1 FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington D.C. 20549 [x] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended SEPTEMBER 30, 1998 ------------------------------------------- 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. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 31-1042001 ---------------------------------------- ------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 300 High Street, Hamilton, Ohio 45011 ---------------------------------------- ------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (513) 867-4700 ------------------------- 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 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Outstanding at November 12, 1998 ----------------------------- ---------------------------------- Common stock, No par value 32,909,629
2 FIRST FINANCIAL BANCORP. INDEX <TABLE> <CAPTION> Page No. -------- <S> <C> PART I-FINANCIAL INFORMATION Consolidated Balance Sheets - September 30, 1998 and December 31, 1997 1 Consolidated Statements of Earnings - Nine Months and Three Months Ended September 30, 1998 and 1997 2 Consolidated Statements of Comprehensive Income - Nine Months and Three Months Ended September 30, 1998 and 1997 3 Consolidated Statements of Cash Flows - Nine Months Ended September 30, 1998 and 1997 4 Notes to Consolidated Financial Statements 6 Management's Discussion and Analysis of Financial Condition and Results of Operations 8 PART II-OTHER INFORMATION Item 6 Exhibits and Reports on Form 8-K 14 SIGNATURES 15 </TABLE>
3 PART I - FINANCIAL INFORMATION FIRST FINANCIAL BANCORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited, dollars in thousands) <TABLE> <CAPTION> September 30, December 31, 1998 1997 ------------ ---------- <S> <C> <C> ASSETS Cash and due from banks $ 123,398 $ 142,334 Interest-bearing deposits with other banks 2,677 3,487 Federal funds sold and securities purchased under agreements to resell 4,850 18,773 Investment securities held-to-maturity, at cost (market value - $40,551 at September 30, 1998 and $60,961 at December 31, 1997) 37,926 58,347 Investment securities available-for-sale, at market value (cost of $329,212 at September 30, 1998 and $329,261 at December 31, 1997) 333,489 332,617 Loans Commercial 593,730 502,919 Real estate-construction 75,846 63,308 Real estate-mortgage 1,011,366 927,985 Installment 469,565 439,744 Credit card 16,405 17,369 Lease financing 29,150 27,260 ---------- ---------- Total loans 2,196,062 1,978,585 Less Unearned income 2,626 1,554 Allowance for loan losses 29,397 27,510 ----------- ---------- Net loans 2,164,039 1,949,521 Premises and equipment 48,602 47,013 Deferred income taxes 2,614 3,070 Accrued interest and other assets 92,122 80,949 ---------- ---------- TOTAL ASSETS $2,809,717 $2,636,111 ========== ========== LIABILITIES Deposits Noninterest-bearing $ 283,543 $ 314,051 Interest-bearing 1,965,059 1,916,127 ---------- ---------- Total deposits 2,248,602 2,230,178 Short-term borrowings Federal funds purchased and securities sold under agreements to repurchase 61,790 46,638 Federal Home Loan Bank borrowings 67,950 2,000 Other 468 3,650 ---------- ---------- Total short-term borrowings 130,208 52,288 Long-term borrowings 101,216 41,054 Accrued interest and other liabilities 27,307 26,332 ---------- ---------- TOTAL LIABILITIES 2,507,333 2,349,852 SHAREHOLDERS' EQUITY Common stock - no par value Authorized - 60,000,000 shares Issued - 33,125,023 in 1998 and 16,558,108 in 1997 231,767 232,593 Retained earnings 69,422 51,973 Unrealized net gains on investment securities available-for-sale, net of deferred income taxes 2,707 2,094 Restricted stock awards (444) (338) Treasury stock, at cost, 37,694 and 1,319 shares (1,068) (63) ---------- ---------- TOTAL SHAREHOLDERS' EQUITY 302,384 286,259 ---------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $2,809,717 $2,636,111 ========== ========== </TABLE> See notes to consolidated financial statements. 1
