1st Source (SRCE) - 2022 Q3 - Quarterly Report

PART I. FINANCIAL INFORMATION Item 1. Financial Statements (Unaudited) Presents 1st Source Corporation's unaudited consolidated financial statements, including condition, income, comprehensive income, equity, and cash flows, for specified periods Consolidated Statements of Financial Condition Consolidated Statements of Financial Condition Highlights (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :------------------------------------------ | :----------- | :----------- | :------- | :------- | | Total assets | $8,097,486 | $8,096,289 | $1,197 | 0.01% | | Cash and due from banks | $86,952 | $54,420 | $32,532 | 59.78% | | Federal funds sold and interest bearing deposits with other banks | $30,652 | $470,767 | $(440,115) | -93.49% | | Investment securities available-for-sale | $1,801,194 | $1,863,041 | $(61,847) | -3.32% | | Total loans and leases | $5,762,078 | $5,346,214 | $415,864 | 7.78% | | Allowance for loan and lease losses | $(135,736) | $(127,492) | $(8,244) | 6.47% | | Net loans and leases | $5,626,342 | $5,218,722 | $407,620 | 7.81% | | Equipment owned under operating leases, net | $32,964 | $48,433 | $(15,469) | -31.94% | | Accrued income and other assets | $362,038 | $269,469 | $92,569 | 34.35% | | Total liabilities | $7,211,126 | $7,126,825 | $84,301 | 1.18% | | Total deposits | $6,621,231 | $6,679,065 | $(57,834) | -0.87% | | Total short-term borrowings | $340,462 | $200,027 | $140,435 | 70.21% | | Total shareholders' equity | $826,059 | $916,255 | $(90,196) | -9.84% | | Accumulated other comprehensive loss | $(162,277) | $(9,861) | $(152,416) | 1545.65% | | Total equity | $886,360 | $969,464 | $(83,104) | -8.57% | - The decrease in investment securities available-for-sale was primarily due to negative market value adjustments resulting from temporary, non-credit-related, net unrealized losses caused by changes in interest rates, market spreads, and market conditions[159] - The increase in total loans and leases was mainly driven by growth in the auto and light truck, construction equipment, and aircraft portfolios, partially offset by approximately $69 million in Paycheck Protection Program (PPP) loans forgiven by the SBA[160] - The decrease in total deposits was primarily due to a decline in time deposits, which was partially offset by an increase in interest-bearing public fund deposits[162] - Short-term borrowings increased significantly, mainly due to higher short-term FHLB borrowings, largely to support strong loan growth[162] - Total shareholders' equity decreased primarily due to a substantial increase in accumulated other comprehensive losses[166] Consolidated Statements of Income Net Income and EPS (in thousands, except per share amounts) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :--------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income available to common shareholders | $32,737 | $32,483 | $89,441 | $90,811 | | Basic net income per common share | $1.32 | $1.29 | $3.59 | $3.59 | | Diluted net income per common share | $1.32 | $1.29 | $3.59 | $3.59 | Key Income Statement Components (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :----- | :------- | | Total interest income | $206,556 | $190,791 | $15,765 | 8.26% | | Total interest expense | $14,542 | $14,220 | $322 | 2.26% | | Net interest income | $192,014 | $176,571 | $15,443 | 8.75% | | Provision (recovery of provision) for credit losses | $7,903 | $(3,186) | $11,089 | NM | | Total noninterest income | $67,982 | $76,264 | $(8,282) | -10.86% | | Total noninterest expense | $136,322 | $137,402 | $(1,080) | -0.79% | | Income before income taxes | $115,771 | $118,619 | $(2,848) | -2.40% | | Income tax expense | $26,295 | $27,797 | $(1,502) | -5.40% | | Net income | $89,476 | $90,822 | $(1,346) | -1.48% | Cash Dividends Per Common Share | Period | 2022 | 2021 | | :-------------------------- | :--- | :--- | | 3 Months Ended Sep 30 | $0.32 | $0.31 | | 9 Months Ended Sep 30 | $0.94 | $0.90 | Consolidated Statements of Comprehensive Income (Loss) Consolidated Statements of Comprehensive Income (Loss) (in thousands) | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :--------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Net income | $32,745 | $32,481 | $89,476 | $90,822 | | Unrealized depreciation of available-for-sale securities | $(72,275) | $(6,833) | $(200,061) | $(21,695) | | Other comprehensive loss, net of tax | $(55,266) | $(5,187) | $(152,416) | $(15,954) | | Comprehensive (loss) income | $(22,521) | $27,294 | $(62,940) | $74,868 | - The significant comprehensive loss for the three and nine months ended September 30, 2022, was primarily driven by a substantial increase in unrealized depreciation of available-for-sale securities, reflecting adverse changes in interest rates and market conditions[10][166] Consolidated Statements of Shareholders' Equity Shareholders' Equity