FIRST COMMONWEALTH FINANCIAL CORP quarterly report, Q3 FY2019

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First Commonwealth Financial Corporation — Q3 2019 Form 10-Q

Business context and reporting period. This unaudited filing covers the three and nine months ended September 30, 2019. First Commonwealth is a bank holding company. On September 6, it acquired 14 Santander branches, expanding into State College, Lock Haven, Williamsport and Lewisburg, Pennsylvania.

Financial performance and position

  • Q3 results: Net income was $26.6 million, or $0.27 per diluted share, versus $25.1 million, or $0.25, a year earlier. Net interest income was $68.4 million GAAP ($68.9 million fully taxable equivalent); noninterest income was $22.2 million; and noninterest expense was $54.9 million.
  • Nine-month results: Net income was $78.5 million, or $0.80 per diluted share, compared with $80.5 million, or $0.81, in 2018. Net interest income was $201.1 million GAAP ($202.4 million fully taxable equivalent); noninterest income was $63.0 million; and noninterest expense was $156.9 million.
  • Margins and returns: Net interest margin was 3.76% for Q3 and 3.75% for the first nine months, compared with 3.67% and 3.71%, respectively, in 2018. Nine-month return on average assets was 1.32% versus 1.44%; return on average equity was 10.39% versus 11.53%.
  • Balance sheet at September 30: Assets were $8.15 billion, loans $6.10 billion, deposits $6.68 billion and shareholders’ equity $1.04 billion. Loans grew $325.4 million and deposits grew $780.0 million from December 31, 2018; the Santander transaction contributed $100.0 million of loans and $471.4 million of deposits.
  • Cash flow and liquidity: Nine-month operating cash flow was $76.8 million, investing cash flow was positive $268.3 million, and financing cash flow was negative $315.4 million. Cash and cash equivalents ended at $128.6 million. The net loans-to-deposits ratio was 90.89%, versus 95.34% at year-end 2018.
  • Funding and debt: Short-term borrowings fell to $83.7 million from $721.8 million at year-end, partly reflecting $243.3 million of repayments funded by the Santander transaction. Long-term debt was $234.4 million, including $170.4 million of subordinated debentures.
  • Credit quality: The allowance for credit losses was $50.0 million, or 0.82% of loans, versus $47.8 million and 0.83% at year-end. Nine-month net charge-offs were $7.4 million, down from $8.6 million. Nonperforming loans were $35.3 million, or 0.58% of loans, compared with $32.0 million and 0.55% at year-end. Criticized loans totaled $128.7 million; classified loans increased to $50.7 million from $40.2 million at year-end.

Material changes versus comparable periods

  • Q3 net income increased year over year, supported by higher net interest income and noninterest income, partly offset by higher operating expenses.
  • Nine-month net income declined despite higher net interest income. The primary comparison item was $8.1 million of securities gains in 2018 from the sale and redemption of pooled trust preferred securities; 2019 securities gains were negligible.
  • Nine-month fully taxable equivalent net interest income rose $13.7 million, reflecting growth in average earning assets and a 4-basis-point margin improvement. Higher funding costs partly offset the benefit.
  • Nine-month noninterest expense rose $11.3 million, including $3.7 million of Santander acquisition costs. Excluding acquisition costs, asset-sale/write-down losses and litigation/operational losses, expense increased 6%, with higher staffing and employee-benefit costs among the drivers.
  • Shareholders’ equity rose $63.6 million from year-end, reflecting net income and improved securities values, partly offset by dividends and share repurchases. Dividends declared were $0.10 per share in Q3; the board declared another $0.10 quarterly dividend payable in November.

Outlook, management commentary and risks

  • The filing gives no specific earnings or revenue guidance. Management noted that Federal Reserve rate cuts since year-end 2018 could reduce yields on variable- and adjustable-rate loans; further cuts could have a similar effect. The company’s modeled gradual-rate scenario showed annual net interest income down 2.93% with a 100-basis-point decline and up 1.45% with a 100-basis-point increase. Management cautions that such models depend on assumptions and may not match actual results.
  • Management expects an increase in the allowance for credit losses when CECL takes effect January 1, 2020, but said the amount could not yet be reasonably estimated. Model validation and a parallel run were planned for Q4 2019.
  • Credit remains a key risk: management cited higher classified loans and delinquency, and noted that economic conditions, interest rates, borrower finances and collateral values could change loss estimates. Management considered the allowance adequate at quarter-end.
  • Other stated risks include economic and market conditions, competition, interest-rate and regulatory changes, acquisition integration, technology and vendor reliability, litigation, and possible goodwill impairment. Goodwill was $303.6 million and was not considered impaired at quarter-end.
  • Commitments to extend credit were $2.0 billion. Management said pending or threatened litigation was not expected to be material to consolidated financial position; reasonably possible aggregate losses beyond any recorded liability were estimated at $0–$1 million, though future-period results or cash flows could still be affected.
  • The company reported that it and its bank subsidiary met applicable capital requirements and were considered well-capitalized. It reported no material changes to the risk factors in its 2018 Form 10-K.

Important facts for investors to verify

  1. Whether acquired Santander deposits and loans retain, and grow, as expected, and how the branches affect recurring earnings after the $3.7 million acquisition expense.
  2. Whether higher deposit costs and lower market rates pressure net interest margin and earnings, including how actual results compare with the company’s interest-rate sensitivity assumptions.
  3. Trends in classified and nonperforming loans, delinquency, net charge-offs and the allowance, particularly in commercial real estate and consumer lending.
  4. The final CECL model, transition-date allowance increase and related impact on earnings and capital.
  5. Capital, liquidity and funding levels after the acquisition, dividends and repurchases, alongside the company’s ability to manage its debt and commitments.