First Commonwealth Financial and Michael Price, the Indiana, Pa., company's chief executive, prefer to look at the bigger picture of what would otherwise seem to be a lackluster third quarter.
The $6.4 billion-asset company's earnings fell 21% from a year earlier, to a solid, but relatively unexceptional, $12.5 million. For Price, however, focusing on the bottom line overlooks three key accomplishments: an $11.8 million system conversion, accelerated expansion in Cleveland and a return to mortgage lending after a nearly decade-long absence.
"We've been very busy the past three months," Price said in an interview, jokingly comparing his company's recent efforts to "a heart-lung transplant."
Operating costs spiked in the quarter, largely because of the conversion and the return to mortgage lending. Such investments, however, will likely pay for themselves soon, industry observers said.
The new core system should cut annual costs by up to $6.8 million now that has been fully implemented, said Bob Ramsey, an analyst at Friedman, Billings, Ramsey. Price, meanwhile, said the system, expected to last 20 years or more, is designed to accommodate significant growth.
The mortgage unit, which should turn a profit this quarter, had a broader purpose, Price said. One of First Commonwealth's five strategic goals is to "deliver a differentiated and authentic community bank experience," which Price said was impossible to reach without a robust, in-house mortgage product.
"Our mission is consumer banking, small-business and middle-market lending, and some of my toughest competitors are smaller banks." Price said. "They're the ones I'd like to emulate. Mortgages are just a foundational offering for a community bank. They're cornerstones, along with car loans and small-business loans."
First Commonwealth struggled to compete against smaller banks before it added home loans to its menu. Adding mortgages was so important to Price that he opted to add the business even though the company was in the midst of the massive conversion that Price described as "eight to ten times more complex" than a bank acquisition.
The conversion "was a monumental effort," that took almost a year and involved nearly 300 people, Price said. (First Commonwealth has 1,400 employees.)
"We planned incessantly," Price said of the two efforts. "We worried about the strain we were causing, but we felt strategically that both the conversion and mortgage banking were critical to get us where we needed to go."
The new unit, First Commonwealth Mortgage Solutions, is based in Wexford, Pa., and opened on July 14. Prior to that, the company offered mortgages through a third-party, private-label arrangement. First Commonwealth, which had avoided home lending since 2005, picked an inauspicious time to get back in.
First Commonwealth began ramping up its operations at a time when a number of community banks announced plans to get out of mortgage lending, including Sun Bancorp in Mt. Laurel, N.J. For every public announcement, industry observers surmise that a number of other institutions are exiting quietly, or have scaled back.
Several community banks in Texas have quit making home loans in recent months, said Jay Isaacs, president of the $848 million-asset FirstCapital Bank of Texas in Midland. Ken Trautman, president and chief executive of the $210 million-asset Peoples Bank of Commerce in Medford, Ore., said in July that many of the community banks he competes against quit making mortgages.
Multiple dynamics are at work.
A spike in long-term interest rates in mid-2013 significantly reduced refinancing demand. Though some bankers reported a small uptick in refi activity in late September, the Mortgage Bankers Association estimated that originations through the first nine months of 2014 fell 44% from a year earlier, to $844 billion. And a recent study by the Federal Reserve Board and the Conference of State Bank Supervisors found that just 28% of community banks surveyed expect 2014 mortgage volume to exceed last year's activity.
Cardinal Financial in Tysons Corner, Va., one of the biggest community bank mortgages lenders, said its mortgage banking unit lost $76,000 in the third quarter, after the volume of its closings fell 11% from a year earlier, to $827 million.
Some banks also curtailed mortgage lending when the Consumer Financial Protection Bureau's qualified-mortgage rule took root in January. Still, the study by the Fed and the Conference of State Bank Supervisors found that only 29% of respondents are refusing to make nonqualified mortgages.
First Commonwealth forecast earlier this year that its mortgage bank would earn about $2 million annually, though the estimate may require "fine-tuning" to reflect the unit's first three months of operation, Chief Financial Officer James Reske said in an interview.
Management remains bullish on its future, and it is intent to proceed with previously announced plans to start offering mortgages in Cleveland, where the company opened a commercial loan production office in April. The office originated about $25 million of loans in the third quarter, Price said.
First Commonwealth should start making home loans in Cleveland next year, said Stan Foraker, CEO of the mortgage unit and a 30-year banking veteran who spent most of his career in northern Ohio. (Price and Reske also have experience with Ohio banking.)
Cleveland has similar demographics to Pittsburgh, where First Commonwealth has a significant presence. "It's got a lot of households, and the average mortgage size is a little healthier than what we've found in western Pennsylvania," Price said.
West Virginia and Maryland also seem well-suited for expansion, Foraker said.
First Commonwealth plans to initially focus on pitching mortgages to existing customers with a monthly goal of originating an average of two mortgages for each of its 110 branches. The unit will need several months to reach that target.
"My two observations after a quarter in the business are that we have less activity, but higher loan amounts," Price told analysts during a conference call last month.
It is too soon to draw definitive conclusions about the long-term success of First Commonwealth's mortgage operation, Ramsay said.
The third-quarter results recognize "the fact that the mortgage business is tough, and it has probably gotten tougher since First Commonwealth entered," Ramsey said. "It's always been a volatile business."