4 FIRST FINANCIAL BANCORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF EARNINGS (Unaudited) (Dollars in thousands, except per share data) <TABLE> <CAPTION> Nine months ended Three months ended September 30, September 30, -------------------- -------------------- 1998 1997 1998 1997 --------- --------- --------- --------- <S> <C> <C> <C> <C> INTEREST INCOME Loans, including fees $ 143,294 $ 122,298 $ 49,590 $ 42,580 Investment securities Taxable 16,299 14,917 5,235 5,059 Tax-exempt 2,931 3,779 866 1,173 --------- --------- --------- --------- Total investment interest 19,230 18,696 6,101 6,232 Interest-bearing deposits with other banks 213 180 80 47 Federal funds sold and securities purchased under agreements to resell 370 380 70 59 --------- --------- --------- --------- TOTAL INTEREST INCOME 163,107 141,554 55,841 48,918 INTEREST EXPENSE Deposits 60,213 51,810 20,384 17,727 Short-term borrowings 3,311 4,304 1,545 1,766 Long-term borrowings 2,400 489 955 165 --------- --------- --------- --------- TOTAL INTEREST EXPENSE 65,924 56,603 22,884 19,658 --------- --------- --------- --------- NET INTEREST INCOME 97,183 84,951 32,957 29,260 Provision for loan losses 4,066 3,059 1,618 1,076 --------- --------- --------- --------- Net interest income after provision for loan losses 93,117 81,892 31,339 28,184 NONINTEREST INCOME Service charges on deposit accounts 8,812 7,560 3,051 2,677 Trust income 8,426 7,024 2,907 2,222 Investment securities gains 494 29 157 22 Other 6,444 4,894 2,378 2,169 --------- --------- --------- --------- Total noninterest income 24,176 19,507 8,493 7,090 NONINTEREST EXPENSES Salaries and employee benefits 36,418 31,066 12,209 10,845 Net occupancy expenses 4,246 3,790 1,446 1,288 Furniture and equipment expenses 3,602 3,298 1,180 1,086 Data processing expenses 4,133 3,680 1,433 1,263 Deposit insurance expense 347 263 149 91 State taxes 1,289 1,277 448 439 Other 18,313 14,003 6,147 5,134 --------- --------- --------- --------- Total noninterest expenses 68,348 57,377 23,012 20,146 --------- --------- --------- --------- Income before income taxes 48,945 44,022 16,820 15,128 Income tax expense 16,598 14,364 5,644 4,898 --------- --------- --------- --------- NET EARNINGS $ 32,347 $ 29,658 $ 11,176 $ 10,230 ========= ========= ========= ========= Net earnings per share-basic $ 0.98 $ 0.90 $ 0.34 $ 0.31 ========= ========= ========= ========= Net earnings per share-diluted $ 0.97 $ 0.89 $ 0.34 $ 0.31 ========= ========= ========= ========= Cash dividends declared per share $ 0.45 $ 0.43 $ 0.15 $ 0.15 ========= ========= ========= ========= Average shares outstanding 33,107,710 33,087,047 33,105,893 33,108,160 ========== ========== ========== ========== </TABLE> See notes to consolidated financial statements. 2
5 FIRST FINANCIAL BANCORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited) (Dollars in thousands) <TABLE> <CAPTION> Nine months ended Three months ended September 30, September 30, --------------------- ------------------- 1998 1997 1998 1997 ---------- --------- --------- -------- <S> <C> <C> <C> <C> NET INCOME $ 32,347 $ 29,658 $ 11,176 $ 10,230 Other comprehensive income, net of tax: Unrealized gains on securities: Unrealized holding gains arising during period 935 808 1,224 560 Less: reclassification adjustment for gains included in net income 322 25 101 13 ---------- --------- --------- -------- Other comprehensive income 613 783 1,123 547 ---------- --------- --------- -------- COMPREHENSIVE INCOME $ 32,960 $ 30,441 $ 12,299 $ 10,777 ========== ========= ========= ======== </TABLE> 3
6 FIRST FINANCIAL BANCORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited, dollars in thousands) <TABLE> <CAPTION> Nine months ended September 30, ----------------------- 1998 1997 ---------- ---------- <S> <C> <C> OPERATING ACTIVITIES Net earnings $ 32,347 $ 29,658 Adjustments to reconcile net earnings to net cash provided by operating activities Provision for loan losses 4,066 3,059 Provision for depreciation and amortization 6,128 3,761 Net amortization of investment security premiums and accretion of discounts 195 344 Realized investment security gains (494) (29) Originations of mortgage loans held for sale (117,161) (42,452) Gains from sales of mortgage loans held for sale (1,609) (529) Proceeds from sale of mortgage loans held for sale 118,770 42,981 Deferred income taxes 59 450 Increase in interest receivable (1,570) (2,504) Increase in cash surrender value of life insurance (5,250) (3,289) Decrease (increase) in prepaid expenses 44 (977) Increase (decrease) in accrued expenses 1,977 (108) Increase in interest payable 456 89 Other (3,515) (1,468) --------- --------- Net cash provided by operating activities 34,443 