German American Bancorp, Inc. — Q2 2019 Form 10-Q
Business context and period. Unaudited results cover the quarter and six months ended June 30, 2019; balance-sheet comparisons are with December 31, 2018. The Indiana-based bank holding company operates banking, trust and investment advisory, and insurance businesses. Figures below are in millions of dollars unless otherwise stated.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $33.6 | $27.5 | $67.2 | $53.1 |
| Provision for loan losses | $0.3 | $1.2 | $0.9 | $1.6 |
| Non-interest income | $10.5 | $8.9 | $22.2 | $18.4 |
| Non-interest expense | $25.6 | $21.7 | $52.4 | $42.2 |
| Net income | $15.3 | $11.1 | $30.3 | $22.9 |
| Diluted EPS | $0.61 | $0.48 | $1.21 | $1.00 |
| Tax-equivalent net interest margin | 3.84% | 3.77% | 3.86% | 3.71% |
- Management reported EPS growth of 27% year over year for Q2 and 21% for the first half. GAAP net income rose approximately 38% and 32%, respectively.
- Margin expansion reflected higher loan yields and increased accretion of acquired-loan discounts; higher funding costs partly offset the benefit. Cost of funds rose to 0.83% in Q2 from 0.54%, and to 0.85% for the half-year from 0.52%.
- Non-interest income growth included higher interchange, deposit service-charge and insurance revenues, as well as securities gains. Q2 securities gains were $0.5 million versus $0.1 million; first-half company-owned life insurance income benefited from $0.6 million in death benefits.
- Expense growth largely reflected ongoing costs and amortization associated with 2018 acquisitions. Acquisition-related expenses were $0.4 million in Q2 and $1.0 million for the first half, compared with $0.9 million and $1.1 million in the respective 2018 periods.
Financial condition, liquidity and capital
- Total assets were $3.97 billion, up $41.6 million from year-end. Gross loans were $2.72 billion, down $11.1 million; growth in commercial and industrial and commercial real estate loans was offset by declines in retail and agricultural loans.
- Deposits rose $56.2 million to $3.13 billion. Cash and cash equivalents were $90.0 million, down $6.5 million during the half year. Operating and investing cash flows were positive $12.9 million and $2.9 million; financing cash flow was negative $22.3 million.
- FHLB advances and other borrowings totaled $305.9 million, down from $376.4 million at year-end. Shareholders’ equity increased to $499.4 million from $458.6 million, partly reflecting $18.3 million of after-tax other comprehensive income as securities values recovered.
- Regulatory capital ratios were above minimum requirements. At June 30, consolidated total capital was 14.33%, Tier 1 capital 12.52%, and CET1 12.15%; the Bank’s total capital ratio was 12.60% and it met the well-capitalized threshold.
- The quarterly cash dividend was $0.17 per share. No shares were repurchased during the quarter.
Credit quality, changes and unusual items
- Non-performing loans were $11.9 million, or 0.44% of loans, versus $13.2 million and 0.48% at year-end. Non-performing assets were $12.5 million, or 0.32% of assets. Allowance coverage of non-performing loans improved to 136.6% from 119.8%.
- The allowance was $16.2 million, 0.60% of period-end loans, versus $15.8 million and 0.58% at year-end. First-half net charge-offs were $0.5 million versus $1.6 million a year earlier; the prior-year period included a partial charge-off on one commercial relationship.
- Q2 and first-half results include the continuing effects of the 2018 branch and First Security acquisitions, including larger average earning assets, deposits, staffing, operating costs, and intangible amortization.
- On July 1, 2019, after quarter-end, the company completed its Citizens First acquisition. Consideration was approximately 1.7 million shares and $15.5 million cash; Citizens First reported March 31 assets of $472.1 million, loans of $377.9 million, and deposits of $381.8 million. Purchase accounting valuations were incomplete, and the company expected to record goodwill and a core deposit intangible.
- In June, the company issued $40 million of 4.50% fixed-to-floating subordinated notes due 2029. Proceeds funded most of the Citizens First cash consideration and repaid a $25 million term loan. The unsecured notes are subordinated, intended to qualify as Tier 2 capital, and reset to three-month LIBOR plus 268 basis points beginning in 2024.
- The company adopted lease accounting in January, recording an operating lease right-of-use asset and liability of approximately $9.0 million at adoption; June balances were $8.5 million and $8.5 million, respectively. No cumulative retained-earnings adjustment was recorded.
Outlook, risks and management commentary
- The filing provides no quantified earnings or margin guidance. Management attributed growth to acquisitions, some organic loan growth, improved loan yields and acquired-loan discount accretion.
- The company planned parallel processing of its current loan-loss model and the new CECL expected-credit-loss model in Q3 2019. It expected a one-time cumulative allowance adjustment at adoption but could not estimate its amount.
- Key stated risks include interest-rate movements, deposit and borrowing costs, credit deterioration, acquisition integration and customer retention, economic conditions, cybersecurity, regulatory changes, and the availability of earnings and capital for dividends.
- Interest-rate simulations estimated next-12-month net interest income declines of 2.65% under an immediate +2% rate shock and 6.12% under a −2% shock. Management cautioned that these are model estimates based on assumptions and a static balance sheet, not forecasts.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material change to previously disclosed risk factors was reported.
Investor verification priorities
- Assess whether deposit pricing and funding costs continue to rise faster than asset yields, and how this affects margin.
- Review Citizens First purchase accounting, integration costs, acquired-asset quality and the resulting goodwill/intangible balances when reported.
- Track loan growth by category, non-performing assets, charge-offs, allowance adequacy and the eventual CECL transition adjustment.
- Verify the impact of securities valuation changes on accumulated other comprehensive income and regulatory capital.
- Monitor subordinated-note terms and the company’s liquidity and parent-company cash available for debt service, acquisitions and dividends.