-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KGkRT61Kmoh1NIX9QjOlQLmbw1oLZn2wz74jlrZvgPiqGH9DDxFf1ue6lo8OrbAb F+cA2Ydv3SsQFTXVc7YNww== 0000712537-98-000017.txt : 19981118 0000712537-98-000017.hdr.sgml : 19981118 ACCESSION NUMBER: 0000712537-98-000017 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19980930 FILED AS OF DATE: 19981116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST COMMONWEALTH FINANCIAL CORP /PA/ CENTRAL INDEX KEY: 0000712537 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 241428528 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11138 FILM NUMBER: 98752598 BUSINESS ADDRESS: STREET 1: OLD COURTHOUSE SQUARE STREET 2: 22 N SIXTH ST CITY: INDIANA STATE: PA ZIP: 15701 BUSINESS PHONE: 4123497220 MAIL ADDRESS: STREET 1: 22 NORTH SIXTH STREET STREET 2: P.O. BOX 400 CITY: INDIANA STATE: PA ZIP: 15701 10-Q 1 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C 20549 ( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1998 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 0-11242 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.) 22 North Sixth Street Indiana, PA 15701 (Address of principal executive offices) (Zip Code) 724-349-7220 (Registrant's telephone number, including area code) N/A (Former name, former address and former fiscal year, if changed since last report.) Indicate 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 . Number of shares outstanding of issuer's common stock, $1.00 Par Value as of November 12, 1998 was 22,110,895. FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Included in Part I of this report: PAGE First Commonwealth Financial Corporation and Subsidiaries Consolidated Balance Sheets . . . . . 3 Consolidated Statements of Income. . . . . . . . . 4 Consolidated Statements of Changes in Shareholders' Equity . . . . . . . . . . . . . . 5 Consolidated Statements of Cash Flows. . . . . . . 6 Notes to Consolidated Financial Statements . . . . 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS . . . . . . . . 10 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . . . . . . . . . . . . . . . . . . . . . . . 26 PART II - OTHER INFORMATION Other Information . . . . . . . . . . . . . . . . . . . . . . 27 Signatures . . . . . . . . . . . . . . . . . . . . Signature Page FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollars in thousands) September 30, December 31, 1998 1997 ASSETS Cash and due from banks on demand.... $ 53,430 $ 60,109 Interest-bearing deposits with banks. 2,374 4,985 Federal funds sold .................. 8,815 2,880 Securities available for sale, at market.............................. 552,668 396,631 Securities held to maturity, at cost, (market value $454,325 in 1998 and $462,086 in 1997).................. 447,729 460,063 Loans................................ 1,943,254 1,937,744 Unearned income.................... (9,086) (16,841) Allowance for possible credit losses (21,864) (19,766) Net loans....................... 1,912,304 1,901,137 Property and equipment............... 34,510 32,578 Other real estate owned.............. 2,204 1,788 Other assets......................... 71,724 69,144 TOTAL ASSETS.................... $3,085,758 $2,929,315 LIABILITIES Deposits (all domestic): Noninterest-bearing................ $ 145,330 $ 150,426 Interest-bearing................... 2,146,137 2,092,052 Total deposits.................. 2,291,467 2,242,478 Short-term borrowings................ 102,488 193,918 Other liabilities.................... 28,408 28,031 Long-term debt....................... 381,622 193,054 Total liabilities............... 2,803,985 2,657,481 SHAREHOLDERS' EQUITY Preferred stock, $1 par value per share, 3,000,000 shares authorized, none issued........................ -0- -0- Common stock $1 par value per share, 100,000,000 shares authorized; 22,436,628 shares issued; 22,110,895 and 22,046,326 shares outstanding in 1998 and 1997, respectively........ 22,437 22,437 Additional paid-in capital........... 75,440 76,171 Retained earnings.................... 191,776 181,137 Accumulated other comprehensive income 4,058 1,632 Treasury stock (325,733 shares at September 30, 1998 and 390,302 at December 31, 1997, at cost)........ (5,931) (7,107) Unearned ESOP shares................. (6,007) (2,436) Total shareholders' equity......... 281,773 271,834 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.......... $3,085,758 $2,929,315 The accompanying notes are an integral part of these consolidated financial statements. 3 FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands except per share data)
For the Quarter For the 9 Months Ended Sept. 30, Ended Sept. 30, 1998 1997 1998 1997 Interest Income Interest and fees on loans....... $41,038 $39,627 $122,400 $115,559 Interest and dividends on investments: Taxable interest............... 14,173 10,068 41,936 28,212 Interest exempt from Federal income taxes.................. 1,508 966 3,900 2,786 Dividends...................... 513 292 1,317 955 Interest on Federal funds sold... 10 4 15 10 Interest on bank deposits........ 83 36 153 213 Total interest income......... 57,325 50,993 169,721 147,735 Interest Expense Interest on deposits............. 23,446 23,563 70,104 67,448 Interest on short-term borrowings 2,850 2,083 8,858 5,311 Interest on long-term debt....... 5,336 859 14,465 2,240 Total interest expense........ 31,632 26,505 93,427 74,999 Net Interest Income................ 25,693 24,488 76,294 72,736 Provision for possible credit losses.......................... 2,183 1,791 5,933 4,422 Net interest income after provision for possible credit losses....... 23,510 22,697 70,361 68,314 Other Income Securities gains................. 1,657 3,193 2,639 5,990 Trust income..................... 1,049 670 2,754 2,061 Service charges on deposit accounts........................ 1,364 1,425 4,087 4,270 Other income..................... 1,926 1,246 5,377 3,316 Total other income............ 5,996 6,534 14,857 15,637 Other Expenses Salaries and employee benefits... 9,434 8,982 28,127 27,251 Net occupancy expense............ 1,228 1,242 3,782 3,775 Furniture and equipment expense.. 1,091 1,199 3,417 3,630 Other operating expenses......... 5,430 5,108 15,592 15,020 Total other expenses.......... 17,183 16,531 50,918 49,676 Income before income taxes......... 12,323 12,700 34,300 34,275 Applicable income taxes.......... 3,104 3,989 9,073 10,685 Net income......................... $ 9,219 $ 8,711 $25,227 $23,590 Average Shares Outstanding.........21,924,762 21,840,434 21,925,757 21,887,122 Average Shares Outstanding Assuming Dilution................22,071,237 21,928,117 22,102,882 21,945,921 Per Share Data: Basic earnings per share......... $ 0.42 $ 0.40 $ 1.15 $ 1.08 Diluted earnings per share....... $ 0.42 $ 0.40 $ 1.14 $ 1.07 Cash dividends per share......... $ 0.22 $ 0.20 $ 0.66 $ 0.60 The accompanying notes are an integral part of these consolidated financial statements.
