First Commonwealth Financial Corporation — Q3 2018 Form 10-Q
Business context and period: Unaudited consolidated results for the quarter and nine months ended September 30, 2018, compared with the corresponding 2017 periods. First Commonwealth is a bank holding company. In May 2018, it acquired Garfield Acquisition Corporation and Foundation Bank, adding five offices in the Cincinnati market.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income, GAAP | $63.8 million | $59.6 million | $187.2 million | $169.2 million |
| Net interest income, fully taxable equivalent | $64.3 million | $60.7 million | $188.7 million | $172.4 million |
| Noninterest income | $19.8 million | $19.8 million | $68.1 million | $55.6 million |
| Provision for credit losses | $3.0 million | $1.2 million | $11.0 million | $2.8 million |
| Noninterest expense | $49.5 million | $47.4 million | $145.5 million | $148.4 million |
| Net income | $25.1 million | $21.3 million | $80.5 million | $51.2 million |
| Diluted earnings per share | $0.25 | $0.22 | $0.81 | $0.54 |
| Net interest margin, fully taxable equivalent | 3.67% | 3.61% | 3.71% | 3.55% |
- Balance sheet at September 30: Total assets were $7.69 billion; portfolio loans were $5.66 billion and deposits $5.90 billion. Since December 31, 2017, assets rose $377.8 million, loans $255.4 million, and deposits $314.4 million.
- Profitability: Nine-month return on average assets was 1.44% (0.96% in 2017), and return on average equity was 11.53% (8.15%). The 2018 nine-month effective tax rate was 19.1%, versus 30.5%, principally reflecting the reduction in the federal statutory rate from 35% to 21%.
- Cash flow: For the first nine months, operating activities provided $93.5 million, investing activities used $206.0 million, and financing activities provided $101.4 million. Cash and cash equivalents ended at $96.2 million, down $11.1 million from year-end.
- Debt and liquidity: Short-term borrowings were $587.8 million, down from $707.5 million at year-end. Long-term debt, including subordinated debentures, was $185.3 million, compared with $87.9 million. A $100 million subordinated debt issuance in May qualified as Tier II capital. The company reported available borrowing capacity through multiple facilities, including $1.6 billion of maximum FHLB capacity and $806.6 million under the Federal Reserve collateral program; the latter was unused at quarter-end.
- Capital: Shareholders’ equity was $972.9 million. The company and bank were reported well-capitalized; company total risk-based capital was 15.08%, Tier I risk-based capital 12.57%, and common equity Tier I 11.44%.
Material changes and notable items
- Q3 net income increased 18% year over year; nine-month net income increased 57%. Management attributed improvement to higher net interest income, lower taxes, and, for the nine-month comparison, higher noninterest income and lower noninterest expense.
- Higher loan yields and growth in average earning assets lifted net interest income. At the same time, the cost of interest-bearing liabilities rose, reflecting higher market rates and funding mix. Nine-month net interest margin increased 16 basis points.
- Nine-month noninterest income included $8.1 million of securities gains, versus $0.7 million a year earlier, mainly from sale and successful calls of pooled trust preferred securities. The remaining portfolio was liquidated in the first half of 2018. A $1.2 million gain on sale of an impaired commercial loan also contributed to gains on loans and other assets.
- Credit provision rose to $11.0 million for nine months. Management cited specific reserves and charge-offs on commercial real estate and commercial borrowers, as well as net charge-offs on consumer loans. Nine-month net charge-offs were $8.6 million, versus $4.8 million in 2017.
- Nonperforming loans were $39.8 million, or 0.70% of loans, versus $42.2 million and 0.78% at year-end 2017. The allowance for credit losses was $50.7 million, 0.90% of loans, and 127.35% of nonperforming loans. Management considered the allowance adequate, while noting that economic, rate, borrower, delinquency, and collateral conditions could change estimates.
- The available-for-sale securities portfolio had $28.3 million of gross unrealized losses at quarter-end; held-to-maturity securities had $15.7 million. Management said losses primarily reflected market interest-rate movements and reported no other-than-temporary impairment charges in the nine-month period.
- Garfield consideration was $59.0 million, including $17.4 million cash and 2.7 million shares; the acquisition added $184.5 million in loans and $141.3 million in deposits and generated $19.0 million of goodwill. Acquisition-related expenses were $1.6 million for the nine months. Management said Garfield results could not be separately identified after integration.
Outlook, risks, and contingencies
- The filing provides no specific earnings or revenue guidance. Management cautions that nine-month results are not necessarily indicative of full-year results. Its forward-looking risk factors include economic and market conditions, interest rates and funding costs, borrower performance, regulation, technology and vendor reliability, competition, acquisitions and integration, and potential goodwill impairment.
- Interest-rate sensitivity modeling estimated that a gradual +100 basis-point move would increase 12-month net interest income by 1.74%, while a gradual -100 basis-point move would reduce it by 2.66%. Management cautioned that model assumptions, including deposit behavior and prepayments, may differ from actual results.
- Credit risk remains a key exposure: criticized loans were $141.6 million, up $17.2 million from year-end, while classified loans were $50.1 million, down $22.9 million. Unfunded commitments to extend credit totaled $1.85 billion; commitments may not be drawn.
- Management did not expect pending or threatened litigation in aggregate to materially affect financial position. Possible losses beyond recorded liabilities were estimated at $0 to $1 million. A previously disclosed repossession-related class action settlement received final approval and was completed in August 2018.
- On October 23, 2018, the board authorized a share repurchase program of up to $25 million and declared a $0.09 quarterly dividend, payable November 16, 2018. These occurred after quarter-end. Management expected the new lease accounting standard to increase reported assets and liabilities without a material effect on financial condition or results; the effect of CECL, effective for the company in 2020, was still being evaluated.
- Disclosure controls were considered effective. In Q3, the company moved its allowance calculation from spreadsheets to third-party software and updated related controls.
Most important facts for investors to verify
- Whether loan growth and higher asset yields can continue to offset rising deposit and borrowing costs, and how rate movements affect net interest margin.
- Whether higher credit provisions and net charge-offs persist, particularly in commercial real estate, commercial borrowers, indirect auto, and personal credit lines.
- How much of reported earnings growth depends on the lower tax rate and nonrecurring securities and loan-sale gains.
- Garfield integration, realized synergies, acquired-loan performance, and the recoverability of acquisition-related goodwill.
- Capital and liquidity after the subordinated debt issuance, dividends, and any implementation of the authorized share repurchase program.