FORM 10-Q
UNITED STATESSECURITIES AND EXCHANGE COMMISSION
[x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended MARCH 31, 2004
OR
[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___ to ____
Commission file number 0-12379
FIRST FINANCIAL BANCORP.
Registrant’s telephone number, including area code (513) 867-5447
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 X No __
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
INDEX
PART I — FINANCIAL INFORMATIONITEM I — FINANCIAL STATEMENTSFIRST FINANCIAL BANCORP. AND SUBSIDIARIESCONSOLIDATED BALANCE SHEETS(Dollars in thousands)
See notes to consolidated financial statements
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FIRST FINANCIAL BANCORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF EARNINGS(Unaudited)(Dollars in thousands, except per share data)
See notes to consolidated financial statements.
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FIRST FINANCIAL BANCORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited, dollars in thousands)
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FIRST FINANCIAL BANCORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)(Unaudited, dollars in thousands)
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FIRST FINANCIAL BANCORP. AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY(Unaudited, dollars in thousands)
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FIRST FINANCIAL BANCORP. AND SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTSMARCH 31, 2004(Unaudited, dollars in thousands)
The consolidated financial statements for interim periods are unaudited; however, in the opinion of the management of First Financial Bancorp. (Bancorp), all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation have been included.
NOTE 1: BASIS OF PRESENTATIONThe consolidated financial statements of Bancorp, a bank and savings and loan holding company, include the accounts of Bancorp and its wholly-owned subsidiaries — First Financial Bank, Community First Bank & Trust, Indiana Lawrence Bank, Fidelity Federal Savings Bank, Citizens First State Bank, Heritage Community Bank, The Clyde Savings Bank Company, Sand Ridge Bank, First Financial Bancorp Service Corp., First Financial (OH) Statutory Trust I and First Financial (OH) Statutory Trust II (both established to facilitate the issuance of trust preferred securities), and First Financial Capital Advisors, LLC, a registered investment advisory company. All significant intercompany transactions and accounts have been eliminated in consolidation.
The accompanying financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary to be in conformity with accounting principles generally accepted in the United States.
The consolidated balance sheet at December 31, 2003 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the First Financial Bancorp. Annual Report on Form 10-K for the year ended December 31, 2003.
Certain reclassifications of prior year’s amounts have been made to conform to current year presentation. Such reclassifications had no effect on earnings.
NOTE 2: FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISKIn the normal course of business, Bancorp offers a variety of financial instruments with off-balance sheet risk to its customers to aid them in meeting their requirements for liquidity and credit enhancement and to reduce its own exposure to fluctuations in interest rates. These financial instruments include standby letters of credit and commitments outstanding to extend credit. Accounting principles generally accepted in the United States do not require these financial instruments to be recorded in the consolidated balance sheets, statements of earnings, changes in shareholders’ equity or cash flows. However, a discussion of these instruments follows.
Bancorp’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit and commitments outstanding to extend credit is represented by the contractual amounts of those instruments. Bancorp uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Following is a discussion of these transactions.
Standby letters of credit are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party. Bancorp’s portfolio of standby letters of credit consists primarily of
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performance assurances made on behalf of customers who have a contractual commitment to produce or deliver goods or services. The risk to Bancorp arises from its obligation to make payment in the event of the customers’ contractual default. As of March 31, 2004, Bancorp had issued standby letters of credit aggregating $41,716 compared to $42,229 issued as of December 31, 2003. Management conducts regular reviews of these instruments on an individual customer basis, and the results are considered in assessing the adequacy of Bancorp’s allowance for loan losses. Management does not anticipate any material losses as a result of these letters of credit.
Loan commitments are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp evaluates each customer’s creditworthiness on an individual basis. The amount of collateral obtained, if deemed necessary by Bancorp upon extension of credit, is based on management’s credit evaluation of the counterparty. The collateral held varies, but may include securities, real estate, inventory, plant, or equipment. Bancorp had commitments outstanding to extend credit totaling $475,744 at March 31, 2004 and $480,632 at December 31, 2003. Management does not anticipate any material losses as a result of these commitments.
