First Commonwealth Financial Corporation — FY 2011 Form 10-K
Business and period: Regional financial holding company headquartered in Pennsylvania, providing banking, trust and wealth-management, and insurance services. This annual report covers the year ended December 31, 2011; selected fourth-quarter figures are noted below. At year-end, the company reported $5.84 billion in assets, $4.04 billion in loans, $4.50 billion in deposits, and $758.5 million in shareholders’ equity.
Financial performance and condition
| Metric | 2011 | 2010 |
|---|---|---|
| Net interest income | $189.9 million | $206.8 million |
| Net interest margin, fully taxable-equivalent | 3.80% | 3.88% |
| Provision for credit losses | $55.8 million | $61.6 million |
| Noninterest income | $57.7 million | $49.2 million |
| Noninterest expense | $176.8 million | $171.2 million |
| Net income | $15.3 million; $0.15 diluted EPS | $23.0 million; $0.25 diluted EPS |
| Return on average assets / equity | 0.27% / 2.00% | 0.37% / 3.33% |
| Net charge-offs | $65.8 million; 1.62% of average loans | $72.0 million; 1.61% |
Fourth quarter: Net loss was $5.7 million, or $0.05 per share, compared with $11.9 million of net income in fourth-quarter 2010. The quarter included a $25.9 million credit-loss provision, driven by revised collateral valuations, loans transferred to held for sale, and restructurings.
Cash flow and liquidity: Operating activities provided $84.1 million in cash; investing activities used $80.0 million; financing activities provided $4.5 million. Cash and cash equivalents ended the year at $78.5 million. Deposits declined $113.2 million, or 2%, while short-term borrowings increased $124.9 million to $312.8 million. Long-term debt was $207.4 million, including $105.8 million of subordinated debentures. The bank reported $697.2 million of available Federal Reserve borrowing capacity and $1.1 billion of maximum FHLB capacity, with $183.8 million outstanding there.
Credit and capital: Nonperforming loans were $112.2 million, or 2.76% of loans; other real estate owned was $30.0 million. The allowance for credit losses was $61.2 million, or 1.51% of loans, down from $71.2 million and 1.69% in 2010. The bank was classified as well capitalized: total risk-based capital of 14.1%, Tier 1 risk-based capital of 12.9%, and Tier 1 leverage of 11.4%.
Material changes versus 2010
- Net income declined $7.7 million. Lower net interest income, increased asset-sale/write-down losses, and a $6.8 million adverse change in swap counterparty credit valuation were key pressures.
- Net interest income on a fully taxable-equivalent basis fell 10%, reflecting an 8% decrease in average interest-earning assets and an 8-basis-point margin contraction. Lower funding costs partly offset lower asset yields.
- Loans fell about 4%, with construction loans down substantially; management cited tighter underwriting, reduced large exposures, weak demand, and planned runoff of residential mortgages. Investments rose 18%, mainly through purchases of agency and asset-backed securities.
- Credit indicators were mixed: criticized loans declined 44% to $292.0 million, and nonaccrual loans fell, but net charge-offs remained elevated. Commercial real estate and construction lending drove much of the provision and losses.
- Noninterest income rose 17%, including the absence of 2010 trust-preferred impairment charges and higher asset-sale gains; expenses rose 3%, largely from problem-credit workouts and property write-downs.
- Dividends declared increased to $0.12 per share from $0.06 in 2010. The company had raised approximately $81.4 million net through a 2010 common-stock offering; no shares were issued under the dividend reinvestment plan in 2011.
Outlook, commentary, risks, and unusual items
The filing provides no specific earnings or revenue guidance. Management described continued efforts to resolve problem credits, maintain tighter underwriting and geographic limits, reduce operating costs, and manage funding and interest-rate exposure. It expected residential mortgage balances to decline by approximately $60–$80 million annually under its existing strategy.
- Credit and collateral risk: About 61% of loans were real-estate-secured. Further property-value declines, weak borrower demand, or larger borrower defaults could increase losses; 13 commercial loans had commitments exceeding $25 million, totaling $440.2 million.
- Trust-preferred securities: The portfolio had $54.8 million amortized cost, $23.0 million fair value, and about $31.8 million unrealized losses at year-end. No impairment charge was recorded in 2011, but future cash-flow deterioration could trigger charges.
- Tax asset and goodwill judgments: Net deferred tax assets were $66.3 million, with no valuation allowance recorded; realization depends on future taxable income. Goodwill was $160.0 million and was not impaired, although the impairment analysis relied on significant estimates.
- Covenants: The company did not meet modified return-on-assets covenants on its $15 million credit line and ESOP loan at year-end. It obtained a waiver for the credit line for fourth-quarter 2011 and was seeking a waiver or further modification for the ESOP loan.
- Litigation: In the McGrogan class action concerning an IRA account’s promised interest rate, the court certified a breach-of-contract class but denied certification of fraud and consumer-protection claims. The company said it could not estimate reasonably possible loss; motions were pending, with argument scheduled for April 2012.
- Interest-rate exposure: Management’s model estimated a $4.0 million decline in 12-month net interest income under a 100-basis-point rate decrease and a $0.7 million increase under a 100-basis-point increase, versus unchanged rates. The filing cautions that model assumptions and very low rates limit reliability.
- Reporting and controls: Management and the auditor concluded internal control over financial reporting was effective. The filing corrected a prior-period cash-flow classification error that did not affect net income, total cash flows, or equity and was deemed immaterial.
Important facts for investors to verify
- Whether problem-credit resolutions, collateral values, charge-offs, and the allowance support the reported improvement in criticized and nonaccrual loans.
- Current performance and impairment assumptions for trust-preferred securities, including the gap between their $54.8 million cost and $23.0 million fair value.
- Compliance or waivers for the credit-line and ESOP-loan covenants, and the impact of deposit runoff and increased wholesale borrowing on funding costs.
- Whether future taxable income supports realization of the $66.3 million deferred tax asset without a valuation allowance.
- Developments in the IRA class action and any resulting loss estimate or reserve.
- Subsequent-period earnings, net interest margin, loan demand, and progress on expense reductions; the filing does not provide formal forward earnings guidance.