activities | ||||||||
Securities available-for-sale: | ||||||||
Proceeds from sales | 775 | — | ||||||
Proceeds from maturities, calls and payments | 38,678 | 35,953 | ||||||
Purchases | (7,202 | ) | (21,943 | ) | ||||
Redemption (purchase) FHLB stock, net | 1,595 | — | ||||||
Decrease) increase in loans, net | (39,119 | ) | (7,661 | ) | ||||
Proceeds from sales of real estate owned | 2,018 | 4,722 | ||||||
(Decrease) increase in property and equipment, net | (887 | ) | 622 | |||||
Net cash used in investing activities | (4,142 | ) | 11,693 | |||||
Financing Activities | ||||||||
(Decrease) Increase in demand and savings deposits, net | (12,015 | ) | 24,759 | |||||
Increase in time deposits, net | 6,564 | (54,479 | ) | |||||
(Decrease) in short term borrowings, net | — | (77,000 | ) | |||||
Repayments (proceeds) of FHLB advances, net | (11,000 | ) | 72,871 | |||||
Proceeds from Issuance of common stock, net | — | 9,189 | ||||||
Dividends paid on preferred stock | (812 | ) | (813 | ) | ||||
Dividends paid on common stock | (826 | ) | (829 | ) | ||||
Net cash provided by financing activities | (18,089 | ) | (26,302 | ) | ||||
Net (decrease) increase in cash and cash equivalents | (4,121 | ) | (11,641 | ) | ||||
Cash and cash equivalents at beginning of period | 60,547 | 78,070 | ||||||
Cash and cash equivalents at end of period | $ | 56,426 | $ | 66,429 | ||||
Supplemental disclosures: | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 11,907 | $ | 17,097 | ||||
Income taxes | — | 4,045 | ||||||
Loans foreclosed | 10,813 | 5,292 | ||||||
Loans securitized into mortgage-backed securities | 87,075 | 67,263 | ||||||
Unrealized (loss) gain on securities available for sale, net of income tax | (2,575 | ) | (296 | ) |
6
FIRST FINANCIAL HOLDINGS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
December 31, 2010
NOTE 1. Basis of Presentation and Accounting Policies
The accompanying unaudited consolidated financial statements for First Financial Holdings, Inc. (“First Financial”) and its wholly-owned subsidiaries, including its depository institution First Federal Savings and Loan Association of Charleston (“First Federal”), have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended December 31, 2010 are not necessarily indicative of the results that may be expected for the year ending September 30, 2011. Certain amounts have been reclassified to conform with the current year presentation. First Financial’s significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in First Financial’s 2010 Annual Report on Form 10-K. For interim reporting purposes, First Financial follows the same basic accounting policies, as updated by the information contained in this report. For further information, refer to the consolidated financial statements and footnotes included in First Financial’s 2010 Annual Report on Form 10-K.
First Financial has one active wholly owned trust formed for the purpose of issuing securities which qualify as regulatory capital and is considered a Variable Interest Entity (“VIE”). First Financial is not the primary beneficiary, and consequently, the trust is not consolidated in the consolidated financial statements. The trust issued $46.4 million in trust preferred securities to investors in 2004 and there remains $46.4 million outstanding at December 31, 2010. The gross proceeds from the issuance was used to purchase junior subordinated deferrable interest debentures issued by First Financial, which is the sole asset of the trust. The trust preferred securities held by this entity qualifies as Tier 1 capital and is classified as long-term debt on the Consolidated Balance Sheets, with the associated interest expense recorded in interest on borrowed money on the Consolidated Statement of Operations. See Note 6 to the Consolidated Financial Statements for additional information. The expected losses and residual returns for this entity are absorbed by the trust preferred security holders, and consequently First Financial is not exposed to loss related to this VIE.
Recently Adopted Accounting Pronouncements
Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses”
This ASU requires new disclosures and clarifies existing disclosure requirements regarding the nature of credit risk inherent in an entity’s loan portfolio; how that risk is analyzed and assessed in arriving at the allowance for loan losses; and the changes and reasons for those changes in the allowance for loan losses. The FASB’s objective is to improve these disclosures and, thus, increase the transparency in financial reporting, as well as clarify the requirements for existing disclosures. The adoption of ASU 2010-20 was effective for First Financial beginning December 15, 2010 and is included in Note 3 to the Consolidated Financial Statements.
Recently Issued Accounting Pronouncements
FASB ASU 2010-28, “Intangibles-Goodwill and Other (Topic 350) - When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts”
This ASU requires a Step 2 impairment test to be performed even if the carrying amount of goodwill is zero or negative for a reporting unit. Additionally, in considering whether it is more likely than not that an impairment exists, an evaluation must be made to determine whether any adverse qualitative factors exist that require goodwill to be tested for impairment more often than annually if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount. The amended disclosure is effective for fiscal years beginning on or after December 15, 2010, with earlier application prohibited. First Financial does not expect the adoption of ASU 2010-28 to have a material impact on its consolidated financial condition or results of operations.
FASB ASU 2010-29, “Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations”
This ASU requires new pro forma revenue and earnings disclosures for business combinations occurring during the year to be presented as if the business combination occurred as of the beginning of the current fiscal year, or if comparative statements are presented, as if the business combination occurred as of the beginning of the comparative year. In addition, this ASU requires disclosure of the nature and amount of any material nonrecurring adjustments directly attributable to the business combination to be included in the pro forma revenue and earnings. The amended disclosure is effective for business combinations consummated on or after December 15, 2010, with earlier application permitted. First Financial does not expect the adoption of ASU 2010-29 to have a material impact on its consolidated financial condition or results of operations.
7
Note 2. Investment Securities
The following table presents amortized cost, gross unrealized gains and losses, and estimated fair value on investment securities.
As of December 31, 2010 | As of September 30, 2010 | |||||||||||||||||||||||||||||||
(in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||||||||||||||
Obligations of the U.S Government agencies and corporations | $ | 1,966 | $ | 16 | $ | — | $ | 1,982 | $ | 2,021 | $ | 28 | $ | — | $ | 2,049 | ||||||||||||||||
State and municipal obligations | 450 | — | 9 | 441 | 450 | 16 | — | 466 | ||||||||||||||||||||||||
Collateralized debt obligations and corporate securities | 12,536 | 1,281 | 4,351 | 9,466 | 13,589 | 1,326 | 4,699 | 10,216 | ||||||||||||||||||||||||
Mortgage-backed securities | 352,468 | 9,651 | 1,731 | 360,388 | 382,842 | 13,731 | 1,328 | 395,245 | ||||||||||||||||||||||||
Total securities available for sale | $ | 367,420 | $ | 10,948 | $ | 6,091 | $ | 372,277 | $ | 398,902 | $ | 15,101 | $ | 6,027 | $ | 407,976 | ||||||||||||||||
Securities held to maturity | ||||||||||||||||||||||||||||||||
State and municipal obligations | $ | 21,041 | $ | 711 | $ | 164 | $ | 21,588 | $ | 21,623 | $ | 2,350 | $ | 1 | $ | 23,972 | ||||||||||||||||
Certificates of deposit | 907 | — | — | 907 | 906 | — | — | 906 | ||||||||||||||||||||||||
Total securities held to maturity | $ | 21,948 | $ | 711 | $ | 164 | $ | 22,495 | $ | 22,529 | $ | 2,350 | $ | 1 | $ | 24,878 | ||||||||||||||||
Nonmarketable securities - FHLB stock | $ | 41,273 | $ | — | $ | — | $ | 41,273 | $ | 42,867 | $ | — | $ | — | $ | 42,867 |
Securities with a fair market value of $272.2 million at December 31, 2010 and $324.9 million at September 30, 2010 were pledged to secure public deposits, repurchase agreements and other liabilities. Except for obligations of the U.S. Government and its agencies, no holdings of securities for any single issuer exceeded 10% of consolidated shareholders’ equity at December 31, 2010 or September 30, 2010.
The amortized cost and estimated fair value of investment securities by contractual maturity are shown below. Actual maturities may differ from contractual maturities, as borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
As of December 31, 2010 | ||||||||
(in thousands) | Amortized Cost | Fair Value | ||||||
Securities available for sale | ||||||||
Due within one year | $ | 1,478 | $ | 1,478 | ||||
Due after one year through five years | 488 | 504 | ||||||
Due after five years through ten years | 1,007 | 1,039 | ||||||
Due after ten years | 11,979 | 8,868 | ||||||
14,952 | 11,889 | |||||||
Mortgage-backed securities | 352,468 | 360,388 | ||||||
Total | $ | 367,420 | $ | 372,277 | ||||
Securities held to maturity | ||||||||
Due within one year | $ | 800 | $ | 800 | ||||
Due after one year through five years | 107 | 107 | ||||||
Due after ten years | 21,041 | 21,588 | ||||||
Total | $ | 21,948 | $ | 22,495 |
The following table presents gross unrealized losses on investment securities and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.
8
Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||||||||||||||
(dollars in thousands) December 31, 2010 | # | Fair Value | Unrealized Losses | # | Fair Value | Unrealized Losses | # | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||||||||||||||||||
State and municipal obligations | 1 | $ | 441 | $ | 9 | — | $ | — | $ | — | 1 | $ | 441 | $ | 9 | |||||||||||||||||||||
Collateralized debt obligations and corporate securities | — | — | — | 16 | 4,839 | 4,351 | 16 | 4,839 | 4,351 | |||||||||||||||||||||||||||
Mortgage-backed securities | 11 | 29,435 | 307 | 9 | 38,460 | 1,424 | 20 | 67,895 | 1,731 | |||||||||||||||||||||||||||
Total | 12 | $ | 29,876 | $ | 316 | 25 | $ | 43,299 | $ | 5,775 | 37 | $ | 73,175 | $ | 6,091 | |||||||||||||||||||||
Securities held to maturity | ||||||||||||||||||||||||||||||||||||
State and municipal obligations | 11 | $ | 8,686 | $ | 164 | — | $ | — | $ | — | 11 | $ | 8,686 | $ | 164 |
Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||||||||||||||
(dollars in thousands) September 30, 2010 | # | Fair Value | Unrealized Losses | # | Fair Value | Unrealized Losses | # | Fair Value | Unrealized Losses | |||||||||||||||||||||||||||
Securities available for sale | ||||||||||||||||||||||||||||||||||||
Collateralized debt obligations and corporate securities | 1 | $ | 292 | $ | 14 | 16 | $ | 4,784 | $ | 4,685 | 17 | $ | 5,076 | $ | 4,699 | |||||||||||||||||||||
Mortgage-backed securities | 11 | 44,214 | 130 | 9 | 39,852 | 1,198 | 20 | 84,066 | 1,328 | |||||||||||||||||||||||||||
Total | 12 | $ | 44,506 | $ | 144 | 25 | $ | 44,636 | $ | 5,883 | 37 | $ | 89,142 | $ | 6,027 | |||||||||||||||||||||
Securities held to maturity | ||||||||||||||||||||||||||||||||||||
State and municipal obligations | 1 | $ | 769 | $ | 1 | — | $ | — | $ | — | 1 | $ | 769 | $ | 1 |
Other-Than-Temporary Impairment (“OTTI”)
Management evaluates securities for OTTI on at least a quarterly basis. In determining OTTI, the investment securities portfolio is evaluated according to ASC 320-10 and management considers many factors including: (1) the length of time and extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether First Financial has the intent to sell the debt security or more likely than not will be required to sell the debt security before its anticipated recovery. The assessment of whether an OTTI decline exists involves a high degree of subjectivity and is based on information available to management at a point in time. In assessing the recovery of value, the key factors reviewed include the length of time and the extent the fair value has been less than the carrying cost, adverse conditions, if any, specifically related to the security, industry or geographic area, historical and implied volatility of the fair value of the security, credit quality factors affecting the issuer or the underlying collateral, payment structure of the security, payment history of the security, changes to the credit rating of the security, recoveries or declines in value subsequent to the balance sheet date or any other relevant factors. Evaluations are performed on a more frequent basis as the degree to which fair value is below carrying cost or the length of time that the fair value has been continuously below carrying cost increases.
At December 31, 2010, the majority of unrealized losses were related to private-label collateralized mortgage obligations (“CMOs”) and trust preferred collateralized debt obligations (“CDOs”) as discussed below. For the three months ended December 31, 2010, credit-related OTTI of $534 thousand was recorded in net impairment losses recognized in earnings in the Consolidated Statement of Operations. The components of the OTTI were: $256 thousand on private-label mortgage-backed security (“MBS”), and $278 thousand on CDOs. The total securities affected by credit-related OTTI represent less than 1.7% of the investment portfolio and therefore have negligible impact on First Financial’s liquidity and capital positions.
The CMO portfolios, which are mainly comprised of private-label, non-agency securities, were priced using fair value cash flow models considered as Level 3 because of market illiquidity. In making this determination, considerations were given to recent transaction volumes, price quotations and related price variability, available broker information, and market liquidity. Deterioration in value was due, in part, to forced sales and illiquid market conditions in which these securities trade; and accordingly, First Financial does not believe that these values accurately reflect the true fair value of these securities. A pricing model is utilized to estimate each security’s cash flow and adjusted price based on coupon, credit rating, constant prepayment rate, and required yields or spreads. If a private label security is rated below investment grade by a credit rating agency, a stress test is performed to determine if the security has any OTTI. See Note 8 to the Consolidated Financial Statements for additional information on fair value.
9
At December 31, 2010, 19 of the 48 private-label CMO securities had unrealized losses totaling $1.7 million. These private-label CMOs were rated AAA or AA by the major rating agencies at purchase. Additionally, there was one U.S. agency MBS with unrealized losses at December 31, 2010, but this unrealized loss was considered temporary and attributable to market turmoil and reduced liquidity. The following table presents the investment grades and OTTI losses for the CMO securities.
Three Months Ended | ||||||||||||
(in thousands) | December 31, 2010 | December 31, 2010 | ||||||||||
Fair | Unrealized | |||||||||||
Moody/S&P Ratings | Value | Loss | OTTI1 | |||||||||
AAA | $ | 5,899 | $ | 5 | $ | — | ||||||
AA | 19,550 | 231 | — | |||||||||
A | 10,808 | 240 | — | |||||||||
BBB | 2,989 | 237 | — | |||||||||
Below Investment Grade | 28,072 | 975 | 256 | |||||||||
Private label CMOs | 67,318 | 1,688 | 256 | |||||||||
U.S. agency MBS | 577 | 43 | — | |||||||||
Total mortgage-backed securities | $ | 67,895 | $ | 1,731 | $ | 256 | ||||||
1 Recognized in noninterest income |
The OTTI recorded in the first quarter of fiscal 2011 for the CMO category was related to one private-label security with credit-related deterioration evidenced by a credit rating downgrade by Moody’s to Caa3, which is considered to be below investment grade; a twelve-month average loss severity of 52.76%, a twelve-month average constant default rate of 5.58%; and a 60 days or more delinquency rate of 35.24% at December 31, 2010. As of December 31, 2010, management does not intend to sell this security, nor is it more likely than not that it will be required to sell the security before the amortized cost basis is recovered.
CDOs and Corporate Securities
The CDO and corporate securities portfolio is collateralized primarily with trust preferred securities issued by other financial institutions, corporate bonds and other corporate securities. At December 31, 2010, corporate bonds totaled $3.9 million, of which two with a fair value of $1.7 million had unrealized losses totaling $304 thousand and the remaining corporate bonds were not in an unrealized loss position. The majority of the OTTI charges and unrealized losses at December 31, 2010 recorded for this category were in the CDO portfolio. To determine the fair value, cash flow models for trust preferred CDOs provided by a third-party pricing service are utilized. The models estimate default vectors for the underlying issuers within each CDO security, estimate expected bank failures across the entire banking system to determine the impact on each CDO, and assign a risk rating to each individual issuer in the collateral pool. The individual risk ratings for the underlying securities in the pools were determined by a number of factors including Tier 1 capital ratio, return on assets, percent of nonperforming loans, percent of commercial/construction loans and broker deposits for each underlying issuer. The risk ratings were used to determine an expected default vector for each CDO. The model assigns assumptions of constant default rate, loss severity, recovery lags, and prepayment assumptions, which were reviewed for reasonableness and consistency by management. Finally, the resulting projected cash flows were compared to book value to determine the amount of any OTTI.
The following tables provide information regarding the CDO portfolio characteristics and fiscal year-to-date OTTI losses.
