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FIRST COMMONWEALTH FINANCIAL CORP /PA/ - Quarter Report: 2009 June (Form 10-Q)

Form 10-Q
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, 2009

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  ¨    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 August 5, 2009 was 85,056,516.

 

 

 


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   
  

Consolidated Statements of Financial Condition

   3
  

Consolidated Statements of Income

   4
  

Consolidated Statements of Changes in Shareholders’ Equity

   5
  

Consolidated Statements of Cash Flows

   7
  

Notes to 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    51
ITEM 4.    Controls and Procedures    51
   PART II. Other Information   
ITEM 1.    Legal Proceedings    52
ITEM 1A.    Risk Factors    52
ITEM 2.    Unregistered Sales of Equity Securities and Use of Proceeds    52
ITEM 3.    Defaults Upon Senior Securities    52
ITEM 4.    Submission of Matters to a Vote of Security Holders    52
ITEM 5.    Other Information    52
ITEM 6.    Exhibits    53
   Signatures    54

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited)

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

 

    June 30,
2009
    December 31,
2008
 
    (dollars in thousands,
except share data)
 

Assets

   

Cash and due from banks

  $ 84,346     $ 88,277  

Interest-bearing bank deposits

    961       289  

Securities available for sale, at fair value

    1,264,685       1,349,920  

Securities held to maturity, at amortized cost, (Fair value $44,161 and $50,558 at June 30, 2009 and December 31, 2008, respectively)

    44,398       50,840  

Other investments

    51,431       51,431  

Loans:

   

Portfolio loans

    4,536,771       4,418,377  

Allowance for credit losses

    (83,056     (52,759
               

Net loans

    4,453,715       4,365,618  
               

Premises and equipment, net

    72,379       72,636  

Other real estate owned

    25,565       3,262  

Goodwill

    159,956       159,956  

Amortizing intangibles, net

    8,747       10,233  

Other assets

    282,814       273,418  
               

Total assets

  $ 6,448,997     $ 6,425,880  
               

Liabilities

   

Deposits (all domestic):

   

Noninterest-bearing

  $ 592,219     $ 566,845  

Interest-bearing

    3,893,671       3,713,498  
               

Total deposits

    4,485,890       4,280,343  

Short-term borrowings

    998,259       1,139,737  

Other liabilities

    44,866       63,778  

Subordinated debentures

    105,750       105,750  

Other long-term debt

    180,922       183,493  
               

Total long-term debt

    286,672       289,243  
               

Total liabilities

    5,815,687       5,773,101  
               

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; 86,600,431 shares issued and 85,055,220 shares outstanding at June 30, 2009; 86,600,431 shares issued and 85,050,744 shares outstanding in 2008

    86,600       86,600  

Additional paid-in capital

    302,602       303,008  

Retained earnings

    287,092       309,947  

Accumulated other comprehensive loss, net

    (18,618     (21,269

Treasury stock (1,545,211 and 1,549,687 shares at June 30, 2009 and December 31, 2008, respectively, at cost)

    (17,766     (17,907

Unearned ESOP shares

    (6,600     (7,600
               

Total shareholders’ equity

    633,310       652,779  
               

Total liabilities and shareholders’ equity

  $ 6,448,997     $ 6,425,880  
               

The accompanying notes are an integral part of these 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)

CONSOLIDATED STATEMENTS OF INCOME

 

    For the Quarter Ended
June 30,
    For the Six Months
Ended June 30,
 
    2009     2008     2009     2008  
    (dollars in thousands, except share data)  

Interest Income

       

Interest and fees on loans

  $ 57,793     $ 62,614     $ 116,068     $ 124,681  

Interest and dividends on investments:

       

Taxable interest

    13,177       15,578       26,885       31,109  

Interest exempt from Federal income taxes

    2,660       3,347       5,554       6,942  

Dividends

    89       678       152       1,287  

Interest on Federal funds sold

    0       2       0       2  

Interest on bank deposits

    1       2       2       7  
                               

Total interest income

    73,720       82,221       148,661       164,028  
                               

Interest Expense

       

Interest on deposits

    17,874       25,370       37,450       56,403  

Interest on short-term borrowings

    1,133       4,251       2,480       7,956  

Interest on subordinated debentures

    1,559       1,878       3,325       3,789  

Interest on other long-term debt

    1,666       3,791       3,319       7,865  
                               

Total interest on long-term debt

    3,225       5,669       6,644       11,654  
                               

Total interest expense

    22,232       35,290       46,574       76,013  
                               

Net Interest Income

    51,488       46,931       102,087       88,015  

Provision for credit losses

    48,248       5,361       56,490       8,540  
                               

Net Interest Income after Provision for Credit Losses

    3,240       41,570       45,597       79,475  
                               

Non-Interest Income

       

Impairment losses on securities

    (14,421     (541     (43,010     (541

Noncredit related losses on securities not expected to be sold (recognized in other comprehensive income)

    5,660       -0-        24,383       -0-   
                               

Net impairment losses

    (8,761     (541     (18,627     (541

Net securities gains

    56       90       80       591  

Trust income

    1,151       1,538       2,238       3,070  

Service charges on deposit accounts

    4,406       4,786       8,243       9,211  

Insurance and retail brokerage commissions

    1,756       1,394       3,372       2,671  

Income from bank owned life insurance

    1,034       1,446       2,172       2,933  

Card related interchange income

    2,138       1,950       4,034       3,703  

Other income

    4,935       2,426       7,943       4,907  
                               

Total non-interest income

    6,715       13,089       9,455       26,545  
                               

Non-Interest Expense

       

Salaries and employee benefits

    21,081       20,428       43,581       40,758  

Net occupancy expense

    3,528       3,728       7,528       7,635  

Furniture and equipment expense

    2,977       3,058       5,952       6,136  

Advertising expense

    595       401       1,108       1,029  

Data processing expense

    1,165       996       2,297       2,047  

Pennsylvania shares tax expense

    1,312       1,339       2,643       2,610  

Intangible amortization

    743       832       1,486       1,663  

Collection and repossession expense

    1,750       704       2,651       1,319  

FDIC insurance

    4,863       125       6,384       248  

Other professional fees and services

    847       934       1,910       1,684  

Other operating expenses

    6,474       6,340       13,143       12,612  
                               

Total non-interest expense

    45,335       38,885       88,683       77,741  
                               

(Loss) Income before income taxes

    (35,380     15,774       (33,631     28,279  

Income tax (benefit) provision

    (16,761     2,861       (16,699     4,245  
                               

Net (Loss) Income

  $ (18,619   $ 12,913     $ (16,932   $ 24,034  
                               

Average Shares Outstanding

    84,559,889        72,624,053       84,540,684        72,538,464  

Average Shares Outstanding Assuming Dilution

    84,594,211        72,734,711       84,601,302        72,647,190  

Per Share Data:

       

Basic Earnings per Share

  $ (0.22   $ 0.18     $ (0.20   $ 0.33  

Diluted Earnings per Share

  $ (0.22   $ 0.18     $ (0.20   $ 0.33  

Cash Dividends Declared per Common Share

  $ 0.00     $ 0.17     $ 0.12     $ 0.34  

The accompanying notes are an integral part of these 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)

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, 2008

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

Cumulative effect from adoption of FSP FAS 115-2 and FAS 124-2 ($6.5 million, net of $2.3 million tax)

    -0-     -0-        4,223       (4,223     -0-        -0-        -0-  
                                                     

Balance at January 1, 2009

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

Comprehensive income

             

Net loss

    -0-     -0-        (16,932     -0-        -0-        -0-       (16,932

Other comprehensive income, net of tax:

             

Unrealized holding gains on securities arising during the period

    -0-     -0-        -0-        10,661       -0-        -0-        10,661  

Noncredit related losses on securities not expected to be sold

    -0-     -0-        -0-        (15,849     -0-        -0-        (15,849

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

    -0-     -0-        -0-        12,062       -0-        -0-        12,062  
                   

Total other comprehensive income

                6,874  
                   

Total comprehensive income

                (10,058

Cash dividends declared

    -0-     -0-        (10,146     -0-        -0-        -0-        (10,146

Net decrease in unearned ESOP shares

    -0-     -0-        -0-        -0-        -0-        1,000       1,000   

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

    -0-     (206     -0-        -0-        -0-        -0-        (206

Discount on dividend reinvestment plan purchases

    -0-     (352     -0-        -0-        -0-        -0-        (352

Tax benefit of stock options exercised

    -0-     149       -0-        -0-        -0-        -0-        149  

Treasury stock reissued

    -0-     1       -0-        -0-        51       -0-        52  

Restricted stock

    -0-     2       -0-        -0-        90       -0-        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 consolidated financial statements.

 

5


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (CONTINUED)

(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, 2007

  $ 75,100   $ 206,889     $ 319,246     $ (147   $ (22,700   $ (9,600   $ 568,788  

Cumulative effect from adoption of EITF Issue No. 06-4 ($1.5 million, net of $0.5 million tax)

    -0-     -0-        (984     -0-        -0-        -0-        (984
                                                     

Balance at January 1, 2008

    75,100     206,889       318,262       (147     (22,700     (9,600     567,804  

Comprehensive income

             

Net income

    -0-     -0-        24,034       -0-        -0-        -0-        24,034  

Other comprehensive income, net of tax:

             

Unrealized holding losses on securities arising during the period

    -0-     -0-        -0-        (22,462     -0-        -0-        (22,462

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

    -0-     -0-        -0-        5       -0-        -0-        5  
                   

Total other comprehensive income

                (22,457
                   

Total comprehensive income

                1,577  

Cash dividends declared

    -0-     -0-        (24,685     -0-        -0-        -0-        (24,685

Net decrease in unearned ESOP shares

    -0-     -0-        -0-        -0-        -0-        1,000       1,000  

Discount on dividend reinvestment plan purchases

    -0-     (458     -0-        -0-        -0-        -0-        (458

Treasury stock reissued

    -0-     (193     -0-        -0-        1,577       -0-        1,384  

Restricted stock

    -0-     7       -0-        -0-        69       -0-        76  
                                                     

Balance at June 30, 2008

  $ 75,100   $ 206,245     $ 317,611     $ (22,604   $ (21,054   $ (8,600   $ 546,698  
                                                     

The accompanying notes are an integral part of these 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)

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     For the Six Months Ended
June 30,
 
     2009     2008  
     (dollars in thousands)  

Operating Activities

    

Net (loss) income

   $ (16,932   $ 24,034  

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

    

Provision for credit losses

     56,490       8,540  

Deferred tax benefit

     (18,711     (1,274

Depreciation and amortization

     4,998       5,569  

Net losses (gains) on securities and other assets

     18,114       (340

Net amortization of premiums and discounts on securities

     (146     21  

Net amortization of premiums and discounts on long-term debt

     (1,049     (2,064

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

     (2,172     (2,933

Decrease in interest receivable

     2,491       2,599  

Decrease in interest payable

     (1,047     (3,767

(Decrease) increase in income taxes payable

     (2,179     1,356  

Other-net

     4,137       (4,158
                

Net cash provided by operating activities

     43,994       27,583  
                

Investing Activities

    

Transactions in securities held to maturity:

    

Proceeds from maturities and redemptions

     6,597       12,525  

Transactions in securities available for sale:

    

Proceeds from sales

     3,829       4,946  

Proceeds from maturities and redemptions

     199,199       225,936  

Purchases

     (125,762     (230,569

Proceeds from sales of other assets

     3,736       3,839  

Net (increase) decrease in interest-bearing deposits with banks

     (672     1,372  

Net increase in loans

     (169,774     (426,717

Purchases of premises and equipment

     (3,987     (4,935
                

Net cash used in investing activities

     (86,834     (413,603
                

Financing Activities

    

Repayments of other long-term debt

     (2,925     (68,478

Proceeds from issuance of long-term debt

     2,403       33,810   

Discount on dividend reinvestment plan purchases

     (352     (458

Dividends paid

     (24,604     (24,660

Net (decrease) increase in Federal funds purchased

     (139,700     34,850   

Net (decrease) increase in other short-term borrowings

     (1,778     445,175   

Net increase (decrease) in deposits

     205,664       (34,534

Proceeds from sale of treasury stock

     52       1,384   

Stock option tax benefit

     149       -0-   
                

Net cash provided by financing activities

     38,909       387,089  
                

Net (decrease) increase in cash and cash equivalents

     (3,931     1,069  

Cash and cash equivalents at January 1

     88,277       100,791  
                

Cash and cash equivalents at June 30

   $ 84,346     $ 101,860  
                

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

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 1 Basis of Presentation

 

The consolidated financial statements include the accounts of First Commonwealth Financial Corporation and its wholly owned subsidiaries (“First Commonwealth”). All material intercompany transactions have been eliminated in consolidation. Certain reclassifications have been made in the consolidated financial statements for 2008 to conform to the classifications presented for 2009. The Consolidated Statements of Financial Condition presented on page 3 reflects amounts for the period ended December 31, 2008 which have been reclassified from the presentation provided in First Commonwealth’s 2008 Annual Report on Form 10-K. This reclassification relates to $13.0 million in borrowings which were presented as short-term in the Annual Report on Form 10-K and are now presented as long-term borrowings in the 2009 financial statements. The amount reclassified represents debt with an original maturity of greater than one year, but remaining maturity of less than one year.

The accounting and reporting policies of First Commonwealth conform with accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with generally accepted accounting principles 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 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, 2009 and 2008 are not necessarily indicative of the results that may be expected for the full year or any other interim period. These interim financial statements should be read in conjunction with First Commonwealth’s 2008 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, 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.

