-----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, U1XPwEx6Z8T5xKrUjwUqaQqWasHqUWpFsOqEnyxLVw7+VIaLMWQLM1RxbL3MZRZa P63WbeRYSMTNY7pbP2I1rA== 0000712537-99-000016.txt : 19990816 0000712537-99-000016.hdr.sgml : 19990816 ACCESSION NUMBER: 0000712537-99-000016 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19990630 FILED AS OF DATE: 19990813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST COMMONWEALTH FINANCIAL CORP /PA/ CENTRAL INDEX KEY: 0000712537 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 251428528 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-11138 FILM NUMBER: 99686582 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 June 30, 1999 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 August 11, 1999 was 30,984,815. 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 . . . . . . . . 9 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK . . . . . . . . . . . . . . . . . . . . . . . . 27 PART II - OTHER INFORMATION Other Information . . . . . . . . . . . . . . . . . . . . . . 28 Signatures . . . . . . . . . . . . . . . . . . . . Signature Page FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (UNAUDITED) (Dollars in thousands) June 30, December 31, 1999 1998 ASSETS Cash and due from banks on demand.... $ 83,709 $ 96,615 Interest-bearing deposits with banks. 500 1,914 Federal funds sold .................. 0 1,000 Securities available for sale, at market.............................. 1,155,808 1,042,636 Securities held to maturity, at cost, (Market value $452,452 in 1999 and $486,185 in 1998).................. 458,761 482,696 Loans................................ 2,374,977 2,382,229 Unearned income.................... (5,072) (7,379) Allowance for credit losses........ (33,644) (32,304) Net loans....................... 2,336,261 2,342,546 Property and equipment............... 40,839 41,929 Other real estate owned.............. 1,808 2,370 Other assets......................... 125,517 85,083 TOTAL ASSETS.................... $4,203,203 $4,096,789 LIABILITIES Deposits (all domestic): Noninterest-bearing................ $ 242,964 $ 264,082 Interest-bearing................... 2,722,169 2,667,049 Total deposits.................. 2,965,133 2,931,131 Short-term borrowings................ 223,831 140,547 Other liabilities.................... 36,534 38,856 Long-term debt....................... 638,525 630,850 Total liabilities............... 3,864,023 3,741,384 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; 31,262,706 shares issued; 30,976,379 and 30,937,973 shares outstanding in 1999 and 1998, respectively........ 31,263 31,263 Additional paid-in capital........... 99,716 100,240 Retained earnings.................... 247,283 235,623 Accumulated other comprehensive income (26,715) 2,199 Treasury stock (286,327 shares at June 30, 1999 and 324,733 at December 31, 1998, at cost)........ (5,213) (5,913) Unearned ESOP shares................. (7,154) (8,007) Total shareholders' equity......... 339,180 355,405 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.......... $4,203,203 $4,096,789 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 6 Months Ended June 30, Ended June 30, 1999 1998 1999 1998 Interest Income Interest and fees on loans....... $48,419 $51,694 $96,692 $102,651 Interest and dividends on investments: Taxable interest............... 22,095 17,737 42,560 33,027 Interest exempt from Federal income taxes.................. 2,348 1,541 4,597 2,915 Dividends...................... 734 544 1,438 915 Interest on Federal funds sold... 10 458 59 886 Interest on bank deposits........ 30 42 91 72 Total interest income......... 73,636 72,016 145,437 140,466 Interest Expense Interest on deposits............. 25,573 28,795 51,440 57,180 Interest on short-term borrowings 2,852 3,361 5,281 6,253 Interest on long-term debt....... 8,564 5,867 17,008 9,791 Total interest expense........ 36,989 38,023 73,729 73,224 Net Interest Income................ 36,647 33,993 71,708 67,242 Provision for credit losses...... 2,337 2,625 4,550 5,100 Net interest income after provision for possible credit losses....... 34,310 31,368 67,158 62,142 Other Income Securities gains................. -0- -0- 563 982 Trust income..................... 1,209 1,354 3,023 2,628 Service charges on deposit accounts........................ 2,233 2,103 4,291 4,064 Gain on sale of loans............ 3,978 56 4,902 93 Other income..................... 2,524 2,320 5,047 4,104 Total other income............ 9,944 5,833 17,826 11,871 Other Expenses Salaries and employee benefits... 12,520 12,014 25,598 24,477 Net occupancy expense............ 1,609 1,698 3,365 3,459 Furniture and equipment expense.. 1,477 1,541 2,968 2,999 Data processing expense.......... 816 798 1,664 1,549 Pennsylvania shares tax expense.. 883 813 1,730 1,596 Other operating expenses......... 6,185 5,979 12,356 11,693 Total other expenses.......... 23,490 22,843 47,681 45,773 Income before income taxes......... 20,764 14,358 37,303 28,240 Applicable income taxes.......... 5,938 3,864 10,472 7,764 Net income......................... $14,826 $10,494 $26,831 $20,476 Average Shares Outstanding.........30,601,694 30,772,797 30,589,094 30,788,301 Average Shares Outstanding Assuming Dilution................30,688,466 30,950,698 30,702,299 30,981,004 Per Share Data: Basic earnings per share......... $ 0.48 $ 0.34 $ 0.88 $ 0.67 Diluted earnings per share....... $ 0.48 $ 0.34 $ 0.87 $ 0.66 Cash dividends per share......... $ 0.26 $ 0.22 $ 0.49 $ 0.44 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, 1997......$31,661 $106,659 $228,230 $ 2,156 $(11,947) $(2,436) $354,323 Comprehensive income Net income...................... -0- -0- 20,476 -0- -0- -0- 20,476 Other comprehensive income, net of tax: Unrealized holding gains on securities arising during the period................... -0- -0- -0- 1,089 -0- -0- 1,089 Less: reclassification adjust- ment for gains on securities included in net income....... -0- -0- -0- (622) -0- -0- (622) Total other comprehensive income....................... -0- -0- -0- 467 -0- -0- 467 Total comprehensive income...... -0- -0- 20,476 467 -0- -0- 20,943 Cash dividends declared......... -0- -0- (11,859) -0- -0- -0- (11,859) Decrease in unearned ESOP shares -0- -0- -0- -0- -0- 286 286 Discount on dividend reinvestment plan purchases................ -0- (444) -0- -0- -0- -0- (444) Treasury stock acquired......... -0- -0- -0- -0- (1,062) -0- (1,062) Treasury stock reissued......... -0- 11 -0- -0- 989 -0- 1,000 Balance at June 30, 1998..........$31,661 $106,226 $236,847 $ 2,623 $(12,020) $(2,150) $363,187 Balance at December 31, 1998......$31,263 $100,240 $235,623 $ 2,199 $ (5,913) $(8,007) $355,405 Comprehensive income Net income...................... -0- -0- 26,831 -0- -0- -0- 26,831 Other comprehensive income, net of tax: Unrealized holding gains (losses) on securities arising during the period............ -0- -0- -0- (28,548) -0- -0- (28,548) Less: reclassification adjust- ment for gains on securities included in net income....... -0- -0- -0- (366) -0- -0- (366) Total other comprehensive income....................... -0- -0- -0- (28,914) -0- -0- (28,914) Total comprehensive income...... -0- -0- 26,831 (28,914) -0- -0- (2,083) Cash dividends declared......... -0- -0- (15,171) -0- -0- -0- (15,171) Decrease in unearned ESOP shares -0- -0- -0- -0- -0- 853 853 Discount on dividend reinvestment plan purchases................ -0- (233) -0- -0- -0- -0- (233) Treasury stock acquired......... -0- -0- -0- -0- -0- -0- -0- Treasury stock reissued......... -0- (291) -0- -0- 700 -0- 409 Balance at June 30, 1999..........$31,263 $ 99,716 $247,283 $(26,715) $ (5,213) $(7,154) $339,180
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 6 Months Ended June 30, 1999 1998 Operating Activities Net income....................................... $26,831 $20,476 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses................... 4,550 5,100 Depreciation and amortization................. 4,048 3,537 Net gains on sales of assets.................. (5,194) (1,051) Income from increase in cash surrender value of bank owned life insurance................. (1,056) (770) Increase in interest receivable............... (635) (3,428) Increase (decrease) in interest payable....... (3,134) 387 Increase (decrease) in income taxes payable... 1,870 (349) Change in deferred taxes...................... (1,902) 467 Other-net..................................... (7,794) (2,479) Net cash provided by operating activities... 17,584 21,890 Investing Activities Transactions with securities held to maturity: Proceeds from sales........................... -0- -0- Proceeds from maturities and redemptions...... 69,747 103,100 Purchases..................................... (45,777) (79,429) Transactions with securities available for sale: Proceeds from sales........................... 38,484 49,036 Proceeds from maturities and redemptions...... 113,743 82,760 Purchases..................................... (309,355) (474,532) Proceeds from sales of loans and other assets.... 86,485 15,710 Sale of subsidiary............................... (2,396) -0- Investment in bank owned life insurance.......... (20,000) -0- Net decrease (increase) in time deposits with banks........................................... 1,408 (2,134) Net increase in loans............................ (79,422) (50,595) Purchases of premises and equipment.............. (2,192) (4,222) Net cash used by investing activities....... (149,275) (360,306) Financing Activities Repayments of long-term debt..................... (110) (19,515) Proceeds from issuance of long-term debt......... 9,000 300,000 Discount on dividend reinvestment plan purchases. (233) (444) Dividends paid................................... (12,202) (11,849) Net increase (decrease) in Federal funds purchased....................................... 9,925 (79,205) Net increase in other short-term borrowings...... 73,359 126,144 Net increase in deposits......................... 37,637 40,749 Purchase of treasury stock....................... -0- (1,062) Proceeds from sale of treasury stock............. 409 936 Net cash provided by financing activities... 117,785 355,754 Net increase (decrease) in cash and cash equivalents................................ (13,906) 17,338 Cash and cash equivalents at January 1............. 97,615 112,380 Cash and cash equivalents at June 30............... $83,709 $129,718 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 June 30, 1999 (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 June 30, 1999 and the results of operations for the three month and six month periods ended June 30, 1999 and 1998, and statements of cash flows and changes in shareholders' equity for the six month periods ended June 30, 1999 and 1998. The results of the three and six months ended June 30, 1999 and 1998 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) 1999 1998 Cash paid during the first six months of the year for: Interest $76,862 $69,158 Income Taxes $10,450 $ 7,654 Noncash investing and financing activities: ESOP loan reductions $ 853 $ 286 Loans transferred to other real estate owned and repossessed assets $ 2,463 $ 3,017 NOTE 3 Comprehensive Income Disclosures 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)
June 30, 1999 June 30, 1998 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 $(43,920) $15,372 $(28,548) $1,675 $(586) $1,089 Less: reclassification adjustment for gains realized in net income (563) 197 (366) (957) 335 (622) Net unrealized gains (44,483) 15,569 (28,914) 718 (251) 467 Other comprehensive income $(44,483) $15,569 $(28,914) $ 718 $(251) $ 467
