First Commonwealth Financial Corporation — 2015 Form 10-K
Business context and reporting period
Annual report for the fiscal year ended December 31, 2015; comparisons are primarily with 2014. First Commonwealth is a Pennsylvania-based financial holding company providing commercial and consumer banking, trust and wealth management, and insurance services. At year-end it had $6.57 billion in assets, $4.68 billion in loans and $4.20 billion in deposits. In October 2015, it acquired Columbus-based First Community Bank for $14.75 million, adding four branches and expanding into central Ohio.
Financial performance and condition
- Earnings: Net income was $50.1 million, or $0.56 per diluted share, versus $44.5 million, or $0.48, in 2014. Return on average assets was 0.78% (0.71% in 2014); return on average equity was 6.98% (6.18%).
- Revenue and margin: Net interest income was $188.5 million, up $4.8 million. On a fully taxable-equivalent basis, it was $191.9 million, up 3%; net interest margin edged up to 3.28% from 3.27%. Noninterest income was $61.3 million, up 1%. Noninterest expense fell 4% to $163.9 million.
- Credit costs and asset quality: Provision for credit losses rose 34% to $14.9 million. Net charge-offs increased to $16.2 million from $13.4 million. Nonperforming loans declined to $50.8 million, or 1.09% of loans, from $55.3 million, or 1.24%. The allowance was $50.8 million, equal to 1.08% of loans and 99.9% of nonperforming loans.
- Balance sheet and funding: Assets increased 3% to $6.57 billion and loans grew 5% to $4.68 billion. Deposits fell 3% to $4.20 billion. Short-term borrowings rose 37% to $1.51 billion, while long-term debt declined 50% to $81.5 million. The net loans-to-deposits ratio increased to 110.42% from 102.08%.
- Liquidity and cash flow: Operating cash flow was $72.8 million; investing activities used $142.4 million and financing activities provided $64.6 million. The company reported $69.5 million in cash and cash equivalents at year-end. Available borrowing capacity included $641.9 million at the Federal Reserve, with none drawn, and $170 million in correspondent-bank lines, of which $4 million was outstanding. Federal Home Loan Bank capacity was $1.6 billion, with $1.4 billion borrowed.
- Capital and shareholder returns: The company and bank were reported well-capitalized and above fully phased-in Basel III minimums. At year-end, the company’s total risk-based capital ratio was 12.25%, CET1 was 10.00%, and leverage ratio was 9.85%. It declared $0.28 per share in dividends and repurchased $25.4 million of stock during 2015.
Changes versus 2014
- Net income improved by $5.7 million, supported by higher net interest income and lower noninterest expense. Lower average funding costs and balance-sheet growth offset pressure on asset yields.
- Credit provision increased, driven mainly by specific reserves or charge-offs involving commercial borrowers; net charge-offs also rose despite improving nonperforming loan measures.
- Funding composition shifted: time deposits declined, while short-term wholesale borrowings increased substantially. Management said this reflected lower-cost wholesale funding replacing certificates of deposit and higher-cost debt.
- Noninterest expense included $0.9 million of First Community acquisition costs and $2.1 million in one-time severance charges. The 2014 comparison included $5.6 million of IT-conversion-related accelerated depreciation, $1.8 million of other conversion costs and an $8.6 million litigation reserve.
Outlook, commentary, risks and unusual items
Management provided no specific earnings or growth guidance. It cited ongoing pricing pressure and runoff of higher-yielding assets, while expecting deposit mix to continue improving as certificates of deposit mature or reprice. It used $200 million of cash-flow interest-rate swaps to fix rates on a portion of LIBOR-based commercial loans. Its year-end sensitivity analysis estimated that an immediate 100-basis-point rate increase would raise 12-month net interest income by 0.94%; a 100-basis-point decrease would reduce it by 2.63%. Management cautioned that models rely on assumptions and that falling-rate estimates are less reliable in the low-rate environment.
Key risks include interest-rate changes, real-estate collateral values, economic conditions, loan-loss estimation, competitive pressure, cybersecurity and third-party system reliance, and regulatory requirements. Real estate secured approximately 62% of loans. Oil-and-gas-related commitments were $144.2 million, with $65.2 million outstanding; certain borrowers faced pressure from lower energy prices. The filing also reports a putative class action concerning vehicle repossession and deficiency-collection practices. Management contests the allegations; aggregate reasonably possible litigation losses beyond recorded liabilities were estimated at $0–$5 million, though outcomes could affect a particular period.
Other notable items: the company recorded $3.1 million of OREO and branch-property write-downs/losses, and agreed to a $0.7 million disputed Pennsylvania tax assessment. A new $25 million stock-repurchase authorization was announced in February 2016. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded disclosure controls were effective.
Important facts for investors to verify
- Whether commercial credit exposures, including energy-sector borrowers, produce further losses and whether the allowance remains adequate.
- Whether the higher reliance on short-term borrowings and the 110.42% loan-to-deposit ratio remain manageable as deposits and lending needs change.
- Whether net interest margin and earnings withstand asset-yield pressure, rate changes and the maturity or repricing of deposits.
- How the First Community acquisition performs, including integration costs, acquired-asset valuations and contribution to growth.
- Developments in the vehicle-repossession litigation, OREO valuations and other contingencies.