Note 12—Loans and Allowance for Credit Losses

The following table provides outstanding balances related to each of our loan types as of December 31:


	2012		2011
	(dollars in thousands)
Commercial, financial, agricultural and other	$	1,019,822	$	996,739
Real estate construction		87,438		76,564
Residential real estate		1,241,565		1,137,059
Commercial real estate		1,273,661		1,267,432
Loans to individuals		582,218		565,849

Total loans net of unearned income	$	4,204,704	$	4,043,643

Credit Quality Information

As part of the on-going monitoring of credit quality within the loan portfolio, the following credit worthiness categories are used in grading our loans:


Pass		Acceptable levels of risk exist in the relationship. Includes all loans not adversely classified as OAEM, substandard or doubtful.

Other Assets Especially Mentioned (OAEM)
		Potential weaknesses that deserve management’s close attention. The potential weaknesses may result in deterioration of the repayment prospects or weaken the Bank’s credit position at some future date. The credit risk may be relatively minor, yet constitute an undesirable risk in light of the circumstances surrounding the specific credit. No loss of principal or interest is expected.

Substandard		Well-defined weakness or a weakness that jeopardizes the repayment of the debt. A loan may be classified as substandard as a result of deterioration of the borrower’s financial condition and repayment capacity. Loans for which repayment plans have not been met or collateral equity margins do not protect the Company may also be classified as substandard.

Doubtful		Loans with the characteristics of substandard loans with the added characteristic that collection or liquidation in full, on the basis of presently existing facts and conditions, is highly improbable.

The use of creditworthiness categories to grade loans permits management’s use of migration analysis to estimate a portion of credit risk. The Company’s internal creditworthiness grading system provides a measurement of credit risk based primarily on an evaluation of the borrower’s cash flow and collateral. Movements between these rating categories provide a predictive measure of credit losses and therefore assists in determining the appropriate level for the loan loss reserves. Category ratings are reviewed each quarter, at which time management analyzes the results, as well as other external statistics and factors related to loan performance. Loans that migrate towards higher risk rating levels generally have an increased risk of default, whereas, loans that migrate toward lower risk ratings generally will result in a lower risk factor being applied to those related loan balances.

The following tables represent our credit risk profile by creditworthiness category for the years ended December 31:


	2012
	Commercial, financial, agricultural and other		Real estate construction		Residential real estate		Commerical real estate		Loans to individuals		Total
	(dollars in thousands)
Pass	$	925,868	$	64,353	$	1,224,849	$	1,119,093	$	582,039	$	3,916,202
Non-Pass
OAEM		31,049		925		5,647		82,581		3		120,205
Substandard		62,905		18,638		11,069		71,987		176		164,775
Doubtful		0		3,522		0		0		0		3,522

Total Non-Pass		93,954		23,085		16,716		154,568		179		288,502

Total	$	1,019,822	$	87,438	$	1,241,565	$	1,273,661	$	582,218	$	4,204,704


	2011
	Commercial, financial, agricultural and other		Real estate construction		Residential real estate		Commercial real estate		Loans to individuals		Total
	(dollars in thousands)
Pass	$	904,057	$	44,914	$	1,126,143	$	1,110,664	$	565,842	$	3,751,620
Non-Pass
OAEM		27,627		4,238		5,484		61,855		7		99,211
Substandard		60,114		21,701		5,432		94,913		0		182,160
Doubtful		4,941		5,711		0		0		0		10,652

Total Non-Pass		92,682		31,650		10,916		156,768		7		292,023

Total	$	996,739	$	76,564	$	1,137,059	$	1,267,432	$	565,849	$	4,043,643

Portfolio Risks

Credit quality of our loan portfolio represents significant risk to our earnings, capital, regulatory agency relationships, investment community and shareholder returns. First Commonwealth devotes a substantial amount of resources managing this risk primarily through our credit administration department that develops and administers policies and procedures for underwriting, maintaining, monitoring and collecting activities. Credit administration is independent of lending departments and oversight is provided by the credit committee of the First Commonwealth Board of Directors.