10
Collateralized Debt Obligations at December 31, 2010
(in thousands)
YTD Other-Than-Temporary Impairment | ||||||||||||||||||||||||||||
Single/ | Class/ | Amortized | Fair | Unrealized | Credit | |||||||||||||||||||||||
Name | Pooled | Tranche | Cost | Value | Loss (Gain) | Portion | Other | Total | ||||||||||||||||||||
ALESCO I | Pooled | B-1 | $ | 563 | $ | 216 | $ | 347 | $ | 48 | $ | — | $ | 48 | ||||||||||||||
ALESCO II | Pooled | B-1 | 371 | 299 | 72 | — | — | — | ||||||||||||||||||||
MCAP III | Pooled | B | 463 | 221 | 242 | — | — | — | ||||||||||||||||||||
MCAP IX | Pooled | B-1 | 449 | 167 | 282 | — | — | — | ||||||||||||||||||||
MCAP XVIII | Pooled | C-1 | 179 | 104 | 75 | — | — | — | ||||||||||||||||||||
PRETZL XI | Pooled | B-1 | 869 | 331 | 538 | 8 | — | 8 | ||||||||||||||||||||
PRETZL XIII | Pooled | B-1 | 378 | 138 | 240 | 36 | — | 36 | ||||||||||||||||||||
PRETZL IV | Pooled | MEZ | 121 | 54 | 67 | — | — | — | ||||||||||||||||||||
PRETZL VII | Pooled | MEZ | 327 | 116 | 211 | — | — | — | ||||||||||||||||||||
PRETZL XII | Pooled | B-2 | 567 | 278 | 289 | — | — | — | ||||||||||||||||||||
PRETZL XIV | Pooled | B-1 | 716 | 236 | 480 | 154 | — | 154 | ||||||||||||||||||||
PRETZLVI | Pooled | MEZ | 494 | 339 | 155 | 32 | — | 32 | ||||||||||||||||||||
TRPREF II | Pooled | B | 719 | 304 | 415 | — | — | — | ||||||||||||||||||||
USCAP II | Pooled | B-1 | 980 | 346 | 634 | — | — | — | ||||||||||||||||||||
USCAPIII | Pooled | B-1 | 306 | 324 | (18 | ) | — | — | — | |||||||||||||||||||
TOTAL | $ | 7,502 | $ | 3,473 | $ | 4,029 | $ | 278 | $ | — | $ | 278 |
Dollar Basis | ||||||||||||||||||||||
Lowest | % Deferrals / | Constant Default Rate | Discount | |||||||||||||||||||
Name | Rating | % Performing | Defaults2 | High | Low | Margin1 | ||||||||||||||||
ALESCO I | C | 64.63 | % | 35.37 | % | 1.54 | % | 0.21 | % | 11.70 | ||||||||||||
ALESCO II | C | 73.88 | 26.12 | 2.57 | 0.35 | 11.65 | ||||||||||||||||
MCAP III | CC | 67.83 | 32.17 | 0.65 | 0.09 | 12.08 | ||||||||||||||||
MCAP IX | C | 57.05 | 42.95 | 2.18 | 0.29 | 16.80 | ||||||||||||||||
MCAP XVIII | C | 65.52 | 34.48 | 1.64 | 0.22 | 11.05 | ||||||||||||||||
PRETZL XI | C | 70.96 | 29.04 | 1.57 | 0.21 | 11.60 | ||||||||||||||||
PRETZL XIII | C | 68.46 | 31.54 | 1.53 | 0.21 | 11.57 | ||||||||||||||||
PRETZL IV | CC | 72.93 | 27.07 | 4.60 | 0.61 | 12.16 | ||||||||||||||||
PRETZL VII | C | 29.52 | 70.48 | 0.35 | 0.05 | 16.80 | ||||||||||||||||
PRETZL XII | C | 67.31 | 32.69 | 1.65 | 0.22 | 11.62 | ||||||||||||||||
PRETZL XIV | C | 66.27 | 33.73 | 1.18 | 0.16 | 11.57 | ||||||||||||||||
PRETZLVI | D | 19.02 | 80.98 | 4.09 | 0.55 | 11.80 | ||||||||||||||||
TRPREF II | C | 63.72 | 36.28 | 2.86 | 0.38 | 11.92 | ||||||||||||||||
US CAP II | C | 81.29 | 18.71 | 1.34 | 0.18 | 11.65 | ||||||||||||||||
USCAPIII | C | 79.43 | 20.57 | 1.12 | 0.15 | 11.53 | ||||||||||||||||
Total | 65.84 | % | 34.16 | % |
1 Fair market value discount margin to LIBOR
2 Represents percentage of the underlying trust preferred collateral not currently making dividend payments or that have been placed into receivership by the FDIC.
The estimated fair value of these CDOs continues to be depressed due to the impact of interest rates, the unusual credit conditions the financial industry has faced over the last two years, and the weakening economy, which has severely reduced the demand for these securities and rendered their trading market relatively inactive. As of December 31, 2010, management does not intend to sell these securities, nor is it more likely than not that it will be required to sell the securities before the amortized cost basis is recovered.
11
The following table presents the cumulative credit-related losses recognized in earnings.
(in thousands) | CDOs | Corporate Securities | CMOs | Total | ||||||||||||
Cumulative credit related losses recognized in earnings at September 30, 2010 | $ | 5,133 | $ | 1,100 | $ | 1,099 | $ | 7,332 | ||||||||
Additions | ||||||||||||||||
Credit loss for which no previous OTTI recognized | — | — | — | — | ||||||||||||
Credit loss for which previous OTTI recognized | 278 | — | 256 | 534 | ||||||||||||
Reductions | ||||||||||||||||
Increase in cash flows expected to be collected | — | — | — | — | ||||||||||||
Cumulative credit related losses recognized in earnings at December 31, 2010 | $ | 5,411 | $ | 1,100 | $ | 1,355 | $ | 7,866 |
NOTE 3. Loans, Impaired Loans, and Allowance for Loan Losses
The following table presents the loan portfolio by major category.
LOANS (in thousands) | December 31, 2010 | September 30, 2010 | ||||||
Residential loans | ||||||||
Residential 1-4 family | $ | 887,924 | $ | 836,644 | ||||
Residential construction | 15,639 | 14,436 | ||||||
Residential land | 53,772 | 56,344 | ||||||
Total residential loans | 957,335 | 907,424 | ||||||
Commercial loans | ||||||||
Commercial business | 91,129 | 92,650 | ||||||
Commercial real estate | 590,816 | 598,547 | ||||||
Commercial construction | 23,895 | 28,449 | ||||||
Commercial land | 133,899 | 143,366 | ||||||
Total commercial loans | 839,739 | 863,012 | ||||||
Consumer loans | ||||||||
Home equity | 396,010 | 397,632 | ||||||
Manufactured housing | 269,555 | 269,857 | ||||||
Marine | 62,830 | 65,901 | ||||||
Other consumer | 57,898 | 60,522 | ||||||
Total consumer loans | 786,293 | 793,912 | ||||||
Total loans | 2,583,367 | 2,564,348 | ||||||
Less: Allowance for loan losses | 88,349 | 86,871 | ||||||
Net loans | $ | 2,495,018 | $ | 2,477,477 | ||||
Loans held for sale | $ | 28,528 | $ | 28,400 |
12
The following table presents the loan portfolio by age of delinquency.
Age Analysis Past Due Loans
(in thousands) | 30-89 Days Past Due | 90 Days and Greater Past Due | Total Past Due | Current | Total Loans | Recorded Investment > 90 Days and Accruing | ||||||||||||||||||
As of December 31, 2010 | ||||||||||||||||||||||||
Residential loans | ||||||||||||||||||||||||
Residential 1-4 family | $ | 6,712 | $ | 20,371 | $ | 27,083 | $ | 860,841 | $ | 887,924 | $ | — | ||||||||||||
Residential construction | — | — | — | 15,639 | 15,639 | — | ||||||||||||||||||
Residential land | 432 | 4,997 | 5,429 | 48,343 | 53,772 | — | ||||||||||||||||||
Total residential loans | 7,144 | 25,368 | 32,512 | 924,823 | 957,335 | — | ||||||||||||||||||
Commercial loans | ||||||||||||||||||||||||
Commercial business | 3,476 | 9,769 | 13,245 | 77,884 | 91,129 | — | ||||||||||||||||||
Commercial real estate | 10,600 | 57,724 | 68,324 | 522,492 | 590,816 | — | ||||||||||||||||||
Commercial construction | 635 | 4,484 | 5,119 | 18,776 | 23,895 | — | ||||||||||||||||||
Commercial land | 5,348 | 43,824 | 49,172 | 84,727 | 133,899 | — | ||||||||||||||||||
Total commercial loans | 20,059 | 115,801 | 135,860 | 703,879 | 839,739 | — | ||||||||||||||||||
Consumer loans | ||||||||||||||||||||||||
Home equity | 4,355 | 9,450 | 13,805 | 382,205 | 396,010 | — | ||||||||||||||||||
Manufactured housing | 4,043 | 3,609 | 7,652 | 261,903 | 269,555 | — | ||||||||||||||||||
Marine | 707 | 67 | 774 | 62,056 | 62,830 | — | ||||||||||||||||||
Other consumer | 905 | 759 | 1,664 | 56,234 | 57,898 | 204 | ||||||||||||||||||
Total consumer loans | 10,010 | 13,885 | 23,895 | 762,398 | 786,293 | 204 | ||||||||||||||||||
Total loans | $ | 37,213 | $ | 155,054 | $ | 192,267 | $ | 2,391,100 | $ | 2,583,367 | $ | 204 | ||||||||||||
Total loans excluding covered loans | $ | 33,011 | $ | 142,051 | $ | 175,062 | $ | 2,227,251 | $ | 2,402,313 | $ | 204 |
The following table summarizes nonperforming assets.
NONPERFORMING ASSETS (dollars in thousands) | December 31, 2010 | September 30, 2010 | ||||||
Nonaccrual loans | $ | 154,850 | $ | 140,231 | ||||
Loans 90+ days still accruing | 204 | 175 | ||||||
Restructured loans, still accruing | 1,578 | 750 | ||||||
Total nonperforming loans | 156,632 | 141,156 | ||||||
Other repossessed assets acquired | 19,660 | 11,950 | ||||||
Total nonperfoming assets | $ | 176,292 | $ | 153,106 |
On April 10, 2009, First Federal entered into a purchase and assumption agreement with the Federal Deposit Insurance Corporation (“FDIC”) to acquire certain assets and liabilities of Cape Fear Bank. Acquired loans that were performing at the time of acquisition and have subsequently become nonaccrual are included in the table above. These loans totaled $13.7 million at December 31, 2010, compared with $14.7 million at September 30, 2010 and are covered under the “loss-share” agreement with the FDIC. Nonperforming loans acquired at acquisition are not included in the table above as these loans are recorded at fair value.
Impaired Loans
Certain of the nonperforming loans are considered to be impaired. In accordance with Accounting Standards Codification (“ASC”) Topic 310-10-35, a loan is considered impaired when First Federal determines it is probable that the principal and interest due under the original underwriting terms of the loan may not be collected. Criticized and classified commercial loans (as defined in the “Criticized Loans, Classified Loans and Other Risk Characteristics” section below) greater than $500,000 are reviewed for potential impairment as a part of the monthly problem loan review process. In addition, homogeneous loans greater than $200,000 which have been modified are reviewed for potential impairment. Smaller balance homogenous loans, such as consumer secured loans, residential mortgage loans and consumer unsecured loans, are evaluated collectively for potential loss.
13
In assessing the impairment of a loan and the related reserve requirement for that loan, various methodologies are employed. Impairment measurement on loans that are not collateral dependent is determined primarily using the present value of expected future cash flows discounted at the loan’s effective interest rate. With respect to most real estate loans, and specifically if the loan is considered to be a probable foreclosure, an approach that estimates the fair value of the underlying collateral is used. The collateral is appraised to reflect realizable value, with the market value being adjusted for an assessment of marketing cost and the total hold period. Our policy is to update collateral appraisals on impaired loans at least annually, and more frequently if deemed necessary based on market conditions or specific circumstances. Significant downward trends in the real estate market can adversely affect First Federal’s collateral position. For larger credits or loans that are classified “substandard” or worse that rely primarily on real estate collateral, re-appraisal would occur earlier than the stated policy if management believes the market has declined or could have declined and the current appraisal may no longer reflect the current market value of the property. At a minimum, at the time a loan with a principal balance of over $500,000 is downgraded to “substandard” or worse, or if the loan is determined to be impaired, the property securing the loan will be re-appraised to update the value. In addition to updated appraisals, market bids or current offers may be utilized to indicate current value.
First Federal maintains a valuation reserve for impaired loans as a part of the allowance for loan losses. Cash collected on impaired nonaccrual loans is generally applied to outstanding principal. A summary of impaired loans, related valuation reserves, and their effect on interest income is as follows:
14
Impaired Loans and Trouble Debt Restructuring
(in thousands) | Impaired Loans With No Specific Allowance1 | Impaired Loans With Specific Allowance1 | Specific Allowance | Interest Income Recognized | Average Balance2 | |||||||||||||||
December 31, 2010 | ||||||||||||||||||||
Residential loans | ||||||||||||||||||||
Residential 1-4 family | $ | 2,467 | $ | 686 | $ | 169 | $ | 10 | $ | 3,167 | ||||||||||
Residential land | 1,649 | — | — | — | 1,917 | |||||||||||||||
Total residential loans | 4,116 | 686 | 169 | 10 | 5,083 | |||||||||||||||
Commercial loans | ||||||||||||||||||||
Commercial business | 1,483 | 2,741 | 816 | — | 3,454 | |||||||||||||||
Commercial real estate | 21,300 | 20,031 | 3,730 | — | 37,599 | |||||||||||||||
Commercial construction | 1,644 | — | — | — | 3,286 | |||||||||||||||
Commercial land | 15,671 | 20,964 | 8,232 | — | 38,166 | |||||||||||||||
Total commercial loans | 40,098 | 43,736 | 12,778 | — | 82,504 | |||||||||||||||
Consumer loans | ||||||||||||||||||||
Home equity | 334 | — | — | — | 336 | |||||||||||||||
Marine | — | — | — | — | 8 | |||||||||||||||
Total consumer loans | 334 | — | — | — | 344 | |||||||||||||||
Total impaired loans | $ | 44,548 | $ | 44,422 | $ | 12,947 | $ | 10 | $ | 87,931 | ||||||||||
September 30, 2010 | ||||||||||||||||||||
Residential loans | ||||||||||||||||||||
Residential 1-4 family | $ | 2,489 | $ | 691 | $ | 178 | $ | — | ||||||||||||
Residential land | 1,635 | 549 | 77 | — | ||||||||||||||||
Total residential loans | 4,124 | 1,240 | 255 | — | ||||||||||||||||
Commercial loans | ||||||||||||||||||||
Commercial business | 1,578 | 1,106 | 877 | — | ||||||||||||||||
Commercial real estate | 19,154 | 14,712 | 2,925 | — | ||||||||||||||||
Commercial construction | 4,148 | 780 | 343 | — | ||||||||||||||||
Commercial land | 17,412 | 22,284 | 8,674 | — | ||||||||||||||||
Total commercial loans | 42,292 | 38,882 | 12,819 | — | ||||||||||||||||
Consumer loans | ||||||||||||||||||||
Home equity | 338 | — | — | — | ||||||||||||||||
Marine | — | 15 | 3 | — | ||||||||||||||||
Total consumer loans | 338 | 15 | 3 | — | ||||||||||||||||
Total impaired loans | $ | 46,754 | $ | 40,137 | $ | 13,077 | $ | — | $ | 89,311 |
1 Amounts represent the carrying value.
2 Represents the average balance for the quarters presented.
Troubled Debt Restructuring
First Federal accounts for certain loan modifications or restructuring as a troubled debt restructuring (“TDR”). In general, the modification or restructuring of a loan is considered a TDR if, for economic or legal reasons related to a borrower’s financial difficulties, a concession is granted to the borrower that First Federal would not otherwise consider. As of December 31, 2010, First Federal had 23 TDRs with an aggregate balance of $17.5 million classified as impaired and included in the appropriate nonperforming loan category in tables above. In addition, there were two TDRs that were considered performing in accordance with modified terms.
15
Criticized Loans, Classified Loans and Other Risk Characteristics
Federal regulations provide for the designation of lower quality loans as special mention, substandard, doubtful or loss. Loans designated as special mention are considered “criticized” by regulatory definitions and possess characteristics of weakness which may not necessarily manifest into future loss. Loans designated as substandard, doubtful or loss are considered “classified” by regulatory definitions. Substandard loans are inadequately protected by the current net worth, liquidity and paying capacity of the borrower or any collateral pledged and include loans characterized by the distinct possibility that some loss will occur if the deficiencies are not corrected. Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses present make collection or liquidation in full highly questionable and improbable on the basis of currently existing facts, conditions and values. Loans classified as loss are those considered uncollectible and of such little value that their continuance without the establishment of a specific loss reserve is not warranted. When First Federal classifies problem loans as a loss, they are charged-off in the period in which they are deemed uncollectible. First Federal evaluates its loans regularly to determine whether they are appropriately rated in accordance with applicable regulations and internal policies. Additionally, loan classifications and the amount of applicable valuation allowances related to such loans are subject to review by the OTS, which can order changes to classifications and the establishment of additional loan loss allowances if applicable. The following tables present the risk profiles for each loan portfolio by the primary categories monitored.
