10-Q 1 p17913_10q.txt QUARTERLY REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the period ended September 30, 2003 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from ____________________ to ____________________ Commission File Number : 0-12499 First Financial Bancorp ----------------------- (Exact name of registrant as specified in its charter) California 94-28222858 ---------- ----------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 701 South Ham Lane, Lodi, California 95242 -------------------------------------- ----- (Address of principal executive offices) (Zip Code) (209) 367-2000 -------------- (Registrant's telephone number, including area code) NA (Former name, former address and former fiscal year, if changed since last report.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. [ X ] Yes [ ] No Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). [ ] Yes [ X ] No As of October 31, 2003 there were 1,621,104 shares of Common Stock, no par value, outstanding. ================================================================================ FIRST FINANCIAL BANCORP FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2003 TABLE OF CONTENTS Page ---- PART I Item 1. Financial Statements ............................................... 1 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations .............................................. 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk ......... 17 Item 4. Controls and Procedures ............................................ 17 PART II Item 1. Legal Proceedings .................................................. 18 Item 2. Changes in Securities and Use of Proceeds .......................... 18 Item 3. Defaults Upon Senior Securities .................................... 18 Item 4. Submission of Matters to a Vote of Security Holders................. 18 Item 5. Other Information .................................................. 18 Item 6. Exhibits and Reports on Form 8-K ................................... 18 Signatures .................................................................. 19 Index to Exhibits ........................................................... 20 i ITEM 1. FINANCIAL STATEMENTS FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Balance Sheets (Unaudited) (in thousands except share amounts) Sept. 30, Dec. 31, Assets 2003 2002 -------- -------- Cash and due from banks $ 18,030 $ 14,988 Federal funds sold and securities purchased under resale agreements 2,709 19,634 Investment securities available for sale, at fair value 68,650 33,125 Loans held for sale 5,610 7,578 Loans, net of deferred loan fees 171,806 157,147 Less allowance for loan losses 3,264 3,057 -------- -------- Net loans 168,542 154,090 Premises and equipment, net 6,632 6,745 Accrued interest receivable 1,247 772 Other assets 18,527 18,314 -------- -------- Total Assets $289,947 $255,246 ======== ======== Liabilities and Stockholders' Equity Liabilities: Deposits: Noninterest bearing $ 42,416 $ 34,673 Interest bearing 217,545 176,006 -------- -------- Total deposits 259,961 210,679 Accrued interest payable 185 144 Short term borrowings -- 14,885 Other liabilities 5,080 5,268 Obligated mandatorily redeemable capital securities of subsidiary trust 5,000 5,000 -------- -------- Total liabilities 270,226 235,976 -------- -------- Stockholders' equity: Preferred stock - no par value; authorized 1,000,000 shares; no shares issued and outstanding -- -- Common stock - no par value; authorized 9,000,000 shares; issued and outstanding in 2003 and 2002, 1,621,104 and 1,621,837, respectively 10,092 10,143 Retained earnings 9,564 8,672 Accumulated other comprehensive income 65 455 -------- -------- Total stockholders' equity 19,721 19,270 -------- -------- $289,947 $255,246 ======== ======== See accompanying notes. 1 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Statements of Income (Unaudited) (in thousands except per share amounts)

See accompanying notes. 2 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Statements of Stockholders' Equity and Comprehensive Income (Unaudited) (in thousands except share amounts) Nine Months Ended September 30, 2003

See accompanying notes. 3 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Consolidated Statements of Cash Flows (Unaudited) (in thousands) Nine Months Ended September 30,

See accompanying notes. 4 FIRST FINANCIAL BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements September 30, 2003 and December 31, 2002 (Unaudited) (1) Summary of Significant Accounting Policies First Financial Bancorp (the "Company") operates principally as a bank holding company for its wholly owned subsidiary, Bank of Lodi, N.A. (the "Bank"). The Bank is the principal source of income for the Company. The Company also holds all of the capital stock of its other subsidiaries, Western Auxiliary Corporation and First Financial (CA) Statutory Trust I. All references herein to the "Company" include the Bank and all other subsidiaries, unless the context otherwise requires. Basis of Presentation The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, the consolidated financial statements reflect all adjustments, including normal recurring adjustments, necessary for a fair presentation of the results for the interim periods. Certain amounts in the prior year have been reclassified to conform with the current presentation. These reclassifications have no effect on previously reported income. These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company's 2002 Annual Report on Form 10-K. Operating results for the three and nine month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. Stock Based Compensation In December 2002, the FASB issued Statement No. 148 ("Statement 148"), Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123. This statement amends Statement 123 to provide alternative methods of transition to a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, Statement 148 amends the disclosure requirements to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Statement 148 is effective for fiscal years ending after December 15, 2002, and for interim periods beginning after December 15, 2002. During the first quarter of 2003, the Company adopted the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation (SFAS No. 123), for stock-based compensation, effective as of January 1, 2003. Under the provisions of Statement 148, the Company has adopted the prospective method whereby stock-based employee compensation expense is recognized as awards are granted, modified or settled. 5 The following table presents the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period.

