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FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549

x  QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended      MARCH 31, 2003      

OR

o  TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

Commission file number 0-12379

FIRST FINANCIAL BANCORP.

Registrant’s telephone number, including area code    (513) 867-5240    

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No  o

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

Yes  x    No  o

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

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FIRST FINANCIAL BANCORP.

INDEX

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PART I — FINANCIAL INFORMATION
ITEM I — FINANCIAL STATEMENTS
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

See notes to consolidated financial statements

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FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
(Dollars in thousands, except per share data)

See notes to consolidated financial statements.

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FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, dollars in thousands)

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FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(Unaudited, dollars in thousands)

See notes to consolidated financial statements.

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FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Unaudited, dollars in thousands)

See notes to consolidated financial statements

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FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2003
(Unaudited, dollars in thousands)

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

NOTE 1:  BASIS OF PRESENTATION
The consolidated financial statements of Bancorp, a bank and savings and loan holding company, include the accounts of Bancorp and its wholly-owned subsidiaries — First Financial Bank, Community First Bank & Trust, Indiana Lawrence Bank, Fidelity Federal Savings Bank, Citizens First State Bank, Heritage Community Bank, The Clyde Savings Bank Company, Sand Ridge Bank, First Financial Bancorp Service Corp., First Financial (OH) Statutory Trust I (established to facilitate the issuance of trust preferred securities), and First Financial Capital Advisors, LLC, a registered investment advisory company. All significant intercompany transactions and accounts have been eliminated in consolidation.

The accompanying financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes necessary to be in conformity with accounting principles generally accepted in the United States.

The consolidated balance sheet at December 31, 2002 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. For further information, refer to the consolidated financial statements and footnotes thereto included in the First Financial Bancorp. Annual Report on Form 10-K for the year ended December 31, 2002.

NOTE 2:  FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
In the normal course of business, Bancorp offers a variety of financial instruments with off-balance sheet risk to its customers to aid them in meeting their requirements for liquidity and credit enhancement and to reduce its own exposure to fluctuations in interest rates. These financial instruments include standby letters of credit and commitments outstanding to extend credit. Accounting principles generally accepted in the United States do not require these financial instruments to be recorded in the consolidated balance sheets, statements of earnings, changes in shareholders’ equity or cash flows. However, a discussion of these instruments follows.

Bancorp’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for standby letters of credit and commitments outstanding to extend credit is represented by the contractual amounts of those instruments. Bancorp uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Following is a discussion of these transactions.

Standby letters of credit are conditional commitments issued by Bancorp to guarantee the performance of a customer to a third party. Bancorp’s portfolio of standby letters of credit consists primarily of performance assurances made on behalf of customers who have a contractual commitment to produce or deliver goods or services. The risk to Bancorp arises from its obligation to make payment in the

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event of the customers’ contractual default. As of March 31, 2003, Bancorp had issued standby letters of credit aggregating $32,596 compared to $33,167 issued as of December 31, 2002. Management conducts regular reviews of these instruments on an individual customer basis, and the results are considered in assessing the adequacy of Bancorp’s allowance for loan losses. Management does not anticipate any material losses as a result of these letters of credit.

Loan commitments are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Bancorp evaluates each customer’s creditworthiness on an individual basis. The amount of collateral obtained, if deemed necessary by Bancorp upon extension of credit, is based on management’s credit evaluation of the counterparty. The collateral held varies, but may include securities, real estate, inventory, plant, or equipment. Bancorp had commitments outstanding to extend credit totaling $464,319 at March 31, 2003 and $464,777 at December 31, 2002. Management does not anticipate any material losses as a result of these commitments.

NOTE 3:  COMPREHENSIVE INCOME
Bancorp discloses comprehensive income in the “Consolidated Statements of Changes in Shareholders’ Equity”. Disclosure of the reclassification adjustments for the three months ended March 31, 2003 and 2002 are shown in the table below.

NOTE 4:  ACCOUNTING FOR DERIVATIVES
Bancorp follows the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” in accounting for its derivative activities. Bancorp has interest rate swaps that are accounted for as fair value hedges under SFAS No. 133. Bancorp utilizes interest rate swap agreements to effectively modify its exposure to interest rate risk by converting certain fixed rate assets to a floating rate. The use of these interest rate swaps allows Bancorp’s subsidiary banks to offer a long-term fixed-rate loan to commercial borrowers. The interest rate swaps allow Bancorp to convert the fixed interest rate to a variable rate that better suits its funding position. The swap agreements involve the receipt of floating rate amounts in exchange for fixed interest payments over the life of the agreements without an exchange of the underlying principal amount. The swaps are accounted for under the short-cut method. These contracts are designated as hedges of specific assets. The net interest receivable or payable on swaps is accrued and recognized as an

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adjustment to the interest income or expense of the hedged asset. At March 31, 2003 Bancorp had interest rate swaps with a notional value of $7,845. The fair value of the swaps was an unrealized loss of $295 at March 31, 2003. This amount is included with other assets on the balance sheet. A corresponding fair value adjustment was also included on the balance sheet as a hedged item.

