Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2010

Or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number 001-11138

 

 

First Commonwealth Financial Corporation

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   25-1428528

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

22 North Sixth Street, Indiana, PA   15701
(Address of principal executive offices)   (Zip Code)

724-349-7220

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨ .

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   x     Accelerated filer   ¨      Smaller reporting company   ¨      Non-accelerated filer   ¨ (Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨      No   x

The number of shares outstanding of issuer’s common stock, $1.00 par value, as of July 28, 2010, was 86,243,009.

 

 

 


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

FORM 10-Q

INDEX

 

          PAGE
   PART I. Financial Information   

ITEM 1.

   Financial Statements and Supplementary Data   
   Included in Part I of this report:   
   First Commonwealth Financial Corporation and Subsidiaries   
  

Condensed Consolidated Statements of Financial Condition

   3
  

Condensed Consolidated Statements of Operations

   4
  

Condensed Consolidated Statements of Changes in Shareholders’ Equity

   5
  

Condensed Consolidated Statements of Cash Flows

   7
  

Notes to Condensed Consolidated Financial Statements

   8

ITEM 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   33

ITEM 3.

   Quantitative and Qualitative Disclosures About Market Risk    58

ITEM 4.

   Controls and Procedures    58
   PART II. Other Information   

ITEM 1.

   Legal Proceedings    59

ITEM 1A.

   Risk Factors    59

ITEM 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    60

ITEM 3.

   Defaults Upon Senior Securities    60

ITEM 4.

   Removed and Reserved    60

ITEM 5.

   Other Information    60

ITEM 6.

   Exhibits    61
   Signatures    62

 

2


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited)

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

     June 30,
2010
    December 31,
2009
 
    

(dollars in thousands,

except share data)

 

Assets

    

Cash and due from banks

   $ 86,855     $ 89,232  

Interest-bearing bank deposits

     1,503       327  

Securities available for sale, at fair value

     996,220       1,133,856  

Securities held to maturity, at amortized cost, (Fair value $0 at June 30, 2010 and $37,586 at December 31, 2009)

     0        36,758  

Other investments

     51,431       51,431  

Loans:

    

Portfolio loans

     4,434,291       4,636,501  

Allowance for credit losses

     (88,046     (81,639
                

Net loans

     4,346,245       4,554,862  
                

Premises and equipment, net

     69,203        70,742  

Other real estate owned

     21,548       24,287  

Goodwill

     159,956       159,956  

Other intangibles, net

     6,175       7,407  

Other assets

     318,933       317,435  
                

Total assets

   $ 6,058,069     $ 6,446,293  
                

Liabilities

    

Deposits (all domestic):

    

Noninterest-bearing

   $ 651,250     $ 641,231  

Interest-bearing

     4,087,388       3,894,554  
                

Total deposits

     4,738,638       4,535,785  

Short-term borrowings

     355,682       958,932  

Subordinated debentures

     105,750       105,750  

Other long-term debt

     155,250       168,697  
                

Total long-term debt

     261,000        274,447  
                

Other liabilities

     48,499       38,318  
                

Total liabilities

     5,403,819       5,807,482  
                

Shareholders’ Equity

    

Preferred stock, $1 par value per share, 3,000,000 shares authorized, none issued

     0        0   

Common stock, $1 par value per share, 200,000,000 shares authorized; 86,971,329 shares issued and 86,242,139 shares outstanding at June 30, 2010; 86,600,431 shares issued and 85,151,875 shares outstanding at December 31, 2009

     86,971       86,600  

Additional paid-in capital

     303,961       301,523  

Retained earnings

     271,139       278,887  

Accumulated other comprehensive income (loss), net

     5,236       (6,045

Treasury stock (729,190 at June 30, 2010 and 1,448,556 shares at December 31, 2009, at cost)

     (8,457     (16,554

Unearned ESOP shares

     (4,600     (5,600
                

Total shareholders’ equity

     654,250       638,811  
                

Total liabilities and shareholders’ equity

   $ 6,058,069     $ 6,446,293  
                

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

 

     For the Quarter Ended
June 30,
    For the Six Months Ended
June 30,
 
     2010     2009     2010     2009  
     (dollars in thousands, except share data)  

Interest Income

        

Interest and fees on loans

   $ 57,367     $ 57,793     $ 114,775     $ 116,068  

Interest and dividends on investments:

        

Taxable interest

     9,664       13,177       20,131       26,885  

Interest exempt from federal income taxes

     1,839       2,660       3,990       5,554  

Dividends

     19       89       46       152  

Interest on bank deposits

     48       1       73       2  
                                

Total interest income

     68,937       73,720       139,015       148,661  
                                

Interest Expense

        

Interest on deposits

     13,067       17,874       26,647       37,450  

Interest on short-term borrowings

     616       1,133       1,468       2,480  

Interest on subordinated debentures

     1,390       1,559       2,765       3,325  

Interest on other long-term debt

     1,268       1,666       2,441       3,319  
                                

Total interest on long-term debt

     2,658       3,225       5,206       6,644  
                                

Total interest expense

     16,341        22,232       33,321        46,574  
                                

Net Interest Income

     52,596       51,488       105,694       102,087  

Provision for credit losses

     4,010       48,248       49,030       56,490  
                                

Net Interest Income after Provision for Credit Losses

     48,586       3,240       56,664       45,597  
                                

Non-Interest Income

        

Changes in fair value on impaired securities

     190       (14,421     (1,327     (43,010

Non-credit related (gains) losses on securities not expected to be sold (recognized in other comprehensive income)

     (2,300     5,660       (3,533     24,383  
                                

Net impairment losses

     (2,110     (8,761     (4,860     (18,627

Net securities gains

     562       56       982       80  

Trust income

     1,398       1,151       2,892       2,238  

Service charges on deposit accounts

     4,603       4,406       8,755       8,243  

Insurance and retail brokerage commissions

     1,866       1,756       3,728       3,372  

Income from bank owned life insurance

     1,301       1,034       2,558       2,172  

Card related interchange income

     2,686       2,138       5,006       4,034  

Other income

     2,343       4,935       5,039       7,943  
                                

Total non-interest income

     12,649       6,715       24,100       9,455  
                                

Non-Interest Expense

        

Salaries and employee benefits

     21,047       21,081       43,374       43,581  

Net occupancy expense

     3,539       3,528       7,432       7,528  

Furniture and equipment expense

     3,101       2,977       6,266       5,952  

Data processing expense

     1,478       1,165       2,915       2,297  

Pennsylvania shares tax expense

     1,457       1,312       2,514       2,643  

Intangible amortization

     576       743       1,233       1,486  

Collection and repossession expense

     794       1,750       1,717       2,651  

Other professional fees and services

     1,062       847       2,228       1,910  

FDIC insurance

     2,012       4,863       3,975       6,384  

Loss on sale or write-down of assets

     2,314       83       2,397       112  

Other operating expenses

     6,298       6,986       12,866       14,139  
                                

Total non-interest expense

     43,678       45,335       86,917       88,683  
                                

Income (Loss) before income taxes

     17,557       (35,380     (6,153     (33,631

Income tax provision (benefit)

     4,015       (16,761     (6,527     (16,699
                                

Net Income (Loss)

   $ 13,542     $ (18,619   $ 374     $ (16,932
                                

Average Shares Outstanding

     85,777,550        84,559,889        85,405,715        84,540,684  

Average Shares Outstanding Assuming Dilution

     85,788,566        84,559,889        85,412,371        84,540,684  

Per Share Data:

        

Basic Earnings (Loss) per Share

   $ 0.15     $ (0.22   $ 0.00     $ (0.20

Diluted Earnings (Loss) per Share

     0.15       (0.22     0.00       (0.20

Cash Dividends Declared per Common Share

     0.01       0.00       0.04       0.12  

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(dollars in thousands)

 

    Common
Stock
  Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss),
Net
    Treasury
Stock
    Unearned
ESOP
Shares
    Total
Shareholders’
Equity
 

Balance at December 31, 2009

  $ 86,600   $ 301,523     $ 278,887     $ (6,045   $ (16,554   $ (5,600   $ 638,811  

Comprehensive income

             

Net income

        374             374  

Other comprehensive income, net of tax:

             

Unrealized holding gains on securities arising during the period

          6,431           6,431  

Non-credit related gains on securities not expected to be sold

          2,297           2,297  

Less: reclassification adjustment for losses on securities included in net income

          2,553           2,553  
                   

Total other comprehensive income

              $ 11,281  
                   

Total comprehensive income

              $ 11,655  

Cash dividends declared

        (3,402           (3,402

Net decrease in unearned ESOP shares

              1,000        1,000   

ESOP market value adjustment ($500 thousand, net of $175 thousand tax benefit)

      (325             (325

Discount on dividend reinvestment plan purchases

      (22             (22

Treasury stock acquired

            (8       (8

Treasury stock reissued

      656       (4,552       7,808         3,912  

Restricted stock

        (168       297         129  

Capital issuance

    371     2,129               2,500  
                                                     

Balance at June 30, 2010

  $ 86,971   $ 303,961     $ 271,139     $ 5,236     $ (8,457   $ (4,600   $ 654,250  
                                                     

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

5


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(dollars in thousands)

(Continued)

 

    Common
Stock
  Additional
Paid-in
Capital
    Retained
Earnings
    Accumulated
Other
Comprehensive
Income (Loss),
Net
    Treasury
Stock
    Unearned
ESOP
Shares
    Total
Shareholders’
Equity
 

Balance at December 31, 2008

  $ 86,600   $ 303,008     $ 309,947     $ (21,269   $ (17,907   $ (7,600   $ 652,779  

Cumulative effect from adoption of FASB ASC Topic 320-10-65 ($6.5 million, net of $2.3 million tax)

        4,223       (4,223      
                                                     

Balance at January 1, 2009

    86,600     303,008       314,170       (25,492     (17,907     (7,600     652,779  

Comprehensive income

             

Net loss

        (16,932 )           (16,932

Other comprehensive income, net of tax:

             

Unrealized holding gains on securities arising during the period

          10,661           10,661  

Non-credit related losses on securities not expected to be sold

          (15,849         (15,849

Less: reclassification adjustment for losses on securities included in net loss

          12,062           12,062  
                   

Total other comprehensive income

              $ 6,874  
                   

Total comprehensive income

              $ (10,058

Cash dividends declared

        (10,146           (10,146

Net decrease in unearned ESOP shares

              1,000       1,000   

ESOP market value adjustment ($316 thousand, net of $110 thousand tax benefit)

      (206             (206

Discount on dividend reinvestment plan purchases

      (352             (352

Tax benefit of stock options exercised

      149               149  

Treasury stock reissued

      1           51         52  

Restricted stock

      2           90         92  
                                                     

Balance at June 30, 2009

  $ 86,600   $ 302,602      $ 287,092     $ (18,618   $ (17,766   $ (6,600   $ 633,310  
                                                     

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Six Months
Ended June 30,
 
     2010     2009  
     (dollars in thousands)  

Operating Activities

    

Net income (loss)

   $ 374     $ (16,932

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

    

Provision for credit losses

     49,030       56,490  

Deferred tax benefit

     (7,526     (18,711

Depreciation and amortization

     5,579       4,998  

Net losses on securities and other assets

     3,634       18,114  

Net amortization of premiums and discounts on securities

     (97     (146

Net amortization of premiums and discounts on long-term debt

     (529     (1,049

Income from increase in cash surrender value of bank owned life insurance

     (2,558     (2,172

Decrease in interest receivable

     2,111       2,491  

Decrease in interest payable

     (146     (1,047

Increase (decrease) in income tax payable

     1,970       (2,179

Other-net

     8,452       4,137  
                

Net cash provided by operating activities

     60,294       43,994  
                

Investing Activities

    

Transactions in securities held to maturity:

    

Proceeds from maturities and redemptions

     13,063       6,597  

Transactions in securities available for sale:

    

Proceeds from sales

     19,019       3,829  

Proceeds from maturities and redemptions

     277,198       199,199  

Purchases

     (121,309     (125,762

Proceeds from sales of other assets

     4,468       3,736  

Net decrease (increase) in loans

     158,234       (169,774

Purchases of premises and equipment

     (2,908     (3,987
                

Net cash provided by (used in) investing activities

     347,765       (86,162
                

Financing Activities

    

Net decrease in federal funds purchased

     (87,550     (139,700

Net decrease in other short-term borrowings

     (515,700     (1,778

Net increase in deposits

     202,929       205,664  

Repayments of other long-term debt

     (61,919     (2,925

Proceeds from issuance of long-term debt

     50,000       2,403  

Proceeds from issuance of common stock

     2,500       0   

Discount on dividend reinvestment plan purchases

     (22     (352

Dividends paid

     (3,402     (24,604

Proceeds from reissuance of treasury stock

     3,912       52  

Purchase of treasury stock

     (8     0   

Stock option tax benefit

     0        149  
                

Net cash (used in) provided by financing activities

     (409,260     38,909  
                

Net decrease in cash and cash equivalents

     (1,201     (3,259

Cash and cash equivalents at beginning of period

     89,559       88,566  
                

Cash and cash equivalents at end of period

   $ 88,358     $ 85,307  
                

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

7


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 1 Basis of Presentation

The accounting and reporting policies of First Commonwealth Financial Corporation and its subsidiaries (“First Commonwealth”) conform with generally accepted accounting principles in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Actual realized amounts could differ from those estimates. In the opinion of management, the unaudited interim condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of First Commonwealth’s financial position, results of operations, cash flows and changes in shareholders’ equity as of and for the periods presented.