28,986 INVESTING ACTIVITIES Proceeds from sales of investment securities available-for-sale 31,387 501 Proceeds from calls, paydowns and maturities of investment securities available-for-sale 110,160 85,659 Purchases of investment securities available-for-sale (121,234) (90,959) Proceeds from calls, paydowns and maturities of investment securities held-to-maturity 23,577 20,440 Purchases of investment securities held-to-maturity (2,100) (1,240) Net decrease in interest-bearing deposits with other banks 810 1,835 Net decrease in federal funds sold and securities purchased under agreements to resell 13,959 21,356 Net increase in loans and leases (182,252) (109,524) Recoveries from loans and leases previously charged off 814 745 Proceeds from disposal of other real estate owned 1,139 448 Cash acquired in merger 0 8,288 Purchase of other financial institutions, net of cash acquired (12,231) (5,909) Purchases of premises and equipment (4,177) (2,449) --------- --------- Net cash used in investing activities (140,148) (70,809) FINANCING ACTIVITIES Net decrease in total deposits (34,374) (30,538) Net increase in short-term borrowings 77,920 69,775 Increase in long-term borrowings 60,162 5,627 Cash dividends declared (14,899) (13,990) Purchase of common stock (2,828) 0 Proceeds from exercise of stock options, net of shares purchased 788 508 --------- --------- Net cash provided by financing activities 86,769 31,382 --------- --------- DECREASE IN CASH AND CASH EQUIVALENTS (18,936) (10,441) Cash and cash equivalents at beginning of period 142,334 110,767 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $123,398 $100,326 ========= ========= </TABLE> 4
7 FIRST FINANCIAL BANCORP. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (Unaudited) (Dollars in thousands) <TABLE> <CAPTION> Nine months ended September 30, ---------------------- 1998 1997 ---------- --------- <S> <C> <C> Supplemental disclosures Interest paid $ 65,310 $ 58,472 ======== ======== Income taxes paid $ 14,920 $ 16,465 ======== ======== Recognition of deferred tax liabilities attributable to FASB Statement No. 115 $ (307) $ (465) ======== ======== Acquisition of other real estate owned through foreclosure $ 1,048 $ 903 ======== ======== Issuance of restricted stock awards $ 215 $ 226 ======== ======== </TABLE> See notes to consolidated financial statements. 5
8 FIRST FINANCIAL BANCORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 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 PRESENTATION The consolidated financial statements of Bancorp, a bank and savings and loan holding company, include the accounts of Bancorp and its wholly-owned subsidiaries - First National Bank of Southwestern Ohio, Community First Bank & Trust, Union Trust Bank, Indiana Lawrence Bank, Fidelity Federal Savings Bank, Citizens First State Bank, Home Federal Bank, A Federal Savings Bank, Union Bank & Trust Company, The Clyde Savings Bank Company, Peoples Bank and Trust Company, Bright National Bank, First Finance Mortgage Company of Southwestern Ohio (d.b.a. Community First Finance), Farmers State Bank, National Bank of Hastings, and Vevay Deposit Bank. All significant intercompany transactions and accounts have been eliminated in consolidation. Intangible assets arising from the acquisition of subsidiaries are being amortized over varying periods, none of which exceeds 25 years. Core deposit balances are being amortized over varying periods, none of which exceeds 10 years. 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 generally accepted accounting principles. On April 28, 1998, the Board of Directors approved a 2 for 1 stock split, issued to shareholders of record as of May 8, 1998, and distributed on June 1, 1998. All per share amounts have been restated for all periods presented. Also on April 28, 1998, the shareholders approved an amendment to the Articles of Incorporation to eliminate the par value of Bancorp's common shares. NOTE 2: FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK In 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. Generally accepted accounting principles do not require these financial instruments to be recorded in the consolidated financial statements, and accordingly, they are not. Bancorp does not use off-balance sheet derivative financial instruments (such as interest rate swaps) as defined in the Financial Accounting Standards Board's (FASB) Statement No. 119 "Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments". 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. 6
