First Financial Bank - 10-Q quarterly report FY

 

(Exact name of registrant as specified in its charter)

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     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

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     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of Exchange Act).

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

See notes to consolidated financial statements.

See notes to consolidated financial statements.

See notes to consolidated financial statements.

See notes to consolidated financial statements.

The consolidated financial statements for interim periods are unaudited; however, in the opinion of the management of First Financial Bancorp. (First Financial), all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation have been included.

The consolidated financial statements of First Financial, a bank holding company, include the accounts of First Financial and its wholly-owned subsidiaries — First Financial Bank, N.A. 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 U.S. generally accepted accounting principles for annual financial statements.

The consolidated balance sheet at December 31, 2005, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements for annual periods. 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, 2005.

First Financial adopted the provisions of SFAS No. 123(R), “Share-Based Payment,” effective January 1, 2006, using the modified-prospective transition method which requires measurement of compensation cost for all stock-based awards at fair value on date of grant and recognition of compensation expense over the service period for awards expected to vest. This Statement applies to all awards granted after January 1, 2006 and to awards modified, repurchased, or cancelled after that date. Prior to January 1, 2006, First Financial accounted for its stock options under the intrinsic value method of APB Opinion No. 25, “Accounting for Stock Issued To Employees” and related Interpretations, and applied the disclosure-only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” First Financial’s employee stock options have fixed terms and the exercise price of the stock options equals the market price on the date of grant. Therefore, no compensation cost was recognized for stock options prior to January 1, 2006.

Certain reclassifications of prior year’s amounts have been made to conform to current year presentation. Such reclassifications had no effect on earnings.

On September 16, 2005, First Financial completed the sale of substantially all of the assets and certain liabilities of its Fidelity Federal Savings Bank subsidiary to Mutual Federal Savings Bank, a subsidiary of MutualFirst Financial, Inc. of Muncie, Indiana. Fidelity Federal is reported as a discontinued operation for financial reporting purposes for all prior periods presented. The results of its operations and its cash flows have been removed from First Financial’s results of continuing operations for all periods presented.

The results of Fidelity Federal are presented as discontinued operations in a separate category on the income statement following the results from continuing operations. The income from discontinued operations for the three months ended March 31, 2005 is as follows:

In the normal course of business, First Financial 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. A discussion of these instruments follows.

First Financial’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. First Financial 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 First Financial to guarantee the performance of a customer to a third party. First Financial’s portfolio of standby letters of credit consists primarily of performance assurances made on behalf of customers who have a contractual commitment to produce or deliver goods or services. The risk to First Financial arises from its obligation to make payment in the event of the customers’ contractual default. As of March 31, 2006, First Financial had issued standby letters of credit aggregating $31,913 compared to $38,296 issued as of December 31, 2005. Management conducts regular reviews of these instruments on an individual customer basis, and the results are considered in assessing the need to provide for 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. First Financial evaluates each customer’s creditworthiness on an individual basis. The amount of collateral obtained, if deemed necessary by First Financial 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. First Financial had commitments outstanding to extend credit totaling $550,895 at March 31, 2006, and $523,276 at December 31, 2005. Management does not anticipate any material losses as a result of these commitments.

First Financial discloses comprehensive income in the “Consolidated Statements of Changes in Shareholders’ Equity.” Disclosure of the reclassification adjustments for the three months ended March 31, 2006, and 2005 are shown in the table below.

At March 31, 2006, the unfunded pension losses, net of taxes, recorded as accumulated comprehensive income are $7,562.

NOTE 5: DERIVATIVES

The use of derivative instruments allows a bank to meet the needs of its customers while reducing the interest-rate risk associated with certain transactions. In 2001, First Financial’s board of directors approved a policy authorizing the use of certain derivative products. The approved derivative instruments included interest rate caps, floors, and swaps. Currently, First Financial utilizes interest rate swaps as a means to offer long-term fixed-rate loans to commercial borrowers while maintaining the variable-rate income that better suits First Financial’s funding position. In this way, First Financial is able to effectively modify its exposure to interest-rate risk by converting certain fixed-rate assets to floating rate.

