FORM 10-Q/A
(Amendment No. 1)
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
------------------------
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-5907
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1st SOURCE CORPORATION
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(Exact name of registrant as specified in its charter)
INDIANA 35-1068133
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(State of other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 North Michigan Street South Bend, Indiana 46601
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(Address of principal executive offices) (Zip Code)
(219) 235-2702
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
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Number of shares of common stock outstanding as of September 30, 1998 -
17,210,100 shares.
INTRODUCTORY STATEMENT
1st Source is filing this on Form 10-Q/A for the quarterly period ended
September 30, 1998 to restate the financial information pertaining to income
recognition on securitized loans in accordance with SFAS No. 125, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." This restatement had the effect of increasing loan servicing and
sale income by $798,000 and net income by $475,000, or $0.02 per diluted common
share, for the three months and nine months ended September 30, 1998. This
restatement reduced retained interest assets by $263,000, decreased the reserve
for loan losses by $1,892,000 and increased shareholders' equity by $969,000 for
the same periods. See Note 2 to Item 1, below.
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Page
Consolidated statements of financial condition -- 3
September 30, 1998, and December 31, 1997
Consolidated statements of income -- 4
three months and nine months ended September 30,
1998 and 1997
Consolidated statements of cash flows -- 5
nine months ended September 30, 1998 and 1997
Notes to the Consolidated Financial Statements 6
-2-
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
1st Source Corporation and Subsidiaries
(Dollars in thousands)
September 30, December 31,
1998 1997
------------- ------------
(Restated)
ASSETS
Cash and due from banks $ 95,053 $ 90,864
Interest bearing deposits with other banks 821 1,677
Federal funds sold 48,500 10,000
Investment securities:
Securities available-for-sale, at fair value
(amortized cost of $368,782 and $298,438
at September 30, 1998 and December 31, 1997) 375,957 299,933
Securities held-to-maturity, at amortized cost
(fair value of $104,657 and $119,369 at
September 30, 1998 and December 31, 1997) 97,545 114,975
---------- ----------
Total Investment Securities 473,502 414,908
Loans - net of unearned discount 1,781,895 1,796,781
Reserve for loan losses (38,397) (35,424)
---------- ----------
Net Loans 1,743,498 1,761,357
Premises and equipment 30,896 30,782
Other assets 137,343 108,566
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Total Assets $2,529,613 $2,418,154
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest bearing $ 243,544 $ 274,906
Interest bearing 1,751,068 1,616,885
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Total Deposits 1,994,612 1,891,791
Federal funds purchased and securities
sold under agreements to repurchase 140,326 117,987
Other short-term borrowings 76,383 117,019
Other liabilities 49,112 34,998
Long-term debt 13,009 16,656
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Total Liabilities 2,273,442 2,178,451
Guaranteed Preferred Beneficial Interests
in the Company's Subordinated Debentures 44,750 44,750
Shareholders' equity:
Common stock-no par value 6,270 5,700
Capital surplus 121,456 69,947
Retained earnings 91,081 124,394
Less cost of common stock in treasury (11,201) (6,978)
Unrealized appreciation of investment
securities, net 3,815 1,890
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Total Shareholders' Equity 211,421 194,953
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Total Liabilities and Shareholders' Equity $2,529,613 $2,418,154
========== ==========
The accompanying notes are a part of the consolidated financial statements.