4 FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) (Dollars in thousands)
Accumulated Additional Other Unearned Total Common Paid-in Retained Comprehensive Treasury ESOP Shareholders' Stock Capital Earnings Income Stock Shares Equity Balance at December 31, 1996......$22,437 $76,664 $168,711 $1,309 $(4,289) $(3,474) $261,358 Comprehensive income Net income...................... -0- -0- 23,590 -0- -0- -0- 23,590 Other comprehensive income, net of tax: Unrealized holding gains (losses) on securities arising during the period............ -0- -0- -0- 3,715 -0- -0- 3,715 Less: reclassification adjust- ment for gains on securities included in net income....... -0- -0- -0- (3,894) -0- -0- (3,894) Total other comprehensive income....................... -0- -0- -0- (179) -0- -0- (179) Total comprehensive income...... -0- -0- 23,590 (179) -0- -0- 23,411 Cash dividends declared......... -0- -0- (13,258) -0- -0- -0- (13,258) Decrease in unearned ESOP shares -0- -0- -0- -0- -0- 831 831 Discount on dividend reinvestment plan purchases................ -0- (488) -0- -0- -0- -0- (488) Treasury stock acquired......... -0- -0- -0- -0- (2,759) -0- (2,759) Treasury stock reissued......... -0- (32) -0- -0- 47 -0- 15 Balance at September 30, 1997.....$22,437 $76,144 $179,043 $1,130 $(7,001) $(2,643) $269,110 Balance at December 31, 1997......$22,437 $76,171 $181,137 $1,632 $(7,107) $(2,436) $271,834 Comprehensive income Net income...................... -0- -0- 25,227 -0- -0- -0- 25,227 Other comprehensive income, net of tax: Unrealized holding gains (losses) on securities arising during the period............ -0- -0- -0- 4,125 -0- -0- 4,125 Less: reclassification adjust- ment for gains on securities included in net income....... -0- -0- -0- (1,699) -0- -0- (1,699) Total other comprehensive income....................... -0- -0- -0- 2,426 -0- -0- 2,426 Total comprehensive income...... -0- -0- 25,227 2,426 -0- -0- 27,653 Cash dividends declared......... -0- -0- (14,588) -0- -0- -0- (14,588) Decrease in unearned ESOP shares -0- 64 -0- -0- -0- (3,571) (3,507) Discount on dividend reinvestment plan purchases................ -0- (757) -0- -0- -0- -0- (757) Treasury stock acquired......... -0- -0- -0- -0- (1,061) -0- (1,061) Treasury stock reissued......... -0- (38) -0- -0- 2,237 -0- 2,199 Balance at September 30, 1998.....$22,437 $75,440 $191,776 $4,058 $(5,931) $(6,007) $281,773
The accompanying notes are an integral part of these consolidated financial statements. 5 FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the 9 Months Ended Sept. 30, 1998 1997 Operating Activities Net income....................................... $25,227 $23,590 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses............ 5,933 4,422 Depreciation and amortization................. 4,280 4,127 Net gains on sales of assets.................. (2,673) (6,158) Income from increase in cash surrender value of bank owned life insurance.................. (1,044) -0- Increase in interest receivable............... (2,606) (5,646) Increase in interest payable.................. 52 1,323 Increase in income taxes payable.............. 462 1,515 Change in deferred taxes...................... 466 -0- Other-net..................................... (2,526) (1,808) Net cash provided by operating activities... 27,571 21,365 Investing Activities Transactions with securities held to maturity: Proceeds from sales........................... -0- -0- Proceeds from maturities and redemptions...... 138,510 75,599 Purchases..................................... (126,081) (105,542) Transactions with securities available for sale: Proceeds from sales........................... 139,831 24,266 Proceeds from maturities and redemptions...... 86,586 39,204 Purchases..................................... (376,177) (80,373) Proceeds from sales of loans and other assets.... 29,235 14,705 Net decrease in time deposits with banks......... 2,612 2,374 Net increase in loans............................ (46,246) (153,840) Purchases of premises and equipment.............. (4,948) (2,574) Net cash used by investing activities....... (156,678) (186,181) Financing Activities Repayments of long-term debt..................... (19,804) (51,169) Proceeds from issuance of long-term debt......... 204,800 71,788 Discount on dividend reinvestment plan purchases. (757) (488) Dividends paid................................... (14,574) (13,286) Net increase (decrease) in Federal funds purchased (108,650) 35,495 Net increase in other short-term borrowings...... 17,220 4,117 Net increase in deposits......................... 48,990 117,468 Purchase of treasury stock....................... (1,061) (2,759) Proceeds from sale of treasury stock............. 2,199 15 Net cash provided by financing activities... 128,363 161,181 Net decrease in cash and cash equivalents... (744) (3,635) Cash and cash equivalents at January 1............. 62,989 69,406 Cash and cash equivalents at September 30.......... $62,245 $65,771 The accompanying notes are an integral part of these consolidated financial statements. 6 FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) NOTE 1 Management Representation In the opinion of management, the unaudited interim consolidated financial statements include all adjustments (consisting of only normal recurring adjustments) necessary for a fair statement of financial position as of September 30, 1998 and the results of operations for the three month and nine month periods ended September 30, 1998 and 1997, and statements of cash flows and changes in shareholders' equity for the nine month periods ended September 30, 1998 and 1997. The results of the three and nine months ended September 30, 1998 and 1997 are not necessarily indicative of the results to be expected for the entire year. The interim consolidated financial statements should be read in conjunction with the annual consolidated financial statements of First Commonwealth Financial Corporation and Subsidiaries, including the notes thereto. NOTE 2 Cash Flow Disclosures (dollar amounts in thousands) 1998 1997 Cash paid during the first nine months of the year for: Interest $93,375 $73,675 Income Taxes $ 8,020 $ 8,850 Noncash investing and financing activities: ESOP borrowings $ 4,000 $ -0- ESOP loan reductions $ 429 $ 831 Gross increase (decrease) in market value adjustment to securities available for sale pursuant to FAS No. 115 $ 3,733 $ (277) Loans transferred to other real estate owned and repossessed assets $ 3,196 $ 3,890 NOTE 3 New Accounting Pronouncements Effective January 1, 1998, the Corporation adopted the Financial Accounting Standards Board Statement No. 130 "Reporting Comprehensive Income" ("FAS No. 130"). Comprehensive income is defined as "the change in equity of a business enterprise during a period from transactions and other events from nonowner sources. Comprehensive income includes all changes in equity except those resulting from investments by owners and distributions to owners." Comprehensive income includes net income and other nonowner changes in equity which qualify as components of comprehensive income but bypass a statement of income and are reported in a separate component of equity in a balance sheet. FAS No. 130 does not change the calculation of net income or earnings per share but requires companies to provide additional disclosures for comprehensive income and its components in financial statements for fiscal years beginning after December 15, 1997, including interim periods. 7 FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) NOTE 3 New Accounting Pronouncements (Continued) The Corporation has elected, as permitted under FAS No. 130, to report comprehensive income in the Statement of Changes in Shareholders' Equity and has reclassified comparative financial statements to conform to the required presentation under FAS No. 130 for comprehensive income. For all periods presented, "other comprehensive income" (comprehensive income excluding net income) includes only one component, which is the change in unrealized holding gains and losses on available for sale securities. The following table identifies the related tax effects allocated to each component of other comprehensive income in the Statements of Changes in Shareholders' Equity (dollar amounts in thousands).