NOTE 3: COMPREHENSIVE INCOMEBancorp discloses comprehensive income in the “Consolidated Statements of Changes in Shareholders’ Equity”. Disclosure of the reclassification adjustments for the three months ended March 31, 2004 and 2003 are shown in the table below.
NOTE 4: ACCOUNTING FOR DERIVATIVESBancorp follows the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” in accounting for its derivative activities. Bancorp has interest rate swaps that are accounted for as fair value hedges under SFAS No. 133. Bancorp utilizes interest rate swap agreements to effectively modify its exposure to interest rate risk by converting certain fixed rate assets to a floating rate. The swap agreements involve receipt of floating rate amounts in exchange for fixed interest payments over the life of the agreements without an exchange of the underlying principal amount. The swaps are accounted for under the short-cut method. These contracts are designated as hedges of specific assets. The net interest receivable or payable on swaps is accrued and recognized as an adjustment to the interest income or expense of the
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hedged asset. At March 31, 2004 and 2003, Bancorp had interest rate swaps with a notional value of $12,122 and $7,845, respectively. The fair value of the swaps was an unrealized loss of $415 and $295 at March 31, 2004 and 2003, respectively. This amount is included with other assets on the balance sheet. A corresponding fair value adjustment was also included on the balance sheet as a hedged item.
Bancorp is exposed to losses if a counterparty fails to make its payment under a contract in which Bancorp is in the receiving position. Although collateral or other security may not be obtained, Bancorp minimizes its credit risk by monitoring the credit standing of each counterparty and believes that each will be able to fully satisfy its obligation under the agreement.
NOTE 5: CORPORATION-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY TRUST
The corporation-obligated mandatorily redeemable capital securities (the “capital securities”) of subsidiary trust, which appears on the balance sheet, are commonly known as Trust Preferred Securities. The subsidiary trust holds solely the junior subordinated debt securities of Bancorp (the “debentures”). Capital securities were issued in third quarter of 2003 by a statutory business trust — First Financial (OH) Statutory Trust II and the third quarter of 2002 by another statutory business trust — First Financial (OH) Statutory Trust I. Bancorp owns 100% of the common equity of both of the trusts. The trusts were formed with the sole purpose of issuing the capital securities and investing the proceeds from the sale of such capital securities in the debentures. The debentures held by the trust are the sole assets of the trust. Distributions on the capital securities are payable quarterly at a variable rate of interest, which is equal to the interest rate being earned by the trust on the debentures and are recorded as interest expense of Bancorp. The interest rate is variable and is subject to change every three months. The base index is three month LIBOR (London Inter-Bank Offered Rate). On March 31, 2004, the rates on Trust I and Trust II were 4.51% and 4.21%, respectively. Bancorp has the option to defer interest for up to five years on the debentures. However, the covenants prevent the payment of dividends on common stock if the interest is deferred. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. Bancorp has entered into agreements which, taken collectively, fully or unconditionally guarantee the capital securities subject to the terms of the guarantees. The debentures issued in 2003 are first redeemable, in whole or in part, by Bancorp on September 30, 2008 and mature on September 30, 2033. The amount outstanding, net of offering costs, as of March 31, 2004 was $20,000. The debentures issued in 2002 are first redeemable, in whole or in part, by Bancorp on September 25, 2007 and mature on September 25, 2032. The amount outstanding, net of offering costs, as of March 31, 2004 was $10,000.
During the first quarter of 2004, Bancorp deconsolidated the accounts of these trust preferred entities in accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46, “Consolidation of Variable Interest Entities”. The deconsolidation of the net assets increased Bancorp’s consolidated debt obligation by $930, the difference representing Bancorp’s common ownership in the trusts. The deconsolidation has no impact on Bancorp’s liquidity position because it continues to be obligated to repay the debentures held by the trust preferred entities and guarantees repayment of the capital securities issued by the trusts.
The debentures currently qualify as Tier I capital under Federal Reserve Board guidelines. The Federal Reserve Board is currently evaluating whether the capital securities will continue to qualify as Tier I capital due to the deconsolidation of the related trust preferred entities. If the Federal Reserve Board does not qualify the capital securities as Tier I capital, the effect of the change
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would be minimal to Bancorp’s regulatory capital ratios. Therefore, Bancorp would continue to have capital ratios that are well above the minimum regulatory requirements.
