SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For Quarter Ended September 30, 2002
------------------
Commission File Number 0-16759
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FIRST FINANCIAL CORPORATION
---------------------------
(Exact name of registrant as specified in its charter)
INDIANA 35-1546989
------- ----------
(State or other jurisdiction (I.R.S. Employer
Incorporation or organization) Identification No.)
One First Financial Plaza, Terre Haute, IN 47807
------------------------------------------ -----
(Address of principal executive office) (Zip Code)
(812)238-6000
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(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 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 __x___ No _____.
As of November 8, 2002 there were outstanding 6,822,284 shares without par
value, of the registrant.
FIRST FINANCIAL CORPORATION
FORM 10-Q
INDEX
PART I. Financial Information Page No.
--------
Item 1. Financial Statements:
Consolidated Statements of Condition................................................................3
Consolidated Statements of Income...................................................................4
Consolidated Statements of Shareholders' Equity and Comprehensive Income............................5
Consolidated Statements of Cash Flows...............................................................7
Notes to Consolidated Financial Statements..........................................................8
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..........................................10
Item 3. Interest Rate Risk and Quantitative and Qualitative Disclosures about Market Risk...........12
Item 4. Controls and Procedures.....................................................................13
PART II. Other Information:
Item 5. Other Information............................................................................14
Item 6. Exhibits and Reports on FORM 8-K.............................................................14
Signatures...........................................................................................15
Certification of Financial Results...................................................................16
2
FIRST FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CONDITION
(Dollar amounts in thousands, except per share data)
September 30, December 31,
2002 2001
---- ----
(Unaudited)
ASSETS
Cash and due from banks $72,727 $68,205
Federal funds sold and short-term investments 5,483 43,376
Securities, available-for-sale 531,449 463,509
Loans:
Commercial, financial and agricultural 325,825 302,496
Real estate - construction 45,737 34,610
Real estate - mortgage 779,494 757,345
Installment 272,958 249,710
Lease financing 3,627 5,023
----- -----
1,427,641 1,349,184
Less:
Unearned income 678 723
Allowance for loan losses 20,870 18,313
------ ------
1,406,093 1,330,148
Accrued interest receivable 14,181 14,948
Premises and equipment, net 29,524 26,237
Bank-owned life insurance 49,823 47,756
Goodwill 7,102 7,102
Other intangible assets 4,414 3,767
Other real estate owned 5,006 3,499
Other assets 34,338 33,358
------ ------
TOTAL ASSETS $2,160,140 $2,041,905
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Noninterest-bearing $150,005 $163,985
Interest-bearing:
Certificates of deposit of $100 or more 201,130 204,474
Other interest-bearing deposits 1,088,328 945,197
--------- -------
1,439,463 1,313,656
Short-term borrowings 25,259 54,596
Other borrowings 423,324 426,078
Other liabilities 33,326 30,064
------ ------
TOTAL LIABILITIES 1,921,372 1,824,394
--------- ---------
Shareholders' equity:
Common stock, $.125 stated value per share;
Authorized shares--40,000,000
Issued shares-7,225,483
Outstanding shares--6,822,284 in 2002 and 6,844,260 in 2001 903 903
Additional capital 66,680 66,680
Retained earnings 173,252 158,038
Accumulated other comprehensive income 15,343 8,299
Treasury shares, at cost - 398,199 in 2002 and 381,223 in 2001 (17,410) (16,409)
------ --------
TOTAL SHAREHOLDERS' EQUITY 238,768 217,511
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,160,140 $2,041,905
========== ==========
See accompanying notes.