First Financial’s portfolio consists of interest-rate swaps that are accounted for as fair-value hedges. These swap agreements are designated as hedges of specific assets and are accounted for under the short-cut method. First Financial’s swap agreements involve the 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.

First Financial had interest rate swaps with a notional value of $25,725 at March 31, 2006, $23,909 at December 31, 2005, and $13,750 at March 31, 2005. The fair value of the swaps was an unrealized gain of $809 at March 31, 2006, $243 at December 31, 2005, and $195 at March 31, 2005. These amounts are included with other assets on the balance sheet. The corresponding fair-value adjustment is also included on the balance sheet with the hedged item.

Other long-term debt, which appears on the balance sheet, consists of junior subordinated debentures owed to two unconsolidated subsidiary trusts. Capital securities were issued in the third quarter of 2003 by a statutory business trust — First Financial (OH) Statutory Trust II and in the third quarter of 2002 by another statutory business trust — First Financial (OH) Statutory Trust I. First Financial 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 each 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 First Financial. The interest rate is variable and is subject to change every three months. The base index is the three-month LIBOR (London Inter-Bank Offered Rate). On March 31, 2006, the rates on Trust I and Trust II were 8.36% and 8.06%, respectively. First Financial 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. First Financial has entered into agreements which, taken collectively, fully or unconditionally guarantee the capital securities subject to the terms of the guarantees. The debentures qualify as Tier I capital under Federal Reserve Board guidelines. The debentures issued in 2003 are first redeemable, in whole or in part, by First Financial on September 30, 2008 and mature on September 30, 2033. The amount outstanding, net of offering costs, as of March 31, 2006, was $20,000. The debentures issued in 2002 are first redeemable, in whole or in part, by First Financial on September 25, 2007, and mature on September 25, 2032. The amount outstanding, net of offering costs, as of March 31, 2006, was $10,000.

First Financial adopted the provisions of SFAS No. 123(R) effective January 1, 2006, using the modified-prospective transition method, which requires measurement of compensation cost for all stock-based awards at fair value on the date of grant and recognition of compensation expense over the service period for awards expected to vest. Share-based compensation expense for stock options and restricted stock awards included in salaries and employee benefits expense was $319 at March 31, 2006. Total unrecognized compensation cost related to nonvested share-based compensation was $2,991 at March 31, 2006 and is expected to be recognized over a weighted average period of 2.6 years.

Under the intrinsic method of accounting, compensation expense had not been recognized in the prior year statements of earnings for stock-based compensation plans, other than for restricted stock awards. The following table illustrates the effect on net earnings and earnings per share if First Financial had applied the fair value recognition provisions of SFAS No. 123 to stock-based compensation in the first quarter 2005:

As of March 31, 2006, First Financial had two stock-based compensation plans. The 1991 Stock Incentive Plan provides incentive stock options and stock awards to certain key employees and non-qualified stock options to directors of First Financial who are not employees for up to 1,691,036 common shares of First Financial. The options are not exercisable for at least one year from the date of grant and are thereafter exercisable for such periods (which may not exceed 10 years) as the board of directors, or a committee thereof, specifies, provided that the optionee has remained in the employment of First Financial and its subsidiaries. All options expire at the end of the exercise period, and forfeited or expired options become available for re-issuance. On April 27, 1999, the shareholders approved the 1999 Stock Incentive Plan which provides for 7,507,500 shares for similar awards and options.

The fair value of stock options is determined using the Black-Scholes valuation model. The expected dividend yield is based on historical dividend payouts; the expected volatility is based on historical volatilities of company stock for a period approximating the expected life; the risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for periods corresponding with the expected life of the option; and the expected life represents the period of time the options are expected to be outstanding and is based on historical trends. The weighted average assumptions used in the computations are as follows (no stock options were granted during the first quarter 2005):

Activity in the above plan for the first quarter 2006 is summarized as follows:

Intrinsic value for stock options is defined as the difference between the current market value and the grant price. The total intrinsic value of options exercised during the first quarter 2006 was $180. The weighted average grant date fair value of options granted during the first quarter 2006 was $3.35. Cash received from stock options exercised during the quarter was $236, and the related tax benefit for tax deductions from stock options exercised totaled $101. First Financial uses treasury shares purchased under the company’s share repurchase program to satisfy share-based exercises.

