1st Source Corporation (NASDAQ: SRCE) — Q2 2023 Form 10-Q
Reporting period: Three and six months ended June 30, 2023. Unaudited results; amounts below are in U.S. dollars. 1st Source is an Indiana-based bank holding company.
Financial performance and position
| Metric | Q2 / June 30, 2023 | Comparable period / prior year-end |
|---|---|---|
| Net income available to common shareholders | $32.4 million; diluted EPS $1.30 | Q2 2022: $29.3 million; $1.18 per diluted share |
| Net interest income | $68.5 million; GAAP net interest margin 3.47% (FTE margin 3.48%) | Q2 2022: $63.5 million; GAAP margin 3.31% (FTE 3.32%) |
| Six-month net income / diluted EPS | $63.6 million / $2.55 | First half 2022: $56.7 million / $2.28 |
| Six-month net interest income / FTE margin | $138.1 million / 3.54% | First half 2022: $123.1 million / 3.25% |
| Total assets | $8.41 billion | December 31, 2022: $8.34 billion |
| Loans and leases | $6.22 billion | December 31, 2022: $6.01 billion |
| Deposits | $6.98 billion | December 31, 2022: $6.93 billion |
| Cash and cash equivalents | $112.7 million | December 31, 2022: $122.8 million |
| Shareholders’ equity | $921.0 million; equity-to-assets ratio 10.95% | December 31, 2022: $864.1 million; 10.36% |
For the first half, net cash provided by operating activities was $91.6 million; investing activities used $100.0 million and financing activities used $1.7 million. Cash and cash equivalents declined $10.1 million. The company reported $3.23 billion of available liquidity, approximately 50% of deposits net of brokered and listing-service certificates of deposit.
Q2 provision for credit losses was $0.05 million, versus $2.50 million in Q2 2022; first-half provision was $3.10 million, versus $4.74 million. The company recorded net recoveries of $1.0 million in Q2 and $1.2 million year to date. Nonperforming assets were $20.8 million, or 0.33% of loans and leases, compared with $26.9 million and 0.45% at year-end 2022. The allowance was $143.5 million, or 2.31% of loans and leases.
Total short-term borrowings were $187.7 million and long-term debt and mandatorily redeemable securities were $46.6 million; subordinated notes were $58.8 million. Regulatory capital remained above stated well-capitalized thresholds: company total capital ratio 16.46%, Tier 1 15.20%, and common equity Tier 1 13.59%.
Material changes and comparisons
- Q2 net income rose about 11% year over year, while first-half net income rose about 12%. Management attributed the first-half increase mainly to higher net interest income and lower credit-loss provision, partly offset by higher operating expenses.
- First-half FTE net interest income increased 12.3% year over year and FTE margin improved 29 basis points. Higher asset yields reflected rising rates and loan growth; funding costs also rose sharply. Q2 FTE margin eased from 3.60% in Q1 2023 to 3.48%.
- Loans and leases increased 3.4% from year-end, led by auto/light truck and construction equipment. Available-for-sale securities declined 6.4%, as sales and maturities helped fund loan growth and liquidity.
- Deposits increased 0.7% from year-end, but their mix shifted: noninterest-bearing demand deposits fell about $276 million, while time deposits rose about $423 million. Management cited ongoing deposit-rate competition.
- Noninterest expense rose 7.7% in Q2 and 8.4% for the first half. Salaries, data processing, and FDIC/other insurance were among the increases; leased-equipment depreciation and professional fees declined.
- Accumulated other comprehensive loss improved to $139.6 million from $147.7 million at year-end, but available-for-sale securities still had $183.5 million of gross unrealized losses at June 30, primarily attributed by the company to interest rates, market spreads, and market conditions.
Outlook, risks, and notable items
The filing gives no specific earnings or financial guidance. Management’s credit-loss forecast assumed economic growth would slow markedly in the second half of 2023 and through 2024, with inflation remaining above the Federal Reserve’s 2% target. Management cited persistent inflation, higher rates, tighter credit, weaker growth prospects, and geopolitical uncertainty as risks; it noted that future loss estimates could differ considerably from current assumptions.
Management described credit metrics as stable, with lower special-attention credit balances, low delinquencies, and minimal charge-offs. It highlighted risks in aircraft lending, including approximately $314 million of foreign exposure, principally in Mexico and Brazil, and collateral-value volatility. It also cited manufacturing risk, commercial real estate sensitivity to higher rates and changing demand, and energy-price, driver-availability, and softer freight-volume challenges in truck lending. Non-owner-occupied office exposure was described as minimal.
Liquidity risk was specifically updated in the risk factors following 2023 bank failures. The company reported no collateral requirement for public-fund deposits at filing, but said a future requirement could create potential collateral needs of approximately $1.27 billion. Cybersecurity, third-party vendor, and payment-card security risks were also discussed. Management said it did not expect pending legal proceedings to materially adversely affect financial position or results.
Notable items included a $1.11 million first-quarter gain on sale of renewable-energy tax-equity investments and a $1.08 million reversal of accrued legal fees in the first quarter. The company recorded $44,000 of net realized investment-security losses in the first half. It completed its LIBOR transition plan as of June 30, 2023. No material change in market risk was reported.
Important facts for investors to verify
- Whether deposit pricing and mix shifts continue, and how they affect net interest margin and funding costs.
- Whether loan growth, credit quality, and the allowance remain consistent with management’s economic assumptions, particularly in aircraft, manufacturing, and commercial real estate exposures.
- How the securities portfolio’s unrealized losses, liquidity sources, and any potential public-deposit collateral requirements affect liquidity and capital.
- Whether elevated compensation, technology, insurance, and other operating costs persist, and whether first-half unusual gains or expense reversals recur.
- Future dividends and repurchases: the company paid $0.32 per share in Q2 and repurchased 33,276 shares in May; the filing stated 1,526,630 shares remained authorized for repurchase.