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FIRST COMMONWEALTH FINANCIAL CORP /PA/ - Quarter Report: 2014 September (Form 10-Q)


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 September 30, 2014
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
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
601 Philadelphia Street, Indiana, PA
 
15701
(Address of principal executive offices)
 
(Zip Code)
724-349-7220
(Registrant’s telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
Indicate by a check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
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 November 6, 2014, was 91,722,649.


Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
FORM 10-Q
INDEX
 
 
 
PAGE
 
 
 
PART I.
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
PART II.
 
 
 
 
ITEM 1.
 
 
 
ITEM 1A.
 
 
 
ITEM 2.
 
 
 
ITEM 3.
 
 
 
ITEM 4.
 
 
 
ITEM 5.
 
 
 
ITEM 6.
 
 
 
 

2

Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)
 
 
September 30,
2014
 
December 31,
2013
 
(dollars in thousands,
except share data)
Assets
 
 
 
Cash and due from banks
$
78,696

 
$
74,427

Interest-bearing bank deposits
5,374

 
3,012

Securities available for sale, at fair value
1,332,774

 
1,318,365

Other investments
50,994

 
35,444

Loans held for sale
1,305

 

Loans:
 
 
 
Portfolio loans
4,411,481

 
4,283,833

Allowance for credit losses
(50,784
)
 
(54,225
)
Net loans
4,360,697

 
4,229,608

Premises and equipment, net
66,278

 
67,940

Other real estate owned
7,751

 
11,728

Goodwill
159,371

 
159,956

Amortizing intangibles, net
781

 
1,311

Bank owned life insurance
176,500

 
174,372

Other assets
115,577

 
138,698

Total assets
$
6,356,098

 
$
6,214,861

Liabilities
 
 
 
Deposits (all domestic):
 
 
 
Noninterest-bearing
$
995,014

 
$
912,361

Interest-bearing
3,377,374

 
3,691,502

Total deposits
4,372,388

 
4,603,863

Short-term borrowings
1,034,967

 
626,615

Subordinated debentures
72,167

 
72,167

Other long-term debt
116,539

 
144,385

Total long-term debt
188,706

 
216,552

Other liabilities
50,553

 
56,134

Total liabilities
5,646,614

 
5,503,164

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

 

Common stock, $1 par value per share, 200,000,000 shares authorized; 105,563,455 shares issued at September 30, 2014 and December 31, 2013, and 91,722,649 and 95,245,215 shares outstanding at September 30, 2014 and December 31, 2013, respectively
105,563

 
105,563

Additional paid-in capital
365,576

 
365,333

Retained earnings
351,718

 
334,748

Accumulated other comprehensive loss, net
(9,676
)
 
(20,588
)
Treasury stock (13,840,806 and 10,318,240 shares at September 30, 2014 and December 31, 2013, respectively)
(103,697
)
 
(73,359
)
Total shareholders’ equity
709,484

 
711,697

Total liabilities and shareholders’ equity
$
6,356,098

 
$
6,214,861


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
3

Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data (Continued)
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
(dollars in thousands, except share data)
Interest Income
 
 
 
 
 
 
 
Interest and fees on loans
$
43,200

 
$
43,935

 
$
128,490

 
$
132,178

Interest and dividends on investments:
 
 
 
 
 
 
 
Taxable interest
7,118

 
8,280

 
21,632

 
22,708

Interest exempt from federal income taxes
104

 
1

 
172

 
3

Dividends
663

 
90

 
1,459

 
156

Interest on bank deposits
4

 
2

 
8

 
5

Total interest income
51,089

 
52,308

 
151,761

 
155,050

Interest Expense
 
 
 
 
 
 
 
Interest on deposits
2,974

 
3,750

 
9,897

 
11,948

Interest on short-term borrowings
662

 
362

 
1,608

 
869

Interest on subordinated debentures
578

 
584

 
1,715

 
2,548

Interest on other long-term debt
322

 
383

 
1,014

 
1,340

Total interest expense
4,536

 
5,079

 
14,234

 
16,705

Net Interest Income
46,553

 
47,229

 
137,527

 
138,345

Provision for credit losses
2,073

 
2,714

 
8,621

 
18,011

Net Interest Income after Provision for Credit Losses
44,480

 
44,515

 
128,906

 
120,334

Noninterest Income
 
 
 
 
 
 
 
Net securities gains
48

 
229

 
50

 
237

Trust income
1,678

 
1,406

 
4,587

 
4,677

Service charges on deposit accounts
4,099

 
4,227

 
12,032

 
11,443

Insurance and retail brokerage commissions
1,709

 
1,822

 
4,704

 
4,623

Income from bank owned life insurance
1,330

 
1,359

 
4,131

 
4,219

Gain on sale of assets
742

 
1,356

 
4,488

 
2,056

Card related interchange income
3,599

 
3,536

 
10,620

 
10,214

Other income
1,845

 
3,148

 
6,360

 
9,430

Total noninterest income
15,050

 
17,083

 
46,972

 
46,899

Noninterest Expense
 
 
 
 
 
 
 
Salaries and employee benefits
22,244

 
20,998

 
65,185

 
64,288

Net occupancy expense
3,180

 
3,274

 
9,969

 
10,130

Furniture and equipment expense
4,471

 
3,294

 
15,050

 
9,863

Data processing expense
1,583

 
1,492

 
4,593

 
4,511

Advertising and promotion expense
861

 
815

 
2,346

 
2,369

Pennsylvania shares tax expense
1,033

 
1,516

 
2,782

 
4,223

Intangible amortization
174

 
193

 
530

 
848

Collection and repossession expense
783

 
860

 
1,941

 
2,862

Other professional fees and services
1,050

 
848

 
2,777

 
2,765

FDIC insurance
926

 
1,178

 
3,026

 
3,312

Loss on redemption of subordinated debt

 

 

 
1,629

Conversion related expenses
783

 
65

 
1,676

 
65

Other operating expenses
4,480

 
5,512

 
13,976

 
16,632

Total noninterest expense
41,568

 
40,045

 
123,851

 
123,497

Income Before Income Taxes
17,962

 
21,553

 
52,027

 
43,736

Income tax provision
5,466

 
5,699

 
15,303

 
11,513

Net Income
$
12,496

 
$
15,854

 
$
36,724

 
$
32,223

Average Shares Outstanding
92,567,503

 
96,194,594

 
93,627,933

 
97,671,343

Average Shares Outstanding Assuming Dilution
92,578,701

 
96,208,545

 
93,632,783

 
97,675,352

Per Share Data:
 
 
 
 
 
 
 
Basic Earnings per Share
$
0.13

 
$
0.16

 
$
0.39

 
$
0.33

Diluted Earnings per Share
$
0.13

 
$
0.16

 
$
0.39

 
$
0.33

Cash Dividends Declared per Common Share
$
0.07

 
$
0.06

 
$
0.21

 
$
0.17


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
4

Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data (Continued)
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2014
 
2013
 
2014
 
2013
 
(dollars in thousands)
Net Income
$
12,496

 
$
15,854

 
$
36,724

 
$
32,223

Other comprehensive (loss) income, before tax benefit (expense):
 
 
 
 
 
 
 
Unrealized holding (losses) gains on securities arising during the period
(5,544
)
 
(4,003
)
 
16,863

 
(31,644
)
Less: reclassification adjustment for gains on securities included in net income
(48
)
 
(229
)
 
(50
)
 
(237
)
Unrealized holding losses on derivatives arising during the period
(27
)
 

 
(27
)
 

Less: reclassification adjustment for losses on derivatives included in net income
1

 

 
1

 

Total other comprehensive (loss) income, before tax benefit (expense)
(5,618
)
 
(4,232
)
 
16,787

 
(31,881
)
Income tax benefit (expense) related to items of other comprehensive (loss) income
1,964

 
1,485

 
(5,875
)
 
11,153

Total other comprehensive (loss) income
(3,654
)
 
(2,747
)
 
10,912

 
(20,728
)
Comprehensive Income
$
8,842

 
$
13,107

 
$
47,636

 
$
11,495



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
5

Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data (Continued)
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
 
 
Shares
Outstanding
 
Common
Stock
 
Additional
Paid-in-
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss),
net
 
Treasury
Stock
 
Total
Shareholders’
Equity
 
(dollars in thousands, except share and per share data)
Balance at December 31, 2013
95,245,215

 
$
105,563

 
$
365,333

 
$
334,748

 
$
(20,588
)
 
$
(73,359
)
 
$
711,697

Net income
 
 
 
 
 
 
36,724

 
 
 
 
 
36,724

Other comprehensive income
 
 
 
 
 
 
 
 
10,912

 
 
 
10,912

Cash dividends declared ($0.21 per share)
 
 
 
 
 
 
(19,754
)
 
 
 
 
 
(19,754
)
Discount on dividend reinvestment plan purchases
 
 
 
 
(65
)
 
 
 
 
 
 
 
(65
)
Treasury stock acquired
(3,633,513
)
 
 
 
 
 
 
 
 
 
(30,928
)
 
(30,928
)
Treasury stock reissued
21,960

 
 
 
35

 

 
 
 
157

 
192

Restricted stock
88,987

 

 
273

 

 
 
 
433

 
706

Balance at September 30, 2014
91,722,649

 
$
105,563

 
$
365,576

 
$
351,718

 
$
(9,676
)
 
$
(103,697
)
 
$
709,484

 
Shares
Outstanding
 
Common
Stock
 
Additional
Paid-in-
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss),
net
 
Treasury
Stock
 
Total
Shareholders’
Equity
 
(dollars in thousands, except share and per share data)
Balance at December 31, 2012
99,629,494

 
$
105,563

 
$
365,354

 
$
315,608

 
$
1,259

 
$
(41,777
)
 
$
746,007

Net income
 
 
 
 
 
 
32,223

 
 
 
 
 
32,223

Other comprehensive loss
 
 
 
 
 
 
 
 
(20,728
)
 
 
 
(20,728
)
Cash dividends declared ($0.17 per share)
 
 
 
 
 
 
(16,630
)
 
 
 
 
 
(16,630
)
Discount on dividend reinvestment plan purchases
 
 
 
 
(84
)
 
 
 
 
 
 
 
(84
)
Treasury stock acquired
(4,168,088
)
 
 
 
 
 
 
 
 
 
(30,001
)
 
(30,001
)
Treasury stock reissued
25,359

 
 
 

 

 
 
 
176

 
176

Restricted stock
58,000

 

 
68

 
2

 
 
 
323

 
393

Balance at September 30, 2013
95,544,765

 
$
105,563

 
$
365,338

 
$
331,203

 
$
(19,469
)
 
$
(71,279
)
 
$
711,356



The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
6

Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data (Continued)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
For the Nine Months Ended
 
September 30,
 
2014
 
2013
Operating Activities
(dollars in thousands)
Net income
$
36,724

 
$
32,223

Adjustment to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
8,621

 
18,011

Deferred tax expense
6,207

 
9,441

Depreciation and amortization
11,659

 
6,899

Net gains on securities and other assets
(3,137
)
 
(892
)
Net amortization of premiums and discounts on securities
1,610

 
278

Net accretion of premiums and discounts on long term debt
(37
)
 
(88
)
Income from increase in cash surrender value of bank owned life insurance
(3,904
)
 
(4,219
)
(Increase) decrease in interest receivable
(339
)
 
1,807

Mortgage loans originated for sale
(3,810
)
 

Proceeds from sale of mortgage loans
2,569

 

Decrease in interest payable
(476
)
 
(1,297
)
Increase (decrease) in income taxes payable
1,157

 
(1,093
)
Decrease in prepaid FDIC insurance

 
9,205

Other-net
772

 
(2,434
)
Net cash provided by operating activities
57,616

 
67,841

Investing Activities
 
 
 
Transactions with securities available for sale:
 
 
 
Proceeds from sales
132,868

 
671

Proceeds from maturities and redemptions
199,580

 
258,097

Purchases
(325,955
)
 
(410,435
)
Purchases of FHLB stock
(32,115
)
 
(15,378
)
Proceeds from the redemption of FHLB stock
16,565

 
9,902

Proceeds from bank owned life insurance
1,776

 
2,092

Proceeds from sale of loans
3,112

 
20,760

Proceeds from sale of other assets
11,314

 
10,880

Net increase in loans
(146,863
)
 
(94,250
)
Purchases of premises and equipment
(9,781
)
 
(4,576
)
Net cash used in investing activities
(149,499
)
 
(222,237
)
Financing Activities
 
 
 
Net increase (decrease) in federal funds purchased
3,500

 
(23,000
)
Net increase in other short-term borrowings
404,852

 
218,401

Net (decrease) increase in deposits
(231,475
)
 
59,945

Repayments of other long-term debt
(32,808
)
 
(29,883
)
Proceeds from other long-term debt
5,000

 

Repayments of subordinated debentures

 
(34,702
)
Discount on dividend reinvestment plan purchases
(65
)
 
(84
)
Dividends paid
(19,754
)
 
(16,630
)
Proceeds from reissuance of treasury stock
192

 
176

Purchase of treasury stock
(30,928
)
 
(29,553
)
Net cash provided by financing activities
98,514

 
144,670

Net increase (decrease) in cash and cash equivalents
6,631

 
(9,726
)
Cash and cash equivalents at January 1
77,439

 
102,982

Cash and cash equivalents at September 30
$
84,070

 
$
93,256


The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.
7


FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Note 1 Basis of Presentation
The accounting and reporting policies of First Commonwealth Financial Corporation and its subsidiaries (“First Commonwealth” or “Company”) conform with generally accepted accounting principles in the United States of America (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Actual realized amounts could differ from those estimates. In the opinion of management, the unaudited interim condensed consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary for a fair presentation of First Commonwealth’s financial position, results of operations, cash flows and changes in shareholders’ equity as of and for the periods presented.
The results of operations for the nine months ended September 30, 2014 are not necessarily indicative of the results that may be expected for the full year of 2014. These interim financial statements should be read in conjunction with First Commonwealth’s 2013 Annual Report on Form 10-K.
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, federal funds sold and interest-bearing bank deposits. Generally, federal funds are sold for one-day periods.
Note 2 Supplemental Comprehensive Income Disclosures
The following table identifies the related tax effects allocated to each component of other comprehensive income (“OCI”) in the Condensed Consolidated Statements of Comprehensive Income. Reclassification adjustments related to securities available for sale are included in the "Net securities gains" line and reclassification adjustments related to losses on derivatives are included in the "Other operating expenses" line in the Condensed Consolidated Statements of Income.
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
Pretax Amount
 
Tax (Expense) Benefit
 
Net of Tax Amount
 
Pretax Amount
 
Tax (Expense) Benefit
 
Net of Tax Amount
 
(dollars in thousands)
Unrealized gains (losses) on securities:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding gains (losses) on securities arising during the period
$
16,863

 
$
(5,902
)
 
$
10,961

 
$
(31,644
)
 
$
11,070

 
$
(20,574
)
Reclassification adjustment for gains on securities included in net income
(50
)
 
18

 
(32
)
 
(237
)
 
83

 
(154
)
Total unrealized gains (losses) on securities
16,813

 
(5,884
)
 
10,929

 
(31,881
)
 
11,153

 
(20,728
)
Unrealized losses on derivatives:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding losses on derivatives arising during the period
$
(27
)
 
$
9

 
$
(18
)
 
$

 
$

 
$

Reclassification adjustment for losses on derivatives included in net income
$
1

 
$

 
$
1

 
$

 
$

 
$

Total unrealized gains on derivatives
$
(26
)
 
$
9

 
$
(17
)
 
$

 
$

 
$

Total other comprehensive income (loss)
$
16,787

 
$
(5,875
)
 
$
10,912

 
$
(31,881
)
 
$
11,153

 
$
(20,728
)


8

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
For the Three Months Ended September 30,
 
2014
 
2013
 
Pretax Amount
 
Tax (Expense) Benefit
 
Net of Tax Amount
 
Pretax Amount
 
Tax (Expense) Benefit
 
Net of Tax Amount
 
(dollars in thousands)
Unrealized losses on securities:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding losses on securities arising during the period
$
(5,544
)
 
$
1,938

 
$
(3,606
)
 
$
(4,003
)
 
$
1,405

 
$
(2,598
)
Reclassification adjustment for gains on securities included in net income
(48
)
 
17

 
(31
)
 
(229
)
 
80

 
(149
)
Total unrealized losses on securities
(5,592
)
 
1,955

 
(3,637
)
 
(4,232
)
 
1,485

 
(2,747
)
Unrealized losses on derivatives:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding losses on derivatives arising during the period
(27
)
 
9

 
(18
)
 

 

 

Reclassification adjustment for losses on derivatives included in net income
1

 

 
1

 

 

 

Total unrealized gains on derivatives
(26
)
 
9

 
(17
)
 

 

 

Total other comprehensive loss
$
(5,618
)
 
$
1,964

 
$
(3,654
)
 
$
(4,232
)
 
$
1,485

 
$
(2,747
)
 
The following table details the change in components of OCI for the nine months ended September 30:
 
2014
 
2013
 
Securities Available for Sale
Post-Retirement Obligation
Derivatives
Accumulated Other Comprehensive Income
 
Securities Available for Sale
Post-Retirement Obligation
Derivatives
Accumulated Other Comprehensive Income
 
(dollars in thousands)
Balance at December 31
$
(20,868
)
$
280

$

$
(20,588
)
 
$
1,121

$
138

$

$
1,259

Other comprehensive income (loss) before reclassification adjustment
10,961


(18
)
10,943

 
(23,786
)


(23,786
)
Amounts reclassified from accumulated other comprehensive income (loss)
(32
)

1

(31
)
 
3,058



3,058

Net other comprehensive income (loss) during the period
10,929


(17
)
10,912

 
(20,728
)


(20,728
)
Balance at September 30
$
(9,939
)
$
280

$
(17
)
$
(9,676
)
 
$
(19,607
)
$
138

$

$
(19,469
)

Note 3 Supplemental Cash Flow Disclosures
The following table presents information related to cash paid during the period for interest as well as detail on non-cash investing and financing activities for the nine months ended September 30:
 
2014
 
2013
 
(dollars in thousands)
Cash paid during the period for:
 
 
 
Interest
$
14,747

 
$
18,115

Income taxes
7,700

 
3,080

Non-cash investing and financing activities:
 
 
 
Loans transferred to other real estate owned and repossessed assets
4,239

 
8,847

Loans transferred from held to maturity to held for sale
3,035

 
20,135

Gross increase (decrease) in market value adjustment to securities available for sale
16,812

 
(31,866
)
Investments committed to purchase, not settled
1,000

 

Unsettled treasury stock repurchases

 
1,670


9

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Note 4 Earnings per Share
The following table summarizes the composition of the weighted-average common shares (denominator) used in the basic and diluted earnings per share computations:
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
Weighted average common shares issued
105,563,455

 
105,563,455

 
105,563,455

 
105,563,455

Average treasury stock shares
(12,836,692
)
 
(9,184,715
)
 
(11,773,187
)
 
(7,715,455
)
Average unearned nonvested shares
(159,260
)
 
(184,146
)
 
(162,335
)
 
(176,657
)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
92,567,503

 
96,194,594

 
93,627,933

 
97,671,343

Additional common stock equivalents (nonvested stock) used to calculate diluted earnings per share
11,198

 
13,951

 
4,850

 
4,009

Additional common stock equivalents (stock options) used to calculate diluted earnings per share

 

 

 

Weighted average common shares and common stock equivalents used to calculate diluted earnings per share
92,578,701

 
96,208,545

 
93,632,783

 
97,675,352

The following table shows the number of shares and the price per share related to common stock equivalents that were not included in the computation of diluted earnings per share for the nine months ended September 30 because to do so would have been antidilutive.
 
