First Commonwealth Financial Corporation — FY 2014 Form 10-K
Business context and reporting period. The filing covers the year ended December 31, 2014; quarterly figures are unaudited. First Commonwealth is a Pennsylvania-based financial holding company providing commercial and consumer banking, wealth and trust services, and insurance, primarily in western and central Pennsylvania. At year-end it operated 110 banking offices and reported $6.36 billion in assets, $4.46 billion in loans and $4.32 billion in deposits.
Key financial results
| Metric | FY 2014 | FY 2013 |
|---|---|---|
| Net interest income | $183.7 million | $184.7 million |
| Net interest margin, fully taxable-equivalent | 3.27% | 3.39% |
| Provision for credit losses | $11.2 million | $19.2 million |
| Noninterest income | $60.9 million | $60.2 million |
| Noninterest expense | $171.2 million | $168.8 million |
| Net income | $44.5 million | $41.5 million |
| Diluted EPS | $0.48 | $0.43 |
| Operating cash flow | $82.1 million | $85.7 million |
FY 2014 return on average assets was 0.71% and return on average equity was 6.18%, versus 0.68% and 5.70%, respectively, in 2013. For Q4 2014, net income was $7.7 million and diluted EPS was $0.08, compared with $9.3 million and $0.10 in Q4 2013.
Balance sheet, liquidity and capital
- Total assets grew 2% to $6.36 billion. Loans increased 4% to $4.46 billion, led by commercial real estate and indirect auto lending; investment securities were $1.31 billion.
- Deposits fell 6% to $4.32 billion, while short-term borrowings rose 76% to $1.11 billion. Long-term debt, including subordinated debentures, totaled $161.6 million, down from $216.6 million.
- Shareholders’ equity was $716.1 million. The year-end net loans-to-deposits ratio was 102.08%, compared with 91.87% in 2013.
- Operating cash flow was $82.1 million; cash and cash equivalents declined $2.9 million to $74.5 million. The company reported unused Federal Reserve borrowing capacity of $667.7 million and maximum FHLB capacity of $1.5 billion, with approximately $1.0 billion outstanding against the latter.
- The bank was classified as well capitalized under the requirements in effect at year-end. Its total risk-based capital ratio was 12.48%, Tier 1 risk-based ratio 11.41%, and Tier 1 leverage ratio 9.66%. Management said the company and bank were expected to meet Basel III requirements on a fully phased-in basis.
Material changes and management commentary
- Net income rose $3.0 million, mainly because the credit-loss provision declined $8.0 million; this was partly offset by lower net interest income and higher expenses.
- Net interest margin contracted as low rates, loan pricing competition and runoff of higher-yielding assets reduced asset yields. Management noted that approximately $3.0 billion of interest-sensitive assets would reprice or mature over the following 12 months, continuing pressure on margin.
- Credit quality measures improved overall: nonperforming loans declined to $55.3 million, or 1.24% of loans, from $59.4 million, or 1.39%. Net charge-offs fell to $13.4 million from $32.2 million. The allowance was $52.1 million, or 1.17% of loans, versus $54.2 million, or 1.27%.
- Deposits decreased, chiefly from time-deposit runoff. Funding shifted toward wholesale borrowings, which management said offered attractive rates compared with certificates of deposit.
- The company reentered residential mortgage lending in Q3 2014 and sold its registered investment advisory business in Q1. It also acquired an insurance agency.
- A core-system conversion was completed in Q3. Related charges totaled $7.4 million in 2014; management estimated recurring savings of approximately $1.5 million to $1.7 million per quarter from pre-conversion levels.
- Dividends declared increased to $0.28 per share from $0.23. The company repurchased $31.0 million of stock in 2014; a further $25 million repurchase authorization was approved in January 2015.
Risks, contingencies and unusual items
- A preliminary global settlement of IRA Market Rate Savings account litigation was reached in January 2015, subject to court approval and other conditions. The company recorded an $8.6 million reserve at year-end 2014.
- Oil-and-gas-industry commitments totaled $148.9 million, including $55.4 million outstanding. Two nonperforming commercial relationships in this category totaled $8.8 million; the company said both were already nonperforming before the 2014 oil-price decline. Management said it would monitor borrowers exposed to reduced drilling activity.
- Approximately 61% of loans were secured by real estate, exposing results to property values and borrower repayment capacity. Other key risks include interest-rate sensitivity, credit losses, deposit competition, cybersecurity and technology/vendor disruptions, regulation, and the valuation of goodwill and securities.
- Pooled trust-preferred securities had $41.9 million amortized cost and $29.0 million fair value, with $12.9 million unrealized losses. No 2014 other-than-temporary impairment charge was recorded, but management disclosed that future impairment remained possible.
- The parent company had a $15 million revolving credit line with no year-end balance, but was not meeting a return-on-average-assets covenant; the lender had granted a waiver.
- No formal earnings or revenue guidance was provided. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting; management also concluded internal controls were effective.
Most important facts for investors to verify
- Whether the preliminary litigation settlement receives court approval and whether the $8.6 million reserve proves adequate.
- Subsequent trends in net interest margin, particularly as the $3.0 billion of interest-sensitive assets reprice or mature and as funding relies more heavily on borrowings.
- Loan-loss trends and reserve adequacy, including exposures to commercial borrowers, real estate and oil-and-gas-related businesses.
- Realized cost savings from the core-system conversion versus the estimated quarterly savings, and any related operational or vendor issues.
- Deposit stability, borrowing capacity and covenant compliance, along with the effect of the 2015 share-repurchase authorization on capital and liquidity.