FIRST COMMONWEALTH FINANCIAL CORP /PA/ (FCF) FY 2022 MD&A

ITEM 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis represents an overview of the financial condition and the results of operations of First Commonwealth, and its subsidiaries, as of and for the years ended December 31, 2022, and 2021. The purpose of this discussion is to focus on information concerning our financial condition and results of operations that is not readily apparent from the Consolidated Financial Statements. In order to obtain a more thorough understanding of this discussion, you should refer to the Consolidated Financial Statements, the notes thereto and other financial information presented in this Annual Report. Refer to Management's Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K filed with the SEC on March 1, 2022 for a discussion and analysis of the factors that affected periods prior to 2022.

Company Overview

First Commonwealth provides a diversified array of consumer and commercial banking services through our bank subsidiary, FCB. We also provide trust and wealth management services through FCB and insurance products through FCIA. At December 31, 2022, FCB operated 119 community banking offices throughout Pennsylvania and Ohio, as well as loan production offices in Pittsburgh, Pennsylvania, and Cleveland, Columbus, Canton, Lewis Center and Hudson, Ohio.

Our consumer services include Internet, mobile and telephone banking, an automated teller machine network, personal checking accounts, interest-earning checking accounts, savings accounts, health savings accounts, insured money market accounts, debit cards, investment certificates, fixed and variable rate certificates of deposit, mortgage loans, secured and unsecured installment loans, construction and real estate loans, safe deposit facilities, credit cards, credit lines with overdraft checking protection and IRA accounts. Commercial banking services include commercial lending, small and high-volume business checking accounts, on-line account management services, ACH origination, payroll direct deposit, commercial cash management services and repurchase agreements. We also provide a variety of trust and asset management services and a full complement of auto, home and business insurance as well as term life insurance. We offer annuities, mutual funds and stock and bond brokerage services through an arrangement with a broker-dealer and insurance brokers. Most of our commercial customers are small and mid-sized businesses in Pennsylvania and Ohio.

As a financial institution with a focus on traditional banking activities, we earn the majority of our revenue through net interest income, which is the difference between interest earned on loans and investments and interest paid on deposits and borrowings. Growth in net interest income is dependent upon balance sheet growth and maintaining or increasing our net interest margin, which is net interest income (on a fully taxable-equivalent basis) as a percentage of our average interest-earning assets. We also generate revenue through fees earned on various services and products that we offer to our customers and, less frequently, through sales of assets, such as loans, investments or properties. These revenue sources are offset by provisions for credit losses on loans, operating expenses, income taxes and, less frequently, loss on sale or other-than-temporary impairments on investment securities.

General economic conditions also affect our business by impacting our customers’ need for financing, thus affecting loan growth, as well as impacting the credit strength of existing and potential borrowers.

Critical Accounting Policies and Significant Accounting Estimates

First Commonwealth’s accounting and reporting policies conform to accounting principles generally accepted in the United States of America (“GAAP”) and predominant practice in the banking industry. The preparation of financial statements in accordance with GAAP requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Over time, these estimates, assumptions and judgments may prove to be inaccurate or vary from actual results and may significantly affect our reported results and financial position for the period presented or in future periods. We currently view the determination of the allowance for credit losses to be critical because it is highly dependent on subjective or complex judgments, assumptions and estimates made by management.

Allowance for Credit Losses

We account for the credit risk associated with our lending activities through the allowance and provision for credit losses. The allowance represents management’s best estimate of expected losses in our existing loan and lease portfolio as of the balance sheet date. The provision is a periodic charge to earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management’s assessment of expected losses. Management determines and reviews with the Board of Directors the appropriateness of the allowance on a quarterly basis in accordance with the methodology described below.

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•Loans are segmented into groups with similar characteristics and risks and an allowance for credit losses is calculated for each segment based on the estimate of credit losses.

•The allowance for credit losses is calculated by pooling loans of similar credit risk characteristics and applying a discounted cash flow methodology after incorporating probability of default and loss given default estimates. Probability of default represents an estimate of the likelihood of default and loss given default measures the expected loss upon default. Inputs impacting the expected losses includes a forecast of macroeconomic factors, using a weighted forecast from a nationally recognized firm.

•Loans that do not have the same risks and characteristics of the loan pools are individually reviewed. These are generally large balance commercial loans and commercial mortgages that are rated less than “satisfactory” based on our internal credit-rating process.

•We assess whether the loans identified for review are “nonperforming”. This means it is expected that all amounts will not be collected according to the contractual terms of the loan agreement, which generally represents loans that management has placed on nonaccrual status and accruing troubled debt restructurings.

•For individually analyzed loans we calculate the estimated fair value of the loans that are selected for review based on observable market prices, discounted cash flows or the value of the underlying collateral and record an allowance if needed.

•We then review the results to determine the appropriate balance of the allowance for credit losses. This review includes consideration of additional factors, such as the mix of loans in the portfolio, the balance of the allowance relative to total loans and nonperforming assets, trends in the overall risk profile in the portfolio, trends in delinquencies and nonaccrual loans, and local and national economic information and industry data, including trends in the industries we believe are higher risk.

There are many factors affecting the allowance for credit losses; some are quantitative, while others require qualitative judgment. These factors require the use of estimates related to the amount and timing of expected future cash flows, appraised values on nonperforming loans, estimated losses for each loan category based on historical loss experience, forecasts of economic trends and conditions, all of which may be susceptible to significant judgment and change. To the extent that actual outcomes differ from estimates, additional provisions for credit losses could be required that could adversely affect our earnings or financial position in future periods.

As noted above, the allowance for credit losses is estimated using a number of inputs and assumptions. Management's sensitivity analysis of the allowance identified that the model has the highest degree of sensitivity around values used in the economic forecast, specifically national unemployment and gross domestic product. Additionally, there is also a high degree of sensitivity related to estimated prepayment speeds as it is a major driver for the life of loan expectations. The sensitivity of estimated prepayment speeds had the largest impact on the residential first lien loan pool.

