First Commonwealth Financial Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited consolidated statements; amounts below are in U.S. dollars, generally millions unless noted. First Commonwealth is a Pennsylvania-based financial holding company with approximately $5.7 billion in assets and a community banking franchise concentrated in western Pennsylvania.
Financial performance
| Metric | Q2 2011 | Six months 2011 | Comparison |
|---|---|---|---|
| Net interest income, GAAP | $46.9 | $94.8 | Down 10.9% and 10.4%, respectively, year over year |
| Net interest income, fully taxable equivalent | $48.3 | $97.7 | Down 13% and 12%, respectively |
| Net interest margin, fully taxable equivalent | 3.76% | 3.81% | Down from 3.88% in both comparable 2010 periods |
| Net income | $7.4 | $12.7 | Q2: $13.5 in 2010; first half: $0.4 in 2010 |
| Diluted earnings per share | $0.07 | $0.12 | Q2: $0.15 in 2010; first half: $0.00 in 2010 |
| Provision for credit losses | $9.1 | $22.9 | Q2 increased from $4.0; first half decreased from $49.0 |
| Noninterest income | $17.1 | $31.4 | Up 35% and 30%; improvement included lower impairment losses and higher securities and asset-sale gains |
| Noninterest expense | $45.7 | $87.1 | Up 5% in Q2 and 0.2% in the first half |
Financial position, cash flow and capital
- At June 30, assets were $5.69 billion, down from $5.81 billion at year-end 2010. Portfolio loans were $3.99 billion, down 5% from year-end; deposits were $4.54 billion, down $81.7 million.
- Cash and cash equivalents were $130.5 million, compared with $69.9 million at year-end. First-half cash flow was $39.2 million provided by operating activities, $159.5 million provided by investing activities, and $138.0 million used in financing activities.
- At quarter-end, short-term borrowings were $161.9 million, long-term debt $73.4 million, and subordinated debentures $105.8 million. Total shareholders’ equity was $762.1 million.
- The bank subsidiary was reported as well capitalized: total risk-based capital 14.3%, Tier 1 risk-based capital 13.1%, and Tier 1 leverage 11.3%. A quarterly dividend of $0.03 per share was declared July 19, payable August 15, 2011; management said future increases depend on consistent earnings and improving economic conditions.
Material changes and management commentary
- First-half earnings improved substantially from 2010, principally as provision for credit losses fell by $26.1 million and no securities impairment charges were recorded, versus $4.9 million in the prior-year period. In contrast, Q2 net income fell year over year as lower net interest income, a higher provision and higher expenses outweighed stronger noninterest income.
- Management attributed weaker net interest income to lower average earning assets and lower asset yields. First-half average loans declined $478.9 million year over year; the fully taxable equivalent yield on earning assets fell to 4.70% from 5.04%.
- Net charge-offs were $19.0 million in the first half, versus $42.6 million in 2010. The allowance was $75.2 million, or 1.88% of loans. Nonperforming loans were $146.9 million, or 3.68% of loans, versus $117.5 million and 2.79% at June 2010. Classified loans were $460.7 million, 11.5% of loans, down from 12.3% at year-end 2010; allowance coverage of nonperforming loans was 51%.
- Commercial real estate and construction remain key credit exposures. Other real estate owned increased to $36.5 million from $24.7 million at year-end. Troubled debt restructurings totaled $34.7 million; 15 relationships were added in the first half, increasing nonperforming loans by $21.5 million and specific reserves by $2.4 million.
- Available-for-sale securities were $1.01 billion. Pooled trust preferred collateralized debt obligations had $56.4 million amortized cost and $27.0 million fair value, with approximately $29.4 million in unrealized losses. Management recorded no related credit impairment in the first half and returned all such securities to performing status based on its cash-flow estimates; future impairment remains a stated risk.
- Management described local western Pennsylvania markets as recovering more quickly than some other regions, while noting limited recovery in commercial real estate and construction. It emphasized ongoing monitoring of problem credits and described loan runoff as a source of funds used to buy liquid investments and repay borrowings.
Outlook, risks and contingencies
- No specific earnings or financial guidance was provided. Management cautioned that interim results are not necessarily indicative of full-year results.
- The company disclosed that it was not meeting debt covenants tied to nonperforming loans on its unused $15 million unsecured credit line and its $2.6 million ESOP loan guarantee. It was working with lenders and expected a waiver or modification.
- A class action concerning the interest rate on certain IRA savings accounts received class certification on the breach-of-contract claim on July 27, 2011; fraud and consumer-protection claims were not certified. The company could not estimate a reasonably possible loss.
- Other risks cited include economic weakness, deteriorating credit quality or real estate values, interest-rate and securities-market changes, regulatory restrictions and increased compliance costs. The filing states that the bank had $1.1 billion of FHLB borrowing capacity, with $70.4 million used and $33.5 million committed for letters of credit; $657.5 million of collateral was available under the Federal Reserve borrower-in-custody program, with no borrowings outstanding.
- The filing corrected a nonmaterial 2010 cash-flow presentation error by reclassifying certain securities proceeds among investing-activity line items. It said the error did not affect net income, total net cash flows or shareholders’ equity.
Key facts for investors to verify
- Whether nonperforming loans, troubled restructurings and OREO stabilize, particularly in commercial real estate and construction.
- Whether net interest margin and net interest income recover as loan balances and yields change.
- Whether management’s projected cash flows for pooled trust preferred securities remain supportable and avoid further impairment.
- Whether lenders waive or modify the disclosed covenant defaults, and the potential exposure in the IRA class action.
- How much of the first-half earnings improvement reflects recurring operations versus lower credit provisions and securities or asset-sale gains.