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FIRST COMMONWEALTH FINANCIAL CORP /PA/ - Quarter Report: 2015 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, 2015
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, 2015, was 88,961,268.


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




ITEM 1. Financial Statements and Supplementary Data
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (Unaudited)
 
 
September 30,
2015
 
December 31,
2014
 
(dollars in thousands,
except share data)
Assets
 
 
 
Cash and due from banks
$
69,235

 
$
72,276

Interest-bearing bank deposits
3,529

 
2,262

Securities available for sale, at fair value
1,050,733

 
1,309,819

Securities held to maturity, at amortized cost (Fair value of $154,837 at September 30, 2015)
154,035

 

Other investments
53,976

 
44,545

Loans held for sale
4,986

 
2,502

Loans:
 
 
 
Portfolio loans
4,575,735

 
4,457,308

Allowance for credit losses
(48,518
)
 
(52,051
)
Net loans
4,527,217

 
4,405,257

Premises and equipment, net
62,812

 
64,989

Other real estate owned
10,542

 
7,197

Goodwill
161,429

 
161,429

Amortizing intangibles, net
1,196

 
1,665

Bank owned life insurance
181,278

 
177,567

Other assets
103,781

 
110,777

Total assets
$
6,384,749

 
$
6,360,285

Liabilities
 
 
 
Deposits (all domestic):
 
 
 
Noninterest-bearing
$
1,077,234

 
$
989,027

Interest-bearing
3,084,256

 
3,326,484

Total deposits
4,161,490

 
4,315,511

Short-term borrowings
1,329,794

 
1,105,876

Subordinated debentures
72,167

 
72,167

Other long-term debt
39,052

 
89,459

Total long-term debt
111,219

 
161,626

Other liabilities
59,478

 
61,127

Total liabilities
5,661,981

 
5,644,140

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, 2015 and December 31, 2014, and 88,961,268 and 91,723,028 shares outstanding at September 30, 2015 and December 31, 2014, respectively
105,563

 
105,563

Additional paid-in capital
365,950

 
365,615

Retained earnings
374,247

 
353,027

Accumulated other comprehensive income (loss), net
4,961

 
(4,499
)
Treasury stock (16,602,187 and 13,840,427 shares at September 30, 2015 and December 31, 2014, respectively)
(127,953
)
 
(103,561
)
Total shareholders’ equity
722,768

 
716,145

Total liabilities and shareholders’ equity
$
6,384,749

 
$
6,360,285


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

Table of Contents



ITEM 1. Financial Statements and Supplementary Data (Continued)
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(dollars in thousands, except share data)
Interest Income
 
 
 
 
 
 
 
Interest and fees on loans
$
43,083

 
$
43,200

 
$
128,334

 
$
128,490

Interest and dividends on investments:
 
 
 
 
 
 
 
Taxable interest
6,470

 
7,118

 
20,022

 
21,632

Interest exempt from federal income taxes
261

 
104

 
646

 
172

Dividends
685

 
663

 
2,727

 
1,459

Interest on bank deposits
2

 
4

 
7

 
8

Total interest income
50,501

 
51,089

 
151,736

 
151,761

Interest Expense
 
 
 
 
 
 
 
Interest on deposits
1,757

 
2,974

 
5,787

 
9,897

Interest on short-term borrowings
1,279

 
662

 
3,353

 
1,608

Interest on subordinated debentures
588

 
578

 
1,736

 
1,715

Interest on other long-term debt
192

 
322

 
633

 
1,014

Total interest expense
3,816

 
4,536

 
11,509

 
14,234

Net Interest Income
46,685

 
46,553

 
140,227

 
137,527

Provision for credit losses
4,621

 
2,073

 
8,818

 
8,621

Net Interest Income after Provision for Credit Losses
42,064

 
44,480

 
131,409

 
128,906

Noninterest Income
 
 
 
 
 
 
 
Net securities gains

 
48

 
125

 
50

Trust income
1,614

 
1,678

 
4,511

 
4,587

Service charges on deposit accounts
4,081

 
4,099

 
11,271

 
12,032

Insurance and retail brokerage commissions
2,163

 
1,709

 
6,536

 
4,704

Income from bank owned life insurance
1,357

 
1,330

 
4,089

 
4,131

Gain on sale of loans
1,196

 
67

 
2,262

 
143

Gain on sale of other assets
444

 
675

 
1,022

 
4,345

Card related interchange income
3,637

 
3,599

 
10,784

 
10,620

Derivatives mark to market (expense) income
(783
)
 
(108
)
 
(420
)
 
175

Other income
1,796

 
1,953

 
5,863

 
6,185

Total noninterest income
15,505

 
15,050

 
46,043

 
46,972

Noninterest Expense
 
 
 
 
 
 
 
Salaries and employee benefits
22,446

 
22,244

 
66,339

 
65,185

Net occupancy expense
3,291

 
3,180

 
10,518

 
9,969

Furniture and equipment expense
2,670

 
4,471

 
7,980

 
15,050

Data processing expense
1,558

 
1,583

 
4,505

 
4,593

Advertising and promotion expense
789

 
861

 
1,946

 
2,346

Pennsylvania shares tax expense
1,713

 
1,033

 
3,617

 
2,782

Intangible amortization
157

 
174

 
469

 
530

Collection and repossession expense
801

 
783

 
2,229

 
1,941

Other professional fees and services
1,007

 
1,050

 
2,882

 
2,777

FDIC insurance
963

 
926

 
3,047

 
3,026

Loss on sale or write-down of assets
140

 
61

 
2,037

 
1,241

Operational losses (recoveries)
314

 
187

 
1,637

 
(273
)
Conversion related expenses

 
783

 

 
1,676

Other operating expenses
4,408

 
4,232

 
13,539

 
13,008

Total noninterest expense
40,257

 
41,568

 
120,745

 
123,851

Income Before Income Taxes
17,312

 
17,962

 
56,707

 
52,027

Income tax provision
4,898

 
5,466

 
16,625

 
15,303

Net Income
$
12,414

 
$
12,496

 
$
40,082

 
$
36,724

Average Shares Outstanding
88,807,294

 
92,567,503

 
89,527,560

 
93,627,933

Average Shares Outstanding Assuming Dilution
88,813,746

 
92,578,701

 
89,531,498

 
93,632,783

Per Share Data:
 
 
 
 
 
 
 
Basic Earnings per Share
$
0.14

 
$
0.13

 
$
0.45

 
$
0.39

Diluted Earnings per Share
$
0.14

 
$
0.13

 
$
0.45

 
$
0.39

Cash Dividends Declared per Common Share
$
0.07

 
$
0.07

 
$
0.21

 
$
0.21


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

Table of Contents



ITEM 1. Financial Statements and Supplementary Data (Continued)
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
 
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2015
 
2014
 
2015
 
2014
 
(dollars in thousands)
Net Income
$
12,414

 
$
12,496

 
$
40,082

 
$
36,724

Other comprehensive income (loss), before tax (expense) benefit:
 
 
 
 
 
 
 
Unrealized holding gains (losses) on securities arising from during the period
6,344

 
(5,544
)
 
12,510

 
16,863

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

 
(48
)
 
(125
)
 
(50
)
Unrealized holding gains (losses) on derivatives arising from during the period
1,504

 
(27
)
 
2,172

 
(27
)
Less: reclassification adjustment for losses (gains) on derivatives included in net income

 
1

 
(6
)
 
1

Total other comprehensive income (loss), before tax (expense) benefit
7,848

 
(5,618
)
 
14,551

 
16,787

Income tax (expense) benefit related to items of other comprehensive income (loss)
(2,747
)
 
1,964

 
(5,091
)
 
(5,875
)
Total other comprehensive income (loss)
5,101

 
(3,654
)
 
9,460

 
10,912

Comprehensive Income
$
17,515

 
$
8,842

 
$
49,542

 
$
47,636



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

Table of Contents



ITEM 1. Financial Statements and Supplementary Data (Continued)
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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, 2014
91,723,028

 
$
105,563

 
$
365,615

 
$
353,027

 
$
(4,499
)
 
$
(103,561
)
 
$
716,145

Net income
 
 
 
 
 
 
40,082

 
 
 
 
 
40,082

Other comprehensive income
 
 
 
 
 
 
 
 
9,460

 
 
 
9,460

Cash dividends declared ($0.21 per share)
 
 
 
 
 
 
(18,862
)
 
 
 
 
 
(18,862
)
Treasury stock acquired
(2,918,066
)
 
 
 
 
 
 
 
 
 
(25,383
)
 
(25,383
)
Treasury stock reissued
20,936

 
 
 
32

 

 
 
 
160

 
192

Restricted stock
135,370

 

 
303

 

 
 
 
831

 
1,134

Balance at September 30, 2015
88,961,268

 
$
105,563

 
$
365,950

 
$
374,247

 
$
4,961

 
$
(127,953
)
 
$
722,768

 
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



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

Table of Contents



ITEM 1. Financial Statements and Supplementary Data (Continued)
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
 
For the Nine Months Ended
 
September 30,
 
2015
 
2014
Operating Activities
(dollars in thousands)
Net income
$
40,082

 
$
36,724

Adjustment to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
8,818

 
8,621

Deferred tax expense
12,520

 
6,207

Depreciation and amortization
5,750

 
11,659

Net gains on securities and other assets
(952
)
 
(3,137
)
Net amortization of premiums and discounts on securities
2,012

 
1,610

Net accretion of premiums and discounts on long term debt

 
(37
)
Income from increase in cash surrender value of bank owned life insurance
(4,089
)
 
(3,904
)
Increase in interest receivable
(167
)
 
(339
)
Mortgage loans originated for sale
(67,708
)
 
(3,810
)
Proceeds from sale of mortgage loans
67,071

 
2,569

Decrease in interest payable
(173
)
 
(476
)
(Decrease) increase in income taxes payable
(22
)
 
1,157

Other-net
(10,757
)
 
772

Net cash provided by operating activities
52,385

 
57,616

Investing Activities
 
 
 
Transactions with securities held to maturity:
 
 
 
Proceeds from maturities and redemptions
3,828

 

Purchases
(156,756
)
 

Transactions with securities available for sale:
 
 
 
Proceeds from sales

 
132,868

Proceeds from maturities and redemptions
286,924

 
199,580

Purchases
(16,600
)
 
(325,955
)
Purchases of FHLB stock
(46,911
)
 
(32,115
)
Proceeds from the redemption of FHLB stock
36,980

 
16,565

Proceeds from bank owned life insurance
378

 
1,776

Proceeds from sale of loans
2,898

 
3,112

Proceeds from sale of other assets
3,668

 
11,314

Net increase in loans
(140,268
)
 
(146,863
)
Purchases of premises and equipment
(3,740
)
 
(9,781
)
Net cash used in investing activities
(29,599
)
 
(149,499
)
Financing Activities
 
 
 
Net increase in federal funds purchased
11,000

 
3,500

Net increase in other short-term borrowings
212,918

 
404,852

Net decrease in deposits
(154,018
)
 
(231,475
)
Repayments of other long-term debt
(50,407
)
 
(32,808
)
Proceeds from other long-term debt

 
5,000

Discount on dividend reinvestment plan purchases

 
(65
)
Dividends paid
(18,862
)
 
(19,754
)
Proceeds from reissuance of treasury stock
192

 
192

Purchase of treasury stock
(25,383
)
 
(30,928
)
Net cash (used in) provided by financing activities
(24,560
)
 
98,514

Net (decrease) increase in cash and cash equivalents
(1,774
)
 
6,631

Cash and cash equivalents at January 1
74,538

 
77,439

Cash and cash equivalents at September 30
$
72,764

 
$
84,070


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


ITEM 1. Financial Statements and Supplementary Data
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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 the “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, comprehensive income, 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, 2015 are not necessarily indicative of the results that may be expected for the full year of 2015. These interim financial statements should be read in conjunction with First Commonwealth’s 2014 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,
 
2015
 
2014
 
Pretax Amount
 
Tax (Expense) Benefit
 
Net of Tax Amount
 
Pretax Amount
 
Tax (Expense) Benefit
 
Net of Tax Amount
 
(dollars in thousands)
Unrealized gains on securities:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding gains on securities arising during the period
$
12,510

 
$
(4,377
)
 
$
8,133

 
$
16,863

 
$
(5,902
)
 
$
10,961

Reclassification adjustment for gains on securities included in net income
(125
)
 
44

 
(81
)
 
(50
)
 
18

 
(32
)
Total unrealized gains on securities
12,385

 
(4,333
)
 
8,052

 
16,813

 
(5,884
)
 
10,929

Unrealized gains (losses) on derivatives:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding gains (losses) on derivatives arising during the period
2,172

 
(760
)
 
1,412

 
(27
)
 
9

 
(18
)
Reclassification adjustment for (gains) losses on derivatives included in net income
(6
)
 
2

 
(4
)
 
1

 

 
1

Total unrealized (losses) gains on derivatives
2,166

 
(758
)
 
1,408

 
(26
)
 
9

 
(17
)
Total other comprehensive income
$
14,551

 
$
(5,091
)
 
$
9,460

 
$
16,787

 
$
(5,875
)
 
$
10,912



8

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


 
For the Three Months Ended September 30,
 
2015
 
2014
 
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
$
6,344

 
$
(2,221
)
 
$
4,123

 
$
(5,544
)
 
$
1,938

 
$
(3,606
)
Reclassification adjustment for gains on securities included in net income

 

 

 
(48
)
 
17

 
(31
)
Total unrealized gains (losses) on securities
6,344

 
(2,221
)
 
4,123

 
(5,592
)
 
1,955

 
(3,637
)
Unrealized gains (losses) on derivatives:
 
 
 
 
 
 
 
 
 
 
 
Unrealized holding gains (losses) on derivatives arising during the period
1,504

 
(526
)
 
978

 
(27
)
 
9

 
(18
)
Reclassification adjustment for losses on derivatives included in net income

