1st Source Corporation — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022; balance-sheet comparisons are to December 31, 2021. 1st Source is an Indiana bank holding company. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and condition
- Earnings: Net income available to common shareholders was $27.4 million, versus $28.1 million a year earlier. Diluted EPS was $1.10 in both periods. Return on average assets was 1.39% versus 1.55%; return on average common equity was 12.20% versus 12.74%.
- Net interest: GAAP net interest income rose to $59.6 million from $57.4 million. Fully tax-equivalent net interest margin was 3.18%, down from 3.35%. Average earning assets grew 9.48%, while their yield declined 33 basis points; the cost of interest-bearing liabilities fell 23 basis points.
- Other income and expenses: Noninterest income fell 10.5% to $23.1 million, chiefly because mortgage banking and equipment rental income declined. Noninterest expense increased 2.7% to $45.3 million. Income tax expense was $7.8 million, with a 22.14% effective tax rate versus 23.51%.
- Loans and credit: Loans and leases totaled $5.39 billion, up 0.89% from year-end, reflecting aircraft and auto/light-truck growth partly offset by PPP forgiveness. The allowance was $130.0 million, or 2.41% of loans and leases. The $2.2 million credit-loss provision was below $2.4 million a year earlier; the quarter recorded $0.23 million in net recoveries versus $3.50 million in net charge-offs in Q1 2021. Nonperforming assets were $36.1 million, or 0.66% of loans and leases, down from $41.3 million and 0.77% at year-end.
- Deposits, debt and liquidity: Deposits were $6.67 billion, nearly unchanged from year-end. Short-term borrowings were $199.2 million; long-term debt and mandatorily redeemable securities were $69.6 million; subordinated notes were $58.8 million. Cash and cash equivalents were $416.9 million, down from $525.2 million. Management reported available additional borrowing capacity of $245.0 million from correspondent banks, $483.6 million from the FHLB and $484.3 million from the Federal Reserve, subject to stated conditions.
- Cash flow: Operating activities provided $41.8 million; investing activities used $132.1 million; financing activities used $18.0 million. Cash and cash equivalents declined $108.3 million during the quarter.
- Equity and securities: Total assets were $8.01 billion and total equity was $919.5 million. Shareholders’ equity fell 5.61% to $864.9 million; the shareholders’ equity-to-assets ratio decreased to 10.79% from 11.32%. Available-for-sale securities were $1.86 billion. Their gross unrealized losses rose to $107.1 million from $22.6 million at year-end, primarily from interest-rate and market changes; the company reported no credit-loss allowance on these securities and said it did not intend, and was not more likely than not required, to sell before recovery.
Material changes and management commentary
- Loan balances increased despite $36.6 million of PPP loan forgiveness; aircraft and auto/light-truck portfolios were major growth contributors. PPP loans outstanding were $37.9 million.
- Net interest income improved, but margin remained below the prior-year level as excess liquidity and the asset mix weighed on earning-asset yields. Lower funding costs partly offset that pressure.
- Management increased its credit-loss forecast adjustment amid the war in Ukraine, inflation, supply-chain disruption and economic uncertainty. It expected slower economic growth in 2022 and 2023 and inflation above the Federal Reserve’s 2% target; management cautioned that future loss estimates could vary considerably.
- Management highlighted ongoing risk in the bus segment and small-business borrowers as government relief wanes, and in aircraft lending, including $212.7 million of foreign exposure, principally in Mexico and Brazil. It also cited collateral-value volatility, energy prices and driver availability as portfolio concerns.
- The company paid a $0.31 per-share dividend in Q1. No specific earnings or financial guidance was provided in the filing.
Risks, contingencies and unusual items
- Investment valuation and equity: The sharp increase in unrealized securities losses reduced accumulated other comprehensive income and contributed to lower book value per share, which fell to $34.97 from $37.04. Management attributed the losses to market and interest-rate movements, not credit deterioration.
- Legal matter: A trustee in the IOI Integrated Systems bankruptcy cases was investigating potential claims involving 1st Source Bank related to accounts and transactions of IOI and its owner, a former bank and company director. No claim had been formally served on the Bank at the filing date; management anticipated litigation might be commenced during 2022 and said the Bank would vigorously defend itself. Management did not expect the outcome of legal proceedings to materially adversely affect consolidated financial position or results.
- Other items: Long-term debt and mandatorily redeemable securities produced negative interest expense of $0.8 million in Q1 2022, versus $0.5 million of expense in Q1 2021; management attributed the change mainly to lower rates on mandatorily redeemable securities. The filing also reported no material change in market risks or risk factors since year-end.
Most important facts for investors to verify
- Whether securities-related unrealized losses, interest-rate movements and deposit repricing materially affect capital, book value, liquidity or future net interest margin.
- Whether management’s macroeconomic assumptions and forecast adjustment adequately reflect inflation, the Ukraine conflict, supply-chain disruptions and potential economic slowdown.
- Credit performance in aircraft lending, foreign exposures, the bus segment and small-business portfolios, including changes in nonperforming assets and allowance coverage.
- Developments in the IOI bankruptcy investigation and any formal claims, litigation or potential financial exposure involving the Bank.
- That reported borrowing capacity is available on the stated terms and that liquidity remains adequate as cash balances and loan growth change.