7 FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS June 30, 1999 (Unaudited) NOTE 4 New Accounting Pronouncements Effective January 1, 1999, the Corporation adopted the Financial Accounting Standards Board 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"). FAS No. 134 amends FAS No. 65 "Accounting for Certain Mortgage Banking Activities". FAS No. 65 requires 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 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. The Corporation currently holds no mortgage backed securities or other beneficial interests retained after the securitization of mortgage loans held for sale. The adoption of FAS No. 134 did not have a material impact on the Corporation's financial condition or results of operations. In June 1998, the Financial Accounting Standards Board ("FASB") issued statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS No. 133"). 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. FAS No. 133 was amended by FASB statement No. 137 in June 1999. FAS No. 137 delays the effective date of FAS No. 133 to the first quarter of years beginning after June 15, 2000. Management believes that adoption of FAS No. 133 will not have a material impact on the Corporation's financial condition or results of operations. NOTE 5 Sale of Subsidiary Effective April 1, 1999 the Corporation sold all of the outstanding common stock of BSI Financial Services Inc. ("BSI"), a wholly-owned subsidiary of the Corporation, to First Bank Richmond headquartered in Richmond, Indiana. The resulting loss on sale of $167 thousand is reflected in the financial statements for the second quarter of 1999. BSI provided mortgage banking, loan servicing and collection services to the Corporation's subsidiary banks and unaffiliated organizations. Services performed by BSI for the subsidiary banks have been transferred to the subsidiary banks or other nonbank subsidiaries of the Corporation. 8 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS NOTE 6 Stock Buyback On July 13, 1999 the Corporation's Board of Directors authorized the buyback of up to two million shares of common stock. The buyback if fully completed would reduce the number of outstanding shares by approximately 6.5%. RESULTS OF OPERATIONS First Six Months of 1999 as Compared to the First Six Months of 1998 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. Net income in the six months of 1999 was $26.8 million reflecting an increase of $6.3 million over 1998 results of $20.5 million. Net income excluding the impact of securities transactions and loan sales reflected an increase of $3.5 million or 18% when comparing the six months of 1999 to the same period of 1998. Basic earnings per share of $0.88 for the six months of 1999 increased $0.21 per share over basic earnings per share of $0.67 for the six months of 1998. Changes in net interest income increased earnings by $0.16 per share during 1999 while the impact of loan sales increased earnings per share $0.16 during 1999. Mortgage loans with a book value of $42.2 million were sold during the first quarter of 1999 resulting in a gain on sale of $890 thousand. Retail credit card loans with a book value of $20.4 million were sold during the second quarter of 1999 resulting in a gain on sale of $4.0 million. Return on average assets was 1.29% and return on average equity was 14.95% during the 1999 period, compared to 1.07% and 11.41%, respectively during the same period of 1998. 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 $71.7 million for the six months of 1999 compared to $67.2 million for the same period of 1998. Net interest margin (net interest income, on a tax-equivalent basis, as a percentage of 9 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 Six Months of 1999 as Compared to the First Six Months of 1998 (Continued) average earning assets) was 3.83%, for both the 1999 and 1998 periods. The following table shows the effect of changes in volumes and rates on interest income and interest expense. Analysis of Changes in Net Interest Income (dollar amounts in thousands) 1999 Change from 1998 Total Change Due Change Due Change To Volume To Rate Interest-earning assets: Time deposits with banks $ 19 $ (27) $ 46 Securities 11,738 12,196 (458) Federal funds sold (827) (818) (9) Loans (5,959) (2,959) (3,000) Total interest income 4,971 8,392 (3,421) Interest-bearing liabilities: Deposits (5,740) 1,845 (7,585) Short-term borrowings (972) (291) (681) Long-term debt 7,217 7,796 (579) Total interest expense 505 9,350 (8,845) Net interest income $ 4,466 $ (958) $ 5,424 Interest and fees on loans decreased $6.0 million for 1999 over 1998 levels including decreases in interest on mortgage loans of $3.2 million and decreases in interest on indirect auto loans of $1.3 million. Average loans for the first half of 1999 decreased $81.2 million compared to averages for the first half of 1998, primarily in residential mortgage loans and indirect auto loans. The decrease in residential mortgage loans for the 1999 period resulted from the sale of $52.5 million and $42.2 million of 1-4 family residential mortgage loans in the fourth quarter of 1998 and the first quarter of 1999, respectively. The average balance of indirect auto loans for the six months of 1999 reflected a decrease of $23.2 million over 1998 averages. The total yield on loans decreased 21 basis points (0.21%) for the six months of 1999 compared to the six months of 1998 reflecting decreased yields in all loan categories as short-term interest rates were lower in the 1999 period. Interest income on investments increased $11.7 million for the six months of 1999 compared to the corresponding period of 1998 as average balances of U.S. government agency securities for the six months of 1999 increased $269.8 million over 1998 averages, and average balances of asset backed securities increased $65.4 million over the same time period. These securities purchases were 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 agency securities and 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 Six Months of 1999 as Compared to the First Six Months of 1998 (Continued) mortgage backed securities. Yields on investments for the 1999 period were