Changes (9 Months Ended Sep 30, 2022, in thousands) | Metric | Jan 1, 2022 | Sep 30, 2022 | Change | | :--------------------------------- | :---------- | :----------- | :------- | | Total shareholders' equity | $916,255 | $826,059 | $(90,196) | | Net income | N/A | $89,441 | N/A | | Other comprehensive loss | $(9,861) | $(162,277) | $(152,416) | | Common stock dividend | N/A | $(23,303) | N/A | | Cost of common stock acquired for treasury | $(114,209) | $(119,743) | $(5,534) | - The primary driver for the decrease in total shareholders' equity was a significant increase in accumulated other comprehensive loss, which rose by $152.42 million[166][12] Consolidated Statements of Cash Flows Cash Flow Summary (9 Months Ended Sep 30, in thousands) | Activity | 2022 | 2021 | Change | | :--------------------------------- | :--- | :--- | :------- | | Net cash provided by operating activities | $131,743 | $105,074 | $26,669 | | Net cash used in investing activities | $(574,696) | $(296,898) | $(277,798) | | Net cash provided by financing activities | $35,370 | $586,059 | $(550,689) | | Net change in cash and cash equivalents | $(407,583) | $394,235 | $(801,818) | | Cash and cash equivalents, end of period | $117,604 | $637,282 | $(519,678) | - The net decrease in cash and cash equivalents was primarily due to a reduction in excess liquidity from fewer PPP loan forgiveness proceeds and positive loan growth[175] - Investing activities saw a significant increase in cash usage, driven by purchases of investment securities available-for-sale and a net increase in loans and leases[14] - Financing activities provided substantially less cash, mainly due to decreases in demand and savings accounts and time deposits, partially offset by an increase in short-term borrowings[14] Notes to the Consolidated Financial Statements Note 1 — Accounting Policies - The unaudited consolidated financial statements are prepared according to SEC rules, with certain GAAP disclosures omitted, and should be read in conjunction with the 2021 Annual Report on Form 10-K[17][18] - Financial statements require management to make estimates and assumptions that affect reported amounts of assets, liabilities, income, and expense[19] - Loans and leases are stated at the principal amount outstanding, net of unamortized deferred fees/costs and unearned income. Interest accrual is generally discontinued when a loan or lease is 90 days delinquent or deemed nonperforming[20][22] - Troubled Debt Restructurings (TDRs) involve economic concessions to borrowers experiencing financial difficulties and are evaluated for impairment based on the present value of expected future cash flows or the current fair value of collateral[23][24] Note 2 — Recent Accounting Pronouncements - ASU 2022-03 clarifies that contractual sale restrictions on equity securities are not considered in fair value measurement, effective for fiscal years beginning after December 15, 2023. The Company does not expect a material impact[25] - ASU 2022-02 eliminates TDR recognition and measurement guidance, requiring evaluation of modifications as new or existing loans, and enhances disclosure requirements. It is effective for fiscal years beginning after December 15, 2022, and the Company is assessing its impact[26] - ASU 2020-04 and 2021-01 provide temporary optional guidance to ease accounting for reference rate reform (e.g., LIBOR transition), effective through December 31, 2022. The Company expects to utilize this relief and does not anticipate a material impact[27] Note 3 — Investment Securities Available-For-Sale Investment Securities Available-for-Sale (Fair Value, in thousands) | Security Type | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :--------------------------------- | :----------- | :----------- | :------- | :------- | | U.S. Treasury and Federal agencies securities | $1,031,577 | $1,084,006 | $(52,429) | -4.84% | | U.S. States and political subdivisions securities | $115,231 | $95,701 | $19,530 | 20.41% | | Mortgage-backed securities — Federal agencies | $637,690 | $659,727 | $(22,037) | -3.34% | | Corporate debt securities | $16,113 | $23,009 | $(6,896) | -29.97% | | Foreign government and other securities | $583 | $598 | $(15) | -2.51% | | Total debt securities available-for-sale | $1,801,194 | $1,863,041 | $(61,847) | -3.32% | Gross Unrealized Losses on Available-for-Sale Securities (in thousands) | Security Type | Sep 30, 2022 | Dec 31, 2021 | Change | | :--------------------------------- | :----------- | :----------- | :------- | | U.S. Treasury and Federal agencies securities | $(99,667) | $(13,018) | $(86,649) | | U.S. States and political subdivisions securities | $(10,777) | $(1,129) | $(9,648) | | Mortgage-backed securities — Federal agencies | $(102,210) | $(8,459) | $(93,751) | | Total gross unrealized losses | $(213,054) | $(22,608) | $(190,446) | - At September 30, 2022, 728 out of 748 