First Commonwealth Financial Corporation — Q2 2014 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2014. Unaudited consolidated results; dollar amounts below are in millions unless otherwise stated.
Financial performance and condition
| Metric | Q2 2014 / June 30, 2014 | Comparable period / prior year-end |
|---|---|---|
| Net income | $11.9; diluted EPS $0.13 | Q2 2013: $5.8; $0.06 per diluted share |
| Six-month net income | $24.2; diluted EPS $0.26 | First half 2013: $16.4; $0.17 per diluted share |
| Net interest income | Q2: $45.4 GAAP; $46.2 fully taxable equivalent (FTE). First half: $91.0 GAAP; $92.7 FTE. | Q2 2013 FTE: $46.7; first half 2013 FTE: $93.2 |
| Net interest margin | Q2: 3.26%; first half: 3.30% (FTE) | Q2 2013: 3.35%; first half 2013: 3.40% |
| Noninterest income and expense | Q2 income $17.0; expense $42.4. First-half income $31.9; expense $82.3. | Q2 2013: $14.9 and $42.0; first half 2013: $29.8 and $83.5 |
| Credit provision | Q2: $3.3; first half: $6.5 | Q2 2013: $10.8; first half 2013: $15.3 |
| Total assets / loans | Assets $6,300; portfolio loans $4,334 | December 31, 2013: assets $6,215; loans $4,284 |
| Deposits / borrowings | Deposits $4,460; short-term borrowings $846; long-term debt including subordinated debentures $209 | December 31, 2013: deposits $4,604; short-term borrowings $627; long-term debt $217 |
| Shareholders’ equity | $725 | December 31, 2013: $712 |
- Q2 pretax income was $16.7 versus $7.8 a year earlier. Management attributed the earnings improvement chiefly to lower credit-loss provision and lower core noninterest expense; higher gains on asset sales also contributed.
- First-half cash from operations was $46.7, investing activities used $67.9, and financing activities provided $41.7. Cash and cash equivalents increased $20.6 to $98.0.
- First-half operating cash flow exceeded the prior-year $43.7; investing outflow was lower than the prior-year $225.8, while financing inflow fell from $161.1. Financing included a $143.4 deposit decline and increased short-term borrowings.
- At June 30, the allowance for credit losses was $50.7, or 1.17% of loans. Nonperforming loans were $46.3, or 1.07% of loans, compared with $59.4 and 1.39% at year-end. Net charge-offs for the first half were $10.0 versus $25.0 in first-half 2013.
Material changes and management commentary
- First-half FTE net interest income declined $0.5 year over year as net interest margin fell 10 basis points. Management cited repricing and runoff of higher-yielding assets and lower yields on new loans and investments; lower funding costs and growth in average earning assets partly offset the pressure.
- Loans grew $50.4, or 1%, from year-end, with growth across most categories; residential real estate loans declined. Deposits fell $143.4, including declines in time, interest-bearing demand and savings deposits, partly offset by $95.7 growth in noninterest-bearing deposits.
- Noninterest income rose $2.1 in the first half, supported by $3.0 higher gains on asset sales, including the sale of the investment advisory business and OREO properties. Excluding securities and asset-sale gains, noninterest income declined $0.9.
- Reported noninterest expense decreased $1.2 year over year in the first half, despite $5.0 of IT-conversion-related charges. Core expense excluding specified unusual items declined $4.2. The company had recognized $9.6 of approximately $12.0 in anticipated conversion charges by June 30; it expected about $2.0 more in Q3 and approximately $1.5 of quarterly savings beginning Q4 2014. Core-system conversion was expected in August 2014.
- Management said credit metrics improved overall, but cited new or continuing problem commercial credits and higher accruing delinquencies. The largest first-half charge-off included $5.8 related to an oil-and-gas servicing borrower.
Outlook, liquidity, risks and contingencies
- No formal earnings or revenue guidance was provided. Management expected the core-system conversion to produce the charges and savings described above, and planned to launch a traditional mortgage division in Q3 2014.
- Management reported the company and bank met applicable capital requirements and were well-capitalized. At June 30, holding-company ratios included total risk-based capital of 13.46%, Tier 1 risk-based capital of 12.38%, and Tier 1 leverage of 10.19%. Management expected to remain well-capitalized under forthcoming capital rules.
- Liquidity sources included core deposits, FHLB advances, federal funds and other facilities. Reported unused capacity included $941.9 under CDARS (with $185.6 outstanding), $636.6 under the Federal Reserve collateral program (none outstanding), and an unsecured $15.0 line (none outstanding). FHLB capacity was $1.6 billion, with $826.7 of borrowings and $28.2 of letter-of-credit commitments using capacity.
- The one-year interest-sensitive asset/liability ratio was 0.73. The company’s model estimated a $13,000 increase in 12-month net interest income under a gradual +100-basis-point scenario and a $1,020 increase under +200 basis points; results depend on assumptions about deposit behavior and other factors and are not forecasts.
- Available-for-sale securities included $28.2 fair value of pooled trust-preferred collateralized debt obligations, with $13.7 of unrealized losses. These securities were below investment grade and illiquid; management reported no new credit-related impairment charge in the first half but warned future impairment remained possible. Changes in rates, collateral performance and modeled cash flows could affect valuation.
- IRA Market Rate Savings litigation remained pending. Claims include individual damages sought in the McGrogan matter and three related cases; the bank said it considered the claims without merit. The filing does not provide a clear estimate of ultimate exposure. A separate tax-reporting contingency was reduced after a $0.4 settlement, with a remaining estimated liability of $0.1.
- Other identified risks include execution and customer-service disruption from the core-system conversion, economic and real-estate weakness, low interest rates and margin pressure, credit deterioration, cyberattacks and fraud, regulatory changes, and uncertain allowance and securities valuations. Management reported disclosure controls were effective and no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the August 2014 core-system conversion proceeded as planned, final conversion costs stayed near estimates, and projected quarterly savings materialized.
- Whether margin pressure persisted and whether loan growth, deposit mix and short-term borrowing levels remained sustainable.
- Whether credit quality continued to improve, especially for commercial borrowers, and whether charge-offs or provisions rose from the first-half levels.
- Whether the IRA litigation or tax-reporting matter produced material costs, settlements or changes in management’s estimates.
- Whether pooled trust-preferred securities, other securities and loan collateral required impairments, and whether capital and liquidity remained adequate as regulatory requirements changed.