Restricted stock awards have historically been recorded as deferred compensation, a component of shareholders’ equity at the fair value of these awards at the grant date and amortized on a straight-line basis to salaries and benefits expense over the specified vesting periods, which is currently four years. For awards granted prior to 2005, the vesting of the awards only required a service period to be met. Therefore, 25% of each grant would vest each of the four years. For the 2005 and 2006 restricted stock awards to vest, the company must meet a performance goal of 12.00% return on equity. Since the return on equity goal was not met in 2005 and the first quarter of 2006, 25% of the awards granted in 2005 and the first quarter of 2006 will not vest. However, if average return on equity for 2005 and 2006 is 12.00% or higher, the first year’s awards, as well as the second year’s awards, will vest in 2006.

The following is a summary of activity in restricted stock for the first quarter 2006:

The fair value of restricted stock is determined based on the number of shares granted and the quoted price of First Financial’s common stock. The total fair value of restricted stock vested during the first quarter 2006 was $1,089.

First Financial sponsors a non-contributory defined benefit pension plan covering substantially all employees. First Financial expects to contribute $7,578 to its pension plan in 2006. The following table sets forth information concerning amounts recognized in First Financial’s Consolidated Balance Sheets and Consolidated Statements of Earnings.

Some of First Financial’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.

Core deposit intangibles are amortized on a straight-line basis over their useful lives. Core deposit balances are being amortized over varying periods, none of which exceeds 10 years.

On April 25, 2006, First Financial’s subsidiary, First Financial Bank, N.A, signed a definitive agreement to sell its Southeastern Indiana banking offices to MainSource Bank, a subsidiary of MainSource Financial Group, Inc. of Greensburg, Indiana.

First Financial Bank signed a purchase and assumption agreement with MainSource Bank for the sale of approximately $30,000 in loans and property of the banking offices, and the assumption of approximately $56,000 in deposit accounts. The resulting financial impact for First Financial is an estimated pre-tax gain of approximately $4,500. Subject to regulatory approval, the sale is expected to be completed on or before September 30, 2006.

These ratios include earnings from continuing and discontinued operations.

On March 14, 2005, First Financial announced its new strategic plan for the organization. First Financial has made steady progress toward completing key elements of the plan in 2006. The areas of focus are the organizational restructure which was completed in 2005, the balance sheet restructure discussed in the net interest income section, the growth plan, and the Performance Improvement Plan.

The growth plan is moving forward. First Financial continues to work with a branding firm to evaluate its market position and brand identity in all markets and business lines and to define a brand strategy for the future. This process should be completed in the first half of 2006. The headquarters for the Cincinnati and Dayton markets have been selected. First Financial will continue to recruit sales staff, evaluate metropolitan markets for expansion, and consider strategic acquisitions to extend and expand the franchise.

The objective of the Performance Improvement Plan is to maximize revenue and develop the proper cost structure for the consolidated organization to achieve a peer-level efficiency ratio. First Financial has established a long-term target efficiency ratio of between 55% and 60%. Management remains confident that it can achieve this target. The largest component of the improvement is a $7,500 to $8,000 planned reduction in salary and benefits through eliminating approximately 200 staff positions. Over half of the staff changes will occur in the second quarter of 2006 and the remainder will occur before the end of the fourth quarter of 2006. These staff reductions are in addition to the estimated $5,000 in consolidation-related staff reductions announced and achieved as part of the strategic plan in March of 2005. Estimated severance charges associated with this staff reduction are $1,300 and will be recognized when incurred.

To date, approximately $1,500 to $2,000 in revenue enhancements have been identified. Enhancements are associated with better management of internal processes such as cash balances in branches and a planned redeployment in low and nonearning assets. These improvements will occur in the second and third quarters of 2006.

First Financial has completed its branch evaluation. The evaluation was conducted using a balanced approach that considered both geography and financial performance.