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Selected Financial Information

The following table provides selected financial information for the periods ended December 31,

Results for 2020 through 2022 reflect accounting for the allowance for credit losses under the current expected credit loss methodology, while results prior to 2020 reflect accounting under the incurred methodology.

Results of Operations—2022 Compared to 2021

Net Income

Net income for 2022 was $128.2 million, or $1.37 per diluted share, as compared to net income of $138.3 million, or $1.44 per diluted share in 2021. The decrease in net income was the result of a $22.5 million increase in provision for credit losses, an

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increase of $15.8 million in noninterest expense and a decrease of $8.0 million in noninterest income offset by an increase of $33.7 million in net interest income.

Our return on average equity was 12.0% and our return on average assets was 1.34% for 2022, compared to 12.6% and 1.47%, respectively, for 2021.

Average diluted shares for the year 2022 were 2% less than the comparable period in 2021 primarily due to $15.6 million of common stock buybacks completed during 2022.

Net Interest Income

Net interest income, which is our primary source of revenue, is the difference between interest income from earning assets (loans and securities) and interest expense paid on liabilities (deposits, short-term borrowings and long-term debt). The amount of net interest income is affected by both changes in the level of interest rates and the amount and composition of interest-earning assets and interest-bearing liabilities. The net interest margin is expressed as the percentage of net interest income, on a fully taxable equivalent basis, to average interest-earning assets. To compare the tax exempt asset yields to taxable yields, amounts are adjusted to the pretax equivalent amounts based on the marginal corporate federal income tax rate of 21%. The taxable equivalent adjustment to net interest income for 2022 was $1.0 million compared to $1.1 million in 2021. Net interest income comprises a majority of our operating revenue (net interest income before provision expense plus noninterest income) at 76% and 72% for the years ended December 31, 2022 and 2021, respectively.

Net interest income, on a fully taxable equivalent basis, was $313.3 million for the year-ended December 31, 2022, a $33.6 million, or 12%, increase compared to $279.6 million for the same period in 2021. The net interest margin, on a fully taxable equivalent basis, increased 32 basis points to 3.58% in 2022 from 3.26% in 2021. The net interest margin is affected by both changes in the level of interest rates and the amount and composition of interest-earning assets and interest-bearing liabilities.

The impact of growth in interest-earning assets in 2022 was further impacted by the effect of the mix of the asset growth and higher interest rates, resulting in an increase in the net interest margin for the year ended December 31, 2022. Average earning assets for the year ended December 31, 2022 increased $153.3 million, or 2%, compared to the year ended December 31, 2021. The change in the volume of interest-earning assets and interest-bearing liabilities positively increased net interest income by $14.8 million in the year ended December 31, 2022 compared to the same period in 2021, and changes in rates positively impacted net interest income by $18.9 million. Interest-sensitive assets totaling $4.3 billion will either reprice or mature over the next twelve months.

The taxable equivalent yield on interest-earning assets was 3.79% for the year ended December 31, 2022, an increase of 36 basis points from the 3.43% yield for the same period in 2021. This change is primarily due to an increase in the yield on our adjustable and variable rate commercial loan portfolios, which increased by 89 basis points largely due to loans repricing in a rising interest rate environment. During 2022, the Federal Reserve increased short-term interest rates by 425 basis points. Also contributing to the increase in yield on interest-earning assets was the yield on the investment portfolio, which increased by 15 basis points compared to the prior year, primarily due to the increased rate environment.

As of December 31, 2022, 43% of our loan portfolio had variable or adjustable interest rates and 57% had fixed interest rates. These percentages incorporate the impact of our cash flow hedges that convert the interest rate on $500.0 million of our 1-month LIBOR based loans to fixed rates. Without these cash flow hedges, the variable and adjustable interest rates would account for 49% of our loan portfolio and include approximately 32% tied to the prime interest rate, 18% tied to SOFR, 14% tied to LIBOR, 10% tied to Federal Home Loan Bank rates, 10% tied to Treasury rates, 9% tied to swap rates and 7% tied to BSBY. As of September 30, 2021, we discontinued originating loans tied to LIBOR and instead have used our preferred replacement rate of SOFR as well as BSBY. All LIBOR based loans are expected to be transitioned to a new index by June 30, 2023.

The loan yield for the year ended December 31, 2022 increased 27 basis points compared to December 31, 2021. This increase is a result of the previously mentioned increase in interest rates as well as growth in the loan portfolio. Average loans increased by $395.4 million during the period, despite a decrease of $292.1 million in average Paycheck Protection Program ("PPP") loans outstanding during the period. These loans were originated under the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") and had a stated loan rate of 1% and a yield of 12.9% and 7.4% for the years ended December 31, 2022 and December 31, 2021, respectively. The yield on PPP loans includes the recognition of PPP loan deferred processing fees, net of deferred origination costs, of $2.3 million for the year ended December 31, 2022 and $19.9 million for the year ended December 31, 2021. These amounts are recognized in interest income as a yield adjustment over the life of the loan with accelerated recognition when a loan is forgiven or paid off. At December 31, 2022, the balance of PPP loans outstanding totaled $4.3 million. PPP loans generated $2.7 million in income during the year ended December 31, 2022 and increased the yield on total loans and the net interest margin by 3 basis points and 2 basis points, respectively. During the year ended

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December 31, 2021, PPP loans generated $23.2 million in income increasing both the loan portfolio yield and net interest margin by 16 basis points.

The investment portfolio yield increased 15 basis points in comparison to the prior year as new volume rates were higher than the portfolio yields. The average investment portfolio balance decreased $113.0 million as maturities and runoff funded loan growth. Additionally, the average balance of interest-bearing deposits with banks has decreased from $317.5 million in 2021 to $188.4 million in 2022 as this liquidity was used to fund loan growth. The impact of the level and rate earned on interest-bearing deposits with banks increased the yield on interest-earnings assets by 6 basis points for the year ended December 31, 2022.

