First Financial - 10-Q quarterly report FY

The accompanying June 30, 2007 and 2006 consolidated financial statements are unaudited. The December 31, 2006 consolidated financial statements are as reported in the First Financial Corporation (the “Corporation”) 2006 annual report. The information presented does not include all information and footnotes required by U.S. generally accepted accounting procedures for complete financial statements. The following notes should be read together with notes to the consolidated financial statements included in the 2006 annual report filed with the Securities and Exchange Commission as an exhibit to Form 10-K.

Interest payments on impaired loans are typically applied to principal unless collection of the principal amount is deemed to be fully assured, in which case interest is recognized on a cash basis.

The amortized cost and fair value of the Corporation’s investments are shown below. All securities are classified as available-for-sale.

First Financial Corporation previously disclosed in its financial statements for the year ended December 31, 2006 that it expected to contribute $1.8 and $1.2 million respectively to its Pension Plan and ESOP and $319,000 to the Post Retirement Health Benefits Plan in 2007. Plan changes to the Post Retirement Health Benefits Plan have reduced the expected contributions for 2007 to $180,000. First Financial Corporation still anticipates contributing $1.8 and $1.2 million respectively to its Pension Plan and ESOP in 2007. Contributions of $87,000 have been made through the first six months of 2007 for the Post Retirement Health Benefits plan.

We adopted the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109” (“FIN 48”), on January 1, 2007. The adoption of Fin 48 was recognized as a cumulative effect adjustment, reducing retained earnings and increasing liabilities by $86 thousand on January 1, 2007.

The amount of unrecognized tax benefits as of January 1, 2007 totaled $588, which would increase income from continuing operations, and thus impact the Company’s effective tax rate, if ultimately recognized into income. Unrecognized state income tax benefits are reported net of their related deferred federal income tax benefit.

It is the Company’s policy to recognize interest and penalties related to uncertain tax positions in income tax expense, and interest was accrued and included in the $588 amount above as of January 1, 2007. There were no material changes in unrecognized tax positions as of June 30, 2007.

The Company and its subsidiaries file a consolidated U.S. federal income tax return and combined returns in the state of Indiana and Illinois. These returns are subject to examination by taxing authorities for years after 2002. We are currently under audit by the Internal Revenue Service for the 2004 and 2005 tax years. The anticipated effect on unrecognized tax benefits resulting from this audit cannot be determined at this time.

Additionally, the Company anticipates that the statute of limitations will close during 2007 on a tax position taken in the federal income tax return. Should this statute close on the position as taken in the return, the Company will recognize these tax benefits, which will reduce income tax expense by an immaterial amount.

The purpose of this discussion is to point out key factors in the Corporation’s recent performance compared with earlier periods. The discussion should be read in conjunction with the financial statements beginning on page three of this report. All figures are for the consolidated entities. It is presumed the readers of these financial statements and of the following narrative have previously read the Corporation’s annual report for 2006.

This Quarterly Report on Form 10-Q contains forward-looking statements. Forward-looking statements provide current expectations or forecasts of future events and are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. The forward-looking statements are based on management’s expectations and are subject to a number of risks and uncertainties. Although management believes that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from those expressed or implied in such statements. Risks and uncertainties that could cause actual results to differ materially include, without limitation, the Corporation’s ability to effectively execute its business plans; changes in general economic and financial market conditions; changes in interest rates; changes in the competitive environment; continuing consolidation in the financial services industry; new litigation or changes in existing litigation; losses, customer bankruptcy, claims and assessments; changes in banking regulations or other regulatory or legislative requirements affecting the Corporation’s business; and changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or other regulatory agencies. Additional information concerning factors that could cause actual results to differ materially from those expressed or implied in the forward-looking statements is available in the Corporation’s Annual Report on Form 10-K for the year ended December 31, 2006, and subsequent filings with the United States Securities and Exchange Commission (SEC). Copies of these filings are available at no cost on the SEC’s Web site at www.sec.gov or on the Corporation’s Web site at www.first-online.com. Management may elect to update forward-looking statements at some future point; however, it specifically disclaims any obligation to do so.

