First Commonwealth Financial Corporation — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. The unaudited results include the April 3 acquisition of DCB Financial Corporation; DCB’s post-acquisition results cannot be separately identified.
Financial results and condition
- Q2 earnings: Net income was $14.0 million, up 16.7% from $12.0 million a year earlier. Diluted EPS was $0.14, unchanged year over year. For the first six months, net income rose to $29.9 million from $24.5 million; diluted EPS increased to $0.32 from $0.28.
- Revenue and margin: Q2 net interest income was $57.8 million, versus $49.1 million; on a fully taxable-equivalent basis it was $58.9 million, up from $50.0 million. Q2 net interest margin increased to 3.54% from 3.27%. Six-month fully taxable-equivalent net interest income was $111.7 million, up from $99.8 million, and margin was 3.52% versus 3.28%. Total noninterest income was $18.9 million in Q2 and $35.8 million for six months, up 22% year over year in both periods.
- Expenses and credit provision: Q2 noninterest expense rose 56% to $58.3 million, including $9.9 million of merger and acquisition costs. The quarter recorded a $1.6 million credit to the provision for credit losses, compared with $10.4 million of provision expense in Q2 2016. Six-month provision expense was $1.6 million, versus $16.9 million.
- Assets, loans and deposits: At June 30, total assets were $7.38 billion, portfolio loans $5.37 billion, and deposits $5.53 billion. Assets rose from $6.68 billion and deposits from $4.95 billion at year-end 2016, substantially reflecting DCB and other recent branch acquisitions. DCB contributed $383.1 million of loans and $484.4 million of deposits.
- Credit quality: Nonperforming loans were $40.2 million, or 0.75% of loans, compared with $41.8 million, or 0.86%, at year-end 2016. The allowance was $48.1 million, 0.89% of loans and 119.61% of nonperforming loans. Six-month net charge-offs were $3.7 million, down from $7.9 million a year earlier. Criticized loans increased $25.8 million to $160.2 million; management attributed most of that increase to a $21.5 million borrower downgrade.
- Cash flow and liquidity: Six-month operating cash flow was $41.7 million, investing cash outflow $105.0 million, and financing cash inflow $63.5 million. Cash and cash equivalents were $115.9 million at June 30. The company reported $846.1 million of short-term borrowings and $88.4 million of long-term debt, including subordinated debentures and a newly recorded capital lease. Available facilities included $1.4 billion maximum FHLB capacity, $772.1 million FRB collateral borrowing capacity, $195.0 million in federal funds lines and $519.8 million in repurchase lines; these latter facilities had no balances outstanding.
- Capital and shareholder returns: Shareholders’ equity was $879.5 million, up from $749.9 million at year-end, principally reflecting $110.8 million of shares issued for DCB. The company and its bank met applicable capital requirements and were considered well-capitalized. Dividends declared were $0.08 per share for Q2 and $0.16 for the first half, versus $0.07 and $0.14, respectively, in 2016.
Material changes and management commentary
- DCB expanded the company’s central Ohio presence with nine banking offices. Consideration was $21.2 million in cash and 8.36 million shares; the acquisition generated $70.5 million of goodwill. Acquisition-related costs were $10.3 million for the first half.
- Management attributed improved net interest income to loan and earning-asset growth and higher asset yields, including the effect of Federal Reserve rate increases. Higher rates also raised funding costs. Average loans increased 7.3% for the first half compared with the prior-year period.
- Noninterest income benefited from higher deposit service charges, card interchange, trust income and mortgage-loan sale gains. Swap fee income declined. Expense growth also reflected acquired operations, higher staffing and occupancy costs, and write-downs of four other-real-estate-owned properties totaling about $1.0 million in the first half.
- No specific earnings or financial guidance is provided. Management cautions that interim results are not necessarily indicative of full-year results. The board declared a $0.08 quarterly dividend on July 26, payable August 18, 2017, subject to the board’s discretion on future dividends.
Risks, contingencies and unusual items
- Interest-rate models show that a gradual 100-basis-point increase could raise 12-month net interest income by 2.40%; a gradual 100-basis-point decrease could reduce it by 3.61%. Management notes that these models depend on assumptions about deposit pricing, prepayments and customer behavior and may not match actual results.
- Oil-and-gas industry commitments totaled $111.7 million, with $50.9 million outstanding. The filing identifies nonperforming exposures in the sector and notes that some ancillary borrowers could be affected by lower drilling activity.
- Pooled trust-preferred securities had a $40.4 million book value and $33.6 million estimated fair value; the securities are below investment grade and the market is illiquid. No credit-related impairment charge was recorded in the first half, but the company states that future impairment is possible.
- Management did not expect pending litigation to create a material aggregate liability to consolidated financial position. It disclosed a reasonably possible loss range of $0 to $7 million beyond any recorded liability. A vehicle-repossession class-action matter remains subject to negotiation of a definitive settlement and court approval.
- Management reported effective disclosure controls and no material change to internal controls during the quarter. The filing reported no material changes to the risk factors in the 2016 Form 10-K.
Important facts for investors to verify
- Whether DCB integration delivers expected synergies and whether acquisition-related and ongoing operating costs moderate.
- How loan growth, criticized credits, nonperforming loans, charge-offs and reserve coverage develop, including the large borrower downgrade and oil-and-gas exposures.
- Whether reported earnings and margin improvement persist as market rates and deposit and borrowing costs change.
- Performance and valuation of the illiquid pooled trust-preferred portfolio, and any future impairment or cash-flow shortfalls.
- Final resolution and costs of the vehicle-repossession litigation, including settlement approval and any exposure beyond recorded amounts.