3
FIRST FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Dollar amounts in thousands, except per share data)
Three Months Ended Nine Months Ended
September 30, September 30,
2001 2002 2002 2001
---- ---- ---- ----
(Unaudited) (Unaudited)
INTEREST INCOME:
Loans including related fees $ 26,314 $ 27,224 $ 79,737 $ 82,404
Securities:
Taxable 4,471 6,037 14,552 19,242
Tax-exempt 2,307 2,075 6,231 6,223
Other 743 712 2,460 2,127
--------- --------- --------- ---------
TOTAL INTEREST INCOME 33,835 36,048 102,980 109,996
--------- --------- --------- ---------
INTEREST EXPENSE:
Deposits 8,631 11,472 26,482 37,302
Short-term borrowings 127 753 575 2,131
Other borrowings 5,784 5,914 17,084 18,592
--------- --------- --------- ---------
TOTAL INTEREST EXPENSE 14,542 18,139 44,141 58,025
--------- --------- --------- ---------
NET INTEREST INCOME 19,293 17,909 58,839 51,971
Provision for loan losses 2,273 1,512 6,621 4,464
--------- --------- --------- ---------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN LOSSES 17,020 16,397 52,218 47,507
NON-INTEREST INCOME:
Trust department income 864 887 2,572 2,721
Service charges and fees on deposit accounts 1,590 1,384 4,557 4,018
Other service charges and fees 1,412 1,172 3,841 3,192
Securities gains - - (79) 172
Insurance commissions 1,739 1,394 4,583 2,167
Gain on sales of mortgage loans 1,003 618 2,293 1,352
Other 831 407 2,130 1,473
--------- --------- --------- ---------
TOTAL NON-INTEREST INCOME 7,439 5,862 19,897 15,095
--------- --------- --------- ---------
NON-INTEREST EXPENSES:
Salaries and employee benefits 9,466 7,881 26,823 21,843
Occupancy expense 882 920 2,691 2,692
Equipment expense 620 849 2,367 2,591
Printing and supplies expenses 768 141 1,279 608
Other 4,700 3,907 13,441 10,937
--------- --------- --------- ---------
TOTAL NON-INTEREST EXPENSE 16,436 13,698 46,601 38,671
--------- --------- --------- ---------
INCOME BEFORE INCOME TAXES 8,023 8,561 25,514 23,931
Provision for income taxes 1,852 2,268 6,063 5,948
--------- --------- --------- ---------
NET INCOME $ 6,171 $ 6,293 $ 19,451 $ 17,983
========= ========= ========= =========
EARNINGS PER SHARE:
Net Income $ 0.90 $ 0.92 $ 2.85 $ 2.63
========= ========= ========= =========
Weighted average number of shares outstanding (in thousands) 6,825 6,855 6,830 6,829
========= ========= ========= =========
See accompanying notes
4
FIRST FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
Three Months Ended
September 30, 2002 and 2001
(Dollar amounts in thousands, except per share data)
(Unaudited)
Accumulated
Other
Common Additional Retained Comprehensive Treasury
Stock Capital Earnings Income Stock Total
Balance, July 1, 2002 $ 903 $ 66,680 $167,081 $ 12,575 $(17,165) $230,074
Comprehensive income:
Net income 6,171 6,171
Change in net unrealized
gains/(losses) on available-
for- sale securities, 2,768 2,768
-----
Total comprehensive income 8,939
Treasury stock purchase (245) (245)
-------- -------- -------- -------- -------- --------
Balance, September 30, 2002 $ 903 $ 66,680 $173,252 $ 15,343 $(17,410) $238,768
======== ======== ======== ======== ======== ========
Balance, July 1, 2001 $ 903 $ 66,680 $149,504 $ 8,660 $(15,939) $209,808
Comprehensive income:
Net income 6,293 6,293
Change in net unrealized
gains/(losses) on available-
for-sale securities 3,596 3,596
-----
Total comprehensive income 9,889
Treasury stock purchase (240) (240)
-------- -------- -------- -------- -------- --------
Balance, September 30, 2001 $ 903 $ 66,680 $155,797 $ 12,256 $(16,179) $219,457
======== ======== ======== ======== ======== ========
See accompanying notes.
5
FIRST FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
AND COMPREHENSIVE INCOME
Nine Months Ended
September 30, 2002, and 2001
(Dollar amounts in thousands, except per share data)
(Unaudited)
Accumulated
Other
Common Additional Retained Comprehensive Treasury
Stock Capital Earnings Income/(Loss) Stock Total
>
Balance, January 1, 2002 $ 903 $ 66,680 $158,038 $ 8,299 $(16,409) $217,511
Comprehensive income:
Net income 19,451 19,451
Change in net unrealized
gains/(losses) on available-
for-sale securities 7,044 7,044
-----
Total comprehensive income 26,495
Cash dividends, $.62 per share (4,237) (4,237)
Treasury stock purchase (1,001) (1,001)
-------- -------- -------- -------- -------- --------
Balance, September 30, 2002 $ 903 $ 66,680 $173,252 $ 15,343 $(17,410) $238,768
======== ======== ======== ======== ======== ========
Balance, January 1, 2001 $ 903 $ 66,680 $141,653 $ 3,900 $(21,913) $191,223
Comprehensive income
Net income 17,983 17,983
Change in net unrealized
gains/(losses) on available-for-
sale securities 8,356 8,356
-----
Total comprehensive income 26,339
Cash dividends, $.56 per share (3,839) (3,839)
Issuance of treasury shares 6,801 6,801
Treasury stock purchase (1,067) (1,067)
-------- -------- -------- -------- -------- --------
Balance, September 30, 2001 $ 903 $ 66,680 $155,797 $ 12,256 $(16,179) $219,457
======== ======== ======== ======== ======== ========
See accompanying notes.