Bancorp is exposed to losses if a counterparty fails to make its payment under a contract in which Bancorp is in the receiving position. Although collateral or other security may not be obtained, Bancorp minimizes its credit risk by monitoring the credit standing of each counterparty and believes that each will be able to fully satisfy its obligation under the agreement.

NOTE 5:  CORPORATION-OBLIGATED MANDATORILY REDEEMABLE CAPITAL SECURITIES OF SUBSIDIARY TRUST
The corporation-obligated mandatorily redeemable capital securities (the “capital securities”) of subsidiary trust, which appears on the balance sheet, are commonly known as Trust Preferred Securities. The subsidiary trust holds solely the junior subordinated debt securities of Bancorp (the “debentures”). The capital securities were issued in third quarter of 2002 by a statutory business trust—First Financial (OH) Statutory Trust I, of which 100% of the common equity of the trust is owned by Bancorp. The trust was formed with the sole purpose of issuing the capital securities and investing the proceeds from the sale of such capital securities in the debentures. The debentures held by the trust are the sole assets of the trust. Distributions on the capital securities are payable quarterly at a variable rate of interest, which is equal to the interest rate being earned by the trust on the debentures and are recorded as interest expense of Bancorp. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the debentures. Bancorp has entered into agreements which, taken collectively, fully or unconditionally guarantee the capital securities subject to the terms of the guarantees. The debentures qualify as Tier I capital under Federal Reserve Board guidelines and are first redeemable, in whole or in part, by Bancorp on September 25, 2007 and mature on September 25, 2032. The amount outstanding, net of offering costs, as of March 31, 2003 is $10,000.

NOTE 6:  STOCK OPTIONS
As of March 31, 2003, Bancorp had two stock-based compensation plans. Bancorp accounts for those plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if Bancorp had applied the fair value recognition provisions of FASB Statement No. 123, “Accounting for Stock-Based Compensation,” to stock-based employee compensation.

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NOTE 7:  OTHER MATTERS
Under a previously approved program to repurchase common shares for general corporate purposes, Bancorp repurchased 447,400 shares during the first three months of 2003.

Core deposit intangibles and mortgage servicing rights are to be amortized over their useful lives. Core deposit balances are being amortized over varying periods, none of which exceeds 10 years.

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ITEM 2 — MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
FIRST FINANCIAL BANCORP. AND SUBSIDIARIES
(Unaudited, dollars in thousands)

SELECTED QUARTERLY FINANCIAL DATA

NET INTEREST INCOME
Net interest income, the principal source of earnings, is the amount by which interest and fees generated by earning assets exceed the interest costs of liabilities obtained to fund them. For analytical purposes, net interest income is also presented in the table below adjusted to a tax equivalent basis assuming a 35% marginal tax rate for interest earned on tax-exempt assets such as municipal loans, tax-free leases, and investments. This is to recognize the income tax savings that facilitates a comparison between taxable and tax-exempt assets.

Net interest income for the first quarter of 2003 was $3,810 or 9.28% less than the first quarter of 2002. The major contributing factor to the decline in net interest income was net interest margin compression due to the asset sensitive position of Bancorp’s balance sheet. Bancorp’s net interest margin decreased to 4.37% in the first quarter of 2003 from 4.72% in the first quarter of 2002. Bancorp also reviews net interest margin on a fully tax equivalent (non-GAAP) basis for peer comparison. Bancorp’s net interest margin on a fully tax equivalent basis decreased to 4.48% in the first quarter of 2003 compared with a 4.85% margin in the first quarter of 2002. This margin compression was due to continued downward repricing of assets without a point-for-point decrease in deposit liability rates. The continued repricing of adjustable and variable rate loans was the primary driver in loan interest in the first quarter of 2003 that was $7,373 or 13.6% lower than the comparable period a year ago. The effect of the 50 basis point (10.5%) decrease in the prime lending rate impacted approximately 20% of the existing loan portfolio during the first quarter of 2003. Investment income declined by $1,376 or 16.6% from the quarter a year ago. As interest rates declined, cash flows from mortgage-related investment prepayments and called securities

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accelerated, causing a redeployment of funds at lower yields. In total, interest income declined by $8,888. A decline in total interest expense of $5,078 or 23.4% in the first quarter of 2003 versus first quarter of 2002 did not offset the decline in interest income. As a result of strategies to manage interest rate risk, Bancorp also increased the amount of its long-term borrowings, thereby increasing the cost of its funding on a relative basis.

A decrease in loan balances also contributed to lower net interest income through reduced interest income. Average outstanding loan balances for the quarter were 2.08% lower than the prior year. Additionally, the margin and net interest income were negatively impacted by fees on loans that were $217 or 11.7% lower in the first quarter of 2003 versus 2002. On a linked-quarter basis, the residential real estate portfolio increased $40,000, and that was comprised of both fixed rate and adjustable rate loan growth. That growth plus increases in commercial loans, offset decreases in construction, installment, credit card, and leases, for total loan growth since December 2002 of $34,154 or 1.24%.