(2) Weighted Average Shares Outstanding Per share information is based on weighted average number of shares of common stock outstanding during each three and nine month period. Basic earnings per share (EPS) is computed by dividing net income available to shareholders by the weighted average common shares outstanding during the period. Diluted earnings per share is computed by dividing net income available to shareholders by the weighted average common shares outstanding during the period plus potential common shares outstanding. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. The following tables provides a reconciliation of the numerator and denominator of the basic and diluted earnings per share computation for the three and nine month periods ending September 30, 2003 and 2002: Income Shares Per-Share Three months ended September 30, 2003 (numerator) (denominator) Amount ------------------------------------------------------------------------------ Basic earnings per share $ 191,000 1,626,893 $.12 Effect of dilutive securities -- 114,770 -- --------- --------- Diluted earnings per share $ 191,000 1,741,663 $ 11 ========= ========= Income Shares Per-Share Three months ended September 30, 2002 (numerator) (denominator) Amount ------------------------------------------------------------------------------ Basic earnings per share $ 612,000 1,642,422 $.37 Effect of dilutive securities -- 55,626 -- --------- --------- Diluted earnings per share $ 612,000 1,698,048 $.36 ========= ========= 6 Income Shares Per-Share Nine months ended September 30, 2003 (numerator) (denominator) Amount ------------------------------------------------------------------------------ Basic earnings per share $ 892,000 1,628,906 $ .55 Effect of dilutive securities -- 93,131 -- ---------- ---------- Diluted earnings per share $ 892,000 1,722,037 $ .52 ========== ========== Income Shares Per-Share Nine months ended September 30, 2002 (numerator) (denominator) Amount ------------------------------------------------------------------------------ Basic earnings per share $1,090,000 1,648,865 $ .66 Effect of dilutive securities -- 56,116 -- ---------- ---------- Diluted earnings per share $1,090,000 1,704,981 $ .64 ========== ========== (3) Investment Securities During the three month period ending September 30, 2003, interest income for investment securities was reduced as a result of accelerated prepayments of mortgage backed securities and collateralized mortgage obligations (MBS/CMO) combined with the impact from general declines in interest rates. As a result of the accelerated prepayments, the Company was required to accelerate the amortization of premiums paid to purchase MBS/CMO securities. (4) Allowance for Loan Losses The following summarizes changes in the allowance for loan losses for the nine month periods ended September 30, 2003 and 2002 and the twelve month period ended December 31, 2002: (in thousands) 9/30/03 9/30/02 12/31/02 ------- ------- ------- Balance at beginning of period $ 3,057 2,668 2,668 Loans charged off (134) (146) (270) Recoveries 29 30 34 Provisions charged to operations 312 538 625 ------- ------- ------- Balance at end of period $ 3,264 3,090 3,057 ======= ======= ======= (5) Impact Of Recently Issued Accounting Standards In January 2003, the FASB issued FIN 46, which clarifies the application of Accounting Research Bulletin ("ARB") 51, consolidated financial statements, to certain entities (called variable interest entities) in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The disclosure requirements of this Interpretation are effective for all financial statements issued after January 31, 2003. The consolidation requirements apply to all variable interest entities created after January 31, 2003. The interpretation's effective date was postponed from June 30, 2003 to December 31, 2003 and requires existing variable interest entities to be consolidated if those entities do not effectively disburse risks among parties involved. Management does not expect this Interpretation to have a material impact to the consolidated financial statements. In May of 2003, the FASB issued Statement No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The provisions of this Statement are effective for financial instruments entered into or modified after May 31, 2003, and otherwise are effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before May 15, 2003 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. Management does not expect this Statement to have a material impact to the consolidated financial statements upon adoption of the Statement on July 1, 2003. 7 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION Cautionary Statement for the Purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Certain statements in this Quarterly Report on Form 10-Q include forward-looking information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are subject to the "safe harbor" created by those sections. These forward-looking statements involve certain risks and uncertainties that could cause actual results to differ materially from those in the forward-looking statements. Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations, are generally identifiable by the use of words such as "believe", "expect", "intend", "anticipate", "estimate", "project", "assume," "plan," "predict," "forecast" or similar expressions. These forward-looking statements relate to, among other things, expectations of the business environment in which the Company operates, projections of future performance, potential future performance, potential future credit experience, perceived opportunities in the market, and statements regarding the Company's mission and vision. The Company's actual results, performance, and achievements may differ materially from the results, performance, and achievements expressed or implied in such forward-looking statements due to a wide range of risks and uncertainties. Such risks and uncertainties include, but are not limited to, the following factors: competitive pressure in the banking industry; changes in the interest rate environment; general economic conditions, either nationally or regionally becoming less favorable than expected and resulting in, among other things, a deterioration in credit quality and an increase in the provision for possible loan losses; changes in the regulatory environment; monetary and fiscal policies of the U.S. Government; changes in real estate valuations; changes in business conditions; volatility of rate sensitive deposits; operational risks, including data processing system failures or fraud; asset/liability matching risks and liquidity risks; civil disturbances or terrorist threats or acts or apprehension about the possible future occurrences of acts of this type; and changes in the securities markets. In addition, other events have increased the uncertainty related to the national and California economic outlook and could have an effect on the future operations of the Company or its customers, including borrowers. The Company does not undertake, and specifically disclaims any obligation, to update any forward-looking statements to reflect occurrences or unanticipated events or circumstances after the date of such statements. Critical Accounting Policies and Estimates The Company's discussion and analysis of its financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, income and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to the allowance for loan losses, other real estate owned, investments and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements. The Company maintains an allowance for loan losses resulting from the inability of borrowers to make required loan payments. If the financial conditions of the Company's customers were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. The Company invests in debt and equity securities. If the Company believes these securities have experienced a decline in value that is other than temporary, an investment impairment charge is recorded. Future adverse changes in market conditions or poor operating results of underlying investments could result in losses or an inability to recover the carrying value of the investments that may not be reflected in an investment's carrying value, thereby requiring an impairment charge in the future. The following discussion addresses information pertaining to the financial condition and results of operations of the Company that may not be otherwise apparent from a review of the consolidated financial statements and related footnotes. It should be read in conjunction with those statements and notes found on pages 1 through 7, as well as other information presented throughout this report. 8 Summary The Company recorded net income totaling $892 thousand for the nine month period ended September 30, 2003, representing a decrease of $198 thousand or 18.2% over net income of $1,090 thousand for the same period in 2002 and had net income of $191 thousand for the three month period ended September 30, 2003, representing a decrease of $421 thousand or 68.8% over net income of $612 thousand for the same period in 2002. Included in net income during the nine month period ending September 30, 2002 were gains on the sale of investment securities totaling $603 thousand. During the same period in 2003, gains on the sale of investment securities totaled $88 thousand, a reduction of $515 thousand from the prior year. Additionally, during the nine month period ending September 30, 2003, the Company incurred unanticipated costs totaling $158 thousand in response to disruptive actions initiated by three dissident directors. During the third quarter of 2002, the Company reported gains on the sale of investment securities totaling $341 thousand. The Company did not sell any securities during the third quarter of 2003. In addition, during the third quarter of 2003, the Company incurred unanticipated costs totaling $64 thousand in response to disruptive actions initiated by three dissident directors. Additionally, on September 2, 2003 the Company opened