2014
 
2013
 
 
 
Price Range
 
 
 
Price Range
 
Shares
 
From
 
To
 
Shares
 
From
 
To
Stock Options
15,000

 
$
14.55

 
$
14.55

 
31,954

 
$
10.46

 
$
14.55

Restricted Stock
94,929

 
4.41

 
9.18

 
92,181

 
5.96

 
7.57

Note 5 Variable Interest Entities
As defined by Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810-10, a Variable Interest Entity (“VIE”) is a corporation, partnership, trust or any other legal structure used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors that do not provide sufficient financial resources for the entity to support its activities. Under ASC 810-10, an entity that holds a variable interest in a VIE is required to consolidate the VIE if the entity is deemed to be the primary beneficiary, which generally means it is subject to a majority of the risk of loss from the VIE’s activities, is entitled to receive a majority of the entity’s residual returns, or both.
First Commonwealth’s VIEs are evaluated under the guidance included in FASB Accounting Standards Update (“ASU”) 2009-17. These VIEs include qualified affordable housing projects that First Commonwealth has invested in as part of its community reinvestment initiatives. We periodically assess whether or not our variable interests in the VIE, based on qualitative analysis, provide us with a controlling interest in the VIE. The analysis includes an assessment of the characteristics of the VIE. We do not have a controlling financial interest in the VIE, which would require consolidation of the VIE, as we do not have the following characteristics: (1) the power to direct the activities that most significantly impact the VIE’s economic performance; and (2) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.
First Commonwealth’s maximum potential exposure is equal to its carrying value and is summarized in the table below:
 
September 30, 2014
 
December 31, 2013
 
(dollars in thousands)
Low Income Housing Limited Partnership Investments
$
109

 
$
207


10

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Note 6 Commitments and Contingent Liabilities
Commitments and letters of credit
Standby letters of credit and commercial 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:
 
September 30, 2014
 
December 31, 2013
 
(dollars in thousands)
Financial instruments whose contract amounts represent credit risk:
 
 
 
Commitments to extend credit
$
1,644,486

 
$
1,571,987

Financial standby letters of credit
29,379

 
38,121

Performance standby letters of credit
26,210

 
32,441

Commercial letters of credit
2,405

 

 
The notional amounts outstanding as of September 30, 2014 include amounts issued in 2014 of $0.3 million in financial standby letters of credit and $0.8 million in performance standby letters of credit. There were $0.2 million commercial letters of credit issued during 2014. A liability of $0.1 million has been recorded as of September 30, 2014 and December 31, 2013, which represents the estimated fair value of letters of credit issued. The fair value of letters of credit is estimated based on the unrecognized portion of fees received at the time the commitment was issued.
Unused commitments and letters of credit provide exposure to future credit loss in the event of nonperformance by the borrower or guaranteed parties. Management’s evaluation of the credit risk related to these commitments resulted in the recording of a liability of $2.9 million as of September 30, 2014 and $3.2 million as of December 31, 2013. The credit risk evaluation incorporated probability of default, loss given default and estimated utilization for the next twelve months for each loan category and the letters of credit.
Legal proceedings
Market Rate Savings IRA Litigation
McGrogan v. First Commonwealth Bank was filed as a class action on January 12, 2009, in the Court of Common Pleas of Allegheny County, Pennsylvania. The action alleges that First Commonwealth Bank (the “Bank”) promised class members a minimum interest rate of 8% on its IRA Market Rate Savings Account for as long as the class members kept their money on deposit in the IRA account. The class asserted that the Bank committed fraud, breached its modified contract with the class members, and violated the Pennsylvania Unfair Trade Practice and Consumer Protection Law ("UTPCPL") when it resigned as custodian of the IRA Market Rate Savings Accounts in 2008 and offered the class members a roll-over IRA account with a 3.5% interest rate. Plaintiffs sought monetary damages for the alleged breach of contract, punitive damages for the alleged fraud and Unfair Trade Practice and Consumer Protection Law violations and attorney’s fees. The court ruled that the IRA contract only guaranteed the 8% return until the 90-day or 18-month maturity of each instrument. The court granted class certification as to the breach of modified contract claim and denied class certification as to the fraud and Pennsylvania Unfair Trade Practice and Consumer Protection Law claims. The breach of contract claim was predicated upon a letter sent to customers in 1998 which reversed an earlier decision by the Bank to reduce the rate paid on the accounts. The letter stated, in relevant part, “This letter will serve as notification that a decision has been made to re-establish the rate on your account to eight percent (8)%. This rate will be retroactive to your most recent maturity date and will continue going forward on deposits presently in the account and on annual additions.” On August 30, 2012, the Court entered an order granting the Bank’s motion for summary judgment and dismissed the class action claims. The Court found that the Bank retained the right to resign as custodian of the accounts and that the act of resigning as custodian and closing the accounts did not breach the terms of the underlying IRA contract. On appeal, the Superior Court affirmed the denial of class certification to the claims of fraud in the execution and violation of the UTPCPL. The Superior Court found that none of the other issues were ripe for appeal. Jurisdiction was returned to the Court of Common Pleas where the individual fraud and UTPCPL claims of Mr. and Mrs. McGrogan are pending. Plaintiffs filed their pretrial statement on June 16, 2014, seeking $0.5 million in damages for the McGrogans and $0.8 million for their adult children beneficiaries. The Bank considers these damage claims exaggerated and otherwise invalid. The Bank has filed a

11

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


motion for summary judgment, which was granted as to the claims of the adult children beneficiaries. The case is scheduled for trial on January 20, 2015.

In December 2013, three new complaints were filed by 34 former members of the McGrogan class:
(1)
Jarrett et al. v. First Commonwealth Bank - An action filed by eight plaintiffs on December 2, 2013 in the Westmoreland County Court of Common Pleas asserting claims for fraud in the inducement, fraud in the execution, violation of the UTPCPL, breach of fiduciary duty and promissory estoppel.
(2)
Young et al. v. First Commonwealth Bank - An action filed by 12 plaintiffs on December 2, 2013 in the Westmoreland County Court of Common Pleas asserting claims for fraud in the inducement, fraud in the execution, violation of the UTPCPL, breach of fiduciary duty and promissory estoppel.
(3)
Fisanik et. al. v. First Commonwealth Bank - An action filed by 14 plaintiffs on December 9, 2013 in the Cambria County Court of Common Pleas asserting claims for fraud in the inducement, fraud in the execution, violation of the UTPCPL, and breach of fiduciary duty.

The 36 plaintiffs who have filed individual actions held Market Rate Savings IRA balances totaling approximately $4 million at the time of the Bank’s resignation as custodian of the IRAs in 2008-09. The average age of the plaintiffs at that time was 62.

The Bank filed preliminary objections to the three new complaints. On July 22, 2014 the court issued an order permitting the three new cases to proceed only on theories of fraud in the execution and violation of the UTPCPL based on fraud in the execution and dismissing the claims for fraud in the inducement, breach of fiduciary duty and promissory estoppel with prejudice. Discovery in the three actions is beginning.

At this time, the Bank believes the claims are without merit.
Other matters
In 2013, First Commonwealth identified an error related to historical tax reporting for approximately 700-900 customers, resulting in the establishment of a $0.8 million contingency reserve. During the second quarter of 2014, a settlement in the amount of $0.4 million was reached with one taxing authority, while resolution with another taxing authority continues. Based on the settlement reached, management's best estimate of the remaining liability for this issue is $0.1 million. As a result, in addition to the settlement amount, $0.3 million of the contingency reserve was reversed during the second quarter of 2014. The contingency reserve is included in “Other liabilities” in the Condensed Consolidated Statements of Financial Condition.
There are no other material legal proceedings to which First Commonwealth or its subsidiaries are a party, or of which 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, financial position or cash flow of First Commonwealth or its subsidiaries.

12

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Note 7 Investment Securities
Below is an analysis of the amortized cost and estimated fair values of securities available for sale at:
 
September 30, 2014
 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
$
21,780

 
$
2,617

 
$
(10
)
 
$
24,387

 
$
22,639

 
$
2,624

 
$
(59
)
 
$
25,204

Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 

 
 
 
 
 
 
 

Mortgage-Backed Securities – Residential
987,530

 
11,642

 
(16,414
)
 
982,758

 
1,009,519

 
12,531

 
(27,163
)
 
994,887

Mortgage-Backed Securities – Commercial
79

 
2

 

 
81

 
104

 
1

 

 
105

Other Government-Sponsored Enterprises
269,177

 

 
(1,460
)
 
267,717

 
267,971

 
81

 
(1,927
)
 
266,125

Obligations of States and Political Subdivisions
19,421

 
251

 
(3
)
 
19,669

 
80

 

 

 
80

Corporate Securities
6,685

 
601

 

 
7,286

 
6,693

 
328

 

 
7,021

Pooled Trust Preferred Collateralized Debt Obligations
41,971

 
248

 
(12,763
)
 
29,456

 
42,040

 

 
(18,517
)
 
23,523

Total Debt Securities
1,346,643

 
15,361

 
(30,650
)
 
1,331,354

 
1,349,046

 
15,565

 
(47,666
)
 
1,316,945

Equities
1,420

 

 

 
1,420

 
1,420

 

 

 
1,420

Total Securities Available for Sale
$
1,348,063

 
$
15,361

 
$
(30,650
)
 
$
1,332,774

 
$
1,350,466

 
$
15,565

 
$
(47,666
)
 
$
1,318,365


Mortgage backed securities include mortgage backed obligations of U.S. Government agencies and obligations of U.S. Government-sponsored enterprises. These obligations have contractual maturities ranging from less than one year to approximately 30 years with lower anticipated lives to maturity due to prepayments. All mortgage backed securities contain a certain amount of risk related to the uncertainty of prepayments of the underlying mortgages. Interest rate changes have a direct impact upon prepayment speeds, therefore First Commonwealth uses computer simulation models to test the average life and yield volatility of all mortgage backed securities under various interest rate scenarios to monitor the potential impact on earnings and interest rate risk positions.

Expected maturities will differ from contractual maturities because issuers may have the right to call or repay obligations with or without call or prepayment penalties. Other fixed income securities within the portfolio also contain prepayment risk.
The amortized cost and estimated fair value of debt securities available for sale at September 30, 2014, by contractual maturity, are shown below.
 
Amortized
Cost
 
Estimated
Fair Value
 
(dollars in thousands)
Due within 1 year
$
2,600

 
$
2,600

Due after 1 but within 5 years
266,577

 
265,117

Due after 5 but within 10 years
11,224

 
11,373

Due after 10 years
56,853

 
45,038

 
337,254

 
324,128

Mortgage-Backed Securities (a)
1,009,389

 
1,007,226

Total Debt Securities
$
1,346,643

 
$
1,331,354

 

13

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


(a)
Mortgage Backed Securities include an amortized cost of $21.8 million and a fair value of $24.4 million for Obligations of U.S. Government agencies issued by Ginnie Mae and an amortized cost of $987.6 million and a fair value of $982.8 million for Obligations of U.S. Government-sponsored enterprises issued by Fannie Mae and Freddie Mac.
 
Proceeds from sales, gross gains (losses) realized on sales, maturities and other-than-temporary impairment charges related to securities available for sale were as follows for the nine months ended September 30:
 
2014
 
2013
 
(dollars in thousands)
Proceeds from sales
$
132,868

 
$
671

Gross gains (losses) realized:
 
 
 
Sales Transactions:
 
 
 
Gross gains
$
489

 
$
233

Gross losses
(441
)
 

 
48

 
233

Maturities and impairment
 
 
 
Gross gains
2

 
4

Gross losses

 

Other-than-temporary impairment

 

 
2

 
4

Net gains and impairment
$
50

 
$
237


During the third quarter of 2014, $132.9 million million in available for sale securities were sold as part of a strategy to protect the Company's net interest margin from the effects of a prolonged low interest rate enviroment. Proceeds from the investment sales were reinvested into like securities with a slightly longer duration and higher yield. The overall effect was to increase the yield on the investment portfolio by 7 basis points, while only extending the overall duration of the entire portfolio by 2.4 months.
Securities available for sale with an estimated fair value of $547.1 million and $594.9 million were pledged as of September 30, 2014 and December 31, 2013, respectively, to secure public deposits and for other purposes required or permitted by law.
Note 8 Impairment of Investment Securities
Securities Available for Sale
As required by FASB ASC Topic 320, “Investments – Debt and Equity Securities,” credit related other-than-temporary impairment on debt securities is recognized in earnings while non-credit related other-than-temporary impairment on debt securities not expected to be sold is recognized in OCI. During the nine months ended September 30, 2014 and 2013, no other-than-temporary impairment charges were recognized.
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 whether we are more likely than not to sell the security. We evaluate whether we are more likely than not to sell debt securities based upon our investment strategy for the particular type of security and our cash flow needs, liquidity position, capital adequacy, tax position and interest rate risk position. In addition, the risk of future other-than-temporary impairment may be influenced by additional bank failures, weakness in the U.S. economy, changes in real estate values and additional interest deferrals in our pooled trust preferred collateralized debt obligations. Our pooled trust preferred collateralized debt obligations are beneficial interests in securitized financial assets within the scope of FASB ASC Topic 325, “Investments – Other,” and are therefore evaluated for other-than-temporary impairment using management’s best estimate of future cash flows. If these estimated cash flows indicate that it is probable that an adverse change in cash flows has occurred, then other-than-temporary impairment would be

14

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


recognized in accordance with FASB ASC Topic 320. There is a risk that First Commonwealth will record other-than-temporary impairment charges in the future. See Note 11, “Fair Values of Assets and Liabilities,” for additional information.
The following table presents the gross unrealized losses and estimated fair values at September 30, 2014 by investment category and time frame for which securities have been in a continuous unrealized loss position:
 
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
$
2,862

 
$
(10
)
 
$

 
$

 
$
2,862

 
$
(10
)
Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
$
282,378

 
$
(1,311
)
 
$
397,581

 
$
(15,103
)
 
$
679,959

 
$
(16,414
)
Other Government-Sponsored Enterprises
159,666

 
(434
)
 
105,451

 
(1,026
)
 
265,117

 
(1,460
)
Obligations of States and Political Subdivisions
1,582

 
(3
)
 

 

 
1,582

 
(3
)
Pooled Trust Preferred Collateralized Debt Obligations

 

 
24,957

 
(12,763
)
 
24,957

 
(12,763
)
Total Securities Available for Sale
$
446,488

 
$
(1,758
)
 
$
527,989

 
$
(28,892
)
 
$
974,477

 
$
(30,650
)

At September 30, 2014, fixed income securities issued by U.S. Government-sponsored enterprises comprised 58% of total unrealized losses due to changes in market interest rates. Pooled trust preferred collateralized debt obligations accounted for 42% of the unrealized losses due to changes in market interest rates and the illiquid market for this investment type. There were no equity securities in an unrealized loss position at September 30, 2014.
The following table presents the gross unrealized losses and estimated fair values at December 31, 2013 by investment category and time frame for which securities have been in a continuous unrealized loss position:
 
Less Than 12 Months
 
12 Months or More
 
Total
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
Gross
Unrealized
Losses
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
$
2,035

 
$
(59
)
 
$

 
$

 
$
2,035

 
$
(59
)
Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
632,231

 
(22,844
)
 
65,324

 
(4,319
)
 
697,555

 
(27,163
)
Other Government-Sponsored Enterprises
183,542

 
(1,448
)
 
24,501

 
(479
)
 
208,043

 
(1,927
)
Pooled Trust Preferred Collateralized Debt Obligations
2,401

 
(237
)
 
21,122

 
(18,280
)
 
23,523

 
(18,517
)
Total Securities Available for Sale
$
820,209

 
$
(24,588
)
 
$
110,947

 
$
(23,078
)
 
$
931,156

 
$
(47,666
)
As of September 30, 2014, our corporate securities had an amortized cost and an estimated fair value of $6.7 million and $7.3 million, respectively, and were comprised of single issue trust preferred securities issued primarily by large regional banks. As of December 31, 2013, the same portion of the portfolio had an amortized cost of $6.7 million and an estimated fair value of $7.0 million. There were no corporate securities in an unrealized loss position as of September 30, 2014 and December 31, 2013. When unrealized losses exist on these investments, management reviews each of the issuer’s asset quality, earnings trends and capital position, to determine whether issues in an unrealized loss position were other-than-temporarily impaired. All interest payments on the corporate securities are being made as contractually required.
As of September 30, 2014, the book value of our pooled trust preferred collateralized debt obligations totaled $42.0 million with an estimated fair value of $29.5 million, which includes securities comprised of 282 banks and other financial institutions. All of our pooled securities are mezzanine tranches, four of which now have no senior class remaining in the issue. The credit rating on all of our issues are below investment grade. At the time of initial issue, the subordinated tranches ranged in size from approximately 7% to 35% of the total principal amount of the respective securities and no more than 5% of any pooled

15

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


security consisted of a security issued by any one institution. As of September 30, 2014, after taking into account management’s best estimates of future interest deferrals and defaults, five of our securities had no excess subordination in the tranches we own and five of our securities had excess subordination which ranged from 2% to 43% of the current performing collateral.
 
The following table provides information related to our pooled trust preferred collateralized debt obligations as of September 30, 2014:
Deal
Class
 
Book
Value
 
Estimated Fair
Value
 
Unrealized
Gain
(Loss)
 
Moody’s/
Fitch
Ratings
 
Number
of
Banks
 
Deferrals
and
Defaults
as a % of
Current
Collateral
 
Excess
Subordination
as a % of
Current
Performing
Collateral
(dollars in thousands)
Pre TSL IV
Mezzanine
 
$
1,830

 
$
1,327

 
$
(503
)
 
B1/BB
 
6

 
18.05
%
 
41.28
%
Pre TSL V
Mezzanine
 
59

 
127

 
68

 
C/-
 
3

 
100.00

 

Pre TSL VII
Mezzanine
 
2,723

 
2,864

 
141

 
Ca/-
 
14

 
54.14

 

Pre TSL VIII
Mezzanine
 
1,956

 
1,332

 
(624
)
 
C/C
 
29

 
59.12

 

Pre TSL IX
Mezzanine
 
2,331

 
1,453

 
(878
)
 
B3/C
 
40

 
26.45

 
2.23

Pre TSL X
Mezzanine
 
1,469

 
1,508

 
39

 
Caa1/C
 
45

 
31.95

 

Pre TSL XII
Mezzanine
 
5,484

 
3,455

 
(2,029
)
 
B3/C
 
66

 
25.53

 

Pre TSL XIII
Mezzanine
 
12,403

 
8,536

 
(3,867
)
 
Caa1/C
 
58

 
20.94

 
23.85

Pre TSL XIV
Mezzanine
 
13,277

 
8,477

 
(4,800
)
 
Caa1/C
 
56

 
27.42

 
43.02

MMCap I
Mezzanine
 
439

 
377

 
(62
)
 
Ca/C
 
11

 
59.24

 
19.70

Total
 
 
$
41,971

 
$
29,456

 
$
(12,515
)
 
 
 
 
 
 
 
 
Lack of liquidity in the market for trust preferred collateralized debt obligations, below investment grade credit ratings and market uncertainties related to the financial industry are factors contributing to the impairment on these securities.
All of the Company's pooled trust preferred securities are included in the non-exclusive list issued by the regulatory agencies and therefore are not considered covered funds under the Volcker Rule.
On a quarterly basis we evaluate our debt securities for other-than-temporary impairment. During the three and nine months ended September 30, 2014 and 2013, there were no credit related other-than-temporary impairment charges recognized on our pooled trust preferred collateralized debt obligations. When evaluating these investments we determine a credit related portion and a non-credit related portion of other-than-temporary impairment. The credit related portion is recognized in earnings and represents the difference between book value and the present value of future cash flows. The non-credit related portion is recognized in OCI 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 the discounted cash flow analysis follows:
Our pooled trust preferred collateralized debt obligations are measured for other-than-temporary impairment within the scope of FASB ASC Topic 325 by determining whether it is probable that an adverse change in estimated cash flows has occurred. Determining whether there has been an adverse change in estimated cash flows from the cash flows previously projected involves comparing the present value of remaining cash flows previously projected against the present value of the cash flows estimated at September 30, 2014. 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 which includes each deal’s structural features. Projected cash flows include prepayment assumptions which are dependent on the issuer's asset size and coupon rate. For collateral issued by financial institutions over $15 billion in asset size with a coupon over 7%, a 100% prepayment rate is assumed. Financial institutions over $15 billion with a coupon of 7% or under are assigned a

16

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


prepayment rate of 40% for two years and 2% thereafter. Financial institutions with assets between $2 billion and $15 billion with coupons over 7% are assigned a 5% prepayment rate. For financial institutions below $2 billion, if the coupon is over 10%, a prepayment rate of 5% is assumed and for all other issuers, there is no prepayment assumption incorporated into the cash flows. The modeled cash flows are then used to estimate if all the scheduled principal and interest payments of our investments will be returned.
Credit Analysis – A quarterly credit evaluation is performed for each of the 282 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. Currently, any bank that is in default is assigned a 100% probability of default and a 0% projected recovery rate. All other banks in the pool are assigned a probability of default based on their unique credit characteristics and market indicators with a 10% projected recovery rate. For the majority of banks currently in deferral we assume the bank continues to defer and will eventually default and, therefore, a 100% probability of default is assigned. However, for some deferring collateral there is the possibility that they become current on interest or principal payments at some point in the future and in those cases a probability that the deferral will ultimately cure is assigned. The probability of default is updated quarterly. As of September 30, 2014, default probabilities for performing collateral ranged from 0.33% to 75%.
Our credit evaluation provides a basis for determining deferral and default probabilities for each underlying piece of collateral. Using the results of the credit evaluation, the next step of the process is to look at pricing of senior debt or credit default swaps for the issuer (or where such information is unavailable, for companies having similar credit profiles as the issuer). The pricing of these market indicators provides the information necessary to determine appropriate default probabilities for each bank.
In addition to the above factors, our evaluation of impairment also includes a stress test analysis which provides an estimate of excess subordination for each tranche. We stress the cash flows of each pool by increasing current default assumptions to the level of defaults which results in an adverse change in estimated cash flows. This stressed breakpoint is then used to calculate excess subordination levels for each pooled trust preferred security. The results of the stress test allow 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.
Our cash flow analysis as of September 30, 2014, indicates that no credit related other-than-temporary impairment has occurred on our pooled trust preferred securities during the nine months ended September 30, 2014. Based upon the analysis performed by management, it is probable that five of our pooled trust preferred securities will experience principal and interest shortfalls and therefore appropriate other-than-temporary charges were recorded in prior periods. These securities are identified in the table on page 16 with 0% “Excess Subordination as a Percentage of Current Performing Collateral.” For the remaining securities listed in that table, our analysis as of September 30, 2014 indicates it is probable that we will collect all contractual principal and interest payments. For four of those securities, PreTSL IX, PreTSL XIII, PreTSL XIV and MMCap I, other-than-temporary impairment charges were recorded in prior periods, however, due to improvement in the expected cash flows of these securities, it is now probable that all contractual payments will be received.
During 2008, 2009 and 2010, other-than-temporary impairment charges were recognized on all of our pooled trust preferred securities, except for PreTSL IV. Our cash flow analysis as of September 30, 2014, for all of these impaired securities indicates that it is now probable we will collect principal and interest in excess of what was estimated at the time other-than-temporary impairment charges were recorded. This change can be attributed to improvement in the underlying collateral for these securities and has resulted in the present value of estimated future principal and interest payments exceeding the securities current book value. The excess for each bond of the present value of future cash flows over our current book value ranges from 22% to 154% and will be recognized as an adjustment to yield over the remaining life of these securities. The excess subordination recognized as an adjustment to yield are reflected in the following table as increases in cash flows expected to be collected.

