First Commonwealth Financial Corporation — Q1 2018 Form 10-Q
Business context and period. First Commonwealth is a regional financial services company with banking operations. This unaudited report covers the three months ended March 31, 2018; income and cash-flow comparisons are with Q1 2017, while balance-sheet comparisons are generally with December 31, 2017. Amounts below are in U.S. dollars.
Key financial results
- Profit: Net income was $23.3 million, or $0.24 per diluted share, versus $15.9 million, or $0.18, a year earlier. Return on average assets was 1.29% and return on average equity was 10.57%, compared with 0.96% and 8.51%.
- Revenue and margin: Net interest income was $59.7 million, up from $51.8 million; on a fully taxable-equivalent basis it was $60.2 million versus $52.8 million. Net interest margin on that basis rose to 3.69% from 3.50%. Noninterest income increased to $22.0 million from $16.9 million.
- Expenses and credit costs: Noninterest expense was $46.9 million, up 10%. Provision for credit losses rose to $6.9 million from $3.2 million. The income-tax provision fell to $4.7 million from $6.9 million, reflecting the federal statutory rate reduction from 35% to 21%; the reported effective tax rates were 18.9% and 30.2%.
- Balance sheet: Total assets were $7.32 billion, deposits $5.70 billion, and shareholders’ equity $899.3 million at March 31. Portfolio loans were $5.38 billion, down $26.1 million from year-end; total loans were higher year over year, supported in part by the 2017 DCB acquisition.
- Debt and liquidity: Short-term borrowings were $588.0 million and long-term debt, including subordinated debentures and capital leases, totaled $87.7 million. Deposits increased $122.8 million during the quarter. Cash and cash equivalents ended at $75.6 million, down $31.7 million from year-end. Operating cash flow was $21.4 million; investing activities used $47.3 million and financing activities used $5.7 million.
- Capital: The company and its bank reported meeting applicable capital requirements and being well-capitalized. The holding company’s total risk-based capital ratio was 12.86% and common equity Tier 1 ratio was 10.71%.
Material changes and notable items
- Net income growth reflected higher net interest and noninterest income, partly offset by increased operating expenses and credit-loss provision. The lower tax rate also contributed materially.
- Net interest income benefited from a $483.6 million increase in average interest-earning assets and a 33-basis-point rise in their taxable-equivalent yield. Higher rates also increased funding costs.
- Noninterest income included $2.8 million of securities gains from a successful call of a pooled trust preferred security, versus $0.7 million in Q1 2017, and a $0.8 million favorable mark-to-market change on customer-related interest-rate derivatives. The derivative mark was unrealized.
- Nonperforming loans rose to $57.3 million from $42.2 million at year-end; nonperforming loans were 1.06% of total loans. The allowance was $53.7 million, or 1.00% of loans, and covered 93.84% of nonperforming loans. Management attributed higher specific reserves mainly to two commercial relationships.
- Available-for-sale securities had $20.8 million of gross unrealized losses at quarter-end, compared with $14.3 million at year-end; management attributed most losses to market interest-rate changes. No other-than-temporary impairment charges were recorded in the quarter.
- On May 1, 2018, after quarter-end, the company completed its acquisition of Garfield Acquisition Corp. and Foundation Bank, which had approximately $207 million of assets and five full-service offices.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management cautions that Q1 results are not necessarily indicative of full-year results.
- Management described interest-rate, credit, liquidity, economic, regulatory, technology, competition, acquisition-integration and legal risks. Its rate-sensitivity model estimated that an immediate 100-basis-point rise could increase annual net interest income by 4.35%, while a 100-basis-point decline could reduce it by 5.35%; management notes the model depends on assumptions and is less meaningful in a declining-rate scenario.
- Unused commitments to extend credit totaled $1.78 billion. The company also reported substantial available borrowing capacity, including $1.5 billion at the FHLB and $781.1 million under the Federal Reserve borrower-in-custody program, with no borrowings under the latter at quarter-end.
- A Pennsylvania vehicle-repossession class action had preliminary settlement approval as of March 31, with final approval scheduled for July 23, 2018. The company had recorded its estimated settlement liability in 2016. Management said aggregate reasonably possible litigation losses beyond any existing liability ranged from zero to $1 million, while noting outcomes could affect a future period’s results or cash flows.
- The company declared a quarterly dividend of $0.09 per share on April 24, payable May 18, an increase of 12.5% from $0.08. Future dividends remain subject to board discretion.
Important facts for investors to verify
- Whether the higher provision and increased nonperforming loans reflect isolated borrower issues or broader deterioration; track criticized loans, specific reserves, charge-offs and allowance coverage.
- How sustainable earnings are after excluding the securities gain and derivative mark-to-market benefit, and how deposit and borrowing costs respond to rate changes.
- The liquidity and funding mix after the quarter, including deposit retention and reliance on short-term borrowings and wholesale facilities.
- The final approval and cost of the repossession settlement, and integration and financial effects of the Foundation Bank acquisition.
- The filing reports no material change to the risk factors in the 2017 Form 10-K; investors should review that filing for the fuller risk discussion.