i Filings Services April 4,2006 SNL Financial, LC 1-800-969-4121 F I R S T F I N A N C I A L C O R P O R A T I O N LETTER TO SHAREHOLDERS To OUT Shareholders and Friends: In 2005 First Financial Corporation continued to pursue strategies that have sustained our long-tcrm s~iccess. In particular, we laid the ground- work for expanding into new markets, conipleted the consolidation of our ctiarters, focuscd on outstanding sales and service, and worked toward capturing more of each ciistomer’s business, all of which scrves to create additional value for our shareholders. 2005 net income was $23.1 million. As the Federal Kesei-vc continued to raise short-term rates, interesr income for the year increascd by $4.8 million over 2004. We were able to iise thesc increases to our advanrage as our tier interest income rose by $2.8 million or 2.75% over the previous year. O u r net interest margin for 2005 increased 12 basis points to 3.92% Non-interest income was $3.7 million less in 2005 than what was reported for 2004. However, in 2004 the Corporation realized a gain of $4.1 million on a Iifc insurance hencfir. When comparing all other non-interest income items except thcse life insurance proceeds, non-interest income for 2005 increased hy $371 thousand. This increase was complemented by a $1 18 thousand rcduction in non-interest expcnsc, demonstrating the Corporations’ commitment to operating cficiency. There was less demand in 2005 for both consumer and commercial loans due to a sluggish economy in our market area. During the year we restruc- tiirrd our loan portfolio, an cffort that allowcd LIS to improvc asset quality as well as reduce the time and resources allocated to underperforming credits. February 2006. We continue to evaluate opportunities for growth that will create valuc for our shareholders. A branch is proposcd in Greencastle, Indiana, to be completed later this year. First is a custoincr-ccntric company dedicated to the success of our custoniers. We continually seek to improve our products arid services in an effort to providc our customers with additional benefits, greater convenience and better value. Ovcr thc past year we concentrated on increasing the number of relationships we have with our customers. The more relcationships we have with each customer, thc bcttcr we can serve them by offering “one-stop shopping” for all their financial needs, from traditional banking services to investments and insurance. A n area of emphasis was to inrroduce our c u w m c r s to thc array of insurance products offered through our €:orrest Sherer subsidiary. This arid similar efforrs allow us to help our custotncrs succeed financially with comprehensive, personalized solutions for saving, borrowing, investing and insuring their assets. T h e First family takes pride in being engaged community partners in the markets we scrve. We are actively involved in economic development in western lndiana and easrerri Illinois. We havc a long tradition of leadership in communi ry scrvicc, both through corporate support for worthwhile programs and through employee involve- ment in liundrcds of civic and charitable organizations. We are proud to provide job opportuniries to the local citi- zenry and, in turn, to be a financial services company wherc ciistonicrs know the people who serve them. In 2005 we were saddened at the passing of two great friends o f t h e Corporation: William “Bill” Niemeyer, who served on the Board of Dircctors of First Financial Corporation for 41 years, and Larry Schopmeyer, President of ‘I’he Morris 1’1~11 Company and a member of our Community Rcgion Board of Directors. Their wise counsel and unwavering support will be remembered and appreciated. 2005 was a year oftransition for several of our bank bodrds. Afrer 16 years as a dircctor of First Financial Corporation, Chapman Root TI rctircd in July. Samuel Deahl, D.D.S., a Marshall Region director for 18 years, retired in October arid Elizabcth Schmidt, a Crawford Rcgion director for 11 years, retired in December. We are grateful for the insight, resourcefulness and sound judgment they shared with us. During the year we welcomed Ronald K. Rich, Financial Representative with thc Northwcstcrn Mutual Financial Network, to the board of First Financial Corpor,atiori arid Avery J. McKitmey, President and Owner of A.M. Transport Services in Olney, to our Community Region board. Their knowledge and experiencc will bc invaluable. We are pleased to recognize e x h member o f the First Financial Corporadon board and our regional boards for their loyalty and leadership. On their behalf, we extend sincere qyrecixiori to our employees, who providc thc out- standing custonicr scrvice that is our Ttrongest competitive advantage. We are especially gratefid to you, our share- holders, for your confidence in rhe Corporation’s future. Donald E. Smith Presidcnt & Chairman +&;, Norman L. Lowery Vice Chairman & CEO F I R S T F I N A N C I A L C O R P O R A T I O N CARING FOR OUR COMMUNITIES First Financial Corporation affiliates are located in 32 cities and towns in Indiana and Illinois. Each is unique, yet all share a sensc of history, a desire ro build for the future and a commitment to provide their citizens with (above left) IXrertors m d guests of First Financial Corporation tookpark in a groundbreaking cerewony for tbe new Vincennes banking center in Februtiry. (above right) First rmployees, fimily mtwibers andfiiends galhered it Saint Mary-of-the- Woods College in October for h e annual Sustm G. Komen h e a t Canccr Founddtion &re j;)r the Cure. First Financial C’orporation is a goklsponsor f i r the event. an environment where all can grow and prosper. The same is true for our Corporation. It is our history of working together to accomplish common goals and ohjccrives that has helped us succeed both as a corporation and as a corporate citizen. In 2005 we completed the unification of bank holdings whcn First Crawford State Bank and First Cornmuniry Bank N.A. became First Financial Rank in February and Septcniber. Also i n February, we hroke ground for our newest First Financial banking center in Vincennes, Indiana. This state-of-the-art, full- service banking center totals over 4,000 square feet and includes five drive-up service lanes, a 24-hour FirsrPlus ATM and a drive-up night drop box. Agriculture has always been and remains a large part oflife in Indiana and Illinois. First Financial Bank and our agri-business lenders arc committed to providing thc best in financial services for area farmers and farm-related busi- nesses. First Financial Bank in Clay County sponsors an annual Farmer‘s Share Breakfast in conjunction with Ag Week, and bank personnel from Vigo and Sullivan counties worked with rhe Vigo C o w r y Soil and Water Conservation District to hring important information to area farmers about watershcd conser- vation and the Conservation Security Program. ‘l’he Unitcd States Deparrnient of Agriculture Rural Development program recognized thc Olney Kegion of First Financial Bank as a million dollar lcnder for 2005. T h e guaranteed home loan program helps familics purchase homes they might not be able to afford with conventional loans. O n April 28, a landmark was lost in Parke County whrn rhe Bridgeton Covered Bridge was destroycd by arson. As devastating as rhis act was to the small corn- inunity of Bridgcton, citizens in Parke and surroiinding counties, along with rcsidents of thc state and beyond, united to raise funds to rcbuild the historic 2 0 0 5 A N N U A L R E P O R T bridge. First Financial Bank, Parke Region, was proud to play a part i n thc efforts by accepting contribu tioris to the Bridgeron Covered Bridge Association, organizing a community document-shredding event at Rockville in August and holding a silent auction o f birdhouses decorated by Parke County organi7ations in December. All communities must deal with complex issues that affect the lives of their citi- zens and businesses. While the size and specifics o f the issues may he diffcrcnt, the basic problems and solutions may be quitc similar. In May First Financial Rank hosted thc annual Wabash Valley Mayors’ Breakfast in Terre Haute. T h e gath cr i n g brings together area governrne ti t and economic d eve1 o p e n t leaders for a morning of fellowship and inforrn,d discussion. Each year First Financial Corporation helps celebrate and support the arts in our communities. T h e Swope Art Muscum i n Terre Hautc i5 the home o f the Wabash Vallcy Juricd Exhibition, one of thc oldest juried exhibirioris in rhe state. First Financial was pleased to underwrite the 2005 exhibition that received more than 500 entries from artists within a 150-milc radius ofTcrrc Hautc. First Financial Bank was a sponsor when the Terre Haute Symphony Orchestra presented a concert in April honoring all veterans and celebrating the 60th anniversary o f the end o f World War IT. T h e hank also participated i n the Arts llliana presentation of Live Music Lunch, a concert series in downtown Terre Haute on the Crossroads Plaza Stagc. Fairbanks Park, locatcd on thc hanks o f thc Wabash Rwcr in Tcrrc Hautc, was the site where many Valley residents relived memories from their younger days or just enjoyed the “oldies” at a sold-out con- cert by Herman’s Hermits. The concert was presented by the ‘IErre Haute I’arks and Rccreation Department with iiriderwriting from First Financid. In 2005 the devastation of the Chlf Coast by multiple hurricancs brought out the best in the citizens of our communities, state and nation. First Financial Bank, in cooperation with a local television station, raiscd ovcr $1 00,000 for thc victims o f 1 lurricane Katrina. Collection sites were set up at all First banks as employees and local citizens came together to help thosc who had been affcctcd by the storms. First Firiancial Corporation is proud to sponsor many activities and events for children and their families, young adults and students of all ages, that are not only educ,itional and recrearional, but also offer opportunities for personal (abovc Icft) Donnld E. S~nith, chuirmun o f’First Financicll C h p n i t i o n , und/ejJSmith, board member o j ’ t h 7erre Huute Boys and (;ids ( k b , present 200 ticketsfor an Indianapoli.c Colts game to./immy Smith, director ff the Boys and Girls Club. (dbove cen ier) Area musicians eritertuin downtown uJ.tYpart oJ’ “Live Music Lunch,” a midday concert J,eries presented by Arts llliana and sponsored by First Financial Hank. (above right) To raisefinds to rebuild the historic Bridgeton Covered Bridge in h k e Couniy, First I’innncial Bank, Parke Repon, auctiorrtd birdhouses decorated and donated by local organzwtionu. High bidder Shirley Fetter (center) accepts her birdhouse from First Financial Bmk employees Linda Bnird and Brenda Cooper. F I R S T F I N A N C I A L C O R P O R A T I O N growth and development. The annual Terre Haute Boys & Girls Club First Fishing Club tcaches children in their siiinmer programs the art of fishing and givcs them the opportunity to test their skills on private area lakes. First Financial has long had an irirerest in auto racing and our support of the Terrc Haute Quartcr Midget Association o#ers children an early start in the sport. T h e same is truc of liiinting. Each year First Financial sponsors hunrer educa- tion classes for