Certain of the Corporation’s accounting policies are important to the portrayal of the Corporation’s financial condition and results of operations, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but without limitation, changes in interest rates, in the performance of the economy or in the financial condition of borrowers. Management believes that its critical accounting policies include determining the allowance for loan losses and the valuation of goodwill. See further discussion of these critical accounting policies in the 2006 Annual Report on Form 10-K.

Net income for the three months ended June 30, 2007 was $6.4 million. Basic earnings per share was $0.48 for the second quarter of 2007. These results are similar to the results for the second quarter of 2006.

The primary components of income and expense affecting net income are discussed in the following analysis.

The Corporation’s primary source of earnings is net interest income, which is the difference between the interest earned on loans and other investments and the interest paid for deposits and other sources of funds. Net interest income increased to $18.6 million in the first three months of 2007 from $18.5 million in the same period in 2006, a 0.3% increase. The net interest margin decreased to 3.87% in 2007 from 3.90% in 2006, a 0.03% decrease, driven by a greater increase in the costs of funding than the increases realized on earning assets. The net interest income increased due to the increase in earning assets. Results for the six months ended June 20, 2007 in comparison with the same period in 2006 is similar to the quarterly comparison. While net interest income increased slightly, net interest margin decreased to 3.89% from 3.92%, or 3%, for the same period in 2006.

Non-interest income for the quarter was $7.5 million. Increased other income from sale of mortgage loans was the major difference between these results and the $7.2 million of non-interest income reported for the same period in 2006. Income from insurance commissions and other service fees were also increased as compared to the same period of 2006. Non-interest income for the six months ended June 30, 2007 was also higher than the same period in 2006, increasing from $14.6 million to $15.7 million, or 7.2%. This higher level of non-interest income is the result of increased other income from sales of other real estate, sale of mortgage loans, insurance commissions and other service fees.

The Corporation’s non-interest expense for the quarter ended June 30, 2007 compared to the same period in 2006 decreased by $103 thousand or 0.6%. Non-interest expense for the six months ended June 20, 2007 in comparison with the same period in 2006 has also decreased, from $32.4 million to $32.2 million or 0.8%. Occupancy and other expenses were higher during the second quarter and for the first six months of 2007 compared to the same periods of 2006. Salaries and benefits expenses were reduced by $689 thousand for the second quarter of 2007 and $996 thousand for the first six months of 2007 compared to the same periods of 2006. The Corporation has reduced the number of full time equivalent employees as a continuation of the benefits of consolidating bank subsidiaries into one bank. The effective tax rate decreased from 27.6% to 26.7% for the second quarter of 2007 when compared to the same quarter in 2006, and increased from 26.6% to 27.1% for the six months ended June 20, 2007 when compared to the same period in 2006. The changes are a result of higher and lower levels of tax-exempt income for the periods.

The Corporation’s provision for loan losses increased $595 thousand for the second quarter and $82 thousand for the first six months of 2007 compared to the same periods of 2006. Net charge-offs were increased $362 thousand for the three months ended June 30, 2007 and $1.0 million for the first six months of 2007 compared to the same periods of 2006. During the second quarter of 2006 the provision was reduced after analysis of the adequacy of the allowance for loan losses revealed that net charge-off’s of previously identified credits were lower than anticipated. The allowance for loan losses has decreased from 1.16% of gross loans, or $16.1 million at June 30, 2006 to 1.09% of gross loans, or $15.3 million at June 30, 2007. Based on management’s analysis of the current portfolio, an evaluation that includes consideration of historical loss experience, non-performing loans trends, and probable incurred losses on identified problem loans, management believes the allowance is adequate.

Non-performing loans consist of (1) non-accrual loans on which the ultimate collectability of the full amount of interest is uncertain, (2) loans which have been renegotiated to provide for a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower, and (3) loans past due ninety days or more as to principal or interest. A summary of non-performing loans at June 30, 2007 and December 31, 2006 follows:

First Financial Corporation has established risk measures, limits and policy guidelines for managing interest rate risk and liquidity. Responsibility for management of these functions resides with the Asset Liability Committee. The primary goal of the Asset Liability Committee is to maximize net interest income within the interest rate risk limits approved by the Board of Directors.

