1st Source Corporation — Q2 2012 Form 10-Q
Business context and period. 1st Source is an Indiana-based bank holding company providing banking and other financial services. This unaudited filing covers the three and six months ended June 30, 2012; balance-sheet comparisons are to December 31, 2011. Amounts below are in millions unless otherwise stated.
Financial performance and position
- Earnings: Q2 net income was $12.57 million, down from $14.87 million a year earlier; diluted EPS was $0.51 versus $0.61. First-half net income was $24.28 million versus $25.47 million; diluted EPS was $0.99 versus $1.04.
- Revenue and margin: Q2 net interest income was $37.98 million versus $37.58 million, while noninterest income was $19.79 million versus $21.42 million. For the first half, those amounts were $75.36 million versus $74.44 million and $40.31 million versus $40.38 million, respectively. Tax-equivalent net interest margin was 3.70% in Q2 versus 3.72%; first-half margin was 3.74% versus 3.72%.
- Credit costs and expenses: Provision for loan and lease losses was $2.06 million in Q2 and $4.31 million for the first half, compared with $0.07 million and $2.27 million in 2011. First-half noninterest expense was $74.63 million versus $74.42 million. Management attributed the first-half earnings decline primarily to higher credit-loss provision.
- Returns: First-half return on average common equity was 9.10% versus 10.36%; return on average assets was 1.10% versus 1.16%.
- Balance sheet: Total assets were $4.49 billion, up 2.57% from year-end. Loans and leases were $3.27 billion, up 5.83%; deposits were $3.59 billion, up 1.87%. Available-for-sale securities were $852.70 million, down 3.43%.
- Credit quality: Nonperforming assets were $55.79 million, down from $72.48 million at year-end and $76.49 million a year earlier; they represented 1.67% of loans and leases versus 2.28% at year-end. The allowance was $83.30 million, or 2.55% of loans and leases. First-half net charge-offs were $2.65 million versus $4.13 million in 2011.
- Cash flow and liquidity: Cash and cash equivalents ended the half at $90.08 million, down $24.25 million from year-end. First-half operating cash flow was $37.91 million, investing cash flow was negative $155.08 million, and financing cash flow was positive $92.92 million. Management said available funding sources were adequate. At June 30, the company reported $144.19 million of additional FHLB borrowing capacity, $351 million available from the Federal Reserve, and approximately $215 million of potential short-term federal funds borrowing.
- Capital and debt: Shareholders’ equity was $542.26 million; the equity-to-assets ratio was 12.09%. At the holding company, total risk-based capital was 16.23%, Tier 1 risk-based capital 14.92%, and Tier 1 leverage 11.95%. Deposits were the primary funding source; reported borrowings included $133.93 million short-term borrowings, $65.51 million long-term debt and mandatorily redeemable securities, and $89.69 million subordinated notes.
Material changes and management commentary
- Loan growth was funded in part by a sharp reduction in interest-bearing deposits at other banks and a decrease in the securities portfolio. Deposit costs declined as certificates of deposit repriced lower, helping offset lower yields on earning assets.
- Mortgage banking income rose on higher loan-sale production and improved margins. Equipment rental income declined as the average rental portfolio contracted and new lease rates faced lower market pricing and greater competition.
- Salaries and benefits rose, primarily due to higher base salaries, commissions, and group insurance costs. First-half noninterest expense overall remained nearly flat.
- Management reported liabilities exceeded assets scheduled to reprice within one year by $196.03 million, or approximately 0.93% of the balance sheet. It reported no material change in market risks since year-end.
- The company identified commercial real estate and aircraft as credit-risk concentrations. It cited declining real estate values and limited sales activity, as well as declining aircraft values since 2010. Foreign loans and leases, all in aircraft financing, totaled $239.59 million, including $167.43 million in Brazil and $39.29 million in Mexico.
Outlook, contingencies, and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautioned that actual results may differ due to interest rates, economic conditions, industry concentrations, competition, and changes in law or accounting standards.
- Proposed Basel III-related capital rules could exclude the company’s $89.69 million of trust preferred securities from Tier 1 capital after implementation; the rules were proposed, not final, in this filing.
- The Department of Justice notified the company on July 17, 2012 that its review of a mortgage-broker pricing investigation did not require DOJ enforcement action at that time. The matter was returned to the Federal Reserve for administrative enforcement; management did not expect a material adverse effect.
- Receipt of $1.95 million held in escrow from the sale of a parking garage depended on the company investing $5.40 million in South Bend properties by December 31, 2013. The company intended to meet the commitment and expected escrow proceeds within 12 months.
- First-half 2011 earnings benefited from a state tax settlement that reduced unrecognized tax benefits and increased earnings by $0.47 million. Q2 2011 also included $1.14 million of investment and other investment gains, compared with $0.01 million in Q2 2012.
Most important facts for investors to verify
- Whether loan growth continues without reversing the improvement in nonperforming assets, delinquencies, and net charge-offs—and whether the higher loan-loss provision remains necessary.
- Credit performance and collateral values in commercial real estate, aircraft financing, and the company’s Brazil and Mexico aircraft exposures.
- Whether lower deposit funding costs can continue to offset pressure on asset yields and changes in net interest margin.
- Capital effects and implementation details if proposed capital rules change the treatment of trust preferred securities.
- Outcome of Federal Reserve administrative review, and satisfaction of the South Bend investment condition for release of escrow proceeds.