area youngsters. The classes are taught with assistance from state conservation offrcers and local volunteers. The regions servcd by First Financial Corporation afiliates are honic to many outstanding educational institutions. Ovcr the years, the Corporation has pro- vided scoreboards, advertising support and underwriting for projects, gifts-in- kind, and many volunteer hours to ensure that students are provided with the educational and extra-curricular activities that make h e i r school cxperience complete. First Financial employees present programs in schools throughout our scrvice area to help children learn important skills such as money management and budgeting. Hutidreds of schoolchildren tour our banking centers cach year. Communities large and small have been affected by the problems caused by methamphetamine use and production. Menibers of the meth awareness study group of Leadership Wabash Valley Class )(xvIl used funds provided by First Financial Rank to print materials promoting nieth awareness. T h e materials were distributed to area junior high school students. In 2005 First Financial Bank marked 171 years of continuous service to wcst- central Tndiana and east-cenrral Illinois. This region has always been blesscd with citizens who are dedicated to creating a better future for their families and communitics. T h e directors arid staff of First Financial Corporation take pride in being a part of this tradition and in providing both financial and human resources that help cnsiire the futurc we are building is secure. (above lcft) Employees ofFirsl Financial Hank, Marshdl Region, lined thr street in front the bank to help welcome of reJ.erve troops home Jiom Iraq. (abovc right) In May locul government and economic development leadm attended the annual Wabash Wley Mdyors’ Breakfast hosted by 1:irst Financial Rank. Among the guests were: Tom Fehrenbacher, mayor, Olnty Ill.; Joe Hayden, cizy councilninn, Robinson, Ill.: Kevin Burke, mayor, %re Haute, ha!; Ken Smith, mayor. Murshall, Ill.; Mike Bledsoe, president, town board of Farmersburg, Ind.: Donald E, Smith, chairmnn, First Financial Corporution; Bernie Gray, mayor, Hutsonville, Ill.; Tim Boles, mayor. Sullivm, Ind.; Dorman Clark, mnyor, jawnville, ha!: Ron Shepard mayor, Clinton, hid,; and Larry Natalie, president, town board uf Fairview, ha! FIVE YEAR C o M P A R i s o N OF SELECTED FINANCIAL DATA 2 0 0 5 A N N U A L R E P O R T (Dollar aiiiouiits in thousands, exceot aer share ilrnoiiiits) BALANCE SHEET DATA: Total assets Securities Loans, net of unearned fees Deposits Borrowings Shareholders' equity INCOME STATEMENT DATA: Interest income Interest expense Nct intcrcst income Provision for loan losses Other inconie Other cxpcnses Net incornc PER SHARE DATA: Net income Cash dividends PERFORMANCE RATIOS: Net income to average assets Net income to average shareholders' equity Average total capital to average assets Average sharcholders' equity to average assets Dividcnd payout 2005 2004 2003 2002 2001 $2,1363 18 536,23 1 1,395,741 1,464,9 18 370,090 269,323 $2,183,992 507,990 1,463,87 I 1,443,121 438,013 268,335 $2,223,057 576,950 1,429,525 1,479,347 45 1,862 255,279 $2,169,748 520,166 1,432,564 1,434,654 457,645 24 1,97 1 $2,041,905 471,888 1,348,461 1,313,656 480,674 217,511 121,647 47,469 74,178 1 1,698 32,025 63,538 23,054 1.72 .82 1 16,888 44,686 72,202 8,292 35,754 63,656 28,009 2.07 .79 122,661 48,225 74,436 7,455 30,819 62,46 1 26,493 1.95 .70 136,262 58,086 78,176 9,478 30,468 63,3 1 7 28,640 2.10 .62 144,673 74,125 70,548 6,6 15 2 1,468 53,323 24,196 1.78 .57 1.07% 1.28% 1.21% 1.30% 1.19% 8.52 13.35 12.51 47.57 10.45 13.24 12.23 38.13 10.57 12.45 11.43 35.88 12.0 1 11.73 10.80 29.57 11.33 11.38 10.46 32.28 W CONSOLTIIATED BALANCE SHEETS F I R S T F I N A N C I A L C O R P O R A T I O N (Dollar amounts in thousatids, cxcrpr per sharc data) ASSETS Cash and due from hanks Federal funds sold Securities available-for-salc Loans, net o f allowance o f $16,042 in 2005 and $1 9,918 in 2004 Accrucd interest receivable Preniiscs arid equipnicn t, net Bank-owned life insurance Goodwill Other iritangible assets Other real estate owried Other assets T o m ASSETS LIABILITIES AND SHAREHOLDERS’ EQUITY Deposits: Non-i t i terest-beari rig In terest-bearing: Certificates of dcposit of $100 or more Other interest-hearing deposits Short-term borrowings Other borrowings Clther liabilities TOTAL LIARIIJTIES Shareholders‘ cqiiity Conirnon stock, $.I25 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 Additional paid-in capital Retained earnings Accumulated other cnrnprehensivc income Less: Trcasury shares at cost - 1,077,396 in 2005 arid 315,196 in 2004 T ~ A I . SHAREHOLDERS’ EQUITY December 31, 2005 2004 $ 78,201 2,982 536,231 1,379,639 12,537 3 1,270 55,832 7,102 2,860 4,115 26,023 $2,136,318 $ 94,928 5,400 507,990 1,443,953 12,016 31,154 49,177 7,102 3,033 3,262 25,917 $2,183,992 $ 182,416 $ 145,852 189,493 1,093,003 1 , 4 6 4 3 18 26,224 343,866 32,587 1,867,595 1,806 67,670 223,710 1,903 (25,766) 269,323 184,604 I, 1 12,665 1,443,12 1 75,527 362,486 34,523 1,915,657 1,806 67,5 19 21 1,623 8,357 (20,970) 268,335 TOTAL LIABILITIES A N D SHAREHOLDERS’ EQUITY $2,136,918 $2,183,992 See accompanying notes. W CONSOLIDATED STATEMENTS OF INCOME 2 0 0 5 A N N U A L R E P O R T (Dollar aiiiouiits in thousands, except per share data) INTEREST AND DIVIDEND INCOME: Loans, including related fees Securities: ‘I‘axable Tax-exe nip t O t h e r TCYI’AL IN’I’LWSI’ AND DIVIDKND INCOME INTEREST EXPENSE: Deposits Short-term borrowings O t h e r borrowings TOTAI. TN‘I’F.RFS’I’ EXI’KNSF. NET INTEREST INCOME Provision for loan losses NIX INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES NON-INTEREST INCOME: I , lrust and financial services Service charges and fees on deposit accounts Other service charges and fees Securities gains (I osscs) Insurance commissions Gain o n sale of mortgage loans Gain on life insurance benefit Other TOTAL NON-INTEREST INCOME NON-INTEREST EXPENSES: Salaries and employee benefits Occupancy expense Equipment cxpc t i sc Other TOTAL NON-INTEREST EXPENSE INCOME BEFORE INCOME TAXES Provision for incomc taxa NET INCOME EARNINGS PER SHARE: BASIC AND DILUTED Years Ended December 31. 2005 2004 2003 $ 96,388 $ 92,440 $ 96,536 16,802 6,306 2,151 12 1,647 27,184 783 19,502 47,469 74,178 11.698 15,315 7,055 2,078 1 16,888 15,714 7,816 2,595 122,661 23,695 1,017 19,974 44,686 72,202 8,292 26,925 43 1 20,869 48,225 74,436 7,455 62,480 63,910 66,98 1 3,626 1 1,732 6,440 57 1 5,995 1,289 - 2,372 32,025 38,617 3,796 3,861 17,264 63,538 30,967 7,9 13 3,918 1 1,499 6,794 (165) 6,142 806 4,113 2,647 35,754 37,876 3,904 3,585 18,291 63,656 36,008 7,999 3,762 8,066 8,063 237 6,282 2,027 - 2,382 30,8 19 36,696 3,830 3,224 18,711 62,461 35,339 8,846 $ 23,054 $ 28,009 $ 26,493 $ 1.72 $ 2.07 $ 1.95 Wcightcd avcragc nutiibcr of s h a m outstanding (in thousands) 13,433 13,525 13,588 Scc accorripanying noics. F I R S T F I N A N C I A L C O R P O R A T I O N CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDEKS’ EQUITY ( 1 ) o k i r amoiiiits in thousands, rxcept per sharc data) Common Stock Additional Paid-In Capital Retained Earnings Comprehensive Treasury Stock Income Total Accumulated Other Balance, January 1,2003 $ 303 $ 66,809 $178,209 $ 14,276 $(18,226) $241,971 C :o m p rehensive iiico m c: Ner income Other cornprehensivc incorne, net of tax: Ctiarige in net un rcalized gains/losscs on securities available-for-sale, tier ‘I’otal cotii preliensive iiicornc - 26,493 - - 26,493 - - (2,813) - (2,813) 23,680 Two-for-otic stock split (6,782,885 skares) Chntributiori of40,000 shares to ESOP Treasury stoclr purchase (80,120 sliarcs) Cash dividends, $’ .70 per share 903 - - - (903) - - 372 - - I (9,505) - - - - - 884 (2,123) - I 1,256 (2,123) (9,505) Balance, December 3 I , 2003 1,806 67,181 1114,294 11,463 (19,465) 255,279 Cotnprehensive income: Net iiicome Other comprehcnsive loss, net of tax: Change in net unrealized gains/losses on securities available-for-sale, net Total comprchensive income - 28,003 - - 28,009 - - (3,106) - (3,106) 24,903 Contribution of 36,000 shares to ESOP Treasury stock purchase (79,000 shares) Cash dividends, $ .79 per share - - - 338 - I - - (10,680) - - - 825 (2,330) - 1,163 (2,330) (10,680) Balance, December 3 1,2004 1,806 67,519 21 1,623 8,357 (20,970) 268,335 Coin p rch cns ive income: Nct income Odier comprehensive loss, net of tax: Change in net unrealized gaiidlosscs on securities available-for-sale, nct Total comp rch ensive income Chitribtition of41,500 shares to ESOP Treasury stock purchasc (203,700 shares) Cash dividends, $ .82 per share - - - 151 - - - 23,054 - - 23,054 - - - - (10,967) (6,454) - - - (6,454) 16,600 - - - 993 (5,789) - 1,144 (5,789) (10,967) Balance, December 31,2005 $ 1,806 !$ 67,670 $223,710 $ 1,903 $ (25,766) $269,323 Scc accompanying notes. CONSOLJDATED STATEMENTS OF CASH FLOWS 2 0 0 5 A N N U A L R E P O R T (l3olla1- ;iniounts in thous;inds, cxccpt pcr share. d;it;i) CASH FLOWS FROM OPERATING ACTIVITIES: Net incotne Adjustments ro reconcile net income to net cash provided by operating activities: Net (accretion) aniortization on securities Provision for loan losses Securities (gains) losses Depreciation arid amortization lhvision for deferred inconie taxes Net change in accrued interest receivable Contribution of shares to ESO1) Gains on life insurance benefit Other, net NET CASH PKOM OIWA'I'INC; AC:'I'IVI'I'IES Years Ended December 31. 2005 2004 2003 $ 23,054 $ 28,009 $ 26,493 (1,462) 1 1,698 (57 1 ) 3,363 1,716 (521) 1,144 - 5 92 39.013 2,092 8,292 165 3,184 1,648 1,057 1,163 (4,113) 1,842 43.339 11,466 105,945 ( 5 5,885) (44,834) 450 - - 7,267 (4,458) 19,951 558 7,455 (237) 2,883 (252) 2,126 1,256 - 5,126 45.408 8,308 189,049 (259,150) (5,844) (5,800) - - - (1,758) (75,195) 44,633 34,274 (8,845) (2,123) 18,013 ( 5 8,070) 27.942 (1,845) 96,043 CASH FLOWS FROM INVESTING ACTlVlTlES: Sales of securities available-for-sale Calls, maturities and principal reductions o n securities available-for-sale Purchases of securities available- for-sale Loans made to customers, net of repayments Net change in federal funds sold Purchase of hank-owned life insurance Purchase of ciistomcr list Proceeds frotn life insurance benefit Additions to premises and equipment NET CASH FKOM INVLSI'ING AC:I'IVI*I'IES 11,376 373,74 1 (422,14 1 ) 49,806 2,4 18 (5,000) (338) - (2,908) 6,954 CASH FLOWS FROM FINANCING ACTIVITIES: Net change in dcposits Net change in other short-tcrm borrowings Dividends paid Purchases of treasury stock Ilroceeds from other borrowings Repayments on other borrowings NW CASH FROM FINANCING AC'I'IVI'I'IES NKl' CHANGE IN CASH AND CASfI EQUIVALLN'I'S 2 1,797 (49,303) ( 1 0,779) (5,783) - ( 1 8,620) (62,694) (16,727) (36,226) 6,898 ( 1 0 , I 5 5 ) (2,330) 85,006 (105,753) (62,5 60) 730 CASH AND CASH EQIJIVALENTS, BE(:INNTNC: OF YEAR 94,928 94,198 CAS11 AND CASII EQUIVALENTS, END OF YEAR $ 78,201 $ 94,928 $ 94,198 SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid during the year for: Interest Income taxes Set. accompanying notcs. $ 46,919 $ 5,413 $ 44,973 $ 6,501 $ 48,791 $ 8,016 NOTES TO CONSOLI~ATED FINANC~AL STATEMENTS F I R S T F I N A N C I A L C O R P O R A T I O N 1. BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES: * 7 BUSINF.SS Organization: ‘I’hc