Business context and reporting period
First Commonwealth Financial Corporation is a Pennsylvania-based financial holding company providing consumer and commercial banking, trust and wealth management, and insurance services, primarily in western and central Pennsylvania. This Form 10-K covers the fiscal year ended December 31, 2012; the filing also reports fourth-quarter results. The company operated 112 community banking offices and reported $6.0 billion in total assets at year-end.
Financial performance and condition
| Metric | 2012 | 2011 |
|---|---|---|
| Net income | $42.0 million; $0.40 diluted EPS | $15.3 million; $0.15 diluted EPS |
| Net interest income | $188.9 million GAAP; $193.3 million fully taxable-equivalent | $189.9 million GAAP; $195.4 million fully taxable-equivalent |
| Net interest margin | 3.61% fully taxable-equivalent | 3.80% fully taxable-equivalent |
| Provision for credit losses | $20.5 million | $55.8 million |
| Net charge-offs | $14.6 million; 0.35% of average loans | $65.8 million; 1.62% of average loans |
| Total assets / loans / deposits | $6.0 billion / $4.2 billion / $4.6 billion | $5.8 billion / $4.0 billion / $4.5 billion |
| Shareholders’ equity | $746.0 million | $758.5 million |
| Operating cash flow | $78.7 million | $84.1 million |
Profitability improved: return on average assets was 0.71% versus 0.27%, and return on average equity was 5.46% versus 2.00%. Total noninterest income was $65.4 million, up 13%, including a $7.4 million year-over-year improvement in derivative mark-to-market results. Noninterest expense was essentially flat at $177.2 million. Fourth-quarter 2012 net income was $8.7 million, or $0.09 per diluted share.
Loans grew 4% during 2012, led by residential real estate, commercial lending and indirect auto lending. The allowance for credit losses was $67.2 million, or 1.60% of loans, compared with $61.2 million, or 1.51%, a year earlier. Nonperforming loans were $107.6 million, or 2.56% of loans, versus $112.2 million, or 2.76%. Commercial real estate made up 47% of nonperforming loans.
Deposits increased 1% to $4.56 billion, with growth in lower-cost transaction and savings accounts partly offset by declining time deposits. Short-term borrowings were $356.2 million; long-term debt, including subordinated debentures, totaled $280.2 million, up from $207.4 million. The bank reported regulatory capital ratios well above minimums: First Commonwealth Bank’s total risk-based capital ratio was 13.75%, Tier 1 risk-based ratio 12.49%, and leverage ratio 10.64%; it was classified as well-capitalized.
Material changes versus the prior year
- Net income rose by $26.7 million, primarily reflecting a $35.3 million reduction in credit-loss provision expense, partly offset by lower net interest income and higher operational losses.
- Net interest margin contracted 19 basis points as asset yields fell faster than funding costs; the average earning-asset yield declined to 4.18% from 4.61%, while the cost of interest-bearing liabilities fell to 0.70% from 0.99%.
- Net charge-offs fell substantially from 2011, while the allowance balance and allowance-to-loan ratio increased.
- Loans increased $161.1 million. Deposits rose $53.2 million; short-term borrowings and long-term debt increased by $43.5 million and $72.8 million, respectively.
- The company repurchased approximately 5.66 million shares under its $50 million authorization during 2012. Cash dividends declared increased to $0.18 per share from $0.12.
Outlook, risks, contingencies and unusual items
Management said low interest rates and runoff of higher-yielding assets would continue to pressure margins; approximately $2.8 billion of interest-sensitive assets were expected to reprice or mature over the following 12 months. About $511 million of certificates of deposit were also expected to mature or reprice over that period. No specific earnings or revenue guidance was provided.
Credit and real estate exposures remain key risks: about 62% of loans were secured by real estate, and management cited ongoing stress in commercial real estate and construction lending. The filing also identifies sensitivity to interest rates, economic conditions, competition, regulatory changes, and cyber and operational risks. The company’s interest-rate model showed a 12-month net-interest-income decline of $4.8 million under a 100-basis-point rate decrease and an increase of $0.5 million under a 100-basis-point increase; management cautioned that model assumptions may not match actual results.
A fraudulent wire-transfer incident involving a commercial customer’s compromised computer system resulted in a $3.5 million charge. The filing said the company’s own systems were not breached; an insurance claim, subject to a deductible of up to $0.5 million, was pending and no receivable had been recorded. Management reported enhanced monitoring and security procedures.
The investment portfolio included $51.9 million book value of pooled trust preferred securities, with fair value of $23.4 million and approximately $28.5 million in gross unrealized losses. No credit-related impairment charge was recorded in 2012, but future impairment remains possible. Net deferred tax assets were $64.1 million, with no valuation allowance; realization depends on future taxable income. Goodwill was $159.9 million and was not considered impaired, though the annual test’s estimated fair value exceeded carrying value by only about 6%.
A class action concerning the interest rate on certain IRA accounts remained on appeal after a trial court dismissed the claims in 2012. The company reported $1.5 billion of commitments to extend credit and a $2.4 million reserve for probable losses on unused commitments and letters of credit. Subsequent events included authorization of an additional $25 million share-repurchase program and the planned redemption of approximately $32.5 million of 9.50% capital securities in 2013. KPMG issued unqualified opinions on the financial statements and internal controls; management also concluded internal controls were effective at year-end.
Important facts for investors to verify
- Whether lower credit costs are sustainable and how commercial real estate nonperforming loans, criticized loans, and charge-offs develop.
- Whether net interest margin stabilizes as assets and certificates of deposit reprice, and how actual results compare with the company’s interest-rate sensitivity model.
- Recoverability and valuation assumptions for trust preferred securities, deferred tax assets, and goodwill.
- Outcome of the cyber-fraud insurance claim and any further operational or fraud losses.
- Funding mix, borrowing growth, liquidity availability, capital levels, and the effect of share repurchases and planned debt redemptions.