First Commonwealth Financial Corporation — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. First Commonwealth is a Pennsylvania-based bank holding company. Figures below are unaudited; dollar amounts are in millions unless noted.
Financial results and key metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net income | $17.2 | $12.4 | $41.7 | $40.1 |
| Diluted EPS | $0.19 | $0.14 | $0.47 | $0.45 |
| Net interest income, fully taxable equivalent | $50.6 | $47.6 | $150.4 | $142.8 |
| Net interest margin, fully taxable equivalent | 3.29% | 3.25% | 3.28% | 3.29% |
| Provision for credit losses | $3.4 | $4.6 | $20.3 | $8.8 |
| Noninterest income | $17.0 | $15.5 | $46.3 | $46.0 |
| Noninterest expense | $38.7 | $40.3 | $114.3 | $120.7 |
- At September 30, total assets were $6,666.5, net loans $4,805.9, deposits $4,459.0, and shareholders’ equity $751.8. Portfolio loans were $4,860.7 before the allowance.
- Cash and cash equivalents were $81.6. For the first nine months, operating cash flow was $59.9, investing cash flow was negative $110.9, and financing cash flow was positive $63.1.
- Short-term borrowings were $1,330.3, down from $1,510.8 at December 31, 2015. Long-term debt, including subordinated debentures, totaled $81.1.
- For Q3, return on average assets was 1.02% and return on average equity 9.14%; for the nine-month period, the respective figures were 0.83% and 7.53%. The nine-month dividend was $0.21 per share.
- At September 30, the allowance for credit losses was $54.7, or 1.13% of loans; nonperforming loans were $54.8, or 1.13% of loans. Net charge-offs were $16.4 for the first nine months, equal to an annualized 0.46% of average loans.
- Regulatory capital ratios exceeded stated well-capitalized thresholds. The company reported a 12.64% total risk-based capital ratio and a 10.34% common equity Tier 1 ratio; the bank reported 11.47% and 10.42%, respectively.
Changes versus comparable periods
- Q3 net income increased 39% year over year, with higher net interest income and lower provision and operating expenses. Nine-month net income increased 4% despite a substantially higher credit-loss provision.
- Nine-month net interest income on a fully taxable equivalent basis rose $7.6, mainly from growth in average earning assets. The margin was nearly unchanged year over year, while the cost of interest-bearing liabilities rose to 0.40% from 0.34%.
- Nine-month provision expense increased $11.5, primarily reflecting specific reserves on commercial borrowers and higher loss and qualitative factors. Net charge-offs increased to $16.4 from $12.4.
- Loans grew $176.9, or 4%, from year-end, with growth in commercial and commercial real estate lending; residential mortgage and consumer balances declined. Deposits rose $263.1, including growth in noninterest-bearing demand and savings deposits.
- Noninterest expense fell 5% for the nine months, led by lower salaries, occupancy, and asset write-downs; data-processing costs increased. Noninterest income was nearly flat, with higher mortgage-sale gains and swap fees offset by lower trust and insurance/brokerage income and derivative fair-value effects.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or margin guidance. Management cited continued loan growth, improved deposit mix, and reinvestment in higher-yielding securities as ways to support net interest income; funding costs and interest-rate movements remain important sensitivities.
- Management said the allowance was adequate, but credit estimates are sensitive to economic conditions, rates, borrower finances, delinquencies, and collateral valuations. Nonperforming loans rose from $50.8 at year-end; criticized loans were $137.3 and classified loans $97.3.
- Commercial credit exposures include oil and gas borrowers: $126.4 of commitments and $66.1 of outstanding loans. Several significant nonaccrual relationships involved steel/aluminum services, oil and gas services, mine-safety products, energy, and manufacturing. The filing also reports a $10.5 commercial relationship with a coal-industry customer among additions to nonperforming loans.
- Unrealized losses on pooled trust-preferred securities were $8.1; the portfolio’s book value was $43.0 and fair value $35.6. These securities are below investment grade and illiquid, and their valuation relies on management’s cash-flow and default assumptions. No impairment charge was recorded in the first nine months. Management disclosed notice in October that Pre TSL VII senior noteholders elected to liquidate the trust; proceeds were expected to approximate book value.
- Litigation includes a putative class action over vehicle repossessions. The company contests the allegations and had reached an agreement in principle to settle, subject to definitive terms and court approval; the estimated settlement cost was accrued. Aggregate reasonably possible losses beyond recorded liabilities were estimated at $0–$7.
- After quarter-end, the company agreed to acquire DCB Financial Corporation for approximately $106 in stock and cash, subject to regulatory approval and expected to close in Q2 2017. Separately, the agreed purchase of 13 FirstMerit branches, with approximately $735 in deposits and $115 in performing loans, was expected to close in Q4 2016. The $25 share-repurchase program was suspended in July in connection with the branch acquisition.
- Interest-rate sensitivity modeling estimated that an immediate +100 basis-point move would increase 12-month net interest income by 1.67%; an immediate −100 basis-point move would reduce it by 3.89%. Management cautioned that model assumptions may not reflect actual results and that falling-rate scenarios are less reliable in the low-rate environment.
Important facts for investors to verify
- Whether elevated commercial credit provisions, charge-offs, and nonperforming loans stabilize, especially among energy, industrial, and coal-related borrowers.
- Whether deposit and loan growth can sustain net interest income as funding costs rise and interest-rate conditions change.
- The final terms, regulatory approvals, timing, and integration effects of the DCB and FirstMerit transactions, including their effect on liquidity and capital.
- Subsequent performance and valuation of pooled trust-preferred securities, including the Pre TSL VII liquidation outcome.
- Settlement terms and court approval for the vehicle-repossession litigation, and any changes in the estimated exposure.