1st Source Corporation — Q3 2019 Form 10-Q
Reporting period: Three and nine months ended September 30, 2019; balance-sheet comparisons are to December 31, 2018 unless stated otherwise. 1st Source is an Indiana-based bank holding company providing banking, lending, leasing and related financial services.
Key financial results
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net interest income | $57.2 million | $54.4 million | $168.6 million | $158.1 million |
| Noninterest income | $25.8 million | $24.1 million | $75.6 million | $72.9 million |
| Noninterest expense | $47.1 million | $47.3 million | $139.7 million | $138.8 million |
| Net income available to common shareholders | $24.4 million | $19.9 million | $70.0 million | $61.0 million |
| Diluted earnings per share | $0.95 | $0.76 | $2.72 | $2.33 |
| Net interest margin, fully taxable-equivalent | 3.68% | 3.71% | 3.74% | 3.71% |
Q3 net income rose 22.9% year over year; nine-month net income rose 14.8%. Management attributed the year-to-date earnings improvement to higher net interest and noninterest income and a lower loan-loss provision, partly offset by increased expenses. Nine-month return on average assets was 1.45% versus 1.33%; return on average common equity was 11.83% versus 11.04%.
Financial position, liquidity and capital
- Assets: $6.69 billion, up 6.3% from year-end 2018. Loans and leases were $5.10 billion, up 5.5%; available-for-sale securities were $1.03 billion, up 4.3%.
- Deposits and borrowings: Deposits totaled $5.39 billion, up 5.3%, including time deposits of $1.72 billion versus $1.47 billion at year-end. Short-term borrowings were $197.2 million; long-term debt and mandatorily redeemable securities were $71.5 million; subordinated notes were $58.8 million.
- Cash flow: Nine-month operating cash flow was $83.2 million, investing cash flow was negative $301.4 million and financing cash flow was positive $246.5 million. Cash and cash equivalents increased $28.4 million to $127.5 million.
- Funding access: Management reported $265 million of additional short-term bank borrowing capacity, $481 million of additional FHLB capacity subject to stock requirements, and $720.7 million of FRB borrowing capacity; no FRB or federal funds market borrowings were outstanding. Management said available funding sources were adequate for cash needs.
- Capital: Shareholders’ equity was $813.2 million; the shareholders’ equity-to-assets ratio was 12.15%. Holding-company total capital, Tier 1 and common equity Tier 1 ratios were 14.59%, 13.33% and 12.26%, respectively; the bank’s corresponding ratios were 13.35%, 12.09% and 11.98%. Each exceeded the filing’s stated well-capitalized thresholds.
Material changes and asset quality
- Average earning assets grew, and loan yields improved; however, funding costs also increased. Q3 FTE margin declined three basis points year over year, while the nine-month FTE margin improved three basis points.
- Loan-loss provision was $3.7 million in Q3 and $12.9 million year to date, down from $6.2 million and $14.8 million, respectively, in 2018. Q3 had net recoveries of $0.3 million, compared with $10.9 million of net charge-offs in Q3 2018. Year-to-date net charge-offs were $4.4 million, or 0.12% of average loans and leases.
- The allowance for loan and lease losses was $108.9 million, or 2.14% of loans and leases, versus 2.04% one year earlier. Nonperforming assets were $17.7 million, or 0.34% of loans and leases, versus $49.7 million and 1.00% at September 30, 2018. Delinquencies of 30 days or more were 0.47% versus 0.42% a year earlier.
- Noninterest income increased 7.1% in Q3, led by higher other income, debit-card, service-charge and mortgage-banking income; trust and wealth advisory and equipment rental income declined. Nine-month noninterest expense rose 0.6%, with salary and technology-related costs partly offset by lower insurance, professional-fee and collection costs.
- Accumulated other comprehensive income moved to positive $4.6 million from negative $10.7 million at year-end, principally reflecting available-for-sale securities appreciation. Management said unrealized securities losses were primarily rate-related and did not reflect credit-quality impairment; it did not intend to sell the securities and expected recovery.
Outlook, risks and unusual items
- The filing provides no numerical earnings or revenue guidance. Management cautioned that results may be affected by interest rates, competition, economic conditions, regulation and GAAP changes, loan prepayment assumptions, and conditions in industries and geographies where the company has credit concentrations.
- Management highlighted aircraft-finance collateral concentration and $198.8 million of foreign loan and lease exposure, primarily Mexico and Brazil. Solar loan and lease outstandings increased to $154.0 million from $96.0 million at year-end. The company cited global economic weakness, trade and tariff disputes, and economic and political uncertainty in Latin America as portfolio risks.
- During Q3, the company amended its corporate-office lease, increasing right-of-use assets by $14.65 million and lease liabilities by $14.64 million. It also reported a $1.32 million gain on the sale of an office building during the first nine months.
- The company was preparing for the expected-credit-loss standard (CECL), effective for it beginning in 2020; management said the adoption impact could not yet be reasonably estimated and would depend on portfolio composition and economic conditions.
- Off-balance-sheet commitments included $1.05 billion of loan commitments, $29.1 million of standby letters of credit and $1.8 million of commercial letters of credit. The company disclosed a $43.1 million maximum exposure to loss from unconsolidated tax-advantaged investment entities, including possible tax-credit recapture; management considered potential losses remote.
- Management did not expect routine legal proceedings to materially adversely affect consolidated results or financial position. It reported no material changes in risk factors since the 2018 Form 10-K and no material changes in market risk.
Important facts for investors to verify
- Whether loan growth, deposit mix and higher deposit costs sustain net interest income and margin, particularly after the Q3 margin decline.
- Whether the improvement in nonperforming assets and charge-offs continues, and how special-attention exposures affect the allowance and future provisions.
- Aircraft and foreign exposure, solar portfolio growth, and the sensitivity of collateral values and borrower performance to economic or trade deterioration.
- The eventual CECL adoption adjustment and its effect on reserves, retained earnings and capital.
- Whether recent noninterest-income gains and lower expense items are recurring, and the earnings contribution of the office-building sale and other unusual items.
- Capital, liquidity and contingent funding capacity under stress, including the potential liquidity impact if collateral were required for public-fund deposits.