First Commonwealth Financial (FCF) is a Pennsylvania-based bank with 147 offices in 28 counties throughout Pennsylvania and Ohio. With a total balance sheet size exceeding $9B and an equity value of in excess of $1B, FCF is decently sized. The current market capitalization of just over $800M represents a discount to the book value per share, and the share price hasn’t recovered at all since the outbreak of the COVID-19 pandemic as the share price is down 42% YTD. However, the bank continues to pay a dividend and the low share price has now pushed the dividend yield to in excess of 5%. Value or a value trap?

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Looking at the EPS, the dividend is more than fully covered

In the third quarter of the year, First Commonwealth reported a total interest income of almost $74M, which is approximately 11% lower than in the same quarter last year. Fortunately its interest expenses fell by almost 50% but in absolute terms the $7M reduction in the interest expenses was not sufficient to cover for the lower interest expenses as well. The net interest income of First Commonwealth Bank in the third quarter fell from $68.4M to $66.4M.

Source: SEC filings

The non-interest income increased to $26.8M while the non-interest expenses also increased, to $58.2M resulting in a net non-interest expense of approximately $31.4M. After deducting this from the net interest income, FCF generated a pre-tax and pre-loan loss provision income of approximately $35M. Lower than in Q3 2019 but the pressure on the net interest income is a sector wide problem and not just limited to First Commonwealth Financial.

Source: financial statements

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As you can see in the image above, the Q3 loan loss provision was just $11.2M. That’s less than twice as high than the already elevated provision in Q3 2019, but more importantly, the bank clearly seems to think the worst is behind us as the Q3 loan loss provision is lower than the almost $38M recorded in H1 2020 (which works out to be around $19 per quarter).

All this works out to a net income of $19.2M in the third quarter of 2020 which represents an EPS of $0.20. So despite the high loan loss provisions, First Commonwealth’s quarterly dividend of 11 cents per share represents a payout ratio of just 55%. The EPS in the first nine months of this year was $0.49, down from $0.80 in 9M 2019 but this could easily be explained by the almost $40M increase in the loan loss provisions. But given the quarterly dividend has been established at $0.11, the $0.49 EPS in the first nine months of the year is sufficient to continue to pay out the dividends.

Source: company presentation

A quick look at the loan book

As mentioned in the introduction, the total size of the balance sheet is approximately $9.3B and the loan book of $6.86B is the main asset on the balance sheet (the remainder of the assets consists of some goodwill, cash and deposits and securities predominantly consisting of obligations of US government sponsored entities).

Source: financial statements, asset side of the balance sheet

To figure out the exposure of First Commonwealth to defaults in its portfolio of loans, we need to have a closer look at what’s actually in the loan book.

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Source: SEC filings

Approximately one-fourth of the loan book consists of residential real estate, and we should consider this to be relatively safe. The $2.2B in commercial real estate is a bit riskier but we can reasonably assume the LTV ratios of the commercial real estate assets to be relatively decent. The $1.7B in commercial, financial, agricultural and other loans is perhaps a bigger question mark, but according to the footnotes to the financial statements, this also includes almost $600M in paycheck protection program loans, which are 100% guaranteed by the Small Business Administration. So with $4.5B of the almost $7B loan book consisting of real estate and assets guaranteed by the SBA, the majority of the loan book appears to have a lower than average risk.

As of the end of September, a total of $51M of the loans were past due and non-accrual loans. $30M (60%) was related to commercial real estate loans, while the residential real estate exposure represented 20% of the total amount of loans past due.

Source: SEC filings

I couldn’t find detailed LTV ratios, but in the Q2 conference call, the management indicated the LTV ratio of the retail portion of the commercial real estate portfolio was 58%. This means that on average, the $30.1M in loans past due and nonaccrual loans are backed by $30.8 / 0.58 = approximately $53M in collateral. So even if FCF will have to take a 50% haircut on the appraisal value of the collateral, it would record a loss of just under $5M on the total $30.8M position. So seeing $30M in loans past due does not mean the bank is about to lose out on the entire $30M.

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Investment thesis

Loan loss provisions are still high, but are trending down. Meanwhile, despite the elevated loan losses, the dividend remains fully covered in the first nine months of the year. We can reasonably expect the loan loss provisions to continue to decrease albeit at a slow pace as I think it’s still better to be safe than sorry in First Commonwealth’s case.

I’m not worried about the 5.2% dividend yield. Now Fist Commonwealth is trading just over its tangible book value of around $7.80/share, the bank seems to be an interesting candidate for both dividend income as well as potential capital gains as the bank is now trading at just over 10 times its annualized Q3 income (which still includes in excess of $11M in loan loss provisions). I currently have no position in First Commonwealth, but I’m adding this regional bank to my watch list.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.