10-Q 1 c71227e10vq.txt QUARTERLY REPORT SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For Quarter Ended June 30, 2002 ------------- Commission File Number 0-16759 ------- FIRST FINANCIAL CORPORATION --------------------------- (Exact name of registrant as specified in its charter) INDIANA 35-1546989 (State or other jurisdiction (I.R.S. Employer Incorporation or organization) Identification No.) One First Financial Plaza, Terre Haute, IN 47807 ------------------------------------------ ----- (Address of principal executive office) (Zip Code) (812) 238-6000 -------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __x___ No _____. As of July 31, 2002 were outstanding 6,827,284 shares without par value, of the registrant. 2 FIRST FINANCIAL CORPORATION FORM 10-Q INDEX PART I. Financial Information Page No. Item 1. Financial Statements: Consolidated Statements of Condition.................................. 4 Consolidated Statements of Income..................................... 5 Consolidated Statements of Shareholders' Equity and Comprehensive Income.................................................. 6 Consolidated Statements of Cash Flows................................. 8 Notes to Consolidated Financial Statements............................ 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..11 Item 3. Interest Rate Risk and Quantitative and Qualitative Disclosures about Market Risk..................11 PART II. Other Information: Signatures..............................................................15 Certification of Financial Results......................................16 3 FIRST FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CONDITION (Dollar amounts in thousands, except per share data)
June 30, December 31, 2002 2001 ---- ---- (Unaudited) ASSETS Cash and due from banks $ 76,575 $ 68,205 Federal funds sold and short-term investments 3,166 43,376 Securities, available-for-sale 529,543 463,509 Loans: Commercial, financial and agricultural 327,925 302,496 Real estate - construction 39,030 34,610 Real estate - mortgage 792,798 757,345 Installment 272,685 249,710 Lease financing 4,428 5,023 ----------- ----------- 1,436,866 1,349,184 Less: Unearned income 704 723 Allowance for loan losses 20,207 18,313 ----------- ----------- 1,415,955 1,330,148 Accrued interest receivable 14,859 14,948 Premises and equipment, net 29,382 26,237 Bank-owned life insurance 49,134 47,756 Goodwill 7,102 7,102 Other intangible assets 4,620 3,767 Other assets 39,207 36,857 ----------- ----------- TOTAL ASSETS $ 2,169,543 $ 2,041,905 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Noninterest-bearing $ 174,995 $ 163,985 Interest-bearing: Certificates of deposit of $100 or more 197,780 204,474 Other interest-bearing deposits 1,062,240 945,197 ----------- ----------- 1,435,015 1,313,656 Short-term borrowings 34,442 54,596 Other borrowings 434,575 426,078 Other liabilities 35,437 30,064 ----------- ----------- TOTAL LIABILITIES 1,939,469 1,824,394 ----------- ----------- Shareholders' equity: Common stock, $.125 stated value per share; Authorized shares--40,000,000 Issued shares-7,225,483 Outstanding shares--6,827,284 in 2002 and 6,844,260 in 2001 903 903 Additional capital 66,680 66,680 Retained earnings 167,081 158,038 Accumulated other comprehensive income 12,575 8,299 Treasury shares, at cost - 398,199 in 2002 and 381,223 in 2001 (17,165) (16,409) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY 230,074 217,511 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,169,543 $ 2,041,905 =========== ===========
See accompanying notes. 4 FIRST FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME (Dollar amounts in thousands, except per share data)
