EX-13 4 c03430exv13.txt ANNUAL REPORT EXHIBIT 13--ANNUAL REPORT . . . EXHIBIT 13 2005 ANNUAL REPORT FIVE YEAR COMPARISON OF SELECTED FINANCIAL DATA
(Dollar amounts in thousands, except per share amounts) 2005 2004 2003 2002 2001 ----------------------------- ---------- ---------- ---------- ---------- ---------- BALANCE SHEET DATA: Total assets $2,136,918 $2,183,992 $2,223,057 $2,169,748 $2,041,905 Securities 536,291 507,990 576,950 520,166 471,888 Loans, net of unearned fees 1,395,741 1,463,871 1,429,525 1,432,564 1,348,461 Deposits 1,464,918 1,443,121 1,479,347 1,434,654 1,313,656 Borrowings 370,090 438,013 451,862 457,645 480,674 Shareholders' equity 269,323 268,335 255,279 241,971 217,511 INCOME STATEMENT DATA: Interest income 121,647 116,888 122,661 136,262 144,673 Interest expense 47,469 44,686 48,225 58,086 74,125 Net interest income 74,178 72,202 74,436 78,176 70,548 Provision for loan losses 11,698 8,292 7,455 9,478 6,615 Other income 32,025 35,754 30,819 30,468 21,468 Other expenses 63,538 63,656 62,461 63,317 53,329 Net income 23,054 28,009 26,493 28,640 24,196 PER SHARE DATA: Net income 1.72 2.07 1.95 2.10 1.78 Cash dividends .82 .79 .70 .62 .57 PERFORMANCE RATIOS: Net income to average assets 1.07% 1.28% 1.21% 1.30% 1.19% Net income to average shareholders' equity 8.52 10.45 10.57 12.01 11.33 Average total capital to average assets 13.35 13.24 12.45 11.73 11.38 Average shareholders' equity to average assets 12.51 12.23 11.43 10.80 10.46 Dividend payout 47.57 38.13 35.88 29.57 32.28
7 FIRST FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ---------------------------- (Dollar amounts in thousands, except per share data) 2005 2004 ---------------------------------------------------- ----------- ----------- ASSETS Cash and due from banks $ 78,201 $ 94,928 Federal funds sold 2,982 5,400 Securities available-for-sale 536,291 507,990 Loans, net of allowance of $16,042 in 2005 and $19,918 in 2004 1,379,699 1,443,953 Accrued interest receivable 12,537 12,016 Premises and equipment, net 31,270 31,154 Bank-owned life insurance 55,832 49,177 Goodwill 7,102 7,102 Other intangible assets 2,860 3,093 Other real estate owned 4,115 3,262 Other assets 26,029 25,917 ----------- ----------- TOTAL ASSETS $ 2,136,918 $ 2,183,992 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Deposits: Non-interest-bearing $ 182,416 $ 145,852 Interest-bearing: Certificates of deposit of $100 or more 189,493 184,604 Other interest-bearing deposits 1,093,009 1,112,665 ----------- ----------- 1,464,918 1,443,121 Short-term borrowings 26,224 75,527 Other borrowings 343,866 362,486 Other liabilities 32,587 34,523 ----------- ----------- TOTAL LIABILITIES 1,867,595 1,915,657 Shareholders' equity Common stock, $.125 stated value per share, Authorized shares -- 40,000,000 Issued shares -- 14,450,966 Outstanding shares -- 13,373,570 in 2005 and 13,535,770 in 2004 1,806 1,806 Additional paid-in capital 67,670 67,519 Retained earnings 223,710 211,623 Accumulated other comprehensive income 1,903 8,357 Less: Treasury shares at cost -- 1,077,396 in 2005 and 915,196 in 2004 (25,766) (20,970) ----------- ----------- TOTAL SHAREHOLDERS' EQUITY 269,323 268,335 ----------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 2,136,918 $ 2,183,992 =========== ===========
See accompanying notes. 8 2005 ANNUAL REPORT CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, ----------------------------------------- (Dollar amounts in thousands, except per share data) 2005 2004 2003 ---------------------------------------------------- ---------- ---------- ---------- INTEREST AND DIVIDEND INCOME: Loans, including related fees $ 96,388 $ 92,440 $ 96,536 Securities: Taxable 16,802 15,315 15,714 Tax-exempt 6,306 7,055 7,816 Other 2,151 2,078 2,595 ---------- ---------- ---------- TOTAL INTEREST AND DIVIDEND INCOME 121,647 116,888 122,661 INTEREST EXPENSE: Deposits 27,184 23,695 26,925 Short-term borrowings 783 1,017 431 Other borrowings 19,502 19,974 20,869 ---------- ---------- ---------- TOTAL INTEREST EXPENSE 47,469 44,686 48,225 ---------- ---------- ---------- NET INTEREST INCOME 74,178 72,202 74,436 Provision for loan losses 11,698 8,292 7,455 ---------- ---------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 62,480 63,910 66,981 NON-INTEREST INCOME: Trust and financial services 3,626 3,918 3,762 Service charges and fees on deposit accounts 11,732 11,499 8,066 Other service charges and fees 6,440 6,794 8,063 Securities gains (losses) 571 (165) 237 Insurance commissions 5,995 6,142 6,282 Gain on sale of mortgage loans 1,289 806 2,027 Gain on life insurance benefit -- 4,113 -- Other 2,372 2,647 2,382 ---------- ---------- ---------- TOTAL NON-INTEREST INCOME 32,025 35,754 30,819 NON-INTEREST EXPENSES: Salaries and employee benefits 38,617 37,876 36,696 Occupancy expense 3,796 3,904 3,830 Equipment expense 3,861 3,585 3,224 Other 17,264 18,291 18,711 ---------- ---------- ---------- TOTAL NON-INTEREST EXPENSE 63,538 63,656 62,461 ---------- ---------- ---------- INCOME BEFORE INCOME TAXES 30,967 36,008 35,339 Provision for income taxes 7,913 7,999 8,846 ---------- ---------- ---------- NET INCOME $ 23,054 $ 28,009 $ 26,493 ========== ========== ========== EARNINGS PER SHARE: BASIC AND DILUTED $ 1.72 $ 2.07 $ 1.95 ========== ========== ========== Weighted average number of shares outstanding (in thousands) 13,433 13,525 13,588 ========== ========== ==========
See accompanying notes. 9 FIRST FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
ACCUMULATED OTHER COMMON ADDITIONAL RETAINED COMPREHENSIVE TREASURY (Dollar amounts in thousands, except per share data) STOCK PAID-IN CAPITAL EARNINGS INCOME STOCK TOTAL ---------------------------------------------------- -------- --------------- --------- ------------- -------- --------- BALANCE, JANUARY 1, 2003 $ 903 $ 66,809 $ 178,209 $ 14,276 $ (18,226) $ 241,971 Comprehensive income: Net income -- -- 26,493 -- -- 26,493 Other comprehensive income, net of tax: Change in net unrealized gains/losses on securities available-for-sale, net -- -- -- (2,813) -- (2,813) --------- Total comprehensive income 23,680 Two-for-one stock split (6,782,885 shares) 903 -- (903) -- -- -- Contribution of 40,000 shares to ESOP -- 372 -- -- 884 1,256 Treasury stock purchase (80,120 shares) -- -- -- -- (2,123) (2,123) Cash dividends, $ .70 per share -- -- (9,505) -- -- (9,505) -------- -------- --------- --------- --------- --------- BALANCE, DECEMBER 31, 2003 1,806 67,181 194,294 11,463 (19,465) 255,279 Comprehensive income: Net income -- -- 28,009 -- -- 28,009 Other comprehensive loss, net of tax: Change in net unrealized gains/losses on securities available-for-sale, net -- -- -- (3,106) -- (3,106) --------- Total comprehensive income 24,903 Contribution of 36,000 shares to ESOP -- 338 -- -- 825 1,163 Treasury stock purchase (79,000 shares) -- -- -- -- (2,330) (2,330) Cash dividends, $ .79 per share -- -- (10,680) -- -- (10,680) -------- -------- --------- --------- --------- --------- BALANCE, DECEMBER 31, 2004 1,806 67,519 211,623 8,357 (20,970) 268,335 Comprehensive income: Net income -- -- 23,054 -- -- 23,054 Other comprehensive loss, net of tax: Change in net unrealized gains/losses on securities available-for-sale, net -- -- -- (6,454) -- (6,454) --------- Total comprehensive income -- -- -- -- -- 16,600 Contribution of 41,500 shares to ESOP -- 151 -- -- 993 1,144 Treasury stock purchase (203,700 shares) -- -- -- -- (5,789) (5,789) Cash dividends, $ .82 per share -- -- (10,967) -- -- (10,967) -------- -------- --------- --------- --------- --------- BALANCE, DECEMBER 31, 2005 $ 1,806 $ 67,670 $ 223,710 $ 1,903 $ (25,766) $ 269,323 ======== ======== ========= ========= ========= =========
See accompanying notes. 10 2005 ANNUAL REPORT CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, --------------------------------------- (Dollar amounts in thousands, except per share data) 2005 2004 2003 --------------------------------------------------- --------- --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 23,054 $ 28,009 $ 26,493 Adjustments to reconcile net income to net cash provided by operating activities: Net (accretion) amortization on securities (1,462) 2,092 558 Provision for loan losses 11,698 8,292 7,455 Securities (gains) losses (571) 165 (237) Depreciation and amortization 3,363 3,184 2,883 Provision for deferred income taxes 1,716 1,648 (252) Net change in accrued interest receivable (521) 1,057 2,126 Contribution of shares to ESOP 1,144 1,163 1,256 Gains on life insurance benefit -- (4,113) -- Other, net 592 1,842 5,126 --------- --------- --------- NET CASH FROM OPERATING ACTIVITIES 39,013 43,339 45,408 --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Sales of securities available-for-sale 11,376 11,466 8,308 Calls, maturities and principal reductions on securities available-for-sale 373,741 105,945 189,049 Purchases of securities available-for-sale (422,141) (55,885) (259,150) Loans made to customers, net of repayments 49,806 (44,834) (5,844) Net change in federal funds sold 2,418 450 (5,800) Purchase of bank-owned life insurance (5,000) -- -- Purchase of customer list (338) -- -- Proceeds from life insurance benefit -- 7,267 -- Additions to premises and equipment (2,908) (4,458) (1,758) --------- --------- --------- NET CASH FROM INVESTING ACTIVITIES 6,954 19,951 (75,195) --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Net change in deposits 21,797 (36,226) 44,693 Net change in other short-term borrowings (49,303) 6,898 34,274 Dividends paid (10,779) (10,155) (8,845) Purchases of treasury stock (5,789) (2,330) (2,123) Proceeds from other borrowings -- 85,006 18,013 Repayments on other borrowings (18,620) (105,753) (58,070) --------- --------- --------- NET CASH FROM FINANCING ACTIVITIES (62,694) (62,560) 27,942 --------- --------- --------- NET CHANGE IN CASH AND CASH EQUIVALENTS (16,727) 730 (1,845) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 94,928 94,198 96,043 --------- --------- --------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 78,201 $ 94,928 $ 94,198 ========= ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest $ 46,919 $ 44,979 $ 48,791 ========= ========= ========= Income taxes $ 5,413 $ 6,501 $ 8,016 ========= ========= =========
See accompanying notes. 11 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES: BUSINESS ORGANIZATION: The consolidated financial statements of First Financial Corporation and its subsidiaries (the Corporation) include the parent company and its wholly-owned subsidiaries, First Financial Bank, N.A. of Vigo County, Indiana, The Morris Plan Company of Terre Haute (Morris Plan), First Financial Reinsurance Company, a corporation incorporated in the country of Turks and Caicos Islands (FFRC) and Forrest Sherer Inc., a full-line insurance agency headquartered in Terre Haute, Indiana. Inter-company transactions and balances have been eliminated. First Financial Bank also has two investment subsidiaries, Portfolio Management Specialists A (Specialists A) and Portfolio Management Specialists B (Specialists B), which were established to hold and manage certain assets as part of a strategy to better manage various income streams and provide opportunities for capital creation as needed. Specialists A and Specialists B subsequently entered into a limited partnership agreement, Global Portfolio Limited Partners. Portfolio Management Specialists B also owns First Financial Real Estate, LLC. At December 31, 2005, $490.8 million of securities and loans were owned by these subsidiaries. Specialists A, Specialists B, Global Portfolio Limited Partners and First Financial Real Estate LLC are included in the consolidated financial statements. The Corporation, which is headquartered in Terre Haute, Indiana, offers a wide variety of financial services including commercial, mortgage and consumer lending, lease financing, trust account services and depositor services through its three subsidiaries. The Corporation's primary source of revenue is derived from loans to customers, primarily middle-income individuals, and investment activities. The Corporation operates 46 branches in west-central Indiana and east-central Illinois. First Financial Bank is the largest bank in Vigo County. It operates 12 full-service banking branches within the county; five in Clay County, Indiana; one in Greene County, Indiana; two in Knox County, Indiana; five in Parke County, Indiana; five in Sullivan County, Indiana; four in Vermillion County, Indiana; one in Clark County, Illinois; one in Coles County, Illinois; three in Crawford County, Illinois; one in Jasper County, Illinois; two in Lawrence County, Illinois; two in Richland County, Illinois; one in Vermilion County, Illinois; and one in Wayne County, Illinois. It also has a main office in downtown Terre Haute and an operations center/office building in southern Terre Haute. REGULATORY AGENCIES: First Financial Corporation is a multi-bank holding company and as such is regulated by various banking agencies. The holding company is regulated by the Seventh District of the Federal Reserve System. The national bank subsidiary is regulated by the Office of the Comptroller of the Currency. The state bank subsidiary is jointly regulated by the state banking organization and the Federal Deposit Insurance Corporation. SIGNIFICANT ACCOUNTING POLICIES USE OF ESTIMATES: To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and disclosures provided, and actual results could differ. The allowance for loan losses, carrying value of intangible assets, loan servicing rights and the fair values of financial instruments are particularly subject to change. CASH FLOWS: Cash and cash equivalents include cash and demand deposits with other financial institutions. Net cash flows are reported for customer loan and deposit transactions and short-term borrowings. SECURITIES: The Corporation classifies all securities as "available for sale." Securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value with unrealized holdings gains and losses, net of taxes, reported in other comprehensive income within shareholders' equity. Interest income includes amortization of purchase premium or discount. Premiums and discounts are amortized on the level yield method without anticipating prepayments. Mortgage-backed securities are amortized over the expected life. Realized gains and losses on sales are based on the amortized cost of the security sold. Declines in the fair value of securities below their cost that are other than temporary are reflected as realized losses. In estimating other-than-temporary losses, management considers: 1) the length of time and extent that fair value has been less than cost; 2) the financial condition and near term prospects of the issuer; and 3) the Corporation's ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. LOANS: Loans that management has the intent and ability to hold for the foreseeable future until maturity or pay-off are reported at the principal balance outstanding, net of unearned interest, deferred loan fees and costs, and allowance for loan losses. Loans held for sale are reported at the lower of cost or market, on an aggregate basis. Interest income is accrued on the unpaid principal balance and includes amortization of net deferred loan fees and costs over the loan term without anticipating prepayments. Interest income is not reported when full loan repayment is in doubt, typically when the loan is impaired or payments are significantly past due. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. In all cases, loans are placed on non-accrual or charged-off if collection of principal or interest is considered doubtful. ALLOWANCE FOR LOAN LOSSES: The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experi- 12 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ence, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired or loans otherwise classified as substandard or doubtful. The general component covers non-classified loans and is based on historical loss experience adjusted for current factors. A loan is impaired when full payment under the loan terms is not expected. Impairment is evaluated in total for smaller-balance loans of similar nature such as residential mortgages, consumer and credit card loans, and on an individual basis for other loans. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows, using the loan's existing rate, or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment and, accordingly, they are not separately identified for impairment disclosures. FORECLOSED ASSETS: Assets acquired through or instead of loan foreclosures are initially recorded at fair value when acquired, establishing a new cost basis. If fair value declines, a valuation allowance is recorded through expense. Costs after acquisition are expensed. PREMISES AND EQUIPMENT: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed over the useful lives of the assets, which range from 3 to 33 years for furniture and equipment and 5 to 39 years for buildings and leasehold improvements. FEDERAL HOME LOAN BANK (FHLB) STOCK: The Corporation is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost and periodically evaluated for impairment. Because this stock is viewed as a long-term investment, impairment is based on ultimate recovery of par value. Both cash and stock dividends are reported as income. FHLB stock is included with securities. SERVICING RIGHTS: Servicing rights are recognized as assets for the allocated value of retained servicing rights on loans sold. Servicing rights are expensed in proportion to, and over the period of, estimated net servicing revenues. Impairment is evaluated based on the fair value of the rights, using groupings of the underlying loans as to loan type and interest rate, and then secondarily as to loan type and investor. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. Any impairment of a grouping is reported as a valuation allowance. Servicing fee income is recorded for fees earned for servicing loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned. The amortization of mortgage servicing rights is netted against loan servicing fee income. BANK-OWNED LIFE INSURANCE: The Corporation has purchased life insurance policies on certain key executives. Bank-owned life insurance is recorded at its cash surrender value, or the amount that can be realized. GOODWILL AND OTHER INTANGIBLE ASSETS: Goodwill results from business acquisitions and represents the excess of the purchase price over the fair value of acquired tangible assets and liabilities and identifiable intangible assets. Goodwill is assessed at least annually for impairment and any such impairment will be recognized in the period identified. Other intangible assets consist of core deposit and acquired customer relationship intangible assets arising from the whole bank, insurance agency and branch acquisitions. They are initially measured at fair value and then are amortized on an accelerated method over their estimated useful lives, which are 12 and 10 years, respectively. LONG-TERM ASSETS: Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. BENEFIT PLANS: Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately recognized. The amount contributed is determined by a formula as decided by the Board of Directors. Deferred compensation and supplemental retirement plan expense allocates the benefits over years of service. DEFERRED COMPENSATION PLAN: A deferred compensation plan covers all directors. Under the plan, the Corporation pays each director, or their beneficiary, the amount of fees deferred plus interest over 10 years, beginning when the director achieves age 65. A liability is accrued for the obligation under these plans. The expense incurred for the deferred compensation for each of the last three years was $164 thousand, $160 thousand and $123 thousand, resulting in a deferred compensation liability of $2.2 million and $2.0 million as of year-end 2005 and 2004. LONG-TERM INCENTIVE PLAN: A long-term incentive plan provides for the payment of incentive rewards as a 10-year annuity to all directors and certain key officers. The plan expires December 31, 2009, and compensation expense is recognized over the service period. Payments under the plan generally do not begin until the earlier of January 1, 2015, or the January 1 immediately following the year in which the participant reaches age 65. Compensation expense for each of the last three years was $1.6 million, $1.5 million and $1.5 million, resulting in a liability of $7.3 million and $5.5 million as of year-end 2005 and 2004. INCOME TAXES: Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized. LOAN COMMITMENTS AND RELATED FINANCIAL INSTRUMENTS: Financial instruments include credit instruments, such as commitments to make loans and standby letters of credit, issued to meet customer financing needs. The face amount for these items 13 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. EARNINGS PER SHARE: Earnings per common share is net income divided by the weighted average number of common shares outstanding during the period. The Corporation does not have any potentially dilutive securities. Earnings and dividends per share are restated for stock splits and dividends through the date of issue of the financial statements. COMPREHENSIVE INCOME: Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale, which are also recognized as separate components of equity. LOSS CONTINGENCIES: Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount of range of loss can be reasonably estimated. Management does not believe there are currently such matters that will have a material effect on the financial statements. DIVIDEND RESTRICTION: Banking regulations require maintaining certain capital levels and may limit the dividends paid by the bank to the holding company or by the holding company to shareholders. FAIR VALUE OF FINANCIAL INSTRUMENTS: Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or market conditions could significantly affect the estimates. OPERATING SEGMENT: While the Corporation's chief decision-makers monitor the revenue streams of the various products and services, the identifiable segments are not material and operations are managed and financial performance is evaluated on a corporate-wide basis. Accordingly, all of the Corporation's financial service operations are considered by management to be aggregated in one reportable operating segment, which is banking. ADOPTION OF NEW ACCOUNTING STANDARDS: During 2005 the Corporation adopted SOP 03-3, which requires that a valuation allowance for loans acquired in a transfer, including in a business combination, reflect only losses incurred after acquisition and should not be recorded at acquisition. It applies to any loan acquired in a transfer that showed evidence of credit quality deterioration since it was made. This new standard had no effect on the Corporation's financial statements and results of operations. In May of 2005, the FASB issued statement 154, "Accounting Changes and Error Corrections," that provides guidance on reporting of accounting changes and correction of errors made in fiscal years beginning after the date of this statement. First Financial Corporation has adopted statement 154. The adoption of this statement had no effect on the financial statements included herein. In November of 2005, the FASB issued a staff position that amended FASB statement No. 115, "Accounting for Certain Investments in Debt and Equity Securities." This amendment addresses the measurement, accounting and disclosures for securities that have been recognized to be other than temporarily impaired as well as those that have not been recognized as other-than-temporarily impaired. First Financial Corporation has adopted these amendments that have had no effect on the financial statements included herein. RECLASSIFICATIONS: Some items in prior year financial statements were reclassified to conform to the current presentation. 2. FAIR VALUES OF FINANCIAL INSTRUMENTS: Carrying amount is the estimated fair value for cash and due from banks, federal funds sold, short-term borrowings, Federal Home Loan Bank stock, accrued interest receivable and payable, demand deposits, short-term debt and variable-rate loans or deposits that reprice frequently and fully. Security fair values are based on market prices or dealer quotes, and if no such information is available, on the rate and term of the security and information about the issuer. For fixed-rate loans or deposits, variable rate loans or deposits with infrequent repricing or repricing limits, and for longer-term borrowings, fair value is based on discounted cash flows using current market rates applied to the estimated life and credit risk. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values. Fair value of debt is based on current rates for similar financing. The carrying amount and estimated fair value of financial instruments are presented in the table below and were determined based on the above assumptions:
DECEMBER 31, ------------------------------------------------------------ 2005 2004 ---------------------------- ---------------------------- CARRYING FAIR CARRYING FAIR (Dollar amounts in thousands) VALUE VALUE VALUE VALUE ----------------------------- ----------- ----------- ----------- ----------- Cash and due from banks $ 78,201 $ 78,201 $ 94,928 $ 94,928 Federal funds sold 2,982 2,982 5,400 5,400 Securities available-for-sale 536,291 536,291 507,990 507,990 Loans, net 1,379,699 1,371,835 1,443,953 1,448,791 Accrued interest receivable 12,537 12,537 12,016 12,016 Deposits (1,464,918) (1,469,670) (1,443,121) (1,449,322) Short-term borrowings (26,224) (26,224) (75,527) (75,527) Federal Home Loan Bank advances (337,266) (338,849) (337,886) (341,148) Other borrowings (6,600) (6,600) (24,600) (24,600) Accrued interest payable (3,692) (3,692) (3,142) (3,142)
14 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 3. RESTRICTIONS ON CASH AND DUE FROM BANKS: Certain affiliate banks are required to maintain average reserve balances with the Federal Reserve Bank that do not earn interest. The amount of those reserve balances was approximately $2.1 million and $33.2 million at December 31, 2005 and 2004, respectively. 4. SECURITIES: The fair value of securities available-for-sale and related gross unrealized gains and losses recognized in accumulated other comprehensive income were as follows:
DECEMBER 31, 2005 ------------------------------------------------ UNREALIZED AMORTIZED --------------------- FAIR (Dollar amounts in thousands) COST GAINS LOSSES VALUE ----------------------------- --------- -------- --------- -------- U.S. Government sponsored entity mortgage-backed securities and agencies $306,697 $ 787 $ (6,081) $301,403 Collateralized mortgage obligations 2,357 7 (4) 2,360 State and municipal 129,916 4,543 (414) 134,045 Corporate obligations 89,740 534 (50) 90,224 Equities 4,410 3,849 -- 8,259 -------- -------- -------- -------- TOTAL $533,120 $ 9,720 $ (6,549) $536,291 ======== ======== ======== ========
DECEMBER 31, 2004 ------------------------------------------------ UNREALIZED AMORTIZED --------------------- FAIR (Dollar amounts in thousands) COST GAINS LOSSES VALUE ----------------------------- --------- -------- -------- -------- U.S. Government sponsored entity mortgage-backed securities and agencies $ 227,927 $ 2,573 $ (1,472) $229,028 Collateralized mortgage obligations 19,895 12 (41) 19,866 State and municipal 137,206 7,263 (175) 144,294 Corporate obligations 104,754 1,333 (10) 106,077 Equities 4,280 4,445 -- 8,725 --------- -------- -------- -------- TOTAL $ 494,062 $ 15,626 $ (1,698) $507,990 ========= ======== ======== ========
As of December 31, 2005, the Corporation does not have any securities from any issuer, other than the U.S. Government, with an aggregate book or fair value that exceeds ten percent of shareholders' equity. Securities with a carrying value of approximately $54.7 million and $33.0 million at December 31, 2005 and 2004, respectively, were pledged as collateral for short-term borrowings and for other purposes. Below is a summary of the gross gains and losses realized by the Corporation on investment sales during the years ended December 31, 2005, 2004 and 2003, respectively.