 

 

 
1

 

 
1

Total unrealized gains on derivatives
1,504

 
(526
)
 
978

 
(26
)
 
9

 
(17
)
Total other comprehensive income (loss)
$
7,848

 
$
(2,747
)
 
$
5,101

 
$
(5,618
)
 
$
1,964

 
$
(3,654
)
 
The following table details the change in components of OCI for the nine months ended September 30:
 
2015
 
2014
 
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
$
(4,875
)
$
76

$
300

$
(4,499
)
 
$
(20,868
)
$
280

$

$
(20,588
)
Other comprehensive income before reclassification adjustment
8,133


1,412

9,545

 
10,961


(18
)
10,943

Amounts reclassified from accumulated other comprehensive (loss) income
(81
)

(4
)
(85
)
 
(32
)

1

(31
)
Net other comprehensive income during the period
8,052


1,408

9,460

 
10,929


(17
)
10,912

Balance at September 30
$
3,177

$
76

$
1,708

$
4,961

 
$
(9,939
)
$
280

$
(17
)
$
(9,676
)

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:
 
2015
 
2014
 
(dollars in thousands)
Cash paid during the period for:
 
 
 
Interest
$
11,682

 
$
14,747

Income taxes
4,000

 
7,700

Non-cash investing and financing activities:
 
 
 
Loans transferred to other real estate owned and repossessed assets
7,413

 
4,239

Loans transferred from held to maturity to held for sale
3,071

 
3,035

Gross increase in market value adjustment to securities available for sale
12,381

 
16,812

Gross increase (decrease) in market value adjustment to derivatives
2,167

 
(27
)
Investments committed to purchase, not settled
1,350

 
1,000


9

ITEM 1. Financial Statements and Supplementary Data
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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,
 
2015
 
2014
 
2015
 
2014
Weighted average common shares issued
105,563,455

 
105,563,455

 
105,563,455

 
105,563,455

Average treasury stock shares
(16,602,502
)
 
(12,836,692
)
 
(15,858,433
)
 
(11,773,187
)
Average unearned nonvested shares
(153,659
)
 
(159,260
)
 
(177,462
)
 
(162,335
)
Weighted average common shares and common stock equivalents used to calculate basic earnings per share
88,807,294

 
92,567,503

 
89,527,560

 
93,627,933

Additional common stock equivalents (nonvested stock) used to calculate diluted earnings per share
6,452

 
11,198

 
3,938

 
4,850

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
88,813,746

 
92,578,701

 
89,531,498

 
93,632,783

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.
 
2015
 
2014
 
 
 
Price Range
 
 
 
Price Range
 
Shares
 
From
 
To
 
Shares
 
From
 
To
Stock Options

 
$

 
$

 
15,000

 
$
14.55

 
$
14.55

Restricted Stock
121,091

 
5.26

 
9.84

 
94,929

 
4.41

 
9.18


Note 5 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, 2015
 
December 31, 2014
 
(dollars in thousands)
Financial instruments whose contract amounts represent credit risk:
 
 
 
Commitments to extend credit
$
1,576,245

 
$
1,635,948

Financial standby letters of credit
20,089

 
36,075

Performance standby letters of credit
26,317

 
25,915

Commercial letters of credit
2,023

 
2,611

 
The notional amounts outstanding as of September 30, 2015 include amounts issued in 2015 of $7.8 million in financial standby letters of credit and $2.3 million in performance standby letters of credit. There have been no commercial letters of credit issued during 2015. A liability of $0.2 million has been recorded as of September 30, 2015 and December 31, 2014, 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.

10

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


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 $3.8 million as of September 30, 2015 and $3.1 million as of December 31, 2014. This liability is reflected in "Other liabilities" in the Condensed Consolidated Statements of Financial Condition. 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
There are no 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, comprehensive income or cash flow of First Commonwealth or its subsidiaries.

Note 6 Investment Securities
Securities Available for Sale
Below is an analysis of the amortized cost and estimated fair values of securities available for sale at:
 
September 30, 2015
 
December 31, 2014
 
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
$
20,902

 
$
2,379

 
$

 
$
23,281

 
$
23,344

 
$
2,595

 
$
(3
)
 
$
25,936

Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 

 
 
 
 
 
 
 

Mortgage-Backed Securities – Residential
816,179

 
12,819

 
(4,846
)
 
824,152

 
947,635

 
13,076

 
(9,830
)
 
950,881

Mortgage-Backed Securities – Commercial
37

 
1

 

 
38

 
72

 
2

 

 
74

Other Government-Sponsored Enterprises
135,853

 
19

 
(91
)
 
135,781

 
269,181

 
4

 
(1,308
)
 
267,877

Obligations of States and Political Subdivisions
27,064

 
397

 
(12
)
 
27,449

 
27,058

 
362

 
(43
)
 
27,377

Corporate Securities
1,895

 
438

 

 
2,333

 
6,682

 
573

 

 
7,255

Pooled Trust Preferred Collateralized Debt Obligations
42,000

 
1,016

 
(7,237
)
 
35,779

 
41,926

 
309

 
(13,236
)
 
28,999

Total Debt Securities
1,043,930

 
17,069

 
(12,186
)
 
1,048,813

 
1,315,898

 
16,921

 
(24,420
)
 
1,308,399

Equities
1,920

 

 

 
1,920

 
1,420

 

 

 
1,420

Total Securities Available for Sale
$
1,045,850

 
$
17,069

 
$
(12,186
)
 
$
1,050,733

 
$
1,317,318

 
$
16,921

 
$
(24,420
)
 
$
1,309,819


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.

11

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



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, 2015, by contractual maturity, are shown below.
 
Amortized
Cost
 
Estimated
Fair Value
 
(dollars in thousands)
Due within 1 year
$
3,000

 
$
3,000

Due after 1 but within 5 years
132,852

 
132,781

Due after 5 but within 10 years
25,657

 
26,031

Due after 10 years
45,303

 
39,530

 
206,812

 
201,342

Mortgage-Backed Securities (a)
837,118

 
847,471

Total Debt Securities
$
1,043,930

 
$
1,048,813

 
(a)
Mortgage Backed Securities include an amortized cost of $20.9 million and a fair value of $23.3 million for Obligations of U.S. Government agencies issued by Ginnie Mae and an amortized cost of $816.2 million and a fair value of $824.2 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:
 
2015
 
2014
 
(dollars in thousands)
Proceeds from sales
$

 
$
132,868

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

 
$
489

Gross losses

 
(441
)
 

 
48

Maturities and impairment
 
 
 
Gross gains
125

 
2

Gross losses

 

Other-than-temporary impairment

 

 
125

 
2

Net gains and impairment
$
125

 
$
50


Securities available for sale with an estimated fair value of $480.1 million and $563.2 million were pledged as of September 30, 2015 and December 31, 2014, respectively, to secure public deposits and for other purposes required or permitted by law.

12

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


Securities Held to Maturity
Below is an analysis of the amortized cost and fair values of debt securities held to maturity at September 30, 2015. There were no held to maturity securities at December 31, 2014.
 
September 30, 2015
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Estimated
Fair Value
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
$
4,806

 
$
24

 
$

 
$
4,830

Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
$
116,065

 
$
520

 
$
(6
)
 
$
116,579

Mortgage-Backed Securities – Commercial
15,299

 
176

 

 
15,475

Obligations of States and Political Subdivisions
17,865

 
131

 
(43
)
 
17,953

Total Securities Held to Maturity
$
154,035

 
$
851

 
$
(49
)
 
$
154,837

The amortized cost and estimated fair value of debt securities held to maturity at September 30, 2015, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.
 
Amortized
Cost
 
Estimated
Fair Value
 
(dollars in thousands)
Due within 1 year
$

 
$

Due after 1 but within 5 years

 

Due after 5 but within 10 years
12,210

 
12,303

Due after 10 years
5,655

 
5,650

 
17,865

 
17,953

Mortgage-Backed Securities (a)
136,170

 
136,884

Total Debt Securities
$
154,035

 
$
154,837

(a)
Mortgage Backed Securities include an amortized cost of $4.8 million and a fair value of $4.8 million for Obligations of U.S. Government agencies issued by Ginnie Mae and an amortized cost of $131.4 million and a fair value of $132.1 million for Obligations of U.S. Government-sponsored enterprises issued by Fannie Mae and Freddie Mac.
Securities held to maturity with an amortized cost of $16.5 million were pledged as of September 30, 2015 to secure public deposits and for other purposes required or permitted by law.

Note 7 Impairment of Investment Securities
Securities Available for Sale and Held to Maturity
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, 2015 and 2014, 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.

13

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


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 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 10, “Fair Values of Assets and Liabilities,” for additional information.
The following table presents the gross unrealized losses and estimated fair values at September 30, 2015 for both available for sale and held to maturity securities 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
$
2,240

 
$

(a)
 
$

 
$

 
$
2,240

 
$

Obligations of U.S. Government-Sponsored Enterprises:
 
 
 

 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
78,300

 
(242
)

 
277,333

 
(4,610
)
 
355,633

 
(4,852
)
Other Government-Sponsored Enterprises
10,091

 
(9
)

 
91,570

 
(82
)
 
101,661

 
(91
)
Obligations of States and Political Subdivisions
7,123

 
(55
)
 
 

 

 
7,123

 
(55
)
Pooled Trust Preferred Collateralized Debt Obligations

 

  
 
30,068

 
(7,237
)
 
30,068

 
(7,237
)
Total Securities
$
97,754

 
$
(306
)

 
$
398,971

 
$
(11,929
)
 
$
496,725

 
$
(12,235
)
(a) less than $1 thousand.

At September 30, 2015, fixed income securities issued by U.S. Government-sponsored enterprises comprised 40% of total unrealized losses due to changes in market interest rates. Pooled trust preferred collateralized debt obligations accounted for 59% of the unrealized losses primarily due to the illiquid market for this investment type. Obligations of state and political subdivisions account for the remaining 1% of total unrealized losses as a result of changes in market interest rates. At September 30, 2015, there are 45 debt securities in an unrealized loss position.

14

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


The following table presents the gross unrealized losses and estimated fair values at December 31, 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
$
2,318

 
$
(3
)
 
$

 
$

 
$
2,318

 
$
(3
)
Obligations of U.S. Government-Sponsored Enterprises:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-Backed Securities – Residential
111,646

 
(419
)
 
368,706

 
(9,411
)
 
480,352

 
(9,830
)
Other Government-Sponsored Enterprises
112,473

 
(229
)
 
130,401

 
(1,079
)
 
242,874

 
(1,308
)
Obligation of States and Political Subdivisions
3,146

 
(43
)
 

 

 
3,146

 
(43
)
Pooled Trust Preferred Collateralized Debt Obligations

 

 
24,356

 
(13,236
)
 
24,356

 
(13,236
)
Total Securities
$
229,583

 
$
(694
)
 
$
523,463

 
$
(23,726
)
 
$
753,046

 
$
(24,420
)
As of September 30, 2015, our corporate securities had an amortized cost and an estimated fair value of $1.9 million and $2.3 million, respectively. As of December 31, 2014, our corporate securities had an amortized cost and estimated fair value of $6.7 million and $7.3 million, respectively. Corporate securities are comprised of single issue trust preferred securities issued primarily by large regional banks. There were no corporate securities in an unrealized loss position as of September 30, 2015 and December 31, 2014. 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, 2015, the book value of our pooled trust preferred collateralized debt obligations totaled $42.0 million with an estimated fair value of $35.8 million, which includes securities comprised of 275 banks and other financial institutions. All of our pooled securities are mezzanine tranches, three of which now have no senior class remaining in the issue. The credit ratings 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 security consisted of a security issued by any one institution. As of September 30, 2015, after taking into account management’s best estimates of future interest deferrals and defaults, four of our securities had no excess subordination in the tranches we own and five of our securities had excess subordination which ranged from 10% to 84% of the current performing collateral.
 
The following table provides information related to our pooled trust preferred collateralized debt obligations as of September 30, 2015:
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

 
$
1,337

 
$
(493
)
 
B1/BB
 
6

 
18.05
%
 
57.96
%
Pre TSL VII
Mezzanine
 
2,905

 
3,494

 
589

 
Ca/-
 
14

 
49.68

 

Pre TSL VIII
Mezzanine
 
2,000

 
1,865

 
(135
)
 
C/C
 
29

 
56.74

 

Pre TSL IX
Mezzanine
 
2,367

 
1,811

 
(556
)
 
B1/C
 
38

 
29.80

 
10.04

Pre TSL X
Mezzanine
 
1,583

 
1,921

 
338

 
Caa1/C
 
43

 
30.66

 

Pre TSL XII
Mezzanine
 
5,643

 
4,598

 
(1,045
)
 
B3/C
 
66

 
23.07

 

Pre TSL XIII
Mezzanine
 
12,646

 
10,704

 
(1,942
)
 
B3/C
 
56

 
12.05

 
26.32

Pre TSL XIV
Mezzanine
 
12,818

 
9,752

 
(3,066
)
 
Caa1/CC
 
56

 
19.72

 
43.57

MMCap I
Mezzanine
 
208

 
297

 
89

 
Ca/C
 
8

 
58.11

 
84.08

Total
 
 
$
42,000

 
$
35,779

 
$
(6,221
)
 
 
 
 
 
 
 
 

15

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


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 nine months ended September 30, 2015 and 2014, 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, 2015. 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 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 275 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, 2015, 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.

