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GABC > SEC Filings for GABC > Form 10-Q on 6-Aug-2013All Recent SEC Filings

Show all filings for GERMAN AMERICAN BANCORP, INC.

Form 10-Q for GERMAN AMERICAN BANCORP, INC.


6-Aug-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 June 30, 2013 and December 31, 2012 and the consolidated results of operations for the three and six months ended June 30, 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 and in the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2013.

The Company's second quarter net income totaled $6,532,000, or $0.52 per diluted share, representing an increase of approximately 11% on a per share basis, from the $5,967,000, or $0.47 per diluted share, recorded during the same quarter last year. On a year-to-date basis, 2013 earnings improved to $12,341,000 or $0.97 per diluted share, as compared to $11,569,000, or $0.92 per diluted share for the first six months of 2012 representing an increase of approximately 5% on a per share basis.

The Company's second quarter and first half of 2013 earnings were positively impacted by lower levels of provision for loan losses as compared with the same periods of 2012. The lower level of provision for loan losses were attributable to improved asset quality for the Company including lower levels of net-charge-offs, decreased non-performing loans, and lower adversely classified assets. The Company's second quarter and first half of 2013 earnings were also positively impacted by a $1,277,000, or 26%, and $2,386,000, or 25%, increase in the level of non-interest income as compared to the same periods of 2012.

Partially mitigating the improvement in earnings was an increased level of operating expenses largely related to higher salaries and benefits costs. Operating expenses for the second quarter of 2013 increased $838,000, or 7%, and for the first half of 2013 increased $1,707,000, or 7%, as compared to the same periods of 2012.

Net interest income remained relatively stable, an increase of $63,000, in the second quarter of 2013 and a decline of $324,000, or 1%, in the first half of 2013 as compared with the same periods in 2012. The Company's net interest margin continues to remain under pressure primarily due to the continuance of historically low interest rates. Partially mitigating the net interest margin pressures during 2013 has been the Company's ability to grow its earning assets and in particular its loan portfolio. Total loans outstanding grew by $49.1 million, or 16%, on an annualized basis in the second quarter of 2013 and $37.8 million, or 6%, on an annualized basis in the first half of 2013.

On July 23, 2013, the Company and United Commerce Bancorp ("United Commerce") entered into a definitive agreement to merge United Commerce into the Company. Upon completion of the transaction, the Company anticipates merging United Commerce's subsidiary bank, United Commerce Bank, into the Company's subsidiary bank, German American Bancorp. United Commerce Bank currently operates two branch locations in the Bloomington, Indiana market. Management believes this in-market transaction will provide an excellent opportunity for the Company to enhance its presence in the Bloomington, Indiana market. The transaction is expected to be completed during the fourth quarter of 2013.

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 in the first quarter of 2013.

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 June 30, 2013, gross unrealized losses on the securities available-for-sale portfolio totaled approximately $10,144,000 and gross unrealized gains totaled approximately $8,311,000. As of June 30, 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 June 30, 2013 totaled $6,532,000, or $0.52 per diluted share, an increase of $565,000 or 9% from the quarter ended June 30, 2012 net income of $5,9674,000, or $0.47 per diluted share. Net income for the six months ended June 30, 2013 totaled $12,341,000, or $0.97 per diluted share, an increase of $772,000 or 7% from the six months ended June 30, 2012 net income of $11,569,000, or $0.92 per diluted 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
                                           June 30, 2013                               June 30, 2012
                               Principal      Income /       Yield /       Principal      Income /       Yield /
                                Balance        Expense        Rate          Balance        Expense        Rate
Assets
Federal Funds Sold and
Other
Short-term Investments        $    14,806     $      13          0.35 %   $    65,760     $      40          0.24 %
Securities:
Taxable                           556,379         2,771          1.99 %       558,788         3,421          2.45 %
Non-taxable                        77,782           983          5.05 %        67,796           905          5.34 %
Total Loans and Leases (2)      1,233,024        15,088          4.91 %     1,121,425        15,579          5.58 %
Total Interest Earning
Assets                          1,881,991        18,855          4.01 %     1,813,769        19,945          4.42 %
Other Assets                      135,116                                     137,860
Less: Allowance for Loan
Losses                            (15,964 )                                   (16,367 )
Total Assets                  $ 2,001,143                                 $ 1,935,262