comparable to the 1998 period. Interest on deposits decreased $5.7 million for the 1999 period compared to 1998, and included decreases in interest on time deposits of $4.1 million and decreases in interest on total savings deposits of $1.6 million primarily as a result of active interest rate management. Cost of total savings deposits decreased 46 basis points (0.46%) and cost of time deposits decreased 38 basis points (0.38%) for the six months of 1999 compared to the six months of 1998. Interest expense on short-term borrowings decreased $972 thousand for the first six months of 1999 compared to the first six months of 1998 as average Federal Funds purchased decreased $25.1 million over 1998 averages. Additionally, the cost of short-term borrowings for the first half of 1999 decreased 71 basis points (0.71%) compared to the first half of 1998. Interest expense on long-term debt increased $7.2 million compared to the 1998 period as average long-term debt for the six months of 1999 increased $279.9 million over 1998 averages. The long-term debt increase for 1999 was primarily 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 leveraging strategy. The average spread of this leverage strategy was 1.23% during the 1999 period. The provision for credit losses was $4.6 million for the six month period of 1999 compared to $5.1 million during the 1998 period. Net charge-offs against the allowance for credit losses were $3.2 million in the 1999 period and $4.1 million in the 1998 period reflecting a decrease of $936 thousand. The 1999 decrease in net charge-offs included decreases in net charge-offs for non- real estate consumer loans compared to 1998 charge-offs. The decreases in net charge-offs for the six months of 1999 were partially offset by increases in net charge-offs of loans secured by residential real estate. See the "Credit Review" section for an analysis of the quality of the loan portfolio. 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 Six Months of 1999 as Compared to the First Six Months of 1998 (Continued) Below is an analysis of the consolidated allowance for credit losses for the six month periods ended June 30, 1999 and 1998. 1999 1998 (Amounts in thousands) Balance January 1, $32,304 $25,932 Loans charged off: Commercial, financial and agricultural 201 483 Real estate-construction -0- -0- Real estate-commercial 67 542 Real estate-residential 625 120 Loans to individuals 2,972 3,766 Lease financing receivables 26 268 Total loans charged off 3,891 5,179 Recoveries of previously charged off loans: Commercial, financial and agricultural 143 325 Real estate-construction -0- -0- Real estate-commercial -0- 26 Real estate-residential 10 47 Loans to individuals 527 633 Lease financing receivables 1 2 Total recoveries 681 1,033 Net charge offs 3,210 4,146 Provision charged to operations 4,550 5,100 Balance June 30, $33,644 $26,886 Net securities gains decreased $419 thousand during the 1999 period from $982 thousand reported in 1998. The security gains during 1999 resulted in part from the sales of fixed rate U.S. government agency securities and U.S. Treasury securities classified as securities "available for sale" having book values of $15.0 million and $21.9 million, respectively, which resulted in security gains of $167 thousand and $317 thousand, respectively. Proceeds from the sale of U.S. Treasury Securities in 1999 were the primary funding source for the acquisition of $20 million of bank owned life insurance. The securities gains during 1998 resulted primarily from the 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. 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 Six Months of 1999 as Compared to the First Six Months of 1998 (Continued) Trust income reflected an increase for the 1999 period of $395 thousand compared to the corresponding period of 1998. During the six months of 1999 gains on the sale of loans were $4.9 million compared to gains on sale of loans of $93 thousand for the first half of 1998. Gains on sale of loans for the 1999 period resulted primarily from the sale of residential mortgage loans and consumer credit card loans during 1999 which generated gains of $890 thousand and $4.0 million respectively. Other income for the first six months of 1999 was $5.0 million representing an increase of $943 thousand compared to the first six months of 1998. Other income for the first half of 1999 compared to the first half of 1998 reflected increases in the cash surrender value of bank owned life insurance of $287 thousand and insurance commissions of $418 thousand. Additional increases included in other income for the six months of 1999 over the 1998 period occurred in merchant discount and ATM fees. Noninterest expense was $47.7 million for the six months of 1999 reflecting an increase of $1.9 million over the 1998 level of $45.8 million. Although total noninterest expense for 1999 increased over 1998 levels, total noninterest expense as a percent of average assets declined from 2.36% for the six months of 1998 to 2.28% for the same period of 1999. Employee costs were $25.6 million in 1999, representing 1.23% of average assets on an annualized basis compared to $24.5 million and 1.27% of average assets on an annualized basis for 1998. Salary and benefit costs increased 4.6% for 1999 over the corresponding period of 1998 but will be favorably impacted during the second half of 1999 by the early retirement plan offered to employees during the fourth quarter of 1998. The success of the early retirement plan accelerated the process of right-sizing the Corporation beyond normal attrition management by adjusting employment levels quickly while continuing the Corporation's tradition of not laying off employees due to merger activity. Employee benefit costs for the first half of 1999 reflected increases of $404 thousand over the first half of 1998 and included increases in disability and health insurance of $112 thousand, increases in the cost of the employee stock ownership plan of $119 thousand and increases in the cost of the 401(k) plan of $128 thousand. 