NOTE 6: STOCK OPTIONS
As of March 31, 2004, Bancorp had two stock-based compensation plans. Bancorp accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if Bancorp had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.
NOTE 7: EMPLOYEE BENEFIT PLANS
FASB Statement No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Postretirement Benefits”, requires additional disclosures about assets, obligations, cash flows, and net periodic benefit cost of defined benefit pension plans and other postretirement benefit plans. The provisions of this Statement are effective for interim periods beginning after December 15, 2003. The components for earlier interim periods presented for comparative purposes have been restated for the components of net benefit cost.
Bancorp sponsors a non-contributory defined benefit pension plan covering substantially all employees. Bancorp expects to contribute $5,691 to its pension plan in 2004. The following table sets forth information concerning amounts recognized in Bancorp’s Consolidated Balance Sheets and Consolidated Statements of Earnings.
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Some of Bancorp’s subsidiaries maintain health care and, in limited instances, life insurance plans for current retired employees. The following table sets forth the components of net periodic postretirement benefit costs.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act (the Act) of 2003 was enacted. Bancorp elected the deferral provided by Financial Staff Position No. FAS 106-1. Any measures of the net periodic postretirement benefit cost in the financial statements or the accompanying notes do not reflect the effects of the Act on the plan. Specific authoritative guidance on the accounting for the federal subsidy is pending and the guidance, when issued, could require Bancorp to change previously reported information. However, Bancorp anticipates the effect of this Act to be immaterial.
NOTE 8: OTHER MATTERS
Core deposit intangibles and mortgage servicing rights are to be amortized over their useful lives. Core deposit balances are being amortized over varying periods, none of which exceeds 10 years.
On April 30, 2004, Bancorp’s subsidiary, Indiana Lawrence Bank, North Manchester, Indiana, signed an agreement with Community State Bank, Royal Center, Indiana, for the assumption of approximately $4,500 in deposits, the purchase of approximately $8,000 in loans, and the purchase of the facilities of the Kewanna, Indiana, office. The impact of this sale is expected to be immaterial. Subject to regulatory approval, the sale is expected to be consummated on or before June 30, 2004.
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ITEM 2-MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND RESULTS OF OPERATIONSFIRST FINANCIAL BANCORP. AND SUBSIDIARIES(Unaudited, dollars in thousands)
SELECTED QUARTERLY FINANCIAL DATA
NET INTEREST INCOME
Net interest income, Bancorp’s principal source of earnings, is the amount by which interest and fees generated by earning assets exceed the interest costs of liabilities obtained to fund them. For analytical purposes, net interest income is also presented in the table below adjusted to a tax equivalent basis assuming a 35% marginal tax rate for interest earned on tax-exempt assets such as municipal loans, tax-free leases, and investments. This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets.
Net interest income for the first quarter of 2004 was $1,079 or 2.90% less than the first quarter of 2003. Bancorp’s net interest margin for 2004 was 4.00% compared to 4.37% in 2003.
The major contributing factor to the decline in net interest income was the net interest margin compression Bancorp experienced during 2003 due to the asset-sensitive position of Bancorp’s balance sheet. This margin compression was the result of the continued downward repricing of assets without a like decrease in deposit liability rates. The net interest margin began to stabilize in the fourth quarter of 2003 and this positive trend continued into the first quarter of 2004. On a linked-quarter basis (first quarter 2004 compared to fourth quarter 2003), net interest income increased $2,064. Of this increase, approximately $1,500 is attributable to the negative impact of the accelerated amortization in the fourth quarter of 2003 associated with a previously announced mobile home loan sale that closed as planned. Likewise, net interest margin on a linked-quarter basis increased 26 basis points to 4.00%. Of this increase in margin, 16 basis points is attributable
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to the fourth quarter 2003 impact of accelerated amortization. Bancorp also reviews net interest margin on a fully tax equivalent (non-GAAP) basis for peer comparison. Bancorp’s net interest margin on a fully tax equivalent basis decreased to 4.10% in the first quarter of 2004 compared with a 4.48% margin in the first quarter of 2003.