-3-
CONSOLIDATED STATEMENTS OF INCOME 1st Source Corporation and Subsidiaries
(Dollars in thousands, except per share amounts)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
1998 1997 1998 1997
---- ---- ---- ----
(Restated) (Restated)
Interest Income:
Loans, including fees $ 42,459 $ 38,471 $127,184 $107,895
Investment securities:
Taxable 4,160 4,295 12,336 12,540
Tax-exempt 1,982 2,042 5,961 6,132
Other 754 34 1,084 179
-------- -------- -------- --------
Total Interest Income 49,355 44,842 146,565 126,746
Interest Expense:
Deposits 22,259 19,143 64,170 53,279
Short-term borrowings 3,352 3,330 11,340 9,154
Long-term debt 232 277 688 875
-------- -------- -------- --------
Total Interest Expense 25,843 22,750 76,198 63,308
-------- -------- -------- --------
Net Interest Income 23,512 22,092 70,367 63,438
Provision for Loan Losses 2,042 2,130 7,132 3,838
-------- -------- -------- --------
Net Interest Income After
Provision for Loan Losses 21,470 19,962 63,235 59,600
Noninterest Income:
Trust fees 2,191 1,999 6,351 5,491
Service charges on deposit accounts 1,482 1,433 4,320 3,969
Loan servicing sale income 4,868 1,768 10,904 4,708
Equipment rental income 3,602 1,955 8,885 4,617
Other income 2,578 1,811 7,405 4,679
Investment securities and other
gains (losses) 0 24 (706) (279)
-------- -------- -------- --------
Total Noninterest Income 14,721 8,990 37,159 23,185
Noninterest Expense:
Salaries and employee benefits 11,905 10,111 35,266 29,853
Net occupancy expense 1,250 1,143 3,695 3,337
Furniture and equipment expense 1,826 1,680 5,165 4,956
Depreciation - leased equipment 2,354 1,400 6,336 3,409
Business development and marketing expense 861 650 2,381 2,532
Other 4,064 2,935 9,758 8,081
-------- -------- -------- --------
Total Noninterest Expense 22,260 17,919 62,601 52,168
-------- -------- -------- --------
Income Before Income Taxes and
Subsidiary Trust Distributions 13,931 11,033 37,793 30,617
Income taxes 5,041 3,831 13,276 10,288
Distribution on Preferred Securities of
Subsidiary Trusts, Net of Tax 554 564 1,679 1,184
-------- -------- -------- --------
Net Income $ 8,336 $ 6,638 $ 22,838 $ 19,145
======== ======== ======== ========
Other Comprehensive Income, Net of Tax:
Unrealized Gain on Securities $ 1,583 $ 1,012 $ 1,925 $ 987
-------- -------- -------- --------
Comprehensive Income $ 9,919 $ 7,650 $ 24,763 $ 20,132
======== ======== ======== ========
Per Common Share: (1)
Basic Net Income Per Common Share $ 0.45 $ 0.35 $ 1.21 $ 1.01
======== ======== ======== ========
Diluted Net Income Per Common Share $ 0.43 $ 0.35 $ 1.17 $ 0.98
======== ======== ======== ========
Dividends $ 0.080 $ 0.068 $ 0.226 $ 0.202
======== ======== ======== ========
Basic Weighted Average Common Shares
Outstanding 18,944,008 18,923,506 19,022,153 18,932,031
========== ========== ========== ==========
Diluted Weighted Average Common Shares
Outstanding 19,314,508 19,567,723 19,406,878 19,534,183
========== ========== ========== ==========
(1) The computation of per share data gives retroactive recognition to a 10%
stock dividend declared on January 14, 1999, a 10% stock dividend declared
on January 20, 1998,and a five-for-four stock split declared on January 21,
1997.
The accompanying notes are a part of the consolidated financial statements.
-4-
CONSOLIDATED STATEMENTS OF CASH FLOWS
1st Source Corporation and Subsidiaries
(Dollars in thousands)
Nine Months Ended September 30
------------------------------
1998 1997
---- ----
(Restated)
Operating Activities:
Net income $ 22,838 $ 19,145
Adjustments to reconcile net income to net cash
provided by operating activities:
Provision for loan losses 7,132 3,838
Depreciation of premises and equipment 9,071 5,858
Amortization of investment security premiums
and accretion of discounts, net 711 656
Deferred income taxes 3,521 3,421
Realized investment securities (gains) losses 706 279
Realized (gains) on securitized loans (1,917) --
Increase in interest receivable (682) (1,343)
Increase in interest payable 6,880 9,330
Other 7,351 (36,250)
-------- --------
Net Cash Provided by Operating Activities 55,611 4,934
Investing Activities:
Proceeds from sales and maturities of
investment securities 148,977 104,016
Purchases of investment securities (206,304) (106,345)
Net decrease in short-term investments (37,644) (311)
Loans sold or participated to others 307,097 113,728
Net increase in loans made to customers
and principal collections on loans (296,646) (368,095)
Net increase in leased assets (16,112) (9,027)
Purchases of premises and equipment (2,380) (2,746)
Increase in other assets (13,100) --
Other (6,806) (4,703)
-------- --------
Net Cash Used in Investing Activities (122,918) (273,483)
Financing Activities:
Net increase (decrease) in demand deposits, NOW
accounts and savings accounts 12,416 (41,715)
Net increase in certificates of deposit 90,405 125,297
Net increase (decrease) in short-term borrowings (18,297) 94,842
New long-term debt 522 --
Payments on long-term debt (4,169) (3,091)
New issuance of trust preferred securities -- 44,750
Acquisition of treasury stock (5,474) (2,046)
Cash dividends (3,919) (3,473)
Other 12 (8)
-------- --------
Net Cash Provided by Financing Activities 71,496 214,556
Increase (Decrease) in Cash and Cash Equivalents 4,189 (53,993)
Cash and Cash Equivalents, Beginning of Year 90,864 137,588
-------- --------
Cash and Cash Equivalents, End of Period $ 95,053 $ 83,595
======== ========
The accompanying notes are a part of the consolidated financial statements.