The results of operations for the six months ended June 30, 2010 are not necessarily indicative of the results that may be expected for the full year of 2010. These interim financial statements should be read in conjunction with First Commonwealth’s 2009 Annual Report on Form 10-K which is available on First Commonwealth’s website at http://www.fcbanking.com. First Commonwealth’s website also provides additional information of interest to investors and clients, including other regulatory filings made to the Securities and Exchange Commission (“SEC”), press releases, historical stock prices, dividend declarations, corporate governance information, policies and documents as well as information about products and services offered by First Commonwealth.

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and interest-bearing bank deposits. Generally, federal funds are sold for one-day periods.

Loan type balances presented for December 31, 2009 were reclassified from those previously disclosed in order to more consistently categorize loans based on collateral rather than purpose and be more consistent with regulatory definitions.

Note 2 Supplemental Comprehensive Income Disclosures

The following table identifies the related tax effects allocated to each component of other comprehensive income in the Condensed Consolidated Statements of Changes in Shareholders’ Equity:

 

     June 30, 2010    June 30, 2009  
     Pre-tax
Amount
   Tax
(Expense)
Benefit
    Net of
Tax
Amount
   Pre-tax
Amount
    Tax
(Expense)
Benefit
    Net of
Tax
Amount
 
     (dollars in thousands)  

Unrealized gains on securities:

              

Unrealized holding gains arising during the period

   $ 9,895    $ (3,464   $ 6,431    $ 16,401     $ (5,740   $ 10,661  

Non-credit related gains (losses) on securities not expected to be sold

     3,533      (1,236     2,297      (24,383     8,534       (15,849

Losses realized in net income

     3,928      (1,375     2,553      18,557       (6,495     12,062  
                                              

Net unrealized gains

     17,356      (6,075     11,281      10,575       (3,701     6,874  
                                              

Other comprehensive income

   $ 17,356    $ (6,075   $ 11,281    $ 10,575     $ (3,701   $ 6,874  
                                              

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 3 Supplemental Cash Flow Disclosures

The following table presents information related to cash paid or received during the year for interest and income taxes as well as detail on non-cash investing and financing activities.

 

     For the Six Months
Ended June 30,
     2010     2009
     (dollars in thousands)

Cash paid (received) during the year for:

    

Interest

   $ 34,071     $ 48,425

Income taxes

     (1,184     3,900

Non-cash investing and financing activities:

    

ESOP loan reductions

   $ 1,000     $ 1,000

Loans transferred to other real estate owned and repossessed assets

     1,769       25,834

Gross increase in market value adjustment to securities available for sale

     17,356       10,575

Transfer of securities from held to maturity to available for sale

     22,433        0

Note 4 Variable Interest Entities

In December 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Codification (“ASC”) 810-10, “Consolidation.” As defined by ASC 810-10, a Variable Interest Entity (“VIE”) is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Under ASC 810-10, an entity that holds a variable interest in a VIE is required to consolidate the VIE if the entity is deemed to be the primary beneficiary, which generally means it is subject to a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the entity’s residual returns, or both.

FASB Accounting Standards Update (“ASU”) No. 2009-17, “Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” amends the ASC for FASB Statement of Financial Accounting Standards No. 167, “Amendments to FASB Interpretation No. 167.” First Commonwealth adopted the new guidance under FASB ASU No. 2009-17 on January 1, 2010.

As part of its community reinvestment initiatives, First Commonwealth has invested in ten qualified affordable housing projects as a limited partner. First Commonwealth receives federal affordable housing tax credits and rehabilitation tax credits for these limited partnership investments. Management evaluates the limited partnerships for impairment on an annual basis or more frequently as events warrant. There was no impairment recorded in 2009 or the first half of 2010. Based on ASC 810-10, First Commonwealth has determined that these investments will not be consolidated, but will continue to be accounted for under the equity method whereby First Commonwealth’s portion of the partnership’s results are recognized as earned. These investments are included in “Other assets” on the Condensed Consolidated Statements of Financial Condition.

First Commonwealth’s maximum potential exposure is equal to its carrying value and is summarized in the table below:

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Low Income Housing Limited Partnership Investments

   $  1,128    $ 1,289

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 5 Commitments and Letters of Credit

Standby letters of credit are conditional commitments issued by First Commonwealth to guarantee the performance of a customer to a third party. The contract or notional amount of these instruments reflects the maximum amount of future payments that First Commonwealth could be required to pay under the guarantees if there were a total default by the guaranteed parties, without consideration of possible recoveries under recourse provisions or from collateral held or pledged. In addition, many of these commitments are expected to expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements.

The following table identifies the notional amount of those instruments at:

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Commitments to extend credit

   $ 1,593,099    $ 1,598,599

Financial standby letters of credit

     75,810      83,630

Performance standby letters of credit

     77,850      76,194

Commercial letters of credit

     788      1,275

The current notional amounts outstanding as of June 30, 2010 include financial standby letters of credit of $2.1 million, performance standby letters of credit of $3.9 million and commercial letters of credit of $0.8 million issued during the first six months of 2010. A liability of $0.2 million has been recorded as of June 30, 2010, which represents the estimated fair value of letters of credit issued. The fair value of letters of credit is estimated based on the unrecognized portion of fees received at the time the commitment was issued. See Note 11, “Fair Value of Assets and Liabilities,” for additional information.

Unused commitments and letters of credit provide exposure to future credit loss in the event of non-performance by the guaranteed parties. An evaluation of the credit risk in these instruments resulted in the recording of a liability of $0.6 million as of June 30, 2010. The credit risk evaluation incorporated probability of default, loss given default and estimated utilization for the next twelve months for each loan category and letters of credit.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 6 Investment Securities

Below is an analysis of the amortized cost and estimated fair values of securities available for sale at:

 

    June 30, 2010   December 31, 2009
    Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
    Estimated
Fair Value
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
    Estimated
Fair Value
    (dollars in thousands)

Obligations of U.S. Government Agencies:

               

Mortgage Backed Securities –Residential

  $ 40,197   $ 4,031   $ 0      $ 44,228   $ 44,357   $ 2,995   $ 0      $ 47,352

Obligations of U.S. Government – Sponsored Enterprises:

               

Mortgage Backed Securities – Residential

    650,354     36,137     (3     686,488     749,417     28,665     (289     777,793

Mortgage Backed Securities – Commercial

    262     1     (1     262     281     1     (6     276

Other Government – Sponsored Enterprises

    84,555     311     (2     84,864     75,000     147     (172     74,975

Obligations of States and Political Subdivisions

    118,175     3,746     0        121,921     170,278     3,476     (897     172,857

Corporate Securities

    21,240     222     (888     20,574     22,545     52     (3,767     18,830

Pooled Trust Preferred Collateralized Debt Obligations

    64,431     0     (35,770     28,661     69,374     0     (39,644     29,730
                                                   

Total Debt Securities

    979,214     44,448     (36,664     986,998     1,131,252     35,336     (44,775     1,121,813

Equity Securities

    9,278     22     (78     9,222     12,231     218     (406     12,043
                                                   

Total Securities Available for Sale

  $ 988,492   $ 44,470   $ (36,742   $ 996,220   $ 1,143,483   $ 35,554   $ (45,181   $ 1,133,856
                                                   

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 6 Investment Securities (Continued)

 

The amortized cost and estimated fair value of debt securities available for sale at June 30, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or repay obligations with or without call or prepayment penalties.

 

     Amortized
Cost
   Estimated
Fair Value
     (dollars in thousands)

Due within one year

   $ 2,402    $ 2,402

Due after one but within five years

     98,359      99,349

Due after five but within ten years

     15,381      16,265

Due after ten years

     172,259      138,004
             
     288,401      256,020

Mortgage Backed Securities (a)

     690,813      730,978
             

Total Debt Securities

   $ 979,214    $ 986,998
             

 

(a) Mortgage Backed Securities include an amortized cost of $40 million and an estimated fair value of $44 million for Obligations of U.S. Government agencies issued by Ginnie Mae. Obligations of U.S. Government-sponsored enterprises includes obligations issued by Fannie Mae and Freddie Mac which had an amortized cost of $651 million and an estimated fair value of $687 million.

For the six months ended June 30, 2010, net securities gains included $1.7 million in gains and $0.8 million in losses for securities available for sale.

Securities available for sale with an estimated fair value of $645 million and $637 million were pledged as of June 30, 2010 and December 31, 2009, respectively, to secure public deposits and for other purposes required or permitted by law.

On June 30, 2010, the company reclassified its entire held to maturity portfolio to the available for sale portfolio. At the time of reclassification, the investments had an amortized cost of $22.4 million of which $22.3 million were obligations of states and political subdivisions and $0.1 million were mortgage backed securities. When the securities were transferred two of the obligations of states and political subdivision securities were in an unrealized loss position totaling $45 thousand, the remaining bonds in that category were in an unrealized gain position of $0.8 million and all of the mortgage backed securities were in an unrealized gain position. Other-than-temporary impairment charges of $45 thousand were recognized on the two state and political subdivision securities that were in an unrealized loss position.

The transfer of securities from the held to maturity portfolio is expected to result in the liquidation of the obligations of states and political subdivisions portfolio in order to mitigate future credit risk and improve our tax position.

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 6 Investment Securities (Continued)

 

As of June 30, 2010, there were no securities classified as held to maturity. Below is an analysis of the amortized cost and estimated fair values of debt securities held to maturity at December 31, 2009:

 

     December 31, 2009
     Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair
Value
     (dollars in thousands)

Obligations of U.S. Government Agencies:

          

Mortgage Backed Securities – Residential

   $ 29    $ 3    $ 0      $ 32

Obligations of U.S. Government – Sponsored Enterprises:

          

Mortgage Backed Securities – Residential

     89      7      0        96

Obligations of States and Political Subdivisions

     36,640      912      (94     37,458
                            

Total Securities Held to Maturity

   $ 36,758    $ 922    $ (94   $ 37,586
                            

For the six months ended June 30, 2010, net securities gains included $50 thousand in gains and no losses for debt securities held to maturity. There were no sales of securities held to maturity in 2009.

Securities held to maturity with an estimated fair value of $37 million were pledged as of December 31, 2009, to secure public deposits and for other purposes required or permitted by law.

Note 7 Other Investments

As a member of the Federal Home Loan Bank (“FHLB”) of Pittsburgh, First Commonwealth is required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements. This stock is restricted in that it can only be sold to the FHLB or to another member institution, and all sales of FHLB stock must be at par. As a result of these restrictions, FHLB stock is unlike other investment securities insofar as there is no trading market for FHLB stock and the transfer price is determined by FHLB membership rules and not by market participants. As of June 30, 2010 and December 31, 2009, our FHLB stock totaled $51.4 million and is included in Other investments on the Condensed Consolidated Statements of Financial Condition.

In December 2008, the FHLB voluntarily suspended dividend payments on its stock, as well as discontinued the repurchase of excess stock from members. The FHLB cited a significant reduction in the level of core earnings resulting from lower short-term interest rates, the increased cost of liquidity and constrained access to the debt markets at attractive rates and maturities as the main reasons for the decision to suspend dividends and the repurchase of excess capital stock. The FHLB last paid a dividend in the third quarter of 2008. Management reviewed the FHLB’s Form 10-Q for the period ended March 31, 2010 filed with the SEC on May 10, 2010.

FHLB stock is held as a long-term investment and its value is determined based on the ultimate recoverability of the par value. First Commonwealth evaluates impairment quarterly. The decision of whether impairment exists is a matter of judgment that reflects our view of the FHLB’s long-term performance, which includes factors such as the following:

 

 

its operating performance;

 

 

the severity and duration of declines in the fair value of its net assets related to its capital stock amount;

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 7 Other Investments (Continued)

 

 

its commitment to make payments required by law or regulation and the level of such payments in relation to its operating performance;

 

 

the impact of legislative and regulatory changes on the FHLB, and accordingly, on the members of the FHLB; and

 

 

its liquidity and funding position.