17

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The following table 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 September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
(dollars in thousands)
Balance, beginning (a)
$
26,842

 
$
42,699

 
$
27,543

 
$
43,274

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

 

 

 

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

 

 

 

Increases in cash flows expected to be collected, recognized over the remaining life of the security (b)
(288
)
 
(1,326
)
 
(989
)
 
(1,901
)
Balance, ending
$
26,554

 
$
41,373

 
$
26,554

 
$
41,373

 
(a)
The beginning balance represents credit related losses included in other-than-temporary impairment charges recognized on debt securities in prior periods.
(b)
Represents the increase in cash flows recognized in interest income during the period.
In the first nine months of 2014 and 2013, no other-than-temporary impairment charges were recorded on equity securities. On a quarterly basis, management evaluates equity securities for other-than-temporary impairment by reviewing the severity and duration of decline in estimated fair value, research reports, analysts’ recommendations, credit rating changes, news stories, annual reports, regulatory filings, impact of interest rate changes and other relevant information. As of September 30, 2014 and 2013, there are no equity securities in an unrealized loss position.
Other Investments
As a member of the Federal Home Loan Bank (“FHLB”), First Commonwealth is required to purchase and hold stock in the FHLB to satisfy membership and borrowing requirements. The level of stock required to be held is dependent on the amount of First Commonwealth's mortgage related assets and outstanding borrowings with the FHLB. 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 September 30, 2014 and December 31, 2013, our FHLB stock totaled $51.0 million and $35.4 million, respectively and is included in “Other investments” on the Condensed Consolidated Statements of Financial Condition.
Beginning in July 2013, the FHLB began repurchasing 100% of a member's excess stock on a monthly basis. In the months prior to that in 2013, the FHLB repurchased the lessor of 5% of the members' total capital stock outstanding or its total excess capital stock on a quarterly basis. As a result, during the nine months ended September 30, 2014 and 2013, $16.6 million and $9.9 million, respectively, of the stock owned by First Commonwealth was repurchased. The FHLB repurchased stock and paid dividends in 2014 and 2013, however, decisions regarding any future repurchase of excess capital stock and dividend payments will be made by the FHLB on an ongoing basis.
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 nine months ended September 30, 2014. Our evaluation of the factors described above in future periods could result in the recognition of impairment charges on FHLB stock.

18

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Note 9 Loans and Allowance for Credit Losses
The following table provides outstanding balances related to each of our loan types:
 
 
September 30, 2014
 
December 31, 2013
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
1,071,531

 
$
1,021,056

Real estate construction
115,788

 
93,289

Residential real estate
1,234,842

 
1,262,718

Commercial real estate
1,345,302

 
1,296,472

Loans to individuals
644,018

 
610,298

Total loans and leases net of unearned income
$
4,411,481

 
$
4,283,833

Credit Quality Information
As part of the on-going monitoring of credit quality within the loan portfolio, the following credit worthiness categories are used in grading our loans:
Pass
  
Acceptable levels of risk exist in the relationship. Includes all loans not adversely classified as OAEM, substandard or doubtful.
Other Assets Especially Mentioned (OAEM)
  
Potential weaknesses that deserve management’s close attention. The potential weaknesses may result in deterioration of the repayment prospects or weaken the Bank’s credit position at some future date. The credit risk may be relatively minor, yet constitute an undesirable risk in light of the circumstances surrounding the specific credit. No loss of principal or interest is expected.
Substandard
  
Well-defined weakness or a weakness that jeopardizes the repayment of the debt. A loan may be classified as substandard as a result of deterioration of the borrower’s financial condition and repayment capacity. Loans for which repayment plans have not been met or collateral equity margins do not protect the Company may also be classified as substandard.
Doubtful
  
Loans with the characteristics of substandard loans with the added characteristic that collection or liquidation in full, on the basis of presently existing facts and conditions, is highly improbable.
The use of creditworthiness categories to grade loans permits management’s use of migration analysis to estimate a portion of credit risk. The Company’s internal creditworthiness grading system provides a measurement of credit risk based primarily on an evaluation of the borrower’s cash flow and collateral. Movement between these rating categories provides a predictive measure of credit losses and therefore assists in determining the appropriate level for the loan loss reserves. Category ratings are reviewed each quarter, at which time management analyzes the results, as well as other external statistics and factors related to loan performance. Loans that migrate towards higher risk rating levels generally have an increased risk of default, whereas loans that migrate toward lower risk ratings generally will result in a lower risk factor being applied to those related loan balances.

19

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The following tables represent our credit risk profile by creditworthiness:
 
September 30, 2014
 
Commercial, financial, agricultural and other
 
Real estate construction
 
Residential real estate
 
Commercial real estate
 
Loans to individuals
 
Total
 
(dollars in thousands)
Pass
$
996,609

 
$
106,989

 
$
1,223,231

 
$
1,301,447

 
$
643,756

 
$
4,272,032

Non-Pass
 
 
 
 
 
 
 
 
 
 
 
OAEM
40,620

 
8,222

 
1,874

 
25,009

 

 
75,725

Substandard
30,382

 
577

 
9,737

 
18,846

 
262

 
59,804

Doubtful
3,920

 

 

 

 

 
3,920

Total Non-Pass
74,922

 
8,799

 
11,611

 
43,855

 
262

 
139,449

Total
$
1,071,531

 
$
115,788

 
$
1,234,842

 
$
1,345,302

 
$
644,018

 
$
4,411,481

 
 
December 31, 2013
 
Commercial, financial, agricultural and other
 
Real estate construction
 
Residential real estate
 
Commercial real estate
 
Loans to individuals
 
Total
 
(dollars in thousands)
Pass
$
943,107

 
$
79,679

 
$
1,245,422

 
$
1,243,170

 
$
610,094

 
$
4,121,472

Non-Pass
 
 
 
 
 
 
 
 
 
 
 
OAEM
35,429

 
9,710

 
5,161

 
28,823

 
1

 
79,124

Substandard
42,520

 
3,900

 
12,135

 
24,479

 
203

 
83,237

Doubtful

 

 

 

 

 

Total Non-Pass
77,949

 
13,610

 
17,296

 
53,302

 
204

 
162,361

Total
$
1,021,056

 
$
93,289

 
$
1,262,718

 
$
1,296,472

 
$
610,298

 
$
4,283,833

Portfolio Risks
The credit quality of our loan portfolio can potentially represent significant risk to our earnings, capital, regulatory agency relationships, investment community reputation and shareholder returns. First Commonwealth devotes a substantial amount of resources managing this risk primarily through our credit administration department that develops and administers policies and procedures for underwriting, maintaining, monitoring and collecting activities. Credit administration is independent of lending departments and oversight is provided by the credit committee of the First Commonwealth Board of Directors.
Criticized loans have been evaluated when determining the appropriateness of the allowance for credit losses, which we believe is adequate to absorb losses inherent to the portfolio as of September 30, 2014. However, changes in economic conditions, interest rates, borrower financial condition, delinquency trends or previously established fair values of collateral factors could significantly change those judgmental estimates.


20

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Age Analysis of Past Due Loans by Segment
The following tables delineate the aging analysis of the recorded investments in past due loans as of September 30, 2014 and December 31, 2013. Also included in these tables are loans that are 90 days or more past due and still accruing because they are well-secured and in the process of collection.
 
 
September 30, 2014
 
30 - 59
days
past due
 
60 - 89
days
past
due
 
90 days
and
greater
and still
accruing
 
Nonaccrual
 
Total past
due and
nonaccrual
 
Current
 
Total
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
467

 
$
165

 
$
267

 
$
18,847

 
$
19,746

 
$
1,051,785

 
$
1,071,531

Real estate construction

 

 

 
291

 
291

 
115,497

 
115,788

Residential real estate
6,371

 
1,636

 
778

 
8,286

 
17,071

 
1,217,771

 
1,234,842

Commercial real estate
2,162

 
75

 

 
6,408

 
8,645

 
1,336,657

 
1,345,302

Loans to individuals
3,797

 
1,105

 
1,329

 
261

 
6,492

 
637,526

 
644,018

Total
$
12,797

 
$
2,981

 
$
2,374

 
$
34,093

 
$
52,245

 
$
4,359,236

 
$
4,411,481

 
 
December 31, 2013
 
30 - 59
days
past due
 
60 - 89
days
past
due
 
90 days
and
greater
and still
accruing
 
Nonaccrual
 
Total past
due and
nonaccrual
 
Current
 
Total
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
594

 
$
319

 
$
185

 
$
23,631

 
$
24,729

 
$
996,327

 
$
1,021,056

Real estate construction

 

 

 
2,567

 
2,567

 
90,722

 
93,289

Residential real estate
4,002

 
524

 
1,041

 
10,520

 
16,087

 
1,246,631

 
1,262,718

Commercial real estate
1,199

 
23

 
13

 
8,966

 
10,201

 
1,286,271

 
1,296,472

Loans to individuals
2,895

 
990

 
1,266

 
204

 
5,355

 
604,943

 
610,298

Total
$
8,690

 
$
1,856

 
$
2,505

 
$
45,888

 
$
58,939

 
$
4,224,894

 
$
4,283,833

Nonaccrual Loans
The previous tables summarize nonaccrual loans by loan segment. The Company generally places loans on nonaccrual status when the full and timely collection of interest or principal becomes uncertain, when part of the principal balance has been charged off and no restructuring has occurred, or the loans reach a certain number of days past due. Generally, loans 90 days or more past due are placed on nonaccrual status, except for consumer loans which are placed in nonaccrual status at 150 days past due.
When a loan is placed on nonaccrual, the accrued unpaid interest receivable is reversed against interest income and all future payments received are applied as a reduction to the loan principal. Generally, the loan is returned to accrual status when (a) all delinquent interest and principal become current under the terms of the loan agreement or (b) the loan is both well-secured and in the process of collection and collectability is no longer doubtful.
Impaired Loans
Management considers loans to be impaired when, based on current information and events, it is determined that the Company will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Determination of impairment is treated the same across all loan categories. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole source for repayment of the loan is the operation or liquidation of collateral. When the loan is collateral dependent, the appraised value less estimated cost to sell is utilized. If management determines the value of the impaired loan is less than the

21

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


recorded investment in the loan, impairment is recognized through an allowance estimate or a charge-off to the allowance. Troubled debt restructured loans on accrual status are considered to be impaired loans.
When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual status, contractual interest is credited to interest income when received, under the cash basis method.
 
Nonperforming loans decreased $14.1 million during the nine months ended September 30, 2014. Contributing to this decrease was the sale of four real estate construction loans totaling $3.0 million and the payoff of six loans totaling $12.5 million. The payoffs included a $4.7 million commercial relationship to a local developer, a $3.1 million commercial real estate loan with a non-profit organization in western Pennsylvania, a $2.9 million commercial real estate loan to a real estate investor in western Pennsylvania, a $0.9 million residential real estate loan in western Pennsylvania, a $0.6 million commercial relationship with a western Pennsylvania glass manufacturer and a $0.3 million commercial real estate loan with a western Pennsylvania real estate investor. Additionally, net charge-offs recognized during the nine-months ended September 30, 2014 totaled $12.1 million including $5.8 million for a commercial industrial loan relationship with a gas drilling business that operated in western Pennsylvania with headquarters in Louisiana and $0.6 million for a commercial loan in western Pennsylvania. The remaining charge-offs were individually for amounts of $0.5 million or less.

Offsetting the previously noted decreases in nonperforming loans is a total of $19.8 million in loans which were moved into nonaccrual status during the nine months ended September 30, 2014, the majority of which relates to a $4.3 million commercial industrial relationship with an audio visual equipment distributor, a $0.7 million commercial real estate relationship with a personal care facility in western Pennsylvania, and a $0.7 million commercial real estate relationship with a western Pennsylvania funeral home. In addition to this, $3.2 million in consumer loans which were 150 days or more past due were moved to nonaccrual status.
The specific allowance for nonperforming loans decreased by $4.2 million at September 30, 2014 compared to December 31, 2013, primarily due to the charge-offs noted on the previously mentioned loans offset by specific reserves recognized on the loans transferred into nonaccrual status. Unfunded commitments related to nonperforming loans were $0.4 million at September 30, 2014 and after consideration of available collateral related to these commitments, a reserve of $14 thousand was established was established for these off balance sheet exposures.
There were $1.3 million loans held for sale at September 30, 2014, all of which were 1-4 family residential loans originated through our recently launched mortgage business. There were no loans held for sale at December 31, 2013. Sales of loans during the nine months ended September 30, 2014 and 2013 resulted in gains of $0.1 million and $0.6 million, respectively.
Significant nonaccrual loans as of September 30, 2014, include the following:
$10.6 million relationship of commercial industrial loans to a local energy company. These loans were originated from 2008 to 2011 and were placed in nonaccrual status during the third quarter of 2013. One of these loans, totaling $2.7 million, was modified, resulting in TDR classification in the second quarter of 2012. A second of these loans, totaling $0.3 million, was modified, resulting in TDR classification in the first quarter of 2013. During the nine months ended September 30, 2014, chargeoffs of $0.5 million related to this relationship were recorded. A valuation of the collateral was completed during the third quarter of 2013, with updates to significant inputs completed in June 2014.
$3.9 million in commercial industrial loans to an audio visual equipment distributor. These loans were originated in 2008 and refinanced by the Company in 2013. In the second quarter of 2014, the loans were placed on nonaccrual status. An updated valuation of the collateral was completed during the second quarter of 2014.
$3.0 million in commercial real estate and industrial loans to a specialty metal processor in western Pennsylvania. These loans were originated in 2003 and were placed on nonaccrual status in the second quarter of 2013. The assets collateralizing this relationship as well as the appraisal for the real estate collateral were valued in the second quarter of 2014.

22

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The following tables include the recorded investment and unpaid principal balance for impaired loans with the associated allowance amount, if applicable, as of September 30, 2014 and December 31, 2013. Also presented are the average recorded investment in impaired loans and the related amount of interest recognized while the loan was considered impaired. Average balances are calculated using month-end balances of the loans for the period reported and are included in the table below based on its period-end allowance position.
 
 
September 30, 2014
 
December 31, 2013
 
Recorded
investment
 
Unpaid
principal
balance
 
Related
allowance
 
Recorded
investment
 
Unpaid
principal
balance
 
Related
allowance
 
(dollars in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
$
10,833

 
$
12,207

 


 
$
6,752

 
$
7,649

 


Real estate construction
291

 
867

 


 
3,486

 
6,664

 


Residential real estate
10,093

 
11,171

 


 
9,333

 
9,952

 


Commercial real estate
8,358

 
9,887

 


 
13,606

 
14,719

 


Loans to individuals
348

 
456

 


 
289

 
307

 


Subtotal
29,923

 
34,588

 


 
33,466

 
39,291

 


With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
13,802

 
14,192

 
4,271

 
21,482

 
22,082

 
7,364

Real estate construction

 

 

 
414

 
737

 
94

Residential real estate
1,445

 
1,579

 
332

 
3,533

 
3,585

 
1,282

Commercial real estate
87

 
88

 
29

 
488

 
612

 
84

Loans to individuals

 

 

 

 

 

Subtotal
15,334

 
15,859

 
4,632

 
25,917

 
27,016

 
8,824

Total
$
45,257

 
$
50,447

 
$
4,632

 
$
59,383

 
$
66,307

 
$
8,824

 
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
Average
recorded
investment
 
Interest
Income
Recognized
 
Average
recorded
investment
 
Interest
Income
Recognized
 
(dollars in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
$
15,209

 
$
77

 
$
14,482

 
$
147

Real estate construction
1,506

 
19

 
5,390

 

Residential real estate
11,047

 
167

 
9,376

 
129

Commercial real estate
9,007

 
78

 
26,390

 
119

Loans to individuals
309

 
3

 
248

 
3

Subtotal
37,078

 
344

 
55,886

 
398

With an allowance recorded:
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
11,944

 
125

 
15,552

 
46

Real estate construction

 

 
1,848

 
35

Residential real estate
1,178

 
12

 
3,001

 
24

Commercial real estate
90

 
3

 
5,628

 
1

Loans to individuals

 

 

 

Subtotal
13,212

 
140

 
26,029

 
106

Total
$
50,290

 
$
484

 
$
81,915

 
$
504


23

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
For the Three Months Ended September 30,
 
2014
 
2013
 
Average
recorded
investment
 
Interest
Income
Recognized
 
Average
recorded
investment
 
Interest
Income
Recognized
 
(dollars in thousands)
With no related allowance recorded:
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
$
10,973

 
$
39

 
$
14,000

 
$
41

Real estate construction
295

 
1

 
2,340

 

Residential real estate
10,590

 
38

 
9,977

 
52

Commercial real estate
8,873

 
24

 
23,428

 
42

Loans to individuals
346

 
1

 
251

 
1

Subtotal
31,077

 
103

 
49,996

 
136

With an allowance recorded:
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
14,140

 
48

 
10,370

 
16

Real estate construction

 

 
1,541

 
8

Residential real estate
1,406

 
3

 
3,349

 
10

Commercial real estate
88

 
2

 
5,371

 
1

Loans to individuals

 

 

 

Subtotal
15,634

 
53

 
20,631

 
35

Total
$
46,711

 
$
156

 
$
70,627

 
$
171

 
Troubled debt 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 financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.
The following table provides detail as to the total troubled debt restructured loans and total commitments outstanding on troubled debt restructured loans:
 
September 30, 2014
 
December 31, 2013
 
(dollars in thousands)
Troubled debt restructured loans
 
 
 
Accrual status
$
11,164

 
$
13,495

Nonaccrual status
6,783

 
16,980

Total
$
17,947

 
$
30,475

Commitments
 
 
 
Letters of credit
$

 
$

Unused lines of credit
974

 
452

Total
$
974

 
$
452

At September 30, 2014, troubled debt restructured loans decreased $12.5 million compared to December 31, 2013, and commitments related to troubled debt restructured loans increased $0.5 million for the same period. This decrease in loans is primarily a result of the payoff of four commercial loans totaling $11.3 million, including a $4.7 million commercial relationship with a local real estate developer, a $3.1 million commercial real estate loan with a non-profit organization and a $2.9 million commercial real estate loan in western Pennsylvania. The increase in unused line of credit commitments is related to two commercial borrowers.

24

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The following tables provide detail, including specific reserves and reasons for modification, related to loans identified as troubled debt restructurings:
 
For the Nine Months Ended September 30, 2014
 
 
 
Type of Modification
 
 
 
 
 
 
 
Number
of
Contracts
 
Extend
Maturity
 
Modify
Rate
 
Modify
Payments
 
Total
Pre-Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Specific
Reserve
 
(dollars in thousands)
Commercial, financial, agricultural and other
2

 
$
1,505

 
$

 
$

 
$
1,505

 
$
1,648

 
$
27

Residential real estate
44

 

 
468

 
1,767

 
2,235

 
2,091

 
22

Commercial real estate
1

 

 

 
8

 
8

 
6

 

Loans to individuals
13

 

 
81

 
42

 
123

 
101

 

Total
60

 
$
1,505

 
$
549

 
$
1,817

 
$
3,871

 
$
3,846

 
$
49


 
For the Nine Months Ended September 30, 2013
 
 
 
Type of Modification
 
 
 
 
 
 
 
Number
of
Contracts
 
Extend
Maturity
 
Modify
Rate
 
Modify
Payments
 
Total
Pre-Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Specific
Reserve
 
(dollars in thousands)
Commercial, financial, agricultural and other
7

 
$
2,969

 
$

 
$
105

 
$
3,074

 
$
1,041

 
$
198

Residential real estate
32

 
347

 
350

 
1,552

 
2,249

 
1,924

 
274

Commercial real estate
6

 
758

 
244

 
1,551

 
2,553

 
2,484

 
1,062

Loans to individuals
12

 
9

 
70

 
28

 
107

 
83

 

Total
57

 
$
4,083

 
$
664

 
$
3,236

 
$
7,983

 
$
5,532

 
$
1,534

The troubled debt restructurings included in the above tables are also included in the impaired loan tables provided earlier in this note. Loans defined as modified due to a change in rate may include loans that were modified for a change in rate as well as a reamortization of the principal and an extension of the maturity. For the nine months ended September 30, 2014 and 2013, $0.5 million and $0.6 million, respectively, of total rate modifications represent loans with modifications to the rate as well as payment as a result of reamortization. For both 2014 and 2013 the changes in loan balances between the pre-modification balance and the post-modification balance are due to customer payments.
 