-5-
Notes to the consolidated Financial Statements
1. The unaudited consolidated condensed financial statements have been
prepared in accordance with the instructions for Form 10-Q and therefore do
not include all information and footnotes necessary for a fair presentation
of financial position, results of operations and cash flows in conformity
with generally accepted accounting principles. The information furnished
herein reflects all adjustments (all of which are normal and recurring in
nature) which are, in the opinion of management, necessary for a fair
presentation of the results for the interim periods for which this report
is submitted. The 1997 1st Source Corporation Annual Report on Form 10-K
and quarterly report on Form 10-Q for the quarters ended March 31, and June
30, 1998, should be read in conjunction with these statements.
2. The financial information for the three months and nine months ended
September 30, 1998 has been restated for adjustments to revise the income
recognition on securitized loans in accordance with SFAS No. 125. Since
July 1, 1998, 1st Source has sold capital equipment loans into a
securitization facility (see Note 6.) As a result of a review of its
accounting policies and procedures relating to securitized loans, 1st
Source refined its method of estimating the timing of cash flows and the
underlying key assumptions of the securitized loans and the value of its
retained interests in the loans. These changes resulted only in a
difference in timing of the revenue recognition from its securitized loans
and has no effect on the total cash flows of the securitized transactions.
The changes were applied retroactively to the commencement of this
securitization program in the third quarter of 1998, and resulted in an
increase in net income in 1998. The following summarizes the impact of
these adjustments on the assets and liabilities as of September 30, 1998
and to the results of operations for the three months and nine months ended
September 30, 1998:
September 30, 1998
------------------
As reported As restated
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BALANCE SHEET
Reserve for Loan Losses $ 40,289 $ 38,397
Net Loans 1,741,606 1,743,498
Retained Interest Assets 7,677 7,414
Total Assets 2,527,984 2,529,613
Total Liabilities 2,272,782 2,273,442
Shareholders' Equity 210,452 211,421
Total Liabilities and
Shareholders' Equity 2,527,984 2,529,613
Three Months Ended Nine Months Ended
September 30, 1998 September 30, 1998
------------------ ------------------
As reported As restated As reported As restated
----------- ----------- ----------- -----------
INCOME STATEMENT
Total Noninterest Income $13,923 $14,721 $36,361 $37,159
Income Before Taxes 13,133 13,931 36,995 37,793
Income Taxes 4,718 5,041 12,953 13,276
Net Income 7,861 8,336 22,363 22,838
Comprehensive Income 8,950 9,919 23,794 24,763
Basic EPS 0.42 0.45 1.18 1.21
Diluted EPS 0.41 0.43 1.15 1.17
-6-
3. 1st Source has adopted Statement of Financial Accounting Standard (SFAS)
No. 130, "Reporting Comprehensive Income," as of March 31, 1998. SFAS No.
130 establishes standards for the reporting and disclosure of comprehensive
income and its components in a full set of general purpose financial
statements. Presently, the only component of comprehensive income not
included in net income is unrealized gains or losses on available-for-sale
investment securities.