9 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 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 September 30, 1998, Bancorp had issued standby letters of credit aggregating $17,298,000 compared to $19,210,000 issued as of December 31, 1997. 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 $425,307,000 at September 30, 1998 and $335,092,000 at December 31, 1997. Management does not anticipate any material losses as a result of these commitments. NOTE 3: BUSINESS COMBINATIONS On April 1, 1998, Bancorp paid $13.6 million in cash for all the outstanding common stock of The Union State Bank (USB). Upon consummation of the merger, USB was merged into Community First and USB's only office in Payne, Ohio became Community First's 22nd branch office. The merger was accounted for using the purchase method of accounting and, accordingly, the consolidated financial statements include The Union State Bank's results of operations from the date of acquisition. NOTE 5: ACCOUNTING CHANGES SFAS No. 130, "Reporting Comprehensive Income," was issued in June, 1997, and was effective for fiscal years beginning after December 15, 1997. SFAS No. 130 established standards for the reporting and display of comprehensive income and its components in a set of financial statements. Comprehensive income is defined as the change in equity of a business enterprise during a period from transactions and other events and circumstances from nonowner sources. Bancorp adopted this statement effective January 1, 1998. See the Consolidated Statements of Comprehensive Income. SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," was released in June, 1997, and was effective for fiscal years beginning after December 15, 1997. SFAS No. 131 established standards for reporting information about operating segments. Operating segments are components of a business about which separate financial information is available, that are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The adoption of this statement did not have a material impact on Bancorp's financial statements. 7
10 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FIRST FINANCIAL BANCORP. AND SUBSIDIARIES SELECTED QUARTERLY FINANCIAL DATA <TABLE> <CAPTION> 1998 1997 ------------------------------------ ----------------------- SEP. 30 JUN. 30 MAR. 31 DEC. 31 SEP. 30 ---------- ---------- ---------- ---------- ---------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> NET EARNINGS $ 11,176 $ 11,068 $ 10,103 $ 10,650 $ 10,230 Average consolidated balance sheet items: Loans less unearned income 2,144,456 2,059,142 1,986,149 1,892,038 1,836,612 Investment securities 397,993 417,942 413,893 377,136 372,769 Other earning assets 10,433 15,635 16,359 21,673 7,070 ---------- ---------- --------- --------- ---------- Total earning assets 2,552,882 2,492,719 2,416,401 2,290,847 2,216,451 Total assets 2,779,792 2,705,412 2,628,149 2,472,131 2,376,040 Deposits 2,256,427 2,261,056 2,179,267 2,020,955 1,925,615 Shareholders' equity 300,228 292,555 290,111 283,541 277,732 KEY RATIOS: Average equity to average total assets 10.80% 10.81% 11.04% 11.47% 11.69% Return on average total assets 1.60% 1.64% 1.54% 1.72% 1.72% Return on average equity 14.77% 15.17% 13.93% 15.02% 14.73% Net interest margin (fully tax equivalent) 5.21% 5.37% 5.39% 5.39% 5.36% </TABLE> NET INTEREST INCOME Net interest income, the 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, interest income presented in the table below has been 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 which facilitates a comparison between taxable and tax-exempt assets. The tax equivalent adjustment to interest income has been declining due to increased calls and maturities of tax-exempt securities. As shown below, net interest income on a fully tax equivalent basis has increased $3,531,000 over the third quarter of 1997 and $139,000 over the second quarter of 1998. Continued loan growth, in all major categories of loans, contributed to higher net interest income in the third quarter of 1998. This growth in earning assets resulted in an increase in net interest income even though the net interest margin had