Three Months Ended Six Months Ended June 30, June 30, 2002 2001 2002 2001 ---- ---- ---- ---- (Unaudited) (Unaudited) INTEREST INCOME: Loans including related fees $ 26,888 $ 27,431 $ 53,423 $ 55,180 Securities: Taxable 5,136 6,262 10,081 13,205 Tax-exempt 1,872 2,078 3,924 4,148 Other 944 709 1,717 1,415 -------- -------- -------- -------- TOTAL INTEREST INCOME 34,840 36,480 69,145 73,948 INTEREST EXPENSE: Deposits 8,874 12,447 17,851 25,830 Short-term borrowings 198 702 448 1,378 Other borrowings 5,688 6,177 11,300 12,678 -------- -------- -------- -------- TOTAL INTEREST EXPENSE 14,760 19,326 29,599 39,886 -------- -------- -------- -------- NET INTEREST INCOME 20,080 17,154 39,546 34,062 Provision for loan losses 2,416 1,464 4,348 2,952 -------- -------- -------- -------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 17,664 15,690 35,198 31,110 -------- -------- -------- -------- NON-INTEREST INCOME: Trust department income 866 948 1,708 1,834 Service charges and fees on deposit accounts 1,461 1,426 2,967 2,634 Other service charges and fees 1,174 1,108 2,429 2,020 Securities gains (80) 172 (79) 172 Insurance commissions 1,520 140 2,844 285 Gain on sales of mortgage loans 724 506 1,290 734 Other 620 1,066 1,299 1,554 -------- -------- -------- -------- TOTAL NON-INTEREST INCOME 6,285 5,366 12,458 9,233 -------- -------- -------- -------- NON-INTEREST EXPENSES: Salaries and employee benefits 8,848 7,771 17,357 13,962 Occupancy expense 870 901 1,809 1,772 Equipment expense 895 790 1,747 1,742 Printing and supplies expenses 295 209 511 467 Other 4,429 3,840 8,741 7,030 -------- -------- -------- -------- TOTAL NON-INTEREST EXPENSE 15,337 13,511 30,165 24,973 -------- -------- -------- -------- INCOME BEFORE INCOME TAXES 8,612 7,545 17,491 15,370 Provision for income taxes 2,060 1,762 4,211 3,680 -------- -------- -------- -------- NET INCOME $ 6,552 $ 5,783 $ 13,280 $ 11,690 ======== ======== ======== ======== EARNINGS PER SHARE: Net Income $ 0.96 $ 0.85 $ 1.94 $ 1.73 ======== ======== ======== ======== Weighted average number of shares outstanding (in thousands) 6,832 6,802 6,832 6,749 ======== ======== ======== ========
See accompanying notes 5 FIRST FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME Three Months Ended June 30, 2002 and 2001 (Dollar amounts in thousands, except per share data) (Unaudited)
Accumulated Other Common Additional Retained Comprehensive Treasury Stock Capital Earnings Income Stock Total Balance, April 1, 2002 $ 903 $ 66,680 $164,766 $ 7,887 $(16,925) $223,311 Comprehensive income: Net income 6,552 6,552 Change in net unrealized gains/(losses) on available for- sale securities, 4,688 4,688 -------- Total comprehensive income 11,240 Cash dividends, $.62 per share (4,237) (4,237) Treasury stock purchase (240) (240) -------- -------- -------- -------- -------- -------- Balance, June 30, 2002 $ 903 $ 66,680 $167,081 $ 12,575 $(17,165) $230,074 ======== ======== ======== ======== ======== ======== Balance, April 1, 2001 $ 903 $ 66,680 $147,560 $ 9,315 $(21,913) $202,545 Comprehensive income: Net income 5,783 5,783 Change in net unrealized gains/(losses) on available- for-sale securities (655) (655) -------- Total comprehensive income 5,128 Cash dividends, $.56 per share (3,837) (3,837) Issuance of treasury shares 6,801 6,801 Treasury stock purchase (827) (827) -------- -------- -------- -------- -------- -------- Balance, June 30, 2001 $ 903 $ 66,680 $149,506 $ 8,660 $(15,939) $209,810 ======== ======== ======== ======== ======== ========
See accompanying notes. 6 FIRST FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY AND COMPREHENSIVE INCOME Six Months Ended June 30, 2002, and 2001 (Dollar amounts in thousands, except per share data) (Unaudited)
Accumulated Other Common Additional Retained Comprehensive Treasury Stock Capital Earnings Income/(Loss) Stock Total Balance, January 1, 2002 $ 903 $ 66,680 $ 158,038 $ 8,299 $ (16,409) $ 217,511 Comprehensive income: Net income 13,280 13,280 Change in net unrealized gains/(losses) on available- for-sale securities 4,276 4,276 --------- Total comprehensive income 17,556 Cash dividends, $.62 per share (4,237) (4,237) Treasury stock purchase (756) (756) --------- --------- --------- --------- --------- --------- Balance, June 30, 2002 $ 903 $ 66,680 $ 167,081 $ 12,575 $ (17,165) $ 230,074 ========= ========= ========= ========= ========= ========= Balance, January 1, 2001 $ 903 $ 66,680 $ 141,653 $ 3,900 $ (21,913) $ 191,223 Comprehensive income Net income 11,690 11,690 Change in net unrealized gains/(losses) on available- for-sale securities 4,760 4,760 --------- Total comprehensive income 16,450 Cash dividends, $.56 per share (3,837) (3,837) Issuance of treasury shares 6,801 6,801 Treasury stock purchase (827) (827) --------- --------- --------- --------- --------- --------- Balance, June 30, 2001 $ 903 $ 66,680 $ 149,506 $ 8,660 $ 15,939 $ 209,810 ========= ========= ========= ========= ========= =========
