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GABC > SEC Filings for GABC > Form 10-Q on 10-May-2013All Recent SEC Filings

Show all filings for GERMAN AMERICAN BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for GERMAN AMERICAN BANCORP, INC.


10-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

GERMAN AMERICAN BANCORP, INC.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

German American Bancorp, Inc. is a financial services holding company based in Jasper, Indiana. The Company's Common Stock is traded on NASDAQ's Global Select Market, under the symbol GABC. The principal subsidiary of German American Bancorp, Inc. is its banking subsidiary, German American Bancorp, which operates through 35 banking offices in 13 Southern Indiana counties. German American Bancorp owns a trust, brokerage, and financial planning subsidiary, which operates from its banking offices, and a full line property and casualty insurance agency with seven insurance agency offices throughout its market area.

Throughout this Management's Discussion and Analysis, as elsewhere in this report, when we use the term "Company," we will usually be referring to the business and affairs (financial and otherwise) of the Company and its subsidiaries and affiliates as a whole. Occasionally, we will refer to the term "parent company" or "holding company" when we mean to refer to only German American Bancorp, Inc.

This section presents an analysis of the consolidated financial condition of the Company as of March 31, 2013 and December 31, 2012 and the consolidated results of operations for the three months ended March 31, 2013 and 2012. This discussion should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein and with the financial statements and other financial data, as well as the Management's Discussion and Analysis of Financial Condition and Results of Operations, included in the Company's December 31, 2012 Annual Report on Form 10-K.

MANAGEMENT OVERVIEW

This updated discussion should be read in conjunction with the Management Overview that was included in our Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's December 31, 2012 Annual Report on Form 10-K.

The Company's first quarter of 2013 net income totaled $5,809,000, or $0.46 per share, as compared to the $5,602,000, or $0.44 per share, recorded during the first quarter of 2012. The improvement in the first quarter 2013 earnings from the first quarter of 2012 represented an increase of approximately 4% and approximately 5% on a per share basis.

As compared to the same quarter prior year results, first quarter 2013 earnings were positively affected by a $1,109,000, or 23%, increase in total non-interest income, driven primarily by increased insurance revenues, increased trust fees, as well as net gains on the sales of securities in the current year. Further enhancing the level of the Company's first quarter of 2013 earnings was a $340,000, or 49%, reduction in the amount of provision for loan loss from that booked during the prior year's first quarter.

The Company's net interest income declined by $387,000, or 2%, while total non-interest expenses increased by $869,000, or 7%, during the first quarter of 2013 compared to the first quarter of 2012. The decline in net interest income during the first quarter of 2013 compared with the first quarter of 2012 was largely attributable to a decline in the accretion of loan discounts on acquired loans. The increase in total non-interest expenses in the current year first quarter relative to that of the same quarter last year resulted primarily from increases in salaries and benefits and data processing expenses.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The financial condition and results of operations for German American Bancorp, Inc. presented in the Consolidated Financial Statements, accompanying Notes to the Consolidated Financial Statements, and selected financial data appearing elsewhere within this Report, are, to a large degree, dependent upon the Company's accounting policies. The selection of and application of these policies involve estimates, judgments, and uncertainties that are subject to change. The critical accounting policies and estimates that the Company has determined to be the most susceptible to change in the near term relate to the determination of the allowance for loan losses, the valuation of securities available for sale, and the valuation allowance on deferred tax assets.

Allowance for Loan Losses

The Company maintains an allowance for loan losses to cover probable incurred credit losses at the balance sheet date. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management's judgment, should be charged-off. A provision for loan losses is charged to operations based on management's periodic evaluation of the necessary allowance balance. Evaluations are conducted at least quarterly and more often if deemed necessary. The ultimate recovery of all loans is susceptible to future market factors beyond the Company's control.

The Company has an established process to determine the adequacy of the allowance for loan losses. The determination of the allowance is inherently subjective, as it requires significant estimates, including the amounts and timing of expected future cash flows on impaired loans, estimated losses on other classified loans and pools of homogeneous loans, and consideration of past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors, all of which may be susceptible to significant change. The allowance consists of two components of allocations, specific and general. These two components represent the total allowance for loan losses deemed adequate to cover losses inherent in the loan portfolio.