corisolidated financial statements of First Financial Corporation arid its subsidiaries (the Chporation) include the parent coriipariy a n d i t s wholly-owned subsidiaries, First Financial Sank, N.A. of Vigo County, Indiana, ‘I’hc Morris Plan Company of Terre Hautc (Morris I’lan), First Financial Reinsurance Company, :I corporation incorporated in the country of Turks and Caicos Islands (F’FIIC) arid Forrest Shcrcr Inc., a full-line insurance agency headquartered in Terre Haute, Indiana. Inter-company transactions arid lialances have bccri eliminated. First Financial Rank also has t w o investiiiciit subsidiaries, Portfolio Management Specialists A (Specialists A) and Portfolio Management Specialists R (Specialists E), which were established to hold arid rrianage certain assets as part of a strategy to ketter nlaila c various income strcairis and provide opportunities for capital ci-eation as nccdcd. Specialists A a d Specialists R subsc- cpent f: y entered into a limited partnership agreement, Global Porrfolio Limited Par-rners. Portfolio Management Specialists R also owns First Financial Kea1 Estate, LLC. At Ikcernber 31, 2005, $400.8 million of securities and loans were owned by thcsc sub- sidiaries. Specialists A, Specialists R, Global Portfolio Limited Partriers anci First Financial Real Estate LLC are included in the coiisolidatcd financial stateiiiciits. ‘l’hc Corporation, which is hcadc uartered in ‘l’crre Haute, Indiana, offers a wide variuty or firiancial services including commer- cial, mortgage arid consumer lei1 d ing, lcase financing, trusl account services and dzpositor services through its three subsidiaries. ‘l’hc Corpofiition’s primary source of reve~iuc is derived from loans to customers, primarily middle-inconic individuals, a n d investment activities. 1 he Corporation operates 46 branches in west-central Indiana arid east-central Illinois. First Financial Uaiik is the lai-gest bank in Vigo County. It operates 12 full-service haiilcing branches within the county; five in Clay County, Indiana; one i n Greene County, Indiana; two in Knox County, Indiana; f h e in Puke County, Indiana; five i n Sullivan County, Indiana; four in Verniillion County, Indiana; o m in Clark Coii~ity, Illinois; one in Coles County, Illinois; three in Crawford County, Illinois; one in Jasper County, Illinois; two in Lawrence C:ounry, Illinois; two in Richlalid County, Illinois; oiic in Vcrrriilion Couiity, Illinois; and one in Wayne County, Illinois. It also has a main office in downtown Terrc Haute antl a n operations ceriter/ofice building in southern ‘I’crre Haute. Regulatory Agencies: First Financial Corporation is a multi-bank holding coiiipariy and as such i s regulated by various banking agencies. ‘lhc holding company is regularcd by the Seventh District of the Federal Reserve System. The national batik subsidiary is regulated ky the Office of the Coniptrollcr of the Currcncy. ‘I’lic state bank subsidiary is jointly regulated by the State baiiliing organization arid the Federal Deposit Insurance Corporation. SIGNIFICANT ACCOUN*I*ING Use of Estimates: To prepare f;nancial statements in conformity with US. generally accepted accounting principles, rnanage- rnent makcs estimates and assurnptions based on available information. These estiiiiatcs arid assumptions affect the anioiiiits reported in the finaricial stateinents and disclosures provided, and actual results could tlit‘fer. ‘I’hc allowance for loan losses, w r y - ing value of intangible assets, loan servicing rights and the fair values of financial instrurrients are particularly subject to changc. Cash Flows: Cash arid cash equivalents include cash arid demand deposits with other thincia1 institutions. Net cash flows are reported for customer loan and deposit transactions and short-term ljorrowiiigs. Securities: The Corporation classities all securities as “availablc for sale.” Securitics arc classitied as available for sale when they might he 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 shareboldcrs’ cquity. Interest income includes amortization of purcllasc premium or discount. Premiums arid discounts are aiiiortized o n the level yield method without anticipating prepayments. Mortga e-backed securities are amortized over the expected life. Realized gains and losses o n sales are based o n the aiiiortizcd cost o F the sccurity sold. Decliiics in the fair value of securities below their cost that ai-e other than temporary arc reflected as realized losses. In estimating other-than-temporary losses, iiiailagcincnt con- siders: 1) the length of time and extent that fair value has bccn less than cost; 2 ) the financial condition anci near tcriri prospects of the issuer; and 3 ) the Corporation’s ability antl intent to hold the security for a period sufXcicnt to allow for any anticipated recovery in Liir value. Loans: Loans that iiianagemeiit has the intent and ability to hold for the heseeable fiitiirc 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, o n a n aggregate basis. Interest incorne is accrued on the unpaid principal txilatice and iricludes amortization of net deferred loan fees and costs over the loan rerni without anticiparing prepayments, lntcrcst income is not reported when fiill loan repayment is in douht, typical- ly when the loan is impaired or payments arc significantly past due. All iiitercst accrued hut not rcccived for loans placed o n nonaccrual is reversed against interest income. Interest received on such loans is accountcd for o n the cash-basis or cost-recovery method, until qualifying for return to accrual. Loam are returned to accrual status when all the principal and interest amoiiiits contractually due arc brought wrrent and future payments arc reason- ably assured. In all cases, loans are placed on noli-accrual or charged-off if collectioii of principal or interest is considered doubtful. Allowance for Loan Losses: The allowance for loan losses is a valuation allowance for probable incurred crcdit losses. Loan losses arc ctlarged against thc allowance wlicn rnanagement bclicves the uncollcctibility of a loan balance is confiriiicd. Subsequent recoveries, if any, are credited to the allowance. Mariagement estiiiiatcs the allowance balance required using past loan loss expcri- eiicc, the riatiire and volutrie of the portfolio, inforimtion akout specifk borrower situations and estimated collateral values, POLICIES I W NOTES TO CONSOLIDA'I'EI) F I N A N C I A L STATEMENTS 2 0 0 5 A N N U A L R E P O R T cconorriic conditions and other factors. Allocations of the allowancc may be made for s ecific loans, hut the entire ~ I ~ O W ~ I J C ~ available for any loan that, in rnanagerrient's judgment, should be charged off. ?'he a1 P owaiicc consists of' specific arid general is components. The specific component relates to loans that arc individually classified as impaired or loans otherwise classified as substandard or doubtfill. Thc general component covers non-classified loans and is based on historical loss experience adjusted for current factors. A loan is irripaired when full payment under the loan ternis is not expected. Im Iairment is evaluated in total for smaller-balance lc)ans of similar natiirc such as residential rriortpges, consumer and credit card / oans, atid on an individual basis for othcr loans. If a loari is irnpaired, a portion of the allowaiicc is allocated so that tlic l ~ a r i is reported, net, a t the present value of estimated fiiturc cash flows, using the loan's existing rare, or a t the fair value of collateral if' repayment is cxpcctcd solcly from the collateral. Large groups of smaller balance homogcncous loans, such as consumer and residential real estate IO~IJS, are collectivcly cvaluatcd for impairrncrit and, accordingly, they are not separately identified for inipairmcnt disclosures. Foreclosed Asscts: Assets acquired through or instead of loari heclosures are initially recorded a t fair value when acquired, cstablishing a new cost 1)asis. If tiir value declines, a valuation allowancc is recorded through expense. Costs after acquisition a re expensed. Premises and Equipment: Land is carried a t cost. Premises and equipment are Lkprcciation is cornpuicd over the useful lives of the assets, which range f'roni 3 to 39 years for buildings and leasehold improvements. Federal Home Loan Bank (FHLB) Stock: 'l'he Corporation is a mcmbcr o l the FHLR system. Memhers are required to vwn a cer- tain anioiiiit of stock bascd on the level of bori-owings and other factors, and may invest in additional amounts. FHLH stock is car- ried at cost and periodically evaluated for impairnicnt. Because this stock is viewed as a long-term investment, impairment is based on ultimate recovery of par value. Both cash arid 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 o n loans sold. servicing rights arc cxpcriscd in proportion to, and over the period of, estimated net servicing revenues. Irnpirrncnt is evaluated hased on the fair value of the rights, using groupings of'thc 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 charactcrisrics, when available, or hased upon dis- counted cadi flows using mal-ket-based assumptions. Any impairrncnt of a grouping is reported as a valuation allowance. Servicing fee income is recorded for fees earned for servicing loans. The fees are based o n a contractual percentage of the out- standing principal or a fixed arriourit per loan and ai-e recorded as income when earned. 'Ihc amortization of rnortgage 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 bc rcalizcd. Goodwill and Other Intangible Assets: Goodwill resiilts from business ac uisitioris arid represents the excess of the purchase red a t cost less accumulated dcprcciation. ycars for liirniturc arid equipment and 5 to price over the fair value of acquired tangible assets and liabilities and identi I iablc iritmgiblc assets. Goodwill is annually for impairment and any such inipairrricrit will ke recognized in the period identifkd. Other intangilile assets consist of core deposit and acquired ciistoniet relationship intangible assets arising from the whole bank, insurance agency and branch acquisitions. They are initially measured at fair value and then arc amortized on an accelerated method over their estimated usefiil lives, which arc 12 arid 10 ycars, respectively. Long-Term Assets: Premises and equipment a d othcr long-tcrrn assets are reviewed for impairment when events indicate their carrying aino~int nlay not bc rccovcrable from future undiscounted cash flows. If impaired, the assets arc recorded at Fair value. Benefit Plans: I'cnsion expense is the net of service and interest cost, return on plan assets arid amortization of gains and losses not immediately recognized. 'I'he amount contributed is determined by a formula as decided by the Board of LXrcctors. Deferred conipcrisatioii arid supplernerital retirement plan expense allocates the bcncfks over years of service. Deferred Compensation Plan: A deferred compensation director, or their bcncfkiary, thc afnount of fees deferred p Y u s interest over 10 ycars, bcgirinirig when the director achieves age 65. Ian covers all directors. IJnder the plan, the Corporation pays cach A liability is accrued for the obligation iinder these plans. The expense incurred for the deferred compensation for each of' thc 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 yur-end 2005 and 2004. Long-Term Incentive Plan: A long-tei-m incentive plan provides for the payincnt of incentive rewards as a 1 0-year annuity to all directors and certain key officers. 