1st Source Corporation (NASDAQ: SRCE) — 2022 Form 10-K
Reporting period: Fiscal year ended December 31, 2022; filed February 16, 2023. This is an annual report, not a standalone fourth-quarter earnings report. 1st Source is an Indiana-based bank holding company with community banking, wealth and insurance services, and nationwide specialty equipment finance.
Financial performance and position
| Metric | 2022 | 2021 |
|---|---|---|
| Net interest income | $263.5 million | $236.6 million |
| Net interest margin, fully taxable-equivalent | 3.45% | 3.23% |
| Net income available to common shareholders | $120.5 million | $118.5 million |
| Diluted earnings per share | $4.84 | $4.70 |
| Return on average assets | 1.49% | 1.53% |
| Return on average common equity | 13.81% | 13.07% |
| Net charge-offs / average loans and leases | 0.03% | 0.16% |
- Net interest income rose 11.3%, principally as higher market rates lifted loan yields. Average earning-asset yield increased 36 basis points to 3.84%; average interest-bearing liability cost rose 23 basis points to 0.61%.
- At year-end, total assets were $8.34 billion, loans and leases $6.01 billion, deposits $6.93 billion, and shareholders’ equity $864.1 million.
- Provision for credit losses was $13.2 million, versus a $4.3 million provision recovery in 2021. The allowance for loan and lease losses was $139.3 million, or 2.32% of loans and leases, compared with $127.5 million, or 2.38%, a year earlier.
- Nonperforming assets fell to $26.9 million from $41.3 million; nonperforming loans and leases were 0.44% of loans and leases, down from 0.73%.
- Operating cash flow was $175.5 million. Investing activities used $784.9 million, largely reflecting $784.4 million of net loan and lease growth; financing activities provided $207.0 million. Cash and cash equivalents ended the year at $122.8 million, down $402.4 million.
- Year-end borrowings included $215.5 million of short-term borrowings, $46.6 million of long-term debt and mandatorily redeemable securities, and $58.8 million of subordinated notes.
- The Bank was categorized as well capitalized. Its year-end total risk-based capital ratio was 15.01%, Tier 1 risk-based ratio 13.75%, common equity Tier 1 ratio 12.90%, and Tier 1 leverage ratio 11.70%.
Material changes and notable items
- Total loans and leases increased 12.4% year over year. Growth was strongest in auto and light truck (+33.8%), construction equipment (+24.4%), aircraft (+20.0%), and residential real estate and home equity (+16.8%). Commercial and agricultural balances declined 11.6%, largely due to PPP loan forgiveness and paydowns.
- Deposits increased 3.7%. The deposit mix shifted toward certificates of deposit as rates rose; brokered deposits also grew in the fourth quarter. Time deposits of $250,000 or more totaled $600.4 million at year-end.
- Noninterest income declined 8.8% to $91.3 million, reflecting lower mortgage banking income and equipment rental income. Mortgage banking income fell 65.1% as higher rates and weaker housing activity reduced originations. Equipment rental income declined 26.3% alongside a smaller operating-lease portfolio.
- Noninterest expense decreased 0.8% to $184.7 million. Lower leased-equipment depreciation and business development and marketing costs were partly offset by higher data processing and other expenses.
- Available-for-sale securities had $194.7 million of gross unrealized losses at year-end, compared with $22.6 million in 2021. After tax, unrealized losses recorded in accumulated other comprehensive loss were $147.7 million. Management attributed the losses mainly to interest-rate and market changes and said it did not intend, and was not likely required, to sell the securities before recovery of amortized cost.
- Common dividends were $1.26 per share for 2022, up from $1.21 in 2021. No shares were repurchased in the fourth quarter; 149,819 shares were acquired for treasury during the year.
Outlook, risks and contingencies
- No formal earnings or financial guidance is provided. Management expected solar-finance momentum to continue into 2023. Its credit-loss forecast assumed weak economic growth in 2023 and below-trend growth in 2024, with inflation gradually moving toward the Federal Reserve’s 2% target; management cautioned that actual losses could differ considerably.
- Key risks include interest-rate and deposit-cost pressure, inflation, potential economic deterioration and borrower stress, collateral-value declines, and concentration in specialty finance assets. The aircraft portfolio includes $297.5 million of foreign exposure, primarily in Brazil and Mexico; management noted economic and political uncertainty in those markets. Construction equipment credit quality and commercial real-estate valuations also warrant monitoring.
- Interest-rate simulations showed that an immediate 200-basis-point increase would reduce modeled net interest income 2.32% over 12 months but increase it 2.99% over 24 months; a 100-basis-point decrease would reduce it 2.39% and 5.10%, respectively. These are simulations, not forecasts.
- Approximately $719 million of loans and other financial instruments had LIBOR-related attributes and maturities beyond June 30, 2023. The Company said it was progressing its transition and expected to complete necessary steps before the cessation deadline; an inadequate transition could adversely affect results.
- Off-balance-sheet commitments included $1.23 billion of loan commitments, $18.1 million of standby letters of credit, and $2.4 million of commercial letters of credit. Management did not expect pending legal proceedings to materially affect consolidated financial position or results.
- Independent auditors 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 of the judgment involved in economic forecasts, model assumptions, and qualitative adjustments.
Important facts for investors to verify
- Whether loan growth, particularly in aircraft, construction equipment, and vehicle finance, is matched by underwriting quality and adequate reserves.
- How deposit pricing, deposit mix, and reliance on brokered or higher-cost funding evolve as interest rates and competition change.
- Whether the large unrealized securities losses remain manageable without forced sales, and how they affect reported equity and liquidity.
- Progress and financial impact of the LIBOR transition for the disclosed $719 million of affected instruments.
- Whether management’s weak-growth assumptions, specialty-finance collateral values, and Brazil/Mexico exposures prove consistent with subsequent credit performance.
- How mortgage banking, equipment rental, technology spending, and credit-loss provisions affect future earnings and operating efficiency.