1st Source Corporation — Q2 2013 Form 10-Q
Business context and reporting period
1st Source is an Indiana bank holding company providing financial products and services through its subsidiaries. This unaudited filing covers the quarter and six months ended June 30, 2013; comparisons are with the corresponding 2012 periods or December 31, 2012, as applicable. Dollar amounts below are in millions unless stated otherwise.
Financial and operating highlights
| Metric | Q2 / June 30, 2013 | Comparison |
|---|---|---|
| Net income | $13.94; diluted EPS $0.56 | Up from $12.57 and $0.51 in Q2 2012 |
| Six-month net income | $26.35; diluted EPS $1.07 | Up from $24.28 and $0.99 in 2012 |
| Net interest income | $38.87 reported for Q2; $76.63 for six months | Six-month figure up from $75.36; taxable-equivalent NII was $39.32 for Q2 and $77.54 for six months |
| Net interest margin | 3.65% taxable-equivalent for Q2; 3.64% for six months | Down 5 and 10 basis points, respectively, year over year |
| Noninterest income | $20.12 Q2; $39.07 six months | Q2 up 1.7%; six months down 3.1% |
| Noninterest expense | $35.74 Q2; $72.29 six months | Down 2.3% and 3.1%, respectively |
| Provision for loan and lease losses | $1.29 Q2; $2.05 six months | Down from $2.06 and $4.31, respectively |
| Total assets | $4,638.8 | Up 1.9% from year-end 2012 |
| Loans and leases | $3,493.4 gross; $3,407.7 net | Gross loans up 5.0% from year-end |
| Deposits | $3,700.8 | Up 2.1% from year-end |
| Shareholders’ equity | $567.8; equity-to-assets ratio 12.24% | Equity up 1.6%; ratio was 12.28% at year-end |
Net interest income benefited from loan growth and lower funding costs, while asset yields declined in the low-rate environment. Average earning assets rose 3.5% in Q2 and 4.4% in the first half year over year; average earning-asset yields fell 27 and 30 basis points, respectively. The lower cost of interest-bearing liabilities partly offset that pressure.
Six-month operating cash flow was $41.5, investing cash outflow was $146.6, and financing cash inflow was $89.2. Cash and cash equivalents ended at $68.0, down from $83.9 at year-end. Total short-term borrowings were $201.9; long-term debt and mandatorily redeemable securities were $58.2, and subordinated notes were $58.8.
Material changes and credit quality
- Nonperforming assets declined to $36.0 from $42.3 at year-end 2012 and $55.8 at June 30, 2012; they were 1.01% of loans and leases, versus 1.25% and 1.67%, respectively. Nonaccrual loans and leases fell to $29.3 from $36.4 at year-end.
- The allowance for loan and lease losses was $85.7, or 2.45% of loans and leases, compared with $83.3 at year-end and 2.55% a year earlier. First-half net recoveries were $0.33, versus net charge-offs of $2.65 in the first half of 2012.
- Loan growth was broad, with notable increases in auto/light truck/equipment, construction equipment, commercial real estate, and consumer lending. Foreign loans and leases, all in aircraft financing, were $265.1, mainly in Brazil ($159.1) and Mexico ($60.9).
- Available-for-sale securities declined to $828.3 from $880.8 at year-end. A $11.7 after-tax first-half unrealized securities loss reduced accumulated other comprehensive income to $7.8 from $19.5. Management reported no credit-quality impairment and no intent or expected need to sell the securities before recovery.
Outlook, commentary, risks and unusual items
- No earnings or financial guidance is provided. Management said current funding sources were adequate for expected cash-flow needs. At June 30, borrowing capacity included approximately $213.0 from correspondent banks, $133.0 additional FHLB capacity, and $343.2 available from the Federal Reserve, with no FRB borrowing outstanding.
- Management cited improving economic conditions and asset sales as contributors to declining nonperforming assets, but noted ongoing commercial real estate borrower stress and historical declines in aircraft collateral values; aircraft values appeared to stabilize in 2013. Commercial real estate was the largest impaired-loan industry exposure, approximately $14.6.
- Equipment rental income fell 19.2% year to date, reflecting a smaller rental portfolio, lower new-lease rates, and competition. Service-charge income also declined as nonsufficient-funds transaction volumes fell.
- Other expense rose $0.8 year to date, primarily in connection with a previously reported trustee matter. Management did not expect the outcome of legal proceedings to materially adversely affect consolidated financial position or results.
- Management identified interest-rate changes, loan prepayment assumptions, economic downturns, concentrated-industry exposure, regulation, and competition among forward-looking risks. It reported no material changes in market risks or risk factors since year-end 2012.
- Capital ratios exceeded the disclosed regulatory minimums at June 30. The company reported total risk-based capital ratios of 15.55% for the holding company and 14.84% for the bank. Basel III rules issued in July 2013 were expected to take effect for the company January 1, 2015.
Most important facts for investors to verify
- Whether loan growth continues without reversing the improvement in nonperforming assets, delinquencies, and net charge-offs.
- Whether net interest margin pressure from lower asset yields persists despite lower deposit and borrowing costs.
- How securities-market value changes affect accumulated other comprehensive income and capital; verify management’s assumptions about recovery and ability to hold securities.
- Developments in commercial real estate and aircraft-finance credit exposure, including foreign aircraft lending and collateral values.
- The amount and resolution of costs associated with the previously reported trustee matter, and the effect of rising operating expenses in selected categories.
- Future liquidity, funding mix, borrowing availability, and capital requirements as Basel III implementation approaches.