UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q/A
(Amendment No. 1)
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2020
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-6233
1st Source Corporation
(Exact name of registrant as specified in its charter)
Indiana | 35-1068133 | |||||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
100 North Michigan Street | ||||||||||||||
South Bend, | IN | 46601 | ||||||||||||
(Address of principal executive offices) | (Zip Code) |
(574) 235-2000
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||||||||
Common Stock - without par value | SRCE | The NASDAQ Stock Market LLC |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). x Yes o No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer | x | Accelerated filer | ☐ | |||||||||||||||||
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | |||||||||||||||||
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes x No
Number of shares of common stock outstanding as of July 17, 2020 — 25,550,365 shares
EXPLANATORY NOTE
1st Source Corporation (the Registrant) is filing this amendment to its Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, as filed with the Securities and Exchange on July 23, 2020, solely to amend the “Coronavirus (COVID-19) Impact” section of Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations of Part I. The table providing information about coronavirus loan and lease modifications was inaccurate with regards to the breakdown between principal only deferrals and principal and interest deferrals of COVID-19 related loan and lease modification balances as of June 30, 2020.
This Form 10-Q/A includes only the Cover Page to this Form 10-Q/A, this Explanatory Note, Part I. Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations, as amended, the Signature Page and Exhibits 31.1, 31.2, 32.1, and 32.2. This Form 10-Q/A speaks as of the original filing date of the Form 10-Q and except as specifically noted above, does not modify or update in any way disclosures in the original Form 10-Q and does not reflect events that may have occurred subsequent to the original filing date.
TABLE OF CONTENTS
Page | |||||||||||
EXHIBITS | |||||||||||
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PART I. FINANCIAL INFORMATION
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management’s discussion and analysis is presented to provide information concerning 1st Source Corporation and its subsidiaries’ (collectively referred to as “the Company”, “we”, and “our”) financial condition as of June 30, 2020, as compared to December 31, 2019, and the results of operations for the three and six months ended June 30, 2020 and 2019. This discussion and analysis should be read in conjunction with our consolidated financial statements and the financial and statistical data appearing elsewhere in this report and our 2019 Annual Report.
Except for historical information contained herein, the matters discussed in this document express “forward-looking statements.” Generally, the words “believe,” “contemplate,” “seek,” “plan,” “possible,” “assume,” “expect,” “intend,” “targeted,” “continue,” “remain,” “estimate,” “anticipate,” “project,” “will,” “should,” “indicate,” “would,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Those statements, including statements, projections, estimates or assumptions concerning future events or performance, and other statements that are other than statements of historical fact, are subject to material risks and uncertainties. We caution readers not to place undue reliance on any forward-looking statements, which speak only as of the date made. We may make other written or oral forward-looking statements from time to time. Readers are advised that various important factors could cause our actual results or circumstances for future periods to differ materially from those anticipated or projected in such forward-looking statements. Such factors include, but are not limited to, changes in law, regulations or GAAP; our competitive position within the markets we serve; increasing consolidation within the banking industry; unforeseen changes in interest rates; unforeseen changes in loan prepayment assumptions; unforeseen downturns in or major events affecting the local, regional or national economies or the industries in which we have credit concentrations; more recently, potential impacts of the COVID-19 pandemic; and other matters discussed in our filings with the SEC, including our Annual Report on Form 10-K for 2019, which filings are available from the SEC. We undertake no obligation to publicly update or revise any forward-looking statements.
FINANCIAL CONDITION
Our total assets at June 30, 2020 were $7.37 billion, an increase of $742.37 million or 11.21% from December 31, 2019. Total investment securities, available-for-sale were $1.06 billion, an increase of $15.21 million or 1.46% from December 31, 2019. Federal funds sold and interest bearing deposits with other banks were $112.65 million, an increase of $96.50 million or 597.49% from December 31, 2019.
Total loans and leases were $5.69 billion, an increase of $606.80 million or 11.93% from December 31, 2019. The largest contributor to the increase in loans and leases was PPP loans funded during the second quarter of 2020. PPP loans are discussed in the “COVID-19 Impact” section below. Our foreign loan and lease balances, all denominated in U.S. dollars were $160.41 million and $184.24 million as of June 30, 2020 and December 31, 2019, respectively. Foreign loans and leases are in aircraft financing. Loan and lease balances to borrowers in Brazil and Mexico were $44.28 million and $109.36 million as of June 30, 2020, respectively, compared to $58.29 million and $111.91 million as of December 31, 2019, respectively. As of June 30, 2020 and December 31, 2019 there was not a significant concentration in any other country. Solar loan and lease balances were $248.40 million as of June 30, 2020, an increase of $78.78 million or 46.45% from the $169.62 million at December 31, 2019. Solar loan and lease balances are included in commercial and agricultural loans. Equipment owned under operating leases was $86.18 million, a decrease of $25.50 million, or 22.83% compared to December 31, 2019. The largest contributor to the decrease in equipment owned under operating leases was reduced leasing volume primarily due to a change in customer preferences.
Total deposits were $5.99 billion, an increase of $636.13 million or 11.87% from the end of 2019. The largest contributors to the increase in total deposits was PPP loan fundings into business accounts and government stimulus payments. Short-term borrowings were $177.02 million, an increase of $31.13 million or 21.33% from December 31, 2019. Long-term debt and mandatorily redeemable securities were $81.76 million, an increase of $10.12 million or 14.13% from December 31, 2019.
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The following table shows accrued income and other assets.
(Dollars in thousands) | June 30, 2020 | December 31, 2019 | ||||||||||||
Accrued income and other assets: | ||||||||||||||
Bank owned life insurance cash surrender value | $ | 69,879 | $ | 68,774 | ||||||||||
Operating lease right of use assets | 22,744 | 24,147 | ||||||||||||
Accrued interest receivable | 20,976 | 19,125 | ||||||||||||
Mortgage servicing rights | 3,748 | 4,200 | ||||||||||||
Other real estate | 303 | 522 | ||||||||||||
Repossessions | 6,132 | 8,623 | ||||||||||||
Partnership investments carrying amount | 77,147 | 61,083 | ||||||||||||
All other assets | 78,390 | 41,516 | ||||||||||||
Total accrued income and other assets | $ | 279,319 | $ | 227,990 |
The largest contributors to the increase in accrued income and other assets from December 31, 2019 was an increase in the fair value of interest rate swaps contracts with customers and higher partnership investment carrying amounts.
CORONAVIRUS (COVID-19) IMPACT
The following is a description of the impact the Coronavirus (COVID-19) pandemic is having on our financial condition and results of operations and certain risks to our business that the pandemic creates or exacerbates.