First Commonwealth has evaluated subsequent events through August 7, 2009, the date these financial statements were issued.

Note 2 Supplemental Comprehensive Income Disclosures

 

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

 

    June 30, 2009     June 30, 2008  
    (dollars in thousands)  
    Pre-tax
Amount
    Tax
(Expense)
Benefit
    Net of
Tax
Amount
    Pre-tax
Amount
    Tax
(Expense)
Benefit
    Net of
Tax
Amount
 

Unrealized gains (losses) on securities:

           

Unrealized holding gains (losses) arising during the period

  $ 16,401     $ (5,740   $ 10,661     $ (34,557   $ 12,095     $ (22,462

Noncredit related losses on securities not expected to be sold

    (24,383     8,534       (15,849     -0-        -0-        -0-   

Less: reclassification adjustment for losses (gains) realized in net income

    18,557       (6,495     12,062       8       (3     5  
                                               

Net unrealized gains (losses)

    10,575       (3,701     6,874       (34,549     12,092        (22,457
                                               

Other comprehensive income (loss)

  $ 10,575     $ (3,701   $ 6,874     $ (34,549   $ 12,092      $ (22,457
                                               

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 3 Supplemental Cash Flow Disclosures

 

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

 

     For the Six Months
Ended June 30,
 
     2009    2008  
     (dollars in thousands)  

Cash paid during the current year for:

     

Interest

   $ 48,425    $ 77,492  

Income taxes

   $ 3,900    $ 4,400  

Noncash investing and financing activities:

     

ESOP loan reductions

   $ 1,000    $ 1,000  

Loans transferred to other real estate owned and repossessed assets

   $ 25,834    $ 4,861  

Investments purchased, not settled

   $ -0-    $ (15,052

Net unrealized gains (losses) on securities available for sale

   $ 10,575    $ (34,548

Correction of Prior Period Error in Cash Flow

For reporting periods prior to March 31, 2009, we have identified an error in the line classification on our Consolidated Statements of Cash Flows. In these periods, we presented the change in “Payable due to investments purchased/not settled” in the Operating Activities section of the Consolidated Statements of Cash Flows, instead of in the Investing Activities section.

The error has been corrected in the Consolidated Statements of Cash Flows presented on page 7 by removing the transaction from the Operating Activities section and including it in the Investing Activities section. Also, unsettled transactions related to the purchase or sale of investment securities are now presented as part of the non-cash transaction disclosure table presented above.

We have not amended or restated any prior period filings as this error does not impact our reported net income, net cash flows, or shareholders’ equity.

The affect of the correction of this error on Net cash (used in) provided by operating activities and Net cash (used in) provided by investing activities for prior reporting periods is reflected below.

 

     For the Six
Months Ended
June 30, 2008
                
     For Years Ended December 31,
     2008     2007    2006
     (dollars in thousands)

Consolidated Statements of Cash Flow

         

Net Cash (used in) provided by operating activities:

         

Original

   $ 12,531     $ 52,320     $ 69,746    $ 62,215

Revised

   $ 27,583     $ 68,782     $ 61,953    $ 53,545

Net Cash (used in) provided by investing activities:

         

Original

   $ (398,551   $ (594,190   $ 156,524    $ 308,136

Revised

   $ (413,603   $ (610,652   $ 164,317    $ 316,806

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 3 Supplemental Cash Flow Disclosures (Continued)

 

The affect of this correction on the Supplemental Disclosure for prior periods is as follows:

 

     For the Six
Months Ended
June 30, 2008
     
     For Years Ended December 31,
         2008            2007            2006    
     (dollars in thousands)

Supplemental Cash Flow Disclosure

          

Investments purchased, not settled:

          

Original

   $ -0-      $ -0-    $ -0-    $ -0-

Revised

   $ (15,052   $ -0-    $ 16,462    $ 8,670

Note 4 Variable Interest Entities

In December 2003, the Financial Accounting Standards Board (“FASB”) issued FIN 46(R), “Consolidation of Variable Interest Entities.” As defined by FIN 46(R), 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 FIN 46(R), 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.

As part of its community reinvestment initiatives, First Commonwealth invests in 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. First Commonwealth’s carrying value, or its maximum potential exposure, to these partnerships is $1.5 million as of June 30, 2009, which consists of eleven limited partnership investments. Management evaluates the limited partnerships annually for impairment and recorded a $1.2 million impairment charge in the fourth quarter of 2008. Based on FIN 46(R), First Commonwealth has determined that these investments will not be consolidated but continue to be accounted for under the equity method whereby First Commonwealth’s portion of the partnerships results are recognized as earned.

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, 2009 (dollars in thousands):

 

Commitments to extend credit

   $ 1,677,384

Financial standby letters of credit

   $ 80,054

Performance standby letters of credit

   $ 81,288

Commercial letters of credit

   $ 29

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 5 Commitments and Letters of Credit (Continued)

 

The current notional amounts outstanding above include financial standby letters of credit of $3.6 million, performance standby letters of credit of $999 thousand, and commercial letters of credit of $9 thousand issued during the first six months of 2009. A liability of $96 thousand has been recorded which represents the fair value of letters of credit issued in 2008 and 2009. See Note 9, “Fair Value of Assets and Liabilities,” for additional information.

Note 6 Investment Securities

Below is an analysis of the amortized cost and fair values of securities available for sale (dollars in thousands):

 

    June 30, 2009   December 31, 2008
    Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
    Fair
Value
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
    Fair
Value

Obligations of U.S. Government Agencies:

               

Mortgage Backed Securities – Residential

  $ 49,857   $ 2,573   $ -0-      $ 52,430   $ 54,500   $ 1,714   $ (7   $ 56,207

Obligations of U.S. Government – Sponsored Enterprises:

               

Mortgage Backed Securities – Residential

    854,122     27,802     (613     881,311     902,965     22,289     (657     924,597

Other Government – Sponsored Enterprises

    75,000     701     -0-        75,701     75,000     1,906     -0-        76,906

Obligations of States and Political Subdivisions

    191,782     2,216     (6,394     187,604     215,965     2,098     (5,922     212,141

Corporate Securities

    23,952     -0-     (6,474     17,478     23,970     179     (4,368     19,781

Pooled Trust Preferred Collateralized Debt Obligations

    87,224     -0-     (48,954     38,270     97,136     371     (50,427     47,080
                                                   

Total Debt Securities

    1,281,937     33,292     (62,435     1,252,794     1,369,536     28,557     (61,381     1,336,712

Equities

    11,912     130     (151     11,891     13,627     100     (519     13,208
                                                   

Total Securities Available for Sale

  $ 1,293,849   $ 33,422   $ (62,586   $ 1,264,685   $ 1,383,163   $ 28,657   $ (61,900   $ 1,349,920
                                                   

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 6 Investment Securities (Continued)

 

The amortized cost and estimated fair value of debt securities available for sale at June 30, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.

 

     Amortized
Cost
   Fair Value
     (dollars in thousands)

Due within 1 year

   $ 310    $ 312

Due after 1 but within 5 years

     84,962      85,998

Due after 5 but within 10 years

     37,078      38,165

Due after 10 years

     255,608      194,578
             
     377,958      319,053

Mortgage Backed Securities – Residential (a)

     903,979      933,741
             

Total Debt Securities

   $ 1,281,937    $ 1,252,794
             

 

(a) Mortgage Backed Securities—Residential include an amortized cost of $50 million and a fair value of $52 million for Obligations of U.S. Government agencies issued by the Government National Mortgage Association. Obligations of U.S. Government-sponsored enterprises includes obligations issued by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation which had an amortized cost of $854 million and a fair value of $881 million.

For the six months ended June 30, 2009, net securities gains included $67 thousand in gains and no losses for securities available for sale.

Below is an analysis of the amortized cost and fair values of debt securities held to maturity (dollars in thousands):

 

    June 30, 2009   December 31, 2008
    Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
    Fair
Value
  Amortized
Cost
  Gross
Unrealized
Gains
  Gross
Unrealized
Losses
    Fair
Value

Obligations of U.S. Government Agencies:

               

Mortgage Backed Securities – Residential

  $ 31   $ 3   $ -0-      $ 34   $ 45   $ 3   $ -0-      $ 48

Obligations of U.S. Government – Sponsored Enterprises:

               

Mortgage Backed Securities – Residential

    119     8     -0-        127     164     8     -0-        172

Obligations of States and Political Subdivisions

    44,248     628     (876     44,000     50,631     588     (881     50,338
                                                   

Total Securities Held to Maturity

  $ 44,398   $ 639   $ (876   $ 44,161   $ 50,840   $ 599   $ (881   $ 50,558
                                                   

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 6 Investment Securities (Continued)

 

The amortized cost and estimated fair value of debt securities held to maturity at June 30, 2009, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.

 

     Amortized
Cost
   Fair
Value
     (dollars in thousands)

Due within 1 year

   $ 1,113    $ 1,129

Due after 1 but within 5 years

     10,879      11,270

Due after 5 but within 10 years

     6,164      6,358

Due after 10 years

     26,092      25,243
             
     44,248      44,000

Mortgage Backed Securities – Residential (a)

     150      161
             

Total Debt Securities

   $ 44,398    $ 44,161
             

 

(a) Mortgage Backed Securities – Residential include an amortized cost of $31 thousand and a fair value of $34 thousand for Obligations of U.S. Government Agencies issued by the Government National Mortgage Association. Obligations of U.S. Government-sponsored enterprises includes obligations issued by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation which had an amortized cost of $119 thousand and a fair value of $127 thousand.

For the six months ended June 30, 2009, net securities gains included $13 thousand in gains and no losses for debt securities held to maturity.

Note 7 Impairment of Investment Securities

As permitted, during the first quarter of 2009, First Commonwealth early adopted FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairment” which requires that credit related other-than-temporary impairment on debt securities be recognized in earnings while noncredit related other-than-temporary impairment on debt securities not expected to be sold be recognized in other comprehensive income (“OCI”). As a result, in the second quarter of 2009 we recorded $8.8 million in other-than-temporary impairment charges. These charges include $7.7 million in credit related other-than-temporary impairment on eight trust preferred collateralized debt obligations and $1.1 million recorded on equity securities related to two Pennsylvania-based financial institutions. All of the securities for which other-than-temporary impairment was recorded were classified as available for sale securities. Additionally, $5.7 million in noncredit related other-than-temporary impairment was recorded in OCI on our trust preferred collateralized debt obligations.

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

FSP FAS 115-2 and FAS 124-2 was adopted as of March 31, 2009. The following table shows the effect on the first quarter 2009 of adopting this (dollars in thousands, except share data):

 

     Prior to
Adoption
    After
Adoption
    Effect of
Adoption
 

Impairment losses on securities

   $ (28,589   $ (9,866   $ 18,723  

Noncredit related losses on securities not expected to be sold (recognized in other comprehensive income)

   $ -0-      $ 18,723     $ 18,723  

Net impairment losses

   $ (28,589   $ (9,866   $ 18,723  

Net (loss) income

   $ (10,483   $ 1,687     $ 12,170  

Basic Earnings Per Share

   $ (0.12   $ 0.02     $ 0.14  

Diluted Earnings Per Share

   $ (0.12   $ 0.02     $ 0.14  

Accumulated other comprehensive loss

   $ (10,593   $ (22,763   $ (12,170

In accordance with the new guidance, the noncredit 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 the year. In 2008, $13.0 million in other-than-temporary impairment charges were recognized, of which $6.5 million related to noncredit related impairment on debt securities. Therefore, the cumulative effect adjustment to retained earnings totaled $6.5 million, or $4.2 million net of tax.

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.

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 condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and the intent and ability to hold the investment for a period of time sufficient to allow for any anticipated recovery in the market. We evaluate our intent and ability to hold debt securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy and interest rate risk position. In addition, the risk of future other-than-temporary impairment may be influenced by additional bank failures, prolonged recession in the U.S. economy, changes in real estate values, interest deferrals, and whether the federal government provides assistance to financial institutions. Our pooled trust preferred collateralized debt obligations are beneficial interests in securitized financial assets within the scope of EITF 99-20, and are therefore evaluated for other-than-temporary impairment using management’s best estimate of future cash flows. If these estimated cash flows determine that it is probable an adverse change in cash flows has occurred, then other-than-temporary impairment would be recognized in accordance with FSP FAS 115-2 and FAS 124-2. There is a risk that this quarterly review could result in First Commonwealth recording other-than-temporary impairment charges in the future. See Note 9 “Fair Values of Assets and Liabilities” for additional information.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

The following table presents the gross unrealized losses and fair values at June 30, 2009 for both available for sale and held to maturity securities by investment category and time frame for which the loss has been outstanding (dollars in thousands):

 

     Less Than 12 Months     12 Months or More     Total  

Description of Securities

   Fair Value     Unrealized
Losses
    Fair Value    Unrealized
Losses
    Fair Value    Unrealized
Losses
 

Obligations of U.S. Government – Sponsored Enterprises:

              

Mortgage Backed Securities – Residential

   $ 73,487     $ (613   $ 27    $ -0-      $ 73,514    $ (613

Corporate Securities

     (3,246     195       20,474      (6,669     17,228      (6,474

Pooled Trust Preferred Collateralized Debt Obligations

     11,805       (6,714     26,465      (42,240     38,270      (48,954

Obligations of States and Political Subdivisions

     110,939       (4,767     26,830      (2,503     137,769      (7,270
                                              

Total Debt Securities

     192,985       (11,899     73,796      (51,412     266,781      (63,311

Equities

     1,107       (151     -0-      -0-        1,107      (151
                                              

Total Securities

   $ 194,092     $ (12,050   $ 73,796    $ (51,412   $ 267,888    $ (63,462
                                              

At June 30 2009, 12.4% of the total unrealized losses were comprised of fixed income securities issued by U.S. Government agencies, U.S. Government-sponsored enterprises and investment grade municipalities. Corporate fixed income comprised 10.2% of the total unrealized losses, while pooled trust preferred collateralized debt obligations accounted for 77.2% and equity securities accounted for the remaining 0.2%. The unrealized losses in the equity securities category consist of five issues, neither of which has been in a continuous unrealized loss position for more than twelve months.