After evaluating all of these considerations, First Commonwealth concluded that the par value of its investment in FHLB stock is recoverable. Accordingly, no impairment charge was recorded on these securities for the six months ended June 30, 2010. Our evaluation of the factors described above in future periods could result in the recognition of impairment charges on FHLB stock.

Note 8 Impairment of Investment Securities

As required by FASB ASC Topic 320, “Investments – Debt and Equity Securities,” credit related other-than-temporary impairment on debt securities is recognized in earnings while non-credit related other-than-temporary impairment on debt securities not expected to be sold is recognized in other comprehensive income (“OCI”). In the second quarter of 2010, we recorded $2.1 million in other-than-temporary impairment charges. These charges include $2.0 million in credit related other-than-temporary impairment on three trust preferred collateralized debt obligations, $0.1 million recorded on one equity security and a $45 thousand write-down on municipals transferred from held to maturity to available for sale. All of the securities for which other-than-temporary impairment was recorded were classified as available for sale securities. Additionally, $2.3 million in non-credit related gains on securities not expected to be sold was recorded in OCI on our trust preferred collateralized debt obligations.

In accordance with FASB ASC Topic 320, the non-credit related portion of other-than-temporary impairment losses recognized in prior year earnings was reclassified as a cumulative effect adjustment that increased retained earnings and decreased accumulated OCI at the beginning of 2009. In 2008, $13.0 million in other-than-temporary impairment charges were recognized, of which $6.5 million related to non-credit related impairment on debt securities. Therefore, the cumulative effect adjustment to retained earnings totaled $6.5 million, or $4.2 million net of tax on January 1, 2009.

First Commonwealth utilizes the specific identification method to determine the net gain or loss on debt securities and the average cost method to determine the net gain or loss on equity securities.

In the Condensed Consolidated Statement of Operations, the “Changes in fair value on impaired securities” line represents the change in fair value of securities impaired in the current or previous periods. The change in fair value includes both non-credit and credit related gains or losses. Credit related losses occur when the entire amortized cost of the security will not be recovered. The “Non-credit related (gains) losses on securities not expected to be sold” line represents the gains and losses on the securities resulting from factors other than credit. The non-credit related gain or loss is disclosed in the Condensed Consolidated Statement of Operations and recognized through other comprehensive income. The “Net impairment losses” line represents the credit related losses recognized in total non-interest income for the related period.

We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the financial

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 8 Impairment of Investment Securities (Continued)

 

condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and whether we are more likely than not to sell the security. We evaluate whether we are more likely than not to sell debt securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy tax position and interest rate risk position. In addition, the risk of future other-than-temporary impairment may be influenced by additional bank failures, weakness in the U.S. economy, changes in real estate values, interest deferrals and whether the federal government continues to provide assistance to financial institutions. Our pooled trust preferred collateralized debt obligations are beneficial interests in securitized financial assets within the scope of FASB ASC Topic 325, “Investments – Other,” and are therefore evaluated for other-than-temporary impairment using management’s best estimate of future cash flows. If these estimated cash flows determine it is probable that an adverse change in cash flows has occurred, then other-than-temporary impairment would be recognized in accordance with FASB ASC Topic 320. There is a risk that First Commonwealth will record other-than-temporary impairment charges in the future. See Note 11, “Fair Values of Assets and Liabilities” for additional information.

The following table presents the gross unrealized losses and estimated fair values at June 30, 2010 for our available for sale securities by investment category and time frame for which the loss has been outstanding:

 

    Less Than 12 Months     12 Months or More     Total  

Description of Securities

  Estimated
Fair Value
  Unrealized
Losses
    Estimated
Fair Value
  Unrealized
Losses
    Estimated
Fair Value
  Unrealized
Losses
 
    (dollars in thousands)  

Obligations of U.S. Government-Sponsored Enterprises:

           

Mortgage Backed Securities – Residential

  $ 25,014   $ (3   $ 0   $ 0      $ 25,014   $ (3

Mortgage Backed Securities – Commercial

    202     (1     0     0        202     (1

Other Government-Sponsored Enterprises

    4,729     (2     0     0        4,729     (2

Corporate Securities

    0     0        14,959     (888     14,959     (888

Pooled Trust Preferred Collateralized Debt Obligations

    0     0        28,661     (35,770     28,661     (35,770
                                         

Total Debt Securities

    29,945     (6     43,620     (36,658     73,565     (36,664

Equity Securities

    933     (68     40     (10     973     (78
                                         

Total Securities

  $ 30,878   $ (74   $ 43,660   $ (36,668   $ 74,538     (36,742
                                         

At June 30, 2010, less than 1% of the total unrealized losses were comprised of fixed income securities issued by U.S. Government agencies, U.S. Government-sponsored enterprises and Obligations of States and Political Subdivisions. Corporate fixed income comprised 2% of the total unrealized losses, while pooled trust preferred collateralized debt obligations accounted for 97% and equity securities accounted for less than 1% of unrealized losses. The unrealized losses in the equity securities category consist of three issues. One of these issues has been in a continuous unrealized loss position for more than twelve months but is not considered impaired based on our analysis of the investment and the amount of the unrealized loss.

Corporate securities had a total unrealized loss of $0.9 million as of June 30, 2010. Included in this category are single issue trust preferred securities and corporate debentures issued primarily by money center and large

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 8 Impairment of Investment Securities (Continued)

 

regional banks. As of June 30, 2010, our single issue trust preferred securities had an amortized cost of $20.0 million and an estimated fair value of $19.3 million, while our corporate debentures had a book value of $1.2 million and an estimated fair value of $1.3 million. After a review of each of the issuer’s asset quality, earnings trend and capital position, it was determined that none of these issues were other-than-temporarily impaired. Additionally, all interest payments on these securities are being made as contractually required.

The following table presents the gross unrealized losses and estimated fair values at December 31, 2009 for both available for sale and held to maturity securities by investment category and time frame for which the loss has been outstanding:

 

    Less Than 12 Months     12 Months or More     Total  

Description of Securities

  Estimated
Fair Value
  Unrealized
Losses
    Estimated
Fair Value
  Unrealized
Losses
    Estimated
Fair Value
  Unrealized
Losses
 
    (dollars in thousands)  

Obligations of U.S. Government – Sponsored Enterprises:

           

Mortgage Backed Securities – Residential

  $ 35,202   $ (286   $ 307   $ (3   $ 35,509   $ (289

Mortgage Backed Securities – Commercial

    169     (5     43     (1     212     (6

Other Government – Sponsored Enterprises

    49,828     (172     0     0        49,828     (172

Corporate Securities

    5,070     (641     12,521     (3,126     17,591     (3,767

Pooled Trust Preferred Collateralized Debt Obligations

    4,985     (3,698     24,745     (35,946     29,730     (39,644

Obligations of States and Political Subdivisions

    25,832     (150     21,154     (841     46,986     (991
                                         

Total Debt Securities

    121,086     (4,952     58,770     (39,917     179,856     (44,869

Equity Securities

    1,476     (402     46     (4     1,522     (406
                                         

Total Securities

  $ 122,562   $ (5,354   $ 58,816   $ (39,921   $ 181,378   $ (45,275
                                         

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 8 Impairment of Investment Securities (Continued)

 

The following table provides additional information related to our corporate securities as of June 30, 2010:

Corporate Securities

(Single Issue Trust Preferred Securities and Corporate Debentures)

(dollars in thousands)

 

Name of Issuer

  

Name of Issuer’s Parent Company

  Amortized
Cost
  Estimated
Fair
Value
  Unrealized
Gain (Loss)
    Current
Moody’s/
Fitch Issuer
Ratings (a)

BP Bank America Inst

   Bank of America Corp   $ 1,025   $ 1,014   $ (11   Baa3/BB/*+

BP MBNA Capital

   Bank of America Corp     1,026     1,004     (22   Baa3/BB/*+

NB Capital Trust II

   Bank of America Corp     3,073     2,988     (85   Baa3/BB/*+

North Fork Cap Trust

   Capital One Financial Corp     1,265     1,263     (2   Baa3/BBB

Reliance Cap Trust

   Capital One Financial Corp     488     387     (101   NA

FCB/SC Cap Trust

   First Citizens Bancorporation     494     405     (89   NA

Fifth Third Cap

   Fifth Third Bancorp     250     256     6     NA

PBI Capital Trust

   Fulton Financial Corp     247     215     (32   NA

KeyCorp Capital II

   KeyCorp     1,854     1,827     (27   Baa3/BBB

Union State Capital Trust I

   KeyCorp     1,032     995     (37   NA

BSB Cap Trust

   M&T Bank Corp     464     234     (230   NA

First Empire Cap MTB

   M&T Bank Corp     4,878     4,626     (252   Baa2/BBB

PNC Capital Trust

   PNC Financial Services Group     453     468     15     NA

Susquehanna Cap

   Susquehanna Bancshares     500     503     3     NA

First Union Instit Cap I

   Wells Fargo Co.     3,000     3,072     72     Baa2/A
                        

Total Single Issue Trust Preferred Securities

       20,049     19,257     (792  
                        

Fulton Financial Corp

   Fulton Financial Corp     449     485     36     Baa2/BBB+

Provident Bk MD

   M&T Bank Corp     245     267     22     NA/BBB+

PNC Bank NA

   PNC Financial Services Group     497     565     68     A2/A
                        

Total Corporate Debentures

       1,191     1,317     126    
                        

Total Corporate Securities

     $ 21,240   $ 20,574   $ (666  
                        

 

(a)*+ indicates positive watch

As of June 30, 2010, the book value of our pooled trust preferred collateralized debt obligations totaled $64.4 million with an estimated fair value of $28.7 million, which includes securities comprised of 371 banks and other financial institutions. Two of our pooled securities are senior tranches and the remainder are mezzanine tranches. Two of the pooled issues, representing $11.9 million of the $64.4 million book value, remain above investment grade. At the time of initial issue, the subordinated tranches ranged in size from approximately 7% to 35% of the total principal amount of the respective securities and no more than 5% of any pooled security consisted of a security issued by any one institution. As of June 30, 2010, after taking into account management’s best estimates of future interest deferrals and defaults, eleven of our securities had no excess subordination in the tranches we own and three of our securities had excess subordination which ranged from 26% to 75% of the

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 8 Impairment of Investment Securities (Continued)

 

current performing collateral. As of June 30, 2010, five of our pooled trust preferred collateralized obligations with an estimated fair value of $6.5 million are not receiving interest payments and therefore are reflected in the table on page 54 as non-performing securities.

The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of June 30, 2010:

Pooled Trust Preferred Collateralized Debt Obligations

(dollars in thousands)

 

Deal

  Class   Amortized
Cost
  Estimated
Fair
Value
  Unrealized
Loss
    Moody’s/
Fitch

Ratings
  Current
Number
of
Banks
  Actual
Deferrals

and
Defaults
as a
Percentage of
Current
Collateral
    Excess
Subordination
as a

Percentage of
Current

Performing
Collateral
 

Pre TSL I

  Senior   $ 3,675   $ 3,238   $ (437   A1/BBB   32   24.86   74.97

Pre TSL IV

  Mezzanine     1,830     774     (1,056   Ca/CCC   6   27.07     25.56  

Pre TSL V

  Mezzanine     452     194     (258   Ba3/C   4   43.12     0.00  

Pre TSL VI

  Mezzanine     239     144     (95   Caa1/CC   5   80.98     0.00  

Pre TSL VII

  Mezzanine     4,012     1,482     (2,530   Ca/C   19   70.48     0.00  

Pre TSL VIII

  Mezzanine     1,619     391     (1,228   C/C   36   43.67     0.00  

Pre TSL IX

  Mezzanine     2,251     854     (1,397   Ca/C   49   29.22     0.00  

Pre TSL X

  Mezzanine     1,300     244     (1,056   C/C   57   43.69     0.00  

Pre TSL XII

  Mezzanine     5,389     1,316     (4,073   Ca/C   77   35.70     0.00  

Pre TSL XIII

  Mezzanine     13,653     5,278     (8,375   Ca/C   65   21.58     0.00  

Pre TSL XIV

  Mezzanine     13,600     4,165     (9,435   Ca/C   64   22.94     0.00  

MMCap I

  Senior     8,260     6,836     (1,424   A3/A   29   21.60     74.54  

MMCap I

  Mezzanine     841     367     (474   Ca/CCC   29   21.60     0.00  

MM Comm IX

  Mezzanine     7,310     3,378     (3,932   Caa3/C   34   38.85     0.00  
                             

Total

    $ 64,431   $ 28,661   $ (35,770        
                             

Lack of liquidity in the market for trust preferred collateralized debt obligations, credit rating downgrades and market uncertainties related to the financial industry are factors contributing to the impairment on these securities.