Operational Impact
As part of our contingency and disaster recovery plans for pandemic outbreaks, we created a dedicated executive COVID-19 response team that is closely monitoring developments and providing guidance for additional precautions and initiatives. We have established separate teams within departments to help ensure that infection will not spread across entire departments. We are encouraging virtual meetings and conference calls in place of in-person meetings, including our annual shareholder meeting which was held virtually this year. Employees with health conditions putting them at higher risk of adverse effects from coronavirus infection are working remotely. Additionally, travel has been restricted. We are promoting social distancing, frequent hand washing, thorough disinfection of all surfaces, and the use of masks or nose and mouth coverings have been mandated in all of our locations. Our banking center lobbies have been closed except for advance appointments only. Banking center drive-ups, ATMs and online/mobile banking services continue to operate. It remains undetermined how long our banking centers will operate at these service levels. Infection rates in the communities we serve vary by region and we will make prudent decisions for the safety of our colleagues and our clients.
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Loan and lease modifications
We began receiving requests from our borrowers for loan and lease deferrals in March. Modifications include the deferral of principal payments or the deferral of principal and interest payments for terms generally 90 - 180 days. Requests are evaluated individually and approved modifications are based on the unique circumstances of each borrower. We are committed to working with our clients to allow time to work through the challenges of this pandemic. At this time, it is uncertain what future impact loan and lease modifications related to COVID-19 difficulties will have on our financial condition, results of operations and reserve for loan and lease losses. The following table shows coronavirus loan and lease modification balances as of June 30, 2020.
(Dollars in millions) | Principal Only Deferrals | Principal and Interest Deferrals | Total COVID-19 Related Modifications | Recorded Investment at June 30, 2020 | Modifications as a % of June 30, 2020 Balance | |||||||||||||||||||||||||||||||||||||||||||||||||||
Auto and light truck rental | $ | 170 | $ | 54 | $ | 224 | $ | 411 | 55 | % | ||||||||||||||||||||||||||||||||||||||||||||||
Specialty vehicle(1) | 2 | 73 | 75 | 153 | 49 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Medium and heavy duty truck | 87 | — | 87 | 284 | 31 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Aircraft | 80 | 13 | 93 | 782 | 12 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Construction | 120 | 19 | 139 | 739 | 19 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Commercial | 129 | 81 | 210 | 2,654 | 8 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Residential real estate and home equity | 2 | 2 | 4 | 532 | 1 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Consumer | — | 8 | 8 | 137 | 6 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Total loans | 590 | 250 | 840 | 5,692 | 15 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
PPP loans, net of unearned discount(2) | — | — | — | 573 | — | % | ||||||||||||||||||||||||||||||||||||||||||||||||||
Total loans less PPP loans | $ | 590 | $ | 250 | $ | 840 | $ | 5,119 | 16 | % | ||||||||||||||||||||||||||||||||||||||||||||||
(1) Includes motor coaches, shuttle buses, step vans, work trucks and funeral cars. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(2) PPP loan balances are located within the Commercial category above. |
Paycheck Protection Program (PPP) and Liquidity
As part of the CARES Act, approved by the President on March 27, 2020 and extended on July 4, 2020, the Small Business Administration (SBA) has been authorized to guarantee loans under the PPP through August 8, 2020 for businesses who meet the necessary eligibility requirements in order to keep their workers on the payroll. We began accepting applications on April 3, 2020. PPP loans are fully guaranteed by the SBA and as such do not represent a credit risk. The following table shows PPP loan disbursements as of June 30, 2020.
Number of Loans | $ of Loans (000's) | Average Loan Size | ||||||||||||||||||
Phase One | 2,024 | $ | 520,583 | $ | 257,000 | |||||||||||||||
Phase Two | 1,326 | 71,649 | 54,000 | |||||||||||||||||
Total | 3,350 | $ | 592,232 | $ | 177,000 |
As of June 30, 2020, PPP loans were $573.15 million which is net of an unearned discount of $16.43 million and located within the commercial and agricultural portfolio. At June 30, 2020, specialty finance customers had $103.43 million of PPP loans and traditional commercial banking customers had $469.72 million of PPP loans.
On April 9, 2020, the FDIC, Federal Reserve and OCC created the Paycheck Protection Program Liquidity Facility (PPPLF) to bolster the effectiveness of the PPP by providing liquidity to and neutralizing the regulatory capital effects on participating financial institutions. We intend to utilize the liquidity relief offered by the PPPLF to the extent needed and as such do not expect our participation in the PPP to have a negative impact on our liquidity position, capital resources, financial condition or results of operations. As of June 30, 2020, we had not yet utilized the PPPLF.
See Part I Financial Information, Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “Capital” for more information regarding the COVID-19 impact on share repurchases and dividend activity.
Asset impairment
Our MSRs have experienced a decrease in their fair value as of June 30, 2020 resulting in impairment charges of $0.55 million due to decreased mortgage rates leading to faster prepayment speeds. We will continue to evaluate MSRs at each reporting date to determine whether further valuation allowances are appropriate.
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We evaluate goodwill for impairment during the fourth quarter of each year, with financial data as of September 30. Based on the analysis performed as of October 1, 2019, we determined that goodwill for our reporting units was not impaired. During the first quarter of 2020, management determined that the deterioration in general economic conditions as a result of the COVID-19 pandemic and responses thereto represented a triggering event prompting an evaluation of goodwill impairment. Based on the analyses performed during the first and second quarters of 2020, we determined that goodwill was not impaired.
At this time, we do not believe there exists any impairment to our intangible assets, long-lived assets, right of use assets, or available-for-sale investment securities due to the COVID-19 pandemic. It is uncertain whether prolonged effects of the COVID-19 pandemic will result in future impairment charges related to any of the aforementioned assets.
Risks
See Part II Other Information, Item 1A, Risk Factors for more information.
Reserve for loan and lease losses
We have experienced increasing downgrades and defaults as a result of the impact COVID-19 is having on our borrowers as evidenced by increasing special attention and non-performing loan balances. Special attention loan balances increased $46.72 million in the second quarter of 2020 and $67.58 million since December 31, 2019 and we anticipate further downgrades during the latter half of 2020 and into 2021. Likewise, non-performing loans increased by $36.56 million during the second quarter and $52.96 million since year-end. Second quarter 2020 downgrades were concentrated in auto rental and bus segments within the auto and light truck portfolio as well as a couple of industry specific downgrades in the construction equipment portfolio. We are in communication with our customers to gain a better understanding of our highest risk exposures and probable defaults. This quarter, we sent questionnaires to all of our bus customers in order to better understand their current situations, their customer bases and the likely long-term impact of the economic downturn on their business models, i.e. their ability to withstand reduced revenues for an extended period of time. As a result of the responses and discussions with our customers, we downgraded an additional eleven bus accounts to special attention and placed several of these accounts on nonaccrual status. We anticipate further defaults in our bus lending during the third quarter of 2020. Furthermore, the bus collateral may be difficult to liquidate, particularly in this environment. We believe our auto rental customers will continue to struggle; however, vehicle auctions are well established and are an effective means of liquidating collateral and used vehicle values, to date, have remained strong, so our loss exposure, with the exception of possible fraud, is well managed. Our local market customers have been buoyed in the short-term with funds from the PPP program. Thus far, we have not seen many downgrades or defaults in our commercial lending, but we anticipate this will change particularly as businesses continue to struggle. During the last recession, we also noted a delayed impact on our commercial lending as compared to our specialty finance lending. Our losses year-to-date remain low but we continue to build reserves as we anticipate some of the current and future downgrades and defaults will eventually result in losses.