16

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


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 that 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, 2015, indicates that no credit-related other-than-temporary impairment has occurred on our pooled trust preferred securities during the nine months ended September 30, 2015. Based upon the analysis performed by management, it is probable that four 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 15 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, 2015 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, 2015, 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 21% to 136% 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 is reflected in the following table as increases in cash flows expected to be collected.
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,
 
2015
 
2014
 
2015
 
2014
 
(dollars in thousands)
Balance, beginning (a)
$
25,366

 
$
26,842

 
$
26,246

 
$
27,543

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)
(255
)
 
(288
)
 
(917
)
 
(989
)
Reduction for debt securities called during the period

 

 
(218
)
 

Balance, ending
$
25,111

 
$
26,554

 
$
25,111

 
$
26,554

 
(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 2015 and 2014, 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, 2015 and 2014, there were 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

17

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


transfer price is determined by FHLB membership rules and not by market participants. As of September 30, 2015 and December 31, 2014, our FHLB stock totaled $54.0 million and $44.5 million, respectively, and is included in “Other investments” on the Condensed Consolidated Statements of Financial Condition.
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 and has concluded that the par value of its investment in FHLB stock will be recovered. Accordingly, no impairment charge was recorded on these securities during the nine months ended September 30, 2015.

Note 8 Loans and Allowance for Credit Losses
The following table provides outstanding balances related to each of our loan types:
 
 
September 30, 2015
 
December 31, 2014
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
1,126,881

 
$
1,052,109

Real estate construction
179,710

 
120,785

Residential real estate
1,204,220

 
1,226,344

Commercial real estate
1,435,954

 
1,405,256

Loans to individuals
628,970

 
652,814

Total loans and leases net of unearned income
$
4,575,735

 
$
4,457,308

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 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 Company’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.

18

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


The following tables represent our credit risk profile by creditworthiness:
 
September 30, 2015
 
Commercial, financial, agricultural and other
 
Real estate construction
 
Residential real estate
 
Commercial real estate
 
Loans to individuals
 
Total
 
(dollars in thousands)
Pass
$
1,043,458

 
$
179,229

 
$
1,192,888

 
$
1,394,506

 
$
628,735

 
$
4,438,816

Non-Pass
 
 
 
 
 
 
 
 
 
 
 
OAEM
22,447

 
450

 
2,926

 
29,373

 

 
55,196

Substandard
60,976

 
31

 
8,406

 
12,075

 
235

 
81,723

Doubtful

 

 

 

 

 

Total Non-Pass
83,423

 
481

 
11,332

 
41,448

 
235

 
136,919

Total
$
1,126,881

 
$
179,710

 
$
1,204,220

 
$
1,435,954

 
$
628,970

 
$
4,575,735

 
 
December 31, 2014
 
Commercial, financial, agricultural and other
 
Real estate construction
 
Residential real estate
 
Commercial real estate
 
Loans to individuals
 
Total
 
(dollars in thousands)
Pass
$
983,357

 
$
112,536

 
$
1,214,920

 
$
1,353,773

 
$
652,596

 
$
4,317,182

Non-Pass
 
 
 
 
 
 
 
 
 
 
 
OAEM
32,563

 
8,013

 
2,315

 
29,479

 

 
72,370

Substandard
32,028

 
236

 
9,109

 
22,004

 
218

 
63,595

Doubtful
4,161

 

 

 

 

 
4,161

Total Non-Pass
68,752

 
8,249

 
11,424

 
51,483

 
218

 
140,126

Total
$
1,052,109

 
$
120,785

 
$
1,226,344

 
$
1,405,256

 
$
652,814

 
$
4,457,308

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, 2015. 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.

19

ITEM 1. Financial Statements and Supplementary Data
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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, 2015 and December 31, 2014. 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, 2015
 
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
$
3,817

 
$
59

 
$
149

 
$
17,334

 
$
21,359

 
$
1,105,522

 
$
1,126,881

Real estate construction

 

 

 
31

 
31

 
179,679

 
179,710

Residential real estate
3,562

 
1,187

 
618

 
6,563

 
11,930

 
1,192,290

 
1,204,220

Commercial real estate
35

 
442

 
331

 
4,640

 
5,448

 
1,430,506

 
1,435,954

Loans to individuals
2,624

 
756

 
956

 
235

 
4,571

 
624,399

 
628,970

Total
$
10,038

 
$
2,444

 
$
2,054

 
$
28,803

 
$
43,339

 
$
4,532,396

 
$
4,575,735

 
 
December 31, 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
$
2,816

 
$
213

 
$
264

 
$
27,007

 
$
30,300

 
$
1,021,809

 
$
1,052,109

Real estate construction

 
1

 

 
236

 
237

 
120,548

 
120,785

Residential real estate
5,162

 
1,295

 
1,077

 
7,900

 
15,434

 
1,210,910

 
1,226,344

Commercial real estate
1,797

 
122

 

 
7,306

 
9,225

 
1,396,031

 
1,405,256

Loans to individuals
3,698

 
1,059

 
1,278

 
218

 
6,253

 
646,561

 
652,814

Total
$
13,473

 
$
2,690

 
$
2,619

 
$
42,667

 
$
61,449

 
$
4,395,859

 
$
4,457,308

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 becomes 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 in doubt.
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

20

ITEM 1. Financial Statements and Supplementary Data
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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 also 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.
There were no impaired loans held for sale at September 30, 2015 and December 31, 2014. During the nine months ended September 30, 2015, $2.4 million of impaired loans were sold, resulting in the recognition of a gain of $0.4 million. During the nine months ended September 30, 2014, $3.1 million of impaired loans were sold, resulting in the recognition of a gain of $0.1 million.
Significant nonaccrual loans as of September 30, 2015, include the following:
$6.1 million relationship of commercial industrial loans to an industrial manufacturer. These loans were originated in 2013 and were placed in nonaccrual status during the third quarter of 2015. A valuation of the collateral was completed during the third quarter of 2015.
$5.7 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. Two of these loans were modified resulting in TDR classification: one loan totaling $2.3 million was modified in 2012, and the other loan totaling $2.9 million was modified in 2014. During the nine months ended September 30, 2015, charge-offs of $3.3 million related to this relationship were recorded. A valuation of the collateral was updated during the first quarter of 2015.
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, 2015 and December 31, 2014. 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 their period-end allowance position.
 
 
September 30, 2015
 
December 31, 2014
 
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
$
10,581

 
$
15,618

 


 
$
9,439

 
$
10,937

 


Real estate construction
31

 
119

 


 
236

 
476

 


Residential real estate
9,778

 
11,399

 


 
10,773

 
12,470

 


Commercial real estate
6,885

 
7,862

 


 
8,768

 
10,178

 


Loans to individuals
296

 
358

 


 
288

 
337

 


Subtotal
27,571

 
35,356

 


 
29,504

 
34,398

 


With an allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
12,812

 
13,254

 
4,202

 
24,826

 
25,583

 
9,304

Real estate construction

 

 

 

 

 

Residential real estate
364

 
556

 
20

 
367

 
380

 
56

Commercial real estate
80

 
80

 
33

 
554

 
554

 
101

Loans to individuals

 

 

 

 

 

Subtotal
13,256

 
13,890

 
4,255

 
25,747

 
26,517

 
9,461

Total
$
40,827

 
$
49,246

 
$
4,255

 
$
55,251

 
$
60,915

 
$
9,461

 

21

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


 
For the Nine Months Ended September 30,
 
2015
 
2014
 
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
$
19,199

 
$
161

 
$
15,209

 
$
77

Real estate construction
102

 

 
1,506

 
19

Residential real estate
10,987

 
118

 
11,047

 
167

Commercial real estate
8,545

 
69

 
9,007

 
78

Loans to individuals
312

 
14

 
309

 
3

Subtotal
39,145

 
362

 
37,078

 
344

With an allowance recorded:
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
6,125

 
100

 
11,944

 
125

Real estate construction

 

 

 

Residential real estate
275

 

 
1,178

 
12

Commercial real estate
83

 
4

 
90

 
3

Loans to individuals

 

 

 

Subtotal
6,483

 
104

 
13,212

 
140

Total
$
45,628

 
$
466

 
$
50,290

 
$
484

 
For the Three Months Ended September 30,
 
2015
 
2014
 
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
$
14,215

 
$
40

 
$
10,973

 
$
39

Real estate construction
32

 

 
295

 
1

Residential real estate
10,748

 
39

 
10,590

 
38

Commercial real estate
7,894

 
26

 
8,873

 
24

Loans to individuals
314

 
5

 
346

 
1

Subtotal
33,203

 
110

 
31,077

 
103

With an allowance recorded:
 
 
 
 
 
 
 
Commercial, financial, agricultural and other
7,700

 
29

 
14,140

 
48

Real estate construction

 

 

 

Residential real estate
351

 

 
1,406

 
3

Commercial real estate
81

 
1

 
88

 
2

Loans to individuals

 

 

 

Subtotal
8,132

 
30

 
15,634

 
53

Total
$
41,335

 
$
140

 
$
46,711

 
$
156

Unfunded commitments related to nonperforming loans were $0.5 million at September 30, 2015 and $46 thousand at December 31, 2014. After consideration of available collateral related to these commitments, a reserve of $13 thousand and $14 thousand was established for these off balance sheet exposures at September 30, 2015 and December 31, 2014, respectively.
 
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.

22

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


The following table provides detail as to the total troubled debt restructured loans and total commitments outstanding on troubled debt restructured loans:
 
September 30, 2015
 
December 31, 2014
 
(dollars in thousands)
Troubled debt restructured loans
 
 
 
Accrual status
$
12,024

 
$
12,584

Nonaccrual status
8,583

 
16,952

Total
$
20,607

 
$
29,536

Commitments
 
 
 
Unused lines of credit
$
1,162

 
$
4,120

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, 2015
 
 
 
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

 
$
1,751

 
$

 
$
652

 
$
2,403

 
$
2,314

 
$
52

Residential real estate
24

 

 
296

 
958

 
1,254

 
1,165

 

Commercial real estate
1

 

 

 
464

 
464

 
407

 

Loans to individuals
8

 

 
61

 
35

 
96

 
77

 

Total
37

 
$
1,751

 
$
357

 
$
2,109

 
$
4,217

 
$
3,963

 
$
52


 
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

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, 2015 and 2014, $0.4 million and $0.5 million, respectively, of total rate modifications represent loans with modifications to the rate as well as payment as a result of reamortization. For both 2015 and 2014 the changes in loan balances between the pre-modification balance and the post-modification balance are due to customer payments.

23

ITEM 1. Financial Statements and Supplementary Data
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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 Three Months Ended September 30, 2015
 
 
 
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
1

 
$

 
$

 
$
543

 
$
543

 
$
525

 
$

Residential real estate
8

 
$

 
$

 
$
455

 
$
455

 
$
455

 
$

Loans to individuals
2

 

 

 
18

 
18

 
16

 

Total
11

 
$

 
$

 
$
1,016

 
$
1,016

 
$
996

 
$


 
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

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. None of the rate modifications for the three months ended September 30, 2015 represent loans with modifications to the rate as well as payment. For the three months ended September 30, 2014, $0.1 million of total rate modifications represent loans with modifications to the rate as well as payment as a result of reamortization. For both 2015 and 2014 the changes in loan balances between the pre-modification balance and the post-modification balance are due to customer payments.

24

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


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 be in default during the nine months ended September 30:
 
2015
 
2014
 
Number of
Contracts
 
Recorded
Investment
 
Number of
Contracts
 
Recorded
Investment
 
(dollars in thousands)
Residential real estate
3

 
$
108

 
3

 
$
18

Total
3

 
$
108

 
3

 
$
18

The following table provides information related to restructured loans that were considered to be in default during the three months ended September 30:
 
2015
 
2014
 
Number of
Contracts
 
Recorded
Investment
 
Number of
Contracts
 
Recorded
Investment
 
(dollars in thousands)
Residential real estate
2

 
$
105

 
1

 
$
5

Total
2

 
$
105

 
1

 
$
5


The following tables provide detail related to the allowance for credit losses:
 
For the Nine Months Ended September 30, 2015
 
Commercial,
financial,
agricultural
and other
 
Real estate
construction
 
Residential
real estate
 
Commercial
real estate
 
Loans to
individuals
 
Total
 
(dollars in thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
29,627

 
$
2,063

 
$
3,664

 
$
11,881

 
$
4,816

 
$
52,051

Charge-offs
(8,579
)
 

 
(1,351
)
 
(1,249
)
 
(3,283
)
 
(14,462
)
Recoveries
922

 
84

 
417

 
186

 
502

 
2,111

Provision (credit)
5,230

 
(554
)
 
(54
)
 
1,584

 
2,612

 
8,818

Ending Balance
$
27,200

 
$
1,593

 
$
2,676

 
$
12,402

 
$
4,647

 
$
48,518

Ending balance: individually evaluated for impairment
$
4,202

 
$

 
$
20

 
$
33

 
$

 
$
4,255

Ending balance: collectively evaluated for impairment
22,998

 
1,593

 
2,656

 
12,369

 
4,647

 
44,263

Loans:
 
 
 
 
 
 
 
 
 
 
 
Ending balance
1,126,881

 
179,710

 
1,204,220

 
1,435,954

 
628,970

 
4,575,735

Ending balance: individually evaluated for impairment
22,852

 

 
6,037

 
5,706

 

 
34,595

Ending balance: collectively evaluated for impairment
1,104,029

 
179,710

 
1,198,183

 
1,430,248

 
628,970

 
4,541,140

 

25

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


 
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
 
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 Three Months Ended September 30, 2015
 
Commercial,
financial,
agricultural
and other
 
Real estate
construction
 
Residential
real estate
 
Commercial
real estate
 
Loans to
individuals
 
 
Total
 
(dollars in thousands)
Allowance for credit losses:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning Balance
$
23,755

 
$
1,518

 
$
2,923

 
$
12,227

 
$
4,921

 
 
$
45,344

Charge-offs
(639
)
 

 
(301
)
 
(561
)
 
(900
)
 
 
(2,401
)
Recoveries
564

 

 
178

 
33

 
179

 
 
954

Provision (credit)
3,520

 
75

 
(124
)
 
703

 
447

 
 
4,621

Ending Balance
$
27,200

 
$
1,593

 
$
2,676

 
$
12,402

 
$
4,647

 
 
$
48,518

 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 
 
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


Note 9 Income Taxes
At September 30, 2015 and December 31, 2014, 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 2012 through 2014 were open for examination as of September 30, 2015.

