GERMAN AMERICAN BANCORP, INC. annual report, FY2017

Business context and reporting period

German American Bancorp, Inc. filed this Form 10-K for the fiscal year ended December 31, 2017. The Indiana-based bank holding company provides commercial and retail banking, trust and investment services, and insurance, primarily in southern Indiana and northern Kentucky. Its 2017 results include a full year of River Valley operations; 2016 included ten months following the March 2016 acquisition.

Financial performance and condition

Unless otherwise indicated, figures are in U.S. dollars; financial statement amounts below are in millions.

Fourth-quarter 2017 net income was $11.6 million, or $0.51 per share, compared with $10.1 million, or $0.44 per share, in fourth-quarter 2016. The 2017 effective tax rate was 22.1%, versus 28.4% in 2016; the 2017 rate benefited from a $2.284 million deferred-tax revaluation benefit following federal tax reform.

At year-end, total assets were $3.144 billion, loans net of unearned income were $2.142 billion, deposits were $2.484 billion, and shareholders’ equity was $364.6 million. Cash and cash equivalents totaled $70.4 million. Total borrowings were $275.2 million, including $141.7 million of long-term borrowings and $133.5 million of short-term borrowings. Equity was 11.6% of assets, compared with 11.2% a year earlier. The Bank exceeded regulatory well-capitalized thresholds; its total risk-based capital ratio was 12.29% and its CET1 ratio was 11.66%.

Material changes versus the prior comparable period

• Loans increased $151.6 million, or 8%, during 2017, with growth across most categories. Commercial real estate was 43% of the loan portfolio; construction and development lending was about 6%.
• Net interest income growth reflected higher earning assets from organic loan growth and the full-year contribution of River Valley. The margin edged up, as improved securities yields were partly offset by higher funding costs and lower acquired-loan discount accretion.
• Non-interest income was nearly flat. Higher wealth fees and interchange income were offset in part by lower securities gains and lower other operating income, including reduced swap-related fees and fair-value adjustments.
• Non-interest expense increased modestly. Salary and occupancy costs rose, while 2016 had included River Valley integration expenses; 2017 also included a $773,000 contribution expense related to donating a former branch facility.
• Credit indicators weakened: non-performing assets rose to $11.9 million from $4.0 million, and non-performing loans rose to 0.55% of loans from 0.19%. Management attributed most of the increase to two commercial lending relationships placed in impaired and non-performing status.

Outlook, risks and unusual items

• No specific earnings or financial guidance was provided. Management cited continued growth opportunities, including potential acquisitions and expansion, while cautioning that forward-looking statements are subject to risks.
• In February 2018, the Company agreed to acquire five MainSource Bank branches in Indiana. It expects to assume approximately $160 million of deposits and purchase approximately $134 million of loans; the transaction was expected to close in the second quarter of 2018, subject to approvals and other conditions. The deposit premium was estimated at approximately $8 million.
• The Company’s most significant risks include local economic and credit conditions, interest-rate and funding-cost changes, competition, regulatory and tax changes, cybersecurity and third-party system exposure, and acquisition integration and execution. The filing emphasizes that estimates for loan-loss allowances and asset valuations involve judgment.
• Non-performing loans increased materially, though net charge-offs remained low at $864,000, or 0.04% of average loans. The allowance was $15.7 million, or 0.73% of loans, at year-end.
• Interest-rate simulations estimated that a sudden 2% increase in rates would reduce one-year net interest income by 2.26%; a 2% decrease would reduce it by 10.81%. These are model estimates based on a static balance sheet, not forecasts.
• The Company reported no material pending litigation and no material off-balance-sheet arrangements other than ordinary-course commitments and standby letters of credit. The independent auditor gave unqualified opinions on the financial statements and internal control over financial reporting.

Important facts for investors to verify

• How much of earnings growth was recurring versus the $2.284 million tax-reform benefit, and whether the 2017 tax-related estimates were finalized in subsequent reporting.
• The status, final purchase accounting, deposit retention, loan quality, and expected returns of the proposed MainSource branch acquisition.
• Whether the rise in non-performing loans, especially the two commercial relationships, leads to additional provisions, charge-offs, or collateral losses.
• Trends in deposit pricing, borrowing costs, net interest margin, and modeled sensitivity as market rates change.
• Capital and liquidity capacity after planned growth, dividends, and acquisitions; the Bank’s disclosed dividend capacity without prior regulatory approval was approximately $64 million.
• The impact of the expected adoption of the current expected credit loss standard (CECL); the Company said it could not yet estimate the opening allowance adjustment.