Total gross charge-offs for the year ended December 31, 2012 were $17.0 million. Total gross charge-offs for the year ended December 31, 2011 were $68.3 million, including charge-offs of $9.5 million recognized on loans transferred to held for sale.

Criticized loans have been evaluated with respect to the adequacy of the allowance for credit losses which we believe is adequate at this time. However, changes in economic conditions, interest rates, borrower financial condition, delinquency trends or previously established fair values of collateral factors could significantly change those judgmental estimates. The credit administration department continually monitors and evaluates those evolving factors in order to adjust the allowance for credit losses.

Our local markets of western Pennsylvania, which comprise 91% of our loan portfolio, have not been as intensely affected by the most recent economic recession as some other regions of the country and are evidencing a quicker economic recovery. We believe adhering to tighter geographic markets and credit standards will improve ongoing credit quality in the portfolios.

Risk factors associated with commercial real estate and construction related loans are monitored closely since this is an area that represents the most significant portion of the loan portfolio and has experienced the most stress during the economic downturn and has evidenced little recovery strength.

Age Analysis of Past Due Loans by Segment

The following tables delineate the aging analysis of the recorded investments in past due loans as of December 31. Also included in these tables are loans that are 90 days or more past due and still accruing because they are well-secured and in the process of collection.


	2012
	30 - 59 days past due		60 - 89 days past due		90 days and greater and still accruing		Nonaccrual		Total past due and nonaccrual		Current		Total
	(dollars in thousands)
Commercial, financial, agricultural and other	$	991	$	620	$	288	$	29,258	$	31,157	$	988,665	$	1,019,822
Real estate construction		2		19		15		9,778		9,814		77,624		87,438
Residential real estate		6,597		2,357		730		9,283		18,967		1,222,598		1,241,565
Commercial real estate		3,339		1,389		195		46,023		50,946		1,222,715		1,273,661
Loans to individuals		3,140		934		1,219		176		5,469		576,749		582,218

Total	$	14,069	$	5,319	$	2,447	$	94,518	$	116,353	$	4,088,351	$	4,204,704


	2011
	30 - 59 days past due		60 - 89 days past due		90 days and greater and still accruing		Nonaccrual		Total past due and nonaccrual		Current		Total
	(dollars in thousands)
Commercial, financial, agricultural and other	$	5,433	$	824	$	287	$	33,459	$	40,003	$	956,736	$	996,739
Real estate construction		0		180		0		14,911		15,091		61,473		76,564
Residential real estate		7,144		2,100		8,767		3,153		21,164		1,115,895		1,137,059
Commercial real estate		3,671		1,241		157		26,953		32,022		1,235,410		1,267,432
Loans to individuals		2,952		962		1,804		0		5,718		560,131		565,849

Total	$	19,200	$	5,307	$	11,015	$	78,476	$	113,998	$	3,929,645	$	4,043,643

Nonaccrual Loans

The previous table summarizes nonaccrual loans by loan segment. The company generally places loans on nonaccrual status when the full and timely collection of interest or principal becomes uncertain, when part of the principal balance has been charged off and no restructuring has occurred or the loans reach a certain number of days past due. Generally loans 90 days or more past due are placed on nonaccrual status, except for consumer loans which are placed in nonaccrual status at 150 days past due. In periods prior to the third quarter of 2012, if a consumer loan was well secured and in the process of collection, it remained on accrual status, as delinquency was not a factor in moving it to nonaccrual status.

When a loan is placed on nonaccrual, the accrued unpaid interest receivable is reversed against interest income and all future payments received are applied as a reduction to the loan principal. Generally, the loan is returned to accrual status when (a) all delinquent interest and principal become current under the terms of the loan agreement or (b) the loan is both well-secured and in the process of collection and collectability is no longer doubtful.

Impaired Loans

Management considers loans to be impaired when, based on current information and events, it is determined that the company will probably not be able to collect all amounts due according to the loan contract, including scheduled interest payments. Determination of impairment is treated the same across all loan categories. When management identifies a loan as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the sole source or repayment for the loan is the operation or liquidation of collateral. When the loan is collateral dependent, the appraised value less estimated cost to sell is utilized. If management determines the value of the impaired loan is less than the recorded investment in the loan, impairment is recognized through an allowance estimate or a charge-off to the allowance. Troubled debt restructured loans on accrual status are considered to be impaired loans.