6
FIRST FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Nine Months Ended
September 30,
2002 2001
---- ----
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net Income $ 19,451 $ 17,983
Adjustments to reconcile net income to net cash
provided by operating activities:
Net accretion of discounts on investments (1,133) (1,558)
Provision for loan losses 6,621 4,464
Securities (gains)/losses 79 (172)
Depreciation and amortization 2,137 2,508
Other, net 1,509 2,427
--------- ---------
NET CASH FROM OPERATING ACTIVITIES 28,664 25,652
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Sales of available-for-sale securities 22,741 -
Maturities and principal reductions on available-for-sale securities 125,663 84,854
Purchases of available-for-sale securities (165,556) (24,045)
Loans made to customers, net of repayments 14,316 (43,267)
Net change in federal funds sold 37,893 2,675
Purchase of First Community Financial Corp. 14,554 -
Purchase of Forrest Sherer - (1,699)
Additions to premises and equipment (1,484) (1,967)
--------- ---------
NET CASH FROM INVESTING ACTIVITIES 48,127 16,551
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net change in deposits (20,829) (70,772)
Net change in short-term borrowings (34,475) 66,401
Dividends paid (8,210) (7,586)
Purchase of treasury stock (1,001) (1,067)
Proceeds from other borrowings 21,006 78,923
Repayments on other borrowings (28,760) (136,785)
--------- ---------
NET CASH FROM FINANCING ACTIVITIES (72,269) (70,886)
--------- ---------
NET CHANGE IN CASH AND CASH EQUIVALENTS 4,522 (28,683)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 68,205 68,755
--------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 72,727 $ 40,072
========= =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 45,527 $ 59,659
========= =========
Income taxes paid $ 8,547 $ 4,851
========= =========
See accompanying notes.
7
FIRST FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The accompanying September 30, 2002 and 2001 consolidated financial
statements are unaudited. The December 31, 2001 consolidated financial
statements are as reported in the First Financial Corporation (the Corporation)
2001 annual report. The following notes should be read together with notes to
the consolidated financial statements included in the 2001 annual report filed
with the Securities and Exchange Commission as an exhibit to Form 10-K.
1. The significant accounting policies followed by the Corporation and its
subsidiaries for interim financial reporting are consistent with the accounting
policies followed for annual financial reporting. All adjustments which are, in
the opinion of management, necessary for a fair statement of the results for the
periods reported have been included in the accompanying consolidated financial
statements and are of a normal recurring nature. The Corporation reports
financial information for only one segment, banking.
2. A loan is considered to be impaired when, based upon current information
and events, it is probable that the Corporation will be unable to collect all
amounts due according to the contractual terms of the loan. Impairment is
primarily measured based on the fair value of the loan's collateral. The
following table summarizes impaired loan information:
(000's)
September 30, December 31,
2002 2001
----- ----
Impaired loans with related allowance for loan losses calculated under
SFAS No. 114....................................................................................$3,402 $3,610
Interest payments on impaired loans are typically applied to principal
unless collection of the principal amount is deemed to be fully assured, in
which case interest is recognized on a cash basis.
3. Securities
The amortized cost and fair value of the Corporation's investments at
September 30, 2002 are shown below. All securities are classified as
available-for-sale.
