First Commonwealth Financial Corporation — Q3 2011 Form 10-Q
Business context and period: Pennsylvania-based bank holding company. This unaudited filing covers the quarter and nine months ended September 30, 2011; balance-sheet comparisons are to December 31, 2010 unless noted. Dollar amounts below are in millions except per-share data.
Financial performance and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net income | $8.3 | $10.7 | $21.0 | $11.0 |
| Diluted EPS | $0.08 | $0.11 | $0.20 | $0.12 |
| Net interest income, GAAP | $47.5 | $51.1 | $142.2 | $156.8 |
| Net interest income, fully taxable equivalent | $48.8 | $53.1 | $146.5 | $164.2 |
| Net interest margin, fully taxable equivalent | 3.81% | 3.90% | 3.81% | 3.89% |
| Provision for credit losses | $7.0 | $4.5 | $29.9 | $53.6 |
| Noninterest income | $10.8 | $10.9 | $42.2 | $35.0 |
| Noninterest expense | $41.1 | $40.9 | $128.3 | $127.8 |
- At September 30, assets were $5.66 billion, net loans $3.90 billion, deposits $4.48 billion, and shareholders’ equity $769.0 million. Total loans were $3.97 billion, down 6% from year-end 2010; deposits declined $133 million.
- For the first nine months, operating cash flow was $58.9 million, investing cash flow was $141.7 million, and financing cash flow was negative $180.7 million. Cash and cash equivalents ended at $89.8 million, versus $135.4 million at September 30, 2010.
- The bank reported well-capitalized status: total risk-based capital 14.4%, Tier 1 risk-based capital 13.2%, and Tier 1 leverage 11.6%.
Material changes and management commentary
- Nine-month net income improved year over year, mainly because provision expense fell 44% and there were no securities impairment charges, compared with $9.2 million of impairment charges in 2010. Q3 earnings declined year over year as lower net interest income and higher credit provision more than offset other items.
- Net interest income fell as earning assets and yields declined. Nine-month average loans were down $451 million; the fully taxable equivalent yield on earning assets fell to 4.67% from 5.03%. Lower funding costs partly cushioned the decline.
- Credit indicators were mixed. Criticized loans decreased $118.8 million, or 23%, and delinquency on accruing loans declined from year-end; however, nonperforming loans rose to $161.9 million, or 4.07% of loans, from $124.2 million, or 2.89%, at December 31. Other real estate owned increased to $33.3 million from $24.7 million.
- The allowance for credit losses was $72.1 million, or 1.81% of loans, versus $71.2 million, or 1.69%, at year-end. Nine-month net charge-offs were $29.0 million. Commercial real estate and construction lending remained key areas of credit risk.
- Pooled trust-preferred securities had $56.6 million amortized cost and $24.7 million fair value, with $31.9 million in gross unrealized losses. No credit-related impairment charges were recorded in the first nine months of 2011; management cited improving underlying deferrals and defaults but warned future impairment remained possible.
- Credit-risk adjustments on interest-rate derivatives totaled $6.4 million at quarter-end, including a $4.5 million adjustment on two swaps deemed less collectible after counterparty deterioration. The income-statement charge was $5.1 million in Q3 and $5.6 million year to date.
- Management’s September goodwill test found fair value approximately 20% below book value at the first step, but the second-step analysis indicated goodwill fair value exceeded carrying value by approximately 17%; no impairment was recorded.
- Liquidity sources included $1.1 billion of FHLB borrowing capacity, of which $70.3 million was drawn and $28.2 million committed for letters of credit, plus $675.9 million of pledged collateral available under the Federal Reserve borrowing program with no outstanding balance. A $15 million unsecured line was undrawn.
- The company declared a $0.03-per-share quarterly dividend in October. Management said future increases would depend on sustained earnings and continued economic improvement; no specific earnings guidance was provided.
Risks, contingencies, and unusual items
- A class action, McGrogan v. First Commonwealth Bank, received class certification on the breach-of-contract claim in July 2011. The company could not estimate a reasonably possible loss.
- The company was not meeting an ESOP loan covenant relating to nonperforming loans as a percentage of total loans; management was working with the lender and expected a modification in Q4.
- Off-balance-sheet credit exposure included $1.44 billion of commitments to extend credit and standby letters of credit. These amounts are contractual maximums and are not necessarily expected cash requirements.
- The filing corrected a 2010 cash-flow statement classification error for certain securities proceeds. The correction did not affect net income, total cash flows, or shareholders’ equity and was deemed immaterial.
- Management identified economic weakness, real estate values, borrower defaults, securities valuations, interest-rate movements, regulatory changes, and competitive pressure among principal risks. The one-year repricing gap was liability-sensitive, and the filing’s model indicated lower net interest income in a rising-rate scenario.
Most important facts to verify
- Whether higher nonperforming loans, OREO, and construction/commercial real estate exposures lead to further charge-offs or reserve needs.
- Whether the $31.9 million unrealized loss position in pooled trust-preferred securities remains supportable under management’s cash-flow assumptions.
- Whether the swap credit adjustment and the ESOP covenant issue are resolved without additional material costs or restrictions.
- The potential outcome and financial exposure from the certified contract claim in the IRA account litigation.
- Whether margin pressure, loan runoff, and deposit trends stabilize, and whether earnings support the current dividend.