FORM 10-Q SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 For the quarterly period ended September 30, 2001 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934 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 9, 2001 was 58,445,047. 1
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 ..12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK ......................27 PART II - OTHER INFORMATION Other Information ...........................28 Signatures ........................Signature Page 2
<TABLE> FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Unaudited) (Dollars in thousands) <CAPTION> September December 30, 31, 2001 2000 <S> <C> <C> ASSETS Cash and due from banks on demand $ $ 82,836 90,723 Interest-bearing deposits with banks 3,147 427 Federal funds sold 1,000 11,125 Securities available for sale, at market 1,516,927 1,238,230 Securities held to maturity, at cost, (Market value 307,825 398,107 $316,112 in 2001 and $398,661 in 2000) Loans 2,595,470 2,492,874 Unearned income (1,441) (2,047) Allowance for credit losses (33,172) (33,601) Net loans 2,560,857 2,457,226 Property and equipment 45,601 44,671 Other real estate owned 1,716 1,661 Other assets 132,103 130,142 TOTAL ASSETS $4,652,01 $4,372,312 2 LIABILITIES Deposits (all domestic): Noninterest-bearing $ $ 80,101 244,010 Interest-bearing 3,127,612 2,820,136 3,207,713 3,064,146 Total deposits Short-term borrowings 371,934 272,171 Other liabilities 27,022 44,984 Company obligated mandatorily redeemable capital securities of subsidiary 35,000 35,000 trust Other long-term debt 621,855 629,790 656,855 Total long-term debt 664,790 4,271,459 4,038,156 Total liabilities SHAREHOLDERS' EQUITY Preferred stock, $1 par value per share, 3,000,000 shares -0- -0- authorized, none issued Common stock $1 par value per share, 100,000,000 shares authorized; 62,525,412 shares issued; 58,442,989 and 62,525 62,525 58,195,450 shares outstanding at September 30, 2001 and December 31, 2000, respectively Additional paid-in capital 66,038 67,223 Retained earnings 283,572 272,169 Accumulated other comprehensive income 24,352 (7,808) Treasury stock (4,082,423 shares at September 30, 2001, and (51,540) (54,666) 4,329,962 at December 31, 2000, at cost) Unearned ESOP shares (4,394) (5,287) Total shareholders' equity 380,553 334,156 $4,652,01 $4,372,312 TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY 2 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 3
<TABLE> FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (Unaudited) (Dollars in thousands except per share data) <CAPTION> For the For the 9 Quarter Months Ended Ended September 30, 0 September 30, 30, Ended June 30, Ended June 30, 2001 2000 2001 2000 <S> <C> <C> <C> <C> Interest Income Interest and fees on loans $50,847 $52,61 $153,8 $155,6 3 24 78 Interest and dividends on investments: Taxable interest 23,639 22,527 70,413 66,860 Interest exempt from Federal 2,432 2,399 7,177 7,264 income taxes Dividends 615 887 2,044 2,721 Interest on Federal funds sold 3 22 491 145 Interest on bank deposits 21 23 59 63 Total interest income 77,557 78,471 234,008 232,731 Interest Expense Interest on deposits 29,723 30,258 93,023 83,967 Interest on short-term 2,742 5,297 8,975 17,071 borrowings Interest on company obligated mandatorily 832 832 2,494 2,494 redeemable capital securities of subsidiary trust mandatorily redeemable capital securities of subsidiary trust Interest on other long-term debt 8,703 8,347 25,769 25,149 Total interest on long-term debt 9,535 9,179 28,263 27,643 Total interest expense 42,000 44,734 130,261 128,681 Net Interest Income 35,557 33,737 103,747 104,050 Provision for credit losses 3,542 2,505 8,506 7,425 Net interest income after 32,015 31,232 95,241 96,625 provision for credit losses for credit losses Other Income Securities gains 1,330 0 3,325 1,686 Trust income 1,265 1,327 3,815 4,091 Service charges on deposit 2,804 2,704 8,092 7,840 accounts Income from bank owned life 1,096 833 3,156 2,565 insurance Other income 4,264 3,378 12,011 9,358 Total other income 10,759 8,242 30,399 25,540 Other Expenses Salaries and employee benefits 13,588 13,044 40,658 39,885 Net occupancy expense 1,577 1,577 4,977 4,897 Furniture and equipment expense 2,168 2,081 6,548 5,889 Data processing expense 795 745 2,383 2,436 Pennsylvania shares tax expense 944 817 2,855 2,627 Other operating expenses 6,961 6,445 20,071 19,173 Total other expenses 26,033 24,709 77,492 74,907 Income before income taxes 16,741 14,765 48,148 47,258 Applicable income taxes 4,023 3,209 11,373 11,161 Net income $12,718 $11,556 $36,775 $36,097 Average Shares Outstanding 57,975, 57,565, 57,833, 57,529, 650 411 280 015 Average Shares Outstanding 58,342, 57,601, 58,062, 57,591, Assuming Dilution 525 162 021 432 Assuming Dilution Per Share Data: Basic earnings per share $ $ $ $ 0.630 0.220 0.200 0.640 Diluted earnings per share $ $ $ 0.630 $ 0.630 0.220 0.200 Cash dividends per share $ $ $ 0.435 $ 0.420 0.145 0.140 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 4
<TABLE> FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Unaudited) (Dollars in thousands) <CAPTION> Accumula Addit ted Unear Total Commo ional Other Trea ned Shareho n Paid- RetainedComprehe sury ESOP lders' Stock in Earn nsive Stoc Share Equity Capit ings Income k s al <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, $62,5 $68,3 $257 $(40,304 $(55 $(6,1 $286,68 1999 25 30 ,773 ) ,448 93) 3 ) Comprehensive income Net income 0 0 36,0 0 0 0 36,097 97 Other comprehensive income, net of tax: Unrealized holding gains on 0 0 0 12,960 0 0 12,960 securities arising during the period Less: reclassification 0 adjustment for gains 0 0 0 (1,096) 0 (1,096) on securities included in net income Total other comprehensive income 0 0 0 11,864 0 0 11,864 Total comprehensive 0 0 36,0 11,864 0 0 47,961 income 97 Cash dividends 0 0 (24, 0 0 0 (24,412 declared 412) ) Decrease in unearned 0 0 0 0 0 429 429 ESOP shares Discount on dividend reinvestment plan 0 (443) 0 0 0 0 (443) purchases Treasury stock 0 0 0 0 (873 0 (873) acquired ) Treasury stock 0 (369) 0 0 1,52 0 1,151 reissued 0 Tax benefit of stock options 0 75 0 0 0 0 75 Balance at September 30, $62,5 $67,5 $269 $(28,440 $(54 $(5,7 $310,57 2000 25 93 ,458 ) ,801 64) 1 ) Balance at December 31, $62,5 $67,2 $272 $(7,808) $(54 $(5,2 $334,15 2000 25 23 ,169 ,666 87) 6 ) Comprehensive income Net income 0 0 36,7 0 0 0 36,775 75 Other comprehensive income, net of tax: Unrealized 0 0 0 34,287 0 0 34,287 holding gains on securities arising during the period Less: reclassification adjustment for gains 0 0 0 (2,127) 0 0 (2,127) on securities included in net income Total other comprehensive income 0 0 0 32,160 0 0 32,160 Total comprehensive 0 0 36,7 32,160 0 0 68,935 income 75 Cash dividends 0 0 (25, 0 0 0 (25,372 declared 372) ) Decrease in unearned 0 0 0 0 0 893 893 ESOP shares Discount on dividend reinvestment plan 0 (460) 0 0 0 0 (460) purchases Treasury stock reissued 0 (725) 0 0 3,12 0 2,401 6 Balance at September 30, $62,5 $66,0 $283 $24,352 $(51 $(4,3 $380,55 2001 25 38 ,572 ,540 94) 3 ) The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 5