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 Six Months of 1999 as Compared to the First Six Months of 1998 (Continued) Outside data processing expenses for the first half of 1999 increased $115 thousand over the first half of 1998 and will continue to be controlled in future periods through centralized management of these costs by the Corporation's data processing subsidiary. Other operating expenses for the 1999 period were $12.4 million reflecting an increase of $663 thousand over the 1998 amount of $11.7 million. Other operating expenses for the first half of 1999 included an increase in the write-down of mortgage servicing rights in the amount of $336 thousand related to the disposition of BSI. The disposition of BSI in the second quarter of 1999 also resulted in a loss on sale of $167 thousand. Advertising and filing and recording fees reflected increases for the first six months of 1999 of $264 thousand and $126 thousand, respectively compared to the 1998 period. Other professional fees for the first half of 1999 decreased compared to 1998 levels as outside professionals contracted during 1998 under limited engagements to review the Corporation's asset/liability management model, analyze fee structures, and provide research and consulting services for marketing, customer profitability analysis and branch automation initiatives were not extended into the 1999 period. Income tax expense was $10.5 million for the six months of 1999 compared to $7.8 million for the same period of 1998. The Corporation's effective tax rate was 28.1% for the 1999 period compared to 27.5% for the 1998 period. Three Months ended June 30, 1999 as Compared to the Three Months Ended June 30, 1998 Net income was $14.8 million for the second quarter of 1999, an increase of $4.3 million over 1998 results of $10.5 million. Basic earnings per share was $0.48 during the 1999 quarter compared to $0.34 for the same period of 1998. Net income excluding the impact of loan sales reflected an increase of $1.8 million or 17% when comparing the second quarter of 1999 to the second quarter of 1998. Basic earnings per share excluding the impact of loan sales was $0.40 during the 1999 quarter compared to $0.34 for the same period of 1998, reflecting an increase of 18%. Gains on sale of loans for the second quarter of 1999 resulted primarily from the sale of retail credit card loans as previously mentioned. Return on average assets was 1.41% and return on average equity was 16.42% during the 1999 quarter, compared to 1.06% and 11.56%, respectively during the 1998 quarter. 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) Three Months ended June 30, 1999 as Compared to the Three Months Ended June 30, 1998 (Continued) Net interest income for the second quarter of 1999 of $36.6 million represented an increase of $2.7 million over the second quarter of 1998. Net interest margin (net interest income, on a tax-equivalent basis, as a percentage of average earning assets) for the 1999 period was 3.86%, reflecting an increase of 10 basis points (0.10%) from 3.76% reported in 1998. Total interest and fees on loans for the three months ended June 30, 1999 decreased $3.3 million compared to the three months ended June 30, 1998. The decrease in interest and fees on loans for the second quarter of 1999 compared to the 1998 quarter was equally attributable to volume decreases and rate decreases. Average loans outstanding for the second quarter of 1999 were $94.4 million lower than average loans outstanding for the second quarter of 1998. This decrease resulted from the sale of $52.5 million and $42.2 million of 1-4 family residential mortgage loans in the fourth quarter of 1998 and the first quarter of 1999, respectively. The total yield on loans (including fees on loans) for the three months ended June 30, 1999 was 8.28%, a decrease of 21 basis points (0.21%) over yields for the three months ended June 30, 1998 as all loan categories reflected decreases reflecting lower short-term market interest rates. Interest income on investments for the three months ended June 30, 1999 was $25.2 million, reflecting an increase of $5.4 million over the three months ended June 30, 1998. The primary factor which generated an increase in interest income was the increased average asset related to the capital management leverage strategy as previously described. Yields on investments for the 1999 quarter were 6.48% compared to 6.46% for the same period of 1998. Interest on deposits for the second quarter of 1999 was $25.6 million reflecting a decrease of $3.2 million compared to the second quarter of 1998. Interest on total savings deposits for the three months ended June 30, 1999 decreased $1.1 million compared to the same period of 1998, primarily as a result of rate decreases. The cost of total savings deposits decreased 54 basis points (0.54%) for the second quarter of 1999 compared to the second quarter of 1998. Interest on time deposits for the 1999 quarter decreased $2.2 million over 1998 levels as decreases due to rate of $3.7 million were partially offset by increases due to volume of $1.5 million. The cost of time deposits decreased 46 basis points (0.46%) for the second quarter of 1999 compared to the second quarter of 1998. Total cost of deposits for the second quarter of 1999 was 3.47% compared to 3.96% for the second quarter of 1998, a decrease of 50 basis points (0.50%). 