'l'hc plan expires Uecerriber 3 1, 2009, and compensation expense is recognized ovcr thc service period. I'ayments under the plan generally do not begin until the earlier ofJanuary 1, 2015, or the Jariiiary I immediately follow- ing the yeai- in which the participant rcachcs age 65. Chmpensation expense for each of the last thrcc years was $1.6 rnillion, $ I .5 million arid $1.5 inillion, resulting in a liability of $7.3 million and $5.5 million as of year-end 2005 and 2004. Income '&xes: liicoiiic tax expense is the total of the current year income tax due or rcfiindable arid the change in deferred tax assets and liabilities. Ikferrcd ax assets arid liakilities are the expected fiiture tax aiiioiiiits for the temporary differences between carrying arriounts a n d tax bases of assets and liabilities, cornputed using enacted tax rates. A valuation allowancc, if needed, reduces deferred tax assets to the amount expected to be realized. 1,oan Corriniitrnents and Related Financial Instruments: Financial instru ts include credit instruments, such as commit- rrients to make loans a n d standby letters of credit, issued to meet custome nancing needs. The face aiiiount for these items represents the exposure to loss, before considering customer collateral or ab to repay. Such financial instruments are record- cd when they are fiinded. NOTES TO CONSOLlDATED FINANCIAL STATEMENTS F I R S T F I N A N C I A L C O R P O R A T I O N Earnings Per Sharc: Earnings er comtno~i share is net income divided by the weighted avcragc riurnher of coinnion shares out- standing during the period. T R e 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: Cornpreherisivc income consists of‘ net income and other corriprehensive income. Other comprehen- sivc income includes unrcalizcd gnins and losses on securities availablc ror sale, whish arc also recognized as sepxatc corripo- nents of equity Loss Contingencies: Loss contingcncics, including claims and legal actions arising in the ordinary coiirse of‘busiriess, are recorded as liabilities when the likelihood of loss is probablc and an amoiint of range of loss can he reasoilably estirnated. Management does not believe there are currently such matters that will have a material effect on the financial statements. Dividend Restriction: Ranking regulations require maintaining certain capital levels and may liniit the dividends paid by thc bank to the holding corripany o r by thc holdirig company to sharcholders. Fair Value of Financial Instruments: Fair values of financial instruments are estiniatccl using relevant market inforrnation and other assutnptions, as niorc fiilly disclosed in a separate note. Fair value estimates involve iinccrtaintics arid matters of significarit judgment regarding interest rates, credit risk, prepaymcnts and other- factors, especially in the absence of broad markets for partic- ular items. Changes in assumptions or market coriditions could significantly affect the estimates. Operating Segnient: While the Corporation’s chief clecision-makers rrionitor the revenue streams of the various products and ser- vices, the idcntifiahle segments arc not material and operatioris are managed and firiaricial performance is cvaluated on a corpo- ratc-wide basis. Accordingly, all of the Corporation’s financial service opcrations are considcrcd by management to bc aggregated in one reporrable operating segment, which is banking. Adoption of New Accounting Standards: During 2005 the Corporation adopted SOP 0.3-3, which requires that a valuation allowance for loans acquired in a transfer, includirig in a busincss cornbination, reflect only losses incurred after acquisition and should riot be recorded at acquisition. It applies to any loan acquired in a transfer that showed evidciicc of credit c~tiality dctcriora- tion since it was made. This new standard had n o effect on thc Corporation’s financial statements and results of operations. In May of 2005, the FASR issucd statement 154, “Accounting Changes and Error (hrrections,” that provides guidance on reporting of accounting changes and correction of errors nladc iri fiscal years bcginning after the date of this statement. First Financial Corporation has adopted statement 154. The adoption of this statement had no effect on the financial statcnicnts included herein. In November of 2005, the FASR issucd a staff position that amended FASR statenlent No. 1 15, “Accounting for Certain lnvestnicnts in Deht and Equity Securities.” This aiiicridnierit addresses the mcasurerrient, accounting and disclosures for securi- ties that have been rccogriized to be other than tern orarily inipircd as well as those that have riot heen recognized as other-than- temporarily impaired. First Financial Corporation [as adopted these arneiidiiicrits that have had no effect on the financial statc- mefits included herein. Reclassifications: Sonic iterris in prior year financial statements were rcclassified to conforiii to the cui-rent presenration. 2. FAIR VALUES OF FINANCIAL INSTRUMENTS: Carrying amount is the cstimared fair valuc for cash and due from banks, federal funds sold, short-term borrowings, Federal Honic Loan Rank stock, accrued interest receivable and payable, denland deposits, short-term debt arid variable-rate loans or deposits that reprice frequently and fully. Security fair values are based o n markct prices o r dealer quotes, and if n o such infornm tion is available, o n the ratc arid term of the security arid information about the issuer. For fixed-rate loans or deposits, variable rate loans or deposits with infrequent repricing or repricing h i t s , and fur longer-term borrowings, fair vahc is based on dis- counted cash flows using ciirrcnt market rates applied to the estimated life and credit risk. Fair vducs for impajred loans arc esti- rriated using discounted cash tlow analysis or underlying collateral values. Fair valuc of debt is t)ased on ciirrcnt rates for similar financing. The carrying amoiint arid estimated fair valuc of financial instruments are presented in ttic table helow and wcrc determined based on tlic ahove sssuniptions: December 31, 2005 2004 (Dollar :i moil n t s in thousands) Cash and due from hanks Federal funds sold Sccurities available-for-sale I m n s , net Accrued interest rcceivable Deposits Short-term borrowings Fedcral HOITW Loan Bank advances Other borrowings Accrued interest payable Fair Value Carrylng Value Carrying Value $ 78,201 2,982 536,291 1,379,699 12,537 $ 78,201 $ 2,382 536,29 1 I ,371,835 12,537 94,928 5,400 5 07,390 1,443,953 12,016 (1,464,‘) 1 8 ) (1,469,670) (1,443,12 1 ) (75,527) (337,886) (24,600) (3,142) (26,224) (337,266) (6,600) (3,632) (26,224) (338,849) (6,600) (3,692) Fair Value $ 94,928 5,400 507,990 1,448,73 1 12,016 (1,449,322) (75,527) (341,1.48) (24,600) (3,142) NOTES ’ro CONSOLTDATED FINANCIAL STATEMENTS 2 0 0 5 ANNUAL R E P O R T 3. RESTRICTIONS ON CASH AND DUE FROM BANKS: Certain affiliate banks are rrqiiired to rriairitain average reserve balances with thc Fcdcral Reserve Bank that do not earn interest. ‘l’he amount of those reserve balances was approxirnarely $2.1 million and $33.2 million at December 3 I , 2005 and 2004, respectively. 4. SECURITIES: ‘I‘he fair value of securities available-for-sale and related gross unrealized gains arid losses rccogn jzcd in accumulated other comprchcnsivc incomc wcrc as follows: (Dollar amounts in thousands) U.S. Government sponsored entity mortgage-baLked securities and agencies Collateralized mortgage obligations State and municipal C : o r p r a t e ohligations Equities TOTAL (Llollar ainoiiiits in thousands) U.S. Governinelit sponsored entity mortgage-backed securities and agencies C.hllateral ized mortgage o hl igatio t i s State arid rriiinicipal Corporate obligations Equities TOTAL Amortized cost $306,697 2,357 129,9 16 89,740 4,4 10 $533,120 Amortized cost $227,927 19,895 137,206 104,754 4,280 $434,062 December 31.2005 Unreallzed Gains Losses Fair Value $ 787 7 4,543 534 3,849 $ 9,720 $(G,081) ( 4 ) (414) ( 5 0 ) - $(6,549) $30 1,403 2,360 134,045 90,224 8,259 $53629 1 December 31,2004 Unreallzed Gains Losses Fair Value $ 2,573 12 7,263 1,333 4,445 $ 15,626 $(1,472) $229,028 19,866 144,294 106,077 8,725 $(1,698) $507,990 (41) ( 1 7 5 ) ( 1 0 ) - As of December 31, 2005, the Corporation does not have any securities from any issuer, other than the U.S. Govcrntnent, with an aggregate hook or fair valuc that exceeds ten percent of shareholders‘ equity. Securities with a carrying value of approximatrly $54.7 million and $33.0 million a t Decernber 31, 2005 and 2004, respectively, were pledged as collateral for short-term borrowings and for other purposes. Relow is a summary of the gross gains and losscs rcalizcd by thc Corporation on investment sales during the years erided December 31, 2005, 2004 arid 2003, respectively. (Doll,ir ~ i i i i w n i 9 i n i h n i i s ~ i n d s ) Proceeds . . I ~ o s s gams Gross losses ( 7 . 2005 $11,376 537 - 2004 $11,466 409 I 2003 $8,308 237 - AclditionA girls of $34 thousand in 2005 arid $47 thousand in 2004 resiilted from redernprion premiums on called securities. The Corporation ev,iluatcs sccuriries for other-than-rcmporary impairrtient on a quarterly basis. Factors considered include lengrh o f t i m e itnpaired, reason for irripairmenr, outlook atid the Corporation’s ability to hold the irivcstnictit to allow for recovery of fair value. There were no securities considered to hc otlicr-than-temporarily impaired at Dccernbcr 31, 2005. A t Dcccmber 31, 2004, the Corporation had o w security that it considered to hc other-than- tct-nporarily impaired, and the Corporation wrote down the value of the investment by $621 thousand to its fair value and d x q u c n t l y wld the security. N OT ES TO C o N s L I DAY' ED F I NAN c 1 A L S T A ~ M EN T s F I R S T F I N A N C I A L C O R P O R A T I O N C:ontractual maturities o f debt securities at year-end 2005 were as follows. Securities not due at a sitiglc nlaturity or with no tnaturity datc, primarily mortgage-backed and equity securities, are shown separately (Dollar arnoiints in thousands) DLK in one year o r less Due after one but within five years Due after five but within ten years Due after ten years Mortgage-hacked securities and eqtiities Tc )TAL Available-for-Sale Fair Value Amortized cost $ 42,057 $ 42,304 107,242 104,704 37,450 35,626 46,095 45,973 228,360 233,091 304,760 303,200 $533,120 $536,291 The following tables show die securities' gross unrealized losses and fair value, aggregated by investment category a n d lengdi of ti mc that individual securities have been in continuous unrealized loss positim, at December 31 , 2005 and 2004. (Dollar anioLint\ In thousands) U.S. Government 5ponsored entity December 31,2005 Less Than l 2 Months More Than 12 Months Total Falr Value Unreallzed Losses Falr Value Unrealized Losses Fair Value Unreallzed Losses Collateralized mortgage obligations State and municipd obligations Corporate obligations mortgage-backed securities and agencies $206,666 $ (4,250) $57,222 1,334 8,994 950 $222,777 $(4,494) $68,500 Total temporarily impaired securities 904 14,509 698 ( 2 ) (240) $( 1,831) $263,888 $(6,08 1 ) ( 4 ) (414) (50) $(2,055) $291,277 $(G,549) 2,238 23,503 1,648 (2) (174) (48 1 ( 2 ) - - ~~- -~~ (Dollar amouriis in thousands) U.S. Government sponsored entity December 31.2004 Less Than 12 Months More Than 12 Months Total Falr Value Unrealized Losses Falr Value Unrealized Losses Fair Value Unrealized Losses mortgage-backed securities arid agcncics $ 72,754 $ Chllateralized mortgage obligations State arid municipal obligations Corporate obligations Total temporarily itnpired securities 17,059 12,979 2,000 !J (437) $40,437 (41 - ( 1 I O ) (375) $1 13,25 1 I 17,059 13,407 3,506 - - - ~ - - (41 (175) ( 1 0) $(I ,045) $147,223 $(1,698) ( 5 ) - 1,506 - (5 1 $(1,472) ( 6 5 ) 428 $104,792 $(653) $42,431 These losses represent negative adjustments to market value relative to the rate o f interest paid on the seuritics atid not losses related to the creditworthiness of thc issuer. Management has thc intent md ability to hold for the foresee- able future and believes the value will reLover as the semrities a p p r o ~ ~ h maturity or market rates chmge. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2 0 0 5 A N N U A L R E P O R T 5. LOANS: Loans are summarized as follows: (Dollar amoiiii ts in thousands) Commercial, financial and agricultural Keal estate - construction Keal estate - niortgage Installment Lease financing Total gross loans Less: unearned income Allowancc for loan losses TOTAL December 31. 2005 $ 382,214 31,918 707,008 272,062 2,845 1,396,047 (306) (1 6,042) $1,379,699 2004 $ 401,724 32,810 753,826 272,261 3,658 1,464,279 (408) ( 1 9 3 1 8 ) $1,443,953 In the nornial course of business, rhe Corporarioris subsidiary banks mdke loans to directors arid executive officers and to their associates. These related parry loans are consistent with sound banking practices and are within applicable bank regulatory lending limitations. Tn 2005 the aggregate dollar anioutit of these loans to directors and executive officers who held officc at thc cnd of the year amounted to $34.1 million at the beginning o f the ycar. During 2005, advances of $19.6 million, repayments of $30.5 million arid changes to persons included o f $(1.2) million were made with respecr to related party loans for an aggregdte dollar amoiint outstanding of $22.0 million at December 31, 2005. Loans serviud for others, which are not reported as assets, total $4 16.6 million and $39 1.3 million at year-end 2005 and 2004. Acriviry for capitalized mortgage servicing rights (included in other assets) and the related valuation allowance was as follows: (Dollar amounts in thousands) Servicing righrs: Beginning of year Additions Amortized to expense End of year Val iiation allowance: Beginning o f year Reductions credited to expense E d of year December 31, 200s 2004 2003 $ 2,960 73 5 (764) $ 2,931 $ 3,114 63 1 (785) $ 2,960 $ 2,548 1,961 (1,395) $ 3,114 $ - $ 200 $ 500 , , 1 hird party valuations are conducted periodically for niortgage servicing rights. Rased on these valuations, fair values approximate carrying values. 6. ALLOWANCE FOR LOAN LOSSES: Changes in the allowance for loan losses are summarized as follows: (1)ollar amounts in thousands) Balance ;it beginning of year Provision for loan losses Recoveries of loans previously charged off Loans charged off BALANCE A I ' END OF YKAR December 31, 200s $ 19,918 11,698 1,918 2004 $21,239 8,292 1,77 1 2003 $21,249 7,455 1,475 NOTES TO CONSOLTDA'I'ED FINANCIAL STATEMENTS F I R S T F I N A N C I A L C O R P O R A T I O N Impaired loans were as follows: (Dullar amounts in thotlsatids) Year-end loans with no allocated allowance for loan losses Year-end loatis with allocated allowance for loan losses TOTAL Amount of the allowance for loan losses allocated Nonperforming loans: 1,oans past due over 90 days still on accrual Non-accrual loans 200s !b 500 3,622 $ 4,122 $ 1,657 6,354 8,464 December 31, 2004 $ 2,582 16,240 $1 8,822 $ 6,331 7,813 19,862 Nonperforming loans include horh smaller balance homogeneous loans that are collectivcly evaluated for impair- nient and individually classified impaired loans. (13ollar aiiioiiiits in t1ious;inds) Average of impaired loans during the year Interest income recognized during impairment Cash-basis intcresr income recognized 2005 $11,992 126 1 1 2004 $14,794 436 315 2005 $ 8,992 583 - It was riot practicable to dctertnine the amount o f cash basis intercst income recognizcd for 2003. 7. PREMISES AND EQUIPMENT: Premises and equipment are summarized as follows: (Dollar a m ~ i i n t s in thousatids) Land Building and leasehold improvements Furniture and equipment Less accumulated depreciation TOTAL December 31, 200s $ 5,617 35,290 23,887 70,794 (33,524) $ 31,270 2004 $ 5,617 35,102 27,928 68,647 (37,493) $ 31,154 Aggregate depreciation expense was $2.79 million, respectively. 62 million and $2.24 million for 00 2004 and 2003, 8. GOODWILL AND INTANGIBLE ASSETS: T h e Corporation completed irs annual i m p i r m e n t testing of goodwill during the second quarter of 2005. Management does not believe any amount of the goodwill is impaired. Intangible asscts subject to amortization at December 31, 2005 and 2004 art: as follows: (Dollar amount\ in thousands) Customer list intangible Core deposit i ntangible Non-co m pe te + p z n i e n t s 2005 2004 Gross Amount $3,446 2,133 500 $6,139 Accumulated Arnortlzatlon $1,692 1 , l 17 470 $3,273 Gross Amount $3,108 2,193 500 $5,801 Accumulated Amortization $1,390 939 379 $2,708 Aggregate amortization expense was $57 1 thousand, $558 thousand and $638 thousand for 2005, 2004 and 2003, respectively. Estimxed amortization expense for the next five years is as follows: 2006 2007 2008 2009 2010 In I l l C l l l ~ l l l d * $ 497 425 425 425 425 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 2 0 0 5 ANNUAL R E P O R T 9. DEPOSITS Scheduled maturities of time deposits for the next five years are a s follows: 2006 2007 2008 2003 2010 $348,575 166,817 75,671 32,139 18,094 10. SHORT-TERM BORROWINGS A sumrnary of the carrying value of the Corporation's short-term borrowings at December 3 1, 2005 and 2004 is presented below: (Dollar ainoiiiits in thousands) Federal funds purchased Repurchase agrcctncnts Other shorr-term borrowings (Dolkir amoiiiits in thouhand.;) Average amount outstanding Maximum amount outstanding a t a month end Avcragc intcrcst ratc during year Interest rate a t year-end 2005 $1 9,032 5,579 1,613 $26,224 200s $25,927 54,808 3.16% 3.77% 2004 $63,002 5,597 328 $75,527 2004 $ 71,745 103,386 1.46% 2.34% Federal funds purchased are generally duc in one day and bear interest at marker Tares. Other borrowings, primari- ly note paphle-U.S. government, arc due on detnarid, secured by a pledge of securities arid bear interest at mar- ket rates. Subsrantially all repurchase agreement liabilities represent amounts advanced by various customers. Securities arc pledged to cover these liabilities, which are not covered by federal dcposit insurancc. Thc Corporation maintains pos- session of and control over these securities. 11. OTHER BORROWINGS: Other horrowings at Ilecemher 3 I , 2005 and 2004 arc summarized as follows: (1)ollar amount\ i n t h o i i w i d \ ) FHLB advances Note payable to A finmcial institution City of Terre Hmte, Iridima economic ctevelopmeiit revenue bonds TOTAL 2005 $337,266 - 6,600 $343,866 2004 $337,886 18,000 6,600 $362,486 T h e aggregate tninitnum aririiial pdyments of other borrowings are as follows: 2006 2007 2008 2003 20 1 0 Thereafter $ 8,665 766 52,632 22,916 257,594 1,293 $343,866 NOTES TO CONSOLIDATED FINANCTAL S'lATEMENl'S F I R S T F I N A N C I A L C O R P O R A T I O N The Corporation's subsidiary hanks are members of the lecteral Home Loan Bank (FHTB) and accordingly are perniittcd to obtain advances. The advances fi.01~1 the FHLB, aggregating $337.3 million at December 31, 2005, accrue int.erest, payablc rnonthly, at anniral rates, primarily fixed, varying from 3.28% to 6.60% with a weighed average rate of 5.46%. The advances are due at various datcs through August 2017. FIILB advances are, gencrally, due in full at rnaturity. They arc securcd by eligible securities totaling $129.9 million and a blanket plcdgc on real estate loan collateral. Certain advances rnay be prepaid, without penalty, prior to maturity. 'l'he FHLB can adjust the intcrcst rate from fixcd to variable on ccrtain advances, but thosc advances may then be prepaid, without penalty. On December 31, 2004, the Corporation entercd into a revolving credit loan agrecrnenr (Note) with a fitlaticia1 institution. The total priticipal amount of loans outstanding at one tirne under this Note could not excccd $20 million. The Note was paid off in the third quarter of 2005. The Notc bore an intcrcst rare equal to the average daily fcdcral funds ratc plus 0.875% atid adjusted daily. l'he Notc was iinsecurcd b u r required the Corporation to rrieet certain finamial covcnants. The Corporation coinplicd with all its dcbr covenants. These covenants included maintaining a primary capital-to-assets ratio higher than 6.2%, net income that excccdcd a 0.6% return oti average asscts, an allowancc for loan and leasc losses that did not Fall below .75% of gross loans and divictend declarations that wcre not in excess of42Yo of net income. The economic development rcvenue bonds (honds) requirc periodic interest payments each ycar unril maturity or redernp- tion. The interest rate, which was 3.58% at Deccmher 3 1 , 2005, and 2.0% at Deccinher 31, 2004, is detertriinect by a for- mula which considers ratcs for comparable bonds and is adjusted periodically. I'he bonds are collateralizcd by a first mort- gage on the Corporation's hcadquarters building. The bonds matiire Deceinhcr 1 , 201 5 , but bondholders may periodically rcquire earlier redemption. The debt agreement for the bonds requires thc Corporation to incct certain financial covenants. Thcse covenants rcquire the Corporacioti to maintain a l'ier I capital ratio of at lcast 6.2% and nct income to average assets of 0.604). A t December 31, 2005 and 2004, the Chporation was i n compliance with all of its debt covenants. The Corpordtion inaiiitains a letter of crcdit with anothcr financial institution, which could be irsed to rcpay the bonds, should they bc called. The letter of credit expired November 1 , 2005, and was automatically extended for one year. Assuming redemption will be fuiidcd by the letter of credit, or by other sitnilar borrowings, there are no anticipated princi- pal maturities ofche bonds within the next five years. 12. INCOME TAXES: Incomc tax expense is summarized as follows: (Dollar :irno~i iics in thousands) Federal: Currently p;ty;able Deferred State: Currently payable Deferred TOTAL 2005 2004 2003 $ 6,202 1,334 7,536 $ 5,884 1,282 7,166 $ 8,046 (544) 7,502 (5 1 382 377 - - 1,052 292 1,344 $ 8,846 _ 467 366 833 $ 7,999 _ $ 7,913 .