Average outstanding loan balances were 1.94% higher than in the first quarter of 2003. The primary area of loan growth from the prior year was the residential real estate category. This increase was achieved notwithstanding the $35,000 of loans sold in December related to both the sale of the Sunman, Indiana, banking center and the distressed loan sale that was announced and completed in 2003. On a linked-quarter basis, commercial and real estate construction loans exhibited growth as demand improved primarily in Bancorp’s southwestern Ohio market. This loan growth contributed positively to net interest income.
Deposit balances decreased $16,484 or 0.56% from a year ago, while average deposit balances increased $22,370 or 0.77% from a year ago. Deposit balances were impacted by the sale of two banking centers since the first quarter of 2003 which reduced deposit balances by approximately $53,000. Bancorp also opened three new banking centers in 2003, two of which were opened in the fourth quarter. Additionally, Bancorp opened a new banking center in Maineville, Ohio, in April of 2004 and plans to open three to five additional new banking centers in 2004 in growing markets.
* Margins are calculated using net interest income annualized divided by average earning assets
RATE/VOLUME ANALYSIS
The impact of changes in volume and interest rates on net interest income is illustrated in the following table. As shown, the effect of the increase in the volume of earning assets more than offset the effect of the increase in the volume of interest-bearing liabilities causing net interest income to increase $1,504. However, the decrease in market interest rates had a significant effect on Bancorp’s rates impacting both interest income and interest expense for the quarter ended March 31, 2004 in comparison to 2003, more than offsetting the positive effect of the increase in volume. The effect of the decrease in rates alone caused net interest income to decline $2,583. The net effect of changes in rates and volumes resulted in net interest income decreasing by $1,079. The decrease in rates affected interest income more significantly than interest expense due to the asset-sensitive position of Bancorp’s balance sheet. Bancorp’s adjustable and variable rate loans repriced downward at a greater magnitude than Bancorp was able to lower its deposit costs.
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The change in interest due to the combined effect of both rate and volume has been allocated to the volume and rate variance on a prorated basis.
OPERATING RESULTS
Net earnings for the first quarter of 2004 were $9,948 or $0.23 in diluted earnings per share versus $10,631 or $0.24 for the first quarter of 2003. Net securities losses for the first quarter of 2004 were $2 and net securities gains for the first quarter of 2003 were $18. A major contributing factor to the decrease in net earnings from a year ago was the $1,079 decrease in net interest income as outlined in the “Rate/Volume Analysis” and “Net Interest Income” sections. Noninterest expense which was $1,485 more than the same period a year ago also contributed to the decline in net earnings. A decline in the provision for loan loss expense of $614 from the first quarter of 2003 and an increase in noninterest income of $591 for the same period helped offset the previously discussed negative variances.
Noninterest income increased $591 or 4.27% in the first quarter of 2004 compared to the same period in 2003. Service charges on deposit accounts increased slightly over 2003, improving less than 1.00%. Trust revenues increased $185 or 4.99% as a result of year-over-year market value improvements. Other noninterest income was positively impacted by a gain of approximately $522 on life insurance due to the death of a retired senior executive officer of a Bancorp affiliate in 2003, recapture of impairment on the mortgage-servicing assets of approximately $246, and increased insurance agency revenue, partially offset by a decrease on gains on the sale of mortgage loans of $843.
Total noninterest expense for the first quarter of 2004 increased $1,485 or 4.68% from the first quarter of 2003. Salaries and employee benefits increased $328 or 1.80%. In the benefits category, reduced healthcare costs were partially offset by increased pension expense. Net occupancy expenses for 2004 increased $127 or 6.11% as a result of increased building rent, depreciation, and related expenses. Data processing expense increased $376 or 25.29% due primarily to a reclassification of certain credit card and merchant processing expenses from other noninterest expense. Other noninterest expense was impacted by costs associated with the mobile home loan sale completed in the quarter, direct consulting work in regard to Sarbanes-Oxley Section 404 internal control documentation and testing, and the executive search.