(Dollar amounts in thousands) 2005 2004 2003 ----------------------------- -------- -------- -------- Proceeds $ 11,376 $ 11,466 $ 8,308 Gross gains 537 409 237 Gross losses -- -- --
Additional gains of $34 thousand in 2005 and $47 thousand in 2004 resulted from redemption premiums on called securities. The Corporation evaluates securities for other-than-temporary impairment on a quarterly basis. Factors considered include length of time impaired, reason for impairment, outlook and the Corporation's ability to hold the investment to allow for recovery of fair value. There were no securities considered to be other-than-temporarily impaired at December 31, 2005. At December 31, 2004, the Corporation had one security that it considered to be other-than-temporarily impaired, and the Corporation wrote down the value of the investment by $621 thousand to its fair value and subsequently sold the security. 15 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Contractual maturities of debt securities at year-end 2005 were as follows. Securities not due at a single maturity or with no maturity date, primarily mortgage-backed and equity securities, are shown separately.
AVAILABLE-FOR-SALE ---------------------- AMORTIZED FAIR (Dollar amounts in thousands) COST VALUE ----------------------------- --------- -------- Due in one year or less $ 42,057 $ 42,304 Due after one but within five years 104,704 107,242 Due after five but within ten years 35,626 37,450 Due after ten years 45,973 46,095 -------- -------- 228,360 233,091 Mortgage-backed securities and equities 304,760 303,200 -------- -------- TOTAL $533,120 $536,291 ======== ========
The following tables show the securities' gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in continuous unrealized loss position, at December 31, 2005 and 2004.
DECEMBER 31, 2005 ------------------------------------------------------------------------------ LESS THAN 12 MONTHS MORE THAN 12 MONTHS TOTAL ------------------------ ------------------------ ------------------------ UNREALIZED UNREALIZED UNREALIZED (Dollar amounts in thousands) FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES ----------------------------- ---------- ---------- ---------- ---------- ---------- ---------- U.S. Government sponsored entity mortgage-backed securities and agencies $206,666 $ (4,250) $ 57,222 $ (1,831) $263,888 $ (6,081) Collateralized mortgage obligations 904 (2) 1,334 (2) 2,238 (4) State and municipal obligations 14,509 (240) 8,994 (174) 23,503 (414) Corporate obligations 698 (2) 950 (48) 1,648 (50) -------- -------- -------- -------- -------- -------- Total temporarily impaired securities $222,777 $ (4,494) $ 68,500 $ (2,055) $291,277 $ (6,549) ======== ======== ======== ======== ======== ========
DECEMBER 31, 2004 ------------------------------------------------------------------------------ LESS THAN 12 MONTHS MORE THAN 12 MONTHS TOTAL ------------------------ ------------------------ ------------------------ UNREALIZED UNREALIZED UNREALIZED (Dollar amounts in thousands) FAIR VALUE LOSSES FAIR VALUE LOSSES FAIR VALUE LOSSES ----------------------------- ---------- ---------- ---------- ---------- ---------- ---------- U.S. Government sponsored entity mortgage-backed securities and agencies $ 72,754 $ (497) $ 40,497 $ (975) $113,251 $ (1,472) Collateralized mortgage obligations 17,059 (41) -- -- 17,059 (41) State and municipal obligations 12,979 (110) 428 (65) 13,407 (175) Corporate obligations 2,000 (5) 1,506 (5) 3,506 (10) -------- -------- -------- -------- -------- -------- Total temporarily impaired securities $104,792 $ (653) $ 42,431 $ (1,045) $147,223 $ (1,698) ======== ======== ======== ======== ======== ========
These losses represent negative adjustments to market value relative to the rate of interest paid on the securities and not losses related to the creditworthiness of the issuer. Management has the intent and ability to hold for the foreseeable future and believes the value will recover as the securities approach maturity or market rates change. 16 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 5. LOANS: Loans are summarized as follows:
DECEMBER 31, ---------------------------- (Dollar amounts in thousands) 2005 2004 ----------- ----------- Commercial, financial and agricultural $ 382,214 $ 401,724 Real estate - construction 31,918 32,810 Real estate - mortgage 707,008 753,826 Installment 272,062 272,261 Lease financing 2,845 3,658 ----------- ----------- Total gross loans 1,396,047 1,464,279 Less: unearned income (306) (408) Allowance for loan losses (16,042) (19,918) ----------- ----------- TOTAL $ 1,379,699 $ 1,443,953 =========== ===========
In the normal course of business, the Corporation's subsidiary banks make loans to directors and executive officers and to their associates. These related party loans are consistent with sound banking practices and are within applicable bank regulatory lending limitations. In 2005 the aggregate dollar amount of these loans to directors and executive officers who held office at the end of the year amounted to $34.1 million at the beginning of the year. During 2005, advances of $19.6 million, repayments of $30.5 million and changes to persons included of $(1.2) million were made with respect to related party loans for an aggregate dollar amount outstanding of $22.0 million at December 31, 2005. Loans serviced for others, which are not reported as assets, total $416.6 million and $391.9 million at year-end 2005 and 2004. Activity for capitalized mortgage servicing rights (included in other assets) and the related valuation allowance was as follows:
DECEMBER 31, --------------------------------- (Dollar amounts in thousands) 2005 2004 2003 ----------------------------- ------- ------- ------- Servicing rights: Beginning of year $ 2,960 $ 3,114 $ 2,548 Additions 735 631 1,961 Amortized to expense (764) (785) (1,395) ------- ------- ------- End of year $ 2,931 $ 2,960 $ 3,114 ======= ======= ======= Valuation allowance: Beginning of year $ -- $ 200 $ 500 Reductions credited to expense -- (200) (300) ------- ------- ------- End of year $ -- $ -- $ 200 ======= ======= =======
Third party valuations are conducted periodically for mortgage servicing rights. Based on these valuations, fair values approximate carrying values. 6. ALLOWANCE FOR LOAN LOSSES: Changes in the allowance for loan losses are summarized as follows:
DECEMBER 31, ------------------------------------ (Dollar amounts in thousands) 2005 2004 2003 ----------------------------- -------- -------- -------- Balance at beginning of year $ 19,918 $ 21,239 $ 21,249 Provision for loan losses 11,698 8,292 7,455 Recoveries of loans previously charged off 1,918 1,771 1,475 Loans charged off (17,492) (11,384) (8,940) -------- -------- -------- BALANCE AT END OF YEAR $ 16,042 $ 19,918 $ 21,239 ======== ======== ========
17 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Impaired loans were as follows:
DECEMBER 31, ----------------------- (Dollar amounts in thousands) 2005 2004 ----------------------------- --------- --------- Year-end loans with no allocated allowance for loan losses $ 500 $ 2,582 Year-end loans with allocated allowance for loan losses 3,622 16,240 --------- --------- TOTAL $ 4,122 $ 18,822 ========= ========= Amount of the allowance for loan losses allocated $ 1,657 $ 6,331 Nonperforming loans: Loans past due over 90 days still on accrual 6,354 7,813 Non-accrual loans 8,464 19,862
Nonperforming loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans.