decreased. Bancorp's net interest margin ranks very high when compared to its peers. However, given the outlook for interest rates and the competitive environment that exists in the banking industry, loan growth will occur only at lower margins than previously earned. As such, the trend in the compression of the margin is expected to continue as Bancorp increases income through quality loan growth. <TABLE> <CAPTION> QUARTER ENDED 1998 1997 ----------------------------- ------------------ SEP. 30 JUN. 30 MAR. 31 DEC. 31 SEP. 30 ------- ------- ------- ------- ------- (DOLLARS IN THOUSANDS) <S> <C> <C> <C> <C> <C> Interest income $55,841 $54,578 $52,688 $50,631 $48,918 Interest expense 22,884 21,823 21,217 20,230 19,658 ------- ------- ------- ------- ------- Net interest income 32,957 32,755 31,471 30,401 29,260 Tax equivalent adjustment to interest income 536 599 647 717 702 ------- ------- ------- ------- ------- Net interest income (fully tax equivalent) $33,493 $33,354 $32,118 $31,118 $29,962 ======= ======= ======= ======= ======= </TABLE> 8
11 RATE/VOLUME ANALYSIS The impact of changes in volume and interest rates on net interest income is illustrated in the table on the following page. As shown, an increase in volume had a significant impact on both interest income and interest expense for the nine months ended September 30, 1998 in comparison to 1997. The increase in volume had more impact on interest income than interest expense. 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. <TABLE> <CAPTION> Nine months Three months ended Change due to: ended Change due to: Sep. 30, 1998 ------------------- Sep. 30, 1998 ----------------- over 1997 Rate Volume over 1997 Rate Volume ------------- -------- -------- ------------- -------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> <C> Interest income $ 21,553 $ 394 $ 21,159 $ 6,923 $ (440) $ 7,363 Interest expense 9,321 474 8,847 3,226 395 2,831 -------- -------- -------- -------- ------- -------- Net interest income $ 12,232 $ (80) $ 12,312 $ 3,697 $ (835) $ 4,532 ======== ======== ======== ======== ======== ======== </TABLE> OPERATING RESULTS Net operating income represents net earnings before net securities transactions. Net operating income for the first nine months of 1998 was $32,025,000 which was an increase of $2,392,000 or 8.07% over that reported in the same period in 1997. The increase in net operating income can partially be attributed to an increase in net interest income of $12,232,000 or 14.4%. Noninterest income, excluding securities transactions, for the first nine months of 1998 increased 21.6% in comparison to the same period in 1997 primarily as a result of new services and fees. These positive variances were offset by increases in provision for loan losses, noninterest expense and income tax expense. The increase in income tax expense is discussed in the next section. The increase in noninterest expense was 19.1%. Most operating income and expense amounts were greater in 1998 versus 1997 due to the cash purchase of KeyBank branches on December 8, 1997 and the cash purchase of The Union State Bank on April 1, 1998. Net operating income for the third quarter of 1998 increased $858,000 or 8.40% over the same period in 1997 due to the same reasons discussed above. INCOME TAXES For the first nine months of 1998, income tax expense was $16,598,000 compared to $14,364,000 for the same period in 1997, or an increase of $2,234,000. In 1998, $16,426,000 of the tax expense was related to operating income with a tax expense of $172,000 related to securities transactions. In the first nine months of 1997, income tax expense related to operating income was $14,360,000, with a tax expense related to securities transactions of $4,000. The increase in taxes on operating income was due to the increase in operating income before taxes and securities transactions of $4,458,000 or 10.1% over that reported for the first nine months of 1997 and a higher effective tax rate for the period in 1998. The higher effective tax rate was primarily attributable to significant calls and maturities of tax-exempt securities which decreased tax-exempt income. Income tax expense for the third quarter of 1998 was $5,644,000 compared to $4,898,000 for the same period in 1997, which was an increase of $746,000. Tax expense relating to operating income totaled $5,588,000 and $4,889,000 for the quarters ended September 30, 1998 and 1997, respectively, with a tax expense related to securities transactions of $56,000 in 1998 and a tax expense of $9,000 in 1997. 9