September 30, 1998 September 30, 1997 Tax Net of Tax Net of Pre-tax (Expense) Tax Pre-tax (Expense) Tax Amount Benefit Amount Amount Benefit Amount Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the period $6,346 $(2,221) $4,125 $5,714 $(2,000) $3,714 Less: reclassification adjustment for gains realized in net income (2,614) 915 (1,699) (5,990) 2,097 (3,893) Net unrealized gains 3,732 (1,306) 2,426 (276) 97 (179) Other comprehensive income $3,732 $(1,306) $2,426 $ (276) $ 97 $ (179)
The adoption of FAS No. 130 did not have a material impact on the Corporation's financial condition or results of operations. In June 1997, The Financial Accounting Standards Board ("FASB") issued Statement No 131, "Disclosures about Segments of an Enterprise and Related Information" ("FAS No. 131") which is effective for financial statements for periods beginning after December 15, 1997. FAS No. 131 redefines how operating segments are determined and requires disclosures of certain financial and descriptive information about a company's operating segments. The disclosures of FAS No. 131 are not required for interim periods in the initial year of application. Management's determination is that, under current conditions, the Corporation will report one business segment. In February 1998, the FASB issued Statement No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("FAS No. 132") which is effective for years beginning after December 15, 1997. FAS No. 132 revises employers' disclosures about pension and other postretirement benefit plans but does not change the measurement or recognition of those plans. In June 1998, the FASB issued statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS No. 133") which is effective for the first quarter of years beginning after June 15, 1999. FAS No. 133 establishes accounting and reporting standards for derivative instruments and for hedging activities which require that an entity recognize all derivatives as either assets or liabilities in a balance sheet and measure those instruments at fair value. Management believes that adoption of FAS No. 132 and FAS No. 133 will not have a material impact on the Corporation's financial condition or results of operations. 8 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 (Unaudited) NOTE 3 New Accounting Pronouncements (Continued) In October 1998, the FASB issued Statement No. 134, "Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise" ("FAS No. 134") which is effective for quarters beginning after December 15, 1998. FAS No. 134 amends FASB statement No. 65 "Accounting for Certain Mortgage Banking Activities" (FAS No. 65). FAS No. 65 required that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities as trading securities while FAS No. 134 requires the resulting mortgage-backed securities or other retained interests to be classified based on the entity's ability and intent to sell or hold those investments. On the date FAS No. 134 is initially applied, an enterprise may reclassify mortgage backed securities and other beneficial interests retained after the securitization of mortgage loans held for sale from the trading category, except for those with sales commitments in place. Management believes that adoption of FAS No. 134 will not have a material impact on the Corporation's financial condition or results of operations. NOTE 4 Pending Business Combination On July 15, 1998, the Corporation entered into a definitive agreement to acquire Southwest National Corporation ("Southwest"). Southwest is a Pennsylvania-chartered bank holding company headquartered in Greensburg, Pennsylvania. Southwest has total assets of approximately $837 million, deposits of $640 million and equity of $86 million at September 30, 1998. The agreement provides for the issuance of 2.9 shares of First Commonwealth Financial Corporation ("First Commonwealth") common stock for each Southwest common share. The transaction has been structured to be a tax-free reorganization accounted for as a pooling of interests. Regulatory approvals for the proposed merger were received from the Federal Reserve Bank and the PA Department of Banking on November 2, 1998 and November 4, 1998, respectively. Subject to approval from First Commonwealth and Southwest shareholders at shareholder meetings scheduled for December 15, 1998, the merger will be completed by December 31, 1998. It is anticipated that the merger will be accretive to earnings per share in 1999, the first full year of combined operations. 9 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion and the related financial data are presented to assist in the understanding and evaluation of the consolidated financial condition and results of operations of First Commonwealth Financial Corporation (the "Corporation") including its subsidiaries. In addition to historical information, this discussion and analysis contains forward-looking statements. The forward-looking statements contained herein are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements. Important factors that might cause such a difference include, but are not limited to, those discussed in this "Management's Discussion and Analysis of Financial Condition and Results of Operations." Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management's analysis only as of the date hereof. The Corporation undertakes no obligation to publicly revise or update these forward-looking statements to reflect events or circumstances that arise after the date hereof. RESULTS OF OPERATIONS First Nine Months of 1998 as Compared to the First Nine Months of 1997 Net income in the nine months of 1998 was $25.2 million reflecting an increase of $1.6 million over 1997 results of $23.6 million. Net income excluding the impact of securities transactions reflected an increase of $3.8 million or 19% when comparing the nine months of 1998 to the same period of 1997. Changes in net interest income increased earnings by $0.16 per share during 1998 while the impact of net securities transactions decreased earnings per share $0.15 in 1998. Trust revenues generated an increase of $0.03 per share for the nine months of 1998 compared to 1997. Return on average assets was 1.08% and return on average equity was 12.02% during the 1998 period, compared to 1.19% and 11.81%, respectively during the same period of 1997. Net interest income, the most significant component of earnings, is the amount by which interest generated from earning assets exceeds interest expense on liabilities. Net interest income was $76.3 million for the nine months of 1998 compared to $72.8 million for the same period of 1997. Net interest margin (net interest income, on a tax-equivalent basis, as a percentage of average earning assets) for the 1998 period was 3.60%, reflecting a decrease of 39 basis points (0.39%) from 3.99% reported in 1997. Interest and fees on loans increased $6.8 million for 1998 over 1997 as average total loans for the nine months of 1998 increased $157.9 million over 1997 averages. The most notable components of loan growth for 1998 were an increase in average mortgage loans of $60.8 million and an increase in average municipal loans of $22.5 million over 1997 averages. The increase in mortgage loans for the 1998 period occurred primarily in loans secured by residential real estate. 