(000's) (000's)
September 30, 2002 December 31, 2001
Amortized Cost Fair Value Amortized Cost Fair Value
-------------- ---------- -------------- ----------
United States Government and its agencies $179,613 $184,409 $208,973 $213,731
Collateralized Mortgage Obligations 66,647 70,064 4,958 5,065
States and Municipal 165,040 175,821 162,886 166,866
Corporate Obligations 99,328 100,155 77,576 77,847
------ ------- ------ ------
$510,628 $531,449 $454,393 $463,509
======== ======== ======== ========
4. Short-Term Borrowings
Period-end short-term borrowings were comprised of the following:
(000's)
September 30, December 31,
2002 2001
---- ----
Federal Funds Purchased $5,760 $9,920
Repurchase Agreements 14,732 37,400
Note Payable - U.S. Government 4,767 7,276
----- -----
$25,259 $54,596
======= =======
8
5. Other Borrowings
Other borrowings at period-end are summarized as follows:
(000's)
September 30, December 31,
2002 2001
---- ----
FHLB Advances $397,224 $419,478
Note Payable to a Financial Institution 19,500 -
City of Terre Haute, Indiana Economic Development Revenue bonds 6,600 6,600
----- -----
$423,324 $426,078
======== =======
6. Derivatives
During 2001, the Corporation purchased an interest rate cap contract with a
notional principal balance of $50 million. The agreement requires the
counterparty to pay the Corporation the excess of the 3 month LIBOR over 6.00%.
The cap has a 36 month term which runs through June, 2004. No payments are
currently required under the agreement. The agreement was entered into to help
protect the Corporation's net interest income should interest rates increase in
excess of the cap's trigger amount. The interest rate cap is carried at fair
value, approximately $7 thousand at September 30, 2002, and is included in other
assets on the statement of condition.
7. Acquisitions
Forrest Sherer, Inc. (FSI) - On May 1, 2001, the Corporation acquired all
of the outstanding common stock of FSI, a full-line insurance agency
headquartered in Terre Haute, Indiana. The purchase price was $8.5 million,
consisting of the issuance of 182,672 shares of the Corporation's common stock
and the payment of $1.7 million in cash. Assets acquired, liabilities assumed
and net assets at acquisition were not significant. The acquisition was
accounted for as a purchase and resulted in the recording of goodwill of
approximately $5.4 million and a customer list intangible of approximately $3.1
million. Prior to the adoption of new accounting guidance, effective January 1,
2002, goodwill was being amortized using the straight-line method over 15 years.
The customer list intangible is being amortized, using an accelerated method,
over ten years.
Community Financial Corporation (CFC) - On January 31, 2002, the
Corporation acquired all of the outstanding stock of CFC for $33 million in
cash. CFC is a bank holding company based in Olney, Illinois, which had total
assets of approximately $190 million and net assets of approximately $32 million
at acquisition. The fair values of significant assets acquired and liabilities
assumed were $98 million of loans, $48 million of cash and cash equivalents, $38
million of securities and $148 million of deposits. The transaction was
accounted for as a purchase and resulted in the recording of a core deposit
intangible of approximately $1 million.
The following table presents proforma revenue, net income, and earnings per
share determined as if the acquisitions had been consummated at January 1, 2001.
Key assumptions include the add back of the amortization of the intangible
assets of $230 thousand of FSI and CFC.
Nine months ended September 30,
(000's omitted,
except per share data)
2002 2001
---- ----
Revenue $123,737 $137,716
Net income 18,589 16,120
Earnings per share $ 2.72 $ 2.36
8. New Accounting Standards
A new accounting standard dealing with asset retirement obligations will
apply for 2003. The Corporation does not believe this standard will have a
material affect on its financial position or results of operations.
Effective January 1, 2002, the Corporation adopted a new accounting
standard dealing with the impairment and disposal of long-lived assets. The
effect of this on the financial position and results of operations of the
Corporation was not significant.
New accounting standards issued in 2001 required all business combinations
initiated after June 30, 2001 to be recorded using the purchase method of
accounting. Under the purchase method, all identifiable tangible and intangible
assets and liabilities of the acquired company are recorded at fair value at
date of acquisition, and the excess of cost over fair value of net assets
acquired is recorded as goodwill. Identifiable intangible assets with finite
useful lives will be separated from goodwill and amortized over their expected
lives, whereas goodwill, both amounts previously recorded and future amounts
purchased,
9
will cease being amortized on January 1, 2002. Annual impairment testing will be
required for goodwill with impairment being recorded if the carrying amount of
goodwill exceeds its implied fair value.
The Corporation adopted this standard on January 1, 2002 and ceased
amortizing goodwill associated with the acquisitions of The Morris Plan Company
of Terre Haute in 1998 and FSI in 2001. No additional goodwill has been recorded
during 2002 and management does not believe any amount of the goodwill recorded
by the Corporation is impaired. The $7.1 million of goodwill on the balance
sheet is net of accumulated amortization of $737 thousand.