4. In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS
No. 131 "Disclosure about Segments of an Enterprise and Related
Information." This Statement changes the manner in which public companies
report significant information in annual reports and requires companies to
report selected segment information in interim financial reports. Companies
are now required to report financial and descriptive information about the
company's operating segments. In the year of adoption, companies are not
required to disclose interim period information. 1st Source will adopt the
Statement in 1998.
5. On June 15, 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities.
SFAS No. 133 is effective for all fiscal quarters of all fiscal years
beginning after June 15, 1999 (January 1, 2000 for 1st Source). SFAS No.
133 requires that all derivative instruments be recorded on the balance
sheet at their fair value. Changes in the fair value of derivatives are
recorded each period in current earnings or other comprehensive income,
depending on whether a derivative is designated as part of a hedge
transaction and, if it is, the type of hedge transaction. 1st Source
anticipates that, due to its limited use of derivative instruments, the
adoption of SFAS No. 133 will not have a significant effect on the
Company's results of operations or its financial position.
6. On July 16, 1998, 1st Source entered into an agreement to securitize up to
$400 million in loans; $205 million for new funding, $100 million for
future growth, and $95 million for replacement funding. The purpose of the
securitization is to fund the continued national growth of the 1st Source
Bank Specialty Finance Group. 1st Source Bank will continue to service the
loans for a fee.
-7-
PART I.
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
As more fully described in Note 2 to the Consolidated Condensed Financial
Statements, certain information related to the activity for the three and nine
months ended September 30, 1998 has been restated.
This discussion and analysis should be read in conjunction with the
Company's consolidated condensed financial statements and the financial and
statistical data appearing elsewhere in this report and the 1997 1st Source
Corporation Annual Report on Form 10-K and the quarterly report on Form 10-Q for
the quarters ended March 31, and June 30, 1998. The amounts shown in this
analysis have been adjusted to reflect tax-exempt income on a tax equivalent
basis using a 40.525% rate.
Except for historical information contained herein, the matters discussed in
this document, and other information contained in the Company's SEC filings, may
express "forward-looking statements." Those "forward-looking statements" may
involve risk and uncertainties, including statements concerning future events or
performance and assumptions and other statements concerning future events or
performance and assumptions and other statements that are other than statements
of historical facts. The Company wishes to caution readers not to place undue
reliance on any forward-looking statements, which speak only as of the date
made. Readers are advised that various factors--including, but not limited to,
changes in laws, regulations or generally accepted accounting principles; the
Company's competitive position within the markets served of increasing
consolidation within the banking industry; certain customers and vendors of
critical systems or services failing to comply with Year 2000 programming
issues; unforeseen changes in interest rates; any unforeseen downturns in the
local, regional or national economies--could cause the Company's actual results
or circumstances for future periods to differ materially from those anticipated
or projected.
1st Source does not undertake, and specifically disclaims any obligation, to
publicly release the result of any revisions that may be made to any
forward-looking statements to reflect the occurrence of unanticipated events or
circumstances after the date of such statements.
-8-
COMPARISON OF THREE-MONTH AND NINE-MONTH PERIODS
ENDED SEPTEMBER 30, 1998 AND 1997
Net income for the three-month and nine-month periods ended September 30,
1998, was $8,336,000 and $22,838,000 respectively, compared to $6,638,000 and
$19,145,000 for the equivalent periods in 1997. The primary reasons for the
increase were an increase in net interest income and a strong increase in
noninterest income offset by an increase in noninterest expense.
Diluted net income per common share increased to $0.43 and $1.17,
respectively, for the three-month and nine-month periods ended September 30,
1998, from $0.35 and $0.98 in 1997. Return on average common shareholders'
equity was 15.06% for the nine months ended September 30, 1998, compared to
14.25% in 1997. The return on total average assets was 1.22% for the nine months
ended September 30, 1998, compared to 1.19% in 1997.
NET INTEREST INCOME
The taxable equivalent net interest income for the three-month period ended
September 30, 1998, was $24,391,000, an increase of 5.94% over the same period
in 1997, resulting in a net yield of 4.15% compared to 4.35% in 1997. The fully
taxable equivalent net interest income for the nine-month period ended September
30, 1998, was $73,066,000, an increase of 10.29% over 1997, resulting in a net
yield of 4.23% compared to 4.42% in 1997.