When the ultimate collectability of the total principal of an impaired loan is in doubt and the loan is on nonaccrual status, all payments are applied to principal, under the cost recovery method. When the ultimate collectability of the total principal of an impaired loan is not in doubt and the loan is on nonaccrual status, contractual interest is credited to interest income when received, under the cash basis method.

Included in the 2011 total of nonperforming loans was $13.4 million of loans held for sale. While these loans were considered to be nonperforming, they were not taken into consideration when determining the allowance for credit losses as they were carried at the lower of cost or fair value. Nonperforming loans at December 31, 2011 included an $11.3 million loan for a waste management company, which was classified as a troubled debt restructured loan. This loan was paid off in full in January 2012. Additionally, a $10.3 million loan to an information technology firm was returned to accrual status in the second quarter of 2012.

The most significant loans placed in nonperforming status during 2012, include $6.5 million to a western Pennsylvania in-patient health care facility, $4.9 million commercial real estate loan for student housing in western Pennsylvania, $4.6 million for a hotel resort syndication loan located in the state of Washington, $3.8 million for a commercial real estate loan to a nonprofit institution in Alabama, $2.8 million to a western Pennsylvania construction firm, and $2.5 million to a manufacturer of medical equipment in Pennsylvania. In addition to the aforementioned loans which were placed on nonaccrual status, a $3.3 million commercial real estate loan in western Pennsylvania was modified with a maturity extension and therefore was classified as a TDR. Also, impacting the balance of nonperforming loans at December 31, 2012, was the inclusion of $6.7 million in consumer loans which were 150 days or more past due. Of the consumer loans on nonaccrual status as of December 31, 2012, $6.5 million of the $6.7 million, were residential real estate loans.

Unfunded commitments related to nonperforming loans were $4.6 million and $6.7 million at December 31, 2012 and 2011, respectively. After consideration of available collateral related to these commitments, an off balance sheet reserve of $0.2 million was established for these commitments at December 31, 2012 and 2011.

Significant nonaccrual loans as of December 31, 2012 include the following;

•

$19.1 million, the remaining portion of a $44.1 million unsecured loan to a western Pennsylvania real estate developer. This loan was originated in 2004 and was placed in nonaccrual status in the fourth quarter of 2009. A settlement plan with the borrower and three other lenders was reached in the fourth quarter of 2010 and resulted in an $8.0 million principal payment and a $15.4 million partial charge-off.

•

$15.7 million commercial real estate loan for a real estate developer in eastern Pennsylvania. This loan was originated in 2007 and restructured in the fourth quarter of 2011 which resulted in a charge-off of $4.2 million. The most recent appraisal for the real estate collateral was completed in the third quarter of 2011, as the bank was expecting a fourth quarter external refinance of this loan.

•

$6.5 million commercial real estate loan to an in-patient health care facility in western Pennsylvania. This loan was originated in 2008 and placed in nonaccrual status in September 2012. The most recent appraisal for the real estate collateral was completed in the fourth quarter of 2012.

•

$4.9 million for a western Pennsylvania student housing complex. This loan was originated in 2008 and placed in nonaccrual status in December 2012. The most recent appraisal for the real estate collateral was completed in the fourth quarter of 2012.

•

$4.6 million real estate secured loan to a hotel resort syndication in Washington. This loan was originated in 2007 and placed in nonaccrual status in December of 2012. The most recent appraisals for the real estate collateral were completed in the second quarter of 2012.

The following tables include the recorded investment and unpaid principal balance for impaired loans with the associated allowance amount, if applicable, as of December 31, 2012 and 2011. Also presented are the average recorded investment in impaired loans and the related amount of interest recognized while the loan was considered impaired for the years ended December 31, 2012, 2011 and 2010. Average balances are calculated based on month-end balances of the loans for the period reported.