Commercial and agricultural loans are subject to a standardized grading process administered by an internal loan review function. The need for specific reserves is considered for credits when graded substandard or when: (a) the customer's cash flow or net worth appears insufficient to repay the loan; (b) the loan has been criticized in a regulatory examination; (c) the loan is on non-accrual; or,
(d) other reasons where the ultimate collectibility of the loan is in question, or the loan characteristics require special monitoring. Specific allowances are established in cases where management has identified significant conditions or circumstances related to an individual credit that we believe indicates the loan is impaired. Specific allocations on impaired loans are determined by comparing the loan balance to the present value of expected cash flows or expected collateral proceeds. Allocations are also applied to categories of loans not considered individually impaired but for which the rate of loss is expected to be greater than historical averages, including those graded substandard and non-performing consumer or residential real estate loans. Such allocations are based on past loss experience and information about specific borrower situations and estimated collateral values.

General allocations are made for other pools of loans, including non-classified loans, homogeneous portfolios of consumer and residential real estate loans, and loans within certain industry categories believed to present unique risk of loss. General allocations of the allowance are primarily made based on a three-year historical average for loan losses for these portfolios, judgmentally adjusted for economic factors and portfolio trends. For 2012, the Company utilized a 4 quarter rolling historical loan loss average.Beginning in 2013, management deemed a rolling 12 quarter historical loan loss average to be more indicative of the inherent losses in the Company's loan portfolio in the current economic environment than the 4 quarter average. This change in methodology resulted in an increase to the required loan loss allowance of approximately $280.

Due to the imprecise nature of estimating the allowance for loan losses, the Company's allowance for loan losses includes a minor unallocated component. The unallocated component of the allowance for loan losses incorporates the Company's judgmental determination of inherent losses that may not be fully reflected in other allocations, including factors such as economic uncertainties, lending staff quality, industry trends impacting specific portfolio segments, and broad portfolio quality trends. Therefore, the ratio of allocated to unallocated components within the total allowance may fluctuate from period to period.

Securities Valuation

Securities available-for-sale are carried at fair value, with unrealized holding gains and losses reported separately in accumulated other comprehensive income
(loss), net of tax. The Company obtains market values from a third party on a monthly basis in order to adjust the securities to fair value. Equity securities that do not have readily determinable fair values are carried at cost. Additionally, when securities are deemed to be other than temporarily impaired, a charge will be recorded through earnings; therefore, future changes in the fair value of securities could have a significant impact on the Company's operating results. In determining whether a market value decline is other than temporary, management considers the reason for the decline, the extent of the decline, the duration of the decline and whether the Company intends to sell or believes it will be required to sell the securities prior to recovery. As of March 31, 2013, gross unrealized losses on the securities available-for-sale portfolio totaled approximately $1,237,000 and gross unrealized gains totaled approximately $14,333,000. As of March 31, 2013, held-to-maturity securities had a gross unrecognized gain of approximately $3,000.

Income Tax Expense

Income tax expense involves estimates related to the valuation allowance on deferred tax assets and loss contingencies related to exposure from tax examinations.

A valuation allowance reduces deferred tax assets to the amount management believes is more likely than not to be realized. In evaluating the realization of deferred tax assets, management considers the likelihood that sufficient taxable income of appropriate character will be generated within carryback and carryforward periods, including consideration of available tax planning strategies. Tax related loss contingencies, including assessments arising from tax examinations and tax strategies, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. In considering the likelihood of loss, management considers the nature of the contingency, the progress of any examination or related protest or appeal, the views of legal counsel and other advisors, experience of the Company or other enterprises in similar matters, if any, and management's intended response to any assessment.

RESULTS OF OPERATIONS

Net Income:

Net income for the quarter ended March 31, 2013 totaled $5,809,000, or $0.46 per share, an increase of $207,000 or 4% from the quarter ended March 31, 2012 net income of $5,602,000, or $0.44 per share.

