1st Source (SRCE) - 2020 Q4 - Annual Report

Part I Business A bank holding company with $7.32 billion in assets, offering diverse financial services and specialized national financing Company Snapshot (as of Dec 31, 2020) | Metric | Value | | :--- | :--- | | Consolidated Total Assets | $7.32 billion | | Total Loans and Leases | $5.49 billion | | Total Deposits | $5.95 billion | | Total Shareholders' Equity | $886.85 million | | Banking Center Locations | 79 | | Full-time Equivalent Colleagues | ~1,175 | - The company operates through several key subsidiaries: 1st Source Bank, Specialty Finance Group, 1st Source Insurance, Inc, and various consolidated variable interest subsidiaries[11][15][21] - The Specialty Finance Group is a significant national business line, focusing on financing for construction equipment, new and used aircraft, and vehicle fleets[15][16][17] - 1st Source has a strong focus on environmental sustainability, having invested $84 million and provided $293 million in debt financing for 32 solar projects across 12 states[37][39] - The company and its bank subsidiary are extensively regulated by multiple agencies, and as of December 31, 2020, the Bank was categorized as "well capitalized"[43][44][46] Risk Factors The company faces significant credit, market, operational, and regulatory risks, heightened by the COVID-19 pandemic - Credit Risks: The company is exposed to credit risks from its loan portfolios, with the Specialty Finance Group's portfolio being particularly sensitive to economic slowdowns[75][80][81] - Market Risks: The COVID-19 pandemic has adversely impacted customers, while interest rate fluctuations and the transition away from LIBOR present further financial risks[85][88][93] - Liquidity Risks: The company relies on dividends from its subsidiaries, primarily 1st Source Bank, which are limited by regulations, to meet its cash flow needs[95][96] - Operational Risks: The company is dependent on its management team and faces risks from technology security breaches, while also relying on third-party vendors for data processing[98][99][103] - Legal/Compliance & Reputational Risks: The company is subject to extensive government regulation and high competition, making compliance and reputation management critical[105][108][109] Unresolved Staff Comments The company reports no unresolved staff comments from the SEC - None[110] Properties The company owns or leases 79 banking centers and plans to develop a new operations and training facility - The headquarters is located in a leased building in South Bend, Indiana, with the lease extending through September 2027[111] - As of year-end 2020, the company operated 79 banking centers across Indiana, Michigan, and Florida[112] - Plans are underway to construct a new operations and training facility on a 29-acre property, with construction anticipated to begin in 2021[112] Legal Proceedings Current legal proceedings are not expected to have a material adverse effect on the company's financial condition - Management does not expect the outcome of any current legal proceedings to have a material adverse effect on the company's consolidated financial position or results of operations[114] Mine Safety Disclosures The company reports no mine safety disclosures - None[116] Part II Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's stock trades on NASDAQ as "SRCE," with an active share repurchase plan in place - The company's common stock is traded on the NASDAQ Global Select Market under the symbol "SRCE"[117] Share Repurchase Activity (Q4 2020) | Period | Total Shares Purchased | Average Price Paid Per Share | | :--- | :--- | :--- | | October 2020 | — | $ — | | November 2020 | 92,885 | $37.86 | | December 2020 | 73,561 | $39.40 | - Under a 2014 stock repurchase plan, 692,928 shares remained available for future repurchase as of the end of 2020[121] Selected Financial Data Net income and EPS declined in 2020 due to a higher provision for credit losses, while total assets grew Selected Financial Data (2018-2020) | (Dollars in thousands, except per share amounts) | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Net interest income | $225,820 | $223,866 | $213,906 | | Provision for credit losses | $36,001 | $15,833 | $19,462 | | Net income | $81,461 | $92,015 | $82,414 | | Diluted net income per common share | $3.17 | $3.57 | $3.16 | | Assets