1st Source Corporation — Q2 2016 Form 10-Q
Business context and period. 1st Source is an Indiana bank holding company providing banking and related financial services. This unaudited filing covers the three and six months ended June 30, 2016; balance-sheet comparisons are with December 31, 2015. Financial amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net interest income | $42.293 | $41.665 | $83.582 | $81.101 |
| Provision for loan and lease losses | $2.049 | $0.811 | $3.024 | $1.168 |
| Noninterest income | $22.297 | $21.531 | $43.924 | $41.282 |
| Noninterest expense | $40.034 | $38.241 | $80.739 | $76.302 |
| Net income | $14.479 | $15.630 | $28.297 | $29.141 |
| Diluted earnings per share | $0.56 | $0.59 | $1.08 | $1.10 |
- Q2 net interest margin was 3.45% on a fully taxable-equivalent basis, versus 3.64% a year earlier. Six-month margin was 3.45%, versus 3.61%.
- For the first half, return on average assets was 1.08% (1.20% in 2015) and return on average common equity was 8.70% (9.36%).
- Six-month operating cash flow was $47.752 million; investing cash outflow was $200.417 million and financing cash inflow was $146.185 million. Cash and cash equivalents ended at $73.241 million, down from $79.721 million at year-end.
Financial condition, liquidity, and capital
- Total assets were $5.380 billion, up 3.7% from year-end. Loans and leases rose 4.0% to $4.153 billion; deposits rose 4.5% to $4.325 billion. Available-for-sale securities totaled $814.258 million.
- Shareholders’ equity was $661.756 million; equity-to-assets was 12.30%. The company reported regulatory capital ratios of 14.73% total capital, 13.41% Tier 1, and 12.20% common equity Tier 1. Management said the company and bank would meet fully phased-in Basel III capital requirements.
- Short-term borrowings were $205.976 million, long-term debt and mandatorily redeemable securities $64.738 million, and subordinated notes $58.764 million. Short-term borrowings declined $27.253 million from year-end.
- Management reported $265 million of potential short-term federal funds borrowing, $154.72 million of additional FHLB borrowing capacity, and $479.26 million available from the Federal Reserve, with no FRB borrowing outstanding. Management considered funding sources adequate.
- Nonperforming assets were $21.032 million, or 0.49% of loans and leases, compared with $20.624 million and 0.50% at year-end. The allowance for loan and lease losses was $91.458 million, or 2.20% of loans and leases.
Material changes and management commentary
- First-half net income fell 2.9% year over year despite higher net interest and noninterest income. Higher credit-loss provision and operating expenses more than offset revenue growth and lower income tax expense. Q2 net income declined to $14.479 million from $15.630 million.
- Equipment rental income rose 20.8% for the first half, with growth in the rental portfolio; related leased-equipment depreciation also increased 24.3%. Noninterest expense overall increased 5.8%.
- Management attributed margin pressure partly to higher deposit costs and lower loan yields, including lower net interest recoveries than in 2015 tied largely to one commercial relationship. First-half average earning assets grew 7.7%, while the cost of interest-bearing liabilities rose to 0.61% from 0.52%.
- The company recorded a $0.294 million other-than-temporary impairment charge on a marketable equity security. Management said unrealized losses on debt securities were primarily rate-related, did not reflect credit quality, and it did not expect to need to sell the affected securities before recovery.
- Credit-loss provision increased; nevertheless, the company recorded net loan and lease recoveries of $0.322 million for the first half, versus recoveries of $0.352 million in the prior-year period. Management said delinquency was 0.28%, compared with 0.30% a year earlier, and considered reserve ratios appropriate.
Outlook, risks, and contingencies
- The filing gives no specific quantitative earnings or revenue guidance. Management cited geopolitical and economic uncertainty, including Brexit, China’s slowdown, and Brazil’s recession, as risks to borrowers and recovery prospects.
- The aircraft portfolio is a key concentration: management cited $230 million of foreign exposure and prolonged low values for some aircraft models. Reported foreign aircraft loans and leases totaled $229.98 million, including $78.78 million to Brazil and $136.45 million to Mexico.
- Interest-rate and liquidity risks remain relevant. The balance sheet had $616.05 million more assets than liabilities scheduled to reprice within one year; management said funding was adequate. A possible future requirement to collateralize public deposits could create approximately $623 million of liquidity exposure.
- Loan commitments were $870.773 million and standby letters of credit $37.191 million; these commitments do not necessarily represent future cash requirements because many may expire undrawn. Management did not expect pending legal proceedings to materially adversely affect financial position or results.
- Management reported no material change in risk factors or market risks since year-end, effective disclosure controls, and no material change in internal control over financial reporting.
Most important facts for investors to verify
- Whether loan growth and equipment rental expansion can sustain revenue while funding costs and operating expenses rise.
- Credit performance and allowance adequacy, particularly in aircraft, consumer, and foreign exposures; monitor repossessions and nonperforming assets.
- Future net interest margin trends, deposit pricing, and sensitivity to interest-rate changes.
- Capital and liquidity capacity, including borrowing availability and any change in collateral requirements for public deposits.
- The effect of the equity-security impairment and market-value movements in the available-for-sale portfolio.