INCOME TAXES
Income tax expense for the first quarter of 2004 was $4,806, a decrease of $676 when compared to $5,482 reported for the same period in 2003. Tax expense relating to operating income totaled $4,807 and $5,472 for the quarters ended March 31, 2004 and 2003, respectively, with a $1 tax benefit related to securities transactions for the first quarter of 2004 and a $10 tax expense for 2003.
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ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management’s periodic evaluation of the adequacy of the allowance is based on Bancorp’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The evaluation of these factors is completed by a group of senior officers from the risk management, credit administration, financial, and lending areas.
The provision for loan losses totaled $2,600 for the three months ended March 31, 2004 or $614 less than the $3,214 recorded for the same period in 2003. Net charge-offs of $2,699 for the first quarter of 2004 were $387 lower than the $3,086 for the first quarter of 2003. Improvements in the level of commercial loans charged-off and strong recoveries on consumer loans previously charged-off positively impacted net charge-offs. The net charge-offs for the first quarter of 2004 were at the lowest level since December of 2002. The percentage of net charge-offs to average loans improved to 0.38% for 2004 compared to 0.45% for the same period in 2003. Bancorp continued to maintain appropriate reserves with an allowance to ending loans ratio of 1.68% at quarter end versus 1.74% for the same period last year. Bancorp will continue to closely monitor the quality of its loan portfolio and respond accordingly.
At March 31, 2004 and 2003, the recorded investment in loans that are considered to be impaired under FASB Statement No. 114 was $3,040 and $6,674, respectively, all of which were on a nonaccrual basis. The related allowance for loan losses on these impaired loans was $1,240 at March 31, 2004, and $941 at March 31, 2003. At March 31, 2004 and 2003, there were no impaired loans that did not have an allowance for loan losses. The average recorded investment in impaired loans for the quarter ended March 31, 2004, and 2003, was approximately $3,134 and $7,343. For the quarter ended March 31, 2004, Bancorp recognized interest income on those impaired loans of $52 compared to $20 for the same period in 2003. Bancorp recognizes income on impaired loans using the cash basis method. The table that follows indicates the activity in the allowance for loan losses for the quarters presented.
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NONPERFORMING/UNDERPERFORMING ASSETS
Total underperforming assets, which includes nonaccrual loans, restructured loans, other real estate owned, and loans 90 days or more past due and still accruing, decreased $2,404 or 6.54% to $34,374 at the end of the first quarter 2004 from $36,778 at the end of the first quarter 2003. On a linked quarter basis (first quarter 2004 compared to fourth quarter 2003), total underperforming assets decreased $506. Nonaccrual loans are composed primarily of commercial, multi-family, and 1-4 family residential properties. Nonaccrual loans increased $2,310 from the first quarter of 2003, while increasing $606 from the linked quarter. Restructured loans decreased to $3,373 from $6,291 a year ago. Other real estate owned increased $434 from the first quarter of 2003 while decreasing slightly from the linked quarter. Bancorp’s level of nonperforming assets over the last several quarters has been reflective of the uncertain economy in the corporation’s primary markets in Ohio and Indiana. In the first quarter of 2004, credit quality indicators stabilized and, in some cases, improved. The stabilization and improvement in regard to credit quality has been positively influenced by signs of economic improvement, strategies such as the fourth quarter 2003 distressed loan sale, and improved credit risk disciplines. Given the current economic environment, Bancorp expects continued stable to improving credit quality trends through 2004 although moderate fluctuations could occur as Bancorp continues to work through credit issues.
Accruing loans past due 90 days or more for the first quarter of 2004 compared to the first quarter of 2003 decreased $2,230 and compared to the linked quarter decreased $527. This represents the lowest level of 90 days past due loans in over five years. Accruing loans, including loans impaired under FASB Statement No. 114, which are past due 90 days or more, where there is not a likelihood of becoming current are transferred to nonaccrual loans. However, those loans which management believes will become current and therefore accruing are classified as “Accruing loans 90 days or more past due” until they become current. Bancorp does not have a concentration of credit in any particular industry.