The remaining offices are expected to meet or exceed financial performance goals and are aligned with the strategic intentions of the company. First Financial will continue to concentrate future growth plans and capital investments in larger metropolitan markets, and continuing to operate in smaller markets. Smaller markets have historically provided stable, low-cost funding sources to First Financial and are an important part of the funding plan for the expansion in the commercial lending market. Furthermore, First Financial’s historical strength in a number of these markets should enable it to hold market share.

First Financial’s branch strategy is to serve a combination of metropolitan and non-metropolitan markets in Indiana, Ohio, and Kentucky. In addition to geographic fit, each market must have growth potential and the ability to meet profit targets.

Seven offices have been offered for sale in two distinct market areas: Michigan and Southern Indiana. Total deposits and loans for the offered offices are approximately $101,116 and $101,928, respectively. The Michigan market area includes 2 offices, Hastings and Gun Lake; and the Southern Indiana market includes 5 offices, Vevay, Vevay Drive-up, East Enterprise, Liberty, and Madison. Subject to regulatory approval, the sale of the Southern Indiana market is expected to be completed on or before September 30, 2006.

First Financial will close an additional 12 offices: in Ohio: Willshire, Mariemont, and Montgomery; in Indiana: West College Corner, Carthage, Montpelier, Winchester, Wabash, Warsaw, Ft. Wayne, and Burlington; in Kentucky: Petersburg. These closures are expected to have a minimal effect on the $72,000 in deposits and $84,000 in loans that will be serviced by other offices. The timing of the closures is expected to be in the third quarter of 2006 and the closures are subject to regulatory approval.

After the branch plan is executed, First Financial will have 87 offices serving 9 distinct markets with an average branch size of approximately $33 million. The operating model for growth includes market presidents managing distinct markets with the authority to make decisions at the point of client contact. The net financial impact of the branch sales is immaterial.

First Financial has entered into an agreement with Jack Henry & Associates Inc. to license their software applications, which will be used to provide primary core data processing. This in-house solution provides First Financial with a more cost-effective model. It is expected that the conversion to the Jack Henry system will occur in October of 2006, and should enhance First Financial’s capability to deliver client services in a better, faster, and more efficient manner.

This decision is consistent with its strategic plan and is an integral component of our comprehensive review of the use of technology. This review includes analysis of First Financial’s data and voice telecommunication usage, on-line and ATM services, and other ancillary services. Expected savings as a result of this comprehensive review are estimated to be between $3,000 and $4,000 per year and should be fully recognized in 2007. Costs associated with this conversion will include the early termination of some existing contracts. To-date, between $500 and $1,000 in likely early-termination penalties have been identified and will be recognized when incurred.

Net earnings for the first three months of 2006 were $3,967 or $0.10 in diluted earnings per share versus $10,726 or $0.25 for the first three months of 2005. Income from continuing operations for the three months ended March 31, 2006, was $3,967 or $0.10 in diluted earnings per share versus $10,532 or $0.25 in diluted earnings per share for the same period in 2005. The $6,565 decrease in income from continuing operations was due to several material items. The effects of the balance sheet restructure of $4,295 in prepayment penalties and the $476 in additional losses on investment securities had a combined effect of $0.08 per share in the quarter. Additionally, other items including losses on property sales, professional services related to the balance-sheet restructure, severance charges, and other expenses amounted to approximately $1,300 or $0.02 per share. In addition to the items above, First Financial has had increased recurring expenses related to the execution of its strategic plan of roughly $600 or $0.01 per share in reduced net interest income due to parent company borrowings used in the repurchase of shares in the fourth quarter of 2005. Additionally, the effects of mortgage loan runoff as part of the intended loan mix shift discussed in the strategic plan totaled approximately $400 or $0.01 per share in reduced net interest income. Other recurring items include increased pension expense and the effects of FAS 123R and state franchise taxes of approximately $600 or $0.01 cent per share.

Return on average assets of 0.45% for the first three months of 2006 compared to 1.13% for the same period in 2005. Return on average shareholders’ equity was 5.39% for the first three months of 2006 versus 11.73% for the comparable period in 2005.

