1st Source Corporation — 2019 Form 10-K Summary
Business context and reporting period
Annual report for the fiscal year ended December 31, 2019. 1st Source is an Indiana-based bank holding company operating banking, specialty equipment finance and leasing, trust and wealth advisory, and insurance businesses, primarily in Indiana and Michigan. At year-end it reported $6.62 billion in assets, $5.09 billion in loans and leases, and $5.36 billion in deposits.
Financial and operating performance
| Metric | 2019 | 2018 |
|---|---|---|
| Interest income | $282.9 million | $257.3 million |
| Net interest income | $223.9 million | $213.9 million |
| Noninterest income | $101.1 million | $97.1 million |
| Net income available to common shareholders | $92.0 million | $82.4 million |
| Diluted earnings per share | $3.57 | $3.16 |
| Net interest margin, fully tax-equivalent | 3.68% | 3.73% |
| Return on average assets | 1.41% | 1.34% |
| Return on average common equity | 11.50% | 11.09% |
| Operating cash flow | $164.6 million | $159.7 million |
- Net income rose 11.6%. Higher net interest income and noninterest income, and a lower loan-loss provision, outweighed higher taxes and operating expenses.
- Loans and leases grew 5.2% to $5.09 billion. Deposits increased 4.6% to $5.36 billion. Year-end shareholders’ equity was $828.3 million.
- The allowance for loan and lease losses was $111.3 million, or 2.19% of loans and leases, versus $100.5 million, or 2.08%, in 2018. Net charge-offs fell to $5.0 million from $13.9 million; provision expense was $15.8 million, down from $19.5 million.
- Nonperforming assets declined to $19.2 million (0.37% of loans, leases and operating leases) from $35.3 million (0.71%). Potential problem loans, however, increased to $17.7 million from $4.2 million.
- Year-end short-term borrowings were $145.9 million, down from $199.3 million; long-term debt and mandatorily redeemable securities totaled $71.6 million, with $58.8 million of subordinated notes. The Bank was categorized as well capitalized; its total risk-based capital ratio was 13.57% and common equity Tier 1 ratio was 12.18%.
- Management reported compliance with internal liquidity guidelines. Available additional borrowing capacity included approximately $520 million from the FHLB and $552 million from the Federal Reserve. Cash and cash equivalents were $83.4 million, down from $99.1 million.
- Cash dividends increased to $1.10 per share from $0.96. The company repurchased $15.1 million of shares during 2019.
Material changes versus prior period
- Net interest income increased 4.7%, but the fully tax-equivalent net interest margin declined five basis points as funding costs rose faster than earning-asset yields. Average deposit cost increased amid rate competition.
- Noninterest income grew 4.2%; equipment rental income declined, while debit-card, mortgage banking, and other income increased. Other income included $0.96 million of nonrecurring rental income on a repossessed asset.
- Noninterest expense increased 1.4%, including higher employee benefits and software-related costs; FDIC and other insurance expense fell, partly due to $0.88 million in FDIC premium credits.
- Available-for-sale securities’ unrealized position improved: accumulated other comprehensive income was $5.2 million at year-end versus a $10.7 million loss in 2018.
Outlook, risks, contingencies, and unusual items
- No specific earnings or revenue guidance is provided. Management described the economy as strong and forecast it to remain robust entering 2020, while emphasizing downside risks and geopolitical and economic uncertainty.
- Credit risks include specialty-finance exposure to aircraft, transportation and construction equipment; $184.2 million of foreign loans, primarily in Mexico and Brazil; and approximately $157 million of agricultural exposure amid weak farm income and low commodity prices. Management also noted increased special-attention credits in construction equipment and guarded optimism for business banking.
- The company estimated adoption of the expected-credit-loss standard (CECL) on January 1, 2020 could produce a one-time retained-earnings adjustment ranging from a $1 million decrease to a $3 million increase in the allowance. The estimate was not finalized at filing.
- Other disclosed risks include interest-rate changes, LIBOR transition, deposit funding and liquidity, cybersecurity and third-party vendors, regulatory change, competition, and realization of tax benefits from tax-advantaged investments. The company had $17.4 million of unfunded commitments to unconsolidated tax-advantaged investment entities; maximum disclosed exposure to loss was $37.9 million.
- Off-balance-sheet loan commitments were $1.10 billion; standby letters of credit were $27.5 million. Management said ordinary-course legal proceedings were not expected to materially affect financial position or results.
- The auditor issued unqualified opinions on the financial statements and internal control over financial reporting. The allowance for loan and lease losses was identified as a critical audit matter because it involves significant judgment and estimation.
Important facts for investors to verify
- Whether the rise in potential problem loans and the larger allowance adequately reflect emerging credit risks, particularly in agriculture and specialty finance.
- Whether deposit pricing pressure continues to compress net interest margin and how loan growth and funding mix evolve.
- The final CECL adoption impact and any subsequent allowance or capital changes.
- Performance and collateral values in aircraft, construction equipment, transportation, and foreign portfolios, including Mexico and Brazil exposure.
- Whether the company sustains earnings growth while funding higher dividends and share repurchases.