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 June 30, 1999 as Compared to the Three Months Ended June 30, 1998 (Continued) Interest on short-term borrowings for the second quarter of 1999 decreased $509 thousand compared to the second quarter of 1998 as the cost of borrowings decreased 70 basis points (0.70%) for the 1999 period compared to the 1998 period. Interest on long-term debt for the three months ended June 30, 1999 increased $2.7 million over the three months ended June 30, 1998, primarily as a result of increases in average long-term debt of $212.5 million for the second quarter of 1999 compared to the 1998 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. Provision for credit losses was $2.3 million for the three months ended June 30, 1999 compared to $2.6 million for the three months ended June 30, 1998. Net loans charged offs in the second quarter of 1999 were $1.8 million, a decrease of $174 thousand from net charge-offs of $2.0 million reported for the corresponding period of 1998. Net charge-offs of commercial loans, both secured by real estate and not secured by real estate, decreased and were partially offset by an increase in net charge-offs of loans secured by 1-4 family residential properties in the 1999 quarter. Total other operating income, increased $4.1 million for the three months ended June 30, 1999, compared to the three months ended June 30, 1998. Gains on sale of loans for the second quarter of 1999 of $4.0 million compared to gains of $56 thousand for the second quarter of 1998. Gains on sale of loans for the second quarter of 1999 resulted from the sale of consumer credit card loans. Other income for the 1999 period also included increases in insurance commissions of $255 thousand, over 1998 amounts. Total noninterest expense for the three months ending June 30, 1999 was $23.5 million reflecting an increase of $647 thousand over the $22.8 million that was reported for the corresponding period of 1998. Employee costs were $12.5 million during the second quarter of 1999 reflecting an increase of $506 thousand over 1998 levels of $12.0 million. Salary expense for the second quarter of 1999 compared to the 1998 quarter was positively impacted by the sale of BSI in the second quarter of 1999 and the early retirement plan offered to employees. Employee benefit costs increased $344 thousand for the second quarter of 1999 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 June 30, 1999 as Compared to the Three Months Ended June 30, 1998 (Continued) compared to the second quarter of 1998. Benefit cost increases for the 1999 period occurred primarily in hospitalization, employee stock ownership plan expenses and 401(k) expenses. Other operating expenses for the three months ended June 30, 1999 included increases in advertising expense, filing and recording fees, and losses on the sale of assets which were partially offset by decreases in legal fees and other professional fees. The increase in loss on sale of assets for the second quarter of 1999 was due in part to the sale of BSI which resulted in a loss on sale of $167 thousand. Income taxes increased $2.1 million for the second quarter of 1999 compared to the 1998 quarter. The Corporation's effective tax rate was 28.6% for the 1999 period compared to 26.9% for the 1998 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 the 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 subsidiaries are members 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 decreased by $6.3 million in the first six months of 1999 as decreases in loans secured by residential real estate of $39.1 million and decreases in loans to individuals of $20.9 million were partially offset by increases in all other loan types, including an increase in commercial loans secured by real estate of $25.4 million. The reduction in residential mortgage loans was primarily the result of the sale of $42.2 million of residential mortgages in March of 1999. The mortgage loans were sold to reduce the Corporation's prepayment risk and to shorten the average life of the fixed rate loan portfolio. The reduction in loans to individuals was primarily the result of the sale of $20.4 million of consumer credit card loans. 17 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) LIQUIDITY (Continued) Total deposits decreased $34.0 million during the first half of 1999 and included decreases in noninterest bearing demand deposits of $21.1 million and increases in total savings deposits and time deposits of $40.0 million and $15.1 million, respectively. The increase in total savings deposits for the first half of 1999 resulted primarily from increases in the Corporation's American Dream savings product. Customers continue to reinvest traditional savings dollars in this 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. 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 June 30, 1999 securities available for sale had an amortized cost of $1,196.8 million and an approximate fair value of $1,155.8 million. Growth of the available for sale portfolio during the first six months of 1999 in the amount of $113.2 million was funded primarily by short-term borrowings. The investment in bank owned life insurance during the first quarter of 1999 was funded primarily from the liquidation of U.S. government agencies and U.S. treasury securities. 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. 18 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) 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. 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. 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 following table lists the amounts and ratios of assets and liabilities with rates or yields subject to change within the periods indicated as of June 30, 1999 and December 31, 1998 (Dollar amounts in thousands): June 30, 1999 0-90 91-180 181-365 Cumulative Days Days Days 0-365 Days Loans....................$ 741,189 $148,504 $235,378 $1,125,071 Investments.............. 61,302 59,340 103,861 224,503 Other interest-earning assets.................. 11,824 1,609 5,170 18,603 Total interest-sensitive assets................ 814,315 209,453 344,409 1,368,177 Certificates of deposits. 442,298 156,159 372,860 971,317 Other deposits........... 1,127,148 -0- -0- 1,127,148 Borrowings............... 226,919 2,693 27,052 256,664 Total interest-sensitive liabilities........... 