Commercial Credit Quality1
As of December 31, 2010 | ||||||||||||||||||||
(in thousands) | Commercial Business | Commercial Real Estate | Commercial Construction | Commercial Land | Total Commercial Loans | |||||||||||||||
As of December 31, 2010 | ||||||||||||||||||||
Pass | $ | 60,119 | $ | 407,846 | $ | 10,860 | $ | 37,260 | $ | 516,085 | ||||||||||
Special mention | 6,305 | 53,174 | 2,474 | 20,807 | 82,760 | |||||||||||||||
Substandard | 19,331 | 112,869 | 8,877 | 66,343 | 207,420 | |||||||||||||||
Doubtful | 2,359 | 2,295 | — | 1,158 | 5,812 | |||||||||||||||
Total | 88,114 | 576,184 | 22,211 | 125,568 | 812,077 | |||||||||||||||
Nonperforming covered loans | 3,015 | 14,632 | 1,684 | 8,331 | 27,662 | |||||||||||||||
Total | $ | 91,129 | $ | 590,816 | $ | 23,895 | $ | 133,899 | $ | 839,739 |
1 | Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies. |
Residential Credit Quality1 | As of December 31, 2010 | |||||||||||||||
(in thousands) | Residential 1-4 Family | Residential Construction | Residential Land | Total Residential Loans | ||||||||||||
Performing | $ | 866,808 | $ | 15,639 | $ | 48,775 | $ | 931,222 | ||||||||
Nonperforming | 21,116 | — | 4,997 | 26,113 | ||||||||||||
Total | $ | 887,924 | $ | 15,639 | $ | 53,772 | $ | 957,335 |
1 | Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies. |
Consumer Credit Quality1 | As of December 31, 2010 | |||||||||||||||||||
(in thousands) | Home Equity | Manufactured Housing | Marine | Other Consumer | Total Consumer Loans | |||||||||||||||
Performing | $ | 386,560 | $ | 265,946 | $ | 62,763 | $ | 57,139 | $ | 772,408 | ||||||||||
Nonperforming | 9,450 | 3,609 | 67 | 759 | 13,885 | |||||||||||||||
Total | $ | 396,010 | $ | 269,555 | $ | 62,830 | $ | 57,898 | $ | 786,293 |
1 | Credit quality indicators are reviewed and updated as applicable on an ongoing basis in accordance with credit policies. |
16
A summary of changes in the allowance for loan losses follows.
Allowance for Loan Losses | Three Months Ended | |||||||
(in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Balance, beginning of period | $ | 86,871 | $ | 68,473 | ||||
Provision for loan losses | 10,483 | 25,327 | ||||||
Loan charge-offs | ||||||||
Residential Loans | ||||||||
Residential 1-4 family | 843 | 224 | ||||||
Residential land | 766 | 2,402 | ||||||
Total residential loans | 1,609 | 2,626 | ||||||
Commercial Loans | ||||||||
Commercial business | 369 | 1,178 | ||||||
Commercial real estate | 270 | 1,808 | ||||||
Commercial construction | 317 | 3,124 | ||||||
Commercial land | 2,127 | 7,797 | ||||||
Total commercial loans | 3,083 | 13,907 | ||||||
Consumer Loans | ||||||||
Home equity | 3,163 | 2,451 | ||||||
Manufactured housing | 845 | 787 | ||||||
Marine | 295 | 673 | ||||||
Other consumer | 755 | 944 | ||||||
Total consumer loans | 5,058 | 4,855 | ||||||
Total charge-offs | 9,750 | 21,388 | ||||||
Recoveries | ||||||||
Residential Loans | ||||||||
Residential 1-4 Family | 231 | 165 | ||||||
Residential land | 31 | 621 | ||||||
Total residential loans | 262 | 786 | ||||||
Commercial Loans | ||||||||
Commercial business | 104 | 132 | ||||||
Commercial real estate | 33 | — | ||||||
Commercial construction | 3 | 10 | ||||||
Commercial land | 1 | 1 | ||||||
Total commercial loans | 141 | 143 | ||||||
Consumer Loans | ||||||||
Home equity | 189 | 19 | ||||||
Manufactured housing | 11 | 24 | ||||||
Marine | 111 | 66 | ||||||
Other consumer | 31 | 84 | ||||||
Total consumer loans | 342 | 193 | ||||||
Total recoveries | 745 | 1,122 | ||||||
Net charge-offs | 9,005 | 20,266 | ||||||
Balance, end of period | $ | 88,349 | $ | 73,534 |
17
The following table presents the change in the FDIC indemnification asset during the current fiscal year.
Amount | Net | |||||||||||
(in thousands) | Receivable | Discount | Receivable | |||||||||
Balance at September 30, 2010 | $ | 70,079 | $ | (2,496 | ) | $ | 67,583 | |||||
Payments from FDIC for losses on covered assets | — | — | — | |||||||||
Valuation adjustment on acquired real estate owned | 66 | — | 66 | |||||||||
Accretion discount | — | 677 | 677 | |||||||||
Balance at December 31, 2010 | $ | 70,145 | $ | (1,819 | ) | $ | 68,326 |
The cumulative losses related to the first loss tranche on covered assets at December 31, 2010, were $42.9 million. As of December 31, 2010, the first loss tranche was exceeded by $10.5 million, of which 80% or $8.4 million is recoverable from the FDIC under the loss-share agreement and is included in the FDIC indemnification asset.
NOTE 5. Deposits
The following table presents major deposit categories:
December 31, | September 30, | |||||||
(in thousands) | 2010 | 2010 | ||||||
Deposit accounts: | ||||||||
Noninterest-bearing checking | $ | 220,861 | $ | 223,915 | ||||
Interest-bearing checking | 405,727 | 390,310 | ||||||
Savings | 169,770 | 167,382 | ||||||
Money market | 317,002 | 343,768 | ||||||
Total core deposits | 1,113,360 | 1,125,375 | ||||||
Time deposits: | ||||||||
Retail < $100 thousand | 542,605 | 556,669 | ||||||
Retail >= $100 thousand | 445,755 | 438,031 | ||||||
Total retail certificates of deposit | 988,360 | 994,700 | ||||||
Wholesale certificates of deposit | 307,892 | 294,988 | ||||||
Total time deposits | 1,296,252 | 1,289,688 | ||||||
Total deposits | $ | 2,409,612 | $ | 2,415,063 |
NOTE 6: Borrowings
The following table presents other borrowings and their related average interest rate:
As of December 31, | As of September 30, | |||||||||||||||
(dollars in thousands) | 2010 | 2010 | ||||||||||||||
Balance | Rate | Balance | Rate | |||||||||||||
Advances from FHLB | $ | 497,106 | 2.81 | % | $ | 508,235 | 2.75 | % | ||||||||
Other short-term borrowings | 812 | 4.59 | 812 | 4.59 | ||||||||||||
Long-term debt | 46,392 | 6.79 | 46,392 | 6.79 | ||||||||||||
$ | 544,310 | 3.15 | % | $ | 555,439 | 3.09 | % |
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NOTE 7. Shareholders’ Equity, Accumulated Other Comprehensive Income, and Earnings Per Share
The components of accumulated other comprehensive income, net of tax, are presented below.
Three Months Ended | ||||||||
December 31, | ||||||||
(in thousands) | 2010 | 2009 | ||||||
Balance at beginning of period | $ | 4,850 | $ | 3,933 | ||||
Unrealized losses on securities available for sale | (4,750 | ) | (980 | ) | ||||
Less: Reclassification of other than temporary loss included in income for the period | 534 | 494 | ||||||
Tax benefit | 1,641 | 190 | ||||||
Total comprehensive loss | (2,575 | ) | (296 | ) | ||||
Accumulated other comprehensive income, net of tax | $ | 2,275 | $ | 3,637 |
Basic earnings (loss) per share (“EPS”) are computed based on net income (loss) available to common shareholders as presented in the accompanying Consolidated Statements of Operations divided by the weighted average number of common shares outstanding or assumed to be outstanding as summarized below.
Three months ended December 31, | ||||||||
(in thousands) | 2010 | 2009 | ||||||
Weighted average number of common shares used in basic EPS | 16,527 | 16,464 | ||||||
Effect of dilutive stock options | 2 | — | ||||||
Weighted average number of common shares and dilutive potential common shares used in diluted EPS | 16,529 | 16,464 |
Dilutive common stock equivalents are composed of outstanding stock warrants and options to purchase First Financial common stock. Common stock equivalents are excluded from the computation of dilutive EPS if the result would be anti-dilutive. Inclusion of dilutive common stock equivalents in the diluted EPS calculation will only occur in circumstances where net income is high enough to result in dilution.
At December 31, 2010, and 2009 there were 924,833 and 1,039,495 shares, respectively, subject to issuance upon the exercise of options and a warrant that were excluded from the calculation of diluted earnings per share because the exercise prices were greater than the average market price of the common shares during the quarter or First Financial’s net loss resulted in such shares being anti-dilutive.
NOTE 8. Fair Value of Financial Instruments
Fair value estimates are intended to represent the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Where there is no active market for a financial instrument, First Financial has made estimates using discounted cash flow or other valuation techniques. Inputs to these valuation methods are subjective in nature, involve uncertainties, and require significant judgment and therefore cannot be determined with precision. Accordingly, the derived fair value estimates presented below are not necessarily indicative of the amounts First Financial could realize in a current market exchange.
Assets and liabilities are recorded at fair value according to a fair value hierarchy comprised of three levels. The levels are based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. The level of an asset or liability within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with Level 1 considered highest and Level 3 considered lowest). A brief description of each level follows.
· | Level 1 – Valuation is based on quoted prices for identical instruments in active markets. |
· | Level 2 – Valuation is based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market. |
· | Level 3 – Valuation is generated from model-based techniques that use at least one significant assumption not observable in the market. These unobservable assumptions reflect estimates that market participants would use in pricing the asset or liability. Valuation techniques include the use of discounted cash flow models and similar techniques. |
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The following table presents the carrying value and fair value of the financial instruments.
As of December 31, 2010 | As of September 30, 2010 | |||||||||||||||
(in thousands) | Carrying Value | Fair Value | Carrying Value | Fair Value | ||||||||||||
Financial instruments: | ||||||||||||||||
Assets | ||||||||||||||||
Cash and cash equivalents | $ | 56,426 | $ | 56,426 | $ | 60,547 | $ | 60,547 | ||||||||
Securities available for sale | 372,277 | 372,277 | 407,976 | 407,976 | ||||||||||||
Securities held to maturity | 21,948 | 22,495 | 22,529 | 24,878 | ||||||||||||
Nonmarketable securites - FHLB stock | 41,273 | 41,273 | 42,867 | 42,867 | ||||||||||||
Net loans | 2,495,018 | 2,544,196 | 2,477,477 | 2,550,329 | ||||||||||||
Loans held for sale | 28,528 | 28,528 | 28,400 | 28,400 | ||||||||||||
FDIC indemnification asset, net | 68,326 | 68,326 | 67,583 | 67,583 | ||||||||||||
Residential mortgage servicing rights1 | 12,547 | 12,547 | 10,200 | 10,200 | ||||||||||||
Accrued interest receivable1 | 9,769 | 9,769 | 9,765 | 9,765 | ||||||||||||
Derivative financial instruments1 | (164 | ) | (164 | ) | 2,205 | 2,205 | ||||||||||
Liabilities | ||||||||||||||||
Deposits | 2,409,612 | 2,424,752 | 2,415,063 | 2,436,024 | ||||||||||||
Advances from FHLB | 497,106 | 526,272 | 508,235 | 546,056 | ||||||||||||
Other short-term borrowings | 812 | 1,252 | 812 | 660 | ||||||||||||
Long-term debt | 46,392 | 40,500 | 46,392 | 40,050 | ||||||||||||
Accrued interest payable2 | 11,320 | 11,320 | 11,257 | 11,257 |
1 Included as part of Other Assets in the Consolidated Balance Sheets at December 31, and September 30, 2010.
2 Included as part of Other Liabilities in the Consolidated Balance Sheets at December 31, and September 30, 2010.
The carrying amount approximates fair value for cash and cash equivalents, accrued interest receivable and accrued interest payable. The methods and assumptions used to estimate the fair value for the other financial instruments are set forth below. There were no changes in the valuation methods used to estimate fair value since September 30, 2010.
Securities available for sale
The fair value of available for sale securities that are classified as Level 3 include certain asset-backed securities, private-label mortgage-backed securities and pooled trust preferred securities. In the absence of observable or corroborated market data, internally developed estimates that incorporate market-based assumptions are used when such information is available. These values take into account recent market activity as well as other market observable data such as interest rate, spread and prepayment information. When market observable data is not available, the valuation of the security is subjective and may involve substantial judgment. First Financial’s fair value models incorporate market participant data and knowledge of the structures of each individual security to develop cash flows specific to each security and applying appropriate discount rates. The discount rates are developed by determining credit spreads above a benchmark rate, such as LIBOR, and adding premiums for illiquidity developed based on a comparison of initial issuance spread to LIBOR versus a financial sector curve for recently issued debt to LIBOR. Specific securities that have increased uncertainty regarding the receipt of cash flows are discounted at higher rates due to the addition of a deal specific credit premium. Pricing is reviewed for reasonableness based on the direction of the specific markets and the general economic indicators. To determine the pricing valuation for private-label CMOs, First Financial obtains fair values for similar agency products from third party pricing vendors and determines an economic spread between agency and non-agency products. A pricing model is utilized to estimate each security’s cash flows and adjusted price based on coupon, constant prepayment rate, and required yields or spreads. If a private label security is rated below investment grade by a credit agency, a stress test is performed to determine other-than-temporary impairment.
Securities Held to Maturity
The fair value of securities classified as held to maturity are based on quoted prices for similar assets.
Nonmarketable securities – FHLB stock
The carrying amount of FHLB stock is used to approximate the fair value as this security is not readily marketable, recorded at cost (par value), and evaluated for impairment based on the ultimate recoverability of the par value. First Financial considers positive and negative evidence, include the profitability and asset quality of the issuer, dividend payment history and recent redemption experience, when determining the ultimate recoverability of the par value. First Financial believes its investment in FHLB stock is ultimately recoverable at par.
20
Net loans
The fair value of loans is estimated based on discounted cash flows. The cash flows take into consideration current portfolio interest rates and repricing characteristics as well as assumptions relating to prepayment speeds. The discount rates take into consideration the current market interest rate environment, a credit risk component based on the credit characteristics of each loan portfolio, and a liquidity premium reflecting the liquidity or illiquidity of the market.
Loans held for sale
The fair value of loans held for sale, which are comprised of residential mortgage loans originated for sale in the secondary market, is based on purchase commitments or quoted prices for the same or similar loans and classified as nonrecurring Level 2.
FDIC indemnification asset, net
The fair value is determined by the projected cash flows from the FDIC loss share agreement based on expected reimbursements for losses at the applicable loss sharing percentages based on the terms of the loss share agreement. Cash flows are discounted to reflect the timing and receipt of the loss sharing reimbursements from the FDIC.
Mortgage Servicing Rights
The estimated fair value of mortgage servicing rights are obtained through independent third party evaluations through an analysis of future cash flows, incorporating estimates of assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, including the market’s perception of future interest rate movements and as such, are classified as Level 3..
Derivative Financial Instruments
Fair value of the derivative instruments is based on quoted market prices.
Deposits
The fair value of core deposits are, by definition, equal to the amount payable on demand as of the valuation date (i.e. their carrying amounts). Fair values for time deposits are based on the discounted value of contractual cash flows at current interest rates. The estimated fair value of deposits does not take into account the value of First Financial’s long-term relationships with depositors, commonly known as core deposit intangibles, which are separate intangible assets, and not considered financial instruments.
Advances from FHLB, Other short-term borrowings, and Long-term debt
The fair value of these financial instruments is estimated using observable market prices and by discounting future cash flows using current interest rates for similar financial instruments.
Fair Values of Level 3 Assets and Liabilities
For the quarter ended December 31, 2010, assets classified as Level 3 had $534 thousand in impairment losses on certain securities that were considered OTTI. Some of the securities are currently paying interest but are not projected to completely repay principal. The break in principal is based on cash flow projections which were modeled using a third party program. At December 31, 2010, management has reviewed the loss severity and duration of the Level 3 securities and has determined it has the ability and intent to hold these securities until the unrealized loss is recovered.
At December 31, 2010, First Financial had $339.2 million, or 10.3% of total assets, valued at fair value that is considered Level 3 valuations on a recurring basis using unobservable inputs.
The following table presents the financial instruments measured at fair value on a recurring basis, on the Consolidated Balance Sheets utilizing the hierarchy discussed on the previous pages:
21
As of December 31, 2010 | ||||||||||||||||
(in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||
Obligations of the U.S. government agencies and corporations | $ | — | $ | 1,982 | $ | — | $ | 1,982 | ||||||||
State and municipal obligations | — | 441 | — | 441 | ||||||||||||
Collateralized debt obligations and corporate securites | 1,000 | 1,533 | 6,933 | 9,466 | ||||||||||||
Mortgage-backed securities | — | 69,032 | 291,356 | 360,388 | ||||||||||||
Securities available for sale | 1,000 | 72,988 | 298,289 | 372,277 | ||||||||||||
Residential mortgage servicing rights | — | — | 12,547 | 12,547 | ||||||||||||
Derivative financial instruments | (164 | ) | — | — | (164 | ) | ||||||||||
Total assets at fair value | $ | 836 | $ | 72,988 | $ | 310,836 | $ | 384,660 |
Changes in Fair Value Measurement Levels
The table below includes changes in Level 3 fair value measurements based on the hierarchy levels previously discussed. The gains (losses) in the following table may include changes to fair value due in part to observable factors that may be part of the valuation methodology.
