First Commonwealth Financial Corporation — 2017 Q3 Form 10-Q
Business context and reporting period. First Commonwealth is a Pennsylvania-based bank holding company. This unaudited report covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless otherwise noted. The April 3, 2017 acquisition of DCB Financial expanded the company’s central Ohio presence and added nine full-service offices, four limited-service locations, approximately $383.1 million of loans and $484.4 million of deposits.
Financial performance and position
| Metric | Third quarter 2017 | Nine months 2017 |
|---|---|---|
| Net interest income, GAAP | $59.6 million, up from $49.6 million | $169.2 million, up from $147.5 million |
| Noninterest income | $19.8 million, up from $17.0 million | $55.6 million, up from $46.3 million |
| Provision for credit losses | $1.2 million, down from $3.4 million | $2.8 million, down from $20.3 million |
| Noninterest expense | $47.4 million, up from $38.7 million | $148.4 million, up from $114.3 million |
| Net income | $21.3 million; diluted EPS $0.22 | $51.2 million; diluted EPS $0.54 |
| Net interest margin, fully taxable equivalent | 3.61%, versus 3.29% | 3.55%, versus 3.28% |
- For the quarter, net income rose from $17.2 million and diluted EPS from $0.19. For the nine months, net income rose from $41.7 million and diluted EPS from $0.47.
- Quarterly return on average assets was 1.14% and return on average equity 9.50%; nine-month figures were 0.96% and 8.15%, respectively.
- At September 30, total assets were $7.384 billion, portfolio loans $5.376 billion, deposits $5.555 billion and shareholders’ equity $894.3 million. The loan allowance was $48.2 million.
- Cash and cash equivalents were $128.0 million. For the nine months, operating cash flow was $63.3 million, investing cash outflow $87.9 million and financing cash inflow $37.0 million.
- Debt and borrowings included $805.8 million of short-term borrowings, $72.2 million of subordinated debentures, $8.3 million of other long-term debt and $7.7 million of capital lease obligations. Total deposits increased $607.6 million from year-end 2016; loan growth was $496.5 million, also including acquired balances.
- The quarterly dividend declared was $0.08 per share, compared with $0.07 a year earlier. The nine-month dividend was $0.24 per share.
Material changes and management commentary
- Management attributed higher net interest income to loan and earning-asset growth and improved asset yields. For the first nine months, average earning assets increased $371.7 million and average loan yield improved 29 basis points. Higher market rates also increased funding costs, especially on short-term borrowings.
- Noninterest income rose 20% year over year for the nine months, supported by deposit-service charges, card interchange, trust income and mortgage-loan sale gains. Swap fee income fell $1.5 million.
- Noninterest expense increased 30% for the nine months. The $10.4 million merger-related expense was primarily associated with DCB; higher staffing and other operating costs also reflected DCB and the 2016 acquisition of 13 FirstMerit branches. Management said it could not separately identify DCB’s post-acquisition revenue or net income following integration.
- Credit metrics improved: nonperforming loans were $38.8 million, or 0.72% of loans, versus $41.8 million, or 0.86%, at year-end 2016. Nine-month net charge-offs were $4.8 million versus $16.4 million a year earlier. The allowance covered 124.16% of nonperforming loans.
- At September 30, the company and bank met applicable regulatory capital requirements and were classified as well-capitalized. The company’s total risk-based capital ratio was 12.32%; its common equity Tier 1 ratio was 10.33%.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management cautioned that nine-month results are not necessarily indicative of full-year results.
- Management’s interest-rate model estimated that a gradual 100-basis-point increase would raise 12-month net interest income by 2.09%, while a 100-basis-point decline would reduce it by 2.94%. The filing cautions that model assumptions may differ from actual outcomes; falling-rate scenarios are also limited by the low level of some deposit rates.
- Liquidity sources included core deposits and unused wholesale facilities. At September 30, reported capacity included $1.6 billion at the FHLB, $781.3 million through the Federal Reserve collateral program, $195.0 million in federal funds lines and $506.6 million in repo lines; the latter three were reported with no amounts outstanding. FHLB borrowings were approximately $0.7 billion.
- The company held $40.6 million book value of pooled trust preferred securities, with estimated fair value of $34.6 million. The securities are below investment grade and trade in an illiquid market; management reported no new credit-related impairment in the period but noted future impairment remains possible.
- Management did not expect pending litigation to materially affect consolidated financial position. Possible aggregate losses beyond recorded liabilities were estimated at $0 to $7 million; a Pennsylvania vehicle-repossession class action remained subject to settlement documentation and court approval.
- Management identified economic conditions, interest rates, borrower credit, acquisition integration, competition, regulatory changes, technology and operational controls, litigation, and potential goodwill impairment among risks. No material changes to the 2016 Form 10-K risk factors were reported. No material control changes were identified, and disclosure controls were deemed effective.
- Management expected adoption of the revenue-recognition standard not to have a material impact; the impact of the new lease and expected-credit-loss standards was still under evaluation.
Investor verification checklist
- Separate organic loan, deposit and earnings growth from balances and costs attributable to DCB and the FirstMerit branch acquisition.
- Monitor whether margin gains persist as deposit and short-term borrowing costs reprice, and compare realized results with the filing’s interest-rate sensitivity estimates.
- Track credit quality, especially commercial real estate growth, criticized loans, the allowance, charge-offs and acquired-loan performance.
- Assess DCB integration, recurring expense levels and whether merger-related costs have ended; verify the expected fourth-quarter call at par of Pre TSL XIII, noted after quarter-end.
- Review liquidity and capital ratios alongside borrowing utilization, and follow developments in the repossession litigation and the valuation of trust preferred securities.