	2012
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(dollars in thousands)
With no related allowance recorded:
Commercial, financial, agricultural and other	$	8,080	$	8,983	$	0	$	9,217	$	173
Real estate construction		8,491		35,555		0		11,912		0
Residential real estate		7,928		8,401		0		8,114		72
Commercial real estate		33,259		35,401		0		28,574		66
Loans to individuals		256		256		0		103		2

Subtotal		58,014		88,596		0		57,920		313
With an allowance recorded:
Commercial, financial, agricultural and other		26,532		27,412		10,331		21,979		9
Real estate construction		2,756		3,087		300		1,457		0
Residential real estate		2,695		2,696		780		1,599		15
Commercial real estate		17,558		17,896		6,367		5,024		32
Loans to individuals		0		0		0		0		0

Subtotal		49,541		51,091		17,778		30,059		56

Total	$	107,555	$	139,687	$	17,778	$	87,979	$	369


	2011
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(dollars in thousands)
With no related allowance recorded:
Commercial, financial, agricultural and other	$	2,010	$	3,418	$	0	$	3,887	$	20
Real estate construction		10,814		20,161		0		23,254		10
Residential real estate		3,125		3,513		0		2,702		9
Commercial real estate		36,777		41,974		0		35,817		799
Loans to individuals		0		0		0		10		0

Subtotal		52,726		69,066		0		65,670		838
With an allowance recorded:
Commercial, financial, agricultural and other		34,056		34,341		9,069		30,456		152
Real estate construction		6,298		21,402		2,960		14,465		0
Residential real estate		955		955		93		615		7
Commercial real estate		4,717		4,863		1,114		28,716		396
Loans to individuals		0		0		0		0		0

Subtotal		46,026		61,561		13,236		74,252		555

Total	$	98,752	$	130,627	$	13,236	$	139,922	$	1,393


	2010
	Average Recorded Investment		Interest Income Recognized
	(dollars in thousands)
With no related allowance recorded:
Commercial, financial, agricultural and other	$	6,051	$	0
Real estate construction		35,898		0
Residential real estate		3,165		0
Commercial real estate		24,198		12
Loans to individuals		58		0

Subtotal		69,370		12
With an allowance recorded:
Commercial, financial, agricultural and other		43,778		14
Real estate construction		16,641		0
Residential real estate		237		0
Commercial real estate		10,711		4
Loans to individuals		0		0

Subtotal		71,367		18

Total	$	140,737	$	30

Troubled debt restructured loans are those loans whose terms have been renegotiated to provide a reduction or deferral of principal or interest as a result of the financial difficulties experienced by the borrower, who could not obtain comparable terms from alternate financing sources.

As a result of adopting the amendments in ASU 2011-02, all restructurings that occurred on or after January 1, 2011 were assessed for identification as troubled debt restructurings considering the new guidance. No additional troubled debt restructurings were identified for loans for which the allowance for credit losses would have previously been measured under a general allowance for credit losses methodology.

The following table provides detail as to the total troubled debt restructured loans and total commitments outstanding on troubled debt restructured loans as of December 31:


	2012		2011		2010
	(dollars in thousands)
Troubled debt restructured loans
Accrual status	$	13,037	$	20,276	$	1,336
Nonaccrual status		50,979		44,841		31,410

Total	$	64,016	$	65,117	$	32,746

Commitments
Letters of credit	$	1,574	$	12,580	$	11,321
Unused lines of credit		0		42		1,095

Total	$	1,574	$	12,622	$	12,416

During, 2012, a $2.8 million nonaccrual loan to a water treatment plant and a $3.7 million accruing loan to a gas well servicing operation were each restructured with a twelve month principal forbearance. The nonaccrual loan is fully reserved for while the accruing loan is secured by company assets with no reserve allocation. These loans are part of a $17.0 million commercial loan relationship with a shallow gas well operator whose business has been impacted by the sharp decline in natural gas prices due to the success of Marcellus deep well drilling. In addition to these two loans, other loans in this relationship include loans to a related exploration and production company and loans to the principal which are secured by real estate and investment securities.

