1st Source Corporation — 2023 Form 10-K
Reporting period: Fiscal year ended December 31, 2023; filed February 20, 2024. This is an annual report, not a standalone fourth-quarter earnings report.
Business context
1st Source is an Indiana-based bank holding company operating primarily in Indiana and Michigan, with additional specialty-finance activity nationwide and selective aircraft lending in Latin America. Its businesses include commercial and consumer banking, equipment lending and leasing, renewable-energy financing, trust and wealth services, and insurance. At year-end, it reported $8.73 billion in assets, $6.52 billion in loans and leases, $7.04 billion in deposits, and $989.6 million in shareholders’ equity.
Financial performance and condition
- Earnings: Net income available to common shareholders was $124.9 million, up 3.7% from $120.5 million in 2022. Diluted EPS was $5.03, versus $4.84. Return on average assets was 1.48% (1.49% in 2022); return on average common equity was 13.48% (13.81%).
- Revenue and margin: Net interest income was $278.6 million, up $15.2 million. Net interest margin was 3.50% GAAP-derived and 3.51% on a fully taxable-equivalent basis, compared with 3.44% and 3.45%, respectively, in 2022. Net interest income plus noninterest income totaled $369.3 million, derived from reported figures.
- Drivers and costs: Higher loan yields and loan growth supported net interest income, while funding costs rose sharply. Interest expense increased to $138.3 million from $30.3 million. Noninterest income was $90.6 million, down 0.7%; noninterest expense rose 9.2% to $201.7 million, chiefly reflecting compensation, data-processing, insurance, and other costs.
- Credit: Provision for credit losses was $5.9 million, down from $13.2 million in 2022. Net recoveries were $2.4 million, compared with net charge-offs of $1.5 million. The allowance for loan and lease losses was $147.6 million, or 2.26% of loans and leases, versus 2.32% a year earlier.
- Credit quality watchpoints: Nonperforming assets declined to $24.2 million from $26.9 million; nonperforming loans were 0.36% of loans and leases. Potential problem loans increased to $34.0 million from $7.8 million. Management cited possible deterioration in some portfolios as higher rates take effect.
- Balance sheet and funding: Loans and leases grew 8.4% year over year, led by commercial real estate, construction equipment, and auto/light-truck financing. Deposits grew 1.6%; noninterest-bearing demand deposits fell to $1.66 billion from $2.00 billion, while time deposits increased. Short-term borrowings were $312.4 million, including $100 million borrowed under the Federal Reserve Bank Term Funding Program; long-term debt and mandatorily redeemable securities were $47.9 million, and subordinated notes were $58.8 million.
- Liquidity and capital: Reported available liquidity was $3.17 billion, approximately 49.5% of deposits excluding brokered and listing-services certificates of deposit. The Bank was categorized as well capitalized; its year-end common equity Tier 1 ratio was 12.93% and total risk-based capital ratio was 15.21%.
- Cash flow and equity: Operating activities provided $187.9 million; investing activities used $358.3 million, principally reflecting loan growth; financing activities provided $177.2 million. Cash and cash equivalents ended the year at $129.7 million. Shareholders’ equity increased to $989.6 million; accumulated other comprehensive loss improved to $106.3 million from $147.7 million, mainly as securities values recovered.
Material changes and unusual items
- Higher market rates lifted average earning-asset yield to 5.25% from 3.84%, but the average cost of interest-bearing liabilities also rose, to 2.50% from 0.61%. Deposit mix shifted toward higher-cost time deposits, and average noninterest-bearing deposits declined.
- The company sold approximately $40 million of lower-yielding securities and reinvested the proceeds in securities yielding approximately 4.80%, versus 1.10% on those sold. Securities-sale losses totaled $2.9 million in 2023, mostly associated with this portfolio repositioning.
- Investment securities available-for-sale had $140.9 million of gross unrealized losses at year-end; the company said it did not intend, and was not likely to be required, to sell them before recovery of amortized cost.
- The company paid $1.30 per share in common dividends, up from $1.26 in 2022. It authorized repurchases of up to one million shares in October 2023 but had not repurchased shares under that plan by year-end.
Outlook, risks, and contingencies
The filing provides no quantified earnings or revenue guidance. Management’s credit-loss forecast assumed below-trend economic growth in 2024 and 2025, with inflation gradually moving toward the Federal Reserve’s 2% target; management noted substantial uncertainty and potential adverse effects on borrowers. It described small-business cost and labor pressures, consumer stress, tighter lending conditions, and elevated interest rates as concerns.
Key risks include interest-rate and deposit-cost pressure; liquidity and reliance on purchased funding; credit deterioration and collateral values in commercial real estate, construction equipment, transportation, and aircraft lending; local-market concentration and aircraft exposure in Mexico and Brazil; cybersecurity and third-party technology risks; and regulatory, climate, and tax-credit risks. Loan commitments to extend credit were $1.45 billion, and standby letters of credit were $17.3 million; commitments may expire undrawn. Management did not expect pending legal proceedings to materially affect consolidated results or financial position. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether potential problem loans’ increase to $34.0 million develops into higher nonperforming assets, charge-offs, or provisions.
- Deposit retention, migration into higher-cost time deposits, and use and repayment of short-term borrowings, including the $100 million BTFP advance.
- Commercial real estate and specialty-finance credit performance, collateral values, and concentration exposure, including aircraft loans in Mexico and Brazil.
- How quickly securities-related unrealized losses recover and whether the portfolio repositioning improves recurring income enough to offset realized losses and funding costs.
- Whether expense growth, especially compensation and technology costs, is contained while loan growth and net interest margins remain sustainable.