Level 3 | ||||||||
Residential | ||||||||
Securities | Mortgage | |||||||
Available For | Servicing | |||||||
(in thousands) | Sale | Rights | ||||||
Balance at September 30, 2010 | $ | 326,668 | $ | 10,200 | ||||
Total net (losses) gains for the year included in: | ||||||||
Income | (534 | ) | 937 | |||||
Other comprehensive income, gross | (3,171 | ) | — | |||||
Purchases, sales or settlements, net | (24,674 | ) | 1,410 | |||||
Transfer in and/or (out) of Level 3 | — | — | ||||||
Balance at December 31, 2010 | $ | 298,289 | $ | 12,547 |
Assets Recorded at Fair Value on a Nonrecurring Basis
The table below presents the assets measured at fair value on a nonrecurring basis categorized by the level of inputs used in the valuation of each asset and the corresponding realized loss.
Quoted Prices in | Significant Other | Significant | ||||||||||||||||||
As of | Active Markets for | Observable | Unobservable | |||||||||||||||||
December 31, | Identical Assets | Inputs | Inputs | YTD | ||||||||||||||||
(in thousands) | 2010 | (Level 1) | (Level 2) | (Level 3) | Losses | |||||||||||||||
Mortgage loans held for sale | $ | 28,528 | $ | — | $ | 28,528 | $ | — | $ | — | ||||||||||
Impaired loans, net of specific allowance | 76,023 | — | — | 76,023 | (2,637 | ) | ||||||||||||||
Other repossessed assets acquired | 19,660 | — | — | 19,660 | (2,299 | ) | ||||||||||||||
Total nonrecurring basis measured assets | $ | 124,211 | $ | — | $ | 28,528 | $ | 95,683 | $ | (4,936 | ) |
Mortgage loans held for sale are recorded at the lower of aggregate cost or fair value. Fair value is generally based on quoted market prices of similar loans and is considered to be Level 2 in the fair value hierarchy.
Impaired loans are evaluated and valued at the time the loan is identified as impaired, at the lower of cost or fair value. These loans are generally collateral dependent and their value is measured based on the value of the collateral securing these loans and are classified at a Level 3 in the fair value hierarchy. Specific reserves for impaired loans were $12.9 million at December 31, 2010.
Real estate and other repossessed assets acquired in settlement of loans are recorded at the lower of the principal balance of the loan or fair value of the property less estimated selling expenses. Fair value is generally based on appraisals of the real estate or market prices for similar non-real estate property and is considered to be Level 3 in the fair value hierarchy.
22
NOTE 9. Income Tax
The income tax provision for the three months ended December 31, 2010 was $656 thousand, compared with a benefit of $3.4 million for the same period of the prior year. The effective tax rate for the three months ended December 31, 2010 was 36.0%, compared to 42.6% for the same period of the prior year. The decrease in the effective tax rate was primarily the result of recording net income instead of net loss, as there were no significant changes to tax-exempt income or temporary tax differences.
NOTE 10. Share-Based Payment Arrangements
First Financial has two share-based compensation plans authorizing the granting of qualified and nonqualified stock options, restricted stock awards, stock appreciation rights, and non-qualified share options to employees and non-employee directors as well as performance awards to non-employee directors. As of December 31, 2010, aggregate shares available for future issuance under the current shareholder approved plans may not exceed 1,289,276. This total includes 338,455 shares still outstanding from previous plans from which no new grants may be issued. At December 31, 2010, First Financial had 525,555 shares related to option and stock appreciation rights and 225,000 shares related to restricted stock awards available for grant.
Stock options currently granted under the plan generally expire five years from the date of grant. Restrictions on non-vested stock generally lapse in three annual installments beginning on the first anniversary of the grant date. Forfeited and expired options become available for future grants.
Compensation expense for stock options is recognized in salaries and employee benefits on the face of the Consolidated Statements of Operations based on the fair value at the date of grant and is recognized on a straight line basis over the requisite service period of the awards. For the three months ended December 31, 2010, First Financial recorded a net share-based compensation expense of $151 thousand, as compared with an expense of $91 thousand for the same period of the prior year. First Financial recognized an income tax benefit of less than $100 thousand during the three months ended December 31, 2010 and 2009, respectively.
A summary of stock option activity is presented below:
Weighted- | ||||||||||||||||
Average | ||||||||||||||||
Weighted- | Remaining | Aggregate | ||||||||||||||
Average | Contractual | Intrinsic | ||||||||||||||
Number of | Exercise | Term | Value | |||||||||||||
Shares | Price ($) | (Years) | $(000) | |||||||||||||
Outstanding at September 30, 2010 | 720,851 | 24.63 | ||||||||||||||
Granted | - | 0.00 | ||||||||||||||
Exercised | - | 0.00 | ||||||||||||||
Forfeited or expired | (37,714 | ) | 26.54 | |||||||||||||
Outstanding at December 31, 2010 | 683,137 | 24.53 | 2.6 | (396 | ) | |||||||||||
Exercisable at December 31, 2010 | 527,281 | 26.83 | 2.3 | (412 | ) |
As of December 31, 2010, there was $730 thousand of total unrecognized compensation cost related to non-vested share-based compensation arrangements (share options) granted under the plans.
NOTE 11. Commitments and Contingencies
Loan Commitments
Outstanding commitments on mortgage loans not yet closed, including commitments issued to correspondent lenders, amounted to $23.3 million at December 31, 2010. These were principally commitments for loans on single-family residential and commercial property loan commitments. Outstanding undisbursed closed mortgage construction loans, primarily consisting of permanent residential construction, and commercial property construction, amounted to $30.7 million at December 31, 2010. In addition, at that date First Financial had undisbursed closed mortgage loans of $1.5 million and undisbursed non-mortgage closed loans of $15.9 million. Other loan commitments to originate non-mortgage loans totaled $135 thousand at December 31, 2010.
23
Commitments to extend credit are agreements to lend to borrowers as long as there is no violation of any condition established by the commitment letter. Commitments generally have fixed expiration dates or other termination clauses. The majority of the commitments will be funded within a 12 month period. We evaluate each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies but primarily consists of residential or income producing commercial properties. Unused lines of credit on equity loans, credit cards, other consumer and commercial loans and standby letters of credit were $378.5 million at December 31, 2010.
Guarantees
Standby letters of credit represent our obligations to a third party contingent upon the failure of our customer to perform under the terms of an underlying contract with the third party or obligate us to guarantee or stand as surety for the benefit of the third party. The underlying contract may entail either financial or non-financial obligations and may involve such things as the customer’s delivery of merchandise, completion of a construction contract, release of a lien, or repayment of an obligation. Under the terms of a standby letter, drafts will generally be drawn only when the underlying event fails to occur as intended. We can seek recovery of the amounts paid from the borrower. In addition, some of these standby letters of credit are collateralized. Commitments under standby letters of credit are usually for one year or less. As of December 31, 2010, there is no current liability associated with these standby letters of credit. The maximum potential amount of undiscounted future payments related to standby letters of credit at December 31, 2010, was $1.1 million.
Derivative Instruments
We use derivatives as part of our interest rate management activities. We do not elect hedge accounting treatment for any of our derivative transactions; consequently, all changes in the fair value of derivative instruments are recorded as noninterest income in the Consolidated Statements of Operations.
As part of our risk management strategy in the mortgage banking area, various derivative instruments such as interest rate lock commitments and forward sales contracts are utilized. Rate lock commitments are residential mortgage loan commitments with customers, which guarantee a specified interest rate for a specified period of time. Forward contracts are agreements to purchase or sell loans, securities or other money market instruments at a future specified date at a specified price or yield. First Federal’s obligations under forward contracts consist of commitments to deliver mortgage loans in the secondary market at a future date and commitments to sell “to be issued” MBS. The commitments to originate fixed rate conforming loans totaled $45.9 million at December 31, 2010. It is anticipated that approximately 80% of these loans will close totaling $36.6 million. The fair value of this $36.6 million represents a liability, which totaled $728 thousand at December 31, 2010. The off-balance sheet obligations under the above derivative instruments totaled $88.6 million at December 31, 2010. The fair value of this $88.6 million represented an asset, which totaled $357 thousand as of December 31, 2010.
First Federal utilizes derivative instruments, such as future contracts and exchange-traded option contracts to achieve a fair value return that would substantially offset the changes in fair value of MSRs attributable to interest rates. Changes in the fair value of these derivative instruments are recorded net in noninterest income in loan servicing operations, and are offset by the changes in the fair value of the MSRs. During the three months ended December 31, 2010, gross MSRs values increased $937 thousand due to positive interest rate movements, while hedge loss totaled $1.7 million. The notional value of our off-balance sheet positions as of December 31, 2010, totaled $49 million with a fair value of a liability of $418 thousand.
NOTE 12. Business Segments
First Financial has two principal operating segments, banking and insurance, which are evaluated regularly by management and the Board of Directors in deciding how to allocate resources and assess performance. Selected financial information is presented below. There are no significant intersegment revenues.
24
Three Months ended December 31, 2010 (in thousands) | Banking | Insurance | Other | Total | ||||||||||||
Interest income | $ | 42,068 | $ | 20 | $ | (4 | ) | $ | 42,084 | |||||||
Interest expense | 11,082 | — | 742 | 11,824 | ||||||||||||
Net interest income | 30,986 | 20 | (746 | ) | 30,260 | |||||||||||
Provision for loan losses | 10,483 | — | — | 10,483 | ||||||||||||
Net interest income after provision for loan losses | 20,503 | 20 | (746 | ) | 19,777 | |||||||||||
Noninterest income | 10,155 | 5,304 | 379 | 15,838 | ||||||||||||
Noninterest expense | 26,918 | 5,323 | 1,551 | 33,792 | ||||||||||||
Income (loss) before income taxes | 3,740 | 1 | (1,918 | ) | 1,823 | |||||||||||
Income tax expense (benefit) | 1,334 | - | (678 | ) | 656 | |||||||||||
Net income (loss) | $ | 2,406 | $ | 1 | $ | (1,240 | ) | $ | 1,167 | |||||||
Total assets, as of December 31, 2010 | $ | 3,252,068 | $ | 48,104 | $ | 1,166 | $ | 3,301,338 | ||||||||
Three Months ended December 31, 2009 (in thousands) | Banking | Insurance | Other | Total | ||||||||||||
Interest income | $ | 48,084 | $ | 19 | $ | (3 | ) | $ | 48,100 | |||||||
Interest expense | 14,285 | 131 | 796 | 15,212 | ||||||||||||
Net interest income | 33,799 | (112 | ) | (799 | ) | 32,888 | ||||||||||
Provision for loan losses | 25,327 | — | — | 25,327 | ||||||||||||
Net interest income after provision for loan losses | 8,472 | (112 | ) | (799 | ) | 7,561 | ||||||||||
Noninterest income | 11,353 | 5,427 | 357 | 17,137 | ||||||||||||
Noninterest expense | 26,338 | 5,296 | 960 | 32,594 | ||||||||||||
(Loss) income before income taxes | (6,513 | ) | 19 | (1,402 | ) | (7,896 | ) | |||||||||
Income tax (benefit) expense | (2,897 | ) | 5 | (472 | ) | (3,364 | ) | |||||||||
Net (loss) income | $ | (3,616 | ) | $ | 14 | $ | (930 | ) | $ | (4,532 | ) | |||||
Total assets, as of December 31, 2009 | $ | 3,424,367 | $ | 53,549 | $ | (1,768 | ) | $ | 3,476,148 |
25
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Five Quarter Summary of Selected Financial Data | ||||||||||||||||||||
Three months ended | ||||||||||||||||||||
(dollars in thousands, except per share data) | December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | |||||||||||||||
Summary of Operations | ||||||||||||||||||||
Interest income | $ | 42,084 | $ | 43,124 | $ | 44,281 | $ | 45,416 | $ | 48,100 | ||||||||||
Interest expense | 11,824 | 12,274 | 13,052 | 13,920 | 15,212 | |||||||||||||||
Net interest income | 30,260 | 30,850 | 31,229 | 31,496 | 32,888 | |||||||||||||||
Provision for loan losses | 10,483 | 17,579 | 36,373 | 45,915 | 25,327 | |||||||||||||||
Net interest income after provision for loan losses | 19,777 | 13,271 | (5,144 | ) | (14,419 | ) | 7,561 | |||||||||||||
Noninterest income | 15,838 | 19,059 | 18,705 | 16,363 | 17,137 | |||||||||||||||
Noninterest expense | 33,792 | 34,717 | 33,103 | 33,296 | 32,594 | |||||||||||||||
Income (loss) before income tax | 1,823 | (2,387 | ) | (19,542 | ) | (31,352 | ) | (7,896 | ) | |||||||||||
Income tax expense (benefit) | 656 | (1,215 | ) | (7,513 | ) | (12,296 | ) | (3,364 | ) | |||||||||||
Net income (loss) | 1,167 | (1,172 | ) | (12,029 | ) | (19,056 | ) | (4,532 | ) | |||||||||||
Preferred stock dividends | 813 | 813 | 813 | 813 | 813 | |||||||||||||||
Accretion on preferred stock | 144 | 142 | 140 | 138 | 136 | |||||||||||||||
Net income (loss) available to common shareholders | $ | 210 | $ | (2,127 | ) | $ | (12,982 | ) | $ | (20,007 | ) | $ | (5,481 | ) | ||||||
Per Common Share Data | ||||||||||||||||||||
Net income (loss) per common share: | ||||||||||||||||||||
Basic | $ | 0.01 | $ | (0.13 | ) | $ | (0.79 | ) | $ | (1.21 | ) | $ | (0.33 | ) | ||||||
Diluted | 0.01 | (0.13 | ) | (0.79 | ) | (1.21 | ) | (0.33 | ) | |||||||||||
Market price, end of period | 11.51 | 11.14 | 11.45 | 15.06 | 13.00 | |||||||||||||||
Book value per common share | 15.15 | 15.32 | 15.66 | 16.34 | 17.52 | |||||||||||||||
Tangible book value per common share (non-GAAP)1 | 12.86 | 13.02 | 13.34 | 14.02 | 15.19 | |||||||||||||||
Dividends | 0.05 | 0.05 | 0.05 | 0.05 | 0.05 | |||||||||||||||
Shares outstanding, end of period | 16,527 | 16,527 | 16,527 | 16,527 | 16,526 | |||||||||||||||
Balance Sheet Summary, at period end | ||||||||||||||||||||
Assets | $ | 3,301,338 | $ | 3,323,015 | $ | 3,324,344 | $ | 3,380,867 | $ | 3,476,148 | ||||||||||
Investment securities | 435,498 | 473,372 | 482,270 | 515,051 | 547,390 | |||||||||||||||
Loans | 2,583,367 | 2,564,348 | 2,590,819 | 2,612,215 | 2,644,202 | |||||||||||||||
Allowance for loan losses | 88,349 | 86,871 | 86,945 | 82,731 | 73,534 | |||||||||||||||
Deposits | 2,409,612 | 2,415,063 | 2,463,657 | 2,454,030 | 2,293,427 | |||||||||||||||
Advances from FHLB, other short-term borrowings and long-term debt | 544,310 | 555,439 | 525,569 | 577,697 | 793,826 | |||||||||||||||
Shareholders’ equity | 315,322 | 318,190 | 323,797 | 335,001 | 354,454 | |||||||||||||||
Balance Sheet Summary, average for the quarter | ||||||||||||||||||||
Assets | $ | 3,323,825 | $ | 3,316,098 | $ | 3,358,635 | $ | 3,429,172 | $ | 3,487,674 | ||||||||||
Investment securities | 452,900 | 457,363 | 494,171 | 531,571 | 549,827 | |||||||||||||||
Loans | 2,614,918 | 2,602,059 | 2,617,584 | 2,645,741 | 2,684,929 | |||||||||||||||
Allowance for loan losses | 87,605 | 86,994 | 84,665 | 76,938 | 71,972 | |||||||||||||||
Deposits | 2,424,807 | 2,450,148 | 2,466,284 | 2,334,035 | 2,312,129 | |||||||||||||||
Advances from FHLB, other short-term borrowings and long-term debt | 543,039 | 519,619 | 547,729 | 739,502 | 763,637 | |||||||||||||||
Shareholders’ equity | 318,202 | 321,379 | 330,829 | 346,194 | 356,897 | |||||||||||||||
Selected Ratios | ||||||||||||||||||||
Return on average assets | 0.04 | % | (0.14 | %) | (1.43 | %) | (2.22 | %) | (0.52 | %) | ||||||||||
Return on average equity | 0.37 | (1.46 | ) | (14.54 | ) | (22.02 | ) | (5.08 | ) | |||||||||||
Net interest margin (FTE)2 | 3.83 | 3.91 | 3.94 | 3.94 | 3.96 | |||||||||||||||
Efficiency ratio (non-GAAP)1 | 72.22 | 69.04 | 65.69 | 66.83 | 64.29 | |||||||||||||||
Asset Quality Ratios | ||||||||||||||||||||
Allowance for loan losses as a percent of loans | 3.42 | % | 3.39 | % | 3.36 | % | 3.17 | % | 2.78 | % | ||||||||||
Allowance for loan losses as a percent of nonperforming loans | 56.41 | 61.54 | 65.75 | 60.94 | 67.55 | |||||||||||||||
Nonperforming loans as a percent of loans | 6.06 | 5.51 | 5.10 | 5.20 | 4.12 | |||||||||||||||
Nonperforming assets as a percent of loans and other repossessed assets aquired | 6.77 | 5.94 | 5.56 | 5.63 | 4.87 | |||||||||||||||
Nonperforming assets as a percent of total assets | 5.34 | 4.61 | 4.35 | 4.37 | 3.73 | |||||||||||||||
Net loans charged-off as a percent of average loans | 1.38 | 2.71 | 4.91 | 5.55 | 3.02 | |||||||||||||||
Net loans charged-off (000) | $ | 9,005 | $ | 17,652 | $ | 32,159 | $ | 36,718 | $ | 20,266 | ||||||||||
Capital Ratios | ||||||||||||||||||||
Equity to assets | 9.55 | % | 9.58 | % | 9.74 | % | 9.91 | % | 10.20 | % | ||||||||||
Tangible common equity to tangible assets (non-GAAP)1 | 6.51 | 6.55 | 6.71 | 6.93 | 7.30 | |||||||||||||||
Dividend payout ratio | ||||||||||||||||||||
Leverage capital ratio3 | 8.58 | 8.47 | 8.46 | 7.74 | 7.67 | |||||||||||||||
Tier 1 risk-based capital ratio3 | 11.42 | 11.27 | 11.19 | 9.83 | 9.78 | |||||||||||||||
Total risk-based capital ratio3 | 12.69 | 12.55 | 12.46 | 11.10 | 11.05 |
1 | See Item 2. Management's Discussion and Anaylsis of Financial Condition and Results of Operations - Use of Non-GAAP Financial Measures |
2 | Net interest margin includes taxable equivalent adjustments to interest income based on a federal tax rate of 35%. |
3 | Calculated for First Federal |
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The following presents management’s discussion and analysis of First Financial Holdings, Inc. (“First Financial”) and its wholly-owned subsidiaries, including its depository institution, First Federal Savings and Loan Association of Charleston (“First Federal”) with regard to their financial condition and results of operations for the three months ended December 31, 2010. It should be read in conjunction with the unaudited Consolidated Financial Statements and Notes included elsewhere in this report and the audited Consolidated Financial Statements and Notes contained in First Financial’s 2010 Annual Report on Form 10-K. In addition, the following discussion and analysis should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in First Financial’s 2010 Annual Report on Form 10-K, which contains important additional information that is necessary to understand First Financial and its financial condition and results of operations for the periods covered by this report.