RATE/VOLUME ANALYSIS
The impact of changes in volume and interest rates on net interest income is illustrated in the table below. As shown, the decrease in market interest rates had a significant effect on Bancorp’s rates impacting both interest income and interest expense for the quarter ended March 31, 2003 in comparison to 2002 contributing $3,143 to the $3,810 decrease in net interest income. The decrease in rates effected interest income more significantly than interest expense due to the asset-sensitive position of Bancorp’s balance sheet. Bancorp’s adjustable and variable rate loans repriced downward at a greater magnitude than Bancorp was able to lower its deposit costs. The decrease in volume on earning assets also had a negative impact on net interest income for the quarter partially offset by lower interest-bearing liabilities. The change in interest due to the combined effect of both rate and volume has been allocated to the volume and rate variance on a prorated basis.

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OPERATING RESULTS
Net operating income represents net earnings before net securities transactions. Net operating income for the first three months of 2002 was $10,613 which was a decrease of $1,786 or 14.4% from the same period in 2002. A major contributing factor to the decrease in net operating income from a year ago was the $3,810 decrease in net interest income as outlined in the “Rate/Volume Analysis” and “Net Interest Income” sections. Noninterest income which was $918 less and a slight increase in noninterest expense of $300 compared to the same period a year ago also contributed to the decline in net operating income. Provision for loan loss expense was $2,426 lower in the first quarter of 2003 compared to the first quarter of 2002. This positive variance in provision for loan loss expense partially offset the negative variances discussed previously.

First quarter 2003 noninterest income was $13,850, a decrease of 6.22% from the first quarter of 2002. Service charge income decreased $149 or 3.14% from the quarter a year ago. Trust revenues for the first quarter of 2003 were $279 or 7.00% less than the comparable period last year, primarily due to the effect of lower market values indicative of the overall stock market performance. The other category of noninterest income decreased $514 or 8.52% from a year ago, as gains on the sale of mortgage loans decreased $504. Included as a reduction in other income for the first quarter of 2003 were impairment charges of $188 against the mortgage-servicing asset in a valuation reserve. There were no such charges in the first quarter of 2002. Additionally, the first quarter of 2002 contained a $223 non-recurring life insurance gain.

Total noninterest expense increased less than 1 percent for the first quarter of 2003 over the first quarter of 2002. The single largest category of increase is salaries and employee benefits, up almost $400 due to increased healthcare costs and the addition of staff in support and risk management functions. The increase in salaries and employee benefits was approximately 6%, adjusting for Project Renaissance expenses in the first quarter of 2002. Data-processing expense was down $380 over 2002 due to the efficiencies gained through Project Renaissance.

INCOME TAXES
Income tax expense for the first quarter of 2003 was $5,482, a decrease of $832 when compared to $6,314 reported for the same period in 2002. Tax expense relating to operating income totaled $5,472 and $6,312 for the quarters ended March 31, 2003 and 2002, respectively, with $10 in tax expense related to securities transactions for the first quarter of 2003 and $2 for 2002.

NET EARNINGS
Net earnings for the first quarter of 2003 were $10,631 or $0.24 in diluted earnings per share versus $12,401 or $0.27 for the first quarter of 2002. Net securities gains for the first quarter of 2003 and 2002 were $18 and $4, respectively. The reasons for the decrease in net earnings were discussed under the “Operating Results” section.

ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level believed adequate by management to absorb estimated probable credit losses. Management’s periodic evaluation of the adequacy of the allowance is based on Bancorp’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay (including the timing of future payments), the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as

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it requires material estimates including the amounts and timing of future cash flows expected to be received on impaired loans that may be susceptible to significant change. The evaluation of these factors is completed by a group of senior officers from the financial and lending areas.

The provision for loan losses totaled $3,214 for the three months ended March 31, 2003 or $2,426 less than the $5,640 recorded for the same period in 2002. Net charge-offs of $3,086 for the first quarter of 2003 were $2,462 lower than the $5,548 for the first quarter of 2002. The percentage of net charge-offs to average loans for the quarter was 0.45% versus 0.80% in 2002. Bancorp continued to maintain appropriate reserves as the reserve to loan ratio increased to 1.74% from 1.68% a year ago. Bancorp will continue to closely monitor the quality of its loan portfolio and respond accordingly.

At March 31, 2003 and 2002, the recorded investment in loans that are considered to be impaired under FASB Statement No. 114 was $6,074 and $1,830, respectively, all of which were on a nonaccrual basis. The related allowance for loan losses on these impaired loans was $941 at March 31, 2003, and $216 at March 31, 2002. At March 31, 2003 and 2002, there were $600 and $1,207, respectively, of impaired loans that did not have an allowance for loan losses. The average recorded investment in impaired loans for the quarter ended March 31, 2003, and 2002, was approximately $7,343 and $1,825. For the quarter ended March 31, 2003, Bancorp recognized interest income on those impaired loans of $20 compared to $6 for the same period in 2002. Bancorp recognizes income on impaired loans using the cash basis method. The table that follows indicates the activity in the allowance for loan losses for the quarters presented.