1st Source Corporation — Q3 2018 Form 10-Q
Business context and period. 1st Source is an Indiana-based bank holding company offering banking, lending, equipment finance and related services. This unaudited filing covers the quarter and nine months ended September 30, 2018; balance-sheet comparisons are to December 31, 2017. Dollar amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q3 / September 30, 2018 | Comparable period / prior date |
|---|---|---|
| Net income | $19.9; diluted EPS $0.76 | Q3 2017: $17.2; $0.66 |
| Nine-month net income | $61.0; diluted EPS $2.33 | Nine months 2017: $50.1; $1.92 |
| Net interest income | Q3 $54.4; nine months $158.1 | Q3 2017 $47.2; nine months 2017 $136.8 |
| Net interest margin | Q3 3.69% GAAP-derived; 3.71% FTE | Q3 2017: 3.53% and 3.57%, respectively |
| Provision for loan and lease losses | Q3 $6.2; nine months $14.8 | Q3 2017 $1.6; nine months 2017 $5.4 |
| Noninterest income / expense | Q3 $24.1 / $47.3; nine months $72.9 / $138.8 | Q3 2017 $25.6 / $44.5; nine months 2017 $73.0 / $126.7 |
| Total assets | $6,293; loans and leases $4,826 | December 31, 2017: assets $5,887; loans and leases $4,528 |
| Deposits / short-term borrowings | $5,062 / $291 | December 31, 2017: $4,753 / $215 |
| Cash and cash equivalents | $113.9 | December 31, 2017: $78.0 |
| Equity / capital | Shareholders’ equity $750; equity-to-assets 11.92% | December 31, 2017: equity $719; ratio 12.20% |
Nine-month operating cash flow was $92.4 million, investing cash flow was negative $420.6 million, and financing cash flow was positive $364.1 million. Net cash increased $35.8 million. The company reported $58.8 million of subordinated notes and $70.9 million of long-term debt and mandatorily redeemable securities at quarter-end. The allowance for loan and lease losses was $98.3 million, or 2.04% of loans and leases.
Material changes versus comparable periods
- Nine-month net income rose 21.8% year over year, while pretax income was nearly flat at $77.4 million versus $77.8 million. The lower 2018 effective tax rate—21.25% year to date versus 35.67%—was a major contributor to higher after-tax earnings.
- Net interest income and FTE margin increased, reflecting loan growth and higher asset yields. Funding costs also rose: the nine-month cost of interest-bearing liabilities increased to 0.96% from 0.67%, including higher deposit costs.
- Loans and leases grew 6.6% from year-end; deposits grew 6.5%. Commercial and agricultural and construction-equipment lending were among the sources of growth.
- Credit costs rose materially. Year-to-date net charge-offs were $11.3 million versus $0.5 million in 2017, primarily following a significant aircraft exposure charge-off. Nonperforming assets increased to $49.7 million, or 1.00% of loans and leases, from $31.3 million and 0.67% at year-end.
- Available-for-sale securities had $21.5 million of gross unrealized losses at September 30, versus $7.5 million at year-end. The company attributed the losses mainly to higher market rates and said it did not believe the securities were credit-impaired or that it would need to sell them before recovery.
- Quarterly noninterest income declined 6.0%, partly because Q3 2017 included a $1.0 million securities gain. Nine-month noninterest expense increased 9.6%, including higher compensation, technology/professional costs and collection and repossession expense.
Outlook, commentary and risks
- The filing provides no specific earnings or revenue guidance. Management said available funding sources were adequate for liquidity needs. It cited $320.6 million of additional FHLB borrowing capacity and $595.6 million of FRB borrowing capacity at September 30, 2018, among other sources.
- Management highlighted consecutive quarterly increases in special-attention credits, rising delinquencies (30 days or more: 0.42%, versus 0.27% a year earlier), and larger nonaccrual relationships in aircraft and auto/light-truck lending. Repossessions were mainly aircraft-related.
- Credit risks identified include aircraft collateral values, approximately $230 million in foreign aircraft exposure (primarily Mexico and Brazil), trade and tariff uncertainty, and political and economic uncertainty in Latin America. Management also noted concerns about delinquency increases in auto/light-truck and construction-equipment portfolios.
- Tax-related items benefited results: a $0.80 million state tax settlement benefit and a $0.88 million benefit from finalizing provisional federal tax-reform accounting. The nine-month securities portfolio repositioning resulted in a net $0.35 million loss, compared with a $2.76 million gain in 2017.
- Management estimated that adoption of the new lease standard on January 1, 2019 would add $10–$20 million of right-of-use assets and lease liabilities; it expected no material change to expense timing. The company was assessing the expected-credit-loss standard, with no quantified impact disclosed.
- Management reported no material changes in market risk or risk factors since year-end 2017, and said it did not expect pending legal proceedings to materially adversely affect financial position or results. Forward-looking statements remain subject to economic, interest-rate, regulatory and industry risks.
Important facts for investors to verify
- Whether aircraft and other larger problem credits generate further charge-offs, nonaccruals, repossessions or reserve needs; track the composition of the $49.7 million in nonperforming assets.
- Whether loan growth and asset yields continue to offset higher deposit and borrowing costs, and how net interest margin responds to interest-rate changes.
- The quality and valuation sensitivity of the securities portfolio, including the $21.5 million of unrealized losses and the resulting accumulated other comprehensive loss.
- The eventual effects of CECL and lease-accounting adoption, as well as any changes to the company’s disclosed implementation estimates.