See accompanying notes. 7 FIRST FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollar amounts in thousands)
Six Months Ended June 30, 2002 2001 ---- ---- (Unaudited) CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 13,280 $ 11,690 Adjustments to reconcile net income to net cash provided by operating activities: Net accretion of discounts on investments (765) (1,055) Provision for loan losses 4,348 2,952 Securities (gains)/losses 79 (172) Depreciation and amortization 1,533 1,537 Other, net (1,635) (1,572) --------- --------- NET CASH FROM OPERATING ACTIVITIES 16,840 13,380 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Sales of available-for-sale securities 22,741 - Maturities and principal reductions on available-for-sale securities 95,353 70,682 Purchases of available-for-sale securities (138,308) (13,545) Loans made to customers, net of repayments 9,725 (21,112) Net change in federal funds sold 40,210 4,175 Purchase of First Community Financial Corp. 14,554 - Purchase of Forrest Sherer - (1,699) Additions to premises and equipment (944) (1,753) --------- --------- NET CASH FROM INVESTING ACTIVITIES 43,331 36,692 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits (25,277) (54,088) Net change in short-term borrowings (25,292) 66,323 Dividends paid (3,973) (3,747) Purchase of treasury stock (756) (827) Proceeds from other borrowings 21,006 43,940 Repayments on other borrowings (17,509) (109,217 --------- --------- NET CASH FROM FINANCING ACTIVITIES (51,801) (57,616) --------- --------- NET CHANGE IN CASH AND CASH EQUIVALENTS 8,370 (7,488) CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 68,205 68,755 --------- --------- CASH AND CASH EQUIVALENTS, END OF PERIOD $ 76,575 $ 61,267 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the period for interest $ 30,672 $ 41,384 ========= ========= Income taxes paid $ 3,330 $ 3,842 ========= =========
See accompanying notes. 8 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accompanying June 30, 2002 and 2001 consolidated financial statements are unaudited. The December 31, 2001 consolidated financial statements are as reported in the First Financial Corporation (the Corporation) 2001 annual report. The following notes should be read together with notes to the consolidated financial statements included in the 2001 annual report filed with the Securities and Exchange Commission as an exhibit to Form 10-K. 1. The significant accounting policies followed by the Corporation and its subsidiaries for interim financial reporting are consistent with the accounting policies followed for annual financial reporting. All adjustments which are, in the opinion of management, necessary for a fair statement of the results for the periods reported have been included in the accompanying consolidated financial statements and are of a normal recurring nature. The Corporation reports financial information for only one segment, banking. 2. A loan is considered to be impaired when, based upon current information and events, it is probable that the Corporation will be unable to collect all amounts due according to the contractual terms of the loan. Impairment is primarily measured based on the fair value of the loan's collateral. The following table summarizes impaired loan information: (000's) June 30, December 31, 2002 2001 ----- ---- Impaired loans with related allowance for loan losses calculated under SFAS No. 114....................... $5,071 $3,610 Interest payments on impaired loans are typically applied to principal unless collection of the principal amount is deemed to be fully assured, in which case interest is recognized on a cash basis. 3. Securities The amortized cost and fair value of the Corporation's investments at June 30, 2002 are shown below. All securities are classified as available-for-sale.