<TABLE> FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) <CAPTION> For the 9 Months Ended September 30, 2001 2000 <S> <C> <C> Operating Activities Net income $ $ 36,775 36,097 Adjustments to reconcile net income to net cash provided by operating activities: Provision for credit losses 8,506 7,425 Depreciation and amortization 5,625 5,415 Net gains on sales of assets (4,456 (1,775 ) ) Income from increase in cash surrender value of (3,156 (2,565 bank owned life insurance ) ) Decrease in interest receivable 999 13 Increase (decrease) in interest payable (18,84 2,475 1) Increase in income taxes payable 945 1,089 Change in deferred taxes (74) 658 Other-net (3,083 (1,487 ) ) Net cash provided (used) by operating activities 23,240 47,345 Investing Activities Transactions with securities held to maturity: Proceeds from sales 0 0 Proceeds from maturities and redemptions 109,05 52,288 7 Purchases (18,62 (8,926 9) ) Transactions with securities available for sale: Proceeds from sales 85,657 16,358 Proceeds from maturities and redemptions 342,07 73,463 1 Purchases (653,6 (122,8 93) 96) Proceeds from sales of loans and other assets 69,219 24,963 Investment in bank owned life insurance (15,00 (15,00 0) 0) Net decrease (increase) in time deposits with banks (2,719 650 ) Net increase in loans (181,3 (24,03 88) 6) Purchases of premises and equipment (5,379 (5,848 ) ) Net cash provided (used) by investing activities (270,8 04) (8,984 ) Financing Activities Repayments of other long-term debt (673) (50,36 5) Proceeds from issuance of other long-term debt 9,500 34,900 Discount on dividend reinvestment plan purchases (460) (443) Dividends paid (25,33 (24,40 5) 7) Net increase in Federal funds purchased 67,525 8,025 Net increase (decrease) in other short-term 32,238 ( borrowings 78,452 ) Sale of branch and deposits, net of cash received (9,591 0 ) Net increase in deposits 153,94 53,143 7 Stock option tax benefit 0 75 Purchase of treasury stock 0 (873) Proceeds from sale of treasury stock 2,401 298 Net cash provided (used) by financing activities 229,55 (58,09 2 9) Net increase (decrease) in cash and cash (18,01 (19,73 equivalents 2) 8) Cash and cash equivalents at January 1 101,84 101,37 8 3 Cash and cash equivalents at September 30 $83,83 $81,63 6 5 The accompanying notes are an integral part of these consolidated financial statements. </TABLE> 6
FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (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, 2001 and the results of operations for the three month and nine month periods ended September 30, 2001 and 2000, and statements of cash flows and changes in shareholders' equity for the nine month periods ended September 30, 2001 and 2000. The results of the three and nine months ended September 30, 2001 and 2000 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) <TABLE> <CAPTION> 2001 2000 <S> <C> <C> Cash paid during the first nine months of the year for: Interest $149,102 $126,206 Income Taxes $ 10,206 $ 9,410 Noncash investing and financing activities: ESOP loan reductions $ 893 $ 429 Loans transferred to other real estate owned and repossessed assets $ 3,743 $ 4,733 Gross increase in market value adjustment to securities available for sale $ 49,477 $ 18,252 Treasury stock reissued for insurance agency interest acquired $ 0 $ 852 </TABLE> 7
FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (Unaudited) 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) <TABLE> <CAPTION> September 30, 2001 September 30, 2000 Tax Net of Tax Net of Pre-Tax (Expense) Tax Pre-tax (Expense) Tax Amount Benefit Amount Amount Benefit Amount <S> <C> <C> <C> <C> <C> <C> Unrealized gains (losses) on securities: Unrealized holding gains (losses) arising during the period $52,750 $(18,463) $34,287 $19,938 $(6,978) $12,960 Less: reclassification adjustment for gains realized in net income (3,273) 1,146 (2,127) (1,686) 590 (1,096) Net unrealized gains (losses) 49,477 (17,317) 32,160 18,252 (6,388) 11,864 Other comprehensive income $49,477 $(17,317) $32,160 $18,252 $(6,388) $11,864 </TABLE> NOTE 4 New Accounting Pronouncements Effective January 1, 2001, the Corporation adopted the Financial Accounting Standards Board ("FASB") Statement No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FAS No. 133") as amended. 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 on a balance sheet and measure those instruments at fair value. Changes in the fair value of derivatives must be recognized in earnings when they occur unless the derivative qualifies as a hedge. If a derivative qualifies as a hedge, a company can elect to use hedge accounting to eliminate or reduce income statement volatility that would arise from reporting changes in a derivative's fair value in income. FAS No. 133 was amended by FASB statement No. 137 which delayed the effective date of FAS No. 133 to the first quarter of fiscal years beginning after June 15, 2000. FAS No. 133 was also amended by FAS No. 138 which addresses and clarifies issues causing implementation difficulties for numerous entities applying FAS No. 133. FAS No. 138 includes amendments to FAS No. 133 which resulted from decisions made by the FASB related to the Derivatives Implementation Group ("DIG") process. The DIG was created by the FASB to facilitate implementation by identifying issues that arise from applying the requirements of FAS No. 133 and to advise the FASB on how to resolve those issues. The Corporation currently has no freestanding derivative or hedging instruments. Management reviewed contracts from various functional areas of the Corporation to identify potential derivatives embedded within selected contracts. In accordance with the guidance provided in DIG Issue C13, management identified embedded derivatives in some loan commitments for residential mortgages where the Corporation has intent to sell to an investor such as the Federal Home Loan Mortgage Corporation ("Freddie Mac") or the Federal National Mortgage Association ("Fannie Mae"). 8
FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (Unaudited) NOTE 4 New Accounting Pronouncements (continued) Due to the short-term nature of these loan commitments (30 days or less) and the historical dollar amount of commitments outstanding at period end, the adoption of FAS No. 133 did not have a material impact on the Corporation's financial condition or results of operations. In September 2000, the FASB issued statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" which replaces FASB statement No. 125, issued in June 1996. FAS No. 140 revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of the provisions of FAS No. 125. The statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. FAS No. 140 is effective for transfers occurring after March 31, 2001 and for disclosures relating to securitization transactions and collateral for years ending after December 15, 2000. Implementation of FAS No. 140 did not have a material impact on the Corporation's financial condition or results of operations. In July 2001, the FASB issued statement No. 141, "Business Combinations". FAS No. 141 requires the purchase method of accounting for business combinations initiated after June 30, 2001 and eliminates the pooling-of interest method. FAS No. 141 also specifies the types of acquired intangible assets that are required to be recognized and reported separately from goodwill. Additional provisions of FAS No.141 include the reclassification of certain existing recognized intangibles to goodwill and reclassification of certain intangibles out of previously reported goodwill upon adoption. Implementation of FAS No. 141 is not expected to have a material impact on the Corporation's financial condition or results of operations. In July 2001, the FASB issued statement No. 142, "Goodwill and Other Intangible Assets", which is effective for fiscal years beginning after December 15, 2001. FAS 142 requires that goodwill and other intangible assets with indefinite useful lives, including goodwill recorded in past business combinations, no longer be amortized, but instead be tested for impairment at least annually and written down and charged to results of operations only in the periods in which the recorded value is more than the estimated fair value. The statement also requires the Corporation to complete a transitional goodwill impairment test six months from the date of adoption including the identification of reporting units for the purpose of assessing potential future impairments of goodwill. After identifying its reporting units, the Corporation must determine the carrying value of each reporting unit by assigning the assets and liabilities, including the existing goodwill and intangible assets to those reporting units and then determine the fair value of each reporting unit. If the carrying value of any reporting unit exceeds its fair value, then detailed fair values for each of the assigned assets (excluding goodwill) and liabilities will be determined to calculate the amount of goodwill impairment, if any. Any transitional impairment loss resulting from the adoption of FAS No. 142 will be recognized as the 9
FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (Unaudited) NOTE 4 New Accounting Pronouncements (continued) effect of a change in accounting principle in the Corporation's income statement. As of September 30, 2001, the Corporation had goodwill, net of accumulated amortization, of approximately $6.0 million, which would be subject to the transitional assessment provisions of FAS No. 142. Goodwill amortization expense was $837 thousand during fiscal 2000, or $0.014 per share. The elimination of goodwill amortization is expected to reduce other operating expenses in periods beginning after December 31, 2001, by $838 thousand annually. Management is currently assessing but has not yet determined the full impact of FAS No. 142 on the Corporation's financial condition or results of operations. In June 2001, the FASB issued statement No. 143, "Accounting for Asset Retirement Obligations" which is effective for financial statements issued for fiscal years beginning after June 15, 2002. The statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and associated asset retirement costs. FAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently allocated to expense over the asset's useful life. Implementation of FAS No. 143 is not expected to have a material impact on the Corporation's financial condition or results of operations. In August 2001, the FASB issued statement No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" which is effective for financial statements issued for fiscal years beginning after December 15, 2001, including interim periods. This statement supersedes FASB Statement No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of", and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions". This statement does not apply to goodwill; intangible assets not being amortized; long-term customer relationships of a financial institution, such as core deposit intangibles, credit card intangibles and servicing assets; financial instruments, including investments in equity securities accounted for under the cost or equity method and deferred tax assets. FAS No. 144 requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances, such as a significant decrease in the market value of an asset or the extent or manner in which an asset is used indicate that the carrying amount of an asset may not be recoverable. If there is an indication that the carrying amount of an asset may not be recoverable, future undiscounted cash flows expected to result from the use and disposition of the asset are estimated. If the sum of the expected cash flows is less than the carrying value of the asset a loss is recognized for the difference between the carrying value and the market value of the asset. FAS No. 144 requires that long-lived assets to be abandoned or exchanged for similar productive assets be considered held and used until disposal. If an entity plans to abandon a 10
FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS September 30, 2001 (Unaudited) NOTE 4 New Accounting Pronouncements (continued) long-lived asset before the end of its previously estimated useful life, depreciation estimates should be revised to reflect the use of the asset over its shortened useful life. A long- lived asset that has been temporarily idled should not be accounted for as if abandoned. This statement also requires measurement of long-lived assets classified as held for sale at the lower of their carrying amount or fail value less cost to sell and to cease depreciation or amortization on these assets. Discontinued operations will therefore no longer be measured at net realizable value or include future operating losses that have not yet occurred. Long-lived assets classified as held for sale after the balance sheet date but before issuance of financial statements are to be retroactively reclassified as held for sale at the balance sheet date. Implementation of FAS No. 144 is not expected to have a material impact on the Corporation's financial condition or results of operations. NOTE 5 Legal Proceedings In 1994 a subsidiary Bank and its President at that time, were named as defendants in a lender liability action. The plaintiff seeks damages in excess of $375 thousand, plus punitive damages. Although the Corporation intends to vigorously defend itself, it is not possible to evaluate the likelihood of an unfavorable outcome or the amount or range of potential loss. A jury trial has been scheduled for the first quarter 2002. 11
ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS First Nine Months of 2001 as Compared to the First Nine Months of 2000 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 for the first nine months of 2001 was $36.8 million reflecting an increase of $678 thousand compared to 2000 results of $36.1 million. The increase in net income for the 2001 period was primarily the result of increases in non-interest income which were partially offset by decreases in net interest income. Non-interest income, excluding gains on asset sales, increased $2.2 million or 9% for the nine months of 2001 compared to 2000. Gains on the sale of assets includes securities gains of $3.3 million and $1.7 million in 2001 and 2000, respectively, as well as $999 thousand gain on the sale of a branch and a block of mortgages in 2001. Basic earnings per share were $0.64 for the nine months of 2001 compared to basic earnings per share of $0.63 for the nine months of 2000. Diluted earnings per share were $0.63 for both the 2001 and 2000 nine month periods. Return on average assets was 1.09% and return on average equity was 13.84% during the 2001 period, compared to 1.12% and 16.29%, respectively during the same period of 2000. Net interest income, the most significant component of earnings, is the amount by which interest income generated from earning assets exceeds interest expense on liabilities. Net interest income was $103.7 million for the nine months of 2001 compared to $104.1 million for the same period of 2000. Net interest margin (net interest income, on a tax-equivalent basis, as a percentage of average earning assets) was 3.49% for the nine months of 2001 compared to 3.64% for the nine months of 2000. The reduction in net interest margin for the 2001 period compared to 2000 resulted primarily from deposit rate increases combined with declining loan and investment yields compared to the 2000 period. The cost of deposits increased by 13 basis points (0.13%) for the first nine months of 2001 compared to the first nine months of 2000, while loan and investment yields decreased by 18 basis points (0.18%) and 35 basis points (0.35%), respectively over the same time period. The Corporation continues to expand its fee-based services to offset persistent pressure on net interest income. 12
ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS (Continued) First Nine Months of 2001 as Compared to the First Nine Months of 2000 (Continued) The following table shows the effect of changes in volumes and rates on interest income and interest expense. <TABLE> <CAPTION> Analysis of Changes in Net Interest Income (dollar amounts in thousands) 2001 Change from 2000 Total Change Due Change Change To Volume Due To Rate <S> <C> <C> <C> Interest-earning assets: Time deposits with banks $ $ $ (4) 16 (20) Securities 2,789 7,824 (5,035) Federal funds sold 346 426 (80) Loans (1,854) 2,368 (4,222) Total interest income 10,634 1,277 (9,357) Interest-bearing liabilities: Deposits 9,056 8,269 787 Short-term debt (8,096) (5,384) (2,712) Long-term debt 620 1,170 (550) Total interest expense 1,580 4,055 (2,475) Net interest income $ $ 6,579 $ (303) (6,882) </TABLE> Interest and fees on loans decreased $1.9 million for 2001 over 2000 levels as volume increases were offset by rate decreases. The total yield on loans for the first nine months of 2001 was 8.28%, compared to loan yields of 8.46% for the first nine months of 2000. Average loans for the nine months of 2001 increased $32.2 million compared to averages for the nine months of 2000 as increases in commercial loans and municipal loans were partially offset by decreases in average consumer loans. Interest income on investments increased $2.8 million for the first nine months of 2001 compared to the corresponding period of 2000 and included increases due to volume for corporate bonds and asset backed securities. Average balances of corporate bonds and asset backed securities increased $102.7 million and $27.5 million, respectively for the first nine months of 2001 compared to 2000 averages. Increases in investment income due to volume were partially offset by decreases in investment income due to rate as yields on investments for the first nine months of 2001 were 6.54% compared to investment yields of 6.89% for the first nine months of 2000. 