See Part I Financial Information, Note 5 to the Consolidated Financial Statements and Part I Financial Information, Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations under the heading “Provision and Reserve for Loan and Lease Losses” for more information.
CAPITAL
As of June 30, 2020, total shareholders’ equity was $865.00 million, up $36.72 million, or 4.43% from the $828.28 million at December 31, 2019. In addition to net income of $34.92 million, other significant changes in shareholders’ equity during the first six months of 2020 included $14.58 million of dividends paid. The accumulated other comprehensive income component of shareholders’ equity totaled $19.89 million at June 30, 2020, compared to $5.17 million at December 31, 2019. Our shareholders’ equity-to-assets ratio was 11.74% as of June 30, 2020, compared to 12.51% at December 31, 2019. Book value per common share rose to $33.85 at June 30, 2020, from $32.47 at December 31, 2019.
We declared and paid cash dividends per common share of $0.28 during the second quarter of 2020. The trailing four quarters dividend payout ratio, representing cash dividends per common share divided by diluted earnings per common share, was 35.65%. The dividend payout is continually reviewed by management and the Board of Directors subject to the Company’s capital and dividend policy. Due to COVID-19, we have temporarily suspended the repurchase of common shares from the open market. Management and the Board of Directors will evaluate future share repurchases and dividend payments based on a careful examination of facts and circumstances at such time and in accordance with the Company’s capital and dividend policy.
The banking regulators have established guidelines for leverage capital requirements, expressed in terms of Tier 1 or core capital as a percentage of average assets, to measure the soundness of a financial institution. In addition, banking regulators have established risk-based capital guidelines for U.S. banking organizations.
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The actual capital amounts and ratios of 1st Source Corporation and 1st Source Bank as of June 30, 2020, are presented in the table below.
Actual | Minimum Capital Adequacy | Minimum Capital Adequacy with Capital Buffer | To Be Well Capitalized Under Prompt Corrective Action Provisions | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | Amount | Ratio | Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total Capital (to Risk-Weighted Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Corporation | $ | 934,880 | 15.58 | % | $ | 479,935 | 8.00 | % | $ | 629,915 | 10.50 | % | $ | 599,919 | 10.00 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Bank | 848,568 | 14.13 | 480,442 | 8.00 | 630,580 | 10.50 | 600,553 | 10.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Tier 1 Capital (to Risk-Weighted Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Corporation | 859,152 | 14.32 | 359,951 | 6.00 | 509,931 | 8.50 | 479,935 | 8.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Bank | 772,761 | 12.87 | 360,332 | 6.00 | 510,470 | 8.50 | 480,442 | 8.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Corporation | 765,494 | 12.76 | 269,964 | 4.50 | 419,943 | 7.00 | 389,947 | 6.50 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Bank | 736,103 | 12.26 | 270,249 | 4.50 | 420,387 | 7.00 | 390,359 | 6.50 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Tier 1 Capital (to Average Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Corporation | 859,152 | 12.12 | 283,609 | 4.00 | N/A | N/A | 354,511 | 5.00 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1st Source Bank | 772,761 | 10.90 | 283,585 | 4.00 | N/A | N/A | 354,481 | 5.00 |
As part of the CARES Act, PPP loan balances have been assigned a zero percent risk weight and therefore had no impact on our total risk-weighted assets at June 30, 2020.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Effective liquidity management ensures that the cash flow requirements of depositors and borrowers, as well as our operating cash needs are met. Funds are available from a number of sources, including the securities portfolio, the core deposit base, access to the national brokered certificates of deposit market, national listing service certificates of deposit, Federal Home Loan Bank (FHLB) borrowings, Federal Reserve Bank (FRB) borrowings, and the capability to package loans for sale.
We have borrowing sources available to supplement deposits and meet our funding needs. 1st Source Bank has established relationships with several banks to provide short term borrowings in the form of federal funds purchased. At June 30, 2020, we had no borrowings in the federal funds market. We could borrow $225.00 million in additional funds for a short time from these banks on a collective basis. As of June 30, 2020, we had $55.48 million outstanding in FHLB advances and could borrow an additional $550.54 million contingent on the FHLB activity-based stock ownership requirement. We also had no outstandings with the FRB and could borrow $449.80 million as of June 30, 2020.
Our loan to asset ratio was 77.29% at June 30, 2020 compared to 76.79% at December 31, 2019 and 76.83% at June 30, 2019. Cash and cash equivalents totaled $180.24 million at June 30, 2020 compared to $83.37 million at December 31, 2019 and $96.49 million at June 30, 2019. The largest contributors to the increase in cash and cash equivalents was higher deposit balances from PPP loan fundings, customer receipts from the government’s Economic Impact Payment program and the Treasury Department’s and Internal Revenue Service’s decision to delay the deadline for tax filings and payments. At June 30, 2020, the Consolidated Statements of Financial Condition was rate sensitive by $303.41 million more assets than liabilities scheduled to reprice within one year, or approximately 1.09%. Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.
Under Indiana law governing the collateralization of public fund deposits, the Indiana Board of Depositories determines which financial institutions are required to pledge collateral based on the strength of their financial ratings. We have been informed that no collateral is required for our public fund deposits. However, the Board of Depositories could alter this requirement in the future and adversely impact our liquidity. Our potential liquidity exposure if we must pledge collateral is approximately $807 million.
RESULTS OF OPERATIONS
Net income available to common shareholders for the three and six month periods ended June 30, 2020 was $18.50 million and $34.92 million, compared to $23.39 million and $45.58 million for the same periods in 2019. Diluted net income per common share was $0.72 and $1.36 for the three and six month periods ended June 30, 2020, compared to $0.91 and $1.76 for the same periods in 2019. Return on average common shareholders’ equity was 8.23% for the six months ended June 30, 2020, compared to 11.75% in 2019. The return on total average assets was 1.02% for the six months ended June 30, 2020, compared to 1.44% in 2019.
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Net income decreased for the six months ended June 30, 2020 compared to the first six months of 2019. Net interest income decreased and the provision for loan and lease losses increased which was offset by a decrease in noninterest expense. Details of the changes in the various components of net income are discussed further below.