Liabilities and
Shareholders' Equity
Interest-bearing Demand,
Savings and Money Market
Deposits                      $ 1,001,535     $     398          0.16 %   $   963,060     $     457          0.19 %
Time Deposits                     334,412           756          0.91 %       364,446         1,398          1.54 %
FHLB Advances and Other
Borrowings                        118,947           592          2.00 %       114,932         1,059          3.71 %
Total Interest-bearing
Liabilities                     1,454,894         1,746          0.48 %     1,442,438         2,914          0.81 %
Demand Deposit Accounts           340,767                                     298,580
Other Liabilities                  16,456                                      19,516
Total Liabilities               1,812,117                                   1,760,534
Shareholders' Equity              189,026                                     174,728
Total Liabilities and
Shareholders' Equity          $ 2,001,143                                 $ 1,935,262

Cost of Funds                                                    0.37 %                                      0.65 %
Net Interest Income                           $  17,109                                   $  17,031
Net Interest Margin                                              3.64 %                                      3.77 %

(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 increased $63,000 or 0.4% (an increase of $78,000 or 0.5% on a tax-equivalent basis) for the quarter ended June 30, 2013 compared with the same quarter of 2012. The modestly increased level of net interest income during the second quarter of 2013 compared with the second quarter of 2012 was largely driven a higher level of earning assets partially mitigated 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).

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 3.64% for the second quarter of 2013 compared to 3.77% during the second quarter of 2012. The yield on earning assets totaled 4.01% during the quarter ended June 30, 2013 compared to 4.42% in the same period of 2012 while the cost of funds (expressed as a percentage of average earning assets) totaled 0.37% during the quarter ended June 30, 2013 compared to 0.65% in the same period of 2012.

The decline in the net interest margin in the second quarter of 2013 compared with the second 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 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 6 basis points on an annualized basis to the net interest margin in the quarter ended June 30, 2013 compared to approximately 18 basis points during the second quarter of 2012. The decline in the Company's cost of funds by approximately 28 basis points during the second quarter of 2013 compared to the second quarter 2012 was driven by a continued decline in deposit rates and the redemption of $19.3 million of subordinated debentures with an interest rate of 8% that occurred in the second quarter of 2013.

Average earning assets increased by approximately $68.2 million for the three months ended June 30, 2013 compared with the same period of 2012. Average loans outstanding increased $111.6 million during the three months ended June 30, 2013 compared with the second quarter of 2012. Average federal funds sold and other short-term investments decreased by $50.9 million during the second quarter of 2013 compared with the same quarter of 2012. The average securities portfolio increased approximately $7.6 million in the three months ended June 30, 2013 compared with the second quarter of 2012. The funding for the increased level of average loans during the second quarter of 2013 compared with the second quarter of 2012 came from the decline in average federal funds sold and an increased level of core deposits (core deposits defined as demand deposits - both interest and non-interest bearing, savings, money market and time deposits in denominations of less than $100,000). The increase in average core deposits totaled $38.3 million during the second quarter of 2013 compared with the second quarter of 2012.

                                                             Average Balance Sheet
                                                 (Tax-equivalent basis / dollars in thousands)
                                         Six Months Ended                            Six Months Ended
                                           June 30, 2013                               June 30, 2012
                               Principal      Income /       Yield /       Principal      Income /       Yield /
                                Balance        Expense        Rate          Balance        Expense        Rate
Assets
Federal Funds Sold and
Other
Short-term Investments        $    15,813     $      23          0.29 %   $    62,950     $      73          0.23 %
Securities:
Taxable                           556,893         5,612          2.02 %       538,651         6,747          2.50 %
Non-taxable                        77,398         1,958          5.06 %        67,328         1,802          5.36 %
Total Loans and Leases (2)      1,222,497        30,024          4.95 %     1,117,706        31,427          5.65 %
Total Interest Earning
Assets                          1,872,601        37,617          4.04 %     1,786,635        40,049          4.50 %
Other Assets                      135,833                                     138,208
Less: Allowance for Loan
Losses                            (15,858 )                                   (16,133 )
Total Assets                  $ 1,992,576                                 $ 1,908,710