On a quarterly basis we evaluate our debt securities for other-than-temporary impairment. In the first six months of 2010, $4.7 million in credit related other-than-temporary impairment charges were recognized on our pooled trust preferred collateralized debt obligations. When evaluating these investments we determine a credit related portion and a non-credit related portion of other-than-temporary impairment. The credit related portion is recognized in earnings and represents the expected shortfall in future cash flows. The non-credit related portion is recognized in OCI and represents the difference between the estimated fair value of the security and the amount of credit related impairment. A discounted cash flow analysis provides the best estimate of credit related other-than-temporary impairment for these securities. Additional information related to this analysis follows.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 8 Impairment of Investment Securities (Continued)

 

Our pooled trust preferred collateralized debt obligations are measured for other-than-temporary impairment within the scope of FASB ASC Topic 325 by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows from the cash flows previously projected involves comparing the present value of remaining cash flows previously projected against the present value of the cash flows estimated at June 30, 2010. We consider the discounted cash flow analysis to be our primary evidence when determining whether credit related other-than-temporary impairment exists.

Results of a discounted cash flow test are significantly affected by other variables such as the estimate of future cash flows, credit worthiness of the underlying banks and determination of probability of default of the underlying collateral. The following provides additional information for each of these variables:

 

 

Estimate of Future Cash Flows – Cash flows are constructed in an INTEX cash flow model. INTEX is a proprietary cash flow model recognized as the industry standard for analyzing all types of collateralized debt obligations. It includes each deal’s structural features updated with trustee information, including asset-by-asset detail, as it becomes available. The modeled cash flows are then used to estimate if all the scheduled principal and interest payments of our investments will be returned.

 

 

Credit Analysis – A quarterly credit evaluation is performed for each of the 371 banks comprising the collateral across the various pooled trust preferred securities. Our credit evaluation considers all evidence available to us and includes the nature of the issuer’s business, its years of operating history, corporate structure, loan composition, loan concentrations, deposit mix, asset growth rates, geographic footprint and local economic environment. Our analysis focuses on profitability, return on assets, shareholders’ equity, net interest margin, credit quality ratios, operating efficiency, capital adequacy and liquidity.

 

 

Probability of Default – A probability of default is determined for each bank and is used to calculate the expected impact of future deferrals and defaults on our expected cash flows. Each bank in the collateral pool is assigned a probability of default for each year until maturity. Banks currently in default or deferring interest payments are assigned a 100% probability of default. All other banks in the pool are assigned a probability of default based on their unique credit characteristics and market indicators. A 10% projected recovery rate is applied to projected deferrals and a 0% projected recovery rate is applied to defaults. The probability of default is updated quarterly. As of June 30, 2010, default probabilities for performing collateral ranged from 0.33% to 75%.

Our credit evaluation provides a basis for determining deferral and default probabilities for each underlying piece of collateral. Using the results of the credit evaluation, the next step of the process is to look at pricing of senior debt or credit default swaps for the issuer (or where such information is unavailable, for companies having similar credit profiles as the issuer). The pricing of these market indicators provides the information necessary to determine appropriate default probabilities for each bank.

In addition to the above factors, our evaluation of impairment also includes a stress test analysis which provides an estimate of excess subordination for each tranche. We stress the cash flows of each pool by increasing current default assumptions to the level of defaults which results in an adverse change in estimated cash flows. This stressed breakpoint is then used to calculate excess subordination levels for each pooled trust preferred security. The results of the stress test allows management to identify those pools that are at a greater risk for a future break in cash flows so that we can monitor banks in those pools more closely for potential deterioration of credit quality.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 8 Impairment of Investment Securities (Continued)

 

Based upon the analysis performed by management as of June 30, 2010, it is probable that eleven of our pooled trust preferred securities will experience principal and interest shortfalls. These securities are identified in the table on page 18 with 0% “Excess Subordination as a Percentage of Current Performing Collateral.” The $2.1 million in credit related other-than-temporary impairment charges recognized in the second quarter of 2010 are primarily the result of additional interest deferrals within these pools. Our analysis as of June 30, 2010 indicates it is probable that we will collect all contractual principal and interest payments on the three remaining pooled trust preferred securities.

The table below provides a cumulative roll forward of credit losses recognized in earnings for debt securities held and not intended to be sold:

 

     For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
     2010    2009    2010    2009
     (dollars in thousands)

Balance, beginning (a)

   $ 38,911    $ 10,921    $ 36,161    $ 2,516

Credit losses on debt securities for which other-than-temporary impairment was not previously recognized

     0      1,613      0      11,675

Additional credit losses on debt securities for which other-than-temporary impairment was previously recognized

     1,965      6,069      4,715      4,412
                           

Balance, ending

   $ 40,876    $ 18,603    $ 40,876    $ 18,603
                           

 

(a) The beginning balance represents credit related losses included in other-than-temporary impairment charges recognized on debt securities in prior periods. For the six months ended June 30, 2010, the beginning balance represents impairment losses taken before January 1, 2010. For the six months ended June 30, 2009, the beginning balance represents impairment losses taken before January 1, 2009.

On a quarterly basis, management evaluates equity securities for other-than-temporary impairment by reviewing the severity and duration of decline in estimated fair value, research reports, analysts’ recommendations, credit rating changes, news stories, annual reports, regulatory filings, impact of interest rate changes and other relevant information. Based on the results of this review, management believes that the equity securities in an unrealized loss position as of June 30, 2010 are not other-than-temporarily impaired and will equal or exceed our cost basis within a reasonable period of time.

Note 9 Loans

The following table provides outstanding balances related to each of our loan types at:

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Commercial, financial, agricultural and other

   $ 1,031,568    $ 1,127,320

Real estate-construction

     406,085      428,744

Real estate-residential

     1,161,012      1,202,386

Real estate-commercial

     1,272,972      1,320,715

Loans to individuals

     562,654      557,336
             

Total loans, net of unearned income

   $ 4,434,291    $ 4,636,501
             

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 9 Loans (Continued)

 

The following table identifies impaired loans, and information regarding the relationship of impaired loans to the allowance for credit losses:

 

     June 30,
2010
   December 31,
2009
     (dollars in thousands)

Recorded balance of impaired loans at end of period

   $ 133,154    $ 148,556

Allowance for credit losses allocated to loans considered impaired

     41,518      33,265

Impaired loans with an allocation in the allowance for credit losses

     88,208      108,318

Impaired loans with no allocation in the allowance for credit losses

     44,946      40,238

For the six and twelve months ended:

     

Average recorded balance of impaired loans

   $ 156,492    $ 83,843

Income recorded on impaired loans recognized on a cash basis

     133      521

Impaired loans totaled $133.2 million at June 30, 2010, a decrease of $15.4 million compared to December 31, 2009. As of June 30, 2010, $129.4 million or 97% of the non-performing loans were commercial, with $53.1 million related to commercial and industrial loans, $48.2 million to construction loans and $28.1 million to commercial real estate loans. Loans originated to borrowers in Pennsylvania accounted for $87.7 million or 66% of the non-performing total while loans outside of Pennsylvania accounted for $45.5 million or 34% of non-performing loans. Significant impaired loans as of June 30, 2010 include the following:

 

 

A $44.5 million balance on a line of credit to a western Pennsylvania real estate developer. The Bank is negotiating the final terms of a workout plan with the borrower and three other lenders.

 

 

A $12.7 million participation loan secured by a condominium development in Missouri. The borrower has experienced significant cash flow problems. Ability to complete the project according to agreed upon terms is questionable.

 

 

A $10.1 million commercial loan to a waste management company in Pennsylvania.

 

 

An $8.6 million participation construction loan for a Nevada resort development. Developers are abandoning upgrade and expansion plans for the currently operating resort.

 

 

A $7.2 million participation loan on a recently completed condominium project in North Carolina. Sales of completed units have slowed.

 

 

$6.4 million, the remaining portion of a $20.8 million construction loan for a Florida condominium project. A charge-off of $14.4 million was previously recorded on this loan.

 

 

$5.4 million, the remaining portion of a $39.6 million construction loan for a Florida condominium project. Continued market deterioration, and questions concerning the developer’s willingness and capacity to complete the project, resulted in a decline in the estimated collateral value from an “as completed” to an “as is” raw land valuation. A $34.2 million charge-off was recorded on this loan in the second quarter of 2010.

Loans past due in excess of 90 days and still accruing decreased $0.1 million, or 1%, to $15.0 million at June 30, 2010 compared to December 31, 2009. Compared to June 30, 2009, loans past due in excess of 90 days increased $0.7 million. Loans past due in excess of 90 days and still accruing are primarily 1-4 family residential loans where the collateral value exceeds outstanding loan balances and are in the process of collection.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 10 Income Taxes

At June 30, 2010 and December 31, 2009, First Commonwealth had no material unrecognized tax benefits or accrued interest and penalties. If applicable, First Commonwealth will record interest and penalties as a component of non-interest expense. Federal and state tax years 2006 through 2009 were open for examination as of June 30, 2010.

Note 11 Fair Values of Assets and Liabilities

FASB ASC Topic 820, “Fair Value Measurements and Disclosures” defines fair value and the methods used for measuring fair value as well as requiring additional disclosures. Authoritative guidance issued under FASB ASC Topic 820 became effective January 1, 2009 and requires disclosures for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). All non-financial assets are included either as a separate line item on the Condensed Consolidated Statements of Financial Condition or in the “Other assets” category of the Condensed Consolidated Statements of Financial Condition. Currently, First Commonwealth does not have any non-financial liabilities to disclose.

FASB ASC Topic 825, “Financial Instruments” permits entities to irrevocably elect to measure select financial instruments and certain other items at fair value. The unrealized gains and losses are required to be included in earnings each reporting period for the items that fair value measurement is elected. First Commonwealth has elected not to measure any existing financial instruments at fair value under FASB ASC Topic 825; however, in the future we may elect to adopt this guidance for select financial instruments.

In accordance with FASB ASC Topic 820, First Commonwealth groups financial assets and financial liabilities measured at fair value in three levels, based on the principal markets in which the assets and liabilities are transacted and the observability of the data points used to determine fair value. These levels are:

 

 

Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange (“NYSE”). Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. Level 1 securities include equity holdings comprised of publicly traded bank stocks which were priced using quoted market prices.

 

 

Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained for identical or comparable assets or liabilities from alternative pricing sources with reasonable levels of price transparency. Level 2 includes Obligations of U.S. Government issued by Agencies and Sponsored Enterprises, Obligations of States and Political Subdivisions, certain equity securities, FHLB stock, interest rate derivatives that include interest rate swaps and risk participation agreements, certain other real estate owned and certain impaired loans.

The estimated fair values for Mortgage Backed Securities – Residential and Mortgage Backed Securities – Commercial were based on market data for these types of asset classes including broker quotes and trade and bid prices.

Obligations of States and Political Subdivisions estimated fair value is based on pricing models that incorporated other benchmark quoted securities with similar insurer, credit support, state of issuance and credit rating.

Other Investments is comprised of FHLB stock whose estimated fair value is based on its par value. Additional information on FHLB stock is provided in Note 7, “Other investments.”

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 11 Fair Values of Assets and Liabilities (Continued)

 

Interest rate derivatives are reported at estimated fair value utilizing Level 2 inputs and are included in Other assets and Other liabilities. First Commonwealth values its interest rate swap positions using a yield curve by taking market prices/rates for an appropriate set of instruments. The set of instruments currently used to determine the U.S. Dollar yield curve includes cash LIBOR rates from overnight to three months, Eurodollar futures contracts and swap rates from three years to thirty years. These yield curves determine the valuations of interest rate swaps. Interest rate derivatives are further described in Note 12, “Derivatives.”

For purposes of potential valuation adjustments to our derivative positions, First Commonwealth evaluates the credit risk of its counterparties as well as our own credit risk. Accordingly, we have considered factors such as the likelihood of default, expected loss given default, net exposures and remaining contractual life, among other things, in determining if any estimated fair value adjustments related to credit risk are required. We review our counterparty exposure quarterly, and when necessary, appropriate adjustments are made to reflect the exposure.