(Dollar amounts in thousands) 2005 2004 2003 ----------------------------- --------- --------- --------- Average of impaired loans during the year $ 11,992 $ 14,794 $ 8,992 Interest income recognized during impairment 126 436 583 Cash-basis interest income recognized 11 315 --
It was not practicable to determine the amount of cash basis interest income recognized for 2003. 7. PREMISES AND EQUIPMENT: Premises and equipment are summarized as follows:
DECEMBER 31, ---------------------- (Dollar amounts in thousands) 2005 2004 ----------------------------- -------- -------- Land $ 5,617 $ 5,617 Building and leasehold improvements 35,290 35,102 Furniture and equipment 29,887 27,928 -------- -------- 70,794 68,647 Less accumulated depreciation (39,524) (37,493) -------- -------- TOTAL $ 31,270 $ 31,154 ======== ========
Aggregate depreciation expense was $2.79 million, $2.62 million and $2.24 million for 2005, 2004 and 2003, respectively. 8. GOODWILL AND INTANGIBLE ASSETS: The Corporation completed its annual impairment testing of goodwill during the second quarter of 2005. Management does not believe any amount of the goodwill is impaired. Intangible assets subject to amortization at December 31, 2005 and 2004 are as follows:
2005 2004 --------------------------- -------------------------- GROSS ACCUMULATED GROSS ACCUMULATED (Dollar amounts in thousands) AMOUNT AMORTIZATION AMOUNT AMORTIZATION ----------------------------- --------- ------------ --------- ------------ Customer list intangible $ 3,446 $ 1,692 $ 3,108 $ 1,390 Core deposit intangible 2,193 1,117 2,193 939 Non-compete agreements 500 470 500 379 --------- --------- --------- --------- $ 6,139 $ 3,279 $ 5,801 $ 2,708 ========= ========= ========= =========
Aggregate amortization expense was $571 thousand, $558 thousand and $638 thousand for 2005, 2004 and 2003, respectively. Estimated amortization expense for the next five years is as follows:
In thousands 2006 $ 497 2007 425 2008 425 2009 425 2010 425
18 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 9. DEPOSITS Scheduled maturities of time deposits for the next five years are as follows:
2006 $ 348,575 2007 166,817 2008 75,671 2009 32,139 2010 18,094
10. SHORT-TERM BORROWINGS A summary of the carrying value of the Corporation's short-term borrowings at December 31, 2005 and 2004 is presented below:
(Dollar amounts in thousands) 2005 2004 ----------------------------- --------- --------- Federal funds purchased $ 19,032 $ 69,002 Repurchase agreements 5,579 5,597 Other short-term borrowings 1,613 928 --------- --------- $ 26,224 $ 75,527 ========= =========
(Dollar amounts in thousands) 2005 2004 ----------------------------- --------- --------- Average amount outstanding $ 25,927 $ 71,745 Maximum amount outstanding at a month end 54,808 103,386 Average interest rate during year 3.16% 1.46% Interest rate at year-end 3.77% 2.34%
Federal funds purchased are generally due in one day and bear interest at market rates. Other borrowings, primarily note payable--U.S. government, are due on demand, secured by a pledge of securities and bear interest at market rates. Substantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. The Corporation maintains possession of and control over these securities. 11. OTHER BORROWINGS: Other borrowings at December 31, 2005 and 2004 are summarized as follows:
(Dollar amounts in thousands) 2005 2004 ----------------------------- --------- --------- FHLB advances $ 337,266 $ 337,886 Note payable to a financial institution -- 18,000 City of Terre Haute, Indiana economic development revenue bonds 6,600 6,600 --------- --------- TOTAL $ 343,866 $ 362,486 ========= =========
The aggregate minimum annual payments of other borrowings are as follows:
2006 $ 8,665 2007 766 2008 52,632 2009 22,916 2010 257,594 Thereafter 1,293 ---------- $ 343,866 ==========
19 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Corporation's subsidiary banks are members of the Federal Home Loan Bank (FHLB) and accordingly are permitted to obtain advances. The advances from the FHLB, aggregating $337.3 million at December 31, 2005, accrue interest, payable monthly, at annual rates, primarily fixed, varying from 3.28% to 6.60% with a weighed average rate of 5.46%. The advances are due at various dates through August 2017. FHLB advances are, generally, due in full at maturity. They are secured by eligible securities totaling $129.9 million and a blanket pledge on real estate loan collateral. Certain advances may be prepaid, without penalty, prior to maturity. The FHLB can adjust the interest rate from fixed to variable on certain advances, but those advances may then be prepaid, without penalty. On December 31, 2004, the Corporation entered into a revolving credit loan agreement (Note) with a financial institution. The total principal amount of loans outstanding at one time under this Note could not exceed $20 million. The Note was paid off in the third quarter of 2005. The Note bore an interest rate equal to the average daily federal funds rate plus 0.875% and adjusted daily. The Note was unsecured but required the Corporation to meet certain financial covenants. The Corporation complied with all its debt covenants. These covenants included maintaining a primary capital-to-assets ratio higher than 6.2%, net income that exceeded a 0.6% return on average assets, an allowance for loan and lease losses that did not fall below .75% of gross loans and dividend declarations that were not in excess of 42% of net income. The economic development revenue bonds (bonds) require periodic interest payments each year until maturity or redemption. The interest rate, which was 3.58% at December 31, 2005, and 2.0% at December 31, 2004, is determined by a formula which considers rates for comparable bonds and is adjusted periodically. The bonds are collateralized by a first mortgage on the Corporation's headquarters building. The bonds mature December 1, 2015, but bondholders may periodically require earlier redemption. The debt agreement for the bonds requires the Corporation to meet certain financial covenants. These covenants require the Corporation to maintain a Tier I capital ratio of at least 6.2% and net income to average assets of 0.6%. At December 31, 2005 and 2004, the Corporation was in compliance with all of its debt covenants. The Corporation maintains a letter of credit with another financial institution, which could be used to repay the bonds, should they be called. The letter of credit expired November 1, 2005, and was automatically extended for one year. Assuming redemption will be funded by the letter of credit, or by other similar borrowings, there are no anticipated principal maturities of the bonds within the next five years. 12. INCOME TAXES: Income tax expense is summarized as follows:
(Dollar amounts in thousands) 2005 2004 2003 ----------------------------- --------- --------- --------- Federal: Currently payable $ 6,202 $ 5,884 $ 8,046 Deferred 1,334 1,282 (544) --------- --------- --------- 7,536 7,166 7,502 State: Currently payable (5) 467 1,052 Deferred 382 366 292 --------- --------- --------- 377 833 1,344 --------- --------- --------- TOTAL $ 7,913 $ 7,999 $ 8,846 ========= ========= =========
The reconciliation of income tax expense with the amount computed by applying the statutory federal income tax rate of 35% to income before income taxes is summarized as follows:
(Dollar amounts in thousands) 2005 2004 2003 ----------------------------- --------- --------- --------- Federal income taxes computed at the statutory rate $ 10,839 $ 12,603 $ 12,369 Add (deduct) tax effect of: Tax exempt income (2,902) (4,889) (3,738) State tax, net of federal benefit 245 541 873 Affordable housing credits (327) (327) (507) Other, net 58 71 (151) --------- --------- --------- TOTAL $ 7,913 $ 7,999 $ 8,846 ========= ========= =========
20 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2005 and 2004, are as follows:
(Dollar amounts in thousands) 2005 2004 ----------------------------- ------------- ------------- Deferred tax assets: Loan losses provision $ 6,454 $ 7,927 Deferred compensation 4,012 3,417 Compensated absences 494 481 Post-retirement benefits 920 698 State net operating loss carry forward 78 243 Other 981 929 ------------- ------------- GROSS DEFERRED ASSETS 12,939 13,695 ============= ============= Deferred tax liabilities: Net unrealized gains on securities available-for-sale (1,268) (5,571) Depreciation (1,440) (1,512) Federal Home Loan Bank stock dividends (1,519) (1,221) Mortgage servicing rights (1,176) (1,176) Pensions (2,394) (2,048) Other (3,012) (2,624) ------------- ------------- GROSS DEFERRED LIABILITIES (10,809) (14,152) ------------- ------------- NET DEFERRED TAX ASSETS (LIABILITIES) $ 2,130 $ (457) ============= =============
13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: The Corporation is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include conditional commitments and commercial letters of credit. The financial instruments involve to varying degrees, elements of credit and interest rate risk in excess of amounts recognized in the financial statements. The Corporation's maximum exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to make loans is limited generally by the contractual amount of those instruments. The Corporation follows the same credit policy to make such commitments as is followed for those loans recorded in the consolidated financial statements. The Corporation's customers had unused lines of credit of $270.0 million and $245.9 million as of December 31, 2005 and 2004. In addition, the Corporation had outstanding commitments of $6.9 million and $5.3 million under commercial letters of credit as of December 31, 2005 and 2004, respectively. The majority of these commitments bear variable interest rates. The Corporation is exposed to credit loss in the event the counterparties to such agreements do not perform in accordance with the agreements. Commitment and contingent liabilities are summarized as follows at December 31:
(Dollar amounts in thousands) 2005 2004 ----------------------------- ------------- ------------- Home equity $ 32,338 $ 32,523 Credit card lines 46,276 52,695 Commercial operating lines 24,270 15,937 Other commitments 169,226 147,871 ------------- ------------- $ 272,110 $ 249,026 Commercial letters of credit 6,933 5,319
The majority of commercial operating lines and home equity lines are variable rate, while the majority of other commitments to fund loans are fixed rate. Since many commitments to make loans expire without being used, these amounts do not necessarily represent future cash commitments. Collateral obtained upon exercise of the commitment is determined using management's credit evaluation of the borrower, and may include accounts receivable, inventory, property, land and other items. The approximate duration of these commitments is generally one year or less. 21 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 14. RETIREMENT PLANS: Substantially all employees of the Corporation are covered by a retirement program that consists of a defined benefit plan and an employee stock ownership plan (ESOP). Plan assets consist primarily of the Corporation's stock and obligations of U.S. Government agencies. Benefits under the defined benefit plan are actuarially determined based on an employee's service and compensation, as defined, and funded as necessary. Assets in the ESOP are considered in calculating the funding to the defined benefit plan required to provide such benefits. Any shortfall of benefits under the ESOP are to be provided by the defined benefit plan. The ESOP may provide benefits beyond those determined under the defined benefit plan. Contributions to the ESOP are determined by the Corporation's Board of Directors. The Corporation made contributions to the defined benefit plan of $1.41 million, $1.42 million and $1.55 million in 2005, 2004 and 2003. The Corporation contributed $1.14 million, $1.16 million and $1.26 million to the ESOP in 2005, 2004 and 2003. The Corporation uses a measurement date of December 31, 2005. Pension expense included the following components:
(Dollar amounts in thousands) 2005 2004 2003 ----------------------------- ------------- ------------- ------------- Service cost -- benefits earned $ 2,725 $ 2,508 $ 2,166 Interest cost on projected benefit obligation 2,451 2,168 2,025 Expected return on plan assets (3,285) (2,799) (2,334) Net amortization and deferral 229 227 240 ------------- ------------- ------------- Total pension expense $ 2,120 $ 2,104 $ 2,097 ============= ============= =============
The following information sets forth the change in projected benefit obligation, reconciliation of plan assets, and the funded status of the Corporation's retirement program. Actuarial present value of benefits is based on service to date and present pay levels.
(Dollar amounts in thousands) 2005 2004 ----------------------------- ------------- ------------- Change in benefit obligation: Benefit obligation at January 1 $ 42,820 $ 36,300 Service cost 2,725 2,508 Interest cost 2,451 2,168 Actuarial (gain) loss (1,831) 3,102 Benefits paid (3,624) (1,258) ------------- ------------- Benefit obligation at December 31 42,541 42,820 ------------- ------------- Reconciliation of fair value of plan assets: Fair value of plan assets at January 1 41,007 34,665 Actual return on plan assets (5,445) 5,017 Employer contributions 2,550 2,583 Benefits paid (3,624) (1,258) ------------- ------------- Fair value of plan assets at December 31 34,488 41,007 ------------- ------------- Funded status: Funded status at December 31 (8,053) (1,813) Unrecognized prior service cost (158) (177) Unrecognized net actuarial cost 14,214 7,562 ------------- ------------- Prepaid pension asset recognized in the consolidated balance sheets $ 6,003 $ 5,572 ============= =============
22 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The accumulated benefit obligation for the defined benefit pension plan was $34,206 and $37,202 at year-end 2005 and 2004. Principal assumptions used: Discount rate 5.50% 5.75% Rate of increase in compensation levels 3.75 3.75 Expected long-term rate of return on plan assets 8.00 8.00