Liabilities and
Shareholders' Equity
Interest-bearing Demand,
Savings
and Money Market Deposits     $   983,842     $     780          0.16 %   $   940,241     $     983          0.21 %
Time Deposits                     334,545         1,608          0.97 %       364,472         2,918          1.61 %
FHLB Advances and Other
Borrowings                        129,596         1,503          2.34 %       116,956         2,128          3.66 %
Total Interest-bearing
Liabilities                     1,447,983         3,891          0.54 %     1,421,669         6,029          0.85 %
Demand Deposit Accounts           338,631                                     295,222
Other Liabilities                  18,430                                      19,469
Total Liabilities               1,805,044                                   1,736,360
Shareholders' Equity              187,532                                     172,350
Total Liabilities and
Shareholders' Equity          $ 1,992,576                                 $ 1,908,710

Cost of Funds                                                    0.42 %                                      0.68 %
Net Interest Income                           $  33,726                                   $  34,020
Net Interest Margin                                              3.62 %                                      3.82 %

(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 $324,000 or 1% (a decrease of $294,000 or 1% on a tax-equivalent basis) for the six months ended June 30, 2013 compared with the first six months of 2012. The decreased level of net interest income during the first half of 2013 compared with the first half 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 tax equivalent net interest margin was 3.62% for the first half of 2013 compared to 3.82% during the first half of 2012. The yield on earning assets totaled 4.04% during the six months ended June 30, 2013 compared to 4.50% in the same period of 2012 while the cost of funds (expressed as a percentage of average earning assets) totaled 0.42% during the first half of 2013 compared to 0.68% in the same period of 2012.

The decline in the net interest margin in the first half of 2013 compared with the first half 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 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 7 basis points on an annualized basis to the net interest margin in the six months ended June 30, 2013 compared to approximately 18 basis points during the first half of 2012. The decline in the Company's cost of funds by approximately 26 basis points during the first half of 2013 compared to the first half 2012 was largely driven by a continued decline in deposit rates and also attributable to the repayment of $19.3 million of subordinated debentures with an interest rate of 8% that occurred in the second quarter of 2013.

Average earning assets increased by approximately $86.0 million for the six months ended June 30, 2013 compared with the same period of 2012. Average loans outstanding increased $104.8 million during the six months ended June 30, 2013 compared with the first half of 2012. Average federal funds sold and other short-term investments decreased by $47.1 million during the first half of 2013 compared with the same period of 2012. The average securities portfolio increased approximately $28.3 million in the six months ended June 30, 2013 compared with the first half 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. During the quarter ended June 30, 2013, the Company recognized a negative $200,000 provision for loan loss which represented a decrease of $591,000 from the second quarter of 2012 provision of $391,000. The provision for loan losses totaled $150,000 for the six months ended June 30, 2013, a decrease of $931,000, or 86%, compared to the provision of $1,081,000 during the six months ended June 30, 2012. The decline in the provision for loan losses in the three and six month periods ended June 30, 2013 compared with the same periods of 2012 was attributable to a reduced level of net charge-offs, lower levels of non-performing loans, and a lower level of adversely classified loans.

Net charge-offs totaled $271,000 or 0.09% on an annualized basis of average loans outstanding during the three months ended June 30, 2013, compared with $465,000 or 0.17% on an annualized basis of average loans outstanding during the same period of 2012. During the six months ended June 30, 2013, the annualized provision for loan losses represented 0.02% of average loans outstanding compared with 0.19% on an annualized basis of average loans outstanding during the first half of 2012. Net charge-offs totaled $407,000 or 0.07% on an annualized basis of average loans outstanding during the six months ended June 30, 2013, compared with $701,000 or 0.13% on an annualized basis of average loans outstanding during the same period of 2012.

The provision for loan losses made during the three and six months ended June 30, 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 June 30, 2013, non-interest income totaled $6,110,000,
an increase of $1,277,000, or 26%, compared with the second quarter of 2012.



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