(000's) (000's) June 30, 2002 December 31, 2001 Amortized Fair Amortized Fair Cost Value Cost Value -------- -------- -------- -------- United States Government and its agencies $172,903 $177,445 $208,973 $213,731 Collateralized Mortgage Obligations 75,647 78,280 4,958 5,065 States and Municipal 166,657 174,207 162,886 166,866 Corporate Obligations 98,584 99,611 77,576 77,847 -------- -------- -------- -------- $513,791 $529,543 $454,393 $463,509 ======== ======== ======== ========
4. Short-Term Borrowings Period-end short-term borrowings were comprised of the following: (000's) June 30, December 31, 2002 2001 ---- ---- Federal Funds Purchased $15,950 $ 9,920 Repurchase Agreements 16,585 37,400 Note Payable - U.S. Government 1,907 7,276 ------- ------- $34,442 $54,596 ======= ======= 9 5. Other Borrowings Other borrowings at period-end are summarized as follows:
(000's) June 30, December 31, 2002 2001 ---- ---- FHLB Advances $407,975 $419,478 Note Payable to a Financial Institution 20,000 - City of Terre Haute, Indiana Economic Development Revenue bonds 6,600 6,600 -------- -------- $434,575 $426,078 ======== ========
6. Derivatives During 2000, the Corporation entered into an interest rate swap with a 24 month term and a notional principal balance of $10 million, under which the Corporation makes variable rate payments, based on LIBOR, and receives fixed rate payments. The interest rate swap was designated as a hedge against a similar maturity certificate of deposit promotion. At June 30, 2002, the interest rate swap contract has a fair value of $291 thousand, which is approximately the same amount as the fair value adjustment to the hedged certificates of deposit. The interest rate swap is included in other assets on the statement of condition. Net settlement income or expense is included in interest expense. During 2001, the Corporation purchased an interest rate cap contract with a notional principal balance of $50 million. The agreement requires the counterparty to pay the Corporation the excess of the 3 month LIBOR over 6.00%. The cap has a 36 month term which runs through June, 2004. No payments are currently required under the agreement. The agreement was entered into to help protect the Corporation's net interest income should interest rates increase in excess of the cap's trigger amount. The interest rate cap is carried at fair value, approximately $48 thousand at June 30, 2002, and is included in other assets on the statement of condition. 7. Acquisitions Forrest Sherer, Inc. (FSI) - On May 1, 2001, the Corporation acquired all of the outstanding common stock of FSI, a full-line insurance agency headquartered in Terre Haute, Indiana. The purchase price was $8.5 million, consisting of the issuance of 182,672 shares of the Corporation's common stock and the payment of $1.7 million in cash. Assets acquired, liabilities assumed and net assets at acquisition were not significant. The acquisition was accounted for as a purchase and resulted in the recording of goodwill of approximately $5.4 million and a customer list intangible of approximately $3.1 million. Prior to the adoption of new accounting guidance, effective January 1, 2002, goodwill was being amortized using the straight-line method over 15 years. The customer list intangible is being amortized, using an accelerated method, over ten years. Community Financial Corporation (CFC) - On January 31, 2002, the Corporation acquired all of the outstanding stock of CFC for $33 million in cash. CFC is a bank holding company based in Olney, Illinois, which had total assets of approximately $190 million and net assets of approximately $32 million at acquisition. The fair values of significant assets acquired and liabilities assumed were $98 million of loans, $48 million of cash and cash equivalents, $38 million of securities and $148 million of deposits. The transaction was accounted for as a purchase and resulted in the recording of a core deposit intangible of approximately $1 million. The following table presents proforma revenue, net income, and earnings per share determined as if the acquisitions had been consummated at January 1, 2001. Key assumptions include the add back of the amortization of the intangible assets of $218 thousand of FSI and CFC. Six months ended June 30, (000's omitted, except per share data) 2002 2001 ---- ----- Revenue $82,463 $92,330 Net income 12,324 9,608 Earnings per share $ 1.80 $ 1.42 10 8. New Accounting Standards A new accounting standard dealing with asset retirement obligations will apply for 2003. The Corporation does not believe this standard will have a material affect on its financial position or results of operations. Effective January 1, 2002, the Corporation adopted a new accounting standard dealing with the impairment and disposal of long-lived assets. The effect of this on the financial position and results of operations of the Corporation was not significant. New accounting standards issued in 2001 required all business combinations initiated after June 30, 2001 to be recorded using the purchase