For the Three Months Ended September 30, 2014
 
 
 
Type of Modification
 
 
 
 
 
 
 
Number
of
Contracts
 
Extend
Maturity
 
Modify
Rate
 
Modify
Payments
 
Total
Pre-Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Specific
Reserve
 
(dollars in thousands)
Residential real estate
24

 
$

 
$
164

 
$
1,116

 
$
1,280

 
$
1,233

 
$
2

Loans to individuals
3

 

 
8

 
15

 
23

 
20

 

Total
27

 
$

 
$
172

 
$
1,131

 
$
1,303

 
$
1,253

 
$
2


25

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
For the Three Months Ended, September 30, 2013
 
 
 
Type of Modification
 
 
 
 
 
 
 
Number
of
Contracts
 
Extend
Maturity
 
Modify
Rate
 
Modify
Payments
 
Total
Pre-Modification
Outstanding
Recorded
Investment
 
Post-
Modification
Outstanding
Recorded
Investment
 
Specific
Reserve
 
(dollars in thousands)
Commercial, financial, agricultural and other
4

 
$
2,442

 
$

 
$
93

 
$
2,535

 
$
601

 
$
198

Residential real estate
10

 
67

 
24

 
269

 
360

 
361

 

Commercial real estate
5

 
758

 

 
1,551

 
2,309

 
2,252

 
1,062

Loans to individuals
6

 
10

 
36

 
21

 
67

 
58

 

Total
25

 
$
3,277

 
$
60

 
$
1,934

 
$
5,271

 
$
3,272

 
$
1,260

The troubled debt restructurings included in the above tables are also included in the impaired loan tables provided earlier in this note. Loans defined as modified due to a change in rate may include loans that were modified for a change in rate as well as a reamortization of the principal and an extension of the maturity. For the three months ended September 30, 2014 and 2013, $0.1 million and $0.1 million, respectively, of total rate modifications represent loans with modifications to the rate as well as payment as a result of reamortization. For both 2014 and 2013 the changes in loan balances between the pre-modification balance and the post-modification balance are due to customer payments.
A troubled debt restructuring is considered to be in default when a restructured loan is 90 days or more past due. The following table provides information related to restructured loans that were considered to default during the nine months ended September 30: 
 
2014
 
2013
 
Number of
Contracts
 
Recorded
Investment
 
Number of
Contracts
 
Recorded
Investment
 
(dollars in thousands)
Residential real estate
3

 
$
18

 
1

 
$
9

Loans to individuals

 

 
2

 
9

Total
3

 
$
18

 
3

 
$
18

 
A troubled debt restructuring is considered to be in default when a restructured loan is 90 days or more past due. The following table provides information related to restructured loans that were considered to default during the three months ended September 30: 

 
2014
 
2013
 
Number of
Contracts
 
Recorded
Investment
 
Number of
Contracts
 
Recorded
Investment
 
(dollars in thousands)
Residential real estate
1

 
$
5

 
1

 
$
9

Loans to individuals

 

 
1

 
5

Total
1

 
$
5

 
2

 
$
14



26

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The following tables provide detail related to the allowance for credit losses:
 
For the Nine Months Ended September 30, 2014
 
Commercial,
financial,
agricultural
and other
 
Real estate
construction
 
Residential
real estate
 
Commercial
real estate
 
Loans to
individuals
 
Unallocated
 
Total
 
(dollars in thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
22,663

 
$
6,600

 
$
7,727

 
$
11,778

 
$
5,457

 
$

 
$
54,225

Charge-offs
(8,357
)
 
(296
)
 
(2,286
)
 
(1,109
)
 
(2,581
)
 

 
(14,629
)
Recoveries
625

 
469

 
420

 
432

 
621

 

 
2,567

Provision (credit)
4,773

 
1,331

 
(407
)
 
1,453

 
1,471

 

 
8,621

Ending Balance
$
19,704

 
$
8,104

 
$
5,454

 
$
12,554

 
$
4,968

 
$

 
$
50,784

Ending balance: individually evaluated for impairment
$
4,271

 
$

 
$
332

 
$
29

 
$

 
$

 
$
4,632

Ending balance: collectively evaluated for impairment
15,433

 
8,104

 
5,122

 
12,525

 
4,968

 

 
46,152

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
1,071,531

 
115,788

 
1,234,842

 
1,345,302

 
644,018

 
 
 
4,411,481

Ending balance: individually evaluated for impairment
23,773

 
199

 
6,854

 
6,890

 

 
 
 
37,716

Ending balance: collectively evaluated for impairment
1,047,758

 
115,589

 
1,227,988

 
1,338,412

 
644,018

 
 
 
4,373,765

 
 
For the Nine Months Ended September 30, 2013
 
Commercial,
financial,
agricultural
and other
 
Real estate
construction
 
Residential
real estate
 
Commercial
real estate
 
Loans to
individuals
 
Unallocated
 
Total
 
(dollars in thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
19,852

 
$
8,928

 
$
5,908

 
$
22,441

 
$
4,132

 
$
5,926

 
$
67,187

Charge-offs
(17,302
)
 
(773
)
 
(1,400
)
 
(10,051
)
 
(2,669
)
 

 
(32,195
)
Recoveries
345

 
140

 
883

 
121

 
465

 

 
1,954

Provision (credit)
12,038

 
(1,865
)
 
446

 
4,318

 
2,266

 
808

 
18,011

Ending Balance
$
14,933

 
$
6,430

 
$
5,837

 
$
16,829

 
$
4,194

 
$
6,734

 
$
54,957

Ending balance: individually evaluated for impairment
$
4,889

 
$
165

 
$
1,377

 
$
1,808

 
$

 
$

 
$
8,239

Ending balance: collectively evaluated for impairment
10,044

 
6,265

 
4,460

 
15,021

 
4,194

 
6,734

 
46,718

Loans:
 
 
 
 
 
 
 
 
 
 
 
 
 
Ending balance
1,008,316

 
74,025

 
1,280,990

 
1,272,366

 
604,307

 
 
 
4,240,004

Ending balance: individually evaluated for impairment
25,620

 
4,028

 
9,794

 
25,197

 

 
 
 
64,639

Ending balance: collectively evaluated for impairment
982,696

 
69,997

 
1,271,196

 
1,247,169

 
604,307

 
 
 
4,175,365


27

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
For the Three Months Ended September 30, 2014
 
Commercial,
financial,
agricultural
and other
 
Real estate
construction
 
Residential
real estate
 
Commercial
real estate
 
Loans to
individuals
 
Unallocated
 
Total
 
(dollars in thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
21,956

 
$
5,899

 
$
6,125

 
$
11,661

 
$
5,084

 
$

 
$
50,725

Charge-offs
(498
)
 

 
(551
)
 
(812
)
 
(1,019
)
 

 
(2,880
)
Recoveries
204

 
132

 
97

 
177

 
256

 

 
866

Provision (credit)
(1,958
)
 
2,073

 
(217
)
 
1,528

 
647

 

 
2,073

Ending Balance
$
19,704

 
$
8,104

 
$
5,454

 
$
12,554

 
$
4,968

 
$

 
$
50,784

 
For the Three Months Ended, September 30, 2013
 
Commercial,
financial,
agricultural
and other
 
Real estate
construction
 
Residential
real estate
 
Commercial
real estate
 
Loans to
individuals
 
Unallocated
 
Total
 
(dollars in thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
16,575

 
$
8,246

 
$
6,439

 
$
16,128

 
$
4,142

 
$
5,922

 
$
57,452

Charge-offs
(3,081
)
 
(18
)
 
(757
)
 
(813
)
 
(914
)
 

 
(5,583
)
Recoveries
81

 
81

 
71

 
13

 
128

 

 
374

Provision (credit)
1,358

 
(1,879
)
 
84

 
1,501

 
838

 
812

 
2,714

Ending Balance
$
14,933

 
$
6,430

 
$
5,837

 
$
16,829

 
$
4,194

 
$
6,734

 
$
54,957


The change in the unallocated portion of the allowance for credit losses comparing September 30, 2014 with September 30, 2013 is a result of the unallocated portion of the allowance for credit losses no longer being treated as a separate component of the allowance as of December 31, 2013. Instead it is incorporated into the reserve provided for each loan category. This portion of the allowance for credit losses reflects the qualitative or environmental factors that are probable to cause estimated credit losses to differ from historical loss experience.
Note 10 Income Taxes
At September 30, 2014 and December 31, 2013, 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 noninterest expense. Federal and state tax years 2011 through 2013 were open for examination as of September 30, 2014.
Note 11 Fair Values of Assets and Liabilities
FASB ASC Topic 820, “Fair Value Measurements and Disclosures” requires disclosures for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). All non-financial assets are included either as a separate line item on the Condensed Consolidated Statements of Financial Condition or in the “Other assets” category of the Condensed Consolidated Statements of Financial Condition. Currently, First Commonwealth does not have any non-financial liabilities to disclose.
FASB ASC Topic 825, “Financial Instruments” permits entities to irrevocably elect to measure select financial instruments and certain other items at fair value. The unrealized gains and losses are required to be included in earnings each reporting period for the items that fair value measurement is elected. First Commonwealth has elected not to measure any existing financial instruments at fair value under FASB ASC Topic 825; however, in the future we may elect to adopt this guidance for select financial instruments.
 
In accordance with FASB ASC Topic 820, First Commonwealth groups financial assets and financial liabilities measured at fair value in three levels based on the principal markets in which the assets and liabilities are transacted and the observability of the data points used to determine fair value. These levels are:

28

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Level 1 – Valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange (“NYSE”). Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities. Level 1 securities include equity holdings comprised of publicly traded bank stocks which were priced using quoted market prices.
Level 2 – Valuations for assets and liabilities traded in less active dealer or broker markets. Valuations are obtained for identical or comparable assets or liabilities from alternative pricing sources with reasonable levels of price transparency. Level 2 includes Obligations of U.S. Government securities issued by Agencies and Sponsored Enterprises, Obligations of States and Political Subdivisions, corporate securities, FHLB stock, interest rate derivatives that include interest rate caps, interest rate swaps and risk participation agreements, certain other real estate owned and certain impaired loans.
Level 2 investment securities are valued by a recognized third party pricing service using observable inputs. The model used by the pricing service varies by asset class and incorporates available market, trade and bid information as well as cash flow information when applicable. Because many fixed-income investment securities do not trade on a daily basis, the model uses available information such as benchmark yield curves, benchmarking of like investment securities, sector groupings and matrix pricing. The model will also use processes such as an option adjusted spread to assess the impact of interest rates and to develop prepayment estimates. Market inputs normally used in the pricing model include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications.
Management validates the market values provided by the third party service by having another recognized pricing service price 100% of the securities on an annual basis and a random sample of securities each quarter, monthly monitoring of variances from prior period pricing and, on a monthly basis, evaluating pricing changes compared to expectations based on changes in the financial markets.
Other Investments are comprised of FHLB stock whose estimated fair value is based on its par value. Additional information on FHLB stock is provided in Note 8, “Impairment of Investment Securities.”
Interest rate derivatives are reported at an estimated fair value utilizing Level 2 inputs and are included in other assets and other liabilities and consist of interest rate swaps where there is no significant deterioration in the counterparties' (loan customers') credit risk since origination of the interest rate swap as well as interest rate caps and risk participation agreements. First Commonwealth values its interest rate swap and cap positions using a yield curve by taking market prices/rates for an appropriate set of instruments. The set of instruments currently used to determine the U.S. Dollar yield curve includes cash LIBOR rates from overnight to three months, Eurodollar futures contracts and swap rates from three years to thirty years. These yield curves determine the valuations of interest rate swaps. Interest rate derivatives are further described in Note 12, “Derivatives.”
For purposes of potential valuation adjustments to our derivative positions, First Commonwealth evaluates the credit risk of its counterparties as well as our own credit risk. Accordingly, we have considered factors such as the likelihood of default, expected loss given default, net exposures and remaining contractual life, among other things, in determining if any 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. In 2014, we have not realized any losses due to a counterparty's inability to pay any uncollateralized positions.
The estimated fair value for other real estate owned included in Level 2 is determined by either an independent market-based appraisal less estimated costs to sell or an executed sales agreement.
Level 3 – Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. If the inputs used to provide the valuation 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 pooled trust preferred collateralized debt obligations, non-marketable equity investments, certain interest rate derivatives, certain other real estate owned and certain impaired loans.
Our pooled trust preferred collateralized debt obligations are collateralized by the trust preferred securities of individual banks, thrifts and bank holding companies in the U.S. There has been little or no active trading in these securities since 2009; therefore

29

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


it is more appropriate to determine estimated fair value using a discounted cash flow analysis. Detail on our process for determining the appropriate cash flows for this analysis is provided in Note 8, “Impairment of Investment Securities.” The discount rate applied to the cash flows is determined by evaluating the current market yields for comparable corporate and structured credit products along with an evaluation of the risks associated with the cash flows of the comparable security. Due to the fact that there is no active market for the pooled trust preferred collateralized debt obligations, one key reference point is the market yield for the single issue trust preferred securities issued by banks and thrifts for which there is more activity than for the pooled securities. Adjustments are then made to reflect the credit and structural differences between these two security types.
Management validates the fair value of the pooled trust preferred collateralized debt obligations by monitoring the performance of the underlying collateral, discussing the discount rate, cash flow assumptions and general market trends with the specialized third party and confirming changes in the underlying collateral to the trustee reports. Management’s monitoring of the underlying collateral includes deferrals of interest payments, payment defaults, cures of previously deferred interest payments, any regulatory filings or actions and general news related to the underlying collateral. Management also evaluates fair value changes compared to expectations based on changes in the interest rates used in determining the discount rate and general financial markets.
The estimated fair value of the non-marketable equity investments included in Level 3 is based on par value.
For interest rate derivatives included in Level 3, the fair value incorporates credit risk by considering such factors as likelihood of default and expected loss given default based on the credit quality of the underlying counterparties (loan customers).
In accordance with ASU 2011-4, the following table provides information related to quantitative inputs and assumptions used in Level 3 fair value measurements.
 
Fair Value (dollars
in thousands)
 
Valuation
Technique
 
Unobservable Inputs
 
Range /
(weighted average)
Pooled Trust Preferred Securities
$29,456
 
Discounted Cash Flow
 
Probability of default
 
0% - 100% (18.02%)
 
 
 
 
 
Prepayment rates
 
0% - 100% (6.61%)
 
 
 
 
 
Discount rates
 
5.25% - 14.00% (a)
Equities
1,420
 
Par Value
 
N/A
 
N/A
Interest Rate Swap
 
Option model
 
Counterparty credit risk
 
3.69% - 6.82% (b)
Impaired Loans
5,934 (c)
 
Reserve study
 
Discount rate
 
10.00%
 
 
 
 
 
Gas per MCF
 
$3.84 - $6.45 (d)
 
 
 
 
 
Oil per BBL/d
 
$83.64 - $107.00 (d)
 
 
 
 
 
NGL per gallon
 
$0.83 (d)
 
113 (c)
 
Discounted Cash Flow
 
Discount Rate
 
9.00%
Other Real Estate Owned
190
 
Internal Valuation
 
N/A
 
N/A
 
(a)
incorporates spread over risk free rate related primarily to credit quality and illiquidity of securities.
(b)
represents the range of the credit spread curve used in valuation.
(c)
the remainder of impaired loans valued using Level 3 inputs are not included in this disclosure as the values of those loans are based on bankruptcy agreement documentation.
(d)
unobservable inputs are defined as follows: MCF - million cubic feet; BBL/d - barrels per day; NGL - natural gas liquid.
The significant unobservable inputs used in the fair value measurement of pooled trust preferred securities are the probability of default, discount rates and prepayment rates. Significant increases in the probability of default or discount rate used would result in a decrease in the estimated fair value of these securities while decreases in these variables would result in higher fair value measurements. In general, a change in the assumption of probability of default is accompanied by a directionally similar change in the discount rate. In most cases, increases in the prepayment rate assumptions would result in a higher estimated fair value for these securities while decreases would provide for a lower value. The direction of this change is somewhat dependent on the structure of the investment and the amount of the investment tranches senior to our position.
The discount rate is the significant unobservable input used in the fair value measurement of impaired loans. Significant increases in this rate would result in a decrease in the estimated fair value of the loans, while a decrease in this rate would result in higher fair value measurement. Other unobservable inputs in the fair value measurement of impaired loans relate to gas, oil and natural gas prices and increases in these rates would result in an increase in the estimated fair value of the loans, while a decrease in these prices would result in a lower fair value measurement.

30

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The significant unobservable input used in the fair value measurement of interest rate swaps classified as Level 3 is counterparty credit risk and the resulting range of the credit spread curve used in the valuation. Higher credit risk would result in an increased credit spread, which would reduce the fair value of the interest rate swap.
The tables below present the balances of assets and liabilities measured at fair value on a recurring basis:
 
September 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
Mortgage-Backed Securities - Residential
$

 
$
24,387

 
$

 
$
24,387

Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 
 
Mortgage-Backed Securities - Residential

 
982,758

 

 
982,758

Mortgage-Backed Securities - Commercial

 
81

 

 
81

Other Government-Sponsored Enterprises

 
267,717

 

 
267,717

Obligations of States and Political Subdivisions

 
19,669

 

 
19,669

Corporate Securities

 
7,286

 

 
7,286

Pooled Trust Preferred Collateralized Debt Obligations

 

 
29,456

 
29,456

Total Debt Securities

 
1,301,898

 
29,456

 
1,331,354

Equities

 

 
1,420

 
1,420

Total Securities Available for Sale

 
1,301,898

 
30,876

 
1,332,774

Other Investments

 
50,994

 

 
50,994

Loans held for sale

 
1,305

 

 
1,305

Other Assets(a)

 
9,468

 

 
9,468

Total Assets
$

 
$
1,363,665

 
$
30,876

 
$
1,394,541

Other Liabilities(a)
$

 
$
9,047

 
$

 
$
9,047

Total Liabilities
$

 
$
9,047

 
$

 
$
9,047

(a)
Hedging and non-hedging interest rate derivatives


31

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
Mortgage-Backed Securities - Residential
$

 
$
25,204

 
$

 
$
25,204

Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 
 
Mortgage-Backed Securities - Residential

 
994,887

 

 
994,887

Mortgage-Backed Securities - Commercial

 
105

 

 
105

Other Government-Sponsored Enterprises

 
266,125

 

 
266,125

Obligations of States and Political Subdivisions

 
80

 

 
80

Corporate Securities

 
7,021

 

 
7,021

Pooled Trust Preferred Collateralized Debt Obligations

 

 
23,523

 
23,523

Total Debt Securities

 
1,293,422

 
23,523

 
1,316,945

Equities

 

 
1,420

 
1,420

Total Securities Available for Sale

 
1,293,422

 
24,943

 
1,318,365

Other Investments

 
35,444

 

 
35,444

Loans Held for Sale

 

 

 

Other Assets(a)

 
14,358

 

 
14,358

Total Assets
$

 
$
1,343,224

 
$
24,943

 
$
1,368,167

Other Liabilities(a)
$

 
$
14,318

 
$

 
$
14,318

Total Liabilities
$

 
$
14,318

 
$

 
$
14,318

(a)
Non-hedging interest rate derivatives

For the nine months ended September 30, changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:
 
2014
 
Pooled Trust
Preferred
Collateralized
Debt
Obligations
 
Equities
 
Loans
Held for
Sale
 
Other
Assets
 
Total
 
(dollars in thousands)
Balance, beginning of period
$
23,523

 
$
1,420

 
$

 
$

 
$
24,943

Total gains or losses
 
 
 
 
 
 
 
 
 
Included in earnings

 

 
77

 

 
77

Included in other comprehensive income
7,266

 

 

 

 
7,266

Purchases, issuances, sales, and settlements
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 

Issuances

 

 

 

 

Sales

 

 
(3,112
)
 

 
(3,112
)
Settlements
(1,333
)
 

 

 

 
(1,333
)
Transfers into Level 3

 

 
3,035

 

 
3,035

Balance, end of period
$
29,456

 
$
1,420

 
$

 
$

 
$
30,876

 

32

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
2013
 
Pooled Trust
Preferred
Collateralized
Debt
Obligations
 
Equities
 
Loans Held for Sale
 
Other
Assets
 
Total
 
(dollars in thousands)
Balance, beginning of period
$
23,373

 
$
1,420

 
$

 
$

 
$
24,793

Total gains or losses
 
 
 
 
 
 
 
 
 
Included in earnings

 

 
625

 

 
625

Included in other comprehensive income
7,399

 

 

 

 
7,399

Purchases, issuances, sales, and settlements
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 

Issuances

 

 

 

 

Sales

 

 
(20,760
)
 

 
(20,760
)
Settlements
(5,315
)
 

 

 

 
(5,315
)
Transfers into Level 3

 

 
20,135

 

 
20,135

Balance, end of period
$
25,457

 
$
1,420

 
$

 
$

 
$
26,877

For the nine months ended September 30, 2014 and 2013, there were no transfers between fair value Levels 1 and 2. However, $3.0 million and $20.1 million of loans were transferred into Level 3 from Level 2 during the nine months ended September 30, 2014 and 2013, respectively, due to the loans being transferred to a held for sale status. The loans transferred and subsequently sold related to three nonperforming loan relationships for which this was determined to be the appropriate exit strategy. There were no gains or losses included in earnings for the periods presented that are attributable to the change in realized gains (losses) relating to assets held at September 30, 2014 and 2013.