We also utilize this approach to estimate our own credit risk on derivative liability positions. To date, we have not realized any losses due to a counterparty’s inability to pay any net uncollateralized position.

The equity investments included in Level 2 are based on broker prices and are included in Level 2 because they are not traded on an active exchange market.

The estimated fair value for other real estate owned included in Level 2 is determined by either an independent market based appraisal less costs to sell or an executed sales agreement.

 

 

Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. If the inputs used to provide the evaluation are unobservable and/or there is very little, if any, market activity for the security or similar securities, the securities would be considered Level 3 securities. Level 3 valuations incorporate certain assumptions and projections in determining the fair value assigned to such assets or liabilities. The assets included in Level 3 are select Obligations of States and Political Subdivisions, corporate securities, pooled trust preferred collateralized debt obligations, non-marketable equity investments, and certain impaired loans.

The estimated fair values for the Obligations of States and Political Subdivisions included in Level 3 and corporate securities, which include our single issue trust preferred securities, were obtained from pricing sources with reasonable pricing transparency, taking into account other unobservable inputs related to the risks for each issuer. These valuations were classified as Level 3 due to the inactivity in the respective markets.

Our pooled trust preferred collateralized debt obligations are collateralized by the trust preferred securities of individual banks, thrifts and bank holding companies in the U.S. There has been little or no active trading in these securities for approximately twenty-four months; therefore it was more appropriate to determine estimated fair value using a discounted cash flow analysis. Detail on our process for determining the appropriate cash flows for this analysis is provided in Note 8, “Impairment of Investment Securities.” The discount rate applied to the cash flows is determined by evaluating the current market yields for comparable corporate and structured credit products along with an evaluation of the risks associated with the cash flows of the comparable security. Due to the fact that there is no active market for the pooled trust preferred collateralized debt obligations, one key reference point is

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 11 Fair Values of Assets and Liabilities (Continued)

 

the market yield for the single issue trust preferred securities issued by banks and thrifts for which there is more activity than for the pooled securities. Adjustments are then made to reflect the credit and structural differences between these two security types.

The estimated fair value of the non-marketable equity investments included in level 3 is based on par value.

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis at June 30, 2010:

 

     Level 1    Level 2    Level 3    Total
     (dollars in thousands)

Securities Available for Sale

           

Obligations of U.S. Government Agencies:

           

Mortgage Backed Securities – Residential

   $ 0    $ 44,228    $ 0    $ 44,228

Obligations of U.S. Government-Sponsored Enterprises:

           

Mortgage Backed Securities – Residential

     0      686,488      0      686,488

Mortgage Backed Securities – Commercial

     0      262      0      262

Other Government-Sponsored Enterprises

     0      84,864      0      84,864

Obligations of States and Political Subdivisions

     0      121,578      343      121,921

Corporate Securities

     0      0      20,574      20,574

Pooled Trust Preferred Collateralized Debt Obligations

     0      0      28,661      28,661
                           

Total Debt Securities

     0      937,420      49,578      986,998

Equity Securities

     1,633      6,019      1,570      9,222
                           

Total Securities Available for Sale

     1,633      943,439      51,148      996,220

Other Investments

     0      51,431      0      51,431

Other Assets (a)

     0      17,923      0      17,923
                           

Total Assets

   $ 1,633    $ 1,012,793    $ 51,148    $ 1,065,574
                           

Other Liabilities (a)

   $ 0    $ 19,082    $ 0    $ 19,082
                           

Total Liabilities

   $ 0    $ 19,082    $ 0    $ 19,082
                           

 

(a) Non-hedging interest rate derivatives

For the six months ended June 30, 2010, there were no transfers between fair value Levels 1 and 2.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 11 Fair Values of Assets and Liabilities (Continued)

 

The table below presents the balances of assets and liabilities measured at fair value on a recurring basis at December 31, 2009:

 

     Level 1    Level 2    Level 3    Total
     (dollars in thousands)

Securities Available for Sale

           

Obligations of U.S. Government Agencies:

           

Mortgage Backed Securities – Residential

   $ 0    $ 47,352    $ 0    $ 47,352

Obligations of U.S. Government-Sponsored Enterprises:

           

Mortgage Backed Securities – Residential

     0      777,793      0      777,793

Mortgage Backed Securities – Commercial

     0      276      0      276

Other Government-Sponsored Enterprises

     0      74,975      0      74,975

Obligations of States and Political Subdivisions

     0      169,257      3,600      172,857

Corporate Securities

     0      0      18,830      18,830

Pooled Trust Preferred Collateralized Debt Obligations

     0      0      29,730      29,730
                           

Total Debt Securities

     0      1,069,653      52,160      1,121,813

Equity Securities

     3,001      7,472      1,570      12,043
                           

Total Securities Available for Sale

     3,001      1,077,125      53,730      1,133,856

Other Investments

     0      51,431      0      51,431

Other Assets (a)

     0      10,626      0      10,626
                           

Total Assets

   $ 3,001    $ 1,139,182    $ 53,730    $ 1,195,913
                           

Other Liabilities (a)

   $ 0    $ 11,491    $ 0    $ 11,491
                           

Total Liabilities

   $ 0    $ 11,491    $ 0    $ 11,491
                           

 

(a) Non-hedging interest rate derivatives

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows at June 30, 2010:

 

      Obligations
of States
and Political
Subdivisions
    Corporate
Securities
    Pooled Trust
Preferred
Collateralized
Debt
Obligations
    Equity
Securities
  Total
Estimated
Fair
Value
 
    (dollars in thousands)  

Securities Available for Sale

         

Balance, beginning of quarter

  $ 3,628     $ 20,967     $ 28,161     $ 1,570   $ 54,326  

Realized and unrealized credit losses included in earnings

    0        0        (1,964     0     (1,964

Total unrealized (losses) gains in other comprehensive income

    (2,344     (393     2,640       0     (97

Purchases, settlements, pay downs, and maturities

    (941     0        (176     0     (1,117

Transfers into Level 3

    0        0        0        0     0   
                                     

Balance, end of quarter

  $ 343     $ 20,574     $ 28,661     $ 1,570   $ 51,148  
                                     

For the three months ended June 30, 2010, there were no transfers between levels of estimated fair value for available for sale securities.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 11 Fair Values of Assets and Liabilities (Continued)

 

Losses of $1.5 million included in earnings for the period are attributable to the change in realized gains (losses) relating to assets held at June 30, 2010 and are reported in the lines “Net impairment losses” and “Net securities gains” in the Condensed Consolidated Statements of Operations.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows at June 30, 2009:

 

      Obligations
of States
and Political
Subdivisions
  Corporate
Securities
  Pooled Trust
Preferred
Collateralized
Debt
Obligations
    Equity
Securities
  Total
Estimated
Fair
Value
 
    (dollars in thousands)  

Securities Available for Sale

         

Balance, beginning of quarter

  $ 3,429   $ 14,209   $ 36,679     $ 1,570   $ 55,887  

Realized and unrealized credit losses included in earnings

    0     0     (7,682     0     (7,682

Total unrealized gains (losses) in other comprehensive income

    22     3,269     9,353       0     12,644  

Purchases, settlements, pay downs, and maturities

    0     0     (80     0     (80

Transfers into Level 3

    0     0     0        0     0   
                                 

Balance, end of quarter

  $ 3,451   $ 17,478   $ 38,270     $ 1,570   $ 60,769  
                                 

For the three months ended June 30, 2009, there were no transfers between levels of estimated fair value for available for sale securities.

Losses of $8.7 million included in earnings for the three month period ending June 30, 2009, are attributable to the change in realized gains (losses) related to assets held at June 30, 2009 and are reported in the lines “Net impairment losses” and “Net securities gains” in the Condensed Consolidated Statements of Operations.

The table below presents the balances of assets measured at fair value on a non-recurring basis at June 30, 2010:

 

     Level 1    Level 2    Level 3    Total
Estimated
Fair Value
     (dollars in thousands)

Impaired loans

   $  0    $ 77,266    $ 30,558    $ 107,824

Other real estate owned

     0      21,250      0      21,250
                           

Total Assets

   $ 0    $ 98,516    $ 30,558    $ 129,074
                           

Impaired loans over $0.1 million are individually reviewed to determine the amount of each loan considered to be at risk of non-collection. The estimated fair value for impaired loans that are collateral based is determined by reviewing real property appraisals, equipment valuations, accounts receivable listings and other financial information. A discounted cash flow analysis is performed to determine fair value for impaired loans when an observable market price or a current appraisal is not available.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 11 Fair Values of Assets and Liabilities (Continued)

 

The estimated fair value for other real estate owned is determined by either an independent market based appraisal less costs to sell or an executed sales agreement and is classified as Level 2. Other real estate owned totaled $21.5 million as of June 30, 2010 and primarily consisted of one property with a carrying value of $18.4 million. This property represents a Pennsylvania based manufacturing plant with related real estate and equipment. In the second quarter of 2010, a $2.2 million write-down was recognized on this property as an agreement for the sale of the plant and equipment was executed. Due diligence continues for this transaction with settlement expected in the third quarter of 2010. We continually review whether events and circumstances subsequent to a transfer to other real estate owned have occurred that indicate the balance of those assets may not be recoverable. If events and circumstances indicate further impairment we will record a charge to the extent that the carrying value of the assets exceed their fair values, less cost to sell, as determined by valuation techniques appropriate in the circumstances.

Certain other assets and liabilities, including goodwill and core deposit intangibles, are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. A goodwill impairment test for First Commonwealth was completed as of June 30, 2010. Based on this analysis, the estimated fair value of First Commonwealth exceeded its book value. Additional information related to this measurement is provided in Note 13, “Goodwill” on page 29. There were no other assets or liabilities measured at fair value on a non-recurring basis during the six months ended June 30, 2010.

FASB ASC 825-10-65, Transition Related to FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis.

The methodologies for estimating the fair value of financial assets and financial liabilities are discussed below.

Cash and due from banks and Interest-bearing bank deposits: The carrying amounts for Cash and due from banks and Interest-bearing bank deposits approximate the estimated fair values of such assets.

Securities: Estimated fair values for securities available for sale and securities held to maturity are based on quoted market prices, if available. If quoted market prices are not available, estimated fair values are based on quoted market prices of comparable instruments. Pooled trust preferred collateralized debt obligations values are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. These valuations incorporate certain assumptions and projections in determining the estimated fair value assigned to each instrument. The carrying value of Other investments, which includes FHLB stock, is considered a reasonable estimate of fair value.

Loans: The fair values of all loans are estimated by discounting the estimated future cash flows using interest rates currently offered for loans with similar terms to borrowers of similar credit quality adjusted for past due and non-performing loans which is not an exit price under FASB ASC Topic 820, “Fair Value Measurements and Disclosures.”

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 11 Fair Values of Assets and Liabilities (Continued)

 

Off-balance sheet instruments: Many of First Commonwealth’s off-balance sheet instruments, primarily loan commitments and standby letters of credit, are expected to expire without being drawn upon; therefore, the commitment amounts do not necessarily represent future cash requirements. FASB ASC Topic 460, “Guarantees” clarified that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The carrying amount and estimated fair value for standby letters of credit was $0.2 million at June 30, 2010. See Note 5, “Commitments and Letters of Credit,” for additional information.

Deposit liabilities: Management estimates that the fair value of deposits is based on a market valuation of similar deposits. The carrying value of variable rate time deposit accounts and certificates of deposit approximate their fair values at the report date. Also, fair values of fixed rate time deposits for both periods are estimated by discounting the future cash flows using interest rates currently being offered and a schedule of aggregated expected maturities.

Short-term borrowings: The estimated fair values of borrowings from the FHLB were estimated based on the estimated incremental borrowing rate for similar types of borrowings. The carrying amounts of other short-term borrowings such as federal funds purchased, securities sold under agreement to repurchase and treasury, tax and loan notes were used to approximate fair value due to the short-term nature of the borrowings.

Long-term debt and subordinated debt: The fair value of long-term debt and subordinated debt is estimated by discounting the future cash flows using First Commonwealth’s estimated incremental borrowing rate for similar types of borrowing arrangements.