Corporate securities had a total unrealized loss of $6.5 million as of June 30, 2009. Included in this category are single issue trust preferred securities and corporate debentures issued primarily by money center and large regional banks. As of June 30, 2009, our single issue trust preferred securities had an amortized cost of $22.8 million and an estimated fair value of $16.4 million, while our corporate debentures had a book value of $1.2 million and an estimated fair value of $1.1 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.

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

The following table presents the gross unrealized losses and fair values at December 31, 2008 for both available for sale and held to maturity securities by investment category and time frame for which the loss has been outstanding (dollars in thousands):

 

     Less Than 12 Months     12 Months or More     Total  

Description of Securities

   Fair Value     Unrealized
Losses
    Fair Value    Unrealized
Losses
    Fair Value    Unrealized
Losses
 

Obligations of U.S. Government – Agencies:

              

Mortgage Backed Securities – Residential

   $ 679     $ (6   $ -0-    $ -0-      $ 679    $ (6

Obligations of U.S. Government – Sponsored Enterprises:

              

Mortgage Backed Securities – Residential

     20,065       (46     64,487      (611     84,552      (657

Corporate Securities

     (1,277     (2,233     8,082      (2,506     6,805      (4,739

Pooled Trust Preferred Collateralized Debt Obligations

     15,209       (1,457     31,871      (48,599     47,080      (50,056

Obligations of States and Political Subdivisions

     146,050       (6,702     1,719      (102     147,769      (6,804
                                              

Total Debt Securities

     180,726       (10,444     106,159      (51,818     286,885      (62,262

Equities

     1,691       (519     -0-      -0-        1,691      (519
                                              

Total Securities

   $ 182,417     $ (10,963   $ 106,159    $ (51,818   $ 288,576    $ (62,781
                                              

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

The following table provides additional information related to our corporate securities as of June 30, 2009:

Corporate Securities

(Single Issue Trust Preferred Securities and Corporate Debentures)

(dollars in thousands)

 

Name of Issuer

  

Name of Issuer’s Parent Company

   Book
Value
   Fair
Value
   Unrealized
Loss
    Current
Moody’s/
Fitch Issuer
Ratings

BP Bank America Inst

   Bank of America Corp    $ 1,028    $ 803    $ (225   Baa3/BB-

BP MBNA Capital

   Bank of America Corp      1,031      859      (172   Baa3/BB-

NB Capital Trust II

   Bank of America Corp      3,083      2,452      (631   Baa3/BB-

North Fork Cap Trust

   Capital One Financial Corp      1,266      542      (724   Baa1/BBB+

Reliance Cap Trust

   Capital One Financial Corp      488      300      (188   NA

FCB/SC Cap Trust

   First Citizens Bancorporation      493      300      (193   NA

Fifth Third Cap

   Fifth Third Bancorp      250      196      (54   Baa2/BBB

Signal Capital Trust I

   FirstMerit Corp      1,297      788      (509   NA

PBI Capital Trust

   Fulton Financial Corp      247      150      (97   NA

KeyCorp Capital II

   KeyCorp      1,848      1,578      (270   Baa2/BBB

Union State Capital Trust I

   KeyCorp      1,036      700      (336   NA

BSB Cap Trust

   M&T Bank Corp      463      227      (236   NA

First Empire Cap MTB

   M&T Bank Corp      4,896      3,086      (1,810   Baa1/BBB+

PNC Capital Trust

   PNC Financial Services Group      453      401      (52   Baa1/A

Valley Cap Trust

   Rabobank Nederland NV      250      250      -0-      NA

Centura Cap Trust

   Royal Bank of Canada      1,138      839      (299   A2/AA-

Susquehanna Cap

   Susquehanna Bancshares      500      406      (94   Ba2/NA

First Union Instit Cap I

   Wells Fargo Co.      3,000      2,534      (466   A3/AA-
                           

Total Single Issue Trust Preferred Securities

        22,767      16,411      (6,356  
                           

Fulton Financial Corp

   Fulton Financial Corp      443      350      (93   Baa2/BBB+

Provident Bk MD

   M&T Bank Corp      245      223      (22   NA/BBB+

PNC Bank NA

   PNC Financial Services Group      497      494      (3   A2/A
                           

Total Corporate Debentures

        1,185      1,067      (118  
                           

Total Corporate Securities

      $ 23,952    $ 17,478    $ (6,474  
                           

As of June 30, 2009, the book value of our pooled trust preferred collateralized debt obligations totaled $87.2 million with an estimated fair value of $38.3 million, which includes securities comprised of 376 banks and other financial institutions. Two of our pooled securities are senior tranches and the remainder are mezzanine tranches. During the first quarter of 2009, all of the pooled issues were downgraded by Moody’s Investor Services. Two of the pooled issues, representing $12.4 million of the $87.2 million book value, remain above investment grade. At the time of initial issue, the subordinated tranches ranged in size from approximately 7.3% to 35.4% 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, 2009, after taking into account management’s best estimates of future interest deferrals and defaults, the excess subordination in our tranches ranged from 0.0% to 109.01% of the current performing collateral.

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

The following table provides additional information related to our pooled trust preferred collateralized debt obligations as of June 30, 2009:

Pooled Trust Preferred Collateralized Debt Obligations

(dollars in thousands)

 

Deal

   Class    Book
Value
   Fair
Value
   Unrealized
Loss
    Moody’s/
Fitch
Ratings
   Current
Number
of
Banks
   Actual
Deferrals
and

Defaults
as a % of
Current
Collateral
    Excess
Subordination
as a % of
Current
Performing
Collateral
 
Pre TSL I    Senior    $ 3,706    $ 3,038    $ (668   A1/A    32    15.86   109.01
Pre TSL IV    Mezzanine      1,830      717      (1,113   Ca/B    6    27.07   25.43
Pre TSL V    Mezzanine      459      167      (292   Ba3/A    4    65.87   0.00
Pre TSL VI    Mezzanine      345      161      (184   Caa1/CCC    5    61.35   0.00
Pre TSL VII    Mezzanine      6,083      2,062      (4,021   Ca/CC    20    57.26   0.00
Pre TSL VIII    Mezzanine      2,338      530      (1,808   Ca/CC    36    42.84   0.00
Pre TSL IX    Mezzanine      2,693      979      (1,714   Ca/CC    49    22.33   0.00
Pre TSL X    Mezzanine      3,510      1,266      (2,244   Ca/CC    58    24.72   0.00
Pre TSL XII    Mezzanine      9,345      3,454      (5,891   Ca/CC    79    18.46   0.00
Pre TSL XIII    Mezzanine      17,500      7,056      (10,444   Ca/CC    65    15.10   4.62
Pre TSL XIV    Mezzanine      16,000      6,231      (9,769   Ca/CC    64    10.68   16.14
MMCap I    Senior      8,730      6,705      (2,025   A3/A    29    9.15   108.78
MMCap I    Mezzanine      1,061      510      (551   Ca/CCC    29    9.15   11.65
MM Comm IX    Mezzanine      13,624      5,394      (8,230   Caa3/CC    34    27.35   0.00
                                   
Total       $ 87,224    $ 38,270    $ (48,954          
                                   

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 temporary impairment on these securities.

On a quarterly basis we evaluate our debt securities for other-than-temporary impairment. In the second quarter of 2009, $7.7 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 noncredit 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 noncredit related portion is recognized in other comprehensive income and represents the difference between the 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:

Our pooled trust preferred collateralized debt obligations are measured for other-than-temporary impairment within the scope of EITF 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to be Held by a Transferor in Securitized Financial Assets,”

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

and FSP EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20,” 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, 2009. 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 determine 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 376 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. In all cases, a 10% projected recovery rate is applied to projected defaults. The probability of default is updated quarterly. As of June 30, 2009, default probabilities for performing collateral ranged from .35% to 95%.

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.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

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.

Based upon the analysis performed by management as of June 30, 2009, it is probable that Pre TSL V, Pre TSL VI, Pre TSL VII, Pre TSL VIII, Pre TSL IX, Pre TSL X, Pre TSL XII and MM Comm IX will experience principal and interest shortfalls. The $7.7 million in credit related other-than-temporary impairment charges recognized in the second quarter of 2009 are primarily the result of additional interest deferrals within these pools. Our analysis as of June 30, 2009 indicates it is probable that we will collect all contractual principal and interest payments on our 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, 2009
   For the Six
Months
Ended
June 30, 2009
   (dollars in thousands)

Balance, beginning (a)

   $ 10,921    $ 2,516

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

     1,613      11,675

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

     6,069      4,412
             

Balance, ending

   $ 18,603    $ 18,603
             

 

(a) The beginning balance represents credit related losses included in other-than-temporary impairment charges recognized on debt securities in prior periods.

Additionally in the second quarter of 2009, other-than-temporary impairment charges of $1.1 million were recorded on equity securities related to two Pennsylvania-based financial institutions. Management evaluates equity securities for other-than-temporary impairment by reviewing 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 and factoring in the level of decline in the fair value of these equity securities, management could not substantiate that their market value would equal or exceed our cost basis within a reasonable period of time.

In connection with a review of our Annual Report on Form 10-K for the year ended December 31, 2008 and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, the staff of the Securities and Exchange Commission (SEC) recently advised us that they believe that certain events that occurred subsequent to December 31, 2008 but prior to the filing of our Annual Report should have been considered in our impairment analysis for trust preferred collateralized debt obligations as of December 31, 2008 and asked us to provide an analysis to the SEC if we believe the impact of those events is not material to our financial statements for the periods ending December 31, 2008 and March 31, 2009. Specifically, the events relate to a cease and desist order issued on February 17, 2009 against a company with securities in two of our trust preferred pools and an announcement on February 20, 2009 by a company with securities in six of our pools that it would defer interest

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 7 Impairment of Investment Securities (Continued)

 

payments under its trust preferred securities beginning in April 2009 unless it received approval to participate in the Treasury Department’s Capital Purchase Program in which event it expected to pay all the deferred amounts out of its then existing funds. We are currently evaluating the SEC’s comment and the appropriateness and impact of considering these events in our impairment analysis as of December 31, 2008.

Note 8 Income Taxes

At January 1, 2009 and June 30, 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 2005 through 2008 were open for examination as of June 30, 2009.

Note 9 Fair Values of Assets and Liabilities

Statement of Financial Accounting Standards No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115” and Statement of Financial Accounting Standards No. 157 (“SFAS 157”), “Fair Value Measurements” became effective January 1, 2008. SFAS 159 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 elected not to measure any existing financial instruments at fair value under SFAS 159; however, in the future we may elect to adopt SFAS 159 for select financial instruments.

SFAS 157 defines fair value and the methods used for measuring fair value as well as requiring additional disclosures; however, it does not expand the use of fair value measurements. FASB Staff Position FAS 157-2, “Effective Date of FASB Statement No. 157” became effective January 1, 2009 and requires disclosures for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). All nonfinancial assets are included either as a separate line item on the Consolidated Statements of Financial Condition or in the “Other assets” category of the Consolidated Statements of Financial Condition. Currently, First Commonwealth does not have any nonfinancial liabilities to disclose. FASB also issued Staff Position FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is not Active” in October 2008, which clarified the application of SFAS 157 in a market that is not active. FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” was issued in April 2009 and provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157 when the volume and level of activity for assets or liabilities have significantly decreased. As permitted, we early adopted FSP FAS 157-4 on March 31, 2009.

In accordance with SFAS 157, 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. 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.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 9 Fair Values of Assets and Liabilities (Continued)

 

 

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 U.S. Government securities, municipal securities, Federal Home Loan Bank (“FHLB”) stock, interest rate derivatives that include interest rate swaps and risk participation agreements, and other real estate owned.

 

 

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 municipal securities, corporate securities, pooled trust preferred collateralized debt obligations, and impaired loans.

In accordance with SFAS 157, fair values for investment securities were based on quoted market prices, if available, and were classified as Level 1. If quoted market prices were not available, the valuation for investment utilized pricing models that varied based on asset class and included available trade, bid and other observable market information. Securities priced using this information are classified as Level 2.

Fair values for 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 markets.

Our pooled trust preferred collateralized debt obligations are collateralized by the trust preferred securities of individual banks and bank holding companies in the U.S. There has been little or no active trading in these securities for approximately twelve months; therefore it was more appropriate to determine 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 7 “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 trust preferred collateralized debt obligations, one key reference point is the market yield for the single issue trust preferred securities issued by banks and thrifts for which there is an active and liquid market. Adjustments are then made to reflect the credit and structural differences between these two security types.