at year-end | $7,316,411 | $6,622,776 | $6,293,745 | | Shareholders' equity at year-end | $886,845 | $828,277 | $762,082 | | Return on average assets | 1.14% | 1.41% | 1.34% | | Return on average common shareholders' equity | 9.41% | 11.50% | 11.09% | Management's Discussion and Analysis of Financial Condition and Results of Operations Net income fell in 2020 due to increased credit loss provisions from the pandemic, despite PPP-driven loan growth Application of Critical Accounting Policies and Estimates The Allowance for Credit Losses and Fair Value Measurements are identified as critical accounting policies - The company adopted the new CECL standard for credit losses as of December 31, 2020, which requires significant judgment regarding future economic conditions[133][135] - Fair value measurements for certain financial instruments rely on a three-level hierarchy, with management judgment crucial for Level 2 and 3 assets[136][137] Coronavirus (COVID-19) Impact The pandemic prompted extensive loan modifications and PPP participation, with bus and hotel portfolios heavily impacted COVID-19 Related Loan and Lease Modifications in Deferment | (Dollars in millions) | Dec 31, 2020 | Sep 30, 2020 | Jun 30, 2020 | | :--- | :--- | :--- | :--- | | Total Loans and Leases | $129 | $126 | $840 | - The bus and hotel lending portfolios were significantly affected, with 56.27% of bus loan balances and 50.69% of hotel loan balances under modification at year-end[145] Paycheck Protection Program (PPP) Loan Disbursements (as of Dec 31, 2020) | | Number of Loans | $ of Loans (000's) | | :--- | :--- | :--- | | Total | 3,540 | $597,451 | - Due to the pandemic's economic impact, special attention loans increased by $76.22 million and nonperforming loans increased by $50.41 million during 2020[159] Earnings Summary Net income decreased 11.4% in 2020, driven by a 127.4% increase in the provision for credit losses Key Performance Indicators (2019 vs 2020) | Metric | 2020 | 2019 | Change | | :--- | :--- | :--- | :--- | | Net Income (millions) | $81.44 | $91.96 | -11.4% | | Diluted EPS | $3.17 | $3.57 | -11.2% | | ROA | 1.14% | 1.41% | -27 bps | | ROE | 9.41% | 11.50% | -209 bps | - The primary driver of lower net income in 2020 was a $20.17 million (127.38%) increase in the provision for credit losses compared to 2019[162] - Net interest margin on a fully taxable-equivalent basis decreased 29 basis points to 3.39% in 2020, reflecting the lower interest rate environment[165][166] - Noninterest income increased by $2.76 million, largely due to a $10.98 million surge in mortgage banking income[181][185][187] - Noninterest expense decreased by $1.64 million, mainly due to a $4.93 million reduction in depreciation on leased equipment[191][192] Financial Condition Total assets grew 10.5% to $7.32 billion, but credit quality deteriorated with a significant rise in nonperforming assets - Total loans and leases grew to $5.49 billion in 2020, primarily driven by $351.56 million in PPP loans[207][208] - The allowance for loan and lease losses increased to $140.65 million (2.56% of loans) at year-end 2020, reflecting increased credit risk and the adoption of CECL[236] - Nonperforming assets rose sharply to $64.53 million at Dec 31, 2020, compared to $19.24 million at Dec 31, 2019[243][244] - Total deposits increased to $5.95 billion, with average noninterest-bearing core deposits growing by 30.65% in 2020[306][257] Quantitative and Qualitative Disclosures About Market Risk A 100 basis point rate decrease would reduce net interest income by 1.21% over 12 months Net Interest Income Sensitivity (as of Dec 31, 2020) | Basis Point Interest Rate Change | % Change in NII (12 Months) | % Change in NII (24 Months) | | :--- | :--- | :--- | | Up 200 | 0.18% | 7.13% | | Up 100 | (0.23)% | 3.46% | | Down 100 | (1.21)% | (2.30)% | Financial Statements and Supplementary Data This section contains the company's audited consolidated financial statements and the independent auditor's report Reports of Independent Registered Public Accounting Firm The auditor issued an unqualified opinion on the financial statements and internal controls, citing CECL adoption as a critical audit matter - The auditor issued an unqualified opinion on the financial statements and the effectiveness of internal controls over financial reporting[285][298] - The auditor identified the