The expected long-term rate of return was estimated using market benchmarks for equities and bonds applied to the plan's target asset allocation. Management estimated the rate by which plan assets would perform based on historical experience as adjusted for changes in asset allocations and expectations for future return on equities as compared to past periods. PLAN ASSETS -- The Corporation's pension plan weighted-average asset allocation for the years 2005 and 2004 by asset category are as follows:
PENSION PLAN ESOP PENSION PLAN ESOP PERCENTAGE OF PLAN PERCENTAGE OF PLAN TARGET ALLOCATION TARGET ALLOCATION ASSETS AT DECEMBER 31, ASSETS AT DECEMBER 31, ASSET CATEGORY 2006 2006 2005 2004 2005 2004 -------------- ----------------- ----------------- ---------------------- ---------------------- Equity securities 40-60% 100-100% 64% 63% 99% 99% Debt securities 40-60 0-0 35 35 0 0 Other 0-0 0-0 1 2 1 1 --- --- --- --- TOTAL 100% 100% 100% 100%
The investment objective for the retirement program is to maximize total return without exposure to undue risk. Asset allocation favors equities, with a target allocation of approximately 88%. This target includes the Corporation's ESOP, which is 99% invested in corporate stock. Other investment allocations include fixed income securities and cash. Equity securities include First Financial Corporation common stock in the amount of $22.1 million (64 percent of total plan assets) and $30.7 million (75 percent of total plan assets) at December 31, 2005 and 2004, respectively. CONTRIBUTIONS -- The Corporation expects to contribute $1.5 million to its pension plan and $1.2 million to its ESOP in 2006. ESTIMATED FUTURE PAYMENTS -- The following benefit payments, which reflect expected future service, are expected:
PENSION BENEFITS (Dollar amounts in thousands) 2006 $ 436 2007 512 2008 595 2009 708 2010 853 2011--2015 6,725
SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN -- The Corporation has established a Supplemental Executive Retirement Plan (SERP) for certain executive officers. The provisions of the SERP allow the Plan's participants who are also participants in the Corporation's defined benefit pension plan to receive supplemental retirement benefits to help recompense for benefits lost due to imposition of IRS limitations on benefits under the Corporation's tax qualified defined benefit pension plan. Expenses related to the plan were $193 thousand in 2005 and $187 thousand in 2004. There was no expense recorded in connection with this plan in years prior to 2004. The SERP has expected benefit payments of $618 thousand after five years, which reflects expected future service. The plan is unfunded and has a measurement date of December 31. 23 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS The Corporation also provides medical benefits to its employees subsequent to their retirement. The Corporation uses a measurement date of December 31, 2005. Accrued post-retirement benefits as of December 31, 2005 and 2004 are as follows:
DECEMBER 31, -------------------------------- (Dollar amounts in thousands) 2005 2004 ----------------------------- ------------- ------------- Change in benefit obligation: Benefit obligation at January 1 $ 6,021 $ 4,284 Service cost 141 83 Interest cost 319 243 Plan participants' contributions 143 119 Actuarial (gain) loss (736) 1,681 Benefits paid (388) (389) ------------- ------------- Benefit obligation at December 31 $ 5,500 $ 6,021 ============= ============= Reconciliation of funded status: Funded status $ 5,500 $ 6,021 Unrecognized transition obligation (482) (543) Unrecognized net gain (loss) (2,726) (3,712) ------------- ------------- Accrued benefit cost $ 2,292 $ 1,766 ============= =============
The post-retirement benefits paid in 2005 and 2004 of $388 thousand and $389 thousand, respectively, were fully funded by company and participant contributions. There were no other changes to plan assets in 2005 and 2004. Weighted-average assumptions as of December 31:
DECEMBER 31, ---------------------- 2005 2004 ---- ---- Discount rate 5.50% 5.50% Initial weighted health care cost trend rate 7.50 7.50 Ultimate health care cost trend rate 5.00 5.00
Post-retirement health benefit expense included the following components:
YEARS ENDED DECEMBER 31, ---------------------------------------------- (Dollar amounts in thousands) 2005 2004 2003 ----------------------------- ------------ ------------ ------------ Service cost $ 141 $ 83 $ 102 Interest cost 319 243 252 Amortization of transition obligation 60 60 60 Recognized actuarial loss 250 137 120 ------------ ------------ ------------ Net periodic benefit cost $ 770 $ 523 $ 534 ============ ============ ============
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A one-percentage-point change in the assumed health care cost trend rates would have the following effects:
1% POINT 1% POINT (Dollar amounts in thousands) INCREASE DECREASE ----------------------------- -------- -------- Effect on total of service and interest cost components $ 58 $ (42) Effect on post-retirement benefit obligation 127 (113)
CONTRIBUTIONS -- The Corporation expects to contribute $294 thousand to its other post-retirement benefit plan in 2006. 24 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ESTIMATED FUTURE PAYMENTS -- The following benefit payments, which reflect expected future service, are expected:
POST-RETIREMENT MEDICAL BENEFITS (Dollar amounts in thousands) 2006 $ 294 2007 312 2008 324 2009 338 2010 355 2011--2015 2,047
15. OTHER COMPREHENSIVE INCOME (LOSS): Other comprehensive loss components and related taxes were as follows:
DECEMBER 31, --------------------------------------------------- (Dollar amounts in thousands) 2005 2004 2003 ----------------------------- ------------- ------------- ------------- Unrealized holding gains and (losses) on securities available-for-sale $ (10,186) $ (5,347) $ (4,450) Reclassification adjustments for (gains) and losses later recognized in income (571) 165 (237) ------------- ------------- ------------- Net unrealized gains and losses (10,757) (5,182) (4,687) Tax effect 4,303 2,076 1,874 ------------- ------------- ------------- Other comprehensive income (loss) $ (6,454) $ (3,106) $ (2,813) ============= ============= =============
16. REGULATORY MATTERS: The Corporation and its bank affiliates are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory--and possibly additional discretionary--actions by regulators that, if undertaken, could have a direct material effect on the Corporation's financial statements. Further, the Corporation's primary source of funds to pay dividends to shareholders is dividends from its subsidiary banks and compliance with these capital requirements can affect the ability of the Corporation and its banking affiliates to pay dividends. At December 31, 2005, approximately $25.8 million of undistributed earnings of the subsidiary banks, included in consolidated retained earnings, were available for distribution to the Corporation without regulatory approval. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Corporation and Banks must meet specific capital guidelines that involve quantitative measures of the Corporation's assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Corporation's and Banks' capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Corporation and Banks to maintain minimum amounts and ratios of Total and Tier I Capital to risk-weighted assets, and of Tier I Capital to average assets. Management believes, as of December 31, 2005 and 2004, that the Corporation meets all capital adequacy requirements to which it is subject. As of December 31, 2005, the most recent notification from the respective regulatory agencies categorized the subsidiary banks as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the banks must maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the banks' category. The following table presents the actual and required capital amounts and related ratios for the Corporation and the lead bank, First Financial Bank, N.A., at year end 2005 and 2004. 25 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
TO BE WELL CAPITALIZED FOR CAPITAL UNDER PROMPT CORRECTIVE ACTUAL ADEQUACY PURPOSES ACTION PROVISIONS ---------------------------- ---------------------------- --------------------------- (Dollar amounts in thousands) AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------------------------------ ----------- ------- ----------- ----- --------- ------- TOTAL RISK-BASED CAPITAL Corporation -- 2005 $ 273,207 16.99% $ 128,637 8.0% N/A N/A Corporation -- 2004 269,405 16.55% 130,239 8.0% N/A N/A First Financial Bank -- 2005 262,282 17.09% 122,804 8.0% 153,506 10.0% First Financial Bank -- 2004 243,390 17.09% 113,956 8.0% 142,445 10.0% TIER I RISK-BASED CAPITAL Corporation -- 2005 $ 257,165 15.99% $ 64,319 4.0% N/A N/A Corporation -- 2004 249,487 15.32% 65,120 4.0% N/A N/A First Financial Bank -- 2005 248,727 16.20% 61,402 4.0% 92,103 6.0% First Financial Bank -- 2004 227,880 16.00% 56,978 4.0% 85,467 6.0% TIER I LEVERAGE CAPITAL Corporation -- 2005 $ 257,165 11.89% $ 86,532 4.0% N/A N/A Corporation -- 2004 249,487 11.42% 87,391 4.0% N/A N/A First Financial Bank -- 2005 248,727 11.94% 83,355 4.0% 104,194 5.0% First Financial Bank -- 2004 227,880 11.82% 77,143 4.0% 96,429 5.0%
17. PARENT COMPANY CONDENSED FINANCIAL STATEMENTS: The parent company's condensed balance sheets as of December 31, 2005 and 2004, and the related condensed statements of income and cash flows for each of the three years in the period ended December 31, 2005, are as follows: CONDENSED BALANCE SHEETS
DECEMBER 31, ------------------------------- (Dollar amounts in thousands) 2005 2004 ----------------------------- ------------- ------------- ASSETS Cash deposits in affiliated banks $ 8,364 $ 9,710 Investments in subsidiaries 267,335 282,435 Land and headquarters building, net 6,244 6,156 Other 8,613 9,709 ------------- ------------- TOTAL ASSETS $ 290,556 $ 308,010 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY LIABILITIES Borrowings $ 10,636 $ 28,636 Dividends payable 5,603 5,414 Other liabilities 4,994 5,625 ------------- ------------- TOTAL LIABILITIES 21,233 39,675 SHAREHOLDERS' EQUITY 269,323 268,335 ------------- ------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 290,556 $ 308,010 ============= =============
26 2005 ANNUAL REPORT NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, ------------------------------------------------ (Dollar amounts in thousands) 2005 2004 2003 ----------------------------- ------------ ------------- ------------- Dividends from subsidiaries $ 33,828 $ 13,670 $ 12,418 Other income 1,013 967 1,006 Interest on borrowings (943) (703) (663) Other operating expenses (3,017) (2,931) (2,759) ------------ ------------- ------------- Income before income taxes and equity in undistributed earnings of subsidiaries 30,881 11,003 10,002 Income tax benefit 1,177 909 907 ------------ ------------- ------------- Income before equity in undistributed earnings of subsidiaries 32,058 11,912 10,909 Equity in undistributed earnings of subsidiaries (9,004) 16,097 15,584 ------------ ------------- ------------- Net income $ 23,054 $ 28,009 $ 26,493 ============ ============= =============
CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, ------------------------------------------------ (Dollar amounts in thousands) 2005 2004 2003 ----------------------------- ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 23,054 $ 28,009 $ 26,493 Adjustments to reconcile net income to net cash provided by operating activities: Provision for depreciation and amortization 258 206 215 Equity in undistributed earnings of subsidiaries 9,004 (16,097) (15,584) Contribution of shares to ESOP 1,144 1,163 1,256 Increase (decrease) in other liabilities 479 416 1,626 (Increase) decrease in other assets (392) 869 852 ------------ ------------ ------------ NET CASH FROM OPERATING ACTIVITIES 33,547 14,566 14,858 CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of furniture and fixtures (325) -- (34) ------------ ------------ ------------ NET CASH FROM INVESTING ACTIVITIES (325) -- (34) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from borrowings -- -- 18,236 Principal payments on long-term borrowings (18,000) -- (19,500) Purchase of treasury stock (5,789) (2,330) (2,123) Dividends paid (10,779) (10,155) (8,845) ------------ ------------ ------------ NET CASH FROM FINANCING ACTIVITIES (34,568) (12,485) (12,232) ------------ ------------ ------------ NET (DECREASE) INCREASE IN CASH (1,346) 2,081 2,592 CASH, BEGINNING OF YEAR 9,710 7,629 5,037 ------------ ------------ ------------ CASH, END OF YEAR $ 8,364 $ 9,710 $ 7,629 ============ ============ ============ Supplemental disclosures of cash flow information: Cash paid during the year for: Interest $ 938 $ 678 $ 663 ============ ============ ============ Income taxes $ 5,413 $ 6,501 $ 8,016 ============ ============ ============
27 FIRST FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 18. SELECTED QUARTERLY DATA (UNAUDITED)
2005 ------------------------------------------------------------------------- NET PROVISION INTEREST INTEREST INTEREST FOR LOAN NET NET INCOME (Dollar amounts in thousands) INCOME EXPENSE INCOME LOSSES INCOME PER SHARE ----------------------------- -------- -------- -------- --------- -------- ---------- March 31 $ 29,365 $ 11,022 $ 18,343 $ 2,223 $ 6,311 $ .48 June 30 $ 29,776 $ 11,498 $ 18,278 $ 3,783 $ 4,992 $ .37 September 30 $ 30,893 $ 12,208 $ 18,685 $ 2,608 $ 6,323 $ .46 December 31 $ 31,613 $ 12,741 $ 18,872 $ 3,084 $ 5,428 $ .41
2004 ------------------------------------------------------------------------- NET PROVISION INTEREST INTEREST INTEREST FOR LOAN NET NET INCOME (Dollar amounts in thousands) INCOME EXPENSE INCOME LOSSES INCOME PER SHARE ----------------------------- -------- -------- -------- --------- -------- ---------- March 31 $ 29,276 $ 11,343 $ 17,933 $ 1,923 $ 10,685 $ .79 June 30 $ 28,825 $ 11,072 $ 17,753 $ 1,923 $ 6,329 $ .47 September 30 $ 29,021 $ 11,174 $ 17,847 $ 2,223 $ 5,975 $ .44 December 31 $ 29,766 $ 11,097 $ 18,669 $ 2,223 $ 5,020 $ .37
