1st Source Corporation — FY2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020. The filing also presents fourth-quarter results. 1st Source is an Indiana-based bank holding company operating banking, trust and wealth advisory, insurance, and specialty equipment and transportation finance businesses, primarily in Indiana and Michigan.
Key financial results
| Metric | 2020 | 2019 |
|---|---|---|
| Total assets at year-end | $7.32 billion | $6.62 billion |
| Total loans and leases | $5.49 billion | $5.09 billion |
| Total deposits | $5.95 billion | $5.36 billion |
| Net interest income | $225.8 million | $223.9 million |
| Provision for credit losses | $36.0 million | $15.8 million |
| Net income available to common shareholders | $81.4 million | $92.0 million |
| Diluted earnings per share | $3.17 | $3.57 |
| Return on average assets | 1.14% | 1.41% |
| Return on average common equity | 9.41% | 11.50% |
Net interest margin was 3.39% on a fully taxable-equivalent basis, down from 3.68%. The average yield on earning assets fell 71 basis points to 3.94%; the average cost of interest-bearing liabilities fell 51 basis points to 0.82%. The effective tax rate was 23.40%, essentially unchanged from 2019.
Cash and cash equivalents were $243.0 million at year-end, versus $83.4 million. Operating activities provided $154.5 million; investing activities used $582.7 million; financing activities provided $587.8 million. These cash-flow movements reflect the company’s banking and lending activities and should not be read as conventional industrial-company free cash flow.
Year-end shareholders’ equity was $886.8 million. Regulatory capital ratios remained above minimums: the Bank’s total risk-based capital ratio was 14.59%, common equity Tier 1 was 12.60%, and Tier 1 leverage was 11.00%; regulators categorized the Bank as well capitalized. Year-end short-term borrowings were $150.6 million, long-term debt and mandatorily redeemable securities were $81.9 million, and subordinated notes were $58.8 million.
Changes and material developments
- Net income declined 11.4% from 2019, principally because the provision for credit losses rose $20.2 million. Lower interest expense and higher noninterest income partly offset the increase.
- The allowance for loan and lease losses rose to $140.7 million, or 2.56% of loans and leases, from $111.3 million, or 2.19%. Net charge-offs were $9.2 million, compared with $5.0 million in 2019.
- Nonperforming assets increased to $64.5 million from $19.2 million; nonperforming loans and leases were 1.11% of loans and leases, versus 0.20% a year earlier. The increase was concentrated in nonaccrual loans, particularly auto/light-truck specialty vehicles, including buses, and construction equipment.
- Net interest income edged higher, but margin contracted amid lower market rates. Average noninterest-bearing demand deposits grew 30.7%.
- Noninterest income increased 2.7%. Mortgage banking income rose to $15.7 million from $4.7 million, supported by greater secondary-market mortgage activity; equipment rental income fell 24.0% as the average operating-lease portfolio contracted.
- Loans and leases grew 7.9%. Commercial and agricultural balances included $351.6 million of outstanding PPP loans; excluding PPP, that portfolio was essentially flat. Solar loans and leases reached $292.6 million, up 78.9%.
- The company adopted CECL effective December 31, 2020, with a January 1 cumulative-effect reduction to retained earnings of $2.55 million, net of tax. The reported 2020 interim-quarter provisions used the prior incurred-loss method.
Outlook, risks, and unusual items
- Management gave no specific earnings or financial guidance. It anticipated continued pandemic-related credit downgrades and defaults in 2021, though at a reduced pace, and expected special-attention exposures to remain elevated. The CECL forecast assumed economic recovery would take time; management cautioned that future loss estimates could vary considerably.
- At December 31, $129 million of COVID-related loan and lease modifications remained in deferment, with another $39 million of extensions expected or being processed; total recorded modifications including those amounts were $168 million. Bus and hotel lending were notable concentrations: modifications represented 56.27% of bus balances and 50.69% of hotel balances, including expected extensions.
- PPP originations totaled $597.5 million across 3,540 loans; $351.6 million remained outstanding at year-end. The filing states that PPP loans are SBA-guaranteed and do not represent credit risk to the company.
- Key risks include pandemic impacts on borrowers and collateral, especially buses, hotels, auto rental, aircraft, and construction-related borrowers; interest-rate sensitivity; local-market and industry concentrations; and foreign aircraft exposure, principally Brazil and Mexico. LIBOR transition, liquidity access, cybersecurity, regulation, and uncertainty in credit-loss estimates are also identified risks.
- Available liquidity sources included $245.0 million of additional federal funds borrowing capacity, $514.1 million of potential FHLB borrowing capacity, and $452.0 million of potential Federal Reserve borrowing capacity, subject to stated conditions. Management reported compliance with its internal liquidity policies.
- Unusual items included $12.06 million of PPP loan fees recognized during 2020, $0.81 million of mortgage-servicing-rights impairment, and $0.68 million of operating-lease residual-value impairment. Management found no goodwill impairment. Legal proceedings were described as ordinary-course matters not expected to materially affect consolidated financial position or results.
Investor verification points
- Track subsequent performance, extensions, delinquencies, collateral values, and charge-offs for bus, hotel, auto-rental, aircraft, and construction borrowers, and compare outcomes with the $140.7 million allowance.
- Verify the pace of PPP forgiveness and the timing and effect of PPP fee recognition as loans are forgiven or repaid.
- Assess whether deposit growth, funding mix, liquidity capacity, and the reported interest-rate sensitivity remain resilient as rates and borrower behavior change.
- Review future margins and earnings contribution from mortgage banking, equipment leasing, and solar lending, including the effect of prepayments and residual-value assumptions.
- Monitor the LIBOR transition and any material changes in CECL assumptions, forecasts, or qualitative adjustments.
The independent auditor issued an unqualified opinion on the financial statements and on internal control over financial reporting. The allowance for loan and lease losses was identified as a critical audit matter.