First-quarter 2006 noninterest income was $14,754, a decrease of $282 or 1.88% from the first quarter of 2005, due primarily to the loss on investment securities of $476. Excluding the effects of the loss on sales of investment securities, noninterest income increased $194 or 1.29% over the same period. First Financial had quarterly increases in service charges on deposit accounts income of $923 which included the positive effects of its new overdraft program. Bankcard interchange income increased $228 due to both increased debit card issuance and usage, while life insurance income decreased $613 due to lower investment performance on a portion of the portfolio and gains on mortgage loan sales decreased $219 due to operating in an increasing rate environment.

On a linked-quarter basis, total noninterest income was up $5,375 or 57.31%. This increase was primarily due to the $6,519 impairment on investment securities recorded in the fourth quarter of 2005. This increase was somewhat offset by a decrease of $787 from a gain on mortgage loans sold in the fourth quarter. Excluding the effects of the loan sales and the impairment on investment securities, noninterest income increased $141 or 0.93% which was primarily due to an increase in recurring executive life insurance income of $229.

Trust revenues were relatively unchanged on both a linked-quarter and year-over-year basis due to the stability in market values of trust assets under management over the periods. First Financial has hired several new Wealth Resources Group personnel to facilitate its growth plans in this business.

Total noninterest expense increased $7,500 or 22.62% for the first quarter of 2006 from the first quarter of 2005. This increase was primarily due to $4,295 in debt extinguishment expense associated with the payoff of Federal Home Loan Bank borrowings of approximately $185,000 in the first quarter of 2006. Excluding the effect of the debt extinguishment, noninterest expense would have increased $3,205. Salaries and employee benefits increased $1,307 or 6.91% over the same period in 2005 due to $345 in increased salaries as additional sales and support staff was added. Also included in the quarter were $155 in severance charges and $537 in increased pension expense due to the use of updated mortality tables and adjustments made to reflect actual plan experience. Occupancy expense increased $490 due primarily to increased maintenance costs, utilities, and new building rent consistent with First Financial’s growth plans. Other noninterest expenses increased $1,355 or 23.39% due primarily to increases in credit and collection expense of $216 and loss on the sale of real estate owned and other property owned of $354.

On a linked-quarter basis (first quarter 2006 compared to fourth quarter 2005), noninterest expense was relatively flat excluding the effects of the prepayment penalty and an increase in data processing expenses more than offset by a reduction in professional services associated with restructuring. First Financial anticipates additional restructuring related expenses primarily in the data processing, professional services,

and severance charges. These amounts will be disclosed when quantified and recognized in the period in which they are incurred.

Net interest income, First Financial’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 that follows, 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. Management believes that it is a standard practice in the banking industry to present net interest margin and net interest income on a fully tax equivalent basis. Therefore, management believes these measures provide useful information to investors by allowing them to make peer comparisons. Management also uses these measures to make peer comparisons.

Net interest income for the first quarter of 2006 was $32,199, compared to $33,980 in the first quarter of 2005, a decline of 5.24% or $1,781. This decrease is due primarily to a managed decline in asset levels and borrowings at the parent company with a quarterly cost of $643. The borrowings at the parent company will be paid down over the next several quarters as dividends are paid from the subsidiary bank to the parent company. Net interest income on a linked-quarter basis increased $260 or 0.81%. This increase is due primarily to the mid-quarter impact of the balance-sheet restructure. First Financial’s net interest margin increased to 4.04% in the first quarter of 2006 from 3.98% in the first quarter of 2005. Linked-quarter net interest margin increased 32 basis points from 3.72% to 4.04% due to the combined effects of: the balance sheet restructure, 31 basis points; the asset sensitivity of the balance sheet, 7 basis points; and the negative effect of mortgage and indirect loan runoff, 6 basis points. Earning asset rates increased on approximately 30% of the loan portfolio with the Prime rate adjustments during the quarter. Approximately 90% of this $766 million Prime and Fed Funds-based portfolio repriced during the first quarter of 2006.

The Statistical Information that follows is presented on a GAAP basis.