10 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) First Nine Months of 1998 as Compared to the First Nine Months of 1997 (Continued) The increase in interest and fees on loans for 1998 included increases due to volume of $8.1 million and decreases due to rate of $1.3 million. The mortgage portfolio continues to be impacted by loan refinancings and loans maturing at higher interest rates than current market rates as well as loan origination during 1998 of innovative loan products introduced during 1995 which bear lower introductory interest rates. Loan yields on these products are expected to increase as these products age and introductory interest rates are no longer offered. Interest income on investments increased $15.2 million for the nine months of 1998 compared to the corresponding period of 1997 primarily as result of increases due to volume of $14.1 million and increases due to rate of $1.5 million in U.S. government agency securities. Average balances of U.S. government agency securities for the nine months of 1998 increased $291.3 million over 1997 averages as part of a capital management leveraging strategy whereby borrowings from the Federal Home Loan Bank classified as long-term debt were invested in U.S. government agencies. Yields on investments for the 1998 period reflected an increase of 33 basis points (0.33%) over 1997 yields and included an increase in yields on U.S. government agencies of 36 basis points (0.36%) for the nine months of 1998 compared to the nine months of 1997. Interest on deposits increased $2.7 million for the 1998 period compared to 1997, and included increases in interest on time deposits of $655 thousand and increases in interest on total savings deposits of $2.0 million. Interest expense on total savings deposits has increased during the nine months of 1998 compared to 1997 primarily as a result of increased utilization by customers of savings products bearing higher interest rates than standard savings accounts. These savings products have been designed to build long-term customer relationships and are intended to produce a favorable impact on the Corporation's net interest margin over the long-term. Volume increases have been achieved through competitive rates and aggressive marketing programs. 11 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) First Nine Months of 1998 as Compared to the First Nine Months of 1997 (Continued) Interest expense on short-term borrowings increased $3.5 million for the first nine months of 1998 compared to the first nine months of 1997 as average Federal Funds purchased increased $41.9 million over 1997 averages. Additional increases in short-term borrowings during the nine months of 1998 occurred in repurchase agreements with original maturities greater than one day but less than one year. Interest expense on long-term debt increased $12.2 million compared to the 1997 period as average long-term debt for the nine months of 1998 increased $301.2 million over 1997 averages. The long-term debt increase for 1998 was a result of borrowings from the Federal Home Loan Bank with maturities of up to 10 years to be utilized as part of the above mentioned capital management leveraging strategy. The average spread of this leverage strategy was approximately 1.36% during the 1998 period. The provision for possible credit losses was $5.9 million for the nine month period of 1998 compared to $4.4 million during the 1997 period. Net charge-offs against the allowance for possible credit losses were $3.8 million in the 1998 period and $4.3 million in the 1997 period. The 1998 decrease in net charge-offs included decreases in net charge-offs for loans secured by residential real estate and net charge-offs for commercial loans not secured by real estate compared to 1997. The decrease in net charge-offs for the nine months of 1998 were partially offset by increases in net chargeoffs of commercial loans secured by real estate. See the "Credit Review" section for an analysis of the quality of the loan portfolio. 12 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) First Nine Months of 1998 as Compared to the First Nine Months of 1997 (Continued) Below is an analysis of the consolidated allowance for possible credit losses for the nine month periods ended September 30, 1998 and 1997. 1998 1997 (Amounts in thousands) Balance January 1, $19,766 $19,324 Loans charged off: Commercial, financial and agricultural 316 820 Real estate-construction -0- -0- Real estate-commercial 648 200 Real estate-residential 241 601 Loans to individuals 3,205 3,370 Lease financing receivables 298 -0- Total loans charged off 4,708 4,991 Recoveries of previously charged off loans: Commercial, financial and agricultural 348 122 Real estate-construction -0- -0- Real estate-commercial 26 13 Real estate-residential 66 22 Loans to individuals 431 485 Lease financing receivables 2 12 Total recoveries 873 654 Net charge offs 3,835 4,337 Provision charged to operations 5,933 4,422 Balance September 30, $21,864 $19,409 Net securities gains decreased $3.4 million during the 1998 period from $6.0 million reported in 1997. The security gains during 1998 resulted in part from the third quarter sale of floating collateralized mortgage obligations classified as securities "available for sale" having a book value of $87.9 million. These securities were sold to reduce the exposure to accelerated prepayments as interest rates were expected to fall. The $89.6 million proceeds from the sale of securities in the third quarter of 1998 were used to reduce outstanding Federal Funds Purchased. The 1998 securities gains also included the first quarter sale of U.S. Treasury securities classified as securities "available for sale" having a book value of $45.8 million with the proceeds being reinvested in mortgage backed and other U.S. government agency securities with similar average expected maturities. The securities gains during 1997 resulted 13 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) First Nine Months of 1998 as Compared to the First Nine Months of 1997 (Continued) from the sale of investments in Pennsylvania bank stocks classified as equity securities "available for sale" having a book value of $16.1 million. Total other operating income, excluding securities gains increased $2.6 million during the first nine months of 1998 compared to the first nine months of 1997. Trust income reflected an increase for the 1998 period of $693 thousand primarily as a result of increases in mutual fund referral fees and income from personal trusts and agency/custodial accounts. The most notable components of the $2.1 million increase in other income for the nine months of 1998 compared to 1997 were increases in the cash surrender value of bank owned life insurance of $1.0 million, increases in insurance commissions of $230 thousand, increases in merchant discount of $277 thousand and increases in fees from noncustomer use of the Corporation's ATMs of $402 thousand. Noninterest expense was $50.9 million for the nine months of 1998 reflecting an increase of $1.2 million over the 1997 level of $49.7 million. Although total noninterest expense for 1998 increased over 1997 levels, total noninterest expense as a percent of average assets declined from 2.50% for the nine months of 1997 to 2.18% for the same period of 1998. Employee costs were $28.1 million in 1998, representing 1.20% of average assets on an annualized basis compared to $27.3 million and 1.37% of average assets on an annualized basis for 1997. Salary and benefits increased only 3.2% for 1998 over the corresponding period of 1997, primarily as a result of attrition management which helped maintain the reduction in the number of full-time equivalent employees for 1998 even after staffing of First Commonwealth Insurance Agency which began operations in January of 1998. The most notable increase in employee benefit costs for the nine months of 1998 compared to 1997 was an increase in health insurance costs resulting from a rate increase. The decrease in furniture and equipment expense for the first nine months of 1998 compared to the 1997 period was primarily the result of a decrease in equipment repairs for the nine months of 1998. Other operating expenses increased $572 thousand in 1998 to $15.6 million. Advertising costs and Director's fees reflected decreases of $484 thousand and $122 thousand, respectively for the nine months of 1998 compared to the corresponding period of 1997. Loan processing fees, lease residual insurance costs and Pennsylvania capital stock and shares taxes for 1998 reflected increases of $319 thousand, $166 thousand and $160 thousand respectively over 1997 levels. The 1998 period also included an increase in other professional fees of $246 thousand which was due in part to the inclusion of First Commonwealth Insurance Agency expenses of $119 thousand during the 1998 period. 