1st Source Corporation — Q3 2017 Form 10-Q
Business context and reporting period. 1st Source is an Indiana-based bank holding company providing banking, specialty finance, equipment leasing, wealth management, insurance, and related services. This unaudited filing covers the quarter and nine months ended September 30, 2017; balance-sheet comparisons are to December 31, 2016. Financial amounts below are in U.S. dollars unless noted.
Financial performance and condition
- Revenue and earnings: Q3 net interest income was $47.23 million, up from $42.69 million a year earlier; noninterest income was $25.59 million, up from $22.67 million. Net income rose to $17.18 million from $14.26 million, and diluted EPS was $0.66 versus $0.55. For the first nine months, net income was $50.06 million versus $42.56 million and diluted EPS was $1.92 versus $1.63.
- Margins: Net interest margin on a GAAP-derived basis was 3.53% in Q3 versus 3.35% a year earlier, and 3.52% for the first nine months versus 3.39%. Management attributed improvement mainly to higher loan and investment yields; funding costs also increased.
- Expenses and taxes: Q3 noninterest expense increased 8.1% to $44.46 million; nine-month expense increased 3.9% to $126.68 million. The effective tax rate was 35.75% for Q3 and 35.67% year to date.
- Balance sheet and growth: Total assets were $5.81 billion, up 5.8% since year-end; loans and leases were $4.44 billion, up 5.9%; deposits were $4.57 billion, up 5.5%. Equipment owned under operating leases increased 22.9% to $145.98 million.
- Credit quality: The allowance for loan and lease losses was $93.37 million, or 2.10% of loans and leases, versus 2.13% a year earlier. Nine-month net charge-offs were $0.53 million versus $4.31 million in 2016. Nonperforming assets were $29.54 million, 0.64% of loans and leases, versus 0.68% at September 30, 2016. Delinquencies of 30 days or more were 0.27%, up from 0.23% a year earlier.
- Cash flow and liquidity: For the first nine months, operating cash flow was $98.68 million, investing cash flow was negative $351.37 million, and financing cash flow was positive $243.81 million. Cash and cash equivalents ended at $99.42 million, down $8.88 million from year-end. Management said funding sources were adequate; reported unused borrowing availability included approximately $265 million of federal funds lines, $65.22 million of additional FHLB capacity, and $525.48 million from the Federal Reserve.
- Debt and capital: Short-term borrowings were $316.77 million; long-term debt and mandatorily redeemable securities were $70.48 million; subordinated notes were $58.76 million. Shareholders’ equity was $710.50 million and the equity-to-assets ratio was 12.24%. The company and bank reported capital ratios above the filing’s stated minimums, including capital-buffer requirements.
- Shareholder returns: The quarterly cash dividend was $0.19 per share, compared with $0.18 a year earlier. Book value per share was $27.39, up from $26.00 at year-end.
Material changes and management commentary
- Higher average earning assets and improved asset yields supported net interest income growth; deposit and borrowing costs rose as rates increased.
- Noninterest income growth was led by equipment rental, trust and wealth advisory, debit card, and service-charge income. Equipment rental growth was accompanied by higher leased-equipment depreciation. Nine-month securities gains were $2.76 million versus $0.79 million in 2016.
- Management highlighted aircraft lending as a concentration and noted softening collateral values, especially for some private jets, alongside foreign exposure in Brazil and Mexico. Foreign aircraft loan and lease outstandings were $239.85 million; Brazil and Mexico exposures were $102.58 million and $125.54 million, respectively.
- Solar loan and lease outstandings increased to $60.57 million from $19.71 million at year-end. Management also cited political and economic uncertainty in Latin America and included a global-risk factor in reserve analysis.
- Management did not expect hurricanes affecting areas served by specialty finance customers to have a material portfolio impact, while noting possible benefits to some construction-equipment customers from rebuilding activity.
Outlook, risks, and unusual items
- The filing provides no specific earnings, revenue, or margin guidance. Management stated that liquidity was adequate and that reserve ratios remained appropriate, while cautioning that actual results may differ because of economic, interest-rate, regulatory, competitive, and industry risks.
- Loan commitments to extend credit totaled $939.80 million; standby letters of credit were $30.22 million. These are off-balance-sheet commitments and do not necessarily represent future cash requirements.
- Investment securities available-for-sale had $5.67 million of gross unrealized losses at quarter-end. Management said it did not intend to sell the affected securities and did not consider them credit-impaired.
- One nonperforming loan modification was classified as a troubled debt restructuring during the first nine months. The filing reported no material expected adverse effect from ordinary-course legal proceedings and no material changes to previously disclosed risk factors.
- Among pending accounting standards, the company was assessing the expected-credit-loss standard (ASU 2016-13). It estimated that lease-standard adoption would result in discounted right-of-use assets and liabilities of approximately $12–$15 million as of January 1, 2019.
Most important facts for investors to verify
- Whether loan and lease growth, particularly in aircraft, auto, construction equipment, and solar, is matched by stable credit quality and adequate reserves.
- Trends in aircraft collateral values, repossessions, and Brazil/Mexico exposure; repossessions increased to $12.91 million from $9.37 million at year-end.
- Whether rising deposit and borrowing costs continue to offset improved loan yields and net interest margin.
- The sustainability of noninterest income and expense trends, including equipment rental growth and associated depreciation and collection costs.
- Liquidity capacity under stress, including the potential collateral requirement of approximately $638 million for public-fund deposits if state requirements change.
- Implementation effects of the expected-credit-loss and lease accounting standards; the filing’s impact assessments were not yet final for all standards.