Increases in the cost of interest-bearing liabilities partially offset the positive impact of higher yields on interest-earning assets. The cost of interest-bearing liabilities was 0.31% for the year-ended December 31, 2022, compared to 0.27% for the same period in 2021. Higher market interest rates resulted in the cost of interest-bearing deposits increasing 2 basis points and short-term borrowings increasing 130 basis points in comparison to the same period in the prior year. Average short-term borrowings increased by $25.0 million for the year ended December 31, 2022 compared to the same period in 2021. Average long-term debt decreased $19.2 million, while the cost of long-term debt increased by 26 basis points due to the maturity of lower costing borrowings and increasing rates on the variable rate portion of the subordinated debentures.

Comparing the year ended December 31, 2022 with the same period in 2021, changes in rates positively impacted net interest income by $18.9 million. The higher yield on interest-earning assets increased net interest income by $22.6 million, while the change in the cost of interest-bearing liabilities negatively impacted net interest income by $3.7 million.

Changes in the volume of interest-earning assets and interest-bearing liabilities positively increased net interest income by $14.8 million in the year ended December 31, 2022 compared to the same period in 2021. Higher levels of interest-earning assets resulted in an increase of $13.5 million in interest income, and changes in the volume and mix of interest-bearing liabilities decreased interest expense by $1.3 million, primarily due to decreases in long-term borrowings and time deposits.

Positively affecting net interest income was a $85.5 million increase in average net free funds at December 31, 2022 as compared to December 31, 2021. Average net free funds are the excess of noninterest-bearing demand deposits, other noninterest-bearing liabilities and shareholders’ equity over noninterest-earning assets. The largest component of the increase in net free funds was a $128.1 million increase in average noninterest-bearing demand deposits. Average time deposits for the year ended December 31, 2022 decreased $96.8 million, or 22%, compared to the comparable period in 2021, while the average rate paid on time deposits decreased 15 basis points. Over the next twelve months, $230.6 million in certificates of deposits are scheduled to mature.

The following table reconciles interest income in the Consolidated Statements of Income to net interest income adjusted to a fully taxable equivalent basis for the periods presented:

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The following table provides information regarding the average balances and yields or rates on interest-earning assets and interest-bearing liabilities for the periods ended December 31:

(a)Income on interest-earning assets has been computed on a fully taxable equivalent basis using the federal income tax statutory rate of 21%.

(b)Income on nonaccrual loans is accounted for on the cash basis, and the loan balances are included in interest-earning assets.

(c)Loan income includes loan fees.

(d)Average balances do not include reallocations from noninterest-bearing demand deposits and interest-bearing demand deposits into savings deposits which were made for regulatory purposes.

(e)Includes held for sale loans.

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The following table sets forth certain information regarding changes in net interest income attributable to changes in the volume of interest-earning assets and interest-bearing liabilities and changes in the rates for the periods indicated:

(a)Changes in interest income or expense not arising solely as a result of volume or rate variances are allocated to rate variances.

(b)Changes in interest income have been computed on a fully taxable equivalent basis using the 21% federal income tax statutory rate.

Provision for Credit Losses

The provision for credit losses is determined based on management’s estimates of the appropriate level of the allowance for credit losses needed to provide for expected losses inherent in the loan and lease portfolio and on off-balance sheet commitments. The provision for credit losses is an amount added to the allowance against which credit losses are charged.

The provision is a result of management's estimate of credit losses over the contractual life of the loan and lease portfolio. The change in the allowance for credit is impacted by estimated expected losses in the portfolio determined by a discounted cash flow analysis considering inputs such as contractual payment schedules, prepayment estimates, historical loss experience, calculated probability of default and loss given default estimates and forecasts for certain macroeconomic variables, such as unemployment, gross domestic product and the housing price index as well as other macroeconomic variables.

The provision for credit losses on loans and leases for 2022 totaled $17.5 million, an increase of $17.9 million compared to the $0.4 million negative provision recognized in 2021. The level of provision expense for the year ended December 31, 2022 is primarily a result of loan growth and changes in the economic forecast. The provision for credit losses was also impacted by a decrease of $0.3 million in reserves on individually analyzed loans. Contributing to the increase in provision for credit losses was a $4.6 million increase in expense related to higher reserves for off-balance sheet commitments.

Provision expense for the commercial, financial, agricultural and other category was impacted by net charge-offs of $2.0 million, as well as an increase of $38.3 million in outstanding balances. Provision expense for the commercial real estate category was impacted by $1.7 million in net charge-offs offset by an increase in general reserves due to $173.9 million in loan growth. Contributing to the negative provision for commercial real estate is the release of the remaining COVID-19 qualitative reserves which were established at the beginning of the pandemic. These reserves have been released as the risk of the COVID-19 pandemic on the loan portfolio declined. Increase in the residential real estate category is due primarily to $274.4 million in loan growth, slowing prepayment speeds and an annual review of loss history data used in the allowance for credit loss model. Net charge-offs related to loans to individuals were $3.3 million for the year ended December 31, 2022, including $1.9 million for indirect auto loans and $1.0 million related to other consumer loans. The provision expense for loans to individuals was also impacted by growth in the portfolio of $297.7 million and the impact of the annual review of loss history data used in the allowance model.

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The table below provides a breakout of the provision for credit losses by loan category for the years ended December 31:

The provision expense for the year ended December 31, 2021 totaled a $0.4 million negative provision and primarily was a result of $8.4 million in net charge-offs offset by a decrease in the allowance for credit losses due to improvement in the economic forecast as compared to the prior year which included a higher level of uncertainty and risks related to the COVID-19 pandemic. Also impacting provision expense in 2021 was a decrease of $4.5 million on individually analyzed loans.

The allowance for credit losses was $102.9 million, or 1.35%, of total loans outstanding at December 31, 2022, compared to $92.5 million, or 1.35%, at December 31, 2021. Nonperforming loans as a percentage of total loans decreased to 0.46% at December 31, 2022 from 0.81% at December 31, 2021. The allowance to nonperforming loan ratio was 290.0% as of December 31, 2022 and 167.7% at December 31, 2021. Net charge-offs were $7.1 million for the year-ended December 31, 2022 compared to $8.4 million for the same period in 2021.