14 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) First Nine Months of 1998 as Compared to the First Nine Months of 1997 (Continued) Income tax expense was $9.1 million for the nine months of 1998 compared to $10.7 million for the same period of 1997. The Corporation's effective tax rate was 26.5% for the 1998 period compared to 31.2% for 1997, reflecting an increase in tax-free income including income from tax-free investment securities and bank-owned life insurance. Three Months ended September 30, 1998 as Compared to the Three Months Ended September 30, 1997 Net income was $9.2 million for the third quarter of 1998, an increase of $508 thousand over the same quarter of 1997. Basic earnings per share was $0.42 during the 1998 quarter compared to $0.40 for the same period of 1997. Net income excluding the impact of securities transactions reflected an increase of $1.5 million or 23% when comparing the third quarter of 1998 to the third quarter of 1997. Net securities gains decreased $1.6 million during the 1998 quarter from $3.2 million reported in 1997. Net interest income for the third quarter of 1998 of $25.7 million represented an increase of $1.2 million compared to the third quarter of 1997. Net interest margin (net interest income, on a tax-equivalent basis, as a percentage of average earnings assets) for the 1998 period was 3.57%, reflecting a decrease of 30 basis points (0.30%) from 3.87% reported in 1997. Total interest and fees on loans for the three months ending September 30, 1998 increased $1.4 million over the three months ending September 30, 1997, reflecting increases due to volume of $2.0 million and decreases due to rate of $568 thousand. Average loans outstanding for the third quarter of 1998 were $113.7 million higher than average loans outstanding for the third quarter of 1997. The most notable components of loan growth for the 1998 quarter were an increase in average mortgage loans of $46.2 million and an increase in average municipal loans of $20.1 million. The total yield on loans (including fees on loans) for the three months ended September 30, 1998 was 8.42%, a decrease of 18 basis points (0.18%) over yields for the three months ended September 30, 1997. Installment loans reflected a decrease of 44 basis points (0.44%) for the third quarter of 1998 compared to 1997, primarily as a result of increased utilization of indirect auto lending. Yields on mortgage loans for the three months of 1998 reflected a decrease of 4 basis points (0.04%) compared to the same three months of 1997 as maturities and refinancings of loans bearing higher interest rates than current market rates occurred. These lower yields were partially offset by rate increases for loan products which originally bore lower introductory rates. 15 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) Three Months ended September 30, 1998 as Compared to the Three Months Ended September 30, 1997 (Continued) Interest income on investments for the three months ended September 30, 1998 was $16.2 million, reflecting an increase of $4.9 million over the three months ended September 30, 1997. Interest on U.S. government agency securities increased $5.0 million for the third quarter of 1998 compared to the 1997 quarter and included increases due to volume of $4.6 million and increases due to rate of $356 thousand. Average U.S. government agency securities for the third quarter of 1998 increased $288 million over averages for the third quarter of 1997 primarily as a result of a capital management leveraging strategy whereby borrowings from the Federal Home Loan Bank classified as long- term debt were invested in U.S. government agency securities. Average U.S. government agency securities for the third quarter of 1998 also increased as a result of the sale of U.S. Treasury securities in the first quarter of 1998 whereby the proceeds were reinvested in U.S. government agency securities. Yields on investments for the 1998 quarter increased 23 basis points (0.23%) compared to yields for the 1997 quarter, primarily as a result of an increase in yields on U.S. government agency securities of 25 basis points (0.25%). Interest on deposits for the third quarter of 1998 decreased by $117 thousand compared to the third quarter of 1997 as decreases in interest on time deposits were partially offset by increases in interest on savings deposits. Interest on total savings deposits for the three months ended September 30, 1998 increased primarily as a result of volume increases while interest on time deposits decreased primarily as a result of rate decreases compared to the three months ended September 30, 1997. Total cost of deposits for the third quarter of 1998 included increases in the cost of total savings deposits of 8 basis points (0.08%) and decreases in the cost of time deposits of 8 basis points (0.08%) compared to the third quarter of 1997. Interest on short-term borrowings for the third quarter of 1998 increased $767 thousand compared to the third quarter of 1997 as quarter to date average balances increased over averages for the same period of 1997. Interest on long-term debt for the three months ending September 30, 1998 increased $4.5 million over the three month ending September 30, 1997, primarily as a result of increases in average long term debt of $319.8 million for the third quarter of 1998 compared to the 1997 quarter. Long-term debt increases were primarily borrowings from the Federal Home Loan Bank with maturities of up to ten years to be utilized as part of the previously discussed capital management leveraging strategy. Net interest margin was 3.57% for the third quarter of 1998 compared to 3.87% during the 1997 period. 16 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) Three Months ended September 30, 1998 as Compared to the Three Months Ended September 30, 1997 (Continued) Provision for possible credit losses was $2.2 million for the three months ended September 30, 1998 compared to $1.8 million for the three months ended September 30, 1997. Net loans charged off in the third quarter of 1998 were $1.1 million, a decrease of $154 thousand from net charge-offs of $1.3 million reported for the corresponding period of 1997. Net charge-offs of loans secured by 1-4 family residential properties decreased by $173 thousand when comparing the third quarter of 1998 to the third quarter of 1997. The decreases in net charge-offs for the third quarter of 1998 compared to the 1997 quarter were partially offset by an increase in net charge-offs of credit card outstandings and auto leases. Securities gains were $1.7 million for the third quarter of 1998 reflecting a decrease of $1.5 million compared to third quarter 1997 gains of $3.2 million. The securities gains during the three months of 1998 resulted from the sale of floating collateralized mortgage obligations classified as securities "available for sale" having a book value of $87.9 million. The $89.6 million proceeds from the sale of securities in the third quarter of 1998 were used to reduce outstanding Federal funds purchased. The securities gains during 1997 resulted from the sale of investments in Pennsylvania bank stocks classified as equity securities "available for sale" having a book value of $7.3 million. Total other operating income, excluding securities gains increased $998 thousand for the three months ended September 30, 1998, compared to the three months ended September 30, 1997. Included in the increase in other income for the third quarter of 1998 compared to the third quarter of 1997 were increases in the cash surrender value of bank owned life insurance of $274 thousand, increases in noncustomer use of the Corporation's ATMs of $147 thousand, increases in insurance commissions of $211 thousand and increases in merchant discount of $154 thousand. Trust income for the three months ended September 30, 1998 increased $379 thousand over the three months ended September 30, 1997 primarily as a result of increases in mutual fund referral fees and income from employee benefit and agency accounts. Total noninterest expense for the three months ending September 30, 1998 was $17.2 million reflecting an increase of $652 thousand over the $16.5 million that was reported for the corresponding period of 1997. Employee costs were $9.4 million during the third quarter of 1998 reflecting an increase of $452 thousand over 1997 levels of $9.0 million. Other operating expenses for the three months ended September 30, 1998 included increases