method of accounting. Under the purchase method, all identifiable tangible and intangible assets and liabilities of the acquired company are recorded at fair value at date of acquisition, and the excess of cost over fair value of net assets acquired is recorded as goodwill. Identifiable intangible assets with finite useful lives will be separated from goodwill and amortized over their expected lives, whereas goodwill, both amounts previously recorded and future amounts purchased, will cease being amortized on January 1, 2002. Annual impairment testing will be required for goodwill with impairment being recorded if the carrying amount of goodwill exceeds its implied fair value. The Corporation adopted this standard on January 1, 2002 and ceased amortizing goodwill associated with the acquisitions of The Morris Plan Company of Terre Haute in 1998 and FSI in 2001. No additional goodwill has been recorded during 2002 and management does not believe any amount of the goodwill recorded by the Corporation is impaired. The $7.1 million of goodwill on the balance sheet is net of accumulated amortization of $737 thousand. Intangible assets at June 30, 2002, subject to amortization are as follows: (000's) Gross Accumulated Amount Amortization ------ ------------ Customer list intangible $3,108 $ 521 Core deposit intangible 1,199 42 Branch purchase intangibles 981 478 Non-compete agreements 500 127 ------ ------ $5,788 $1,168 ====== ====== Amortization expense for the second quarter of 2002 and year to-date was $189 thousand and $346 thousand respectively. Estimated amortization expense for the next five years is: (000's) ------- 2002 641 2003 689 2004 689 2005 689 2006 681 If this standard had been in effect in 2001, net income for the three and six months ended June 30, 2001, would not have included goodwill amortization of $100 thousand, and $142 thousand and would have been $5.9 million and $11.8 million. Earnings per share would have been $0.86 and $1.75. FIRST FINANCIAL CORPORATION ITEMS 2. and 3. Management's Discussion and Analysis of Financial Condition and Results of Operations and Quantitative and Qualitative Disclosures About Market Risk The purpose of this discussion is to point out key factors in the Corporation's recent performance compared with earlier periods. The discussion should be read in conjunction with the financial statements beginning on page four of this report. All figures are for the consolidated entities. It is presumed the readers of these financial statements and of the following narrative have previously read the Corporation's annual report for 2001. 11 Forward-looking statements contained in the following discussion are based on estimates and assumptions that are subject to significant business, economic and competitive uncertainties, many of which are beyond the Corporation's control and are subject to change. These uncertainties can affect actual results and could cause actual results to differ materially from those expressed in any forward-looking statements in this discussion. Summary of Operating Results Net income for the six months ended June 30, 2002 was $13.3 million, a 13.6% improvement from the $11.7 million in the same period in 2001. Basic earnings per share increased to $1.94 through the second quarter of 2002 compared to $1.73 for 2001, a 12.1% improvement. Quarterly results for the second period showed net income of $6.6 million, just shy of the quarterly earnings record of $6.7 million set in the first quarter of 2002. This represents a 13.3% increase over net income of $5.8 million in the second quarter of 2001. Compared to the same quarter last year, earnings per share increased 12.9% to $0.96 per share from $0.85 per share, and the net interest margin increased 9.1% to 4.07% from 3.73%. The return on average assets increased to 1.2%, a 4.4% improvement in 2002 over 2001. The primary components of income and expense affecting net income are discussed in the following analysis. Net Interest Income The Corporation's primary source of earnings is net interest income, which is the difference between the interest earned on loans and other investments and the interest paid for deposits and other sources of funds. Net interest income increased to $39.5 million in the first six months of 2002 from $34.1 million in the same period of 2001, a 16.1%, or $5.5 million increase. This was the result of an increase of $177.4 million in average interest earning assets and an improved net interest margin for 2002. The net interest margin increased from 3.9% in 2001 to 4.1% in 2002, a 4.6% increase driven by a greater decline in the average cost of funds than in the yield on earning assets. Non-Interest Income Non-interest income increased $3.2 million, or 34.9%, over 2001, which was driven by increases in fee-based income, higher gains from the sales of mortgage loans and insurance commission income related to the recent acquisition of Forrest Sherer, Inc. in May 2001. Non-Interest Expenses Non-interest expenses increased $5.2 million, or 20.8%, due mainly to added