a new full service branch in downtown Sacramento, adding its ninth full service branch. The addition of the Downtown Sacramento Branch further enhances the Company's ability to market within the greater Sacramento Area, adding to the existing Sacramento area branches which are located in Elk Grove and Folsom. Changes in Financial Condition Consolidated total assets as of September 30, 2003 were $290 million, which represents an increase of $34,701 thousand, or 13.6% above the amount reported at December 31, 2002. The increase in total assets was attributable to a $49,282 thousand, or 23.4% increase in total deposits net of a decrease in short term borrowings totaling $14,885 thousand, or 100.0% since December 31, 2002. During the first nine months of 2003, the growth in deposits resulted primarily from an increase of $41,539 thousand, or 23.6% in interest bearing deposits combined with a $7,743 thousand or 22.3% increase in non-interest bearing deposits. The interest bearing deposit growth consisted of an increase of $19,637 thousand, or 35.3%, $9,996 thousand, or 33.0%, $6,722 thousand, or 17.0%, and $5,184 thousand, or 10.2% in certificates of deposit, money market accounts, savings accounts and NOW accounts, respectively. The increase in total assets included an increase of $35,525 thousand, or 107.2%, in investment securities, an increase totaling $12,631 thousand, or 7.6%, in gross loans combined with a $16,925 thousand, or 86.2%, decrease in federal funds sold as compared to December 31, 2002. The net increase in gross loans is primarily the result of increases of $8,643 thousand, or 13.7%, $4,058 thousand, or 28.4%, and $2,896 thousand, or 10.9%, in real estate loans, agricultural loans, and commercial loans, respectively, combined with a decrease of $1,198 thousand, or 5.8%, in construction loans. Allowance for Loan Losses The allowance for loan losses (the "allowance") is established through a provision for possible loan losses charged to expense. The allowance at September 30, 2003 was in excess of the December 31, 2002 allowance by $207 thousand, or 6.8%, as a result of a provision of $312 thousand combined with net charge-offs of $105 thousand. During the first nine months of 2003, nonperforming loans decreased by $49 thousand, to $2,360 thousand. Management continues to actively work to resolve the nonperforming loans, the majority of which are secured by real estate and, in the opinion of management, are well collateralized. Management believes that the allowance at September 30, 2003 is adequate to absorb known and reasonably estimated loan losses. However, there can be no assurances that future economic events may not negatively impact the Bank's borrowers, thereby causing loan losses to exceed the current allowance. The following tables depict activity in the allowance for loan losses and allocation of reserves for and at the nine and twelve months ended September 30, 2003 and December 31, 2002, respectively: 9 Nine Months Ended Year Ended September 30, December 31, 2003 2002 ------- ------- Balance at beginning of period $ 3,057 $ 2,668 Charge-offs: Commercial (88) (178) Real estate -- (62) Consumer (46) (30) ------- ------- Total charge-offs (134) (270) Recoveries: Commercial 25 26 Real estate -- -- Consumer 4 8 ------- ------- Total recoveries 29 34 ------- ------- Net charge-offs (105) (236) Provision charged to operations 312 625 ------- ------- Balance at end of period $ 3,264 $ 3,057 ======= ======= Allocation of the Allowance for Loan Losses

Investments Investment securities increased $35,525 thousand, or 107.2%, from December 31, 2002 to September 30, 2003. This increase resulted from the purchase of investment securities totaling $62,474 thousand net of prepayments on mortgage-backed securities totaling $24,149 thousand and sales of investment securities totaling $1,056 thousand. The Company realized gross gains totaling $88 thousand on the sale of investment securities during the first quarter of 2003. Equity Consolidated equity increased $451 thousand from December 31, 2002 to September 30, 2003. Consolidated equity represented 6.80% and 7.55% of consolidated assets at September 30, 2003 and December 31, 2002, respectively. The increase in equity during 2003 resulted from earnings of $892 thousand for the nine months ended September 30, 2003 and $101 thousand in cash received on the exercise of stock options combined with reductions to equity totaling $152 thousand resulting from stock repurchases and a $390 thousand decline in the after-tax market value of the available-for-sale investment securities portfolio. The decline in the investment security portfolio's market value resulted from gains realized on the sale of investment securities combined with the effects of changes in interest rates at September 30, 2003 compared to December 31, 2002. The total risk-based capital ratio for the Company's wholly owned subsidiary, Bank of Lodi was 10.98% at September 30, 2003 compared to 11.16% at December 31, 2002. 10 Changes in Results of Operations - Three and Nine Months ended September 30, 2003 Summary of Earnings Performance

