1st Source Corporation — Q1 2020 Form 10-Q
Business context and reporting period
1st Source is an Indiana-based bank holding company providing banking and financial services. This unaudited filing covers the quarter ended March 31, 2020; income and cash flow comparisons are with Q1 2019, while balance-sheet changes are generally versus December 31, 2019. Dollar amounts below are in millions unless stated otherwise.
Financial results and condition
- Profitability: Net income available to common shareholders was $16.4, down 26.1% from $22.2; diluted EPS was $0.64 versus $0.86. Return on average assets was 1.00% versus 1.43%, and return on average common equity was 7.81% versus 11.61%.
- Interest income and margins: Net interest income was $54.8, down slightly from $54.9. Fully tax-equivalent net interest margin fell to 3.58% from 3.79%, as lower asset yields more than offset lower funding costs.
- Credit provision: Provision for loan and lease losses rose to $11.4 from $4.9. Net charge-offs improved to $1.8, or 0.14% of average loans and leases, from $3.5, or 0.30%.
- Other income and expenses: Noninterest income increased 2.1% to $24.6, including higher mortgage banking income, partly offset by lower equipment rental and insurance income. Noninterest expense rose 2.9% to $46.5.
- Assets and lending: Total assets were $6.74 billion, up 1.7% from year-end. Loans and leases totaled $5.13 billion, up 0.9%; the reserve was $120.8, or 2.35% of loans and leases, versus 2.07% a year earlier.
- Asset quality: Nonperforming assets increased to $35.9 from $19.2 at year-end, or 0.68% of loans and leases versus 0.37%. Nonaccrual loans and leases rose to $26.3 from $9.8, chiefly reflecting construction equipment, commercial and agricultural, and aircraft exposures. Delinquencies of 30 days or more were 0.24% of outstandings.
- Funding and liquidity: Deposits were $5.28 billion, down 1.5% from year-end; short-term borrowings increased to $282.8 from $145.9. Cash and cash equivalents were $122.3, versus $83.4 at year-end. Management reported additional borrowing capacity of $401.9 from the FHLB, $543.3 from the Federal Reserve, and $225.0 through bank relationships, subject to stated conditions.
- Debt and capital: Long-term debt and mandatorily redeemable securities were $81.9; subordinated notes were $58.8. Shareholders’ equity was $850.9, up 2.7%, and the shareholders’ equity-to-assets ratio was 12.63%. The company’s total capital ratio was 15.23%, Tier 1 capital ratio 13.97%, and common equity Tier 1 ratio 12.57%.
- Cash flow: Operating activities provided $33.3 versus $35.4 in Q1 2019; investing activities used $56.4 versus $109.6; financing activities provided $62.0 versus $42.8. Cash and cash equivalents increased $38.9 during the quarter.
- Shareholder returns: The quarterly dividend was $0.29 per share, compared with $0.27 in Q1 2019. No shares were repurchased in Q1 2020.
Material changes, outlook and risks
- COVID-19 and credit: Management increased the provision amid higher special-attention exposures and uncertainty related to pandemic-driven shutdowns. It identified transportation and hospitality as early affected sectors, and highlighted aircraft concentration and foreign exposure, particularly in Mexico and Brazil. Management said the pandemic’s future effect on results, loan modifications and reserves remained uncertain.
- Borrower relief and PPP: By mid-April, the company had approved $494 million of COVID-related loan and lease modifications, associated with $4.44 billion of recorded balances at March 31. It had processed 2,061 Paycheck Protection Program loans totaling $554 million by mid-April, after quarter-end; management stated these loans are SBA-guaranteed and expected no adverse liquidity or capital effect from participation.
- CECL: The company elected under the CARES Act to defer adoption of the expected-credit-loss standard until the earlier of the end of the COVID-19 national emergency or December 31, 2020. It expected a $2.58 million opening allowance increase and a $0.78 million increase in the unfunded commitment liability upon adoption, plus an estimated further $2 million to $10 million allowance increase based on March 31 conditions. Management did not expect a significant effect on regulatory capital ratios.
- Other commentary: Management reported no current impairment it attributed to COVID-19 in goodwill, long-lived assets, mortgage servicing rights, right-of-use assets or available-for-sale securities, but noted mortgage servicing rights had declined in fair value and would continue to be assessed. It gave no specific earnings or revenue guidance.
- Key risks: The filing cites possible pandemic-related borrower defaults, collateral value declines, deposit instability, reduced revenue and additional costs; lower interest rates may pressure results. Other risks include economic and geopolitical conditions, loan concentrations, foreign aircraft exposure, and potential future impairment. Management stated its liquidity sources were adequate at quarter-end.
- Contingencies and controls: Management did not expect pending ordinary-course legal proceedings to materially adversely affect financial position or results. Disclosure controls were assessed as effective, with no reported material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Subsequent-quarter trends in nonaccrual loans, nonperforming assets, charge-offs and the reserve, especially in construction equipment, transportation, hospitality and aircraft.
- Whether the $494 million of approved deferrals result in payment resumption, further modifications or credit deterioration; confirm the evolving status of PPP lending and funding.
- The timing and final CECL adoption impact, including the additional allowance estimate of $2 million to $10 million and the unfunded commitment liability.
- Deposit and borrowing trends, available contingent liquidity, and the effect of reduced interest rates on net interest margin and earnings.
- Changes in mortgage servicing rights fair value and whether future impairment or valuation allowances are required.