Total average earning assets increased 10.90% and 15.24%, respectively, for
the three-month and nine-month periods ended September 30, 1998, over the
comparative amounts in 1997. Total average investment securities and average
other investments combined increased by 10.89% for the three-month period and
increased by 4.95% for the nine-month period, while a 10.91% and 18.07% increase
for the three-month and nine-month periods for average loans occurred primarily
in retail mortgages, commercial mortgages, and transportation and equipment
loans. The taxable equivalent yields on total average earning assets were 8.55%
and 8.64% for the three-month period ended September 30, 1998, and 1997, and
8.65% for both the nine-month periods ended September 30, 1998 and 1997.
Average deposits increased 15.78% and 17.92%, respectively, for the
three-month and nine-month periods over the same amounts from 1997. The cost
rate on average interest-bearing funds was 5.15% and 5.08% for the three-months
ended September 30, 1998, and 1997, and 5.16% and 5.00% for the nine-month
periods ended September 30, 1998, and 1997. The majority of the growth in
deposits from last year has occurred in time deposits of $100 thousand and over
and time deposits greater than one year.
The following table sets forth consolidated information regarding average
balances and rates.
-9-
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Three Months Ended September 30
-------------------------------
1998 1997
---- ----
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
(Restated)
ASSETS:
Investment securities:
Taxable $ 282,635 $ 4,160 5.84% $ 283,097 $ 4,295 6.02%
Tax exempt (1) 151,086 2,809 7.38% 153,679 2,919 7.54%
Net loans (2 & 3) 1,842,592 42,512 9.15% 1,661,407 38,526 9.20%
Other investments 54,493 753 5.48% 3,497 33 3.74%
---------- -------- ---- ---------- -------- ----
Total Earning Assets 2,330,806 50,234 8.55% 2,101,680 45,773 8.64%
Cash and due from banks 86,283 75,689
Reserve for loan losses (39,385) (32,326)
Other assets 161,647 114,290
---------- ----------
Total $2,539,351 $2,259,333
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing deposits $1,761,760 $ 22,259 5.01% $1,525,952 $ 19,144 4.97%
Short-term borrowings 214,418 3,352 6.20% 236,157 3,329 5.59%
Long-term debt 13,006 232 7.08% 15,505 277 7.09%
---------- -------- ---- ---------- -------- ----
Total Interest Bearing Liabilities 1,989,184 25,843 5.15% 1,777,614 22,750 5.08%
Noninterest bearing deposits 252,015 213,338
Other liabilities 91,048 83,324
Shareholders' equity 207,104 185,057
---------- ----------
Total $2,539,351 $2,259,333
========== ==========
-------- --------
Net Interest Income $ 24,391 $ 23,023
======== ========
Net Yield on Earning Assets on a Taxable
Equivalent Basis 4.15% 4.35%
==== ====
-10-
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY
INTEREST RATES AND INTEREST DIFFERENTIAL
(Dollars in thousands)
Nine Months Ended September 30
------------------------------
1998 1997
---- ----
Interest Interest
Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ----
(Restated)
ASSETS:
Investment securities:
Taxable $ 276,183 $ 12,336 5.97% $ 274,197 $ 12,540 6.11%
Tax exempt (1) 150,437 8,504 7.56% 152,017 8,819 7.76%
Net loans (2 & 3) 1,854,384 127,341 9.18% 1,570,527 108,017 9.20%
Other investments 26,349 1,083 5.50% 5,402 179 4.44%
---------- -------- ---- ---------- -------- ----
Total Earning Assets 2,307,353 149,264 8.65% 2,002,143 129,555 8.65%
Cash and due from banks 83,278 72,286
Reserve for loan losses (37,938) (31,126)
Other assets 153,021 103,147
---------- ----------
Total $2,505,714 $2,146,450
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY:
Interest bearing deposits $1,716,770 $ 64,170 5.00% $1,455,834 $ 53,279 4.89%
Short-term borrowings 244,567 11,340 6.20% 221,850 9,154 5.52%
Long-term debt 12,990 688 7.08% 16,750 875 6.98%
---------- -------- ---- ---------- -------- ----
Total Interest Bearing
Liabilities 1,974,327 76,198 5.16% 1,694,434 63,308 5.00%
Noninterest bearing deposits 241,802 205,048
Other liabilities 86,791 67,295
Shareholders' equity 202,794 179,673
---------- ----------
Total $2,505,714 $2,146,450
========== ==========
-------- --------
Net Interest Income $ 73,066 $ 66,247
======== ========
Net Yield on Earning Assets on a
Taxable Equivalent Basis 4.23% 4.42%
==== ====
(1) Interest income includes the effects of taxable equivalent adjustments,
using a 40.525% rate for 1998 and 1997. Tax equivalent adjustments for the
three-month periods were $827 in 1998 and $876 in 1997 and for the
nine-month periods were $2,543 in 1998 and $2,687 in 1997.
