First Commonwealth Financial Corporation — Q2 2012 Form 10-Q
Business context and reporting period
Regional banking company reporting unaudited results for the quarter and six months ended June 30, 2012. Comparisons are with the corresponding 2011 periods; balance-sheet comparisons are primarily with December 31, 2011. Dollar amounts below are in millions unless otherwise noted.
Financial results and position
- Q2 earnings: Net income was $12.3 million, or $0.12 per diluted share, versus $7.4 million, or $0.07, in Q2 2011. First-half net income was $23.4 million, or $0.22 per diluted share, compared with $12.7 million, or $0.12.
- Net interest and margin: Q2 GAAP net interest income was $46.9 million, essentially unchanged year over year; fully taxable-equivalent net interest income was $48.0 million versus $48.3 million. Q2 net interest margin (fully taxable equivalent) was 3.61%, down from 3.76%. For the first half, fully taxable-equivalent net interest income was $97.4 million versus $97.7 million, and margin was 3.68% versus 3.81%.
- Other income and expenses: Q2 noninterest income was $16.1 million versus $17.1 million, including no securities gains compared with $1.6 million a year earlier. Q2 noninterest expense declined to $41.8 million from $45.7 million, reflecting lower credit-resolution costs and asset write-downs. First-half noninterest income increased to $33.5 million from $31.4 million; noninterest expense rose to $88.6 million from $87.1 million.
- Credit costs: Provision for credit losses was $4.3 million in Q2 versus $9.1 million; for the first half it was $8.1 million versus $22.9 million. Net charge-offs were $3.4 million in Q2 and $7.6 million for the first half. The allowance was $61.7 million, or 1.48% of loans, versus $61.2 million, or 1.51%, at year-end.
- Assets and funding: Total assets were $5.95 billion, up from $5.84 billion at year-end. Gross loans grew 3% to $4.16 billion; deposits decreased $42.7 million to $4.46 billion. Shareholders’ equity was $772.5 million. Short-term borrowings increased to $474.3 million from $312.8 million; long-term debt, including subordinated debentures, totaled $181.1 million, down from $207.4 million.
- Cash flow and liquidity: First-half operating cash flow was $37.6 million, investing cash flow was negative $113.2 million, and financing cash flow was positive $83.7 million. Cash and cash equivalents increased $8.0 million to $86.5 million. Available borrowing capacity included $885.5 million under CDARS and $788.1 million through the Federal Reserve collateral program; FHLB capacity was $1.2 billion, with $339.3 million borrowed.
- Capital and shareholder returns: The company and bank exceeded regulatory capital minimums; the bank’s total risk-based capital ratio was 14.5% and Tier 1 ratio was 13.3%. A $50 million share repurchase program was announced in June; 469,700 shares had been repurchased at an average $6.48 per share by quarter-end. The quarterly dividend declared July 24 was $0.05 per share.
Material changes and management commentary
- Lower credit provision was the principal contributor to higher year-over-year earnings. First-half net income also benefited from asset-sale gains; loan interest income declined.
- Management attributed margin pressure to the low-rate environment and repricing or runoff of higher-yielding assets. Lower funding costs, balance-sheet growth and improved deposit mix partly offset the impact. Management expected margin pressure to continue, with $2.4 billion of interest-sensitive assets scheduled to reprice or mature over the next six months.
- Loan balances increased $115.9 million in the first half, led by residential real estate and commercial lending. Nonperforming loans declined to $84.9 million from $98.8 million at year-end; criticized loans fell $19.5 million to $272.5 million. Commercial real estate and construction exposures remained areas of focus.
- Management provided no specific numerical earnings or revenue guidance. It noted that $345.4 million of certificates of deposit were due to mature or reprice over the next six months and expected deposit mix improvement to continue.
Risks, contingencies and unusual items
- Investment securities: Pooled trust-preferred CDOs had $52.9 million of book value and $21.8 million fair value, with $31.3 million of gross unrealized losses. No new credit-related impairment charge was recorded in the first half, but valuation depends on estimated defaults, deferrals, prepayments and discount rates; further impairment remains possible.
- Credit exposure: Nonperforming loans were $84.9 million, including $45.2 million of nonaccrual troubled debt restructurings. Five relationships comprising eight loans were restructured during the first half. Management said the allowance was adequate, while noting that economic conditions, borrower performance and collateral values could change estimates.
- Legal matter: A certified class-action claim alleges breach of an 8% minimum rate promise on certain IRA accounts. Summary-judgment decision was pending; the company could not estimate a reasonably possible loss range.
- Other items: The company reported it was not meeting a return-on-average-assets covenant on its $0.6 million guaranteed ESOP loan and was seeking a waiver or modification. Management expected one. The company stated its disclosure controls were effective and reported no material changes in internal control over financial reporting.
- Forward-looking risks include economic weakness, borrower defaults, real-estate values, interest-rate and market changes, regulatory requirements and competition.
Important facts for investors to verify
- Whether improving credit metrics and lower provisions persist, and how the allowance compares with future charge-offs and nonperforming loans.
- Performance and valuation assumptions for the pooled trust-preferred CDO portfolio, including the potential for additional impairment.
- Deposit trends, increased reliance on short-term borrowings, and the availability and cost of wholesale liquidity.
- Net interest margin sensitivity as assets and certificates of deposit reprice in the low-rate environment.
- Developments in the IRA class action and the status of the ESOP loan covenant waiver or modification.
- Execution and remaining authorization under the $50 million share repurchase program, alongside capital and dividend needs.