Net Interest Income:

Net interest income is the Company's single largest source of earnings, and represents the difference between interest and fees realized on earning assets, less interest paid on deposits and borrowed funds. Several factors contribute to the determination of net interest income and net interest margin, including the volume and mix of earning assets, interest rates, and income taxes. Many factors affecting net interest income are subject to control by management policies and actions. Factors beyond the control of management include the general level of credit and deposit demand, Federal Reserve Board monetary policy, and changes in tax laws.

The following table summarizes net interest income (on a tax-equivalent basis). For tax-equivalent adjustments an effective tax rate of 35% was used for all periods presented (1).

                                                                  Average Balance Sheet
                                                      (Tax-equivalent basis / dollars in thousands)
                                             Three Months Ended                          Three Months Ended
                                               March 31, 2013                              March 31, 2012
                                    Principal      Income /       Yield /       Principal      Income /       Yield /
                                     Balance        Expense        Rate          Balance        Expense        Rate
Assets
Federal Funds Sold and Other
Short-term Investments             $    16,831     $      10          0.24 %   $    60,139     $      33          0.22 %
Securities:
Taxable                                557,412         2,841          2.04 %       518,514         3,326          2.57 %
Non-taxable                             77,011           975          5.07 %        66,861           898          5.37 %
Total Loans and Leases (2)           1,211,852        14,936          4.99 %     1,113,987        15,848          5.72 %
Total Interest Earning Assets        1,863,106        18,762          4.07 %     1,759,501        20,105          4.59 %
Other Assets                           136,559                                     138,555
Less: Allowance for Loan Losses        (15,750 )                                   (15,899 )
Total Assets                       $ 1,983,915                                 $ 1,882,157

Liabilities and Shareholders'
Equity
Interest-bearing Demand, Savings
and Money Market Deposits          $   965,953     $     382          0.16 %   $   917,422     $     526          0.23 %
Time Deposits                          334,679           852          1.03 %       364,499         1,520          1.68 %
FHLB Advances and Other
Borrowings                             140,363           911          2.63 %       118,979         1,069          3.61 %
Total Interest-bearing
Liabilities                          1,440,995         2,145          0.60 %     1,400,900         3,115          0.89 %
Demand Deposit Accounts                336,472                                     291,863
Other Liabilities                       20,428                                      19,423
Total Liabilities                    1,797,895                                   1,712,186
Shareholders' Equity                   186,020                                     169,971
Total Liabilities and
Shareholders' Equity               $ 1,983,915                                 $ 1,882,157

Cost of Funds                                                         0.47 %                                      0.71 %
Net Interest Income                                $  16,617                                   $  16,990
Net Interest Margin                                                   3.60 %                                      3.88 %

(1) Effective tax rates were determined as though interest earned on the Company's investments in municipal bonds and loans was fully taxable.

(2) Loans held-for-sale and non-accruing loans have been included in average loans.

Net interest income decreased $387,000 or 2% (a decrease of $373,000 or 2% on a tax-equivalent basis) for the quarter ended March 31, 2013 compared with the same quarter of 2012. The decreased level of net interest income during the first quarter of 2013 compared with the first quarter of 2012 was largely driven by a decline in the accretion of loan discounts on acquired loans, and a lower net interest margin (expressed as a percentage of average earning assets) partially mitigated by a higher level of earning assets.

The net interest margin represents tax-equivalent net interest income expressed as a percentage of average earning assets. The tax equivalent net interest margin was 3.60% for the first quarter of 2013 compared to 3.88% during the first quarter of 2012. The yield on earning assets totaled 4.07% during the quarter ended March 31, 2013 compared to 4.59% in the same period of 2012 while the cost of funds (expressed as a percentage of average earning assets) totaled 0.47% during the quarter ended March 31, 2013 compared to 0.71% in the same period of 2012.

The decline in the net interest margin in the first quarter of 2013 compared with the first quarter of 2012 was largely attributable to the continued downward pressure on earning asset yields being driven by a historically low market interest rate environment and a very competitive marketplace for lending opportunities. Also contributing to the lower net interest margin was a decline in the accretion of loan discounts on certain acquired loans. Accretion contributed approximately 8 basis points on an annualized basis to the net interest margin in the quarter ended March 31, 2013 compared to approximately 18 basis points during the first quarter of 2012. The decline in the Company's cost of funds by approximately 24 basis points during the first quarter of 2013 compared to the first quarter 2012 was largely driven by a continued decline in deposit rates.