In the first quarter of 2004, the Corporation realized $4.1 million of income from gain on a life insurance benefit. ---------- REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON FINANCIAL STATEMENTS To the Shareholders and Board of Directors of First Financial Corporation: We have audited the accompanying consolidated balance sheets of First Financial Corporation as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Financial Corporation as of December 31, 2005 and 2004, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of First Financial Corporation's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control--Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report, dated February 21, 2006, expressed an unqualified opinion thereon. /s/ Crowe Chizek and Company LLC Indianapolis, Indiana February 21, 2006 28 2005 ANNUAL REPORT REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER FINANCIAL REPORTING To the Shareholders and Board of Directors of First Financial Corporation: We have audited management's assessment, included in the accompanying "Report on Internal Control Over Financial Reporting," that First Financial Corporation (Corporation) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in "Internal Control--Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). First Financial Corporation's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Corporation's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U. S. generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, management's assessment that First Financial Corporation maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established in "Internal Control--Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also in our opinion, First Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established in "Internal Control--Integrated Framework" issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 2005 of First Financial Corporation and our report dated February 21, 2006 expressed an unqualified opinion. /s/ Crowe Chizek and Company LLC Indianapolis, Indiana February 21, 2006 29 FIRST FINANCIAL CORPORATION MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of First Financial Corporation (the "Corporation") has prepared and is responsible for the preparation and accuracy of the consolidated financial statements and related financial information included in the Annual Report. The management of the Corporation is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Corporation's internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. The Corporation's internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Corporation; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Corporation are being made only in accordance with authorizations of management and directors of the Corporation; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Corporation's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the Corporation's system of internal control over financial reporting as of December 31, 2005, in relation to criteria for effective internal control over financial reporting as described in "Internal Control--Integrated Framework," issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that, as of December 31, 2005, its system of internal control over financial reporting is effective and meets the criteria of the "Internal Control--Integrated Framework." Crowe Chizek and Company LLC, independent registered public accounting firm, has issued an attestation report dated February 21, 2006 on management's assessment of the Corporation's internal control over financial reporting. MANAGEMENT'S DISCUSSION AND ANALYSIS Management's discussion and analysis reviews the financial condition of First Financial Corporation at December 31, 2005 and 2004, and the results of its operations for the three years ended December 31, 2005. Where appropriate, factors that may affect future financial performance are also discussed. The discussion should be read in conjunction with the accompanying consolidated financial statements, related footnotes and selected financial data. A cautionary note about forward-looking statements: In its oral and written communication, First Financial Corporation from time to time includes forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements can include statements about estimated cost savings, plans and objectives for future operations and expectations about performance, as well as economic and market conditions and trends. They often can be identified by the use of words such as "expect," "may," "could," "intend," "project," "estimate," "believe" or "anticipate." First Financial Corporation may include forward-looking statements in filings with the Securities and Exchange Commission, in other written materials such as this Annual Report and in oral statements made by senior management to analysts, investors, representatives of the media and others. It is intended that these forward-looking statements speak only as of the date they are made, and First Financial Corporation undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the forward-looking statement is made or to reflect the occurrence of unanticipated events. By their nature, forward-looking statements are based on assumptions and are subject to risks, uncertainties and other factors. Actual results may differ materially from those contained in the forward-looking statement. The discussion in this "Management's Discussion and Analysis of Results of Operations and Financial Condition" lists some of the factors which could cause actual results to vary materially from those in any forward-looking statements. Other uncertainties which could affect First Financial Corporation's future performance include the effects of competition, technological changes and regulatory developments; changes in fiscal, monetary and tax policies; market, economic, operational, liquidity, credit and interest rate risks associated with First Financial Corporation's business; inflation; competition in the financial services industry; changes in general economic conditions, either nationally or regionally, resulting in, among other things, credit quality deterioration; and changes in securities markets. Investors should consider these risks, uncertainties and other factors in addition to those mentioned by First Financial Corporation in its other filings from time to time when considering any forward-looking statement. 30 2005 ANNUAL REPORT MANAGEMENT'S DISCUSSION AND ANALYSIS First Financial Corporation (the Corporation) is a financial services company. The Corporation, which is headquartered in Terre Haute, Ind., offers a wide variety of financial services including commercial, mortgage and consumer lending, lease financing, trust account services and depositor services through its three subsidiaries. At the close of business in 2005 the Corporation and its subsidiaries had 808 full-time equivalent employees. First Financial Bank is the largest bank in Vigo County, Ind. It operates 12 full-service banking branches within the county; five in Clay County, Ind.; one in Greene County, Ind.; two in Knox County, Ind.; five in Parke County, Ind.; five in Sullivan County, Ind.; four in Vermillion County, Ind.; one in Clark County, Ill.; one in Coles County, Ill.; three in Crawford County, Ill.; one in Jasper County, Ill.; two in Lawrence County, Ill.; two in Richland County, Ill.; one in Vermilion County, Ill.; and one in Wayne County, Ill. In addition to its branches, it has a main office in downtown Terre Haute and a 50,000-square-foot commercial building on South Third Street in Terre Haute, which serves as the Corporation's operations center and provides additional office space. Morris Plan has one office and is located in Vigo County. First Financial Bank and Morris Plan face competition from other financial institutions. These competitors consist of commercial banks, a mutual savings bank and other financial institutions, including consumer finance companies, insurance companies, brokerage firms and credit unions. The Corporation's business activities are centered in west-central Indiana and east-central Illinois. The Corporation has no foreign activities other than periodically investing available funds in time deposits held in foreign branches of domestic banks. Forrest Sherer Inc. is a premier regional supplier of insurance, surety and other financial products. The Forrest Sherer brand is well recognized in the Midwest, with more than 62 professionals and over 85 years of successful service to both businesses and households in their market area. The agency has representation agreements with more than 40 regional and national insurers to market their products of property and casualty insurance, surety bonds, employee benefit plans, life insurance and annuities. CRITICAL ACCOUNTING POLICIES AND ESTIMATES The Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as disclosures found elsewhere in this report are based upon First Financial Corporation's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires the Corporation to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and goodwill. Actual results could differ from those estimates. ALLOWANCE FOR LOAN LOSSES. The allowance for loan losses represents management's estimate of losses inherent in the existing loan portfolio. The allowance for loan losses is increased by the provision for loan losses charged to expense and reduced by loans charged off, net of recoveries. The allowance for loan losses is determined based on management's assessment of several factors: reviews and evaluations of specific loans, changes in the nature and volume of the loan portfolio, current economic conditions and the related impact on segments of the loan portfolio, historical loan loss experience and the level of classified and nonperforming loans. Loans are considered impaired if, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest according to the contractual terms of the loan agreement. When a loan is deemed impaired, impairment is measured by using the fair value of underlying collateral, the present value of the future cash flows discounted at the effective interest rate stipulated in the loan agreement, or the estimated market value of the loan. In measuring the fair value of the collateral, management uses assumptions (e.g., discount rate) and methodologies (e.g., comparison to the recent selling price of similar assets) consistent with those that would be utilized by unrelated third parties. Changes in the financial condition of individual borrowers, economic conditions, historical loss experience, or the condition of the various markets in which collateral may be sold may affect the required level of the allowance for loan losses and the associated provision for loan losses. Should cash flow assumptions or market conditions change, a different amount may be recorded for the allowance for loan losses and the associated provision for loan losses. GOODWILL. The carrying value of goodwill requires management to use estimates and assumptions about the fair value of the reporting unit compared to its book value. An impairment analysis is prepared on an annual basis. Fair values of the reporting units are determined by an analysis which considers cash flows streams, profitability and estimated market values of the business unit. The majority of the Corporation's goodwill is recorded at Forest Sherer, Inc. Management believes the accounting estimates related to the allowance for loan losses and the valuation of goodwill are "critical accounting estimates" because: (1) the estimates are highly susceptible to change from period to period because they require management to make assumptions concerning, among other factors, the changes in the types and volumes of the portfolios, valuation assumptions, and economic conditions, and (2) the impact of recognizing an impairment or loan loss could have a material effect on the Corporation's assets reported on the balance sheet as well as net income. 31 FIRST FINANCIAL CORPORATION RESULTS OF OPERATIONS -- SUMMARY FOR 2005 Net income for 2005 was $23.1 million, or $1.72 per share. This represents a 17.7% decrease in net income and a 16.9% decrease in earnings per share, compared to 2004. 2004 net income was favorably affected by $4.1 million in life insurance proceeds, which increased 2004 earnings per share by $.30. NET INTEREST INCOME The principal source of the Corporation's earnings is net interest income, which represents the difference between interest earned on loans and investments and the interest cost associated with deposits and other sources of funding. Net interest income increased $2 million to $74.2 million in 2005. Total average interest-earning assets decreased to $2.01 billion in 2005 from $2.04 billion in 2004. The tax-equivalent yield on these assets increased to 6.28% in 2005 from 6.00% in 2004. Total average interest-bearing liabilities of $1.74 billion in 2004 decreased to $1.71 billion in 2005. The average cost of these interest-bearing liabilities increased to 2.77% in 2005 from 2.56% in 2004. The net interest margin increased from 3.81% in 2004 to 3.92% in 2005. This increase is primarily the result of the increased yield on earning assets having a larger impact than the increased cost of interest-bearing liabilities. Earning assets yields increased 28 basis points while the cost of interest-bearing liabilities increased by 21 basis points. The costs of funding earning assets were reduced as more funding was provided by lower cost deposits, including non-interest bearing deposits, than borrowings in 2005 compared to 2004. The following table sets forth the components of net interest income due to changes in volume and rate. The table information compares 2005 to 2004 and 2004 to 2003.