12 NET EARNINGS Net earnings for the first nine months of 1998 were $2,689,000 or 9.07% greater than that recorded during the same period in 1997. As was discussed previously, net operating income was $32,025,000 which was 8.07% greater than the same period in 1997. Net securities gains through September 30, 1998 were $322,000 compared to $25,000 for the period ending September 30, 1997. Net earnings for the three months ended September 30, 1998 were $946,000 or 9.25% greater than the same period in 1997. As was discussed above, net operating income was $858,000 or 8.40% greater than third quarter 1997. Net securities gains for the third quarter of 1998 and 1997 were $101,000 and $13,000, respectively. 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. At September 30, 1998 and 1997, the recorded investment in loans that are considered to be impaired under FASB Statement No. 114 was $4,738,000 and $2,842,000, respectively, all of which were on a nonaccrual basis. The related allowance for loan losses on these impaired loans was $1,853,000 at September 30, 1998 and $826,000 at September 30, 1997. There were no impaired loans that as a result of write-downs did not have an allowance for loan losses. The average recorded investment in impaired loans for the respective nine months and quarters ended September 30, 1998 and 1997, was approximately $3,644,000 and $5,384,000 for 1998 and $2,929,000 and $2,726,000 in 1997. For the nine months and quarter ended September 30, 1998, Bancorp recognized interest income on those impaired loans of $80,000 and $29,000 compared to $150,000 and $43,000 for the same periods in 1997. Bancorp recognizes income on impaired loans using the cash basis method. The table below indicates the activity in the allowance for loan losses for the quarters presented. <TABLE> <CAPTION> Quarter Ended 1998 1997 ---------------------------------- --------------------- Sep. 30 Jun. 30 Mar. 31 Dec. 31 Sep. 30 -------- -------- -------- -------- -------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Balance at beginning of period $ 28,917 $ 27,967 $ 27,510 $ 24,875 $ 24,553 Allowance acquired through merger 0 806 0 2,101 0 Provision for loan losses 1,618 1,198 1,250 1,677 1,076 Loans charged off (1,403) (1,344) (1,052) (1,401) (956) Recoveries 265 290 259 258 202 --------- --------- --------- --------- -------- Net charge offs (1,138) (1,054) (793) (1,143) (754) --------- --------- --------- --------- --------- Balance at end of period $ 29,397 $ 28,917 $ 27,967 $ 27,510 $ 24,875 ========= ========= ========= ========= ======== Ratios: Allowance to period end loans, net of unearned income 1.34% 1.38% 1.40% 1.39% 1.33% Recoveries to charge offs 18.89% 21.58% 24.62% 18.42% 21.13% Allowance as a multiple of net charge offs 25.83X 27.44X 35.27X 24.07X 32.99X </TABLE> 10
13 NONPERFORMING/UNDERPERFORMING ASSETS The table below shows the categories which are included in nonperforming and underperforming assets. Nonperforming assets increased $614,000 or 7.92% in the third quarter of 1998 when compared to the third quarter of 1997, and in that same period, accruing loans past due 90 days or more increased $1,204,000. Nonperforming assets increased $1,649,000 in the third quarter of 1998 when compared to the second quarter of 1998 however, nonperforming assets as a percent of loans has remained consistent over the periods presented. 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 feels will become current and, therefore accruing, will be classified as "Accruing loans 90 days or more past due" until they become current. <TABLE> <CAPTION> Quarter Ended 1998 1997 ------------------------------- ------------------- Sep. 30 Jun. 30 Mar. 31 Dec. 31 Sep. 30 ------- ------- ------- ------- ------- (Dollars in thousands) <S> <C> <C> <C> <C> <C> Nonaccrual loans $ 6,993 $ 5,306 $ 5,985 $ 5,257 $ 6,418 Restructured loans 512 1,170 1,812 1,581 630 OREO/ISF* 857 237 1,017 950 700 ------- ------- ------- ------- ------- Total nonperforming assets 8,362 6,713 8,814 7,788 7,748 Accruing loans past due 90 days or more 1,993 1,746 2,585 1,203 789 ------- ------- ------- ------- ------- Total