The following table presents carrying amounts and estimated fair values of First Commonwealth’s financial instruments:

 

     June 30, 2010    December 31, 2009
     Carrying
Value (a)
   Estimated
Fair Value
   Carrying
Value (a)
   Estimated
Fair Value
     (dollars in thousands)

Assets

           

Cash and due from banks

   $ 86,855    $ 86,855    $ 89,232    $ 89,232

Interest-bearing bank deposits

     1,503      1,503      327      327

Securities available for sale

     996,220      996,220      1,133,856      1,133,856

Securities held to maturity

     0      0      36,758      37,586

Other investments

     51,431      51,431      51,431      51,431

Loans

     4,434,291      4,466,273      4,636,501      4,655,167

Liabilities

           

Deposits

   $ 4,738,638    $ 4,825,966    $ 4,535,785    $ 4,619,070

Short-term borrowings

     355,682      348,224      958,932      950,799

Long-term debt

     155,250      158,556      168,697      172,249

Subordinated debt

     105,750      68,258      105,750      70,874

 

(a) As reported in the Condensed Consolidated Statements of Financial Condition.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 12 Derivatives

First Commonwealth is a party to interest rate derivatives that are not designated as hedging instruments. These derivatives relate to interest rate swaps that First Commonwealth enters into with customers to allow customers to convert variable rate loans to a fixed rate. First Commonwealth pays interest to the customer at a floating rate on the notional amount and receives interest from the customer at a fixed rate for the same notional amount. At the same time the interest rate swap is entered into with the customer, an offsetting interest rate swap is entered into with another financial institution. First Commonwealth pays the other financial institution interest at the same fixed rate on the same notional amount as the swap entered into with the customer, and receives interest from the financial institution for the same floating rate on the same notional amount. The changes in the estimated fair value of the swaps offset each other, except for the credit risk of the counterparties, which is calculated by taking into consideration the risk rating, probability of default and loss given default for all counterparties.

We have four risk participation agreements with financial institution counterparties for interest rate swaps related to loans in which we are a participant. The risk participation agreements provide credit protection to the financial institution should the borrower fail to perform on its interest rate derivative contract with the financial institution. The fee received, less the estimate of the liability for the credit exposure, was recognized in earnings at the time of the transaction.

A liability of $1.2 million was recorded for credit risk on an aggregate notional amount outstanding of $219.7 million for interest rate derivatives and $132.7 million of risk participation agreements at June 30, 2010. The estimated fair value of our derivatives is included in a table in Note 11 “Fair Values of Assets and Liabilities” in the line items “Other assets” and “Other liabilities.”

The table below presents the amount representing the change in the estimated fair value of derivative assets and derivative liabilities attributable to credit risk included in “Other income” on the Condensed Consolidated Statements of Operations:

 

     For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
         2010             2009            2010             2009    
     (dollars in thousands)

Non-hedging interest rate derivatives:

  

(Decrease) increase in other income

   $ (263   $ 52    $ (294   $ 128

Note 13 Goodwill

In accordance with ASC 805, “Business Combinations” and ASC 350, “Intangibles – Goodwill and Other,” all assets and liabilities acquired in purchase acquisitions, including goodwill, indefinite-lived intangibles and other intangibles are recorded at fair value. We consider our accounting policies related to goodwill and other intangible assets to be critical because the assumptions or judgment used in determining the fair value of assets and liabilities acquired in past acquisitions are subjective and complex. As a result, changes in these assumptions or judgment could have a significant impact on our financial condition or results of operations.

The fair value of acquired assets and liabilities, including the resulting goodwill, was based either on quoted market prices or provided by other third-party sources, when available. When third-party information was not available, estimates were made in good faith by management primarily through the use of internal cash flow modeling techniques. The assumptions that were used in the cash flow modeling were subjective and are susceptible to significant changes.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 13 Goodwill (Continued)

 

Goodwill is tested for impairment at least annually and written down and charged to results of operations only in periods in which the recorded value is more than the estimated fair value. As of June 30, 2010 and December 31, 2009, goodwill totaled $160.0 million.

First Commonwealth is one reporting unit and goodwill is tested in November of each year for impairment. As a result of the negative impact other-than-temporary impairment charges and credit losses in our loan portfolio have had on our earnings and the resulting decrease in our stock price, we evaluated our goodwill for impairment more frequently, beginning June 30, 2009 and each subsequent quarter end thereafter.

Goodwill is tested for impairment using a two-step process that begins with an estimation of fair value. The first step compares the estimated fair value of First Commonwealth with its carrying amount, including goodwill. If the estimated fair value exceeds its carrying amount, goodwill is not considered impaired. However, if the carrying amount exceeds its estimated fair value, a second step would be performed that would compare the implied fair value to the carrying amount of goodwill. An impairment loss would be recorded to the extent that the carrying amount of goodwill exceeds its implied fair value.

Fair value may be determined using market prices, comparison to similar assets, market multiples, discounted cash flow analysis and other variables. Estimated cash flows extend five years into the future and, by their nature, are difficult to estimate over such an extended time-frame. Factors that may significantly affect the estimates include, but not limited to, balance sheet growth assumptions, credit losses in our investment and loan portfolios, competitive pressures in our market area, changes in customer base and customer product preferences, changes in revenue growth trends, cost structure, changes in discount rates, conditions in the banking sector and general economic variables.

As of June 30, 2010, we retained a third-party valuation firm to assist in our Step 1 test for potential goodwill impairment. The valuation incorporated both income and market based analyses and indicated the fair value of our goodwill was 3% below carrying amount, therefore in accordance with ASC Topic 350-20-35-8, a Step 2 analysis was undertaken.

The Step 2 test follows the purchase price allocation under the purchase method described in ASC 820-10, and fair value estimates as defined and prescribed by ASC 820-10-30. To determine the implied fair value of goodwill, the fair value of all assets other than goodwill, less the fair value of liabilities is subtracted from the fair value of the company. Significant judgment and estimates are involved in estimating the fair value of the assets and liabilities of the company. Key valuations used in the analysis were the mark-to-fair-value on the loan portfolio, assessment of core deposit intangibles and the mark-to-fair-value of outstanding debt and deposits.

As a result of the Step 2 analysis, it was determined that the fair value of our goodwill exceeded its carrying value by at least 31% and therefore no impairment charge was required.

As of June 30, 2010, goodwill was not considered impaired; however, changing economic conditions that may adversely affect our performance and stock price could result in impairment, which could adversely affect earnings in future periods (see additional discussion of goodwill impairment under “Risk Factors” on page 59).

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

 

Note 14 New Accounting Pronouncements

FASB ASU No. 2009-16, “Transfers and Servicing (Topic 860) Accounting for Transfers of Financial Assets” makes several significant amendments to FASB ASC Topic 860, “Transfers and Servicing” including the removal of the concept of a qualifying special-purpose entity. The new guidance also clarifies that a transferor must evaluate whether it has maintained effective control of a financial asset by considering its continuing direct or indirect involvement with the transferred financial asset. The new authoritative accounting guidance became effective for fiscal years beginning after November 15, 2009. First Commonwealth adopted the new guidance under FASB ASU No. 2009-16 on January 1, 2010. The adoption did not have a material impact on First Commonwealth’s financial condition or results of operations.

FASB ASU No. 2009-17, “Consolidations (Topic 810) Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a VIE for consolidation purposes. The primary beneficiary of a VIE is the enterprise that has: (1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance, and (2) the obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits of the VIE that could potentially be significant to the VIE. The new guidance became effective for fiscal years beginning after November 15, 2009. First Commonwealth adopted the new guidance under FASB ASU No. 2009-17 on January 1, 2010. The adoption did not have a material impact on First Commonwealth’s financial condition or results of operations.

In January 2010, FASB issued FASB ASU No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820) – Improving Disclosures about Fair Value Measurements.” The ASU revises two disclosure requirements concerning fair value measurements and clarifies two others. It requires separate presentation of significant transfers into and out of Levels 1 and 2 of the fair value hierarchy and disclosure of the reasons for such transfers. It will also require the presentation of purchases, sales, issuances and settlements within Level 3 on a gross basis rather than a net basis. The amendments also clarify that disclosures should be disaggregated by class of asset or liability and that disclosures about inputs and valuation techniques should be provided for both recurring and non-recurring fair value measurements. We adopted these new disclosure requirements during the current period, with the exception of the requirement concerning gross presentation of Level 3 activity, which is effective for fiscal years beginning after December 15, 2010. With respect to the portions of this ASU that were adopted during the current period, the adoption of this standard did not have a material impact on First Commonwealth’s financial condition or results of operations. Management does not believe that the adoption of the remaining portion of the ASU will have a material impact on First Commonwealth’s financial condition or results of operations.

In February 2010, FASB issued FASB ASU No. 2010-09, “Subsequent Event – Amendments to Certain Recognition and Disclosure Requirements.” The ASU establishes separate subsequent event recognition criteria and disclosure requirements for SEC filers. Effective with the release date, the financial statements of SEC filers will no longer disclose either the date through which subsequent events were reviewed or that subsequent events were evaluated through the date financial statements were issued. The requirement to evaluate subsequent events through the date of issuance is still in place. Only the disclosure is affected. The ASU also removes the requirement to make subsequent events disclosures in financial statements revised for either a correction of an error or a retrospective application of an accounting change.

In April 2010, FASB issued ASU No. 2010-18, “Receivables (Topic 310): Effect of a Loan Modification When the Loan is Part of a Pool that is Accounted for as a Single Asset – a consensus of the FASB Emerging Issues Task Force.” The ASU provides guidance on the accounting for loan modifications when the loan is part of a

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2010

Note 14 New Accounting Pronouncements (Continued)

 

pool of loans accounted for as a single asset such as acquired loans that have evidence of credit deterioration upon acquisition that are accounted for under the guidance in ASC 310-30. The ASU addresses diversity in practice on whether a loan that is part of a pool of loans accounted for as a single asset should be removed from that pool upon a modification that would constitute a troubled debt restructuring or remain in the pool after modification. The ASU clarifies that modifications of loans that are accounted for within a pool under ASC 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a troubled debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loan is included is impaired if the expected cash flows for the pool change. The amendments in this update do not require any additional disclosures and are effective for modifications of loans accounted for within pools under ASC 310-30 occurring in the first interim or annual period ending on or after July 15, 2010. Management does not believe the adoption of the ASU will have a material impact on First Commonwealth’s financial condition or results of operations.

In July 2010, FASB issued ASU No. 2010-20, “Receivables (Topic 310): Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The objective of this ASU is to provide financial statement users with greater transparency about an entity’s allowance for credit losses and the credit quality of its financing receivables by providing additional information to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. For public entities, the disclosures as of the end of a reporting period are effective for interim and annual reporting periods ending on or after December 15, 2010. The disclosures about activity that occurs during a reporting period are effective for interim and annual reporting periods beginning on or after December 15, 2010. Only disclosures are affected. Management does not believe the adoption of the ASU will have a material impact on First Commonwealth’s financial condition or results of operations.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

This discussion and the related financial data are presented to assist in the understanding and evaluation of the consolidated financial condition and the results of operations of First Commonwealth Financial Corporation including its subsidiaries (“First Commonwealth”) for the six months ended June 30, 2010 and 2009, and should be read in conjunction with the Consolidated Financial Statements and notes thereto included in this Form 10-Q.

Forward-Looking Statements

Certain statements contained in this report that are not historical facts may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of words such as “may,” “will,” “should,” “could,” “would,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “estimate” or words of similar meaning. These forward-looking statements include statements relating to our anticipated future financial performance, projected growth and management’s long-term performance goals, as well as statements relating to the anticipated effects on results of operations and financial condition from developments or events, our business and growth strategies.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, and could be affected by many factors. The following list, which is not intended to be an all-encompassing list of risks and uncertainties affecting us, summarizes several factors that could cause our actual results to differ materially from those anticipated or expected in these forward-looking statements:

 

 

economic conditions (both generally and in our markets) may be less favorable than expected, resulting in, among other things, a continued deterioration in credit quality, a further reduction in demand for credit and/or a further decline in real estate values;

 

 

the general decline in the real estate and lending market may continue to negatively affect our financial results;

 

 

inaccuracies in our assumptions used in calculating the appropriate amount to be placed into our allowance for loan and lease losses;

 

 

restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals;

 

 

legislative and regulatory changes (including the unexpected impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act and related regulations) subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;

 

 

changes in accounting standards and compliance requirements may adversely affect the business in which we are engaged;

 

 

competitive pressures among depository and other financial institutions may increase significantly;

 

 

changes in the interest rate environment, our disposal of municipal bonds and our reduction in large credits, may reduce margins or the volumes or values of the loans we make;

 

 

competitors may have greater financial resources and develop products that enable those competitors to compete more successfully than we can;

 

 

our ability to attract and retain key personnel can be affected by the increased competition for experienced employees in the banking industry;

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Forward-Looking Statements (Continued)

 

 

adverse changes may occur in the bond and equity markets;

 

 

war or terrorist activities may cause further deterioration in the economy or cause instability in credit markets; and

 

 

economic, governmental or other factors may prevent the projected population, residential and commercial growth in the markets in which we operate.