Also, in 2012 a $3.3 million commercial real estate loan was restructured with a six month maturity extension. This loan has remained on accruing status and the collateral shortfall is fully reserved.

During 2012, all decreases in balances between the pre-modification and post-modification balance are due to customer payments.

During 2011, a $2.7 million charge-off was recorded in relation to the transfer to held for sale of one of the loans included in commercial real estate in the table below. The sale of this loan was completed in 2012. Three commercial real estate loans, totaling $10.2 million, were classified as troubled debt restructured loans during 2011 and subsequently paid off prior to December 31, 2011. In addition, $5.6 million was charged-off in the restructuring of one relationship modified during the fourth quarter of 2011. As December 31, 2012, the remaining balance of the loans included in this relationship is $17.4 million. The remainder of changes in loan balances for 2011 between the pre-modification balance and the post-modification balance is due to customer payments.

During 2010, a $15.4 million charge-off was recorded on a loan to a Pennsylvania real estate developer. The remaining changes between pre-modification balances and post-modification balances during 2010 are due to customer payments.

The outstanding commitments as of December 31, 2011 and 2010 were primarily committed to one loan relationship that paid off in full in January 2012.

The following tables provide detail, including specific reserve and reasons for modification, related to loans identified as troubled debt restructurings during the years ending December 31:


	2012
			Reason for Modification
	Number of Contracts		Extend Maturity		Modify Rate		Modify Payments		Other		Total Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Specific Reserve
	(dollars in thousands)
Commercial, financial, agricultural and other		12	$	1,599	$	187	$	9,476	$	0	$	11,262	$	11,335	$	4,237
Real estate construction		2		1,697		0		0		0		1,697		2,133		200
Residential real estate		25		200		132		697		48		1,077		973		69
Commercial real estate		4		3,280		4,308		71		0		7,659		7,607		409
Loans to individuals		17		0		97		88		6		191		173		0

Total		60	$	6,776	$	4,724	$	10,332	$	54	$	21,886	$	22,221	$	4,915


	2011
			Reason for Modification
	Number of Contracts		Extend Maturity		Modify Rate		Modify Payments		Total Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Specific Reserve
	(dollars in thousands)
Commercial, financial, agricultural and other		13	$	100	$	475	$	2,218	$	2,793	$	2,749	$	743
Real estate construction		6		2,554		86		0		2,640		2,852		0
Residential real estate		10		0		515		601		1,116		1,100		65
Commercial real estate		22		17,202		24,226		2,311		43,739		25,292		507

Total		51	$	19,856	$	25,302	$	5,130	$	50,288	$	31,993	$	1,315


	2010
			Reason for Modification
	Number of Contracts		Extend Maturity		Modify Rate		Modify Payments		Total Pre-Modification Outstanding Recorded Investment		Post- Modification Outstanding Recorded Investment		Specific Reserve
	(dollars in thousands)
Commercial, financial, agricultural and other		7	$	250	$	105	$	36,591	$	36,946	$	21,180	$	4,972
Real estate construction		2		109		2,070		0		2,179		1,051		0
Residential real estate		2		0		13		57		70		67		0
Commercial real estate		4		0		10,685		241		10,926		9,870		3

Total		15	$	359	$	12,873	$	36,889	$	50,121	$	32,168	$	4,975

The troubled debt restructurings included in the above tables are also included in the impaired loan tables provided earlier in this footnote. Loans defined as modified due to a change in rate include loans that were modified for a change in rate as well as a reamortization of the principal and an extension of the maturity. For the years ended December 31, 2012, 2011 and 2010, $4.7 million, $25.2 million and $0.1 million, respectively, of total rate modifications represent loans with modifications to the rate as well as payment due to reamortization.

A troubled debt restructuring is considered to be in default when a restructured loan is 90 days or more past due. As of December 31, 2012, there were no loans restructured within the preceding twelve months which were considered to be in default. As of December 31, 2011, a $4.1 million commercial real estate loan, restructured during the first quarter of 2011 was considered to be in default. As of December 31, 2011, this loan was transferred to held for sale and the sale was completed in 2012. As of December 31, 2010, there were no loans restructured within the preceding twelve months which were considered to be in default.