All of First Financial’s electronic filings with the Securities and Exchange Commission (SEC”), including the Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other documents filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, are accessible at no cost on First Financial’s website, www.firstfinancialholdings.com. The information on the website does not constitute a part of this report. First Financial’s filings are also available through the SEC’s website at www.sec.gov.
Forward-Looking Statements
Statements in this report that are not statements of historical fact, including without limitation, statements that include terms such as “believes,” “expects,” “anticipates,” “estimates,” “forecasts,” “intends,” “plans,” “targets,” “potentially,” “probably,” “projects,” “outlook,” or similar expressions or future conditional verbs such as “may,” “will,” “should,” “would,” or “could” constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements regarding First Financial’s future financial and operating results, plans, objectives, expectations and intentions involve risks and uncertainties, many of which are beyond First Financial’s control or are subject to change. No forward-looking statement is a guarantee of future performance and actual results could differ materially. Factors that could cause or contribute to such differences include, but are not limited to:
· | A large portion of First Financial’s loan portfolio is secured by residential and commercial real estate. Continued deterioration in residential and commercial real estate values could lead to additional losses, which may cause First Financial’s net income to decline and could have a negative impact on its capital, financial condition, and results of operations. |
· | Repayment of First Financial’s commercial loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value. |
· | First Financial’s allowance for loan losses may not be sufficient to absorb losses in its loan portfolio. Additions to the allowance for loan losses may be required by increasing the provision for loan losses, which would cause net income to decline and could have a negative impact on First Financial’s capital and financial position. |
· | The current economic conditions in the nation and the market areas First Financial serves may continue to adversely impact First Financial’s earnings and could increase credit risk associated with its loan portfolios. |
· | While First Financial attempts to manage the risk from changes in market interest rates, interest rate risk management techniques are not exact and a rapid or substantial increase or decrease in interest rates could adversely affect net interest income and results of operations. |
· | First Financial is highly dependent on key members of its senior management team, which has changed significantly during the past year, and there is risk that it will not be able to develop a cohesive and unified management team. |
· | Further economic downturns may adversely affect First Financial’s investment securities portfolio and profitability. |
· | If First Financial is unable to continue to attract or retain core deposits, to obtain third party borrowings on favorable terms, or to have access to interbank or other liquidity sources, its cost of funds will increase, adversely affecting its ability to generate funds necessary for lending operations, reducing net interest margin and negatively affecting results of operations. |
· | A general decline in economic conditions and volatility or decline in premiums or claims associated with catastrophic events may adversely affect the revenues of First Financial’s insurance segment. |
· | Economic and other circumstances may require First Financial to raise capital at times or in amounts that are unfavorable. |
· | First Financial’s participation in the Troubled Asset Relief Program Capital Purchase Program and other government regulations impose restrictions and obligations that limit its ability to pay or increase dividends, repurchase shares of preferred or common stock, and access the equity capital markets. |
· | If First Financial is unable to redeem its Series A Preferred Stock within five years from the issuance date, the cost of this capital will increase substantially. |
· | First Financial is subject to extensive governmental regulation, which could have an adverse impact on its operations. |
· | Financial reform legislation recently enacted by the U.S. Congress will, among other things, eliminate the Office of Thrift Supervision, tighten capital standards, create a new Bureau of Consumer Financial Protection and result in new laws and regulations that are expected to increase First Financial’s costs of operations. |
· | Increased competition with other financial institutions may have an adverse effect on First Financial’s ability to retain and grow its client base, which could have a negative effect on financial condition and results of operations. |
· | First Financial may be adversely affected by the soundness of other financial institutions. |
· | If First Financial’s goodwill becomes impaired, it may need to record an impairment charge, which could negatively affect results of operations and capital. |
27
· | First Financial’s potential inability to integrate companies it may acquire in the future could expose it to financial, execution, and operational risks that could negatively affect its financial condition and results of operations. Acquisitions may be dilutive to common shareholders and Federal Deposit Insurance Corporation (“FDIC”)-assisted transactions have additional compliance risk that other acquisitions do not have. |
· | If the FDIC changes its assessment rate or deposit insurance premium methodology, First Financial’s FDIC insurance premium may increase and this could have a negative effect on financial condition or results of operations. |
· | First Financial is party to various lawsuits incidental to its business. Litigation is subject to many uncertainties such that the expenses and ultimate exposure with respect to many of these matters cannot be ascertained. |
· | First Financial’s business continuity plans or data security systems could prove to be inadequate, resulting in a material interruption in, or disruption to, business and a negative impact on results of operations. |
· | First Financial’s controls and procedures may fail or be circumvented, which could have a material adverse effect on business, results of operations, and financial condition. |
· | The price of First Financial’s common stock may fluctuate significantly, and this may make it difficult for investors to resell their common stock when they want or at prices they find attractive. |
· | Anti-takeover provisions could negatively impact First Financial shareholders. |
These factors also include risks and uncertainties detailed from time to time in First Financial’s other filings with the SEC, such as the risk factors listed in “Item 1A. Risk Factors,” of First Financial’s 2010 Annual Report on Form 10-K and subsequent Forms 10-Q (including this Form 10-Q). Other factors not currently anticipated may also materially and adversely affect First Financial’s results of operations, cash flows, and financial condition. There can be no assurance that future results will meet expectations. While First Financial believes that the forward-looking statements in this report are reasonable, the reader should not place undue reliance on any forward-looking statement. In addition, these statements speak only as of the date made. First Financial does not undertake, and expressly disclaims any obligation to update or alter any statements, whether as a result of new information, future events or otherwise, except as required by applicable law.
Critical Accounting Policies
First Financial’s Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) and follow general practices within the financial institutions industry. Application of these principles requires management to make estimates, assumptions, and complex judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements. Accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Actual results could differ significantly from these estimates. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses, goodwill, fair value measurements, and income taxes. First Financial believes that these estimates and the related policies discussed below are important to the portrayal of its financial condition and results of operations. Therefore, management considers them to be critical accounting policies and discusses them directly with the Audit Committee of the Board of Directors. First Financial’s accounting policies are more fully described in Note 1 to the Consolidated Financial Statements contained in First Financial’s 2010 Annual Report on Form 10-K and the more significant assumptions and estimates made by management are more fully described in “Management’s Discussion and Results of Operations – Critical Accounting Policies” in First Financial’s 2010 Annual Report on Form 10-K. For additional information regarding updates during fiscal 2011, see Note 1 to the Consolidated Financial Statements in this report.
Use of Non-GAAP Financial Measures
In addition to results presented in accordance with GAAP, this report includes non-GAAP financial measures such as the efficiency ratio, tangible common equity to tangible assets ratio, and tangible common book value. We believe these non-GAAP financial measures provide additional information that is useful to investors in understanding our underlying performance, our business, and performance trends and such measures help facilitate performance comparisons with others in the banking industry. Non-GAAP measures have inherent limitations, are not required to be uniformly applied and are not audited. Readers should be aware of these limitations and should be cautious to their use of such measures. To mitigate these limitations, we have procedures in place to ensure that these measures are calculated using the appropriate GAAP or regulatory components in their entirety and to ensure that our performance is properly reflected to facilitate consistent period-to-period comparisons. Although we believe the above non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP measures should not be considered in isolation, or as a substitute for GAAP basis financial measures.
First Financial believes that the exclusion of goodwill and other intangible assets facilitates the comparison of results for ongoing business operations. The tangible common equity (“TCE”) ratio and tangible common book value (“TBV”) have become a focus of some investors, analysts and banking regulators. Management believes these measures may assist in analyzing First Financial’s capital position absent the effects of intangible assets and preferred stock. Because TCE and TBV are not formally defined by GAAP or codified in the federal banking regulations, these measures are considered to be non-GAAP financial measures. However, analysts and banking regulators may assess First Financial’s capital adequacy using TCE or TBV, therefore, management believes that it is useful to provide investors the ability to assess its capital adequacy on the same basis.
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The efficiency ratio measures the amount of revenue (defined as the sum of net interest income on a fully tax-equivalent basis and noninterest income) is needed to cover noninterest expenses. In accordance with industry standards, the presentation of net interest margin on a taxable equivalent basis using a 35% effective federal tax rate allows comparability of net interest margin with industry peers by eliminating the effect of the differences in portfolios attributable to the proportion represented by both taxable and tax-exempt investments.
The following table presents the calculation of these non-GAAP measures for the past five quarters.
FIRST FINANCIAL HOLDINGS, INC. | ||||||||||||||||||||
Non-GAAP Reconciliation (Unaudited) | For the Quarter Ended | |||||||||||||||||||
(dollars in thousands, except per share data) | December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | |||||||||||||||
Efficiency Ratio | ||||||||||||||||||||
Net interest income (A) | $ | 30,260 | $ | 30,850 | $ | 31,229 | $ | 31,496 | $ | 32,888 | ||||||||||
Taxable equivalent adjustment (B) | 157 | 149 | 148 | 148 | 183 | |||||||||||||||
Noninterest income (C) | 15,838 | 19,059 | 18,705 | 16,363 | 17,137 | |||||||||||||||
Net securities losses (D) | (534 | ) | (230 | ) | (311 | ) | (1,818 | ) | (494 | ) | ||||||||||
Noninterest expense (E) | 33,792 | 34,717 | 33,103 | 33,296 | 32,594 | |||||||||||||||
Efficiency Ratio: E/(A+B+C-D) | 72.22 | % | 69.04 | % | 65.69 | % | 66.83 | % | 64.29 | % | ||||||||||
Tangible Assets and Tangible Common Equity | ||||||||||||||||||||
Total assets | $ | 3,301,338 | $ | 3,323,015 | $ | 3,324,344 | $ | 3,380,867 | $ | 3,476,148 | ||||||||||
Goodwill | (28,260 | ) | (28,260 | ) | (28,260 | ) | (28,024 | ) | (28,025 | ) | ||||||||||
Other intangible assets, net | (9,515 | ) | (9,754 | ) | (9,997 | ) | (10,228 | ) | (10,470 | ) | ||||||||||
Tangible assets (non-GAAP) | $ | 3,263,563 | $ | 3,285,001 | $ | 3,286,087 | $ | 3,342,615 | $ | 3,437,653 | ||||||||||
Total shareholders' equity | $ | 315,322 | $ | 318,190 | $ | 323,797 | $ | 335,001 | $ | 354,454 | ||||||||||
Preferred stock | (65,000 | ) | (65,000 | ) | (65,000 | ) | (65,000 | ) | (65,000 | ) | ||||||||||
Goodwill | (28,260 | ) | (28,260 | ) | (28,260 | ) | (28,024 | ) | (28,025 | ) | ||||||||||
Other intangible assets, net | (9,515 | ) | (9,754 | ) | (9,997 | ) | (10,228 | ) | (10,470 | ) | ||||||||||
Tangible common equity (non-GAAP) | $ | 212,547 | $ | 215,176 | $ | 220,540 | $ | 231,749 | $ | 250,959 | ||||||||||
Shares outstanding, end of period (000s) | 16,527 | 16,527 | 16,527 | 16,527 | 16,526 | |||||||||||||||
Tangible common equity to tangible assets | 6.51 | % | 6.55 | % | 6.71 | % | 6.93 | % | 7.30 | % | ||||||||||
Tangible common book value per share | $ | 12.86 | $ | 13.02 | $ | 13.34 | $ | 14.02 | $ | 15.19 |
Results of Operations
First Financial recorded net income of $1.2 million for the three months ended December 31, 2010, compared with a net loss of $(4.5) million for the three months ended December 31, 2009. After the effect of the preferred stock dividend and related accretion, First Financial reported net income available to common shareholders of $210 thousand for the three months ended December 31, 2010, compared with a net loss available to common shareholders of $(5.5) million for the three months ended December 31, 2009. Diluted net income per common share was $0.01 for the current quarter, compared with diluted net loss per common share of $(0.33) for the same quarter last year.
Net Interest Income
The following table presents an analysis of net interest income, interest spread and net interest margin with average balances and related weighted average interest rates.