11 Net Interest Income The following tables provides a detailed analysis of the net interest spread and net interest margin for the periods indicated:

(1) Yield for period annualized on actual number of days in period and based on a 365-day year. (2) Income on tax-exempt securities has not been adjusted to a tax equivalent basis. (3) Nonaccrual loans are included in the loan totals for each period; however, only collected interest on such loans is included in interest income. During the first nine months of 2003, net interest income increased $433 thousand, or 5.8%, over the same period of 2002. The increase is the result of increases in volumes of earning assets and liabilities combined with the effects of decreases in the yield on average earning assets and in the cost of funding average earning assets. An increase in net interest income totaling $1,243 thousand resulted from the increase in volumes of average earning assets and liabilities while the decline in interest rates resulted in a decrease in net interest income totaling $810 thousand when comparing the first nine months of 2003 to 2002. 14 During the first nine months of 2003, average earning assets increased $31,319 thousand when compared to the same period of 2002. Average loans increased $17,275 thousand, federal funds sold increased $2,375 thousand, and investment securities increased $11,669 thousand. The September 30, 2003 year-to-date increase in the volume of average earning assets resulted in an increase in interest income totaling $1,459 thousand when compared to the September 30, 2002 year-to-date figures. However, interest rates on average earning assets declined 110 basis points (from 6.98% to 5.88%) when compared to the same period in 2002, resulting in a decrease in interest income totaling $1,704 thousand. In addition, during the first nine months of 2003, interest income for investment securities was reduced as a result of accelerated prepayments of mortgage backed securities and collateralized mortgage obligations (MBS/CMO) combined with the impact from general declines in interest rates. As a result of the accelerated prepayments, the Company was required to accelerate the amortization of premiums paid to purchase MBS/CMO securities. During the first nine months of 2003, the Company received proceeds from prepayments of MBS/CMO totaling $24,149 thousand versus proceeds totaling $9,597 thousand during the same period in 2002. As a result of increased liquidity during the third quarter of 2003 (resulting primarily from increased deposits combined with the proceeds from prepayments of MBS/CMO), the Company purchased $62,474 thousand in investment securities. The purchases represent an increase of 189% in the balance of investment securities owned by the Company at December 31, 2002. These securities were purchased with a weighted average yield of 2.56% and a weighted average life of 3.03 years. At September 30, 2003, the investment securities portfolio is projected to yield 2.24% with an average life of 3.05 years. While the direction of future interest rates and the prepayment pattern of MBS/CMO is uncertain, management does not anticipate the accelerated level of prepayments experienced during the third quarter of 2003 to continue throughout the remainder of the year. Average liabilities increased $27,241 thousand during the first nine months of 2003 as compared to the same period of 2002. Of that increase, average noninterest bearing deposits increased $6,677 thousand, NOW and money market accounts increased $11,657 thousand, savings accounts increased $7,545 thousand, certificates of deposit increased $2,900 thousand while other borrowings decreased $1,538. An increase in interest expense totaling $216 thousand resulted from the increased volume in average liabilities. As a result of the decline in interest rates from 2003 to 2002, the cost of interest bearing liabilities decreased 56 basis points (from 1.70% to 1.14%) resulting in a reduction in interest expense totaling $894 thousand. Nonaccrual loan activity also affects interest income. Interest forgone or reversed on nonaccrual loans during the first nine months of 2003 was approximately $251 thousand and approximately $76 thousand for the third quarter of 2003. Interest was collected on nonaccrual loans for the first nine months of 2003 and for the third quarter of 2003 in the amount of $35 thousand and $9 thousand, respectively. Provision for Loan Losses The provision for loan losses for the three and nine months ended September 30, 2003 was $0 and $312 thousand compared with $162 and $538 thousand for the three and nine months ended September 30, 2002. Though the Company reduced the provision for loan loss (when compared to the prior year three and nine month periods) the allowance for loan losses has remained consistent as a percentage of total loans. As of September 30, 2003 the allowance for loan losses was $3,264 thousand or 1.8% of total loans, which compares to the