First Commonwealth Financial Corporation — Q2 2020 Form 10-Q
Business context and period. This unaudited filing covers the quarter and six months ended June 30, 2020. First Commonwealth is a bank holding company. Results reflect the COVID-19 pandemic, lower interest rates, substantial Paycheck Protection Program (PPP) lending, customer deposit growth, and the 2019 acquisition of Santander branches. Unless stated otherwise, dollar figures below are in millions.
Financial results and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net income | $23.9 | $27.3 | $28.6 | $51.9 |
| Diluted EPS | $0.24 | $0.28 | $0.29 | $0.53 |
| Net interest income, GAAP | $66.7 | $67.1 | $134.4 | $132.6 |
| Provision for credit losses | $6.9 | $2.8 | $37.8 | $6.9 |
| Noninterest income | $21.8 | $21.9 | $41.1 | $40.8 |
| Noninterest expense | $52.8 | $52.2 | $103.0 | $102.0 |
- Margins and returns: Net interest margin was 3.29% in Q2 versus 3.75% a year earlier; six-month margin was 3.46% versus 3.75%. Return on average assets/equity was 1.06%/8.95% in Q2 and 0.66%/5.36% for the first six months.
- Balance sheet at June 30: Total assets were $9.36 billion, up from $8.31 billion at December 31, 2019. Portfolio loans were $6.92 billion, compared with $6.19 billion; deposits were $7.78 billion, compared with $6.68 billion. Shareholders’ equity was $1.08 billion.
- Credit and debt: The allowance for credit losses was $81.4 million, or 1.18% of loans, versus $51.6 million, or 0.83%, at year-end. Nonperforming loans were $56.0 million (0.81% of loans), up from $32.2 million. Short-term borrowings were $108.5 million and long-term debt, including subordinated debentures and lease obligations, was $233.7 million.
- Cash flow and liquidity: For the six months, operating cash flow was $51.2 million, investing cash outflow $699.6 million, and financing cash inflow $984.3 million. Cash and cash equivalents increased $335.9 million to $457.7 million. Liquidity sources included unused FHLB capacity of $1.5 billion, Federal Reserve collateral borrowing capacity of $805.4 million, and unused correspondent-bank federal funds and repo lines of $180.0 million and $455.9 million, respectively.
- Capital: The company and bank reported well-capitalized status. The company’s total risk-based capital ratio was 14.40%, Tier 1 leverage ratio 9.28%, and common equity Tier 1 ratio 10.73%.
Material changes versus comparable periods
- Six-month net income fell to $28.6 million from $51.9 million, chiefly due to the $37.8 million credit-loss provision, compared with $6.9 million in 2019. Q2 earnings declined more modestly, primarily because the quarterly provision rose by $4.0 million year over year.
- Net interest income was slightly higher for the first six months but lower in Q2. Growth in earning assets and lower funding costs partly offset lower asset yields following Federal Reserve rate cuts; PPP loans also weighed on loan yield.
- Mortgage-loan sale gains rose to $6.8 million for the first six months from $3.5 million, while deposit service charges declined to $8.0 million from $8.8 million. Salaries and benefits increased $4.2 million, partly reflecting the Santander branches and business growth.
- Deposits rose $1.1 billion from year-end, primarily due to PPP proceeds and federal stimulus deposits. Loans increased $732.9 million, including $570.9 million of PPP originations.
Outlook, commentary, and risks
- Management attributed higher credit reserves to economic uncertainty, borrower forbearances, and potential exposure in sectors such as hospitality and retail. It cited $22.3 million of six-month provision related to higher qualitative reserves and $5.9 million of specific reserves for four commercial real estate borrowers placed on nonaccrual.
- About 6,500 COVID-related short-term modifications covered $1.4 billion of principal; $611.1 million remained in deferral status at June 30. Management said some borrowers could receive an additional 90-day deferral, subject to credit review. These modifications generally defer principal and interest and are treated under applicable CARES Act and regulatory relief.
- The company deferred CECL adoption under CARES Act relief and continued using the incurred-loss method. It had previously estimated that eventual CECL adoption would increase the year-end 2019 allowance by approximately 20%–30%; timing remained subject to the applicable relief period.
- On July 28, 2020, the company announced Project THRIVE, including consolidation of 20% of retail locations by year-end and expected consolidation costs of approximately $3.5 million, primarily in Q3. On August 4, it approved a voluntary retirement program; maximum estimated expense would be approximately $7.0 million if all potentially eligible employees participated. Participation and savings were uncertain.
- The board declared a quarterly dividend of $0.11 per share in July. The share repurchase program had been temporarily suspended in March 2020. No specific earnings or margin guidance was provided.
- Management identified risks including the duration and economic effects of COVID-19, credit deterioration, interest-rate changes, and possible goodwill impairment. It concluded no goodwill impairment trigger existed at June 30. The company reported that pending legal proceedings were not expected to be material to consolidated financial position; aggregate reasonably possible losses beyond recorded liabilities were estimated at $0–$1 million.
Important facts for investors to verify
- Whether COVID-related deferrals convert into renewed forbearances, delinquencies, nonaccrual loans, or losses, especially in commercial real estate, hospitality, retail, and consumer lending.
- Whether the $81.4 million allowance remains adequate as economic conditions and portfolio credit quality evolve, and how CECL adoption timing and its estimated allowance impact change.
- How quickly PPP loans are forgiven or repaid and when the remaining estimated $17.1 million of net deferred PPP processing fees is recognized.
- Whether deposit growth persists after stimulus and PPP-related balances change, and whether funding costs and net interest margin stabilize after rate cuts.
- Actual costs, savings, employee participation, and execution of Project THRIVE branch consolidations and the voluntary retirement program.
- Capital, liquidity, and dividend capacity under adverse credit and economic scenarios; reported capital ratios and available borrowing capacity are as of June 30, 2020.