The table that follows shows the categories which are included in nonperforming and underperforming assets.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity management is the process by which Bancorp provides for the continuing flow of funds necessary to meet its financial commitments on a timely basis. These commitments include withdrawals by depositors, funding credit commitments to borrowers, shareholder dividends, paying expenses of operations, and funding capital expenditures.
Liquidity is derived primarily from deposit growth, maturing loans, the maturity of investment securities, access to other funding sources and markets, and a strong capital position. Total year-to-date average deposits are up $22,370 or 0.77% from the prior year. However, average deposits on a linked quarter basis decreased $26,739 or 0.91%. Short-term borrowings decreased $63,718 or 24.61% from year-end, while long-term borrowings increased $31,636 or 9.80%, in conjunction with asset/liability management and funding strategies.
The principal source of asset-funded liquidity is marketable investment securities, particularly those of shorter maturities. At March 31, 2004, securities maturing in one year or less amounted to $36,122, representing 4.61% of the total of the investment securities portfolio. In addition, other types of assets such as cash and due from banks, federal funds sold and securities purchased under agreements to resell, as well as loans and interest-bearing deposits with other banks maturing within one year, are sources of liquidity. Total asset-funded sources of liquidity at March 31, 2004, amounted to $708,270, representing 18.07% of total assets. Sources of long-term asset funded liquidity are derived from the maturity of investment securities and maturing loans in excess of one year.
At March 31, 2004, Bancorp had classified $771,765 in investment securities available-for-sale. Management examines Bancorp’s liquidity needs in establishing this classification in accordance with the Financial Accounting Standards Board Statement No. 115 on accounting for certain investments in debt and equity securities.
Liquidity is very important and as such is both monitored and managed closely by the asset/liability committee at each affiliate. Liquidity may be used to fund capital expenditures. Capital expenditures were $2,077 for the first three months of 2004. In addition, remodeling is a planned and ongoing process given the 109 offices of Bancorp and its subsidiaries. Material commitments for capital expenditures as of March 31, 2004 were approximately $12,908 which primarily reflects commitments for three new facilities. Two of these facilities are full-service branches, the other building is a multi-level facility designed to serve as a hub in First Financial Bank’s southeastern Butler County, Ohio market. Management believes that Bancorp has sufficient liquidity to fund its current commitments.
CAPITAL ADEQUACY
The Federal Reserve established risk-based capital requirements for U.S. banking organizations which have been adopted by the Office of Thrift Supervision for savings and loan associations. Risk weights are assigned to on-and off-balance sheet items in arriving at risk-adjusted total assets. Regulatory capital is divided by risk-adjusted total assets, with the resulting ratios compared to minimum standards to determine whether a bank has adequate capital.
Regulatory guidelines require a 4.00% Tier 1 capital ratio, an 8.00% total risk-based capital ratio, and a 4.00% leverage ratio. Tier 1 capital consists primarily of common shareholders’ equity, net of certain intangibles, and total risked-based capital is Tier 1 capital plus Tier 2 supplementary capital, which is primarily the allowance for loan losses subject to certain limits. The leverage ratio is a result of Tier 1 capital divided by average total assets less certain intangibles.
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Bancorp’s Tier I ratio at March 31, 2004, was 13.19%, its total risked-based capital was 14.45% and its leverage ratio was 9.30%. While Bancorp subsidiaries’ ratios are well above regulatory requirements, management will continue to monitor the asset mix which affects these ratios due to the risk weights assigned various assets, and the allowance for loan losses, which influences the total risk-based capital ratio.
The table below illustrates the risk-based capital calculations and ratios for the last five quarters.
FORWARD-LOOKING INFORMATION
The Form 10-Q should be read in conjunction with the consolidated financial statements, notes and table included elsewhere in the report and in the First Financial Bancorp. Annual Report on Form 10-K for the year ended December 31, 2003.
Management’s analysis may contain forward-looking statements that are provided to assist in the understanding of anticipated future financial performance. However, such performance involves risks and uncertainties that may cause actual results to differ materially. Factors that could cause actual results to differ from those discussed in the forward looking statements include, but are not limited to, the strength of the local economies in which operations are conducted, the effects of and changes in policies and laws of regulatory agencies, inflation, and interest rates. For further discussion of certain factors that may cause such forward-looking statements to differ materially from actual results, refer to the 2003 Form 10-K.