Intangible assets at September 30, 2002, subject to amortization are as
follows:
(000's)
Accumulated
Gross Amount Amortization
------------ ------------
Customer list intangible $3,108 $ 625
Core deposit intangible 1,165 67
Branch purchase intangibles 981 496
Non-compete agreements 500 152
--- ---
$5,754 $1,340
====== ======
Amortization expense for the second quarter of 2002 and year to-date was
$172 thousand and $519 thousand respectively.
Estimated amortization expense for the next five years is:
(000's)
2002 691
2003 689
2004 689
2005 689
2006 681
If this standard had been in effect in 2001, net income for the three and
nine months ended September 30, 2001, would not have included goodwill
amortization of $100 thousand and $270 thousand and would have been $5.9 million
and $18.3 million. Earnings per share would have been $0.86 and $2.67.
FIRST FINANCIAL CORPORATION
ITEMS 2. and 3. Management's Discussion and Analysis of Financial Condition and
Results of Operations and Quantitative and Qualitative Disclosures About
Market Risk
The purpose of this discussion is to point out key factors in the
Corporation's recent performance compared with earlier periods. The discussion
should be read in conjunction with the financial statements beginning on page
four of this report. All figures are for the consolidated entities. It is
presumed the readers of these financial statements and of the following
narrative have previously read the Corporation's annual report for 2001.
Forward-looking statements contained in the following discussion are based
on estimates and assumptions that are subject to significant business, economic
and competitive uncertainties, many of which are beyond the Corporation's
control and are subject to change. These uncertainties can affect actual results
and could cause actual results to differ materially from those expressed in any
forward-looking statements in this discussion.
Summary of Operating Results
Net income for the nine months ended September 30, 2002 was $19.5 million,
an 8.2% improvement from the $18.0 million in the same period in 2001. Basic
earnings per share increased to $2.85 through the third quarter of 2002 compared
to $2.63 for 2001, an 8.4% improvement.
Third quarter net income was $6.2 million, a 1.9% decrease from net income
of $6.3 million in the third quarter of 2001. Compared to the same quarter last
year, earnings per share decreased 2.2% to $0.90 per share from $0.92 per share,
and the net interest margin increased 1.5% to 4.11% from 4.05%.
10
The primary components of income and expense affecting net income are
discussed in the following analysis.
Net Interest Income
The Corporation's primary source of earnings is net interest income, which
is the difference between the interest earned on loans and other investments and
the interest paid for deposits and other sources of funds. Net interest income
increased to $58.8 million in the first nine months of 2002 from $52.0 million
in the same period of 2001, a 13.2%, or $6.9 million increase. This was the
result of an increase of $161.4 million in average interest earning assets and
an improved net interest margin for 2002. The net interest margin increased from
3.9% in 2001 to 4.1% in 2002, a 3.5% increase driven by a greater decline in the
average cost of funds than in the yield on earning assets.
Non-Interest Income
Non-interest income increased $4.8 million, or 31.8%, over 2001, which was
driven by increases in fee-based income, higher gains from the sales of mortgage
loans and insurance commission income related to the recent acquisition of
Forrest Sherer, Inc. in May 2001.
Non-Interest Expenses
Non-interest expenses increased $7.9 million, or 20.5%, due mainly to added
costs, primarily personnel costs, associated with the recent acquisitions, as
well as increases in employee salaries and fringe benefit programs.
Allowance for Loan Losses
The Corporation's provision for loan losses increased to $6.6 million for
the first nine months of 2002 compared to $4.5 million in the same period of
2001. At September 30, 2002, the allowance for loan losses was 1.46% of net
loans, an increase from 1.36% at December 31, 2001. Net chargeoffs for the first
nine months of 2002 were $5.8 million compared to $6.0 million for the same
period of 2001. Based on management's analysis of the current portfolio, an
evaluation that includes consideration of historical loss experience and
potential loss exposure on identified problem loans, management believes the
allowance of $20.9 million at September 30, 2002 is adequate.
Nonperforming Loans and Leases
Nonperforming loans and leases consist of (1) nonaccrual loans and leases
on which the ultimate collectability of the full amount of interest is
uncertain, (2) loans and leases which have been renegotiated to provide for a
reduction or deferral of interest or principal because of a deterioration in the
financial position of the borrower, and (3) loans and leases past due ninety
days or more as to principal or interest. A summary of nonperforming loans and
leases at September 30, 2002 and December 31, 2001 follows:
(000's)
September 30, 2002 December 31, 2001
------------------ -----------------
Nonaccrual loans and leases $9,945 $8,854
Renegotiated loans and leases 574 590
Ninety days past due loans and leases 3,975 4,925
----- -----
Total nonperforming loans and leases $14,494 $14,369
======= =======
Ratio of the allowance for loan losses
as a percentage of nonperforming loans and leases 144% 127%
11
The following loan categories comprise significant components of the
nonperforming loans at September 30, 2002 and December 31, 2001.