Interest rate derivatives are reported at 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 US 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 11 “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

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 9 Fair Values of Assets and Liabilities (Continued)

 

things, in determining if any 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 table below presents the balances of assets and liabilities measured at fair value on a recurring basis at June 30, 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-    $ 52,430    $ -0-    $ 52,430

Obligations of U.S. Government – Sponsored Enterprises:

           

Mortgage Backed Securities – Residential

     -0-      881,311      -0-      881,311

Other Government-Sponsored Enterprises

     -0-      75,701      -0-      75,701

Obligations of States and Political Subdivisions

     -0-      184,153      3,451      187,604

Corporate Securities

     -0-      -0-      17,478      17,478

Pooled Trust Preferred Collateralized Debt Obligations

     -0-      -0-      38,270      38,270
                           

Total Debt Securities

     -0-      1,193,595      59,199      1,252,794

Equities

     4,229      6,092      1,570      11,891
                           

Total Securities Available for Sale

     4,229      1,199,687      60,769      1,264,685

Other Investments

     -0-      51,431      -0-      51,431

Other Assets (a)

     -0-      11,350      -0-      11,350
                           

Total Assets

   $ 4,229    $ 1,262,468    $ 60,769    $ 1,327,466
                           

Other Liabilities (a)

   $ -0-    $ 11,427    $ -0-    $ 11,427
                           

Total Liabilities

   $ -0-    $ 11,427    $ -0-    $ 11,427
                           

 

(a) Non-hedging interest rate derivatives

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 9 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, 2008:

 

     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-    $ 56,207    $ -0-    $ 56,207

Obligations of U.S. Government – Sponsored Enterprises:

           

Mortgage Backed Securities – Residential

     -0-      924,598      -0-      924,598

Other Government – Sponsored Enterprises

     -0-      76,906      -0-      76,906

Obligations of States and Political Subdivisions

     -0-      212,141      -0-      212,141

Corporate Securities

     -0-      -0-      19,780      19,780

Pooled Trust Preferred Collateralized Debt Obligations

     -0-      -0-      47,080      47,080
                           

Total Debt Securities

     -0-      1,269,852      66,860      1,336,712

Equities

     6,370      5,268      1,570      13,208
                           

Total Securities Available for Sale

     6,370      1,275,120      68,430      1,349,920

Other Investments

     -0-      51,431      -0-      51,431

Other Assets (a)

     -0-      19,552      -0-      19,552
                           

Total Assets

   $ 6,370    $ 1,346,103    $ 68,430    $ 1,420,903
                           

Other Liabilities (a)

   $ -0-    $ 19,757    $ -0-    $ 19,757
                           

Total Liabilities

   $ -0-    $ 19,757    $ -0-    $ 19,757
                           

 

(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, 2009:

 

     Obligations
of States
and Political
Subdivisions
   Corporate
Securities
   Pooled Trust
Preferred
Collateralized
Debt
Obligations
    Equities    Total 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 gains (losses) realized/unrealized 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  
                                     

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 9 Fair Values of Assets and Liabilities (Continued)

 

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

Losses of $8.8 million included in earnings for the period are attributable to the change in realized losses relating to assets held at June 30, 2009 and are reported in the line “Net impairment losses on securities” in the Consolidated Statements of Income.

The changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows at June 30, 2008:

 

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

Securities Available for Sale

             

Balance, beginning of quarter

   $ -0-    $ 971     $ -0-    $ 1,570    $ 2,541  

Realized and unrealized credit losses included in earnings

     -0-      -0-        -0-      -0-      -0-   

Total gains (losses) realized/unrealized in other comprehensive income

     -0-      (75     -0-      -0-      (75

Purchases, settlements, pay downs, and maturities

     -0-      (506     -0-      -0-      (506

Transfers into Level 3

     3,629      9,382       82,301      -0-      95,312  
                                     

Balance, end of quarter

   $ 3,629    $ 9,772     $ 82,301    $ 1,570    $ 97,272  
                                     

At June 30, 2008, the securities transferred from Level 2 to Level 3 were municipal securities. The primary reason for the transfer into Level 3 was the inactivity in the market for these securities which resulted in a lack of observable market activity or comparable trades that could be used to establish a benchmark for valuation.

Losses of $0.5 million included in earnings for the period are attributable to the change in realized losses relating to assets held at June 30, 2008 and are reported in the line “Net impairment (losses)” in the Consolidated Statements of Income.

The table below presents the balances of assets measured at fair value on a nonrecurring basis at June 30, 2009:

 

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

Impaired loans

   $ -0-    $ -0-    $ 50,998    $ 50,998

Other real estate owned

     -0-      25,244      -0-      25,244
                           

Total Assets

   $  -0-    $ 25,244    $ 50,998    $ 76,242
                           

Impaired loans over $100,000 are individually reviewed to determine the amount of each loan considered to be at risk of noncollection. The impaired loans are collateral based and the fair value is determined by reviewing real property appraisals, equipment valuations, accounts receivable listings and other financial information.

 

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Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 9 Fair Values of Assets and Liabilities (Continued)

 

Fair value for other real estate owned is determined by an independent market based appraisal less costs to sell and is classified as level 2.

Certain other assets and liabilities, including goodwill and core deposit intangibles, are measured at fair value on a nonrecurring 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. There were no other assets or liabilities measured at fair value on a nonrecurring basis during the six months ended June 30, 2009.

SFAS 107, “Disclosures about Fair Value of Financial Instruments,” and FASB Staff Position (“FSP”) No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” require 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 that are measured at fair value on a recurring or non-recurring basis are as discussed above. The methodologies for other financial assets and financial liabilities are discussed below.

Cash and short-term instruments: The carrying amounts for cash and short-term instruments approximate the estimated fair values of such assets.

Securities Available for Sale: Refer to discussion related to securities available for sale as previously discussed in this note.

Securities Held to Maturity: Fair values for securities held to maturity are based on quoted market prices, if available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying value of nonmarketable equity securities, such as Federal Home Loan Bank stock, is considered a reasonable estimate of fair value.

Loans: The estimated fair values of all loans are estimated by discounting the future cash flows using interest rates currently offered for loans with similar terms to borrowers of similar credit quality adjusted for past due and nonperforming loans.

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. Management has determined that due to the uncertainties of cash flows and difficulty in predicting the timing of cash flows for loan commitments, fair values were not estimated for either period. FIN 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (as amended),” 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 $96 thousand at June 30, 2009. 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

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 9 Fair Values of Assets and Liabilities (Continued)

 

expected maturities.

Short-term borrowings: The estimated fair values of borrowings from the Federal Home Loan Bank 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.

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 at June 30, 2009:

 

     Carrying
Amount
   Estimated
Fair

Value
   (dollars in thousands)

Financial assets

     

Cash and due from banks

   $ 84,346    $ 84,346

Interest-bearing bank deposits

     961      961

Securities available for sale

     1,264,685      1,264,685

Securities held to maturity

     44,398      44,161

Loans

     4,536,771      4,558,528

Allowance for loan loss

     83,056      -0-

Financial liabilities

     

Deposits

   $ 4,485,890    $ 4,384,819

Short-term borrowings

     998,259      991,756

Long-term debt

     180,922      184,065

Subordinated debt

     105,750      166,240

Note 10 Other Investments

As a member of the Federal Home Loan Bank of Pittsburgh (“FHLB”), 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, 2009 and December 31, 2008, our FHLB stock totaled $51.4 million and is included in Other Investments on the Consolidated Statements of Financial Condition.

In December 2008, the FHLB voluntarily suspended dividend payments on its stock, as well as 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.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 10 Other Investments (Continued)

 

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;

 

 

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 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 will be recovered. Accordingly, no impairment charge was recorded on these securities for the six months ended June 30, 2009. Our evaluation of the factors described above in future periods could result in the recognition of impairment charges on FHLB stock.

Note 11 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 market value of the swaps offset each other, except for the credit risk of the counterparties, which was calculated by taking into consideration the risk rating, probability of default and loss given default for all counterparties.

We have three 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 $76 thousand was recorded for credit risk on an aggregate notional amount outstanding of $208.1 million for interest rate derivatives and $67.0 million for risk participation agreements at June 30, 2009. The fair value of our derivatives is included in a table in Note 9 “Fair Values of Assets and Liabilities” in the line items “Other Assets” and “Other Liabilities.”

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 11 Derivatives (Continued)

 

The table below presents the amount representing the change in value of derivative assets and derivative liabilities attributable to credit risk included in the Consolidated Statements of Income:

 

     For the Three Months
Ended June 30,
   For the Six Months
Ended June 30,
   2009    2008    2009    2008
   (dollars in thousands)    (dollars in thousands)

Non-hedging interest rate derivatives:

           

Other non-interest expense

   $ 52    $  -0-    $ 128    $  -0-

Note 12 New Accounting Pronouncements

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168 (“SFAS 168”), “The ‘FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a replacement of FASB Statement No. 162.” SFAS No. 168 established the FASB Accounting Standards Codification (the “Codification”) to become the single source of authoritative GAAP recognized by the FASB to be applied by nongovernmental entities, with the exception of guidance issued by the U.S. Securities and Exchange Commission (the “SEC”) and its staff. All guidance contained in the Codification carries an equal level of authority. The provisions of SFAS No. 168 are effective for interim and annual periods ending after September 15, 2009. As the Codification is neither expected nor intended to change GAAP, the adoption of SFAS 168 will have no impact on First Commonwealth’s financial condition or results of operations.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 167 (“SFAS 167”), “Amendments to FASB Interpretation No. 46(R).” SFAS No. 167 requires a qualitative rather than a quantitative analysis to determine the primary beneficiary of a variable interest entity (“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. This statement is effective for fiscal years beginning after November 15, 2009. Management is currently evaluating the impact of adopting this standard.

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 166 (“SFAS 166”), “Accounting for Transfers of Financial Assets, an amendment of FASB Statement No. 140.” SFAS No. 166 makes several significant amendments to SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” including the removal of the concept of a qualifying special-purpose entity from SFAS No. 140. SFAS No. 166 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. This statement is effective for fiscal years beginning after November 15, 2009. Management does not expect the adoption of SFAS 166 to have a material impact on its financial condition or results of operations.

In June 2009, the FASB issued Statement of Financial Accounting Standards No.165 (“SFAS 165”), “Subsequent Events.” This standard establishes general standards of accounting for and disclosures of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date. SFAS 165 was effective for interim or annual financial periods ending after June 15, 2009. The adoption of SFAS 165 did not have a material impact First Commonwealth’s financial condition or results of operations.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 12 New Accounting Pronouncements (Continued)

 

In April 2009, FASB issued FASB Staff Position (“FSP”) No. FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” Effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, FSP FAS 157-4 provides guidelines for making fair value measurements more consistent with the principles presented in SFAS 157, “Fair Value Measurements,” when the volume and level of activity for assets or liabilities have significantly decreased. FSP FAS 157-4 relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. We early adopted FSP FAS 157-4 on March 31, 2009, and the adoption did not have a material impact on our financial condition or results of operations.

In April 2009, FASB issued FASB Staff Position (“FSP”) No. FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” Effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, FSP FAS 115-2 and FAS 124-2 amended Other-Than-Temporary Impairment guidance in U.S. GAAP to improve the presentation and disclosure of other-than-temporary impairment on debt and equity securities in the financial statements. FSP FAS 115-2 and FAS 124-2 is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity about the credit and noncredit components of impaired debt securities that are not expected to be sold. The FSP also requires increased and more timely disclosures regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. We early adopted FSP FAS 115-2 and FAS 124-2 on March 31, 2009. In accordance with this new accounting guidance, the noncredit related portion of other-than-temporary impairment losses previously recognized in earnings during 2008 was reclassified as a cumulative effect adjustment that increased retained earnings and decreased accumulated OCI. Of the $13.0 million in other-than-temporary impairment charges recognized in 2008, $6.5 million related to noncredit related impairment, and accordingly, has been recorded, net of tax, as a cumulative effect adjustment in the Consolidated Statements of Changes in Shareholders’ Equity as of January 1, 2009. Refer to Note 7 “Impairment of Investment Securities” for further discussion.

In April 2009, FASB issued FASB Staff Position (“FSP”) No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” Effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009, FSP FAS 107-1 and APB 28-1 amends SFAS 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. FSP FAS 107-1 and APB 28-1 only relates to disclosures and therefore will not have an impact on First Commonwealth’s financial condition or results of operations. We adopted FSP FAS 107-1 and APB 28-1 on June 30, 2009.

In January 2009, FASB issued FASB Staff Position (“FSP”) No. EITF 99-20-1, “Amendments to the Impairment Guidance of EITF Issue No. 99-20.” Effective for interim and annual reporting periods ending after December 15, 2008, FSP EITF 99-20-1 amended EITF 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to achieve a more consistent evaluation of whether there is other-than-temporary impairment for the debt securities under the scope of EITF 99-20 and the debt securities not within the scope of EITF 99-20 that would fall under the scope of SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” The adoption of FSP EITF 99-20-1 did not 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 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

Note 12 New Accounting Pronouncements (Continued)

 

In June 2008, FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” Effective for interim and annual reporting periods ending after December 15, 2008, FSP EITF 03-6-1 clarifies that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents are considered participating securities and should be included in the calculation of basic earnings per share using the two-class method prescribed by SFAS 128, “Earnings Per Share.” The adoption of FSP EITF 03-6-1 did not have a material impact on First Commonwealth’s financial condition or results of operations.