2005 COMPARED TO 2004 2004 COMPARED TO 2003 INCREASE (DECREASE) DUE TO INCREASE (DECREASE) DUE TO ------------------------------------- ------------------------------------- VOLUME/ VOLUME/ (Dollar amounts in thousands) VOLUME RATE RATE TOTAL VOLUME RATE RATE TOTAL ---------------------------------------------- ------- ------- -------- ------- ------- ------- -------- ------- Interest earned on interest-earning assets: Loans (1)(2) $ (726) $ 4,592 $ (37) $ 3,829 $ 2,473 $(7,717) $ (194) $(5,438) securities (564) 2,129 (78) 1,487 (541) 147 (5) (399) Tax-exempt investment securities(2) (835) (947) 56 (1,726) (1,593) (413) 42 (1,964) Federal funds sold 212 45 189 446 (25) 47 (24) (2) ------- ------- ------- ------- ------- ------- ------- ------- Total interest income (1,913) 5,819 130 4,036 (314) (7,936) (181) (7,803 ------- ------- ------- ------- ------- ------- ------- ------- Interest paid on interest-bearing liabilities: Transaction accounts 206 2,804 149 3,159 460 (816) (87) (443) Time deposits 16 314 -- 330 (2,298) (544) 55 (2,787) Short-term borrowings (653) 1,169 (750) (234) 448 68 70 586 Other borrowings (1,054) 614 (32) (472) (847) (50) 2 (895) ------- ------- ------- ------- ------- ------- ------- ------- Total interest expense (1,485) 4,901 (633) 2,783 (2,237) (1,342) 40 (3,539) ------- ------- ------- ------- ------- ------- ------- ------- Net interest income $ (428) $ 918 $ 763 $ 1,253 $ 2,551 $(6,594) $ (221) $(4,264) ======= ======= ======= ======= ======= ======= ======= =======
(1) For purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding. (2) Interest income includes the effect of tax equivalent adjustments using a federal tax rate of 35%. 32 2005 ANNUAL REPORT RESULTS OF OPERATIONS -- SUMMARY FOR 2005 PROVISION FOR LOAN LOSSES The provision for loan losses charged to expense is based upon credit loss experience and the results of a detailed analysis estimating an appropriate and adequate allowance for loan losses. The analysis includes the evaluation of impaired loans as prescribed under Statement of Financial Accounting Standards (SFAS) Nos. 114 and 118, pooled loans as prescribed under SFAS No. 5, and economic and other risk factors as outlined in various Joint Interagency Statements issued by the bank regulatory agencies. For the year ended December 31, 2005, the provision for loan losses was $11.7 million, an increase of $3.4 million, or 41.1%, compared to 2004. The increase was the result of several components related to the analysis of the Corporation's Allowance for Loan and Lease Losses. Although net charge-offs for 2005 were $15.6 million as compared to $9.6 million for 2004, classified credits were reduced by $12.5 million, or 17.3%, from prior year totals and nonperforming loans decreased by $13.2 million. During the year commercial and real estate credits were identified for sale and written down to realizable value. This caused both an increase in provision for loan losses as well as decreased nonperforming loans and classified credits. Changes in bankruptcy statutes increased the amount of charge-offs of consumer credits in the second half of 2005. At December 31, 2005, the resulting allowance for loan losses was $16.0 million or 1.15% of total loans, net of unearned income. A year earlier the allowance was $19.9 million or 1.36% of total loans. NON-INTEREST INCOME Non-interest income of $32.0 million decreased $3.8 million from the $35.8 million earned in 2004. Excluding the $4.1 million non-taxable gain on life insurance benefit realized in 2004, the non-interest income is up by $384 thousand. Increased gains on loan and security sales were partially offset by reduced income from insurance commissions and trust fees. NON-INTEREST EXPENSES Non-interest expenses totaled $63.5 million for 2005 compared to $63.7 million for 2004. Salaries and employee benefits increased $741 thousand or 2.0%. Occupancy expense decreased 2.8% or $108 thousand while equipment expense increased by 7.7% or $276 thousand. All other expenses decreased to $17.3 million from $18.3 million in 2004. Consolidation of affiliate banks, which has contributed to the control of non-interest expenses, was completed in the third quarter of 2005. INCOME TAXES The Corporation's federal income tax provision was $7.9 million in 2005 compared to a provision of $8.0 million in 2004. The overall effective tax rate in 2004 of 22.2% compares to a 2005 effective rate of 25.6%. The life insurance benefit received in 2004 was not subject to income tax, thereby reducing the effective tax rate. COMPARISON OF 2004 TO 2003 Net income for 2004 was $28.0 million or $2.07 per share compared to $26.5 million in 2003 or $1.95 per share. This increased income was primarily the result of increased non-interest income in 2004 from a gain on life insurance benefit of $4.1 million. Total average interest-earning assets decreased $1.8 million in 2004 from $2.04 billion in 2003. The tax equivalent net interest margin decreased to 3.81% in 2004 from 4.02% in 2003. This decrease is primarily the result of funding costs decreasing at a slower rate than the yield on earning assets. The provision for loan losses increased $837 thousand from $7.5 million in 2003 to $8.3 million in 2004, and net charge-offs increased $2.1 million from $7.5 million in 2003 to $9.6 million in 2004. There was a $3.7 million improvement in net non-interest income and expense from 2003 to 2004. Non-interest expenses increased $1.2 million while non-interest income increased $4.9 million. The majority of this increase in non-interest income was the result of the gain on life insurance benefit of $4.1 million realized in 2004. The provision for income taxes fell $847 thousand from 2003 to 2004, reducing the effective tax rate from 25.0% in 2003 to 22.2% in 2004. This decrease in the effective tax rate was the result of the increase in non-taxable income from the gain on life insurance benefit realized in 2004. Without this gain the effective tax rate would have been 25.1%. 33 FIRST FINANCIAL CORPORATION FINANCIAL CONDITION -- SUMMARY The Corporation's total assets decreased 2.2% or $47.1 million at December 31, 2005, from a year earlier. Available-for-sale securities increased $28.3 million at December 31, 2005, from the previous year. Loans, net of unearned income, decreased by $68.3 million, to $1.40 billion. Deposits increased $21.8 million while borrowings decreased by $67.9 million. Total shareholders' equity increased $988 thousand to $269.3 million at December 31, 2005. Net income was partially offset by higher dividends and the continued repurchase of corporate stock. The Corporation had higher purchases of treasury stock in 2005, acquiring 203,700 shares at a cost of $5.8 million compared to 79,000 shares during 2004 at a cost of $2.3 million. There were also 41,500 shares from the treasury with a value of $1.14 million that were contributed to the ESOP plan. Increased interest rates reduced other comprehensive income as the Corporation recorded a net unrealized loss on available-for-sale securities of $6.5 million. While this fluctuation in fair value decreased shareholders' equity, no loss is recognized in net income unless the security is actually sold or considered to be other-than-temporarily impaired. Following is an analysis of the components of the Corporation's balance sheet. SECURITIES The Corporation's investment strategy seeks to maximize income from the investment portfolio while using it as a risk management tool and ensuring safety of principal and capital. During 2005 the portfolio's balance increased by 5.57%. During 2005 the Federal Reserve increased the fed funds rate by 2.00% to 4.25%. The average life of the portfolio was extended from 4.00 years to 4.36 years. The portfolio structure will continue to provide cash flows to be reinvested during 2006. Year-end securities maturity schedules were comprised of the following:
1 YEAR AND LESS 1 TO 5 YEARS 5 TO 10 YEARS OVER 10 YEARS ---------------------------------------------------------------------------- 2005 (Dollar amounts in thousands) BALANCE RATE BALANCE RATE BALANCE RATE BALANCE RATE TOTAL -------------------------------------- ------- ---- -------- ---- -------- ---- ------- ---- ------- U.S. government sponsored entity mortgage-backed securities and agencies $11,759 4.28% $284,815 4.56% $ 4,829 5.50% -- --% $301,403 Collateralized mortgage obligations(1) 2,215 4.22 145 9.73 -- -- -- -- 2,360 States and political subdivisions 29,760 4.24 66,383 3.25 34,591 1.63 3,311 3.31 134,045 Corporate obligations 6,679 4.88 37,901 5.75 2,860 5.41 42,784 5.09 90,224 ------- -------- ------- ------ -------- Total 50,413 4.33 389,244 4.45 42,280 2.33 46,095 4.96 528,032 ------- -------- ------- ------ -------- Equities -- -- -- -- -- -- 8,259 -- 8,259 ------- -------- ------- ------ -------- TOTAL $50,413 $389,244 $42,280 $54,354 $536,291 ======= ======== ======= ======= ========
(1) Distribution of maturities is based on the estimated average life of the asset. 34 2005 ANNUAL REPORT FINANCIAL CONDITION -- SUMMARY LOAN PORTFOLIO Loans outstanding by major category as of December 31 for each of the last five years and the maturities at year end 2005 are set forth in the following analyses.
(Dollar amounts in thousands) 2005 2004 2003 2002 2001 -------------------------------------- ---------- ---------- --------- ---------- ---------- LOAN CATEGORY Commercial, financial and agricultural $ 382,214 $ 401,724 $ 374,638 $ 331,316 $ 302,496 Real estate - construction 31,918 32,810 35,361 42,930 34,610 Real estate - mortgage 707,008 753,826 766,911 789,618 757,345 Installment 272,062 272,261 248,290 268,067 249,710 Lease financing 2,845 3,658 4,884 1,281 5,023 ---------- ---------- ---------- ---------- ---------- TOTAL $1,396,047 $1,464,279 $1,430,084 $1,433,212 $1,349,184 ========== ========== ========== ========== ==========
AFTER ONE WITHIN BUT WITHIN AFTER FIVE (Dollar amounts in thousands) ONE YEAR FIVE YEARS YEARS TOTAL ----------------------------- -------- ---------- ---------- --------- MATURITY DISTRIBUTION Commercial, financial and agricultural $197,534 $151,941 $32,739 $ 382,214 Real estate - construction 17,342 7,740 6,836 31,918 -------- -------- ------- ---------- TOTAL $214,876 $159,681 $39,575 414,132 ======== ======== ======= Real estate - mortgage 707,008 Installment 272,062 Lease financing 2,845 ---------- TOTAL $1,396,047 ========== Loans maturing after one year with: Fixed interest rates $ 59,011 $34,335 Variable interest rates 100,670 5,240 -------- ------- TOTAL $159,681 $39,575 ======== =======
35 FIRST FINANCIAL CORPORATION FINANCIAL CONDITION -- SUMMARY ALLOWANCE FOR LOAN LOSSES The activity in the Corporation's allowance for loan losses is shown in the following analysis:
(Dollar amounts in thousands) 2005 2004 2003 2002 2001 ------------------------------------------- ---- ---- ---- ---- ---- Amount of loans outstanding at December 31, $1,396,047 $1,464,279 $1,430,084 $1,433,212 $1,349,184 ========== ========== ========== ========== ========== Average amount of loans by year $1,441,247 $1,452,572 $1,417,026 $1,432,290 $1,315,725 ========== ========== ========== ========== ========== Allowance for loan losses at beginning of year $ 19,918 $ 21,239 $ 21,249 $ 18,313 $ 19,072 Addition resulting from acquisition -- -- -- 1,711 -- Loans charged off: Commercial, financial and agricultural 6,093 4,080 2,253 4,627 4,079 Real estate - mortgage 2,590 623 1,101 892 557 Installment 8,809 6,680 5,586 4,619 4,395 Leasing -- 1 -- -- 12 ---------- ---------- ---------- ---------- ---------- Total loans charged off 17,492 11,384 8,940 10,138 9,043 ---------- ---------- ---------- ---------- ---------- Recoveries of loans previously charged off: Commercial, financial and agricultural 284 452 432 840 819 Real estate - mortgage 343 37 166 110 60 Installment 1,291 1,281 877 935 790 Leasing -- 1 -- -- -- ---------- ---------- ---------- ---------- ---------- Total recoveries 1,918 1,771 1,475 1,885 1,669 ---------- ---------- ---------- ---------- ---------- Net loans charged off 15,574 9,613 7,465 8,253 7,374 Provision charged to expense 11,698 8,292 7,455 9,478 6,615 ---------- ---------- ---------- ---------- ---------- Balance at end of year $ 16,042 $ 19,918 $ 21,239 $ 21,249 $ 18,313 ========== ========== ========== ========== ========== Ratio of net charge-offs during period to average loans outstanding 1.08% .66% .53% .58% .56% ========== ========== ========== ========== ==========
The allowance is maintained at an amount management believes sufficient to absorb probable incurred losses in the loan portfolio. Monitoring loan quality and maintaining an adequate allowance is an ongoing process overseen by senior management and the loan review function. On at least a quarterly basis, a formal analysis of the adequacy of the allowance is prepared and reviewed by management and the Board of Directors. This analysis serves as a point in time assessment of the level of the allowance and serves as a basis for provisions for loan losses. The loan quality monitoring process includes assigning loan grades and the use of a watch list to identify loans of concern. The analysis of the allowance for loan losses includes the allocation of specific amounts of the allowance to individual problem loans, generally based on an analysis of the collateral securing those loans. Portions of the allowance are also allocated to loan portfolios, based upon a variety of factors including historical loss experience, trends in the type and volume of the loan portfolios, trends in delinquent and non-performing loans, and economic trends affecting our market. These components are added together and compared to the balance of our allowance at the evaluation date. The following table presents the allocation of the allowance to the loan portfolios at year-end. 36 2005 ANNUAL REPORT FINANCIAL CONDITION -- SUMMARY
YEARS ENDED DECEMBER 31, ------------------------------------------------------- (Dollar amounts in thousands) 2005 2004 2003 2002 2001 -------------------------------------- ------ ------- ------- ------- ------- Commercial, financial and agricultural $ 8,148 $11,840 $13,844 $12,993 $11,151 Real estate -- mortgage 867 850 1,254 1,471 1,330 Installment 7,027 7,228 6,141 5,856 4,489 Leasing -- -- -- 15 17 Unallocated -- -- -- 914 1,326 ------- ------- ------- ------- ------- TOTAL ALLOWANCE FOR LOAN LOSSES $16,042 $19,918 $21,239 $21,249 $18,313 ======= ======= ======= ======= =======
NONPERFORMING LOANS Management monitors the components and status of nonperforming loans as a part of the evaluation procedures used in determining the adequacy of the allowance for loan losses. It is the Corporation's policy to discontinue the accrual of interest on loans where, in management's opinion, serious doubt exists as to collectibility. The amounts shown below represent non-accrual loans, loans which have been restructured to provide for a reduction or deferral of interest or principal because of deterioration in the financial condition of the borrower and those loans which are past due more than 90 days where the Corporation continues to accrue interest.
