First Commonwealth Financial Stock: Still Upside Left (NYSE:FCF)

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Earnings of First Commonwealth Financial Corporation (NYSE:FCF) likely to decline next year due to higher provision charge. On the other hand, strong loan growth will likely support the bottom line. Loan growth will likely return to pre-pandemic levels thanks to management’s efforts. Additionally, the rising interest rate environment will boost the margin and limit the decline in earnings. Overall, I expect First Commonwealth to report earnings of $1.33 per share in 2022, down 6% from expected earnings of $1.41 per share in 2021. The target price next year suggests a decent upside from the current market price. Additionally, First Commonwealth offers a modest dividend yield. Based on the expected total return, I maintain a bullish rating on First Commonwealth.

Return to strong loan growth

First Commonwealth’s loan portfolio fell approximately 0.3% in the first nine months of 2021. Loan growth for 2022 is likely to return to pre-pandemic average in the mid- to high-single digits due to the following factors.

  1. Sound credit markets.
  2. Limited balance of remaining Paycheck Protection Program loans.
  3. Launch of the equipment financing activity.
  4. Hiring new team members.

First Commonwealth operates in the states of Pennsylvania and Ohio. Even though both states have unemployment rates below the national average, their credit markets look promising. Management mentioned on the third quarter conference call that it sees good activity in the commercial real estate segment, including lending to multifamily and industrial warehouses. The strong demand for credit was already visible in the third quarter when total loans, excluding Paycheck Protection Program loans, increased 8.2% annualized from the previous quarter, as mentioned in the presentation.

Plus, most of the Paycheck Protection Program (“PPP”) rebate has already passed. Outstanding PPP loans made up just 2.3% of total loans at the end of the last quarter, according to details given in the 10-Q filing. I expect most of these loans to be canceled before the end of 2021. Due to the small size of the remaining PPP portfolio, the cancellation will have a limited impact on the total size of the loan portfolio.

In addition, the new equipment financing activity should boost the loan portfolio next year. First Commonwealth announced the launch of this business in mid-2021. Management is targeting $200-250 million in equipment finance assets by the end of 2022, before accelerating in 2023 and 2024, as mentioned in the conference call. This means that management expects loan growth of 300 to 370 basis points for equipment financing alone.

Additionally, management plans to hire new bankers through 2022, as mentioned in the conference call. Given these factors, I expect loan growth of around 7.2% in 2022. Additionally, I expect deposits to move mostly in line with loans. The following table shows my balance sheet estimates.

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Moderately sensitive margin to take advantage of rising interest rates

In addition to loan growth, First Commonwealth’s revenues will also be supported by net interest margin expansion. Non-interest bearing deposits represented 33.5% of total deposits at the end of the last quarter, as mentioned in the presentation. These deposits will make the total cost of deposit rigid in a rising interest rate environment. As a result, the expected increase in the federal funds rate will benefit First Commonwealth’s earnings. The Federal Reserve has forecast an interest rate hike of about 75 basis points in 2022.

Management’s interest rate sensitivity analysis shows that net interest income can increase by approximately 2.42% over 12 months if rates are increased by 100 basis points. The following table in Filing 10-Q provides the results of management’s interest rate sensitivity analysis.

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Given these factors, I expect the net interest margin to increase by four basis points in 2022. In my last First Commonwealth report, I expected the average margin in 2022 to be lower seven basis points to the 2021 margin.

Higher provisioning for loan additions to counter reserve releases

First Commonwealth’s provisioning for loan losses remained subdued in the first nine months of 2021. The level of provisioning represented 247% of non-performing loans at the end of September 2021, as mentioned in the presentation. Due to the relatively high level of allocations, a further reversal of provisioning is likely in the coming quarters. Management also mentioned on the conference call that they were under modeling pressure to release some reserves.

On the other hand, expanding the loan portfolio will require provisioning for expected loan losses. Equipment financing will require higher provisioning than the portfolio average as it is inherently a risky business. Management said on the conference call that it expects net charges of 55 to 75 basis points from equipment financing activity. By comparison, net write-offs for the entire loan book were just 19 basis points in Q3 2021.

Overall, I expect provisioning expense, net of reversals, to be around 0.11% of total loans in 2022. By comparison, provisioning expense was around 0.23% of total loans. loans from 2016 to 2019.

Expected earnings of $1.33 per share in 2022

To summarize the discussion above, higher provisioning will likely weigh on earnings next year, while loan growth and margin expansion will support the bottom line. Overall, I expect the company to report earnings of $1.33 per share in 2022. For the last quarter of 2021, I expect the company to report earnings of 0.33 $ per share, which will bring annual earnings to $1.41 per share. . The following table shows my income statement estimates.

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Compared to my last report on First Commonwealth, I have slightly raised my earnings estimates for 2021 and 2022. The upward revision is due to an improved outlook for net interest margin and loan growth.

Actual earnings may differ materially from estimates due to risks and uncertainties related to the COVID-19 pandemic, particularly the Omicron variant.

The expected total return calls for a bullish rating

First Commonwealth Financial offers a dividend yield of 3.0% at the current quarterly dividend rate of $0.115 per share. Earnings and dividend estimates suggest a payout ratio of 35% for 2022, which is below the 2016-2019 average of 42%. Therefore, I don’t fear that a decline in earnings could threaten the dividend next year.

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

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Multiplying the average P/TB multiple by the expected tangible book value per share of $9.4 yields a target price of $16.3 for the end of 2022. This price target implies an upside of 6.7% compared to the closing price on December 17. The following table shows the sensitivity of the target price to the P/TB ratio.

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The stock has traded at an average P/E ratio of around 13.0x in the past, as shown below.

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Multiplying the average P/E multiple by the expected earnings per share of $1.33 yields a price target of $17.3 for the end of 2022. This price target implies a 13.1% upside from at the December 17 closing price. The following table shows the sensitivity of the target price to the P/E ratio.

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Equal weighting of the target prices from the two valuation methods results in a combined target price of $16.8, implying a 9.9% upside from the current market price. Adding the forward dividend yield gives an expected total return of 12.9%. Therefore, I maintain a bullish rating on First Commonwealth. I had also adopted a bullish note on the company in my last report. Although the market price has recovered since my last report, there are still some upsides.

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