Forward-looking statements speak only as of the date on which they are made. We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made. You should consider all risks and uncertainties set forth in this report, as well as the risks and uncertainties disclosed in our other periodic and current reports filed with the SEC including our 2009 Annual Report on Form 10-K, our subsequent Quarterly Reports on Form 10-Q and our Current Reports on Form 8-K.

Business Summary

First Commonwealth is a financial holding company that is headquartered in Indiana, Pennsylvania with assets of approximately $6.1 billion at June 30, 2010, total loans of $4.4 billion, total deposits of $4.7 billion and shareholders’ equity of $654.3 million. First Commonwealth provides a diversified array of consumer and commercial banking services through our bank subsidiary, First Commonwealth Bank, which operates 115 community banking offices throughout western Pennsylvania and three loan production offices in downtown Pittsburgh, State College and Canonsburg, Pennsylvania. The largest concentration of our branch offices are located within the greater Pittsburgh metropolitan area in Allegheny, Butler, Washington and Westmoreland counties, while our remaining offices are located in smaller cities, such as Altoona, Johnstown and Indiana, Pennsylvania, and in towns and villages throughout predominantly rural counties. We also provide trust and wealth management services and offer insurance products through First Commonwealth Bank and our other operating subsidiaries. First Commonwealth’s common stock trades on the NYSE under the symbol “FCF.”

The challenging economic environment and its effects on our commercial loan portfolio have negatively impacted our financial performance during the first six months of 2010. Out-of-market loans and large exposures to a relatively small number of commercial borrowers represent a small portion of our total assets, but have had a disproportionate effect on earnings. Management continues to focus on these issues as well as taking necessary steps to mitigate the risks of these exposures.

During the first six months of 2010, the profile of our balance sheet changed with growth in lower costing transactions and savings deposits, reduced loan volumes and a strategy of allowing the securities portfolio to mature without being replaced in order to provide funds to pay down borrowings as the risk/reward for balance sheet leveraging activities has become less attractive in the current rate environment. These changes resulted in a decline in total assets, but are expected to mitigate liquidity and interest rate risk.

Explanation of Use of Non-GAAP Financial Measure

In addition to the results of operations presented in accordance with generally accepted accounting principles (“GAAP”), First Commonwealth management uses, and this quarterly report contains or references, certain non-GAAP financial measures, such as net interest income on a fully tax-equivalent basis. We believe this non-GAAP financial measure provides information useful to investors in understanding our underlying

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Explanation of Use of Non-GAAP Financial Measure (Continued)

 

operational performance and our business and performance trends as it facilitates comparison with the performance of others in the financial services industry. Although we believe that this non-GAAP financial measure enhances investors’ understanding of our business and performance, this non-GAAP financial measure should not be considered an alternative to GAAP.

We believe the presentation of net interest income on a fully tax-equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Interest income per the Condensed Consolidated Statements of Operation is reconciled to net interest income adjusted to a fully tax-equivalent basis on page 36 for the six month period ended June 30 and on page 44 for the three month period ended June 30.

Results of Operations

Six months ended June 30, 2010 compared to six months ended June 30, 2009

Net Income

For the six months ended June 30, 2010, First Commonwealth had net income of $0.4 million, or $0.00 per share, compared to a net loss of $16.9 million or $0.20 per share in the six months ended June 30, 2009. Net income for both periods was negatively impacted by the level of provision for loan losses and other-than-temporary impairment charges. Results for 2010 reflects improvement in both of these areas as the provision for loan losses in the first six months of 2010 was $49.0 million, a decrease of $7.5 million or 13% compared to $56.5 million recorded in the comparable period of 2009. Other-than-temporary impairment charges were $4.9 million for the six months ended June 30, 2010, a decrease of $13.8 million or 74% compared to $18.6 million recorded in the same period in 2009.

Other items affecting results for the six months ended June 30, 2010 include an increase of 16 basis points or $2.8 million in the net interest margin on a fully tax-equivalent basis and a decrease of $1.8 million in non-interest expense compared to the same period as last year. Non-interest income, excluding net security losses, was basically flat compared to 2009, despite a $2.1 million gain from a favorable legal settlement recorded in 2009.

Net Interest Income

Net interest income, on a fully tax-equivalent basis, increased $2.8 million, or 3%, in the first six months of 2010 as compared to the same period in 2009, despite the negative impact of a $51.2 million increase in the level of non-performing loans. The increase in net interest income resulted from a 16 basis point increase in the net interest margin, partially offset by a decline of $89.5 million in average interest-earning assets. Net interest margin, on a fully tax-equivalent basis, was 3.88% and 3.72% for the six month periods ended June 30, 2010 and 2009, respectively. The improved net interest margin can be attributed to a more favorable deposit mix, improved loan pricing and reduced balance sheet leveraging activities.

Comparing the first six months of 2010 with the same period of 2009, interest income, on a fully tax-equivalent basis, decreased $10.5 million, or 7%, as the contribution from loan growth was negatively offset by a decrease in average investment securities and lower interest rates. Average loans increased $107.6 million primarily in the commercial real estate, home equity and indirect lending categories, while average investments declined $253.3 million as proceeds from maturing securities contributed to a decrease in average borrowings. The tax-equivalent

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Net Interest Income (Continued)

 

yield on interest-earning assets decreased 29 basis points from 5.33% for the six months ended June 30, 2009 to 5.04% for the same period in 2010.

Interest expense, in the first six months of 2010 as compared to the same period in 2009, decreased $13.3 million or 28%, primarily due to a 48 basis point decline on rates paid for interest-bearing liabilities. The cost of interest- bearing liabilities was 1.34% and 1.82% at June 30, 2010 and 2009, respectively. The benefit from the lower interest rates paid was offset by growth in average deposits which increased $300.1 million, including $457.0 million of lower costing transaction and savings deposits, offset by a $156.9 million decrease in time deposits.

The following table reconciles interest income in the Condensed Consolidated Statements of Operations to net interest income adjusted to a fully tax-equivalent basis:

 

     Six Months Ended
June 30,
     2010    2009
     (dollars in thousands)

Interest income per Condensed Consolidated Statement of Operations

   $ 139,015    $ 148,661

Adjustment to fully tax-equivalent basis

     5,437      6,276
             

Interest income adjusted to fully tax-equivalent basis (non-GAAP)

     144,452      154,937

Interest expense

     33,321      46,574
             

Net interest income adjusted to fully tax-equivalent basis
(non-GAAP)

   $ 111,131    $ 108,363
             

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Net Interest Income (Continued)

 

The following is an analysis of the average balance sheets and net interest income on a fully tax-equivalent basis, for the six months ended June 30:

 

    Average Balance Sheets and Net Interest Income Analysis  
    2010     2009  
    Average
Balance
    Income/
Expense (a)
  Yield
or
Rate
    Average
Balance
    Income/
Expense (a)
  Yield
or
Rate
 
    (dollars in thousands)  

Assets

           

Interest-earning assets:

           

Interest-bearing deposits with banks

  $ 57,005     $ 73   0.26   $ 790      $ 2   0.47

Tax-free investment securities

    184,296       6,139   6.72       248,540        8,544   6.93  

Taxable investment securities

    942,203       20,177   4.32       1,131,230        27,037   4.82  

Loans, net of unearned income (b)(c)

    4,593,781       118,063   5.18       4,486,216        119,354   5.37  
                               

Total interest-earning assets

    5,777,285       144,452   5.04       5,866,776        154,937   5.33  
                               

Non-interest-earning assets:

           

Cash

    76,322           74,721       

Allowance for credit losses

    (103,920         (48,187    

Other assets

    591,143           541,810       
                       

Total non-interest-earning assets

    563,545           568,344       
                       

Total Assets

  $ 6,340,830         $ 6,435,120       
                       

Liabilities and Shareholders’ Equity

           

Interest-bearing liabilities:

           

Interest-bearing demand deposits (d)

  $ 615,618     $ 416   0.14     $ 598,399     $ 980   0.33  

Savings deposits (d)

    1,758,365       6,870   0.79       1,373,299       8,294   1.22  

Time deposits

    1,639,283       19,361   2.38       1,796,155       28,176   3.16  

Short-term borrowings

    761,066       1,468   0.39       1,100,660       2,480   0.45  

Long-term debt

    249,778        5,206   4.20       289,133       6,644   4.63  
                               

Total interest-bearing liabilities

    5,024,110       33,321   1.34       5,157,646       46,574   1.82  
                               

Non-interest-bearing liabilities and shareholders’ equity:

           

Non-interest-bearing demand deposits (d)

    629,202           574,488      

Other liabilities

    37,799           42,587      

Shareholders’ equity

    649,719           660,399      
                       

Total non-interest-bearing funding sources

    1,316,720           1,277,474      
                       

Total Liabilities and Shareholders’ Equity

  $ 6,340,830         $ 6,435,120      
                       

Net Interest Income and Net Yield on Interest-Earning Assets

    $ 111,131   3.88     $ 108,363   3.72
                   

 

(a) Income on interest-earning assets has been computed on a tax-equivalent basis using the 35% federal income tax statutory rate.
(b) Income on non-accrual loans is accounted for on the cash basis, and the loan balances are included in interest-earning assets.
(c) Loan income includes loan fees earned.
(d) Average balances do not include reallocations from non-interest-bearing demand deposits and interest-bearing demand deposits into savings deposits, which were made for regulatory purposes.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Net Interest Income (Continued)

 

The following table shows the effect of changes in volumes and rates on interest income and interest expense for the six months ended June 30:

 

     Analysis of Changes in Net Interest Income  
     Six Months Ended June 30, 2010
Compared with June 30, 2009
 
     Total
    Change    
    Change
Due to
    Volume    
    Change
Due to
    Rate (a)    
 
     (dollars in thousands)  

Interest-earning assets:

      

Interest-bearing deposits with banks

   $ 71     $ 131     $ (60

Tax-free investment securities

     (2,405     (2,208     (197

Taxable investment securities

     (6,860     (4,518     (2,342

Loans

     (1,291     2,864        (4,155
                        

Total interest income (b)

     (10,485     (3,731     (6,754
                        

Interest-bearing liabilities:

      

Interest-bearing demand deposits

     (564     28       (592

Savings deposits

     (1,424     2,325       (3,749

Time deposits

     (8,815     (2,461     (6,354

Short-term borrowings

     (1,012     (765     (247

Long-term debt

     (1,438     (904     (534
                        

Total interest expense

     (13,253     (1,777     (11,476
                        

Net interest income

   $ 2,768     $ (1,954   $ 4,722   
                        

 

(a) Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances.
(b) Changes in interest income have been computed on a tax-equivalent basis using the 35% federal income tax statutory rate.

Provision for Credit Losses

The provision for credit losses is determined based on management’s estimates of the appropriate level of allowance for credit losses needed to absorb probable losses inherent in the loan portfolio, after giving consideration to charge-offs and recoveries for the period. The provision for credit losses is an amount added to the allowance against which credit losses are charged.

The provision for credit losses for the six months ended June 30, 2010 totaled $49.0 million, a decrease of $7.5 million as compared to the same period in 2009. The 2010 provision resulted primarily from an updated collateral valuation for a commercial real estate construction loan in Florida that was placed in non-performing status during the third quarter of 2009, an out-of market commercial real estate construction loan that migrated to non-performing status during the first quarter of 2010 and deterioration in a western Pennsylvania commercial loan that was placed in non-performing status in the fourth quarter of 2009.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Provision for Credit Losses (Continued)

 

The table below provides a breakout of the provision for credit losses by loan category for the six months ended:

 

     June 30, 2010     June 30, 2009  
     Dollars     Percentage     Dollars    Percentage  
     (dollars in thousands)  

Commercial, financial and agricultural

   $ 2,315      5   $ 9,067    16

Real estate-construction

     45,508      93       34,078    60  

Real estate-residential

     1,819      4       3,375    6  

Real estate-commercial

     (2,273   (5     7,631    14  

Loans to individuals

     1,661      3       2,339    4  
                           

Total

   $ 49,030      100 %   $ 56,490    100 %
                           

For the first six months of 2010, the provision related to commercial, financial and agricultural loans was primarily due to $2.3 million allocated for a $44.5 million line of credit to a western Pennsylvania real estate developer. The Bank has been working with multiple financial institutions in order to develop a work-out plan. Partially offsetting this additional provision was $2.7 million in recoveries on previously charged-off loans or reduction of established specific reserves related to two loans which provided higher than expected proceeds from bankruptcy sales.