Upon adoption of CECL at January 1, 2020, the provision for credit losses on off-balance sheet credit exposures are recorded as part of the provision for credit losses instead of a component of non-interest expense as it previously was recorded. The provision for credit losses recorded for off-balance sheet credit exposures totaled $3.6 million for the year ended December 31, 2022 compared to a negative provision of $1.0 million for the year ended December 31, 2021.

Management believes that the allowance for credit losses is at a level deemed appropriate to absorb expected losses inherent in the loan portfolio at December 31, 2022.

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A detailed analysis of our credit loss experience for the previous five years is shown below:

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Noninterest Income

The components of noninterest income for each year in the three-year period ended December 31 are as follows:

Noninterest income, excluding net securities gains, gain on sale of mortgage loans, gain on sale of other loans and assets and the derivatives mark to market, increased $4.3 million, or 5%, in 2022. Swap fee income increased $2.1 million due to an increase in interest rate swaps entered into for our commercial customers. Other income increased $2.1 million primarily due to income related to limited partnership investments. Service charges on deposit accounts increased $1.7 million as customer activity began to return to pre-COVID levels. Income from bank owned life insurance decreased $1.0 million due to the recognition of benefits during 2021 with no similar benefits in 2022, card related interchange income decreased $0.4 million due to a decline in transactions, and trust income decreased $0.6 million due to declines in the values of assets under management, all of which offset the aforementioned growth.

Total noninterest income decreased $8.0 million, or 8%, in comparison to the year ended December 31, 2021. The most significant change, other than the changes noted above, includes a decrease of $8.3 million in gain on sale of mortgage loans due to a decline in volume and spread received on mortgage loans sold. The mark to market adjustment on interest rate swaps entered into for our commercial loan customers decreased $2.0 million. This adjustment does not reflect a realized gain or loss on the swaps, but rather relates to a change in fair value due to movements in corporate bond spreads and swap rates as well as changes in counterparty credit risk. Gain on sale of other loans and assets decreased $2.1 million due to a decrease in the sale of other loans, primarily SBA loans, in comparison to the prior year.

If the Company's total assets would equal or exceed $10 billion, as of the end of the previous calendar year, we would no longer qualify for exemption from the interchange fee cap included in the Dodd-Frank Act. We estimate the application of the interchange fee cap would have decreased interchange income by approximately $14.1 million in 2022. First Commonwealth's total assets are expected to exceed $10 billion as of December 31, 2023, and as such, we expect to become subject to the interchange fee cap beginning July 1, 2024.

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Noninterest Expense

The components of noninterest expense for each year in the three-year period ended December 31 are as follows:

Total noninterest expense increased $15.8 million, or 7%, compared to the year ended December 31, 2021. Contributing to the change is the recognition of $1.7 million in merger and acquisition related expenses for the acquisition of Centric. Also contributing to the increase in noninterest expense is a $6.5 million increase in salaries and employee benefits due to annual merit increases and salary adjustments. Net occupancy increased $1.5 million due to higher building repairs and maintenance costs. Data processing costs increased $1.5 million due to continued investment in our digital banking and other product offerings. Contributing to the $4.0 million increase in other operating expenses were several expense categories, including travel, interview and placement, subscriptions and credit reporting expenses, none of which were individually significant.

Income Tax

The provision for income taxes of $32.0 million in 2022 reflects a decrease of $2.6 million compared to the provision for income taxes in 2021, as a result of a $12.6 million decrease in the level of income before taxes.

The effective tax rate was 20.0% for tax expense in both 2022 and 2021. We ordinarily generate an annual effective tax rate that is less than the statutory rate due to benefits resulting from tax-exempt interest, income from bank owned life insurance, and tax benefits associated with low income housing tax credits, all of which are relatively consistent regardless of the level of pretax income.

Financial Condition

First Commonwealth’s total assets increased $260.6 million as of December 31, 2022 compared to December 31, 2021. Loans, including loans held for sale, increased $796.2 million, or 12%. Loan growth in 2022 was experienced in all loan categories, with loans to individuals and residential real estate loans accounting for a majority of the growth. Investment securities decreased $358.9 million, or 23% and cash and interest-bearing balances with banks decreased $241.1 million, or 61%, as these funds provided liquidity necessary to fund the strong loan growth.

First Commonwealth’s total liabilities increased $317.9 million, or 4%, in 2022. Deposits increased $23.0 million and short-term borrowings increased $234.4 million, or 169%. The increase in short-term borrowings provided the liquidity necessary to fund loan growth. Also impacting total liabilities in 2022, was a $55.1 million increase in the fair value of interest rate swaps due to changes in the interest rate environment.

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Total shareholders' equity decreased $57.3 million in 2022. The decline in shareholders' equity was the result of net income of $128.2 million, offset by a $128.9 million decrease in accumulated other comprehensive income, $44.6 million in dividends declared and $15.6 million in stock repurchases.

Loan and Lease Portfolio

Following is a summary of our loan and lease portfolio as of December 31:

The loan and lease portfolio totaled $7.6 billion as of December 31, 2022, reflecting growth of $802.9 million, or 12%, compared to December 31, 2021. All categories experienced loan growth.

Commercial, financial, agricultural and other loans increased $38.3 million, or 3%, as a result of growth in this category exceeding runoff of $67.0 million in PPP loans. As of December 31, 2022, PPP loans totaled $4.3 million compared to $71.3 million at December 31, 2021. In the first quarter of 2022, we entered the equipment leasing and finance business, which accounted for $79.7 million of the growth in this category

Residential real estate loans increased $274.4 million, or 14%, primarily due to originations of first lien closed-end 1-4 family mortgage loans.

Growth in the loans to individuals category of $297.7 million, or 30%, was the result of growth in indirect auto and recreational vehicle loans.

Commercial real estate loans increased $173.9 million, or 7%, primarily due to growth in owner occupied properties.

The majority of our loan and lease portfolio is with borrowers located in the states of Pennsylvania and Ohio. As of December 31, 2022 and 2021, there were no concentrations of loans relating to any industry in excess of 10% of total loans.