in filing and recording fees, other professional fees and losses on the sale of assets which were partially offset by decreases in advertising, director's fees and stationery and 17 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) RESULTS OF OPERATIONS (Continued) Three Months ended September 30, 1998 as Compared to the Three Months Ended September 30, 1997 (Continued) supplies expenses compared to the three months ended September 30, 1997. Income taxes decreased $885 thousand for the third quarter of 1998 compared to the 1997 quarter as a result of an increase in tax free income, including income from increases in cash surrender value of bank owned life insurance. The Corporation's effective tax rate was 25.2% for the 1998 period compared to 31.4% for the 1997 period. LIQUIDITY Liquidity is a measure of the Corporation's ability to efficiently meet normal cash flow requirements of both borrowers and depositors. In the ordinary course of business, funds are generated from deposits (primary source) and maturity or repayment of earning assets, such as securities and loans. As an additional secondary source, short-term liquidity needs may be provided through the use of overnight Federal funds purchased, borrowings through the use of lines available for repurchase agreements, and borrowings from the Federal Reserve Bank. Additionally, the banking subsidiary is a member of the Federal Home Loan Bank and may borrow under overnight and term borrowing arrangements. The sale of earning assets may also provide an additional source of liquidity. Net loans increased by only $11.2 million in the first nine months of 1998 as increases in loans secured by residential real estate and municipal loans were partially offset by decreases in consumer installment and revolving credit loans. Municipal loan growth for 1998 occurred primarily in short-term tax anticipation notes. Increases in total savings deposits of $79.8 million during the first nine months of 1998 were partially offset by decreases of $25.7 million in time deposits. Included in total savings deposits growth for the nine months of 1998 was growth of $60.0 million in the Corporation's American Dream Savings product as customers reinvested traditional savings dollars in this innovative product which offers higher interest rates than traditional savings accounts. This product was designed to build long-term customer relationships and is intended to produce a favorable impact on the Corporation's net interest margin over the long-term. 18 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) LIQUIDITY (Continued) Marketable securities that the Corporation holds in its investment portfolio are an additional source of liquidity. These securities are classified as "securities available for sale" and while the Corporation does not have specific intentions to sell these securities they have been designated as "available for sale" because they may be sold for the purpose of obtaining future liquidity, for management of interest rate risk or as part of the implementation of tax management strategies. As of September 30, 1998 securities available for sale had an amortized cost of $546.3 million and an approximate fair value of $552.7 million. Growth of the available for sale portfolio during the first nine months of 1998 was funded by borrowings from the Federal Home Loan Bank with maturities of up to ten years which are classified as long-term debt and the sale of U.S. treasury securities classified as "securities available for sale". INTEREST SENSITIVITY The objective of interest rate sensitivity management is to maintain an appropriate balance between the stable growth of income and the risks associated with maximizing income through interest sensitivity imbalances. While no single number can accurately describe the impact of changes in interest rates on net interest income, interest rate sensitivity positions, or "gaps", when measured over a variety of time periods, may be helpful. An asset or liability is considered to be interest-sensitive if the rate it yields or bears is subject to change within a predetermined time period. If interest-sensitive assets ("ISA") exceed interest-sensitive liabilities ("ISL") during the prescribed time period, a positive gap results. Conversely, when ISL exceeds ISA during a time period, a negative gap results. A positive gap tends to indicate that earnings will be impacted favorably if interest rates rise during the period and negatively when interest rates fall during the time period. A negative gap tends to indicate that earnings will be affected inversely to interest rate changes. In other words, as interest rates fall, a negative gap should tend to produce a positive effect on earnings and when interest rates rise, a negative gap should tend to affect earnings negatively. 19 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Interest Sensitivity (Continued) The primary components of ISA include adjustable rate loans and investments, loan repayments, investment maturities and money market investments. The primary components of ISL include maturing certificates of deposit, money market deposits, savings deposits, NOW accounts and short-term borrowings. The following table lists the amounts and ratios of assets and liabilities with rates or yields subject to change within the periods indicated as of September 30, 1998 and December 31, 1997. September 30, 1998 0-90 91-180 181-365 Cumulative Days Days Days 0-365 Days Loans....................$ 521,512 $143,976 $276,597 $ 942,085 Investments.............. 59,495 43,830 126,728 230,053 Other interest-earning assets.................. 37,936 3,653 3,324 44,913 Total interest-sensitive assets................ 618,943 191,459 406,649 1,217,051 Certificates of deposits. 324,395 197,393 335,364 857,152 Other deposits........... 819,063 -0- -0- 819,063 Borrowings............... 102,875 1,369 1,203 105,447 Total interest-sensitive liabilities........... 1,246,333 198,762 336,567 1,781,662 GAP....................$ (627,390) $ (7,303) $ 70,082 $ (564,611) ISA/ISL.................. 0.50 0.96 1.21 0.68 Gap/Total assets......... 20.33% 0.24% 2.27% 18.30% December 31, 1997 0-90 91-180 181-365 Cumulative Days Days Days 0-365 Days Loans....................$ 799,956 $125,950 $250,725 $1,176,631 Investments.............. 51,528 63,717 102,631 217,876 Other interest-earning assets.................. 130,666 5,214 10,043 145,923 Total interest-sensitive assets................ 982,150 194,881 363,399 1,540,430 Certificates of deposits. 252,652 161,264 225,113 639,029 Other deposits........... 804,672 -0- -0- 804,672 Borrowings............... 207,190 1,441 1,725 210,356 Total interest-sensitive liabilities........... 1,264,514 162,705 226,838 1,654,057 GAP....................$ (282,364) $ 32,176 $136,561 $ (113,627) ISA/ISL.................. 0.78 1.20 1.60 0.93 Gap/Total assets......... 9.64% 1.10% 4.66% 3.88% 20 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) Interest Sensitivity (continued) Although the periodic gap analysis provides management with a method of measuring current interest rate risk, it only measures rate sensitivity at a specific point in time. Therefore, to more precisely measure the impact of interest rate changes on the Corporation's net interest income, management simulates the potential effects of changing interest rates through computer modeling. The income simulation model used by the Corporation captures all assets, liabilities, and off-balance sheet financial instruments, accounting for significant variables that are believed to be affected by interest rates. These variables include prepayment speeds on mortgage loans and mortgage backed securities, cash flows from loans, deposits and investments and balance sheet growth assumptions. The model also captures embedded options, such as interest rate caps/floors or call options, and accounts for changes in rate relationships as various rate indices lead or lag changes in market rates. The Corporation is then better able to implement strategies which would include an acceleration of a deposit rate reduction or lag in a deposit rate increase. The repricing strategies for loans would be inversely related. The Corporation's asset/liability