The provision for credit losses related to real estate-construction loans was primarily due to $24.3 million allocated for a $39.6 million construction loan for a Florida condominium project that was placed into non-performing status in the third quarter of 2009. Continued market deterioration, and questions concerning the developer’s willingness and capacity to complete the project, resulted in a change in the estimated collateral value from an “as completed” to an “as is” raw land valuation. Additionally, $10.9 million was allocated for a $12.7 million condominium development project in Missouri and $3.3 million was allocated for an $8.6 million participation construction loan for development of a Nevada resort. The Missouri condominium project was placed in non-performing status in the first quarter of 2010. Reduced market demand and cash flow issues have delayed project completion and a work-out plan is being developed. Developers for the operating Nevada resort are abandoning expansion plans due to market conditions and this loan was placed into non-performing status in the first quarter of 2010. The bank has personal recourse to the developers on all three projects, however, that recourse was not given any consideration in the reserve assessments.

Net charge-offs were $42.6 million in the first six months of 2010 compared to $26.2 million for the same period in 2009. Net charge-offs in 2010 included $34.2 million for the previously mentioned Florida condominium project and $2.1 million for a participation loan secured by real estate in Illinois. The original Illinois loan was $5.0 million and currently has an outstanding balance of $2.9 million. The loan was placed in non-performing status in the second quarter of 2009. Additionally, net charge-offs of $1.0 million were recorded for a participation loan secured by real estate in Ohio. The original loan was $6.2 million and was moved to non-performing status in the second quarter of 2009. The outstanding balance is currently $1.3 million.

The allowance for credit losses was $88.0 million or 1.99% of total loans outstanding at June 30, 2010 compared to $81.6 million or 1.76% at December 31, 2009 and $83.1 million or 1.83% at June 30, 2009. The provision is a result of management’s assessment of credit quality statistics and other factors that would have an impact on probable losses in the loan portfolio and the methodology used for determination of the adequacy of the allowance for credit losses. The change in the allowance for credit losses is directionally consistent with the

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Provision for Credit Losses (Continued)

 

increase in estimated losses within the loan portfolio determined by factors including certain loss events, portfolio migration analysis, historical loss experience, delinquency trends, deterioration in collateral values and volatility in the economy. Management believes that the allowance for credit losses is at a level deemed sufficient to absorb losses inherent in the loan portfolio at June 30, 2010.

Below is an analysis of the consolidated allowance for credit losses for the six months ended June 30:

 

     2010    2009
     (dollars in thousands)

Balance, beginning of year

   $ 81,639    $ 52,759

Loans charged-off:

     

Commercial, financial and agricultural

     1,545      9,442

Loans to individuals

     1,946      2,242

Real estate-construction

     38,182      7,695

Real estate-commercial

     1,059      5,487

Real estate-residential

     2,540      1,807
             

Total loans charged off

     45,272      26,673
             

Recoveries of loans previously charged off:

     

Commercial, financial and agricultural

     2,188      231

Loans to individuals

     298      217

Real estate-construction

     0      0

Real estate-commercial

     115      9

Real estate-residential

     48      16

Lease financing receivables

     0      7
             

Total recoveries

     2,649      480
             

Net charge-offs

     42,623      26,193

Provision charged to expense

     49,030      56,490
             

Balance, end of period

   $ 88,046    $ 83,056
             

Additional information on our loan portfolio is provided in the Credit Risk section of Management’s Discussion and Analysis.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

 

Non-Interest Income

The following table presents the components of non-interest income for the six months ended June 30:

 

     Six Months Ended
June 30
 
     2010     2009  
     (dollars in thousands)  

Non-Interest Income

    

Trust income

   $ 2,892     $ 2,238  

Service charges on deposit accounts

     8,755       8,243  

Insurance and retail brokerage commissions

     3,728       3,372  

Income from bank owned life insurance

     2,558       2,172  

Card related interchange income

     5,006       4,034  

Other income

     5,039       7,943  
                

Subtotal

     27,978       28,002  

Net securities gains

     982        80  

Net impairment losses

     (4,860     (18,627
                

Total non-interest income

   $ 24,100     $ 9,455  
                

Total non-interest income for the six months ended June 30, 2010 increased $14.7 million, or 155%, compared to the same period in 2009 primarily due to a decline in net impairment losses. Non-interest income, excluding net security gains and net impairment losses, was basically flat compared to 2009, despite a $2.1 million gain from a favorable legal settlement recorded in 2009.

Net impairment losses of $4.9 million for the six months ended June 30, 2010 decreased $13.8 million compared to the six months ended June 30, 2009. Other-than-temporary impairment charges recorded in the first six months of 2010 are the result of $4.8 million in credit related other-than-temporary impairment losses on pooled trust preferred collateralized debt obligations and $0.1 million on a bank equity security. In the first six months of 2009, other-than-temporary impairment charges included $16.1 million on pooled trust preferred collateralized debt obligations and $2.6 million on bank equity securities. The decreased level of impairment charges on pooled trust preferred securities experienced in the first six months of 2010 can be attributed to a decline in the level of interest deferrals and payment defaults by the underlying banks in these investments.

Service charges on deposit accounts for the six months ended June 30, 2010 increased $0.5 million, or 6%, as compared to the same 2009 period, due to increased overdraft and business account analysis fees. Card-related interchange income includes income on debit, credit and ATM cards that are issued to consumers and/or businesses. Card related interchange income for the six months ended June 30, 2010 increased $1.0 million, or 24%, as compared to the same 2009 period, due to growth in usage of debit cards, increased demand deposit accounts and larger dollar transactions.

Trust income increased $0.7 million, or 29%, for the first six months of 2010 as compared to the same period of 2009 as a result of increased market values of assets under management and implementation of a new fee schedule in the second quarter of 2010.

Insurance and retail brokerage commissions increased $0.4 million, or 11%, for the six months ended June 30, 2010 compared to the corresponding period of 2009 mainly due to higher sales resulting from additional producers and an enhanced calling program.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition  

and Results of Operations (Continued)

Results of Operations (Continued)

Non-Interest Income (Continued)

 

Other income decreased $2.9 million, or 37%, for the first six months of 2010 compared to the first six months of 2009. This decrease is primarily due to a $2.1 million gain resulting from a legal settlement recorded in 2009, a decrease of $0.9 million in fee income generated from new commercial loan interest rate swaps and reversal of $0.6 million of previously accrued rent due from operators of an Other Real Estate Owned (“OREO”) property.

Non-Interest Expense

The following table presents the components of non-interest expense for the six months ended June 30:

 

     Six Months Ended
June 30,
     2010    2009
     (dollars in thousands)

Non-Interest Expense

     

Salaries and employee benefits

   $ 43,374    $ 43,581

Net occupancy expense

     7,432      7,528

Furniture and equipment expense

     6,266      5,952

Data processing expense

     2,915      2,297

Pennsylvania shares tax expense

     2,514      2,643

Intangible amortization

     1,233      1,486

Collection and repossession expense

     1,717      2,651

FDIC insurance

     3,975      6,384

Other professional fees and services

     2,228      1,910

Loss on sale or write-down of assets

     2,397      112

Other operating expenses

     12,866      14,139
             

Total non-interest expense

   $ 86,917    $ 88,683
             

Total non-interest expense for the six months ended June 30, 2010 decreased $1.8 million compared to the same period in 2009. Compared to 2009, decreases were recognized in FDIC insurance and collection and repossession expense while increases were recognized as the result of the write-down of an OREO property and increased data processing expense.

Salaries and employee benefits decreased $0.2 million, or 0.5%, for the six months ended June 30, 2010 compared with the same period in 2009. The decrease is primarily attributable to a reduction in staffing levels and decreased expenses related to incentive and benefit plans. Full time equivalent staff decreased to 1,605 as compared to 1,675 at June 30, 2009.

FDIC insurance premiums decreased $2.4 million, or 38%, compared to 2009 due to the $2.9 million special assessment recorded in 2009. Collection and repossession expense decreased $0.9 million or 35% as a result of expenses recognized in 2009 for two properties that were transferred to OREO. Additionally, a successful expense initiative resulted in significant reductions in other operating expenses, including occupancy, advertising, travel and entertainment.

Loss on sale or write-down of assets increased $2.3 million primarily due to a $2.2 million write-down to fair value for an OREO property that is currently under a sales agreement.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Non-Interest Income (Continued)

 

Other operating expenses decreased $1.3 million, or 9.0%, as a result of declines in advertising related expenses of $0.6 million, loan processing costs of $0.4 million and travel expenses of $0.2 million. Offsetting these decreases are data processing expense which increased $0.6 million or 27% and furniture and equipment expense which increased $0.3 million, or 5%, both as a result of higher investments in technology solutions.

Three months ended June 30, 2010 compared to three months ended June 30, 2009

Net Income

For the three months ended June 30, 2010, First Commonwealth had net income of $13.5 million, or $0.15 per share, compared to a net loss of $18.6 million or $0.22 per share in the three month period ended June 30, 2009. The increase in net income was primarily the result of lower levels for provision for loan losses and other-than-temporary impairment charges as well as improved net interest income and a decrease in FDIC premiums.

Net Interest Income

Net interest income, on a fully tax-equivalent basis, increased $0.7 million, or 1%, in the three month period ending June 30, 2010 as compared to the same period in 2009. The net interest income increase was a result of a 15 basis point increase in the net interest margin, partially offset by a decline in average interest-earning assets. Net interest margin, on a fully tax-equivalent basis, was 3.88% and 3.73% for the three months ended June 30, 2010 and 2009, respectively. The improved net interest margin can be attributed to a more favorable deposit mix, improved loan pricing and reduced balance sheet leveraging activities.

For the three months ended June 30, 2010 as compared to the same period in 2009, interest income, on a fully tax-equivalent basis, decreased $5.2 million, or 7%, as the contribution from loan growth was negatively offset by a decrease in average investment securities and lower interest rates. Comparing the three months ended June 30, 2010 with the same period in 2009, average loans increased $40.5 million primarily in the home equity and indirect lending categories, while average investments declined $273.8 million as proceeds from maturing securities and investment sales contributed to a decrease in average borrowings. The tax-equivalent yield on interest-earning assets decreased 22 basis points from 5.25% for the three months ended June 30, 2009 to 5.03% for the same period in 2010.

Interest expense decreased $5.9 million or 27%, for the three months ended June 30, 2010 as compared to the same period in 2009, primarily due to a 40 basis point decline on rates paid for interest-bearing liabilities. The cost of interest-bearing liabilities was 1.33% and 1.73% for the three months ended June 30, 2010 and 2009, respectively. The benefit from the lower interest rates paid was offset by growth in average deposits which increased $304.7 million, including $379.8 million of lower costing transaction and savings deposits and $51.9 million in noninterest-bearing deposits, offset by a $127.0 million decrease in time deposits.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Net Interest Income (Continued)

 

The following table reconciles interest income in the Condensed Consolidated Statements of Operations to net interest income adjusted to a fully tax-equivalent basis:

 

     Three Months Ended
June 30,
     2010    2009
     (dollars in thousands)

Interest income per Condensed Consolidated Statement of Operations

   $ 68,937    $ 73,720

Adjustment to fully tax-equivalent basis

     2,639      3,091
             

Interest income adjusted to fully tax-equivalent basis (non-GAAP)

     71,576      76,811

Interest expense

     16,341      22,232
             

Net interest income adjusted to fully tax-equivalent basis (non-GAAP)

   $ 55,235    $ 54,579
             

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations (Continued)

Results of Operations (Continued)

Net Interest Income (Continued)

 

The following is an analysis of the average balance sheets and net interest income on a fully tax-equivalent basis, for the three months ended June 30:

 

    Average Balance Sheets and Net Interest Income Analysis  
    2010     2009  
    Average
Balance
    Income/
Expense (a)
  Yield
or
Rate
    Average
Balance
    Income/
Expense (a)
  Yield
or
Rate
 
    (dollars in thousands)  

Assets

           

Interest-earning assets:

           

Interest-bearing deposits with banks

  $ 74,996     $ 48   0.26   $ 767     $ 1   0.43

Tax-free investment securities

    170,002       2,830   6.68       238,958       4,092   6.87  

Taxable investment securities

    907,504       9,683   4.28       1,112,350       13,266   4.78  

Loans, net of unearned income (b)(c)

    4,552,312       59,015   5.20       4,511,811       59,452   5.29  
                               

Total interest-earning assets

    5,704,814       71,576   5.03       5,863,886       76,811   5.25  
                               

Non-interest-earning assets:

           

Cash

    77,141           75,318      

Allowance for credit losses (d)

    (123,418         (43,039    

Other assets

    595,621           555,202