(2) Loan income includes fees on loans for the three-month periods of $1,279
in 1998 and $876 in 1997 and for the nine-month periods of $3,594 in 1998
and $2,912 in 1997. Loan income also includes the effects of taxable
equivalent adjustments, using a 40.525% rate for 1998 and 1997. The tax
equivalent adjustments for the three-month periods were $53 in 1998 and $54
in 1997 and for the nine-month periods were $157 in 1998 and $121 in 1997.
(3) For purposes of this computation, non-accruing loans are included in the
daily average loan amounts outstanding.
-11-
PROVISION FOR LOAN LOSSES
The provision for loan losses for the three-month period ended September
30, 1998, and 1997, was $2,042,000 and $2,130,000, respectively, and was
$7,132,000 and $3,838,000 for the nine-month periods ended September 30, 1998
and 1997. Net Charge-offs of $1,462,000 have been recorded for the three-month
period ended September 30, 1998, compared to $370,000 of Net Charge-offs for the
same period in 1997. Year-to-date Net Charge-offs of $2,267,000 have been
recorded in 1998, compared to Net Recoveries of $295,000 through September 1997.
The reserve for loan losses was $38,397,000 or 2.15% of net loans at September
30, 1998, compared to $35,424,000 or 1.97% of net loans at December 31, 1997.
Non-performing assets at September 30, 1998, were $12,532,000 compared to
$11,436,000 at December 31, 1997, an increase of 9.58%. At September 30, 1998,
non-performing assets were .70% of net loans compared to .64% at December 31,
1997. It is management's opinion that the reserve for loan losses is adequate to
absorb anticipated losses in the loan portfolio as of September 30, 1998.
NONINTEREST INCOME
Noninterest income for the three-month periods ended September 30, 1998,
and 1997 was $14,721,000 and $8,966,000, respectively, and for the nine-month
periods was $37,159,000 in 1998 and $23,185,000 in 1997. For the nine-month
period, trust fees increased 15.66%, service charges on deposit accounts
increased 8.84%, loan servicing and sale income increased 131.61%, equipment
rental income increased 92.44% and other income increased 58.26%. The increase
in servicing and sale income is due to increased loan securitization activity
and income recognition required by SFAS No. 125. The significant increase in
equipment rental income was primarily due to substantial growth in operating
leases. Bank Owned Life Insurance income was primarily the reason for the
increase in the Other Income category. Investment Security losses and other
losses for the nine-month period ended September 30, 1998, were $706,000
compared to net losses of $279,000 in 1997. The net losses in 1998 and 1997 were
primarily attributed to certain partnership and venture capital investments.
NONINTEREST EXPENSE
Noninterest expense for the three-month period ended September 30, 1998,
was $22,260,000, an increase of 24.23% over the same period in 1997 and was
$62,601,000 for the nine-month period ended September 30, 1998, an increase of
20.00% over 1997. For the nine-month period ended September 30, 1998, salaries
and employee benefits increased 18.13%, net occupancy expense increased 10.73%,
furniture and equipment expense increased 4.22%, depreciation on leased
equipment increased 85.86%, business development and marketing expense decreased
5.96%, and miscellaneous other expenses increased 20.75% over the same period in
1997. The increase in salaries and employee benefits expense is primarily
attributed to a 10% increase in our employee base compared to 1997, and
additional expense provisions to fund our stock incentive reserves. Business
development and marketing expense decreased due to a $590,000 decrease in
charitable contributions. The increase in depreciation of leased equipment is
due to a significant volume increase of operating leases from the prior year as
mentioned above. The increase in miscellaneous other expenses is primarily due
to expenses incurred for the loan securitization during the third quarter.
