Business context and reporting period
1st Source Corporation is an Indiana bank holding company providing banking, lending, equipment finance and related services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; balance-sheet comparisons are with December 31, 2018.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Interest income | $71.6 million | $63.9 million | $140.7 million | $123.1 million |
| Net interest income | $56.4 million | $53.2 million | $111.4 million | $103.7 million |
| Noninterest income | $25.7 million | $25.0 million | $49.8 million | $48.8 million |
| Net income available to common shareholders | $23.4 million | $22.0 million | $45.6 million | $41.1 million |
| Diluted earnings per share | $0.91 | $0.84 | $1.76 | $1.57 |
| Net interest margin, fully taxable-equivalent | 3.74% | 3.71% | 3.77% | 3.71% |
At June 30, 2019, total assets were $6.65 billion, up 5.7% from year-end; loans and leases were $5.11 billion, up 5.7%; and deposits were $5.40 billion, up 5.5%. Shareholders’ equity was $794.7 million, and the shareholders’ equity-to-assets ratio was 11.95%. The company reported regulatory capital ratios above applicable “well capitalized” thresholds: consolidated total capital 14.20%, Tier 1 capital 12.94%, and common equity Tier 1 11.83%.
Interest expense rose to $15.2 million in Q2 from $10.7 million, and to $29.3 million for the first half from $19.4 million, reflecting higher deposit costs and other funding costs. The six-month effective tax rate was 23.26%, compared with 21.74% in 2018; a $0.8 million state tax settlement benefited the prior-year period.
Cash flow, credit and liquidity
For the six months, operating activities provided $56.0 million, investing activities used $305.3 million, and financing activities provided $246.7 million. Cash and cash equivalents ended at $96.5 million, down $2.6 million from year-end. The filing describes liquidity as adequate and reports available additional borrowing capacity of $265 million from correspondent banks, $447.5 million from the FHLB and $735.8 million from the Federal Reserve, subject to stated conditions.
Provision for loan and lease losses was $9.2 million for the first half versus $8.6 million a year earlier. Net charge-offs rose to $4.7 million (0.19% of average loans and leases) from $0.5 million (0.02%). The allowance was $104.9 million, or 2.05% of loans and leases. Nonperforming assets declined to $21.7 million, or 0.41% of loans and leases, from $35.3 million at year-end and $44.4 million a year earlier.
Material changes versus prior periods
- Six-month net income increased 11.0%; diluted EPS rose from $1.57 to $1.76. Management attributed earnings growth primarily to higher net interest and noninterest income, partly offset by higher provision and expenses.
- Six-month fully taxable-equivalent net interest income increased 7.3%, and margin improved six basis points. Loan yields increased, while the cost of interest-bearing deposits also rose materially.
- Loans grew $273.9 million in the first half. Deposits grew $281.5 million, including $221.9 million growth in time deposits.
- Other comprehensive income improved, moving accumulated other comprehensive loss of $10.7 million at year-end to income of $2.4 million, largely reflecting unrealized gains on available-for-sale securities.
- Nonaccrual loans fell, particularly in aircraft and auto/light truck, while repossessions increased. Q2 net charge-offs were $1.2 million versus $0.1 million in Q2 2018.
Outlook, commentary, risks and unusual items
The filing provides no quantified earnings or balance-sheet guidance. Management said the U.S. economy remained strong while global conditions showed signs of weakness, and cited slower global growth, trade and tariff disputes, and political and economic uncertainty in Latin America. Aircraft financing is a notable concentration: foreign loans and leases were $211.8 million, principally in Brazil and Mexico. Solar loans and leases totaled $114.9 million.
Management identified economic conditions, interest rates, loan prepayments, competition, regulation and credit concentrations among factors that could cause results to differ from forward-looking statements. The company is preparing to adopt the expected-credit-loss standard (CECL); management said the impact could not yet be reasonably estimated. Off-balance-sheet loan commitments were $1.11 billion, with standby letters of credit of $27.9 million. Unconsolidated tax-advantaged VIE investments had a reported maximum exposure to loss of $35.9 million, including potential tax-credit recapture.
Unusual or notable items included a $1.32 million gain on the sale of an office building in the first half, followed by leasing part of the property from the buyer; $13.7 million of treasury-share purchases; and a $0.30 million cumulative-effect retained-earnings adjustment from adopting a securities-premium accounting update. Management expected no material adverse effect from pending legal proceedings and reported no material change in risk factors or market risk from year-end.
Important facts for investors to verify
- Whether loan growth and deposit pricing sustain net interest income and margin as funding costs rise.
- Aircraft and other specialty-finance credit performance, foreign exposures, repossessions and the elevated first-half charge-offs.
- The adequacy of the allowance and the eventual CECL adoption impact.
- Liquidity and funding access under stress, including the size and draw conditions of borrowing facilities and $1.11 billion of loan commitments.
- Potential effects of global and regional economic risks and the tax-credit recapture exposure from VIE investments.
- How much reported earnings benefited from the building-sale gain and other nonrecurring or timing-sensitive items.