For the three months ended September 30, changes in Level 3 assets and liabilities measured at fair value on a recurring basis are summarized as follows:
 
2014
 
Pooled Trust
Preferred
Collateralized
Debt
Obligations
 
Equities
 
Loans Held
for Sale
 
Other
Assets
 
Total
 
(dollars in thousands)
Balance, beginning of period
$
28,154

 
$
1,420

 
$

 
$

 
$
29,574

Total gains or losses
 
 
 
 
 
 
 
 
 
Included in earnings

 

 

 

 

Included in other comprehensive income
1,470

 

 

 

 
1,470

Purchases, issuances, sales, and settlements
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 

Issuances

 

 

 

 

Sales

 

 

 

 

Settlements
(168
)
 

 

 

 
(168
)
Balance, end of period
$
29,456

 
$
1,420

 
$

 
$

 
$
30,876


33

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
2013
 
Pooled Trust
Preferred
Collateralized
Debt
Obligations
 
Equities
 
Loans Held for Sale
 
Other
Assets
 
Total
 
(dollars in thousands)
Balance, beginning of period
$
25,869

 
$
1,420

 
$

 
$

 
27,289

Total gains or losses
 
 
 
 
 
 
 
 
 
Included in earnings

 

 
242

 

 
242

Included in other comprehensive income
1,716

 

 

 

 
1,716

Purchases, issuances, sales, and settlements
 
 
 
 
 
 
 
 
 
Purchases

 

 

 

 

Issuances

 

 

 

 

Sales

 

 
(242
)
 

 
(242
)
Settlements
(2,128
)
 

 

 

 
(2,128
)
Balance, end of period
$
25,457

 
$
1,420

 
$

 
$

 
$
26,877

For the three months ended September 30, 2014 and 2013, there were no transfers between fair value Levels 1 and 2. Additional proceeds from a loan sale in the second quarter of 2013 resulted in a $0.2 million gain for the three months ended September 30, 2013. There were no gains or losses included in earnings for periods presented that are attributable to the change in realized gains(losses) relating to assets held at September 30, 2014 and 2013.
The tables below present the balances of assets measured at fair value on a non-recurring basis at:
 
September 30, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Impaired loans
$

 
$
27,037

 
$
13,589

 
$
40,626

Other real estate owned

 
8,119

 
190

 
8,309

Total Assets
$

 
$
35,156

 
$
13,779

 
$
48,935

 
December 31, 2013
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Impaired loans
$

 
$
36,903

 
$
13,656

 
$
50,559

Other real estate owned

 
12,752

 
172

 
12,924

Total Assets
$

 
$
49,655

 
$
13,828

 
$
63,483

The following gains(losses) were realized on the assets measured on a nonrecurring basis:
 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
(dollars in thousands)
Impaired loans
$
456

 
$
(1,468
)
 
$
(1,291
)
 
$
(13,063
)
Other real estate owned
(51
)
 
(90
)
 
(1,109
)
 
(188
)
Total losses
$
405

 
$
(1,558
)
 
$
(2,400
)
 
$
(13,251
)
Impaired loans over $0.1 million are individually reviewed to determine the amount of each loan considered to be at risk of non-collection. The fair value for impaired loans that are collateral based is determined by reviewing real property appraisals, equipment valuations, accounts receivable listings and other financial information. A discounted cash flow analysis is performed to determine fair value for impaired loans when an observable market price or a current appraisal is not available. For real estate secured loans, First Commonwealth’s loan policy requires updated appraisals be obtained at least every twelve

34

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


months on all impaired loans with balances of $250 thousand and over. For real estate secured loans with balances under $250 thousand, we rely on broker price opinions. For non-real estate secured assets, the Company normally relies on third party valuations specific to the collateral type.
The fair value for other real estate owned determined by either an independent market based appraisal less estimated costs to sell or an executed sales agreement is classified as Level 2. The fair value for other real estate owned determined using an internal valuation is classified as Level 3. Other real estate owned has a book cost of $7.8 million as of September 30, 2014 and consisted primarily of commercial real estate properties in Pennsylvania. We review whether events and circumstances subsequent to a transfer to other real estate owned have occurred that indicate the balance of those assets may not be recoverable. If events and circumstances indicate further impairment we will record a charge to the extent that the carrying value of the assets exceed their fair values, less estimated cost to sell, as determined by valuation techniques appropriate in the circumstances.
Certain other assets and liabilities, including goodwill and core deposit intangibles, are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances. Additional information related to goodwill is provided in Note 13, “Goodwill.” There were no other assets or liabilities measured at fair value on a non-recurring basis during the nine months ended September 30, 2014.
FASB ASC 825-10, “Transition Related to FSP FAS 107-1” and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities 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 due from banks and interest-bearing bank deposits: The carrying amounts for cash and due from banks and interest-bearing bank deposits approximate the estimated fair values of such assets.
Securities: Fair values for securities available for sale 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. Pooled trust preferred collateralized debt obligations values are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker traded transactions. These valuations incorporate certain assumptions and projections in determining the fair value assigned to each instrument. The carrying value of other investments, which includes FHLB stock, is considered a reasonable estimate of fair value.
Loans: The fair values of all loans are estimated by discounting the estimated future cash flows using interest rates currently offered for loans with similar terms to borrowers of similar credit quality adjusted for past due and nonperforming loans, which is not an exit price under FASB ASC Topic 820, “Fair Value Measurements and Disclosures.”
Off-balance sheet instruments: Many of First Commonwealth’s off-balance sheet instruments, primarily loan commitments and standby letters of credit, are expected to expire without being drawn upon; therefore, the commitment amounts do not necessarily represent future cash requirements. FASB ASC Topic 460, “Guarantees” clarified that a guarantor is required to recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. The carrying amount and fair value for standby letters of credit was $0.1 million at September 30, 2014 and December 31, 2013, respectively. See Note 6, “Commitments and Contingent Liabilities,” for additional information.
Deposit liabilities: Estimated fair value of demand deposits, savings accounts and money market deposits is the amount payable on demand at the reporting date because of the customers’ ability to withdraw funds immediately. The carrying value of variable rate time deposit accounts and certificates of deposit approximate their fair values at the report date. Also, fair values of fixed rate time deposits for both periods are estimated by discounting the future cash flows using interest rates currently being offered and a schedule of aggregated expected maturities.
Short-term borrowings: The fair values of borrowings from the FHLB were estimated based on the estimated incremental borrowing rate for similar types of borrowings. The carrying amounts of other short-term borrowings such as federal funds purchased and securities sold under agreement to repurchase were used to approximate fair value due to the short-term nature of the borrowings.

35

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


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 estimate of the current market rate for similar types of borrowing arrangements or an announced redemption price.
The following table presents carrying amounts and fair values of First Commonwealth’s financial instruments:
 
September 30, 2014
 
 
 
Fair Value Measurements Using:
 
Carrying
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(dollars in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
78,696

 
$
78,696

 
$
78,696

 
$

 
$

Interest-bearing deposits
5,374

 
5,374

 
5,374

 

 

Securities available for sale
1,332,774

 
1,332,774

 

 
1,301,898

 
30,876

Other investments
50,994

 
50,994

 

 
50,994

 

Loans held for sale
1,305

 
1,305

 

 
1,305

 

Loans
4,411,481

 
4,391,765

 

 
27,037

 
4,364,728

Financial liabilities
 
 
 
 
 
 
 
 
 
Deposits
4,372,388

 
4,376,654

 

 
4,376,654

 

Short-term borrowings
1,034,967

 
1,034,917

 

 
1,034,917

 

Long-term debt
116,539

 
117,655

 

 
117,655

 

Subordinated debt
72,167

 
62,714

 

 

 
62,714


 
December 31, 2013
 
 
 
Fair Value Measurements Using:
 
Carrying
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(dollars in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
74,427

 
$
74,427

 
$
74,427

 
$

 
$

Interest-bearing deposits
3,012

 
3,012

 
3,012

 

 

Securities available for sale
1,318,365

 
1,318,365

 

 
1,293,422

 
24,943

Other investments
35,444

 
35,444

 

 
35,444

 

Loans
4,283,833

 
4,321,847

 

 
36,903

 
4,284,944

Financial liabilities
 
 
 
 
 
 
 
 
 
Deposits
4,603,863

 
4,531,685

 

 
4,531,685

 

Short-term borrowings
626,615

 
626,603

 

 
626,603

 

Long-term debt
144,385

 
145,477

 

 
145,477

 

Subordinated debt
72,167

 
51,706

 

 

 
51,706

Note 12 Derivatives
Derivatives Not Designated as Hedging Instruments
First Commonwealth is a party to interest rate derivatives that are not designated as accounting hedges. These derivatives relate to interest rate swaps that First Commonwealth entered 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.

36

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


The changes in the fair value of the swaps offset each other, except for the credit risk of the counterparties, which is determined by taking into consideration the risk rating, probability of default and loss given default for all counterparties.
We have thirteen 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. We have four risk participation agreements with financial institution counterparties for interest rate swaps related to loans in which we are the lead bank. The risk participation agreement provides credit protection to us should the borrower fail to perform on its interest rate derivative contract with us.
First Commonwealth is also party to interest rate caps that are not designated as hedging instruments. These derivatives relate to contracts that First Commonwealth enters into with loan customers providing a maximum interest rate on their variable rate loan. At the same time the interest rate cap is entered into with the customer, First Commonwealth enters into an offsetting interest rate cap with another financial institution. The notional amount and maximum interest rate on both interest cap contracts are identical.
The fee received, less the estimate of the loss for the credit exposure, was recognized in earnings at the time of the transaction.
Derivatives Designated as Hedging Instruments
During the third quarter of 2014, the Company entered into two interest rate swap contracts which were designated as cash flow hedges. Both of the interest rate swaps have a notional amount of $50.0 million with a maturity of three years on one and four years on the other. The Company's risk management objective for these hedges is to reduce its exposure to variability in expected future cash flows related to interest payments on commercial loans benchmarked to the 1-month LIBOR rate. Therefore, the interest rate swaps convert the interest payments on the first $100.0 million of 1-month LIBOR based commercial loans into fixed rate payments.
The periodic net settlement of interest rate swaps is recorded as an adjustment to Interest and fees on loans in the Condensed Consolidated Statement of Income. For the three and nine months ended September 30, 2014, there was no impact on interest income as a result of these interest rate swaps. Changes in the fair value of the effective portion of cash flow hedges are reported in OCI. When the cash flows associated with the hedged item are realized, the gain or loss included in OCI is recognized in Interest and fees on loans, the same line item in the Condensed Consolidated Statement of Income as the income on the hedged items. The cash flow hedges were highly effective at September 30, 2014, and changes in the fair value attributed to hedge ineffectiveness were not material. There were no cash flow hedges at December 31, 2013.
The following table depicts the credit value adjustment recorded related to the notional amount of derivatives outstanding as well as the notional amount of risk participation agreements participated to other banks:
 
 
September 30, 2014
 
December 31, 2013
 
(dollars in thousands)
Derivatives not Designated as Hedging Instruments
 
 
 
Credit value adjustment
$
252

 
$
77

Notional Amount:
 
 
 
Interest rate derivatives
297,347

 
274,718

Interest rate caps
6,938

 
7,500

Risk participation agreements
113,296

 
82,197

Sold credit protection on risk participation agreements
(24,796
)
 
(19,161
)
Derivatives Designated as Hedging Instruments
 
 
 
Fair value adjustment
(26
)
 

Notional Amount - Interest rate derivatives
100,000

 


37

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


 
The table below presents the amount representing the change in the fair value of derivative assets and derivative liabilities attributable to credit risk included in Other income on the Condensed Consolidated Statements of Income:
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2014
 
2013
 
2014
 
2013
 
(dollars in thousands)
Non-hedging interest rate derivatives
 
 
 
 
 
 
 
Increase in other income
$
137

 
$
206

 
$
147

 
$
1,273

Hedging interest rate derivatives
 
 
 
 
 
 
 
Increase in interest and fees on loans
29

 

 
29

 

Increase in other expense

 

 

 

Note 13 Goodwill
FASB ASC Topic 350-20, “Intangibles – Goodwill and Other” requires an annual valuation of the fair value of a reporting unit that has goodwill and a comparison of the fair value to the book value of equity to determine whether the goodwill has been impaired. Goodwill is also required to be tested on an interim basis if an event or circumstance indicates that it is more likely than not that an impairment loss has been incurred. When triggering events or circumstances indicate goodwill testing is required, an assessment of qualitative factors can be completed before performing the two step goodwill impairment test. ASU 2011-8 provides that if an assessment of qualitative factors determines it is more likely than not that the fair value of a reporting unit exceeds its carrying amount, then the two step goodwill impairment test is not required.
First Commonwealth is considered to be one reporting unit. The carrying amount of goodwill as of September 30, 2014 and December 31, 2013 was $159.4 million and $159.9 million, respectively. No impairment charges on goodwill or other intangible assets were incurred in 2014 or 2013. The $0.5 million decline in goodwill during the nine months ended September 30, 2014 represents the amount of goodwill included in the carrying value of the investment advisory business which was sold during the first quarter of 2014.
We test goodwill for impairment as of November 30th each year and again at any quarter-end if any material events occur during a quarter that may affect goodwill. An assessment of qualitative factors was completed as of September 30, 2014 and indicated that it is more likely than not that the fair value of First Commonwealth exceeds its carrying amount, therefore the two step goodwill impairment test was not considered necessary. The assessment of qualitative factors incorporated the results of the Step 1 goodwill impairment test completed as of November 30, 2013 as well as macroeconomic factors, industry and market considerations, the company’s overall financial performance, and other company specific events occurring since the completion of the November 30, 2013 test.
As of September 30, 2014, goodwill was not considered impaired; however, changing economic conditions that may adversely affect our performance, fair value of our assets and liabilities, or stock price could result in impairment, which could adversely affect earnings in future periods. Management will continue to monitor events that could impact this conclusion in the future.
Note 14 Subsequent Events
On October 1, 2014, the Company acquired Thompson/McLay Insurance Associates an Indiana, PA based insurance agency. The addition of Thompson/McLay provides access to approximately twelve new insurance carriers, allowing for greater scale and product offerings. Thompson/McLay will initially retain its name and operate as a division of First Commonwealth Insurance Agency.


38

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)


Note 15 New Accounting Pronouncements

In January 2014, the FASB issued ASU 2014-01, "Investments - Equity Method and Joint Ventures (Topic 323)," which permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. The proportional amortization method allows an entity to amortize the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). This amendment is effective for interim and annual periods beginning after December 15, 2014. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

In January 2014, the FASB issued ASU 2014-04, "Receivables - Troubled Debt Restructurings by Creditors (Subtopic 310-40)." This amendment clarifies that an in-substance repossession or foreclosure occurs and a creditor is considered to have received physical possession of property upon either, 1. the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure, or 2. the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Interim and annual disclosure of both the amount of foreclosed residential real estate property held by the creditor and the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction are required. This amendment is effective for annual periods beginning after December 15, 2014 and for interim periods within annual periods beginning after December 15, 2015. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360)." This amendment changes the reporting requirements for discontinued operations. A disposal of a component of an entity or group of components of an entity is required to be reported in discontinued operations if the disposal represents a strategic shift resulting in a major effect on the entity's operations and financial results when any of the following occurs: 1. the component or group of components of an entity meets the criteria to be classified as held for sale, 2. the component or group of components of an entity is disposed of by sale, or 3. the component or group of components of an entity is disposed of other than by sale. If one of these criteria are met, the entity will present the assets and liabilities of a disposal group that includes a discontinued operation separately in the asset and liability sections of the statement of financial position for each comparative period along with additional footnote disclosure. This amendment is effective for annual periods beginning on or after December 15, 2014 and interim periods within annual periods beginning on or after December 15, 2015. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

In May 2014, the FASB issued Update No. 2014-09, "Revenue from Contracts with Customers (Topic 606)." The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should: 1) identify the contract(s) with a customer, 2) identify the performance obligations in the contract, 3) determine the transaction price, 4) allocate the transaction price to the performance obligations in the contract, and 5) recognize revenue when (or as) the entity satisfies a performance obligation. This update is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early adoption is not permitted. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

In June 2014, the FASB issued ASU 2014-11, "Transfers and Servicing (Topic 860)," which requires two accounting changes. One changes the accounting for repurchase-to-maturity transactions to secured borrowing accounting and the other requires separate accounting for a transfer of a financial asset executed contemporaneously with a repurchase agreement with the same counterparty in regards to repurchase financing arrangements, which will result in secured borrowing accounting for the repurchase agreement. The Update requires disclosure for certain transactions comprising a transfer of a financial asset accounted for as a sale and an agreement with the same transferee entered into in contemplation of the initial transfer that results in the transferor retaining substantially all of the exposure to economic return. The amendment also requires disclosure for repurchase agreements, securities lending transactions, and repurchase-to-maturity transactions that are accounted for as secured borrowings. This amendment will be effective for public entities for the first interim or annual period beginning after December 15, 2014. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

39

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 1. Financial Statements and Supplementary Data
NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)



In June 2014, the FASB issued ASU 2014-12, "Compensation - Stock Compensation (Topic 718)," which requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. This amendment is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015 with earlier adoption permitted. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

In August 2014, the FASB issued ASU No. 2014-14. "Receivables – Troubled Debt Restructurings by Creditors (Subtopic 310-40): Classification of Certain Government-Guaranteed Mortgage Loans upon Foreclosure." These amendments address the diversity in practice regarding the classification and measurement of foreclosed loans which were part of a government-sponsored loan guarantee program (e.g. HUD, FHA, VA). The ASU outlines certain criteria that, if met, the loan (residential or commercial) should be derecognized and a separate other receivable should be recorded upon foreclosure at the amount of the loan balance (principal and interest) expected to be recovered from the guarantor. This ASU will be effective for annual reporting periods beginning after December 15, 2014, including interim periods within that reporting period. Early adoption is permitted, provided the entity has adopted ASU 2014-04. The ASU should be adopted either prospectively or on a modified retrospective basis. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.

In August 2014, the FASB issued ASU 2014-15, "Presentation of Financial Statements - Going Concern (Topic 205-40)," which requires management to evaluate, for each annual and interim period, whether conditions or events, considered in the aggregate, raise substantial doubt about the entity's ability to continue as a going concern within one year after the date that the financial statements are issued. When management identifies conditions or events that raise substantial doubt regarding an entity's ability to continue as a going concern, management should consider whether its plans that are intended to mitigate those relevant conditions or events will alleviate the substantial doubt. Certain footnote disclosures are required, the nature of which depends on if substantial doubt is alleviated as a result of consideration of management's plan. This amendment is effective for the annual period ending after December 15, 2016 and for annual and interim periods thereafter. The adoption of this ASU is not expected to have a material impact on First Commonwealth’s financial condition or results of operations.