NET INTEREST INCOME
The following tables provide an analysis of net interest income and illustrates the interest income earned and interest expense charged for each major component of interest earning assets and interest bearing liabilities. Yields/rates are computed on a tax-equivalent basis, using a 21% rate. Nonaccrual loans and leases are included in the average loan and lease balance outstanding.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
Three Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
June 30, 2020 | March 31, 2020 | June 30, 2019 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | Average Balance | Interest Income/Expense | Yield/ Rate | Average Balance | Interest Income/Expense | Yield/ Rate | Average Balance | Interest Income/Expense | Yield/ Rate | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Investment securities available-for-sale: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Taxable | $ | 995,776 | $ | 4,487 | 1.81 | % | $ | 973,421 | $ | 5,550 | 2.29 | % | $ | 929,264 | $ | 5,186 | 2.24 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Tax exempt(1) | 49,534 | 286 | 2.32 | % | 57,219 | 325 | 2.28 | % | 71,878 | 437 | 2.44 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Mortgages held for sale | 27,016 | 198 | 2.95 | % | 11,294 | 96 | 3.42 | % | 12,014 | 127 | 4.24 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Loans and leases, net of unearned discount(1) | 5,565,160 | 58,700 | 4.24 | % | 5,098,397 | 61,520 | 4.85 | % | 5,001,392 | 65,565 | 5.26 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other investments | 89,525 | 316 | 1.42 | % | 41,463 | 346 | 3.36 | % | 53,323 | 499 | 3.75 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total earning assets(1) | 6,727,011 | 63,987 | 3.83 | % | 6,181,794 | 67,837 | 4.41 | % | 6,067,871 | 71,814 | 4.75 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cash and due from banks | 73,523 | 65,407 | 67,448 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Reserve for loan and lease losses | (124,186) | (112,239) | (102,787) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other assets | 509,058 | 476,159 | 455,212 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total assets | $ | 7,185,406 | $ | 6,611,121 | $ | 6,487,744 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Interest-bearing deposits | $ | 4,248,478 | $ | 8,265 | 0.78 | % | $ | 4,076,270 | $ | 10,851 | 1.07 | % | $ | 4,137,118 | $ | 12,978 | 1.26 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Short-term borrowings | 191,411 | 90 | 0.19 | % | 202,545 | 254 | 0.50 | % | 201,401 | 540 | 1.08 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Subordinated notes | 58,764 | 835 | 5.71 | % | 58,764 | 884 | 6.05 | % | 58,764 | 928 | 6.33 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Long-term debt and mandatorily redeemable securities | 81,766 | 659 | 3.24 | % | 77,973 | 853 | 4.40 | % | 71,308 | 764 | 4.30 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total interest-bearing liabilities | 4,580,419 | 9,849 | 0.86 | % | 4,415,552 | 12,842 | 1.17 | % | 4,468,591 | 15,210 | 1.37 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Noninterest-bearing deposits | 1,562,100 | 1,196,106 | 1,127,794 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other liabilities | 151,281 | 131,858 | 98,475 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Shareholders’ equity | 862,209 | 844,724 | 789,009 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Noncontrolling interests | 29,397 | 22,881 | 3,875 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total liabilities and equity | $ | 7,185,406 | $ | 6,611,121 | $ | 6,487,744 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Less: Fully tax-equivalent adjustments | (137) | (151) | (177) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin (GAAP-derived)(1) | $ | 54,001 | 3.23 | % | $ | 54,844 | 3.57 | % | $ | 56,427 | 3.73 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Fully tax-equivalent adjustments | 137 | 151 | 177 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin - FTE(1) | $ | 54,138 | 3.24 | % | $ | 54,995 | 3.58 | % | $ | 56,604 | 3.74 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(1) See “Reconciliation of Non-GAAP Financial Measures” at the end of this section for additional information on this performance measure/ratio. |
Quarter Ended June 30, 2020 compared to the Quarter Ended June 30, 2019
The taxable-equivalent net interest income for the three months ended June 30, 2020 was $54.14 million, a decrease of 4.36% over the same period in 2019. The net interest margin on a fully taxable-equivalent basis was 3.24% for the three months ended June 30, 2020, compared to 3.74% for the three months ended June 30, 2019.
During the three month period ended June 30, 2020, average earning assets increased $659.14 million, up 10.86% over the comparable period in 2019. Average interest-bearing liabilities increased $111.83 million or 2.50%. The yield on average earning assets decreased 92 basis points to 3.83% from 4.75% primarily due to lower rates on loans and leases and investment securities. Total cost of average interest-bearing liabilities decreased 51 basis points to 0.86% from 1.37% as a result of a lower interest rate environment during 2020. The result to the net interest margin, or the ratio of net interest income to average earning assets, was a decrease of 50 basis points.
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The largest contributor to the reduced yield on average earning assets for the three months ended June 30, 2020, compared to the three months ended June 30, 2019, was a decrease in yields on net loans and leases of 102 basis points primarily due to market conditions as a result of several Federal Reserve interest rate decreases during the second half of 2019 and first three months of 2020. The yield on net loans and leases was also negatively impacted by a net 16 basis points due to PPP loans which earn interest at 1.00% and negatively impacted by two basis points due to net interest reversals of $0.26 million in the second quarter of 2020. Average net loans and leases increased $563.77 million or 11.27% with the largest increase due to average PPP loans of $464.38 million in the commercial and agricultural loan portfolio. The construction equipment and commercial real estate portfolios also increased during the quarter as a result of market demand. Total average investment securities increased $44.17 million or 4.41%. Average mortgages held for sale increased $15.00 million or 124.87%. Average other investments, which include federal funds sold, time deposits with other banks, Federal Reserve Bank excess balances, Federal Reserve Bank and Federal Home Loan Bank (FHLB) stock and commercial paper increased $36.20 million or 67.89% from the second quarter of 2019.
Average interest-bearing deposits increased $111.36 million or 2.69% for the second quarter of 2020 over the same period in 2019 primarily due to government stimulus payments. The effective rate paid on average interest-bearing deposits decreased 48 basis points to 0.78% from 1.26%. The decrease in the average cost of interest-bearing deposits was primarily the result of lower rates and a shift in the deposit mix from the second quarter of 2019. Average noninterest-bearing deposits grew $434.31 million or 38.51% for the second quarter of 2020 over the same period in 2019 primarily due to PPP loan fundings in business accounts.
Average short-term borrowings decreased $9.99 million or 4.96% for the second quarter of 2020 compared to the same period in 2019. Interest paid on short-term borrowings decreased 89 basis points. Interest paid on subordinated notes decreased 62 basis points during the second quarter of 2020 from the same period a year ago due to a variable rate on one traunche. Average long-term debt and mandatorily redeemable securities balances increased $10.46 million or 14.67%. Interest paid on long-term debt and mandatorily redeemable securities decreased 106 basis points during the second quarter of 2020 from the same period in 2019 primarily due to lower rates on mandatorily redeemable securities.