26

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


Note 10 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:
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, loans held for sale, interest rate derivatives (including 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 recorded in the Condensed Consolidated Statements of Financial Condition are comprised of FHLB stock whose estimated fair value is based on its par value. Additional information on FHLB stock is provided in Note 7, “Impairment of Investment Securities.”
Loans held for sale include residential mortgage loans originated for sale in the secondary mortgage market. The estimated fair value for these loans was determined on the basis of rates obtained in the respective secondary market.
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 11, “Derivatives.”

27

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


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 2015, 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 United States. There has been little or no active trading in these securities since 2009; therefore, 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 7, “Impairment of Investment Securities.” The discount rate applied to the cash flows is determined by evaluating the current market yields for comparable corporate and structured credit products along with an evaluation of the risks associated with the cash flows of the comparable security. Due to the fact that there is no active market for the 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).

28

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


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
$
35,779

 
Discounted Cash Flow
 
Probability of default
 
0% - 100% (13.72%)
 
 
 
 
 
Prepayment rates
 
0% - 73.52% (5.09%)
 
 
 
 
 
Discount rates
 
5.25% - 12.00% (a)
Equities
1,920

 
Par Value
 
N/A
 
N/A
Impaired Loans
2,903
 (b)
 
Reserve study
 
Discount rate
 
10.00%
 
 
 
 
 
Gas per MCF
 
$2.71 - $3.48 (c)
 
 
 
 
 
Oil per BBL/d
 
$55.00 (c)
 
520
 (b)
 
Discounted Cash Flow
 
Discount Rate
 
1.90%
Other Real Estate Owned
8

 
Internal Valuation
 
N/A
 
N/A
 
(a)
incorporates spread over risk free rate related primarily to credit quality and illiquidity of securities.
(b)
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.
(c)
unobservable inputs are defined as follows: MCF - million cubic feet; BBL/d - barrels per day.
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 a higher fair value measurement. Other unobservable inputs in the fair value measurement of impaired loans relate to gas, oil and natural gas prices. Increases in these prices 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.

29

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


The tables below present the balances of assets and liabilities measured at fair value on a recurring basis:
 
September 30, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
Mortgage-Backed Securities - Residential
$

 
$
23,281

 
$

 
$
23,281

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

 
824,152

 

 
824,152

Mortgage-Backed Securities - Commercial

 
38

 

 
38

Other Government-Sponsored Enterprises

 
135,781

 

 
135,781

Obligations of States and Political Subdivisions

 
27,449

 

 
27,449

Corporate Securities

 
2,333

 

 
2,333

Pooled Trust Preferred Collateralized Debt Obligations

 

 
35,779

 
35,779

Total Debt Securities

 
1,013,034

 
35,779

 
1,048,813

Equities

 

 
1,920

 
1,920

Total Securities Available for Sale

 
1,013,034

 
37,699

 
1,050,733

Other Investments

 
53,976

 

 
53,976

Loans held for sale

 
4,986

 

 
4,986

Other Assets(a)

 
16,303

 

 
16,303

Total Assets
$

 
$
1,088,299

 
$
37,699

 
$
1,125,998

Other Liabilities(a)
$

 
$
14,333

 
$

 
$
14,333

Total Liabilities
$

 
$
14,333

 
$

 
$
14,333

(a)
Hedging and non-hedging interest rate derivatives

 
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Obligations of U.S. Government Agencies:
 
 
 
 
 
 
 
Mortgage-Backed Securities - Residential
$

 
$
25,936

 
$

 
$
25,936

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

 
950,881

 

 
950,881

Mortgage-Backed Securities - Commercial

 
74

 

 
74

Other Government-Sponsored Enterprises

 
267,877

 

 
267,877

Obligations of States and Political Subdivisions

 
27,377

 

 
27,377

Corporate Securities

 
7,255

 

 
7,255

Pooled Trust Preferred Collateralized Debt Obligations

 

 
28,999

 
28,999

Total Debt Securities

 
1,279,400

 
28,999

 
1,308,399

Equities

 

 
1,420

 
1,420

Total Securities Available for Sale

 
1,279,400

 
30,419

 
1,309,819

Other Investments

 
44,545

 

 
44,545

Loans Held for Sale

 
2,502

 

 
2,502

Other Assets(a)

 
11,186

 

 
11,186

Total Assets
$

 
$
1,337,633

 
$
30,419

 
$
1,368,052

Other Liabilities(a)
$

 
$
10,671

 
$

 
$
10,671

Total Liabilities
$

 
$
10,671

 
$

 
$
10,671

(a)
Hedging and non-hedging interest rate derivatives


30

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


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:
 
2015
 
Pooled Trust Preferred Collateralized Debt Obligations
 
Equities
 
Total
 
(dollars in thousands)
Balance, beginning of period
$
28,999

 
$
1,420

 
$
30,419

Total gains or losses
 
 
 
 
 
Included in earnings
105

 

 
105

Included in other comprehensive income
7,729

 

 
7,729

Purchases, issuances, sales, and settlements
 
 
 
 
 
Purchases

 
500

 
500

Issuances

 

 

Sales

 

 

Settlements
(1,054
)
 

 
(1,054
)
Transfers into Level 3

 

 

Balance, end of period
$
35,779

 
$
1,920

 
$
37,699

 
 
2014
 
Pooled Trust Preferred Collateralized Debt Obligations
 
Equities
 
Loans Held for Sale
 
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

During the nine months ended September 30, 2015 and 2014, there were no transfers between fair value Levels 1 and 2. During the nine months ended September 30, 2015, there were no transfers between fair value Levels 2 and 3. However, $3.0 million of loans were transferred into Level 3 from Level 2 during the nine months ended September 30, 2014 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, 2015 and 2014.

31

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


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:

 
2015
 
Pooled Trust Preferred Collateralized Debt Obligations
 
Equities
 
Total
 
(dollars in thousands)
Balance, beginning of period
$
35,521

 
$
1,920

 
$
37,441

Total gains or losses
 
 
 
 
 
Included in earnings

 

 

Included in other comprehensive income
258

 

 
258

Purchases, issuances, sales, and settlements
 
 
 
 
 
Purchases

 

 

Issuances

 

 

Sales

 

 

Settlements

 

 

Transfers into Level 3

 

 

Balance, end of period
$
35,779

 
$
1,920

 
$
37,699

 
2014
 
Pooled Trust Preferred Collateralized Debt Obligations
 
Equities
 
Loans Held for Sale
 
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
)
Transfers into Level 3

 

 

 

Balance, end of period
$
29,456

 
$
1,420

 
$

 
$
30,876

During the three months ended September 30, 2015 and 2014, there were no transfers between fair value Levels 1 and 2.
The tables below present the balances of assets measured at fair value on a non-recurring basis at:
 
September 30, 2015
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Impaired loans
$

 
$
26,916

 
$
9,656

 
$
36,572

Other real estate owned

 
12,386

 
8

 
12,394

Total Assets
$

 
$
39,302

 
$
9,664

 
$
48,966


32

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


 
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Total
 
(dollars in thousands)
Impaired loans
$

 
$
34,864

 
$
10,926

 
$
45,790

Other real estate owned

 
7,828

 
153

 
7,981

Total Assets
$

 
$
42,692

 
$
11,079

 
$
53,771

The following 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,
 
2015
 
2014
 
2015
 
2014
 
(dollars in thousands)
Impaired loans
$
(2,838
)
 
$
456

 
$
(3,532
)
 
$
(1,291
)
Other real estate owned
(78
)
 
(51
)
 
(1,205
)
 
(1,109
)
Total losses
$
(2,916
)
 
$
405

 
$
(4,737
)
 
$
(2,400
)
Impaired loans over $100 thousand 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 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 $10.5 million as of September 30, 2015 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 12, “Goodwill.” There were no other assets or liabilities measured at fair value on a non-recurring basis during the nine months ended September 30, 2015.
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 and held to maturity are based on quoted market prices, if available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. 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

33

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


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.”
Loans Held for Sale: The estimated fair value of loans held for sale is based on market bids obtained from potential buyers.
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 $0.2 million at September 30, 2015 and December 31, 2014, respectively. See Note 5, “Commitments and Contingent Liabilities,” for additional information.
Deposit liabilities: The 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.
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, 2015
 
 
 
Fair Value Measurements Using:
 
Carrying
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(dollars in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
69,235

 
$
69,235

 
$
69,235

 
$

 
$

Interest-bearing deposits
3,529

 
3,529

 
3,529

 

 

Securities available for sale
1,050,733

 
1,050,733

 

 
1,013,034

 
37,699

Securities held to maturity
154,035

 
154,837

 

 
154,837

 

Other investments
53,976

 
53,976

 

 
53,976

 

Loans held for sale
4,986

 
4,986

 

 
4,986

 

Loans
4,575,735

 
4,596,889

 

 
26,916

 
4,569,973

Financial liabilities
 
 
 
 
 
 
 
 
 
Deposits
4,161,490

 
4,164,660

 

 
4,164,660

 

Short-term borrowings
1,329,794

 
1,329,920

 

 
1,329,920

 

Subordinated debt
72,167

 
62,227

 

 

 
62,227

Long-term debt
39,052

 
39,704

 

 
39,704

 



34

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


 
December 31, 2014
 
 
 
Fair Value Measurements Using:
 
Carrying
Amount
 
Total
 
Level 1
 
Level 2
 
Level 3
 
(dollars in thousands)
Financial assets
 
 
 
 
 
 
 
 
 
Cash and due from banks
$
72,276

 
$
72,276

 
$
72,276

 
$

 
$

Interest-bearing deposits
2,262

 
2,262

 
2,262

 

 

Securities available for sale
1,309,819

 
1,309,819

 

 
1,279,400

 
30,419

Other investments
44,545

 
44,545

 

 
44,545

 

Loans held for sale
2,502

 
2,502

 

 
2,502

 

Loans
4,457,308

 
4,439,766

 

 
34,864

 
4,404,902

Financial liabilities
 
 
 
 
 
 
 
 
 
Deposits
4,315,511

 
4,319,997

 

 
4,319,997

 

Short-term borrowings
1,105,876

 
1,105,867

 

 
1,105,867

 

Subordinated debt
72,167

 
62,815

 

 

 
62,815

Long-term debt
89,459

 
90,319

 

 
90,319

 

Note 11 Derivatives
Derivatives Not Designated as Hedging Instruments
First Commonwealth is a party to interest rate derivatives that are not designated as hedging instruments. These derivatives relate to interest rate swaps that First Commonwealth enters into with customers to allow customers to convert variable rate loans to a fixed rate. First Commonwealth pays interest to the customer at a floating rate on the notional amount and receives interest from the customer at a fixed rate for the same notional amount. At the same time the interest rate swap is entered into with the customer, an offsetting interest rate swap is entered into with another financial institution. First Commonwealth pays the other financial institution interest at the same fixed rate on the same notional amount as the swap entered into with the customer, and receives interest from the financial institution for the same floating rate on the same notional amount.
The changes in the 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 fifteen 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 three 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 that provide 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
The Company has entered into four interest rate swap contracts that were designated as cash flow hedges. The interest rate swaps have a total notional amount of $200.0 million, $85.0 million with an original maturity of three years and $115.0 million with and original maturity of four years. 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 $200.0 million of 1-month LIBOR based commercial loans into fixed rate payments.

35

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


The periodic net settlement of interest rate swaps is recorded as an adjustment to Interest and fees on loans in the Condensed Consolidated Statements of Income. For the nine months ended September 30, 2015, there was a $1.5 million 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 Statements of Income as the income on the hedged items. The cash flow hedges were highly effective at September 30, 2015, and December 31, 2014, and changes in the fair value attributed to hedge ineffectiveness were not material.
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, 2015
 
December 31, 2014
 
(dollars in thousands)
Derivatives not Designated as Hedging Instruments
 
 
 
Credit value adjustment
$
(688
)
 
$
(268
)
Notional Amount:
 
 
 
Interest rate derivatives
271,371

 
273,388

Interest rate caps
23,447

 
6,656

Risk participation agreements
124,116

 
113,624

Sold credit protection on risk participation agreements
(17,635
)
 
(17,296
)
Derivatives Designated as Hedging Instruments
 
 
 
Fair value adjustment
2,644

 
472

Notional Amount - Interest rate derivatives
200,000

 
100,000

 
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,
 
2015
 
2014
 
2015
 
2014
 
(dollars in thousands)
Non-hedging interest rate derivatives
 
 
 
 
 
 
 
(Decrease) increase in other income
$
(783
)
 
$
(108
)
 
$
(420
)
 
$
175

Hedging interest rate derivatives
 
 
 
 
 
 
 
Increase in interest and fees on loans
565

 
29

 
1,503

 
29

Increase in other expense

 

 
21

 

Note 12 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 that 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.
We consider First Commonwealth to be one reporting unit. The carrying amount of goodwill as of September 30, 2015 and December 31, 2014 was $161.4 million. No impairment charges on goodwill or other intangible assets were incurred in 2015 or 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.
As of September 30, 2015, goodwill was not considered impaired; however, changing economic conditions that may adversely affect our performance, the fair value of our assets and liabilities, or our stock price could result in impairment, which could

36

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


adversely affect earnings in future periods. Management will continue to monitor events that could impact this conclusion in the future.
Note 13 Subsequent Events

On October 1, 2015, First Commonwealth Bank, the banking subsidiary of First Commonwealth Financial Corporation, completed its acquisition of Columbus, Ohio based First Community Bank in an all-cash deal valued at $14.8 million. First Community Bank has assets of $102.8 million and four branch locations which will operate under the First Commonwealth name.

