1st Source Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are primarily with December 31, 2017. 1st Source is an Indiana-based bank holding company providing banking, wealth, insurance, and equipment-finance services. Unless stated otherwise, dollar amounts below are in millions.
Financial performance and position
- Earnings: Net income was $19.1 million, up 18.0% from $16.2 million; diluted EPS was $0.73 versus $0.62. Return on average assets rose to 1.31% from 1.21%, and return on average common equity to 10.67% from 9.61%.
- Interest income and margins: Net interest income was $50.5 million, up 15.6%. Fully tax-equivalent net interest income was $50.7 million, up 14.8%; the FTE net interest margin increased to 3.71% from 3.53%. Average earning assets grew 9.4%; their yield rose 36 basis points to 4.34%, while the cost of average interest-bearing liabilities increased 24 basis points to 0.85%.
- Other income and costs: Noninterest income increased 2.2% to $23.8 million, including equipment rental income up 13.5%. The securities line shifted from a $1.3 million gain to a $0.3 million loss, which management attributed primarily to portfolio repositioning following tax reform. Noninterest expense rose 10.8% to $45.6 million, with higher professional fees, employee costs, and leased-equipment depreciation.
- Credit costs: Loan and lease loss provision rose to $3.8 million from $1.0 million. Net charge-offs were $0.3 million versus net recoveries of $0.6 million a year earlier. The allowance was $98.3 million, or 2.10% of loans and leases, compared with 2.13% a year earlier.
- Assets and lending: Total assets were $6.05 billion, up 2.8% since year-end. Loans and leases grew 3.6% to $4.69 billion; growth was $163.4 million versus $46.8 million in Q1 2017. Deposits increased 0.6% to $4.78 billion; available-for-sale securities increased 4.2% to $942.1 million.
- Credit quality: Nonperforming assets rose to $36.1 million from $31.3 million at year-end and $27.5 million a year earlier; they equaled 0.74% of loans and leases, versus 0.63% a year earlier. Nonaccrual loans and leases were $25.4 million. Delinquencies of 30 days or more were 0.27% of outstandings, versus 0.17% a year earlier.
- Cash flow and liquidity: Operating cash flow was $34.3 million; investing outflow was $223.8 million, largely reflecting loan growth and securities purchases; financing inflow was $162.6 million. Cash and cash equivalents declined $26.9 million during the quarter to $51.2 million. Management said funding sources were adequate. At quarter-end, disclosed additional borrowing capacity included $245 million from correspondent banks, $50.1 million from the FHLB, and $560.7 million from the Federal Reserve.
- Debt and capital: Short-term borrowings increased $141.4 million from year-end to $356.0 million, while deposits were $4.78 billion. Shareholders’ equity was $725.6 million; the equity-to-assets ratio was 11.99%. The company reported total capital of 14.54%, Tier 1 capital of 13.29%, and common equity Tier 1 of 12.22%, all above stated regulatory minimums. The quarterly dividend was $0.22 per share.
Material changes, outlook, and risks
- Management attributed stronger earnings mainly to higher net interest income and lower income tax expense, partly offset by increased credit provision and operating expenses. The effective tax rate fell to 23.52% from 34.95%, primarily reflecting the federal corporate tax rate reduction from 35% to 21%.
- Other comprehensive loss was $6.9 million, principally from unrealized depreciation in available-for-sale securities; accumulated other comprehensive loss widened to $10.9 million. Management said it did not intend to sell the securities in an unrealized-loss position and did not consider them impaired for credit reasons.
- Management cited loan growth and a slight increase in special-attention credits and nonaccrual loans as factors in the higher provision. It highlighted aircraft collateral concentration and foreign aircraft exposure of $241.3 million, including Brazil and Mexico, as well as potential economic, trade, political, and geopolitical risks. Delinquency increases were attributed largely to aircraft and construction-equipment portfolios.
- Off-balance-sheet exposures included $1.03 billion of loan commitments and $31.4 million of standby letters of credit; commitment totals do not necessarily represent expected funding needs. Management noted potential liquidity exposure of approximately $680 million if collateral were required for public-fund deposits.
- No specific earnings or growth guidance was provided. Management cautioned that forward-looking results are subject to interest-rate, economic, regulatory, competitive, and industry-concentration risks. It reported no material changes to risk factors or market risks since year-end; routine legal proceedings were not expected to materially affect results.
- Unusual accounting and tax items: the company early adopted guidance permitting a $0.72 million transfer from accumulated other comprehensive income to retained earnings. It also said its accounting for certain Tax Cuts and Jobs Act effects remained provisional. The company estimated $7–$10 million of right-of-use assets and lease liabilities upon expected lease-standard adoption on January 1, 2019.
Important facts for investors to verify
- Whether the rise in nonaccrual loans, nonperforming assets, and delinquencies continues, especially in aircraft, auto/light-truck, and construction-equipment lending.
- Whether loan growth and portfolio risk require further increases in the allowance or credit-loss provision.
- How higher deposit and borrowing costs affect net interest margin as rates and funding mix change.
- Whether increased short-term borrowings and reduced cash balances remain consistent with the company’s liquidity needs and available borrowing capacity.
- How aircraft and foreign exposures, including Brazil and Mexico, perform amid market, political, and trade uncertainty.
- Final tax-reform accounting, securities portfolio valuation and losses, and implementation estimates for the new lease and credit-loss standards.