29
Average Balances, Net Interest Income, Average Rates | Three Months Ended December 31, | |||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
(dollars in thousands) | Average Balance | Interest | Average Rate | Average Balance | Interest | Average Rate | ||||||||||||||||||
Earning assets | ||||||||||||||||||||||||
Interest-bearing deposits with banks | $ | 16,660 | $ | 19 | 0.45 | % | $ | 12,378 | $ | 10 | 0.32 | % | ||||||||||||
Securities available for sale | 388,375 | 4,716 | 4.82 | 481,254 | 6,583 | 5.43 | ||||||||||||||||||
Securities held to maturity1 | 22,454 | 296 | 8.01 | 22,432 | 345 | 9.33 | ||||||||||||||||||
Nonmarketable securities - FHLB stock | 42,071 | 10 | 0.09 | 46,141 | 36 | 0.31 | ||||||||||||||||||
Loans2 | 2,614,918 | 36,366 | 5.52 | 2,684,929 | 40,018 | 5.91 | ||||||||||||||||||
FDIC indemnification asset, net | 67,854 | 677 | 3.96 | 63,159 | 1,108 | 6.96 | ||||||||||||||||||
Total earning assets | 3,152,332 | 42,084 | 5.32 | % | 3,310,293 | 48,100 | 5.79 | % | ||||||||||||||||
Nonearning assets | ||||||||||||||||||||||||
Cash and due from banks | 56,693 | 57,866 | ||||||||||||||||||||||
Allowance for loan losses | (87,605 | ) | (71,972 | ) | ||||||||||||||||||||
Other assets | 202,405 | 191,487 | ||||||||||||||||||||||
Total assets | $ | 3,323,825 | $ | 3,487,674 | ||||||||||||||||||||
Interest-bearing liabilities | ||||||||||||||||||||||||
Deposit accounts: | ||||||||||||||||||||||||
Interest-bearing checking | $ | 400,009 | $ | 361 | 0.36 | % | $ | 344,699 | $ | 332 | 0.38 | % | ||||||||||||
Savings | 168,523 | 112 | 0.26 | 153,384 | 175 | 0.45 | ||||||||||||||||||
Money market | 333,715 | 560 | 0.67 | 344,940 | 868 | 1.00 | ||||||||||||||||||
Certificate of deposits | 1,295,400 | 6,567 | 2.01 | 1,252,352 | 7,343 | 2.33 | ||||||||||||||||||
Total deposits | 2,197,647 | 7,600 | 1.37 | % | 2,095,375 | 8,718 | 1.65 | % | ||||||||||||||||
Advances from FHLB | 497,226 | 3,427 | 2.73 | 521,325 | 5,415 | 4.12 | ||||||||||||||||||
Other short-term borrowings and long-term debt | 45,813 | 797 | 6.90 | 242,312 | 1,079 | 1.77 | ||||||||||||||||||
Total interest-bearing liabilities | 2,740,686 | 11,824 | 1.71 | % | 2,859,012 | 15,212 | 2.11 | % | ||||||||||||||||
Noninterest-bearing liabilities | ||||||||||||||||||||||||
Noninterest-bearing deposits | 227,160 | 216,754 | ||||||||||||||||||||||
Other liabilities | 91,925 | 7,646 | ||||||||||||||||||||||
Total liabilities | 3,059,771 | 3,083,412 | ||||||||||||||||||||||
Shareholders’ equity | 318,202 | 356,897 | ||||||||||||||||||||||
Total liabilities and shareholder's equity | $ | 3,323,825 | $ | 3,487,674 | ||||||||||||||||||||
Net interest income/interest spread | $ | 30,260 | 3.61 | % | $ | 32,888 | 3.68 | % | ||||||||||||||||
Contribution of noninterest bearing sources of funds3 | 0.22 | 0.28 | ||||||||||||||||||||||
Net interest margin (FTE)4 | 3.83 | % | 3.96 | % |
1 | Interest income used in the average rate calculation includes the tax equivalent adjustment of $157 thousand, and $183 thousand for the three months ended December 31, 2010, and 2009, respectively, calculated based on a federal tax rate of 35%. |
2 | Average balances of loans include loans held for sale and nonaccrual loans. |
3 | Equates to total cost of funds of 1.58% and 1.96% at December 31, 2010 and 2009, respectively. |
4 | Net interest margin exceeds the interest spread due to noninterest-bearing funding sources supporting earning assets. |
Net interest margin, on a fully tax-equivalent basis, was 3.83% for the quarter ended December 31, 2010, compared with 3.96% for the same quarter last year. While First Financial realized a 40 basis point reduction in interest-bearing liabilities due to repricing deposits and borrowed funds, a 47 basis point decrease in the average yield on assets resulted in a net decrease in net interest margin from the same quarter last year. While First Financial reprices deposits lower subject to market competition, earning assets continue to reprice and be replaced with lower yielding assets due to the current interest rate environment. Additionally, the average yield on earning assets was further reduced by the increase in nonperforming loans during the last twelve months.
Net interest income for the quarter ended December 31, 2010 was $30.3 million, a decrease of $2.6 million or 8.0% from the same quarter last year. The decrease was primarily the result of the lower net interest margin, combined with a decrease in average earning assets. The decrease in average earning assets was primarily the result of a decline in loan balances due to lower loan demand from creditworthy borrowers and loan charge-offs, combined with using cash flow from investment securities to paydown borrowings.
30
The following table presents changes in interest income, interest expense and net interest income due to volume and rate variances for major categories of earning assets and interest-bearing liabilities.
For The Three Months Ended December 31, | ||||||||||||
2010 versus 2009 | ||||||||||||
Increase (Decrease) | ||||||||||||
Due to | ||||||||||||
(in thousands) | Volume | Rate | Net | |||||||||
Interest income | ||||||||||||
Interest-bearing deposits with banks | $ | 4 | $ | 5 | $ | 9 | ||||||
Securities available for sale | (1,185 | ) | (724 | ) | (1,909 | ) | ||||||
Securities held to maturity | - | (49 | ) | (49 | ) | |||||||
Nonmarketable securities - FHLB stock | 1 | 16 | 17 | |||||||||
Loans | (1,024 | ) | (2,628 | ) | (3,652 | ) | ||||||
FDIC indemnification asset, net | 77 | (509 | ) | (432 | ) | |||||||
Total interest income | $ | (2,127 | ) | $ | (3,889 | ) | $ | (6,016 | ) | |||
Interest expense | ||||||||||||
Deposit accounts | ||||||||||||
Interest-bearing checking | $ | 51 | $ | (22 | ) | $ | 29 | |||||
Savings | 16 | (79 | ) | (63 | ) | |||||||
Money market | (27 | ) | (281 | ) | (308 | ) | ||||||
Certificate of deposits | 245 | (1,021 | ) | (776 | ) | |||||||
Total deposits | 285 | (1,403 | ) | (1,118 | ) | |||||||
Advances from FHLB, other short-term | ||||||||||||
borrowings and long-term debt | (1,670 | ) | (600 | ) | (2,270 | ) | ||||||
Total interest expense | (1,385 | ) | (2,003 | ) | (3,388 | ) | ||||||
Net interest income | $ | (742 | ) | $ | (1,886 | ) | $ | (2,628 | ) |
Note: The change in interest not solely due to changes in volume or rates has been allocated in proportion to the absolute dollar amounts of the change in each. |
Provision for Loan Losses
After determining what First Financial believes is an adequate allowance for loan losses based on the risk in the portfolio, the provision for loan losses is calculated based on the net effect of the quarterly change in the allowance for loan losses and net charge-offs. The provision for loan losses was $10.5 million for the quarter ended December 31, 2010, compared with $25.3 million for the same quarter last year. The decrease was primarily the result of lower net charge-offs and some stabilization in the level of impaired loans requiring specific reserves, combined with no significant additional valuation adjustments required as a result of updated appraisals. See “ – Asset Quality” and “ – Allowance for Loan Losses” for additional discussion regarding the calculation of the allowance for loan losses and information related to loan charge-offs.
Noninterest Income
The following table summarizes the components of noninterest income.
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Noninterest income | ||||||||||||||||
Three Months ended December 31, | 2010-2009 Change | |||||||||||||||
(dollars in thousands) | 2010 | 2009 | $ | % | ||||||||||||
Service charges and fees on deposit accounts | $ | 6,278 | $ | 6,300 | $ | (22 | ) | (0.3 | )% | |||||||
Insurance | 5,291 | 5,429 | (138 | ) | (2.5 | )% | ||||||||||
Mortgage and other loan income | 2,636 | 2,439 | 197 | 8.1 | % | |||||||||||
Trust and plan administration | 1,177 | 1,269 | (92 | ) | (7.2 | )% | ||||||||||
Brokerage fees | 514 | 496 | 18 | 3.6 | % | |||||||||||
Other | 476 | 1,698 | (1,222 | ) | (72.0 | )% | ||||||||||
Net impairment losses recognized in earnings | (534 | ) | (494 | ) | (40 | ) | 8.1 | % | ||||||||
Total noninterest income | $ | 15,838 | $ | 17,137 | $ | (1,299 | ) | (7.6 | )% |
The decrease in noninterest income for the three months ended December 31, 2010 as compared with the same period last year was primarily the result of declines in insurance and other income, partially offset by higher mortgage and other loan income. The decrease in insurance was primarily the result of current economic market conditions and an increase in customer loss claims, which adversely affect contingent performance-based premiums. The decrease in other income was primarily the result of a $1.2 million gain on the donation of a branch location recorded during the quarter ended December 31, 2009. The increase in mortgage and other loan income was primarily the result of higher origination volume due to the current low interest rate environment.
Noninterest Expense
The following table summarizes the components of noninterest expense.
Noninterest expense | ||||||||||||||||
Three Months ended December 31, | 2010-2009 Change | |||||||||||||||
(dollars in thousands) | 2010 | 2009 | $ | % | ||||||||||||
Salaries and employee benefits | $ | 19,287 | $ | 17,780 | $ | 1,507 | 8.5 | % | ||||||||
Occupancy costs | 2,370 | 2,447 | (77 | ) | (3.1 | )% | ||||||||||
Furniture and equipment | 2,003 | 2,139 | (136 | ) | (6.4 | )% | ||||||||||
Real estate owned (REO) expenses, net | 1,254 | 1,560 | (306 | ) | (19.6 | )% | ||||||||||
FDIC insurance and regulatory fees | 1,180 | 941 | 239 | 25.4 | % | |||||||||||
Professional services | 1,567 | 767 | 800 | 104.3 | % | |||||||||||
Advertising and marketing | 612 | 786 | (174 | ) | (22.1 | )% | ||||||||||
Other loan expense | 773 | 417 | 356 | 85.4 | % | |||||||||||
Intangible asset amortization | 239 | 243 | (4 | ) | (1.6 | )% | ||||||||||
Other expense | 4,507 | 5,514 | (1,007 | ) | (18.3 | )% | ||||||||||
Total noninterest expense | $ | 33,792 | $ | 32,594 | $ | 1,198 | 3.7 | % |
The increase in noninterest expense for the three months ended December 31, 2010 as compared with the same period last year was primarily the result of higher salaries and employee benefits and professional services, partially offset by lower other expense. The $1.5 million increase in salaries and employee benefits was primarily the result of new positions added during 2010 in wealth management, correspondent lending, mortgage originations, operations and administrative areas. The increase in professional services was primarily the result of using external resources to assist in the implementation of several strategic initiatives including loss-share management, REO management, and compensation studies. The decrease in other expense was primarily the result of a $1.2 million contribution in conjunction with the donation of a branch location recorded during the quarter ended December 31, 2009.
Income Taxes
The income tax provision for the three months ended December 31, 2010 totaled $656 thousand, compared with an income tax benefit of $3.4 million for the same period last year. The increase was primarily the result of the change in pre-tax income from loss to income, as there were no significant changes to tax-exempt income or temporary tax differences.
32
Line of Business Results
A brief summary of the financial performance for each of the business segments follows. See Note 12 to the Consolidated Financial Statements for additional information.
Banking
The Banking line of business, which represents First Federal’s activities, recorded net income of $2.4 million for the three months ended December 31, 2010, compared with a net loss of $(3.6) million for the same period last year. The increase was primarily the result of lower provision for loan losses, partially offset by lower net interest income. The decrease in the provision for loan losses was primarily the result of lower net charge-offs and some stabilization in the level of impaired loans requiring specific reserves. The decrease in net interest income was primarily the result of a decline in net interest margin and fewer earning assets as discussed in the “Net Interest Income” section above.
Insurance
The Insurance business segment, which represents the activities of First Southeast Insurance Services, Inc. and Kimbrell Insurance Group, Inc., recorded net income of $1 thousand for the three months ended December 31, 2010, compared with $14 thousand for the same period last year. The decrease was primarily the result of lower insurance revenue due to current economic market conditions and an increase in customer loss claims affecting contingency premiums received.
Other
The entities included in the “Other” column of the table in Note 12 represent the holding company, registered investment advisor and registered broker-dealer, as well as intercompany eliminations. This segment recorded a net loss of $(1.2) million for the three months ended December 31, 2010, compared with a net loss of $(930) thousand for the same period last year. The decline was primarily the result of higher noninterest expense primarily the result of an increase in salaries and employee benefits due to new positions added during 2010 in administrative areas and an increase in professional services due to using external resources to assist in the implementation of several strategic initiatives.
Financial Condition
Total assets at December 31, 2010 were $3.3 billion, a slight decrease of $21.7 million or 0.7% from September 30, 2010 and a decrease of $174.8 million or 5.0% from December 31, 2009. The decline from the same period last year was primarily the result of reductions in investment securities due to prepayments and declines in the loan portfolios due to lower loan demand from creditworthy borrowers, transfers of nonperforming loans to REO, and charge-offs during the year.
Investment Securities
Investment securities, primarily mortgage-backed securities, totaled $435.5 million at December 31, 2010, a decrease of $37.9 million or 8.0% from September 30, 2010 and a decrease of $111.9 million or 20.4% from December 31, 2009. The declines were primarily the result of high prepayment levels on higher yielding securities and the challenge in finding replacement securities with acceptable risk profiles and yields. As a result, the cash flows from maturities and prepayments were used to paydown advances from the FHLB and other borrowings rather than fully reinvesting these proceeds in other securities. See Note 2 to the Consolidated Financial Statements for additional information.
Loans
The following table summarizes the loan portfolio by major categories.
33
LOANS (in thousands) | December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | |||||||||||||||
Residential loans | ||||||||||||||||||||
Residential 1-4 family | $ | 887,924 | $ | 836,644 | $ | 810,180 | $ | 778,747 | $ | 767,923 | ||||||||||
Residential construction | 15,639 | 14,436 | 12,016 | 16,926 | 14,502 | |||||||||||||||
Residential land | 53,772 | 56,344 | 57,977 | 61,893 | 65,606 | |||||||||||||||
Total residential loans | 957,335 | 907,424 | 880,173 | 857,566 | 848,031 | |||||||||||||||
Commercial loans | ||||||||||||||||||||
Commercial business | 91,129 | 92,650 | 111,826 | 115,417 | 123,543 | |||||||||||||||
Commercial real estate | 590,816 | 598,547 | 593,894 | 593,128 | 591,787 | |||||||||||||||
Commercial construction | 23,895 | 28,449 | 40,102 | 60,561 | 69,865 | |||||||||||||||
Commercial land | 133,899 | 143,366 | 164,671 | 188,838 | 214,023 | |||||||||||||||
Total commercial loans | 839,739 | 863,012 | 910,493 | 957,944 | 999,218 | |||||||||||||||
Consumer loans | ||||||||||||||||||||
Home equity | 396,010 | 397,632 | 404,140 | 406,872 | 405,701 | |||||||||||||||
Manufactured housing | 269,555 | 269,857 | 264,815 | 256,193 | 250,646 | |||||||||||||||
Marine | 62,830 | 65,901 | 68,393 | 70,506 | 73,536 | |||||||||||||||
Other consumer | 57,898 | 60,522 | 62,805 | 63,134 | 67,070 | |||||||||||||||
Total consumer loans | 786,293 | 793,912 | 800,153 | 796,705 | 796,953 | |||||||||||||||
Total loans | 2,583,367 | 2,564,348 | 2,590,819 | 2,612,215 | 2,644,202 | |||||||||||||||
Less: Allowance for loan losses | 88,349 | 86,871 | 86,945 | 82,731 | 73,534 | |||||||||||||||
Net loans | $ | 2,495,018 | $ | 2,477,477 | $ | 2,503,874 | $ | 2,529,484 | $ | 2,570,668 |
Total loans at December 31, 2010 decreased $60.8 million or 2.3% from December 31, 2009. Increases in residential 1-4 family loans, were related to higher levels of originations resulting from the low interest rate environment, combined with First Financial retaining substantially all 15-year residential mortgage loan originations in the loan portfolio during the period. These increases were offset by declines in most other loan categories primarily due to lower loan demand from creditworthy borrowers, transfers of nonperforming loans to REO, and charge-offs in most other loan categories, combined with paydowns from normal borrower activity. Included in the table above are loans covered under the loss share agreement with the FDIC (“covered loans”). The following table includes the outstanding balance for the covered loans at December 31, 2010. The table also includes the amount of delinquent loans and nonperforming loans by category, as well as total other repossessed assets acquired and total classified covered loans.
34
Loans Covered Under Loss Share Agreement | ||||||||||||
December 31, 2010 | ||||||||||||
Delinquent | Nonperforming | |||||||||||
(dollars in thousands) | Loan | Loans | Loans | |||||||||
Residential loans | ||||||||||||
Residential 1-4 family1 | $ | 3,047 | $ | — | $ | 1,449 | ||||||
Residential land | 10,471 | — | 328 | |||||||||
Total residential loans | 13,518 | — | 1,777 | |||||||||
Commercial loans | ||||||||||||
Commercial business | 15,506 | 570 | 4,164 | |||||||||
Commercial real estate | 96,807 | 1,728 | 5,459 | |||||||||
Commercial construction | 2,285 | 324 | — | |||||||||
Commercial land | 22,106 | 1,448 | 1,712 | |||||||||
Total commercial loans | 136,704 | 4,070 | 11,335 | |||||||||
Consumer loans | ||||||||||||
Home equity | 28,690 | 126 | 458 | |||||||||
Marine | 168 | — | — | |||||||||
Other consumer | 1,974 | 6 | 178 | |||||||||
Total consumer loans | 30,832 | 132 | 636 | |||||||||
Total loans | $ | 181,054 | $ | 4,202 | $ | 13,748 | ||||||
Other repossessed assets acquired | $ | 6,586 | ||||||||||
Classified loans | $ | 29,040 |
1 | Residential 1-4 family nonperforming loans includes a restructured loan, still accruing interest in the amount of $745 thousand. |
Asset Quality
National credit conditions have contributed to the historical high credit costs as compared with lower credit cost levels in past years. The markets in which First Financial operates are not immune to these conditions, which have been a factor in higher levels of delinquent loans, nonperforming assets, and charge-offs. The increase in these trends has contributed to the higher level of allowance for loan losses, which was 3.42% of total loans as of December 31, 2010, compared with 3.39% at September 30, 2010. The increase in delinquent loans, nonperforming assets, and loan losses generally reflect the operating difficulties of individual borrowers resulting from weakness in the local economy, deterioration in the collateral values in the coastal areas of our markets, and declines in individual borrower and guarantor financial positions.
