FIRST COMMONWEALTH FINANCIAL CORP annual report, FY2021

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First Commonwealth Financial Corp. — 2021 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2021, with comparisons primarily to 2020. First Commonwealth is a Pennsylvania-based financial holding company providing consumer and commercial banking, wealth management and insurance services across Pennsylvania and Ohio. At year-end it operated 118 community banking offices and reported $9.5 billion in assets.

Financial performance and condition

  • Earnings: Net income was $138.3 million, or $1.44 per diluted share, compared with $73.4 million, or $0.75, in 2020. Return on average assets was 1.47% (0.82% in 2020) and return on average equity was 12.55% (6.82%).
  • Revenue and margins: Net interest income was $278.5 million, up $10.3 million. On a fully taxable-equivalent basis, net interest income was $279.6 million and net interest margin was 3.26%, down 6 basis points. Noninterest income increased 13% to $106.8 million; noninterest expense decreased 1% to $213.9 million. The effective tax rate was 20.0%.
  • Credit costs and asset quality: The provision for credit losses was a $1.4 million credit, versus $56.7 million of expense in 2020, mainly reflecting a more favorable economic forecast and lower expected pandemic-related losses. Net charge-offs declined to $8.4 million from $17.2 million. The allowance was $92.5 million, or 1.35% of loans, versus $101.3 million, or 1.50%. Nonperforming loans were $55.2 million, 0.81% of loans, compared with $54.1 million, 0.80%.
  • Balance sheet: Total assets were $9.55 billion; loans were $6.84 billion; deposits were $7.98 billion; and shareholders’ equity was $1.11 billion. Commercial real estate was 33% of loans. The net loans-to-deposits ratio was 84.52%, down from 89.53%.
  • Cash flow: Operating activities provided $165.0 million; investing activities used $565.3 million; and financing activities provided $439.1 million. Cash and cash equivalents ended the year at $395.4 million.
  • Debt and liquidity: Year-end short-term borrowings were $138.3 million; subordinated debentures were $170.8 million; other long-term debt was $5.6 million; and capital lease obligations were $5.9 million. The company reported substantial available borrowing capacity, including $982.1 million at the Federal Reserve and $1.9 billion at the FHLB, with little of that capacity drawn. The bank could pay $311.1 million in dividends to the parent without falling below well-capitalized levels or requiring state approval.
  • Capital returns: Dividends declared were $0.455 per share, up from $0.440. The company repurchased $31.3 million of stock during 2021. Regulatory capital ratios remained above well-capitalized thresholds; the bank’s CET1 ratio was 11.83% and total capital ratio was 14.26%.

Material changes versus 2020

  • Net income rose by $64.8 million, driven principally by the $58.1 million year-over-year reduction in credit-loss provision and increased net interest and noninterest income.
  • Deposits grew 7% to $8.0 billion, partly due to PPP proceeds and federal stimulus payments. Investment securities increased 33% to $1.60 billion.
  • Loans increased only 1% overall as $407.6 million of PPP loans were forgiven or repaid; year-end PPP balances fell to $71.3 million from $478.9 million. Residential real estate and consumer loans grew.
  • Net interest margin declined as lower asset yields outweighed the benefit of lower funding costs. Average earning assets grew 6%; average interest-bearing liability cost fell to 0.27% from 0.58%.
  • Accumulated other comprehensive income declined $26.0 million, largely reflecting unrealized losses on available-for-sale securities and derivatives.

Outlook, commentary and risks

  • The filing provides no quantified earnings or revenue guidance. Management describes objectives of franchise expansion, fee-income growth, internal growth and selective acquisitions. The equipment leasing and finance division, announced in 2021, became operational in the first quarter of 2022.
  • Management cited improved economic forecasts as the main reason for the credit-provision release, but cautioned that credit-loss estimates rely on uncertain assumptions and forecasts. COVID-related loan deferrals had fallen to $6.2 million at year-end from $1.4 billion in aggregate balances granted deferrals at the end of 2020.
  • Key risks include interest-rate and liquidity sensitivity, commercial real estate exposure, borrower credit deterioration, pandemic and economic uncertainty, cybersecurity and vendor disruptions, competition, regulatory change, and acquisition execution. The LIBOR transition remains relevant to existing loans, derivatives and debt; the company said it had stopped originating new LIBOR-linked contracts by year-end 2021.
  • At year-end, assets remained below $10 billion; management estimated that crossing that threshold would end the company’s interchange-fee-cap exemption and could reduce annual interchange income by about $13.8 million based on 2021 activity.
  • Legal proceedings were not expected to create material aggregate liability to consolidated financial position; reasonably possible losses beyond recorded amounts were estimated at $0–$1 million. Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. The allowance for credit losses was the audit’s critical audit matter.

Important facts for investors to verify

  • Whether credit quality and the allowance remain adequate as commercial real estate conditions, economic forecasts and loan performance evolve.
  • How deposit balances and funding costs change as stimulus- and PPP-related deposits normalize, and whether the bank’s interest-rate sensitivity assumptions match actual repricing behavior.
  • The investment portfolio’s duration and unrealized losses: available-for-sale securities had $13.7 million of gross unrealized losses, while year-end accumulated other comprehensive income was a loss of $8.8 million.
  • Progress on LIBOR-linked contract conversions and the effect of alternative reference rates on loan, derivative and debt cash flows.
  • Whether asset growth approaches $10 billion and the resulting effect on interchange income, regulatory requirements and business strategy.
  • The filing’s balance-sheet discussion contains an apparent inconsistency about short-term borrowings; the reported year-end balances show an increase to $138.3 million from $117.4 million.