Note 14 New Accounting Pronouncements
In January 2015, the FASB issued ASU No. 2015-01, "Income Statement - Extraordinary and Unusual Items (Subtopic 225-20)," which finalizes Proposed ASU No. 2014-220, and eliminates the concept of extraordinary items from U.S. GAAP. Accordingly, this ASU eliminates FASB ASC Subtopic 225-20, "Income Statement - Extraordinary and Unusual Items", which, until now, required that an entity separately classify, present, and disclose extraordinary events and transactions. This ASU is effective for fiscal years, and interim periods within those fiscal years, 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 September 2015, the FASB issued ASU No. 2015-16, "Business Combinations (Topic 805)," requires that the acquirer recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which the adjustment amounts are determined. The adjustments are required to be presented separately on the face of the income statement or disclosed in the notes to show the portion of current-period earnings by line item that would have been recorded in previous reporting periods if the adjustments to the provisional amounts had been recognized as of the acquisition date. This ASU is effective for fiscal years, and interim periods within those fiscal years, 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.

37

Table of Contents



ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES
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 nine months ended September 30, 2015 and 2014, 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, notwithstanding that such statements are not specifically identified as such. In addition, certain statements may be contained in our future filings with the Securities and Exchange Commission, in press releases, and in oral and written statements made by us or with our approval that are not statements of historical fact and constitute “forward-looking statements” as well. 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, including, but not limited to: (1) local, regional, national and international economic conditions and the impact they may have on First Commonwealth and its customers; (2) volatility and disruption in national and international financial markets; (3) the effects of and changes in trade and monetary and fiscal policies and laws, including the interest rate policies of the Federal Reserve Board; (4) inflation, interest rate, commodity price, securities market and monetary fluctuations; (5) the effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, securities and insurance) with which First Commonwealth or its customers must comply; (6) the soundness of other financial institutions; (7) political instability; (8) impairment of First Commonwealth’s goodwill or other intangible assets; (9) acts of God or of war or terrorism; (10) the timely development and acceptance of new products and services and perceived overall value of these products and services by users; (11) changes in consumer spending, borrowings and savings habits; (12) changes in the financial performance and/or condition of First Commonwealth’s borrowers; (13) technological changes; (14) acquisitions and integration of acquired businesses; (15) First Commonwealth’s ability to attract and retain qualified employees; (16) changes in the competitive environment in First Commonwealth’s markets and among banking organizations and other financial service providers; (17) the ability to increase market share and control expenses; (18) the effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters; (19) the reliability of First Commonwealth’s vendors, internal control systems or information systems; (20) the costs and effects of legal and regulatory developments, the resolution of legal proceedings or regulatory or other governmental inquiries, the results of regulatory examinations or reviews and the ability to obtain required regulatory approvals; and (21) 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.
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 pages 40 and 47 for the nine and three months ended September 30, 2015 and 2014, respectively.

38

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



Selected Financial Data
The following selected financial data is not covered by the auditor’s report and should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations, which follows, and with the Condensed Consolidated Financial Statements and related notes. 
 
For the Three Months Ended September 30,
 
For the Nine Months Ended September 30,
 
2015
 
2014
 
2015
 
2014
 
(dollars in thousands, except per share data)
Net Income
$
12,414

 
$
12,496

 
$
40,082

 
$
36,724

Per Share Data:
 
 
 
 
 
 
 
Basic Earnings per Share
$
0.14

 
$
0.13

 
$
0.45

 
$
0.39

Diluted Earnings per Share
0.14

 
0.13

 
0.45

 
0.39

Cash Dividends Declared per Common Share
0.07

 
0.07

 
0.21

 
0.21

Average Balance:
 
 
 
 
 
 
 
Total assets
$
6,343,009

 
$
6,325,068

 
$
6,354,128

 
$
6,260,109

Total equity
718,178

 
717,859

 
716,200

 
719,002

End of Period Balance:
 
 
 
 
 
 
 
Net loans
 
 
 
 
$
4,532,203

 
$
4,360,697

Total assets
 
 
 
 
6,384,749

 
6,356,098

Total deposits
 
 
 
 
4,161,490

 
4,372,388

Total equity
 
 
 
 
722,768

 
709,484

Key Ratios:
 
 
 
 
 
 
 
Return on average assets
0.78
%
 
0.78
%
 
0.84
%
 
0.78
%
Return on average equity
6.86
%
 
6.91
%
 
7.48
%
 
6.83
%
Dividends payout ratio
50.00
%
 
53.85
%
 
46.67
%
 
53.85
%
Average equity to average assets ratio
11.32
%
 
11.35
%
 
11.27
%
 
11.49
%
Net interest margin
3.25
%
 
3.26
%
 
3.29
%
 
3.28
%
Net loans to deposits ratio
 
 
 
 
108.91
%
 
99.73
%

Results of Operations
Nine Months Ended September 30, 2015 Compared to Nine Months Ended September 30, 2014
Net Income
For the nine months ended September 30, 2015, First Commonwealth had net income of $40.1 million, or $0.45 diluted earnings per share, compared to net income of $36.7 million, or $0.39 diluted earnings per share, in the nine months ended September 30, 2014. The increase in net income was primarily the result of an increase in net interest income and declines in noninterest expense, partially offset by declines in noninterest income.
For the nine months ended September 30, 2015, the Company’s return on average equity was 7.48% and its return on average assets was 0.84%, compared to 6.83% and 0.78%, respectively, for the nine months ended September 30, 2014.
Net Interest Income
Net interest income, on a fully taxable equivalent basis, was $142.8 million in the first nine months of 2015, compared to $140.0 million for the same period in 2014. This increase was primarily due to growth in earning assets of $105.9 million, an 8 basis point, or $2.7 million, decrease in interest expense and a $1.0 million special dividend on FHLB stock received in 2015. Net interest income comprises a majority of our operating revenue (net interest income before provision expense plus noninterest income) at 75% for the nine months ended September 30, 2015 and 2014. The net interest margin, on a fully taxable equivalent basis, was 3.29% and 3.28% for the nine months ended September 30, 2015 and September 30, 2014, respectively.


39

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



 
The taxable equivalent yield on interest-earning assets was 3.55% for the nine months ended September 30, 2015, a decrease of 7 basis points compared to the 3.62% yield for the same period in 2014. Growth in earning assets has helped to offset the spread compression, as average earning assets for the nine months ended September 30, 2015 increased $105.9 million, or 2%, compared to the same period in 2014. Average loans for the nine months ended September 30, 2015 increased $177.8 million, or 4.1% compared to the same period in 2014. Investment portfolio purchases during the nine months ended September 30, 2015 have been primarily in mortgage-related assets with approximate durations of 48-60 months and municipal securities with a duration of five 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 offset the impact of lower yields on interest-earning assets. The cost of interest-bearing liabilities was 0.34% for the nine months ended September 30, 2015, compared to 0.42% for the same period in 2014. This decline is primarily due to a 30 basis point decrease in the cost of time deposits as maturities repriced to lower rates or were replaced with lower cost short-term borrowings.
For the nine months ended September 30, 2015, changes in interest rates negatively impacted net interest income by $4.5 million when compared with the same period in 2014. The lower yield on interest-earning assets adversely impacted net interest income by $4.5 million, while the decline in the cost of interest-bearing liabilities had a positive impact of $25 thousand. 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 offset the effect on net interest income. Changes in the volumes of interest-earning assets and interest-bearing liabilities positively impacted net interest income by $7.2 million in the nine months ended September 30, 2015, as compared to the same period in 2014. Higher levels of interest-earning assets resulted in an increase of $4.5 million in interest income, while volume changes decreased interest expense by $2.8 million, primarily as the result of changes in time deposits, including brokered deposits.
Net interest income also benefited from a $96.2 million increase in average net free funds at September 30, 2015 as compared to September 30, 2014. 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 $84.1 million, or 8.8%, in noninterest-bearing demand deposit average balances. Additionally, higher cost time deposits continue to mature and reprice into lower cost deposits or other funding alternatives. Average time deposits for the nine months ended September 30, 2015 decreased by $351.5 million compared to the comparable period in 2014.
 
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:
 
 
2015
2014
 
(dollars in thousands)
Interest income per Condensed Consolidated Statements of Income
$
151,736

$
151,761

Adjustment to fully taxable equivalent basis
2,536

2,502

Interest income adjusted to fully taxable equivalent basis (non-GAAP)
154,272

154,263

Interest expense
11,509

14,234

Net interest income adjusted to fully taxable equivalent basis (non-GAAP)
$
142,763

$
140,029




40

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



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:
 
 
2015
2014
 
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
$
3,993

$
7

0.23
%
$
4,113

$
8

0.26
%
Tax-free investment securities
34,374

994

3.87

8,998

265

3.94

Taxable investment securities
1,260,030

22,749

2.41

1,357,220

23,091

2.27

Loans, net of unearned income (b)(c)
4,509,628

130,522

3.87

4,331,807

130,899

4.04

Total interest-earning assets
5,808,025

154,272

3.55

5,702,138

154,263

3.62

Noninterest-earning assets:
 
 
 
 
 
 
Cash
66,249

 
 
71,589

 
 
Allowance for credit losses
(49,617
)
 
 
(54,986
)
 
 
Other assets
529,471

 
 
541,368

 
 
Total noninterest-earning assets
546,103

 
 
557,971

 
 
Total Assets
$
6,354,128

 
 
$
6,260,109

 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits (d)
$
653,737

$
172

0.04
%
$
636,551

$
150

0.03
%
Savings deposits (d)
1,857,077

1,872

0.13

1,875,064

1,745

0.12

Time deposits
714,005

3,743

0.70

1,065,458

8,002

1.00

Short-term borrowings
1,193,122

3,353

0.38

749,269

1,608

0.29

Long-term debt
126,896

2,369

2.50

208,818

2,729

1.75

Total interest-bearing liabilities
4,544,837

11,509

0.34

4,535,160

14,234

0.42

Noninterest-bearing liabilities and shareholders’ equity:
 
 
 
 
 
 
Noninterest-bearing demand deposits (d)
1,038,016

 
 
953,946

 
 
Other liabilities
55,075

 
 
52,001

 
 
Shareholders’ equity
716,200

 
 
719,002

 
 
Total Noninterest-Bearing Funding Sources
1,809,291

 
 
1,724,949

 
 
Total Liabilities and Shareholders’ Equity
$
6,354,128

 
 
$
6,260,109

 
 
Net Interest Income and Net Yield on Interest-Earning Assets
 
$
142,763

3.29
%
 
$
140,029

3.28
%
(a)
Income on interest-earning assets has been computed on a fully taxable equivalent basis using the 35% federal income tax statutory rate.
(b)
Loan balances include held for sale and nonaccrual loans. Income on nonaccrual loans is accounted for on the cash basis.
(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.

 

41

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



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, 2015 compared with September 30, 2014:
 
 
 
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
 
$
(1
)
 
$

 
$
(1
)
Tax-free investment securities
 
729

 
748

 
(19
)
Taxable investment securities
 
(342
)
 
(1,650
)
 
1,308

Loans
 
(377
)
 
5,373

 
(5,750
)
Total interest income (b)
 
9

 
4,471

 
(4,462
)
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits
 
22

 
4

 
18

Savings deposits
 
127

 
(16
)
 
143

Time deposits
 
(4,259
)
 
(2,629
)
 
(1,630
)
Short-term borrowings
 
1,745

 
963

 
782

Long-term debt
 
(360
)
 
(1,072
)
 
712

Total interest expense
 
(2,725
)
 
(2,750
)
 
25

Net interest income
 
$
2,734

 
$
7,221

 
$
(4,487
)
 
(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 for 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:
 
 
2015
 
2014
 
Dollars
Percentage
 
Dollars
Percentage
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
5,230

59
 %
 
$
4,773

55
 %
Real estate construction
(554
)
(6
)
 
1,331

16

Residential real estate
(54
)
(1
)
 
(407
)
(5
)
Commercial real estate
1,584

18

 
1,453

17

Loans to individuals
2,612

30

 
1,471

17

Total
$
8,818

100
 %
 
$
8,621

100
 %
The provision for credit losses for the nine months ended September 30, 2015 increased in comparison to the nine months ended September 30, 2014 by $0.2 million, or 2%. The majority of the 2015 provision expense is attributable to commercial, financial, agricultural and other loans resulting from an increase in historical loss factors as well as specific reserves established for three loans, partially offset by the release of $1.1 million in specific reserves for loans transferred to held for sale in the first quarter of 2015. These held for sale loans were sold during the third quarter quarter of 2015, at which time a gain of $0.4 million was recognized. Provision expense for commercial real estate loans was impacted by charge-offs and increases in qualitative factors including those associated with vacancy and rents. The provision for loans to individuals is primarily due to charge-offs in the indirect automobile portfolio. Real estate construction and residential real estate reflect a negative provision expense due to a decline in historical loss factors for these categories.

42

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



The majority of the 2014 provision expense is attributable to specific reserves for one oil and gas servicing company which was transferred to nonaccrual status in the first quarter of 2014 and sold during the second quarter of 2014.
The allowance for credit losses was $48.5 million, or 1.06%, of total loans outstanding at September 30, 2015, compared to $52.1 million, or 1.17%, at December 31, 2014 and $50.8 million, or 1.15%, at September 30, 2014. The change compared to December 31, 2014, can be attributed to a $3.2 million, or 2%, decrease in criticized loans, which includes a reduction of $14.4 million, or 26%, in nonperforming loans as well as a $5.2 million decrease in the level of specific reserves held on impaired loans. Nonperforming loans as a percentage of total loans decreased to 0.89% at September 30, 2015 from 1.24% at December 31, 2014 and 1.03% as of September 30, 2014. The allowance to nonperforming loan ratio was 118.84%, 94.21% and 112.21% as of September 30, 2015, December 31, 2014 and September 30, 2014, respectively.
 