available-for-sale securities were in an unrealized loss position. The Company does not consider these to be credit losses and does not intend to sell these investments before recovery of amortized cost, as the losses are due to changes in interest rates, market spreads, and market conditions[33][34] Note 4 — Loan and Lease Financings - The Company categorizes its loan and lease portfolios into nine segments based on similar risk characteristics, using credit quality grades (1-12) and credit risk classifications to assess risk[37][39][40] Total Loans and Leases (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :------------------- | :----------- | :----------- | :------- | :------- | | Total loans and leases | $5,762,078 | $5,346,214 | $415,864 | 7.78% | Loan and Lease Portfolio Amortized Cost (Top 3 Growth Segments, in thousands) | Segment | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :----------------------- | :----------- | :----------- | :------- | :------- | | Auto and light truck | $743,324 | $603,775 | $139,549 | 23.11% | | Construction equipment | $878,692 | $754,273 | $124,419 | 16.49% | | Aircraft | $997,995 | $898,401 | $99,594 | 11.09% | Loan and Lease Delinquency Aging (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :--------------------------------- | :----------- | :----------- | :------- | :------- | | Current | $5,728,821 | $5,301,658 | $427,163 | 8.06% | | 30-59 Days Past Due | $3,116 | $2,987 | $129 | 4.32% | | 60-89 Days Past Due | $2,162 | $2,614 | $(452) | -17.29% | | 90 Days or More Past Due and Accruing | $166 | $249 | $(83) | -33.33% | | Nonaccrual | $27,813 | $38,706 | $(10,893) | -28.14% | - No loan and lease modifications were classified as troubled debt restructurings (TDRs) during the three and nine months ended September 30, 2022. The recorded investment of TDRs decreased to $4.04 million at September 30, 2022, from $7.06 million at December 31, 2021[56][59] Note 5 — Allowance for Credit Losses Allowance for Loan and Lease Losses (ALLL, in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :------------------- | :----------- | :----------- | :------- | :------- | | Balance, end of period | $135,736 | $127,492 | $8,244 | 6.47% | Provision (Recovery of Provision) for Credit Losses (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | | :--------------------------------- | :--- | :--- | :------- | | Provision (recovery of provision) | $7,903 | $(3,186) | $11,089 | Net Charge-offs (Recoveries) (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | | :--------------------------------- | :--- | :--- | :------- | | Net charge-offs (recoveries) | $(341) | $3,713 | $(4,054) | - The increase in the ALLL was primarily due to loan growth, particularly in construction equipment, aircraft, medium and heavy duty truck, and residential real estate portfolios, and the maintenance of the forecast adjustment due to economic concerns[64][70] - Credit quality remains on an improving trend, evidenced by declining total special attention credit outstandings and minimal charge-off activity during the quarter[64] - The economic outlook includes a weakened domestic GDP outlook, continued geopolitical uncertainty (Ukraine war), ongoing supply chain difficulties, and persistent inflation, which are expected to adversely impact the loan and lease portfolio over the next two years[70][71] Liability for Credit Losses on Unfunded Loan Commitments (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | | :--------------------------------- | :--- | :--- | | Balance, end of period | $5,216 | $4,363 | Note 6 — Lease Investments Direct Finance Leases - Interest Income (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :------- | :------- | | Interest income on lease receivable | $6,112 | $4,880 | $1,232 | 25.25% | Operating Leases - Income and Depreciation (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :------- | :------- | | Income related to lease payments | $9,718 | $12,830 | $(3,112) | -24.26% | | Depreciation expense | $7,912 | $10,562 | $(2,650) | -25.09% | - The decline in operating lease equipment rental income and depreciation was due to a reduction in the construction equipment and auto and light truck portfolios, resulting in a 19% decrease in the average equipment rental portfolio, driven by changing customer preferences and competitive pricing pressures[223] Note 7 — Mortgage Servicing Rights Mortgage Servicing Rights (MSRs) Carrying and Fair Value (in thousands) | Metric | Sep 30, 2022 | Sep 30, 2021 | Change | % Change | | :--------------------------------- | :----------- | :----------- | :------- | :------- | | Net carrying value of MSRs | $4,298 | $4,519 | $(221) | -4.89% | | Fair value of MSRs | $7,493 | $4,999 | $2,494 | 49.89% | - At September 30, 2022, the fair value of MSRs exceeded their carrying value by $3.20 million, an increase from $0.48 million at September 30, 2021, representing