Final loan maturities and rate sensitivities of the loan portfolio excluding consumer installment and mortgage loans at December 31, 2022 were as follows:

(a)The maturities of real estate construction loans include term commitments that follow the construction period. Loans with these term commitments will be moved to the commercial real estate category when the construction phase of the project is completed.

First Commonwealth has a legal lending limit of $165.1 million to any one borrower or closely related group of borrowers, but has established lower thresholds for credit risk management.

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Nonperforming Loans

Nonperforming loans include nonaccrual loans and restructured loans. Nonaccrual loans represent loans on which interest accruals have been discontinued. 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 deteriorating financial position of the borrower under terms not available in the market.

We discontinue interest accruals on a loan when, based on current information and events, it is probable that we will be unable to fully collect principal or interest due according to the contractual terms of the loan. Consumer loans are placed in nonaccrual status at 150 days past due.  Other types of loans are typically placed in nonaccrual status when there is evidence of a significantly weakened financial condition or principal and interest is 90 days or more delinquent. Interest received on a nonaccrual loan is normally applied as a reduction to loan principal rather than interest income utilizing the cost recovery methodology of revenue recognition.

Nonperforming loans are closely monitored on an ongoing basis as part of our loan review and work-out process. The estimated credit loss on these loans is evaluated by comparing the loan balance to the fair value of any underlying collateral and the present value of projected future cash flows. Losses are recognized when a loss is expected and the amount is reasonably estimable.

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The following is a comparison of nonperforming assets and the effects on interest due to nonaccrual loans for the period ended December 31:

(a)End of period loans and nonperforming loans exclude loans held for sale.

Nonperforming loans decreased $19.7 million to $35.5 million at December 31, 2022, compared to $55.2 million at December 31, 2021. Nonperforming loans as a percentage of total loans decreased to 0.46% from 0.81% at December 31, 2022 compared to December 31, 2021.

Also included in nonperforming loans are TDRs, which are those loans whose 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 under terms not available in the market. TDRs decreased $5.0 million during 2022. For additional information on TDRs please refer to Note 9 “Loans and Leases and Allowance for Credit Losses.”

Net charge-offs were $7.1 million in 2022 compared to $8.4 million for the year 2021. The most significant credit losses recognized during the year include $2.5 million in charge-offs recognized on six commercial real estate relationships. Net charge-offs in the loans to individuals category totaled $3.3 million for 2022, primarily due to charge-offs of indirect auto loans.

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Additional detail on credit risk is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under “Provision for Credit Losses,” “Allowance for Credit Losses" and "Credit Risk.”

Provision for credit losses on loans and leases as a percentage of net charge-offs increased to a 245.5% for the year ended December 31, 2022 from a negative 4.5% for the year ended December 31, 2021. This change was not driven by net charge-offs, but rather an increase in the provision for loan credit losses on loans. This increased provision in 2022 is primarily a result of loan growth and changes in the economic forecast used in calculating the allowance.

Allowance for Credit Losses

Following is a summary of the allocation of the allowance for credit losses at December 31:

(a)Represents the ratio of loans in each category to total loans.

Effective January 1, 2020, the company adopted the CECL methodology of calculating the allowance for credit losses which provides for expected losses over the life of a loan. Prior periods are reported in accordance with previously applicable GAAP and was calculated to provide for credit losses as they were incurred.

The allowance for credit losses increased $10.4 million from December 31, 2021 to December 31, 2022. The allowance for credit losses as a percentage of end-of-period loans outstanding was 1.35% at both December 31, 2022 and 2021. The allowance for credit losses includes both a general reserve for performing loans and reserves for individually analyzed loans. Comparing December 31, 2022 to December 31, 2021, the general reserve for performing loans is 1.34% and 1.36%, respectively, of total performing loans for both periods. Reserves for individually analyzed loans increased from 0.7% of nonperforming loans at December 31, 2021 to 2.0% of nonperforming loans at December 31, 2022. The allowance for credit losses as a percentage of nonperforming loans was 290.0% and 167.7% at December 31, 2022 and 2021, respectively.

The allowance for credit losses represents management’s estimate of expected losses in the loan portfolio at a specific point in time. This estimate includes losses associated with specifically identified loans, as well as estimated credit losses inherent in the remainder of the loan portfolio. Additions are made to the allowance through both periodic provisions charged to income and recoveries of losses previously incurred. Reductions to the allowance occur as loans are charged off. Management evaluates the appropriateness of the allowance at least quarterly, and in doing so relies on various factors including, but not limited to, assessment of historical loss experience, contractual payment schedules, prepayment estimates, calculated probability of default and loss given default estimates and forecasts of certain macroeconomic variables, such as unemployment, gross domestic product, housing price index as well as other macroeconomic variables. This evaluation is subjective and requires material estimates that may change over time. For a description of the methodology used to calculate the allowance for credit losses, please refer to “Critical Accounting Policies and Significant Accounting Estimates—Allowance for Credit Losses.”

Investment Portfolio

Marketable securities that we hold in our investment portfolio, which are classified as “securities available for sale,” act as a source of liquidity. However, we do not anticipate liquidating the investments prior to maturity.

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Following is a detailed schedule of the amortized cost of securities available for sale as of December 31:

As of December 31, 2022, securities available for sale had a fair value of $0.8 billion. Gross unrealized gains were $0.3 million and gross unrealized losses were $136.3 million. The level of gross unrealized losses is directly related to the change in market interest rates.

The following is a schedule of the contractual maturity distribution of securities available for sale at December 31, 2022.

(a)Equities are excluded from this schedule because they have an indefinite maturity.

(b)Yields are calculated on a taxable equivalent basis.

Mortgage-backed securities, which include mortgage-backed obligations of U.S. Government agencies and obligations of U.S. Government-sponsored enterprises, have contractual maturities ranging from less than one year to approximately 45 years and have anticipated average lives to maturity ranging from less than three years to approximately six years.

