First Commonwealth Financial Corporation — Q1 2016 Form 10-Q
Business context and reporting period
First Commonwealth is a Pennsylvania-based bank holding company. This unaudited filing covers the three months ended March 31, 2016, compared with Q1 2015; balance-sheet comparisons are to December 31, 2015 unless noted. Results for the quarter are not necessarily indicative of full-year results. The company added four branch locations through its fourth-quarter 2015 First Community Bank acquisition.
Financial performance and condition
- Earnings: Net income was $12.5 million, down 12% from $14.2 million; diluted EPS was $0.14 versus $0.16. Pretax income was $17.9 million. Return on average assets was 0.76% and return on average equity 6.87%, versus 0.91% and 8.03% a year earlier.
- Revenue and margins: GAAP net interest income increased 3% to $48.8 million. On a fully taxable-equivalent basis, it was $49.7 million versus $48.0 million. Net interest margin on that basis was 3.29%, down from 3.35%. Noninterest income declined 3% to $13.7 million; noninterest expense declined 4% to $38.1 million.
- Credit costs: Provision for credit losses rose to $6.5 million from $1.2 million. Net charge-offs were $2.1 million, down from $6.5 million. The allowance was $55.2 million, or 1.15% of loans, versus $50.8 million, or 1.08%, at year-end.
- Cash flow: Operating activities provided $19.6 million, investing activities used $122.8 million, and financing activities provided $106.9 million. Cash and cash equivalents ended at $73.2 million, up $3.7 million during the quarter. Loan growth was a major investing cash use.
- Balance sheet and funding: Total assets were $6.70 billion; portfolio loans were $4.80 billion, up $115.0 million during the quarter. Deposits rose $105.8 million to $4.30 billion. The net loans-to-deposits ratio was 110.41%, compared with 102.26% a year earlier. Short-term borrowings were $1.52 billion; long-term debt, including subordinated debentures, totaled $81.3 million.
- Capital and shareholder returns: Shareholders’ equity was $733.3 million. The company and bank met regulatory capital requirements and were classified as well-capitalized; the company’s common equity Tier 1 ratio was 9.86%. The quarterly dividend was $0.07 per share. A $25 million repurchase authorization was approved in February; 19,447 shares had been repurchased under it by quarter-end.
Material changes versus the prior comparable period
- Higher credit-loss provision was the primary reason net income fell, despite higher net interest income and lower operating expense.
- Management attributed the $5.4 million year-over-year increase in provision mainly to commercial and industrial loans, including higher loss factors and a specific reserve for one relationship. Nonperforming loans increased to $61.8 million from $50.8 million at year-end, largely due to an $11.5 million steel and aluminum servicing company relationship placed on nonaccrual in Q1.
- Classified loans increased $24.4 million, or 28%, from year-end to $110.8 million; criticized loans reached $142.6 million. The allowance covered 89.33% of nonperforming loans, down from 99.94% at year-end.
- Net interest income benefited from $258.6 million growth in average earning assets and $267.0 million growth in average loans. Rate effects reduced net interest income by $1.3 million year over year; management noted higher short-term borrowing costs. The prior-year quarter included a $1.0 million FHLB special dividend, which added about seven basis points to that period’s margin.
- Noninterest income included a $1.0 million mark-to-market expense on non-hedging derivatives, versus $0.2 million in Q1 2015. Management said the change reflected fair-value movements, not an actual loss on the offsetting swap positions. Lower litigation and operational losses also reduced expense, partly because Q1 2015 included merchant debit-card fraud losses.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or financial guidance. Management described ongoing efforts to grow loans, improve deposit funding mix and investment yields, and manage interest-rate effects.
- Interest-rate modeling showed gradual +100 and +200 basis-point scenarios increasing annual net interest income by 0.65% and 1.20%, respectively; corresponding -100 and -200 basis-point scenarios reduced it by 1.79% and 3.54%. Management cautioned that assumptions and results are less reliable in a low-rate environment and in the -200 basis-point case.
- Oil-and-gas industry exposure totaled $146.3 million in commitments, including $63.7 million outstanding. The filing identifies nonperforming relationships in ancillary businesses and one nonperforming relationship in exploration and production.
- Available-for-sale pooled trust preferred securities had $42.5 million book value and $33.3 million estimated fair value, with $9.2 million of unrealized loss. The securities are below investment grade and illiquid; management reported no new credit-related impairment charge in the quarter but noted future impairment risk.
- Management estimated aggregate reasonably possible litigation losses beyond any recorded liability at $0–$7 million. A putative class action alleges deficiencies in vehicle repossession, sale and deficiency-collection practices; the company contests the claims and intends to oppose class certification.
- Management stated that disclosure controls were effective and that no material changes to internal control over financial reporting occurred during the quarter. The filing reported no material changes to the risk factors in the 2015 Form 10-K.
Important facts for investors to verify
- Whether the elevated provision, nonperforming loans and classified commercial credits stabilize or require further reserves or charge-offs.
- Whether loan growth can continue without increasing credit risk or further widening the loans-to-deposits ratio.
- How deposit and short-term borrowing costs affect net interest margin as interest rates and funding needs change.
- Whether the oil-and-gas-related borrowers and pooled trust preferred securities create additional losses or impairment charges.
- Progress and potential exposure in the repossession class action and other litigation; the disclosed $0–$7 million range is an estimate of reasonably possible aggregate losses beyond recorded liabilities.
- Execution of the $25 million share-repurchase program and the board’s future dividend decisions, which remain discretionary and depend on capital, asset quality, liquidity and earnings.