-12-
INCOME TAXES
The provision for income taxes for the three-month and nine-month periods
ended September 30, 1998, was $5,041,000 and $13,276,000, respectively, compared
to $3,831,000 and $10,288,000 for the comparable periods in 1997. The provision
for income taxes for the nine months ended September 30, 1998, and 1997, is at a
rate which management believes approximates the effective rate for the year.
CAPITAL RESOURCES
The banking regulators have established guidelines for leverage capital
requirements, expressed in terms of Tier 1 or core capital as a percentage of
average assets, to measure the soundness of a financial institution. These
guidelines require all banks to maintain a minimum leverage capital ratio of
4.00% for adequately capitalized banks and 5.00% for well-capitalized banks. 1st
Source's leverage capital ratio was 9.83% at September 30, 1998.
The Federal Reserve Board has established risk-based capital guidelines for
U.S. banking organizations. The guidelines established a conceptual framework
calling for risk weights to be assigned to on and off-balance sheet items in
arriving at risk-adjusted total assets, with the resulting ratio compared to a
minimum standard to determine whether a bank has adequate capital. The minimum
standard risk-based capital ratios effective in 1998 are 4.00% for adequately
capitalized banks and 6.00% for well-capitalized banks for Tier 1 risk-based
capital and 8.00% and 10.00%, respectively, for total risk-based capital. 1st
Source's Tier 1 risk-based capital ratio on September 30, 1998, was 12.68% and
the total risk-based capital ratio was 13.96%.
LIQUIDITY AND INTEREST RATE SENSITIVITY
Asset and liability management includes the management of interest rate
sensitivity and the maintenance of an adequate liquidity position. The purpose
of liquidity management is to match the sources and uses of funds to anticipated
customers' deposits and withdrawals, to anticipate borrowing requirements and to
provide for the cash flow needs of 1st Source. The purpose of interest rate
sensitivity management is to stabilize net interest income during periods of
changing interest rates.
Close attention is given to various interest rate sensitivity gaps and
interest rate spreads. Maturities of rate sensitive assets are carefully
maintained relative to the maturities of rate sensitive liabilities and interest
rate forecasts. At September 30, 1998 the consolidated statement of financial
condition was rate sensitive by $297,544,000 more liabilities than assets
scheduled to reprice within one year or 81.82%.
Management adjusts the composition of its assets and liabilities to manage
the interest rate sensitivity gap based upon its expectations of interest rate
fluctuations.
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1st Source has two off-balance sheet interest rate swaps as part of its
interest rate risk management strategy. The swaps are being used to hedge
against the Company's prime floating rate loans. The notional amount of the
first swap as of September 30, 1998, is $17.7 million. It has a maturity date of
January, 2002, and has a current fair value of $34,917. The second swap has a
notional amount of $17.3 million as of September 30, 1998. It has a maturity
date of March, 2001, and has a current fair value of $41,165.
The Company pays a variable interest rate (one-month LIBOR) on each swap
and receives a fixed rate. The interest rate swaps are the most efficient means
of protecting the bank's net interest rate margin in a declining interest rate
environment. Conversely, if interest rates increase, the increased contribution
to net interest income from on-balance sheet assets will substantially offset
any negative impact on net interest income from these swap transactions.
YEAR 2000
The Year 2000 issue is the result of potential problems with computer
systems or any equipment with computer chips that store the year portion of the
date as just two digits (e.g., 98 for 1998). Systems using this two-digit
approach may not be able to determine whether "00" represents the Year 2000 or
1900. The problem, if not corrected, may make those systems fail altogether or,
even worse, allow them to generate incorrect calculations causing a disruption
of normal operations.
