1st Source Corporation — Q1 2013 Form 10-Q
Business context and period: 1st Source is an Indiana-based bank holding company offering banking and related financial services. This unaudited report covers the three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012 unless otherwise noted. Dollar amounts below are in millions unless stated.
Financial performance and position
- Earnings: Net income was $12.40 million, versus $11.72 million in Q1 2012; diluted EPS was $0.50 versus $0.48. Return on average assets was 1.11% (1.08%); return on average common equity was 8.90% (8.84%).
- Income and margins: Interest income was $43.88 million and interest expense $6.12 million, producing net interest income of $37.75 million versus $37.39 million. Tax-equivalent net interest income was $38.22 million versus $37.92 million; net interest margin declined to 3.64% from 3.77%. Noninterest income was $18.95 million versus $20.52 million. Income before taxes was $19.40 million; income tax expense was $6.99 million and the effective tax rate was 36.05%.
- Expenses and credit costs: Noninterest expense was $36.55 million versus $38.05 million. Provision for loan and lease losses fell to $0.76 million from $2.25 million; net charge-offs were $0.06 million versus $1.50 million.
- Balance sheet: Total assets were $4.56 billion, up 0.16%; loans and leases were $3.37 billion, up 1.37%; deposits were $3.68 billion, up 1.55%. Available-for-sale securities totaled $860.14 million, down 2.34%.
- Credit quality: Nonperforming assets were $48.43 million, or 1.41% of loans and leases, up from $42.27 million and 1.25% at year-end, but down from $70.42 million and 2.19% a year earlier. The increase from year-end was primarily in nonaccrual aircraft loans. The allowance was $84.01 million, or 2.49% of loans and leases.
- Capital and distributions: Shareholders’ equity was $568.36 million; equity-to-assets was 12.47%. The company reported total risk-based capital of 15.73% and Tier 1 capital to average assets of 11.73%, both above the stated “well capitalized” thresholds. The quarterly dividend was $0.17 per share.
- Cash flow and liquidity: Operating cash flow was $19.38 million versus $16.62 million. Cash and cash equivalents ended at $64.46 million, down from $83.93 million at year-end. The company cited $235 million of potential short-term federal funds borrowing, $143.05 million of additional FHLB borrowing capacity, and $334.84 million available from the Federal Reserve. Management said funding sources were adequate.
- Debt: Short-term borrowings were $114.88 million, down from $169.19 million. Long-term debt and mandatorily redeemable securities were $68.26 million; subordinated notes were $58.76 million.
Material changes and management commentary
- Net income improved primarily because of the lower loan-loss provision. Lower funding costs partly offset falling asset yields; the yield on average earning assets declined 33 basis points while the cost of interest-bearing liabilities declined 24 basis points.
- Noninterest income fell 7.67%, principally due to lower equipment rental income, mortgage banking income, and investment gains. Rental income declined as the average rental portfolio contracted and new leases were priced at lower rates amid competition.
- Noninterest expense fell 3.94%, including lower leased-equipment depreciation and collection/repo costs. Other expense rose partly because of a previously reported trustee matter.
- Management anticipated approximately $7 million in refunded prepaid FDIC assessments on June 28, 2013. The filing provides no earnings or other formal financial guidance.
Risks, contingencies, and unusual items
- Credit risks include rising nonperforming assets since year-end, aircraft-loan exposure, commercial real estate borrowers affected by weak property values and sales, and foreign aircraft lending. Foreign loans and leases were $266.24 million, including $164.00 million to Brazil and $56.22 million to Mexico.
- The company reported $17.84 million of standby letters of credit and other off-balance-sheet commitments; commitment totals do not necessarily represent future cash requirements.
- No collateral was then required for public-fund deposits, but a change in that determination could create an estimated collateral requirement of approximately $582 million and adversely affect liquidity.
- Available-for-sale securities had $0.98 million of gross unrealized losses. Management said it did not intend to sell the affected securities and did not consider them credit-impaired; it attributed losses mainly to market volatility and illiquidity in auction-rate securities.
- Management reported no material changes since year-end in market risks or risk factors. It cautioned that forward-looking statements are subject to risks including interest-rate changes, economic downturns, industry credit concentrations, and regulatory or accounting changes. Legal proceedings were described as incidental, with no expected material adverse effect.
- Disclosure controls were assessed as effective, and no material change in internal control over financial reporting was reported for the quarter.
Important facts for investors to verify
- Whether the increase in nonaccrual aircraft loans and nonperforming assets continues, and how it affects credit provisions and the allowance.
- Whether loan growth and lower deposit funding costs can offset continued pressure on asset yields and net interest margin.
- Whether equipment rental income and the rental portfolio stabilize, and whether mortgage banking volumes and margins recover.
- Current liquidity, available borrowing capacity, and any change in collateral requirements for public deposits; also whether the anticipated FDIC refund was received.
- Developments in the trustee matter, uncertain tax positions, and aircraft-related foreign credit exposure.