increases in fair value that could not be recorded above cost basis[80] Mortgage Loan Contractual Servicing Fees (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :------- | :------- | | Contractual servicing fees | $2,130 | $2,400 | $(270) | -11.25% | Note 8 — Commitments and Financial Instruments with Off-Balance-Sheet Risk Off-Balance-Sheet Financial Instruments (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :--------------------------------- | :----------- | :----------- | :------- | :------- | | Loan commitments to extend credit | $1,199,066 | $1,148,984 | $50,082 | 4.36% | | Standby letters of credit | $18,761 | $24,657 | $(5,896) | -23.91% | | Commercial and similar letters of credit | $400 | $8,531 | $(8,131) | -95.31% | - The Company uses the same credit policies and collateral requirements for off-balance-sheet instruments as it does for on-balance-sheet instruments[84] - Interest rate risk associated with mortgage loan commitments is managed by entering into contracts for future deliveries of loans[85] Note 9 — Derivative Financial Instruments Non-Hedging Derivative Financial Instruments (Notional/Contractual Amount, in thousands) | Instrument | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :--------------------------------- | :----------- | :----------- | :------- | :------- | | Interest rate swap contracts | $947,564 | $1,064,721 | $(117,157) | -11.00% | | Loan commitments | $1,460 | $15,086 | $(13,626) | -90.32% | | Forward contracts - mortgage loan | $2,250 | $22,000 | $(19,750) | -89.77% | Gain (Loss) from Non-Hedging Derivative Financial Instruments (9 Months Ended Sep 30, in thousands) | Instrument | 2022 | 2021 | | :--------------------------------- | :--- | :--- | | Interest rate swap contracts (Other expense) | $(69) | $420 | | Interest rate swap contracts (Other income) | $83 | $307 | | Loan commitments (Mortgage banking) | $(424) | $(704) | | Forward contracts - mortgage loan (Mortgage banking) | $93 | $512 | | Total | $(317) | $535 | - The Company enters into offsetting interest rate swaps with clients and other financial institutions, which means changes in the fair value of these underlying derivative contracts do not significantly impact the Company's results of operations[89] Note 10 — Variable Interest Entities Unconsolidated VIE Investments (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :--------------------------------- | :----------- | :----------- | :------- | :------- | | Investment carrying amount | $55,546 | $35,968 | $19,578 | 54.43% | | Unfunded capital and other commitments | $51,428 | $29,670 | $21,758 | 73.33% | | Maximum exposure to loss | $50,048 | $50,319 | $(271) | -0.54% | - The Company's investments in VIEs primarily relate to affordable housing, community development, and renewable energy sources, generating returns through federal and state income tax credits and other tax benefits[97] Tax Credits Recognized from VIEs (9 Months Ended Sep 30, in thousands) | Credit Type | 2022 | 2021 | | :--------------------------------- | :--- | :--- | | Federal income tax credits (affordable housing/community development) | $1,550 | $1,560 | | Investment tax credits (renewable energy) | $9,480 | $3,320 | - The Company sponsors the 1st Source Master Trust (Capital Trust), an unconsolidated VIE, which issues mandatorily redeemable capital securities backed by the Company's junior subordinated debentures. These subordinated notes qualify as Tier 1 capital[103][104] Subordinated Notes (in thousands) | Issuance | Amount | Interest Rate | Maturity Date | | :----------------- | :----- | :------------ | :------------ | | June 2007 issuance | $41,238 | 7.22% | 6/15/2037 | | August 2007 issuance | $17,526 | 4.77% | 9/15/2037 | | Total | $58,764 | | | Note 11 — Earnings Per Share Earnings Per Common Share | Metric | 3 Months Ended Sep 30, 2022 | 3 Months Ended Sep 30, 2021 | 9 Months Ended Sep 30, 2022 | 9 Months Ended Sep 30, 2021 | | :--------------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | :-------------------------- | | Basic earnings per common share | $1.32 | $1.29 | $3.59 | $3.59 | | Diluted earnings per common share | $1.32 | $1.29 | $3.59 | $3.59 | Weighted Average Common Shares Outstanding (9 Months Ended Sep 30) | Metric | 2022 | 2021 | | :--------------------------------- | :----------- | :----------- | | Basic | 24,697,106 | 25,126,703 | | Diluted | 24,697,106 | 25,126,703 | - No stock options were outstanding or had a dilutive effect on earnings per common share for the periods presented[108][109] Note 12 — Stock Based Compensation - The Company has four active stock-based employee compensation plans: the Executive Incentive Plan (EIP), the Restricted Stock Award Plan (RSAP), the Strategic Deployment Incentive Plan (SDP), and the Employee Stock Purchase Plan[110] - As of September 30, 2022, total unrecognized compensation cost related to non-vested share-based