Below is an analysis of the consolidated allowance for credit losses for the nine months ended September 30, 2015 and 2014 and the year-ended December 31, 2014:
 
 
 
September 30, 2015
 
September 30, 2014
 
December 31, 2014
 
 
(dollars in thousands)
Balance, beginning of period
 
$
52,051

 
$
54,225

 
$
54,225

Loans charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
8,579

 
8,357

 
8,911

Real estate construction
 

 
296

 
296

Residential real estate
 
1,351

 
2,286

 
3,153

Commercial real estate
 
1,249

 
1,109

 
1,148

Loans to individuals
 
3,283

 
2,581

 
3,964

Total loans charged off
 
14,462

 
14,629

 
17,472

Recoveries of loans previously charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
922

 
625

 
734

Real estate construction
 
84

 
469

 
1,340

Residential real estate
 
417

 
420

 
650

Commercial real estate
 
186

 
432

 
612

Loans to individuals
 
502

 
621

 
766

Total recoveries
 
2,111

 
2,567

 
4,102

Net credit losses
 
12,351

 
12,062

 
13,370

Provision charged to expense
 
8,818

 
8,621

 
11,196

Balance, end of period
 
$
48,518

 
$
50,784

 
$
52,051



43

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



Noninterest Income
The following table presents the components of noninterest income for the nine months ended September 30: 
 
 
2015
 
2014
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Income:
 
 
 
 
 
 
 
 
Trust income
 
$
4,511

 
$
4,587

 
$
(76
)
 
(2
)%
Service charges on deposit accounts
 
11,271

 
12,032

 
(761
)
 
(6
)
Insurance and retail brokerage commissions
 
6,536

 
4,704

 
1,832

 
39

Income from bank owned life insurance
 
4,089

 
4,131

 
(42
)
 
(1
)
Card related interchange income
 
10,784

 
10,620

 
164

 
2

Other income
 
5,863

 
6,185

 
(322
)
 
(5
)
Subtotal
 
43,054

 
42,259

 
795

 
2

Net securities gains
 
125

 
50

 
75

 
150

Gain on sale of loans
 
2,262

 
143

 
2,119

 
1,482

Gain on sale of other assets
 
1,022

 
4,345

 
(3,323
)
 
(76
)
Derivatives mark to market (expense) income
 
(420
)
 
175

 
(595
)
 
(340
)
Total noninterest income
 
$
46,043

 
$
46,972

 
$
(929
)
 
(2
)%
 
Noninterest income, excluding net securities gains, gain on sale of loans and other assets and the derivative mark to market, increased $0.8 million, or 2%, for the first nine months of 2015 compared to 2014. Insurance and retail brokerage commissions increased $1.8 million as a result of increased production and an agency acquisition in the fourth quarter of 2014. Offsetting that increase is a $0.8 million decrease in service charges on deposit accounts and a $0.3 million decrease in the other income category. The decrease in service charge on deposits is a result of lower overdraft fees, and the decline in other income can be attributed to $0.3 million in revenue recognized in 2014 from our registered investment advisory business, which was sold in the first quarter of 2014.
Total noninterest income for the nine months ended September 30, 2015 decreased $0.9 million in comparison to the nine months ended September 30, 2014. The most significant change includes a $3.3 million decrease in gain on sale of other assets as a result of a $1.2 million gain recognized in 2014 from the sale of the Company's registered investment advisory business and the sale of three OREO properties that resulted in gains of $2.4 million. Additionally, the quarterly fair value adjustment on derivatives resulted in a $0.6 million decrease in income as a result of changes in corporate bond spreads and swap rates during the nine month period. Offsetting these decreases is a $2.1 million increase in the gain on sale of loans primarily due to the Company reentering the secondary mortgage market.


44

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



Noninterest Expense
The following table presents the components of noninterest expense for the nine months ended September 30: 
 
 
2015
 
2014
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Expense:
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
$
66,339

 
$
65,185

 
$
1,154

 
2
 %
Net occupancy expense
 
10,518

 
9,969

 
549

 
6

Furniture and equipment expense - excluding IT conversion
 
7,980

 
9,473

 
(1,493
)
 
(16
)
Data processing expense
 
4,505

 
4,593

 
(88
)
 
(2
)
Advertising and promotion expense
 
1,946

 
2,346

 
(400
)
 
(17
)
Pennsylvania shares tax expense
 
3,617

 
2,782

 
835

 
30

Intangible amortization
 
469

 
530

 
(61
)
 
(12
)
Collection and repossession expense
 
2,229

 
1,941

 
288

 
15

Other professional fees and services
 
2,882

 
2,777

 
105

 
4

FDIC insurance
 
3,047

 
3,026

 
21

 
1

Other operating expenses
 
13,539

 
13,008

 
531

 
4

Subtotal
 
117,071

 
115,630

 
1,441

 
1

Loss on sale or write-down of assets
 
2,037

 
1,241

 
796

 
64

Furniture and equipment expense - related to IT conversion
 

 
5,577

 
(5,577
)
 
(100
)%
Conversion related expenses
 

 
1,676

 
(1,676
)
 
(100
)%
Operational losses (recoveries)
 
1,637

 
(273
)
 
1,910

 
700
 %
Total noninterest expense
 
$
120,745

 
$
123,851

 
$
(3,106
)
 
(3
)%

Noninterest expense, excluding loss on sale or write-down of assets, furniture and equipment expense related to IT conversion, conversion related expenses and operational losses (recoveries), increased $1.4 million, or 1%, for the nine months ended September 30, 2015 compared to the same period in 2014. Contributing to the 2015 increases are $1.2 million in salary and employee benefits expense due to strategic initiatives such as the launch of the mortgage initiative and the acquisition of an insurance agency as well as normal merit increases. Net occupancy increased $0.5 million due to higher property taxes and building repairs, and collection and repossession expense increased $0.3 million primarily due to costs related to one commercial relationship.

Pennsylvania shares tax expense increased $0.8 million as the result of a $0.7 million agreement reached for a disputed tax assessment. The dispute related to the capital treatment of minority interest in a non-controlled subsidiary for the years 2011, 2012 and 2013. Prior to the third quarter of 2015, the Company believed it would prevail on its appeal of the assessment based on the intention of the tax statute, which specifically excluded minority interests from the shares tax assessment base. However, during the third quarter of 2015, the Pennsylvania Commonwealth Court settled the first case related to this issue which set the precedent for all other appeals on this issue. As a result, the Company agreed to a similar settlement. There are no other tax years open for assessment of this minority interest issue.

Offsetting these increases is a $1.5 million decrease in furniture and equipment expense due to declines in equipment and software maintenance costs as a result of the IT system conversion which was completed in the third quarter of 2014.

Loss on sale or write-down of assets for the nine months ended September 30, 2015 increased $0.8 million as compared to the same period in 2014. The loss in 2015 includes $1.1 million in write-downs on three OREO properties recognized as a result of updated appraisals as well as a $0.4 million write-down due to the anticipated sale of a bank building. The sale of this building and closing of the related branch office is estimated to provide $0.2 million in annual savings. The loss on sale or write-down of assets for the nine months ended September 30, 2014 included a $0.7 million write-down on one OREO property.

Operational losses (recoveries) increased $1.9 million for the nine months ended September 30, 2015. In the first nine months of 2015, operational losses are largely due to fraud losses recognized in conjunction with several merchant debit card breaches. The negative expense recognized in the nine months ended September 30, 2014 is a result of a $0.9 million insurance recovery related to a fraud loss recognized in 2012.

45

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




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. Expenses related to the conversion included 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.
Income Tax
The provision for income taxes increased $1.3 million for the nine months ended September 30, 2015, compared to the corresponding period in 2014. The higher provision for income taxes was the result of a $4.7 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, 2015 and 2014.
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 29.3% and 29.4% for the nine months ended September 30, 2015 and 2014, respectively.
As of September 30, 2015, our deferred tax assets totaled $32.0 million. Based on our evaluation as of September 30, 2015, we determined that it is more likely than not that all of these assets will be realized. As a result, a valuation allowance against these assets was not needed. 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, 2015 Compared to Three Months Ended September 30, 2014

Net Income
For the three months ended September 30, 2015, First Commonwealth had net income of $12.4 million, or $0.14 per share, compared to net income of $12.5 million, or $0.13 per share, in the three months ended September 30, 2014. For the three months ended September 30, 2015, the Company’s return on average equity was 6.86% and its return on average assets was 0.78%, compared to 6.91% and 0.78%, respectively, for the three months ended September 30, 2014. The decrease in net income was primarily the result of an increase in the provision for credit losses offset by declines in noninterest expense and an increase in noninterest income.

Net Interest Income
Net interest income, on a fully taxable equivalent basis, was $47.6 million in the third quarter of 2015, compared to $47.4 million for the same period in 2014. This increase was primarily due a growth in interest-earning assets and a decline in the cost of interest-bearing liabilities. The net interest margin, on a fully taxable equivalent basis, was 3.25% and 3.26% for the three months ended September 30, 2015 and September 30, 2014, respectively.
 
The taxable equivalent yield on interest-earning assets was 3.52% for the three months ended September 30, 2015, a decrease of 5 basis points compared to the 3.57% yield for the same period in 2014. Growth in earning assets has helped to offset the spread compression, as average interest-earning assets for the three months ended September 30, 2015 increased $27.7 million, or 0.5%, compared to the comparable period in 2014. Average loans increased $162.8 million, or 3.7%, comparing the three months ended September 30, 2015 to the same period in 2014. Investment portfolio purchases during the three months ended September 30, 2015 have been primarily in mortgage-related assets with approximate durations of 48-60 months and municipal securities with a duration of five 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 offset the impact of lower yields on interest-earning assets. The cost of interest-bearing liabilities was 0.34% for the three months ended September 30, 2015, compared to 0.39% for the same period

46

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



in 2014. This decline can be attributed to a 35 basis point decrease in the cost of time deposits, as maturities were repriced lower or replaced with lower cost short-term borrowings.
For the three months ended September 30, 2015, changes in interest rates negatively impacted net interest income by $1.7 million when compared with the same period in 2014. The lower yield on interest-earning assets adversely impacted net interest income by $1.5 million, while increases in the cost of short-term borrowings and long term debt resulted in a negative impact of $0.7 million.
While decreases in interest rates and yields compressed the net interest margin, increases in average interest-earning assets offset the effect on net interest income. Changes in the volumes of interest-earning assets and interest-bearing liabilities positively impacted net interest income by $1.9 million in the three months ended September 30, 2015, as compared to the same period in 2014. Higher levels of interest-earning assets resulted in an increase of $1.0 million in interest income, while volume changes decreased interest expense by $0.9 million, primarily as the result of changes in time deposits, including brokered deposits, and long-term debt.
Net interest income also benefited from a $79.8 million increase in average net free funds at September 30, 2015 as compared to September 30, 2014. 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 $69.5 million, or 7.0%, in noninterest-bearing demand deposit average balances. Additionally, higher cost time deposits continue to mature and reprice into lower cost deposits or other funding alternatives. Average time deposits for the three months ended September 30, 2015 decreased by $295.0 million compared to the comparable period in 2014.

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:
 
2015
 
2014
 
(dollars in thousands)
Interest income per Condensed Consolidated Statements of Income
$
50,501

 
$
51,089

Adjustment to fully taxable equivalent basis
883

 
811

Interest income adjusted to fully taxable equivalent basis (non-GAAP)
51,384

 
51,900

Interest expense
3,816

 
4,536

Net interest income adjusted to fully taxable equivalent basis (non-GAAP)
$
47,568

 
$
47,364



47

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



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:
 
 
2015
2014
 
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
$
3,221

$
2

0.25
%
$
4,758

$
4

0.33
%
Tax-free investment securities
41,671

401

3.82

16,233

160

3.91

Taxable investment securities
1,203,603

7,155

2.36

1,362,563

7,781

2.27

Loans, net of unearned income (b)(c)
4,550,882

43,826

3.82

4,388,130

43,955

3.97

Total interest-earning assets
5,799,377

51,384

3.52

5,771,684

51,900

3.57

Noninterest-earning assets:
 
 
 
 
 
 
Cash
66,685

 
 
71,391

 
 
Allowance for credit losses
(47,152
)
 
 
(52,522
)
 
 
Other assets
524,099

 
 
534,515

 
 
Total noninterest-earning assets
543,632

 
 
553,384

 
 
Total Assets
$
6,343,009

 
 
$
6,325,068

 
 
Liabilities and Shareholders’ Equity
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits (d)
$
656,008

$
66

0.04
%
$
633,213

$
49

0.03
%
Savings deposits (d)
1,848,508

647

0.14

1,832,914

578

0.13

Time deposits
659,445

1,044

0.63

954,474

2,347

0.98

Short-term borrowings
1,232,795

1,279

0.41

940,156

662

0.28

Long-term debt
111,285

780

2.78

199,435

900

1.79

Total interest-bearing liabilities
4,508,041

3,816

0.34

4,560,192

4,536

0.39

Noninterest-bearing liabilities and shareholders’ equity:
 
 
 
 
 
 
Noninterest-bearing demand deposits (d)
1,065,204

 
 
995,690

 
 
Other liabilities
51,586

 
 
51,327

 
 
Shareholders’ equity
718,178

 
 
717,859

 
 
Total noninterest-bearing funding sources
1,834,968

 
 
1,764,876

 
 
Total Liabilities and Shareholders’ Equity
$
6,343,009

 
 
$
6,325,068

 
 
Net Interest Income and Net Yield on Interest-Earning Assets
 
$
47,568

3.25
%
 
$
47,364

3.26
%
(a)
Income on interest-earning assets has been computed on a fully taxable equivalent basis using the 35% federal income tax statutory rate.
(b)
Loan balances include held for sale and nonaccrual loans. Income on nonaccrual loans is accounted for on the cash basis.
(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.

