Business context and reporting period
First Commonwealth Financial Corporation is a Pennsylvania-based financial holding company providing consumer and commercial banking, trust and wealth management, and insurance services, primarily in Pennsylvania and Ohio. This Form 10-K covers the fiscal year ended December 31, 2016; quarterly data includes the fourth quarter. The company reported $6.68 billion in assets, $4.88 billion in loans and $4.95 billion in deposits at year-end.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net income | $59.6 million | $50.1 million |
| Diluted earnings per share | $0.67 | $0.56 |
| Net interest income | $199.0 million | $188.5 million |
| Net interest margin, fully taxable-equivalent | 3.32% | 3.28% |
| Return on average assets | 0.89% | 0.78% |
| Return on average equity | 8.02% | 6.98% |
| Provision for credit losses | $18.5 million | $14.9 million |
| Noninterest income | $64.6 million | $61.3 million |
| Noninterest expense | $159.9 million | $163.9 million |
Net interest income plus noninterest income was $263.6 million. Operating cash flow was $89.3 million; investing activities provided $493.8 million, largely reflecting the FirstMerit transaction, while financing activities used $536.8 million. Cash and cash equivalents increased $46.2 million to $115.7 million.
Year-end deposits were $4.95 billion, up 18%, and shareholders’ equity was $749.9 million. Short-term borrowings were $867.9 million; subordinated debentures were $72.2 million and other long-term debt was $8.7 million. The net-loans-to-deposits ratio was 97.61%. The bank had $767.6 million of available Federal Reserve borrowing capacity and $1.5 billion of maximum FHLB capacity; the filing reports no Federal Reserve borrowings under the collateral program.
Material changes versus the prior comparable period
- Net income increased 19% as net interest income grew $10.6 million, noninterest income rose $3.3 million and noninterest expense fell $3.9 million. Average earning assets increased 4%; the fully taxable-equivalent net interest margin rose 4 basis points.
- Loans increased $195.6 million, or 4%, with commercial real estate growth partly offset by declines in commercial and consumer lending. Commercial real estate loans were 36% of total loans.
- Provision expense rose 23.6%, mainly from specific reserves on two commercial relationships and higher loss and qualitative factors. Net charge-offs increased to $19.1 million from $16.2 million.
- Asset-quality measures improved in some respects: nonperforming loans fell to $41.8 million from $50.8 million, and to 0.86% of loans from 1.09%. The allowance was $50.2 million, or 1.03% of loans, versus $50.8 million, or 1.08%.
- The December 2016 FirstMerit branch acquisition added $619.7 million of deposits and $105.6 million of loans; $22.0 million of goodwill was recorded. Deposit growth funded a reduction in short-term borrowings of $642.9 million. The company incurred $3.2 million of acquisition-related expenses.
Outlook, commentary, risks and unusual items
The filing provides no formal numerical earnings or revenue guidance. Management expected the pending DCB Financial acquisition, involving approximately $550 million of assets, $477 million of deposits, $388 million of loans and nine offices, to close in the second quarter of 2017. Management said it believed capital levels met fully phased-in Basel III requirements; at year-end, the company’s CET1 ratio was 10.06% and the bank’s was 10.09%. Both were classified as well capitalized.
Interest-rate exposure is material: the modeled impact on annual net interest income from an immediate 100-basis-point increase was positive 4.06%, while a 100-basis-point decrease was negative 4.42%. Management cautioned that these are model estimates dependent on assumptions about repricing, prepayments and deposit behavior. Credit risks include commercial exposures and real-estate collateral; the company reported $56.2 million in outstanding oil-and-gas-related loans and continued monitoring affected borrowers.
Other notable items include a $0.6 million gain from early redemption of a pooled trust preferred security, with an additional $0.7 million gain expected in first-quarter 2017. No impairment charges were recorded on investment securities in 2016. A Pennsylvania class-action lawsuit concerning vehicle repossessions is contested; management estimated reasonably possible aggregate litigation losses beyond recorded liabilities at $0 to $7 million and said the ultimate excess exposure was not estimable. The company identified cybersecurity, competition, economic conditions, interest rates, credit-loss estimates and regulatory changes among its significant risks. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether the 2016 increase in net income and margin persists after acquisition effects and higher short-term borrowing costs.
- Loan-loss trends, particularly commercial charge-offs, criticized credits, oil-and-gas exposures and the adequacy of the allowance.
- Integration and expected closing of the DCB acquisition, including its effects on capital, goodwill, expenses and tangible book value.
- Funding mix and sensitivity to rate changes, including deposit pricing, certificate maturities and reliance on wholesale borrowings.
- Outcome and potential financial effect of the repossession litigation, and changes in the valuation of pooled trust preferred securities.