arrangements was $8.70 million, expected to be recognized over a weighted-average period of 3.24 years[113] - No stock options were outstanding or exercised during the nine months ended September 30, 2022 and 2021[112] Note 13 — Accumulated Other Comprehensive Income (Loss) Reclassifications Out of Accumulated Other Comprehensive Income (Loss) (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | | :--------------------------------- | :--- | :--- | | Realized losses included in net income | $0 | $(680) | | Tax effect | $0 | $164 | | Net of tax | $0 | $(516) | - For the nine months ended September 30, 2022, there were no realized losses on investment securities available-for-sale reclassified into net income, in contrast to the prior year[115] Note 14 — Income Taxes - The total amount of unrecognized tax benefits that would affect the effective tax rate was zero at September 30, 2022, and December 31, 2021[116] - No interest or penalties related to income taxes were recognized for the three and nine months ended September 30, 2022 and 2021[116] - Tax years 2018-2021 remain open and subject to audit for both federal and Indiana income taxes[117] Note 15 — Fair Value Measurements - Fair value measurements are classified into Level 1 (quoted prices in active markets), Level 2 (observable inputs), or Level 3 (unobservable inputs and significant management judgment)[119][127] Assets Measured at Fair Value on a Recurring Basis (Sep 30, 2022, in thousands) | Asset Type | Level 1 | Level 2 | Level 3 | Total | | :--------------------------------- | :------ | :------ | :------ | :------ | | Investment securities available-for-sale | $570,045 | $1,226,751 | $4,398 | $1,801,194 | | Mortgages held for sale | $0 | $3,058 | $0 | $3,058 | | Interest rate swap agreements (assets) | $0 | $26,918 | $0 | $26,918 | | Total Assets | $570,045 | $1,256,727 | $4,398 | $1,831,170 | Liabilities Measured at Fair Value on a Recurring Basis (Sep 30, 2022, in thousands) | Liability Type | Level 1 | Level 2 | Level 3 | Total | | :--------------------------------- | :------ | :------ | :------ | :------ | | Interest rate swap agreements (liabilities) | $0 | $27,424 | $0 | $27,424 | | Total Liabilities | $0 | $27,424 | $0 | $27,424 | Level 3 Assets (Direct Placement Municipal Securities) Valuation (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | | :--------------------------------- | :----------- | :----------- | | Fair Value | $4,398 | $1,849 | | Valuation Methodology | Discounted cash flows | Discounted cash flows | | Unobservable Input | Credit spread assumption | Credit spread assumption | | Weighted Average Input | 4.79% | 1.58% | Non-recurring Fair Value Measurements (Sep 30, 2022, in thousands) | Asset Type | Carrying Value | Fair Value | Unobservable Inputs (Weighted Average) | | :--------------------------------- | :------------- | :----------- | :------------------------------------- | | Collateral-dependent impaired loans | $851 | $851 | Discount for lack of marketability (36.2%) | | Mortgage servicing rights | $4,298 | $7,493 | Constant prepayment rate (9.6%), Discount rate (12.0%) | | Repossessions | $26 | $30 | Discount for lack of marketability (13%) | - Impairment charges (recoveries) on collateral-dependent impaired loans, mortgage servicing rights, repossessions, and other real estate were $0.00 million for the quarter ended September 30, 2022[145] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial condition, operating results, capital, liquidity, and interest rate sensitivity for specified periods FINANCIAL CONDITION Total Assets (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :----------- | :----------- | :----------- | :------- | :------- | | Total assets | $8,097,486 | $8,096,289 | $1,197 | 0.01% | Key Balance Sheet Changes (Sep 30, 2022 vs Dec 31, 2021, in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :------------------------------------------ | :----------- | :----------- | :------- | :------- | | Federal funds sold and interest bearing deposits with other banks | $30,652 | $470,767 | $(440,115) | -93.49% | | Total loans and leases | $5,762,078 | $5,346,214 | $415,864 | 7.78% | | Equipment owned under operating leases | $32,964 | $48,433 | $(15,469) | -31.94% | | Total deposits | $6,621,231 | $6,679,065 | $(57,834) | -0.87% | | Short-term borrowings | $340,462 | $200,027 | $140,435 | 70.21% | | Long-term debt and mandatorily redeemable securities | $47,587 | $71,251 | $(23,664) | -33.21% | | Accrued expenses and other liabilities | $143,082 | $117,718 | $25,364 | 21.55% | - The increase in loans and leases was primarily driven by growth in the auto and light truck, construction equipment, and aircraft portfolios, partially offset by approximately $69 million in forgiven PPP loans[160] - Foreign loan and lease balances, all denominated in U.S. dollars and primarily in aircraft financing, increased to $239.80 million at