GERMAN AMERICAN BANCORP, INC. quarterly report, Q3 FY2011

German American Bancorp, Inc. — 2011 Third-Quarter 10-Q

Reporting period: Quarter and nine months ended September 30, 2011. The Indiana-based financial services company operates banking, trust and investment advisory, and insurance businesses. Financial statements are unaudited and amounts below are in millions unless stated otherwise.

Financial performance and condition

• Management reported record earnings: Q3 net income rose 44% year over year and nine-month net income rose 43%. Diluted EPS increased 28% and 27%, respectively.
• Tax-equivalent net interest margin was 3.83% in Q3 versus 4.00% a year earlier, and 3.87% for nine months versus 4.01%. Management attributed margin pressure to low market rates and a larger balance of lower-yielding short-term investments and securities, while higher earning-asset volume drove income growth.
• At September 30, total assets were $1.871 billion, loans $1.115 billion, deposits $1.554 billion, and shareholders’ equity $167.0 million. Loans increased $196.1 million and deposits $466.5 million from year-end 2010.
• Allowance for loan losses was $15.2 million, or 1.36% of period-end loans, versus $13.3 million, or 1.45%, at year-end. Non-performing assets were $17.8 million (0.95% of assets); non-performing loans were 1.33% of loans versus 1.22% at year-end. Q3 net charge-offs were $0.9 million; nine-month net charge-offs were $2.1 million.
• Nine-month cash from operations was $26.3 million; investing cash outflow was $112.6 million and financing cash inflow was $119.5 million. Cash and cash equivalents increased $33.3 million to $52.6 million.
• FHLB advances and other borrowings totaled $131.4 million, down from $153.7 million at year-end. The bank was categorized as well-capitalized. Consolidated leverage, Tier 1 risk-based, and total risk-based capital ratios were 7.45%, 10.58%, and 13.61%, respectively.

Material changes and unusual items

• The January 1, 2011 acquisition of American Community Bancorp, including the Bank of Evansville, materially expanded the company. It added three banking offices, about $324 million of deposits, and was funded in part by issuing approximately 1.449 million common shares. Acquisition accounting added $9.3 million of goodwill and $3.7 million of core-deposit intangibles.
• Growth in net interest income and balance sheet size reflects the acquisition as well as organic deposit growth; comparisons with 2010 are therefore not fully like-for-like. Management cited $142.6 million of organic deposit growth from the existing branch network since year-end.
• Non-interest expense rose 15% in Q3 and 25% year to date, principally due to acquired operations, added staffing and branch costs, integration, data processing, and intangible amortization. Nine-month acquisition-related items included $1.584 million of non-recurring expense.
• Nine-month non-interest income included a $1.045 million gain related to the company’s pre-acquisition American Community investment. Q3 other operating income was reduced by approximately $294,000 of losses and write-downs on other real estate.
• Commercial real estate nonaccrual loans included two notable relationships: a restaurant-related credit of $3.9 million and a convenience-store participation loan of $2.4 million. The filing attributes part of the increase in non-performing loans to these credits and part to acquired loans.
• The company reported no Q3 troubled debt restructurings; one occurred year to date. No modified loans subsequently defaulted during the reported periods.

Outlook, risks and contingencies

The filing provides no specific earnings or financial guidance. Management said provisions reflected its estimate of probable incurred credit losses and noted that allowance estimates depend on borrower conditions, collateral values, economic conditions, and other judgmental factors. Key disclosed risks include changing interest rates, local and national economic weakness and credit deterioration, acquisition integration and acquired-asset quality, deposit competition and funding, regulatory and FDIC assessment changes, and the parent company’s reliance on bank-subsidiary dividends subject to regulatory limits.

A modeled immediate and sustained 2% rate increase reduced estimated net portfolio value 14.43%; a 2% decrease reduced it 21.77%. Management cautioned that the model relies on assumptions and does not predict actual results. Disclosure controls were deemed effective, with no material change in internal control over financial reporting reported for the quarter.

Investor verification priorities

• Assess how much reported earnings growth reflects the American Community acquisition versus organic growth, and track integration costs and expected benefits.
• Review margin trends and sensitivity to interest rates, including the effect of sizable cash and securities balances.
• Monitor nonperforming and past-due loans, especially commercial real estate exposures, acquired-loan marks, charge-offs, and allowance coverage.
• Reconcile non-interest income growth for the one-time securities gain and other unusual items, and evaluate ongoing expense levels after integration.
• Confirm liquidity and capital resilience, including parent-company cash needs and the bank’s capacity to upstream dividends.