1st Source Corporation — Q2 2015 Form 10-Q
Business context and reporting period
1st Source is an Indiana bank holding company providing banking and other financial services. This unaudited report covers the quarter and six months ended June 30, 2015; balance-sheet comparisons are with December 31, 2014. Dollar amounts below are in millions unless otherwise noted.
Financial performance and position
| Metric | Q2/H1 2015 | Comparable 2014 or prior date |
|---|---|---|
| Net income | Q2 $15.63; H1 $29.14 | Q2 $14.49; H1 $28.13 |
| Diluted EPS | Q2 $0.59; H1 $1.10 | Q2 $0.54; H1 $1.04 |
| Net interest income | Q2 $41.67; H1 $81.10 | Q2 $40.16; H1 $78.78 |
| Tax-equivalent net interest margin | Q2 3.64%; H1 3.61% | Q2 3.59%; H1 3.59% |
| Noninterest income | Q2 $21.53; H1 $41.28 | Q2 $19.22; H1 $38.62 |
| Noninterest expense | Q2 $38.24; H1 $76.30 | Q2 $34.42; H1 $70.40 |
- Q2 net income rose about 7.8% year over year; H1 net income rose about 3.6%. H1 return on average assets was 1.20% versus 1.19%; return on average common equity was 9.36% versus 9.50%.
- Total assets were $5.014 billion, up 3.8% from year-end. Loans and leases were $3.853 billion, up 4.5%; deposits were $3.963 billion, up 4.2%. Available-for-sale securities were $786.5 million, down from $791.1 million.
- Cash and cash equivalents were $77.7 million at June 30. H1 cash-flow statement reported $43.5 million provided by operating activities, $193.9 million used in investing activities, and $162.0 million provided by financing activities; cash increased $11.5 million from year-end.
- Total liabilities were $4.382 billion. Short-term borrowings were $262.2 million, long-term debt and mandatorily redeemable securities $57.5 million, and subordinated notes $58.8 million. Shareholders’ equity was $631.6 million; equity-to-assets ratio was 12.60%, versus 12.72% at year-end.
- Capital ratios exceeded stated “well-capitalized” thresholds: holding-company total capital ratio 15.36%, Tier 1 risk-based 14.05%, common equity Tier 1 12.72%, and Tier 1 leverage 12.37%.
- Credit indicators improved: nonperforming assets fell to $21.72 million from $42.48 million at year-end (0.55% versus 1.13% of loans and leases). H1 net recoveries were $0.35 million; the allowance for loan and lease losses was $86.6 million, or 2.25% of loans and leases.
Material changes and management commentary
- Growth in net interest income and noninterest income, together with lower loan-loss provision, supported H1 earnings; higher noninterest expense and taxes partly offset the gains.
- Q2 noninterest income growth was led by equipment rental income, up 30.4%, and trust fees, up 5.9%. H1 equipment rental income rose 27.4%. Management attributed rental growth to a larger portfolio and improving equipment-finance conditions.
- Q2 noninterest expense rose 11.1%; H1 rose 8.4%. Salary and benefit costs increased with higher staffing, compensation and insurance claims; leased-equipment depreciation increased alongside rental activity.
- Management cited a $1.24 million increase in net interest recoveries, largely related to one commercial loan relationship, as a factor in the higher Q2 asset yield.
- Foreign aircraft-finance exposure was $202.7 million, including $78.9 million in Brazil and $110.8 million in Mexico. Management noted Brazilian recession and currency weakness, aircraft collateral concentration, and continued uncertainty in certain aircraft values. It also identified broader global economic and geopolitical concerns as potential borrower risks.
- Liquidity sources include deposits, securities, loan sales, and borrowing facilities. The company reported $225 million of short-term bank borrowing capacity, $70 million of additional FHLB capacity, and $415.95 million available from the Federal Reserve; it stated current funding sources were adequate. Potential collateral requirements for public deposits could create approximately $586 million of liquidity exposure if requirements change.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or revenue guidance. Management’s forward-looking statements are subject to risks including interest-rate changes, competition, economic downturns, concentration exposures, and changes in law, regulation or accounting rules.
- Management reported no material change in market risks or risk factors since December 31, 2014. It said legal proceedings are not expected to materially adversely affect financial position or results.
- Unrealized available-for-sale securities losses reduced H1 other comprehensive income by $1.12 million after tax. The company reported no other-than-temporary impairment write-downs and said it did not intend, and was not more likely than not required, to sell the affected securities before recovery.
- On July 22, 2015, after quarter-end, the company declared a 10% stock dividend. Per-share and share data were retrospectively adjusted; common stock and retained earnings were each adjusted by $90.0 million in the June 30 statements. The dividend is a stock dividend, not cash income.
- Disclosure controls were assessed as effective, with no material change in internal control over financial reporting during the quarter. The company adopted certain accounting updates without material impact; the effects of other newly issued standards were still being assessed.
Important facts for investors to verify
- Whether loan and lease growth, especially aircraft and equipment finance, is accompanied by stable credit quality and adequate loss reserves.
- Developments in Brazil and Mexico, foreign-currency effects on borrowers, and aircraft collateral values and repossessions.
- Whether operating-expense growth—particularly compensation and leased-equipment depreciation—remains proportionate to revenue growth.
- Deposit mix, borrowing usage and available liquidity, including the potential impact of any new public-deposit collateral requirements.
- Interest-rate sensitivity and the effect of market rates on net interest margin and securities’ unrealized values.
- The post-quarter 10% stock dividend’s retrospective share and per-share adjustments when comparing results and valuation metrics.