In 1997, a project plan to address the Year 2000 issue as it relates to the
Company's operations was developed, approved by the Board of Directors and
implemented. The scope of the plan has five phases including Awareness,
Assessment, Renovation, Validation and Implementation as defined by federal
banking regulatory agencies. Two project teams were assigned. The first consists
of key members of the technology staff, representatives of functional business
units and senior management. The second primarily consists of lenders and credit
personnel. The first team assessed our systems and equipment and vendors to
ascertain their readiness and to develop the overall plan to bring our systems
into compliance. The second team assessed the readiness of our customers and
determine what risk, if any, our key customers pose to the Company with respect
to their Year 2000 readiness. Additionally, the duties of the Senior Vice
President of Operations were realigned to serve as the Year 2000 Project
Manager.
An assessment of the impact of the Year 2000 issue on the Company's
computer systems has been completed. The scope of the project also includes
other operational and environmental systems since they may be impacted if
embedded computer chips control the functionality of those systems. From the
assessment, the Company has identified and prioritized those systems deemed to
be mission critical or those that have a significant impact on normal
operations.
The Company relies on third-party vendors and service providers for much of
its data processing capabilities and to maintain its computer systems. Formal
communications with these providers were initiated in 1997 to assess the Year
2000 readiness of their products and services. Their progress in meeting their
targeted schedules is being monitored continually for any indication that they
may not be able to address the problems in time. Thus far, all of the
significant providers have advised us that they have compliant versions
available or are well into the renovation and testing phases with completion
scheduled for sometime in 1998. However, the Company can give no guarantee that
the systems of these service providers and vendors on which the Company's
systems rely will be timely renovated.
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Additionally, the Company has implemented a plan to manage the potential
risk posed by the impact of the Year 2000 issue on its major borrowing
customers. Formal communications have been initiated, with an assessment
substantially completed on September 30, 1998. Loan losses attributed to the
Year 2000 issue are not anticipated to be material to the Company. However,
there can be no guarantee that any loss incurred will be immaterial.
The project teams feel that the Company's Year 2000 readiness project is on
schedule. The following table provides a summary of the current status of the
five phases involved and a projected timetable for completion.
Project Phase % Completed Estimated Completion
- ------------- ----------- --------------------
Awareness 100% - -
Assessment 100% - -
Renovation 85% December 32, 1998
Validation 35% March 31, 1999
Implementation 35% June 30, 1999
The Company's estimated total cost of the Year 2000 project is estimated to
be between $700,000 and $1,700,000. The total amount expended on the project
through September 30, 1998, was $352,000 of which approximately $333,000 was
related to the cost to repair or replace software; approximately $9,000 to the
cost of replacing equipment, and approximately $10,000 to miscellaneous items
such as training for employees and communications with customers. Funds have
been provided from our normal operating budget and costs are expensed as they
are incurred. The total cost to the Company of these Year 2000 readiness
activities has not been, and is not anticipated to be, material to its financial
position or results of operations in any given year. No other specific projects
have been deferred due to this project. Much of the work done within this
project is an acceleration of work that would have been done in the normal
course of business.
The costs and timetable in which the Company plans to complete the Year
2000 readiness activities are based on management's best estimates, which were
derived using numerous assumptions of future events including the continued
availability of certain resources, third-party readiness plans and other
factors. The Company can make no guarantee that these estimates will be achieved
and actual results could differ from such plans.
Based upon current information related to the progress of its major vendors
and service providers, management believes that the Year 2000 issue will not
pose significant operational problems for its computer systems. This belief is
based on the ability of those vendors and service providers to renovate, in a
timely manner, the products and services on which the Company's systems rely.
However, the Company can give no guarantee that these systems will be renovated
in a timely manner.
Realizing that some disruption may occur despite its best efforts, the
Company is in the process of developing contingency plans for each critical
system in the event that one or more of those systems fail. While this is an
ongoing process, the Company expects to have the plan substantially documented
by June 30, 1999.
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PART II. OTHER INFORMATION
ITEM 6. Exhibits and Reports on Form 8-K.
Exhibit 27 - Restated Financial Data Schedule
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
1st Source Corporation
----------------------
DATE 03/14/00 /s/ Christopher J. Murphy III
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(Signature)
Christopher J. Murphy III,
Chairman of the Board, President and CEO
DATE 03/14/00 /s/ Larry E. Lentych
----------- -----------------------------------
(Signature)
Larry E. Lentych,
Treasurer and Chief Financial Officer
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