(000's)
September 30, 2002 December 31, 2001
------------------ -----------------
Non-Accrual Loans:
1-4 family residential $2,010 $3,033
Commercial loans 6,336 4,406
Installment loans 1,599 1,415
Other, various - -
----- -----
$9,945 $8,854
====== ======
Past due 90 days or more:
1-4 family residential $1,821 $1,587
Commercial loans 1,201 2,177
Installment loans 953 1,161
Other, various - -
----- -----
$3,975 $4,925
====== ======
There are no material industry concentrations within the nonperforming
loans.
Interest Rate Sensitivity and Liquidity
The Corporation charges the nine subsidiary banks with monitoring and
managing their individual sensitivity to fluctuations in interest rates and
assuring that they have adequate liquidity to meet loan demand or any potential
unexpected deposit withdrawals. This function is facilitated by the
Asset/Liability Committee (the Committee). The primary goal of the committee is
to maximize net interest income within the interest rate risk limits approved by
the Board of Directors. This goal is accomplished through management of the
subsidiary bank's balance sheet liquidity and interest rate risk exposures due
to the changes in economic conditions and interest rate levels.
Interest Rate Risk and Quantitative and Qualitative Disclosures About Market
Risk
Management considers interest rate risk to be the Corporation's most
significant market risk. Interest rate risk is the exposure to changes in net
interest income as a result of changes in interest rates. Consistency in the
Corporation's net income is largely dependent on the effective management of
this risk.
The Committee reviews a series of monthly reports to ensure that
performance objectives are being met. It monitors and controls interest rate
risk through earnings simulation. Simulation modeling measures the effects of
changes in interest rates, changes in the shape of the yield curve, and changes
in prepayment speeds on net interest income. The primary measure of Interest
Rate Risk is "Earnings at Risk." This measure projects the earnings effect of
various rate movements over the next three years on net interest income. It is
important to note that measures of interest rate risk have limitations and are
dependent upon certain assumptions. These assumptions are inherently uncertain
and, as a result, the model cannot precisely predict the impact of interest rate
fluctuations on net interest income. Actual results will differ from simulated
results due to timing, frequency, and amount of interest rate changes as well as
overall market conditions. The Committee has performed a thorough analysis and
believes the assumptions to be valid and theoretically sound. The relationships
are continuously monitored for behavioral changes.
As outlined in Note 6, the Corporation makes limited use of derivatives to
facilitate its interest rate risk management activities. The Corporation
currently does not invest in derivative products for short-term gain, nor is
engaged in securities trading activity. The Corporation invests in assets whose
value is derived from an underlying asset. These assets include government
agency issued mortgage-backed securities. The performance of these assets in
changing rate environments and the impact of derivatives are included in the
following table.
The table below shows the Corporation's estimated earnings sensitivity
profile as of September 30, 2002. Given a 100 basis point increase in rates, net
interest income would increase 1.78% over the next 12 months and increase 7.02%
over the second 12 month period. A 100 basis point decrease would result in a
1.79% decrease in net interest income over the next 12 months and a 6.79%
decrease over the second 12 month period. These estimates assume all rates
changed overnight and management took no action as a result of this change.
12
Basis Point Percentage Change in Net Interest Income
----------------------------------------
Interest Rate Change 12 months 24 months 36 months
-------------------------------------------------------------------------------------
Down 300 -9.71 -23.46 -29.74
Down 200 -5.46 -15.00 -19.12
Down 100 -2.87 -7.67 -9.65
Up 100 2.96 8.03 10.31
Up 200 6.55 17.28 21.89
Up 300 9.86 25.12 31.99
The Corporation does have other assets and liabilities, which contain
embedded options, most notably callable agency securities, and putable Federal
Home Loan Bank advances. The securities pay a premium rate and the advances
charge a discounted rate in exchange for the option. Therefore, there is a
benefit to current income from using these products. Management believes these
put and call options are clearly and closely related to the underlying
instruments and that they are therefore not considered derivatives. Typical rate
shock analysis does not reflect management's ability to react and thereby reduce
the effects of rate changes, and represents a worst case scenario. The model
assumes no actions are taken and prices change to the full extent of the rate
shock.