The available for sale investment portfolio amortized cost decreased $146.9 million, or 14%, at December 31, 2022 compared to 2021. Available for sale investment calls or maturities totaled $145.6 million during 2022. Liquidity provided from sales, calls and maturities was utilized to fund growth in the loan portfolio or reinvested into investment securities and interest-bearing deposits with banks.

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Following is a detailed schedule of the amortized cost of securities held to maturity as of December 31:

The following is a schedule of the contractual maturity distribution of securities held to maturity at December 31, 2022.

The held to maturity investment portfolio decreased $80.1 million, or 15%, at December 31, 2022 compared to 2021. Held to maturity investment purchases of $0.2 million were offset by the calls or maturities of $79.6 million in investments.

See Note 8 “Investment Securities" and Note 17 “Fair Values of Assets and Liabilities” for additional information related to the investment portfolio.

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Deposits

Total deposits increased $23.0 million in 2022. Interest-bearing demand and savings deposits decreased $8.7 million, noninterest-bearing demand deposits increased $11.7 million and time deposits increased $20.0 million. For additional information concerning our deposits, please refer to Note 13 “Interest-Bearing Deposits.”

At December 31, 2022 and 2021, time deposits of $100 thousand or more totaled $172.0 million and $136.1 million, respectively. Time deposits of $250 thousand or more had remaining maturities as follows as of the end of each year in the two-year period ended December 31:

The estimated total amount of uninsured deposits was $2.1 billion at both December 31, 2022 and 2021. Uninsured amounts are estimated based on known deposit account relationships for each depositor and insurance guidelines provided by the FDIC.

Short-Term Borrowings and Long-Term Debt

Short-term borrowings increased $234.4 million, or 169%, from $138.3 million at December 31, 2021 to $372.7 million at December 31, 2022. Long-term debt decreased $1.0 million, from $182.3 million at December 31, 2021 to $181.2 million at December 31, 2022. For additional information concerning our short-term borrowings, subordinated debentures and other long-term debt, please refer to Note 14 “Short-term Borrowings,” Note 15 “Subordinated Debentures” and Note 16 “Other Long-term Debt” of the Consolidated Financial Statements.

Contractual Obligations and Off-Balance Sheet Arrangements

The table below sets forth our contractual obligations to make future payments as of December 31, 2022. For a more detailed description of each category of obligation, refer to the note in our Consolidated Financial Statements indicated in the table below.

The table above excludes our cash obligations upon maturity of certificates of deposit, which is set forth in Note 13 “Interest-Bearing Deposits” of the Consolidated Financial Statements.

In addition, see Note 10 “Commitments and Letters of Credit” for detail related to our off-balance sheet commitments to extend credit, financial standby letters of credit, performance standby letters of credit and commercial letters of credit as of December 31, 2022. Commitments to extend credit, standby letters of credit and commercial letters of credit do not necessarily represent future cash requirements since it is unknown if the borrower will draw upon these commitments and often these commitments expire without being drawn upon. As of December 31, 2022, a reserve for expected credit losses of $10.0 million was recorded for unused commitments and letters of credit.

Liquidity

Liquidity refers to our ability to meet the cash flow requirements of depositors and borrowers as well as our operating cash needs with cost-effective funding. Liquidity risk arises from the possibility that we may not be able to meet our financial obligations and operating cash needs or may become overly reliant upon external funding sources. In order to manage this risk, our Board of Directors has established a Liquidity Policy that identifies primary sources of liquidity, establishes procedures for

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monitoring and measuring liquidity and quantifies minimum liquidity requirements based on limits approved by our Board of Directors. This policy designates our Asset/Liability Committee (“ALCO”) as the body responsible for meeting these objectives. The ALCO, which includes members of executive management, reviews liquidity on a periodic basis and approves significant changes in strategies that affect balance sheet or cash flow positions. Liquidity is centrally managed on a daily basis by our Treasury Department, which monitors it by using such measures as a 30-day liquidity stress analysis, liquidity gap ratios and noncore funding ratios.

We generate funds to meet our cash flow needs primarily through the core deposit base of FCB and the maturity or repayment of loans and other interest-earning assets, including investments. Core deposits are the most stable source of liquidity a bank can have due to the long-term relationship with a deposit customer. The level of deposits during any period is sometimes influenced by factors outside of management’s control, such as the level of short-term and long-term market interest rates and yields offered on competing investments, such as money market mutual funds. Deposits increased $23.0 million during 2022, and comprised 91% of total liabilities at December 31, 2022, as compared to 95% at December 31, 2021. Proceeds from the sale, maturity and redemption of investment securities totaled $225.2 million during 2022 and provided liquidity to fund loans, purchase investment securities and fund depositor withdrawals.

We also have available unused wholesale sources of liquidity, including overnight federal funds and repurchase agreements, advances from the Federal Home Loan Bank of Pittsburgh, borrowings through the discount window at the Federal Reserve Bank of Cleveland and access to certificates of deposit through brokers. We have increased our borrowing capacity at the Federal Reserve by establishing a Borrower-in-Custody of Collateral arrangement that enables us to pledge certain loans, not being used as collateral at the Federal Home Loan Bank, as collateral for borrowings at the Federal Reserve. At December 31, 2022 our borrowing capacity at the Federal Reserve related to this program was $1.0 billion and there were no amounts outstanding. Additionally, as of December 31, 2022, our maximum borrowing capacity at the Federal Home Loan Bank of Pittsburgh was $2.0 billion and as of that date amounts used against this capacity included $289.9 million in outstanding borrowings.

We participate in the Certificate of Deposit Account Registry Services (“CDARS”) program as part of an ALCO strategy to increase and diversify funding sources. As of December 31, 2022, our maximum borrowing capacity under this program was $1.5 billion and as of that date there was $4.9 million outstanding. CDARS includes a wholesale and a reciprocal program. The reciprocal program allows our depositors to receive expanded FDIC coverage by placing multiple certificates of deposit at other CDARS member banks. The current outstanding balance in its entirety relates to the reciprocal program. As of December 31, 2022, our outstanding certificates of deposits from this program have an average weighted rate of 0.48% and an average original term of 364 days.