underperforming assets $10,355 $ 8,459 $11,399 $ 8,991 $ 8,537 ======= ======= ======= ======= ======= Nonperforming assets as a percent of loans, net of unearned income plus OREO/ISF 0.38% 0.32% 0.44% 0.39% 0.42% ======= ======= ======= ======= ======= Underperforming assets as a percent of loans, net of unearned income plus OREO/ISF 0.47% 0.40% 0.57% 0.45% 0.46% ======= ======= ======= ======= ======= *Other Real Estate Owned/In-Substance Foreclosure </TABLE> 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. The most stable source of liability-funded liquidity for both the long-term and short-term is deposit growth and retention in the core deposit base. At the end of the third quarter of 1998 Bancorp's deposit liabilities had increased by 8.26% from December 31, 1997. Another source of funding is through short-term borrowings. As part of Bancorp's asset/liability management strategy, Bancorp's short-term borrowings increased to $130,208,000 at September 30, 1998, compared to $52,288,000 at December 31, 1997, as one source of funding loan growth. The principal source of asset-funded liquidity is marketable investment securities, particularly those of shorter maturities. At September 30, 1998, securities maturing in one year or less amounted to $44,936,000, representing 12.1% 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 September 30, 1998, amounted to $635,876,000, representing 22.6% of total 11
14 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 September 30, 1998, Bancorp had classified $333,489,000 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 $4,177,000 for the first nine months of 1998. In addition, remodeling is a planned and ongoing process given the 106 offices of Bancorp and its subsidiaries. Material commitments for capital expenditures as of September 30, 1998 were approximately $1,375,000. 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 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. Bancorp's Tier I ratio at September 30, 1998, was 12.6%, its Total risked-based capital was 13.8% and its Leverage ratio was 9.44%. 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. <TABLE> <CAPTION> Quarter Ended 1998 1997 ------------------------------------ ---------------------- Sep. 30 Jun. 30 Mar. 31 Dec. 31 Sep. 30 ---------- ---------- ---------- ---------- --------- <S> <C> <C> <C> <C> <C> Tier I capital: (Dollars in thousands) SHAREHOLDER'S EQUITY $ 302,384 $ 295,616 $ 290,493 $ 286,259 $ 280,593 Less: Intangible assets 41,382 42,321 38,316 39,169 8,684 Less: Unrealized net securities gains 2,707 1,584 1,967 2,094 1,945 ---------- ---------- ---------- ---------- ---------- Total Tier I capital $ 258,295 $ 251,711 $ 250,210 $ 244,996 $ 269,964 ========== ========== ========== ========== ========== Total risk-based capital: Tier I Capital $ 258,295 $ 251,711 $ 250,210 $ 244,996 $ 269,964 Qualifying allowance for loan losses 25,711 25,122 24,313 23,591 21,818 ---------- ---------- ---------- --------- ---------- Total risk-based capital $ 284,006 $ 276,833 $ 274,523 $ 268,587 $ 291,782 ========== ========== ========== ========= ========== Risk weighted assets $2,053,120 $2,005,962 $1,941,265 $1,883,335 $1,742,394 ========== ========== ========== ========== ========== Risk-based ratios: Tier I 12.58% 12.55% 12.89% 13.01% 15.49% ========== ========== ========== ========== ========== Total risk-based capital 13.83% 13.80% 14.14% 14.26% 16.75% ========== ========== ========== ========== ========== Leverage 9.44% 9.45% 9.66% 10.07% 11.40% ========== ========== ========== ========== ========== </TABLE> 12
15 YEAR 2000 Many computer systems process transactions using two digits for the year of the transaction, rather than a full four digits. These systems may not function properly at the beginning of the year 2000. Bancorp has devoted significant time and attention to the Year 2000 issue, and will repair or replace non-compliant hardware and software prior to the new millennium. Several regulatory agencies and authorities have issued regulations and guidelines which regulated financial institutions must use in measuring their progress. Five commonly recognized phases of Year 2000 remediation are awareness, assessment, renovation, validation and implementation. During 1997, the awareness phase was completed by Bancorp and each