Management monitors the loan portfolio on a monthly basis to determine where risk mitigation efforts can be utilized to assist in preventing or mitigating future losses. An element of our credit risk management process is regular loan reviews to determine risk levels and exposure to loss. The depth of review varies by asset types, depending on the nature of those assets. While certain assets may represent a substantial investment and warrant individual reviews, other assets may have less risk because the asset size is small, the risk is spread over a large number of obligors or the obligations are well collateralized and further analysis of individual assets would expand the review process without measurable advantage to risk assessment. Asset types with these characteristics may be reviewed as a total homogenous portfolio on the basis of risk indicators such as delinquency (as with consumer and residential real estate loans) or credit rating. In addition, a formal review process may be conducted on individual assets within the homogenous pool that represent potential risk.
The monthly loan review process covers problem loans including all commercial loans greater than $200,000 and more than 30 days past due, and all criticized and classified loans over $500,000. Action plans to address the credit weaknesses are presented, approved and monitored. Loan reviews emphasize the borrower’s and guarantor’s global cash flow analysis as a key determinant in the credit quality risk rating and to identify deterioration in the financial condition of the borrowers that may limit their ability to continue to service their debt or to carry their obligations to contractual term. In addition, reviews may include evaluations of collateral values as determined necessary based on credit policies and credit risk rating. First Federal’s policy is to update collateral appraisals on problem loans at least annually, or more frequently if circumstances warrant.
35
Delinquent Loans
The following table presents delinquent loans by portfolio for the last five quarters. The table includes covered loans which became delinquent since acquisition and which were not acquired with deteriorated credit quality and accounted for in accordance with ASC Topic 310-30.
DELINQUENT LOANS | December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||||||
(30-89 days past due) (in thousands) | $ | % of Portfolio | $ | % of Portfolio | $ | % of Portfolio | $ | % of Portfolio | $ | % of Portfolio | ||||||||||||||||||||||||||||||
Residential loans | ||||||||||||||||||||||||||||||||||||||||
Residential 1-4 family | $ | 6,712 | 0.76 | % | $ | 3,486 | 0.42 | % | $ | 5,244 | 0.65 | % | $ | 8,214 | 1.05 | % | $ | 6,076 | 0.79 | % | ||||||||||||||||||||
Residential construction | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Residential land | 432 | 0.80 | 302 | 0.54 | 799 | 1.38 | 791 | 1.28 | 2,799 | 4.27 | ||||||||||||||||||||||||||||||
Total residential loans | 7,144 | 0.75 | 3,788 | 0.42 | 6,043 | 0.69 | 9,005 | 1.05 | 8,875 | 1.05 | ||||||||||||||||||||||||||||||
Commercial loans | ||||||||||||||||||||||||||||||||||||||||
Commercial business | 3,476 | 3.81 | 2,140 | 2.31 | 2,355 | 2.11 | 4,315 | 3.74 | 4,909 | 3.97 | ||||||||||||||||||||||||||||||
Commercial real estate | 10,600 | 1.79 | 8,920 | 1.49 | 7,441 | 1.25 | 13,381 | 2.26 | 12,249 | 2.07 | ||||||||||||||||||||||||||||||
Commercial construction | 635 | 2.66 | 1,981 | 6.96 | — | — | 1,602 | 2.65 | 947 | 1.36 | ||||||||||||||||||||||||||||||
Commercial land | 5,348 | 3.99 | 3,428 | 2.39 | 1,192 | 0.72 | 2,314 | 1.23 | 4,662 | 2.18 | ||||||||||||||||||||||||||||||
Total commercial loans | 20,059 | 2.39 | 16,469 | 1.91 | 10,988 | 1.21 | 21,612 | 2.26 | 22,767 | 2.28 | ||||||||||||||||||||||||||||||
Consumer loans | ||||||||||||||||||||||||||||||||||||||||
Home equity | 4,355 | 1.10 | 4,625 | 1.16 | 4,661 | 1.15 | 4,477 | 1.10 | 4,609 | 1.14 | ||||||||||||||||||||||||||||||
Manufactured housing | 4,043 | 1.50 | 3,207 | 1.19 | 2,992 | 1.13 | 3,806 | 1.49 | 3,697 | 1.47 | ||||||||||||||||||||||||||||||
Marine | 707 | 1.13 | 462 | 0.70 | 425 | 0.62 | 981 | 1.39 | 1,754 | 2.39 | ||||||||||||||||||||||||||||||
Other consumer | 905 | 1.56 | 1,765 | 2.92 | 527 | 0.84 | 594 | 0.94 | 1,172 | 1.75 | ||||||||||||||||||||||||||||||
Total consumer loans | 10,010 | 1.27 | 10,059 | 1.27 | 8,605 | 1.08 | 9,858 | 1.24 | 11,232 | 1.41 | ||||||||||||||||||||||||||||||
Total delinquent loans | $ | 37,213 | 1.44 | % | $ | 30,316 | 1.18 | % | $ | 25,636 | 0.99 | % | $ | 40,475 | 1.55 | % | $ | 42,874 | 1.62 | % |
Total delinquencies at December 31, 2010 increased $6.9 million or 22.8% over September 30, 2010. The increase in the residential 1-4 family category was primarily related to one large borrower with a $1.6 million loan, which currently has adequate collateral to mitigate any potential loss. Increases in the commercial business and commercial real estate categories were related to one loan totaling $1.8 million, which is supported by income-producing collateral, as well as numerous smaller dollar loans. These commercial and small business loans have started to show signs of weakness and are being actively monitored for resolution. The increase in delinquent commercial land loans was primarily the result of one loan totaling $1.8 million, which matured while negotiations with the borrowers were ongoing and currently continue.
Total delinquent loans at December 31, 2010 also included $4.2 million in covered loans, as compared with $5.0 million at September 30, 2010.
Nonperforming Assets
Nonperforming assets include nonaccrual loans, loans delinquent 90 days or more and still accruing, restructured loans still accruing, and other repossessed assets acquired through foreclosure. With the exception of the credit card portfolio, loans are placed on nonaccrual status when they become 90 days delinquent. In addition, loans that were not delinquent in excess of 90 days but exhibit weaknesses and doubt as to their ability to repay all contractual principal and interest have been classified as impaired under ASC 310-10-35 and placed on nonaccrual status.
The following table presents the composition of nonperforming assets. The table includes covered loans which have migrated to nonaccrual status since acquisition and which were not acquired with deteriorated credit quality and accounted for in accordance with ASC 310-10. Loans classified as nonperforming at acquisition are not included below since these loans were adjusted to fair value, which included estimates of credit loss at acquisition date. The acquired portfolio is subject to a loss sharing agreement with the FDIC.
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December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | ||||||||||||||||||||||||||||||||||||
NONPERFORMING ASSETS (in thousands) | $ | % of Portfolio | $ | % of Portfolio | $ | % of Portfolio | $ | % of Portfolio | $ | % of Portfolio | ||||||||||||||||||||||||||||||
Residential loans | ||||||||||||||||||||||||||||||||||||||||
Residential 1-4 family | $ | 20,371 | 2.29 | % | $ | 17,350 | 2.07 | % | $ | 17,898 | 2.21 | % | $ | 13,763 | 1.77 | % | $ | 15,759 | 2.05 | % | ||||||||||||||||||||
Residential construction | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Residential land | 4,997 | 9.29 | 4,872 | 8.65 | 5,527 | 9.53 | 5,922 | 9.57 | 5,485 | 8.36 | ||||||||||||||||||||||||||||||
Total residential loans | 25,368 | 2.65 | 22,222 | 2.45 | 23,425 | 2.66 | 19,685 | 2.30 | 21,244 | 2.51 | ||||||||||||||||||||||||||||||
Commercial loans | ||||||||||||||||||||||||||||||||||||||||
Commercial business | 9,769 | 10.72 | 6,951 | 7.50 | 6,789 | 6.07 | 7,563 | 6.55 | 5,238 | 4.24 | ||||||||||||||||||||||||||||||
Commercial real estate | 57,724 | 9.77 | 48,973 | 8.18 | 35,560 | 5.99 | 34,583 | 5.83 | 28,637 | 4.84 | ||||||||||||||||||||||||||||||
Commercial construction | 4,484 | 18.77 | 5,704 | 20.05 | 5,738 | 14.31 | 7,127 | 11.77 | 3,706 | 5.30 | ||||||||||||||||||||||||||||||
Commercial land | 43,824 | 32.73 | 46,109 | 32.16 | 50,269 | 30.53 | 55,719 | 29.51 | 40,164 | 18.77 | ||||||||||||||||||||||||||||||
Total commercial loans | 115,801 | 13.79 | 107,737 | 12.48 | 98,356 | 10.80 | 104,992 | 10.96 | 77,745 | 7.78 | ||||||||||||||||||||||||||||||
Consumer loans | ||||||||||||||||||||||||||||||||||||||||
Home equity | 9,450 | 2.39 | 6,969 | 1.75 | 6,937 | 1.72 | 7,773 | 1.91 | 6,626 | 1.63 | ||||||||||||||||||||||||||||||
Manufactured housing | 3,609 | 1.34 | 2,909 | 1.08 | 3,189 | 1.20 | 2,899 | 1.13 | 2,715 | 1.08 | ||||||||||||||||||||||||||||||
Marine | 67 | 0.11 | 188 | 0.29 | 135 | 0.20 | 166 | 0.24 | 259 | 0.35 | ||||||||||||||||||||||||||||||
Other consumer | 555 | 0.96 | 206 | 0.34 | 16 | 0.03 | 143 | 0.23 | 153 | 0.23 | ||||||||||||||||||||||||||||||
Total consumer loans | 13,681 | 1.74 | 10,272 | 1.29 | 10,277 | 1.28 | 10,981 | 1.38 | 9,753 | 1.22 | ||||||||||||||||||||||||||||||
Total nonaccrual loans | 154,850 | 5.99 | 140,231 | 5.47 | 132,058 | 5.10 | 135,658 | 5.19 | 108,742 | 4.11 | ||||||||||||||||||||||||||||||
Loans 90+ days still accruing | 204 | 175 | 170 | 104 | 124 | |||||||||||||||||||||||||||||||||||
Restructured loans, still accruing | 1,578 | 750 | — | — | — | |||||||||||||||||||||||||||||||||||
Total nonperforming loans | 156,632 | 6.06 | % | 141,156 | 5.51 | % | 132,228 | 5.10 | % | 135,762 | 5.20 | % | 108,866 | 4.12 | % | |||||||||||||||||||||||||
Other repossessed assets acquired | 19,660 | 11,950 | 12,543 | 11,957 | 20,864 | |||||||||||||||||||||||||||||||||||
Total nonperfoming assets | $ | 176,292 | $ | 153,106 | $ | 144,771 | $ | 147,719 | $ | 129,730 |
Total nonperforming assets at December 31, 2010 increased $23.2 million or 15.1% over September 30, 2010. The increase in nonperforming loans included $9.3 million of predominantly commercial loans determined to be impaired and moved to nonperforming status prior to becoming 90 days past due. Three loans accounted for 47% of this total. Additionally, 30 loans totaling $6.1 million were matured in excess of 90 days and were moved to nonperforming status while negotiations with the borrowers continue toward renewal or alternate resolution. The remaining net increase from September 30, 2010 was related primarily to a higher number of relatively small loans migrating from delinquent to nonperforming. Reductions offsetting the new nonperforming loans include $3.2 million in charged-off loans, $8.0 million in transfers to REO, and $5.3 million in paydowns as a result of normal borrower activity.
The nonperforming loans at December 31, 2010 included $13.7 million in covered loans, as compared with $14.7 million at September 30, 2010.
The following table presents net charge-offs by loan category.
December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | ||||||||||||||||||||||||||||||||||||
NET CHARGE-OFFS (in thousands) | $ | % of Portfolio* | $ | % of Portfolio* | $ | % of Portfolio* | $ | % of Portfolio* | $ | % of Portfolio* | ||||||||||||||||||||||||||||||
Residential loans | ||||||||||||||||||||||||||||||||||||||||
Residential 1-4 family | $ | 612 | 0.28 | % | $ | 2,311 | 1.12 | % | $ | 1,673 | 0.84 | % | $ | 2,715 | 1.40 | % | $ | 59 | 0.03 | % | ||||||||||||||||||||
Residential construction | — | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||
Residential land | 735 | 5.34 | 1,297 | 9.08 | 975 | 6.51 | 1,127 | 7.07 | 1,781 | 10.08 | ||||||||||||||||||||||||||||||
Total residential loans | 1,347 | 0.58 | 3,608 | 1.61 | 2,648 | 1.22 | 3,842 | 1.80 | 1,840 | 0.87 | ||||||||||||||||||||||||||||||
Commercial loans | ||||||||||||||||||||||||||||||||||||||||
Commercial business | 264 | 1.15 | 1,789 | 7.00 | 3,868 | 13.62 | 1,656 | 5.54 | 1,046 | 3.33 | ||||||||||||||||||||||||||||||
Commercial real estate | 237 | 0.16 | 3,402 | 2.28 | 5,267 | 3.55 | 8,085 | 5.46 | 1,807 | 1.21 | ||||||||||||||||||||||||||||||
Commercial construction | 314 | 4.80 | 270 | 3.15 | 2,051 | 16.30 | 1,094 | 6.71 | 3,114 | 16.60 | ||||||||||||||||||||||||||||||
Commercial land | 2,127 | 6.14 | 4,175 | 10.84 | 12,165 | 27.53 | 17,017 | 33.79 | 7,796 | 14.31 | ||||||||||||||||||||||||||||||
Total commercial loans | 2,942 | 1.38 | 9,636 | 4.35 | 23,351 | 10.00 | 27,852 | 11.38 | 13,763 | 5.42 | ||||||||||||||||||||||||||||||
Consumer loans | ||||||||||||||||||||||||||||||||||||||||
Home equity | 2,974 | 3.00 | 2,669 | 2.66 | 4,379 | 4.32 | 3,017 | 2.97 | 2,432 | 2.42 | ||||||||||||||||||||||||||||||
Manufactured housing | 834 | 1.24 | 1,145 | 1.71 | 950 | 1.46 | 638 | 1.01 | 763 | 1.23 | ||||||||||||||||||||||||||||||
Marine | 184 | 1.14 | 195 | 1.16 | 401 | 2.31 | 621 | 3.45 | 608 | 3.24 | ||||||||||||||||||||||||||||||
Other consumer | 724 | 4.89 | 399 | 2.59 | 430 | 2.73 | 748 | 4.60 | 860 | 4.99 | ||||||||||||||||||||||||||||||
Total consumer loans | 4,716 | 2.39 | 4,408 | 2.21 | 6,160 | 3.09 | 5,024 | 2.52 | 4,663 | 2.35 | ||||||||||||||||||||||||||||||
Total net charge-offs | $ | 9,005 | 1.38 | % | $ | 17,652 | 2.71 | % | $ | 32,159 | 4.91 | % | $ | 36,718 | 5.55 | % | $ | 20,266 | 3.02 | % |
*Represents an annualized rate
The decrease in net charge-offs for the quarter ended December 31, 2010 from the prior quarter was primarily the result of lower credit writedowns in the residential 1-4 family and all commercial loan categories as there were fewer loans requiring valuation adjustments on the underlying collateral.
37
Allowance for Loan Losses
The allowance for loan losses (“allowance”) totaled $88.3 million, or 3.42%, of loans at December 31, 2010, compared with $86.9 million, or 3.39% of loans at September 30, 2010. Excluding the effect of covered loans, the allowance would be 3.68% and 3.66% of non-covered loans at December 31, 2010 and September 30, 2010, respectively. During the three months ended December 31, 2010, the allowance was increased through charges to the provision for loan losses of $10.5 million in connection with increases in the level of classified and nonperforming loans, changes in the composition and quality of the loan portfolio, changes in the risk ratings of loans in the portfolio, and the level of charge-offs. Net charge-offs during the three months ended December 31, 2010 of $9.0 million offset increases to the allowance.
First Federal maintains an allowance, which is intended to be management’s best estimate of probable inherent losses in the outstanding loan portfolio. The allowance is periodically decreased by actual loan charge-offs, net of recoveries, and is increased as necessary by charges to current period operating results through the provision for loan losses. A committee consisting of members of lending management, credit risk management, and accounting and finance meets at least quarterly with executive management to review the credit quality of the loan portfolios and to evaluate the allowance. First Federal utilizes an external firm to review the loan quality and reports the results of its reviews to executive management and the Board of Directors on a quarterly basis. Such reviews also assist management in establishing the level of the allowance. The following table sets forth the changes in the allowance.