We also have available unused federal funds lines with four correspondent banks. These lines have an aggregate commitment of $160.0 million and there were no amounts outstanding as of December 31, 2022. In addition, we have available unused repo lines with two correspondent banks. These lines have an aggregate commitment of $265.0 million with no outstanding balance as of December 31, 2022.

The liquidity needs of First Commonwealth on an unconsolidated basis (the "Parent Company") consist primarily of operating expenses, debt service payments and dividend payments to our stockholders, which collectively totaled $52.6 million for the year ended December 31, 2022, as well as any cash necessary to repurchase our shares, which totaled $15.6 million for the year ended December 31, 2022. The primary source of liquidity for the Parent Company is dividends from subsidiaries. The Parent Company had $72.2 million in junior subordinated debentures and cash and interest-bearing deposits of $37.7 million at December 31, 2022. At the end of 2022, the Parent Company had a $20.0 million short-term, unsecured revolving line of credit with another financial institution. As of December 31, 2022, there were no amounts outstanding under this line. The Parent Company has the ability to enhance its liquidity position by raising capital or incurring debt.

Refer to “Financial Condition” above for additional information concerning our deposits, loan portfolio, investment securities and borrowings.

Market Risk

Market risk refers to potential losses arising from changes in interest rates, foreign exchange rates, equity prices and commodity prices. Our market risk is composed primarily of interest rate risk. Interest rate risk is comprised of repricing risk, basis risk, yield curve risk and options risk. Repricing risk arises from differences in the cash flow or repricing between asset and liability portfolios. Basis risk arises when asset and liability portfolios are related to different market rate indices, which do not always change by the same amount. Yield curve risk arises when asset and liability portfolios are related to different maturities on a given yield curve; when the yield curve changes shape, the risk position is altered. Options risk arises from “embedded options” within asset and liability products as certain borrowers have the option to prepay their loans when rates fall, while certain depositors can redeem or withdraw their deposits early when rates rise.

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The process by which we manage our interest rate risk is called asset/liability management. The goals of our asset/liability management are increasing net interest income without taking undue interest rate risk or material loss of net market value of our equity, while maintaining adequate liquidity. Net interest income is increased by growing earning assets and increasing the difference between the rate earned on earning assets and the rate paid on interest-bearing liabilities. Liquidity is measured by the ability to meet both depositors’ and credit customers’ requirements.

We use an asset/liability model to measure our interest rate risk. Interest rate risk measures include earnings simulation and gap analysis. Gap analysis is a static measure that does not incorporate assumptions regarding future events. Gap analysis, while a helpful diagnostic tool, displays cash flows for only a single rate environment. Net interest income simulations explicitly measure the exposure to earnings from changes in market rates of interest. Under simulation analysis, our current financial position is combined with assumptions regarding future business to calculate net interest income under various hypothetical rate scenarios. Our net interest income simulations assume a level balance sheet whereby new volume equals run-off. The ALCO reviews earnings simulations over multiple years under various interest rate scenarios. Reviewing these various measures provides us with a reasonably comprehensive view of our interest rate profile.

The following gap analysis compares the difference between the amount of interest-earning assets and interest-bearing liabilities subject to repricing over a period of time. The ratio of rate sensitive assets to rate sensitive liabilities repricing within a one-year period was 0.76 and 0.84 at December 31, 2022 and 2021, respectively. A ratio of less than one indicates a higher level of repricing liabilities over repricing assets over the next twelve months. The level of First Commonwealth's ratio is largely driven by the modeling of interest-bearing non-maturity deposits, which are included in the analysis as repricing within one year.

Following is the gap analysis as of December 31:

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Gap analysis has limitations due to the static nature of the model, which holds volumes and consumer behaviors constant in all economic and interest rate scenarios. A lower level of rate sensitive assets to rate sensitive liabilities repricing in one year could indicate reduced net interest income in a rising interest rate scenario, and conversely, increased net interest income in a declining interest rate scenario. However, the gap analysis incorporates only the level of interest-earning assets and interest-bearing liabilities and not the sensitivity each has to changes in interest rates. The impact of the sensitivity to changes in interest rates is provided in the table below.

The following table presents an analysis of the potential sensitivity of our annual net interest income to gradual changes in interest rates over a 12-month time frame as compared with net interest income if rates remained unchanged and there are no changes in balance sheet categories.

The following table represents the potential sensitivity of our annual net interest income to immediate changes in interest rates as compared to if rates remained unchanged, assuming there are no changes in balance sheet categories.

The analysis and model used to quantify the sensitivity of our net interest income becomes less meaningful in a decreasing 200 basis point scenario given the current interest rate environment. Results of the 100 and 200 basis point interest rate decline

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scenario are affected by the fact that many of our interest-bearing liabilities are at rates below 1%, with an assumed floor of zero in the model. For the years 2022 and 2021, the cost of our interest-bearing liabilities averaged 0.31% and 0.27%, respectively, and the yield on our average interest-earning assets, on a fully taxable equivalent basis, averaged 3.79% and 3.43%, respectively.

The ALCO is responsible for the identification and management of interest rate risk exposure. As such, the ALCO continuously evaluates strategies to manage our exposure to interest rate fluctuations.

Asset/liability models require that certain assumptions be made, such as prepayment rates on earning assets and the impact of pricing on non-maturity deposits, which may differ from actual experience. These business assumptions are based upon our experience, business plans and published industry experience. While management believes such assumptions to be reasonable, there can be no assurance that modeled results will approximate actual results.

Credit Risk

First Commonwealth maintains an allowance for credit losses at a level deemed sufficient for losses inherent in the loan and lease portfolio at the date of each statement of financial condition. Management reviews the appropriateness of the allowance on a quarterly basis to ensure that the provision for credit losses has been charged against earnings in an amount necessary to maintain the allowance at a level that is appropriate based on management’s assessment of estimated expected losses.

First Commonwealth’s methodology for assessing the appropriateness of the allowance for credit losses consists of several key elements. These elements include an assessment of individual nonperforming loans with a balance greater than $250 thousand, loss experience trends and other relevant factors.