Six Months Ended | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
June 30, 2020 | June 30, 2019 | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | Average Balance | Interest Income/Expense | Yield/ Rate | Average Balance | Interest Income/Expense | Yield/ Rate | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
ASSETS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Investment securities available-for-sale: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Taxable | $ | 984,598 | $ | 10,037 | 2.05 | % | $ | 919,398 | $ | 10,701 | 2.35 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Tax exempt(1) | 53,377 | 611 | 2.30 | % | 75,007 | 909 | 2.44 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Mortgages held for sale | 19,155 | 294 | 3.09 | % | 10,429 | 228 | 4.41 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Loans and leases, net of unearned discount(1) | 5,331,779 | 120,220 | 4.53 | % | 4,930,183 | 128,242 | 5.25 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other investments | 65,494 | 662 | 2.03 | % | 47,740 | 937 | 3.96 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total earning assets(1) | 6,454,403 | 131,824 | 4.11 | % | 5,982,757 | 141,017 | 4.75 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Cash and due from banks | 69,465 | 65,677 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Reserve for loan and lease losses | (118,212) | (102,245) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other assets | 492,608 | 443,421 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total assets | $ | 6,898,264 | $ | 6,389,610 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Interest-bearing deposits | $ | 4,162,374 | $ | 19,116 | 0.92 | % | $ | 4,036,578 | $ | 24,448 | 1.22 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Short-term borrowings | 196,978 | 344 | 0.35 | % | 226,252 | 1,471 | 1.31 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Subordinated notes | 58,764 | 1,719 | 5.88 | % | 58,764 | 1,856 | 6.37 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Long-term debt and mandatorily redeemable securities | 79,870 | 1,512 | 3.81 | % | 70,897 | 1,508 | 4.29 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total interest-bearing liabilities | 4,497,986 | 22,691 | 1.01 | % | 4,392,491 | 29,283 | 1.34 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Noninterest-bearing deposits | 1,379,103 | 1,126,126 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other liabilities | 141,570 | 85,899 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Shareholders’ equity | 853,467 | 782,370 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Noncontrolling interests | 26,138 | 2,724 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total liabilities and equity | $ | 6,898,264 | $ | 6,389,610 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Less: Fully tax-equivalent adjustments | (288) | (359) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin (GAAP-derived)(1) | $ | 108,845 | 3.39 | % | $ | 111,375 | 3.75 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Fully tax-equivalent adjustments | 288 | 359 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin - FTE(1) | $ | 109,133 | 3.40 | % | $ | 111,734 | 3.77 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(1) See “Reconciliation of Non-GAAP Financial Measures” at the end of this section for additional information on this performance measure/ratio. |
9
Six Months Ended June 30, 2020 compared to the Six Months Ended June 30, 2019
The taxable-equivalent net interest income for the six months ended June 30, 2020 was $109.13 million, a decrease of 2.33% over the comparable period in 2019. The net interest margin on a fully taxable-equivalent basis was 3.40% compared to a net interest margin of 3.77% for the same period in 2019.
During the six month period ended June 30, 2020, average earning assets increased $471.65 million or 7.88% over the comparable period in 2019. Average interest-bearing liabilities increased $105.50 million or 2.40%. The yield on average earning assets decreased 64 basis points to 4.11% from 4.75% primarily due to lower rates on loans and leases and taxable investment securities available-for-sale. The total cost of average interest-bearing liabilities decreased 33 basis points to 1.01% from 1.34%. The result to the net interest margin, or the ratio of net interest income to average earning assets, was a decrease of 37 basis points.
The largest contributor to the lower yield on average earning assets for the six months ended June 30, 2020, compared to the six months ended June 30, 2019, was a decrease in yields on net loans and leases of 72 basis points primarily due to market conditions as a result of several Federal Reserve interest rate decreases during the second half of 2019 and first three months of 2020. The yield on net loans and leases was also negatively impacted by a net nine basis points due to PPP loan balances that earn interest at 1.00% and negatively impacted by two basis points due to net interest reversals of $0.17 million in 2020 vs. net interest recoveries of $0.08 million in 2019. Average net loans and leases increased $401.60 million or 8.15% primarily due to average PPP loan balances of $232.19 million in the commercial and agricultural portfolio and also due to increases in the commercial real estate portfolio as a result of market demand. Total average investment securities increased $43.57 million or 4.38%. Average mortgages held for sale increased $8.73 million or 83.67%. Average other investments, which include federal funds sold, time deposits with other banks, Federal Reserve bank excess balances, Federal Reserve Bank and FHLB stock and commercial paper, increased $17.75 million or 37.19%.
Average interest-bearing deposits increased $125.80 million or 3.12% for the first six months of 2020 over the same period in 2019 largely due to government stimulus payments in the second quarter. The effective rate paid on average interest-bearing deposits decreased 30 basis points to 0.92% compared to 1.22%. The decrease in the average cost of interest-bearing deposits was primarily the result of lower rates and a shift in the deposit mix. Average noninterest-bearing deposits grew $252.98 million or 22.46% for the first six months of 2020 over the same period in 2019 primarily due to PPP loan fundings in business accounts.
Average short-term borrowings decreased $29.27 million or 12.94% for the first six months of 2020 compared to the same period in 2019. Interest paid on short-term borrowings decreased 96 basis points. The decrease in short-term borrowings was primarily the result of lower borrowings with the FHLB. Interest paid on subordinated notes decreased 49 basis points due to a variable rate associated with one traunche. Average long-term debt and mandatorily redeemable securities increased $8.97 million or 12.66%. Interest paid on long-term debt and mandatorily redeemable securities decreased 48 basis points due to lower rates on mandatorily redeemable securities.
Reconciliation of Non-GAAP Financial Measures
The accounting and reporting policies of 1st Source conform to generally accepted accounting principles (“GAAP”) in the United States and prevailing practices in the banking industry. However, certain non-GAAP performance measures are used by management to evaluate and measure the Company’s performance. These include taxable-equivalent net interest income (including its individual components) and net interest margin (including its individual components). Management believes that these measures provide users of the Company’s financial information a more meaningful view of the performance of the interest-earning assets and interest-bearing liabilities.
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Management reviews yields on certain asset categories and the net interest margin of the Company and its banking subsidiaries on a fully taxable-equivalent (“FTE”) basis. In this non-GAAP presentation, net interest income is adjusted to reflect tax-exempt interest income on an equivalent before-tax basis. This measure ensures comparability of net interest income arising from both taxable and tax-exempt sources.
Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||
(Dollars in thousands) | June 30, 2020 | March 31, 2020 | June 30, 2019 | June 30, 2020 | June 30, 2019 | |||||||||||||||||||||||||||
Calculation of Net Interest Margin | ||||||||||||||||||||||||||||||||
(A) | Interest income (GAAP) | $ | 63,850 | $ | 67,686 | $ | 71,637 | $ | 131,536 | $ | 140,658 | |||||||||||||||||||||
Fully tax-equivalent adjustments: | ||||||||||||||||||||||||||||||||
(B) | - Loans and leases | 83 | 90 | 93 | 173 | 188 | ||||||||||||||||||||||||||
(C) | - Tax-exempt investment securities | 54 | 61 | 84 | 115 | 171 | ||||||||||||||||||||||||||
(D) | Interest income - FTE (A+B+C) | 63,987 | 67,837 | 71,814 | 131,824 | 141,017 | ||||||||||||||||||||||||||
(E) | Interest expense (GAAP) | 9,849 | 12,842 | 15,210 | 22,691 | 29,283 | ||||||||||||||||||||||||||
(F) | Net interest income (GAAP) (A–E) | 54,001 | 54,844 | 56,427 | 108,845 | 111,375 | ||||||||||||||||||||||||||
(G) | Net interest income - FTE (D–E) | 54,138 | 54,995 | 56,604 | 109,133 | 111,734 | ||||||||||||||||||||||||||
(H) | Annualization factor | 4.022 | 4.022 | 4.011 | 2.011 | 2.017 | ||||||||||||||||||||||||||
(I) | Total earning assets | $ | 6,727,011 | $ | 6,181,794 | $ | 6,067,871 | $ | 6,454,403 | $ | 5,982,757 | |||||||||||||||||||||
Net interest margin (GAAP-derived) (F*H)/I | 3.23 | % | 3.57 | % | 3.73 | % | 3.39 | % | 3.75 | % | ||||||||||||||||||||||
Net interest margin - FTE (G*H)/I | 3.24 | % | 3.58 | % | 3.74 | % | 3.40 | % | 3.77 | % |
PROVISION AND RESERVE FOR LOAN AND LEASE LOSSES
The provision for loan and lease losses for the three and six months ended June 30, 2020 was $10.38 million and $21.73 million compared to a provision for loan and lease losses in the three and six months ended June 30, 2019 of $4.25 million and $9.17 million. Net recoveries of $0.11 million or (0.01)% of average loans and leases were recorded for the second quarter 2020, compared to net charge-offs of $1.19 million or 0.10% of average loans and leases for the same quarter a year ago. Year-to-date net charge-offs of $1.70 million or 0.06% of average loans and leases have been recorded in 2020, compared to net charge-offs of $4.72 million or 0.19% of average loans and leases through June 30, 2019.
The provision for the three months ended June 30, 2020 was principally driven by increases in special attention loan balances and nonperforming loans. Loan growth this quarter was related to the PPP loan program. The Bank funded $592 million under this program, which carries a 100% SBA guarantee and a debt forgiveness component by the CARES Act, thus PPP loans did not drive a material increase in the provision. The Bank established a small reserve against this pool of loans to cover procedural and other unanticipated risks. Five accounts with loan balances greater than $5 million were downgraded to special attention this quarter, three in the auto and light truck portfolio, one in the construction equipment portfolio and one construction-related account which is included in the commercial and agricultural portfolio as our exposure is a line of credit secured by accounts receivable and inventory. Of these five accounts, two of the auto and light truck accounts and the line of credit were placed in nonaccrual status in June. The line of credit has a large impairment reserve and the nonperforming auto account also has an impairment reserve. The construction equipment account downgraded last quarter which had a sizeable impairment reserve continues to have a similar impairment reserve this quarter. We continued to have COVID-19 related downgrades this quarter, including all five large-dollar accounts plus numerous additional accounts with less exposure. There were 21 accounts greater than $100,000 downgraded to special attention this quarter compared to 29 last quarter and 40 accounts for all of 2019. The initial wave of customers experiencing difficulties related to shutdowns imposed to reduce the spread of the coronavirus were primarily in the transportation (including auto rental and bus) and hotel industries. As of June 30, 2020, COVID-19 related loan modifications for our bus lending were $70.05 million or 76% of our total bus loan balances and COVID-19 related loan modifications for the hotel industry were $83.33 million or 53% of our total hotel loan balances. This quarter, we also continued to see downgrades in these industries as well as in construction equipment. We extended PPP loans to 45 of our special attention customers aggregating $19.87 million.
We continue to evaluate risks which may impact our loan portfolios. Last quarter, as a result of the coronavirus pandemic and resultant business shutdowns and unemployment spikes, we reviewed our loan portfolio segments, assessing the likely impact of COVID-19 on each segment and established specific qualitative adjustment factors which we believe continue to be appropriate. We remain concerned that geopolitical events, particularly in the aftermath of the pandemic, will have the potential to further negatively impact the U.S. economy. Current concerns include slower growth projections for world economies and the sharp decline in global trade growth exacerbated by trade supply concerns raised during the pandemic and ongoing tariff disputes, particularly between China and the U.S. Political uncertainty continues in Latin America, with governments facing increased pressures with the pandemic and ongoing corruption scandals, fueling U.S. border concerns. Concerns continue to be heightened globally due to actual and potential terrorist attacks.
11
Another area of concern continues to be our aircraft portfolio where we have a collateral concentration and $160 million in foreign exposure. The majority of our foreign exposure is in Mexico and Brazil. As we ended 2019, the Brazilian economy was on a path of gradual improvement and Mexico’s economy, although stronger, was beginning to exhibit some weaknesses. Now, considering the pandemic, both are projected to contract in 2020. We continue to monitor individual customer performance and assess risks in the portfolio as a whole.
On June 30, 2020, 30 day and over loan and lease delinquencies as a percentage of loan and lease balances were 0.60%, compared to 0.37% on June 30, 2019. The reserve for loan and lease losses as a percentage of loans and leases outstanding at the end of the period was 2.31% compared to 2.05% one year ago. The reserve as a percentage of loans and leases outstanding, net of PPP loans, was 2.54%. The increase in the reserve as a percent of loans and leases outstanding was primarily due to higher special attention loan outstanding balances and qualitative adjustment factors related to COVID-19 concerns. A summary of loan and lease loss experience during the three and six months ended June 30, 2020 and 2019 is located in Note 5 of the Consolidated Financial Statements.
A loan or lease is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. We evaluate loans and leases exceeding $100,000 for impairment and establish a specific reserve as a component of the reserve for loan and lease losses when it is probable all amounts due will not be collected pursuant to the contractual terms of the loan or lease and the recorded investment in the loan or lease exceeds its fair value. A summary of impaired loans as of June 30, 2020 and December 31, 2019 is reflected in Note 4 of the Consolidated Financial Statements.