(Dollar amounts in thousands) 2005 2004 2003 2002 2001 ------------------------------------ ------ ------- ------- ------- ------ Non-accrual loans $ 8,464 $19,862 $ 8,429 $11,807 $ 8,854 Restructured loans 57 430 542 546 590 Accruing loans past due over 90 days 6,354 7,813 5,384 5,899 4,925 ------- ------- ------- ------- ------- $14,875 $28,105 $14,355 $18,252 $14,369 ======= ======= ======= ======= =======
The ratio of the allowance for loan losses as a percentage of nonperforming loans was 108% at December 31, 2005, compared to 71% in 2004. The following loan categories comprise significant components of the nonperforming loans at December 31, 2005 and 2004:
(Dollar amounts in thousands) 2005 2004 ----------------------------- ---- ---- Non-accrual loans: 1-4 family residential $ 1,118 13% $ 608 3% Commercial loans 5,888 70 17,635 89 Installment loans 1,458 17 1,619 8 ------- --- ------- --- $ 8,464 100% $19,862 100% ======= === ======= === Past due 90 days or more: 1-4 family residential $ 3,197 51% $ 3,723 47% Commercial loans 1,554 24 2,159 28 Installment loans 1,603 25 1,931 25 ------- --- ------- --- $ 6,354 100% $ 7,813 100% ======= === ======= ===
Non-performing loans were significantly reduced during 2005 as a result of sales and charge-offs of commercial credits. This also reduced the amount of the allowance for loan losses allocated to commercial loans. There are no material concentrations by industry within the nonperforming loans. 37 FIRST FINANCIAL CORPORATION FINANCIAL CONDITION -- SUMMARY An element of the Corporation's asset quality management process is the ongoing review and grading of each affiliate's commercial loan portfolio. At December 31, 2005, approximately $52.0 million of commercial loans are graded doubtful or substandard, including $8.2 million of non-accrual and past-due commercial loans listed on the previous page. This compares to $56.5 million in 2004, which included $18.7 million of non-performing loans. The classification of these loans, however, does not imply that management expects losses on each of these loans, but believes that a higher level of scrutiny is prudent under the circumstances. Many of these loans are still accruing and are, generally, performing in accordance with their loan agreements. However, for reasons such as previous payment history, bankruptcy proceedings, industry concerns or information specific to that borrower, it is the opinion of management that these loans require close monitoring. DEPOSITS The information below presents the average amount of deposits and rates paid on those deposits for 2005, 2004 and 2003.
2005 2004 2003 -------------------- ------------------ ---------------------- (Dollar amounts in thousands) AMOUNT RATE AMOUNT RATE AMOUNT RATE -------------------------------- ---------- ----- ---------- ---- ---------- -------- Non-interest-bearing demand deposits $ 153,027 $ 150,944 $ 177,712 Interest-bearing demand deposits 294,344 .77% 259,859 .50% 231,590 .63% Savings deposits 392,791 1.21% 392,635 .65% 357,989 .80% Time deposits: $100,000 or more 185,436 3.11% 163,890 2.86% 197,946 2.87% Other time deposits 457,685 3.11% 478,706 3.04% 517,364 3.27% ---------- ---------- ---------- TOTAL $1,483,283 $1,446,034 $1,482,601 ========== ========== ==========
The maturities of certificates of deposit of $100 thousand or more outstanding at December 31, 2005, are summarized as follows:
3 months or less $ 28,602 Over 3 through 6 months 22,312 Over 6 through 12 months 22,675 Over 12 months 115,904 -------- TOTAL $189,493 ========
38 2005 ANNUAL REPORT FINANCIAL CONDITION -- SUMMARY OTHER BORROWINGS Advances from the Federal Home Loan Bank decreased to $337.3 million in 2005 compared to $337.9 million in 2004. The Asset/Liability Committee reviews these investments and funding sources and considers the related strategies on a weekly basis. See Interest Rate Sensitivity and Liquidity below for more information. CAPITAL RESOURCES Bank regulatory agencies have established capital adequacy standards which are used extensively in their monitoring and control of the industry. These standards relate capital to level of risk by assigning different weightings to assets and certain off-balance-sheet activity. As shown in the footnote to the consolidated financial statements ("Regulatory Matters"), the Corporation's capital exceeds the requirements to be considered well capitalized at December 31, 2005. First Financial Corporation's objective continues to be to maintain adequate capital to merit the confidence of its customers and shareholders. To warrant this confidence, the Corporation's management maintains a capital position which they believe is sufficient to absorb unforeseen financial shocks without unnecessarily restricting dividends to its shareholders. The Corporation's dividend payout ratio for 2005 and 2004 was 47.6% and 38.1%, respectively. The Corporation expects to continue its policy of paying regular cash dividends, subject to future earnings and regulatory restrictions and capital requirements. INTEREST RATE SENSITIVITY AND LIQUIDITY 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. INTEREST RATE 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 interest income is largely dependent on the effective management of this risk. The Asset Liability position is measured using sophisticated risk management tools, including earnings simulation and market value of equity sensitivity analysis. These tools allow management to quantify and monitor both short- 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 and the effects of embedded options on net interest income. This measure projects earnings in the various environments over the next three years. It is important to note that measures of interest rate risk have limitations and are dependent on various 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 of these assumptions and believes them to be valid and theoretically sound. These assumptions are continuously monitored for behavioral changes. 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 on the following page shows the Corporation's estimated sensitivity profile as of December 31, 2005. 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 .32% over the next 12 months and increase 2.26% over the following 12 months. Given a 100 basis point decrease in rates, net interest income would decrease 2.89% over the next 12 months and decrease 5.77% over the following 12 months. These estimates assume all rate changes occur overnight and management takes no action as a result of this change. 39 FIRST FINANCIAL CORPORATION FINANCIAL CONDITION -- SUMMARY
PERCENTAGE CHANGE IN NET INTEREST INCOME BASIS POINT ----------------------------------------- INTEREST RATE CHANGE 12 MONTHS 24 MONTHS 36 MONTHS -------------------- --------- --------- --------- Down 200 -6.22% -12.11% -17.45% Down 100 -2.89 -5.77 -8.50 Up 100 -0.32 2.26 5.14 Up 200 -5.44 -0.63 5.36
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. LIQUIDITY RISK: 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 $14.3 million of investments that mature throughout the coming 12 months. The Corporation also anticipates $71.9 million of principal payments from mortgage-backed securities. Given the current rate environment, the Corporation anticipates $18.5 million in securities to be called within the next 12 months. CONTRACTUAL OBLIGATIONS, COMMITMENTS, CONTINGENT LIABILITIES AND OFF-BALANCE SHEET ARRANGEMENTS The Corporation has various financial obligations, including contractual obligations and commitments, that may require future cash payments. CONTRACTUAL OBLIGATIONS: The following table presents, as of December 31, 2005, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.
PAYMENTS DUE IN ---------------------------------------------------------------------- NOTE ONE YEAR ONE TO THREE TO OVER FIVE (Dollar amounts in thousands) REFERENCE OR LESS THREE YEARS FIVE YEARS YEARS TOTAL ----------------------------- --------- -------- ----------- ---------- --------- -------- Deposits without a stated maturity $823,190 $ -- $ -- $ -- $823,190 Consumer certificates of deposit 348,575 242,488 50,233 432 641,728 Short-term borrowings 10 26,224 -- -- -- 26,224 Other borrowings 11 8,665 53,398 280,510 1,293 343,866
COMMITMENTS: The following table details the amount and expected maturities of significant commitments as of December 31, 2005. Further discussion of these commitments is included in Note 13 to the consolidated financial statements.
TOTAL AMOUNT ONE YEAR OVER ONE (Dollar amounts in thousands) COMMITTED OR LESS YEAR ----------------------------- ------------ -------- -------- Commitments to extend credit: Unused loan commitments $270,017 $144,962 $125,055 Commercial letters of credit 6,933 6,933 --
Commitments to extend credit, including loan commitments, standby and commercial letters of credit do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. OUTLOOK The Corporation's primary market is west-central Indiana and east-central Illinois. Typically, this market does not expand or contract at rates that are experienced by both the state and national economies. This area continues to be driven primarily by the retail, higher education and health care industries. During 2005 the area's employment data were mixed. East-central Illinois generally experienced falling unemployment rates while west-central Indiana experienced rising rates. A number of projects remain under development; however, there are limited significant growth opportunities currently available. 40 2005 ANNUAL REPORT CONSOLIDATED BALANCE SHEET -- AVERAGE BALANCES AND INTEREST RATES
DECEMBER 31, -------------------------------------------------------------------------------------------------- 2005 2004 2003 ------------------------------ ------------------------------ ------------------------------ AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/ (Dollar amounts in thousands) BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE ------------------------------- ---------- -------- ------ ---------- -------- ------- ---------- -------- ------ ASSETS Interest-earning assets: Loans (1)(2) $1,441,247 96,957 6.73% $1,452,572 93,128 6.41% $1,417,026 98,565 6.96% Taxable investment securities 387,269 16,802 4.39 402,063 15,315 3.81 416,403 15,714 3.77 Tax-exempt investments (2) 171,802 12,248 7.13 182,727 13,974 7.65 203,021 15,938 7.85 Federal funds sold 13,772 496 3.60 2,628 50 1.90 5,129 52 .99 ---------- ------- ---- ---------- ------- ---- --------- ------- ---- Total interest-earning assets 2,014,090 126,503 6.28% 2,039,990 122,467 6.00% 2,041,579 130,269 6.38% ------- ==== ------- ==== ------- ==== Non-interest earning assets: Cash and due from banks 74,005 77,443 80,261 Premises and equipment, net 30,720 30,610 29,634 Other assets 62,779 66,177 63,753 Less allowance for loan losses (18,298) (22,052) (22,242) ---------- ---------- ---------- TOTALS $2,163,296 $2,192,168 $2,192,985 ========== ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Interest-bearing liabilities: Transaction accounts $ 687,135 7,031 1.02% $ 652,494 3,872 .59% $ 589,579 4,315 .73% Time deposits 643,121 20,153 3.13 642,596 19,823 3.08 715,310 22,610 3.16 Short-term borrowings 25,766 783 3.04 71,926 1,017 1.41 35,262 431 1.22 Other borrowings 356,728 19,502 5.47 376,600 19,974 5.30 392,540 20,869 5.32 ---------- ------- ---- ---------- ------- ---- --------- ------- ---- Total interest-bearing liabilities: 1,712,750 47,469 2.77% 1,743,616 44,686 2.56% 1,732,691 48,225 2.78% ------- ==== ------- ==== ------- ==== Non interest-bearing liabilities: Demand deposits 153,027 150,944 177,712 Other 26,942 29,519 30,441 ---------- ---------- ---------- 1,892,719 1,924,079 1,940,844 Shareholders' equity 270,577 268,089 252,141 ---------- ---------- ---------- TOTALS $2,163,296 $2,192,168 $2,192,985 ========== ========== ========== Net interest earnings $79,034 $77,781 $82,044 ======= ======= ======= Net yield on interest-earning assets 3.92% 3.81% 4.02% ==== ==== ====
(1) For purposes of these computations, nonaccruing loans are included in the daily average loan amounts outstanding. (2) Interest income includes the effect of tax equivalent adjustments using a federal tax rate of 35%. FIRST FINANCIAL CORPORATION MARKET AND DIVIDEND INFORMATION At year-end 2005 shareholders owned 13,373,570 shares of the Corporation's common stock. The stock is traded over-the-counter under the NASDAQ National Market System with the symbol THFF. Such over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. Historically, the Corporation has paid cash dividends semi-annually and currently expects that comparable cash dividends will continue to be paid in the future. The following table gives quarterly high and low trade prices and dividends per share during each quarter for 2005 and 2004.
2005 2004 ---------------------------- ------------------------------ TRADE PRICE CASH TRADE PRICE CASH DIVIDENDS DIVIDENDS Quarter ended HIGH LOW DECLARED HIGH LOW DECLARED ------------- ------ ------ --------- ------ ------ --------- March 31 $34.48 $29.55 $31.49 $28.50 June 30 $29.57 $25.39 $.40 $32.43 $27.81 $.39 September 30 $31.99 $25.70 $32.91 $30.38 December 31 $28.29 $25.75 $.42 $37.07 $30.72 $.40
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