FIRST COMMONWEALTH FINANCIAL CORP annual report, FY2013

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First Commonwealth Financial Corp. — 2013 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2013. First Commonwealth is a Pennsylvania-based financial holding company providing commercial and consumer banking, trust and wealth management, and insurance services, principally in western and central Pennsylvania. At year-end it reported $6.21 billion in assets, $4.28 billion in loans, $4.60 billion in deposits and $711.7 million in shareholders’ equity.

Financial performance and condition

  • Profit and revenue: Net income was $41.5 million, or $0.43 per diluted share, versus $42.0 million, or $0.40 per diluted share, in 2012. Net interest income was $184.7 million, down 2.3%; noninterest income was $60.2 million, down 8.1%. Pretax income was $56.8 million, approximately unchanged, while lower average shares outstanding helped lift per-share earnings.
  • Margins: Fully taxable-equivalent net interest income was $188.7 million, down 2% from 2012, and net interest margin declined to 3.39% from 3.61%. The yield on earning assets fell 39 basis points to 3.79%; the cost of interest-bearing liabilities declined to 0.48% from 0.70%.
  • Credit and asset quality: Provision for credit losses decreased to $19.2 million from $20.5 million, but net charge-offs rose to $32.2 million from $14.6 million. The allowance declined to $54.2 million, or 1.27% of loans, from $67.2 million, or 1.60%. Nonperforming loans fell to $59.4 million, or 1.39% of loans, from $107.6 million, or 2.56%.
  • Balance sheet and liquidity: Assets increased 3.7% year over year; loans grew 1.9%, investments 12.5%, and deposits 1.0%. The net loans-to-deposits ratio was 91.87%, compared with 90.78%. Cash and cash equivalents ended the year at $77.4 million, down $25.5 million. Operating cash flow was $85.7 million; investing activities used $307.3 million and financing activities provided $196.0 million.
  • Debt and capital: Year-end short-term borrowings were $626.6 million, up from $356.2 million; long-term debt, including subordinated debentures, totaled $216.6 million, down from $280.2 million. First Commonwealth Bank was classified as well-capitalized: total risk-based capital was 12.87%, Tier 1 risk-based capital 11.71%, and Tier 1 leverage 9.75%.
  • Returns and shareholder distributions: Return on average assets was 0.68% versus 0.71%; return on average equity was 5.70% versus 5.46%. Dividends declared were $0.23 per share, up from $0.18. The company repurchased approximately $33.4 million of stock during 2013.
  • Fourth quarter: Net income was $9.3 million, or $0.10 per diluted share, versus $8.7 million, or $0.09, in fourth-quarter 2012. Fourth-quarter net interest income was $46.3 million versus $47.2 million; provision expense was $1.2 million versus $5.7 million.

Material changes versus 2012

  • Net income was slightly lower, but diluted EPS increased as average diluted shares declined about 7%, primarily reflecting share repurchases.
  • Net interest margin continued to contract amid low rates, competitive loan pricing and runoff of higher-yielding assets. Lower funding costs and higher average earning assets partly offset the effect.
  • Credit indicators improved overall, with lower nonperforming and criticized loans, but higher charge-offs—including large commercial borrower losses—reduced the allowance.
  • Available-for-sale securities grew, while shareholders’ equity fell to $711.7 million from $746.0 million. A $21.8 million after-tax other comprehensive loss, largely from unrealized securities losses, was a key factor.

Outlook, commentary, risks and unusual items

  • Management expected margin pressure to continue: approximately $2.9 billion of interest-sensitive assets were due to reprice or mature over the following 12 months. The filing’s rate simulation estimated a modest decline in 12-month net interest income under +100 and +200 basis-point scenarios at year-end 2013; management cautioned that model assumptions and low-rate conditions limit reliability.
  • A new core-processing system conversion was planned for the third quarter of 2014. The company expected about $12 million of related costs and projected $6–$8 million in annual technology, employment and other operating expense savings. It recorded $2.6 million of conversion expense in 2013 and recognized accelerated depreciation as equipment expense.
  • The company planned to reenter residential mortgage banking, with the division expected to begin accepting applications in the second half of 2014. A Cleveland loan production office was also planned for 2014.
  • Material risks include interest-rate and economic conditions, real-estate collateral values, credit-loss estimation, cybercrime and systems interruption, regulatory changes, and realization of the $63.2 million net deferred tax asset. The core-system conversion presents operational and customer-service risk.
  • The investment portfolio included $42.0 million book value of pooled trust-preferred securities, fair-valued at $23.5 million, with $18.5 million of unrealized losses. No new credit-related other-than-temporary impairment was recorded in 2013; future impairment remains possible.
  • Contingencies include a $0.8 million reserve for a historical tax-reporting issue affecting approximately 700–900 customers and litigation involving former IRA Market Rate Savings account holders. Management stated it believed the claims were without merit; the filing does not provide a clear estimate of potential litigation exposure.
  • The company redeemed $32.5 million of 9.50% capital securities in April 2013 and recorded a $1.6 million loss. KPMG issued unqualified opinions on the consolidated financial statements and internal control over financial reporting; management also concluded controls were effective.

Important facts for investors to verify

  • Whether credit quality continues to improve and whether the reduced allowance remains adequate given 2013 charge-offs and remaining problem credits.
  • Progress and actual costs, timing and realized savings from the 2014 core-processing conversion.
  • Net interest margin sensitivity as assets reprice, deposit costs reach practical floors and funding mix changes.
  • Performance, valuation assumptions and potential further losses in pooled trust-preferred securities and other investment holdings.
  • Liquidity and funding trends, including increased short-term borrowings, large certificate maturities and capacity available through the Federal Reserve, FHLB and CDARS programs.
  • Resolution of the IRA litigation and customer tax-reporting matter, and realization of deferred tax assets.