September 30, 2022, from $193.31 million at December 31, 2021, with concentrations in Mexico ($131.39 million) and Brazil ($79.29 million)[160] - The increase in accrued income and other assets was mainly due to higher partnership investments carrying amounts, bank owned life insurance cash surrender value, and deferred tax assets related to available-for-sale debt securities[164] CAPITAL Total Shareholders' Equity (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Change | % Change | | :----------------------- | :----------- | :----------- | :------- | :------- | | Total shareholders' equity | $826,059 | $916,255 | $(90,196) | -9.84% | - The decrease in total shareholders' equity was primarily due to an increase in accumulated other comprehensive loss to $162.28 million at September 30, 2022, from $9.86 million at December 31, 2021[166] Key Capital Ratios | Metric | Sep 30, 2022 | Dec 31, 2021 | | :--------------------------------- | :----------- | :----------- | | Shareholders' equity-to-assets ratio | 10.20% | 11.32% | | Book value per common share | $33.50 | $37.04 | | Trailing four quarters dividend payout ratio | 26.54% | N/A | Regulatory Capital Ratios (1st Source Corporation, Sep 30, 2022) | Capital Ratio | Actual Ratio | Minimum Capital Adequacy | To Be Well Capitalized | | :--------------------------------- | :----------- | :----------------------- | :--------------------- | | Total Capital (to Risk-Weighted Assets) | 16.50% | 8.00% | 10.00% | | Tier 1 Capital (to Risk-Weighted Assets) | 15.24% | 6.00% | 8.00% | | Common Equity Tier 1 Capital (to Risk-Weighted Assets) | 13.50% | 4.50% | 6.50% | | Tier 1 Capital (to Average Assets) | 12.69% | 4.00% | 5.00% | - PPP loan balances were assigned a zero percent risk weight, thus having no impact on total risk-weighted assets at September 30, 2022[171] LIQUIDITY AND INTEREST RATE SENSITIVITY Cash and Cash Equivalents (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Sep 30, 2021 | | :----------------------- | :----------- | :----------- | :----------- | | Cash and cash equivalents | $117,604 | $525,187 | $637,282 | - The decrease in cash and cash equivalents was primarily due to a reduction in excess liquidity from fewer PPP loan forgiveness proceeds and positive loan growth[175] Loan to Asset Ratio | Metric | Sep 30, 2022 | Dec 31, 2021 | | :----------------- | :----------- | :----------- | | Loan to asset ratio | 71.16% | 66.03% | - The Company has available borrowing sources including $230.00 million in additional federal funds, $337.68 million in additional FHLB advances, and $468.00 million from the Federal Reserve Bank[174] - The Consolidated Statements of Financial Condition was rate sensitive by $307.87 million more liabilities than assets scheduled to reprice within one year, or approximately 0.91%[175] - No collateral is currently required for public fund deposits under Indiana law, but a potential liquidity exposure of approximately $981 million exists if this requirement changes[176] RESULTS OF OPERATIONS Net Income and EPS (9 Months Ended Sep 30, in thousands, except per share amounts) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :----- | :------- | | Net income available to common shareholders | $89,441 | $90,811 | $(1,370) | -1.51% | | Diluted net income per common share | $3.59 | $3.59 | $0.00 | 0.00% | Return Ratios (9 Months Ended Sep 30) | Metric | 2022 | 2021 | | :--------------------------------- | :----- | :----- | | Return on average common shareholders' equity | 13.56% | 13.45% | | Return on total average assets | 1.49% | 1.60% | - The slight decrease in net income for the nine months ended September 30, 2022, was primarily due to an increased provision for credit losses and decreased noninterest income, partially offset by higher net interest income and lower noninterest expense[179] NET INTEREST INCOME Net Interest Income and Margin (9 Months Ended Sep 30, FTE Basis, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :----- | :------- | | Net interest income - FTE | $192,427 | $176,921 | $15,506 | 8.76% | | Net interest margin - FTE | 3.37% | 3.28% | 0.09% | 2.74% | Yield on Average Earning Assets (9 Months Ended Sep 30) | Metric | 2022 | 2021 | Change (bps) | | :--------------------------------- | :----- | :----- | :----------- | | Yield on total earning assets | 3.62% | 3.54% | 8 bps | | Yield on loans and leases | 4.51% | 4.31% | 20 bps | Cost of Average Interest-Bearing Liabilities (9 Months Ended Sep 30) | Metric | 2022 | 2021 | Change (bps) | | :--------------------------------- | :----- | :----- | :----------- | | Total cost of average interest-bearing liabilities | 0.39% | 0.40% | -1 bps | | Effective rate on average interest-bearing deposits | 0.36% | 0.29% | 7 bps | Average Earning Assets and Liabilities (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :----- | :------- | | Average earning assets | $7,645,464 | $7,211,523 | $433,941 | 6.02% | | Average interest-bearing liabilities | $4,973,767 | $4,725,850 | $247,917 | 5.25% | | Average noninterest-bearing deposits | $2,037,113 | $1,818,271 | $218,842 | 12.04% | - The yield on net loans and leases was positively impacted by 5 basis points due to the recognition of unearned fees on forgiven PPP loans in 2022, compared to a 12 basis point impact in 2021[194] PROVISION AND ALLOWANCE FOR CREDIT LOSSES Provision (Recovery of Provision) for Credit Losses (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | | :--------------------------------- | :--- | :--- | :------- | | Provision (recovery of provision) for credit losses | $7,903 | $(3,186) | $11,089 | Net Charge-offs (Recoveries) (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | | :--------------------------------- | :--- | :--- | :------- | | Net charge-offs (recoveries) | $(341) | $3,713 | $(4,054) | - The provision for credit losses for the three months ended September 30, 2022, was primarily driven by loan growth, with the prior quarter's forecast adjustment maintained due to the current economic outlook[202] - 30-day and over loan and lease delinquency as a percentage of loan and lease balances decreased to 0.09% at September 30, 2022, from 0.20% a year ago, indicating an improving credit quality trend[205] - Economic concerns include a weakened economic outlook, geopolitical uncertainty from the Ukraine war, persistent inflation, and potential supply chain disruptions, which raise the potential for adverse impacts to the U.S. economy[203] - The aircraft portfolio remains a concern due to collateral concentration and $240 million of foreign exposure, mainly in Mexico and Brazil, where political and economic data are regularly assessed for potential impacts[204] NONPERFORMING ASSETS Total Nonperforming Assets (in thousands) | Metric | Sep 30, 2022 | Dec 31, 2021 | Sep 30, 2021 | Change (Sep 30, 2022 vs Dec 31, 2021) | % Change (Sep 30, 2022 vs Dec 31, 2021) | Change (Sep 30, 2022 vs Sep 30, 2021) | % Change (Sep 30, 2022 vs Sep 30, 2021) | | :----------------------- | :----------- | :----------- | :----------- | :-------------------------------------- | :-------------------------------------- | :-------------------------------------- | :-------------------------------------- | | Total nonperforming assets | $28,005 | $41,334 | $45,550 | $(13,329) | -32.25% | $(17,545) | -38.52% | Nonperforming Assets as % of Loans and Leases | Metric | Sep 30, 2022 | Dec 31, 2021 | Sep 30, 2021 | | :--------------------------------- | :----------- | :----------- | :----------- | | Nonperforming assets as % of loans and leases | 0.48% | 0.77% | 0.84% | - The decrease in nonperforming assets was related to continued recovery from the pandemic, leading to lower nonaccrual loans and leases (especially in the bus segment of the auto and light truck portfolio and construction equipment) and a decrease in equipment owned under operating leases[209][210] - Repossessions decreased primarily due to the sale of repossessed buses in the auto and light truck portfolio[212] - The Company currently holds no properties in other real estate assets[211] NONINTEREST INCOME Total Noninterest Income (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :----------------------- | :--- | :--- | :----- | :------- | | Total noninterest income | $67,982 | $76,264 | $(8,282) | -10.86% | Key Noninterest Income Components (9 Months Ended Sep 30, in thousands) | Component | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :----- | :------- | | Trust and wealth advisory | $17,499 | $17,833 | $(334) | -1.87% | | Service charges on deposit accounts | $8,974 | $7,722 | $1,252 | 16.21% | | Debit card | $13,383 | $13,506 | $(123) | -0.91% | | Mortgage banking | $3,303 | $9,909 | $(6,606) | -66.67% | | Insurance commissions | $5,168 | $5,698 | $(530) | -9.30% | | Equipment rental | $9,718 | $12,830 | $(3,112) | -24.26% | | Other | $9,937 | $9,446 | $491 | 5.20% | - Mortgage banking income decreased significantly due to reduced origination volumes caused by higher interest rates impacting refinancing demand[221] - Equipment rental income declined due to a reduction in the average equipment rental portfolio (construction equipment and auto and light truck) resulting from changing customer preferences and competitive pricing pressures[223] - Service charges on deposit accounts increased, primarily reflecting a higher volume of consumer nonsufficient fund transactions[220] - Trust and wealth advisory fees decreased due to stock and bond market corrections impacting the market value of assets under management[219] NONINTEREST EXPENSE Total Noninterest Expense (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :----------------------- | :--- | :--- | :----- | :------- | | Total noninterest expense | $136,322 | $137,402 | $(1,080) | -0.79% | Key Noninterest Expense Components (9 Months Ended Sep 30, in