of its subsidiaries. During 1998, Bancorp's Operating Committee continues to meet at least weekly to direct and implement all Year 2000 tasks. In addition, Bancorp's work groups continue to make presentations to Bancorp's management and Board of Directors, who have pledged their support for this issue. Bancorp has inventoried and assessed the magnitude of hardware and software programs which must be remediated, contacted vendors, identified resource needs and appropriately hired or contracted for qualified personnel to guide Bancorp through the Year 2000 issue. A Year 2000 Loan Committee, comprised of senior lenders of Bancorp's affiliates, has assessed the impact of Year 2000 on lending customers and the related risks inherent in those loans as they relate to the year 2000. Management has also assessed non-information technology systems and issues. Bancorp is currently in the renovation process of information technology systems, having completed the major deposit systems and most of the loan systems. Most mission critical ancillary systems have also been completed. Remaining mission critical systems are currently in the process of renovation or are scheduled to begin renovation during the fourth quarter of 1998. Management's goal is to have the mission critical renovation phase completed by the end of 1998. Non-information technology systems are substantially compliant as of the end of third quarter 1998. Management has tested incremental changes made to renovated software applications, but has not yet validated overall Year 2000 compliance. Overall validation testing is anticipated to begin in first quarter 1999. Implementation will follow satisfactory results of validation testing and is anticipated to be completed during third quarter 1999. Management of Bancorp believes it has an effective program in place to resolve the Year 2000 issue in a timely manner. As noted above, Bancorp has not yet completed all necessary phases of the Year 2000 program. In the event that the Bancorp does not complete any additional phases, it may be unable to properly process customer transactions in a timely and accurate manner. In addition, disruptions in the economy generally resulting from Year 2000 issues could also materially adversely affect Bancorp. For example, Bancorp could be subject to litigation for computer systems failure. The amount of potential liability and lost revenue cannot be reasonably estimated at this time. Bancorp has developed contingency plans in the event any particular system may not function properly. The contingency plans for information technology systems primarily call for manual intervention where required. Management has also developed contingency plans to support our reliance on transportation, communication and outside vendors. During third quarter 1998, Bancorp incurred approximately $402,000 in noninterest expense for costs related to Year 2000 issues, bringing 1998 total costs to approximately $1,028,000. Based on management's current assessment and anticipated reprogramming costs, Bancorp 13
16 expects to spend an additional $2,778,000 for the remainder of 1998 and in 1999, of which about $1,500,000 will be capitalized. However, there can be no assurance as to the accuracy of these estimates. 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, 1997. 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 which may cause actual results to differ materially. For a discussion of certain factors that may cause such forward-looking statements to differ materially from actual results, refer to the 1997 Form 10-K. ACCOUNTING AND REGULATORY MATTERS 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. PART II-OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Report on Form 8-K On August 31, 1998, Bancorp filed a Form 8-K regarding the announcement of two stock repurchase programs. 14
17 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. FIRST FINANCIAL BANCORP. ------------------------ (Registrant) /s/ Michael R. O'Dell /s/ Joseph M. Gallina - ---------------------------------- --------------------------------- Michael R. O'Dell, Senior Vice Joseph M. Gallina, President, Chief Financial Comptroller Officer and Secretary (Principal Accounting Officer) Date November 12, 1998 Date November 12, 1998 ----------------------------- ----------------------------- 15