Three Months Ended | ||||||||
(in thousands) | December 31, 2010 | December 31, 2009 | ||||||
Balance, beginning of period | $ | 86,871 | $ | 68,473 | ||||
Provision for loan losses | 10,483 | 25,327 | ||||||
Charge-offs | (9,750 | ) | (21,388 | ) | ||||
Recoveries | 745 | 1,122 | ||||||
Net charge-offs | (9,005 | ) | (20,266 | ) | ||||
Balance, end of period | $ | 88,349 | $ | 73,534 |
The allowance is based on management’s continuing review and credit risk evaluation of the loan portfolio. The factors that are considered in a determination of the level of the allowance include our assessment of current economic conditions, the composition of the loan portfolio, historical trends in the loan portfolio, historical loss experience by categories of loans, ongoing reviews of the loan portfolio, monitoring watch list loans, and concentrations of credit exposure. The value of the underlying collateral is also considered as necessary. This process provides an allowance consisting of two components: allocated and unallocated, as appropriate. To arrive at the allocated component of the allowance, First Federal combines estimates of the allowance needed for loans analyzed individually and on a pooled basis. The result of the allocation may determine that there is no unallocated portion. In addition to being used to categorize risk, First Federal’s internal risk rating system is used as part of the total factors that are used to determine the allocated allowance for the loan portfolio. Loans are segmented into categories for analysis based in part on the risk profile inherent in each category. Loans are further segmented into risk rating pools within each category to appropriately recognize changes in inherent risk.
A primary component of determining appropriate reserve factors in the allowance calculation is the actual loss history for a rolling 36-month period, tracked by major loan category. In addition, more recent trends are considered by evaluating one-year and the most recent quarter historical loss ratios to ensure appropriate consideration of trends by loan sector. First Federal’s policy is to adjust the rolling 36-month loss history with internal and external qualitative factors as considered necessary at each period end given the facts at the time. The following qualitative factors that are likely to cause estimated credit losses in First Federal’s existing portfolio to differ from historical loss experience include:
· | Changes in lending policies and procedures. |
· | Changes in regional and local economic and business conditions and developments that affect the collectability of the portfolio. |
· | Changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of classified loans. |
· | Changes in the quality of First Federal’s loan review system. |
· | Changes in the value of underlying collateral for collateral-dependent loans. |
Upon completion of the qualitative adjustments, the allowance is allocated to the components of the portfolio based on the adjusted loss rates. The portion of the allowance that is allocated to impaired loans is determined by estimating the inherent loss on each problem credit through a discounted cash flow methodology or based on the value of the underlying collateral.
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The allowance for loan losses as a percent of total loans has increased while the allowance as a percent of nonperforming loans has trended downward. The ratio of the allowance to nonperforming loans, which is comprised of nonaccrual loans and accruing loans 90 days or more delinquent, was 56.41% at December 31, 2010 compared with 61.54% at September 30, 2010 and 67.55% at December 31, 2009. While this ratio has declined, management believes that the allowance for loan losses is adequate to provide for estimated probable losses in our loan portfolio as of each period end based on the analysis performed and quantification of potential loss in the portfolio relative to known factors. A primary factor contributing to the decrease in the ratio of allowance to nonperforming loans is related to First Federal proactively placing loans on nonaccrual status which have not yet reached 90 days past due, but are determined impaired. These loans have previously been appropriately considered in the allowance, but were not categorized as “nonperforming loans” until placed on nonaccrual. A majority of the impaired loans have been adjusted to an amount that approximates estimated net realizable value through a partial charge-off, thus no additional specific reserves were considered necessary at December 31, 2010.
Management and the Board have approved appropriate policies surrounding loan loss identification, loan monitoring and allowance for loan loss methodologies, have consistently applied processes implemented, have utilized relevant information available to make determinations about the allowance, and have determined that the controls in place are adequate to ensure that the allowance is appropriate at each balance sheet date. Because events affecting borrowers and collateral charge-offs cannot be predicted with certainty, there can be no assurance that increases to the allowance will not be necessary should the quality of any loans deteriorate. Management believes that the allowance is adequate and sufficient for the risk inherent in the portfolio as of each balance sheet date. Further, management believes that the allowance is appropriate under GAAP for all periods presented.
Deposits
Deposits totaled $2.4 billion at December 31, 2010 and September 30, 2010. Core deposits, which exclude certificates of deposit, decreased $12.0 million or 1.1% from September 30, 2010 to $1.1 billion at December 31, 2010, due in part to calendar year-end seasonal changes in customer activity, with the majority of the decline occurring in the money market category. Time deposits totaled $1.3 billion at December 31, 2010, essentially unchanged from September 30, 2010. Wholesale certificates of deposit totaled 12.8% of total deposits at December 31, 2010, compared with 12.2% at September 30, 2010. See Note 5 to the Consolidated Financial Statements for additional information.
Borrowed Funds
Borrowed funds are comprised of advances from the FHLB, other short-term borrowings, and long-term debt. Borrowings totaled $544.3 million at December 31, 2010, a decrease of $11.1 million or 2.0% from September 30, 2010. The decrease was primarily the result of using cash flow from the investment securities and loan portfolios to paydown FHLB advances and payoff short-term borrowings at the Federal Reserve, as well as the shift in funding mix to core and time deposits. First Financial maintains a strong liquidity position, with substantial on- and off-balance sheet liquidity sources and a stable funding base comprised of approximately 73% deposits, 16% borrowings, 10% equity, and 1% short-term liabilities at December 31, 2010. See Note 6 to the Consolidated Financial Statements for additional information.
Capital
First Financial continues to maintain a strong capital position to support current needs and provide a sound foundation to support future expansion.�� Shareholders’ equity totaled $315.3 million at December 31, 2010, essentially unchanged from September 30, 2010. First Federal’s regulatory capital ratios continue to be above “well-capitalized” minimums, as evidenced by the key capital ratios and additional capital information presented in the following table.
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For the Quarter Ended | ||||||||||||||||||||||||
December 31, 2010 | September 30, 2010 | June 30, 2010 | March 31, 2010 | December 31, 2009 | ||||||||||||||||||||
First Financial: | ||||||||||||||||||||||||
Equity to assets | 9.55 | % | 9.58 | % | 9.74 | % | 9.91 | % | 10.20 | % | ||||||||||||||
Tangible common equity to tangible assets (non-GAAP)1 | 6.51 | 6.55 | 6.71 | 6.93 | 7.30 | |||||||||||||||||||
Book value per common share | $ | 15.15 | $ | 15.32 | $ | 15.66 | $ | 16.34 | $ | 17.52 | ||||||||||||||
Tangible common book value per share (non-GAAP)1 | 12.86 | 13.02 | 13.34 | 14.02 | 15.19 | |||||||||||||||||||
Dividends paid per common share, authorized | 0.05 | 0.05 | 0.05 | 0.05 | 0.05 | |||||||||||||||||||
Common shares outstanding, end of period (000s) | 16,527 | 16,527 | 16,527 | 16,527 | 16,526 | |||||||||||||||||||
First Federal: | Regulatory Minimum for "Well- Capitalized" | |||||||||||||||||||||||
Leverage capital ratio | 4.00 | % | 8.58 | % | 8.47 | % | 8.46 | % | 7.74 | % | 7.67 | % | ||||||||||||
Tier 1 risk-based capital ratio | 6.00 | 11.42 | 11.27 | 11.19 | 9.83 | 9.78 | ||||||||||||||||||
Total risk-based capital ratio | 10.00 | 12.69 | 12.55 | 12.46 | 11.10 | 11.05 |
1 See Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations - Use of Non-GAAP Measures
On January 27, 2010, First Financial’s shareholders approved a proposal to amend its Certificate of Incorporation to increase the number of authorized shares of common stock from 24,000,000 to 34,000,000 shares.
Contractual Obligations and Off-Balance Sheet Arrangements
Contractual obligations and off-balance sheet arrangements are described in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” in First Financial’s 2010 Annual Report on Form 10-K. There have been no material changes to those obligations or arrangements outside the ordinary course of business since the most recent fiscal year end.
Liquidity
First Federal Liquidity
An important component of First Federal’s asset/liability structure is the level of liquidity available to meet the needs of its customers and creditors. Primary sources of liquidity include deposit growth, loan repayments, investment maturities, asset sales, borrowings and interest received. Our desired level of liquidity is determined by management in conjunction with the Asset/Liability Committee (“ALCO”) of First Federal and officers of other affiliates. The level of liquidity is based on management’s strategic direction, commitments to make loans and the ALCO’s assessment of First Federal’s ability to generate funds. Management believes First Federal has sufficient liquidity to meet future funding needs.
First Federal’s primary sources of funds consist of retail and commercial deposits, borrowings from the FHLB and Federal Reserve, other short term borrowings, principal repayments on loans and mortgage-backed securities, securities sold under agreements to repurchase, the sale of loans and securities and brokered deposits. Each of First Federal’s sources of liquidity is subject to various uncertainties beyond the control of First Federal. As a measure of protection, First Federal has back-up sources of funds available, including excess borrowing capacity and excess liquidity in securities available for sale.
First Financial Liquidity
As a holding company, First Financial conducts its business through its subsidiaries. Unlike First Federal, First Financial is not subject to any regulatory liquidity requirements. Potential sources for First Financial’s payment of principal and interest on its borrowings, preferred and common stock dividends and for its future funding needs include dividends from First Federal and other subsidiaries, payments from existing cash reserves and sales of marketable securities, interest on our investment securities and additional borrowings or stock offerings. As of December 31, 2010, First Financial had liquid assets of $29.6 million compared with $26.1 million at September 30, 2010.
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Asset and Liability Management
First Federal’s treasury function manages the wholesale segments of the balance sheet, including investments, purchased funds, long-term debt and derivatives. Management’s objective is to achieve the maximum level of stable earnings over the long term, while controlling the level of interest rate risk, credit risk, market risk and liquidity risk, and optimizing capital utilization. Market risk reflects the risk of economic loss resulting from adverse changes in market price and interest rates. This risk of loss can be reflected in diminished current market values and/or reduced potential net interest income in future periods. Our market risk arises primarily from interest rate risk inherent in our lending, deposit-gathering, and other funding activities. The structure of our loan, investment, deposit, and borrowing portfolios is such that a significant increase in interest rates may adversely impact net market values and net interest income. In managing the investment portfolio to achieve its stated objective, First Federal invests predominately in U.S. Treasury and agency securities, MBS, asset-backed and collateralized debt securities, including trust preferred securities, corporate bonds and municipal bonds. Treasury strategies and activities are overseen by First Federal’s ALCO and the Investment Committee. ALCO activities are summarized and reviewed quarterly with the Board of Directors.
Interest Rate Risk
The nature of the banking business, which involves paying interest on deposits at varying rates and terms and charging interest on loans at other rates and terms, creates interest rate risk. As a result, net interest margin, earnings and the market value of assets and liabilities are subject to fluctuations arising from the movement of interest rates. First Federal manages several forms of interest rate risk, including asset/liability mismatch, basis risk and prepayment risk. Our profitability is affected by fluctuations in interest rates, thus we focus on maintaining a reasonable balance between exposure to interest rate fluctuations and earnings. A sudden and substantial increase in interest rates may adversely impact our earnings to the extent that the interest rates on interest-earning assets and interest-bearing liabilities do not change at the same speed, to the same degree or on the same basis.
Rate sensitive assets repricing within one year exceeded rate sensitive liabilities repricing within one year by $73.1 million or 2.21% of total assets as of December 31, 2010, compared with $82.9 million or 2.5% of total assets at September 30, 2010. This reflects a less asset-sensitive position than at September 30, 2010. Repricing gap analysis is limited in its ability to measure interest rate sensitivity. The repricing characteristics of assets, liabilities, and off-balance sheet derivatives can change in different interest rate scenarios, thereby changing the repricing position from that outlined above. Further, basis risk is not captured by repricing gap analysis. Basis risk is the risk that changes in interest rates will reprice interest-bearing liabilities differently from interest-earning assets, thus causing an asset/liability mismatch. This analysis does not take into consideration the repricing dynamics in adjustable-rate loans, such as minimum and maximum annual and lifetime interest rate adjustments and also the index utilized and whether the index is a current or lagging index. Included in the analysis are our estimates of prepayments of fixed-rate loans and mortgage-backed securities in a one-year period and our expectation that under current interest rates, certain advances of the FHLB of Atlanta will not be called and loans will not reprice due to floors. Also included in the analysis are our estimates of core deposit decay rates, based on recent studies and regression analysis of our core deposits.
We are essentially interest rate neutral; however, the slight positive gap normally indicates that a rise in market rates would have a positive effect on net interest income. The opposite would generally occur when an institution has a negative gap position. A negative gap would suggest that net interest income would increase if market rates declined.
Net interest income simulations were performed as of December 31, 2010 to evaluate the impact of market rate changes on net interest income over the subsequent 12 months assuming expected changes in balance sheet composition over that time period. If market interest rates were to increase immediately by 100 or 200 basis points net interest income would be expected to decrease by .32% and .69%, respectively, from what it would be if rates were to remain at December 31, 2010 levels. Based on GAP analysis we are asset sensitive, therefore interest income would be expected to increase in a rising rate environment. However, our net interest income is expected to decrease due to basis risk as our assets are generally forecast not to reprice to the same degree or pursuant to the same indices as our liabilities. Net interest income simulation for 100 and 200 basis point declines in market rates were not performed at December 31, 2010 as the results would not have been meaningful given the current levels of short-term market interest rates. Net interest income is not only affected by the level and direction of interest rates, but also by the shape of the yield curve, pricing spreads in relation to market rates, balance sheet growth, the mix of different types of assets and liabilities, and the timing of changes in these variables. Another measure, required to be performed by OTS-regulated institutions, is the test specified by OTS Thrift Bulletin No. 13A, “Interest Rate Risk Management.” This test measures the economic value of equity at risk by analyzing the impact of an immediate change in interest rates on the market value of portfolio equity. If market interest rates were to increase immediately by 100 or 200 basis points (a parallel and immediate shift in the yield curve), the economic value of equity would increase by 0.12% and decrease by 4.21%, respectively, from where it would be if rates were to remain at December 31, 2010 levels. During interest rate shock scenarios, the value of most interest-earning assets and interest-bearing liabilities move in linear proportion to changes in interest rates. However, as interest rates increase, the incremental value of the core deposit intangible and mortgage servicing rights assets does not increase in linear proportion. As a result, the economic value of equity decreases in the 200 basis point scenario because the increase in the value of these two assets does not offset the net decline in the value of the other assets and liabilities to the same extent as in the 100 basis point scenario. Scenarios different from those outlined above, whether different by timing, level, or a combination of factors, could produce different results.
Computation of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay rates, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions that we could undertake in response to changes in interest rates.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
There has been no material change in the information concerning quantitative and qualitative disclosures about market risk contained in Item 7A of First Financial’s 2010 Annual Report on Form 10-K, except as set forth in “Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations – Interest Rate Risk” of this Form 10-Q.
Item 4. Controls and Procedures
a) An evaluation of First Financial’s disclosure controls and procedures (as defined in Section 13a-15(e) or 15d-15(e) of the Securities Exchange Act of 1934 (the “Act”) was carried out under the supervision and with the participation of First Financial’s Chief Executive Officer, Chief Financial Officer and First Financial’s Disclosure Committee as of the end of the period covered by this quarterly report. In designing and evaluating First Financial’s disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Based on their evaluation, First Financial’s Chief Executive Officer and Chief Financial Officer concluded that First Financial’s disclosure controls and procedures as of December 31, 2010, are effective in ensuring that the information required to be disclosed by First Financial in the reports it files or submits under the Act is (i) accumulated and communicated to First Financial’s management (including the Chief Executive Officer and Chief Financial Officer) in a timely manner, and (ii) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
b) There have been no changes in First Financial’s internal control over financial reporting (as defined in Rule 13a-15(f) of the Act) that occurred during the quarter ended December 31, 2010, that has materially affected, or is reasonably likely to materially affect, First Financial’s internal control over financial reporting. First Financial does not expect that its internal control over financial reporting will prevent all error and all fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within First Financial have been detected. These inherent limitations include the realities that judgments in decision making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in cost-effective control procedures, misstatements due to error or fraud may occur and not be detected.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, First Financial is subject to various legal proceedings and claims which arise in the ordinary course of business. As of December 31, 2010, such litigation would not materially affect First Financial’s consolidated financial position or results of operations.
Item 1A. Risk Factors
There have been no material changes to the risk factors disclosed in First Financial’s 2010 Annual Report on Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults Upon Senior Securities
None.
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Item 4. Reserved
None.
Item 5. Other Information
None.
Item 6. Exhibits
EXHIBIT INDEX
Exhibit | ||
Number | Description | |
3.1 | First Financial's Certificate of Incorporation, as amended | |
3.3 | First Financial's Bylaws, as amended (incorporated by reference to First Financial's Form 8-K filed on December 22, 2010). | |
31.1 | Rule 13a-14(a)/15(d)-149a) Certificate of Chief Executive Officer | |
31.2 | Rule 13a-14(a)/15(d)-149a) Certificate of Chief Financial Officer | |
32 | Section 1350 Certificate of Chief Executivbe Officer and Chief Financial Officer |
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, First Financial Holdings, Inc. has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
FIRST FINANCIAL HOLDINGS, INC. | |
Date: February 9, 2011 | /s/ Blaise B. Bettendorf |
Blaise B. Bettendorf | |
Executive Vice President and Chief Financial Officer | |
(Principal Financial and Accounting Officer) |
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