thousands) | Component | 2022 | 2021 | Change | % Change | | :--------------------------------- | :--- | :--- | :----- | :------- | | Salaries and employee benefits | $77,415 | $77,680 | $(265) | -0.34% | | Data processing | $16,412 | $14,851 | $1,561 | 10.51% | | Depreciation – leased equipment | $7,912 | $10,562 | $(2,650) | -25.09% | | FDIC and other insurance | $2,682 | $1,833 | $849 | 46.32% | | Business development and marketing | $4,352 | $6,813 | $(2,461) | -36.12% | | Other | $10,340 | $7,801 | $2,539 | 32.55% | - FDIC and other insurance expenses increased significantly due to higher assessments from a larger asset base and a one-time $0.38 million recovery in the third quarter of 2021[233] - Business development and marketing expense decreased primarily due to a $3.00 million charitable contribution made in the third quarter of 2021, partially offset by increased business meals, entertainment, and travel[234] - Other expenses increased due to a rise in the loan loss provision for unfunded loan commitments, an increase in the interest rate swap valuation provision, and higher postage and printing costs[235] - Depreciation on leased equipment decreased in correlation with the reduction in equipment rental income and the average equipment rental portfolio[231] INCOME TAXES Provision for Income Taxes (9 Months Ended Sep 30, in thousands) | Metric | 2022 | 2021 | Change | % Change | | :----------------------- | :--- | :--- | :----- | :------- | | Provision for income taxes | $26,295 | $27,797 | $(1,502) | -5.40% | Effective Tax Rate (9 Months Ended Sep 30) | Metric | 2022 | 2021 | Change (bps) | | :----------------- | :----- | :----- | :----------- | | Effective tax rate | 22.71% | 23.43% | -72 bps | - The decrease in the year-to-date effective tax rate was primarily due to a slight decrease in the tax provision for state income taxes[237] Item 3. Quantitative and Qualitative Disclosures About Market Risk No material changes in market risks since December 31, 2021, with further details in the Annual Report on Form 10-K - No material changes in market risks have occurred since December 31, 2021[239] Item 4. Controls and Procedures Management affirmed effective disclosure controls and no material changes in internal control over financial reporting as of September 30, 2022 - The Company's disclosure controls and procedures were effective as of September 30, 2022, ensuring timely and accurate reporting of information[241] - No material changes in internal control over financial reporting occurred during the third fiscal quarter of 2022[242] PART II. OTHER INFORMATION Item 1. Legal Proceedings Ongoing legal proceedings are not expected to materially impact financial results; a prior claim was settled for a non-material payment - Management does not expect the outcome of any legal proceedings to have a material adverse effect on the Company's consolidated financial position or results of operations[244] - A previously reported claim asserted by the liquidating trustee in the consolidated bankruptcy cases of IOI Integrated Systems, Inc. and Najeeb Khan was settled on September 23, 2022, for a non-material cash payment[244] Item 1A. Risk Factors No material changes in risk factors since December 31, 2021, with further details in the Annual Report on Form 10-K - No material changes in risk factors have occurred since December 31, 2021[245] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds No equity securities were repurchased in Q3 2022; 1,576,265 shares remain available under the repurchase plan - No shares of equity securities were purchased by the issuer during July, August, or September 2022[247] - As of September 30, 2022, 1,576,265 shares remained available for repurchase under the stock repurchase plan authorized on July 22, 2021, which permits the repurchase of up to 2,000,000 shares[247] Item 3. Defaults Upon Senior Securities No defaults upon senior securities were reported - No defaults upon senior securities were reported[248] Item 4. Mine Safety Disclosures No mine safety disclosures were reported - No mine safety disclosures were reported[248] Item 5. Other Information This section reports no other information - No other information is reported in this section[249] Item 6. Exhibits Lists filed exhibits, including securities descriptions, CEO/CFO certifications, and XBRL documents - Exhibits filed include a description of the Company's securities (4.1), CEO and CFO certifications (31.1, 31.2, 32.1, 32.2), and various XBRL taxonomy documents (101.INS, 101.SCH, 101.CAL, 101.LAB, 101.PRE, 101.DEF, 104)[249] SIGNATURES Report signed on October 20, 2022, by Chairman/CEO Christopher J. Murphy III and CFO Brett A. Bauer - The report was signed on October 20, 2022, by Christopher J. Murphy III (Chairman of the Board, President and CEO) and Brett A. Bauer (Treasurer and Chief Financial Officer, Principal Accounting Officer)[252]