FIRST COMMONWEALTH FINANCIAL CORP annual report, FY2018

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First Commonwealth Financial Corporation — FY2018 Form 10-K

Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited fourth-quarter results. First Commonwealth is a Pennsylvania-based financial holding company providing consumer and commercial banking, trust and wealth management, and insurance services across Pennsylvania and Ohio. It completed its acquisition of Garfield Acquisition Corporation in May 2018, adding five Cincinnati-area branches.

Financial performance and position

  • FY2018 earnings: Net income was $107.5 million, or $1.08 per diluted share, versus $55.2 million, or $0.58, in 2017. Return on average assets was 1.42% (0.77% in 2017); return on average equity was 11.41% (6.45%). Fourth-quarter net income was $27.0 million, or $0.27 per diluted share, compared with $4.0 million, or $0.04, in Q4 2017.
  • Net interest income and margin: GAAP net interest income increased to $252.2 million from $228.8 million. On a fully taxable-equivalent basis, it was $254.2 million, up 9%; net interest margin rose to 3.71% from 3.57%. Higher loan yields and earning-asset growth helped, while funding costs rose.
  • Other income and expenses: Noninterest income was $88.6 million, up 10%, including $8.1 million of securities gains. Noninterest expense declined 2% to $195.6 million, mainly reflecting lower merger-related costs; underlying expenses excluding certain items rose 3%.
  • Credit: Provision for credit losses was $12.5 million, up from $5.1 million; net charge-offs rose to $13.1 million from $7.0 million. Nonperforming loans declined to $32.0 million from $42.2 million, or 0.55% of loans versus 0.78%. The allowance was $47.8 million, 0.83% of loans and 149.1% of nonperforming loans.
  • Balance sheet: Total assets were $7.83 billion, up $519.7 million. Loans were $5.77 billion, up 7%; deposits were $5.90 billion, up 6%. Shareholders’ equity increased to $975.4 million from $888.1 million.
  • Cash flow: Operating activities provided $135.3 million; investing activities used $347.7 million; financing activities provided $204.1 million. Cash and cash equivalents decreased $8.3 million to $98.9 million.
  • Debt and liquidity: Short-term borrowings were $721.8 million. Long-term debt was $185.1 million, including $100 million of subordinated notes issued in 2018. Deposits funded 86% of liabilities. Available capacity included $768.7 million at the Federal Reserve, $1.6 billion at the Federal Home Loan Bank (with $0.6 billion outstanding), and $205 million in correspondent-bank lines (with $11 million outstanding).
  • Capital: At year-end, the company’s total risk-based capital ratio was 14.65%, CET1 ratio 11.13%, and Tier 1 leverage ratio 10.28%; the bank was reported well-capitalized.

Changes and notable items

  • FY2018 net income increased substantially, but comparison with 2017 is affected by a $16.7 million noncash charge in 2017 to remeasure deferred tax assets after federal tax reform. The federal statutory rate fell from 35% to 21%; the effective tax rate was 19% in 2018 versus 47% in 2017.
  • Garfield added $184.5 million in loans and $141.3 million in deposits; acquisition consideration included $17.4 million cash and 2.7 million shares. The acquisition generated $19.0 million of goodwill.
  • The company sold or redeemed its remaining pooled trust preferred securities, contributing to securities gains. It also completed a $25 million share repurchase program, buying 1.84 million shares at an average $13.58 per share.
  • Interest expense increased to $40.0 million from $21.8 million, reflecting higher market rates, deposit repricing, and new subordinated debt. The average cost of interest-bearing liabilities rose to 0.78% from 0.44%.
  • Net charge-offs increased despite lower nonperforming loans, including significant commercial real estate and commercial loan charge-offs and indirect auto losses.

Outlook, risks and contingencies

  • The filing provides no specific quantitative earnings or revenue guidance. Management describes a strategy focused on expansion, diversification, fee-income growth, organic growth and acquisitions.
  • Management identifies interest-rate sensitivity as a key risk. Its model showed a 0.51% increase in 12-month net interest income under a gradual +100-basis-point scenario, but a 2.41% decrease under a gradual -100-basis-point scenario; outcomes depend on assumptions and actual deposit and loan repricing.
  • Other key risks include credit losses and real-estate collateral values, economic and competitive conditions, regulatory changes, cybersecurity and vendor disruptions, goodwill impairment, and the transition away from LIBOR. The company had significant financial instruments linked directly or indirectly to LIBOR and said transition impacts were not yet estimable.
  • CECL was scheduled for adoption January 1, 2020; management was evaluating its impact. A material weakness concerning controls over the qualitative component of the credit-loss allowance was identified in 2018 and management reported remediation during Q4. Management and KPMG concluded internal control over financial reporting was effective at December 31, 2018; the financial-statement audit opinion was unqualified.
  • Management did not expect pending or threatened litigation to materially affect consolidated financial position. The disclosed aggregate reasonably possible losses beyond recorded liabilities were estimated at $0–$1 million, though material effects on a future period’s results or cash flows could not be ruled out.
  • Adoption of the new lease standard in 2019 was expected to recognize right-of-use assets of $38.8 million and lease liabilities of $42.1 million, with an estimated 8-basis-point reduction in the Tier 1 risk-weighted capital ratio.

Important facts for investors to verify

  • How much of the earnings increase reflects recurring operating performance versus the 2017 tax-remeasurement charge, securities gains, and other nonrecurring items.
  • Whether credit costs and net charge-offs remain elevated, especially in commercial real estate, commercial lending and indirect auto, and whether the allowance remains appropriate.
  • The sustainability of net interest margin as deposit and borrowing costs rise, including the $509.2 million of certificates of deposit scheduled to mature or reprice within 12 months.
  • Capital, funding and integration effects of the Garfield acquisition and the $100 million subordinated-debt issuance.
  • Progress on LIBOR transition and CECL readiness, and continued effectiveness of the remediated allowance-related controls.