Business context and reporting period
First Commonwealth Financial Corporation is a Pennsylvania-based financial holding company providing commercial and consumer banking, wealth management and insurance services, principally in Pennsylvania and Ohio. This Form 10-K covers the year ended December 31, 2017; quarterly figures below identify fourth-quarter performance. The April 2017 acquisition of DCB Financial expanded the company’s central Ohio presence.
Financial performance and condition
| Metric | 2017 | 2016 |
|---|---|---|
| Total assets at year-end | $7.31 billion | $6.68 billion |
| Loans at year-end | $5.41 billion | $4.88 billion |
| Deposits at year-end | $5.58 billion | $4.95 billion |
| Net interest income | $228.8 million | $199.0 million |
| Net interest margin, fully taxable-equivalent | 3.57% | 3.32% |
| Net income | $55.2 million | $59.6 million |
| Diluted earnings per share | $0.58 | $0.67 |
| Return on average assets / equity | 0.77% / 6.45% | 0.89% / 8.02% |
| Operating cash flow | $88.3 million | $89.3 million |
Total noninterest income was $80.3 million, up 24%; noninterest expense was $200.3 million, up 25%. The allowance for credit losses was $48.3 million, or 0.89% of loans, versus $50.2 million, or 1.03%, a year earlier. Nonperforming loans were $42.2 million (0.78% of loans), compared with $41.8 million (0.86%). Net charge-offs fell to $7.0 million from $19.1 million.
Year-end deposits were 87% of liabilities. Short-term borrowings were $707.5 million, down from $867.9 million; subordinated debentures were $72.2 million and total long-term debt, including the capital lease obligation, was $87.9 million. The net loans-to-deposits ratio was 96.03%. The company and bank reported fully phased-in Basel III capital ratios above applicable minimums; the bank’s total capital ratio was 11.83% and common equity Tier 1 ratio was 10.94%.
Cash and cash equivalents declined $8.4 million to $107.3 million. Investing activities used $52.8 million and financing activities used $43.9 million. The bank reported $785.8 million of unused Federal Reserve borrowing capacity and $1.6 billion of maximum FHLB capacity, with $0.6 billion outstanding.
Material changes versus prior period
- Net income declined 7.4% despite higher net interest income and noninterest revenue. A $16.7 million noncash tax charge from remeasuring deferred tax assets under the Tax Cuts and Jobs Act and $7.0 million of additional merger-related expense were significant factors. The reported effective tax rate rose to 47%; excluding the tax-remeasurement charge, management calculated 31%.
- Net interest income increased 15% on a fully taxable-equivalent basis, reflecting 7% growth in average earning assets and improved asset yields. The average cost of interest-bearing liabilities also rose, to 0.44% from 0.39%.
- Provision for credit losses fell to $5.1 million from $18.5 million. Loan growth was 11%; $383.1 million of loans and $484.4 million of deposits were acquired with DCB. Deposits grew 13%, and short-term borrowings decreased 18%.
- Shareholders’ equity increased to $888.1 million, including $110.7 million of stock issued for the DCB acquisition. Average diluted shares rose about 7%, principally due to the acquisition issuance.
Outlook, commentary, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management cited balance-sheet growth, loan yields and interest-rate movements as important drivers of future net interest income. It also noted that $3.5 billion of interest-sensitive assets would reprice or mature within twelve months. Modelled 12-month net interest income sensitivity to an immediate 100-basis-point increase was +5.94%; a 100-basis-point decrease was -6.74%. Management cautioned that these estimates depend on assumptions about deposit pricing, prepayments and customer behavior.
In January 2018, the company announced a proposed acquisition of Foundation Bank in the Cincinnati area for approximately $58 million, subject to regulatory approval and then expected to close in the second quarter of 2018. A February 2018 auction call on pooled trust preferred security PreTSL XIV was expected to result in a par redemption; its year-end book value was $13.1 million.
Key risks include interest-rate and funding sensitivity, real-estate concentration (about 68% of loans were secured by real estate), borrower credit deterioration, competition, regulatory and consumer-compliance requirements, cybersecurity and third-party service-provider disruptions, and goodwill valuation. Pooled trust preferred securities had a $23.6 million fair value and included below-investment-grade, illiquid exposures. The company reported no 2017 other-than-temporary impairment charges on investment securities. Management said pending or threatened litigation was not expected to create a material consolidated financial-position impact; reasonably possible losses beyond recorded liabilities were estimated at $0 to $7 million, though period-specific effects on earnings or cash flows could not be ruled out. Auditors issued unqualified opinions on the financial statements and internal controls; management also concluded controls were effective.
Most important facts for investors to verify
- How much of loan, deposit and earnings growth is organic versus attributable to DCB and other branch acquisitions, and whether acquisition-related costs and expected synergies develop as anticipated.
- The sustainability of the improved net interest margin as funding costs rise, including the company’s interest-rate sensitivity assumptions and certificate-of-deposit repricing schedule.
- Credit quality and reserve adequacy, particularly commercial real estate exposures, indirect auto charge-offs, nonperforming loans and the allowance’s decline as a share of loans.
- The remaining tax-reform accounting estimates and the recurring effective tax rate after the one-time deferred-tax remeasurement.
- Completion, regulatory approval and integration of the Foundation Bank transaction, as well as the valuation and cash realization of the remaining pooled trust preferred investments.