FIRST COMMONWEALTH FINANCIAL CORP quarterly report, Q2 FY2019

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First Commonwealth Financial Corporation — Q2 2019 Form 10-Q

Reporting period: Three and six months ended June 30, 2019; unaudited consolidated results. Comparisons are with the same 2018 periods unless otherwise noted. Amounts are in U.S. dollars.

Business context and reporting period

First Commonwealth is a regional banking and financial services company. Its balance sheet expanded during the first half of 2019, including growth in loans and deposits. The company also announced an agreement to acquire 14 Santander branches in Pennsylvania, with approximately $525 million of deposits and $120 million of loans at announcement. Regulatory approvals were obtained, and closing was expected in Q3 2019.

Financial performance and position

  • Q2 earnings: Net income was $27.3 million, or $0.28 per diluted share, versus $32.1 million, or $0.32, in Q2 2018. First-half net income was $51.9 million, or $0.53 per diluted share, versus $55.4 million, or $0.56.
  • Net interest income: Q2 GAAP net interest income was $67.1 million versus $63.7 million; fully taxable-equivalent (non-GAAP) net interest income was $67.6 million versus $64.2 million. First-half GAAP net interest income was $132.6 million versus $123.4 million; fully taxable-equivalent net interest income was $133.5 million versus $124.4 million.
  • Margin and returns: Q2 net interest margin was 3.75%, compared with 3.78%; first-half margin was 3.75%, compared with 3.74%. Q2 return on average assets/equity was 1.37%/10.84%, versus 1.71%/13.74%; first-half ratios were 1.32%/10.48%, versus 1.51%/12.20%.
  • Credit costs: Provision for credit losses was $2.8 million in Q2 versus $1.2 million; first-half provision was $6.9 million versus $8.1 million. First-half net charge-offs were $3.6 million versus $5.1 million.
  • Noninterest income and expense: Q2 noninterest income was $21.9 million versus $26.3 million; first-half income was $40.8 million versus $48.4 million. Noninterest expense rose 6% to $52.2 million in Q2 and 6% to $102.0 million for the first half.
  • Assets, loans, deposits: At June 30, total assets were $8.07 billion, portfolio loans $6.00 billion, deposits $6.16 billion, and shareholders’ equity $1.02 billion. From December 31, 2018, loans rose 4.0% and deposits increased $258 million.
  • Debt and funding: Short-term borrowings were $555.1 million, down from $721.8 million at year-end. Long-term debt totaled $234.6 million, including $170.4 million of subordinated debentures. Interest expense rose to $14.9 million in Q2 from $9.3 million.
  • Cash flow and liquidity: First-half operating cash flow was $30.1 million versus $60.6 million; investing cash outflow was $150.3 million and financing cash inflow was $117.5 million. Cash and cash equivalents ended the period at $96.3 million. The company reported unused borrowing capacity of $833 million under the Federal Reserve collateral program, $205 million of federal funds lines and $520.1 million of repo lines.
  • Capital and shareholder returns: At June 30, the company reported a 14.57% total risk-based capital ratio and 11.15% common equity Tier 1 ratio and said it met applicable requirements and was well-capitalized. First-half dividends declared were $0.20 per share versus $0.17. It repurchased 142,190 shares for approximately $4.0 million under a new $25 million authorization.

Material changes versus prior comparable periods

  • Lower reported earnings primarily reflected the absence of 2018 securities gains from the sale and calls of pooled trust preferred securities: $5.3 million in Q2 2018 and $8.1 million in the first half of 2018, compared with $6,000 in 2019 periods.
  • Higher loan yields and growth in average earning assets lifted net interest income, but higher funding costs partially offset the benefit. The first-half cost of interest-bearing liabilities increased to 1.09% from 0.64%.
  • First-half expense growth reflected higher salaries, employee benefits, occupancy and operating costs, including costs associated with the 2018 Garfield acquisition and business expansion. Q2 also included a $0.5 million commercial-property write-down.
  • Nonperforming loans were $35.6 million, or 0.59% of loans, versus $32.0 million and 0.55% at year-end; they were below $45.9 million and 0.81% a year earlier. The allowance was $51.1 million, or 0.85% of loans, and 143.62% of nonperforming loans.
  • Accumulated other comprehensive income improved to $3.7 million from a loss of $11.3 million at year-end, mainly reflecting higher fair values of available-for-sale securities.

Outlook, risks, contingencies and unusual items

  • The filing provides no specific earnings or financial guidance. Management cautions that first-half results are not necessarily indicative of full-year results.
  • The expected Q3 Santander branch acquisition would add a sizeable deposit base; integration and transaction execution remain relevant considerations.
  • Management was preparing for CECL adoption on January 1, 2020, had engaged third-party support, and was evaluating the financial impact. Parallel model runs were anticipated in Q3 2019.
  • Interest-rate modeling showed that a gradual +100 basis-point change could increase annual net interest income by 1.18%, while -100 basis points could reduce it by 3.54%. Management cautioned that model assumptions may not match actual outcomes.
  • Credit risks include changes in economic conditions, rates, borrower finances, delinquencies and collateral values. The company cited $118.0 million of criticized loans and $50.0 million of classified loans at June 30; classified loans increased 24.2% from year-end.
  • Off-balance-sheet commitments to extend credit totaled $1.90 billion, with additional standby and commercial letters of credit. These amounts are not necessarily expected cash requirements because many commitments may expire undrawn.
  • Management did not expect pending or threatened litigation to materially affect consolidated financial position; reasonably possible losses beyond recorded liabilities were estimated at $0–$1 million, though a material effect on a particular future period’s results or cash flows could not be ruled out.
  • The company adopted lease accounting in 2019 and recognized $47.6 million of operating lease assets and $51.7 million of lease liabilities at June 30. No goodwill impairment was recorded; future adverse economic or company developments could trigger a reassessment.

Important facts for investors to verify

  • Whether the Santander branch acquisition closed as expected and how deposits, loans, integration costs and funding needs developed.
  • Whether loan growth, credit quality, classified loans, nonperforming assets and the allowance remained consistent with management’s assessments.
  • Whether deposit pricing and other funding costs continued to pressure net interest margin and earnings.
  • The eventual CECL adoption impact on the allowance, retained earnings, capital and reported credit costs.
  • Actual capital and liquidity levels, including borrowing availability, alongside dividends and share repurchases.
  • Whether operating expense increases and the absence of prior-year securities gains continued to affect year-over-year profitability.