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 2001 as Compared to the First Nine Months of 2000 (Continued) Interest on deposits increased $9.1 million for the 2001 period compared to 2000, as interest on time deposits increased $10.2 million for the nine months of 2001 compared to 2000. Average time deposits increased $186.5 million for the nine months of 2001 compared to 2000 averages, resulting in an increase in interest expense due to volume of $7.8 million. The cost of time deposits for the nine months of 2001 increased by 20 basis points (0.20%) compared to 2000 costs of 5.49% resulting in an increase in interest expense due to rate of $2.4 million. The increase in interest expense on time deposits for the 2001 period compared to 2000 was partially offset by decreases in interest expense on savings deposits, primarily due to rate decreases during the same time period. Interest expense on short-term borrowings decreased $8.1 million for the nine months of 2001 compared to the nine months of 2000 as the average balance of short-term borrowings decreased by $111.8 million over 2000 averages. The cost of short-term borrowings for the 2001 period also decreased by 151 basis points (1.51%) compared to 2000 costs of 5.88%. Interest expense on long-term debt increased $620 thousand for the nine months of 2001 compared to the 2000 period as increases in interest expense due to volume were partially offset by decreases in interest expense due to rate. Average long-term debt for the nine months of 2001 increased by $26.9 million compared to 2000 averages as maturities were extended for short- term borrowings from the Federal Home Loan Bank, to take advantage of lower interest rates. The provision for credit losses was $8.5 million for the nine months of 2001 compared to $7.4 million during the nine months of 2000. Net charge-offs against the allowance for credit losses were $8.9 million in the 2001 period, reflecting an increase of $2.7 million compared to 2000 levels. The 2001 period included increases in net charge-offs for commercial loans of $1.9 million and increases in net charge-offs for consumer real estate loans of $1.1 million compared to 2000 net charge-offs. The aforementioned increases in net charge-offs during the nine months of 2001 were partially offset by decreases in net charge- offs for loans to individuals of $721 thousand compared to 2000 net charge-offs. See the "Credit Review" section for an analysis of the quality of the loan portfolio. 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 2001 as Compared to the First Nine Months of 2000 (Continued) Below is an analysis of the consolidated allowance for credit losses for the nine month periods ended September 30, 2001 and 2000. <TABLE> <CAPTION> 2001 2000 (Amounts in thousands) <S> <C> <C> Balance January 1, $ 33,601 $ 33,539 Loans charged off: Commercial, financial and agricultural 2,413 2,304 Real estate-construction 0 0 Real estate-commercial 1,963 43 Real estate-residential 1,616 491 Loans to individuals 3,406 4,171 Lease financing receivables 392 297 Total loans charged off 9,790 7,306 Recoveries of previously charged off loans: Commercial, financial and agricultural 217 344 Real estate-construction 0 0 Real estate-commercial 0 0 Real estate-residential 48 28 Loans to individuals 585 629 Lease financing receivables 5 25 Total recoveries 855 1,026 Net charge offs 8,935 6,280 Provision charged to operations 8,506 7,425 Balance, September 30, $ 33,172 $ 34,684 </TABLE> 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) First Nine Months of 2001 as Compared to the First Nine Months of 2000 (Continued) Net securities gains were $3.3 million during the first nine months of 2001 compared to $1.7 million for the first nine months of 2000. Securities gains during the nine months of 2001 resulted primarily from the sales of fixed rate corporate bonds classified as securities "available for sale" and Pennsylvania bank stocks with book values of $37.4 million and $12.7 million, respectively. The securities gains during 2000 resulted primarily from the sale of Pennsylvania bank stocks with a book value of $14.4 million. Service charges on deposits for the first nine months of 2001 increased $252 thousand compared to the first nine months of 2000 primarily as a result of increases in NSF fees. Income from bank owned life insurance was $3.2 million for the first nine months of 2001 compared to $2.6 million for the first nine months of 2000. The 2001 period included an additional investment in bank owned life insurance of $15.0 million compared to 2000 levels. Other income for the first nine months of 2001 was $12.0 million representing an increase of $2.6 million compared to $9.4 million reported for the first nine months of 2000. Gains on the sale of loans were $889 thousand for the nine months of 2001 compared to gains on sale of loans of $162 thousand for the nine months of 2000. Gains on sale of loans for the 2001 period resulted primarily from the sale of $12.9 million of 30 year residential mortgage loans with significant prepayment exposure during falling interest rates. As a result of branch analysis including the evaluation of the potential sale or consolidation of branches competing in the same market area, the Corporation sold one of its branches located in Bethel Park, Pennsylvania during 2001. The premium on the sale of $10.4 million of deposits from the branch resulted in a gain of $767 thousand. Other income for the nine months of 2001 also reflected increases in debit and credit card interchange, merchant discount and letter of credit fees of $140 thousand, $166 thousand and $81 thousand, respectively over 2000 revenues. Fee based revenue, such as insurance commissions, has been positively impacted by implementation of an integrated advisory sales model to integrate products between the Corporation's bank, insurance and trust subsidiaries as well as utilization of an employee team to deliver products Management" approach. The first nine months of 2001 also included increases in insurance and services to commercial customers through our "Total Solutions Financial commissions of $921 thousand over the first nine months of 2000. Non-interest expense was $77.5 million for the nine months of 2001 reflecting an increase of $2.6 million over the 2000 level of $74.9 million. Total non-interest expense as a percent of average assets was 2.31% for the 2001 period compared to 2.32% for the 2000 period. Employee costs were $40.7 million for the first nine months of 2001, representing 1.21% of average assets on an annualized basis compared to $39.9 million 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) First Nine Months of 2001 as Compared to the First Nine Months of 2000 (Continued) or 1.24% of average assets on an annualized basis for 2000. Salary costs