1,796,365 158,852 399,912 2,355,129 GAP....................$ (982,050) $ 50,601 $(55,503) $ (986,952) ISA/ISL.................. 0.45 1.32 0.86 0.58 Gap/Total assets......... 23.36% 1.20% 1.32% 23.48% December 31, 1998 0-90 91-180 181-365 Cumulative Days Days Days 0-365 Days Loans....................$ 765,948 $168,297 $293,082 $1,227,327 Investments.............. 59,942 87,042 149,497 296,481 Other interest-earning assets.................. 38,048 4,120 6,207 48,375 Total interest-sensitive assets................ 863,938 259,459 448,786 1,572,183 Certificates of deposits. 359,487 323,760 318,282 1,001,529 Other deposits........... 1,094,125 -0- -0- 1,094,125 Borrowings............... 142,509 1,085 2,413 146,007 Total interest-sensitive liabilities........... 1,596,121 324,845 320,695 2,241,661 GAP....................$ (732,183) $(65,386) $128,091 $ (669,478) ISA/ISL.................. 0.54 0.80 1.40 0.70 Gap/Total assets......... 17.87% 1.60% 3.13% 16.34% 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 June 30, 1999, 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 are 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. At June 30, 1999 1998 (amounts in thousands) Nonperforming Loans: Loans on nonaccrual basis $ 9,869 $ 10,654 Past due loans 12,507 14,106 Renegotiated loans 63 66 Total Nonperforming Loans $ 22,439 $ 24,826 Other real estate owned $ 1,808 $ 2,198 Loans outstanding at end of period $2,369,905 $2,467,764 Average loans outstanding (year-to-date) $2,382,276 $2,463,442 Nonperforming loans as percent of total loans 0.95% 1.01% Provision for credit losses $ 4,550 $ 5,100 Net charge-offs $ 3,210 $ 4,146 Net charge-offs as percent of average loans outstanding 0.13% 0.17% Provision for credit losses as percent of net charge-offs 141.74% 123.01% Allowance for credit losses as percent of average loans outstanding 1.41% 1.09% Allowance for credit losses as percent of end-of-period loans outstanding 1.42% 1.09% Allowance for credit losses as percent of nonperforming loans 149.94% 108.30% 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 credit losses at June 30, 1999 and June 30, 1998. 1999 1998 (amounts in thousands) Recorded investment in impaired loans at end of period $ 9,932 $10,720 Year to date average balance of impaired loans $10,252 $11,436 Allowance for credit losses related to impaired loans $ 2,299 $ 1,937 Impaired loans with an allocation of the allowance for credit losses $ 4,392 $ 4,817 Impaired loans with no allocation of the allowance for credit losses $ 5,540 $ 5,903 Year to date income recorded on impaired loans on a cash basis $ 124 $ 167 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 June 30, 1999, there were no significant concentrations of credit. Nonperforming loans at June 30, 1999 decreased $2.4 million compared to 1998 levels and included decreases in past due loans of $1.6 million and decreases in nonaccrual loans of $785 thousand. Past due loans reflected decreases in commercial loans secured by real estate of $918 thousand, and residential loans secured by real estate of $1.2 million which were partially offset by increases in past due loans to individuals of $523 thousand. Nonaccrual loans reflected decreases in commercial loans not secured by real estate of $376 thousand, loans secured by residential real estate of $1.4 million and auto leases of 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) $209 thousand. Nonaccrual construction loans increased $1.1 million at June 30, 1999 compared to June 30, 1998. Nonperforming loans as a percent of total loans were 0.95% at June 30, 1999 compared to 1.01% at June 30, 1998. The allowance for credit losses as a percent of nonperforming loans at June 30, 1999 has increased over both June 30, 1998 and year-end 1998 levels. Net charge-offs in both dollars and as a percentage of average loans at June 30, 1999 have decreased over 1998 levels. 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 credit losses and nonperforming loans remain safely within acceptable levels. CAPITAL RESOURCES Equity capital decreased $16.2 million in the first six months of 1999. Dividends declared reduced equity by $15.2 million during the 1999 period, while earnings retention was $11.7 million, representing an earnings retention rate of 43.5%. The retained net income remains in permanent capital to fund future growth and expansion. Payments by the Corporation's Employee Stock Ownership Plan ("ESOP") to reduce debt it incurred to acquire the Corporation's common stock for future distribution as employee compensation, net of fair value adjustments to Unearned ESOP shares, increased equity by $853 thousand. Amounts paid to fund the discount on reinvested dividends and optional cash payments reduced equity by $233 thousand. The market value adjustment to securities available for sale decreased equity by $28.9 million. Proceeds from the reissuance of treasury shares to provide for stock options exercised increased equity by $409 thousand. 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. 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) The Federal Reserve Board has issued risk-based capital adequacy guidelines which are designed principally as a measure of credit risk. These guidelines require: (1) at least 50% of a banking organization's total capital be common and other "core" equity capital ("Tier I Capital"); (2) assets and off-balance-sheet items be weighted according to risk; (3) the total capital to risk-weighted assets ratio be at least 8%; and (4) a minimum leverage ratio of Tier I capital to average total assets. 