management policy guidelines limit interest rate risk exposure for the succeeding twenty-four month period. Simulations are prepared under the base case where interest rates remain flat and most likely case where interest rates are defined using projections of economic factors. Additional simulations are produced estimating the impact on net interest income of a 300 basis point (3.00%) movement upward or downward from the base case scenario. The Corporation's current asset/liability management policy indicates that a 300 basis point (3.00%) change in interest rates up or down cannot result in more than a 7.5% change in net interest income when compared to a base case without Board approval and a strategy in place to reduce interest rate risk below the established maximum level. The analysis at September 30, 1998, indicated that a 300 basis point (3.00%) movement in interest rates in either direction over the next twelve months would not have a significant impact on the Corporation's anticipated net interest income over that time frame nor over the next twenty-four months and the Corporation's position would remain well within current policy guidelines. The Corporation's "Asset/Liability Management Committee" ("ALCO") is responsible for the identification, assessment and management of interest rate risk exposure, liquidity, capital adequacy and investment portfolio position. The primary objective of the ALCO process is to ensure that the Corporation's balance sheet structure maintains prudent levels of risk within the context of currently known and forecasted economic conditions and to establish strategies which provide the Corporation with appropriate compensation for the assumption of those risks. The ALCO attempts to mitigate interest rate risk through the use of strategies such as asset disposition, asset and liability pricing and matched maturity funding. The ALCO strategies are established by the Corporation's senior management and are approved by the Corporation's board of directors. 21 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) CREDIT REVIEW The following table identifies amounts of loan losses and nonperforming loans. Past due loans are those which were contractually past due 90 days or more as to interest or principal payments but were well secured and in the process of collection. Renegotiated loans are those loans which 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 and are in compliance with the restructured terms. Loans on a nonaccrual basis include impaired loans (see description below). At September 30, 1998 1997 (amounts in thousands) Nonperforming Loans: Loans on nonaccrual basis $ 6,274 $ 7,094 Past due loans 13,618 12,277 Renegotiated loans 65 275 Total Nonperforming Loans $ 19,957 $ 19,646 Other real estate owned $ 2,204 $ 1,802 Loans outstanding at end of period $1,934,168 $1,881,844 Average loans outstanding (year-to-date) $1,963,378 $1,805,487 Nonperforming loans as percent of total loans 1.03% 1.04% Provision for possible credit losses $ 5,933 $ 4,422 Net charge-offs $ 3,835 $ 4,337 Net charge-offs as percent of average loans 0.20% 0.24% Provision for possible credit losses as percent of net charge-offs 154.71% 101.96% Allowance for possible credit losses as percent of average loans outstanding 1.11% 1.08% Allowance for possible credit losses as percent of end-of-period loans outstanding 1.13% 1.03% Allowance for possible credit losses as percent of nonperforming loans 109.56% 98.79% 22 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) CREDIT REVIEW (Continued) The Corporation considers a loan to be impaired when, based on current information and events, it is probable that the Corporation will be unable to collect principal or interest due according to the contractual terms of the loan. Loan impairment is measured based on the present value of expected cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the fair value of the collateral if the loan is collateral dependent. Payments received on impaired loans are applied against the recorded investment in the loan. For loans other than those that the Corporation expects repayment through liquidation of the collateral, when the remaining recorded investment in the impaired loan is less than or equal to the present value of the expected cash flows, income is recorded on a cash basis. Impaired loans include loans on a nonaccrual basis and renegotiated loans. The following table identifies impaired loans, and information regarding the relationship of impaired loans to the reserve for possible credit losses at September 30, 1998 and September 30, 1997. 1998 1997 (amounts in thousands) Recorded investment in impaired loans at end of period $6,339 $7,369 Year to date average balance of impaired loans $7,995 $8,217 Allowance for possible credit losses related to impaired loans $1,814 $1,733 Impaired loans with an allocation of the allowance for possible credit losses $4,924 $3,259 Impaired loans with no allocation of the allowance for possible credit losses $1,415 $4,110 Year to date income recorded on impaired loans on a cash basis $ 118 $ 86 Other than those described above, there are no material credits that management has serious doubts as to the borrower's ability to comply with the present loan repayment terms. Additionally, the portfolio is well diversified and as of September 30, 1998, there were no significant concentrations of credit. Nonperforming loans at September 30, 1998 increased $311 thousand over 1997 levels and included increases in past due loans of $1.3 million which were partially offset by decreases in nonaccrual loans of $820 thousand. Past due loans reflected increases in commercial loans secured by real estate of $1.2 million, and commercial loans not secured by real estate of $597 thousand which were partially offset by decreases in past due loans secured by residential real estate of $773 thousand. Nonaccrual loans reflected decreases in loans secured by residential real estate and auto leases of $167 thousand and $495 thousand respectively. Nonperforming loans as a percent of total loans 23 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) CREDIT REVIEW (Continued) were 1.03% at September 30, 1998 compared to 1.04% at September 30, 1997. The allowance for possible credit losses as a percent of nonperforming loans at September 30, 1998 has increased over both September 30, 1997 and year end 1997 levels. Net charge-offs in both dollars and as a percentage of average loans at September 30, 1998 have decreased over 1997 levels. Although net charge-offs as a percentage of average loans has historically been below peer averages, this ratio slightly exceeded peer averages based on the most recent peer statistics published which used June 30, 1998 data for both the Corporation and peer comparisons. The peer group was defined using the Uniform Bank Holding Company Performance Report published by the Federal Financial Institutions Examination Council. Management does not believe that charge-offs are at a level to cause major concern. The allowance for possible credit losses as a percent of average loans outstanding remains below peer levels but has increased when compared to year end 1997. Since all identified losses are immediately charged off, no portion of the allowance for possible credit losses is restricted to any individual credit or groups of credits and the entire allowance is available to absorb any and all credit losses. However, for analytical purposes, the allowance for possible credit losses can be thought to include an amount allocated to various loan types and an additional unallocated amount. Based on the analysis of the adequacy of the allowance for possible credit losses at September 30, 1998, the unallocated portion of the allowance in dollars has increased since year end 1997. The Corporation's loan portfolio continues to be monitored by senior management to identify potential portfolio risks and detect potential credit deterioration in the early stages. Credit risk is mitigated through the use of sound underwriting policies and collateral requirements. Management attempts to minimize loan losses by analyzing and modifying collection techniques on a periodic basis. Management