1st Source Corporation — Q3 2021 Form 10-Q
Business context and period. 1st Source Corporation is an Indiana bank holding company providing banking, specialty finance, equipment leasing, wealth advisory and insurance services. This unaudited report covers the quarter and nine months ended September 30, 2021. Balance-sheet comparisons are against December 31, 2020; income comparisons are against the corresponding 2020 periods. Dollar amounts below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Net interest income | $62.2 | $54.9 | $176.6 | $163.7 |
| Provision (recovery) for credit losses | ($2.6) | $9.3 | ($3.2) | $31.0 |
| Noninterest income | $25.5 | $28.0 | $76.3 | $77.9 |
| Noninterest expense | $48.1 | $47.0 | $137.4 | $138.4 |
| Net income available to common shareholders | $32.5 | $20.1 | $90.8 | $55.0 |
| Diluted EPS | $1.29 | $0.78 | $3.59 | $2.14 |
| Net interest margin, fully tax-equivalent | 3.34% | 3.20% | 3.28% | 3.33% |
- Balance sheet and liquidity: Assets were $7.96 billion, up 8.9% from year-end 2020. Loans and leases were $5.36 billion, down 2.4%, principally because of PPP loan forgiveness. Deposits rose 9.7% to $6.52 billion. Cash and cash equivalents reached $637.3 million versus $243.0 million at year-end, reflecting deposit growth, excess liquidity and PPP forgiveness proceeds. Available-for-sale securities totaled $1.58 billion, up 32.2%.
- Funding and debt: Short-term borrowings were $215.7 million, including $210.3 million in federal funds purchased and repurchase agreements. Long-term debt and mandatorily redeemable securities were $81.3 million; subordinated notes were $58.8 million. Management reported available additional borrowing capacity of $245.0 million from correspondent banks, $511.6 million from the FHLB and $449.1 million from the Federal Reserve, subject to stated conditions.
- Credit quality: The allowance for loan and lease losses was $133.8 million, 2.50% of loans and leases. The company recorded net charge-offs of $0.04 million in Q3 and $3.71 million year to date. Nonperforming assets were $45.6 million, or 0.84% of loans and leases, versus $64.5 million and 1.16% at year-end 2020. Delinquencies of 30 days or more were 0.20% of loans and leases.
- Capital and shareholder returns: Total shareholders’ equity was $911.3 million; the equity-to-assets ratio was 11.44%, versus 12.12% at year-end 2020. The company reported Common Equity Tier 1 ratios of 13.65% at the holding company and 13.51% at the bank. It paid a quarterly dividend of $0.31 per share and repurchased $30.1 million of stock during the first nine months.
- Cash flow: For the first nine months, operating activities provided $105.1 million, investing activities used $296.9 million and financing activities provided $586.1 million. Cash and cash equivalents increased $394.2 million to $637.3 million.
Material changes versus comparable periods
- Q3 net income available to common shareholders rose 62% year over year; nine-month net income rose 65%. The principal drivers were higher net interest income and substantially lower credit-loss provision expense compared with the elevated 2020 provision.
- Q3 fully tax-equivalent net interest margin increased 14 basis points year over year to 3.34%; the nine-month margin declined 5 basis points to 3.28%. Deposit costs fell, while yields on securities and other liquid assets also declined in the low-rate environment.
- Nine-month noninterest income declined 2.1%. Lower mortgage banking and equipment rental income, and a $0.7 million net securities loss versus a gain in 2020, were partly offset by growth in trust, debit-card and deposit-service income. Noninterest expense was down 0.7% year to date; Q3 expense included a $3.0 million charitable contribution, contributing to higher business-development and marketing expense.
- PPP balances fell as loans were forgiven. At September 30, reported PPP loans were $171.6 million net of unearned discount; they are SBA-guaranteed and carry minimal credit reserves. COVID-related loan modifications in deferment fell to $1 million from $129 million at year-end 2020.
- Accumulated other comprehensive income fell to $2.4 million from $18.4 million at year-end, primarily reflecting after-tax unrealized depreciation in available-for-sale securities. Management attributed the unrealized losses to interest-rate, spread and market changes and said it did not expect to sell the securities before recovery.
Outlook, commentary, risks and unusual items
- No specific earnings or financial guidance was provided. Management said economic growth and job growth were slowing sooner than previously expected and expects pandemic effects to adversely affect loan and lease portfolios over the next two years, with greater impact in the first 12 months of its forecast period. Credit-loss estimates remain subject to significant uncertainty.
- Management cited continued risks in the bus portion of auto and light-truck lending, small-business borrowers as government relief fades, and commercial real estate—particularly hotels, commercial buildings and retail properties. It also highlighted aircraft collateral volatility and approximately $203 million of foreign aircraft exposure, mainly in Mexico and Brazil.
- The company maintained larger reserves for bus borrowers despite many resuming payments and receiving CERTS funds. It also noted that some hotel customers reported improved occupancy. Special-attention credits declined, supporting the quarter’s credit-loss recovery, but management cautioned that downgrades and defaults could increase as relief programs end.
- Q3 noninterest expense included a $3.0 million charitable contribution. Nine-month securities results included a $0.68 million net realized loss associated primarily with portfolio repositioning. Mortgage servicing rights impairment recoveries were $0.81 million year to date.
- Contingency: The liquidating trustee in the IOI Integrated Systems and Najeeb Khan bankruptcy cases is investigating potential claims involving banks and other parties, including 1st Source Bank. The bank says it is cooperating and will vigorously defend any claim; management does not expect the legal proceedings to have a material adverse effect.
- Management reported no material change in market risks or risk factors since year-end 2020, and no material change in internal control over financial reporting during the quarter. It identified no material impairment to specified assets at the reporting date but said prolonged pandemic effects could result in future impairment charges.
Important facts for investors to verify
- Whether loan growth excluding PPP, deposit trends and excess liquidity continue to support net interest income and margin as rates and asset mix change.
- Whether credit quality remains stable as pandemic-related relief expires, especially for bus borrowers, small businesses and commercial real estate; monitor allowance coverage, charge-offs and nonperforming assets.
- Aircraft portfolio exposure, collateral values and foreign borrower concentrations, including Mexico and Brazil.
- Performance of equipment leasing and mortgage banking, both of which had lower income than in the prior-year period.
- Progress and potential exposure in the IOI/Khan bankruptcy-related investigation, along with any developments in capital, liquidity or collateral requirements for public deposits.
- The effects of interest-rate changes on the securities portfolio and accumulated other comprehensive income; confirm subsequent-period valuation and any realized losses.