for the first nine months of 2001 increased $1.0 million or 3.31% compared to 2000 levels of $31.1 million. Employee benefit costs for the first nine months of 2001 reflected decreases of $256 thousand over the first nine months of 2000 and included decreases in health insurance costs of $103 thousand and decreases in expenses of the Corporation's employee stock ownership plan of $222 thousand compared to the first nine months 2000. Furniture and equipment expenses of $6.5 million for the first nine months of 2001 reflected increases of $659 thousand over 2000 levels and included increases in computer software depreciation and software maintenance of $240 thousand and $351 thousand, respectively, primarily related to the upgrade of the core banking software. Other operating expenses for the 2001 period were $20.1 million reflecting an increase of $898 thousand over the 2000 amount of $19.2 million. The first nine months of 2001 included increases in filing and recording fees, legal fees, postage, printing and telephone expense of $179 thousand, $206 thousand, $275 thousand, $140 thousand and $273 thousand, respectively compared to 2000 levels. The 2001 period also included increases in losses on sale of leased vehicles as the used auto market continues to be weak compared to published residual values in prior periods. Other operating expenses for the first nine months of 2001 reflected decreases in insurance expense, promotions and other professional fees compared to the first nine months of 2000. Income tax expense was $11.4 million for the nine months of 2001 compared to $11.2 million for the same period of 2000. The Corporation's effective tax rate was 23.62% for the 2001 and 2000 periods. Three Months ended September 30, 2001 as Compared to the Three Months Ended September 30, 2000 Net income was $12.7 million for the third quarter of 2001, an increase of $1.1 million compared to 2000 results of $11.6 million. Basic and diluted earnings per share were $0.22 during the 2001 quarter compared to $0.20 for the same period of 2000. Return on average assets was 1.10% and return on average equity was 13.72% during the 2001 quarter, compared to 1.07% and 14.97% respectively, during the 2000 quarter. Net interest income for the third quarter of 2001 of $35.6 million represented an increase of $1.8 million compared to the third quarter of 2000, primarily as a result of volume increases for loans and investments combined with rate decreases for deposits. Net interest margin (net interest income, on a tax-equivalent basis, as a percentage of 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, 2001 as Compared to the Three Months Ended September 30, 2000 (Continued) average earning assets) for the 2001 period was 3.48%, reflecting a decrease of 5 basis points (0.05%) from 3.53% reported in 2000. Interest and fees on loans for the three months ended September 30, 2001 decreased $1.8 million compared to the three months ended September 30, 2000, primarily as a result of rate decreases, most notably for variable rate commercial loans. The total yield on loans for the third quarter of 2001 was 8.02% representing a decrease of 55 basis points (0.55%) compared to yields for the third quarter of 2000. Decreases in interest and fees on loans due to rate for the third quarter of 2001 compared to the third quarter of 2000 were partially offset by increases in interest income due to volume for commercial loans. Average loans for the third quarter of 2001 increased $85.8 million compared to averages for the third quarter of 2000 and included increases in commercial loans and municipal loans which were partially offset by decreases in residential mortgage loans. Interest income on investments for the three months ended September 30, 2001 was $26.7 million, reflecting an increase of $873 thousand compared to the three months ended September 30, 2000. Volume increases for corporate bonds and U.S. government agency securities increased interest income by $2.0 million and $771 thousand, respectively compared to interest income for the third quarter of 2000. Average corporate bonds for the third quarter of 2001 increased $105.0 million compared to 2000 averages while average U.S. government agency securities increased by $46.1 million over the same time period. Yields on investments for the three months ending September 30, 2001 were 6.37% compared to 6.88% for the same period of 2000 reflecting a decrease of 51 basis points (0.51%) which resulted in a decrease in interest income due to rate of $2.4 million for the third quarter of 2001 compared to the third quarter of 2000. Interest on deposits for the third quarter of 2001 was $29.7 million reflecting a decrease of $535 thousand compared to the third quarter of 2000 as rate decreases were partially offset by volume increases compared to 2000 levels. Deposit costs were 3.66% for the third quarter of 2001 compared to 4.00% for the third quarter of 2000, resulting in a decrease in interest expense due to rate of $3.5 million. The cost of total savings deposits decreased 50 basis points (0.50%) for the third quarter of 2001 compared to the third quarter of 2000 while the cost of time deposits decreased 35 basis points (0.35%) over the same time period, reflecting lower market interest rates. Average deposits increased $216.3 million for the three months ended September 30, 2001 compared to 2000 averages, resulting in an increase in interest expense due to volume of $2.9 million. Included in the increase in average deposits for the third quarter of 2001 compared to the third quarter of 2000 was an increase of $126.9 million in average time deposits and an increase in total savings deposits of $68.7 million. 18