Average earning assets increased by approximately $103.6 million for the three months ended March 31, 2013 compared with the same period of 2012. Average loans outstanding increased $97.9 million during the three months ended March 31, 2013 compared with the first quarter of 2012. Average federal funds sold and other short-term investments decreased by $43.3 million during the first quarter of 2013 compared with the same quarter of 2012. The average securities portfolio increased approximately $49.0 million in the three months ended March 31, 2013 compared with the first quarter of 2012.

Provision for Loan Losses:

The Company provides for loan losses through regular provisions to the allowance for loan losses. The provision is affected by net charge-offs on loans and changes in specific and general allocations of the allowance. The provision for loan losses totaled $350,000 during the quarter ended March 31, 2013, a decrease of $340,000 or 49% compared to the provision of $690,000 during the quarter ended March 31, 2012. The decline in the provision for loan losses in the three month period ended March 31, 2013 compared with the same period of 2012 was attributable to a reduced level of net charge-offs and a lower level of non-performing loans.

During the first quarter of 2013, annualized provision for loan losses represented 0.12% of average loans outstanding compared with 0.25% on an annualized basis of average loans outstanding during the first quarter of 2012. Net charge-offs totaled $136,000 or 0.04% on an annualized basis of average loans outstanding during the three months ended March 31, 2013, compared with $236,000 or 0.08% on an annualized basis of average loans outstanding during the same period of 2012.

The provision for loan losses made during the three months ended March 31, 2013 was made at a level deemed necessary by management to absorb estimated, probable incurred losses in the loan portfolio. A detailed evaluation of the adequacy of the allowance for loan losses is completed quarterly by management, the results of which are used to determine provision for loan losses. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors.

Non-interest Income:



During the quarter ended March 31, 2013, non-interest income totaled $5,910,000,
an increase of $1,109,000 or 23% compared with the first quarter of 2012.



                                                                    Change from
Non-interest Income                       Three Months             Prior Period
(dollars in thousands)                  Ended March 31,        Amount       Percent
                                        2013        2012       Change       Change
Trust and Investment Product Fees     $    817     $   696     $   121            17 %
Service Charges on Deposit Accounts        955         935          20             2
Insurance Revenues                       1,784       1,391         393            28
Company Owned Life Insurance               266         244          22             9
Interchange Fee Income                     430         431          (1 )         n/m
Other Operating Income                     291         373         (82 )         (22 )
Subtotal                                 4,543       4,070         473            12
Net Gains on Sales of Loans                754         713          41             6
Net Gains on Securities                    613          18         595           n/m
Total Non-interest Income             $  5,910     $ 4,801     $ 1,109            23

n/m = not meaningful

Trust and investment product fees increased $121,000, or 17%, in the first quarter of 2013 compared with the first quarter of 2012. The increase was due primarily to increased trust revenues.

Insurance revenues increased $393,000, or 28%, during the quarter ended March 31, 2013, compared with the first quarter of 2012. The increase during the first quarter of 2013 compared with first quarter of 2012 was due to increased contingency revenue and increased commercial insurance revenue. Contingency revenue during the first quarter of 2013 totaled $246,000 compared with $52,000 during the first quarter of 2012. The fluctuation in contingency revenue during 2013 and 2012 is a normal course of business type of variance and is reflective of claims and loss experience with insurance carriers that the Company represents through its property and casualty insurance agency.

Other operating income decreased $82,000 or 22% during the quarter ended March 31, 2013 compared with the first quarter of 2012. The decrease was largely related to the net loss on sales and write-downs of other real estate which totaled approximately $142,000 during the first quarter of 2013 compared with a net loss of $35,000 during the first quarter of 2012.

Net gains on sales of loans totaled $754,000 during the quarter ended March 31, 2013, an increase of $41,000, or 6%, compared with the first quarter of 2012. Loan sales totaled $42.5 million during the first quarter of 2013, compared with $54.1 million during the first quarter of 2012.

During the first quarter of 2013, the Company realized a net gain on the sale of securities of $613,000 related to the sale of approximately $29.8 million of securities.

