GERMAN AMERICAN BANCORP, INC. quarterly report, Q3 FY2016

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German American Bancorp, Inc. — Q3 2016 Form 10-Q

Reporting period: Three and nine months ended September 30, 2016. The company is an Indiana-based bank holding company with banking, trust and investment advisory, and insurance operations. Unless noted, amounts below are in U.S. dollars.

Financial performance

  • Third quarter: Net income was $10.2 million, or $0.67 per diluted share, versus $7.7 million and $0.58 a year earlier. Net interest income increased 30% to $24.6 million; non-interest income rose 8% to $8.4 million. Non-interest expense increased 10% to $18.7 million. The quarter recorded no loan-loss provision, compared with a $0.5 million provision release in Q3 2015.
  • First nine months: Net income increased 12% to $25.1 million; diluted EPS was $1.70 versus $1.69. Net interest income rose 25% to $70.0 million, non-interest income rose 13% to $23.7 million, and non-interest expense rose 24% to $57.2 million. The company recorded a $1.2 million loan-loss provision, versus none in the comparable 2015 period.
  • Net interest margin: Tax-equivalent margin was 3.75% in both Q3 and the first nine months, compared with 3.67% and 3.70%, respectively, in 2015. Management attributed improvement to acquired-loan discount accretion, loan yields and, year to date, a greater share of tax-exempt securities; higher funding costs partly offset the gains.
  • Cash flow: Nine-month operating cash inflow was $32.8 million, investing cash outflow $76.2 million, and financing cash inflow $46.1 million. Cash and cash equivalents ended the period at $54.8 million, up $2.8 million from year-end 2015.

Financial position, liquidity and credit

  • Total assets were $3.0 billion at September 30, up $605.8 million from year-end 2015. Loans were $2.0 billion, up $438.0 million; deposits were $2.33 billion, up $503.3 million. Management attributed much of the growth to the March 1 acquisition of River Valley Bancorp, with additional organic loan growth.
  • FHLB advances and other borrowings totaled $279.1 million, compared with $273.3 million at year-end. Shareholders’ equity was $341.0 million, including $56.8 million of goodwill and other intangible assets. The parent company reported $12.5 million of cash and cash equivalents available for its needs; its access to bank-subsidiary dividends is subject to regulatory restrictions.
  • The allowance for loan losses was $15.2 million, or 0.76% of period-end loans, versus $14.4 million, or 0.92%, at year-end. Management cited acquired-loan accounting as a principal reason for the lower coverage ratio and increased agricultural-sector reserves due to weaker borrower debt-service coverage and crop-land values.
  • Non-performing assets were $5.5 million, or 0.18% of assets, versus $3.5 million, or 0.15%, at year-end. Non-performing loans were $5.1 million, or 0.25% of loans, versus $3.3 million, or 0.21%. Management attributed much of the increase to River Valley-acquired loans.
  • The bank remained above regulatory well-capitalized thresholds: Common Equity Tier 1 was 11.39%, total capital 12.05%, and Tier 1 leverage 9.22% at September 30. Consolidated total capital was 12.94%.

Material changes, acquisition and unusual items

  • River Valley Bancorp, which operated 15 offices, was acquired effective March 1, 2016. German American issued approximately 1.942 million shares and paid approximately $25.0 million in cash consideration; total consideration transferred was $87.4 million. The acquired company had approximately $516.3 million of assets at the effective date. The transaction added $33.1 million of goodwill and $2.6 million of core-deposit intangibles.
  • First-nine-month results included $4.318 million of pre-tax merger costs ($2.724 million after tax, approximately $0.18 per share). The acquisition also increased the weighted share count, helping explain why year-to-date EPS grew less than net income. Q3 included a full quarter of River Valley operations; the year-to-date period included seven months.
  • Q3 included $458,000 of securities-sale gains. Other operating income fell year over year partly because Q3 2015 included a gain of approximately $1.4 million on a building disposition; 2015 advertising expense also included a $1.75 million related contribution expense.
  • Available-for-sale securities were $732.9 million, with $19.4 million of gross unrealized gains and $0.6 million of gross unrealized losses. Nine-month other comprehensive income was $8.3 million, primarily reflecting securities valuation changes.

Outlook, risks and contingencies

  • The filing provides no specific earnings or revenue guidance. Management said it expects to complete final acquisition fair-value estimates during 2016 and was evaluating the effects of newly issued accounting standards.
  • Management identifies interest-rate and liquidity risk, credit quality, economic conditions, competition, acquisition integration and acquired-asset quality, regulatory changes, cybersecurity, and the availability of earnings and excess capital for dividends as risks. The company’s interest-rate model estimated a 4.06% decline in next-12-month net interest income under an immediate sustained 2% rate increase; modeled net portfolio value fell 29.42% under a 2% rate decrease. Management cautioned that these models rely on assumptions and do not predict actual results.
  • The allowance is based on estimates and judgment, and agricultural credit conditions were specifically noted as an area of concern. The company reported no material pending legal proceedings beyond ordinary-course litigation, no material risk-factor changes from its 2015 Form 10-K, and effective disclosure controls as of quarter-end.

Important facts for investors to verify

  • River Valley’s post-acquisition contribution, integration progress, customer retention, and realization of expected profitability benefits.
  • Merger-related costs and acquired-loan discount accretion, including their effects on reported earnings and the sustainability of net interest margin.
  • Agricultural borrower performance, non-performing loan trends, and the adequacy of the allowance—particularly given the decline in allowance coverage as a percentage of loans.
  • Funding costs, deposit mix, borrowing levels, parent-company liquidity, and the effect of rate movements on net interest income and economic value.
  • The filing reports $203,000 of loans 90 days past due and still accruing in a loan footnote, while MD&A reports $191,000; verify the underlying reported amount and reconciliation.