1st Source Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited consolidated results; balance-sheet comparisons are against December 31, 2010. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net interest income | $37.58 | $36.25 | $74.44 | $71.15 |
| Provision for loan and lease losses | $0.07 | $5.80 | $2.27 | $10.19 |
| Noninterest income | $21.42 | $20.60 | $40.38 | $41.52 |
| Noninterest expense | $35.94 | $39.65 | $74.42 | $76.76 |
| Income before taxes | $23.00 | $11.40 | $38.14 | $25.73 |
| Net income | $14.87 | $7.80 | $25.47 | $17.47 |
| Diluted EPS | $0.61 | $0.25 | $1.04 | $0.57 |
- Net interest margin on a fully taxable-equivalent basis was 3.72% in both Q2 and the first half, versus 3.57% and 3.53%, respectively, in 2010. Average earning-asset yields fell, but lower funding costs more than offset the decline.
- Combined net interest income and noninterest income was $59.01 million in Q2, up from $56.85 million; for the first half it was $114.82 million, compared with $112.68 million.
- For the first half, return on average common equity was 10.36% versus 5.93%; return on average assets was 1.16% versus 0.78%.
Financial condition, cash flow and liquidity
- Total assets were $4.35 billion, down 2.0% from year-end 2010. Loans and leases were $3.12 billion, up 1.5%; deposits were $3.52 billion, down 2.7%. Available-for-sale securities were $902.74 million, down 6.8%.
- Shareholders’ equity was $505.59 million, up 4.0%; equity-to-assets was 11.61%, versus 10.94% at year-end. Book value per common share rose to $20.88 from $20.12. Total capital ratios at June 30 were 15.82% for the Corporation and 15.67% for the Bank.
- Cash and cash equivalents were $59.35 million, down from $96.87 million at year-end. First-half operating cash flow was $77.93 million, investing cash flow $10.56 million, and financing cash flow negative $126.02 million; cash declined $37.52 million.
- Management reported available borrowing capacity of approximately $255 million from correspondent banks, $169.76 million of additional FHLB borrowing capacity, and $354.88 million available from the Federal Reserve. No correspondent-bank or Federal Reserve borrowings were outstanding; FHLB advances outstanding were $25.93 million.
- The company reported $127.10 million more liabilities than assets scheduled to reprice within one year, approximately 0.95% of the balance sheet. Management said existing funding sources were adequate for cash-flow needs.
Material changes and credit quality
- First-half net income increased primarily because of lower loan-loss provision and noninterest expense, and higher net interest income; lower noninterest income partly offset those gains. The provision fell to $2.27 million from $10.19 million, while net charge-offs fell to $4.13 million from $10.41 million.
- Nonperforming assets declined to $76.49 million from $88.71 million at year-end and $87.71 million a year earlier; they were 2.39% of loans and leases, versus 2.81% and 2.71%, respectively. Delinquencies of 30 days or more were 0.49%, compared with 1.15% a year earlier. The reserve was $85.01 million, or 2.73% of loans and leases.
- Impaired loans totaled $66.29 million, down from $78.07 million at year-end. Performing troubled-debt restructurings were $6.61 million, compared with $7.31 million at year-end. Management identified commercial-real-estate-related borrowers as the largest impaired exposure and noted risks from weak real-estate values and sales activity, as well as past declines in aircraft values.
- Noninterest income for the first half decreased 2.8%. Lower equipment rental income, deposit service charges and insurance commissions were partly offset by higher trust fees and investment gains. The rental portfolio’s average size declined 9.24% year over year.
- Noninterest expense fell 3.1% for the first half. Lower collection and repossession costs, FDIC insurance, professional fees and leased-equipment depreciation were partly offset by higher furniture and equipment costs and a $1.68 million provision for unfunded loan commitments.
Outlook, risks and unusual items
- The filing provides no specific earnings or financial guidance. Management cited economic conditions, interest rates, loan prepayment assumptions, competition, regulation, and downturns in markets or industries with credit concentrations as factors that could affect future results.
- Indiana public-deposit collateral rules could change. No collateral was required through September 30, 2011, but the company estimated potential collateral exposure of approximately $567 million if requirements apply.
- The Department of Justice notified the company in April 2011 of an investigation under the Equal Credit Opportunity Act and Fair Housing Act concerning pricing practices of mortgage brokers from which it had purchased loans. The company said it was cooperating and did not expect a material adverse outcome based on its current understanding; it ended third-party broker relationships in 2010.
- A 2008 state tax settlement reduced unrecognized tax benefits by $0.84 million and increased first-quarter earnings by $0.47 million. The company also recorded $1.68 million of provision for unfunded commitments in the first half. Q2 investment and other investment gains were $1.14 million, including agency-security sale gains; the filing says securities sales were undertaken partly to reduce certain state credit exposures and improve future yield.
- The company repurchased its common-stock warrant for $3.75 million during the first half and repurchased 100,499 common shares in May and June. It paid $0.16 per common share in Q2 dividends. Management reported no material change in market risks or risk factors from year-end 2010, and no material subsequent event requiring disclosure.
Most important facts for investors to verify
- Whether the sharp decline in provision expense and net charge-offs is sustainable, and how reserve adequacy responds to portfolio and economic conditions.
- Trends in nonperforming assets, impaired commercial-real-estate-related credits, aircraft exposures and foreign aircraft loans; foreign loans and leases totaled $206.20 million, primarily in Brazil and Mexico.
- Deposit trends, funding costs, rate sensitivity and the potential liquidity effect of Indiana public-deposit collateral requirements.
- Progress and any developments in the DOJ mortgage-pricing investigation, including any financial or operational consequences.
- How much reported earnings benefited from tax settlement effects, securities gains and other unusual items, and whether recurring fee income and equipment-rental activity improve.