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, 2001 as Compared to the Three Months Ended September 30, 2000 (Continued) Interest on short-term borrowings for the third quarter of 2001 decreased $2.6 million compared to the third quarter of 2000 as both volumes and rates decreased compared to 2000 levels. Average short-term borrowings decreased $34.6 million for the third quarter of 2001 compared to the corresponding period of 2000. The cost of short-term borrowings for the third quarter of 2001 was 3.57% compared to 6.21% for the third quarter of 2000. Interest on long-term debt for the three months ended September 30, 2001 increased $357 thousand over the three months ended September 30, 2000. Long-term debt increases during 2001 were primarily the result of extending the maturity of borrowings from the Federal Home Loan Bank. Provision for credit losses was $3.5 million for the three months ended September 30, 2001 compared to $2.5 million for the three months ended September 30, 2000. Net charge-offs for the third quarter of 2001 were $4.3 million, compared to net charge-offs of $1.5 million for the third quarter of 2000. Net charge-offs for the third quarter of 2001 included increases in charge-offs of residential mortgage loans and commercial loans of $360 thousand and $2.6 million respectively, compared to 2000 levels. Net securities gains were $1.3 million for the three months ended September 30, 2001 while there were no securities gains for the three months ended September 30, 2000. The securities gains during the third quarter of 2001 resulted primarily from the sale of Pennsylvania bank stocks with a book value of $12.7 million. Income from bank owned life insurance increased $263 thousand for the third quarter of 2001 compared to the third quarter of 2000. Other income for the three months ended September 30, 2001 was $4.3 million, an increase of $886 thousand over $3.4 million reported for the three months ended September 30, 2000. Insurance commissions increased $697 thousand for the third quarter of 2001 compared to the third quarter of 2000. Other income for the third quarter of 2001 also reflected increases in gain on sale of loans, debit card interchange, SBA servicing revenue, and mutual fund revenue compared to amounts reported for the third quarter of 2000. Total noninterest expense for the three months ended September 30, 2001 was $26.0 million reflecting an increase of $1.3 million over the $24.7 million that was reported for the corresponding period of 2000. Employee costs were $13.6 million during the third quarter of 2001 reflecting an increase of $544 thousand over 2000 levels. Salaries increased by $534 thousand for the third quarter of 2001 compared to third quarter of 2000, while employee benefit costs remained flat over the same time period. 19
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, 2001 as Compared to the Three Months Ended September 30, 2000 (Continued) Other operating expenses for the three months ended September 30, 2001 were $7.0 million compared to $6.4 million for the corresponding period of 2000. The third quarter of 2001 included increases in filing and recording fees, legal fees, postage, printing and telephone expense of $141 thousand, $118 thousand, $146 thousand, $136 thousand and $124 thousand, respectively compared to 2000 levels. The third quarter of 2001 also included increases in losses on sale of leased vehicles. Cost decreases for the third quarter of 2001 included a reduction in collection and repossession expenses, check printing and deferred loan origination costs compared to the third quarter of 2000. Income taxes were $4.0 million for the third quarter of 2001 compared to $3.2 million for the third quarter of 2000. The Corporation's effective tax rate was 24.03% for the 2001 period compared to 21.73% for the corresponding period of 2000. 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. The Corporation monitors liquidity through regular computations of prescribed liquidity ratios. The Corporation actively manages liquidity within a defined range and has developed liquidity contingency plans, including ensuring availability of alternate funding sources to maintain liquidity under a variety of business conditions. In addition to the previously described funding sources, the Corporation's ability to access the capital markets was demonstrated during 1999 through the issuance of $35 million of capital securities. Net loans increased $103.6 million in the first nine months of 2001 as increases in commercial loans, municipal loans and loans to individuals were partially offset by decreases in residential real estate loans. The decrease in residential real estate loans was partially the result of the previously discussed residential mortgage sale during the first quarter of 2001. Total deposits increased $143.6 million for the first nine months of 2001 as total savings deposits increased $313.2 million compared to year-end 2000. 20
ITEM 2. FIRST COMMONWEALTH FINANCIAL CORPORATION AND CONSOLIDATED SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Continued) LIQUIDITY (Continued) Demand deposits and time deposits reflected decreases of $163.9 million and $5.7 million for the first nine months of 2001. The increase in total savings deposits during 2001 resulted primarily from increases in a high yield money market deposit product. Interest-bearing deposits at September 30, 2001 include reallocations from demand deposits and reallocations from NOW accounts into MMDA accounts for nonpersonal deposit accounts. These reallocations are based on a formula approved by the regulatory authorities and have been made to reduce the Corporation's reserve requirement. In periods prior to the third quarter of 2001 these reallocations from demand deposits and NOW accounts into MMDA accounts included amounts for personal accounts only, and although permitted by the regulatory authorities, did not include amounts related to nonpersonal deposit accounts. Time deposits for the first nine months of 2001 included a decrease of $21.1 million in brokered time deposits. Strong deposit growth during 2001 continues as customers return to the safety of traditional banking products due to the uncertainties of the stock and bond markets. 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, 2001 securities "available for sale" had an amortized cost of $1,479.4 million and an approximate fair value of $1,516.9 million. 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 exceed 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 21