Current Expected Credit Losses (CECL)
As permitted by the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act), we opted to delay adoption of CECL until the earlier of the end of the coronavirus national emergency or December 31, 2020. We will recognize a one-time cumulative effect adjustment through retained earnings of $2.58 million to increase the allowance for credit losses as of January 1, 2020. As of June 30, 2020, we estimate an additional increase to the allowance for credit losses of between $0 million and $8 million which will be recognized through earnings after adoption. We believe that as of June 30, 2020, a forecast adjustment is necessary as well as qualitative factor adjustments for portfolio segments most severely impacted by the COVID-19 business shutdowns. Given the shelter in place orders, resultant business shutdowns and skyrocketing unemployment, we project the next twelve-month period as the most adverse and applied a more severe forecast adjustment. Furthermore, we reviewed portfolio segments on a granular level, adjusting for greater loss potential in segments immediately impacted such as transportation and hotels, as evidenced by deferral requests. Additionally, the forecast factor adjustment and the life of loan methodology have a more significant impact on longer duration portfolios.
NONPERFORMING ASSETS
The following table shows nonperforming assets.
(Dollars in thousands) | June 30, 2020 | December 31, 2019 | June 30, 2019 | |||||||||||||||||
Loans and leases past due 90 days or more | $ | 256 | $ | 309 | $ | 156 | ||||||||||||||
Nonaccrual loans and leases | 62,800 | 9,789 | 12,212 | |||||||||||||||||
Other real estate | 303 | 522 | 543 | |||||||||||||||||
Repossessions | 6,132 | 8,623 | 8,799 | |||||||||||||||||
Equipment owned under operating leases | 57 | — | — | |||||||||||||||||
Total nonperforming assets | $ | 69,548 | $ | 19,243 | $ | 21,710 |
Nonperforming assets as a percentage of loans and leases were 1.20% at June 30, 2020, 0.37% at December 31, 2019, and 0.41% at June 30, 2019. Excluding PPP loans, nonperforming assets as a percentage of loan and leases were 1.33% at June 30, 2020, 0.37% at December 31, 2019, and 0.14% at June 30, 2019. Nonperforming assets totaled $69.55 million at June 30, 2020, an increase of 261.42% from the $19.24 million reported at December 31, 2019, and a 220.35% increase from the $21.71 million reported at June 30, 2019. The increase in nonperforming assets during the first six months of 2020 was related to higher nonaccrual loans and leases. The increase in nonperforming assets at June 30, 2020 from June 30, 2019 also occurred primarily in nonaccrual loans and leases.
The increase in nonaccrual loans and leases at June 30, 2020 from December 31, 2019 occurred primarily in the auto and light truck, construction equipment and commercial and agricultural. During the first half of 2020, two relationships of a combined $25.70 million in the auto and light truck portfolio and two relationships of a combined $21.49 million in the construction equipment portfolio went into nonaccrual. The increase in nonaccrual loans and leases at June 30, 2020 from June 30, 2019 occurred primarily in the auto and light truck and construction equipment. A summary of nonaccrual loans and leases and past due aging for the period ended June 30, 2020 and December 31, 2019 is located in Note 4 of the Consolidated Financial Statements.
12
Other real estate is the result of foreclosing on real estate in the local market for which we have a current appraisal and are well secured. Other real estate decreased over the past year due to sales of existing properties outpacing current foreclosures.
Repossessions consisted mainly of aircraft and auto and light trucks. At the time of repossession, the recorded amount of the loan or lease is written down to the fair value of the equipment or vehicle by a charge to the reserve for loan and lease losses or other income, if a positive adjustment, unless the equipment is in the process of immediate sale. Any subsequent fair value write-downs or write-ups, to the extent of previous write-downs, are included in noninterest expense.
The following table shows a summary of other real estate and repossessions.
(Dollars in thousands) | June 30, 2020 | December 31, 2019 | June 30, 2019 | |||||||||||||||||
Commercial and agricultural | $ | — | $ | — | $ | 16 | ||||||||||||||
Auto and light truck | 630 | 1,865 | 3,810 | |||||||||||||||||
Medium and heavy duty truck | — | — | 554 | |||||||||||||||||
Aircraft | 5,450 | 6,707 | 4,400 | |||||||||||||||||
Construction equipment | 35 | 35 | — | |||||||||||||||||
Commercial real estate | 303 | 303 | — | |||||||||||||||||
Residential real estate and home equity | — | 219 | 543 | |||||||||||||||||
Consumer | 17 | 16 | 19 | |||||||||||||||||
Total | $ | 6,435 | $ | 9,145 | $ | 9,342 |
For financial statement purposes, nonaccrual loans and leases are included in loan and lease outstandings, whereas repossessions and other real estate are included in other assets.
NONINTEREST INCOME
The following table shows the details of noninterest income.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2020 | 2019 | $ Change | % Change | 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Noninterest income: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Trust and wealth advisory | $ | 5,589 | $ | 5,583 | 6 | 0.11 | % | $ | 10,437 | $ | 10,441 | (4) | (0.04) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Service charges on deposit accounts | 1,910 | 2,785 | (875) | (31.42) | % | 4,515 | 5,283 | (768) | (14.54) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Debit card | 3,601 | 3,669 | (68) | (1.85) | % | 6,974 | 6,889 | 85 | 1.23 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Mortgage banking | 3,315 | 999 | 2,316 | NM | 5,651 | 1,935 | 3,716 | NM | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Insurance commissions | 1,695 | 1,518 | 177 | 11.66 | % | 3,576 | 3,692 | (116) | (3.14) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Equipment rental | 5,990 | 7,809 | (1,819) | (23.29) | % | 12,620 | 15,791 | (3,171) | (20.08) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Losses) gains on investment securities available-for-sale | (1) | — | (1) | NM | 279 | — | 279 | NM | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other | 3,142 | 3,301 | (159) | (4.82) | % | 5,811 | 5,757 | 54 | 0.94 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total noninterest income | $ | 25,241 | $ | 25,664 | (423) | (1.65) | % | $ | 49,863 | $ | 49,788 | 75 | 0.15 | % |
NM = Not Meaningful
Trust and wealth advisory fees (which include investment management fees, estate administration fees, mutual fund fees, annuity fees, and fiduciary fees) were flat during the three and six months ended June 30, 2020 compared with the same periods a year ago. Trust and wealth advisory fees are largely based on the number and size of client relationships and the market value of assets under management. The market value of trust assets under management at June 30, 2020, December 31, 2019, and June 30, 2019 was $4.20 billion, $4.48 billion, and $4.25 billion, respectively.
Service charges on deposit accounts decreased for the three and six months ended June 30, 2020 over the comparable periods in 2019. The decrease in service charges on deposit accounts primarily reflects a lower volume of nonsufficient fund transactions and reduced ATM fees. Higher deposit balances from government stimulus payments resulted in fewer overdrawn accounts.
Debit card income was relatively flat in the three and six months ended June 30, 2020 over the same periods a year ago.
Mortgage banking income increased in the three and six months ended June 30, 2020 as compared to the same periods in 2019. The increase was primarily caused by increased gains on a higher volume of loan sales as a result of more loans originated for the secondary market offset by higher mortgage servicing rights amortization expense and a $0.55 million impairment charge on mortgage servicing rights.
