First Commonwealth Financial Corporation — 2014 Q3 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods unless otherwise noted. First Commonwealth is a bank holding company. Dollar amounts below are in millions unless stated otherwise.
Key financial metrics
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net income | $12.5 | $15.9 | $36.7 | $32.2 |
| Diluted EPS | $0.13 | $0.16 | $0.39 | $0.33 |
| Net interest income, GAAP | $46.6 | $47.2 | $137.5 | $138.3 |
| Net interest margin, fully taxable equivalent | 3.26% | 3.43% | 3.28% | 3.41% |
| Provision for credit losses | $2.1 | $2.7 | $8.6 | $18.0 |
| Total noninterest income | $15.1 | $17.1 | $47.0 | $46.9 |
| Total noninterest expense | $41.6 | $40.0 | $123.9 | $123.5 |
Balance sheet at September 30, 2014: Assets were $6,356.1, up from $6,214.9 at December 31, 2013. Portfolio loans were $4,411.5, up $127.6; deposits were $4,372.4, down $231.5. Cash and cash equivalents totaled $84.1. Short-term borrowings were $1,035.0, compared with $626.6 at year-end; long-term debt was $188.7, including $72.2 of subordinated debentures. Shareholders’ equity was $709.5.
Cash flow for the first nine months: Operating activities provided $57.6; investing activities used $149.5; financing activities provided $98.5. Cash and cash equivalents increased $6.6 to $84.1.
Material changes and management commentary
- Q3 net income fell about 21% year over year, mainly as noninterest income declined and noninterest expense rose. Nine-month net income increased about 14%, primarily because credit-loss provision expense was lower.
- Net interest margin compressed 17 basis points in Q3 and 13 basis points year to date. Management attributed pressure to lower asset yields, repricing of adjustable-rate loans, runoff of higher-yielding assets and lower yields on new loans and investments. Lower funding costs and growth in earning assets partly offset the pressure.
- Credit measures improved overall: nonperforming loans were $45.3, or 1.03% of loans, versus $59.4, or 1.39%, at year-end 2013. The allowance was $50.8, or 1.15% of loans, and equaled 112.21% of nonperforming loans. Nine-month net charge-offs were $12.1, versus $30.2 in 2013. Commercial lending still accounted for most nonperforming loans and net charge-offs; a $5.8 charge-off related to an energy-services borrower was a notable item.
- Deposits declined, while short-term borrowings increased substantially. Management reported available liquidity sources including FHLB and Federal Reserve borrowing capacity, CDARS and other funding channels. CDARS capacity was $950.7, with $194.6 outstanding; FHLB capacity was $1.6 billion, with $988.6 outstanding and $28.2 of letter-of-credit commitments against capacity. The FRB collateral program had $702.4 of capacity and no outstanding borrowings.
- Regulatory capital ratios showed the company and bank above applicable minimums and classified as well-capitalized. At the company, total risk-based capital was 12.77%, Tier 1 risk-based capital 11.73%, and Tier 1 leverage 9.79%. Management expected to remain well-capitalized under upcoming capital rule changes.
Outlook, risks, contingencies and unusual items
- Technology conversion: The core processing conversion was completed in Q3. Charges totaled $11.8 over four quarters, including $7.3 recognized in the first nine months of 2014. Management expected quarterly savings of approximately $1.5–$1.7 beginning with the full effect in Q4 2014; these are estimates, not reported results.
- Interest-rate strategies: The company sold and reinvested about $132.9 of securities, increasing portfolio yield by 7 basis points and duration by 2.4 months. It also entered cash-flow swaps covering $100.0 of LIBOR-based commercial loans. Management estimated these actions could add about $1.8 of pretax income on an annualized basis in the first year if short-term rates remain low. Results depend on market conditions and modeling assumptions.
- Interest-rate exposure: Management’s 12-month model estimated annual net interest income changes of -$0.5 for a 100-basis-point rate increase and -$0.1 for a 200-basis-point increase; decreases of 100 and 200 basis points were estimated at -$2.7 and -$6.4, respectively. The filing cautions that the model is less reliable in a 200-basis-point decline scenario.
- Credit and investment risks: Management cited economic and real-estate weakness, borrower defaults, interest-rate changes and uncertainty in collateral values as risks to credit quality and allowance estimates. Available-for-sale securities included $29.5 fair value of pooled trust-preferred debt obligations, rated below investment grade, with $12.5 in unrealized losses. No impairment charge was recorded in the period, but future impairment remains possible.
- Legal matters: Market Rate Savings IRA litigation continued. A trial in the McGrogan matter was scheduled for January 20, 2015; related individual actions were proceeding on limited claims. The bank stated it believed the claims lacked merit. Management said other ordinary-course proceedings were not expected to have a material adverse effect, while acknowledging litigation uncertainty.
- Other items: A tax-reporting contingency reserve was reduced by $0.3 after a $0.4 settlement, with an estimated remaining liability of $0.1. The company acquired Thompson/McLay Insurance Associates on October 1, 2014; management expected the acquisition to be minimally accretive near term. The quarterly dividend was $0.07 per share, and the company completed a $25.0 million repurchase authorization during 2014.
- The filing provides no formal earnings or revenue guidance. Management’s estimates on conversion savings and interest-rate strategies are the principal quantified forward-looking expectations presented.
Important facts for investors to verify
- Whether margin pressure continues and whether the expected Q4 technology-conversion savings are realized.
- Whether lower nonperforming loans and charge-offs persist, and whether commercial borrower exposures require additional provisions or charge-offs.
- How the higher short-term borrowing balance, deposit contraction and available contingent funding affect funding costs and liquidity.
- Whether pooled trust-preferred securities or other investments incur impairment, given low ratings, illiquidity and significant unrealized losses.
- Developments in the IRA litigation and the remaining tax-reporting contingency.
- Capital, dividend and buyback capacity under evolving regulatory requirements and future earnings conditions.