costs, primarily personnel costs, associated with the recent acquisitions, as well as increases in employee salaries and fringe benefit programs. Allowance for Loan Losses The Corporation's provision for loan losses increased to $4.3 million for the first six months of 2002 compared to $3.0 million in the same period of 2001. At June 30, 2002, the allowance for loan losses was 1.41% of net loans, an increase from 1.36% at December 31, 2001. Net chargeoffs for the first six months of 2002 were $4.2 million compared to $4.5 million for the same period of 2001. Based on management's analysis of the current portfolio, an evaluation that includes consideration of historical loss experience and potential loss exposure on identified problem loans, management believes the allowance of $20.2 million at June 30, 2002 is adequate. Nonperforming Loans and Leases Nonperforming loans and leases consist of (1) nonaccrual loans and leases on which the ultimate collectability of the full amount of interest is uncertain, (2) loans and leases which have been renegotiated to provide for a reduction or deferral of interest or principal because of a deterioration in the financial position of the borrower, and (3) loans and leases past due ninety days or more as to principal or interest. A summary of nonperforming loans and leases at June 30, 2002 and December 31, 2001 follows: 12
(000's) June 30, 2002 December 31, 2001 ------------- ----------------- Nonaccrual loans and leases $12,605 $ 8,854 Renegotiated loans and leases 508 590 Ninety days past due loans and leases 4,115 4,925 ------- ------- Total nonperforming loans and leases $17,228 $14,369 ======= ======= Ratio of the allowance for loan losses as a percentage of nonperforming loans and leases 117% 127%
The following loan categories comprise significant components of the nonperforming loans at June 30, 2002 and December 31, 2001.
(000's) June 30, 2002 December 31, 2001 ------------- ----------------- Non-Accrual Loans: 1-4 family residential $ 1,918 $ 3,033 Commercial loans 9,396 4,406 Installment loans 1,291 1,415 Other, various - - ------- ------- $12,605 $ 8,854 ======= ======= Past due 90 days or more: 1-4 family residential $ 2,318 $ 1,587 Commercial loans 1,078 2,177 Installment loans 719 1,161 Other, various - - ------- ------- $ 4,115 $ 4,925 ======= =======
There are no material industry concentrations within the nonperforming loans. Interest Rate Sensitivity and Liquidity The Corporation charges the nine subsidiary banks with monitoring and managing their individual sensitivity to fluctuations in interest rates and assuring that they have adequate liquidity to meet loan demand or any potential unexpected deposit withdrawals. This function is facilitated by the Asset/Liability Committee (the Committee). The primary goal of the committee is to maximize net interest income within the interest rate risk limits approved by the Board of Directors. This goal is accomplished through management of the subsidiary bank's balance sheet liquidity and interest rate risk exposures due to the changes in economic conditions and interest rate levels. Interest Rate Risk and Quantitative and Qualitative Disclosures About Market Risk Management considers interest rate risk to be the Corporation's most significant market risk. Interest rate risk is the exposure to changes in net interest income as a result of changes in interest rates. Consistency in the Corporation's net income is largely dependent on the effective management of this risk. The Committee reviews a series of monthly reports to ensure that performance objectives are being met. It monitors and controls interest rate risk through earnings simulation. Simulation modeling measures the effects of changes in interest rates, changes in the shape of the yield curve, and changes in prepayment speeds on net interest income. The primary measure of Interest Rate Risk is "Earnings at Risk." This measure projects the earnings effect of various rate movements over the next three years on net interest income. It is important to note that measures of interest rate risk have limitations and are dependent upon certain assumptions. These assumptions are inherently uncertain and, as a result, the model cannot precisely predict the impact of interest rate fluctuations on net interest income. Actual results will differ from simulated results due to timing, frequency, and amount of interest rate changes as well as overall market conditions. The Committee has performed a thorough analysis and believes the assumptions to be valid and theoretically sound. The relationships are continuously monitored for behavioral changes. 