The following tables provide detail related to the allowance for credit losses for the years ended December 31:


	2012
	Commercial, financial, agricultural and other			Real estate construction			Residential real estate			Commercial real estate			Loans to individuals			Unallocated		Total
	(dollars in thousands)
Allowance for credit losses:
Beginning Balance	$	18,200		$	6,756		$	8,237		$	18,961		$	4,244		$	4,836	$	61,234
Charge-offs		(5,207	)		(3,601	)		(3,828	)		(851	)		(3,482	)		0		(16,969	)
Recoveries		443			582			422			410			521			0		2,378
Provision		6,416			5,191			1,077			3,921			2,849			1,090		20,544

Ending Balance	$	19,852		$	8,928		$	5,908		$	22,441		$	4,132		$	5,926	$	67,187

Ending balance: individually evaluated for impaired	$	10,331		$	300		$	780		$	6,367		$	0		$	0	$	17,778
Ending balance: collectively evaluated for impaired		9,521			8,628			5,128			16,074			4,132			5,926		49,409
Loans:
Ending balance		1,019,822			87,438			1,241,565			1,273,661			582,218					4,204,704
Ending balance: individually evaluated for impaired		33,443			11,177			6,444			49,123			0					100,187
Ending balance: collectively evaluated for impaired		986,379			76,261			1,235,121			1,224,538			582,218					4,104,517


	2011
	Commercial, financial, agricultural and other			Real estate construction			Residential real estate			Commercial real estate			Loans to individuals			Unallocated			Total
	(dollars in thousands)
Allowance for credit losses:
Beginning Balance	$	21,700		$	18,002		$	5,454		$	16,913		$	4,215		$	4,945		$	71,229
Charge-offs		(7,114	)		(28,886	)		(4,107	)		(24,861	)		(3,325	)		0			(68,293	)
Recoveries		473			955			132			349			573			0			2,482
Provision		3,141			16,685			6,758			26,560			2,781			(109	)		55,816

Ending Balance	$	18,200		$	6,756		$	8,237		$	18,961		$	4,244		$	4,836		$	61,234

Ending balance: individually evaluated for impaired	$	9,069		$	2,960		$	93		$	1,114		$	0		$	0		$	13,236
Ending balance: collectively evaluated for impaired		9,131			3,796			8,144			17,847			4,244			4,836			47,998
Loans:
Ending balance		996,739			76,564			1,137,059			1,267,432			565,849						4,043,643
Ending balance: individually evaluated for impaired		37,639			14,667			2,606			39,832			0						94,744
Ending balance: collectively evaluated for impaired		959,100			61,897			1,134,453			1,227,600			565,849						3,948,899


	2010
	Commercial, financial, agricultural and other			Real estate construction			Residential real estate			Commercial real estate			Loans to individuals			Unallocated		Total
	(dollars in thousands)
Allowance for credit losses:
Beginning Balance	$	31,369		$	18,224		$	5,847		$	17,526		$	4,731		$	3,942	$	81,639
Charge-offs		(22,293	)		(41,483	)		(5,226	)		(2,466	)		(3,841	)		0		(75,309	)
Recoveries		2,409			0			252			163			523			0		3,347
Provision		10,215			41,261			4,581			1,690			2,802			1,003		61,552

Ending Balance	$	21,700		$	18,002		$	5,454		$	16,913		$	4,215		$	4,945	$	71,229

Ending balance: individually evaluated for impaired	$	6,709		$	11,855		$	56		$	5,287		$	0		$	0	$	23,907
Ending balance: collectively evaluated for impaired		14,991			6,147			5,398			11,626			4,215			4,945		47,322
Loans:
Ending balance		913,814			261,482			1,127,273			1,354,074			561,440					4,218,083
Ending balance: individually evaluated for impaired		25,694			44,485			832			42,863			0					113,874
Ending balance: collectively evaluated for impaired		888,120			216,997			1,126,441			1,311,211			561,440					4,104,209