40

Table of Contents

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
This discussion and the related financial data are presented to assist in the understanding and evaluation of the consolidated financial condition and the results of operations of First Commonwealth Financial Corporation including its subsidiaries (“First Commonwealth”) for the three and nine months ended September 30, 2014 and 2013, and should be read in conjunction with the Condensed Consolidated Financial Statements and notes thereto included in this Form 10-Q.
Forward-Looking Statements
Certain statements contained in this report that are not historical facts may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements, which are based on certain assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of words such as “may,” “will,” “should,” “could,” “would,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “estimate” or words of similar meaning. These forward-looking statements are subject to significant risks, assumptions and uncertainties, and could be affected by many factors. The following list, which is not intended to be an all-encompassing list of risks and uncertainties affecting us, summarizes several factors that could cause our actual results to differ materially from those anticipated or expected in these forward-looking statements:
weakening economic and business conditions, both nationally and in our markets, which could cause deterioration in credit quality, a further reduction in demand for credit and/or a further decline in real estate values;
prolonged low interest rates, which could reduce our net interest margin;
increases in defaults by borrowers and other delinquencies, which could result in increases in our provision for credit losses and related expenses;
cyber-attacks and fraud, which could disrupt our systems and services, breach the privacy of our customer and business information or result in loss of client assets;
legislative and regulatory changes, including the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Consumer Financial Protection Bureau, the capital ratios of Basel III as adopted by federal banking authorities and related regulations, subject us to additional regulatory oversight which may result in increased compliance costs and/or require us to change our business model;
declines in the valuations of real estate, which could negatively affect the creditworthiness of our borrowers and the value of collateral securing our loans;
the assumptions used in calculating the appropriate amount to be placed into our allowance for credit losses may prove to be inaccurate;
restrictions or conditions imposed by our regulators on our operations may make it more difficult for us to achieve our goals;
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;
changes in accounting standards and compliance requirements may have an adverse affect on our operating results and financial condition;
competitive pressures among depository and other financial institutions, some of which may have greater financial resources or more attractive product or service offerings, may adversely affect growth or profitability of our products and services; and
other risks and uncertainties described in this report and in the other reports that we file with the Securities and Exchange Commission, including our 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.
Explanation of Use of Non-GAAP Financial Measure
In addition to the results of operations presented in accordance with generally accepted accounting principles (“GAAP”), First Commonwealth management uses, and this quarterly report contains or references, certain non-GAAP financial measures, such as net interest income on a fully taxable equivalent basis. We believe this non-GAAP financial measure provides information useful to investors in understanding our underlying operational performance and our business and performance trends as it facilitates comparison with the performance of others in the financial services industry. Although we believe that this non-GAAP financial measure enhances investors’ understanding of our business and performance, this non-GAAP financial measure should not be considered an alternative to GAAP.

41

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


We believe the presentation of net interest income on a fully taxable equivalent basis ensures comparability of net interest income arising from both taxable and tax-exempt sources and is consistent with industry practice. Interest income per the Condensed Consolidated Statements of Income is reconciled to net interest income adjusted to a fully taxable equivalent basis on page 43 and 50 for the three and nine months ended September 30, 2014 and 2013.
Results of Operations
Nine Months Ended September 30, 2014 Compared to Nine Months Ended September 30, 2013
Net Income
For the nine months ended September 30, 2014, First Commonwealth had net income of $36.7 million, or $0.39 per share, compared to net income of $32.2 million, or $0.33 per share, in the nine months ended September 30, 2013. The increase in net income was primarily the result of a reduction in the provision for credit losses, offset by declines in net interest income. Noninterest expense remained relatively flat, despite $7.3 million in IT conversion related expenses recognized during the nine months ended September 30, 2014.
Net Interest Income
Net interest income, on a fully taxable equivalent basis, was $140.0 million in the first nine months of 2014, compared to $141.4 million for the same period in 2013. This decrease was primarily the result of $1.0 million in income recognized on other-than-temporarily impaired pooled trust preferred collateralized debt obligations that received non-recurring payments during the third quarter of 2013. These payments added two basis points to the net interest margin for the nine month period ending September 30, 2013. Net interest income comprises a majority of our operating revenue (net interest income before provision expense plus noninterest income) at 75% for both the nine months ended September 30, 2014 and 2013.
The net interest margin, on a fully taxable equivalent basis, was 3.28% for the nine months ended September 30, 2014 compared to 3.41% for the nine months ended September 30, 2013. The 13 basis point decline can be attributed to the previously mentioned income on pooled trust preferred securities, rate decreases resulting from the repricing of our adjustable rate assets, lower replacement yields for the repayment or amortization of fixed rate assets as well as lower interest rates available on new investments and loans.
 
The taxable equivalent yield on interest-earning assets was 3.62% for the nine months ended September 30, 2014, a decrease of 19 basis points from the 3.81% yield for the same period in 2013. Growth in earning assets has helped to offset the spread compression, as average earning assets for the nine months ended September 30, 2014 increased $155.0 million, or 3%, compared to the comparable period in 2013. However, approximately 45% of the growth in earning assets for the period was generated by the investment portfolio, where purchases provide approximately 118 basis points less yield than the loan portfolio. Investment portfolio purchases during the nine months ended September 30, 2014 have been primarily in mortgage-related assets with approximate durations of 36-48 months and municipal securities with a duration of 10 years. The mortgage-related investments have monthly principal payments that will provide for reinvestment opportunities as interest rates rise.
Reductions in the cost of interest-bearing liabilities partially offset the impact of lower yields on interest-earning assets. The cost of interest-bearing liabilities was 0.42% for the nine months ended September 30, 2014, compared to 0.50% for the same period in 2013.
For the nine months ended September 30, 2014 , changes in interest rates negatively impacted net interest income by $6.5 million when compared with the same period in 2013. The lower yield on interest-earning assets adversely impacted net interest income by $8.1 million, while the decline in the cost of interest-bearing liabilities had a positive impact of $1.6 million. We have been able to partially mitigate the impact of lower interest rates and the effect on net interest income through improving the mix of deposits and borrowed funds, growing the loan portfolio and increasing our investment volumes within established interest rate risk management guidelines.
While decreases in interest rates and yields compressed the net interest margin, increases in average interest-earning assets tempered the effect on net interest income. Changes in the volumes of interest-earning assets and interest-bearing liabilities positively impacted net interest income by $5.1 million in the nine months ended September 30, 2014, as compared to the same period in 2013. Higher levels of interest-earning assets resulted in an increase of $4.2 million in interest income, while volume changes decreased interest expense by $0.8 million, primarily as the result of changes in long-term debt and time deposits, including brokered deposits.

42

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


Net interest income also benefited from a $91.9 million increase in average net free funds at September 30, 2014 as compared to September 30, 2013. Average net free funds are the excess of noninterest-bearing demand deposits, other noninterest-bearing liabilities and shareholders’ equity over noninterest-earning assets. The largest component of the increase in net free funds was an increase of $84.4 million, or 9.7%, in noninterest-bearing demand deposit average balances as a result of marketing promotions aimed at attracting new and retaining existing ones. Additionally, higher cost time deposits continue to mature and reprice to lower cost customers certificates of deposit or other deposit alternatives. Average time deposits for the nine months ended September 30, 2014 decreased by $102.1 million compared to the comparable period in 2013.
 
The following table reconciles interest income in the Condensed Consolidated Statements of Income to net interest income adjusted to a fully taxable equivalent basis for the nine months ended September 30, 2014:
 
 
2014
2013
 
(dollars in thousands)
Interest income per Condensed Consolidated Statements of Income
$
151,761

$
155,050

Adjustment to fully taxable equivalent basis
2,502

3,084

Interest income adjusted to fully taxable equivalent basis (non-GAAP)
154,263

158,134

Interest expense
14,234

16,705

Net interest income adjusted to fully taxable equivalent basis (non-GAAP)
$
140,029

$
141,429




43

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


The following is an analysis of the average balance sheets and net interest income on a fully taxable equivalent basis, for the nine months ended September 30, 2014:
 
 
2014
2013
 
Average
Balance
Income /
Expense (a)
Yield
or
Rate
Average
Balance
Income /
Expense (a)
Yield
or
Rate
 
(dollars in thousands)
Assets
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
Interest-bearing deposits with banks
$
4,113

$
8

0.26
%
$
3,311

$
5

0.20
%
Tax-free investment securities (e)
8,998

265

3.94

84

4

7.39

Taxable investment securities
1,357,220

23,091

2.27

1,295,743

22,864

2.36

Loans, net of unearned income (b)(c)
4,331,807

130,899

4.04

4,248,048

135,261

4.26

Total interest-earning assets
5,702,138

154,263

3.62

5,547,186

158,134

3.81

Noninterest-earning assets:
 
 
 
 
 
 
Cash
71,589

 
 
72,008

 
 
Allowance for credit losses
(54,986
)
 
 
(64,378
)
 
 
Other assets
541,368

 
 
567,009

 
 
Total noninterest-earning assets
557,971

 
 
574,639

 
 
Total Assets
$
6,260,109

 
 
$
6,121,825

 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits (d)
$
636,551

$
150

0.03
%
$
675,498

$
184

0.04
%
Savings deposits (d)
1,875,064

1,745

0.12

1,939,660

2,326

0.16

Time deposits
1,065,458

8,002

1.00

1,167,593

9,438

1.08

Short-term borrowings
749,269

1,608

0.29

450,219

869

0.26

Long-term debt
208,818

2,729

1.75

239,166

3,888

2.17

Total interest-bearing liabilities
4,535,160

14,234

0.42

4,472,136

16,705

0.50

Noninterest-bearing liabilities and shareholders’ equity:
 
 
 
 
 
 
Noninterest-bearing demand deposits (d)
953,946

 
 
869,526

 
 
Other liabilities
52,001

 
 
48,020

 
 
Shareholders’ equity
719,002

 
 
732,143

 
 
Total noninterest-bearing funding sources
1,724,949

 
 
1,649,689

 
 
Total Liabilities and Shareholders’ Equity
$
6,260,109

 
 
$
6,121,825

 
 
Net Interest Income and Net Yield on Interest-Earning Assets
 
$
140,029

3.28
%
 
$
141,429

3.41
%
(a)
Income on interest-earning assets has been computed on a fully taxable 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.
(e)
Yield on tax-free investment securities calculated using fully taxable equivalent interest income of $4,648 for the nine months ended September 30, 2013.

 

44

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


The following table shows the effect of changes in volumes and rates on interest income and interest expense for the nine months ended September 30, 2014 compared with September 30, 2013:
 
 
 
Analysis of Year-to-Year Changes in Net Interest Income
 
 
Total
Change
 
Change Due To
Volume
 
Change Due To
Rate (a)
 
 
(dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
Interest-bearing deposits with banks
 
$
3

 
$
1

 
$
2

Tax-free investment securities
 
261

 
493

 
(232
)
Taxable investment securities
 
227

 
1,085

 
(858
)
Loans
 
(4,362
)
 
2,669

 
(7,031
)
Total interest income (b)
 
(3,871
)
 
4,248

 
(8,119
)
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits
 
(34
)
 
(12
)
 
(22
)
Savings deposits
 
(581
)
 
(77
)
 
(504
)
Time deposits
 
(1,436
)
 
(825
)
 
(611
)
Short-term borrowings
 
739

 
582

 
157

Long-term debt
 
(1,159
)
 
(493
)
 
(666
)
Total interest expense
 
(2,471
)
 
(825
)
 
(1,646
)
Net interest income
 
$
(1,400
)
 
$
5,073

 
$
(6,473
)
 
(a)
Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances.
(b)
Changes in interest income have been computed on a fully taxable equivalent basis using the 35% federal income tax statutory rate.
Provision for Credit Losses
The provision for credit losses is determined based on management’s estimates of the appropriate level of the allowance for credit losses needed or 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 table below provides a breakout of the provision for credit losses by loan category for the nine months ended September 30:
 
 
2014
 
2013
 
Dollars
Percentage
 
Dollars
Percentage
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
4,773

55
 %
 
$
12,038

67
 %
Real estate construction
1,331

16

 
(1,865
)
(10
)
Residential real estate
(407
)
(5
)
 
446

2

Commercial real estate
1,453

17

 
4,318

24

Loans to individuals
1,471

17

 
2,266

13

Unallocated


 
808

4

Total
$
8,621

100
 %
 
$
18,011

100
 %
The provision for credit losses for the nine months ended September 30, 2014 decreased in comparison to the nine months ended September 30, 2013 by $9.4 million, or 52%, as a result of overall improvement in loan portfolio credit metrics. The majority of the 2014 provision expense, or $5.8 million, is attributable to specific reserves for an $8.2 million loan to an oil and gas servicing company, which was transferred to nonaccrual status during the first quarter of 2014. This loan was sold during the second quarter of 2014, resulting in a $5.8 million charge-off. Also impacting the provision expense for the commercial, financial, and agricultural loan category were specific reserves related to a $3.9 million loan to an audio visual equipment distributor, which was transferred into nonaccrual status during the second quarter of 2014. Offsetting these increases in provision expense was the release of approximately $2.7 million in specific reserves related to the payoff of a $4.7 million

45

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


nonaccrual loan to a local developer. For the nine months ended September 30, 2014, the negative provision expense for residential real estate is a result of declines in both the level of impaired loans and historical loss rates for this loan category. Provision expense for real estate construction and real estate commercial loan were impacted by an increase in historical loss percentages and qualitative factors including vacancy, capitalization and absorption rates. Provision expense for loans to individuals is directly related to the level of charge-offs for the nine-month period. The level of provision expense for the nine months ended September 30, 2013 was primarily due to further deterioration in the value of certain assets of a commercial relationship with a local developer, which resulted in a net charge-off of $10.1 million, as well as the sale of two commercial real estate loans sold in the first quarter of 2013 that resulted in an additional $3.1 million in provision expense.
The allowance for credit losses was $50.8 million, or 1.15%, of total loans outstanding at September 30, 2014, compared to $54.2 million, or 1.27%, at December 31, 2013 and $55.0 million, or 1.30%, at September 30, 2013. The change compared to December 31, 2013, can be attributed to a $22.9 million, or 14%, decrease in criticized loans, which includes a reduction of $14.1 million, or 24%, in nonperforming loans as well as a $4.2 million decrease in the level of specific reserves held on impaired loans. Nonperforming loans as a percentage of total loans decreased to 1.03% at September 30, 2014 from 1.39% at December 31, 2013 and 1.68% as of September 30, 2013. The allowance to nonperforming loan ratio was 112.21%, 91.31% and 77.17% as of September 30, 2014, December 31, 2013 and September 30, 2013, respectively.
 
Below is an analysis of the consolidated allowance for credit losses for the nine months ended September 30, 2014 and 2013 and the year-ended December 31, 2013:
 
 
 
September 30, 2014
 
September 30, 2013
 
December 31, 2013
 
 
(dollars in thousands)
Balance, beginning of period
 
$
54,225

 
$
67,187

 
$
67,187

Loans charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
8,357

 
17,302

 
18,399

Real estate construction
 
296

 
773

 
773

Residential real estate
 
2,286

 
1,400

 
1,814

Commercial real estate
 
1,109

 
10,051

 
10,513

Loans to individuals
 
2,581

 
2,669

 
3,679

Total loans charged off
 
14,629

 
32,195

 
35,178

Recoveries of loans previously charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
625

 
345

 
455

Real estate construction
 
469

 
140

 
501

Residential real estate
 
420

 
883

 
1,264

Commercial real estate
 
432

 
121

 
136

Loans to individuals
 
621

 
465

 
633

Total recoveries
 
2,567

 
1,954

 
2,989

Net credit losses
 
12,062

 
30,241

 
32,189

Provision charged to expense
 
8,621

 
18,011

 
19,227

Balance, end of period
 
$
50,784

 
$
54,957

 
$
54,225


46

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


Noninterest Income
The following table presents the components of noninterest income for the nine months ended September 30, 2014: 
 
 
2014
 
2013
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Income:
 
 
 
 
 
 
 
 
Trust income
 
$
4,587

 
$
4,677

 
$
(90
)
 
(2
)%
Service charges on deposit accounts
 
12,032

 
11,443

 
589

 
5

Insurance and retail brokerage commissions
 
4,704

 
4,623

 
81

 
2

Income from bank owned life insurance
 
4,131

 
4,219

 
(88
)
 
(2
)
Card related interchange income
 
10,620

 
10,214

 
406

 
4

Other income
 
6,360

 
9,430

 
(3,070
)
 
(33
)
Subtotal
 
42,434

 
44,606

 
(2,172
)
 
(5
)
Net securities gains
 
50

 
237

 
(187
)
 
(79
)
Gain on sale of assets
 
4,488

 
2,056

 
2,432

 
118

Total noninterest income
 
$
46,972

 
$
46,899

 
$
73

 
 %
 
Noninterest income, excluding net securities gains and gain on sale of assets, decreased $2.2 million, or 5%, for the first nine months of 2014 compared to 2013. The most notable change is a $3.1 million decrease in the other income category, which is largely attributable to a $1.6 million reduction in commercial loan swap-related income as well as a $0.2 million decrease in letter of credit fees. The decline in swap-related income is primarily due to a $1.0 million decline in counterparty credit risk.
Total noninterest income for the nine months ended September 30, 2014 was basically unchanged in comparison to the nine months ended September 30, 2013. The most significant change includes a $2.4 million increase in gain on sale of assets as a result of a $1.2 million gain recognized on the sale of the Company's registered investment advisory business and $3.1 million in gains on the sale of several OREO properties.
During the third quarter of 2014, the Company acquired Thompson/McLay Insurance Associates an Indiana, PA based insurance agency. Although this transaction will provide additional non-interest income, in the near term it is expected to be minimally accretive to earnings.


47

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


Noninterest Expense
The following table presents the components of noninterest expense for the nine months ended September 30: 
 
 
2014
 
2013
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Expense:
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
$
65,185

 
$
64,288

 
$
897

 
1
 %
Net occupancy expense
 
9,969

 
10,130

 
(161
)
 
(2
)
Furniture and equipment expense - excluding IT conversion
 
9,473

 
9,863

 
(390
)
 
(4
)
Data processing expense
 
4,593

 
4,511

 
82

 
2

Advertising and promotion expense
 
2,346

 
2,369

 
(23
)
 
(1
)
Pennsylvania shares tax expense
 
2,782

 
4,223

 
(1,441
)
 
(34
)
Intangible amortization
 
530

 
848

 
(318
)
 
(38
)
Collection and repossession expense
 
1,941

 
2,862

 
(921
)
 
(32
)
Other professional fees and services
 
2,777

 
2,765

 
12

 

FDIC insurance
 
3,026

 
3,312

 
(286
)
 
(9
)
Other operating expenses
 
13,976

 
16,632

 
(2,656
)
 
(16
)
Subtotal
 
116,598

 
121,803

 
(5,205
)
 
(4
)
Loss on redemption of subordinated debt
 

 
1,629

 
(1,629
)
 

Furniture and equipment expense - related to IT conversion
 
5,577

 

 
5,577

 
N/A

Conversion related expenses
 
1,676

 
65

 
1,611

 
2,478
 %
Total noninterest expense
 
$
123,851

 
$
123,497

 
$
354

 
 %

Noninterest expense, excluding loss on redemption of subordinated debt and conversion related expenses, decreased $5.2 million, or 4%, for the nine months ended September 30, 2014 compared to the same period in 2013. Contributing to the 2014 decrease is a $1.4 million decline in Pennsylvania shares tax as a result of changes in the Pennsylvania tax law and a $0.9 million decrease in collection and repossession expense due to the resolution of several large credits. Additionally, there was a $2.7 million decline in other operating expense, in part due to a $0.9 million insurance recovery received in the first quarter of 2014 related to a $3.5 million fraud loss recognized in 2012. Also contributing to the decline in other operating expenses was $0.8 million in expense recognized during the nine months ended September 30, 2013 related to a contingency reserve for a 1099 tax reporting issue. During the nine months ended September 30, 2014, an agreement was reached with one taxing authority resulting in the reversal of $0.3 million of the reserve from expense.

During the third quarter of 2014, First Commonwealth completed a system conversion to the Jack Henry and Associates SilverLake System core processing software and outsourced certain data processing services that had previously been performed in-house. As a result of this conversion, First Commonwealth incurred $11.8 million of charges, of which $7.3 million was recognized during the nine months ended September 30, 2014. These expenses include accelerated depreciation for data processing hardware and software, early termination charges on previous contracts, and staffing and employment-related charges. During the nine months ended September 30, 2014, $5.6 million in accelerated depreciation and $1.7 million in other conversion related expenses were recognized. The system conversion is expected to provide expense savings from pre-conversion levels of approximately $1.5 million to $1.7 million per quarter, the full effect of which is expected to be recognized starting in the fourth quarter of 2014.

On April 1, 2013, $32.5 million in redeemable capital securities issued by First Commonwealth Capital Trust I were redeemed, resulting in a loss of $1.6 million. This loss includes a $1.1 million prepayment penalty and $0.5 million of unamortized deferred issuance costs. There were no similar expenses in 2014.