In March 2008, FASB issued Statement of Financial Accounting Standards No. 161 (“SFAS 161”), “Disclosures about Derivative Instruments and Hedging Activities-an amendment of FASB Statement No. 133.” Effective for fiscal years and interim periods beginning after November 15, 2008, SFAS 161 amends and expands the disclosure requirements of Statement No. 133 by requiring enhanced disclosures for how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for under Statement No. 133 and its related interpretations; and how derivative instruments and related items affect an entity’s financial position, financial performance and cash flows. The adoption of SFAS 161 did not have a material impact on First Commonwealth’s financial condition or results of operations as it only relates to disclosures.

In December 2007, FASB also issued Statement of Financial Accounting Standards No. 141(revised) (“SFAS 141(R)”), “Business Combinations,” which will apply to any business combination entered into with an acquisition date that is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Under SFAS 141(R), an acquiring entity will be required to recognize all the assets acquired and liabilities assumed in a transaction at fair value on the date of acquisition with limited exceptions. SFAS 141(R) also changes the accounting and disclosures for certain items related to business combinations to more accurately reflect the cost of the acquisition. The adoption of SFAS 141(R) will have an impact on accounting for business combinations once adopted, but the effect is dependent upon acquisitions at that time.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 158 (“SFAS 158”), “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans – an amendment of FASB Statements No. 87, 88, 106, and 132R.” This Statement requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position, with limited exceptions, effective for fiscal years ending after December 15, 2008. The implementation did not 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 1. Financial Statements and Supplementary Data

(Unaudited) (Continued)

June 30, 2009

 

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, 2009 and 2008, and should be read in conjunction with the Consolidated Financial Statements and notes thereto included in this Form 10-Q.

Forward-Looking Statements

This report contains forward-looking statements that describe our future plans, strategies and expectations. Forward-looking statements can be identified by the fact that they do not relate strictly to historical or current facts. They often include words such as “believe,” “expect,” “anticipate,” “intend,” “plan,” “estimate” or words of similar meaning, or future or conditional verbs such as “will,” “would,” “should,” “could” or “may.” All forward-looking statements are based on assumptions and involve risks and uncertainties, many of which are beyond our control and which may cause our actual results, performance or achievements to differ materially from the results, performance or achievements contemplated by the forward-looking statements. These risks and uncertainties include, among other things:

 

 

Competitive pressures among depository and other financial institutions nationally and in our market areas may increase significantly.

 

 

Deepened or prolonged weakness in economic and business conditions, nationally and in our market areas, which could increase credit-related losses and expenses and/or limit growth.

 

 

Further declines in the market value of investment securities that are considered to be other-than-temporary, which would negatively impact our earnings and capital levels.

 

 

Increases in defaults by borrowers and other delinquencies could result in increases in our provision for credit losses and related expenses.

 

 

Our inability to manage growth effectively, including the successful expansion of our customer support, administrative infrastructure and internal management systems, could adversely affect our results of operations and prospects.

 

 

Fluctuations in interest rates and market prices could reduce our net interest margin and asset valuations and increase our expenses.

 

 

Reduced wholesale funding capacity or higher borrowing costs due to capital constraints at the Federal Home Loan Bank, which would reduce our liquidity and negatively impact earnings and net interest margin.

 

 

The consequences of continued bank acquisitions and mergers in our market areas, resulting in fewer but much larger and financially stronger competitors, could increase competition for financial services to our detriment.

 

 

Changes in legislative or regulatory requirements applicable to us and our subsidiaries could increase costs, limit certain operations and adversely affect results of operations.

 

 

Changes in tax requirements, including tax rate changes, new tax laws and revised tax law interpretations may increase our tax expense or adversely affect our customers’ businesses.

 

 

Other risks and uncertainties described in this report and the other reports that First Commonwealth files with the Securities and Exchange Commission, including its most recent Annual Report on Form 10-K.

In light of these risks, uncertainties and assumptions, you should not place undue reliance on any forward-looking statements in this report. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

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

and Results of Operations

Results of Operation

Summary of Results

First Commonwealth has experienced the following developments during the second quarter of 2009 compared to the second quarter of 2008.

 

 

Net interest income increased 9.7%.

 

 

Net interest margin, on a tax equivalent basis, improved 19 basis points.

 

 

Total loans increased 10.3% and commercial loans increased 15.4%.

 

 

Average demand and savings deposits increased 15.2%.

 

 

Nonaccrual loans increased 59.7% primarily due to deterioration during the second quarter of 2009 in commercial real estate construction loans as a result of economic conditions.

 

 

Provision for credit losses increased $42.9 million.

 

 

Impairment losses of $8.8 million were recorded on collateralized debt obligations and bank equity securities.

 

 

FDIC insurance costs increased $4.7 million driven by premium increases and the special assessment of $2.9 million.

 

 

First Commonwealth Bank relocated its Latrobe office to a more visible location.

We recorded a net loss for the second quarter 2009 of $(18.6) million or $(0.22) per diluted share, as compared to net income of $12.9 million or $0.18 per diluted share for the same period in 2008. The decrease in net income was primarily the result of a $42.9 million ($27.9 million after tax) increase in the provision for credit losses as well as an increase of $8.2 million ($5.3 million after tax) in other-than-temporary impairment charges. The higher provision was primarily related to deterioration in our out of state commercial real estate construction credits. The other-than-temporary impairment charges were primarily related to the credit deterioration of the company’s pooled trust preferred collateralized debt obligations. FDIC insurance costs rose $4.7 million driven by premium increases and the special assessment of $2.9 million. Although we have experienced increased provision for loan loss and other-than-temporary impairment charges, we achieved growth in loans and deposits and remain well capitalized with significant liquidity.

Average diluted shares in the second quarter 2009 were 16.3% greater than the comparable quarter in 2008 primarily due to the issuance of 11.5 million shares of common stock in connection with the capital raising transaction completed on November 5, 2008. Second quarter 2009 annualized return on average equity and average assets was (11.34)% and (1.16)%, respectively, compared to 9.03% and 0.84% for the prior year period.

We recorded a net loss for the six months ended June 30, 2009 of $(16.9) million, or $(0.20) per diluted share compared to net income of $24.0 million, or $0.33 per diluted share in the same period last year. The decrease was due to the $48.0 million ($31.2 million after tax) increase in the provision for credit losses and an $18.1 million ($11.8 million after tax) increase in other-than-temporary impairment losses related to our trust preferred collateralized debt obligations and two equity securities. FDIC insurance costs rose $6.1 million mainly from premium increases and the special assessment of $2.9 million. Year-to-date June 30, 2009 annualized return on average equity and average assets was (5.17)% and (0.53)%, respectively, compared to 8.38% and 0.79% for the same period last year.

 

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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)

Summary of Results (Continued)

 

The following table illustrates the impact on diluted earnings per share of changes in certain components of net income for the three and six months ending June 30, 2009 compared to the prior periods and after adjusting for the affect of the 11.5 million additional shares issued in November 2008. This adjustment reduced shares used in calculating the change for each component by 11.5 million in order to be comparable to the baseline from the prior year period.

 

     Three Months Ended
June 30, 2009
    Six Months Ended
June 30, 2009
 

Net income per diluted share, prior year period

   $ 0.18     $ 0.33  

Increase (decrease) from changes in:

    

Net interest income

     0.06       0.00  

Provision for credit losses

     (0.59     (0.55

Net impairment losses on securities

     (0.11     (0.21

Net losses on securities transactions

     0.00       (0.01

Trust income

     0.00       (0.02

Service charges on deposit accounts

     0.00       (0.03

Insurance commissions

     0.01       0.00  

Income from bank owned life insurance

     0.00       (0.01

Other operating income

     0.03       0.03  

Salaries and employee benefits

     0.00       0.04  

Occupancy and equipment costs

     0.00       0.03  

Collection and repossession expenses

     (0.01     (0.01

FDIC insurance

     (0.06     (0.07

Other operating expenses

     0.00       0.02  

Tax benefit

     0.27       0.26  
                

Net loss per diluted share

   $ (0.22   $ (0.20
                

Net Interest Income

Net interest income increased $4.6 million, or 9.7%, in the second quarter of 2009 from the second quarter of 2008 as a result of both growth in earning assets and a decline in the cost of interest-bearing liabilities. Interest income decreased $8.5 million, or 10.3%, as the contribution from loan growth was negatively offset by lower interest rates. Interest expense declined $13.1 million, or 37.0%, as a 109 basis point decline on rates paid for interest-bearing liabilities more than offset additional interest expense resulting from a $100.6 million, or 2.0%, increase in average interest-bearing liabilities.

Average interest-earning assets increased $180.4 million, or 3.2%, in the second quarter of 2009 compared to the second quarter of 2008 primarily due to a $463.7 million, or 11.5%, increase in average loans. This loan growth was partially funded by investment run-off and short-term borrowings. Average investment securities decreased $283.4 million, or 17.3%, while average short-term borrowings increased $293.0 million. We refinanced $190.0 million of longer term Federal Home Loan Bank advances in the fourth quarter of 2008. These advances were due to mature in the first seven months of 2009 and were replaced with lower costing overnight borrowings.

In the second quarter of 2009, average interest-bearing liabilities increased $100.6 million when compared to the second quarter of 2008. Management continued to supplement deposit growth with wholesale borrowings due to

 

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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 significant spread between wholesale borrowing costs and rates paid on time deposits. In the second quarter of 2009 compared to the second quarter of 2008, average time deposits decreased $261.3 million, or 12.9%, which were offset with increases in lower costing transaction and savings deposits. Average noninterest-bearing demand deposits increased $46.5 million, or 8.6%, while average interest-bearing demand and savings deposits increased $301.4 million, or 17.3%.

The net interest margin on a tax equivalent basis for the second quarter 2009 increased 19 basis points to 3.73% compared with 3.54% in the corresponding period last year. The increase in net interest margin can be attributed to increased loan volume and declines in the cost of interest-bearing liabilities exceeding the declines in yields on total interest-earning assets. The decrease in the cost of interest-bearing liabilities can be attributed to lower interest rates, combined with a shift in the mix of our liabilities to low cost deposits and short-term borrowings from time deposits and long-term debt. First Commonwealth uses simulation models to help manage exposure to changes in interest rates. A discussion of the effects of changing interest rates is included in the “Market Risk” section of this discussion.

Net interest income increased $14.1million, or 16.0%, for the six months ended June 30, 2009 from the corresponding period in 2008 as a result of both growth in earning assets and a decline in the cost of interest-bearing liabilities. Interest income decreased $15.4 million, or 9.4%, as the contribution from loan growth was negatively offset by lower interest rates. Interest expense declined $29.4 million, or 38.7%, as a 126 basis point decline on rates paid for interest-bearing liabilities more than offset additional interest expense resulting from a $191.0 million, or 3.8%, increase in average interest-bearing liabilities.

Average interest-earning assets increased $286.3 million, or 5.1%, in the first six months of 2009 compared to the comparable period in 2008 driven primarily by a $544.4 million, or 13.8%, increase in average loans. This loan growth was partially funded by investment run-off and short-term borrowings. Average investment securities decreased $258.3 million, or 15.8%, and a portion of the increase of $466.2 million in average short-term borrowings was also due to refinancing $190.0 million of longer term Federal Home Loan Bank advances in the fourth quarter of 2008. These advances were due to mature in the first seven months of 2009 and were replaced with lower costing overnight borrowings.

In the six months ended June 30, 2009, average interest-bearing liabilities increased $191.0 million when compared to the corresponding period in 2008. Management continued to supplement deposit growth with wholesale borrowings due to the significant spread between wholesale borrowing costs and rates paid on time deposits. In the first six months of 2009 compared to the first six months of 2008, average time deposits decreased $299.7 million, or 14.3%, which were offset with increases in lower costing transaction and savings deposits. Average noninterest-bearing demand deposits increased $48.5 million, or 9.2%, and average interest-bearing demand and savings deposits increased $270.3 million, or 15.9%.

The net interest margin on a tax equivalent basis for the six months ended June 30, 2009 increased 31 basis points to 3.72% compared with 3.41% in the corresponding period last year. The increase in net interest margin can be attributed to increased loan volume and declines in the cost of interest-bearing liabilities exceeding the declines in yields on total interest-earning assets. The decrease in the cost of interest-bearing liabilities is the result of lower interest rates, combined with a shift in the mix of our liabilities to low cost deposits and short-term borrowings from time deposits and long-term debt.

