German American Bancorp, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018. Unaudited results are compared with the corresponding 2017 periods; balance-sheet comparisons are with December 31, 2017. The company is an Indiana-based banking and financial-services holding company.
Financial performance and condition
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $28.5 million | $24.9 million | $81.6 million | $74.5 million |
| Provision for loan losses | $0.5 million | $0.3 million | $2.1 million | $1.1 million |
| Non-interest income | $9.0 million | $8.3 million | $27.3 million | $24.3 million |
| Non-interest expense | $21.6 million | $19.8 million | $63.7 million | $57.8 million |
| Net income | $12.6 million | $9.7 million | $35.5 million | $29.1 million |
| Diluted EPS | $0.55 | $0.42 | $1.55 | $1.27 |
| Dividends per share | $0.15 | $0.13 | $0.45 | $0.39 |
- Margins and earnings drivers: Tax-equivalent net interest margin was 3.76% in Q3 versus 3.70% a year earlier; for the nine months it was 3.72% versus 3.78%. Q3 net interest income rose 15%, primarily on higher average earning assets and improved margin. Higher loan yields and acquired-loan discount accretion helped, while rising funding costs and the lower tax rate weighed on margin. Nine-month average cost of funds rose to 0.56% from 0.38%.
- Taxes: Effective tax rates were 18.1% in Q3 and 17.6% for the first nine months, compared with 26.7% and 27.0%, respectively, in 2017. Management estimated the lower federal tax rate added about $0.07 per share in Q3 and $0.20 per share year to date.
- Balance sheet at September 30: Total assets were $3.364 billion, loans $2.340 billion, deposits $2.641 billion, cash and cash equivalents $65.6 million, and shareholders’ equity $376.1 million. Since year-end, loans increased $195.2 million and deposits $156.8 million, largely reflecting the five-branch acquisition and organic growth. Total borrowings were $327.0 million, up from $275.2 million at year-end.
- Cash flow, nine months: The cash flow statement reports operating inflows of $42.5 million, investing outflows of $70.0 million, and financing inflows of $22.8 million. Cash and cash equivalents declined $4.8 million to $65.6 million.
- Credit quality and capital: Allowance for loan losses was $16.1 million, or 0.69% of period-end loans, versus 0.73% at year-end. Nonperforming loans were $8.5 million, or 0.36% of loans, down from $11.8 million and 0.55%. Nine-month net charge-offs were $1.7 million, primarily from a partial charge-off on one commercial lending relationship. The company reported consolidated total capital of 13.23% and CET1 of 12.21%; the bank exceeded applicable well-capitalized thresholds.
Material changes and unusual items
- Q3 net income increased 31% per diluted share; nine-month net income increased 22% per diluted share. Growth reflected higher net interest income and fee income, as well as lower income taxes.
- On May 18, the bank acquired five Indiana branches, initially taking on approximately $175.3 million of deposits and $117.6 million of loans. At quarter-end, acquired loans were $112.9 million and acquired deposits approximately $132.1 million. The transaction included a roughly $7.4 million deposit premium; final valuations were still preliminary.
- On October 15, after the reporting date, the company completed its acquisition of First Security, Inc. First Security had approximately $572 million in assets, $406 million in loans, and $432 million in deposits at September 30. Consideration included about 2.0 million company shares and $31.2 million cash; acquisition accounting valuations were incomplete.
- Acquisition-related expenses were approximately $0.4 million in Q3 and $1.5 million for the first nine months. The company also reported a $14.6 million after-tax nine-month other comprehensive loss, primarily from lower available-for-sale securities values. Management attributed the decline mainly to interest-rate changes and did not consider the securities other-than-temporarily impaired.
- Adoption of the revenue-recognition standard changed the presentation of certain debit-card costs from contra-revenue to expense, including $0.4 million in Q3 and $1.1 million year to date; management said the adoption did not materially affect overall results.
Outlook, risks, and contingencies
- The filing provides no specific earnings or revenue guidance. Management noted continued sensitivity to market rates, deposit costs, loan growth, credit quality, and acquisition integration. It cautioned that actual results may differ from forward-looking statements.
- Interest-rate simulations estimated that a sudden, sustained 2% increase would reduce next-12-month net interest income by 3.19%, while a 2% decrease would reduce it by 7.64%. Estimated net portfolio value fell 9.61% under a 2% increase and 7.76% under a 2% decrease. These are model-based estimates using a static balance sheet, not forecasts.
- On October 11, the company borrowed $25 million under a term loan at 5.24% to fund part of the First Security cash consideration, and entered a revolving facility of up to $15 million, with no revolver borrowings reported as of the filing. The term loan is due September 30, 2021; the revolver is due September 30, 2019.
- The company expected adoption of the new lease standard to increase reported assets by approximately $6 million, without a material impact on consolidated operating results. It expects a one-time CECL allowance adjustment upon adoption but could not estimate the amount.
- Management cited acquisition execution and integration, interest-rate movements, economic and credit conditions, cybersecurity, regulatory and tax changes, and liquidity and dividend capacity among the risks. The filing reported no material change to previously disclosed risk factors and no material pending legal proceedings.
Important facts for investors to verify
- How the First Security acquisition affects share count, funding costs, integration expenses, acquired-asset marks, and subsequent-period earnings.
- Whether organic loan and deposit growth continues, and how deposit repricing affects net interest margin and funding costs.
- Credit trends behind the year-to-date increase in provision and charge-offs, including performance of the commercial relationship noted by management and acquired loans.
- The sensitivity of securities values, accumulated other comprehensive loss, and capital to further interest-rate movements.
- The final branch-acquisition valuations and deposit-premium adjustment, as well as the eventual CECL allowance impact.