Allowance for Loan and Lease Losses as a critical audit matter due to the significant judgment and complexity involved with implementing the new CECL standard[291][294] Consolidated Financial Statements The statements show total assets of $7.32 billion and net income of $81.4 million for the year ended December 31, 2020 Consolidated Statement of Financial Condition Highlights (Dec 31, 2020 vs 2019) | (Dollars in thousands) | 2020 | 2019 | | :--- | :--- | :--- | | Total Assets | $7,316,411 | $6,622,776 | | Net Loans and Leases | $5,348,647 | $4,974,273 | | Total Deposits | $5,946,028 | $5,357,326 | | Total Liabilities | $6,385,741 | $5,774,140 | | Total Shareholders' Equity | $886,845 | $828,277 | Consolidated Statement of Income Highlights (2018-2020) | (Dollars in thousands) | 2020 | 2019 | 2018 | | :--- | :--- | :--- | :--- | | Net Interest Income | $225,820 | $223,866 | $213,906 | | Provision for Credit Losses | $36,001 | $15,833 | $19,462 | | Noninterest Income | $103,889 | $101,130 | $97,050 | | Noninterest Expense | $187,367 | $189,009 | $186,467 | | Net Income | $81,461 | $92,015 | $82,414 | Notes to Consolidated Financial Statements The notes detail the adoption of the CECL standard, credit quality metrics, and the company's "well capitalized" regulatory status - CECL Adoption: The company adopted ASU 2016-13 (CECL) on January 1, 2020, resulting in a cumulative-effect adjustment that decreased retained earnings by $2.55 million, net of tax[383][386] - Credit Quality: The allowance for loan and lease losses increased from $111.3 million to $140.7 million in 2020, driven by a $36.0 million provision[424] - Regulatory Capital: Both 1st Source Corporation and 1st Source Bank exceeded all minimum capital requirements to be considered "well capitalized" as of December 31, 2020[532][535] - Fair Value: The vast majority of assets measured at fair value, such as investment securities and interest rate swaps, are classified as Level 1 or Level 2[546] Changes in and Disagreements with Accountants on Accounting and Financial Disclosure The company reports no changes in or disagreements with its accountants - None[572] Controls and Procedures Management concluded that disclosure controls, procedures, and internal controls over financial reporting were effective - Management concluded that disclosure controls and procedures were effective as of December 31, 2020[573] - Management assessed internal control over financial reporting as effective as of December 31, 2020, based on the COSO framework[577] Other Information The company reports no other information for this item - None[579] Part III Directors, Executive Officers and Corporate Governance Information is incorporated by reference from the company's 2021 Proxy Statement - The required information is incorporated by reference from the 2021 Proxy Statement[582] Executive Compensation Information is incorporated by reference from the company's 2021 Proxy Statement - The required information is incorporated by reference from the 2021 Proxy Statement[584] Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information is incorporated by reference, with details on securities available under equity compensation plans provided Equity Compensation Plan Information (as of Dec 31, 2020) | Plan Category | Securities to be Issued Upon Exercise | Securities Remaining Available for Future Issuance | | :--- | :--- | :--- | | Approved by Shareholders | 11,793 | 690,257 | | Not Approved by Shareholders | — | 16,546 | | Total | 11,793 | 706,803 | Certain Relationships and Related Transactions, and Director Independence Information is incorporated by reference from the company's 2021 Proxy Statement - The required information is incorporated by reference from the 2021 Proxy Statement[588] Principal Accounting Fees and Services Information is incorporated by reference from the company's 2021 Proxy Statement - The required information is incorporated by reference from the 2021 Proxy Statement[590] Part IV Exhibits and Financial Statement Schedules This section lists the financial statements and exhibits filed with the report - The report includes the Consolidated Financial Statements and Notes for the years 2018, 2019, and 2020[593] - Exhibits filed with the report include corporate governance documents, material contracts, and certifications required by the Sarbanes-Oxley Act[594][595]