First Commonwealth also maintains a reserve for unfunded loan commitments and letters of credit based upon credit risk and probability of funding. The reserve totaled $10.0 million at December 31, 2022 and is classified in “Other liabilities” on the Consolidated Statements of Financial Condition.

Nonperforming loans include nonaccrual loans and loans classified as troubled debt restructurings. Nonaccrual loans represent loans on which interest accruals have been discontinued. 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 deteriorating financial position of the borrower, who could not obtain comparable terms from alternate financing sources. In 2022, five loans totaling $0.7 million were identified as troubled debt restructurings. These loans were individually analyzed and no additional reserves were required.

We discontinue interest accruals on a loan when, based on current information and events, it is probable that we will be unable to fully collect principal or interest due according to the contractual terms of the loan. A loan is also placed in nonaccrual status when, based on regulatory definitions, the loan is maintained on a “cash basis” due to the weakened financial condition of the borrower. Generally, loans 90 days or more past due are placed on nonaccrual status, except for consumer loans which are placed on nonaccrual status at 150 days past due.

Nonperforming loans are closely monitored on an ongoing basis as part of our loan review and work-out process. The risk of loss on these loans is evaluated by comparing the loan balance to the estimated fair value of any underlying collateral or the present value of projected future cash flows. Losses or specifically assigned allowance for credit losses are recognized where appropriate.

The allowance for credit losses was $102.9 million at December 31, 2022 or 1.35% of loans outstanding, compared to $92.5 million, or 1.35% of loans outstanding, at December 31, 2021. Credit measures as of December 31, 2022 compared to December 31, 2021 reflect a decrease in the level of criticized loans of $65.3 million, from $198.1 million at December 31, 2021 to $132.9 million at December 31, 2022. Commercial real estate loans accounted for $60.0 million of this decrease. Classified assets decreased $33.1 million, from $77.6 million at December 31, 2021 to $44.4 million at December 31, 2022. Delinquency on accruing loans decreased $9.4 million, or 90%, and the level of nonperforming loans decreased $19.7 million for the same period.

The allowance for credit losses as a percentage of nonperforming loans was 290.0% at December 31, 2022 and 167.7% as of December 31, 2021. The allowance for credit losses includes specific allocations of $0.7 million related to nonperforming loans covering 2% of the total nonperforming balance at December 31, 2022 and specific allocations of $0.4 million covering 1% of the total nonperforming balance at December 31, 2021. The amount of allowance related to nonperforming loans was determined by using estimated fair values obtained from current appraisals and updated discounted cash flow analyses.

Management believes that the allowance for credit losses is at a level that is sufficient to absorb expected losses in the loan and lease portfolio at December 31, 2022.

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The following table provides information on net charge-offs and nonperforming loans by loan category:

As the above table illustrates, commercial real estate and residential real estate loans were the most significant portions of the nonperforming loans as of December 31, 2022. See discussions related to the provision for credit losses and loans for more information.

New Accounting Pronouncements

In March 2020, FASB released Accounting Standards Update (“ASU”) 2020-04 - Reference Rate Reform (Topic 848), which provides optional guidance to ease the accounting burden in accounting for, or recognizing the effects from, reference rate reform on financial reporting. The new standard is a result of the discontinuance of the London Interbank Offered Rate ("LIBOR") as an available benchmark rate. The standard is elective and provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, or other transactions that reference LIBOR, or another reference rate expected to be discontinued. The Company has elected to apply the practical expedient allowing for a contract modification, due to reference rate reform, to be accounted for as a continuation of the existing contract and does not require contract remeasurement at the modification date or reassessment of a previous accounting determination. The amendments in the update are effective for all entities between March 12, 2020 and December 31, 2024 (In December 2022, FASB released ASU 2022-06, which extended the original sunset date in ASU 2020-04 from December 31, 2022 to December 31, 2024). The Company has established a cross-functional working group to manage the Company’s transition from LIBOR. Products that utilize LIBOR have been identified and have incorporated enhanced language to accommodate the transition to alternative reference rates and the use of LIBOR has been discontinued as an index for new loans. All LIBOR based loans are expected to be transitioned to a new index by June 30, 2023. The impact of the LIBOR transition is not expected to have a material impact on the Company's consolidated financial statements.

In October 2021, FASB released ASU 2021-08 – “Business Combinations (Topic 805), Accounting for Contract Assets and Contract Liabilities from Contracts with Customers” (“ASU 2021-08”). ASU 2021-08 requires that an acquirer recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606, “Revenue from Contracts with Customers.” ASU 2021-08 is effective for the Company for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. The standard should be applied prospectively to business combinations occurring on or after the effective date of the amendments. The Company is in the process of assessing the impact of adoption on its consolidated financial statements.

In March 2022, FASB released ASU 2022-02 – “Financial Instruments – Credit Losses (Topic 326), Troubled Debt Restructurings and Vintage Disclosures” (“ASU 2022-02”). ASU 2022-22 eliminates the accounting guidance for troubled debt restructurings (“TDRs”) while expanding modification and vintage disclosure requirements. Under the previous guidance a TDR occurs when a loan to a borrower experiencing financial difficulty is restructured with a concession provided that a creditor would not otherwise consider. ASU 2022-02 removes the TDR accounting model, instead requiring modifications to apply existing refinancing and restructuring guidance to determine if the modification results in a new loan or is a continuation of the existing one. The update also requires additional disclosures on the nature, magnitude and subsequent performance of certain types of modifications with borrowers experiencing financial difficulties. ASU 2022-02 further includes a requirement to disclose gross charge-offs incurred by year of origination of the related loan or lease. ASU 2022-02 is effective for the Company for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years, with early adoption permitted. ASU 2022-02 is not expected to have a material impact on the Company's consolidated financial statements, but will result in additional disclosure requirements.

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In December 2019, FASB issued ASU 2019-12 - "Simplifying the Accounting for Income Taxes". ASU 2019-12 eliminates certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. It also clarifies and simplifies other aspects of the accounting for income taxes. The company adopted the ASU in 2022 and had no material adjustments.