First Commonwealth Financial Stock: Earnings will fall (NYSE:FCF)

Earnings of First Commonwealth Financial Corporation (NYSE: FCF) will most likely dip this year due to the normalization of provisions. On the other hand, rising interest rates and management’s efforts to improve loan production will stimulate net interest income, supporting net income. Overall, I expect First Commonwealth Financial to report earnings of $1.35 per share for 2022, down 6% year-over-year. Compared to my last report on the company, I barely changed my earnings estimate for the year. The year-end target price suggests a strong upside from the current market price. Therefore, I maintain a buy rating on First Commonwealth Financial.

Internal factors and strength of the regional economy to drive loan growth

First Commonwealth Financial’s loan portfolio grew by 1.7% in the first quarter of 2022, which was slightly below my expectations. The growth was the strongest quarterly loan growth since the second quarter of 2022, when the Paycheck Protection Program gave the loan portfolio a boost. Management mentioned on the last conference call that the quarter saw the first significant increase in commercial line usage since the pandemic began.

Management’s continued efforts will likely maintain the loan growth momentum for the remainder of the year. As mentioned on the conference call, First Commonwealth Financial is currently working on its initial lending scheme. Additionally, the company is rolling out a new credit card platform for consumers and business customers later this year.

In addition, improving economic activity will help support loan growth. First Commonwealth Financial operates in the states of Pennsylvania and Ohio. Although the labor markets in these two states are lagging the national average, they are still much better than the past two years and are returning to pre-pandemic levels.

Given these factors, I expect the loan portfolio to grow by 7.9% by the end of 2022 compared to the end of 2021. In my latest report on First Commonwealth Financial, I have estimated loan growth at 8.2%. I have now revised my estimate down as growth was slightly below my expectations for the first quarter of the year.

Meanwhile, deposits will increase mainly in line with loans. The following table shows my balance sheet estimates.

	EX17	EX18	FY19	FY20	FY21	FY22E
Financial situation
Total loans	5,407	5,774	6,189	6,761	6,839	7,378
Growth in total loans	11.0%	6.9%	7.2%	8.5%	1.3%	7.9%
Other productive assets	1,207	1,350	1,292	1,495	2,443	1,989
Deposits	5,581	5,898	6,678	7,439	7,982	8,608
Loans and sub-debts	795	907	436	351	321	282
Common Equity	888	975	1,056	1,069	1,109	1,134
Book value per share ($)	9.3	9.8	10.7	10.9	11.6	12.0
Tangible BVPS ($)	6.5	6.9	7.5	7.7	8.3	8.7
Source: SEC Filings, Author’s Estimates (In millions of dollars, unless otherwise indicated)

Interest income is barely sensitive to rate hikes

Although approximately 51% of the loan portfolio is based on variable rates (source: results presentation), the average yield on First Commonwealth Financial’s loans is not very sensitive to interest rate increases. Indeed, approximately 45.3% of the variable portfolio has in-the-money floors, which means that the yields on these loans will begin to react after a sharp rise in interest rates.

Nevertheless, net interest income will generally benefit from higher rates this year, as more assets than liabilities will be revalued in 2022. The asset-liability gap was 11.10% of total assets at the end March 2022, as mentioned in Ranking 10-Q. Management’s interest rate sensitivity analysis shows that a 200 basis point increase in interest rates can only increase net interest income by 3.36% year-over-year.

Overall, I expect the margin to increase by 18 basis points in 2022. In my last report on First Commonwealth Financial, I estimated that the margin would only increase by eight basis points this year . I increased my margin estimate following the publication of revised projections from the Federal Reserve.

Due to the combination of a downward revision to the loan growth estimate and an upward revision to the margin estimate, my estimate of net interest income for the full year is now lower than I had previously anticipated.

Supply standardization to drag revenue

Unlike last year when First Commonwealth recorded a net provision reversal, the company will report a net provision charge this year as provision reversals cannot be sustained for extended periods.

In addition, high interest rates are likely to weigh on asset quality in the coming year. However, provisions for loan losses are already quite high, thanks to which the company will not have to replenish too much of its reserves. The provisions to non-performing loans ratio stood at 243.38% at the end of March 2022, compared to 192.06% at the end of March 2021. As a result, I expect the provision charge to be at a normal level this year, despite rising interest rates and the threat of a recession.