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Insurance commissions were higher during the three months ended June 30, 2020 compared to the same period a year ago and were lower during the six months ended June 30, 2020 over the same period a year ago. The increase in insurance commissions during the second quarter was primarily due to increased business. The decrease over the first six months of 2020 was the result of a reduction in contingent commissions received offset by higher insurance commissions primarily from increased business.
Equipment rental income decreased for the three and six months ended June 30, 2020 over the comparable periods in 2019. The decrease was the result of reduced leasing volume primarily in the construction equipment, aircraft and auto and light truck portfolios resulting in the average equipment rental portfolio decreasing by 18.3% over the same period a year ago.
Gains on investment securities available-for-sale during the six months ended June 30, 2019 were primarily from the sale of corporate securities in managing portfolio risk.
Other income decreased for the three months ended June 30, 2020 compared to one year ago and was relatively stable for the six months ended June 30, 2020 over the comparable period in 2019. The decrease during the second quarter was primarily a result of lower claim proceeds from bank owned life insurance, reduced rental income on a repossessed asset, and a decrease in customer swap fees offset by higher partnership investment gains.
NONINTEREST EXPENSE
The following table shows the details of noninterest expense.
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(Dollars in thousands) | 2020 | 2019 | $ Change | % Change | 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Noninterest expense: | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Salaries and employee benefits | $ | 23,999 | $ | 23,787 | 212 | 0.89 | % | $ | 48,400 | $ | 47,282 | 1,118 | 2.36 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Net occupancy | 2,504 | 2,481 | 23 | 0.93 | % | 5,225 | 5,253 | (28) | (0.53) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Furniture and equipment | 6,258 | 6,289 | (31) | (0.49) | % | 12,665 | 12,313 | 352 | 2.86 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Depreciation – leased equipment | 5,142 | 6,400 | (1,258) | (19.66) | % | 10,569 | 12,924 | (2,355) | (18.22) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Professional fees | 1,258 | 1,706 | (448) | (26.26) | % | 2,700 | 3,304 | (604) | (18.28) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Supplies and communication | 1,390 | 1,608 | (218) | (13.56) | % | 3,024 | 3,101 | (77) | (2.48) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
FDIC and other insurance | 599 | 608 | (9) | (1.48) | % | 887 | 1,253 | (366) | (29.21) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Business development and marketing | 1,121 | 1,678 | (557) | (33.19) | % | 2,480 | 2,627 | (147) | (5.60) | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Loan and lease collection and repossession | 838 | 230 | 608 | NM | 1,601 | 1,591 | 10 | 0.63 | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Other | 1,716 | 2,566 | (850) | (33.13) | % | 3,809 | 2,909 | 900 | 30.94 | % | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Total noninterest expense | $ | 44,825 | $ | 47,353 | (2,528) | (5.34) | % | $ | 91,360 | $ | 92,557 | (1,197) | (1.29) | % |
NM = Not Meaningful
Salaries and employee benefits increased during the three and six months ended June 30, 2020 compared to the same periods in 2019. The increase was mainly due to higher base salaries as a result of normal merit increases and a slight increase in average staffing levels along with a rise in commission compensation primarily in our mortgage area offset by a decrease in group insurance claims and incentive compensation.
Net occupancy expense was relatively flat during the three and six months ended June 30, 2020 compared to the same periods a year ago.
Furniture and equipment expense, including depreciation, was flat during the three months ended June 30, 2020 compared to one year ago and increased during the six months ended June 30, 2020 compared to the same period a year ago. Furniture and equipment expense was higher in the first six months of 2020 mainly due to higher computer processing charges, increased software maintenance costs and a rise in general furniture and equipment expense from new branch openings/remodels and COVID-19 related items offset by a reduction in equipment depreciation.
Depreciation on leased equipment decreased for the three and six months ended June 30, 2020 compared to the same periods in 2019. Depreciation on leased equipment correlates with the decrease in equipment rental income.
Professional fees decreased during the second quarter and first six months of 2020 compared to the same periods a year ago. The decrease was mainly due to reduced utilization of consulting services offset by an increase in board of director fees.
Supplies and communication decreased during the second quarter and first six months of 2020 compared to the same periods a year ago. The decrease resulted primarily from lower printing costs and reduced telephone line and equipment expenses.
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FDIC and other insurance was lower during the three and six months ended June 30, 2020 compared to the same periods in 2019. The decrease in 2020 was mainly due to $0.55 million in FDIC insurance premium credits received in 2020.
Business development and marketing expense decreased during the second quarter and first six months of 2020 compared to the same periods a year ago. The decrease during the first six months of 2020 was primarily due to lower business development expense as a result of fewer business entertainment and travel opportunities tied to COVID-19 precautions offset by higher marketing promotions compared to 2019.
Loan and lease collection and repossession expense increased during the second quarter 2020 compared to the same period in 2019 and was flat during the first half of 2020 compared to the first half of 2019. The increase in the second quarter was mainly due to higher collection expenses related to the repossession of an aircraft and fewer gains on the sale of repossessed assets.
Other expenses decreased during the second quarter of 2020 compared to the same period in 2019 and increased during the first six months of 2020 compared to the same period in 2019. The decrease during the second quarter of 2020 was primarily the result of lower employee training expenses due to COVID-19 precautions, a decrease in the provision for unfunded loan commitments, a reduced valuation provision for interest rate swaps with customers, and a trust loss recovery of $0.17 million. The increase during the first six months was primarily the result of lower gains on the sale of fixed assets, a higher provision for interest rate swaps with customers offset by increased gains on the sale of operating lease equipment.
INCOME TAXES
The provision for income taxes for the three and six month periods ended June 30, 2020 was $5.52 million and $10.68 million, compared to $7.07 million and $13.83 million for the same periods in 2019. The effective tax rate was 22.94% and 23.20% for the quarter ended June 30, 2020 and 2019, respectively and 23.40% and 23.26% for the first six months ended June 30, 2020 and 2019, respectively.
PART II. OTHER INFORMATION
ITEM 6. Exhibits
The following exhibits are filed with this report:
101.INS | XBRL Instance Document — The instance document does not appear in the interactive data file because its XBRL tags are embedded within the Inline XBRL document. | |||||||
101.SCH | XBRL Taxonomy Extension Schema Document | |||||||
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
101.LAB | XBRL Taxonomy Extension Labels Linkbase Document | |||||||
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |||||||
104 | Cover Page Interactive Data File (embedded within the Inline XBRL document and included in Exhibit 101) |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
1st Source Corporation | ||||||||||||||
DATE | July 31, 2020 | /s/ CHRISTOPHER J. MURPHY III | ||||||||||||
Christopher J. Murphy III Chairman of the Board, President and CEO | ||||||||||||||
DATE | July 31, 2020 | /s/ ANDREA G. SHORT | ||||||||||||
Andrea G. Short Treasurer and Chief Financial Officer Principal Accounting Officer |
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