Non-interest Expense:



During the quarter ended March 31, 2013, non-interest expense totaled
$13,462,000, an increase of $869,000 or 7% compared with the first quarter of
2012.



                                                                    Change from
Non-interest Expense                     Three Months              Prior Period
(dollars in thousands)                  Ended March 31,        Amount       Percent
                                       2013         2012       Change       Change
Salaries and Employee Benefits       $  7,784     $  7,320     $   464             6 %
Occupancy, Furniture and Equipment
Expense                                 1,850        1,772          78             4
FDIC Premiums                             255          297         (42 )         (14 )
Data Processing Fees                      353          114         239           210
Professional Fees                         661          605          56             9
Advertising and Promotion                 490          373         117            31
Intangible Amortization                   367          442         (75 )         (17 )
Other Operating Expenses                1,702        1,670          32             2
Total Non-interest Expense           $ 13,462     $ 12,593     $   869             7

Salaries and benefits increased $464,000, or 6%, during the quarter ended March 31, 2013 compared with the first quarter of 2012. The increase in salaries and benefits during the first quarter of 2013 compared with the first quarter of 2012 was primarily the result of an increased number of full-time equivalent employees due in part to an increased number of banking locations and increased costs related to the Company's partially self-insured health insurance plan.

Data processing fees increased $239,000, or 210%, during the quarter ended March 31, 2013 compared with the first quarter 2012. The increase was largely related to the resolution of a contractual dispute during the first quarter of 2012 related to the acquisition of American Community Bancorp. An expense for the cancellation of a data processing contract was recorded in the first quarter of 2011, and upon resolution of the contractual dispute, a portion of that accrued expense was reversed in the first quarter of 2012.

Advertising and promotion expense increased $117,000, or 31%, during the quarter ended March 31, 2013 compared with the first quarter 2012. The increase was largely related to an increased level of community contributions made in the Company's primary market areas.

Income Taxes:

The Company's effective income tax rate was 30.2% and 31.1% during the three months ended March 31, 2013 and 2012. The effective tax rate in all periods presented was lower than the blended statutory rate of 40.5% resulting primarily from the Company's tax-exempt investment income on securities, loans and company owned life insurance, income tax credits generated from investments in a new markets tax credit project and affordable housing projects, and income generated by subsidiaries domiciled in a state with no state or local income tax.

FINANCIAL CONDITION

Total assets at March 31, 2013 decreased $27.3 million to $1.979 billion compared with $2.006 billion in total assets at December 31, 2012. Securities available-for-sale increased $43.3 million to $630.9 million at March 31, 2013 compared with $587.6 million at year-end 2012. This increase was primarily the result of the re-investment of funds early during the first quarter of 2013 following a security sale transaction late in the fourth quarter of 2012.

March 31, 2013 loans outstanding decreased by $11.3 million, or approximately 4% on an annualized basis, compared with year-end 2012. The reduction in loans during the first quarter of 2013 compared with year end was largely related to a seasonal decline in agricultural loans.

End of Period Loan Balances:                                        Current
(dollars in thousands)           March 31,       December 31,       Period
                                   2013              2012           Change

Commercial & Industrial Loans   $   332,142     $      335,373     $  (3,231 )
Commercial Real Estate Loans        498,582            488,496        10,086
Agricultural Loans                  164,903            179,906       (15,003 )
Home Equity & Consumer Loans        114,715            115,540          (825 )
Residential Mortgage Loans           86,276             88,586        (2,310 )
Total Loans                     $ 1,196,618     $    1,207,901     $ (11,283 )

The Company's allowance for loan losses totaled $15.7 million at March 31, 2013 representing an increase of $214,000, or 6% on an annualized basis, from December 31, 2012. The allowance for loan losses represented 1.32% of period-end loans at March 31, 2013 compared with 1.29% of period-end loans at December 31, 2012. Under acquisition accounting treatment, loans acquired are recorded at fair value which includes a credit risk component, and therefore the allowance on loans acquired is not carried over from the seller. The Company held a discount on acquired loans of $3.1 million as of March 31, 2013 and $3.5 million at year-end 2012.

Total deposits increased $19.0 million, or 5% on an annualized basis, as of March 31, 2013 compared with December 31, 2012 total deposits.

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