~ ~ The reconciliation of income tax expense with the amount computed by applying the statutory federal income tax rate of35% to income before income taxcs is siinimarizcd as follows: (Dollar amounts in thousands) Fedcral income taxes computed at the statutory rate Add (deduct) tax effcct of: ~ ~ ~ 9nnR $10,833 2004 $12,603 2005 $12,369 Tax exempt income State tax, ncr of federal hcriefit Mordable housing crcdirs Other, net TOTAL (2,902) 24 5 (327) 58 $ 7,913 (4,889) 54 1 (327) 71 (3,738) 873 (507) ( 1 5 1 ) - - $ 8,846 - - $ 7,999 NOTFS TO CONSOLIDATED FINANCIAL STATEMENTS 2 0 0 5 A N N U A L R E P O R T T h e tax effecrs of rerriporary differences that give rise to significant portions of the deferred tax assets and liabili- tics at Deccrnbcr 31, 2005 and 2004, are as follows: ( 1 ) O l h l a m O l l l l r S 111 thousands) Dcfcrrcd tax aswts: Lom losses provision Deferred compensation Co m pc nsa tcd abscn ces Po5t-retirctnenr benefirs State net operating loss carry f o r w d Othcr GROSS DFFFRRFD ASSFTS Deferred rax liabilities: Net iirirealized gains on securities available-for-sale Depreciation Fcdcral Homc 1,oati Rank stock dividends Mortgage servicing righrs Perisi o t i s Othcr GROSS D F F F R R F ~ Nk:r D w ~ R R ~ I ) T A X ASSETS (LIABILITIES) LIARIT TTTES 2005 2004 $ 6,454 4,012 494 920 78 98 1 12,939 $ 7,927 3,417 48 1 698 243 929 13,695 (1,268) (1,440) (1,519) (1,176) (2,334) (3,012) (10,809) $ 2,130 (5,571 ) (1,512) (1,221 ) (1,176) (2,048 ) (2,624) (14,152) ( 4 5 7 ) $ 13. FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK: The Corporation is a party to financial jtistrtmients wirh off-balance-sheet risk in the normal course of business to meet thc financing nccds of its customers. These financial instruments include conditional commitments and com- tncrcial lcttcrs o f crcdir. The fitiaricial instriiments involve to varying degrees, elements of credit and interest rate risk in cxccss of anioiin ts recognized in the financial statements. 'I'he Corporation's inaxiinum exposure to credit loss i t i the event o f nonperformaticc by the other party to the financial instrument for commitments to make loans is limit- ed generally by the contractual amoutit of those insrruments. Tlie Corporation follows the same credit policy to makc such comniittncnts as is followed for those loans recorded in the consolidated financial statements. T h e Corporatjotis ciistotiiers had iiriiised lines of credit of $270.0 million and $245.9 million as of Dcccmber 31, 2005 arid 2004. In addition, tlie Corporation had outstanding comrnitmcnts of $6.9 million and $5.3 niilliori iirider commercial letters of credit as o f Dcccniber 31, 2005 arid 2004, respectively. Tlie majority of these commitments bear variable interest rates. Thc Corporatjon is exposed to credit loss in the event the counterparties to such agree- ments do not pcrforrii i n accordance with tlie agreements. C:ommitment and contingent liabilitics are summarized as follows at December 31: ( h l l a r :inloutits in rhoussnils) Home equity Ckdit card lines C.hrntncrcial opcratitig lines Other commitments Commercial letters of credit 2005 $ 32,338 46,276 24,270 163,226 $272,110 6,933 2004 $ 32,523 52,695 15,937 147,871 $249,026 5,319 Thc riiajority of corxirriercidl operating lines and home equity lines are variahlc ratc, while the rnajoriry of other ccmirnittnenrs to fiirid loms are fixed rate. Since many commitmcnts to makc loans expirc without being used, thcse anioii~i ts do not riecessdrily represent future cash commitments. Collateral obtaiticd upon cxercise of the com- mjttnent is deterrriined using management's credit evaluation of the borrower, and rnay include accounts reLeivablr, inventory, property, larid md other items. The approximate duration of thcsc comrnj mien ts is generJly one year or less. NOTES TO CONSOLIDATF,D FINANCIAL STATEMEN’I’S F I R S T F I N A N C I A L C O R P O R A T I O N 14. RETIREMENT PLANS: Substatitially all employee5 of the Corporation are covcred by A retirement program t h ~ t consists of a defined benefit pl,in arid an employee stock ownership plan (ESOP). Plan) Federal funds sold Total interest income Interest paid o n intcrcst-bcaring liabilities: Transaction accounts Time deposits Shot-t-ter-ti? borrowings Other borrowings Total interesr cxpciisc Net i nrerest income $ (726) (564) $ 4,592 2,129 $ (37) $ 3,829 1,487 (78) !$ 2,473 (541 ) $ (7,717) $ (194) $ (5,438) (393 ) 147 ( 5 ) (835 ) 212 11.9131 (1,364) - ~- - ( 2 (7,803) - - - - - - (1,726) 446 4,036 (1,593) ( 2 5 ) (314) (413) 47 (7,936) (947 45 5,813 42 (24 1 (181 ) 56 189 130 2,804 314 1,169 614 (443) 460 206 (2,787) (2,298) 16 586 448 (653) (1,054) (895) (847) ~~- (3,539) (2,237) (1,485) - ~ - - $ 2,551 $ (6,534) $ (221) $ (4,264) $(428) $ - - - - - - - - 3,159 330 (234) (472) 4,301 ~- 149 - (750) ( 3 2 ) (633) 2,783 9; 763 $ 1,253 (816) (544) 68 ( S O ) (1,342) ( 8 7 ) 55 70 2 40 318 ( 1 ) For- put-poses of‘thesc compiit&ms, nonaccruing loans are includcd in the daily average loan amounts outstandi ng. ( 2 ) Iiitcrcsi iricome includes rhe effect of tax cqiiivalcrit adjustments using B fedel-al tax rate of 35%. RESULTS OF OPERATIONS - S U M M A R Y FOR 2005 2 0 0 5 A N N U A L R E P O R T PROVISION FOR LOAN LOSSES T h e provision for loan losses charged to expense is hascd upon credit loss expcrience and the results of a derailed analysis csrirriating an appropriate arid adequate allowance for loan losses. Thc analysis includes thc cvaluarion of impaircd loans as prescribed under Statement of Financial Accounting Standards (SFAS) Nos. 114 and 1 1 8 , poo1ed loans as prescribed under SFAS No. 5 , and economic arid other risk factors as outlined in various Joint Iriteragency Sratements issucd by the banlc regulatory agencies. For the ycar ended December 3 I , 2005, the provision for loari Iosscs was $1 1.7 million, an increase of $3.4 million, or 41.10/0, compared to 2004. ’l’he increasc was the result of several components related to the analysis of the Corporation’s Allowance for Loan and Lcasc 1.osses. Although net charge-offs for 2005 were $15.6 tiiillion as cornpared to $9.6 triillion for 2004, classified credits wcre rediiced by $12.5 million, or 17.396, from prior year totals and nonperforniing loans dccreased by $13.2 million. During the year commercial and real estatc crcdirs were identified for sale arid written down to realizable valuc. This caused both an increase in provision for loan losses as wcll as decreased nonperforniing loam and clas- sificd credits. Changes i n bankruptcy statutcs increased the amount of charge-offs of consumcr credits in the sec- ond half of 2005. At Dcccrnber 31, 2005, thc resulting allowancc for loari 10s was $16.0 million or 1.15% of roral loans, net of iitiearried income. A year earlier the allowance was $19.9 millioti or l.360/0 of total loans. NON-INTEREST INCOME Non-i titerest income of $32.0 million decreascd $3.8 million from the $35.8 million earned i n 2004. Excluding the $4.1 rriillion non-taxablc gain on life insurance benefit realized i n 2004, the non-intercst income is up by $384 thousand. Increased gains on loan and security sales were partially offscr by recliicecl income from insurance commis- sions atid trust fees. NON-INTEREST EXPENSES Non-interest expenscs totaled $63.5 million for 2005 coniparcd to $63.7 niillion for 2004. Salaries and employee benefits increascd $741 thousand or 2.09’0. Occupancy expense decreased 2.Wo or $108 thousand while equip- ment cxpcnse increased by 7.79’0 or $276 thousand. All other expcnses decreased to $17.3 million from $18.3 million in 2004. Consolidation of affiliate hanks, which has contributed to the control of non-interest expenscs, was completed in the third quarter of2005. INCOME TAXES T h e Corporation’s federal income tax provision was $7.3 million i n 2005 compared to a provision of $8.0 million in 2004. The overall effective tax rate in 2004 of 22.2% comparcs to a 2005 effective ratc of 25.6%. The Iifc insurance benefit receivcd ixi 2004 was not subject to income tax, thereby reducing thc effective tax rate. COMPARISON OF 2004 TO 2003 Net income for 2004 was $28.0 million or $2.07 per share coniparcd to $26.5 million i n 2003 or $1.95 per sharc. This iricreased income was primarily thc result of increased non-interest income i n 2004 froni a gain on life insurance benefit of $4. I inillion. ‘l’otal average interest-earning assets decreased $1 .X tnilljoti in 2004 fi-om $2.04 hillion in 2003. T h e tax equivalent net intcrest margin decrcascd to 3.81% in 2004 from 4.02% in 2003. This decrcase is primarily the rcsult offiinding costs decreasing at a slower rate than the yicld O K ~ earning assets. T h e provision for loan losses increased $837 thousand from $7.5 million in 2003 to $8.3 million in 2004, and nct charge-offs increascd $2.1 million frotn $7.5 niillion in 2003 to $9.6 million in 2004. ‘There was a $3.7 million improvement in net noti-interest income and expense from 2003 to 2004. Non-intercst expenses incrcased $1.2 million while non-interest income increased $4.3 million. ’I’he majority of this increasc i n noti-interest income was the result of the gain on life insurance benefit of $4.1 million realized in 2004. T h c provision for incomc taxes fell $847 thousand from 2003 to 2004, reducing thc effective tax rate from 25.0% in 2003 to 22.2%) i n 2004. ‘i‘his decreasc in the effective tax rate was the result of the increase i n non-taxable income from the gain on life insurance hcnefit realized in 2004. Without this gain the effective tax rite would havc been 25.1%. FINANCIAL CONDIT~ON - SUMMARY F I R S T F I N A N C I A L C O R P O R A T I O N Thc Corporation’s total assets decreased 2.2% or $47.1 million at Ilecember 31, 2005, from a year earlier. Available-for-sale securities jncrexed $28.3 million at Urcember 3 1, 2005, from the previous year. Loans, net of unearned incomc, dccrcascd by $68.3 rnillion, to $1 A0 billion. Deposits increased $2 1.8 million while borrow- ings decreased hy $67.9 million. Total shareholders’ equity increased $988 thousand to $269.3 million a t December 31, 2005. Net iricorne was partially offset by higher dividends and thc con ti nucd rcpurchase o f corporate stock. T h e Corporiition had higher purchases of treasury stock in 2005, acquiring 203,700 shares at a cost of $5.8 million cornpared to 79,000 shares during 2004 a t a cost o f $2.3 million. There were also 41,500 shares from the treasury with a valuc of $ 1 . I4 mil- lion that were contributed to the ESOP plan. Incrcascd intcrcst rates reduced other cornprehensive incorrie as the Corporation recorded a net unrcalizcd loss on av;dable-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 o f the components of the Corporation’s balance sheet. SECURITIES ‘I‘lie Corporation’s investment strategy seek5 to rnaxirnizc income from the investrrient portfolio while using it as a risk management tool and ensuring safery of principal and capital. During 2005 the portfolio’s balance incrcascd by 5.57% Diiririg 2005 the Federal Reserve increased the fed funds rate by 2.00i2/0 to 4.25%. T h e aver- &age life o f the portfolio was extended from 4.00 year5 to 4.36 ycars. T h e portfolio structure will coritiriiie to pro- vide a s h flows to be reinvested during 2006. Ycar-cnd sccurities rnaturiry scliedules were comprised of the following: (Lh~llar artlotitiis in t h o L 1 h d h ) U.S. government sponsored entity morrgagc-backed securities ant1 agencies Cokitcralizcd rnortpge oblig&ns( 1) States and political subdivisions Corporm obligations Totdl Bqu i t i es ‘ W l ’ A 1, 1 Year and Less Rate Balance 1 to S Years 5 to 10 Years Over 10 Years Balance Rate Balance Rate Balance Rate 2005 Total $ 1 1,753 2,2 1 5 23,760 6,670 50,413 - $50,4 13 4.28% $284,8 I 5 4.22 145 66,383 4.24 37,301 4.88 389,244 4.33 - - $3 83,244 4.56% $ 4,823 3.73 - 34,531 3.25 2,860 5.75 42,280 4.45 - - $42,280 5.50% - 1.63 5.41 2.33 - - - 331 1 42,784 46,095 8 259 $54,354 -%r - 3.31 5.09 4.30 - $301,403 2,360 1,34,045 90,224 528,032 8,253 $536,2c) 1 1 (1) Distti1)ution of maturities is based on the estiiilarcd avcragc lifc of thc asset. FINANCIAL CONDITION - SUMMARY 2 0 0 S A N N U A L R E P O R T LOAN PORTFOLIO Loans outstanding by major category a s of Ilccctnber 31 for each o f tlic last five years and the maturiries at year- end 2005 are set forth in the following analyses. (Dollar ailloutits in thousands) 2005 2004 2003 2002 2001 Loan Category C.hmmercia1, financial and agricultural Real estate - construction Real estate - mortgagc Installmeiit Lease financing TOTAL (hilar a1riotitit\ in thousands) Maturity Distribution Commercial, ft nancial and agricultural Real estate - constrtictioii TOTAL Rcal estate - mortgagc 1 t i s rallment Lcase firlancing ‘rOTAL Loans maturing aftcr one year with: Fixed interest rates Variable interest rates TOTAL $ 382,214 $ 401,724 $ 374,638 $331,316 42,930 783,618 268,067 I ,28 1 $ 302,496 34,G 10 757,345 249,710 5,023 $1,336,047 $1,464,279 $1,430,084 $1,433,212 $1,343,184 31,918 707,008 272,062 2,845 32,810 753,826 272,261 3,658 3536 1 766,91 1 248,290 4,884 Within One Year After One But Within Five Years After Five Years Total $137,534 17,342 $214,876 $151,941 7,740 $159,681 $ 32,739 6,836 $ 39,575 $ 382,214 31,918 414,132 707,008 272,062 2,845 $1,396,047 $ 59,011 100,670 $ 34,335 5,240 $159,681 $ 39,575 FINANCIAL CONDTTION SUMMAKY ~ F I R S T F I N A N C I A L C O R P O R A T I O N ALLOWANCE FOR LOAN LOSSES T h e activity in the Corporation’s allowance for loan losses is shown in tlic following analysis: (noll;ir ;inioiints in thousands) Amount of loans outstanding at Dccembcr 31, 2005 2004 2008 2002 2001 $1,396,047 $1,464,279 $1,430,084 $’ 1,433,2 12 $1,349,184 Average amoiirit of loans by year $ I ,44 1,247 $1,452,572 $1,417,026 $1,432,290 $ 1 3 1 5,725 Allowance for loan losses at beginning of year Addition resulting from acquisition Loans chargcd of6 Coni mcrcial, financial arid agricultural Rcal cstatc - rnortgagc I tis tal 1 m cti t Lcasing Total loans charged off Recoveries of loans previously charged off: Commercial, financial and agricultural Real estate - mortgage Ins tal I me tit Leas i rig Total recoveries Net loans charged off Provision charged to expense $ 19,918 $ - 21,239 - $ 21,249 $ - 18,313 1,711 $ 13,072 - 6,093 2,590 8,809 - 17,432 284 343 1,29 1 - 1,918 15,574 11,638 4,080 623 6,680 1 11,384 452 37 1,28 1 1 1,771 9,613 8,292 2,253 1 , 1 0 1 5,586 - 8,940 432 166 877 - 1,475 7,465 7,455 4,627 892 4,619 - 10,138 840 110 935 - 1,885 8,253 9,478 4,079 557 4,395 12 9,043 819 GO 790 I 1,669 7,374 6,615 Balance at end of year $’ 16,042 $ 19,918 $ 21,233 $ 21,249 $ 18,313 Ratio of net charge-offs during period to avercage loans outstanding I .080/0 .66% .53% .58% .56% ‘I‘he allowance is maintained at an amount iiianagenient believes sufficient to absorb probable incurred losses in the loan portfolio. Monitoring loan q i d i t y and maintaining an adequate allowance is an ongoing proccss overseen by senior management and thc loan review fiinctiori. On at least a quarterly basis, a formal analysis of tlic adcquacy of the allowance is p r e p - c d and reviewed by management and the Board of Directors. This analysis serves as ii point in time assessment of thc level of rhe allowance and serves as a basis for provisions for loan losscs. Tlic loan quality monitoring proccss includes assigning loan grades and the use of a watch list to identify loans of concern. Tlic analysis o f the allowarice for loan losses includes the allocation of specific i ~ ~ n o ~ i r i r s of the allowance to individ- i d problem loans, generally based on an analysis of the collateral securing those loans. Portions of the allowancc are also allocated to loan portfolios, based tipon a variety of factors including historical loss expcricticc, trends in the type and volumc of tlic loan portfolios, trends in delinquent and non-perforniing loans, and cconomic trends affecting our markct. Tlicse components are added together and compared to thc balancc of our allowance at the evaluation datc. Tlic following rable presents the allocation of the allowance to thc loan portfolios at year-end. FINANCIAL CONDITION - S~JMMAKY 2 0 0 5 ANNUAL R E P O R T (Dollar xinount\ i n thousands) C:ommcrcial, financial and agricultural Real cstare - mortgage In stall in enr 1,easing Una1 located TOTAL ALLOWANW FOR LOAN Losses NONPERFORMING LOANS Years Ended December 31, 2005 $ 8,148 867 7,027 - 2004 $11,840 850 7,228 - 2003 $13,844 1,254 6,141 - 2002 $12,393 1,471 5,856 I5 2001 $11,151 1,330 4,489 17 - ~- $13,918 $16,042 $21,239 - - 914 1. ,326 $21,249 $18,313 Management monitors the componenrs and status of nonperforming loans as a part of the evaluation procedures used in determining thc adeqiixy of thc allowarice for loan losses. It is the Chporatioris policy to discontinue the accrual o f interest on loans where, in managcment’s opinion, xrious doubt exists as to collectibility. Thc amounts shown below represent non-accrual loans, loans which have hccn restructured to provide for a reduction or deferral of interest or principal because of deterioration in tlie financial condition of the horrower and those loans which are past duc more than 90 days where tlie Corporation continues to accrue interest. (Dollar amounis in thousands) Non-accrual loans Restructured loans Accruing loans past due over 9O days ~ - 2005 $ 8,464 57 6,354 $14,875 ~ ~ - 2002 $ 1 1,807 546 5,839 $18,252 2004 $19,862 430 7,813 $28,105 2003 $ 8,429 542 5,384 $14,355 2001 $ 8,854 590 4,325 $14,369 ~ ~ _ _ _ - I - ~ ~ - The ratio of the allowance for loan losses as a percentage of nonperforniing loaris was 10894) at December 3 I , 2005, compared to 71 (X) in 2004. The following loan catcgories comprise significant components of the nonperforming loans at December 3 1, 2005 arid 2004: (I)oll.ir amoiints in t l i o u \ ~ n d s ) Non-accrual loans: 1 -4 hniily residen rial Commercial loans Installment loans Past due 90 days or more: 1-4 fimily midenrial Commercial loans Installrnent loans 2005 2004 $ 1,118 5,888 1,458 $ 8,464 13% 70 ~ 17 E Y o - $ 608 17,635 1,619 $19,862 51% 24 $ 3,137 1,554 1,603 - 25 100% - $ 6,354 $ 3,723 2,159 1,931 2 $ m G yJ7% - 3% 89 8 - 1 - OO(% - 47% 28 Non-performing loans were significantly reduced during 2005 as a result of sales and charge-off5 of commercial credits. This also reduced the amount of the allowance for loan losses allocated to commcrcial loans. There are no niatcrial concentrations by industry within the nonperforniing loans. FINANCJAI, CONDJTJON - SUMMARY F I R S T F I N A N C I A L C O R P O R A T I O N An element of the Corporation’s asset qiialiry management process is the ongoing review and grading of each afftliatc’s comniercial loan portfolio. At December 3 1, 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 compxes to $56.5 million in 2004, which included $18.7 million o f non-performing loans. The classifica- tion of these loms, 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. kiowever, for reasons such as previous paymenr history, bank- ruptcy proceedings, industry concerns or inforniation specific to that borrower, it is the opinion of management that these loans require close monitoring. DEPOSITS T h e inforrnation below presents the average amoiint of deposits and rates paid on those deposits for 2005, 2004 and 2003. (Dollar ammints in thousands) Non-interest-bearing demand deposits Interest-bearing demand deposits Savings deposits Ti me dcposits: $100,000 or more Other time deposits TUTAL 2005 2004 2003 Amount Rate Amount Rate Amount Rate $ 153,027 294,344 392,79 1 .77% 1.2 1% $ 150,944 259,859 392,635 $ 177,712 231,590 357,989 .50% .650/0 185,436 3.11% 3.11% 457,685 $1,483,283 163,890 2.86% 478,706 3.04% $1,446,034 197,946 517,364 $1,482,601 .63% .8O% 2.87% 3.27% ‘I’he maturities of certificates of deposit of $100 thousand or more outstanding at December 3 I , 2005, are summa- rized as follows: 3 months or less Over 3 through 6 months Over 6 through 12 nioiiths Over 1 2 months ‘I’O‘I’AL $ 28,602 22,3 12 22,675 1 15,304 $189,493 FINANCIAL CONDITION SUMMARY ~ 2 0 0 5 A N N U A L R E P O R T OTHER BORROWINGS Advanccs from thc Federal Home Loan Bank decreased to $337.3 million in 2005 compared to $337.9 million in 2004. The Assct/T,iabiIity Cotnniittce reviews these investments and funding sources and considcrs the rclatcd strate- gies on a weekly basis. See Interest Rarc Sensitivity and Liquidity below for more information. CAPITAL RESOURCES Rank regulatory agencies have established capital adequacy standards which are used extensively in their monitor- ing and control of the industry. These standards relate capital to level of risk by assigning different weiglitings to asscts and ccrtain off-halancc-shcct activity. As shown in the footnote to the consolidated financial staternenrs (“Regulatory Matters”), the Corporation’s capital exceeds the requirements to be considered well capitalized a t December 3 1, 2005. First Financial Corporation’s objective continues to be to maintain adequate capital to merit the confidence of its customers arid shareholders. To warrant this confidence, the Corporation’s managcmcn t maintains a capital posi- tion which they believe is suflkient to absorb unforeseen financial shocks without urineccssarily restricting divi- dends to its shareholders. ‘l’he Corporation’s dividend payout rdtio for 2005 and 2004 was 47.6% and 38.1 Yo, respectively. T h e Corporation expects to continue its policy of paying regular cash dividends, subject to fiiturc earnings and regulatory restrictions and capital requirements. INTEREST RATE SENSITIVITY AND LIQUIDIN First Financial Corporation has established risk measures, limits and policy guidelines for managing interest rate risk and liquidity. Responsibility for nianagernent of these functions resides with the Asset Liability Committee. Thc pri- mary 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 tlie 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 o n tlie effective rrianagement of this risk. T h c Assct Liability position is rneasurcd using sophisticated risk tnariagemerit tools, including carnings simulation and markct value of equity sensitivity analysis. These tools allow rnanagernent to qiiantify and monitor both short- and long-term exposure to interest rate risk. Simulation modeling measures the effects of changes in interest rates, changcs in the shape of thc yicld ciirvc and the effects of embedded options on net intercst income. This mcasurc prnjccts earnings in thc various environments over the next three years. It is important to notc t h a t measures of interest rate risk have limitations and arc dcpendcnt on various assumptions. Thcsc assumptions arc inhcrently uncertain and, as a result, thc modcl cannot preciscly prcdict thc impact of intcrcst ratc fluctuations on nct intcrcst income. Actual results will diffcr from simulatcd rcsults duc to titning, frcqucncy and amount of intcrcst ratc changes as well as overall markct conditions. The Comrnittcc has performed a thorough analysis of thcsc assump- tions and hclicvcs them to be valid and theoretically sound. These assumptions are