 

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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 for the three months ended June 30:

 

    Average Balance Sheets and Net Interest Income Analysis  
    2009     2008  
    (dollars in thousands)  
    Average
Balance
    Income/
Expense
  Yield
or
Rate (a)
    Average
Balance
    Income/
Expense
  Yield
or
Rate (a)
 

Assets

           

Interest-earning assets:

           

Interest-bearing deposits with banks

  $ 767     $ 1   0.43   $ 349     $ 2   2.05

Tax-free investment securities

    238,958       2,660   6.87       300,631       3,347   6.89  

Taxable investment securities

    1,112,350       13,266   4.78       1,334,118       16,256   4.90  

Federal funds sold

    -0-        -0-   0.00       286       2   2.53  

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

    4,511,811       57,793   5.29       4,048,141       62,614   6.35  
                               

Total interest-earning assets

    5,863,886       73,720   5.25        5,683,525       82,221   6.04  
                               

Noninterest-earning assets:

           

Cash

    75,318           74,860      

Allowance for credit losses

    (43,039         (42,011    

Other assets

    555,202           498,205       
                       

Total noninterest-earning assets

    587,481           531,054       
                       

Total Assets

  $ 6,451,367         $ 6,214,579       
                       

Liabilities and Shareholders’ Equity

           

Interest-bearing liabilities:

           

Interest-bearing demand deposits (d)

  $ 611,384     $ 431   0.28   $ 609,977     $ 1,241   0.82

Savings deposits (d)

    1,430,613       3,883   1.09       1,130,583       4,149   1.48  

Time deposits

    1,766,035       13,560   3.08       2,027,373       19,980   3.96  

Short-term borrowings

    1,068,183       1,133   0.43       775,183       4,251   2.21  

Long-term debt

    288,263       3,225   4.49       520,733       5,669   4.38  
                               

Total interest-bearing liabilities

    5,164,478       22,232   1.73       5,063,849       35,290   2.80  
                               

Noninterest-bearing liabilities and capital:

           

Noninterest-bearing demand deposits (d)

    588,246           541,752      

Other liabilities

    39,823           34,017      

Shareholders’ equity

    658,820           574,961      
                       

Total noninterest-bearing funding sources

    1,286,889           1,150,730      
                       

Total Liabilities and Shareholders’ Equity

  $ 6,451,367         $ 6,214,579      
                       

Net Interest Income and Net Yield on Interest-Earning Assets

    $ 51,488   3.73     $ 46,931   3.54
                   

 

(a) Yields on interest-earning assets have been computed on a tax equivalent basis using the 35% Federal income tax statutory rate.
(b) Income on nonaccrual 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 noninterest-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 is an analysis of the average balance sheets and net interest income for the six months ended June 30:

 

    Average Balance Sheets and Net Interest Income Analysis  
    2009     2008  
    (dollars in thousands)  
    Average
Balance
    Income/
Expense
  Yield
or
Rate (a)
    Average
Balance
    Income/
Expense
  Yield
or
Rate (a)
 

Assets

           

Interest-earning assets:

           

Interest-bearing deposits with banks

  $ $790      $ 2   0.47   $ 448     $ 7   3.06

Tax-free investment securities

    248,540        5,554   6.93       310,411       6,942   6.92  

Taxable investment securities

    1,131,230        27,037   4.82       1,327,618       32,396   4.91  

Federal funds sold

    0        -0-   0.00       164       2   2.57  

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

    4,486,216        116,068   5.37       3,941,864       124,681   6.51  
                               

Total interest-earning assets

    5,866,776        148,661   5.33       5,580,505       164,028   6.15  
                               

Noninterest-earning assets:

           

Cash

    74,721            74,360      

Allowance for credit losses

    (48,187         (42,185    

Other assets

    541,810            492,876       
                       

Total noninterest-earning assets

    568,344            525,051       
                       

Total Assets

  $ 6,435,120          $ 6,105,556       
                       

Liabilities and Shareholders’ Equity

           

Interest-bearing liabilities:

           

Interest-bearing demand deposits (d)

  $ 598,399     $ 980   0.33     $ 591,549     $ 2,988   1.02

Savings deposits (d)

    1,373,299       8,294   1.22       1,109,822       9,497   1.72  

Time deposits

    1,796,155       28,176   3.16       2,095,883       43,918   4.21  

Short-term borrowings

    1,100,660       2,480   0.45       634,479       7,956   2.52  

Long-term debt

    289,133       6,644   4.63       534,874       11,654   4.38  
                               

Total interest-bearing liabilities

    5,157,646       46,574   1.82       4,966,607       76,013   3.08  
                               

Noninterest-bearing liabilities and capital:

           

Noninterest-bearing demand deposits (d)

    574,488           525,951      

Other liabilities

    42,587           36,037      

Shareholders’ equity

    660,399           576,961      
                       

Total noninterest-bearing funding sources

    1,277,474           1,138,949      
                       

Total Liabilities and Shareholders’ Equity

  $ 6,435,120         $ 6,105,556      
                       

Net Interest Income and Net Yield on Interest-Earning Assets

    $ 102,087   3.72     $ 88,015   3.41
                   

 

(a) Yields on interest-earning assets have been computed on a tax equivalent basis using the 35% Federal income tax statutory rate.
(b) Income on nonaccrual 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 noninterest-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 three and six months ended June 30:

 

     Analysis of Changes in Net Interest Income  
     (dollars in thousands)  
     Three Months Ended June 30, 2009
Compared with June 30, 2008
    Six Months Ended June 30, 2009
Compared with June 30, 2008
 
     Total
Change
    Change
Due to
Volume
    Change
Due to
Rate (a)
    Total
Change
    Change
Due to
Volume
    Change
Due to
Rate (a)
 

Interest-earning assets:

            

Interest-bearing deposits with banks

   $ (1   $ 2     $ (3   $ (5   $ 5     $ (10

Tax-free investment securities

     (687     (1,057     370       (1,388     (2,129     741  

Taxable investment securities

     (2,990     (2,702     (288     (5,359     (4,795     (564

Federal funds sold

     (2     (2     -0-        (2     (2     -0-   

Loans

     (4,821     7,321       (12,142     (8,613     17,622       (26,235
                                                

Total interest income

     (8,501     3,562       (12,063     (15,367     10,701       (26,068
                                                

Interest-bearing liabilities:

            

Interest-bearing demand deposits

     (810     3       (813     (2,008     35       (2,043

Savings deposits

     (266     1,101       (1,367     (1,203     2,255       (3,458

Time deposits

     (6,420     (2,576     (3,844     (15,742     (6,281     (9,461

Short-term borrowings

     (3,118     1,610       (4,728     (5,476     5,846       (11,322

Long-term debt

     (2,444     (2,531     87       (5,010     (5,354     344  
                                                

Total interest expense

     (13,058     (2,393     (10,665     (29,439     (3,499     (25,940
                                                

Net interest income

   $ 4,557     $ 5,955     $ (1,398   $ 14,072     $ 14,200     $ (128
                                                

 

(a) Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances due to interest sensitivity of consolidated assets and liabilities.

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 second quarter of 2009 increased $42.9 million compared to the second quarter of 2008 as a result of increased allocations for new nonperforming loans, loan growth and trends in losses.

The significant increase primarily reflects deterioration in our out of state commercial real estate and commercial construction portfolios. In the second quarter of 2009, $36.1 million or 74.8% of the provision for credit losses related to out of market loans.

 

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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)

 

Significant provisions for loan losses were recorded in the second quarter on the following credits;

 

 

A $38.7 million land loan in Florida which was originated in the first quarter of 2008. Due to weakness in the Florida market and the borrowers failure to fund interest reserves the credit was classified as substandard in June 2009. In the second quarter of 2009, a $9.7 million specific reserve has been allocated to the allowance for this credit.

 

 

A $20.8 million real estate construction loan in Florida for condominiums. This loan was originated in August 2006 and was placed on nonaccrual in June 2009. The project was 100% pre-sold with a 30% down payment on each unit and is approximately 60% complete. In May 2009, the bank group received notice that closings on the first phase of the project may not be completed in time to provide cash flow needed to finish the next two phases of the project. A Shared National Credit review in June 2009 graded the loan 100% doubtful and nonaccrual. In the second quarter of 2009, a $10.8 million specific reserve has been allocated to the allowance for this credit.

 

 

A $9.2 million commercial and industrial loan in Maryland to a business that develops and manages retirement centers. This loan was originated in July 2007 and was placed on nonaccrual in June 2009. Underlying collateral for the loan is a pledge on all deposit accounts and financial assets of the borrower. Weakened real estate markets created cash flow and financial issues for the borrower. In April 2009, a Forbearance Agreement was signed adjusting covenants. The last indication of value, a liquidation analysis, was obtained in June 2009. In the second quarter of 2009, a $6.7 million specific reserve has been allocated to the allowance.

 

 

A $6.2 million real estate construction loan in Ohio for senior housing/independent living facilities. This loan was originated in June 2008 and placed on nonaccrual in June 2009. The project is approximately 80% complete. Declines in real estate prices have caused financial issues for the borrower. In April 2009, the bank group suspended construction advances on the project due to a combination of insufficient absorption, a default on related debt and the guarantor’s inability to provide financial support. The last appraisal was completed in April 2009. A Shared National Credit review in June 2009 classified 54% of the loan as substandard and 46% loss. In the second quarter of 2009, a $3.6 million specific reserve was allocated to the allowance of which $2.9 million was charged off.

 

 

A $5.0 million commercial construction loan in Illinois for a hotel and indoor water park. This loan was originated in July 2007 and placed on nonaccrual in June 2009. Current economic climate and affect on recreation industry has resulted in poor financial performance and inability to service debt payments. In June 2009, a Forbearance Agreement was entered into providing one year of interest only payments. A Shared National Credit review in June 2009 downgraded the loan to doubtful. In the second quarter, a $2.0 million specific reserve has been allocated to the allowance for this credit.

 

 

A $5.0 million commercial construction loan in Utah for a commercial residential mixed use project. This loan was originated in April 2007 and placed on nonaccrual in June 2008. In April 2009, the bank learned that construction on the project had stopped due to cash flow problems. The last appraisal was completed in September 2008. A Shared National Credit review in June 2009 downgraded the loan to loss. A $5.0 million specific reserve has been allocated for this credit, of which $2.6 million was provided in the second quarter of 2009. This loan has not been charged off because there is an unresolved court case that may result in some recovery.

 

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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)

 

Net credit losses were $6.7 million in the second quarter of 2009 compared to $2.5 million in the second quarter of 2008. Two commercial credit relationships accounted for $3.4 million, or 50.6%, of the net credit losses in the second quarter of 2009. Both of the commercial credit relationships were out of state participation loans. One was a commercial and industrial loan and the other was a construction loan secured by real estate.

The allowance for credit losses was $83.1 million at June 30, 2009, which represents a ratio of 1.85% of average loans outstanding compared to 1.13% reported at June 30, 2008. 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, 2009.

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

 

     2009    2008
     (dollars in thousands)

Balance, beginning of year

   $ 52,759    $ 42,396

Loans charged off:

     

Commercial, financial and agricultural

     9,442      1,777

Loans to individuals

     2,242      1,918

Real estate-construction

     7,695      68

Real estate-commercial

     5,487      2,106

Real estate-residential

     1,807      1,272
             

Total loans charged off

     26,673      7,141
             

Recoveries of loans previously charged off:

     

Commercial, financial and agricultural

     231      267

Loans to individuals

     217      299

Real estate-construction

     -0-      -0-

Real estate-commercial

     9      136

Real estate-residential

     16      8

Lease financing receivables

     7      -0-
             

Total recoveries

     480      710
             

Net credit losses

     26,193      6,431

Provision charged to expense

     56,490      8,540
             

Balance, end of period

   $ 83,056    $ 44,505
             

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 three and six months ended June 30:

 

     Three Months Ended
June 30,
    Six Months Ended
June 30,
 
     2009     2008     2009     2008  
     (dollars in thousands)  

Non-Interest Income

        

Trust income

   $ 1,151     $ 1,538     $ 2,238     $ 3,070  

Service charges on deposit accounts

     4,406       4,786       8,243       9,211  

Insurance and retail brokerage commissions

     1,756       1,394       3,372       2,671  

Income from bank owned life insurance

     1,034       1,446       2,172       2,933  

Card related interchange income

     2,138       1,950       4,034       3,703  

Other income

     4,935       2,426       7,943       4,907  
                                

Subtotal

     15,420       13,540       28,002       26,495  

Net securities gains

     56       90       80       591  

Net impairment losses

     (8,761     (541     (18,627     (541
                                

Total non-interest income

   $ 6,715     $ 13,089     $ 9,455     $ 26,545  
                                

Total non-interest income for the three and six month periods ended June 30, 2009 decreased $6.4 million, or 48.7%, and $17.1 million, or 64.4% respectively, compared to the same periods in 2008 primarily due to net impairment losses on securities, and decreases in service charges on deposit accounts, income from bank owned life insurance and trust income. These decreases were partially offset by higher insurance and retail brokerage commissions, increases in card related interchange income, and higher other operating income.

Net impairment losses increased $8.2 million for the second quarter of 2009 and $18.1 million for the first six months of 2009 compared to the corresponding periods of 2008. The $8.8 million net impairment charges in the second quarter of 2009 are due to higher credit related other-than-temporary impairment losses of $7.7 million on trust preferred collateralized debt obligations and $1.1 million on bank equity securities. The year-to-date $18.6 million net impairment charges are due to $16.1 million in credit related other-than-temporary impairment losses on trust preferred collateralized debt obligations and $2.5 million on bank equity securities.

Service charges on deposit accounts decreased $380 thousand, or 7.9%, for the second quarter of 2009 and $968 thousand, or 10.5%, for the first six months of 2009 compared to the corresponding periods of 2008 primarily due to reduced overdraft charges as a result of a drop in the frequency of occurrences.

Income from bank owned life insurance decreased $412 thousand, or 28.5%, for the second quarter of 2009 and $761 thousand, or 25.9%, for the first six months of 2009 compared to the corresponding periods of 2008 due to reductions in the crediting rates of our separately managed accounts.

The reduction in trust income of $387 thousand, or 25.2%, for the second quarter of 2009 and $832 thousand, or 27.1%, for the first six months of 2009 compared to the corresponding periods of 2008 was primarily due to a sharp decline in the market value of assets under management.

