million. The deposit mix changed in 2003 as clients registered  a preference for savings products, which jumped $64.8  million or 8.9%, while time deposits dropped $67.6 million or  4.2% due to continued economic uncertainties. Average  interest-bearing demand deposit balances for 2003 also  advanced, up $41.1 million over 2002 balances. During its  management of deposit levels and mix, the Corporation  continues to evaluate the cost of time deposits compared to  alternative funding sources as it balances its goals of  providing clients with the competitive rates they are looking  for while also minimizing the Corporation’s cost of funds. years or less as well as adjustable rate mortgages. Average  commercial and municipal loans offset the decline in 1-4  family mortgage loans and grew $142.9 million, primarily in  shorter term and variable rate lending. In addition, 2003  included increases in average installment loans of $41.4  million over 2002 levels. The Corporation has continued to  capitalize on lending opportunities with small to mid-sized  commercial borrowers, including loans generated through its  preferred Small Business Administration (“SBA”) lender  status. The Corporation has consistently been one of the top  small business lenders in Pennsylvania. Interest expense on short-term borrowings rose $726  thousand during 2003 primarily as a result of volume  increases of $3.8 million which were partially offset by rate  decreases of $3.1 million. Average short-term borrowings  rose by $214.2 million for 2003 compared to 2002 while the  cost of short-term borrowings fell by 55 basis points (0.55%)  compared to the prior year. All categories of short-term  borrowing costs declined from year-to-year. The increase in  short-term borrowings is due in part to $100 million of long- term debt that matured during the fourth quarter of 2002 and  was replaced with short-term borrowings. In addition, the  increase in short-term borrowings can be attributed to an  ALCO strategy implemented to mitigate the risk of further  declines in net interest income resulting from a low or  declining interest rate environment. The increase in short- term borrowings funded the purchase of U.S. government  agency securities maturing in approximately 3.5 years.  Interest expense on long-term debt declined $4.7 million for  2003 compared to the 2002 period as decreases due to volume  of $4.3 million were further reduced by decreases due to rate  of $376 thousand. Average long-term debt for 2003 decreased  by $75.9 million compared to 2002. This was due in part to  the $100 million of long-term debt that matured during the  fourth quarter of 2002 that was replaced by short-term  borrowings. Long-term debt includes additional subordinated  debentures in the amount of $30.9 million, which were issued  during 2003, bearing an adjustable interest rate based upon  the three-month LIBOR and maturing in 30 years. The  proceeds will be used by the Corporation to partially fund the  pending acquisition of GA Financial, Inc. (“GAF”). Refer to  NOTE 17 for further discussion of subordinated debentures  that are included in long-term debt.  Net interest margin (net interest income, on a tax-equivalent  basis as a percentage of average earning assets) declined to  3.47% for 2003, a decrease of 33 basis points (0.33%)  compared to 2002. The year-to-year decrease in the margin was  due to asset yields declining more quickly than the cost of  funds as interest rates fell to historic lows. Continued pressure  on net interest income is anticipated by the Corporation, despite  active management of interest rate risk. The Corporation’s use  of computer simulation to manage interest rate risk is described  in the “Interest Sensitivity” section of this discussion. Interest on deposits dropped $18.5 million for 2003 compared  to 2002 primarily as result of decreases due to interest rates of  $16.9 million. The Corporation also registered decreases in  interest expense of $1.6 million due to declines in average  volumes of deposits in 2003 compared to 2002. The rate on  savings deposits fell 40 basis points (0.40%) resulting in a  decrease to interest expense of $3.2 million for 2003  compared to 2002, while the rate on time deposits for 2003  also declined, down 76 basis points (0.76%), compared to  2002 resulting in a decrease to interest expense of $11.6  Interest income on investments declined $16.3 million for  2003 compared to 2002 primarily due to interest rate  decreases. Interest rate decreases were also the primary cause  of the decline of $10.5 million in interest income on  investments in 2002 compared to 2001 levels. Yields on  investments for 2003 continued to decline, falling to 4.64%  compared to 5.95% for 2002 and 6.45% for 2001. As with the  loan category, the increase in average investment security  volumes was not enough to offset the reduced interest income  caused by declining yields. All categories of interest income  on investments were negatively impacted by interest rate  changes with the largest decline being registered in the U.S.  government agency category, declining $20.4 million due to  interest rates declining 162 basis points (1.62%) for 2003  compared to 2002. This decline was partially offset by an  increase of $10.4 million in interest income on U.S.  government agency securities as a result of average volume  increases from 2003 to 2002. Prepayment speeds of mortgage  backed securities (“MBS”) continued to accelerate in 2003 as  interest rates continued to decline. Interest rate changes have a  direct impact on prepayment speeds. As interest rates increase,  prepayments tend to decline and average lives of MBS  increase. As interest rates decrease, prepayment speeds tend to  increase and average lives of MBS decline, which accelerates  the amount of premium amortization that is realized, further  reducing the yields in current periods. Using computer  simulation modeling, the Corporation tests the average life and  yield volatility of all MBS under various interest rate scenarios  on a continuing basis to insure that volatility falls within  acceptable limits. The Corporation holds no “high risk”  securities nor does the Corporation own any securities of a  single issuer exceeding 10% of shareholders’ equity other than  U.S. government and agency securities. 46 FIRST COMMONWEALTH FINANCIAL CORPORATION AND SUBSIDIARIES MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS