1ST SOURCE CORP - Quarter Report: 2023 March (Form 10-Q)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2023
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 April 14, 2023 — 24,695,552 shares
TABLE OF CONTENTS
| Page | ||||||||
| EXHIBITS | ||||||||
2
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited - Dollars in thousands)
| March 31, 2023 | December 31, 2022 | ||||||||||
| ASSETS | |||||||||||
| Cash and due from banks | $ | 66,866 | $ | 84,703 | |||||||
| Federal funds sold and interest bearing deposits with other banks | 27,171 | 38,094 | |||||||||
| Investment securities available-for-sale | 1,713,480 | 1,775,128 | |||||||||
| Other investments | 25,293 | 25,293 | |||||||||
| Mortgages held for sale | 2,068 | 3,914 | |||||||||
| Loans and leases, net of unearned discount: | |||||||||||
| Commercial and agricultural | 795,429 | 812,031 | |||||||||
| Solar | 375,330 | 381,163 | |||||||||
| Auto and light truck | 875,564 | 808,117 | |||||||||
| Medium and heavy duty truck | 326,588 | 313,862 | |||||||||
| Aircraft | 1,056,829 | 1,077,722 | |||||||||
| Construction equipment | 991,412 | 938,503 | |||||||||
| Commercial real estate | 954,221 | 943,745 | |||||||||
| Residential real estate and home equity | 594,618 | 584,737 | |||||||||
| Consumer | 146,725 | 151,282 | |||||||||
| Total loans and leases | 6,116,716 | 6,011,162 | |||||||||
| Allowance for loan and lease losses | (142,511) | (139,268) | |||||||||
| Net loans and leases | 5,974,205 | 5,871,894 | |||||||||
| Equipment owned under operating leases, net | 30,083 | 31,700 | |||||||||
| Net premises and equipment | 44,034 | 44,773 | |||||||||
| Goodwill and intangible assets | 83,901 | 83,907 | |||||||||
| Accrued income and other assets | 362,702 | 380,010 | |||||||||
| Total assets | $ | 8,329,803 | $ | 8,339,416 | |||||||
| LIABILITIES | |||||||||||
| Deposits: | |||||||||||
| Noninterest-bearing demand | $ | 1,815,123 | $ | 1,998,151 | |||||||
| Interest-bearing deposits: | |||||||||||
| Interest-bearing demand | 2,403,818 | 2,591,464 | |||||||||
| Savings | 1,171,418 | 1,198,191 | |||||||||
| Time | 1,411,105 | 1,140,459 | |||||||||
| Total interest-bearing deposits | 4,986,341 | 4,930,114 | |||||||||
| Total deposits | 6,801,464 | 6,928,265 | |||||||||
| Short-term borrowings: | |||||||||||
| Federal funds purchased and securities sold under agreements to repurchase | 73,396 | 141,432 | |||||||||
| Other short-term borrowings | 229,640 | 74,097 | |||||||||
| Total short-term borrowings | 303,036 | 215,529 | |||||||||
| Long-term debt and mandatorily redeemable securities | 46,714 | 46,555 | |||||||||
| Subordinated notes | 58,764 | 58,764 | |||||||||
| Accrued expenses and other liabilities | 151,381 | 166,537 | |||||||||
| Total liabilities | 7,361,359 | 7,415,650 | |||||||||
| SHAREHOLDERS’ EQUITY | |||||||||||
Preferred stock; no par value | |||||||||||
Authorized 10,000,000 shares; none issued or outstanding | — | — | |||||||||
Common stock; no par value | |||||||||||
Authorized 40,000,000 shares; issued 28,205,674 at March 31, 2023 and December 31, 2022 | 436,538 | 436,538 | |||||||||
| Retained earnings | 719,495 | 694,862 | |||||||||
Cost of common stock in treasury (3,510,122 shares at March 31, 2023 and 3,543,388 shares at December 31, 2022) | (119,409) | (119,642) | |||||||||
| Accumulated other comprehensive loss | (127,465) | (147,690) | |||||||||
| Total shareholders’ equity | 909,159 | 864,068 | |||||||||
| Noncontrolling interests | 59,285 | $ | 59,698 | ||||||||
| Total equity | 968,444 | 923,766 | |||||||||
| Total liabilities and equity | $ | 8,329,803 | $ | 8,339,416 | |||||||
The accompanying notes are a part of the unaudited consolidated financial statements.
3
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited - Dollars in thousands, except per share amounts)
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Interest income: | |||||||||||
| Loans and leases | $ | 86,689 | $ | 55,208 | |||||||
| Investment securities, taxable | 6,648 | 6,344 | |||||||||
| Investment securities, tax-exempt | 482 | 134 | |||||||||
| Other | 637 | 363 | |||||||||
| Total interest income | 94,456 | 62,049 | |||||||||
| Interest expense: | |||||||||||
| Deposits | 21,263 | 2,376 | |||||||||
| Short-term borrowings | 1,393 | 24 | |||||||||
| Subordinated notes | 1,020 | 823 | |||||||||
| Long-term debt and mandatorily redeemable securities | 1,215 | (792) | |||||||||
| Total interest expense | 24,891 | 2,431 | |||||||||
| Net interest income | 69,565 | 59,618 | |||||||||
| Provision for credit losses | 3,049 | 2,233 | |||||||||
| Net interest income after provision for credit losses | 66,516 | 57,385 | |||||||||
| Noninterest income: | |||||||||||
| Trust and wealth advisory | 5,679 | 5,914 | |||||||||
| Service charges on deposit accounts | 3,003 | 2,792 | |||||||||
| Debit card | 4,507 | 4,194 | |||||||||
| Mortgage banking | 802 | 1,377 | |||||||||
| Insurance commissions | 2,029 | 1,905 | |||||||||
| Equipment rental | 2,503 | 3,662 | |||||||||
| Losses on investment securities available-for-sale | (44) | — | |||||||||
| Other | 4,844 | 3,301 | |||||||||
| Total noninterest income | 23,323 | 23,145 | |||||||||
| Noninterest expense: | |||||||||||
| Salaries and employee benefits | 28,597 | 25,467 | |||||||||
| Net occupancy | 2,622 | 2,811 | |||||||||
| Furniture and equipment | 1,307 | 1,295 | |||||||||
| Data processing | 6,157 | 5,208 | |||||||||
| Depreciation – leased equipment | 2,022 | 3,015 | |||||||||
| Professional fees | 682 | 1,608 | |||||||||
| FDIC and other insurance | 1,360 | 850 | |||||||||
| Business development and marketing | 1,972 | 1,268 | |||||||||
| Other | 4,702 | 3,814 | |||||||||
| Total noninterest expense | 49,421 | 45,336 | |||||||||
| Income before income taxes | 40,418 | 35,194 | |||||||||
| Income tax expense | 9,287 | 7,793 | |||||||||
| Net income | 31,131 | 27,401 | |||||||||
| Net (income) loss attributable to noncontrolling interests | (7) | (11) | |||||||||
| Net income available to common shareholders | $ | 31,124 | $ | 27,390 | |||||||
| Per common share: | |||||||||||
| Basic net income per common share | $ | 1.25 | $ | 1.10 | |||||||
| Diluted net income per common share | $ | 1.25 | $ | 1.10 | |||||||
| Cash dividends | $ | 0.32 | $ | 0.31 | |||||||
| Basic weighted average common shares outstanding | 24,687,087 | 24,743,790 | |||||||||
| Diluted weighted average common shares outstanding | 24,687,087 | 24,743,790 | |||||||||
The accompanying notes are a part of the unaudited consolidated financial statements.
4
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited - Dollars in thousands)
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Net income | $ | 31,131 | $ | 27,401 | |||||||
| Other comprehensive income (loss): | |||||||||||
| Unrealized appreciation (depreciation) of available-for-sale securities | 26,476 | (93,094) | |||||||||
| Reclassification adjustment for realized losses included in net income | 44 | — | |||||||||
| Income tax effect | (6,295) | 22,418 | |||||||||
| Other comprehensive income (loss), net of tax | 20,225 | (70,676) | |||||||||
| Comprehensive income (loss) | $ | 51,356 | $ | (43,275) | |||||||
| Comprehensive (income) loss attributable to noncontrolling interests | (7) | (11) | |||||||||
| Comprehensive income (loss) available to common shareholders | $ | 51,349 | $ | (43,286) | |||||||
The accompanying notes are a part of the unaudited consolidated financial statements.
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Unaudited - Dollars in thousands, except per share amounts)
| Three Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||
| Preferred Stock | Common Stock | Retained Earnings | Cost of Common Stock in Treasury | Accumulated Other Comprehensive Income (Loss), Net | Total Shareholders’ Equity | Noncontrolling Interests | Total Equity | ||||||||||||||||||||||||||||||||||||||||
| Balance at January 1, 2022 | $ | — | $ | 436,538 | $ | 603,787 | $ | (114,209) | $ | (9,861) | $ | 916,255 | $ | 53,209 | $ | 969,464 | |||||||||||||||||||||||||||||||
| Net income | — | — | 27,390 | — | — | 27,390 | 11 | 27,401 | |||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss | — | — | — | — | (70,676) | (70,676) | — | (70,676) | |||||||||||||||||||||||||||||||||||||||
Issuance of 38,442 common shares under stock based compensation awards | — | — | 1,024 | 730 | — | 1,754 | — | 1,754 | |||||||||||||||||||||||||||||||||||||||
Cost of 45,419 shares of common stock acquired for treasury | — | — | — | (2,175) | — | (2,175) | — | (2,175) | |||||||||||||||||||||||||||||||||||||||
Common stock dividend ($0.31 per share) | — | — | (7,698) | — | — | (7,698) | — | (7,698) | |||||||||||||||||||||||||||||||||||||||
| Contributions from noncontrolling interests | — | — | — | — | — | — | 1,627 | 1,627 | |||||||||||||||||||||||||||||||||||||||
| Distributions to noncontrolling interests | — | — | — | — | — | — | (227) | (227) | |||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2022 | $ | — | $ | 436,538 | $ | 624,503 | $ | (115,654) | $ | (80,537) | $ | 864,850 | $ | 54,620 | 919,470 | ||||||||||||||||||||||||||||||||
| Balance at January 1, 2023 | $ | — | $ | 436,538 | $ | 694,862 | $ | (119,642) | $ | (147,690) | $ | 864,068 | $ | 59,698 | $ | 923,766 | |||||||||||||||||||||||||||||||
| Net income | — | — | 31,124 | — | — | 31,124 | 7 | 31,131 | |||||||||||||||||||||||||||||||||||||||
| Other comprehensive income | — | — | — | — | 20,225 | 20,225 | — | 20,225 | |||||||||||||||||||||||||||||||||||||||
Issuance of 49,625 common shares under stock based compensation awards | — | — | 1,426 | 999 | — | 2,425 | — | 2,425 | |||||||||||||||||||||||||||||||||||||||
Cost of 16,359 shares of common stock acquired for treasury | — | — | — | (766) | — | (766) | — | (766) | |||||||||||||||||||||||||||||||||||||||
Common stock dividend ($0.32 per share) | — | — | (7,917) | — | — | (7,917) | — | (7,917) | |||||||||||||||||||||||||||||||||||||||
| Distributions to noncontrolling interests | — | — | — | — | — | — | (420) | (420) | |||||||||||||||||||||||||||||||||||||||
| Balance at March 31, 2023 | $ | — | $ | 436,538 | $ | 719,495 | $ | (119,409) | $ | (127,465) | $ | 909,159 | $ | 59,285 | $ | 968,444 | |||||||||||||||||||||||||||||||
The accompanying notes are a part of the unaudited consolidated financial statements.
5
1st SOURCE CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited - Dollars in thousands)
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Operating activities: | |||||||||||
| Net income | $ | 31,131 | $ | 27,401 | |||||||
| Adjustments to reconcile net income to net cash provided by operating activities: | |||||||||||
| Provision for credit losses | 3,049 | 2,233 | |||||||||
| Depreciation of premises and equipment | 1,146 | 1,177 | |||||||||
| Depreciation of equipment owned and leased to others | 2,022 | 3,015 | |||||||||
| Stock-based compensation | 1,121 | 732 | |||||||||
| Amortization of investment securities premiums and accretion of discounts, net | 855 | 967 | |||||||||
| Amortization of mortgage servicing rights | 221 | 381 | |||||||||
| Amortization of right of use assets | 778 | 785 | |||||||||
| Deferred income taxes | (993) | 80 | |||||||||
| Losses on investment securities available-for-sale | 44 | — | |||||||||
| Originations of loans held for sale, net of principal collected | (8,862) | (32,314) | |||||||||
| Proceeds from the sales of loans held for sale | 10,934 | 41,456 | |||||||||
| Net gain on sale of loans held for sale | (226) | (615) | |||||||||
| Net gain on sale of other real estate and repossessions | (39) | (47) | |||||||||
| Change in interest receivable | (125) | (530) | |||||||||
| Change in interest payable | 7,599 | 199 | |||||||||
| Change in other assets | (5,422) | 9,099 | |||||||||
| Change in other liabilities | 3,987 | (10,882) | |||||||||
| Other | (367) | (1,334) | |||||||||
| Net change in operating activities | 46,853 | 41,803 | |||||||||
| Investing activities: | |||||||||||
| Proceeds from sales of investment securities available-for-sale | 64,928 | — | |||||||||
| Proceeds from maturities and paydowns of investment securities available-for-sale | 25,341 | 57,392 | |||||||||
| Purchases of investment securities available-for-sale | (3,000) | (145,843) | |||||||||
| Net change in partnership investments | (5,274) | (2,128) | |||||||||
| Net change in other investments | — | 1,651 | |||||||||
| Loans sold or participated to others | 16,026 | 7,987 | |||||||||
| Proceeds from principal payments on direct finance leases | 13,043 | 9,377 | |||||||||
| Net change in loans and leases | (134,913) | (66,069) | |||||||||
| Net change in equipment owned under operating leases | (405) | 3,626 | |||||||||
| Purchases of premises and equipment | (408) | (113) | |||||||||
| Proceeds from disposal of premises and equipment | 2 | 14 | |||||||||
| Proceeds from sales of other real estate and repossessions | 391 | 1,983 | |||||||||
| Net change in investing activities | (24,269) | (132,123) | |||||||||
| Financing activities: | |||||||||||
| Net change in demand deposits and savings accounts | (397,447) | 26,143 | |||||||||
| Net change in time deposits | 270,646 | (32,116) | |||||||||
| Net change in short-term borrowings | 87,507 | (869) | |||||||||
| Payments on long-term debt | (2,727) | (2,440) | |||||||||
| Acquisition of treasury stock | (766) | (2,175) | |||||||||
| Net (distributions to) contributions from noncontrolling interests | (420) | 1,400 | |||||||||
| Cash dividends paid on common stock | (8,137) | (7,918) | |||||||||
| Net change in financing activities | (51,344) | (17,975) | |||||||||
| Net change in cash and cash equivalents | (28,760) | (108,295) | |||||||||
| Cash and cash equivalents, beginning of year | 122,797 | 525,187 | |||||||||
| Cash and cash equivalents, end of period | $ | 94,037 | $ | 416,892 | |||||||
| Supplemental Information: | |||||||||||
| Non-cash transactions: | |||||||||||
| Loans transferred to other real estate and repossessed assets | $ | 484 | $ | 1,150 | |||||||
| Common stock matching contribution to Employee Stock Ownership and Profit Sharing Plan | 1,753 | 683 | |||||||||
| Right of use assets obtained in exchange for lease obligations | 2,495 | 116 | |||||||||
The accompanying notes are a part of the unaudited consolidated financial statements.
6
1ST SOURCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1 — Accounting Policies
1st Source Corporation is a bank holding company headquartered in South Bend, Indiana that provides, through its subsidiaries (collectively referred to as “1st Source” or “the Company”), a broad array of financial products and services.
Basis of Presentation – The accompanying unaudited consolidated financial statements reflect all adjustments (all of which are normal and recurring in nature) which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, the results of operations, changes in comprehensive income (loss), changes in shareholders’ equity, and cash flows for the periods presented. These unaudited consolidated financial statements have been prepared according to the rules and regulations of the Securities and Exchange Commission (SEC) and, therefore, certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been omitted.
The Notes to the Consolidated Financial Statements appearing in 1st Source Corporation’s Annual Report on Form 10-K (2022 Annual Report), which include descriptions of significant accounting policies, should be read in conjunction with these interim financial statements. The Consolidated Statement of Financial Condition at December 31, 2022 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. Certain amounts in the prior period consolidated financial statements have been reclassified to conform to the current period presentation.
Use of Estimates in the Preparation of Financial Statements – Financial statements prepared in accordance with GAAP require the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expense during the reporting period. Actual results could differ from those estimates.
Loans and Leases – Loans are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs and net of unearned income. Interest income is accrued as earned based on unpaid principal balances. Origination fees and direct loan and lease origination costs are deferred, and the net amount amortized to interest income over the estimated life of the related loan or lease. Loan commitment fees are deferred and amortized into other income over the commitment period.
Direct financing leases are carried at the aggregate of lease payments plus estimated residual value of the leased property, net of unamortized deferred lease origination fees and costs and unearned income. Only those costs incurred as a direct result of closing a lease transaction are capitalized and all other initial direct costs are expensed immediately. Interest income on direct financing leases is recognized over the term of the lease to achieve a constant periodic rate of return on the outstanding investment.
Accrued interest is included in Accrued Income and Other Assets on the Consolidated Statements of Financial Condition and is excluded from the calculation of the allowance for credit losses. The accrual of interest on loans and leases is discontinued when a loan or lease becomes contractually delinquent for 90 days, or when an individual analysis of a borrower’s credit worthiness indicates a credit should be placed on nonperforming status, except for residential mortgage loans and consumer loans that are well secured and in the process of collection. Residential mortgage loans are placed on nonaccrual at the time the loan is placed in foreclosure. When interest accruals are discontinued, interest credited to income in the current year is reversed and interest accrued in the prior year is charged to the allowance for loan and lease losses. However, in some cases, the Company may elect to continue the accrual of interest when the net realizable value of collateral is sufficient to cover the principal and accrued interest. When a loan or lease is classified as nonaccrual and the future collectability of the recorded loan or lease balance is doubtful, collections on interest and principal are applied as a reduction to principal outstanding. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured, which is typically evidenced by a sustained repayment performance of at least six months.
Occasionally, the Company modifies loans and leases to borrowers in financial distress (typically denoted by internal credit quality graded “substandard” or worse) by providing term extensions, other-than-insignificant payment delays, or interest rate reductions. In some cases, a combination of modifications are made to the same loan or lease. These modifications typically result from the Company’s loss mitigation activities. If the Company determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance for loan and lease losses estimate or a charge-off to the allowance for loan and lease losses.
8
Note 2 — Recent Accounting Pronouncements
Investments-Equity Method and Joint Ventures: In March 2023, the Financial Accounting Standards Board (FASB) issued Accounting Standards (ASU) No. 2023-02 “Investments Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method.” These amendments allow reporting entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. This guidance is effective for public business entities for fiscal years including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted in any interim period. The Company is assessing ASU 2023-02 and its impact on its accounting and disclosures.
Fair Value Measurements: In June 2022, the FASB issued ASU No. 2022-03 “Fair Value Measurements (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions.” These amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This guidance is effective for public business entities for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2023. Early adoption is permitted. The Company has assessed ASU 2022-03 and does not expect it to have a material impact on its accounting and disclosures.
Reference Rate Reform: In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. In January 2021, the FASB issued ASU 2021-01 which clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. In December of 2022, the FASB issued ASU No. 2022-06 which extended the period of time preparers can utilize the reference rate reform relief guidance in Topic 848. The guidance ensures the relief in Topic 848 covers the period of time during which a significant number of modifications may take place and the ASU defers the sunset date of Topic 848 from December 31, 2022 to December 31, 2024. The Company continues to implement its transition plan towards cessation of LIBOR and the modification of its loans and other financial instruments with attributes that are either directly or indirectly influenced by LIBOR. The Company expects to utilize the LIBOR transition relief allowed under ASU 2020-04, ASU 2021-01 and ASU 2022-06, as applicable, and does not expect such adoption to have a material impact on its accounting and disclosures.
Note 3 — Investment Securities Available-For-Sale
The following table shows investment securities available-for-sale.
| (Dollars in thousands) | Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Fair Value | ||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||
| U.S. Treasury and Federal agencies securities | $ | 1,052,191 | $ | — | $ | (76,970) | $ | 975,221 | ||||||||||||||||||
| U.S. States and political subdivisions securities | 114,237 | 412 | (6,774) | 107,875 | ||||||||||||||||||||||
| Mortgage-backed securities — Federal agencies | 702,499 | 35 | (83,922) | 618,612 | ||||||||||||||||||||||
| Corporate debt securities | 11,476 | — | (281) | 11,195 | ||||||||||||||||||||||
| Foreign government and other securities | 600 | — | (23) | 577 | ||||||||||||||||||||||
| Total debt securities available-for-sale | $ | 1,881,003 | $ | 447 | $ | (167,970) | $ | 1,713,480 | ||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||
| U.S. Treasury and Federal agencies securities | $ | 1,090,743 | $ | — | $ | (92,145) | $ | 998,598 | ||||||||||||||||||
| U.S. States and political subdivisions securities | 130,670 | 591 | (8,499) | 122,762 | ||||||||||||||||||||||
| Mortgage-backed securities — Federal agencies | 730,672 | 60 | (93,674) | 637,058 | ||||||||||||||||||||||
| Corporate debt securities | 16,486 | — | (355) | 16,131 | ||||||||||||||||||||||
| Foreign government and other securities | 600 | — | (21) | 579 | ||||||||||||||||||||||
| Total debt securities available-for-sale | $ | 1,969,171 | $ | 651 | $ | (194,694) | $ | 1,775,128 | ||||||||||||||||||
Amortized cost excludes accrued interest receivable which is included in Accrued Income and Other Assets on the Consolidated Statements of Financial Condition. At March 31, 2023 and December 31, 2022, accrued interest receivable on investment securities available-for-sale was $4.88 million and $5.98 million, respectively.
At March 31, 2023 and December 31, 2022, the residential mortgage-backed securities held by the Company consisted primarily of GNMA, FNMA and FHLMC pass-through certificates which are guaranteed by those respective agencies of the United States government (Government Sponsored Enterprise, GSEs).
9
The following table shows the contractual maturities of investments in debt securities available-for-sale at March 31, 2023. Expected maturities will differ from contractual maturities, because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
| (Dollars in thousands) | Amortized Cost | Fair Value | ||||||||||||
| Due in one year or less | $ | 96,181 | $ | 94,493 | ||||||||||
| Due after one year through five years | 1,040,653 | 960,875 | ||||||||||||
| Due after five years through ten years | 17,843 | 15,396 | ||||||||||||
| Due after ten years | 23,827 | 24,104 | ||||||||||||
| Mortgage-backed securities | 702,499 | 618,612 | ||||||||||||
| Total debt securities available-for-sale | $ | 1,881,003 | $ | 1,713,480 | ||||||||||
The following table summarizes gross unrealized losses and fair value by investment category and age. At March 31, 2023, the Company’s available-for-sale securities portfolio consisted of 717 securities, 650 of which were in an unrealized loss position.
| Less than 12 Months | 12 months or Longer | Total | ||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | Fair Value | Unrealized Losses | ||||||||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||||||||
| U.S. Treasury and Federal agencies securities | $ | 14,465 | $ | (292) | $ | 960,756 | $ | (76,678) | $ | 975,221 | $ | (76,970) | ||||||||||||||||||||||||||
| U.S. States and political subdivisions securities | 19,458 | (331) | 63,258 | (6,443) | 82,716 | (6,774) | ||||||||||||||||||||||||||||||||
| Mortgage-backed securities - Federal agencies | 90,318 | (2,945) | 524,803 | (80,977) | 615,121 | (83,922) | ||||||||||||||||||||||||||||||||
| Corporate debt securities | 3,317 | (10) | 7,878 | (271) | 11,195 | (281) | ||||||||||||||||||||||||||||||||
| Foreign government and other securities | — | — | 577 | (23) | 577 | (23) | ||||||||||||||||||||||||||||||||
| Total debt securities available-for-sale | $ | 127,558 | $ | (3,578) | $ | 1,557,272 | $ | (164,392) | $ | 1,684,830 | $ | (167,970) | ||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| U.S. Treasury and Federal agencies securities | $ | 164,481 | $ | (6,299) | $ | 834,117 | $ | (85,846) | $ | 998,598 | $ | (92,145) | ||||||||||||||||||||||||||
| U.S. States and political subdivisions securities | 57,592 | (2,126) | 38,834 | (6,373) | 96,426 | (8,499) | ||||||||||||||||||||||||||||||||
| Mortgage-backed securities - Federal agencies | 198,469 | (13,482) | 426,989 | (80,192) | 625,458 | (93,674) | ||||||||||||||||||||||||||||||||
| Corporate debt securities | 16,132 | (355) | — | — | 16,132 | (355) | ||||||||||||||||||||||||||||||||
| Foreign government and other securities | 484 | (16) | 95 | (5) | 579 | (21) | ||||||||||||||||||||||||||||||||
| Total debt securities available-for-sale | $ | 437,158 | $ | (22,278) | $ | 1,300,035 | $ | (172,416) | $ | 1,737,193 | $ | (194,694) | ||||||||||||||||||||||||||
The Company does not consider available-for-sale securities with unrealized losses at March 31, 2023 to be experiencing credit losses and recognized no resulting allowance for credit losses. The Company does not intend to sell these investments and it is more likely than not that the Company will not be required to sell these investments before recovery of the amortized cost basis, which may be the maturity dates of the securities. The unrealized losses occurred as a result of changes in interest rates, market spreads and market conditions subsequent to purchase.
The following table shows the gross realized gains and losses from the available-for-sale debt securities portfolio. Realized gains and losses of all securities are computed using the specific identification cost basis.
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands) | 2023 | 2022 | |||||||||
| Gross realized gains | $ | 1,286 | $ | — | |||||||
| Gross realized losses | (1,330) | — | |||||||||
| Net realized losses | $ | (44) | $ | — | |||||||
At March 31, 2023 and December 31, 2022, investment securities available-for-sale with carrying values of $284.67 million and $282.87 million, respectively, were pledged as collateral for security repurchase agreements and for other purposes.
10
Note 4 — Loan and Lease Financings
The Company evaluates loans and leases for credit quality at least annually but more frequently if certain circumstances occur (such as material new information which becomes available and indicates a potential change in credit risk). The Company uses two methods to assess credit risk: loan or lease credit quality grades and credit risk classifications. The purpose of the loan or lease credit quality grade is to document the degree of risk associated with individual credits as well as inform management of the degree of risk in the portfolio taken as a whole. Credit risk classifications are used to categorize loans by degree of risk and to designate individual or committee approval authorities for higher risk credits at the time of origination. Credit risk classifications include categories for: Acceptable, Marginal, Special Attention, Special Risk, Restricted by Policy, Regulated and Prohibited by Law.
All loans and leases, except residential real estate and home equity loans and consumer loans, are assigned credit quality grades on a scale from 1 to 12 with grade 1 representing superior credit quality. The criteria used to assign grades to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily based upon the degree of risk and the likelihood of orderly repayment, and their effect on the Company’s safety and soundness. Loans or leases graded 7 or weaker are considered “special attention” credits and, as such, relationships in excess of $250,000 are reviewed quarterly as part of management’s evaluation of the appropriateness of the allowance for loan and lease losses. Grade 7 credits are defined as “watch” and contain greater than average credit risk and are monitored to limit the exposure to increased risk; grade 8 credits are “special mention” and, following regulatory guidelines, are defined as having potential weaknesses that deserve management’s close attention. Credits that exhibit well-defined weaknesses and a distinct possibility of loss are considered “classified” and are graded 9 through 12 corresponding to the regulatory definitions of “substandard” (grades 9 and 10) and the more severe “doubtful” (grade 11) and “loss” (grade 12). For residential real estate and home equity and consumer loans, credit quality is based on the aging status of the loan and by payment activity. Nonperforming loans are those loans which are on nonaccrual status or are 90 days or more past due.
Below is a summary of the Company’s loan and lease portfolio segments and a discussion of the risk characteristics relevant to each portfolio segment.
Commercial and agricultural – loans are to entities within the Company’s local market communities. Loans are for business or agri-business purposes and include working capital lines of credit secured by accounts receivable and inventory that are generally renewable annually and term loans secured by equipment with amortizations based on the expected life of the underlying collateral, generally to seven years. These loans are typically further supported by personal guarantees. Commercial exposure is to a wide range of industries and services. Risks in this sector are also varied and are most impacted by general economic conditions. Risk mitigants include appropriate underwriting and monitoring and, when appropriate, government guarantees, including SBA and FSA.
Solar – loans are for the purpose of financing solar related projects and may include construction draw notes, operating loans, letters of credit and may entail a tax equity structure. Collateral in a multi-state area includes tangible assets of the borrower, assignment of intangible assets including power purchase agreements, and pledges of permits and licenses. Financing is provided to qualified borrowers throughout the continental United States with an emphasis on the region east of the Rocky Mountains.
Auto and light truck – loans are secured by vehicles and borrowers are nationwide. The portfolio predominantly consists of loans to borrowers in the auto rental and commercial auto leasing industries. Borrowers in the auto rental segment are primarily independent auto rental entities with on-airport and off-airport locations, and some insurance replacement business. Loan amortizations are relatively short, generally eighteen months, but up to four years. Auto leasing customers lease to businesses and the Company takes assignment of the lease stream and places its lien on the vehicles. Terms are generally longer than the auto rental sector, to seven years and match the underlying leases. Risks in both these segments include economic risks and collateral risks, principally used vehicle values.
Medium and heavy duty truck – loans and full-service truck leases are secured by heavy-duty trucks, commonly Class 8 trucks, and are generally personally guaranteed. In addition to economic risks, collateral risk is significant. Financing is generally at full cost, plus additional expenditures to get the vehicle operational, such as taxes, insurance and fees. It takes to four years of debt amortization to reach an equity position in the collateral.
Aircraft – loans are to domestic and foreign borrowers with the domestic segment further divided into two pools: 1) personal and business use, and 2) dealers and operators. The Company’s focus for the foreign sector is Latin America, principally Mexico and Brazil. Loans are primarily secured by new and used business jets and helicopters, with appropriate advances, amortizations of to fifteen years, and are generally guaranteed by individuals. The most significant risk in the Aircraft portfolio is collateral risk - volatility in underlying values and maintenance concerns. The portfolio is subject to national and global economic risks.
11
Construction equipment – loans are to borrowers throughout the country secured by specific equipment. The borrowers include highway and road builders, asphalt producers and pavers, suppliers of aggregate products, site developers, frac sand operations, general construction equipment dealers and operators, and crane rental entities. Generally, loans include personal guarantees. The construction equipment industry is heavily dependent on the U.S. economy and the global economy. Market growth is reliant on investments from public and private sectors into urbanization and infrastructure projects.
Commercial real estate – loans are generally to entities within the local market communities served by the Company with advances generally within regulatory guidelines. Historically, the Company’s exposure to commercial real estate has been primarily to the less risky owner-occupied segment. The non-owner-occupied segment accounts for less than half of the commercial real estate portfolio and includes hotels, apartment complexes and warehousing facilities. There is limited exposure to construction loans. Many commercial real estate loans carry personal guarantees. Additional risks in the commercial real estate portfolio stem from geographical concentration in northern Indiana and southwest Michigan and general economic conditions.
Residential real estate and home equity – loans predominantly include one-to-four family mortgages to borrowers in the Company’s local market communities and are appropriately underwritten and secured by residential real estate.
Consumer – loans are to individuals in the Company’s local markets and auto loans are generally secured by personal vehicles and appropriately underwritten.
12
The following table shows the amortized cost of loans and leases, segregated by portfolio segment, credit quality rating and year of origination as of March 31, 2023 and gross charge-offs for the three months ended March 31, 2023.
| Term Loans and Leases by Origination Year | |||||||||||||||||||||||||||||
| (Dollars in thousands) | 2023 | 2022 | 2021 | 2020 | 2019 | Prior | Revolving Loans | Revolving Loans Converted to Term | Total | ||||||||||||||||||||
| Commercial and agricultural | |||||||||||||||||||||||||||||
| Grades 1-6 | $ | 45,821 | $ | 149,606 | $ | 99,146 | $ | 62,310 | $ | 29,946 | $ | 27,265 | $ | 346,317 | $ | — | $ | 760,411 | |||||||||||
| Grades 7-12 | 500 | 3,464 | 6,231 | 184 | 1,407 | 2,207 | 21,025 | — | 35,018 | ||||||||||||||||||||
| Total commercial and agricultural | 46,321 | 153,070 | 105,377 | 62,494 | 31,353 | 29,472 | 367,342 | — | 795,429 | ||||||||||||||||||||
| Current period gross charge-offs | — | 411 | — | 13 | — | — | 140 | — | 564 | ||||||||||||||||||||
| Solar | |||||||||||||||||||||||||||||
| Grades 1-6 | 3,777 | 108,743 | 106,603 | 34,112 | 72,254 | 38,906 | — | — | 364,395 | ||||||||||||||||||||
| Grades 7-12 | — | — | — | 1,086 | 5,634 | 4,215 | — | — | 10,935 | ||||||||||||||||||||
| Total solar | 3,777 | 108,743 | 106,603 | 35,198 | 77,888 | 43,121 | — | — | 375,330 | ||||||||||||||||||||
| Current period gross charge-offs | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
| Auto and light truck | |||||||||||||||||||||||||||||
| Grades 1-6 | 190,009 | 455,563 | 127,423 | 47,856 | 26,206 | 11,049 | — | — | 858,106 | ||||||||||||||||||||
| Grades 7-12 | 888 | 5,487 | 1,540 | 4,940 | 2,264 | 2,339 | — | — | 17,458 | ||||||||||||||||||||
| Total auto and light truck | 190,897 | 461,050 | 128,963 | 52,796 | 28,470 | 13,388 | — | — | 875,564 | ||||||||||||||||||||
| Current period gross charge-offs | — | — | 25 | 5 | 19 | 63 | — | — | 112 | ||||||||||||||||||||
| Medium and heavy duty truck | |||||||||||||||||||||||||||||
| Grades 1-6 | 41,739 | 149,331 | 60,669 | 37,513 | 27,527 | 9,809 | — | — | 326,588 | ||||||||||||||||||||
| Grades 7-12 | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
| Total medium and heavy duty truck | 41,739 | 149,331 | 60,669 | 37,513 | 27,527 | 9,809 | — | — | 326,588 | ||||||||||||||||||||
| Current period gross charge-offs | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
| Aircraft | |||||||||||||||||||||||||||||
| Grades 1-6 | 26,669 | 425,103 | 255,143 | 201,937 | 53,072 | 61,214 | 5,865 | — | 1,029,003 | ||||||||||||||||||||
| Grades 7-12 | 2,502 | 11,362 | 7,059 | 5,896 | — | 1,007 | — | — | 27,826 | ||||||||||||||||||||
| Total aircraft | 29,171 | 436,465 | 262,202 | 207,833 | 53,072 | 62,221 | 5,865 | — | 1,056,829 | ||||||||||||||||||||
| Current period gross charge-offs | — | — | — | — | — | — | — | — | — | ||||||||||||||||||||
| Construction equipment | |||||||||||||||||||||||||||||
| Grades 1-6 | 142,305 | 442,999 | 188,726 | 95,472 | 51,591 | 15,529 | 18,496 | 2,912 | 958,030 | ||||||||||||||||||||
| Grades 7-12 | — | 19,676 | 4,986 | 1,514 | 1,618 | 84 | 136 | 5,368 | 33,382 | ||||||||||||||||||||
| Total construction equipment | 142,305 | 462,675 | 193,712 | 96,986 | 53,209 | 15,613 | 18,632 | 8,280 | 991,412 | ||||||||||||||||||||
| Current period gross charge-offs | — | — | 1 | — | — | — | — | — | 1 | ||||||||||||||||||||
| Commercial real estate | |||||||||||||||||||||||||||||
| Grades 1-6 | 51,163 | 256,208 | 162,337 | 117,541 | 95,078 | 254,145 | 336 | — | 936,808 | ||||||||||||||||||||
| Grades 7-12 | 38 | 1,969 | 1,695 | 7,630 | 5,057 | 1,024 | — | — | 17,413 | ||||||||||||||||||||
| Total commercial real estate | 51,201 | 258,177 | 164,032 | 125,171 | 100,135 | 255,169 | 336 | — | 954,221 | ||||||||||||||||||||
| Current period gross charge-offs | — | 39 | — | — | — | — | — | — | 39 | ||||||||||||||||||||
| Residential real estate and home equity | |||||||||||||||||||||||||||||
| Performing | 20,510 | 113,006 | 99,425 | 95,591 | 32,888 | 83,659 | 144,185 | 3,946 | 593,210 | ||||||||||||||||||||
| Nonperforming | — | — | — | — | 414 | 729 | 190 | 75 | 1,408 | ||||||||||||||||||||
| Total residential real estate and home equity | 20,510 | 113,006 | 99,425 | 95,591 | 33,302 | 84,388 | 144,375 | 4,021 | 594,618 | ||||||||||||||||||||
| Current period gross charge-offs | — | — | — | — | — | — | 1 | — | 1 | ||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||
| Performing | 15,137 | 67,476 | 30,376 | 10,658 | 5,797 | 2,578 | 14,471 | — | 146,493 | ||||||||||||||||||||
| Nonperforming | — | 75 | 43 | 46 | 51 | 17 | — | — | 232 | ||||||||||||||||||||
| Total consumer | 15,137 | 67,551 | 30,419 | 10,704 | 5,848 | 2,595 | 14,471 | — | 146,725 | ||||||||||||||||||||
| Current period gross charge-offs | $ | 112 | $ | 174 | $ | 30 | $ | 1 | $ | 4 | $ | — | $ | 3 | $ | — | $ | 324 | |||||||||||
13
The following table shows the amortized cost of loans and leases, segregated by portfolio segment, credit quality rating and year of origination as of December 31, 2022.
| Term Loans and Leases by Origination Year | |||||||||||||||||||||||||||||
| (Dollars in thousands) | 2022 | 2021 | 2020 | 2019 | 2018 | Prior | Revolving Loans | Revolving Loans Converted to Term | Total | ||||||||||||||||||||
| Commercial and agricultural | |||||||||||||||||||||||||||||
| Grades 1-6 | $ | 159,317 | $ | 107,232 | $ | 71,365 | $ | 35,874 | $ | 17,192 | $ | 13,860 | $ | 370,553 | $ | — | $ | 775,393 | |||||||||||
| Grades 7-12 | 4,491 | 5,934 | 60 | 2,094 | 1,644 | 1,040 | 21,375 | — | 36,638 | ||||||||||||||||||||
| Total commercial and agricultural | 163,808 | 113,166 | 71,425 | 37,968 | 18,836 | 14,900 | 391,928 | — | 812,031 | ||||||||||||||||||||
| Solar | |||||||||||||||||||||||||||||
| Grades 1-6 | 109,393 | 113,276 | 35,660 | 72,652 | 18,518 | 20,654 | — | — | 370,153 | ||||||||||||||||||||
| Grades 7-12 | — | — | 1,091 | 5,678 | 701 | 3,540 | — | — | 11,010 | ||||||||||||||||||||
| Total solar | 109,393 | 113,276 | 36,751 | 78,330 | 19,219 | 24,194 | — | — | 381,163 | ||||||||||||||||||||
| Auto and light truck | |||||||||||||||||||||||||||||
| Grades 1-6 | 521,399 | 155,508 | 62,063 | 32,975 | 10,946 | 3,476 | — | — | 786,367 | ||||||||||||||||||||
| Grades 7-12 | 5,972 | 3,366 | 5,836 | 2,836 | 1,792 | 1,948 | — | — | 21,750 | ||||||||||||||||||||
| Total auto and light truck | 527,371 | 158,874 | 67,899 | 35,811 | 12,738 | 5,424 | — | — | 808,117 | ||||||||||||||||||||
| Medium and heavy duty truck | |||||||||||||||||||||||||||||
| Grades 1-6 | 158,296 | 66,533 | 43,711 | 31,980 | 10,053 | 3,274 | — | — | 313,847 | ||||||||||||||||||||
| Grades 7-12 | — | — | — | — | — | 15 | — | — | 15 | ||||||||||||||||||||
| Total medium and heavy duty truck | 158,296 | 66,533 | 43,711 | 31,980 | 10,053 | 3,289 | — | — | 313,862 | ||||||||||||||||||||
| Aircraft | |||||||||||||||||||||||||||||
| Grades 1-6 | 438,481 | 273,726 | 213,661 | 57,379 | 31,085 | 35,012 | 3,687 | — | 1,053,031 | ||||||||||||||||||||
| Grades 7-12 | 12,962 | 4,253 | 6,190 | — | — | 1,286 | — | — | 24,691 | ||||||||||||||||||||
| Total aircraft | 451,443 | 277,979 | 219,851 | 57,379 | 31,085 | 36,298 | 3,687 | — | 1,077,722 | ||||||||||||||||||||
| Construction equipment | |||||||||||||||||||||||||||||
| Grades 1-6 | 475,854 | 213,349 | 106,409 | 59,204 | 17,834 | 4,593 | 23,310 | 2,754 | 903,307 | ||||||||||||||||||||
| Grades 7-12 | 20,709 | 7,757 | 2,483 | 1,878 | 313 | 32 | 583 | 1,441 | 35,196 | ||||||||||||||||||||
| Total construction equipment | 496,563 | 221,106 | 108,892 | 61,082 | 18,147 | 4,625 | 23,893 | 4,195 | 938,503 | ||||||||||||||||||||
| Commercial real estate | |||||||||||||||||||||||||||||
| Grades 1-6 | 271,526 | 164,173 | 121,685 | 97,470 | 102,271 | 168,391 | 251 | — | 925,767 | ||||||||||||||||||||
| Grades 7-12 | 1,532 | 1,716 | 7,824 | 5,789 | 47 | 1,070 | — | — | 17,978 | ||||||||||||||||||||
| Total commercial real estate | 273,058 | 165,889 | 129,509 | 103,259 | 102,318 | 169,461 | 251 | — | 943,745 | ||||||||||||||||||||
| Residential real estate and home equity | |||||||||||||||||||||||||||||
| Performing | 115,154 | 100,690 | 97,205 | 34,498 | 6,864 | 81,653 | 142,724 | 4,115 | 582,903 | ||||||||||||||||||||
| Nonperforming | — | 131 | 693 | — | — | 725 | 180 | 105 | 1,834 | ||||||||||||||||||||
| Total residential real estate and home equity | 115,154 | 100,821 | 97,898 | 34,498 | 6,864 | 82,378 | 142,904 | 4,220 | 584,737 | ||||||||||||||||||||
| Consumer | |||||||||||||||||||||||||||||
| Performing | 74,258 | 34,619 | 12,924 | 7,375 | 2,977 | 692 | 18,098 | — | 150,943 | ||||||||||||||||||||
| Nonperforming | 148 | 65 | 49 | 53 | 12 | 12 | — | — | 339 | ||||||||||||||||||||
| Total consumer | 74,406 | 34,684 | 12,973 | 7,428 | 2,989 | 704 | 18,098 | — | 151,282 | ||||||||||||||||||||
14
The following table shows the amortized cost of loans and leases, segregated by portfolio segment, with delinquency aging and nonaccrual status.
| (Dollars in thousands) | Current | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due and Accruing | Total Accruing Loans | Nonaccrual | Total Financing Receivables | |||||||||||||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial and agricultural | $ | 793,509 | $ | 836 | $ | — | $ | — | $ | 794,345 | $ | 1,084 | $ | 795,429 | ||||||||||||||||||||||||||||||
| Solar | 375,330 | — | — | — | 375,330 | — | 375,330 | |||||||||||||||||||||||||||||||||||||
| Auto and light truck | 865,316 | 32 | — | — | 865,348 | 10,216 | 875,564 | |||||||||||||||||||||||||||||||||||||
| Medium and heavy duty truck | 326,588 | — | — | — | 326,588 | — | 326,588 | |||||||||||||||||||||||||||||||||||||
| Aircraft | 1,055,282 | — | 1,007 | — | 1,056,289 | 540 | 1,056,829 | |||||||||||||||||||||||||||||||||||||
| Construction equipment | 989,525 | 340 | — | — | 989,865 | 1,547 | 991,412 | |||||||||||||||||||||||||||||||||||||
| Commercial real estate | 951,111 | 51 | — | — | 951,162 | 3,059 | 954,221 | |||||||||||||||||||||||||||||||||||||
| Residential real estate and home equity | 592,464 | 623 | 123 | 24 | 593,234 | 1,384 | 594,618 | |||||||||||||||||||||||||||||||||||||
| Consumer | 146,035 | 390 | 68 | — | 146,493 | 232 | 146,725 | |||||||||||||||||||||||||||||||||||||
| Total | $ | 6,095,160 | $ | 2,272 | $ | 1,198 | $ | 24 | $ | 6,098,654 | $ | 18,062 | $ | 6,116,716 | ||||||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||||||||||||||
| Commercial and agricultural | $ | 810,223 | $ | 944 | $ | — | $ | — | $ | 811,167 | $ | 864 | $ | 812,031 | ||||||||||||||||||||||||||||||
| Solar | 381,163 | — | — | — | 381,163 | — | 381,163 | |||||||||||||||||||||||||||||||||||||
| Auto and light truck | 793,610 | 353 | 1 | — | 793,964 | 14,153 | 808,117 | |||||||||||||||||||||||||||||||||||||
| Medium and heavy duty truck | 313,845 | — | 2 | — | 313,847 | 15 | 313,862 | |||||||||||||||||||||||||||||||||||||
| Aircraft | 1,075,865 | 223 | 1,063 | — | 1,077,151 | 571 | 1,077,722 | |||||||||||||||||||||||||||||||||||||
| Construction equipment | 932,603 | 431 | — | — | 933,034 | 5,469 | 938,503 | |||||||||||||||||||||||||||||||||||||
| Commercial real estate | 940,516 | — | — | — | 940,516 | 3,229 | 943,745 | |||||||||||||||||||||||||||||||||||||
| Residential real estate and home equity | 582,053 | 562 | 288 | 49 | 582,952 | 1,785 | 584,737 | |||||||||||||||||||||||||||||||||||||
| Consumer | 150,328 | 416 | 199 | 5 | 150,948 | 334 | 151,282 | |||||||||||||||||||||||||||||||||||||
| Total | $ | 5,980,206 | $ | 2,929 | $ | 1,553 | $ | 54 | $ | 5,984,742 | $ | 26,420 | $ | 6,011,162 | ||||||||||||||||||||||||||||||
Accrued interest receivable on loans and leases at March 31, 2023 and December 31, 2022 was $19.82 million and $18.75 million, respectively.
Loan Modification Disclosures Pursuant to ASU 2022-02
The following table shows the amortized cost of loans and leases at March 31, 2023 that were both experiencing financial difficulty and modified during the three months ended March 31, 2023, segregated by portfolio segment and type of modification. The percentage of the amortized cost of loans and leases that were modified to borrowers in financial distress as compared to the amortized cost of each segment of financial receivable is also presented below.
| (Dollars in thousands) | Payment Delay | Term Extension | Interest Rate Reduction | Combination Term Extension and Interest Rate Reduction | % of Total Segment Financing Receivables | ||||||||||||
| Commercial and agricultural | $ | — | $ | 752 | $ | — | $ | — | 0.09 | % | |||||||
| Construction equipment | — | 3,912 | — | — | 0.39 | ||||||||||||
| Commercial real estate | — | — | 511 | — | 0.05 | ||||||||||||
| Total | $ | — | $ | 4,664 | $ | 511 | $ | — | 0.08 | % | |||||||
There were no commitments to lend additional amounts to the borrowers included in the previous table.
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The Company closely monitors the performance of loans and leases that have been modified to borrowers experiencing financial difficulty to understand the effectiveness of its modification efforts. The following table shows the performance of such loans and leases that have been modified during the three months ended March 31, 2023.
| (Dollars in thousands) | Current | 30-59 Days Past Due | 60-89 Days Past Due | 90 Days or More Past Due | Total Past Due | ||||||||||||
| Commercial and agricultural | $ | 752 | $ | — | $ | — | $ | — | $ | — | |||||||
| Construction equipment | 3,912 | — | — | — | — | ||||||||||||
| Commercial real estate | 511 | — | — | — | — | ||||||||||||
| Total | $ | 5,175 | $ | — | $ | — | $ | — | $ | — | |||||||
The following table shows the financial effect of loan and lease modifications presented above to borrowers experiencing financial difficulty for the three months ended March 31, 2023.
| Weighted- Average Interest Rate Reduction | Weighted- Average Term Extension (in months) | |||||||
| Commercial and agricultural | — | % | 3 | |||||
| Construction equipment | — | % | 5 | |||||
| Commercial real estate | 3.00 | % | — | |||||
| Total | 3.00 | % | 4 | |||||
There were no modified loans and leases that had a payment default during the three months ended March 31, 2023 and were modified in the twelve months prior to that default to borrowers experiencing financial difficulty.
Troubled Debt Restructuring (TDR) Disclosures Prior to the Adoption of ASU 2022-02
There were no loan and lease modifications classified as a TDR during the three months ended March 31, 2022. The classification between nonperforming and performing is determined at the time of modification. Modification programs focus on extending maturity dates or modifying payment patterns with most TDRs experiencing a combination of concessions. Modifications do not result in the contractual forgiveness of principal or interest. There were no modifications during the three months ended March 31, 2022 that resulted in an interest rate below market rate.
There were no TDRs which had a payment default within the twelve months following modification during the three months ended March 31, 2022. Default occurs when a loan or lease is 90 days or more past due under the modified terms or transferred to nonaccrual.
The following table shows the recorded investment of loans and leases classified as troubled debt restructurings as of December 31, 2022.
| (Dollars in thousands) | December 31, 2022 | |||||||
| Performing TDRs | $ | — | ||||||
| Nonperforming TDRs | 3,640 | |||||||
| Total TDRs | $ | 3,640 | ||||||
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Note 5 — Allowance for Credit Losses
Allowance for Loan and Lease Losses
The allowance for credit losses is established for current expected credit losses on the Company’s loan and lease portfolios utilizing guidance in Accounting Standards Codification (ASC) Topic 326. The determination of the allowance requires significant judgment to estimate credit losses measured on a collective pool basis when similar risk characteristics exist, and for loans evaluated individually. In determining the allowance, the Company estimates expected future losses for the loan’s entire contractual term adjusted for expected payments when appropriate. The allowance estimate considers relevant available information, from internal and external sources relating to the historical loss experience, current conditions, and reasonable and supportable forecasts for the Company’s outstanding loan and lease balances. The allowance is an estimation that reflects management’s evaluation of expected losses related to the Company’s financial assets measured at amortized cost. To ensure that the allowance is maintained at an adequate level, a detailed analysis is performed on a quarterly basis and an appropriate provision is made to adjust the allowance.
The Company categorizes its loan portfolios into nine segments based on similar risk characteristics. Loans within each segment are collectively evaluated using either: 1) a cohort cumulative loss rate methodology (“cohort”) or, 2) the probability of default (“PD”)/loss given default (“LGD”) methodology (PD/LGD).
The following table shows the changes in the allowance for loan and lease losses, segregated by portfolio segment, for the three months ended March 31, 2023 and 2022.
| (Dollars in thousands) | Commercial and agricultural | Solar | Auto and light truck | Medium and heavy duty truck | Aircraft | Construction equipment | Commercial real estate | Residential real estate and home equity | Consumer | Total | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, beginning of period | $ | 14,635 | $ | 7,217 | $ | 18,634 | $ | 7,566 | $ | 41,093 | $ | 24,039 | $ | 17,431 | $ | 6,478 | $ | 2,175 | $ | 139,268 | ||||||||||||||||||||||||||||||||||||||||||
| Charge-offs | 564 | — | 112 | — | — | 1 | 39 | 1 | 324 | 1,041 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Recoveries | 172 | — | 541 | — | 226 | — | 3 | 233 | 60 | 1,235 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net charge-offs (recoveries) | 392 | — | (429) | — | (226) | 1 | 36 | (232) | 264 | (194) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Provision (recovery of provision) | 1,844 | (929) | (505) | 263 | (1,186) | 1,541 | 1,905 | (89) | 205 | 3,049 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, end of period | $ | 16,087 | $ | 6,288 | $ | 18,558 | $ | 7,829 | $ | 40,133 | $ | 25,579 | $ | 19,300 | $ | 6,621 | $ | 2,116 | $ | 142,511 | ||||||||||||||||||||||||||||||||||||||||||
| March 31, 2022 | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, beginning of period | $ | 15,409 | $ | 6,585 | $ | 19,624 | $ | 6,015 | $ | 33,628 | $ | 19,673 | $ | 19,691 | $ | 5,084 | $ | 1,783 | $ | 127,492 | ||||||||||||||||||||||||||||||||||||||||||
| Charge-offs | — | — | — | — | — | 48 | — | 4 | 165 | 217 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Recoveries | 4 | — | 65 | — | 316 | — | — | 1 | 65 | 451 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Net charge-offs (recoveries) | (4) | — | (65) | — | (316) | 48 | — | 3 | 100 | (234) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Provision (recovery of provision) | 185 | (168) | (168) | 34 | 2,024 | 416 | (445) | 137 | 218 | 2,233 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Balance, end of period | $ | 15,598 | $ | 6,417 | $ | 19,521 | $ | 6,049 | $ | 35,968 | $ | 20,041 | $ | 19,246 | $ | 5,218 | $ | 1,901 | $ | 129,959 | ||||||||||||||||||||||||||||||||||||||||||
The allowance for credit losses increased during the quarter in response to loan growth along with an increase to the forecast adjustment. Broader market liquidity concerns and tightening credit conditions have added additional uncertainty and increased downside risks in the forecast period. Ongoing risks include a weakened domestic GDP outlook, persistent inflation, higher interest rates, and continued geopolitical uncertainty. Credit quality metrics remain relatively stable as evidenced by a modest decline in total special attention credit outstandings during the quarter and continued low delinquency rates. Charge-off activity during the quarter was offset with an uptick in recoveries leading to a net recovery position for the period. Total special attention balances were down slightly, but downgrades within the special attention pool during the quarter indicate some additional credit risk within the problem loan pool.
Commercial and agricultural – the increase in the allowance during the quarter was principally due to a change in mix within the commercial special attention pool towards higher risk rated loans which carry higher loss ratios along with the impact of the forecast adjustment.
Solar – the allowance decreased due to a decline in outstanding loan balances during the quarter. Credit quality is stable.
Auto and light truck – the allowance reported minimal change as continued growth in the auto rental and leasing sectors was offset by a decline in loan outstandings in higher risk sectors of the portfolio.
Medium and heavy duty truck – the allowance increased due to higher loan outstandings during the quarter. Credit quality metrics continue to be strong for this portfolio. Energy price volatility and driver availability remain a challenge.
Aircraft – the allowance decreased due to lower loan outstandings in both the domestic and foreign sectors. The portfolio is currently bolstered by strong collateral values somewhat offset by continuing economic concerns related primarily to Latin American-based foreign loans. The Company has historically carried a higher allowance in this portfolio due to risk volatility.
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Construction equipment – the allowance increased primarily due to strong loan growth in the portfolio.
Commercial real estate – the allowance increased during the quarter due to loan growth along with the impact of the forecast adjustment.
Residential real estate and home equity – the allowance increased primarily due to loan growth.
Consumer – the allowance decreased slightly due to lower loan outstandings during the period.
Economic Outlook
As of March 31, 2023, the most significant economic factors impacting the Company’s loan portfolios are a weakened domestic growth outlook, exacerbated by persistent inflation, higher interest rates and the protracted war in Ukraine and resultant increased geopolitical uncertainty. Recent market liquidity events have added uncertainty and the Company is concerned about the impact of tighter credit conditions on the economy and the effect that may have on future economic growth. The forecast considers global and domestic economic impacts from these factors as well as other key economic factors such as change in gross domestic product and unemployment which may impact the Company’s clients. The Company’s assumption was that economic growth will slow markedly in 2023 and 2024 and inflation will remain well above the 2% Federal Reserve target rate resulting in an adverse impact on the loan and lease portfolio over the next two years.
As a result of geopolitical risks and economic uncertainty, the Company’s future loss estimates may vary considerably from the March 31, 2023 assumptions.
Liability for Credit Losses on Unfunded Loan Commitments
The liability for credit losses inherent in unfunded loan commitments is included in Accrued Expenses and Other Liabilities on the Consolidated Statements of Financial Condition. The following table shows the changes in the liability for credit losses on unfunded loan commitments.
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands) | 2023 | 2022 | |||||||||
| Balance, beginning of period | $ | 5,616 | $ | 4,196 | |||||||
| Provision | 1,035 | 728 | |||||||||
| Balance, end of period | $ | 6,651 | $ | 4,924 | |||||||
Note 6 — Lease Investments
As a lessor, the Company’s loan and lease portfolio includes direct finance leases, which are included in Commercial and Agricultural, Solar, Auto and Light Truck, Medium and Heavy Duty Truck, Aircraft, and Construction Equipment on the Consolidated Statements of Financial Condition. The Company also finances various types of construction equipment, medium and heavy duty trucks, automobiles and other equipment under leases classified as operating leases, which are included in Equipment Owned Under Operating Leases, net, on the Consolidated Statements of Financial Condition.
The following table shows interest income recognized from direct finance lease payments and operating lease equipment rental income and related depreciation expense.
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands) | 2023 | 2022 | |||||||||
| Direct finance leases: | |||||||||||
| Interest income on lease receivable | $ | 3,121 | $ | 1,781 | |||||||
| Operating leases: | |||||||||||
| Income related to lease payments | $ | 2,503 | $ | 3,662 | |||||||
| Depreciation expense | 2,022 | 3,015 | |||||||||
Income related to reimbursements from lessees for personal property tax on operating leased equipment for the three months ended March 31, 2023 and 2022 was $0.22 million and $0.20 million, respectively. Expense related to personal property tax payments on operating leased equipment for the three months ended March 31, 2023 and 2022 was $0.22 million and $0.20 million, respectively.
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Note 7 — Mortgage Servicing Rights
The Company recognizes the rights to service residential mortgage loans for others as separate assets, whether the servicing rights are acquired through a separate purchase or through the sale of originated loans with servicing rights retained. The Company allocates a portion of the total proceeds of a mortgage loan to servicing rights based on the relative fair value. The unpaid principal balance of residential mortgage loans serviced for third parties was $838.24 million and $848.96 million at March 31, 2023 and December 31, 2022, respectively.
Mortgage servicing rights (MSRs) are evaluated for impairment at each reporting date. For purposes of impairment measurement, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. If temporary impairment exists within a tranche, a valuation allowance is established through a charge to income equal to the amount by which the carrying value exceeds the fair value. If it is later determined all or a portion of the temporary impairment no longer exists for a particular tranche, the valuation allowance is reduced through a recovery of income.
The following table shows changes in the carrying value of MSRs and the associated valuation allowance.
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands) | 2023 | 2022 | |||||||||
| Mortgage servicing rights: | |||||||||||
| Balance at beginning of period | $ | 4,137 | $ | 4,671 | |||||||
| Additions | 91 | 335 | |||||||||
| Amortization | (221) | (381) | |||||||||
| Carrying value before valuation allowance at end of period | 4,007 | 4,625 | |||||||||
| Valuation allowance: | |||||||||||
| Balance at beginning of period | — | — | |||||||||
| Impairment recoveries | — | — | |||||||||
| Balance at end of period | $ | — | $ | — | |||||||
| Net carrying value of mortgage servicing rights at end of period | $ | 4,007 | $ | 4,625 | |||||||
| Fair value of mortgage servicing rights at end of period | $ | 8,053 | $ | 6,363 | |||||||
At March 31, 2023 and 2022, the fair value of MSRs exceeded the carrying value reported in the Consolidated Statements of Financial Condition by $4.05 million and $1.74 million, respectively. This difference represents increases in the fair value of certain MSRs that could not be recorded above cost basis.
Mortgage loan contractual servicing fees, including late fees and ancillary income, were $0.66 million and $0.72 million for the three months ended March 31, 2023 and 2022, respectively. Mortgage loan contractual servicing fees are included in Mortgage Banking on the Consolidated Statements of Income.
Note 8 — Commitments and Financial Instruments with Off-Balance-Sheet Risk
Financial Instruments with Off-Balance-Sheet Risk — 1st Source and its subsidiaries are parties to financial instruments with off-balance-sheet risk in the normal course of business. These off-balance-sheet financial instruments include commitments to originate and sell loans and standby letters of credit. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Statements of Financial Condition.
The following table shows financial instruments whose contract amounts represent credit risk.
| (Dollars in thousands) | March 31, 2023 | December 31, 2022 | ||||||||||||
| Amounts of commitments: | ||||||||||||||
| Loan commitments to extend credit | $ | 1,303,869 | $ | 1,234,866 | ||||||||||
| Standby letters of credit | $ | 17,782 | $ | 18,055 | ||||||||||
| Commercial and similar letters of credit | $ | 1,960 | $ | 2,368 | ||||||||||
The exposure to credit loss in the event of nonperformance by the other party to the financial instruments for loan commitments and standby letters of credit is represented by the dollar amount of those instruments. The Company uses the same credit policies and collateral requirements in making commitments and conditional obligations as it does for on-balance-sheet instruments.
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The Company grants mortgage loan commitments to borrowers, subject to normal loan underwriting standards. The interest rate risk associated with these loan commitments is managed by entering into contracts for future deliveries of loans. Loan commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit are conditional commitments that guarantee the performance of a client to a third party. The credit risk involved in and collateral obtained when issuing standby letters of credit is essentially the same as that involved in extending loan commitments to clients. Standby letters of credit generally have terms ranging from two months to one year.
Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn on when the underlying transaction is consummated between the customer and the third party. Commercial letters of credit generally have terms ranging from two months to six months.
Note 9 — Derivative Financial Instruments
Commitments to originate residential mortgage loans held for sale and forward commitments to sell residential mortgage loans are considered derivative instruments. See Note 8 for further information.
The Company has certain interest rate derivative positions that are not designated as hedging instruments. Derivative assets and liabilities are recorded at fair value on the Consolidated Statements of Financial Condition and do not take into account the effects of master netting agreements. Master netting agreements allow the Company to settle all derivative contracts held with a single counterparty on a net basis, and to offset net derivative positions with related collateral, where applicable. These derivative positions relate to transactions in which the Company enters into an interest rate swap with a client while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each transaction, the Company agrees to pay interest to the client on a notional amount at a variable interest rate and receive interest from the client on the same notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows the client to effectively convert a variable rate loan to a fixed rate. Because the terms of the swaps with the customers and the other financial institutions offset each other, with the only difference being counterparty credit risk, changes in the fair value of the underlying derivative contracts are not materially different and do not significantly impact the Company’s results of operations.
The following table shows the amounts of non-hedging derivative financial instruments.
| Asset derivatives | Liability derivatives | |||||||||||||||||||||||||||||||
| (Dollars in thousands) | Notional or contractual amount | Statement of Financial Condition classification | Fair value | Statement of Financial Condition classification | Fair value | |||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||
| Interest rate swap contracts | $ | 866,390 | Other assets | $ | 19,724 | Other liabilities | $ | 20,094 | ||||||||||||||||||||||||
| Loan commitments | 3,495 | Mortgages held for sale | 92 | N/A | — | |||||||||||||||||||||||||||
| Forward contracts - mortgage loan | 4,000 | N/A | — | Mortgages held for sale | 16 | |||||||||||||||||||||||||||
| Total | $ | 873,885 | $ | 19,816 | $ | 20,110 | ||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||
| Interest rate swap contracts | $ | 881,600 | Other assets | $ | 24,838 | Other liabilities | $ | 25,307 | ||||||||||||||||||||||||
| Loan commitments | 2,638 | Mortgages held for sale | 67 | N/A | — | |||||||||||||||||||||||||||
| Forward contracts - mortgage loan | 3,750 | Mortgages held for sale | 24 | N/A | — | |||||||||||||||||||||||||||
| Total | $ | 887,988 | $ | 24,929 | $ | 25,307 | ||||||||||||||||||||||||||
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The following table shows the amounts included in the Consolidated Statements of Income for non-hedging derivative financial instruments.
| Gain (loss) | |||||||||||||||||
| Three Months Ended March 31, | |||||||||||||||||
| (Dollars in thousands) | Statement of Income classification | 2023 | 2022 | ||||||||||||||
| Interest rate swap contracts | Other expense | $ | 99 | $ | 237 | ||||||||||||
| Interest rate swap contracts | Other income | 195 | — | ||||||||||||||
| Loan commitments | Mortgage banking | 25 | (165) | ||||||||||||||
| Forward contracts - mortgage loan | Mortgage banking | (40) | 211 | ||||||||||||||
| Total | $ | 279 | $ | 283 | |||||||||||||
The following table shows the offsetting of financial assets and derivative assets.
| Gross Amounts Not Offset in the Statement of Financial Condition | ||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Gross Amounts of Recognized Assets | Gross Amounts Offset in the Statement of Financial Condition | Net Amounts of Assets Presented in the Statement of Financial Condition | Financial Instruments | Cash Collateral Received | Net Amount | ||||||||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||||||||
| Interest rate swaps | $ | 19,724 | $ | — | $ | 19,724 | $ | — | $ | 20,155 | $ | (431) | ||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Interest rate swaps | $ | 24,838 | $ | — | $ | 24,838 | $ | — | $ | 25,295 | $ | (457) | ||||||||||||||||||||||||||
The following table shows the offsetting of financial liabilities and derivative liabilities.
| Gross Amounts Not Offset in the Statement of Financial Condition | ||||||||||||||||||||||||||||||||||||||
| (Dollars in thousands) | Gross Amounts of Recognized Liabilities | Gross Amounts Offset in the Statement of Financial Condition | Net Amounts of Liabilities Presented in the Statement of Financial Condition | Financial Instruments | Cash Collateral Pledged | Net Amount | ||||||||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||||||||
| Interest rate swaps | $ | 20,094 | $ | — | $ | 20,094 | $ | — | $ | — | $ | 20,094 | ||||||||||||||||||||||||||
| Repurchase agreements | 73,396 | — | 73,396 | 73,396 | — | — | ||||||||||||||||||||||||||||||||
| Total | $ | 93,490 | $ | — | $ | 93,490 | $ | 73,396 | $ | — | $ | 20,094 | ||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Interest rate swaps | $ | 25,307 | $ | — | $ | 25,307 | $ | — | $ | — | $ | 25,307 | ||||||||||||||||||||||||||
| Repurchase agreements | 141,432 | — | 141,432 | 141,432 | — | — | ||||||||||||||||||||||||||||||||
| Total | $ | 166,739 | $ | — | $ | 166,739 | $ | 141,432 | $ | — | $ | 25,307 | ||||||||||||||||||||||||||
If a default in performance of any obligation of a repurchase agreement occurs, each party will set-off property held in respect of transactions against obligations owing in respect of any other transactions. At March 31, 2023 and December 31, 2022, repurchase agreements had a remaining contractual maturity of $70.71 million and $138.08 million in overnight and $2.69 million and $3.35 million in up to 30 days, respectively and were collateralized by U.S. Treasury and Federal agencies securities.
Note 10 — Variable Interest Entities
A variable interest entity (VIE) is a partnership, limited liability company, trust or other legal entity that meets any one of the following criteria:
•The entity does not have sufficient equity to conduct its activities without additional subordinated financial support from another party.
•The entity’s investors lack the power to direct the activities that most significantly affect the entity’s economic performance.
•The entity’s at-risk holders do not have the obligation to absorb the losses or the right to receive residual returns.
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•The voting rights of some investors are not proportional to their economic interests in the entity, and substantially all of the entity’s activities involve, or are conducted on behalf of, investors with disproportionately few voting rights.
The Company is involved in various entities that are considered to be VIEs. The Company’s investments in VIEs are primarily related to investments promoting affordable housing, community development and renewable energy sources. Some of these tax-advantaged investments support the Company’s regulatory compliance with the Community Reinvestment Act. The Company’s investments in these entities generate a return primarily through the realization of federal and state income tax credits, and other tax benefits, such as tax deductions from operating losses of the investments, over specified time periods. Tax credits from affordable housing investments and community development investments are recognized as a reduction of tax expense. Investments in renewable energy sources qualify for investment tax credits which are recognized as a reduction to the related investment asset. The Company recognized federal income tax credits related to its affordable housing and community development tax-advantaged investments in tax expense of $0.66 million and $0.50 million for the three months ended March 31, 2023 and 2022, respectively. The Company also recognized $17.49 million and $0.00 million of investment tax credits for the three months ended March 31, 2023 and 2022, respectively.
The Company is not required to consolidate VIEs in which it has concluded it does not have a controlling financial interest, and thus is not the primary beneficiary. In such cases, the Company does not have both the power to direct the entities’ most significant activities and the obligation to absorb losses or the right to receive benefits that could potentially be significant to the VIEs. As a limited partner in these operating partnerships, the Company is allocated credits and deductions associated with the underlying properties. The Company has determined that it is not the primary beneficiary of these investments because the general partners have the power to direct activities that most significantly influence the economic performance of their respective partnerships.
The Company’s investments in these unconsolidated VIEs are carried in Other Assets on the Consolidated Statements of Financial Condition. The Company’s unfunded capital and other commitments related to these unconsolidated VIEs are generally carried in Other Liabilities on the Consolidated Statements of Financial Condition. The Company’s maximum exposure to loss from these unconsolidated VIEs includes the investment recorded on the Company’s Consolidated Statements of Financial Condition, net of unfunded capital commitments, and previously recorded tax credits which remain subject to recapture by taxing authorities based on compliance features required to be met at the project level. While the Company believes potential losses from these investments are remote, the maximum exposure was determined by assuming a scenario where the community-based business, housing projects and renewable energy projects completely fail and do not meet certain taxing authority compliance requirements resulting in recapture of the related tax credits.
The following table provides a summary of investments in affordable housing, community development and renewable energy VIEs that the Company has not consolidated.
| (Dollars in thousands) | March 31, 2023 | December 31, 2022 | |||||||||
| Investment carrying amount | $ | 53,691 | $ | 70,887 | |||||||
| Unfunded capital and other commitments | 62,097 | 64,520 | |||||||||
| Maximum exposure to loss | 45,302 | 45,020 | |||||||||
The Company is required to consolidate VIEs in which it has concluded it has significant involvement in and the ability to direct the activities that impact the entity’s economic performance. The Company is the managing general partner of entities to which it shares interest in tax-advantaged investments with third parties. At March 31, 2023 and December 31, 2022, approximately $65.79 million and $66.26 million, respectively, of the Company’s assets and $0.00 million and $0.00 million, respectively, of its liabilities included on the Consolidated Statements of Financial Condition were related to tax-advantaged investment VIEs which the Company has consolidated, respectively. The assets of the consolidated VIEs are reported in Other Assets, the liabilities are reported in Other Liabilities and the non-controlling interest is reported in Equity on the Consolidated Statements of Financial Condition. The assets of a particular VIE are the primary source of funds to settle its obligations. The creditors of the VIE do not have recourse to the general credit of the Company. The Company’s exposure to the consolidated VIE is generally limited to the carrying value of its variable interest plus any related tax credits previously recognized.
Additionally, the Company sponsors one trust, 1st Source Master Trust (Capital Trust) of which 100% of the common equity is owned by the Company. The Capital Trust was formed in 2007 for the purpose of issuing corporation-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of the capital securities solely in junior subordinated debenture securities of the Company (the subordinated notes). The subordinated notes held by the Capital Trust are the sole assets of the Capital Trust. The Capital Trust qualifies as a variable interest entity for which the Company is not the primary beneficiary and is therefore reported in the financial statements as an unconsolidated subsidiary. The junior subordinated debentures are reflected as subordinated notes on the Consolidated Statements of Financial Condition with the corresponding interest distributions reflected as Interest Expense on the Consolidated Statements of Income. The common shares issued by the Capital Trust are included in Other Assets on the Consolidated Statements of Financial Condition.
22
Distributions on the capital securities issued by the Capital Trust are payable quarterly at a rate per annum equal to the interest rate being earned by the Capital Trust on the subordinated notes held by the Capital Trust. The capital securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated notes. The Company has entered into agreements which, taken collectively, fully and unconditionally guarantee the capital securities subject to the terms of each of the guarantees. The capital securities held by the Capital Trust qualify as Tier 1 capital under Federal Reserve Board guidelines.
The following table shows subordinated notes at March 31, 2023.
| (Dollars in thousands) | Amount of Subordinated Notes | Interest Rate | Maturity Date | |||||||||||||||||
| June 2007 issuance (1) | $ | 41,238 | 7.22 | % | 6/15/2037 | |||||||||||||||
| August 2007 issuance (2) | 17,526 | 6.35 | % | 9/15/2037 | ||||||||||||||||
| Total | $ | 58,764 | ||||||||||||||||||
(1) Fixed rate through life of debt.
(2) 3-Month LIBOR +1.48% through remaining life of debt.
Note 11 — Earnings Per Share
Earnings per common share is computed using the two-class method. Basic earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securities include non-vested restricted stock awards. Non-vested restricted stock awards are considered participating securities to the extent the holders of these securities receive non-forfeitable dividends at the same rate as holders of common stock. Diluted earnings per common share is computed using the weighted-average number of shares determined for the basic earnings per common share computation plus the dilutive effect of stock compensation using the treasury stock method.
Stock options, where the exercise price was greater than the average market price of the common shares, were excluded from the computation of diluted earnings per common share because the result would have been antidilutive. There were no stock options outstanding as of March 31, 2023 and 2022. The following table presents a reconciliation of the number of shares used in the calculation of basic and diluted earnings per common share.
| Three Months Ended March 31, | |||||||||||
| (Dollars in thousands - except per share amounts) | 2023 | 2022 | |||||||||
| Distributed earnings allocated to common stock | $ | 7,892 | $ | 7,672 | |||||||
| Undistributed earnings allocated to common stock | 22,977 | 19,516 | |||||||||
| Net earnings allocated to common stock | 30,869 | 27,188 | |||||||||
| Net earnings allocated to participating securities | 255 | 202 | |||||||||
| Net income allocated to common stock and participating securities | $ | 31,124 | $ | 27,390 | |||||||
| Weighted average shares outstanding for basic earnings per common share | 24,687,087 | 24,743,790 | |||||||||
| Dilutive effect of stock compensation | — | — | |||||||||
| Weighted average shares outstanding for diluted earnings per common share | 24,687,087 | 24,743,790 | |||||||||
| Basic earnings per common share | $ | 1.25 | $ | 1.10 | |||||||
| Diluted earnings per common share | $ | 1.25 | $ | 1.10 | |||||||
Note 12 — Stock Based Compensation
As of March 31, 2023, the Company had four active stock-based employee compensation plans, which are more fully described in Note 16 of the Consolidated Financial Statements in 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2022. These plans include three executive stock award plans, the Executive Incentive Plan (EIP), the Restricted Stock Award Plan (RSAP), the Strategic Deployment Incentive Plan (SDP); and the Employee Stock Purchase Plan (ESPP). The 2011 Stock Option Plan was approved by the shareholders on April 21, 2011 but the Company had not made any grants through March 31, 2023.
23
Stock-based compensation expense for all stock-based compensation awards granted is based on the grant-date fair value. For all awards except stock option awards, the grant date fair value is either the fair market value per share or book value per share (corresponding to the type of stock awarded) as of the grant date. For stock option awards, the grant date fair value is estimated using the Black-Scholes option pricing model. For all awards, the Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award, for which the Company uses the related vesting term.
Total fair value of options vested and expensed was zero for the three months ended March 31, 2023 and 2022. As of March 31, 2023 and 2022 there were no outstanding stock options. There were no stock options exercised during the three months ended March 31, 2023 and 2022. All shares issued in connection with stock option exercises are issued from available treasury stock.
As of March 31, 2023, there was $12.66 million of total unrecognized compensation cost related to non-vested share-based compensation arrangements. That cost is expected to be recognized over a weighted-average period of 3.72 years.
Note 13 — Accumulated Other Comprehensive Loss
The following table presents reclassifications out of accumulated other comprehensive income (loss) related to unrealized gains and losses on available-for-sale securities.
| Three Months Ended March 31, | Affected Line Item in the Statements of Income | ||||||||||||||||
| (Dollars in thousands) | 2023 | 2022 | |||||||||||||||
| Realized losses included in net income | $ | (44) | $ | — | Losses on investment securities available-for-sale | ||||||||||||
| (44) | — | Income before income taxes | |||||||||||||||
| Tax effect | 10 | — | Income tax expense | ||||||||||||||
| Net of tax | $ | (34) | $ | — | Net income | ||||||||||||
Note 14 — Income Taxes
The total amount of unrecognized tax benefits that would affect the effective tax rate if recognized was zero at March 31, 2023 and December 31, 2022. Interest and penalties are recognized through the income tax provision. For the three months ended March 31, 2023 and 2022, the Company recognized no interest or penalties. There were no accrued interest and penalties at March 31, 2023 and December 31, 2022.
Tax years that remain open and subject to audit include the federal 2019-2022 years and the Indiana 2019-2022 years. The Company does not anticipate a significant change in the amount of uncertain tax positions within the next 12 months.
Note 15 — Fair Value Measurements
The Company records certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are also utilized to determine the initial value of certain assets and liabilities, to perform impairment assessments, and for disclosure purposes. The Company uses quoted market prices and observable inputs to the maximum extent possible when measuring fair value. In the absence of quoted market prices, various valuation techniques are utilized to measure fair value. When possible, observable market data for identical or similar financial instruments is used in the valuation. When market data is not available, fair value is determined using valuation models that incorporate management’s estimates of the assumptions a market participant would use in pricing the asset or liability.
Fair value measurements are classified within one of three levels based on the observability of the inputs used to determine fair value, as follows:
•Level 1 — The valuation is based on quoted prices in active markets for identical instruments.
•Level 2 — The valuation is based on observable inputs such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
•Level 3 — The valuation is based on unobservable inputs that are supported by minimal or no market activity and that are significant to the fair value of the instrument. Level 3 valuations are typically performed using pricing models, discounted cash flow methodologies, or similar techniques that incorporate management’s own estimates of assumptions that market participants would use in pricing the instrument, or valuations that require significant management judgment or estimation.
24
A financial instrument’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.
The Company elected fair value accounting for mortgages held for sale and for its best-efforts forward sales commitments. The Company economically hedges its mortgages held for sale at the time the interest rate locks are issued to the customers. The Company believes the election for mortgages held for sale will reduce certain timing differences and better match changes in the value of these assets with changes in the value of derivatives or best-best efforts forward sales commitments. At March 31, 2023 and December 31, 2022, all mortgages held for sale were carried at fair value.
The following table shows the differences between the fair value carrying amount of mortgages held for sale measured at fair value and the aggregate unpaid principal amount the Company is contractually entitled to receive at maturity.
| (Dollars in thousands) | Fair value carrying amount | Aggregate unpaid principal | Excess of fair value carrying amount over (under) unpaid principal | |||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||
| Mortgages held for sale reported at fair value | $ | 2,068 | $ | 1,944 | $ | 124 | (1) | |||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||
| Mortgages held for sale reported at fair value | $ | 3,914 | $ | 3,766 | $ | 148 | (1) | |||||||||||||||||||
(1)The excess of fair value carrying amount over (under) unpaid principal is included in mortgage banking income and includes changes in fair value at and subsequent to funding and gains and losses on the related loan commitment prior to funding.
Financial Instruments on Recurring Basis:
The following is a description of the valuation methodologies used for financial instruments measured at fair value on a recurring basis:
Investment securities available-for-sale are valued primarily by a third party pricing agent. Prices supplied by the independent pricing agent, as well as their pricing methodologies and assumptions, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market levels. In general, the Company’s investment securities do not possess a complex structure that could introduce greater valuation risk. The portfolio mainly consists of traditional investments including U.S. Treasury and Federal agencies securities, Federal agency mortgage pass-through securities, and general obligation and revenue municipal bonds. Pricing for such instruments is fairly generic and is easily obtained. On a quarterly basis, prices supplied by the pricing agent are validated by comparison to prices obtained from other third party sources for a material portion of the portfolio.
The valuation policy and procedures for Level 3 fair value measurements of available-for-sale debt securities are decided through collaboration between management of the Corporate Accounting and Funds Management departments. The changes in fair value measurement for Level 3 securities are analyzed on a periodic basis under a collaborative framework with the aforementioned departments. The methodology and variables used for input are derived from the combination of observable and unobservable inputs. The unobservable inputs are determined through internal assumptions that may vary from period to period due to external factors, such as market movement and credit rating adjustments.
Both the market and income valuation approaches are implemented using the following types of inputs:
•U.S. treasuries are priced using the market approach and utilizing live data feeds from active market exchanges for identical securities.
•Government-sponsored agency debt securities and corporate bonds are primarily priced using available market information through processes such as benchmark curves, market valuations of like securities, sector groupings and matrix pricing.
•Other government-sponsored agency securities, mortgage-backed securities and some of the actively traded REMICs and CMOs, are primarily priced using available market information including benchmark yields, prepayment speeds, spreads and volatility of similar securities.
25
•State and political subdivisions are largely grouped by characteristics, i.e., geographical data and source of revenue in trade dissemination systems. Since some securities are not traded daily and due to other grouping limitations, active market quotes are often obtained using benchmarking for like securities. Local direct placement municipal securities, with very little market activity, are priced using an appropriate market yield curve, which includes a credit spread assumption.
Mortgages held for sale and the related loan commitments and forward contracts (hedges) are valued by a third party pricing agent. Prices supplied by the independent pricing agent, as well as their pricing methodologies, are reviewed by the Company for reasonableness and to ensure such prices are aligned with market values. On a quarterly basis, prices supplied by the pricing agent are validated by comparison to the prices obtained from other third party sources.
Interest rate swap positions, both assets and liabilities, are valued by a third-party pricing agent using an income approach and utilizing models that use as their basis readily observable market parameters. This valuation process considers various factors including interest rate yield curves, time value and volatility factors. Validation of third party agent valuations is accomplished by comparing those values to the Company’s swap counterparty valuations. Management believes an adjustment is required to “mid-market” valuations for derivatives tied to its performing loan portfolio to recognize the imprecision and related exposure inherent in the process of estimating expected credit losses as well as velocity of deterioration evident with systemic risks embedded in these portfolios. Any change in the mid-market derivative valuation adjustment will be recognized immediately through the Consolidated Statements of Income.
The following table shows the balance of assets and liabilities measured at fair value on a recurring basis.
| (Dollars in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||
| Investment securities available-for-sale: | ||||||||||||||||||||||||||
| U.S. Treasury and Federal agencies securities | $ | 548,587 | $ | 426,634 | $ | — | $ | 975,221 | ||||||||||||||||||
| U.S. States and political subdivisions securities | — | 103,554 | 4,321 | 107,875 | ||||||||||||||||||||||
| Mortgage-backed securities — Federal agencies | — | 618,612 | — | 618,612 | ||||||||||||||||||||||
| Corporate debt securities | — | 11,195 | — | 11,195 | ||||||||||||||||||||||
| Foreign government and other securities | — | 577 | — | 577 | ||||||||||||||||||||||
| Total debt securities available-for-sale | 548,587 | 1,160,572 | 4,321 | 1,713,480 | ||||||||||||||||||||||
| Mortgages held for sale | — | 2,068 | — | 2,068 | ||||||||||||||||||||||
| Accrued income and other assets (interest rate swap agreements) | — | 19,724 | — | 19,724 | ||||||||||||||||||||||
| Total | $ | 548,587 | $ | 1,182,364 | $ | 4,321 | $ | 1,735,272 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||
| Accrued expenses and other liabilities (interest rate swap agreements) | $ | — | $ | 20,094 | $ | — | $ | 20,094 | ||||||||||||||||||
| Total | $ | — | $ | 20,094 | $ | — | $ | 20,094 | ||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||
| Investment securities available-for-sale: | ||||||||||||||||||||||||||
| U.S. Treasury and Federal agencies securities | $ | 573,679 | $ | 424,919 | $ | — | $ | 998,598 | ||||||||||||||||||
| U.S. States and political subdivisions securities | — | 121,298 | 1,464 | 122,762 | ||||||||||||||||||||||
| Mortgage-backed securities — Federal agencies | — | 637,058 | — | 637,058 | ||||||||||||||||||||||
| Corporate debt securities | — | 16,131 | — | 16,131 | ||||||||||||||||||||||
| Foreign government and other securities | — | 579 | — | 579 | ||||||||||||||||||||||
| Total debt securities available-for-sale | 573,679 | 1,199,985 | 1,464 | 1,775,128 | ||||||||||||||||||||||
| Mortgages held for sale | — | 3,914 | — | 3,914 | ||||||||||||||||||||||
| Accrued income and other assets (interest rate swap agreements) | — | 24,838 | — | 24,838 | ||||||||||||||||||||||
| Total | $ | 573,679 | $ | 1,228,737 | $ | 1,464 | $ | 1,803,880 | ||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||
| Accrued expenses and other liabilities (interest rate swap agreements) | $ | — | $ | 25,307 | $ | — | $ | 25,307 | ||||||||||||||||||
| Total | $ | — | $ | 25,307 | $ | — | $ | 25,307 | ||||||||||||||||||
26
The following table shows changes in Level 3 assets measured at fair value on a recurring basis for the quarter ended March 31, 2023 and 2022.
| (Dollars in thousands) | U.S. States and political subdivisions securities | |||||||
| Beginning balance January 1, 2023 | $ | 1,464 | ||||||
| Total gains or losses (realized/unrealized): | ||||||||
| Included in earnings | — | |||||||
| Included in other comprehensive income (loss) | 32 | |||||||
| Purchases | 3,000 | |||||||
| Issuances | — | |||||||
| Sales | — | |||||||
| Settlements | — | |||||||
| Maturities | (175) | |||||||
| Transfers into Level 3 | — | |||||||
| Transfers out of Level 3 | — | |||||||
| Ending balance March 31, 2023 | $ | 4,321 | ||||||
| Beginning balance January 1, 2022 | $ | 1,849 | ||||||
| Total gains or losses (realized/unrealized): | ||||||||
| Included in earnings | — | |||||||
| Included in other comprehensive income (loss) | (155) | |||||||
| Purchases | 3,000 | |||||||
| Issuances | — | |||||||
| Sales | — | |||||||
| Settlements | — | |||||||
| Maturities | (165) | |||||||
| Transfers into Level 3 | — | |||||||
| Transfers out of Level 3 | — | |||||||
| Ending balance March 31, 2022 | $ | 4,529 | ||||||
There were no gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at March 31, 2023 or 2022.
The following table shows the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a recurring basis.
| (Dollars in thousands) | Fair Value | Valuation Methodology | Unobservable Inputs | Range of Inputs | Weighted Average | |||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||
| Debt securities available-for sale | ||||||||||||||||||||||||||||||||
Direct placement municipal securities | $ | 4,321 | Discounted cash flows | Credit spread assumption | 3.49% - 4.59% | 3.68 | % | |||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||
Debt securities available-for sale | ||||||||||||||||||||||||||||||||
Direct placement municipal securities | $ | 1,464 | Discounted cash flows | Credit spread assumption | 0.22% - 4.09% | 3.49 | % | |||||||||||||||||||||||||
Financial Instruments on Non-recurring Basis:
The Company may be required, from time to time, to measure certain other financial assets at fair value on a non-recurring basis in accordance with GAAP. These adjustments to fair value usually result from application of lower of cost or market accounting or impairment charges of individual assets.
27
The Credit Policy Committee (CPC), a management committee, is responsible for overseeing the valuation processes and procedures for Level 3 measurements of impaired loans, other real estate and repossessions. The CPC reviews these assets on a quarterly basis to determine the accuracy of the observable inputs, generally third party appraisals, auction values, values derived from trade publications and data submitted by the borrower, and the appropriateness of the unobservable inputs, generally discounts due to current market conditions and collection issues. The CPC establishes discounts based on asset type and valuation source; deviations from the standard are documented. The discounts are reviewed periodically, annually at a minimum, to determine they remain appropriate. Consideration is given to current trends in market values for the asset categories and gains and losses on sales of similar assets. The Loan and Funds Management Committee of the Board of Directors is responsible for overseeing the CPC.
Discounts vary depending on the nature of the assets and the source of value. Aircraft are generally valued using quarterly trade publications adjusted for engine time, condition, maintenance programs, discounted by 10%. Likewise, autos are valued using current auction values, discounted by 10%; medium and heavy duty trucks are valued using trade publications and auction values, discounted by 15%. Construction equipment is generally valued using trade publications and auction values, discounted by 20%. Real estate is valued based on appraisals or evaluations, discounted by 20% with higher discounts for property in poor condition or property with characteristics which may make it more difficult to market. Commercial loans subject to borrowing base certificates are generally discounted by 20% for receivables and 40% - 75% for inventory with higher discounts when monthly borrowing base certificates are not required or received.
Collateral-dependent impaired loans and related write-downs are based on the fair value of the underlying collateral if repayment is expected solely from the collateral. Collateral values are reviewed quarterly and estimated using customized discounting criteria, appraisals and dealer and trade magazine quotes which are used in a market valuation approach. In accordance with fair value measurements, only impaired loans for which an allowance for loan loss has been established based on the fair value of collateral require classification in the fair value hierarchy. As a result, only a portion of the Company’s impaired loans are classified in the fair value hierarchy.
The Company has established MSRs valuation policies and procedures based on industry standards and to ensure valuation methodologies are consistent and verifiable. MSRs and related adjustments to fair value result from application of lower of cost or fair value accounting. For purposes of impairment, MSRs are stratified based on the predominant risk characteristics of the underlying servicing, principally by loan type. The fair value of each tranche of the servicing portfolio is estimated by calculating the present value of estimated future net servicing cash flows, taking into consideration actual and expected mortgage loan prepayment rates, discount rates, servicing costs, and other economic factors. Prepayment rates and discount rates are derived through a third party pricing agent. Changes in the most significant inputs, including prepayment rates and discount rates, are compared to the changes in the fair value measurements and appropriate resolution is made. A fair value analysis is also obtained from an independent third party agent and compared to the internal valuation for reasonableness. MSRs do not trade in an active, open market with readily observable prices and though sales of MSRs do occur, precise terms and conditions typically are not readily available and the characteristics of the Company’s servicing portfolio may differ from those of any servicing portfolios that do trade.
Other real estate is based on the fair value of the underlying collateral less expected selling costs. Collateral values are estimated primarily using appraisals and reflect a market value approach. Fair values are reviewed quarterly, and new appraisals are obtained annually. Repossessions are similarly valued.
For assets measured at fair value on a nonrecurring basis the following represents impairment charges (recoveries) recognized on these assets during the quarter ended March 31, 2023: collateral-dependent impaired loans - $0.00 million; mortgage servicing rights - $0.00 million; repossessions - $0.00 million; and other real estate - $0.00 million.
28
The following table shows the carrying value of assets measured at fair value on a non-recurring basis.
| (Dollars in thousands) | Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||
| Collateral-dependent impaired loans | $ | — | $ | — | $ | 213 | $ | 213 | ||||||||||||||||||
| Accrued income and other assets (mortgage servicing rights) | — | — | 4,007 | 4,007 | ||||||||||||||||||||||
| Accrued income and other assets (repossessions) | — | — | 445 | 445 | ||||||||||||||||||||||
| Accrued income and other assets (other real estate) | — | — | 117 | 117 | ||||||||||||||||||||||
| Total | $ | — | $ | — | $ | 4,782 | $ | 4,782 | ||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||
| Collateral-dependent impaired loans | $ | — | $ | — | $ | — | $ | — | ||||||||||||||||||
| Accrued income and other assets (mortgage servicing rights) | — | — | 4,137 | 4,137 | ||||||||||||||||||||||
| Accrued income and other assets (repossessions) | — | — | 327 | 327 | ||||||||||||||||||||||
| Accrued income and other assets (other real estate) | — | — | 104 | 104 | ||||||||||||||||||||||
| Total | $ | — | $ | — | $ | 4,568 | $ | 4,568 | ||||||||||||||||||
The following table below shows the valuation methodology and unobservable inputs for Level 3 assets and liabilities measured at fair value on a non-recurring basis.
| (Dollars in thousands) | Carrying Value | Fair Value | Valuation Methodology | Unobservable Inputs | Range of Inputs | Weighted Average | ||||||||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||||||||
| Collateral-dependent impaired loans | $ | 213 | $ | 213 | Collateral based measurements including appraisals, trade publications, and auction values | Discount for lack of marketability and current conditions | 10% - 30% | 27.6 | % | |||||||||||||||||||||||||||||
| Mortgage servicing rights | 4,007 | 8,053 | Discounted cash flows | Constant prepayment rate (CPR) | 7.3% - 12.7% | 7.9 | % | |||||||||||||||||||||||||||||||
| Discount rate | 11.4% - 14.2% | 11.5 | % | |||||||||||||||||||||||||||||||||||
| Repossessions | 445 | 487 | Appraisals, trade publications and auction values | Discount for lack of marketability | 2% - 9% | 5 | % | |||||||||||||||||||||||||||||||
| Other real estate | 117 | 117 | Appraisals | Discount for lack of marketability | 0% - 0% | 0 | % | |||||||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||||||||
| Collateral-dependent impaired loans | $ | — | $ | — | Collateral based measurements including appraisals, trade publications, and auction values | Discount for lack of marketability and current conditions | 0% - 0% | 0.0 | % | |||||||||||||||||||||||||||||
| Mortgage servicing rights | 4,137 | 8,007 | Discounted cash flows | Constant prepayment rate (CPR) | 7.6% - 9.6% | 8.2 | % | |||||||||||||||||||||||||||||||
| Discount rate | 11.4% - 14.2% | 11.5 | % | |||||||||||||||||||||||||||||||||||
| Repossessions | 327 | 370 | Appraisals, trade publications and auction values | Discount for lack of marketability | 2% - 9% | 7 | % | |||||||||||||||||||||||||||||||
| Other real estate | 104 | 104 | Appraisals | Discount for lack of marketability | 0% - 0% | 0 | % | |||||||||||||||||||||||||||||||
GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or non-recurring basis.
29
The following table shows the fair values of the Company’s financial instruments.
| (Dollars in thousands) | Carrying or Contract Value | Fair Value | Level 1 | Level 2 | Level 3 | |||||||||||||||||||||||||||
| March 31, 2023 | ||||||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||
| Cash and due from banks | $ | 66,866 | $ | 66,866 | $ | 66,866 | $ | — | $ | — | ||||||||||||||||||||||
| Federal funds sold and interest bearing deposits with other banks | 27,171 | 27,171 | 27,171 | — | — | |||||||||||||||||||||||||||
| Investment securities, available-for-sale | 1,713,480 | 1,713,480 | 548,587 | 1,160,572 | 4,321 | |||||||||||||||||||||||||||
| Other investments | 25,293 | 25,293 | 25,293 | — | — | |||||||||||||||||||||||||||
| Mortgages held for sale | 2,068 | 2,068 | — | 2,068 | — | |||||||||||||||||||||||||||
| Loans and leases, net of allowance for loan and lease losses | 5,974,205 | 5,839,491 | — | — | 5,839,491 | |||||||||||||||||||||||||||
| Mortgage servicing rights | 4,007 | 8,053 | — | — | 8,053 | |||||||||||||||||||||||||||
| Accrued interest receivable | 24,872 | 24,872 | — | 24,872 | — | |||||||||||||||||||||||||||
| Interest rate swaps | 19,724 | 19,724 | — | 19,724 | — | |||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||
| Deposits | $ | 6,801,464 | $ | 6,787,043 | $ | 5,390,359 | $ | 1,396,684 | $ | — | ||||||||||||||||||||||
| Short-term borrowings | 303,036 | 303,036 | 71,856 | 231,180 | — | |||||||||||||||||||||||||||
| Long-term debt and mandatorily redeemable securities | 46,714 | 45,471 | — | 45,471 | — | |||||||||||||||||||||||||||
| Subordinated notes | 58,764 | 53,297 | — | 53,297 | — | |||||||||||||||||||||||||||
| Accrued interest payable | 13,598 | 13,598 | — | 13,598 | — | |||||||||||||||||||||||||||
| Interest rate swaps | 20,094 | 20,094 | — | 20,094 | — | |||||||||||||||||||||||||||
| Off-balance-sheet instruments * | — | 99 | — | 99 | — | |||||||||||||||||||||||||||
| December 31, 2022 | ||||||||||||||||||||||||||||||||
| Assets: | ||||||||||||||||||||||||||||||||
| Cash and due from banks | $ | 84,703 | $ | 84,703 | $ | 84,703 | $ | — | $ | — | ||||||||||||||||||||||
| Federal funds sold and interest bearing deposits with other banks | 38,094 | 38,094 | 38,094 | — | — | |||||||||||||||||||||||||||
| Investment securities, available-for-sale | 1,775,128 | 1,775,128 | 573,679 | 1,199,985 | 1,464 | |||||||||||||||||||||||||||
| Other investments | 25,293 | 25,293 | 25,293 | — | — | |||||||||||||||||||||||||||
| Mortgages held for sale | 3,914 | 3,914 | — | 3,914 | — | |||||||||||||||||||||||||||
| Loans and leases, net of allowance for loan and lease losses | 5,871,894 | 5,712,972 | — | — | 5,712,972 | |||||||||||||||||||||||||||
| Mortgage servicing rights | 4,137 | 8,007 | — | — | 8,007 | |||||||||||||||||||||||||||
| Accrued interest receivable | 24,747 | 24,747 | — | 24,747 | — | |||||||||||||||||||||||||||
| Interest rate swaps | 24,838 | 24,838 | — | 24,838 | — | |||||||||||||||||||||||||||
| Liabilities: | ||||||||||||||||||||||||||||||||
| Deposits | $ | 6,928,265 | $ | 6,909,392 | $ | 5,787,806 | $ | 1,121,586 | $ | — | ||||||||||||||||||||||
| Short-term borrowings | 215,529 | 215,529 | 139,079 | 76,450 | — | |||||||||||||||||||||||||||
| Long-term debt and mandatorily redeemable securities | 46,555 | 45,111 | — | 45,111 | — | |||||||||||||||||||||||||||
| Subordinated notes | 58,764 | 51,398 | — | 51,398 | — | |||||||||||||||||||||||||||
| Accrued interest payable | 5,999 | 5,999 | — | 5,999 | — | |||||||||||||||||||||||||||
| Interest rate swaps | 25,307 | 25,307 | — | 25,307 | — | |||||||||||||||||||||||||||
| Off-balance-sheet instruments * | — | 108 | — | 108 | — | |||||||||||||||||||||||||||
* Represents estimated cash outflows required to currently settle the obligations at current market rates.
These estimates do not reflect any premium or discount that could result from offering for sale at one time the Company’s entire holdings of a particular financial instrument. These estimates are subjective in nature and require considerable judgment to interpret market data. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange, nor are they intended to represent the fair value of the Company as a whole. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. The fair value estimates presented herein are based on pertinent information available to management as of the respective balance sheet date. Although the Company is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued since the presentation dates, and therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented herein.
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Other significant assets, such as premises and equipment, other assets, and liabilities not defined as financial instruments, are not included in the above disclosures. Also, the fair value estimates for deposits do not include the benefit that results from the low-cost funding provided by the deposit liabilities compared to the cost of borrowing funds in the market.
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 March 31, 2023, as compared to December 31, 2022, and the results of operations for the three months ended March 31, 2023 and 2022. 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 2022 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,” “hope,” “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; 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 2022, 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 March 31, 2023 were $8.33 billion, a decrease of $9.61 million or 0.12% from December 31, 2022. Total investment securities available-for-sale were $1.71 billion, a decrease of $61.65 million or 3.47% from December 31, 2022. The largest contributor to the decrease in investment securities available-for-sale was securities sales during the first quarter to support liquidity and fund loan growth. Federal funds sold and interest bearing deposits with other banks were $27.17 million, a decrease of $10.92 million or 28.67% from December 31, 2022. The decrease in federal funds sold and interest bearing deposits with other banks was due to lower interest bearing deposits at other banks which were used to fund loan growth.
Total loans and leases were $6.12 billion, an increase of $105.55 million or 1.76% from December 31, 2022. The largest contributors to the increase in loans and leases was growth in the auto and light truck and construction equipment portfolios. Our foreign loan and lease balances, all denominated in U.S. dollars were $294.76 million and $297.46 million as of March 31, 2023 and December 31, 2022, respectively. Foreign loans and leases are in aircraft financing. Loan and lease balances to borrowers in Brazil and Mexico were $131.13 million and $135.23 million as of March 31, 2023, respectively, compared to $129.98 million and $136.68 million as of December 31, 2022, respectively. As of March 31, 2023 and December 31, 2022 there was not a significant concentration in any other country.
Equipment owned under operating leases was $30.08 million, a decrease of $1.62 million, or 5.10% compared to December 31, 2022. The largest contributor to the decrease in equipment owned under operating leases was reduced leasing volume primarily due to a change in customer preferences and competitive pricing pressure for new business.
Total deposits were $6.80 billion, a decrease of $126.80 million or 1.83% from the end of 2022. Balances were modestly lower primarily due to expected first quarter seasonal outflows which aligned with movements experienced in pre-pandemic years, greater utilization of excess funds by our business customers, drawdown of stimulus monies in consumer accounts, and a heightened rate sensitivity in our entire customer base given the overall level of market yields. Rate competition for deposits increased during the quarter from various areas including traditional bank and credit union competitors, money market funds, bond markets, and other non-bank alternatives.
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Our deposits are well-diversified with a stable profile which is largely representative of the local communities we serve in Northern Indiana and Southwestern Michigan. Our specialty finance niche, which operates among diverse industries nationally, only accounted for 3.46% of total deposits at March 31, 2023. For the full bank, we had approximately 225,500 total accounts with an average balance of $30,150. Uninsured deposits net of public fund deposits represented 29.14% of total deposits at March 31, 2023 compared to 30.07% at December 31, 2022. Uninsured deposits as a percentage of total deposits, including public funds, was 45.95% at March 31, 2023, compared to 47.67% at December 31, 2022.
Short-term borrowings were $303.04 million, an increase of $87.51 million or 40.60% from December 31, 2022 due primarily to increased short-term FHLB borrowings largely to support strong loan growth. Long-term debt and mandatorily redeemable securities were $46.71 million, an increase of $0.16 million or 0.34% from December 31, 2022 due primarily to an increase in mandatorily redeemable securities. Accrued expenses and other liabilities were $151.38 million, a decrease of $15.16 million or 9.10% from December 31, 2022 primarily due to annual incentive related payments to employees and the fair value of interest rate swap contracts with customers.
The following table shows accrued income and other assets.
| (Dollars in thousands) | March 31, 2023 | December 31, 2022 | ||||||||||||
| Accrued income and other assets: | ||||||||||||||
| Bank owned life insurance cash surrender value | $ | 83,016 | $ | 83,046 | ||||||||||
| Operating lease right of use assets | 22,633 | 20,916 | ||||||||||||
| Accrued interest receivable | 24,872 | 24,747 | ||||||||||||
| Mortgage servicing rights | 4,007 | 4,137 | ||||||||||||
| Other real estate | 117 | 104 | ||||||||||||
| Repossessions | 445 | 327 | ||||||||||||
| Partnership investments carrying amount | 119,485 | 137,149 | ||||||||||||
| All other assets | 108,127 | 109,584 | ||||||||||||
| Total accrued income and other assets | $ | 362,702 | $ | 380,010 | ||||||||||
The largest contributor to the decrease in accrued income and other assets from December 31, 2022 was lower partnership investments carrying amounts due to tax equity credit reductions on renewable energy tax equity investments during the period.
CAPITAL
As of March 31, 2023, total shareholders’ equity was $909.16 million, up $45.09 million, or 5.22% from the $864.07 million at December 31, 2022. In addition to net income of $31.12 million, other significant changes in shareholders’ equity during the first three months of 2023 included $7.92 million of dividends paid and $0.77 million in common stock repurchased. The accumulated other comprehensive loss component of shareholders’ equity decreased to $127.47 million at March 31, 2023, compared to $147.69 million at December 31, 2022 due to changes in market conditions on our available-for-sale investment portfolio. Our shareholders’ equity-to-assets ratio was 10.91% as of March 31, 2023, compared to 10.36% at December 31, 2022. Book value per common share increased to $36.81 at March 31, 2023, from $35.04 at December 31, 2022 primarily due to a decrease in accumulated other comprehensive losses.
We declared and paid cash dividends per common share of $0.32 during the first quarter of 2023. The trailing four quarters dividend payout ratio, representing cash dividends per common share divided by diluted earnings per common share, was 25.40%. The dividend payout is continually reviewed by management and the Board of Directors subject to 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 March 31, 2023 remained at their historically strong and conservative levels and 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 | $ | 1,162,713 | 16.41 | % | $ | 566,710 | 8.00 | % | $ | 743,807 | 10.50 | % | $ | 708,387 | 10.00 | % | ||||||||||||||||||||||||||||||||||
| 1st Source Bank | 1,080,913 | 15.26 | 566,491 | 8.00 | 743,520 | 10.50 | 708,114 | 10.00 | ||||||||||||||||||||||||||||||||||||||||||
| Tier 1 Capital (to Risk-Weighted Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||
| 1st Source Corporation | 1,073,416 | 15.15 | 425,032 | 6.00 | 602,129 | 8.50 | 566,710 | 8.00 | ||||||||||||||||||||||||||||||||||||||||||
| 1st Source Bank | 991,650 | 14.00 | 424,869 | 6.00 | 601,897 | 8.50 | 566,491 | 8.00 | ||||||||||||||||||||||||||||||||||||||||||
Common Equity Tier 1 Capital (to Risk-Weighted Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||
| 1st Source Corporation | 957,131 | 13.51 | 318,774 | 4.50 | 495,871 | 7.00 | 460,452 | 6.50 | ||||||||||||||||||||||||||||||||||||||||||
| 1st Source Bank | 932,365 | 13.17 | 318,651 | 4.50 | 495,680 | 7.00 | 460,274 | 6.50 | ||||||||||||||||||||||||||||||||||||||||||
| Tier 1 Capital (to Average Assets): | ||||||||||||||||||||||||||||||||||||||||||||||||||
| 1st Source Corporation | 1,073,416 | 12.72 | 337,626 | 4.00 | N/A | N/A | 422,033 | 5.00 | ||||||||||||||||||||||||||||||||||||||||||
| 1st Source Bank | 991,650 | 11.75 | 337,501 | 4.00 | N/A | N/A | 421,876 | 5.00 | ||||||||||||||||||||||||||||||||||||||||||
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 maintain prudent strategies to support a strong liquidity position. The following table represents our expanded sources of liquidity as of March 31, 2023.
| (Dollars in thousands) | Total Available | Utilized | Net Available | ||||||||
| Internal Sources | |||||||||||
| Free securities | $ | 1,713,480 | $ | 284,671 | $ | 1,428,809 | |||||
| External Sources | |||||||||||
FHLB advances(1) | 631,811 | 245,896 | 385,915 | ||||||||
FRB borrowings(2) | 401,312 | — | 401,312 | ||||||||
Fed funds purchased(3) | 245,000 | — | 245,000 | ||||||||
Brokered deposits(4) | 833,491 | 468,956 | 364,535 | ||||||||
Listing services deposits(4) | 416,745 | 24,197 | 392,548 | ||||||||
| Total liquidity | $ | 4,241,839 | $ | 1,023,720 | $ | 3,218,119 | |||||
| % of Total deposits net brokered and listing services certificates of deposit | 51.01 | % | |||||||||
| (1) Availability contingent on the FHLB activity-based stock ownership requirement | |||||||||||
| (2) Includes access to discount window and Bank Term Funding Program | |||||||||||
| (3) Availability contingent on correspondent bank approvals at time of borrowing | |||||||||||
| (4) Availability contingent on internal borrowing guidelines | |||||||||||
External sources as listed in the table above are managed to approved guidelines by our Board of Directors. FHLB and FRB capacities were secured borrowings backed by pledged collateral primarily from our loan and lease portfolios. Total net available liquidity was $3.22 billion at March 31, 2023, which accounted for 51.01% of total deposits net of brokered and listing services certificates of deposit.
Our loan to asset ratio was 73.43% at March 31, 2023 compared to 72.08% at December 31, 2022 and 67.32% at March 31, 2022. Cash and cash equivalents totaled $94.04 million at March 31, 2023 compared to $122.80 million at December 31, 2022 and $416.89 million at March 31, 2022. The decrease in cash and cash equivalents was primarily due to funding loan growth. At March 31, 2023, the Consolidated Statements of Financial Condition was rate sensitive by $359.30 million more liabilities than assets scheduled to reprice within one year, or approximately 0.90%. Management believes that the present funding sources provide adequate liquidity to meet our cash flow needs.
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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 $1.06 billion.
RESULTS OF OPERATIONS
Net income available to common shareholders for the three month period ended March 31, 2023 was $31.12 million compared to $27.39 million for the same period in 2022. Diluted net income per common share was $1.25 for the three month period ended March 31, 2023, compared to $1.10 earned for the same period in 2022. Return on average common shareholders’ equity was 14.18% for the three months ended March 31, 2023, compared to 12.20% in 2022. The return on total average assets was 1.52% for the three months ended March 31, 2023, compared to 1.39% in 2022.
Net income increased for the three months ended March 31, 2023 compared to the first three months of 2022. Net interest income and noninterest income increased offset by increases to the provision for credit losses and noninterest expense. Details of the changes in the various components of net income are discussed further below.
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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 | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| March 31, 2023 | December 31, 2022 | March 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| (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 | $ | 1,711,177 | $ | 6,648 | 1.58 | % | $ | 1,742,567 | $ | 6,970 | 1.59 | % | $ | 1,857,557 | $ | 6,344 | 1.39 | % | |||||||||||||||||||||||||||||||||||
Tax exempt(1) | 57,444 | 605 | 4.27 | % | 52,633 | 525 | 3.96 | % | 29,498 | 165 | 2.27 | % | |||||||||||||||||||||||||||||||||||||||||
| Mortgages held for sale | 2,410 | 32 | 5.38 | % | 2,834 | 40 | 5.60 | % | 8,791 | 67 | 3.09 | % | |||||||||||||||||||||||||||||||||||||||||
Loans and leases, net of unearned discount(1) | 6,036,203 | 86,760 | 5.83 | % | 5,840,593 | 79,313 | 5.39 | % | 5,324,344 | 55,218 | 4.21 | % | |||||||||||||||||||||||||||||||||||||||||
| Other investments | 57,361 | 637 | 4.50 | % | 69,142 | 627 | 3.60 | % | 400,058 | 363 | 0.37 | % | |||||||||||||||||||||||||||||||||||||||||
Total earning assets(1) | 7,864,595 | 94,682 | 4.88 | % | 7,707,769 | 87,475 | 4.50 | % | 7,620,248 | 62,157 | 3.31 | % | |||||||||||||||||||||||||||||||||||||||||
| Cash and due from banks | 71,921 | 76,843 | 77,063 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Allowance for loan and lease losses | (141,054) | (137,350) | (128,647) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other assets | 527,969 | 523,833 | 440,074 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Total assets | $ | 8,323,431 | $ | 8,171,095 | $ | 8,008,738 | |||||||||||||||||||||||||||||||||||||||||||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Interest-bearing deposits | $ | 4,988,093 | $ | 21,263 | 1.73 | % | $ | 4,718,303 | $ | 12,746 | 1.07 | % | $ | 4,587,242 | $ | 2,376 | 0.21 | % | |||||||||||||||||||||||||||||||||||
| Short-term borrowings: | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Securities sold under agreements to repurchase | 134,501 | 40 | 0.12 | % | 137,248 | 18 | 0.05 | % | 192,108 | 23 | 0.05 | % | |||||||||||||||||||||||||||||||||||||||||
| Other short-term borrowings | 118,760 | 1,353 | 4.62 | % | 125,078 | 1,052 | 3.34 | % | 5,372 | 1 | 0.08 | % | |||||||||||||||||||||||||||||||||||||||||
| Subordinated notes | 58,764 | 1,020 | 7.04 | % | 58,764 | 972 | 6.56 | % | 58,764 | 823 | 5.68 | % | |||||||||||||||||||||||||||||||||||||||||
Long-term debt and mandatorily redeemable securities | 45,380 | 1,215 | 10.86 | % | 47,053 | 1,017 | 8.58 | % | 69,967 | (792) | (4.59) | % | |||||||||||||||||||||||||||||||||||||||||
Total interest-bearing liabilities | 5,345,498 | 24,891 | 1.89 | % | 5,086,446 | 15,805 | 1.23 | % | 4,913,453 | 2,431 | 0.20 | % | |||||||||||||||||||||||||||||||||||||||||
Noninterest-bearing deposits | 1,880,913 | 2,040,162 | 2,029,627 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other liabilities | 147,141 | 137,874 | 101,502 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Shareholders’ equity | 890,294 | 846,449 | 910,793 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Noncontrolling interests | 59,585 | 60,164 | 53,363 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Total liabilities and equity | $ | 8,323,431 | $ | 8,171,095 | $ | 8,008,738 | |||||||||||||||||||||||||||||||||||||||||||||||
| Less: Fully tax-equivalent adjustments | (226) | (215) | (108) | ||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin (GAAP-derived)(1) | $ | 69,565 | 3.59 | % | $ | 71,455 | 3.68 | % | $ | 59,618 | 3.17 | % | |||||||||||||||||||||||||||||||||||||||||
Fully tax-equivalent adjustments | 226 | 215 | 108 | ||||||||||||||||||||||||||||||||||||||||||||||||||
Net interest income/margin - FTE(1) | $ | 69,791 | 3.60 | % | $ | 71,670 | 3.69 | % | $ | 59,726 | 3.18 | % | |||||||||||||||||||||||||||||||||||||||||
(1) See “Reconciliation of Non-GAAP Financial Measures” at the end of this section for additional information on this performance measure/ratio. | |||||||||||||||||||||||||||||||||||||||||||||||||||||
Quarter Ended March 31, 2023 compared to the Quarter Ended March 31, 2022
The taxable-equivalent net interest income for the three months ended March 31, 2023 was $69.79 million, an increase of 16.85% over the same period in 2022. The net interest margin on a fully taxable-equivalent basis was 3.60% for the three months ended March 31, 2023, compared to 3.18% for the three months ended March 31, 2022.
During the three month period ended March 31, 2023, average earning assets increased $244.35 million, up 3.21% over the comparable period in 2022. Average interest-bearing liabilities increased $432.05 million or 8.79%. The yield on average earning assets increased 157 basis points to 4.88% from 3.31% primarily due to higher rates on loans and leases, investment securities and 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. Total cost of average interest-bearing liabilities increased 169 basis points to 1.89% from 0.20% as a result of higher rates on interest-bearing deposits, short-term FHLB borrowings and mandatorily redeemable securities. The result to the net interest margin, or the ratio of net interest income to average earning assets, was an increase of 42 basis points.
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The largest contributors to the improved yield on average earning assets for the three months ended March 31, 2023 compared to the three months ended March 31, 2022 was an increase in yields on net loans and leases and taxable investment securities. The yield on net loans and leases grew 162 basis points primarily from rising interest rates. Average net loans and leases increased $711.86 million or 13.37% primarily in the auto and light truck, construction equipment, and aircraft portfolios. Average investment securities decreased $118.43 million or 6.28% which was the result of elevated fair value unrealized losses and securities sales in the first quarter of 2023 to fund loan growth. Average other investments, primarily held at the Federal Reserve Bank, decreased $342.70 million or 85.66% largely to fund loan growth.
Average interest-bearing deposits increased $400.85 million or 8.74% for the first quarter of 2023 over the same period in 2022 primarily due to public fund deposits, time deposits and brokered deposits. The effective rate paid on average interest-bearing deposits increased 152 basis points to 1.73% from 0.21% in line with the general rising rate environment. Average noninterest-bearing deposits declined $148.71 million or 7.33% for the first quarter of 2023 over the same period in 2022 primarily due to greater utilization of excess funds by our business customers, and a heightened rate sensitivity in our customer base given the overall level of market yields.
Average short-term borrowings increased $55.78 million or 28.25% for the first quarter of 2023 compared to the same period in 2022 primarily to support loan growth and liquidity during the quarter. Interest paid on short-term borrowings increased 213 basis points due to higher short-term FHLB borrowings. Interest paid on subordinated notes increased 136 basis points during the first quarter of 2023 from the same period a year ago due to a variable rate increase on one tranche. Average long-term debt and mandatorily redeemable securities balances decreased $24.59 million or 35.14%. Interest paid on long-term debt and mandatorily redeemable securities increased 1,545 basis points during the first quarter of 2023 from the same period in 2022 primarily due to higher rates on mandatorily redeemable securities from an increase in book value per share during the quarter. Mandatorily redeemable shares are issued under the terms of one of our executive incentive compensation plans and are settled based on book value per share with changes from the previous reporting date recorded as interest expense.
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.
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 | ||||||||||||||
| March 31, | December 31, | March 31, | ||||||||||||
| (Dollars in thousands) | 2023 | 2022 | 2022 | |||||||||||
| Calculation of Net Interest Margin | ||||||||||||||
| (A) | Interest income (GAAP) | $ | 94,456 | $ | 87,260 | $ | 62,049 | |||||||
| Fully tax-equivalent adjustments: | ||||||||||||||
| (B) | - Loans and leases | 103 | 109 | 77 | ||||||||||
| (C) | - Tax-exempt investment securities | 123 | 106 | 31 | ||||||||||
| (D) | Interest income - FTE (A+B+C) | 94,682 | 87,475 | 62,157 | ||||||||||
| (E) | Interest expense (GAAP) | 24,891 | 15,805 | 2,431 | ||||||||||
| (F) | Net interest income (GAAP) (A–E) | 69,565 | 71,455 | 59,618 | ||||||||||
| (G) | Net interest income - FTE (D–E) | 69,791 | 71,670 | 59,726 | ||||||||||
| (H) | Annualization factor | 4.056 | 3.967 | 4.056 | ||||||||||
| (I) | Total earning assets | $ | 7,864,595 | $ | 7,707,769 | $ | 7,620,248 | |||||||
| Net interest margin (GAAP-derived) (F*H)/I | 3.59 | % | 3.68 | % | 3.17 | % | ||||||||
| Net interest margin - FTE (G*H)/I | 3.60 | % | 3.69 | % | 3.18 | % | ||||||||
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PROVISION AND ALLOWANCE FOR CREDIT LOSSES
The provision for credit losses for the three months ended March 31, 2023 was $3.05 million compared to $2.23 million during the three months ended March 31, 2022. Net recoveries of $0.19 million or 0.01% of average loans and leases were recorded for the first quarter 2023, compared to net recoveries of $0.23 million or 0.02% of average loans and leases for the same quarter a year ago. Net recoveries in 2023 were principally in the aircraft, auto and light truck, and residential real estate and home equity portfolios.
The provision for credit losses for the three months ended March 31, 2023 was principally driven by loan growth during the quarter along with an upward revision to the forecast adjustment as broader market liquidity concerns and tightening credit conditions have added uncertainty and increased downside risks in the forecast period. Ongoing risks include a weakened domestic GDP outlook, persistent inflation, higher interest rates, and geopolitical uncertainty. We remain concerned about the potential risks in our small business portfolio as liquidity provided by government programs afforded to our lending clients dissipates and economic growth slows. Impairment reserves for assets individually evaluated increased slightly this quarter, but continue to be a small component of our overall allowance.
We continue to evaluate risks which may impact our loan portfolios. Most notably, the weakened economic outlook and increased uncertainty characterized by persistent inflation, ongoing hostilities in Ukraine, and the Federal Reserve’s challenge of taming inflation while maintaining overall stability and liquidity in the financial sector. The direct impacts of the pandemic and related economic disruptions which previously dominated our risk analysis, have lessened, however, economic disruption remains a concern, particularly the availability of raw materials, components, and price volatility across the supply chain. We remain concerned that geopolitical events and persistently high inflation with weakened growth prospects raises the potential for adverse impacts in the domestic and global economies. Increasing interest rates could impact valuations of assets which collateralize our loans and the persistently inverted yield curve may lead to tightening credit market conditions. Weakened growth projections in the U.S. and abroad along with the potential for raw material shortages and prolonged trade disruption caused by the war in Ukraine increases overall uncertainty. Congressional spending initiatives face multiple challenges and uncompromising partisanship. Political discord continues in Latin America, with governments facing increased pressures from social tensions, continued high unemployment, and elevated inflation. Corruption scandals persist, fueling U.S. border concerns. Globally, concerns continue to be heightened due to the ongoing threat of terrorism.
Another area of concern continues to be our aircraft portfolio where we have a collateral concentration and $295 million of foreign exposure, the majority of which is in Mexico and Brazil. We review political and economic data for these countries on a regular basis to assess the impact the environment may have on our customers. Historically, we have experienced volatile and unanticipated losses in both the foreign and domestic segments of our aircraft portfolios. Losses have been primarily attributable to unexpected declines in the value of specific aircraft collateral at a time when the borrower is experiencing financial difficulties. We review and assess aircraft values on an ongoing basis and use a tiered approach to establish advance rates and amortization schedules to limit collateral exposure. We continue to monitor individual customer performance and assess risks in the overall portfolio.
On March 31, 2023, 30 day and over loan and lease delinquency as a percentage of loan and lease balances was 0.06%, compared to 0.19% on March 31, 2022. The allowance for loan and lease losses as a percentage of loans and leases outstanding at the end of the period was 2.33% compared to 2.41% one year ago. A summary of loan and lease loss experience during the three months ended March 31, 2023 and 2022 is located in Note 5 of the Consolidated Financial Statements.
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NONPERFORMING ASSETS
The following table shows nonperforming assets.
| (Dollars in thousands) | March 31, 2023 | December 31, 2022 | March 31, 2022 | |||||||||||||||||
| Loans and leases past due 90 days or more | $ | 24 | $ | 54 | $ | 274 | ||||||||||||||
| Nonaccrual loans and leases | 18,062 | 26,420 | 35,435 | |||||||||||||||||
| Other real estate | 117 | 104 | — | |||||||||||||||||
| Repossessions | 445 | 327 | 73 | |||||||||||||||||
| Equipment owned under operating leases | — | 22 | 343 | |||||||||||||||||
| Total nonperforming assets | $ | 18,648 | $ | 26,927 | $ | 36,125 | ||||||||||||||
Nonperforming assets as a percentage of loans and leases were 0.30% at March 31, 2023, 0.45% at December 31, 2022, and 0.66% at March 31, 2022. Nonperforming assets totaled $18.65 million at March 31, 2023, a decrease of 30.75% from the $26.93 million reported at December 31, 2022, and a 48.38% decrease from the $36.13 million reported at March 31, 2022. The decrease in nonperforming assets during the first three months of 2023 was related to lower nonaccrual loans and leases. The decrease in nonperforming assets at March 31, 2023 from March 31, 2022 was related to a decrease in nonaccrual loans and leases and decreased equipment owned under operating leases.
The decrease in nonaccrual loans and leases at March 31, 2023 from December 31, 2022 and March 31, 2022 occurred primarily due to multiple pay-downs in the construction equipment portfolio along with balance reduction from fleet sales and scheduled payments in the auto and light truck portfolio and a pay-off in the residential mortgage portfolio. A summary of nonaccrual loans and leases and past due aging for the period ended March 31, 2023 and December 31, 2022 is located in Note 4 of the Consolidated Financial Statements.
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. We currently have one property held in other real estate assets.
Repossessions consisted of a few loans in the consumer portfolio and the auto and light truck portfolio at March 31, 2023. 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 allowance 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 increase in repossession balances at March 31, 2023 compared to March 31, 2022 was primarily the result of repossession activity in the auto and light truck portfolio.
The following table shows a summary of other real estate and repossessions.
| (Dollars in thousands) | March 31, 2023 | December 31, 2022 | March 31, 2022 | |||||||||||||||||
| Commercial and agricultural | $ | — | $ | — | $ | — | ||||||||||||||
| Solar | — | — | — | |||||||||||||||||
| Auto and light truck | 367 | 311 | 26 | |||||||||||||||||
| Medium and heavy duty truck | — | — | — | |||||||||||||||||
| Aircraft | — | — | — | |||||||||||||||||
| Construction equipment | — | — | 47 | |||||||||||||||||
| Commercial real estate | — | — | — | |||||||||||||||||
| Residential real estate and home equity | 117 | 104 | — | |||||||||||||||||
| Consumer | 78 | 16 | — | |||||||||||||||||
| Total | $ | 562 | $ | 431 | $ | 73 | ||||||||||||||
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.
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NONINTEREST INCOME
The following table shows the details of noninterest income.
| Three Months Ended March 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2023 | 2022 | $ Change | % Change | |||||||||||||||||||
| Noninterest income: | |||||||||||||||||||||||
| Trust and wealth advisory | $ | 5,679 | $ | 5,914 | (235) | (3.97) | % | ||||||||||||||||
| Service charges on deposit accounts | 3,003 | 2,792 | 211 | 7.56 | % | ||||||||||||||||||
| Debit card | 4,507 | 4,194 | 313 | 7.46 | % | ||||||||||||||||||
| Mortgage banking | 802 | 1,377 | (575) | (41.76) | % | ||||||||||||||||||
| Insurance commissions | 2,029 | 1,905 | 124 | 6.51 | % | ||||||||||||||||||
| Equipment rental | 2,503 | 3,662 | (1,159) | (31.65) | % | ||||||||||||||||||
| Losses on investment securities available-for-sale | (44) | — | (44) | NM | |||||||||||||||||||
| Other | 4,844 | 3,301 | 1,543 | 46.74 | % | ||||||||||||||||||
| Total noninterest income | $ | 23,323 | $ | 23,145 | 178 | 0.77 | % | ||||||||||||||||
NM = Not Meaningful
Trust and wealth advisory fees (which include investment management fees, estate administration fees, mutual fund fees, annuity fees, and fiduciary fees) decreased during the three months ended March 31, 2023 compared with the same period 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 March 31, 2023, December 31, 2022, and March 31, 2022 was $4.91 billion, $4.84 billion, and $5.09 billion, respectively. The stock and bond market made steady trends upward during the first three months of 2023 and resulted in an increase in the market value of trust assets under management compared to December 31, 2022, however revenue decreased due to the loss of two large employee benefit accounts as our clients were acquired and the acquiring companies merged the plan management into their current plans.
Service charges on deposit accounts increased for the three months ended March 31, 2023 over the comparable period in 2022. The increase primarily reflects a higher volume of consumer nonsufficient fund transactions.
Debit card income increased during the first three months ended March 31, 2023 compared to the same period a year ago due to an increased volume of debit card transactions.
Mortgage banking income decreased in the three months ended March 31, 2023 as compared to the same period in 2022. The reduction is mainly from lower mortgage origination volumes resulting in lower income from loans sold in the secondary market. Demand for mortgages has continued to decline as higher rates have negatively impacted refinancing volumes, affordability and market activity.
Insurance commissions grew during the three months ended March 31, 2023 compared to the same period a year ago. The increase during 2023 was mainly due to increased contingent commissions received.
Equipment rental income decreased for the three months ended March 31, 2023 over the comparable period in 2022. The decline was the result of a reduction in the construction equipment and medium and heavy duty truck portfolios resulting in the average equipment rental portfolio decreasing by 32.3% over the same period a year ago due to changing customer preferences and competitive pricing pressures for new business.
Losses on available-for-sale investment securities sold during the three months ended March 31, 2023 were immaterial. The sales proceeds were used to support liquidity and fund loan growth during the quarter.
Other income increased for the quarter compared to the comparable period in 2022. The increase is primarily due to partnership investment gains on sale of renewable energy tax equity investments of $1.11 million, increased customer interest rate swap fees, and higher bank owned life insurance policy income.
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NONINTEREST EXPENSE
The following table shows the details of noninterest expense.
| Three Months Ended March 31, | |||||||||||||||||||||||
| (Dollars in thousands) | 2023 | 2022 | $ Change | % Change | |||||||||||||||||||
| Noninterest expense: | |||||||||||||||||||||||
| Salaries and employee benefits | $ | 28,597 | $ | 25,467 | 3,130 | 12.29 | % | ||||||||||||||||
| Net occupancy | 2,622 | 2,811 | (189) | (6.72) | % | ||||||||||||||||||
| Furniture and equipment | 1,307 | 1,295 | 12 | 0.93 | % | ||||||||||||||||||
| Data processing | 6,157 | 5,208 | 949 | 18.22 | % | ||||||||||||||||||
| Depreciation – leased equipment | 2,022 | 3,015 | (993) | (32.94) | % | ||||||||||||||||||
| Professional fees | 682 | 1,608 | (926) | (57.59) | % | ||||||||||||||||||
| FDIC and other insurance | 1,360 | 850 | 510 | 60.00 | % | ||||||||||||||||||
Business development and marketing | 1,972 | 1,268 | 704 | 55.52 | % | ||||||||||||||||||
| Other | 4,702 | 3,814 | 888 | 23.28 | % | ||||||||||||||||||
| Total noninterest expense | $ | 49,421 | $ | 45,336 | 4,085 | 9.01 | % | ||||||||||||||||
Salaries and employee benefits increased during the three months ended March 31, 2023 compared to the same period in 2022. Higher base salaries were a result of normal merit increases, wage inflation as well as a higher headcount. Group insurance claims were elevated.
Net occupancy expense decreased during the three months ended March 31, 2023 compared to the same period in 2022. The quarterly decrease was primarily due to higher snow removal costs due to seasonal weather conditions in the first quarter of 2022.
Furniture and equipment expense, including depreciation, was flat during the three months ended March 31, 2023 compared to the same period a year ago.
Data processing expense grew during the first quarter of 2023 compared to the same period a year ago due primarily to higher computer processing charges and software maintenance expense on technology projects.
Depreciation on leased equipment decreased for the three months ended March 31, 2023 compared to the same period in 2022. Depreciation on leased equipment correlates with the decrease in equipment rental income.
Professional fees were lower during the first quarter of 2023 compared to the same period a year ago. The decline was mostly due to a $1.08 million reversal of accrued legal fees offset by increased board of directors fees.
FDIC and other insurance was higher during the three months ended March 31, 2023 compared to the same period in 2022. The increase was mainly due to higher FDIC insurance premiums due to a two basis-point increase in assessment rates during the first quarter 2023.
Business development and marketing expense was higher during the first quarter of 2023 compared to the same period a year ago. The increase was due to marketing promotions during the first quarter of 2023 as well as increased business meals, entertainment, and travel opportunities compared to the same period a year ago due to lingering COVID-19 restrictions in the first quarter of 2022.
Other expenses were higher during the three months ended March 31, 2023 compared to the same period in 2022. The increase was primarily the result of a rise in the loan loss provision for unfunded loan commitments, an increase in the interest rate swap valuation provision, increased postage costs, and travel for employee training.
INCOME TAXES
The provision for income taxes for the three month period ended March 31, 2023 was $9.29 million compared to $7.79 million for the same period in 2022. The effective tax rate was 22.98% and 22.14% for the quarter ended March 31, 2023 and 2022, respectively. The increase in the quarterly effective tax rate was due to higher permanent book and tax differences in relationship to pretax income in 2023 compared to 2022.
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ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in market risks faced by 1st Source since December 31, 2022. For information regarding our market risk, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2022.
ITEM 4.
CONTROLS AND PROCEDURES
As of the end of the period covered by this report an evaluation was carried out, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, at March 31, 2023, our disclosure controls and procedures were effective in ensuring that information required to be disclosed by 1st Source in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.
In addition, there were no changes in our internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the first fiscal quarter of 2023 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings.
1st Source and its subsidiaries are involved in various legal proceedings that are inherent risks of, or incidental to, the conduct of our businesses. Management does not expect the outcome of any such proceedings will have a material adverse effect on our consolidated financial position or results of operations.
ITEM 1A. Risk Factors.
The Company is attentive to various risks and continuously evaluates the potential impact of such risks. Except as set forth below, where an already disclosed risk factor has been updated for the current period, there have been no material updates or changes in risks faced by 1st Source since December 31, 2022. For information regarding our risk factors, refer to 1st Source’s Annual Report on Form 10-K for the year ended December 31, 2022.
We could experience an unexpected inability to obtain needed liquidity which could adversely affect our business, profitability, and viability as a going concern— Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities and is essential to a financial institution’s business. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets, and its access to alternative sources of funds. The bank failures in March 2023 exemplify the potential serious results of the unexpected inability of insured depository institutions to obtain needed liquidity to satisfy deposit withdrawal requests, including how quickly such requests can accelerate once uninsured depositors lose confidence in an institutions ability to satisfy its obligations to depositors. We seek to ensure our funding needs are met by maintaining a level of liquidity through asset and liability management. If we become unable to obtain funds when needed, it could have a material adverse effect on our business, financial condition, and results of operations. Additionally, under Indiana law governing the collateralization of public fund deposits, the Indiana Board for 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, which could adversely affect our liquidity depending on the amount of collateral we may be required to pledge.
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ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.
ISSUER PURCHASES OF EQUITY SECURITIES
| Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs* | Maximum Number (or Approximate Dollar Value) of Shares that may yet be Purchased Under the Plans or Programs | ||||||||||||||||||||||
| January 01 - 31, 2023 | — | $ | — | — | 1,576,265 | |||||||||||||||||||||
| February 01 - 28, 2023 | — | — | — | 1,576,265 | ||||||||||||||||||||||
| March 01 - 31, 2023 | 16,359 | 46.79 | 16,359 | 1,559,906 | ||||||||||||||||||||||
* 1st Source maintains a stock repurchase plan that was authorized by the Board of Directors on July 22, 2021. Under the terms of the plan, 1st Source may repurchase up to 2,000,000 shares of its common stock from time to time to mitigate the potential dilutive effects of stock-based incentive plans and other potential uses of common stock for corporate purposes. Since the inception of the plan, 1st Source has repurchased a total of 440,094 shares.
ITEM 3. Defaults Upon Senior Securities.
None
ITEM 4. Mine Safety Disclosures.
None
ITEM 5. Other Information.
None
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 | April 20, 2023 | /s/ CHRISTOPHER J. MURPHY III | |||||||||
| Christopher J. Murphy III Chairman of the Board, President and CEO | |||||||||||
| DATE | April 20, 2023 | /s/ BRETT A. BAUER | |||||||||
| Brett A. Bauer Treasurer and Chief Financial Officer Principal Accounting Officer | |||||||||||
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