Liquidity Risk
Liquidity is measured by each bank's ability to raise funds to meet the
obligations from its customers, including deposit withdrawals and credit needs.
This is accomplished primarily by maintaining sufficient liquid assets in the
form of investment securities and core deposits. The Corporation has $15.3
million of investments that mature throughout the coming 12 months. The
Corporation also anticipates $59.8 million of principal payments from
mortgage-backed securities. Given the current interest rate environment, the
Corporation anticipates $19.8 million of securities to be called within the next
12 months. With these sources of funds, the Corporation currently anticipates
adequate liquidity to meet the expected obligations of its customers.
Financial Condition
Comparing 2002 to 2001, year-to-date average deposits were up $180.1
million, or 13.9%. These deposits were used to fund an increase in total average
loans of $125.5 million, or 9.6%, and pay down average borrowings by $36.9
million. Average assets increased $175.7 million, or 8.6%, and average
shareholders' equity increased $27.3 million, or 13.0%. Book value per share
increased 9.2% to $35.00 in 2002 from $32.04 in 2001.
The purchase of Community Bank and Trust, N.A was consummated on January
31, 2002. The average balances reported above include Community's $94.5 million
of average loans, $130.3 million of average deposits, and $161.2 million of
average total assets.
Capital Adequacy
As of September 30, 2002, the Corporation's leverage ratio was 10.45%
compared to 9.87% at December 31, 2001.
At September 30, 2002, the Corporation's total risk-based capital ratio,
which includes Tier II capital, was 15.80% compared to 15.15% at December 31,
2001. These amounts exceed minimum regulatory capital requirements.
ITEM 4. Controls and Procedures
(a) Within the 90-day period prior to the filing date of this report, an
evaluation was carried out under the supervision and with the participation of
First Financial Corporation's management, including our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of our disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14(c) and 15d-14(c) under the
Securities Exchange Act of 1934). Based on their evaluation, our Chief Executive
Officer and Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are, to the best of their knowledge, effective.
(b) Subsequent to the date of their evaluation, our Chief Executive Officer and
Chief Financial Officer have concluded that there were no significant changes in
First Financial Corporation's internal controls or in other factors that could
significantly affect its internal controls, including any corrective actions
with regard to significant deficiencies and material weaknesses.
13
FIRST FINANCIAL CORPORATION
PART II OTHER INFORMATION
FORM 10-Q
Item 5 Other Information
At the October 15, 2002 board meeting, Norman L. Lowery was named by the
Board of Directors as the Chief Executive Officer of the Corporation.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits
3 (i) Articles of Incorporation of First Financial Corporation
3(ii) By-laws of First Financial Corporation
10.1 Deferred Compensation Agreement and Split Dollar Insurance
Agreement for Donald E. Smith
10.2 Employment Agreement for Norman L. Lowery
10.3 2001 Long-Term Incentive Plan of the Corporation
99.1 Chief Executive Officer and Chief Financial Officer Certification
pursuant to 18 U.S.C. Section 1350
(b) No reports on Form 8-K were filed during the quarter of the fiscal year
for which this report is filed.
14
FIRST FINANCIAL CORPORATION
PART II OTHER INFORMATION
FORM 10-Q
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
FIRST FINANCIAL CORPORATION
---------------------------
(Registrant)
Date: November 14, 2002 By /s/ Donald E. Smith
-------------------------
Donald E. Smith, Chairman
Date: November 14, 2002 By /s/ Norman L. Lowery
-------------------------
Norman L. Lowery, Vice Chairman
Date: November 14, 2002 By /s/ Michael A. Carty
-------------------------
Michael A. Carty, Treasurer
15
CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER
I, Norman L. Lowery, certify that:
1) I have reviewed this quarterly report on Form 10-Q of First Financial
Corporation;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
Signed: /s/ Norman L. Lowery
-------------------------
Norman L. Lowery,
Vice Chairman and CEO
16
CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER
I, Michael A. Carty, certify that:
1) I have reviewed this quarterly report on Form 10-Q of First Financial
Corporation;
2) Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3) Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4) The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5) The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6) The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: November 14, 2002
Signed: /s/ Michael A. Carty
------------------------
Michael A. Carty,
Treasurer and CFO
17