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 June 30, 1999: Percent Amount of Adjusted (in thousands) Assets Tier I Capital $356,458 14.2% Risk-Based Requirement 100,536 4.0 Total Capital 387,876 15.4 Risk-Based Requirement 201,073 8.0 Minimum Leverage Capital 356,458 8.4 Minimum Leverage Requirement 126,644 3.0 At June 30, 1999 the Corporation's banking subsidiaries are considered well capitalized as defined by the Federal Deposit Insurance Corporation Improvement Act of 1991. YEAR 2000 UPDATE The Corporation's data processing subsidiary, Commonwealth Systems Corporation continued to address year 2000 issues during the second quarter of 1999. Renovation whereby code enhancements, hardware and software upgrades and system replacements are implemented was substantially complete for mission critical systems as of June 30, 1999. An application is considered mission critical if it is vital to the successful continuation of a core business activity. Validation or testing of all changes to hardware and software components, including connections with other systems, and implementation of mission critical systems were also substantially complete by the same time frame, placing the Corporation within guidelines established by federal regulatory agencies. Regulatory agencies will continue to perform quarterly reviews of the Corporation's year 2000 readiness throughout 1999. Outside professionals engaged by the Corporation during 1998 to provide additional independent verification and validation processes and to assure the reliability of internal risk and cost estimates will continue their engagements during 1999. 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 (Continued) The Corporation will continue to strengthen its remediation contingency plan for year 2000 events during the remainder of 1999. The remediation contingency plan addresses major identifiable internal and external components and identifies alternative processes in event that a system fails. Third party vendors have been evaluated and outside sources have been tested where possible. Contingencies established for critical systems and processes include manual processing of transactions, utilization of tape transfer rather than electronic medium, use of alternate communication lines or methods and the installation of a generator as a backup power source. Contingencies for communication with customers include maintaining access to the Corporation's telephone banking center by relocation of the center if necessary. Short-term liquidity needs have been estimated and multiple sources of funds have been identified. Contingency planning will continue throughout the remainder of 1999. Although all possible problems can not possibly be anticipated, management believes that potential difficulties associated with implementation are likely to result in only minor delays in transaction or information availability. The Corporation utilized internal resources to evaluate, reprogram and test software and hardware for year 2000 issues to the extent possible. Salary and benefit costs related to year 2000 activities were expensed as incurred. External year 2000 expenditures included amounts for capitalized hardware and software which will be amortized over three years for software and five years for hardware. Year 2000 expenditures which were expensed as incurred included the cost of leased off-site testing of mainframe systems, outside professionals utilized for independent verification, travel and lodging during off-site testing and vendor testing. The Corporation's estimates of additional year 2000 expenditures to be incurred during 1999 are based on presently available information and estimates. Cash outlays were funded through operating cash flows. Due to the Corporation's commitment to mitigate year 2000 risks where possible, management does not believe the year 2000 problem will have a material impact on the Corporation's financial condition or results of operations. 26 ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS YEAR 2000 UPDATE (Continued) The following table summarizes year 2000 expenditures incurred through the end of the second quarter of 1999 and estimated amounts to be incurred throughout the remainder of 1999. (Dollar amounts in thousands)
6 Months Estimate 12 Months 12 Months Ended for Remainder Ended Ended 06/30/99 of 1999 12/31/98 12/31/97 Capitalized hardware and software $ 81 $ 19 $ 250 $106 Nonemployee expenses including testing 44 105 152 20 Employee related costs 429 427 1,003 163 Subtotal 554 551 1,405 289 Capitalized hardware and software replaced without acceleration due to year 2000 567 147 2,043 70 Total expenditures $1,121 $ 698 $3,448 $359
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. 27 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 On April 26, 1999, the Corporation held its regularly scheduled annual meeting of shareholders. The following proposals were considered and acted upon. Proposal 1 The following directors were elected for terms to expire in 2002: Sumner E. Brumbaugh Ray T. Charley Edward T. Cote Clayton C. Dovey, Jr. Johnston A. Glass Dale P. Latimer Joseph E. O'Dell David R. Tomb, Jr. Proposal 2 A proposal to amend the Corporation's 1995 Compensatory Stock Option Plan to allow the participation of non- employee directors in the plan. For 18,007,387 Against 2,658,287 Abstain 519,079 Non-voting 9,753,220 ITEM 5. OTHER INFORMATION Not applicable. 28 FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES PART II - OTHER INFORMATION (Continued) ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) Reports on Form 8-K None 29 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. FIRST COMMONWEALTH FINANCIAL CORPORATION (Registrant) DATED: AUGUST 12, 1999 /S/ Joseph E. O'Dell Joseph E. O'Dell, President and Chief Executive Officer DATED: AUGUST 12, 1999 /S/ John J. Dolan John J. Dolan, Sr. Vice President and Chief Financial Officer 30 EX-27 2
9 1,000 3-MOS DEC-31-1999 JAN-01-1999 JUN-30-1999 83,709 500 0 0 1,155,808 458,761 452,452 2,374,977 33,644 4,203,203 2,965,133 223,831 36,534 638,525 0 0 31,263 307,917 4,203,203 48,419 25,177 40 73,636 25,573 36,989 36,647 2,337 0 23,490 20,764 20,764 0 0 14,826 0.48 0.48 7.55 9,869 12,507 63 0 32,304 3,891 681 33,644 0 0 0
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