allowance for loan losses of $3,057 thousand or 1.8% of total loans as of December 31, 2002. As of September 30, 2003, nonperforming loans totaled $2,360 thousand or 1.3% of total loans compared to $2,409 thousand or 1.5% at December 31, 2002. No assurance can be given that nonperforming loans will not increase or that the allowance for loan losses will be adequate to cover losses inherent in the loan portfolio. Also see "Allowance for Loan Losses" contained herein. Noninterest Income Noninterest income for the three and nine months ended September 30, 2003 decreased by $327 thousand, or 23.1%, and $197 thousand, or 5.5%, when compared to the same periods in 2002. The decreases are primarily the result of reductions in the gains realized on the sale of investment securities totaling $341 thousand and $515 thousand during the three and nine months ending September 30, 2003. During the third quarter of 2003, the Company did not sell any investment securities. During the third quarter of 2002, the Company realized gains on the sale of investment securities totaling $341 thousand. During the first nine months of 2003, the Company realized gains on the sale of investment securities totaling $88 thousand compared to $603 thousand for the same period of 2002. In addition, the Company realized gains from the sale of other real estate totaling $5 thousand and $16 thousand during the first nine months of 2003 and 2002, respectively. Income from the sale and servicing of loans totaled $448 thousand during the third quarter of 2003, which increased by $38 thousand, or 9.3%, compared to the prior year quarter. During the first nine months of 2003, income from the sale and servicing of loans totaled $1,315 thousand, an increase of $349 thousand or 36.1% over the same period of 2002. The decline in mortgage loan rates during 2002 and 2003 led to increased refinancing activity of residential mortgage loans resulting in increased income from the sale and servicing of those loans. The income recognized on the cash surrender value of life insurance decreased $35 thousand and $89 thousand, during the third quarter and year to date for 2003, respectively, when compared to the same periods in 2002. The decrease was the result of an overall decline in interest rates in 2003 as compared to the same period in 2002. The income recognized from the increase in the cash 15 surrender value of life insurance is exempt from income taxes. The tax effective yield of the increase in the cash surrender value of the life insurance totaled 7.1% during the third quarter of 2003 as compared to 8.2% during the third quarter of 2002. For the first nine months of 2003, the tax effective yield totaled 6.8% as compared to 5.9% during the same period in 2002. Noninterest Expenses Noninterest expenses increased $253 thousand, or 8.2%, and $736 thousand, or 8.1%, when comparing the three and nine month periods ending September 30, 2003 to the same periods of 2002. Personnel expense increased $112 thousand, or 6.8% and $556 thousand, or 11.8% when comparing the three and nine month periods ending September 30, 2003 to 2002. This increase is primarily due to general merit increases for existing personnel combined with an increase in number of full time equivalent employees, from 122 at September 30, 2002 to 136 at September 30, 2003. Four of the additional full time equivalent employees were new hires for the Sacramento branch. The increase in the Company's mortgage origination activities has also led to increased sales commissions. When comparing the first nine months of 2003 to 2002, occupancy expense increased $31 thousand or 4.1% of which $20 thousand is due to increased taxes, insurance and utilities. Occupancy expense increased $18 thousand, or 6.6% when comparing the third quarter of 2003 to 2002. Equipment expense during the first nine months of 2003 decreased $9 thousand, or 1.4% when compared to 2002 and is due to a $17 thousand decrease in depreciation expense and a $7 thousand increase in equipment maintenance expense. During the third quarter of 2003, equipment expense decreased $45 thousand, or 17.9%, when compared to the third quarter of 2002. For the three and nine month periods ended September 30, 2003, other noninterest expense increased $168 thousand, or 18.4% and $158 thousand, or 5.4%, respectively, when compared to the same periods of 2002. Included in other noninterest expense during the three and nine month periods ended September 30, 2003 are costs totaling $64 thousand and $158 thousand associated with responding to the disruptive actions initiated by three dissident directors. Without this unanticipated expense, other noninterest expense would have increased $104 thousand, or 11.3% and would have been unchanged during the three and nine month periods during 2003 when compared to the same period in 2002. Income Taxes As a result of increases in tax exempt income combined with reduced taxable income, the Company's income tax provision for the third quarter of 2003 was $13,000 compared to a tax provision of $304,000 during the third quarter of 2002. For the first nine months of 2003, the provision for income taxes totaled $282,000 as compared to $358,000 during the same period last year. During the third quarter of 2003 the Company had an effective tax rate of 6.4% compared to 33.2% during the third quarter of 2002. For the first nine months of 2003, the Company's effective tax rate was 24.0% as compared to 24.7% for the same period in 2002. Liquidity The Company's primary sources of liquidity are the proceeds from the trust preferred securities combined with dividends from the Bank. The Company's primary uses of liquidity are associated with interest payments on the trust preferred securities, dividend payments made to shareholders and operating expenses. Loan demand, deposit fluctuations, and investment leveraging opportunities are affected by a number of factors, including economic conditions, seasonality of the borrowing and deposit bases, and the general level of interest rates; therefore, the Bank's liquidity is actively managed on a daily basis. The sale of loans, sale of investment securities and use of borrowing facilities are all employed to maintain cash, federal funds sold, and short-term investments at levels commensurate with estimated liquidity needs. The Bank maintains two lines of credit with correspondent banks and has reverse repurchase agreements with two brokerage firms, which allow for short-term borrowings that are secured by investment securities. Finally, the Bank may also borrow on a short-term basis from the Federal Reserve in the event that the aforementioned liquidity sources are not adequate. At September 30, 2003 liquidity was considered adequate given the funds available in the local deposit market, scheduled maturities of loans and investments, and the available capacity on borrowing facilities. Compared to 2002 liquidity decreased in 2003 primarily as a as a result of reductions in short term borrowings. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK While there are several varieties of market risk, the market risk material to the Company and the Bank is interest rate risk. Within the context of interest rate risk, market risk is the risk of loss due to changes in market interest rates that have an adverse effect on net interest income, earnings, capital or the fair value of financial instruments. Exposure to this type of risk is a regular part of a financial institution's operations. The fundamental activities of making loans, purchasing investment securities, and accepting deposits inherently involve exposure to interest rate risk. The Company monitors the repricing differences between assets and liabilities on a regular basis and estimates exposure to net interest income, net income, and capital based upon assumed changes in the market yield curve. As of and for the three and nine months ended September 30, 2003, there were no material changes in the market risk profile of the Company or the Bank as described in the Company's 2002 Form 10-K. ITEM 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures We carried out an evaluation, under the supervision and with the participation of our management, including our President and Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report, pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based on their review of our disclosure controls and procedures, the President and Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective in timely alerting them to material information relating to us that is required to be included in our periodic SEC filings. Internal Controls and Procedures There were no changes in our internal controls over financial reporting that occurred during our last fiscal quarter that has materially affected, or are reasonably likely to materially effect, our internal controls over financial reporting. 17 PART II -- OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Not Applicable. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not Applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not Applicable. ITEM 5. OTHER INFORMATION Not Applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The exhibit list required by this item is incorporated by reference to the Index to Exhibits filed as part of this report. (b) Reports on Form 8-K None. 18 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST FINANCIAL BANCORP By: /s/ Allen R. Christenson Date: November 12, 2003 ------------------------------- ----------------- Allen R. Christenson Senior Vice President Chief Financial Officer (Principal Accounting and Financial Officer) 19 INDEX TO EXHIBITS Exhibit Description ------- ----------- 31.1 Certification of Registrant's Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003 31.2 Certification of Registrant's Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2003 32.1 Certification of Registrant's Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 32.2 Certification of Registrant's Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 20

FIRST FINANCIAL BANCORP /CA/ 10-Q