1ST SOURCE CORP annual report, FY2021

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1st Source Corporation — FY2021 Form 10-K

Reporting period: Year ended December 31, 2021, compared primarily with FY2020. 1st Source is an Indiana-based bank holding company with commercial and consumer banking, wealth and insurance services, and nationwide specialty equipment finance.

Financial results and condition

  • Profitability: Net income available to common shareholders rose 45.6% to $118.5 million from $81.4 million. Diluted EPS increased to $4.70 from $3.17. Return on average assets was 1.53% (1.14% in 2020); return on average common equity was 13.07% (9.41%).
  • Revenue and margin: Net interest income increased 4.8% to $236.6 million; fully taxable-equivalent net interest income was $237.1 million. Net interest margin declined to 3.23% from 3.39%, as earning-asset yields fell; lower funding costs partly offset the pressure. Noninterest income decreased 3.7% to $100.1 million.
  • Expenses and taxes: Noninterest expense declined 0.7% to $186.1 million. Income tax expense rose to $36.3 million; the effective tax rate was 23.45% versus 23.40%.
  • Credit costs and asset quality: The company recorded a $4.3 million recovery of provision for credit losses, versus a $36.0 million provision in 2020. Net charge-offs were $8.9 million, or 0.16% of average loans, versus $9.2 million, or 0.17%. The allowance was $127.5 million, 2.38% of loans, down from $140.7 million, or 2.56%. Nonperforming assets fell to $41.3 million from $64.5 million.
  • Balance sheet: Total assets grew to $8.10 billion from $7.32 billion. Loans and leases declined to $5.35 billion from $5.49 billion, while deposits increased to $6.68 billion from $5.95 billion. Shareholders’ equity was $916.3 million; total equity, including noncontrolling interests, was $969.5 million.
  • Cash flow: Operating activities provided $166.8 million; investing activities used $598.6 million; financing activities provided $713.9 million. Cash and cash equivalents ended the year at $525.2 million, compared with $243.0 million.
  • Debt and liquidity: Year-end short-term borrowings were $200.0 million; long-term debt and mandatorily redeemable securities were $71.3 million; subordinated notes were $58.8 million. Management reported compliance with internal liquidity policies. Available borrowing capacity included $245.0 million from correspondent banks, $510.3 million from the FHLB, and $453.9 million from the Federal Reserve, subject to applicable conditions.
  • Capital and shareholder returns: The Bank was classified as well capitalized. Its total risk-based capital ratio was 15.71%, common equity Tier 1 ratio 13.59%, and Tier 1 leverage ratio 11.08%. The annual common dividend was $1.21 per share, up from $1.13; the company repurchased 713,132 shares during 2021.

Material changes versus FY2020

  • Earnings improved substantially, led by a $40.3 million year-over-year reduction in provision for credit losses and higher net interest income. These gains were partly offset by lower noninterest income and higher taxes.
  • Average earning assets increased 9.8%, but the average earning-asset yield fell 46 basis points to 3.48%. The average cost of interest-bearing liabilities fell 44 basis points to 0.38%.
  • Noninterest income was affected by lower equipment rental income ($16.6 million versus $23.4 million) and mortgage banking income ($11.8 million versus $15.7 million), partly offset by higher trust, debit-card, and deposit-service income.
  • Investment securities available-for-sale increased to $1.86 billion from $1.20 billion. Unrealized after-tax losses on these securities shifted accumulated other comprehensive income to a $9.9 million loss from an $18.4 million gain.
  • Commercial and agricultural loans declined, mainly as PPP loans were forgiven or repaid. Excluding PPP loans, that portfolio increased 1.3%. Solar, auto and light truck, aircraft, and construction equipment balances grew; total loans and leases decreased 2.6%.
  • COVID-related loan and lease modifications in deferment declined to zero at year-end from $129 million a year earlier.

Outlook, commentary, risks, and unusual items

  • Outlook: The filing provides no formal earnings or EPS guidance. Management expected solar-finance momentum to continue into 2022. Its credit-loss forecast assumed slower economic growth in 2022 and 2023 and inflation above the Federal Reserve’s 2% target; management cautioned that pandemic, supply-chain, and inflation uncertainty could make loss estimates vary considerably.
  • Credit risks: Bus-related specialty vehicle borrowers remained a concern; the company charged off $7.16 million in the bus segment during 2021, although it reported no year-end delinquency in that segment. Management also highlighted uncertainty in hotels, commercial property, construction equipment, and foreign aircraft lending, particularly in Mexico and Brazil.
  • Interest rates and LIBOR: The company reported approximately $1.1 billion of loans and other financial instruments directly or indirectly influenced by LIBOR and continued its transition to replacement benchmarks. Its interest-rate model showed that an immediate 100-basis-point decline could reduce net interest income by 3.22% over 12 months and 8.00% over 24 months; actual results may differ.
  • Legal contingency: A bankruptcy trustee investigating alleged misconduct by former director and customer Najeeb Khan and related entities asserted potential claims against the Bank involving deposit-account transactions. No claim had been formally served as of the filing; management expected litigation might commence in the first or second quarter of 2022 and said the Bank would vigorously defend itself. Management did not expect other ordinary-course proceedings to materially affect consolidated results.
  • Other notable items: FY2021 included a $3.0 million charitable contribution supporting COVID-19 initiatives and $0.81 million of mortgage-servicing-rights impairment recoveries. The auditor issued unqualified opinions on the financial statements and internal control; the allowance for loan and lease losses was identified as a critical audit matter.

Most important facts for investors to verify

  • Whether the improvement in credit quality and the provision recovery are sustainable as pandemic support fades, especially in the bus, hotel, and commercial real estate exposures.
  • How higher interest rates, deposit repricing, and the large securities portfolio affect net interest margin, earnings, and unrealized securities values.
  • The status and potential financial exposure of the IOI bankruptcy-trustee matter and any claims formally brought against the Bank.
  • Progress and any costs or effects from the LIBOR transition for the approximately $1.1 billion of affected instruments.
  • Reconciliation of PPP balances: the filing reports $75.8 million of remaining loans in one table and $73.1 million net of unearned discount elsewhere.