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) 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. 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, 2001 and December 31, 2000 (Dollar amounts in thousands): <TABLE> <CAPTION> September 30, 2001 0-90 91-180 181-365 Cumulativ Days Days Days e 0-365 Days <S> <C> <C> <C> <C> Loans $ $ $ $1,233,23 802,699 143,327 287,208 4 Investments 160,043 73,395 204,172 437,610 Other interest-earning assets 4,147 -0- -0- 4,147 Total interest- 491,380 sensitive assets 966,889 216,722 1,674,991 Certificates of deposits 449,471 225,983 458,164 1,133,618 Other deposits 1,129,5 -0- -0- 1,129,548 48 Borrowings 372,229 2,600 350 375,179 Total interest- 458,514 sensitive liabilities 1,951,2 228,583 2,638,345 48 GAP $(984,3 $(11,86 $ 32,866 $ 59) 1) (963,354) ISA/ISL 0.50 0.95 1.07 0.63 Gap/Total assets 21.16% 0.25% 0.71% 20.71% </TABLE> <TABLE> <CAPTION> December 31, 2000 0-90 91-180 181-365 Cumulativ Days Days Days e 0-365 Days <S> <C> <C> <C> <C> Loans $ $ $ $ 621,536 130,374 244,605 996,515 Investments 130,220 47,279 105,423 282,922 Other interest-earning assets 11,552 -0- -0- 11,552 Total interest- sensitive assets 763,308 177,653 350,028 1,290,989 Certificates of deposits 274,963 264,805 470,828 1,010,596 Other deposits 1,018,2 -0- -0- 1,018,205 05 Borrowings 274,673 884 457 276,014 Total interest- sensitive liabilities 1,567,8 265,689 471,285 2,304,815 41 GAP $(804,5 $(88,03 $(121,25 $(1,013,8 33) 6) 7) 26) ISA/ISL 0.49 0.67 0.74 0.56 Gap/Total assets 18.40% 2.01% 2.77% 23.19% </TABLE> 22
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 twelve 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, 2001, 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 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. 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 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. <TABLE> <CAPTION> At September 30, 2001 2000 (amounts in thousands) <S> <C> <C> Nonperforming Loans: Loans on nonaccrual basis $ $ 23,068 11,953 Past due loans 20,449 17,687 Renegotiated loans 835 1,630 Total Nonperforming Loans $ $ 44,352 31,270 Other real estate owned $ $ 1,716 1,224 Loans outstanding at end of period $2,594,0 $2,493,98 29 7 Average loans outstanding (year-to-date) $2,537,1 $2,504,99 92 8 Nonperforming loans as percent of total 1.71% 1.25% loans Provision for credit losses $ $ 8,506 7,425 Net charge-offs $ $ 8,935 6,280 Net charge-offs as percent of average 0.35% 0.25% loans outstanding Provision for credit losses as percent of 95.20% 118.23% net charge-offs Allowance for credit losses as percent of 1.31% 1.38% average loans outstanding Allowance for credit losses as percent of 1.28% 1.39% end-of-period loans outstanding Allowance for credit losses as percent of 74.79% 110.92% nonperforming loans </TABLE> 24
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 September 30, 2001 and September 30, 2000: <TABLE> <CAPTION> 2001 2000 (amounts in thousands) <C> <C> <S> Recorded investment in impaired loans at $23,903 $13,583 end of period Year-to-date average balance of impaired $13,332 $13,166 loans Allowance for credit losses related to $ 3,242 $ 2,483 impaired loans Impaired loans with an allocation of the $15,683 $ 5,200 allowance for credit losses Impaired loans with no allocation of the $ 8,220 $ 8,383 allowance for credit losses Year-to-date income recorded on impaired $ $ loans on a cash basis 379 300 </TABLE> 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, 2001, there were no significant concentrations of credit. Nonperforming loans at September 30, 2001 increased $13.1 million compared to 2000 levels primarily because of the inclusion of two loans in the 2001 period. One is a $6.7 million credit that is not past due and carries an 80% guaranty of a U.S. governmental agency but is experiencing cash flow difficulties and has been placed in nonaccrual status. A resolution of this credit is expected by the end of the first quarter 2002. 25
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 second credit is in the amount of $5.9 million and the Corporation is in the process of liquidating the collateral. The Corporation anticipates a final resolution of this credit by the end of 2001 without significant loss. Nonperforming loans were $35.0 million at December 31, 2000 and $31.7 million at June 30, 2001. Nonperforming loans as a percent of total loans was 1.71% at September 30, 2001 compared to 1.41% at December 31, 2000 and 1.25% at September 30, 2000, while the allowance for credit losses as a percent of nonperforming loans was 74.79%, 95.87% and 110.92%, respectively for the same periods. 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. The Corporation feels that the allowance for credit losses is adequate at this time. The uncertain economic conditions presents a risk to the industry but management feels that its risk management process is thorough and serves as an early warning system so that an appropriate response will be promptly implemented. CAPITAL RESOURCES Equity capital increased $46.4 million in the first nine months of 2001. Dividends declared reduced equity by $25.4 million during the 2001 period, while earnings retention was $11.4 million, representing an earnings retention rate of 31.01%. 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 $893 thousand. Amounts paid to fund the discount on reinvested dividends reduced equity by $460 thousand. The market value adjustment to securities available for sale increased equity by $32.2 million. Proceeds from the reissuance of treasury shares to fund stock options exercised increased equity by $2.4 million during 2001. 26
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) 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 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 September 30, 2001: <TABLE> <CAPTION> Percent Amount Of Adjusted (in Assets thousands) <S> <C> <C> Tier I Capital $383,975 12.7% Risk-Based Requirement 120,763 4.0 Total Capital 417,147 13.8 Risk-Based Requirement 241,526 8.0 Minimum Leverage Capital 383,975 8.4 Minimum Leverage Requirement 137,296 3.0 </TABLE> At September 30, 2001 the Corporation's banking subsidiaries are considered well capitalized as defined by the Federal Deposit Insurance Corporation Improvement Act of 1991. 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. See NOTE 5 to the consolidated financial statements for additional information. 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 Not applicable ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits None (b) Reports on Form 8-K None 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, 2001 /S/ Joseph E. O'Dell Joseph E. O'Dell, President and Chief Executive Officer DATED: NOVEMBER 13, 2001 /S/ John J. Dolan John J. Dolan, Executive Vice President and Chief Financial Officer 29