FIRST COMMONWEALTH FINANCIAL CORP quarterly report, Q2 FY2010

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First Commonwealth Financial Corporation — Q2 2010 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2010. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise. The company is a Pennsylvania-based bank holding company with 115 community banking offices, primarily in western Pennsylvania.

Financial performance

  • Q2 earnings: Net income was $13.5 million, or $0.15 per diluted share, versus a net loss of $18.6 million, or $0.22 per share, in Q2 2009. Pretax income was $17.6 million, compared with a $35.4 million pretax loss.
  • First-half earnings: Net income was $0.4 million, or $0.00 per share, versus a $16.9 million loss, or $0.20 per share, in first-half 2009. First-half pretax loss was $6.2 million; a $6.5 million income tax benefit brought net income slightly above zero.
  • Net interest income and margin: Q2 fully tax-equivalent net interest income was $55.2 million, up 1%; net interest margin was 3.88%, versus 3.73%. First-half fully tax-equivalent net interest income was $111.1 million, up 3%, and margin was 3.88%, versus 3.72%.
  • Credit costs: First-half provision for credit losses was $49.0 million, down from $56.5 million. Net charge-offs increased to $42.6 million from $26.2 million, including a $34.2 million charge-off on a Florida condominium construction loan. Allowance for credit losses was $88.0 million, or 1.99% of loans, versus $81.6 million, or 1.76%, at year-end 2009.
  • Noninterest income and expense: First-half noninterest income was $24.1 million versus $9.5 million, primarily reflecting lower securities impairment losses; excluding securities gains and impairment losses, it was broadly flat. Noninterest expense fell to $86.9 million from $88.7 million. A $2.2 million write-down of an other-real-estate-owned property partly offset expense reductions.
  • Cash flow: First-half operating cash flow was $60.3 million; investing activities provided $347.8 million, largely reflecting securities maturities and loan contraction; financing activities used $409.3 million. Cash and cash equivalents declined $1.2 million to $88.4 million.

Balance sheet, debt and liquidity

  • Total assets were $6.06 billion, down from $6.45 billion at December 31, 2009. Loans declined $202 million to $4.43 billion; deposits increased $203 million to $4.74 billion.
  • Short-term borrowings fell to $355.7 million from $958.9 million. Long-term debt, including subordinated debentures, was $261.0 million versus $274.4 million; total borrowings and debt therefore declined substantially. Shareholders’ equity rose to $654.3 million from $638.8 million.
  • Management attributed the balance-sheet shift to deposit growth, reduced loan volumes, and allowing securities to mature without replacement to pay down borrowings and reduce liquidity and interest-rate risk. The company reported $653 million of borrowing capacity through its Federal Reserve collateral arrangement and $48.9 million of CDARS brokered deposits.
  • The company and its bank subsidiary were reported as well capitalized. The bank’s total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios were 11.4%, 10.1%, and 8.8%, respectively.

Material changes, outlook and risks

  • Earnings improved sharply year over year, chiefly because provisions and securities impairment charges were lower than in 2009, alongside lower funding costs and a better deposit mix. Credit stress remained material: nonperforming loans were $133.2 million, or 3.00% of loans, versus $81.9 million, or 1.81%, a year earlier.
  • Commercial construction exposures were a particular concern. Management identified significant impaired loans tied to projects in Florida, Missouri, Nevada, and North Carolina, as well as a $44.5 million line of credit to a western Pennsylvania real estate developer. Management said it was pursuing workouts and had tightened controls on loan size, market focus, and credit concentrations.
  • The company recorded $4.9 million of first-half securities impairment losses, including $4.8 million on pooled trust-preferred CDOs. Those securities had $64.4 million amortized cost and $28.7 million fair value; five securities with $6.5 million fair value were not receiving interest. Management noted that additional impairment remained possible.
  • On June 30, the company moved its entire $22.4 million held-to-maturity securities portfolio to available-for-sale, citing plans to liquidate municipal securities to mitigate credit risk and improve its tax position.
  • No quantified earnings guidance was provided. Management emphasized continued credit-quality and liquidity management. It cautioned that results depend on economic conditions, real estate values, credit losses, interest rates, competition, regulatory developments, and the assumptions used in allowance and fair-value estimates.
  • The company disclosed it was not meeting financial-ratio covenants on its $15 million holding-company credit line and a $4.6 million ESOP loan guarantee; it was working with lenders and expected a waiver or modification. The filing does not state that either lender had granted one.
  • The Dodd-Frank Act, signed July 21, 2010, and regulatory changes to overdraft and interchange fees could increase compliance costs, constrain products or capital strategies, and reduce noninterest income; the company had not fully quantified the impact. A $0.01-per-share quarterly dividend was declared July 20, payable August 13, 2010.

Important facts for investors to verify

  • Progress, recoveries, collateral values, and any further charge-offs on the major nonperforming commercial and construction loans, especially the Florida project and western Pennsylvania developer exposure.
  • Subsequent performance and impairment assumptions for pooled trust-preferred CDOs, including interest deferrals, defaults, and estimated cash flows.
  • Whether covenant waivers or modifications were obtained, and the company’s continuing access to its credit facilities and other liquidity sources.
  • The realized effect of the held-to-maturity reclassification and planned municipal bond sales on earnings, capital, liquidity, and tax position.
  • Capital and earnings effects of regulatory changes, including Dodd-Frank and overdraft/interchange restrictions; management said impacts were not yet fully quantified.