believes that the allowance for possible credit losses and nonperforming loans remain safely within acceptable levels. CAPITAL RESOURCES Equity capital increased $9.9 million in the first nine months of 1998. Dividends declared reduced equity by $14.6 million during the 1998 period, while earnings retention was $10.6 million, representing an earnings retention rate of 42.2%. The retained net income remains in permanent capital to fund future growth and expansion. Debt incurred by the Corporation's Employee Stock Ownership Plan ("ESOP") to acquire the Corporation's common stock for future distribution as employee compensation, net of debt payments and fair value adjustments to Unearned ESOP shares, decreased equity by $3.5 million. Amounts paid to fund the discount on reinvested dividends and optional cash payments 24 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) CAPITAL RESOURCES (Continued) reduced equity by $757 thousand. The market value adjustment to securities available for sale increased equity by $2.4 million. Proceeds from the reissuance of treasury shares to provide for stock options exercised increased equity by $2.2 million. Acquisition of treasury stock decreased equity by $1.1 million. A capital base can be considered adequate when it enables the Corporation to intermediate funds responsibly and provide related services, while protecting against future uncertainties. The evaluation of capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings history and prospects, internal controls and management caliber. In consideration of these factors, management's primary emphasis with respect to the Corporation's capital position is to maintain an adequate and stable ratio of equity to assets. The Federal Reserve Board has issued risk-based capital adequacy guidelines which are designed principally as a measure of credit risk. These guidelines require: (1) at least 50% of a banking organization's total capital be common and other "core" equity capital ("Tier I Capital"); (2) assets and off-balance-sheet items must be weighted according to risk; (3) the total capital to risk-weighted assets ratio be at least 8%; and (4) a minimum everage ratio of Tier I capital to average total assets. The minimum leverage ratio is not specifically defined, but is generally expected to be 3-5 percent for all but the most highly rated banks, as determined by a regulatory rating system. The table below presents the Corporation's capital position at September 30, 1998: Percent Amount of Adjusted (in thousands) Assets Tier I Capital $267,004 14.2% Risk-Based Requirement 75,212 4.0 Total Capital 288,868 15.4 Risk-Based Requirement 150,424 8.0 Minimum Leverage Capital 267,004 9.8 Minimum Leverage Requirement 94,795 3.0 At September 30, 1998 the Corporation and its banking subsidiary are considered well capitalized as defined by the Federal Deposit Insurance Corporation Improvement Act of 1991. 25 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS YEAR 2000 UPDATE The Corporation's data processing subsidiary, Commonwealth Systems Corporation continued to test or validate year 2000 compliance during 1998. Mainframe software systems will be renovated or replaced throughout 1998 as the systems are successfully tested for the ability to properly utilize dates beyond December 31, 1999. Based upon presently available information and time estimates, the Corporation remains on schedule to achieve its goal of implementing the majority of the critical mainframe software systems by December 31, 1998. The Corporation continues to evaluate significant suppliers and outside professional service contractors to determine the extent to which the Corporation is vulnerable to those parties' failure to remediate their own year 2000 issues. During 1998 the Corporation has continued to utilize internal resources to reprogram and test software for year 2000 modifications to the extent possible. Although the Corporation's estimate for total year 2000 project costs and estimated times for completion are subject to certain risks and uncertainties, as of September 30, 1998, the Corporation estimates that expenditures for the year 2000 issue will not have a material impact on the Corporation's financial condition or results of operations. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Information appearing in Item 2 of this report under the caption "Interest Sensitivity" is incorporated herein by reference in response to this item. 26 FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS There were no material legal proceedings to which the Corporation or its subsidiaries are a party, or of which any of their property is the subject, except proceedings which arise in the normal course of business and, in the opinion of management, will not have a material adverse effect on the consolidated operations or financial position of the Corporation and its subsidiaries. ITEM 2. CHANGES IN SECURITIES Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5. OTHER INFORMATION Pending Business Combination On July 15, 1998, the Corporation entered into a definitive agreement to acquire Southwest National Corporation ("Southwest"). Southwest is a Pennsylvania-chartered bank holding company headquartered in Greensburg, Pennsylvania. Southwest has total assets of approximately $837 million, deposits of $640 million and equity of $86 million at September 30, 1998. The agreement provides for the issuance of 2.9 shares of First Commonwealth Financial Corporation ("First Commonwealth") common stock for each Southwest common share. The transaction has been structured to be a tax-free reorganization accounted for as pooling of interests. Regulatory approvals for the proposed merger were received from the Federal Reserve Bank and the PA Department of Banking on November 2, 1998 and November 4, 1998, respectively. Subject to approval from First Commonwealth and Southwest shareholders at shareholder meetings scheduled for December 15, 1998, the merger will be completed by December 31, 1998. It is anticipated that the merger will be accretive to earnings per share in 1999, the first full year of combined operations. 27 FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES PART II - OTHER INFORMATION (Continued) ITEM 5. OTHER INFORMATION (Continued) Branch Sale On October 30, 1998, First Commonwealth Bank, a wholly-owned subsidiary of the registrant closed on the sale of two branch offices located in State College, PA to Nittany Financial Corp., also located in State College, PA. Nittany Financial Corp. assumed deposit liabilities of approximately $10.2 million and purchased deposit related loans and other branch-related assets from First Commonwealth Bank. The sale resulted in a gain of approximately $949 thousand which will be included in the registrant's financial results for the fourth quarter of 1998. ESOP Plan Stock Purchase During the third quarter of 1998 the registrant's ESOP Plan began buying back the registrant's common stock. Proceeds from long-term debt incurred by the ESOP during the third and fourth quarters of 1998 in the amount of $6 million will be used to fund the stock purchases which are anticipated to be completed by November 30, 1998. Shares are expected to be distributed to employees over the next seven years and be included in compensation cost by the registrant at the shares fair value at the time of allocation to the employees. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) Reports on Form 8-K Form 8k dated July 15, 1998, reporting the Corporation entered into a definitive agreement to acquire Southwest National Corporation. 28 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 13, 1998 /S/ Joseph E. O'Dell Joseph E. O'Dell, President and Chief Executive Officer DATED: NOVEMBER 13, 1998 /S/ John J. Dolan John J. Dolan, Sr. Vice President and Chief Financial Officer 29 EX-27 2
9 3-MOS DEC-31-1998 SEP-30-1998 53,430 2,374 8,815 0 552,668 447,729 454,325 1,943,254 21,864 3,085,758 2,291,467 102,488 28,408 381,622 0 0 22,437 259,336 3,085,758 41,038 16,194 93 57,325 23,446 31,632 25,693 2,183 1,657 17,183 12,323 9,219 0 0 9,219 0.42 0.42 3.57 6,274 13,618 65 0 19,766 4,708 873 21,864 0 0 0
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