German American Bancorp, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Unaudited consolidated results; dollar amounts below are in millions except per-share data.
Business context and financial performance
The company is an Indiana-based regional banking and financial-services holding company, with core banking, trust and investment advisory, and insurance operations. It operated 58 banking offices at June 30, 2018.
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Net interest income | $27.5 | $24.8 | $53.1 | $49.5 |
| Provision for loan losses | $1.2 | $0.4 | $1.6 | $0.9 |
| Non-interest income | $8.9 | $7.8 | $18.4 | $16.0 |
| Non-interest expense | $21.7 | $19.0 | $42.2 | $38.0 |
| Net income | $11.1 | $9.8 | $22.9 | $19.4 |
| Diluted EPS | $0.48 | $0.43 | $1.00 | $0.85 |
Tax-equivalent net interest margin was 3.77% in Q2 versus 3.78%; for the first half it was 3.71% versus 3.82%. The first-half effective tax rate fell to 17.4% from 27.2%, with management attributing approximately $0.13 of first-half EPS benefit to lower federal tax rates under the Tax Act (approximately $0.06 in Q2).
Financial position, cash flow and credit
- Total assets were $3.345 billion at June 30, up $200.2 million from year-end 2017. Loans were $2.322 billion, up $176.8 million; deposits were $2.601 billion, up $117.4 million.
- Cash and cash equivalents totaled $71.3 million. For the first half, operating cash flow was $28.6 million, investing cash outflow was $42.2 million, financing cash inflow was $14.5 million, and cash increased $0.9 million.
- FHLB advances and other borrowings were $354.8 million, compared with $275.2 million at year-end. Shareholders’ equity was $370.5 million; equity was 11.1% of assets, versus 11.6% at year-end. Regulatory capital ratios remained above applicable minimums; the bank’s total capital ratio was 11.67%.
- The allowance for loan losses was $15.6 million, or 0.67% of period-end loans, versus 0.73% at year-end. Non-performing assets declined to $9.5 million from $11.9 million; non-performing loans were 0.41% of loans versus 0.55%.
- First-half net charge-offs were $1.627 million, compared with $0.338 million a year earlier. Management attributed the increase primarily to a partial charge-off on one commercial lending relationship in Q1. Q2 net charge-offs were $43,000.
Material changes, outlook and risks
- Higher average earning assets, organic loan growth and the May branch acquisition supported interest income. Higher short-term rates also lifted loan yields, but increased funding costs; management reported a 17-basis-point year-over-year increase in Q2 cost of funds.
- Non-interest expense rose 14% in Q2 and 11% in the first half. It included $0.904 million of non-recurring acquisition-related costs in Q2 and $1.090 million in the first half. Revenue-recognition adoption also reclassified debit-card-related costs from contra-revenue to expense: $0.389 million in Q2 and $0.700 million in the first half, with an immaterial overall effect on results.
- On May 18, the company acquired five Indiana branches, including approximately $175.3 million in deposits and $117.6 million in loans; the deposit premium was approximately $7.4 million. Purchase-accounting valuations remained preliminary, and the deposit premium was subject to adjustment. The company also had a contractual ability, in certain circumstances, to return loans to the seller during a six-month period.
- The pending First Security acquisition was expected to close effective October 1, 2018, subject to regulatory and shareholder approvals and other conditions. The proposed consideration included approximately 2.0 million company shares and $31 million cash, based on then-current First Security shares outstanding.
- No earnings guidance is provided in the supplied filing text. Management identified interest-rate, credit, liquidity, acquisition-integration, economic, regulatory, cybersecurity and other risks. Its static interest-rate model estimated next-12-month net interest income declines of 3.37% under a 2-percentage-point rate increase and 10.19% under a 2-point decrease; management cautioned that model assumptions and actual outcomes may differ.
- Available-for-sale securities had $20.4 million of gross unrealized losses at June 30, versus $10.2 million at year-end. Accumulated other comprehensive loss was $13.3 million, primarily reflecting securities valuation changes; management said it did not intend, and did not expect to be required, to sell the loss-position securities before recovery.
- The company expected the new lease standard to increase reported assets by approximately $6 million. It was still assessing the future expected-credit-loss standard (CECL) and could not estimate the adoption adjustment.
Important facts for investors to verify
- Whether loan growth, deposit retention and funding costs sustain net interest income and margin as rates change.
- Whether credit quality and the allowance remain adequate, particularly after the first-half commercial-loan charge-off.
- Completion, final terms and integration costs of the First Security deal, and final purchase-accounting adjustments for the acquired branches.
- The effect of securities valuation movements on accumulated other comprehensive loss and capital, alongside the company’s reported regulatory capital ratios.
- Actual CECL adoption impact and whether lease-related balance-sheet changes differ from management’s estimate.