First Commonwealth Financial Corporation — Q2 2018 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and six months ended June 30, 2018. First Commonwealth is a bank holding company. On May 1, it acquired Garfield Acquisition Corporation and Foundation Bank, adding five branches in the Cincinnati market.
Financial results and key metrics
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net interest income (GAAP) | $63.7 million | $57.8 million | $123.4 million | $109.6 million |
| Net interest income, fully taxable equivalent | $64.2 million | $58.9 million | $124.4 million | $111.7 million |
| Noninterest income | $26.3 million | $18.9 million | $48.4 million | $35.8 million |
| Provision for credit losses | $1.2 million | $(1.6) million | $8.1 million | $1.6 million |
| Noninterest expense | $49.1 million | $58.3 million | $96.0 million | $101.0 million |
| Net income | $32.1 million | $14.0 million | $55.4 million | $29.9 million |
| Diluted EPS | $0.32 | $0.14 | $0.56 | $0.32 |
| Net interest margin, fully taxable equivalent | 3.78% | 3.54% | 3.74% | 3.52% |
- Balance sheet at June 30: Total assets were $7.65 billion; portfolio loans were $5.64 billion; deposits were $5.91 billion; and shareholders’ equity was $960.8 million. Assets increased from $7.31 billion at year-end 2017, including acquired assets.
- Cash flow, six months: Operating activities provided $60.6 million, investing activities used $150.4 million, and financing activities provided $86.4 million. Cash and cash equivalents ended at $104.0 million, down $3.3 million from year-end.
- Debt and funding: Short-term borrowings were $545.2 million, down from $707.5 million at year-end. Subordinated debentures were $170.3 million, up from $72.2 million, following $100 million of notes issued in May. Deposits increased $332.9 million from year-end, including $141.3 million acquired with Garfield.
- Credit: The allowance for credit losses was $51.3 million, or 0.91% of loans. Six-month net charge-offs were $5.1 million. Nonperforming loans were $45.9 million, 0.81% of loans, versus $42.2 million and 0.78% at year-end. Troubled debt restructurings totaled $29.7 million, up from $22.8 million.
- Capital and distributions: The company and bank were reported well-capitalized. Company total risk-based capital was 14.80%; the bank’s was 14.39%. The quarterly dividend declared was $0.09 per share, compared with $0.08 in Q2 2017.
Material changes versus prior periods
- Q2 net income more than doubled year over year, supported by higher net interest income and noninterest income, lower merger-related costs, and the lower federal statutory tax rate. First-half net income rose to $55.4 million from $29.9 million.
- Net interest margin expanded 24 basis points in Q2 and 22 basis points for the first half. Management attributed the increase to higher asset yields, including floating-rate commercial loans, and changes in the mix of earning assets and funding.
- Noninterest income included $5.3 million of Q2 securities gains; first-half securities gains were $8.1 million. These primarily reflected sale and redemption of the company’s pooled trust preferred securities. The remaining portfolio was liquidated by June 30.
- First-half provision expense rose to $8.1 million from $1.6 million, reflecting specific reserves on commercial borrowers and charge-offs, including indirect auto and personal credit-line losses. Net charge-offs increased to $5.1 million from $3.7 million.
- Noninterest expense declined year over year mainly because merger and acquisition expense fell to $1.6 million for the first half from $10.5 million. Excluding specified unusual expense categories, management reported underlying expense increases, including higher compensation and costs associated with acquisitions.
- The effective tax rate was 19.1% for the first half, compared with 30.2% in 2017, primarily reflecting the reduction in the federal statutory rate from 35% to 21%.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings, revenue, or margin guidance. Management cautions that interim results are not necessarily indicative of full-year results and makes no commitment to update forward-looking statements.
- Management identified exposure to economic conditions, interest rates, borrower performance, competition, acquisitions and integration, regulation, technology and vendor reliability, and legal or regulatory developments. The company’s modeled 12-month net interest income response to an immediate +100 basis-point rate change was +3.48%; a -100 basis-point change was -5.10%. Management cautions that model assumptions may not match actual experience.
- Liquidity sources include core deposits and available wholesale facilities. At June 30, reported unused capacity included $1.1 billion under CDARS, $795.5 million under the Federal Reserve collateral program, and $501.5 million in correspondent-bank repo lines; availability and terms remain subject to applicable conditions.
- Garfield consideration totaled $59.0 million, including cash and shares; the acquisition added $184.5 million of loans and $141.3 million of deposits and generated $19.2 million of goodwill. Acquisition valuations remained provisional, and the company said it could not separately identify Garfield’s post-acquisition results.
- A Pennsylvania vehicle-repossession class action settlement received final court approval on July 23, 2018; completion was expected in Q3. The estimated settlement cost had been accrued in 2016. Management said aggregate reasonably possible litigation losses beyond recorded liabilities ranged from $0 to $1 million, while noting that future period results or cash flows could still be affected.
- The company reported no material changes to the risk factors in its 2017 Form 10-K. It also reported effective disclosure controls and no identified material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of earnings growth recurs after the securities gains, loan-sale gain, and other nonrecurring or acquisition-related effects.
- Whether loan delinquencies, nonperforming loans, troubled restructurings, and charge-offs stabilize, and whether the allowance remains adequate as credit conditions evolve.
- How Garfield integration affects future growth, expenses, credit quality, and capital, and whether provisional acquisition valuations change.
- How deposit pricing and borrowing costs respond to further rate changes, given the increase in interest expense and the company’s modeled rate sensitivity.
- Whether the class action settlement is completed as expected and whether any other legal or regulatory matters change the company’s estimated exposure.