FIRST COMMONWEALTH FINANCIAL CORP annual report, FY2019

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First Commonwealth Financial Corporation — FY2019 Form 10-K

Business context and reporting period: This annual report covers the year ended December 31, 2019; it also presents unaudited fourth-quarter results. First Commonwealth is a Pennsylvania-based financial holding company providing commercial and consumer banking, wealth management and insurance services, primarily in Pennsylvania and Ohio. It completed its acquisition of 14 Santander branches in September 2019, expanding into central Pennsylvania.

Financial performance and position

  • FY2019 earnings: Net income was $105.3 million, or $1.07 per diluted share, versus $107.5 million, or $1.08, in 2018. Return on average assets was 1.31% (1.42% in 2018); return on average equity was 10.32% (11.41%).
  • Revenue and margin: Net interest income was $269.9 million, up $17.6 million. On a fully taxable-equivalent basis, net interest income rose 7% to $271.6 million and net interest margin increased 4 basis points to 3.75%. Total noninterest income declined 4% to $85.5 million; the 2018 comparison included $8.1 million of securities gains. Income before tax was $130.8 million, compared with $132.8 million.
  • Costs and credit: Noninterest expense increased 7% to $210.0 million, including $3.5 million of merger-related expense. Provision for credit losses rose 16% to $14.5 million. Net charge-offs were $10.7 million, down from $13.1 million; the allowance was $51.6 million, or 0.83% of loans. Nonperforming loans were $32.2 million, or 0.52% of loans.
  • Loans, deposits and assets: Total assets increased 6% to $8.31 billion. Loans grew 7% to $6.19 billion; deposits grew 13% to $6.68 billion, including $471.4 million acquired from Santander. At year-end, deposits comprised 92% of liabilities. Shareholders’ equity was $1.06 billion.
  • Cash flow: Operating activities provided $107.6 million, compared with $135.3 million in 2018. Investing activities provided $122.9 million, versus $347.7 million used in 2018; financing activities used $207.7 million, versus $204.1 million provided. Cash and cash equivalents ended the year at $121.9 million.
  • Debt and liquidity: Short-term borrowings fell $520.0 million to $201.9 million. Long-term debt, including subordinated debentures, was $234.2 million, up from $185.1 million. Management reported $882.4 million of available Federal Reserve borrowing capacity, $1.5 billion maximum FHLB capacity with about $0.2 billion used, and additional unused correspondent-bank lines.
  • Capital: The company and bank exceeded well-capitalized thresholds. At year-end, the company’s total risk-based capital ratio was 14.26%, CET1 was 10.91%, and Tier 1 leverage was 10.17%; the bank’s respective ratios were 13.67%, 11.36%, and 9.66%.

Material changes versus 2018

  • Net income and diluted EPS edged lower despite higher net interest income, as higher operating expenses and credit provision, plus the absence of 2018 securities gains, offset revenue growth.
  • Loan growth was broad-based, led by residential real estate, construction and consumer lending; commercial real estate loans were slightly lower. The Santander acquisition contributed $100.0 million of loans and $471.4 million of deposits.
  • Deposit growth and acquisition cash proceeds helped reduce short-term borrowings substantially. The investment portfolio declined as maturities and sales helped fund loan growth and debt repayment.
  • Criticized loans declined to $100.6 million from $127.2 million, while classified assets rose to $52.0 million from $40.2 million. Nonperforming loans were broadly stable in dollars, and their ratio to loans improved.

Fourth-quarter snapshot

Q4 2019 net income was $26.8 million, or $0.27 per diluted share, versus $27.0 million and $0.27 in Q4 2018. Net interest income increased to $68.8 million from $65.0 million, while provision expense rose to $4.9 million from $1.5 million. Income before tax was $33.3 million, compared with $34.1 million.

Outlook, commentary and risks

  • The filing provides no numerical earnings or revenue guidance. Management said future results are sensitive to rates, balance-sheet mix, credit quality and economic conditions. Its year-end interest-rate simulation estimated that a gradual 100-basis-point increase would raise 12-month net interest income by 1.54%, while an immediate 100-basis-point increase would raise it by 4.42%; modeled declines would reduce income. These are scenarios, not forecasts.
  • CECL became effective for the company on January 1, 2020. Based on preliminary parallel runs, management estimated adoption would increase the December 31, 2019 allowance by approximately 20%–30%; the ultimate impact depends on credit quality, economic forecasts, portfolio composition and management assumptions.
  • Key risks include interest-rate movements, borrower and real-estate credit deterioration, allowance-estimation uncertainty, competition, regulatory change, cybersecurity and vendor disruptions, and the transition away from LIBOR. The filing also identifies coronavirus-related uncertainty, trade tensions and depressed oil prices as potential economic risks; these were forward-looking concerns at the filing date.
  • Potentially significant unusual items include the Santander acquisition and its $29.1 million goodwill addition, $3.7 million in related costs, and 2018 pooled trust-preferred-security gains that did not recur in 2019. Goodwill was $303.3 million; management reported no impairment in 2019.
  • Management said pending and threatened litigation was not expected to materially affect consolidated financial position. Possible losses beyond recorded liabilities were estimated at $0–$1 million in aggregate, though outcomes could affect a particular period’s results or cash flows.
  • Ernst & Young issued unqualified opinions on the 2019 financial statements and internal control over financial reporting. The auditor identified the allowance for credit losses, particularly qualitative reserve adjustments, as a critical audit matter.

Important facts for investors to verify

  • Track the realized CECL transition adjustment against management’s preliminary 20%–30% allowance-increase estimate.
  • Review subsequent credit trends, including consumer and commercial charge-offs, delinquency growth, classified assets, and allowance coverage.
  • Assess deposit pricing and retention, certificate maturities, loan growth, and the effect of further interest-rate changes on net interest margin.
  • Monitor integration and returns from the Santander branches, acquisition-related costs, and goodwill impairment indicators.
  • Confirm capital, liquidity and dividend capacity, including the dependence of the parent company on bank-subsidiary dividends.
  • Reconcile the filing’s dividend disclosures: quarterly 2019 amounts and selected financial data indicate $0.40 per share, while the statement of changes in equity labels 2019 dividends as $0.35 per share.