First Commonwealth Financial Corporation — Q2 2015 Form 10-Q
Business context and reporting period. The company is a Pennsylvania-based bank holding company. This unaudited filing covers the quarter and six months ended June 30, 2015; comparisons are with the same 2014 periods unless stated otherwise. Dollar amounts below are in millions, except per-share data.
Financial performance and condition
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net income | $13.4 | $11.9 | $27.7 | $24.2 |
| Diluted EPS | $0.15 | $0.13 | $0.31 | $0.26 |
| Net interest income, GAAP | $46.4 | $45.4 | $93.5 | $91.0 |
| Net interest income, fully taxable equivalent | $47.2 | $46.2 | $95.2 | $92.7 |
| Net interest margin, fully taxable equivalent | 3.26% | 3.26% | 3.30% | 3.30% |
| Provision for credit losses | $3.0 | $3.3 | $4.2 | $6.5 |
| Noninterest income | $16.3 | $17.0 | $30.5 | $31.9 |
| Noninterest expense | $40.6 | $42.4 | $80.5 | $82.3 |
- Profitability: Q2 return on average assets was 0.85% and return on average equity was 7.57%; for the six months, the respective returns were 0.88% and 7.80%. Six-month dividend declarations were $0.14 per share.
- Balance sheet at June 30: Total assets were $6,316.7; portfolio loans were $4,490.9 gross and $4,445.5 net of allowance; deposits were $4,210.1; shareholders’ equity was $711.2.
- Funding and debt: Short-term borrowings were $1,231.9, subordinated debentures $72.2, and other long-term debt $39.2. Deposits declined $105.4 from year-end 2014 while short-term borrowings rose $126.0. Noninterest-bearing deposits increased $79.2, but time deposits fell $219.2.
- Cash flows, six months: Operating activities provided $22.7; investing activities provided $37.7; financing activities used $67.5. Cash and cash equivalents ended at $67.4, down $7.1 from year-end.
- Capital: The company reported a 12.42% total risk-based capital ratio, 11.51% Tier 1 risk-based ratio, 9.99% Tier 1 leverage ratio, and 10.21% common equity Tier 1 ratio. It reported that the company and bank met applicable capital requirements and were well-capitalized.
Material changes versus comparable periods
- Six-month net income increased $3.4, supported by higher net interest income, lower credit-loss provision, and lower total noninterest expense; lower noninterest income partly offset the gains.
- Net interest margin was unchanged year over year. Management attributed higher net interest income mainly to growth in earning assets and lower funding costs; lower asset yields remained a headwind.
- Noninterest income declined 4% for the first half, mainly because 2014 included gains from asset and advisory-business sales. Insurance and brokerage commissions rose, while the company’s return to secondary-market mortgage lending contributed to higher loan-sale gains.
- Six-month noninterest expense fell 2%, in part because 2014 included IT-conversion costs. This was partly offset by higher operating losses, asset write-downs, salaries, and collection costs.
- Gross portfolio loans increased $33.5 from December 31, 2014. Nonperforming loans declined to $45.1 from $55.3; the allowance for credit losses fell to $45.3 from $52.1.
- Shareholders’ equity declined $4.9 from year-end, primarily reflecting $25.4 of share repurchases and $12.6 of dividends, partly offset by net income and improved securities-related accumulated OCI.
Outlook, management commentary, risks, and unusual items
- Outlook: The filing provides no quantified earnings or revenue guidance. Management described efforts to offset low interest rates through loan growth, deposit mix and investment management. Future dividends remain at the board’s discretion.
- Acquisition: In May, the bank agreed to acquire First Community Bank for $14.75 cash. The target had about $100 in assets and four branches; closing was expected in October 2015, subject to completion. Management estimated cost savings of approximately 40% of the target’s operating expenses and expected the deal to be accretive in its first full year. Required regulatory approvals had been received.
- Interest-rate risk: The one-year rate-sensitive assets-to-liabilities ratio was 0.72. The company’s model estimated that a gradual +100 basis-point rate change would reduce annual net interest income by 0.2%, while a -100 basis-point change would reduce it by 1.2%. Management cautioned that model assumptions and low-rate conditions limit reliability. Cash-flow swaps covered $200 of loans and were intended to provide some protection in a prolonged low-rate environment.
- Credit and investment risks: The allowance was 1.01% of loans; net charge-offs were $10.9 for the first half. Classified loans rose to $79.9 from $67.8 at year-end, despite lower total criticized loans. Oil-and-gas-industry commitments were $139.7, with $59.4 outstanding. Pooled trust-preferred securities had a $41.7 book value, $35.5 fair value, and $6.2 unrealized loss; management noted below-investment-grade ratings, illiquidity, and possible future impairment.
- Unusual items: Q2 included $1.1 of write-downs on three other-real-estate-owned properties and a $0.4 write-down on a bank building expected to be sold. First-half operational losses were largely attributed to fraud associated with several merchant debit-card breaches. The company repurchased approximately 2.9 million shares for $25.0 under a program completed in May.
- Contingencies and controls: Management said ordinary-course legal proceedings were not expected to have a material adverse effect, while acknowledging litigation uncertainty. It reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the First Community Bank acquisition closed on the expected timetable and whether projected savings and accretion were achieved.
- Subsequent trends in criticized and classified loans, nonperforming assets, charge-offs, and allowance coverage—especially the significant commercial relationships described in the filing.
- Oil-and-gas borrower performance and any additional exposure or credit deterioration.
- Changes in deposit balances and funding mix, short-term borrowing reliance, and sensitivity of net interest income to rate movements.
- Performance and valuation assumptions for pooled trust-preferred securities, including whether cash-flow expectations or impairment assessments changed.
- Any further debit-card fraud losses, property write-downs, or other nonrecurring costs, and the sustainability of earnings excluding these items.