I expect the provision charge, net of reversals, to be 0.18% of total loans in 2022, which is the same as the average from 2017 to 2019.

Profits will fall by 6%

The normalization of provisions will likely be the main reason for lower earnings this year. In addition, non-interest expense will increase primarily with balance sheet growth. I expect the company to report non-interest expense of $225 million for 2022, up 5.0% year-over-year. Compared to my last report on First Commonwealth Financial, I have revised down my estimate for non-interest expense following the first quarter’s performance, which was better than expected.

On the other hand, expected loan growth and margin expansion will support the bottom line. Overall, I expect First Commonwealth Financial to report earnings of $1.35 per share for 2022, down 6% year-over-year. The following table shows my income statement estimates.

	EX17	EX18	FY19	FY20	FY21	FY22E
income statement
Net interest income	229	252	270	268	279	294
Allowance for loan losses	5	13	15	57	(1)	13
Non-interest income	80	89	85	94	107	105
Non-interest charges	200	196	210	216	214	225
Net Income – Common Sh.	55	107	105	73	138	128
EPS – diluted ($)	0.58	1.08	1.07	0.75	1.44	1.35
Source: SEC filings, earnings releases, author’s estimates (In millions of dollars, unless otherwise indicated)

In my last report on First Commonwealth Financial, I estimated earnings of $1.34 per share for 2022. My updated earnings estimate has barely changed, as my downward revision to the net income estimate of interest cancels the downward revision to my estimate of non-interest revenue.

Actual earnings may differ materially from estimates due to the risks and uncertainties associated with inflation and, therefore, the timing and magnitude of interest rate increases. Also, the threat of a recession may increase the provisioning of expected loan losses beyond my expectations.

A high expected total return warrants a buy rating

First Commonwealth offers a dividend yield of 3.5% at the current quarterly dividend rate of $0.12 per share. Earnings and dividend estimates suggest a payout ratio of 35% for 2022, which is below the five-year average of 43%. Although the payout ratio suggests there is room for another dividend hike this year, I don’t suppose a change in the level of dividends is on the upside.

I use historical price/book tangible (“P/TB”) and price/earnings (“P/E”) multiples to value First Commonwealth Financial. The stock has traded at an average P/TB ratio of 1.7x in the past, as shown below.

	EX18	FY19	FY20	FY21	Medium
T. Book value per share ($)	6.9	7.5	7.7	8.3
Average market price ($)	15.0	13.4	9.6	14.1
Historical P/TB	2.2x	1.8x	1.2x	1.7x	1.7x
Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/TB multiple by the expected tangible book value per share of $8.7 yields a target price of $15.0 for the end of 2022. This price target implies an upside of 9.6% compared to the closing price on July 1. The following table shows the sensitivity of the target price to the P/TB ratio.

Multiple P/TB	1.5x	1.6x	1.7x	1.8x	1.9x
TBVPS – Dec 2022 ($)	8.7	8.7	8.7	8.7	8.7
Target price ($)	13.3	14.1	15.0	15.9	16.7
Market price ($)	13.7	13.7	13.7	13.7	13.7
Up/(down)	(3.1)%	3.2%	9.6%	15.9%	22.3%

Source: Author’s estimates

The stock has traded at an average P/E ratio of around 12.2x in the past, as shown below.

	EX18	FY19	FY20	FY21	Medium
Earnings per share ($)	1.08	1.07	0.75	1.44
Average market price ($)	15.0	13.4	9.6	14.1
Historical PER	13.9x	12.5x	12.7x	9.8x	12.2x

Source: Company Financials, Yahoo Finance, Author’s Estimates

Multiplying the average P/E multiple by the expected earnings per share of $1.35 yields a price target of $16.6 for the end of 2022. This price target implies a 20.9% upside from at the July 1 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

Multiple P/E	10.2x	11.2x	12.2x	13.2x	14.2x
EPS – 2022 ($)	1.35	1.35	1.35	1.35	1.35
Target price ($)	13.9	15.2	16.6	17.9	19.3
Market price ($)	13.7	13.7	13.7	13.7	13.7
Up/(down)	1.2%	11.0%	20.9%	30.8%	40.7%
Source: Author’s estimates

Equal weighting of target prices from both valuation methods gives a combined result target price of $15.8, implying a 15.2% upside from the current market price. Adding the forward dividend yield gives an expected total return of 18.7%. Therefore, I maintain a buy rating on First Commonwealth Financial.