 

48

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



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, 2015 compared with September 30, 2014:
 
 
 
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
 
241

 
251

 
(10
)
Taxable investment securities
 
(626
)
 
(910
)
 
284

Loans
 
(129
)
 
1,629

 
(1,758
)
Total interest income (b)
 
(516
)
 
969

 
(1,485
)
Interest-bearing liabilities:
 
 
 
 
 
 
Interest-bearing demand deposits
 
17

 
2

 
15

Savings deposits
 
69

 
5

 
64

Time deposits
 
(1,303
)
 
(729
)
 
(574
)
Short-term borrowings
 
617

 
207

 
410

Long-term debt
 
(120
)
 
(398
)
 
278

Total interest expense
 
(720
)
 
(913
)
 
193

Net interest income
 
$
204

 
$
1,882

 
$
(1,678
)
 
(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 for 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:
 
 
2015
 
2014
 
Dollars
Percentage
 
Dollars
Percentage
 
(dollars in thousands)
Commercial, financial, agricultural and other
$
3,520

76
 %
 
$
(1,958
)
(94
)%
Real estate construction
75

2

 
2,073

100

Residential real estate
(124
)
(3
)
 
(217
)
(11
)
Commercial real estate
703

15

 
1,528

74

Loans to individuals
447

10

 
647

31

Total
$
4,621

100
 %
 
$
2,073

100
 %
The provision for credit losses for the three months ended September 30, 2015 increased in comparison to the three months ended September 30, 2014 by $2.5 million, or 123%. The majority of the 2015 provision expense is attributable to commercial, financial, agricultural and other loans because of a $2.5 million increase in specific reserves for two impaired loans. Increases in the commercial real estate and loans to individual categories are the result of charge-offs during the quarter, while the negative provision for residential real estate can be attributed to declines in qualitative factors, including those associated with inflation and wages.
The majority of the 2014 provision expense is attributable to loan growth in the real estate construction and commercial real estate categories, as well as increases in qualitative factors such as those associated with vacancy, capitalization rates and absorption.


49

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



Below is an analysis of the consolidated allowance for credit losses for three months ended September 30, 2015 and 2014 and the year-ended December 31, 2014:
 
 
 
September 30, 2015
 
September 30, 2014
 
December 31, 2014
 
 
(dollars in thousands)
Balance, beginning of period
 
$
45,344

 
$
50,725

 
$
54,225

Loans charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
639

 
498

 
8,911

Real estate construction
 

 

 
296

Residential real estate
 
301

 
551

 
3,153

Commercial real estate
 
561

 
812

 
1,148

Loans to individuals
 
900

 
1,019

 
3,964

Total loans charged off
 
2,401

 
2,880

 
17,472

Recoveries of loans previously charged off:
 
 
 
 
 
 
Commercial, financial, agricultural and other
 
564

 
204

 
734

Real estate construction
 

 
132

 
1,340

Residential real estate
 
178

 
97

 
650

Commercial real estate
 
33

 
177

 
612

Loans to individuals
 
179

 
256

 
766

Total recoveries
 
954

 
866

 
4,102

Net credit losses
 
1,447

 
2,014

 
13,370

Provision charged to expense
 
4,621

 
2,073

 
11,196

Balance, end of period
 
$
48,518

 
$
50,784

 
$
52,051


Noninterest Income
The following table presents the components of noninterest income for the three months ended September 30: 
 
 
2015
 
2014
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Income:
 
 
 
 
 
 
 
 
Trust income
 
$
1,614

 
$
1,678

 
$
(64
)
 
(4
)%
Service charges on deposit accounts
 
4,081

 
4,099

 
(18
)
 

Insurance and retail brokerage commissions
 
2,163

 
1,709

 
454

 
27

Income from bank owned life insurance
 
1,357

 
1,330

 
27

 
2

Card related interchange income
 
3,637

 
3,599

 
38

 
1

Other income
 
1,796

 
1,953

 
(157
)
 
(8
)
Subtotal
 
14,648

 
14,368

 
280

 
2

Net securities gains
 

 
48

 
(48
)
 
(100
)
Gain on sale of loans
 
1,196

 
67

 
1,129

 
1,685

Gain on sale of other assets
 
444

 
675

 
(231
)
 
(34
)
Derivatives mark to market expense
 
(783
)
 
(108
)
 
(675
)
 
625

Total noninterest income
 
$
15,505

 
$
15,050

 
$
455

 
3
 %
 
Noninterest income, excluding net securities gains, gain on sale of loans and other assets and derivative mark to market expense, increased $0.3 million, or 2%, for the third quarter of 2015 compared to 2014. Insurance and retail brokerage commissions increased $0.5 million as a result of increased production and an agency acquisition in the fourth quarter of 2014. Offsetting that increase is a $0.2 million decrease in other income.
Total noninterest income for the three months ended September 30, 2015 increased $0.5 million in comparison to the three months ended September 30, 2014. The most significant change includes a $1.1 million increase in gains on the sale of loans due primarily to the Company reentering the secondary mortgage market. This increase was offset by a $0.7 million decrease in

50

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



income as a result of the quarterly fair value adjustment on derivatives due to changes in corporate bond spreads and swap rates during the third quarter.
Noninterest Expense
The following table presents the components of noninterest expense for the three months ended September 30: 
 
 
2015
 
2014
 
$ Change
 
% Change
 
 
(dollars in thousands)
Noninterest Expense:
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
$
22,446

 
$
22,244

 
$
202

 
1
 %
Net occupancy expense
 
3,291

 
3,180

 
111

 
3

Furniture and equipment expense
 
2,670

 
3,046

 
(376
)
 
(12
)
Data processing expense
 
1,558

 
1,583

 
(25
)
 
(2
)
Advertising and promotion expense
 
789

 
861

 
(72
)
 
(8
)
Pennsylvania shares tax expense
 
1,713

 
1,033

 
680

 
66

Intangible amortization
 
157

 
174

 
(17
)
 
(10
)
Collection and repossession expense
 
801

 
783

 
18

 
2

Other professional fees and services
 
1,007

 
1,050

 
(43
)
 
(4
)
FDIC insurance
 
963

 
926

 
37

 
4

Other operating expenses
 
4,408

 
4,232

 
176

 
4

Subtotal
 
39,803

 
39,112

 
691

 
2

Loss on sale or write-down of assets
 
140

 
61

 
79

 
130

Furniture and equipment expense - related to IT conversion
 

 
1,425

 
(1,425
)
 
(100
)
Conversion related expenses
 

 
783

 
(783
)
 
(100
)
Operational losses (recoveries)
 
314

 
187

 
127

 
68

Total noninterest expense
 
$
40,257

 
$
41,568

 
$
(1,311
)
 
(3
)%

Noninterest expense, excluding loss on sale or write-down of assets, furniture and equipment expense related to IT conversion, conversion related expenses and operational losses (recoveries), increased $0.7 million for the three months ended September 30, 2015 compared to the same period in 2014. The primary reason for this increase is the $0.7 million increase in Pennsylvania shares tax expense as a result of the settlement of the previously discussed tax dispute. Offsetting this increase is a decrease of $0.4 million in furniture and equipment expense due to lower maintenance costs resulting from the IT system conversion completed in the third quarter of 2014.

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. Expenses related to the conversion included accelerated depreciation for data processing hardware and software, early termination charges on previous contracts, and staffing and employment-related charges. 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 $0.6 million for the three months ended September 30, 2015, compared to the corresponding period in 2014. The lower provision for income taxes was the result of a $0.7 million decrease in the level of income before taxes and an increase in the level of tax-exempt income.
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, 2015 and 2014.
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 28.3% and 30.4% for the three months ended September 30, 2015 and 2014, respectively.


51

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



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 2015, liquidity provided from the net increase in short-term borrowings totaled $223.9 million, while the maturity and redemption of investment securities provided $290.8 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 of Cleveland (“FRB”) 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, 2015, our maximum borrowing capacity under this program was $955.6 million and as of that date there was $3.6 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, 2015, our outstanding certificates of deposits from this program have an average weighted rate of 0.26% and an average original term of 138 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, 2015, the borrowing capacity under this program totaled $665.6 million and there were no amounts outstanding.
As of September 30, 2015, our maximum borrowing capacity at the FHLB of Pittsburgh was $1.6 billion and as of that date amounts used against this capacity included $1.2 billion in outstanding borrowings and $24.5 million in letter of credit commitments used for pledging public funds and other non-deposit purposes.
We also have available unused federal funds lines with four correspondent banks. These lines have an aggregate commitment of $170.0 million with $20.0 million outstanding as of September 30, 2015.
First Commonwealth Financial Corporation has an unsecured $15.0 million line of credit with another financial institution. As of September 30, 2015, 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, 2015
 
December 31, 2014
 
 
(dollars in thousands)
Noninterest-bearing demand deposits
 
$
1,077,234

 
$
989,027

Interest-bearing demand deposits
 
70,662

 
81,851

Savings deposits
 
2,427,326

 
2,402,288

Time deposits
 
586,268

 
842,345

Total
 
$
4,161,490

 
$
4,315,511

During the first nine months of 2015, total deposits decreased $154.0 million due to a $256.1 million decrease in time deposits partially offset by increases of $13.8 million in interest-bearing demand and savings deposits and $88.2 million in noninterest-bearing deposits. The decrease in time deposits is due to a decline in wholesale certificates of deposit of $146.3 million coupled with a decline in core certificates of deposit of $109.7 million. Wholesale certificates can, at times, offer a more attractive source of incremental funding as they can, depending on market conditions, have a lower incremental cost of funds than traditional certificate of deposit funding.
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

52

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



a one-year period was 0.74 and 0.69 at September 30, 2015 and December 31, 2014, 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, 2015 and December 31, 2014:
 
 
 
September 30, 2015
 
 
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
 
$
2,330,773

 
$
170,888

 
$
305,469

 
$
2,807,130

 
$
1,429,116

 
$
315,771

Investments
 
148,048

 
42,952

 
162,874

 
353,874

 
523,351

 
371,076

Other interest-earning assets
 
3,529

 

 

 
3,529

 

 

Total interest-sensitive assets (ISA)
 
2,482,350

 
213,840

 
468,343

 
3,164,533

 
1,952,467

 
686,847

Certificates of Deposit
 
125,567

 
96,274

 
145,380

 
367,221

 
215,033

 
4,014

Other deposits
 
2,497,989

 

 

 
2,497,989

 

 

Borrowings
 
1,431,700

 
139

 
282

 
1,432,121

 
2,463

 
6,430

Total interest-sensitive liabilities (ISL)
 
4,055,256

 
96,413

 
145,662

 
4,297,331

 
217,496

 
10,444

Gap
 
$
(1,572,906
)
 
$
117,427

 
$
322,681

 
$
(1,132,798
)
 
$
1,734,971

 
$
676,403

ISA/ISL
 
0.61

 
2.22

 
3.22

 
0.74

 
8.98

 
65.76

Gap/Total assets
 
24.64
%
 
1.84
%
 
5.05
%
 
17.74
%
 
27.17
%
 
10.59
%

 
 
 
December 31, 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
 
$
2,274,687

 
$
166,818

 
$
294,772

 
$
2,736,277

 
$
1,412,835

 
$
267,876

Investments
 
52,057

 
60,708

 
125,801

 
238,566

 
767,521

 
338,182

Other interest-earning assets
 
2,262

 

 

 
2,262

 

 

Total interest-sensitive assets (ISA)
 
2,329,006

 
227,526

 
420,573

 
2,977,105

 
2,180,356

 
606,058

Certificates of Deposit
 
278,659

 
114,932

 
193,346

 
586,937

 
251,153

 
4,255

Other deposits
 
2,484,139

 

 

 
2,484,139

 

 

Borrowings
 
1,203,176

 
25,135

 
29,873

 
1,258,184

 
2,385

 
6,931

Total interest-sensitive liabilities (ISL)
 
3,965,974

 
140,067

 
223,219

 
4,329,260

 
253,538

 
11,186

Gap
 
$
(1,636,968
)
 
$
87,459

 
$
197,354

 
$
(1,352,155
)
 
$
1,926,818

 
$
594,872

ISA/ISL
 
0.59

 
1.62

 
1.88

 
0.69

 
8.60

 
54.18

Gap/Total assets
 
25.74
%
 
1.38
%
 
3.10
%
 
21.26
%
 
30.29
%
 
9.35
%


53

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



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, 2015 ($)
 
$
(7,830
)
 
$
(3,408
)
 
$
(387
)
 
$
(324
)
September 30, 2015 (%)
 
(4.2
)%
 
(1.8
)%
 
(0.2
)%
 
(0.2
)%
 
 
 
 
 
 
 
 
 
December 31, 2014 ($)
 
$
(5,280
)
 
$
(1,414
)
 
$
211

 
$
869

December 31, 2014 (%)
 
(2.9
)%
 
(0.8
)%
 
0.1
 %
 
0.5
 %
The following table represents the potential sensitivity of our annual net interest income to immediate changes in interest rates versus if rates remained unchanged utilizing a flat balance sheet.
 
 
Net interest income change (12 months)
 
 
-200
 
-100
 
+100
 
+200
 
 
(dollars in thousands)
September 30, 2015 ($)
 
$
(13,027
)
 
$
(7,483
)
 
$
1,487

 
$
3,800

September 30, 2015 (%)
 
(7.0
)%
 
(4.0
)%
 
0.8
%
 
2.0
%
 
 
 
 
 
 
 
 
 
December 31, 2014 ($)
 
$
(11,925
)
 
$
(6,532
)
 
$
577

 
$
1,511

December 31, 2014 (%)
 
(6.4
)%
 
(3.5
)%
 
0.3
%
 
0.8
%
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, 2015 and 2014, the cost of our interest-bearing liabilities averaged 0.34% and 0.42%, respectively, and the yield on our average interest-earning assets, on a fully taxable equivalent basis, averaged 3.55% and 3.62%, respectively.
During the first quarter of 2015, the Company entered into cash flow interest rate swaps in which we extended the duration of $100.0 million of the $1.3 billion LIBOR based loans in our loan portfolio into fixed interest rates for a period of three or four years. These swaps add approximately two basis points of protection to the net interest margin as a hedge against a prolonged low-rate environment. A similar cash flow interest rate swap, with a notional amount of $100.0 million, was entered into in 2014. Please refer to Note 11, "Derivatives," for additional information on interest rate swaps.
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 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 and other relevant factors.