continuously monitored for behavioral changcs. The Corporation from time to time utilizes derivatives to manage intcrcst rate risk. Management continuously eval- uates the merits o f 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 xs of December 3 1, 2005. T h e change in interest rates assunies a parallel shift in interest rates of IO0 and 200 basis points. Given a I O 0 basis point increase in rates, net interest income would decrease 3 2 % 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 decreasc 5.77% over thc following 12 months. Thesc cstitiiates assume all rate changes occur overnight and management takes no action as a result of this change. FINANCIAL C O N D I T I O N - SUMMARY F l R S T F I N A N C I A L C O R P O R A T I O N Basis Point Interest Rate Change Down 200 Down 100 u p 100 u p 200 Percentage Change In Net Interest Income 12 months -6.22% -2.89 -0.32 -5.44 24 months -1 2.1 1 Yo -5.77 2.26 -0.63 36 months -1 7.45% -8.50 5.14 5.36 I , Iypical rate shock analysis does not reflect management’s ability to rcact and thereby reduce thc effccts of rate changes, and represents a worst-case scenario. Liquidity Risk: Liquidity is measured by each bank’s ability to raisc funds to incct thc obligations of its customcrs, including deposit withdrawals and credit nccds. This is accomplished primarily by maintaitiitig sufficient liquid assets in the form of invcstmen t securities and core deposits. T h e Corporation has $14.3 million of investments that tnaturc throughout the coming 12 months. T h e Corporation also anticipates $71.3 million of principal pay- ments 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 T h e Corporation has various financial obligations, including contractual obligations and commitments, that may require future cash paymcnts. Contractual Obligations: The following tahlc prcscnts, as of Dcccmber 3 1 , 2005, significant fixed and determinable contractual obligations to third partics by payment date. Further discussion of the nature of each obligation is included in the referenced notc to the consolidated financial statements. (Dollar amounts in thousands) Deposits without a stated maturity Consumer certificatcs of dcposir S ho rt- term borrowings Other borrowings Note Reference OneYear or Less Oneto Three to Three Years Fhre Years Over Five Years Total Pavments Due In $823,190 $ 348,575 26,224 8,665 - $ - $ 242,488 - 53,398 50,233 - 280,5 10 - $823,190 641,728 26,224 343,866 432 - 1,293 10 11 Commitments: The following table details the amount and cxpccted tnaturities of significant commitments AS of December 31, 2005. Further discussion of these conimitments is included in Note 1 3 to the consolidated financial statements. (Ljollar amounts 111 ihousxrids) Cornmitments to extend credit: Unused loan commitments Commercial letters of credit Total Amount One Year or Less Committed Over One Year $270,017 $144,962 6,933 6,333 $1 25,055 - Committnents to extend credit, including loan commitments, standby and commercial letters of credit do not necessarily represent fiiture cash requirements, in that thcsc coniniitnicnts often expire without heing drawn upon. OUTLOOK T h e Corporation’s primary market is west-central Indiana and east-central Illinois. Typicdly, this market does not expand or contract at rates that are experienced by both thc state and national economies. This area continues to be driven primarily by the retail, higher education and hcalth care industries. During 2005 the area’s employment data werc mixed. Em-central lllinois generally experienced falling unemployment rates whilc wcst-central Indiana experienced rising rates. A number of projects remain under development; howcvcr, there are limited significant growth opportunities currently available. CONSOLIDATED BALANCE SHEET - AVERAGE BALANCES A N D INTEREST RATES 2 0 0 5 A N N U A L REPORT (nollar afiioufits i f i thousands) Average Balance Interest Yield/ Rate Average Balance interest Meld/ Rate Average Balance Interest Meld/ Rate 2005 December 31, 2004 2003 ASSETS Intcrcst-carning assets: ( 2 ) 96,357 6.73% $1,452,572 Loans (1) ‘1’:mbIc invcsunient securities 16,802 4.39 402,063 ‘l’ax-cxcrnpt investments (2) 12,248 7.1 3 182,727 Federal f~inds sold 496 3.60 2,628 I’otal intcrcst-carning assets 2,014,090 126,503 6.28% 2,039,990 122,467 6.00% 2,041,579 130,269 6.38% -- 93,128 6.41% $1 ,417,026 15,315 3.81 416,403 13,374 7.65 203,021 50 1.30 5,129 98,565 6.96% 15,714 3.77 15,938 7.85 52 .99 $1,441,247 387,269 171,802 13,772 Non-interest earning assets: Cash and duc from banks Premises and equipment, net Other assets Less dlowance for loan losscs Tc SI’AI s 74,005 30,720 62,779 ( I 8,298) $2,163,291; 77,443 30B I O 66, 1 77 (22,052) $2,132,168 80,261 29,634 63,753 (22,242 ) $2,132,385 LIABILITIES AND SHAREHOLDERS’ EQUITY Interest-bcaring liabilities: ’ I ’ransaction accounts T i m e deposits Short-tcrm borrowings Other borrowings Total intei-est-hearing liabilities: Non interest-bearing liabili tics: Demand dcposiis 0 ther $ 687,135 643,121 25,766 356,728 7,031 1.02%) $ 652,494 642,596 71,926 376,600 20,153 3.13 783 3.04 19,502 5.47 3,872 19,823 3.08 1,017 1.41 19,974 5.30 .59%) $ 589,579 715,310 35,262 332,540 .73% 4,315 22,610 3.16 431 1.22 20,869 5.32 -~ 1,712,750 47,469 2.77% 1,743,616 44,686 2.560/0 1,732,631 48,225 2.78% -- 153,027 26,942 1,892,719 Shareholders’ equity TOTALS 270,577 $2,163,296 150,944 29,5 1 9 1,924,079 268,089 $2,192,168 177,712 30,441 1,940,844 252,14 1 $2,192,985 Net interest eai-nings $ 79,034 $ 77,781 $ 82,044 Nct yicld on interest-earning assets 3.92940 3.81% 4.02% (I) For prposcs of these computations, rionaccruing loans are includcd in the daily average loan amounts outstanding. ( 2 ) Intcrest income includes thc cffect of tax equivalent adjustrnents using a federal tax late of 35%. F I R S T F I N A N C I A L C O R P O R A T I O N MARKET AND DIVIDEND INFORMATION At year-end 2005 shareholders owned 13,373,570 shares of the Corporation’s common stock. T h e stock is traded over-the-counter under the NASDAQ National Market System with the symbol THFF. Such over-the-counrer market qiiotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. 1. iistorically, 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 Dividends Low Declared C)uartcr cndcd March 31 June 30 September 30 December 3 I High $34.48 $29.57 $3 1.99 $28.29 $29.55 $25.39 $25.70 $25.75 $ .40 $ .42 Trade Price High Low Cash Dividends Declared $31.49 $32.43 $32.9 1 $37.07 $28.50 $27.81 $30.38 $30.72 $ .39 $ .40 2 0 0 5 A N N U A L R E P O R T DIRECTORS William F. Mcehling A ttorricy-at-Law George T. Mitchell, M.D. General Practitioner Norrnan P. Yeley Farmer In Memoriam Flrst Financial Bank Cltlzens Region Henry J. Antonini Attorney-at-Law Michael A. Carty Senior Vice President First Financial Bank Robert DeVerter Owner DcVcrter Brothers Funeral Home Scott McCullougli Vice Prcsidcrrt First Financial Rarilc Danny 1;. Wesch Farmer Tcrri Williamson Vicc Prcsident Rrarison Insurance Agency Flrst Financial Bank Sulllvan Region Thomas s. Clary Senior Vice President & Chief Credit Officer First Financial Ranlc Robert F. 1)ukcs Educator, Retired Henry Smith General Manager 500 Express Robert E. Springcr Attorney-at-Law V. Bruce Walkup Community Ptrsiclent Flrst Financial Bank Parke Region J;inics R. Bosky Community l’residen t Michacl A. Carty Senior Vice President First Financial Rank Thorrras S. Clary Scnior Vire President & CIhicf Credit Officer First Financial Rank Clrarles A. Cooper President, Ketired First Parke State Bank Larry Schopnieyer pa Forrest Sherer, Inc. J . Barton Douglas Vice President, Surety Forrest Sherer, Inc. Norman I.. 1,owcry President tcr CEO First Financial Rank Jo111r S. I,UIWIS Executive Vice President &L Chief Operating Office Forrest Sherer, Inc. Dennis S. Michael Ketired Forrest Shrrrr, Inc. Donald I,. Miller Vice Prcsidcn I , Ad ni i n istra ti o n , 8r Chief Financial Officcr Forrest Sherer, Inc. Jerry K. Mueller Ketired Forrrst Sherer, lnc. Robert F. l’rox 111 Senior Vice President, Commercial Insurance Ibrrest Shrrrr, Inc. F I R S T A N K I N G C E N T E R L O C A T I O N S First Financial Bank N.A. Vlgo County Terre Haute Main Of%ce* Onr First Financial Plaza Sixth & W,tbasli 8 1 2-238-6000 Honey Creek Mall* U.S. 41 South 812-238-6000 Indiana State University" H ul nian M crnori al U t i io ti 8 12-238-6000 Illdustrial Park* 1749 East Tndwtrial Drive 8 1 2-238-6000 M ~ p l e Aveiiiie* 4065 Maplc A V C I ~ L ~ C 81 2-238-6000 M e d o w s * 350 South 25th Street 8 12-238-6000 Plaza Norih* I:[. Harrisori &L 1,afiiyette 8 1 2-238-6000 Seelyville" 9520 East U.S. 40 8 12-238-6OOO Southland* 3005 Souih Seventh Street 8 1 2-238-6000 Spi-inghill" 4500 U.S. 41 South 8 12-238-6000 Wrst Terre I IaLm* 309 National Avcnitc 812-238-6000 Wcst i n i n s tcr Vi I I age 1 120 East Lhvis Drive 81 2-2.38-6000 The Morris Plan Company of Terre Haute 817 Wahash Avenue 81 2-2.38-606.3 First Financial Bank N.A. Clay County Brazil* 7995 North State Iload 59 8 1 2-44.3-448 1 Brazil Downtown* 18 North W h i t 812-448-3357 Brazil Eastside* 2 180 East Natioiial Avenue 8 1 2-448-81 1 0 Clay C i w 502-504 Main Street 81 2-939-2115 Poland" 8490 East State Road 42 8 12-986-2 1 1 5 First Financial Bank N.A. Greene County Worthington* 3 North Commercial Street 812-875-3021 First Financial Bank N.A. Knox County Monroe City* 201 West 1;irst Street 812-743-5151 Sandborn 102 North Anderson Strcct 8 12-694-8462 Vincennes* 2707 North Sixth Sireet 81 2-882-4800 First Financial Bank N.A. Parke County Rockville* 131 I North Lincoln Road 765-563-31 71 Roclwille Downtown* 120 East Ohio Street 765-569-3442 Marshall 10 South Main Strcct 765-537-2261 Montezuma* 232 East Crawford Street 765-215-2706 Rosedale 62 List Centid Street 765-548-2266 Flrst Flnanclal Bank N.A. Sulllvan County Sullivan* 15 South Mdjn Street 8 12-268-333 I Carlisle" 8571 Old US 41 South 81 2-338-41 00 Dugger 81 00 l-,aqi M.iiti Street 81 2-648-2251 Farmersburg 819 West Main Street 8 1 2-636-2 1 06 Hymera 102 South Main Strrrt 8 1 2-383-4933 First Financial Bank N.A. Vermillion County Newpore 100 Wcst Market Strcct 765-432-3321 Cayuga 2 I 1 Curtis Street 765-492-339 1 Clinton* 221 South Main Sircer 765-832-3504 Clinton Crown Hill* 1775 Fdst State Road 163 765-832-5516 First Financial Bank N.A. Clark County Marshall* 21 5 North MiLhigan 21 7-826-63 11 First Financial Bank N.A. Coles County Charleston* 820 West Lincoln Avcnuc 217- 345-4824 First Financial Bank N.A. Crawford County Robinson* 108 Wcst Main Strcci 6 18-544-8GOO Robinson Motor Bank* (Llrive-'l'hrough Only) 602 Wcst Walnui Slreet 61 8-544-3355 Oblong* 301 F a M ~ i n Street 6 18-592-4252 First Financial Bank N.A. Jasper County Newton" h01 Wcst Jourd%iri Street 61 8-783-2022 First Financial Bank N.A. Lawrence County Lawrenceville* 1601 Stxe Street 6 1 X-943-3323 Sumncr 21 1 South Chiisty G 1 8-936-232 1 Flrst Financial Bank N.A. Richland County Olney* 240 l+ai (3iestriut Street 61 8-395-8676 Olnef 1 1 I O South Wcst Strcct 618-395-21 12 First Financlal Bank N.A. Vermlllon County Ridge Farm* 1 1 South Stdte Strrrt 2 17-247-2 126 First Financlal Bank N.A. Wayne County Fair field* 303 West DelaWLirc 6 1 8-842-2 145 *FirstPlus 24-hour A'I'M availahlc a t these locations FIRST FINANCIAL CORPORATION ONE FIRST FINANCIAL PLAZA TERRE HAUTE, INDIANA 47807 812-238-6000 -.first-online.com