13 As outlined in Note 6, the Corporation makes limited use of derivatives to facilitate its interest rate risk management activities. At June 30, 2002, derivatives include a $10 million interest rate swap directly related to a certificate of deposit special and a $50 million interest rate cap designed to help protect net interest income should rates rise significantly in the near term. The Corporation currently does not invest in derivative products for short-term gain, nor is engaged in securities trading activity. The Corporation invests in assets whose value is derived from an underlying asset. These assets include government agency issued mortgage-backed securities. The performance of these assets in changing rate environments and the impact of derivatives are included in the following table. The table below shows the Corporation's estimated earnings sensitivity profile as of June 30, 2002. Given a 100 basis point increase in rates, net interest income would increase 3.19% over the next 12 months and increase 6.79% over the second 12 month period. A 100 basis point decrease would result in a 1.89% decrease in net interest income over the next 12 months and a 6.11% decrease over the second 12 month period. These estimates assume all rates changed overnight and management took no action as a result of this change. Percentage Change in Net Interest Income Basis Point ---------------------------------------- Interest Rate Change 12 months 24 months 36 months ------------------------------------------------------------------------- Down 300 -11.71 -25.42 -34.75 Down 200 -6.20 -15.01 -21.15 Down 100 -1.89 -6.11 -9.13 Up 100 3.19 6.79 9.55 Up 200 6.49 13.37 18.60 Up 300 8.53 18.41 26.23 The Corporation does have other assets and liabilities, which contain embedded options, most notably callable agency securities, and putable Federal Home Loan Bank advances. The securities pay a premium rate and the advances charge a discounted rate in exchange for the option. Therefore, there is a benefit to current income from using these products. Management believes these put and call options are clearly and closely related to the underlying instruments and that they are therefore not considered derivatives. Typical rate shock analysis does not reflect management's ability to react and thereby reduce the effects of rate changes, and represents a worst case scenario. The model assumes no actions are taken and prices change to the full extent of the rate shock. Liquidity Risk Liquidity is measured by each bank's ability to raise funds to meet the obligations from its customers, including deposit withdrawals and credit needs. This is accomplished primarily by maintaining sufficient liquid assets in the form of investment securities and core deposits. The Corporation has $16.6 million of investments that mature throughout the coming 12 months. The Corporation also anticipates $38.0 million of principal payments from mortgage-backed securities. Given the current interest rate environment, the Corporation anticipates $9.5 million of securities to be called within the next 12 months. With these sources of funds, the Corporation currently anticipates adequate liquidity to meet the expected obligations of its customers. Financial Condition Comparing 2002 to 2001, year-to-date average deposits were up $176.7 million, or 13.6%. These deposits were used to fund an increase in total average loans of $138.8 million, or 10.6%, and pay down average borrowings by $27.6 million. Average assets increased $182.9 million, or 9.0%, and average shareholders' equity increased $30.9 million, or 14.9%. Book value per share increased 10.1% to $33.70 in 2002 from $30.60 in 2001. The purchase of Community Bank and Trust, N.A was consummated on January 31, 2002. The average balances reported above include Community's $96.5 million of average loans, $132.5 million of average deposits, and $165.0 million of average total assets. Capital Adequacy As of June 30, 2002, the Corporation's leverage ratio was 9.52% compared to 9.87% at December 31, 2001. At June 30, 2002, the Corporation's total risk-based capital ratio, which includes Tier II capital, was 14.48% compared to 15.15% at December 31, 2001. These amounts exceed minimum regulatory capital requirements. 14 FIRST FINANCIAL CORPORATION PART II OTHER INFORMATION FORM 10-Q SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST FINANCIAL CORPORATION --------------------------- (Registrant) Date: August 9, 2002 By /s/ Donald E. Smith -------------------- Donald E. Smith, Chairman Date: August 9, 2002 By /s/ Norman L. Lowery -------------------- Norman L. Lowery, Vice Chairman Date: August 9, 2002 By /s/ Michael A. Carty -------------------- Michael A. Carty, Treasurer 15 FIRST FINANCIAL CORPORATION PART II. OTHER INFORMATION FORM 10-Q CERTIFICATION OF FINANCIAL RESULTS We, Donald E. Smith, Chairman and CEO, and Michael A. Carty, Chief Financial Officer, of First Financial Corp., hereby certify the following: - This Form 10-Q fully complies with the requirements of Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, and, - The information contained in the report fairly presents, in all material respects, the financial position and results of operations of First Financial Corp. as of and for the periods presented. August 9, 2002 By /s/ Donald E. Smith ---------------------- Donald E. Smith, Chairman August 9, 2002 By /s/ Michael A. Carty ---------------------- Michael A. Carty, Treasurer & CFO 16