Management considers interest rate risk to be the Corporation’s most significant market risk. Interest rate risk is the exposure to changes in net interest income as a result of changes in interest rates. Consistency in the Corporation’s net interest income is largely dependent on the effective management of this risk.

The Asset Liability position is measured using sophisticated risk management tools, including earning simulation and market value of equity sensitivity analysis. These tools allow management to quantify and monitor both short-term and long-term exposure to interest rate risk. Simulation modeling measures the effects of changes in interest rates, changes in the shape of the yield curve

The Corporation from time to time utilizes derivatives to manage interest rate risk. Management continuously evaluates the merits of such interest rate risk products but does not anticipate the use of such products to become a major part of the Corporation’s risk management strategy.

The table below shows the Corporation’s estimated sensitivity profile as of June 30, 2007. The change in interest rates assumes a parallel shift in interest rates of 100 and 200 basis points. Given a 100 basis point increase in rates, net interest income would decrease 3.46% over the next 12 months and decrease 1.94% over the following 12 months. Given a 100 basis point decrease in rates, net interest income would increase 1.73% over the next 12 months and increase .21% over the following 12 months. These estimates assume all rate changes occur overnight and management takes no action as a result of this change.

Typical rate shock analysis does not reflect management’s ability to react and thereby reduce the effect of rate changes, and represents a worst-case scenario.

Liquidity is measured by each bank’s ability to raise funds to meet the obligations of its customers, including deposit withdrawals and credit needs. This is accomplished primarily by maintaining sufficient liquid assets in the form of investment securities and core deposits. The Corporation has $12.5 million of investments that mature throughout the coming 12 months. The Corporation also anticipates $65.7 million of principal payments from mortgage-backed securities. Given the current rate environment, the Corporation anticipates $13.2 million in securities to be called within the next 12 months. With these sources of funds, the Corporation currently anticipates adequate liquidity to meet the expected obligations of its customers.

Comparing the first six months of 2007 to the same period in 2006, average net loans are up $16.2 million. Average deposits are up $5.2 million. Average investments increased $12.5 million. Average borrowings increased $9.9 million. The average allowance for loan and lease losses declined from 1.23% at June 30, 2006 to 1.15% at June 30, 2007. Although there was an increase amount of net-charge-offs, the improved overall credit quality allowed the Corporation to reduce its allowance percentage of loans outstanding.

First Financial Corporation’s management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of June 30, 2007, an evaluation was performed under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on that evaluation, management concluded that the Corporation’s disclosure controls and procedures as of June 30, 2007 were effective in ensuring material information required to be disclosed in this Quarterly Report on Form 10-Q was recorded, processed, summarized, and reported on a timely basis. Additionally, there were no changes in the Corporation’s internal control over financial reporting that occurred during the quarter ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, the Corporation’s internal control over financial reporting.

There are no material pending legal proceedings, other than routine litigation incidental to the business of the Corporation or its subsidiaries, to which the Corporation or any of the subsidiaries is a party or of which any of their respective property is subject. Further, there is no material legal proceeding in which any director, officer, principal shareholder, or affiliate of the Corporation or any of its subsidiaries, or any associate of such director, officer, principal shareholder or affiliate is a party, or has a material interest, adverse to the Corporation or any of its subsidiaries.

There have been no material changes in the risk factors from those disclosed in the Corporation’s 2006 Annual Report on Form 10-K.

The Corporation periodically acquires shares of its common stock directly from shareholders in individually negotiated transactions. The Corporation has not adopted a formal policy or adopted a formal program for repurchases of shares of its common stock. Following is certain information regarding shares of common stock purchased by the Corporation during the quarter covered by this report.

The following individual’s terms as directors continued after the meeting: B. Guille Cox, Jr., Thomas T. Dinkel, Anton H. George, Gregory Gibson, Norman L. Lowery, Patrick O’Leary and Virginia L. Smith.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.