48

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


Income Tax
The provision for income taxes increased $3.8 million for the nine months ended September 30, 2014, compared to the corresponding period in 2013. The higher provision for income taxes was primarily the result of an $8.3 million increase in the level of income before taxes.
We applied the “annual effective tax rate approach” to determine the provision for income taxes, which applies an annual forecast of tax expense as a percentage of expected full year income, for the nine months ended September 30, 2014 and 2013.
We generate an annual effective tax rate that is less than the statutory rate of 35% due to benefits resulting from tax-exempt interest, income from bank-owned life insurance and tax benefits associated with low income housing tax credits, which are relatively consistent regardless of the level of pretax income. The level of tax benefits that reduced our tax rate below the 35% statutory rate produced an annual effective tax rate of 29.4% and 26.3% for the nine months ended September 30, 2014 and 2013, respectively.
As of September 30, 2014, our deferred tax assets totaled $51.1 million. Based on our evaluation as of September 30, 2014, we determined that it is more likely than not that all of these assets will be realized. As a result, we did not record a valuation allowance against these assets. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved forecasts, evaluation of historical earning levels and consideration of potential tax strategies. If future events differ from our current forecasts, we may need to establish a valuation allowance, which could have a material impact on our financial condition and results of operations.

Three Months Ended September 30, 2014 Compared to Three Months Ended September 30, 2013

Net Income
For the three months ended September 30, 2014, First Commonwealth had net income of $12.5 million, or $0.13 per share, compared to net income of $15.9 million, or $0.16 per share, in the three months ended September 30, 2013. The decrease in net income was driven by a decrease in noninterest income and increased noninterest expense.
Net Interest Income
Net interest income, on a fully taxable equivalent basis, was $47.4 million in the third quarter of 2014 compared to $48.3 million for the same period in 2013. Net interest income comprises a majority of our operating revenue (net interest income before provision expense plus noninterest income), at 76% and 73% for the three months ended September 30, 2014 and 2013, respectively.
The net interest margin, on a fully taxable equivalent basis, was 3.26% for the three months ended September 30, 2014, compared to 3.43% for the three months ended September 30, 2013. The 17 basis point decline was the result of by both changes in the level of interest rates and the amount and composition of interest-earning assets and interest-bearing liabilities.
 
Runoff of existing assets earning higher interest rates and competitive pricing pressure has continued to provide for lower yields on earning assets. Growth in earning assets has helped to offset the spread compression, as average earning assets for the three months ended September 30, 2014 increased $185.7 million, or 3%, compared to the comparable period in 2013. However, during the third quarter of 2014, approximately 30% of the growth in earning assets, was generated by the investment portfolio, where purchases provide approximately 129 basis points less yield than the loan portfolio. Investment portfolio purchases during the three months ended September 30, 2014 have been primarily in mortgage-related assets with approximate durations of 36-48 months and municipal securities with a duration of 10 years. The mortgage-related investments have monthly principal payments that will provide for reinvestment opportunities as interest rates rise.
The taxable equivalent yield on interest-earning assets was 3.57% for the three months ended September 30, 2014, a decrease of 22 basis points from the 3.79% yield for the same period in 2013. This decline can be attributed to the repricing of our adjustable rate assets and the repayment or amortization of fixed rate assets in a declining interest rate environment, as well as lower interest rates available on new investments and loans. Reductions in the cost of interest-bearing liabilities partially offset the impact of lower yields on interest-earning assets. The cost of interest-bearing liabilities was 0.39% for the three months ended September 30, 2014, compared to 0.45% for the same period in 2013.

49

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


Comparing the three months ended September 30, 2014 with the same period in 2013, changes in interest rates negatively impacted net interest income by $3.2 million. The lower yield on interest-earning assets adversely impacted net interest income by $3.3 million, while the decline in the cost of interest-bearing liabilities had a positive impact of $0.2 million.
While decreases in interest rates and yields compressed the net interest margin, increases in average interest-earning assets tempered the effect on net interest income. Changes in the volumes of interest-earning assets and interest-bearing liabilities positively impacted net interest income by $2.3 million in the three months ended September 30, 2014, as compared to the same period in 2013. Higher levels of interest-earning assets resulted in an increase of $1.9 million in interest income, while volume changes decreased interest expense by $0.4 million, primarily as the result of runoff in time deposits.
Positively affecting net interest income was a $142.6 million increase in average net free funds at September 30, 2014, as compared to September 30, 2013. Average net free funds are the excess of noninterest-bearing demand deposits, other noninterest-bearing liabilities and shareholders’ equity over noninterest-earning assets. The largest component of the increase in net free funds was an increase in noninterest-bearing demand deposit average balances. Additionally, higher costing time deposits continue to mature and reprice to lower costing certificates or other deposit alternatives. Average time deposits for the three months ended September 30, 2014 decreased $190.3 million compared to the comparable period in 2013.
 
The following table reconciles interest income in the Condensed Consolidated Statements of Income to net interest income adjusted to a fully taxable equivalent basis for the three months ended September 30:
 
 
2014
2013
 
(dollars in thousands)
Interest income per Condensed Consolidated Statements of Income
$
51,089

$
52,308

Adjustment to fully taxable equivalent basis
811

1,026

Interest income adjusted to fully taxable equivalent basis (non-GAAP)
51,900

53,334

Interest expense
4,536

5,079

Net interest income adjusted to fully taxable equivalent basis (non-GAAP)
$
47,364

$
48,255



50

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)



The following is an analysis of the average balance sheets and net interest income on a fully taxable equivalent basis for the three months ended September 30, 2013 and 2014:
 
 
2014
2013
 
Average
Balance
Income /
Expense (a)
Yield
or
Rate
Average
Balance
Income /
Expense (a)
Yield
or
Rate
 
(dollars in thousands)
Assets
 
 
 
 
 
 
Interest-earning assets:
 
 
 
 
 
 
Interest-bearing deposits with banks
$
4,758

$
4

0.33
%
$
3,629

$
2

0.22
%
Tax-free investment securities (e)
16,233

160

3.91

83

2

7.36

Taxable investment securities
1,362,563

7,781

2.27

1,323,944

8,370

2.51

Loans, net of unearned income (b)(c)
4,388,130

43,955

3.97

4,258,372

44,960

4.19

Total interest-earning assets
5,771,684

51,900

3.57

5,586,028

53,334

3.79

Noninterest-earning assets:
 
 
 
 
 
 
Cash
71,391

 
 
72,255

 
 
Allowance for credit losses
(52,522
)
 
 
(60,061
)
 
 
Other assets
534,515

 
 
564,547

 
 
Total noninterest-earning assets
553,384

 
 
576,741

 
 
Total Assets
$
6,325,068

 
 
$
6,162,769

 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits (d)
$
633,213

$
49

0.03
%
$
670,813

$
54

0.03
%
Savings deposits (d)
1,832,914

578

0.13

1,937,436

645

0.13

Time deposits
954,474

2,347

0.98

1,144,766

3,051

1.06

Short-term borrowings
940,156

662

0.28

547,393

362

0.26

Long-term debt
199,435

900

1.79

216,733

967

1.77

Total interest-bearing liabilities
4,560,192

4,536

0.39

4,517,141

5,079

0.45

Noninterest-bearing liabilities and shareholders’ equity:
 
 
 
 
 
 
Noninterest-bearing demand deposits (d)
995,690

 
 
885,346

 
 
Other liabilities
51,327

 
 
47,932

 
 
Shareholders’ equity
717,859

 
 
712,350

 
 
Total noninterest-bearing funding sources
1,764,876

 
 
1,645,628

 
 
Total Liabilities and Shareholders’ Equity
$
6,325,068

 
 
$
6,162,769

 
 
Net Interest Income and Net Yield on Interest-Earning Assets
 
$
47,364

3.26
%
 
$
48,255

3.43
%
(a)
Income on interest-earning assets has been computed on a fully taxable 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.
(e)
Yield on tax-free investment securities calculated using fully taxable equivalent interest income of $1,535 for the three months ended September 30, 2013.

 

51

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)



The following table shows the effect of changes in volumes and rates on interest income and interest expense for the three months ended September 30, 2014 compared with September 30, 2013:
 
 
 
Analysis of Year-to-Year Changes in Net Interest Income
 
 
Total
Change
 
Change Due To
Volume
 
Change Due To
Rate (a)
 
 
(dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
Interest-bearing deposits with banks
 
$
2

 
$
1

 
$
1

Tax-free investment securities
 
158

 
300

 
(142
)
Taxable investment securities
 
(589
)
 
244

 
(833
)
Loans
 
(1,005
)
 
1,370

 
(2,375
)
Total interest income (b)
 
(1,434
)
 
1,915

 
(3,349
)
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits
 
(5
)
 
(3
)
 
(2
)
Savings deposits
 
(67
)
 
(34
)
 
(33
)
Time deposits
 
(704
)
 
(508
)
 
(196
)
Short-term borrowings
 
300

 
257

 
43

Long-term debt
 
(67
)
 
(77
)
 
10

Total interest expense
 
(543
)
 
(365
)
 
(178
)
Net interest income
 
$
(891
)
 
$
2,280

 
$
(3,171
)
 
(a)
Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances.
(b)
Changes in interest income have been computed on a fully taxable equivalent basis using the 35% federal income tax statutory rate.

Provision for Credit Losses
The provision for credit losses is determined based on management’s estimates of the appropriate level of the allowance for credit losses needed or 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 table below provides a breakout of the provision for credit losses by loan category for the three months ended September 30, 2013 and 2014:
 
 
2014
 
2013
 
Dollars
Percentage
 
Dollars
Percentage
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
(1,958
)
(94
)%
 
$
1,358

50
 %
Real estate construction
2,073

100

 
(1,879
)
(69
)
Residential real estate
(217
)
(11
)
 
84

3

Commercial real estate
1,528

74

 
1,501

55

Loans to individuals
647

31

 
838

31

Unallocated


 
812

30

Total
$
2,073

100
 %
 
$
2,714

100
 %
The provision for credit losses for the three months ended September 30, 2014 decreased in comparison to comparable period in 2013 by $0.6 million, or 23.6%. For the three months ended September 30, 2014, the negative provision expense for the commercial, financial and agricultural loans is primarily due to a decline in historical loss rates, while the negative provision for residential real estate loans is a result of declines in both historical loss rates and qualitative factors, such as national delinquency and consumer sentiment. The level of provision expense for real estate construction loans and commercial real estate loans can be attributed to loan growth in these categories, as well as an increase in qualitative factors such as vacancy,

52

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


capitalization rates and absorption. During the third quarter of 2013, the negative provision expense for real estate construction loans can be attributed to a decline in the historical loss percentage used to determine the appropriate level of allowance for credit losses.
 
Below is an analysis of the consolidated allowance for credit losses for the three months ended September 30, 2014 and 2013 and the year ended December 31, 2013:
 
 
 
September 30, 2014
 
September 30, 2013
 
December 31, 2013
 
 
(dollars in thousands)
Balance, beginning of period
 
$
50,725

 
$
57,452

 
$
67,187

Loans charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
498

 
3,081

 
18,399

Real estate construction
 

 
18

 
773

Residential real estate
 
551

 
757

 
1,814

Commercial real estate
 
812

 
813

 
10,513

Loans to individuals
 
1,019

 
914

 
3,679

Total loans charged off
 
2,880

 
5,583

 
35,178

Recoveries of loans previously charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
204

 
81

 
455

Real estate construction
 
132

 
81

 
501

Residential real estate
 
97

 
71

 
1,264

Commercial real estate
 
177

 
13

 
136

Loans to individuals
 
256

 
128

 
633

Total recoveries
 
866

 
374

 
2,989

Net credit losses
 
2,014

 
5,209

 
32,189

Provision charged to expense
 
2,073

 
2,714

 
19,227

Balance, end of period
 
$
50,784

 
$
54,957

 
$
54,225


Noninterest Income
The following table presents the components of noninterest income for the three months ended September 30, 2014: 
 
 
2014
 
2013
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Income:
 
 
 
 
 
 
 
 
Trust income
 
$
1,678

 
$
1,406

 
$
272

 
19
 %
Service charges on deposit accounts
 
4,099

 
4,227

 
(128
)
 
(3
)
Insurance and retail brokerage commissions
 
1,709

 
1,822

 
(113
)
 
(6
)
Income from bank owned life insurance
 
1,330

 
1,359

 
(29
)
 
(2
)
Card related interchange income
 
3,599

 
3,536

 
63

 
2

Other income
 
1,845

 
3,148

 
(1,303
)
 
(41
)
Subtotal
 
14,260

 
15,498

 
(1,238
)
 
(8
)
Net securities gains
 
48

 
229

 
(181
)
 
(79
)
Gain on sale of assets
 
742

 
1,356

 
(614
)
 
(45
)
Total noninterest income
 
$
15,050

 
$
17,083

 
$
(2,033
)
 
(12
)%
 
Noninterest income, excluding net securities gains and gain on sale of assets, decreased $1.2 million, or 8%, for the third quarter of 2014 compared to the same period in 2013. Total noninterest income decreased $2.0 million, or 12%, in comparison to the three months ended September 30, 2013. The most significant change was in the other income category, which decreased

53

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


by $1.3 million as a result of a $0.5 million decrease in interest rate swap related income, a $0.4 million decline in income generated from the management advisory business sold in the first quarter of 2014, and a $0.1 million decrease in letter of credit fees.
Noninterest Expense
The following table presents the components of noninterest expense for the three months ended September 30, 2013 and 2014: 
 
 
2014
 
2013
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Expense:
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
$
22,244

 
$
20,998

 
$
1,246

 
6
 %
Net occupancy expense
 
3,180

 
3,274

 
(94
)
 
(3
)
Furniture and equipment expense
 
3,046

 
3,294

 
(248
)
 
(8
)
Data processing expense
 
1,583

 
1,492

 
91

 
6

Advertising and promotion expense
 
861

 
815

 
46

 
6

Pennsylvania shares tax expense
 
1,033

 
1,516

 
(483
)
 
(32
)
Intangible amortization
 
174

 
193

 
(19
)
 
(10
)
Collection and repossession expense
 
783

 
860

 
(77
)
 
(9
)
Other professional fees and services
 
1,050

 
848

 
202

 
24

FDIC insurance
 
926

 
1,178

 
(252
)
 
(21
)
Other operating expenses
 
4,480

 
5,512

 
(1,032
)
 
(19
)
Subtotal
 
39,360

 
39,980

 
(620
)
 
(2
)
Furniture and equipment expense - related to IT conversion
 
1,425

 

 
1,425

 
N/A

Conversion related expenses
 
783

 
65

 
718

 
1,105
 %
Total noninterest expense
 
$
41,568

 
$
40,045

 
$
1,523

 
4
 %

Noninterest expense, excluding conversion related expenses, decreased $0.6 million, or 2%, for the three months ended September 30, 2014, as compared to the same period in 2013. The primary reason for this decline was a lower level of other operating expense in the three months ended September 30, 2014, due to a $0.6 million decline in the reserve for unfunded commitments and a $0.4 million decrease in loss on sale or writedown of OREO properties. Additionally, changes in the Pennsylvania tax law provided for a $0.5 million decline in the Pennsylvania shares tax expense.

Partially offseting the decline in other operating expense was a $1.2 million increase in salary and employee benefit expense. Contributing to this increase were higher incentive payments of $0.8 million as a result of successful sales efforts and increased loan volumes. Additionally, an increase of $0.4 million in overtime expense was recognized as a result of the additional hours related to the system conversion completed in the third quarter of 2014.

As previously noted, in 2013 First Commonwealth executed a contract with Jack Henry and Associates to license the Jack Henry and Associates SilverLake System core processing software and to outsource certain data processing services. A system conversion was completed in the third quarter of 2014 and resulted in a total of $11.8 million of conversion related charges over the four quarter period ending September 30, 2014. During the three months ended September 30, 2014, $1.4 million in accelerated depreciation and $0.8 million in other conversion-related expenses were recognized.


Income Tax
The provision for income taxes decreased $0.2 million for the three months ended September 30, 2014, compared to the corresponding period in 2013. The lower provision for income taxes was primarily the result of a $3.6 million decrease in the level of income before taxes.

54

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


We applied the “annual effective tax rate approach” to determine the provision for income taxes, which applies an annual forecast of tax expense as a percentage of expected full year income, for the three months ended September 30, 2014 and 2013.
We generate an annual effective tax rate that is less than the statutory rate of 35% due to benefits resulting from tax-exempt interest, income from bank owned life insurance and tax benefits associated with low income housing tax credits, which are relatively consistent regardless of the level of pretax income. The level of tax benefits that reduced our tax rate below the 35% statutory rate produced an annual effective tax rate of 30.4% and 26.4% for the three months ended September 30, 2014 and 2013, respectively.

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. During the first nine months of 2014, liquidity provided from the net increase in short-term borrowings totaled $408.4 million, while the maturity and redemption of investment securities provided $199.6 million. This liquidity provided funds needed to originate loans, purchase investment securities and fund depositor withdrawals.  We also have available unused wholesale sources of liquidity, including overnight federal funds and repurchase agreements, advances from the FHLB of Pittsburgh, borrowings through the discount window at the Federal Reserve Bank (“FRB”) of Cleveland and access to certificates of deposit through brokers.
In order to increase and diversify our funding sources, we participate in the Certificate of Deposit Account Registry Services (“CDARS”) program as part of an Asset/Liability Committee (“ALCO”) strategy to increase and diversify funding sources. As of September 30, 2014, our maximum borrowing capacity under this program was $950.7 million and as of that date there was $194.6 million outstanding. Also included in this amount is a reciprocal program which allows our depositors to receive expanded FDIC coverage by placing multiple certificates of deposit at other CDARS member banks. As of September 30, 2014, our outstanding certificates of deposits from this program have an average weighted rate of 0.26% and an average original term of 65 days.
An additional source of liquidity is the FRB Borrower-in-Custody of Collateral program which enables us to pledge certain loans, that are not being used as collateral at the FHLB, as collateral for borrowings at the FRB. At September 30, 2014, the borrowing capacity under this program totaled $702.4 million and there were no amounts outstanding.
As of September 30, 2014, our maximum borrowing capacity at the FHLB of Pittsburgh was $1.6 billion and as of that date amounts used against this capacity included $988.6 million in outstanding borrowings and $28.2 million in letter of credit commitments used for pledging public funds and other non-deposit purposes.
First Commonwealth Financial Corporation has an unsecured $15.0 million line of credit with another financial institution. As of September 30, 2014, there are no amounts outstanding on this line.
First Commonwealth’s long-term liquidity source is its core deposit base. 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. The following table shows a breakdown of the components of First Commonwealth’s deposits:
 
 
 
September 30, 2014
 
December 31, 2013
 
 
(dollars in thousands)
Noninterest-bearing demand deposits
 
$
995,014

 
$
912,361

Interest-bearing demand deposits
 
82,221

 
89,149

Savings deposits
 
2,363,464

 
2,506,631

Time deposits
 
931,689

 
1,095,722

Total
 
$
4,372,388

 
$
4,603,863

During the first nine months of 2014, total deposits decreased $231.5 million due to a $164.0 million decrease in time deposits and a decrease of $150.1 million in interest-bearing and savings deposits, offset by a $82.7 million increase in noninterest-

55

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


bearing deposits. The decrease in time deposits is due to a decline in wholesale certificates of deposits of $56.5 million coupled with a decline in core certificates of deposit of $107.5 million. Wholesale certificates can offer a more attractive source of incremental funding as they generally have a lower incremental cost of funds than traditional certificates of deposit funding. The decline in interest-bearing demand and savings deposits are partially due to the elimination in 2014 of several promotional interest rates as a means of standardizing rates in anticipation of the IT system conversion described earlier.
Market Risk
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 0.72 and 0.71 at September 30, 2014 and December 31, 2013, respectively. A ratio of less than one indicates a higher level of repricing liabilities over repricing assets over the next twelve months. The level of First Commonwealth's ratio is largely driven by the modeling of interest-bearing non-maturity deposits, which are included in the analysis as repricing within one year.
 
