1st Source Corporation — FY2015 Form 10-K
Business context and reporting period. This annual report covers the year ended December 31, 2015; fourth-quarter figures are also summarized. 1st Source is an Indiana bank holding company operating primarily in Indiana and Michigan, with nationwide specialty financing for aircraft, vehicles, trucks and construction equipment. At year-end, it reported $5.19 billion in assets, $3.99 billion in loans and leases, $4.14 billion in deposits and $644.1 million in shareholders’ equity.
Financial performance and position
- Earnings: Net income was $57.5 million, down 1.0% from $58.1 million in 2014. Diluted earnings per share were $2.17, unchanged. Return on average assets was 1.15% (1.21% in 2014); return on average common equity was 9.05% (9.65%).
- Income and margins: Net interest income rose 3.9% to $166.5 million; tax-equivalent net interest margin was 3.60%, versus 3.59%. Noninterest income rose 7.0% to $83.3 million, while noninterest expense increased 6.1% to $159.1 million. Pretax income was $88.6 million.
- Quarterly results: Fourth-quarter net income was $14.4 million and diluted EPS was $0.55, compared with $15.0 million and $0.57 in Q4 2014. Q4 tax-equivalent net interest income increased 5.8%; net interest margin was 3.61% in both periods.
- Credit: Loans and leases grew 8.3% year over year. Nonperforming assets fell to $20.6 million from $42.5 million; nonperforming loans were 0.32% of loans and leases, versus 0.96%. Net recoveries were $0.9 million, compared with $2.2 million of net charge-offs in 2014. The allowance was $88.1 million, or 2.21% of loans and leases, compared with $85.1 million, or 2.31%.
- Cash flow and liquidity: Operating cash flow was $101.0 million; investing activities used $382.0 million, primarily reflecting loan growth and equipment leased to customers; financing activities provided $294.5 million. Cash and cash equivalents ended at $79.7 million, up $13.5 million. Average core deposits were 74.3% of average assets. The Bank reported compliance with its internal liquidity guidelines and access to additional borrowing capacity, including $356.1 million from the FHLB and $424.7 million from the Federal Reserve.
- Debt and capital: Year-end short-term borrowings were $233.2 million, long-term debt and mandatorily redeemable securities were $57.4 million, and subordinated notes were $58.8 million. The Bank was categorized as well capitalized: total risk-based capital was 14.13%, Tier 1 risk-based capital 12.87%, common equity Tier 1 12.87%, and leverage 11.50%.
- Shareholder returns: Cash dividends were $0.671 per share for 2015, versus $0.645 in 2014; the payout ratio was 30.85%. The company repurchased 338,985 shares during 2015. Per-share data reflects the 10% stock dividend issued in August 2015.
Material changes versus 2014
- Loan and lease balances increased $306.1 million; growth was notable in commercial real estate, construction equipment and aircraft financing.
- Equipment rental income rose 30.0% to $22.3 million, accompanied by a 31.6% increase in leased-equipment depreciation. Salaries and benefits rose 7.0%, contributing to higher operating expenses.
- Income tax expense increased to $31.1 million from $26.4 million, and the effective tax rate rose to 35.09% from 31.23%. The 2014 rate benefited from a $3.3 million one-time reduction in uncertain tax positions.
- Net interest income improved, but higher expenses and taxes more than offset the benefit, leaving net income slightly lower.
Outlook, commentary, risks and unusual items
- Management provided no specific numerical earnings or growth guidance. It described business banking prospects as guardedly optimistic, while citing continued global and sector risks.
- Management highlighted aircraft lending exposure in Brazil and Mexico, including approximately $205.8 million of foreign aircraft loans and leases. Brazilian recession and currency weakness had contributed to higher delinquencies and defaults than in other lending segments. The aircraft portfolio also presents collateral-concentration risk.
- Other key risks include interest-rate sensitivity, economic deterioration, loan-loss estimation uncertainty, competition, cybersecurity and technology dependence, regulatory changes, and potential liquidity pressure. A hypothetical 200-basis-point rate increase was modeled to raise net interest income 4.41% over 12 months; a 100-basis-point decrease was modeled to reduce it 2.60%. Actual results may differ.
- A settlement of the Morris Family Trust litigation was approved and effective October 8, 2015. The trusts, which held approximately 21% of outstanding shares, were divided into four family trust lines with options for future diversification. The company agreed to cooperate with potential share sales, provide a $150,000 credit for certain trustee fees, and bear up to $400,000 of specified future diversification expenses. Approximately 1.9 million shares remained registered for possible sale after February 28, 2016.
- Loan commitments to extend credit totaled $829.5 million and standby letters of credit $38.0 million; these amounts are not necessarily future cash outflows. Management did not expect other legal proceedings to materially affect the company’s financial position or results. The 2015 financial statements received an unqualified audit opinion, and the auditor also reported effective internal control over financial reporting.
Important facts for investors to verify
- Whether loan growth—particularly in aircraft, commercial real estate and equipment finance—is being matched by sustained credit quality and adequate reserves.
- Developments in Brazilian and Mexican aircraft exposures, repossessed aircraft, and the valuation and sale of repossessed equipment.
- Whether expense growth, especially compensation and leased-equipment depreciation, continues to outpace operating income growth.
- The durability of earnings excluding the 2014 one-time tax benefit, and the effect of future tax settlements or changes in effective tax rates.
- Potential timing and market impact of sales of the registered trust shares, and the company’s related costs under the settlement.
- Deposit stability, reliance on purchased funds, available contingent borrowing capacity, and the effect of interest-rate changes on net interest income.