 

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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)

 

Insurance and retail brokerage commissions increased $362 thousand, or 26.0%, for the second quarter of 2009 and $701 thousand, or 26.2%, for the first six months of 2009 compared to the corresponding periods of 2008 mainly due to higher sales, additional producers and an enhanced calling program.

Card related interchange income includes income on debit, credit and ATM cards that are issued to consumers and/or businesses. Card related interchange income increased $188 thousand, or 9.6%, for the second quarter of 2009 and $331 thousand, or 8.9%, for the first six months of 2009 compared to the corresponding periods of 2008 primarily due to higher usage.

Other operating income increased $2.5 million, or 103.4%, for the second quarter of 2009 and $3.0 million, or 61.9%, for the first six months of 2009 compared to the corresponding periods of 2008 primarily due to a $2.1 million gain from a favorable legal settlement.

Non-Interest Expense

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

 

     Three Months Ended
June 30,
   Six Months Ended
June 30,
     2009    2008    2009    2008
     (dollars in thousands)

Non-Interest Expense

           

Salaries and employee benefits

   $ 21,081    $ 20,428    $ 43,581    $ 40,758

Net occupancy expense

     3,528      3,728      7,528      7,635

Furniture and equipment expense

     2,977      3,058      5,952      6,136

Advertising expense

     595      401      1,108      1,029

Data processing expense

     1,165      996      2,297      2,047

Pennsylvania shares tax expense

     1,312      1,339      2,643      2,610

Intangible amortization

     743      832      1,486      1,663

Collection and repossession expense

     1,750      704      2,651      1,319

FDIC insurance

     4,863      125      6,384      248

Other professional fees and services

     847      934      1,910      1,684

Other operating expenses

     6,474      6,340      13,143      12,612
                           

Total non-interest expense

   $ 45,335    $ 38,885    $ 88,683    $ 77,741
                           

Total non-interest expense for the three and six months ended June 30, 2009, increased $6.5 million, or 16.6%, and $10.9 million, or 14.1%, over the corresponding periods in 2008. The increase for the six months was primarily due to FDIC insurance, higher salaries and employee benefits, and collection and repossession expense.

Salaries and employee benefits increased $653 thousand, or 3.2%, for the second quarter of 2009 and $2.8 million, or 6.9%, for the six months ended June 30, 2009 compared with the same periods in 2008. The increases were primarily due to an increase in the number of employees due to new branch offices, enhancing the consumer infrastructure for small business banking and retail brokerage, annual merit increases in the first quarter, higher 401(K) expense and higher hospitalization expense. Full time equivalent employees were 1,675 at June 30, 2009 compared to 1,589 at June 30, 2008.

 

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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 Expense (Continued)

 

Collection and repossession expenses increased $1.0 million, or 148.6%, for the second quarter of 2009 and $1.3 million, or 101.0%, for the six months ended June 30, 2009 compared to the same periods in 2008 primarily due to costs associated with two loans that were transferred to other real estate owned in the first quarter of 2009.

FDIC expense increased $4.7 million for the second quarter of 2009 and $6.1 million for the six months ended June 30, 2009 compared to the same periods in 2008 due to the premium increases and the special assessment in the second quarter of $2.9 million.

Income Tax

The provision for income taxes decreased $19.6 million for the second quarter of 2009 and $20.9 million for the first six months ended June 30, 2009, compared to the corresponding periods in 2008. Our effective tax rate was 47.4% for the tax benefit in the second quarter of 2009 and 49.7% for the tax benefit for the first six months of 2009 compared to 18.1% and 15.0% for the tax expense for the corresponding periods of 2008. The 2009 effective tax rate is the result of negative income before taxes as well as permanent differences and tax credits.

LIQUIDITY

Liquidity refers to our ability to meet the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. We generate funds to meet these needs primarily through the core deposit base of First Commonwealth Bank and the maturity or repayment of loans and other interest-earning assets, including investments. Proceeds from the maturity and redemption of investment securities totaled $205.8 million during the first six months of 2009 and were used either for liquidity or to invest in securities of similar quality as our current investment portfolio. We also have available unused wholesale sources of liquidity, including overnight federal funds and repurchase agreements, advances from the Federal Home Loan Bank of Pittsburgh, borrowings through the discount window at the Federal Reserve Bank of Cleveland and access to certificates of deposit through brokers. We have increased our borrowing capacity at the Federal Reserve by establishing a Borrower-in-Custody of Collateral arrangement that enables us to pledge certain loans, not being used as collateral at the Federal Home Loan Bank, as collateral for borrowings at the Federal Reserve. At June 30, 2009, our borrowing capacity at the Federal Reserve related to this program was $697.8 million. We can also raise cash through the sale of earning assets, such as loans and marketable securities, or the sale of debt or equity securities in the capital markets. In the fourth quarter of 2008, we issued 11,500,000 shares of our common stock through a public stock offering, which resulted in gross proceeds of $115.0 million and increased our capital by $108.8 million after deducting underwriting discounts, commissions and offering expenses.

Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, our Board of Directors has established an Asset and Liability Management Policy that identifies primary sources of liquidity, establishes procedures for monitoring and measuring liquidity and quantifies minimum liquidity requirements based on limits approved by our Board. This policy designates our Asset/Liability Committee (ALCO) as the body responsible for meeting these objectives. The ALCO, which includes members of executive management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by our Treasury Department.

 

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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)

LIQUIDITY (Continued)

 

First Commonwealth’s long-term liquidity source is a large core deposit base and a strong capital position. Core deposits are the most stable source of liquidity a bank can have due to the long-term relationship with a deposit customer. The level of deposits during any period is influenced by factors outside of management’s control, such as the level of short-term and long-term market interest rates and yields offered on competing investments, such as money market mutual funds. During the first six months of 2009, total deposits increased $205.5 million funding loan growth of $118.4 million. The following table shows a breakdown of the components of First Commonwealth’s interest-bearing deposits:

 

     June 30,
2009
   December 31,
2008
     (dollars in thousands)

Interest-bearing demand deposits

   $ 99,281    $ 97,011

Savings deposits

     2,045,970      1,773,843

Time deposits

     1,748,420      1,842,644
             

Total interest-bearing deposits

   $ 3,893,671    $ 3,713,498
             

At June 30, 2009, noninterest-bearing deposits increased by $25.3 million and interest-bearing deposits increased $180.2 million compared to December 31, 2008. The $2.3 million increase in interest-bearing demand deposits and $272.1 million increase in savings deposits for the first six months of 2009 was partly offset by the $94.2 million decrease in time deposits.

Core deposits continue to be a source of liquidity and the growth in these accounts during the past six months has funded loan growth during that period. The following table shows a breakdown of loans by classification as of the periods presented:

 

    June 30,
2009
  March 31,
2009
  December 31,
2008
  September 30,
2008
  June 30,
2008
    (dollars in thousands)

Commercial, financial, agricultural and other

  $ 1,233,131   $ 1,259,498   $ 1,272,014   $ 1,148,601   $ 1,115,536

Real estate-construction

    476,762     449,771     464,806     382,225     347,477

Real estate-residential

    1,223,690     1,199,472     1,210,985     1,223,611     1,232,071

Real estate-commercial

    1,075,659     1,047,331     974,772     938,044     951,250

Loans to individuals

    527,529     501,286     495,800     492,119     467,089
                             

Total loans

  $ 4,536,771   $ 4,457,358   $ 4,418,377   $ 4,184,600   $ 4,113,423
                             

MARKET RISK

Market risk refers to potential losses arising from changes in interest rates, foreign exchange rates, equity prices and commodity prices. Our market risk is composed primarily of interest rate risk. Interest rate risk is comprised of repricing risk, basis risk, yield curve risk and options risk. Repricing risk arises from differences in the cash flow or repricing between asset and liability portfolios. Basis risk arises when asset and liability portfolios are related to different market rate indices, which do not always change by the same amount. Yield curve risk arises when asset and liability portfolios are related to different maturities on a given yield curve; when the yield curve changes shape, the risk position is altered. Options risk arises from “embedded options” within asset and liability products as certain borrowers have the option to prepay their loans when rates fall while certain depositors can redeem their certificates early when rates rise.

 

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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)

MARKET RISK (Continued)

 

The process by which we manage our interest rate risk is called asset/liability management. The goals of our asset/liability management are increasing net interest income without taking undue interest rate risk or material loss of net market value of our equity, while maintaining adequate liquidity. Net interest income is increased by widening the interest spread and increasing earning assets. Liquidity is measured by the ability to meet both depositors’ and credit customers’ requirements.

We use an asset/liability model to measure our interest rate risk. Interest rate risk measures include earnings simulation and gap analysis. Gap analysis is a static measure that does not incorporate assumptions regarding future business. Gap analysis, while a helpful diagnostic tool, displays cash flows for only a single rate environment. Net interest income simulations explicitly measure the exposure to earnings from changes in market rates of interest. Our current financial position is combined with assumptions regarding future business to calculate net interest income under various hypothetical rate scenarios. Our net interest income simulations assume a level balance sheet whereby new volumes equal run-offs. The ALCO reviews earnings simulations over multiple years under various interest rate scenarios. Reviewing these various measures provides us with a reasonably comprehensive view of our interest rate profile.

The following gap analysis compares the difference between the amount of interest-earning assets and interest-bearing liabilities subject to repricing over a period of time. The ratio of rate sensitive assets to rate sensitive liabilities repricing within a one year period was 0.74 at both June 30, 2009 and December 31, 2008. A ratio of less than one indicates a higher level of repricing liabilities over repricing assets over the next twelve months.

Following is the gap analysis as of June 30, 2009 and December 31, 2008:

 

     June 30, 2009  
     (dollars in thousands)  
     0-90
Days
    91-180
Days
    181-365
Days
    Cumulative
0-365 Days
    Over 1 Year
Thru 5
Years
    Over
5 Years
 

Loans

   $ 2,143,149     $ 170,565     $ 412,258     $ 2,725,972     $ 1,628,017     $ 182,782  

Investments

     228,954       161,561       173,036       563,551       371,850       424,938  

Other interest-earning assets

     961       -0-        -0-        961       -0-        -0-   
                                                

Total interest-sensitive assets (ISA)

     2,373,064       332,126       585,294       3,290,484       1,999,867       607,720  
                                                

Certificates of deposit

     471,769       310,363       345,275       1,127,407       606,185       14,746  

Other deposits

     2,145,333       -0-        -0-        2,145,333       -0-        -0-   

Borrowings

     1,076,783       10,458       61,919       1,149,160       92,908       40,655  
                                                

Total interest-sensitive liabilities (ISL)

     3,693,885       320,821       407,194       4,421,900        699,093       55,401  
                                                

Gap

   $ (1,320,821   $ 11,305     $ 178,100     $ (1,131,416   $ 1,300,774     $ 552,319  
                                                

ISA/ISL

     0.64        1.04        1.44        0.74        2.86        10.97   

Gap/Total assets

     20.48     0.18     2.76     17.54     20.17     8.56

 

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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)

MARKET RISK (Continued)

 

     December 31, 2008  
     (dollars in thousands)  
     0-90
Days
    91-180
Days
    181-365
Days
    Cumulative
0-365 Days
    Over 1 Year
Thru 5
Years
    Over
5 Years
 

Loans

   $ 2,059,435     $ 202,071     $ 351,213     $ 2,612,719     $ 1,607,006     $ 198,652  

Investments

     227,511       186,099       231,478       645,088       358,419       450,422  

Other interest-earning assets

     289       -0-        -0-        289       -0-        -0-   
                                                

Total interest-sensitive assets (ISA)

     2,287,235       388,170       582,691       3,258,096       1,965,425       649,074  
                                                

Certificates of deposit

     379,513       336,641       576,788       1,292,942       535,510       14,103  

Other deposits

     1,870,943       -0-        -0-        1,870,943       -0-        -0-   

Borrowings

     1,179,358       43,043       10,178       1,232,579       146,830       46,314  
                                                

Total interest-sensitive liabilities (ISL)

     3,429,814       379,684       586,966       4,396,464       682,340       60,417  
                                                

Gap

   $ (1,142,579   $ 8,486     $ (4,275   $ (1,138,368   $ 1,283,085     $ 588,657  
                                                

ISA/ISL

     0.67       1.02       0.99       0.74       2.88       10.74  

Gap/Total assets

     17.78     0.13     0.07     17.72     19.97     9.16

The following table presents an analysis of the potential sensitivity of our annual net interest income to gradual changes in interest rates over a 12 month time frame versus if rates remained unchanged utilizing a flat balance sheet, based on June 30, 2009 information (dollars in thousands):

 

     - 200     - 100     + 100     + 200  

Net interest income change (12 months):

   (4,502   (22   (1,473   (1,725

The ALCO is responsible for the identification and management of interest rate risk exposure. As such, the ALCO continuously evaluates strategies to manage our exposure to interest rate fluctuations.

We recognize that asset/liability models are based on methodologies that may have inherent shortcomings. Furthermore, asset/liability models require certain assumptions be made, such as prepayment rates on earning assets and pricing impact on non-maturity deposits, which may differ from actual experience. These business assumptions are based upon our experience, business plans and published industry experience. While management believes such assumptions to be reasonable, there can be no assurance that modeled results will approximate actual results.

CREDIT RISK

We maintain an allowance for credit losses at a level deemed sufficient to absorb losses inherent in the loan portfolio at the date of each statement of financial condition. Management reviews the adequacy of the allowance on a quarterly basis to ensure that the provision for credit losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management’s assessment of probable estimated losses.