Gap analysis has limitations due to the static nature of the model that holds volumes and consumer behaviors constant in all economic and interest rate scenarios. A lower level of rate sensitive assets to rate sensitive liabilities repricing in one year could indicate reduced net interest income in a rising interest rate scenario, and conversely, increased net interest income in a declining interest rate scenario. However, the gap analysis incorporates only the level of interest-earning assets and interest-bearing liabilities and not the sensitivity each has to changes in interest rates. The impact of the sensitivity to changes in interest rates is provided in the table below the gap analysis. The following is the gap analysis as of September 30, 2014 and December 31, 2013:
 
 
 
September 30, 2014
 
 
0-90 Days
 
91-180
Days
 
181-365
Days
 
Cumulative
0-365 Days
 
Over 1 Year
Through 5
Years
 
Over 5
Years
 
 
(dollars in thousands)
Loans
 
$
2,213,485

 
$
167,731

 
$
292,194

 
$
2,673,410

 
$
1,392,414

 
$
312,870

Investments
 
138,164

 
121,082

 
139,404

 
398,650

 
536,929

 
437,627

Other interest-earning assets
 
5,374

 

 

 
5,374

 

 

Total interest-sensitive assets (ISA)
 
2,357,023

 
288,813

 
431,598

 
3,077,434

 
1,929,343

 
750,497

Certificates of Deposit
 
335,725

 
121,018

 
199,682

 
656,425

 
271,066

 
4,198

Other deposits
 
2,445,685

 

 

 
2,445,685

 

 

Borrowings
 
1,132,290

 
25,157

 
25,320

 
1,182,767

 
32,402

 
8,504

Total interest-sensitive liabilitites (ISL)
 
3,913,700

 
146,175

 
225,002

 
4,284,877

 
303,468

 
12,702

Gap
 
$
(1,556,677
)
 
$
142,638

 
$
206,596

 
$
(1,207,443
)
 
$
1,625,875

 
$
737,795

ISA/ISL
 
0.60

 
1.98

 
1.92

 
0.72

 
6.36

 
59.08

Gap/Total assets
 
24.49
%
 
2.24
%
 
3.25
%
 
19.00
%
 
25.58
%
 
11.61
%

 

56

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


 
 
December 31, 2013
 
 
0-90 Days
 
91-180
Days
 
181-365
Days
 
Cumulative
0-365 Days
 
Over 1 Year
Through 5
Years
 
Over 5
Years
 
 
(dollars in thousands)
Loans
 
$
2,026,232

 
$
215,614

 
$
310,437

 
$
2,552,283

 
$
1,401,095

 
$
282,761

Investments
 
106,382

 
54,440

 
209,855

 
370,677

 
586,363

 
387,180

Other interest-earning assets
 
3,012

 

 

 
3,012

 

 

Total interest-sensitive assets (ISA)
 
2,135,626

 
270,054

 
520,292

 
2,925,972

 
1,987,458

 
669,941

Certificates of Deposit
 
373,426

 
146,037

 
231,283

 
750,746

 
338,488

 
6,488

Other deposits
 
2,595,780

 

 

 
2,595,780

 

 

Borrowings
 
698,899

 
7,595

 
50,179

 
756,673

 
81,192

 
5,302

Total interest-sensitive liabilitites (ISL)
 
3,668,105

 
153,632

 
281,462

 
4,103,199

 
419,680

 
11,790

Gap
 
$
(1,532,479
)
 
$
116,422

 
$
238,830

 
$
(1,177,227
)
 
$
1,567,778

 
$
658,151

ISA/ISL
 
0.58

 
1.76

 
1.85

 
0.71

 
4.74

 
56.82

Gap/Total assets
 
24.66
%
 
1.87
%
 
3.84
%
 
18.94
%
 
25.23
%
 
10.59
%

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 as compared with net interest income if rates remained unchanged and there are no changes in balance sheet categories.
 
 
 
Net interest income change (12 months)
 
 
-200
 
-100
 
+100
 
+200
 
 
(dollars in thousands)
September 30, 2014
 
$
(6,407
)
 
$
(2,662
)
 
$
(503
)
 
$
(67
)
December 31, 2013
 
(8,878
)
 
(4,355
)
 
(833
)
 
(646
)
The analysis and model used to quantify the sensitivity of our net interest income becomes less reliable in a decreasing 200 basis point scenario given the current low interest rate environment. Results of the 100 and 200 basis point interest rate decline scenario are affected by the fact that many of our interest-bearing liabilities are at rates below 1%, and therefore cannot decline 100 or 200 basis points, yet our interest-sensitive assets are able to decline by these amounts. In the nine months ended September 30, 2014 and 2013, the cost of our interest-bearing liabilities averaged 0.42% and 0.50%, respectively, and the yield on our average interest-earning assets, on a fully taxable equivalent basis, averaged 3.62% and 3.81%, respectively.
During the second quarter of 2014, the Company analyzed the assumptions used when estimating the volatility of our non-maturity deposits. As a result of this analysis, the duration of our nonmaturity deposits was determined to be 1.4 years longer than previously modeled and the repricing sensitivity was determined to 26 basis points less in a 100 basis point increase in interest rates.
The above mentioned nonmaturity deposit analysis, which helped the Company better understand the duration of its liabilities, provided management with the opportunity to employ alternative ALCO strategies to help protect the net interest margin. As a result, during the third quarter of 2014 the Company implemented two ALCO strategies; a bond exchange transaction and a cash flow interest rate hedge. The bond exchange transaction involved the sale of $132.8 million in securities and the purchase of a like amount of similar securities with slightly longer durations. The overall effect of this transaction was to increase the yield on the investment portfolio by 7 basis points, while extending the overall duration of the entire investment portfolio by 2.4 months. The second transaction was a cash flow interest rate swap, in which we extended the duration of $100.0 million of the $1.3 billion LIBOR based loans in our loan portfolio. If short-term interest rates remain low, the effect of these two strategies is expected to add approximately $1.8 million of pre-tax income on an annualized basis in the first year. These strategies add two to three basis points of protection to the net interest margin as a hedge against a prolonged low-rate environment, while still maintaining the overall asset-sensitive position of the bank to take advantage of rising rates when they eventually do occur.
Asset/liability models require that certain assumptions be made, such as prepayment rates on earning assets and the impact of pricing on non-maturity deposits, which may differ from actual experience. These business assumptions are based upon our

57

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


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
First Commonwealth maintains an allowance for credit losses at a level deemed sufficient for 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 impaired loans with a balance greater than $0.1 million, loss experience trends, delinquency and other relevant factors.
First Commonwealth also maintains a reserve for unfunded loan commitments and letters of credit based upon credit risk and probability of funding. The reserve totaled $2.9 million at September 30, 2014 and is classified in "Other liabilities" on the Condensed Consolidated Statements of Financial Condition.
Nonperforming loans include nonaccrual loans and loans classified as troubled debt restructurings. Nonaccrual loans represent loans on which interest accruals have been discontinued. Troubled debt 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, who could not obtain comparable terms from alternative financing sources. In the first nine months of 2014, 60 loans totaling $3.9 million were identified as troubled debt restructurings. Please refer to Note 9, “Loans and Allowance for Credit Losses,” for additional information on troubled debt restructurings.

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 on nonaccrual status when, based on regulatory definitions, the loan is maintained on a “cash basis” due to the weakened financial condition of the borrower. Generally, loans 90 days or more past due are placed on nonaccrual status, except for consumer loans which are placed on nonaccrual status at 150 days past due.
Nonperforming loans are closely monitored on an ongoing basis as part of our loan review and work-out process. The probable 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 or specifically assigned allowance for loan losses are recognized where appropriate.
There was continued improvement in the majority of the Company's credit metrics during the third quarter of 2014. The allowance for credit losses was $50.8 million at September 30, 2014 or 1.15% of total loans outstanding compared to 1.27% reported at December 31, 2013 and 1.30% at September 30, 2013. General reserves as a percentage of non-impaired loans were 1.06% at September 30, 2014 compared to 1.07% at December 31, 2013 and 1.12% at September 30, 2013. Nonperforming loan balances decreased $14.1 million during the first nine months of 2014. Criticized loans totaled $139.4 million at September 30, 2014 and represented 3% of the loan portfolio. The level of criticized loans decreased as of September 30, 2014 when compared to December 31, 2013, by $22.9 million, or 14%. Delinquency on accruing loans for the same period increased $5.1 million, or 39%, the majority of which are commercial real estate and residential real estate loans.
The allowance for credit losses as a percentage of nonperforming loans was 112.21% as of September 30, 2014 compared to 91.31% at December 31, 2013 and 77.17% at September 30, 2013. The amount of allowance related to nonperforming loans was determined by using fair values obtained from current appraisals and updated discounted cash flow analyses. The allowance for credit losses includes specific allocations of $4.6 million and general reserves of $46.2 million. Management believes that the allowance for credit losses is at a level deemed sufficient to absorb losses inherent in the loan portfolio at September 30, 2014.

 

58

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


The following table provides information related to nonperforming assets, the allowance for credit losses and other credit-related measures:
 
 
 
September 30,
 
 
 
December 31, 2013
 
 
 
 
2014
 
 
 
2013
 
 
 
 
 
(dollars in thousands)
 
 
Nonperforming Loans:
 
 
 
 
Loans on nonaccrual basis
 
$
27,310

 
  
 
$
42,122

 

 
$
28,908

 
  
Troubled debt restructured loans on nonaccrual basis
 
6,783

 
  
 
17,807

 
  
 
16,980

 
  
Troubled debt restructured loans on accrual basis
 
11,164

 
  
 
11,290

 
  
 
13,495

 
  
Total nonperforming loans
 
$
45,257

 
  
 
$
71,219

 
  
 
$
59,383

 
  
Loans past due in excess of 90 days and still accruing
 
$
2,374

 
  
 
$
2,364

 
  
 
$
2,505

 
  
Other real estate owned
 
$
7,751

 
  
 
$
9,656

 
  
 
$
11,728

 
  
Loans outstanding at end of period
 
$
4,411,481

 
  
 
$
4,240,004

 

 
$
4,283,833

 
  
Average loans outstanding
 
$
4,331,807

 
(a) 
 
$
4,248,048

 
(a) 
 
$
4,255,593

 
(b) 
Nonperforming loans as a percentage of total loans
 
1.03
%
 
 
 
1.68
%
 
 
 
1.39
%
 
 
Provision for credit losses
 
$
8,621

 
(a) 
 
$
18,011

 
(a) 
 
$
19,227

 
(b) 
Allowance for credit losses
 
$
50,784

 
  
 
$
54,957

 
  
 
$
54,225

 
  
Net charge-offs
 
$
12,062

 
(a) 
 
$
30,241

 
(a) 
 
$
32,189

 
(b) 
Net charge-offs as a percentage of average loans outstanding (annualized)
 
0.37
%
 
 
 
0.95
%
 
 
 
0.76
%
 
 
Provision for credit losses as a percentage of net charge-offs
 
71.47
%
 
(a) 
 
59.56
%
 
(a) 
 
59.73
%
 
(b) 
Allowance for credit losses as a percentage of end-of-period loans outstanding
 
1.15
%
 
 
 
1.30
%
 
 
 
1.27
%
 
 
Allowance for credit losses as a percentage of nonperforming loans
 
112.21
%
 
 
 
77.17
%
 
 
 
91.31
%
 
 
 
(a)
For the nine-month period ended.
(b)
For the twelve-month period ended.

Nonperforming loans decreased $14.1 million to $45.3 million at September 30, 2014 compared to $59.4 million at December 31, 2013. This decrease can be primarily attributed to the payoff of five nonperforming loan relationships totaling $11.6 million and the sale of three nonperforming loans totaling $0.7 million. Offsetting these decreases was the addition of a $3.9 million commercial industrial loan to an audio visual equipment distributor.

The following tables show the outstanding balances of our loan portfolio and the breakdown of net charge-offs and nonperforming loans by loan type as of and for the periods presented:
 
 
 
September 30, 2014
 
December 31, 2013
 
 
Amount
 
%
 
Amount
 
%
 
 
(dollars in thousands)
Commercial, financial, agricultural and other
 
$
1,071,531

 
24
%
 
$
1,021,056

 
24
%
Real estate construction
 
115,788

 
3

 
93,289

 
2

Residential real estate
 
1,234,842

 
28

 
1,262,718

 
30

Commercial real estate
 
1,345,302

 
30

 
1,296,472

 
30

Loans to individuals
 
644,018

 
15

 
610,298

 
14

Total loans and leases net of unearned income
 
$
4,411,481

 
100
%
 
$
4,283,833

 
100
%
During the nine months ended September 30, 2014, loans increased $127.6 million or 3% compared to balances outstanding at December 31, 2013. Loan growth was experienced in all categories, except residential real estate. Impacting commercial financial and agricultural loans as well as commercial real estate loans was the opening in early 2014 of a new commercial business center in Cleveland as well as growth in direct middle market lending and syndications in Pennsylvania and contiguous states. Loans to Individuals increased due to growth in indirect auto lending.

59

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


The decline in the residential real estate category can be attributed to continued runoff in our mortgage portfolio, since the Company has not offered a traditional mortgage product in close to ten years. During the third quarter of 2014, the Company launched its mortgage banking division, which will provide purchase and refinance mortgage products across our western Pennsylvania footprint. Many of the mortgage loans originated through this division will be sold in the secondary market; therefore, it is likely that non-interest income will be impacted more than the loan portfolio.
Net charge-offs for the nine months ended September 30, 2014 totaled $12.1 million compared to $30.2 million for the nine months ended September 30, 2013. The most significant charge-offs during the nine months ended September 30, 2014 were $8.0 million recognized on two commercial loans and sixteen consumer loan relationships. During the nine months ended September 30, 2013, the most significant charge-offs were a $21.2 million charge recognized on four commercial real estate loans and a $3.1 million charge-off recognized upon transfer of two loans to held for sale. 
 
 
For the Nine Months Ended September 30, 2014
 
As of September 30, 2014
 
 
Net
Charge-
offs
 
% of
Total Net
Charge-offs
 
Net Charge-
offs as a % of
Average
Loans (annualized)
 
Nonperforming
Loans
 
% of Total
Nonperforming
Loans
 
Nonperforming
Loans as a % of
Total Loans
 
 
(dollars in thousands)
Commercial, financial, agricultural and other
 
$
7,732

 
64.10
 %
 
0.24
 %
 
$
24,635

 
54.44
%
 
0.56
%
Real estate construction
 
(173
)
 
(1.43
)
 
(0.01
)
 
291

 
0.64

 
0.01

Residential real estate
 
1,866

 
15.47

 
0.06

 
11,538

 
25.49

 
0.26

Commercial real estate
 
677

 
5.61

 
0.02

 
8,445

 
18.66

 
0.19

Loans to individuals
 
1,960

 
16.25

 
0.06

 
348

 
0.77

 
0.01

Total loans, net of unearned income
 
$
12,062

 
100.00
 %
 
0.37
 %
 
$
45,257

 
100.00
%
 
1.03
%
As the above table illustrates, commercial, financial, agricultural and other and residential real estate loans represented a significant portion of the nonperforming loans as of September 30, 2014. See discussions related to the provision for credit losses and loans for more information.
Capital Resources
At September 30, 2014, shareholders’ equity was $709.5 million, a decrease of $2.2 million from December 31, 2013. The decrease was primarily the result of $36.7 million in net income and increases of $10.9 million in the fair value of available for sale investments, offset by $30.9 million of common stock repurchases and $19.8 million of dividends paid to shareholders. Cash dividends declared per common share were $0.21 and $0.17 for the nine months ended September 30, 2014 and 2013, respectively.
First Commonwealth is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on First Commonwealth’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, First Commonwealth and its banking subsidiary must meet specific capital guidelines that involve quantitative measures of First Commonwealth’s assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. First Commonwealth’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weighting and other factors.
First Commonwealth maintains capital to absorb unexpected losses. In order to provide assurance that our capital levels are adequate for our risk exposure we test our capital position under several stress scenarios on a bi-annual basis. This analysis is subject to Board of Director review and approval. Our most recent capital stress test was completed in December 2013.
On July 9, 2013, federal banking agencies approved changes to the regulatory capital framework which are effective beginning on January 1, 2015, with some items phasing in over a period of time. The most significant of these changes include higher minimum capital requirements, as the minimum Tier I capital ratio increased from 4.0% to 6.0% and the establishment of a new common equity Tier I capital ratio with a minimum level of 4.5%. Additionally, the new rules improve the quality of capital by providing stricter eligibility criteria for regulatory capital instruments and provide for a phase-in, beginning January 1, 2016, of

60

FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. Management’s Discussion and Analysis of Financial Condition and
Results of Operations (Continued)


a capital conservation buffer of 2.5% of risk-weighted assets. This buffer provides a requirement to hold common equity Tier 1 capital above the minimum risk-based capital requirements. Management currently expects First Commonwealth will remain well-capitalized after the adoption of these changes.
Under current regulations, quantitative measures to ensure capital adequacy require First Commonwealth to maintain minimum amounts and ratios of Total and Tier I capital (common and certain other “core” equity capital) to risk weighted assets, and of Tier I capital to average assets. As of September 30, 2014, First Commonwealth and its banking subsidiary met all capital adequacy requirements to which they are subject.
As of September 30, 2014, First Commonwealth was considered well-capitalized under the regulatory framework for prompt corrective action. To be considered well capitalized, the Company must maintain minimum Total risk-based capital, Tier I risk-based capital and Tier I leverage ratios as set forth in the table below:
 
Actual
 
Regulatory
Minumum
 
Well
Capitalized
Regulatory
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
(dollars in thousands)
Total Capital to Risk Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
655,604

 
12.77
%
 
$
410,619

 
8.00
%
 
 
 
 
First Commonwealth Bank
639,615

 
12.44

 
411,244

 
8.00

 
$
514,055

 
10.00
%
Tier I Capital to Risk Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
601,844

 
11.73
%
 
$
205,310

 
4.00
%
 
 
 
 
First Commonwealth Bank
585,955

 
11.40

 
205,622

 
4.00

 
$
308,433

 
6.00
%
Tier I Capital to Average Assets
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
601,844

 
9.79
%
 
$
245,994

 
4.00
%
 
 
 
 
First Commonwealth Bank
585,955

 
9.58

 
244,535

 
4.00

 
$
305,669

 
5.00
%
During the first quarter of 2014, First Commonwealth completed share repurchase programs in the amount of $25.0 million and $50.0 million which were previously announced on January 29, 2013 and June 19, 2012, respectively. On February 19, 2014, First Commonwealth's Board of Directors authorized an additional $25.0 million common stock repurchase program. As of September 30, 2014, First Commonwealth had completed this program by purchasing 2,924,066 shares at an average price of $8.58 per share. Under all three share repurchase programs, First Commonwealth purchased a total of 13,734,185 shares of common stock at an average price of $7.31 per share.
On October 28, 2014, First Commonwealth Financial Corporation declared a quarterly dividend of $0.07 per share payable on November 21, 2014 to shareholders of record as of November 10, 2014. The timing and amount of future dividends are at the discretion of First Commonwealth's Board of Directors based upon, among other factors, capital levels, asset quality, liquidity and current and projected earnings.

61

Table of Contents

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.

62

Table of Contents
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
PART II – OTHER INFORMATION


 
ITEM 1.
LEGAL PROCEEDINGS
Market Rate Savings IRA Litigation
For a description of litigation relating to the Market Rate Savings IRA product, refer to the "Legal proceedings" section in Part I, Item 1, Note 6, "Commitments and Contingent Liabilities," which is incorporated herein by reference to this item.
Other Legal Proceedings
First Commonwealth and certain of its subsidiaries have been named as defendants in various legal actions arising out of the normal course of business.  In the opinion of management, the ultimate resolution of these lawsuits should not have a material adverse effect on First Commonwealth's business, consolidated financial position or results of operations. It is possible, however, that future developments could result in an unfavorable ultimate outcome for or resolution of any one or more of the lawsuits in which First Commonwealth or its subsidiaries are defendants, which may be material to First Commonwealth's results of operations for a particular quarterly reporting period. Litigation is inherently uncertain, and management cannot make assurances that First Commonwealth will prevail in any of these actions, nor can management reasonably estimate the amount of damages that First Commonwealth might incur.

ITEM 1A.
RISK FACTORS
There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013.






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Table of Contents
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
PART II – OTHER INFORMATION

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    
On June 19, 2012, the Company announced a share repurchase program through which the Board of Directors authorized management to repurchase up to $50.0 million of the Company’s common stock. On both January 29, 2013 and February 19, 2014, additional share repurchase programs were authorized for up to $25.0 million each in shares of the Company’s common stock. The following table details the amount of shares repurchased under this program during the third quarter of 2014:
 
Month Ending:
Total Number of
Shares
Purchased
 
Average Price
Paid per Share
(or Unit)
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
 
Maximum Number
of Shares that
May Yet Be
Purchased Under
the Plans or
Programs*
July 31, 2014
242,411

 
$
8.75

 
242,411

 
1,747,630

August 31, 2014
1,615,987

 
8.58

 
1,612,838

 
126,212

September 30, 2014
171,765

 
8.91

 
171,765

 

Total
2,030,163

 
$
8.63

 
2,027,014

 
 
 
 
 
 
 
 
 
 
* Remaining number of shares approved under the Plan is based on the market value of the Company's common stock of $8.56 at July 31, 2014, $8.86 at August 31, 2014 and $8.39 at September 30, 2014.

ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4.
MINE SAFETY DISCLOSURES
Not applicable
ITEM 5.
OTHER INFORMATION
None

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Table of Contents
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
PART II – OTHER INFORMATION

ITEM 6.     EXHIBITS
Exhibit
Number
  
Description
  
Incorporated by Reference to
 
 
 
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
 
 
 
101
  
The following materials from First Commonwealth Financial Corporation’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2014, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets at September 30, 2014 and December 31, 2013, (ii) the Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2014 and 2013, (iii) the Condensed Consolidated Statements of Changes in Stockholders’ Equity for the nine months ended September 30, 2014 and 2013, (iv) the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013, and (v) the Notes to Unaudited Condensed Consolidated Financial Statements.

  
Filed herewith

65

Table of Contents

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: November 10, 2014
 
/s/ T. Michael Price
 
 
T. Michael Price
President and Chief Executive Officer
 
 
DATED: November 10, 2014
 
/s/ James R. Reske
 
 
James R. Reske
Executive Vice President and Chief Financial Officer


66