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of Bancorp comply with accounting principles generally accepted in the United States and conform to general practices within the banking industry. These policies require estimates and assumptions. Changes in underlying factors, assumptions, or
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estimates in any of these areas could have a material impact on Bancorp’s future financial condition and results of operations. In management’s opinion, some of these areas have a more significant impact than others on Bancorp’s financial reporting. For Bancorp, these areas currently include accounting for the allowance for loan losses, pension costs, and goodwill.
Allowance for Loan Losses—The level of the allowance for loan losses is based upon management’s evaluation of the loan and lease portfolios, past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, economic conditions, and other pertinent factors. This evaluation is inherently subjective as it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The level of allowance maintained is believed by management to be adequate to cover losses inherent in the portfolio. The allowance is increased by provisions charged to expense and decreased by charge-offs, net of recoveries of amounts previously charged-off.
Pension—Bancorp sponsors a non-contributory defined benefit pension plan covering substantially all employees. In accordance with applicable accounting rules, Bancorp does not consolidate the assets and liabilities associated with the pension plan. At the end of 2003, Bancorp’s fair value of the plan assets was less than its benefit obligation. Therefore, Bancorp recognized an accrued benefit liability. The measurement of the accrued benefit liability and the annual pension expense involves actuarial and economic assumptions. The assumptions used in pension accounting relate to the discount rates, the expected return on plan assets, and the rate of compensation increase.
Goodwill—Statement of Financial Accounting Standards No. 141 “Business Combinations” and No. 142 “Goodwill and Other Intangible Assets” were issued in June of 2001 and were effective for fiscal years beginning after December 15, 2001. Under these rules, goodwill and intangible assets deemed to have indefinite lives, if any, will no longer be amortized, but will be subject to annual impairment tests in accordance with the Statements. Bancorp has selected October 1 as its date for annual impairment testing.
ACCOUNTING AND REGULATORY MATTERSThe $10,353 in lease financing presented on Bancorp’s balance sheet in the loan portfolio was reviewed in the first quarter of 2003 and has been determined to be largely operating leases rather than direct financing leases, as they are currently reported. Due to the immateriality of the lease portfolio, Bancorp will only change the prospective reporting of similar transactions. Amounts currently presented as direct financing leases will continue to be reported as such until their maturity in approximately 9 months. The related balance sheet and income statement impact of the misclassification is immaterial. The difference in presentation between direct financing leases and operating leases is in the asset classification on the balance sheet and the timing and classification of the income from the transactions. Operating leases are reported as fixed assets with periodic depreciation expense and rental income, whereas direct financing leases are reported as loan assets with periodic interest income.
Management is not aware of any other events or regulatory recommendations which, if implemented, are likely to have a material effect on Bancorp’s liquidity, capital resources, or operations.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
As described in Bancorp’s Form 10-K for the year ended December 31, 2003, Bancorp’s market risk is composed primarily of interest rate risk. There have been no material changes in market risk or the manner in which Bancorp manages market risk since December 31, 2003.
ITEM 4. CONTROLS AND PROCEDURES
Bancorp has established controls and other procedures designed to ensure that the information required to be disclosed in this report is recorded, processed, summarized, and reported within the required time periods (the “disclosure controls and procedures”). Bancorp’s Interim Chief Executive Officer and Chief Financial Officer, together with members of senior management, have evaluated the disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, Bancorp’s Interim Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures are effective (i) to ensure that material information relating to Bancorp, including its consolidated subsidiaries, is communicated to them on a timely basis, and (ii) to accomplish the purposes for which they were designed.
There were no changes in Bancorp’s internal control over financial reporting that occurred during the period covered by this report that have materially affected, or are reasonably likely to materially affect, Bancorp’s internal control over financial reporting.
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PART II-OTHER INFORMATION
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.
Issuer Purchases of Equity Securities (1)
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Item 6. Exhibits and Reports on Form 8-K.
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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 hereunto duly authorized.
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