First Commonwealth’s methodology for assessing the appropriateness of the allowance for credit losses consists of several key elements. These elements include an assessment of individual problem loans with a balance

 

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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)

CREDIT RISK (Continued)

 

greater than $100,000, loss experience trends, delinquency, and other relevant factors. While allocations are made to specific loans and pools of loans, the total allowance is available for all loan losses.

Nonperforming loans include nonaccrual loans and restructured loans. Nonaccrual loans represent loans on which interest accruals have been discontinued. Restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the deteriorating financial position of the borrower.

We discontinue interest accruals on a loan when, based on current information and events, it is probable that we will be unable to fully collect principal or interest due according to the contractual terms of the loan. A loan is also placed in nonaccrual status when, based on regulatory definitions, the loan is maintained on a “cash basis” due to the weakened financial condition of the borrower. Past due loans are those loans which are contractually past due 90 days or more as to interest or principal payments but are well secured and in the process of collection.

Nonperforming loans are closely monitored on an ongoing basis as part of our loan review and work-out process. The potential risk of loss on these loans is evaluated by comparing the loan balance to the fair value of any underlying collateral or the present value of projected future cash flows. Losses are recognized where appropriate.

The following table identifies amounts of loan losses and nonperforming loans:

 

     June 30,  
     2009     2008  
     (dollars in thousands)  

Nonperforming Loans:

    

Loans on nonaccrual basis

   $ 81,285     $ 50,910  

Troubled debt restructured loans

     637       139  
                

Total nonperforming loans

   $ 81,922     $ 51,049  
                

Loans past due in excess of 90 days and still accruing

   $ 14,978     $ 14,210  

Other real estate owned

   $ 25,565     $ 3,271  

Loans outstanding at end of period

   $ 4,536,711     $ 4,113,423  

Average loans outstanding

   $ 4,486,216     $ 3,941,864  

Nonperforming loans as a percentage of total loans

     1.81     1.24

Provision for credit losses

   $ 56,490     $ 8,540  

Allowance for credit losses

   $ 83,056     $ 44,505  

Net credit losses

   $ 26,193     $ 6,431  

Net credit losses as a percentage of average loans outstanding (annualized)

     1.18     0.33

Provision for credit losses as a percentage of net credit losses

     215.67     132.79

Allowance for credit losses as a percentage of average loans outstanding

     1.85     1.13

Allowance for credit losses as a percentage of end-of-period loans outstanding

     1.83     1.08

Allowance for credit losses as a percentage of nonperforming loans

     101.38     87.18

 

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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)

CREDIT RISK (Continued)

 

The following table identifies impaired loans, and information regarding the relationship of impaired loans to the allowance for credit losses at June 30:

 

     2009    2008
     (dollars in thousands)

Recorded investment in impaired loans at end of period

   $ 81,922    $ 51,049

Average balance of impaired loans for the period

   $ 49,909    $ 50,948

Allowance for credit losses related to impaired loans

   $ 34,389    $ 13,721

Impaired loans with an allocation of the allowance for credit losses

   $ 67,977    $ 44,573

Impaired loans with no allocation of the allowance for credit losses

   $ 13,945    $ 6,476

Income recorded on impaired loans on a cash basis

   $ 343    $ 319

Impaired loans increased $30.9 million to $81.9 million at June 30, 2009 compared to $51.0 million at June 30, 2008. During the second quarter of 2009, impaired loans increased $52.3 million. As of June 30, 2009, commercial loans outside the state of Pennsylvania accounted for $46.8 million of the $81.9 million of total impaired loans. Significant additions to impaired loans in the second quarter of 2009 include the following, all of which are out of state participation loans:

 

 

A $20.8 million real estate construction loan in Florida for condominiums

 

 

A $9.2 million commercial and industrial loan in Maryland to a business that develops and manages retirement centers

 

 

A $6.2 million real estate construction loan in Ohio for senior housing/independent living facilities.

 

 

A $5.0 million commercial construction loan in Illinois for a hotel and indoor water park.

Additional information on each of these credits is provided in the Provision for Loan Losses section of Management’s Discussion and Analysis.

Offsetting the above mentioned growth in nonperforming loans was the transfer of $20 million related to two commercial properties to other real estate owned in the first quarter of 2009. As a result, as of June 30, 2009, other real estate owned increased $22.3 million, to $25.6 million, when compared to a balance of $3.3 million at June 30, 2008. Charge-offs of $12.0 million were recorded in the first quarter of 2009 as a result of the $20.0 million transfer into other real estate owned.

Loans past due in excess of 90 days and still accruing remained relatively flat at $15.0 million at June 30, 2009 compared to $14.2 million at June 30, 2008.

The following tables provide information related to loan losses and nonaccrual loans as of June 30, 2009:

 

     As of June 30, 2009  
     Outstanding
Balance
   % of Total
Portfolio
 

Commercial, financial, agricultural and other

   $ 1,233,131    27.18

Real estate-construction

     476,762    10.51

Real estate-residential

     1,223,690    26.97

Real estate-commercial

     1,075,659    23.71

Loans to individuals

     527,529    11.63
             

Total loans, net of unearned income

   $ 4,536,771    100.00
             

 

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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)

CREDIT RISK (Continued)

 

 

     For Six Months Ended
June 30, 2009
    As of June 30, 2009  
     Net
Charge-offs
   % of Total Net
Charge-offs
    Nonaccrual
Loans
   Nonaccrual
as % of
Loans
 

Commercial, financial, agricultural and other

   $ 9,211    35.17   $ 16,673    20.51

Real estate-construction

     7,695    29.38     44,112    54.27

Real estate-residential

     1,791    6.84     5,265    6.48

Real estate-commercial

     5,478    20.91     15,220    18.72

Loans to individuals

     2,018    7.70     15    0.02
                          

Total loans, net of unearned income

   $ 26,193    100.00   $ 81,285    100.00
                          

As this table illustrates, two categories of loans, Real estate – construction and Commercial, financial, agricultural and other, represent a significant portion of the net charge-offs and nonaccrual loans as of and for the six months ended June 30, 2009. Real estate – construction loans, which represent only 10.5% of total loans, were 29.4% of net charge-offs and 54.3% of total nonaccrual loans. Commercial, financial, agricultural and other loans were 27.2% of total loans, 35.2% of net charge-offs and 20.5% of total nonaccrual loans.

In each of these two categories, loans generated outside of Pennsylvania represented a greater percentage of the net charge-offs and nonaccrual loans than those generated within Pennsylvania, our core market area. We track market location for loans having an original principal balance greater than $1 million; loans with original principal balances of $1 million or less are considered small business loans and are not currently broken down by geographic location. In the case of Real estate – construction loans, $450.6 million or 94.5% had an original balance of $1 million or greater, and in the case of Commercial, financial, agricultural and other loans, $1.0 billion or 81.4% had an original balance of $1 million or greater. The following table for Real estate – construction and Commercial, financial, agricultural and other loans having an original balance of greater than $1 million shows the percentage of such loans that were generated in and out of Pennsylvania; the percentage of net charge-offs for the six months ended June 30, 2009; and the percentage of nonaccrual loans as of June 30, 2009 attributable to loans generated in and out of Pennsylvania.

 

     % of Loans     % of Net
Charge-offs
    % of
Nonaccrual
Loans
 
     In Category     In Category     In Category  

Commercial, financial, agricultural and other (original balances greater than $1 million)

      

Loans generated in Pennsylvania

   75.94   100.00   36.62

Loans generated out of Pennsylvania

   24.06   0.00   63.38

Real estate – construction (original balances greater than $1 million)

      

Loans generated in Pennsylvania

   56.31   0.36   15.10

Loans generated out of Pennsylvania

   43.69   99.64   84.90

CAPITAL RESOURCES

At June 30, 2009, shareholders’ equity was $633.3 million, a decrease of $19.5 million from December 31, 2008. The decrease was primarily due to net loss and dividends paid offset by unrealized holding gains on securities. A strong capital base provides First Commonwealth with a foundation to expand lending, to protect depositors, and

 

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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)

CAPITAL RESOURCES (Continued)

 

to provide for growth while protecting against future uncertainties. The evaluation of capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings history and prospects. In consideration of these factors, management’s primary emphasis with respect to First Commonwealth’s capital position is to maintain an adequate and stable equity to assets ratio.

While First Commonwealth has no direct sub prime lending exposure, major financial institutions that do have such exposure have incurred significant losses. As a result, the supply of capital needed by these large institutions has outpaced the demand by investors, and regional financial institutions such as First Commonwealth may experience difficulty accessing the capital markets. First Commonwealth and its banking subsidiary are “well capitalized;” however, we may seek to raise additional capital in the future to fund growth in interest-earning assets or to expand our market area or product offerings through acquisitions or de novo expansion.

In July 2009, First Commonwealth Financial Corporation declared a quarter dividend of $0.03 per share payable on August 14, 2009. This dividend represents a decrease from the prior quarterly dividend of $0.12 per share. The dividend reduction was implemented in order to preserve capital during the unprecedented uncertainty and market volatility.

The Federal Reserve Board has issued risk-based capital adequacy guidelines, which are designed principally as a measure of credit risk. These guidelines require: (1) at least 50% of a banking organization’s total capital be common and other “core” equity capital (“Tier I Capital”); (2) assets and off-balance-sheet items be weighted according to risk; (3) the total capital to risk-weighted assets ratio be at least 8%; and (4) a minimum leverage ratio of Tier I capital to average total assets of 4%.

The table below presents First Commonwealth’s capital position at June 30, 2009:

 

     Actual     Regulatory Minimum  
     Capital
Amount
   Ratio     Capital
    Amount    
       Ratio      
     (dollars in thousands)  

Total Capital to Risk Weighted Assets

          

First Commonwealth Financial Corporation

   $ 671,661    11.9   $ 440,839    8.0

First Commonwealth Bank

   $ 600,868    11.0   $ 436,579    8.0

Tier I Capital to Risk Weighted Assets

          

First Commonwealth Financial Corporation

   $ 588,605    10.7   $ 220,420    4.0

First Commonwealth Bank

   $ 532,582    9.8   $ 218,290    4.0

Tier I Capital to Average Assets

          

First Commonwealth Financial Corporation

   $ 588,605    9.4   $ 251,307    4.0

First Commonwealth Bank

   $ 532,582    8.5   $ 249,421    4.0

For an institution to qualify as well capitalized under regulatory guidelines, total risk-based capital, Tier I risk-based capital and Tier I capital to average asset ratios must be at least 10%, 6.0%, and 5.0%, respectively. At June 30, 2009, First Commonwealth’s banking subsidiary exceeded those requirements.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

Information appearing in Item 2 of this report under the caption “Market Risk” is incorporated by reference in response to this item.

ITEM 4. Controls and Procedures

We carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 (the “Exchange Act”). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that the information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in applicable rules and forms of the Securities and Exchange Commission.

In addition, our management, including our Chief Executive Officer and Chief Financial Officer, also conducted an evaluation of our internal controls over financial reporting to determine whether any changes occurred during the current fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. No such changes were identified in connection with this evaluation.

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

PART II – OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

There are no material legal proceedings to which First Commonwealth is a party, or of which any of their property is the subject, except proceedings which arise in the normal course of business and, in the opinion of management, will not have a material adverse effect on the consolidated operations or financial position of First Commonwealth.

ITEM 1A. RISK FACTORS

There were no material changes to the risk factors described in Item 1A in First Commonwealth’s Annual Report on Form 10-K for the period ended December 31, 2008.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

On April 20, 2009, First Commonwealth Financial Corporation held its Annual Meeting of Shareholders. A total of 65,290,604 of First Commonwealth’s shares were present or represented by proxy at the meeting. First Commonwealth’s shareholders voted upon (1) the election of 3 persons, named in the Proxy Statement, to serve as directors of First Commonwealth for terms expiring in 2011, and (2) the approval of the First Commonwealth Financial Corporation Incentive Compensation Plan. All directors were elected and there was no solicitation in opposition to management’s nominees as listed in the Proxy Statement. The Incentive Compensation Plan was also approved. The following table details the votes cast “For” and “Withhold” for each of the Director nominees and “For,” “Against” and “Abstain” for the approval of the Incentive Compensation Plan.

(1) Election of Directors for Terms Expiring in 2011:

 

     Number of Votes Cast

Name

   For    Withhold

James W. Newill

   59,595,131    5,695,473

Laurie S. Singer

   60,750,702    4,539,902

Robert J. Ventura

   60,979,332    4,311,272

(2) Approval of the First Commonwealth Financial Corporation Incentive Compensation Plan

 

Number of Votes Cast

For

  

Against

  

Abstain

47,213,909

   8,073,103    943,007

ITEM 5. OTHER INFORMATION

None

 

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FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

PART II – OTHER INFORMATION (Continued)

ITEM 6. EXHIBITS

 

Exhibit
Number

  

Description

   Incorporated by Reference to
10.1    Director Fee Stock Plan    Filed herewith
31.1    Chief Executive Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    Filed herewith
31.2    Chief Financial Officer Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002    Filed herewith
32.1    Chief Executive Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    Filed herewith
32.2    Chief Financial Officer Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002    Filed herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

FIRST COMMONWEALTH FINANCIAL CORPORATION

(Registrant)

 

DATED: August 7, 2009  

/s/ John J. Dolan

  John J. Dolan
  President and Chief Executive Officer
DATED: August 7, 2009  

/s/ Edward J. Lipkus, III

  Edward J. Lipkus, III
  Executive Vice President and Chief Financial Officer

 

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