FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 2002 as dividends were increased over 2001 levels. The retained net income of $7.9 million remained in permanent capital to fund future growth and expansion. Long-term debt payments and fair value adjustments to unearned ESOP shares increased equity by $1.2 million. The market value adjustment to securities available for sale increased equity by $17.1 million in 2002. Amounts paid to fund the discount on reinvested dividends reduced equity by $637 thousand. Proceeds from the issuance of treasury shares to provide for stock options exercised increased equity by $5.5 million during 2002, while the tax benefit related to the stock options, increased equity by $224 thousand. Senior Vice President, Risk Management, an executive officer level position, oversees all aspects of the risk process. Our committee structure embraces a risk management culture, which begins with the Risk Committee that provides oversight and monitoring of key risk areas. The Risk Committee, which is chaired by the Senior Vice President, Risk Management, and has representation from all of the disciplines across the organization, meets to discuss and assess current risks and emerging risks as well as to identify solutions and mitigants. Credit quality and loan loss adequacy issues are addressed by the Credit Quality, Watch List and Loan Loss Reserve committees. Additional committees include Security which is responsible for coordinating the security program, Privacy which focuses on safeguarding client information, ALCO which monitors interest rate and liquidity risks and Disclosure which evaluates internal controls regarding information utilized in certain regulatory reports as well as reviewing those reports and the disclosure process to ensure that disclosures are timely, complete and accurate. A capital base can be considered adequate when it enables the Corporation to intermediate funds responsibly and provide related services while protecting against future uncertainties. The evaluation of capital adequacy depends on a variety of factors, including asset quality, liquidity, earnings history and prospects, internal controls and management caliber. In consideration of these factors, management’s primary emphasis with respect to the Corporation’s capital position is to maintain an adequate and stable ratio of equity to assets. See Note 25 to the Consolidated Financial Statements for an analysis of regulatory capital guidelines and the Corporation’s capital ratios relative to these measurement standards. The Risk Department has specific procedures to analyze and quantify risks in the seven major risk categories. Gaps between inherent risks and mitigants are quantified and reviewed by the Risk Committee, while management continually reviews the mitigants and controls to ensure their continuity with internal audit validating their existence and effectiveness. Risk gaps are compiled to develop a risk rating, which is incorporated into the balanced scorecard measure and is reported to the Board of Directors. An analytical review of key indicators, both monetary and non-monetary, as well as other current information that may become available through discussions with management serves as an early warning system to detect potential deteriorating internal controls. All new initiatives and products are subject to a risk assessment prior to being presented for implementation. An annual assessment of risk is also performed to identify potential threat areas to our computer systems. Our Internal Audit staff performs routine and consistent information technology reviews of identified risk areas, security measures, and control processes. In addition, the Corporation annually retains outside experts to test potential high-risk areas such as Internet based processes. In the normal course of business the Corporation assumes various types of risk. The Corporation has identified twenty- six standard risks which have been summarized into seven major risk categories. The seven major risk categories include credit risk, market risk, liquidity risk, compliance/ legal risk, operational risk, reputation risk and strategic risk. Credit risk, market risk and liquidity risk are discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations section. The remaining major risk categories are defined as follows: compliance/ legal risk — arises from violations of, or non-compliance with laws, rules, regulations, prescribed practices, or ethical standards; operational risk — threat created by inadequate information systems, operational problems, weak internal control systems, fraud, or any other unforeseen catastrophes; reputation risk — the risk to earnings or capital arising from negative public opinion; and strategic risk — this risk arises from adverse business decisions or improper implementation of those decisions. These factors and others could impact the Corporation’s business, financial condition and results of operation. With these processes in place the Corporation believes that its objective of establishing a risk culture that identifies, measures, controls and monitors events or actions that may adversely affect our organization has been achieved. Our goal is not to eliminate risk but to understand fully the risk the Corporation is assuming and appropriately manage those risks. Management is aware of the impact inflation has on interest rates and therefore the impact it can have on a bank’s performance. The ability of a financial institution to cope Corporate management has taken strong and wide-ranging actions to enhance the awareness of and proactively manage risk within the Corporation. In addition to establishing a comprehensive policy and procedure manual that is updated and regularly communicated throughout the Corporation, the Inflation and Changing Prices Risk Management 54