54

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



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 $3.8 million at September 30, 2015 and is classified in "Other liabilities" on the Condensed Consolidated Statements of Financial Condition.
First Commonwealth defines exposure to the Oil and Gas Industry as any borrower who is involved in exploration and production, and any company in the industry supply chain that generates 40% or more of their sales revenue from exploration and production companies.
As of September 30, 2015, the Company had a total of $145.5 million in commitments to the Oil and Gas Industry, with $69.6 million in outstanding loan balances against those commitments. Of this total, commitments of $41.1 million with outstanding balances of $13.2 million are for exploration and production, while $104.4 million in commitments, with outstanding balances of $56.4 million, are related to ancillary businesses.
Two customers account for 85.1% of the loans related to exploration and production and both are pass-rated credits. These credit facilities are primarily used to support letters of credit and have little or no usage. Two commercial relationships in this category, totaling $3.4 million, are on non-performing status and have been even before the oil price decline in the third quarter of 2014.
The ancillary businesses sector consist of well services, transportation, and providing equipment and materials to support the oil and gas industry. Two customers, which account for 37.4% of the ancillary business exposure, are bulk transporters of refined product and are not expected to be negatively impacted from lower oil prices. There are four pass-rated credits, with total commitments of $39.2 million, in the ancillary business sector that will see some impact from reduced drilling activity due to lower oil and gas prices. The Company will continue to monitor their performance accordingly. One commercial relationship with $2.3 million in outstanding loans for an ancillary business has been on non-performing status since 2012.
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 2015, 37 loans totaling $4.2 million were identified as troubled debt restructurings.
The balance of troubled debt restructured loans, including held for sale loans, decreased $8.9 million due primarily to a charge-off of $3.3 million related to a loan relationship with a local energy company, the payoff of a $1.4 million commercial industrial loan with a local lumber company and a $1.2 million charge-off on a loan transferred to held for sale and $2.4 million related to the subsequent sale of the loan. Please refer to Note 8, “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 a specifically assigned allowance for loan losses are recognized where appropriate.
Nonperforming loans, including loans held for sale, decreased $14.4 million to $40.8 million at September 30, 2015 compared to $55.3 million at December 31, 2014. This decrease is primarily due to $6.8 million in charge-offs on three commercial relationships, $5.9 million in payments from two commercial relationships, $2.4 million transferred to OREO and the sale of $2.4 million in loans for one commercial relationship. Offsetting this decrease is the addition of a $6.1 million commercial relationship with an industrial manufacturer.
The allowance for credit losses as a percentage of nonperforming loans was 118.84% as of September 30, 2015 compared to 94.21% at December 31, 2014 and 112.21% at September 30, 2014. The amount of specific reserves included in the allowance for 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 reserves of $4.3 million and general reserves of $44.3 million as of September 30, 2015. Specific reserves decreased $5.2 million from December 31, 2014, and $0.4 million from September 30, 2014. The decrease in specific reserves in the first nine months of 2015 is primarily due to charge-offs of loans

55

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



which were provided for in prior periods. 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, 2015.
Criticized loans totaled $136.9 million at September 30, 2015 and represented 3.0% of the loan portfolio. The level of criticized loans decreased as of September 30, 2015 when compared to December 31, 2014, by $3.2 million, or 2.3%. Classified loans totaled $81.7 million at September 30, 2015 compared to $67.8 million at December 31, 2014, an increase of $14.0 million, or 20.6%. Delinquency on accruing loans for the same period decreased $4.2 million, or 22.6%, the majority of which are commercial real estate and residential real estate loans.
The allowance for credit losses was $48.5 million at September 30, 2015 or 1.06% of total loans outstanding compared to 1.17% reported at December 31, 2014 and 1.15% at September 30, 2014. General reserves, or the portion of the allowance related to loans which were not specifically evaluated for impairment, as a percentage of non-impaired loans were 0.98% at September 30, 2015 compared to 0.97% at December 31, 2014 and 1.06% at September 30, 2014.

56

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



The following table provides information related to nonperforming assets, the allowance for credit losses and other credit-related measures:
 
 
 
September 30,
 
 
 
December 31, 2014
 
 
 
 
2015
 
 
 
2014
 
 
 
 
 
(dollars in thousands)
 
 
Nonperforming Loans:
 
 
 
 
Loans on nonaccrual basis
 
$
20,220

 
  
 
$
27,310

 

 
$
25,715

 
  
Troubled debt restructured loans on nonaccrual basis
 
8,583

 
  
 
6,783

 
  
 
16,952

 
  
Troubled debt restructured loans on accrual basis
 
12,024

 
  
 
11,164

 
  
 
12,584

 
  
Total nonperforming loans
 
$
40,827

 
  
 
$
45,257

 
  
 
$
55,251

 
  
Loans past due 30 to 90 days and still accruing
 
$
12,482

 
 
 
$
15,778

 
 
 
$
16,163

 
 
Loans past due in excess of 90 days and still accruing
 
$
2,054

 
  
 
$
2,374

 
  
 
$
2,619

 
  
Other real estate owned
 
$
10,542

 
  
 
$
7,751

 
  
 
$
7,197

 
  
Loans held for sale at end of period
 
$
4,986

 
 
 
$
1,305

 
 
 
$
2,502

 
 
Loans outstanding at end of period
 
$
4,575,735

 
  
 
$
4,411,481

 

 
$
4,457,308

 
  
Average loans outstanding
 
$
4,509,628

 
(a) 
 
$
4,331,807

 
(a) 
 
$
4,356,566

 
(b) 
Nonperforming loans as a percentage of total loans
 
0.89
%
 
 
 
1.03
%
 
 
 
1.24
%
 
 
Provision for credit losses
 
$
8,818

 
(a) 
 
$
8,621

 
(a) 
 
$
11,196

 
(b) 
Allowance for credit losses
 
$
48,518

 
  
 
$
50,784

 
  
 
$
52,051

 
  
Net charge-offs
 
$
12,351

 
(a) 
 
$
12,062

 
(a) 
 
$
13,370

 
(b) 
Net charge-offs as a percentage of average loans outstanding (annualized)
 
0.37
%
 
 
 
0.37
%
 
 
 
0.31
%
 
 
Provision for credit losses as a percentage of net charge-offs
 
71.40
%
 
(a) 
 
71.47
%
 
(a) 
 
83.74
%
 
(b) 
Allowance for credit losses as a percentage of end-of-period loans outstanding
 
1.06
%
 
 
 
1.15
%
 
 
 
1.17
%
 
 
Allowance for credit losses as a percentage of nonperforming loans (c)
 
118.84
%
 
 
 
112.21
%
 
 
 
94.21
%
 
 
 
(a)
For the nine-month period ended.
(b)
For the twelve-month period ended.
(c)
Does not include nonperforming loans held for sale.

The following tables show the outstanding balances of our loan portfolio and the breakdown of net charge-offs and nonperforming loans, excluding loans held for sale, by loan type as of and for the periods presented:
 
 
 
September 30, 2015
 
December 31, 2014
 
 
Amount
 
%
 
Amount
 
%
 
 
(dollars in thousands)
Commercial, financial, agricultural and other
 
$
1,126,881

 
25
%
 
$
1,052,109

 
24
%
Real estate construction
 
179,710

 
4

 
120,785

 
3

Residential real estate
 
1,204,220

 
26

 
1,226,344

 
27

Commercial real estate
 
1,435,954

 
31

 
1,405,256

 
31

Loans to individuals
 
628,970

 
14

 
652,814

 
15

Total loans and leases net of unearned income
 
$
4,575,735

 
100
%
 
$
4,457,308

 
100
%
During the nine months ended September 30, 2015, loans increased $118.4 million, or 3%, compared to balances outstanding at December 31, 2014. All categories of loans reflected growth during the first nine months of 2015, except for residential real estate loans and loans to individuals. Declines in the loans to individuals category is primarily due to a decline in indirect auto loans. The decline in residential real estate loans is the result of continued runoff in our mortgage portfolio, as many of the loans originated by our mortgage banking area are sold in the secondary market.
Net charge-offs for the nine months ended September 30, 2015 totaled $12.4 million compared to $12.1 million for the nine months ended September 30, 2014. The most significant charge-offs during the nine months ended September 30, 2015 include a $2.3 million partial charge-off of two commercial industrial loans related to a local energy company and a $1.2 million

57

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



charge-off of a commercial relationship that was transferred to loans held for sale. During the nine months ended September 30, 2014, the most significant charge-offs included $8.0 million recognized on two commercial loans and 16 consumer loan relationships.  
 
 
For the Nine Months Ended September 30, 2015
 
As of September 30, 2015
 
 
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
 
$
7,657

 
61.99
 %
 
0.23
%
 
$
23,393

 
57.29
%
 
0.51
%
Real estate construction
 
(84
)
 
(0.68
)
 

 
31

 
0.08

 

Residential real estate
 
934

 
7.56

 
0.03

 
10,142

 
24.84

 
0.22

Commercial real estate
 
1,063

 
8.61

 
0.03

 
6,965

 
17.06

 
0.15

Loans to individuals
 
2,781

 
22.52

 
0.08

 
296

 
0.73

 
0.01

Total loans, net of unearned income
 
$
12,351

 
100.00
 %
 
0.37
%
 
$
40,827

 
100.00
%
 
0.89
%
As the above table illustrates, commercial, financial, agricultural and other, residential real estate and commercial real estate loans represented a significant portion of the nonperforming loans as of September 30, 2015. See discussions related to the provision for credit losses and loans for more information.
Capital Resources
At September 30, 2015, shareholders’ equity was $722.8 million, an increase of $6.6 million from December 31, 2014. The increase was primarily the result of $25.4 million of common stock repurchases and $18.9 million of dividends paid to shareholders, offset by $40.1 million in net income and increases of $9.5 million in the fair value of available for sale investments. Cash dividends declared per common share were $0.21 for the nine months ended September 30, 2015 and 2014.
First Commonwealth and First Commonwealth Bank are 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 First Commonwealth Bank 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 annual basis. This analysis is subject to Board of Director review and approval. Our most recent capital stress test was completed in December 2014.
Effective January 1, 2015, the Company is subject to the new regulatory risk-based capital rules adopted by the federal banking agencies implementing Basel III. The most significant 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 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, resulting in an effective common equity Tier I risk-weighted asset minimum ratio of 7% on a fully phased-in basis.
The Basel III Rules also permit banking organizations with less than $15.0 billion in assets to retain, through a one-time election, the existing treatment for accumulated other comprehensive income, which currently does not affect regulatory capital. The Company elected to retain this treatment, which reduces the volatility of regulatory capital levels.
As of September 30, 2015, First Commonwealth and First Commonwealth Bank met all capital adequacy requirements to which they are subject and was considered well-capitalized under the regulatory rules all on a fully phased in basis. To be

58

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



considered well capitalized, the Company must maintain minimum Total risk-based capital, Tier I risk-based capital, Tier I leverage ratio and Common equity tier I as set forth in the table below:
 
Actual
 
Minimum Capital Required - Basel III Phase-In Schedule
 
Minimum Capital Required - Basel III Fully Phased-In
 
Required to be Considered Well
Capitalized
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
Capital
Amount
 
Ratio
 
(dollars in thousands)
Total Capital to Risk Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
678,234

 
12.46
%
 
$
435,319

 
8.00
%
 
$
571,357

 
10.50
%
 
$
544,149

 
10.00
%
First Commonwealth Bank
650,874

 
11.96

 
435,539

 
8.00

 
571,645

 
10.50

 
544,424

 
10.00

Tier I Capital to Risk Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
625,898

 
11.50
%
 
$
326,490

 
6.00
%
 
$
462,527

 
8.50
%
 
$
435,319

 
8.00
%
First Commonwealth Bank
598,538

 
10.99

 
326,654

 
6.00

 
462,760

 
8.50

 
435,539

 
8.00

Tier I Capital to Average Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
625,898

 
10.13
%
 
$
247,244

 
4.00
%
 
$
247,244

 
4.00
%
 
$
309,055

 
5.00
%
First Commonwealth Bank
598,538

 
9.70

 
246,715

 
4.00

 
246,715

 
4.00

 
308,394

 
5.00

Common Equity Tier I to Risk Weighted Assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
First Commonwealth Financial Corporation
$
555,898

 
10.22
%
 
$
244,867

 
4.50
%
 
$
380,905

 
7.00
%
 
$
353,697

 
6.50
%
First Commonwealth Bank
532,774

 
9.79

 
244,991

 
4.50

 
381,097

 
7.00

 
353,876

 
6.50

On January 27, 2015, First Commonwealth's Board of Directors authorized a $25.0 million common stock repurchase program. As of September 30, 2015, First Commonwealth had repurchased 2,885,020 shares at an average price of $8.70 per share under this program. This program was completed in May of 2015.
On October 28, 2015, First Commonwealth Financial Corporation declared a quarterly dividend of $0.07 per share payable on November 20, 2015 to shareholders of record as of November 9, 2015. 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.

59

Table of Contents

ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

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.

60

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


 
ITEM 1.
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, 2014.






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

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    
None.

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
PART II – OTHER INFORMATION
FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES

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, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income and Comprehensive Income, (iii) the Condensed Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows, and (v) the Notes to Unaudited Condensed Consolidated Financial Statements.

  
Filed herewith

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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 9, 2015
 
/s/ T. Michael Price
 
 
T. Michael Price
President and Chief Executive Officer
 
 
DATED: November 9, 2015
 
/s/ James R. Reske
 
 
James R. Reske
Executive Vice President and Chief Financial Officer


64